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(000)CT03PC(INT)_FP.

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CAT Intermediate Paper 3


Maintaining Financial Records
International Stream
(000)CT03PC(INT)_FP.qxp 31/10/2008 13:04 Page ii

First edition 2005


Fifth edition January 2009
ISBN 9780 7517 5785 9 (Previous edition 9780 7517 4792 8)
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British Library
Published by
BPP Learning Media Ltd, BPP House, Aldine Place, London W12 8AA
www.bpp.com/learningmedia
Printed in the United Kingdom
Your learning materials, published by BPP Learning Media Ltd, are printed on paper
sourced from sustainable, managed forests.
All our rights reserved. No part of this publication may be reproduced, stored in a retrieval
system or transmitted, in any form or by any means, electronic, mechanical, photocopying,
recording or otherwise, without the prior written permission of BPP Learning Media Ltd.
©
BPP Learning Media Ltd
2009
(000)CT03PC(INT)_FP.qxp 31/10/2008 13:04 Page iii

Preface Contents

Welcome to BPP Learning Media’s new CAT Passcards.


 They save you time. Important topics are summarised for you.
 They incorporate diagrams to kick start your memory.
 They follow the overall structure of the BPP Learning Media Interactive Texts, but BPP Learning Media’s
new CAT Passcards are not just a condensed book. Each card has been separately designed for clear
presentation. Topics are self contained and can be grasped visually.
 CAT Passcards are just the right size for pockets, briefcases and bags.
 CAT Passcards focus on the exam you will be facing.
Run through the complete set of Passcards as often as you can during your final revision period. The day
before the exam, try to go through the Passcards again! You will then be well on your way to completing your
exam successfully.
Good luck!

Page iii
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Preface Contents

Page Page
1 Assets, liabilities and the accounting equation 1 8 Cost of goods sold and the treatment
2 Statement of financial position and income of inventories 49
statement 11 9 Non-current assets and depreciation 55
3 Recording and summarising transactions 17 10 Extended trial balance 67
4 Posting transactions, balancing accounts 11 The accounts of sole traders 71
and the trial balance 23
12 Incomplete records 77
5 Accounting concepts and standards 33
13 Partnerships 85
6 Control accounts and the correction of errors 37
7 Accruals and prepayments, receivables and
irrecoverable debts 41
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1: Assets, liabilities and the accounting


equation

Topic List

Assets and liabilities


Double entry
Payables and receivables
The accounting equation
(001)CT03PC(INT)_CH01.qxp 31/10/2008 13:05 Page 2

Assets and Double Payables and The accounting


liabilities entry receivables equation

Assets Liabilities
An item of value which a business owns or has Something which is owed to someone else
the use of

Eg: Eg:
 Land and buildings  Bank loan/overdraft
 Vehicles  Amounts owed to trade payables (suppliers)
 Inventories  Tax
 Cash

A receivable is an asset. A receivable represents A payable is a liability. A payable represents money


money owed to the business. owed by the business.
(001)CT03PC(INT)_CH01.qxp 31/10/2008 13:05 Page 3

Non-current asset: an asset acquired for use within Current liabilities: debts which must be settled
the business over more than one accounting period within one year

Current assets: items owned by the business with Non-current liabilities: debts which are not
the intention of turning them into cash payable within one year

The cash cycle


Cash
Cash is used to buy goods which are sold. Sales on
credit create receivables, but eventually cash is pay buys
earned from the sales. Some of the cash will then be
used to replenish inventories. Receivables Inventories of goods

Sales on credit

Page 3 1: Assets, liabilities and the accounting equation


(001)CT03PC(INT)_CH01.qxp 31/10/2008 13:05 Page 4

Assets and Double Payables and The accounting


liabilities entry receivables equation

Basic principles Double entry bookkeeping


Double entry bookkeeping is based on the same idea as the
accounting equation. The rules of double entry bookkeeping
 Every accounting transaction has two equal but opposite are best learnt by considering the cash
effects book.
 Equality of assets and liabilities is preserved  A credit entry indicates a payment
In a system of double entry bookkeeping every accounting made by the business; the matching
event must be entered in ledger accounts both as a debit and debit entry is then made in an account
as an equal but opposite credit. denoting an expense paid, an asset
purchased or a liability settled
Debit Credit  A debit entry in the cash book
indicates cash received by the
An increase in an expense An increase in income business; the matching credit entry is
An increase in an asset An increase in a liability then made in an account denoting
A decrease in a liability A decrease in an asset revenue received, a liability created or
an asset sold
(001)CT03PC(INT)_CH01.qxp 31/10/2008 13:05 Page 5

D DEBIT C CREDIT
Increases in Increases in

E EXPENSES L LIABILITIES
eg incur advertising costs eg buy goods on credit

A ASSETS I INCOME
eg new office equipment eg make a sale

D DRAWINGS C CAPITAL
eg the owner takes cash for his own use eg owner pays in personal money

Decreases in liabilities, capital or Decreases in assets, drawings or


income expenses

Left hand side Right hand side

Page 5 1: Assets, liabilities and the accounting equation


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Assets and Double Payables and The accounting


liabilities entry receivables equation

Every transaction has a debit and a credit. Total debits = Total credits
If a business buys goods for resale with cash
then:
DEBIT Purchases
CREDIT Cash Accounting equation
Cash sales result in: Assets = Liabilities + Capital
DEBIT Cash
CREDIT Sales
Profit = Income - Expenditure
(001)CT03PC(INT)_CH01.qxp 31/10/2008 13:05 Page 7

Assets and Double Payables and The accounting


liabilities entry receivables equation

SALES PURCHASES
by the business to a customer by the business from a supplier
creates an creates an

ACCOUNT RECEIVABLE ACCOUNT PAYABLE


a customer who owes money to the business a supplier who is owed money by the business
recorded as an recorded as a

ASSET LIABILITY
of the business of the business
settled when the business settled when the business

RECEIVES CASH PAYS CASH

Page 7 1: Assets, liabilities and the accounting equation


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Assets and Double Payables and The accounting


liabilities entry receivables equation

What is a business? Separate entity


A business exists to make a profit. Profit is the A business must always be treated as a separate
excess of income over expenditure. entity from its owner when preparing accounts.

Business equation
P=I+D–C
P is profit earned in current period
This derives from the accounting
I is increase (or decrease) in net assets in current
equation: Assets = Capital + Liabilities.
period
D is drawings in current period Net assets = total assets less total
liabilities
C is capital introduced in current period
Drawings = capital withdrawn from
the business by the
owner(s)
(001)CT03PC(INT)_CH01.qxp 31/10/2008 13:05 Page 9

Accounting equation
Capital: amount invested in the business by the owner(s). It is owed to the owners(s) and so is a liability.

