Management Management Management

BScBusinessManagement
Account
i
ngFundament
als
(
OUbs003111)
OPEN UNIVERSITY
of MAURITIUS
Accounting
Fundamentals
(OUbs 003111, OUbs 002111,
OUbs 008111 and OUbs 009111)
Open University of Mauritius - Accounting Fundamentals i

PROJECT COORDINATION
Open University of Mauritius
© Open University of Mauritius, May 2013

First published 2013
All rights reserved. No part of this work may be reproduced in any form or by any means, without prior
written permission from the Open University of Mauritius. Commercial use and distribution of this material
is strictly prohibited.
ii Open University of Mauritius - Accounting Fundamentals

Table of Contents
UNIT 1 - The need for accounting and the accounting equation 1
UNIT 2 - The Double-Entry System of Book-keeping 11
UNIT 3 - The Cash Book 27
UNIT 4 - Books of Original Entry 35
UNIT 5 - The Income Statement and Statement of Financial Position 45
UNIT 6 - Accounting for depreciation and disposal of

non-current assets 55
UNIT 7 - Adjustments on Final Accounts 63
UNIT 8 - Bank Reconciliation 75
UNIT 9 - Introduction to Costing 81
UNIT 10 - Marginal Costing and decision making 93
Open University of Mauritius - Accounting Fundamentals iii

iv Open University of Mauritius - Accounting Fundamentals
OUbs 003111
MODULE
OUbs 002111
OUbs 008111
OUbs 009111 ACCOUNTING FUNDAMENTALS
AIM OF THE MODULE
This module is designed to introduce basic accounting concepts to students who do not
intend to major in accounting. Accounting is said to be the language of business and a
basic knowledge of it will no doubt enhance students understanding of the business world.
Students learn commonly used accounting terminology, recording financial transactions
and preparing financial statements which are essential for business students. The module
also prepares learners for further accounting modules included in their programmes.
TEACHING AND LEARNING STRATEGY

The teaching and learning strategy is designed to develop the student’s ability to prepare
financial statements. A strong emphasis is laid on the recording and summarizing part
which is the foundation for preparing financial statements. Activities have been devised in
such a way to ensure that proper learning takes place. Regular contact between the learner
and the tutor will ease the learning process.
ASSESSMENT STRATEGY
The assessment strategy is designed to assess the extent to which students have understood,
and mastered basic accounting.
Unit(s) of Assessment Weighting Towards

Module Mark (%)
Time Constrained Module Specific
Examination (multiple choice/structured 60
questions) on Accounting.
Assessments 40
LEARNING OBJECTIVES OF THE MODULE

Module Outline
The accounting equation - the double entry system of bookkeeping - books of original
entry-preparing financial statements-adjustments to final accounts-depreciation and
disposal of non-current assets-Introduction to costing
Learning Objectives
By the end of the semester, you will be able to do the following:
UNITS LEARNING OBJECTIVES

zz Explain the nature and role of accounting
zz Identify the main users of accounting information and their
information needs
Unit 1 zz Explain the various assumptions used in preparing financial
statements
zz Record business transactions using the accounting equation
zz Record transactions using the double-entry system
Unit 2 zz Balance accounts at the end of an accounting period
zz Extract a trial balance
zz Explain the use of the cash book

zz Prepare a three-column cash book
Unit 3 zz Post entries from the cash book on discount allowed and discount
received to the respective ledger accounts
Open University of Mauritius - Accounting Fundamentals v

zz State the reasons for keeping books of original entry
zz State the source documents used for keeping books of original entry
Unit 4 zz Record transactions in books of original entry
zz Post transactions from books of original entry to the ledger
zz Differentiate between gross and net profit

zz Prepare an income statement
Unit 5 zz Classify assets into current and non-current
zz Classify liabilities into current and non-current
zz Prepare a statement of financial position
zz ecord the purchase of non-current assets
R
zz Calculate the cost of an asset
Unit 6 zz Calculate depreciation using the different methods of depreciation
zz Record disposal of non-current assets
zz Effect entries for the revaluation of non-current assets
zz Adjust financial statements for expenses due and prepaid
zz Account for the creation, increase and decrease in allowance for
Unit 7 doubtful debts
zz Prepare financial statements after adjustment
zz Explain the reasons for a discrepancy in the cash book balance and
Unit 8 the bank statement balance
zz Update the cash book
zz Prepare a bank reconciliation statement
zz Differentiate between different types of cost
Unit 9 zz Prepare income statements using marginal and absorption costing
zz Reconcile profit under absorption costing with marginal costing
profit
zz Calculate and interpret the break-even point
Unit 10 zz Determine the production schedule which maximizes contribution
when faced with a limiting factor
zz Decide whether accepting a special order is worthwhile
Guidelines for self-study

This manual aims at fulfilling the preciously identified learning objectives. Despite the
fact that this manual is self-contained, you are expected to do some additional research in
books and academic articles to deepen your understanding of quantitative techniques and
research methodology.
References
zz Betsy Li Tan Sai Kim and Goh Lin Chin (2001). Principles of Accounting, Oxford
University press.
zz Benedict and Elliot (2009). Financial Accounting: An Introduction, FT Prentice
Hall.
zz Emile Woolf (2012). Financial Accounting, Emile Woolf Publishing.
zz Atrill and Mc Laney (2008). Management Accounting for Decision Makers, Prentice
Hall.
zz ACCA website: www.accaglobal.com
vi Open University of Mauritius - Accounting Fundamentals

How to use the Manual
zz Read the overview and learning objectives of each Unit. This will help you in
identifying the knowledge and skills that is required to successfully complete the
study of the Unit.
zz Use the accompanying video.
zz E-mail the tutor in case you don’t understand any part of the manual.
How to study
zz Plan your study time carefully
zz Read the Unit thoroughly. Prepare a list of questions that you may ask your tutor.
Note that the questions should be relevant to the Unit studied.
zz Be a critical thinker
zz Work your activities. It is important for you to attempt all activities as this will give
you an idea of concepts that you have not understood.
zz Re-work your corrected activities later.
zz You are expected to study regularly as there is no ‘easy’ way to pass the examination.
Open University of Mauritius - Accounting Fundamentals vii

8 Open University of Mauritius - Accounting Fundamentals
1 THE NEED FOR ACCOUNTING
UNIT
AND THE ACCOUNTING EQUATION

Unit 1
The need for accounting and the accounting equation
1.0 Introduction
1.1 Users of accounting information
1.2 Main elements of financial reports
1.3 Underlying assumptions when preparing financial statements
1.4 Types of business entity
1.5 The Accounting Equation
1.6 Elements in the accounting equation
1.7 Activity
After studying this chapter you should be able to:

zz Explain the nature and role of accounting
zz Identify the main users of accounting information and their information needs
zz Explain the various assumptions used in preparing financial statements
zz Record business transactions using the accounting equation
1.0 INTRODUCTION
What is accounting?
Accounting is concerned with collecting, analyzing and communicating financial
information to those people who need the information for decision making, planning and
control purposes. For instance the manager of a business may need accounting information
to decide whether to:
zz Develop new products or services;
zz Increase or decrease the price or quantity of existing products or services;
zz Borrow money to help finance the business.
The information provided should help in identifying and assessing the financial
consequence of these decisions (Atrill and Mc Laney, 2008). Apart from managers other
people/ organizations are also interested in accounting information.
1.1 USERS OF ACCOUNTING INFORMATION

Lenders - Banks and other financial institutions need to assess the ability of the business
to pay what is due to them.
Employees - they are interested in the security of their employment. They want to
assess whether the business will survive and continue to provide employment and pension
benefits.
The government and its agencies - for collecting appropriate taxes and for
regulating the activities of the business in the interest of the whole community.
Investors - Investors invest their money to earn a financial return on their investment.
They need information which will help them to make financial decision. In case
of shareholders in a company their decision will involve whether to buy, hold or sell
shares in the company. Companies are owned by shareholders but managed by directors.
Shareholders will judge the performance of directors on the basis of information provided
in the financial statements. If shareholders are not satisfied with the results, they have the
power to change the management team.
Open University of Mauritius - Accounting Fundamentals 1

The public - The public in general might have an interest in the financial statements of a
company. A company might employ people in the vicinity of its location or could support
local suppliers.
1.2 MAIN ELEMENTS OF FINANCIAL REPORTS

Financial statements present information about:
zz The financial position of a business
zz The financial performance of a business
zz Its cash flows and
zz Changes in the financial position during the period
Information about the financial position is provided by the statement of financial position
(previously called balance sheet). The statement of financial position contains information
about assets, liabilities and equity.
Assets
Assets are rights or access to future economic benefits controlled by an entity as a result of
past transaction or events. At this stage we can take assets to be what the business owns.
They can be classified as:
zz Non-current
zz These are purchased for use in the business and not for resale. They can last for
several accounting periods, e.g. motor vehicles, land, buildings, furniture.
zz Current
zz Current assets include cash and bank balances and any assets (inventory and
receivables)
Liabilities are the obligation of an entity to transfer economic benefits as a result of past
events. Liabilities are amounts owed by the business to external parties. They can be
classified as:
zz Non-current liabilities
These are debts of the business which have a repayment period of more than one
year from the balance sheet date, e.g. loans.
zz Current liabilities
These are short term debts intended to be repaid within one year from the balance
sheet date. E.g. trade payables and bank overdraft.
Owner’s Equity or Capital is the residual amount found by deducting all of the entity’s
liabilities from the entity’s assets. This represents the owner’s claim on the business.
Information about an entity’s financial performance is found in the income statement
previously known as the profit and loss account. It contains information about income
and expenses.
Information about the cash flows is provided by the statement of cash flows. Additional
information is provided in the notes to the financial statements which contains information
of both a narrative and numerical nature.
1.3 UNDERLYING ASSUMPTIONS

WHEN PREPARING FINANCIAL STATEMENTS
If every business produced its financial statements without observing some rules and
principles then the results will only be meaningful for the people connected to that
particular business. Comparison with another business will not be meaningful. Some
form of standardisation is essential if financial statements are capable of being effectively
compared with other periods and other businesses. This is the main reason why those
involved in the preparation of financial statements need to observe certain concepts or
conventions

Separate entity
When accounting for transactions, it is assumed that the entity for which the accounting
records are maintained is separate from its owner(s). A clear dividing line is assumed to
exist between the business and its owner. Without such boundary it would be difficult to
identify the resources and activities of the business from those of its owner. The capital
contributed by the owner is treated as a liability from the entity’s perspective as the
business is assumed to have borrowed this amount from its owner. Applying the boundary
rule means that if the owner purchases a sofa set for his house from his private funds, no
records for this transaction should be kept in the books of the business.
Going concern
The financial statements are prepared assuming that the business is a going concern i.e.
the entity will be in operation in the foreseeable future and there is no intention to close
down the business or curtail its activities significantly. Thus, it is not in the interest of
the business to know the realizable (saleable) value of the business. As such, non-current
assets are shown at depreciated historical cost even if the realizable value is higher. If a
business is not a going concern, the assets should be shown in the statement of financial
position at the amount they may be expected to realize when sold.
Money measurement
An entity’s accounting records are kept using a common unit of measurement such as$.
This makes comparison between entities or with the same entity easier over time. Only
transactions which are capable of being measured in monetary terms are recorded in the
books of the entity. For this reason the financial statements of an entity shows a limited
picture of the affairs of the business. For instance, if the health of a sole trader is failing,
can this be shown in the financial statements? Since the effect cannot be quantified reliably
it cannot be shown. This is one of the reasons for the increase in narrative content in the
annual report of companies.
Realisation concept
The realization concept requires that income should not be recorded in the accounts unless
it has been realized. It is inappropriate to include the profit on a transaction in the income
statement if the transaction has not happened yet. As a general rule a sale is deemed to
happen when the goods which are subject to sale have been replaced by cash or a debtor
for the sale..
Accruals including matching

Revenue, other income and expenses should be recognized, recorded and reported in the
financial statements based in the period in which they occur and not when cash is received
or paid. A credit sale which occurs just before the year-end should be recorded in the period
in which the sale has occurred not when cash will be received from debtors. The revenue
(sales) figure in the income statement includes both cash and credit sales. Expenses shown in
the income statement are expenses which relates to the accounting period and not necessarily
expenses paid. Expenses which have been incurred but not paid must be accrued and shown
in the statement of financial position under current liabilities. Similarly, expenses which have
been paid but relates to a future accounting period should be treated as ‘prepaid expenses’
and shown under current assets in the statement of financial position. Financial statements
which are prepared on an accrual basis inform users not only of past transactions involving
payments and receipt of cash but also of obligations to pay cash in the future and resources
which represent cash in the future.
Historical cost
It is common accounting practice to record assets and expenses at cost price. Historical
cost accounting has the virtue of being objective. The cost of assets, goods and services

purchased is ascertainable from invoices, contracts or costing records if an asset has
been built by an entity’s own work force. However, historical cost accounting has some
shortcomings; it fails to take into account the changing value of money and cannot record
assets and services for which no payment has been effected.
Materiality
In the accounting context materiality means assessing the significance of the information
to stakeholders. An item is said to be material if its inclusion or non inclusion will affect
the way users view the financial statements. The concept of materiality permits the normal
accounting treatment of an item to be disregarded if the amount involved is not significant
in the context of the business as a whole. For example, a multinational company purchasing
a laptop costing $800 may treat the purchase as an expense while a small company can
treat the same purchase as an asset, on account of the firm’s size.
Prudence
Prudence is the exercise of caution under conditions of uncertainty. The objective is
to ensure that income and assets are not over-estimated and liabilities are not under-
estimated. The uncertainties could be of a recurring nature such as providing for bad
debts. If the allowance set is too low this will result in profit and receivables being
overstated. However, an overstatement of expenses or liabilities is not permitted on the
grounds of prudence. For example if a company knows based on past experience that 2%
of receivables might turn into bad debt, it would be inappropriate to make an allowance
of 10% of trade receivables.
Substance over form

Information contained in financial reports should represent the substance or economic
reality of a transaction even if it differs from the legal form. For example a business could
lease an asset for the major part of its useful life from a leasing company. The leasing
company is the legal owner but the lessee controls the asset. Applying the concept of
substance over form, the lessee should record the asset though the leasing company is the
legal owner.
1.4 TYPES OF BUSINESS ENTITY

The term entity is used to describe any form of business organization. There are three main
types of business all aiming to make profit; sole trader, partnership and limited company.
Sole trader
An individual who sets up in business on his own is a sole trader. A sole trader is owned
and managed by one person. The sole trader suffers from unlimited liability. The owner is
personally liable for the debts of the business. If the business does not have enough money
to pay its debts, the owner can be made personally liable to make payment out of his ‘non-
business’ assets. The profit of a sole trader is treated as income for taxation purposes..
Partnership
A partnership is an association of two or more people who pool their resources to set up a
business. A partnership just like a sole trader can have employees but they have no share
in the ownership. A partnership deed is drawn which sets out the terms of the partnership.
The partners are personally responsible for the debts of the business. Alike sole traders
the personal assets of partners are at stake. The share of profit of each partner is treated as
personal income for the purpose of calculating the tax liability.

Limited Company
Ownership of a company is represented by ownership of shares. Shareholders (owners)
appoint directors to manage their business. Unlike a sole trader or a partnership, a company
has a separate legal status. This means that in the eyes of the law a company is regarded
as a person. As such the company can own assets and can sue and be sued in its own
name. A company pays tax separately from its owners. Shareholders in a limited company
benefit from limited liability meaning that their liability is limited to the amount that they
have invested in the business. If the company’s shares are ‘fully paid’ shareholders have
no further liability as regards the unpaid debts and further obligations of their company.
This is the main reason why limited company is the most common form of business
organization.
1.5 THE ACCOUNTING EQUATION

To start a business we require funds. These funds can basically come from two sources;
past savings of the owner or borrowing (loan). You would recall that the business entity
concept regards the business as being separate from its owner. Let’s assume that Devi
commences business with $10,000 in the bank. The business of Devi is an entity created
separate from her that has acquired the $10,000 (bank). At the same time the business has
incurred a liability or debt of $10,000 to the owner. The accounting equation depicts the
equality which must exist between the resources owned/controlled by the business and the
claims against these resources. In its simplest form the accounting equation is:
Assets = Capital
Resources (uses of funds) = Sources of Funds (where they come from)
The accounting equation for Devi’s business can be stated as follows:
Assets = Capital
Bank = Capital
$10,000 = $10,000
Let us now assume that the funds required are not sufficient and Devi borrows $5,000
from the bank (loan). The accounting equation can be states as follows:
Assets = Capital + Liabilities
Bank = Capital + Loan
$10,000 + $5,000 = $10,000 + $5,000
The loan increases the bank account balance by $5,000. The bank account balance stands
at $15,000. Where does the $15,000 come from? Part of it was introduced by the owner
($10,000) and the remainder by borrowing from the bank ($5,000).
1.6 ELEMENTS IN THE ACCOUNTING EQUATION

Assets are rights or access to future economic benefits controlled by an entity as a result of
past transaction or events. At this point we can take assets to be what the business owns.
They consist of land, buildings, machinery, motor vehicles, stock of goods, debts owed by
customers called receivables/debtors, cash at bank and cash in hand.
Liabilities are the obligation of an entity to transfer economic benefits as a result of past
events. Liabilities are amounts owed by the business to external parties. They include
suppliers of credit purchases called payables, loans, unpaid expenses and bank overdraft.
Owner’s Equity or Capitalis the residual amount found by deducting all of the entity’s
liabilities from the entity’s assets. This represents the owner’s claim on the business. The
owner’s equity can be derived from the accounting equation by rearranging the elements

in the accounting equation.
Capital = Assets - Liabilities
Owner’s equity can increase when the owner injects additional funds in the business or
when the business makes profit. Alternatively, owner’s equity will decrease when the
owner withdraws assets for personal use or when the business incurs a loss.
Taking into account the items which can impact on capital, we can rewrite the accounting
equation as follows:
Assets = Capital + Profit - Drawings + Liabilities
We can rearrange the accounting equation to avoid the negative sign as follows:
Assets + Drawings = Capital + Profit + Liabilities
Worked example
20X8
Oct 1 Yan commenced business by depositing $25,000 in a bank account.
Oct 4 A delivery van was purchased by cheque for $12,000.
Oct 10 Goods for resale costing $3,000 were purchased on credit from Ali.
Oct 20 Yan withdrew $500 from the business bank account for his personal use.
Oct 22 Paid Ali $800 on account by cheque.
Write the accounting equation for each of the above transaction.

Oct 1 Yan commenced business by depositing $25,000 in a bank account.
The business has an asset, bank ($25,000) and simultaneously an owner’s equity of
$25,000 is created. The accounting equation is as follows:
Assets = Capital
Bank = Capital
+25,000 = +25,000
Oct 4 A delivery van was purchased by cheque for $12,000.

This transaction results in an increase in assets (vehicle) and a corresponding decrease in
another asset (Bank).
Assets = Capital
Bank Vehicle = Capital
+25,000 = +25,000
-12,000 +12,000 = 0
13,000 12,000 = 25,000
Oct 10 Goods for resale costing $3,000 were purchased on credit from Ali.
These are goods for resale which increases inventory with a corresponding increase in
payables (creditors).
Assets = Capital + Liabilities
Bank Vehicle Inventory = Capital Payable
13,000 12,000 = 25,000
+3,000 = +3,000
13,000 12,000 3,000 = 25,000 + 3,000
Oct 20 Yan withdrew $500 from the business bank account for his personal use.

