1.
ACCOUNTING
CYCLE
The
Accounting
Cycle
is
a
series
of
steps,
which
are
repeated
every
reporting
period.
The
process
starts
with
making
accounting
entries
for
each
transaction
and
goes
through
closing
the
books.
This
Involves
recording
transactions
in
the
daybooks,
posting
them
to
ledger,
extracting
a
trial
balance
and
finally
drawing
up
financial
statements.
Step
1:
Recording
Transactions
in
Daybooks
Each
transaction
is
recorded
first
in
one
of
the
following
daybook
(
book
of
original
entry)
according
to
the
nature
of
the
transaction.
1.
All
goods
sold
on
Credit
(
Credit
Sales)
….>
Sales
Daybook
2.
All
goods
purchased
on
Credit
(Credit
Purchases)
….>
Purchases
Daybook
3.
All
goods
sold
on
credit
but
now
returned
by
costumers
..>
Sales
Return
(Inwards)
Daybook
4.
All
goods
purchased
on
credit
but
now
returned
to
suppliers…>
Purchases
Return
Daybook
The
above
four
daybooks
only
record
credit
transactions
related
to
movement
in
inventory.
There
are
no
accounts
maintained
inside
the
daybooks.
It
Just
contains
Date,
Name,
Source
document
number
and
Amount.
5.
All
transactions
which
relate
to
receipts
and
payments
through
cash
or
cheque
..>
Cashbook
Cash
and
Bank
accounts
are
made
inside
the
cashbook
hence
it
also
serves
the
purpose
of
ledger.
6.
All
other
transactions
…..>
General
Journal
In
this
we
actually
write
the
double
entry
of
only
those
transactions
which
cannot
be
recorded
in
the
above
five
daybooks.
To
name
a
few
-­‐ Non
Current
Assets
Purchased
or
Sold
on
Credit
-­‐ Writing
off
Bad
debts
-­‐ Entries
for
Provisions
of
doubtful
debts
and
depreciation
-­‐ Adjustments
for
Prepaid
and
Owings
-­‐ Correction
of
Errors

2.
Step
2:
Posting
Transactions
In
Ledgers
A
ledger
is
a
book
which
contains
accounts
(
the
actual
T
Accounts
guys).
There
are
three
types
of
Ledgers.
In
each
type
we
have
different
type
of
accounts.
Sales
Ledger:
This
contains
accounts
of
credit
costumers
(
people
to
who
we
sell
goods
on
credit)
–
Trader
Receivables
At
the
end
of
the
year
all
the
account
balances
in
the
sales
ledger
are
listed
in
a
schedule
which
is
called
list
of
Trade
receivables.
This
shows
the
individual
account
balances(
closing)
and
also
the
total
debtors
which
goes
into
the
trail
balance.
Purchase
Ledger:
This
contains
accounts
of
credit
suppliers
(
people
from
whom
we
buy
goods
on
credit)
–
Trader
Payables
At
the
end
of
the
year
all
the
account
balances
in
the
purchase
ledger
are
listed
in
a
schedule
which
is
called
list
of
Trade
Payables.
This
shows
the
individual
account
balances(
closing)
and
also
the
total
creditors
which
goes
into
the
trail
balance.
General
Ledger:
This
contains
all
the
other
accounts.
Like
all
expenses
,incomes
,provisions
(literally
all
other
accounts)
Please
remember
Sales
and
Purchases
accounts
are
in
the
General
Ledger
cause
they
are
not
our
costumers
or
suppliers
.
Once
all
the
transactions
are
posted
all
the
accounts
are
balanced
via
inserting
a
balance
C/d
in
all
accounts.
Step
3
:
Extracting
a
Trial
Balance
All
the
closing
balances
in
the
General
Ledger
along
with
the
figure
of
total
trade
receivables
and
payables
are
listed
in
a
trail
balance.
Debit
balances
and
Credit
Balances
are
listed
separately
side
by
side.
The
Sum
of
all
Debits
should
be
equal
to
sum
of
all
credit
balances.
The
trail
balances
is
used
to
check
the
completion
of
the
double
entry.
The
trail
balance
will
balance
because
-­‐ For
each
debit
entry
there
is
a
credit
entry
(
vice
versa)
-­‐ The
sum
of
all
debit
entries
is
equal
to
the
sum
of
credit
entries

3.
Step
4:
Closing
Entries
with
Year
end
Adjustments
(
Details
in
following
pages)
After
making
the
trail
balance
we
also
have
to
adjust
for
certain
items.
Remember
only
Incomes
and
Expenses
are
taken
into
account
while
calculating
profit.
These
accounts
are
closed
by
transferring
them
to
the
income
statement
(
the
Profit
and
Loss
Account).
This
process
is
called
Closing
Entries.
Some
common
adjustments
are
-­‐ Expenses
and
Incomes
are
adjusted
for
prepaid
(advance)
and
accruals(Owings)
-­‐ Non
Current
Assets
are
depreciated
-­‐ Provision
for
doubtful
debt
is
adjusted
-­‐ Closing
inventory
is
valued
by
physical
stock
take
and
it
is
adjusted
in
calculating
cost
of
goods
sold
and
also
for
Balance
Sheet
-­‐ Adjustments
for
goods
withdrawn
by
owner
or
Stock
Losses
Step
5
:
Final
Accounts:
An
income
statement
and
Balance
Sheet
is
drawn
which
ends
the
Accounting
Cycle.
Now
by
looking
at
Income
Statement
owner
can
check
his
Profit
and
by
looking
at
the
Balance
Sheet
he
can
check
his
Net
worth
of
the
Business.
ADJUSTMENTS
IN
DETAIL
BAD
DEBTS
AND
PROVISION
FOR
DOUBTFUL(BAD)
DEBTS
What
is
a
bad
debt?
When
a
costumer
to
whom
goods
were
sold
on
credit
basis,
is
unable
to
pay
his
debt
then
it
results
into
an
expense
for
the
business.
Selling
goods
on
credit
basis
involves
this
risk
of
bad
debt.
Any
amount
of
debt
which
becomes
irrecoverable
should
be
written
off
as
bad
debt.
Debit:
Bad
Debts
Credit
:
Person
Who
is
Bad
:>/Trade
receivable
What
is
a
Provision
for
bad
debt?
A
business
must
consider
that
some
costumers
might
not
pay
the
amount
owed
by
them;
these
debts
are
considered
to
be
doubtful.
Since
the
business
does
not
know
the
exact
amount
of
the
doubtful
debts(
and
also
which
costumer
might
not
pay),
an
estimate
for
such
amount
is
kept
in
a
provision
for
doubtful
debt
account
(
this
account
is
not
an
expense
account,
it’s
a
reduction
in
asset
from
the
balance
sheet).
Provision
is
created
to
reduce
profit
now
for
an
expense
which
might
happen
in
future.
This
is
done
to
be
pessimistic
,
in
Accounting
we
call
this
being
prudent
or
the
Prudence
Concept.

4.
A
business
usually
keeps
a
general
provision
(
an
estimated
%
of
the
all
debtors),
but
it
is
also
possible
to
make
a
specific
provision
against
a
highly
doubtful
debt.
Specific
provision
mean
the
whole
amount
due
by
a
particular
debtor
is
added
to
the
provision.
For
example
Trade
Receivables
At
End=
60000
Case
1:
Only
General
Provision
of
5%
..
>
provision
=
5%
of
60000
=
$3000
How
is
the
amount
of
provision
estimated?
(
Factors
effecting
it)
-­‐ Age
of
Debts
(
Since
how
long
they
owe
us),
higher
the
age
more
likely
bad
debts
(
so
high
provision
is
kept
If
majority
of
the
debts
are
owed
for
long)
-­‐ Historical
percentage
of
actual
bad
debts
from
previous
years
-­‐ Reputation
of
people
who
us
money
in
the
market
-­‐ Nature
of
Business
-­‐ Some
specific
debts
may
be
identified
and
full
amount
of
them
is
charged
in
provision.
What
is
the
difference
between
accounting
treatment
of
Provision
for
doubtful
debts
and
the
actual
Bad
debts?
The
Journal
entry
for
provision:
To
create
/
Increase
Debit
:
Profit
and
Loss
Credit
:
Provision
for
doubtful
Debts
To
Decrease
Debit
:
Provision
for
doubtful
debts
Credit
:
Profit
and
Loss
The
difference
in
accounting
treatment
is
that
the
whole
of
bad
debt
is
treated
as
an
expense
but
only
the
change
in
provision
is
treated
as
either
an
expense
(if
increasing)
or
an
income
(
if
decreasing).
When
we
write
off
a
bad
debt,
we
remove
the
debtor
from
our
books
but
in
case
of
a
provision
we
don’t
adjust
the
debtor
account
as
a
separate
account
is
maintained.