Accounting equation 1
Assets = Capital + Liabilities

Accounting equation 2
Assets - Liabilities = Capital

Accounting equation 3
Net assets = Capital introduced + retained profits - drawings. Also known as the Business equation.

Page 9 1: Assets, liabilities and the accounting equation


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Notes
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2: Statement of financial position and


income statement

Topic List

Statement of financial position


Income statement
Capital and revenue
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Statement of Income Capital and


financial position statement revenue

Statement of financial position Income statement


A statement of the assets, liabilities and capital of A statement of revenue earned and costs incurred
a business at a given time in earning it

The statement of financial position The income statement usually highlights gross profit
demonstrates the accounting equation: and net profit.
Assets (A) = Capital (B) + Liabilities (C). The first part shows the gross profit for the period.
Gross profit = Sales – Cost of goods sold
The gross profit is then adjusted to show the net
profit for the period.
Net profit = Gross profit + Other income – Other
expenses
(002)ct03pc(int)_ch02.qxp 31/10/2008 13:21 Page 13

PROFORMA STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20X5


£ £
Non-current assets
Land and buildings X
Plant and machinery X
Fixtures and fittings X
X
Current assets
Inventories X
Receivables X
Cash at bank and in hand X
Total assets X
A
Equity and liabilities
Equity
Proprietor’s capital X
Retained earnings X
B
Non-current liabilities X
Current liabilities
Trade payables X
Bank overdraft X X
A

Page 13 2: Statement of financial position and income statement


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Statement of Income Capital and


financial position statement revenue

INCOME STATEMENT FOR THE PERIOD ENDED 31 MARCH 20X5


$ $
Sales X
Cost of sales (X)
Gross profit X
Distribution costs X
Administrative expenses X
(X)
Profit for the year X
(002)ct03pc(int)_ch02.qxp 31/10/2008 13:21 Page 15

Statement of Income Capital and


financial position statement revenue

Capital and revenue items


Capital expenditure Revenue expenditure
Results in the acquisition of non-current assets or Expenditure incurred during trading activities or to
an improvement in an existing non-current asset’s maintain current earning capacity (ie repairs)
earning capacity.

Capital income Revenue income


Proceeds from the sale of non-current assets Proceeds from sale of goods or rent, interest and
dividends earned from non-current assets

Alert. You must be able to identify, record and account for capital and revenue items accurately.

Page 15 2: Statement of financial position and income statement


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Notes
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3: Recording and summarising transactions

This chapter covers the main sources of data and the


Topic List function each source or record has.
We will see how the documents are recorded in books of
The role of source documents prime entry to reflect business transactions.
Sales and purchase day books
Cash books
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The role of source Sales and purchase Cash


documents day books books

Source documents Books of prime entry


Business transactions are nearly always recorded on The source documents are recorded in books of
a document. These documents are the source of the prime entry.
information in the accounts. Such documents include
the following:  Sales day book
 Purchases day book
 Sales order
 Sales returns day book
 Purchase order
 Purchases returns day book
 Invoice
 Cash book
 Credit note
 Petty cash book
 Debit note
 Journal (see Chapter 6)
 Goods received note
 Remittance advice
 Cheque stubs
 Petty cash vouchers
(003)CT03PC(INT)_CH03.qxp 31/10/2008 13:29 Page 19

The role of source Sales and purchase Cash


documents day books books

Sales day book Purchases day book


The sales day book is used to keep a list of all invoices This is used to keep a record of invoices which a
sent out to customers each day. Here is an example. business receives. Here is an example.
SALES DAY BOOK PURCHASES DAY BOOK

Invoice Receivables ledger Total Payables Total


Date number Customer ref. invoiced Date Supplier ledger ref. invoiced
$ £
3.3.X9 207 ABC SL12 4,000 3.4.X9 RST PL31 215
208 XYZ SL59 1,200 10.4.X9 JMU PL19 1,804
5,200 15.4.X9 DDT PL24 758
2,777

There are also sales and purchase returns day books, which record goods returned by customers / to suppliers.

Page 19 3: Recording and summarising transactions


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The role of source Sales and purchase Cash


documents day books books

Cash book
Cash receipts and payments are recorded in the cash book.

Cash receipts are recorded as follows, with the total column analysed into its
component parts.
CASH RECEIPTS

Discounts Receivables Cash


Date Narrative Total allowed ledger sales Sundry
$ $ $ $ $
3.3.X9 Cash sale 150 150
Receivable:
ABC 1,000 50 1,050
(discount taken)
1,150 50 1,050 150 –
(003)CT03PC(INT)_CH03.qxp 31/10/2008 13:29 Page 21

Cash payments are recorded in a similar way.


CASH PAYMENTS

Discounts Payables Cash Petty


Date Narrative Total received ledger purchases Cash
$ $ $ $ $
3.3.X9 DEF 300 – 300 –
Petty Cash 100 – – – 100
400 – 300 – 100

Note that for accounting purposes ‘cash’ includes cheques, unless specified as ‘cash in
hand’ or ‘petty cash’ (see next page).

Page 21 3: Recording and summarising transactions


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The role of source Sales and purchase Cash


documents day books books

Petty cash book


Most businesses keep a small amount of cash on the premises for small payments, eg stamps,
coffee. Petty cash payments and receipts are recorded in a petty cash book.
PETTY CASH BOOK

RECEIPTS PAYMENTS
Date Narrative Total Date Narrative Total Stationery Coffee
$ Date $ $ $
3.3.X9 Bank 50 3.3.X9 Paper 10 10
Coffee 5 5
50 15 10 5

Under the ‘imprest system’: $


Cash still held in petty cash X
Plus voucher payments X
__
Must equal the agreed sum or float X
__
__
(004)CT03PC(INT)_CH04.qxp 31/10/2008 13:33 Page 23

4: Posting transactions, balancing accounts


and the trial balance

This chapter looks at ledger accounting.


Topic List
The balances on the ledgers help provide the business
with information about what it is doing.
The general ledger
Sale tax is a general consumer expenditure tax. It is not
The journal and imprest system a major area of the syllabus but may appear in MCQs.
Day book analysis
The receivables and payables ledgers
Accounting for sales tax
The trial balance
(004)CT03PC(INT)_CH04.qxp 31/10/2008 13:33 Page 24

The The journal and Day book The receivables Accounting The trial
general ledger imprest system analysis and payables ledgers for sales tax balance

Ledger accounting The general ledger


is the process by which a business keeps a record is an accounting record which summarises the
of its transactions: financial affairs of a business. Accounts within the
nominal ledger include the following.
 In chronological order
 Built up in cumulative totals  Plant and machinery (non current asset)
 Inventories (current asset)
 Sales (income)
A ledger account or ‘T’ account looks like this.  Rent (expense)
NAME OF ACCOUNT  Total payables (current liability)
$ $
DEBIT SIDE CREDIT SIDE
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The The journal and Day book The receivables Accounting The trial
general ledger imprest system analysis and payables ledgers for sales tax balance

Journal
Format of journal entries is as follows.
Date Debit Credit
$ $
DEBIT A/c to be debited X Journal entries are often required in an exam
CREDIT A/c to be credited X where you would not use the journal in practice,
to save you the time that would be involved in
Narrative to explain transaction drawing up ‘T’ accounts.

