Course Notes

Accounts Preparation
Level 3
Course Notes
For exams in 2015/16
ISBN 9781 4727 8410 0
Chapter 1: Tax implications
ISBN 9781 4727 8410 0
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CONTENTS
Page
Introduction to the course
Skills bank
13
Topic: Accounting principles and concepts
1. Accounting principles
25
2. Accounting concepts
55
Topic: Purchase of non-current assets
3. Purchase of non-current assets
67
ACHIEVEMENT LADDER STEP 1
81
Topic: Depreciation of non-current assets
4. Depreciation of non-current assets
83
Topic: Disposal of non-current assets
5. Disposal of non-current assets
103
131
Topic: Accruals and prepayments
6. Accruals and prepayments
133
Topic: Inventories
7. Inventories
161
175
Contents
Topic: Irrecoverable and doubtful debts
8. Irrecoverable and doubtful debts
177
Topic: Bank and control account reconciliations
9. Bank reconciliations
199
10. Control account reconciliations
217
239
Topic: The trial balance, errors and the suspense account
11. The trial balance, errors and the suspense

account
241
Topic: The extended trial balance
12. The extended trial balance
259
275
277
Glossary of terms
279
Prepare for and book your CBT!

You should plan to sit your CBT within a couple of weeks of finishing ALL phases of the
study programme whilst your knowledge is still fresh. In preparation for the CBT, you
must attempt Step 6 of the Achievement Ladder as check that you are exam ready.
Contents
INTRODUCTION TO THE COURSE

Purpose
Accounts Preparation is designed to develop basic double entry bookkeeping skills and
knowledge, such as that acquired in the level 2 units, Processing bookkeeping
transactions and Control accounts, journals and the banking system.
Candidates will deal with more advanced and complex situations such as those needed
for preparing final accounts. It consolidates learning at level 2 and introduces new areas
such as accounting for non-current assets and using the extended trial balance.
The logical progression from Accounts Preparation is to Prepare final accounts for sole
traders and partnerships which deals with final accounts, but the sequence in which the
units are taken is not mandatory. After completion of both level 3 accounting units,
candidates will be ready to start developing skills and knowledge for the level 4 unit,
Financial Statements.
Terminology
Students should be familiar with international terminology.
Learning objectives
On successful completion of this paper, candidates should be able to:
1.
Record and account for non-current assets. Candidates will be able to record both
the purchase and disposal of a non-current asset, identifying any gains or losses
made on disposal and be able to calculate and apply depreciation by a given
method.
2.
Demonstrate an appropriate understanding of the principles that lie behind

accounting procedures, including an awareness of the accounting systems that
must be in place in order to produce meaningful information at the end of an
accounting period. Candidates should also develop an understanding of the
environment and principles within which the business operates.
Candidates must already have an understanding of double entry bookkeeping

including using ledger accounts and the journal.
These skills will be developed into more advanced and complex areas, including
adjustments for closing inventory, accrued and prepaid expenses and income, and how
these are incorporated into an extended trial balance.
Provisions for depreciation on non-current assets, irrecoverable debts and allowances for
doubtful debts are also to be calculated and accounted for.
LEARNING OUTCOMES
Assessment Criteria
1.
Understand generally accepted accounting principles

and concepts
1.1 K
Explain the accounting principles of going concern,

accruals, prudence and consistency
Accounting concepts
1.2 K
Explain the purpose of maintaining financial records

for internal and external use
Accounting principles
1.3 K
Describe the types of accounting records that a

business should maintain and the main uses of
each
1.4 K
Describe the main requirements of accounting

standards (IFRS) in relation to inventory and noncurrent asset valuations
1.5 K
Explain the accounting characteristics of relevance,

reliability, comparability, ease of understanding and
materiality
1.6 K
Explain the differences between capital and

revenue expenditure, classifying items as one or
the other
2.
Chapter ref
Purchase of noncurrent assets and

Inventories
Accounting concepts
Purchase of noncurrent assets
Understand the principles of double entry

bookkeeping
2.1 K
Explain the accounting equation
2.2 K
Define assets, liabilities and equity in an accounting

context
2.3 K
Explain the purpose and use of books of prime

entry and ledger accounts
2.4 K
Explain the purpose of reconciling the sales and

purchases ledgers, and the cash book
Bank reconciliations
and Control account
reconciliation
3.
Understand the accounting methods used to record

non-current assets
3.1 K
Describe how the acquisition of non-current assets

can be funded, including part exchange
3.2 K
Explain the accounting treatment for recording the

acquisition and disposal of non-current assets
3.3 K
Explain the need for, and methods of, providing for

depreciation on non-current assets
Disposal of noncurrent assets
3.4 K
Describe the contents and use of the non-current

assets register
3.5 K
Resolve any queries, unusual features or

discrepancies relating to the accounting records for
non-current assets or refer to an appropriate person
4.
Account for the purchase of non-current assets
4.1 S
Calculate total capital expenditure including all

associated costs
4.2 S
Record prior authority for the capital expenditure
4.3 S
Record in the appropriate accounts the acquisition

of a non-current asset including funded by/part
exchange
4.4 S
Record the acquisition in a non-current assets

register
4.5 S
Close off or transfer the ledger account balances at

the end of the financial period
5.
Account for depreciation
5.1 S
Calculate the depreciation charges for a noncurrent asset using the:
Straight line method
Diminishing balance method
5.2 S
Record the depreciation in the non-current assets

register
5.3 S
Record depreciation in the appropriate ledger

accounts
Depreciation of noncurrent assets
5.4 S
Close off the ledger accounts at the end of the

financial period, correctly identifying any transfers
to the statement of profit or loss
6.
6.1 S
Identify the correct asset, removing it from the

non-current assets register
Disposal of non-current
assets
6.2 S
Record the disposal of non-current assets in the

appropriate accounts
assets
6.3 S
Calculate any gain or loss arising from the

disposal, closing off or transferring the account
balance
assets
7.
Account for the disposal of non-current assets
Account for adjustments
7.1 K
Explain the accounting treatment of accruals and

prepayments to expenses and revenue
Accruals and
prepayments
7.2 K
Explain the reasons for, and method of,

accounting for irrecoverable debts and allowances
for doubtful debts
Irrecoverable and
doubtful debts
7.3 S
Record the journal entries for closing inventory
7.4 S
Record the journal entries for accrued and

prepaid expenses and income
7.5 S
Record the journal entries for provision for

depreciation, irrecoverable debts and allowances
for doubtful debts
7.6 S
Record the journal entries to close off revenue

accounts in preparation for the transfer of
balances to the final accounts
Inventories
Accruals and
prepayments
Depreciation of noncurrent assets and
Irrecoverable and
doubtful debts
Various
8.
Prepare and extend the trial balance
8.1 S
Prepare ledger account balances; reconciling

them, identifying any discrepancies and taking
appropriate action
Bank reconciliations and

Control account
reconciliation
8.2 S
Prepare a trial balance
The trial balance, errors

and the suspense
account and The
extended trial balance
8.3 S
Account for these adjustments:

Closing inventory
Accruals and prepayments to expenses and
income
Provisions for depreciation on non-current
assets
Irrecoverable debts
Allowance for doubtful debts
8.4 S
Prepare the trial balance after adjustments
8.5 S
Check for errors and/or inaccuracies in the trial

balance, taking appropriate action
Various
The extended trial

balance
The trial balance, errors
and the suspense
account
COMPUTER-BASED TEST FORMAT

Computer-based test
2 hours duration
Competency is 70%
Your exam will consist of 6 tasks.

Task
Task 1
Expected Content
Non-current asset register
Max
marks
18 marks
Non-current
assets chapters
17 marks
Non-current
assets chapters
16 marks
Accruals and
prepayments
19 marks
The trial balance,

errors and the
suspense
account / Bank
reconciliations /
Control account
reconciliations
Complete an extract from a non-current

asset register, including:
Task 2
Any acquisitions
Any disposals
Depreciation
Ledger account for non-current assets

This may include entries to record:
Task 3
Chapter Ref
Acquisitions
Disposals
Depreciation
Differentiating between capital and
revenue expenditure
Accounting for accruals and

prepayments of income and expenses
This may include entries to record:
Task 4
Accrued and prepaid income

Accrued and prepaid expenses
Trial balance and reconciliations

Likely to be 2 requirements in which you are
asked to:
(a)
(b)
10
Complete an extract of a trial balance

Perform a reconciliation and process
adjustments where necessary (for
example, reviewing the bank
statement and updating the cash
book)
Study
complete
Task
Task 5
Expected Content
Accounting adjustments in an extended
trial balance or journals
Max
marks
20 marks
The trial balance,

errors and the
suspense
account
20 marks
The extended
trial balance
You may be asked to:
Task 6
Remove any incorrect entries

Post the correct entries
Extend the trial balance (ETB) and

knowledge of good accounting practice
Extend the figures from the ledger

balance and adjustment columns of an
ETB to the statement of profit or loss
and statement of financial position
columns
Show knowledge of the accounting
framework, accounting equation,
records and standards
Chapter Ref
Study
complete
All chapters
Remember to book your CBT!

For UK Centres call 0845 0751100
The AAT exams do not have a specific 'pass mark' but rather students must be deemed
'competent' in order to be successful in the CBT. For this purpose the competency level
is set at 70%.
Note, however, that following completion of the exam, students will not receive an actual
percentage mark; they will simply be deemed competent or not competent.
The rules on entering negative numbers will be given in the exam instructions at the
start of the Accounts Preparation CBT. At present, both minus signs and brackets can be
used to enter negative numbers, unless task instructions say otherwise.
The rate of VAT used in AAT assessments is 20%. Where relevant, this rate has been
used in the course material.
11
12
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13
1
SKILL 1 LEARNING AND APPLYING THE

SYLLABUS THEORY
What do I need to know to do well in the exam?
Accounts Preparation is the first of two financial accounting assessments at level three.
It follows on from the level 2 accounting papers (Processing bookkeeping transactions
(PBJT) and Control accounts, journals and the banking system (CJBS)) which introduced
you to double entry bookkeeping. It is designed to test more complex accounting
transactions and adjustments which are necessary for a business to produce its final
accounts.
It is examined via a computer based exam and will test areas such as:
Non-current assets (additions, depreciation and disposals)

Accruals and prepayments
Inventory
Irrecoverable and doubtful debts
Bank and control account reconciliations
The correction of errors and suspense accounts
The trial balance and the extended trial balance.
This is quite a broad syllabus and although some of these topics were included in your
level 2 studies, there are also new topics to master.
There are therefore two key factors to gaining competency in the Accounts
Preparation exam:
Being confident in the topics previously studied in the level 2 accounting papers
and
Testing your understanding of the knowledge taught through question practice.
Assumed knowledge from Level 2

The following topics were studied in PBKT and CJBS and are still relevant in Accounts
Preparation:
Double entry bookkeeping Accounts Preparation is still largely a test of your

double entry skills albeit set in the context of slightly more complex accounting
transactions. There will be some time spent recapping double entry during the
course but it is imperative that you brush up on these skills if you are a little rusty,
contacting your tutor as necessary.
Irrecoverable debts this area is revisited and extended to include doubtful

debts.
Bank and control account reconciliations control account reconciliations can

be a difficult topic to get to grips with and so this area will be taught from first
principles.
The correction of errors and suspense accounts this is another area which
may have caused difficulties in your previous studies and it will be covered in
detail.
You can see from the list above that we will be covering these areas again. The most
important thing though, is to consolidate your understanding of double entry
bookkeeping.
14
Skills bank
Question practice
Knowledge is important. For example you need to know that inventory is valued at the
lower of cost and net realisable value and also why this is the case.
However, it is more important to be able to apply this knowledge to the information
presented in each task.
There are two main ways to help you learn the facts:
1.
Use the overview summary diagrams at the end of each chapter as a base for
brainstorming the contents of the chapter. Ask yourself what you can remember
about that stage of your studies. Add some notes to help you remember the key
facts.
2.
Question practice! Practising questions will hopefully give you confidence about
what you do know and what you have understood during your studies but it will
also identify areas where your understanding needs to be improved.
Keep a list of areas where you are getting questions wrong and see if you can
identify a common lack of understanding. Remember to make use of the online
my.bpp.com platform resources as well as your tutor to improve your
understanding of areas where you are weaker.
Being able to apply your understanding to exam style questions is the skill that will make
the difference between gaining competency or not in the exam.
During your studies, you must gradually build up your exposure to exam standard
questions so that you can become flexible and able to deal with whatever questions you
see in your exam.
Skills bank
15
Introduction to the exam

The question practice will prepare you for the format of tasks you will see in the
Accounts Preparation CBT. It is also useful to familiarise yourself with the introductory
information you may be given at the start of the exam. For example:
Each task is independent. You will not need to refer to your answers to
previous tasks. Read every task carefully to make sure you understand
what is required.
Where the date is relevant, it is given in the task data.
Both minus signs and brackets can be used to indicate negative numbers
UNLESS task instructions say otherwise.
The standard rate of VAT is 20%.
You must use a full stop to indicate a decimal point. For example, write
100.57 NOT 100,57 OR 100 57
You may use a comma to indicate a number in the thousands, but you dont
have to. For example, 10000 and 10,000 are both OK.
Other indicators are not compatible with the computer-marked system.
Complete all 6 tasks.
SKILLS PRACTICE
Learn the content of the syllabus actively and then practise applying it by:
16
1.
Revising double entry.
2.
Using the overview summary diagrams to brainstorm each topic area.
3.
Practise as many questions as you can, and use them to identify any weaknesses
in your understanding and take action to resolve them.
Skills bank
SKILL 2 LOGICAL APPROACH TO QUESTIONS

The Accounts Preparation exam will comprise several different tasks in order to test your
understanding of the syllabus. Whilst there are many different tasks, most questions will
follow one of a number of standard formats.
The types of questions you should expect to see will include:
Completing a sentence/definition
Ticking a box to identify a correct option or definition or to indicate whether a

statement is true or false
Calculating a specific number
Completing a nominal ledger (T) account
Completing a journal entry
Completing a trial balance/extended trial balance
There are different skills required to answer each of these types of questions, although
there is also some overlap.
It is important that you practise as many questions as you can in order to familiarise
yourself with the approach to each of these different types of questions.
Completing a sentence/definition
Here you will need to complete a sentence and/ or definition by selecting the appropriate
wording from a list of options.
These options would be presented in a drop down box and would be presented in
alphabetical order.
For example, the following question appears in the Accounts Preparation Practice Paper I
(Task 3 (a)):
(a) Complete the following statement:
On 01/01/X6, the commission receivable account shows a debit /
credit balance of 2,400.
The best approach to these questions is to read the entire sentence at least two or three
times and decide what narrative you would expect to use to make the sentence make
sense. Then search for these options in the list provided.
If the options you had hoped for are not in the list provided, then go back and reread the
sentence once more. You may then need to consider each of the options in turn until
you arrive at a sentence which firstly makes sense and secondly is technically accurate.
Ticking a box
These tasks will often provide you with a question or statement and will then give you a
list of options. You may need to decide which of these options best answers the
question or statement and denote this by placing a tick in the relevant box. The
question may however be asking which statements are true or false in which case you
need to place a tick against each option in either the true column or the false column.
Skills bank
17
For example, the following question appears in the Accounts Preparation Practice Paper 1
(Task 2 (c)):
(c) Which is the additional cost to be recorded as capital
expenditure? Choose ONE answer.
Tick
Nil
430
650
820
Here you should read the initial sentence and think of an answer in your own mind, then
read through the list of options to:
1.
Locate the correct answer
2.
Check the other answers
3.
Read the question again
4.
Confirm that you have the correct answer
Calculating a specific number, completing a trial balance/

extended trial balance gapfill questions
Some questions will require you to calculate a specific number based on facts given in
the scenario.
For example, the following question appears in the Accounts Preparation Practice Paper 1
(Task 3 (b)):
(b) Calculate the commission receivables for the year ended
31/03/X7.
Gapfill
As with all numerical questions, it is important that you set out a proper working to
calculate the answer in order to avoid making unnecessary mistakes.
Even though the exam is a computer based assessment, there will be rough working
paper available on which you can carry out calculations.
Note the instructions regarding the use of commas when entering numbers in the CBT.
The current information given in the introduction to the AP exam says 'You may use a
comma to indicate a number in thousands, but you dont have to. For example, 10000
and 10,000 are both OK. Other indicators are not compatible with the computer-marked
system.'
Tasks which require you to produce a trial balance or extended trial balance require the
same technique. You will be given a proforma for the trial balance or extended trial
balance and will need to insert the relevant number.
18
Skills bank
This example is taken from the Accounts Preparation Practice Paper 1 (Task 4):
Using all the information given above and the figures given in the
table below, enter amounts in the appropriate trial balance columns
for the accounts shown.
Do NOT enter zeros in unused column cells.
figures as negatives.
Do NOT enter any
Extract from the trial balance as at 31 March 20X7:

Ledger
balance
Account
Dr
Cr
Accrued income
Gapfill
Gapfill
Bank
Gapfill
Gapfill
Gapfill
Gapfill
Internet and telephone costs
Gapfill
Gapfill
Irrecoverable debts
Gapfill
Gapfill
50
Gapfill
Gapfill
2,000
Gapfill
Gapfill
Prepaid expenses
Gapfill
Gapfill
VAT
Gapfill
Gapfill
Vending machine income
Gapfill
Gapfill
Drawings
Loan interest received

Loan receivable
Trial balance
26,000
Completing nominal ledger (T) accounts and journals picklist and gapfill questions
Many of the tasks in your exam will require you either to complete a nominal ledger (T)
account or a journal.
This might be to record the transactions in the scenario in (for example) the sales ledger
control account or an expense account or a journal to correct an error and therefore
eliminate a suspense account.
Here as well as providing you with the scenario information, the computer based exam
will give you a proforma for your answer.
Skills bank
19
For example, in terms of completing T accounts, the following question appears in the
Accounts Preparation Practice Paper (Task 3 (c)):
The cashbook for the year shows payments for administration
expenses of 12,580.
(c) Update the administration expenses account for this, showing
clearly the balance to be carried down.
Administration expenses
Picklist
Gapfill
Accrued expenses b/d
Picklist
Gapfill
Picklist
Gapfill
Picklist
Gapfill
Picklist
Gapfill
Autofill
1,990
Autofill
And looking at recording a journal, the following question appears in the Accounts
Preparation Practice Paper (Task 5(a)):
(a) Travel expenses of 620 have been posted to the vehicle cost
account in error. The other side of the entry is correct.
Journal
Dr
Cr
Picklist
Gapfill
Gapfill
Picklist
Gapfill
Gapfill
'Picklists'
You will need to choose the narrative for your answer (usually the account name) from a
list of narratives, known as a picklist.
This will take the form of a drop down menu of options and you need to click on the
correct narrative to answer the question. The list will be in alphabetical order and one of
the options will contain the correct answer.
Make sure you click on the answer you believe is correct. Dont let the mouse or cursor
slip onto a different answer by mistake!
As before, if you know the answer to a question you should:
1.
2.
3.
4.
Locate the correct answer

Check the other answers
Read the question again
Confirm that you have the correct answer
This systematic check will ensure that you do not throw away marks when you really do
know the answer.
20
Skills bank
Picklist questions beware the distracters

The majority of narrative questions will have more than one possible answer one
correct answer and several incorrect but seemingly plausible answers.
The incorrect answers are known as distracters and they are not random
narratives! the examiner goes to great lengths to produce distracters that represent
the answers that students will arrive at if they go slightly wrong in their calculations. You
need to develop a sound technique that means you do not fall into this trap!
What you SHOULD do
You must concentrate and read questions carefully to ensure that you know exactly that
it is asking for.
If the answer you arrive at is amongst the available options, just take a moment to check
that youve answered the question properly, and have not fallen for one of the
examiners distracters.
If your answer is not amongst the available options then you must have misunderstood
the question. Read the question again carefully and see if you have missed anything, or
if there are any clues that will allow you to eliminate any wrong answers. Remember to
guess if all else fails!
SKILLS PRACTICE
1.
Practise as many exam style questions as possible.
2.
Be very logical in your approach to the questions. Apply the relevant approach
outlined above.
3.
If you dont know the answer to a question dont just go to the answer at the
back or just guess set up a working for a calculation or work by process of
elimination for narrative questions.
Skills bank
21
SKILL 3 EFFECTIVE USE OF YOUR TIME IN THE

EXAM
It is important that you use your time wisely in the exam itself.
Before the Exam

In order to start the exam in the best frame of mind, you should ensure that you are
practically prepared.
STEP
1
STEP
Before the exam

Make sure that you are registered with the AAT and that your exam
centre has your exam booking. This is important because you cannot sit the
exam if you are not a registered student.
At the beginning of the exam
You want to make the start of the exam as stress free as possible so ensure
you have the following available:
Photo identification and your student number

Paper, pens and a calculator
Details of which exam you are planning to sit
Exam approach
What you SHOULD NOT do
Panic! For many questions you will get the answer straight away and so you are likely to
have a bit more time to think about some of the others. The examiner has commented
that a number of students struggle with the exam because they rush through the
questions to avoid running out of time, and make mistakes as a result.
What you SHOULD do
It is important to start the exam positively and keep focused to maximise the use of your
time.
STEP
Work through tasks systematically

Start at Task 1 and work through the questions in order.
If you find a question that you dont know the answer to go onto the next
question. Flag any unanswered questions by selecting the 'Flag
Question' option so that you can come back to them at the end.
Overall, try not to jump around tasks as you risk leaving some
unanswered.
22
Skills bank
STEP
Monitor your time

Do a quick check after each half hour to assess how well you are managing
your time.
It may be necessary to move on more quickly from questions that you are
struggling with so you get a chance to make a considered attempt at all of
the questions.
STEP
Check your solutions before the end of the exam

Having gone through the assessment once you should:
1.
2.
Go back to any unanswered tasks and make your best attempt at an

answer.
Go through your answers a second time, checking you are happy with
all the options you have selected.
If you take this logical and systematic approach you will give yourself the best chance of
doing well and gaining competency in the exam.
SKILLS PRACTICE
1.
Keep track of the questions you have answered when doing tasks from the
Question Bank.
2.
Always check your answers through before looking at the solutions.
3.
Log on to the my.bpp.com platform and complete all Achievement Ladder steps
before sitting the computer-based test.
Skills bank
23
24
Skills bank
1
ACCOUNTING PRINCIPLES
Assessment Criteria
Having studied this chapter you will be able to:
Explain the purpose of maintaining financial records for internal and external use
Describe the types of accounting records that a business should maintain and the
main uses of each
Explain the accounting equation
Define assets, liabilities and equity in an accounting context
Explain the purpose and use of books of prime entry and ledger accounts
Exam Context
This chapter is not likely to form the basis of many exam questions as it is really an
introductory chapter and one which serves to remind you of your level 2 AAT accounting
studies.
Qualification Context
As mentioned above, the knowledge covered in this chapter is largely a reminder of the
key skills learnt in the level 2 accounting papers. You must be familiar with the purpose,
form and content of the books of prime entry, how their totals are posted to the nominal
ledger and how the closing balances on the nominal ledger accounts are used to produce
the trial balance.
Business Context
Maintaining proper accounting records is essential for all businesses. Accounting records
which are complete, accurate and valid will provide both internal and external users with
good information. This may then assist a business in assessing its performance, raising
finance and meeting its statutory requirements.
1: Accounting principles
25
OVERVIEW
Users of financial
information
Types of business entity
Recording accounting
transactions
26
Books of prime entry
Nominal ledger
Trial balance
Subsidiary sales and

purchases ledgers
Balancing off
Financial statements
Users of financial information

Definition
Accounting is a way of recording, analysing and summarising the transactions of a
business.
Ultimately the process of accounting allows a business to produce financial information

which relates to a particular period of time.
There are many different 'groups' who use this financial information. These groups
include both internal and external users.
USERS OF THE FINANCIAL INFORMATION

Detailed below are some of the many user groups which have an interest in financial
information.
Required
What information would these users of financial information be interested in?
Solution
(a)
Managers
(b)
Employees
(c)
Investors
(d)
Lenders
(e)
Suppliers
(f)
Customers
27
Types of business entities

Businesses fall into three main types:
a)
Sole trader (this was introduced in your AAT level 2 studies but is further
extended in Accounts Preparation and Prepare Final Accounts for Sole Traders and
Partnerships)
b)
Partnership (covered only in Prepare Final Accounts for Sole Traders and
Partnerships)
c)
Limited liability company (covered in the Level 4 paper, Financial Statements)
Whether a business is a sole trader, partnership or limited liability company, the

requirement to keep accounting records is still the same although the complexity of these
varies.
By the end of your level 3 AAT studies, you will be able to produce a statement of profit
or loss and a statement of financial position for both a sole trader and a partnership.
Proforma financial statements

The sole trader has the simplest financial statements out of all of the different business
entities.
28
Statement of profit or loss

Statement of profit or loss for the year ended 31 December 20X9:
Sales revenue
200,000
Less cost of goods sold

Opening inventories
Purchases
Carriage inwards
40,000
110,000
20,000
170,000
Closing inventories
(50,000)
120,000
Gross profit
80,000
Sundry income
5,000
Discounts receivable
3,000
88,000
Less expenses
Rent
11,000
Carriage outwards
4,000
Telephone
1,000
Electricity
2,000
Wages and salaries
9,000
Depreciation charges
7,000
3,000
Motor expenses
5,000
Discounts allowable
1,000
43,000
Profit for the year
45,000
Key features
a)
Headed up with the period for which the income and expenses are being included.
b)
The top part

Sales
Less cost of goods sold
Gross profit
X
X
X
is called the trading account as it records just the trading activities (buying and
selling) of the business.
29
c)
Sundry income includes items like bank account interest.