The withdrawal of cash from the business for personal use increases drawings (decreases
owner’s equity) and results in a decrease in the bank account balance.
Assets + Drawings = Capital + Liabilities
13,000 12,000 3,000 = 25,000 + 3,000
-500 + +500 = +
12,500 12,000 3,000 + 500 = 25,000 + 3,000
Oct 22 Paid Ali $800 on account by cheque.
This payment will decrease the bank account balance and the amount owed to Ali.
Assets + Drawings = Capital + Liabilities
12,500 12,000 3,000 + 500 = 25,000 + 3,000
-800 = -800
11,700 12,000 3,000 + 500 = 25,000 + 2,200
Observations
zz All transactions have two effects.
zz If the effects are of the same side of the accounting equation, they have to be of
alternate signs (+ and -).
zz If the transaction affects items on different sides of the accounting equation, they
have to be of the same signs (+ and+ or - and -) to keep the accounting equation
balanced.
1.7 ACTIVITY
Activity 1*
Write the accounting equation for the following transactions
20X8
Oct 1 Anjeli commenced business by depositing $35,000 in a bank account.
Oct 4 Furniture costing $5,000 was purchased by cheque.
Oct 10 Goods for resale costing $4,000 were purchased on credit from Ken.
Oct 20 The owner withdrew $700 from the business bank account for her personal use.
Oct 22 Paid Ken $800 on account by cheque.
Activity 2
Complete the gaps in the following table:
Assets Liabilities Capital

$ $ $
(a) 26,500 3,670 ?
(b) 14,333 ? 9,505
(c) ? 4,490 12,660
(d) 54,337 ? 38,990
(e) 29,001 ? 27,555
(f) 9,560 58 ?

Activity 3*
Classify the following items into assets and liabilities:
1. Land and Buildings
2. Loan from bank
3. Trade payables
4. Cash in hand
5. Motor car
6. Stocks of goods
Activity 4
Complete the gaps in the following table:

$ $ $
(a) 1,143 564 ?
(b) ? 7,868 24,684
(c) ? 43,244 130,990
(d) 56,826 ? 14,512
(e) 98,693 21,414 ?
(f) 77,657 ? 22,193
Activity 5
Which of the following are shown under the wrong headings?
Assets Liabilities
Stocks of goods for resale Cash in till
Amounts due on stocks purchased Amounts owing to firm by trade receivables
Loan made by the firm to another firm Loan
Bank overdraft
Machinery
ANSWER TO ACTIVITIES
Activity 2
26,500 3,670 22,830
14,333 4,828 9,505
17,150 4,490 12,660
54,337 15,347 38,990
29,001 1,446 27,555
9,560 58 9,502
Activity 4
$ $ $
(a) 1,143 564 579

(b) 32,552 7,868 24,684
(c) 174,234 43,244 130,990
(d) 56,826 42,314 14,512
(e) 98,693 21,414 77,279
(f) 77,657 55,464 22,193
Activity 5
The following were under the wrong headings:
zz Amounts due on stocks purchased
zz Loan made by the firm to another firm
zz Bank overdraft
zz Amounts owing to firm by trade receivables
zz overdraft

2 THE DOUBLE-ENTRY SYSTEM OF
UNIT
BOOK-KEEPING
Unit 2
2.0 Introduction
2.1 Rules for recording transactions
2.2 Credit Transactions
2.3 Balancing accounts
2.4 Return inwards
2.5 Return outwards
2.6 The Trial Balance
After studying this unit you should be able to:

zz Record transactions using the double-entry system
zz Balance accounts at the end of an accounting period
zz Extract a trial balance
2.0 INTRODUCTION
We have seen in chapter 1 that all transactions have a twofold effect. The twofold effects
were recorded using the accounting equation. However, it would not be practical to use the
accounting equation to record transactions as a business might be involved in numerous
transactions during a day itself. The double entry system is a systematic way of recording
the dual effects of transactions in a business. The book used to record transactions is
called the ledger. The ledger is a collection of accounts. An account keeps records of
transactions for a specific item.
Ruling of the ledger

Dr. Title of account Cr.
Date Details Folio Amount Date Details Folio Amount
$ $
Each page of the ledger is drawn in the form of a T. The page is divided in two equal parts
with the same columns and headings on either side. The left hand side is called the debit
side (Dr.) and the right hand side the credit side (Cr.) The title of the account is written at
the top and is centered
2.1 RULES FOR RECORDING TRANSACTIONS

Every transaction has two effects, one of which will be recorded as a debit in one account
and the other which will be recorded as a credit in another account. You shall be asking
yourself; when do we debit an account and when do we credit an account?
Accounts are divided into 2 sets; those having debit balances and those having credit balances.
Debit balances Credit balances
Assets Liabilities
Expenses Revenue
Purchases Income

Drawings Capital
A transaction will cause an increase/decrease in one item and an increase/decrease in
another item. To know which account to debit and which account to credit we follow the
following:
Increase Decrease
Assets Dr Cr
Expenses
Purchases
Liabilities Cr. Dr.
Revenue
Income
For assets, Expenses and Purchases increases are recorded on the debit side and decreases
are recorded on the credit side.
For Liabilities, revenue and income increases are recorded on the credit side while
decreases are recorded on the debit side.
To illustrate how transactions are recorded using the double entry system, let us consider
the following transactions:
Jan 1 20x8 John starts business with $5,000.
The two effects of the transaction are an increase in cash and an increase in capital.
Cash is an asset so increasing it means to debit the cash account.
To increase capital we need to credit the capital account.
Dr. Cash account Cr.

$ $
Jan 1 *Capital 5,000
Capital Account
Jan 1 *Cash 5,000
*The details in an account refer to the name of the other account where the double entry
is recorded. In the cash account we write ‘Capital’ as the corresponding entry is in the
Capital account. Similarly, in the Capital account we write ‘Cash’ to show that the other
entry for this transaction is found in the Cash account.

22 Jan 20x8 Office furniture was purchased for cash $500.
Account Effect Entry
Office furniture Asset  Dr.
Cash Asset  Cr.
$ $
Jan 22 Office Furniture 500
Office Furniture account

Jan 22 Cash 500
25 Jan Purchased goods paying cash $900

Purchases Purchases  Dr.
Cash Asset  Cr.

$ $
25 Jan Purchases 900
Purchases account
25 Jan Cash 900
26 Jan Sold goods for cash $1,100

Cash Asset  Dr.
Revenue/Sales Revenue  Cr.

$ $
Jan 26 Sales 1,100
Sales account
Jan 26 Cash 1,100

2.2 CREDIT TRANSACTIONS
So far we have considered only cash transactions. Many transactions in the business world
take place on a credit basis. This implies that receipt or payment of money is delayed in the
future. Let’s consider a couple of examples to explain how to record credit transactions.
Jan 27 Purchased goods on credit from Rebecca $800
Rebecca (Trade payable) Liability  Cr.
The purchase of goods on credit does not involve any movement of cash. The cash account
is therefore not involved. Even though the transaction is on credit goods purchase still
increase the inventory. So we debit Purchases.
The credit purchase creates a liability towards Rebecca. We then credit Rebecca’s account
(Trade payable).
Dr. Purchases account Cr.
$ $
Jan 27 Rebecca 800
Rebecca account (Trade payable)

Jan 27 Purchases 800
Jan 28 Sold goods on credit to Leena $1,200

Sales/Revenue Sales  Cr.
Trade receivable/Debtor Asset  Dr.
The sale of goods on credit will increase sales/Revenue by $1,200 even though there is no
receipt of cash at this point. We therefore credit sales account. This transaction will lead
to a debt towards the business. Since Leena owes the business $1,200, we debit Leena’s
account by this amount.
Dr. Sales account Cr.

$ $
Jan 28 Leena 1,200
Leena account (Trade receivable)

Jan 28 Sales 1,200
Jan 30 Paid Rebecca cash on account $400

Trade payable (Rebecca) Liability Dr.
Cash Asset Cr.
Payment to Rebecca reduces the balance the business owes to her, hence the debit in her
account (reduction of a liability). Cash also decreases, so we credit the cash account.

Jan 30 Rebecca 400
Cash account
Jan 30 Rebecca 400
Jan 31 Received cash on account from Leena $1,000.

Trade receivable/Debtor Asset  Cr.
Cash Asset  Dr.
Leena (Trade receivable)

Jan 31 Cash 1,000
Cash account
Jan 31 Leena 1,000
Cash received from Leena increases the cash account balance (shown as debit). After
the payment Leena will therefore owe $1,000 less to the business. We need to reduce the
balance due by crediting her account by $1,000.
For the sake of your understanding we have opened a new account for an item for
each transaction. However, the purpose of opening an account is to group transactions
for the same item. We would need only one Cash account which would record all cash
transactions. Similarly, we would need only one Sales account to record all sales whether
cash or credit. We reproduce the above example in the way it should normally appear.
$ $
Jan 1 Capital 5,000 Jan Office Furniture 500
22
Jan 26 Sales 1,100 Jan Purchases 900
25
Jan 31 Leena 1,000 Jan Rebecca 400
30
Capital Account
Jan 1 Cash 5,000

Jan 22 Cash 500
Purchases account
25 Jan Cash 900
Jan 27 Rebecca 800
Jan 30 Purchases 400 Jan Purchases 800
27
Sales account
Jan Cash 1,100
26
Jan Leena 1,200
28

Jan 28 Sales 1,200 Jan Cash 1,000
31
2.3 BALANCING ACCOUNTS

After recording the transactions, accounts need to be balanced. You will learn in a later
chapter that the life of a business is divided into arbitrary periods which we term as
accounting period. So at the end of an accounting period we shall balance the accounts.
You need to follow these steps.
Step1 Leave one line after the last transaction and draw total lines (double lines)
Step 2 Total the debit and credit side of the account
Step 3 Within the total lines write the total which is the higher of the two sides
Step 4 Fill in the figure on the smaller of the two sides- this is the balance on the
account, written as balance c/d (carried down)
Step 5 Bring down the balance on the opposite side of the account, one line after the
total lines. This is the balance which is carried forward to the next period.
Let’s take Leena’s account to illustrate.

Jan 28 Sales 1,200 Jan 31 Cash 1,000
Jan 31 Balance c/d 200
1200 1200
Jan 31 Balance b/d 200
Total lines (step1) Step 3
Step 5 Step 4
The date (Jan 31) of the balance c/d is the last date of the accounting period. The balance
is the brought down one day later (Feb 1). The balance c/d of $200 means that Leena
owed the business $200 at the end of January. The closing balance for January becomes
the opening balance for February. So at the start of February, Leena is a trade receivable
(Debtor) owing $200 to the business.

Activity 1- Balance all accounts in the books of John above and
check your answer.
Date Details F Amount Date Details F Amount
$ $
Jan 1 Capital 5,000 Jan 22 Office Furniture 500
Jan 26 Sales 1,100 Jan 25 Purchases 900
Jan 31 Leena 1,000 Jan 30 Rebecca 400
Jan 31 Balance c/d 2,400
7,200 7,200
Feb 1 Balance b/d 2,400
Capital Account
Jan 31 Balance c/d 5000 Jan 1 Cash 5,000
5000 5000
Feb 1 Balance b/d 5,000

Jan 22 Cash 500 Jan 31 Balance c/d 500
500 500
Feb 1 Balance b/d 500
Purchases account
Jan 25 Cash 900
Jan 27 Rebecca 800 Jan 31 Balance c/d 1,700
1,700 1,700
Feb 1 Balance c/d 1,700

Jan 30 Rebecca 400 Jan 27 Purchases 800
800 800
Feb 1 Balance c/d 400
Sales account
Jan 26 Cash 1,100
Jan 31 Balance c/d 2,300 Jan 28 Leena 1,200
2,300
Feb 1 Balance c/d 2,300

Jan 28 Sales 1,200 Jan 31 Cash 1,000
1,200 1,200
Feb 1 Balance c/d 200

2.4 RETURN INWARDS
A customer may return goods because they are of wrong specification, damaged or
defective. The goods come back to the business hence the term return inwards. The effect
of sales returns and allowances is to reduce revenue. To reduce revenue we need to debit
revenue. However, to have better control a separate account called return inwards account
or sales return account is opened and debited. The second effect of a sales return is to
reduce trade receivable. We would therefore credit trade receivable.
Example
Jan 22 Sold goods on credit to Kate $2,000
Trade receivable/Debtor Asset  Dr.
Sales Revenue  Cr.
Jan 30 Kate returned goods worth $800
Sales return/Return inwards Revenue  Dr.
Jan 31 Kate settled her account paying cash

Cash Asset  Dr.
Kate account (Trade receivable)

Jan 22 Sales 2,000 Jan 30 Return inwards 800
Jan 31 Cash 1,200
2,000 2,000
*The debit side equals the credit side there is no balance c/d
Sales Account
Jan 22 Kate 2,000
Return inwards account

Jan 30 Kate 800
Cash account
Jan 31 Kate 1,200
2.5 RETURN OUTWARDS

A trader may return goods which are defective or are of wrong type to the supplier. The
effect of purchases return is to reduce purchases. For the same reason mentioned earlier, a
return outwards account is created to record purchases return. The account is credited and
the corresponding entry is in the trade payable account.

Jan 25 Purchased goods from Reena $3,500
Trade Payable (Reena) Liability  Cr.
Jan 31 Returned goods worth $500 because of wrong specification

Purchases Return Purchases  Cr.
Trade Payable (Reena) Liability  Dr.
Reena account (Trade Payable)

Jan 31 Return outwards 500 Jan 25 Purchases 3,500
3,500 3,500
Purchases Account
Jan 25 Reena 3,500
Return outwards Account

Jan 31 Reena 500
A comprehensive example
Record the following transactions in the books of Robin who has just started trading.
Balance off all accounts at the end of October 20X8.
20X8
October 1 Started business with $7,000 deposited in bank
October 4 Purchased delivery van for $1,500 paying by cheque
October 5 Bought office equipment on credit from Eves Ltd for $800
October 8 Paid for repairs to van $54 by cheque
October 11 Withdrew $300 cash from bank for office use
October 14 Bought stock on credit from: S Gary $56 and S Rai $76
October 14 Paid carriage on purchases $15 cash
October 16 Returned defective goods to Gary worth $15
October 19 Sold goods on credit to: S Lords $113 and C Rock $89
October 21 Paid for stationery $25 cash
October 22 Withdrew $275 from bank for personal use
October 25 Paid rent by cheque $270
October 26 Goods returned by Lords worth $27
October 29 Sales made on credit to J Rudra for $96
October 30 Commission received by the business: $30 cash

Solution
Dr. Cr.
Date Details $ Date Details $
Capital account
Oct-31 Balance c/d 7,000 Oct-01 Bank 7,000

7,000 7,000
Nov-1 Balance b/d 7,000
Bank account
Oct-01 Capital 7,000 Oct-04 Van 1,500
Oct-08 Repairs 54
Oct-11 Cash 300
Oct-22 Drawings 275
Oct-25 Rent 270
Oct-31 Balance c/d 4,601
7,000 7,000
Van a/c
Oct-04 Bank 1,500 Oct-31 Balance c/d 1,500

1,500 1,500
Nov-1 Balance c/d 1,500
Office Equipment a/c

Oct-05 Eves Ltd 800 Oct-31 Balance c/d 800
800 800
Nov-1 Balance b/d 800
Eves Ltd a/c

Oct-31 Balance c/d 800 Oct-05 Office equipment 800

800 800
Repairs a/c
Oct-08 Bank 54 Oct-31 Balance c/d 54

54 54
Cash a/c
Oct-11 Bank 300 Oct-14 Carr. inwards 15
Oct-30 Commission 30 Oct-21 Stationery 25
Oct-31 Balance c/d 290
330 330

Purchases a/c
Oct-14 S Gary 56 Oct-31 Balance c/d 132
Oct-14 S Rai 76
132 132
S Gary a/c
Oct-16 Returns out 15 Oct-14 Purchases 56
56 56
S Rai a/c
Oct-31 Balance c/d 76 Oct-14 Purchases 76

76 76
Returns outwards a/c

Oct-31 Balance c/d 15 Oct-16 S Gary 15

10 10
Sales a/c
Oct-31 Balance c/d 298 Oct-19 S Lords 113
Oct-19 C Rock 89
Oct-29 J Rudra 96
298 298
S Lords a/c
Oct-19 Sales 113 Oct-26 Returns inwards 27

113 113
Nov-1 Balance c/d 86
C Rock a/c
Oct-19 Sales 89 Oct-31 Balance c/d 89

89 89
Stationery a/c
Oct-21 Cash 25 Oct-31 Balance c/d 25

25 25

Drawings a/c
275 275
Returns inwards a/c

Oct-26 S Lords 27 Oct-31 Balance c/d 27

27 27
J Rudra a/c
96 96
Commission Received a/c

Oct-31 Balance c/d 30 Oct-30 Cash 30
30 30
Rent a/c
270 270
Carriage on purchases a/c

Oct-14 Cash 15 Oct-31 Balance c/d 15
15 15
Oct-31 Balance b/d 15
2.6 THE TRIAL BALANCE

According to the double entry system of book keeping each transaction will have one
debit and one credit entry. Therefore if we add all entries on the debit side and all entries
on the credit side in our ledger, they must be equal. This is one way to check whether total
debits equal total credits. Instead of adding all entries we shall work with balances in the
ledger. A trial balance is a list of all balances from the ledger. The purpose is to check the
arithmetical accuracy of entries made in the ledger (debit=credit). After balancing accounts
we shall draw a list of accounts having a balance. A trial balance has two columns a debit
one and a credit one. In which of the columns the balance will be placed will depend on
which side the balance b/d is found. For instance the balance b/d in the sales account is
found on the credit side, it will therefore be listed in the trial balance in the credit column.
We take the above example to illustrate.