Journal
Journals are used to record source information that is Imprest system
not contained within the other books of prime entry. The double entry for topping up the petty cash is as
They record the following: follows:
Period end adjustments $ $
DEBIT Petty cash X
Correction of errors
CREDIT Cash at bank X
Large / unusual transactions

Page 25 4: Posting transactions, balancing accounts and the trial balance


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The The journal and Day book The receivables Accounting The trial
general ledger imprest system analysis and payables ledgers for sales tax balance

Day books
Note that day books are often analysed as in the following extract (date and customer name not shown).
Total invoiced CD sales Cassette sales
$ $ $
340 160 180
120 70 50
600
_____ 350
___ 250
___
1,060
_____
_____ 580
___
___ 480
___
___
To identify sales by product, total sales would be entered (‘posted’) as follows.
$ $
DEBIT Receivables a/c 1,060
CREDIT Sales: CDs 580
Sales: Cassettes 480
Other books of prime entry are analysed in a similar way.
(004)CT03PC(INT)_CH04.qxp 31/10/2008 13:33 Page 27

The The journal and Day book The receivables Accounting The trial
general ledger imprest system analysis and payables ledgers for sales tax balance

Receivables and payables ledgers


To keep track of individual customer and supplier Entries to the receivables ledger are made as follows.
balances it is common to maintain subsidiary  When making an entry in the sales day book, an
ledgers called the receivables ledger and the entry is then made on the debit side of the
payables ledger. Each account in these ledgers customer’s account in the receivables ledger
represents the balance owed by or to an individual
customer or supplier.  When cash is received and an entry made in the
cash book, an entry is also made on the credit
Note that these receivables and payables ledgers side of the customer’s account in the receivables
are kept purely for reference and are therefore ledger
known as memorandum records. They do not form
The payables ledger operates in much the same way.
part of the double entry system.

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The The journal and Day book The receivables Accounting The trial
general ledger imprest system analysis and payables ledgers for sales tax balance

Sales tax
Administered by the Is an indirect tax levied on the UK (VAT):
tax authority sale of goods and services Standard rate 17.5%
Reduced rate 5%
Each country has its
own rates
Output tax
Greater than input?
Tax charged by the business on Pay difference to tax
goods/services authority Input tax
Greater than output? Tax on purchases made by the
business
Refund due to business
(004)CT03PC(INT)_CH04.qxp 31/10/2008 13:33 Page 29

a Credit sales b Credit purchases


(i) Include sales tax in sales day book; show it (i) Include sales tax in purchases day book; show it
separately separately
(ii) Include gross receipts from customers in (ii) Include gross payments in cashbook; no need to
cashbook; no need to show sales tax separately show sales tax separately
(iii) Exclude sales tax element from income (iii) Exclude recoverable sales tax from income
statement statement
(iv) Credit sales tax payable with output tax element (iv) Include irrecoverable sales tax in income
of sales invoices statement
(v) Debit sales tax creditor with recoverable input
tax element of payable credit purchases

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The The journal and Day book The receivables Accounting The trial
general ledger imprest system analysis and payables ledgers for sales tax balance

c Cash sales d Cash purchases


(i) Include gross receipts in cashbook; show sales (i) Include gross payments in cashbook: show sales
tax separately tax separately
(ii) Exclude sales tax element from income (ii) Exclude recoverable sales tax from income
statement statement
(iii) Credit sales tax payable with output tax element (iii) Include irrecoverable sales tax in income
of cash sales statement
(iv) Debit sales tax payable with recoverable input
tax element of cash purchases
(004)CT03PC(INT)_CH04.qxp 31/10/2008 13:33 Page 31

SALES TAX PAYABLE


$ $
Input tax 8,000 Output tax (credit sales) 15,000
Amount due to tax Output tax
authority (cash paid) 9,000 (cash sales) 2,000
17,000 17,000

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The The journal and Day book The receivables Accounting The trial
general ledger imprest system analysis and payables ledgers for sales tax balance

Trial balance
Errors not highlighted by trial balance
A trial balance is a list of ledger balances shown
in debit and credit columns.
 Complete omission of a transaction
The debits should equal the credits.  Error of commission: posting to the wrong
account
If the trial balance does not balance, you need to set
 Compensating errors
up a suspense account.
 Errors of principle

Suspense account. This is a temporary


account set up to make the trial balance work.
Errors need to be found and corrected, clearing the
suspense account, before the final accounts are
prepared
(005)CT03PC(INT)_CH05.qxp 31/10/2008 13:33 Page 33

5: Accounting concepts and standards

This chapter deals with the conceptual basis of accounts


Topic List preparation, the ‘why?’ as opposed to the ‘how?’.

Accounting concepts
Development of accounting standards
Relevant accounting standards
(005)CT03PC(INT)_CH05.qxp 31/10/2008 13:33 Page 34

Accounting Development of Relevant


concepts accounting standards accounting standards

What are accounting concepts?


Accounting concepts are the assumptions underlying the financial accounts. The most important accounting
concepts are going concern and accruals.

Going concern Accruals (matching)


Assumes that the business will continue to operate Transactions should be recognised when they
into the foreseeable future at its current level of occur, not as cash is received or paid.
activity.
(005)CT03PC(INT)_CH05.qxp 31/10/2008 13:33 Page 35

Other concepts
Prudence Consistency Materiality
Where there is a choice of Similar items should be Only material items should appear in
procedures or valuations, the one given similar treatment the financial statements.
selected should give the most Items are material if their omission or
cautious presentation of the The same treatment should
be applied from one period misstatement would affect the impact of
business results. the financial statements on the reader.
to another
Where a loss is foreseen it should Context important
be accounted for Some items are 'sensitive'
Profit should not be accounted for Borrowing should not be 'netted off’
until it is realised against cash balances

Page 35 5: Accounting concepts and standards


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Accounting Development of Relevant


concepts accounting standards accounting standards

Development of accounting standards Relevant standards for Paper 3


Accounting standard: IAS 16 Property, plant and equipment
A set of rules which prescribe the methods by IAS 1 Presentation of financial statements
which accounts should be prepared and
presented. IAS 2 Inventories

1. A discussion document about the topic is published


Important concepts
2. Following public comment an exposure draft is Relevance
published
Reliability
3. Following further comment and consultation, a Comparability
standard is issued by the IASB. Understandability
(006)CT03PC(INT)_CH06.qxp 31/10/2008 13:34 Page 37

6: Control accounts and the correction of


errors

Topic List

Control accounts
Sales tax
Errors
(006)CT03PC(INT)_CH06.qxp 31/10/2008 13:34 Page 38

Control Sales Errors


accounts tax

Control accounts
A control account is the grand total of similar The main control accounts are:
items (usually receivables or payables) recorded in
the main ledger.  Receivables ledger control account
(receivables)
 Payables ledger control account (payables)

The control account value should agree with the


total of the individual balances.

