Notes

GCE O Level Accounting

Subject Code: 7707/7110

ABSTRACT
Definitions, Terms and templates/formats of basic concepts

Table of Contents
Topic: Basic Accounting ................................................................................................................. 3
Topic: Books of Original Entry ....................................................................................................... 6
Topic: Bank Reconciliation Statement ........................................................................................... 8
Topic: Payroll Accounting .............................................................................................................. 9
Topic: Accounting for Depreciation ............................................................................................. 12
Topic: Bad and Doubtful Debts .................................................................................................... 14
Topic: Final Accounts of Sole Traders with adjustments .............................................................. 15
Adjustments in Final Accounts .............................................................................................................. 19
Accruals and Prepayments ........................................................................................................................ 20

Topic: Departmental Accounts .................................................................................................... 22

Topic: Partnership Accounts ........................................................................................................ 24
Topic: Capital and Revenue Expenditures .................................................................................... 30
Topic: Correction of Errors and Suspense Account ....................................................................... 31
Errors Not Affecting the Trial Balance ................................................................................................... 32
Errors which do affect the Trial Balance (Suspense Account) ................................................................. 39

Topic: Control Accounts .............................................................................................................. 43

Topic: Manufacturing Account .................................................................................................... 46
Topic: Ratio Analysis ................................................................................................................... 48
Topic: Incomplete Records (or Single Entry System) .................................................................... 51
Topic: Company Accounts ........................................................................................................... 53
Public Limited Company: .......................................................................................................................... 53
Private Limited Company: ......................................................................................................................... 53

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Topic: Basic Accounting

Role of Accounting
Accounting - It is collecting, recording, analyzing and summarizing, and communicating financial
data.
Bookkeeping – is branch of accounting in which financial data is recorded.
Role of Accounting in providing information for monitoring progress and decision making
Ø Monitoring progress is checking with whether the set targets are being or likely to be
achieved or not, for this purpose information from final account such as profit, sales,
expenses, and capital can be provided over number of years to make various calculations and
to compare the same from previous years
Ø Helpful in decision making e.g. if the set targets are not being achieved or there is a threat
that progress might not be made, the reasons could be diagnosed by the managers using the
yearly comparison and made a decision to overcome them
This way based on accounting information possible to monitor progress and decision making.
The Double Entry System of Book – Keeping
Assets – are the resources owned by the business.
Fixed Assets or Non-Current Assets – are the assets bought for the purpose of use rather than for
sale; assets which do not change their form; and the assets remain in business for longer period.
E.g. building (or premises), land, motor vehicle, fixtures and fittings, and equipment etc
Current Assets – are the assets which are either cash or near cash; they change their form, and
remain in the business for a period of 1 year.
E.g. Accounts receivable – also called debtors and they are the people who have to pay to the
business; inventor, cash at bank, and cash in hand
Liabilities – are the debts or loans of the business.
Current Liabilities – are the debts or loans which businesses have to pay off in a period of one year
or less.
E.g. Accounts Payable – also called creditors, they are the people whom business has to pay, and
bank overdraft – short tem bank loans
Capital – money invested in the business by the owner using his own resources; capital is also called
equity. Capital is also the liability of the business because it is the liability of the business to pay to
the owner when he will wind up or close his business.
Capital Employed: Money invested by the business using all of its resources.

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Capital Employed = capital + Long term loan

Debtors (Accounts Receivable): The people from whom businesses have to receive cash; they
are current assets of the business.
Creditors (Accounts Payable): The people to whom businesses have to pay the cash; they are
current liabilities of the business.
Accounting Equation – is the simple idea of financial accounting based on which whole accounting
is performed.
Accounting Equation is:
Ø Assets = Liabilities + Capital
Ø Liabilities = Assets – Capital
Ø Capital = Assets – Liabilities
Double Entry System – is where each accounting transaction is recorded in two separate records.
Double entry system is based on rules of debit and credit in which:
Assets (increase) means debit, and assets (decrease) means credit;
Liabilities and Capital (increase) means credit and (decrease) means debit.
Under double entry system, T-accounts are prepared for each aspect of transaction to maintain a
separate record. In T- accounts left hand side is a debit side and right side is a credit side. Each T –
account has a title to identify the type of record.
Stock Movement
Stocks (or Inventories): These are the current assets of the business, which change with following
movements:
Purchases – goods or stocks bought, it will bring increase in stocks;
Purchases Returns or Return Outwards – goods being returned after buying, they will decrease
the stocks;
Sales – goods being sold to the customers, they will decrease the stocks;
Sales Return or Return Inwards – goods being returned by the customers; they will increase the
stocks.
Expenses – are the spending by the business for running its day to day operations. They will always
be debited.
E.g. Rent, Salaries, Electricity / Telephone bill, Depreciation of machinery, Bad Debts (irrecoverable
loans), Carriage Inwards (Transport expense on goods purchased), Carriage outwards (Transport
expense on goods sold / Delivery Services provided to the customers)
Drawings - There are personal expenses of the owner also, which could be goods taken for personal
use, or cash withdrawn for personal use, either way they are called drawings.

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Double Entry for Drawings

Drawing (Dr)
Cash / Purchases (Cr)
Incomes
These are the direct or indirect earnings by the business, and always credited. E.g. Commission
Received, Rent Received, Salaries Received, Discount Received.
General Journal
The journal is used for recording of those transactions which are not part of other books of original
entries; and to record the correction of errors.
In journal, the narratives are also written; narratives are the detailed statements of transactions.
The Ledger
Ledgers are the T-accounts in which records of each element of transactions are posted; Ledgers or
T-accounts are finally balanced to see the current situation of each element at a particular date.
Running balance ledgers are computerized accounts. The major benefit of such ledgers is balance
shown after each transaction.
The Trial Balance
Trial balance is the list of balances of various items of T-accounts at a particular date.
Trial balance gives the following benefits / purposes
Ø Shows the arithmetical accuracy of T-accounts;
Ø Facilitate the errors’ identification
Ø Helps in preparation of final accounts

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Topic: Books of Original Entry

Books of Original Entry
The books of original entry or prime entry are the books, where transactions are recorded first time.
Book of Original Entry Source Document Purpose of Original Entry
Sales Day Book/Book/Journal Sales Invoice Recording of credit sales
Purchase Day Book / Book / Journal Purchase Invoice Recording of Credit Purchases
Sales Return Day Book / Book / Credit Note Issued Recording of Sales Return
Journal
Purchases Return Day Book / Book Credit Notes Received / Recording of Purchases Return
/ Journal Debit Note
Cash Book – Cheque payments Cheque counterfoil Recording of cheque payments
Cash Book – Cheque Received Copy of Cheque Recording of payment received
by cheque
Cash Book – Cash payments Receipt for cash payments Recording of cash payments
Cash Book – Cash received Receipt of cash received Recording of cash received
The Journal / General Journal Other documents Recording of other transactions

Types of Ledgers
Sales Ledger – includes all debtors or accounts receivable
Purchase Ledger – includes all creditors or accounts payable
General Ledger – rest of all T – accounts will be part of this.
Cash Book and Discounts
Cash Book – used for recording of cash and cheque payments and receipts
Cash book is the only book of original entry which is also part of double entry system, because all
the cash and bank transactions are recorded first time in cash book; also cash book is combination of
cash and bank T-accounts.
Cash book is the only book of prime entry which becomes part of the double entry also.
Cash book can be prepared in three forms:
• Single column (for bank transactions only)
• Double columns (for bank and cash transactions both)
• Three columns (for bank, cash, and cash discounts)
When cash is deposited and withdrawn, it is called contra entry and the transaction has to be on
both receipt and payment sides of cash book.

