ACCOUNTING FOR BEGINNERS

ACCOUNTING WORK BOOK

COMPLIED BY:
MR JOSHUA PATA
CONTACTS; 76073118
[email protected]

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 ACCOUNTING FOR BEGINNERS

Accounting - The systematic recording, reporting, and analysis of financial transactions of a

business. Accounting allows a company to analyze the financial performance of the business, and
look at statistics such as net profit.

Balance Sheet
Balance Sheet - A quantitative summary of a company's financial condition at a specific point in time,
including assets, liabilities and net worth.
The first part of a balance sheet shows all the productive assets a company owns, and the second
part shows all the financing methods (such as liabilities and shareholders' equity).

Asset - Any item of economic value owned by an individual or corporation, especially that which could
be converted to cash. Examples are cash, securities, accounts receivable, inventory, office
equipment, real estate, a car, and other property.

On a balance sheet, assets are equal to the sum of liabilities, common stock, preferred stock, and
retained earnings.

From an accounting perspective, assets are divided into the following categories:

 current assets (cash and other liquid items),

 long-term assets (real estate, plant, equipment),
 prepaid and deferred assets (expenditures for future costs such as insurance, rent, interest),
and
 intangible assets (trademarks, patents, copyrights, goodwill).

Liability - An obligation that legally binds a company to settle a debt. When one is liable for a debt,
they are responsible for paying the debt. A liability is recorded on the balance sheet and can include
accounts payable, taxes, wages, accrued expenses, and deferred revenues. Current liabilities are
debts payable within one year, while long-term liabilities are debts payable over a longer period.

Shareholders' Equity - An ownership interest in a corporation in the form of common stock or

preferred stock. It is calculated by taking the total assets minus total liabilities; here also called
shareholder's equity or net worth or book value.

Income Statement
Income Statement - An accounting of sales, expenses, and net profit for a given period. an income
statement depicts what happened over a month, quarter, or year. It is based on a fundamental
accounting equation (Income = Revenue - Expenses) and shows the rate at which the owners equity
is changing for better or worse.

Revenue - The total amount of money received by the company for goods sold or services provided
during a certain time period. It also includes all net sales, exchange of assets; interest and any other
increase in owner's equity and is calculated before any expenses are subtracted.

Expense - Any cost of doing business resulting from revenue-generating activities.

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Cash Flow Statement

Cash Flow Statement - A summary of the actual or anticipated incomings and outgoings of cash in a
firm over an accounting period (month, quarter, year).

It answers the questions:

 Where the money came (will come) from?

 Where it went (will go)?

Cash flow statements assess the amount, timing, and predictability of cash-inflows and cash-outflows,

and are used as the basis for budgeting and business-planning.

The accounting data is presented usually in three main sections:

1. Operating-activities (sales of goods or services),
2. Investing-activities (sale or purchase of an asset, for example), and
3. Financing-activities (borrowings, or sale of common stock, for example).

Together, these sections show the overall (net) change in the firm's cash-flow for the period the
statement is prepared.

Accounting Methods
Accounting Method - A process used by a business to report income and expenses. Companies
must choose between two methods acceptable to the IRS, cash accounting or accrual accounting.

Cash Basis Accounting - An accepted form of accounting that records all revenues and
expenditures at the time when payments are actually received or sent. This straightforward method of
accounting is appropriate for small or newer businesses that conduct business on a cash basis or that
don't carry inventories.

Accrual Basis Accounting - An accepted form of accounting that reports income when earned and
expenses when incurred. Under the accrual method, companies do have some discretion as to when
income and expenses are recognized, but there are rules governing the recognition. In addition,
companies are required to make prudent estimates against revenues that are recorded but may not
be received, called a bad debt expense.

Other Accounting Concepts

Accounts Payable - Money which a company owes to vendors for products and services purchased
on credit. This item appears on the company's balance sheet as a current liability, since the
expectation is that the liability will be fulfilled in less than a year. When accounts payable are paid off,
it represents a negative cash flow for the company.

Accounts Receivable - Money which is owed to a company by a customer for products and services
provided on credit. This is often treated as a current asset on a balance sheet. A specific sale is
generally only treated as an account receivable after the customer is sent an invoice.

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ACCOUNTING CONCEPTS

Popular Terms:
Rules of accounting that should be followed in preparation of all accounts and financial statements.
The four fundamental concepts are

(1) Accruals concept: revenue and expenses are recorded when they occur and not when the cash
is received or paid out; 

(2) Consistency concept: once an accounting method has been chosen, that method should be
used unless there is a sound reason to do otherwise; 

(3) Going concern: the business entity for which accounts are being prepared is in good condition
and will continue to be in business in the foreseeable future;

(4) Prudence concept (also conservation concept): revenue and profits are included in the balance
sheet only when they are realized (or there is reasonable 'certainty' of realizing them) but liabilities are
included when there is reasonable 'possibility' of incurring them.

Other concepts include

(5) Accounting equation: total assets equal total liabilities plus owners' equity; 

(6) Accounting period: financial records pertaining only to a specific period are to be considered in
preparing accounts for that period; 

(7) Cost basis: asset value recorded in the account books should be the actual cost paid, and not the
asset's current market value; 

(8) Entity: accounting records reflect the financial activities of a specific business or organization, not
of its owners or employees; 

(9) Full disclosure: financial statements and their notes should contain all relevant data; 

(10) Lower of cost or market value: inventory is valued either at cost or the market value (whichever
is lower); 

(11) Maintenance of capital: profit can be realized only after capital of the firm has been restored to
its original level, or is maintained at a predetermined level; 

(12) Matching: transactions affecting both revenues and expenses should be recognized in the same
accounting period; 

(13) Materiality: minor events may be ignored, but the major ones should be fully disclosed; 

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(14) Money measurement: the accounting process records only activities that can be expressed in
monetary terms (with some exceptions); 

(15) Objectivity: financial statements should be based only on verifiable evidence, including an audit
trail; 

(16) Realization: any change in the market value of an asset or liability is not recognized as a profit or
loss until the asset is sold or the liability is paid off; 

(17) Unit of measurement: financial data should be recorded with a common unit of measure
(dollar, pound sterling, yen, etc.).

THE ROLES OF THE ACCOUNTANT:

 The collection and recording of financial data

 The organization of financial data into books of accounts

 The control of cash resources

 The preparation of financial statements (Trading, Profit and loss Account and Balance Sheet)

 The assessment and evaluation of financial reports

 The examination of Accounts in the role of Auditor

 The preparation of budgets

 The preparation of costing estimates

USERS OF ACCOUNTING INFORMATION

 Owners of the Business

 A Prospective Buyer

 Employee

 A Prospective Partner

 Investors

 Suppliers

 Tax inspector

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BUSINESS DOCUMENTS

The complete process of supplying goods and services from ordering to payment is called a
transaction. A variety of documents are raised at various stages in the process of buying and selling
(between the buyer and the seller).

 Enquiry
 Order
 Cheque
 Quotation
 Acknowledgement
 Advice Note
 Delivery Note
 Invoice
 Statement of Account

SOURCES OF FINANCE

 Internal Sources of Finance VS External Sources of Finance

 Trade Credit

 Personal Savings

 Commercial Banks

 Factoring Services

 Share Issue

 Debentures

 Venture capital

 Leasing

 Hire Purchase

 Government assistance

 Franchising

CONTENTS OF PARTNERSHIP AGREEMENTS

 The capital to be contributed by each partner

 The ratio in which profits (or losses) are to be shared

 The rate of interest to be paid on capital before the profits are shared

 The rate of interest to be charged on partners’ drawings

 Salaries to be paid to working partners

 Arrangements for the admission of new partners

 Procedures to be carried out when a partner retires or dies

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What is the Journal's Role in the Accounting Cycle?

Most business firms record and report financial activity with a double entry accounting
system. Exhibit 1 below shows the major steps in the accounting cycle for these firms. Note
especially that the journal is the initial data entry point for transaction records. And, these records
build ultimately into the firm's financial accounting reports at the end of the accounting cycle. 

Exhibit 1. The accounting cycle. Transactions enter the journal as the first step in the cycle. The
journal builds into a chronological list, adding entries one after another in the order they
occur. Journal entries transfer (post) to the ledger as the second step
Day Books

There are four Day Books:

Sales Day Book

Purchases Day Book

Sales Returns Day Book

Purchases Returns Day Book

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Students may be given the Day books in the question or they may be asked to complete them.

Example: 2005 Q1 Paper 2 Part (b)

Record the folowing Credit Transactions in the Purchases and Purchases Returns Books.

5/3/05 Purchased goods on credit from Doyle Ltd Invoice No.12 €80,000 + VAT 21%.

9/3/05 Returned goods to COYLE Ltd Credit Note No. 30

€15,000 + VAT 21%.

PURCHASES DAY BOOK

Date Details F NET VAT TOTAL

5/3/05 DOYLE Ltd (Inv. 12) CL 80,000 16,800 96,800

80,000 16,800 96,800

PURCHASES RETURNS DAY BOOK

Date Details F NET VAT TOTAL

9/3/05 COYLE Ltd (CrN. 30) CL 15,000 3,150 18,150

15,000 3,150 18,150

STUDENTS WILL BE ASKED TO ENTER THE RELEVANT FIGURES TO THE LEDGER

ACCOUNTS.

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Example 2008 Paper

PURCHASES DAY BOOK There are three figures

PURCHASES DAY BOOK

NET VAT TOTAL

€80,000 €16,800 €96,800

CREDIT SIDE CREDITORS A/C

DEBIT SIDE VAT A/C

DEBIT SIDE PURCHASES A/C

PURCHASES RETURNS DAY BOOK

NET VAT TOTAL

€15,000 €3,150 €18,150

DEBIT SIDE CREDITORS A/C

CREDIT SIDE VAT A/C

CREDIT SIDE PURCHSES RETURNS A/C

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SIMILAR RULES APPLY TO THE SALES DAY BOOK AND THE SALES RETURNS DAY
BOOK. SEE EXAMPLE BELOW.

SALES DAY BOOK

NET VAT TOTAL

€ € €

DEBIT SIDE DEBTORS A/C

CREDIT SIDE VAT A/C

CREDIT SIDE SALES A/C

SALES RETURNS DAY BOOK

NET VAT TOTAL

€ € €

CREDIT SIDE DEBTORS A/C

DEBIT SIDE VAT A/C

DEBIT SIDE SALES RETURNS A/C

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QUESTIONS

1. You are to enter up the Sales Day Book from the following details. Post the items to the relevant
accounts in the sales ledger

20X1   £
May 1 Credit sales to I Curtis 90
May 5 Credit sales to B Sumner 45
May 11 Credit sales to G Gilbert 114
May 18 Credit sales to S Morris 87
May 21 Credit sales to P Hook 55
May 31 Credit sales to T Wilson 32

2. You are to enter up the Sales Day Book from the following details. Post the items to the relevant
accounts in the sales ledger

20X3   £
June 1 Credit sales to P Oakey 432
June 5 Credit sales to G Gregory 390
June 11 Credit sales to M Ware 234
June 18 Credit sales to A Wright 758
June 21 Credit sales to I Marsh 250
June 31 Credit sales to I Burdon 540

3. From the following transactions of a trader prepare the purchases day book and post it into ledger:-
1991 $

January 5 Purchased goods from Rasool & Co. 2,400

”     15 Purchased goods from Iqbal Bros. 6,000

”     25 Purchased goods from More & Co. 1,500

”     30 Purchased goods from Maqbool & Co. 3,000

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Concept of Double Entry

Every transaction has two effects. For example, if someone transacts a purchase of a drink from a
local store, he pays cash to the shopkeeper and in return, he gets a bottle of dink. This simple
transaction has two effects from the perspective of both, the buyer as well as the seller. The buyer's
cash balance would decrease by the amount of the cost of purchase while on the other hand he will
acquire a bottle of drink. Conversely, the seller will be one drink short though his cash balance would
increase by the price of the drink.