Trial balance as at 31 October 20X8
Title of account Dr. Cr.
$ $
Capital 7000
Bank 4,601
Van 1,500
Office Equipment 800
Eves Ltd 800
Repairs 54
Cash 290
Purchases 132
S Gary 41
S Rai 76
Returns outwards 15
Sales 298
S Lords 86
C Rock 89
Stationery 25
Drawings 275
Returns inwards 27
J Rudra 96
Commission Received 30
Rent 270
Carriage on purchases 15
8,260 8,260
The equality of the debit and credit columns means that debit entries equal credit entries.
However, it does not prove that the entries made in the ledger are correct. For instance,
the trial balance will still agree if a double entry is made with the same but wrong amount.
There are numerous mistakes which the trial balance cannot capture. You shall learn more
in a further chapter.
2.7 ACTIVITY
Activity1*
Enter each transaction in the double-entry accounts for the month of September, balance
off the accounts and then extract a trial balance as at 30 September 20X7.
20X7
September 1 Started business with $1,000 cash
September 3 Paid $800 of cash into bank account
September 7 Bought goods on credit from: M Willis $45and S Halls $78
September 10 Bought office supplies for $25 cash
September 12 Sold goods on credit to: K Curnock $87 and A Hynam $95
September 15 Returned goods to Halls worth $12
September 16 Paid wages by cheque $140
September 20 Bought office fixtures for $350 paying by cheque
September 25 Cash sales made for $34
September 30 Sent cheque to Wills for $40

Activity 2*
Record the above transactions into the appropriate accounts in the ledger. Balance off the
accounts and then extract a trial balance as at 31 July 20X8.
20X8
Jul1 Trader started business with cash $3,000. He intends to deal in second hand cars.
Jul 8 Bought a car for cash $2,500
Jul 10 Paid for repairs $110
Jul 12 Sold a car for cash $3,750
Jul 16 Bought a car on credit from Lam & Co. $2,500
Jul 20 Sold a car on credit to Mc. Adam $3,100
Jul 25 Bought a car for cash $2,500
Jul 27 Paid for repairs $ 350
Jul 27 Received cash from Mc. Adam $2,000
Jul 29 Paid Lan & Co. $1,500 Cash
Jul 30 Paid assistant in cash $140
Jul31 Drew out cash for own use $500
Activity 3
State whether the following accounts have debit or credit balances. Indicate your answer
with a tick (√) in the appropriate column.
Account title Debit balance Credit balance

Premises
Cash
Transport
Bank Charges
Returns Inwards
Returns Outwards
Sales
Purchases
Fixtures and Fittings
Commission Expense
Interest Revenue
Wages and Salaries
Drawings
Advertising
Capital
Insurance
Bank Loan
Candy (Trade receivable)
Activity 4
From the following list of balances extracted from the ledger of Wendy on 31 December
20X9, prepare a Trial Balance as at that date.
$
Cash in hand 425

Cash at bank 6,800
Capital 18,000
Drawings 300
Motor vehicle 8,500
Trade receivables 2,100
Trade payables 5,450
Sales 12,400
Purchases 9,400
Returns Outwards 275
Wages 5,000
Rent and rates 3,600
Activity 3
Account title Debit balance Credit balance
Premises √
Cash √
Transport √
Bank Charges √
Returns Inwards √
Returns Outwards √
Sales √
Purchases √
Fixtures and Fittings √
Commission Expense √
Interest Revenue √
Wages and Salaries √
Drawings √
Advertising √
Capital √
Insurance √
Bank Loan √
Candy (Trade receivable) √

Activity 4
Trial balance as at 31 December 20X9 $ $
Cash in hand 425
Cash at bank 6,800
Capital 18,000
Drawings 300
Motor vehicle 8,500
Sales 12,400
Purchases 9,400
Returns Outwards 275
Wages 5,000
Rent and rates 3,600
36,125 36,125

3
UNIT
THE CASH BOOK

Unit 3
3.0 Introduction
3.1 The two-column cash book
3.2 Cash discounts
3.2.1 Discount allowed
3.3 The Three-column cash book
3.4 Activity

zz Explain the use of the cash book
zz Prepare a three-column cash book
zz Post entries from the cash book on discount allowed and discount received to the
respective ledger accounts
3.0 INTRODUCTION
Cash is said to be the life blood of an organization. Proper records have to be kept of cash
inflows and outflows. This chapter explains the recording of cash and bank transactions
through the use of a cash book.
3.1 THE TWO-COLUMN CASH BOOK

In the previous chapter we have recorded cash and bank accounts using two separate
accounts. However, in both accounts we record receipts on the debit side and payments
on the credit side. Instead of keeping two accounts in the ledger, we can keep one account
having two columns serving the same purpose. The cash book can be put under the
responsibility of one person, thus increasing efficiency.
The ruling of a two column cash book is as follows:

Date Details F Cash Bank Date Details F Cash Bank
Receipts Payments
Note:
1. The cash column represents the cash account
2. The bank column represents the bank account
3. The folio column is used for reference and indicates the page number of the ledger which
contains the account where the double entry is made.
Example
Record the following transactions in the cash book of Matthew.
20X8 $
Jan 1 Cash in hand 100
Jan 1 Cash at bank 700
Jan8 Received cheque from Katy 1,200
Jan 15 Paid Tim by cheque 900
Jan 22 Cash sales 1,800
Jan 23 Paid cash into bank 1,700
Jan 25 Received cheque from Robin 750
Jan 28 Paid rent by cheque 150
Jan 29 Cash sales paid directly into bank 125
Jan 30 $100 is withdrawn from bank for office use

Cash Book
Jan 1 Bal b/d 100 700 Jan 15 Tim 900
Jan8 Katy 1,200 Jan 23 Bank c 1,700
Jan 22 Sales 1,800 Jan 28 Rent 150
Jan 23 Bank c 1,700 Jan 30 Cash c 100
Jan 25 Robin 750 Jan 31 Bal c/d 200 3,425
Jan 29 Sales 125
Jan 30 Bank c 100
1,900 4,575 1,900 4,575
Feb 1 Bal b/d 200 3,425
Note:
1. All cash receipts are recorded in the cash column on the debit side of the cash book
2. All cash payments are recorded in the cash column on the credit side of the cash book
3. Cheques received are entered in the bank column on the debit side of the cash book
4. Cheques issued are entered in the bank column on the credit side of the cash book
5. Entries denoted with a ‘c’ are contra entries. The debit and credit entries for the transactions are
found in the cash book. There shall be no further entries for these items in the ledger.
6. On 23 Jan, cash $1,700 was paid into bank. The cash column is credited to record the decrease
in the cash balance and the bank column is debited to show the increase in the bank balance.
7. On Jan 30, $100 is withdrawn from bank for office use. This transaction is not drawings as it is
for office use. The cash column is debited to show the increase in the cash balance and the bank
column is credited to effect the decrease in the bank balance.
8. The columns are balanced separately and the balances are carried down to the appropriate
columns for the next period.
3.2 CASH DISCOUNTS

A cash discount is an allowance for prompt payment. It is an allowance off the amount
due. The terms of payment are normally mentioned on an invoice. For instance, ‘5% 7
days; 2% 20 days’ means that if payment is made within 7 days, a cash discount of 5%
will be allowed. If payment is made after 7 days but within 20 days, a cash discount of 2%
will be allowed. Customers are encouraged to pay promptly to benefit from favourable
payment terms.
3.2.1 Discount allowed

This is a cash discount allowed by the trader to a customer. Since the trader will receive a
lower amount than what is owed to him, it becomes a cost for the trader.
Example
20X8
June 1 Sold goods to Andy on credit $500
June 22 Andy paid the amount due by cheque less 10% cash discount
Cash Book
Jun 22 Andy 450

Dr. Sales account Cr.
Date Details F $ Date Details F $
Jun 1 Andy 500

Andy account
Jun 1 Sales 500 Jun 22 Bank 450
Jun 22 Discount allowed 50
500 500
Discount Allowed account

Jun 22 Andy 50
Note:
1. The amount received by Andy is calculated as follows:
$
Amount due 500
Less cash discount 50
450
2. On the receipt of cheque ($450) from Andy the bank account is debited and the personal account
of Andy is credited.
3. To record the discount allowed Andy’s account is credited and Discount allowed account is
debited.
Double entry for Discount Allowed
Dr Discount Allowed 50
Cr Debtor/Receivable 50
Discount Received
A trader will receive a cash discount upon payment within the terms stated by the supplier. A
discount received adds to gross profit.
Example
20X8
June 1 Purchased goods on credit from Siva $2000.
June 22 Paid Siva the amount due by cheque less 10% cash discount.
Dr. Purchases account Cr.

Jun 1 Siva 2,000
Siva account
Jun 22 Bank 1,800 Jun 1 Purchases 2,000
Jun 22 Discount received 200
2,000 2,000
Discount Received account
Jun 22 Siva 200

Cash Book
Jun 22 Bank 1,800
1. The amount paid to Siva is calculated as follows:

$
Amount due 2,000
Less cash discount (10%) 200
1,800
2. Payment to Siva ($1,800) is debited to Siva’s account and credited to the cash book.
3. The discount received of $200 is debited to Siva’s account and credited to discount
received account.
3.3 THE THREE-COLUMN CASH BOOK

Since cash discounts are related to receipts and payments of money, one additional column
can be placed on each side of the cash book to record discounts. These columns will be
memorandum columns only and are not part of the double entry system. We only have to
cast the columns and not balance them. Discount received is connected to payments (we
can only receive a cash discount when we pay a supplier) so the discount received column
is placed on the credit side on the cash book. Similarly, a discount is allowed when money
is received from a customer. The discount allowed column will thus be placed on the debit
side on the cash book.
Example
20X8
Dec 1 Started business with cash $5,000
Dec 2 Took $4,000 of the cash to open a bank account.
Dec 10 Purchased goods from Nancy $2,000 on credit
Dec 12 Sold goods to Peter $1,000 on credit
Dec 22 Paid Nancy half the amount due by cheque less 5% cash discount
Dec 24 Paid rent $500 cash.
Dec 25 Received cheque $900 from Peter in full settlement of amount due.
Dec 25 Sold goods to Kiron $700 on credit
Dec 26 Received cheque from Kiron $700
Dec 30 Kiron’s cheque was returned by the bank marked ‘’Insufficient funds’’
Required: Record the above transactions in the books of Mr. Allen, a trader.
Solution
Cash Book
Date Details Disc Cash Bank Date Details Disc Cash Bank
All Rec
Dec 1 Capital 5,000 Dec 2 Bank 4,000
Dec 2 Cash 4,000 Dec Nancy 50 950
22
Dec 25 Peter 100 900 Dec Rent 500
24

Dec 26 Kiron 700 Dec Kiron 700
30
Dec Balance 500 3,950
31 c/d
100 5,000 5,600 50 5,000 5,600
Dec 31 Bal c/d 500 3,950
Capital account
Dec 31 Balance c/d 5,000 Dec 1 Cash 5,000
5,000 5,000
Dec 31 Balance b/d 5,000
Purchases account
Dec 10 Nancy 2,000 Dec 31 Balance c/d 2,000
2,000 2,000
Nancy account
Dec 22 Bank 950 Dec 10 Purchases 2,000
Dec 22 Discount received 50
Dec 31 Balance c/d 1,000
2,000 2,000
Sales account
Dec 31 Balance c/d 1,700 Dec 12 Peter 1,000
Dec 25 Kiron 700
1,700 1,700
Peter Account
Dec 12 Sales 1,000 Dec 25 Bank 900
Dec 25 Discount allowed 100
1,000 1,000
Discount received account

Dec 31 Balance c/d 50 Dec 22 Nancy 50
50 50
Kiron Account
Dec 25 Sales 700 Dec 26 Bank 700
Dec 30 Bank (Dishonoured Dec 31 Balance c/d 700
700
cheque)
1400 1400

Rent account
Dec 24 Cash 500 Dec 31 Balance c/d 500
500 500
Discount Allowed account

Dec 24 Peter 100 Dec 31 Balance c/d 100
100 100
Note:
1. The bank account balance is $3,950 debit meaning that the business has $3,950 in its bank
account. Contrary to the cash account the bank account balance can be credit i.e. payments
exceed receipts. This is possible if prior arrangement is made by the trader with his bank
for an overdraft facility. The bank will extend this facility to the trader subject to payment of
interest on the overdrawn amount and limited to a ceiling. This overdrawn amount called a
bank overdraft is shown under current liabilities in the statement of financial position.
2. The cheque from Kiron was returned due to insufficient funds. This is termed as a ‘dishonoured
cheque’(a cheque which is not backed by sufficient funds). The double entry to record the
dishonoured cheque is to reverse the entry for ‘cheque received’.
3.4 ACTIVITY

Activity1
Write up the two-column cashbook for the following details and balance it off at the end
of the month of May 20X3.
20X3
May 1 Balances brought forward from April: Cash $54, Bank $140
May 4 Paid advertising costs by cheque, $32
May 6 Cash purchases $25
May 11 Received cheque from Carragher, $90
May 14 Took $45 cash out of bank account for office use.
May 17 Paid sundry expenses $34 cash
May 20 Paid cheque to Madison$72
May 22 Cash sales $95
May 24 Paid $55 cash into bank
May 28 Borrowed $205 from Jacky – received money by cheque
Activity 2*
A three-column cashbook is required from the following month from the following
transactions. The cashbook should be balanced off at the end of the month and the totals
should be transferred to the relevant discount accounts in the general ledger.
20X5
October 1 Balances brought forward: Cash $115, Bank $290 (Cr.)
October 3 Paid creditors by cheque; Pepe $440, Lenon $120 (before discount) and received a
5% discount on invoice totals.
October 5 Cash sales $489
October 9 Paid $300 cash into bank account
October 13 Received cheques from suppliers for accounts totals as follows: Moore $264,
Wendy $360 and Sergio $120, in each case allowing a 2.5% discount.

October 19 Cash purchases $78
October 20 Paid rent by cheque $56
October 22 Received cheque of $90 from Kassim in settlement of sales worth $95.
October 25 Cash withdrawn from bank for personal use $100
October 29 Paid Vanina by cheque for $85 in settlement of $95 account balance.
October 30 Received commission by cheque $46
Answer to Activity 1
Cash Book
Cash Bank Cash Bank
20X3 $ $ 20X3 $ $
May-01 Balances b/d 54 140 May-04 Advertising 32
May-11 Carragher 90 May-06 Purchases 25
May-14 Bank 45 May-14 Cash 45
May-22 Sales 95 May-17 Sundries 34
May-24 Cash 55 May-20 Madison 72
May-28 Jacky 205 May-24 Bank 55
Balance c/d 80 341
194 490 194 490

4
UNIT
BOOKS OF ORIGINAL ENTRY

Unit 4
4.0 I ntroduction
4.1 Source Documents
4.2 Cash and trade discount
4.3 Division of the ledger
4.4 The Purchases Journal
4.5 The Sales Journal
4.6 Return inwards and return outwards journal
4.6.1 Credit Note
4.6.2 The Return Inwards Journal
4.6.3 Return Outwards Journal
4.7 The Journal
4.8 The Petty Cash Book

zz State the reasons for keeping books of original entry
zz State the source documents used for keeping books of original entry
zz Record transactions in books of original entry
zz Post transactions from books of original entry to the ledger
zz 4.0 Introduction
Several transactions occur in an accounting period and they need to be recorded.

Consequently, the ledger might be overloaded with information. Recording each
transaction as they occur in the ledger will be too time-consuming. Instead, they are
initially recorded in books of prime entry or original entry. Thus books of original entry
aim to reduce the number of entries in the ledger and save time in the recording process.
4.1 SOURCE DOCUMENTS

All entries made in books of original entry must be supported by source documents
as evidence of transactions in line with the concept of objectivity. The following table
summarizes the books of original entry and their respective source documents.
Books of original entry Source documents
Cash Book counterfoils for cheques sent to suppliers or creditors
cheques received from trade receivables
receipts issued to trade payables for payments made
till slips for cash payments
Petty cash book petty cash vouchers signed by employees
Journal Invoices and receipts either received from suppliers or sent to
customers or other relevant documents
Sales journal copies of invoices for goods sent to customers
Purchases Journal invoices for goods received from suppliers
Return inwards journal copies of credit notes sent to customers
Return outwards journal Credit notes received from suppliers
Source (Betsy Li et al., 2001)

4.2 CASH AND TRADE DISCOUNT
A trade discount is an allowance off the list price or catalogue price of goods given by a
trader to another trader. The amount of trade discount will depend on the quantity of goods
purchased and the regularity of purchases. Unlike cash discount, a trade discount is not
recorded in the ledger. It is shown in the books of prime entry as a deduction from the list
price. It is the net amount which is transferred to the ledger. A cash discount is a deduction
off the net amount which is given by the seller if the buyer pays within a specified period
of time. Examples provided later in this chapter will make the treatment of trade discounts
more explicit.
4.3 DIVISION OF THE LEDGER

Most businesses divide their ledger into three parts:
zz The sales ledger or receivables ledger – to keep accounts of receivables (debtors)
zz The purchases or payables ledger- to keep accounts of payables (creditors)
zz The general ledger- to keep remaining accounts not entered in purchases or sales
ledgers
You can now attempt activity 1
4.4 THE PURCHASES JOURNAL

The purchases journal or purchases day book records credit purchases. The entries in the
purchases journal are written from the purchases invoices which are sent by suppliers.
It is worth noting that the purchases journal is not an account and as such does not have
a debit and a credit side. The total of the purchases journal is posted to the debit side of
the purchases account and individual amounts are credited to their respective suppliers
account in the purchases ledger.
Example 1
Record the following transactions in the purchases journal. Post the items to the relevant
accounts in the purchases ledger and show the purchases account as it would be found in
the general ledger.
Date Supplier Invoices received List price Trade discount
Jan 5 Ronnie & Co. R403 $800 5%
Jan 22 Derek 420 $9,000 10%
Jan 31 Ash 007 $1,500 5%
Solution
Purchases journal
Date Details Folio Details of Amount
invoice $
Jan 2 Ronnie & Co. PL2 800
Less trade discount 5% 40 760
Jan 22 Derek PL6 9,000
Less trade discount 10% 900 8,100
Jan 31 Ash PL8 1,500
Jan 31 Purchases a/c GL 4 10,285

Purchases ledger
Dr. Ronnie & Co. account Page 2 Cr.
Date Details F Amount Date Details F Amount
$ $
Jan 2 Purchases GL4 760
Derek account Page 6

Jan 22 Purchases GL4 8,100
Ash account Page 8

Jan 31 Purchases GL4 1,425
General ledger
Purchases account Page 4
Jan 31 Sundries 10,285
Note:
1. There are no entries for the trade discount. It is the net amount which is recorded in the ledger.
2. All purchases for the month are represented by one line in the purchases account.
4.5 THE SALES JOURNAL

The prime entry for each credit sale is made in the sales day book. The sales journal is
a chronological listing of sales invoices issued in sequential order. The sales journal is
written up from carbon copies of sales invoices which are sent to customers. The total
of the sales journal is posted to the credit side of the sales account in the general ledger.
Individual receivable accounts are then debited with their respective amounts.
Example 2
Record the following transactions in the sales journal. Post the items to the relevant
accounts in the sales ledger and show the sales account as it would be found in the general
ledger.
Date Customer Invoice number List price Trade discount
Jan 5 Ali 007 $8000 5%
Jan 22 King 008 $9,000 10%
Jan 31 Vinesh 009 $15,000 10%
Solution
Sales journal
Date Details F Invoice No. Details of $
invoice
Jan 2 Ali SL2 007 8000
Jan 22 King SL6 008 9,000
Jan 31 Vinesh SL8 009 15,000
Less trade discount 10% 1,500 13,500
Jan 31 Sales a/c GL 4 29,200

Sales ledger
Dr. Ali account Page 2 Cr
Jan 2 Sales 7,600
King account Page 6

Jan 22 Sales 8,100
Vinesh account Page 8

Jan 31 Sales 13,500
General ledger
Sales account Page 4
Jan 31 Sundries 29,200
4.6 RETURN INWARDS

AND RETURN OUTWARDS JOURNAL
Customers may return goods if they are damaged or of wrong specification. Some
businesses allow customers to return goods if they are not satisfied. When the business
accepts these goods it will issue a credit note to the customer to inform him that his
account will be credited. The customer’s account is credited as the amount owing by the
customer is reduced when the he returns goods. The amount credited to is the value of
goods returned less any trade discount allowed when the goods were initially sold
4.6.1 Credit Note

A credit note is a document sent by the seller to the buyer informing him that his account
has been credited. The seller will issue a credit note to the buyer when the latter returns
goods or when goods sold have been overcharged. For example Mr. X sells goods on
credit to Miss Y for $120. Later Mr. X finds that the correct amount of these goods should
have been $100 and not $120. Mr. X will therefore issue a credit note of $20 to Miss Y.
4.6.2 The Return Inwards Journal

