3. Main capabilities
On successful completion of this paper, candidates should be
able to:
A. Explain the context and purpose of financial reporting
B. Define the qualitative characteristics of financial information
C. Demonstrate the use of double-entry and accounting systems
D. Record transactions and events
E. Prepare trial balance including identifying and correcting errors
F. Prepare basic financial statements for incorporated and
unincorporated entities
G. Prepare simple consolidated financial statements
H. Interpretation of financial statements
4. Detailed syllabus
A. The context and purpose of financial
reporting
The scope and purpose of, financial
statements for external reporting
Users‟ and stakeholders‟ needs
The main elements of financial reports
The regulatory framework
Duties and responsibilities of those charged
with governance.
5. Continues…
B. The qualitative characteristics of financial
information
The qualitative characteristics of financial information
6. Continues…
C. The use of double-entry and accounting systems
Double entry bookkeeping principles including the
maintenance of accounting records and sources of
information.
Ledger accounts, books of prime entry, and journals
7. Continues…
D. Recording transactions and events
Sales
Cash
Inventory
Tangible non-current assets
Depreciation
Intangible non-current assets and amortisation
Accrual and prepayments
Receivables and payables
Provisions and contingencies
Capital structure and finance costs
8. Continues…
E. Preparing trial balance
Trial balance
Correction of errors
Control accounts and reconciliations
Bank reconciliations
Suspense accounts
9. Continues…
F. Preparing basic financial statements
Statements of financial position
Income statements and statements of
comprehensive income
Disclosure notes
Events after the reporting period
Statements of cash flows
Incomplete records
11. Continues…
H. Interpretation of financial statements
Importance and purpose of analysis of financial
statements
Ratios
Analysis of financial statements
12. Examination Approach
The syllabus is assessed by a two hour paper
based or computer-based examination.
Questions will assess all parts of the syllabus
and will include both computational and non-
computational elements. The examination will
consist of 50 two mark questions.
13. News!!!!
From December 2011, Paper F3/FFA saw two main
new examinable areas added to its syllabus – the
preparation of simple consolidated financial
statements and the interpretation of financial
statements.
14. Lecture 1 –The scope and purpose of, financial
statements for external reporting
15. What is Accounting?
Accounting is the process of collecting, recording,
summarising and communicating financial information.
There are many purposes of accounting. You may have
considered the following.
Control over the use of resources
Knowledge of what the business owes and owns
Calculation of profits and losses
Cash budgeting
Effective financial planning
16. Objectives of a business - Financial
Profit maximisation
Growth and market
sustainability
Survival
Discourage competitors
17. Non-financial
Welfare of employees
Customer satisfaction
Welfare of management
Supplier relationship
Responsibility to society
18. User‟s and stakeholders‟ needs
Users of financial statements need relevant and
reliable information.
To provide such information, the profession has
developed a set of principles and guidelines called
Conceptual Framework.
The framework is to be the foundation for building a
set of coherent accounting standards and rules.
Also to be a reference of basic accounting theory for
solving emerging practical problems of reporting.
19. User groups of financial Statements
Accounting information is required for a wide range of users
both within and outside the business.
Managers
Shareholders
Suppliers
Lenders
The tax authorities
Employees
Government
The Public
20. Continues…
User Group Explanation
Manager/Directors Managers/Directors are appointed by the company's
owners to supervise the daily activities of the company
on their behalf. They need information about the
company's current and expected future financial
situation, to make informed decisions.
Shareholders Want to assess how effectively management is
performing and how much profit they can withdraw from
the business for their own use.
Suppliers/Customers Suppliers want to know about the company's ability to
pay its debts; customers need to know that the company
is a secure source of supply and is in no danger of
closing down.
Lenders Lenders will want to ensure that the company is able to
meet interest payments, and eventually to repay the
amounts advanced.
21. Continues…
User Group Explanation
The Tax authorities Want to know about business profits in order to assess
the tax payable by the company.
Employees Need to know about the company's financial situation
because their future careers and the level of their
wages and salaries depend on it.
Government Interested in the allocation of resources and in the
activities of enterprises. Also require information in
order to provide a basis for national statistics.
The Public Want information because enterprises affect them in
many ways, e.g. by providing jobs and using local
suppliers, or by affecting the environment (e.g.
pollution).
22. Management accounting and financial accounting
Management accounts are produced for internal
purposes – they provide information to assist
managers in running the business.
Financial accounts are produced to satisfy the
information requirements of external users.
Financial accounting is the preparation of accounting
reports for external use.
Management accounting is the preparation of
accounting reports for internal use.
23. Continues…
Management accountants produce information which is forward-looking,
and used to prepare budgets and make decisions about the future
activities of a business.
They also compare actual performance with budget and try to take
corrective action where necessary.
Financial accountants, however, are usually solely concerned with
summarising historical data, often from the same basic records as
management accountants but in a different way. This difference arises
partly because external users have different interests from management
and do not need very detailed information.
In addition, financial statements are prepared under constraints (such as
International Financial Reporting Standards and company law) which do
not apply to management accounts.
24. Types of business entity
Sole Trader, Partnership and Limited
Liabilities companies
25. Sole Trader/Proprietorship
A sole proprietorship business is owned by one
person who is called a sole proprietor.
Since the sole proprietor is not a legal entity, the
owner is entitled to all profits generated from the
business.
However, the owner‟s liability is unlimited, not just
when the business is having financial difficulty, but
also when the business fails and he faces bankruptcy.
In this case, the creditors may sue him for debts
incurred and also obtain a court order to claim against
his personal assets, including his house.
