TVET PROGRAM TITLE: Accounts and Budget Support Level –III

MODULE TITLE: Preparing Financial Reports

LEARNING OUTCOMES:

At the end of this module the trainer will be able to

LO1: Maintain asset register

LO2: Record general journal entries for balance day adjustments

LO3: Prepare final general ledger accounts

LO4: Prepare end of period financial reports

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Contents
LO1: Maintain asset register ........................................................................................................... 3
How to Prepare an Asset Register .............................................................................................. 3
Bookkeeping ............................................................................................................................... 7
Recording Transactions .............................................................................................................. 7
Depreciation ................................................................................................................................ 8
Methods of Depreciation............................................................................................................. 8
Types of depreciation .................................................................................................................. 8
Impact of using different depreciation methods ....................................................................... 17
Comparison of Depreciation Methods ...................................................................................... 18
LO2 Record general journal entries for balance day adjustments ................................................ 18
JOURNAL ................................................................................................................................ 19
SUB-DIVISION OF JOURNAL .............................................................................................. 20
Advantages of Using Journal .................................................................................................... 21
Journalizing ............................................................................................................................... 22
Difference between a general ledger and a general journal ...................................................... 23
LO3 Prepare final general ledger accounts ................................................................................... 23
Ledger ....................................................................................................................................... 23
Sub-division of ledger ............................................................................................................... 24
Distinction between journal and ledger .................................................................................... 24
Posting....................................................................................................................................... 25
Rules Regarding Posting ........................................................................................................... 25
LO4 Prepare end of period financial reports................................................................................. 28
Introduction to Balance Sheet ....................................................................................................... 28
What is a balance sheet and why is it prepared? ....................................................................... 28
Preparing A Balance Sheet ....................................................................................................... 29
Income Statement...................................................................................................................... 43
Operating section ...................................................................................................................... 36
Revenue..................................................................................................................................... 36
A Sample Income Statement ..................................................................................................... 37
Expenses ................................................................................................................................... 37

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LO1: Maintain asset register
How to Prepare an Asset Register
An asset register -- also known as a fixed asset register -- is simply a record that clearly identifies
all the fixed assets of a business. Fixed assets refer to assets that a business uses regularly to
produce its income, and unlike assets like inventory, these assets are not considered products to
be sold. The register allows a business owner to quickly retrieve information on an asset
including it's description, purchase date, location, purchase price, accumulated depreciation, and
estimated salvage value.

Part 1 of 2: Preparing To Create An Asset Register

1. Learn the purpose of an asset register. Asset registers are typically used to help
business owners keep track of all their fixed assets and the details surrounding them. It
assists in tracking the correct value of the assets, which can be useful for tax purposes, as
well as for managing and controlling the assets. A fixed asset register provides a single
location to quickly learn about any asset owned by the business.[1]

Fixed assets refer to long-term assets that are used in the production of the businesses income
and typically refers to things like land, machines, buildings, office equipment, copyrights, and
vehicles. Quite simply, they can be seen as assets not intended for sale but rather for use in
production, as opposed to something like inventory.[2]

For example, assume a business owns a small fleet of trucks. The fixed asset register would
describe the trucks (indicate color, make, model), indicate their purchase date and price, their
amount of depreciation accumulated, and their estimated salvage value.

The asset register is important for keeping track of whether or not assets are still in possession or
are working, and is an important way of of keeping track of the value of your assets. It can be
helpful not only for business management purposes, but should also be provided to your
accountant as it is an easy way for him or her to to find information regarding the assets and their
values

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 2. Identify fixed assets by looking at the balance sheet of the business. In order for a
fixed asset register to be successful, it is required that the information be accurate,
complete, and comprehensive. To do this, it is important to make sure all assets are
included in the register.

Look at the balance sheet of the business. Create a list of all the fixed assets that are listed and
recorded here, as this indicates the assets that are currently reflected in the company's books.

These assets will typically be located under the assets section of the balance sheet. Typically,
fixed assets will including anything under "property, plant & equipment" and will include land,
buildings, equipment, and vehicles.

Note that fixed assets can also include things like patents, copyrights or brand names. These are
known as "intangible assets", and can be found under the "intangible assets" portion of the
balance sheet. A good tip is, if you plan on owning it for more than a year, it should be
considered a fixed asset

3. Identify assets by performing a physical audit or walk-around of the company's

locations. Perform a walk-around of the business location(s) to check and make sure all
the assets in the balance sheet are listed. Make special note of any assets not listed.

If for example, you find a machine that is not recorded in the company's books, make sure you
make note to include it in the register. The register should include assets both listed and unlisted
in the books.

If an asset is not in the books, it is most often because the asset has been depreciated to zero and
removed from the books. That is to say, the asset's value depreciated over time until it no longer
had any accounting value.

Be sure to be thorough, and keep in mind that any piece of property that you plan on keeping and
not converting into cash for over a year that is involved in the production of the company's
income would be considered a fixed asset. This means things like office equipment, furniture, or
fixtures would also be considered. These things are long-term, and are all involved -- although
indirectly sometimes -- in the production of income.

4. Decide on a method of organizing your asset register. Once you have a detailed list of
all the company's fixed assets (from both a walk-around and the general ledger), it is time
to create the structure for the register. Note the register can be kept physically, or
digitally, depending on your preference. While there are several ways to organize an asset
register, here are a few:

If you are opting for a physical asset register, one approach is to use a loose leaf binder, and
simply allocate one page per asset. Each page would indicate the asset (for example, a fleet of

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trucks), and then list several categories of information to be filled in pertaining to the asset (these
categories will be described in the next part). You can write out the pages by hand, although
using a computer and printing is recommended.

If you opt for a digital version, using a spreadsheet is a wise idea. One way to organize a
spreadsheet is to have a row for each asset, and then columns for information on each asset. For
example, each row of the spreadsheet Asset Register would apply to a single, specific asset such
as Truck, or Milling Machine. The horizontal columns would have titles such as Description,
manufacturer, serial number or identifier, date of purchase, purchase price, etc. The next part will
go into detail regarding each column.

You can also find numerous templates for asset registers online by simply searching "fixed asset
register template" into a search engine.

Part 2 of 2: Creating Your Fixed Asset Register

1. Create an account record for each fixed asset. As mentioned earlier, each asset will
need its own "account", or area to store the information. If you opt for a loose leaf binder,
each page would feature an asset, and then various pieces of information. If you opt for a
spreadsheet, each row would feature an asset. Regardless of your format, the following
information is necessary for each account:
 Description: The description should be able to distinguish the specific asset from other
similar assets. For example, a company that owns multiple Ford trucks might describe
them by color, model, and year of manufacture (Ford 2012 F-250 brown truck). Note
whether the asset is New, Used, or Reconditioned. Include the location of the asset here
as well.
 Serial number: This is the identification assigned by the manufacturer. If your company
has also assigned a company ID, note that in your record.
 Date of purchase: Include the date the asset was purchased.
 Purchase price: Include the price the item was acquired at
 Insurance coverage: Include any details regarding the insurance policy for the asset,
including broker name and company.
 Warranty information: If applicable, including contact information for warranty
provider.
 Date asset placed in service:: List the first day of usage for the asset.
 Estimated life of the asset: Here you would include how long you expect the item to last
in years, or hours. This is also known as the depreciation period, which will be discussed
in detail in the next part.
 Salvage value: Include the salvage value -- that is to say, the resale value of the asset at
the end of its life. In many cases, this would not apply as the asset would be used until
not capable of resale.

