BAD DEBTS AND PROVISION FOR DOUBTFUL DEBTS

Bad debts
The amount of the debtors which cannot be recovered is known as bad debt. At the end the
accounting year, the amount of bad debt is shown as an expense in the profit & loss account
and deducted from the debtors. The double entry for recording the bad debt is:
Debit Bad debt account
Credit Debtors account

At the end of the year, while preparing the final accounts, the bad debt account is transferred
to the profit & loss account by passing the following adjustment entry:
Debit Profit & loss account
Credit Bad debt account

Provision for bad debts (Provision for doubtful debts)

The provision created to cover the next year’s bad debt expense out of the current year’s
debtors is known as provision for bad debts. This provision is created on the debtors after
deducting the current year’s bad debt. The double entries required forcreating the provision
for bad debt are:

First year Debit Profit & loss account and

Credit Provision for bad debts account.

Second year and subsequent years:

For an increase in the provision for bad debt:

Debit Profit & loss account and (with the amount increased)
Credit Provision for bad debts account.

For a decrease in the provision for bad debt:

Debit Provision for bad debt account and
Credit Profit & loss account
The amount of decrease in the provision for bad debt is shown as an income in the profit and
loss account
While preparing the balance sheet, always the new provision for bad debt is deducted from
the amount of debtors.

Provision for discount on debtors

This is the provision created to cover the expense of discount that may be allowed to the
debtors during the coming year when they pay their debt on time. The increase in the
provision for discount on debtors is also shown as an expense in the profit & loss account and
the new provision for discount on debtors is deducted from the debtors in the balance sheet.
The amount of provision for decrease in the provision for discount on debtors is shown as an
income in the profit & loss account.

The double entries required for the provision for bad debt are:

During the first year to create the provision for discount on debtors:
Profit & loss account Dr
Provision for discount on debtors account Cr

During the subsequent years, for an increase in the provision for discount on debtors:

Profit & loss account Dr.

Provisions for discount on debtors account Cr.

For a decrease in the provision for discount on debtors:

Provisions for discount on debtors account Dr.

Profit & loss account Cr.
Key points
 A debt written off is recorded in the books by debiting bad debts account and
crediting debtors account.
 The provision for bad debt is calculated on the debtors’ balance obtained after
deducting the bad debt written off.
 In the balance sheet, always the new provision for bad debt is deducted from the
Debtors.
 Increase in the provision for bad debt is debited in the profit & loss account and
credited in the provision for bad debt account.
 Decrease in the provision for bad debt is credited to profit & loss account and debited
in the provision for bad debt account.
 Increase in the provision for bad debt is an expense and decrease in the provision for
bad debt is an income to be shown to in the profit & loss account.
 The provision for discount on debtors is calculated on the debtors balance after
deducting the bad debt and the provision for bad debt amount.
 Always new provision for discount on debtors is deducted from debtors, after
deducting the provision for bad debt.
 Increase in the provision for discount on debtors is debited to profit & loss account
and credited to provision for discount on debtors account.
 Decrease in the provision for bad debt is debited to provision for discount on debtors
account and credited to profit & loss account.
 Increase in the provision for discount on debtors is an expense and decrease in the
provision for discount on debtors is an income to be shown in the profit & loss
account.
Thursday, January 5, 2012
ACCOUNTING FOR NON TRADING CONCERNS

The business concerns are of two types: Trading concerns and non trading concerns.
Trading concerns are existing for the purpose of earning profit. But non trading concerns are
existing for the purpose of rendering service to the public. E.g. of such concerns are clubs,
societies, libraries etc. At the end of an accounting year the trading concerns prepare final
accounts such as trading and profit and loss account and balance sheet. But non trading
concerns prepare the following at the end of its accounting year:

a. Receipts and Payments accounts - it is summary of cash transactions of a non trading

concern. It shows all receipts and payments during a year and the final balance of cash
in hand or at bank or balance of bank overdraft. It is the cashbook prepared by a non
trading concern.

b. The income and expenditure account- this is similar to the profit and loss account
prepared by a trading concern. It lists all the incomes and expenses of the non trading
organization for a year. The result of this account is referred to assurplus or excess of
income over expenditure or deficit or excess of expenditure over income. When
the income is more than the expenditure the result is known as surplus. When the
expenditure is more than the income, the result is known as deficit. It is prepared by
considering all expenditures and incomes relating to the current year whether it is paid
or not.

