BBFA2103 Financial Accounting and Reporting 1 OUM

OUM Business School
BBFA2103
Financial Accounting and Reporting I
Copyright Open University Malaysia (OUM)

BBFA2103
FINANCIAL
ACCOUNTING AND
REPORTING I
Prof Dr Ong Tze San
Rosila Abu Zarin

Project Directors: Prof Dato Dr Mansor Fadzil
Prof Dr Wardah Mohamad
Open University Malaysia
Module Writers: Prof Dr Ong Tze San

Universiti Putra Malaysia
Rosila Abu Zarin

Moderator: Baldev Singh Pertab Singh

Developed by: Centre for Instructional Design and Technology

First Edition, December 2014

Second Edition, December 2016 (rs)
Copyright Open University Malaysia (OUM), December 2016, BBFA2103

All rights reserved. No part of this work may be reproduced in any form or by any means without
the written permission of the President, Open University Malaysia (OUM).

Table of Contents
Course Guide xiiixviii
Topic 1 Overview of Accounting 1

1.1 The Importance of Accounting 2
1.2 Definition of Accounting 4
1.3 Users of Accounting Information 6
1.3.1 Internal Users 6
1.3.2 External Users 7
1.4 Branches of Accounting 9
1.5 Forms of Business 10
1.5.1 Types of Business 10
1.5.2 Types of Ownership of Business 12
1.6 Functions or Roles of Accounting 16
1.6.1 Accounting as the Language of Trade 16
1.6.2 Accounting Creating Accountability and Control 16
1.6.3 Accounting is Information Systems 17
1.6.4 Accounting as a Decision-making Tool 19
Summary 20
Key Terms 21
Self-Test 1 21
Self-Test 2 22
Self-Test 3 23
Topic 2 Accounting Principles and Concepts 24

2.1 Regulatory and Conceptual Framework for Corporate 25
Reporting
2.2 Financial Statements 26
2.2.1 The Purpose of Financial Statements 27
2.3 The Components of Financial Statements 28
2.4 Elements of Financial Statements 36
2.5 Qualitative Characteristics of Accounting Information 38
2.5.1 Relevant 39
2.5.2 Reliable 40
2.5.3 Comparable 41
2.5.4 Consistent 42
2.5.5 Materiality 42
2.5.6 Understandable 43
2.5.7 Timely 43

iv TABLE OF CONTENTS
2.6 Accounting Assumptions 43

2.6.1 Assumption 1: Separate Entity 43
2.6.2 Assumption 2: Going Concern 44
2.6.3 Assumption 3: Monetary Unit 45
2.6.4 Assumption 4: Accounting Period 45
2.7 Basic Accounting Principles 45
2.7.1 Principle 1: Historical Cost 46
2.7.2 Principle 2: Revenue Recognition 46
2.7.3 Principle 3: Matching 47
2.7.4 Principle 4: Full Disclosure 47
2.8 Accounting Standards 47
Summary 49
Key Terms 50
Self-Test 1 50
Self-Test 2 51
Self-Test 3 51
Self-Test 4 52
Topic 3 Accounting Cycle 53

3.1 The Accounting Cycle 54
3.1.1 Source Documents 55
3.1.2 Transactions Analysis 55
3.1.3 Journalising 55
3.1.4 Posting to Ledgers 55
3.1.5 Preparing of Unadjusted Trial Balance 55
3.1.6 Adjusting Entries 56
3.1.7 Preparing of Adjusted Trial Balance 56
3.1.8 Preparing of Financial Statements 56
3.1.9 Closing Entries 56
3.2 Accounting Equation 58
3.3 Transaction Analysis 61
3.3.1 Transaction 1: Initial Investment by Owner 62
3.3.2 Transaction 2: Purchase of Non-current Asset 63
3.3.3 Transaction 3: Withdrawals by Owners 63
3.3.4 Transaction 4: Borrowing Money 64
3.3.5 Transaction 5: Repayment of Borrowings 65
3.3.6 Transaction 6: Earning Revenues 66
3.3.7 Transaction 7: Paying for Expenses 67
3.4 Presentation of Financial Statement (MFRS 101) 70
3.4.1 Statement of Financial Position (Balance Sheet) 70
3.4.2 Income Statement 70
3.4.3 Statement of Changes in Equity 70
3.4.4 Cash Flow Statements 71

TABLE OF CONTENTS v
3.4.5 Notes to the Accounts 71

Summary 71
Key Terms 72
Self-Test 1 72
Self-Test 2 73
Self-Test 3 75
Self-Test 4 76
References 76
Topic 4 Adjusting Entries and Closing Entries 77

4.1 Accounting Basis 78
4.1.1 Cash Basis Accounting 78
4.1.2 Accrual Basis Accounting 79
4.2 Adjusting Entries 81
4.2.1 Prepaid Expenses 82
4.2.2 Unearned Revenue 85
4.2.3 Accrued Expenses 86
4.2.4 Accrued Revenues 87
4.2.5 Depreciation 88
4.2.6 Bad Debts 90
4.2.7 Provision for Doubtful Debts 96
4.3 Adjusted Trial Balance 102
4.4 Closing Entries 103
4.4.1 Temporary Accounts 103
4.4.2 Permanent Accounts 103
4.4.3 Recording Closing Entries 103
Summary 109
Key Terms 110
Self-Test 1 110
Self-Test 2 112
Topic 5 Accounting for Current Assets 115

5.1 Assets 116
5.1.1 Internal Control for Assets 116
5.1.2 Current Assets 118
5.2 Accounting for Cash 119
5.3 Bank Reconciliation 120
5.3.1 Types of Bank Accounts 120
5.3.2 Purposes of Preparing Bank Reconciliation 123
5.3.3 Preparation of Bank Reconciliation Statement 124
5.4 Petty Cash 131
5.4.1 Creating the Petty Cash Fund 131
5.4.2 Using the Petty Cash Fund 132

vi TABLE OF CONTENTS
5.4.3 Reimbursement of the Petty Cash Fund 133

5.5 Receivables 135
5.5.1 Credit Control 135
5.5.2 Reliability Values of Accounts Receivables 136
Collection
5.5.3 Loan Loss Provisioning 136
5.5.4 Notes to Increase and Decrease in the Provision for 137
Doubtful Debts
5.5.5 Bad Debt Write Off 138
5.5.6 Reporting of Accounts Receivable in the Financial 139
Statements
5.6 Inventories 139
5.6.1 Management and Stock Control 140
5.6.2 Recording System (Periodic and Continuous) 140
5.6.3 Calculation Method for Stocks Value 142
5.6.4 Effect of Different Flow Assumptions Practice in 146
Inflation and Deflation
5.6.5 Stock Reported in the Financial Statements 147
5.6.6 Under First Real Impact and Value Stocks 148
Summary 148
Key Terms 149
Self-Test 1 150
Self-Test 2 151
Topic 6 Accounting for Non-current Assets 152

6.1 Definition of Non-current Assets 153
6.2 Accounting for Tangible Non-current Assets 154
6.3 Intangible Assets 156
6.3.1 Types 156
6.3.2 Evaluation 157
6.4 Presentation in the Balance Sheet 157
6.5 Depreciation 158
6.5.1 Straight Line Method 160
6.5.2 Reducing Balance Method 162
6.5.3 Units-of-production Method 163
6.6 Disposal of Non-current Assets 165
6.6.1 Retiring or Discarding the Non-current Asset 165
6.6.2 Selling the Non-current Asset 167
6.6.3 Exchanging the Non-current Asset for Another 173
Non-current Asset
6.7 Non-current Assets Held for Sale (FRS 5) 175
6.7.1 The Concept of Provisions of Depreciation 175
6.7.2 Factors Affecting the Useful Lives 176

TABLE OF CONTENTS vii
6.7.3 Methods of Calculating Depreciation 176

6.7.4 Disposal of Fixed Assets 180
6.8 Government Grants (FRS 120) 182
6.8.1 Categories of Grants 182
6.8.2 Disclosure 183
6.9 Investments 183
Summary 185
Key Terms 186
Self-Test 1 186
Self-Test 2 187
References 188
Topic 7 Property, Plant and Equipment (MFRS 116) 189

7.1 Property, Plant and Equipment 190
7.2 Recognition of Fixed Assets 191
7.3 Initial Measurement 192
7.3.1 Acquired Assets for Cash or Cash Equivalent 192
7.3.2 Self-constructed Fixed Asset 195
7.3.3 Exchange Fixed Asset 197
7.4 Subsequent Expenditure 199
7.5 Subsequent Measurement 202
7.6 Impairment, Retirement and Disposal 207
7.6.1 Impairment 207
7.6.2 Retirement and Disposal 209
7.7 Disclosure Requirements 211
Summary 213
Key Terms 214
Self-Test 1 214
Self-Test 2 216
References 217
Topic 8 Accounting for Liabilities and Equity 218

8.1 Definition of Liabilities 219
8.2 Current Liabilities 220
8.2.1 Bank Overdraft 221
8.2.2 Dividend Payable 222
8.2.3 Bank Loans 222
8.2.4 Bill Payable 223
8.3 Long-term Liabilities 225
8.3.1 Long-term Bank Loans 226
8.3.2 Bonds and Debentures 226
8.3.3 Mortgage Loans 227
8.4 Provisions and Contingencies 227

viii TABLE OF CONTENTS
8.4.1 Provisions 228

8.4.2 Contingencies 229
8.5 Equity 230
8.5.1 The Equity of a Single Proprietorship 230
8.5.2 The Equity of a Partnership 232
8.5.3 The Equity of a Company 233
Summary 243
Key Terms 243
Self-Test 1 244
Self-Test 2 244
Self-Test 3 246
Self-Test 4 246
Self-Test 5 247
Self-Test 6 247
References 248
Topic 9 Integrity and Ethics in Preparing and Reporting Financial 249

Information
9.1 Ethical Code 250
9.2 Ethical Behaviour 251
9.2.1 Integrity 251
9.2.2 Objectivity 252
9.2.3 Competence 252
9.2.4 Independence 253
9.2.5 Confidentiality 253
Summary 253
Key Terms 254
Self-Test 1 254
Self-Test 2 255
Topic 10 Comprehensive Cases (Partnership: Changes in Ownership) 256

10.1 Changes of Ownership in a Partnership 257
10.2 Goodwill 258
10.3 Admission of New Partners in a Partnership 261
10.4 Withdrawal of Partners in a Partnership 264
10.5 Revaluation of Assets 265
Summary 269
Key Terms 270
Self-Test 1 270
Self-Test 2 272

TABLE OF CONTENTS ix
Topic 11 Comprehensive Cases (Dissolution of a Partnership) 276

11.1 Reasons for Dissolution of a Partnership 277
11.2 Disposal of Assets and Settlement of Liabilities 280
11.3 The Garner versus Murray Rule 283
11.4 The Piecemeal Realisation 286
Summary 288
Key Terms 289
Self-Test 1 289
Self-Test 2 291
Answers 294

x TABLE OF CONTENTS

COURSE GUIDE

COURSE GUIDE xiii
COURSE GUIDE DESCRIPTION

You must read this Course Guide carefully from the beginning to the end. It tells
you briefly what the course is about and how you can work your way through
the course material. It also suggests the amount of time you are likely to spend in
order to complete the course successfully. Please keep on referring to the Course
Guide as you go through the course material as it will help you to clarify
important study components or points that you might miss or overlook.
INTRODUCTION
BBFA2103 Financial Accounting and Reporting I is one of the courses offered by
OUM Business School at Open University Malaysia (OUM). This course is worth
3 credit hours and should be covered over 8 to 15 weeks.
COURSE AUDIENCE
This is a core major course for all learners taking the Bachelor of Accounting
programme.
As an open and distance learner, you should be acquainted with learning

independently and being able to optimise the learning modes and environment
available to you. Before you begin this course, please ensure that you have the
right course material, and understand the course requirements as well as how the
course is conducted.
STUDY SCHEDULE
It is a standard OUM practice that learners accumulate 40 study hours for every
credit hour. As such, for a three-credit hour course, you are expected to spend
120 study hours. Table 1 gives an estimation of how the 120 study hours could be
accumulated.

xiv COURSE GUIDE
Table 1: Estimation of Time Accumulation of Study Hours
Study
Study Activities
Hours
Briefly go through the course content and participate in initial discussion 3
Study the module 60
Attend 3 to 5 tutorial sessions 10
Online participation 12
Revision 15
Assignment(s), Test(s) and Examination(s) 20
TOTAL STUDY HOURS ACCUMULATED 120
COURSE OUTCOMES
By the end of this course, you should be able to:
1. Distinguish between the different forms of businesses and their reporting
environments;
2. Describe the issues in the conceptual framework for financial accounting
and reporting;
3. Prepare the balance sheet and income statement;
4. Analyse the approved accounting standards to account for cash,
receivables, inventories and property, plant and equipment as well as
intangibles and investments;
5. Distinguish between the current and non-current liabilities, provisions and
contingencies;
6. Describe the different types of share capital and reserves; and
7. Evaluate the importance of ethics in the financial reporting process.
COURSE SYNOPSIS
This course is divided into 11 topics. The synopsis for each topic can be listed as
follows:
Topic 1 begins with an overview of accounting. It introduces the various forms

of business and different reporting requirements. The functions and roles of
accounting are also presented at the end of this topic.

COURSE GUIDE xv
Topic 2 discusses the regulatory and conceptual framework for corporate

reporting. These cover objectives of financial statements, components of financial
statements, elements of financial statements, qualitative characteristics and
accounting principles as well as concepts. The next part reveals the general
purpose of financial statements. Lastly, the topic ends with the description of
users of financial statements.
Topic 3 briefly explores the various stages of accounting cycles. It starts with the
accounting equation; introduction of journals, ledges and trial balance;
adjustments such as accruals and prepayments; and financial statements. The
presentation of financial statements based on MFRS101 is shown in this topic
which covers balance sheets; income statements; statements of changes in equity;
cash flow statements; and notes to the accounts.
Topic 4 differentiates cash and accrual basis of accounting. This topic also
explains the types and purposes of adjusting entries. Discussion on adjusting
entries: prepaid expenses, unearned revenues, accrued expenses, accrued
revenues, depreciation, bad debts and doubtful debts will be covered. Lastly, the
preparation of adjusted trial balances and closing entries will be illustrated.
Topic 5 deals with accounting for current assets. It explains the various
components of current assets, that is, cash, receivables and inventories.
Topic 6 explores the accounting for non-current assets. It looks at the definition of
non-current assets. Other non-current assets such as non-current assets held for
sale; intangible assets, presentation in the balance sheet, depreciation,
government grants and investments are also discussed.
Topic 7 discusses the accounting for property, plant and equipment (PP&E),
which covers the recognition of fixed assets, measurement, subsequent
expenditure and measurement, impairment, retirement, disposal and disclosure
requirements of PP&E.
Topic 8 deals with accounting for liabilities. It provides the definition of

liabilities. It explains the various components of current and non-current
liabilities and provisions as well as contingencies. This topic also deals with
accounting for equity. It further explains the different types of share capitals and
reserves.
Topic 9 elaborates the issues of integrity and ethics in preparing and reporting
financial information.

xvi COURSE GUIDE
Topic 10 and Topic 11 include a comprehensive case study so that learners can
encapsulate their learning from the earlier topics for this course. This topic is
designed to enable learners to answer comprehensive examination questions.
TEXT ARRANGEMENT GUIDE

Before you go through this module, it is important that you note the text
arrangement. Understanding the text arrangement will help you to organise your
study of this course in a more objective and effective way. Generally, the text
arrangement for each topic is as follows:
Learning Outcomes: This section refers to what you should achieve after you
have completely covered a topic. As you go through each topic, you should
frequently refer to these learning outcomes. By doing this, you can continuously
gauge your understanding of the topic.
Self-Check: This component of the module is inserted at strategic locations

throughout the module. It may be inserted after one sub-section or a few sub-
sections. It usually comes in the form of a question. When you come across this
component, try to reflect on what you have already learnt thus far. By attempting
to answer the question, you should be able to gauge how well you have
understood the sub-section(s). Most of the time, the answers to the questions can
be found directly from the module itself.
Activity: Like Self-Check, the Activity component is also placed at various

locations or junctures throughout the module. This component may require you to
solve questions, explore short case studies, or conduct an observation or research.
It may even require you to evaluate a given scenario. When you come across an
Activity, you should try to reflect on what you have gathered from the module and
apply it to real situations. You should, at the same time, engage yourself in higher
order thinking where you might be required to analyse, synthesise and evaluate
instead of only having to recall and define.
Summary: You will find this component at the end of each topic. This component
helps you to recap the whole topic. By going through the summary, you should
be able to gauge your knowledge retention level. Should you find points in the
summary that you do not fully understand, it would be a good idea for you to
revisit the details in the module.

COURSE GUIDE xvii
Key Terms: This component can be found at the end of each topic. You should go
through this component to remind yourself of important terms or jargon used
throughout the module. Should you find terms here that you are not able to
explain, you should look for the terms in the module.
References: The References section is where a list of relevant and useful

textbooks, journals, articles, electronic contents or sources can be found. The list
can appear in a few locations such as in the Course Guide (at the References
section), at the end of every topic or at the back of the module. You are
encouraged to read or refer to the suggested sources to obtain the additional
information needed and to enhance your overall understanding of the course.
PRIOR KNOWLEDGE
Learners of this course are required to pass the BBFA1103 Introduction to
Financial Accounting course.
ASSESSMENT METHOD
Please refer to myINSPIRE.
REFERENCES
Kean Kok, N., Weina, Z., Marimuthu, M., & Bhattacharya, S. (2010). Financial
management. Oxford Fajar.
Larson, K. D., Wild, J. J., & Chiappetta, B. (Omar, R., Hassan, H., Sulaiman, A.J.,
& Mohamad, L.) (2005). Accounting principles. Malaysia: McGraw-Hill.
Lazar, J., Roshayani Arshad., & Huang Ching Choo. (2006). Financial reporting:
An introduction. Malaysia: McGraw-Hill.
Lerner, J. L., & Cashin, J. M. (1998). Schaums outline of theory and problems of
principles of accounting I (5th ed.). Black Lick, OH: McGraw-Hill.
Loh, B. F., & Ng., K. H. (2006). Principles of accounts. Singapore: Longman/
Pearson Education Asia.
Ng, E. (2006). A practical guide to financial reporting standards (Malaysia).
Singapore: CCH Asia.
Ng, E. (2009). A practical guide to financial reporting standards (Malaysia).
Singapore: CCH Asia.

xviii COURSE GUIDE
Serway, R. A., & Jewett Jr, J. W. (2002). Principles of physics, A calculus-based

text (3rd ed.). Fort Worth, TX: Harcourt College.
Stice, E. K., Stice, J. D., & Skousen, K. F. (2004). Intermediate accounting (15th
ed.). Mason, OH: Thompson South-Western.
Tan, L. (2000). Financial accounting & reporting in Malaysia, volume 1 (2nd ed.).
Malaysia: PAAC.
Tan, L. (2000). Financial accounting & reporting in Malaysia, volume 2 (2nd ed.).
Malaysia: PAAC.
Thomson, A. (2006). Introduction to financial accounting (5th ed.). McGraw Hill
Education, Asia.
Wood, F., & Sangster, A. (2002). Business accounting 1 (9th ed.). England:
Financial Times/Pearson Education.
TAN SRI DR ABDULLAH SANUSI (TSDAS) DIGITAL

LIBRARY
The TSDAS Digital Library has a wide range of print and online resources for the
use of its learners. This comprehensive digital library, which is accessible
through the OUM portal, provides access to more than 30 online databases
comprising e-journals, e-theses, e-books and more. Examples of databases
available are EBSCOhost, ProQuest, SpringerLink, Books24x7, InfoSci Books,
Emerald Management Plus and Ebrary Electronic Books. As an OUM learner,
you are encouraged to make full use of the resources available through this
library.

Topic Overview of
Accounting
1
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Explain the importance of accounting;
2. Define accounting and its four components;
3. Describe the users and branches of accounting;
4. Discuss the qualitative characteristics of accounting information;
5. Describe the purpose of financial statements;
6. Describe the four components of financial statements; and
7. Distinguish between the roles of external and internal users of
accounting.
INTRODUCTION
Accountancy is the process of communicating financial information on a business
entity to users such as shareholders and managers. Accounting information helps
users to make better financial decisions. Users of financial information may be
both internal and external to the organisation. Accounting is a very dynamic
profession which is constantly adapting itself to varying needs of its users.
Did you know that the movie Forrest Gump starring Tom Hanks made over
USD329.7 million in gross domestic revenue, and yet it was reported as having a net
loss? Tom Hanks made millions from his fees which included certain shares of the
gross revenue, and yet the original author, Winston Groom, who sold the screenplay
rights to his novel for a price plus a share of the movie profit, received none.

2 TOPIC 1 OVERVIEW OF ACCOUNTING
Had Mr Groom known the accounting language, he would have understood the
difference between revenue and profit, and this situation could have been
avoided. The movie might have made millions but the expenses which included
production costs, marketing and distribution costs and even the fees (based on
revenue sharing) paid to Tom Hanks, the directors, etc., reduced the millions of
revenue to a net loss.
The mentioned case is a good example of how accounting plays an important

role in making the right decision. It enables us to make informed and better
economic decisions. But how or where can you obtain this accounting
information?
This information is provided through the financial statement of a business. Now, it is

common for public listed companies to publish their financial statements in the
newspapers. After you have completed this module, the financial statements will not
look so strange after all as you would have understood the language of accounting.
This topic introduces accounting, its importance and definition. We will then
look at who the users of accounting information are, and we will also look at the
qualitative characteristics that must exist in order to generate valuable
information for the users.
You will later learn the purpose of preparing financial statements and the
components of financial statements.
ACTIVITY 1.1
Do you think accounting is assumed as a language? Discuss.
1.1 THE IMPORTANCE OF ACCOUNTING

Accounting plays an important role in our daily lives, directly or indirectly. The
views that accounting is only important for businesses and accountants are not
true. Accounting provides valuable financial information that enables us to make
informed and better decisions.
An example of making this economic decision in our daily lives is the handling of
our monthly income. You need to know your financial position in order to spend
wisely. You need some accounting knowledge to plan or budget for your
spending. You need to determine your net income which is gross pay minus all
expenses.

TOPIC 1 OVERVIEW OF ACCOUNTING 3
In deciding whether to purchase your dream car, you need to know if you can
afford it. This is where accounting knowledge plays an important role, providing
you with the necessary financial information to make decisions.
In The Life of Mahatma Gandhi, the author quoted that Gandhi once wrote a
letter to his son saying, You should keep an account of every penny you spend.
Gandhi used to keep daily records of whatever he spent! According to him, you
will be able to manage your money by keeping track of it.
Similarly for businesses, they need accounting information to help them run their
business effectively and efficiently. They need to know whether the business is
profitable or not, whether they have enough cash to pay their workers salaries
and more. If they know that their business is not profitable, they could do
something about it, like selling it or try to improve the situation by changing
their operations. Only with proper financial information will businesses be able
to make the right decisions.
So what is accounting? Before we go on to discuss the definition of accounting,

let us look at the history of accounting.
Luca Pacioli (see Figure 1.1), who is regarded as the Father of Accounting did
not invent the accounting system, but in 1494 described the methods used by
Italian merchants to record their business transactions in his book Summa de
Arithmetica, Geometria, Proportioni et Proportionalita (Everything About
Arithmetic, Geometry and Proportion). He described most importantly the
double entry accounting system, emphasising that debit must equal credit.
The system described by Pacioli changed little over the next four centuries, and
you will soon learn the systems throughout this module.
Figure 1.1: Luca Pacioli

Source: http://acct.tamu.edu/smith/ethics/pacioli.htm

ACTIVITY 1.2
In your own words, try to reason out the need for us to study
accounting.
1.2 DEFINITION OF ACCOUNTING
Accounting is described as a system or a process that provides reports on an

entitys economic transactions to users.
Accounting can be defined as a process of collecting, identifying, measuring,

recording, summarising and communicating the results of business or economic
transactions to users in order for them to make informed or better decisions.
Refer to Figure 1.2 for the information flow in an accountancy system.
Figure 1.2: The information flow in an accountancy system

There are four components in accounting:

(a) Recording written records of journalising and posting business
transactions;
(b) Summarising preparing the financial statements;
(c) Analysing examining the results to determine the financial position and
performance; and
(d) Interpreting using the financial statements to make judgments and
decisions.
Accounting systems process inputs which are business transactions (making

sales, paying expenses, buying assets, borrowing money etc.) into outputs of
financial statements (for example, income statements and balance sheets).
This module will teach you the recording and summarising processes in detail.
The final topic of the module will introduce basic techniques that are used to
analyse and interpret financial statements.
From these outputs, information such as how much resources the business owns,
how much is owed and its business performance are known. The process is
shown in Figure 1.3.
Figure 1.3: The accounting system

ACTIVITY 1.3
Imagine running a business with no knowledge of accounting. In my
opinion, it is really necessary to have at least some basic knowledge of
preparing accounts.
What is your opinion? Can you think of ways how accounting helps a
business?
1.3 USERS OF ACCOUNTING INFORMATION

Accounting information is useful to anyone who makes decisions that have an
economic result. Think about this; we as users have scarce resources (capital,
cash) and want to allocate these resources so that they give a maximum return to
us. Somehow you need information to enable you to make the right decisions.
Users of accounting information can be classified into several categories and

groups. Each group makes a different decision and requires different
accounting information to aid its decision making. This is very complicated but
it is not impossible to provide accounting information that meets the needs of
all types of users.
There are two types of users; internal and external users of accounting
information. These users will be discussed in the next subtopic.
1.3.1 Internal Users

Internal users are part of the business entity and they make decisions for the
organisation. Examples are:
(a) Directors of companies, in deciding the amount of dividend to pay to
shareholders or bonus to employees who need to know the company profit.
(b) Managers who want to know if a new product will be profitable.
Management accounting is the area of accounting that provides information

for internal usage. These among others include areas of costing, budgeting
and payroll.

Managers are responsible for daily operations. Their role is to plan for the
business and then determine how the plan is carried out. Planning and control
involves many big decisions. These may include:
(a) Determining what kind of goods or services should be offered by a
business.
(b) Determining sales targets and determining what action to take when the
target is not achieved.
(c) Preparing budgets and what should be done if performance does not meet
the budget.
(d) Choosing the investment opportunities available.
(e) Determining how much money you have borrowed and from where to
borrow.
(f) Determining the selling price of the goods or services offered by the
business.
To make these decisions, managers need information related to the past and
current activities together with forecast predictions.
On the other hand, financial accounting provides the financial statements to be

used by mainly external users and to some extent the internal users.
1.3.2 External Users

External users are those outside of the organisation and they make decisions
about the organisation. Examples are shown in Table 1.1.
Table 1.1: External Users
External Users Description

Owners Owners have some economic decisions to be made among others:
To decide whether to proceed, sell or close their businesses.
To decide whether to invest more or not.
To decide how much money can be taken out of the business
without jeopardising the financial stability of the business.
When you want to make these decision, owners may find the
following information:
Information about the financial performance of the business,
to show how good or if the business has failed.

Information about the current financial position, showing the

assets (property owned) and liabilities (external claims
payable) as well as business owners equity claims that can be
made on the business property.
Investors Before buying a companys shares, they will want to know the
companys profitability and the amount of dividends paid out to
shareholders. Shareholders holding shares in a company might want
to decide whether to buy more shares or dispose the shares they have.
Creditors Suppliers and bankers who want to know if they should extend credit
to the business, how much to extend and for how long. They will
assess the ability of the business to repay the loan.
Government For example, Lembaga Hasil Dalam Negeri (LHDN) needs to
agencies know the income of a business entity in order to determine the
amount of tax to be collected by them.
The most obvious purpose is the tax that should be imposed (the
role played by the Inland Revenue Board), other purposes include
complying with business laws and statistical output for the
economy.
Banks and The main decision to be made by the bank and the borrower is
other lenders whether or not to lend to businesses. The bank and the borrower
would also like to know the ability of the company to repay
interest and the whole loan amount at the end of the loan period.
In the case of short-term loans, accounting information required
is the current financial position of the business and expected
financial position in the near future. For long term, a more
general analysis is needed on the financial prospects in the long
run.
Suppliers They decide whether they will offer a credit period or not and
whether they want to be suppliers. Information about financial
position is required.
Customer Customers want to know the source provider before signing a
contract. Customers are offered a guarantee by the suppliers and are
also interested in information about the continued existence of the
supplier.
Employees The main thing for employees is job security and payment in kind for
their work. Information on the performance and financial position of
the employer will help them to decide whether they will continue to
work or look for other alternatives.

ACTIVITY 1.4
Can you consider the internal and external users as the stakeholders of
a company? Discuss.
1.4 BRANCHES OF ACCOUNTING

In the earlier subtopics, you have learned that internal users information
requirements are provided by both management accounting and financial
accounting, while external users information requirements are provided only by
financial accounting. Accounting has expanded and changed in response to
global changes and needs. Accounting has developed into several branches, as
shown in Figure 1.4:
Figure 1.4: Accounting disciplines
This introductory accounting course will cover financial accounting only.

However, it is important for you to understand the differences between financial
accounting and management accounting. A summary of differences is shown in
Table 1.2.
Table 1.2: Comparison between Financial Accounting and Management Accounting
Comparison Financial Accounting Management Accounting

Users External users and internal Internal users only.
users.
Reports Provides financial statements Provides financial and non-financial
of an entity. information required by an entity to
plan, evaluate and control its operations.

Format of Financial reports are produced Reports are produced at any time
reports periodically according to a according to needs and are not subjected
specific format or standards. to a specific format or standards.
1.5 FORMS OF BUSINESS
Relationship between Business and Accounting

Business deals with a lot of decision making. Decisions include pricing of
products, deciding on investment, borrowing money, hiring employees and
expanding the business. To make decisions properly, managers need useful
information. Accounting information plays an important role in this decision-
making process. Business may be classified according to the types of activities
they are involved in and by the types of ownership. Different types of business
have different reporting requirements.
1.5.1 Types of Business

Business organisations can be categorised into several types according to their
main activities (refer to Figure 1.5).
Figure 1.5: Types of business organisations

Now, let us discuss the types one by one.
(a) Merchandising/Retailing/Trading
The business main activities involve purchasing goods which are then sold to
customers. Examples are supermarkets, departmental stores, wholesalers and
grocery stores. These merchandisers buy various goods at a price (cost or purchase
price) and sell them to customers at a higher price (sale price). One such example is
Giant, a leader in Malaysias retail sector (see Figure 1.6). You will learn in detail
the accounting for a merchandiser in Topic 6.
Figure 1.6: Giant, a well-known retailer for its cost effective goods
(b) Manufacturing
Manufacturing firms convert raw materials into finished goods. Examples
are an oil refinery, a car manufacturing company and a toy manufacturing
company. A car manufacturing company purchases tyres and windshields
as their raw materials (parts) and hires labour to assemble these materials
into finished products (cars). The cost of all materials, labour and other
expenses used to manufacture the car is the cost of manufacturing. The
finished product is then sold at a higher price than the manufacturing cost.
One example of a local car manufacturer is Perodua. Its subsidiary,

Perodua Manufacturing Sdn Bhd, is responsible for the manufacturing of
the Perodua vehicles and selected vehicle component parts.
You will learn the accounting for manufacturing in the management

accounting subject.
(c) Services
This business provides services to its customers. Examples are lawyers,
photocopying services, hotels, car rentals and education. Lawyers provide
legal services or consultation services, they earn fees for services rendered
to customers.
SELF-CHECK 1.1
Can you name a specific business that you have encountered in the
following sectors?
(a) Services;
(b) Merchandising; and
(c) Manufacturing.
1.5.2 Types of Ownership of Business

Types of ownership will have an impact on the accounting practices and
procedures of an organisation. Formats and information contained in the
financial statements are slightly different. Therefore you must understand the
different characteristics among the three types of ownership. There are three
basic forms of ownership, which are shown in Figure 1.7:
Figure 1.7: Types of business ownership

Let us now discuss the types in greater detail.
(a) Sole Proprietorship/Sole Trader

As indicated by the name, the ownership belongs to any one individual.
Think of the pisang goreng seller at the corner of the street. The
formation of this type of business is relatively easy as there are only a few
legal requirements required before starting the business. For accounting
purposes, the owners are considered a separate entity from the business,
however for legal purposes the owner and the business are one entity.
The advantages of sole proprietorship are as follows:

(i) Sole proprietorship is easy to set up;
(ii) Owner has full control over the business decisions and activities;
(iii) Income of the business belongs to owner, and not shared with other
people; and
(iv) Compared to other form of business organisations, it has less legal
requirement.
The disadvantages of sole proprietorship:

(i) Difficult to expand as expertise and capital might be limited;
(ii) Owner bears all the risks; and
(iii) Unlimited liabilities.
(b) Partnership
This type of business is owned by two or more individuals, called partners.
Just like the sole trader the formation requires no or little legal
requirements. The pisang goreng seller might want to expand his
business to include nasi lemak. As such, he might invite an expert in
making nasi lemak to become his partner. However, an agreement must
exist between partners normally on how the profit or losses should be
shared. Similar to the sole trader, no distinction is made between partners
and business for legal purposes. Therefore, all partners are responsible for
business liabilities.

The advantages of a partnership are as follows:

(i) Higher sources of capital as owners are more than one;
(ii) Partners might have additional skills and expertise to strengthen the
business partnership; and
(iii) Unlike companies, a partnership is not required to disclose business
information to an external party.
The disadvantages of sole partnership:

(i) Unlimited liabilities;
(ii) Conflicts among partners will lead to instability in the management of
business; and
(iii) Lack of continuity; a partnership will dissolve if one partner dies, or
pulls out of the partnership, or is declared bankrupt.
(c) Company (Corporation)

Companies like Coca Cola and Maxis are owned by many people called
shareholders. Shareholders are people who own shares in the company. A
company is a separate legal entity from the owners, in other words an
artificial person that can conduct business in its own name, unlike sole
traders and partnerships.
The advantages of companies are as follows:

(i) Limited liabilities;
(ii) Easy to expand as they can issue shares and debentures to generate
funds as capital;
(iii) Continuity; and
(iv) Shares can be transferred from one person to another easily.

The disadvantages of companies are as follows:

(i) Subjected to rules and regulations of the government;
(ii) Ownership is separate from the management; and
(iii) Set up cost is high compared to other forms of business.
Table 1.3 summarises the differences between the various types of ownership in a
business entity.
Table 1.3: Comparison of Types of Ownership in a Business Entity
Comparison Proprietorship Partnerships Company

Owner (s) Proprietor Partners Shareholders
Life of Limited Limited Indefinite
organisation
Liabilities Unlimited Unlimited Limited
Accounting Business is separate Business is separate Business is separate
status from the proprietor from the partners from the shareholders
Legal status None None A separate legal entity
Formation Relatively easy Relatively easy Complex
Management Normally by the Normally by the Managers or directors
owner partners
Tax Proprietor pays tax Each partner pays Companies pay tax on
on business profit tax on his share of the business profit and
the profits shareholders pay tax
on the amount of
dividend they receive
(double taxation)
ACTIVITY 1.5
If you plan to open up a gift store in Mid Valley Megamall, what form
of business and type of ownership will you choose? Give your reasons.

1.6 FUNCTIONS OR ROLES OF ACCOUNTING

Accounting contains elements of science and art. It is a term used to reflect some
of the techniques and a wide field of study and most importantly, it is not only a
collection of arithmetic techniques but is a complex process that is prepared for
the public as consumers. The need to have the knowledge of accounting is not
only limited to those directly involved in business management.
Those who are about to enter a business career or any career which involves a
relationship with a business organisation should understand the basic concepts
of accounting so that they can communicate with the accountant or interpret the
reports containing accounting data.
As individuals, we are always confronted with the operation of business

enterprises that make a big impact in daily life.
1.6.1 Accounting as the Language of Trade

Accounting is deemed to be the language in world trade. This is because
accounting has become common in the delivery of system information pertinent
to managers and administrators. This information is then used for making
business decisions.
Accounting systems not only provide information that is essential for business
managers, it also provides the decision of whether to lend or not in the firm. The
other creditors will also need to know the information about the financial
position of the firm to ensure that the firm has sufficient funds to repay its debts.
1.6.2 Accounting Creating Accountability and Control

The following are the explanations for the accountability and control in
accounting:
(a) Accountability
Accountability is usually the term used to describe two ideas associated
with the provision of trust (stewardship) and the related performance
evaluation.
Granting trust refers to entrusting a person to manage a property.
Performance evaluation is a comparison between actual performance and
the expected results.

(b) Control
Knowledge of the past may help in anticipating the future state. For
example, a manager wants to anticipate manufacturing costs for new
products; it is easier if he knows the cost of manufacturing for the same
product in the last year based on the experience of other firms or from any
other source that is available.
Other aspects of the past to measure the condition are controlled. Here the
last result compared with a target or standard and the difference between
actual and target is used in various ways to improve performance,
including:
(i) If past results are not as good as expected (assumed to be an expected

finding and reasonably achievable), appropriate action should be
taken and this will involve the planning and current decision.
(ii) The difference between the previous findings and the results showed
that the target may have made mistakes in the past, and this will not
be repeated again.
1.6.3 Accounting is Information Systems

The accounting system covers the entire joint procedure, personnel, equipment,
records and report documents used to collect, summarise and report financial
and accounting information about the business. Generally, factors in accounting
information systems can be described as follows (refer to Table 1.4):
Table 1.4: Factors in Accounting Information Systems
Factor Description
Employees Covers staff who are directly involved with accounting activities such as
working in the activity of buying, selling, receiving materials and use of
materials.
Documents Include all documents in business activities such as invoices, vouchers,
sales order, purchase order, agreements, receipts and so on.
Records All books of account kept by the business such as accounting books
(journals and ledgers).
Procedure Refers to the narrative that is followed to do the work. For example the
procedure of receiving money from buyers in the supermarket. The
cashier records the price of each item based on the price of the goods on a
slip. Prices of all items purchased will be aggregated and claimed from
the customer.

Equipment The equipment used for accounting jobs such as storage devices and
separate ledger card, cash registers, hardware and software computer.
Knowledge To solve a problem, knowledge is needed in various fields such as the
field of statistical analysis, mathematics, finance and so on. Use of
knowledge in accounting can improve the quality of information
produced.
Report Accounting systems should strive to provide reports to meet the needs of
every consumer for information.
The accounting system is a subset of the management information system and it

contains a common set of basic functions of collecting, recording (processing),
reporting (presentation) and evaluating data:
(a) Collecting data all data processed by the system must be collected at a
certain time.
(b) Recording data data must be recorded in some form before it can be used.
(c) Reporting data the system is divided into two subsystems for the
calculation and presentation. The calculation system changes data input to
output.
(d) Assessing/evaluating data this system involves the comparison of
parameters in real output and the expected output.
Characteristics of Accounting Information

In most accounting books, the following characteristics are considered important
to ensure the quality of accounting information.
(a) Relevant or appropriate

Information may not be used if it is not relevant to users in helping them to
make economic decisions. Relevant information has predicted values that
help users make decisions in the future. Information relevant to the setting
(confirmatory value) helps users evaluate past decisions.
(b) Reliable (reliability)

Reliable information must be complete and free of significant errors. It is
also unbiased and has valid proof.
(c) Comparability
Users may need to compare financial information issued by businesses
with:
(i) The information produced by the same firm in the last year; and

(ii) The information produced by other businesses.
(d) Can be understood (understandability)

Users must understand the information provided. This level of
understanding must also be taken into account in preparing the financial
statements.
1.6.4 Accounting as a Decision-making Tool

We can say that accounting emphasises the provision of information in the form
of finance that can help in making decisions about the allocation of resources and
providing reports on financial forms explaining the effect of resource allocation
decisions of the past.
Examples of resource allocation decisions are:

(a) Should investors buy or sell shares?
(b) Will bankers lend money to the firm?
(c) How much tax should be paid by the company or firm?
Accountants and their interpretations emphasise the provision of financial

information. Many accountants will be directly involved in decision making but
the functions performed are different (only supply the relevant information).
Accounting reports prepared by accountants influence fundamental decisions
and actions that will be taken by the individual.
Information Flow and Information Users

The main purpose of accounting is to help users of accounting information to
make better decisions. To meet this goal, we have to answer the following
questions:
(a) Who are users of accounting information?
(b) What kind of decisions must they make?
(c) What is the accounting information necessary to help them in making the
decisions?

Accounting can be defined as a process of collecting, identifying, measuring,

recording, summarising and communicating the results of business or economic
transactions to users in order for them to make informed or better decisions.
Accounting information is important as it helps users to make decisions.
Financial accounting provides financial information for external users and

also internal users while management accounting provides financial and non-
financial information for internal users.
For accounting information to be useful and valuable to decision makers, it

must be relevant, reliable, comparable and consistent. Useful information
should also be understandable, material and timely.
The main function of financial statements is to provide information of the

business financial position and financial performance to users.
The four main components of financial statements are as follows:

Income statement;
Balance sheet;
Statement of changes in owners equity; and
Cash flow statement.
Income statements report the financial performance of a business entity.
Balance sheets report the financial position of a business entity.
Statements of changes in owners equity report how the owners equity has
changed over the reporting period.
Cash flow statements show the in-flow and out-flow of cash of an

organisation from three main activities; operating, investing and financing.
Internal users and management are the parties involved with accounting in
the company. They cope with the daily operations of a company.
External users are those involved with a companys accounting externally.

They are:
Owners;

Investors;
Creditors;
Government agencies;
Banks and other lenders;
Suppliers;
Customers; and
Employees.
Accountability Internal users

Accounting Materiality principle
Control Relevance concept
Decision making Reliability concept
External users True and fair view
Financial statement
1. Define accounting and explain the four components of accounting.
2. List the qualitative characteristics of accounting information.
3. What are the items reported in the income statement?
4. For each of the following users, can you identify the type of accounting
information they require?
External Users Type of Information Required

Lenders
Suppliers
Government agencies
Customers

Internal Users
Employees
Sales Managers
Production Managers
Budget Officers
1. Explain the comparability concept and its role in making accounting

information useful.
2. What are the items reported in the balance sheet?
3. What are the items reported in the statement of changes in owners equity?
4. What are the items reported in the cash flow statement?
5. The following are the accounts balances of Smart Tuition Centres as at 31

December 2013.
RM
Accounts receivable 8,855
Accounts payable 2,200
Bank loan 15,000
Supplies 8,480
Supplies expenses 6,300
Advertising expense 4,200
Salaries expenses 18,000
General expenses 1,265
Rent expenses 14,400
Utilities expenses 7,350
Tuition fees 75,750
Computer equipment 17,800
Cash RM20,000 20,000
Capital (1/1/2012) 23,700
Drawings 10,000

You are required to prepare:

(a) An income statement for Smart Tuition Centres for the year ended 31
December 2013;
(b) A statement of changes in owners equity for Smart Tuition Centres for the
year ended 31 December 2013; and
(c) A balance sheet for Smart Tuition Centres as at year ended 31 December
2013.
What are the differences between financial and management accounting?

Topic Accounting
2 Principles
and Concepts
LEARNING OUTCOMES
1. Describe regulatory and conceptual framework for corporate
reporting;
2. Explain the components of financial statements;
3. Identify the elements of financial statements;
4. Discuss the qualitative characteristics of accounting information;
5. Describe the accounting assumptions and principles; and
6. Assess the accounting standards.
INTRODUCTION
Accounting concepts and principles are built to measure the economic activities
of a company. Accounting systems in each country are different depending on
their influences of the economic structure and legal systems.
Imagine the world without traffic laws and enforcement! There will be havoc, as
people will drive as fast as they want, beat traffic lights as they please or park
their cars anywhere they like. To ensure our safety on the road, we have rules
and drivers need licenses before they can drive. Now, can you imagine the
accounting profession without rules and regulations?
You have learned earlier that external users rely on accounting information
produced by businesses to make decisions. How can users be assured that the
TOPIC 2 ACCOUNTING PRINCIPLES AND CONCEPTS 25
information presented is reliable? After all, the financial statements are prepared
by the companys accountant. Knowing that to prepare financial statements,
accounting professionals have to follow certain rules and regulation increases the
reliability of information provided by the financial statement. But who regulates
the accounting profession?
This topic begins with the introduction to the various accounting bodies in
Malaysia that govern the accounting profession. The main functions of these
bodies will be described.
We have to follow certain guidelines called the accounting standards in

preparing the financial statements. You will learn why it is important to have
such standards; the following article proves the consequence of not doing so!
Accountant Held Liable for Interest Expense from Tax Error
Accounting WEB.com - 26th June 2006 - The South Dakota Supreme Court last
week upheld a Circuit Court decision allowing a jury to award damages to
Doug OBryan Contracting Inc. for interest expense on underpayment of taxes
that resulted from an error made by his accountant. The states high court had
not previously allowed recovery of interest expense in lawsuits against tax
advisers, the Associated Press reports.
Bruce Ashland, a certified public accountant, understated OBryans income

for 1995. The well-drilling company, located in Martin, South Dakota,
incorporated in April 1995, and Ashland used the wrong method to calculate
income for the first quarter of the year. When the error was discovered several
years later, OBryan owed an additional $239,933 in taxes and about $50,000 in
interest.
Source: http://www.accountingweb.com/tax/irs/accountant-held-liable-for-interest-
expense-from-tax-error
2.1 REGULATORY AND CONCEPTUAL

FRAMEWORK FOR CORPORATE
REPORTING
Framework is the basic requirement. The proposed framework by the Malaysian
Accounting Standards Board (MASB) for the preparation and presentation of
financial statements is similar with the one issued by the International
Accounting Standards Board (IASB) which deals with:

26 TOPIC 2 ACCOUNTING PRINCIPLES AND CONCEPTS
(a) Definition of financial statements;

(b) Purpose of financial statements;
(c) Qualitative characteristics of financial information;
(d) Definition, identification and recognition of the elements of financial
statements;
(e) Concepts of capital and capital maintenance; and
(f) Basis for the measurement of the elements of financial statements.
Conceptual framework is the guidance in preparing and presenting financial

statements instead of an accounting standard. Four aspects should be dealt with
by the preparers of financial statements. The four aspects are:
(i) Recognition Whether the transactions concerning elements of financial
statements had taken place, relates to the timing of when the transactions
were taken place.
(ii) Measurement The amounts of the elements which need to be recorded.
(iii) Recording Procedure of debiting and crediting the relevant accounts.
(iv) Presentation Transactions are disclosed in financial statements.
2.2 FINANCIAL STATEMENTS

The final output of an accounting system is the financial statements. The main
function of financial statements is to provide information of the business
financial position and financial performance to users.
This information is normally obtained from the income statement, balance sheet,
statement of changes in owners equity and cash flow statement. The information
provided will give a picture of how the resources are used by the business entity.
This module covers the steps required in the preparation of the income
statement, statement of changes in owners equity and balance sheet. You will
learn how to prepare the cash flow statement in another module.
The Malaysian accounting standard, MFRS 101, provides the guidelines on the
presentation of financial statements.

