Beruflich Dokumente
Kultur Dokumente
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
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withdrawn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
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,
its
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.
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
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
doesnt
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)
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.
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.
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
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)
To
adjust
Incomes:
Prepaid:
Owing/Due
Debit:
Income
(as
the
income
reduces
because
its
prepaid)
Credit:
Prepaid
Income
(because
its
a
current
liability)
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.
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
doesnt
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),
dont
memorize
the
formula,
its
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
dont)
2. Purchase
ledger
control
account
3. Bank
account
(if
it
is
already
given
in
the
question,
then
its
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.
Dont
panic
if
it
doesnt
balance,
because
marks
are
for
working.
Dont
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.
Dont
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
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
But
if
Sales
=
80000
Cost
=
?
Markup
=25%
Sales
Cost
=
Profit
80000-
x
=
25
%
of
X
Cost
=
64000
TERMINOLOGY
DIFFERENCE
Non-profit
organizations
Receipts
and
Payments
Account
Income
and
Expenditure
Account
Surplus
Deficit
Accumulated
Funds
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)
-
-
-
-
-
Gain
on
disposal.
Interest
on
deposit
account
or
investment
account.
Profits
from
different
events
(say
Dinner
dance)
Life
Subscription
(dont
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
It
considers
only
revenue
incomes
and
capital
receipts,
e.g.
Long
term
donations
and
all
expenditure.
type
of
money
going
out,
e.g.
Purchase
of
fixed
asset
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,
lets
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.
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.
Additional
capital
from
other
partners,
and
also
easier
to
get
loans.
Additional
expertise.
Additional
management
time.
Risk
(losses)
is
shared.
LIMITED
COMPANIES
Limited
companies
are
business
organizations,
whose
owners
liabilities
are
limited
to
their
capital
contributed
or
guarantees
made.
2. Limited
liability:
3. Perpetual
succession:
4.
5.
6.
7.
8.
Number
of
members:
Capital:
Profit
distribution:
Retained
profits:
Legislation:
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.
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
companys
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
companys
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
Preference
shares
Limited
or
no
voting
power
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.
1. Priority
of
payment
before
ordinary
shareholders,
but
after
all
other
liabilities.
2. Not
entitled
to
surplus
assets
on
liquidation.
Issued
share
capital:
Called-up
capital:
Paid-up
capital:
Uncalled
capital:
Dividends:
the
maximum
share
capital
that
the
company
is
empowered
to
issue
per
its
memorandum
of
association.
It
is
sometimes
called
as
registered
capital.
The
total
nominal
value
of
share
capital
that
has
actually
been
issued
to
the
shareholders.
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.
This
is
the
total
amount
of
the
money
already
collected
from
the
shareholders
to
date.
Dividend
is
paid
on
this.
This
is
the
part
of
issued
capital,
which
the
company
has
not
yet
requested
its
shareholders
to
pay
for.
According
to
the
new
law,
we
only
subtract
the
amount
of
dividends
paid
from
profit.
Dividends
which
are
announced
are
ignored.
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.
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.
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.
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
ACCOUNTING
CONCEPTS
Accrual
Concept
/
Matching
Business
Entity
Consistency
Concept
Dual
Aspect
Concept
Going
Concern
Concept
Historical
Cost
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.
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.
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.
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.
Double
entry
system.
For
every
debit,
there
is
a
credit
entry
of
an
equal
amount.
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.
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
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
Also
known
as
Monetary
unit.
Transactions
related
to
the
Concept
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
Objectivity
is
following
rules
of
the
industry
and
based
on
Subjectivity
objective
evidence
and
subjectivity
is
to
follow
ones
own
rules
and
methods.
Prudence
/
Conservatism
Take
into
account
unrealized
losses,
not
unrealized
profits/gains.
Assets
should
not
be
over-valued,
liabilities
under-valued.
Concept
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
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%).
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.
Operating
Profit_
Capital
Employed
100
Operating
Profit_
Total
Assets
100
100
NOTE:
Capital
Employed
=
Fixed
Assets
+
Current
Assets
Current
Liabilities
OR
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
havent
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
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
firms
stock.
If
the
firm
has
a
high
level
of
stock,
it
may
mean
one
of
the
two
things,
1. Sales
are
booming
and
theyre
producing
a
lot
to
keep
up
with
demand.
2. They
cant
sell
all
theyre
producing
and
its
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
isnt
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.
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
firms
ability
to
meet
its
debts.
____ Times
Stock
Days:
This
is
Rate
of
stock
turnover
in
days.
Lower
the
better.
____ Days
Debtor
Days:
Shows
how
long
it
takes
on
average
to
recover
the
money
from
debtors.
Lower
the
better.
____ Days
____ Days
____ Days
Note:
Average
Stock
Opening
+
Closing
2
Net Sales
Total Assets
____ Times
Net Sales
Fixed Assets
____ Times
Net Sales
Working Capital
____ Times
Advantages
of
Ratios
1.
2.
3.
4.
Shows
a
trend
Helps
to
compare
a
single
firm
over
a
two
years
(time
series)
Helps
to
compare
to
similar
firms
over
a
particular
year.
Helps
in
making
decisions
Disadvantages
(Limitations):
1.
2.
3.
4.
5.
6.
7.
8.