c. Balance sheet- the balance sheet is prepared as in the case of a trading concern. But
the excess of assets over liabilities of a non trading concern is known as accumulated
fund. The surplus from income and expenditure account is added to and the deficit is
deducted from accumulated fund.
Difference between receipts and payments account and incomes and expenditure
account.
Receipts and payments account Income and expenditure account
1 It is the cash book prepared by a 1 It is the profit and loss account
non trading concern prepared by non trading concern

It records all receipts and 2 It records only incomes and

payments of cash and cheque only expenditures during the current year
 3 It records receipts and 3 It records incomes and expenditures
payments without considering relating to the current year only
whether for current year or
previous year or for next year
4 The balance in this account is 4 The balance in this account represents
either cash in hand or cash at surplus or deficit
bank or balance of bank overdraft

Trading account
Some non-trading organizations do carry out regular trading activity, but this is not the main
purpose of the organization. Many clubs and societies have a café, a shop, a bar and so on,
where goods are bought and sold. A trading account should be prepared for each trading
activity in order to calculate the gross profit or loss earned. The gross profit or loss of a
trading activity of a non- trading concern is transferred to the income and expenditure
account. If it is gross profit, it is shown as income and if it is gross loss, shown as expenditure
in the income and expenditure account.

Key points
 Accumulated fund on the opening date = total assets on the opening date – total
liabilities on the opening date. It can be calculated by preparing an opening statement
of affairs (balance sheet format) on the opening date, as a balancing figure.
 While preparing the trading account of bar or any other trading activity, if the
purchase figure is not given, it can be calculated as :-
Purchases = closing creditors + payments to creditors – opening creditors.
 The profit or loss as a result of sale of a fixed asset should be shown as income (if
profit ) or expenditure( if loss) in the income and expenditure account.
 Usually the depreciation on fixed assets will be calculated by comparing the opening
and closing values.
 The surplus is added with accumulated fund and deficit is deducted from accumulated
fund.
 The stock items from trading activity are shown as current assets in the balance sheet.
 The subscription is one of the most important incomes for a non-trading concern. It
may be given as a single amount or separately for three years (for last year, this year
and next year)
If it is given as a single amount, to find out the amount of subscription to be shown in the
income and expenditure account, use the following formula:
Thursday, January 5, 2012
TRADING AND PROFIT AND LOSS ACCOUNT

Final Accounts of sole Traders: show the calculation of profit earned or the loss incurred
during the period and the financial position of the business at the end of the period. Final
accounts usually prepared from a trial balance.

1. Trading Account: deals with trading (buying and selling). The account shows the
calculation of profit earned on goods sold.

Gross Profit = Sales – Cost of Goods Sold

Cost of goods sold = opening stock + purchases + carriage inwards - closing
stock

Drawings of goods for personal use is deducted from

purchases
Carriage inwards is added to the purchases

2. Profit and Loss Account: shows the calculation of final or true profit. This is the profit
after all running expenses and any other items of income.
Net Profit = Gross profit + other incomes - Expenses

Specimen of Profit and Loss Account

Amount
Sales – Sales Returns X
Less: Cost of goods sold:
Opening stock of goods X
Add: Purchases X (-)
 Add: Carriage inwards/Carriage on purchases X

Less: Closing stock X Xx

Gross Profit
Add: Rent received Xx
Add: Discount received Xx
Add: Commission received Xx
Add : Decrease in provision for bad debts Xx

xxx
Less: Expenses:
Rent paid + Accrued/unpaid X
Salary paid + Accrued/ unpaid X
Bad debt X
General expenses X
Office expenses X
Insurance – prepaid/ paid in advance X (-)
Increase in provision for bad debts X
Depreciation of fixed assets X
Bank charges X
Loan interest paid X
Repairs to building X
Delivery van expenses x xxx

Net profit for the year transferred to capital a/c in xxx

the balance sheet

3. Balance Sheet: is a statement of the financial position of the business on a certain date. It
shows what the business owns, and amounts owing to the business- the assets and what
the business owes, the liabilities and the capital.
Specimen of Balance Sheet
 Amoun
t

