Accounts

Finance & Accounts Training Fundamentals of Accounting
Infosys BPO Bangalore
Finance Center of Excellence
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Table of Contents Accounting ........................................................................................................................................4 Overview ................................................................................................................................................... 4 Classification of accounting ...................................................................................................................... 4 Key Accounting Concepts.......................................................................................................................... 5 Fundamental Accounting Assumptions .................................................................................................... 6 Qualitative characteristics of Financial Statements.................................................................................. 7 Purpose of financial statements ............................................................................................................... 8 Accounting Policies ................................................................................................................................... 8 Double-entry System ................................................................................................................................ 9 Books of Accounts ..................................................................................................................................... 9 Accounting Process ................................................................................................................................. 12 a) Identification of Transaction ........................................................................................................... 12 b) Preparation of documents .............................................................................................................. 12 c) Recording of Transaction ................................................................................................................ 12
Subsidiary Books .................................................................................................................................................... 13
d) Posting to Ledger ............................................................................................................................ 18 e) Preparation of Trial Balance ........................................................................................................... 18 f) Passing Adjusting Entries ................................................................................................................. 19 g) Preparation of Financial statements ............................................................................................... 20 Components of Financial Statements ..................................................................................................... 21 1. Income Statement:.......................................................................................................................... 21 2. Balance Sheet .................................................................................................................................. 22 3. Cash flow statement ...................................................................................................................... 23 4. Notes to the financial statements................................................................................................... 28 Assets ...................................................................................................................................................... 47 Current assets ..................................................................................................................................... 47
1. Cash and cash equivalents ................................................................................................................................... 48 2. Receivables ......................................................................................................................................................... 48 Sales return...................................................................................................................................................... 48 Uncollectible Account Receivables ................................................................................................................. 49 3. Short term Investments ....................................................................................................................................... 54 4. Prepaid Expenses ................................................................................................................................................ 54 5. Inventory ............................................................................................................................................................. 54
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Non Current Assets ............................................................................................................................. 58

1) Long term Investments ....................................................................................................................................... 58 2) Fixed assets ......................................................................................................................................................... 58 3) Intangible assets .................................................................................................................................................. 64
LIABILITIES ............................................................................................................................................... 64 1. Short-term or current liabilities ...................................................................................................... 64 2. Long-term liabilities ........................................................................................................................ 65 OWNERS' EQUITY .................................................................................................................................... 65 Rectification of Errors ............................................................................................................................. 65 Bank Reconciliation Statement ............................................................................................................... 66 Self Study Book ................................................................................................................................ 75 Inventory Valuation ................................................................................................................................ 75 Preparation of Final Accounts ................................................................................................................. 79 Subsidiary Book ..................................................................................................................................... 106 Rectification of Errors ........................................................................................................................... 121 Bank Reconciliation Statement ............................................................................................................. 133
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Accounting
Overview
Accounting is the language of the business. It is defined as the art of recording, classifying, and summarizing in terms of money, the transactions and events which are in part at least of a financial nature, and interpreting the result thereof. Accounting is important to any company because the financial information allows the entrepreneurs to take an informed business decision. The utility of accounting information is greatly increased when it is compiled in a systematic manner and financial statements are prepared at periodic intervals. For the purpose of compilation all monetary events are recognized as transactions and classified into various account heads. The account heads are then summarized under related and significant groups so that interpretation becomes possible. Ex: When a trader procures an item, this event is recognized as a transaction. This transaction will be recorded under the account head purchases. At the end of the specified period, all purchases and other costs associated with sales would be summarized into Costs of goods sold. On comparing the costs of goods sold with sales, the difference is interpreted as profit or loss for the period.
Classification of accounting
Accounting is generally classified into three different disciplines. Financial Accounting Cost Accounting Management Accounting a) Financial Accounting: Financial Accounting is the process of summarizing financial data taken from an organization's accounting records and publishing in the form of annual (or more frequent) reports for the benefit of people outside the organization. b) Management accounting: Management accounting is the analysis and presentation of financial and allied operational data which help management to carry out its planning, control and administration duties effectively. This involves the use of techniques such as costing, budgetary control, marginal costing, and the preparation of management and financial ratios. c) Cost accounting: Cost accounting is that part of management accounting which establishes budget and actual cost of operations, processes, departments or product and the analysis of variances, profitability or use of funds. Managers use cost accounting to support decision making to reduce a company's costs and improve its profitability. As a form of management accounting, cost accounting need not follow standards such as GAAP, because its primary use is for internal managers, rather than external users, and what to compute is instead decided pragmatically.
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Key Accounting Concepts

a) Entity: In accounting the separate entity concept treats a business as distinct and completely separate from the owners. Accounts are kept for entities and not the people who own or run the company. Even in proprietorships and partnerships, the accounts for the business must be kept separate from those of the owner(s). b) Money-Measurement: The money measurement concept underlines the fact that in accounting, every recorded event or transaction is measured in terms of money. Using this principle, a fact or a happening which cannot be expressed in terms of money is not recorded in the accounting books. There are four generally accepted measurement bases. These are: Historical cost is the amount paid or payable to acquire a benefit, e.g., A Ltd. has purchased machinery for $700,000 on 1st January 2000. So, the historical cost of the machinery will be $700,000. Current cost is the amount that needs to be paid if the asset is to be acquired currently. Assume in the above example that on 1st January 2003, A Ltd. found that it would cost $2,500,000 to purchase that machine. So, as per the current cost basis, the machine value will be $2,500,000 Realizable value is the net amount collectible in the event of assets disposal. Present value is the present discounted value of the future inflows that an item is expected to generate in the normal course of business. c) Cost: By this concept, the value of an asset is to be determined on the basis of acquisition cost. Although there are various measurement bases, accountants traditionally prefer this concept in the interests of objectivity. Other measurement bases are not so objective. Current cost of an asset is not easily determinable. If the asset is purchased on 1st January 2000 and such model is not available in the market, it becomes difficult to determine which model is the appropriate equivalent to the existing one. Similarly, unless the machinery is actually sold, realizable value will give only a hypothetical figure. Lastly, present value base is highly subjective because to know the value of the asset, one has to chase the uncertain future. d) Dual Aspect: This concept is the basis of the fundamental accounting equation: Assets = Liabilities + Equity Assets are what the company owns. Liabilities are what the company owes to creditors against those assets Equity is the difference between the two and represents what the company owes to its investors/owners. All accounting transactions must keep this equation balanced so when there is an increase on one side there must be an equal increase on the other side or an equal decrease on the same side e) Objectivity: The objectivity concept states that accounting will be recorded on the basis of objective evidence (invoices, receipts, bank statement, etc). This means that accounting
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records will initiate from a source document and that the information recorded is based on fact and not personal opinion. f) Time Period: This concept defines a specific interval of time for which an entitys reports are prepared. This can be a fiscal year (Mar 1 Feb 28), natural year (Jan 1 Dec 31), or any other meaningful period such as a quarter or a month.
g) Conservatism: Conservatism states that the accountant should not anticipate income and should provide for all possible losses. The reasons for accounting in this manner are so that financial statements do not overstate the companys financial position. Accounting chooses to be on the side of caution and protect investors from inflated or overly positive results. h) Realization: Revenues are recognized when they are (1) realized or realizable and (2) earned no matter when cash is received. Revenues are realized when goods and services are exchanged for cash or claims to cash (that is, receivables). Revenues are realizable when assets received in exchange are readily convertible to known amounts of cash or claims to cash. Revenues are earned when the entity has performed its duties to be entitled to compensation. i) Matching: To avoid overstatement of income in any one period, the matching principle requires that revenues and related expenses be recorded in the same accounting period. If you bill $20,000 of services in a month, in order to accurately represent the income for the month you must report the expenses you incurred while generating that income in the same month. Materiality: Accounting practice only records events that are significant enough to justify the usefulness of the information. Information is material if its omission or misstatement could influence the economic decision of users taken on the basis of the financial statements. Materiality depends on the size and nature of the item.
j)
Fundamental Accounting Assumptions

Certain fundamental accounting assumptions underlie the preparation and presentation of financial statements. They are usually not specifically stated because their acceptance and use are assumed. The following are the generally accepted as fundamental accounting assumptions: a) Going Concern: The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operation. This concept implies that financial statements do not represent a companys worth if its assets were to be liquidated, but rather that the assets will be used in future operations. This concept also allows businesses to spread (amortize) the cost of an asset over its expected useful life. b) Consistency: It is assumed that accounting policies are consistent from one period to another. Once an entity decides on one method of reporting (e.g., method of accounting for inventory) it must use that same method for all subsequent events. This ensures that differences in financial Finance Center of Excellence Page 6
position between reporting periods are a result of changed in the operations and not to changes in the way items are accounted for. c) Accrual: Revenues and costs are accrued, that is, recognized as they are earned or incurred (and not as money is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate. Financial statements prepared on the accrual basis inform users not only of the past events involving the payment and receipt of cash but also of obligations to pay cash in the future and of resources that represents cash to be received in the future. Example: On July 1, X Ltd enters into a 6-month network service contract totaling $2400 and receives an $800 advance payment. What is the entry to be passed to account for this transaction? What entry do you pass at the end of one month? Solution: To account for receipt of advance Dr. Cash $800 Cr. Unearned Revenue $800 Entry passed at the end of the month Dr. Unearned Revenue $400 Cr. Revenue $400 Note: At the end of July one month of revenue from that contract was earned. Each month X Ltd earns $400 from the contract; therefore $400 must be removed from the liability account of Unearned Revenue and transferred to earned Revenue account.
Qualitative characteristics of Financial Statements

Qualitative characteristics are the attributes that make the information provided in the financial statements useful to the users. a) Understandability: An essential quality of the information provided in financial statements is that it is readily understandable by users. For this purpose, users are assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence. However, information about complex matters that should be included in the financial statements because of its relevance to the economic decision-making needs of users should not be excluded merely on the grounds that it may be too difficult for certain users to understand. b) Relevance: To be useful, information must be relevant to the decision-making needs of users. Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations. c) Reliability: To be useful, information must also be reliable. Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to Finance Center of Excellence Page 7
represent faithfully that which it either purports to represent or could reasonably be expected to represent. d) Comparability: Users must be able to compare the financial statements of an entity through time in order to identify trends in its financial position and performance. Users must also be able to compare the financial statements of different entities in order to evaluate their relative financial position, performance and changes in financial position.
Purpose of financial statements

"The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions." Reported assets, liabilities and equity are directly related to an organization's financial position. Reported income and expenses are directly related to an organization's financial performance. Financial statements are intended to be understandable by readers who have "a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently." 1. Internal Users: Owners and managers require financial statements to make important business decisions that affect its continued operations. Financial analyses are then performed on these statements to provide management with a more detailed understanding of the figures. These statements are also used as part of management's annual report to the stockholders. Employees also need these reports in making collective bargaining agreements (CBA) with the management, in the case of labor unions or for individuals in discussing their compensation, promotion and rankings. 2. External Users: Prospective investors make use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and is prepared by professionals (financial analysts), thus providing them with the basis in making investment decisions. Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures. Government entities (tax authorities) need financial statements to ascertain the propriety and accuracy of taxes and other duties declared and paid by a company. Media and the general public are also interested in financial statements for a variety of reasons.
Accounting Policies
The accounting policies refer to the specific accounting principles and the methods of applying those principles adopted by the enterprise in the preparation and presentation of financial statements. There is no single list of accounting policies which are applicable to all circumstances. Enterprises operate in diverse and complex environment and so they have to adopt various policies. The choice of specific Finance Center of Excellence Page 8
accounting policy appropriate to the specific circumstances in which the enterprise is operating calls for a considerable judgment by the management of the enterprise. Examples of Areas in Which Differing Accounting Policies are encountered: a) Methods of depreciation, depletion and amortization b) Treatment of expenditure during construction c) Valuation of inventories d) Valuation of investments e) Valuation of fixed assets, etc. Considerations in the Selection of Accounting Policies Major considerations governing the selection and application of accounting policies are: a) Prudence: In view of the uncertainty attached to future events, profits are not anticipated but recognized only when realized though not necessarily in cash. Provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information. b) Substance over Form: The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form. c) Materiality: Financial statements should disclose all material items, i.e. items the knowledge of which might influence the decisions of the user of the financial statements.
Double-entry System
Every transaction has two aspects and double entry system is a system that recognizes and records both the aspects of the transactions, e.g., on purchase of furniture either the cash balance will be reduced or a liability to the supplier will arise.
Books of Accounts
Books of accounts are the books in which business transactions are recorded. There are two main books of accounts maintained under double entry system. They are Journal and Ledger Journal is the book of original entry as it records the transaction as and when it takes place. Journal can be a purchase Journal, Sales Journal, Purchase returns Journal or Sales returns Journal. Ledger is the book of final entry where in the entries are posted from journal. Cash book is a book of original entry (since all cash transactions are first recorded in cash book) and also a ledger account (since cash account acts itself as ledger account and no separate cash account is opened in ledger) What are different Kinds of accounts?
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1. PERSONAL ACCOUNT These are accounts of parties with whom the business is carried on. Personal accounts may be: Accounts of natural or physical persons. Ex: Rama Account, Krishna Account Accounts of artificial or legal persons. Ex: ABC & Co Representative personal account. Ex: Outstanding Expenses account (represents the accounts of parties whom expenses or due). Prepaid Expenses (represents accounts of parties to whom some expenses have been paid in advance). Outstanding income (represents accounts of parties from whom some incomes are due). Income received in advance (represents accounts of parties from whom income has been received in advance). 2. REAL ACCOUNT - Asset, liability, reserve, and capital accounts that appear on a balance sheet. The balances of real accounts are not cancelled out at the end of an accounting period but are carried over to the next period. Also called permanent accounts. Ex, cash. Land, building etc. 3. NOMINAL ACCOUNT - These are accounts of expenses and losses which a business incurs and income and gains which a business earn in the course of business. Ex: Rent account, Interest account. Golden Rules of Accounting
Personal account
Debit the Receiver Credit the Giver
Real Account
Debit what comes in Credit what goes out
Nominal Account
Debit all expenses and losses Credit all income and gains
Alternatively Assets Debit increase in asset account Credit decrease in asset account Expenses and Losses Debit increase in expense account Credit decrease in expense account Finance Center of Excellence Liabilities/ Capital Debit decrease in liability/ capital account Credit increase in liability/ capital account Income and Gains Debit decrease in income account Credit increase in income account Page 10
Assets: Asset is a resource owned/controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity. They are not meant for resale. Liability: Liability is an entity's present obligation arising from a past event, the settlement of which will result in an outflow of economic benefits from the entity. Income: Income includes both revenue and gains Income is increases in economic benefits during the period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants Expenses: Expenses include both expenses and losses. Expenses are decreases in economic benefits during the period in the form of outflows or depletions of assets or increases of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
Debits and Credits These are the backbone of any accounting system. Every accounting entry in the general ledger contains both a debit and a credit. Further, all debits must equal all credits. If they don't, the entry is out of balance. Out-of-balance entries throw balance sheet out of balance. Therefore, the accounting system must have a mechanism to ensure that all entries balance. Indeed, most automated accounting systems won't let you enter an out-of-balance entry-they'll just beep at you until you fix your error. Ending on what type of account you are dealing with, a debit or credit will either increase or decrease the account balance. Debits are denominated by abbreviation Dr. and Credit are denominated by abbreviation Cr.
Example: What entries do you pass to account for the following transactions? 1. X Ltd bought goods from A Ltd. for sum of $1,000 2. X Ltd sold part of the goods for $ 600 cash Finance Center of Excellence Page 11
3. X Ltd paid $ 200 cash for electricity expenses (Expense Voucher 001). 4. X Ltd received Rent $500 Solution: 1) Dr. Purchases Account Cr. A Ltd. Account Dr. Cash Account Cr. Sales Account Dr. Electricity Expenses Cr. Cash Dr. Cash Cr. Rent received $ 1,000 $ 1,000 $ 600 $600 $200 $ 200 $500 $500
2)
3)
4)
Accounting Process
a) b) c) d) e) f) g) Identification of Transaction Preparation of documents Recording of transactions in the books of account Posting to ledger Preparation of trial balance Passing of adjusting entries Preparation of Financial statements
a) Identification of Transaction This involves identifying the two accounts involved in a transaction and the category to which it belongs by applying the golden rules.
b) Preparation of documents This involves preparation of vouchers, attaching the relevant document etc to support a transaction. c) Recording of Transaction This process begins when a business transaction occurs and has been quantified. This involves: What to record: All the events and transactions which affect the business have to be recorded in accordance with principles of accountancy. Distinction is to be made between the transactions which are of personal nature and those of business. Finance Center of Excellence Page 12
When to record: Accounting is historical in nature because of which the recording is to be effected only after the occurrence of the subject transaction. Ex: Goods sold are recorded when the sale is complete and property in goods is transferred to buyer but not when goods are merely intended to be sold. How to record: Entries are first recorded in journal and are called journal entries. Value at which it is to be recorded: Value refers to the benefits derived from objects and different valuation bases are used in accounting, of which the frequently used are Historical cost, Current cost, Realizable value and Present Value as given above in the money measurement concept section. Subsidiary Books In business most of the transactions relate to receipts and payments of cash, sale of goods and their purchase. It is convenient to keep a separate register for each such class of transactions. These register is called as a book of original entry or of prime entry. There will be no journal entry for the transactions recorded in these books. These books of original or prime entry is also called subsidiary books since ledger accounts are prepared on their basis and without the further process of ledger posting, a trial balance cannot be taken out. Normally, the following subsidiary books are used in a business: (i) Cash Book to record receipts and payments of cash, including receipts into and payments out of the bank. Cash book is a principal as well as subsidiary book. Subsidiary book because it is the books of original or prime entry. Principal book because cash book is also treated as the cash account and bank account; the balances are entered in the trail balance directly. Purchases Book to record credit purchases of goods dealt in or of the materials and stores required in the factory. The total of the amount column of the purchase book shows the total purchase made in a period. This amount will be debited to the purchase account to indicate the receipt of goods. The creditors accounts will be credited with the respective amounts as shown in the purchase book. Purchase Returns Books to record the returns of goods and materials previously purchased. The total of the amount column of the purchase return book will be credited to the purchase return accounts. The suppliers whose names appear in the purchase return book have received the goods, so their accounts have to be debited. and the customers who have returned the goods are credited with the respective amount Sales Books to record the sales of the goods dealt in by the entity. The total of the amount column of the sales book shows the credit sales made during the period concerned; the amount is credited to the sales account. The debtors accounts will be debited with the respective amount as shown in the sales book. Page 13
(ii)
(iii)
(iv)
(v)
Sales Returns Books to record the returns made by the customers. The total of the amount column of the sales return book will be debited to the sales return accounts and the customers who have returned the goods are credited with the respective amount. Journal to record the transactions which cannot be recorded in any of the above five books.
(vi)
Illustration Enter the following transaction in the purchase Book and post them into ledger: April-07 4 Purchased from A Ltd.: 300 units @ $ 240 per unit. Trade discount is 10%. Freight charged: $150. 15 Purchased from B Ltd.: 200 units @ $170 per unit. Trade discount is 10%. Freight charged: $200. 28 Purchased from C Ltd.: 340 units @ $100 per unit. Trade discount is 10%. Freight charged: $100. Purchases are subject to sales tax @ 10%. Solution Date April-07 4 Particulars A Ltd. 300 units @ $ 240 per unit Less: Trade Discount@10% B Ltd. 200 units @ $ 170 per unit Less: Trade Discount@10% C Ltd. 340 units @ $ 100 per unit Less: Trade Discount@10% Purchases Book Gross Trade Net Amount Discount Price 72,000 7,200 64,800 Sales Tax 6,480 Freight 150 Total Amount 71,430
15
34,000
3,400
30,600
3,060
200
33,860
28
34,000
3,400
30,600
3,060
100
33,760
140,000
14,000
126,000 12,600
450
139,050
Date April-07 30th
Particulars To Amount as per
J.F.
Ledger Purchases A/c $ Date
Particulars
J.F.
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Purchase Book
139,050
Date
Particulars
J.F.
A Ltd. A/c Date Particulars April-07 4th By Purchases
J.F.
$ 71,430
Date
Particulars
J.F.
B Ltd. A/c Date Particulars April-07 15th By Purchases
J.F.
$ 33,860
Date
Particulars
J.F.
C Ltd. A/c Date Particulars April-07 28th By Purchases
J.F.
$ 33,760
Illustration Enter the following transaction in the Sales Day Book and post them into ledger: April-07 2 Sold to A Ltd.: 5 pieces of color T.V. @6,000 each less trade discount@ 10%. 8 Sold to A Ltd.: 2 pieces of color T.V. for cash @5,5000 each less trade discount@ 10% 10 Sold to B Ltd.: 10 pieces of washing machines @8,000 each less trade discount@ 5%. 15 Sold to C Ltd.: 5 pieces of black & white T.V. @3,500 each less trade discount@ 10%. 20 Sold old furniture to D Ltd. on credit $1000 All sales are subject to sales tax @ 10% and 10% surcharge on sales tax. Solution Sales Book Gross Trade Amount Discount 30,000 3,000
Date April-07 2
Particulars A Ltd. 5 pieces of color T.V. @6,000 each Less: Trade Discount@10% B Ltd. 10 pieces of washing machines @8,000 each Less: Trade Discount@5%
Net Price 27,000
Sales Tax 2,970
Total Amount 29,970
10
80,000
4,000
76,000
8,360
84,360
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15
C Ltd. 5 pieces of black & white T.V. @3,500 each Less: Trade Discount@10%
17,500
1,750
15,750
1,733
17,483
127,500
8,750
118,750
13,063
131,813
Date
Particulars
J.F.
Ledger Sales A/c Date April-07 30th
Particulars By Amount as per Sales Book
J.F.
118,75 0
Date
Particulars
J.F.
Sales tax Payable A/c $ Date Particulars April-07 30th By Amount as per Sales Book A Ltd. A/c $ Date 27,000 2,970 B Ltd. A/c $ Date 76,000 8,360 C Ltd. A/c Date
J.F.
$ 13,063
Date April-07 2nd 2nd
Particulars To Sales To Sales Tax Payable
J.F.
Particulars
J.F.
Date April-07 10th 10th
J.F.
Particulars
J.F.
Date April-07 15th 15th
J.F.
Particulars
J.F.
15,750 1,733
Illustration Finance Center of Excellence Page 16
Enter the following transactions in a Cash Book with Discount and Bank columns. Cheques are first treated as cash receipts. Jan. 2007 1 3 4 7 10 12 15 20 25 27 30 30 31 31 31 31 31 31 31 31 31 31 $ 20,000 19,000 600 600 330 475 450 1,000 275 50 375 200 250 300 400 25 125 300 1,575 500 450
David commences business with cash. He deposited into bank. He received cheque from Kirty & Co. on account He pays in bank Kirty & Co.s cheque He pays Rattan & Co. by cheque and is allowed discount $20 Tripathi & co. pays into his Bank account He receives cheque from Warshi and allows him discount $ 35 He receives cash$75 and cheque $100 for cash sale He pays into bank, including cheques received on 15th and 20th He pays by cheque for cash purchases He pays office expenses in cash He pays John & Co. in cash and is allowed discount $35 He pays office rent by cheque He draws a cheque for personal use He pays staff salaries by cheque He draws a cheque for office use He pays cash for stationery He purchases goods for cash He pays Jagpal by cash for commission He gives cheque to Ram for cash purchase of furniture for office He receives cheque for commission from Raghubir & co. and immediately pays the same into bank He receives cheque form Kesri & co.
Solution CASH BOOK Payme nts Disco unt $
Date
Receipts
L.F. Discount $
Cash $
Bank $
Date
L.F.
Cash $
Bank $
Jan. 2007 1 To capital 3 To Cash To Kirti & 4 Co. 7 To Cash 12 To Tripathi
Jan. 2007 20,000 3 By Bank 19,000 7 By Bank By Rattan & 600 10 Co. 600 25 By Bank 475 27 By
C C
20 -
19,000 600 1,000 Page 17
330 275
& Co. 15 20 25 31 31 31 To Warshi To Sales To Cash 35 450 175 400 450 1,000 500 30 30 31 31 31 31 31 31 31 31 31 35 Feb. To Balance 2007 b/d 22,075 21,575
To Bank C To Commission To Kesri & Co.
Purchases By Office Expenses By John & Co. By Rent By Drawings By Salaries By Cash C By Stationery By Purchases By Commission By Furniture By Balance c/d
35 55
50 375 25 125 300 600 22,075
200 250 300 400 1,575 18,245 21,575
600
18,245
d) Posting to Ledger Grouping of transactions (which are recorded in journal) of similar nature together in one place in the form of an account is called posting. e) Preparation of Trial Balance After posting the accounts in the ledger, a statement is prepared to show separately the debit and credit balances. Such statement is known as trail balance. The preparation of trial balance is based on the fundamental principle of double entry system that for every debit in one account there is a corresponding credit in some other account. Invariably the total of Debit column and Credit column should match. It ensures the accuracy of books of account.
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f) Passing Adjusting Entries All the day to day transactions are recorded in the books of accounts as and when they take place, such as cash transactions, incomes and expenses. But some transactions, which are not occurring every day and which require only accounting adjustment are not recorded throughout the year. Such unrecorded transactions are to be adjusted at the end of an accounting period while preparing financial statements. For example, depreciation, prepaid expenses, income received in advance, outstanding expenses. Adjusting entries are required to implement the accrual accounting model. More specifically, these entries are required to satisfy the realization principle and the matching principle. Adjusting entries help ensure that all revenues earned in a period are recognized in that period, regardless of when the cash is received. Also, they enable a company to recognize the all expenses incurred during a period, regardless of when cash payment is made. As a result a periods income statement provides a more complete measure of a companys operating performance and a better measure of predicting the future operating cash flows. The balance sheet also provides a more complete assessment of assets and liabilities as source of future cash receipts and disbursements. In summary, we can say that Adjusting entries are journal entries usually made at the end of an accounting period to allocate income and expenditure to the period in which they actually occurred. Most adjusting entries could be classified this way: Prepayments (Deferral - cash paid or received before consumption) Expenses Prepaid expenses: for expenses paid in cash and recorded as assets before they are used Revenues Unearned revenue: for revenues received in cash and recorded as liabilities before they are earned.
Accrual - cash paid or received after consumption Accrued expenses: for expenses incurred but not yet paid in cash or recorded Accrued revenues: for revenues earned but not yet recorded or received in cash
i) Prepayments: Adjusting entries for prepayments are necessary to account for cash that has been received prior to delivery of goods or completion of services. When this cash is paid, it is first recorded in a prepaid expense asset account; the account is to be expensed either with the passage of time (e.g. rent, insurance) or through use and consumption (e.g. supplies). A company receiving the cash for benefits yet to be delivered will have to record the amount in an unearned revenue liability account. Then, an adjusting entry to recognize the revenue is used as necessary. Example for Prepaid Expenses and unearned revenue A Ltd. has given a building on rent to B Ltd. Monthly rental is $10,000 per month. B Ltd. paid the rent for the month of January 2009 in advance in the month of December 2008. What will be the journal entry in the books of A Ltd. and B Ltd. in the month of December 2008 and January 2009? In the books of A Ltd. In the books of B Ltd. Accounting Treatment of Unearned Revenue Accounting Treatment of Prepaid Expenses December 2008 Bank Account Dr. Finance Center of Excellence December 2008 Prepaid Rent Account Dr. $10,000 Page 19
$10,000
To Unearned Rent Account
$10,000
To Bank Account
$10,000
January 2009 Unearned Rent Account Dr. $10,000 To Rent Income Account $10,000
January 2009 Rent Expenses Account Dr. $10,000 To Prepaid Rent Account $10,000
ii) Accruals: Accrued revenues are revenues that have been recognized (that is, services have been performed or goods have been delivered), but their cash payment have not yet been recorded or received. When the revenue is recognized, it is recorded as a receivable. Accrued expenses have not yet been paid for, so they are recorded in a payable account. Expenses for interest, taxes, rent, and salaries are commonly accrued for reporting purposes.
Example of Accrued Expenses and Accrued Revenue A Ltd. has given a building on rent to B Ltd. Monthly rental is $10,000 per month. B Ltd. paid the rent for the month of December 2008 in the month of January 2009. What will be the journal entry in the books of A Ltd. and B Ltd. in the month of December 2008 and January 2009? In the books of A Ltd. In the books of B Ltd. Accounting Treatment of Accrued Revenue Accounting Treatment of Accrued Expenses December 2008 Accrued Rent Income Account Dr. $10,000 To Rent Income Account $10,000 January 2009 Bank Account Dr. $10,000 To Accrued Rent Income Account $10,000 December 2008 Rent Expense Account Dr. $10,000 To Outstanding Rent Account $10,000 January 2009 Outstanding Rent Account Dr. $10,000 To Bank Account $10,000
iii) Estimates: A third classification of adjusting entry occurs where the exact amount of an expense cannot easily be determined. The depreciation of fixed assets, for example, is an expense which has to be estimated. The entry for bad debt expense can also be classified as an estimate.
g) Preparation of Financial statements The four important components of financial statements prepared by an entity are: 1. Income Statement 2. Balance Sheet 3. Statement of Cash Flows 4. Notes to the financial statements
Page 20
Components of Financial Statements