Accounting attempts to record both effects of a transaction or event on the entity's financial
statements. This is the application of double entry concept. Without applying double entry concept,
accounting records would only reflect a partial view of the company's affairs. Imagine if an entity
purchased a machine during a year, but the accounting records do not show whether the machine
was purchased for cash or on credit. Perhaps the machine was bought in exchange of another
machine. Such information can only be gained from accounting records if both effects of a transaction
are accounted for.

Traditionally, the two effects of an accounting entry are known as Debit (Dr) and Credit (Cr).
Accounting system is based on the principal that for every Debit entry, there will always be an equal
Credit entry. This is known as the Duality Principal.

Debit entries are ones that account for the following effects:

 Increase in assets

 Increase in expense

 Decrease in liability

 Decrease in equity

 Decrease in income

Credit entries are ones that account for the following effects:

 Decrease in assets

 Decrease in expense

 Increase in liability

 Increase in equity

 Increase in income

Double Entry is recorded in a manner that the Accounting Equation is always in balance.

Assets - Liabilities = Capital

Any increase in expense (Dr) will be offset by a decrease in assets (Cr) or increase in liability or equity
(Cr) and vice-versa. Hence, the accounting equation will still be in equilibrium.

Double-entry book keeping questions appear in a number of different ways.

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Ledger Accounts

There are two parts/accounts for each transaction. Students are asked to name the account and
decide which side, whether it is on the Debit or Credit side.

Example

Daly Ltd purchased equipment by cheque.

Account 1 ____Equipment Account________(Debit side)_____

Account 2 ____Bank Account_____________(Credit side)_____

When goods are purchased or sold there are three main ways of payment:

1. Bank Account (watch out for the words “lodged” or “cheque”)

2. Cash Account
3. Credit

All Assets should be recorded in an account named after the asset e.g. Machinery Account

All expenses should be recorded in an account named after the expense e.g. Insurance Account

All goods purchased should be recorded in an account called Purchases Account.

All goods sold should be recorded in an account called Sales Account.

The same rule applies to goods returned e.g Sales Returns Account and Purchases Returns Account.

Example 2008 Paper Section A

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Credit Transactions

This applies where goods are bought and sold ON CREDIT. This means goods are bought or sold
now and payment is not received till a later date.

The following is how to treat credit transactions

Selling on Credit Sales Account and Debtors Account

Buying on Credit Purchases A/C and Creditors Account

Returning goods to Creditor Purchases Returns Account and Creditors

Account

Goods returned by a Debtor Sales Returns A/C and Debtors A/C

Transaction Debit Credit

Purchased goods on credit from B Giles

Purchased equipment on credit from

Dental Suplies Ltd

Sold goods on credit to M Reilly

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Layout of Accounts – T Accounts

These types of questions appear all over the paper especially at the end of long questions. Students
should complete all parts outlined below.

There are two sides to T Accounts:

Debit Side

Credit Side

As mentioned every transaction has two accounts. When posting a T- Account, each transaction will
have an entry on both sides.

Example

Debit Account Name Credit

Date Details F € Date Details F €

Divides the T Account in two

Monetary value of transaction

(Folio) Reference to find other account of transaction

Record of the other account

Date of transaction

When completing T Accounts students must always fill the following in on both the DEBIT AND
CREDIT SIDES.

Dates

Details

Folio

“DEBIT THE RECEIVER AND CREDIT THE GIVER”

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BALANCING T-ACCOUNTS

These types of questions appear all over the paper from Section A short questions and part (c) of long
questions and other long accounting questions.

Example

Debit BANK ACCOUNT Credit

DATE DETAILS F € DATE DETAILS F €

1/3/08 Balance b/d 14,000 3/3/08 Purchases PB 4,500

10/3/08 Sales SB 5,000 20/3/08 Insurane GL 3,000

31/3/08 Balance c/d 11,500

19,000 19,000

1/4/08 Balance b/d 11,500

 Add up both Debit and Credit side of account

 Insert Balance c/d on the smaller side
 Draw a single line and a double line to denote that the account is
finished

 Put the larger amount in both total boxes i.e. accounts must show
same totals to balance

 Calculate the Balance c/d by adding up the amounts and

subtracting it from the total e.g. €11,500

 The closing balance should be brought down (b/d) for the

beginning of the next month.

 This closing balance b/d is on the debit side and will be used in the
trial balance.

Examples of Double Entry

1. Purchase of machine by cash

Debit Machine Increase in Asset

Credit Cash Decrease in Asset

2. Payment of utility bills

Debit Utility Expense Increase in Expense

Credit Cash Decrease in Asset

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3. Interest received on bank deposit account

Debit Cash Increase in Asset

Credit Finance Income Increase in Income

4. Receipt of bank loan principal

Debit Cash Increase in Asset

Credit Bank Loan Increase in Liability

5. Issue of ordinary shares for cash

Debit Cash Increase in Asset

Credit Share Capital Increase in Equity

Debits & Credits in Accounting

What are debits and credits?

Debit and Credit are the respective sides of an account.

Debit refers to the left side of an account.

Credit refers to the right side of an account.

Explanation

In accounting, every account or statement (e.g. accounting ledger, trial balance, profit and loss

account, balance sheet) has 2 sides known as debit and credit.

In a typical accounting ledger (often referred to as a T-Account) the debit and credit sides are split
horizontally as shown below:

XYZ Receivable A/C

Date Particulars $ Date Particulars $

01-Dec-14 Sales 12,500 10-Dec-14 Discount allowed 500

10-Dec-14 Bank 12,000

12,500 12,500

Debit Side Credit Side

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According to the dual aspect principle, each accounting entry is recorded in 2 equal debit and credit
portions. In other words, the total amount that will be recorded in the left side (debit) of accounting
ledgers will always equal to the total amount recorded on the right side (credit).

For example, you may consider how the accounting entries have been recorded in the Receivable
A/C shown above.

The ledger has been debited on account of credit sales amounting $12,500 and (as can be
ascertained from the particulars) the same amount has been credited in the Sales A/C. Similarly,
the credit entries in the Receivable A/C relating to discount allowed and bank receipts are matched
with equal amounts recorded on the debit sides of Discount Allowed A/C and Bank A/C respectively.

In case of any confusion, please refer Accounting for Sales section for more thorough explanation of
the accounting entries discussed above.

Now the question arises, how do we know what to record on the debit side of an account and
what to record on the credit side?

Accounting has specific rules regarding what should be debited and what should be credited as
summarized in the chart below:

Debit Entries account for: Credit Entries account for:

Increase in assets Decrease in assets

Increase in expenses Decrease in expenses

Decrease in liabilities Increase in liabilities

Decrease in income Increase in income

Decrease in equity Increase in equity

Assets, expenses, liabilities, income & equity are the 5 elements of financial statements. For
explanation and examples of the various elements, please refer elements of financial
statements section.

As with accounting ledgers, all accounting statements are based on the rules of debit and credit. For
example, in a balance sheet, assets are reported on the debit side whereas liabilities and equity are
presented on the credit side. Although traditional accounts and statements are presented in a T-
Account format as above (which makes understanding debits and credits a bit easier for beginners)
many accounts and statements nowadays are reported in a vertical format.

But fear not! As long as you master the rules of debit and credit, you shall have no problem in
understanding their application and presentation.

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Example

Record the debit and credit entries of the following transactions:

a) Purchase of an office building for $1 million via funds transfer

b) Bonus payable to various employees amounting $5 million

c) Credit Sales during the period amounting $7 million

d) Issuance of ordinary shares at par for $10 million

a) Purchase of an office building

Account $ Effect

Debit Office Building 1,000,000 Increase in Asset

Credit Bank 1,000,000 Decrease in Assets

b) Performance Bonus

Account $ Effect

Debit Salaries, wages and benefits 5,000,000 Increase in Expense

Credit Bonus Payable 5,000,000 Increase in Liabilities

c) Credit Sales

Account $ Effect

Debit Accounts Receivables 7,000,000 Increase in Asset

Credit Sales Revenue 7,000,000 Increase in Income

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d) Issuance of ordinary shares

Account $ Effect

Debit Bank 10,000,000 Increase in Asset

Credit Share Capital 10,000,000 Increase in Equity

If you face any problem in understanding the double entries, please refer double entry
accounting section.

Accounting equation

Describes that the total value of assets of a business is always equal to its liabilities plus owner’s
equity. This equation is the foundation of modern double entry system of accounting being used by
small proprietors to large multinational corporations. Other names used for accounting equation
are balance sheet equation and fundamental or basic accounting equation.

Definition and explanation

We know that every business owns some properties known as assets. The claims to the assets
owned by a business entity are primarily divided into two types – the claims of creditors and the
claims of owner. In accounting, the claims of creditors are referred to as liabilities and the claims of
owner are referred to as owner’s equity.

Accounting equation is simply an expression of the relationship among assets, liabilities and owner’s
equity in a business. The general form of this equation is given below:

Assets = Liabilities + Owner’s Equity

Notice that the left hand side (also known as assets side) of the equation shows the resources owned
by the business and the right hand side (also known as equity side) shows the sources of funds used
to acquire the resources. All assets owned by a business are acquired with the funds supplied either
by creditors or by owner. In other words, we can say that the value of assets in a business is always
equal to the sum of the value of liabilities and owner’s equity. The total dollar amounts of two sides of
accounting equation are always equal because they represent two different views of the same thing.

In accounting equation, the liabilities are normally placed before owner’s equity because the rights of
creditors are always given a priority over the rights of owners. Because of this preference, the
liabilities are sometime transposed to the left side which results in the following form of accounting
equation:

Assets – Liabilities =  Owner’s Equity

If dollar amounts of any two of the three elements are known, we can solve the equation to find the
third one. For example, if a business has total assets amounting to $200,000 and total liabilities
amounting to $60,000, the owners equity must be equal to $140,000 as computed below:

Assets – Liabilities =  Owner’s Equity

$200,000 – $60,000 = $140,000

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Example 1:

Using the concept of accounting equation, compute missing figures from the following:

1. Assets = $50,000, Liabilities = $20,000, Owner’s equity = ?

2. Assets = ?, Liabilities = $10,000, Owner’s equity = $15,000
3. Assets = $60,000, Liabilities = ?, Owner’s equity = $40,000
4. Assets = ?, Liabilities + Owner’s equity = $150,000

Solution

1. Owner’s equity = Assets – Liabilities

= $50,000 – $20,000
= $30,000
2. Assets = Liabilities + Owner’s equity
= $10,000 + $15,000
= $$25,000
3. Liabilities = Assets – Owner’s equity
= $60,000 – $40,000
= $20,000
4. The basic accounting equation is: Assets = Liabilities + Owner’s equity. If liabilities plus
owner’s equity is equal to $150,000, the assets must also be equal to $150,000.