FIXED ASSETS:
Freehold Premises / Land and Buildings X
Equipment less depreciation X
Furniture – (depreciation of current year+ previous years) X
Motor van / Motor vehicle – depreciation X
Goodwill X
CURRENT ASSETS:
Cash in hand/ cash at bank X
Debtors less provision for bad debts X (+)
Closing stock X
Prepaid rent/insurance etc. X
xx
LESS: CURRENT LIABILITIES
Creditors for
goods xx
Creditors for expenses such as accrued rent, delivery van
X Xx
expenses x
x
Xxx
Bank
overdraft
x
WORKING CAPITAL
X
FINANCED BY: X
Capital
Xx
Add: Net profit from P&L account
(+)
x
Less: (Drawings of cash + goods) X
xxx
LONG TERM LIABILITIES
Bank Loan
 Adjustment of items in Final accounts

Items Trading, Profit and Balance Sheet

Loss a/c
1. unpaid expenses + to the expenses Current liability
2. Prepaid expenses - from the expenses Current assets
3. Drawings of goods - from purchases in Added to drawings
trading a/c
4. Bank charges Deducted from cash at
Expenses in profit and bank
5. Provision for bad debts
loss a/c
Deducted from debtors
6. Provision for depreciation on
Expenses
fixed assets Deducted from fixed
Expenses assets
7. Accrued income
Add to the g/p Current asset
8. Purchases, purchase returns,
sales, Trading a/c ……………..
sales returns
9. Discount/commission/rent Added to gross profit ………………
received
Expenses in p&l a/c ……………..
10. Discount allowed, commission
paid, rent,
bad debt, wages, salaries, bank
charges,
general expenses, office ……….. Fixed asset
expenses,
repairs to building
………. Current asset
11. Machinery, equipment,
furniture, ……….. Current liability

premises, land and buildings

12. Cash in hand, debtors, cash at Added to subscriptions Current liability in the
bank in I&E a/c opening b/s

13. Creditors, bank overdraft Deducted from Current liability in the

subscription closing b/s
Club Accounts
Deducted from Current asset in the
subscriptions opening b/s
 1. subscription received in Added to subscriptions Current asset in the
advance at start closing b/s
2. subscription received in
advance at end
3. subscription in arrear in the
beginning
4. subscription in arrear at the end

List of some common Expenses, Income, Assets and Liabilities

EXPENSES. FIXED ASSETS CURRENT LIABILITY

Carriage inwards, carriage Plant and Machinery Creditors for goods
outwards
Land and Buildings Creditors for expenses:
Purchases, wages and
Premises Eg. Rent owing,
salaries,
Equipment Salary accrued
Rent and insurance,
electricity charges, Furniture and Fittings Wages unpaid
advertising charges, bank
charges, Fixtures and Fittings General expenses
unpaid
Discount allowed, bad debts, Lawn Mover
Commission
Depreciation of fixed assets, Computers
outstanding
Provision for bad debts, Motor van/Motor vehicle
Bank overdraft
office expenses, Motor car
[ all unpaid amounts]
Provision for discount on
debtors
General expenses, motor
expenses,
Motor vehicle expenses
Repairs to building or
machinery
Interest on loan
 INCOMES: CURRENT ASSETS LONG TERM
LIABILITIES
Sales, discount received, Cash in hand
Loan from bank
Commission received Cash at bank
Mortgage loans
Interest received rent Debtors
received, Debenture
Closing stock
profit on sale of old fixed
Prepaid rent, insurance,
assets
rates

The trading and profit & loss account and balance sheet prepared at the end of a year is
known as Final accounts. While preparing the final accounts, there may be some items so far
not adjusted. These items are to be adjusted in the final accounts for calculating the correct
profit or loss of the business. The usual adjustments in the final accounts are:

a. Expenses owing: These are the expenses incurred during the year but not paid in cash.
This amount will be paid in the near future (next year). The owing expense is to be added
with the amount of same expense already paid given in the trial balance and it should be
shown in the balance sheet as a current liability.

The double entry for recording the expenses owing is

Debit Expenses account
Credit Expenses owing account

This expense is also known as outstanding expenses, expenses payable or expensepayable.

b. Prepaid expense. : This is the expense paid during the year for the benefit of the next
year. The portion of the expense which is prepaid is to be deducted from the total expenses
already paid during the year (given in the trial balance) and shown as current asset in the
balance sheet.