1. Income Statement: The purpose of Income statement to Report the revenues earned by the company's efforts during a given period, and Report the expenses incurred by the company during the same period Under the accrual basis of accounting revenues are recorded when they are earned, not when the company receives the money. Recording revenues when they are earned is the result of one of the basic accounting principles known as the revenue recognition principle. The recording of expenses with the related revenues is associated with another basic accounting principle known as the matching principle. The format of the income statement will vary according to the complexity of the business activities. However, most companies will have the following elements in their income statements: A. Revenues and Gains 1. Revenues from primary activities 2. Revenues or income from secondary activities 3. Gains (e.g., gain on the sale of long-term assets, gain on lawsuits) B. Expenses and Losses 1. Expenses involved in primary activities 2. Expenses from secondary activities 3. Losses (e.g., loss on the sale of long-term assets, loss on lawsuits) If the net amount of revenues and gains minus expenses and losses is positive, the bottom line of the income statement is labeled as net income. If the net amount (or bottom line) is negative, there is a net loss. The format of an Income statement is given below:
Sample Income Statement Amount in $
Sales Cost of Goods Sold
XXXXXX XXXXXX
Gross Profit Selling & Administrative Expenses
XXXXX XXXX
Earnings Before Interest & Taxes Interest
XXXXX XXXXX
Page 21
Taxable Income Taxes
XXXXX XXXXX
Net Income Dividends
XXXXX XXXXX
Transfer to Retained Earnings
XXXXX
* Cost of goods sold, COGS, includes the direct costs attributable to the production of the goods sold by a company. This amount includes the materials cost used in creating the goods along with the direct labor costs used to produce the good and other direct expenses e.g. power, factory rent, depreciation on factory machine, etc. It excludes indirect expenses such as distribution costs and sales force costs. **material used in the production= Beginning material+ material purchased during the period-Ending material. ***Selling and administrative expenses includes office rent, depreciation on office furniture and equipment, salary of office staff, advertisement charges, packing and delivery charges etc.
2. Balance Sheet It is the company's financial statement that reports the assets, liabilities and net worth at a specific time. Assets = liabilities + shareholders' equity. This equation is true for all balance sheets. If the balance sheet is "consolidated" it just means that the company is a corporate group rather than a single company. Balance sheets are typically presented in two different forms. (i) In the report form, asset accounts are listed first, with the liability and owners' equity accounts listed in sequential order directly below the assets. In the account form, the balance sheet is organized in a horizontal manner, with the asset accounts listed on the left side and the liabilities and owners' equity accounts listed on the right side.
(ii)
Contents of the Balance Sheet Most of the contents of a business's balance sheet are classified under one of three categories: Finance Center of Excellence Page 22
(i) (ii) (iii)
Assets, Liabilities, and Owner equity.
Format of a Balance sheet is given below: Balance Sheet of ABC Inc. as on 31st December 2007 Assets $ Liabilities/Equity Current Assets Current Liabilities Cash 123,000 Accounts Payable Marketable securities 200,000 Notes payable Accounts Receivable 345,000 Total Current Liabilities Inventories 100,000 Total Current Assets 768,000 Long term Liabilities Long term Note Long term Assets Total Liabilities Building (Gross) 350,000 - Accumulated depreciation 50,000 Owners Equity Net Building 300,000 Land 325,000 Total Long term Assets 625,000 Total 1,393,000 Total
$ 100,000 150,000 250,000
300,000 550,000 843,000
1,393,000
3. Cash flow statement A cash flow statement or statement of cash flows is a financial statement that shows a companys cash inflow and cash outflow. The money coming into the business is called cash inflow, and money going out from the business is called cash outflow. The cash flow statement is intended to 1. provide information on a firm's liquidity and solvency and its ability to change cash flows in future circumstances 2. provide additional information for evaluating changes in assets, liabilities and equity 3. improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods 4. indicate the amount, timing and probability of future cash flows The statement shows how changes in balance sheet and income accounts affect cash and cash equivalents and breaks the analysis down to operating, investing, and financing activities: Finance Center of Excellence Page 23
i.
Operating Activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities. For example, Cash receipts from the sale of goods and the rendering of services; Cash receipts from royalties, fees, commissions and other revenue; Cash payments to suppliers for goods and services; Cash payments to and on behalf of employees. An entity shall report cash flows from operating activities using either direct method or indirect method: a) Direct Method: The direct method is a reporting format whereby major classes of gross cash receipts and gross cash payments are disclosed. The operating cash flows section of the cash flow statement under the direct method would appear something like this: Cash receipts from customers Cash paid to suppliers Cash paid to employees Cash paid for other operating expenses Interest paid Income taxes paid Net cash from operating activities xxx xxx xxx xxx xxx xxx xxx
b) The indirect method is a reporting format whereby the net cash flow from operating activities is determined by adjusting profit or loss for the effects of: changes during the period in inventories and operating receivables and payables; non-cash items such as depreciation, provisions, deferred taxes, unrealised foreign currency gains and losses, undistributed profits of associates, and minority interests; and All other items for which the cash effects are investing or financing cash flows. The operating cash flows section of the cash flow statement under the indirect method would appear something like this: Profit before interest and income taxes xxx Add back depreciation Add back amortization of goodwill Increase in receivables Decrease in inventories Increase in trade payables Interest expense Less Interest accrued but not yet paid Interest paid Finance Center of Excellence xxx xxx xxx Page 24 xxx xxx xxx xxx xxx
Income taxes paid Net cash from operating activities
xxx xxx
ii. Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. iii. Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity, e.g., Cash proceeds from issuing shares or other equity instruments; Cash payments to owners to acquire or redeem the entitys shares; Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short or long-term borrowings; Cash repayments of amounts borrowed. Format of Cash Flow Statement Statement of Cash Flows of A Ltd. For Year Ended December 31, 2008 31st Dec. 2008 $ in $ in millions millions 31st Dec. 2007 $ in $ in millions millions
PARTICULARS Cash Flows from Operating Activities Cash inflows: From customers From investment revenue Cash outflows: To Supplier of goods To employees For interest For insurance For income taxes Net cash flows from operating activities (A) Cash Flows from Investing Activities Purchase of land Purchase of Machinery Purchase of short term investment Sale of land sale of equipment Finance Center of Excellence
98 3 -50 -11 -3 -4 -11 22
80 3 -30 -8 -2 -4 -8 31
-30 -12 18 5
-10 -20 Page 25
Amount received from maturity of investment Net cash flows from investing activities (B) Cash Flows from Financing Activities Issue of common shares Retirement of bonds payable Repayment of loan Payments of cash dividends Net cash flows from financing activities (C) Net increase in Cash (A+B+C) Cash balance, January 1 Cash balance, December 31
-19
15 -15
26 -15 -5 6 9 20 $29
10 -20 -2 -12 4 16 $20
Illustration Prepare the Cash Flow Statement for the entity A on the basis of following information: $000 20,000 42,190 20,000 15,000 10,000 2,000 400 250 250 1,200
Cash and cash equivalents as on 1 January 2008 Cash and cash equivalents as on 31st January 2008 Cash sales Cash received from rendering of services Cash payment to suppliers Payment made to employees Interest expenses (out of which 170 was paid during the period. 100 relating to interest expense of the prior period were also paid during the period). Amount raised from the issue of share capital Amount raised from long-term borrowings Dividend paid The company acquired machinery at the cost of $1,250 in the year 2008. Out of the cost $1,250, $900 is settled through an exchange of old machinery and $350 settled in cash. Tax paid Plant (original cost: $1,200 and accumulated depreciation: 200) sold at a profit of 500. Profit for the year Depreciation Interest received Amount invested in securities Finance Center of Excellence
st
900 22,100 300 500 590 Page 26
Solution: Direct Method Statement of Cash Flows of A (For the year ended Dec.31, 2008) $000 Cash Flows from operating Activities Cash sales Cash received from rendering of services Cash payment to suppliers Payment made to employees Income Tax paid Net Cash Flow from Operating Activities (A) Cash Flows from Investing Activities Amount invested in securities Purchase of Machinery in cash Sale of Plant Interest Received Net Cash Flow from Investing Activities (B) Cash Flows from Financing Activities Proceeds from issue of share capital Proceeds from long-term borrowings Interest paid Dividend paid Net Cash Flow from Financing Activities (C) Net Increase in Cash and Cash Equivalents (A+B+C) Cash and Cash Equivalents at the beginning of the period Cash and Cash Equivalents at the end of the period 20,000 15,000 (10,000) (2,000) (900) 22,100 $000
(590) (350) 1,500 500 1,060
250 250 (270) (1,200) (970) 22,190 20,000 42,190
Page 27
Indirect method Statement of Cash Flows of A (For the year ended Dec.31, 2008) $000 Cash Flows from operating Activities Net profit Adjustment for: Depreciation Interest Paid Interest received Dividend paid Income tax paid Profit on sale of assets Net Cash Flow from Operating Activities Cash Flows from Investing Activities Amount invested in securities Purchase of Machinery in cash Sale of Plant Interest Received Net Cash Flow from Investing Activities Cash Flows from Financing Activities Proceeds from issue of share capital Proceeds from long-term borrowings Interest paid Dividend paid Net Cash Flow from Financing Activities Net Increase in Cash and Cash Equivalents Cash and Cash Equivalents at the beginning of the period Cash and Cash Equivalents at the end of the period 22,100 300 400 (500) 1,200 (900) (500) 22,100 $000
(590) (350) 1,500 500 1,060
250 250 (270) (1,200) (970) 22,190 20,000 42,190
4. Notes to the financial statements Notes include information about the basis of preparation of the financial statements and the specific accounting policies used. Finance Center of Excellence Page 28
It provides additional information that is not presented on the face of the balance sheet, income statement and cash flow statement, but is relevant to an understanding of any of them. Example Record the below transactions in the Journal book, post it to ledger and then prepare the trial balance. Jan. 2008 $ 1 John commences business with cash. 100,000 3 Purchased goods on credit with Mike 20,000 4 Purchased machinery by cheque payment 6,000 10 Sold goods on credit to Bob 10,000 15 Received the cheque of $4900 from Bob and allowed him a discount of $100. John deposited the cheque into bank on the same day. 16 Paid the cheque of $ 9,800 to Mike. Mike has given a discount of $200. 17 Deposited cash into bank. 50,000 20 Paid wages in cash 500 20 Paid cash for stationery 50 20 Paid electricity charges by cheque. 800 25 Cash withdrawal from bank. 2,000 27 Purchases goods for cash 1,000 30 Paid office expenses in cash 100 31 Paid office rent by cheque 1,000 31 Paid staff salaries by cheque 1,500
Solution In the books of John Journal Particulars
Date Jan 08 1
L.F.
Dr. $ 100,000
Cr. $
10
15
Cash A/c To capital A/c (Amount invested in business as capital). Purchases A/c To Mike A/c (Goods purchased on credit form Mike). Machinery A/c To Bank A/c (Machinery purchased). Bob A/c To Sales A/c (Goods sold on credit to Bob). Banks A/c Discount Allowed A/c To Bob A/c
Dr.
100,000 Dr. 20,000 20,000 Dr. 6,000 6,000 Dr. 10,000 10,000 Dr. Dr. 4,900 100 5,000 Page 29
(Cheque received from Bob and allowed him discount of $100).
16
17
20
20
20
25
27
30
31
31
Mike A/c Dr. To Bank A/c To Discount Received A/c (Payment made to Mike. Received the discount of $200). Bank A/c Dr. To Cash A/c (Amount deposited into bank). Wages A/c Dr. To Cash A/c (Wages paid). Stationery A/c Dr. To Cash (Paid cash for stationery). Electricity charges A/c Dr. To Bank A/c ((Make the payment for electricity charges by cheque). Cash A/c Dr. To Bank A/c (Cash withdrawal from bank). Purchases A/c Dr. To Cash A/c (Goods purchased for cash). Office Expenses A/c Dr. To Cash (Paid office expenses in cash). Office Rent A/c Dr. To Bank A/c (Paid office rent by cheque). Salaries A/c Dr. To Bank A/c (Paid staff salaries by cheque).
10,000 9,800 200 50,000 50,000 500 500 50 50 800 800 2,000 2,000 1,000 1,000 100 100 1,000 1,000 1,500 1,500 207,950 207,950
Ledger Dr. Date Particulars Jan-08 J.F. $ Cash Account Date Particulars Jan-08 J.F. Cr. $ Page 30
1 To Capital 25 To Bank
100,000 2,000
17 20 20 27 30 31
By Bank By Wages By Stationery By Purchases By Office Expenses By Balance c/d
102,000
50,000 500 50 1,000 100 50,350 102,000
Date Particulars Jan-08 31 By Balance c/d
J.F.
Capital Account $ Date Particulars Jan-08 100,000 1 By Cash
J.F.
$ 100,000
Date Particulars Jan-08 15 To Bob 17 To Cash
J.F.
$ 4,900 50,000
Bank Account Date Particulars Jan-08 4 By Machinery 16 By Mike 20 By Electricity charges 25 By Cash 31 By Office Rent 31 By Salaries 31 By Balance c/d
J.F.
$ 6000 9,800 800 2,000 1,000 1,500 33,800 54,900
54,900
Date Particulars Jan-08 3 To Mike 27 To Cash
J.F.
Purchases Account $ Date Particulars Jan-08 20,000 31 By P&L 1,000 21,000
J.F.
$ 21,000 21,000
Date Particulars Jan-08 31 To P&L Finance Center of Excellence
J.F.
Sales Account $ Date Particulars Jan-08 10,000 10 By Bob
J.F.
$ 10,000 Page 31
Date Jan-08 16 16 31
Particulars To Bank To Discount Received To Balance c/d
Mike Account J.F. $ Date Particulars Jan-08 9,800 3 By Purchases 200 10,000 20,000
J.F.
$ 20,000
20,000
Date Particulars Jan-08 10 To Sales
J.F.
$ 10,000
Bob Account Date Particulars Jan-08 15 By Bank 15 By Discount Allowed 31 By Balance c/d
J.F.
$ 4,900 100 5,000 10,000
10,000
Date Particulars Jan-08 31 To P&L
Discount Received Account J.F. $ Date Particulars Jan-08 200 16 By Mike
J.F.
$ 200
Date Particulars Jan-08 15 To Bob
Discount Allowed Account J.F. $ Date Particulars Jan-08 100 31 By P&L
J.F.
$ 100
Date Particulars Jan-08 20 To Cash
J.F.
Wages Account $ Date Particulars Jan-08 500 31 By P&L
J.F.
$ 500
Stationery Account J.F. $ Date Particulars Jan-08 50 31 By P&L
J.F.
$ 50
Page 32
Date Particulars Jan-08 31 To Bank
J.F.
Salaries Account $ Date Particulars Jan-08 1,500 31 By P&L
J.F.
$ 1,500
Electricity Charges Account J.F. $ Date Particulars Jan-08 800 31 By P&L
J.F.
$ 800
J.F.
Office Rent Account $ Date Particulars Jan-08 1,000 31 By P&L
J.F.
$ 1,000
J.F.
Office Expenses Account $ Date Particulars Jan-08 100 31 By P&L
J.F.
$ 100
J.F.
Machinery Account $ Date Particulars Jan-08 6,000 31 By Balance c/d
J.F.
$ 6,000
Trial Balance for the year ended 31st Jan 2008 Dr. $ 50,350 33,800 Dr. $ Page 33
Accounts Cash Bank Finance Center of Excellence
Capital Purchases Sales Mike Bob Discount Allowed Discount Received Wages Stationery Salaries Electricity charges Office Expenses Office Rent Machinery
21,000 5,000 100 500 50 1,500 800 100 1,000 6,000 120,200
100,000 10,000 10,000 200 120,200
Example: Assets Current Assets Cash in hand Cash at Bank Inventory Receivables Narain Bros. $1,500 B.K. Bros. $2,500 Non Current Assets Machinery Furniture Balance Sheet of A Ltd. as on 1st January 2007 $000 Liabilities/Equity $000 Owners Equity 200 Capital 19,000 6,800 4,000 Current Liabilities 4,000 Payables 2,000 Jacob Bros. $2,000 Non-Current Liabilities Loan 10,000 1,000 26,000
5,000
26,000
Below are the transaction details for the month of January 2007 Date 2007 Particulars 1st Jan 2 Jan 3 Jan 4 Jan
th rd nd
Amount $000 100 1,000 5,000 1,000 Page 34
Old furniture sold for cash Bought goods on credit from Samuel & Co. Sold Goods for cash to Dhiraj & Co. Sold Goods to Narain Bros. on credit
5 Jan 6 Jan 10 Jan 11 Jan 13 Jan 16 Jan 17 Jan 18th Jan 19th Jan 21 Jan 24 Jan 25th Jan 26 Jan 28 Jan 31st Jan 31 Jan 31st Jan 31st Jan 31 Jan 31st Jan
st st th th th st th th th th th th
th
Received from Narain Bros. in full settlement of amount due on January 1, 2007. Payment made to Jacob Bros. Ltd. by cheque They allowed discount Bought goods for cash B.K. Bros. paid cheque; deposited in bank Paid for repairs to machinery Bought goods of Jacob Bros. Ltd Paid cartage on these goods Received cheque from Narain Bros. and deposited in bank Discount allowed to them Paid cheque o Jacob Bros. Ltd. Bank intimates that cheque of Narain Bros. has been returned unpaid Sold goods for cash to Kay Bros. Cash deposited in bank Paid Municipal Taxes in cash Amount borrowed form Urania Investment Co. Ltd. Money deposited with bank for the time being Old newspapers sold Paid for advertisements Paid rent by cheque (Rent include 100 for factory and 50 for office building) Paid salaries for the month Narain Bros, become insolvent, 50% of the dues has been received from him. An old amount, written off as bad debt in previous year, is recovered Paid Wages in cash Paid electricity in cash (500 for factory and 200 for office building)
1,450 975 25 750 2,500 100 1,000 50 950 50 1,000
3,000 500 100 10,000 20 100 150 300
150 500 700
From the above details of A Ltd.: a) Write up the Journal in proper form, b) Post the ledger c) Prepare the Trial Balance d) Prepare the Income Statement and Balance Sheet: i) Ending inventory $2,000,000 ii) Charge 10% depreciation on machinery and 5% on furniture. Solution: Finance Center of Excellence Page 35
A LTD. a) JOURNAL Date 2007 1-Jan Cash Account Bank Account Beginning Inventory Account 1-Jan Machinery Account Furniture Account Narain Bros B.K. Bros. Dr. Dr. Dr. Dr. Dr. Dr. Dr. Particulars L.F. Dr. Amount $000 200 6800 4000 10000 1000 1500 2500 5000 2000 19000 100 100 Dr. 1000 1000 Dr. To Sales Account (Goods sold for cash to Dhiraj & Co.) 4-Jan Narain Bros. To Sales Account (Goods sold to Narain Bros.) 5-Jan Cash Account Dr. Discount Allowed Account Dr. To Narain Bros. (The amount of $1450 received as a full payment for a debit of $1500; hence discount allowed is $50) Jacob Bros. Ltd. To Bank Account To Discount Received Account Finance Center of Excellence Dr. 1450 50 1500 Dr. 1000 1000 5,000 5,000 Cr. Amount $000
To Loan Account To Jacob Bros. Ltd. To Capital Account (The assets and liabilities brought forward from last year. ) 1-Jan Cash Account To Furniture Account (sale of old furniture) 2-Jan Purchase Account To Samuel & Co. (Goods purchased from Samuel & Co.) 3-Jan Cash Account Dr.
6-Jan
1000 975 25 Page 36
(The amount paid by cheque to Jacob Bros. Ltd. who allowed discount $25) 10-Jan Purchase Account To Cash Account (Goods purchased in cash) 11-Jan Bank Account To B.K. Bros. (Cheque received from B.K.Bros.) 12-Jan Repairs Account To Cash Account (amount paid for repairs to machinery) 13-Jan Purchases Account Dr. 1000 1000 50 50 950 50 1000 1000 1000 Dr. To Bank Account To Discount Allowed Account (Cheque received from Narain Bros. dishonoured. They are debited with full amount due; Bank credited with $950 because previous debit has to be cancelled; Discount amount credited because the discount allowed previously will be written back) 19-Jan Cash Account To Sales Account (goods sold for cash) 21-Jan Bank Account To Cash Account (Cash deposited into Bank) 24-Jan Municipal Taxes A/c Finance Center of Excellence Dr. 100 Page 37 Dr. 500 500 Dr. 3,000 3,000 1000 950 50 To Jacob Bros. Ltd (goods purchased from Jacob Bros. Ltd. on credit) Cartage Account Dr. To Cash Account (Amount paid for cartage on goods bought from Jacob Bros. Ltd.) Bank Account Dr. Discount Allowed Account Dr. To Narain Bros. (cheque received from Narain Bros.; discount allowed $50 Jacob Bros. Ltd. To Bank Account (Amount paid by cheque to Jacob Bros. Ltd.) 18-Jan Narain Bros. Dr. Dr. 100 100 Dr. 2500 2500 Dr. 750 750
13-Jan
16-Jan
17-Jan
To Cash Account (amount paid for municipal tax) 25-Jan Bank Account To Loan Account (amount borrowed from Urania Investments Co., Ltd) 26-Jan Cash Account To Miscellaneous Income Account (income derived by sale of old newspapers) 28-Jan Advertisement Account To Cash Account (payment of advertisement charges ) 31-Jan Rent Account To Bank Account (The amount paid as rent ) 31-Jan Salaries Account To Cash Account (salaries paid to the employees) 31-Jan Cash Account Bad Debts Account Dr. Dr. 500 500 Dr. 300 Dr. 150 Dr. 100 Dr. 20 Dr. 10000
100
10000
20
100
150
300
To Narain Bros. (Receipt of 50% of the sum due from Narain Bros. in cash and the other half written off as being irrecoverable) 31-Jan Cash Account Dr. 150 To Bad Debts Recovered A/c (the sum previously treated as lost, now recovered-it is a gain) 31-Jan Wages Account To Cash Account (Wages paid in cash). 31-Jan Electricity Account Dr. 700 To Cash Account (Paid 700 as electricity charges in cash out of 700, 500 belong to the factory and 200 belong to the office building). Total 58,320 Dr. 500
1000
150
500
700
58,320
b) LEDGER Finance Center of Excellence Page 38
Capital Account Dr. Date 2007 31st Jan To Balance c/d Particulars J.F. Amount $000 Date 2007 By Balance b/d By Balance b/d 1st Feb Particulars J.F. Cr. Amount $000 19,000 19,000
19,000 1st Jan
Cash Account Dr. Date 2007 1 Jan 1 Jan 3 Jan 5th Jan 19th Jan 26th Jan 31st Jan 31st Jan
rd st st
Cr. Particulars To Balance b/d To Furniture To Sales To Narain Bros. To Sales To Miscellaneous Income Account To Narain Bros. To Bad Debts Recovered J.F. Amount $000 Date 2007
th th th st
Particulars By Purchases By Repairs By Cartage By Bank By Municipal Taxes By Advertisement By Salaries By Wages By Electricity By Balance c/d
J.F.
Amount $000 750 100 50 500 100 100 300 500 700 7,320 10,420
200 10 Jan 100 12 Jan 5,000 13 Jan 1,450 21 Jan 3,000 24th Jan 20 28th Jan 500 31st Jan 150 31st Jan 31 Jan 31 Jan 10,420
st st
1 Feb
st
To Balance b/d
7,320 Bank Account
Dr. Date 2007 1st Jan 11th Jan 16th Jan 21st Jan 25th Jan 1st Feb
Particulars To Balance b/d To B.K. Bros. To Narain Bros. To Cash To Loan To Balance b/d
J.F.
Amount $000 6,800 2,500 950 500 10,000 20,750 17,675
Date 2007 6th Jan 17th Jan 18th Jan 31st Jan 31st Jan
Particulars By Jacob bros. By Jacob bros. By Narain Bros. By Rent By Balance c/d
J.F.
Cr. Amount $000 975 1,000 950 150 17,675 20,750
Page 39
Beginning Inventory Account Dr. Date 2007 1st Jan 1st Feb Particulars To Balance b/d To Balance b/d J.F. Amount Date $ 2007 4,000 31st Jan 4,000 Machinery Account Dr. Date 2007 1st Jan 1st Feb Particulars To Balance b/d To Balance b/d J.F. Amount Date $000 2007 10,000 31st Jan 10,000 Furniture Account Dr. Date 2007 1st Jan To Balance b/d Particulars J.F. Amount $000 Date 2007
st
Particulars By Balance c/d
J.F.
Cr. Amount $ 4,000
Particulars By Balance c/d
J.F.
Cr. Amount $000 10,000
Cr. Particulars By Cash By Balance c/d J.F. Amount $000 100 900 1,000
1,000 1 Jan 31st Jan 1,000
1st Feb
To Balance b/d
900 Narain Bros. Account
Dr. Date 2007 1st Jan 4th Jan 18th Jan 18th Jan To Balance b/d To Sales To Bank To Discount Allowed Particulars J.F. Amount $000 Date 2007 By Cash By Discount Allowed By Bank By Discount Allowed By Cash By Bad Debts Particulars J.F.
Cr. Amount $000 1,450 50 950 50 500 500 3,500
1,500 5th Jan 1,000 5th Jan 16th 950 Jan 16th 50 Jan 31st Jan 31st Jan 3,500
Page 40
B.K. Bros. Account Dr. Date 2007 1st Jan Particulars To Balance b/d J.F. Amount Date $000 2007 2,500 11th Jan Loan Account Dr. Date 2007 31st Jan Particulars To Balance c/d J.F. Amount Date $000 2007 15,000 1st Jan 25th Jan 15,000 1st Feb Particulars By Balance b/d By Bank By Balance b/d J.F. Cr. Amount $000 5,000 10,000 15,000 15,000 Particulars By Bank J.F. Cr. Amount $000 2,500
Jacob Bros. Account Dr. Date 2007 6th Jan 6th Jan 17th Jan 31st Jan Particulars To Bank To Discount received To Bank To Balance c/d J.F. Amount Date $000 2007 975 1st Jan 25 13th Jan 1,000 1,000 3,000 1st Feb Purchase Account Dr. Date 2007 2nd Jan 10th Jan 13th Jan Particulars To Samuel & Co. To Cash Jacob Bros. Ltd J.F. Amount $000 Date 2007 Particulars By Profit & Loss J.F. Cr. Amount $000 2,750 Particulars By Balance b/d Purchases J.F. Cr. Amount $000 2,000 1,000
By Balance b/d
3,000 1,000
1,000 31st Jan 750 1,000 2,750 Samuel & Co. Account
2,750
Dr. Finance Center of Excellence
Cr. Page 41
Date 2007 31st Jan
Particulars To Balance c/d
J.F.
Amount Date $000 2007 1,000 2nd Jan 1st Feb Sales Account
Particulars By Purchases By Balance b/d
J.F. Amount $000 1,000 1,000
Dr. Date 2007 31st Jan
Particulars To Profit & Loss
J.F.
Amount $000 9,000
Date 2007 3rd Jan 4th Jan 19th Jan
Particulars By Cash By Narain Bros. By Cash
J.F.
9,000 Discount Allowed Account Dr. Date 2007 5th Jan 16th Jan Particulars To Narain Bros. To Narain Bros. J.F. Amount Date $000 2007 50 18th Jan 50 31st Jan 100 Particulars By Narain Bros. By Profit & Loss J.F.
Cr. Amount $000 5,000 1,000 3,000 9,000
Cr. Amount $000 50 50 100
Discount Received Account Dr. Date 2007 31st Jan Particulars To Profit & Loss J.F. Amount $000 25 Date 2007 6th Jan Particulars By Jacob Bros. Cr. J.F. Amount $000 25
Repairs Account Dr. Date 2007 12th Jan Particulars To Cash J.F. Amount $000 100 Date 2007 31st Jan Particulars By Profit & Loss Cr. J.F. Amount $000 100
Cartage Account Dr. Date 2007 13th Jan Particulars To Cash J.F. Amount $000 50 Date 2007 31st Jan Particulars By Profit & Loss Cr. J.F. Amount $000 50
Municipal Taxes Account Dr. Finance Center of Excellence Cr. Page 42
Date 2007 24th Jan
Particulars To Cash
J.F.
Amount $000 100
Date 2007 31st Jan
Particulars By Profit & Loss
J.F.
Amount $000 100
Miscellaneous Income Account Dr. Date 2007 31st Jan Particulars To Profit & Loss J.F. Amount $000 Date 2007 Particulars By Cash Cr. J.F. Amount $000 20
20 26th Jan
Advertisement Account Dr. Date 2007 28th Jan Particulars To Cash Account J.F. Amount $000 Date 2007 Particulars By Profit & Loss Cr. J.F. Amount $000 100
100 31st Jan Rent Account
Particulars To Cash
J.F.
Amount Date $000 2007 150 31st Jan Salaries Account
Cr. J.F. Amount $000 150
Particulars To Bank
L.F. Amount Date $000 2007 300 31st Jan Bad Debt Account
Cr. L.F. Amount $000 300
Particulars To Narain Bros.
J.F.
Amount $000
Date 2007
500 31st Jan
Bad Debt Recovered Account Dr. Date 2007 Particulars J.F. Amount $000 Date 2007 Particulars Cr. J.F. Amount $000 Page 43
31st Jan
To Profit & Loss
150 31st Jan Wages Account
By Cash
150
Particulars To Cash
J.F.
Amount $000
Date 2007
500 31st Jan
Electricity Account Dr. Date 2007 31st Jan Particulars J.F. Amount $000 Date 2007 31st 700 Jan Particulars J.F. Cr. Amount $000 700
To Cash
By Profit & Loss
Machinery Depreciation Account Dr. Date 2007 Particulars To Accumulated depreciation on Machinery J.F. Amount $000 Date 2007 Particulars J.F. Cr. Amount $000
31st Jan
1,000 31st Jan
By Profit & Loss
1,000
Furniture Depreciation Account Dr. Date 2007 Particulars To Accumulated depreciation on Machinery J.F. Amount $000 Date 2007 Particulars J.F. Cr. Amount $000
31st Jan
45 31st Jan
By Profit & Loss
45
Accumulated Depreciation on Machinery Account Dr. Date 2007 31st Jan Particulars J.F. Amount $000 Date 2007 Particulars By Machinery Depreciation By Balance b/d J.F. Cr. Amount $000 1,000
To Balance c/d
1,000 31st Jan 1 Feb