TRIAL BALANCE

TRIAL BALANCE

A trial balance is a list and total of all the debit and credit accounts for an entity for a given period –
usually a month. The format of the trial balance is a two-column schedule with all the debit balances
listed in one column and all the credit balances listed in the other. The trial balance is prepared after
all the transactions for the period have been journalized and posted to the General Ledger.

Key to preparing a trial balance is making sure that all the account balances are listed under the
correct column. The appropriate columns are as follows:

Assets = Debit balance

Liabilities = Credit balance
Expenses = Debit Balance
Equity = Credit balance
Revenue = Credit balance

A trial balance only checks the sum of debits against the sum of credits. That is why it does not
guarantee that there are no errors. The following are the main classes of errors that are not detected
by the trial balance.

 An error of original entry is when both sides of a transaction include the wrong amount.[2] For
example, if a purchase invoice for £21 is entered as £12, this will result in an incorrect debit entry
(to purchases), and an incorrect credit entry (to the relevant creditor account), both for £9 less, so
the total of both columns will be £9 less, and will thus balance.
 An error of omission is when a transaction is completely omitted from the accounting records.
[3]
 As the debits and credits for the transaction would balance, omitting it would still leave the
totals balanced. A variation of this error is omitting one of the ledger account totals from the trial
balance (but in this case the trial balance will not balance).

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 An error of reversal is when entries are made to the correct amount, but with debits instead of
credits, and vice versa.[4] For example, if a cash sale for £100 is debited to the Sales account, and
credited to the Cash account. Such an error will not affect the totals.
 An error of commission is when the entries are made at the correct amount, and the
appropriate side (debit or credit), but one or more entries are made to the wrong account of the
correct type.[5] For example, if fuel costs are incorrectly debited to the postage account (both
expense accounts). This will not affect the totals.
 An error of principle is when the entries are made to the correct amount, and the appropriate
side (debit or credit), as with an error of commission, but the wrongtype of account is used. For
example, if fuel costs (an expense account), are debited to stock (an asset account).[3] This will
not affect the totals.
 Compensating errors are multiple unrelated errors that would individually lead to an imbalance,
but together cancel each other out.[3]

How to use the Trial Balance

Here’s an example trial balance. As you can see, the report has a heading that identifies the
company, report name, and date that it was created. The accounts are listed on the left with the
balances under the debit and credit columns.

Example:

Enter the following transactions in journal and post them into the ledger and also prepare a trial
balance.

2005  
Jan. 1 Mr. X started business with cash $80,000 and furniture $20,000.
Jan. 2 Purchased goods on credit worth $30,000 from Y.
Jan. 3 Sold goods for cash $16,000.
Jan. 4 Sold goods on credit to S for $10,000
Jan. 8 Cash received from S $9,800 in full settlement of his account.

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Solution:

Journal

Date Particulars L.F DR. Cr.

2005 Amount ($) Amount ($)
Jan. 1 Cash A/C 5 80,000  
  Furniture A/C 7 20,000  
       Capital A/C 9   1,00,000
  (Owner invested cash and furniture)      
       
Jan. 2 Purchases Account 11 30,000  
       Y 13   30,000
  (Bought goods on credit)      
       
Jan. 3 Cash A/C 5 16,000  
       Sales A/C 15   16,000
  (Sold goods for cash)      
       
Jan. 4 S A/C 17 10,000  
       Sales A/C 15   10,000
  (Sold goods on credit)      
       
Jan. 8 Cash A/C 5 9,800  
  Discount A/C 19 200  
       S A/C 17   10,000
  (Cash received and discount allowed)      

Ledger

Cash Account (No.5)

Date references J.R Debit Credit Balance

2005 Dr. Cr.
Jan. 1 Capital A/C 5 80,000   80,000  
Jan. 3 Sales A/C 5 16,000   96,000  
Jan. 8 S A/C 5 9,800   105,800  

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Furniture Account (No.7)

Date references J.R Debit Credit Balance

2005 Dr. Cr.
Jan. 1 Capital A/C 5 20,000   20,000  

Capital Account (No.9)

Date references J.R Debit Credit Balance

2005 Dr. Cr.
Jan. 1 Cash A/C 5   80,000   80,000
Jan. 1 Furniture A/C 5   20,000   1,00,000

Purchases Account (No.11)

Date references J.R Debit Credit Balance

2005 Dr. Cr.
Jan. 2 Y A/C 5 30,000   30,000  

Y Account (No.13)

Date references J.R Debit Credit Balance

2005 Dr. Cr.
Jan. 2 Purchases A/C 5   30,000   30,000

Sales Account (No.15)

Date references J.R Debit Credit Balance

2005 Dr. Cr.
Jan. 3 Cash A/C 5   16,000   16,000
Jan. 4 S A/C 5   10,000   26,000

S Account (No.17)

Date references J.R Debit Credit Balance

2005 Dr. Cr.
Jan. 4 Sales A/C 5 10,000   10,000  
Jan. 8 Cash A/C 5   9,800    
Jan. 8 Discount A/C 5   200 Nil  

Discount Account (No.19)

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Date references J.R Debit Credit Balance

2005 Dr. Cr.
Jan. 8 S A/C 5 200   200  

Trial Balance

S. No. Account Name A/C No. Debit Credit

1 Cash Account 5 105,800  
2 Furniture Account 7 20,000  
3 Capital Account 9 -- 100,000
4 Purchases Account 11 30,000  
5 Y Account 13 -- 30,000
6 Sales Account 15 -- 26,000
7 S Account 17 -- --
8 Discount Account 19 200 --
  Total   156,000 1,56,000

Note: If an account shows zero balance, it is not necessary to record it in trial balance.

1. What is a trial balance and why is it prepared? 

A trial balance is a statement comprised of balances of ledger accounts. It has two columns -

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a debit column in which all debit balances are recorded and a credit column in which all credit
balances are recorded. It is basically prepared to check the arithmetical accuracy of
bookkeeping work done in a particular accounting period. It also provides necessary
information for the preparation of financial statements.

2. When do businesses prepare a trial balance? 

A trial balance can be prepared at any time however it is mostly prepared at the end of an
accounting period.

3. If an account has a debit balance, where will you place it in the trial balance? 

All debit balances are placed in debit column of the trial balance.

4. If an account has a credit balance, where will you place it in the trial balance? 

All credit balances are placed in credit column of the trial balance.

5. What does an agreed trial balance tells us? 

An agreed trial balance tells us that the books of accounts are arithmetically correct. But it
does not mean that every transaction in journal and ledger has been correctly recorded and
there is no error in the books. A trial balance may agree and still there may be one or more
errors in books of accounts. For example, a trail balance will not detect the omission of a
transaction because the omitted transactions don't affect the agreement of trial balance.

6. What does a disagreed trial balance tells us? 

A disagreed trial balance indicates the presence of one or more errors in the books of
accounts. It may also be the result of incorrect total of debit or credit column or both.

7. Which accounts don't need to be transferred to the trail balance? 

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The accounts with zero balance don't affect trial balance and are therefore not needed to be
transferred to trial balance.

8. What are the two methods of preparing trial balance? 

The two methods of preparing trial balance are balance method and total method. Balance
method is more popular whereas total method is less popular

FINACIAL STATENMENTS

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Trading, profit and Loss Account for the year (period) ended 31 December 2007
Sales   XXX
Less Sales Returns (Returns Inwards)   XXXX
Net Sales   XXXX
     
Less Cost of Sales    
Opening Stock XXX  
Add Purchases XXX  
Carriage Inwards XXX  
Custom duties XXX  
Gross Purchases XXX  
Less Purchases Returns (Returns Outwards) XXXX  
Cost of Purchases available for resale XXXX  
Less Closing Stock XXXX  
Cost of Sales   XXXX
Gross Profit   XXXX
Add Revenue Received:    
Discount Received   XXX
Rent Received   XXX
Decrease in Provision for doubtful debts   XXX
Profit on sale of fixed asset   XXXX
    XXXX
Less Operating Expenses  
Heating and Lighting XXX  
Wages and Salaries XXX  
Rent and Rates (TB figure + outstanding
figure) XXX  
Stationery XXX  
Motor Expenses XXX  
Advertising XXX  
Depreciation: Machinery XXX  
Motor Vehicles XXX  
Insurance (TB figure - prepayment) XXX  
General expenses XXX  
Bad Debts XXX  
Telephone XXX  
  XXX
Net Profit   XXX
   

Balance Sheet as at 31 December 2007

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Accumulate Net Book

Fixed Assets Cost d Value
Plant and Machinery

XXX XXX XXX

Fixtures and Fittings XXX XXX XXX
Motor Vehicles XXX XXX XXX
Equipment XXX XXX XXX
Premises XXX XXX XXX
  XXX XXX XXX
Current Assets      
Stock   XXX  
Debtors (TB figure - Provision for Bad
Debts)   XXX  
Prepayments   XXX  
Cash at Bank   XXX  
Cash in Hand   XXX  
    XXX  
Less Current Liabilities      
Creditors XXX    
Accruals (Outstanding payments) XXX    
    XXX  
Working Capital (Net Current Assets)     XXX
      XXX
Less Long Term Liabilities: Loans     XXX
     
Financed by:      
Capital   XXX  
Add Net Profit   XXX  
    XXX  
Less Drawings   XXX  
    XXX
       

Question

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Rush and Aldridge are in partnership sharing profits and

losses in the ratio 3:2 respectively. The following list of
balances has been extracted from the books, of the
business, for the year ended 30 November 2006.
£
land at cost 120,000
fixtures and fittings (cost) 70,000
fixtures and fittings (depreciation) 20,000
creditors 17,000
debtors 21,000
balance at bank (cr) 7,500
bank loan 20,000
provision for bad debts 1,000a
sales 98,000
purchases 39,000
stock (1-12-05) 11,000
rent and rates 3,000
insurance 1,500
salaries and wages 13,700
office expenses 2,800
heating and lighting 1,750
advertising 900
capital account – Rush 80,000
– Aldridge 50,000
current account – Rush (cr) 3,850
– Aldridge (dr) (2,000)
drawings – Rush 3,700
– Aldridge 7,000

The following information is also available:

– At 30.11.06:
– Closing stock £13,800
– Rent outstanding £500
– Salaries outstanding £1,120
– £80 insurance prepaid for the following year
– Provision for bad debts needs increasing to £1,150
– Interest of £2,000 on the bank loan needs to be
included in the accounts
– Fixtures and fittings are depreciated at 10% on a
reducing balance basis
– Partnership salaries are as follows:
– Rush £8,000
– Aldridge £2,000
– Interest on capital is allowed at 10%
Required:
(a) From the list of balances (at 30-11-06) prepare the
trial balance for Rush and Aldridge. (6 marks)

(b) Prepare a trading and profit and loss account and a

balance sheet as at 30 November 2006. (25 marks)

(Total 31 marks)

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Question 1

1) The following list of balances was extracted from Bamba’s ledger at 31 March 2011.