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The recording of transactions in cash book bank column will only correspond with the business
current account, not with any other accounts such as fixed deposit account.
Bank, if has credit balance, it is called bank overdraft, means business has to pay to the bank the
amount due.
Cash vs. Trade Discounts
Cash Discount – is received or allowed on prompt payments.
Discount is allowed by the business to its debtors or accounts receivable, when they pay promptly or
on due dates.
Discount is received by the business from its creditors, when the business pays promptly or within
due date.
Discount allowed is an expense; whereas discount received is an income.
Trade Discount – is allowed or received at the time of trading.
Trade discount earns the business a gross profit and it does not become part of books of accounts.
Trade discount is the difference between the retail (or list price), and the price paid by the business to
the producers.

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Topic: Bank Reconciliation Statement

Bank Reconciliation: is a statement of account which is prepared to bring cash book and bank
statement balances the same.
Steps in preparation of Bank Reconciliation Statement
Step # 01
Compare bank statement with cash book to find out the missing figures from cash book, and prepare
adjusted cash book or updated cash book to adjust the items which are in the bank statement but not
in the cash book.
(The final balance of adjusted cash book is transferred to the balance sheet as bank balance
under current assets).
Step # 02
Compare cash book with bank statement to find out missing figures in bank state and prepare bank
reconciliation in which cheques issued but not presented (called unpresented cheques), and cheques
deposited but not credited (called uncredited cheques) or any other banking errors are adjusted.
Other important Terms
Direct Debit: the direct payment system under which bank is instructed to pay to the creditors on
demand.
Credit Transfer: It is the direct deposit system under which a debtor pays the due amounts in
business bank account electronically.
Standing Order: The regular series of payments by a business, which are instructed to the bank in
advance and the bank acts accordingly on regular basis.
Bank Giro System: It also acts like a credit transfer in which a debtor pays in the business bank
account electronically.
Unpresented Cheques: Cheques issued by the business but it is not presented by the bearer of the
cheque.
Uncredited Cheques: Cheques received from the debtors or customers, and sent to the bank, but not
credited in the business bank account.

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Topic: Payroll Accounting

Clock Cards
These are the electronic devises, which are used by the businesses to maintain the sign in and sign
out records of their employees.
Time Sheet
It is the manual attendance recording system of the employees in which employees signs in when
they arrive and sign out when they leave.
Pay slip
It is the formal record of details of employees’ pay given it to him or her every month or fortnightly
or weekly when the due date for payment arrives.
Payroll register
This is the formal record of details of employees’ pay kept with the company’s accountant to
confirm, how much the employee has to be paid for the month or fornightly, or weekly.
Wages Sheet
An alternative to payroll register which is prepared to provide individual record of employees’ pay
along with other details of financial benefits or any deductions and calculate the final figure of net
wages.
Wages – a payment system work weekly
Time Rate – a wage system which works in accordance with time; under this payment system
workers are paid for basic 40 hours, and overtime working hours.
Piece rate
A system under which employees are paid a basic pay rate and then greater they produce they earn.
Over Time Payment
It is the amount of financial reward paid to the employees who work in unsocial hours such as after
usual working hours of 9 a.m to 5 p.m
e.g. Mr. Ahmed worked for 50 hours in a week. He is paid $8 per hour and overtime pay rate one and
half times.
Basic pay 40 hours @ $8 = $320
Overtime pay 10 hours @ $8 * 1.50 = $120
Total pay $320 + $120 = $440

Statutory Deductions

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These are legal deductions which are mandatory; and have to be deducted from the salaries or wages
of employees, e.g. income tax, social security, and national insurance.
Income Tax: It is the tax on gross pay of the employees, if it falls into taxable income category, then
deductions are mandatory and has to be made.
Social Security: It is another mandatory deduction by the state to assure the security of the society;
Govt. finances the security services expenditures using this contribution from every one employed.
National Insurance Contribution: These are another mandatory deductions have to be made from
the employees’ pay for their own benefits, because when they get retired, they are paid a lump sum
amount to keep rest of their lives comfortable. The employer also contributes in the national
insurance contribution equally as the employees’ contribution, which is paid to the government along
with employees’ contribution.
Voluntary Deductions
These are deductions which are on the discretion of the employees, if they want to get deducted from
their pay, if not, then they could be exempted from the deductions.
E.g. pension contribution, subscriptions, and charitable donations.
Pension Contribution
Pension is the regular series of income paid to the employee, which he gets on monthly basis after
his retirement for rest of his life. Pension Contribution is deducted from employees’ salary and
deposited in pension fund (i.e. a public sector organisation, which collects the monthly deduction and
puts into profitable use for the growth of money).
Subscription and Charitable Donations
These are also voluntary deductions, which are made from the employees’ pay on their own
discretion, if they are members of a club or charitable institute, or they want this money to be
deducted from their pay to contribute for the welfare of the deserving ones.
Accounting Treatment of Payroll
(1) Prepare a Statement of calculation of net pay / wages
(2) Double entry for recording of wages in both cash book and general journal

Name of the employee

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Statement of calculation of net pay / wages

For the period ended ----------------------------
------------------------------------------------------------------------------------------------------------
$ $
Basic Pay xxx
Additions:
Allowances for medical / rent / dearness xxx
Employer’s NI contribution xxx
------- xxx
-------
Gross Pay xxx
Deductions:
Income Tax xxx
Social Security benefits xxx
National Insurance Contribution xxx
-------- (xxx)
--------
Net Pay xxx
--------

Double Entry for Payroll

If the taxes will be paid to the authorities at later date:
Wages (Dr)
Bank (Cr)
Tax authorities – Creditors (Cr)

If the taxes will be paid as the employees earn, called Pay As You Earn (PAYE):
Wages (Dr)
Income Tax (Dr)
Bank (Cr)

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Topic: Accounting for Depreciation

Depreciation – is the reduced value of fixed asset; it is a non-cash expense, and part of the profit and
loss account.
Reasons for accounting for depreciation
• Wear and tear / asset gets old
• Time lapse
• Economic Factors such as recession or boom, assets were expensive when bought due to
boom, and cheaper due to recession
• Arrival of new models / versions
Methods of Depreciation
Straight Line Method
Using this method, every year the same depreciation is taken against the assets.
However, the depreciation calculation can be as percentage of fixed asset or the following formula is
used:

Cost – Residual / Scrap/ Disposal Value

-------------------------------------------------------
Useful life of the asset
Diminishing (Reducing) Balance Method
Using this method, in the first year given percentage of depreciation is calculated against the cost of
the fixed asset, and in the following years, the given percentage is calculated against the net book
value of the fixed assets.
Under reducing balance method, in the beginning depreciation will be high and in later years it falls
as amount of net book value decreases.
Revaluation Method
Under this method, the addition of fixed asset is added to the opening value of fixed assets, and
deducted the closing value of fixed assets; the balance is depreciation for the current year.
Suitability of Method of Depreciation
(1) Straight Line Method: Used for the assets which do not have large variations or every year a
new model or version does not arrive in the market.
(2) Reducing (or diminishing) Balance Method: Used for the assets which have a new arrivals
every year and previous models of such assets lose their value drastically.