Other control accounts can be used for:


 Inventories  Wages and salaries  Sales tax
(006)CT03PC(INT)_CH06.qxp 31/10/2008 13:34 Page 39

Control Sales Errors


accounts tax

Accounting for sales tax


Sales tax is a tax on the sale of goods and services. Gross price = Net price + sales tax.

Output tax Input tax


Tax on goods or services sold. Tax on goods or services purchased.
DEBIT Cash (or receivables)$1,175 DEBIT Purchases £800
CREDIT Sales $1,000 DEBIT Sales tax account £140
CREDIT Sales tax account $175 CREDIT Trade payables £940
Each quarter the balance on the sales tax account (output tax less input tax) is calculated to establish the
amount owed to (or by) the tax authority.

Sales tax is calculated on the discounted price, even if the discount is not taken.
Receivables and payables shown in the statement of financial position include sales tax.
Sales and purchases shown in the income statement exclude sales tax.

Page 39 6: Control accounts and the correction of errors


(006)CT03PC(INT)_CH06.qxp 31/10/2008 14:31 Page 40

Control Sales Errors


accounts tax

Types of error
Journal
The journal records transactions not covered by other books
of original entry.  Errors of transposition
eg writing $381 instead of $318
The format of a journal entry is:
 Errors of omission eg do not record an
Date Reference $
invoice
DEBIT Account to be debited
 Errors of principle eg treating capital
CREDIT Account to be credited
expense as revenue
Narrative to explain the transaction  Errors of commission eg recording
Journals can be used to correct errors. The telephone expenses as electricity costs
error must have a debit equal in value to  Compensating errors eg telephone costs
the credit. understated by $342 and electricity cost
overstated by $342
(007)CT03PC(INT)_CH07.qxp 31/10/2008 13:40 Page 41

7: Accruals and prepayments, receivables


and irrecoverable debts

You’ve met the concept of accruals before - this chapter


Topic List tells you how to deal with them in practice.
You also cover the treatment of irrecoverable debts and
allowances for receivables.
Accruals and prepayments
Irrecoverable debts and allowances
(007)CT03PC(INT)_CH07.qxp 31/10/2008 13:40 Page 42

Accruals and Irrecoverable debts


prepayments and allowances

Matching concept Accruals


Accrual: 1 Review accruals listing for previous year.
An unpaid expense charged to the period because
it was incurred in the period
2 Review every income and expenditure account.

3 Review all invoices received after the year end.


Prepayment:
4 Calculate the relevant accruals.
A payment made in one period but charged to the
later period to which it relates
(007)CT03PC(INT)_CH07.qxp 31/10/2008 13:40 Page 43

Prepayments Accounting entries


Accruals:
1 Review list of prepayments from previous year.
DEBIT Expenses
2 Review all expense accounts for the year. CREDIT Accruals
Prepayments:
3 Calculate and list all prepayments.
DEBIT Prepayments
CREDIT Expenses

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Accruals and Irrecoverable debts


prepayments and allowances

Types of accrual and prepayment


$
Electricity/gas X Estimate based on previous bills (accrual)

Telephone X Calls estimate (accrual); rental is prepaid


Is rent paid in advance (prepayment) or
Rent X arrears (accrual)?
Salaries X One month's accrual if paid in arrears?

Salesmen's expenses X Specific expense claims (accrual)

Purchases X Goods received not invoiced (accrual)


X
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Accruals and Irrecoverable debts


prepayments and allowances

Irrecoverable debts and allowances


A receivable should only be classed as an asset if it is recoverable.

Irrecoverable debts Allowances


If definitely irrecoverable, the prudence concept If uncertainty exists as to the recoverability of the
dictates that it should be written off to the income debt, prudence dictates that an allowance should be
statement as an irrecoverable debt. set up. This is offset against the receivables balance
on the statement of financial position.
DEBIT Irrecoverable debts expense (income
statement) DEBIT Irrecoverable debts expense
CREDIT Receivables ledger control CREDIT Allowance for receivables

Allowances can either be specific, against a particular receivable, or general, against a proportion of all
receivables not specifically allowed for.

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Accruals and Irrecoverable debts


prepayments and allowances

When calculating the general allowance to be made, Note. Only the movement in the general allowance
the following order applies. needs to be accounted for.
$ $
Receivables balance per receivables ledger control X Allowance required X
Less: irrecoverable debts written off (X) Existing allowance (X)
amounts specifically allowed (X) Increase/(decrease) required X/(X)
Balance on which general allowance is calculated X

Accounting entries
DR CR
(1) Write off irrecoverable debts Irrecoverable debt expense Receivables ledger control

(2) Write back irrecoverable debts paid in period Receivables ledger control Irrecoverable debt expense

(3) Set up general allowance Irrecoverable debts expense Allowance for receivables

(4) Increase general allowance Irrecoverable debts expense Allowance for receivables

(5) Reduce general allowance Allowance for receivables Irrecoverable debts expense
(007)CT03PC(INT)_CH07.qxp 31/10/2008 13:40 Page 47

Subsequent recovery of debts


If an irrecoverable debt is If a debt previously provided for If a debt that was provided for in
recovered, having previously is recovered, then: the prior year turns irrecoverable,
been written off, then: DEBIT Cash then:
DEBIT Receivables ledger control CREDIT Receivables ledger control DEBIT Allowance for receivables
CREDIT Irrecoverable debts expense CREDIT Receivables ledger control
DEBIT Allowance for receivables
or, if written off in a previous CREDIT Irrecoverable debts expense
accounting period,
DEBIT Cash
CREDIT Sundry income

Page 47 7: Accruals and prepayments, receivables and irrecoverable debts


(007)CT03PC(INT)_CH07.qxp 31/10/2008 13:40 Page 48

Notes
(008)CT03PC(INT)_CH08.qxp 31/10/2008 13:41 Page 49

8: Cost of goods sold and the treatment of


inventories

This is an important chapter. It covers inventory which is


Topic List a key figure in both the income statement and the
balance sheet.
Cost of goods sold You also cover the calculation of cost of goods sold.
Accounting for opening and closing
inventories
Counting inventory
Valuing inventories
Valuation and profit: IAS 2
(008)CT03PC(INT)_CH08.qxp 31/10/2008 13:41 Page 50