2.2.1 The Purpose of Financial Statements

MFRS 101 states the purpose of financial statement as the following:
Figure 2.1: MFRS 101

Source: MASB MFRS 101 Presentation of Financial Statements
In other words, the objective of preparing financial statements is to provide

useful information with regards to the financial position, performance and cash
flow of a business to all types of users in order for them to make an economic
decision. The result of the financial statements shows how the manager of a
business entity manages resources contributed by owners.
The information provided by the financial statements together with other

information provided in the explanatory notes will be used by users to
understand and make decisions.

SELF-CHECK 2.1
Users depend not only on financial information provided by the

financial statements but also on non-financial information to make
investment decisions. Can you identify the qualitative information that
users need to make decisions?
2.3 THE COMPONENTS OF FINANCIAL

STATEMENTS
Financial statements of listed public company can be obtained by the public
easily. Kuala Lumpur Stock Exchange (KLSE) provides access to the annual
reports of listed companies at its website.
ACTIVITY 2.1
You may visit KLSEs website for further information,
http://www.bursamalaysia.com/market/
Please take note that the following illustrations of financial statements are of a
sole proprietorship (single ownership). There are slight differences in reporting
requirement and format for a partnership and also a company.
(a) Income Statement

Income statement reports the financial performance of an entity. It contains
information on revenues and expenses including the profit and loss of the
business entity. It is also known as revenue statements or profit and loss
statements.

There are several formats in reporting the revenue and expenses depending
on the nature of business run by the entity. Figure 2.2 is an example of an
income statement for service providers. Service providers such as travel
agents, hotels and colleges earn their revenues by performing or providing
services to customers.
Figure 2.2: Income statement for a service provider

Meanwhile Figure 2.3 is an example of a merchandiser income statement. A

merchandisers (or traders) revenues come from selling goods to customers.
Figure 2.3: Income statement for a merchandiser
(b) Balance Sheet

A balance sheet reports the financial position of a business entity. It
contains information on the entitys assets, liabilities and owners equity.
Assets are categorised into two:
(i) Current assets are those assets that are expected to provide benefits
for twelve months or less from the reporting date. Examples are cash,
account receivables, inventories, prepaid expenses and short-term
investments.

(ii) Non-current assets are those assets that will provide benefits for a
period longer than twelve months from the reporting date, which
include land and building, motor vehicles, furniture and fittings,
equipment and long-term investments.
Liabilities are also categorised into two:

(i) Current liabilities are liabilities that are due within twelve months
from the reporting date. Examples are account payables and short
term loans.
(ii) Non-current liabilities are expected to be settled in a period longer
than twelve months from the reporting date, such as a long term bank
loan.
There are several formats of balance sheets, in T format (see Figure 2.4) or
in a statement format (see Figure 2.5). There are also differences in
reporting the owners equity depending on the form of business; whether it
is a sole proprietorship, a partnership or a company. However, at this level
the focus will be on a sole proprietorships balance sheet.

Figure 2.4: Balance sheet T Format

Figure 2.5: Balance sheet Statement Format

There are several different formats available for preparing balance sheets.
You might read one textbook showing one format and another textbook
showing another format. One format might show the working capital
which is current assets minus current liabilities while another lists current
assets first and then only non-current assets are listed.
At first you might find that this is confusing as one format is slightly
different than the next. Do take note that whichever format is used, all
assets, liabilities and owners equity, whether they are current or non-
current, will be categorised accordingly.
(c) Statement of Changes in Owners Equity

Statement of changes in owners equity reports how the owners equity has
changed over the reporting period. It reports how opening capital has
increased through net income, and how it decreased through net losses and
drawings. Refer to Figure 2.6 for an example.
Figure 2.6: Statement of changes in owners equity
(d) Cash Flow Statement

Cash flow statement shows the in-flow and out-flow of cash of an
organisation according to three main activities which are operating,
investing and financing. The format is shown in Figure 2.7, however, as
stated earlier preparing a cash flow statement is not part of the syllabus.

Figure 2.7: Cash flow statement
ACTIVITY 2.2
Do you know your net worth? Let us calculate your net worth.
1. List all your assets. These will be items that you own, house, car,
computer etc. Estimate how much they are worth in the market.
In other words you might have spent RM5,000 to buy your
computer, but now, if you were to sell your computer, the shop is
willing to pay RM300 for it. RM300 is the value of your computer.
2. List all your liabilities. These include any loans you have
outstanding on your house, education and even credit card.
3. Determine the difference (Total Assets minus Total Liabilities).
This is your net worth or capital.

ACTIVITY 2.3
Many online resources for accounting glossary and terms are available
on the net. If you need to look up certain accounting terms, do visit:
http://www.ventureline.com/accounting-glossary/A/
2.4 ELEMENTS OF FINANCIAL STATEMENTS

The financial statements reflect the financial position and performance as a result
of transactions carried out by the business. The primary objective of financial
statements is to provide information about the financial position, performance
and cash flows of the business that can be used by each user to make economic
decisions. The financial statements show the results from the completion of the
monitoring task (stewardship), and management must account for every action
related to the asset.
To meet this objective, the financial statements provide elements as shown in

Figure 2.8:
Figure 2.8: Elements of financial statements

The following are the details of the elements.
(a) Asset
Assets are economic resources owned or controlled by a firm whether it
was paid or not. Asset is something that is used to assist in the conduct of
business operations. Assets are divided into two groups, fixed assets and
current assets.
(i) Fixed Assets

Fixed assets are assets that are not easily changed in shape and there
is more than one financial period. Fixed assets are divided into two,
namely tangible assets and intangible assets. Tangible assets are assets
that can be seen physically such as machinery, cars and equipment.
Intangible assets are fixed assets that exist but cannot be seen
physically such as goodwill, patents, copyrights and trademarks.
(ii) Current Assets

Current assets are assets that exist for accounting periods and are
highly liquid. Examples of current assets are cash, receivables,
prepaid expenses and proceeds receivable.
(b) Liability
Liability is a debt to people outside the business. Liabilities are divided into
two groups, current liabilities and long-term liabilities.
(i) Current Liabilities

Current liabilities are liabilities that exist for an accounting period and
the borrower must pay off or settle the debt within one year.
Examples of current liabilities are accounts payable, payables, notes
payable, short-term loans and bank overdrafts.
(ii) Long-Term Liabilities

Long-term liabilities are debts that must be paid within a period
exceeding one year. Examples of long-term liabilities are long-term
loans and notes payable where the payment is more than a year.
(c) Owners Equity

Equity is the owner's intended claim against the assets of business to
business owners. Owners' equity is the amount of surplus assets over
business liabilities.

Owners' equity for each business structure is different where:

(i) Equity in a company consists of the owners of the paid-up capital,
share premium, retained earnings and reserves (over isolated);
(ii) Equity in partnerships comprise the owners of partner capital
accounts; and
(iii) Equity in sole business owners comprise capital contributed by the
owners.
(d) Revenue
This is the increase in gross value of assets as a result of the sale of goods or
provision of services by businesses to customers. Examples of revenue are
sales, discounts received, interest received and rent received.
(e) Expense
Expense is cost of services or goods used in the process to get revenue.
Expense is also known as part of the cost of assets that have been written-
off. Examples of expenses are rent, interest, electricity and water, salaries
and other expenses.
These elements together with other information (notes to the accounts) help users
predict the cash flow of a business in the future.
2.5 QUALITATIVE CHARACTERISTICS OF

ACCOUNTING INFORMATION
We will now discuss the characteristics that must exist in accounting information
in order to make it useful as listed in Figure 2.9:

Figure 2.9: Seven characteristics of accounting information
These characteristics will be discussed further in the next subtopics.
2.5.1 Relevant
The relevance principle stipulates that all relevant information should be
included in the financial statements. Information is considered relevant if it can
assist users in making decisions.

Let us assume that you have extra money and want to buy shares in one of the
companies listed in Bursa Malaysia. What type of information might be useful for
your needs? You might want to know:
(i) The companys performance for the past five years;
(ii) What are future projects or new products of the company?; and
(iii) Who managed the company?
All the mentioned information, quantitative and/or qualitative, is relevant as it

will assist you in deciding whether to buy the company shares or not. For
example, the company has made a good profit of RM2,000,000 for the current
year. You should not rely on this information only. You must look at the past
trend. Assume you find out that the company has been making big losses for
three years before the current year. Will you invest your money in the company?
Knowing how the company performed in the past years is relevant to your
decision. Big losses for three consecutive years might indicate it is risky to invest
in the company even though it has been profitable in the current year.
2.5.2 Reliable
Reliable information is information that can be trusted by users. Information
must be objective, free from bias and significant errors. Only reliable information
will enable users to make better decisions.
How are external users of a financial statement ensured of the reliability of

information provided? After all, this statement is prepared by the companys
accountant. The comic strip (refer to Figure 2.10) proves us the actual scenario in
the accounting profession.

Figure 2.10: How reliable is the accounting practice?
The accountant and the companys management are bound by law to follow the
rules and regulations in preparing the financial statements. It is assumed that if
accountants follow the rules and regulations, the information that is reported in
the financial statements show a true and fair view of the companys financial
performance and position and hence is reliable to users.
External users, to some extent are assured of the trustworthiness of the

information presented in the financial statement. Public listed companies are
required to have their financial statements audited by external auditors to ensure
the financial statement has been prepared according to accounting rules and
principles and it provides a true and fair view.
2.5.3 Comparable
Comparability refers to the quality of the information that enables users to make
comparison in evaluating similarities or differences between companies,
industries or over time. This characteristic is important as comparable
information is more useful.
Consider this example. You are only given this information on Syarikat Along;
Syarikat Along made RM10 million profit last year. Is this information enough
for you to decide whether you want to invest in the company or not? Will your

decision change if you had known that the company has made RM20 million in
the previous year? Comparing the companys performance over two periods
can lead to a better decision as you can see that there has been a 50 per cent
drop in profit.
It is a requirement that a company must provide the previous years information

to enable comparison to be made by users.
2.5.4 Consistent
For information to be comparable across industries or over time, information
needs to be consistent from one company to another and also over time.
Consistency refers to the requirement that companies maintain consistency in the
treatment of various items for all accounting periods. In other words, companies
should not change the accounting procedures or methods used each year.
An example is methods for depreciating non-current assets. There are several

acceptable methods to recognise depreciation expense; among them are the
straight line method and the reducing balance method. If a company had used
the straight line method in one period, they ought to use the same method in the
next accounting period.
For your information, a company may change accounting methods they use.
However, a full disclosure is required in the notes to financial statements to explain
why the changes are made and the effects of the changes to the financial statements.
2.5.5 Materiality
Materiality is another important concept, which states that an entity must
account for items that are significant to the entitys financial statements. In other
words, an amount can be ignored if the effect on the financial statements is
unimportant to users business decisions.
The materiality of an item depends on the size or value of the items according to
the main activities of the business and the nature of the items involved.
For example, a separate account for postage expenses for a grocery store is not
required to be kept, as the amount is small and not significant for the grocery
store. It is sufficient to lump this expense with other expenses under a
miscellaneous expense account. However, for a courier company, postage
expenses are material and must be disclosed separately.

2.5.6 Understandable
The understandability principle requires information to be presented in a format
that can be easily understood. The information reported should be understood
by users, who are generally assumed to have reasonable knowledge of business
and economic activities.
2.5.7 Timely
Relevant and reliable information will be useless if you do not get the
information on time. Hence, it is extremely important to prepare the financial
statements on time.
ACTIVITY 2.4
You just read on the seven qualitative characteristics of accounting.
Based on your experience, which one quality is the most difficult to
comply with? Try to justify your claim.
2.6 ACCOUNTING ASSUMPTIONS

Let us now look at the four assumptions used to facilitate the preparation of
financial statements.
2.6.1 Assumption 1: Separate Entity

For accounting purposes, the business is considered as a separate entity from the
owner. Both the owner and the business are two separate accounting entities. An
accounting entity is an economic unit that controls its own resources. Activities
of each entity must be separated from its owner.
For example, Kak Long owns three different businesses; a restaurant, a

laundrette and a grocery store. Imagine, if only one account is prepared for all
businesses, would she be able to identify which business is profitable or not? For
accounting purpose there are four separate accounting entities; Kak Longs
personal entity, the restaurant, the laundrette and the grocery store (see Figure
2.11). It means each entity will need to have a separate accounting record.
Separation of accounts will enable the owner to know the financial position and
performance of each entity.

Figure 2.11: Separate entity
It is important to note that accounting entity is not the same as legal entity. A
business that is registered as a company is recognised as a legal entity. While for
a sole proprietorship and partnership the law does not differentiate the business
and its owner.
2.6.2 Assumption 2: Going Concern

An entity is assumed to be continuing its operations in the foreseeable future and
will not cease operations. This has important implication in valuing assets and
liabilities of a company.
Suppose Mak & Anak Bakery owned a unique bread making machine costing
RM100,000. If Mak & Anak Bakery decides to close down, the machine is
worthless, as nobody else wants to use the bread making machine.
Therefore in order to report the bread making machine as an asset worth

RM100,000, we have to make an assumption that Mak & Anak Bakery will
continue operating.

ACTIVITY 2.5
Syarikat Jojo has been making big profits for the past 10 years of
operation. However, it will only continue to exist for the next two
years. Will you consider investing your money in Syarikat Jojo? Justify
your claim.
2.6.3 Assumption 3: Monetary Unit

All transactions can be measured in monetary units. In Malaysia the monetary
unit is Ringgit Malaysia (RM). Items that cannot be measured in monetary unit
will not be reported in the financial statements but disclosed as notes.
Transactions in foreign currency will be converted to RM for recording purposes.
2.6.4 Assumption 4: Accounting Period

This assumption states that the life of a business entity can be divided into
periodic intervals. This enables financial statements to be prepared periodically.
The accounting year of a 12 month period has been established as the normal
period for reporting. This enables the comparison of present and past
performance to be made for each accounting period.
Accounting year or fiscal year can start at any period but normally it is from 1st
January until 31st December, or it starts from 1st July and ends on 30th June the
next year.
Interim reports can be produced for a period of less than a year; monthly,
quarterly and semi-annually reports. These reports are produced to meet the
requirements of users for timely information.
2.7 BASIC ACCOUNTING PRINCIPLES
SELF-CHECK 2.2
You purchased a new Ferrari for RM500,000 to be used in your
business. The day after, a tree fell onto your new Ferrari. Once
repaired, the insurance company valued the Ferrari at RM300,000.
Can you record the value of the Ferrari at RM300,000? Why?

The four basic assumptions have resulted in the following principles:
2.7.1 Principle 1: Historical Cost

This principle states that all transactions must be recorded and accounted for
according to their historical cost, in other words, the original cost incurred at the
time of transactions as agreed by both buyer and seller.
2.7.2 Principle 2: Revenue Recognition

This principle states that revenue must be recognised when it is earned. Earned
revenue commonly refers to the act of providing goods or services to customers.
Recognising revenue means the amount is recorded in the account.
This principle indicates that although cash has not been received, goods have
been delivered or services have been performed and, thus, revenue should be
recognised. The opposite also applies, if you have received cash in advance but
have not performed any service or provided any goods to your customer, you
cannot record the amount of cash received as revenue. In other words, revenue is
recognised when earned rather than when cash is received. This notion of
recognising revenue when it is earned and not when cash is received is called
accrual accounting.
The same applies to the recognition of expenses, where expenses should be

recognised when it is incurred not when cash changes hand. If you have received
the goods or services, although payments are to be made in the future, expense
must be recognised at that time (refer to Figure 2.12).
Figure 2.12: Relationship between revenues and expenses

2.7.3 Principle 3: Matching

To determine profit for the accounting period, the revenues of that period must
be matched with the expenses for the same period. As long as the revenue is
earned and expenses are incurred during the period, it must be taken into
account.
Take note that revenues can be cash or non-cash, and expenses can be cash or
non-cash as well. Hence, profit (revenues minus expenses) is not the same as
cash. You can make a large profit but might have a liquidity problem; in other
words you do not have enough cash to pay your creditors.
Use the time line diagram to help you learn the matching concepts and later
the calculation of revenue and expenses.
All Revenues for Year 1
match with Year 2

Year 1
All Expenses for Year 1
Profit for Year 1 = Total Revenue in Year 1 - Total Expenses in Year 1
2.7.4 Principle 4: Full Disclosure

This principle states that all relevant and material information must be
adequately disclosed either in the financial statements or as notes accompanying
the statements.
2.8 ACCOUNTING STANDARDS
Accounting standards are guidelines that need to be adhered by the

accounting profession in preparing and reporting of the financial statements.
Rules and guidelines will definitely increase the work quality of accounting
professionals. How can we be assured that companies will follow the prescribed
guidelines?
The Companies Act 1965 requires companies to comply with approved

accounting standards. Section 166A of the Companies Act 1965 requires directors
of companies incorporated under the Act to ensure accounts are prepared in

accordance with the applicable accounting standards to the extent that the
accounts give a true and fair view.
In Malaysia, the approved accounting standards comprise the following:

(a) Financial reporting standards issued by MASB;
(b) International accounting standards issued by International Accounting
Standard Board (IASB); and
(c) Technical pronouncements published by MASB.
These accounting standards are developed from guidelines, practices and rules
that are acceptable by the accounting profession and known as Generally
Accepted Accounting Principles (GAAP). The standards are established so that
the accounting practised is standardised and this increases the reliability and
comparability of financial statements.
Generally Accepted Accounting Principles (GAAP)

In preparing the financial statements, accountants have to follow certain
standards, guidelines, practices and rules which are known as Generally
Accepted Accounting Principles (GAAP). This is to ensure that the financial
information provided to external parties to the business is prepared according to
a uniform set of assumptions and principles.
To prepare, use and interpret financial statements effectively we need to
understand these assumptions and principles. There are a number of
assumptions and principles. However, this module will only introduce selected
assumptions and principles.
GAAP is the common set of accounting principles, standards and procedures

that companies use to compile their financial statements. GAAP is a combination
of authoritative standards (set by policy boards) and is simply the commonly
accepted ways of recording and reporting accounting information
(http://www.investopedia.com/terms/g/gaap.asp)
ACTIVITY 2.6
Even though GAAP principles have been in practice for a long time,
why do you think that unscrupulous accountants still distort figures?
Discuss.

The accounting profession has to follow standards, rules and guidelines

known as the Generally Accepted Accounting Principles (GAAP) to ensure
uniformity in preparing and reporting the accounting information.
The standards are established so that the accounting practised is standardised

and comparability of financial statements is increased.
The proposed framework is a guide and is useful when confronted with

issues for which there are no pronouncements.
The objective of the financial statement is to present information about the

financial position and performance of a company.
Principal characteristics are relevant, reliable, comparable, consistent,

materiality, understandable and timely.
There are four assumptions used to facilitate the preparation of financial

statements.
Separate entity assumption;
Going concern assumption;
Monetary unit assumption; and
Time period assumption.
The basic principles in accounting are:

Historical cost principle;
Revenue recognition principle;
Matching principle; and
Full disclosure principle.

Accounting assumption
Accounting entity assumption Generally Accepted Accounting
Principles (GAAP)
Accounting principle
Maturation
Behaviourism
Reflex arc
Constructivism
1. Match the following accounting bodies with the main function listed as
follows:
MIA MICPA MASB
(a) ________________ publishes accounting standards.

(b) ________________ provides training to accountants.
(c) ________________ controls the accounting practice in Malaysia.
(d) ________________ issues statements of principles for financial
reporting.
2. Can a company ignore the accounting standards in the preparation and

reporting of its financial statements?
3. Malaysian Airlines (MAS) revenues come from a number of different

sources: ticket sales, holiday packages, rentals of planes and advertising.
Take for example, ticket sales; normal tickets sold are fully refundable until
24 hours of flight cancellation. However, tickets sold on super saver plan
are not refundable. At what point of time will MAS recognise the revenue
from these situations?
4. Classify the following businesses according to their type of business.
Business Type of Business

Car Rental
Car Dealership

Tuition Centres
Batik Factory
Tailor
Clothing Stores
1. Explain the following accounting assumptions:

(a) Separate entity;
(b) Going concern;
(c) Monetary units; and
(d) Accounting period.
2. Explain the following accounting principles:

(a) Historical cost;
(b) Revenue recognition;
(c) Matching; and
(d) Full disclosure.
3. Identify three types of business ownerships.
4. Explain the characteristics of each of the business ownership identified in

Question 3.
1. Which of the items in the following list are liabilities and which are assets?
(a) Loan to Permata SB
(b) Bank overdraft
(c) Fixtures and fittings
(d) Computers
(e) We owe a supplier for goods
(f) Warehouse we own

1. Classify the following items into liabilities and assets:

(a) Motor vehicles
(b) Premises
(c) Creditors for goods
(d) Stock of goods
(e) Debtors
(f) Owing to bank
(g) Cash in hand
(h) Loan from Mr. JS
(i) Machinery

Topic Accounting
3 Cycle
LEARNING OUTCOMES
1. Describe the steps involved in the accounting cycle;
2. Explain the basic accounting equation;
3. Analyse transactions;
4. Demonstrate the effect of transactions on the accounting equation;
and
5. Explain the financial statement (MRFS 101).
INTRODUCTION
By now, you would be wondering how to prepare the financial statements
discussed earlier. Can you recall the definition of accounting or recall the four
components of the accounting process? You need to be able to collect, identify,
measure and record before communicating the information to users in the form
of financial statements. This process describes the accounting cycle of a business.
In this topic, we will begin by introducing the accounting cycle to you. These are
the steps that will be repeated at every accounting period. We will then look at
the accounting equation, which is Assets equal Liabilities plus Owners Equity.
This equation will always remain in balance at all times. This is the basis of all
accounting as every transaction will have certain effects on the accounting
equations.
MYOB (Mind Your Own Business) is one of the many computer-based

accounting systems available in Malaysia. Many companies rely on an

54 TOPIC 3 ACCOUNTING CYCLE
accounting system to generate reports. An accounting package is an integral part

of a business in completing an accounting cycle, as highlighted by a chartered
accountant:
Having the right accounting system is essential for any business. It can save time
and money. Having the wrong one, however, can cost you hours in inefficiencies
and eat into your profits.
(Tania Parkyn)
Chartered Accountant and the Director of Innovative Accounting Systems
3.1 THE ACCOUNTING CYCLE

The accounting process begins with a transaction and ends with closing the
books at the end of a period. These steps are repeated at every accounting period
and are called the accounting cycle. It begins with the occurrence of the
transaction itself, analysing and recording the transactions in journals, posting it
to the ledgers and then preparing a trial balance. At the end of the period,
adjusting entries are made, adjusted trial balances and financial statements are
prepared and then closing entries are done to prepare the temporary accounts for
the next periods accounting cycle (refer to Figure 3.1).
Figure 3.1: The accounting cycle
In the following subtopics, we will look at all the steps in the accounting cycle
briefly.

TOPIC 3 ACCOUNTING CYCLE 55
3.1.1 Source Documents

At this stage, information is gathered, generally in the form of source documents,
about transactions or events. Source documents are documents that provide
proof that a transaction had actually occurred, and this is the basis of accounting
records. Examples of source document are sales invoice, purchase invoice, debit
note, credit notes, cheques and receipts. Controls on source documents are
important to ensure accounting information is accurate and reliable.
At a minimum, each source document should include the data, the amount and a
description of the transaction. During an audit, source documents are used as
evidence that a particular business transaction occurred.
ACTIVITY 3.1
Look at a sample of a sales or purchase invoice. Can you list down the
information documented in this source document?
3.1.2 Transactions Analysis

Transactions are analysed; how each transaction affects the accounting equation
is looked into. At this stage the accounts affected by the transaction and how it is
affected (increased or decreased) will be identified.
3.1.3 Journalising
These transactions are then recorded in journals. A journal is also known as the
book of prime entry. It is a chronological record of transactions. Journal entries
will facilitate the posting of transactions to ledgers.
3.1.4 Posting to Ledgers

Records from the journal are then posted (transferred) to ledgers. Posting should
be done on a timely basis, to ensure the ledger is up to date.
3.1.5 Preparing of Unadjusted Trial Balance

At the end of an accounting period, the balance of all accounts of a business will
be listed in the trial balance.

3.1.6 Adjusting Entries

At the end of an accounting period, adjusting entries are prepared to assign
revenues and expenses to the periods they are earned and incurred.
3.1.7 Preparing of Adjusted Trial Balance

Listing of all business accounts balances after adjustment entries are made.
3.1.8 Preparing of Financial Statements

The result of the business is communicated to users through financial statements.
Can you recall the financial statements that you have learned in Topic 1 earlier?
An income statement is prepared in order to report the financial performance of
the business. The balance sheet is prepared to report the financial position of the
business.
3.1.9 Closing Entries

At the end of an accounting period, all temporary accounts are closed. Revenues
and expenses are closed to income summary. Profit or loss is then transferred to
capital account. Drawings are also closed to capital account.
The mentioned stages are depicted in Figure 3.2 for quick reference.

Figure 3.2: The stages involved in preparing the financial statement

Source: Horngren (2004)
You will learn in detail all the steps of the accounting cycle. However, let us first
look at the accounting equation. This is the most basic concept of the double
entry book keeping.

3.2 ACCOUNTING EQUATION

Before we look at the accounting equation, you need to understand that all
economic events can be classified into three categories which are assets, liabilities
and owners equity.
Assets are resources that are owned by the entity. Land, properties, equipment,
motor vehicles, cash, receivables (debtors) are examples of assets. These assets
are expected to provide future economic benefits to the entity.
Liabilities are debts or obligation of the entity. Loans, bank overdrafts and
payables (creditors) are examples of liabilities. The liabilities are expected to be
cleared off by sacrificing the entitys assets.
Owners equity is the residual claim (rights) of entity assets. Let us say you
purchase a car using your own money and the car belongs to you. You can do
whatever you want with the car, even sell it. However, if you take a loan to
purchase a car, although you have the right to use the car, the ownership is not
yours and the car is not yours until you pay off your loan. If you sell the car, the
loan amount will be deducted (settled) and the difference (the residual) will be
refunded to you.
To illustrate, let us look at this situation. You have decided to start a new
business. You only have RM5,000. So you asked your friend to lend you
another RM5,000. The business now has an asset (cash) of RM10,000 whereby
only RM5,000 belongs to you and another RM5,000 belongs to your friend.
If you were to stop your business immediately, the business asset (cash) of
RM10,000 is not yours alone; you have to pay off your borrowings and only
the balance belongs to you (residual claim).
The accounting equation is the fundamental of accounting. The equation presents

the resources of a business and the claim against those resources.

Can you see the relationship between the assets of the business with liabilities of
the business and the owners equity interest? The relationships are presented in
the following basic accounting equation (see Figure 3.3).
Figure 3.3: The basic accounting equation
All economic transactions in an entity will affect the equation, meaning they will
affect assets, liabilities or owners equity.
Although the items in the equations are affected (increased or decreased), the
equation will remain in balance at all times.
The basic accounting equation can be expanded to include items of owners

equity.

There are four items that can affect the owners equity, and they are shown in
Figure 3.4:
Figure 3.4: Transactions effect on owners equity
The following are the explanation for the items:

(a) Capital investments they will increase owners equity;
(b) Drawings they will decrease owners equity;
(c) Revenues they will increase the owners equity; and
(d) Expenses they will decrease the owners equity.
Hence the equations can be rewritten as shown in Figure 3.5:
Figure 3.5: The expanded accounting equation

The next subtopic will look at the second step in the accounting cycle: analysing a
transaction to determine how it affects the accounting equation.
ACTIVITY 3.2
1. You have a personal wealth of RM100,000, comprising RM10,000

cash and a car worth RM90,000. You had borrowed RM40,000
from your parents to purchase the car. Can you write your
accounting equation?
2. Without looking back, write down the commonly used form of the
accounting equation.
3.3 TRANSACTION ANALYSIS

It is important for you to remember that the accounting equation must be in
equilibrium at all times. Business transactions must be analysed to see their
effects on the components of the equation.
The following are the steps that you can use to help you analyse business
transactions:
STEP 1: Read and think about the transaction.

STEP 2: Identify components in the equations that are affected. Is it
asset, liability or owners equity?
STEP 3: Identify the accounts and the effects. Decreased? Increased?
STEP 4: Check the equation; it has to be balanced.
It is important for you to understand this analysis as it is the basis for preparing
journal entries for all transactions. You will need to spend more time learning
this before proceeding to the next level.
We will see in detail how transaction analysis works by looking into the
following transactions of a service based business (refer to Table 3.1).

Table 3.1: Transactions of a Company
Date Transactions
1 Sept. 2013 Sonic invested RM50,000 cash to start a photography business.
3 Sept. 2013 Sonic purchased a photo processing machine costing RM1,000 cash.
5 Sept. 2013 Sonic withdrew RM10,000 cash for personal use.
6 Sept. 2013 Sonic borrowed RM20,000 cash from Digi Bank.
25 Sept. 2013 Sonic paid off RM5,000 of the bank loan.
26 Sept. 2013 Sonic provided professional photography service for a wedding;
RM2,000 cash was received and another RM1,000 will be received
within 14 days.
28 Sept. 2013 Sonic paid RM500 cash for his employees salary, RM300 cash for
utilities and RM200 cash for shop rental.
3.3.1 Transaction 1: Initial Investment by Owner

An owner can contribute cash or other assets to the business as capital. For
example, the owner can bring his own motor vehicle into the business and this
will be considered as capital contribution by the owner to the business. Capital
contributions by the owner will increase both the business assets and owners
equity. These are shown in Table 3.2.
Table 3.2: Transaction 1
Equation Description
Transaction 1 Sept 2013, Sonic invested RM50,000 cash to start a
photography business Sonic Enterprise.
Basic Analysis The asset (cash) has increased by RM50,000.
The owners equity (capital) has increased by RM50,000.
Accounting Assets = Liabilities + Owners Equity

Equation Cash RM50,000 Capital RM50,000

Equation after
Transaction 1
The equation remains in balance.

3.3.2 Transaction 2: Purchase of Non-current Asset

To operate, most business must have non-current assets (fixed assets) that will be
used to generate revenues. For example, a delivery van is needed to deliver
goods; a machine to produce products and so on. The purchase of such items can
either be on cash terms or credit terms. Paying cash for your purchase of non-
current asset will see your cash asset decreases and your non-current asset
increases. Purchasing non-current assets on credit will see your non-current
assets increased and your liabilities increased. Refer to Table 3.3 for the
explanation of the Transaction 1 to 2.
Table 3.3: Transaction 1 to 2
Transaction 3 Sept. 2013, Sonic purchased a photo processing machine

costing RM1,000 cash.
Basic Analysis The asset (cash) has decreased by RM1,000.
The asset (equipment) has increased by RM1,000.
Accounting Equation Assets = Liabilities + Owners Equity

Cash RM 1,000 Equipment 1,000

after Transaction 1 Cash + Equipment Capital
and 2
49,000 1,000 50,000
3.3.3 Transaction 3: Withdrawals by Owners

It is normal for the owner to take the business cash and use it for their personal
purpose. Business and owners assets are two separate things and need to be
accounted as so. If business cash are used for personal (owner) purposes, it is
considered as drawings by the owner. Drawings will reduce the owners equity
(capital) and asset (cash). It should be noted, too, that any consumption of
business assets such as office supplies or stationeries for personal usages must be

recorded as drawings. Refer to Table 3.4 for the explanation of the Transaction 1
to 3.
Transaction 5th Sept. 2013, Sonic withdrew RM10,000 cash for
personal use.
The owners equity (capital*) has decreased by RM10,000.
Cash 10,000 Capital * 10,000
Accounting Equation after Assets = Liabilities + Owners Equity
Transaction 1, 2 and 3
Note: * Withdrawals by owners are not recorded in the capital account directly but will
be recorded in an account called drawings. Drawings represent a reduction in owners
equity.
3.3.4 Transaction 4: Borrowing Money

To finance business operations such as buying non-current assets, office supplies,
and paying employees, sometimes the cash capital from the owner is not enough.
Business can borrow money from another company, a person or a financial
institution to increase its available funds. This borrowing represents an
obligation to business to pay the principle amount plus interest charges.
Borrowing increases both assets (cash) and liabilities of a business. Refer to Table
3.5 for the explanation of Transaction 1 to 4.

Transaction 6 Sept. 2013, Sonic borrowed RM20,000 cash from Digi
Bank.
(In this example we will ignore the interest charges)
The liability (loan) has increased by RM20,000.
Cash 20,000 Loan 20,000
Accounting Equation after Assets = Liabilities + Owners Equity
Transaction 1, 2, 3 and 4
The equation remains in balance
3.3.5 Transaction 5: Repayment of Borrowings

Borrowings must be paid off. Repayment methods and amount varies according
to the loan agreement. For example a borrower might pay only monthly interest
charges over the period of the loan and the whole principle at the end of the loan
term or a borrower might pay equal monthly sum which includes interest and
principle amount over the period of the loan. Repayment of borrowing will
reduce both assets (cash) and liabilities of the business. Refer to Table 3.6 for the
explanation of Transaction 1 to 5.

Transaction 25 Sept. 2013, Sonic paid off RM5,000 of the bank loan.
The liability (loan) has decreased by RM5,000.
Cash 5,000 Loan 5,000
after Transaction 1, 2, 3, Cash + Equipment Loan Capital
4 and 5
54,000 1,000 15,000 40,000
3.3.6 Transaction 6: Earning Revenues

The main objective of business is to make profit. In order to make profit,
businesses must earn revenues. Revenues can be in many forms, a service
provider provides services to customers, a merchandiser sells goods to customers
and a manufacturer sells manufactured goods to a wholesaler. A business can
earn sales commission revenues, interest revenues from cash deposits in bank or
event rental revenues for renting out office space to clients.
Most of the time, customers will pay cash for service rendered or goods delivered
to them, but some will pay later (credit term). Regardless whether cash has been
received or not, as long as you have earned the revenue it should be recorded as
such. Revenues will increase assets (cash or receivables) and owners equity.
Refer to Table 3.7 for the explanation of Transaction 1 to 6.

Transaction 26 Sept. 2013, Sonic provided professional photography service for
a wedding, RM2,000 cash was received and another RM1,000 will
be received within 14 days.
The asset (accounts receivable) has increased RM1,000.
The owners equity (photography fees) has increased by RM3,000.
Equation Cash 2,000 OE through
Accounts Receivable 1,000 photography fees 3,000
Equation after Cash + AR Loan Capital
Transaction 1, 2,
56,000 1,000 15,000 43,000
3, 4, 5 and 6
+
Equipment
1,000
3.3.7 Transaction 7: Paying for Expenses

In generating sales, business will incur expenses. Examples of such expenses are
paying for shop rentals, wages and salary, utilities, insurance, advertising, office
supplies, motor vehicle maintenance, repairs and many more. You might pay the
expenses with cash as they incurred or you pay it later. Nonetheless, expenses
will reduce your assets (cash) if paid by cash, or increase your liabilities (if no
cash is paid) and reduce owners equity. Refer to Table 3.8 for the explanation of
Transaction 1 to 7.

Transaction 28 Sept 2013, Sonic paid RM500 cash for his employees salary,
RM300 cash for utilities and RM200 cash for shop rental.
The owners equity (expense) has decreased by RM1,000.
Cash 1,000 OE by 1,000
through in expenses
after Transaction 1, 2, Cash 55,000 Loan Capital
3, 4, 5, 6 and 7
15,000 42,000
+
Equipments 1,000
+
AR 1,000
There are many transactions other than the examples given earlier. All will have
an effect on the accounting equation. However, the accounting equation will
always remain balanced.

SELF-CHECK 3.1
Can you give examples of a business transaction that will have the
following effects to the accounting equation?
1. Increase in an asset and increase in a liability.
2. Increase in an asset and decrease in another asset.
3. Decrease in an asset and increase in a liability.
4. Increase in an asset and increase in owners equity.
5. Decrease in an asset and decrease in owners equity.
Summaries of how each of the mentioned transaction affects the accounting

equation are given in the following Table 3.9. Go through this again to check
your understanding.
Table 3.9: Transaction Analysis

Owners
Date ASSETS = LIABILITIES +
Equity
(Sept.
Accounts
2013) Cash + + Equipment = Loan + Capital
Receivable
1st 50,000 = 50,000
Balance 50,000 = 50,000
3rd (1,000) + 1,000 =
Balance 49,000 + 1,000 = 50,000
(10,000)
5th (10,000) =
Drawings
Balance 39,000 + 1,000 = 40,000
6th 20,000 = 20,000
Balance 59,000 + 1,000 = 20,000 + 40,000
25th (5,000) = (5,000)
Balance 54,000 + 1,000 = 15,000 + 40,000
26th 3,000
2,000 1,000 =
Revenues
Balance 56,000 + 1,000 1,000 = 15,000 + 43,000
(500)
salaries
(300)
28th (1,000) =
utilities
(200)
rentals
Balance 55,000 + 1,000 + 1,000 = 15,000 + 42,000

3.4 PRESENTATION OF FINANCIAL

STATEMENT (MFRS 101)
You can refer to the MASB website (http://www.masb.org.my/) for more
information on the format for presentation of financial statements.
3.4.1 Statement of Financial Position (Balance Sheet)

Statements of financial position or balance sheets of the organisation on a specific
date provide information about:
(a) Tangible fixed assets such as plant, land, machinery, vehicles and
equipment.
(b) Intangible fixed assets such as goodwill.
(c) Current assets which are assets that can be converted to cash within one
year.
(d) Liability of current liabilities (debt due within one year and long-term
liabilities.
(e) Equity of owner(s) (owner claims on business).
(f) Working capital surplus of current assets over current liabilities (current
assets current liabilities).
3.4.2 Income Statement

Income statements are reports on the financial performance and results of the
organisation for a certain period of time.
3.4.3 Statement of Changes in Equity

Statement of changes in equity shows:
(a) All changes in equity; and
(b) Changes in either equity from capital transactions with owners or
distributed to owners.

3.4.4 Cash Flow Statements

Cash flow statements report cash inflows and cash outflows for the period. This
is influenced by:
(a) Operating activities (sales, collection, receivables, purchases and pay
creditors);
(b) Investing activities (contribution of investment funds and dividend
payments);
(c) Financing activities (loans and loan payments); and
(d) Cash flow is important to know the level of survival of the organisation's
ability to generate cash and cash needs of the organisation to be used.
3.4.5 Notes to the Accounts

Notes to the accounts should be as follows:
(a) Present information about the basis of preparation of the financial
statements and the specific accounting policies selected and applied for
significant transactions and details.
(b) Disclose the information required by MASB Standards that is not presented
in any place in the financial statements.
(c) Provide additional information that is not presented on the face of the
financial statements, but it is necessary for a fair presentation.
Notes to the accounts are presented in an orderly manner. Each item of the
balance sheet, income statement and cash flow statement should be referenced to
any related information with explanatory notes.
The accounting cycle begins with the occurrence of the transaction itself,
analysing and recording the transactions in journals, posting them to ledgers
and then preparing a trial balance. At end of the period, adjusting entries are
made, adjusted trial balance and financial statements are prepared and then
closing entries are done to prepare the temporary accounts for the next
periods accounting cycle.
The basic accounting equation is Assets equal Liabilities plus Owners Equity.

There are four items that can affect the owners equity, they are:
Capital investments; they will increase owners equity;
Drawings; they will decrease owners equity;
Revenues; they will increase the owners equity; and
Expenses; they will decrease the owners equity.
The expanded accounting equation can be written as Assets equal Liability

plus Owners Equity plus Revenues minus Expenses and minus Drawings.
All transactions will have an effect on the accounting equation; however, the
accounting equation will remain in equilibrium at all times.
Transactions are analysed to see the accounts affected and the effects they
have on the accounting equation.
Accounting equation Liability

Adjustment Presentation
Asset Statement
Equation
1. Calculate the missing figures.
Assets Liabilities Owner's Equity

Business A 79,500 45,000 ?
Business B ? 23,000 45,600
Business C 163,700 ? 104,500

2. (a) Indicate whether the following items are A (Assets), L (Liabilities), R

(Revenues) or E (Expenses).
(i) Cash (viii) Accounts payable

(ii) Bank loan (ix) Accounts receivable
(iii) Equipment (x) Sales
(iv) Notes payable (xi) Supplies
(v) Insurance (xii) Advertising
(vi) Salaries (xiii) Salaries payable
(vii) Furniture and fittings (xiv) Motor vehicle
(b) Explain how the following transactions will affect the accounting
equation. Identify the account affected.
(i) Pay cash for postage.

(ii) Buy furniture and fittings on credit.
(iii) Bring own motor vehicle to be used for business purposes.
(iv) Pay salaries to workers.
(v) Receive rentals from tenants.
1. (a) Based on the following transaction analysis worksheet of Azwan

Enterprise, describe the nature of each transaction (1-9). Azwan
Enterprise provides printing services to its clients.
Accounts Accounts Bank

Date Cash Supplies Land Capital
Receivable payable Loan
Opening 7,500 3,800 400 38,000 3,700 10,000 36,000
Balance
1/1/2013
Trans 1 -1,000 1,000
Trans 2 2,000 -2,000
Trans 3 -4,000 -4,000
Trans 4 -1,000 -1,000
(Rent)

Trans 5 2,000 -2,000

(Wages)
Trans 6 7,000 7,000
(Revenue)
Trans 7 1,500 1,500
Trans 8 3,500 3,500
(Revenue)
Trans 9 -1,200 -1,200
Cash Accounts Supplies Land Accounts Bank Capital
Receivable payable Loan
Ending
Balance,
31/1/2013
(b) Determine the balance of each account in the worksheet.

(c) Show the accounting equation for Azwan Enterprise.
(d) Based on information provided in the transaction analysis worksheet
earlier, calculate Azwan Enterprises income.
2. Che Wan opens a beauty salon on 1 February 2013. During the first month
of operation the following transactions occurred:
February 1 Che Wan invested RM150,000 of her own cash in the business
and borrowed RM100,000 from a bank
2 She paid cash for furniture and fittings for the shop costing
RM25,000.
5 Purchased on credit beauty supplies worth RM4,000.
7 Performed makeup service for a wedding and billed the
customer for RM5,000.
10 Che Wan withdrew RM20,000 and invested it in a restaurant
business.
12 Che Wan renovated her apartment, paying RM10,000 from
her own funds.
15 Provided beauty consultation for a client and received
RM3,000 cash for her service.
16 Purchase a second hand car for business use. She paid
RM5,000 cash and borrowed another RM15,000 from a bank.

17 Received RM3,000 cash as partial payment for service

rendered on 7th February.
25 Paid the full amount owed for beauty products purchased on
5 February.
27 Purchased beauty supplies worth RM5,000 for cash.
28 Paid the following expenses for cash:
Electricity RM100
Rental RM1,500
Workers salaries RM2,000
You are required to:
(a) Analyse the effects (increase and decrease) that the mentioned
transactions have on the accounting equations and identify the
specific accounts affected; and
(b) Analyse the effects of the above transactions to the accounting

equation, by using the format similar to Table 3.1.
1. Draw up Purupurus balance sheet from the following information as at 31

December 2013.
RM
Capital 7,200
Debtors 1,200
Van 3,800
Creditors 1,600
Fixtures 1,800
Stock of goods 4,200
Cash at bank 300

1. You are required to open the asset, liability, capital accounts and record the
following transactions for June 2013 in the records of BerryCo.
2013
June
1 Started business with RM1,200.

2 Paid RM11,700 of the opening cash into a bank account for the
business.
5 Bought office furniture on credit from OrangeCo for RM1,900.
8 Bought a van paying by cheque RM5,250.
12 Bought equipment from PineappleCo on credit RM2,300.
18 Returned faulty office furniture costing RM120 to OrangeCo.
25 Sold some of the equipment for RM200.
26 Paid amount owing to OrangeCo RM1,780 by cheque.
28 Took RM130 out of the bank and added to cash.
30 KiwiCo lent RM4,000 giving the money by cheque.
Horngren, C. T. (2004). Management accounting: Some comments. Journal of

Management Accounting Research, 16 (1), 207-211.