26. Continues…
Normally, a person‟s ability to run a sole
proprietorship business is limited to his area of
expertise, which means he relies mainly on himself.
He has the freedom to use his entrepreneurial skills to
the maximum, make his own decisions and run the
business as he wishes.
However, to be a successful entrepreneur, he will
need to get relevant advice from experts in fields he is
unfamiliar with.
This expertise is sometimes unavailable when one
operates as a sole proprietor.
27. Advantages
Easy and cheap to set up since there is a limited
paperwork.
The owner is in full control of the business
He/she takes all the rewards alone
Relax compliance for reporting obligations
It is usually flexible
28. Disadvantages
His capital is limited to the availability of his funds and
the profit generated from the business, this would be
the reason why many sole proprietorship businesses
never take off in a big way.
In many cases, even when a sole proprietorship
business is successful, all profits generated are taxed
on a personal basis and tax exemptions are limited to
personal and family matters.
Very often in sole-proprietorship operations, there is
no business succession plan and the business may
no longer operates with the retirement or demise of
the sole proprietor.
The owner‟s liability is unlimited, in the event of
bankruptcy.
29. Partnership
As its name suggests, this form of entity is when two or
more persons come together to carry out a business.
However, the maximum number of persons allowed in a
partnership is 20.
Examples include an accountancy/audit firm, a medical
practice and legal practice and they are generally formed
by contractual agreement which is legally binding on all
partners.
In the UK, the provisions of the Partnership Act 1890 apply
where no partnership agreement exists.
Partnerships are not separate legal entities from their
owners and they have unlimited personal liability for debts
of the business.
A new form of partnership called Limited liability
partnership (LLP) has emerged in some jurisdictions.
30. Advantages
This form of business is cheap, easy to set up, with
minimal documentation and paperwork.
There are much fewer guidelines and formalities
wherein there is no requirement to appoint auditors,
company secretary or tax agents.
They do not need to disclose their financial
statements to the general public.
Access to wider pull of resources – additional capital,
skills and expertise.
Division of roles and responsibilities.
Risk is spread among partners.
No company tax on the business
31. Disadvantages
Partners have unlimited liability in the case the
business runs into trouble.
There are costs to be incurred in setting up the
partnership agreements.
In the event of the death or illness of partners, the
partnership may cease to exist.
Consensus between partners are required when
taking decisions and this could lead to slower decision
making.
In the absence of any agreement to the contrary, the
resignation of one partner automatically terminates
the partnership agreement.
32. Limited liability companies
The meaning of limited companies is that the
liabilities of its members are limited to the amount
of shares they hold in the company.
Members/shareholders are not responsible for
debts of the company unless if there is any
personal guarantee.
Shareholders may be individuals or other
companies.
Company Act 2006 is the legislation applicable in
the UK.
A LLC is a separate entity from its owners.
33. Agency theory
The principals (shareholders) appoint some
agents (directors) to run the business on their
behalf.
Shareholders are the owners – they provide
capital and receive a return usually inform of
dividends.
Declaration of dividends is at the discretion of the
directors.
In some cases directors could also be
shareholders.
34. The reporting requirements for LLCs in the UK
Must be registered at Companies House
There must be MoA and AoA deposited with the
Registrar of Companies
Have at least one director for Private LLC and two for
Public LLC who may also be the shareholder(s)
Financial statements must be prepared for filing to
Companies House
Large companies should have audited financial
reports
The financial should be available to the shareholders
35. Advantages
The most obvious advantage is the liability
“protection” to its shareholders which limits their
exposures to the amount of share capital that they
subscribed for.
Another advantage is the simplicity to transfer existing
shares or issue additional shares to new investors.
Unlike sole proprietors or partnerships, there is no
need to wind up the company in the event of death of
its shareholders or directors.
They have access to wider pull of resources
Tax advantages to being a LLC. The company tax
rate may be lower than income tax rate for individuals.
LLC is a separate entity from its owners which may
sue or be sued separately.
36. Disadvantages
The company‟s financial affairs will be accessible by
the public.
Compliance with the Companies Act. Although
complying itself is not a disadvantage, the amount of
effort required to comply with the Act is much more
than a sole proprietor/partnership.
The company had to perform annual audits on its
financial statements.
At least one company secretary is required to manage
its statutory submissions and returns as well as
attending and preparing minutes for board and
shareholders‟ meetings.
Incorporation cost is high, and there are yearly
recurring fees to be paid such as audit, accounting,
company secretarial and tax fees.