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  Depreciation method: Depreciation refers to the reduction in the assets value over time,
and this can occur according to several methods
2. Select an appropriate depreciation period. The depreciation period is the period during
which the value of the asset will decrease. In order to determine depreciation, it is important
to first know the time period the depreciation will occur within. [7]

A percentage of the asset's value is converted from an asset to an expense at the end of each
accounting period during the depreciation period of the asset. The amount of the asset's value
that is expended in each accounting period is determined by the depreciation method, which is
explained later.

The depreciation period is based on the projected useful life of the asset. Contact the
manufacturer to determine this specifically.

Often, the depreciation period for a specific asset is dictated by tax regulations. Confirm this
with tax authorities.

3. Determine the most appropriate depreciation method. Since each asset depreciates
over time, it is important to know what the common depreciation methods are, so it can
be indicated on the fixed asset register. [8]

Similar to the depreciation period, allowable depreciation methods are often dictated by tax
authorities.

Straight-line is a very common method for depreciating assets. With this method, the percentage
of the value of the asset that is depreciated is the same in each period. For instance, if an asset
has a depreciation period of 5 years, then, under straight-line depreciation, 20 percent of the asset
value will be converted to expense each year.

Accelerated depreciation methods increase expense realization in the short term, which results in
lower net income in the early depreciation periods of the asset. This shifts depreciation expense
from later periods to earlier periods and has the effect of deferring tax expenses to the later
periods. Note, however, that accelerated depreciation also reduces shareholder equity more
rapidly. Contact an accounting professional to determine if this method is right for you, as it can
have certain tax benefits.

The depreciation method cannot be changed once an asset is placed into service and a
depreciation method is applied to it.

For further clarification on this, consult an accounting or bookkeeping professional.

4. Conduct periodic audits to verify the accuracy of the fixed asset register.Each year,
ensure the accuracy of the register by doing a physical inventory check. As mentioned

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 earlier, compare physical assets with assets on the books, and make sure that the asset
register is always up to date

Assets that have been lost, stolen or have become nonfunctional no longer have value to the
organization and, therefore, the remaining book value of such assets must be written off. It is
very important, however, to keep all records whether or not the asset has any value, or is in use
or not.

Bookkeeping

The term bookkeeping means different things to different people:

 Some people think that bookkeeping is the same as accounting. They assume that keeping
a company's books and preparing its financial statements and tax reports are all part of
bookkeeping. Accountants do not share their view.

 Others see bookkeeping as limited to recording transactions in journals or daybooks and

then posting the amounts into accounts in ledgers. After the amounts are posted, the
bookkeeping has ended and an accountant with a college degree takes over. The
accountant will make adjusting entries and then prepare the financial statements and other
reports.

 The past distinctions between bookkeeping and accounting have become blurred with the
use of computers and accounting software. For example, a person with little bookkeeping
training can use the accounting software to record vendor invoices, prepare sales
invoices, etc. and the software will update the accounts in the general ledger
automatically. Once the format of the financial statements has been established, the
software will be able to generate the financial statements with the click of a button.

 At mid-size and larger corporations the term bookkeeping might be absent. Often
corporations have accounting departments staffed with accounting clerks who process
accounts payable, accounts receivable, payroll, etc. The accounting clerks will be
supervised by one or more accountants.

Our explanation of bookkeeping attempts to provide you with an understanding of bookkeeping

and its relationship with accounting. Our goal is to increase your knowledge and confidence in
bookkeeping, accounting and business. In turn, we hope that you will become more valuable in
your current and future roles.

Recording Transactions

Bookkeeping (and accounting) involves the recording of a company's financial transactions. The
transactions will have to be identified, approved, sorted and stored in a manner so they can be
retrieved and presented in the company's financial statements and other reports.

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Here are a few examples of some of a company's financial transactions:

 The purchase of supplies with cash.

 The purchase of merchandise on credit.

 The sale of merchandise on credit.

 Rent for the business office.

 Salaries and wages earned by employees.

 Buying equipment for the office.

 Borrowing money from a bank.

The transactions will be sorted into perhaps hundreds of accounts including Cash, Accounts
Receivable, Loans Payable, Accounts Payable, Sales, Rent Expense, Salaries Expense, Wages
Expense Dept 1, Wages Expense Dept 2, etc. The amounts in each of the accounts will be
reported on the company's financial statements in detail or in summary form.

With hundreds of accounts and perhaps thousands of transactions, it is clear that once a person
learns the accounting software there will be efficiencies and better information available for
managing a business.

Depreciation
Depreciation is systematic allocation the cost of a fixed asset over its useful life. It is a way of
matching the cost of a fixed asset with the revenue (or other economic benefits) it generates over
its useful life. Without depreciation accounting, the entire cost of a fixed asset will be recognized
in the year of purchase. This will give a misleading view of the profitability of the entity

Methods of Depreciation
Cost of a fixed asset must be charged to the income statement in a manner that best reflects the
pattern of economic use of assets.

Types of depreciation
Depreciation is a systematic and rational process of distributing the cost of tangible assets over
the life of assets.
Depreciation is a process of allocation.
Cost to be allocated = acquisition cot - salvage value
Allocated over the estimated useful life of assets.
Allocation method should be systematic and rational.

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 A. Straight Line Depreciation
Depreciation = (Cost - Residual value) / Useful life

Example

On April 1, 2011, Company A purchased an equipment at the cost of $140,000. This equipment
is estimated to have 5 year useful life. At the end of the 5th year, the salvage value (residual
value) will be $20,000. Company A recognizes depreciation to the nearest whole month.
Calculate the depreciation expenses for 2011, 2012 and 2013 using straight line depreciation
method.

Depreciation for 2011

= ($140,000 - $20,000) x 1/5 x 9/12 = $18,000

Depreciation for 2012

= ($140,000 - $20,000) x 1/5 x 12/12 = $24,000

Depreciation for 2013

= ($140,000 - $20,000) x 1/5 x 12/12 = $24,000

Fig1. Shows that as the straight line method was used, the depreciation would be
constant and the maintenance cost would increase which would increase the total
expenses.

B. Declining balance depreciation

Declining balance method of depreciation is similar to reducing balance method but there is a
slight difference between these two methods of depreciation. In declining balance method, we
use a fixed predetermined rate which is not directly applied on the book value of a fixed asset
rather than it‘s first applied on straight line rate of depreciation and the resultant rate of
depreciation is used to calculate depreciation expense

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There are two versions of decline balance method

150% declining balance method of depreciation which is commonly known as Declining balance
method
200% declining balance method of depreciation which is called double declining balance method

Consider the example of double declining blance method to help grasp the concept. XYZ
Company purchased a machine for $9000. Machine‘s useful life = 5 years and residual value =
$1000

To calculate depreciation expense under double declining balance method, follow these steps

Step one
Calculate the straight line rate of depreciation which in this case is ―20%‖ (1/5=0.2 or 20%)

Step two
Double the straight line rate of depreciation or make it 200%. Therefore, the rate should be
―40%‖ (20% X 2=40%)

Step Three
Apply the doubled straight line rate of depreciation (40%) on the book value of the fixed asset
and you should be done, you would get the depreciation expense for an accounting period.

