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Preface Contents
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
(001)CT03PC(INT)_CH01.qxp 31/10/2008 13:05 Page 1
Topic List
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
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
Sales on credit
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
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
SALES PURCHASES
by the business to a customer by the business from a supplier
creates an creates an
ASSET LIABILITY
of the business of the business
settled when the business settled when the business
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)
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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.
Notes
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Topic List
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
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Alert. You must be able to identify, record and account for capital and revenue items accurately.
Notes
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There are also sales and purchase returns day books, which record goods returned by customers / to suppliers.
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
Note that for accounting purposes ‘cash’ includes cheques, unless specified as ‘cash in
hand’ or ‘petty cash’ (see next page).
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
The The journal and Day book The receivables Accounting The trial
general ledger imprest system analysis and payables ledgers for sales tax balance
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
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.
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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
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
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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
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
Accounting concepts
Development of accounting standards
Relevant accounting standards
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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
Topic List
Control accounts
Sales tax
Errors
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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)
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.
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
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Allowances can either be specific, against a particular receivable, or general, against a proportion of all
receivables not specifically allowed for.
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
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Notes
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$
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
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.
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.
Journal 2
13 Sept X2 DEBIT Plant & machinery $14,000
DEBIT Sales tax $2,450
CREDIT Cash $16,450
Being purchase of printing machine
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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
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.
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.
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.
Topic List
Purpose
Preparing the ETB
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Purpose Preparing
the ETB
Purpose Preparing
the ETB
2 If debits don’t equal credits, check the entries are correct, then insert a suspense account.
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.
Purpose Preparing
the ETB
8 Take the profit or loss for the period to the statement of financial position columns.
Preparing accounts
Legal status of sole traders
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An extended trial balance essentially records the adjustments which are required to the trial balance in order to
produce the final accounts.
The ETB is essentially a worksheet, representing all the ledger account balances and what happens to them.
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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.
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.
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
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.
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
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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
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.
Opening statement of Credit sales, purchases Stolen or Cash book Accruals, prepayments
financial position and cost of sales destroyed goods and drawings
Opening statement of Credit sales, purchases Stolen or Cash book Accruals, prepayments
financial position and cost of sales destroyed goods and drawings
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
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
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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
Notes
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13: Partnerships
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.
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
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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
Characteristics Preparing
partnership accounts
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.
Characteristics Preparing
partnership accounts
$ $
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
__
__
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$ $
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.
Notes