42. Lecture 2 – The qualitative characteristics of financial
information
43. Statements of Financial Accounting Concepts
SFAC No.1: Objectives of Financial Reporting (Business)
SFAC No.2: Qualitative Characteristics of Accounting Information
SFAC No.6. Elements of Financial Statements - defines the broad
classifications of items found in financial statements and replaces
SFAC No.3, expanding its scope to include not-for profit
organisations
SFAC No.4: Objectives of Financial Reporting (Non-Business) –
Guidelines for Non-for-profit and governmental entities
SFAC No.5: Recognition and Measurement Criteria in Financial
Statements
SFAC No.7: Using Cash Flows information and Present Value in
Accounting Measurements
44. Overview of the conceptual Framework
Basic Objectives:
The basic objectives of financial reporting are to provide
information that is:-
1. Useful to those making investment and credit decisions who
have a reasonable understanding of business and
economic activities
2. Helpful to present and future investors, creditors and other
users in assessing future cash flows
3. About economic resources, the claims on those resources
and the changes in them
45. Qualitative Characteristics
The IASB has identified the qualitative
characteristics of accounting information that
distinguish better (more useful) information from
inferior (less useful) information for decision making
purposes
Primary qualities are relevance and reliability of
accounting information
Secondary qualities are comparability and
consistency of reported information
46. Primary qualities - Relevance
To be relevant, accounting information must be capable of
making a difference in a decision
For information to be relevant, it should have predictive or
feedback value, and it must be presented on a timely basis
Predictive value – helps users make predictions about
ultimate outcome of past, present and future events
Feedback value - helps users confirm or correct prior
expectations
Timeliness - available to decision makers before it loses its
capacity to influence their decisions
47. Primary qualities - Reliability
Information is reliable when it can be relied on to represent the
true situation
For accounting information to be reliable, it should be verifiable, is
a faithful representation, and it is reasonably free of error and bias
Verifiability – when given the same information and using the
same measurement methods, independent users can obtain the
same results
Representational faithfulness - when it represents what really
existed or happened
Neutrality – when it is factual, truthful and unbiased
48. Secondary qualities - Comparability
Comparability and consistency of reported information
Information about an enterprise is more useful if it can be
compared with similar information about another enterprise
(comparability) and with similar information about the same
enterprise at other points in time (consistency)
For information to be comparable, it must be
1. Measured and reported in a similar manner for different
enterprises
2. Useful to users in identifying real similarities and
differences between enterprises
49. Secondary qualities - Consistency
Entity is considered to be consistent in its use of accounting
standards when it applies the same accounting treatment to
similar events from period to period
Companies can change methods, if the change results in
better reporting
Disclosure for change :-
1. Nature of the change
2. Effect of the change
3. Justification for the change
50. Basic Elements of Financial Statements
Balance Sheet Income Statement
Assets: Probable future Comprehensive Income: All
economic benefits resulting changes in equity from
from past transactions non-owner sources
Liabilities: Probable future Revenues: Inflows from
sacrifices of economic benefits entity‟s ongoing operations
resulting from past transactions
Equity/Net assets: Residual Expenses: Outflows from
interest in assets after entity‟s ongoing operations
deducting liabilities or Gains: Increases in equity
ownership interest from incidental transactions
Investment by Owners:
Losses: Decreases in
Increases in net assets
equity from incidental
Distributions to Owners:
Decreases in net assets
transactions
51. Recognition and Measurement in Financial
Statements of Business Enterprises.
Basic Assumptions:
Economic Entity Assumption - The economic activities of an entity can be
accumulated and reported in a manner that assumes the entity is separate
and distinct from its owners or other business units.
Going-Concern Assumption - In the absence of contrary information, a
business entity is assumed to remain in existence for an indeterminate
period of time. The current relevance of the historical cost principle is
dependent on the going-concern assumption.
Monetary Unit Assumption - In the United Kingdom, economic activities of an
entity are measured and reported in pound. These pounds are assumed to
remain relatively stable over the years in terms of purchasing power. In
essence, this assumption disregards any inflation or deflation in the
economy in which the entity operates.
Periodicity Assumption - The life of an economic entity can be divided into
artificial time periods for the purpose of providing periodic reports on the
economic activities of the entity.
52. Basic Principles
Historical Cost Principle - Acquisition cost is the most objective and
verifiable basis upon which to account for assets and liabilities of a business
enterprise. Cost has been found to be more definite and determinable than
other suggested valuation methods.
Revenue Recognition Principle - Revenue is recognised when the earning
process is virtually complete and an exchange transaction has occurred.
Generally, this takes place when a sale to another individual or independent
entity has been confirmed. Confirmation is usually accomplished by a
transfer of ownership in an exchange transaction.
Matching Principle - Accountants attempt to match expenses incurred while
earning revenues with the related revenues. Use of accrual accounting
procedures assists the accountant in allocating revenues and expenses
properly among the fiscal periods that compose the life of a business
enterprise.
Full Disclosure Principle - In the preparation of financial statements, the
accountant should include sufficient information to permit the knowledgeable
reader to make an informed judgment about the financial condition of the
enterprise in question.
54. The Regulatory framework of accounting
The main objective of accounting is to present
financial information to users. Users need to be
able to rely on the information provided in those
financial statements to enable them to make
appropriate decisions.
Accountants need some guidance in the way in
which they prepare the financial statements.
Lecture 12 looks at some of the ways in which
accountants take decisions on methods of
accounting and valuation for certain items. It also
looks at the role of auditors, who check that the
rules on accounting have been followed.
55. Accounting Conventions/concepts/principles
Going concern - Going concern implies that the
business will continue in operation for the foreseeable
future, and that there is no intention to put the
company into liquidation or to make drastic cutbacks to
the scale of operations.
Accruals - The accruals concept states that, in
computing profit, amounts are included in the accounts
in the period when they are earned or incurred, not
received or paid.
Prudence - Prudence is the concept that specifies, in
situations where there is uncertainty, appropriate
caution is exercised in recognising transactions in
financial records.
56. Continues…
Consistency - The consistency convention is
that the accounting treatment of like items should
be consistently applied from one accounting
period to the next.
Materiality - A matter is material if its omission
or misstatement would reasonably influence the
decisions of a user of the accounts. In preparing
accounts it is important to decide what is material
and what is not, so that time and money are not
wasted in the pursuit of excessive detail.
57. Continues…
Substance over form - Substance over form is the
principle that transactions and other events are
accounted for and presented in accordance with their
substance and economic reality and not merely their
legal from.
Business entity (the entity concept) - This convention
separates the individual(s) behind a business from the
business itself, and only records transactions in the
accounts that affect the business.
Money measurement - This limits the recognition of
accounting events to those that can be expressed in
money terms.