The double entry for recording the prepaid expense is

Debit Prepaid expense account and
Credit Expense account
This expense is also known as expense paid in advance or unexpired expense

c. Accrued income: The income earned during the year but not received in cash is known as
accrued income. The amount of accrued income is to be considered as current year’s income
and added with the concerned income received during the year (given in the trial balance) and
shown as a current asset in the balance sheet.

The double entry for recording the accrued income is:

Debit Accrued income account and
Credit Income account
The accrued income is also known as outstanding income.

d. Income received in advance: This is the income received during the year for the services
to be rendered during the next year. Since this income is not related to the current year, it
should be deducted from the concerned income (given in the trial balance) and shown as a
current liability in the balance sheet.

The double entry for recording the income received in advance is:
Debit Income account and
Credit Income received in advance
This is also known as unexpired income.
e. Depreciation: The part of the cost of a fixed asset that is consumed by a business during
the period of its use is known as depreciation. It is considered as an expense in the business
therefore shown as an expense in the profit & loss account and deducted from the cost price
of the concerned fixed asset in the balance sheet.

The double entry for recording depreciation is:

Debit Profit & loss account and
Credit Depreciation account

f. Bad debt: The part of the amount of debtors which cannot be recovered is known as bad
debt. It is an expense to be shown in the profit & loss account. If the bad debt appears in the
trial balance, it is known as bad debt written off and shown in the profit & loss account only.
If bad debt information appears among the adjustment points below the trial balance, then it
should be shown as an expense in the profit & loss account and shown as a deduction from
the debtors in the balance sheet under the heading “current assets”.

The double entry for recording the bad debt is:

Debit Bad debt account and
Credit Debtors account
g. Goods drawings by the owner for his personal use:-
The amount of goods withdrawn by the owner for his personal use is to be considered as
drawing.
The double entry for recording the goods drawings is:
Debit Drawings account and
Credit Purchase account or sales account
The amount of goods drawings should be deducted form purchases and capital in the balance
sheet.
MANUFACTURING ACCOUNTS
The businesses which produce and sell the items prepare the following accounts at the end of
its accounting year :-
a. The Manufacturing account (to calculate the total cost of production)
b. The Trading and profit & loss account (to find out the net profit or loss)
c. The balance sheet. (to show the financial position of the business)

The total cost of production = Prime cost + Factory overhead

The Prime cost = Direct material + Direct labour + Direct expenses
Direct material cost = Opening stock of raw materials + purchase of raw materials
+ carriage inwards – returns outwards – closing stock of raw materials.
Factory overhead expenses = All expenses related to the factory (indirect expenses)

The format of a manufacturing account

Manufacturing account for the year ended . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
...

Opening stock of raw materials xxxx

Add purchase of raw materials xxxxx
Add carriage inwards ( if any ) Xxxx
Xxxxx
Less Returns outwards (of raw materials) xxxx
Xxxxx
Less Goods drawings ( if any ) xxxx
xxxxx
Less Closing stock of raw materials xxxx
Cost of Direct Materials xxxxxxx
Add Direct labour xxxxxxx

Add Direct expenses (Eg: royalties) xxxxxxx

Prime Cost xxxxxxx

Add Factory overhead expenses
 Factory lighting xxxxxx
Factory heating xxxxxx

Factory insurance xxxxxx

Factory rent xxxxxx
Factory maintenance xxxxxx
Factory indirect wages xxxxxx
Factory supervisor’s wages xxxxxx (+)
Depreciation on plant & machinery xxxxxx
Depreciation on factory building xxxxxx
Depreciation on factory furniture xxxxxx
Depreciation on factory motor van xxxxxx
Depreciation on other factory fixedassets xxxxxx XXXXXXX
XXXXXXX

Add Opening stock of work in progress xxxxxx

XXXXXXX
Less Closing stock of work in progress xxxxxx

Cost of production XXXXXXX

In a manufacturing concern, usually there are three kinds of stocks:
Stock of Raw materials (the materials which are mainly used for production of the item)
Stock of Work in progress (the materials on which some work process have been completed)
Stock of Finished goods (The materials on which all the production processes are completed
and ready for sale to the customers)

In the examination questions, the stock figures will be given separately.