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(3) Revaluation Method: Used for the assets which gets lost very often or they are loosely used
such as loose tools including pliers, or screw drivers.
Accounting Treatment for Depreciation
Profit and Loss a/c (Dr)
Provision for Depreciation (Cr)
Fixed assets’ Disposal
Fixed assets are also disposed off after certain number of years or when the business does not need
the fixed asset any more.
The double entries for disposal are:
Double Entry Amount
1 Fixed Asset Disposal (Dr) Amount will be the cost of fixed asset
Fixed Asset (Cr)
2 Provision for Depreciation (Dr) Amount will be total depreciation till the
Fixed Asset Disposal (Cr) disposal of fixed asset
3 Cash / Bank / Amount will be the sale proceed
Accounts Receivable (Dr)
Fixed Asset Disposal (Cr)
4 In case of loss on sale Amount will be the difference of debit
Profit and Loss a/c (Dr) and credit sides of disposal account /
Fixed Asset Disposal (Cr) amount of profit or loss on sale of fixed
In case of profit on sale asset.
Fixed Asset Disposal (Dr)
Profit and Loss a/c (Cr)

Calculation of Rate of Depreciation

If you were asked to calculate rate of depreciation (usually in straight line method), remember the
rate will be calculated on the basis of :
Ø Per annum depreciation
Ø Depreciable amount (i.e. cost – scrap / disposable value)
Rate of Depreciation = Annual Depreciation / Depreciable amount*100

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Topic: Bad and Doubtful Debts

Bad Debts: are irrecoverable loans. They are the expenses of the business.
Allowances for doubtful debts: are the estimates about the debtors or accounts receivable which are
unlikely to be unpaid in future.
When provision is calculated in the second or following years, they are compared with the previous
year and the transaction is decided according to increase or decrease in provision for doubtful debt.
Accounting Treatment
Bad Debts Provision for Bad Debts
Bad Debts (Dr) First Time Created / First Year
Accounts Receivable (Cr) Profit and Loss a/c (Dr)
Allowances for Doubtful Debts (Cr)
Profit and Loss Account (Dr) Second Year (in case of increase)
Bad Debts (Cr) Profit and Loss a/c (Dr)
Allowances for Doubtful Debts (Cr)
Third Year (in case of decrease)
Allowances for Doubtful Debts (Dr)
Profit and Loss a/c (Cr)

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Topic: Final Accounts of Sole Traders with adjustments

Income Statement and Balance Sheet (Final Accounts) for Sole trader
Income Statement (previously Trading and Profit and Loss Account) has two parts:
(1) Trading Account – includes only the trading activities such as buying and selling. In trading
account part of the income statement, business calculates gross profit / loss.
(2) Profit and Loss Account – includes the other incomes and expenses. In profit and loss
account part of the income statement, business calculates net profit / loss.
Income statement can be prepared in both vertical and horizontal formats:
Horizontal Format
Name of the Business
Income Statement
For the Year Ended ---------------------------
$ $
Opening Inventory (Stock) xxx Revenue (Sales) xxx
Add: Purchases xxx Less: Sales Return (xxx)
Less: Purchase Return (xxx)
Add: Carriage Inwards xxx
Less: Closing
Inventory(Stock) (xxx)

Cost of Sales xxx

Gross Profit c/d xxx
----------------- -------------------
xxxx Net Sales xxx
---------------- -----------------

Gross Profit b/ d xxx

Less: Expenses: xxx
xxx Add: Other Incomes
Salaries xxx
Rent xxx Commission Received xxx
Electricity Bill xxx Discount Received xxx
Depreciation xxx
Bad Debts xxx
Insurance --------------------
Net Profit -----------------
-------------------

-----------------

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Name of the business

Balance Sheet
As at -------------------------------------
Non-Current (Fixed) Assets $ Capital (Owner’s Equity) $
Land xxx Capital xxx
Building / Premises xxx Add: Net Profit xxx
Motor Vehicles xxx Less: Drawings xxx
Fixtures and Fitting xxx
Equipment xxx
Current Assets Current Liabilities
Inventory (Stock) xxx Accounts Payable (Creditors) xxx
Accounts Receivable (Debtors) xxx Bank Overdraft xxx
Bank xxx
Cash xxx

xxx xxx

Income Statement and Balance Sheet are prepared with the help of trial balance.
In trial balance, all the assets and expenses will always be debited, and all the incomes and liabilities
will be credited. Hence, find these items on their respective sides in trial balance.
Capital amount given in trial balance is called opening or old capital, which may change by new
investment, earning net profit or sustaining losses, and withdrawing money for personal use (i.e.
drawing). The new capital after adjustments of above items is closing capital.
Capital increases due to incomes, and decreases due to expenses.
New Capital = Old Capital +Net Profit + New Investment – Drawings

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Vertical Format
Name of the Business
Income Statement
For the Year Ended ---------------------------
$ $
Revenue (Sales) xxx
Less: Sales Return xxx
------------------
Net Sales xxx

Less: Cost of Sales

Opening Inventory (Stock) xxx
Add: Purchases xxx
Less: Purchase Return (xxx)
Add: Carriage Inwards xxx
Less: Closing Inventory(Stock) (xxx)
----------------- (xxx)
-----------------
Gross Profit xxx
Less: Expenses
Electricity xxx
Insurance xxx
Rent xxx
Bad Debts xxx
Depreciation on fixed assets xxx
----------------- (xxx)
Add: Other Incomes
Commission Received xxx
Discount Received xxx xxx
---------------- --------------
Net Profit xxx

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Name of the business

Balance Sheet
As at -------------------------------------
Non-Current (Fixed) Assets $ $
Land xxx
Building / Premises xxx
Motor Vehicles xxx
Fixtures and Fitting xxx
Equipment xxx
------------
Current Assets xxx
Inventory (Stock) xxx
Accounts Receivable (Debtors) xxx
Bank xxx
Cash xxx
-------------
xxx
Less: Current Liabilities
Bank Overdraft (xxx)
Accounts payable (xxx)
------------
Working Capital (or Non-current assets)
Net Assets xxx
------------
xxx
Financed By -------------

Capital xxx
Add: Net Profit xxx
Less: Drawings (xxx)
-----------
xxx
----------

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Adjustments in Final Accounts

Accruals and Prepayments
Accruals: are the expenses or incomes which are due but unpaid or not received.
Accrued incomes are the current assets; and accrued expenses are the current liabilities.
In profit and loss accounts, they should be added to their respective incomes and expenses
considering they belong to current year though unpaid and not yet received.
Prepayments: are the expenses or incomes which are paid or received in advance. Prepaid Expenses
are current assets; prepaid incomes are current liabilities.
They should be deducted from their expenses or incomes under profit and loss accounts as they do
not belong to current year.
General Entries
Prepaid Expenses Prepaid Incomes
Prepaid Expenses (Dr) Incomes (Dr)
Expenses (Cr) Prepaid Incomes (Cr)
Accrued Expenses Accrued Incomes
Expenses (Dr) Accrued Income (Dr)
Accrued Expenses (Cr) Income (Cr)

Prepaid expenses and accrued income are the current assets therefore their opening balances will be
debit; and prepaid incomes and accrued expenses are the current liabilities and their opening
balances will be credit.
You will be required to prepare the expenses and incomes accounts in which you will have to find
out the figures for expenses and revenues, which will be required to be transferred to the profit and
loss account, or the closing balances of prepaid or accrued.

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Accruals and Prepayments

Accruals are expenses incurred but not yet paid while prepayments are
payments for expenses for that are not yet incurred. Accruals and prepayments
give rise to current liabilities and current assets respectively in accordance with
the matching principle and accrual accounting.

Matching principle requires accountants to record revenues and expenses in the

period in which they are incurred regardless of when the relevant payments are
made. In order to create this 1-on- 1 correspondence between revenue and
expenses, expenses are recorded if they are incurred in a particular period even
if they are not yet paid, because they were necessary to earn the revenue for
that period. On the other hand, prepayments are recorded to represent
payments related to goods and services that are to be consumed in future
periods. It is this matching principle that differentiates accrual accounting from
cash-basis accounting, which records revenues and expenses when they are
received and not when they are earned or incurred.

Examples:

Woodworks, Inc. is a furniture manufacturer and retailer. You are closing the

books of the company for the year ended 30 June 2014. Suggest appropriate

accounting treatment for the following transactions:

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 Like Page

4. Semi-annual rent of $30,000 on Outlet B was also paid on 1 April 2014 and the whole amount was charged
to the income statement. Be the first of y
5. On 30 June 2014, $50,000 was paid on account of 5-year premium membership of relevant business
association.

Journal entries

The basic principle behind accrual accounting is to record revenues and expenses regardless of payment.
Following accrual and prepayment adjustments are required for 2014.