The statement of profit or loss is a summary of the business'
performance over a period of time think of it as a DVD!
Statement of financial position

Statement of financial position as at 31 December 20X9:
ASSETS
Non-current assets
Property, plant and equipment
200,000
Current assets
Inventories
50,000
Trade and other receivables
33,000
Cash and cash equivalents

Total current assets
Total assets
7,000
90,000
290,000
CAPITAL AND LIABILITIES

Capital
Capital
170,000
Profit
45,000
Less drawings
25,000
190,000
Non-current liabilities
Bank loans
40,000
Current liabilities
Bank overdraft
16,000
Trade and other payables
44,000
Total current liabilities
60,000
Total capital and liabilities
30
290,000
Key features
a)
Always headed as at, for the date of the statement of financial position.
b)
Non-current assets assets held and used in the business over the long-term
(ie more than one year).
c)
Current assets not non-current assets! Conventionally listed in increasing order

of liquidity (ie closeness of assets to cash).
d)
Capital what the business owes the proprietor/ owner. In this case the sole
trader owns all of the business, ie its total net worth.
CAPITAL
ASSETS LIABILITIES
NET ASSETS
The statement of financial position is a snapshot of the business at one

point in time.
From business transactions to financial statements

A business will enter into a number and variety of transactions during an accounting
period:
CASH TRANSACTIONS
Sales
Purchases
Wages
Stationery
Acquisition
of non-current
assets
CREDIT TRANSACTIONS
Sales
Purchases
Ultimately all of these transactions must be summarised in the business' financial

statements (ie the statement of financial position and statement of profit or loss).
31
This is achieved by having accounting records to record each stage of the process:
Assorted transactions
(eg invoices)
Categorised
(in Books of Prime Entry)
Summarised
(eg nominal ledger, trial balance)
Financial Statements
(eg Statement of Financial Position and
Statement of Profit or Loss)
Books of prime entry, a recap

As we have seen, accounting records exist at each stage of the process.
First, the business' transactions are categorised with other similar transactions in the
books of prime entry.
BOOKS OF PRIME ENTRY

Required
Can you name the books of prime entry studied in the level 2 AAT accounting
papers and their purpose?
SOLUTION
BOPE
32
Purpose
SUBSIDIARY LEDGERS
Required
What are the subsidiary sales and purchases ledgers used for?
Solution
Ledgers
Use
Subsidiary sales ledger
Subsidiary purchases ledger
Double entry and the nominal ledger, a recap

Once a business transactions have been categorised in books of prime entry, the
next step is to summarise the information in a format nearer to that of the final
financial statements.
Each item in the statement of financial position or statement of profit or loss has a ledger
(or T) account and these accounts are collected together in the nominal ledger.
The books of prime entry are totalled up periodically and the totals posted, using double
entry, to the relevant ledger accounts.
pg 24 - 33
The nominal ledger may also be referred to as the main or general ledger.
Reminder: general rules of double entry bookkeeping

a)
A DEBIT entry represents:

(i)
(ii)
(iii)
(iv)
b)
An increase in an asset
An item of expense
An increase in drawings
A decrease in liabilities, income or capital.
A CREDIT entry represents:

(i)
(ii)
(iii)
(iv)
An increase in a liability
An item of income
An increase in capital
A decrease in assets, expenses or drawings.
33
This can be remembered as follows
Debits
Credits
(increase)
(increase)
Expenses
L iabilities
Assets
Income
Drawings
Capital
DOUBLE ENTRY BOOKKEEPING

ABC Co had the following books of prime entry relating to January and February:
Cash book (receipts)
Date
Description
Total
Capital
1 Jan
Capital introduced
5,000
5,000
8 Jan
Cash sales
14 Feb
Jo Man
26 Feb
Cash sales
60
Sales
Sales
ledger
60
200
200
1,500
1,500
6,760
5,000
1,560
200
Cash book (payments)

Total
Date
Description
3 Jan
Rent paid
200
5 Jan
Books R Us
420
6 Jan
Repairs/
painting
75
1 Feb
Paperleaf
525
12 Feb
Cleaning
40
21 Feb
Drawings
100
1,360
34
Rent
Purchases
Rep. &
Maint.
Purchase
ledger
Cleaning
Drawings
200
420
75
525
40
100
200
420
75
525
40
100
Sales day book

Date
Customer
11 Jan
Jo Man
300
TOTAL
300
Date
Supplier
2 Jan
Paperleaf
825
TOTAL
825
Purchase day book
Required
(a)
Prepare the double entry that will be required to post the totals on the
books of prime entry above.
(b)
Show the posting in the relevant nominal ledger accounts.
Solution
Dr
Cr
Account name
Dr
Cr
Account name
Dr
Cr
Account name
Sales day book
35
Purchase day book

Dr
Account name
Cr
Nominal ledger
Bank
Capital
Sales
Sales ledger control account
36
Rent
Purchases
Repairs and maintenance
Purchase ledger control account
Cleaning
37
Drawings
Balancing off the ledger accounts

Once the totals from the books of prime entry have been posted to the nominal ledger,
the business will want to know the balance on each account. This is done by 'balancing
off' each ledger account.
Steps
Add the debit and credit sides separately. Then:
1.
Fill in the higher of the two totals on one side.
2.
Copy that total across to the other side.
3.
Calculate the balancing figure on the side with the lower total and describe this
as the balance carried down (balance c/d).
4.
Complete the double entry by entering the balancing figure on the opposite side,
below the totals line, and describe this figure as the balance brought down
(balance b/d).The following information has been posted to the cash account
below.
BALANCING OFF THE LEDGER ACCOUNTS

Required
Balance off the cash account to determine the amount of cash held at the end
of January.
Solution
Dr
Cash
1 Jan
Sales
10 Jan Sales
38
Cr
700
3 Jan Purchases
300
500
25 Jan Telephone
50
BALANCING OFF THE LEDGER ACCOUNTS FOR ABC CO

Refer to the example, Double entry bookkeeping.
Required
Balance off the ledger accounts for ABC Co showing the balance c/d at 28
February and the balance b/d at 1 March.
SOLUTION
Complete in the solution space for Double entry bookkeeping.
The trial balance, a recap

Once all of the postings to the nominal ledger accounts have been completed and the
accounts balanced off, a business can extract a trial balance.
The trial balance consists of a list of the balances brought down on each ledger account,
separated into debits and credits as below.
Example
A Business Trial Balance at as 31 December 20X9:
Debit
Account name
Cash
Credit
720
Capital
500
Sales
2,200
Purchases
1,100
Furniture
500
Electricity
120
Telephone
60
Drawings
200
Total
2,700
2,700
The trial balance is used to see whether the ledger accounts have been prepared
correctly.
The trial balance should balance, ie
Total debits = Total credits
39
If the trial balance does balance this is a good indication that the nominal ledger is free
from accounting errors. However, this is not a foolproof method as some errors are
not highlighted by the trial balance.
If however the trial balance doesn't balance then an error must have occurred.
The correction of errors is covered in a later chapter, The trial balance, errors and the
suspense account.
TRIAL BALANCE
Refer to example Double entry bookkeeping where the ledger accounts have now been
balanced off.
Required
Prepare the trial balance as at the end of February.
Solution
ABC Co Trial Balance as at 28 February
Debit
Credit
Preparing the financial statements

So far we have seen how similar transactions are categorised in the books of prime
entry and their totals are then summarised in the nominal ledger accounts. Finally, the
balances on these ledger accounts are used to produce a trial balance. This trial balance
is called an initial or a preliminary trial balance.
In reality there are several adjustments such as accounting for accruals and prepayments
and the depreciation of non-current assets which still need to be processed. These
adjustments will be covered later in the course.
Such adjustments will be processed using an extended trial balance (seen in a later
chapter) and from this the financial statements will be produced: a statement of profit or
loss and a statement of financial position.
For now, however, we will see how the statement of profit or loss and statement of
financial position are prepared from the initial trial balance.
40
FROM AN INITIAL TRIAL BALANCE TO THE FINANCIAL

STATEMENTS
Required
Using the trial balance in the previous example, prepare an statement of profit
or loss and a statement of financial position at 28 February.
Solution
ABC Co Statement of profit or loss for the 2 months ended 28 February
Sales revenue
Less purchases
Gross profit
Less expenses:
Rent
Cleaning
Net profit
ABC Co Statement of financial position as at 28 February
Current assets
Trade receivables (sales ledger control account)
Cash
_____
_____
Proprietors interest
Capital
Profit for the period
Less drawings
_____
_____
Balance 28 February
Current liabilities
Trade payables (purchase ledger control account)
_____
_____
41
Knowledge test preparation

The final task of the Accounts Preparation exam will include short-form, objective style
requirements on any area of the syllabus. If the requirements are based on accounting
principles, they could be structured as follows.
ACCOUNTS PREPARATION - KNOWLEDGE

This task is to test your knowledge.
Required
(a)
Which ONE of the following would you expect to find in the general
ledger?

Purchases returns day book
Customer As sales ledger account
Purchases ledger control account
(b)
Which of the following best describes why the sales ledger control
account is a current asset? Choose ONE.
It is expected that credit customers will pay over more than one
accounting period.
It can be used by the business to fund day-to-day expenditure.
It is an amount receivable by the business.
It is an amount payable by the business that is due more than a year
after the year-end date.
42
SUMMARY
43
ANSWERS
USERS OF THE FINANCIAL INFORMATION
What information would these users of financial information be interested in?
(a)
Managers
(b)
Employees
(c)
Likelihood of payment on time

Likelihood of payment at all
Whether they should continue to supply
Customers
44
Likelihood of repayment of capital amount

Extent of other loans and the security of their debt
Suppliers
(f)
Profitability
Future prospects
Likely risk and return
Chance of capital growth
Ability to pay dividends
Lenders
(e)
Profitability
Long-term growth
Job security
Likelihood of bonus
Ability to pay retirement benefits/pensions
Investors
(d)
Profitability
Future prospects/plans to develop the business
Current financial security
Future financing needs/concerns
Ability to pay a return to the owners (drawings/dividends)
Ability of entity to continue supplying

Profitability as a measure of value for money of goods bought
BOOKS OF PRIME ENTRY

Can you name the books of prime entry studied in the level 2 AAT accounting
papers and their purpose?
BOPE
Purpose
Cash book (receipts and payments)
To record cash transactions in and out of

the bank account
Sales day book
To record credit sales (ie each invoice

raised)
Sales returns day book
To records returns from sales made on

credit (ie each credit note raised)
Purchase day book
To record credit purchases (ie each invoice

received)
Purchase returns day book
To record returns of purchases made on

credit (ie each credit note received)
Petty cash book
To record small cash transactions
Journal book
To record adjustments and correct errors
SUBSIDIARY LEDGERS
What are the subsidiary sales and purchases ledgers used for?
Ledgers
Use
To know how much is owed by each individual credit

customer at a point in time.
The sales day book and sales returns day books are
posted to the sales ledger control account and will provide
the business with information as to how much it is owed in
total by all credit customers.
The subsidiary sales ledger breaks this information down
on a customer by customer basis.
This effectively has the same use as the subsidiary sales

ledger but on the purchases side!
The subsidiary purchase ledger will show how much is
owed to each individual credit supplier at a point in time.
The purchase day book and purchase returns day books
are posted to the purchase ledger control account and will
provide the business with information as to how much it
owes in total to all credit suppliers.
The subsidiary purchase ledger breaks this information
down on a supplier by supplier basis.
45
DOUBLE ENTRY BOOKKEEPING

(a)
Prepare the double entry that will be required to post the totals on the
books of prime entry above.
(b)
Show the posting in the relevant nominal ledger accounts.

Dr
Account name
Bank
Cr
6,760
Capital
5,000
Sales
1,560
200

Dr
Account name
Cr
Rent
200
Purchases
420
75
525
Cleaning
40
Drawings
100
Bank
1,360
Sales day book

Dr
Account name
Cr
300
Sales
300
Purchase day book

Dr
Account name
Purchases
825
825
Nominal ledger
Bank
28 Feb: CB Receipts
46
Cr
6,760
28 Feb: CB Payments
1,360
Capital
28 Feb: CB Receipts
5,000
Sales
28 Feb: CB Receipts
28 Feb: SDB
1,560
300
28 Feb: SDB
300
28 Feb: CB Receipts
200
Rent
28 Feb: CB Payments
200
Purchases
28 Feb: CB Payments
420
28 Feb: PDB
825
28 Feb: CB Payments
75
47
28 Feb: CB Payments
525
28 Feb: PDB
825
Cleaning
28 Feb: CB Payments
40
Drawings
28 Feb: CB Payments
100
BALANCING OFF THE LEDGER ACCOUNTS

Balance off the cash account to determine the amount of cash held at the end
of January.
Dr
Cash
1 Jan
Sales
700
3 Jan Purchases
300
10 Jan Sales
500
25 Jan Telephone
50
31 Jan Balance c/d
850
1,200
1 Feb Balance b/d
48
Cr
850
1,200
BALANCING OFF THE LEDGER ACCOUNTS FOR ABC CO

Balance off the ledger accounts for ABC Co showing the balance c/d at 28
February and the balance b/d at 1 March.
Bank
28 Feb: CB Receipts
6,760
28 Feb: CB Payments
1,360
28 Feb: Balance c/d
5,400
6,760
1 Mar: Balance b/d
6,760
5,400
Capital
28 Feb: Balance c/d
5,000
28 Feb: CB Receipts
5,000
5,000
5,000
1 Mar: Balance b/d
5,000
Sales
28 Feb: CB Receipts
28 Feb: Balance c/d
1,860
28 Feb: SDB
1,860
1,560
300
1,860
1 Mar: Balance b/d
1,860
28 Feb: SDB
300
300
1 Mar: Balance b/d
28 Feb: CB Receipts
200
28 Feb: Balance c/d
100
300
100
49
Rent
28 Feb: CB Payments
200
28 Feb: Balance c/d
200
1 Mar: Balance b/d
200
200
200
Purchases
28 Feb: CB Payments
420
28 Feb: PDB
825
28 Feb: Balance c/d
1,245
1 Mar: Balance b/d
1,245
1,245
1,245
28 Feb: CB Payments
75
28 Feb: Balance c/d
75
1 Mar: Balance b/d
75
75
75
28 Feb: CB Payments
525
28 Feb: Balance c/d
300
28 Feb: PDB
825
825
825
1 Mar: Balance b/d
300
Cleaning
28 Feb: CB Payments
40
40
1 Mar: Balance b/d
50
40
28 Feb: Balance c/d
40
40
Drawings
28 Feb: CB Payments
100
28 Feb: Balance c/d
100
100
1 Mar: Balance b/d
100
100
TRIAL BALANCE
Prepare the trial balance as at the end of February.
ABC Co Trial Balance as at 28 February
Debit
Bank
Credit
5,400
Capital
5,000
Sales
1,860
100
Rent
200
Purchases
1,245
75
300
Cleaning
40
Drawings
100
Total
7,160
7,160
51
FROM AN INITIAL TRIAL BALANCE TO THE FINANCIAL

STATEMENTS
Using the trial balance in the previous example, prepare an statement of profit
or loss and a statement of financial position at 28 February.
ABC Co Statement of profit or loss for the 2 months ended 28 February
Sales revenue
1,860
Less purchases
1,245
615
Gross profit
Less expenses:
Rent
200
75
Cleaning
40
315
300
Net profit
ABC Co Statement of financial position as at 28 February
Current assets
Trade receivables (sales ledger control account)
100
Cash
5,400
5,500
Proprietors interest
Capital
5,000
Profit for the period
300
Less drawings
100
Balance 28 February
200
5,200
Current liabilities
Trade payables (purchase ledger control account)
300
5,500
52

(a)
Which ONE of the following would you expect to find in the general
ledger?

Customer As sales ledger account

(b)
Which of the following best describes why the sales ledger control
account is a current asset? Choose ONE.
It is expected that credit customers will pay over more than one
accounting period.
It can be used by the business to fund day-to-day expenditure.
It is an amount receivable by the business.

It is an amount payable by the business that is due more than a year
after the year-end date.
53
54
2
ACCOUNTING CONCEPTS
Assessment Criteria
Explain the accounting principles of going concern, accruals, prudence and

consistency
Explain the accounting characteristics of relevance, reliability, comparability, ease

of understanding and materiality
Exam Context
The accounting principles and characteristics detailed above are fundamental to the way
financial statements are prepared and are all crucial to your understanding of the
foundation on which accounting is based. Questions on this area are likely to require you
to indicate the meaning of the terms or identify the implications of them for items in the
accounting records.
The knowledge covered in this chapter is developed in the Level 4 paper, Financial
Statements where you will learn about the IASBs Conceptual Framework.
Business Context
As mentioned above all business must adhere to these four accounting principles when
preparing their financial statements. All users of financial statements will presume that a
business will continue on in to the foreseeable future (going concern) unless disclosure is
made to the contrary in its financial statements. It is also important that different
businesses prepare their financial statements on a consistent basis otherwise it is difficult
for potential investors to compare the performance of different businesses.
2: Accounting concepts
55
OVERVIEW
56
Introduction
In the chapter Accounting principles we were reminded of our level 2 accounting studies
and how individual transactions are first categorised in the books of prime entry, then
summarised in the nominal ledger and how these balances are used to prepare the initial
trial balance.
After the initial trial balance is produced some final adjustments may need to be made
using the journal book and then the final financial statements can be produced.
We also saw that there are many different user groups who are interested in financial
information and that whilst each user group has different specific needs, all are
interested in the performance, profitability and security of an individual business.
Users therefore want to be able to compare the financial information of different
businesses and so it is imperative that the accounting profession has a set of common
concepts on which financial information is based.
There are four such accounting principles: going concern, accruals, prudence and
consistency.
Going concern
The financial statements are normally prepared on the assumption that an entity is a
going concern and will continue in operation for the foreseeable future.
pg 45 - 47
In general terms, this means that the business is expected to continue trading for the
next 12 months.
If this assumption is not appropriate, then additional disclosure about the basis of
preparation must be made in the financial statements.
Accruals
The effects of transactions and other events are recognised when they occur.
This means that:
Income and expenses are recorded in the financial statements when the business
has earned the income or incurred the cost rather than when cash is received
or paid
Income and costs are matched to each other so that the cost of buying something
that a business later sells is shown in the same financial period as the income from
the sale (again regardless of when the cash is received or paid)
Items are reported in the financial statements of the period to which they relate
The accruals principle is also known as the matching principle.
57
There are many adjustments made in a set of financial statements due to the accruals
principle. Below is a summary of the ones you will see in your Accounts Preparation
syllabus.
Accruals and
prepayments
Depreciation
Adjustments made due to

the accruals principle
Closing inventory
adjustment
Prudence
Income and profits are not anticipated but are only recognised once they can be
assessed with reasonable certainty.
Costs, losses and liabilities are recognised once you have an obligation in relation to
them.
There are many adjustments made in a set of financial statements due to prudence.
Below is a summary of the ones you will see in your Accounts Preparation syllabus.
Inventory valuation (lower of
cost and net realisable value)
Adjustments made due to

the principle of prudence
Irrecoverable and doubtful

debts
58
PRUDENCE
Required
Indicate whether it would be prudent for a business to recognise (include) the
transactions below in its financial statements.
Yes
No
A customer buys 50 litres of paint from you and you provide

them with an invoice which is payable in 30 days.
Another customer enquires about the cost of 75 litres of paint
and says hell come back next week to get them.
You obtain a quote from your supplier about the price of
stocking a new 'wipe clean' paint.
Your supplier delivers 30 litres of the 'wipe clean' paint to you
and says he will send the invoice in the post.
Consistency
Like items are accounted for on a consistent basis within each accounting period
and from one period to the next.
Accounting characteristics
In the previous chapter we discussed how stakeholders use the financial statements.
The overriding purpose of preparing these is to provide information, particularly to the
business owner.
This information should enable those using the final accounts to make good economic
decisions, such as:
Whether to invest more in the business

Whether to expand and buy more non-current assets
Whether the business could secure a bank loan to fund these purchases
If these sorts of decisions are to be made then there is a need for the financial
information to possess certain characteristics.
59
These characteristics are: relevance, reliability, comparability, ease of understanding and

materiality.
pg 47 - 48
Materiality
An item is material if its omission or misstatement could reasonably influence the
economic decisions taken by a user of the financial statements.
The materiality of an item should always be considered when determining whether
information is relevant.
Accounting policies
An accounting policy relates to the way in which an item is treated in the financial
statements. For example, inventories are valued at the lower of cost and net realisable
value.
The above qualities should all be kept in mind when deciding on the most appropriate
accounting policy for each item in the financial statements. For example, using the same
accounting policies as those which are standard for a particular industry is likely to
improve the relevance of the information provided.
60
ACCOUNTING CHARACTERISTICS
Required
(a)
Complete the following sentence.

A large cash balance is likely to be a
item in the financial
statements.
Picklist: insignificant, material, relevant, reliable
(b)
Indicate whether the following statements are true or false.

True
False
Users of the financial statements are assumed to have

some business, economic and accounting knowledge and
to be able to study the information properly.
A 50 error in the recording of an electricity expense is
likely to be material in the financial statements.
In an accounting context, reliability means users can
depend on the financial information to give a faithful
representation of what it is intended to represent.
61

requirements on any area of the syllabus. If the requirements are based on accounting
concepts, they could be structured as follows.

Required
(a)
Why must like items be accounted for on a consistent basis? Choose the
ONE most suitable reason.
To ensure that all items are recorded.

So that financial statements are more useful and comparable.
So that we know the company will continue in operation for the
foreseeable future.
So that the company can be valued.
Income and expenses are recorded in the financial statements when the business
has earned the income or incurred the cost rather than when cash is received or
paid.
(b)
Which principle does this reflect?
Accruals
Consistency
Going concern
Prudence
62
SUMMARY
63
ANSWERS
PRUDENCE
Indicate whether it would be prudent for a business to recognise (include) the
transactions below in its financial statements.
Yes
A customer buys 50 litres of paint from you and you provide
them with an invoice which is payable in 30 days.
No
Another customer enquires about the cost of 75 litres of paint

and says hell come back next week to get them.
You obtain a quote from your supplier about the price of

stocking a new 'wipe clean' paint.
Your supplier delivers 30 litres of the 'wipe clean' paint to you

and says he will send the invoice in the post.
ACCOUNTING CHARACTERISTICS
(a)
Complete the following sentence.

A large cash balance is likely to be a
material
item in the financial
statements.
Picklist: insignificant, material, relevant, reliable
(b)

True
Users of the financial statements are assumed to have

some business, economic and accounting knowledge and
to be able to study the information properly.
A 50 error in the recording of an electricity expense is

likely to be material in the financial statements.
In an accounting context, reliability means users can
depend on the financial information to give a faithful
representation of what it is intended to represent.
64
False

(a)
Why must like items be accounted for on a consistent basis? Choose the
ONE most suitable reason.
To ensure that all items are recorded.
So that financial statements are more useful and comparable.

So that we know the company will continue in operation for the
foreseeable future.
So that the company can be valued.
(b)
Which principle does this reflect?
Accruals
Consistency
Going concern
Prudence
65
66
3
PURCHASE OF NONCURRENT ASSETS
Assessment Criteria
Describe the main requirements of accounting standards (IFRS) in relation to noncurrent asset valuations
Explain the differences between capital and revenue expenditure
Describe how the acquisition of non-current assets can be funded, including part
exchange
Explain the accounting treatment for recording the acquisition and disposal of noncurrent assets
Calculate total capital expenditure including all associated costs
Record prior authority for the capital expenditure
Record in the appropriate accounts the acquisition of a non-current asset including

funded by/part exchange
Exam Context
Non-current assets and depreciation are an important part of the Accounts Preparation
syllabus and will be the main topic which is tested in tasks 1 and 2 of the exam.
Questions are likely to focus on areas such as the definition of a non-current asset; the
difference between capital and revenue expenditure; determining which items can be
included in the cost of a non-current asset; calculating depreciation and the journal to
record it; calculating the gain or loss on disposal of an asset and the accounting entries
required to record the disposal. You may also be asked about the purpose and content
of the non-current asset register.
Recording and accounting for non-current assets is developed in the level 4 paper,
Financial Statements where you will deal with more complex issues such as revaluations,
impairments and intangible non-current assets.
3: Purchase of non-current assets
67
Business Context
Non-current assets are often one of the most expensive items purchased by a business
and they can have a big impact on the financial statements. It is important therefore
that a business adopts and discloses a consistent approach in accounting for these items.
68
OVERVIEW
69
Introduction
The purchase of a non-current asset is often a significant cost to a business which will
have a large impact on its financial statements.
It is important therefore that this expenditure is accounted for appropriately.
Non-current assets
EXAMPLES OF NON-CURRENT ASSETS

Required
What examples of non-current assets can you identify?
Solution
Definition
The accounting treatment of non-current assets is covered by IAS 16 Property, plant and
equipment.
Non-current assets are defined as those which:
a)
Are held for use in the production or supply of goods or services or for
administrative purposes; and
b)
Are expected to be used during more than one period.
Capital versus revenue expenditure
70
a)
Capital expenditure:
results in the acquisition, replacement or

improvement of non-current assets.
b)
Revenue expenditure:
For the trade of the business, or
To repair, maintain and service non-current

assets.
Capital expenditure results in the appearance of a non-current asset in the

statement of financial position of the business.
Revenue expenditure results in an expense in the statement of profit or loss.
Capital expenditure should also be recorded in a non-current asset register. This is
covered in the chapter, Disposal of non-current assets.
Capitalisation policy
Businesses will often purchase lots of smaller items which meet the definition of capital
expenditure above but which are for relatively small amounts.
Many businesses will therefore set a minimum level of expenditure for items to be
capitalised, say 500.
This means that any items of capital expenditure under 500 will be recorded as an
expense in the statement of profit or loss even though they meet the definition of capital
expenditure.
In the assessment this will be communicated to you through the phrase 'X has a
policy of capitalising expenditure over 500'.
For example, if a business sets its capitalisation policy at 500 and subsequently
purchases a printer for 200, the printer will be expensed. It is not included as an asset
in the non-current asset register.
This treatment is allowed under current accounting standards and is an example of the
materiality concept which is discussed in the chapter, Accounting concepts.
As well as materiality, there are other factors that a business should consider in
deciding whether or not to capitalise smaller items. These include:
The lifespan of the asset if the asset has a very short lifespan it will be written
off to the statement of profit or loss reasonably quickly (say within one or two
years) and so there is not much difference in the financial statements between
depreciating the item and recording it as an expense.
The accruals concept the importance of matching the usage of an asset to the
revenue it generates.
All businesses must communicate the capitalisation policy to relevant employees.
Classes of non-current assets

A business may well use many different types of non-current assets and it will categorise
them into separate asset ledger accounts in the accounting records.
The most common classifications of types of non-current assets are:
a)
b)
c)
d)
e)
Land and buildings

Machinery
Motor vehicles
Furniture and fittings
Computers
71
Cost
Non-current assets should initially be recorded at cost.
Cost includes:
pg 58 - 60
Purchase price:
a)
b)
After deducting trade discounts

Excluding recoverable VAT
Directly attributable costs to bring the asset to its intended location and ready
to use. These include the following:
a)
b)
c)
d)
Initial delivery and handling costs