st
Accumulated Depreciation on Furniture Account Dr. Finance Center of Excellence Cr. Page 44
Date 2007 31st Jan
Particulars To Balance c/d
J.F.
Amount $000
Date 2007 1 Feb

st
Particulars By Cash By Balance b/d
J.F.
Amount $000 45 45
45 31st Jan
c) Trial Balance As on 31st January 2007 S. NO. 1 CapitalAccount 2 Cash Account 3 Bank Account 4 Machinery Account 5 Furniture Account 6 Purchases Account 7 Sales Account 8 Loan Account 9 Jacob Brothers 10 Samuel & Co. 11 Discount Allowed Account 12 Discount Received Account 13 Repairs Account 14 Cartage Account 15 Municipal Taxes Account 16 Miscellaneous Income Account 17 Advertisements A/c Rent Account (100 for factory and 50 for office 18 building) 19 Beginning Inventory 20 Salaries 21 Bad Debts Account 22 Bad Debts Recovered Account 23 Wages (Direct Labor) Finance Center of Excellence Particulars Dr. $000 7,320 17,675 10,000 900 2,750 50 100 50 100 100 150 4,000 300 500 500 Cr. $000 19,000 9,000 15,000 1,000 1,000 25 20 150 Page 45
24 Electricity 25 Machinery Depreciation 26 Furniture Depreciation 27 Accumulated depreciation on Machinery 28 Accumulated depreciation on Furniture
700 1,000 45 46,240
1,000 45 46,240
d) Income Statement for the month of January 2007 Particulars $000 $000 Sales 9,000 Less: Cost of Goods Sold 6,900 Gross Income 2,100 Less: Administrative & Selling (Expenses)/Income Discount Allowed Discount Received Repairs Municipal Taxes Miscellaneous Income Advertisements Rent Salaries Bad Debt Bad debt Recovered Electricity Furniture Depreciation Net Income Note: 1) COGS $000 Material Consumed Beginning Inventory +Purchases -Ending Inventory Direct Labor Direct Cost Cartage Factory Rent Factory Electricity Finance Center of Excellence 4,000 2,750 (2,000) $000 50 -25 100 100 -20 100 50 300 500 -150 200 45
1,250 850
4,750 500
50 100 500 Page 46
Machinery Depreciation
1,000
1,650 6,900
Assets Current Assets Cash in hand Cash at bank Inventory Receivables Non-Current Assets Machinery 10,000 Less: Accumulated Depreciation 1,000 Furniture Less: Accumulated depreciation 900 45
Balance Sheet as on 31st January 2007 $000 Liabilities/Equity Owners Equity 7,320 Common Stock 17,675 Retained earnings 2,000 Current Liabilities Payables Jacob Bros. 1,000 Samuel & Co. 1,000
$000 19,000 850
2,000
9,000 Non-Current Liabilities Loan 855 36,850 36,850 15,000
Assets
Asset is a resource owned/controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity. They are not meant for resale. Assets are further categorized into the following classifications: current assets & non-current or fixed assets. Current assets Current assets are cash and other assets expected to be converted to cash, sold, or consumed either in a year or in the operating cycle, whichever is higher. These assets are continually turned over in the course of a business during normal business activity. There are 5 major items included into current assets: 1. Cash and cash equivalents 2. Receivables 3. Short-term investments 4. Prepaid expenses Finance Center of Excellence Page 47
5. Inventory
1. Cash and cash equivalents Cash includes money an entity holds and money deposited with financial institutions that can be withdrawn without notice. Cash equivalents consists of short term, highly liquid investments that are readily convertible to known amounts of cash and are so near to their maturity when they were acquired by the entity (90 days or less from date of purchase) that they present negligible risk of changes in value due to changes in interest rates. Examples include treasury bills, commercial paper, Certificates of Deposits (CDs) and money market fund. 2. Receivables It is the money owed by customers (individuals or corporations) to another entity in exchange for goods or services that have been delivered or used, but not yet paid for. It will be usually reported as net of allowance for uncollectable accounts.
Sales return
Customers frequently are given the right to return the merchandise they purchase if they are not satisfied. When merchandise is returned for a refund or for credit to be applied to other purchases, the situation is called a sales return. Returns are common and often substantial in some industries such as food products, publishing and retailing. In these cases, recognizing returns only as they occur could cause profit to be overstated in the period of the sale and understated in the return period. For example, assume merchandise is sold to a customer for $10,000 in December 2007, the last month in the selling companys fiscal year, and that the merchandise cost $6,000.if all of the merchandise is returned in 2008 after financial statements of 2007 are issued, gross profit will be overstated in 2007 and understated in 2008 by $4,000. Assets at the end of 2006 also will be overstated by $4,000 because a $10,000 receivable would be recorded instead of $6,000 in inventory. To avoid misstating the financial statements, when amount are material, returns should be anticipated by subtracting an allowance for estimated returns or allowance for sales return. Allowance for sales return is contra account to account receivables. When returns actually occur in the following reporting period, the allowance for sales return will be debited and accounts receivable will be credited. Example: During 2006, its first year of operations, the ABC Ltd., a manufacturing company, sold merchandise on account for $2,000,000. This merchandise cost $1,200,000 (60% of the selling price). Industry experience indicates that 10% of all sales will be returned. Customers returned $130,000 in sales during 2006, prior to making payment. The entries to record sales and merchandise returned during the year are as follows: Finance Center of Excellence Page 48
Sales Dr. Accounts Receivable Cr. Sales Revenue Dr. Cost of Goods Sold (60%*$2,000,000) Cr. Inventory Returns Dr. Sales return (actual returns) Cr. Accounts Receivable Dr. Inventory Cr. Cost of Goods sold (60%*$130,000)
$2,000,000 $2,000,000 $1,200,000 $1,200,000
$130,000 $130,000 $78,000 $78,000
At the end of 2006, the company would anticipate the remaining estimated returns using the following adjusting entries: Adjusting Entries: Dr. Sales Returns [(10% of 2,000,000)-$130,000] $70,000 Cr. Allowance for Sales Returns $70,000 Dr. Inventory-estimated returns Cr. Cost of Goods sold (60% *$70,000) $42,000 $42,000
Now assume that the estimates of future returns are correct, the following journal entry would be recorded in 2007: Dr. Allowance for sales returns $70,000 Cr. Account Receivables $70,000
Uncollectible Account Receivables
Companies that extend credit to customers know that its unlikely that all the customers will fully pay their accounts. Bad debt expense is an inherent cost of granting credit. Its an operating expense incurred to boost sales. As a result, even when specific customers accounts havent been proven uncollectible by the end of the reporting period, the expense properly should be matched with sales revenue in the income statement for that period. Likewise, as its not expected that all account receivable will be collected, the balance sheet should report only the expected net realizable value of the asset, i.e., the amount of cash the company expects to actually collect form the customers. An estimate is therefore needed to record bad debt expense and the related reduction of account receivable. In an adjusting entry, we record bad debt expense and reduce accounts receivable indirectly by crediting a contra account (allowance for uncollectible receivables or provision for bad and doubtful debts) to account receivable for an estimate of the amount that eventually will prove uncollectible. Finance Center of Excellence Page 49
There are two ways commonly used to arrive at this estimate of the future bad debts: the income statement approach and the balance sheet approach. a) Income statement approach: In this approach, we estimate bad debt expense as a percentage of each periods net credit sales. This percentage is usually determined by reviewing the companys recent history of the relationship between credit sales and actual bad debts. For a relatively new company, this percentage may be obtained by referring to other sources such as industry averages. Examples: The ABC manufacturing company sells its products offering 30 days credit to its customers. During 2006, its first year of operations, the following events occurred: Sale son credit $1,200,000 Cash collections from credit customers $(895,000) Accounts Receivable, end of year $305,000
There were no specific accounts determined to be uncollectible in 2006. The company anticipates that 2% of all credit sales will ultimately become uncollectible.
The company would make the following adjusting entry at the end of 2006: Dr. Bad debt expense (2% *$1,200,000) $24,000 Cr. Allowance for uncollectible Receivables $24,000 Allowance for uncollectible receivables is contra account to account receivables. In the current asset section of 2006 balance sheet, account receivable would be reported net of the allowance, as follows: Account receivable $305,000 Less: Allowance for Uncollectible Receivable $(24,000) Net Account Receivable $281,000 b) Balance sheet approach: Using the balance sheet approach to estimate future bad debts, we determine bad debt expense by estimating the net realizable value of account receivables to be reported in the balance sheet. In other words, the allowance for uncollectible receivable is determined. This could be done by analyzing each customers account, by applying a percentage to the entire outstanding receivable balance, or by applying the different percentage to the accounts receivable balances depending on the length of time outstanding. Bad debt expense is an indirect outcome of adjusting the allowance account to the desired balance. Example: The ageing schedule of Account Receivables for the ABC Manufacturing company is given below: Customer Accounts Receivable 0-60 days 61-90 days 91-120 days Over 120 days st 31 December 2006 A Ltd. $120,000 $114,000 $6,000 B Ltd. $50,000 $50,000 C Ltd. $60,000 $44,000 $16,000 Finance Center of Excellence Page 50
D Ltd.
$75,000 $305,000
$56,000 $220,000
$50,000
$9,000 $25,000
$10,000 $10,000
Age Group 0-60 days 61-90 days 91-120 days
Amount $220,000 $50,000 $25,000
Estimated Percent Uncollectible 5% 10% 20% 45%
Estimated Allowance $11,000 $5,000 $5,000 $4,500 $25,500
Over 120 days $10,000
The schedule classifies the year-end receivable balances according to their length of time outstanding. Presumable, the longer an account has been outstanding the more likely it will prove uncollectible. Based on past experience or other sources of information, a percentage is applied to age group totals. The company would make the following adjusting entry at the end of 2006: Dr. Bad debt expense $25,500 Cr. Allowance for uncollectible Receivables $25,500 The 2006 entry to record bad debts adjusts the balance in the allowance for uncollectible receivables to this required amount of $25,500. Because it is the first year of operations for ABC manufacturing company and the beginning balance in the allowance account is zero, the adjusting entry would be booked for the $25,500. To illustrate the concept further lets assume that this was not the first year of operation and the allowance account prior to the adjusting entry had a credit balance of $4,000. Then the amount of entry would be $21,500- the amount necessary to adjust the credit balance of $4,000 to the credit balance of $25,500. Similarly, if the allowance account prior to the adjusting entry had a debit balance of $4,000, then the amount of the entry would be $29,500. In the current asset section of 2006 balance sheet, account receivable would be reported net of the allowance, as follows: Account receivable $305,000 Less: Allowance for Uncollectible Receivable $(25,500) Net Account Receivable $279,500 Some companies use a combination of approaches in estimating bad debts. For example, ABC manufacturing company could decide to accrue bad debts on a monthly basis using the income statement approach and then employ the balance sheet approach at the end of the year based on an ageing of receivables. Each month an adjusting entry would record a debit to bad debt expense a nd a Finance Center of Excellence Page 51
credit to allowance for uncollectible accounts equal to 2% of credit sales. In our Illustration, the month accruals for 2006 would result in the following balances at the end of 2006: Accounts Receivable Bad Debt Expenses Allowance for uncollectible receivables $305,000 Dr $24,000 Dr. $24,000 Cr.
At the end of the year, if the ageing revealed a required allowance of $25,500; the following adjusting entry would be recorded: Dr. Bad Debt Expense $1,500 Cr. Allowance for uncollectible Receivables $1,500 When accounts are deemed uncollectible: The actual write-off of a receivable occurs when it is determined that all or a portion of the amount due will not be collected. The write off will be recorded by debiting the Allowance for uncollectible receivables account and crediting account receivables account. Example: In our illustration, assume that actual bad debts in 2007 were $25,000. These write-offs would be recorded as follows: Dr. Allowance for Uncollectible Receivables Account $25,000 Cr. Account receivables account $25,000 The net realizable value of the account receivable after write-off will be: Account receivable $280,000 Less: Allowance for Uncollectible Receivable $(25,500) Net Account Receivable $279,500 When previously written off accounts are collected: Occasionally, a receivable that has been written off will be collected in part or in full. For example, assume that in our illustration, $1,200 that was previously written off is collected. The following journal entries record the event: Dr. Cash Account $1,200 Cr. Bad Debt Recovered Account $1,200 Comprehensive Example for Allowance for Uncollectible Receivables A Ltd. sells its products, offering a 30 days credit to its customers. Uncollectible amounts are estimated by accruing a monthly charge to bad debt expense equal to 2% of credit sales. At the end of the year, the allowance for uncollectible receivables account is adjusted based on the ageing of account receivables. The company began 2007 with the following balances in its accounts: Accounts Receivable $305,000 Allowance for Uncollectible Receivables account $(25,500) During 2007, sales on credit were $1,300,000, cash collections from customers were $1,250,000, and actual write-offs of accounts were $25,000. An ageing of account receivables at the end of 2007 indicates a required allowance of $30,000. Finance Center of Excellence Page 52
Required: a) Determine the balances in accounts receivable and allowance for uncollectible returns accounts at the end of 2007. b) Determine the bad debt expense for 2007. c) Prepare the journal entries for the monthly accrual of bad debts, the write-offs of receivables, and the year-end adjusting entry for bad debts. Solution a) Balances in Accounts receivable and allowance for Uncollectible Receivables Account Accounts Receivables $ Beginning balances 305,000 Add: Credit sales 1,300,000 Less: cash Collections (1,250,000) Less: Write-offs (25000) Ending balances 330,000 Allowance for Uncollectible Receivables Beginning Balances Add: bad debt expense recorded monthly (2% of $1,300,000) Less: Write-offs Balance before year-end adjustment Year-end adjustment Ending balance $ 25,500 26,000 (25,000) 26,500 3,500* 30,000
* Required allowance of $30,000 less $26,500 already in allowance account.
b) Bad debt expense for 2007 Bad debt expense would be $29,500 (monthly accrual of $26,000 plus year-end adjustment of an additional $3,500). c) Journal Entry Dr. Bad debt Expenses (2% *$1,300,000) $26,000 Cr. Allowance for Uncollectible Receivables $26,000 (Monthly accrual of 2% of credit sales) Dr. Allowance for Uncollectible Receivables $25,000 Cr. Accounts Receivable $25,000 (Write off of accounts receivable as they are determined uncollectible). Dr. Bad debt Expenses $3,500 Cr. Allowance for Uncollectible Receivables $3,500 (Year-end adjusting entry for bad debts)
Page 53
3. Short term Investments It includes securities bought and held for sale in the near future to generate income on short-term price differences (trading securities). 4. Prepaid Expenses They are assets that arise as a result of business making payments for goods and services to be received in the near future. While prepaid expenses are initially recorded as assets, their value is expensed over time as the benefit is received onto the income statement. Ex: A Company had a one-year insurance policy cost of $12000. As each month elapses, $1000 of prepaid insurance would be expensed to the income statement until the account is closed. Prepaid expenses can be current or non-current depending on the length of period for which the expenses has been made in advance. 5. Inventory Inventory represents one of the most important assets that most businesses possess, because the turnover of inventory represents one of the primary sources of revenue generation and subsequent earnings for the companies' shareholders/owners. It includes raw materials, work-in-process goods and completely finished goods that are considered to be the portion of a business's assets that are ready or will be ready for selling. Inventory Valuation: Usually inventory is valued at the lower of a historical cost and net realizable value. Historical cost means cost of purchase, cost of conversion and other costs incurred in a normal course of business in bringing the inventories up to their present location and condition. Net realizable value is estimated selling price in the ordinary course of business less costs incurred in order to make the sale. There is no unique formula for determination of historical cost of inventories. In case of large quantity of inventories, cost can be determined using FIFO, LIFO or weighted average method: (i) FIFO: The FIFO method of inventory assumes that the first goods purchased are the first goods sold or used, regardless of the actual physical flow. The cost of goods sold is based upon the cost of material bought earliest in the period, while the cost of inventory is based upon the cost of material bought later in the year. This results in inventory being valued close to current replacement cost. LIFO: The LIFO method of inventory assumes that the last goods purchased are the first goods used or sold. The cost of goods sold is based upon the cost of material bought towards the end of the period, resulting in costs that closely approximate current costs. The inventory, however, is valued on the basis of the cost of materials bought earlier in the year. Average price: Page 54
(ii)
(iii)
a) Weighted Average: - Under this method the cost of goods available for sale (opening inventory + net purchases) is divided by the no. of units available for sale to obtain weighted average cost per unit. Ending inventory and the cost of goods sold are then priced at this average cost. b) Moving Average: - The Moving average is determined each time there is a purchase by dividing the total cost of inventory available (inventory plus current purchase) by total units available at that time. Thus the moving average is more current than weighted average. This method does require a perpetual inventory system. (iv) Specific Identification Method: This method attributes specific costs to identified goods that have been purchased or manufactured and are segregated for a specific purpose. The historical cost of such specific purpose inventories may be determined on the basis of their specific purchase price or production cost. The specific identification method might be used in the purchase and sale of high-priced articles, such as automobiles, heavy equipment, and works of art.
Example: Determine the cost of inventory using FIFO, LIFO and Average price method on the basis of following details: Receipt Quantity (Units) 900 400 300 200 800 2,600 Issue Quantity (Units) 05-12-2007 600 12-12-2007 400 29-12-2007 600 Date
Date 04-12-2007 10-12-2007 11-12-2007 19-12-2007 28-12-2007 Total Solution: a) FIFO Date Dec. Receipts 07 Qty. Rate (Units) $ 4 900 5.0 5 10 400 5.5
Price per Unit $ 5.00 5.50 5.50 6.00 4.75
1,600
Amount $ 4,500 2,200
Issues Qty. (Units) 600 -
Rate $ 5.0 -
Amount $ 3,000 -
Balance Qty. (Units) 900 300 300
Rate $ 5.0 5.0 5.0
Amount $ 4,500 1,500 1,500 Page 55
300 11 12 200 19 800 28 29 Total 2600
5.5
1,650
6.0
1,200
300 100 -
5.0 5.5 -
1,500 550 -
4.75
3,800
13,350
300 300 1,600
5.5 5.5
1,650 1,650 8350
400 300 400 300 300 300 300 300 200 300 300 200 800 200 800 1,000
5.5 5.0 5.5 5.5 5.5 5.5 5.5 5.5 6.0 5.5 5.5 6.0 4.75 6.0 4.75
2,200 1,500 2,200 1,650 1,650 1,650 1,650 1,650 1,200 1,650 1,650 1,200 3,800 1,200 3,800 5,000
COGS= 1600 units=$8,350 Ending Inventory=1000 units=$5,000 b) LIFO Date Dec. Receipts 07 Qty. Rate (Units) $ 4 900 5.0 5 10 400 5.5 300 11 12 200 19 800 28 29 600 4.75 2,850 4.75 3,800 6.0 1,200 300 100 5.5 5.5 1,650 550 5.5
Amount $ 4,500 2,200 1,650
Issues Qty. (Units) 600 -
Rate $ 5.0 -
Amount $ 3,000 -
Balance Qty. (Units) 900 300 300 400 300 400 300 300 300 300 300 200 300 300 200 800 300 300 200 200
Rate $ 5.0 5.0 5.0 5.5 5.0 5.5 5.5 5.0 5.5 5.0 5.5 6.0 5.0 5.5 6.0 4.75 5.0 5.5 6.0 4.75
Amount $ 4,500 1,500 1,500 2,200 1,500 2,200 1,650 1,500 1,650 1,500 1,650 1,200 1,500 1,650 1,200 3,800 1,500 1,650 1,200 950 Page 56
2600 13,350 Total COGS= 1600 units=$8,050 Ending Inventory=1000 units=$5,300 c) Average Price
1600
8,050
1000
5,300
i) Weighted Average Computation of Weighted average price: Quantity (Units) Price per Unit($) Price Paid ($) 900 5.00 4500 400 5.50 2200 300 5.50 1650 200 6.00 1200 800 4.75 3800 2600 13,350 Weighted Average Price= $13,350/2,600 Units= $5.135 per Unit COGS= 1,600 units= 1,600*5.135=$8,216 Ending Inventory=1,000 units=$5,135 ii) Moving Average Date Receipts Dec. Qty. Rate 07 (Units) $ 4 5 10 11 12 19 28 29 Total 900 400 300 200 800 2600 5.00 5.50 5.50 6.00 4.75 -
Amou nt $ 4,500 2,200 1,650 1,200 3,800 13,350
Issues Qty. (Units) 600 400 600 1600
Rate $ 5.00 5.35 5.13
Amou nt $ 3,000 2,140 3,078 8,218
Balance Qty. (Units) 900 300 700 1000 600 800 1600 1000 1000
Rate $ 5.00 5.00 5.29(i) 5.35(ii) 5.35 5.51(iii) 5.13(iv) 5.13
Amou nt $ 4,500 1,500 3,703 5,350 3,210 4,408 8,208 5,130 5,130
COGS= 1600 units= $8,218 Ending Inventory=1000 units=$5,130 Note: (i) $(1,500+2,200)/(300+400)Units= $5.29 per Unit (ii) $(3,703+1,650)/(700+300)Units= $5.35 per Unit (iii) $(3,210+1,200)/(600+200)Units= $5.51 per Unit (iv) $(4,408+3,800)/(800+800)Units= $5.13 per Unit Finance Center of Excellence Page 57
Non Current Assets 1) Long term Investments Long-term investments are to be held for many years and are not intended to be disposed in the near future. This group usually consists of four types of investments: 1. Investments in securities, such as bonds, common stock, or long-term notes. 2. Investments in fixed assets not used in operations (e.g., land held for sale). 3. Investments in special funds (e.g., sinking funds or pension funds). 4. Investments in subsidiaries or affiliated companies. 2) Fixed assets Fixed Assets are tangible property used in productive capacity that will benefit the reporting entity for a period longer than one year. Fixed assets normally include items such as land and buildings, motor vehicles, furniture, office equipment, computers, fixtures and fittings, and plant and machinery. What are the Characteristics of Fixed Assets? a. Fixed assets are acquired for use in operations and not for resale. b. They are long term in nature and subject to depreciation. c. They are tangible in nature.
Cost of Fixed Assets: Cost of a fixed asset is its purchase price, including import duties and other deductible trade discounts and rebates. In addition, cost attributable to bringing and installing the asset in its needed location and the initial estimate of dismantling and removing the item if they are eventually no longer needed on the location, will also be added to the fixed assets cost. Following costs must be capitalized with the value of fixed assets when an asset is built in-house: All direct costs Labor, material, payroll, and related construction cost Allocable overhead costs (Variable overheads) Repairs and maintenance expenses, which add value to the fixed assets. interest on the borrowings that are necessary for the project is capitalized Do not include profit. Example: K Ltd. completed constructed a building at cost of $1,000, 000 on 30th June 2006. For this construction it took a loan of $500,000 from Bank of America at 10%. Calculate the amount of interest to be capitalized and pass the necessary journal entry Solution: Interest on $500,000 at10% for 6 months is $ 25,000 Journal entry Finance Center of Excellence Page 58
Dr. Interest Cr. Bank Dr. Building Cr. Interest
$25,000 $25,000 $25,000 $25,000
Depreciation: Depreciation is the reduction in the value of an asset due to usage, passage of time, wear and tear, technological outdating or obsolescence, depletion or other such factors. The recording of depreciation will cause an expense to be recognized, thereby lowering stated profits on the income statement, while the net value of the asset (the portion of the historical cost of the asset that remains to provide future value to the company) will decline on the balance sheet. A company needs to report depreciation accurately in its financial statements in order to achieve two main objectives: 1) To match its expenses with the income generated by means of those expenses, and 2) To ensure that the asset values in the balance sheet are not overstated Depreciation is calculated after deducting the salvage value of the asset from the cost. Salvage value is the estimated value of an asset at the end of its useful life. This is also known as residual value or scrap value. Methods of depreciation a) Straight-line depreciation: Under Straight-line depreciation method the company depreciates the asset evenly over the useful life of the asset. An estimate is made of the useful life of the asset and the "salvage value" of the asset. Straight line Depreciation= Cost of assets-Salvage Value Useful Life For example, a vehicle that depreciates over 5 years, is purchased at a cost of US$17,000, and will have a salvage value of US$2000, will depreciate at US$3,000 per year: ($17,000 - $2,000/ 5 years = $3,000 annual straight-line depreciation expense. b) Declining balance Method: Under this method, a fixed percentage is applied on the written down value (original cost less depreciation charged till the end of the previous year) of the asset. This results in higher depreciation in the earlier years and lesser depreciation in the later years. c) Activity depreciation: Activity depreciation methods are not based on time, but on a level of activity. This could be miles driven for a vehicle, or a cycle count for a machine. When the asset is acquired, we estimate its life in terms of this level of activity. Assume the vehicle above is estimated to go 50,000 miles in its lifetime. We calculate a per-mile depreciation rate: ($17,000 cost - $2,000 salvage) / 50,000 miles = $0.30 per mile. Each year, we then calculate the depreciation expense by multiplying the rate by the actual activity level. Finance Center of Excellence Page 59
d) Sum-of-Years' Digits Method: Sum of Years Digits is a historical depreciation method that results in a more accelerated write off than straight line, but less than declining balance. This method is just like weighted average where the first year gets the highest weight. Example: If an asset costs $1000 has a depreciable life of 5 years and a salvage value of $90, compute its depreciation schedule. Year Depreciable amount Weight Depreciation amount 1 $1000 - $ 90 = $910 5/15* $303 2 $1000 - $ 90 = $910 4/15 $243 3 $1000 - $ 90 = $910 3/15 $182 4 $1000 - $ 90 = $910 2/15 $121 5 $1000 - $ 90 = $910 1/15 $61 *Since the useful file is 5 years we give the weight starting with 5 and decreasing by 1 every year. 15 is the total of the weights for all the years (5+4+3+2+1= 15)
e) Units-of-Production Depreciation Method: Under the Units-of-Production method, useful life of the asset is expressed in terms of the total number of units expected to be produced.
Example: a) A Ltd. acquired a machine on 1st July 1998 at a cost of $14,000 and spent $1,000 on its installation. The firm writes off depreciation at 10% of the original cost every year. The books are closed on 31st December every year. On March 31, 2001 the machine is sold for $9,500. Show the required ledger account. b) Work out on the basis of the declining balance method also. Solution: a) Straight Line Method Machinery Account Amount $ Date 14,000 1,000 15000 Finance Center of Excellence 15000 Page 60 31-12-1998
Date
Particulars
Particulars By Balance c/f
Amount $ 15000
01-07-1998 To Bank A/c To Bank-Installation Expenses A/c
01-01-1999 To Balance b/f 01-01-2000 To Balance b/f To Balance b/f 01-01-2001
15000 15000 15000
31-12-1999 31-12-2000 31-03-2001
By Balance c/f By Balance c/f By Accumulated Depreciation A/c By Bank A/c By Loss on sale of Machinery A/c
15000 15000
4125 9500 1375 15000
15000
Date
31-12-1998
Particulars To Accumulated Depreciation A/c (10% on 15,000 for 6 months) To Accumulated Depreciation A/c (10% on 15,000) To Accumulated Depreciation A/c (10% on 15,000) To Accumulated Depreciation A/c (10% on 15,000 for 3 months)
Depreciation Account Amount $ Date
Particulars
Amount $
750
31-12-1998
By Profit $ Loss A/c
750
31-12-1999
1,500
31-12-1999
1,500
31-12-2000
1,500
31-12-2000
1,500
31-03-2001
375
31-03-2001
375
Date 31-12-1998
Accumulated Depreciation Account Amount Particulars $ Date Particulars To Balance c/f 750 31-12-1998 By Depreciation A/c
Amount $ 750 Page 61
31-12-1999
To Balance c/f
2250 2250
01-01-1999 By Balance b/f 31-12-1999 By Depreciation A/c
750 1500 2,250 2250 1500 3750 3750 375 4125
31-12-2000
To Balance c/f
3750 3750
31-03-2001
To Machinery A/c
4125 4125
Date 31-03-2001
Loss on Sale of Machinery Account Amount $ Date Particulars Particulars To Machinery A/c 1375 31-03-2001 By Profit & Loss A/c
Amount $ 1375
b) Declining balance Method Machinery Account Amount $ Date 14,000.00 31-12-1998 1,000.00 15000.00 01-01-1999 To Balance b/f 01-01-2000 To Balance b/f 01-01-2001 To Balance b/f 15000.00 15000.00 15000.00 31-12-1999 31-12-2000 31-03-2001 By Balance c/f By Balance c/f By Accumulated Depreciation A/c By Bank A/c By Loss on sale of Machinery A/c 15000.00 15000.00 15000.00
Date
Particulars
Particulars By Balance c/f
Amount $ 15000.00
01-07-1998 To Bank A/c To Bank-Installation Expenses A/c
3746.06 9500.00 1753.94 15000.00
15000.00
Depreciation Account
Page 62
Date
31-12-1998
Particulars To Accumulated Depreciation A/c (10% on 15,000 for 6 months) To Accumulated Depreciation A/c (10% on 15,000) To Accumulated Depreciation A/c (10% on 15,000) To Accumulated Depreciation A/c (10% on 15,000 for 3 months)
Amount $
Date
Particulars
Amount $
750.00
31-12-1998
750.00
31-12-1999
1425.00
31-12-1999
1425.00
31-12-2000
1282.50
31-12-2000
1282.50
31-03-2001
288.56
31-03-2001
288.56
Date 31-12-1998 31-12-1999
Accumulated Depreciation Account Amount Particulars $ Date Particulars To Balance c/f 750.00 31-12-1998 By Depreciation A/c To Balance c/f 2175.00 2175.00 01-01-1999 By Balance b/f 31-12-1999 By Depreciation A/c
Amount $ 750.00 750.00 1425.00 2175.00 2250.00 1282.50 3457.50 3457.50 288.56 3746.06
31-12-2000
To Balance c/f
3457.50 3457.50
31-03-2001
To Machinery A/c
3746.06 3746.06
Date 31-03-2001
Loss on Sale of Machinery Account Amount Particulars $ Date Particulars To Machinery A/c 1753.94 31-03-2001 By Profit & Loss A/c
Amount $ 1753.94 Page 63
3) Intangible assets Intangible assets are those assets which provide future economic benefit but doesnt have physical substance, i.e., cannot be seen or touched. They include patents, copyrights, goodwill, trademarks, trade names, etc. An intangible asset can be classified as either indefinite or definite. A company brand name is considered to be an indefinite asset, as it stays with the company as long as the company continues operations. However, if a company enters a legal agreement to operate under another company's patent, with no plans of extending the agreement, it would have a limited life and would be classified as a definite asset Good will: Goodwill reflects the value of intangible assets such as a strong brand name, good customer relations, good employee relations and any patents or proprietary technology. It is the amount in excess of the company's book value that a purchaser would be willing to pay to acquire it. Amortization: Amortization refers to expensing the acquisition cost minus the residual value of intangible assets (often intellectual property such as patents and trademarks or copyrights) in a systematic manner over their estimated useful economic lives so as to reflect their consumption, expiration, obsolescence or other decline in value as a result of use or the passage of time. Amortization is recorded in the financial statements of an entity as a reduction in the carrying value of the intangible asset in the balance sheet and as an expense in the income statement.
LIABILITIES
Liability is an entity's present obligation arising from a past event, the settlement of which will result in an outflow of economic benefits from the entity. Liabilities are reported on a balance sheet and are usually divided into two categories: 1) short-term or current liabilities 2) Long-term liabilities. Liabilities of uncertain value or timing are called provisions 1. Short-term or current liabilities Short-term or current liabilities are liabilities which are reasonably expected to be liquidated within a year. They usually include payables such as wages, accounts, taxes, and accounts payables, unearned revenue when adjusting entries, portions of long-term debt to be paid this year, short-term obligations (e.g. from purchase of equipment), and others. Finance Center of Excellence Page 64
2. Long-term liabilities Long term liabilities are liabilities which are reasonably expected not to be liquidated within a year. They usually include issued long-term bonds, notes payables, long-term leases, pension obligations, and longterm product warranties.
OWNERS' EQUITY
It is the owners' interest in the assets of the enterprise after deducting all its liabilities The accounting equation used to represent this is: Assets - Liabilities = Owners Equity It can be depicted as follows
Rectification of Errors
While recording transactions and events various errors may be committed by the accountant unintentionally. Some of these errors may effect the trail balance (i.e., the debit and credit side of the trail balance will not tally) and some of these do not have any impact on the Trail balance although such errors may effect the determination of profit or loss, assets and liabilities of the business. Rectification of errors means systematic and scientific way of correction of errors occurred during the course of maintaining the books of accounts by legal manner as permitted by accounting system i.e. by booking a rectification entry. In other words illegal / unauthentic way of rectification is not permissible. Types of errors: a) Errors of principles When the errors are being made in application of accounting principles, known as errors of principles. Finance Center of Excellence Page 65
These errors dont affect Trial balance. b) Compensatory errors When one error is being adjusted / compensated by another error, known as Compensatory Errors. These errors dont affect Trial balance. c) Errors of Omission When a particular transaction is completely omitted to record in the books of accounts, known as errors of omission. These errors dont affect Trial balance. d) Errors of Commission If an amount is posted in a wrong account or it is written wrong on the wrong side or the totals are wrong or a wrong balance is struck, it will be a case of errors of commission. Trial Balance affected. Examples: i) Goods purchased (worth of $1,000) from A Ltd. have been credited wrongly to B Ltd. account. Wrong entry Correct Entry Rectification Entry Dr. Purchases Account 1,000 Dr. Purchases Account 1,000 Dr. B Ltd. Account 1,000 Cr. B Ltd. Account 1,000 Cr. A Ltd. Account 1,000 Cr. A Ltd. Account 1,000 ii) A Ltd. has paid the salary of $1,000 to its employees. He has debited Cash with $1,000 and credited Employees Salary with $1,000. What will be the rectification entry? Wrong entry Correct Entry Rectification Entry Dr. Cash 1,000 Dr. Employees Salary 1,000 Dr. Employees Salary 2,000 Cr. Employees Salary 1,000 Cr. Cash 1,000 Cr. Cash 2,000
Note: In this case the rectification entry will be with the double amount, first to nullify the wrong entry and second to book the correct entry.
iii) A Ltd. has purchased machinery for $10,000 with B Ltd. on credit but by mistake it has credited cash. Wrong entry Correct Entry Rectification Entry Dr. Machinery 10,000 Dr. Machinery 10,000 Dr. Cash 10,000 Cr. Cash 10,000 Cr. B Ltd. 10,000 Cr. B Ltd. 10,000
Bank Reconciliation Statement