Bamba Trading:
1) Cash in hand 2,100
2) Fixture & Fittings 5,900
3) Motor vehicle 9,200
4) Accounts payable 13,188
5) Bank overdraft 2,400
6) Inventory at 1 April 2010 15,170
7) Land and buildings 51,600
8) Discount allowed 1,300
9) Accounts receivable 13,200
10) Purchases 61,610
11) General expenses 260
12) Interest expenses 210
13) Carriage inwards 66
14) Advertising 504
15) Maintains to Building 670
16) Mortgage on premises 3,840
17) Capital 69,808
18) Insurance paid 746
19) Bad debts 300
20) Drawings – Bamba
21) Inventory at 31 March 2011 12,976
22) Wages & salaries 17,070
23) Sales 98,370
24) Discount received 300 

a) Extract a Trial Balance as at 31 March 2011 (30 marks)

b) Prepare an Income Statement for year ended 31 March 2011 (15 marks)
c) Prepare the Balance Sheet as at 31 March 2011 (10 marks)

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The following is the trial balance of XYZ company on 31st December 2005

    Dr. Cr.
  $ $
1 Opening stock 64,000  
2 Purchases 460,000  
3 Returns inwards 50,000  
4 Carriage inwards 16,000  
5 Salaries 96,000  
6 Carriage outwards 10,000  
7 Rent 72,000  
8 Discount allowed 8,000  
9 Sundry debtors 240,000  
10 Plant and Machinery 360,000  
11 Furniture 60,000  
12 Drawings 18,000  
13 Sundry creditors   350,000
14 Returns outwards   36,000
15 Sales   740,000
16 Capital   328,000
   
    1,454,000 1,454,000
   
       

The closing stock is valued at $126,000.

Required: Prepare a profit and loss account for the year ended 31st December 2005.

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The following trial balance have been taken out from the books of XYZ as on 31st December, 2005

Dr. Cr.
 
$ $
Plant and Machinery 100,000  
Opening stock 60,000  
Purchases 160,000  
Building 170,000  
Carriage inward 3,400  
Carriage outward 5,000  
Wages 32,000  
Sundry debtors 100,000  
Salaries 24,000  
Furniture 36,000   .
Trade expense 12,000  
Discount on sales 1,900  
Advertisement 5,000  
Bad debts 1,800  
Drawings 10,000  
Bills receivable 50,000  
Insurance 4,400  
Bank balances 20,000  
Sales   480,000
Interest received   2,000
Sundry creditors   40,000
Bank loan   100,000
Discount on purchases   2,000
Capital   171,500
 
  795,500 795,500
 

Closing stock is valued at $90,000

Required: Prepare the trading and profit and loss account of the business for the year

ended 31.12.2005 and a balance sheet as at that date.

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FINANCIAL RATIOS
 
Liquidity Analysis Ratios   
   
 Current Ratio
    Current Assets
  Current Ratio = ------------------------
    Current Liabilities
      
 Quick Ratio
    Quick Assets
  Quick Ratio = ----------------------
    Current Liabilities
     
Quick Assets = Current Assets - Inventories
   
 Net Working Capital Ratio
    Net Working Capital
  Net Working Capital Ratio = --------------------------
    Total Assets
     
Net Working Capital = Current Assets - Current Liabilities
   
 
Profitability Analysis Ratios   

 Return on Assets (ROA)

    Net Income
  Return on Assets (ROA) = ----------------------------------
    Average Total Assets
     
Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2
   
 Return on Equity (ROE)
    Net Income
  Return on Equity (ROE) = --------------------------------------------
    Average Stockholders' Equity
     
Average Stockholders' Equity 
= (Beginning Stockholders' Equity + Ending Stockholders' Equity) / 2
   
 Return on Common Equity (ROCE)
    Net Income
  Return on Common Equity = --------------------------------------------
    Average Common Stockholders' Equity
     
Average Common Stockholders' Equity 
= (Beginning Common Stockholders' Equity + Ending Common Stockholders' Equity) / 2
   
 Profit Margin
    Net Income
  Profit Margin = -----------------
    Sales

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 Earnings Per Share (EPS)
    Net Income
  Earnings Per Share = ---------------------------------------------
    Number of Common Shares Outstanding
     
   
 
Activity Analysis Ratios   

 Assets Turnover Ratio

    Sales
  Assets Turnover Ratio = ----------------------------
    Average Total Assets
     
Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2
   
 Accounts Receivable Turnover Ratio
    Sales
  Accounts Receivable Turnover Ratio = -----------------------------------
    Average Accounts Receivable
     
Average Accounts Receivable 
= (Beginning Accounts Receivable + Ending Accounts Receivable) / 2
   
 Inventory Turnover Ratio
    Cost of Goods Sold
  Inventory Turnover Ratio = ---------------------------
    Average Inventories
     
Average Inventories = (Beginning Inventories + Ending Inventories) / 2
   

Capital Structure Analysis Ratios   

 Debt to Equity Ratio

    Total Liabilities
  Debt to Equity Ratio = ----------------------------------
    Total Stockholders' Equity
     
     
 Interest Coverage Ratio
    Income Before Interest and Income Tax Expenses
  Interest Coverage Ratio = -------------------------------------------------------
    Interest Expense
     
Income Before Interest and Income Tax Expenses 
= Income Before Income Taxes + Interest Expense
   

Capital Market Analysis Ratios   

 Price Earnings (PE) Ratio

    Market Price of Common Stock Per Share
  Price Earnings Ratio = ------------------------------------------------------
    Earnings Per Share

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 Market to Book Ratio
    Market Price of Common Stock Per Share
  Market to Book Ratio = -------------------------------------------------------
    Book Value of Equity Per Common Share
     
Book Value of Equity Per Common Share 
= Book Value of Equity for Common Stock / Number of Common Shares
   
 Dividend Yield
    Annual Dividends Per Common Share
  Dividend Yield = ------------------------------------------------
    Market Price of Common Stock Per Share
     
Book Value of Equity Per Common Share 
= Book Value of Equity for Common Stock / Number of Common Shares
   
 Dividend Payout Ratio
    Cash Dividends
  Dividend Payout Ratio = --------------------
    Net Income
     
     
 
ROA = Profit Margin X Assets Turnover Ratio   

 ROA = Profit Margin X Assets Turnover Ratio

    Net Income Net Income Sales
  ROA = ------------------------  = --------------  X -------------
    Average Total Assets  Sales Average Total Assets 
       
Profit Margin = Net Income / Sales 
Assets Turnover Ratio = Sales / Averages Total Assets

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DEPRECIATION

Straight Line Method of Depreciation:

Definition and Explanation:

Straight line method is also known as fixed installment method and original cost method. This
method is very simple and conceptually appropriate to employ. This is one of the most widely used
method for the calculation of depreciation charge. By this method, the number of years of use is
estimated and the the cost is then divided by the number of years to give the depreciation charge
each year.

Under this method , the amount of depreciation will be equal each year, since depreciation is
charged at fixed rate on cost of asset. This is the special feature of this method. If the annual
depreciation is plotted on a graph paper, it will show a straight line, since the amount of depreciation
is equal every year. This is why this method is called straight line method.

Formula:

Depreciation charge under this method is calculated by using the following formula:

   
Cost less salvage value
Depreciation
=
charge

Estimated service life    

Example:

Assume a machine was bought for $500,000 and we thought we would keep it for four years and
then sell it for $50,000 (salvage value) the depreciation to be charged each year would be calculated
as follows:

   
Cost less salvage value
Depreciation
=
charge

Estimated service life    

     

500,000 - $50,000*    

= $90,000

5    

   
*Salvage value

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Merits:

1. Straight line method or fixed installment method is very easy to employ because of its
simplicity.
2. The asset can be written off to zero value under this method.
3. This method is useful for providing depreciation on leasehold property, patent right, trade
mark, copyright etc.

Demerits:

There are two major objections to the straight line method. These are:

1. This method assumes the same economic usefulness of the asset each year.
2. The repair and maintenance expenses are essentially same each period.

Another problem in the use of straight line method or fixed installment method of depreciation is that
its use results in distortion in the rate of return analysis (income/assets). The following example
shows how the rate of return increases, given constant revenue flows, because the asset's book
value decreases.

Year Depreciation Book value

0   $500,000

1 $90,000 $410,000

2 $90,000 $320,000

3 $90,000 $230,000

4 $90,000 $140,000

5 $90,000 $50,000

Journal Entries:

Under this method depreciation is recorded as follows:

When depreciation is provided:    

Depreciation Account   Dr.

          Asset Account   Cr.

(Being depreciation charged on -@- for the year)    

   

When depreciation is transferred to profit and loss account:    

Profit and Loss Account   Dr.

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          Depreciation Account   Cr.

(Being depreciation account transferred to profit and loss account)    

   

When asset is sold on expiry of its useful life:    

Bank Account   Dr.

          Asset Account   Cr.

(Being scrap of asset sold)    

   

If profit is earned on sale of asset:    

Asset Account   Dr.

          Profit and Loss Account   Cr.

(Being profit on sale of scrap transferred to profit and loss account)    

   

If loss is incurred on sale of asset:    

Profit and Loss Account    

          Asset Account    

 
(Being loss on sale of scrap transferred to profit and loss account)

Reducing Balance Method of Depreciation:

Definition and Explanation:

Under reducing balance method, the depreciation is charged at a fixed rate like straight line
method (also known as fixed installment method). But the rate percent is not calculated on cost of
asset as is done under fixed installment method - it is calculated on the book value of asset. The
book value of an asset is obtained by deducting depreciation from its cost. The book value of asset
gradually reduces on account of charging depreciation. Since the depreciation rate per cent is
applied on reducing balance of asset, this method is called reducing balance
method or diminishing balance method. The calculation of depreciation under this method will be
clear from the following example.

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Example:

Suppose the cost of asset is $1,000 and rate of depreciation 10% p.a.

Cost of asset 1,000

Depreciation:  

1st year: 10% of 1,000 100

Book value 900

2nd year: 10% of 900 90

Book value 810

3rd year: 10% of 810 81

Book value 729

   

and so on.......
Under fixed installment method the amount of annual depreciation remains the same but under
reducing balance method the amount of annual depreciation gradually reduces.

This method is especially suitable to assets with long life, e.g., plant and machinery, furniture, motor
car etc.

Under this method the real cost of using an asset is the depreciation and repair expenses so this
method gives better results because in early years when repair expenses are less the depreciation is
more. As the asset gets older repair charges on it increases and the amount of depreciation
decreases. So the combined effect of both these costs remain almost constant on the profit and loss
of each year.

The great weakness of this method is that it takes very long time to write off an asset to
approximately nil, unless a very high rate is used, in which case the burden on earlier years shall be
excessive. This method is used by income tax authorities for granting depreciation allowance to
assesses.