Installation and assembly costs
Costs of testing whether the asset is working properly
Professional fees
The following costs may not be included:

a)
b)
c)
The cost of maintenance contracts

Administration and general overhead costs
Staff training costs
COST OF THE ASSET

On 10 December 20X7 a business bought a machine.
The breakdown on the invoice showed:
Cost of machine
Delivery costs
One-year maintenance contract
20,000
200
900
21,100
Further installation costs of 500 were also incurred.
Required
At what amount should the machine be capitalised in the entity's records?
Solution
72
CAPITAL VERSUS REVENUE EXPENDITURE

On 9 August 20X7 a business bought a building.
Required
Indicate whether the following items should be treated as capital or revenue
expenditure.
Capital
expenditure
Revenue
expenditure
Cost of the plot

Surveyors fees
Legal fees drawing up the purchase contract
Cost of researching alternative buildings to purchase
Authorising capital expenditure

Non-current assets are often some of the most expensive items a business will purchase.
It is imperative therefore that this expenditure is appropriately authorised prior to the
item being purchased.
The need for authorisation will help ensure:
a)
b)
That assets are not bought unnecessarily

That assets are acquired at the best prices.
The level of authorisation required will vary according to the cost of the item, for
example the following authorisation levels may apply:
Assets costing less than 500 supervisor

Assets costing between 500 and 1,000 manager
Assets over 1,000 director/ partner/ business owner
It is also possible that some more expensive items will need two levels of authorisation,
for example a business may have the policy that expenditure over 2,500 must be
authorised by both a manager and a director.
73
Illustration
A business needs a new computer costing 450 for the accounts department.
Consider which of the following persons is most appropriate to authorise the purchase:
The accounts clerk who needs the new computer

The accounts department supervisor
The purchasing department supervisor
The purchasing department manager
A director
Authorisation may be evidenced by the completion of a capital expenditure

authorisation form.
Capital Expenditure Authorisation Form
Business/Department
Supplier ..
Description of item and reason for purchase
Cost ..
No. of Quotes received
1st Authorisation 2nd Authorisation (>1,000)..
Purchase/Lease/Part Exchange.
Terms of lease (if applicable).
PLEASE RETURN TO PURCHASE LEDGER DEPARTMENT
74
Financing the purchase of non-current assets
FINANCING THE PURCHASE OF NON-CURRENT ASSETS

Required
Imagine that you are buying a car; identify some of the methods you could
use to finance the purchase.
Solution
As you can see, there are many methods available to a business to finance the purchase
of non-current assets. However, cash purchases are often tested in the CBT.
Accounting for non-current assets

Dual effect
When a non-current asset is purchased for cash, there is a dual effect which needs to be
accounted for:
a)
It increases the cost of the non-current assets in the statement of financial

position.
b)
It reduces the cash/ bank funds held by the business.
Two accounts are used to record the purchase:

Account name
Non-current asset cost account (SOFP)
Bank (SOFP)
Dr
Cr
X
X
75
RECORDING A MACHINE IN THE MAIN LEDGER

In the example Capitalising a machine, a business bought a machine with the following
invoice details:
Cost of machine
20,000
Delivery costs
200
One-year maintenance contract
900
21,100
Further installation costs of 500 were also incurred.
The cost of the machine to be included in non-current assets was 20,700. The machine
was paid for in cash.
Required
Record the journal entry needed in the main ledger to show the purchase of
the machine.
Solution
Account name
Dr
Cr
Picklist: Bank, Inventory, Machine at cost, Purchases, Repairs and maintenance, Sales
RECORDING A MOTOR VEHICLE IN THE MAIN LEDGER

On 14 April a business acquired a motor vehicle and wrote a cheque for 18,500 to the
garage.
Required
the motor vehicle.
Solution
Account name
Dr
Cr
Picklist: Bank, Inventory, Motor vehicle at cost, Purchases, Repairs and maintenance,
Sales
76
Double entry summary for the chapter

Purchase of non-current asset:
Account name
Bank (SOFP)
Dr
Cr
X
X
77
SUMMARY
78
ANSWERS
EXAMPLES OF NON-CURRENT ASSETS
What examples of non-current assets can you identify?
Examples include:
1.
2.
3.
4.
Land and buildings

Plant and equipment
Motor vehicles
Furniture and fittings, computers
COST OF THE ASSET

At what amount should the machine be capitalised in the entity's records?
20,700
The cost capitalised should include the purchase price (20,000) plus all directly
attributable costs (delivery and installation).
The cost of the maintenance contract should be shown as an expense in the statement
of profit or loss.
CAPITAL VERSUS REVENUE EXPENDITURE

Indicate whether the following items should be treated as capital or revenue
expenditure.
Capital
expenditure
Cost of the plot
Surveyors fees
Legal fees drawing up the purchase contract
Cost of researching alternative buildings to purchase
Revenue
expenditure
79
FINANCING THE PURCHASE OF NON-CURRENT ASSETS

Imagine that you are buying a car; identify some of the methods you could
use to finance the purchase.
1.
2.
3.
4.
Cash purchase from savings

Take out a loan from a bank/ friends/ parents
Lease the car/ buy it on hire purchase (HP)
Offering another asset in part exchange
RECORDING A MACHINE IN THE MAIN LEDGER

the machine.
Account name
Machine at cost
Dr
Cr
20,700
Bank
20,700
RECORDING A MOTOR VEHICLE IN THE MAIN LEDGER

the motor vehicle.
Account name
Motor vehicle at cost
Bank
80
Dr
Cr
18,500
18,500
You have now covered the Topics that will be assessed in Step 1 of your Achievement
Ladder.
It is vital in terms of your progress towards the AAT computer-based test that you
attempt this Step in the near future. You will receive feedback on your performance, and
you can use the wide range of online resources and ongoing BPP support to help address
any improvement areas. This will help you to tailor your learning exactly to your own
individual requirements.
Topic name
Subtopic/Chapter name
Accounting principles and

concepts
Accounting concepts
1
2
Purchase of non-current
assets
Purchase of non-current assets
Course notes
chapter
Achievement Ladder Step 1
81
82
4
DEPRECIATION OF NONCURRENT ASSETS
Assessment Criteria
Calculate the depreciation charges for a non-current asset using the:
Record the depreciation in the non-current assets register
Record depreciation in the appropriate ledger accounts
Close off the ledger accounts at the end of the financial period, correctly
identifying any transfers to the statement of profit or loss
Record the journal entries to close off revenue accounts in preparation for the
transfer of balances to the final accounts
Record the journal entries for provision for depreciation
Account for the adjustment, provision for depreciation on non-current assets
Exam Context
4: Depreciation of non-current assets
83
Business Context
that a business adopts and discloses a consistent approach in accounting for these items.
84
OVERVIEW
Accruals concept
Depreciation of non-current
assets
Depreciation methods
Straight line
method
Accounting entries
Diminishing balance
depreciation
85
Depreciation
Non-current assets are used in the business to generate income which is shown in the
statement of profit or loss.
Assets will eventually be worn out (used up) and so there is a cost to the business of
generating this income. This cost should be shown as an expense in the statement of
profit or loss to 'match' against the income.
This expense is called depreciation.
Depreciation results in the non-current asset being systematically charged to the
statement of profit or loss over several accounting periods in recognition of the fact that
the asset will contribute to the income-generating activities of each of these periods.
This means that instead of the cost of the asset being recorded in the accounting period
when the asset is purchased, it is spread over the different accounting periods expected
to benefit from the assets use.
A formal definition of depreciation is given by the accounting standard, IAS 16 Property,
plant and equipment:
'the systematic allocation of the depreciable amount of an asset over its useful life.'
'Depreciable amount'
cost residual value
'Residual value'
the amount the asset is expected to be sold for at the

end of its useful life (scrap value).
Generally all non-current assets should be depreciated as they will only last for a
certain period of time.
However, land normally has an unlimited useful life and therefore is not depreciated.
Buildings, though, do have a limited life and are depreciable assets.
Depreciation is an example of the accruals concept. Depreciation is charged on noncurrent assets to match the wearing out of the asset to the income it has helped to
generate. This will then allow the business to record the 'true profit' it has made in any
accounting period.
The cost of the asset accumulated depreciation to date = carrying amount of the asset.
Methods of depreciation
There are two main methods for calculating depreciation:
a)
b)
86


The depreciation charge is the same every year.
pg 83 - 85
Formula
Depreciation
Cost Residual value

Useful life (years)
or
(Cost Residual value) %
where:
Residual value
expected proceeds/scrap value at the end of the asset's

useful life.
Useful life
the number of years (or other period of time) the

business expects to make use of the asset.
The straight line method of depreciation is suitable for assets which are used up
evenly over their useful life.
STRAIGHT LINE DEPRECIATION - MACHINE

A business buys a machine for 2,500. It is expected to have a useful life of three years
after which time it will have a scrap value of 250.
Required
(a)
Calculate the annual depreciation charge.
(b)
Calculate the cost, accumulated depreciation and carrying amount for

each year of the asset's life.
Year
Cost
Accumulated
depreciation
Carrying
amount
1
2
3
87
STRAIGHT LINE DEPRECIATION - BUILDING

A business has the following balances relating to non-current assets:
Balances as at:
30 June 20X5
30 June 20X6
Buildings at cost
100,000
100,000
12,000
To be calculated
Buildings accumulated depreciation

Depreciation is provided at 2% on a straight line basis.
Required
(a)
Calculate the depreciation charge for the year ended 30 June 20X6.
(b)
Calculate the updated accumulated depreciation as at 30 June 20X6.
Diminishing balance depreciation

This method is suitable for those assets which generate more revenue in earlier years
than in later years; for example a machine which may become progressively less efficient
as it gets older.
Under this method the depreciation charge will be higher in the earlier years and
reduce over time.
Formula
Depreciation
Depreciation rate (%) Carrying amount
where: carrying amount = cost accumulated depreciation to date

Note:
88
This method does not take account of any residual value, since the carrying
amount under this method will never reach zero. The depreciation rate
percentage will be provided in the question.
DIMINISHING BALANCE DEPRECIATION - MACHINE

A business buys a machine costing 6,000. The depreciation rate is 40% on a
diminishing balance basis.
Required
Calculate the depreciation charge, accumulated depreciation and carrying
amount of the asset for the first three years.
Solution
Carrying
amount b/d
Year
Depreciation
rate
Depreciation
charge
Accumulated
depreciation
Carrying
amount c/d
1
2
3
DIMINISHING BALANCE DEPRECIATION - VEHICLE

31 January
20X8
31 January
20X9
Vehicle at cost
50,000
50,000
Vehicle accumulated depreciation
32,850
To be calculated
Balances as at:
Depreciation is provided at 30% on a diminishing balance basis.
Required
(a)
Calculate the depreciation charge for the year ended 31 January 20X9.
(b)
Calculate the updated accumulated depreciation as at 31 January 20X9.
89
STRAIGHT LINE AND DIMINISHING BALANCE

DEPRECIATION
Balances as at:
Office equipment at cost
Office equipment accumulated depreciation
31 May 20X7
31 May 20X8
20,000
26,000
8,000
Machinery at cost
60,000
Machinery accumulated depreciation
15,000
To be calculated
85,000
To be calculated
Office equipment is depreciated over 5 years on a straight line basis and machinery is
depreciated at 25% on a diminishing balance basis.
A full years depreciation charge is made in the year of acquisition and none in the year
of disposal.
Required
(a)
Calculate the depreciation charge for the year ended 31 May 20X8.
Office
equipment
(b)
Machinery
Calculate the updated accumulated depreciation as at 31 May 20X8.

Office
equipment
Machinery
Workings:
Note that whichever depreciation method is chosen, straight line or diminishing balance,
the method should be reviewed from time to time to ensure that it is still appropriate.
The useful life, residual value and depreciation rate should also be reviewed.
90
Assets acquired part way through the year

In our examples, the assets were held by the business for an entire year and so a full 12
months of depreciation has been charged.
Should an asset be acquired part way through the year then the business has a choice:
Options
Task instructions
Either to charge 12 months worth of

depreciation irrespective of when the asset
was acquired.
Here the exam task will state that 'a full

years depreciation charge is made in
the year of acquisition and none in
the year of disposal'.
Or to calculate depreciation on a pro-rata

basis which means it will only charge
depreciation on the asset for the number
of months it was held.
Here the exam task is likely to state that

depreciation is calculated on a pro-rata
basis.
Illustration
A business bought a machine for 10,000 on 1 October 20X9. It charges depreciation on
a pro-rata basis at a rate of 20% and has a year end of 31 December.
What is the depreciation charge for the year ended 31 December 20X9?
Here the business buys the asset with 3 months of the year remaining; it will therefore
charge only 3 months depreciation.
The depreciation for the year is calculated as:
10,000 20% 3/12 = 500
ASSETS ACQUIRED PART WAY THROUGH THE YEAR

A business has the following information relating to non-current assets:
A piece of furniture described as 'FUJ838' was acquired on 1 April 20X8 for 8,000.
Furniture is depreciated at 10% using the straight line method.
Depreciation is calculated on an annual basis and charged in equal instalments for

each full month an asset is owned in the year.
Required
(a)
Calculate the accumulated depreciation and carrying amount for the year
ended 31 December 20X8.
Accumulated
depreciation
Carrying
amount
91
(b)
Accumulated
depreciation
Carrying
amount
Accounting for depreciation

Dual effect
Depreciation has a dual effect which needs to be accounted for:
a)
It reduces the value of the non-current asset on the statement of financial

position by increasing the accumulated depreciation on the non-current asset.
b)
It is an expense in the statement of profit or loss.
The asset remains at its original cost in the asset account.

Two additional accounts are set up to record depreciation:
Account name
Depreciation charge account (SPL)
Dr
Cr
Non-current asset accumulated depreciation (SOFP)
Non-current asset accumulated depreciation account

a)
Used to provide for the reduction in value of the asset.
b)
Reduces original cost of the asset on the statement of financial position. (The
balance on the account is offset against the cost account for the corresponding
asset.)
c)
Separate account kept for each class of asset (eg motor vehicles, buildings, plant
and machinery).
DEPRECIATION IN THE FINANCIAL STATEMENTS

Required
Using the information in the example, Straight line depreciation machine, show the
following:
92
(a)
The journal entry which would have been written at the end of the first
year.
(b)
The entries that would be made in the ledger accounts to record the
initial purchase of the asset (assume a cash purchase) and the
depreciation on the asset for each year of the assets life.
(c)
The relevant statement of profit or loss and statement of financial

position extracts for each year.
SOLUTION
(a)
Journal entry
Dr
Account name
(b)
Cr
Machinery at cost (SOFP)
Bank (SOFP)
Depreciation charge (SPL)
93
Machinery accumulated depreciation (SOFP)
(c)
Statement of profit or loss (extracts)

Year 1
Year 2
Year 3
Accumulated
Depreciation
Carrying
amount
Expenses
Statement of financial position (extracts)

Cost
(Year 1)
(Year 2)
(Year 3)
94
LEDGER ACCOUNTING FOR NON-CURRENT ASSETS

This task is about ledger accounting for non-current assets.
You are working on the accounts of a business that is registered for VAT.
The financial year end is 31 August 20X9.
A new vehicle has been acquired. VAT can be reclaimed on this vehicle.
The cost excluding VAT was 28,000; this was paid from the bank.
The residual value is expected to be 4,000 excluding VAT. It is estimated it will

be used for four years.
Vehicles are deprecated on a straight line basis. A full years depreciation is

applied in the year of acquisition.
Depreciation has already been entered into the accounts for existing vehicles.
Required
(a)
Calculate the depreciation charge for the year on the new vehicle.
Make entries to account for:

(b)
The purchase of new vehicle.
(c)
The depreciation charge on the new vehicle.

On each account, show clearly the balance carried down or transferred to
the profit or loss account in the general ledger, as appropriate.
Vehicles at cost
Balance b/d
36,000
Balance b/d
9,000
95
Vehicles accumulated depreciation
Balance b/d
18,000
Picklist: Balance b/d, Balance c/d, Bank, Depreciation charges, Disposals, Profit or
loss account, Purchases, Purchases ledger control account, Sales, Sales ledger
control account, Vehicles at cost, Vehicles accumulated depreciation, Vehicles
running expenses

Depreciation adjustment:
Account name
Non-current asset accumulated depreciation
(SOFP)
96
Dr
Cr
X
X
SUMMARY
Matching the cost of the 'wearing

out of an asset' to the income it
generates
Accruals concept
assets
Depreciation methods
Accounting entries
Dr Depreciation charge (SPL)
Cr Non-current asset accumulated
depreciation ( SOFP)
Straight line
method
Depreciation charge
is the same each
year
Formula:
cost - residualvalue
useful life
or
(cost residual
value) %
Diminishing balance
depreciation
Depreciation charge is
higher in the earlier
years of the asset's life
Formula:
Depreciation rate (%)
carrying amount
97
ANSWERS
STRAIGHT LINE DEPRECIATION - MACHINE
(a)
Calculate the annual depreciation charge.

Straight line method:
Depreciation charge
2,500 250
3 years
=
(b)
750 per annum
Calculate the cost, accumulated depreciation and carrying amount for

each year of the asset's life.
Year
Cost
Accumulated
depreciation
Carrying
amount
2,500
750
1,750
2,500
1,500
1,000
2,500
2,250
250
STRAIGHT LINE DEPRECIATION - BUILDING

(a)
Calculate the depreciation charge for the year ended 30 June 20X6.
2,000
(100,000 2%)
(b)
Calculate the updated accumulated depreciation as at 30 June 20X6.
14,000
(12,000 + 2,000)
98
DIMINISHING BALANCE DEPRECIATION MACHINE

Calculate the depreciation charge, accumulated depreciation and carrying
amount of the asset for the first three years.
Carrying
amount b/d
Year
Depreciation
rate
Depreciation
charge
Accumulated
depreciation
Carrying
amount c/d
(6,000)
40%
2,400
2,400
3,600
(6,000 2,400)
40%
1,440
3,840
2,160
(6,000 3,840)
40%
864
4,704
1,296
DIMINISHING BALANCE DEPRECIATION VEHICLE

(a)
Calculate the depreciation charge for the year ended 31 January 20X9.
(b)
5,145
(50,000 32,850) 30%

Calculate the updated accumulated depreciation as at 31 January 20X9.
37,995
(32,850 + 5,145)
STRAIGHT LINE AND DIMINISHING BALANCE

DEPRECIATION
(a)
Calculate the depreciation charge for the year ended 31 May 20X8.
Office
equipment
5,200
Machinery
17,500
Workings:
Office equipment: 5,200 (26,000 5 years)
Machinery: 17,500 (85,000 - 15,000) 25%
99
(b)
Calculate the updated accumulated depreciation as at 31 May 20X8.

Office
equipment
13,200
Machinery
32,500
Workings:
Office equipment: 13,200 (8,000 + 5,200)
Machinery: 32,500 (15,000 + 17,500)
ASSETS ACQUIRED PART WAY THROUGH THE YEAR

(a)
Accumulated
depreciation
(b)
600
Carrying
amount
7,400
Accumulated
depreciation
1,400
Carrying
amount
6,600
DEPRECIATION IN THE FINANCIAL STATEMENTS

(a)
The journal entry which would have been written at the end of the first
year.
Account name
Depreciation charge
100
Dr
Cr
750
750
(b)
The entries that would be made in the ledger accounts to record the
initial purchase of the asset (assume a cash purchase) and the
depreciation on the asset for each year of the assets life.
Machinery at cost (SOFP)
Bank
2,500
Balance c/d
2,500
2,500
Balance b/d
2,500
2,500
Bank (SOFP)
Machinery at cost
2,500
Year 1 Machinery acc. depn
750
Year 1
To SPL
750
750
Year 2
To SPL
750
750
Year 3
To SPL
750
Machinery accumulated depreciation (SOFP)
Balance c/d
750
Balance c/d
1,500
Year 1 Depreciation
charge
750
Year 2 Balance b/d
750
Depreciation charge
750
1,500
Balance c/d
2,250
1,500
Year 3 Balance b/d
1,500
Depreciation charge
750
2,250
(c)
2,250
The relevant statement of profit or loss and statement of financial

position extracts for each year.
Statement of profit or loss (extracts)
Year 1
Year 2
Year 3
750
750
750
Expenses
Depreciation charge
101
Statement of financial position (extracts)

Cost
Accumulated
Depreciation
Carrying
amount
(Year 1)
Machine
2,500
(750)
1,750
(Year 2)
Machine
2,500
(1,500)
1,000
(Year 3)
Machine
2,500
(2,250)
250
LEDGER ACCOUNTING FOR NON-CURRENT ASSETS

(a)
Calculate the depreciation charge for the year on the new vehicle.
6,000
(b)
The purchase of new vehicle.
(c)
The depreciation charge on the new vehicle.

Vehicles at cost
Balance b/d
36,000
Bank
28,000
Balance c/d
64,000
64,000
64,000
Balance b/d
9,000
Vehicles accumulated
depreciation
6,000
Profit or loss account
15,000
15,000
15,000
Vehicles accumulated depreciation
Balance c/d
24,000
Balance b/d
24,000
102
18,000
6,000
24,000
5
DISPOSAL OF NONCURRENT ASSETS
Assessment Criteria
Explain the need for, and methods of, providing for depreciation on non-current
assets
Describe the contents and use of the non-current assets register
Resolve any queries, unusual features or discrepancies relating to the accounting

records for non-current assets or refer to an appropriate person
Record the acquisition in a non-current assets register
Close off or transfer the ledger account balances at the end of the financial period
Record the depreciation in the non-current assets register
Identify the correct asset, removing it from the non-current assets register
Record the disposal of non-current assets in the appropriate accounts
Calculate any gain or loss arising from the disposal, closing off or transferring the
account balance
Exam Context
5: Disposal of non-current assets
103
Business Context
that businesses adopt and disclose a consistent approach in accounting for these items.
104
OVERVIEW
The non-current asset

register
assets
Disposals
Gain/ loss on disposal
Accounting entries
Part exchange
105
Non-current assets, a recap

We have seen in previous chapters that the purchase of an asset such as a building, an
item of machinery or motor vehicle will result in a non-current asset being shown in the
business statement of financial position.
This asset will generally wear out over time and so it is depreciated. This is because of
the accruals concept whereby the cost of using up the asset is matched to the
accounting periods over which the asset helps to generate income.
The actual amount shown in the statement of financial position is the carrying amount of
the asset; this is the cost of the asset less the accumulated depreciation charged to date
on the asset.
Disposal of non-current assets

Due to the fact that most assets have a finite useful life, they will need to be replaced
from time to time.
There are three main considerations:
1.
2.
3.
The accounting entries to record the disposal

The gain or loss that will arise on the disposal and
Offering an asset in part exchange against the purchase of a new asset.
Gain or loss on disposal

As mentioned above, the actual amount shown in the statement of financial position is
the carrying amount of the asset, and when a non-current asset is disposed of, its
carrying amount needs to be removed from the statement of financial position.
The sales proceeds received are unlikely to be exactly the same as the asset's carrying
amount and so a gain or loss on disposal will arise.
If:
sales proceeds > carrying amount gain on disposal
sales proceeds < carrying amount loss on disposal
This is not a 'true' gain or loss, but rather a 'book adjustment' to reflect the fact that the
depreciation charged over the asset's life wasn't completely accurate.
If there is a gain on disposal, the asset suffered too much depreciation during its lifetime
and some of this must be credited back to the statement of profit or loss.
If there is a loss on disposal then the asset wasnt depreciated enough during its lifetime
and so an extra charge is needed on disposal in the statement of profit or loss.
Accounting treatment
Everything to do with the disposal is transferred to a Disposal Account.
Steps:
1.
Remove the cost of the asset:

Dr
Cr
2.
Remove the accumulated depreciation charged to date:

Dr
Cr
106
Disposal account
Non-current asset cost account
Disposal account
Note: Steps (1) and (2) have effectively transferred the carrying amount of the asset to
the disposal account.
3.
Account for the sales proceeds:

Dr
Cr
4.
Cash
Disposal account
Balance off disposal account to find the gain or loss on disposal.
A gain on disposal is shown in the statement of profit or loss as sundry income, a loss
as an expense.
DISPOSAL OF A MACHINE FOR CASH

A business bought a machine for 6,000 and has held it for 2 years. The machine is sold
in year 3 for 3,000. The business depreciates its machines on a diminishing balance
basis at a rate of 40%. No depreciation is charged in the year of disposal.
Required
(a)
Calculate the gain or loss on disposal of the machine. Place a tick in the
relevant box to denote whether the amount is a gain or a loss.
(b)
Complete the ledger accounts to show how the disposal would be

accounted for.
Solution
(a)
Gain
Loss
Workings:
(b)
Machine at cost (SOFP)
Balance b/d
6,000
107
Machine accumulated depreciation (SOFP)
Balance b/d
3,840
Disposal account (SPL)
Part exchange allowance

Instead of receiving sales proceeds as cash, a part exchange allowance could be offered
against the cost of a replacement asset:
Dr
Account name
New asset cost account
Cr
Disposal account
The part exchange allowance takes the place of proceeds in the disposals account.
DISPOSAL OF A MACHINE PART EXCHANGE

Assume in the example, Disposal of a machine for cash, that instead of cash proceeds of
3,000, there is a part exchange allowance of 3,000 on a replacement machine costing
10,000.
Required
(a)
(b)
Calculate the amount of cash paid for the new machine.
(c)
Complete the ledger accounts to show both the disposal and the
acquisition.
Solution
(a)
Gain
108
Loss
(b)
(c)
Old machine at cost (SOFP)
Balance b/d
6,000
Old machine accumulated depreciation (SOFP)
Balance b/d
3,840
New machine at cost (SOFP)
109
VANS PART EXCHANGE

During the year a business part exchanged some vans.
The original van was bought for 16,000.

Four years' depreciation has been applied.
Depreciation is provided over six years on a straight line basis.
The estimated residual value of the asset at the date of acquisition was 1,000.
A part-exchange allowance of 5,200 was given.
18,000 was paid from the bank for the new vans.
Required
(a)
Calculate the accumulated depreciation on the original van that was part
exchanged during the year.
Workings:
(b)
Complete the disposals account.