5.
What
is
Bad
Debt
Recovered?
This
is
when
a
debtor
whose
debt
was
previously
written
off
,
pays
us
back.
This
is
treated
as
an
income
in
the
year
in
which
the
debt
is
recovered
.
The
accounting
treatment
is
done
in
two
steps
-­‐ Make
him
or
her
your
debtor
(receivable
)
as
the
debt
has
been
written
off
previously
and
the
account
of
that
costumer
doesn’t
exist
in
our
books
Debit
:
Name
of
Person(debtor)
Credit:
Bad
debt
recovered
account
-­‐ Now
record
the
entry
to
receive
the
money
Debit:
Bank
Credit
:
Name
of
person
(debtor)
ACCOUNTING
FOR
NON
CURRENT
ASSETS
Whenever
we
spend
money
we
call
it
expenditure.
The
expenditure
can
be
divided
in
two
Capital
Expenditure
Revenue
Expenditure
Any
expenditure
incurred
on
buying
new
non-­‐current
asset.
We
take
this
to
balance
Sheet
Any
day
to
day
expense
to
run
the
business.
We
take
this
to
income
statement
Usually
one
off
(doesn’t
happen
on
daily
basis)
Its
recurring
in
nature
(
we
have
to
do
it
again
and
again)
Includes
initial
expenses
incurred
till
we
start
using
the
asset
e.g.
Installation,
delivery
charges
Usually
occurs
after
we
start
using
the
asset
Increases
the
value
of
earning
capability
of
the
asset
e.g.
Adding
a
Safety
device
Maintains
the
value
or
earning
capability
of
the
asset.
E.g.
Repainting
or
Repair
In
the
same
way
we
can
have
Capital
receipts
and
Revenue
Receipts
.
Capital
Receipts
would
include
money
received
from
capital
transactions
e.g.
taking
a
bank
loan
,
selling
a
non
current
asset
or
additional
capital
introduced
by
the
owners
(
note
this
money
coming
in
not
earned
by
the
business
from
profits)
Revenue
Receipts
are
incomes
generated
from
day
to
day
operations
of
a
business
(
taken
to
income
statement)
e.g.
Sale
of
goods
,
Interest
received
rent
received
If
these
expenditures
and
receipts
are
treated
in
the
wrong
way
then
both
income
statement
and
balance
sheet
will
be
wrong.

6.
Depreciation
This
is
an
expense
recorded
to
allocate
a
non
current
asset
cost
over
its
useful
life.
Deprecation
is
used
in
accounting
to
try
to
match
the
expense
of
an
asset
to
the
income
that
the
asset
helps
the
business
to
earn.
For
example
if
a
business
buys
a
piece
of
equipment
for
$1
million
and
expects
to
use
it
over
a
life
of
10
years,
it
will
be
depreciated
over
10
years
.
Every
accounting
year,
the
company
will
expense
$100000
(assuming
straight
line
,
which
will
be
matched
with
the
money
that
the
equipment
helps
to
make
each
year.
The
Double
Entry
for
Depreciation
is
:
Debit
:
Profit
and
Loss
Account
(
Income
Statement)
Credit
:
Provision
for
Depreciation
Methods
of
Depreciation:
1. Straight
Line
:
An
equal
amount
of
deprecation
is
charged
every
year.
It
is
always
calculated
on
cost
.
In
case
of
scrap
value
(residual
value)
and
life
given
use
:
Cost
–Scrap/Life
2. Reducing
Balance
Method:
In
this
deprecation
for
initial
years
in
always
higher
then
the
later
years.
It
is
simply
a
percentage
on
net
book
value
(written
down
value)
.
Net
Book
value
represents
cost
minus
total
deprecation
till
date.
3. Revaluation
Method:
This
is
usually
used
for
loose
tools
(
or
any
asset
which
can
only
be
valued
collectively)
.
In
this
method
at
the
end
of
the
year
the
market
value
is
estimated.
A
numerical
example
best
explains
this
At
the
start
of
the
year
Loose
Tools
Valued
at
$5000
During
the
year
Loose
Tools
purchased
=
$2000
Loose
Tools
Sold
=
$300
At
the
End
Loose
tools
are
worth
$4500
Deprecation
=
5000
+
2000
–
300-­‐
4500
=
2200
Opening
Value+
Purchased
–Sold
–
Closing
Value

7. Which
Method
is
best
to
use?
It
depends
on
the
nature
of
Non
Current
Asset
Straight
Line
method
is
appropriate
for
assets
like
office
furniture
and
fittings
(which
are
used
evenly
through
out
the
year
useful
life,
and
the
efficiency
of
them
doesn’t
fall
by
great
amount
in
initial
years)
Reducing
Balance
Method
is
appropriate
for
assets
like
machinery
or
van.
Since
these
assets
are
more
efficient
when
new,
more
depreciation
is
charged
in
initial
years.
As
the
asset
gets
old
it
looses
efficiency
and
so
we
charge
less
deprecation.
Another
way
to
look
at
it
is
that
the
maintenance
and
repairs
of
asset
will
increase
in
later
years
so
to
maintain
the
overall
expense
it
makes
sense
to
charge
more
depreciation
in
initial
years
when
maintenance
is
low
and
then
reduce
it
as
maintenance
increases.
How
to
record
disposal
of
Asset:
Disposal
of
means
getting
ride
of
the
fixed
asset
.
it
can
be
sold
or
may
be
stolen
or
just
discarded.
Usually
there
are
4
entries
to
record
sale
of
asset
1. Remove
the
Cost
of
the
Asset
Sold
Debit
:
Disposal
Credit:
Asset
2.
Remove
the
Total
Deprecation
Debit
:
Provision
for
Depreciation
Credit
:
Disposal
3. Record
the
Selling
Price
Debit:
Bank
Credit
:
Disposal
If
exchanged
then
Debit
:
Asset
Credit
Disposal
4. Close
the
Disposal
Account
Close
with
income
statement
.

8.
All
of
this
can
be
done
in
one
single
entry
without
using
disposal
For
example
Cost
of
Asset
Sold
=
50000
Net
book
Value
=
30000
Sold
For
28000
Note
:
total
depreciation
is
20000
as
NBV
is
30000
We
can
do
Bank
28000
Prov
for
Depn
20000
Loss
2000
Asset
50000
If
sold
for
$31000
then
Bank
31000
Prov
for
Depn
20000
Asset
50000
Gain
1000
Adjusting
Entries
To
Adjust
expenses
Prepaid
:
Debit
:
Prepaid
Expense
(
its
an
asset)
Credit
:
Expense
(reduces
expense)
Owing/Accrual
Debit
:
Expense
(increases
expense)
Credit
:
Owing
Expense
(
it
is
a
liability)

9.
To
adjust
Incomes:
Prepaid:
Debit:
Income
(as
the
income
reduces
because
it’s
prepaid)
Credit:
Prepaid
Income
(because
it’s
a
current
liability)
Owing/Due
Debit:
Owing
Income
(because
it’s
an
asset)
Credit:
Income
(as
the
income
increases)
To
adjust
closing
stock
Overstated:
Debit:
Trading
account
(or
simply
Profit
and
Los)
Credit:
Closing
stock
Understated:
Debit:
Closing
sock
Credit:
Trading
account
(or
simply
Profit
and
Loss)
To
adjust
Opening
stock
Overstated:
Debit:
Opening
Capital
Credit:
Trading
account
(or
simply
Profit
and
Loss)
Understated:
Debit:
Trading
account
(or
simply
Profit
and
Loss)
Credit:
Opening
Capital
This
is
because
opening
stock
has
opposite
relation
with
profits.
So
if
understated
profits
are
overstated
and
we
need
to
reduce
them
(debit:
Trading
account).
Also
opening
stock
of
this
year
was
closing
stock
of
last
year
so
we
need
to
amend
the
opening
capital.