Book value of the machine in the first year is $9000. Therefore, its depreciation should be:
―3600‖ (9000 X 40% =3600)

Following table shows the depreciation expense for each year

Years Calculation of Depreciation Depreciation Accumulated Book

Expenses Depreciation value of
the Asset

Purchase $9000

1st year $9000 X 40%=3600 $3600 $3600 $5400

2nd year $5400 X 40%=2160 2160 5760 $3240

3rd year $3240 X 40%=1296 $1296 $7056 $1944

4th year $1944 X40%=778 $778 $7834 $1166

5th year $1166 X 40%=466 **166 $166 $8000 $1000

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*Accumulated depreciation = The total or accumulated amount of depreciation expenses at a
point in time
*Book value = Cost the asset - Accumulated depreciation expenses
*Depreciable amount = Cost the asset - Residual value the asset

**Note that the estimated residual value of the machine was $1000 and the depreciaton expense
for the last year in accordance with the declining balance method should be $466 which gives
1000-466=534 residual value (less than the estimated residual value). Therefore, we are not
counting 466 and 1166-1000=166 should be regarded as the depreciation expense for the last
year of machine useful life in order to justify the estimated residual value ($1000)

Example, 150% declining balance depreciation

On April 1, 2011, Company A purchased an equipment at the cost of $140,000. This

equipment is estimated to have 5 year useful life. At the end of the 5th year, the salvage value
(residual value) will be $20,000. Company A recognizes depreciation to the nearest whole
month. Calculate the depreciation expenses for 2011, 2012 and 2013 using double declining
balance depreciation method.

Useful life = 5 years --> Straight line depreciation rate = 1/5 = 20% per year

Depreciation rate for double declining balance method

= 20% x 150% = 20% x 1.5 = 30% per year

Depreciation for 2011

= $140,000 x 30% x 9/12 = $31,500

Depreciation for 2012

= ($140,000 - $31,500) x 30% x 12/12 = $32,550

Depreciation for 2013

= ($140,000 - $31,500 - $32,550) x 30% x 12/12 = $22,785

150% Declining Balance Depreciation Method

Book Value
Depreciation Depreciation Book Value at
Year at the
Rate Expense the year-end
beginning
2011 $140,000 30% $31,500 (*1) $108,500
2012 $108,500 30% $32,550 (*2) $75,950
2013 $75.950 30% $22,785 (*3) $53,165

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 2014 $53,165 30% $15,950 (*4) $37,216
2015 $37,216 30% $11,165 (*5) $26,051
2016 $26,051 30% $6,051 (*6) $20,000
(*1) $140,000 x 30% x 9/12 = $31,500
(*2) $108,500 x 30% x 12/12 = $32,550
(*3) $75,950 x 30% x 12/12 = $22,785
(*4) $53,165 x 30% x 12/12 = $15,950
(*5) $37,216 x 30% x 12/12 = $11,165
(*6) $26,051 x 30% x 12/12 = $7,815

--> Depreciation for 2016 is $6,051 to keep book value same as salvage value.
--> $26,051 - $20,000 = $6,051 (At this point, depreciation stops.)

C. Sum-of-the-years-digits method
Also known as SYD, another method of depreciation which gives higher depreciation expense in
the early life of an asset and lower depreciation afterward. In this method, depreciation rate is
shown as a fraction. The fraction gets smaller each accounting period and this is the reason why
depreciation expense constantly decreases with the passage of time. To calculated depreciation
expense for a given accounting period, you just need to apply this fraction on depreciable amount
(Depreciable amount = Cost – Residual value) of the fixed asset

Example
XYZ Company purchased a vehicle for $6000. The vehicle will be used for 5 years and $1000
was estimated as its residual value

To calculate depreciation expenses follow these steps

Step one
Calculate the depreciable amount of the fixed asset

Depreciable amount = Cost – Residual value

In the current example,

Cost = $6000
Residual value = $100

By putting values in the formula

Depreciable amount = 6000 – 1000

Depreciable amount = 5000

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Hence, the depreciable amount is equal to $5000. This is the amount that will be depreciated
over the useful life of that vehicle

Step Two
Calculate the ―sum of the digits fraction‖ (which is a kind of depreciation rate)

At the time of purchase, the vehicle‘s useful life is = 5 years

At the beginning of 2nd year, the vehicle‘s useful life is = 4 years
At the beginning of 3rd year, the vehicle‘s useful life is = 3 years
At the beginning of 4th year, the vehicle‘s useful life is = 2 years
At the beginning of 5th year, the vehicle‘s useful life is = 1 years

Now sum these digits 5 years+4 years+3 years+2 years+1 year = 15 years (or 15)

Finally, the "sum of the digits fractions" for each year

Sum of the digits fraction for the 1st year = 5/15

Sum of the digits fraction for the 2nd year = 4/15
Sum of the digits fraction for the 3rd year = 3/15
Sum of the digits fraction for the 4th year = 2/15
Sum of the digits fraction for the 5th year = 1/15

These fractions are applied on the depreciable amount to calculated the depreciation expense for
each year or accounting period as the following table shows

Years Calculation of Depreciation Accumulated Book value of

Depreciation Expenses Depreciation the Asset

Purchase $6000

1st year $5000 X 5/15 $1667 $1667 $4333

2nd year $5000 X 4/15 $1334 $3001 $2999

3rd year $5000 X 3/15 $1000 $4001 $1999

4th year $5000 X 2/15 $667 $4668 $1332

5th year $5000 X 1/15 $334 Approx. $5000 Approx.

$1000

*Accumulated depreciation = The total or accumulated amount of depreciation expenses at a

point in time

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*Book value = Cost the asset - Accumulated depreciation expenses
*Depreciable amount = Cost the asset - Residual value the asset

Depreciation expense = (Cost - Salvage value) x Fraction

Fraction for the first year = n / (1+2+3+...+ n)
Fraction for the second year = (n-1) / (1+2+3+...+ n)
Fraction for the third year = (n-2) / (1+2+3+...+ n)
...
Fraction for the last year = 1 / (1+2+3+...+ n)

n represents the number of years for useful life.

Additional Depreciation Examples

Cost $ 110,000
Salvage value $ 20,000
Useful life 5
Purchase date January 1, 2011

 Straight line depreciation

Year Depreciation
2011 $ 18,000 =($110,000 - $20,000) x 1/5
2012 $ 18,000 =($110,000 - $20,000) x 1/5
2013 $ 18,000 =($110,000 - $20,000) x 1/5
2014 $ 18,000 =($110,000 - $20,000) x 1/5
2015 $ 18,000 =($110,000 - $20,000) x 1/5
Total $ 90,000

 Double declining balance depreciation

Depreciation rate = 1/5 x 200% = 40%

Book value at Accumulate

Depreciation Depreciation Book value
Year the beginning d
rate expense at year-end
of year depreciation
2011 $ 110,000 40% $ 44,000 $ 44,000 $ 66,000
2012 $ 66,000 40% $ 26,400 $ 70,400 $ 39,600
2013 $ 39,600 40% $ 15,840 $ 86,240 $ 23,760
2014 $ 23,760 40% $ 3,760 (*1) $ 90,000 $ 20,000

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 2015 $ 20,000 40% $ - $ 90,000 $ 20,000
Total $ 90,000

(*1) Depreciation stops when accumulated depreciation reaches depreciation base.