Disposals
Picklist: Bank, Depreciation charges, Gain on disposal, Inventory, Loss on

disposal, Sales, Van accumulated depreciation, Van at cost, Van at cost (part
exchange allowance)
110
Assets disposed of part way through the year

In the previous chapter we saw that a business may buy assets part way through the
year and that it will either charge a 'full years depreciation in the year of
acquisition and none in the year of disposal' or that it will charge depreciation on a
'pro-rata basis'.
The same is true with disposals. A business may dispose of assets part way through the
year and these assets may or may not need to be depreciated in the year of disposal,
depending on the business policy.
If the business policy is to charge 'a full years depreciation charge in the year of
acquisition and none in the year of disposal' then no depreciation charge is made
in the year of disposal as a full 12 month charge was made during the year of
acquisition.
If, however, the business charges depreciation on a 'pro-rata basis' then you will need
to charge depreciation on the asset for the number of months it was held in the year of
disposal.
Illustration
A business sold a van for 3,000 on 30 April 20X9. It had originally cost 12,000 and
had accumulated depreciation brought forward at 1 January 20X9 of 7,200. The
business charges depreciation on a pro-rata basis at a rate of 20% and has a year end of
31 December.
What is the depreciation charge for the van for the year ended 31 December
20X9?
Here the business has used the asset for the first 4 months of the year and so should
charge depreciation for 4 months.
The depreciation for the year is calculated as:
12,000 20% 4/12 = 800
What is the gain or loss on disposal of the asset?
Proceeds
3,000
Less carrying amount*
4,000
Loss on disposal
1,000
*Carrying amount:
Original cost
Less accumulated depreciation (7,200 + 800)
12,000
8,000
4,000
The next example provides exam standard practice at recording the disposal of a noncurrent asset in the general ledger.
111
PART EXCHANGE OF A MACHINE

This task is about ledger accounting for non-current assets.
You are working on the accounts of a business for the year ended 31 August 20X9.
VAT can be ignored.
A machine was part-exchanged on 1 January 20X9.
The original machine was bought for 10,600 on 14 February 20X5.
Depreciation is provided at 20% per year on a straight line basis.
A full years depreciation is applied in the year of acquisition and none in the year
of disposal.
A part-exchange allowance of 1,250 was given.
8,900 was paid from the bank to complete the purchase of the new machine.
Required
Make entries relating to the disposal:
(a)
(b)
Update the bank account.

On each account, show clearly the balance carried down or transferred to
the profit or loss account in the general ledger, as appropriate.
Disposals
Bank
Balance b/d
8,700
Picklist: Balance b/d, Balance c/d, Bank, Depreciation charges, Disposals,

Machinery accumulated depreciation, Machinery at cost, Profit or loss account,
Purchases, Purchases ledger control, Repairs and maintenance costs, Sales, Sales
ledger control
112
(c)
Calculate the purchase cost of the new machine from the information
above.
(d)
What will be the carrying amount of the new machine as at 31 August

20Y0?
The non-current asset register

Nearly all large organisations will keep some form of non-current asset register.
A non-current asset register is a listing of all non-current assets owned by a business,
and can be broken down by department, location or by asset type.
pg 74 - 75
The register can exist in a very simple format such as a spreadsheet or a business may
have a database which records its non-current assets.
The register is kept mainly for internal use and does not form part of the business
double entry system. Rather it is part of the business internal control system.
Note that just as a business should have policies about the levels of capital expenditure
which should be capitalised, it should also have policies to ensure assets recorded are
accurately entered in the non-current asset register.
NON-CURRENT ASSET INFORMATION

Required
What are some of the different types of information a business may want to
hold about their non-current assets?
113
Example non-current asset register

Description
Acquisition
Date
Cost
Depreciation
charges
Carrying
amount
Funding
Method
Disposal
proceeds
Disposal
Date
Computer equipment
Laser Printer
(Packard Bell)
20/08/X7
600
Cash
Year end
31/12/X7
120
480
Year end
31/12/X8
120
360
Year end
31/12/X9
120
240
InkJet
(Canon)
22/05/X8
400
Cash
Year end
31/12/X8
80
320
Year end
31/12/X9
80
240
Motor vehicles
Ford Mondeo
CD06 UVS
14/02/X6
Part
exchange
8,000
Year end
31/12/X6
2,000
6,000
Year end
31/12/X7
1,500
4,500
Year end
31/12/X8
1,125
3,375
Year end
31/12/X9
844
2,531
Depreciation column
114
On each row of the depreciation column the annual depreciation charge is

given for each asset. For example, for the Ford Mondeo for the year ended
31/12/X6 this is 2,000.
If we add up all of the annual depreciation charges for each asset we can find the
accumulated depreciation to date. For example, the accumulated depreciation for
the Ford Mondeo by the year ended 31/12/X9 is 5,469.
Therefore, we can establish the carrying value, which is cost less accumulated
depreciation. Again, looking at the Ford Mondeo this is 8,000 minus 5,469
equals 2,531.
Recording the acquisition of non-current assets in the non-current

asset register
NON-CURRENT ASSET REGISTER

Required
(a)
Identify, by placing a tick in the relevant box, which of the items below
should be recorded in the non-current asset register.
Item
Yes
No
Motor van (reg. no. AT59 CBA) cost 6,000 purchased on

23/09/X9, paid for in cash.
Optional insurance taken out on the above van for a cost of
350.
A Dell laptop cost 2,000 purchased on 24/05/X9, on credit
from Dell.
A second hand scanner and printer cost 50 purchased on
19/01/X9, paid for in cash. These items have an expected
life of approximately 10 months.
A photocopier cost 3,525 purchased on 24/03/X9, paid for
in cash.
(b)
Where an item should be recorded in the non-current asset register,

make the relevant entry in the table below.
Description
Acquisition
Date
Cost
Depreciation
charges
Carrying
amount
Funding
Method
Disposal
Proceeds
Disposal
Date
Motor vehicles
Computers
Office equipment
115
Exam tasks on the non-current asset register

In the Accounts Preparation CBT you may well be given information regarding the noncurrent assets of a business and a partially completed an extract from a non-current
assets register. You will be required to complete the extract from the non-current asset
register.
This type of task will bring together all your knowledge of non-current assets (identifying
cost, calculating depreciation and carrying amount, and also recording information on
acquisition and disposal dates as well as disposal proceeds).
It is important to practise the skills involved in completing a non-current asset register,
as we will see in the next activity.
Recommended approach
This will be a lengthy task in the CBT and it is advisable to have a methodical approach.
Steps
1.
Read the requirements.
2.
Scan the information and non-current asset register so you have an overview of
the task. Note the depreciation method(s).
3.
Read the information on the acquisition of a non-current asset. Make the

relevant postings to the non-current asset register.
4.
Read the information relating to the disposal of a non-current asset. Make the
relevant postings to the non-current asset register.
5.
Complete the other rows in the non-current asset register.
6.
Review your answer. Does it make sense?
MIL TRADING
This task is about recording information for non-current assets for a business known as
MIL Trading. MIL Trading is registered for VAT and has a financial year end of 31
August.
The following is a purchase invoice received by MIL Trading relating to some items to be
used in its office.
To:
MIL Trading
18 High Road
Norton NW3 9MD
Invoice 3920
Bordon Ltd
Clapton Park
BC2 9MJ
Date: 28 May 20X9

Quantity
Total
Printer / Scanner
950.00
Ink and toner
75.00
Pre-delivery testing
50.00
First year general

maintenance
Total
Delivery date: 28/05/X9
116
Model BORMK95B
90.00
1,165.00
MIL Trading paid 1,165.00 to Borton Ltd on 30 June 20X9 with 1,165.00 borrowed
interest-free from a third party. This amount is to be repaid in full on 30 May 20Y1.
The following information relates to the sale of a motor vehicle no longer required by the
business:
Description
1.2 litre car MN06 HNF
Date of sale
23 July 20X9
Selling price
2,250.00
VAT can be ignored.
MIL Trading has a policy of capitalising expenditure over 500.
Office equipment is depreciated at 20% per year on a straight line basis.
Motor vehicles are depreciated at 25% per year on a diminishing balance basis.
A full years depreciation is applied in the year of acquisition and none in the year
of disposal.
Required
Record the following in the extract from the non-current assets register below
for:
(a)
Any acquisitions of non-current assets during the year ended 31 August

20X9
(b)
Any disposals of non-current assets during the year ended 31 August

20X9
(c)
Depreciation for the year ended 31 August 20X9
Notes: Not every cell will require an entry, and not all cells will accept entries.
Show your answer to 2 decimal places.
Picklists
Locating the cell
Heading
Drop down options
Column and row
Description / Serial Number

column Office equipment,
2nd item
1.2 litre car MN06 HNF, 1.6 litre

van HG03 YHG, Laptop
computer 081, Printer / Scanner
Column and row
Depreciation charges 1.2 litre

car MN06 HNF, y/end 31/08/X9
632.81, 843.75, Nil
Column and row
Carrying amount 1.2 litre car

MN06 HNF, y/end 31/08/X9
1,898.44, 2.531.25, Nil
Column and row
Funding method Printer /

scanner
Cash, Loan, Part exchange
Note: the above picklists are intended to represent the AAT online Practice Assessments,
where different words/numbers are attached to specific cells. It is advisable to view this
on the AAT website too.
If there is no picklist attached to a cell in the non-current asset register then data (ie
numbers) can be typed in, as is typical of gapfill style questions.
117
Extract from non-current assets register

Description
/ Serial
Number
Acquisition
date
Cost
Carrying
amount
Funding
method
Office
equipment
Laptop
computer
081
30/06/X8
600.00
Year end
31/08/X8
Cash
120.00
480.00
Year end
31/08/X9
Year end
31/08/X9
Motor
vehicles
1.6 litre van
HG03 YHG
01/08/X7
Partexchange
8,940.00
Year end
31/08/X7
2,235.00
6,705.00
Year end
31/08/X8
1,676.25
5,028.75
Year end
31/08/X9
1.2 litre car
MN06 HNF
01/04/X7
Year end
31/08/X7
1,500.00
4,500.00
Year end
31/08/X8
1,125.00
3,375.00
Year end
31/08/X9
118
Partexchange
6,000.00
Disposal
proceeds
Disposal
date

The final task in the Accounts Preparation exam will test your knowledge of any area of
the syllabus. If the task is based on non-current assets it could be structured as follows.

Required
(a)
What is depreciation? Choose the ONE most suitable description.
Depreciation shows the wear and tear on an asset.

The systematic allocation of the depreciable amount of an asset over
its useful life.
This accounting treatment helps management establish the
replacement cost of the asset.
It results in the asset being expensed to the statement of profit or
loss in the period it is acquired.
(b)

True
False
Directly attributable costs cannot be capitalised as part of

the cost of a new non-current asset.
The depreciable amount of an asset is its cost less
residual balance.
When a NCA is disposed of, if the sales proceeds exceed
the carrying amount there will be a loss on disposal.
Depreciation is an example of the accruals concept.

Disposal of a non-current asset (four steps):
1.

Account name
Dr
Cr
X
X
119
2.

Account name
(SOFP)
Dr

3.

Account name
Bank (SOFP)
Dr
Cr

4.
Cr
Balance off the disposal account to determine the gain or loss on disposal.
Disposal of a non-current asset in part exchange for a new asset:

1.

Account name
Dr

2.

Account name
(SOFP)
Dr

Account name
Non-current asset cost account (new asset)
(SOFP)
Dr
4.
Balance off the disposal account to determine the gain or loss on disposal.
5.
Record any additional payment made for the part exchanged asset:
Account name
Non-current asset cost account (new asset)
(SOFP)
Bank/ Loan account (SOFP)
Cr
120
Cr

3.
Cr
Dr
Cr
X
X
SUMMARY
Records the different assets held by a

business according to their category
Includes information such as:
- acquisition date
- cost
- depreciation policy & depreciation
charged
- carrying amount
- method of funding
- insurance details
- physical location/ serial numbers
- disposal date and proceeds
The non-current asset

register
assets
Disposals

calculation
Proceeds:
X
Less:
(X)
Carrying
amount
Gain/(loss)
X/(X)
Accounting entries
Steps:
(1) Remove the cost of
the asset
(2) Remove the
accumulated
depreciation charged
to date
(3) Account for sales
proceeds
(4) Balance off disposal
account to find the
gain or loss on
disposal
Part exchange
Replace the sales proceeds

in step (3) with the part
exchange allowance
Remember to complete the
purchase of the new asset
121
ANSWERS
DISPOSAL OF A MACHINE FOR CASH
(a)
Gain
840
Loss
Working:
Sales proceeds
Carrying amount at end of year 2 (6,000 - 3,840)
Gain on disposal
(b)
3,000
(2,160)
840
Complete the ledger accounts to show how the disposal would be

accounted for.
Machine at cost (SOFP)
Balance b/d
6,000
(1) Disposal account
6,000
Machine accumulated depreciation (SOFP)
3,840
Balance b/d
3,840
(1) Machine at cost
6,000
(4) Balance = gain
840
on disposal (SPL)
6,840
122
(2) Machine acc depn
3,840
(3) Bank
3,000
6,840
DISPOSAL OF A MACHINE PART EXCHANGE

(a)
Gain
840
Loss
The gain on disposal is still 840; the only difference is that the proceeds were not
received in cash, but in the form of a part exchange allowance.
(b)
Calculate the amount of cash paid for the new machine.

Cash paid for the new machine is 7,000 (10,000 3,000)
(c)
Complete the ledger accounts to show both the disposal and the
acquisition.
Old machine at cost (SOFP)
Balance b/d
6,000
6,000
Old machine accumulated depreciation (SOFP)
3,840
Balance b/d
3,840
New machine at cost (SOFP)

(part exchange)
3,000
(5) Bank
7,000
Balance c/d
10,000
10,000
Balance b/d
10,000
10,000
(1) Old machine at cost

(4) Gain on disposal
(SPL)
6,000
840
6,840
(2) Old machine acc

deprecation
3,840
(3) New machine (part

exchange)
3,000
6,840
123
VANS PART EXCHANGE

(a)
Calculate the accumulated depreciation on the original van that was part
exchanged during the year.
10,000
Workings:
Depreciation charge per year:
16,000 1,000 (residual value) = 15,000 depreciable amount
15,000 over 6 years = 2,500 per year
Van held for 4 years: 2,500 4 years = 10,000
(b)

Disposals
Van at cost
16,000
Van accumulated
depreciation
Van at cost (part
exchange allowance)
Loss on disposal
16,000
10,000
5,200
800
16,000
PART EXCHANGE OF A MACHINE

(a)

Disposals
Machinery at cost
10,600
Machinery accumulated
depreciation
8,480
Machinery at cost
1,250
10,600
124
870
10,600
(b)
Update the bank account.

Bank
Balance b/d
8,700
Balance c/d
200
Machinery at cost
8,900
8,900
(c)
8,900
Calculate the purchase cost of the new machine from the information
above.
10,150
Tutorial working: 8,900 + 1,250 = 10,150

(d)
What will be the carrying amount of the new machine as at 31 August

20Y0?
6,090
Working:
W1: Depreciation: 10,150 * 20% = 2,030 per annum
W2:
Cost
10,150
Depreciation 31/08/X9
(2,030)
Depreciation 31/08/Y0
(2,030)
Carrying amount
6,090
125
NON-CURRENT ASSET INFORMATION

What are some of the different types of information a business may want to
hold about their non-current assets?
Some important types of information include:
Description/serial number/location of the asset

Date of acquisition
Original cost
Depreciation policy for the asset
Depreciation amount charged to date
Carrying amount
Method of funding used to purchase the asset
Disposal date
Disposal proceeds/part exchange allowance
NON-CURRENT ASSET REGISTER

(a)
Identify, by placing a tick in the relevant box, which of the items below
should be recorded in the non-current asset register.
Item
Motor van (reg. no. AT59 CBA) cost 6,000 purchased on
23/09/X9, paid for in cash.
Yes
Optional insurance taken out on the above van for a cost of

350.
A Dell laptop cost 2,000 purchased on 24/05/X9, on credit
from Dell.
A second hand scanner and printer cost 50 purchased on

19/01/X9, paid for in cash. These items have an expected
life of approximately 10 months.
A photocopier cost 3,525 purchased on 24/03/X9, paid for
in cash.
126
No
(b)
Where an item should be recorded in the non-current asset register,

make the relevant entry in the table below.
Description
Acquisition
Date
Cost
Depreciation
charges
Carrying
amount
Funding
Method
Disposal
Proceeds
Disposal
Date
Motor vehicles
Van: AT59
CBA
23/09/X9
6,000
Cash
24/05/X9
2,000
Credit from
Dell
3,525
Cash
Computers
Dell laptop
Office equipment
Photocopier
24/03/X9
127
MIL TRADING
Record the following in the extract from the non-current assets register below
for:
(a) Any acquisitions of non-current assets during the year ended 31 August
20X9
(b)
Any disposals of non-current assets during the year ended 31 August

20X9
(c)
Depreciation for the year ended 31 August 20X9
Extract from non-current assets register

Description /
Serial Number
Acquisition
date
Cost
Carrying
amount
Funding
method
Disposal
proceeds
Disposal
date
Office
equipment
Laptop computer
081
30/06/X8
600.00
Cash
Year end
31/08/X8
120.00
480.00
Year end
31/08/X9
120.00
360.00
Printer /
Scanner
28/05/X9
1,000.00
Year end
31/08/X9
Loan
200.00
800.00
Motor vehicles
1.6 litre van
HG03 YHG
01/08/X7
Partexchange
8,940.00
Year end
31/08/X7
2,235.00
6,705.00
Year end
31/08/X8
1,676.25
5,028.75
Year end
31/08/X9
1,257.19
3,771.56
1.2 litre car

MN06 HNF
01/04/X7
Partexchange
6,000.00
Year end
31/08/X7
1,500.00
4,500.00
Year end
31/08/X8
1,125.00
3,375.00
Year end
31/08/X9
Nil
Nil
128
2,250.00
23/07/X9

(a)
What is depreciation? Choose the ONE most suitable description.
Depreciation shows the wear and tear on an asset.

The systematic allocation of the depreciable amount of an asset over
its useful life.
This accounting treatment helps management establish the

replacement cost of the asset.
It results in the asset being expensed to the statement of profit or
loss in the period it is acquired.
(b)

True
Directly attributable costs cannot be capitalised as part of

the cost of a new non-current asset.
The depreciable amount of an asset is its cost less
residual balance.
When a NCA is disposed of, if the sales proceeds exceed

the carrying amount there will be a loss on disposal.
Depreciation is an example of the accruals concept.
False
129
130
Ladder. This mainly focuses on the shaded topics below but will also include some
recap questions on earlier topics.
Topic name

concepts
Accounting concepts
1
2
assets
assets
Depreciation of non-current assets
assets
Course notes
chapter
131
132
6
ACCRUALS AND
PREPAYMENTS
Assessment Criteria
Explain the accounting treatment of accruals and prepayments to expenses and

revenue
Record the journal entries for accrued and prepaid expenses and income
Account for these adjustments: accruals and prepayments to expenses and

income
Record the journal entries to close off revenue accounts in preparation for the
transfer of balances to the final accounts
Exam Context
Accruals and prepayments will be an important part of the Accounts Preparation exam.
There are two different styles of tasks you need to be familiar with.
You should expect to have to complete an income or expense ledger account (for
example, the electricity expense account) showing the accrual or prepayment at the
beginning of the year, the amount that has passed through the bank account, the accrual
or prepayment at the end of the year and the income or expense that would be shown in
the statement of profit or loss for the period.
A separate task could ask you to produce an extract from the trial balance showing the
relevant income or expense amount and also the accrual or prepayment which would be
shown in the statement of financial position.
This area is assumed knowledge for your level 4 paper, Financial Statements, where you
may need to take account of accruals and prepayments in calculating the final figures for
income and expenses in the statement of profit or loss.
6: Accruals and prepayments
133
Business Context
The adjustment for accruals and prepayments is an example of the accruals or matching
concept. Businesses need accurate financial information in order to assess their past and
current performance and make future predictions. As such it is imperative that this
information includes all income earned and expenses incurred in a particular period even
if no money has changed hands.
134
OVERVIEW
135
Introduction
This chapter is designed to enable you to calculate accruals and prepayments.
Financial statements should be prepared on an accruals basis. This is so that transactions
and events are recognised when they occur (and not as cash or its equivalent is received
or paid) and they are recorded in the accounting records and reported in the financial
statements of the period to which they relate.
The accruals basis is also a key concept from the chapter Accounting concepts.
The exam may test your knowledge of accruals and prepayments in various ways:
Calculating a year end accrual or prepayment
Recording an accrual or prepayment in the accounting records by means of a

journal entry
Posting an adjustment in respect of an accrual or prepayment to an extract from a

trial balance
In addition, this topic could form the basis of the knowledge based task, which will be
the final question in the CBT.
You need to understand and be able to account for:
Accrued income
Accrued expenses
Prepaid expenses
Prepaid income
Accrued expenses
Accrued expenses are expenses incurred by the business during the accounting period
but not yet paid for, i.e. expenses in arrears.
Example
Fred prepares his accounts to 31 December each year. On 1 January 20X8, he pays a
telephone bill of 60 which relates to the period October December 20X7.
Although the payment does not go through the cash book until 20X8, this expense must
be included in the accounts for the year ended 31 December 20X7, as it was incurred
during this period.
136
ACCRUED EXPENSES
Fiona set up a business on 1 January 20X7. Her cash payments for the year to 31
December 20X7 included:
Date
paid
Amount
10.03.X7
96
12.06.X7
120
quarter to 31 May 20X7
14.09.X7
104
quarter to 31 August 20X7
10.12.X7
145
quarter to 30 November 20X7
Period
Electricity
2 months to 28 February 20X7
On 6 March 20X8 Fiona received an electricity bill for 168 for the quarter to 28 February
20X8.
Required
(a)
Calculate the electricity expense for the year ended 31/12/X7.
(b)
Calculate the accrued expense at the end of the year.
(c)
Show how the above transactions would be recorded in the ledger

accounts.
Electricity expense
137
Bank
Journal entry for accrued expenses

Adjustments for accruals and prepayments tend to occur at the end of the year and are
made by way of a journal entry.
The adjustment for accruals can be done in one account as shown in the example above.
However the actual journal which would be posted in the main ledger is:
Account name
Dr
Expense account (SPL)
Cr
Accruals (SOFP)
Whenever a journal adjustment is made, a business should provide a 'narrative' so that

anyone reviewing the adjustment can see why the journal was made. A suitable
narrative for the above journal entry is:
'being: an adjustment to accrue the xx expense for the year ended xx'.
Some CBT tasks will require a narrative explanation. In the exam they are usually
entered by selecting the correct option from a picklist.
Statement of financial position presentation

Accruals are a liability of the business and are shown in the statement of financial
position within the 'current liabilities' section.
ACCRUED EXPENSES JOURNAL

Refer back to your solution to the previous example, Accrued expenses.
Required
Enter the journal entry required for the year end accrual. Include a narrative.
Account name
Being:
138
Dr
Cr
Picklist:
Accrued expenses, Electricity expense, Prepaid expenses
An adjustment to accrue the electricity expense for the year ended December 20X7
An adjustment to record the electricity prepayment for the year ended December 20X7
Prepaid expenses
Prepaid expenses arise when expenses are paid for before they have been used, ie
expenses in advance.
Example
On 20 December 20X7 Fred pays for insurance on his business premises for the 12
months commencing 1 January 20X8.
Although the payment was made in 20X7, the expense should not appear in the accounts
for 20X7. The accounts for 20X7 will show a prepayment for the full amount of the
insurance cost and the expense will be recorded in 20X8.
PREPAID EXPENSES
Following on from the example, Accrued expenses, Fiona also made the following rent
payments for the year to 31 December 20X7:
Date
paid
Amount
Period
Rent
01.02.X7
375
06.04.X7
1,584
3 months to 31 March 20X7

12 months to 31 March 20X8
Required
(a)
Calculate the expense incurred by Fiona for rent for the year ended 31
December 20X7.
Working
139
(b)
Calculate the prepaid expense at the end of the year.
(c)

accounts.
Rent expense
Bank
Journal entry for prepaid expenses

As we saw with accruals, the adjustment for prepayments can also be done in one
account. However, the actual journal which would be posted in the main ledger is:
Account name
Prepaid expenses (SOFP)
Dr
Cr
X
X
Again, whenever a journal adjustment is made, a business should provide a 'narrative'

so that anyone reviewing the adjustment can see why the journal was made. A suitable
narrative for the above journal entry is:
'being: an adjustment to record the xx prepayment for the year ended xx '.
140

Prepayments are an asset of the business and are shown in the statement of financial
position within the 'current assets' section.
PREPAID EXPENSES JOURNAL

Required
Referring back to the previous example, record the journal entry required for
the year end prepayment. Include a narrative.
Account name
Dr
Cr
Being:
Picklist:
Accrued expenses, Prepaid expenses, Rent expense
An adjustment to accrue the rent expense for the year ended December 20X7
An adjustment to record the rent prepayment for the year ended December 20X7
TRANSFER TO PROFIT OR LOSS

Following on from Accrued expenses, in 20X8 Fiona paid the following electricity bills:
Date paid
Amount
12.03.X8
168
quarter to 28 February 20X8
09.06.X8
134
quarter to 31 May 20X8
12.09.X8
118
quarter to 31 August 20X8
12.12.X8
158
quarter to 30 November 20X8
Period
During March 20X9 Fiona received an electricity bill for 189 for the quarter to 28
February 20X9.
Required
Prepare the electricity expense account for the year ended 31 December 20X8
and close it off by showing the transfer to the statement of profit or loss.
141
Solution
Electricity expense
01.01.X8 Balance b/d
56
Bank
Accrued income
So far we have considered the situation where we are making accruals and prepayments
for expenses (when they are paid in arrears or advance).
Income may also be received in arrears or advance and so the same principles apply.
pg 126 to
127
Remember, though, that here we are considering income rather than expense. Income
and expenses are opposite items and so the entries for accruals and prepayments for
income will also be the other way round.
Accrued income is income which has been earned during the accounting period but
not invoiced or received.
Example
Fred owns a property which he rents out for 3,000 per quarter. The property was
occupied all year; however, Fred only received 9,000 in rent because he forgot to send
out the final invoice of the year.
As the property was let for 12 months, Fred's statement of profit or loss should show
income of 12,000 (4 3,000) as this is what he has earned. This means there will be
accrued income of 3,000 in the statement of financial position at the year end.
142
ACCRUED INCOME
A business has a year end of 31 December 20X9.
A client has paid commission receivable of 17,000. A further 4,000 is also due;
however, a bill has not yet been sent out for this amount or recorded in the accounting
records.
Required
(a)
Calculate the income in respect of commission receivable for the year

(b)
Calculate the amount of accrued income due at the end of the year.
Journal entry for accrued income

The journal which would be posted in the main ledger is:
Account name
Accrued income (SOFP)
Dr
Cr
Profit or loss account (SPL)
A suitable narrative for the above journal entry is:

'being: an adjustment to record the xx accrued income for the year ended xx'.
ACCRUED INCOME JOURNAL

Following on from the example, Accrued income:
Required
Show the journal entry required to record the year end accrued income in the
main ledger. Include a narrative.
Account name
Dr
Cr
Being:
Picklist:
Accrued expenses, Accrued income, Commission receivable, Prepaid expenses, Prepaid
income
An adjustment to accrue the commission receivable for the year ended December 20X9
An adjustment to record the prepaid commission receivable for the year ended December
20X9
143

Accrued income is an asset of the business and shown in the statement of financial
position within the 'current assets' section.
Prepaid income (deferred income)

pg 127 128
Prepaid income is income which is received in advance of being earned.