Topic Adjusting
4 Entries and
Closing Entries
LEARNING OUTCOMES
1. Distinguish cash basis accounting from accrual basis accounting;
2. Identify the types and purpose of adjusting entries;
3. Prepare adjusting entries;
4. Prepare an adjusted trial balance;
5. Prepare closing entries; and
6. Prepare the financial statements from the adjusted trial balance.
INTRODUCTION
In Topic 3 you have learned how to analyse, journalise, post, prepare transactions
and trial balances and the basic financial statements for a business that provides
services. However, you are not done yet!
The transactions that you have previously recorded occurred in the same
accounting period (you recorded the transactions as they occur). However, not
all transactions have been recorded, as there are internal transactions and events
that need adjustment at the end of the accounting period. This is due to the
accrual accounting principles that recognise revenues when they are earned and
match these revenues with expenses that are incurred in the same accounting
period.

78 TOPIC 4 ADJUSTING ENTRIES AND CLOSING ENTRIES
It is most important to understand the difference between cash basis accounting

and accrual basis accounting. In this topic, you will also learn how to record
adjusting entries and prepare an adjusted trial balance before preparing the
financial statements and close temporary accounts.
Many small construction firms find the option of utilising cash basis
accounting to be a practical method of bookkeeping. The cash basis method
allows deductions for expenses to be taken in the year that they are paid
and reporting of income in the year received. For businesses, however,
where merchandise is an income-producing factor, the Internal Revenue
Service (IRS) strongly favours the accrual method...In April 2002,
the IRS issued regulation 2001-76, which expands the number of businesses
that are permitted to use the cash accounting method. Specifically, the rule
states that qualifying businesses with less than $10 million in annual
revenues can use cash accounting for tax purposesThe rule change will
benefit more than 500,000 small businesses by reducing administrative cost
allowing deduction..
Associated Builders and Contractors (2014)
4.1 ACCOUNTING BASIS

In order to understand adjusting entries it is best for us to understand and
differentiate accrual and cash basis accounting.
4.1.1 Cash Basis Accounting

Under cash basis accounting, transactions are recognised (recorded) when they
involve cash. Revenues are recognised when cash is received while expenses are
recognised when there are payments of cash (refer to Figure 4.1).
Figure 4.1: Cash basis accounting
This system is simple but at the same time it does not give an accurate picture of
the financial performance and financial position of the entity. The information
provided by a financial statement prepared under cash basis will be incomplete.
TOPIC 4 ADJUSTING ENTRIES AND CLOSING ENTRIES 79
To explain this, let us assume a business entity has provided services on

credit terms for RM15,000. Under cash basis, no revenue can be recognised as
no cash has been received by the business. If the business prepares financial
statements before the cash is received, the revenues under cash basis
accounting will be understated, resulting in a lower profit (income). From a
financial position point of view, the assets will also be understated.
The same concept applies to expenses recognition. Take utility bills for
example. The January bill is received at the end of the month for RM100 and
will only be paid the following month. Under cash basis accounting, no
utility expenses will be recognised in January; as a result, the amount of
expenses is understated, hence overstating Januarys profit (income). From a
financial position point of view, Januarys liabilities are understated too.
To summarise, the weaknesses of cash basis accounting are:

(a) It does not follow the matching principle if credit transactions exist;
(b) As a result of understating revenue or overstating expenses, profit or loss
calculated under cash basis accounting does not reflect the true business
performance; and
(c) Since the liabilities and assets are not recognised, the balance sheet does not
provide the true picture of the business financial position.
Do take note that the cash basis accounting is not consistent with the generally
accepted accounting principles and is not allowed to be used in practice.
4.1.2 Accrual Basis Accounting

Accrual accounting recognises revenue after goods are delivered or services
provided to customers, regardless of whether cash has been received or not. Let
us take the example in subtopic 4.1.1, where a firm provided services worth
RM15,000 on credit terms. The RM15,000 will be recognised as revenue under
accrual basis accounting as services have been provided to customers even
though no cash has been received.
It is the same with Januarys utility expenses; you have used the utilities during
January. It is Januarys expenses and should be recognised as so.

Let us look at another example. Suppose Che Ah Enterprise paid for one year
insurance in advance for RM1,200 on January 1, 2013. Assuming now it is March
30, 2013 and Che Ah Enterprise wants to calculate its income for the first three
months of operation, how much insurance expenses should be recognised? Can
you draw the time line for this example?
Accrual basis accounting will recognise that only three months expenses are
matched with the same period revenues. Hence only RM300 (RM1,200 3/12) will
be recognised as expenses. Another RM900 will be reported as an asset (prepaid
insurance) at the end of that period (March 30, 2013). Cash basis accounting on the
other hand will recognise the full amount of RM1,200 as expenses.
Accrual basis accounting takes into account all revenues that are earned during
the accounting period, and match them with all expenses incurred in generating
the said revenues. This in fact, gives a true picture of the business performance
compared to using cash basis accounting, and this is the reason why accrual basis
accounting is better than cash basis accounting.
The strengths of accrual basis accounting are:

(a) It measures the true financial performance of a business, through
accurate measurement of revenue and expenses for the period;
(b) It shows the true financial position of a business, through accurate
reporting of liabilities and assets; and
(c) It matches revenues with expenses for the period.
Accrual basis accounting is used in practice to prepare and report financial

statements.
Figure 4.2 explains the differences between cash basis and accrual basis.
Figure 4.2: Cash versus accrual basis accounting

As explained in the previous subtopics, under accrual basis accounting some

transactions need to be adjusted to reflect their true measurement of revenues,
expenses, assets and liabilities.
ACTIVITY 4.1
1. The difference between cash and accrual basis accounting has to do
with the time frame in which revenues and expenses are recorded
and reported. These websites offers an explanation of how accrual
basis accounting and cash basis accounting differ.
(a) http://accountinginfo.com/study/accrual-101.htm
(b) http://office.microsoft.com/en-us/support/understanding-
cash-and-accrual-basis-accounting-HA010164612.aspx
2. An income statement of a firm that uses the accrual basis

accounting shows a profit of RM1 million. Does this mean the firm
has RM1 million cash?
4.2 ADJUSTING ENTRIES

At the end of an accounting period, information obtained from the trial balance is
not sufficient to prepare a complete financial statement of a business entity. This
is due to the need to prepare adjusting entries to match revenues and expenses of
an accounting period in order to obtain an accurate profit or loss for the said
period.
There are items like prepaid expenses, accrued expenses, unearned revenues,
accrued revenues, depreciation, bad debts and doubtful debts that need to be
accounted for at the end of the accounting period. We will now discuss each of
these adjustments in detail.

Figure 4.3 summarises the adjustment entries that need to be made at the end of a
financial year.
Figure 4.3: Adjusting entries that need to be made at the end of a financial year
4.2.1 Prepaid Expenses
Prepaid expenses are items that are paid for before their benefits are received
or used.
Prepaid expense is an asset. When the assets are used, consumed or expired, they
become expenses and should be recognised. These items include supplies, rentals
and insurance.
Let us look at this example. Suppose on 1 January 2013 you purchased office
supplies worth RM500 for cash. The following entries will be made to record the
purchase.
1/1/13 Dr Office supplies 500

Cr Cash 500
To record purchase office supplies for cash.

You will be using these office supplies during the operation of your business like
taking a pen, diskettes, paper, etc. from the supplies, but it is very unlikely for
you to record this as expense every time you take these items as it is not practical
to do so.
At the end of the month, you do a stock check and find that the office supplies
worth is RM300.
Can you see that you do not have RM500 worth of office supplies anymore, only
RM300 are left? You have used up RM200 worth of office supplies and this usage
(expense) has never been recorded. Thus, it is necessary to make the following
adjusting entry at the end of the month to account for the supplies used.
30/1/13 Dr Supplies expense 200

Cr Office supplies 200
To record supplies used.
The effect of the adjusting entry is to recognise the expense of RM200 and reduce
the office supplies from RM500 to RM200. See the following accounts:
Office Supplies
Date Description Amount Date Description Amount
1/1/13 Cash 500 30/1/13 Supplies expense 200
30/1/13 Closing Balance 300
500 500
This amount will be reported as an asset (office supplies) in the balance

sheet as at 30 Jan 2013.
Supplies Expense
30/1/13 Office Supplies 200 30/1/13 Closing Balance 200
200 200
This amount will be transferred to income summary account as supplies

expense for the month.

Another example is prepaid insurance. Let us assume Xtrail Enterprise paid for
three years of insurance coverage of RM3,600 on 1 January 2013. The transaction
will be recorded as the following:
1/1/13 Dr Prepaid insurance 3,600

Cr Cash 3,600
Paid cash for a three year coverage of insurance policy
Prepaid insurance account is a current assets account. As at January 1, 2012,

Xtrail Enterprises insurance benefits cover the period of 1 January 2012 until 31
December 2014 (36 months). Xtrail wants to prepare its income statement for the
year ended 31 December 2012, or after one year of operation. Has any insurance
expense been recorded? Does Xtrail have RM3,600 worth of insurance as asset as
at 31 December 2012? The answer to both questions is a NO.
In fact, you should realise that Xtrail has used up one year of the insurance;
hence, this amount should be recognised and recorded as expense. As Xtrails
asset has been used up, it should be reduced. Hence, the following adjusting
entry should be made.
31/12/12 Dr Insurance expense 1,200

Cr Prepaid insurance 1,200
To record the insurance expense for the year.
The effect of the adjusting entry is to recognise the insurance expense of

RM1,200, and reduce the prepaid insurance from RM3,600 to RM2,400. As at
31/12/2012 your prepaid insurance will provide coverage for two years. See the
following account:
Prepaid Insurance
1/1/12 Cash 3,600 31/12/12 Insurance expense 1,200
31/12/12 Closing Balance 2,400
3,600 3,600
This amount will be reported as asset (prepaid insurance) in the balance

sheet of the business as at 31 Dec 2012.

Insurance Expense
31/12/12 Prepaid insurance 1,200 31/12/12 Closing Balance 1,200
This amount will be transferred to the income summary account as the

insurance expense for the year ended 31 December 2012.
4.2.2 Unearned Revenue

There are a few situations where you will receive cash in advance before
delivering goods or providing services. These include rent received in advanced
and subscriptions received in advance.
According to the revenue recognition principle, revenue can only be recognised

when you have earned it, not when you receive cash for it. In fact, when you
receive cash in advance, you have an obligation (a liability) to provide goods or
services to the customer.
Xtrail Enterprise rents out an office space to Keno. On 1 July 2013, Keno paid three
months rental of RM4,500. The journal entry to record this in Xtrails book is:
1/7/13 Dr Cash 4,500

Cr Rental Revenue 4,500
To record received three months rentals in advance from
K
Assume that Xtrail Enterprise prepares its financial statement at 31 July 2013. If
no adjustment is made, the account Rental Revenue will show an amount of
RM4,500. In fact, Xtrail has not earned the RM4,500 rental revenue; only RM1,500
is earned and it owes Keno another two months rental or RM3,000 worth of
rental services. Hence, the following adjusting entries need to be made:
31/7/13 Dr Rental Revenue 3,000

Cr Unearned Rental Revenue 3,000
To record the earning of one month rental that was received in advance.

The entry reduces the Rental Revenue amount to RM1,500 (which is already
earned by Xtrail) and creates a liability account, Unearned Rental Revenue of
RM3,000. See the following accounts:
Rental Revenue
31/7/13 Unearned Rental 3,000 1/7/13 Cash 4,500
Revenue
31/7/13 Closing balance 1,500
4,500 4,500

rental revenue for the month ended 31 July 2013.
Unearned Rental Revenue

31/7/13 Closing Balance 3,000 31/7/13 Rental Revenue 3,000
This amount will be reported as current liabilities in the balance sheet as

at 31 July 2013.
In all unearned revenue, cash is received before the work is performed or the
goods are delivered. Any unearned revenue is a liability.
4.2.3 Accrued Expenses

Accrued expenses refer to expenses that a business incurs before paying them.
These include items such as electricity and telephone bills, salaries and wages,
and interest on loans.
For example, on 30 January 2013, the utility bill for January was received for the
amount of RM250, but no payment was made. Adjusting entries on 30 January
2013 will be made to recognise the utility expense of RM250 and the existence of
a liability (Utilities Payable) of RM250 as at 30 January 2013.

30/1/13 Dr Utilities expenses 250

Cr Utilities payable 250
To record accrued utilities expenses of RM250.
The related accounts are shown as follows:
Utilities Expense
30/1/13 Utilities Payable 250 30/1/13 Closing Balance 250

utilities expense for the month ended 30 January 2013.
Utilities Payable
30/1/13 Closing Balance 250 30/1/13 Utilities Expense 250
This amount will be reported as current liabilities (Utilities Payable) in

the balance sheet as at 30 January 2013.
4.2.4 Accrued Revenues

Accrued revenues refer to revenues that a business has earned but cash has not
been received. These include items such as interest, rent and commissions.
Xtrail Enterprise provides consulting services to Keno. The contract is from 1

January until 30 June 2013 and payment of RM6,000 will only be made at the end
of the contract.
Suppose Xtrail prepares its financial statement on 30 January 2013, a month after
signing the contract. If no adjusting entries are made, Xtrail Enterprise will not be
reporting the consultation revenue of RM1,000 that they have earned.
30/1/13 Dr Consultation fees receivable 1,000

Cr Consultation fees 1,000
To record accrued
Copyright Open University Malaysia (OUM) provided.
revenues for consultation service
Consultation fees
30/1/13 Closing Balance 1,000 30/1/13 Consultation 1,000
fees receivables

revenues (Consultation fees) for the month ended 30 Jan 2013.
Consultation Fees Receivable

30/1/13 Consultation fees 1,000 30/1/13 Closing Balance 1,000
This amount will be reported as current asset in the balance sheet as at 30

Jan 2013.
An accrued expense is expensed first and paid later. A prepaid expense is paid
first and expensed later. Accruals and prepayments are opposites.
4.2.5 Depreciation
Depreciation is the allocation of non-current assets cost as expense over its

estimated useful life.
The reason for this allocation is that you use non-current assets to generate
revenues; for example, you use a motor vehicle to deliver goods to customers
and plants and machinery to produce goods. The matching principle states that
revenues must be matched with expenses, and therefore we must allocate the
cost of using the non-current assets as expense.
There are many ways of calculating depreciation. One method is the straight line
method. The rest of the methods will be covered in another topic.

As an example, on 1 January 2013, Xtrail Enterprise purchased a delivery van for

RM60,000 cash. The expected useful life of this van is 10 years and there is no
residual value. Using the straight line method, the assets cost minus its residual
value will be allocated evenly over 10 years. As the delivery van has zero
residual value, the amount of RM60,000 will be allocated evenly over the 10 year
period. This means RM6,000 will be expensed as depreciation annually.
The adjusting entry at the end of the first year for depreciation is as the
following:
31/12/13 Dr Depreciation Expense 6,000

Cr Accumulated Depreciation Motor Vehicle 6,000
To record depreciation expense for the period.
Depreciation Expense
31/12/13 Acc. Depreciation 6,000 31/12/13 Closing Balance 6,000
Motor Vehicle

depreciation expense for the year ended 31 December 2013.
Accumulated Depreciation Motor Vehicle

31/12/13 Closing Balance 6,000 31/12/13 Depreciation 6,000
expense
This amount will be reported as a contra to motor vehicle in the balance

sheet as at 31 December 2013.
You will not credit the non-current asset account directly but use a contra
account called accumulated depreciation account.

Depreciation account contains only the depreciation charges for the current year
while accumulated depreciation account contains total depreciation charges from
the date of purchase.
Contra account figure will be deducted from the non-current assets original cost
in the balance sheet to get the net value of the non-current assets. An example is
shown next:
Xtrail Enterprise
Extract of Balance Sheet
for the year ended 31 December 2013
RM RM RM
Non-current Assets
Vehicle 60,000
Less Accumulated Depreciation (6,000) 54,000
Other non-current asset XXX XXX
4.2.6 Bad Debts
ACTIVITY 4.2
A firms balance sheet shows an accounts receivable balance of
RM500,000. Do you believe that the firm will be able to collect all of the
RM500,000? Why do you think so? Discuss.
It is common for businesses to allow credit sales. If you recall, an account called
accounts receivable (an asset) will be debited when such a transaction occurs.
This accounts receivable or debtors represent an asset to your business, as in the
future you will be able to receive the payment. However, businesses are exposed
to risks that some of these accounts receivable will not be able to be collected.
For example in the event of a debtors death, business bankrupt or other reasons,
you will not be able to collect from your debtors. When this happens, the debts
will be known as bad debts.
In other words, if someone owes you money that you cannot collect, you have
a bad debt.

The accounting for bad debts is as follows:
Date Dr Bad debts expense XX

Cr Accounts receivable XX
To record the write off of accounts receivable as a result of bad debt.
Date Dr Income summary XX

Cr Bad debts expense XX
To record transfer bad debts expense to income summary.
Consider the following transaction. On 1 July 2013, Raz & Partners provide
consultancy services to Hamza Stores worth RM1,500 on credit. On 1 March 2014,
the debts remained unpaid as Hamza has migrated to Australia and could not be
traced. Raz & Partners decides to write off Hamza Stores debt of RM1,500. Raz &
Partners closes its account on 30 June every year.
The transactions will be recorded as follows:
1/7/13 Dr Accounts Receivable - Hamza Store 1,500

Cr Consultancy Fees 1,500
To record consultancy services on account.
Accounts Receivable Hamza Store

1/7/13 Consultancy fees 1,500

1 March 2014, Raz & Partners will make the following entry to write off the debts
as it was determined to be bad (uncollectable). Writing off is the process of
eliminating amount owed by Hamza from the business records.
1/3/14 Dr Bad debts expense 1,500

Cr Account Receivable - Hamza Store 1,500
Writing off Hamza Stores debt.
This entry brings the Accounts receivable Hamza Store to zero. The debt that is
bad has been eliminated or written off.
Accounts receivable Hamza Store

1/7/13 Consultancy fees 1,500 1/3/14 Bad debts expense 1,500
Bad Debts Expense

1/3/14 Accounts 1,500
Receivable
Hamza Store
At the end of the period, bad debts expenses account will be closed to the income
summary.
30/6/14 Dr Income summary 1,500

Cr Bad debts expense 1,500
To record transfer bad debts expense to income summary.

Bad Debts Expense

1/3/14 Accounts 1,500 30/6/14 Income summary 1,500
Receivable
Hamza Store
Business should never give up on bad debts. You must try to recover the debts
by all means, even by going through a court order to demand payments from
your debtors. Debts that are recovered after being written off are treated as
revenue. The following discusses the accounting treatment for recovery of bad
debts.
ACTIVITY 4.3
1. There are many precautionary measures you can take to avoid the
risk of bad debts. One of them is to get new customers who cannot
provide a satisfactory credit, to provide a guarantor who is
financially sound.
What are other ways that can you think of to minimise the risk of
bad debts?
2. To do further reading on how to avoid bad debts, do check out

these websites:
(a) http://www.australia-
migration.com/page/Bad_Debts/150; and
(b) https://www.ema.co.nz/resources/EMA%20Guides%20
and%20Templates/Advocacy%20Documents/Bad_Debts.
pdf
Recovery of Bad Debts

In the event that the debts can be recovered after they have been written off, the
debts recovered will be recognised as gain and will be reported as other
revenues. When an accounts receivable is recovered, the following accounting
treatment is applicable:

Date Dr Accounts Receivable XX

Cr Bad debts recovered XX
To record bad debts recovered
Date Dr Cash XX
Cr Accounts Receivable XX
To record cash received from bad debts recovered
Date Dr Bad debts recovered XX

Cr Income summary XX
To record transfer of bad debts recovered to income summary
From the Raz & Partners example, assume that on 31 December 2013, Hamza was
finally located, and payment for his debts was demanded. He agreed to pay a
final sum of RM500 to avoid any legal action, and this was accepted by Raz &
Partners.

On 31 December 2013, Raz & Partners will record the following:
31/12/13 Dr Accounts Receivable - Hamza 500

Cr Bad debts recovered 500
To record bad debts recovered from Hamza.
31/12/13 Dr Cash 500

Cr Accounts Receivable Hamza 500
To record cash received from Hamza.
Accounts receivable - Hamza Store

30/12/13 Bad debts recovered 500 31/12/13 Cash 500
Bad Debts Recovered

31/12/13 Accounts receivable - 500
Hamza
Transfer the bad debts recovered to income summary at end of period.
30/6/14 Dr Bad debts recovered 500

Cr Income summary 500
To record transfer bad debts recovered to income summary
Bad Debts Recovered

30/12/13 Income 500 31/12/13 Accounts receivable 500
summary - Hamza

4.2.7 Provision for Doubtful Debts

As discussed earlier, not all accounts receivable can be collected. A balance sheet
that shows accounts receivable of RM500,000 as their current assets does not
necessarily mean that the business will be able to collect the amount in full.
Therefore a business needs to make an estimate or provision of how much of the

accounts receivable might not be collected in the future. Accounts receivable are
reported in the balance sheet less the provision for doubtful debts (shown as
follows). Provision of doubtful debts is a contra account to accounts receivable.
Normally, provision for doubtful debts is calculated based on a certain

percentage of the accounts receivable balance that might not be collected. There
are several bases used to estimate the provision of doubtful debts. They can be
based on past experience, knowledge of the debtors financial position and
ageing analysis.
(a) Creating Provision for Doubtful Debts

Doubtful debts are recorded for the first time as the following:

Cr Provision for Doubtful Debts XX
Providing for uncollectible debts in the future.
Assume that Peter Printing Company has been operating for a year, and at
end of year 31 December 2012, has accounts receivable balance of
RM55,000. Peter estimates that 10 per cent of his debtors will not be able to
pay up.
On 31 December 2012, the provision of doubtful debts is created.

Cr Provision for Doubtful Debts 5,500
Creating provision for doubtful debts

Provision for Doubtful Debts

30/12/13 Closing 5,500 30/12/12 Income
5,500
balance summary
1/1/13 Opening
balance
5,500
The closing balance of RM5,500 will be the opening balance for the
next period stated 1 January 2013.
At year end 31 December 2012, the accounts receivable and provision of

doubtful debts will be reported as the following:
Peter Printing Company

RM RM RM
Current Assets
Accounts Receivable 55,000
Less Provision of Doubtful debts (5,500) 49,500
Other current assets XXX XXX
(b) Increase or Decrease in Provision for Doubtful Debts

In the next accounting period year end, there might be an increase or
decrease in the provision of doubtful debts, in this case only the increment
or decrement is recorded. An increase in the provision of doubtful debts
represents a loss or an expense and thus is reported as one in the income
statement. A decrease in the provision of doubtful debts represents a gain
or revenue and thus is reported as one in the income statement.

Company Name
Extract of Income statement
For the year ended XX/XX/XXXX
RM RM RM
Other revenues
Provision of doubtful debts (decreased in) XX
Bad debts recovered XX XXX
Operating
expenses
Bad debts XX
Provision of doubtful debts ( increased in) XX XXX
Assume that Peter Printing Company has an accounts receivable balance of

RM90,000 as at 31 December 2013. He estimates that 10 per cent of these
accounts are uncollectable. Then the following entry is made to reflect the
increase in his estimate from RM5,500 to RM9,000 which is an increase of
RM3,500.

Cr Provision for Doubtful Debts 3,500
To record an increase in the provision of doubtful debts.

31/12/12 Closing 31/12/12 Income
5,500 5,500
balance summary
1/1/13 Opening
5,500
balance
31/12/13 Closing 31/12/13 Income
9,000 3,500
balance summary
9,000 9,000
Now, let us assume that Peter Printing Company has an accounts

receivable balance of RM70,000 as at 31 December 2014. He estimates that

10 per cent of these accounts are uncollectable. Then the following entry is
made to reflect the decrease in his estimate from RM9,000 to RM7,000,
which is a decrease of RM2,200.
31/12/13 Dr Provision for Doubtful Debts 2,000

Cr Income summary 2,000
To record a decrease in the provision of doubtful debts.

31/12/13 Income 1/1/13 Opening
2,000 9,000
summary balance
31/12/13 Closing balance 7,000
9,000 9,000
1/1/14 Opening
7,000
balance
Ask the following questions before you make adjusting entries.

(a) How was the transaction recorded and what is the current balance?
(b) What should the balance be?
(c) How much is the adjustment?
To summarise, Figure 4.4 shows the effect of prepayments and accruals on items
in the balance sheet and profit and loss (P & L) statement before adjustments are
made. In order to report the correct figure the relevant adjusting entries (as
shown) must be made. For example, if no adjustments are made to expenses (for
example, insurance expense) initially recorded as prepaid expenses (for example,
prepaid insurance) at the end of accounting period, the asset (prepaid insurance)
will be overstated while expense (insurance expense) will be understated.

Figure 4.4: Summary of effects and adjustment entries

ACTIVITY 4.4
This crossword puzzle is for you to test your understanding. Go for it!
Down
1. We measure expenses when _________.
2. Which basis of accounting poses lesser ethical challenges?
3. A _________ expense is paid first and expensed later.
4. We measure revenues when _________.
Across
1. Which basis of accounting better measures business profit
(revenue-expenses)?
2. A category of adjusting entries.
3. Money you cannot recover is called bad ______.

4.3 ADJUSTED TRIAL BALANCE
A trial balance is initially prepared at the end of an accounting period before

adjustments are made. This trial balance is known as unadjusted trial balance.
Later after adjusting entries are made, another trial balance is prepared. This is
known as adjusted trial balance. Similar to the first unadjusted trial balance, the
adjusted trial balance lists all the accounts with their normal balance. However,
all accounts created under the adjustment entries are included in the adjusted
trial balance such as depreciations, accrued expenses, accrued revenues and
unearned revenues.
From this adjusted trial balance figure, the financial statements will be prepared.
See an example as shown in Figure 4.5.
Xtrail Enterprise
Adjusted Trial Balance as at 30 June 2013
Account
Account Debit RM Credit RM
Number
1001 Cash 45,000
1002 Accounts receivable 1,000
1003 Prepaid insurance 2,000
1004 Accrued consultation fees 2,000
1005 Motor vehicle 10,000
Accumulated depreciation motor 3,000
1006
vehicle
2001 Accounts payable 2,700
2002 Accrued utilities expenses 300
2003 Bank loan 14,000
3001 Capital Xtrail 40,000
3002 Drawings - Xtrail 5,000
4001 Consultation fees 13,000
4002 Interest revenues 1,000
5001 Salaries expenses 2,500
5002 Utilities expenses 3,300
5003 Insurance expense 1,700
5003 Depreciation 1,500
74,000 74,000
Figure 4.5: Example of adjusted trial balance Xtrail Enterprise

4.4 CLOSING ENTRIES

At the end of an accounting period, a closing process is required to prepare
accounts for recording transactions in the next period.
Before we go on to discuss the steps in closing accounts, we will look at the types
of accounts in a business. There are two types of accounts; temporary and
permanent accounts. Only temporary accounts are closed at the end of an
accounting period.
4.4.1 Temporary Accounts

Also known as nominal accounts, temporary accounts are used to record
expenses, revenues, drawings and income summary accounts. These accounts are
temporary because they are opened at the beginning of an accounting period,
related transactions are recorded for the period and the account is later closed at
the end of the accounting period.
Accounts are closed so that their balance will be zero at the end of the accounting
period. In the next period, the account will record the amounts incurred in the
next period only. This enables revenues, expenses, drawings and income for the
period to be measured accurately.
4.4.2 Permanent Accounts

Also known as real accounts, permanent accounts are used to report assets,
liabilities and capital. They record transactions related to more than one
accounting period. Their balance at the end of an accounting period will be
carried forward to the next period. These are items that are reported in the
balance sheet.
4.4.3 Recording Closing Entries

There are four steps in closing entries as explained next. Using the earlier
adjusted trial balance for Xtrail Enterprise as at 30 June 2013, you will learn how
to do the closing entries.

The first step is to transfer the credit balance of revenue and gain accounts to the
income summary account. This is done through the following entry:
Date Dr Revenue (or gain) account XX

Cr Income Summary account XX
Closing revenues account to income summary
For Xtrail, the following entry should be made:
30/6/13 Dr Consultation fees 13,000

Dr Interest revenue 1,000
Cr Income Summary account 14,000
Closing revenues account to income summary
The effect of this entry is it will bring the revenues account balance to zero.
Consultation fees
30/6/13 Income summary 13,000 30/6/13 Balance 13,000
Income Summary Account

30/6/13 Consultation fees 13,000
Interest revenue 1,000
This amount will be transferred to the income summary as the revenues

(consultation fees) for the month ended 30 June 2013, and the
consultation fees account balance is zero.

Interest Revenue
30/6/13 Income summary 1,000 30/6/13 Balance 1,000
The second step is to transfer the debit balance of expense and loss accounts to
the income summary account. This is done through the following entry:
Date Dr Income Summary account XX

Cr Expense (or loss) account XX
Closing expenses account to income summary.
30/6/13 Dr Income Summary account 9,000

Cr Salaries expenses 2,500
Insurance expense 1,700
Depreciation 1,500
Closing expenses account to income summary.
The mentioned entry will effectively bring all the expenses account balance to
zero.
Salaries expenses
30/6/13 Balance 2,500 30/6/13 Income summary 2,500


30/6/13 Salaries expenses 2,500 30/6/13 Consultation fees 13,000
Utilities expenses 3,300 Interest revenue 1,000
Insurance
1,700
expense
Depreciation
1,500
expense
Closing balance 5,000
14,000 14,000
This amount will be transferred to the income summary as the expense

(salaries expenses) for the month ended 30 June 2013, and the salaries
expenses account balance is zero.
Can you see that the income summary account only contains revenues and
expenses accounts? Can you also see that revenue items are listed on the credit
side of the income summary account while expense items are listed on the debit
side? If you remember these, you will be able to learn how to prepare an income
summary account.
An income summary account calculates the income of the business. If revenues

are higher than the expenses, the business will record a profit. On the other hand,
if expenses are higher than revenues, the business will record a loss.
The third step is to transfer the balance (profit or loss) of the income summary
account to capital account.
If profit is recorded, the following entry is made:
Date Dr Income Summary account XX

Cr Capital XX
Transferring profit to capital account.

On the other hand, if loss is recorded, the following entry is made:
Date Dr Capital XX
Cr Income Summary account XX
Transferring loss to capital account.
30/6/13 Dr Income Summary account 5,000

Cr Capital 5,000
Transferring profit to capital account.
This entry will bring the income summary account balance to zero.

30/6/13 Salaries 2,500 30/6/13 Consultation 13,000
expenses fees
Utilities 3,300 Interest 1,000
expenses revenue
Insurance 1,700
expense
Depreciation 1,500
expense
Capital 5,000
14,000 14,000
Capital
30/6/13 Closing balance 45,000 30/6/13 Balance 40,000
Income
summary
5,000
45,000 45,000

The profit will be transferred to the capital account and it increases the
capital balance.
The last step of the closing process is to close the debit balance of drawing
accounts to capital account. The following entry is made:
Date Dr Capital XX
Cr Drawings XX
To close drawings account to capital account.
30/6/13 Dr Capital 5,000

Cr Drawings 5,000
To close drawings account to capital account.
As a result, the entry will bring the drawings account balance to zero.
Drawings
30/6/13 Balance 5,000 30/6/13 Capital 5,000
Capital
30/6/13 Drawings 5,000 30/6/13 Balance 40,000
Closing balance 40,000 Income summary 5,000
45,000 45,000

The drawing balance will be transferred to capital account and this

decreases the capital balance.
The closing balance of the capital account will be reported in the balance
sheet as the balance as at 30 June 2013.
Note the distinction between adjusting and closing entries. Adjusting entries
are required to update certain accounts in your general ledger at the end of an
accounting period. They must be done before you can prepare your financial
statements and income tax return. Closing entries are needed to clear out your
revenue and expense accounts as you start the beginning of a new accounting
period.
ACTIVITY 4.5
There is a simple quiz in this website on closing entries. Have a go!

http://school.discoveryeducation.com/quizcenter/info/about.html
Cash basis accounting recognises revenue when cash is received and

expenses when there are cash payments.
Accrual basis accounting recognises revenue when it is earned and expense

when it is incurred regardless of whether cash has been received or paid.
Adjusting entries are made at the end of an accounting period to assign

revenues to the period they are earned and expenses to the period they are
incurred.
Prepaid expenses refer to items paid in advance before receiving the benefits.
Hence, they are reported as current assets in the balance sheet.
Depreciation is the cost of allocating cost of non-current assets over its

Unearned revenues refer to cash that is received in advance before services

are provided or goods delivered to customers. They are reported as current
liabilities in the balance sheet.
Accrued expenses are expenses incurred but not paid yet. Recognition of
accrued expenses will increase expenses and liability (payables).
Accrued revenues are revenues earned but not received yet. Recognition of
accrued revenues will increase revenues and asset (receivables).
Adjusted trial balance is prepared after recording adjusting entries. The new
balances are used to prepare the financial statements.
Temporary accounts consist of revenue, expense, income summary and

drawings. Accounts will be closed at the end of an accounting period to bring
its balance to zero.
Permanent accounts consist of assets, liabilities and equity accounts which

will not be closed. They will show balances which will be brought forward to
the next period.
Accrual basis of accounting Closing entry

Adjusting entries Prepaid expenses
Cash basis of accounting Unearned revenue income
1. The following is information on Onn & Sons Enterprise for the month of
January 2013.
(a) Total revenue from service provided is RM35,000. RM7,500 of these
revenues still remain uncollected.
(b) Onn & Sons has purchased RM5,000 supplies for cash. During
January, Sen Ang used RM3,000 worth of supplies.
(c) Onn & Sons has paid three months rent in advance (Jan, Feb and
March 2013) for RM3,000.
(d) Onn & Sons has not paid his workers salaries for January amounting
to RM2,000.
You are required to calculate the profit or loss of Onn & Sons Enterprise for
the month of January 2013 under:

(a) Cash basis accounting; and

(b) Accrual basis accounting.
2. Crystal had a balance of RM1,617 in office supplies on hand on January 1,

2013. During the year, more office supplies were purchased amounting to
RM3,603 and recorded in the asset account. A physical count of the office
supplies on December 31, 2013 revealed that RM526 remained on hand.
You are required to calculate the office supplies used and provide the
journal entry to record the adjustments that need to be made on December
31, 2013.
3. Bintang Corp. had a RM400 balance in its prepaid insurance account on

January 1, 2013 from a three year insurance policy acquired on Sept 1, 2010.
This policy was renewed on September 1, 2013 for an additional three years
with a payment of RM2,160. Bintang initially records purchase of insurance
in the prepaid account.
You are required to calculate the insurance expense and provide the journal
entry to record the adjustment that needs to be made on December 31, 2013.
4. Ujang Magazine sells magazines on a subscription basis. On 1 April 2010,

cash in the amount of RM1,800 was received for magazine subscriptions for
the next 36 months. Ujang made a credit entry to a liability account when
the cash is received.
You are required to calculate the subscription revenues for 2010 and
provide the journal entry to record the adjustment that need to be made on
31 December 2010.

1. Lyd Enterprise has a RM30,000, 12 per cent note payable due to Malayan
Banking on March 30 2013. The money was borrowed on 1 October 2010.
The first interest payment of RM900 [(RM30,000 12%) 3/12] is due on
31 March 2011.
You are required to provide the journal entry to record the adjustment that
needs to be made on 31 December 2010.
2. On 1 October 2013, Gigantic Corp deposited RM24,000 in a fixed deposit

account at one of the local banks. 12 per cent interest will be paid every six
months. As at 31 December 2013 interest earned on the fixed deposit
amounted to RM720 (RM2,400 12%) 3/12).
You are required to provide the journal entry to record the adjustment that
needs to be made on 31 December 2013 by Gigantic Corp.
3. Read the following information regarding Imran Khan Enterprise.
01.01.2013 Balance of a debtor, Star, of RM300 has remained

uncollected for six months.
05.01.2013 Sold goods on credit to Venus for RM600 and the credit
terms are 2/10, n30.
10.02.2013 Star was declared bankrupt and unable repay his debt.
Imran Khan decides to write off Stars debt.
07.10.2013 Venus, having difficulty in meeting up payment, offers to

pay RM200 as full settlement for his debts. The offer has
been accepted and payment of RM200 is received. To write
off the remaining balance as bad debts.
01.12.2013 After much pursuance, Star pays up RM100 of what he

previously owed as full settlement.

(a) Record the transactions in general journal; and
(b) Show the individual accounts receivable, bad debts expense account
and bad debts recovered account.

4. MKS Accounting firm starts operation on 1 July 2012. They provide

accounting and auditing services to businesses. The following is the
unadjusted trial balance of MKS Accounting firm as at 30 June 2013.
MKS Accounting Firm

Trial Balance as at 30 June 2013
Debit Credit
Accounts
RM RM
Cash 13,000
Office supplies 500
Prepaid insurance 4,800
Building 60,000
Motor vehicle 30,000
Bank loan 25,000
Capital - MKS 60,000
Drawings - MKS 1,200
Accounting fees 25,700
Rental revenues 2,400
Interest expense 1,000
118,700 118,700
Additional information:
(a) Office supplies used during the year amounted to RM350.
(b) Insurance was paid on 1 July 2012 for two years (24 months) coverage.
(c) Building is depreciated at five per cent of original cost.
(d) Motor vehicle is expected to have five years of useful life.

(e) The accounting fees include retainer fees received for service to be provided
in July and August 2013, amounting to RM3,400.
(f) Tenant owed RM500 for May and June shop rentals as at 30 June 2013.
(g) Interest on loan of RM300 is due on 30 June 2013, but this has not been paid.
(h) Salaries accrued amount to RM600 and utilities expense accrued is RM200.
(i) Provision of doubtful debts for RM300 is to be created.
(j) As at 30 June 2013, you are required to:
(i) Prepare the adjusting entries.
(ii) Prepare the adjusted trial balance.
(iii) Prepare
Income statement; and
Balance sheet of MKS.
(iv) Prepare the closing entries for MKS.
(v) Show the income summary account and capital account of MKS.

Topic Accounting
5 for Current
Assets
LEARNING OUTCOMES
1. Discuss the importance of internal control for assets;
2. Describe the guidelines on the internal control for cash;
3. Explain the purpose of preparing bank reconciliation;
4. Prepare bank reconciliation;
5. Explain the purpose of petty cash fund;
6. Journalise the creation and reimbursement of petty cash fund; and
7. Record the inventories.
INTRODUCTION
Is it a good idea to keep your hard earned money under the mattress instead of
in the bank? Well, there are several reasons why you should not keep your
money under the mattress. First of all, it is for security reasons and imagine all
the interest you could have earned if you had deposited your money in the bank.
Just as cash is important to you, it is vital for a business to manage not only cash
but other assets as well.
This topic looks at accounting for current assets. What is current asset? Current
assets of a business comprise cash, receivables, inventories, short-term
investment and prepayments. These current assets are important to businesses.
For example, businesses sell inventories to generate revenues. Sales of
inventories can be made in cash or credit terms and credit sales will give rise to
116 TOPIC 5 ACCOUNTING FOR CURRENT ASSETS
accounts receivables. Businesses must manage the cash so as to avoid theft or

misappropriation. Accounts receivables must be managed effectively in order to
collect the amount owed from debtors. This topic will look at the definition of
assets according to MFRS. Focus is given to current assets, in particular, cash. We
will discuss the basic internal control procedures to protect business assets. Then
look at the definition of cash and why it is important to control it. You will also
learn how to prepare bank reconciliation statements. Finally, you will learn
accounting for petty cash funds.
5.1 ASSETS
Financial Reporting Standard (FRS) defines assets as resources controlled by an

entity as a result of past events and from which future economic benefits are
expected to flow to the entity.
The definition states control rather than ownership. In other words, an entity
may not own the resources; as long as it has the control over the use of the assets,
the item will be reported as assets. Let us say you had purchased a car with 100
per cent financing from the bank; the car ownership will be transferred to you
only when you have settled the loan. The bank owns the car, but you will have to
report the car as your asset as you have full control of the car (resources). You
will also report the liability (the loan) in your balance sheet.
Assets are used to generate revenue for an entity. Hence it is important to protect
the assets. Good internal control must exist to ensure assets are safe.
5.1.1 Internal Control for Assets

Internal controls are used to monitor and control business activities. An internal
control system comprises policy and procedures used to:
(a) Safeguard the assets used in its operation;
(b) Ensure accurate and reliable accounting records;
(c) Promote efficient operation; and
(d) Encourage adherence to company policy.

TOPIC 5 ACCOUNTING FOR CURRENT ASSETS 117
ACTIVITY 5.1
1. The Institute of Internal Auditors Malaysia has published a
Statement on Internal Control Guidance for Directors of Public
Listed Companies. A copy of this statement can be found at
http://www.bursamalaysia.com/market/listed-companies/
This statement provides guidance on the disclosure in the

annual report of public listed companies on the state of internal
control in accordance to the listing requirements of KLSE.
2. Visit your favourite departmental store. Can you identify and

list the various types of internal controls that are used to protect
their assets?
These policies and procedures vary from one organisation to another, depending
on the nature of their business and size. Among others, the following procedures
must exist to ensure adequate internal control in an organisation.
(a) Maintain adequate records. For example, detailed record of assets should
be kept so that it is difficult for assets to be stolen or go missing without
detection;
(b) Insure assets. Protect business property assets and human resources with
adequate insurance coverage. For example, assets must be protected
(warehouse locked and guarded) and insured against theft and fire;
(c) Separate bookkeeping from custody of assets. Responsibility for initiating
business transactions and custody of business assets must be separated
from the responsibility for maintaining accounting records. This is to avoid
or minimise the risk of misappropriation of assets. For example, a
storekeeper is not the same person initiating the purchase of office supplies;
(d) Apply technological controls. Use devices designed to protect assets and
improve accuracy of the accounting process. For example, the use of
electronic tags to protect books in the library from getting stolen;
(e) Perform regular and independent reviews.

5.1.2 Current Assets

According to Malaysian accounting standard MFRS 101 Presentation of
Financial Statement, an asset is classified as a current asset when it is:
(a) Expected to be realised in, or is held for sale or consumption in, the
normal course of the enterprises operating cycle; or
(b) Held primarily for trading purposes or for the short term and expected
to be realised within twelve months of the balance sheet date; or
(c) Cash or a cash equivalent asset which is not restricted in its use.
All other assets should be classified as non-current assets.
Source: http://www.masb.org.my/
In other words, current assets include cash or cash equivalents and other assets
that can be converted into cash, and other assets that can be resold or used in
manufacturing goods within a period of one accounting year or less.
Current assets are shown in Figure 5.1.
Figure 5.1: Current assets
The following subtopics will look at accounting for cash in detail.

5.2 ACCOUNTING FOR CASH

Cash is the most important asset a business has. Cash is crucial to the survival of
a business entity. A business may report high profit, but without cash to run its
operations, the business will be faced with a liquidity problem.
Cash is defined as cash and bank deposits and any items that are accepted by a
bank as deposit. These items include coins, currencies, cheques, bank draft,
postal order, money order, travellers cheques and others.
Cash is the most liquid asset and thus is easily hidden and moved. Hence a good
internal control is required to avoid theft and misappropriation of cash.
Internal Control for Cash

An effective system of internal control to protect cash should have the following
guidelines:
(a) All cash receipts and payments must be accompanied by a document or
evidence: a receipt, bill, invoice or cheque butt. The use of pre-numbered
receipts and cheques helps internal control for cash;
(b) All cash receipts must be deposited into the bank account at the end of each
day. In the event that cash is kept at the premise of the business, it must be
stored in a locked vault at the premise until it is deposited into the bank
account;
(c) All payments must be made through issuing of cheques, except for a
smaller amount which uses the petty cash. In many business organisations,
a cheque requires two signatories rather than one for tighter cash control;
(d) Established responsibility assign tasks that are suited to an individuals
qualification and experience. This reduces the possibility of errors and
when a problem occurs, it is easy to identify the person responsible;
For example, at the check-out counter, only the cashier can receive cash
from the customer;
(e) Separation of duties, staff who receive and handle cash should not be
involved in recording (book keeping) of cash transactions;
(f) Rotation of duties. Temptation and fraud can be reduced if employees
know that they can be transferred without notice from one department to
another. For example, banks rarely allow their employees to work at the
same branch for more than three years;

(g) Periodical visits and random checks. Management and supervisors must
check on their employees; for example check records and tabulate cash to
see if they tally; and
(h) Perform bank reconciliation.
ACTIVITY 5.2
In your opinion, why must a business protect its cash? How do you
control your own cash? Discuss with your coursemates.
5.3 BANK RECONCILIATION

Bank reconciliation is a document to explain all differences between a firms
own cash records and the bank statement figures on a certain date. It is
prepared by the firm (not the bank) to ensure accuracy of financial records.
Before we go on to discuss the steps involved in preparing a bank reconciliation

statement, we will look at the types of bank accounts available. We will then look
at the purposes of preparing a bank reconciliation statement.
5.3.1 Types of Bank Accounts

Businesses will keep their cash in the bank. There are at least three different types
of bank accounts (see Figure 5.2).
Figure 5.2: Types of bank accounts

Now, let us see the types in detail.

(a) Savings account The account holder can withdraw money at any time
through a passbook or any automatic teller machine (ATM). The account
holder can update the passbook to know the detailed transactions and
current balance of account.
(b) Current account No passbook is given to account holders although
money can be withdrawn through the ATM at any time. An additional
feature of a current account is the ability of an account holder to draw
cheques to make payments. The account holder will receive a bank
statement detailing transactions of a particular month.
(c) Fixed deposit account Cash is kept at the bank for a certain period of time.
Cash cannot be withdrawn within this period without a penalty. Higher
interest rate is earned compared to savings and current accounts.
A business normally owns a few types of bank accounts. However, in this topic,
we will assume that business only keeps one type of bank account, which is a
current account.
Firms will record cash as receipts when they receive cheques from another party.
Hence, the firms cash account will record an increment (DEBIT CASH). These
cheques are later deposited into the firms bank account. Once the cheques are
cleared, the amount will be added to the firms current account balance (CREDIT
CURRENT ACCOUNT).
The same applies when the firm draws cheques to make payments to another
party (suppliers, employees, creditors); it will be recorded as cash payment and
hence the firms cash account will record a decrease (CREDIT CASH). The holder
of the cheque will later present it to the bank to demand payment. If there are
sufficient funds in the account of the drawer (the firm), the bank will honour the
cheque and deduct the amount from the firms current account (DEBIT
CURRENT ACCOUNT).
Did you notice that when we deposit cash or cheque in the bank, the bank
statement will show as a credit? When this cash is deposited in a bank, the bank
has an obligation to pay the money back to the customer on demand. The deposit
represents a liability to banks, and therefore, customers bank accounts have
credit balances.
Figure 5.3 summarises the flow of bank deposits and payments.