Returns from credit customers are recorded in the return inwards journal or sales return book.
The sales return journal is written up from copies of credit notes issued to customers. The
total of the sales return journal is posted to the debit side of the return inwards account in the
general ledger and individual receivable accounts are credited with the respective amounts.
Example 3
Assume that on 25 January Ali and King (in example 2) returned goods with list price
$200 and $300 respectively. Recording of these transactions in the return inwards journal
and posting to the ledger will be done as follows:
Return inwards journal
Date Details Folio Details of $
credit note
Jan 25 Ali SL2 200
Jan 25 King SL6 300
Jan 31 Sales return a/c GL 4 460

Sales ledger
Dr. Ali account Page 2 Cr
King account Page 6

General ledger
Return inwards account Page 4
Jan 31 Sundries 460
4.6.3 Return Outwards Journal

Businesses may return goods previously purchased to the supplier for reasons mentioned
before. The business can send a debit note to the supplier to whom it has returned the
goods. This is to inform him that his account has been debited. From the business point of
view, a purchase return will reduce the amount owing to the supplier thus the supplier’s
account has to be debited. In practice, the business will mail the supplier informing him
about the description of goods returned and reason for the return of goods. It will then wait
for the supplier to send a credit note for the value of goods returned.
Example 4
Assume that on 25 January the business returned goods to Ronnie & Co. and Derek (in
example 1) with list price $100 and $500 respectively. Recording of these transactions in
the return outwards journal and posting to the ledger will be done as follows:
Purchases journal
Date Details Folio Details of $
invoice
Jan 25 Ronnie & Co. PL2 100
Jan 25 Derek PL6 500
Jan 31 Purchases return a/c GL 4 545
Purchases ledger
Dr. Ronnie & Co. account Page 2 Cr
Jan 25 Purchases return 95 Jan 2 Purchases GL4 760
Derek account Page 6

Jan 25 Purchases return 450 Jan Purchases GL4 8,100
22
General ledger
Purchases return account Page 4
Jan 31 Sundries 545

4.7 THE JOURNAL
The journal or general journal is a memorandum of daily business transactions recorded
in chronological order. The journal records transactions which have not been recorded
in other books of original entry. It shows the title of accounts to be debited and credited
followed by an explanation of the transaction called the ‘narrative’. The narrative will help
the accountant to recall business transactions which he would otherwise have forgotten.
It will also be useful to any other person who replaces the accountant having made the
entries to understand the reason for making such entries. The general journal is usually
used to record the following items:
zz opening and closing entries
zz purchase and sale of non-current assets on credit
zz transactions not recorded in other books of original entry e.g. correction of errors
Example
Record the following transactions in the journal of Elisa Ann.
July 10 A laptop costing $500 was purchased on credit from Court Ltd.
July 20 Inventory costing $69 was taken as samples for an advertising campaign.
July 30 A motor van was sold on credit to Madingo for $1,500.
Solution
Date Details Dr. Cr.
July 10 Office equipment 500
Court Ltd 500
Being purchase of laptop on credit
July 20 Advertising 69
Purchases 69
Being goods used as samples for advertising campaign
July 30 Madingo 1500
Disposal of Motor Van 1500
Being motor van sold on credit
4.8 THE PETTY CASH BOOK

You learnt in chapter 3 that the cash book records receipt and payment of cash and cheques.
In a business the need to pay for minor expenses like postage, stationery, travelling
expenses and miscellaneous expenses often arises. To reduce the work load of the chief
cashier, a petty cash book is kept to keep records of outgoing cash for minor expenses.
This responsibility can be delegated to a junior staff. Payments from the petty cash are
made after presentation of an invoice or receipt. In circumstances when a receipt cannot
be produced e.g. for the purchase of stamps, a petty cash voucher must be filled by the
person requesting the payment and signed by an authorised person. The petty cashier will
then effect payment.
The petty cash book is normally operated using the imprest system. Here the chief cashier
will hand an amount of money, say $100 to the petty cashier. This amount is called the
float. The petty cashier will effect payment from this amount and at the end of a suitable
period, say a week, the chief cashier will reimburse the petty cashier the amount of cash
spent. E.g if the petty cashier has made payments of $70, then the chief cashier will top up
the amount left ($30) to the amount of the float ($100) by reimbursing $70. The balance in
the petty cash book is shown under current assets.

Example
July 1 Petty cash in hand $20
July 1 Reimbursement from chief cashier $80
July 2 Paid for postage $8
July 6 Paid for cleaning expenses $25
July 6 Paid for coffee and milk $12
July 7 Paid for stamps $5
July 8 Paid for pens and pencils $4
Receipts Date Details Voucher Total Analysis

no. payments
$ $ Postage Stationery Sundries
20 Jul 1 Balance b/d
80 Jul 1 Bank
Jul 2 Postage 1 8 8
July 6 Cleaning 2 25 25
July 6 Coffee 12 12
July 7 Stamps 3 5 5
July 8 Pens and 4 4
pencils
54 13 4 37
Balance c/d 46
100 100
46 Balance b/d
ACTIVITY
Activity 1
State the ledger in which the following accounts are kept;
(a) Sales account
(b) Supplier C.Kay account
(c) Customer A.Bee account
(d) Purchases account
Activity 2
You are required to enter up the Purchases Day Book and the Returns Outwards Day Book
from the following details, then to post the items to the relevant account in the Purchases
Ledger and then to the show the transfers to the General Ledger at the end of the month.
20X8
September 1 Credit purchases from Sandy $87
September 7 Credit purchases from Walters $65 and Croft $90
September 9 Goods retuned by us to Sandy worth $56
September 14 Credit purchases from L Evans $45
September 15 Credit purchases from Tomkins $135
September 18 Goods retuned by us to Evans worth $20
September 21 Goods retuned by us to Tomkins worth $50

Activity 3*
You are required to enter up the Sales Day Book and the Returns Inwards Day Book from
the following details, then to post the items to the relevant account in the Sales Ledger and
then to the show the transfers to the General Ledger at the end of the month.
20X8
November 1 Credit sales to Lordmax $70 and T Lawson $120 less 5% trade discount
November 4 Credit sales to Barnett $180 less 5% trade discount
November 7 Goods retuned to us by Lordmax worth $20 (listprice)
November 10 Credit sales to Kinson $210
November 18 Goods retuned to us by Lawson, list price $45
November 19 Credit sales to Anderton $380
November 24 Goods retuned to us by Kinson, list price $100
Activity 4
Record the following in the Returns Outwards Journal and then post the entries to their
relevant accounts in the Purchase Ledger and the total of Returns Outwards to the Returns
Outwards Account in the General Ledger.
Jan 1 Returned goods worth $56 to Yong Ltd. Because their goods were defective
Jan 2 Received a credit note from Winny Ltd. For return of empty bottles worth$30
Jan 2 Received a credit note from Rose for return of damaged goods invoiced at $27
Jan 22 Sent Hazel Ltd a debit note together with goods worth $19 because they were of the
wrong size
Activity 2.
Purchases Day Book
20X8 $
September 1 Sandy 87
September 7 Walters 65
September 7 Croft 90
September 14 L Evans 45
September 15 Tomkins 135
Transferred to purchases account 422
Returns Outwards Day Book

20X8 $
September 9 Sandy 56
September 15 L Evans 20
September 21 Tomkins 50
Transferred to purchases account 126
Purchases Ledger:
Sandy
20X8 $ 20X8 $
Sep 9 Returns outwards 56 Sep 1 Purchases 87

Walters
20X8 $ 20X8 $
Sep 7 Purchases 65
Croft
20X8 $ 20X8 $
Sep 7 Purchases 90
L Evans
20X8 $ 20X8 $
Tomkins
20X8 $ 20X8 $
General Ledger
Purchases
20X8 $ 20X8 $
Sep 31 Total credit purchases 422
for month
Returns Outwards
20X8 $ 20X8 $
Sep 31 Sundries 126

5
UNIT
THE INCOME STATEMENT
AND STATEMENT OF FINANCIAL POSITION
UNIT
5.0 Introduction
5.1 Closing nominal accounts
5.2 Additional cost on purchases
5.3 Closing inventory
5.4 Real accounts
5.5 The statement of financial position
5.5.1 Elements of the statement of financial position
5.6 Vertical format of financial statements
5.7 Activity

zz Differentiate between gross and net profit
zz Prepare an income statement
zz Classify assets into current and non-current
zz Classify liabilities into current and non-current
zz Prepare a statement of financial position
5.0 INTRODUCTION
The life of a business is divided into arbitrary time periods called accounting period. Owners
will like to have periodic information about the performance of the business. This information
is provided by the income statement. Owners and other interested parties would also require
information about the assets and liabilities of the business (what the business owns and what
it owes). This need is fulfilled by preparing the statement of financial position.
5.1 CLOSING NOMINAL ACCOUNTS

Expenses and revenue accounts are temporary accounts which exist ‘in name only’
hence the term nominal. These accounts affect the profit of the business and are therefore
transferred to the income statement. Nominal accounts are reset to zero balance at the
start of each accounting period. The objective of the income statement is to calculate the
net profit or net loss made by a business for an accounting period. The steps involved in
preparing the income statement are shown below.
Example
We reproduce the example from chapter 2 to illustrate the preparation of the income statement
  Sales a/c
Oct-31 Transfer to income statement 298 Oct-19 S Lords 113
Oct-19 C Rock 89
Oct-29 J Rudra 96
298 298
Purchases a/c
Transfer to income
Oct-14 S Gary 56 Oct-31 statement 132
 
Oct-14 S Rai 76
132 132
Dr Income Statement for the month ended 31 October 20xx (Extract) Cr

Purchases 132 Sales 298

Note:
1. Using the double entry principle the sales account is closed by transfer to the credit side of the
income statement. Similarly the purchases account is transferred to the debit side of the income
statement.
Returns outwards a/c

Oct-31 Transfer to income statement 15 Oct-16 S Gary 15

15 15
Returns inwards a/c

Transfer to income
Oct-26 S Lords 27 Oct-31 statement 27

27 27

Return inwards 27 Return Outwards 15
Note
Purchases and Return Outwards, Sales and Return inwards are related but found on different sides
of the income statement. We can group them together on the same side but items moving side
from debit to credit and vice versa will change sign from ‘+’ to ‘-’.
The income statement can be redrafted as follows:

Less Return Outwards 15 Less Return inwards 27
5.2 ADDITIONAL COST ON PURCHASES

Purchases relates to the cost of goods bought. The expenses incurred in purchasing these
goods and bringing them to a saleable condition should be added to the cost of purchases
to give the actual cost of goods bought. These costs include the cost of transporting goods
from a supplier’s place to the trader’s place (carriage inwards/carriage on purchases).
Similarly, Import duty and freight charges are added to the purchases figure. Wages of
employees involved in getting goods ready for resale will also add to the cost of purchases.
Carriage on purchases a/c
Transfer to income
Oct-14 Cash 15 Oct-31 statement 15
 
15 15

Carriage on purchases 15 Less Return inwards 27
Less Return Outwards 15 Net sales/Turnover 271

Net purchases 132
5.3 CLOSING INVENTORY

It is quite unlikely that all goods purchased will be sold at the end of an accounting period.
Goods which are left unsold at the end of the accounting period is termed as ‘closing
inventory’. The trader will undertake a stock count to evaluate the amount of goods
unsold. These goods are valued at the lower of cost or net realizable value (selling price
less any selling expense) in line with the prudence concept. The closing inventory must be
subtracted from the net purchases to match sales with the cost of goods sold. Assume that
inventory at 31 October 20x8 was valued at $27. The income statement will be as follows:

Net purchases 132
Less closing inventory 27
Cost of sales 105
Gross profit 166
Turnover – Cost of sales = Gross profit/ Gross loss

At this stage there are other nominal accounts which have yet to be transferred to the
income statement.
Repairs a/c
54 Transfer to income 54
Oct-08 Bank Oct-31 statement

54 54
Dr Income Statement for the month ended 31 October 20x

x Cr
Net purchases 132
Cost of sales 105
Gross profit c/d 166
271 271
Expenses: Gross profit b/d 166
Repairs 54
Stationery 25
Rent 270

Other income
Commission Received a/c

Oct-31 Transfer to income statement 29 Oct-30 Cash 29
29 29
Commission received is transferred to the credit side of the income statement and will add
to gross profit.
Dr Income Statement for the month ended 31 October 20xx Cr
Net purchases 132
Cost of sales 105
Gross profit c/d 166
271 271
Expenses: Gross profit b/d 166
Repairs 54 Receipts
Stationery 25 Commission received 30
Rent 270 Net loss c/d 153
349 349
Net loss b/d 153
Net profit = Gross profit + receipts – expenses

The financial performance of the business for the month of October 20xx has been prepared
and shows a net loss of $153.
5.4 REAL ACCOUNTS

Real accounts are assets and liability accounts. These accounts are permanent in nature
and are carried forward to the next accounting period. Real accounts can be classified
into personal and impersonal. Those accounts relating to a person or organization are
personal accounts (E.g. receivables and payables). Non-current assets and Inventory are
examples of impersonal accounts. Real accounts are used to prepare the statement of
financial position.
5.5 THE STATEMENT OF FINANCIAL POSITION

The statement of financial position or balance sheet is a reflection of the accounting
equation. It depicts the financial position of the business at a point in time. Unlike the
income statement which has a debit and a credit side, the statement of financial position has
an asset and a liability side. The real accounts from the previous example are reproduced
to prepare the statement of financial position.
Dr. Cr.
Capital account
Oct-31 Balance c/d 7,000 Oct-01 Bank 7,000

7,000 7,000

Bank account
Oct-01 Capital 7,000 Oct-04 Van 1,500
Oct-08 Repairs 54
Oct-11 Cash 300
Oct-22 Drawings 275
Oct-25 Rent 270
Oct-31 Balance c/d 4,601
5,000 5,000
Van a/c
Oct-04 Bank 1,500 Oct-31 Balance c/d 1,500

1,500 1,500
Nov-1 Balance c/d 1,500
Office Equipment a/c

Oct-05 Eva Ltd 800 Oct-31 Balance c/d 800
800 800
Eves Ltd a/c

800 Office 800
Oct-31 Balance c/d Oct-05 equipment

800 800
Cash a/c
300 Carriage 15
Oct-11 Bank Oct-14 inwards
Oct-30 Commission 30 Oct-21 Stationery 25
330 330
S Gary a/c
Oct-16 Returns out 15 Oct-14 Purchases 56
56 56
S Rai a/c
Oct-31 Balance c/d 76 Oct-14 Purchases 76

76 76
S Lords a/c
113 Returns 27
Oct-19 Sales Oct-26 inwards

113 113

C Rock a/c

89 89
Drawings a/c
275 275
J Rudra a/c
96 96
Statement of financial position as at 31 October 20xx

Assets $ Capital and Liabilities $
Non-current assets Capital 7000

Van 1,500 Less net loss 153
Office Equipment 800 Less drawings 275
2,300 6,572
Current assets Current liabilities
Closing inventory 27 Trade payables (800+41+76)
917
Trade receivables (86+89+96) 271
Bank 4,601
Cash 290
7,489 7,489
5.5.1 Elements of the statement of financial position

Assets
At this stage we can take assets to be what the business owns. They can be classified as:
Non-current
These are purchased for use in the business and not for resale. They can last for several
accounting periods, e.g. motor vehicles, land, buildings, furniture.
Current
Current assets include cash and bank balances and any assets (inventory and receivables)
expected to be converted into cash within one year from the balance sheet date. Current
assets are listed in the reverse order of liquidity in the statement of financial position, i.e.
from the least liquid to the most liquid. The least liquid (most difficult to turn into cash)
being inventory and most liquid being cash itself.
Liabilities
Liabilities represent what the business owes to outsiders. The business may use funds
borrowed from sources outside the business. These outside sources have a claim on the
assets of the business. Liabilities are ordered in the reverse order in which the business
intends to discharge them. Since the amount owed to the owner reported as ‘capital’ is not
intended to be repaid until the business ceases, the capital account is therefore reported first
(Benedict and Elliot, 2009).
Non-current liabilities
These are debts of the business which have a repayment period of more than one year
from the balance sheet date, e.g. loans.
Current liabilities
These are short term debts intended to be repaid within one year from the balance sheet
date. E.g. trade payables and bank overdraft.
Owner’s equity
Owner’s equity represents what the business owes to its owners. The business entity concept
states that the owner is separate from the business. The capital is treated as a loan by the owner to
the business. The owner’s equity represents the claims on the assets of the business after external
debts and obligations have been settled. It is equal to total assets minus total liabilities.
Owner’s equity represents what the business owes to its owners. The business entity
concept states that the owner is separate from the business. The capital is treated as a loan
by the owner to the business. The owner’s equity represents the claims on the assets of the
business after external debts and obligations have been settled. It is equal to total assets
minus total liabilities.
5.6 VERTICAL FORMAT OF FINANCIAL STATEMENTS

It is common nowadays to present the financial statements using the vertical format. The
pro forma of the income statement and statement of financial position are as follows:
Income statement for year ended 31 December 20x7
$ $ $
Revenue x
Less return inwards x
Net Revenue/Turnover x
Less cost of Sales
Opening inventory x
Purchases x
Add carriage on purchases x
Less return outwards x
Net purchases x
Cost of goods available for sale x
Less closing inventory x x

Gross Profit/(Gross loss) x
Add Receipts
Discount Received x
x
Less Expenses
Carriage outwards x
Salaries and wages x
Insurance x
Motor exp x
Rent x
office exp x
General exp x
Light & heat x
Total expenses x
Net Profit/( Net Loss) x

Opening inventory + net purchases = cost of goods available for sale
Cost of goods available for sale – closing inventory = cost of sales
Sales – cost of sales = Gross profit
Gross profit + receipts – expenses = Net profit/ net loss
Statement of financial position as at 31 December 20x7
$ $ $
cost Acc Dep NBV
Non-current Assets
Land and Buildings x x x
Plant and machinery x x x
Furniture and fittings x x x
Motor vehicles x x x
x x x
Current assets
Closing inventory x
Trade receivables x
Cash at bank x
Cash in hand x x
Total assets x
Capital and liabilities

Capital x
add net profit x
Less drawings x
Owner's capital x
Non-Current Liabilities
Loan x
Current liabilities
Trade payables x
Bank overdraft x x
Total capital and liabilities x
5.7 ACTIVITY
Activity 1
From the following trial balance of Lezley, you are asked to draw up an income statement
for the year ended 31 March 20X2 and a statement of financial position as at that date.
Dr Cr
$ $
Sales 168,000
Purchases 99,995
Inventory as at 1 April 20X1 4,330
Premises 75,000
Equipment 18,500
Carriage inwards 230
Carriage outwards 195
Returns inwards 375
Bank 5,995