You may also hear this referred to as deferred income.
Example
Fred has a year end of December and rents out his property for 1,000 per month. His
tenant normally pays the rent due to Fred on a monthly basis.
However, during December 20X7 the tenant paid 2,000 as he would be on holiday when
the January 20X8 payment was due.
In 20X7 Fred has received income of 13,000 but only 12,000 of this relates to the
current year. Therefore, there is 1,000 prepaid income as at 31 December 20X7.
PREPAID INCOME
A business has a year end of 31 December 20X9. It rents out a property in exchange for
rental income of 2,000 per month.
On 25 December 20X9 the client overpays, and 2,000 is received into the bank account
which relates to rental income for the year ended 31 December 20Y0.
Required
(a)
Calculate the rental income for the year ended 31 December 20X9.
(b)
Calculate the amount of prepaid income at the end of the year.
144
Journal entry for prepaid income

The journal which would be posted in the main ledger is:
Account name
Statement of profit or loss account (SPL)
Dr
Cr
Prepaid income (SOFP)
A suitable narrative for the above journal entry is:

'being: an adjustment to record the xx prepaid income for the year ended xx'.
PREPAID INCOME - JOURNAL

Following on from the example, Prepaid income:
Required
Show the journal entry required to record the year end prepaid income in the
Account name
Dr
Cr
Being:
Picklist:
Accrued expenses, Accrued income, Prepaid expenses, Prepaid income, Rental income
An adjustment to accrue the rental income as at December 20X9
An adjustment to record the prepaid rental income as at December 20X9

Prepaid income is a liability of the business and shown in the statement of financial
position within the 'current liabilities' section.
Preparing an extract from the trial balance

In the level 2 accounting courses we prepared a trial balance. The trial balance is also
tested in Accounts Preparation and this topic is explained in detail in the chapter The trial
balance, errors and the suspense account.
Exam tasks may ask you to prepare a trial balance, taking into account accrued expenses
and income or prepaid expenses and income.
Therefore, it is useful to complete relevant extracts from the trial balance in this chapter.
145
EXTRACT FROM A TRIAL BALANCE ACCRUED INCOME

AND EXPENSES
This task is about preparing an extract from a trial balance.
You are working on the accounting records of a business with a year end of 31 July.
You have two extracts from the ledger accounts as at 31 July 20X9.
Office costs
31/07/X9
Balance b/f
2,637
Included in this balance is an amount for accrued expenses of 110 as at 31/07/X9.

Recycling rebates
31/07/X9
Balance b/f
12,535
Included in this balance is an amount for accrued income of 489 as at 31/07/X9.

There were no accruals or prepayments of expenses and income other than those stated.
Required
Using all the information given above, enter amounts in the appropriate trial
balance columns for the accounts shown.
Do NOT enter zeros in unused column cells. Do NOT enter any figures as
negatives.
Extract from the trial balance as at 31 July 20X9:
Ledger balances
Account
Accrued expenses
Accrued income
Office costs
Recycling rebates
146
Trial balance
Dr
Cr
EXTRACT FROM A TRIAL BALANCE PREPAID INCOME

AND EXPENSES
This task is about preparing an extract from a trial balance.
You are working on the accounting records of a business with a year end of 31 July.
You have two extracts from the ledger accounts as at 31 July 20X9.
General expenses
31/07/X9
Balance b/f
8,626
This balance has been adjusted for prepaid expenses of 2,017 as at 31/07/X9.
Sundry income
31/07/X9
Balance b/f
36,535
This balance has been adjusted for prepaid income of 1,111 as at 31/07/X9.
Required
negatives.
Ledger balances
Account
Trial balance
Dr
Cr
General expenses
Prepaid expenses
Prepaid income
Sundry income
147
Further preparation for the CBT

Having looked at accruals and prepayments in some detail, it is important to work
through exam standard questions.
ACCOUNTING FOR ACCRUED AND PREPAID INCOME AND

EXPENSES
This task is about accounting for accrued and prepaid income and expenses.
You are working on the accounts of a business for the year ended 31 August 20X9. In
this task, you can ignore VAT.
You have the following information:
The balance on the commission receivable account at the beginning of the financial
year is 6,000.
This is the commission receivable that was accrued at the end of the year on
31/08/X8.
The bank summary for the year shows receipts for commission receivable of
42,000.
The commission receivable account has been adjusted for commission of 5,800
relating to the month of August 20X9 but received after the year end.
Double entry accounting is done in the general ledger.
Required
(a)
Which of the following shows how the general ledger account for
commission receivable looked at the beginning of the financial year? Tick
the correct answer.
Commission receivable
01/09/X8
Accrued income
6,000
01/09/X9
Accrued income
6,000
01/09/X8
Accrued income
6,000
01/09/X9
148
Accrued income
6,000
(b)
Complete the following statement:

On 31/08/X9, the commission receivable account shows an adjustment for
income
of
Picklist: accrued, credit, debit, prepaid

(c)
Calculate the commission receivable for the year ended 31/08/X9.
The bank summary for the year shows payments for advertising expenses of 9,110.
(d)
Update the advertising expenses account for this, showing clearly the
balance to be carried down.
Advertising expenses
Balance b/d
2,200
Picklist: Accrued expenses, Accrued income, Advertising expenses, Balance b/d,

Balance c/d, Bank, Commission receivable, Prepaid expenses, Prepaid income,
Profit or loss account, Purchases, Purchases ledger control account, Sales, Sales
ledger control account
Before transferring the balance on the advertising expenses account to the statement of
profit or loss you find that the payments figure for advertising expenses included 660
relating to the period 01/08/X9 to 31/01/Y0.
(e)

An adjustment of
needs to be made, which will
the advertising expenses for the year ended 31/08/X9.

Picklist: decrease, increase
149

requirements on any area of the syllabus. If the requirements are based on accruals and
prepayments, they could be structured as follows.
ACCOUNTS PREPARATION KNOWLEDGE

A company has a year end of 31 December 20X8. On 25 December the accountant pays
rent for the quarter ended 31 March 20X9.
Required
(a)
Identify how it will be shown in the statement of financial position.

Choose the ONE most suitable option.
Accrued expenses (current liability)

Accrued income (current asset)
Prepaid expenses (current asset)
Prepaid income (current liability)
(b)

True
Application of the accruals concept means accounting on a

cash basis.
Prepaid income is accounted for on the debit side of the trial
balance.
A customer owed 400 rent at the year end. This will be
adjusted as a credit to the statement of profit or loss and a
debit to the accrued income account, in the SOFP.
150
False

Expense accruals adjustment:
Account name
Dr
Cr
Accrued expenses (SOFP)
Expense prepayments adjustment:

Account name
Prepaid expenses (SOFP)
Dr
Cr
Accrual for income adjustment:

Account name
Accrued income (SOFP)
Dr
Cr
Prepayment of income adjustment:

Account name
Dr
Cr
Prepaid income (SOFP)
Summary of statement of financial position presentation

If you are asked to include accruals and prepayments in a trial balance, remember that:
Current assets
Current liabilities
Accrued income
Accrued expenses
Prepaid expenses
Prepaid income
151
SUMMARY
152
ANSWERS
ACCRUED EXPENSES
(a)
Calculate the electricity expense for the year ended 31/12/X7.
Electricity expense
Cash paid:
10.03.X7
12.06.X7
14.09.X7
10.12.X7
December expense missing ( 1
96
120
104
145
56
168)
521
(b)
Calculate the accrued expense at the end of the year.

Electricity accrued expense is 56
(c)

accounts.
Electricity expense
10.03.X7 Bank
96
12.06.X7 Bank
120
14.09.X7 Bank
104
10.12.X7 Bank
145
31.12.X7 Balance c/d

(accrued expense)
56
31.12.X7 SPL
521
521
521
01.1.X8 Balance b/d
56
Bank
10.03.X7 Electricity
expense
96
expense
120
expense
104
expense
145
153
ACCRUED EXPENSES JOURNAL

Enter the journal entry required for the year end accrual. Include a narrative.
Dr
Account name
Electricity expense
Cr
56
Accrued expenses
56
Being: an adjustment to accrue the electricity expense for December 20X7
PREPAID EXPENSES
(a)
Calculate the expense incurred by Fiona for rent for the year ended 31
December 20X7.
Rent expense
Cash paid:
1.2.X7
6.4.X7
Less expense relating to Jan March X8 ( 3
12
1,584)
375
1,584
(396)
1,563
(b)
Calculate the prepaid expense at the end of the year.

Rent prepaid expense is 396
(c)

accounts.
Rent expense
1.2.X7 Bank
375
6.4.X7 Bank
1,584
31.12.X7 SPL
(prepaid expense)
1,959
1.1.X8 Balance b/d
1,563
396
1,959
396
Bank
154
1.2.X7 Rent expense
375
6.4.X7 Rent expense
1,584
PREPAID EXPENSES JOURNAL

Referring back to the previous example, record the journal entry required for
the year end prepayment. Include a narrative.
Dr
Account name
Prepaid expenses
Cr
396
Rent expense
396
Being: an adjustment to record the rent prepayment for the year ended 31 December
20X7
TRANSFER TO PROFIT OR LOSS

Prepare the electricity expense account for the year ended 31 December 20X8
and close it off by showing the transfer to the statement of profit or loss.
Electricity expense
12.3.X8 Bank
168
09.6.X8 Bank
134
12.9.X8 Bank
118
12.12.X8 Bank
158
31.12.X8 Balance c/d (accrued

expense)
63
1.1.X8 Balance b/d
31.12.X8 SPL
56
585
641
641
1.1.X9 Balance b/d
63
Bank
12.3.X8 Electricity expense
168
134
118
158
155
ACCRUED INCOME
(a)
Calculate the income in respect of commission receivable for the year

(b)
21,000
Calculate the amount of accrued income due at the end of the year.
4,000
ACCRUED INCOME JOURNAL

Show the journal entry required to record the year end accrued income in the
Account name
Accrued income
Dr
Cr
4,000
4,000
Being: An adjustment to accrue the commission receivable for the year ended December
20X9
PREPAID INCOME
(a)
Calculate the rental income for the year ended 31 December 20X9.
(b)
Calculate the amount of prepaid income at the end of the year.
156
24,000
2,000
PREPAID INCOME JOURNAL

Show the journal entry required to record the year end prepaid income in the
Dr
Account name
Rental income
Cr
2,000
Prepaid income
2,000
Being: An adjustment to record the prepaid rental income as at December 20X9
EXTRACT FROM A TRIAL BALANCE ACCRUED INCOME

AND EXPENSES
Ledger balances
Account
Trial balance
Dr
Accrued expenses
Accrued income
Office costs
Recycling rebates
Cr
110
489
2,637
12,535
157
EXTRACT FROM A TRIAL BALANCE PREPAID INCOME

AND EXPENSES
Ledger balances
Account
Trial balance
Dr
General expenses
8,626
Prepaid expenses
2,017
Cr
Prepaid income
1,111
Sundry income
36,535
ACCOUNTING FOR ACCRUED AND PREPAID INCOME AND

EXPENSES
(a)
Which of the following shows how the general ledger account for
commission receivable looked at the beginning of the financial year? Tick
the correct answer.
01/09/X8
(b)
Accrued income
6,000

On 31/08/X9, the commission receivable account shows an adjustment for
accrued
income
of
5,800
credit.
(c) Calculate the commission receivable for the year ended 31/08/X9.
41,800
Working: 42,000 minus 6,000 plus 5,800
158
(d)
Update the advertising expenses account for this, showing clearly the
balance to be carried down.
Advertising expenses
Bank
9,110
Balance b/d
2,200
Balance c/d
6,910
9,110
(e)
9,110

An adjustment of
550
needs to be made, which will
decrease
the advertising expenses for the year ended 31/08/X9.

(a)
Identify how it will be shown in the statement of financial position.

Choose the ONE most suitable option.
Accrued expenses (current liability)

Accrued income (current asset)
Prepaid expenses (current asset)

Prepaid income (current liability)
(b)

True
False
Application of the accruals concept means accounting on a

cash basis.
Prepaid income is accounted for on the debit side of the trial

balance.
A customer owed 400 rent at the year end. This will be

adjusted as a credit to the statement of profit or loss and a
debit to the accrued income account, in the SOFP.
159
160
7
INVENTORIES
Assessment Criteria
Describe the main requirements of accounting standards (IFRS) in relation to

inventory
Record the journal entries for closing inventory
Account for these adjustments: closing inventory
Exam Context
Questions on inventory are likely to focus on areas such as how inventories should be
valued, what can be included in the cost of inventories and also how the net realisable
value of inventories is calculated. Also, and as you will see in the chapter, The extended
trial balance, you need to know how to record inventory in the accounting records.
The knowledge covered in this chapter is also examinable in the level 4 paper, Financial
Statements. However, there is no additional knowledge required at level 4 and so this
area is largely assumed knowledge in the next paper.
Business Context
For businesses such as retailers, which buy and sell goods, the inventories figure in a set
of accounts represents money tied up in working capital. Businesses will seek to
minimise the amount of inventories they hold, partly so that they reduce the amount of
money tied up in it, but also to reduce the risk of their inventories becoming obsolete as
tastes and fashions change.
7: Inventories
161
OVERVIEW
Accounting adjustment
Inventories
Valuation
Cost
Net realisable value
Methods of estimating cost
FIFO
162
7: Inventories
AVCO
LIFO
Introduction
For some businesses, for example manufacturing entities, inventories can be a significant
figure.
It impacts the financial statements in two ways:
a)
Statement of financial position: a potentially large balance within current assets
b)
Statement of profit or loss: opening and closing inventory have a direct impact on
cost of goods sold and therefore profits
Businesses must therefore ensure that their financial statements account for inventories
accurately in terms of:
a)
b)
The accounting adjustment

Its valuation
Inventories are generally accounted for as a year end adjustment via a journal entry.
Again as with all journals, a narrative should be provided.
Closing inventories
The goods held by the business at the end of the year must be included as an asset in
the statement of financial position and within cost of goods sold in the statement of
profit or loss.
The accounting entry is:
Account name
Closing inventories (SOFP)
Dr
Cr
Closing inventories (SPL)
RECORDING INVENTORIES IN THE FINANCIAL

STATEMENTS
During the year ended 31 December, Colin opened a business selling telephones. He
bought 50 phones for 20 each, and sold 15 for 30 each.
Required
(a)
Prepare the journal for closing inventories and include a narrative.

Account name
Dr
Cr
Being:
7: Inventories
163
Working:
(b)
Complete the financial statement extracts.
Statement of profit or loss as at 31 December
Sales revenue
Cost of goods sold:
Purchases
Less closing inventories
Gross profit
Statement of financial position as at 31 December
Non-current assets
Cost
Depreciation
Carrying
amount
1,900
400
1,500
Current assets
Inventories
Receivables
200
Bank
100

Total assets
164
7: Inventories
The inventories figure comprises two elements:

QUANTITY VALUATION
Quantity:
normally ascertained by inventory count at end of accounting period or by

continuous inventory records.
Valuation:
much more subjective, so guidance is provided in the International

accounting standard: IAS 2
Inventory overview
Inventories
Quantity
Continuous
inventory records
Inventory
count
All costs to get

item to current
location in
current condition
Actual cost
Valuation
Lower of
Cost
and
NRV
Selling price
Less: completion costs
Less: selling costs
X
(X)
(X)
X
Deemed cost
FIFO / Average Cost
LIFO
Valuation
The basic rule per IAS 2 Inventories is:
'Inventories should be measured at the lower of cost and net realisable value.'
This is an example of 'prudence' in presenting financial information.
a)
If inventories are expected to be sold at a profit:

i)
ii)
b)
Value at cost
Do not anticipate profit
If inventories are expected to be sold at a loss:

i)
ii)
Value at net realisable value

Do provide for the future loss
7: Inventories
165
Cost
The cost of an item of inventories includes:
For example:
Purchase price
Import duties
Cost of purchase
But not:
VAT (reclaimable from HMRC)

Trade discounts (deducted from
cost of purchase)
Costs of conversion
Other costs incurred in bringing

the inventories to their
present location and condition
Relating to production:
Direct labour
Direct/variable overheads
An allocation of fixed overheads
For example:
Carriage inwards
DETERMINING THE COST OF INVENTORIES

Required
According to IAS 2 Inventories, which of the following should not be included
in determining the cost of the inventories of an entity?
Tick
Labour costs
Transport costs to deliver goods to customers
Administrative overheads
Depreciation on a factory machine
Net realisable value (NRV)

The net realisable value of an item is essentially its net selling proceeds after all costs
have been deducted.
It is calculated as:
Estimated selling price
Less estimated costs of completion
Less estimated selling and distribution costs
166
7: Inventories
X
(X)
(X)
X
NET REALISABLE VALUE

Jessie is trying to value her inventories. She has the following information available:
Selling price
35
Costs incurred to date
20
Cost of work to complete item
12
Selling costs per item
1
Required
What is the net realisable value of Jessie's inventories?
Workings
No netting off
The IAS 2 rule 'lower of cost and net realisable value' should be applied as far as
possible on an item by item (or line by line) basis.
Illustration
Suppose an entity has four items of inventories on hand at the year end. Their costs and
NRVs are as follows:
Inventory item
Lower of cost and

NRV
Cost
NRV
27
32
27
14
43
55
43
29
40
29
113
135
107
It would be incorrect to compare total cost of 113 with total NRV of 135 and state
inventories as 113.
A loss on item 2 of 6 can be foreseen and should therefore be recognised.
The comparison should be made for each item of inventory and thus a value of 107
would be attributed to inventories.
7: Inventories
167
This would be accounted for by the journal entry:

Account name
Dr
Cr
107
107
CALCULATING CLOSING INVENTORIES

Badger Boy makes widgets and has not made any entries for closing inventory for the
year ended 31 August 20X9. Closing inventory has been valued at cost of 14,700.
Included in this figure is a widget costing 1,800 that will be sold for 1,500.
Required
Give the journal entry needed to record closing inventory. Provide a narrative
for the journal entry.
Account name
Dr
Cr
Being:
Working:
Theoretical methods of estimating cost

Issue
If various batches of inventories have been purchased at different times during the year
and at different prices, it may be impossible to determine precisely which items are still
held at the year end and therefore what the actual purchase cost of the goods was. The
accounting standards therefore allow an entity to approximate the cost of its inventories.
In Accounts Preparation paper, the AAT requires you to be aware of the methods
available to an organisation to estimate the cost of its inventories. You will not
however be asked to perform calculations in relation to these methods.
The methods are:
168
First in, first out (FIFO)

Average cost
Last in, first out (LIFO)
7: Inventories
a)
FIFO
Under FIFO it is assumed that:
i)
ii)
First goods purchased/produced will be the first to be sold

Remaining inventories are therefore the most recent purchases/production
This is a sensible approximation method especially if the business sells perishable

items!
b)
Weighted average cost (AVCO)

There are various averaging methods available by which a business can
approximate the cost of its inventories. These range from a simple average cost
whereby the cost of all purchases/production during the year is divided by the total
number of units purchased to a weighted average cost whereby a new average
is calculated every time new items are purchased.
This is a good approximation method where the inventory items are
interchangeable, for example in a timber merchants.
c)
LIFO
Under LIFO it is assumed that:
i)
Last goods purchased/produced will be the first to be sold
ii)
Remaining inventories are therefore the oldest or earliest purchases/

production
Note that the LIFO method is prohibited by international accounting

standards because it is unlikely to produce a cost figure which is a close
approximation to actual costs.
Inventory reconciliation
We mentioned that a business may work out the quantity of inventory it holds either by
performing a inventory count at the year end or by maintaining continuous inventory
records on a computer system.
Where a business maintains inventory records, the computer system will generate a
figure at the year end for the quantity of each inventory item held. However, as with
any computer system, errors can occur. For example:
Incorrect entries regarding quantities received

Inventories damaged and not recorded
Inventories stolen
Inventory sold but included in inventory counts as it has not yet been despatched
Due to the above risks all businesses should perform periodic inventory counts to ensure
that the information held by the computerised records agrees to the actual inventory
levels in the warehouse.
Where discrepancies are noted, the computerised inventory records should be corrected
and updated.
7: Inventories
169

requirements on any area of the syllabus. If the requirements are based on inventories,
they could be structured as follows.

Required
(a)
Which of these statements is true? Choose ONE:
The first in first out method of inventory valuation is the only

method acceptable under accounting standards.
Advertising costs may be included in the cost of inventory.
Inventory costs may include direct labour relating to the production
of goods for sale.
Inventory is always valued at cost.
A business estimates the cost of its inventories at the year end by assuming that
the last goods purchased will be the first to be sold.
(b)
What is this method of inventory valuation known as?
First in, first out

Lower of cost and net realisable value
Average cost
Last in, first out
170
7: Inventories
SUMMARY
Closing inventory:
Dr Closing inventories (SOFP)
Cr Closing inventories (SPL)
Inventories
'Inventories should be measured

at the lower of cost and net
realisable value'
This is on a line by line basis
Valuation
Cost
Net realisable value
Cost includes:
- costs of purchase
- costs of conversion
- other costs
Cost includes:
costs of purchase
costs of conversion
other costs
X
(X)
(X)
X
Methods of estimating cost
FIFO
'First in, first out'
The first goods
purchased will be
the first sold
Year-end
inventories relate
to the most
recent purchases
AVCO
'Average cost'
Simple average
calculation:
Total purchases
cost total
number of units
purchased
LIFO
'Last in, first out'
The last goods
purchased will be
the first sold
Year-end
inventories relate
to the oldest
purchases
Not a reliable
method
7: Inventories
171
ANSWERS
RECORDING INVENTORIES IN THE FINANCIAL
STATEMENTS
(a)
Prepare the journal for closing inventories and include a narrative.

Dr
Account name
Cr
700
700
Being: year end adjustment to record closing inventories
Working:
Phones bought
Less phones sold
Phones held at year end
(b)
50
(15)
35 20 cost = 700
Complete the financial statement extracts.
Statement of profit or loss as at 31 December
450
Sales revenue (15 30)

Cost of goods sold:
1,000
Purchases (50 20)

Less closing inventories
(700)
Gross profit
300
150
Statement of financial position as at 31 December
Non-current assets
Cost
Depreciation
Carrying
amount
1,900
400
1,500
Current assets
172
Inventories
700
Receivables
200
Bank
100
1,000
Total assets
2,500
7: Inventories
DETERMINING THE COST OF INVENTORIES

According to IAS 2 Inventories, which of the following should not be included
in determining the cost of the inventories of an entity?
Tick
Labour costs
Transport costs to deliver goods to customers
Administrative overheads
Depreciation on a factory machine

Transport costs to deliver goods to customers are an example of carriage outwards and
should not be included. Administrative overheads do not relate to production and cannot
therefore be included.
The depreciation of the factory machine is a production overhead and should be
included.
NET REALISABLE VALUE

What is the net realisable value of Jessie's inventories?
22
Net realisable value is:
Estimated selling price

Less costs of completion
Less selling costs
35
(12)
(1)
22
Tutorial note: value at cost 20 being lower than NRV of 22.
7: Inventories
173
CALCULATING CLOSING INVENTORIES

Give the journal entry needed to record closing inventory. Provide a narrative
for the journal entry.
Account name
Dr
Cr
14,400
14,400
Being: year end adjustment to record inventory at the lower of cost and NRV
Working:
Inventory costing 1,800 can only be sold for 1,500 and so the total closing inventory
figure needs to be written down by 300.
Original cost
Less write down
Lower of cost and NRV
14,700
(300)
14,400

(a)
The first in first out method of inventory valuation is the only

method acceptable under accounting standards.
Advertising costs may be included in the cost of inventory.
Inventory costs may include direct labour relating to the production
of goods for sale.
Inventory is always valued at cost.