58. Continues…
Historical cost – The historical cost of an asset is the
original amount paid for an asset when it was acquired
and thus non-current assets should be stated in their
historical costs less accumulated depreciation.
The dual aspect - This convention is the basis of double-
entry bookkeeping and it means that every transaction
entered into has a double effect on the position of the
entity as recorded in the ledger accounts at the time of
that transaction.
The realisation convention - This convention states that
we recognise sales revenue as having been earned at
the time when goods or services have been supplied and
a sales invoice issued.
59. The theory of capital expenditure
Current purchasing power (CPP) accounting - This
method of accounting considers the effects of changing
price levels by reference to an index, for example
movements in the retail price index (RPI) in the UK. It
distinguishes between monetary and non-monetary
items.
RPI - The RPI is a measure of inflation published each
month. It is based on the prices of items bought by the
average family.
Monetary items - Examples of monetary items include
cash and bank balances, receivables and payables.
These are valued in a currency – such as dollar, yen or
sterling – regardless of the changes in the price level.
60. Non-monetary assets
These are items that do not suffer a loss in value in a
period of changing price levels. They include non-
current assets, inventories and shareholders‟ equity
(ordinary shares and reserves).
Holding gains/losses - The holding of monetary items
will, in periods of inflation, give rise to holding gains or
losses.
61. Current cost accounting
Current cost accounting (CCA) is a method of adjusting
historical cost accounts for the effects of changing
price levels by using indices specific to the
organisation. Thus CCA attempts to measure the
actual rate of inflation experienced by the business
whereas CPP attempts to measure the rate of inflation
experienced by the business owners.
Fair Value - fair value may be defined as the value of
an asset in an arm‟s length transaction between
knowledgeable buyer and seller of that asset.
63. Duties
Those charged with governing a company are
responsible for the preparation of the financial
statements.
Corporate governance (CG) is the system used in
directing and controlling a company.
This is necessitated because the management and
ownership of a company reside in the hands of
different people and this could lead to conflicts of
interest.
The board of directors (BOD) of a company are
usually charged with governance of a company since
they are the top echelons.
The duties and responsibilities of directors are usually
laid down in law and are wide ranging.
64. Legal responsibilities of directors
Directors have a duty of care to show reasonable
competence in the discharge of their duties and
may have to indemnify the company against loss
caused by their negligence.
Directors also have fiduciary duty to the company
which means that they must act in the best
interest of the company, in utmost good faith and
honesty.
The Company Act 2006 in the UK sets out 7
statutory duties of directors as shown below:
65. Directors should:
Act within their powers
Promote the success of the company
Exercise independent judgement
Exercise reasonable skill, care and diligence
Avoid conflicts of interest
Not accept benefits from their parties
Declare an interest in a proposed transaction or
arrangement
The primary aim is create wealth for the
shareholders
66. Responsibility for the financial statements
The responsibility to the preparations of financial
statements lies with the directors.
This preparation must be in accordance with the applicable
financial reporting framework such as IFRS.
Directors are responsible for the internal controls
necessary to forestall any material misstatement to due to
error or fraud in the preparation of the financial statements.
They are also responsible for the prevention and detection
of fraud.
It is also their responsibility to ensure that company
complies with relevant laws and regulations.
This responsibility should stated in the financial
statements.
The company should be reported as going concern unless
if there is any information to the contrary.
73. Books of prime entry
Books of prime entry are used to list and
summarise the information on source
documents.
Sales day book - all credit sales are
recorded in the sales day book.
Sales returns day book – any credit sales
returned by the customers are recorded in the
sales returns day book.
Purchase day book – all credit purchases
are recorded in the purchase day book.
74. Continues…
Purchase returns day book – any credit purchases
returned to the suppliers are record in the purchase
returns day book.
Cash book – All cash transaction are recorded in the
cash book.
Petty cash book – lists all cash payments for small
items, and occasional small receipts.
Journal – is a record of unusual transactions. It is
used to record any double entries made which do not
arise from the other books of prime entry.
75. Sales and purchase day books
The sales day book list all invoices sent out to customers.
Sales Day Book
Date Invoice Customer Sales ledger Total amt
ref invoiced
Jan 10 247 Jones & Co SL14 105.00
248 Smith Ltd. SL8 86.40
249 Alex & Co SL6 31.80
250 FTMS College SL9 1,264.60
1,487.80
76. Continues…
The column called sales ledger ref is a reference
to the sales ledger which is a record of what each
customer owes the business. It means, for
example, that the sale to Jones & Co for $105 is
also recorded on page 14 of the sales ledger.
77. The Purchase day book
The purchase day book list all invoices from suppliers.
Purchase Day Book
Date Supplier Purchase Total Purchases Electricity
ledger ref amount
invoiced
Mar 15 Abbey PL 31 315.00 315.00
Ahmad PL 46 29.40 29.40
TEN PL 42 116.80 116.80
Emmy PL 12 100.00 100.00
561.20 444.40 116.80
78. Continues…
The purchase ledger reference is a reference
to the purchase ledger which is a record of
what each supplier is owed.
The purchase day book analyses the invoices
which have been received. In this example,
three of the invoices related to goods which
the business intends to re-sell (called
purchases) and the other invoice was an
electricity bill.
79. Sales and purchase returns day
books
The sales returns day book lists goods (or services
returned (or rejected) by customers for which credit
notes are issued.
Sales returns day book
Date Customer Goods Sales ledger Amount
ref
30 April Emily 3 pairs of SL 82 135.00
boots
80. The purchase returns day book
The purchase returns day book lists goods (or
services) returned to suppliers (or rejected) for
which credit notes have been received or are
expected.