1. Though salaries of $70,000 were paid on 4 July 2014, they related to services provided by employees in
June 2014. These salaries are the cost of June 2014 revenue and must be recorded as part of June financial
statements even if the payment is made after 30 June. The following journal entry must be made:

Salaries expense $70,000

Salaries payable $70,000

On 4 July 2014, at the time of actual payment is made, the following journal entry is made:

Salaries payable $70,000

Cash $70,000

2. Utility bills related to utilities consumed in June, so they must be reflected in financial statements for the
year ended 30 June 2014, even if they are paid later.

Utilities expense $30,000

Utilities payable $30,000

When the bills are actually paid, the following journal entry reflects the actual payment:

Utilities payable $30,000

Cash $30,000

3. 12 months of rent was paid on 1 January 2014 and it was recorded as prepaid rent. Half of this rent is
related to the year ended 30 June 2014, so a journal entry should be made to expense out half of the
prepaid rent.

Rent expense ($100,000/2) $50,000

Prepaid rent $50,000

4. In April 2014, $30,000 was paid on account of six months of rent on Outlet B and it was expensed out.
However, only three months of the relevant rent payment belong to financial year 2014. A journal entry
should be made to reduce the recorded rent expense and create a prepaid rent asset equivalent to three
months of use.

Prepaid rent ($300,000/6×3) $15,000

Rent expense $15,000

5. The payment of $50,000 on 30 June 2014 relates to membership fee due in next 5 year. This payment is a
prepayment.

Prepaid membership fee $50,000

Cash $50,000

This prepaid membership fee will be expensed out proportionately in next 5 years.

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Related Topics


Topic: Departmental Accounts

These accounts are prepared and used by the businesses having range of products or services divided
into various sales departments in which each department has to prepare its own income statement,
however a combined balance sheet is prepared.
There is no problem in allocation of direct incomes and costs such as sales (or turnover), wages, and
material costs as they are already separate for each department.
There are other overheads, or expenses which have to be apportioned among the departments using
particular basis such as:
Ø Rent
Ø Telephone bills
Ø Canteen expenses
Ø Electricity bills
Ø Depreciation of fixed assets
The above overheads are not given pre-divided, because they are combined for all the departments.

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Name of the business

Income Statement
For the year ended-----------------------------------------

Electrical Garments Groceries

Appliances

Sales (Turnover)
Less Cost of Sales
Opening Inventory
Add: Purchases
Less: Closing Inventory

Gross Profit
Less: Expenses
Salaries
Carriage Outwards
Electricity
Canteen Expenses
Telephone
Depreciation on plant and
machinery

Net Profit

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Topic: Partnership Accounts

Partnership
A business which involves voluntary association of two to twenty people as partners in the business
Partnership Deed
Also called partnership agreement; all the partners are required to sign a written partnership
agreement before starting partnership business so that in business disputes could be avoided.
A partnership agreement may include the following:
Ø The amount of capital invested in the business by all the partners
Ø The nature of work the partnership will carry out
Ø The profit and loss sharing ratio
Ø The duration of the partnership
Ø The arrangement for absence, retirement, and how new partner will be admitted
Advantages of partnership
ü More capital than that of sole trader business as there are more than one person as investor in
the business (however in banking partnership, there could be more than 20 partners as
investors, because the banking business needs as much capital as possible)
ü Responsibility of work, decision making, and burden of unlimited liability can be shared
among the partners
ü Motivation for all the partners as greater the hard work and dedication is contributed by the
partners, the more profit is enjoyed by all the partners
Disadvantages of partnership
× Unlimited liability for all the partners, however in limited partnership, all the partners will
have limited liability except one partner who will be responsible for the debts and losses of
the business and he will be the one who will sell all of his property to compensate the losses
× No separate legal identity which means in partnership also there will be a risk of
discontinuity but not as much as in sole trader ship. If there are two partners, one dies,
business could be at the risk of discontinuity.
× (Businesses with no separate legal identity is called unincorporated business)
× Risk of disagreement among partners on various decision making
× Dishonesty of one particular partner may put every one into loss
× Limited capital as the partners will only be limited to 20 partners except banking partnership

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Accounting Treatment
Income Statement – It will be same as sole trader accounts except the appropriation accounts.
Appropriation part of the income statement shows the distribution of profit among the
partners
Name of the Firm
Profit and Loss Appropriation Account
For the year ended ---------------------------------------------
------------------------------------------------------------------------------------------------------------------------------------------------
$ $
Net Profit xxx
Add: Interest on Drawings
A xxx
B xxx
------- xxx
------
xxx
Less: Interest on Capital
A xxx
B xxx
Salary – A / B xxx
------- (xxx)
--------
xxx
Profit Share: A xxx
B xxx
------- xxx
------
----------------------------------------------------------------------------------------------------------------------------------------------

Conditions in Partnership for treatment of capital

If Capital has to be fixed:
(a) Prepare Capital Accounts with no change;
(b) Prepare Current Accounts with postings of appropriation transactions
Double Entries
In Case of incomes of partners such as interest on loan / capital; share of profit, and salary of
partners:
Income Statement (Profit and Loss Appropriation a/c) (Dr)
Current a/c (Cr)
In Case of partners’ expenses such as drawings, and interest on drawings:
Current a/c (Dr)
Income Statement (Profit and Loss Appropriation a/c) (Cr)

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Partners’ Current account is prepared to maintain the records of partners’ incomes and expenses. The
debit balance of partners’ current account shows a negative balance and partners have withdrawn
more than their incomes; the credit balance of partners’ current account shows a positive balance
means partners have not overdrawn from the business.
Partners’ Current Account
A B A B
Balance b/d xxx xxx Balance b/d xxx xxx
Drawings Interest on capital
Interest on drawings xxx xxx Salary xxx xxx
Share of Profit
Balance c/d xxx xxx xxx xxx

xxx xxx

----------- --------- -------- ---------

xxx xxx xxx xxx
====== ===== Balance b/d ===== =====

xxx xxx

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In case partners’ capital is kept fluctuating, no current account is opened; in this case all the
current account transactions are posted to the capital account
Partners’ Capital Account
A B A B
Balance b/d xxx xxx Balance b/d xxx xxx
Drawings Interest on capital
Interest on drawings xxx xxx Salary xxx xxx
Share of Profit
Balance c/d xxx xxx xxx xxx

xxx xxx

----------- --------- -------- ---------

xxx xxx xxx xxx
====== ===== Balance b/d ===== =====

xxx xxx

Important points to be noted

Ø If no profit or loss ratio is being given, assume equal distribution;
Ø If interest on loan is not given, assume it is 5%
Balance Sheet in partnership
It is same as common balance sheet, however financed by will include only current account balances
and capital balance. Current account balances can be either calculated in the separate current account
or in the balance sheet itself.