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Difference Between Straight Line Method and Reducing Balance Method:

Following are the main points of difference between straight line method and reducing balance
method of depreciation:

Straight Line Method Reducing Balance Method

1. The rate and amount of depreciation 1. The rate remains the same, but the amount of
remain the same each year. depreciation diminishes gradually.
2. Depreciation rate per cent is calculated on 2. Depreciation rate per cent is calculated on
cost of assets each year book value of asset.
3. At the end of its life the value of asset is 3. The value of asset is never reduced to zero at
reduced to zero or scrap value. the end of its life.
4. The older the asset the larger the cost of 4. The amount of depreciation decreases
its repair. But the amount of depreciation gradually, while the cost of repairs increases.
remain the same each year. Hence, the So the total of depreciation and repairs remain
total of depreciation and repairs increases more or less the same each year. Hence, it
every year. This reduces annual profit causes little or no change in annual profit/loss.
gradually.
5. Computation of depreciation under straight 5. Depreciation can be computed without any
line method is comparatively easy and difficulty, but it
simple.

Income and Expenditure Account for the year ended 31.12.2005.

 

1. Income and Expenditure Account is a Nominal Account. Hence, only revenue (no capital)
items will find place in it.

2. All items of revenue income and expenditure relating to the current year will appear in it. In
other words, all items of income relating to the current year - whether received in cash or not -
and all items of expenditure relating to the current year - whether paid in cash or not - will find
place in this account. No items of income or expenditure relating to last year or next year will
be included in this account.

Method of Conversion of Receipts and Payments Accounting into Income and Expenditure
Account:

At first, Receipts and Payments Account is prepared by analyzing the Cash Book—subsequently,

Income and Expenditure Account is prepared in the following manner:

1. Exclude the opening and closing balance of receipt and payment account.

2. Exclude all the payment items.

3. Exclude all revenue items relating to last or next year.

4. Include all items of income or expenditure relating to the current year, if they are not received
or paid in the current year.

5. Charge depreciation on all wasting assets.

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Hints:

While preparing income and expenditure account from receipts and

payments account, apply the following rules:

1. Exclude all capital items.

2. Adjust all revenue items with outstanding and advance items in the
following manner:
(i) If relates to current year: Add
(ii) If relates to last or next year: Deduct

Example:

The following is the receipt and payment account of a club for the year ended 31.12.2005

Receipt and Payment Account

For the Year Ended 31.12.2005

Receipts $   Payments $

Balance b/d 5,000   Supports equipment 7,000

Subscription:     Salaries & wages 3,000

     2004 2,000   Office expenses 400

     2005 10,000   Electric charges 600

Donation 1,000   Telephone charges 600

Entrance fees (To be capitalized) 2,000   Balanced c/d 8,400

    

  20,000    20,000

    

        

1. In 2004 subscription for 2005 was received $1,000.

2. Outstanding subscription $1,500
3. Outstanding salaries & wages $ 1,000.
4. Depreciation to be charged @ 20% on sports equipments.

Required: Prepare from the above particulars the income and expenditure account of the club.

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Income and Expenditure Account

For the Year Ended 31.12.2005

Receipts   $   Income   $

Salaries & wages 3,000     Subscription 10,000  

Add received in
Add outstanding 1,000 4,000   1,000  
2004

      Add accrued 1,500 12,500

Office expenses         

Electric charges       Donation   1,000

Telephone
          
charges

Depreciation on
          
sports equip.

20% of 7,000   1,400       

Surplus i.e.
excess of income   6,500       
over expenditures

        

    13,500      13,500

        

Note:

Rate of depreciation on sports equipment is 20% (not 20% p.a). so the amount of depreciation will be
$1,400 (20 % of 7,000). The date of purchase is immaterial here.

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RECEIPT AND PAYMENT ACCOUNT:

Definition and Explanation:

"A receipt and payment account is a summarized cash book (cash and bank) for a given period".

or

"This is simply a summary of the cash transactions as in the cash book, analyzed and classified under
suitable headings, including the opening and closing balances".

Non-profit organizations (also called non-trading concerns) prepare a receipt and payment account at
the end of year. With the help of this account and some additional information, an income and
expenditure account is prepared to disclose the true results of non-profit organizations. Receipt and
payment account cannot disclose the true result of non-trading concern.

All the information necessary for the preparation of this account is available from cash book. Various
cash receipts and cash payments during the whole year find place in this account in a classified
manner. Its closing balance indicates cash in hand and cash at bank at the year end.

Characteristics of Receipt and Payment Account:

Following are the features of receipt and payment account:

1. It is abridged addition of cash book - it is, in effect, a summary of cash book.

2. All cash receipts during the whole year are recorded on its left hand (i.e., debit) side. While all
the cash payments during the whole year written on its right hand (i.e., credit) side, arranged
in a classified form.
3. Cash receipts and cash payments of both capital and revenue nature are recorded here.
4. Only cash transactions are recorded in this account.
5. It generally shows a debit balance. In case of bank overdraft balance, however, its net
balance may be credit. Again, it may also show nil balance but such occasion is rare.
6. Its closing balance indicates closing cash in hand and closing cash at bank.
7. It is not an account within the double entry system - it is a statement only.
8. It is prepared on the last day of the accounting year.

Advantages:

The following are the advantages of receipt and payment account:

1. Total receipts and total payments under various heads are available at a glance.
2. The amount of cash in hand at the year end can be ascertained.
3. The correctness of cash book can be verified through it. The total of debit side of cash book
will agree with the total of receipt side of this account. On the other hand, the total of credit
side of cash book will agree with that of payment of this account.

Method of Preparation:

Receipts and payment account is prepared with all the cash receipts and cash payments of the whole
year. The net result of cash receipts and cash payments of a fixed time is determined through this
account. So it is its heading will be:

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Receipt and Payment Account

For the Year Ended 31.12.2005

Its left hand side is called "Receipts" and right hand side "payments". On the left hand side all cash
receipts are recorded, while on the right hand side all cash payments are recorded arranged in a
classified form. It starts with last year's closing cash in hand and cash at bank and closes with current
year's closing cash in hand and cash at bank. In other words, its opening balance indicates last year's
closing cash in hand and cash at bank, while its closing balance means current year's closing cash in
hand and cash at bank.

Example:

From the following cash book prepare receipts and payments account for the year ended 31
December 2005.

Cash Book

Date References L/R Amount Date References L/R Amount

2005       2005      

Jan. 1 Balance b/d   250 Jan. 5 Rent   200

Feb. 2 Subscription   600 Jan. 16 Traveling expenses   15

Mar.
Admission fee   25 Fed. 12 Salaries   250
10

Entertainment
Apr. 5 Subscription   950 Mar. 17   50
expenses

Sale of old
May 20   10 Apr. 20 Electric charges   20
newspapers

June 3 Subscription   880 May 5 Furniture   300

July 15 Admission fee   30 May 10 Postage   18

Aug. Sale of old

  15 June 3 Stationary   120
20 newspaper

Sep. 5 Donation   100 July 12 Electric charges   30

Oct. 1 Sale of old furniture   150 Aug. 3 Newspaper   25

Nov.
Donation   50 Sep. 15 Salaries   320
15

Dec.
Subscription   250 Sep. 20 Newspaper   65
28

        Oct. 3 Traveling expenses   25

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        Oct. 12 Postage   12

        Nov. 5 Rent   300

Entertainment
        Nov. 16   80
expenses

        Dec. 5 Books   450

        Dec. 12 Salaries   350

        Dec. 25 Rent   130

        Dec. 31 Balance c/d   550

           

      3,310       3,310

           

2006              

Jan. 1     550        

Solution:

ABC Club
Receipt and Payment Account

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For the year ended 31st December, 2005

Receipts $ Payments $

Balance b/d 250 Rent [200+300+130] 630

Traveling expenses
Subscription [600+950+880+250] 2,680 40
[15+25]

Admission fee [25+30] 55 Salaries [250+320+350] 920

Entertainment expenses
Sale of old newspaper [10+15] 25 130
[50+80]

Donation [100+50] 150 Electric charges [20+30] 50

Furniture
Sale of old furniture 150 300
[200+300+130]

    Postage [18+12] 30

    Stationary 120

    Newspaper [25+65] 90

    Books 450

    Balance c/d 550

   

  3,310   3,310

   

Balance b/d 550    

Difference between Receipt and Payment Account and Income and Expenditure Account:

Following are the points of difference between and receipt and payment account and income and
expenditure account.

  Receipts and Payments Account   Income and Expenditure Account

       

1  It is a summarized statement of all cash 1 It is the account of revenue income and

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transactions during an accounting year. revenue expenditure of an accounting

year.

2 Only cash transactions are recorded here. 2  It is not confined to, cash transactions
only, i.e. non-cash transactions are also
included in it.

3 The portion of income or expenditure which 3  The whole amount of income or

has been received or paid in cash this year, expenditure—whether received or paid in
is recorded here cash or not—is recorded in it.

4 Transactions involving cash receipts are 4 All expenditures are recorded on Debit
recorded on Debit side and those involving side and all incomes on Credit side.
cash payments are recorded on Credit side.

5 Transactions—both capital and revenue-are 5 Only revenue transactions are recorded

recorded here. here.

6  Its balance can never be credit. 6 Its balance may be either debit or credit.

7  Its balance is carried over to Receipts & 7 Its balance is transferred to Capital Fund.
Payments Account of the next year.

8 This account shows opening balance except 8 It has no opening balance.

in the first year.

9 The closing balance of this account 9 Its. closing balance represents either
represent in the first year. surplus or deficit. Credit balance indicates
surplus, while debit balance indicates
deficit.

10 This account records transactions relating to 10 Transactions relating to the current year
past, present and future, years. Hence, no only are recorded in it. Hence, adjustments
adjustment is made for pre-received or are invariably made for pre-received or
accrued incomes and pre-paid or accrued incomes and pre-paid or
outstanding expenses. In a word, it is outstanding expenses. In a word, it is
prepared on cash basis. prepared on Accrual basis.

11 It is, in fact, an abridged Cash Book. 11 It is, infect, similar to Profit & Loss '
Account of a profit-seeking business
concern.

12 It is outside the Double Entry system. 12 It is within the Double Entry system.

13  It is not accompanied by Balance Sheet. 13 It is accompanied by Balance Sheet

14 Its preparation is not compulsory. 14  It is compulsory. It must be prepared in

order to ascertain the true result of a
concern.

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Revenue Expenditure:

Definition and Explanation:

All the expenditures which are incurred in the day to day conduct and administration of a business
and the effect-of which is completely exhausted within the current accounting year are known
as "revenue expenditures". These expenditures are recurring by nature i.e. which are incurred for
meeting day today requirements of a business and the effect of these expenditures is always short-
lived i.e. the benefit thereof is enjoyed by the business within the current accounting year. These

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expenditures are also known as "expenses or expired costs." e.g. Purchase of goods, salaries paid,
postages, rent, traveling expenses, stationery purchased, wages paid on goods purchased etc.