Cash in hand 877
Wages 9,500
Insurance 750
Advertising 205
Motor repairs 590
Capital 76,850
Drawings 11,540
Returns outwards 560
Vehicles 12,000
Sundries 328
Rent 3,260
Rates 4,350
25,6970 25,6970
Inventory as at 31 March 20X2 was valued at $11,855
Activity 2*
From the following trial balance of V.Vette, you are asked to draw up an income statement
for the year ended 31 December 20X3 and a statement of financial position as at that date.
Dr Cr
$ $
Sales 108,000
Purchases 82,190
Carriage inwards 555
Wages 9,255
Insurance 542
Returns inwards 180
Returns outwards 212
Drawings 4,600
Premises 34,000
Equipment 8,600
Bank 3,250
Cash in hand 123
Sundries 500
Inventory as at 1 January 20X3 7,950
Rent 1,200
Rates 860
Capital 47,500
159,145 159,145
Inventory as at 31 December 20X3 $8,990

ANSWER TO ACTIVITY 1
Lezley
Income statement for year ended 31 March 20x2
$ $ $
Sales 168,000
Less Returns inwards 375
Net turnover 167,625
Less Cost of goods sold

Opening stock 4,330
Add Purchases 99,995
104,325
Less Returns outwards 560
103,765
Add Carriage inwards 230
103,995
Less Closing inventory 11,855 92,140
Gross profit 75,485
Less Expenses
Wages 9,500
Insurance 750
Advertising 205
Motor repairs 590
Sundries 328
Rent 3,260
Rates 4,350 19,178
Net profit 56,307
Statement of financial position as at 31 March 20x2

$ $ $
Non current Assets
Premises 75,000
Equipment 18,500
Vehicles 12,000
105,500
Current Assets
Inventory 11,855
Receivables 8,950
Bank 5,995
Cash 877 27,677
133,177
Financed by:
Capital 76,850
Add Net profit 56,307
133,157
Less Drawings 11,540
121,617
Current Liabilities
Payables 11,560
133,177

6
UNIT
ACCOUNTING FOR DEPRECIATION
AND DISPOSAL OF NON-CURRENT ASSETS
UNIT
6.0 Introduction
6.1 Accounting entries
6.2 Cost of an Asset
6.3 Depreciation
6.4 Calculating Depreciation
6.4.1 Straight line or Equal Instalment Method
6.4.2 Reducing Balance or Declining Method
6.4.3 Usage Method
6.4.4 Revaluation Method
6.5 Accounting Entries for Depreciation
6.6 Depreciation Policies
6.7 Disposals of Non–Current Assets
6.8 Activity

zz Record the purchase of non-current assets
zz Calculate the cost of an asset
zz Calculate depreciation using the different methods of depreciation
zz Record disposal of non-current assets
zz Effect entries for the revaluation of non-current assets
6.0 INTRODUCTION
Firms need to invest in fixed assets in order to create capacity. This could be in the form
of buildings, office furniture, motor vehicles and computer equipment. Such expenditures
are classified as capital expenditure and are not expected to recur frequently. It is important
to note that recording of items of capital expenditure are made under specific categories
while the details of the items are recorded in a separate fixed assets register. For financial
reporting purpose, fixed assets are referred to as non-current assets.
6.1 ACCOUNTING ENTRIES

Fixed assets can be acquired either in cash or credit – for example:
(i) Purchase of motor vehicles from ABC Motors Ltd for $ 500,000 on credit
(ii) Purchase of Air conditioner from J Kalachand Ltd for $ 25,000, paying by cheque.
In both cases, we debit the Assets Account and Credit ABC Motors Ltd Account for (i)
and Bank Account for (ii).
6.2 COST OF AN ASSET

To ascertain the cost of an asset, it is important to apply the concept of operational use –
i.e. all the costs incurred in bringing the asset to its operational use. This may include the
following costs:
zz Transportation to bring the item to its location
zz Installation costs – e.g. electrical wiring
zz Testing and commissioning
zz License fee to obtain clearance and approval

zz Adaptation costs – tailor made software
6.3 DEPRECIATION
Firms invest in fixed assets to generate revenue and to be in line with the matching concept;
part of the costs should be released against the calculation of profit. This is achieved by
providing for depreciation at the end of an accounting period. Depreciation is a non –
cash item and it also represents the loss in value which arises through use, wear and tear,
obsolesce and changes in technology.
6.4 CALCULATING DEPRECIATION

Firms have a choice as regards the calculation of depreciation and the choice made is
often guided by the nature of the assets and industry norms. However, once a method
of depreciation is chosen, firms are expected to use the same method over a number of
accounting periods. This is stipulated by the consistency concept.
6.4.1 Straight line or Equal Instalment Method

As the name implies, an equal charge for depreciation is made over the economic useful
life of the asset. Depreciation is calculated either on a percentage basis on the cost of
the assets or by making reference to the cost of the assets, residual value and the useful
economic life of the assets.
Example
Firm A acquires a plant at a cost of $ 100,000, having a residual value of $ 10,000 at the
end of 5 year. The annual depreciation charge can be calculated as follows:
Cost ($100,000) – Estimated disposal value ($10,000)

Number of expected years of use (5)
6.4.2 Reducing Balance or Declining Method

Under this method, except for the first year, depreciation is calculated on the net book
value of the assets. Proponents of this method consider the total charge to the firm while
using an asset, say a machine. In order to maintain the machine in its operational state, the
firm needs to incur costs for repairs and maintenance. In the early years of the assets the
repairs and maintenance costs are low while in later years, it tends to be high.
Depreciation charge under the reducing balance method makes a higher charge in the
early years of the assets and a lower charge in later years. Thus when combining the
depreciation charge and the repairs and maintenance, there is more or less a constant
charge for using the assets to generate revenue.
Example
Firm B acquires a computer for $ 50,000 and decides to depreciate the computer at the rate
of 15% using the reducing balance method.
Year 1 Depreciation charge = [15% of 50,000] = $ 7,500

Year 2 Depreciation charge = [15% of (50,000 – 7,500)] = $ 6,375

The table below shows how depreciation is treated in the Income statement and the
Statement of Financial Position.
Income
Year Statement Statement of Financial Position
Cost Acc.Depn NBV
1 [15% * 50,000] 7500 50,000 7,500 42,500

6375 50,000 13,875 36,125
2 [15%* 42,500]

3 [15% * 36,125] 5419 50,000 19,295 30,705

6.4.3 Usage Method

This method makes a charge to profit which reflects the actual usage of the assets. It is
most commonly used for depletion of mines/quarries and machinery, where operating
hours varies from period to period.
6.4.4 Revaluation Method

There are instances when it is not practical to calculate depreciation for a single item
– mostly for the case of loose tools. Here the charge for depreciation is calculated by
making a revaluation of the loose tools at the end of the accounting period. The difference
between the value at end and at beginning represents the depreciation charge.
6.5 ACCOUNTING ENTRIES FOR DEPRECIATION

Depreciation represents a charge against profit and a fall in the value of the assets. This is
reflected in the books of accounts by:
Dr Depreciation Expense Account xx

Cr Provision for Depreciation Account xx
At the end of the accounting period, the depreciation expense is posted to the income
statement and the provision for depreciation is shown as a deduction from non - current
assets in the statement of financial position.
Note
Cost – Accumulated depreciation – Net Book Value of the Asset at Balance sheet date.
6.6 DEPRECIATION POLICIES

Some businesses adopt a policy of charging a full year’s depreciation in the year the asset
was purchased, and none in the year of its sale. Others take proportionate depreciation
for the number of months of ownership of the asset in the year. The first requirement,
therefore, is to read the question carefully to find out what has to be done for each non-
current asset.
Income Statement/Profit and loss account

The current year’s depreciation charge is calculated and appears as an expense. Do
not include the accumulated depreciation. The accumulated depreciation is the total
depreciation charged during an asset’s life (assuming no revaluation) and as such previous
depreciation charges have already been charged against profits in earlier periods.

Statement of Financial Position/Balance sheet
The balance sheet shows the cost, accumulated depreciation (the figure in the trial balance
plus the current year’s charge from the income statement), and net book value. The easiest
way to present this is as a table, as follows (figures invented):
Cost Accumulated Net book
depreciation value
$ $ $
Buildings 800,000 80,000 720,000
Plant and 390,000 260,000 130,000
equipment
Motor vehicles 210,000 100,000 110,000
1,400,000 440,000 960,000
Workings may have to be shown separately to explain the build-up of the figures.
6.7 DISPOSAL OF NON –CURRENT ASSETS

It is quite normal for firms to dispose their assets at the end of their economic useful life.
This is usually followed by a replacement of the assets. On disposal, there are a number of
accounting entries to be followed to record the disposal. These are as follows:
- Remove the cost of the asset from the ledger
Dr Asset Disposal Account
Cr Asset Account
- Account for the depreciation already provided on the asset sold

Dr Provision for Depreciation Account
Cr Asset Disposal Account
- Record the proceeds on disposal

Dr Bank Account
- Balance off the disposal account with either a loss (Cr entry) or a profit (Dr entry) on
disposal.
If there is a part exchange against the newly acquired assets then the accounting entries
to record this part exchange:
Dr Asset Account (newly acquired)
Example
On 1st July 2010 Jim Ltd acquired three motor vehicles for $ 75,000 each, paying by
cheque. It is the company policy to provide for depreciation at the end of year at the
rate of 20% using the reducing balance method. After providing for the second years
depreciation, the company sold one of the vehicles for $ 50,000. On the same date Jim Ltd
purchase a mini cab for $ 100,000 on credit from ABC Motors Ltd.
Required:
(a) Prepare the Motor Vehicles Cost Account for the two years 2011 and 2012.
(b) Prepare the Provision for Depreciation Account for the two years 2011 and 2012
(c) Prepare the Motor Vehicles Disposal Account.

Solution
Dr Motor Vehicle Account Cr
$ $
Jul-10 Bank 225000
Jun-11 Balance c/d 225000
225000 250000
Jun-11 Balance b/d 225000 Jun-12 Disposal 75000
ABC Motors 100000 Balance c/d 250000
325000 325000
Dr Provision for Depreciation Account Cr

$ $
Jun-11 Balance c/d 45000 Jun-11 Inc St 45000
Jun-11 Balance b/d 45000

Jun-12 Disposal 27000 45000
Balance c/d 54000 Jun-12 Inc St 36000
81000 81000
Jun-12 Balance b/d 54000
Dr Disposal Account Cr
$ $
Jun-12 M/V Cost a/c 75000 Jun-12 Provn doe depn
Profit 2000 Bank 27000
50000
77000 77000
6.8 ACTIVITY
A. Multiple Choice Questions
1. Gary bought a new machine. The invoice included costs for:
(i) installation charges
(ii) routine maintenance for the first year of operation
(iii) testing the machine prior to operation
Which of the costs are capital expenditure?
A (i), (ii) and (iii) B (i) and (ii) only C (i) and (iii) only D (ii) and (iii) only
2. In the year to 30 November 2009, Lall accounted for $7,000 of expenditure on

machinery repairs as the cost of a new machine. Lall depreciates machinery on a
straight-line basis over 10 years and charges depreciation for a full year in the year an
asset is acquired.
What is the effect of the error on Lall’s profit for the year to 30 November 2009?
A understated by $6,300 B understated by $7,700
C overstated by $6,300 D overstated by $7,700
3. In the financial year ended 31 October 2009, Edita sold a car for $5,600. The car
had been bought in January 2006 for $14,000. Edita depreciates motor vehicles on
the reducing balance basis at a rate of 25% per annum. She charges a full year’s
depreciation in the year an asset is bought, and no depreciation in the year it is sold.

What is the profit or loss on disposal of the car (to the nearest $1)?
A $306 loss B $306 profit C $2,100 loss D $2,100 profit
5. Which TWO of the following will be classified as non-current assets for a dealer
in computer equipment?
(1) Computers for resale
(2) Vehicles for delivering computers
(3) Business capital
(4) Office furniture
A 1 and 2 B 2 and 3 C 2 and 4 D 3 and 4
The following information is relevant to questions 6 to 10 inclusive:

Boggs Ltd. bought 2 vehicles, A and B costing $40,000 each on 1st January 2004. It
acquired a new vehicle C on 1st July 2006 by trading in A for $20,000 and paying by
cheque $30,000. On 1st October 2006 vehicle B was sold for $22,000 and immediately
replaced by vehicle D costing $55,000. The depreciation policy is to depreciate at an
annual rate of 20% reducing balance. All vehicles are depreciated up to the date they are
disposed of and new vehicles from the date they are acquired for each month owned in the
year of acquisition. Boggs Ltd. makes up its account to 31st December each year.
At 30 April 2008 machinery was reported in Boggs balance sheet at a value of $170,650.
This represented cost less accumulated depreciation of $98,450.
6. The disposal of vehicle A gave rise to

A. A loss of $ 3,040 B. No loss/no gain
C. A profit of $ 3,040 D. None of the above
7. The disposal of vehicle B gave rise to

A. Loss of $1,500 B. Profit of $240 C. Profit of $4,000 D. None of the above
8. The Income Statement charge for depreciation of vehicles for 2006 was
A. $22,000 B. $14,150 C. $12,150 D. None of the above
9. The net book value of the vehicles at 31/12/2006 was

A $97,050 B $105,000 C $185,000 D None of the above
10. The net book value of the vehicles at 1/1/2006 was

A $55,000 B $51,200 C $48,000 D none of the above
B. Structured Questions
B1. During the year to 30 April 2009, Martin traded-in a machine in part exchange for a
new model. The machine he traded in cost $44,000 when he bought it in July 2005.
He received a trade-in allowance of $22,750 and paid the supplier the balance of
$32,250 by cheque.
Martin depreciates machinery at 20% per annum on the reducing balance basis.
He charges a full year’s depreciation in the year of acquisition. No depreciation
is charged in the year of disposal.
Required:
(a) Calculate:
(i) the cost of the machine acquired during the year to 30 April 2009;
(ii) the profit on the trade-in of the machine;
(iii) the depreciation charge for machinery for the year to 30 April 2009; and
(iv) the net effect on Martin’s profit for the year to 30 April 2009 in respect of
machinery;
(b) Prepare the Machinery Cost account for the year to 30 April 2009 from
Martin’s nominal ledger.

(c) State the value of machinery which should be included in Martin’s statement of
financial position at 30 April 2009.
B2. The two main methods of calculating depreciation are:-

The straight line method and
The reducing balance method.
(a) Explain both methods and compare them using the figures from the following
example:-
A machine costing $8,000 had an estimated useful life of 4 years and an estimated
residual value of $500. After 2 years use it was sold at the start of year 3 for
$2,500. You are to use a rate of 50% for the reducing balance.
(b) Define capital expenditure, revenue expenditure, revenue receipts and capital
receipts and clearly distinguish between each.
SOLUTION TO ACTIVITY
A. MCQ
1. C 2. C 3. A 4. C 5. B 6. A 7. B 8. D 9. A 10. B
B. Solution to structured questions

B1
(i) Cost of Machine: $
Trade – in Allowance 22,750
Paid by cheque 32,250
55,000
(ii) Profit or Loss on Trade in

Cost of Machine 44,000
Depreciation charged up to date of disposal:
30 April 2006 – [20/100* 44,000] 8,800
30 April 2007 – [20/100* 35,200] 7,040
30 April 2008 – [20/100*28,160] 5,632
21,472
Net book value at date of sale 22,528
Trade in allowance 22,750
PROFIT 222
(iii) Depreciation charged for the year 30 April 2009

New Machine – [20/100*55,000] 11,000
(iv) Net effect on profit for April 2009

Depreciation charge 11,000
Profit on trade – in (222)
10,778
(v) Value of Machinery as at 30 April 2009
Cost 55,000
Less Depreciation 11,000
44,000
Machinery Account
2008 $ 2008 $
May 1 Balance b/d 44,000 Apr 09 Disposal 44,000
Apr 09 Disposal – Trade in 22,750
Bank 32,250 Apr 09 Balance c/d 55,000
99,000 99,000

Sources:
ACCA Technical article: Adjustment to Financial Statement, Student Accountant January 2006
IIPA – Accounting Framework
Glossary
The term depletion is used for the depreciation of wasting assets such as mines, oil wells,
timber trees etc.
The term amortization is used in respect of intangible assets like patents, copyrights, leasehold
and goodwill which are recorded at cost. Some intangible assets have limited useful life and
are, therefore, written off. The process of their writing off is called amortization.

7
UNIT
ADJUSTMENTS
ON FINAL ACCOUNTS
UNIT
7.0 Introduction
7.1 Accrued Expenses
7.2 Adjustments made for Accrued Expenses
7.3 Prepaid Expenses
7.3.1 Adjustments made for Prepaid Expenses
7.4 Bad debts and provision for bad debts
7.4.1 ad debts
7.4.2 Adjustments made for bad debts
7.4.3 Bad debts as an adjustment in final accounts
7.5 Provision for doubtful debts
7.5.1 Creation of a provision for bad debts
7.5.2 Increase in provision for bad debts
7.5.3 Decrease in provision for bad debts
7.6 Goods taken for own use
7.7 Activity

zz Adjust financial statements for expenses due and prepaid
zz Account for the creation, increase and decrease in allowance for doubtful debts
zz Prepare financial statements after adjustment
7.0 INTRODUCTION
When preparing the Income Statement, sales is matched with the expenses incurred in
generating the sales, resulting in either a Net Profit or a Net Loss. Situations we have
encountered so far assume expenses and revenues belong exactly to the period in question.
According to the matching/accrual concept, revenue included in the income statement is
the revenue earned for the accounting period even if cash has not been received. Similarly
expenses recognized in the income statement are expenses incurred for the accounting
period and not expenses paid. In many instances adjustments have to be made to amounts
paid and received when preparing the financial statements.
7.1 ACCRUED EXPENSES

An accrued expense (Accrual) is the name we give to an amount owing for which we
have not yet received an invoice. You will notice in preparing accounts that the term
“Accrued” can also be referred to as outstanding, due, unpaid, unsettled and not paid.
When an expense is accrued, it means that we have paid less than the amount payable for
that expense. Therefore an adjustment has to be made for the amount unpaid.
7.2 ADJUSTMENTS MADE FOR ACCRUED EXPENSES

A firm preparing accounts on a calendar year basis incurs an annual rent of $2400, payable
at the end of every quarter. Three payments of $600 each were made during the year ended
31 December 2011 on 30 March, 29 June and 1 Oct by cheque. The Rent Account for the
year ended 31 December 2011 can be shown as follows:
Dr Rent Account Cr
Date Details ($) Date Details ($)
30Mar Bank 600

29 Jun Bank 600
1 Oct Bank 600 31 Dec Transfer to IS 2400
31 Dec Bal c/f (accrued) 600
2400 2400
1 Jan Bal b/f (accrued) 600
The firm is supposed to make a total payment of $2400 for the year whilst the actual total
payment made is only $1800. The accrued balance of $600 is shown by a credit balance
in the rent account since it is a liability. As such the amount transferred to the income
statement is the amount payable for the year i.e. $2,400.
The amount of Rent to be shown in the Trial Balance as at 31 December 2011 will be only
$1800.
Trial Balance as at 31 Dec 2011 (Extract)

Debit Credit
Rent 1800
The adjustment that you are required to make when you are preparing the final accounts
should be as follows:
zz $ 600 should be added to the actual amount paid of $1800, which makes Rent equal
to $ 2400 in the Income Statement for the year ended 31 December 2011
zz $ 600 should be treated as a current liability in the Statement of Financial Position
as at 31 December 2011.
Extract of Income Statement for the year ended 31 December 2011

Expenses:
Rent 1800
Add amount due 600 2400
Extract of Statement of Financial Position as at 31 December 2011

Current Liabilities:
Accruals: Rent 600
7.3 PREPAID EXPENSES

The term ‘Prepaid’ can also be referred to as a payment in advance or prepayment.
Expenses prepaid refer to the expenses that have already been paid for the next financial
year. Obviously they will represent an asset for the firm. When an expense is prepaid, it
means that we have paid more than the amount payable for that expense. In other words
it refers to an expense that has been paid for in the financial period prior to the one in
which the benefit of the expense is received. Therefore an adjustment has to be made for
the amount paid in excess.
7.3.1 Adjustments made for Prepaid Expenses

Let us assume that the firm referred to in the previous example pays a monthly insurance
of $300 and during the year makes a total payment for insurance amounting to $4,500.
The Insurance account for the year ended 31 Dec 2011can be shown as follows:

Dr Insurance Account Cr

Jan-Dec 11 Cash and bank 4500 31 Dec 11 Transfer to IS 3600
31 Dec 11 Bal c/f (prepaid) 900
4500 4500
1 Jan 12 Bal b/f 900
Since the monthly insurance is $300, then the total insurance for the year 2011 should
be $300 multiplied by 12 which makes $3600. Hence $900 has been paid in advance
and relates to a future period’s expense. This is shown by a balance b/d on the debit side
(being an asset). The amount transferred to the income statement is $3,600 (payable for
the period) and not the amount paid.
The amount of Insurance to be shown in the Trial Balance as at 31 December 2011 will
be the amount paid i.e. $4500.
Trial Balance Extract (31 Dec 2011)

Debit Credit
Insurance 4500
The adjustment you are required to make when preparing final accounts should be as
follows:
zz $ 900 should be deducted from the actual amount paid of $4500, which makes Insurance
equal to $3600 in the Income Statement for the year ended 31 December 2011
zz $900 should be treated as a current asset in the Statement of Financial Position as at
31 December 2011.