Figure 5.3: Flow of bank deposits and payments
At the end of the month, banks will issue statements detailing transactions to the
firm. It is uncommon to see the balance of a firm's cash account exactly equal the
cash balance shown on the firm's bank statement. Therefore, the need arises for
reconciliation of the firms cash account and the bank statement.
ACTIVITY 5.3
Can you figure out the reasons for the difference in the bank balance
and the book balance?

5.3.2 Purposes of Preparing Bank Reconciliation

Bank reconciliation is prepared by a firm in order to:
(a) Reconcile the balance of firms cash account with the balance stated in the
bank statement for a particular month; and
(b) Ensure the accuracy and the validity of items recorded in the cash account.
Any omissions and errors can then be corrected.
The balance on the bank statement usually disagrees with the cash account
balance according to the firms records because of the following reasons:
(a) Items (transactions) which appear in the bank statement (for example, bank
charges, interest, dishonoured cheques and others) but have not yet been
recorded by the firm.
(b) Items recorded in the firm's cash account (for the same period) may NOT be
recorded by the bank on the bank statement, for example,
unpresented/outstanding cheques drawn by the firm, late deposits and deposits
in transit.
(c) Errors made by the firm or bank in their respective accounts.
Figure 5.4 shows an example of bank statement.

Figure 5.4: Bank statement
5.3.3 Preparation of Bank Reconciliation Statement

The following are the steps that you should follow in order to prepare bank
reconciliation:

(a) If items appear in cash account and bank statement, tick () the items off.
(b) Check also for errors in figures recorded in the cash accounts. We always
assume the figures shown in the bank statements are correct unless stated
otherwise.
(c) Items that are not ticked in the debit side of cash account are deposit in
transit or deposit not yet credited (cash receipts that a firm has deposited
into the bank but not yet credited into the firms current account by the
bank).
(d) Items that are not ticked in the credit column of the bank statement, are
items that the firm has not recorded as receipt in the firms cash account.
(Bank has recorded receipts of cash in the firms current account).
(e) If items appear in the cash account and bank statement, tick () the items
off.
(f) Check also for errors in figures recorded in the cash accounts. We always
assume the figures shown in the bank statements are correct unless stated
otherwise.
(g) Items that are not ticked in the credit side cash account are unpresented
cheques (Cheques that have been issued to creditors, but the amount has
not been deducted by the bank from the firms current account).
(h) Items that are not ticked in the debit column of the bank statements are
items that the firm has not recorded as payments in the firms cash account.
(Bank has deducted payments of cash in the firms current account)
(i) Examples of items that appear in the bank statement but not yet recorded in
the firms cash account and their treatment are as follows (see Table 5.1):

Table 5.1: Items in Bank Statement
Debit Firms Cash Account Credit Firms Cash Account

Dividend received Bank charges or fees
Direct credit Stamp duty and taxes
Interest on deposit Dishonoured cheques
Direct debit
(j) Dishonoured cheques are cheques that are received by a firm, and are
recorded as receipts in the cash book. However, due to several factors such
as insufficient funds in the drawers account, wrong signatures, errors or
expired dates; the cheques will not be honoured by the paying bank. In this
case, firm must correct the entry first made to record the receipt. Therefore,
credit the bank account and debit the related account, for example, debit
accounts receivable.
(k) Amend errors made in the firms cash account.
(l) Normally, journal entries are required to be made before the cash book is
updated. In the illustration, you will be shown the journal entries.
After taking into account all of the adjustment from the above, you need to
determine the new cash account balance (Important! This will be the starting
figure for your bank reconciliation statement).
Cash accounts can have credit balances, when it means the firm has drawn more
funds than it has. If firms have arranged for overdraft facilities with the bank, the
bank will allow an overdraft. Firm will need to pay interest on the overdraft
facilities, as well as paying off the overdraft. Overdraft will be reported as
current liabilities in the balance sheet.

Cash Account
Opening bank Cash payments
XX XX
balance
Cash receipts Bank fees and
XX XX
charges
Dividend received XX Stamp duties XX
Interest on deposit XX Direct debit XX
Direct credit Dishonoured
XX XX
cheque
Correction of errors Correction of
XXX XX
errors
Balance c/d XXX
XXX XXX
Firms Name
Bank Reconciliation as at 31 December 2013
RM RM
Balance as per cash account XXX
Add Unpresented cheques (list all items)
Cheque no 10## XX
Cheque no 11## XX
Bank errors in crediting current account XX XXX
XXX
Less Deposit in transit
Deposit not yet credited XX
Bank errors in debiting current account XX XXX
Balance as per bank statement XXX

This balance will be the balance used in the bank reconciliation

statement
Bank can make errors through crediting (adding) funds that do not
belong to customers or debiting (deducting) funds.
This figure should be the same as the balance stated in the bank
statement. An overdraft will be shown as DEBIT balance in the bank
statement.
* Note: If the cash account balance is credit, the figure will be shown in brackets (XX)
To help you learn the preparation of bank reconciliation, let us look at this
illustration. You were asked to prepare a bank reconciliation for Syarikat Kejora
for the month ended 30 March 2013. The bank showed a balance of RM9,750
while the bank statement showed a balance of RM9,812.
Example 5.1
Assuming that you have completed step 1 and step 2, whereby you compare
the cash account and bank statements, you must have ticked items that
appeared in both accounts. The cash account and bank statement will look like
the following:
Step 1 and 2: Compare cash account and bank statement
Cash Account
1/3 Balance b/d 5,700 4/3 A/P Eda (1008) 300
2/3 A/R Ali 1,500 10/3 A/P Loo (1009) 150
13/3 A/R Zack 2,600 15/3 Salaries (1010) 400
23/3 Rental revenue 300 27/3 Purchase (1011) 1,200
burn
25/3 Sales 3,300 30/3 Insurance (1012) 1,600

30/3 Balance b/d 9,750
13,400 13,400

Syarikat Kejora
Bank Statement as at 30 March 2013
DEBIT CREDIT BALANCE
1/3 Balance b/d 5,700
3/3 Deposits 1,500 7,200
6/3 Cheque 1008 300 6,900
Standing instruction to pay
10/3 450 6,450
subscription fees
15/3 Cheque 1010 400 6,050
17/3 Deposits (for A/R - Alin) 2,300 8,350
23/3 Deposits 300 8,650
25/3 Deposits 3,300 11,950
27/3 Cheque 1011 2,100 9,850
30/3 Bank charges 40 9,810
30/3 Stamp duties 8 9,802
30/3 Interest 10 9,812
Deposit in transit.
Unpresented cheques.
Error has been made in recording purchase as RM1,200, the correct

amount should be RM2,100.
Item not yet recorded in the cash book.

Step 3: Update cash account

Cash Account
30/3 Balance b/d 9,750 30/3 Bank charges 40
A/R-Wan 2,300 Stamp duties 8
Interest 10 Purchase 900
Subscription fees 450
Balance c/d 10,662
12,060 12,060
Remember the accounting cycle? Journal first, then only post to accounts. The
following are journal entries required to record the unrecorded transactions and
correct errors:
Debit Credit
Dr Cash 2,300
Cr Accounts Receivable Wan 2,300
To record receipt of payment into bank account from AR-Wan
Dr Cash 10
Cr Interest Revenue 10
To record interest on cash deposit
Dr Bank Charges 40
Cr Cash 40
To record bank charges
Dr Stamp duties 8
Cr Cash 8
To record stamp duties
Dr Purchase 900
Cr Cash 900
To correct amount of purchases recorded
Dr Subscription fees 450

Cr Cash 450
To record payment of subscription fees through standing instruction

Step 4: Prepare the bank reconciliation statement
Syarikat Kejora
Bank Reconciliation as at 30 March 2013
RM RM
Balance as per cash account 10,662
Add Unpresented cheques
Cheque 1009 150
Cheque 1012 1,600 1,750
12,412
A/R Zack 2,600
Balance as per bank statement 9,812
This figure must equal the balance as per the bank statement of Syarikat
Kejora.
5.4 PETTY CASH

Although we emphasise the use of cheques for all cash transactions of business to
enhance control of cash, it is unavoidable to use cash in certain transactions. It is
inconvenient to use cheques to make payments for small amounts, for example,
such as stamps, drinks, provisions or taxi fares.
The cash kept at the business premise is known as petty cash. This cash is used to
pay for items of smaller amounts. Although the amount involved is small,
frequent transactions can lead to a bigger amount. This petty cash must be
controlled in order to avoid misappropriation and fraud.
The imprest petty cash system is used to operate the petty cash book. We will
look at how the system is used to control petty cash.
5.4.1 Creating the Petty Cash Fund

A specific individual is appointed to handle the petty cash. He will be
responsible for all payments made using the petty cash. To create the petty cash,
an estimate of cash required for a specific period must be made. This amount is
then withdrawn from the bank account and given to the person in charge of the
petty cash, known as the petty cashier (custodian).

The petty cashier will keep the petty cash in a safe place (safe deposit or vault).
Another control practice is to set the maximum amount for payment. For
example, any payment exceeding RM50 must not be made using petty cash. Or
conditions or terms of usage; only payment for postage, stationeries or fares shall
be allowed from the petty cash.
Assume that on 1 January 2013, Segar Berhad agreed to create a petty cash fund
of RM500. It was also agreed that the funds will be reimbursed at the end of
every month or whenever the amount used reaches RM400, whichever comes
first.
The journal entry to create the petty cash fund for Segar Berhad on 1 January
2013 is as follows:
Dr Petty cash 500

Cr Cash 500
To record the establishment of petty cash fund of RM500.
5.4.2 Using the Petty Cash Fund

Employees or other parties that demand payment from the business must
provide bills or receipts as evidence of payment to the petty cashier. These bills
and receipts must be kept together with the petty cash. The petty cashier must
ensure that all conditions set earlier (for example, amount not exceeding RM50)
must be met before reimbursement is made. The petty cashier will issue a receipt
to the employees or other parties that demand payments.
At all times, the petty cash amount and the total of claimed payments (based on
the bills or receipts collected) must be equal to the amount originally set as petty
cash fund.
Do take note that no records are made when payments are made by the petty
cashier. These transactions (expenses) will be recorded only when the petty cash
fund is reimbursed again. For control purposes, the person responsible to record
the transaction must not be the same as the petty cashier; this is to avoid
misappropriation or fraud by the petty cashier. The petty cashier will submit the
receipts or bills of payment to the person responsible to make the journal entries
and receive the amount to reimburse its petty cash.
No journal entries are made for petty cash payments until the fund is
replenished. This system avoids the need to journalise many small payments.

5.4.3 Reimbursement of the Petty Cash Fund

As mentioned earlier, no records are made at the times of reimbursing the
amount claimed by employees or other parties. Petty cash will decrease as more
and more reimbursement is made.
For illustration purposes, let us assume that for the month of January 2013,
payments using the petty cash fund comprise the following: stationeries RM46;
postage RM15; newspaper RM33, petrol RM45; taxi fare RM5 and magazines
RM12.
The journal entries to record the expenses and the reimbursement of petty cash
fund are the following:
Dr Stationeries 46
Dr Transportation expense* 50
Dr Miscellaneous expense** 60
Cr Cash 156
To record expenses using the petty cash fund and the reimbursement of petty
cash fund
* Expenses of the same nature are added together.

** Depends on company size, bigger companies will have separate individual expenses
account for postage and subscriptions of newspapers and magazines.
The earlier entry will bring the petty cash amount to the original amount of
RM500.
Did you notice that there is no entry made to petty cash account? Entry to petty
cash account is only made only for the following situations:
(a) The creation of petty cash fund; and
(b) The petty cash amount is to be reduced or increased.
Assume Segar Berhad decides to reduce its petty cash fund to RM400 from
RM500. The following entry will be made:
Dr Cash 100
Cr Petty cash 100
To record decrease amount of petty cash fund

If Segar Berhad decides to increase its petty cash fund from RM500 to
RM700, the following entry will be made:
Dr Petty cash 200

Cr Cash 200
To record increase amount of petty cash fund
(c) The petty cash account is to be eliminated

If for some reason, Segar Berhad decides to close its petty cash fund of
RM700, the following entry will be made:
Dr Cash 700
Cr Petty cash 700
To close off petty cash fund.
In some instances, the balance of petty cash fund added to the total expenses do
not tally (amount different than the original amount of petty cash fund). This is
probably due to errors where we have overpaid or underpaid claims for
reimbursement, or even fraud or theft. How would we record this short of petty
cash or over of petty cash?
To illustrate, the following entries are made to reimburse a RM100 petty cash
fund when its payments receipts show RM75 and only RM15 cash remains. This
indicates a shortage of RM10.
Dr Miscellaneous expense 75
Dr Cash short and over 10
Cr Cash 85
To record shortage of petty cash of RM10.
In the event that the balance of petty cash fund is more than what it should be,
the amount then will be credited to cash short and over account.
To illustrate, the following entries are made to reimburse a RM200 petty cash
fund when its payments receipts shows RM185 and only RM45 cash remains.
This indicates cash over of RM30.

Dr Miscellaneous expense 185

Cr Cash short and over 30
Cr Cash 155
To record revenue (over) of petty cash of RM30.
Cash short and over will be reported as revenue or expense in the income
statement depending on the balance of the account at the end of the accounting
period. A debit balance is expense (shortage), while credit balance is revenue
(over).
5.5 RECEIVABLES
Receivables are one item of current assets. Receivables consist of two types,
which are:
(a) Trade receivables receivables from the sale of goods is common; and
(b) Non-trade receivables receivables other than the above example is from
the sale of assets of the debtor.
Some of the purposes in the extension of credit are:

(a) To increase sales to increase profit;
(b) Compete with other competitors; and
(c) Provide convenience to buyers who buy in bulk. They do not have to pay a
lump sum amount.
However, credit (debt) must be controlled so that there is no fraud and

opportunism.
5.5.1 Credit Control

Credit control measures commonly performed are:
(a) Approval of credit where the background should be investigated on the
previous performance of the debtor, measuring the ability to repay other
important documents to avoid high bad loans.
(b) Credit policy to be utilised will determine the minimum requirements: that
allow credit purchase to be made, that the credit should be given, the value

of the discount that should be granted, interest that will be charged for late
payment of debts and the sending of a statement to the debtor.
(c) Keep complete records of the debtor through subsidiary ledgers and
accounts receivable and accounts regulation is to be constantly updated.
5.5.2 Reliability Values of Accounts Receivables

Collection
This is commonly made through aging reports, and uncollectible debt can be
estimated.
Example: Aging Report
Debtors/Time Credit Total 30 >90

Duration 60 days 90 days
Payment limit debt days days
Ali 6000 4000 2500 1500
Baba 5000 4000 3000 1000
Caca 9000 8000 2000 4000 2000
Duda 3000 2500 1500 1000
Conclusion: From the report on aging, most likely Duda could not pay the debt.
5.5.3 Loan Loss Provisioning

Bad loans are uncollectible debt while provision for doubtful debts is estimated
as uncollectible debt.
This is because of the following reasons:

(a) Debtors died;
(b) Bankruptcy of debtors;
(c) Debtors giving false information; and
(d) The problem with the overall economy.

An example of the recording of bad debt is:
Dr. Bad debt Expense XX

Cr. Provision for doubtful debts XX
(record of bad debts)
But if the debtor has made a purchase and was recognised earlier than when he
declared bankruptcy (such as purchases made in 2013 and declared bankruptcy
in the next year, 2014), the recognised revenue would have declined and would
not comply with the matching concept (which has been studied previously). To
address this problem, the provision for doubtful debts is made to estimate the
possibility that it cannot be collected. It can be done on the revenue recognised
(from the mentioned example, the provision for doubtful debts can be made in
2013).
Steps to be taken to estimate doubtful debts can be done:

(a) Based on past experience;
(b) Based on the aging report; and
(c) Based on the percentage of net credit sales.
The following is an example of recording provision for doubtful debts:
Sample questions 1: If the debtor balance is RM10,000 and the provision for
doubtful debts at 2 per cent of the remaining debtors.
Dr. Bad debt expense 200

Cr. Provision for doubtful debts 200
(provision for doubtful debts of 2 per cent of outstanding receivables)
5.5.4 Notes to Increase and Decrease in the Provision

for Doubtful Debts
When an allowance account already exists, it just needs to be increased or
decreased according to a predetermined budget. Notes to add the provision for
doubtful debts is the same as before:
Dr. Bad debt expense

Cr. Provision for doubtful debts

While if we want to reduce the allowance for doubtful debts, the notes are as
follows:
Dr. Provision for doubtful debts XX

Cr. Over provision for doubtful debts * XX
*is a kind of new account opened and will be reported as other revenue in the
income statement
Sample question 2: If the balance of receivables increased from Sample question 1

to RM12,000 and the provision for doubtful debts is at 2 per cent of the remaining
debtors, then, the allowance will increase from RM200 to RM240. We just need to
add another RM40 in the allowance for doubtful debts. Notation is as follows:
Dr. Of bad debt expense 40

Cr. Provision for doubtful debts/obsolete 40
Sample question 3: If the remaining debtors from Sample question 1 were

reduced to RM9,000 and provision for doubtful debts is at 2 per cent of the
remaining debtors, the allowance will be reduced from RM200 to RM180. We just
need to cut RM20 from the allowance for doubtful debts. Notation is as follows:
Dr. Provision for doubtful debts / obsolete 20

Cr. Doubtful debts / obsolete Over provision 20
5.5.5 Bad Debt Write Off

When an account receivable has been determined to be uncollectible, it is no
longer classified as current assets and should be eliminated.
Recording of bad debts are:
Dr. Provision for bad/doubtful XX

Cr. receivables XX
Sometimes customers will come back after a long time to pay back the debt.
Should this happen, we must first create the account debtors with a record.
Dr. receivables XX
Cr. Bad debts recovered * XX
* created a new account and will be reported as other revenue in the current
period income statement.
Once the cash payment is made by the debtor then we need to record it with the
following entry:
Dr. cash XX
Cr. Receivables XX
5.5.6 Reporting of Accounts Receivable in the

Financial Statements
Accounts receivable is a current asset a diluted net of cash and cash in banks. In
the balance sheet current assets are shown as follows:
Excerpt of Balance Sheet

In 31/12/200X
Current assets XX
Cash XX
Cash in bank XX
Receivables XX
- Provision for doubtful debts (XX)
Total current assets XX
5.6 INVENTORIES
According to MASB 2, inventories are:
(a) Assets held for resale in the ordinary business operations;
(b) Assets that are in the process of reselling; and
(c) Assets in the form of raw materials or supplied for use in the production
process or in the conduct of service.

5.6.1 Management and Stock Control

Inventory or stock is important in the calculation of profit and loss. Hand
inventory items are usually the biggest items in current assets. These assets must
be controlled to prevent theft or damage to minimise losses. Stock turnover must
also be fast because the faster it is, the higher the profit to be gained. But the
stock must be controlled by means of the following actions commonly performed
by most businesses:
(a) Physical stock is recorded regardless of the system or method of calculation
that used stock;
(b) Stock is kept in a safe place away from any theft or damage (depending on
the type of stock);
(c) Give responsibility for keeping inventory to employees who are unrelated
to inventory recording (storing and recording are different people); and
(d) Keep continuous records for the expensive goods such as jewellery and
other luxury goods.
5.6.2 Recording System (Periodic and Continuous)

The recording system is divided into two types, which are:
(a) Periodic Inventory System

(i) Inventory balances in the balance sheet are available from the
calculation of physical residual;
(ii) Stock account is not updated every time a transaction involving
inventory is made;
(iii) Cost of goods sold is calculated as the initial stock + Net Purchases -
Closing stock; and
(iv) Inventories are measured at each period (such as once a month or
once a year depending on the type of stock).
(b) Continuous Inventory System

(i) Account stock is updated every time a transaction involving
inventory is made.
(ii) Each time the sale of goods is made, the cost of goods sold will be
calculated.

(iii) A physical calculation is also made as a control measure to have a

separate record for comparison.
(iv) Loss of stock can be easily detected and recorded as:
Dr. Loss on stock loss XX

Cr. stock XX
(recording stock loss)
Table 5.2 explains the comparison of general journal entries for a periodic
inventory system and continuous inventory system.
Table 5.2: Comparison of General Journal Entries for Periodic Inventory System and
Continuous Inventory System
Periodic Inventory System Continuous Inventory System
1 Dr. Purchases 6000 1. Dr. Stock 6000

Cr. Creditors 6000 Cr. Creditors 6000
(recording credit (recording credit
purchases) purchases)
2. Dr. Goods transported 120 2. Dr. Stock 120
Cr. Cash 120 Cr. Cash 120
(recording goods in (recording goods in
transport) transport)
3. Dr. Debtors 1600 3. Dr. Debtors 1600
Cr. Sales 1600 Cr. Sales 1600
(recording credit sales)
Dr. COGS
Cr. Stock 800
(recording credit sales) 800
4. Dr. Debtors 220 4. Dr. Debtors 220
Cr. Purchase return 220 Cr. Stock 220
(recording purchase (recording purchase
return) return)

5. Dr. Sales return 300 5. Dr. Sales return 300

Cr. Debtors 300 Cr. Debtors 300
(recording sales return)
Dr. Stock 150
Cr. COGS 150
(recording sales return)
5.6.3 Calculation Method for Stocks Value

Generally, there are two calculation methods for stocks value, which are:
(a) The actual method

The actual method is also known as identification method. It is used for
items that are easily identifiable with the total cost easily identifiable or
easily calculated. Examples are the items that are requested or ordered.
(b) Method assumptions

The method assumptions are FIFO method (first in first out), LIFO (Last In
First Out) and Weighted Average. In addition to identifying the method
you want to use, the system used must be determined (either periodic or
continuous systems).
A sample solution is as follows:
Example 1 (periodic inventory system)
The following data is related to Mariah Sdn Bhd for the month of April 2013.
Stocks on 1 April 2013 were 100 units at a cost of RM4 each. April purchases are
as follows:
2 April 200 units 4.15 830

7 April 200 units 4.20 840
15 April 300 units 4.30 1,290
22 April 100 units 4.40 440
28 April 200 units 4.65 930
Total 1000 units 4,330

Throughout the month of April the company sold 800 units with a unit price of
RM8
Required: Calculate stocks end, cost of goods sold and gross profit using the
assumption 1. FIFO 2. LIFO 3. Weighted Average
Solution:
FIFO
Stocks end (in units) = 1100 units 800 units = 300 units
Calculated as the closing costs:

100 units @4.40 + 200 units @ 4.65 = RM1370
Cost of Goods Sold is calculated as;
COGS = Opening stock + Purchases Closing stock

400 + 4330 1370 = 3360
LIFO
Stocks end (in units) = 1100 units 800 units = 300 units
Closing cost is calculated as:
100 units @4.00 + 200 units @ 4.15 = RM400 + RM830 = RM1230
Cost of Goods Sold is calculated as:

400 + 4330 1230 = 3500
Weighted Average
(Opening stock + Purchases)/ Quantity = (400 + 4330)/1100 = RM4.30 per unit
Closing stock = 300 units @ RM4.30 = RM1,290
Cost of goods sold is calculated as:

400 + 4330 1290 = 3440
No gross profits were calculated

Example 2 (Continuous Inventory system)
Here we use Example 1 but the sales made according to dates are as follows:
April 3 250 units

April 10 200 units
April 16 250 units
April 23 100 units
Required: Calculate stocks end, cost of goods sold and gross profit using the
assumption 1. FIFO 2. LIFO 3. Weighted Average.
Solution for FIFO:
Date In (Purchases) Out (Sales) Balance

Quantity Costs Quantity Costs Quantity Costs
April 1 100 4
April 2 200 4.15 100 4
200 4.15
April 3 250 ;
100 4
150 4.15 50 4.15
April 7 200 4.20 50 4.15
200 4.20
April 10 200;
50 4.15
150 4.20 50 4.20
April 15 300 4.30 50 4.20
300 4.30
April 16 250;
50 4.20
200 4.30 100 4.30
April 22 100 4.40 100 4.30
100 4.40
April 23 100 4.30 100 4.40
April 28 200 4.65 100 4.40
200 4.65

Cost of goods sold = 3360 Closing stock = 1370
Solution for LIFO:
Date In (purchases) Out (sales) Balance

April 1 100 4
April 2 200 4.15 100 4
200 4.15
April 3 250 ;
200 4.15
50 4.00 50 4.00
April 7 200 4.20 50 4.00
200 4.20
April 10 200;
200 4.20 50 4.00
April 15 300 4.30 50 4.00
300 4.30
April 16 250;
250 4.30 50 4.00
50 4.30
April 22 100 4.40 50 4.00
50 4.30
100 4.40
April 23 100 4.40 50 4.00
50 4.30
April 28 200 4.65 50 4.00
50 4.30
200 4.65
Cost of goods sold = 3385 Closing stock = 1345

Solution for Weighted Average:
Date In (purchases) Out (sales) Balance

April 1 100 4
April 2 200 4.15 300 4.10
April 3 250 4.10 50 4.10
April 7 200 4.20 250 4.18
April 10 200 4.18 50 4.18
April 15 300 4.30 350 4.28
April 16 250 4.28 100 4.28
April 22 100 4.40 200 4.34
April 23 100 4.34 100 4.34
April 28 200 4.65 300 4.55
* Cost of goods sold =3365 Closing stock =1365

** No gross profits calculated
5.6.4 Effect of Different Flow Assumptions Practice

in Inflation and Deflation
In the event of inflation
FIFO generally produces higher profits than LIFO. But when viewed in terms of
a more accurate profit reports, with each level of inventory purchase in the event
of inflation, profit should decline as the cost of goods increases. If the sales price
is fixed, then the gain will be less and less as the cost of goods goes up. If the
LIFO method is used, the profit will increase as ending inventory is the most
expensive inventory compared with that previously purchased. While in the
FIFO method of inventory, purchased first are issued first, the initial inventory
purchase when the price is cheap will be sold first. Thus, fortunately the cost is
becoming less and the latest inventory value is more.
In the event of deflation
In the event of sustained deflation, it is the opposite of the current state of

inflation mentioned.

The concept of the lower of cost and market value:
This method will compare the cost price to the market price of each item in
inventory. The added lowest value will then be the value of the cost of goods
sold reported.
Example:
Inventory
Cost Price Market Price Lowest Value
Types
Shirts 20 23 20
T-shirts 10 8 8
Total 30 31 28
5.6.5 Stock Reported in the Financial Statements

Closing stock items will be shown in both the income statement and balance
sheet. In the income statement it is one of the items to calculate the cost of goods
sold. It is shown as follows:
Excerpts income statement

for the year ended 31/12/200X
Cost of goods sold:
initial stock XX
+ Net purchases XX
-Stocks end (XX)
COGS XX
In the balance sheet it is shown in the current assets after more liquid current
assets thereof or otherwise as follows:
Balance Sheet as at 31/12/200X
Current assets
Cash XX
Cash at bank XX
Receivables XX
-Provision for doubtful debts XX
Stock or inventory (XX)
Total current asset XX

5.6.6 Under First Real Impact and Value Stocks

If the closing is overstated, then the consequences are as follows:
(a) Cost of goods sold will be reduced significantly;
(b) Gross profit/net will be overstated; and
(c) Overstatement of owners' equity.
If the closing is significantly reduced, then the consequences are as follows:

(a) Cost of goods sold will be overstated;
(b) Gross profit/net will be significantly reduced; and
(c) Significantly reduced shareholders' equity.
Assets are defined as resources controlled by an entity as a result of past

events and from which future economic benefits are expected to flow to the
entity.
Current assets include cash or cash equivalent and other assets that can be
converted into cash, and other assets that can be resold or used in
manufacturing goods within a period of one accounting year or less.
Internal controls are used to monitor and control business activities. An

internal control system comprises policy and procedures used to:
Safeguard the assets the business uses in its operation;
Ensure accurate and reliable accounting records;
Promote efficient operation; and
Encourage adherence to company policy.
Cash includes coins, currencies, cheques, bank drafts, postal orders, money
orders, travellers cheques and others.
Bank reconciliation is prepared to check the accuracy of the firms cash

account with the banks record.

Bank reconciliation is prepared by a firm in order to:

Reconcile the balance of firms cash account with the balance stated in
the bank statement for a particular month; and
Ensure the accuracy and the validity of items recorded in the cash
account.
Bank reconciliation First In First Oot (FIFO)

Bank statement Internal control
Cash and equivalents Inventories
Cash on hand Last In First Out (LIFO)
Cash short/over account Receivables
Deposits in transit Stock
1. The following is information regarding Syarikat Kampung as at 31 May

2013.
RM
Cash account balance 1/5/2013 4,650
Total cash receipts in May 2013 7,600
Total cash payments in May 2013 3,670
Bank statement as at 31/5/2013 shows closing balance of RM6,675
A reconciliation exercise found the following:

(i) A cash deposit made on 31 May 2013 of RM2,460 does not appear in
the bank statement.
(ii) Bank has erroneously deducted a cheque (cheque number 20345) of
RM1,200 drawn by another company, Syarikat Lampong.

(iii) Three cheques drawn in May remains unpresented:

Cheque 10345 450
Cheque 10347 590
Cheque 10348 430
(iv) Bank has recorded a receipt of RM3,300; Jaya Holding paid its debts
directly to Syarikat Kampungs current account.
(v) Bank service charge for May is RM20
(vi) Interest revenue for May is RM15
(vii) Syarikat Kampung has a standing instruction to pay insurance though
auto debit. RM2,400 was deducted in May.
(viii) The bank statement shows a dishonoured cheque from A/R - Sukar of
RM700.
(ix) Cheque drawn as payment to A/P-Anita was recorded in the cash
account as RM540; the correct amount should be RM450.

(i) Update the cash account of Syarikat Kampung.
(ii) Provide the journal entries for the adjustment made in the cash
account.
(iii) Prepare a bank reconciliation statement for Syarikat Kampung as at 31
May 2013.
2. In your opinion, why must businesses prepare bank reconciliations?
3. Some items in the bank statement must be journalised. What are examples
of items that need to be journalised? What will happen if a business does
not make the journal entry?
4. Explain why the amount of dishonoured cheques due to insufficient fund

will be deducted from the cash account when preparing a bank
reconciliation.

1. The following is information regarding the petty cash fund of Mushy

Enterprise as at 28 February 2013.
RM
Petty cash fund amount as at 1 February 2013 250.00
Petty cash fund amount as at 28 February 2013 46.70
Bills and receipts details for the months of February 2013 are the following:
RM
Stationeries 73.50
Postage 15.60
Taxi fare 12.60
Minor repairs on office printer 45.00
Bus fare 5.50
Newspaper 30.00
Mushy also planned to increase the petty cash fund to RM300.
You are required to provide the journal entries for the mentioned
transactions.

Topic Accounting for
6 Non-current
Assets
LEARNING OUTCOMES
1. Define non-current assets;
2. Determine the cost of a tangible non-current asset;
3. Differentiate between the concepts of revenue expenditures and
capital expenditures;
4. Describe the concept of depreciation;
5. Prepare the account for the disposal of non-current assets;
6. Explain government grants; and
7 Analyse intangible assets and investments.
INTRODUCTION
Imagine that you have just purchased a brand new red Ferrari for RM500,000. As
a strong believer of Feng Shui, you were told that the colour red is not auspicious
for you. You had only used the car for a month and plan to sell it. Can you sell
the Ferrari for RM500,000? One should not expect to be able to sell the Ferrari at
the original price paid. After all, you have used it and therefore, the value of the
Ferrari has depreciated. A buyer might be willing to pay RM450,000. The
difference of RM50,000 is a loss to you.

TOPIC 6 ACCOUNTING FOR NON-CURRENT ASSETS 153
Businesses own various non-current assets such as buildings, equipment, motor

vehicles and machinery to generate sales. These assets will depreciate, sometimes
businesses sell their non-current assets or replace them with another. How does a
business account for these transactions?
Just to give you an idea of how much money is allocated for depreciation, let us
look at the excerpt of this article.
Maxis Third Quarter Revenue Up 11% To RM1.23 Billion Net Profit Up 2%

To RM234 Million
Profit after tax (PAT) was up 2% to RM234 million from RM229 million in
the preceding quarter. This improvement in net profit was achieved despite
the higher depreciation and amortisation expense of RM241 million for the
current three months compared to the RM200 million charged in the
preceding quarter.
This topic will discuss accounting for non-current assets. You will learn how to
calculate depreciation for non-current assets under different methods. You will
also learn how to account for the disposal (sales) of non-current assets.
This topic will also explain why depreciation must be provided and how to
calculate it employing the most widely used methods, in the year of acquisition
and the year of disposal, and all the years in between.
6.1 DEFINITION OF NON-CURRENT ASSETS

MFRS 101 defined non-current asset as assets other than current assets. Non-
current assets provide benefits for a period longer than twelve months.
Non-current assets are used to generate revenue and not for resale. Non-current
assets include items such as land, building, plant, equipment, machinery, motor
vehicles, fixtures and fitting and long-term investments (see Figure 6.1).

154 TOPIC 6 ACCOUNTING FOR NON-CURRENT ASSETS
Figure 6.1: Types of non-current assets
These non-current assets are normally classified into the following groups:
(a) Tangible non-current assets (property, land, building, plant and
equipment);
(b) Intangible non-current assets (copyrights, goodwill, patterns, franchises
and trademarks); and
(c) Long-term investments (shares in another company).
For intangible assets such as brands and intellectual property, the process of
allocating costs over time is called amortisation.
ACTIVITY 6.1
Take a look at all your assets and categorise them into current and
non-current.
6.2 ACCOUNTING FOR TANGIBLE

NON-CURRENT ASSETS
The financial reporting standard, MFRS 116 Property, Plant and Equipment
prescribes the accounting treatment for property, plant and equipment. MFRS
116 defines property, plant and equipment as tangible assets that:

(a) Are held by an enterprise for use in the production or supply of goods or
services, for rental to others, or for administrative or maintenance
purposes; and
(b) Are expected to be used during more than one reporting period.
MFRS 116 also states that these assets must be recorded at cost. This cost includes
the purchase price and any directly attributable cost in bringing the asset to
working condition. Examples of directly attributable costs are:
(a) The cost of site preparation;

(b) Initial delivery and handling costs;
(c) Installation costs;
(d) Professional fees such as for architects and engineers; and
(e) The estimated cost of dismantling and removing the asset and restoring
the site, to the extent that it is recognised as a provision.
Example 6.1
For example, you purchase an office building. The selling price of the building
is RM100,000. You also incurred additional fees agent fees of RM5,000 and
legal fees and stamp duty of RM10,000. You will record the cost of building as
RM115,000.
Capital Expenditures versus Revenue Expenditures
After purchasing the non-current assets, there are additional costs incurred in
maintaining and repairing assets in order to enable the asset to be used
effectively and efficiently. For example, buildings need to be repainted and
broken windows replaced. Should the cost be added to the cost of the asset or be
written off as expense?
In general, any cost that increases the estimated useful life and the capability of
the non-current assets shall be capitalised (added to the cost of assets). This type
of expenditure is called capital expenditure. For example, you incurred expenses
of RM50,000 for renovating your shop to extend the show room. Renovating the
show room will definitely increase the estimated useful life and capability of

your shop, and hence the cost of renovating the shop will be added to the cost of
the shop. In this example, the following journal entry will be made:
Date Dr Shop Building 50,000

Cr Cash 50,000
(renovating show room for RM50,000 cash.)
Expenditures like repairs and maintenance do not extend the estimated useful
life or capability of the asset. These expenditures only provide benefit for the
current accounting period. This type of expenditure is called revenue
expenditures and will be charged as expense in the period incurred.
For example, you incurred expenses of RM10,000 to replace the window glass
that was broken. You cannot add the cost of this repair to the cost of shop, but
rather treat it as expenses for the period. The following journal entry will be
made.
Date Dr Repairs Expenses 10,000

Cr Cash 10,000
(replacing window glass of shop for RM10,000 cash.)
6.3 INTANGIBLE ASSETS

Intangible fixed assets are assets that essentially have no monetary value and do
not have a physical form. Its value is determined by the law or the rights or
benefits to the owners or businesses.
6.3.1 Types
One example of an intangible asset that is often found or used is goodwill.
Goodwill is the amount of intangible assets that contribute to the success of a
business such as location, reputation or good image, skills as well as
competencies of employees or management or close contacts between the
debtors, customers and suppliers.
There are two types of goodwill in the business, which are:

(a) Goodwill inherited (inherent goodwill); and
(b) Goodwill purchased (purchased goodwill).

Inherited goodwill has to be recorded in the business because there are no

documents that can prove it (the concept of objectivity). Goodwill bought occurs
when a company purchases another business. This value should be shown in the
balance sheet.
6.3.2 Evaluation
Goodwill acquired for the maximum amortisation period is 25 years. Useful lives
commence on the date it is purchased and amortisation is on a straight-line basis.
6.4 PRESENTATION IN THE BALANCE SHEET

Assets are reported in the balance sheet according to their categories, current or
non-current. The following is example how current and non-current assets are
reported in the balance sheet (refer Figure 6.2).
Figure 6.2: Assets presentation in the balance sheet

6.5 DEPRECIATION
We expect the benefits (service potential) of assets will decline as the assets are
used to generate revenue. Non-current asset value (benefits) will depreciate
through:
(a) Physical wear and tear non-current assets can lose their value by physical
deterioration.
(b) Normal usage think of buildings deteriorating from weather effects.
(c) Technical and commercial obsolescence old models will lose their value
when a latest model that is more effective and efficient is available in the
market. Think of computers!
(d) Time factor assets that are leased, patterns and copyrights have a set time
limit. The values of these assets decrease as time goes by.
(e) Depletions natural resources like ores and oil will deplete as production
continues.
MFRS 104 Depreciation accounting defines depreciation as the allocation of

the depreciable amount of an asset over its estimated useful life. In other
words, the cost of assets less its residual value (depreciable amount) will be
depreciated over its estimated useful life.
To measure depreciation of an asset, the following information is required:

(a) Original cost of the assets (C)
(b) The estimated useful life of the asset (n)
(c) The estimated residual value of the asset (R)
at the end of estimated useful life
There are three main methods in calculating depreciation as shown in Figure 6.3.

Figure 6.3: Methods to calculate depreciation
There are many other methods that can be adopted to calculate depreciation; for
example, double declining balance and sum-of-year digit methods. Readings on
this topic can be found in many of the accounting text books.
Earlier, you have learned how to journalise the adjusting entries to recognise
depreciation and report the related items in income statements and balance
sheets. Using the following data, we will learn the various methods of calculating
depreciation (refer to Figure 6.4).
Take note that land does not wear out so it appreciates (not depreciate).

Figure 6.4: Data to calculate depreciation
6.5.1 Straight Line Method

Straight line method assigns equal amount of depreciation over the assets

The depreciation charges for AMT lorry is calculated as the following:
The entry to record one year depreciation on 31/12/2011 will be as follows:
31/12/11 Dr Depreciation expense 10,000

Cr Accumulated depreciation - lorry 10,000
To record one year depreciation expense of lorry.
Depreciation account is an expense account and will be closed to the income

summary. Accumulated depreciation-lorry is a contra account to lorry and
contains the total depreciation charges since the assets were acquired.
The following is the depreciation schedule for AMTs lorry under the straight
line method.
Asset Depreciation Depreciable Depreciation Accumulated Carrying

Date
Cost Rate Amount Expense Depreciation Amount
RM RM RM RM RM
01/01/2011 52,000
31/12/2011 20% 50,000 10,000 10,000 42,000
31/12/2012 20% 50,000 10,000 20,000 32,000
31/12/2013 20% 50,000 10,000 30,000 22,000
31/12/2014 20% 50,000 10,000 40,000 12,000
31/12/2015 20% 50,000 10,000 50,000 2,000
Carrying amount is also known as net realisable value, net book value and this is
the amount reported in the balance sheet.

6.5.2 Reducing Balance Method

The reducing balance method allocates more of the assets depreciable amount in
the earlier life of the asset. The assets original cost is multiplied with a set
depreciation rate. The depreciation rate can be calculated with the following
formula.
n
n is the estimated 1 Residual value (R)
useful life Cost (C)
However, this formula cannot be used if the residual value is zero.
For AMTs lorry, the depreciation rate is calculated as follows:
2, 000
1 5 1 0.52 0.48 48%
52, 000
Depreciation expenses under reducing balance are determined by the following

formula.
At the end of the first and second year, depreciation expenses are calculated as
follows.
Reducing balance = RM52,000 48% = RM24, 960

depreciation 1st year
Original cost Accumulated

depreciation; RM52,000 0
Reducing balance = RM27,400 48% = RM12,979

depreciation 2nd year
Original cost Accumulated

depreciation; RM52,000 RM24,960

The following is the depreciation schedule for AMTs lorry under the reducing
balance method.
Asset Depreciation Carrying Depreciati Accumulated Carrying

Date
Cost Rate Amount on Expense Depreciation Amount
RM RM RM RM RM
1/1/2011 52,000
31/12/2011 48% 52,000 24,960 24,960 27,040
31/12/2012 48% 27,040 12,979 37,939 14,061
31/12/2013 48% 14,061 6,749 44,688 7,312
31/12/2014 48% 7,312 3,510 48,198 3,802
31/12/2015 3,802 1,802 50,000 2,000
Depreciation for 2015 is RM1,802 (RM3,892 RM2,000). You cannot

depreciate the asset more than its depreciable value (CR).
6.5.3 Units-of-production Method

Unit-of-production method calculates the depreciation rate per unit of
production. The following formula is used.
For AMTs lorry the depreciation rate is:
Depreciation expense is then determined through the actual usage per annum.

The depreciation expense based on the actual usage for the first year is as
follows:
The following is the depreciation schedule for AMTs lorry under the unit-of-
production method.
Asset Depreciation Carrying Depreciation Accumulated Carrying

Date
RM RM RM RM RM
01/01/2011 52,000
31/12/2011 50 cent 33,000 16,500 16,500 35,500
31/12/2012 50 cent 27,000 13,500 30,000 22,000
31/12/2013 50 cent 20,000 10,000 40,000 12,000
31/12/2014 50 cent 15,000 7,500 47,500 4,500
31/12/2015 50 cent 5,000 2,500 50,000 2,000
Microsoft Excel has a built-in function to auto calculate depreciation. Open up

an Excel file, go to Function, and select to view the financial category. They
have functions to calculate straight line, double declining balance and sum-of-
year digit depreciation.
Figure 6.5 explains the depreciation patterns through time:
Figure 6.5: Depreciation patterns through time

Source: Horngren & Harrison (2001)

ACTIVITY 6.2
Investors need to exercise judgment when examining numbers on
financial statements. The article titled Appreciating Depreciation in
this website will help you achieve this awareness on depreciation:
http://www.investopedia.com/articles/fundamental/04/090804.asp
6.6 DISPOSAL OF NON-CURRENT ASSETS

Non-current assets are disposed when they are not able to provide services or
benefits to the businesses due to:
(a) Normal wear and tear;
(b) Obsolescence;
(c) Unproductivity; and
(d) Inefficiency.
Non-current assets can be disposed through the retirement or discarding the

non-current asset; selling the non-current asset or exchanging the non-current
asset for another non-current assets.
We will now look at each method of disposal in detail. You need to know the
journal entries to record the disposal of non-current assets.
SELF-CHECK 6.1
Malaysian Airlines has decided to sell their headquarters building to

cut down its losses. How would they account for this sale?
6.6.1 Retiring or Discarding the Non-current Asset

This method is used when the asset is no longer useful to the business and it has
no market value.

Example 6.2
As an example, take a machine with an original cost of RM5,000 and
accumulated depreciation of RM5,000 and no resale value at the end of its five
year estimated useful life. The machine cannot be used and is therefore
The following entry will be made to account for the retirement of the machine:
Dr Accumulated depreciation 5,000

Cr Machinery 5,000
To record the retirement of machinery that has been fully depreciated
The entry in effect has written off the machinery from the business record, as
shown by the following ledger.
Machinery
Description Amount Date Description Amount
Balance b/d 5,000 Accumulated 5,000
Depreciation
Accumulated Depreciation - Machinery

Machinery 5,000 Balance b/d 5,000
This entry writes off both machinery and its contra account from the
business ledger, that is, the balance becomes zero.
There are cases when the asset is discarded (retired) before the end of its
estimated useful life. For example, a motor vehicle that originally costs RM50,000
with an estimated useful life of 10 years. At the end of the sixth year, with an
accumulated depreciation of RM30,000, the vehicle gets involved in a very bad
accident and cannot be used anymore. When this happens, loss on disposal has
occurred. Loss on disposal will be reported as operating expenses (losses) in the
income statement.

Using the given example as an illustration, the following journal entry is made
when the motor vehicle is discarded before it is fully depreciated.