Introduction:
Page 66
Each and every bank maintains its customers account in its ledger. Similarly a customer of the bank opens a bank account in his cash book for recording bank transactions. Thus the cash book and pass book are prepared separately. The business man prepares the Cash book and the Pass Book is prepared by the Bank. As both the books are related to one person and same transactions are recorded in both the books, so the balance of both the books should match i.e. the balance as per Pass Book should match to balance at bank as per cash book. Meaning:
As a matter of fact balance shown by the Cash book (with bank column) and by the Bank Pass Book (Customers account) on a particular date must tally. But in actual practice they differ due to many reasons. It, therefore, becomes necessary to reconcile (explain) the difference to ascertain that there are no mistakes committed. After finding the reason for non-agreement of the bank balances of pass book and cash-book, efforts are made for their reconciliation. This reconciliation is prepared and presented in the form of a statement commonly known as Bank Reconciliation Statement.
What is a Bank Statement?
Bank sends a statement to each of its customers at least once in a month. The bank statement shows the balance at the beginning of the month, the deposits, the checks paid, other debits and credits during the month, and the balance at the end of the month.
Format of Bank Statement:
STATEMENT
National Bank PLC 5-6 Christmas Square Mereford MR1 7GH
Account Teme Computers Account Number 12037661 Sheet 17 Date 31 October 2007 Date Details Withdrawals Debit Deposits Credit Balance
Page 67
$ 2007 01 Oct 01 Oct 07 Oct 07 Oct 13 Oct 15 Oct 17 Oct 20 Oct 20 Oct 23 Oct 24 Oct 27 Oct 31 Oct 31 Oct Balance Cheques 619651 619652 RT Telecom(DD) 619653 Mereford City Council (SO) GH Trading (BGC) Cheque Cash Tombenco (BACS) Unpaid cheque 619654 Bank charges
590.53 298.64 100.00 154.00 58.90 240.00 230.00 127.80 450.00 120.50 127.80 45.75 24.30
405.93 CR 996.46 CR 697.82 CR 597.82 CR 443.82 CR 384.92 CR 144.92 CR 374.92 CR 502.72 CR 952.72 CR 1073.22 CR 945.42 CR 899.67 CR 875.37 CR
Reason for Differences in Balance:
Reconciliation between the cash book and the bank statement final balance simply means an explanation of the differences. Differences between the cash book and the bank statement can arise from: Timing of the recording of the transactions Errors made by the business, or by the bank
Timing Differences:
When the same entry is recorded in either of the book earlier and in the other book later, it is termed as timing difference. The timing difference may arise on account of the following: Outstanding Checks: A cashier may send checks out to suppliers, some of whom may pay in the check at the bank immediately while others may keep the check for several days before paying it in. When this happens the cashier will have recorded all the payments in the cash book. However, the bank records will only show the checks that have actually been paid in by the suppliers and deducted from the business bank account. These checks are known as unpresented checks.
Finance Center of Excellence Page 68
Deposits in transit: Most companies make frequent cash deposits. Therefore, company records may show one or more deposits, usually made on the last day included on the bank statement that do not appear on the bank statement. These deposits are called deposits in transit and cause the bank statement balance to understate the company's actual cash balance. Since deposits in transit have already been recorded in the company's books as cash receipts, they must be added to the bank statement balance.
With another type of timing difference known as outstanding lodgments the firm's cashier records a receipt in the cash book as he or she prepares the bank paying-in slip. However, the receipt may not be recorded by the bank on the bank statement for a day or so, particularly if it is paid in late in the day (when the bank will put it into the next day's work), or if it is paid in at a bank branch other than the one at which the account is maintained. Payments in: Another timing difference may also occur when the bank has received a direct payment from a customer of the business. In this instance the bank will have recorded the receipt in the businesss account at the bank but the business will be unaware of the payment and will not, therefore, have recorded the receipt in the cash book. This type of payment includes: Bankers' Automated Clearing Services, i.e. incoming payments received on the account, e.g. payments from debtors (customers) when the payment has not been advised to the business Interest and refunds credited by the bank Payments out: Another reason why the balance of the cash book and the balance of the bank statement may not agree is because the bank may have deducted items from the customers account, but the customer may not be aware of the deduction until the bank statement arrives. Examples of these deductions include: Standing order and direct debit payments which the customer did not know about Bank charges for running the account Interest charged for overdrawn balances Unpaid checks deducted by the bank i.e. stopped and 'bounced' checks
Difference Caused by the Error:
Sometimes the difference between the two balances may be accounted for by an error on the part of the bank or an error in the cash book of the business. It is for this reason that bank reconciliation is carried out frequently so that errors may be identified and rectified as soon as possible.
It is good business practice to prepare a bank reconciliation statement each time a bank statement is received. The reconciliation statement should be prepared as quickly as possible so that any queries either with the bank statement or in the firms cash book can be resolved. Many firms will specify to their accounting staff the timescales for preparing bank reconciliation statements.
How to prepare Bank Reconciliation Statement:
In reality to prepare a BRS we should have a copy of companys cash book and the bank statement for the same period. Lets take an example. Given below is the Cash book of Fern Ltd for the month of August 2007 and the statement from CITI Bank for the same period. Fern LTD - Cash Book Receipts
Date 2007 1-Aug 1-Aug 5-Aug 8-Aug 10-Aug 18-Aug 27-Aug 30-Aug Details Balance b/d I watts & Co B Rogers (BACS) E Shaws J Moore Ltd Simms Ltd Martin Black Davies Partners Bank $ 1,946 249 188 150 440 65 520 82 3,640 1-Sep Balance b/d 2,284 Date 2007 2-Aug 2-Aug 4-Aug 7-Aug 9-Aug 13-Aug 20-Aug 27-Aug 31-Aug
Payments
Details DD Bell Insurance Harvey & Co Durose Ltd Motts Garage SO Rock Finance Hill Bros Ashley's Ltd DD Rates Balance c/d Bank $ 75 206 315 211 120 22 137 270 2,284 3,640
200100 200101 200102 200103 200104
CITI BANK STATEMENT