10. Concept
of
Sale
or
Return
basis:
If
we
send
goods
on
sale
or
return
basis
which
means
goods
can
be
returned
by
the
customer
if
not
sold.
When
goods
are
send
nothing
is
recorded,
just
a
memorandum
is
kept.
These
goods
should
not
be
included
in
sales
and
should
be
included
in
closing
stock
(since
they
belong
to
us).
If
this
is
recorded
as
sales
and
not
included
in
closing
stock,
then
we
need
to:
• Correct
sales:
Cancel
them
Debit:
Sales
Credit:
Debtor
• Correct
Closing
Stock
which
is
understated
Note:
We
won’t
have
to
correct
the
stock
if
the
goods
were
included
in
closing
sock.

11. BANK
RECONCILIATION
STATEMENTS
Cashbook
is
owner’s
record
(Debit
means
+
balance,
Credit
means
–
balance)
Bank
statement
is
bank’s
record
(Credit
means
+
balance,
Debit
means
–
balance)
Some
entries
which
are
recorded
in
the
bank
statement
but
not
in
the
cashbook:
For
these,
we
will
have
to
correct
the
cashbook
1. Credit
transfer
(Bank
Giro):
Money
deposited
by
customer
directly
in
the
bank
account
(We
should
add
it
to
cashbook
balance)
2. Standing
order/
Direct
Debit:
Money
paid
to
supplier
directly
by
the
bank.
(We
should
subtract
this
from
cashbook
balance)
3. Bank
Charges/
Interest
Charged:
Money
deducted
directly
by
the
Bank.
(We
should
subtract
this
from
cashbook
balance)
4. Interest
Received/
Dividends
Received:
Money
added
to
the
bank
account
in
form
of
interest
or
dividend
(We
should
ad
it
to
the
cashbook
balance)
5. Dishonored
Cheque:
A
cheque
received
from
customer
but
not
acknowledged
by
the
bank
(We
should
subtract
this
from
cashbook
balance
because
we
need
to
cancel
the
entry
made
when
the
cheque
was
received).
Some
entries
which
are
recorded
in
the
cashbook
but
not
on
the
bank
statement.
For
this,
we
will
have
to
correct
the
bank
statement:
1. Unpresented
Cheque:
Cheques
written
by
us
to
a
creditor
but
not
yet
presented
to
the
bank
for
payment,
so
the
bank
has
not
deducted
money
from
our
account.
(We
should
subtract
this
from
bank
statement
balance)
2. Uncredited
Cheque
(Lodgments):
Cheques
received
by
us
but
not
yet
deposited
in
the
bank,
so
the
bank
has
not
increased
the
bank
balance.
(We
should
add
this
to
the
bank
statement
balance)
FOR
MCQ’s
remember
Balance
as
per
Bank
statement
+
Uncredited
Cheques
–
Unpresented
Cheques
=
Balance
as
per
corrected
Cashbook.
If
balance
as
per
corrected
cashbook
is
given
in
the
question,
simply
ignores
the
entries
which
will
affect
the
cashbook
balance.
If
there
is
an
overdraft
(for
either
cashbook
or
bank
statement),
take
it
as
a
negative
figure
in
the
equation.

12. CONTROL
ACCOUNTS
What
is
the
difference
between
Sales
Ledger
and
Salas
Ledger
Control
Account?
Sales
ledger
is
where
we
make
individual
accounts
of
credit
customers.
It
is
part
of
double
entry
system
and
it
gives
details
of
amounts
owing
by
each
customer.
A
list
of
debtors
is
extracted
from
the
sales
ledger,
which
gives
the
figure
of
debtors
for
the
trial
balance.
Sales
ledger
control
account
on
the
other
hand
is
the
total
debtors
account
in
the
general
ledger.
It
is
not
part
of
the
double
entry
system.
It
I
often
referred
as
total
debtors
account.
All
the
entries
recorded
here
are
totals
taken
from
daybooks
e.g.
Sales
figure
is
the
total
of
the
sales
daybook,
discount
allowed
is
total
discount
allowed
from
the
discount
allowed
account
or
the
column
in
the
cashbook.
USES
OF
CONTROL
ACCOUNT
1. Helps
to
prevent
fraud
2. Helps
to
detect
errors
3. Quickly
provide
figures
of
total
debtors
and
creditor.
LIMITATIONS
OF
CONTROL
ACCOUNT
1. Cant
trace
error
of
omission
2. Cant
trace
error
of
original
entry
RECONCILIATION
OF
CONTROL
ACOUNT
In
these
types
of
questions,
two
sets
of
balances
of
debtors
or
creditors
are
known.
One
is
from
the
control
account
and
the
other
is
from
the
sales
ledger
(or
list
of
debtors).
They
will
also
give
you
several
errors
and
you
will
have
to
reconcile
both
the
balances.
Errors
can
be
classified
as:
1. If
an
error
is
made
in
the
personal
(individual)
debtors
account,
than
it
will
only
affect
the
sales
ledger
(list)
balances.
E.g.
Sales
made
not
posted
to
debtor’s
account,
this
means
we
should
increase
the
debtor
balances
in
the
ledger.
2. If
an
error
is
made
in
any
total
figure
of
the
daybook,
it
will
effect
only
the
control
account
balance,
e.g.
Sales
daybook
undercast,
Total
sales
understated
so
add
it
to
control
account
balance.
3. If
an
entry
is
completely
omitted
from
the
books,
it
will
affect
both
the
balances.
E.g.
A
sales
invoice
completely
omitted
from
the
books,
add
it
to
both
balances.
4. If
an
entry
is
originally
recorded
in
the
daybook
with
the
wrong
amount,
it
will
affect
both
the
balances,
as
the
total
will
also
be
wrong.
E.g.
A
sales
invoice
of
$500
was
originally
recorded
as
$600,
this
means
the
total
sales
are
overstated
and
also
the
individual
account
of
the
customer
has
been
debited
with
$600.
We
should
subtract
$100
from
both.
5. If
a
balance
is
omitted
from
the
list
of
debtors,
it
will
only
affect
the
sales
ledger
(list)
balance.
It
cannot
affect
control
account
balance.

13. ERRORS
AND
SUSPENSE
Error
not
affecting
the
Trial
Balance:
1. Error
of
complete
omission:
When
nothing
has
been
recorded
in
the
books.
To
correct
this,
simply
record
the
transaction.
2. Error
of
original
entry:
Where
correct
double
entry
is
passed
but
with
the
wrong
amount.
To
correct
this,
adjust
for
the
difference.
3. Error
of
principal:
Where
a
wrong
type
of
account
has
been
debited
or
credited
instead.
For
example,
we
have
debited
Rent
instead
of
Motor
Van.
4. Error
of
commission:
Where
a
wrong
account
but
of
same
type
(usually
debtors
or
creditors)
has
been
debited
or
credited
instead.
For
example,
we
have
credited
Mr.
A
instead
of
Mr.
B.
5. Error
of
complete
reversal:
Where
a
completely
opposite
entry
is
passed
with
the
right
amount.
To
correct
this,
pass
the
correct
entry
with
double
amounts.
6. Compensating
error:
Where
one
error
compensates
for
other.
Like
a
debit
item
(say
purchase)
and
a
credit
item
(say
sales)
are
both
undercast
with
same
amounts.
(don’t
worry
about
this
too
much
:P)
All
the
above
errors
do
not
affect
the
Trial
Balance
because
in
all
situations
the
total
debits
are
equal
to
total
credits.
Errors
can
be
made
which
can
lead
to
disagreement
of
the
trial
balance.
This
is
when
either
we
have
only
debited
something
and
forgot
to
credit
(Incomplete
double
entry)
or
we
have
debited
something
with
a
correct
amount
and
credited
the
other
with
the
wrong
amount
(Incorrect
double
entry).
And
it
can
also
happen
if
any
daybook
is
over
or
under
cast.
E.g.
Sales
daybook
is
undercast.
In
these
situations
Suspense
account
comes
into
the
picture.
Since
sales
daybook
is
undercast,
this
means
only
the
total
sales
were
wrong
(understated),
so
we
need
to
amend
the
sales
accounts.
Debit:
Suspense
Credit:
Sales
Also
sometimes
an
error
is
made
in
the
list
of
debtors
or
creditors.
Like
a
debit
balance
is
excluded
from
the
list
of
debtors.
This
makes
the
debtors
figure
in
the
trial
balance
understated.
Logically
we
should
Debit:
Debtors
Credit:
Suspense
But
guys
do
you
realize
that
only
the
list
of
debtors
is
wrong
(which
is
not
an
account),
so
we
should
Debit:
NO
DEBIT
ENTRY
Credit:
Suspense
What
if
there
is
still
balance
left
in
the
suspense
account?
This
means
all
the
errors
are
still
not
found.
If
the
balance
comes
on
the
debit
side,
then
treat
it
as
a
current
asset
in
the
balance
sheet,
if
it
comes
on
the
credit
side
then
treat
it
as
a
current
liability.