Format of trading account of a manufacturing concern

Sales of finished goods xxxxx

Less Returns inwards xxxxx

xxxxxx
 Less Production cost of goods sold
Opening stock of finished goods xxxxx

Add Cost of production xxxxxxx (-)

xxxxxx
Less closing stock of finished goods xxxxx

xxxxxxx
Less finished goods drawings by the owner xxxxx xxxxxxx
Gross profit or Gross loss XXXXXX

The profit & loss account and the balance sheet preparations will be the same as that of a
sole trader’s. So the students have to follow the previous method for the preparation of these.
Fixed expenses and Variable expenses
Some expenses will remain constant whether the level of activity increases or falls. These
expenses are called fixed expenses E.g. rent of building
The expenses which change with changes in activity are called variable expenses
E.g: cost of materials.

Key points:
· Carriage on raw materials means carriage inwards and it is a part of prime cost.
· Carriage outwards is shown in the profit & loss account as an expense.
· Royalties paid is to be treated as direct expense.
· Depreciation on Plant and Machinery or any other factory asset is to be treated as
factory overhead expense.
· Stocks of raw materials and work-in-progress are taken in the manufacturing account
and stock of finished goods is taken in the trading account.
· Stocks at the end of the year (raw materials, work-in-progress and finished goods) are
shown in the balance sheet as current assets.
· Owner’s raw materials drawings are shown in the manufacturing account while
calculating the prime cost.
· Finished goods drawings are shown in the trading account while calculating the cost of
goods sold.
· The purchase of finished goods is added with cost of production in the trading account.
· The depreciation of any asset used in the office should be shown as an expense in the
profit & loss account.
· Cost of readymade items bought for the production of items manufactured should be
treated as direct expense.
· Unit cost of production = Total cost of production
GOODWILL AND PARTNERSHIP

A firm in which two or more persons are working together as owners is known as a
partnership.
The individuals working in a partnership firm are known as Partners.

Partnership Agreement: It is desirable that there should be a written agreement between the
partners to avoid any dispute that may arise in future. The document which contains the terms
and conditions regarding the conduct of partnership business is known as Partnership
Agreement.

Contents of Partnership Agreement: The usual contents of a partnership agreement are:

1. The capital to be contributed by the each partner.
2. The maximum amount of drawings which a partner can make during a year.
3. The rate of interest, if any, to be paid on capital before the profits are shared.
4. The rate of interest, if any, to be charged on drawings made by the partners during the
year.
5. Salaries, Commission, Remuneration, if any, to be allowed to any partner.
6. The ratio in which the profits and losses shall be shared among the partners.
Profits and losses are generally shared either
(a) Equally; or
(b) In the ratio of capital contributed by each partner (Capital ratio); or
(c) In any other ratio to which the partners may agree.
7. Arrangements for the admission of a new partner
8. Procedures to be carried out in the event of retirement or death of a partner.
Capital accounts in Partnership: The capital accounts in partnership may be maintained
under:
A. Fixed capital method
B. Fluctuating capital method
Fixed Capital Method: Under this method two accounts are kept for each partner
viz.Capital account and Current account. In the capital account the original
capital investment only will be shown every year. The current account is kept for
recording Interest on capital allowed, salary allowed, share of profit, drawings,
interest on drawings etc. This account may show either a debit balance or a credit
balance. Debit balance represents drawings in excess of profits to which a partner
was entitled. Credit balance means profits undrawn.
COMPANY ACCOUNTS
The capital of a limited company is divided into shares. A person can become the member of
a company if he buys a share. Then he is known as the shareholder. If the shareholder has
paid in full for the shares he has taken, his liability is limited to the nominal value of those
shares only. When the company loses its assets, it cannot ask the shareholders to pay
anything out of their private property in respect of the company’s losses. If the shareholder
has paid partly only for the shares, he can be forced to pay the balance owing on the shares.
In short, the liability of each member is limited to the nominal value of the shares he has
taken. This is known as limited liability and the company is known as limited company.

Share capital (different meaning)

1. Authorized/registered/nominal share capital. This is the total of the share capital which
the company is allowed to issue to the shareholders.

2. Issued share capital: This is the total of the share capital actually issued to the
shareholders.

3. Called up capital: Where only part of the amounts payable on each share has been asked
for, the total amount asked for on all the shares is known as the called up capital.

