O Level Principles of Accounts Notes and Worksheets by Faisal Durrani 0303-4898049

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
 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
 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.
Benefits of ICT (Information and Communication Technology)
 Speed of processing information
 Ability to process high volumes of information
 Performing reconciliation
 Ease and capacity of information storage
 Security
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.

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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. 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:
 Assets = Liabilities + Capital
 Liabilities = Assets – Capital
 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.

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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.
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
 Shows the arithmetical accuracy of T-accounts;
 Facilitate the errors’ identification
 Helps in preparation of final accounts

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May 2004 P2 Q2

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November 2007 P2 Q3 (a & b)

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May 2008 P2 Q4

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November 2008 P2 Q1 (a, b & c)

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November 2008 P2 Q4 (f & g)

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Specimen 2010 P2 Q1 (e)

Specimen 2010 P2 Q4 (c & d)

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Specimen 2010 P2 Q5 (e)

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May 2010 P2 Q1

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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 / Credit Notes Received / Recording of Purchases Return
Book / 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)

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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.
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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November2003 P2 Q1

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May 2005 P2 Q1

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November 2005 P2 Q1

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November 2006 P2 Q1 (a, b & d (ii)

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May 2008 P2 Q1

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May 2009 P2 Q1

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November 2009 P2 Q1

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Specimen 2010 P2 Q1 (a to d)

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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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May 2003 P2 Q1

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November 2004 P2 Q1

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May 2006 P2 Q1

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Specimen 2010 P2 Q2

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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

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Statutory Deductions
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

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Name of the employee

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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November 2008 P2 Q2 (c & d)

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May 2009 P2 Q3 (a & b)

The Ranford sports club keeps a full set of double entry accounts and prepares monthly accounts.

The wages for the café’ manager have not been paid for the month of April.

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November 2009 P2 Q2 (f & g)

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Specimen 2010 P2 Q3 (d)

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May 2010 P2 Q2 (b & d)

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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 :
 Per annum depreciation
 Depreciable amount (i.e. cost – scrap / disposable value)
Rate of Depreciation = Annual Depreciation / Depreciable amount*100

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May 2004 P2 Q4

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November 2006 P2 Q4

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May 2008 P2 Q2 (c & d)

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November 2009 P2 Q2 (a to e)

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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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May 2002 P2 Q3

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May 2007 P2 Q2

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

$ $
xxx Revenue (Sales) xxx
Opening Inventory (Stock)
xxx Less: Sales Return (xxx)
Add: Purchases
(xxx)
Less: Purchase Return
xxx
Add: Carriage Inwards
Less: Closing
(xxx)
Inventory(Stock)

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

Gross Profit b/ d xxx

xxx
Less: Expenses:
xxx Add: Other Incomes
xxx
Salaries
xxx Commission Received xxx
Rent
xxx Discount Received xxx
Electricity Bill
xxx
Depreciation
xxx
Bad Debts
--------------------
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 xxx Bank Overdraft xxx
(Debtors) xxx
Bank xxx
Cash

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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May 2003 P2 Q5

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November 2003 P2 Q6

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November 2004 P2 Q5

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May 2005 P2Q5

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November 2005 P2Q5

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November 2006 P2Q5

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May 2007 P2Q5

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May 2009 P2Q5

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Topic: Departmental Accounts

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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:
 Rent
 Telephone bills
 Canteen expenses
 Electricity bills
 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:
 The amount of capital invested in the business by all the partners
 The nature of work the partnership will carry out
 The profit and loss sharing ratio
 The duration of the partnership
 The arrangement for absence, retirement, and how new partner will be admitted
Advantages of partnership
 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)
 Responsibility of work, decision making, and burden of unlimited liability can be shared
among the partners
 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)
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Income Statement (Profit and Loss Appropriation a/c) (Cr)

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

 If no profit or loss ratio is being given, assume equal distribution;
 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)

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Old partners’ Capital Account (Cr)

(Division of good will according to the old ratio)

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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May 2004 P2 Q5