14. INCOMPLETE
RECORDS:
Remember
Net
profit
can
be
calculated
using
the
following
formula.
If
a
question
says
make
a
trading
profit
and
loss
account,
than
this
doesn’t
apply.
Only
when
it
says
to
calculate
net
profit
or
make
a
statement
showing
net
profit.
Opening
Capital
+
Additional
Capital
+
Net
profit
–
Drawings
=
Closing
Capital
(I
really
hope
you
can
solve
for
net
profit),
don’t
memorize
the
formula,
it’s
the
financed
by
section.

For
the
final
account
questions
(where
the
trading,
profit
and
loss
account
and
a
balance
sheet
is
required),
always
make
the
following
accounts.
(By
always,
I
mean
always).
1. Sales
ledger
control
account
(If
business
only
deals
in
cash
sales,
then
don’t)
2. Purchase
ledger
control
account
3. Bank
account
(if
it
is
already
given
in
the
question,
then
it’s
okay)
4. Cash
account
(only
make
this
when
the
question
gives
cash
balances)
Once
you
have
filled
in
your
accounts,
and
then
move
to
the
Final
accounts.
Don’t
panic
if
it
doesn’t
balance,
because
marks
are
for
working.
Don’t
spend
your
entire
lifetime
on
this
question.
NEVER
NEVER
NEVER
forget
depreciation.
They
will
usually
give
you
net
book
values
at
start
and
end.
Depreciation
=
Opening
NBV
+
Purchase
of
assets
–
Sale
of
assets
(at
NBV)
–
Closing
NBV
Also
make
expense
accounts
or
adjust
for
prepaid
and
owings
directly.
But
show
all
working.
In
your
financed
by
section,
you
will
need
opening
capital.
This
will
come
from
Opening
Assets
–
Opening
Liabilities.
Don’t
forget
to
include
the
opening
balance
of
the
bank
account
in
your
calculation
(like
other
idiots).
On
the
following
pages,
I
have
given
few
exercises.
Try
to
fill
in
the
missing
figures.
MARGINS
AND
MARK-­‐UPS
These
are
tools
used
in
conjunction
with
trading
account
to
compute
the
missing
figures
of
sales,
figures
or
stocks.
If
either
of
these
percentages
is
given,
it
is
a
sign
that
we
are
expected
to
compute
the
missing
figures
by
using
the
trading
account
technique.

15. MARGINS
Represent
Gross
Profit
as
a
percentage
of
selling
price.
Example:
A
company
sells
its
goods
at
a
selling
price
of
$80.
Its
profits
are
set
at
20%
no
selling
price.
Profits
will
be
$80
x
20%
=
$16
By
using
trading
account
format,
we
can
determine
the
cost
of
goods
sold
as:
$
Sales
80
Less:
Cost
of
goods
sold
(balancing
figure)
(64)
Profit
16_
MARK-­‐UP
Represent
Gross
profit
as
a
percentage
of
cost.
Its
application
is
like
margin,
that
if
we
get
one
of
the
trading
figures,
we
will
be
able
to
compute
the
others.
Let
us
assume
that
the
information
we
have
from
the
above
example
is
that
a
company
sells
goods,
which
cost
$64.
Its
profit
on
cost
is
25%.
Profits
would
be
computed
as
follows:
Profits
=
$64
x
25%
=
$16.
By
using
trading
account
format,
we
can
determine
sales
as:
$
Sales
(balancing
figure)
80
Less:
Cost
of
goods
sold
(64)
Profit
16_
Try
to
use
Sales
–
Cost
=
Profit
If
Mark
up
if
given
Profit
is
a
%
of
Cost
and
IF
margin
is
given
Profit
is
a
%
of
Sales
For
eg.
Sales
=
80000
Cost
=
?
Margin
=
25%
Sales
–
Cost
=
Profit
80000-­‐
x
=
25
%
of
80000
Cost
=
60000

16. But
if
Sales
=
80000
Cost
=
?
Markup
=25%
Sales
–
Cost
=
Profit
80000-­‐
x
=
25
%
of
X
Cost
=
64000
NON-­‐PROFIT
ORGANIZATION
(CLUBS
AND
SOCITIES)
The
non-­‐profit
organization
is
with
a
view
of
providing
services
to
its
members.
The
aim
is
not
to
make
profits
out
of
trading
activities,
but
to
increase
to
welfare
of
members
through
social
interaction
and
other
activities.
A
club
is
owned
by
all
the
members
collectively
and
since
there
is
no
single
owner,
there
are
no
DRAWINGS.
TERMINOLOGY
DIFFERENCE
Non-­‐profit
organizations
Normal
trading
Businesses
Receipts
and
Payments
Account
Bank
Account
Income
and
Expenditure
Account
Trading,
Profit
and
Loss
Account
Surplus
Profit
Deficit
Loss
Accumulated
Funds
Capital
Why
is
a
Receipts
and
Payments
Account
unsatisfactory
for
the
members?
The
receipts
and
Payments
account
does
not
provide
information
to
the
members
relating
to
1. Assets
owned
by
the
club
2. Liabilities
owed
by
the
club
3. Surplus
or
Deficit
4. Depreciation
of
fixed
assets
5. Performance
of
the
club
6. Financial
position
of
the
club.
In
order
to
make
the
income
and
expenditure
account,
you
will
need
to
determine
the
incomes
separately.
Incomes
may
include:
-­‐ Refreshment
Profit/Bar
profit
(make
a
separate
account
to
calculate
net
profit
from
this)
-­‐ Annual
subscription
(separate
subscription
account
for
this)