Expenses:
Insurance 4500
Less amount prepaid 900 3600

Current Assets:
Prepayments: Insurance 900
Therefore the general rule for an expense account is as follows:

Dr Expense Account Cr
1 Jan Bal at start (prepaid) x 1 Jan Bal at start (accrued) x
Jan-Dec Bank (amount paid) xxx 31 Dec Transfer to IS xxx
31 Dec Bal c/d (accrued) x 31 Dec Bal c/d (prepaid) x
xxxxx xxxxx
1 Jan Bal b/d (prepaid) x 1 Jan Bal b/d (accrued) x
7.4 BAD DEBTS AND PROVISION FOR BAD DEBTS

In this part we will examine what a firm should do in a situation when a debtor (Accounts
Receivable) does not pay his debt or there is some doubt about the eventual payment of
all or part of the amount due.

7.4.1 Bad debts
For many businesses a large proportion of sales is on a credit basis. The business is
therefore taking the risk that some of the customers never pay for the goods sold to them
on credit. This is a normal business risk which we call bad debts. Bad debt is a normal
business expense and must be charged to the income statement when calculating the profit
or loss for the period.
When a debt is found to be bad, the asset as shown by the debtor’s account is worthless and
must accordingly be eliminated as an asset account (in line with the prudence concept). This
can be done by crediting the debtor’s account to cancel the asset and increasing the bad debt
account by debiting it. Sometimes the debtor may have paid part of the debt leaving the
remainder to be written off as a bad debt. The total of the bad debts account is later transferred
to the Income Statement.
7.4.2 Adjustments made for bad debts

Consider the account of customer Al in the books of a business.
Dr Al Account Cr
Jan 15 Sales 2000 Jan 17 Return Inwards 300
Jan 22 Sales 1000 Jan 31 Bad Debts 2700
3000 3000
The business has sold goods worth $3000 on credit to Al and the latter has returned goods
worth Rs300. He has a debt of $2700 but since he has left the country and will never be
back, the business has written off the balance due of $2700 as Bad debts.
The double entry for bad debts is
Dr Bad debts
Cr Debtor/ Trade receivable
The bad debts account can be shown as follows:

Dr Bad Debts Account Cr
Jan 31 Al 2,700 Jan 31 Transfer to IS 2,700
2,700 2,700
The Trial balance and the Income Statement will show bad debts as follows:
Trial Balance Extract (31 Jan 2012)

Debit Credit
Bad Debts 5500
Extract of Income Statement for the year ended 31 January 2012

Expenses:
Bad debts 5500
7.4.3 Bad debts as an adjustment in final accounts

So far we have been looking at bad debts which are already dealt with in the respective
debtors’ accounts and in the Trial Balance. However it may happen that bad debts do not
appear in the Trial Balance but is given as a form of adjustment to be made in final accounts.
Consider the following:

Trial Balance Extract (31 Jan 2012)
Debit Credit
Trade receivable 42000
Let us suppose you are given additional information as an adjustment (appearing after the
trial balance):
A trade receivable having a debt of $7,000 has left the country and the business has
decided to write off his account.
In this case when you are preparing the Income Statement for the year ended 31 January
2012 and the Statement of Financial Position as at 31 January 2012, you need to make
the following adjustments:
zz Consider Bad Debts as an expense in the Income Statement
zz Deduct Bad debts from Trade receivables in the Statement of Financial Position
Extract of Income Statement for the year ended 31 January 2012

Expenses:
Bad debts 7000
Extract of Statement of Financial Position as at 31 January 2012

Current Assets:
Trade Receivables (Debtors) 42,000
Less Bad Debts 7,000 35000
7.5 PROVISION FOR DOUBTFUL DEBTS

In addition to accounting for bad debts that we have dealt with above, you may also
find that firms also need to make a provision in respect of debts owing at the end of the
accounting period which may eventually turn out to be bad debts. To be on the safe side
a provision for doubtful debts is created when we have doubts about recovering amounts
due from debtors. For example the debt has been overdue for a long time and the customer
may not be replying to letters.
You will note that the difference between bad debts and provision for bad debts is that for
the former we have already eliminated the debtor’s figure from our list of debtors whereas
for provisions, we are leaving the debt as part of debtors because we are still trying to
collect the money and it is certain that the debtors are not going to pay.
When considering provisions for bad debts, there are three situations that may occur:
zz Creation of a provision for bad debts
zz An increase in provision for bad debts
zz A decrease in provision for bad debts
zz
In the next section we are looking at how each scenario will be dealt with in accounts.
7.5.1 Creation of a provision for bad debts

The creation of a provision for bad debts will occur when for the first time a firm is making
a provision. To be more illustrative, you may consider the following numerical example:
RS Ltd has a total amount of receivables of $ 10,000 at the end of the year 2009 and
decides to create a provision for bad debts of 5% of debtors at year end.
The Trial Balance at 31 December 2009 will be shown as follows:

Debit Credit
Debtors 10000

The accounting entries for the creation of the provision for bad debts are:
zz Debit the Income Statement with $500 and
zz Credit a Provision for bad debts with $500.

Expenses:
Provision for Bad Debts 500
Dr Provision for Bad Debts Account Cr

31Dec 09 Bal c/f 500 31Dec 09 IS 500
500 500
1Jan10 Bal b/f 500
You will note that the balance of $500 in the Provision for bad debts account should be
deducted from Debtors in the Statement of Financial Position as follows:

Current Assets:
Trade Receivables (Debtors) 10000
Less Provision for Bad Debts 500 9500
7.5.2 Increase in provision for bad debts

In 2010 RS Ltd has a Total Receivables of $15000 and has already an existing provision
of Rs 500 which has been brought forward from the year 2009. These will be shown in the
Trial Balance as at 31 December 2010 as follows:

Debit Credit
Debtors 15000
Provision for bad debts ( 1Jan 2010) 500
RS Ltd has found that there is a high probability that many debtors will not pay and has decided
to revise its provision to 6% of receivables at year end. The accounting entries will be:
zz Debit the Income Statement only by the Increase ($400)
zz Credit the Provision for bad debts account by $400 so that the balance becomes $900.

Expenses:
Increase in Provision for Bad Debts 400

1Jan10 Bal b/f 500
31Dec10 Bal c/f (6% of 15000) 900 31Dec10 IS (Increase) 400
900 900
1Jan11 Bal b/f 900
In the Statement of Financial Position, it is the closing balance of $900 that should be
deducted from Accounts Receivable.

Current Assets:

7.5.3 Decrease in provision for bad debts
Now, let us assume that Total Receivables amount to $ 18000 in 2011 and the firm has
brought forward a provision of $900 from the year 2010. These are shown in the Trial
Balance as at 31 December 2011 as follows:

Debit Credit
Trade receivables 18000
Provision for bad debts (1 Jan 2011) 900
In 2011, RS Ltd decides to revise its provision to only 3% of its trade receivables.
Existing provision for bad debts 900
New provision for bad debts (3% x 18,000) 540
Decrease 360
The accounting entries will be:

Debit the Provision for Bad Debts Account only by the decrease ($360)
Credit the Income Statement by the amount decreased (Added to Income)
31Dec11 IS (Decrease) 360 1Jan11 Bal b/f 900
31Dec11 Bal c/f (3% of 18000) 540
900 900
1Jan12 Bal b/f 540

Add receipts:
Decrease in Provision for Bad Debts 360
Again you will note that the closing balance should be deducted from Trade Receivables
in the Statement for Financial Position as at 31 December 2011
Current Assets:
7.6 GOODS TAKEN FOR OWN USE

It is common for a trader to take out items from his business shelves for his private
consumption. There is nothing wrong about it, but the necessary entries have to be made.
Example to record goods drawn

A firm has the following Trial Balance extract at 31 December

Debit Credit
Purchases 12000
Drawings( Cash and Goods) 500
It is found that for the year ended 31 December 2011, the owner has taken goods costing
$300 for his private use and no entries have been made to deal with this event. The
accounting entries are:

zz Debit Drawings Account
zz Credit Purchases Account
The impact of the above entries on the Income Statement and the Statement of Financial
Position can be shown as follows:

Cost of Goods sold:
Purchases 12000
Less Goods withdrawn 300 11700

Drawings (500+300) 800
A complete question
Uma is a retailer of footwear products. The following balances were extracted from her
books on 30 September 2011.
$
Revenue (sales) 240 000
Purchases 143 500
Returns Inwards 8 120
Returns Outwards 3 400
Inventory at 1 October 2010 10 430
Carriage 1 700
Insurance 5 600
Light and heat 6 300
Staff wages 27 000
Sundry Expenses 10 600
General expenses 15 850
Discount received 1 750
Building costs 20 100
Land and buildings at cost 100 000
Fixtures and fittings at cost 18 000
Computer equipment at cost 12 000
Provisions for depreciation:
Fixtures and fittings 7 200
Computer equipment 3 600
Disposal account 200 Cr
7% Bank loan repayable 30 March 2014 20 000
Bank overdraft 18 500
Trade receivables 8 200
Trade payables 26 750
Provision for doubtful debts 500
Drawings 15 500
Capital at 1 October 2010 81 000
Additional information:
1. Inventory at 30 September 2011 was valued at $11 770.
2. The cost of carriage from suppliers was $500, the remainder of the cost related to the
delivery of goods to customers.
3. At 30 September 2011:
Heating expenses, $375, were accrued.
Insurance, $1120, is prepaid.

4. The 7% bank loan was received on 1 April 2011. Interest is payable on each anniversary
of the loan.

5 .Buildings costs consists of $16 000 to build an extension to the building and $4100 to
repair the heating system.
6. Depreciation is charged on:

Fixtures and fittings at the rate of 20% per annum on cost using the straight line method.
Computer equipment at the rate of 30% per annum using the diminishing (reducing)
balance method.
7. The provision for doubtful debts is to be maintained at 5% of trade receivables.
Required
(a) Prepare the income statement for Uma for the year ended 30 September 2011.
(b) Prepare the Statement of Financial Position as at 30 September 2011.
Answer
Uma’s Income Statement for year ended 30 September 2011
$ $ $
Revenue (sales) 240000
Returns (8 120)
241880
Inventory 1 October 2010 10430
Purchases 143500
Carriage Inwards 500
154430
Returns outwards (3400)
151030
Inventory 30 Sept 2011 (11 770)
Cost of sales (139260)
Gross profit 92620
Add other income
Discount received 1750
Profit on disposal 200
Dec Provision Doubtful Debts 90
94 660
Less Overheads
Insurance(5600-1120) 4480
Light and Heat (6300+375) 6675
Wages 27000
Sundry Expenses 10600
General Expenses 15850
Building Repairs 4100
Depreciation:
Fixtures 3600
Computers 2520
Loan Interest 700
(76725)
Profit for the year 17935

Statement of Financial Position as at 30 September 2011
Cost Acc Dep NBV
Non-current assets:
Land and buildings 116 000 - 116 000
Fixtures and fittings 18 000 10 800 7 200
Computer equipment 12000 6120 5880
146000 16920 129080
Current assets:
Inventory 11770
Trade receivables 8200
Less prov. For bad debts 410 7790
Other receivables 120
20 680
Less Current liabilities:

Trade payables 26750
Other payables(375+700) 1075
Bank overdraft 18500 46325
Net current liabilities (25645)
103435
Non-current liabilities:
7% Bank loan (20000)
83435
Financed by:
Capital at 1 October 81000
Add profit for the year 17935
Less drawings (15500) 83435
83435
7.7 ACTIVITY
Activity 1
RT Ltd has a monthly stationery fee of $100. During the year ended 31 December 2011,
the business has made cash payments only for the months of January up to October 2011.
It is the company’s policy to end its accounts every 31 December. You are required to show:
(i) Stationery Account
(ii) Extract of Trial Balance
(iii) Extract of Income Statement
(iv) Extract of Statement of Financial Position
Activity 2
AC Ltd has incurred the following payments for Rent and Rates in the year 1 January
until 31 December 2010.
■■ 30 January 2010 $ 2400 for the months of January up to June 2010.
■■ 29 March 2010 $ 1600 for the months of July until October 2010
■■ 22 November 2010 $ 2400 for the months of November 2010 up to April
2011

It is the company’s policy to end its accounts every 31 December. You are required to show:
(i) Rent and Rates Account
(ii) Extract of Trial Balance
(iii) Extract of Income Statement
(iv) Extract of Statement of Financial Position
Activity 3
DS Ltd has trade receivables as follows:
2010 2011 2012
Accounts Receivable $5000 $6000 $3500
At 31 December 2010, the company decided to create a provision for doubtful debts of
5% of trade receivables wants to maintain the same rate for 2011 and 2012.
You are required to show for the years 2010, 2011 and 2012:
(i) Provision for Doubtful Debts Account
(ii) Extract of Income Statement
(iii) Extract of Statement of Financial Position
Activity 4
Dinraj has a retail business. The following balances were extracted from his books at the
end of his financial year on 31 March 2012.
Dr Cr
$ $
Buildings 40 000
Equipment (cost) 54 000
Provision for depreciation: Equipment 17 000
6% Bank loan repayable 31 December 2015 8 000
Bank 5 150
Trade receivables 6 750
Trade payables 4 010
Provision for doubtful debts 700
Revenue 78 580
Purchases 18 240
Purchase returns 1 600
Inventory at 1 April 2011 4 690
Equipment repairs 850
Equipment running expenses 2 650
General expenses 8 400
Wages 15 300
Insurance 3 640
Power and water 2 300
Advertising 5 100
Discount allowed 1 650
Commission received 330
Capital at 1 April 2011 50 000
Drawings 8 500
168,720 168,720
Additional information at 31 March 2012
1. Inventory was valued at $3870.
2. Dinraj took stock valued at $450 for his own use.
3 .Equipment running expenses, $750, were accrued and insurance, $1350, was prepaid.

4. The 6% bank loan was received on 1 December 2011.
5. Bad Debts amounted to $ 120 was to be written off.
6. Provision for doubtful debts is to be maintained at 8% of remaining trade receivables.
7. Commission Received due at 31 March 2012 amounted to $ 170
You are required to:

(a) Prepare the income statement for the year ended 31 March 2012.
(b) Prepare the statement of financial position at 31 March 2012.

8
UNIT
BANK RECONCILIATION
UNIT 8
8.0 Introduction
8.1 Items not appearing in the bank statements
8.2 Items not appearing in the Cash Book
8.3 Common terms used
8.4 Steps in preparing a bank reconciliation statement
8.5 Worked example
8.6 A further example
8.7 Activity

zz Explain the reasons for a discrepancy in the cash book balance and the bank
statement balance
zz Update the cash book
zz Prepare a bank reconciliation statement
8.0 INTRODUCTION
Most individuals including yourself and businesses operate a bank account. While we
trust our bank it is important that we match the correctness of amounts and transactions
found on the bank statement with that of the cash book. When a business receives a
cheque from a client, the cheque is deposited in its bank account. The business would
debit its cash book to record money coming in the business. Similarly the bank keeps an
account for every client. When the client deposits money in his bank account the bank
would credit his account. Students are sometimes confused as to why the bank credits the
client’s account. From the bank’s point of view the client is a creditor as the bank owes
him money. When the business issues a cheque, the business will credit its cash book, the
bank will debit the client’s account in its books. Technically, the cash book balance and
the bank statement balance should be equal. However, in reality they may differ because
of timing differences. The main reasons are explained below.
8.1 ITEMS NOT APPEARING IN THE BANK STATEMENT

1. Uncredited cheques
When a cheque is deposited in the bank account, it takes some time for the bank to clear
the cheque. The business will normally debit its cash book but since the bank has not yet
credited the bank account of the business it is called an ‘uncredited cheque’.
2. Unpresented cheques
When a business issues a cheque it will usually credit its cash book. However, the bank can
only debit the account of the customer when the cheque is presented for payment. Pending
this event the cheque is called an unpresented cheque.
3. Bank errors
Bank employees are above all humans and it is perfectly possible for them to make errors.

8.2 ITEMS NOT APPEARING IN THE CASH BOOK
1. Credit transfers- Amounts paid in directly to the business’s bank account
2. Amounts charged by the bank from the customer’s account e.g. Bank charges and
interest)
3. Amounts paid from the bank account based on instructions of the customer e.g.
standing orders and direct debits)
4. Errors in the cash book.
These items will only be known to the business on the receipt of the bank statement.
8.3 COMMON TERMS USED

Direct Debit
Instructions given by the business to its suppliers of goods and services which give the
bank authority to transfer out of the bank balance varying amounts as instructed by those
in favour of whom the instructions have been issued. A common example is the payment
of utility bills.