4. Uncalled capital: This is the total amount which is to be received in future, but which has
not yet been asked for.

5. Calls in arrears: The total amount for which payment has been asked but has not been
paid by share holders.

6. Paid up capital: This is the total of the amount of share capital which has been actually
paid by the shareholders.(Paid up capital = Called up capital – Calls in arrears)

Key points
1. Debentures- loan to the company from the public carrying fixed rate of interest.
2. Dividend: The profit that is being distributed to shareholders is called dividends.
3. Debenture interest: This is the interest paid on debentures to the debenture holders. This
is an expense to be charged in the profit and loss account and if it owes it is known as a
current
liability in the balance sheet.
4. Ordinary shares: Shares entitled to dividend after the preference shareholders have been
paid their dividends.
5. Preference shares: Shares that are entitled to an agreed rate of dividend before the
ordinary shareholders receive anything.
6. Reserves: The transfer of apportioned profits to accounts for use in future.
7. Directors remunerations: This is the remuneration given to the directors and an expense
to be shown in the profit and loss account.
8. Interim dividend: The dividend paid to the shareholders in between two annual general
meetings.
It is shown in the profit & loss appropriation account only.
9. Proposed dividend: This dividend agreed by the board of directors but not paid. It is
deducted
from the profit & loss appropriation account and shown as a current liability in the balance
sheet
10. Dividend is calculated on the paid up capital only.

11. For preference shares prefixed rate of dividend is paid.

E.g.: 7% Preference shares ----------------- rate of dividend is 7%
Therefore, preference dividend = Issued preference share capital x rate (%) / 100

12. For ordinary shares:

if dividend is paid as percentage of capital
Dividend = Issued ordinary share capital (nominal value) x rate(%) / 100
If dividend is payable per share:
Dividend = Number of ordinary issued shares x dividend per share

13. Distinction between shares and debentures

Shares Debentures
1 Owner’s capital. 1 Loan capital.
2 Owners/ Share holders. 2 Creditors.
3 Dividend paid is appropriation of profit. 3 Interest paid is a charge or expense
 4 Dividends paid according to the profit earned 4 Interest payment is compulsory whether
and at the direction of the directors. profits are earned or not.

5 Not repaid or redeemed except redeemable
preference shares.
6 Unsecured. The shareholders will get the
repayment of capital on winding up, only if
there is surplus.
5 Redeemed after certain period at the option
or discretion of the company.
6 Normally having fixed charge or floating
charge on the assets of the company.

14. Distinction between ordinary shares and preference shares

Ordinary shares
1 Ultimate control of the company
2 Dividend is available only if there are
sufficient profits.
3 No preferential treatment of dividend
4 Treated as own capital
Preference shares
1 No control of the company
2 Fixed rate of dividends. If cumulative
preference shareholders miss
dividends in one year, they get arrears
of dividends in good years.
3 Preferential treatment of dividend and
repayment of capital
4 Treated as prior charge capital, that is
part of loan capital

Profit and loss appropriation account.

This is the account prepared after the preparation of the trading and profit & loss account of a
limited company. This account starts with the net profit obtained from the profit & loss
account and the last year’s retained profit (if any). The appropriations of profits are shown in
this account. After the appropriation, if there is any profit left over, it is called retained profit
and it will be carried forward to the next year.
ACCOUNTING RATIOS

1. Mark up: is the gross profit measured as a percentage of the cost price; this is the amount
added to the cost price to determine the selling price.

Mark up = Gross profit x 100

Cost of sales

Margin: is the gross profit measured as a percentage of the Selling price.

Gross profit ratio = Gross profit

x100
Sales

Cost price + gross profit = Selling

price

2. Rate of Stock turn over: this is the number of times a business replaces its stock in a
given period.
Rate of stock turn over = cost of goods sold .
Average stock

Average stock = opening stock + closing stock

2

It is sometimes necessary to calculate a missing figure in a trading account

3. Return on capital employed: This is the measure of the profit as a percentage of the
amount invested in the business in order to earn that profit.
ROEC = Net profit
Capital employed
Capital employed: to be the total of the capital owned and long term liabilities.

4. Current Ratio: is sometimes known as the working capital ratio.

Current ratio = Current assets
Current liabilities

Note: Anything between 1.5:1

and 2:1 may be regarded as satisfactory. A ratio over 2:1 may imply poor management of
current assets.

5. Quick ratio or Acid Test ratio: It compares the assets which are in money form or which
will convert into money quickly with the liabilities due for payment in the near future.

Quick ratio = Current Assets – Stock

Current liabilities

Note: A ratio of 1:1 is usually regarded as satisfactory.