17. -­‐ Gain
on
disposal.
-­‐ Interest
on
deposit
account
or
investment
account.
-­‐ Profits
from
different
events
(say
Dinner
dance)
-­‐ Life
Subscription
(don’t
mix
this
with
Annual
Subscription)
-­‐ Donations
(only
day
to
day)
Check
debit
side
of
Receipts
and
Payments
account
for
anything
else.
What
is
the
difference
between
receipts
and
payments
account
and
Income
and
Expenditure
account?
Receipts
and
Payment
account
Income
and
Expenditure
account
It
shows
balance
of
bank
at
start
and
end
It
shows
Surplus
of
Deficit
for
the
year
It
records
money
coming
in
and
going
out
It
records
Incomes
and
expenses
incurred
It
considers
all
type
of
money
coming
including
capital
receipts,
e.g.
Long
term
donations
and
all
type
of
money
going
out,
e.g.
Purchase
of
fixed
asset
It
considers
only
revenue
incomes
and
expenditure.
It
is
an
alternative
name
for
cashbook
It
is
an
alternative
name
for
profit
and
Loss
What
is
a
donation
and
what
are
two
accounting
treatments
for
it?
An
amount
received
by
a
club
which
the
club
does
not
have
to
pay
back.
This
includes
donations,
gifts,
legacy
and
grants.
If
donation
is
for
a
day
to
day
expenditure
or
will
remain
with
the
club
only
for
a
short
period
then
it
should
be
treated
as
an
income
in
the
income
and
expenditure
account.
If
donation
is
for
purpose
of
capital
expenditure
on
long
term
assets,
then
it
is
shown
as
a
special
fund
in
the
balance
sheet.
(Financed
by
section
added
it
to
accumulated
funds).
What
is
life
subscription
(Life
membership
or
admission
fees)?
All
of
these
are
treated
in
the
same
way.
The
club
receives
money
for
subscription
for
the
entire
life
of
the
member.
This
is
put
in
a
separate
life
membership
account.
Every
year
an
amount
of
it
is
transferred
to
the
income
and
expenditure
account
(this
will
be
given
in
the
question),
e.g.
the
amount
of
money
received
from
this
life
membership
scheme
is
$300
and
club
decides
to
transfer
20%
every
year.
This
would
mean
that
$60
(20%
of
$300)
is
transferred
to
income
and
expenditure
account
and
the
remainder
$240
should
go
to
the
balance
sheet
as
a
long
term
liability.
If
the
life
membership
fund
already
has
a
balance,
let’s
say
$2
000
and
we
have
received
$500
during
the
year
and
club
transfers
10%
year.
This
would
mean
we
would
show
250
(10%
of
2
500)
as
an
income
and
the
remainder
2
250
(2
500
–
250)
as
a
long
term
liability.

18. PARTNERSHIP
ACCOUNTS
A
partnership
is
defined
by
the
Partnership
Act
1890
as
a
relationship,
which
exists
between
two
or
more
persons
who
carry
business
with
a
view
of
profit.
CHARACTERISTICS
OF
PARTNERSHIP
• Partners
are
jointly
and
severally
liable
for
the
debts
of
the
partnership.
They
have
unlimited
liabilities
for
the
debts
of
the
partnership.
• The
minimum
number
of
partners
is
usually
two
and
maximum
number
is
twenty,
with
exception
of
banks,
where
the
maximum
number
is
fixed
at
ten
and
some
professional
practices
where
there
is
no
maximum
number.
• All
partners
usually
participate
in
the
running
of
their
business.
• There
is
usually
a
written
partnership
agreement.
THE
PARTNERSHIP
AGREEMENT
The
partnership
agreement
is
a
written
agreement
which
sets
up
the
terms
of
the
partnership,
especially
the
financial
arrangements
between
the
partners.
The
contents
of
the
partnership
agreement
can
vary
from
one
partnership
to
another.
A
standard
Partnership
Agreement
may
include
the
following
items:
1. The
name
of
the
firm,
business
type
and
duration
2. Capital
contribution.
3. Profit
sharing
ratios.
4. Interest
on
Capital.
5. Partners’
salaries.
6. Drawings.
7. Interest
on
drawings.
8. Arrangements
in
case
of
dissolution,
death
or
retirement
of
partners.
9. Arrangement
for
settling
disputes.
In
absence
of
a
formal
agreement
between
the
partners,
certain
rules
laid
down
by
the
Partnership
Act
1890
are
presumed
to
apply.
These
are:
1. Residual
profits
are
shared
equally
between
the
partners.
2. There
are
no
partners’
salaries.
3. No
interest
is
charged
on
drawings
made
by
the
partners
4. Partners
receive
no
interest
on
capital
invested
in
the
business.
5. Partners
are
entitled
to
interest
of
5%
per
annum
on
any
loans
they
advance
to
the
business
in
excess
of
their
agreed
capital.

19. CHANGES
IN
THE
PARTNERSHIP
A
change
in
partnership
is
when
the
agreement
has
to
be
changed
between
the
partners
due
to
-­‐ Admission
of
a
new
partner
-­‐ Retirement
of
an
existing
partner
-­‐ Or
simply
change
in
profit
sharing
ratio.
Whenever
there
is
a
change
in
a
partnership,
partners
are
allowed
to
revalue
their
assets
and
also
attach
a
value
of
goodwill
to
the
business.
For
this
purpose,
they
make
a
revaluation
account.
In
revaluation
account
we
simply
record
the
gains
or
losses
on
each
asset
due
to
revaluation.
We
can
also
include
the
goodwill
in
this
account
on
the
credit
(gain)
side.
This
account
is
then
closed
by
transferring
the
balance
to
partners’
capital
account
in
the
old
profit
sharing
ratio.
Two
situations
for
Goodwill:
1. If
partners
decide
to
keep
the
goodwill,
then
we
will
show
the
amount
of
goodwill
in
the
balance
sheet.
(No
other
entry
needs
to
be
made
if
we
already
included
the
goodwill
in
the
revaluation
account).
2. If
partners
decide
to
write
off
the
goodwill
then
we
will
write
off
the
entire
goodwill
from
the
capital
account
(debit
side)
in
the
new
profit
sharing
ratio.
Goodwill
will
not
be
shown
in
the
balance
sheet
in
this
case.

20. ADVANTAGES
OF
PARTNERSHIP
OVER
SOLE
TRADER
1. Additional
capital
from
other
partners,
and
also
easier
to
get
loans.
2. Additional
expertise.
3. Additional
management
time.
4. Risk
(losses)
is
shared.
DISADVANTAGES
OF
PARTNERSHIOP
OVER
A
SOLE
TRADER
1. Profit
are
shared
2. Possibility
of
disputes
3. Loss
of
control
What
is
a
current
account?
Majority
of
partnership
keep
a
fixed
capital
account,
whenever
they
have
fixed
capital
accounts,
they
will
have
to
maintain
a
current
account
for
each
partner.
By
fixed
capital
account,
we
mean
that
all
the
appropriation
and
drawings
will
pass
through
a
temporary
capital
account
(current
account),
only
additional
investment
by
a
partner
will
be
recorded
in
the
capital
account.
This
gives
information
relating
to
long
term
and
short
term
aspects
separately.
This
also
helps
to
determine
the
investment
made
by
partner
in
the
business.
Some
partnerships
also
maintain
a
fluctuating
capital
account;
in
this
case
they
will
not
maintain
a
current
account.
All
the
transactions
will
pass
through
the
capital
account.
What
is
total
share
of
profit?
This
is
different
than
just
the
remaining
share
of
profit
which
we
get
at
the
end
of
appropriation
account.
Total
share
of
profit
means
out
of
this
year’s
net
profit,
how
much
profit
goes
to
a
particular
partner.
As
we
know
interest
on
capital
and
salary
etc
are
deducted
from
net
profit
only
so
they
also
constitute
as
part
of
profit.
Hence,
total
share
of
profit
is:
Interest
on
capital
+
Salary
+
Remaining
share
of
Profit
–
Interest
on
drawings

21. LIMITED
COMPANIES
Limited
companies
are
business
organizations,
whose
owners’
liabilities
are
limited
to
their
capital
contributed
or
guarantees
made.
CHARACTERISTICS
OF
LIMITED
COMPANIES
1. Separate
legal
entity:
A
company
is
regarded
as
a
separate
person
from
its
owners
and
managers.
As
a
result,
it
can
sue
or
be
sued,
it
can
own
property.
This
concept
is
often
referred
to
as
veil
of
incorporation.
2. Limited
liability:
Shareholders’
liability
is
limited
to
what
they
have
paid
for
shares.
3. Perpetual
succession:
Unlike
partnership
and
sole
trader,
a
company
does
not
cease
to
exist
on
the
death
or
retirement
of
any
of
the
owners.
Owners
can
buy
and
sell
their
shares
without
affecting
the
running
of
the
business.
4. Number
of
members:
There
is
no
limit
as
to
the
number
of
members
5. Capital:
Company’s
capital
is
raised
through
the
issuance
of
shares
6. Profit
distribution:
Profits
are
distributed
to
members
through
dividends.
7. Retained
profits:
The
retained
profits
are
capitalized
are
reserves.
8. Legislation:
Companies
are
highly
regulated.
They
are
required
to
comply
with
the
requirements
of
Company’s
ACT
as
well
as
Financial
Reporting
Standards.
ADVANTAGES
OF
OPERATING
AS
A
LIMITED
COMPANY:
1. The
liability
of
the
shareholders
is
limited.
Therefore,
in
case
of
company
going
bankrupt,
the
individual
assets
of
the
owners
will
not
be
used
to
meet
the
company’s
debts.
Only
shareholders
who
have
only
partly
paid
for
their
shares
can
be
forced
to
pay
the
balance
owing
on
the
shares,
but
nothing
else.
2. There
is
a
formal
separation
between
the
ownership
and
management
of
the
business.
This
helps
in
clearly
identifying
the
responsible
persons.
3. Ownership
is
vastly
shared
by
many
people,
hence
diversifying
risk,
and
funds
become
available
is
substantial
amounts.
4. Shares
in
the
business
can
be
transferred
relatively
easily.
DISADVANTAGES:
1. Formation
costs
are
normally
very
high.
2. Companies
are
highly
regulated.
3. Running
costs
are
also
very
high
i.e.
preparation
and
submission
of
annual
returns,
audit
fees
etc.
4. Profit
distribution
is
also
subject
to
some
restrictions.
Not
all
surpluses
from
the
business
transactions
can
be
distributed
back
to
the
shareholders.
5. Company
accounts
must
be
available
for
inspection
to
the
public.