Depreciation base = cost - salvage value = $110,000 - $20,000 = $90,000

 150% declining balance depreciation

Depreciation rate = 1/5 x 150% = 30%

Book value
at the Depreciation Depreciation Accumulated Book value
Year
beginning rate expense depreciation at year-end
of year
$
2011 110,000 30% $ 33,000 $ 33,000 $ 77,000
$
2012 77,000 30% $ 23,100 $ 56,100 $ 53,900
$
2013 53,900 30% $ 16,170 $ 72,270 $ 37,730
$
2014 37,730 30% $ 11,319 $ 83,589 $ 26,411
$
2015 26,411 30% $ 6,411 (*2) $ 90,000 $ 20,000
Total $ 90,000

(*2) Depreciation stops when accumulated depreciation reaches depreciation base.

Depreciation base = cost - salvage value = $110,000 - $20,000 = $90,000

 Sum-of-the-years'-digits depreciation

Sum of the years'

digits 15 =1+2+3+4+5
Years'
Year
digits Depreciation

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2011 5 $ 30,000 =($110,000 - $20,000) x 5/15
2012 4 $ 24,000 =($110,000 - $20,000) x 4/15
2013 3 $ 18,000 =($110,000 - $20,000) x 3/15
2014 2 $ 12,000 =($110,000 - $20,000) x 2/15
2015 1 $ 6,000 =($110,000 - $20,000) x 1/15
Total 15 $ 90,000

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Impact of using different depreciation methods
The total amount of depreciation charged over an asset's entire useful life (i.e. depreciable
amount) is the same irrespective of the choice of depreciation method. The adoption of a
particular depreciation method does however effect the amount of depreciation expense charged
in each year of an asset's life.
Following diagram illustrates the effect of using different depreciation methods on yearly
depreciation expense:

The above illustration is based on the following information:

$100,00
Cost of fixed asset
0
Residual Value Nil
Useful Life 4 Years
Total Machine hours 20,000 (for calculating depreciation using units of activity method)
Rate of depreciation 40% (for calculating depreciation using reducing balance method)
For calculation and working, you may view the depreciation worksheet.
Following can be deduced from the diagram:
Straight Line Results in an equal expense of $25,000 each year.

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 Depreciation
Reducing Balance Depreciation charge is reduced by 40% in each period (i.e. the rate used in this
Depreciation example) until the last year in which the entire un-depreciated amount is charged
off.
Sum of the Year' Depreciation expense decreases each year by $10,000.
Digits
Depreciation

Comparison of Depreciation Methods

Advantages Disadvantages

Straight Easy to calculate May not reflect the true pattern of asset's
Line economic benefits.
Useful where the pattern of economic benefits
are hard to determine with precision.

Suitable for depreciating assets that provide

similar level of economic benefits throughout
their useful life (e.g. buildings).
Reducing Appropriate where the usefulness of an asset The rate of depreciation selected is subject to
Balance declines over its useful life (e.g. IT equipment). bias
Sum of Easier to understand More difficult to calculate.
the Year'
Digits The effect of decrease in depreciation expense
compared to reducing balance method.

Self-check Exercises

Question1. Company A purchased the following asset on January 1, 2011.What is the amount of
depreciation expense for the year ended December 31, 2011 by considering givens below?
Acquisition cost of the asset --> $100,000
Useful life of the asset --> 5 years
Residual value (or salvage value) at the end of useful life --> $10,000
Depreciation method --> sum-of-the-years'-digits method

Question2. On April 1, 2011, Company A purchased an equipment at the cost of $138,000. This
equipment is estimated to have 5 year useful life. At the end of the 5th year, the salvage value

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(residual value) will be $20,000. Company A recognizes depreciation to the nearest whole
month. Calculate the depreciation expenses for 2011, 2012 and 2013 using double declining
balance depreciation method.

(Clue)
Useful life = 5 years --> Straight line depreciation rate = 1/5 = 20% per year
Depreciation rate for double declining balance method = 20% x 200% = 20% x 2 = 40% per
year

LO2. Record general journal entries for

balance day adjustments
JOURNAL
Journal is a historical record of business transaction or events. The word journal comes from the
French word ―Jour‖ meaning ―day‖. It is a book of original or prime entry. Journal is a primary
book for recording the day to day transactions in a chronological order i.e. the order in which
they occur. The journal is a form of diary for business transactions. This is called the book of
first entry since every transaction is recorded firstly in the journal.

Journal Entry

Journal entry means recording the business transactions in the journal. For each transaction a
separate entry is recorded. Before recording, the transaction is analyzed to determine which
account is to be debited and which account is to be credited.

The Performa of journal is shown as follows:

JOURNAL

Name of the Journal Page No

Date Particulars L.F Debit Credit

(Items) (Post. Ref) (Amount) (Amount)

(1) (2) (3) (4) (5)

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(1) Date: In each page of the journal at the top of the date column, the year is written and in the
next line, month and date of the first entry are written. The year and month need not be repeated
until a new page is begun or the month or the year changes. Thus, in this column, the date on
which the transaction takes place is alone written.

(2) Particulars: In this column, the details regarding account titles and description are recorded.
The name of the account to be debited is entered first at the extreme left of the particulars
column next to the date and the abbreviation ‗Dr.‘ is written at the right extreme of the same
column in the same line. The name of the account to be credited is entered in the next line
preceded by the word ―To‖ leaving a few spaces away from the extreme left of the particulars
column. In the next line immediately to the account credited, a short about the transaction is
given which is known as ―Narration‖. ―Narration‖ may include particulars required to identify
and understand the transaction and should be adequate enough to explain the transaction.

It usually starts with the word ―Being‖ which means what it is and is written within parentheses.
The use of the word ―Being‖ is completely dispensed with, in modern parlance. To indicate the
completion of the entry for a transaction, a line is usually drawn all through the particulars
column.

(3) Ledger Folio: This column is meant to record the reference of the main book, i.e., ledger and
is not filled in when the transactions are recorded in the journal.

The page number of the ledger in which the accounts are appearing is indicated in this column,
while the debits and credits are posted o the ledger accounts.

(4) Amount (Debit): The amount to be debited along with its unit of measurement at the top of
this column on each page is written against the account debited.

(5) Amount (Credit): The amount to be credited along with its unit of measurement at the top of
this column on each page is written against the account credited.

SUB-DIVISION OF JOURNAL
When innumerable number of transactions takes place, the journal, as the sole book of the
original entry becomes inadequate. Thus, the number and the number and type of journals
required are determined by the nature of operations and the volume of transactions in a particular
business. There are many types of journals and the following are the important ones:

1. Sales Day Book- to record all credit sales.

2. Purchases Day Book- to record all credit purchases.

3. Cash Book- to record all cash transactions of receipts as well as payments.

4. Sales Returns Day Book- to record the return of goods sold to customers on credit.

5. Purchases Returns Day Book- to record the return of goods purchased from suppliers on
credit.

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 6. Bills Receivable Book- to record the details of all the bills received.

7. Bills Payable Book- to record the details of all the bills accepted.

8. Journal Proper-to record all residual transactions which do not find place in any of the
aforementioned books of original entry.

Advantages of Using Journal

Journal is used because of the following advantages:

· A journal contains a permanent record of all the business transactions.

· The journal provides a complete chronological (in order of the time of occurrence) history of
all business transactions and the task of later tracing of some transactions is facilitated.