This expenditure is incurred on items or services which are useful to the business but are used up in
less than one year and, therefore, only temporarily increase the profit-making capacity of the
business.

Revenue expenditure also includes the expenditure incurred for the purchase of raw material and
stores required for manufacturing saleable goods and the expenditure incurred to maintain the- fixed
assets in proper working conditions i.e. repair of machinery, building, furniture etc.

Examples:

Following are the examples of revenue expenditure.

1. Wages paid to factory workers.

2. Oil to lubricate machines.
3. Power required to run machine or motor.
4. Expenditure incurred in the ordinary conduct and administration of business, i.e. rent, ,
carriage on saleable goods, salaries, wages manufacturing expenses, commission, legal
expenses, insurance, advertisement, free samples, postage, printing charges etc.
5. Repair and maintenance expenses incurred on fixed assets.
6. Cost of saleable goods.
7. Depreciation of fixed assets used in the business.
8. Interest on borrowed money.
9. Freight, cartage, octroi duty, transportation, insurance paid on saleable goods.
10. Petrol consumed in motor vehicles.
11. Service charges to motor vehicles.
12. Bad debts.

Capital Expenditures:

Definition and Explanation:

An expenditure which results in the acquisition of permanent asset which is intended lo be

permanently used in the business for the purpose of earning revenue, is known as capital
expenditure. These expenditures are 'non-recurring' by nature. Assets acquired by incurring these
expenditures are utilized by the business for a long time and thereby they earn revenue. For example,
money spent on the purchase of building, machinery, furniture etc. Take the case of machinery-

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machinery is permanently used for, producing goods and profit is earned by selling those goods. This
is not an expenditure for one accounting period, machinery has long life and its benefit will be enjoyed
over a long period of time. By long period of time we mean a period exceeding one accounting period.

Moreover, any expenditure which is incurred for the purpose of increasing profit earning capacity or
reducing cost of production is a capital expenditure. Sometimes the expenditure even not resulting in
the increase of profit earning capacity but acquires an asset comparatively permanent in nature will
also be a capital expenditure.

It should be remembered that when an asset is purchased, all amounts spent up to the point till the
asset is ready for use should be treated as capital expenditure. Examples are: (a): A machinery was
purchased for $50,000 from Karachi. We paid carriage $1,000, octroi duty $500 to bring the
machinery from Karachi to Lahore. Then we paid wages $1,000 for its installation in the factory. For
all these expenditures, we should debit machinery account instead of debiting carriage A/c, octroi A/c
and wages A/c. (b): Fees paid to a lawyer for drawing up the purchase deed of land, (c): Overhaul
expenses of second-hand machinery etc. (d): Interest paid on loans raised to acquire a fixed asset
etc.

Examples:

1. Purchase of furniture, motor vehicles, electric motors, office equipment, loose tools and other
tangible assets.
2. Cost of acquiring intangible assets like goodwill, patents, copy rights, trade marks, patterns
and designs etc.
3. Addition or extension of assets.
4. Money spent on installation and erection of plant and machinery and other fixed assets.
5. Wages paid for the construction of building.
6. Structural improvements or alterations in fixed assets resulting in an increase in their useful
life or profit earning capacity.
7. Cost of issue of shares and debentures (certain expenditures are incurred by the companies
when share and debentures are issued).
8. Legal expenses on raising loans for the purchase of fixed assets.
9. Interest on loan and capital during the construction period.
10. Expenditures incurred for the development of mines and plantations etc.
11. Money spent to bring a second-hand asset into working condition.
12. Cost of replacing factory building from an old place to a new arid better site.
13. Premium given for a lease.

Difference between Capital Expenditure and Revenue Expenditure:

Revenue Expenditure Capital Expenditure

1. Its effect is temporary, i.e. the benefit is 1. Its effect is long-term, i.e. it is not exhausted
received within the accounting year. within the current accounting year-its benefit is
received for a number of years in future.

2. Neither an asset is acquired nor the value 2. An asset is acquired or the value of an existing
of an asset is increased. asset is increased.

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3. It has no physical existence because it is 3. Generally it has physical existence except

incurred on items which are used by the intangible assets.
business.

4. It is recurring and regular and it occurs 4. It does not occur again and again. It is
repeatedly. nonrecurring and irregular.

5. This expenditure helps to maintain the 5. This expenditure improves the position of the
business. business.

6. The whole amount of this expenditure is 6. A portion of this expenditure (depreciation on

shown in trading P & L A/c or income assets) is shown in trading & P & L A/c and the
statement. balance is shown in the balance sheet on asset
side.

7. It does not appear in the balance sheet. 7. It appears in the balance sheet until its benefit is
fully exhausted.

8. It reduces revenue (profit) of the business. 8. It does not reduce the revenue of the concern.
Purchase of fixed asset does not affect revenue.

Question

State with reasons whether the fallowing items of expenditure are capital or revenue.

(i) Wages paid on the purchase of goods.

(ii) Carriage paid on goods purchased.

(iii) Transportation paid on machinery purchased.

(iv) Octroi duty paid on machinery.

(v) Octroi duty paid on goods.

(vi) A second-hand car was purchased for $7,000 and $5,000 were spent for its repairs and
overhauling.

(vii) Office building was whitewashed at a cost of $3,000.

(viii) A new machinery was purchased for Rs.80,000 and a sum of Rs.1,000 was spent on its      
installation and erection.

(ix) Books were purchased for $50,000 and $1,000 were paid for carrying books to the library.

(x) Land was purchased for $1,00,000 and $5,000 were paid for legal expenses.

(xi) $50,000 were paid for customs duty and freight on machinery purchased fromJapan.

(xii) Old furniture was repaired at a cost of $500.

(xiii) An additional room was constructed at a cost of $15,000.

(xiv) Damages paid on account of the breach of contract to supply certain goods.

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(xv) Cost of replacement of an old and worn out part of machinery.

(xvi) Repairs to a motor car met with an accident.

(xvii) $10,000 paid for improving a machinery.

(xviii) Cost of removing plant and machinery to a new site.

(xix) Cost of acquiring the goodwill of an old firm.

(xx) Cost of redecorating a cinema hall.

(xxi) Cost of putting up a. gallery in a cinema hall.

CASH FLOWS

Format and Sections of  Statement of Cash Flows:

A statement of cash flows has three sections. These are:

1. Operating activities section

2. Investing activities section
3. Financing activities section

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Operating, investing and financing activities constitute the general format of statement of cash

flows. The cash flows from operating activities section always appear the first, followed by
the investing section and then financing activities section.

The individual cash inflows and cash outflows from investing and financing activities are reported
separately. That is, they are reported gross, not netted against one another. Thus, cash outflow from
the purchase of property is reported separately from the cash inflow from the sale of property.
Similarly, the cash inflow from the issuance of debt is reported separately from the cash outflow from
its retirement.

The net increase or decrease in cash reported during the period should reconcile the beginning and
ending cash balances as reported in the comparative balance sheets.

the skeleton format of statement of cash flows is prepared as follows:

Company Name
Statement of Cash flows
Period Covered

Cash Flows from Operating Activities:    

     Net income   xxx

     Adjustments to reconcile net income to net cash

   
provided by operating activities:

          (List of individual items) xx  

     Net cash flow from operating activities   xxx

     

Cash Flows from Investing Activities:    

     (List of individual inflows and outflows) xx

   

Net cash provided (used) by investing activities   xxx

     

Cash Flows from Financing Activities:    

     (List of individual inflows and outflows) xx  

   

     Net cash provided (used) by financing activities   xxx

   

Net increase (decrease) in cash   xxx

Cash at beginning of period   xxx

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Cash at the end of the period   xxx

   

Classification of Cash Flows:

The statement of cash flows classifies cash receipts and cash payments by operating, investing, and
financing activities. Transactions and other events characteristics of each kind of activity are as
follows:

1. Operating activities
2. Investing activities
3. Financing activities

These business activities are briefly explained below:

Operating Activities:

Operating activities involve the cash effects of transactions that enter into the determination of net
income, such as cash receipts from sales of goods and services and cash payments to suppliers
and employees for acquisitions of inventory and expenses.

Investing Activities:

Investing activities generally involve long-term assets and include:

 Making and collecting loans.

 Acquiring and disposal of investments and productive long-lived assets.

Financing Activities:

Financing activities liability and stockholders; equity items and include:

 Obtaining cash from creditors and repaying the amounts borrowed.

 Obtaining capital from owners and providing them with a return, and return of, their
investment.

Examples of Typical Cash Receipts and Payments of a Business Enterprise

Operating Activities Income Statement

Items
     Cash inflows:
         From sale of goods and services
         From returns on loans (interest) and on equity securities
(dividend)

     Cash outflows:

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          To suppliers for inventory

          To employees for service
          To government for taxes
          To lenders for interest
          To others for expenses
Investing Activities

     Cash inflows:

          From sale of property, plant, and equipment.
          From sale of debt or equity securities of other entities.
Generally Long-term
          From collection of principal on loans to other entities.
Asset Items
     Cash outflows:
          To purchase property, plant, and equipment.
          To purchase debt or equity securities of other entities.
          To make loans to entities.
Financing Activities

     Cash inflows:

          From sale of equity securities. Generally Long-term
          From issuance of debt (bonds and notes). Liability and Equity
Items
     Outflows:
          To stockholders as dividend.
          To redeem long-term debt or reacquire capital stock    
Some cash flows relating to investing or financing activities are classified as operating activities. For
example, receipts of investment income (interest and dividends) and payments of interest to lenders
are classified as investing or financing activities. Conversely, some cash flows relating to operating
activities are classified as investing and financing activities. For example, the cash received from the
sale of property, plant, and equipment at a gain, although reported in the income statement, is
classified as an investing activity, and the effects of the related gain would not be included in the net
cash flow from operating activities. Likewise a gain or loss on the payment of debt would generally
be part of the cash outflow to the repayment of the amount borrowed, and therefore it is a financing
activity.

Steps in Preparing Statement of Cash Flows:

Unlike other major financial statements, statement of cash flows is not prepared from the adjusted
trial balance. The information to prepare this statement usually comes from three sources. These
are:

 Comparative balance sheets that provide the amount of the changes in assets liabilities,
and equities from the beginning to the end of the period.
 
 Current income statement data that help readers determine the amount of cash provided
by or used by operations during the period.
 

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 Selected transaction data from the general ledger that provide additional detailed
information needed to determine hw cash was provided or used during the period.

Preparing statement of cash flows from the data source above involves three major steps:

Determine the change in cash:

This procedure is straightforward because the difference between the beginning and the ending
cash balance can be easily computed from an examination of the comparative balance sheets.

Determine the net cash flow from operating activities:

This procedure is complex. It involves analyzing not only the current year's income statement but
also comparative balance sheets and selected transaction data.

Determine net cash flows from investing and financing activities:

All other changes in the balance sheet accounts must be analyzed to determine their effects on
cash.
 