Purchase returns day book
Date Supplier Goods Purchase Amount
ledger ref
29 April Boxes Ltd 300 boxes PL 123 46.60
81. The cash book
The cash book lists all money received into and paid
out of the business bank account.
The cash book records transactions involving the bank
account, such as cheque payments, lodgements of
cash and cheques into the bank account, standing
orders, direct debits and bank charges.
Some cash, in notes and coins, is usually kept on the
premises in order to make occasional payments for
small items of expense. This cash is accounted for
separately in a petty cash book (which we will look at
shortly).
82. Lecture example 1
At the beginning of 1 September, Robin Plenty had $900
in the bank. During 1 September 2011, Robin Plenty had
the following receipts and payments.
a) Cash sale – receipt of $80
b) Payment from credit customer Hay $400 less
discount allowed $20
c) Payment from credit customer Been $720
d) Payment from credit customer Seed $150 less
discount allowed $10
83. Continues…
e) Cheque received for cash to provide a short-term
loan from Len Dinger $1,800
f) Second cash sale – receipts of $150
g) Cash received for sale of machine $200
h) Payment to supplier Kew $120
i) Payment to supplier Hare $310
j) Payment of telephone bill $400
k) Payment of gas bill $280
l) $100 in cash withdrawn from bank for petty cash
m) Payment of $1,500 to Hess for new plant and
machinery
84. Solution
The receipts part of the cash book for 1 September would look like this.
CASH BOOK (RECEIPTS)
Date Narrative Total
2011 $
1 Sept Balance b/d* 900
Cash sale 80
Receivable: Hay 380
Receivable: Been 720
Receivable: Seed 140
Loan: Len Dinger 1,800
Cash sale 150
Sale of non-current asset 200
4,370
2 Sept Balance b/d* 1,660
* 'b/d' = brought down (i.e. brought forward)
85. Continues…
The cash received in the day amounted to $3,470.
Added to the $900 at the start of the day, this comes
to $4,370.
However this is not the amount to be carried forward
to the next day. First we have to subtract all the
payments made during 1 September.
86. Continues…
The payments part of the cash book for 1 September would look
like this.
CASH BOOK (PAYMENTS)
Date Narrative Total
2011 $
1 Sept Payable: Kew 120
Payable: Hare 310
Telephone 400
Gas bill 280
Petty cash 100
Machinery purchase 1,500
Balance c/d 1,660
4,370
87. Continues…
Payments during 1 September totalled $2,710. We
know that the total of receipts was $4,370. That means
that there is a balance of $4,370 – $2,710 = $1,660 to
be 'carried down' to the start of the next day.
As you can see this 'balance carried down' is noted at
the end of the payments column, so that the receipts
and payments totals show the same figure of $4,370 at
the end of 1 September.
And if you look to the receipts part of this example, you
can see that $1,660 has been brought down ready for
the next day.
88. Lecture example 2 - Two-column cash book
2011 February
1
Opening cash balance RM 10,000. Opening bank balance RM 600.
2 Kong lent us RM 20,000 by cheque.
3 Paid building rent by cash RM 2,300.
4 We paid Mehdi by cheque RM 8,600.
5 Cash sales RM 1,900.
7 Kwai paid us by cheque RM 340.
9 We paid Moore in cash RM 920.
10 Vehicles repairs of RM 460 were paid by cheque.
11 Cash sales paid direct into the bank RM 1,510.
89. Continues…
15 Hood paid us in cash RM 960.
16 Owner withdrew by cheque RM 1,000.
19 We repaid a previous loan taken from Robertson RM5,000 by cheque.
21 Goods for resale were purchased. This was paid by cash, RM 1,300.
22 Cash sales paid direct into the bank RM 1,220.
25 Paid wages by cash RM 2,760.
26 Paid a fine to the government by cheque RM 750.
30 Withdrew RM 2,000 from the bank account for personal use of the
owner.
31 Paid consultancy fees in cash RM 3,200.
Hood paid us in cash RM 960.
90. Solution Cash book
Bank Cash Bank Cash
(RM) (RM) (RM) (RM)
Balance b/d 600 10,000 Building rent 2,300
Kong 20,000 Mehdi 8,600
Sales 1,900 Moore 920
Kwai 340 Vehicle repairs 460
Sales 1,510 Drawings 1,000
Hood 960 Robertson 5,000
Sales 1,220 Purchases 1,300
Wages 2,760
Fine 750
Drawings 2,000
Consultancy fee 3,200
Balance c/d 5,860 2,380
23,670 12,860 23,670 12,860
91. Bank statements
Weekly or monthly, a business will receive a bank
statement.
Bank statements are used to check that the balance
shown in the cash book agrees with the amount on
the bank statement.
This agreement or 'reconciliation' is the subject of a
later chapter.
92. Petty cash book
The petty cash book lists all cash payments for small
items, and occasional small receipts.
Most businesses keep a small amount of cash on the
premises to make occasional small payments in cash –
e.g. to buy a few postage stamps etc.
This is often called the cash float or petty cash
account.
Petty cash can also be used for occasional small
receipts, such as cash paid by a visitor to make a
phone call or to take some photocopies.
There are usually more payments than receipts and
petty cash must be 'topped up' with cash from the
business bank account.
93. Continues…
Under what is called the imprest system, the amount of
money in petty cash is kept at an agreed sum or 'float'
(say $100).
Expense items are recorded on vouchers as they
occur.
$
Cash still held in petty cash X
Plus voucher payments X
Must equal the agreed sum/float X
94. Continues…
The total float is made up regularly (to $100,or
whatever the agreed sum is) by means of a cash
payment from the bank account into petty cash.