Standing order
This is an instruction given by the business to the bank to transfer regular amounts at
specified intervals to third parties. Insurance and loan repayments are usually paid by
standing order.
8.4 STEPS IN PREPARING

A BANK RECONCILIATION STATEMENT
Reconciliation is the process of agreeing information from two different sources. If the
two sources are independent of each other, the reconciliation of the information would
corroborate the other (Benedict and Elliot, 2009).

zz Step 1- Compare the cash book with the bank statement. Items appearing on the
debit side of the cash book will appear on the credit side of the bank statement and
vice versa. Strikethrough items which appear in both the cash book and the bank
statement to indicate they have been cancelled.
zz tep 2- Some of the items in the cash book and some in the bank statement might
S
be left out. Prepare an adjusted cash book from items left out in the bank statement.
The adjusted cash book starts from the closing cash book balance.
zz Step 3- Prepare a bank reconciliation statement from items left out in the cash book.
Pro forma of bank reconciliation statement

Balance as per bank statement X
Add/(Less) bank errors X
X
Add lodgements not yet credited X
Less unpresented cheques (X)
Balance as per updated cash book X
8.5 WORKED EXAMPLE

Shown below are the cash book and Bank statement of John Allen for the period ended
31 August 20X8

Dr. Cash Book (Bank only) Cr.
20X8 Chq No. $ 20X8 Chq no. $
Aug 1 Balance b/d 14 Aug 8 S Mallinder 007 182
Aug 8 Raj 184 94 Aug 21 Green 008 35
Aug 14 Lucky 421 113 Aug 28 Asif 009 74
Aug 27 T .Wright 888 265 Aug 31 Balance c/d 235
526 526
Citi Bank
Bank Statement
Client’s name: John Allen
Dr Cr Balance
20X8 $ $ $
Aug 1 Balance b/d 54
Aug 11 Deposit 94 148
Aug 12 Chq 007 182 34 o/d
Aug 16 Bank charges 45 79 o/d
Aug 24 Chq 008 35 1 o/d
Aug 29 Credit transfer: Dividend CDC Ltd. 55 54
Aug 29 Chq 006 40 14
Aug 31 Standing order- Insurance 20 6 o/d
Required
(a) Prepare the bank reconciliation statement as at 31August 20X8.
(b) State the balance which will appear in the statement of financial position
Solution
Step 1- Cancel common items in cash book and bank statement
Dr. Cash Book (Bank only) Cr.
20X8 Chq No. $ 20X8 Chq no. $
Aug 1 Balance b/d 14 Aug 8 S Mallinder 007 182
Aug 8 Raj 184 94 Aug 21 Green 008 35
Aug 14 Lucky 421 113 Aug 28 Asif 009 74
Aug 27 T .Wright 888 265 Aug 31 Balance c/d 235
526 526
Citi Bank
Bank Statement
Client’s name: John Allen
Dr Cr Balance
20X8 $ $ $
Aug 1 Balance b/d 54
Aug 12 Chq 007 182 34 o/d
Aug 16 Bank charges 45 79 o/d
Aug 24 Chq 008 35 1 o/d
Aug 29 Credit transfer: Dividend CDC Ltd. 55 54
Aug 29 Chq 006 40 14
Aug 31 Standing order- Insurance 20 6 o/d
Step 2 Prepare adjusted cash book from items left out in the bank statement

Adjusted Cash Book
Balance b/d 195 Bank charges 45
Dividend CDC Ltd 55 Insurance 20
Balance c/d 185
250 250
Step 3 Prepare bank reconciliation statement from items left out in the cash book
Bank reconciliation statement as at 31 August 20x8
Balance as per bank statement (6)
Add lodgements not yet credited: T.Wright 265
Less unpresented cheque: Chq 009 (74)
Balance as per updated cash book 185
Tutorial notes
The closing bank statement balance is ($?) 6 o/d meaning that it is an overdraft (payments
exceeds balance available resulting in a liability to the bank). An overdraft is shown as a
debit balance in the bank statement or credit balance in the cash book.

The cheque 006 is not entered in the adjusted cash book. Since cheques are issued in
consecutive numbers we can deduce that Cheque 006 was issued during the previous
month and was therefore entered in the cash book of the month of July.

Items left out in the cash book include: T.Wright $265 and Assif $74.

The cheque received from T.Wright was deposited in the bank account but the bank has
not yet credited the account by 31 Aug 20X8 when the bank statement was issued.
Assif was issued a cheque of $74 but has not yet presented the cheque for payment.
8.6 A FURTHER EXAMPLE

At the end of each month, Kamakshi prepares a bank reconciliation statement for her business
bank account. At 31 January 20X7 her ledger balance was $2,739 (credit) and her bank
statement showed that she owes the bank $34. She has the following information
(i) The bank debited Kamakshi’s account with charges of $115 during January. Kamakshi
has not recorded these charges.
(ii) Kamakshi took a loan of $2,300 from the bank. The bank made the transfer on 30
January, but Kamakshi has not made any entry for it in her records.
(iii) On 22 January, Kamakshi withdrew $150 cash which she did not record.
(iv) On 31 January, Kamakshi lodged $457. On the bank statement, this amount is dated 3
June.
(v) Kamakshi was advised by the bank that she earned $52 interest for the period in
January that her account was in credit. Kamakshi recorded this in January, but the bank
did not credit her account until June.
(vi) Two of the cheques issued in January, with a total value of $875, were not presented
for payment by 31 January.
(vii) A cheque for $252, issued to a supplier, was cancelled but Kamakshi has not recorded
the cancellation of the cheque.

Solution
Adjusted Cash Book
Loan 2,300 Balance b/d 2,739
Cheque cancelled 252 Bank charges 115
Drawings 150
Balance c/d 452
3,004 3,004
Bank reconciliation statement as at 31 January 20X7

Balance as per bank statement (34)
Add lodgements not yet credited: Deposit 457
Less unpresented cheques: (875)
Balance as per updated cash book (452)
8.7 ACTIVITY
Activity 1
The bank columns in the cash book for February 20X5 and the bank statement for that
month for Martin Kelly are:
Cashbook
20X5 Dr $ 20X5 Cr $
Feb 5 Poney 80 Feb 1 Balance b/d 110
Feb 14 Mark 115 Feb 4 Kevin 74
Feb 18 Rye 86 Feb 21 Gower 95
Feb 25 Saunders 190 Feb 24 Davies 167
Feb 26 Thompson 64 Feb 28 Balance c/d 89
535 535
Bank Statement
Dr Cr Balance
20X2 $ $ $
Feb 1 Balance b/d 110 (Dr)
Feb 8 Kevin 74 184 (Dr)
Feb 9 Poney 80 104 (Dr)
Feb 11 Bank charges 41 145 (Dr)
Feb 18 Standing order: M Chase 75 220 (Dr)
Feb 19 Mark 115 105 (Dr)
Feb 24 Gower 95 200 (Dr)
Feb 25 Rye 86 114 (Dr)
Feb 29 Dividends 22 92 (Dr)
You are required to:

Write up the cashbook up to date and state the new balance as on 28 February 20X2.
Draw up a bank reconciliation statement as on 28 February 20X2.

9
UNIT
INTRODUCTION TO COSTING
UNIT 9
9.0 Introduction
9.1 Types of Costs by Behavior
9.1.1 Fixed Costs
9.1.2 Variable Costs
9.1.3 Mixed Costs
9.1.4 Product costs
9.1.5 Period costs
9.1.6 Relevant costs and irrelevant costs
9.2 Cost Allocation
9.3 Allocation and Apportionment
9.4 Overhead absorption
9.5 Under-/Over absorption
9.6 Marginal Costing (MC)
9.7 Absorption costing
9.7.1 Income Statement Template
9.8 Reconciliation of Profit
9.9 Impact on profit summarized
9.10 Summary
9.11 Activity

zz Differentiate between different types of cost
zz Prepare income statements using marginal and absorption costing
zz Reconcile profit under absorption costing with marginal costing profit
9.0 INTRODUCTION
This chapter will first introduce you to the different cost terms, the common costs classification
and how to deal with overheads. Thereafter the chapter will explain the two costing principles,
namely absorption costing and marginal costing.
9.1 TYPES OF COSTS BY BEHAVIOR

Cost behavior refers to the way different types of production costs change when there is a
change in level of production. There are three main types of costs according to their behavior:
9.1.1 Fixed Costs

Fixed costs are those which do not change with the level of activity within the relevant
range. These costs will incur even if no units are produced. For example rent expense,
straight-line depreciation expense, etc.
Fixed cost per unit decreases with increase in production. Following example explains
this fact:
Total Fixed Cost (Rs) 30,000 30,000 30,000
÷ Units Produced 5,000 10,000 15,000
Fixed Cost per Unit (Rs) 6.00 3.00 2.00

9.1.2 Variable Costs
Variable costs are costs which change with a change in the level of activity. This means
that total variable cost increase when more units are produced and decreases when less
units are produced. Examples include direct materials, direct labor, etc
Although variable in total, these costs are constant per unit. For example
Total Variable Cost (Rs) 10,000 20,000 30,000
÷ Units Produced 5,000 10,000 15,000
Variable Cost per Unit (Rs) 2.00 2.00 2.00
9.1.3 Mixed Costs

Mixed costs or semi-variable costs have properties of both fixed and variable costs due
to presence of both variable and fixed components in them. An example of mixed cost
is telephone expense because it usually consists of a fixed component such as line rent
and fixed subscription charges as well as variable cost charged per minute cost. Another
example of mixed cost is delivery cost which has a fixed component of depreciation cost
of trucks and a variable component of fuel expense.
Since mixed cost figures are not useful in their raw form, therefore they are split into their
fixed and variable components by using cost behavior analysis techniques such as High-
Low Method, Scatter Diagram Method and Regression Analysis.
High-Low Method
High-Low method is one of the several techniques used to split a mixed cost into its fixed
and variable components. Although easy to understand, high low method is relatively
unreliable. This is because it takes two extreme activity levels (i.e. labour hours, machine
hours, etc.) from a set of actual data of various activity levels and their corresponding total
costs. These figures are then used to calculate the approximate variable cost per unit (b)
and total fixed cost (a) for the cost volume formula:
y = a + bx

High-Low Method Formulas
Variable Cost per Unit
Variable cost per unit (b) is calculated using the following formula:
y2 - y1
Variable Cost per Unit =
x2 - x1
Where,
y2 is the total cost at highest level of activity;
y1 is the total cost at lowest level of activity;
x2 are the number of units/labor hours etc. at highest level of activity; and
x1 are the number of units/labor hours etc. at lowest level of activity
In other words, variable cost per unit is equal to the slope of the cost volume line
(i.e. change in total cost ÷ change in number of units produced).
Total Fixed Cost

Total fixed cost (a) is calculated using the following formula:
Total Fixed Cost = y2 - bx2 = y1 - bx1
Example
Company Alpha wants to construct a cost volume relation between its factory overhead cost
and number of units produced. Use the high-low method to analyze its factory overhead
(FOH) costs and build a cost volume formula. The volume and the corresponding total cost
information of the factory for past eight months are given below:
Month Units FOH
Rs
1 1,520 36,375
2 1,250 38,000
3 1,750 41,750
4 1,600 42,360
5 2,350 55,080
6 2,100 48,100
7 3,000 59,000
8 2,750 56,800
Solution
We have,
x2 = 3,000 y2 = $59,000
x1 = 1,250 y1 = $38,000
Variable Cost per Unit = ( $59,000 - $38,000 ) ÷ ( 3,000 - 1,250 ) = $12 per unit
Total Fixed Cost = $59,000 - ( $12 × 3,000 ) = $38,000 - ( $12 × 1,250 ) = $23,000
Cost Volume Formula: y = $23,000 + 12x
9.1.4 Product Costs

Product costs are costs assigned to the manufacture of products and recognized for
financial reporting when sold. They include direct materials, direct labor, factory wages,
factory depreciation, etc.

9.1.5 Period costs
Period Costs are on the other hand are all costs other than product costs. They include
marketing costs and administrative costs, etc. They are written off in the period incurred.
The product costs that can be specifically identified with each unit of a product are called
direct product costs whereas those which cannot be traced to a specific unit are indirect
product costs. Thus direct material cost and direct labor cost are direct product costs
whereas manufacturing overhead cost is indirect product cost.
9.1.6 Relevant costs and Irrelevant costs

The nature of the costs that are relevant for short-run tactical decisions will depend on the
type of decision problem for which they are required. In general, however, the relevant
costs have two important characteristics:
zz They are future costs, that is; they are costs not yet incurred. Past costs, that is; sunk
costs are irrelevant costs – their only usefulness is the extent to which they may help
the accountant to estimate the trend of future costs.
zz Relevant costs are differential costs. Not all future costs are relevant: differential
costs will be different under the alternative courses of action under examination.
9.2 COST ALLOCATION

Costs of a product are made up of both direct and indirect costs (also termed as overheads)
and it is important to trace a share of the overheads to each unit of product. These overhead
costs are those costs incurred which cannot be economically attributed directly to cost
units. Overhead costs are classified by function.
Manufacturing overhead includes indirect materials, indirect wages and indirect expenses
attributable to production and the service activities associated with manufacturing.
Indirect manufacturing costs arise from:

■■ Production activities – costs arising in production departments such as the costs of
fuel, protective clothing, depreciation and supervision
■■ Service activities – the cost of operating support departments or sections within the
factory, e.g. cost of materials handling, production control, canteen
■■ Establishment costs – general production overhead such as factory rent/rates.

A sequence of procedures is undertaken for the sharing (or allotment) of indirect costs to
cost units:
1. Collecting production overhead costs by item
2. Establishing cost centers
3. Allocating and apportioning overhead costs to cost centers
4. Apportioning service cost center costs to production cost centers
5. Absorbing production cost center costs into cost units.
9.3 ALLOCATION AND APPORTIONMENT

Allocation relates to costs that can be identified with a specific cost center.
Apportionment relates to costs that cannot be identified with a specific cost center but
must be shared out between two or more cost centers.
The basis for apportioning a total amount will be selected so that the charge to a specific
center will reflect, with reasonable accuracy, the benefit obtained by that center from the
cost incurred.
Absorption is the calculation of the amount of overhead that is to be treated as a cost of

each cost unit (or product).
Production cost centers will have been allotted with the total amount of factory overhead,
representing;
■■ Allocated costs
■■ Apportioned costs
■■ Share of service department costs.
9.4 OVERHEAD ABSORPTION

The overhead absorption rate is defined as follows:
OAR = Cost center overhead in £s
Cost center activity
The cost center activity can be based on:

Resource inputs (as a % of cost)
■■ Cost of materials
■■ Cost of labour
■■ Prime cost
■■ Direct labour hours }absorption basis is
■■ Machine hours }£ per hour
Production/service output
■■ Units of product/service - - - - (£ per unit)
■■ Cost of sales - - - - (as a %)
■■ Sales value - - - - - (as a %)
More than one OAR can be used in a single cost center. For example some overheads may
be absorbed on a labour hour basis and others on a cost of materials basis.
The choice of activity basis used should reflect how overheads are incurred or the different
amounts of effort that go into making different products or services.

9.5 UNDER-/OVER ABSORPTION
It is the difference between the amount of overhead absorbed (using predetermined
OAR) and the amount of overhead actually incurred in the period. This can arise from a
combination of two compensating factors:
■■ Overhead costs were higher/lower than budget
■■ Volume was greater/lower than budget
This topic is taken further under a different unit later in the course.
Costing Principles: Marginal and Absorption Costing

Either marginal or absorption costing can be applied in job, batch and contract costing.
The decision is influenced by IAS 2, which requires absorption costing for stock valuation
purposes in financial accounts, and therefore encourages its application for all costing.
The aims of this unit are:

zz to familiarise you with the techniques of Absorption Costing and Marginal Costing
zz to explain the basic features and in that process bring out explicitly the differences
between the two techniques
9.6 MARGINAL COSTING (MC)

zz MC is an invaluable management accounting tool used to provide management with
information about cost, volume and profit relationships in a form that is easy to understand.
zz The key advantage of MC is that it facilitates decision making, cost management

and profit planning.
zz However, for financial reporting to external users the conventional method of product
costing based on full or absorption costing is required under generally GAAP.
zz The system of recording only the variable expenses, is known as marginal costing.
MC assigns only the marginal costs, that is the costs which vary with the level of
production, to the products, and fixed manufacturing costs are written off each year
as period costs.
zz Under MC stock valuation will consist only variable production costs and fixed
costs are treated as a period cost and deducted from contribution to arrive at profit.
zz The MC statement shows the figure for contribution, which is the excess of sales over
variable costs. The philosophy of MC is that sales revenue should first meet the VC,
and contribute towards fixed costs, before the enterprise begins to earn a profit.
9.7 ABSORPTION COSTING

Absorption Costing technique is also termed as Traditional or Full Cost Method. According to
this method, the cost of a product is determined after considering both fixed and variable costs.
The variable costs, such as those of direct materials, direct labour, etc. are directly charged to
the products, while the fixed costs are apportioned on a suitable basis over different products
manufactured during a period. Thus, in case of Absorption Costing all costs are identified with
the manufactured products. This will be clear with the help illustration. Other features:
zz Under AC, all costs are recorded as a part of the total costs and thus stock valuation
includes a proportion of fixed production costs.
zz Absorption costing principles must be used when preparing financial statements for
external purposes. One of the key principles of absorption costing is that inventory
and units produced must include a share of all production costs, both fixed and
variable, incurred in getting them to their present condition.

9.7.1 Income Statement Template
Income statement using Absorption Costing
Rs Rs
Revenue xxxxx
Less Production Cost of sales
Opening Stock [qty * FPC] xxx
Production [qty * FPC] xxxx
Closing Stock [qty * FPC] (xxx)
(xxxx)
Gross Profit
Less Non – Production costs
Variable Selling and Administrative costs xxx
Fixed Selling and Administrative costs xxx
(xxxx)
Adjustment for Over/(Under) Absorption xx/(xx)
Net Profit xxx
Income statement using Marginal Costing

Rs Rs
Revenue xxxxx
Less Variable Production Cost of sales
Opening Stock [qty * VPC] xxx
Production [qty * VPC] xxxx
Closing Stock [qty * VPC] (xxx)
(xxxx)
Other Variable Costs
Selling and Administrative costs (xx)
Contribution xxxx
Less Fixed Costs:
Production xxx
Fixed Selling and Administrative costs xxx
(xxx)
Net Profit xxx
9.8 RECONCILIATION OF PROFIT

The difference in profit between the two costing principles is due to the treatment of
fixed production overheads. Under AC, the FPO is included in the valuation of stocks
while under MC it is treated as a period costs. Therefore, the difference in profit could be
explained by calculating the difference in stock valuation.
Profit reported under Absorption Costing xx

Difference in stock valuation:
Closing stock [ AC – MC] (xx)
Opening stock [AC – MC] xx
Marginal costing profit xx

9.9 IMPACT ON PROFIT SUMMARIZED
zz Where sales and production levels are constant through time, profit is the same
under the two methods;
zz Where production remains constant but sales fluctuate, profit rises or falls with the
level of sales, assuming that costs and prices remain constant, but the fluctuations
in net profit figures are greater with marginal costing than with absorption costing;
zz Where sales are constant but production fluctuates, marginal costing provides for
constant profit, whereas under absorption costing, profit fluctuates;
zz Where production exceeds sales, profit is higher under AC than under MC, since
the absorption of fixed overheads into closing stock increases their value thereby
reducing the cost of goods sold;
zz Where sales exceed production, profit is higher under MC. The fixed costs, which
previously were part of stock values, are now charged against revenue under AC.
Therefore, under AC the value of fixed costs charged against revenue is greater than
that incurred for the period.
9.10 SUMMARY
zz If the central purpose of accounting is to make possible the periodic matching of
costs and revenues, and if the matching principle is the ‘nucleus of accounting
theory’, then the proponents of absorption costing are correct in their view.
zz But if, as it is argued, the prime objective of accounting is to provide information

which is useful for decision making, then the case for marginal costing seems to be
very strong.
zz Marginal costing is said to have a ‘profit and loss account emphasis’, whereas
absorption costing is said to have a ‘balance sheet emphasis’.
zz The AC method allows overheads to be carried into the next period, thus enabling a
manipulation of the profit figure.
Example
Supersonic manufactures and sells a single product. The budgeted income statement for
this month, which has been prepared using marginal costing principles, is as follows:
Rs’000 Rs’000
Sales (24,000 units) 864
Less Variable production cost of sales:
Opening stock (3,000 units) 69
Production (22,000 units) 506
Closing stock (23) (552)
Less Variable selling cost (60)

Contribution 252
Less Fixed overhead cost:
Production 125
Selling and administration 40 165
Net Profit 87
The normal monthly level of production is 25,000 units and stocks are valued at standard cost.