6. Net profit ratio

Net profit ratio = Net profit x 100
Sales
ACCOUNTS FROM INCOMPLETE RECORDS (Single Entry)
Some times, businesses, especially small businesses do not maintain a full set of double entry
records. Consequently, no trial balance will be produced and a complete set of final accounts
cannot be prepared without further analysis of the records that do exist.

Where only records available are the assets and liabilities at the beginning of the year and at
the end of the year, it is not possible to prepare a Trading and Profit and Loss account. The
assets and liabilities are usually listed in a Statement of Affairs (Similar to a Balance Sheet).
This would have been called a Balance Sheet if it had been drawn up from a set of double
entry records. Like a Balance Sheet, a Statement of Affairs can be prepared horizontally or
vertically

The only way the profit for the year can be found is by comparing the capital shown in the
opening Statement of Affairs with the capital shown in the closing Statement of Affairs.

The basic formula is:

Profit Loss = Closing Capital – Opening Capital (Positive figure means Profit and
Negative figure means Loss)

It may be that the owner has made drawings during the year, which will account for some of
the difference in the capital figures. Similarly the owner might have brought in additional
capital during the year, which will also account for some of the difference in the capital
figures. In this case the formula must again be modified:-

Profit or Loss = Closing Capital + Drawings during the year – Additional Capital
during the year – Opening Capital (Positive figure means Profit and Negative figure
means Loss)

Calculation of Profit or Loss by converting the Incomplete Records into Double entry
Records

In this case, in order to calculate the profit or loss of the business during the year, the Trading
and Profit and Loss accounts are prepared. For preparing the Trading and Profit and Loss
accounts, all necessary information is not available in the books. So first the missing items
have to be calculated which are necessary for the preparation of Trading and Profit and Loss
accounts.

Usual missing items are:-

Opening/ Closing balances of Debtors, Credit Sales, and Amounts received from
Debtors. When any of these items is missing from the question, it can be calculated by
preparing the Trade Debtors Account as follows.

Trade Debtors Account (Total Debtors A/C)

In another way Credit Sales = Closing Debtors + Bad debts written off + Return
inwards + Discount Allowed + Receipts from Debtors (Cash and Cheques)-
Opening debtors

Opening/Closing balances of creditors/ Payments to creditors/ Credit purchases. When any of

these items is missing, it can be calculated by preparing the following Trade Creditors A/C
Trade Creditors Account (Total Creditors A/C)

Similarly Credit Purchases = Closing Creditors + Payments to Creditors (By cash and
Cheques) + Discount Received + Return Outwards – Opening Creditors
Opening or Closing Bank Balance: To calculate any of these, the bank a/c is to be prepared
in T form by showing the receipts on the debit side and payments on the credit side.
Bank A/C

The closing bank balance can be calculated in another way also as follows:-

Closing Bank Balance = Opening Balance + All Receipts – All Payments

Opening Capital:- It can be calculated by preparing opening Statement of Affairs by

incorporating all the assets and liabilities on the opening date and calculating it as a balancing
figure.
Key point
Before solving the question, find out the missing items. The next step should be to find out the
missing items from the given items in the question. After making sure that, all the items
necessary for the for the preparation of the required account, then start preparation. The
final accounts will be prepared as in the case of a sole trader’s finalaccount.

The depreciation on fixed assets is calculated by comparing the opening and closing values
of the concerned fixed asset.
ACCOUNTING CONCEPTS
1. Cost concept: Assets are normally shown at cost price
2. Money measurement concept: The concept that accounting is concerned only with
facts measurable in money, and for which measurement can obtain general
agreement.
3. The business entity concept: Assumption that only transactions that effect firm and
not the owner’s private transactions will be recorded.
4. The dual aspect concept: The concept that each transaction is recorded by taking
both aspects, debit and credit.
5. Accrual concept: The concept that profit is the difference between revenue and
expenditure.
6. Going concern concept: The assumption that the business will continue to operate
for the foreseeable future or continue for a long time
7. Materiality concept: Recording something is a special way only if the amount is not
a small one.
8. Subjectivity: Using a method that other people may not agree to derived from one’s
own personal preferences.
9. Prudence: Ensuring that profit is not shown as being too high or that assets are
shown at too high value.
10. Consistency: Each firm should follow constant method of treatment for each item. If
the method is changing every year, then the profit calculated will be misleading one
11. Time interval concept: Final accounts are prepared at regular intervals.