The amount paid into petty cash will be the total
of the voucher payments since the previous top-
up.
The format of a petty cash book is the same as
for the cash book, with analysis columns for items
of expenditure.
95. The Journal
The journal is a record of unusual transactions. It is
used to record any double entries made which do not
arise from the other books of prime entry.
Whatever type of transaction is being recorded, the
format of a journal entry is as follows.
Date Debit Credit
$ $
Account to be debited X
Account to be credited X
(Narrative to explain the transaction)
96. Continues…
A narrative explanation must accompany each
journal entry. It is required for audit and control, to
indicate the purpose and authority of every
transaction which is not first recorded in a book of
prime entry.
97. Lecture example 3
The following is a summary of the transactions of Abbey beauty salon
1 January Put in cash of $2,000 as capital
Purchased brushes and combs for cash $50
Purchased hair driers from Gilroy Ltd on credit $150
30 January Paid three months rent to 31 March $300
Collected and paid-in takings $600
31 January Gave Mrs Sullivan a perm, highlights etc on credit $80
Although these entries would normally go through the other books of
prime entry (eg the cash book), it is good practice for you to show these
transactions as journal entries.
98. Solution
JOURNAL
$ $
Dr. Cr.
1 January Cash account 2,000
Capital account 2,000
(Initial capital introduced)
1 January Brushes & combs a/c 50
Cash account 50
(The purchase for cash of brushes &
combs as non-current assets)
1 January Hair dryer asset account 150
Sundry payables account * 150
(The purchase on credit of hair driers as non-current assets)
30 January Rent expense account 300
Cash account 300
(The payment of rent to 31 March)
99. Continues…
Dr. Cr.
30 January Cash account 600
Sales account 600
(Cash takings)
31 January Receivables account 80
Sales account 80
(The provision of a hair-do on credit)
* Note. Payables who have supplied non-current assets are
included amongst sundry payables. Payables who have supplied
raw materials or goods for resale are trade payables. It is quite
common to have separate payables accounts for trade and
sundry payables.
100. Lecture 4 – Double entry and accounting system
101. Bookkeeping
What is it?
System of recording financial transactions
Known as double-entry bookkeeping
Two sides to every transaction
Is part of and feeds into the financial reporting
system.
102. Aims
This lecture seeks to provide a introduction to
bookkeeping – what it is and how it is carried out.
To do this we will consider:
The financial reporting system
Examine how records are kept
Explain the transactions and how they are recorded
Consider how adjustments can be made
And how the records are used to generate month end
and year end figures
103. Lecture Content
The lecture will aim to cover:
an introduction to financial reporting
terminology
the accounting process
the financial statements
105. Financial Reporting
What is it?
Financial reporting is the means of reporting what
has happened in the past in an organisation
It is part of the accountability system
It relates yesterdays activities in financial terms
Reports
Annual Financial Statements
o Annual Report and Statutory Accounts
Monthly control reports
106. Example: Monthly Control Report
Current Month As at 30th June Year to date
Budget Actual Variance Expenditure Budget to Actual to Variance
Date Date
Supplies and
General Charges
40,000 43,000 -3,000 Basic pay 230,000 250,000 -20,000
25,000 26,000 -1,000 Part tim e basic 150,000 165,000 -15,000
15,000 14,500 500 Casual pay 90,000 80,000 10,000
20,000 19,000 1,000 Adm inistrative staff 150,000 148,000 2,000
18,000 20,000 -2,000 Photocopy costs 100,000 110,000 -10,000
21,000 24,000 -3,000 Materials 120,000 125,000 -5,000
10,000 6,000 4,000 Books 50,000 56,000 -6,000
6,000 6,000 0 Heating Pow er & Light 39,000 40,000 -1,000
5,000 4,000 1,000 Cleaning 30,000 31,000 -1,000
1,000 1,500 -500 Fax 6,000 5,000 1,000
2,000 1,800 200 Telephone 12,000 10,000 2,000
1,000 2,000 -1,000 Consum ables 6,000 6,000 0
500 500 0 Hospitality 9,000 10,000 -1,000
1,500 2,000 -500 Maintenance 6000 7000 -1,000
800 700 100 Travelling Expenses 5,000 4,500 500
200 500 -300 Stationery 1,000 1,500 -500
700 100 600 Office Expenses 4,000 5,000 -1,000
200 - 2000 Office Equipm ent 1,000 1,500 -500
3,000 3,500 -500 Rent & Rates 20,000 19,000 1,000
1,000 1,000 0 Sundries 6,000 10,000 -4,000
171,900 176,100 -4,200 Sub Total 1,029,000 1,077,500 -48,500
107. Key Terms
assets liabilities/
capital
expenses revenue
/income
108. What is an expense?
An expense is a short term ‘consumable’, which will be
incurred repeatedly, for example the cost of a
telephone call, a days pay, a box of bandages, a litre of
fuel…
They are items which have a one–off use..once bought
and used…a second must be bought..and a third..etc
In general, expense items represent day-to-day
operational activity….low value long term items .. such
as a mobile phone will also be included…
Expenses are recorded and totalled at the end of each
month and each year.
109. What is income?
Income is the sum earned for providing goods or
service, whether or not any payment has been
received.
It too represents monies from operational activity
and, items which are frequently repeated for
example, the sale of a chocolate bar or the price of
a bus ticket.
Income is totalled monthly and annually to reflect
what has been earned during that time period.
110. What is an asset?
An asset is an item owned by the organisation, it has
value and can be ‘fixed’ or ‘current’.
Fixed assets provide benefit beyond a year and
current assets have a life less than one year.