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Balance Sheet (Extract)

------------------------------------------------------------------------------------------------------------
Financed by
Capital Accounts: A xxx
B xxx
-------- xxx

A B
Current Account Balance b / d xxx xxx
Add: Interest on Capital xxx xxx
Salary xxx xxx
Profit Share xxx xxx
--------- -------
xxx xxx
===== =====
Less: Interest on drawings xxx xxx
Drawings xxx xxx
--------- ---------
(xxx) ( xxx)
===== =====
Current Account Balance c / d xxx xxx xxx
------- --------- -----
xxx
====
Concept of good will in partnership
When a new partner enters in the partnership firm, he makes investment but pays the share in good
will. The profit and loss sharing ratio changes in partnership agreement. It involves two conditions
for good will.
Good will account will be opened and good will remain in the books of accounts
Good Will is retained in the books of accounts
Good Will a / c (Dr)
Old partners’ Capital Account (Cr)
(Division of good will according to the old ratio)

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Good will account is opened and good will is written off in the books of accounts
Good Will is created
Good will a / c (Dr)
Old partners’ capital account ( Cr)
(Division of good will according to the old ratio)
Good will is written off
Old and new partners’ capital account (Dr)
Good Will a/c (Cr)
(Division of good will according to the new ratio)

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Topic: Capital and Revenue Expenditures

Capital and Revenue Expenditure and Receipts
Capital Expenditures: are the expenses on fixed assets or extension of fixed assets; any expense
which brings the fixed asset in useable condition such as installation of machinery or to bring the
asset in ownership of the business. Any other type of expense which goes with the time span of more
than one year is called capital expenditures.
Revenue Expenditures: are the expenses on day to day operations of the business. Any expense less
than or within period of 1 year.
Capital Receipts: are the incomes from sale of fixed assets.
Revenue Receipts: are the incomes earned by the business from usual sales of goods or services

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Topic: Correction of Errors and Suspense Account

There are two types of categories of errors:
(1) Effecting trial balance
(2) Not effecting trial balance
Errors not effecting trial balance
There are seven errors which does not affect trial balance
Error of Omission – the transaction is completely omitted from the books
Error of Commission – the error is made between two items on the same side either debit or credit
Error of Original entry – the total amount of the transaction is being made wrong on both debit and
credit sides
Transposition Error – the sequence of the amount is being made inaccurate
(The result of error of original entry and transposition error could be either overcast or under cast –
in case of overcast, do the debit items credit and credit as debit; and in case of under cast, do the
right transaction, however use the amount of difference in transaction)
Error of reversal entry – it is when the debit transaction is being made credit and credit as debit –
in this case double the amount to correct the transaction
Compensating Error – It is when two errors on opposite sides cancel each other
Error of Principles – When asset is taken as expense or liability is taken as income.
Errors effecting trial balance – When an error is single sided, it will effect the accuracy of trial
balance.
Open a suspense account – post the difference in trial balance on the smaller side with respect of
trial balance, and post the transactions of correction
Statement of Corrected net profit
Ø Start from profit before correction
Ø Add sales and income
Ø Less expenses
Ø Result will be profit after correction

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Errors Not Affecting the Trial Balance

With these types of errors, the debit and credit columns of the Trial Balance will still be the
same total.
These errors are corrected by means of JOURNAL ENTRIES.

Types of errors:

1. Errors of Commission – correct amount but wrong persons’ account eg

entered the amount into Davies’ account instead of Davids’ account.

Journal entry – cancel out of the wrong persons’ account and put it into the correct
persons’ account

2. Errors of Principle – the transaction was entered into the wrong type of account
eg entered the amount into the asset Vehicles instead of the expense Motor
Expenses

Journal Entry – cancel out of the wrong account and put it into the correct account

3. Errors of Original Entry – the wrong amount was entered into the ledger
accounts. Eg 100 instead of 1000

Journal entry – entry for the difference between the correct and incorrect amounts

4. Errors of Omission – a transaction which was not entered in the books at all. Eg
an entry which should have been put in the sales day book

Journal entry – the entry will be the same as you would post from the day book
concerned

5. Compensating errors – errors which cancel each other out eg when balancing the
ledger account, the purchases account was added up by 100 too much as was the
Sales account.

Journal entry – cancel the error by putting the amount on the opposite sides of each
account

6. Complete Reversal - the amount is entered on the wrong sides of both

accounts
Journal entry - Make sure the amount is DOUBLED

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The double-entry for correction of errors not affecting the Trial Balance

1- Errors of Commission: D Short paid us by cheque $500 on 18th May 20X8.

It is correctly entered in the cash book, but it is entered by mistake in the
account for D. Small. We find the error on May 3 l 20X8.

Journal
Date Details Dr Cr

20X8 $ $

May 31 D Short 500

D Small 500

Narrative Correction of error of

commission.

Dr D Small Account Cr
$ $
May 18 Bank 500 May 31 D. Short 500

Dr D Short Account Cr
$ $
May 31 D Small 500

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2- Errors of Principle: The purchase of a motor vehicle $55,500 by cheque on 14 May

20X8 has been debited in error to a motor expenses account. In the cash book it
is shown correctly. We find the error on May 31 20X8.

Journal
Date Details Dr Cr

20X8 $ $

May 31 Motor Vehicle 55,500

Motor Expenses 55,500

Narrative Correction of error of

principle.

Dr Motor Expenses Account Cr

$ $
May 14 Bank 55,500 May 31 Motor 55,500
Vehicle

Dr Motor Vehicle Account Cr

$ $
May 31 Motor 55,500
Expenses

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3- Errors of Original Entry: Sales of $1500 on May 13 20X8 to T. Biggins have

been entered as both a debit and credit entry of $1300 to the correct
accounts. We find the error on May 31 20X8.

Journal
Date Details Dr Cr

20X8 $ $

May 31 T. Biggins 200

Sales 200

Narrative Correction of error of

original entry.

Dr Sales Account Cr
$ $
May 13 T. Biggins 1,300
May 31 T. Biggins 200

Dr T. Biggins Account Cr
$ $
May 13 Sales 1,300
May 31 Sales 200

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4- Errors of Omission: A firm purchased goods from T Slope on May 13 20X8 for
$2500 but forgot to enter them into the accounts. We find the error on May 31
20X8.

Journal
Date Details Dr Cr

20X8 $ $

May 31 Purchases 2,500

T Slope 2,500

Narrative Correction of error of

ommission.

Purchases Ledger

Dr T Slope Account Cr
$ $
May 31 Purchases 2,500

General Ledger

Dr Purchases Account Cr
$ $
May 31 T Slope 2,500

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5- Compensating Errors: A firms Sales Day Book added up incorrectly to $100 to

much but by coincidence so did the Purchases Day Book. We find the error on May
31 20X8.

Journal
Date Details Dr Cr

20X8 $ $

May 31 Sales 100

Purchases 100

Narrative Correction of
compensation error.

General Ledger

Dr Sales Account Cr
$ $
May 31 Purchases 100 May 31 Total Sales 9,500
Day Book
(Overcast
by $100)

Dr Purchases Account Cr
$ $
May 31 Total 4,500 May 31 Sales 100
Purchases
Day Book
(Overcast
by $100)

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6- Complete Reversal of Entries: We receive a cheque from D Charles on 28 May

20X8. However the $2,000 is entered as a credit entry in the cash book (Bank)
and a Debit entry in the D Charles account. We find the error on May 31 20X8.

Journal
Date Details Dr Cr

20X8 $ $

May 31 Bank 4,000

Charles 4,000

Narrative Correction of reversal

entry

General Ledger

Dr Bank (Cash Book) Account Cr

$ $
May 31 D Charles 4,000 May 28 D. Charles 2,000
(Double to
cancel out
and correct
error)

Purchases Ledger
Dr D Charles Account Cr
$ $
May 28 Bank 2,000 May 31 Bank 4,000
(Cash (Double to
Book) cancel out
error and
put on
correct side)
,

Compiled by: Waseem Akhlaque O Level Accounting Notes 38

 Written by D.El-Hoss & Adapted from F. Woods Accounting

Errors which do affect the Trial Balance

Errors which do affect the Trial Balance (Suspense Account)
(Suspense Account)
These are errors which cause the debit total of the Trial Balance to be a different amount
to the credit total.

Journal entries are then made to correct the following types of errors:

1. Overcasting and undercasting errors – adding up Day Books incorrectly and

balancing off ledger accounts incorrectly.
Overcast – the amount is too large
Undercast – the amount is too small

Impact of Undercasting and Overcasting on Gross Profit & Net Profit

Sales Overcast Gross Profit Overcast Net Profit Overcast
Opening Stock Overcast Gross Profit Undercast Net Profit Undercast
Purchases Overcast Gross Profit Undercast Net Profit Undercast
Returns Inwards Overcast Gross Profit Undercast Net Profit Undercast
Return Outwards Overcast Gross Profit Overcast Net Profit Overcast
Carriage Inwards Gross Profit Undercast Net Profit Undercast
Expenses Overcast Gross Profit Unchanged Net Profit Undercast
Add. Income Overcast Gross Profit Unchanged Net Pfofit Overcast

2. Debit entry in one ledger account but no credit entry

3. Different amounts in the debit and credit entries

ALL journal entries must have the contra account as the Suspense account.