Dr Loss on disposal of vehicle 20,000
Cr Motor vehicle
To record the retirement of vehicle due to accident.
Motor Vehicle
Balance b/d 50,000 Accumulated 30,000
depreciation
Income summary 20,000
50,000 50,000
The amount is transferred to income summary as loss on disposal of motor

vehicle
Accumulated Depreciation Motor Vehicle

Motor vehicle 30,000 Balance b/d 30,000
6.6.2 Selling the Non-current Asset

In the event that a business sells its non-current assets, the consideration received
might be higher or lower than its carrying amount (original cost minus
accumulated depreciation).
If selling price is higher than the assets carrying amount, a gain on disposal will
be recorded, while a loss on disposal will be recorded if the selling price is lower
than the assets carrying amount.

In order to learn how to record the disposal of asset through selling, we will look
at the following example:
Example 6.3
Omni Express has sold one of its machineries on 1 July 2014 for RM10,000
cash. The machine was originally purchased on 1 January 2011 for RM20,000,
with an estimated useful life of five years and no residual value. The
accumulated depreciation as at 1 January 2014 is RM12,000. Omni Express
uses the straight line method to calculate depreciation at the end of the year.
It will be useful to draw a timeline diagram to help you understand the problem
(see Figure 6.6).
Figure 6.6: Timeline diagram
Firstly, it is important to know the exact accumulated depreciation until the date
of disposal. You might be required to calculate the accumulated depreciation
depending on the information given in the problem.
From the given example, the last depreciation was recorded on the 31/12/2013,
and total accumulated depreciation was RM12,000 (RM4,000 3 years).
No depreciation has been recorded for the period of 1/1/14 until 1/7/14
(disposal date). In other words, you have used the machine for six months and
therefore depreciation expense of RM2,000 (RM4,000 6/12) must be recorded.
Hence, the following entry must be made to record the depreciation expenses.
1/7/14 Dr Depreciation Expense 2,000

Cr Accumulated Depreciation 2,000
(recording the six months depreciation expense of machinery.)

This will bring the accumulated depreciation balance of the machinery to

RM14,000 (RM12,000 + RM2,000), and therefore the carrying amount of the
machinery is RM6,000 (RM20,000 RM14,000). The cash received from the sales
is RM10,000; therefore, there is gain on disposal of RM4,000. The following
entries are made to record the disposal.
1/7/14 Dr Cash 10,000

Cr Machinery 20,000
(recording the disposal of machinery)
The effect of the above journal entry to the machinery account is as follows:
Machinery
1/7/14 Balance b/d 20,000 1/7/14 Cash 10,000
1/7/14 Income 1/7/14 Accumulated depreciation
4,000 14,000
summary
24,000 24,000
The next step is to transfer the gain or losses to income summary.
1/7/14 Dr Machinery 4,000

(recording the transfer of gain on disposal of asset to income summary)
Gain on disposal will be recorded in the income statement as other revenues

(gains).

To illustrate loss on disposal, let us assume the above machinery is sold below its
carrying amount value, at RM1,000, while other information remains the same.
RM
Original cost of machinery 20,000
Accumulated depreciation as at 1/7/14 14,000
Carrying amount of the machine 6,000
Selling price of the disposed asset 1,000
Loss on disposal 5,000
The following journal entry is made to record the disposal of machinery:
1/7/14 Dr Cash 1,000

Dr Income summary 5,000
Cr Machinery 20,000
(recording the disposal of machinery.)
The next step is to transfer the losses to the income summary.

Cr Machinery 5,000
(recording the transfer of gain on disposal of asset to the income summary.)
Loss on disposal will be recorded in the income statement as other expenses

(losses).
Machinery
1/7/14 Balance b/d 20,000 1/7/14 Cash 1,000
1/7/14 Accumulated 14,000
depreciation
1/7/14 Income summary 5,000
20,000 20,000

It is common accounting practice to use a disposal account to record gains or

losses on disposal of assets. We will look at this method next.
Under this method, the receipt of cash from the disposal is recorded through the
following entry:
1/7/14 Dr Cash 10,000

Cr Disposal 10,000
(recording the receipt of cash from the disposal of machinery)
Write off the assets and their accumulated depreciation to Disposal Account.
1/7/14 Dr Disposal 20,000

Cr Machinery 20,000
To record the selling of machinery.
1/7/14 Dr Accumulated depreciation 14,000

Cr Disposal 14,000
(recording the selling of machinery.)
Let us look at the following accounts after the previous entries are made:
Machinery
1/7/14 Balance b/d 20,000 1/7/14 Disposal 20,000
20,000 20,000

Accumulated Depreciation - Machinery

1/7/14 Disposal 14,000 1/1/14 Balance b/d 12,000
1/7/14 Depreciation 2,000
expense
14,000 14,000
Disposal - Machinery
1/7/14 Machinery 20,000 1/7/14 Cash 10,000
Income 4,000 1/7/14 Accumulated 14,000
summary depreciation
24,000 24,000
The last step is to transfer the gain or losses to the income summary.
1/7/14 Dr Disposal 4,000

(recording the transfer of gain on disposal to income summary.)
Gain on disposal will be recorded in the income statement as other revenues

(gains).
Steps to record disposal of assets for cash using disposal account
Step 1: Ensure depreciation of the disposed asset is up to date. The following

journal entry is necessary:
Date Dr Depreciation expense XX

Cr Accumulated Depreciation XX
(recording the depreciation expense of non-current asset)

Step 2: Record the cash receipts.
Date Dr Cash XX
Cr Disposal XX
(recording the cash receipt from selling of non-current asset)
Step 3: Record the written off of assets and its contra account
Date Dr Disposal XX
Cr Non-current assets XX
To record the selling of non-current asset
Date Dr Accumulated depreciation

non-current assets XX
Cr Disposal XX
(recording the selling of non-current asset)
Step 4: Transfer the gain or losses to income summary
For gain:
Date Dr Disposal XX
Cr Income summary XX
(recording the transfer gain on disposal to income summary)
or loss:

Cr Disposal XX
(recording the transfer loss on disposal to income summary)
6.6.3 Exchanging the Non-current Asset for Another

Non-current Asset
It is normal for businesses to exchange a non-current asset for another. Normally
the seller will receive a trade in value for the asset exchanged. In other words, the
buyer will only pay the difference between the costs of the new asset less the
trade in value of the old asset.

To illustrate, let us look at the following example:
Example 6.4
Tamka Tech Enterprise owned a delivery van, purchased on 1 January 2010 for
RM60,000. The estimated useful life of the van is 10 years with no residual
value; it used the straight line method to depreciate motor vehicle. In July 2014,
Tamka Tech Enterprise traded in the delivery van for a latest model costing
RM100,000. Tamka Tech Enterprise received RM35,000 trade in for the old
delivery van and paid the difference in price in cash.
Again, let us use time a diagram for the given example (see Figure 6.7).
Figure 6.7: Timeline diagram
The calculation of gain or loss on trade-in is as the following:
RM
Original cost of delivery van 60,000
Accumulated depreciation as at 1/7/14 27,000
Carrying amount of the machine 33,000
Trade in value of delivery van 35,000
Gain on trade in of delivery van 2,000
The exchange will be recorded by the following journal entries:
1/7/14 Dr Motor vehicle (new delivery van) 100,000

Cr Income summary (gain on trade in) 2,000
Cr Motor vehicle (old delivery van) 60,000
Cr Cash 65,000
(recording the acquisition of new delivery van and trade in of old delivery van)

The motor vehicle account after the entry has been made looks like the following:
Motor Vehicle
1/7/14 Balance b/d 60,000 1/7/14 Accumulated 27,000
depreciation
Cash 65,000 1/7/14 Balance c/d 100,000
Income 2,000
summary
127,000 127,000
6.7 NON-CURRENT ASSETS HELD FOR SALE

(FRS 5)
Fixed assets are assets that can be seen physically and stay long in the business. It
is used to operate the business but not for sale as stock.
Capital Expenditure Concept

Capital expenditure is expenditure incurred to acquire assets or increase the
capacity and value of the asset. These expenses are included in the cost of the
asset.
Capital Revenue Concept

Revenue expenditure is expenditure other than capital expenditure. These
include selling expenses and financial expenses and administrative expenses.
This expenditure will be debited to the income statement.
6.7.1 The Concept of Provisions of Depreciation

Depreciation is defined as the process of allocating the depreciable amount of the
assets over their useful lives. It is considered a business expense on fixed assets
purchased for use in business operations
The availability of fixed asset depreciation costs are divided into a number of
accounting periods. No cash is involved. The depreciable amount is the cost
(value at purchase) subtracted by the salvage value (estimated value is set to sell
for end of life of the asset).

6.7.2 Factors Affecting the Useful Lives

The useful life is how long the expected value of an asset can be utilised. The
useful life is influenced by several factors including (refer to Figure 6.8):
Figure 6.8: Factors affecting the useful lives
6.7.3 Methods of Calculating Depreciation

The commonly used depreciation methods are:
(a) Straight-line Method

The formula used is:
Depreciation = (Cost Salvage Value) / Useful life

Example 6.5:
On January 1, 2014, Rose bought a machine for business priced at RM31,500 on
credit from Takar Sdn Bhd. Other payments involved are:
Goods in transport = RM500
Installation expenses = RM200
Import tax = RM300
Travelling Insurance = RM500
Fire insurance = RM150
Other information:
The estimated useful life is four years
The estimated salvage value is RM3,000
Required:
Calculate the depreciation on a straight line basis.
Solution:
Depreciation expense = Costs Salvage value/ Useful life
= 33,000 3,000 = 7,500
4
Recording depreciation:
Cr Provisions for depreciation 7,500
(recording depreciation charge for one year)
For half year:

Cr Provisions for depreciation 3,750
(recording depreciation charge for half-year)

(b) Reducing Balance Method

In this method the rate (per cent to less depreciable value) is determined in
advance.
The formula used:

r = 1 n s/c where;
r= depreciation rate used
n= total useful life
s= salvage value
c= asset cost
Based on Example 6.5, solution by the reducing balance method is as
follows:
Depreciation = Rate Book value
Book Value Year Depreciation Depreciation Book Value Year

Year
Beginning Rate Expense End
1 33,000 45% 14,850 18,150
2 18,150 45% 8,165 9,982
3 9,982 45% 4,492 5,490
4 5,490 Less balance 2,490 3,000
Net book value = Book value Depreciation
(c) Number of Years Method

This method assumes that the asset is used more in the early years from
next year. Depreciation is charged much more in the early years than in the
subsequent ones.
The method of calculation is as follows:
(i) Calculate the number of digits plus years; and
(ii) Increase the number of lifetime.
(iii) To calculate the depreciation for each period, cost less residual values
and useful lives are multiplied by the balance divided by the number
of digits added.

Based on Example 6.5, solution on a straight-digit number plus the year are
as follows:
Plus the sum of digits = 1 +2 +3 +4 = 10
Remaining Useful
Year Lives / Total Digits Depreciable Cost Depreciation Charge
Plus Years
1 4/10 33,000-3,000 12,000
2 3/10 33,000-3,000 9,000
3 2/10 33,000-3,000 6,000
4 1/10 33,000-3,000 3,000
(d) Units of Production Method

Depreciation is calculated based on the annual production capacity.
The method of calculation requires two steps:
(i) Calculation of depreciation rate per unit of production

Rate = {Cost Salvage Value}/Estimated production unit
(ii) The annual count

Depreciation = Rate Actual production
Example 6.6:
A business purchased a machine at a cost of RM50,000. Estimated residual
value is 5,000 and the expected use of the machine is 90,000 hours.
Calculate:
(i) Depreciation rates; and
(ii) If the first year of depreciation for the first year of production is 6,000
hours.
Solution:
Depreciation rate = {50,000-5,000}/90,000= 50 cents/unit
Depreciation = 0.5 6000 = RM3,000

6.7.4 Disposal of Fixed Assets

Generally, there are three ways to dispose the assets:
(a) Sales of assets;
(b) Asset swap with the same type or different types of; and
(c) Dispose of immediately.
The gain or loss on disposal will be recorded as other revenue (revenue from sale
of assets) or loss from the sale of assets in the income statement.
Example 6.7:
Perniagaan Mawar had bought a machine on 1/7/2011 and the cost is RM33,000
where the salvage value is RM3,000 and useful life is four years. Method to use is
straight line method. Show the solution for each disposal assumptions as follows:
(i) Assume the machine is sold at the price of RM19,000 by cash. Sales was
made on 1/7/2013.
(ii) Assume the machine is sold to Hong Enterprise at RM16,000 on credit on
1/7/2013.
(iii) Assume on 1/7/2013, the old machine was replaced with a new machine at
a price of RM40,000. Perniagaan Mawar has paid the supplier RM20,000 to
own the machine.
(iv) Assume on 1/7/2013, the old machine was replaced with a new machine at
a price of RM40,000. Replacing allowances given by supplier is RM15,000.
Perniagaan Mawar settles the balances to the supplier in three months.
(v) Assume on 1/7/2013, the machine is repaired. Repairing expenses
amounted to RM7,000 has increased the useful life of the machine by
another THREE years.
Solution:
Calculation (i):
Sale price = 19,000
Book value = 33,000-15,000 (PSN) = 18,000
Profit = RM1,000

Dr (RM) Cr(RM)
Recording:
Dr. Depreciation 15,000
Cash 19,000
Cr. Machine 33,000
Gain on disposal 1,000
Calculation (ii):
Sale price = 16,000
Book value = 33,000 15,000 (PSN) = 18,000
Loss = RM2,000
Recording:
Dr. Depreciation 15,000
Hong Enterprise 16,000
Loss 2,000
Cr. Machine 33,000
Calculation (iii):
Book value = 33,000 15,000 (PSN) = 18,000

Replacement allowance = 40,000-20,000=20,000
Gain = RM2,000
Recording:
Dr Depreciation 15,000
New machine 40,000
Cr Cash 20,000
Machine 33,000
Revenue 2,000
Calculation (iv):
Book value = 33,000 15,000 (PSN) = 18,000
Replacement allowance = 15,000
Loss = RM3,000
Recording:
Dr Depreciation 15,000
New machine 40,000
Loss 3,000
Cr Creditor 25,000
Machine 33,000

(d) The resolution of this question does not involve the disposal but only
requires adjustment of depreciation. If the salvage value is not changed
then the depreciation for the next year is:
(Value of the new machine Depreciation for the previous two years The
salvage value)/(The age of the machine + extension of useful life)
= (40,000 15,000 3,000) / (2 + 3) = 4,400 per year
Adjusting entries for depreciation on 31.12.2000 (meaning, the amount of

amortisation is only for half of the year)
Dr (RM) Cr (RM)
Dr Depreciation expense 2,200
Cr Provisions for depreciation
machinery 2,200
ACTIVITY 6.3
State two characteristics that you know can differentiate fixed assets from
current assets.
6.8 GOVERNMENT GRANTS (FRS 120)

FRS 120 defines government grants as the assistance in the form of transfers of
resources to an enterprise in return for past or future compliance with certain
conditions relating to the operating activities of the entity.
6.8.1 Categories of Grants

Categories of grants are:
(a) Grants related to assets (grants are given on the condition that the
enterprise purchases, constructs or otherwise acquires long-term assets);
and
(b) Grants related to income (any grant not related to assets).

Complying with the prudence concept, government grants should not be

recognised until there is reasonable assurance that the enterprise will:
(i) Comply with any conditions attached to the grant; and
(ii) Actually receive the grants.
Two approaches to accounting for government grants are shown in Figure 6.9:
Figure 6.9: Two approaches to accounting for government grants
6.8.2 Disclosure
The following matters regarding government grants should be disclosed:
(a) The accounting policy adopted for government grants, including the
methods of presentation adopted in financial statements;
(b) The nature and extent of government grants recognised in the financial
statements and other forms of government assistance received; and
(c) Unfulfilled conditions and other contingencies attached to government
assistance that has been recognised.
6.9 INVESTMENTS
Investments refer to assets that can increase wealth (through the distribution of
royalties, dividends and rental income). In conclusion, investments provide
economic benefits to businesses in the form of interest received, dividends,
royalties or capital appreciation.

Examples of investments are:

(a) Investing in a company or other business;
(b) Investing in the stock exchange; and
(c) Purchase of fixed assets with the purpose of price speculation.
Investments consist of two types, which are explained in Figure 6.10:
Figure 6.10: Types of investments
How to Record in the Financial Statements?
If it is the current investment, this investment will be shown in the balance sheet
under current assets as follows:
Current Assets
Cash XX
Cash at bank XX
Investment XX
Receivables XX
-Provision for doubtful debts (XX)
Stock/Inventory XX
Total current assets XX

However, if it is a long-term investment, these investments will be reflected in

the balance sheet as follows:
Non-current Assets
Land XX
Furniture XX
Vehicle XX
Equipment XX
Investment XX
Long-term investment XX
Total non-current asset XX
Non-current assets are used to generate revenue and are not for resale.
Capital expenditures that increase the estimated useful life and the capability
of the non-current asset shall be capitalised.
Revenue expenditure does not extend the estimated useful life or capability
of the assets, they only provide benefits for the current accounting period,
and will be treated as expense for the current period.
Depreciation accounting defines depreciation as the allocation of the

depreciable amount of an asset over its estimated useful life.
The three main methods to calculate depreciation are:

Straight line;
Reducing balance; and
Unit-of-production.
Non-current assets can be disposed through discarding at scrap value,

selling, and exchanging the old asset for another asset. Any gain and loss on
disposal will be reported in the income statement.

Capital expenditure (Capex) Depreciation allocation

Capital improvement Revenue expenditure
Depreciation
1. Mega Enterprise purchased a delivery van on 1 July 2013.
RM
Purchase price 65,700
Sales tax 6,500
Road tax 2,000
Insurance 1,200
You are required to calculate the amount that should be recorded as the
cost of the delivery van.
2. During the year ended 30 June 2013, Mega Enterprise incurred the
following expenditures with regards to the delivery van purchased in
Question 1.
RM
Repairs (replaced two punctured tyres) 1,500
Installed roof top carrier 2,000
Replaced front windshield 1,000
Petrol 2,200
Required:
Identify the mentioned expenditures as capital or revenue expenditures.

1. The following information is provided from Azie Printing.

On 1 Jan 2009, Azie Printing purchased a printing machine to increase its
production output.
Cost of Machine RM66,000
Estimated residual value at the end of estimated useful RM6,000
life
Estimated useful life
Years 10 years
Total Unit of production (printing pages) 100,000,000 pages
Actual usage
For the year ended of December 2009 15,400,000 pages
You are required to calculate and show the depreciation table for the first
five years of operation of the machine using the following methods:
(a) Straight line method;
(b) Reducing balance method; and
(c) Unit-of-production method.

2. As at 31 December 2013, Stargazer Limited owns a machine that originally

cost RM77,000. The accumulated depreciation as at 31 December 2013 is
RM64,000. Provide the journal entries for the disposal of the machine under
the following circumstances:
(a) It is discarded as scrap without any value
(b) It is sold at its carrying amount, RM13,000
(c) It is sold for RM20,000
(d) It is sold for RM10,000
(e) It is exchanged with another machine. The trade-in value of the old
machine is RM23,000 and the cost of the new machine is RM55,000.
(f) It is exchanged with another machine. The trade-in value of the old
machine is RM9,000 and the cost of the new machine is RM65,000.
Horngren, C. T., & Harrison, W. T. (2001). Financial accounting (4th ed.). Upper
Saddle River, NJ: Prentice Hall.

Topic Property,
7 Plant and
Equipment
(MFRS 116)
LEARNING OUTCOMES
1. Define the term assets;
2. Explain the criteria for the recognition of fixed assets;
3. Identify the components of the costs for initial measurement;
4. Demonstrate the techniques for measuring subsequent
expenditure;
5. Apply the techniques for impairment, retirement and disposal of
tangible property, plant and equipment; and
6. Discuss the disclosure requirements for property, plant and
equipment.
INTRODUCTION
Let us look at our own lives. Perhaps, after working for several years, we will
have some money to buy a car. Then, later on, we might buy a house. These are
two examples of non-current assets an individual may own, instead of cash.
In this topic, we will discuss property, plant and equipment, which are referred
to as non-current assets or fixed assets. Non-current assets have a relatively long
economic life and can be classified according to their tangibility. A tangible

190 TOPIC 7 PROPERTY, PLANT AND EQUIPMENT (MFRS 116)
item is something we can touch. Thus, property, plant and equipment are
tangible non-current assets.
Examples of tangible non-current assets are those with physical forms such as
land, warehouse, factory, motor vehicles, machinery, delivery equipment, cash
registers, office furniture, fittings, etc. Accounting for property, plant and
equipment has a significant impact on an enterprises operations because an item
of expenditure can either represent an asset or an expense. The accounting
standards for property, plant and equipment are covered in MFRS 116. MFRS 116
is applied for annual periods from or after 1 January 2006. MASB 15 is applied in
private entities and MFRS 116 is applied in all other entities.
7.1 PROPERTY, PLANT AND EQUIPMENT

MFRS 116 defines property, plant and equipment as follows:
The assets that are held by an enterprise for use in the production of goods
and services, for rental to others, or for administrative or maintenance
purposes; and are expected to be used during more than one reporting
period.
Based on the given definition of property, learners should understand that plant
and equipment are tangible assets used in normal business operations. They are
also reminded that tangible assets come in physical forms and are expected to
provide services over several accounting periods.
ACTIVITY 7.1
1. You have learnt what the term tangible asset means. What about
intangible assets? List two examples of intangible assets.
2. Give an example for each of the following:
(a) Property;
(b) Plant; and
(c) Equipment.

TOPIC 7 PROPERTY, PLANT AND EQUIPMENT (MFRS 116) 191
7.2 RECOGNITION OF FIXED ASSETS

An item of property, plant or equipment should be recognised as an asset when:
(a) It is probable that future economic benefits associated with the asset will
flow to the enterprise; and
(b) The cost of the asset to the enterprise can be measured reliably.
Property, plant and equipment are often a major portion of the total assets of an
enterprise. Therefore, they are important in the presentation of its financial position.
As can be seen in Figure 7.1, let us look at the two distinct criteria needed for
recognition of fixed assets:
Figure 7.1: Criteria for recognition of fixed assets
(a) Future Economic Flow to the Enterprise

The first criterion for recognition is met when future economic benefits to
the enterprise can be determined with a degree of certainty. Therefore, risks
and rewards in relation to the ownership of the assets are passed to the
enterprise from the onset.
(b) The Existence of an External Transaction

The second criterion for recognition of acquired assets is easily met because
of the existence of an external transaction. In the case of a self-constructed
asset, a reliable measurement of the cost of construction is readily available.
In the next subtopics, we will look at the measurement of cash, cash equivalents
and fixed assets.

7.3 INITIAL MEASUREMENT

According to MFRS 116, an item of property, plant or equipment which qualifies
for recognition as an asset should initially be measured at cost.
SELF-CHECK 7.1
Why do we record asset initially at cost?
7.3.1 Acquired Assets for Cash or Cash Equivalent

The initial cost of a fixed asset should comprise:
(a) Import duties;
(b) Purchase price;
(c) Taxes; and
(d) Any directly attributable costs incurred to bring the asset to working
condition for its intended use.
Purchase price should deduct any trade or cash discount, irrespective of whether
or not the discount is taken. Therefore, only cash price equivalent is recorded.
Examples of directly attributable costs are listed in Figure 7.2.

Figure 7.2: Directly attributable costs

Example 7.1
Zazy Sdn. Bhd. bought specialised machinery from Taiwan. The invoice price
was RM350,000. Zazy Sdn. Bhd. is given a discount of 2 per cent by the seller
if the company manages to pay within 45 days. The company has incurred the
following payments for the machinery:
Machinery-related expenses RM
Import duties and taxes 7,000
Delivery charges 3,000
Installation charges 12,000
Inspection costs 4,000
Pre-production costs 8,000
Required
Determine the initial historical cost of the machinery.
Solution
The components of the historical initial cost of the machinery are tabulated in
Table 7.1.
Table 7.1: Components of the Historical Initial Cost of the Machinery
Items RM
Invoice price of machinery 350,000
Less 2 per cent cash discount (irrespective of whether the discount is (7,000)
taken)
343,000
Import duties and taxes 7,000
Delivery charges 3,000
Historical cost of the machinery 365,000

ACTIVITY 7.2
Discuss with your coursemates the following questions:
(a) What do you understand by the term maintenance costs?
(b) Can maintenance charges be part of the cost of an asset? Give
your reasons.
However, we should not include administrative and general overhead expenses

in the cost of a fixed asset. Similarly, start-up and related pre-production costs
should be excluded, unless they are necessary to bring the asset to its working
condition.
7.3.2 Self-constructed Fixed Asset

The cost of a self-constructed fixed asset is determined using the same principles
for an acquired asset.
A self-constructed fixed asset is property, plant or equipment constructed or

built by an enterprise for its own use instead of buying a ready-made asset.
The cost of a self-constructed fixed asset includes all expenses necessary to bring
it to good working condition. The normal costs incurred are:
(a) Direct materials;
(b) Direct labour; and
(c) Overheads.
Material and labour costs are directly related to the asset, while overheads
incurred are based on the amount allocated to the asset.
The cost of a self-constructed fixed asset should not include internal profit, and
costs arising from delays, idle capacity or industrial disputes in the course of its
construction.
In any situation, we have to ensure that the initial cost capitalised for a self-
constructed fixed asset does not exceed its estimated recoverable amount.

Example 7.2
Mega Sdn. Bhd. built a factory. The costs incurred were as follows:
Items RM
Contractors costs 1,000,000
Direct materials purchased 800,000
Labour used in construction 600,000
Architects and engineers fees 400,000
General administrative costs allocated 300,000
Overheads directly attributable 460,000
Estimated amount of unused materials at the construction site worth

RM200,000 will be used in the construction of a warehouse next to the factory.
10 per cent of the direct labour used was attributable to the cost inefficiencies
caused by a labour strike. The contractors costs include RM100,000 spent on
rectification. It is determined by the accountant of the company that the
recoverable amount of the factory could be RM10,000,000.
Required
Determine the historical cost of the factory building.
Solution
Items RM RM
Direct materials 800,000
Less: Unused material (200,000) 600,000
Labour 600,000
Less: Cost inefficiencies (60,000) 540,000
Overheads directly attributable 460,000
Architects and engineers fees 400,000
Contractors cost 1,000,000
Less: Rectification costs (100,000) 900,000
Total cost 2,900,000
Now, let us compare the asset costs (RM2,900,000) with the recoverable
amount (RM10,000,000). Therefore, only RM10,000,000 will be capitalised and
the balance of RM1,000,000 will be expensed off in the income statement.

7.3.3 Exchange Fixed Asset

The company may acquire property, plant and equipment via non-monetary
consideration, by giving one or more assets in exchange for another. For
example, you trade in your old car for a new one.
When we exchange one asset for another, the asset we acquire may or may not be
similar to the one we had.
(a) Similar Asset
A similar asset is used for the same purpose in the same line of business
and has similar fair values.
In this situation, we should measure the asset acquired based on the carrying
amount of the asset given up, so there is no gain or loss recognised.
Example 7.3
Speed Sdn. Bhd. trades in a used Nissan Serena, a multipurpose van, for a new
Proton Waja. The Nissan Serena was bought at RM140,000; the carrying amount
is RM56,000 and the market value is RM64,000 at the time of the trade-in. The
new Proton Waja has a market value of RM60,000.
Required
(a) Determine the cost of the Proton Waja; and
(b) Show the journal entry to record the transaction.
Solution
(a) This is a case of exchanging similar assets. In accordance with the
provision of MASB 15, we measure the new Proton Waja car based on the
carrying amount of the used Nissan Serena multipurpose van, that is
RM56,000.
(b) The journal entry:
Dr (RM) Cr (RM)
Dr Motor vehicle (Proton Waja) 56,000
Dr Accumulated Depreciation 84,000
Cr Motor vehicle
(Nissan Serena) 140,000

(b) Dissimilar Asset

If we acquire an item of property, plant or equipment of a dissimilar item, we
should measure the asset acquired at its fair value. This is equivalent to the
fair value of the asset given up adjusted by the amount of any cash or cash
equivalent transferred.
Example 7.4
In line with its business expansion, Sunshine Transport Sdn. Bhd. trades in a
used lorry for a new BMW. The lorry was bought for RM100,000; the carrying
amount is RM40,000 and the market value of RM54,000 at the time of the
trade-in. The new BMW has a market value of RM150,000.
Required
(a) Determine the cost of the BMW; and
(b) Show the journal entry to record the transaction.
Solution
(a) This is a case of exchanging dissimilar assets. In accordance with the
provision of MASB 15, the new BMW should be measured based on the
fair value of the asset received, that is RM150,000.
(b) The journal entry:
Dr (RM) Cr (RM)
Dr Motor vehicle (BMW) 150,000
Cr Motor vehicle (Lorry) 100,000
Cr Gain on disposal 14,000
Cr Cash 96,000
In the next subtopic, we will discuss subsequent expenditure. Let us take a short
break by examining the following quote:
Some folks go through life, pleased that the glass is half full. Others spend a
lifetime lamenting that it is half-empty. The truth is that there is a glass with
a certain volume of liquid in it. From there, it is up to you!
Dr. James S. Vuocolo (as cited in Klein, 2014)

SELF-CHECK 7.2
Why should capitalised costs not exceed the recoverable amount of
the asset?
7.4 SUBSEQUENT EXPENDITURE

Please be reminded that subsequent expenditure is expenditure incurred on an
asset after the date of acquisition/exchange/construction. In fact, we will incur
subsequent expenditure throughout the lifespan of such assets, as illustrated in
Figure 7.3.
Figure 7.3: Things to consider after purchasing a new car
Questions we need to ask ourselves:

(a) Should we capitalise the expenditure as part of the cost of the asset?
(b) Should we treat it as revenue expenditure and charge against revenue as
and when incurred?

ACTIVITY 7.3
Do the following: Take out a piece of paper.
(a) Jot down expenditures you will incur after purchasing a car.
(b) Identify the more important ones and compare them with the
others. Explain.
The rule of thumb that we should apply here is that:
Subsequent expenditure on property, plant and equipment is recognised as an

asset when the expenditure improves the condition of the asset beyond its
originally-assessed standard of performance.
According to MASB 15 [para 28], examples of improvements which result in

increased future economic benefits include:
(a) Modification of an item of plant to extend its useful life, including an
increase in its capacity;
(b) Upgrading machine parts to achieve a substantial improvement in the
quality of output;
(c) Adoption of new production processes to enable a substantial reduction in
previously-assessed operating costs; and
(d) Upgrading of a component of the asset that has been treated separately for
depreciation purposes such as hotel furniture and fixtures, as well as
fittings. Under this situation, the expenditure incurred in replacing or
renewing the component is accounted for by the acquisition of a separate
asset and the replaced asset is written off.
We should assess the expenditure on repairs or maintenance of property, plant

and equipment since these are made to restore or maintain the asset.
If the subsequent expenditure is recognised as an asset, this will affect the

amount of depreciation. Students are reminded of the following formula to
calculate the depreciation of an asset after the subsequent expenditure:
*Net Carrying Amount + Subsequent Expenditure Residual Value

Remaining Useful Life
(*Net Carrying Amount = Book value Accumulated depreciation)

Example 7.5
Peach Tree Sdn. Bhd., a manufacturer in Klang, bought machinery at a cost of
RM210,000 from Korea in 2008. The residual value was estimated at RM10,000.
It is the companys policy to depreciate the machinery on the straight line

method over 10 years and charge full year depreciation in the year of purchase
and none in the year of disposal.
The following subsequent expenditures were incurred in 2013:

(a) In view of excessive usage, an important component of the machinery
was damaged and the company replaced it with a similar component at
a cost of RM25,000;
(b) The machine requires annual servicing and the cost in 2013 was
RM15,000; and
(c) The company incurred RM50,000 for a major overhaul, which increased
the output capacity by 40 per cent.
Required
(a) How should each of the subsequent expenditures be accounted for?
(b) Calculate the depreciation for the year ended 31 Dec 2013.
Solution
(a) The cost of replacing a similar component and annual service should be
expensed. The cost of major overhaul should be capitalised as an asset.
Net carrying amount + Subsequent expenditure - Residual value

(b) Depreciation =
Remaining useful life
= RM110,000 + RM50,000 RM10,000
10 5
= RM30,000
Net carrying amount = Book value Accumulated depreciation

= RM210,000 (RM200,000/10 5)
= RM110,000

SELF-CHECK 7.3
Why does a company prefer to record assets at market value?
7.5 SUBSEQUENT MEASUREMENT

Normally, property, plant and equipment are recorded at historical costs and
depreciate over their useful life. However, there is one exception to this; no
depreciation is charged for freehold land. As the net book value of the non-
current asset may be different from the fair value, the non-current asset will not
reflect the true value or market value of the business.
For example, a building which is five years old may have a carrying value of
RM800,000, whereas the market value might be RM1,600,000 due to its strategic
location and regular maintenance. As such, should this company disclose the
building at the market value or continue to record at cost less accumulated
depreciation?
If we follow strictly historical cost accounting, the building should be disclosed at

cost less accumulated depreciation. However, many enterprises would prefer to
disclose at market value less depreciation. For decision-making purposes, we
should use the fair value.
With reference to MASB 15: Property, Plant and Equipment, the benchmark
treatment is that property, plant and equipment should be recorded at cost less
accumulated depreciation. Similar treatment is also applied in MFRS 116. It is
referred to as the Cost Model [para 30].
ACTIVITY 7.4
The price for renting a house in Damansara Utama usually is about
twice that for a house in Rawang.
In your opinion, why is this so?
MASB 15 also provides that revaluation should be made with sufficient

regularity such that the carrying amount does not differ materially from that
which would be determined using fair value at the balance sheet [para 34].

Under MFRS 116, it is regarded as the Revaluation Model.
If the enterprise wants to revalue its property, plant or equipment, then the
following rules are applicable:
(a) The non-current assets are shown at fair value, which for:
(i) Land and building is normally at the market value; and
(ii) Plant and equipment at their market value or depreciated replacement
cost (para 35).
(b) Once revaluation has been done by an appraiser, regular revaluation

should be carried out every three or five years (para 35).
(c) When an item of property, plant and equipment is revalued, the entire class
of property, plant and equipment to which that asset belongs should be
revalued (Para 39).
Upon an initial revaluation, increase in net carrying amount (revaluation

surplus) should be credited directly to equity and a decrease in net carrying
amount should be charged directly as an expense.
However, upon a subsequent revaluation, a revaluation increase should be

recognised as income to the extent that it reserves a revaluation decrease of the
same asset previously recognised as an expense [para 43]. Conversely, a decrease
in revaluation should be charged directly against any related revaluation surplus
to the extent that decreases do not exceed the amount held in the revaluation
surplus in respect of the same asset.
Only upon disposal of the asset, can the revaluation surplus be transferred to the
income statement as realised gain.

Example 7.6
SSL Sdn. Bhd., a developer in Kuala Selangor, bought three blocks of
commercial buildings in Kuala Lumpur and Selangor on 1 January 2010. They
are situated in Kepong, Selayang and Rawang. In compliance with the
accounting standard, it is the companys practice to revalue the buildings
every five years. The following data relate to the three blocks of buildings:
Building Cost Revalued Amount

1.1.2010 1.1.2011 1.1.2016 1.1.2021
RM (000) RM (000) RM (000) RM (000)
Kepong 800 1,000 1,300 960
Selayang 800 600 570 970
Rawang 600 900 700 Sold for 740
Required
Show the journal entries to record the above transactions.
Solution
Building in Kepong
Debit Credit
Date Item
RM(000) RM (000)
1.1.2011 Dr Building A 200
Cr Revaluation surplus 200
1.1.2016 Dr Building A 300

1.1.2021 Dr Revaluation surplus 340

Cr Buildings A 340

Building in Selayang
Debit Credit
Date Item
RM(000) RM (000)
1.1.2011 Dr Income statement 200
Cr Building B 200
1.1.2016 Dr Income statement 30

Cr Building B 30
1.1.2021 Dr Building B 400

Cr Income statement 230
Building in Rawang
Debit Credit
Date Item
RM(000) RM (000)
1.1.2011 Dr Building C 300
1.1.2016 Dr Revaluation surplus 200

Cr Building C 200
1.1.2021 Dr Bank 740

Cr Building C 700
Cr Income statement (gain on disposal) 40
Dr Revaluation surplus 100

Cr Income statement 100

To record the effects of the revaluation, MFRS 116 provides the following two
methods:
(a) Restated proportionately with the change in the gross carrying amount of
the asset so that the carrying amount of the asset after revaluation equals its
revalued amount; and
(b) Eliminated against the gross carrying amount of the asset and the net
amount restated to the revalued amount of the asset.
Example 7.7
On 1 May 2013, Superman Sdn. Bhd. had machinery costing RM250,000 and
accumulated depreciation of RM50,000. The machinery was purchased two
years ago and was depreciated on the straight-line method over 10 years.
On that date, the machinery was revalued upward because current prices had
increased substantially. The basis of the revaluation was based on the
replacement cost and the relevant data were as follows:
Descriptions RM
Replacement cost of a similar or equivalent new machine 400,000
Less depreciation for two years (80,000)
Depreciated replacement cost 320,000
Required:
(a) Calculate the surplus arising on the revaluation and show the journal
entry under each of the two methods of recording revaluation of assets.
(b) Present the machinery account under each of the two methods.
Solution
(a) Revaluation surplus = Net revalued amount Net book value
= RM320,000 RM200,000
= RM120,000

Journal entry:
Method 1
Dr (RM) Cr (RM)
Dr Machinery account 150,000
Cr Accumulated depreciation 30,000
Cr Revaluation reserve 120,000
Method 2
Dr (RM) Cr (RM)
Cr Machinery account 70,000
Cr Revaluation reserve 120,000
(b) Presentation of machinery

Items Method 1 Method 2
Machinery, at valuation 400,000 320,000
Less: Accumulated depreciation (80,000)
Net carrying amount 320,000 320,000
7.6 IMPAIRMENT, RETIREMENT AND

DISPOSAL
In the following subtopics, we will discuss in details the three important
elements; impairment, retirement and disposal.
7.6.1 Impairment
Various factors, such as those internal (obsolescence or physical damage to
assets) or external (economic or legal environment), can cause diminution in the
value of an asset. This drastic change in value is an impairment loss.
Diminution = The process of decreasing or diminishing.

Impairment loss arises when the carrying amount of an asset exceeds its
recoverable amount. Paragraph 64 72 of MFRS 136 deal with issues in
connection with impairment loss.
Let us look at the descriptions of a few important terms, shown in Table 7.2
which will be used later in this course.
Table 7.2: A Few Important Terms and Their Descriptions
Terms Descriptions
Recoverable Amount Recoverable amount is the higher of an assets net selling price
and its value in use.
Value in use The present value of estimated future cash flows expected to
arise from the continuing use of an asset and from its disposal
at the end of its useful life.
Net selling price The amount obtainable from the sale of an asset in an arms
length transaction between knowledgeable, willing parties,
less the costs of disposal.
When there are indications of impairment, we should compare the carrying value
of the asset with its recoverable amount. There are times when the recoverable
amount of the property, plant or equipment is below the net carrying amount.
When this happens, the asset should be assessed on its recoverable amount. We
need to immediately recognise the amount of reduction as an expense, and
charge it in the current years profit and loss account.
When do we need to do the impairment test? Paragraph 64 of MASB 15 states that:
An enterprise should assess at each balance sheet date whether there is

any indication that an asset may be impaired. If any such indication exists,
the enterprise should estimate the recoverable amount of the asset.
The accounting treatment of an impairment loss will depend on whether the

asset value is carried at cost or revalued amount:
(a) Assets Carried at Cost
The impairment loss should be recognised as an expense in the income
statement immediately.
(b) Assets Carried at Revalued Amount

The impairment loss should be treated as a decrease in revaluation surplus
to the extent the impairment loss does not exceed the amount held in the
revaluation reserve of that asset.
Example 7.8
A machine has carrying amount of RM100,000. Its realisable value is RM60,000
and the value in use is RM75,000. Determine any impairment loss.
Solution
The recoverable amount is RM75,000 and the machine is considered impaired.
The impairment loss of RM25,000 (RM100,000 RM75,000) should be
recognised immediately by writing down the carrying amount to RM75,000.
An impairment loss should be recognised in the income statement for assets
carried at cost and treated as a revaluation decrease for assets carried at
revalued amount.
7.6.2 Retirement and Disposal

We should eliminate the property, plant and equipment from the account upon
the disposal or retirement of an asset. For fully depreciated property, plant and
equipment which continue to be in use, we should retain these assets in their
accounts with RM1 to show their benefit to the enterprise.
When we dispose of property, plant and equipment, one of the following

situations shown in Figure 7.4 will arise:
Figure 7.4: Situations which arise after disposing of property, plant and equipment

Gain or loss upon disposal should be recognised in the income statement in the
year of disposal.
When property, plant and equipment retire from active use, the assets held
should be valued lower than the net carrying amount and net realisable value,
and any loss should be recognised immediately in the income statement.
Example 7.9
On 1 January 2013, Streamline Sdn. Bhd. acquired machinery costing
RM300,000. It is the company policy to depreciate the machine on the straight
line method over 10 years. It is also the company policy to charge full year
depreciation in the year of purchase and none in the year of disposal. There
was no residual value at the end of the useful life.
The company sold the machine for RM120,000 in 2013.
In 2013, a machine retired from active use. It has a net book value of
RM10,000. The estimated net realisable value of the equipment is RM2,000.
Required
(a) Calculate the disposal gain or loss for the machinery; and
(b) Show the journal entries to record the transactions.
Solution
(a) Net carrying amount = RM300,000 [(RM300,000/ 10) 5 years]
= RM150,000
Disposal Loss = RM120,000 RM150,000

= RM30,000
(b) The journal entry

Dr (RM) Cr (RM)
Dr Bank 120,000
Dr Accumulated Depreciation 150,000
Dr Income Statement Loss on disposal 30,000
Cr Machinery 300,000
(Disposal of machinery)

Dr (RM) Cr (RM)
Dr Income Statement written down value 8,000
Cr Equipment 8,000
(Retirement of equipment from active use)
7.7 DISCLOSURE REQUIREMENTS

Based on MFRS 116, the financial statements shall disclose, for each class of
property, plant and equipment:
(a) The measurement bases used for determining the gross carrying amount;
(b) The depreciation methods used;
(c) The useful lives or the depreciation rates used;
(d) The gross carrying amount and the accumulated depreciation (aggregated
with accumulated impairment losses) at the beginning and end of the
period; and
(e) A reconciliation of the carrying amount at the beginning and end of the
period showing:
(i) Additions;
(ii) Disposals;
(iii) Acquisitions through business combinations;
(iv) Increases or decreases during the period resulting from revaluations
under paragraphs 34, 43 and 44 and from impairment losses
recognised or reversed directly in equity as required under
paragraphs 64 to 58 (if any);
(v) Impairment losses recognised in income statement during the period
(if any);
(vi) Impairment losses reversed in income statement during the period (if any);
(vii) Depreciation;
(viii) The net exchange differences arising from the translation of the
financial statements of a foreign entity; and

(ix) Other movements.

Comparative information is not required for the reconciliation in (e)
mentioned.
(f) Monetary or non-monetary compensation recognised for impairment or lost

items of property, plant and equipment, which should be disclosed separately.
ACTIVITY 7.5
Find out how property, plant and equipment are presented and
disclosed in annual audited accounts from the website of Bursa Malaysia
at http://www.bursamalaysia.com/market/
The following example is taken from the notes of the accounts of an annual
report of a Malaysian company. It illustrates the accounting policy for property,
plant and equipment and the disclosure practice based on MFRS 116 for
property, plant and equipment.
Example 7.10
CAB CAKARAN CORPORATION BERHAD
Year ended 30 September 2009
Extract from notes to accounts
Significant accounting policies
Property, plant and equipment are stated at cost or valuation less accumulated
depreciation and accumulated impairment. Land and buildings stated at
valuation are revalued at regular intervals of at least once every five years by the
directors based on the valuation reports of independent professional valuers.
This is based on market value using comparison and cost methods of valuation
with additional valuations in the intervening years where market conditions
indicate that the carrying value of revalued assets differ materially from the
market values.
An increase in the carrying amount arising from revaluation of property, plant

and equipment is credited to the revaluation reserve account as revaluation
surplus. Any deficit arising from revaluation is charged against the revaluation
reserve account to the extent of a previous surplus held in the revaluation reserve
account for the same asset. In all other cases, a decrease in carrying amount is
charged to the income statement. An increase in revaluation directly related to a
previous decrease in the carrying amount for that same asset that was recognised
as an expense, is credited to income statements to the extent that it offsets the
previously recorded decrease. Upon disposal of revalued assets or crystallisation

of deferred tax liabilities on revalued assets, the amounts in revaluation reserve

accounts relating to such assets are transferred to retained profit accounts.
The carrying amount of property, plant and equipment is reviewed at each

balance sheet date to determine whether there is any indication of impairment.
An impairment loss is recognised whenever the carrying amount of an item of
property, plant and equipment exceeds its recoverable amount. The impairment
loss is charged to the income statement unless it reverses a previous revaluation,
in which case it is treated as a revaluation decrease.
Freehold land and construction-in-progress are not depreciated. Leasehold land

is amortised over the lease period of 12, 52, 54, 63, 66, 96 and 880 years. All other
property, plant and equipment are depreciated on the straight-line method in
order to write off the cost of each asset to its residual value over its estimated
useful life.
The annual depreciation rates are as follows:

Buildings 5 to 96 years
Plant, machinery and equipment 2%50%
Electrical installation 10% & 12%
Office equipment 10%50%
Furniture, fixtures and fittings 10%50%
Motor vehicles 10%50%
Renovation 2% - 15%
10%
Pasaraya equipment
10%
Warehouse
Learners are advised to refer to the disclosure of property, plant and equipment
from the annual report on the website above.
Source: http://www.bursamalaysia.com/market/listed-companies/company-
announcements/#/?category=all
MASB 15 and MFRS 116 prescribe the accounting treatment for property,
plant and equipment.
An item of property, plant and equipment should be recognised as an asset

when it is probable that future economic benefits associated with the asset

will flow to the enterprise and the cost of the asset to the enterprise can be
measured reliably.
The property, plant or equipment which qualifies for recognition as an asset

should initially be measured at its cost.
Subsequent expenditure can only be capitalised when it is probable that

future economic benefits, in excess of the originally assessed standard of
performance of the existing asset, will flow to the enterprise.
All other subsequent expenditure should be recognised as an expense in the

period in which it incurred.
Carrying amount Property, plant and equipment

Cost Recoverable amount
Depreciation Residual value
Equipment Revaluation
Fair value Useful life
Impairment loss Value in use
Net selling price
1. Florida Sdn. Bhd. acquired machinery from Taiko Bhd, a Japanese

subsidiary in Malaysia. The following expenditures were incurred:
Items RM
Trade discount given 3%
Delivery and handling costs 7,000
Maintenance charges per year 2,000
General administrative costs 3,000

Required
Calculate the initial amount at which this machinery should be valued.
2. Mika Sdn. Bhd. has incurred the following costs for the construction of a factory:
Items RM
Land cost 500,000
Legal fees and stamp duty for purchase of land 14,000
Cost of demolishing old building on the land 50,000
Cost of clearing and levelling the land 50,000
Architect fees 55,000
Piling and foundation works 200,000
Legal fees for agreement with building contractor 3,000
Construction cost 480,000
Plumbing and wiring 200,000
1,552,000
Required
Determine separately the amount to be recorded as the cost of land and of
the factory building.
3. Super Max Sdn. Bhd. started its business on 1 January 2008. The company
bought two machines in 2010, costing RM50,000 each. It is the company
policy to depreciate the machinery at the rate of 10 per cent per annum,
using the straight-line method. It is also the company policy to provide full
year depreciation in the year of purchase and none for the year of disposal.
In 2014, one of the machines bought in 2010 was sold for RM15,000 on
credit to Wong Sdn. Bhd. At the same time, another machine was modified
to increase the quality of its output. The cost of modification was RM20,000.
The useful life of this machine after the modification was estimated to be 13
years.
Required
Prepare the following accounts for 2014:
(a) Machinery account;
(b) Accumulated depreciation account; and
(c) Machinery disposal account.