22. There
are
two
types
of
limited
companies:
1. Public
limited
companies:
a-­‐ They
have
the
abbreviation
Plc
of
public
limited
company
at
the
end
of
their
names
b-­‐ Their
minimum
allotted
share
is
required
to
be
£50
000.
c-­‐ They
can
invite
the
general
public
to
subscribe
for
their
shares
d-­‐ Their
shares
may
be
traded
in
the
stock
exchange
i.e.
they
can
be
quoted
with
the
stock
exchange.
2. Private
limited
companies:
a-­‐ They
have
the
abbreviation
‘Ltd’
for
limited
at
the
end
of
their
names.
b-­‐ They
are
not
allowed
to
invite
general
public
for
the
subscription
of
their
share
capital.
COMPANY
FINANCE
As
is
a
case
with
sole
traders
and
partnerships,
companies
also
have
two
main
sources
of
finance,
namely;
capital
and
liabilities.
The
difference
is
on
naming
and
classification
of
these
terms.
When
the
company
is
formed,
it
normally
issues
shares
to
be
subscribed
by
the
potential
members.
People
who
subscribe
and
buy
company’s
shares
are
known
as
shareholders,
and
they
become
the
legal
owners
of
the
company
depending
in
the
proportion
and
type
of
shares
they
hold.
They
receive
dividends
as
return
on
their
invested
capital.
Dividends
are,
therefore,
appropriations
of
the
profits.
On
the
other
hand,
the
company
can
borrow
funds
from
other
people
who
are
not
owners.
The
main
form
of
company
borrowings
is
by
issuing
debenture,
which
is
a
written
acknowledgement
of
a
loan
to
a
company,
given
under
the
company’s
seal.
The
debenture
holders
are
not
owners
of
the
company
but
they
are
liabilities.
Debenture
holders
receive
a
fixed
percentage
of
interest
on
the
loan
amount.
Debenture
interest
is
a
business
expense,
which
must
be
paid
when
is
due.
Other
forms
of
borrowings
include
trade
creditors
and
bank
overdrafts.
The
difference
between
shareholders
and
debenture
holders
can
be
analyzed
in
terms
of:
1. Ownership;
and
2. Return
on
investment
(Debenture
holders
will
get
it
even
if
the
company
makes
losses)
SHARE
CAPITAL
Share
capital
is
normally
of
two
types:
1. Ordinary
share
capital;
and
2. Preference
share
capital

23. Their
difference
is
summarized
in
the
table
below:
Aspect
Ordinary
shares
Preference
shares
Voting
power
Carry
a
vote
Limited
or
no
voting
power
Dividends
1. Vary
between
one
year
to
another,
depending
on
the
profit
for
the
period.
2. Rank
after
preference
shareholders.
3. Not
cumulative.
1. Fixed
percentage
of
the
nominal
value.
2. Cumulative.
If
not
paid
in
the
year
of
low
or
no
profits,
it
is
carried
forward
to
the
next
years.
3. They
may
be
non-­‐cumulative.
Liquidation
(Company
closing
down)
Entitled
to
surplus
assets
on
liquidation,
after
all
liabilities
and
preference
shareholders
have
been
paid.
Whatever
is
left,
go
to
Ordinary
shareholders.
1. Priority
of
payment
before
ordinary
shareholders,
but
after
all
other
liabilities.
2. Not
entitled
to
surplus
assets
on
liquidation.
SHARE
CAPITAL
STRUCTURE
Authorized
share
capital:
the
maximum
share
capital
that
the
company
is
empowered
to
issue
per
its
memorandum
of
association.
It
is
sometimes
called
as
registered
capital.
Issued
share
capital:
The
total
nominal
value
of
share
capital
that
has
actually
been
issued
to
the
shareholders.
Called-­‐up
capital:
This
is
a
part
of
issued
capital
that
the
company
has
already
asked
the
shareholders
to
pay.
Normally
when
the
company
issues
shares,
it
does
not
require
its
shareholders
to
pay
the
full
price
on
spot.
Rather
it
calls
the
installments
from
time
to
time.
It
is
the
amount
that
is
included
in
the
balance
sheet.
Paid-­‐up
capital:
This
is
the
total
amount
of
the
money
already
collected
from
the
shareholders
to
date.
Dividend
is
paid
on
this.
Uncalled
capital:
This
is
the
part
of
issued
capital,
which
the
company
has
not
yet
requested
its
shareholders
to
pay
for.
Dividends:
According
to
the
new
law,
we
only
subtract
the
amount
of
dividends
paid
from
profit.
Dividends
which
are
announced
are
ignored.

24.
DEBENTURES
A
debenture
is
a
document
containing
details
of
a
loan
made
to
a
company.
The
loan
may
be
secured
on
the
assets
of
the
company,
when
it
is
known
as
a
mortgage
debenture.
If
the
security
for
the
loan
is
on
certain
specified
assets
of
the
company,
the
debenture
is
said
to
be
secured
by
a
fixed
charge
on
the
assets.
If
the
assets
are
not
specified,
but
the
security
is
on
the
assets
as
they
may
exist
from
time
to
time,
it
is
known
as
a
floating
charge
on
the
assets.
An
unsecured
debenture
is
known
as
a
simple
or
naked
debenture.
Debentures
holders
are
not
members
of
the
company
in
the
same
way
as
shareholders
are,
and
debentures
must
not
be
confused
with
the
share
capital
and
reserves
in
the
balance
sheet.

25. RESERVES
The
net
assets
of
the
company
are
represented
with
capital
and
reserves.
While
capital
represents
the
claim
that
owners
have
because
of
the
number
if
shares
they
own,
reserves
represent
the
claim
that
owners
have
because
of
the
wealth
created
by
the
company
over
the
years
but
not
distributed
to
them.
There
are
two
main
types
of
reserves:
Revenue
Reserve
The
reserves
which
arise
from
profit
(Trading
activities
of
the
company).
These
are
transferred
from
the
Appropriation
account.
Examples
include
General
Reserve
and
Retained
Profit
(Profit
and
Loss).
Dividends
can
only
be
paid
to
the
amount
of
revenue
reserve
on
the
balance
sheet.
i.e.
the
maximum
dividend
possible
is
the
sum
of
both
revenue
reserves.
Capital
Reserve
These
are
reserves
which
the
company
is
required
to
set
up
by
law
and
cannot
be
distributed
as
dividends.
They
normally
arise
out
of
capital
transactions.
These
include
Share
Premium
and
Revaluation
Reserve.
Share
Premium
Share
premium
occurs
when
a
company
issues
shares
at
a
price
above
its
nominal
(par)
value.
This
excess
of
share
price
over
nominal
value
is
what
is
known
as
share
premium.
What
are
the
uses
of
Share
Premium?
1. Issue
Bonus
Shares
2. Write
off
Formation
(Preliminary
Expenses)
3. Write
off
Goodwill.
What
are
the
different
Types
of
Preference
Shares?
1. Non-­‐cumulative
Preference
shares:
In
case
company
doesn’t
pay
enough
profits,
these
shareholders
will
get
no
dividends
in
the
year
and
that
amount
of
dividend
will
never
be
given.
2. Cumulative
Preference
Shares:
In
case
company
doesn’t
have
enough
profits,
these
shareholders
will
get
no
dividend
in
the
year
and
that
amount
of
dividend
will
be
carried
forward
to
next
year,
when
the
company
makes
enough
profit,
the
entire
amount
will
be
payable
as
dividend.
3. Participating
Preference
Shares:
These
shareholders
have
limited
voting
right,
i.e.
they
can
participate
in
the
decision
making.