Statement of Cash Flows - Direct Method:

Definition and Explanation:

Normally, two methods are used to prepare statement of cash flows. One is the direct method and
other is theindirect method. On this page we are going to explain direct method. This method is also
known as income statement method. This method reports cash receipts and cash disbursements
from operating activities. The difference between theses two amounts is the net cash flow from
operating activities. In other words, the direct method deducts from operating cash receipts the
operating cash disbursements. This method results in the presentation of condensed cash receipts
and cash disbursements statement.

The direct and indirect methods are different only to the extent of calculation of cash flows from
operating activities. The cash flow from investing activities and financing activities are calculated in
the same way under both the methods.

Example:

To illustrate direct method of statement of cash flows, we will use the first year of operation for  Tax
Consultants Inc. The company started on 1st January 2003, When it issued 60,000 shares of $1 par
value common stock for $60,000 cash. The company rented its office space and furniture and
equipment, and it performed tax consulting services throughout the first year. The comparative
balance sheets at the beginning and end of the year 2003 appear as follows:

Tax Consultants Inc.

Comparative Balance Sheets

Change
Dec. 31, 2003 Jan. 1, 2003
(Increase/Decrease)
Assets
Cash $49,000 $-0- $49,000 Increase

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Accounts receivable 36,000 -0- 36,000 Increase

   

Total $85,000 -0-  

   

Liabilities and Stockholders'      

Equity
Accounts payable $5,000 $-0- $5,000 Increase

Common stock ($1 par) 60,000 -0- 60,000 Increase

Retained earnings 20,000 -0- 20,000 Increase

   

Total $85,000 $-0-  

   

The income statement and additional information for tax consultants Inc. are as follows:

Tax Consultants Inc.

Income Statement
For the year ended Dec. 31, 2003

Revenues $125000

Operating expenses 85000

Income before income taxes 40,000

Income tax expenses 6,000

Net income $34,000

Additional Information:
Examination of selected data indicates that a dividend of $14,000 was paid during the year.

Read the following 3 steps for the preparation of statement of cash flows of Tax consultant Inc.
carefully:

Step 1: Determine the Change in Cash:

To prepare a statement of cash flows, the first step is to determine the change in cash. This is a
simple step. Tax Consultants Inc. had no cash on hand at the beginning of the year 2003, but
$49000 was on hand at the end of the year 2003. Thus the change in cash for 2003 was an increase

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of $49,000.

Step2: Determine Net Cash Flow From Operating Activities:

Under generally accepted accounting principles, most companies use the accrual basis of
accounting, requiring that revenue be reported when earned and that expenses be recorded when
incurred. Net income may include credit sales that have not been collected in cash and expenses
incurred that may not have been paid in cash. Thus, under accrual basis of accounting, net income
will not indicate the net cash flow from operating activities.

To arrive at net cash flow from operating activities, it is necessary to report revenues and expenses
on a cash basis. This is done by eliminating the effects of income statement transactions that did not
result in a corresponding increase or decrease in cash. The relationship between net income and net
cash flow from operating activities is graphically depicted as follow:

Net income versus Net cash Flow From Operating Activities

The conversion of net income to net cash flow from operating activities may be done through either a
direct or indirect method. But on this page we will discuss only direct method.

As indicated from the accrual basis income statement, Tax Consultants Inc. reported revenues of $
125,000. However, because the company's accounts receivable increased during 2003 by $36,000,
only 89,000 ($125000 - $36,000) in cash was collected on these revenues. Similarly, Tax
Consultants Inc. reported operating expenses of $85,000, but accounts payable increased during the
period by $5,000. Assuming that these payables related to operating expenses, cash operating
expenses were $80,000 ($85,000 - $5,000). Because no taxes payable exist at the end of the year,
the $6,000 income tax expenses for 2003 must have been paid in cash during the year. Then the
computation of net cash flow from operating activities is as follows:

Cash collected from revenues $89,000

Cash payment for expenses 80,000

Income before income taxes 9,000

Cash payments for income taxes 6,000

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Net cash provided by operating activities $3,000

   

"Net cash provided by operating activities" is the equivalent of cash-basis net

income.

"Net cash used by operating activities" is equivalent to cash-basis net loss

Step 3: Determine Net Cash Flows from Investing and Financing Activities:

Once the net cash from operating activities is computed, the next step is to determine whether any
other changes in balance sheet accounts caused an increase or decrease in cash.

For example, an examination of the remaining balance sheet accounts for Tax Consultation Inc.
shows that both common stock and retained earnings have increased. The common stock increase
of $60,000 resulted from the issuance of common stock for cash. The issuance of common stock is
a receipt of cash from a financing activity and is reported as such in the statement of cash flows. The
retained earnings increase of $20,000 is caused by two items:

1. Net income of $34000 increased earnings.

2. Dividends declared of $14,000 decreased retained earnings.

Net income has been converted into net cash flow from operating activities, as explained earlier. The
additional data indicate that the dividend was paid. Thus, the dividend payment on common stock is
reported as a cash outflow, classified as a financing activity.

The statement of cash flows of Tax Consultants Inc. is as follows:

Tax Consultants INC.

Statement of Cash Flows
For the year ended December 31, 2003

Cash Flows from Operating Activities    

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Cash collected from revenues   $89,000

Cash payment for expenses   80,000

   

Income before income taxes   40,000

Income tax expenses   6,000

   

Net cash provided by operating activities   $3,000

Cash Flows from Investing Activities    

Issuance of common stock 60,000

Payment of cash dividends (14,000)  

   

Net cash provided by financing activities   46,000

   

Net increase in cash   49,000

Cash, January 1 2003   -0-

   

Cash, December 31, 2003   $49,000

BANK RECONCILIATION STATEMENT

Rules for Preparing Bank Reconciliation Statement:

The statement must be given a proper heading. The statement is usually prepared at the end of the
month or year, so the heading will be given in the following way:

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Name of Business
Bank Reconciliation Statement
As on 31st Jan...........

Bank reconciliation statement may be started with either cash book balance or pass book balance. If it
is started with cash book balance, it will be finished with pass book balance and if it is started with
pass book balance, it will be finished with cash book balance.

After heading, the balance given to us should be written in the following way:

Balance as per cash book or pass book                                               XXX

The causes of disagreement are added with or deducted from the starting balance to get balance of
the other book.

Usually the cash book shows a debit balance (a favorable balance for depositor) and the pass book
shows a credit balance (a favorable balance for depositor).

The bank reconciliation statement is a statement showing causes of disagreement between the cash
book balance and pass book balance on a specific date, so while preparing it only those items should
be considered which cause disagreement up to that specific date. For example, a checks for $2,000
were sent to bank for collection on 20th December, out of these $1,100 were collected and credited
by the bank up to 31st December. The statement was prepared on 31 December. The collected
checks were only $1,100 and un-collected checks were $900 which caused disagreement between
two balances, so checks for $900 (being not collected) were considered only while preparing the bank
reconciliation statement.

Example:

From the following particulars, prepare a bank reconciliation statement of Mr. N as on 31st December
2005.

1. Balance as per cash book (Dr.) $64,000

2. Checks deposited but not yet collect $40,400

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3. Checks issued but not yet paid by bank $26,000

4. Interest credited by bank but not recorded in cash book. $500

5. Bank charges debited by bank but not entered in cash book $100

Solution:
Mr. N
Bank Reconciliation Statement
As on 31st Jan...........

  $ $

Bank balance as per cash book      Dr.   64,000

Less:    

      Checks deposited but not yet collected

40,400  
by the bank

      Bank charges debited in pass book 100 40,500

    23,500

     

Add:    

       Checks issued but not yet paid by the

26,000  
bank

       Interest credited by the bank in pass

500 26,500
book

Ans: The balance as per pass book     Cr.   50,000

   

If the statement is started with pass book balance:

Mr. N
Bank Reconciliation Statement
As on 31st Jan...........

  $ $

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The balance as per pass book     Cr.   50,000

Less:    

      Checks issued but not yet paid by the bank 26,000  

      Interest credited by the bank but not entered in

500 26,500
the pass book

    23,500

     

Add:    

      Checks deposited but not yet collected by the

40,400  
bank

      Bank charges debited but not entered in the

100 40,500
cash book

Ans: Bank balance as per cash book      Dr.   64,000

   

It may be noted from the above two statements that the causes of disagreement which are added in
the first method are deducted in the second method.

Example 6.1

The following cashbook was extracted from the ledger of Murehwa.

Cashbook

June 1 Bal b/d √ 120 June 7 Josh √ 160

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10 Chigubhu √ 180 13 Samuel √ 100

28 Masendeke 50 25 Chiro 20

30 Chidhumo 100 30 Rent 60

___ 30 Bal c/d 110

450 450

=== ===

June 1 Bal b/d 110

The bank statement for the month of June showed the following details

Bank Statement

Date Details Debit Credit Balance

May 1 √ 120 Cr

8 Cheque 54021 √ 160 40 Dr

13 Cheque 36944 √ 180 140 Cr

20 Cheque 54022 √ 100 40 Cr

29 Bank charges 15 25 Cr

30 Transfer: Marwa 90 115 Cr

30 Standing order: Telone 10 105 Cr

Update Murehwa’s cashbook and draw up a bank reconciliation statement.

Solution

The first step is to tick the items that appear on both records.

The cashbook should be updated by the transaction appearing on the bank statement but not on the
cashbook.

Cashbook

June 30 Bal b/d 110 June 30 Bank charges 15

30 Chigubhu 90 30 Telone 10

___ 30 Bal c/d 175

200 200

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=== ===

June 1 Bal b/d 175

The reconciliation will now be done using the amount appearing in the cashbook but not in the bank
statement.

Bank reconciliation for the month of June

$ $

Balance as per cashbook 175

Add: Unpresented cheques

Chiro 20

Rent paid 60 80

255

Less: Bank lodgements

Masendeke 50

Chidhumo 100 150

Balance as per bank statement 105

Alternatively one can start with the balance as per bank statement and add bank lodgements then
subtract unpresented cheques to get the balance as per cashbooK

CASH BOOK

three column cash book

The three column cash book (also known as triple column cash book) has three money columns
on both debit and credit side – one on each side for recording discount, cash and bank amounts. If a
business keeps a bank account and receipts and payments are frequently made through bank
account than it is useful to maintain a three column cash book rather than a single or a double column
cash book.

Where, the single and double column cash books are alternatives to a cash account, the three column
cash book serves the purpose of a cash as well as bank account.

Format

The common format of three column cash book is given below:

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Notice that the format of three column cash book is similar to that of a two column cash book with the
exception of an additional column to account for bank related transactions.

Hints for recording in three/triple column cash book

Remember the following points while recording entries in a three column cash book:

(1). Opening balance: The opening balance of cash in hand and cash at bank are recorded on the
debit side in cash and bank column respectively. If the bank balance is a credit balance (overdraft)
then it is entered on the credit side in the bank column.

(2). Receipt of check or cash: If a check is received and is deposited into bank account on the same
date, it will appear on the debit side on the cash book in bank column. If the check is not deposited
into bank on the same date, the check is treated as cash and therefore the amount will appear in cash
column. The receipt of cash is recorded in the cash column in usual manner.

(3). Payment by check or cash: If payment is made by check, it will be recorded in the credit side in
the bank column because the cash at bank is decreased. If the payment is made in cash, it will be
recorded in cash column in usual manner.