Cost of Accounting for opening Counting Valuing Valuation and


goods sold and closing inventories inventory inventories profit: IAS 2

Formula for the cost of goods sold Carriage inwards

$
 Cost paid by purchaser of having goods
Opening inventory value X transported to his business.
Add purchases (or production costs) X  Added to cost of purchases.
X
Less closing inventory value (X)
Cost of goods sold X
Carriage outwards

 Cost to the seller, paid by the seller, of having


goods transported to customer.
 Is a selling and distribution expense.
(008)CT03PC(INT)_CH08.qxp 31/10/2008 13:41 Page 51

Cost of Accounting for opening Counting Valuing Valuation and


goods sold and closing inventories inventory inventories profit: IAS 2

Entries during the year


During the year, purchases are recorded by the
following entry. The exact reverse entry is made for the closing
DEBIT Purchases $ amount bought
inventory (which will be next year’s opening
CREDIT Cash or payables $ amount bought
inventory):
DEBIT Inventory $ closing inventory
The inventory account is not touched at all. CREDIT Income statement $ closing inventory

Entries at year-end The balance on the inventory account is still the


The first thing to do is to transfer the purchases opening inventory balance. This must also be
account balance to the income statement: transferred to the income statement:
DEBIT Income statement $ total purchases DEBIT Income statement $ opening inventory
CREDIT Purchases $ total purchases CREDIT Inventory $ opening inventory

Page 51 8: Cost of goods sold and the treatment of inventories


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Cost of Accounting for opening Counting Valuing Valuation and


goods sold and closing inventories inventory inventories profit: IAS 2

Counting inventory
In order to make the entry for the closing inventory
we need to know what is in inventory at the year-
end. We find this out not from the accounting
records, but by going into the warehouse and
actually counting the boxes on the shelves.

Some businesses keep detailed records of inventory


coming in and going out, so as not to have to count
everything on the last day of the year. These records
are not part of the double entry system.
(008)CT03PC(INT)_CH08.qxp 31/10/2008 13:41 Page 53

Cost of Accounting for opening Counting Valuing Valuation and


goods sold and closing inventories inventory inventories profit: IAS 2

A dealer in, say, kitchen appliances, may know from Identification rules
counting his inventory that he has 350 toasters in
inventory at the year-end. He then needs to know If we are using cost, and units have been bought at
what cash value to place on each toaster. This is the different prices during the year, we need to decide
problem of valuation. which items are left in inventory at the year-end.

Prices The possible rules are as follows. Only the first two
The price used to value an item of inventory might should be used for financial accounts (as opposed to
be any of a number of possibilities, eg selling management accounts).
price, replacement cost. However, we use the
lower of the following.  FIFO: first in, first out
 Average cost
 The cost of buying it  LIFO: last in, first out
 The net realisable value (NRV): the expected
selling price less future costs in getting the item
ready for sale and selling it Your syllabus does not require you to apply LIFO.

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Cost of Accounting for opening Counting Valuing Valuation and


goods sold and closing inventories inventory inventories profit: IAS 2

Valuation and profit IAS 2


Different inventory valuations produce different cost of  Inventory should be valued at the lower of cost
sales figures and therefore different profits. This is a and net realisable value – the comparison
temporary difference. between the two should ideally be made
separately for each item
 Cost is the cost incurred in the normal course of
business in bringing the product to its present
location and condition, including production
Remember. The higher the closing inventory overheads and some other overheads
value, the higher the profit.
 Net realisable value is selling price less costs
from now to completion and costs of marketing,
selling and distribution
 FIFO and average cost may be used, but not
LIFO
(009)CT03PC(INT)_CH09.qxp 31/10/2008 13:44 Page 55

9: Non-current assets and depreciation

This is a very important chapter. It covers capital


Topic List transactions, which you are very likely to come across,
both in the workplace and in your exam.
The basics
Acquisitions
Non-current assets register
Depreciation
Disposals
Reconciliation
(009)CT03PC(INT)_CH09.qxp 31/10/2008 13:44 Page 56

The basics Acquisitions Non-current Depreciation Disposals Reconciliation


assets register

Non-current assets: the basics


Non-current asset:
Acquired and retained within the business with a
view to earning profits, normally used over more Generally only material assets are capitalised.
than one accounting period.

Property, plant and equipment Intangible non-current asset


A physically present non-current asset: A non-current asset with no physical existence:
 Plant and machinery  Patent right
 Motor vehicles  Database
 Land and buildings  Trademark
(009)CT03PC(INT)_CH09.qxp 31/10/2008 13:44 Page 57

The basics Acquisitions Non-current Depreciation Disposals Reconciliation


assets register

Funding Organisational implications


 Cash  Leasing
 Borrowing  Part exchange  Liquidity. The purchase of a non-current
 Hire purchase asset may seriously affect cash flow
 Staffing/training. A new machine may need
skilled operatives
Step 1 Record inflow of funds.
 Productivity/profitability. New machinery
should improve productivity and profitability
 Marketing. Existing customers informed
Step 2 Record outflow of funds and acquisition and new customers found in order to fully
of the asset. utilise asset
 Running expenses. Most non-current
Authorisation: Any capital expenditure above a assets require fuel and/or maintenance
certain amount must be authorised; usually a capital  Premises. Is there room for more non-
expenditure authorisation form records this. current assets?

Page 57 9: Non-current assets and depreciation


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The basics Acquisitions Non-current Depreciation Disposals Reconciliation


assets register

Recording capital acquisitions Journal 1


The acquisition may be recorded in the cash book 13 Sept X2 DEBIT Motor vehicles a/c
or in the purchase day book. $13,200

However, the acquisition is more likely to be CREDIT Spiller $13,200


recorded with a journal. Being purchase of Peugeot 206
LM23 OLE

Journal 2
13 Sept X2 DEBIT Plant & machinery $14,000
DEBIT Sales tax $2,450
CREDIT Cash $16,450
Being purchase of printing machine
(009)CT03PC(INT)_CH09.qxp 31/10/2008 13:44 Page 59

The basics Acquisitions Non-current Depreciation Disposals Reconciliation


assets register

Non-current assets register


Listing of all assets owned by the organisation.