26. STOCK
VALUATION
Remember
stock
is
valued
at
lower
of
cost
or
net
realisable
value
(N.R.V).
This
is
basically
the
current
market
value
of
the
stock
after
deducting
any
repair
cost.
This
is
application
of
the
prudence
concept.
E.g.
If
a
piece
of
stock
costing
$40
is
damaged.
Now
it
can
be
sold
for
$48
but
only
if
$10
of
repair
is
undertaken.
This
means
the
NRV
of
stock
is
38
(48
–
10).
Since
NRV
(38)
is
lower
than
the
cost
(40),
we
should
value
it
as
38.
It
lets
say
the
NRV
was
$41,
then
than
the
stock
would
have
been
valued
at
$40.
Assumptions
in
Stock
Valuations
FIFO
Advantages
1. Good
representation
of
sound
storekeeping
as
oldest
stock
is
issued
first.
2. Stock
is
shown
close
to
the
current
market
value
(because
it
is
valued
at
most
recent
price)
3. This
method
is
acceptable
by
accounting
regulations
Disadvantages
1. In
inflation
stock
is
valued
the
highest
and
it
overstates
profit
2. Since
the
value
of
stock
issued
fluctuates,
this
will
lead
to
a
different
cost
for
an
identical
unit.
LIFO
Advantages
1. In
inflation
stock
is
valued
at
the
lowest
and
it
understates
profit
(Prudence
concept)
2. Cost
of
goods
sold
is
close
to
the
current
market
value.
Disadvantages
1. Not
acceptable
by
accounting
regulations
2. Since
the
value
of
stock
issued
fluctuates,
this
will
lead
to
a
different
cost
for
an
identical
unit.
3. Closing
stock
is
not
valued
at
most
recent
price.
4. LIFO
periodic
is
unrealistic
AVCO
Advantages
1. Since
the
value
of
stock
issued
does
not
fluctuate,
this
will
lead
to
a
same
cost
for
an
identical
unit.
2. This
method
is
acceptable
by
accounting
regulations.
Disadvantages
1. Difficult
to
calculate.
2. Average
price
does
not
represents
the
true
value
of
stock

27. ACCOUNTING
CONCEPTS
TABLE/SUMMARY/SNAPSHOT
OF
ACCOUNTING
CONCEPTS/CONVENTION
Accounting
period
Concept
Also
known
as
Time
Period
where
business
operation
can
be
divided
into
specific
period
of
time
such
as
month,
a
quarter
or
a
year
(accounting
period)
Final
accounts
are
prepared
at
the
end
of
the
accounting
period,
i.e.
one
year.
Internal
accounts
can
be
prepared
monthly,
quarterly
or
half
yearly.
Accrual
Concept
/
Matching
Requires
all
revenues
and
expenses
to
be
taken
into
account
for
the
period
in
which
they
are
earned
and
incurred
when
determining
the
profit
/
(loss)
of
the
business.
The
net
profit
/
(loss)
is
the
difference
between
the
revenue
EARNED
and
the
expenses
INCURRED
and
not
the
difference
between
the
revenue
RECEIVED
and
expenses
PAID.
Business
Entity
Also
known
as
Accounting
Entity
convention
which
states
that
the
business
is
an
entity
or
body
separate
from
its
owner.
Therefore
business
records
should
be
separated
and
distinct
from
personal
records
of
business
owner.
Consistency
Concept
According
to
this
convention,
accounting
practices
should
remain
unchanged
from
one
period
to
another.
For
example,
if
depreciation
is
charged
on
fixed
assets
according
to
a
particular
method,
it
should
be
done
year
after
year.
This
is
necessary
for
purpose
of
comparison.
Dual
Aspect
Concept
Double
entry
system.
For
every
debit,
there
is
a
credit
entry
of
an
equal
amount.
Going
Concern
Concept
The
business
will
follow
accounting
concepts
and
methods
on
the
assumption
that
business
will
continue
its
operation
to
the
foreseeable
future
or
for
an
indefinite
period
of
time.
Historical
Cost
Concept
Business
should
report
its
activities
or
economic
events
at
their
actual
costs.
For
example,
fixed
assets
are
recorded
at
their
cost
in
account
except
for
land
which
can
be
revalued
due
to
appreciation

28.
Materiality
Concept
The
accountant
should
attach
importance
to
material
details
and
ignore
insignificant
details
otherwise
accounting
will
be
burdened
with
minute
details.
Only
items
that
are
deemed
significant
for
a
given
size
of
operation.
Money
Measurement
Concept
Also
known
as
Monetary
unit.
Transactions
related
to
the
business,
and
having
money
value
are
recorded
in
the
books
of
accounts.
Events
or
transactions
which
cannot
be
expressed
in
term
of
money
do
not
find
a
place
in
the
books
of
accounts.
Objectivity
and
Subjectivity
Objectivity
is
following
rules
of
the
industry
and
based
on
objective
evidence
and
subjectivity
is
to
follow
one’s
own
rules
and
methods.
Prudence
/
Conservatism
Concept
Take
into
account
unrealized
losses,
not
unrealized
profits/gains.
Assets
should
not
be
over-­‐valued,
liabilities
under-­‐valued.
Provisions
are
example
of
prudence
or
conservatism
concept.
Also
under
this
prudence/conservatism
concept,
stock/inventory
is
value
at
lower
of
cost
or
market
value.
This
concept
guides
accountants
to
choose
option
that
minimize
the
possibility
of
overstating
an
asset
or
income.
Substance
Over
Form
Real
substance
takes
over
legal
form
namely
we
consider
the
economic
or
accounting
point
of
view
rather
than
the
legal
point
of
view
in
recording
transactions.
Realization
Concept
Revenue
is
recognized
when
goods
are
sold
either
for
cash
or
credit
namely
the
debtor
accepts
the
goods
or
services
and
the
responsibility
to
pay
for
them.
RATIOS
PROFITABILITY
GROSS
PROFIT
MARGIN
(
Gross
Profit
x
100
)
Net
Sales
While
the
gross
profit
is
a
dollar
amount,
the
gross
profit
margin
is
expressed
as
a
percentage
of
net
sales.
The
Gross
Profit
Margin
illustrates
the
profit
a
company
makes
after
paying
off
its
Cost
of
Goods
sold.
The
Gross
Profit
Margin
shows
how
efficient
the
management
is
in
using
its
labour
and
raw
materials
in
the
process
of
production
(In
case
of
a
trader,
how
efficient
the
management
is
in
purchasing
the
good).
There
are
two
key
ways
for
you
to
improve
your
gross
profit
margin.
First,
you
can
increase
your
process.
Second,
you
can
decrease
the
costs
of
the
goods.
Once
you
calculate
the
gross
profit
margin
of
a
firm,
compare
it
with
industry
standards
or
with
the
ratio
of
last
year.
For
example,
it
does
not
make
sense
to
compare
the
profit
margin
of
a
software
company
(typically
90%)
with
that
of
an
airline
company
(5%).