Account Date Date 2007 Fern Ltd 31-Aug-07 Account # Statement # Debit 78300582 16 Credit 249 75 315 Balance 1,946 Cr 2,195 Cr 2,120 Cr 1,805 Cr Page 70
Details 1-Aug Balance 2-Aug Cheques 4-Aug Bell Insurance (DD) 4-Aug 200101 Finance Center of Excellence
5-Aug 8-Aug 9-Aug 12-Aug 12-Aug 20-Aug 27-Aug 30-Aug 31-Aug 31-Aug
B Rogers (BACS) Cheques 200102 Cheques Rock Finance (SO) Cheques DD Rates Torr Bros (BGC) Bank Charges City Finance (SO)
188 150 211 440 120 65 270 92 55 1,000
1,993 Cr 2,143 Cr 1,932 Cr 2,372 Cr 2,252 Cr 2,317 Cr 2,047 Cr 2,139 Cr 2,084 Cr 1,084 Cr
Now lets see what are the different steps in preparing the BRS: Step 1: Check all the entries in the cash book against those in the bank statement. It is better to use penciled tick marks next to each entry in the cash book and bank statement that appears in both the records. If there are any differences in the amount, working has to be done to figure out which one is correct. Now as mentioned in the step 1 lets do the checking of both the statements. Fern LTD - Cash Book Receipts Payments
Date 2007 1-Aug 1-Aug 5-Aug 8-Aug 10-Aug 18-Aug 27-Aug 30-Aug Details Balance b/d I watts & Co B Rogers (BACS) E Shaws J Moore Ltd Simms Ltd Martin Black Davies Partners Bank $ 1,946 249 188 150 440 65 520 82 3,640 1-Sep Account Date Date 2007 Balance b/d Fern Ltd 31-Aug-07 2,284 Date 2007 2-Aug 2-Aug 4-Aug 7-Aug 9-Aug 13-Aug 20-Aug 27-Aug 31-Aug Details DD Bell Insurance Harvey & Co Durose Ltd Motts Garage SO Rock Finance Hill Bros Ashley's Ltd DD Rates Balance c/d Bank $ 75 206 315 211 120 22 137 270 2,284 3,640
200100 200101 200102 200103 200104
CITI BANK STATEMENT

Account # Statement # Debit 78300582 16 Credit 249 Balance 1,946 Cr 2,195 Cr Page 71
Details 1-Aug Balance 2-Aug Cheques Finance Center of Excellence
4-Aug 4-Aug 5-Aug 8-Aug 9-Aug 12-Aug 12-Aug 20-Aug 27-Aug 30-Aug 31-Aug 31-Aug
Bell Insurance (DD) 200101 B Rogers (BACS) Cheques 200102 Cheques Rock Finance (SO) Cheques DD Rates Torr Bros (BGC) Bank Charges City Finance (SO)
75 315 188 150 211 440 120 65 270 92 55 1,000
2,120 Cr 1,805 Cr 1,993 Cr 2,143 Cr 1,932 Cr 2,372 Cr 2,252 Cr 2,317 Cr 2,047 Cr 2,139 Cr 2,084 Cr 1,084 Cr
Now we can find that there are some unticked items in Cash book as well as in Bank Statement.
Step 2: If there are any unticked items in the bank statement (for example, bank fees or direct debits), and you find those are genuine entries, record these in the cash books. Once youve done this, your cash books should contain details of every transaction for the period.
If we take our example into consideration there are three items in the bank statement which are unticked. Lets take these three items into consideration and pass relevant entries in the Cash book. After passing the entry the cash book shows the below balance.
Fern LTD - Cash Book Receipts

Date 2007 1-Aug 1-Aug 5-Aug 8-Aug 10-Aug 18-Aug 27-Aug 30-Aug 30-Aug Details Balance b/d I watts & Co B Rogers (BACS) E Shaws J Moore Ltd Simms Ltd Martin Black Davies Partners Torr Bros (BGC) Bank $ 1,946 249 188 150 440 65 520 82 92 Date 2007 2-Aug 2-Aug 4-Aug 7-Aug 9-Aug 13-Aug 20-Aug 27-Aug 31-Aug
Payments
Details DD Bell Insurance Harvey & Co Durose Ltd Motts Garage SO Rock Finance Hill Bros Ashley's Ltd DD Rates Bank Charges Bank $ 75 206 315 211 120 22 137 270 55 Page 72
200100 200101 200102 200103 200104
31-Aug SO City Finance 31-Aug Balance c/d 3,732 1-Sep Balance b/d 1,321
1,000 1,321 3,732
Step 3: If there are still any unticked items in your cash books, these are items the bank didnt know about during the period of the statement. For example, a check you sent someone may not have been presented against your account, or money you received on the last day of the period may not have been banked until the next period. It can sometimes be several months before checks are finally presented. Step 4: Create the BRS to consider the items mentioned in Step. 3
Bank Reconciliation Statement as on 31 August 2007 $ Balance as per Cash Book as on 31st Aug 2007 Add: Cheques issued but not encashed Harvey & Co Hill Bros Ashley's Ltd Less: Cheques deposited into the bank but not credited by the bank Martin Black Davies Partners Balance as per Bank Statement as on 31 Aug 2007 Importance of the bank reconciliation statement:$ 1,321 206 22 137
365 1,686
520 82
602 1,084
There are three main purposes of reconciliation. They are as follows:It is a form of control to check the accuracy of the records kept by the bank and the business. It provides accounting information for entries in the books of the business of items shows on the bank statements that have not been recorded by the business like the bank charge and credit transfer. The adjusted balance to which the two balances are reconciled provides the data to be used for cash in the preparation of the balance sheet. Bank reconciliation statement can also show any undue delay in the clearance of cheques.
Sometimes the cashier may have the tendency of cheating like he may made entries in the cash book only but never deposit the cash into bank. These types of frauds by the entrepreneurs staff or bank staff may be detected only through BRS. So, in this way also BRS acts as a control technique too.
Key Risk Indicators
Number of unusual/high value items lying un-reconciled in Bank Reconciliation Statement Number of open items in the reconciliation sheet for more than 30 days.
Key Performance Indicators

Number of bank accounts reconciled Time taken to reconcile the bank accounts Resolution for unusual/high value items
Page 74
Self Study Book

Inventory Valuation
Illustration 1
Determine the value of inventory as on 31-3-2007 using FIFO, LIFO, Weighted average and Moving Average method the basis of following details: Receipts Date Quantity (Units) $ 01-01-2007 01-02-2007 01-03-2007 100 200 150 30 40 50 15-01-2007 15-02-2007 20-02-2007 15-03-2007 Finance Center of Excellence 50 100 100 100 Page 75 Price per Unit Date Issue Quantity (Units)
Total
450
350
Solution: a) FIFO
Receipts Date 2007 Qty. Rat e $ 30 Amount Qty. (Unit s) 50
Issues Rate Amount Qty. (Unit s) 100 50 50
Balance Rate Amount
(Units) 01-Jan 15-Jan 100 -
$ 3,000 -
$ 30
$ 1,500
$ 30 30 30 40
$ 3,000 1,500 1,500 8,000
01-Feb
200
40
8,000
200
50 15-Feb 50 20-Feb 100
30 40 40
1,500 150 2,000 4,000 50 50 40 40 50 2,000 2,000 7,500 40 6,000
01-Mar
150
50
7,500
150
50 15-Mar 50 Total 450 18,500 350
40 50
2,000 100 2,500 13,500 100 5,000 50 5,000
COGS= 350 units=$ 13,500 Ending Inventory=100 units=$5,000
Page 76
b) LIFO
Date 2007 Qty. (Units) 01-Jan 15-Jan 100 -
Receipts Rat e $ 30 Amount $ 3,000 Qty. (Units) 50
Issues Rate $ 30 Amount $ 1,500 Qty. (Units) 100 50 50
Balance Rate $ 30 30 30 40 30 40 30 30 50 30 50 Amount $ 3,000 1,500 1,500 8,000 1,500 4,000 1,500 1,500 7,500 1,500 2,500 4,000
01-Feb
200
40
8,000
200 50
15-Feb
100
40
4,000 100
20-Feb
100
40
4,000
50 50
01-Mar
150
50
7,500
150 50
15-Mar
100
50
5,000 50
Total
450
18,500
350
14,500
100
COGS= 350 units=$14,500 Ending Inventory=100 units=$4,000
c) Weighted Average
Computation of Weighted average price:
Page 77
Quantity (Units) 100 200 150 450
Price per Unit($) 30 40 50
Price Paid ($) 3,000 8,000 7,500 18,500
Weighted Average Price= $18,500/450 Units= $41.11 per Unit COGS= 350 units= 350*41.11=$14,388.50 Ending Inventory=100 units=$4,111
d) Moving Average Receipts Date 2007 (Units) 01-01 15-01 01-02 15-02 20-02 01-03 15-03 Total 100 200 150 450 $ 30 40 50 $ 3,000 8,000 7,500 18,500 (Uni ts) 50 100 100 100 350 $ 30 38 38 47 $ 1,500 3,800 3,800 4,700 13,800 (Units) 100 50 250 150 50 200 100 100 $ 30 30 38(i) 38 38 47(ii) 47 $ 3,000 1,500 9,500 5,700 1,900 9,400 4,700 4,700 Qty. Rate Amoun t Qty. Issues Rate Amou nt Qty. Balance Rate Amou nt
COGS= 350 units= $13,800 Finance Center of Excellence Page 78
Ending Inventory=100 units=$4,700 Note: (i) (ii) $ (1,500+8,000)/(50+200)Units = $38 per Unit $ (1,900+7,500)/(150+50)Units = $47 per Unit
Preparation of Final Accounts