Not part of the double entry


An internal control

Likely details:
Description and location of asset
Purchase date
Cost
Depn method and estimated useful life
Accumulated depn b/f and c/f
Disposal date and proceeds
Profit/loss on disposal

Page 59 9: Non-current assets and depreciation


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The basics Acquisitions Non-current Depreciation Disposals Reconciliation


assets register

Depreciation Depreciation is charged to allocate a fair proportion


of the non-current asset’s cost to the period
benefiting from its use.
The measure of the use, wearing out and other
fall in useful life of a non-current asset. Depreciable amount = Cost – Expected residual
value

DEBIT Income statement Depn charge for the year


CREDIT Statement of financial position Accumulated depn
Depreciation is not a cash expense. Depreciation is not an asset replacement fund.
Judgements must be made on:
 Estimated useful life
 Method and rate of depreciation
 Residual value
The consistency concept demands that the same method of depreciation is used year on year.
(009)CT03PC(INT)_CH09.qxp 31/10/2008 13:44 Page 61

Methods of depreciation
Straight line Reducing balance
Cost of asset – residual value
n% × The net book value of the asset.
Expected useful life of asset
The depreciation charge is the same year on year. The depreciation charge is higher in the first years
of the asset's life.

Alert. Make sure that you learn both methods of depreciation. If you are given details of a non-current asset
which is purchased in the middle of the year, remember to adjust the depreciation charge for the months it was
not in use during the year.

Page 61 9: Non-current assets and depreciation


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The basics Acquisitions Non-current Depreciation Disposals Reconciliation


assets register

Recording depreciation in the accounts


1 Bring the credit balance of the accumulated depreciation down.

2 Depreciation charge:
DEBIT Depreciation expense (income statement)
CREDIT Allowance for depreciation a/c (accumulated depreciation)

3 Non-current asset accounts are unchanged, showing the cost of the non-current assets.

Net book value = Non-current asset cost less accumulated depreciation


(009)CT03PC(INT)_CH09.qxp 31/10/2008 13:44 Page 63

The basics Acquisitions Non-current Depreciation Disposals Reconciliation


assets register

Disposing of non-current assets $ $


Sales proceeds X
Less cost of making the sale (X)
Net sale proceeds X
Cost of non-current asset X
Less accumulated depreciation (X)
Net book value (X)
Profit/(loss) on disposal X/(X)

1 Calculate the profit/loss on disposal.

2 The following must appear in the disposals account.


 Original cost of the asset (DR)
 Accumulated depn (CR)
 Net sales proceeds (CR)

Page 63 9: Non-current assets and depreciation


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The basics Acquisitions Non-current Depreciation Disposals Reconciliation


assets register

3 Ledger accounting entries: DISPOSAL OF NON-CURRENT ASSET


(a) DEBIT Disposal of non-current asset $ $
account Non-current asset a/c 200 Acc. depn a/c 100
CREDIT Non-current asset account Income statement a/c Cash/receivable a/c 130
(profit) 30 ___
with cost of asset
230
___ 230
___
___
(b) DEBIT Accumulated depn a/c
CREDIT Disposal of non-current asset
account
with accumulated depn Alert. Disposals are a key area. Make sure
you can post the ledger entries correctly.
(c) DEBIT Receivable account or cash book
CREDIT Disposal of non-current asset account
4 with proceeds of asset sale
The balance on the disposal account is the profit/loss which
is recorded in the income statement.
(009)CT03PC(INT)_CH09.qxp 31/10/2008 13:44 Page 65

Part exchange
This is an added complication.
The sales proceeds for the disposal is the part
exchange value.
DEBIT The new non-current assets account
CREDIT The disposal account
with the part exchange values
Any additional cost of the new asset is accounted
for by:
DEBIT The new non-current assets account
CREDIT Cash/payable
with the balance paid on the new asset
Disposals, like acquisitions, need to be authorised.

Page 65 9: Non-current assets and depreciation


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The basics Acquisitions Non-current Depreciation Disposals Reconciliation


assets register

Reconciling physical assets ledgers accounts Discrepancies


and register
 Discrepancies have to be investigated.
 The non-current assets register must reconcile  Items listed in the non-current assets register
with both the general ledger and the assets must be physically inspected on a regular
themselves. basis.
 The cost and accumulated depn totals in the  The non-current assets register must be kept
non-current assets register must be compared up to date.
to the general ledger accounts.  Discrepancies need to be followed up.
(010)CT03PC(INT)_CH10.qxp 31/10/2008 13:45 Page 67

10: Extended trial balance

Topic List

Purpose
Preparing the ETB
(010)CT03PC(INT)_CH10.qxp 31/10/2008 13:45 Page 68

Purpose Preparing
the ETB

Extended trial balance (ETB):


a worksheet used to record adjustments between
the trial balance and the final accounts

The ETB headings will look something like this.


Ledger account Trial balance Adjustments Income Statement of
figure statement financial position
Dr Cr Dr Cr Dr Cr Dr Cr
$ $ $ $ $ $ $ $
(010)CT03PC(INT)_CH10.qxp 31/10/2008 13:45 Page 69

Purpose Preparing
the ETB

Preparing the ETB


1 Draw up the trial balance. Enter it on the ETB and add it up.

2 If debits don’t equal credits, check the entries are correct, then insert a suspense account.

3 Make the adjustments required:


 Accruals and prepayments
 Adjustments to inventory figures
 Other adjustments (eg depn and bad debts)

4 Check that the suspense a/c has been cleared by your adjustments.

5 Add the adjustments columns. Check the entries are correct and debits equal credits.

6 Add the figures across each line of the ETB and record total income statement or statement of financial
postion as appropriate.

7 Add the income statement debit and credits.

Page 69 10: Extended trial balance


(010)CT03PC(INT)_CH10.qxp 31/10/2008 13:45 Page 70

Purpose Preparing
the ETB

8 Take the profit or loss for the period to the statement of financial position columns.

 Profit = DEBIT INCOME STATEMENT = CREDIT B/S


 Loss = CREDIT INCOME STATEMENT = DEBIT B/S
9 Add up the debits and credits in the statement of financial position and ensure they are equal. Investigate
and resolve any differences.
(011)CT03PC(INT)_CH11.qxp 31/10/2008 13:45 Page 71

11: The accounts of sole traders

You need to be able to prepare accounts of a sole trader.


Topic List This usually requires preparation of financial accounts
from the trial balance or ETB.You must be familiar with
Purpose of an ETB this type of question.

Preparing accounts
Legal status of sole traders
(011)CT03PC(INT)_CH11.qxp 31/10/2008 13:45 Page 72

Purpose of Preparing Legal status of


an ETB accounts sole traders

An extended trial balance essentially records the adjustments which are required to the trial balance in order to
produce the final accounts.