(b)
What is this method of inventory valuation known as?
First in, first out

Lower of cost and net realisable value
Average cost
Last in, first out
174
7: Inventories
individual requirements..
Topic name

concepts
Accounting concepts
1
2
assets
assets
assets
Inventories
Inventories
Course notes
chapter
175
176
8
IRRECOVERABLE AND
DOUBTFUL DEBTS
Assessment Criteria
Explain the reasons for, and method of, accounting for irrecoverable debts and
allowances for doubtful debts
Record the journal entries for irrecoverable debts and allowances for doubtful
debts
Account for these adjustments:
Irrecoverable debts
Exam Context
This topic could be examined in several ways. You may be asked to identify the
concepts which require us to adjust for irrecoverable and doubtful debts in our accounts
or complete journal entries to record these adjustments. Also, the irrecoverable and
doubtful debt accounts may also feature in an extended trial balance task (studied later
in the course).
Irrecoverable debts is a topic you covered in level 2 Control accounts, journals and the
banking system. The Accounts Preparation exam extends this knowledge and requires
you to be able to account for doubtful debts as well. This area is also assumed
knowledge for the level 4 paper, Financial Statements.
Business Context
Irrecoverable and doubtful debts is always a topical area and no more so than in todays
economic climate. Nowadays, most businesses sell on credit and this immediately
exposes them to the risk that the customer doesnt pay. This will inevitably mean that a
business year end receivables figure will need to be reduced for any amounts that may
not be recoverable.
8: Irrecoverable and doubtful debts
177
OVERVIEW
Irrecoverable debts

debts
Doubtful debts
Allowances
Specific
178
General
Introduction
This chapter is designed to enable you to calculate and make adjustment for
irrecoverable debts, and allowances for receivables.
A trade receivable should only be classed as an asset if it is probable that it is
recoverable (ie that the customer will pay the amounts due).
Irrecoverable debts
If a debt is definitely irrecoverable it should be written off to the statement of profit
or loss as an irrecoverable debt. This is an example of prudence.
Dr
Account name
Irrecoverable debts expense (SPL)
Cr
Sales ledger control account (SOFP)
SEND CO (PART I)
Send Co has a balance on its sales ledger control account at 31 December 20X8 of
105,000. A review of customer files indicates that two customers, A and B, which owe
15,000 and 22,000 respectively, have gone bankrupt and their debts are considered
irrecoverable.
Required
(a)
Calculate the balance b/d on the sales ledger control account at the end
of the year.
(b)
Calculate the irrecoverable debts expense shown in the statement of

profit or loss.
Solution
105,000
179
G CO
G Co has a balance on its sales ledger control account at 31 July 20X9 of 52,000. As
part of its year end procedures, it has reviewed its customer files and realised that one
customer, Pat Co, which owes 7,800, has severe financial difficulties and is unlikely to
be able to pay its debt.
Required
(a)
What will be the accounting entries to write off the debt in the main
ledger?
Account name
Dr
Cr
Picklist:
Bank; Irrecoverable debts expense; Purchases; Sales; Sales ledger control account.
(b)
What will be the closing balance on the trade receivables account in G

Cos financial statements?
Doubtful debts
If a debt is possibly irrecoverable an allowance for the potential irrecoverability of that
debt should be made. A new account is created, called the allowance for doubtful
debts account. This account is offset against the sales ledger control account balance
in the statement of financial position and the expense taken to the statement of profit or
loss.
Adjusting for the allowance for doubtful debts is an example of the prudence concept
from the chapter, Accounting concepts.
180
Dr
Account name
Allowance for doubtful debts adjustment
account (SPL)*
Cr
Allowance for doubtful debts account (SOFP)
*Again, an 'irrecoverable debts expense' account can also be used.
SEND CO (PART II)

Following on from Send Co (part I), a further review of Send Co's customer files indicates
there is some uncertainty as to whether a debt of 8,000 owed by C is recoverable.
Required
(a)
Calculate the allowance for doubtful debts to include in the statement of

financial position.
(b)
Calculate the balance on the allowance for doubtful debts adjustment

account which will be shown in the statement of profit or loss.
(c)
Show how the information from Send Co (part I) and Send Co (part II)
would be recorded in extracts from the statement of profit or loss and
statement of financial position.
Solution
(a) & (b)
Allowance for doubtful debts adjustment account (SPL)
181
(c)
Statement of profit or loss (extract)
Expenses
Irrecoverable debts expense (see Send Co (part I))
Allowance for doubtful debts adjustment account
Statement of financial position (extract)
Current assets
Trade receivables (see Send Co (part I))
Less allowance for doubtful debts
Types of allowance
a)
Specific:
provided against a particular/named individual customer.
b)
General:
percentage applied to the total on the sales ledger control account

after:
i)
Writing off irrecoverable debts;
ii)
Deducting the full balance of any customers for which specific allowance has
been created.
Order of calculation
a)
Write up the SLCA and account for credit sales and cash received in period.
b)
Write off irrecoverable debts.

Account name
Dr

c)

account (SPL)
Allowance for doubtful debts account
(SOFP)
182
Make any entries for specific allowances:

Account name
d)
Cr
Dr
Cr
X
X
In workings, calculate the general allowance on the receivables balance (after

irrecoverable debts written off and excluding full amounts for which specific
allowance has been made).
e)
Illustration
Total receivables
100
Less specific allowances
(20)
80
General allowance @ 5% =
total allowance:
Specific
20
General
4
24
DODGY CO
A business sales ledger control account showed a year end balance of 47,440. It was
decided that amounts totalling 340 should be written off as irrecoverable, a specific
allowance was to be made against an amount of 400 due from Dodgy Co, a customer,
and a general allowance of 2% was to be made against remaining debts.
Required
(a)
Calculate the allowance for doubtful debts shown in the statement of

financial position.
(b)
Calculate the total amount which will be shown in the statement of profit
or loss for the irrecoverable debts expense and the balance on the
allowance for doubtful debts adjustment account.
Workings
Balance b/d
47,440
183
General allowance
SLCA balance (net of irrecoverable debts written off)

Less specific allowance
General allowance @ 2%
184
Effect in subsequent periods

Irrecoverable debt written off last year, customer pays this year
If an irrecoverable debt is recovered having previously been written off, it is credited to
the irrecoverable debts expense account, ie the accounting treatment from the original
write-off is reversed.
1.
Cash received
Account name
Cash
Dr

2.
Cr
Reverse original write off

Account name
Dr
Cr
Irrecoverable debts expense
OR
3.
Short method
Account name
Cash
Dr
Cr
SEND CO (PART III)

Following on from the example Send Co (part I), Send Co subsequently received a
cheque for 15,000 from customer A.
Required
What will be the accounting entries to record the monies received in the main
ledger?
Account name
Dr
Cr
Picklist:
Allowance for doubtful debts account, Allowance for doubtful debts adjustment account,
Bank, Irrecoverable debt expense, Sales, Sales ledger control account
185
Changes in the allowance for doubtful debts

We saw in Dodgy Co that a business will review its customer list at the end of an
accounting period and will make an allowance for any amounts where there is doubt over
the recovery of the amount.
This allowance may be a specific allowance against a particular customer or a general
allowance against all remaining customers.
At the end of each accounting period, the business will decide whether it needs to
increase or decrease the allowance for doubtful debts.
There are two ways to account for this change:
1.
Remove opening allowance

Account name
(SOFP)
Dr
Cr
X
X

account (SPL)
and replace with closing allowance
Account name
account (SPL)
Dr
Cr
X
X

(SOFP)
Or
2.
Short method:
Increase/decrease opening allowance to arrive at required closing allowance
Increase:
Account name
account (SPL)
Dr
Cr
X
X

(SOFP)
Decrease:
Account name
(SOFP)
account (SPL)
186
Dr
Cr
X
X
A CO
The following information is available for A Co.
Year ended 31 December 20X7: Sales ledger control account balance 20,000
Year ended 31 December 20X8: Sales ledger control account balance 30,000
A Co requires a general allowance of 5% of receivables in each year.
Required
Show the required adjustment to the allowance for receivables account for the
year ended 31 December 20X8 using both methods described above.
Solution
Long method:
Allowance for doubtful debts (SOFP)
187
Short method:
Workings:
E CO
At 30 September 20X7 E Co had an allowance for doubtful debts of 24,000.
During the year ended 30 September 20X8 E Co wrote off irrecoverable debts totalling
18,000. The closing allowance for doubtful debts is required to be 21,000.
Required
What is the total expense to record in the statement of profit or loss for the
year ended 30 September 20X8 for the above items?
Workings
188

The final task in the Accounts Preparation exam will test your knowledge of any area of
the syllabus. If the task is based on irrecoverable and doubtful debts, it could be as
follows.

Required
(a)
An irrecoverable debt should remain in the sales ledger control

account at the year end.
Once a company has calculated the allowance for doubtful debts it
will remain unchanged each year.
The doubtful debt adjustment will effect the statement of profit or
loss and statement of financial position.
If a debt is definitely irrecoverable it should be written off to the
statement of profit or loss. This is an example of going concern.
(b)
Which ONE of the accounting principles best explains why doubtful debts
are adjusted for the year end?
Accruals
Consistency
Going concern
Prudence
189

Irrecoverable debt adjustment:
Account name
Irrecoverable debts account (SPL)
Dr
Cr
Doubtful debt adjustment:

Account name
Dr
Cr
Recording of cash received from a customer whose balance was previously written off:
Account name
Bank (SOFP)
Dr
Cr
Adjusting the opening allowance for doubtful debts to arrive at the required closing
allowance:
To increase the opening allowance:
Account name
Dr
Cr
To decrease the opening allowance:

Account name
190
Dr
Cr
X
X
SUMMARY
'A debt which is definitely irrecoverable'

Write off to the statement of profit or loss:
Dr Irrecoverable debts expense (SPL)
Cr Sales ledger control account (SOFP)
Irrecoverable debts

debts
Doubtful debts
'A debt which is possibly irrecoverable'
Make an allowance against the debt:
Dr Allowance for doubtful debts
adjustment account (SPL)
Cr Allowance for doubtful debts (SOFP)
Allowances
Reduce the value of receivables shown in

the SOFP
Specific
Provided where there is

doubt over the recoverability
of a particular customer's
balance
General
A percentage applied to
total receivables after
(1) writing off irrecoverable
debts
(2) deducting the total
balance owed by
customers where a
specific allowance has
been made
The general allowance is
increased or decreased as
necessary at each year end
191
ANSWERS
SEND CO (PART I)
(a)
Calculate the balance b/d on the sales ledger control account at the end
of the year.
105,000
31.12.X8 Irrecoverable
debts exp
37,000
68,000
105,000
(b)
105,000
68,000
Calculate the irrecoverable debts expense shown in the statement of

profit or loss.
31.12.X8 SLCA
37,000
31.12.X8 To SPL
37,000
37,000
37,000
G CO
(a)
What will be the accounting entries to write off the debt in the main
ledger?
Account name
(b)
Cr
7,800
7,800
What will be the closing balance on the trade receivables account in G

Cos financial statements?
44,200
52,000 7,800
192
Dr
SEND CO (PART II)

(a)
Calculate the allowance for doubtful debts to include in the statement of

financial position.
8,000
31.12.X8 Allowance for

doubtful debts adjustment
account
8,000
8,000
(b)
8,000
8,000
Calculate the balance on the allowance for doubtful debts adjustment

account which will be shown in the statement of profit or loss.
31.12.X8 Allowance for

doubtful debts account
8,000
31.12.X8 To SPL
8,000
(c)
8,000
8,000
Show how the information from Send Co (part I) and Send Co (part II)
would be recorded in extracts from the statement of profit or loss and
statement of financial position.
Statement of profit or loss (extract)
Expenses
Irrecoverable debts expense (see Send Co (part I))
Allowance for doubtful debts adjustment account
37,000
8,000
Statement of financial position (extract)
Current assets
Trade receivables (see Send Co (part I))
68,000
Less allowance for doubtful debts
(8,000)
60,000
193
DODGY CO
(a)
Calculate the allowance for doubtful debts shown in the statement of

financial position.
(b)
1,334
Calculate the total amount which will be shown in the statement of profit
or loss for the irrecoverable debts expense and the balance on the
allowance for doubtful debts adjustment account.
1,674
Balance b/d
47,440
Irrecoverable debts
expense
Balance c/d
47,440
Balance b/d
340
47,100
47,440
47,100
Balance c/d
1,334
Allowance for doubtful

debts adjustment account
(specific)
400

(general)
934
1,334
1,334
Balance b/d
1,334
SLCA
340
340
194
To SPL
340
340

debts account (specific
allowance)
400

debts account (general
allowance (W))
934
To SPL
1,334
1,334
1,334
General allowance
47,100
SLCA balance (net of irrecoverable debts written off)
(400)
Less specific allowance
46,700
934
General allowance @ 2%
SEND CO (PART III)

What will be the accounting entries to record the monies received in the main
ledger?
Account name
Bank
Dr
Cr
15,000
15,000
195
A CO
Show the required adjustment to the allowance for receivables account for the
year ended 31 December 20X8 using both methods described above.
Long method:
(a) Allowance for doubtful

Balance b/d
1,000
(b) Allowance for doubtful

1,500
1,000
Balance c/d
1,500
2,500
2,500
Balance b/d
1,500
1,500
(b) Allowance for doubtful

debts
(a) Allowance for doubtful

debts
To SPL
1,500
1,000
500
1,500
Short method:
Balance b/d
Balance c/d
1,500

adjustment account
1,500
500
1,500
Balance b/d
196
1,000
1,500
500
To SPL
500
Workings:
Allowance required at 31 December 20X7: 20,000 5% = 1,000
Allowance required at 31 December 20X8: 30,000 5% = 1,500
Therefore, there is an increase in the allowance required of 500
E CO
What is the total expense to record in the statement of profit or loss for the
year ended 30 September 20X8 for the above items?
15,000
There will be an expense of 18,000 to write off the irrecoverable debt but the allowance
needs to be reduced by 3,000 (24,000 21,000)

(a)
An irrecoverable debt should remain in the sales ledger control

account at the year end.
Once a company has calculated the allowance for doubtful debts it
will remain unchanged each year.
The doubtful debt adjustment will effect the statement of profit or
loss and statement of financial position.
If a debt is definitely irrecoverable it should be written off to the

statement of profit or loss. This is an example of going concern.
197
(b)
Which ONE of the accounting principles best explains why doubtful debts
are adjusted for the year end?
Accruals
Consistency
Going concern
Prudence
198
9
BANK RECONCILIATIONS
Assessment Criteria
Explain the purpose of reconciling the cash book
Prepare ledger account balances; reconciling them, identifying any discrepancies

and taking appropriate action
Exam Context
Bank reconciliations, along with control account reconciliations form an important part of
the Accounts Preparation syllabus. Questions on bank reconciliations may require you to
determine the adjusted cash book balance or identify which items would be classed as
timing differences and which would require an adjustment to the cash account.
The knowledge covered in this chapter was also examined in the level 2 paper, Control
accounts, journals and the banking system and so this chapter is a revision chapter.
Business Context
Cash flow is of great importance to all businesses and so it is imperative that a business
reconciles its bank account on a regular basis (at least monthly). This will ensure that
the business knows exactly what level of cash resources it has available at any point in
time.
9: Bank reconciliations
199
OVERVIEW
Cash book balance
Bank statement balance
Differences
Timing differences
200
Errors by the business
Errors by the bank
Introduction
Bank reconciliations were tested in the level 2 paper, Control accounts, journals and the
banking system and so you should already have an understanding of the purpose of the
bank reconciliation and the process by which the balance on the business cash book is
reconciled to the balance per the bank statement.
The cash book is used to record receipts and payments into and out of the bank account.
Cash is a very important asset (or liability) for the business and the company directors
must be able to see how much money the company has.
As a security measure, they will want to make sure that the balance shown in the
accounting records (prepared by the accountant) agrees with the bank statement.
Bank statements provide an independent record of the balance on the bank account but
this balance is unlikely to agree exactly with the cash book balance therefore a
reconciliation is required.
Differences between the cash book balance and the bank statement
Differences essentially occur for three reasons:
a)
b)
Timing differences:
i)
Unrecorded lodgements money paid into the bank by the business but
not yet appearing as a receipt on the bank statement.
ii)
Unpresented cheques cheques paid out by the business which have not
yet appeared on the bank statement.
Errors by the business (ie in the cash book):

i)
Omissions, such as:

standing orders
direct debits
bank charges
interest (received or paid)
These items affect the bank statement but have not yet been reflected in the
cash book.
ii)
c)
Transposition errors / casting errors
Errors by the bank (rare in assessments).
A word of warning
Note that the bank statement shows the balance from the banks point of view whereas
the cash book is from the businesss point of view.
Therefore, should a task state the bank account is in credit, this means that there is a
debit balance in the businesss records.
Conversely, should a question state that the bank account balance is overdrawn, then
there is a credit balance in the businesss records.
201
Preparing a bank reconciliation

Recommended approach
You will not be required to prepare a full bank reconciliation in the Accounts Preparation
CBT. However, the following steps will help you to complete the recap example.
1.
Enter the closing balance on the bank statement in the box at the top of the
reconciliation.
2.
Tick off matching items between the bank statement and the cash book.
3.
Take any unticked receipts in the cash book and enter them in the add section of
the reconciliation. Enter a total for the add section.
4.
Take any unticked payments in the cash book and enter them in the less section
of the reconciliation. Enter a total for the less section.
5.
Take any unticked receipts and payments on the bank statement and enter them
in the cash book.
6.
Balance off the adjusted cash book, ensuring you use the dates asked for in the
question.
7.
Total the reconciliation statement which should give the same number as the
brought down balance on the cash book.
The Accounts Preparation exam will test your understanding of bank reconciliations
through a short form, objective test style question.
To answer these questions successfully you need to understand the full process of
preparing a bank reconciliation. This is recapped in the example.
Reminder of how a bank reconciliation is set out

Cash book
Date
20XX
Details
01 July
Balance b/d
16 July
28 July
Date
20XX
Cheque
no.
Details
06 July
248952
Cash payment
6,250
Cash received
5,349
10 July
248953
Cash payment
1,164
Cash received
2,147
17 July
248954
Cash payment
2,250
23 July
248955
Cash payment
275
29 July
248956
Cash payment
76
XX July
Bank interest
received
XX July
Bank interest
paid
XX July
Bank giro credit
XX July
Bank charges
XX July
Standing orders
XX July
Direct debits
31 July
Balance c/d
1 August
Bank
12,597
Total
202
Bank
Balance b/d
Total
Bank reconciliation statement as at 31 July 20XX
Balance per bank statement

Add:
Name:
Name:
Total to add
Less:
Name:
Name:
Total to subtract
Balance as per cash book
203
BANK RECONCILIATION (RECAP)

On 3 May, Jonll Fix It received the following bank statement as at 30 April
20X9.
GEF Bank
Main Street, Badright, BA6 8TU
To:
Jonll Fix It
Account
no:
8965423
Date:
30 April 20X9
STATEMENT OF ACCOUNT
Date
20X9
01 April
Details
Paid out
Balance b/f
Balance
32,637
03 April
Cheque 5678
8,880
23,757
09 April
Cheque 5679
14,700
9,057
10 April
Bank interest
9,237
10 April
Cheque 5672
3,900
5,337
15 April
Direct Debit Power Ltd
1,950
3,387
16 April
Cheque 5680
3,000
387
18 April
Bank Giro Credit QTK Ltd
20,937
22 April
Bank charges
150
20,787
22 April
BACS RDC Ltd
891
19,896
26 April
Bank Giro Credit R57 Ltd
21,246
27 April
Cheque 5681
13,146
180
20,550
1,350
8,100
D = Debit C = Credit
204
Paid in
The cash book as at 30 April 20X9 is shown below.

Cash book
Date 20X9
Details
01 April
Balance b/f
18 April
QTK Ltd
26 April
KT Ltd
Bank
Date 20X9
Cheque no.
Details
Bank
28,737
01 April
5678
ABC Ltd
8,880
20,550
05 April
5679
SRG Ltd
14,700
1,770
12 April
5680
HAL Ltd
3,000
15 April
DD
Power Ltd
1,950
21 April
5681
ERT Ltd
8,100
24 April
5682
TGN Ltd
2,280
Required
(a)
Check the items on the bank statement against the items in the cash
book.
(b)
Enter any items in the cash book as needed.
(c)
Total the cash book and clearly show the balance carried down at 30
April and brought down at 1 May.
(d)
Identify the TWO transactions that are included in the cash book but
missing from the bank statement and complete the bank reconciliation
statement below as at 30 April.
Bank reconciliation statement as at 30 April 20X9

Add:
Name:
Total to add
Less:
Name:
Total to subtract
205
CBT questions
As has been mentioned, the Accounts Preparation exam will test your understanding of
bank reconciliations through a short form, objective test style question.
Now that we have recapped the main principles, we can work through exam standard
questions.
In the CBT, the reconciliation question is likely to follow on from the requirement to
prepare an extract to the trial balance.
ADJUSTMENTS TO THE CASH BOOK (EXAMPLE 1)

The balance showing on the bank statement is a credit of 7,150 and the balance in the
cash book is a debit of 4,190.
The bank statement has been compared with the cash book and the following differences
identified:
1.
Bank interest received of 90 was not entered into the cash book.
2.
Cash sales totalling 200 have been entered in the cash book but are not yet
banked.
3.
A cheque received for 620 has been incorrectly entered in the cash book as 260.
4.
Cheques received from customer for 400 have been entered into the cash book
but are not showing on the bank statement.
5.
A BACS payment of 1,100 to a supplier has not been entered in the cash book.
6.
Cheques totalling 4,210 sent to suppliers at the end of the month are not showing
on the bank statement.
Required
Use the following table to show the THREE adjustments you need to make to
the cash book.
Adjustment
Amount
Debit
Credit
Picklist: Adjustment for (1), Adjustment for (2), Adjustment for (3), Adjustment for (4),
Adjustment for (5), Adjustment for (6)
206

The balance showing on the bank statement is a debit of 12,056 and the balance in the
cash book is a credit of 7,871.
identified:
1.
Cheques received from customers of 2,956 are not showing on the bank
statement.
2.
An automated payment to a supplier of 550 has been delayed by the bank due to
an error in the account number given.
3.
A BACs payment of 950 has been incorrectly entered in the cash book as 980.
4.
A standing order payment of 1,919 has not been entered in the cash book.
5.
An automated receipt from a credit customer for 844 has been incorrectly entered
in the cash book as 484.
6.
Cash receipts totalling 250 have been entered in the cash book but are not yet
banked.
Required
the cash book.
Adjustment
Amount
Debit
Credit
207
BANK STATEMENT
The balance showing on the bank statement is a credit of 19,750 and the balance in the
cash book is a debit of 21,434.
identified:
1.
Bank charges of 46 have not yet been entered into the cash book.
2.
Cheques totalling 4,210 sent to suppliers at the end of the month are not showing
on the bank statement.
3.
Cheques received from customers of 6,543 are not showing on the bank
statement.
4.
A refund in respect of an over payments of rates of 135 has not yet been entered
in the cash book.
5.
A cheque from a customer for 440 has been dishonoured by the bank. This has
not yet been reflected in the cash book.
6.
An automated payment to a supplier of 1,000 has been delayed by the bank due
to an error in the account number given.
Required
Use the following table to show the THREE items you would expect to appear
on the next bank statement. Indicate whether they will be debit or credit
entries on the bank statement.
Adjustment
Amount
Debit
Credit
208

requirements on any area of the syllabus. If the requirements are based on bank
reconciliations, they could be structured as follows.

Whilst preparing a bank reconciliation statement at 31 December, the following items
caused a difference between the bank statement balance and the cash book balance.
Required
(a)
Identify the items that WILL be shown in the bank reconciliation as an

adjustment to the balance per the bank statement.
Bank interest charged to the account in error

Direct debit for 500 for insurance
Bank charges of 70
Cheque paid to a supplier on 29 December
Receipt from a credit customer by electronic transfer (BACS)
(b)

True
False
A bank reconciliation should be performed on a regular basis

(eg monthly).
The bookkeeper may have to update the cash book for items
on the bank statement which are not yet included in the
businesss nominal ledger.
Outstanding lodgements are normally a cash book
adjustment.
Cheques sent to suppliers which have not yet cleared the
bank statement are normally a cash book adjustment.
209
SUMMARY
Cash book balance
Bank statement balance
Business' record of the

amount of cash held by the
business at any point in time
Business' record of the

amount of cash held by the
business at any point in time
Differences
Timing differences
Items shown in the cashbook but not currently on

the bank statement
Only:
- unrecorded lodgements
- unpresented cheques
Include in bank
reconciliation statement
Errors by the business
210
Items on the bank statement

which have been omitted
from the cash-book
Examples:
- standing orders
- direct debits
- bank charges
- interest (received or paid)
Adjust in the cash-book
Errors by the bank
Rare in assessments
ANSWERS
BANK RECONCILIATION (RECAP)
(a)
Check the items on the bank statement against the items in the cash
book.
(b)
Enter any items in the cash book as needed.
(c)
Total the cash book and clearly show the balance carried down at 30
April and brought down at 1 May.
Cash book
Date 20X9
Details
01 April
Balance b/f
18 April
QTK Ltd
26 April
KT Ltd
10 April
Bank interest
26 April
R57 Ltd
Bank
Date 20X9
Cheque no.
Details
28,737
01 April
5678
ABC Ltd
8,880
20,550
05 April
5679
SRG Ltd
14,700
1,770
12 April
5680
HAL Ltd
3,000
180
15 April
DD
Power Ltd
1,950
1,350
21 April
5681
ERT Ltd
8,100
24 April
5682
TGN Ltd
2,280
Bank
charges
150
RDC Ltd
891
22 April
22 April
30 April
52,587
1 May
Balance b/d
BACS
Balance c/d
Bank
12,636
52,587
12,636
Note that there is a difference of 3,900 between the opening cash book balance
of 28,737 and the opening balance on the bank statement of 32,637.
This relates to cheque number 5672 for 3,900 which would have been an
uncleared cheque brought forward at 1 April. As such this would have been
included in the reconciliation as at 31 March and so does not need to be included
in this reconciliation.
211
(d)
Identify the TWO transactions that are included in the cash book but
missing from the bank statement and complete the bank reconciliation
statement below as at 30 April.
Bank reconciliation statement as at 30 April 20X9
13,146
Add:
Name: KT Ltd
1,770
Total to add
1,770
Less:
Name: TGN Ltd
2,280
Total to subtract
2,280
12,636

the cash book.
Amount
Adjustment
Debit
Adjustment for (1)
90
Adjustment for (3)
360
Adjustment for (5)
1,100
Credit
Tutorial working (cash book):

Narrative
Unadjusted balance per cash book
4,190
Adjustment for (1)
90
Adjustment for (3)
360
Adjustment for (5)

Adjusted balance per cash book
212
Amount
(1,100)
3,540
Tutorial working (bank statement):

Amount
Narrative
7,150
Cash sales (note 2)
200
Cheques received from customer (note 4)
400
Outstanding cheques to suppliers (note 6)
(4,210)
3,540

the cash book.
Amount
Adjustment
Adjustment for (3)
30
Adjustment for (4)
1,919
Adjustment for (5)
360
Debit
Credit

Narrative
Adjustment for (3)
Amount
(7,871)
30
Adjustment for (4)
(1,919)
Adjustment for (5)
360
(9,400)

Narrative
Unrecorded lodgements (note 1)
Automated payment to supplier (note 2)
Cash receipts (note 6)
Amount
(12,056)
2,956
(550)
250
(9,400)
213
BANK STATEMENT
Use the following table to show the THREE items you would expect to appear
on the next bank statement. Indicate whether they will be debit or credit
entries on the bank statement.
Amount
Adjustment
Adjustment for (2)
4,210
Adjustment for (3)
6,543
Adjustment for (6)
1,000
Debit
Credit

Narrative
Amount
21,434
Bank charges (note 1)
(46)
Refund of rates overpayment (note 4)
135
Dishonoured cheque (note 5)

(440)
21,083

Narrative
Amount
19,750
Outstanding cheques (note 2)
(4,210)
Unrecorded lodgements (note 3)

Automated payment (note 6)
6,543
(1,000)
21,083
214

(a)
Identify the items that WILL be shown in the bank reconciliation as an

adjustment to the balance per the bank statement.
Bank interest charged to the account in error