Illustration 1 Trial Balance As on 31st December 2007 Particulars Dr. $ CapitalA/c Beginning Inventory A/c Cash at Bank Cash in hand Machinery A/c Furniture and Fittings A/c Purchases A/c Direct Labor A/c Fuel and Power A/c Factory Lighting A/c Salaries A/c Discount Allowed A/c Finance Center of Excellence 2,000 1,000 440 6,000 1,360 15,000 10,000 3,000 200 7,000 500 Page 79 Cr. $ 10,000
Discount Received A/c Advertisement Expenses A/c Office Expenses A/c Sales A/c Debtors Creditors Total 64,000 8,500 5,000 4,000
300
50,000
3,700 64,000
Value of ending inventory on 31st Dec. 2007 was $2,700.
Solution Income Statement for the year ended 31st December 2007 Particulars Sales Less: Cost of Goods Sold (Note) Gross Income Less: Administrative and Selling Expenses/(Income) salaries Discount Allowed Discount Received Advertisement Expenses A/c Office Expenses A/c Net income Dr. $ Cr. $ 50,000 27,500 22,500
7,000 500 (300) 5,000 4,000
16,200 6,300
Page 80
Note: Cost of Goods Sold $ Material Consumed Beginning Inventory Add: Purchases Less: Ending Inventory Direct Labor Direct Cost Fuel and Power Factory lighting 2,000 15,000 2,700 $
14,300 10,000
3,000 200
3,200 27,500
Balance Sheet as on 31st December 2007 Assets Current Assets Cash in hand Cash at bank Ending Inventory Accounts Receivables Non-Current Assets Machinery Furniture & Fittings Illustration 2 Prepare the Income Statement and Balance Sheet using the below Trial balance: Trial Balance As on 31st December 2007 Particulars Account Receivables Beginning Inventory on 1st January 2007 Cash in Hand Cash at Bank Direct Labor Interest Bad Debts Finance Center of Excellence Dr. $ 3,500 5,000 1,600 4,000 3,000 200 500 Page 81 Cr. $ $ Liabilities/Equity Owners equity 440 1,000 2,700 8,500 Capital Retained earnings Current Liabilities Accounts Payable Non-Current Liabilities $
10,000 6,300
3,700 -
6,000 1,360 20,000
20,000
Repairs Furniture and Fixtures Machinery Land Buildings Depreciation on Furniture and Fixtures Depreciation on Machinery (Factory) Depreciation on Building (Allocate between factory and office in 1:1 ratio) 10% Investments Rent (300 for factory and 500 for office building) Salaries Purchases Office Expenses Capital Interest on Investments Accounts Payables Sales Accumulated Depreciation on Furniture and Fixtures Accumulated Depreciation on Machinery Accumulated Depreciation on Building Loan Total On 31st December, 2007 the ending inventory was valued at $8,000.
300 1,500 5,700 7,000 11,000 500 1000 1,200 6,000 800 4,000 10,000 2,500 25,000 600 11,000 25,000 700 2,000 3,000 2000 69,300
69,300
Solution: Income Statement for the year ended 31st December 2007 $ Sales Less: COGS Gross Income Less: Administrative & Selling Expense/(Income) Interest Bad Debts Repairs Finance Center of Excellence $ 25,000 11,900 13,100 200 500 300 Page 82
Depreciation on Furniture and Fixtures Depreciation on Building Rent Salaries Office Expenses Interest on Investments Net Income
500 600 500 4,000 2,500 -600
8,500 4,600
Note: Cost of Goods Sold $ Material Consumed Beginning Inventory Add: Purchases Less: Ending Inventory Direct Labor Direct Cost Depreciation on Machinery (Factory) Depreciation on Building Factory Rent 5,000 10,000 -8,000 $
7,000 3,000
1,000 600 300
1,900 11,900
Balance Sheet as on 31st December 2007 Assets Current Assets Cash in Hand Cash at Bank Inventory Account Receivables Non-Current Assets Land Furniture and Fixtures 1,500 Less: Accumulated depreciation 700 Machinery Less: Accumulated Depreciation 5,700 2,000 3,700 Loan 2000 $ 1,600 4,000 8000 3500 7,000 800 Non-Current Liabilities Liabilities/Equity Owners equity Capital Retained Earnings Current Liabilities Accounts Payables $ 25,000 4600
11,000
Page 83
Buildings Less: Accumulated Depreciation 10% Investments
11,000 3,000 8,000 6,000 42600 42600
Illustration 3 Prepare the Income Statement and Balance Sheet using the below Trial balance: Trial Balance As on 31st March 2007 Particulars Plant & Machinery Furniture & Fittings Bank Overdraft Capital Purchases Beginning Inventory Direct labor Allowance for Uncollectible Returns Accounts Receivable Accounts Payable Bad Debt Bad debt recovered Salaries Salaries Payable Prepaid Rent Rent Office Expenses Freight Sales Advertisement Expenses Printing & Stationery Cash in Hand Cash at Bank Miscellaneous Income Finance Center of Excellence Dr. $ 40,500 15,250 245,500 132,250 22,325 152,500 2,200 32,650 500 6,500 2,350 3,250 6,750 2,200 2,300 7,250 Cr. $ 160,000 115,000 5,700 77,500 1,250 5,350 290,600 18,875 Page 84
Total
674,275
674,275
Additional Information: 1. Purchases include sales return of $5,500 and sales include purchase return of $4,750. 2. Installation charges paid for plant & machinery amounting to $750 was included in Direct Labor account. 3. Advance given to one of the supplier ($2,500) is included in the Account receivables balance. 4. Free sample distributed for publicity costing $1,250 is included in purchases. 5. Depreciation is to be provided on plant & machinery @ 15% p.a. and on furniture & fittings @10% p.a. Allocate the plant and machinery deprecation between factory and administrative on 1:1 ratio. 6. Create a provision for doubtful debts @ 5% 7. Ending Inventory $250,000 8. Rent includes $2,500 for factory and $4,000 for office building. Solution Rectification and Adjusting Entries: Date 2007 1 Sales return A/c Sales A/c To purchases A/c To Purchases Return A/c (Sales return and purchase returns wrongly included in purchase and sales, now rectified.) 2 Plant & Machinery A/c To Direct Labor A/c (Installation charges paid for plant & machinery wrongly debited to direct labor account, now rectified.) 3 Advance to Suppliers A/c Dr. 2,500 2,500 Page 85 Dr. 750 750 Dr. Dr. Particulars L.F. Amount $ 5,500 4,750 5,500 4,750 Amount $
To Account Receivables A/c Finance Center of Excellence
(Advance to suppliers wrongly included in the receivables, now rectified.) 4 Advertisement A/c To Purchases A/c (Free samples distributed for publicity out of purchases now properly recorded.) 5 Depreciation on Plant & Machinery A/c Depreciation on furniture & fittings A/c Dr. Dr. 6,188 1,525 6,188 1,525 To Accumulated Depreciation on furniture & fittings A/c (Accounted depreciation for plant & machinery and furniture & fittings.) 6 Bad debts A/c Dr. 1,800 1,800 Dr. 1250 1,250
To Accumulated Depreciation on Plant & Machinery A/c
To Allowance for Uncollectible Returns A/c (Created additional allowance for uncollectible returns @ 5% on account receivables balance, i.e., (5% on $150,000)-$5,700=$7,500$5,700=$1,800.)
Trial Balance (Rectified) As on 31st March 2007 Particulars Plant & Machinery Furniture & Fittings Depreciation on Plant & Machinery Depreciation on furniture & fittings Finance Center of Excellence Dr. $ 41,250 15,250 6188 1525 Cr. $ -
Page 86
Accumulated Depreciation on Plant & Machinery Accumulated Depreciation on furniture & fittings Bank Overdraft Capital Purchases Purchases Returns Beginning Inventory Direct labor Allowance for Uncollectible Returns Accounts Receivable Advance to Suppliers Accounts Payable Bad Debt Bad debt recovered Salaries Salaries Payable Prepaid Rent Rent Office Expenses Freight Sales Sales Returns Advertisement Expenses Printing & Stationery Cash in Hand Cash at Bank Miscellaneous Income Total
238,750 132,250 21,575 150,000 2,500 4,000 32,650 500 6,500 2,350 3,250 5500 8,000 2,200 2,300 7,250 683,788
6188 1525 160,000 115,000 4750 7,500 77,500 1,250 5,350 285,850 18,875 683,788
Income Statement for the year ended 31st December 2007 $ Sales Less: sales Returns Less: COGS Gross Income Less: Administrative & Selling Expense/(Income) Finance Center of Excellence Page 87 $ 285,850 5,500 280,350 146,669 133,681
Bad Debt Bad debt recovered Salaries Office Expenses Advertisement Expenses Printing & Stationery Miscellaneous Income Depreciation on Plant & Machinery Depreciation on furniture & fittings Rent Net Income
4,000 -1,250 32,650 2,350 8,000 2,200 -18,875 3094 1525 4000
37,694 95,987
Note: Cost of Goods Sold $ Material Consumed Beginning Inventory Add: Purchases Less: Ending Inventory Direct Labor Direct Cost Depreciation on Plant & Machinery Factory Rent Freight 132250 234,000 -250,000 $
116,250 21,575
3094 2500 3250
8,844 146,669
Balance Sheet as on 31st December 2007
Assets Current Assets Cash in Hand Cash at Bank Inventory Account Receivables 150,000 Less: Allowance for Uncollectible Returns
$ 2,300 7,250 250000
Liabilities/Equity Owners equity Capital Retained Earnings
$ 115,000 95987
142500
Current Liabilities
Page 88
7,500
Advance to Suppliers Prepaid Rent Non-Current Assets Plant & Machinery Less: Accumulated Depreciation Furniture & Fittings Less: Accumulated Depreciation
2,500 500
Accounts Payables Bank Overdraft Salaries Payable
77,500 160,000 5,350
41,250 6,188 15,250 1,525 35,062 Non-Current Liabilities -
13725 453,837 453,837
Illustration 4 Post the below details to ledger and prepare trial balance, Income Statement and Balance Sheet: Balance Sheet as on 1st Oct 2007 Assets Current Assets Cash Bank Inventory Accounts Receivables Edward Wade 2,120 Thos Elliot 1,130 Non-Current Assets Furniture & Fittings $ 200 26,000 8,430 3,250 Liabilities/Equity Owners Equity Capital Current Liabilities Accounts Payables Ogden & Co 1,900 Bell & Sons 2,500 Will & Co 8,000 Hignett & C0 5,050 Martin Bros 6,060 Non-Current Liabilities 41,680 $ 18,170
23,510
3,800
41,680
Date Oct-07
Particulars
Amount $ Page 89
1 1 2 4 4 5 5 6 7 7 8 8 8 8 9 9 11 11 11 12 14 16 16 16 18 20 20 21 21 21 22 22 22 23 25 26
Sold to Edward Wade: Tobacco $200, Cigars $500, Cigarettes $150 Received from him cheque $2020, Discount $100 Paid Cash for Stationery Bought from Hignett & Co. : Tobacco $420, Cigars $960, Cigarettes $190 Paid them cheque $4800, Discount $250 Paid Wills & Co. Cheque on A/c Sold Jone Parson: Tobacco $300, Cigars $800, Cigarettes $200 Received from him cheque $1210, Discount $90 Sold Cigars to Alberty Kershaw Received cheque form him Bought Cigars from Martin Bron Paid them cheque $2850, Discount $150 Received cheque from Jone Parosn A/c Paid Ogden & Co. cheque $1800, Discount 90 Sold Cigarettes to Thomas Elliot Sold to Heny Hirst :- Tobacco $630, Cigars $360, Cigarettes $210 Edward Wade paid Cheque on A/c (not banked) Endorsed Wade's cheque and sent it to Bells Sons Bought of Ogden & Co. : Tobacco $1300, Cigars $160, Cigarettes $320 Parson's cheque returned by Bank dishonoured Sold to Thomas Elliot; Tobacco $890, Cigards $1130, Cigarettes $450 Withdrew from Bank Paid Wages in Cash Paid for Postage Bought of Bell & Sons : Tobacco $830, Cigars $540, Cigarettes $270 Received Cheque from Heny Hirst (not banked) Endorsed Hirst's cheque and sent it to Martin Bros Paid Municipal Taxes in Cash Sold Edward Wade : Tobacco $530, Cigars $480, Cigarettes $270 Received from him cheque $320, Discount $40 Sold to Heny Hirst : Tobacco $680, Cigars $1000, Cigarettes $280 Received from him cheque $1240, Discount $60 Drew cheque for cash Paid Wages in cash Paid cheque for new Show Case Bought of Wills & Co : Tobacco $1300, Cigars $1800, Cigarettes $630
850 2,120 50 1,570 5,050 4,000 1,300 1,300 880 500 1,500 3,000 430 1,890 180 1,200 500 1,780 430 2,470 200 80 50 1,640 1,000 1,000 110 1,280 360 1,960 1,300 200 80 200 3,730 Page 90
26 27 27 27 28 28 28 30 30 31 31
Paid them Cheque $3600, Discount $400 Bought Cigars from Martin Bros. Paid them Cheque $2750, Discount $300 Paid Cash for Fire Insurance Premium Received from Thomas Elliot Cheque $1240, Discount $60 Sent Elliot's Cheque to Wills & Co. on account Paid rent by cheque Cash Sales : Tobacco $190, Cigars $230, Cigarettes $80 Paid Wages in Cash Depreciation of Furniture, etc. Bank interest credited
4,000 1,230 3,050 40 1,300 100 500 80 220 80
Solution:
DEBTOR'S ACCOUNT Edward Wade Dr. Date Oct-07 1 To Balance b/d Particular Amount $ 2,120 Date Oct-07 1 By Bank A/c By Discount Allowed A/c 11 21 By Cash A/c By Bank A/c By Discount Allowed A/c 31 4,250 By Balance c/d Particular Cr. Amount $ 2,020
1 21
To Sales A/c To Sales A/c
850 1,280
100 500 320
40 1,270 4,250
Page 91
Thomas Elliot Dr. Date Oct07 1 To Balance b/d Particular Amount Date Particular Cr. Amount
$ 1,130
Oct-07 28 By Cash A/c By Discount Allowed A/c By Balance c/d
$ 1,240
9 14
To Sales A/c To Sales A/c
180 2,470 3,780
28 31
60 2,480 3,780
Jone Parson Dr. Date Oct07 5 To Sales A/c Particular Amount Date Particular Cr. Amount
$ 1,300
Oct-07 6 By Bank A/c By Discount Allowed A/c 8 By Bank A/c
$ 1,210
12
To Bank A/c
430
90 430 1,730
1,730
Albert Kershaw Dr. Finance Center of Excellence Cr. Page 92
Date Oct07 7
Particular
Amount
Date
Particular
Amount
$ To Sales A/c 880
Oct-07 7 31 By Bank A/c By Balance c/d
$ 500 380 880
880
Heny Hirst Dr. Date Oct07 2 22 To Sales A/c To Sales A/c Particular Amount Date Particular Cr. Amount
$ 1,200 1,960
Oct-07 20 22 By Cash A/c By Bank A/c By Discount Allowed A/c By Balance c/d
$ 1,000 1,240
22 31 3,160
60 860 3,160
CREDITOR'S ACCOUNT Ogden & Co. Dr. Date Oct07 Finance Center of Excellence Particular Amount Date Particular Cr. Amount
Oct-07
$ Page 93
To Bank To Discount Received
1,800
By Balance b/d
1,900
90 1,790 3,680
11
By Purchases
1,780
31
To Balance c/d
3,680
Bell & Sons Dr. Date Oct-07 11 31 To Cash To Balance c/d Particular Amount $ 500 3,640 4,140 Date Oct-07 1 18 By Balance b/d By Purchases Particular Cr. Amount $ 2,500 1,640 4,140
Wills & Co. Dr. Date Oct-07 5 26 To Bank To Bank To Discount Received A/c To Cash To Balance c/d Particular Amount Date $ 4,000 3,600 Oct-07 1 26 By Balance b/d By Purchases Particular Cr. Amount $ 8,000 3,730
26 28 31
400 1,240 2,490
Page 94
11,730
11,730
Hignett & Co. Dr. Date Oct-07 4 To Bank To Discount Received A/c To Balance Particular Amount $ 4,800 Date Oct-07 1 By Balance b/d Particular Cr. Amount $ 5,050
4 31
250 1,570 6,620
By Purchases
1,570
6,620
Martin Brothers Dr. Date Oct-07 8 To Bank To Discount Received A/c To Cash To Bank To Discount Received A/c To Balance c/d Particular Amount $ 2,850 Date Oct-07 1 By Balance b/d Particular Cr. Amount $ 6,060
8 20 27
150 1,000 2,750
8 27
By Purchases By Purchases
1,500 1,230
27 31
300 1,740
Page 95
8,790
8,790
Cash Account Dr. Date Oct-07 1 11 16 20 22 28 30 To Balance b/d To Edward Wade To Bank To Heny Hirst To Bank To Thomas Elliot To Sales Particular Amount $ 200 500 200 1,000 200 1,240 500 Date Oct-07 2 11 16 16 20 21 23 27 28 30 31 3,840 By Stationery By Bell & Sons By Wages By Postage By Martin Bros. By Municipal Tax By Wages By Insurance Premium By Wills & Co. By Wages By Balance c/d Particular Cr. Amount $ 50 500 80 50 1,000 110 80 40 1,240 80 610 3,840
Bank Account Dr. Date Particular Amount Date Oct07 Particular Cr. Amount
Oct-07 Finance Center of Excellence
$ Page 96
1 1 6 7 8 21 22 31
To Balance b/d To Edward Wade To Jone Parson To Albert Kershaw To Jone Parson To Edward Wade To Heny Hirst To Interest
26,000 2,020 1,210 500 430 320 1,240 80
4 5 8 8 12 16 22 25 26 27 28 31
By Hignett & Co. By Wills & Co. By Martin Bros. By Ogden & Co. By Jone Parson By Cash By Cash By Furniture By Wills & Co. By Martin Bros. By Rent By Balance b/d
4,800 4,000 2,850 1,800 430 200 200 200 3,600 2,750 100 10,870 31,800
31,800
Discount Received Account Dr. Date Oct-07 31 To Balance b/d Particular Amount $ 1,190 Date Oct-07 4 8 26 26 27 By Hignett & Co. By Martin Bros. By Orgden & Co. By Wills & Co. By Martin Bros. Particular Cr. Amount $ 250 150 90 400 300
Page 97
1,190
1,190
Discount Allowed Account Dr. Date Oct-07 4 6 21 22 28 To Edward & Wade To Jone Parson To Edward Wade To Heny Hirst To T.Elliot Particular Amount $ 100 90 40 60 60 350 350 Date Oct-07 31 By Balance c/d Particular Cr. Amount $ 350
Purchases Account Dr. Date Oct07 4 8 11 18 18 27 To Hignett & Co. To Martin Bros. To Odgen & Co. To Bells & Sons. To Wills & Co. To Martin Bros. Particular Amount Date Oct07 31 By Balance b/d Particular Cr. Amount
$ 1,570 1,500 1,780 1,640 3,730 1,230
$ 11,450
Page 98
11,450
11,450
Sales Account Dr. Date Oct-07 31 To Balance c/d Particular Amount $ 10,620 Date Oct-07 1 5 7 9 9 14 21 22 30 10,620 By Edward Wade By Jone Parson By Albert Keshaw By Thomas Elliot By Heny Hirst By Thomas Elliot By Edward Wade By Heny Hirst By Cash A/c Particular Cr. Amount $ 850 1,300 880 180 1,200 2,470 1,280 1,960 500 10,620
Inventory Dr. Date Oct-07 1 To Balance b/d Particular Amount $ 8,430 8,430 Date Oct-07 31 By Balance c/d Particular Cr. Amount $ 8,430 8,430
Page 99
Furniture & Fitting Account Dr. Date Oct-07 1 25 To Balance b/d To Bank A/c Particular Amount $ 3,800 200 4,000 4,000 Date Oct-07 31 By Balance c/d Particular Cr. Amount $ 4,000
Capital Account Dr. Date Oct-07 31 To Balance c/d Particular Amount $ 18,170 Date Oct-07 1 By Balance b/d Particular Cr. Amount $ 18,170
18,170
18,170
Stationery & Postage Account Dr. Date Oct-07 2 16 To Cash A/c To Cash A/c Particular Amount $ 50 50 100 100 Date Oct-07 31 By Balance c/d Particular Cr. Amount $ 100
Page 100
Depreciation Account Dr. Date Oct-07 To Accumulated Depreciation A/c Particular Amount $ Date Oct-07 Particular Cr. Amount $
31
220 220
31
By Balance c/d
220 220
Accumulated Depreciation Account Dr. Date Oct-07 31 To Balance c/d Particular Amount $ 220 220 Date Oct-07 31 By Depreciation Particular Cr. Amount $ 220 220
Wages Account Dr. Date Oct-07 16 23 30 To Cash A/c To Cash A/c To Cash A/c Particular Amount $ 80 80 80 240 240 Date Oct-07 31 By Balance c/d Particular Cr. Amount $ 240
Page 101
Municipal Taxes Account Dr. Date Oct-07 21 To Cash A/c Particular Amount $ 110 110 Date Oct-07 31 By Balance c/d Particular Cr. Amount $ 110 110
Insurance Premium Account Dr. Date Oct-07 4 To Cash A/c Particular Amount $ 40 40 Date Oct-07 31 By Balance c/d Particular Cr. Amount $ 40 40
Rent Account Dr. Date Oct-07 28 To Bank A/c Particular Amount $ 100 100 Date Oct-07 31 By Balance c/d Particular Cr. Amount $ 100 100
Interest Account Dr. Cr.
Page 102
Date Oct-07 31
Particular
Amount $
Date Oct-07 31
Particular
Amount $
To Balance c/d
80 80
By Bank A/c
80 80
Trial Balance As on October 31, 2007 Particulars Dr. $ Capital Account Beginning Inventory (1st October 2007) Furniture & Fittings Depreciation on Furniture Accumulated Depreciation Stationery and Postage A/c Wages A/c Municipal Taxes Insurance Premium Rent A/c Interest A/c Accounts Receivable (1270+860+2480+380) Accounts Payable (1,790+3,640+2,490+1,570+1,740) 8,430 4,000 220 100 240 110 40 100 4,990 Cr. $ 18,170 220 80 11,230
Page 103
Purchases A/c Sales A/c Cash Bank Discount Received Discount Allowed A/c
11,450 610 10,870 350 41,510
10,620 1,190 41,510
Note: Balances of various debtors account are summed up and shown as Accounts Receivable in the Trial Balance. Similarly, balance of various creditors accounts are summed up and shown as Accounts Payable in the Trial Balance.
Income Statement for the year ended 31st October 2007 $ Sales Less: COGS Gross Income Less: Administrative & Selling Expense/(Income) Stationery and Postage A/c Municipal Taxes Insurance Premium Rent A/c Interest A/c Depreciation on furniture & fittings (100) (110) (40) (100) 80 (220) $ 10,620 (8,120) 2,500
Page 104
Discount Received Discount Allowed A/c Net Income