29. Reasons
for
this
ratio
to
go
UP
(opposite
for
down)
1. Increase
in
selling
price
per
unit
2. Decrease
in
purchase
price
per
unit
due
to
lower
quality
of
goods
or
a
different
supplier.
3. Decrease
in
purchase
price
per
unit
due
to
bulk
(trade)
discounts.
4. Extensive
advertising
raising
sales
volume
(units)
along
with
selling
price.
5. Understatement
of
opening
stock.
6. Overstatement
of
closing
stock.
7. Decrease
in
carriage
inwards/Duties
(trading
expenses)
8. Change
in
Sales
Mix
(maybe
we
are
selling
some
new
products
which
give
a
higher
margin).
NET
PROFIT
MARGIN
(
Net
Profit
x
100
)
Net
Sales
Net
profit
margin
tells
you
exactly
how
the
management
and
operations
of
a
business
are
performing.
Net
Profit
Margin
compares
the
net
profit
of
a
firm
with
total
sales
achieved.
The
main
difference
between
GP
Margin
and
NP
Margin
are
the
overhead
expenses
(Expenses
and
loss).
In
some
businesses
Gross
Margin
is
very
high
but
Net
Margin
is
low
due
to
high
expenses,
e.g.
Software
Company
will
have
high
Research
expenses.
Reasons
for
this
ratio
to
go
UP
(opposite
for
down)
All
the
reasons
for
GP
margin
apply
here.
Additionally
1. Increase
in
cash
discounts
from
suppliers
2. A
decrease
in
overhead
expenses
3. Increase
in
other
incomes
like
gain
on
disposal,
Rent
Received
etc.
Return
on
Capital
Employed
(ROCE)
This
is
the
key
profitability
ratio
since
it
calculates
return
on
amount
invested
in
the
business.
If
this
ratio
is
high,
this
means
more
profitability
(In
exam
if
ROCE
is
higher
for
any
firm
it
is
better
than
the
other
firm
irrespective
of
GP
and
NP
Margin).
This
return
is
important
as
it
can
be
compared
to
other
businesses
and
potential
investment
or
even
the
Interest
rate
offered
by
the
bank.
If
ROCE
is
lower
than
the
bank
interest
then
the
owner
should
shoot
himself.
This
ratio
can
go
up
if
profits
increase
and
capital
employed
remains
the
same.
Also
if
Capital
employed
decreases,
this
ratio
might
go
up.
Operating
Profit_
x
100
Capital
Employed
Net
Profit
before
Interest
and
Tax

30. Return
on
Total
Assets
This
shows
how
much
profit
is
generated
on
total
assets
(Fixed
and
Current).
The
ratio
is
considered
and
indicator
of
how
effectively
a
company
is
using
its
assets
to
generate
profits.
Operating
Profit_
x
100
Total
Assets
Return
on
Shareholders’
Funds:
Since
all
the
capital
employed
is
not
provided
by
the
shareholders,
this
specifically
calculates
the
return
to
the
shareholders
(It’s
almost
the
same
thing
as
ROCE)
Net
Profit
after
Tax
x
100
Shareholders
Funds
O.S.C
+
P.S.C
+
RESERVES
NOTE:
Capital
Employed
=
Fixed
Assets
+
Current
Assets
–
Current
Liabilities
OR
=
Ordinary
Share
Capital
+
Preference
Share
Capital
+
Reserves
+
Long-­‐term
Liabilities
LIQUIDITY
AND
FINANCIAL
As
we
know
a
firm
has
to
have
different
liquidity.
In
other
words
they
have
to
be
able
to
meet
their
day
to
day
payments.
It
is
no
good
having
your
money
tied
up
or
invested
so
that
you
haven’t
enough
money
to
meet
your
bills!
Current
assets
and
liabilities
are
an
important
part
of
this
liquidity
and
so
to
measure
the
firms
liquidity
situation
we
can
work
out
a
ratio.
The
current
ratio
is
worked
out
by
dividing
the
current
assets
by
the
current
liabilities.
CURRENT
RATIO
=
Current
assets
_
Current
liabilities

31. The
figure
should
always
be
above
1
or
the
form
does
not
have
enough
assets
to
meet
its
liabilities
and
is
therefore
technically
insolvent.
However,
a
figure
close
to
1
would
be
a
little
close
for
a
firm
as
they
would
only
just
be
able
to
meet
their
liabilities
and
so
a
figure
of
between
1.5
and
2
is
generally
considered
being
desirable.
A
figure
of
2
means
that
they
can
meet
their
liabilities
twice
over
and
so
is
safe
for
them.
If
the
figure
is
any
bigger
than
this
then
the
firm
may
be
tying
too
much
of
their
money
in
a
form
that
is
not
earning
them
anything.
If
the
current
ratio
is
bigger
than
2
they
should
therefore
perhaps
consider
investing
some
for
a
longer
period
to
earn
them
more.
However,
the
current
assets
also
include
the
firm’s
stock.
If
the
firm
has
a
high
level
of
stock,
it
may
mean
one
of
the
two
things,
1. Sales
are
booming
and
they’re
producing
a
lot
to
keep
up
with
demand.
2. They
can’t
sell
all
they’re
producing
and
it’s
piling
up
in
the
warehouse!
If
the
second
of
these
is
true
then
stock
may
not
be
a
very
useful
current
asset,
and
even
if
they
could
sell
it
isn’t
as
liquid
as
cash
in
the
bank,
and
so
a
better
measure
of
liquidity
is
the
ACID
TEST
(or
QUICK)
RATIO.
This
excludes
stock
from
the
current
assets,
but
is
otherwise
the
same
as
the
current
ratio.
ACID
TEST
RATIO
=
Current
assets
–
stock
Current
liabilities
Ideally
this
figure
should
also
be
above
1
for
the
firm
to
be
comfortable.
That
would
mean
that
they
can
meet
all
their
liabilities
without
having
to
pay
any
of
their
stock.
This
would
make
potential
investors
feel
more
comfortable
about
their
liquidity.
If
the
figure
is
far
below
1,
they
may
begin
to
get
worried
about
their
firm’s
ability
to
meet
its
debts.
Rate
of
Stock
Turnover
It
shows
the
number
of
times,
on
average,
that
the
business
will
sell
its
stock
in
a
given
period
of
time.
It
basically
gives
an
indication
of
how
well
the
stock
has
been
managed.
A
high
ratio
is
desirable
because
the
quicker
the
stock
is
turned
over,
more
profit
can
be
generated.
A
low
ratio
indicates
that
stocks
are
kept
for
a
longer
period
of
time
(which
is
not
good).
Cost
of
Goods
Sold
=
____
Times
Average
Stock

32. Stock
Days:
This
is
Rate
of
stock
turnover
in
days.
Lower
the
better.
Average
Stock
x
365
=
____
Days
Cost
of
Goods
Sold
Debtor
Days:
Shows
how
long
it
takes
on
average
to
recover
the
money
from
debtors.
Lower
the
better.
Average
Debtors
x
365
=
____
Days
Credit
Sales
Creditor
Days:
(Creditor
Payment
Period)
Shows
how
long
it
takes
on
average
to
payback
the
creditors.
Higher
the
better.
Average
Creditors
x
365
=
____
Days
Credit
Purchases
Working
Capital
Cycle:
(Only
for
MCQ).
(Lower
the
better)
Stock
Days
+
Debtor
Days
–
Creditor
Days
=
____
Days
Note:
Average
Stock
=
Opening
+
Closing
2
Utilization
Ratios
(All
higher
the
better)
Total
Asset
utilization
(Total
Asset
Turnover)
Shows
how
much
sales
are
being
generated
on
Total
Assets.
Higher
ratio
indicates
better
utilization
of
Total
Assets.
Net
Sales
=
____
Times
Total
Assets

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

34.
At
the
end
of
your
answer,
always
give
a
conclusion
• When
comparing
a
single
firm
over
two
years
then
do
mention
performance
of
which
year
is
better.
(In
terms
of
profitability
and
liquidity)
• When
comparing
two
different
firms
over
the
same
year
do
mention
performance
of
which
firm
is
better.
(In
terms
of
profitability
and
liquidity).
If
the
question
says
evaluate
profitability
then
use
(GP
Margin,
NP
Margin
and
ROCE)
If
the
question
says
evaluate
liquidity,
use
(Current
Ratio,
Acid
Test
and
Rate
of
Stock
Turnover)
If
the
question
says
evaluate
the
performance
it
means
both
profitability
and
liquidity.
Best
ways:
3
–
Profitability
2
–
Liquidity
&
1
–
Utilization