A
ratio
on
its
own
is
isolated
(We
need
to
compare
it
with
some
figures)
Depends
upon
the
reliability
of
the
information
from
which
ratios
are
calculated.
Different
industries
will
have
different
ideal
ratios.
Different
companies
have
different
accounting
policies.
E.g.
Method
of
depreciation
used.
Ratios
do
not
take
inflation
into
account.
Ratios
can
ever
simplify
a
situation
so
can
be
misleading.
Outside
influences
can
affect
ratios
e.g.
world
economy,
trade
cycles.
After
calculating
ratios
we
still
have
to
analyze
them
in
order
to
derive
a
conclusion.
How
to
Comment:
Usually
in
CIE
they
assign
2
marks
for
comment
on
each
ratio.
One
mark
is
for
indicating
if
the
ratio
is
better
or
worse
(not
higher
or
lower).
The
second
mark
is
to
explain
the
importance
or
the
reason
of
the
change
in
ratio.
For
e.g.
If
Gross
Profit
Margin
was
40%
and
now
its
50%,
you
should
say
that
the
Gross
profit
Margin
has
improved
(rather
than
increased)
and
this
may
be
due
to
an
increase
in
selling
price
or
a
decrease
in
cost
of
goods
sold
(depending
upon
the
question).
Also
remember
that
the
liquidity
and
utilization
ratios
should
be
close
to
industry
average.
Too
less
or
too
much
liquidity
is
bad!
At
the
end
of
your
answer,
always
give
a
conclusion
When
comparing
a
single
firm
over
two
years
then
do
mention
performance
of
which
year
is
better.
(In
terms
of
profitability
and
liquidity)
When
comparing
two
different
firms
over
the
same
year
do
mention
performance
of
which
firm
is
better.
(In
terms
of
profitability
and
liquidity).
If
the
question
says
evaluate
profitability
then
use
(GP
Margin,
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
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
In
trading
account
we
show
stock
of
finished
goods
at
transfer
value.
In
balance
sheet,
they
should
be
recorded
at
cost.
Indirect
Material,
Indirect
Labour,
Depreciation
of
plant
and
machinery
will
always
be
Factory
Overheads.
Administration
and
selling
goes
in
the
profit
and
loss
account.
Net
Assets
=
Assets
Liabilities,
but
in
some
cases
CIE
uses
Net
Assets
as
Capital
Employed
which
is
Assets
Current
Liabilities.
Sale
or
Purchase
is
recorded
when
the
goods
are
accepted
not
when
the
invoice
is
sent
or
the
payment
is
made.
If
only
net
book
values
are
available
Depreciation
for
the
year
=
Opening
Net
Book
Value
+
Purchase
of
Asset
Sale
of
Asset
(Nbv)
Closing
Net
book
value.
In
most
question
they
dont
mention
depreciation,
that
doesnt
mean
there
is
no
depreciation,
use
the
above
formula
to
determine.
(Dont
forget
the
depreciation
like
idiots).
Accumulated
funds
at
start
or
Capital
at
start
=
Opening
Asset
Opening
Liabilities
(please
dont
forget
the
opening
balance
of
bank
account).
Cash
banked
will
come
on
the
debit
side
of
bank
and
credit
side
of
cash
account.
Subscription
owing
is
an
asset
and
prepaid
is
a
liability.
Loan
is
as
long
term
liability
unless
payable
within
one
year.
If
nothing
is
written,
assume
long
term.
POOP
is
for
expenses.
OPPO
is
for
incomes.
Net
realizable
value
=
current
selling
price
any
expenses
(repairs)
We
always
ignore
replacement
cost
in
stock
valuation.
Perpetual
methods
are
those
where
we
make
a
table.
Markup
is
on
cost
(cost
is
100)
Margin
is
on
sales
(Sales
is
100)
EXAM
TIPS
PAPER
1
You
have
60
minutes
of
30
mcqs.
2
minutes
for
each.
First
only
attempt
those
questions
which
you
are
100%
sure
of
and
skip
others.
Read
the
MCQ
carefully,
because
CIE
likes
to
play
around.
Now
spend
time
on
these
questions.
If
you
are
stuck
try
to
eliminate
the
most
obvious
wrong
answer.
5-6
questions
are
theoretical,
at
least
read
them
thrice.
Sometimes
its
best
to
use
the
answer
to
check
if
its
wrong
or
right.
If
you
see
something
in
the
answer
choice
which
you
havent
heard
of
(that
can
never
be
the
answer).
Please
dont
leave
it
blank.
Take
an
educated
guess.
There
is
no
negative
marking.
PAPER
2
Always
attempt
the
question
which
you
know
the
best
out
of
all.
This
will
give
you
confidence
and
save
time.
You
will
end
up
spending
time
and
getting
it
wrong
if
you
do
the
toughest
one
first.
Dont
panic,
usually
in
every
paper
one
question
is
tricky.
Do
it
at
last.
You
wont
get
any
award
if
you
balance
the
balance
sheet.
If
the
balance
sheet
is
off
by
a
large
amount,
that
doesnt
mean
everything
is
wrong,
might
be
a
single
big
figure
which
you
have
missed.
DONT
WASTE
YOUR
TIME.
Remember
you
dont
have
to
get
90
on
90.
Go
for
the
maximum.