Required
(a) Prepare in full a budgeted income statement for this month using absorption
costing principles.
(b) Prepare a statement that reconciles the net profit calculated in (a) with the net
profit using marginal costing .
(c) Give three reasons why you might prefer variable costing over absorption costing.
Solution
Workings:
Standard marginal costs:
Production costs/units produced = [506,000/22,000] = Rs 23/unit
Add Fixed production costs = [125,000/25,000] = Rs 5/unit
Standard full production cost = Rs 23 + Rs 5 = Rs 28
(a) Budgeted Profit Statement using Absorption Costing

Rs’000 Rs’000
Sales (24,000 units) 864
Less Variable production cost of sales:
Opening stock (3,000 units @ Rs 28) 84
Production (22,000 units @ Rs 28) 616
Closing stock (28) (672)
Gross Profit 192
Less Non – Production Costs
Variable selling cost 60
Fixed Selling and administration 40
(100)
92
Adjustment for under absorption (3000 units @ Rs 5) (15)
Net Profit 77
(b) Profit reported under Absorption Costing 77

Difference in stock valuation:
Closing stock [ 28 – 23] (5)
Opening stock [84 – 69] 15 10
Marginal costing profit 87

9.11 ACTIVITY
Activity 1*
The data below represent the production and costs for the first four month of operation.
Month Production Cost (Rs)
January 2,000 20,000
February 2,500 21,000
March 3,000 23,000
April 1,900 18,500
Using high-low method:
(i) Calculate the variable cost per unit
(ii) The monthly fixed costs
(iii) The expected production costs for an estimated output of 22,000 units.
Activity 2*
Listed below are six commonly used accounting terms.

Required:
Briefly describe the meaning of the following terms:
(a) Variable costs
(b) Semi – Fixed costs
(c) Committed fixed costs
(d) Sunk costs
(e) Relevant costs
(f) Avoidable costs.
You should include in your description a brief outline of any accounting treatments,
methods of calculation or examples where appropriate.
Activity 3*
X Limited is planning to make a cleaning fluid for use in the motor industry. The fluid is
expected to sell for $9 per litre and the following standard costs are expected to apply to
the production of the fluid during the year ended 31 December 2011.
Chemical B1: 0·30 litres at $2·50 per litre

Chemical B2: 0·70 litres at $3·50 per litre
Direct Labour : 0·25 hours at $4·00 per hour
Variable factory overheads are absorbed at the rate of $6·00 per direct labour hour.
Fixed factory overheads are expected to be $8,448 per year. They are expected to accrue
evenly over the year and will be absorbed on a unit basis.
Planned production and sales for 2011 are expected to be as follows:

January to April to Total
March 2011 December 2011
Production 2,400 litres 7,200 litres 9,600 litres
Sales 2,200 litres 7,400 litres 9,600 litres
There is no loss or wastage during the production process.
Required:
(a) Produce a detailed forecast profit and loss account for the three-month period ending
31 March 2001using:
(i) absorption costing; and
(ii) marginal costing.
Your calculations should clearly show the cost of production and the value of closing
stock for each method and the contribution if relevant.
Question 4
Galway Plc manufactures and sells a single product .The following budgeted/ actual
information is provided in relation to the production of this product:
$
Selling price per unit 50.00
Direct materials per unit 8.00
Direct labour per unit 5.00
Variable production overheads per unit 3.00
Details for the months of May and June 2010 are as follows:
May June
Production of Product A 500 380
Sales of Product A (units) 300 500
Fixed production overheads are budgeted at $4,000 per month and are absorbed on a unit
basis. The normal level of production is budgeted at 400 units per month.
Other costs
Fixed selling $4,000 per month

Fixed Administration $2,000 per month
Variable sales commission 5% of sales revenue
There was no opening inventory of Product A at the start of May.
Using the following example,

zz Prepare a profit statement using absorption costing principles for the months of May
and June.
zz Prepare a profit statement using marginal costing principles for the months of May
and June.
zz Reconcile the profit calculated in (a) with the profit using marginal cosing.
Answer to Activity 4
Working 1: Calculate full production cost
$
Direct materials 8.00
Direct labour 5.00
Variable production o/h’s 3.00
Fixed production o/h’s [$4,000/400 units]
10.00
Full production cost 26.00

Working 2: Over/(under) absorption of fixed production overhead
May June
Actual level of activity 500 380
Expected level of activity 400 400
Volume variance 100 (20)
Over/(Under) Absorption (@10) 1,000 (200)
You may refer to the solution as worked out in the above example to prepare the two
income statements.

10 MARGINAL COSTING
UNIT
AND DECISION MAKING

UNIT
10.0 Introduction
10.1 Accepting a special order
10.2 Cost-Volume-Profit (CVP) analysis
10.3 Break-even analysis
10.4 Limiting factor
10.5 Activity

Calculate and interpret the break-even point
Determine the production schedule which maximizes contribution when faced with a
limiting factor
Decide whether accepting a special order is worthwhile
10.0 INTRODUCTION
Decision making is about the future and involves a choice between alternative courses of
action. Only relevant costs and revenues - those incremental future cash flows that will
arise as a direct consequence of a particular decision - should be considered. Costs and
revenues that will not change as a result of the decision under consideration are irrelevant.
Relevant costs are therefore: (i) future non-committed costs (ii) cash costs (iii) avoidable
costs (iv) costs which differ among alternatives i.e. differential costs.
Since in the short term, fixed costs remain constant whatever course of action is selected,
fixed costs are irrelevant and only variable costs are relevant! However, DO NOT
systematically assume that ALL fixed costs are irrelevant! Incremental fixed costs that
flow direct from a decision WILL be relevant!
10.1 ACCEPTING A SPECIAL ORDER

Red Bull ltd produces and markets a slimming drink which is sold for Rs20 per can.
Current output is 40,000 cans per month which represents 80% of capacity. Total costs
for last month were Rs560,000 of which Rs160,000 were fixed costs. A super market
chain has just requested an order for 10,000 cans at a price of Rs13 per can. Should Red
Bull accept the order? What other factors should be considered?
560,000 - 160,000
Variable cost per unit: = Rs 10
40,000
160,000
Fixed cost per unit: = Rs 4
40,000
Rule: Accept the order if it brings in additional contribution.

Rs
Sales (10,000 cans x Rs13 per can) 130,000
Less: variable cost (10,000 cans x Rs10 per can)
100,000
Additional Contribution from order. 30,000

Although the price of Rs13 is less than total cost per unit of Rs14 (and also lower than
the normal selling price of Rs20), accepting the order does provide some additional
contribution toward covering fixed costs of Rs160,000.
PROOF
Without order With order
Rs Rs
Sales 800,000 930,000
Variable cost 400,000 500,000
Contribution 400,000 430,000
Fixed costs 160,000 160,000
Net profit 240,000 270,000
The decision rule

Since fixed costs are irrelevant (unless there are additional fixed costs that will be
incurred as a direct result of a particular course of action or decision), the firm
should choose that course of action that will MAXIMISE TOTAL CONTRIBUTION
NET OF ANY INCREMENTAL FIXED COST INCURRED.
10.2 COST-VOLUME-PROFIT (CVP) ANALYSIS

Cost-Volume-Profit (CVP) analysis considers how costs and profits change with changes
in volume. The relationship between cost and output you have learned in the previous
chapter has to be applied.
Assumptions of CVP analysis
zz Costs are either fixed or variable. The variable cost per unit is the same at all levels
of activity (output and sales). Total fixed costs are a constant amount in each period.
zz Profit is measured as contribution (sales revenue minus variable costs) minus fixed
costs.
zz Since fixed costs are normally assumed to remain unchanged at all levels of output
and sales, profit is maximised by maximising total contribution.
zz The contribution per unit is constant for each unit sold (of the same product).
zz The sales price per unit is also constant for every unit of product sold; therefore the
contribution to sales ratio is also a constant value at all levels of sales.
zz All units produced are sold.
zz (Emile Woolf, 2010)
Example
A company makes and sells a single product. The product is sold at $20 per unit has a
variable production cost of $10 per unit and a variable selling cost of $3 per unit. Total
fixed costs (production, administration and sales and distribution fixed costs) are expected
to be $550,000. The contribution per unit is $20– $10 – $3 = $7.
CVP analysis can be used for profit planning purposes. The table below shows how the
profit or loss would be calculated for 70,000 units, 80,000 units and 90,000 units of sale.
70,000 units 80,000 units 90,000 units
$ $ $
Contribution ($7 per unit) 490,000 560,000 630,000
Fixed costs (550,000) (550,000) (550,000)
Net profit/(Loss) (60,000) 10,000 80,000
A loss is incurred at 70,000 units of sales because total contribution is insufficient to cover
fixed costs. Profit increases as sales volume increases, and the increase in profit is due to
the increase in total contribution as sales volume increases.

10.3 BREAK-EVEN ANALYSIS
CVP analysis can be used to calculate a break-even point for sales.
Break-even is the level of activity where there is neither profit nor loss. At this point total
cost equals total revenue. Since we are adopting a marginal costing approach, at the break-
even point total contribution equals total fixed cost.
Management might want to know what the break-even point is in order to:
zz assess the probability of avoiding a loss, or
zz identify the minimum volume of sales that must be achieved in order to avoid a loss,
or
zz assess the amount of risk in the budget, by comparing the budgeted volume of sales
with the break-even volume.
zz (Emile Woolf, 2010)
Total fixed costs

Break-even point in sales units =
Contribution per unit
Fixed costs
Break-even sales revenue = c ratio
s
Contribution
Contribution to sales ratio (c/s) = X 100
Sales
Fixed cost + target profit
Number of units required to be sold to achieve a target profit =
Contribution/unit
Example
A firm makes only one product which sells for Rs10. The variable cost per unit is Rs5
and total fixed costs amount to Rs75,000 per annum. Maximum capacity would be 25,000
units but the firm normally operates around the 80% capacity level.
1. How many units must be sold to achieve zero profit or zero loss (i.e. to break even)?
fixed cost 75,000

BEP (Rs) = = = 15,000 units
contribution per unit 5

2. What’s the level of sales(in value) to achieve break even?
Break even sales value = break even sales units * SP
OR
fixed cost
BEP (Rs) =
contribution ratio
75,000
= Rs 15,000
50%
Contribution 5
Contribution ratio (or contribution margin) = = = 50%
Sales 10

3. How many units must be sold to achieve a profit of Rs30,000?

Fixed cost + Profit 75,000 + 30,000 = 21,000 units
=
Contribution per unit 5

4. What sales value must be achieved to obtain a target profit of Rs30,000?
Fixed cost + Profit
75,000 + 30,000 = Rs 21,000
C/S ratio 50%
5. Calculate the margin of safety in units. The margin of safety indicates by how much
sales (in units or in value) could fall before the firm makes no profit.
Margin of safety:
(i) In volume: Actual units sold or budgeted units sold - Break even sales units

20,000units - 15,000units = 5,000 units
(ii) In value: (20,000 * 10) - (15,000 *10) = Rs50,000
10.4 LIMITING FACTOR

Limiting factor involves a situation where a resource is scarce. If the company uses this
resource to produce several products then production will be limited. The objective is to
decide the best production schedule for the company.
When there is just one limiting factor (other than sales demand), total profit will be
maximised in a period by maximising the total contribution earned with the available
scarce resources.
zz The objective should be to maximise total contribution.
zz This will be achieved by maximising the contribution in total from the scarce
resource.
zz
If there is only one limiting factor the way to proceed is as follows:
Step 1- Determine the limiting (Key) factor
Step 2- For each product calculate the contribution per unit
Step 3- Calculate the contribution per unit of limiting factor
Step 4- Rank the products in descending order (highest to lowest) based on contribution
per limiting factor
Step 5- Devise a production schedule starting from the product ranking first until the
supply of the limiting factor is exhausted.
Example
A company manufactures three products. Sales demand for the products in the next period
is estimated to be:
Crunchies 6,200 units
Twistys 8,000 units
Curlies 11,500 units
Selling prices and unit costs are:

Crunchies Twistys Curlies
$ per unit $ per unit $ per unit
Selling price 9·70 11·10 13·80
Costs:
Direct materials 2·80 3·90 4·92
Direct labour ($8·00 per hour) 2·40 2·40 3·20
Variable overhead 0·90 0·90 1·20
Fixed overheads 2·80 2·80 3·70

The company is experiencing a shortage of direct labour and estimates that a maximum of
8,500 hours will be available in the next period.
Required:
(a) Demonstrate that the availability of direct labour will be a limiting factor in the next
period.
(b) Determine the production schedule for the next period that will maximise profit.
Solution
Direct labours hours per unit 2·40/8.00 2·40/8.00 3·20/8.00
=0.3 =0.3 =0.4
Demand (units) 6,200 units 8,000 units 11,500 units
Labour hours required 1,860 2,400 4,600
Total
Labour hours available 8,500
Labour hours required 8,860
Shortage 360
Calculation of contribution per unit

$ per unit $ per unit $ per unit
Selling price 9·70 11·10 13·80
Less variable costs:
Direct materials 2·80 3·90 4·92
Direct labour ($8·00 per hour) 2·40 2·40 3·20
Variable overhead 0·90 0·90 1·20
Contribution 3.60 3.90 4.48
Contribution per labour hour

Contribution per unit 3.60 3.90 4.48
Direct labours hours per unit 0.3 0.3 0.4
Contribution per labour hour 12.00 13.00 11.20
Ranking 2nd 1st 3rd
Production schedule
Twistys (8,000 x 0.3) 2,400
Crunchies (6,200 x 0.3) 1,860
Labour hours left (8,500-2,400-1,860) 4,240
Curlies (4,240 / 0.4) 10,600

10.5 ACTIVITY
Activity 1
Austin Ltd budgets its costs and revenue for product A for the next financial period as
follows:
Rs per Unit
Selling Price 40
Direct Material 8
Direct Labour 6
Variable Overhead 3
For the period concerned the budgeted fixed overhead is Rs100,000 and the budgeted
sales are 12,000 units.
Required:
(a) Calculate the budgeted profit for the period.

(b) Calculate and explain the significance of
(i) The Break Even Point in units and dollars
(ii) The Margin of Safety in units and dollars.
(c) Show by means of a statement, the effect on the budgeted profit of each
of the following independent courses of action, and calculate the Break
Even Point for each of the three courses of action.
Reduce the selling price to Rs35 per unit, this will increase sales by 2,000 units with an
increase in fixed overhead of Rs10,000.
Increase the selling price to Rs45 per unit, this will reduce sales by 4,000 units and increase
direct material costs by Rs2 per unit for all units, with fixed costs being unchanged.
Reduce the selling price to Rs30 per unit, this will increase sales by 5,000 units, increase
fixed overhead by Rs12,000 and decrease direct material costs by Rs3 per unit for all units.
Activity 2
Candy Ltd makes four products F,C,K and U using the same raw material A.
The company has produced the following budget for the forthcoming period.
F C K U
Demand (000 units) 5 3 2 5
Income ($000) 33 36 22 36
Variable Costs ($000)
Material A 10 12 10 10
Labour 9 7 4 7
Overheads 3 2 4 6
Fixed costs ($000) 4 5 2 7
Material A costs $4 per kilo, and the company has been informed that, owing to a strike at the
supplier’s factory, Material A will be restricted to 8,500 kilos during the forthcoming period.
Required
(a) Calculate the shortfall in Material A for the forthcoming period.
(b) Calculate the production mix that will maximise profit for the forthcoming period
with Material A as the limiting factor of production.
(c) Calculate the profit that will be achieved if the mix calculated in (b) above is
produced.


Management Management Management

Caricato da

Informazioni sul documento

Titolo originale

Copyright

Formati disponibili

Condividi questo documento

Condividi o incorpora il documento

Opzioni di condivisione

Hai trovato utile questo documento?

Questo contenuto è inappropriato?

Copyright:

Formati disponibili

Management Management Management

Caricato da

Copyright:

Formati disponibili

BScBusinessManagement

Open University of Mauritius - Accounting Fundamentals i

© Open University of Mauritius, May 2013

ii Open University of Mauritius - Accounting Fundamentals

UNIT 2 - The Double-Entry System of Book-keeping 11

UNIT 3 - The Cash Book 27

UNIT 4 - Books of Original Entry 35

UNIT 5 - The Income Statement and Statement of Financial Position 45

UNIT 6 - Accounting for depreciation and disposal of

UNIT 7 - Adjustments on Final Accounts 63

UNIT 8 - Bank Reconciliation 75

UNIT 9 - Introduction to Costing 81

UNIT 10 - Marginal Costing and decision making 93

Open University of Mauritius - Accounting Fundamentals iii

TEACHING AND LEARNING STRATEGY

Unit(s) of Assessment Weighting Towards

LEARNING OBJECTIVES OF THE MODULE

UNITS LEARNING OBJECTIVES

zz Explain the use of the cash book

Open University of Mauritius - Accounting Fundamentals v

zz Differentiate between gross and net profit

Guidelines for self-study

vi Open University of Mauritius - Accounting Fundamentals

Open University of Mauritius - Accounting Fundamentals vii

AND THE ACCOUNTING EQUATION

After studying this chapter you should be able to:

1.1 USERS OF ACCOUNTING INFORMATION

Open University of Mauritius - Accounting Fundamentals 1

1.2 MAIN ELEMENTS OF FINANCIAL REPORTS

1.3 UNDERLYING ASSUMPTIONS

2 Open University of Mauritius - Accounting Fundamentals

Accruals including matching

Open University of Mauritius - Accounting Fundamentals 3

Substance over form

1.4 TYPES OF BUSINESS ENTITY

4 Open University of Mauritius - Accounting Fundamentals

1.5 THE ACCOUNTING EQUATION

1.6 ELEMENTS IN THE ACCOUNTING EQUATION

Open University of Mauritius - Accounting Fundamentals 5

Write the accounting equation for each of the above transaction.

Oct 4 A delivery van was purchased by cheque for $12,000.

6 Open University of Mauritius - Accounting Fundamentals

Oct 22 Paid Ali $800 on account by cheque.

Assets Liabilities Capital

Open University of Mauritius - Accounting Fundamentals 7

Assets Liabilities Capital

8 Open University of Mauritius - Accounting Fundamentals

Open University of Mauritius - Accounting Fundamentals 9

After studying this unit you should be able to:

Ruling of the ledger

2.1 RULES FOR RECORDING TRANSACTIONS

Open University of Mauritius - Accounting Fundamentals 11

Dr. Cash account Cr.

Jan 1 *Capital 5,000

Jan 1 *Cash 5,000

12 Open University of Mauritius - Accounting Fundamentals

Office Furniture account

25 Jan Purchased goods paying cash $900

Dr. Cash account Cr.

26 Jan Sold goods for cash $1,100

Dr. Cash account Cr.

Open University of Mauritius - Accounting Fundamentals 13

Rebecca account (Trade payable)