Direct debit for 500 for insurance
Bank charges of 70
Cheque paid to a supplier on 29 December

Receipt from a credit customer by electronic transfer (BACS)
(b)

True
A bank reconciliation should be performed on a regular basis

(eg monthly).
The bookkeeper may have to update the cash book for items
on the bank statement which are not yet included in the
businesss nominal ledger.
False
Outstanding lodgements are normally a cash book

adjustment.
Cheques sent to suppliers which have not yet cleared the

bank statement are normally a cash book adjustment.
215
216
10
CONTROL ACCOUNT
RECONCILIATIONS
Assessment Criteria
Explain the purpose of reconciling the sales and purchases ledgers
Prepare ledger account balances; reconciling them, identifying any discrepancies

and taking appropriate action
Exam Context
Control accounts are an area which was examined in your level 2 Control accounts,
journals and the banking system studies but it is equally examinable in Accounts
Preparation. Questions on control account reconciliations may require you to identify the
reason as to why reconciliations are carried out as well as to determine the adjustments
that may need to be made either to the control account balance and/ or the individual
subsidiary sales or purchases ledger balance.
The knowledge covered in this chapter was also examined in the Control accounts,
journals and the banking system and so this chapter is partly revision. However control
accounts are an area which students often find challenging and so this chapter will be
taught from first principles, with some revision of the level 2 control accounts chapters.
However, contra entries are not studied at level 2 and so are new to this course.
Business Context
Cash flow is of great importance to all businesses. One of the major cash inflows for a
business is monies received from its customers and a significant cash outflow (other than
wages and salaries) is payments to suppliers. Therefore, managing the balances owed
to/from suppliers/customers will in turn help a business manage its cash flow. To do this
it is imperative that a business knows that the balances on the individual subsidiary sales
or purchases ledgers are accurate and one way to determine this is to perform a
reconciliation with the relevant control account.
10: Control account reconciliations
217
OVERVIEW
Reconciliations


Control account reconciliations
Contra entries
Returns
Discounts
allowed and received
Trade discounts
Settlement discounts
VAT considerations
218
Recap
In your level 2 studies we saw how a business' individual transactions were categorised
in the books of prime entry.
Transaction
Book of prime entry
Sales invoices, in respect of credit sales
Sales day book
Sales credit notes, in respect of credit sales returns
Sales returns day book
Cash receipts
Cash book (debit side)
Purchases invoices, in respect of credit purchases
Purchases day book
Purchases credit notes, in respect of credit purchases

returns
Cash payments
Cash book (credit side)
Periodically, the sales day book, sales returns day book, purchases day book and
purchases returns day book will be totalled.
The totals will be posted to the main ledger accounts using the double entry bookkeeping
system we are familiar with.
In the Accounts Preparation CBT, the following terms may be used interchangeably:
Receivables ledger control account and sales ledger control account

Subsidiary receivables ledger and subsidiary sales ledger
Payables ledger control account and purchases ledger control account
Subsidiary payables ledger and subsidiary purchases ledger
Example: sales ledger control account and subsidiary sales ledger

The sales ledger control account shows the total amount owed by all customers (or
sales) at a particular point in time.
However, in order to chase overdue debts, a business must know how much they are
owed by each individual customer.
A subsidiary sales ledger is maintained to produce this information.
The information in the subsidiary sales ledger also comes from the books of prime entry.
It is the individual invoices, credit notes and cash receipts which are posted from the day
books and entered into the subsidiary sales ledgers.
As the balance in the sales ledger control account and sales ledger comes from the same
source, in theory if we were to add up the total of all of the sales ledger accounts they
should equal the balance on the sales ledger control account.
219
This can be illustrated using the diagrams below:
Making a sale on credit

Books of prime entry
Invoice
Invoice
Invoice
15
10
Sales ledger
Customer A
SDB 5
Customer B
SDB 15
Sales day book

Customer C
INVOICE
INVOICE
5
15
10
TOTAL
30
INVOICE
SDB 10
TOTAL
Reconcile
Main ledger
Sales
Double
entry
SDB 30
DR SLCA
CR Sales
SLCA
SDB 30
220
30 Dr
Cash receipts
Sales ledger
Customer A
Cash book receipts
NARRATIVE
TOTAL
SDB 5
SALES
LEDGER
CASH
SALES
CB 5
CAPITA
L
Customer B
RECEIPT A
RECEIPT C
10
10
CASH SALE
10
SDB 15
Customer C
10
SD B 10
25
DR
Bank
15
10
CR
SLCA
CR
Sales
CB 10
TOTAL 15
Reconcile
Main ledger
Bank
Sales
SDB 30
CB 25
CB 10
SLCA
CB 15
SDB 30
C/d
30
B/d
15
30
15
221
Discounts
As we saw in the level 2 accounting papers, many businesses offer discounts to their
customers.
There are three types:
a)
b)
c)
Trade discounts
i)
Given at the time of the sale/purchase, they reduce the selling price in order
to try to induce customers to purchase
ii)
Usually for regular customers
Bulk discounts
i)
A type of trade discount
ii)
Given as a percentage reduction on the list price of the goods, offered

because the customers order is large
iii)
Eg 10% on orders where the list price net of trade discount exceeds 10,000
Settlement discounts (cash discounts)

i)
Offered, but not necessarily taken, as an inducement to settle a debt early
ii)
Eg 5% discount if an invoice is settled within 14 days
Trade and bulk discounts never appear in the financial statements.

The journal record settlement discounts given to customers is:
Account name
Discounts allowed (SPL)
Dr
Cr
The journal record settlement discounts received from suppliers is:

Account name
Purchases ledger control account (SOFP)
Dr
Cr
Discounts received (SPL)
VAT is calculated on the amount after all discounts (trade, bulk and settlement
discounts).
Therefore, where discounts are involved the steps for calculating .VAT are:
1.
Identify the total amount before any discounts.
2.
Deduct any trade or bulk discounts to find the net amount after trade/bulk
discounts.
3.
Calculate and deduct the settlement discount from this net amount.
4.
Multiply the net amount after all discounts by the VAT rate.
The following example provides a reminder of calculating VAT after deducting all
discounts.
222
CALCULATING VAT DUE TO HMRC

Machinery is sold to B Good for 40,000. A trade discount of 5% is available and a 10%
settlement discount is offered if the invoice is paid within 14 days.
The company is registered for VAT and the rate is 20%.
Required
Complete the table to show the VAT due to HMRC.
List price
Trade discount
Sales price net of trade discount
Settlement discount
Sales price net of all discounts (only calculated in order to work out
VAT)
VAT due to HMRC is
Reconciling the sales ledger control account and

subsidiary sales ledger
The sales ledger control account is an important general ledger account for sales made
on credit.
Example
Details
Amount
Details
Amount
Balance b/f
5,000
Bank
3,500
Sales
2,000
Sales returns
600
Discounts allowed
400
Balance c/d
2,500
7,000
Balance b/d
7,000
2,500
You will be familiar with the items shown in the example above.
223
Contra entries
An additional transaction tested in Accounts Preparation is contra entries.
Sometimes a business may have a customer which also supplies the business with goods.
Illustration
P Co is a printing business which sells stationery to F Co, a florist. F Co supplies P Co
with flowers and plants for its offices.
During October, P Co sells stationery worth 200 to F Co and F Co delivers flowers and
plants to P Co worth 70.
P Co has the following amounts in its books:
Receivables:
200
Payables:
70
The two businesses agree to offset the balances receivable and payable via a contra.
The contra will be for the lower of the two amounts: 70. This will decrease both
receivables and payables by 70 and the remaining 130 can then be paid in cash.
A contra entry is always recorded as:
Account name
Purchases ledger control account (SOFP)
Dr
Cr
This will reduce both receivables and payables.

Note that the subsidiary sales and purchase ledgers will also need to be updated for the
contra entry.
The next examples will recap your knowledge of the sales ledger control account and
subsidiary sales ledger, and test your understanding of contra entries.
SALES LEDGER
Silver has a credit customer, Rosie Co. Rosie Co is also a credit supplier of Silver.
The following sales transactions relate to Rosie Co for the month of August.
Transactions
Sales invoices
5,400
Credit notes
798
Discount allowed
120
Contra entry
200
Bank receipt
3,042
Required
Enter the items in Rosie Cos subsidiary sales ledger account, in the books of
Silver. Show the balance c/d and the balance b/d.
224
Sales ledger (Rosie Co)

Amount
Details
Balance b/d
Details
Amount
2,600
SALES LEDGER CONTROL ACCOUNT RECONCILIATION

This is a summary of transactions of Silvers transactions with credit customers during
August 20X1.
Transactions
Balance of sales at 1 August 20X1
18,234
Goods sold on credit
29,211
Money received from credit customers
16,321
Discount allowed
2,421
Goods returned by credit customers
5,311
Contra entries
500
Irrecoverable debts written off
360
Required
(a)
Enter the following items in the sales ledger control account. Show the
balance c/d and the balance b/d.
Details
Amount
Details
Amount
225
The following balances were in Silvers sales ledger on 1 September 20X1.

Transactions
Edward
2,690
Emily Co
5,321
Henry
1,273
Gordon
9,408
Rosie Co
3,840
(b)
Reconcile the balances shown above with the sales ledger control
account balance you have calculated in part (a).
Sales ledger control account balance as at 1 September 20X1

Total of sales ledger accounts as at 1 September 20X1
Difference
Reconciling the purchases ledger control account and

subsidiary purchases ledger
The purchases ledger control account is an important general ledger account when
purchases are made from suppliers on credit.
Before we move on to exam standard questions you must also understand how the
purchases ledger control account and subsidiary purchases ledger are reconciled.
This will be recapped in the next example.
PURCHASES LEDGER CONTROL ACCOUNT AND THE

PURCHASES LEDGER
This is a summary of Silvers transactions with credit suppliers during August 20X1.
Transactions
Balance of purchases at 1 August 20X1
12,325
Goods bought on credit
22,573
Payments made to credit suppliers
10,325
Discount received
3,721
Goods returned to credit suppliers
2,811
Contra entries
226
500
Required
(a)
Enter the following items in the purchases ledger control account. Show
the balance c/d and the balance b/d.
Details
Amount
Details
Amount
The total of the balances on the purchases ledger on 1 September 20X1 are 18,041.
(b)
Reconcile the balances shown above with the purchase ledger control
Purchases ledger control account balance as at 1 September 20X1

Total of purchases ledger accounts as at 1 September 20X1
Difference
227
Control account reconciliations in the CBT

As mentioned earlier in the chapter, if we add up the balances in the subsidiary sales and
purchases ledgers, they should agree to the balances per the sales and purchases ledger
control accounts.
If not, an error or omission must have occurred at some point in the system.
The easiest way to identify the error is to perform a reconciliation between the two
amounts.
This can be done using a reconciliation working, which may include the following items:
Proforma control account reconciliation:
Amount
Details
Amount
Balance b/f
Sales day book total overcast
Sales day book total

undercast
Credit note omitted from

SDB
Sales omitted from SDB
Cash received, not recorded
Balance c/d
Details
X
(Adjusted) balance b/d
X
Adjusted balances
should agree
Reconciliation statement
Details
Total per listing of sales ledger
balances
Adjustments
Balance omitted
Credit balance listed as debit
Totals
(Adjusted) balance b/d per control
account
228
(2X)
(X)
(X)
X/(X)
X
RECONCILING THE SALES LEDGER CONTROL ACCOUNT

AND THE SALES LEDGER
This task is about preparing reconciliations.
The individual balances of the accounts in the subsidiary sales ledger have been listed
and totalled to 16,600. The total has been compared with the 10,674 balance on the
sales ledger control account. After investigation the following errors were found:
1.
A total in the sales day book of 3,500 was recorded as 3,050.
2.
A sales invoice of 763 has been posted to Customer As account in the subsidiary
sales ledger, rather than Customer B.
3.
Cheques of 5,492 received from customers have not been recorded in the
subsidiary accounts.
4.
A customer account with a debit balance of 3,200 has been listed in the
subsidiary sales ledger as 3,020.
5.
A contra for 200 was only recorded in the sales ledger.
6.
A credit note issued for 182 has been debited to a customer account in the
subsidiary sales ledger.
Required
Use the following table to show the THREE adjustments required to the listing
of subsidiary sales ledger balances.
Adjustment
Amount
Add
Deduct
229
RECONCILING THE PURCHASES LEDGER CONTROL

ACCOUNT AND THE PURCHASES LEDGER
This task is about preparing reconciliations.
The individual balances of the accounts in the purchases ledger have been listed and
totalled to 4,406. The total has been compared with the 6,426 balance on the
purchases ledger control account. After investigation the following errors were found:
1.
Purchases credit notes received from suppliers totalling 760 had been entered as
a credit entry in the purchases ledger control account.
2.
A suppliers account with a balance of 390 had been omitted from the purchases
ledger listing.
3.
Cheques paid to suppliers totalling 1,460 had been omitted from the purchases
ledger control account.
4.
A page in the purchases day book had been understated by 900.
5.
A purchases credit note for 300 had been omitted from supplier Xs account in the
subsidiary purchases ledger.
6.
Returns to a supplier of 150 had not been recorded in the purchases ledger
account.
Required
Use the following table to show the THREE adjustments required to the
purchases ledger control account.
Adjustment
Amount
Add
Deduct
230

requirements on any area of the syllabus. If the requirements are based on control
account reconciliations, they could be structured as follows.

This task is to test your knowledge. A reconciliation is performed between the sales
ledger control account and the subsidiary sales ledger.
Required
(a)
Which items will be adjusted in the sales ledger control account?
Cheques received from customers omitted from the sales ledger

control account.
A credit note entered on the debit side of a customers account in
the subsidiary sales ledger.
A sales invoice omitted from a customers account in the subsidiary
sales ledger.
A purchases day book total posted to the sales ledger control
account.
A BACs receipt has been recorded on the debit side of the
customers account in the subsidiary sales ledger.
(b)
Which items will be adjusted in the subsidiary sales ledger accounts?

control account.
sales ledger.
account.
A BACs receipts has been recorded on the debit side of the
231
SUMMARY
The SLCA and the SL and the PLCA and

the PL show the same information and
so the balances should reconcile
Reconciliations


SLCA: The total owed by all

credit customers at a
particular point in time
PLCA: Total owed to all credit
suppliers at a particular point
in time
Contra entries
Where a business has a

customer which is also a
supplier
A contra will always be for
the lower of the two
amounts and will always
reduce both the SLCA and
PLCA balances
The subsidiary sales and
purchases ledgers must
also be updated for the
contra entry
Discounts
allowed and received
Returns
Returns reduce the balance

owed by a customer and to
a supplier.
Trade discounts
SL: a list of the amounts owed by

each individual credit customer at
a particular point in time
PL: a list of the amounts owed to
each individual credit supplier at a
particular point in time
Discounts allowed are offered by a business

to their customer (an expense)
Discounts received are received by a
business from their supplier (sundry income)
Settlement discounts
Given at the time of sale/purchase

For example: bulk buying discounts
Never appear in the financial
statements
VAT considerations
232
VAT is calculated after all discounts,

and does not change regardless of
whether they are taken or not
Offered as an incentive to
settle a debt early
For example: 3% discount
if settled within 10 days
May or may not be taken
Sales and purchases are
recorded after trade
discounts but before
settlement discounts
ANSWERS
CALCULATING VAT DUE TO HMRC
Complete the table to show the VAT due to HMRC.
List price
40,000
Trade discount
(2,000)
Sales price net of trade discount
38,000
Settlement discount
(3,800)
Sales price net of all discounts (only calculated in order to work out
VAT)
34,200
VAT due to HMRC is
6,840
SALES LEDGER
Enter the items in Rosie Cos subsidiary sales ledger account, in the books of
Silver. Show the balance c/d and the balance b/d.
Sales ledger (Rosie Co)
Details
Amount
Details
Amount
Balance b/d
2,600
Sales returns
798
Sales
5,400
Discount allowed
120
Purchases ledger control

account
200
8,000
Balance b/d
Bank
3,042
Balance c/d
3,840
8,000
3,840
233
SALES LEDGER CONTROL ACCOUNT RECONCILIATION

(a)
Enter the following items in the sales ledger control account. Show the
balance c/d and the balance b/d.
Details
Amount
Details
Balance b/d
18,234
Bank
Sales
29,211
Discount allowed
2,421
Sales returns
5,311
500
Irrecoverable debt
expense
360
47,445
Balance b/d
16,321

account
Balance c/d
(b)
Amount
22,532
47,445
22,532
Reconcile the balances shown above with the sales ledger control
Sales ledger control account balance as at 1 September 20X1
22,532
Total of sales ledger accounts as at 1 September 20X1
22,532
Difference
234
PURCHASES LEDGER CONTROL ACCOUNT AND THE

PURCHASES LEDGER
(a)
Enter the following items in the purchases ledger control account. Show
the balance c/d and the balance b/d.
Details
Bank
Amount
10,325
Discount received
3,721
Purchases returns
2,811
Sales ledger control

account
Balance c/d
Details
Balance b/d
12,325
Purchases
22,573
500
17,541
34,898
34,898
Balance b/d
(b)
Amount
17,541
Reconcile the balances shown above with the purchase ledger control
Purchases ledger control account balance as at 1 September 20X1
17,541
Total of purchases ledger accounts as at 1 September 20X1
18,041
Difference
500
235
RECONCILING THE SALES LEDGER CONTROL ACCOUNT

AND THE SALES LEDGER
Use the following table to show the THREE adjustments required to the listing
of subsidiary sales ledger balances.
Amount
Adjustment
Adjustment for (3)
5,492
Adjustment for (4)
180
Adjustment for (6)
364
Add
Deduct
Tutorial working (subsidiary sales ledger balances):

Narrative
Amount
Per scenario:
16,600
Adjustment for (3)
(5,492)
Adjustment for (4)
180
Adjustment for (6)
(364)
Adjusted subsidiary sales ledger balance:
10,924
(Note: adjustment 2 does not change the sales ledger totals)
Tutorial working (sales ledger control account):

Narrative
Per scenario:
10,674
Adjustment for (1)
450
Adjustment for (5)
(200)
Adjusted sales ledger control account balance:
236
Amount
10,924
RECONCILING THE PURCHASES LEDGER CONTROL

ACCOUNT AND THE PURCHASES LEDGER
Use the following table to show the THREE adjustments required to the
purchases ledger control account.
Amount
Adjustment
Add
Deduct
Adjustment for (1)
1,520
Adjustment for (3)
1,460
Adjustment for (4)
900
Tutorial working (subsidiary purchases ledger balances):

Amount
Narrative
Per scenario:
4,406
Adjustment for (2)
390
Adjustment for (5)
(300)
Adjustment for (6)
(150)
Adjusted subsidiary purchases ledger balance:
4,346
Tutorial working (purchases ledger control account):

Narrative
Per scenario:
Amount
6,426
Adjustment for (1)
(1,520)
Adjustment for (3)
(1,460)
Adjustment for (4)

Adjusted purchases ledger control account balance:
900
4,346
237

(a)
Which items will be adjusted in the sales ledger control account?

control account.

sales ledger.
account.
A BACs receipt has been recorded on the debit side of the

(b)
Which items will be adjusted in the subsidiary sales ledger accounts?

control account.

sales ledger.

account.
A BACs receipts has been recorded on the debit side of the
238
Topic name

concepts
Accounting concepts
1
2
assets
assets
assets
Inventories
Inventories

debts
Bank and control account

reconciliations
9
10
Course notes
chapter
239
240
11
THE TRIAL BALANCE,
ERRORS AND THE
SUSPENSE ACCOUNT
Assessment Criteria
Check for errors and/or inaccuracies in the trial balance, taking appropriate action
Exam Context
You are likely to be presented with the situation where a trial balance does not balance
and a suspense account is inserted to make it balance. You will then need to determine
the journal entries necessary to correct the errors and clear the suspense account.
A suspense account may also feature in a question on the extended trial balance
(explained in the next chapter).
Suspense accounts were introduced in level 2 Control accounts, journals and the banking
system. You may also be required to make adjustments to a trial balance in your level 4
paper, Financial Statements.
Business Context
The production of a trial balance allows a business to see whether it has recorded
transactions accurately throughout the accounting period. Any errors should be
identified and corrected as soon as possible.
11: The trial balance, errors and the suspense account
241
OVERVIEW
Errors which allow the trial

balance to balance
The trial balance, errors and

the suspense account
Errors which do NOT allow the trial

balance to balance
Suspense account
242
Introduction
In Control accounts, journals and the banking system you re-drafted a trial balance
following the correction of errors. This topic will be developed in this chapter.
The Accounts Preparation CBT is likely to test this topic over two tasks.
Firstly, preparing an extract from a trial balance using ledger accounts
Then, recording adjustments in an extract from the extended trial balance and
closing off accounts.
In addition, this topic could form the basis of the knowledge based task, which will be
the final question in the CBT.
Preparing a trial balance

With a manual accounting system, accountants have to transfer the balances brought
down in the ledger accounts to the trial balance. This is performed before the financial
statements are prepared.
Generally transferring balances to the ledger accounts is straight forward.
Items which require more thought are accrued/prepaid income and expenses.
Approach to preparing a trial balance

This type of task should be approached as follows:
1.
Read the requirement and review the extract from the trial balance.
2.
Transfer any ledger balances already included in the trial balance extract to the
debit or credit column, as appropriate.
3.
Work through the ledger accounts transferring the balances brought forward to the
debit or credit columns of the trial balance, as appropriate.
4.
Read the information on accrued or prepaid income and expenses. Include these
items in the trial balance too.
5.
Review your answer. Does it make sense?
Note that if it is an extract from the trial balance, you will not be required to total the
debit and credit columns.
We will practise this approach in the example which follows.
243
EXTRACT FROM THE TRIAL BALANCE

This task is about preparing a trial balance.
You are working on the accounting records of a business with a year end of 31 August.
You have five extracts from the ledger accounts as at 31 August 20X9:
Office costs
31/08/X9
Balance b/f
6,321
Included in this balance is an amount for accrued expenses of 110 as at 31/08/X9.

Purchases returns
31/08/X9
Balance b/f
775
Recycling rebates
31/08/X9
Balance b/f
11,550
Included in this balance is an amount for accrued income of 886 as at 31/08/X9.

Sales returns
31/08/X9
Balance b/f
4,367
VAT
31/08/X9
Balance b/f
9,440
You need to start preparing the trial balance as at 31 August 20X9.
Required
Using all the information given above and the figures given in the table below,
enter amounts in the appropriate trial balance columns for the accounts
shown.
negatives.
244
Extract from the trial balance as at 31 August 20X9:
Account
Ledger
balances
Trial balance
Dr
Cr
Accrued expenses
Accrued income
Office costs
Purchases
30,100
Purchases returns
Recycling rebates
Salaries
13,500
Sales
58,304
Sales returns
VAT
245
Errors and the suspense account

As was mentioned above, this is a topic you are familiar with from Control accounts,
journals and the banking system.
To recap, there are two categories of errors that can affect the accounting records:
Errors which are still allow the trial balance to balance

Errors which cause an imbalance in the trial balance.
The following errors will still allow the trial balance to balance.
Type of error
Example
Error of omission
Where both sides of a transaction have been completely left out.
Error of original
entry
Where an entry has been made so that debits = credits but the
amount is incorrect.
For example, a credit sale of 1,000 is posted as:
Dr Sales ledger control account
150
Cr Sales
150
Reversal of
entries
Where a transaction has been recorded at the correct amount

but the debit and credit entries have been reversed.
For example, posting the credit sale above as:
Dr Sales
1,000
Cr Sales ledger control account
1,000
Error of principle
Here debits = credits; however, one of the entries has been

made to the wrong type of account.
For example, 500 spent on repairing a motor vehicle has been
recorded as:
Dr Motor vehicles at cost
500
Cr Bank
500
Repairs are an item of expense which should be shown in the
statement of profit or loss whereas the item has been recorded
as a non-current asset.
Error of
commission
Here debits = credits however one of the entries has been made
to the wrong account, but not the wrong type of account.
For example, 200 spent on telephone costs has been recorded
as:
Dr Insurance expense
200
Cr Bank
200
Both accounts (telephone and insurance costs) are expenses and
so this is an error of commission rather than an error of principle.
These errors will be corrected through a journal.
246
The trial balance will not balance if total debits do not equal total credits. The following
errors cause an imbalance in the trial balance:
Type of error
Example
Unequal entry
Here an entry has been posted where debits credits.

A common example of this is where a transposition error has
been made and a figure has been reversed.
For example, 450 of rent costs have been posted as follows:
Dr Rent
450
Cr Bank
540
Here debits credits and so the trial balance will not balance.
One sided entry
Here a debit entry has been posted with no corresponding credit

made or vice versa.
For example, a credit sale of 300 has been posted as:
300
or as:
Cr Sales
300
Entry duplicated
on one side,
nothing on the
other
Here two debit entries or two credit entries have been posted.
For example, the credit sale of 300 above has been posted as:
300
Dr Sales
300
or as:
Cr Sales ledger control account
300
Cr Sales
300
Account balance
incorrectly
transferred to the
trial balance
Here the final balance on the nominal ledger account is

incorrectly transferred to the trial balance.
For example, a balance of 560 on the sales account was
recorded in the trial balance as 650 or 400.
Note that this type of error also includes the situation where the
560 balance on the sales account was completely omitted from
the trial balance.
These errors will be corrected by creating a suspense account in order to make the
trial balance balance and then making a journal entry to correct the error.
Suspense accounts
A suspense account is a temporary account. It never appears in the final accounts.
It is used for two main reasons:
1.
To account for a debit or credit entry when the accountant is unsure as to where it
should go
2.
To make a preliminary trial balance balance when an error has been detected.
247
Steps to clear a suspense account.

1.
2.
3.
Determine the original accounting entry which was made.

Decide what entry should have been made.
Make the required adjustment.
Illustration
W Co sold goods with a value of 2,500 to James, a credit customer. When recording the
sale W Co posted the transaction to the correct accounts but made two debit entries.
Steps
1.
Entry made was:

Dr
Dr

Sales
2,500
2,500
Therefore the suspense account must have been credited 5,000.

2.
Entry should have been:

Dr
Cr
3.