1. Mikuyo Sdn. Bhd. has a multi-purpose van worth RM270,000. Its policy is
to charge full years depreciation in the year of acquisition and none in the
year of disposal. The residual value at the end of its useful life is RM20,000.
In 2013, the accumulated depreciation for the van before the current year
provision is RM100,000.
During the year, major repairs were made costing RM60,000 due to a severe
accident. The multi-purpose van was also installed with an advanced alarm
system costing RM15,000. The vans remaining useful life is expected to be
three years.
Required
(a) How would you treat the expenses incurred in 2013?
(b) Calculate the depreciation charge for 2013.
2. Triple A Rice Sdn. Bhd. bought a machine on 1 July 2008 at a cost of

RM80,000. The machine had an estimated residual value of RM8,000 and a
useful life of eight years. The company sold it for RM25,000 on 31
December 2013, the last day of its accounting year. Triple A Rice Sdn. Bhd.
incurred dismantling costs and costs of transporting the machine to the
buyers factory, amounting to RM3,000. The company uses the straight-line
method of depreciation.
Required
What was the gain or loss upon disposal of the machine?
3. SR Medical Centre in Kuala Lumpur bought medical equipment costing

RM400,000 on 1 January 2009. The estimated useful life of the equipment
was five years. On 1 January 2013, it was revalued at RM300,000. Following
an inspection, the equipment is expected to last another three years. On 1
January 2013, the equipment was disposed of for RM120,000. The
accumulated depreciation is to be eliminated on revaluation.
Required
Write up the necessary ledger accounts.

Klein, A. (2014). Having the time of your life: Little lessons to live by. Berkeley,
CA: Viva Editions.

Topic Accounting
8 for Liabilities
and Equity
LEARNING OUTCOMES
1. Describe current and long-term liabilities;
2. Explain the provisions and contingencies;
3. Differentiate between the equity components of a single
proprietorship, partnership and company;
4. Record the amount of dividend entitled to shareholders
based on the different types of shares;
5. Record earnings before tax of company and amount; and
6. Prepare a balance sheet of a company and statement of
retained earnings.
INTRODUCTION
You have a great idea for a business that will guarantee a big profit. To start this
business you need RM1,000,000 cash. You managed to raise RM600,000 cash after
selling all your personal assets and belongings. How can you get the remaining
RM400,000 cash needed to start the business? You might be able to find a partner
who is willing to invest RM400,000 cash in the business or you can borrow the
amount needed from your friend or a financial institution. There are several
ways to raise capital (money) needed for a business. This can be done through
borrowing (liability) or through equity financing.

TOPIC 8 ACCOUNTING FOR LIABILITIES AND EQUITY 219
Companies borrow to finance operations and to expand their businesses. But

borrowing can be dangerous. Pasminco Limited was a world-class zinc and
lead producer. It borrowed heavily to take over other businesses. Then, the
price of zinc dropped to historic lows. Pasminco crashed in September 2001
with $800 million in currency hedging losses and 1.8 billion in debt.but
many companies are able to manage their borrowings quite successfully.
PaperlinX Ltd, reported that its financial position is solid. Another gas
company also felt comfortable with its level of debtThese statements show
the importance of the levels of borrowings,
Horngren (2004)
We will start by looking at the definition of current liabilities as defined by

Malaysian accounting standards. The components of selected current liabilities and
long-term liabilities will be explained. Then, we will look at the owners equity and
the different components of equity for single proprietorship, partnership and
company. Emphasis is on the equity component of a company. Comparisons of how
equity will be reported by each form of business will be made too. It is important to
understand the equity component of a company, as in the next topic financial
statements analysis, company financial statements will be used.
8.1 DEFINITION OF LIABILITIES

Funds or money to finance business activities (buying fixed assets, paying
expenses, etc.) comes either from borrowing (liabilities) or from owners
contributions (owners equity). You have learned earlier how to record
borrowings from banks and also the purchase of goods on credit. All these
transactions gave rise to liabilities.
Liabilities represent an obligation of an entity. This obligation needs to be

satisfied by the entity through payment of cash or the surrendering of the
entitys assets or services.
To illustrate further, assume you received cash today for two cakes to be
delivered to your client in two weeks time. Have you earned your revenue? Did
you deliver goods or services? The fact is that you have received cash in
advanced for goods that will be delivered later, hence no revenue is earned.
Upon receiving the cash, you have the obligation to deliver the cakes in two
weeks time, thus you should record the receipts of cash (unearned revenue) as a
liability.

220 TOPIC 8 ACCOUNTING FOR LIABILITIES AND EQUITY
Earlier, you were told that liabilities can be categorised as current or non-current.
Now let us look at how the Malaysian accounting standard defines current
liabilities.
According to the Malaysian financial accounting standard MFRS 101-

Presentation of Financial Statement, a liability shall be classified as current when
it satisfies any of the following criteria:
(a) It is expected to be settled in the entity's normal operating cycle;

(b) It is held primarily for the purpose of being traded;
(c) It is due to be settled within twelve months after the balance sheet date;
or
(d) The entity does not have an unconditional right to defer settlement of
the liability for at least twelve months after the balance sheet date.
All other liabilities shall be classified as non-current.
Source: http://www.masb.org.my/
ACTIVITY 8.1
List all your liabilities and identify the years you need to settle them.
Do you plan to settle any of them sooner? Why?
8.2 CURRENT LIABILITIES

Current liabilities are obligations by an entity that need to be settled using
current assets or by creating another current liability within a period of one
year.
Current liabilities comprise the following, as shown in Figure 8.1.

Figure 8.1: Current liabilities
You have learned how to record transactions related to accounts payable,

borrowings and accrued expenses in the earlier topic.
Now you shall learn about the other forms of current liabilities.
8.2.1 Bank Overdraft

Bank overdraft is a facility given by banks to current account holders that enable
the holder to draw cheques larger than the holders bank balance. An overdraft is
indicated by a credit balance in a firms cash account. The bank will charge the
firm a fixed interest rate for the overdraft amount. The original amount plus the
interest must be paid by the current accounts holder.

8.2.2 Dividend Payable
Dividend payable is a liability unique to companies. It arises as a result of the

difference in the date when dividend is declared and the date dividend is
paid.
Dates of dividends declared and dates of payments might be months apart. For
example, final dividends are declared at the end of the accounting period, while
the payment will be made two or three months later in the next period. This
represents a liability for the company to pay the amount in the next period. You
will learn more about dividends in the subtopic 8.5.
8.2.3 Bank Loans

Bank loans, also referred to as notes payable, represent borrowings made by
businesses. Borrowings can be long term or short term. Short term refers to
borrowing that needs to be paid within a period of one year. Borrowings are
subjected to interest. Interest rate is normally quoted per annum.
Example 8.1
For example, you borrow RM10,000 from Giant Bank and the interest rate is
10 per cent. You are required to pay back the original amount borrowed plus
the interest in six months time. How much will you pay back? RM10,000 the
original amount plus interest of RM500 (RM10,000 x 10 per cent x 6/12), not
RM1,000 as you only borrowed the money for six months.
The journal entry to be recorded at the date of payment is:
Dr (RM) Cr (RM)
Date Dr Bank Loan 10,000

Dr Interest expense 500
Cr Cash 10,500
To record repayment of bank loan plus interest charges.

If you have long-term borrowing, for reporting purposes, you will need to
identify the amount that is due within the next 12 month period and separate this
from the amount that is due after the 12 months. The amount that is due within
12 months will be reported as the current portion of long-term liabilities under
current liabilities and the remaining balance will be reported as non-current
liabilities.
Example 8.2
For example, on 31 December 2013 you borrowed RM1,000,000 from Giant
Bank and the interest rate is 10 per cent. You are required to pay back the
original amount in 10 instalments (at the end of every year) plus the annual
interest. What will be reported in the balance sheet as at 31 December 2013?
You will report RM100,000 as the current portion of long-term liabilities (as
the first instalment is due on 31 December 2014 within 12 months). For your
information no accrued interest will be recorded on 31 December 2013 as it is
the first day of the borrowing.
The remaining RM900,000 will be reported as long-term liabilities in the

balance sheet.
8.2.4 Bill Payable
Bill payable is a note issued by one entity, promising to pay another entity. It
is usually issued when you, as the debtor, are unable to pay for your accounts
payable balance to your supplier (creditor).
You will issue a bill payable, a note promising to pay the amount within a certain
period at a certain interest. In other words, your accounts payable balance will be
zero, but you have created another liability called bills payable. The amount plus
interest will need to be paid within the promised time period.

Example 8.3
For example, you purchased goods on credit from Paris Trading for RM6,000
on 1 June 2013. Credit terms was n30. If after thirty days you are unable to pay
for the amount, you can issue a bill payable to Paris Trading. The note
promises to pay the amount in three months time, and at a 10 per cent
interest.
You will record the issue of bill payable as the following:
Dr (RM) Cr(RM)
1 July 2013 Dr Accounts Payable 6,000
Cr Bills Payable 6,000
To record the issue of bill payable, term three months and 10
per cent interest.
On the date of settlement of the bill payable (you can pay earlier, which means
the interest charges will be lower!) Assume payment is made on 1 September
2013 (two months instead of the promised three months). Interest of RM100
(RM6,000 x 10% x 2/12). The following entries will be made:
Dr(RM) Cr(RM)
1 Sept 2013 Dr Bills Payable 6,000
Cr Cash 6,100
To record the settlement of bill payable and the interest charged.
The receiver of the bill payable will record this as bill receivable and will report
this as current assets.

Example 8.4
To illustrate, we will look at how the mentioned example will be recorded in
Paris Trading.
Paris Trading will record the receipt of bill payable from you in his book as the
following:
Dr(RM) Cr(RM)_
1 July 2013 Dr Bills Receivable 6,000
Cr Accounts Receivable 6,000
To record the bill receivable term three months and 10 per cent
interest.
When payment is received on 1 Sept 2013, the following will be recorded:
Dr(RM) Cr(RM)
1 Sept 2013 Dr Cash 6,100
Cr Bills Receivable 6,000
Cr Interest revenue 100
To record the receipts of bill receivable and interest received.
8.3 LONG-TERM LIABILITIES
Long-term liabilities are obligations of an entity that need to be settled in a

period of more than twelve months from the date of reporting. The obligation
is settled by giving up (sacrificing) the entitys current assets.
Long-term liabilities are as shown in Figure 8.2.

Figure 8.2: Long-term liabilities
8.3.1 Long-term Bank Loans

Long-term bank loans (notes payable) are borrowings that need to be paid within
a period of more than twelve months. As we learned earlier, long term loans can
be classified partially as current and partially as a long-term liability.
8.3.2 Bonds and Debentures

Bonds and debentures are issued by an entity in order to finance its activities.
Normally big corporations and government will issue bonds. You might have
read about the WAWASAN Islamic bond issued by the World Bank in Malaysia,
amounting to RM760 million and due in 2014. The issuer will have an obligation
to pay the interest payment to the bond holder, normally semi-annually until the
bond matures. The face value of the bond will be paid by the issuer on maturity.
ACTIVITY 8.2
The government has issued several bonds for the public.
Can you identify and list the reasons as to why these bonds are
offered to the public?

8.3.3 Mortgage Loans

Mortgage loans refer to borrowings made by an entity (for example bank), that
involves securing a loan against an asset. In other words, the amount of
borrowing is tied against the entity assets (building, vehicle or land). For this
type of liability, in the event that the borrower cannot pay the amount, the lender
can sell off the assets secured, and the payment received will be used to pay off
the debts. Your housing loan is an example of a secured loan. If you are unable to
pay off the loan, the bank can take control of your house, sell it and the money
will be used to pay off the amount borrowed and any difference is returned to
the borrower.
ACTIVITY 8.3
Can you try to categorise all obligations that you have into current
and non-current?
8.4 PROVISIONS AND CONTINGENCIES

MFRS 137 Provisions, Contingent Liabilities and Contingent Assets prescribed
the accounting treatment for:
(a) Provisions;
(b) Contingent liabilities; and
(c) Contingent assets.
Provisions, contingent liabilities and contingent assets would not be covered by

MFRS 137 if:
(i) It results from financial instruments that are carried at fair value;
(ii) It results from executory contracts, except where the contract is onerous;
(iii) They arise in insurance enterprises from contracts with policyholders; and
(iv) They are covered by another MFRS (for example; provision for taxation is
covered under MFRS 112 Income Taxes).

8.4.1 Provisions
MFRS 137 defines provision as a liability of uncertain timing or amount or
both. Provision is quite different from other liabilities such as accruals and
payables. For provision, there is uncertainty as to the timing or amount of the
future expenditure.
Provision can be recognised when:

(a) An enterprise has a present obligation (legal or constructive) as a result of a
past event;
(b) It is probable that an outflow of resources embodying economic benefits
will be required to settle the obligation; and
(c) A reliable estimate can be made of the amount of the obligation.
Present Obligations
Present obligations are divided into:
(a) Legal obligation

For example, an obligation to replace defective parts for cars sold
stipulated in the sales agreement is a legal obligation. Legal obligations
arise due to legislations, operation of law, or contract.
(b) Constructive Obligations

Constructive obligations derive from an entitys action when:
(i) By an established pattern of past practice, published policies or a
sufficiently specific current statement, the entity has indicated to
other parties that it will accept certain responsibilities; and
(ii) As a result, the entity has created a valid expectation on the part of
those other parties that it will discharge those responsibilities. For
example, the practice of a company paying two months bonus to its
current employees, even though there is no contract to do so.
Past Events
If past event leads to a present obligation, it is called an obligating event. If a
company has an obligating event, it has to settle the obligation. If the obligation
event is a legal or constructive one, the entity has to accrue the liability. Past
events have to be independent of future actions of the entity.
For example, if the entity has polluted the environment it has to pay penalties.
These penalties entail an outflow of economic resources because of a past event.

However, the entity could install a filtering system to reduce pollutants. It is not
an obligation if the entity can avoid future expenditure. On the other hand, a
current non-obligating event may become an obligating event in the future.
8.4.2 Contingencies
Contingencies are events, the outcome of which is determined by other events
whose outcomes are uncertain. Contingencies are classified into:
(a) Contingent Liabilities

Contingent liabilities can be defined as:
(i) A possible obligation that arises from past events and whose existence
will be confirmed only on the occurrence or non-occurrence of one or
more uncertain future events not wholly within the control of the
enterprise; or
(ii) A present obligation that arises from past events but is not recognised
because:
It is not probable that an outflow of resources embodying
economic benefits will be required to settle the obligation, or
The amount of the obligation cannot be measured with sufficient
reliability.
Recognition of contingent liabilities

A contingent liability that is probable is considered as a liability. To recognise it,
an entity should determine whether the contingency is probable or possible
which involves judgement. If the probability is more than 50 per cent, it is
probable. If it is less than 50 per cent, it is possible. Less than 30 per cent is
remote.
For possible contingent liabilities, a disclosure is made in the financial statement

by way of a note if the contingent liability is possible but not remote. If it is
remote, no disclosure is needed.
(b) Contingent Assets

Contingent assets can be defined as:
(i) A possible asset that arises from past events and whose existence will
be confirmed only by the occurrence or non-occurrence of one or
more uncertain future events not wholly within the control of the
enterprise; and

(ii) MFRS 137 provides that contingent asset should not be recognised.
However, contingent assets should be disclosed where inflow of
economic benefits is probable.
When the realisation of income is virtually certain, then the related asset is not a
contingent asset and its recognition is appropriate, where a contingent asset is
disclosed. But contingent assets are seldom disclosed in financial statements
according to MFRS 137 unless in rare cases.
8.5 EQUITY
Do you remember equity or owners equity from earlier topics? It is the owners
residual claims of the business assets after paying off liabilities. You will now
learn the difference in reporting equity for single proprietorship, partnership and
company.
SELF-CHECK 8.1
Explain the difference in reporting equity for single proprietorship,

partnership and company.
8.5.1 The Equity of a Single Proprietorship

For a single proprietorship the equity section of a balance sheet will have only
one account, that is, the capital account. The balance of the capital account
represents (see Figure 8.3):
(a) The original amount contributed by the owner;
(b) Any increase or decrease as a result of profits or losses;
(c) Any increase as a result of additional contribution by owner; and
(d) Any decrease as a result of drawings made by owner.

Figure 8.3: Capital account
Let us look at an extract of a balance sheet of a single proprietorship, Perniagaan

Runcit Tunggal owned by Ammar (see Figure 8.4).
Figure 8.4: Owners equity of a single proprietorship

The closing balance of RM21,000 shows the equity of the proprietorship; the
owners (Ammars) claims against the business net assets.
8.5.2 The Equity of a Partnership

For the purpose of comparison let us look at a partnership, where we know there
are at least two owners. These owners might not contribute capital in equal
amounts, make equal amounts of drawings; and nor do they share profits the
same way. Therefore, it is necessary to separate the capital and drawings
accounts of partners.
Under partnership, the capital account only records the amounts originally
contributed by partners, while another account called Current Account is used to
record the profit or loss made by the partnership and also the drawings made by
them (see Figure 8.5).
Figure 8.5: Equity component of a partnership
In other words, when comparing the reporting of equity of a proprietorship in

the balance sheet, the equity of partnership will be reported as the following (see
Figure 8.6).

Figure 8.6: Reporting equity of a partnership
From the given example you can see that the total owners equity is RM255,000,
which is the total of capital and the current account of both partners, Ali and Amir.
How net income is shared or allocated to partners will be taught in another module.
8.5.3 The Equity of a Company
SELF-CHECK 8.2
Can you suggest ways for a company to raise money to increase its
capital?
We will look at the financial analysis of an income statement using a company

balance sheet and income statement. Hence, it is important for you to understand
the composition of owners equity of company and the difference in reporting
owners equity for a company.

The components of a companys equity are as follows:

(a) Shareholders funds;
(b) Retained earnings; and
(c) Reserves.
Before we look at these components in detail, let us learn the types of shares
available.
For a company, the owners comprise many individuals called shareholders.

Thus, it is impractical to have a capital account for each shareholder.
Shareholders own shares of the company. Shareholders (owners) cannot
withdraw profits from the company whenever they like; however companies will
give shareholders dividends.
Companys capital comprises of share capital (equity) and loan capital (liability).
The issuer (company) will classify the financial instrument as an equity or a
liability in accordance with the substance of the contractual arrangement.
A company will initially offer shares (stocks) to the public. You have probably
seen a prospectus in the newspaper inviting the public to purchase shares in a
listed company. In general, there are two types of shares: common or ordinary
shares and preference shares. Shares will be issued at a fixed face value or par
value. The face value is also called the nominal value. The par value of a share
can be 50 cents, RM1 or any other value.
Shares are first issued by a company to the public at a price that is normally
different from the par value of shares. For example, a share with par value of
RM1 can be issued at RM2 or any other value when it is first offered to the
public. A primary market is where the company issues the shares to trade with
the public.
After shares are issued to the public, the shareholders can sell their shares to
other buyers or buy more shares from other shareholders in the Kuala Lumpur
Stock Exchange (KLSE) or Bursa Malaysia. In other words, the KLSE is a
secondary market for shares.

Figure 8.7 explains the primary and secondary market.
Figure 8.7: Primary and secondary market Bursa Malaysia

Source: Kean Kok, Weina, Marimuthu & Bhattacharya (2010)
Now let us look at the composition of shareholders funds.
(a) Shareholders funds

Shareholders funds are the par value of shares times the number of shares
issued by a company. For example, if a company issues three million
ordinary shares of RM1 par value each, then the shareholders fund is RM3
million. Let us look at the characteristics of these shares.
(i) Ordinary or Common Shares

All companies must have ordinary shares and usually the ordinary
shares comprise the bulk of the companys equity. They carry the
right to vote and the ordinary shareholders are entitled to share in the
profits for dividends only after any dividend has been paid to the
other classes of shares.
Due to this, ordinary shareholders are considered to be risk takers

because if the business fails, they can lose their capital. Vice versa, if
the business proves to be successful, the reward might be very high.
The rate of dividends paid to ordinary shareholders is not fixed. It is
dependent on the companys level of profits and the companys
dividend policy. The ordinary shareholders are effectively the owners
of the company.
In the event that a business turns bad, the company does not have an
obligation to declare dividends for ordinary shares. However, once a
company declares its dividend, the company must fulfil its obligation
to pay.

(ii) Preference Shares

Preference shares carry preferential rights, as to the payment of
dividends and repayment of capital in the event of liquidation, over
the other classes of shares. Preference shareholders receive a fixed rate
of dividend which is expressed as a percentage of the nominal value.
Preference shares have special rights attached to them, that is, rights to
receive dividends before ordinary shareholders and also rights to the
residual assets before ordinary shareholders, if the company winds up.
A company has the obligation to pay this dividend regardless

whether the business is good or bad. Hence, in ratio analysis,
preference shares are treated as liabilities rather than equity.
The rights attaching to the preference shares are set out in the
Memorandum of Articles (MoA) of the company. The MoA of the
company will state the rights of the preference shares with respect to
repayment of capital, participation in surplus profits, and priority of
repayment of capital and dividends as to other classes of capital.
Preference shareholders do not have any voting rights and therefore
leave the management of the company to the ordinary shareholders.
There are five types of preference shares (refer to Table 8.1).
Table 8.1: Types of Preference Shares
Types Description
Cumulative The holders of these shares are entitled to receive a fixed
preference shares dividend per annum. If there is any insufficient or absence of
dividend payment in any year, the arrears can be carried
forward and become payable in the future.
Non-cumulative Holders of this preference shares receive a fixed rate of
preference shares dividend if the company has sufficient profits to declare
dividend. If not, the dividend for that year is forfeited and
cannot be carried forward.
Participating The holders receive fixed dividends, are allowed to receive
preference shares additional dividends depending on profits after all other
classes of shareholders have received their dividends.
Redeemable Redeemable preference shares can be repurchased from the

preference shares shareholders at a future date as pre-determined at the time of
the issue of the redeemable preference shares. This type of
shares allows the company to obtain capital of a semi-
permanent nature at a fixed rate of dividend.

Convertible The holders are entitled to convert their preference shares to

preference shares ordinary shares as expressed in the Articles. The date and the
rate of conversion will be specified.
(b) Retained Earnings

The second component of equity for company is retained earnings.
Retained earnings account is the accumulation of a companys net earnings
(profit) after tax after distributions to shareholders and/or reserves.
Earnings after tax will increase retained earnings, while net losses will
decrease the retained earnings balance.
For a single proprietorship and partnership, the business is not taxed on the
profit it makes; the individual will need to report the profit of the business
as its income, and will be taxed individually. However, for a company, the
company will have to pay tax on its income or profit. Therefore, the income
statement of company will include an additional item of expense which is
tax expense. See example in Figure 8.8.
Figure 8.8: Income statement of a company

Unlike a proprietorship and partnership, where the owner can withdraw his
profits at any time, shareholders cannot do the same. However, a company will
pay dividends out of net income after tax (profits/earnings). This dividend will
reduce the balance of retained earnings.
The retained earning balance reported in the balance sheet is net after deducting
dividends and transfer of earnings to reserves. Normally two types of dividends
are paid to shareholders:
(i) Interim dividend. Interim dividend is declared and paid during the current
financial year,
(ii) Final dividend. Final dividend is declared at the end of the current financial
year and will be paid in the next financial period.
ACTIVITY 8.4
Surf the web for the balance sheets of companies. You can also go to the
Bursa Malaysia website http://www.bursamalaysia.com/market/.
You can see how these corporations report their assets, liabilities and
equity. Do take note of the types of reserves being reported.
Dividends are always quoted based on the nominal value of shares, not the
current market price (quoted in Bursa Malaysia) or the issue price of the shares.
For example, a company has issued two million ordinary share par value 50 cents
each, at a price of RM2 and currently the shares are traded at RM3.50 each.
Assuming that at the end of year the company declares a 5 per cent dividend for
ordinary shares. What is the amount of dividend that will be paid by the
company?
The amount of dividend is RM50,000 which is 5 per cent times RM1 million (the
nominal value of the ordinary shares).
(c) Reserves
A company might also create reserves to set aside funds from earnings for
the following purposes:
(i) To cover themselves from future loses;
(ii) To buy fixed assets;
(iii) To repay liabilities; and
(iv) To buy back their shares.

The most common reserve created is the general reserves, and this will be
reported in the equity section of the balance sheet.
Reserves can be classified into two (see Table 8.2):
Table 8.2: Classes of Reserves
Classes Description
Revenue reserves Revenue reserves are profits arising through trading
activities set aside to meet specific or general purposes.
They are realised profits and can be distributed in cash
form. General reserves and retained profits are common
examples of revenue reserves. The retained profits are
available for distribution as dividends. If the company
wants, it can transfer all or a part of the general reserve
to retained earnings to make it available for distribution.
Capital reserves Increases to the shareholders equity by non-trading
activities are categorised as capital reserves. Capital
reserves may be created due to:
Statutory requirements;
Accounting standard requirements; or
Good accounting practice.
The source of the capital reserves is identified by the title
to the account. Asset revaluation reserve identifies the
reserve that arises due to an increase in the value of non-
current assets through a revaluation exercise and the
company has adopted the value for that particular non-
current asset in the accounts.
The general rule regarding capital reserve is that the
company cannot distribute capital reserve in the form of
cash dividends. Even if it is distributed, it can be only in
the form of bonus shares. For example, one of the
purposes for which the share premium could be utilised
is to issue bonus shares.

Figure 8.9 summarises the components of a companys equity.
Figure 8.9: Components of a companys equity
After learning about retained earnings, dividends and reserves let us look at the
Statement of Retained Earnings (see Figure 8.10). Statement of retained earnings
shows the changes in retained earnings of a company over a period.
Figure 8.10: Format of statement of retained earnings

Let us look at the following example, in order to learn how to prepare the
statement of retained earnings and the equity portion of balance sheet of a
corporation.
Example 8.5
Cyber Corporation has issued five million ordinary shares par value RM1
each and two million 10 per cent preference shares par value RM2 each.
Earnings after tax for the year ended 31 December 2013 is RM23,000,000.
Balance of retained earnings as at 1 January 2013 is RM123,000,000. No
dividends have been paid during the year. The Director decided to pay 20
cents dividend per share to ordinary shareholders and the amount due to
preference shareholders. The directors also decided to transfer RM10,000,000
of earnings to general reserves. General reserves balance as at 1 January 2013
is RM35,000,000.
Dividend to ordinary shareholders is 20 cents per share and there are five
million shares; therefore, the total dividend for ordinary shareholder is
RM1,000,000 (five million shares x 20 cents).
For preference shares, the dividend rate is 10 per cent (as stated 10 per cent
preference share), and the amount of preference shares is RM4,000,000 (two
million shares x RM2 par value), and therefore the dividend is RM400,000
(RM4,000,000 x 10%).
The statement of retained earnings of Cyber Corporation will look like the
following (see Figure 8.11):

Figure 8.11: Statement of retained earnings of Cyber Corporation
If the extract of a balance sheet is to be prepared (equity) for Cyber Corporation,

it will look like the following (see Figure 8.12):
Figure 8.12: Balance sheet extract of Cyber Corporation

There are two categories of liabilities; current liabilities and long-term

liabilities.
Current liabilities are obligations by an entity that need to be settled using

current assets or by creating another current liability within a period of one
year. Example: bank overdraft.
Long-term liabilities are items that have to be paid more than a year after the
balance sheet date. Example: bank loans.
Bank overdraft is a facility given by banks to current account holders that

enable the holder to draw cheques larger than the holders bank balance.
Bill payable is a note issued by one entity, promising to pay another entity.
Long-term bank loans (notes payable) are borrowings that need to be paid
within a period of more than twelve months.
Equity components of a company comprises (i) shareholders funds; (ii)

retained earnings; and (iii) reserves.
Shareholders funds are the par value of shares times the number of shares
issued by a company.
Retained earnings account is the accumulation of companys net earnings

(profit) after tax after distributions to shareholders and/or reserves.
Bills payable Ordinary share

Bills receivable Preference share
Common stock or ordinary shares Preferred stock or preference shares
Contingencies Reserve accounts
Current liability Retained earnings
Long-term liability Share capital

1. Syarikat Demo borrowed RM500,000 from Putrajaya Bank on 1 July 2012.

Interest rate is 5 per cent of the original loan amount and is to be paid semi-
annually. The first interest payment is due on 1 January 2013. The loan
principle is to be paid over 10 instalments, to be made annually, and the
first instalment is due on 1 July 2013.

(a) Prepare the extract of a balance sheet as at 31 December 2012;
(b) Provide the journal entries to record the first interest payment;
(c) Provide the journal entries to record the payment of the first
instalment of the principle amount; and
(d) Prepare the extract of a balance sheet as at 31 December 2014.
2. Calculate the amounts of dividends for the following situations.

(a) Exxone Corporation issued 300,000 8 per cent preference shares par
value RM1 each.
(b) Shellex Corporation issued 400,000 9 per cent preference shares par
value RM2 each.
(c) Dividend of 15 per cent for 500,000 ordinary shares, par value 50 cents
each.
(d) Dividend of 10 per cent for 200,000 ordinary shares, par value RM1
each.
(e) Dividend of 5 cents each for 500,000 ordinary shares, par value 50
cents each.
1. Fill in the blanks

(a) Equity of a partnership comprises ______________ and
______________ accounts.
(b) Equity of a company comprises ______________, ______________ and
______________accounts.
(c) There are two main types of shares: ______________ shares and
_____________ shares.

(d) Instead of making drawings, shareholders are paid ______________.

(e) ______________ and ______________ will decrease the retained
earnings balance, while ______________ will increase the retained
earnings.
2. The following information is obtained from M&S Corporation as at 31

December 2010.
Ordinary shares par value 70 cents 3,000,0000 shares issued
5 per cent preference shares par value 50 cents 5,000,0000 shares issued
Sales revenues RM57,500,000
Cost of goods sold RM15,000,000
Operating expenses RM18,000,000
Company tax rate is 30 per cent
Retained earnings 1/1/2013 RM25,600,000
General reserves 1/1/2013 RM12,000,000
On 31 December 2013, The Director declared the following final dividend:
(i) 10 per cent to ordinary share to ordinary shareholders; and
(ii) The due amount to preference shareholders.
The directors also decided to transfer RM3,500,000 of retained earnings to

general reserves.

(a) Calculate the earnings after tax for M&S Corporation for the year
ended December 2013;
(b) Prepare the statement of retained earnings for M&S Corporation for
the year ended December 2013; and
(c) Prepare the extract of balance sheet for M&S Corporation as at 31
December 2013.

1. DJ started a business on 1 July 2013, with RM40,000 capital in cash. During

the first year he kept very few records of his transactions.
The assets and liabilities of the business at 30 June 2014 were:

RM
Freehold premises 76,000
Mortgage on the premises 50,000
Stock 24,000
Debtors 2,800
Cash and bank balances 5,400
Creditors 7,600
During the year, DJ withdrew RM9,000 cash for his personal use but he also
paid RM6,000 received from the sale of his private car into the business
bank account.
From the given information, prepare a balance sheet showing the financial
position of the business at 30 June 2014 and indicate the net profit for the
year.
1. From the following items provided, draw up a balance sheet for Lafferty as
at 31 December 2014.
RM RM
Fixtures and fittings 5,000
Stock 3,000
Debtors 6,800
Bank 15,100
Cash 200
Creditors 16,000
Net profit for year 8,000
Cash introduced 20,000
Drawings 7,000

1. The chairman of a public limited company has written his annual report to
the shareholders, an extract of which is quoted as follows:
In May 2012, in order to provide a basis for more efficient operations, we

acquired REX Warehousing and Transport limited. The agreed valuation of
the net tangible assets acquired was RM1.4 million. The purchase
consideration, RM1.7 million, was satisfied by an issue of 6.4 million equity
shares, of RM0.25 per share, to REXs shareholders. These shares do not
rank for dividend until 2013.
Answer the following questions on the above extract:

(a) What does the difference of RM0.3 million between the purchase
consideration (RM1.7m) and the net tangible assets value (RM1.4m)
represent?
(b) What does the difference of RM0.1m between the purchase
consideration (RM1.7m) and the nominal value of the equity shares
(RM1.6m) represent?
(c) What is the meaning of the term equity shares?
(d) What is the meaning of the phrase do not rank for dividend?
Fujida
Balance sheet as at 31 March 2013
Fixed assets: RM RM
Premises 190,000
Current assets:
Stock 39,200
Debtor 18,417
Bank 828__
58,445
Less: Current liabilities
Creditors (23,216)
35,229
225,229
Capital 225,229

(a) The business of Fujida is taken over by Kagawa in its entirety. The assets
are deemed to be worth the balance sheet values as shown. The price paid
by Kagawa is RM260,000. Show the opening balance sheet of Kagawa.
(b) Suppose instead that Kenshin had taken over Fujidas business. He did not
take over the bank balance, and valued the premises at RM205,000 and
stock at RM36,100. The price paid by him is also RM260,000. Show the
opening balance sheet of Kenshin.
Horngren, C. T. (2004). Management accounting: Some comments. Journal of

Management Accounting Research, 16 (1), 207-211.
Kean Kok, N., Weina, Z., Marimuthu, M., & Bhattacharya, S. (2011). Financial
management. Kuala Lumpur, Malaysia: Oxford Fajar.

Topic Integrity and
9 Ethics in
Preparing and
Reporting
Financial
Information
LEARNING OUTCOMES
1. Describe the ethical code; and
2. Discuss the factors in ethical behaviour.
INTRODUCTION
Ethics is a term that refers to a code or moral system that provides criteria for
evaluating right and wrong. An ethical dilemma is a situation in which an
individual or group is faced with a decision that tests this code. Many of these
dilemmas are simple to recognise and resolve. For example, have you ever been
tempted to call your professor and ask for an extension on the due date of an
assignment by claiming a fictitious illness? Temptations like these will test your
personal ethics.

250 TOPIC 9 INTEGRITY AND ETHICS IN PREPARING AND
REPORTING FINANCIAL INFORMATION
Accountants, like others operating in the business world, are faced with many
ethical dilemmas, some of which are complex and difficult to resolve. For
instance, the capital markets focus on periodic profits may tempt a companys
management to bend or even break accounting rules to inflate reported net
income. In these situations, technical competence is not enough to resolve the
dilemma.
ACTIVITY 9.1
Do you know of any real cases happening in the accounting world
involving ethical issues? Discuss these cases with your coursemates.
9.1 ETHICAL CODE

All accounting members acting in the public interest have to comply with certain
ethical codes. The difference in the accountancy profession is its acceptance of the
responsibility to act in the public interest. Thus, an accountants or any
accounting members responsibility is not more than to satisfy the needs of an
individual client or employer.
Ethical codes consist of fundamental principles of professional ethics for

accounting members and provide a conceptual framework that members can
apply to:
(a) Identify threats to comply with the fundamental principles;
(b) Evaluate the significance of the threats identified; and
(c) Apply safeguards, when necessary, to eliminate the threats or reduce them
to an acceptable level.
Safeguards are necessary when the member determines that the threats are not at
a level at which a reasonable and informed third party would be likely to
conclude, weighing all the specific facts and circumstances available to the
member at that time, that compliance with the fundamental principles is not
compromised.
A member shall use professional judgment in applying this conceptual

framework.

TOPIC 9 INTEGRITY AND ETHICS IN PREPARING AND 251
9.2 ETHICAL BEHAVIOUR

Ethical behaviour is necessary for a society to function in an orderly manner. It
can be argued that ethics is the glue that holds a society together. The need for
ethics in society is sufficiently important that many commonly held ethical
values are incorporated into laws.
Ethical behaviour should be practised by all accounting members and is essential

in accounting professional practices. Those are listed in Figure 9.1.
Figure 9.1: Essential ethical behaviour in accounting professional practices
Now, let us discuss these ethical behaviours one by one in greater detail.
9.2.1 Integrity
Integrity imposes an obligation on all accountants to be straightforward and
honest either in the business or professional relationship. Integrity dealing is fair
and truthful.

Accountants shall not be involved in any report, returns, communication or other

information if they knew it:
(a) Contains a materially false or misleading statement;
(b) Contains statements or information furnished recklessly; or
(c) Omits or obscures information required to be included where such
omission or obscurity would be misleading.
If accountants become aware that they have been associated with such
information, they shall take steps to be disassociated from that information.
9.2.2 Objectivity
The principle of objectivity imposes an obligation on all members not to
compromise their professional or business judgment because of bias, conflict of
interest or the undue influence of others.
A member may be exposed to situations that may impair objectivity. It is

impracticable to define and prescribe all such situations. A member shall not
perform a professional service if a circumstance or relationship biases unduly
influences the members professional judgment with respect to that service.
9.2.3 Competence
The principle of professional competence and due care imposes the following
obligations on all members:
(a) To maintain professional knowledge and skill at the level required to
ensure that clients or employers receive competent professional service;
and
(b) To act diligently in accordance with applicable technical and professional
standards when providing professional services.
The maintenance of professional competence requires a continuing awareness

and an understanding of relevant technical, professional and business
developments. Continuing professional development enables a member to
develop and maintain the capabilities to perform competently within the
professional environment.

9.2.4 Independence
Independence for accounting members refers to behaving professionally. The
principle of professional behaviour imposes an obligation on all members to
comply with relevant laws and regulations and avoid any action or omission that
the member knows or should know may discredit the profession. This includes
actions or omissions that a reasonable and informed third party, weighing all the
specific facts and circumstances available to the member at that time, would be
likely to conclude that they adversely affect the good reputation of the profession.
9.2.5 Confidentiality
The principle of confidentiality imposes an obligation on all members to
refrain from:
(a) Disclosing outside the firm or employing organisation confidential
information acquired as a result of professional and business relationships
without proper and specific authority or unless there is a legal or
professional right or duty to disclose; and
(b) Using confidential information acquired as a result of professional and
business relationships, to their personal advantage or the advantage of
third parties.
A member shall maintain confidentiality, including in a social environment, be

alert to the possibility of inadvertent disclosure, particularly to a close business
associate or a close or immediate family member, maintain confidentiality of
information disclosed by a prospective client or employer, maintain
confidentiality of information within the firm or employing organisation, and
take reasonable steps to ensure that staff under the members control and persons
from whom advice and assistance is obtained, respect the members duty of
confidentiality.
Ethical codes consist of fundamental principles of professional ethics for

accounting members and provide a conceptual framework to them.
Integrity is being straightforward, honest and truthful in all professional and

business relationships. You should not be associated with any information
that you believe contains a materially false or misleading statement, or which
is misleading by omission.

Objectivity does not allow bias, conflict of interest or the influence of other
people to override your professional judgement.
Professional competence and due care are an ongoing commitment to your

level of professional knowledge and skill. Base this on current developments
in practice, legislation and techniques. Those working under your authority
must also have the appropriate training and supervision.
In confidentiality, you should not disclose professional information unless

you have specific permission or a legal or professional duty to do so.
Professional behaviour complies with relevant laws and regulations. You

must also avoid any action that could negatively affect the reputation of the
profession.
Behaviour Personal
Ethical Professional
Misconduct Safeguards
1. You are the financial director of a large multinational organisation and have
been privy to information on a takeover bid to acquire a rival firm. A family
friend is considering selling shares in this rival organisation and has asked
you, as an expert in the industry, for advice on this matter. What would
you do? Which principles are affected and how? Explain based on the
categories given:
(a) Integrity;
(b) Objectivity;
(c) Professional competence and due care;
(d) Confidentiality; and
(e) Professional behaviour.

1. You are a CIMA member who is a non-executive director of a large services

company. The board of directors meets on a monthly basis to discuss the
quarterly forecast and other business issues. It is the responsibility of the
finance director to distribute papers at least two weeks prior to the date of
the meeting. These papers should first be signed off by the CEO. Recently
documents have only been received a day before the meeting. You have
raised this with the finance director who has stated the delay is due to the
sign off by the CEO.
You do not feel that you are given sufficient time to review the papers and
also believe the information that is available is not complete and therefore
difficult to fully appraise. The CEO is a dominant character and many
members of the board are nervous about broaching the matter. What would
you do? Which principles are affected and how? Explain based on the
categories given next:
(a) Integrity;
(b) Objectivity;
(c) Professional competence and due care;
(d) Confidentiality; and
(e) Professional behaviour.

Topic Comprehensive
10 Cases
(Partnership:
Changes in
Ownership)
LEARNING OUTCOMES
1. Identify the changes in ownership of a partnership;
2. Explain the methods of valuing goodwill;
3. Prepare the accounting entries for admission of new partners,
retirement and withdrawal of existing partners;
4. Discuss the reasons why existing partners withdraw from a
partnership;
5. Describe the importance of asset revaluation in a partnership;
6. Demonstrate accounting entries for asset revaluation; and
7. Prepare financial statements for a partnership.
INTRODUCTION
In a partnership business, it is very common for changes in ownership to take
place. In this topic, we will discuss changes in a partnership including the
admission of new partners, retirement and the withdrawal of partners. You will
be introduced to the revaluation of a partnerships assets and recognition of

TOPIC 10 COMPREHENSIVE CASES (PARTNERSHIP: CHANGES IN OWNERSHIP) 257
goodwill upon changes in ownership. All these will be discussed in detail in the
following subtopics.
10.1 CHANGES OF OWNERSHIP IN A

PARTNERSHIP
When you talk about change of ownership in a partnership, the following three
questions need to be answered:
(a) When does ownership change take place?

Change of ownership in a partnership takes place in the event of the
admission of new partners, retirement or death of existing partners.
(b) What kind of adjustments is needed?

Under such circumstances, a new partnership is deemed to be set up.
Therefore, adjustments to the profit-sharing ratio must be made. The reason
is, part or all of the old partnerships profits or losses could be related to an
earlier period when the business was under a different profit-sharing basis.
(c) What are the processes?

Figure 10.1 shows that the outgoing partner may ask for his fair share from
the partnership before he leaves. The new partner, on the other hand, may
pay a premium upon joining the partnership in view of the business
potential. In short, the incoming partner would be expected to bring in new
capital, whereas the outgoing partner, owing to either retirement or death,
would have to withdraw his share of the business assets.

258 TOPIC 10 COMPREHENSIVE CASES (PARTNERSHIP: CHANGES IN OWNERSHIP)
Figure 10.1: Changes of ownership in partnership
After having an agreed profit-sharing ratio, the old partnership is deemed to be

non-existent. A new partnership agreement will become the legal binding
document for all the partners in the partnership.
ACTIVITY 10.1
Find the answers to the following questions and discuss with your
coursemates:
(a) What would happen to a partnership if one of the owners died?
(b) Do we need to find a replacement?
Share your thoughts in myINSPIRE.
10.2 GOODWILL
In a partnership, goodwill arises when there is an admission of new partners into
the partnership. This is to compensate the existing partners who have put in
effort in building up the business over the years. It is important to note that the
goodwill at the time of an admission belongs entirely to the existing partners.

Goodwill is the difference between the price that the purchaser pays to buy a
business and the fair value of the net assets of the business.
For example, Ali paid RM1 million to buy a business where the fair value of
the net assets is RM800,000. In this case, the goodwill is RM200,000.
Goodwill arises when there is an increase in the perceived value of the business which
is not reflected in the books. It is commonly known as a form of intangible assets.
Goodwill is an asset which is difficult to quantify as it is a very subjective

process. There are several methods of valuing goodwill. The most common
methods of valuing goodwill are as illustrated in Figure 10.2:
(a) A given multiple of turnover;
(b) A given multiple of the annual profit; or
(c) The excess of the capitalised value of the profit over the current market
value of the net tangible assets.
Figure 10.2: Methods of valuing goodwill
SELF-CHECK 10.1
What are the methods used to value goodwill?
Let us look at these three methods of valuing goodwill in the following example.