Extended trial balance


Trial balance Keeps track of adjustments for
List of all  Correction of errors
balances in the Final accounts
ledger accounts  Accruals and prepayments
Income statement
 Allowance for depreciation,
irrecoverable debts Statement of
financial position
 Closing inventory

The ETB is essentially a worksheet, representing all the ledger account balances and what happens to them.
(011)CT03PC(INT)_CH11.qxp 31/10/2008 13:45 Page 73

Purpose of Preparing Legal status of


an ETB accounts sole traders

Accounts from the ETB Examples of workings


Ideally it should be a straightforward matter to use the
figures in the last two columns of the extended trial  Sales and sales returns to be netted off
balance to draw up the statement of financial position  Cost of sales working: (opening inventory
and income statement. However, bear in mind the plus purchases less closing inventory)
following points.  Distribution and admin costs, aggregating
 You must know the format for an income statement figures in the ETB
and statement of financial position.  NBV of all non-current assets for final
accounts. Note - total depreciation charge
 You will need to produce workings to get the figures to income statement
in the ETB into a suitable format  Receivables - need to add in prepayments
 Payables - need to add in accruals

Some of these workings, eg cost of sales, can be shown on the face of the income statement or statement
of financial position. Others may need to be shown separately. Use your judgement as to how complicated
the working is likely to be.

Page 73 11: The accounts of sole traders


(011)CT03PC(INT)_CH11.qxp 31/10/2008 13:45 Page 74

Purpose of Preparing Legal status of


an ETB accounts sole traders

You may have to deal with some post ETB adjustments. These will be set out in the form of journal entries.
Here are the ones that are likely to come up most often.

Accrued accountancy fees Bank charges


The accountant estimates that a further $330 needs The bank sends a letter stating that interest of $170
to be accrued for finalising the accounts. and charges of $138 were accrued at the year end.
DEBIT Accountancy $330 DEBIT Bank interest $170
CREDIT Accruals $330 Bank charges $138
CREDIT Accruals $308
Drawings, not wages
The owner realises that £500 in the wages account Write off of an irrecoverable debt
was actually drawn by her, not paid to a staff
member. A customer has gone bankrupt owing $5,000.
DEBIT Drawings $500 DEBIT Irrecoverable debt expense $5,000
CREDIT Wages $500 CREDIT Receivables ledger control $5,000
(011)CT03PC(INT)_CH11.qxp 31/10/2008 13:45 Page 75

You will normally do the journal entries before producing the final accounts.
Remember to take account of these adjustments, as well as the information on the ETB, in preparing your final
accounts. For instance:
 Your payables figure may now include accountancy and bank interest accruals
 Your receivables may be less and your income statement bad debt expense will need to be increased
Accounts from other sources
You may be required to draft sole trader accounts from sources other than the ETB.
 You may have to write up the ledger accounts, extract a trial balance and include final adjustments
 You may be given a trial balance and a list of items to be adjusted
 A trial balance may include a suspense account to be cleared

Page 75 11: The accounts of sole traders


(011)CT03PC(INT)_CH11.qxp 31/10/2008 13:45 Page 76

Purpose of Preparing Legal status of


an ETB accounts sole traders

The sole trader is liable for all the liabilities of a business to the extent of his or her personal wealth.
Contrast with limited liability companies: shareholders’ liability is limited to the extent of their shareholding in the
company.

Advantages of sole traders Disadvantages of sole traders


 Fewer rules to follow  Unlimited liability
 Only simplified accounts  Harder to raise capital
 No audit
 No supervision from government departments
(012)CT03PC(INT)_CH12.qxp 31/10/2008 13:46 Page 77

12: Incomplete records

This area is a very good test of your accounts


Topic List preparation knowledge.
You need to know how the accounts fit together in order
Opening statement of financial to fill in the blanks.
position
Credit sales, purchases and cost of
sales
Stolen or destroyed goods
Cash book
Accruals, prepayments and drawings
(012)CT03PC(INT)_CH12.qxp 31/10/2008 13:46 Page 78

Opening statement of Credit sales, purchases Stolen or Cash book Accruals, prepayments
financial position and cost of sales destroyed goods and drawings

Types of question
Opening statement of
An incomplete records question may require competence in financial position
dealing with one or more of the following.
Often a question provides information
 Preparation of accounts from information in the question about the assets and liabilities of a
 Theft of cash (balance on the cash in hand account is business at the beginning of a period,
unknown) leaving you to calculate capital as the
 Theft or destruction of inventory (closing inventory is the balancing figure.
unknown) Remember
 Estimated figures, eg 'drawings are between $15 and $20 Assets - liabilities = Proprietor's capital
per week'
 Calculation of capital by means of net assets
 Calculation of profit by P = increase in net assets plus
drawings minus increase in capital
 Calculation of year end inventory when the count was
done after the year end
(012)CT03PC(INT)_CH12.qxp 31/10/2008 13:46 Page 79

Opening statement of Credit sales, purchases Stolen or Cash book Accruals, prepayments
financial position and cost of sales destroyed goods and drawings

Credit sales and receivables Purchases and trade payables

 The key lies in the formula linking sales, cash  Similarly you need a formula for linking
receipts and receivables. purchases, cash payments and payables.
 Remember Opening payables + purchases – cash payments
Opening receivables + sales – cash receipts = closing = closing payables
receivables  Use a control account.
 Alternatively put all the workings into a control
account to calculate the figure you want.

RECEIVABLES LEDGER CONTROL ACCOUNT PAYABLES LEDGER CONTROL ACCOUNT


$ $ $ $
Opening receivables X Cash receipts X Cash payments X Opening payables X
Sales X Closing receivables X Closing payables X Purchases X
X X X X

Page 79 12: Incomplete records


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Opening statement of Credit sales, purchases Stolen or Cash book Accruals, prepayments
financial position and cost of sales destroyed goods and drawings

Gross margins and mark ups


Other incomplete records problems revolve around Gross profit may be expressed either as a percentage
the relationship between sales, cost of sales and of cost of sales or as a percentage of sales.
gross profit. Bear in mind the crucial formula.  In the example, gross profit is 25% of cost of sales
% (ie 25/100). The terminology is a 25% mark up
Cost of sales 100
Plus Gross profit 25  Gross profit can also be expressed as 20% of
sales (ie 25/125). The terminology is a 20% gross
Equals Sales 125
margin or gross profit percentage. The proforma
would appear as follows
%
Cost of sales 80
Plus Gross profit 20
Equals Sales 100
(012)CT03PC(INT)_CH12.qxp 31/10/2008 13:46 Page 81

Opening statement of Credit sales, purchases Stolen or Cash book Accruals, prepayments
financial position and cost of sales destroyed goods and drawings

Stolen goods or goods destroyed


The cost of goods stolen/destroyed can be calculated as follows.
$
Cost of goods sold based on gross profit margin or mark up A
Cost of goods sold calculated using standard formula
(ie opening inventory plus purchases less closing inventory) (B)
Difference (lost/stolen inventory) C