Fixed assets are made up of physical and financial
assets. Land, buildings, equipment, vehicles and
furniture and fittings make up the physical fixed
assets, which put in place the infrastructure through
which operational activity is conducted.
Stock, debtors and cash make up the current assets.
111. What is a liability?
Liabilities are sums owed from the organisation.
They can be short-term such as overdraft or sums
owed to suppliers, known as creditors, or long-term
such as loans, leases and mortgages.
These latter items contribute to long term funding,
without which, the organisation would not be able to
purchase assets.
All liabilities carry with them the obligation to repay
and many of them carry interest payments.
112. What is capital?
Capital is the owners’ original investment
although it is rarely repaid, it is ‘technically’ a debt.
Without this money the organisation would not exist.
Further investment from the ‘owners’ increases this
sum. A key way this sum is increased is through the
Income and Expenditure account. Any excess income
over expenditure belongs to the ‘owners’ and can be
left in the organisation by way of an increase in capital.
Without capital an organisation cannot begin its’ life nor
grow, as without money new assets cannot be
purchased.
113. ……key terms…..
assets liabilities/ balance
capital sheet
revenue income
expenses
/income statement
114. The statement of financial position
Is a position statement which evaluates wealth at a
point in time.
It considers capital costs.
Consists of assets and claims on those assets
Assets (owned) Claims (owed)
Current Current liabilities
Non-Current Long-term Loans
Owners capital
But, as Claims = Liabilities + Capital
then, Assets = Liabilities + Capital
115. Income Statement
The difference between costs & income
Profit & loss account / Income & expenditure
account
Shows where the resource was spent
Covers a period of time
Matches expenses and income to time period
Expenses represent the cost INCURRED, resource
used or consumed in providing the service during
the accounting period
Income is that which is EARNED from and related
to the service provided
117. Basis of Preparation
= Accrual Accounting
Income and expenditure based system
Income and expenditure are matched so that they are
allocated to the period in which the benefit /expense is
incurred
Starting point: Transactions must be recorded….
Basis of gathering accounting information is double-
entry bookkeeping
118. The double entry system
Records transactions - two sides to each
debit and credit side
Separate accounts – uniquely identified
called ledger accounts
based on chart of accounts
Ledgers - books of record
general/nominal
accounts payable
accounts receivable
Trial balance
119. …..etc…...
Trial Balance
Adjustments
stock/inventory
depreciation
bad debts
accruals and prepayments
Annual Financial Statements
... but it begins with recording transactions….
120. The ledgers
General /nominal
Main list of all accounts
Total balances maintained on this ledger
Accounts payable
Records purchases
Links to suppliers / creditors / payables
Also called purchase or bought ledger
Accounts receivable
Records „sales‟ or income
Links to customers / debtors /receivables
Also called sales ledger
121. Ledger Accounts
Each item (asset, expense, liability, capital or income) has its
own ledger account
It records the details of transactions relating to the
particular item
Original paper system was „T‟ accounts
Each account is identified by a unique code
Debit Credit
122. Lecture example 1
The accounts of MSU
reveal the following: Consider how the following
Capital 18 900 transactions will affect the
Fixtures 3 500 accounts;
Loan 2 000 MSU buys stocks of goods on
Stocks 4 950 credit for £770.
Debtors 3 280 One of the debtors pays £280
Creditors 1 600 in cash.
Vehicles 4 200 New fixtures are purchased
Cash - bank 6 450 with a cheque for £1000.
Cash - hand 120
124. Rules of Debit & Credit
Every transaction effects two accounts
A debit
increases an asset or expense account
decreases an income or liability account
A credit
increases an income or liability account
decreases an asset or expense account
125. Types of accounts
Asset and liability accounts – are ongoing
accounts
Non Current (fixed) assets, loan and capital accounts once
established – remain..
Current assets and liability accounts also remain but move
very regularly up and down as, for example, cash at bank
Income and expenditure accounts differ in that
each year we start with a zero balance and
record all income and all expenditure into its
own separate account. The aim is to establish
a total amount for each item, e.g. telephone
126. An exception… purchases/stock
Purchases …are an expense item
For example – chocolate bars in a shop
Inventory/Stock is an asset…
Unsold chocolate bars in a shop
We record all purchases as expenses..
At year end…we measure if we have any items
left…
What remains = stock/inventory to carry forward, i.e.: closing
stock/inventory
What‟s used = purchases
Purchases are the only expense item where we cannot simply
look to the balance on the account
127. But…
Through the year we record all the purchases of each
stock item… at the end we then see how much we
have left…this determines how much of the item we
have used..i.e. the expense incurred
But we may have
had stock/inventory at the beginning…opening
stock/inventory
sent goods back…returns outwards
been charged for delivery…carriage in
All the above help determine the value of the items
used
128. Returns..
When we send something back…
returns outwards
When something comes back to us…
returns inwards
Set up separate accounts for each…
For a return outwards:
reduce supplier account
increase returns outwards account
For a return inwards:
reduce customer account
increase returns inwards account
129. ..and how much did we use?
£
Opening Stock/Inventory X
+ Purchases X
- Returns outwards (X)
+ Carriage inwards X
- Closing Stock/Inventory (X)
= Cost of Goods Used X
130. Lecture example 2
A hospital is trying to establish the cost of
cleaning materials used in a year.
Opening stock/inventory value £ 12,400
Purchases £ 87,300
Returns £ 7,600
Carriage inwards £ 1,200
Closing stock/inventory £ 14,250
What is the cost of the cleaning materials
used?