Example 10.1
Ahmad and Ali have run a cafe under a partnership since 2010. At the end of
2013, Fatimah joined the partnership. The business has the following financial
information for the three years prior to Fatimahs admission. The market
value of the net tangible assets of the business was estimated to be RM120,000.
2011 (RM) 2012(RM) 2013 (RM)

Profit 48,000 64,000 80,000
Turnover 160,000 240,000 440,000
Required
Compute the goodwill of the partnership using the following methods:
(a) Goodwill is valued at two years average profit for the last three years;
(b) Goodwill is valued at a half years average turnover for the last three
years; and
(c) Goodwill is the excess of the capitalised value of the profit over the
current market value of the net tangible assets.
Solution
(a) Average profit = (RM48,000 + RM64,000 + RM80,000) / 3 = RM64,000
Goodwill is valued at two years average profit for the last three years,
that is:
Goodwill = 2 RM64,000 = RM128,000
(b) Average turnover = (RM160,000 + RM240,000 + RM440,000) / 3

= RM280,000
Goodwill is valued at a half years average turnover for the last three
years, that is:
Goodwill = 1/2 RM280,000 = RM140,000
(c) Capitalised value of profit = (RM48,000 + RM64,000 + RM80,000)

= RM192,000
Goodwill is the excess of the capitalised value of the profit over the
current market value of the net tangible assets, that is:
Goodwill = RM192,000 RM120,000 = RM72,000

ACTIVITY 10.2
Why is goodwill commonly known as intangible assets?
10.3 ADMISSION OF NEW PARTNERS IN A

PARTNERSHIP
Businesses commonly require additional monetary and human capital as
expansion takes place. As such, it is necessary for the existing partners to look for
new partners. When a new partner enters the partnership, it is always necessary
for the partners to draw up a new partnership agreement. This is important
because the new agreement can accommodate changes in the ownership of the
business. The old partnership will then cease and a new partnership is formed.
As mentioned earlier, goodwill will arise when new partners join a partnership.
There are three methods of dealing with goodwill upon the admission of new
partners, as seen in Figure 10.3.
Figure 10.3: Dealing with goodwill upon admission of new partners
ACTIVITY 10.3
As an incoming partner, would you agree to the assets remaining in the book
being valued at their historical costs? If not, why? State your reasons.

The three methods mentioned will be discussed in the following example:
Example 10.2
Ali and Ballu are partners in a business that provides transport services in
Kuala Lumpur. Each has made a capital contribution of RM30,400 and
RM22,400 respectively. Profit-sharing is in the ratio of 3:2.
Due to business expansion in the next couple of months, which will require
additional capital injection, they decided to admit Cheng on 31 December 2013
as a third partner. Cheng agreed to contribute RM54,400 as his initial capital.
The new profits and losses sharing ratio will be 3:2:5.
Upon Chengs admission, all three have agreed that goodwill is to be

calculated at twice the average profits of the last three years. The profits
recorded for the last three years were RM4,344, RM7,752 and RM13,104.
Required
Compute the goodwill for the above partnership.
Solution
Goodwill = 2 (RM4,344 + RM7,752 + RM13,104) / 3
= RM16,800
After having determined the goodwill and new profit-sharing ratio, the
different methods of dealing with goodwill upon the admission of a new
partner are as follows:
Method 1: Goodwill is recorded in full in the books
In this method, a goodwill account is created with a debit entry. The old
partners capital accounts are credited the goodwill based on the old partners
profits and losses sharing ratio. This is because the goodwill, as a result of the
admission of a new partner, belongs solely to the old partners.
Goodwill Account
2013 RM 2013 RM
31 Dec Capital Ali 10,080 31 Dec Balance c/f 16,800
6,720
Capital Ballu
16,800 16,800

Partners Capital Account

Ali Ballu Cheng Ali Ballu Cheng
2013 RM RM RM 2013 RM RM RM
31 Dec Balance 40,480 29,120 54,400 31 Dec Balance 30,400 22,400
c/f c/f
Bank 54,400
Goodwill 10,080 6,720

40,480 29,120 54,400 40,480 29,120 54,400
Method 2: Goodwill is not recorded in the books
When goodwill is recognised upon the admission of new partners, such an

amount will be amortised and written off against the partners capital
accounts.
Under this method, the goodwill is credited to the partners capital accounts
based on the old profit and loss sharing ratio (as shown in Method 1). The
goodwill is then written off by debiting the partners capital accounts in their
new profit and loss sharing ratio. Such an attempt is to recognise a loss that
would otherwise have been charged to future years profit and loss accounts.
Thus, this amount is to be shared among the partners in their new profit-
sharing ratio.

Ali Ballu Cheng Ali Ballu Cheng
31 Dec Goodwill 5,040 3,360 8,400 31 Dec Balance 30,400 22,400
c/f
Balance c/f 25,360 19,040 46,000 Bank 54,400
30,400 22,400 54,400 30,400 22,400 54,400

Goodwill Account
2013 RM 2013 RM
31 Dec Capital Ali 10,080 31 Dec Capital Ali 5,040
31 Dec Capital Ballu 6,720 Capital Ballu 3,360
Capital Cheng 8,400
16,800 16,800
As you can see earlier, the goodwill account is no longer kept in the book after
it is written off against the partners capital accounts. The partners capital
accounts will show the effect of goodwill recognition upon the admission of
partners.
Method 3: Goodwill is paid directly to the old partners and no record is made
in the books
This method is the least beneficial to the incoming partner because the money
which he pays for goodwill is not reflected in the business transaction.
Using the same example, after the goodwill is written off based on the new
profit-sharing ratio, Cheng is required to debit from his capital account,
RM10,500 (as shown in Method 2).
Under Method 3, such amount is to be shared between Ali and Ballu based on
their old profit-sharing ratio. Effectively, Cheng will pay Ali RM6,300 and
Ballu RM4,200, off the record, leaving the actual capital introduced by Cheng
to be reduced to RM57,500 (RM68,000 RM6,300 RM4,200).
ACTIVITY 10.4
What are the business attributes that are thought to give rise to
goodwill?
10.4 WITHDRAWAL OF PARTNERS IN A

PARTNERSHIP
The existing partners can withdraw from a partnership for a number of reasons,
such as retirement, business disputes, personal advancement or death. When a
partner leaves a partnership, the outgoing partner should be rewarded more than
the amount recorded in his capital account for the goodwill he has helped to

generate for the business over the years. It is only fair that the compensation
should reflect his contributions to the partnership over the years.
When a partner leaves a partnership, his capital and current accounts are to be
fully repaid. Before the accounts are repaid, it is necessary to make adjustments
in order to recognise the value of goodwill that has been created. The three
methods of dealing with goodwill mentioned earlier can be applied.
After taking into account all the necessary adjustments, including goodwill
recognition, and profits and losses arising from asset revaluation (which will be
discussed later), the outgoing or deceased partners current account is to be
transferred to his capital account.
The remaining balance in the capital account shall, therefore, represent the
amount payable to the individual. The balance in the capital account of the
deceased partner can be paid to his estate immediately or settled partly and the
remaining is to be regarded as loan repayable over a period of time.
SELF-CHECK 10.2
What are the reasons for the withdrawal of an existing partner from a
partnership?
10.5 REVALUATION OF ASSETS

Revaluation of the assets of the business is necessary for the following reasons:
(a) Admission of new partners;
(b) Withdrawal of existing partners; and
(c) Change in profit-sharing ratio.
Revaluation of assets is needed because some assets may have appreciated in

value, while others may have depreciated. If the revaluation of assets is not done,
the new partner admitted would have benefited or lost out due to increases or
decreases in value before he joined the partnership without paying or giving
anything for it. A revaluation account, therefore, is required.

SELF-CHECK 10.3
What are the functions of asset revaluation in a partnership?
Example 10.3
Micky and Donald are in partnership selling water sport equipment in
Petaling Street. Donald has been upset over the existing profit-sharing ratio
and demanded a revision. With effect from 1 January 2011, they decided to
change their profit-sharing ratio from 2:1 to 1:1.
Following is the balance sheet of Micky and Donald as at 31 December 2013:
Micky and Donald

Balance Sheet as at 31 December 2013
RM RM
Fixed assets:
Land and building 208,000
Equipment 48,000
256,000
Current assets:
Stock 64,000
Debtors 38,400
Bank 25,600
128,000
384,000
Capital:
Micky 224,000
Donald 160,000
384,000

Following negotiations, they finally agreed to revalue the following assets

before the new profit-sharing ratio took effect:
(a) Land and building RM308,000;
(b) Equipment RM32,000; and
(c) Other assets remained at the same values.
Required
Prepare the following accounts for Micky and Donald to effect the change in
the profit-sharing ratio:
(a) Revaluation account;
(b) Land and building;
(c) Equipment;
(d) Partners capital accounts; and
(e) Balance sheet as at 1 January 2011.
Solution
Revaluation Account
2014 RM 2014 RM
1 Jan Asset reduced in value 1 Jan Asset increased in value
Equipment 16,000 Land and building 100,000
Profit on revaluation
Micky (2/3) 56,000
Donald (1/3) 28,000
100,000 100,000
Land and Building

201 RM 2014 RM
4
1 Balance b/f 208,000 1 Jan Balance c/f 308,000
Jan
Revaluation 100,000
308,000 308,000

Equipment
2014 RM 2014 RM
1 Jan Balance b/f 48,000 1 Jan Revaluation 16,000
Balance c/f 32,000
48,000 48,000
Capital Account Micky

2014 RM 2014 RM
1 Jan Balance c/f 280,000 1 Jan Balance b/f 224,000
Revaluation:
Share of profit 56,000
280,000 280,000
Capital Account Donald

2014 RM 2014 RM
Revaluation:
188,000 188,000
Micky and Donald

Balance Sheet as at 1 January 2014
RM RM
Fixed assets:
Equipment 32,000
340,000
Current assets:
Stock 64,000
Debtors 38,400
Bank 25,600
128,000
468,000
Capital:
Micky 280,000
Donald 188,000
468,000

As you can see from the given example, the benefits or profit arising from the
assets revaluation are credited to the partners capital accounts based on the old
profit-sharing ratio of 2:1. The new profit-sharing ratio of 1:1 will be in the
following financial year. This is because the partnership before revaluation that
takes place is still regarded as the old partnership. Once the revaluation of assets
is completed, the new sharing ratio will take effect.
In the case of an admission of new partners, retirement of old partners or

death of an existing partner, the old partnership is deemed to have ceased
and a new partnership agreement needs to be created for the continuation of
the business.
From the accounting perspective, goodwill results from changes in

ownership of a partnership.
There are several methods of valuing goodwill:

A given multiple of turnover;
A given multiple of the annual profit; or
The excess of the capitalised value of the profit over the current market
value of net tangible assets.
An existing partner can withdraw from a partnership due to a number of

reasons, such as retirement, business disputes, personal advancement or
death.
To capture the fair value of the business before the new owner can take over
the business, the revaluation of assets is required.
Revaluation of the assets of the business is necessary for the following reasons:
Admission of new partners;
Withdrawal of existing partners; and
Change in profit-sharing ratio.
The apportionment of the benefits or losses resulting from the recognition of

goodwill or revaluation of assets must be based on the old partners profit
and loss sharing ratio. This is because the goodwill or revaluation of benefits
belongs solely to the old partners in the old partnership agreement.

The new agreement reached among partners will only take effect upon the
start of the new business.
Asset revaluation Intangible asset

Changes of ownership Partnership
Goodwill
1. Liono and Tigra are partners in a hardware business in Kuala Lumpur.

They are sharing profits and losses in the ratio of 3:2 respectively. Their
capital contributions were RM21,000 and RM19,600 respectively.
After several years of economic downturn, they are of the view that
demand for hardware in the country may pick up tremendously in the near
future. In view of this, they expanded their business by admitting Pentron
as their new partner on 1 January 2014. Pentron agreed to contribute
RM33,600 as his share of the capital.
The business made profits of RM5,040, RM6,720, RM7,770 and RM8,190

over the last four years.
Three of the partners agreed to compute the goodwill by taking three times
the net average net profit over the last four years.
Required
(a) Compute the goodwill for the business;
(b) Prepare the capital accounts for Liono, Tigra and Pentron, assuming
goodwill is to be kept in the books of the partnership; and
(c) If the goodwill is to be written off in the business, compute Pentrons
share of the goodwill, assuming he is to share 1:5 of the goodwill.
2. Siew Meng and Lily contributed RM36,000 and RM24,000 respectively as

initial capital when they started up a partnership three years ago in Kajang.
Based on the partnership agreement, Siew Meng and Lily share profits and
losses equally. On 1 January 2014, Adeline was admitted as a new partner

in the business. Adeline brought in RM12,000 as capital and paid RM3,600
as premium for the business goodwill. The new profit and loss sharing ratio
after admitting Adeline is 1:2, 1:3 and 1:6 for Siew Meng, Lily and Adeline
respectively. The partners agreed that goodwill is not to be recorded in the
books.
Required
Show the necessary ledger accounts upon the admission of Adeline as at 1
January 2014.
3. Proton and Jaguar are in a partnership trading in car accessories in a

shopping complex in Kuala Lumpur. They share the profits and losses of
the business on the ratio of 3:2 respectively. They intend to expand their
business in view of the enforcement of the new automotive policy recently
announced by the Federal Territory government.
The following is the balance sheet of the business as at 31 December 2013:
Proton and Jaguar

RM RM
Fixed assets:
Equipment 256,000
Furniture 179,200
435,200
Current assets:
Stock 19,200
Debtors 140,800
Bank 12,800
172,800
Less:
Current liabilities
Creditors 115,200
57,600
492,800
Capital:
Proton 281,600
Jaguar 211,200
492,800

Proton and Jaguar decided to admit Benz into the partnership effective 1
January 2014 under the following terms and conditions:
(a) The old partners share profits and losses in the same ratios as before;
(b) Benz contributes RM128,000 in cash as capital;
(c) Benz receives 1:4 share of the profits and losses;
(d) The following assets of the old firm are to be revalued as follows; and
RM
(i) Equipment 288,000
(ii) Furniture 192,000
(iii) Debtors 128,000
(iv) Stock 25,600
(e) Business goodwill is to be valued at RM64,000.
Note: Goodwill is to be kept in the books for future amortisation.
Required
(a) Prepare a revaluation account;
(b) Prepare the balance sheet of the new firm after all adjustments have
been made; and
(c) State the partners new profit-sharing ratios.
1. Gordon and Gerald run a business selling household products in Klang. To

start the business, they each contributed RM304,000 and RM240,000
respectively as initial capital. They share profits and losses in the ratio of
2:1. On 1 January 2014, due to family commitment, Gordon faced some
financial difficulty and requested RM64,000 from the partnership. The
withdrawal, as a reduction of Gordons capital contribution, was agreed to
and the partners changed their profit-sharing ratio to 1:1, from 1 January
2014.
Upon the cash withdrawal by Gordon, the partners also agreed to revalue
the land and building to RM128,000 and motor vehicles to RM37,600. Other
assets remained at the same values.

As the accountant for the partnership, you were furnished with the
following balance sheet of Gordon and Gerald as at 31 December 2013:
Gordon and Gerald
RM RM
Fixed assets:
Land and buildings 96,000
Motor vehicles 48,000
Computer 32,000
Current assets: 176,000

Stock 144,000
Debtors 118,400
Bank 105,600
368,000
Capital: 544,000
Gordon
Gerald 304,000
240,000
544,000
Required
Prepare the following accounts for the partnership to reflect the
arrangement made on 1 January 2014:
(a) Revaluation account;
(b) Motor vehicle;
(c) Equipment;
(d) Bank;
(e) Partners capital accounts; and
(f) Balance sheet as at 1 January 2014, immediately after the change in
profit-sharing ratio.

2. Chan, Moseen and Nuzul have been in a partnership business since 2005.
The business involves manufacturing a famous solar system brand in
Malaysia. Currently, they are sharing profits and losses in the ratio of 4:3:3.
The following balance sheet shows the results of the business as at 30
September 2014:
CMN Partners
Balance Sheet as at 30 September 2014
RM RM
Fixed assets:
Premises 75,600
Furniture 20,160
95,760
Current assets:
Stock 18,480
Debtors 20,160
Bank 31,080
69,720
Less:
Current liabilities:
Creditors 18,480
51,240
Long-term liabilities:
Loan Moseen (21,000)
126,000
Capital:
Chan 50,400
Moseen 25,200
Nuzul 25,200
100,800
Current account:
Chan 12,600
Moseen 8,400
Nuzul 4,200
25,200
126,000

Moseen decided to retire on 30 September 2014 when he reached the age of

60. However, Chan and Nuzul are still in their 40s and hope to continue in
the partnership without inviting any new partner to replace Moseen. They
agreed to share the profit in the ratio of 3:2. Moseens loan was repaid on
1 October 2014 and it was agreed that the remaining balance due to him,
other than that on his current account, should remain on loan to the
partnership.
It was agreed that the following adjustments were to be made to the

balance sheet as at 30 September 2014:
(i) Premises to be revalued at RM126,000;
(ii) Furniture to be revalued at RM21,000;
(iii) Debt to be reduced by RM840;
(iv) Credit to be increased by RM1,680;
(v) Stock to be reduced by RM1,260 due to damaged goods;
(vi) Provision of RM420 to be made for professional charges in connection
with the revaluation; and
(vii) Goodwill to be valued at RM58,800 and no goodwill account to be
recorded in the books.
Required
Prepare the following accounts:
(a) The revaluation account;
(b) Capital and current accounts for Chan, Moseen and Nuzul;
(c) Balance sheet of Chan and Nuzul as at 1 October 2014; and
(d) Discuss briefly the different methods in valuing goodwill.

Topic Comprehensive
11 Cases
(Dissolution of
a Partnership)
LEARNING OUTCOMES
1. Explain the reasons for the dissolution of a partnership;
2. Apply the principles in disposal of assets and settlement of
liabilities;
3. Prepare accounts, including realisation account and partners
capital accounts;
4. Apply the principle of Garner versus Murray in the event of a
dissolution; and
5. Calculate cash distribution to partners in the disposal of assets.
INTRODUCTION
Consider yourself involved in a partnership. To make a business decision, all
partners must come to an agreement. What difficulties do you anticipate when
partners are facing a situation similar to that in Figure 11.1?

TOPIC 11 COMPREHENSIVE CASES (DISSOLUTION OF A PARTNERSHIP) 277
Figure 11.1: Partnership and decision-making

Source: www.valdosta.edu/spec/20020214/opinion.shtml
In the previous topic, we discussed changes in ownership of a partnership. In this

topic, we will learn about the circumstances where all the partners leave the
partnership in a cessation of business operations. In this case, all the assets and
liabilities of the partnership will be disposed of and settled in full. The
accounting treatments in this situation are discussed in the following sections.
11.1 REASONS FOR DISSOLUTION OF A

PARTNERSHIP
A partnership agreement is a vital document in ensuring the smooth running of
the business. All partners should agree to run the business indefinitely as long as
the operation is profitable. However, due to personal reasons or unprofitable
trading conditions, a partnership may be terminated.
There are many factors that can bring about the dissolution of a partnership, as
shown in Figure 11.2.

278 TOPIC 11 COMPREHENSIVE CASES (DISSOLUTION OF A PARTNERSHIP)
Figure 11.2: Reasons for dissolution of a partnership
SELF-CHECK 11.1
List at least five reasons for the dissolution of a partnership.

Apart from the mentioned reasons, certain provisions in the Partnership Act can
be applied in court by the partners to wind up the partnership, as illustrated in
Figure 11.3.
Figure 11.3: Provisions in the Partnership Act which can be applied to dissolve a
partnership
When a partnership is dissolved, all its assets and liabilities should be fully
disposed of and settled. Unlike the admission or retirement of partners, the
dissolution of a partnership means the business will no longer exist and therefore
no new partnership agreement is needed.
ACTIVITY 11.1
Find out other reasons for the dissolution of a partnership, apart from
those given earlier. You may refer to a book or to the Internet.
Present your findings in the classroom.

11.2 DISPOSAL OF ASSETS AND SETTLEMENT

OF LIABILITIES
When a partnership is to be closed down, partners have to look for buyers of
their business assets. They are also required to pay off the liabilities of the
partnership by using the proceeds or money generated from the disposal of
assets, plus the cash available in the partnership. Once this is done, partners can
determine the final settlement of their capital and current accounts.
Under normal circumstances, the disposal of the business assets will result in
either a profit or loss. Such profit or loss is to be shared among the partners based
on their profit-sharing ratio.
ACTIVITY 11.2
Imagine you want to wind up your business. Based on your basic
business knowledge, list out at least three things you need to do.
The basic accounting entries for the dissolution of partnerships are relatively
simple. When the dissolution of a partnership takes place, a realisation account is
created (refer to Figure 11.4).
Figure 11.4: Items in a realisation account
Upon the full settlement of the liabilities in the partnership, the available cash in
hand can then be used in paying the partners capital accounts. The following,
Example 11.1, aims to explain the proper accounting entries upon the dissolution
of a partnership.

Example 11.1
Baba and Nyonya have been partners in the floor tiles business for the past 40
years. Despite the wide difference that exists in the partnerships initial capital
contribution, they agree to share profit and loss on a 1:1 basis. As at 30 June
2013, their assets and liabilities were as follows:
Baba and Nyonya

Balance Sheet as at 30 June 2013
RM RM
Fixed asset:
72,800
Equipment
Current assets:
Stock 39,200
Debtors 128,800
Cash at bank 11,200
179,200
Less:
Current liabilities
Creditors 56,000
Loan Baba 28,000
84,000
168,000
Capital accounts:
Baba 156,800
Nyonya 11,200
168,000
Over the years, the partners have been arguing a lot over certain business
practices. On 30 June 2013, they decided to dissolve the partnership.
Baba agreed to take over the stock at a valuation of RM28,000. They managed
to sell the equipment for RM56,000. They only received RM112,000 from
debtors but agreed to treat the amount as final and full settlement. The
realisation expenses were RM11,200. The liabilities had to be paid in full.
Nyonya would pay the amount she owed the firm. The dissolution was
completed by 31 July 2013.

Required
Prepare all relevant accounts, including the realisation account and partners
capital accounts for the purpose of the dissolution.
Solution
Realisation Account
2013 RM 2013 RM
31 Jul Equipment 72,800 31 Jul Cash (Equipment) 56,000
Debtors 128,800 Cash (Debtors) 112,000
Stock 39,200 Baba stock 28,000
Cash realisation exp 11,200 Loss on realisation:
Baba 28,000
Nyonya 28,000
252,000 252,000
Creditors
2013 RM 2013 RM
31 Jul Cash 56,000 1 Jul Balance b/f 56,000
Equipment
2013 RM 2013 RM
1 Jul Balance b/f 72,800 31 Jul Realisation 72,800
Debtors
2013 RM 2013 RM
1 Jul Balance b/f 128,800 31 Jul Realisation 128,800
Loan Baba
2013 RM 2013 RM
31 Jul Cash 28,000 1 Jul Balance b/f 28,000
Cash Account
2013 RM 2013 RM
1 Jul Balance b/f 11,200 31 Jul Realisation exp 11,200
31 Jul Realisation: Equipment 56,000 Creditors 56,000
Realisation: Debtors 112,000 Loan Baba 28,000
Capital Nyonya 16,800 Capital Baba 100,800
196,000 196,000

Capital Account Baba

2013 RM 2013 RM
31 Jul Realisation: Stock 28,000 1 Jul Balance b/f 156,800
Loss on realisation 28,000
Cash 100,800
156,800 156,800
Capital Account Nyonya

2013 RM 2013 RM
31 Jul Loss on realisation 28,000 1 Jul Balance b/f 11,200
31 Jul Cash 16,800
28,000 28,000
ACTIVITY 11.3
Do you agree that the incidence of partnership dissolution among
newly-developed companies is higher compared to that in partnerships
among well-established companies? If yes, state your reasons. Share
your thoughts with your coursemates in the myINSPIRE forum.
11.3 THE GARNER VERSUS MURRAY RULE

The rule of Garner versus Murray is applicable in the case where one partner is
unable to repay his debts in the event of dissolution. When the partners capital
account is in debit, this means that the partner owes the firm. He may not be able
to repay his debts to the partnership due to lack of funds or bankruptcy. This rule
is universally accepted in such a situation.
Garner versus Murray stipulates that in the event of a dissolution, where there
are three or more partners and one of the partners fails to repay his debts to
the partnership, then the solvent partners must take over such debts in the
ratio of their capital contributions at the start of the dissolution.

The following example illustrates the application of the rule of Garner versus
Murray:
Example 11.2
Wilson, Beh and Tee have been in partnership selling toys at Midvalley since
2005. They are sharing profit and loss in the ratio of 3:2:1. Despite its location
in a busy mall, business has not been good. Moreover, Tee has been
withdrawing goods from the business, leaving a debit balance in his capital
account.
On 31 December 2013, the partners decided to dissolve the partnership and

the following is the balance on that date:
WBT Partners
RM RM
Fixed asset:
Furniture 216,000
Current assets:
Stock 162,000
Debtors 54,000
Bank 14,400
230,400
Less:
Current liability:
Creditors 72,000
158,400
Capital:
Tee 57,600
432,000
Capital:
Wilson 288,000
Beh 144,000
432,000
Tee was unable to contribute anything towards the debit in his capital
account. Wilson and Beh agreed to absorb his share in the ratio of their
capitals. Upon the dissolution, they incurred RM7,200 for the realisation of
assets. They managed to dispose of all their assets (other than cash) for
RM396,000.

Required
Prepare all relevant accounts to close the books for the partnership.
Solution
Realisation Account
2013 RM 2013 RM
31 Dec Furniture 216,000 31 Dec Cash 396,000
Stock 162,000 Loss on realisation:

Debtors 54,000 Wilson(3/6) 21,600
Cash realisation
exp 7,200 Beh (2/6) 14,400
Tee (1/6) 7,200
439,200
Creditors
2013 RM 2013 RM
31 Dec Cash 72,000 31 Dec Balance b/f 72,000
Debtors
2013 RM 2013 RM
31 Dec Balance b/f 54,000 31 Dec Realisation 54,000
Stock
2013 RM 2013 RM
Cash Account
2013 RM 2013 RM
Realisation
31 Dec Balance b/f 14,400 31 Dec expenses 7,200
Realisation 396,000 Creditors 72,000
Capital Wilson 223,200
Capital Beh 108,000
410,400 410,400
Capital Account Wong

2013 RM 2013 RM
31 Dec Loss on realisation 21,600 31 Dec Balance b/f 288,000
Capital Tee (2/3) 43,200
Cash 223,200
288,000 288,000

Capital Account Beh

2013 RM 2013 RM
31 Dec Loss on realisation 14,400 31 Dec Balance b/f 144,000
Capital Tee (1/3) 21,600
Cash 108,000
144,000 144,000
Capital Account Tee

2013 RM 2013 RM
31 Dec Balance b/f 57,600 31 Dec Capital Wilson 43,200
Loss on realisation 7,200 Capital Beh 21,600
64,800 64,800
As you can see from the given example, Tee was unable to settle the amount he owed
the partnership. Therefore, Wilson and Beh had to absorb Tees deficit in the ratio of
their capital contributions, that is, RM288,000: RM144,000 (2:1).
Tees deficiency of RM72,000 was shared by Wong and Beh in the ratio of
2:1. Wong was to share 2/3 RM72,000 = RM48,000 whereas, Beh was to share
1/3 RM72,000 = RM24,000.
ACTIVITY 11.4
Do you think the Garner versus Murray rule is important? State your
reasons.
11.4 THE PIECEMEAL REALISATION

To dissolve a partnership, partners may take some time to dispose of all their
assets before profits or losses can be computed and shared among them. Some
partners may want to withdraw cash that is available for distribution among
them rather than wait until the last piece of asset is sold. In this case, proper
accounting records are vital to avoid overpaying the partner before the
dissolution is completed.
In a situation where assets are being disposed of over a period of time, each
disposal of an asset is treated as the last disposal of the partnership assets. Any
profit or loss arising from the disposal is shared among the partners in their
profit and loss sharing ratio. If a partner is unable to meet his financial obligation
after the distribution of profit and loss, the Garner versus Murray rule is to be

applied. The remaining partners have to share the deficit in the ratio of their
capital.
SELF-CHECK 11.2
Answer the following questions:
(a) How long can partnership dissolutions take?
(b) What are the factors that contribute to the delay of the dissolution
process?
The following illustrates the computation mechanism when assets are disposed
of over a period of time.
Example 11.3
Ahmad, John and Silva are childhood friends. Upon graduation, they enter
into a partnership selling nasi lemak in KLSS. They share profit and loss in the
ratio of 3:3:2 respectively. Due to some disagreements among them, the
partnership is dissolved. The following is the balance sheet as at the date of
dissolution:
AJS Partners
RM RM
Fixed assets:
Furniture 64,000
Office equipment 48,000
Current asset:
Stock 80,000
Less: Current liability:

Creditors (28,800)
51,200
163,200
Capital:
Ahmad 64,000
John 96,000
Silva 3,200
163,200

On 1 January 2014, the partners managed to sell some assets for RM60,800.
The creditors and the dissolution cost them RM3,200. The balance of
RM28,800 was left for distribution. On 1 March 2014, John sold more assets
for RM70,400 and this amount was available for distribution. The last group
of assets was sold for RM51,200 on 1 May 2014.
Required
Compute the cash distribution to the partners upon each disposal.
Third and Final Distribution RM RM RM RM

Loss if no further assets sold
Assets 192,000
Proceeds 205,200
Loss of disposal 9,600
Dissolution expenses 3,200
Loss to be shared 12,800 (4,800) (4,800) 3,200
Cash paid to partners (RM64,000) 24,320 26,880
The dissolution of a partnership happens when there are issues such as

disagreements among partners or the business is no longer profitable.
In the event of dissolution, all assets and liabilities of the partnership are to be
disposed of and settled in full.
The capital contributions of partners are to be repaid at the end of the

realisation process.
If a partner is insolvent and unable to contribute further financial resources,

the rule of Garner versus Murray is applied.
The Garner versus Murray rule stipulates that the deficiency of the insolvent
partner must be shared by the solvent partners based on their capital
contributions ratio.

Assets realisation Insolvent partner

Dissolution Realisation account
Garner versus Murray rule
1. Tip, Top and Ted have been in partnership since 2003. Due to Tips poor
health, they decided to dissolve their partnership as at 31 December 2013.
Upon realisation of the business assets, they made a profit of RM4,480.
They were sharing profits and losses in the ratio of 4:3:1. The following
information was extracted from the books of the partnership as at 31
December 2013:
RM
Capital Tip 14,000
Top 11,200
Ted 8,400
Cash at bank 42,280
Sundry creditors 4,200
Required
Prepare the accounts to close the books of the partnership.
2. Alfa and Beta run a florist and shared profit and loss on a 1:1 basis. Due to
the economic downturn and unprofitable trading conditions, they decided
to sell off their business as at 31 March 2014 to a local businessman. Their
balance sheet as at 31 March 2014 was as follows:

AB Florist & Co.

Balance Sheet as at 31 March 2014
RM RM
Fixed assets:
Equipment 81,000
Furniture 10,800
91,800
Current assets:
Stock 5,400
Debtors 22,950
Bank 37,800
66,150
Less:
Current liability:
Creditors (76,950)
(10,800)
81,000
Capital:
Alfa 54,000
Beta 27,000
81,000
The expenses of dissolution were RM3,240. Alfa was to take the stock at a
valuation of RM1,350. They sold the assets as follows:
(a) Debtors RM20,250;
(b) Equipment RM108,000; and
(c) Furniture RM2,700.
Beta managed to get RM4,050 in discount from the creditors.
Required
Prepare the necessary accounts to show the results of the dissolution of the
partnership.
3. May, June and Steven were partners in a catering business in Kajang. In

view of poor management, the partners decided to dissolve their
partnership on 31 December 2013. They made a profit on assets realisation
of RM11,040. The liabilities of the business included sundry creditors of
RM3,840. Cash at bank was RM161,600 after taking into account the
proceeds from the disposal of assets. The capital accounts of the partners
are May RM64,000 (CR), June RM96,000 (CR) and Steven RM13,280
(DR).

Upon the dissolution, Steven claimed that he had no further financial

resources to repay the partnership even though the partners were supposed
to share profits and losses equally.
Required
Draw up the final accounts to close the books of the partnership.
1. Fernandez, Tengku and Ramli were partners selling hand phone gadgets at
a shop in Johor Bahru. They were sharing profits and losses on a 1:1:1 basis.
Tengku was declared bankrupt recently and wanted to withdraw from the
partnership. Fernandez and Ramli felt they would not be able to cope with
the workload and decided to dissolve the partnership on 31 December 2013.
The balance sheet as at the date of dissolution was as follows:
Fernandez, Tengku and Ramli

RM RM
Fixed assets:
192,000
Current assets:
Stock 2,400
Debtors 4,800
Bank 7,200
14,400
Less:
Current liability:
Creditors 19,200
(4,800)
Long-term liabilities:
Mortgage loan (48,000)
Capital
Tengku 4,800
144,000
Capital:
Fernandez 96,000
Ramli 48,000
144,000

They realised their assets at the following valuations:

(i) Land and building RM120,000;
(ii) Motor vehicles RM36,000 (taken by Fernandez);
(iii) Stock RM1,200 (taken by Fernandez); and
(iv) Debtors RM2,400.
The mortgage loan on the land and building was duly discharged and
creditors were settled in full for RM18,000. The costs of dissolution
amounted to RM1,200.
Required
Prepare the following accounts
(a) The realisation account;
(b) The cash account; and
(c) The partners capital accounts.
2. Anson, Henry and Chris ran a pharmacy in Penang. They were sharing
profits and losses on a 1:1:1 basis. As Henry and Chris wanted to do a
Masters course in Canada, they decided to dissolve the partnership. After
several rounds of negotiations, the partners managed to sell their outlet to a
leading pharmaceutical chain in Malaysia at a goodwill of RM52,800. The
company would pay the partners RM180,000 (excluding goodwill) in order
to take over all their assets and liabilities except cash at bank. The balance
sheet as at 31 December 2013, before the buyover was as follows:

AHC Pharmacy
RM RM
Fixed assets:
Equipment 53,700
Computer 33,480
137,580
Current assets:
Stock 59,220
Bank 48,000
107,220
Less:
Current liability:
Creditors (28,800)
78,420
216,000
Capital:
Anson 72,000
Henry 72,000
Chris 72,000
216,000
Required
Prepare the following accounts to reflect the dissolution as at 31 December
2013:
(a) Realisation account;
(b) Cash account; and
(c) Partners capital accounts.

294 ANSWERS
Answers
TOPIC 1: OVERVIEW OF ACCOUNTING
Self-Test 1
1. Accounting can be defined as a process of collecting, identifying,
measuring, recording, summarising and communicating the results of
business or economic transactions to users in order for them to make
informed or better decisions.
There are four components in accounting:
(a) Recording written records of journalising and posting business

transactions;
(b) Summarising preparing the financial statements;
(c) Analysing examining the results to determine the financial position
and performance; and
(d) Interpreting using the financial statements to make judgments and
decisions.
2. To be useful, accounting information has to have the following qualitative

characteristics
(a) Relevance;
(b) Reliability;
(c) Comparability; and
(d) Consistency.
3. Income statements report the financial performance of an entity. It contains

information on revenues and expenses including the profit and loss of the
business entity.

ANSWERS 295
4. Answers are not limited to this.
External Users Type of Information Required
Lenders Cash flow - They are interested to know if the business

will have enough cash to pay back the loan.
Suppliers Profitability - They are interested to know if the business

is profitable and will continue operating before selling
goods on credit.
Government Profitability - Government agencies such as Lembaga

agencies Hasil Dalam Negeri (LHDN) need to know the profit in
order to determine the amount to be taxed.
Customers Profitability - They are interested to know if the business

is profitable and will continue operating before
committing in a long-term relationship.
Internal Users
Employees Profitability - They are interested to know if they will get

bonuses or increments.
Sales managers They need to know what, when and how much to sell.
Production They need to know what, when and how much to

managers produce.
Budget officers
They need the information to monitor cost and
performance.
Self-Test 2
1. Comparability refers to quality of the information that enables users to
make comparison in evaluating similarities or differences between
companies, industries or over time.

296 ANSWERS
Decision making always involves comparing at least two pieces of

information. A single information, for example Syarikat X profit of RM5
million, is not useful to a decision maker. They need to compare it to other
companies profits, last years profits or the industry average in order to
make a decision.
2. Balance Sheet reports the financial position of a business entity. It contains

information on the entitys assets, liabilities and owners equity.
3. Statement of changes in owners equity reports how the owners equity has
changed over the reporting period. It reports how opening capital has
increased through net income, and how it decreased through net losses and
drawings.
4. Cash flow statements show the in-flow and out-flow of cash of an

organisation according to three main activities which are operating,
investing and financing.
5. (a) Income Statement
SMART TUITION CENTRE

Income Statement
RM RM
Revenues
Tuition fees 75,750 75,750
less Expenses
Supplies expenses 6,300
Advertising expense 4,200
General expenses 1,265
Rent expenses 14,400
Utilities expenses 7,350 51,515
Net income 24,235

ANSWERS 297
(b) Statement of changes in owners equity

Statement of Changes in Owners Equity
RM
Opening Capital (1/1/2013) 23,700
+ net income 24,235
47,935
drawings (10,000)
Closing Capital (31/12/2013) 37,935
(c) Balance sheet

RM RM RM
Non-current assets
Computer equipment 17,800 17,800
Current assets
Supplies 8,480
Account Receivables 8,855
Cash 20,000 37,335
Total Assets 55,135
Non-current liabilities
Bank Loan 15,000 15,000
Current liabilities
Account Payables 2,200 2,200
Total liabilities 17,200
Net assets 37,935
Owners equity*
Closing Capital 37,935

298 ANSWERS
Self-Test 3
1.
Financial Accounting Management Accounting

Financial accounting presents a summary Management accounting information is
view of the financial results of past tracked and presented at a much more
operations and its reports are generally detailed level, such as by programme or
aimed at external audiences. branch.
TOPIC 2: ACCOUNTING PRINCIPLES AND CONCEPTS
Self-Test 1
1. (a) MASB publishes accounting standards.
(b) MICPA and MIA provide training to accountants.
(c) MIA controls the accounting practice in Malaysia
(d) MASB issues statements of principles for financial reporting.
2. No. The Companies Act 1965 requires companies to comply with approved
accounting standards. Section 166A of the Companies Act 1965 requires
directors of companies incorporated under the Act to ensure accounts are
prepared in accordance with the applicable accounting standards to the
extent that the accounts give a true and fair view.
3. Ticket sales, holiday package, rentals of planes and advertising are

subjected to full or partial refund if customers cancel their booking. For this
type of transaction when the seller has an obligation to refund money upon
cancellation, it is normal to recognise revenue only at the date which the
service is provided or on the date that cancellation will not be refunded at
all.
For sales of tickets for super saver flight which is non-refundable, the airline
can recognise them as revenue at the point of sale as they do not have any
obligation to refund the fees.

ANSWERS 299
4.
Business Type of Business
Car rentals Service
Car dealerships Merchandising (trading/retailing)
Tuition centres Service
Batik factory Manufacturing
Tailor Service
Clothing stores Merchandising (trading/retailing)
Self-Test 2
1. Explain the following accounting assumptions:
(a) Separate Entity

For accounting purposes, the business is considered as a separate
entity from the owner. Both the owner and the business are two
separate accounting entities. An accounting entity is an economic unit
that controls its own resources.
(b) Going Concern

An entity is assumed to be continuing its operations in the foreseeable
future and will not cease operations.
(c) Monetary Units

All transactions can be measured in monetary units. In Malaysia, the
monetary unit is Ringgit Malaysia (RM). Items that cannot be
measured in monetary unit will not be reported in the financial
statements but disclosed as notes.
(d) Accounting Period

This assumption states that the life of a business entity can be divided
into periodic intervals. This enables financial statements to be
prepared periodically.
2. Explain the following accounting principles:
(a) Historical Cost

This principle states that all transactions must be recorded and
accounted for according to their historical cost.

300 ANSWERS
(b) Revenue Recognition

This principle states that revenues must be recognised when they are
earned. Earned commonly refers to the act of providing goods or
services to customers.
(c) Matching
To determine profit for the accounting period, the revenues of that
period must be matched with the expenses for the same period.
(d) Full Disclosure

This principle states that all relevant and material information must be
adequately disclosed either in the financial statements or as notes
accompanying the statements.
3. (a) Sole Proprietorship;

(b) Partnership; and
(c) Company.
4. Characteristics of sole proprietorship, partnership and company.
Sole Proprietorship Partnership Company

1. Owner (s) Proprietor Partners Shareholders
2. Life of Limited Limited Indefinite
organisation
3. Liabilities Unlimited Unlimited Limited
4. Accounting Business is Business is separate Business is separate
status separate from the from the partners. from the shareholders.
proprietor.
5. Legal status None None A separate legal entity
6. Formation Relatively easy Relatively easy Complex
7. Management Normally by the Normally by the Managers or directors
owner partners
8. Tax Proprietor pays tax Each partner pays Companies pay tax on
on business profit. tax on his share of the business profit and
the profits. shareholders pay tax
on the amount of
dividend they receive.
(Double Taxation)

ANSWERS 301
Self-Test 3
1.
(a) Liability
(b) Liability
(c) Asset
(d) Asset
(e) Liability
(f) Asset
Self-Test 4
1.
(a) Asset
(b) Asset
(c) Liability
(d) Asset
(e) Asset
(f) Liability
(g) Asset
(h) Liability
(i) Asset
TOPIC 3: ACCOUNTING CYCLE

Self-Test 1
1.
Assets Liabilities Owner's Equity
Business A 79,500 45,000 34,500
Business B 68,600 23,000 45,600
Business C 163,700 59,200 104,500

302 ANSWERS
2 (a) Indicate whether the following items are A (Assets), L (Liabilities), R

(Revenues) or E (Expenses).
(i) Cash (A) (viii) Accounts payable (L)
(ii) Bank loan (L) (ix) Accounts receivable (A)
(iii) Equipment (A) (x) Sales (R)
(iv) Notes payable (L) (xi) Supplies (A)
(v) Insurance (E) (xii) Advertising (E)
(vi) Salaries (E) (xiii) Salaries payables (L)
(vii) Furniture and fittings (A) (xiv) Motor vehicle (A)
(b) Explain how the following transactions will affect the accounting
equation. Identify the account affected.
(i) Pay cash for postage
Decrease in asset (cash) and decrease in owners equity through
increase in expense (postage).
(ii) Buy furniture and fittings on credit
Increase in assets (furniture and fittings) and increase in
liabilities (accounts payable).
(iii) Bring own motor vehicle to be used for business purposes
Increase in assets (motor vehicle) and increase in owners equity
(capital).
(iv) Pay salaries to workers
Decrease in asset (cash) and decrease in owners equity through
increase in expense (salaries).
(v) Receive rentals from tenants
Increase in asset (cash) and increase in owners equity through
increase in revenue (rental income).
Self-Test 2
1. (a) Transactions of Azwan Enterprise.
Transactions Descriptions
1 - Purchased supplies worth RM1,000 for cash.
2 - Received RM2,000 cash from debtor.
3 - Paid off bank loan for the amount of RM4,000 cash.

ANSWERS 303
4 - Paid rental RM1,000 cash.

5 - Paid wages RM2,000 cash.
6 - Received RM7,000 cash for work performed (printing service).
7 - Purchased supplies worth RM1,500 on credit.
8 - Provided printing services to client but payment will be received
later.
9 - Supplies used.
(b) Balance of the account as at 31/1/2013.
Accounts Account Bank

Date Cash Supplies Land Capital
Receivable Payable Loan
Ending
balance, 8,500 5,300 1,700 38,000 5,200 6,000 42,300
31/1/2013
(c) Accounting equation of Azwan Enterprise.
Assets = Liabilities + Owners Equity

Cash + A/R + Supplies + Land = A/P + Bank Loan + Capital
8,500 + 5,300 + 1,700 + 38,000 = 5,200 + 6,000 + 42,300
53,500 = 11,200 + 42,300
(d) Total Revenue Total Expense = Income

(i) Service Revenue (Rental expense + Wages expense +
Supplies used) = Income
(ii) RM10,500 (RM1,000 + RM2,000 + RM1,200) =
Income
(iii) Therefore income (profit) is RM6,300.
Did you notice that the difference between the opening capital balance
(RM36,000) and closing capital balance (42,300) is exactly RM6,300, which is
the profit made by Azwan Enterprise?
Can you see the relationship between them?

304 ANSWERS
Profit is revenue minus expense, and you have learned earlier that revenue
will increase owners equity while expense will decrease owners equity.
Therefore, if you know the opening capital balance and closing capital
balance (assuming there is no drawing made by owner) you can determine
the profit.
2. (a) Transactions analysis: Effects on accounting equation.

Feb
1 Asset (cash) increased, liability (loan) increased and owner's
equity (capital) increased.
2 Asset (cash) decreased and another asset (furniture and fittings)
increased.
5 Asset (beauty supplies) increased, liability (accounts payable)
increased.
7 Asset (accounts receivable) increased, owner's equity (revenue)
increased.
10 Asset (cash) decreased, owner's equity (drawings) decreased.
12 Not a transaction for the beauty salon.
15 Asset (cash) increased, owner's equity (consultation fees) increased.
16 Asset (cash) decreased, another asset (motor vehicle) increased
and liability (loan) increased.
17 Asset (cash) increased and another asset (accounts receivable)
decreased.
25 Asset (cash) decreased, liability (account payables) decreased.
27 Asset (beauty supplies) increased and another asset (cash)
decreased.
28 Asset (cash) decreased, owners equity (expenses) decreased.