· Complete information relating to one single business transaction is available in one place
with all its aspects.

· The transaction is provided with an explanation technically called a narration.

· Use of the journal reduces the possibility of an error when transactions are first recorded in
this book.

· The journal establishes the quality of debits and credits for a transaction and reconciles any
problems. If a business purchases a bicycle, it is necessary to decide whether the bicycle
represents ordinary goods or machinery. Further any amount paid is debited to bicycle
account and credited to cash account.

· The use of journals avoids omission or duplication of transactions or parts of transaction.

Without the journal the accountant would be forced to got to the individual account to enter
debits and credits. Therefore it is possible for accountant to miss part of a transaction,
duplicate all or part of a transaction or incorrectly record debits and credits. Even with the
Journal, it is still possible to omit transactions and make other errors. However, the Journal
reduces these problems.

· Once a transaction is recorded in the journal, it is not necessary to post it immediately in the
ledger accounts. In this, way, the journal allows the delayed posting.

In connection with the journal, the following points are to be remembered:

· For each transaction, the exact accounts should be debited and credited. For that, the two
accounts involved must be identified to pass a proper journal entry.

· Sometimes, a journal entry may have more than one debit or more than one credit. This
type of journal entry is called compound journal entry. Regardless of how many debits or
credits are contained in a compound journal entry, all the debits are entered before any

21
 credits are entered. The aggregate amount of debits should be equal to the aggregate
amount of credits.

· For a business, journal entries generally extend to several pages. Therefore, the totals are
cast at the end of each page, against the debit and credit columns, the following words and
written in the particular column, which indicates, carried forward (of the amount on the
next page) ―Total c/f‖.

The debits and credits totals of the page are then written on the next page in the amount columns;
and opposite to that on the left, the following words are written in the particulars column to
indicate brought forward (of the amount of the previous page) ―Total b/f‖. This process is
repeated on every page and on the last page, ―Grand Total‖ is cast.

Journalizing
Journalizing is the process of recording journal entries in the Journal. It is a systematic act of
entering the transaction in a day book in order of their occurrence i.e., date-wise or event-wise.
After analyzing the business transactions, the following steps in journalizing are followed:

(i) Find out what accounts are involved in business transaction.

(ii) Ascertain what is the nature of accounts involved?

(iii) Ascertain the golden rule of debit and credit is applicable for each of the accounts
involved.

(iv) Find out what account is to be debited which is to be credited.

(v) Record the date of transaction in the ―Date Column‖.

(vi) Write the name of the account to be debited very near to the left hand side in the
‗Particulars Column‘ along with the word ‗Dr‘ on the same line against the name of the
account in the ‗Particulars Column‘ and the amount to be debited in the ‗Debit Amount
column‘ against the name of the account.

(vii) Record the name of the account to be credited in the next line preceded by the word ‗To‘
at a few space towards right in the ‗Particulars Column‘ and the amount to be credited in
the ‗Credit Amount Column‘ in front of the name of the account.

(viii) Record narration (i.e. a brief explanation of the transaction) within brackets in the
following line in ‗Particulars Column‘.

(ix) A thin line is drawn all through the particulars column to separate one Journal entry from
the other and it shows that the entry of a transaction has been completed.

22
Difference between a general ledger and a general journal
Journals are referred to as books of original entry. Accounting entries are recorded in a journal in
order by date. A company might use special journals (sales, purchases, cash disbursements, cash
receipts), or its accounting software will generate entries for routine transactions, but there will
always be a general journal in which to record non routine transactions, such
as depreciation, bad debts, sale of an asset, etc. In the general journal you must enter the account
to be debited and the account to be credited and the amounts. Once a transaction is recorded in
the general journal, the amounts are then posted to the appropriate accounts.
Accounts (such as Cash, Accounts Receivable, Equipment, Accumulated Depreciation, Accounts
Payable, Sales, Telephone Expense, etc.) are contained in the general ledger.
To recap...the general ledger houses the company's accounts. The general journal is a place to
first record an entry before it gets posted to the appropriate accounts.

LO3. Prepare final general ledger accounts

Ledger
It has already been discussed in earlier lesson that accounting involves recording, classifying and
summarizing the financial transactions. Recording is made in Journal, which has been explained
in the preceding lesson. Classification of the recorded transactions is made in the ledger. This is
being discussed in the present lesson.

Ledger is a main book of account in which various accounts of personal, real and nominal nature,
are opened and maintained. In journal, as all the business transactions are recorded
chronologically, it is very difficult to obtain all the transactions pertaining to one head of account
together at one place. But, the preparation of different ledger accounts helps to get a consolidated
picture of the transactions pertaining to one ledger account at a time. Thus, a ledger account may
be defined as a summary statement of all the transactions relating to a person, asset, expense, or
income or gain or loss which have taken place during a specified period and shows their net
effect ultimately. From the above definition, it is clear that when transactions take place, they are
first entered in the journal and subsequently posted to the concerned accounts in the ledger.
Posting refers to the process of entering in the ledger the information given in the journal. In the
past, the ledgers were kept in bound books. But with the passage of time, they became loose-leaf
ones and the advantages of the same lie in the removal of completed accounts, insertion of new
accounts and arrangement of accounts in any required manner.

Ledger is a book which contains various accounts. In simple words, ledger is a set of accounts. It
includes all accounts of the business enterprise whether Real, Nominal or Personal. Ledger may
be kept in any of the following two forms:

· Bound Ledger; and

· Loose Leaf Ledger.

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It is common to keep the ledger in the form of loose-leaf cards these days instead of keeping
them in bounded form. This helps in posting transactions particularly when mechanized system
of accounting is used.

Interestingly, nowadays, mechanized system of accounting is preferred over the manual system
of accounting.

Sub-division of ledger
In a big business, the number of accounts is numerous and it is found necessary to maintain a
separate ledger for customers, suppliers and for others.

Usually, the following three types of ledgers are maintained in such big business concerns.

(i) Debtors’ Ledger: It contains accounts of all customers to whom goods have been sold on
credit. From the Sales Day Book, Sales Returns Book and Cash

Book, the entries are made in this ledger. This ledger is also known as sales ledger.

(ii) Creditors’ Ledger: It contains accounts of all suppliers from whom goods have been bought
on credit. From the Purchases Day Book, Purchases Returns Book and Cash Book, the entries are
made in this ledger. This ledger is also known as

Purchase Ledger.

(iii) General Ledger: It contains all the residual accounts of real and nominal nature. It is also
known as Nominal Ledger.

Distinction between journal and ledger

(i) Journal is a book of prime entry, whereas ledger is a book of final entry.

(ii) Transactions are recorded daily in the journal, whereas posting in the ledger is made
periodically.

(iii) In the journal, information about a particular account is not found at one place, whereas
in the ledger information about a particular account is found at one place only.

(iv) Recording of transactions in the journal is called journalizing and recording of

transactions in the ledger is called posting.

(v) A journal entry shows both the aspects debit as well as credit but each entry in the ledger
shows only one aspect.

(vi) Narration is written after each entry in the journal but no narration is given in the ledger.

(vii) Vouchers, receipts, debit notes, credit notes etc., from the basic documents form journal
entry, whereas journal constitutes basic record for ledger entries.