The Suspense Account should have a zero balance once all errors have been posted to it.

IGCSE Accounts

Compiled by: Waseem Akhlaque O Level Accounting Notes 39

 Written by D.El-Hoss & Adapted from F. Woods Accounting

Example:

The difference between the debit and credit totals is put into a SUSPENSE ACCOUNT in
the smaller of the two columns. If the debit column total is $12 000 and the credit column
total is $11 500, then the difference of $500 is put into the suspense account on the Credit
(smaller) side.

Trial Balance as at 31 December

$ $
Bank 1,000
Wages 300
Cash 500
Capital 7,000
Drawings 200
Purchases 2,000
Sales 3,000
Vehicles 3,000
Debtors 5,000

Creditors 1,500
12,000 11,500

In 20X8 the errors were later found on the following dates:

1- February 5 - Motor expenses invoice was entered as $400 instead of $20 in the
cash book.
2- March 8 - The total sales in the Sales Day Book was undercast by $240.
3- March 28 – The total in the purchases day book was undercast by $50.
4- April 15 – A cash withdrawal by the owner of the business of $70 was entered in
the cash book but was not recorded in the Journal.
Dr Suspense Account Cr

$ $
31.12.X7 Bal. c/d 500 31.12.X7 Difference 500
as per trial balance
500 500
5.2.X8 Motor Expenses 380 1.1.X8 Bal. b/d 500
8.3.X8 Sales 240 28.3.X8 Purchases 50
15.4.X8 Drawings 70
620 620

In this case as the difference in the Trial Balance is

on the credit side it will be entered under Current
Liabilities so that the Balance Sheet will balance.

IGCSE Accounts
Compiled by: Waseem Akhlaque O Level Accounting Notes 40
 Written by D.El-Hoss & Adapted from F. Woods Accounting

Dr Motor Expenses Account Cr

$ $
5.2.X8 Suspense 380

Dr Sales Account Cr

$ $
31.3.98 Suspense 240

Dr Purchases Account Cr

$ $
28.3.X8 Suspense 50

Dr Drawings Account Cr

$ $
28.3.X8 Suspense 70

Dr Suspense Account Cr

$ $
31.12.X7 Bal. c/d 500 31.12.X7 Difference 500
as per trial balance
500 500
5.2.X8 Motor Expenses 380 1.1.X8 Bal. b/d 500
8.3.X8 Sales 240 28.3.X8 Purchases 50
15.4.X8 Drawings 70
620 620

In this case as the difference in the Trial Balance is

on the credit side it will be entered under Current
Liabilities so that the Balance Sheet will balance.

Compiled by: Waseem Akhlaque OAccounts

IGCSE Level Accounting Notes 41
 Written by D.El-Hoss & Adapted from F. Woods Accounting

Entries in the Journal

Journal
Date Details Dr Cr

20X8 $ $

February 5 Suspense 380

Motor Expenses 380

Narrative Correction of overcasting

of motor expenses

March 8 Suspense 240

Sales 240

Narrative Sales Day Book

Undercast

March 28 Purchases 50

Suspense 50

Narrative Purchases Day Book

undercast

April 15 Drawings 70

Suspense 70

Narrative Cash withdrawal not

recorded in the Journal

Compiled by: Waseem Akhlaque O Level Accounting Notes 42

IGCSE Accounts


Topic: Control Accounts

Control Accounts
Control Accounts are memorandum accounts for debtors and creditors. They are prepared as:
Sales Ledger Control Account – for debtors (or accounts receivable)
Purchases Ledger Control Account – for creditors (or accounts payable)
Sales Ledger Control Account Source of Information
(Items included)
Opening balances Total of balances in debtors accounts under sales
ledger
Credit sales Total of sales day book
Return Inwards Total of sales return day book
Bad Debts / Bad Debt Recovered General Journal
Bank and Cash received from debtors Cash Book (Receipt side)
Discount Allowed Cash Book (Receipt Side)
Interest Received on over due payments from General Journal
debtors
Set off / Contra General Journal
Closing Balance Total of balances in debtors accounts under sales
ledger

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Purchases Ledger Control Account Source of Information

(Items included)
Opening balances Total of balances in creditors accounts under
purchases ledger
Credit Purchases Total of purchases day book
Return Outwards or Purchase Return Total of purchases return day book
Bank and Cash paid to creditors Cash Book (Payment side)
Discount Received Cash Book (Payment Side)
Interest charged by creditors General Journal
Closing Balance Total of balances in creditors accounts under
purchases ledger

Set Off: The concept of set off refers to clearing off the due amounts with the creditors who are
business debtors also:
To set off, businesses reduce the creditors, and debtors both against each other, the excess amount is
then paid by the party, who had larger due amount.
Double Entry
Set Off: Purchase Ledger (Dr)
Set Off: Sales Ledger (Cr)
Sales Ledger Control Account
$ $
Balance b/d xxx Balance b/d xxx
Credit Sales xxx Sales Return xxx
Dishonoured Cheque xxx Bad Debts xxx
Interest Received xxx Discount Allowed xxx
Balance c/d xxx Bank and Cash xxx
Set off: PL xxx
Balance c/d xxx
-------
------ xxx
xxx ====

===

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Purchase Ledger Control Account

$ $
Balance b/d xxx Balance b/d xxx
Purchases Return xxx Credit Purchases xxx
Set off: SL xxx Interest due xxx
Discount Received xxx Balance c/d xxx
Bank and Cash xxx
Balance c/d xxx

-------
------ xxx
xxx ====

===

Uses / Advantages of Control Account

ü Control accounts provide a check on the internal accuracy of the ledger accounts
ü They identify the ledger or ledgers in which errors have been made when there is difference
on trial balance
ü Provide the final balances of debtors or creditors
ü Limit the frauds or deception with respect to sales and purchases or cash / cheque payments
or receipts
ü Any missing figure such as credit sales or credit purchases can be identified
Limitations/Drawbacks of Control Account
× If control account itself is based on some errors such as posting or entering of data from day
books or ledgers, it might not restrict the errors
× If the system of maintaining day books, ledgers and control accounts are prepared by the
same group or individuals, the frauds might not be restricted
× Control accounts are only limited to debtors and creditors, they do not focus on other items
such as stocks, or accruals.

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Topic: Manufacturing Account

All the organizations or enterprises involve in production of goods will have to prepare
manufacturing account to calculate the cost of goods manufactured or cost of production.
Name of the business
Manufacturing Account
For the year ended -----------------------------------------
$ $
Opening inventory of raw material xxx xxx
Add purchases of raw material xxx
Less purchases return of raw material (xxx)
Add carriage inwards xxx
Less Closing inventory of raw material (xxx)
---------------
Direct Material Consumed xxx
Add Direct Labour (wages) xxx
Add Direct Expenses xxx

Prime Cost xxx

Add Factory Overheads
Supervisors’ salaries xxx
Rent of the factory xxx
Depreciation of plant and machinery xxx
Indirect material xxx
Factory heat and light xxx
---------------- (xxx)
--------------
Total Factory Cost xxx
Add Opening inventory of work in progress xxx
Less Closing inventory of work in progress (xxx)
---------------
Cost of production (or cost of goods manufactured) xxx
---------------

Prime Cost: is the addition of all direct costs including material labour and any other direct expense.
Conversion cost: is the addition of direct labour cost and factory overheads.
Direct and Indirect Costs
Direct Cost: is the cost directly related to production and mostly variable costs and change with the
level of production. E.g. direct material and labour costs