 If no goods have been lost, A and B should be the same and therefore C should be nil
 If goods have been lost, B will be larger than A, because some goods which have been purchased were
neither sold nor remaining in inventory, ie they have been lost
 Stolen or lost inventory is accounted for in two ways depending on whether the goods were insured
If insured If not insured
DEBIT Insurance claim (receivable) DEBIT Expenses (inventory losses)
CREDIT Purchases CREDIT Purchases

Page 81 12: Incomplete records


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Opening statement of Credit sales, purchases Stolen or Cash book Accruals, prepayments
financial position and cost of sales destroyed goods and drawings

Cash book Don't forget that movements between cash and bank need to
be recorded by contra entries. This will usually be cash
Incomplete records problems often concern small receipts lodged in the bank (debit bank column, credit cash
retail businesses where sales are mainly for cash. column), but could also be withdrawals of cash from the bank
A two-column cash book is often the key to to top up the till (debit cash column, credit bank column).
preparing final accounts.
Again, incomplete records problems will often feature an
 The bank column records cheques drawn on unknown figure to be derived. Enter in the credit of the cash
the business bank account and cheques column all amounts known to have been paid from till
received from customers and other sources receipts: expenses, drawings, lodgements into bank. Enter in
 The cash column records till receipts and any the debit of the cash column all receipts from cash
expenses or drawings paid out of till receipts customers or other cash sources.
before banking
 The balancing figure may then be a large debit,
Debits (receipts) Credits (payments) representing the value of cash sales if that is the
Cash Bank Cash Bank unknown figure
$ $ $ $  Alternatively it may be a credit entry that is needed to
balance, representing the amount of cash drawings or of
cash stolen
(012)CT03PC(INT)_CH12.qxp 31/10/2008 13:46 Page 83

Opening statement of Credit sales, purchases Stolen or Cash book Accruals, prepayments
financial position and cost of sales destroyed goods and drawings

Accruals and prepayments Drawings


When there is an accrued expense or prepayment, Note two tricky points about drawings.
the charge to income statement can be calculated  Owner pays personal income into business bank
from the opening balance, the cash movement and account
the closing balance. DEBIT Cash
Sometimes it helps to use a ‘T’ account, eg as follows CREDIT Drawings
(for a rent payment).  Owner pays personal expenses out of business
bank account
RENT DEBIT Drawings
$ $ CREDIT Cash
Prepayment: bal b/f 700 Income statement (bal fig) 9,000
Cash 9,300 Prepayment: bal c/f 1,000
10,000 10,000

Page 83 12: Incomplete records


(012)CT03PC(INT)_CH12.qxp 31/10/2008 13:46 Page 84

Notes
(013)CT03PC(INT)_CH13.qxp 31/10/2008 13:47 Page 85

13: Partnerships

Partnership accounts have a lot in common with sole


Topic List trader accounts. However, there are differences in the
way profit is appropriated and the way capital is
Characteristics presented in the statement of financial position.

Preparing partnership accounts


(013)CT03PC(INT)_CH13.qxp 31/10/2008 13:47 Page 86

Characteristics Preparing
partnership accounts

Definition: A partnership is an arrangement between two or more individuals in which they undertake to
share the risks and rewards of a joint business operation.

Partnership agreement No partnership agreement

There is usually a partnership agreement setting out These are the UK rules - they will vary between
the financial arrangements, eg: countries
 The amount of capital to be provided by each  Residual profits are shared equally between the
partner partners
 The division of profits between partners. Profits  There are no partners’ salaries
might be earned in the form of salaries, interest
 Partners receive no interest on the capital they
on capital and residual profit share. The
invest in the business
agreement will usually specify a ratio (the profit
sharing ratio) in which residual profits are to be  Partners are entitled to interest of 5% per
shared by the partners annum on any loans they advance to the
business in excess of their agreed capital
(013)CT03PC(INT)_CH13.qxp 31/10/2008 13:47 Page 87

Advantages and disadvantages


Partnership v sole trader Partnership v limited liability company

Advantages Advantages
 Spread risk  No need to comply with statutory requirements
 Network of contacts such as audit
 Partners bring in business, skills and experience  No need to comply with accounting standards
 Easier to raise finance
 No formation or registration fees
Disadvantages
Disadvantage
 Profits spread
 No limited liability
 Dilution of control
 Disputes between partners

Page 87 13: Partnerships


(013)CT03PC(INT)_CH13.qxp 31/10/2008 13:47 Page 88

Characteristics Preparing
partnership accounts

Capital and current accounts


It is usual to maintain both a capital account and a current account for each partner.
A partner’s capital account shows any cash or other assets brought by him into the business. He will usually
make an initial capital contribution when he joins the partnership, but there may also be further injections (or
withdrawals) of capital later on.
While the balance on a partner’s capital account is likely to remain stable for long periods, his current account
balance will fluctuate more rapidly.

PROFORMA CURRENT ACCOUNT


X Y Z X Y Z
$ $ $ $ $ $
Drawings X X X Balance b/f X X X
Interest on drawings X X X Salary X X X
Interest on capital X X X
Balance c/f X X X Profit share X X X
X X X X X X
(013)CT03PC(INT)_CH13.qxp 31/10/2008 13:47 Page 89

Appropriation accounts
The sum available for appropriation must now
After calculating the net profit earned by the 4 be shared amongst the partners and credited to
1 business an appropriation account must be their current accounts.
prepared to determine the allocation of profit
between the partners. Some partners may be entitled to a salary. This
5 is credited to the partner concerned and taken
2 To discourage excessive drawings partners out of the ‘pool’ available for appropriation.
often agree to charge themselves interest on
any sums withdrawn from the business. Partners may be entitled to interest on their
6 capital account balances. Each partner is
3 Such interest is charged to the partner credited with the appropriate amount and again
concerned (ie debited to his current account) the ‘pool’ is reduced.
and credited to the appropriation account,
increasing the profit available for sharing 7 Finally, the residual ‘pool’ of profits is shared
between the partners. amongst the partners in their profit sharing
ratio.

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Characteristics Preparing
partnership accounts

PROFORMA APPROPRIATION ACCOUNT

$ $
Net profit X
Add interest on drawings
A X
B X
C X
__
X
__
X
Less: salary: A X
interest on capital: A X
B X
C X
__
(X)
__
Profit X
__
__
(013)CT03PC(INT)_CH13.qxp 31/10/2008 13:47 Page 91

$ $
Appropriation: A X
B X
C X
__
X
__
__

When a partner makes a loan to the partnership he is a payable of the partnership. The loan is shown
separately from the partner’s capital as a long-term liability.
Remember:
Interest on a partner’s loan is an expense charged to the income statement not an appropriation. However, the
interest is added to the partner’s current account.
If no interest rate is specified, the rate is 5%. In an exam question, you will be told the rate.

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Notes

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