131. Balances on Accounts
Each ledger account is „balanced off‟
all debit balances are assets or expenses
all credit balances are liabilities or income
Balance sheet = asset & liability accounts
The balances on these accounts are „ongoing‟ ie
closed and re-opened for the next accounting
period
Income statement = income & expenses
The closing balances on these accounts are
transferred out and the new accounting period
starts with zero balances.
132. Balancing off accounts
Supplier A
10/5 Returns out 40 1/5 Purchases 690
24/5 Paid cash 300 4/5 Purchases 66
bal c/d 416 756
756
1/6 bal b/d 416
A balance on a supplier account is a ‘credit’ balance which means
we have a ‘creditor’ (payable).
For customer accounts, a ‘debit’ balance means we have a ‘debtor’
(receivable).
133. Trial Balance
List of balances on ledger Dr Cr
accounts Income 155
Total debit entries Purchases 60
= total credit entries Expenses 25
Starting point for the Wages 30
derivation of the financial Vehicle 120
statements Fittings 70
Adjustments to the trial Capital 150
balance lead to the creation
of the operating statement 305 305
and the balance sheet
134. Preparing accounts
From trial balance we prepare year end and
month end figures..
Accrual basis – 4 main adjustments
Stock/inventory
Depreciation of fixed assets
Bad debts
Accruals & prepayments
135. Fixed Assets
Capital expenditure
buildings, equipment, vehicles, fixtures and fittings
Provide benefit beyond the accounting period
Accruals system - match cost to benefit
- by depreciation
136. Depreciation
Allocation of the cost of an asset to the years in
which benefit is gained
Key
historic cost
useful life
residual value
method
main - straight line or reducing balance
Assets recorded at :
Net Book Value = cost - accumulated depreciation
137. Lecture example 3
An asset is bought for £100,000
It has an estimated useful life of 4 years
The residual value will be £20 000.
What depreciation - assuming the straight line
basis is appropriate - will be charged to the
I&E accounts in each of the years and what is
shown in the balance sheet?
Using a reducing balance of 33% recalculate
the above.
138. Entering the transactions
Cost of asset is recorded when purchased
Only removed when asset disposed of
Two accounts record depreciation
Depreciation expense
Income Statement account
Depreciation provision (accumulated depreciation)
Balance sheet account
Carry forward each year of assets life
Offsets cost to give NBV on balance sheet
139. Bad Debts
Debtors are sums owing to us – but not yet paid
Bad debt - money owed which is unlikely to be received
Treatments
specific debts are written off
Dr bad debts expense account
Cr debtor account
general provision is established as policy
Dr bad debts expense
Cr bad and doubtful debt provision
Provision is a balance sheet account – it offsets the debtors in
the BS – the account is carried forward and is adjusted each
year based on debtors balance – any movement in the provision
is treated as an expense on the income statement.
140. The Month – End result
Management accounts
On-going figures on a monthly basis
Current month and year to date
Reports on individual cost centres
Line items included
Compared to budgets - variances
Basis is accruals – prepayments and accruals
included
141. Example: Monthly Control Report
Current Month As at 30th June Year to date
Budget Actual Variance Expenditure Budget to Actual to Variance
Date Date
Supplies and
General Charges
40,000 43,000 -3,000 Basic pay 230,000 250,000 -20,000
25,000 26,000 -1,000 Part tim e basic 150,000 165,000 -15,000
15,000 14,500 500 Casual pay 90,000 80,000 10,000
20,000 19,000 1,000 Adm inistrative staff 150,000 148,000 2,000
18,000 20,000 -2,000 Photocopy costs 100,000 110,000 -10,000
21,000 24,000 -3,000 Materials 120,000 125,000 -5,000
10,000 6,000 4,000 Books 50,000 56,000 -6,000
6,000 6,000 0 Heating Pow er & Light 39,000 40,000 -1,000
5,000 4,000 1,000 Cleaning 30,000 31,000 -1,000
1,000 1,500 -500 Fax 6,000 5,000 1,000
2,000 1,800 200 Telephone 12,000 10,000 2,000
1,000 2,000 -1,000 Consum ables 6,000 6,000 0
500 500 0 Hospitality 9,000 10,000 -1,000
1,500 2,000 -500 Maintenance 6000 7000 -1,000
800 700 100 Travelling Expenses 5,000 4,500 500
200 500 -300 Stationery 1,000 1,500 -500
700 100 600 Office Expenses 4,000 5,000 -1,000
200 - 2000 Office Equipm ent 1,000 1,500 -500
3,000 3,500 -500 Rent & Rates 20,000 19,000 1,000
1,000 1,000 0 Sundries 6,000 10,000 -4,000
171,900 176,100 -4,200 Sub Total 1,029,000 1,077,500 -48,500
142. The Year- End Result
Accounting statements
Operating Statement
Income and Expenditure
Profit and Loss Account
Income Statement
Balance Sheet
Accounting policies
Additional notes
143. Reports…content in brief
Balance Sheet
Own
Income Statement
Assets
Income Non-Current
Current
Less
Owe
Expenses Liabilities
= Long term
Current
Profit/Loss
Capital
Original
Accumulated surplus‟s
144. Basic Income Statement
£ £
Income 1000
Cost of goods sold (750)
Gross Profit 250
Expenses (50)
Net Profit to be retained 200 Balance
Sheet
145. The Balance Sheet - format
£
Non-Current Assets 1000
Current Assets
Inventory 150
Receivables 250
Cash 200
600
Total Assets 1600
Current Liabilities
Payables 150
Overdraft 250
400
Long Term Liabilities 300
Net Assets 900
Capital
Owners Share Capital 700
Retained profit 200
900