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Indirect Cost: is the cost indirectly related to production and mostly overhead charges or fixed
costs. E.g. factory supervisor’s salary, rent of the factory, building and any other fixed asset
depreciation, carriage outwards.
Factory overheads: are factor’s direct expenses or overheads which are indirect to the factory.
Final Accounts
1. Income Statement and balance sheet in manufacturing account are prepared on the similar
patterns as previously learned, But trading account will include Opening finished goods, cost
of goods manufactured and closing stock of finished goods.
2. The closing inventories under current assets in the balance sheet will be three items of:
• Work in progress: Stocks of incomplete goods
• Finished Goods: Stocks of completed goods
• Raw material: Stocks of raw material for manufacturing

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Topic: Ratio Analysis

In ratio analysis, various formulas and interpretation of results are carried out to communicate with
the stakeholders of the business.
Profitability Ratios
These compare the profits of the business with sales, assets and the capital employed in the business.
These are used to assess how successful the management of a business has been at earning profits for
the business from sales and from the assets employed. They are widely used to measure the
performance of a company as it makes profit on sales by controlling the costs and expenses, and on
the capital invested in the business.
Gross Profit Margin
It measures the gross profit at each one unit of sales. It shows business’ performance of increasing
sales and controlling cost of sales.
Gross profit margin = Gross profit / Sales turnover * 100
Gross profit margin can be improved by following steps:
1. Increase in sales through improving the product quality, advertising and marketing activities
2. Controlling cost of production through reducing wastage of raw material and labour idle time
Net Profit Margin
It measures the net profit at each one unit of sales. It shows business performance of increasing sales,
controlling cost of sales, and expenses.
Net profit margin = Net (or operating) profit / Sales turnover * 100
Net profit margin can be improved by the following steps:
Point 1 and 2 above under gross profit margin, and the point below:
3. Controlling expenses or overheads by identifying excess amounts of expenses
Return on Capital Employed
It shows the profit earned at each $1 of capital invested.
Return on Capital Employed = Net (operating) profit / Capital Employed * 100
Return on Capital Employed can be improved by:
1. Increasing profit
2. Decreasing capital employed

Liquidity Ratios
These ratios show the liquidity of the business; means ability to pay for its short term debts.
This ratio effects the business working capital position.

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Current Ratio
This is the proportion of current assets to current liabilities. The standard ratio is 2:1. It means
business should have double of its current assets than its current liabilities to maintain its liquidity
position.
Current Ratio = Current Assets / Current Liabilities
Always show your answer in ratio form.
Current Ratio can be improved by:
1. increasing cash or bank balance
2. increasing sales on credit or by cash
3. by making more of closing stocks available in stock
4. by depending less on credit supplies
5. by depending less on bank overdraft
Acid Test Ratio
This is the proportion of quick assets or acid test ratio to current liabilities. The standard ratio is
1.5:1. It means business should have one and half times of its assets more than its current liabilities
to maintain its liquidity position.
Acid Test Ratio = Current Assets – Stocks / Current Liabilities
Always show your answer in ratio form.
Acid Test ratio can be improved by all of the above points except point number 3.
Efficiency / Performance Ratio
This gives an indication of how efficiently a business is using its resources and collecting its debts. It
assesses how effectively the assets or resources of a business are being used.
Stock Turnover Ratio
This records the number of times the stock of a business is bought in and resold in a period of time.
Stock turnover ratio = cost of goods sold / Average stock
Average stock = opening stock + closing stock / 2
The ratio shows the performance of the business about reducing stocks in hand and increasing sales.
The ratio can be improved by all the ways of increasing sales including quality improvement, and
sales promotion activities; however cost should not be increased by wastage of material or labour
idle time, otherwise sales will not reflect increase in cost of sales effectively.
Debtors’ Days Ratio
Debtors are the current assets of the business and they are the people who actually have to pay to the
business.

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Debtors Days Ratio shows the number of days it will take for the business to collect cash from the
debtors.
Debtors Days Ratio = Debtors / Sales turnover *365
Always take credit sales in your calculation
In order to improve debtors’ days, following ways can be adopted:
1. Reduce the debtors by revising credit policies of the business
2. Sending debtors reminders of payment regularly
3. Decreasing credit sales
4. Offering cash discounts to the debtors on prompt payment
Creditors Days Ratio
Creditors are the current liabilities of the business and they are the people whom business has to pay.
Creditors’ days ratio shows the number of days it will take for the business to pay its debts.
Creditors Days Ratio = Creditors / Purchases * 365
In order to improve creditors’ days, following can be adopted:
Ø Reduce the creditors by not buying raw material on credit;
Ø Reduce the wastage of raw material so that less could be bought
The analysis for ratio analysis could be made in two following forms:
Inter-firm comparison – the results of two firms from the same industry are compared;
Historical Comparison – the results of current year are compared with the reults of previous years
of the same business
Advantages of Ratio Analysis
ü Shows liquidity, profitability, and performance of the business
ü Helps managers in decision making
ü Communicates with shareholders, and loan providers about business performance
ü Shows comparison with previous years or similar businesses
Disadvantages of Ratio Analysis
× Does not show the effects of inflation, economic conditions, and management’s policies for
the business
× Possible to hide the facts such as reducing or increasing expenses (i.e. called window
dressing)
× Does not indicate future performance

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Topic: Incomplete Records (or Single Entry System)

The businesses such as unincorporated businesses or the sole traders are run by the businessmen who
might not know the detailed accounting knowledge hence they do not maintain the double entry
system. However, they have scattered information about their business. They might not know how
much profit the business has earned or how much loss it has sustained. The tax department asks them
to submit their returns to calculate the tax payable, they might not know the profits of the businesses,
hence they have to get the services of some experts in accounting who prepares their books of
accounts using the available scattered information.
Statement of Calculation of Net Profit
In the exam, you are asked to calculate net profit for the business, but not given any information such
as sales, cost of sales, and expenses. However you are provided the information about opening
capital, closing capital, and drawings, or any additional capital invested. For this purpose, we prepare
statement of calculation of net profit
Name of the business
Statement of Calculation of net profit
For the year ended --------------------------------------------------------
------------------------------------------------------------------------------------------------------------
$
Closing Capital xxx
Add: Drawings xxx
Less: New Capital Introduced (xxx)
Less: Opening Capital (xxx)
Net Profit / (Loss) xxx
------------------------------------------------------------------------------------------------------------
Statement of Affairs
It is same as balance sheet, only the title is written as Statement of Affairs. The purpose of the
statement at the opening and closing dates is to find out capitals, because the soletrader business’
owners do not know how much capital they had in the beginning and how much it has become now.
Credit and Total sales
In order to calculate credit sales, total debtors account is drawn; it is same as sales ledger control
account.
Total sales are calculated by adding cash and credit sales

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Credit and Total Purchases

In order to calculate credit purchases, total creditors account is drawn; it is same as purchases ledger
control account.
Total purchases are calculated by adding cash and credit purchases
Expenses and Income Accounts
Always prepare expenses and incomes accounts to make adjustments for prepayments and accruals
amounts.
(Refer to above adjustments in final accounts)
Cash and Bank Accounts
This is a great help in identifying the missing figures of cash or bank, if cash and bank accounts are
prepared. Also any payments received from debtors or paid to creditors can also be found through
these accounts.
Two Pieces of information are missing
In order to find out two pieces of information missing in which one can be identified with assurance
and other could be based on estimation based on given information. E.g. in the question, it is
mentioned that the owner has withdrawn some cash amounts or by cheque, but cannot remember
how much. In this case, one figure is easily found based on given information and the other could be
estimated i.e. cash drawings or cheque drawings stating as balancing figure.
Finding out closing stock or stock lost by fire or theft
Often a question is being asked that the business does not know its closing stock or stock lost by fire
or theft, but business does not know what the value was.
To find out above, we have to use the concept of margin or mark up in which simply mark up or
margin information are provided. One can easily find out cost of sales and assume opening stock and
purchases are given and closing stock or stock lost by theft or fire will be the amount of difference
between cost of sales, and addition of opening stock and purchases.
Concept of margin and mark-up to find out Sales and Cost of Sales
Margin is profit percentage on sales; and Mark-up is profit percentage on cost of sales. If sales and
mark-up are given, and the business wants to find out cost of sales, first convert mark-up into
margin, which is mark-up / mark-up + 100, then multiply margin with sales to calculate profit and
take the difference of sales and profit to calculate the cost of sales;
If margin and Cost of sales are given, convert margin into mark-up by margin / 100 – margin and
multiply mark up with cost of sales to calculate the profit, which then added with cost of sales to
calculate sales.