1190 (350) 350 2,850
Note: Cost of Goods Sold $ Material Consumed Beginning Inventory Add: Purchases Less: Ending Inventory Direct Labor (Wages) Direct Cost 8430 11,450 -12,000 7,880 240 3690 $
Balance Sheet as on 31st October 2007 Assets Current Assets Cash Bank Inventory Account Receivables 610 10,870 12000 4990 Current Liabilities Accounts Payables 11,230 $ Liabilities/Equity Owners equity Capital Retained Earnings 18,170 2850 $
Page 105
Non-Current Assets Non-Current Liabilities Furniture & Fittings 4,000 Less: Accumulated Depreciation 220 -
3780 32,250 32,250
Subsidiary Book
Illustration 1
Record the following transactions: a) In subsidiary books and post them into ledger b) Prepare a trail balance c) Prepare Income Statement and Balance Sheet
June 2007 1 3 4 7 9 12 15 18 Cash: $15,700;Bank:$25,400;Capital:$41,100 Purchased goods for cash $4,100 Purchased goods from Mahesh & Co. for $5,800 less 10% trade discount Sold goods to Bindia & Co. for $8,900 less 20% trade discount Withdrew $500 from bank for private use Sold goods to Amjad for $6,400 $5,000 paid to Mahesh & Co. in full settlement of their account. Goods worth $400 returned by Amjad.
Page 106
20 21 23 24 26 28 29 30 30 30 30 30 30 30 30
Received $4,000 from Amjad Purchased goods form Shiv & Co. $8,700 $6,000 paid to Shiv & Co. by cheque; discount allowed $300 Purchased furniture of $800 form Surjeet furniture House on credit Paid into bank $2,200 Amjad declared insolvent; only 50% of the dues has been collected from him. Goods worth $600 returned to Shiv & Co. Goods worth $400 taken by the proprietor Interest on capital provided $411 Paid $500 or advertisement by cheque Cash salaries to staff $1,800 Cash sales $21,800 Paid into bank $20,000 Purchased 100 shares in Hindi mills Ltd. at $11 per share brokerage paid $25. Received $5,900 from Bindia & Co., discount allowed $100
Closing Inventory $ 2,000
Solution Journal Date June 2007 1 Cash A/c Bank A/c Finance Center of Excellence Dr. Dr. Particulars L.F. $ 15,700 25,400 Page 107 Dr. $ Cr.
To Capital A/c (Previous year balance has been brought to current year.) 24 Furniture A/c To Surjeet Furniture House A/c (Furniture purchased on credit) 28 Bad debts A/c To Amjad A/c (50% of the amount due written off as bad debt o Amjad becoming insolvent.) 30 Interest on Capital A/c To Capital A/c (Interest on capital provided.) 30 Drawings A/c To Purchases A/c (Goods taken for personal use of the owner.) 30 Capital A/c To Drawings A/c (Drawing account balance transferred to capital account.) 44,611 Dr. 900 Dr. 400 Dr. 411 Dr. 1,000 Dr. 800
41,100
800
1,000
411
400
900
44,611
Sales Book Date June 2007 7 Bindia & Co.: Goods sold 8,900 Particulars L.F. $ $
Page 108
Less: 20% Trade Discount 12 30 Amjad Sales Account
1,780
7,120 6,400 13,520
Purchase Book Date June 2007 4 Mahesh & Co.: Goods Purchases Less: 10% Trade Discount 21 30 Shiv & co. Purchases Account 5,800 580 5,220 8,700 13,920 Particulars L.F. $ $
Sales Returns Book Date June 2007 18 30 Amjad Sales Return Account Particulars L.F. $ Dr. $ 400 400 Cr.
Purchase Returns Book Date June 2007 29 30 Shiv & Co. Purchases Return Account Particulars L.F. $ Dr. $ 600 600 Cr.
Page 109
CASH BOOK Receip ts Disco unt $ June 07 To Balanc e c/d To Amjad To Cash To Amjad To Sales Disco unt $ June 2007
Date
L.F
Cash $
Bank $
Date
Payments
L.F.
Cash $
Bank $
15,700
25,400
By Purchases By Drawings By Mahesh & Co. By Shiv & Co.
4,100
20
4,000
500
26
2,200
15
220
5,000
28
1,000
23
300
6,000
30
21,800
26
By Bank By Advertisem ent
2,200
30
To Cash To Bindia & Co.
20,000
30
500
30
100
5,900
30 30
By Salaries By Bank By Investment in Shares By Balance c/d
1,800 20,000
30
1,125
30
14,175
40,600
Page 110
100 To Balanc e b/d
48,400
47,600
520
48,400
47,600
Jul07
14,175
40,600
Ledger Capital Account Dr. Date Jun-07 30 To Drawings 30 To Balance c/d 900 40,611 41,511 1st July-07 By Balance b/d Particulars J.F. $ Date Jun-07 1 30 By Balance c/d By Interest on Capital 41,100 411 41,511 40,611 Particulars Cr. J.F. $
Furniture Account Dr. Date Jun-07 To Surjeet 24 Furniture House 30 To Balance b/d Particulars J.F. $ Date Jun-07 Particulars J.F. Cr. $
800 800
30
By Balance c/d
800
Surjeet furniture House Finance Center of Excellence Page 111
Dr. Date Jun-07 30 To Balance c/d 800 Particulars J.F. $ Date Jun-07 24 1st July07 By Furniture Particulars J.F.
Cr. $
800
By Balance b/d
800
Bad Debts Account Dr. Date Jun-07 28 To Amjad 1,000 Particulars J.F. $ Date Jun-07 30 By Profit & Loss 1,000 Particulars J.F. Cr. $
Amjad Account Dr. Date Jun-07 12 To sales 6,400 Particulars J.F. $ Date Jun-07 18 20 28 28 6,400 By Sales Return By cash By cash By Bad Debts 400 4,000 1,000 1,000 6,400 Particulars J.F. Cr. $
Page 112
Drawings Account Dr. Date Jun-07 9 To Bank 30 To Purchases 500 400 900 900 Particulars J.F. $ Date Jun-07 30 By Capital 900 Particulars J.F. Cr. $
Purchases Account Dr. Date Jun-07 3 To cash To Amount as per Purchases 30 Book 4100 Particulars J.F. $ Date Jun-07 30 By Drawings 400 Particulars J.F. Cr. $
13,920 18,020
30
By Profit & Loss
17,620 18,020
Bindia & Co. Account Dr. Date Particulars J.F. $ Date Particulars J.F. Cr. $
Jun-07 7 To Sales 7,120
Jun-07 30 30 By Cash By Discount 5,900 100 Page 113
30 7,120
By Balance c/d
1,120 7,120
Interest on Capital Account Dr. Date Jun-07 30 To Capital 411 Particulars J.F. $ Date Jun-07 30 By profit & Loss 411 Particulars J.F. Cr. $
Shiv & Co. Account Dr. Date Jun-07 23 23 To Bank To Discount To Purchases 29 Return 30 To Balance c/d 6,000 300 Particulars J.F. $ Date Jun-07 21 By Purchases 8,700 Particulars J.F. $ Cr.
600 1,800 8,700 1st July07 8,700
By Balance b/d
1,800
Sales Account
Page 114
Dr. Date Jun07 To Profit & Loss Particulars J.F. $ Date Particulars J.F. $
Cr.
Jun-07
30
35,320
30
By Cash By Amount as per Sales Book
21,800
30 35,320
13,520 35,320
Mahesh & Co. Account Dr. Date Jun07 15 15 To cash To Discount 5,000 220 5,220 5,220 Particulars J.F. $ Date Particulars J.F. $ Cr.
Jun-07 4 By Purchases 5,220
Sales Return Account Dr. Cr.
Date Jun07
Particulars
J.F.
Date
Particulars
J.F.
Jun-07
Page 115
30
To Amount as per Sales Return Book
400
By Profit & 30 Loss
400
Purchases Returns Account Dr. Date Jun07 Particulars J.F. $ Date Particulars J.F. $ Cr.
Jun-07 By Amount as per Purchase Return Book
To Profit & 30 Loss
600
30
600
Advertisement Account Dr. Date Jun07 Particulars J.F. $ Date Particulars J.F. $ Cr.
Jun-07 By Profit & 30 Loss
30
To Bank
500
500
Salaries Account Dr. Date Jun07 Finance Center of Excellence Particulars J.F. $ Date Particulars J.F. $ Cr.
Jun-07 Page 116
30
To Cash
1,800
By Profit & 30 Loss
1,800
Investment in Shares Account Dr. Date Jun07 30 1st July07 To Cash 1,125 Particulars J.F. $ Date Particulars J.F. $ Cr.
Jun-07 30 By Balance c/d 1,125
To Balance b/d
1,125
Discount Allowed Account Dr. Date Jun07 To Amount as per Cash Book Particulars J.F. $ Date Particulars J.F. $ Cr.
Jun-07 By Profit & 30 Loss
30
100
100
Discount Receivable Account Dr. Date JunFinance Center of Excellence Particulars J.F. $ Date Jun-07 Particulars J.F. $ Cr.
Page 117
07 To Profit & 30 Loss By Amount as per Cash Book
520
30
520
Trail Balance as on June 30, 2007 S. No. Name of Account Dr. $ 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Capital Account Furniture Account Surjeet furniture House Bad Debts Account Amjad Account Purchases Account Bindia & Co. Account Interest on Capital Account Sales Shiv & Co. Account Sales Return Account Purchases Returns Account Advertisement Account Salaries Account Investment in Shares Account Discount Allowed Account Discount Receivable Account 800 1000 17620 1120 411 400 500 1800 1125 100 Cr. $ 40,611 800 35320 1800 600 520 Page 118
18 19
Cash Bank Total
14175 40600 79651
79651
Income Statement for the year ended 31st December 2007 Particulars Dr. $ Sales Less: Sales Returns Cr. $ 35,320 400 34,920 Less: Cost of Goods Sold (Note) Gross Income Less: Administrative and Selling Expenses/(Income) salaries Bad Debts Interest on Capital Advertisement Expenses A/c Discount Allowed Account Discount Receivable Account Net income 1,800 1,000 411 500 100 -520 3,291 16,609 15,020 19,900
Note: Cost of Goods Sold
Page 119
$ Material Consumed Beginning Inventory Add: Purchases Less: Purchases Returns Less: Ending Inventory Direct Labor Direct Cost 17,620 -600 -2,000
15,020 15020
Balance Sheet as on 31st December 2007 Assets Current Assets Cash Bank Ending Inventory Accounts Receivables Bindia & Co. Account 1,120 14175 40600 2,000 1,120 Current Liabilities Accounts Payable Surjeet furniture House 800 Non-Current Assets Furniture Investment in Shares Account 800 1,125 Shiv & Co. Account 1,800 2,600 $ Liabilities/Equity Owners equity Capital Retained earnings 40,611 16,609 $
Page 120
Non-Current Liabilities 59820
59820
Rectification of Errors
Illustration 1
Book the rectification entry for the below items: a) $500 paid for furniture purchased has been charged to ordinary Purchases A/c. b) Repairs made were debited to Building A/c for $50. c) $100 paid for rent debited to Landlords A/c. d) $700 Paid in cash for a typewriter was charged to Office Expenses Account. e) A Purchase of goods from Ram amounting to $150 on credit has been wrongly treated as sales transaction. f) A Credit sale of goods amounting $120 to Ramesh has been wrongly treated as a purchased transaction. g) On 1st Dec. 2007, a credit sale for goods worth $300 has been made to Hari and the sales transaction has been booked on that day. On 31st Dec.2007, Hari has returned all the goods and the goods were taken into stock on the same date but no entry was passed in the books. h) An amount of $200 due from Mahesh Chand, which had been written off as a Bad Debt in a previous year, was unexpectedly recovered, and had been posted to the personal account of Mahesh Chand. i) A Cheque for $100 received form Man Mohan was dishonoured and had been posted to the debit of Sales Returns Account. Solution: a) $500 paid for furniture purchased has been charged to ordinary Purchases A/c. Wrong entry Finance Center of Excellence Correct entry Rectification entry Page 121
Dr. Purchases Account 500 Cr. Cash Account 500
Dr. Furniture Account Cr. Cash Account
500 500
Dr. Furniture Account Cr. Purchases Account
500 500
b) Repairs made were debited to Building A/c for $50. Wrong entry Dr. Building Account Cr. Cash Account 50 50 Correct entry Dr. Repairs Account Cr. Cash Account 50 50 Rectification entry Dr. Repairs Account Cr. Building Account 50 50
c) $100 paid for rent debited to Landlords A/c. Wrong entry Dr. Landlord's Account Cr. Cash Account 100 100 Correct entry Dr. Rent Account Cr. Cash Account 100 100 Rectification entry Dr. Rent Account Cr. Landlord's Account 100 100
d) $700 Paid in cash for a typewriter was charged to Office Expenses Account. Wrong entry Correct entry Rectification entry Dr. Typewriter Account 700 Cr. Office Expenses Account 700
Dr. Office Expenses Account 700
Dr. Typewriter Account 700
Cr. Cash Account
700
Cr. Cash Account
700
e) A Purchase of goods from Ram amounting to $150 on credit has been wrongly treated as sales transaction. Wrong entry Dr. Ram A/c 150 Cr. Sales A/c 150 Correct entry Dr. Purchases A/c 150 Cr. Ram A/c 150 Rectification entry Dr. Sales Dr. Purchases 150 150 Page 122
Cr. Rams A/c 300
f) A Credit sale of goods amounting $120 to Ramesh has been wrongly treated as a purchased transaction. Wrong entry Dr. Purchases A/c 120 Cr. Rameshs A/c 120 Correct entry Dr. Ramesh A/c Cr. Sales A/c 120 120 Rectification entry Dr. Rameshs A/c Cr. Sales A/c Cr. Purchases A/c 240 120 120
g) On 1st Dec. 2007, a credit sale for goods worth $300 has been made to Hari and the sales transaction has been booked on that day. On 31st Dec.2007, Hari has returned all the goods and the goods were taken into stock on the same date but no entry was passed in the books. Wrong entry Correct entry Rectification entry Dr. Sales Return A/c Cr. Hari A/c 300 300
h) An amount of $200 due from Mahesh Chand, which had been written off as a Bad Debt in a previous year, was unexpectedly recovered, and had been posted to the personal account of Mahesh Chand. Wrong entry Dr. Cash A/c 200 Correct entry Dr. Cash A/c Cr. Bad Debt recovered Cr. Mahesh Chand A/c 200 A/ c 200 Cr. Bad Debt Recovered A/c 200 200 Rectification entry Dr. Mahesh Chand A/c 200
i) A Cheque for $100 received form Man Mohan was dishonored and had been posted to the debit of Sales Returns Account. Wrong entry Finance Center of Excellence Correct entry Rectification entry Page 123
Dr. Sales Return A/c 100 Cr. Bank A/c 100
Dr. Man Mohan A/c Cr. Bank A/c
100 100
Dr. Man Mohan A/c Cr. Sales Return A/c
100 100
Illustration 2
Flame started business on 1st October, 2007. On that date he possessed machinery valued at $1,200 and Bank balance of $5,500. This bank balance includes $1,000 borrowed from bank. Flame's transactions during October, 2007, were as follows: Date Oct-07 1 2 4 5 6 8 11 12 16 17 19 22 23 Drew cheque for use in office Purchased 50 units of goods from B.Nutwell @ $50 per unit Paid cash for stationery Sold on credit to G.Norwood 16 units of goods @ $20 per unit Sold for cash 5 units of goods @ $20 per unit Paid Wages Purchased on credit from B.Farmer 15 units of goods @ $8 per unit Paid by cheque to B.Nutwell the amount due less 5 percent cash discount G.Norwood paid his account by cheque less 2.5 per cent cash discount Paid rent out of cash Purchased on credit from Cardiff Coal Co. 20 units of goods @ $40 per unit Sold on credit to Bracebridge Mills Ltd., 10 units of goods @$60 per unit Returned to B.Farmer 5 units of goods purchased on 11th October 100 25 50 Particulars Amount $ 250
Page 124
26 31
Cardiff coal Co. allowed $15 for short weight in coal purchased from them Paid salaries out of bank 150
Flame has posted the above transactions in ledger and prepared the trail balance but the debit and credit side of trail balance are not in balance. You are required to locate the errors and make the Trial Balance agree.
Cash A/c Dr. Date Oct-07 1 6 To Bank To sales 250 100 Particulars J.F. $ Date Oct-07 4 17 31 350 By Stationery By Rent By Balance c/d 50 100 200 350 Particulars J.F. Cr. $
Bank A/c Dr. Date Oct-07 1 16 To capital To G. Norwood 5,500 312 Particulars J.F. $ Date Oct-07 1 12 31 31 By cash By B. Nutwell By Salaries By Balance c/d 250 2,375 150 2,537 Particulars J.F. Cr. $
Page 125
5812
5812
Purchases A/c Dr. Date Oct-07 11 19 2 To B. Farmer To Cardiff Coal Co. To B. Nutwell 120 800 2,500 3,420 3,420 Particulars J.F. $ Date Oct-07 26 31 By Cardiff Coal Co. By Profit & Loss 15 3,405 Particulars J.F. Cr. $
Sales A/c Dr. Date Oct-07 31 To Profit & Loss 1,020 Particulars J.F. $ Date Oct-07 5 6 By G. Norwood By cash By Bracebridge Mills Ltd. 320 100 Particulars Cr. J.F. $
22 1,020
600 1,020
B.Farmer A/c Dr. Date Particulars J.F. $ Date Particulars J.F. Cr. $
Page 126
Oct-07 To Purchases Returns To Balance c/d
Oct-07
23 31
40 80 120
11
By Purchases
120
120
B. Nutwell A/c Dr. Date Oct-07 2 12 To Purchases To Bank To Discount Received 2,500 2,375 Particulars J.F. $ Date Oct-07 31 By Balance c/d 5,000 Particulars J.F. Cr. $
12
125 5,000 5,000
G. Norwood A/c Dr. Date Oct-07 5 To sales 320 Particulars J.F. $ Date Oct-07 16 16 320 By Bank By Discount Allowed 312 8 320 Particulars J.F. Cr. $
Cardiff Coal Co. A/c Finance Center of Excellence Page 127
Dr. Date Oct-07 26 31 To Purchases To Balance c/d 15 785 800 Particulars J.F. $ Date Oct-07 19 By Purchases Particulars J.F.
Cr. $
800
800
Capital A/c Dr. Date Oct-07 31 To Balance c/d 6,700 Particulars J.F. $ Date Oct-07 1 1 6,700 By Bank By Horse & Cart 5,500 1,200 6,700 Particulars J.F. Cr. $
Machinery A/c Dr. Date Oct-07 1 To capital 1,200 Particulars J.F. $ Date Oct-07 31 By Balance c/d 1,200 Particulars J.F. $ Cr.
Wages A/c Dr. Date Particulars J.F. $ Date Particulars Cr. J.F. $ Page 128
Oct-07 8 To cash 25
Oct-07 31 By Profit & Loss 25
Stationery A/c Dr. Date Oct-07 4 To cash 50 Particulars J.F. $ Date Oct-07 31 By Profit & Loss Particulars J.F. $ Cr.
Rent Dr. Date Oct-07 17 By Rent 100 Particulars J.F. $ Date Oct-07 31 By Profit & Loss 50 Particulars J.F. $ Cr.
Salaries A/c Dr. Date Oct-07 31 To Bank 150 Particulars J.F. $ Date Oct-07 31 By Profit & Loss 150 Particulars J.F. $ Cr.
Discount Received A/c Dr. Finance Center of Excellence Cr. Page 129
Date Oct-07
Particulars
J.F.
Date Oct-07
Particulars
J.F. $
31
To Profit & Loss
1,250
12
By B. Nutwell
1,250
Discount Allowed A/c Dr. Date Oct07 16 To G. Norwood 8 Particulars J.F. $ Date Particulars J.F. $ Cr.
Oct-07 31 By Profit & Loss 8
Bracebridge Mills Ltd. A/c Dr. Date Oct-07 22 To sales 600 Particulars J.F. $ Date Oct-07 31 By Balance c/d 600 Particulars J.F. $ Cr.
Purchases Returns A/c Dr. Date Oct-07 To Profit & Loss Particulars J.F. $ Date Oct-07 Particulars J.F. $ Cr.
31
40
23
By B. Farmer
40
Page 130
Trail Balance as on 31st October 2007 Particulars Dr. $ Capital A/c Horse & Cart A/c B.Farmer Cardiff Coal Co. Bracebridge Mills Ltd. Purchases A/c Sales A/c B. Nutwell Wages A/c Rent A/c Salaries A/c Purchase Returns Cash Bank Discount Allowed Discount Received Total 1,200 3,405 5,000 25 50 150 200 2,537 8 12,575 Cr. $ 6,700 80 785 600 1,020 40 1,250 10,475
Solution: Trail Balance as on 31st October 2007 (Rectified)
Page 131
Particulars
Dr. $
Cr. $ 5,700 1,000
Capital A/c (Note 8) Bank Loan (Note 8) Horse & Cart A/c B.Farmer Cardiff Coal Co. Bracebridge Mills Ltd (Note 7) Purchases A/c Sales A/c B. Nutwell (Note 2) Stationery A/c (Note 3) Wages A/c Rent A/c (Note 4) Salaries A/c Purchase Returns Cash (previously reported as 200) (Note 5) Bank (previously reported as 2,537) (Note 1) Discount Allowed Discount Received(previously reported as 1,250) (Note 6) Total
1,200 600 3,405 50 25 100 150 175 3,037 8
80 785 1,020 40 125
8,750
8,750
Notes:
Page 132
The closing balance for bank account should be 3037 but its wrongly entered in the trail balance as 2537 which is causing the difference of $500. 2. Amount purchased from B.Nutwell of $2,500 has been wrongly debited in his account. There will not any balance in his account as we have made the payment to him. Correct Entry Rectification entry Wrong Entry B. Nutwell Dr. 2,500 To Purchases 2,500 Purchases Dr. 2,500 2,500 Purchases Dr. 5,000 5,000
1.
To B. Nutwell
To B. Nutwell
Stationery purchased for $50 has not been recorded in trail balance. $100 has been paid as rent but by mistake only 50 have been taken to trail balance. $25 paid as wages is not recorded in cash account. To rectify the mistake, debit $25 in the cash account as wages. After rectification, the closing balance of cash will be reduced from $200 to $175. 6. Discount received from B. Nutwell is $125 but wrongly recorded as 1,250 in the discount received account. 7. Amount due from a customer Bracebridge Mills Ltd. $600 is wrongly entered in the credit side of trail balance. 8. Capital balance should be only 4,500 because $1,000 is a borrowed amount which should be shown as a bank loan. Wrong Entry Correct Entry Rectification entry Bank Dr. 5,500 To Capital 5,500 Bank Dr. 5,500 To Capital 4,500 Capital Dr. 1,000
3. 4. 5.
To Bank Loan 1,000
To Bank Loan 1,000
Bank Reconciliation Statement