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Posting
The term ‗Posting‘ means transferring the debit and credit items from the Journal to their
respective accounts in the ledger. It is important to note that the exact names of accounts used in
the Journal should be carried to the ledger. For example:

If in the Journal, Salary Account has been debited, it would not be correct to debit the
Outstanding Salary Account in the Ledger. Therefore, the correct course would be to use the
same account in both the Journal and Ledger.

Ledger posting may be done at any time. However, it must be completed before the annual
financial statements are prepared. It is advisable to keep the more active accounts posted upto
date. The examples of such accounts are the cash account, personal accounts of various parties,
etc.

The Ledger posting may be made by the book-keeper from the

Journal to the Ledger by any of the following methods:

· He may take a particular side first. For example, he may take the debits first and make the
complete postings of all debits from Journal to the Ledger.

· He may take a particular account first and post all debits and credits relating to that account
appearing on one particular page of Journal. He may then take some other account and follow the
same procedure.

· He may complete posting of each journal entry before proceeding to the next entry.

It is advisable to follow the last method. Further, one should post each debit and credit item as it
appears in the Journal.

The Ledger Folio (L.F.) column in the Journal is used at the time when debits and credits are
posted to the Ledger. The page number of the

Ledger on which the posting has been done is mentioned in the L.F. Column of the Journal.
Similarly a folio column in the Ledger can also be kept where the page from which posting has
been made from the Journal. Thus, these are cross references in both the Journal and the Ledger.
A proper index must be maintained in the Ledger giving the names of the accounts and the page
number.

Rules Regarding Posting

The following rules must be observed while posting transactions in the Ledger from the Journal:

i) Separate accounts should be opened in the Ledger for posting transactions relating to different
accounts recorded in the Journal. For example, separate accounts may be opened for sales,
purchases, sales returns, purchases returns, salaries, rent, cash, etc.

25
ii) The concerned account which has been debited in the Journal should also be debited in the
Ledger. However, a reference should be made of the other account which has been credited
in the Journal. For example, for salaries paid, the salaries account should be debited in the
Ledger, but reference should be given of the Cash Account which has been credited in the
Journal.

iii) The concerned account, which has been credited in the Journal; should also be credited in the
Ledger, but reference should be given of the account, which has been debited in the
Journal. For example, for salaries paid, Cash Account has been credited in the Journal. It
will be credited in the Ledger also, but reference will be given of the Salaries Account in
the Ledger.

Thus, it may be concluded that while making posting in the Ledger, the concerned account which
has been debited or credited in the Journal should also be debited or credited in the Ledger, but
reference has to be given of the other account which has been credited or debited in the Journal,
as the case may be.

This will be clear with the following example:

Suppose salaries of Rs. 10,000 have been paid in cash, the following entry will be passed in the
Journal:

Salaries Account Dr. 10,000

To Cash Account 10,000

In the Ledger two accounts will be opened (i) Salaries Account, and

(ii) Cash Account. Since Salaries Account has been debited in the Journal, it will also be debited
in the Ledger. Similarly Cash Account has been credited in the Journal and, therefore, it will also
be credited in the

Ledger, but reference will be given of the other account involved. Thus, the accounts will appear
as follows in the Ledger:

Salaries Account Account No

Balance

Date Particulars Post. Ref Debit Credit Debit Credit

Salary 10000

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Cash Account Account No

Balance

Date Particulars Post. Ref Debit Credit Debit Credit

Cash A/c 10000

Use of the words “To” and “By”: It is customary to use words ‗To‘ and ‗By‘ while making
posting in the Ledger. The word ‗To‘ is used with the accounts which appear on the debit side of
a Ledger Account. For example in the Salaries Account, instead of writing only ―Cash‖ as shown
above, the words ―To Cash‖ will appear on the debit side of the account.

Similarly, the word ―By‖ is used with accounts which appear on the credit side of a Ledger
Account. For example in the above case, the words ―By

Salaries A/c‖ will appear on the credit side of the Cash Account instead of only ―Salaries A/c‖.
The words ‗To‘ and ‗By‘ do not have any specific meanings. Modern accountants are, therefore,
ignoring the use of these words.

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LO4. Prepare end of period financial reports
Introduction to Balance Sheet
The accounting balance sheet is one of the major financial statements used by accountants and
business owners. (The other major financial statements are theincome statement, statement of
cash flows, and statement of stockholders' equity) The balance sheet is also referred to as
the statement of financial position.

The balance sheet presents a company's financial position at the end of a specified date. Some
describe the balance sheet as a "snapshot" of the company's financial position at a point (a
moment or an instant) in time. For example, the amounts reported on a balance sheet dated
December 31, 2014 reflect that instant when all the transactions through December 31 have been
recorded.

Because the balance sheet informs the reader of a company's financial position as of one moment
in time, it allows someone—like a creditor—to see what a company owns as well as what
it owes to other parties as of the date indicated in the heading. This is valuable information to the
banker who wants to determine whether or not a company qualifies for additional credit or loans.
Others who would be interested in the balance sheet include current investors, potential
investors, company management, suppliers, some customers, competitors, government agencies,
and labor unions.

What is a balance sheet and why is it prepared?

The balance sheet is prepared in order to report an organization's financial position as of a

specified moment, such as midnight on December 31.

A corporation's balance sheet reports its assets (resources that were acquired in past
transactions), its liabilities (obligations and customer deposits), and its stockholders' equity(the
difference between the amount of assets and liabilities). Some people state that the balance sheet
reports the amounts of the assets and the claims against those assets (liabilities and stockholders'
equity). Others state that the balance sheet reports a corporation's assets and the amount that was
provided by creditors (the liabilities) and the amounts provided by the owners (stockholders'
equity).

A classified balance sheet reports the current assets in a section that is separate from the long-
term asset. Similarly, current liabilities are reported in a section that is separate from long-term
liabilities. This allows bankers, owners, and others to easily compute the amount of an

28
organization's working capital. (Working capital is defined as current assets minus current
liabilities.)

The balance sheet has some limitations. For example, land and buildings are usually reported at
cost minus the accumulated depreciation of the buildings. If these assets have increased in value,
the fair value is not reported due to the cost principle. Also, brand names and trademarks may
have significant value, but are not reported on the balance sheet, if they were not acquired in a
transaction.

The balance sheet should be read with the other financial statements (income statement,
statement of cash flows, and the statement of changes in stockholders' equity) and with the notes
to the financial statements.

Preparing A Balance Sheet

Overview

When someone, whether a creditor or investor, asks you how your company is doing, you'll want
to have the answer ready and documented. The way to show off the success of your company is a
balance sheet. A balance sheet is a documented report of your company's assets and obligations,
as well as the residual ownership claims against your equity at any given point in time. It is a
cumulative record that reflects the result of all recorded accounting transactions since your
enterprise was formed. You need a balance sheet to specifically know what your company's net
worth is on any given date. With a properly prepared balance sheet, you can look at a balance
sheet at the end of each accounting period and know if your business has more or less value, if
your debts are higher or lower, and if your working capital is higher or lower. By analyzing your
balance sheet, investors, creditors and others can assess your ability to meet short-term
obligations and solvency, as well as your ability to pay all current and long-term debts as they
come due. The balance sheet also shows the composition of assets and liabilities, the relative
proportions of debt and equity financing and the amount of earnings that you have had to retain.
Collectively, this information will be used by external parties to help assess your company's
financial status, which is required by both lending institutions and investors before they will allot
any money toward your business.