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Topic: Company Accounts

A Limited Company is a business where the shareholders (Owners) have separate legal
identity from the firm itself. As a result shareholders can only loose the value of their shares
and are not liable (responsible) for the debts of the business from their own assets.

There are two types of Limited Liability Company:

Public Limited Company:

a. The company can offer its shares to the public and its shares which are traded on the
stock exchange

b. The company name must end with "public limited company" or "plc."

c. The authorized capital by the stock exchange must be greater than $50,000

Private Limited Company:

a. The company may only offer shares to business associates, friends and family. Once the
company is started no new shares can be sold to new shareholders without the agreement of all
existing shareholders

b. Shares will not be traded on the stock exchange

c. The company name will end with "limited" or "ltd."

d. The authorized sharecapital will be $50,000 or less

Raising Capital
One of the main reasons for forming a limited company is to raise large amounts of capital to
finance the business. The way in which companies raise capital is by issuing (selling) two
types of shares to investors:

1. Preference Shares – owners of preference shares will:

Ø receive a fixed rate of dividend.
Ø not be entitled to vote in the shareholders' annual general meeting.
Ø receive their dividends of profit before the ordinary share dividend (higher
priority).
Ø receive capital before ordinary shareholders in the event the company is closed down.
2. Ordinary Shares – owners of ordinary shares will:
Ø receive variable dividends each year.
Ø be entitled to vote in shareholders' meetings with one vote per share.
Ø be given their dividends of profit after the preference share dividend.
Ø be the last to receive their share capital if the company goes bankrupt.

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Share Capital

The share capital is the capital of a company which is divided into preference and ordinary shares which are
then bought and owned by the shareholders. There are two main types of share capital:

• Authorized share capital is the maximum amount of share capital a company is allowed to sell to
shareholders.

• Issued share capital is the amount of share capital actually issued (sold)

Furthermore the issued share capital falls into two categories:

a) Called-up capital is the total amount of capital a company has asked for from its preference and
ordinary shareholders.

b) Paid-up capital is the part of the called-up capital where money has actually been received from the
ordinary and preference shareholders.

c) Calls in arrears the part of the called-up capital where money has still not been received from
shareholders.

Share Capital Example: Trotter Enterprises Ltd

Trotter Enterprises Ltd was started with the authorised right to sell 100,000 ordinary shares of $1 each and
25,000 preference shares of $1 each. The company has actually issued 50,000 ordinary shares and 25,000
preference shares. None of the shares has yet been fully paid; so far the company has made calls of $0.80 per
share, All of the calls have been paid by shareholders, except for $200 owing from one particular shareholder.
The share capital of Trotter Ltd will therefore be:

Authorised Share Capital (100,000 ordinary x $1 + 25,000 Preference x $1) $125,000

Issued Share Capital (50,000 Ordinary x $1 + 25,000 Preference x $1) $75,000
Called-up Share Capital ($0.80 x $50,000 + $0.80 x $25,000) $60,000
Paid-up Share Capital ($60,000 - $200) $59,800
Calls in Arrears $200

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Dividends

Dividends are paid to shareholders as a way of distributing the profits of the company. Dividends are normally
expressed as “dollars per share” eg $0.10 for every share held. Directors decide if a company will be paying
out a dividend or not. They look at factors such as:

• the availability of profits

• the availability of cash to pay the dividend
• whether it would be better to keep the profits in the company to allow it to grow
• whether the market price of the shares will be affected or not

Directors may pay out a dividend more than once per year. A dividend paid half way through the year is called
an INTERIM dividend, and at the end of the year it is called a FINAL dividend.

Dividends payable at the end of the year are entered in the Profit and Loss Appropriation Account (Income
Statement) and as a Current Liability in the Balance Sheet. This is because at the end of the year when the
Balance Sheet is drawn up the dividend payable to the shareholder will not have yet been paid and so the
company is still liable in the short term.

Revenue Reserves – are created by ploughing profits back into the company

Examples:

• General Reserve – created for general purposes in future

• Fixed Asset Reserve – created to purchase fixed assets

Revenue reserves and retained profit are recorded in the balance sheet under the heading "Share Capital and
Reserves" or “Shareholders’ Funds”.

Retained Profit and Reserves

Retained profit - is the profit that is not appropriated (divided) for dividends or reserves and remains as a
balance on the profit and loss

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Debentures

A debenture is a document given to someone who has loaned the company money. It states the
amount of the loan, the interest payable each year, and the date on which the loan is to be repaid.

1- Debenture holders are liabilities of the company – NOT owners as it is with shareholders.
2- The interest must be paid regardless of the profitability of the company.
3- Debentures due to be paid within a year are shown on the balance sheet as CURRENT
LIABILITIES.
4- Those due to be paid in more than one year are shown as LONG TERM LIABILITIES.
5- Debenture holders have no voting rights within the company's meetings.
6- Debenture holders receive a fixed rate of interest
7- Debenture holders are repaid before any shareholders in case the company is closed down.

Interest Payable on debentures is shown as an expense in the Profit and Loss account (Income
Statement) and a Current Liability in the Balance Sheet. This is because at the end of the year when
the Balance Sheet is drawn up the interest payable to the debenture holder will not have yet been
paid and so the company is still liable in the short term.

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Layout of a Limited Liability Income Statement

Example: B. Calm provides the following information for the year beginning on the 1
January 20X2
1 The issued share capital consisted of 150 000 ordinary shares of $0.50 each and
100,000 (8%) preference shares at $1. (c)
2 The company had issued 1000 5% debentures of $100 each.
3 On 1 January 20X2:
General reserve $18 500
Retained profit $7 050 (b)
4 The profit for the year ended 31 December 20X2 was $36 000.
5 During the year ended 31 December 20X2 an interim dividend of 7% on the ordinary
shares was paid.
6 On 31 December 20X2 it was decided to transfer $10 000 (a) to general reserve and
pay a dividend of 9% on the ordinary shares.
B. Calm
Trading, Profit and Loss & Appropriation Account for the year ended 31 12 20X2
$ $
Sales Turnover 300,000
Less Returns Inwards 10,000
290,000
Less Cost of Goods Sold
Opening Stock 10,000
Purchases 140,000
150,000
Closing Stock 50,000 100,000
Gross Profit 190,000

kExpenses
Sales Staff Salaries 30,000
Advertising 10,000
Wages 30,000
Depreciation of Motor Vehicle 4,000
Provision for Bad Debts 1,000
Rent 3,000
Electricity 1,500
Directors Remuneration (Salary) 69,500
Debenture Interest 5,000 154,000
Profit for the year (Operating Profit) 36,000
Less Transfer to general reserve 10,000 (a)
Preference Share Dividend - Interim 8,000 (c)
Ordinary share dividend – Final 5,250
- Interim 6,750 30,000
Retained profit for the year 6,000
Retained profit brought down 7,050 (b)
Retained profit carried down 13,050

Directors Remuneration is the amount of Debenture Interest is the cost of

salary directors will be paid for running the borrowing money from the general
business. It is entered as a Profit and Loss public through a debenture issue.
expense and not in the appropriation Therefore it is included in the
account. Profit and Loss Account as an
expense.

www.igcseaccounts.com
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