Sales
2,500
2,500
Correction:
The entry to the sales ledger control account is correct but sales have been
debited by 2,500 when they should have been credited by that amount.
The correction is therefore twice the original error:
Dr
Cr
Suspense account
Sales (2 2,500)
5,000
5,000
Being: correction of sales posting.
JOURNALS AND THE SUSPENSE ACCOUNT

This task is about accounting adjustments and journals.
You are working on the accounting records of a business with a year end of 31 August.
A trial balance has been drawn up and a suspense account opened. You now need to
make some corrections and adjustments for the year ended 31 August 20X9.
You may ignore VAT in this task.
Required
Record the journal entries needed in the general ledger to deal with the items
below.
You should:
Remove any incorrect entries where appropriate

Post the correct entries.
You do not need to give narratives.

Do NOT enter zeros into unused column cells.
248
(a)
A rent payment of 350 had been debited to the sales ledger control
account.
Journal
Account name
(b)
Debit
Credit
Depreciation of 1,900 was charged on the machinery during the year.

The only entry made was to record the expense.
Journal
Account name
(c)
Debit
Credit
Discounts allowed of 500 had not been recorded in the books.

Journal
Account name
(d)
Debit
Credit
The purchase of stationery for 1,460 cash has been correctly entered in
the bank account, but no entry has been made to the appropriate
expense account.
Journal
Account name
(e)
Debit
Credit
Capital of 35,000 was recorded incorrectly as 53,000. The posting to

bank was made correctly.
Journal
Account name
Debit
Credit
249
Working: (NB not part of the CBT answer)

Suspense account
Details
Balance b/f
Amount
Details
Amount
17,560
This example above has recapped the correction of errors and clearing a suspense
account. The next question takes this a stage further by requiring adjustments to be
made and then recorded in an extended trial balance.
ADJUSTMENTS AND THE EXTENDED TRIAL BALANCE

This task is about recording adjustments in the extended trial balance and closing off
accounts.
You are working on the accounts of a business with a year end of 31 August.
A trial balance has been drawn up and a suspense account opened.
You now need to make some corrections and adjustments for the year ended 31 August
20X9.
You may ignore VAT in this task.
Required
(a)
Record the adjustments needed in the extract from the extended trial
balance to deal with the items below. You will not need to enter
adjustments on every line. Do NOT enter zeros into unused cells.
(i)
A bank payment of 950 made on 25 August 20X9 for buildings insurance for
the year ended 31 August 20Y0 is included in the insurance expenses figures
as at 31 August 20X9.
(ii)
Travel expenses of 230 paid by business debit card have been correctly
entered into the travel expenses account but no other entries were made.
(iii)
The allowance for doubtful debts needs to be adjusted to 5% of the

outstanding trade receivables.
(iv)
On 21 August 20X9, a customer account was settled by prompt payment

which meant that a discount was allowed.
Customer account balance
Discount allowed
Bank receipt
1,200
100
1,100
When posting the figures, the entry for discounts was omitted. The other entries
were made correctly.
250
Extract from extended trial balance

Ledger account
Ledger balance
Dr
Accrued expenses
Adjustment
Cr
Dr
Cr
1,050
14,039

debts
1,400

debts adjustment
Bank
1,970
Discounts allowed
2,100
Insurance expenses
2,400
Irrecoverable debts
300
Prepaid expenses
Purchases
106,032

account
21,324
Sales
account
179,323
25,840
Suspense
Travel expenses
130
8,245
The ledgers are now ready to be closed off for the year ended 31 August 20X9.
(b)
Show the correct journal entries to close off the administration expenses
account and select an appropriate narrative.
Journal
Debit
Credit
Picklist: Accrued expenses, Administration expenses, Allowance for doubtful debt,

Allowance for doubtful debts adjustment, Bank, Discounts allowed, Insurance
expenses, Irrecoverable debts, Prepaid expenses, Purchases, Purchases ledger
control account, Sales, Sales ledger control account, Statement of financial
position, Statement of profit or loss account, Suspense, Travel expenses
251
Narrative:
Picklist:
Transfer of administration expenses for the year ended 31 August 20X9 to the
statement of financial position
bank account
suspense account
profit or loss account

requirements on any area of the syllabus. If the requirements are based on the trial
balance, errors and the suspense account, they could be structured as follows.

There is an error in the accounting records. The accountant has recorded discounts
received by debiting the discounts received account and crediting the purchases ledger
control account.
Required
(a)
What type of error is this? Choose the ONE most suitable description:
Error of commission
Reversal of entries
Error of omission
One sided entry
(b)

True
The suspense account can appear in the financial

statements.
All errors cause an imbalance in the trial balance.
A trial balance is prepared before the financial statements.
A trial balance includes the closing balances of the subsidiary
sales ledgers.
252
False
SUMMARY
Error of omission:
Error of original entry:
Reversal of entries:
Error of principle:
Error of commission:
Transaction not recorded

Transaction recorded at wrong amount
Debits = credits but posted the wrong way round
Debits and credits balance but the entry is made to the wrong 'type' of account
For example, machine repairs debited to the machine asset account
Debits and credits balance but the entry is made to the wrong account
For example, an expense is debited to the rent account rather than the electricity
account
Errors which allow the trial

balance to balance

the suspense account
Errors which do NOT allow the trial

balance to balance
Unequal entry:
One sided entry:
Entry duplicated on
one side:
Account balance
incorrectly transferred:
Transaction posted where debits credits, perhaps due to a transposition error

Only the debit or the credit entry has been posted
Two debit entries or two credit entries posted
Closing balance on nominal ledger account incorrectly transferred to or omitted
from the trial balance
Suspense account
A temporary account which never appears in the
financial statements'
Used when:
- an accountant is unsure of a double entry
- a preliminary trial balance does not balance
Must be cleared out.
Steps:
(1) What entry was made?
(2) Decide what entry should have been made?
(3) Make the required adjustment.
253
ANSWERS
EXTRACT FROM THE TRIAL BALANCE
Using all the information given above and the figures given in the table below,
enter amounts in the appropriate trial balance columns for the accounts
shown.
Extract from the trial balance as at 31 August 20X9:
Ledger
balances
Account
Trial balance
Dr
Cr
Accrued expenses
110
Accrued income
886
Office costs
6,321
Purchases
30,100
30,100
Purchases returns
775
Recycling rebates
11,550
Salaries
13,500
Sales
58,304
Sales returns
13,500
58,304
4,367
VAT
9,440
JOURNALS AND THE SUSPENSE ACCOUNT

What are the journals to correct the errors and clear the suspense account?
(a)
A rent payment of 350 had been debited to the sales ledger control
account.
Journal
Account name
Rent
254
Debit
Credit
350
350
(b)
Depreciation of 1,900 was charged on the machinery during the year.

The only entry made was to record the expense.
Journal
Debit
Account name
Suspense
1,900

(c)
Credit
1,900
Discounts allowed of 500 had not been recorded in the books.

Journal
Debit
Account name
Discounts allowed
500

(d)
Credit
500
The purchase of stationery for 1,460 cash has been correctly entered in
the bank account, but no entry has been made to the appropriate
expense account.
Journal
Debit
Account name
Stationery expense
1,460
Suspense
(e)
Credit
1,460
Capital of 35,000 was recorded incorrectly as 53,000. The posting to

bank was made correctly.
Journal
Debit
Account name
Capital
Credit
18,000
Suspense
18,000
Working: (NB not part of the CBT answer)
Suspense account
Details
Balance b/f
Machinery accumulated
depreciation (b)
Amount
17,560
1,900
19,460
Details
Stationery expense (d)
Capital (e)
Amount
1,460
18,000
19,460
255

(a)
Record the adjustments needed in the extract from the extended trial
balance to deal with the items below. You will not need to enter
adjustments on every line. Do NOT enter zeros into unused cells.
Extract from extended trial balance
Ledger account
Ledger balance
Dr
Accrued expenses
Cr
Adjustment
Dr
1,050
14,039

debts
1,400
108

debts adjustment
108
Bank
1,970
Discounts allowed
2,100
Insurance expenses
2,400
Irrecoverable debts
300
950
950
106,032

account
21,324
Sales
account
179,323
25,840
Suspense
Travel expenses
256
230
100
Prepaid expenses
Purchases
Cr
130
8,245
230
100
(b)
Show the correct journal entries to close off the administration expenses
account and select an appropriate narrative.
Journal
Debit
Credit
14,039
Statement of profit or loss account
14,039
Narrative:
statement of profit or loss

(a)
What type of error is this? Choose the ONE most suitable description:
Error of commission
Reversal of entries
Error of omission
One sided entry
(b)

True
False
The suspense account can appear in the financial

statements.
All errors cause an imbalance in the trial balance.
A trial balance is prepared before the financial statements.

A trial balance includes the closing balances of the subsidiary
sales ledgers.
257
258
12
THE EXTENDED TRIAL
BALANCE
Assessment Criteria
Prepare the trial balance after adjustments
Exam Context
Questions are likely to provide you with a series of adjustments that need to be included
in the extended trial balance. You are also likely to need to show the calculation of the
profit or loss for the year and to transfer this to the statement of financial position.
This area is only tested in the Accounts Preparation assessment.
Business Context
For businesses using a manual accounting system, the extended trial balance allows
them to see all the journal adjustments they have posted after the initial trial balance has
been extracted. These adjustments can then be added to/ deducted from the original
trial balance amounts to provide the final figures which will then be shown in the
statement of profit or loss and statement of financial position.
Nowadays however, most businesses keep their accounting records on a computerised
system. It is important to note that the computer still uses the same techniques
although it may be that the only output reviewed by the owners is the final statement of
profit or loss and statement of financial position.
12: The extended trial balance
259
OVERVIEW
The extended trial balance
Trial balance
Adjustments
Extended Trial Balance
260
Statement of financial
position
Introduction
In the chapters Accounting principles and The trial balance, errors and the suspense
account we saw that the initial trial balance is extracted using the final balance on each
nominal ledger account.
There are many other adjustments which need to be made via a journal entry before the
final financial statements can be produced. The adjustments which are examinable in
the Accounts Preparation syllabus are:

Closing inventory adjustments
Irrecoverable and doubtful debts and
Correcting errors and clearing a suspense account.
A business needs to keep track of any post trial balance adjustments it makes and these
are recorded using an extended trial balance.
Approach to preparing an extended trial balance

This type of task should be approached as follows:
1.
Read the requirement and review the proforma extended trial balance.
2.
Work down the ledger accounts line by line. Identify whether they relate to the
statement of profit or loss or statement of financial position and insert the ledger
account balances into the appropriate boxes.
3.
Include the adjustments where relevant. Think carefully whether they increase or
decrease the final balance in the statement of profit or loss or statement of
financial position.
4.
Once you have completed step (3) add up the totals of the debit and credit
columns in the statement of profit or loss columns.
pg 229 243
These two columns should not balance and the difference will be the
profit or loss for the period.
5.
Insert the profit or loss on the debit or credit side of the statement of profit or loss
as appropriate:
Statement of profit or loss columns
During the
period:
Total of the credit column is higher than

the total of the debit column
Profit
Debit side
statement of
profit or loss
Total of the debit column is higher than

the total of the credit column
Loss
Credit side
statement of
profit or loss
Post to:
The statement of profit or loss columns will now balance.

6.
This is a double entry and so you need to insert a corresponding debit or credit
balance in the statement of financial position.
7.
Once you have transferred the profit or loss to the statement of financial position,
total both of the statement of financial position columns. These should balance.
261
The next example provides practice at these steps. It is a preparation example designed
to familiarise you with the process of:
Identifying whether the ledger balances should be included on the statement of

profit or loss or statement of financial position
Adding across (and correctly deciding whether the adjustments increase or

decrease the opening ledger balance)
Completing the double entry with the profit or loss for the year
In addition, the example requires you to calculate and record the adjustment journals in
the extended trial balance. This is not something you will be asked to do in the
Accounts Preparation CBT. However, it is useful in illustrating how the extended trial
balance is prepared.

An extended trial balance has been drawn up and a suspense account opened with a
debit balance of 900. You now need to make some corrections and adjustments for the
year ended 31 December 20X9.
(i)
The annual depreciation of plant has yet to be accounted for. Plant is depreciated
at the rate of 10% using the straight-line method.
(ii)
Inventories were valued at 1,500 on 31 December 20X9.
(iii)
Wages of 900 were not entered in the wages expense account. The other side of
the double entry was correctly made.
(iv)
A rates payment of 250 has been charged to the rent expense account.
Required
(a)
Record the journals which need to be entered in the adjustments column

in the extended trial balance.
(i)
Plant depreciation
Debit
Credit
Account name
Debit
Credit
Account name
Debit
Credit
Account name
(ii)
Closing inventory
(iii) Wages
262
(iv) Rates
Debit
Account name
(b)
Credit
Enter the journals you have recorded in part (a) in the adjustments
column.
Then, extend the figures into the statement profit or loss and statement
of financial position columns.
Complete the extended trial balance by entering figures and a label in
the correct places.
Picklist: Gross profit/loss for the year, Profit/loss for the year, Balance c/d,
Suspense, Balance b/d
Extended trial balance

Ledger account
Ledger balances
Dr
Bank
Plant
Cr
Adjustments
Dr
Cr
Statement of
profit or loss
Dr
Cr
Statement of
Financial Position
Dr
Cr
7,435
20,000
Closing inventory
Depreciation
charges
Opening
inventory
Purchases
800
20,301
Purchases ledger
control
5,755
Plant accumulated
depreciation
Rates
1,600
Rent
2,866
Sales
Sales ledger
control
Suspense
Wages expense
TOTAL
49,126
8,325
900
7,524
62,316
62,316
263
Balances to watch out for

You will be familiar with most ledger account balances you see on the extended trial
balance.
For example, you know that sales is always on the credit side of the statement of profit
or loss column.
Vehicles at cost is always on the debit side of the extended trial balance in the
statement of financial position column.
Other balances require more detailed consideration.
Remember, that the opening position of each balance (ie whether it is the debit or credit
column) gives important information on the type of balance it is.
264
Balance
Considerations
Accumulated depreciation
The accumulated depreciation is on the credit side of the

SOFP column.
The allowance for doubtful debts is on the credit side of

the SOFP column.

adjustment
The movement in doubtful debt allowance is a debit or

credit to the statement of profit or loss.
Bank
A debit balance indicates the business has an asset (ie

money on deposit). It is included in the debit column of
the SOFP.
Bank overdraft
A credit balance indicates this is a liability (ie an

overdraft). It is included in the credit column of the
SOFP.
This is an expense to the statement of profit or loss and

therefore a debit balance.
Purchases returns
This will be on the credit side of the statement of profit

or loss column (a reduction in expenses).
Sales returns
This will be on the debit side of the statement of profit

or loss column (a reduction in income).
Suspense
This will be cleared in the adjustment columns and

therefore does not appear in the statement of profit or
loss or SOFP.
VAT
A credit balance indicates VAT is due to HMRC and is

included in the SOFP credit column.
A debit balances indicates VAT is due from HMRC and
is included in the SOFP debit column.
Inventories in the extended trial balance

It is likely that the preliminary extended trial balance will include opening inventory.
The phrase opening inventory just means it was held by the company at the start of the
accounting period.
It is also probable that the adjustments columns will include closing inventory.
We need to ensure inventory (and purchases) and recorded correctly in the statement of
profit or loss and statement of financial position columns.
Remember:
Cost of goods sold = opening inventory + purchases closing inventory

Opening inventory will be an expense this year as it will be used up by the business as
part of cost of goods sold. Therefore, this balance is included as a debit entry to the
statement of profit or loss.
From the chapter Inventories, we know that closing inventory is accounted for via the
following journal entry:
Dr Inventories (asset in the SOFP)
Cr Inventories (reduction in expenses in the SPL)
The extended trial balance may well show this as follows:
Ledger
account
Ledger Balances
Adjustments
SPL
SOFP
Debit
Credit
Debit
Credit
Debit
Credit
Debit
Credit
2,000
2,000
Opening
inventory
3,000
3,000
Purchases
11,000
11,000
Closing
inventory
(SOFP)
2,000
2,000
Alternatively, the proforma for the extended trial balance may show one cost of goods
sold line and closing inventory in the statement of financial position on a separate line.
Ledger
account
Cost of goods
sold (SPL)
Closing
inventory
(SOFP)
Ledger Balances
Adjustments
SPL
SOFP
Debit
Credit
Debit
Credit
Debit
Credit
Debit
Credit
14,000
2,000
2,000
12,000
2,000
265
COMPLETING THE EXTENDED TRIAL BALANCE

This task is about the extended trial balance.
You have the following extended trial balance. The adjustments have already been
correctly entered.
Required
Extend the figures into the statement of profit or loss and statement of
financial position columns.
Complete the extended trial balance by entering figures and a label in the
correct places.
Picklist: (for penultimate row, 1st column only):
Balance b/d, Balance c/d, Gross profit/loss for the year, Profit/loss for the year, Suspense
266

Ledger account
Ledger balances
Adjustments
Statement of
profit or loss
Dr
Dr
Dr
Allowance for
doubtful debts
Cr
4,243
80,213
80,000
36,000
Depreciation
charges
20,000
Office expenses
50,000
Opening inventory
31,000
Payroll expenses
30,632
750
433,764
50,323
5,068
Suspense
3,100
VAT
3,850
750
18,330
155,000
Vehicles
accumulated
depreciation
TOTAL
250
43,221
Sales
Vehicles at cost
36,000
1,000
210,422
Purchases ledger
control account
Selling expenses
Cr
2,600
Closing inventory

account
Dr
400
Capital
Purchases
Cr
400
Allowance for
doubtful debts
adjustment
Bank
Cr
Statement of
Financial Position
30,000
612,658
612,658
20,000
61,000
61,000
267
Final steps
The statement of profit or loss ledger account
At the end of the period any balances on the income and expenditure nominal ledger (or
'T') accounts are closed off and transferred to the statement of profit or loss ledger
account.
This leaves a nil balance on those ledger accounts ready for the next period.
Completing the statement of financial position

The statement of financial position:
a)
b)
c)
Lists all ledger accounts with balances remaining;

Ie all assets and liabilities;
It is not part of double entry system so these balances are not transferred out.
Completing the capital account

At the end of the period the statement of profit or loss nominal ledger account is
cleared out with the balance being transferred to the capital account. The double
entry is:
Dr
Cr
Capital account
With any profit
or
Dr
Capital account
Cr
With any loss
The overall effect is to leave the profit or loss account with no balance at the start of the
following period and to adjust the capital account to reflect the increase/decrease in the
amount owed to the owner by the business as a result of any profit or loss made during
the period.
The amount owed to the owner by the business is also affected by drawings which
represents amounts that the owner has effectively received back. Therefore, the balance
on the drawings account will also be transferred to the capital account using the double
entry:
Dr
Capital account
Cr
Drawings account
The final balance carried down on the capital account after all adjustments have been
made will show the net asset value of the business.
268

requirements on any area of the syllabus. If the requirements are based on the
extended trial balance, they could be structured as follows.

Required
(a)
Which of the following best describes the purpose of an extended trial

balance? Select ONE option.
It ensures the accuracy of the sales and purchases ledger accounts.

The extended trial balance can form the basis for the preparation of
the financial statements.
It is used in place of the financial statements.
It ensures that all transactions are recorded in the financial
statements.
(b)

True
False
A bank overdraft will be shown on the debit side of the

extended trial balance, in the statement of financial position
column.
The irrecoverable debt expense will be shown in one of the
statement of profit or loss columns in the extended trial
balance.
Drawings will be shown in one of the statement of financial
position columns in the extended trial balance.
VAT will be excluded from the extended trial balance.
269
SUMMARY
270
ANSWERS
(a)
Record the journals which need to be entered in the adjustments column

in the extended trial balance.
(i)
Plant depreciation
Account name
Debit
2,000
Plant accumulated depreciation

(ii)
Credit
2,000
Closing inventory
Account name
Closing inventory (SOFP)
Debit
Credit
1,500
Closing inventory (SPL)
1,500
(iii) Wages
Account name
Wages expense
Debit
Credit
900
Suspense
900
(iv) Rates
Account name
Rates
Rent
Debit
Credit
250
250
271
(b)
Enter the journals you have recorded in part (a) in the adjustments
column.
Then, extend the figures into the statement profit or loss and statement
of financial position columns.
Ledger account
Ledger balances
Dr
Bank
Plant
Cr
Adjustments
Dr
20,000
2,000
20,301
5,755
2,000
Rent
2,866
Sales
250
2,000
1,850
250
2,616
49,126
49,126
8,325
8,325
900
900
7,524
900
8,424
Profit / loss for

the year
272
1,500
5,755
1,600
14,635
62,316
Cr
2,000
20,301
Rates
TOTAL
1,500
800
Plant accumulated
depreciation
Wages expense
1,500
800
Purchases ledger
control
Suspense
Dr
20,000
Depreciation
charges
Sales ledger
control
Cr
7,435
1,500
Purchases
Dr
Statement of
Financial Position
7,435
Closing inventory
Opening
inventory
Cr
Statement of
profit or loss
62,316
4,650
4,650
50,626
14,635
50,626
29,825
29,825
COMPLETING THE EXTENDED TRIAL BALANCE

Extend the figures into the statement of profit or loss and statement of
financial position columns.
Ledger account
Ledger balances
Adjustments
Dr
Dr

debts
Cr
4,243
80,213
80,000
20,000
Office expenses
50,000
Opening inventory
31,000
Payroll expenses
30,632
36,000
20,000
49,000
31,000
250
750
30,382
211,172
43,221
433,764
433,764
50,323
50,323
5,068
Suspense
5,068
3,100
VAT
3,850
750
18,330
18,330
155,000
Vehicles accumulated
depreciation
155,000
30,000
20,000
Profit / loss for the

year
TOTAL
36,000
43,221
Sales
Vehicles at cost
36,000
1,000
210,422
Purchases ledger
control account
50,000
123,542
612,658
Cr
77,613
80,000
36,000
Selling expenses
Dr
400
2,600
Closing inventory

account
Cr
3,843
400
Capital
Purchases
Dr
Statement of
Financial Position
400

debts adjustment
Bank
Cr
Statement of profit
or loss
612,658
61,000
61,000
470,164
123,542
470,164
318,936
318,936
273

(a)
Which of the following best describes the purpose of an extended trial

balance? Select ONE option.
It ensures the accuracy of the sales and purchases ledger accounts.

The extended trial balance can form the basis for the preparation of
the financial statements.
It is used in place of the financial statements.

It ensures that all transactions are recorded in the financial
statements.
(b)

True
A bank overdraft will be shown on the debit side of the

extended trial balance, in the statement of financial position
column.
274
The irrecoverable debt expense will be shown in one of the

statement of profit or loss columns in the extended trial
balance.
Drawings will be shown in one of the statement of financial

position columns in the extended trial balance.
VAT will be excluded from the extended trial balance.
False
You have now covered the Topics that will be assessed in Step 5 in your Achievement
Topic name

concepts
Accounting concepts
1
2
assets
assets
assets
Inventories
Inventories

debts

reconciliations
9
10

suspense accounts
The trial balance, errors and suspense

accounts
11
12
Course notes
chapter
275
276
In the final run up to your exam, you should attempt Step 6 as the final check that you
are ready to sit the AAT computer-based test exam ready.
It covers all the Topics in your course. As ever, you will receive feedback on your
performance, and you can use the wide range of online resources to help address any
final areas where you need to fine tune your knowledge or technique.
Topic name

concepts
Accounting concepts
1
2
assets
assets
assets
Inventories
Inventories

debts

reconciliations
9
10

suspense accounts
The trial balance, errors and suspense

accounts
11
12
Course notes
chapter
277
278
Glossary of terms
It is useful to be familiar with interchangeable terminology including IFRS and UK GAAP
(generally accepted accounting principles).
Below is a short list of the most important terms you are likely to use or come across,
together with their International and UK equivalents.
UK term
International term
Profit and loss account
Statement of profit or loss (or

statement of profit or loss and other
comprehensive income)
Turnover or Sales
Revenue or Sales Revenue
Operating profit
Profit from operations
Reducing balance depreciation
Diminishing balance depreciation
Depreciation/depreciation expense(s)
Depreciation charge(s)
Balance sheet
Statement of financial position
Fixed assets
Non-current assets
Net book value
Carrying amount
Tangible assets
Stocks
Inventories
Trade debtors or Debtors
Trade receivables
Prepayments
Other receivables
Debtors and prepayments
Trade and other receivables
Cash at bank and in hand
Cash and cash equivalents
Long-term liabilities
Non-current liabilities
Trade creditors or Creditors
Trade payables
Accruals
Other payables
Creditors and accruals
Trade and other payables
Capital and reserves
Equity (limited companies)
Profit and loss balance
Retained earnings
Cash flow statement
Statement of cash flows
Accountants often have a tendency to use several phrases to describe the same thing!
Some of these are listed below:
Different terms for the same thing
Nominal ledger, main ledger or general ledger
Memorandum ledger, sales ledger and purchases ledger, subsidiary ledger
Glossary of terms
279
280
Glossary of terms
Notes
281
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Introduction to the course

Topic: Accounting principles and concepts

Topic: Purchase of non-current assets

3. Purchase of non-current assets

ACHIEVEMENT LADDER STEP 1

Topic: Depreciation of non-current assets

4. Depreciation of non-current assets

Topic: Disposal of non-current assets

5. Disposal of non-current assets

ACHIEVEMENT LADDER STEP 2

Topic: Accruals and prepayments

6. Accruals and prepayments

ACHIEVEMENT LADDER STEP 3

Topic: Irrecoverable and doubtful debts

8. Irrecoverable and doubtful debts

Topic: Bank and control account reconciliations

10. Control account reconciliations

ACHIEVEMENT LADDER STEP 4

Topic: The trial balance, errors and the suspense account

11. The trial balance, errors and the suspense

Topic: The extended trial balance

12. The extended trial balance

ACHIEVEMENT LADDER STEP 5

ACHIEVEMENT LADDER STEP 6

Prepare for and book your CBT!

INTRODUCTION TO THE COURSE

Demonstrate an appropriate understanding of the principles that lie behind

Candidates must already have an understanding of double entry bookkeeping

Introduction to the course

Understand generally accepted accounting principles

Explain the accounting principles of going concern,

Explain the purpose of maintaining financial records

Describe the types of accounting records that a

Describe the main requirements of accounting

Explain the accounting characteristics of relevance,

Explain the differences between capital and

Purchase of noncurrent assets and

Purchase of noncurrent assets

Understand the principles of double entry

Explain the accounting equation

Define assets, liabilities and equity in an accounting

Explain the purpose and use of books of prime

Explain the purpose of reconciling the sales and

Introduction to the course

Understand the accounting methods used to record

Describe how the acquisition of non-current assets

Purchase of noncurrent assets

Explain the accounting treatment for recording the