I. Who Wants to See Your Balance Sheet

Many people and organizations are interested in the financial affairs of your company, whether
you want them to be or not. You of course want to know about the progress of your enterprise
and what's happening to your livelihood. However, your creditors also want assurance that you
will be able to pay them when they ask. Prospective investors are looking for a solid company to
bet their money on, and they want financial information to help them make a sound decision.

29
Your management group also requires detailed financial data and the labor unions (if applicable)
will want to know your employees are getting a fair share of your business earnings.

II. Common Classifications

On the balance sheet you list your assets and equities under classifications according to their
general characteristics. It is a relatively simple matter to make a comparison of one classification
with another or to make comparisons within a classification because similar assets or similar
equities are listed together. Some of the most commonly used classifications are:

Current Assets

Current assets include cash and other assets that in the normal course of events are converted into
cash within the operating cycle. For example, a manufacturing enterprise will use cash to acquire
inventories of materials. These inventories of materials are converted into finished products and
then sold to customers. Cash is collected from the customers. This circle from cash back to cash
is called an operating cycle. In a merchandising business one part of the cycle is eliminated.
Materials are not purchased for conversion into finished products. Instead, the finished products
are purchased and are sold directly to the customers. Several operating cycles may be completed
in a year, or it may take more than a year to complete one operating cycle. The time required to
complete an operating cycle depends upon the nature of the business. It is conceivable that
almost all of the assets that are used to conduct your business, such as buildings, machinery, and
equipment, can be converted into cash within the time required to complete an operating cycle.
However, your current assets are only those that will be converted into cash within the normal
course of your business. The other assets are only held because they provide useful services and
are excluded from the current asset classification. If you happen to hold these assets in the
regular course of business, you can include them in the inventory under the classification of
current assets. Current assets are usually listed in the order of their liquidity and frequently
consist of cash, temporary investments, accounts receivable, inventories and prepaid expenses.

Cash

Cash is simply the money on hand and/or on deposit that is available for general business
purposes. It is always listed first on a balance sheet. Cash held for some designated purpose, such
as the cash held in a fund for eventual retirement of a bond issue, is excluded from current assets.

Marketable Securities

These investments are temporary and are made from excess funds that you do not immediately
need to conduct operations. Until you need these funds, they are invested to earn a return. You

30
should make these investments in securities that can be converted into cash easily; usually short-
term government obligations.

Accounts Receivable

Simply stated, accounts receivables are the amounts owed to you and are evidenced on your
balance sheet by promissory notes. Accounts receivable are the amounts billed to your customers
and owed to you on the balance sheet's date. You should label all other accounts receivable
appropriately and show them apart from the accounts receivable arising in the course of trade. If
these other amounts are currently collectible, they may be classified as current assets.

Inventories

Your inventories are your goods that are available for sale, products that you have in a partial
stage of completion, and the materials that you will use to create your products. The costs of
purchasing merchandise and materials and the costs of manufacturing your various product lines
are accumulated in the accounting records and are identified with either the cost of the goods
sold during the fiscal period or as the cost of the inventories remaining at the end of the period.

Prepaid expenses

These expenses are payments made for services that will be received in the near future. Strictly
speaking, your prepaid expenses will not be converted to current assets in order to avoid
penalizing companies that choose to pay current operating costs in advance rather than to hold
cash. Often your insurance premiums or rentals are paid in advance.

Investments

Investments are cash funds or securities that you hold for a designated purpose for an indefinite
period of time. Investments include stocks or the bonds you may hold for another company, real
estate or mortgages that you are holding for income-producing purposes. Your investments also
include money that you may be holding for a pension fund.

Plant Assets

Often classified as fixed assets, or as plant and equipment, your plant assets include land,
buildings, machinery, and equipment that are to be used in business operations over a relatively
long period of time. It is not expected that you will sell these assets and convert them into cash.
Plant assets simply produce income indirectly through their use in operations.

Intangible Assets

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Your other fixed assets that lack physical substance are referred to as intangible assets and
consist of valuable rights, privileges or advantages. Although your intangibles lack physical
substance, they still hold value for your company. Sometimes the rights, privileges and
advantages of your business are worth more than all other assets combined. These valuable
assets include items such as patents, franchises, organization expenses and goodwill expenses.
For example, in order to become incorporated you must incur legal costs. You can designate
these legal costs as organizing expenses.

Other Assets

During the course of preparing your balance sheet you will notice other assets that cannot be
classified as current assets, investments, plant assets, or intangible assets. These assets are listed
on your balance sheet as other assets. Frequently, your other assets consist of advances made to
company officers, the cash surrender value of life insurance on officers, the cost of buildings in
the process of construction, and the miscellaneous funds held for special purposes.

Current Liabilities

On the equity side of the balance sheet, as on the asset side, you need to make a distinction
between current and long-term items. Your current liabilities are obligations that you will
discharge within the normal operating cycle of your business. In most circumstances your current
liabilities will be paid within the next year by using the assets you classified as current. The
amount you owe under current liabilities often arises as a result of acquiring current assets such
as inventory or services that will be used in current operations. You show the amounts owed to
trade creditors that arise from the purchase of materials or merchandise as accounts payable. If
you are obligated under promissory notes that support bank loans or other amounts owed, your
liability is shown as notes payable. Other current liabilities may include the estimated amount
payable for income taxes and the various amounts owed for wages and salaries of employees,
utility bills, payroll taxes, local property taxes and other services.

Long-Term Liabilities

Your debts that are not due until more than a year from the balance sheet date are generally
classified as long-term liabilities. Notes, bonds and mortgages are often listed under this heading.
If a portion of your long-term debt is due within the next year, it should be removed from the
long-term debt classification and shown under current liabilities.

Deferred Revenues

Your customers may make advance payments for merchandise or services. The obligation to the
customer will, as a general rule, be settled by delivery of the products or services and not by cash

32
payment. Advance collections received from customers are classified as deferred revenues,
pending delivery of the products or services.

Owner's Equity

Your owner's equity must be subdivided on your balance sheet: One portion represents the
amount invested directly by you, plus any portion of retained earnings converted into paid-in
capital. The other portion represents your net earnings that are retained. This rigid distinction is
necessary because of the nature of any corporation. Ordinarily, stockholders, or owners, are not
personally liable for the debts contracted by a company. A stockholder may lose his investment,
but creditors usually cannot look to his personal assets for satisfaction of their claims. Under
normal circumstances, the stockholders may withdraw as cash dividends an amount measured by
the corporate earnings. The distinction in this rule gives the creditors some assurance that a
certain portion of the assets equivalent to the owner's investment cannot be arbitrarily
withdrawn. Of course, this portion could be depleted from your balance sheet because of
operating losses. The owner's equity in an unincorporated business is shown more simply. The
interest of each owner is given in total, usually with no distinction being made between the
portion invested and the accumulated net earnings. The creditors are not concerned about the
amount invested. If necessary, creditors can attach the personal assets of the owners.