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May 2005 P2 Q2

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May 2006 P2 Q5

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November 2007 P2 Q6

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May 2008 P2 Q5

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May 2009 P2 Q4 (A to C)

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November 2009 P2 Q5

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May 2010 P2 Q3

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Amalgamation

Nov 1997 P1Q4

Jay and Kay traded separately up to 31December 1996, at which date their Balance Sheets were as
shown below:

Jay ($) Kay($) Jay($) Kay($)

Premises 30000 24000 Capital 72000 39600

Equipment 21000 13200 Loan 12000
Inventory 13800 8700 Accounts Payable 6000 3000
Accounts 9600 11100 Bank 2400
Receivable 3600
Bank --------- --------- --------- --------
78000 57000 78000 57000
--------- --------- --------- --------

Jay and Kay agreed to amalgamate their businesses their businesses and become equal partners as
from 1 January 1997. It was agreed that:

1. The partnership should takes over all the assets and liabilities of the two businesses except for
the premises belonging to Jay and the loan owed by Kay.
2. Equipment should be re-valued at $18000 for Jay and at $15000 for Kay
3. $600 of Kay’s receivables were bad and should be written off
4. Good will was to be valued at $9000 for Jay and $7200 for Kay
5. All other items were to be taken over by the partnership at the Balance Sheet values

Required

(a) Draw up the two Capital Accounts for the partners showing clearly how the final
balances at 1January 1997 are obtained
(b) Prepare the balance sheet of the partnership at 1 January 1997
(c) Briefly explain the meaning of Good Will

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November 2002 P2 Q3

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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
May 2006 P2 Q4

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May 2008 P2 Q2 (A & B)

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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
 Start from profit before correction
 Add sales and income
 Less expenses
 Result will be profit after correction

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November 2002 P2 Q1

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November 2003 P2 Q2

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May 2004 P2 Q3

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November 2004 P2 Q2

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November 2007 P2 Q1

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November 2008 P2 Q1 (C & D)

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May 2009 P2 Q2

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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 xxx Bad Debts xxx
Cheque xxx Discount xxx
Interest Received xxx Allowed xxx
Balance c/d Bank and Cash xxx
Set off: PL xxx
Balance c/d -------
------ xxx
xxx ==== 126

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Purchase Ledger Control Account

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

===

Uses / Advantages of Control Account

 Control accounts provide a check on the internal accuracy of the ledger accounts
 They identify the ledger or ledgers in which errors have been made when there is difference
on trial balance
 Provide the final balances of debtors or creditors
 Limit the frauds or deception with respect to sales and purchases or cash / cheque payments
or receipts
 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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Nov 2002 P2 Q4

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Nov 2003 P2 Q3

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May 2005 P2 Q3 (B & C)

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May 2007 P2 Q1

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May 2010 P2 Q2 (A)

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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

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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
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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Nov 2003 P2 Q5

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May 2005 P2 Q4

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Nov 2007 P2 Q4

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Nov 2008 P2 Q5

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Specimen 2010 P2 Q6

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May 2010 P2 Q5

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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

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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.
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

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Debtors are the current assets of the business and they are the people who actually have to pay to the
business.
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:
 Reduce the creditors by not buying raw material on credit;
 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
 Shows liquidity, profitability, and performance of the business
 Helps managers in decision making
 Communicates with shareholders, and loan providers about business performance
 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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Nov 2002 P2 Q2

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May 2003 P2 Q2

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May 2003 P2 Q4

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Nov 2003 P2 Q5

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Nov 2003 P2 Q5

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Nov 2004 P2 Q4

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Nov 2005 P2 Q4

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Nov 2006 P2 Q3

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May 2007 P2 Q4

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Nov 2007 P2 Q2; 3

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Nov 2007 P2 Q5 (C & D)

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May 2008 P2 Q3

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May 2009 P2 Q4

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Specimen 2010 P2 Q4

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May 2010 P2 Q4

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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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Finally prepare income statement and balance sheet as all the information required is
available.
May 2003 P2 Q2 (A & B)

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May 2005 P2 Q3 (A)

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