Illustration 1 Prepare the bank reconciliation statement with the help of below information: PASS BOOK Date Jan 2006 2 4 4 10 12 Details Withdrawals Deposits Dr. Cr. $ $ 4,000 600 1,250 350 1,000 Balance $ 4,000 3,400 2,150 2,500 1,500 Page 133
By Cash To Furniture Dealers Ltd. To D Ltd. By Johns cheque To Roy
15 16 20 26 31 31 31
By B Ltd.s cheque By cash To Cash By Jacks cheque To Premium paid as per standing instructions To Bank charges To Interest collected on Government Securities
760 300 500 430 250 10 200
2,260 2,560 2,060 2,490 2,240 2,230 2,430
Date 2006 Jan. 1 Jan. 2 Jan. 8 Jan. 10 Jan. 16 Jan. 20 Jan. 22 Feb. 1
Particulars
To Cash To John To B Ltd. To cash To Jack To Mike To Bob To Balance b/d
CASH BOOK (Bank Column only) Amount Date Particulars $ 2006 4,000 Jan. 2 By Furniture Dealers Ltd. 350 Jan. 2 By Roy 760 Jan. 2 By D Ltd. 300 Jan. 4 By Ram 430 Jan. 17 By Cash 1,050 Jan. 20 By B Ltd. 340 Jan. 31 By Balance c/d 7,230 2,370
Amount $ 600 1,000 1,250 730 500 780 2,370 7,230
Solution Bank Reconciliation Statement As on 31st January 2006 Particulars Balance as per Pass Book Add: Cheque paid not yet credited: Mike Bob Add: Premium paid and bank charges entered in Pass book but not yet entered in Cash book Less: Cheques issued but not yet presented: Ram B Ltd. Less: Interest credited by bank but not yet entered in Cash Book Balance as per Cash Book
$ 2,430
1,050 340
1,390 260 4,080
730 780
1,510 2,570 200 2,370
Page 134
OR Particulars Balance as per Cash Book Add: Cheques issued but not yet presented: Ram B Ltd. Add: Interest credited by bank but not yet entered in Cash Book $ $ 2,370
730 780
1,510 200 4,080
Less: Cheque paid not yet credited: Mike Bob Less: Premium paid and bank charges entered in Pass book but not yet entered in Cash book Balance as per Pass Book
1,050 340
1,390 2,690 260 2,430
Illustration 2 From the following transaction prepare a bank reconciliation statement as on August 31, 2008. a) Bank balance as per Cash Book $8,000 b) Cheques of $1,000; $2,000; and $3,000 issued on 8th, 10th, and 13th August. Out of these cheques, only the cheque issued on the 10th August presented for payment till 31st August. c) Interest and dividend collected by the banker on 25th August and informed the customer on 1st September: $500 d) Cheque of $3,300 deposited into bank of which a cheque of $2,300 only collected in August. e) A cheque of $2,000 received and debited in cash book but not sent to bank till 31st August. f) The following entries found in the Pass book only: Interest on bank balance $250 Electricity bill paid $400 Commission charged $50 Solution Bank Reconciliation Statement As on 31st August 2008 Particulars Balance as per Cash Book Add: Cheques issued but not yet presented ($1,000+$3,000) Add: Interest and dividend collected by bank but not recorded in the cash book Add: Interest on bank balance found credited in the pass book Less: Cheque deposited but not yet collected by the bank ($3,300-$2,300) Finance Center of Excellence $ 4,000 500 250 1,000 Page 135 $ 8,000
4,750
Less: Cheque received and debited in the cash book but not sent to bank Less: Electricity bill paid by the bank and credited in the passbook Less: Commission paid by bank and recorded in the pass book Balance as per Pass Book
2,000 400 50
3,450 9,300
Page 136

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Finance & Accounts Training Fundamentals of Accounting

Infosys BPO Bangalore

Finance Center of Excellence

Finance Center of Excellence

Non Current Assets ............................................................................................................................. 58

Finance Center of Excellence

Finance Center of Excellence

Key Accounting Concepts

Finance Center of Excellence

Fundamental Accounting Assumptions

Qualitative characteristics of Financial Statements

Purpose of financial statements

Finance Center of Excellence

Debit the Receiver Credit the Giver

Debit what comes in Credit what goes out

Finance Center of Excellence

Date April-07 30th

Particulars To Amount as per

Ledger Purchases A/c $ Date

Finance Center of Excellence

A Ltd. A/c Date Particulars April-07 4th By Purchases

B Ltd. A/c Date Particulars April-07 15th By Purchases

C Ltd. A/c Date Particulars April-07 28th By Purchases

Net Price 27,000

Sales Tax 2,970

Total Amount 29,970

Finance Center of Excellence

Ledger Sales A/c Date April-07 30th

Particulars By Amount as per Sales Book

Date April-07 2nd 2nd

Particulars To Sales To Sales Tax Payable

Date April-07 10th 10th

Particulars To Sales To Sales Tax Payable

Date April-07 15th 15th

Particulars To Sales To Sales Tax Payable

Illustration Finance Center of Excellence Page 16

Solution CASH BOOK Payme nts Disco unt $

Jan. 2007 1 To capital 3 To Cash To Kirti & 4 Co. 7 To Cash 12 To Tripathi

19,000 600 1,000 Page 17

Finance Center of Excellence

To Bank C To Commission To Kesri & Co.

50 375 25 125 300 600 22,075

200 250 300 400 1,575 18,245 21,575

Finance Center of Excellence

To Unearned Rent Account

Finance Center of Excellence

Components of Financial Statements

Sales Cost of Goods Sold

Gross Profit Selling & Administrative Expenses

Earnings Before Interest & Taxes Interest

Finance Center of Excellence

Taxable Income Taxes

Net Income Dividends

Transfer to Retained Earnings

(i) (ii) (iii)

Assets, Liabilities, and Owner equity.

$ 100,000 150,000 250,000

300,000 550,000 843,000

Income taxes paid Net cash from operating activities

98 3 -50 -11 -3 -4 -11 22

-10 -20 Page 25

10 -20 -2 -12 4 16 $20

900 22,100 300 500 590 Page 26