ANSWERS 305
(b) Transaction analysis.
Transa Owners
ASSETS = LIABILITIES +
ctions Equity
(Feb.
2005) Furniture Account
Beauty Motor Account
Cash + + and + + Receivab = Loan + + Capital
Supplies Vehicle Payables
fittings les
1 250,000 = 100,000 + 150,000

Bal. 250,000 = 100,000 + 150,000
2 (25,000) + 25,000 =
Bal. 225,000 + 25,000 = 100,000 + 150,000
5 4,000 = 4,000
Bal. 225,000 + 4,000 + 25,000 = 100,000 + 4,000 + 150,000
5,000
5,000 =
7 Revenues
Bal.e 225,000 + 4,000 + 25,000 5,000 = 100,000 + 4,000 + 155,000
(20,000)
(20,000) =
10 Drawings
Bal. 205,000 + 4,000 + 25,000 5,000 = 100,000 + 4,000 + 135,000
12 Not a transaction for the beauty salon
Bal. 205,000 + 4,000 + 25,000 5,000 = 100,000 + 4,000 + 135,000
3,000
3,000 =
15 Revenues
Bal. 208,000 + 4,000 + 25,000 5,000 = 100,000 + 4,000 + 138,000
16 (5,000) + 20,000 = 15,000
Bal. 203,000 + 4,000 + 25,000 + 20,000 5,000 = 115,000 + 4,000 + 138,000
17 3,000 + (3,000) =
Bal. 206,000 + 4,000 + 25,000 + 20,000 + 2,000 = 115,000 4,000 138,000
25 (4,000) = (4,000)
Bal. 202,000 + 4,000 + 25,000 + 20,000 + 2,000 = 115,000 + 0 + 138,000
27 (5,000) + 5,000 =
Bal. 197,000 + 9,000 + 25,000 + 20,000 2,000 = 115,000 + 0 + 138,000
(100)
(3,600) =
28 electricity
(1,500)
+
rentals
(2,000)
+
salaries
Bal. 193,400 + 9,000 + 25,000 + 20,000 + 2,000 = 115,000 + 0 + 134,400

306 ANSWERS
Self-Test 3
1.
Purupuru
Balance sheet as at 31 December 2013
RM RM
Fixed assets:
Fixtures 1,800
Van 3,800 5,600
Current assets:
Stock of goods 4.200
Debtors 1.200
Cash at bank 300
5,700
Less: Current liabilities
Creditors 4,100 1,600
7,200
Capital 7,200
Self-Test 4
1.
Cash
June 1 Capital 12,000 June 2 Bank 11,700
25 Equipment 200
28 Bank 300
Capital
June 1 Cash 12,000
Office furniture
June 5 OrangeCo 1,900 June 18 OrangeCo 120
Van
June 8 Bank 5,250

ANSWERS 307
Equipment
June 12 PineappleCo 2,300 June 25 Cash 200
Bank
June 2 Cash 11,700 June 8 Van 5,250
30 KiwiCo 4,000 26 OrangeCo 1,780
28 Cash 130
OrangeCo
June 18 Office furniture 120 June 5 Office furniture 1,900
26 Bank 1,780
PineappleCo
June 12 Equipment 2,300
KiwiCo
June 30 Bank 4,000
TOPIC 4: ADJUSTING ENTRIES AND CLOSING ENTRIES

Self-Test 1
1. (a) Cash basis accounting
Onn & Sons Enterprise

Income Statement for the month ended 31 January 2013
RM RM
Revenues
Service revenues 27,500
less Expenses
Supplies expense (5,000)
Rental expenses (3,000) (8,000)
Net income 19,500

308 ANSWERS
(b) Accrual basis accounting
Onn & Sons Enterprise

Income Statement for the month ended 31 January 2013
RM RM
Revenues
Service revenues 35,000
less Expenses
Salaries expenses (2,000)
Supplies expense (3,000)
Rental expenses (1,000) (6,000)
Net income 29,000
2. Working
Total office supplies Supplies on hand at the end of period = Office used
supplies
(RM1,617 + RM3,603) RM526 = RM4,694
Journal entry
Dr Office Supplies Expense 4,694

Cr Office Supplies 4,694
To record office supplies used
3. This exercise will be easier to see if you draw the timeline diagram.
Working
1/1/2013 31/8/2013 31/12/2013
Prepaid insurance = RM400 1 Renewed 3 years policy RM2,160 2 2013

Expenses?

ANSWERS 309
1 This will expire (used up) by 1/9/2013 and will be expensed for 2013.
2 This will provide coverage until 31/8/2016, however until 31/12/2013 it

provides four months coverage to the business and hence needs to be
expensed.
1 January to 31 August 2013 insurance expense = RM400 + 1 Sept to 31

December 2013 insurance expense = RM240 (RM2,160 4/36)
Journal entry
Dr Insurance Expense 640

Cr Prepaid Insurance 640
To record insurance expired.
4. Working
For only nine months (April to September) the magazine has been sent to
client therefore Ujang only earned RM450 revenue (RM1,800 9/36).
Journal Entry
Dr Subscription Received in Advanced 450

Cr Subscription Revenue 450
To record subscription revenue earned (9 months)
Self-Test 2
1. Interest on note payable = (RM30,000 12%) 3/12) = RM900.
Journal entry
Dr Interest Expense 900

Cr Interest Payable 900
To record interest expense accrued.
2. Interest earned on the fixed deposit = (RM24,000 12%) 3/12) = RM720.
This will not be received until 31 March 2013, but you have earned the
interest revenue and will be receiving it later. Hence, revenues should be
recognised.

310 ANSWERS
Journal entry
Dr Interest receivables 720

Cr Interest income 720
To record interest income earned.
3. (a) Journal entries
01/01/2013 Not a transaction. Balance is shown in the Accounts Receivable
05/01/2013 Dr Accounts Receivable - Venus 600

Cr Sales 600
Sold goods on credit to Venus
10/02/2013 Dr Bad Debts Expenses 300

Cr Accounts Receivable - Star 300
Writing off Star accounts as bad due to bankruptcy.
07/10/2013 Dr Cash 200

Cr Accounts Receivable - Venus 200
Venus paid RM200 as full settlement of his account
Dr Bad Debts Expenses 400

Cr Accounts Receivable - Venus 400
Writing off balance of Venus account RM400 as bad
01/12/2013 Dr Accounts Receivable - Star 100

Cr Bad debts recovered 100
Bad debt recovered from Star RM100
Dr Cash 100
Cr Accounts Receivable - Star 100
To record the receipt of RM100 from Star.

ANSWERS 311
(b) Ledger
Bad Debts Expense

10/2 Accounts receivable Star 300 Year end P&L 600
10/2 Accounts receivable 300
Venus
600 600
Bad Debts Recovered

Year end 100 1/6 Account receivable Star 100
P&L
Accounts Receivable- Star

1/1 b/d 300 10/2 Bad Debts Expense 300
1/6 Bad Debts Recovered 100 1/6 Cash 100
Accounts Receivable- Venus

5/1 Sales 500 10/5 Cash 200
10/5 Bad Debts Expense 300
500 500
4. (i) Journal entries Debit Credit

Dr Supplies expense 350
Cr Supplies 350
Dr Insurance expense 2,400

Cr Prepaid insurance 2,400
(RM4,800 / 2 years = RM 2,400 p.a.)

312 ANSWERS
Cr Accumulated depreciation - Building 3,000

(RM60,000 x 5%)

Cr Accumulated depreciation - Motor vehicle 6,000
(RM30,000 / 5 years = RM6,000 p.a.)
Dr Accounting fees 3,400
Cr Unearned accounting fees 3,400
Dr Rental receivables 500

Cr Rental revenues 500

Cr Interest payable 300
Dr Salaries expenses 600

Cr Salaries payable 600
Dr Utilities expense 200

Cr Utilities payable 200
Dr Income summary 300

Cr Provision for doubtful debts 300

ANSWERS 313
(ii) Adjusted trial balance
MKS Accounting Firm

Adjusted Trial Balance as at 30 June 2013
Accounts Debit (RM) Credit (RM)
Cash 13,000
Office supplies 150
Provision for doubtful 300
debts
Rental receivables 500
Building 60,000
Accumulated 3,000
Depreciation - Building
Accumulated 6,000
Depreciation - Motor
vehicle
Unearned accounting fees 3,400
Salaries payable 600
Utilities payable 200
Interest payable 300
Bank loan 25,000
Capital - MKS 60,000
Drawings - MKS 1,200
Rental revenues 2,900
Interest expense 1,300
Supplies expense 350
Doubtful debts 300
Depreciation expense 9,000
129,600 129,600

314 ANSWERS
The adjusting entries and adjusted trial balance can also be combined as a
worksheet (see the following worksheet):
MKS Accounting Firm

Worksheet as at 30 June 2013
Unadjusted T.B. Adjustment Adjusted T.B.
Account
Dr Cr Dr Cr Dr Cr
Cash 13,000 13,000
Office supplies 500 350 150
Accounts receivable 2,300 2,300
Prepaid insurance 4,800 2,400 2,400
Building 60,000 60,000
Motor vehicle 30,000 30,000
Accounts payable 5,600 5,600
Bank loan 25,000 25,000
Capital - MKS 60,000 60,000
Drawings - MKS 1,200 1,200
Accounting fees 25,700 3,400 22,300
Rental revenues 2,400 500 2,900
Interest expense 1,000 300 1,300
Salaries expenses 4,500 600 5,100
Utilities expenses 1,400 200 1,600
Supplies expense 350 350
Insurance expense 2,400 2,400
Depreciation expense 9,000 9,000
Accumulated depreciation 3,000 3,000
Building
Accumulated depreciation 6,000 6,000
- Motor vehicle
Unearned accounting fees 3,400 3,400
Rental receivables 500 500
Utilities payable 200 200
Interest payable 300 300
Salaries payable 600 600
Doubtful debts 300 300
Provision for doubtful 300 300
Debts
118,700 118,700 17,050 17,050 129,600 129,600

ANSWERS 315
It is common for a business not to record an adjusting entry in a journal, but

instead, show it in a ten column worksheet. The above is a partial
worksheet, as it does not include the income summary and balance sheet
column. Can you see the effect of adjustment entries to the unadjusted trial
balance figure? Some adjustments will increase the balances, while others
decrease the balance. This increase and decrease are according to their
normal balances rules.
Can you see that additional accounts are created after adjustments are
made? Did you notice how there are no adjustment entries that involve
cash. And for each adjustment entry there will be one item of balance sheet
and another item of income statement affected.
(iii) Income statement for MKS Accounting Firm
MKS Accounting Firm

Income statement for the year ended 30 June 2013
RM RM
Revenues
Rental revenues 2,900 25,200
Less Operating expenses
Interest expense (1,300)
Salaries expenses (5,100)
Utilities expenses (1,600)
Supplies expense (350)
Insurance expense (2,400)
Doubtful debts (300)
Depreciation expense (9,000) (20,050)
Net Income 5,150
(iv) Balance Sheet for MKS Accounting Firm
MKS Accounting Firm

Balance Sheet as at 30 June 2013
RM RM RM
Current assets
Cash 13,000
Office supplies 150

316 ANSWERS
Less provision for doubtful 300 2,000

debts
Rental receivables 500
Total current assets 18,050
Non-current assets
Building 60,000
Accumulated depreciation (3,000) 57,000
Building
Accumulated depreciation - (6,000) 24,000
Motor vehicle
Total non-current assets 81,000
TOTAL ASSETS 99,050
Current liabilities
Unearned accounting fees 3,400
Salaries payable 600
Interest payable 300
Utilities payable 200
Total current liabilities 10,100
Non-current liabilities
Bank loan 25,000
Total non-current liabilities 25,000
TOTAL LIABILITIES 35,100
NET ASSETS 63,950
Owners Equity
Beginning capital 1/7/12 60,000
Add net income 5,150
65,150
Less drawings 1,200
Closing capital 30/6/13 63,950

ANSWERS 317
(v) Closing entries
Dr Accounting fees 22,300

Dr Rental revenues 2,900
To close revenue accounts to income summary account

Cr Interest expense 1,300
Cr Salaries expenses 5,100
Cr Utilities expenses 1,600
Cr Supplies expense 350
Cr Insurance expense 2,400
Cr Doubtful Debts 300
Cr Depreciation expense 9,000
To close expense accounts to income summary account

Cr Capital 5,150
To close income summary to capital account
Dr Drawings 1,200
Cr Capital 1,200
To close drawings account to capital account
(vi) Income summary account
Income Summary
30/6/13 Interest expense 1,300 30/6/13 Accounting fees 22,300
Salaries expenses 5,100 Rental revenues 2,900
Supplies expense 350
Doubtful debts 300
Depreciation expense 9,000
Capital 5,150
25,200 25,200

318 ANSWERS
(v) Capital account
Capital
30/6/13 Drawings 1,200 30/6/13 Balance 60,000
Closing balance 63,950 Income 5,150
summary
65,150 65,150
Can you see the relationship between the capital account and the statement of
changes in owners equity? Statement of changes in owners equity (or the
owners equity component in the balance sheet) is actually the statement format
of capital account. See the following statement of owners equity for MKS.
MKS Accounting Firm
Statement of Changes in Owners Equity as at 30 June 2013

RM RM RM
Beginning capital 1/7/12 60,000
Add net income 5,150
65,150
Less drawings (1,200)
Closing capital 30/6/13 63,950

ANSWERS 319
TOPIC 5: ACCOUNTING FOR CURRENT ASSETS

Self-Test 1
1. (i) Update the cash account
Cash Account
Balance b/d 4,650 Cash payments 3,670
Cash receipts 7,600 Service charge 20
A/R - Jaya Holding 3,300 Insurance 2,400
Interest revenue 15 A/R - Sukar 700
A/P-Anita 90 Balance c/d 8,865
15,655 15,655
(ii) Journal entries
Journal Entries
31/5/08 Dr Cash 3,300
Cr A/R - Jaya Holding 3,300
To record receipt of payment into bank account from AR-Jaya
Holding
Dr Cash 15
Cr Interest revenue 15
To record interest revenue
Dr Cash 90
Cr AP-Anita 90
To correct error in recording payment to AP-Anita
Dr Service charge 20
Cr Cash 20
To record service charge
Dr Insurance 2,400
Cr Cash 2,400
To record insurance
Dr A/R - Sukar 700

Cr Cash 700
To record dishonoured cheque from AR-Sukar

320 ANSWERS
(iii) Prepare bank reconciliation statement.
Syarikat Kampung
Bank Reconciliation as at 31 May 2008
RM RM
Balance per cash account 8,865
Add Unpresented cheques
Cheque 10345 450
Cheque 10347 590
Cheque 10348 430 1,470
10,335
Cash deposit 2,460
Less Bank error 1,200 3,660
6,675
2. Bank reconciliation is prepared to identify and to explain why there are

differences in the balance of cash in the cash account and the balance
reported by the bank in the bank statement.
This also helps businesses to detect mistakes and misappropriation that

might have happened.
3. Items that require adjustments are amounts that have been deducted
(debited) by banks before a business makes the entries. Examples are
standing instructions to repay loan amounts, and auto debit giro to pay
utility bills. Amounts that have been added (credited) to the bank current
account also need to be journalised, for example, deposits made directly to
the bank by another third party, dividends credited by banks or interests
earned on the bank account.
The entries are made to ensure the balance of cash account is correct. This is
due to the fact that the items have not been recorded in the cash account or
items have been recorded in the cash book, but errors have been made and
need to be corrected or cancelled.

ANSWERS 321
If no entries are made, the cash account balance will not reflect the true
amount. Certain expenses or revenues will also be understated, as they are
not recorded (for example, bank service charges deducted). Certain
liabilities or assets will be overstated, for example auto payment of bank
loan was not recorded.
4. A dishonoured cheque will be deducted (credited) from the cash account as

originally the amount had been added (debited) when the cheque was
received as payment. In fact, as the cheque was dishonoured, the amount of
cash balance should exclude the amount of the dishonoured cheque as we
would not be able to receive any cash from it. Therefore by crediting
(deducting) the amount from cash account, we actually cancel the amount
that we had originally debited.
Self-Test 2
1. There is a shortage of RM21.10. Petty cash on hand of RM46.70 plus
payments of RM182.20 is not equal to RM250.
Dr Stationeries 73.50
Dr Transportation expenses 18.10
Dr Repairs and maintenance 45.00
Dr Miscellaneous expenses 45.60
Dr Cash short and over 21.10
Cr Cash 203.30
To record petty cash reimbursement
The journal entry to record the increase in petty cash fund is as follows:
Dr Petty cash 50
Cr Cash 50
To increase the amount of petty cash fund.
TOPIC 6: ACCOUNTING FOR NON CURRENT ASSETS

Self-Test 1
1. Cost of delivery Van
RM
Purchase price 65,700
Sales tax 6,500
72,200

322 ANSWERS
Road tax and insurance are revenue expenditures and you will incur these
types of expenses each year in order to be able to use the delivery van.
2.
RM
Repairs (replaced two punctured tyres) 1,500 - Revenue
expenditure.
Installed roof top carrier 2,000 - Capital
expenditure, the roof
carrier will extend the
capabilities of the delivery
van.
Replaced front windshield 1,000 - Revenue
expenditure.
Petrol 2,200 - Revenue
expenditure.
Self-Test 2
1. Depreciation table
(a) Straight line method

Date
RM RM RM RM RM
01/01/2008 66,000
31/12/2008 10% X 60,000 6,000 6,000 60,000
31/12/2009 10% X 60,000 6,000 12,000 54,000
31/12/2010 10% X 60,000 6,000 18,000 48,000
31/12/2011 10% X 60,000 6,000 24,000 42,000
31/12/2012 10% X 60,000 6,000 30,000 36,000
100% / 10 years = 10% per annum or RM60,000 / 10 years = RM6,000 per annum
(b) Reducing balance
6,600
1 10 1 0.79 0.21 21%
66,000

ANSWERS 323

Date Amount Expense Depreciation Amount
Cost Rate
RM RM RM RM RM
1/1/2008 66,000
31/12/2008 21% X 66,000 13,860 13,860 52,140
31/12/2009 21% X 52,140 10,949 24,809 41,191
31/12/2010 21% X 41,191 8,650 33,459 32,541
31/12/2011 21% X 32,541 6,834 40,293 25,707
31/12/2012 21% X 25,707 5,398 45,691 20,309
(c) Unit-of-production

Date
RM RM RM RM RM
1/1/2008 66,000
31/12/2008 $ 0.0006 X 15,400,000 9,240 9,240 56,760
31/12/2009 $ 0.0006 X 13,600,000 8,160 17,400 48,600
31/12/2010 $ 0.0006 X 11,200,000 6,720 24,120 41,880
31/12/2011 $ 0.0006 X 12,500,000 7,500 31,620 34,380
31/12/2012 $ 0.0006 X 12,500,000 7,500 39,120 26,880
Depreciation rate per page = (RM60,000 / 100,000,000 pages) = RM0.0006 per page
2. Journal entries to record the disposal of non-current assets.
(a)
Dr
Accumulated depreciation 64,000
Dr
Income summary 13,000
Cr Machinery 77,000
To record the retirement of machinery as scrap (no value)
(b)
Dr Cash 13,000
Cr Machinery 77,000

324 ANSWERS
To record the disposal of machinery at carrying amount.
(c) Dr Cash 20,000

Cr Machinery 77,000
To record the loss on disposal of machinery
(d) Dr Cash 10,000

Cr Machinery 77,000
To record the loss on disposal of machinery
(e) Dr Machinery (new) 55,000

Cr Machinery 77,000
Cr Cash 32,000
To record the gain on trade in of machinery
(f) Dr Machinery (new) 65,000

Cr Machinery 77,000
Cr Cash 56,000
To record the loss on trade in of machinery

ANSWERS 325
TOPIC 7: PROPERTY, PLANT AND EQUIPMENT (MFRS

116)
Self-Test 1
1. RM
Less: Trade discount (4,500)
145,500
Delivery and handling costs 7,000
Total 162,500
2. Cost of land:
RM
Land cost 500,000
Legal fees and stamp duty for purchase of land 14,000
Cost of demolishing old building on the land 50,000
Cost of clearing and levelling the land 50,000
614,000
Cost of Factory:
Architect fees RM
Piling and foundation works 55,000
Legal fees for agreement with building contractor 200,000
Construction cost 3,000
Plumbing and wiring 480,000
200,000
938,000
3. Machinery Account
2014 Bal b/f 100,000 2014 Disposal 50,000
Bank 20,000 Bal c/f 70,000
120,000 120,000

326 ANSWERS
Accumulated Depreciation Account

2014 Machinery 2014 Bal b/d 60,000
Disposal 30,000
Bal c/f 33,077 Depreciation Income
statement 3,077
63,077 63,077
Machinery Disposal
2014 Machinery 50,000 2014 Accumulated depreciation 30,000
Wong Sdn Bhd 15,000
Loss in disposal 5,000
50,000 50,000
Self-Test 2
1. (a) Write off RM60,000 and capitalise RM15,000
(b) Depreciation charge for 2013
Net Carrying Amount * + Subsequent Expenditure Residual Value

=
Remaining Useful Life
= RM270,000 RM100,000 + RM15,000 RM20,000

3 years
= RM55,000
RM (80,000 8,000)
2. Annual depreciation =
8 years
= RM9,000
It is assumed that in 2008 only a half years depreciation was charged
because the asset was purchased six months into the year.
RM RM
Machine at cost 80,000
Depreciation 2008 4,500
Depreciation 2009, 2010, 2011, 2012, 2013 45,000
Accumulated depreciation (49,500)
Net carrying amount at the date of disposal (31/12/2013) 30,500
Sale price 25,000
Cost incurred in making the sale (3,000)
Net selling price (22,000)
Loss on disposal 8,500
This loss will be shown as an expense in the income statement.

ANSWERS 327
3. Medical Equipment
1.1.2009 Cash 400,000 1.1.2012 Accumulated
depreciation 240,000
1.1.2013 Revaluation surplus 140,000 1.1.2014 Disposal 300,000
540,000 540,000
Accumulated Depreciation
1.1.2012 Medical equipment 240,000 31.12.2009 Depreciation 80,000
31.12.2010 Depreciation 80,000
31.12.2011 Depreciation 80,000
240,000 240,000
1.1.2014 Disposal 200,000 31.12.2012 Depreciation 100,000

31.12.2013 Depreciation 100,000
200,000 200,000
Disposal of Medical Equipment

1.1.2014 Medical equipment 300,000 1.1.2014 Accumulated 200,000
depreciation
Gain on disposal 20,000 Cash 120,000
320,000 320,000
Revaluation Reserve
Medical
1.1.2014 Income statement 140,000 1.1.2012 equipment 140,000

328 ANSWERS
TOPIC 8: ACCOUNTING FOR LIABILITIES AND EQUITY

Self-Test 1
1. (a) Extract of balance sheet as at 31 December 2012
Syarikat Demo
as at 31/12/2012
RM RM
Current Liabilities
Accrued interest 12,500
Current portion of long term loan - Putrajaya Bank 50,000 62,500
Long Term Loan

Long term loan - Putrajaya Bank 450,000
512,500
Working:
Accrued interest of the loan is RM500,000 x 5% x 6/12 = RM12,500.
First instalment due within twelve months is RM50,000.
(b) Journal entries to record payment of interest on 1 January 2013
Dr Interest payable 12,500

Cr Cash 12,500
To record the payment of accrued interest.
(c) Journal entries to record payment of interest on 1 July 2013
Dr Interest expense 12,500

Dr Bank Loan - Putrajaya 50,000
Cr Cash 62,500
To record the payment of first instalment and the interest charges.

ANSWERS 329
(d) Extract of balance sheet as at 31/12/2014
Syarikat Demo
as at 31/12/2014
RM RM
Current Liabilities
Accrued interest 12,500
Current portion of long term loan - Putrajaya Bank 50,000 62,500
Long Term Loan

Long term loan - Putrajaya Bank 350,000
412,500
Working:
From 31/12/ 2012 until 31/12/2014, two instalments of principles were
made, meaning the balance of the loan is RM400,000. Out of this amount,
RM50,000 is due within the next twelve months (1 June 2015). As at
31/12/2010, Syarikat Demo has accrued RM12,500 (original loan amount of
RM500,000 x 5% x 6/12) interest and this to be paid on 1 January 2015.
2. (a) Nominal value of preference share is RM300,000

(300,000 shares x RM1 par value)
Dividend is RM24,000 (8% x RM300,000)
(b) Nominal value of preference share is RM800,000

(c) Nominal value of ordinary share is RM250,000

(500,000 shares x 50 cents par value)
(d) Nominal value of ordinary share is RM200,000

(e) Nominal value of ordinary share is RM250,000

(500,000 shares x RM0.50 par value)

330 ANSWERS
However dividend is paid 5 cents per share, therefore dividend paid

is RM25,000 (500,000 shares x 5 cents)
Self-Test 2
1. (a) Equity of a partnership comprises capital and current accounts.
(b) Equity of a company comprises shareholders fund, retained earnings
and reserves accounts.
(c) There are two main types of shares: ordinary shares and preference
shares.
(d) Instead of making drawings, shareholders are paid dividends.
(e) Dividends and transfer to reserves will decrease the retained earnings
balance, while earnings after tax will increase the retained earnings.
2. (a) Calculate earnings after tax
M&S Corporation
Income Statement
for the year ended 31/12/2013
RM
Revenue 57,500,000
Less Cost of goods sold (15,000,000)
Gross margin 42,500,000
Less Operating Expenses (18,000,000)
Earnings before tax 24,500,000
Less Tax expenses (7,350,000)
Earnings after tax 17,150,000

ANSWERS 331
(b) Prepare statement of retained earnings
M&S Corporation
Statement of Retained Earnings
for the year ended 31/12/2013
RM RM
Opening retained earnings 25,600,000
Add earnings after tax 17,150,000
Earnings available for distribution 42,750,000
Less
Ordinary Shares Dividends (210,000)
Preference Shares Dividends (125,000) (335,000)
Transfer to General Reserves (3,500,000)
Closing Retained Earnings 38,915,000
(c) Extract of balance sheet
M&S Corporation
as at 31/12/2013
RM RM
Equity
Shareholders funds
Ordinary shares 3 million shares 2,100,000
Preference shares 5 million shares 2,500,000 4,600,000
Retained earnings 38,915,000
General reserves 15,500,000
Total equity 59,015,000

332 ANSWERS
Self-Test 3
1.
DJ
Balance sheet as at 30 June 2014
Fixed assets: RM RM
Premises 76,000
Current assets:
Stock 24,000
Debtors 2,800
Cash and bank 5,400
32,200
Less: current liabilities
Creditors 7,600 24,600
100,600
Mortgage 50,000
50,600
Capital:
Balance at 1/7/2013 40,000
Capital introduced 6,000
Net profit 13,600
59,600
Less: Drawings 9,000
50,600
Self-Test 4
1.
Lafferty
Balance sheet as at 31 December 2014
Fixed assets: RM RM
Fixtures and fittings 5,000
Current assets:
Stock 3,000
Debtors 6,800
Bank 15,100
Cash 200
25,100

ANSWERS 333
Less: current liabilities

Creditors (9,100)
16,000
21,000
Capital:
Cash introduced 20,000
Add: Net profit for the year 8,000
28,000
Less: Drawings (7,000)
21,000
Self-Test 5
1.
(a) The amount paid for goodwill.
(b) The excess represents share premium.
(c) Equity shares generally mean ordinary shares.
(d) That although issued in 2013 a dividend will not be paid in that year.
The first year that dividends could be paid is 2014.
Self-Test 6
1.
Balance sheet
As at 31 March 2013
(a) Kagawa (b) Kenshin
Goodwill 34,771 23,699
Premises 190,000 205,000
Stock 39,200 36,100
Debtors 18,417 18,417
Bank 828___ -______
283,216 283,216
Less: Creditors (23,216) (23,216)
260,000 260,000
Capital 260,000 260,000

334 ANSWERS
TOPIC 9: INTEGRITY AND ETHICS IN PREPARING

FINANCIAL STATEMENTS
Self-Test 1
1.
(a) Integrity This situation has a clear impact on your integrity - fair
dealing and truthfulness. Your obligations in this instance are to
confidentiality.
(b) Objectivity Your objectivity would be at risk if you allow a personal
relationship to influence the ethical and legal responsibilities you have
to your employer.
(c) Professional competence and due care You have a duty to maintain
professional knowledge, to act diligently in accordance with
professional standards and to uphold legal and regulatory
requirements.
(d) Confidentiality - You have an obligation to refrain from disclosure of
information outside the firm or employing organisation.
(e) Professional Behaviour - You cannot compromise your professional
judgment as a result of a personal relationship.
Personal relationships can sometimes compromise your objectivity it is

important that you know what your obligations are and that you act with
integrity.
In this case, you have obligations of confidentiality both in relation to your

organisation and in financial regulation. In advising your family friend, you
would not only risk losing your job, but are also compromising your professional
judgement, integrity and future career. You should decline to discuss the issue.
Self-Test 2
1.
(a) Integrity - you need to uphold your integrity by addressing the

matterthere is a need to be straightforward and honest.

ANSWERS 335
(b) Objectivity - Your objectivity is being compromised not only on the

basis of lack of full and timely information, but also the perceived
threats of the CEOs behaviour.
(c) Professional competence and due care - You need to have full and
correct information in a timely manner in order to carry out your role.
(d) Confidentiality - You would be expected to resolve the issues
internally where possible without disclosing confidential information.
(e) Professional behaviour - Your professional behaviour is being
compromised without addressing the issue and you would not be
discharging your duties (and nor would your colleagues).
Without sufficient information in good time for the meeting, you will not be able
to act with sufficient expertise. In this situation, acting with integrity means that
you have to address the matter in a straightforward manner.
As suggested by the principles affected earlier, this is an internal matter that you
should at first hand try resolve within the organisation. Revisit the issue with the
finance director and CEO in writing and be sure if the issue continues to have it
on the agenda of the next board meeting. This issue has to be resolved
satisfactorily in order for you and your colleagues to be able to carry out your
roles in a professional manner.
TOPIC 10: COMPREHENSIVE CASES (PARTNERSHIP:

CHANGES IN OWNERSHIP)
Self-Test 1
1. (a) Goodwill of the partnership
= 3 (RM5,040 + RM6,720 + RM7,770 + RM8,190) / 4
= RM20,790
(b)
L T P L T P
31 Jan Balance 33,474 27,916 33,600 31 Jan Balance 21,000 19,600
c/f b/f
Bank 33,600
Goodwill 12,474 8,316
33,474 27,916 33,600 33,474 27,916 33,600

336 ANSWERS
(c) If the goodwill is to be written off from the accounts, Pentrons share
of goodwill will be:
= RM20,790 1/5
= RM4,158
2.
S L A S L A
1 Jan Goodwill 1,800 1,200 600 1 Jan Balance 36,000 24,000
w/off b/f
Balance 36,000 24,600 11,400 Bank 12,000
c/f
Goodwill 1,800 1,800
37,800 25,800 12,000 37,800 25,800 12,000
Goodwill Account
2014 RM 2014 RM
1 Jan Capital S 1,800 1 Jan Capital S 1,800
Capital L 1,800 Capital L 1,200
Capital A 600
3,600 3,600
3. (a) Revaluation Account

2014 RM 2014 RM
Asset increased in
1 Jan Asset reduced in value 1 Jan value
Debtors 12,800 Equipment 32,000
Furniture 12,800
Profit on revaluation Stock 6,400
Proton (3/5) 61,440 Goodwill 64,000
Jaguar (2/5) 40,960
115,200 115,200
Equipment
2014 RM 2014 RM
1 Jan Balance b/f 256,000 1 Jan Balance c/f 288,000
Revaluation 32,000
288,000 288,000

ANSWERS 337
Furniture
2014 RM 2014 RM
1 Jan 179,200 1 Jan Balance c/f 192,000
12,800
192,000 192,000
Debtors
2014 RM 2014 RM
Balance c/f 128,000
140,800 140,800
Stock
2014 RM 2014 RM
Revaluation 6,400
25,600 25,600
Capital Account Proton

2014 RM 2014 RM
Revaluation: 61,440
343,040 343,040
Capital Account Jaguar

2014 RM 2014 RM
Revaluation: 40,960
252,160 252,160
Capital Account Benz

2014 RM 2014 RM
1 Jan Balance c/f 128,000 1 Jan Cash 128,000

338 ANSWERS
(b) Proton, Jaguar and Benz

RM RM
Intangible assets
Goodwill 64,000
Fixed assets
Equipment 288,000
Furniture 192,000
480,000
Current assets
Stock 25,600
Debtors 128,000
Bank (RM12,800 + RM128,000) 140,800
294,400
Less:
Current Liabilities
Creditors 115,200
179,200
723,200
Capital
Proton 343,040
Jaguar 252,160
Benz 128,000
723,200
(c) New profit sharing ratio

Benz is to share 25% of the total profit.
The remaining 75% is to be shared by Proton and Jaguar.
The profit-sharing ratio between Proton and Jaguar remains as

60%:40%.
Therefore,
Proton will share 75% 60% = 45%
Jaguar will share 75% 40% = 30%
Benz will share 25% of the total profit
The new sharing ratio is therefore 45% : 30% : 25% for Proton, Jaguar
and Benz respectively.

ANSWERS 339
Self-Test 2
2014 RM 2014 RM
Asset reduced in Asset increased in
1 Jan
1 Jan value value
Motor vehicle 10,400 Land and Building 32,000
Profit on revaluation
Micky (2/3) 14,400
Donald (1/3) 7,200
32,000 32,000
(b) Land and Building

2014 RM 2014 RM
Revaluation 32,000
128,000 128,00
(c) Motor Vehicles

2014 RM 2014 RM
Balance c/f 37,600
48,000 48,000
(d) Cash at Bank

2014 RM 2014 RM
1 Jan Balance b/f 105,600 1 Jan Capital Gordon 64,000
Balance c/f 41,600
105,600 105,600
(e) Capital Account Gordon

2014 RM 2014 RM
1 Jan Bank 64,000 1 Jan Balance b/f 304,000
Balance c/f 254,400 Revaluation:
share of profit 14,400
318,400 318,400
Capital Account Gerald

2014 RM 2014 RM
Revaluation:
share of profit 7,200
247,200 247,200

340 ANSWERS
(f) Gordon and Gerald

RM RM
Fixed Assets
Computer 32,000
197,600
Current assets
Stock 144,000
Debtors 118,400
Bank 41,600
304,000
501,600
Capital
Gordon 254,400
Gerald 247,200
501,600

2014 RM 2014 RM
1 Oct Asset reduced in 1 Oct Asset increased
value in value
Debtors 840 Premises 50,400
Creditor 1,680 Furniture 840
Stock 1,260
Professional 420
charges
Profit on
revaluation
Chan (4/10) 18,816
Moseen (3/10) 14,112
Nuzul (3/10) 14,112
51,240 51,240
Premises
2014 RM 2014 RM
1 Oct Balance b/f 75,600 1 Oct Balance c/f 126,000
Revaluation 50,400
126,000 126,000

ANSWERS 341
Furniture
2014 RM 2014 RM
1 Oct Balance b/f 20,160 1 Oct Balance c/f 21,000
Revaluation 840
21,000 21,000
Debtors
2014 RM 2014 RM
1 Oct Balance b/f 20,160 1 Oct Revaluation 840
Balance c/f 19,320
20,160 20,160
(b) Creditors
2014 RM 2014 RM
1 Oct Balance c/f 20,580 1 Oct Balance b/f 18,480
Revaluation 1,680
Professional
charges 420
20,580 20,580
Stock
2014 RM 2014 RM
1 Oct Balance b/f 18,480 1 Oct Revaluation 1,260
Balance c/f 17,220
18,480 18,480
Capital Account Chan

2014 RM 2014 RM
1 Oct Goodwill 35,280 1 Oct Balance b/f 50,400
written off
Balance c/f 57,456 Revaluation:
Goodwill 23,520
92,736 92,736
Capital Account Moseen

2014 RM 2014 RM
1 Oct Goodwill 23,520 1 Oct Balance b/f 25,200
written off
Balance c/f 33,432 Revaluation
Goodwill 17,640
56,952 56,952

342 ANSWERS
Capital Account Nuzul

2014 RM 2014 RM
1 Oct Balance c/f 56,952 1 Oct Balance b/f 25,200
Revaluation:
Goodwill 17,640
56,952 56,952
(c) CN Partners
Balance Sheet as at 1 October 2014
RM RM
Fixed assets
Premises 126,000
Furniture 21,000
147,000
Current assets
Stock 17,220
Debtors 19,320
Bank (RM31,080 RM21,000 RM8,400)* 1,680
Less: 38,220
Current liabilities
Creditors 20,580
17,640
Long-term liabilities
Loan Moseen (33,432)
131,208
Capital
Chan 57,456
Nuzul 56,952
114,408
Current Account
Chan 12,600
Nuzul 4,200
16,800
131,208
* Repayment of Moseens loan and his current accounts

ANSWERS 343
(d) Different methods in valuing goodwill

Goodwill is an asset which is difficult to quantify as the rule of beauty is in
the eyes of beholder always applies. There are several methods of valuing
goodwill. The most common methods are:
(i) A given multiple of turnover;
(ii) A given multiple of the annual profit; or
(iii) The excess of the capitalised value of the profit over the current
market value of the net tangible assets.
TOPIC 11: COMPREHENSIVE CASES (DISSOLUTION OF

PARTNERSHIP)
Self-Test 1
1. Share of profit on realisation,
Tip = RM4,480 4/8 = RM2,240
Top = RM4,480 3/8 = RM1,680
Ted = RM4,480 1/8 = RM560
Cash Account
2013 RM 2013 RM
31 Dec Balance b/f 42,280 31 Dec Creditors 4,200
Capital Tip 16,240
Capital Top 12,880
Capital Ted 8,960
42,280 42,280
Capital Account Tip

2013 RM 2013 RM
Profit on realisation 2,240
16,240 16,240

344 ANSWERS
Capital Account Top

2013 RM 2013 RM
12,880 12,880
Capital Account Ted

2013 RM 2013 RM
Profit on realisation 560
8,960 8,960
2. Realisation Account
2014 RM 2014 RM
31 Mar Equipment 81,000 31 Mar Cash Equipment 108,000
Furniture 10,800 Cash Furniture 2,700
Debtors 22,950 Cash Debtors 20,250
Stock 5,400 Capital Alfa (stock) 1,350
Cash realisation 3,240 Creditors 4,050
exp
Profit on
realisation
Alfa 6,480
Beta 6,480
136,350 136,350
Creditors
2014 RM 2014 RM
31 Mar Cash 72,900 31 Mar Balance b/f 76,950
Realisation 4,050
76,950 76,950
Debtors
2014 RM 2014 RM
31 Mar Balance b/f 22,950 31 Mar Realisation 22,950

ANSWERS 345
Stock
2014 RM 2014 RM
31 Mar Balance b/f 5,400 31 Mar Realisation 5,400
Cash Account
2014 RM 2014 RM
31 Mar Balance b/f 37,800 31 Mar Realisation expenses
Creditors 72,900
Realisation 130,950 Cash realisation exp 3,240
Capital Alfa 59,130
Capital Beta 33,480
168,750 168,750
Capital Account Alfa

2014 RM 2014 RM
31 Mar Stock 1,350 31 Mar Balance b/f 54,000
Cash 59,130 Profit on realisation 6,480
60,480 60,480
Capital Account Beta

2014 RM 2014 RM
31 Mar Cash 33,480 31 Mar Balance b/f 27,000
33,480 33,480
3. Share of profit on realisation:

May = RM11,040 1/3 = RM3,680
June = RM11,040 1/3 = RM3,680
Steven = RM11,040 1/3 = RM3,680
Cash Account
2013 RM 2013 RM
31 Dec Balance b/f 161,600 31 Dec Creditors 3,840
Capital May 63,840
Capital June 93,920
161,600 161,600

346 ANSWERS
Capital Account May

2013 RM 2013 RM
Capital Steven
31 Dec (2/5)* 3,840 31 Dec Balance b/f 64,000
67,680 67,680
Capital Account June

2013 RM 2013 RM
Capital Steven
31 Dec (3/5)* 5,760 31 Dec Balance b/f 96,000
99,680 99,680
Capital Account Steven

2013 RM 2013 RM
31 Dec Balance b/f 13,280 31 Dec Profit on realisation 3,680
Capital May 3,840
Capital June 5,760
13,280 13,280
* Sharing ratio based on capital contribution i.e. RM64,000 (May):

RM96,000 (June) = 2:3
Self-Test 2
1. (a) Realisation Account
2013 RM 2013 RM
31 Dec Land and 144,000 31 Dec Cash Land and 120,000
Building building
Motor vehicle 48,000 Debtors 2,400
Debtors 4,800 Capital F (M/V) 36,000
Stock 2,400 Capital F (stock) 1,200
Cash 1,200 Creditors 1,200
realisation exp
Loss on realisation
F (1/3) 13,200
T (1/3) 13,200
R (1/3) 13,200
200,400 200,400

ANSWERS 347
(b) Cash Account

2013 RM 2013 RM
expenses
Land and 120,000 Creditors 18,000
Building
Debtors 2,400 Mortgage loan 48,000
Capital F 33,600
Capital R 28,800
129,600 129,600
(c) Capital Account Fernandez

2013 RM 2013 RM
31 Dec Loss on 13,200 31 Dec Balance b/f 96,000
realisation
Motor Vehicles 36,000
Stock 1,200
Capital 12,000
Tengku (2/3)*
Cash 33,600
96,000 96,000
Capital Account Ramli

2013 RM 2013 RM
31 Dec Loss on 13,200 31 Dec Balance b/f 48,000
realisation
Capital
Tengku (1/3)* 6,000
Cash 28,800
48,000 48,000
Capital Account Tengku

2013 RM 2013 RM
31 Dec Balance b/f 4,800 31 Dec Capital F 12,000
Loss on 13,200 Capital R 6,000
realisation
18,000 18,000
* Sharing ratio based on capital contribution i.e. RM96,000 (F):

RM48,000 (R) = 2:1

348 ANSWERS
2. (a) Realisation Account

2013 RM 2013 RM
31 Dec Equipment 53,700 31 Dec Creditors 28,800
Motor vehicles 50,400 Cash 180,000
Computer 33,480 Cash Goodwill 52,800
Stock 59,220
Profit on
realisation
Anson (1/3) 21,600
Henry (1/3) 21,600
Chris (1/3) 21,600
261,600 261,600
(b) Cash Account

2013 RM 2013 RM
31 Dec Balance b/f 48,000 31 Dec Capital Anson 93,600
Realisation 180,000 Capital Henry 93,600
Realisation 52,800 Capital Chris 93,600
Goodwill
280,800 280,800
(c) Capital Account Anson

2013 RM 2013 RM
Profit on 21,600
Realisation
93,600 93,600
Capital Account Henry

2013 RM 2013 RM

Profit on 21,600
Realisation
93,600 93,600
Capital Account Chris

2013 RM 2013 RM
Profit on 21,600
Realisation
93,600 93,600

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OUM Business School

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Module Writers: Prof Dr Ong Tze San

Rosila Abu Zarin

Moderator: Baldev Singh Pertab Singh

Developed by: Centre for Instructional Design and Technology

First Edition, December 2014

Copyright Open University Malaysia (OUM), December 2016, BBFA2103

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Topic 1 Overview of Accounting 1

Topic 2 Accounting Principles and Concepts 24

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2.6 Accounting Assumptions 43

Topic 3 Accounting Cycle 53

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3.4.5 Notes to the Accounts 71

Topic 4 Adjusting Entries and Closing Entries 77

Topic 5 Accounting for Current Assets 115

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5.4.3 Reimbursement of the Petty Cash Fund 133

Topic 6 Accounting for Non-current Assets 152

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6.7.3 Methods of Calculating Depreciation 176

Topic 7 Property, Plant and Equipment (MFRS 116) 189

Topic 8 Accounting for Liabilities and Equity 218

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8.4.1 Provisions 228

Topic 9 Integrity and Ethics in Preparing and Reporting Financial 249

Topic 10 Comprehensive Cases (Partnership: Changes in Ownership) 256

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Topic 11 Comprehensive Cases (Dissolution of a Partnership) 276

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COURSE GUIDE DESCRIPTION

As an open and distance learner, you should be acquainted with learning

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Table 1: Estimation of Time Accumulation of Study Hours

Topic 1 begins with an overview of accounting. It introduces the various forms

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Topic 2 discusses the regulatory and conceptual framework for corporate

Topic 8 deals with accounting for liabilities. It provides the definition of

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TEXT ARRANGEMENT GUIDE

Self-Check: This component of the module is inserted at strategic locations

Activity: Like Self-Check, the Activity component is also placed at various

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References: The References section is where a list of relevant and useful

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Serway, R. A., & Jewett Jr, J. W. (2002). Principles of physics, A calculus-based

TAN SRI DR ABDULLAH SANUSI (TSDAS) DIGITAL

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The mentioned case is a good example of how accounting plays an important

This information is provided through the financial statement of a business. Now, it is

1.1 THE IMPORTANCE OF ACCOUNTING

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So what is accounting? Before we go on to discuss the definition of accounting,

Figure 1.1: Luca Pacioli

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1.2 DEFINITION OF ACCOUNTING

Accounting is described as a system or a process that provides reports on an