Cost

Cost is conventionally used as the basis for accountability. Assets, when acquired under normal
circumstances, are recorded at the price negotiated between two independent parties dealing at
arm's length. Simply stated, the cost of an asset to the purchaser is the price that he or she must
pay now or later in order to obtain it. The fair value of the asset is not relevant in recording the
transaction on your balance sheet. A purchaser may acquire an asset at a cost that is greater or
less than the fair value determined in the marketplace. If the asset is acquired, the purchaser
accounts for the assets at his cost, value notwithstanding. A simple formula to remember in
determining cost is: Assets = Liability + Equity or Equity = Assets – Liability

III. Preparing Your Balance Sheet

Title and Heading

In practice, the most widely used title is Balance Sheet; however Statement of Financial Position
is also acceptable. Naturally, when the presentation includes more than one time period the title
"Balance Sheets" should be used.

Heading

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In addition to the statement title, the heading of your balance sheet should include the legal name
of your company and the date or dates that your statement is presented. For example, a
comparative presentation might be headed:

XYZ CORPORATION

BALANCE SHEETS

December 31, 2009 and 2010

Format

There are two basic ways that balance sheets can be arranged. In Account Form, your assets are
listed on the left-hand side and totaled to equal the sum of liabilities and stockholders' equity on
the right-hand side. Another format is Report Form, a running format in which your assets are
listed at the top of the page and followed by liabilities and stockholders' equity. Sometimes total
liabilities are deducted from total assets to equal stockholders' equity.

Captions

Captions are headings within your statement that designate major groups of accounts to be
totaled or subtotaled. Your balance sheet should include three primary captions: Assets,
Liabilities and Stockholders' Equity.

LIABILITIES AND STOCKHOLDERS' EQUITY

Except in certain specialized industries your balance sheet should include the following
secondary captions:

CURRENT ASSETS

CURRENT LIABILITIES

Your remaining assets and liabilities are generally combined into two or three other secondary
captions, based on their materiality.

Order of Presentation of Captions

First, start with items held primarily for conversion into cash and rank them in the order of their
expected conversion. Then, follow with items held primarily for use in operations but that could
be converted into cash, and rank them in the order of liquidity. Finally, finish with items whose

34
costs you will defer to future periods or that you cannot convert into cash. Following these
guidelines, your major assets should normally be presented in the following order:

Cash

 Short-term marketable securities

 Trade notes and accounts receivable

 Inventories

 Long-term investments

 Property and equipment

 Intangible assets

 Deferred charges

Liabilities are ordinarily presented in the order of maturity as follows:

 Demand notes

 Trade accounts payable

 Accrued expenses

 Long-term debt

 Other long-term liabilities

Components of stockholders' equity are usually presented the following order:

 Preferred stock

 Common stock

 Additional paid-in capital

 Retained earnings

 Accumulated other comprehensive income

 Treasury stock

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Income Statement

An income statement is a company's financial statement that indicates how the revenue (money
received from the sale of products and services before expenses are taken out, also known as the
"top line") is transformed into the net income (the result after all revenues and expenses have
been accounted for, also known as net profit or the "bottom line"). It displays the revenues
recognized for a specific period, and the cost and expenses charged against these revenues,
including write-offs (e.g.,depreciation and amortization of various assets) and taxes. The purpose
of the income statement is to show managers and investors whether the company made or lost
money during the period being reported.

Operating section

Revenue

Cash inflows or other enhancements of assets of an entity during a period from delivering or
producing goods, rendering services, or other activities constitute the entity's ongoing major
operations. It is usually presented as sales minus sales discounts, returns, and allowances. Every
time a business sells a product or performs a service, it obtains revenue. This often is referred to
as gross revenue or sales revenue.

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A Sample Income Statement

Expenses

Cash outflows or other using-up of assets or incurrence of liabilities during a period from
delivering or producing goods, rendering services, or carrying out other activities constitute the
entity's ongoing major operations.

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 Cost of Goods Sold (COGS)/Cost of Sales represents the direct costs attributable to goods
produced and sold by a business (manufacturing or merchandising). It includes material costs,
direct labor, and overhead costs (as in absorption costing), and excludes operating costs (period
costs), such as selling, administrative, advertising or R&D, etc.

 Selling, General, and Administrative expenses (SG&A or SGA) consist of the combined payroll
costs. SGA is usually understood as a major portion of non-production related costs, in contrast
to production costs, such as direct labor. Selling expenses represent expenses needed to sell
products (e.g., salaries of sales people, commissions and travel expenses, advertising, freight,
shipping, depreciation of sales store buildings and equipment, etc.). General and Administrative
(G&A) expenses represent expenses to manage the business (salaries of officers/executives, legal
and professional fees, utilities, insurance, depreciation of office building and equipment, office
rents, office supplies, etc.).

 Depreciation / Amortization is the charge with respect to fixed assets/intangible assets that have
been capitalized on the balance sheet for a specific (accounting) period. It is a systematic and
rational allocation of cost rather than the recognitionof market value decrement.

 Research & Development (R&D) expenses represent expenses included in research and
development.

Non-operating Section

 Other revenues or gains include those from other than primary business activities (e.g., rent,
income from patents). They also includes unusual gains that are either unusual or infrequent, but
not both (e.g., gains from the sale of securities or gain from disposal of fixed assets)

 Other expenses or losses not related to primary business operations (e.g., foreign exchange loss).

 Finance costs are costs of borrowing from various creditors (e.g., interest expenses, bank
charges).

 Income tax expense is the sum of the amount of tax payable to tax authorities in the
current reporting period (current tax liabilities/ tax payable) and the amount of
deferred tax liabilities (or assets).

IV. Sample Trial Balance Sheet

Trial Balance

Cash 10000

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Accounts Receivable 28000

Inventory 55000

Prepaid Expenses 2000

Equipment 25000

Computers 15000

Accum. Depr Equip 8000

Accum. Depr Computers 6000

Goodwill 10000

Accounts Payable 25000

Expenses Payable 5000

Payroll Taxes Withheld 2500

Loans Payable - Short Term 10000

Loans Payable - Long Term 30000

Capital Stock 10000

Paid In Capital 5000

Retained Earnings 22000

145000 123500

Net Profit 21500

145000 145000

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Examples

A. balance sheet for XYZ Company

ASSETS
Current Assets
Cash $ 20,000
Accounts receivable $ 15,000
Inventory $ 150,000
Total Current Assets $ 185,000

Non-Current Assets
Plant and equipment $ 50,000
Business premises $ 650,000
Vehicles $ 70,000
Total Non-Current Assets $ 770,000

TOTAL ASSETS $ 955,000

Current Liabilities
Accounts payable $ 25,000
Bank overdraft $ 10,000
Credit card debt $ 5,000
Tax liability $ 30,000
Total Current Liabilities $ 70,000

Non-Current Liabilities
Long term business loan 1 $ 450,000
Long term business loan 2 $ 50,000
Total Non-Current Liabilities $ 500,000

TOTAL LIABILITIES $ 570,000

NET ASSETS $ 385,000

OWNERS EQUITY $ 385,000

B. balance sheet for MrA Company

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 C. balance sheet for Coca Cola Company

 This is a sample sheet taken from a Coca Cola annual report with all lines to the value of
$0 lines removed. It deviates from a format in which they are often presented, which is to
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have assets on the left side and liabilities & equity on the right hand side, and actually
looks quite similar to the format in which Cash Flow produces them.

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It is found that this balance sheet example above and decided to include it because it‘s always
helpful to see a real document when you‘re learning about the theory behind them. You‘ll notice
that, in both of the above columns, Total Stockholder Equity + Total Liabilities = Total Assets,
i.e. Coke‘s Balance Sheet balances!

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