(4). Bank charges: Bank charges are recorded on the credit side of cash book in bank column
because cash at bank is decreased as a result of such charges.

(5). Contra entries: If an entry is made on the debit side and the same entry is recorded on the credit
side of the cash book, it is called  a “contra entry”. In order to distinguish the contra entries from other
entries, letter “C” is put in posting reference column against these entries on both debit and credit
sides of the cash book. Letter “C” shows that the contra effect of this transaction is recorded on the
opposite side. Contra entries may be of the following types:

1. When cash is deposited into bank by the office two entries are required, one on the credit
(payment) side in the cash column to record the reduction in cash in hand and the other on
the debit (receipt) side in the bank column to record the increase in cash at bank.
2. When cash is withdrawn from bank for office use, two entries are needed, one on the credit
side in the bank column to record the reduction of cash at bank and the other on the debit
side in the cash column to record the increase in cash in hand.
3. It has already been explained that when a check is received and not deposited into bank on
the same date, the amount will be recorded on the debit side in the cash column. When the
same check is deposited into bank account on a other date, two entries are required, one on
the debit side in the bank column to record the increase in amount at bank and the other on
the credit side in the cash column to record the cash (check) paid into bank.

Balancing the three column cash book

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Whenever it is desired to ascertain the bank balance, the bank columns are totaled on both the sides.
If debit column is bigger than the credit column, the difference represents cash at bank. If, on the
other hand, credit column is bigger than the debit column, the difference represents “overdrawn
balance”. Bank account may have an overdrawn balance because by arranging an overdraft with the
bank, it is possible that more money may be withdrawn from the bank than what has been deposited.

Example

The John trading company has undertaken the following transactions during the month of May 2016.

Year: 2016
May 01: Cash balance $2,200, bank overdraft $365.
May 03: Paid J & Co. by check $1,200, discount received from him $15.
May 05: Received from A & Co. a check for $980, discount allowed to them $20.
May 07: Deposited into bank the check received from A & Co. on May 05.
May 10: Purchased stationary for cash, $150.
May 15: Purchased merchandise for cash, $1,300.
May 15: Cash sales for the first half of the month, 2,350.
May 16: Deposited into bank $1,600.
May 18: Cash withdrawn from bank for personal expenses $150.
May 19: Issued a check for merchandise purchased, $1,650.
May 21: Drew from bank for office use, $650.
May 24: Received a check from S & Sons and deposited the same into bank, $1,560.
May 25: Paid a check to Ali Inc. for $400 and received a discount of $15.
May 27: Bought furniture for cash for office use, $390.
May 29: Paid office rent by check, $450.
May 30: Cash sales for the second half of the month $4,300.
May 31: Paid salaries by check $1,760.
May 31: Withdrew from bank for office use $1,470.

Required: Record the above transactions in a three/triple column cash book.

Solution

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TWO/ Double column cash book

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The double column cash book (also known as two column cash book) has two money columns on
both debit and credit sides – one to record cash transactions and one to record bank transactions. In
other words, we can say that if we add a bank column to both sides of a single column cash book, it
would become a double column cash book. The cash column is used to record all cash transactions
and works as a cash account whereas bank column is used to record all receipts and payments made
by checks and works as a bank account. Both the columns are totaled and balanced like a traditional
T-account at the end of an appropriate period which is usually one month.

Since a double column cash book provides cash as well as bank balance at the end of a period, some
organizations prefer to maintain a double column cash book rather than maintaining two separate
ledger accounts for recording cash and bank transactions.

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Format

The format/specimen of a double column cash book is given below:

The above format of double column cash book has six columns on both debit and credit sides. The
purpose of cash and bank columns has been explained at the start of this article and the purpose of
date, description, voucher number (VN) and posting reference (PR) columns has been explained
in single column cash book article.

The following example summarizes the whole explanation given above.

Example

The Edward Company uses a double column cash book to record its cash and bank related
transactions. It engaged in the following transactions during the month of March 2018:

 March 01: Cash balance $2,000 (Dr.), bank balance $2,500 (Dr.).
 March 02: Paid Mark & Co. by check $120.
 March 04: Received from John & Co. a check amounting to $400.
 March 05: Deposited into bank the check received from John & Co. on May 04.
 March 08: Purchased stationary for cash, $25.
 March 12: Purchased merchandise for cash, $525.
 March 13: Sold merchandise for cash, $1,800.
 March 15: Cash deposited into bank, $850.
 March 17: Withdrew from bank for personal expenses, $40.
 March 19: Issued a check for merchandise purchased, $630.
 March 20: Drew from bank for office use, $150.
 March 22: Received a check from Peter & Co. and deposited the same into bank immediately,
$880.
 March 25: Paid a check to Daniel Inc. for $270.
 March 26: Bought furniture for cash for office use, $175.
 March 28: Paid office rent by check, $120.
 March 29: Cash sales, $2,200.
 March 30: Withdrew from bank for office use, $145.
 March 31: Paid salary to employees by check, $300.

Required: Record the above transactions in a double column cash book and post entries therefrom
into relevant ledger accounts.

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Solution

Cash book:

General ledger:

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Accounts receivable subsidiary ledger:

Accounts payable subsidiary ledger:

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Question 1

From the following transactions prepare a two column cash book and post entries therefore to ledger
accounts.

Year: 2016
Jan. 01: Opening balance of cash $4,500.
Jan. 03: Received cash from R & Co. $3,880 and allowed them a discount of $20.
Jan. 05: Paid cash to H & Co. $3,590 and received a discount of $10.
Jan. 07: Merchandise purchased for cash $940.
Jan. 09: Received interest on investment $365.
Jan. 12: Purchased machinery for cash $4,100.
Jan. 15: Cash sales for the first half of the month $6,500.
Jan. 17: Paid cash for stationary $635.
Jan. 20: Paid for office furniture $710.
Jan. 21: Paid to H & Co. $970 and received a cash discount of $30.
Jan. 28: Cash received from R & Co. $670 and allowed them a discount of $30.
Jan. 31: Cash sales for the second half of the month $7,600.
Jan. 31: Paid for salaries $1,250.

Question 2

Enter the following transactions in a double column cash book/two column cash book.

2005   $
March 1 Cash in hand 80,000
March 1 Bank Balance 120,000
March 3 Received a cheque from Osman 24,000
March 4 Deposited Osman's cheque with bank --
March 8 Withdrawn from bank for business use 20,000
March 10 Goods sold for cash 30,000
March 15 Goods bought for cash 80,000
March 18 Goods sold for cash 60,000
March 20 Paid Rahim by cheque 26,000
March 30 Deposited into bank 16,000
March 31 Paid salary in cash 10,000
March 31 Paid rent by cheque

Question 3

Enter the following transactions of M. Rauf in a Double Column Cash Book and post them to
concerned accounts in ledger:

2005   $
Jan. 1 Cash in hand 100,000
Jan. 1 Cash at Bank 60,000
Jan. 3 Cash Sales 40,000
Jan. 4 Paid M. Arshad by a cheque 14,000
Jan. 6 Received a cheque from Babar 8,000
Jan. 8 Cash deposited into bank 19,000
Jan. 8 Babar's cheque deposited into bank  --
Jan. 10 Drew from bank for office use 15,000
Jan. 11 Drew from bank for personal use of owner 24,000

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Jan. 12 Cash purchases 57,000

Jan. 15 Received a cheque from S. Rashid 10,000
Jan. 16 Rashid's cheque endorsed to Shakeel  --
Jan. 17 Paid Arshad Khan by a cheque 36,000
Jan. 18 Rashid's cheque returned dishonored  --
Jan. 19 Our cheque to Arshad Khan was dishonored  --
Jan. 21 Received interest from bank 1,400
Jan. 24 Cash sales 33,00
Jan. 27 Incidental charges debited by bank 700
Jan. 31 Salary paid by cheque 14,000

Question 4

From the following particulars write up a Three Column Cash Book of Mr. Naseem.

2005   $
May 1: Cash in hand 40,000
May 1: Cash at Bank 30,000
May 3: Goods sold for cash 9,000
May 5: Goods bought for cash 18,000
Received a cheque from M. Farooq for $19,300 in full settlement of his dues
May 8:  
$19,600 and deposited into the bank.
Paid to Zulfiqar Cash $10,000 and a cheque for $9,400 in full settlement of
May 11:  
his dues $20,000
May 15: Cash received from M. Kaleem $9,800 in full settlement of his dues $10,000  
May 17: Paid cash to Adnan $3,900 in full clearance of his dues $4,000  
Received a cheque from Asim Tufail $7,800 in full settlement of his dues
May 20:  
$8,000
Asim Tufail's cheque endorsed to a creditor Akif in settlement of
May 23:  
$8,100
May 25: Bank credited interest 1,000
May 31: Bank debited bank charges . 1,400

PETTY CASH BOOK:

It is another Cash Book which is maintained, generally, in large business concerns to reduce the
burden of 'Main Cash Book', in which numerous transactions involving petty (small) amounts are
recorded. For this purpose, a Petty Cashier is appointed by the Chief Cashier. The Chief Cashier
advances a sum of money to the Petty Cashier to enable him to meet petty expenses for a fixed
period. The Petty Cashier will record this amount on the Debit Side of the Petty Cash Book while the
Chief Cashier will record the same amount on the Credit Side of the Main Cash Book.
 

The fundamental difference between the Main Cash Book and the Petty Cash Book is that only petty
expenses are recorded in the Petty Cash Book. No receipt (with the exception of money received from
the Chief Cashier), however small it may be, is recorded in it. But in the main Cash Book all receipts
(big and small) and large expenses are recorded.

Thus we see that in large organizations both the books are essential, although the importance of the
Petty Cash Book is somewhat less than the Main Cash Book.
Thus, the book in which small payments, which are not convenient to record in the Main Cash Book,
(like postage, traveling expenses, purchase of stationery etc.) are recorded is called Petty Cash Book.

System Of Petty Cash Accounting :

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1. Open System:

Under this system the Petty Cashier at first receives from the Chief Cashier a fixed sum of money for
meeting petty expenses. As soon as the said amount is spent, the Chief Cashier again pays the
required sum to the Petty Cashier.

2. Fixed Advance System:

Under this system the Petty Cashier receives from the Chief Cashier a fixed Slim of money for a fixed
period of time i.e. $200 per month. The Chief Cashier will pay $200 to the Petty Cashier every month
irrespective of this that whether the Petty Cashier has spent the total sum or not.

3. Imprest System :

This system is generally followed by most of the business concerns. Under this system, the total petty
expenses for a particular period are estimated and that amount is advanced by the Chief Cashier to
the Petty Cashier. This amount is called Imprest Cash. On the expiry of the fixed period the Petty
Cashier prepares a statement of his expenses and submits it to the Chief Cashier. This statement is
known as Statement of Petty, Expenses. The Chief Cashier examines the statement and if he finds it
correct, hands over the Petty Cashier an amount equal to the amount actually spent. This amount
plus the amount lying unspent with the Petty Cashier will be equal to the Imprest Cash.

In this way the Petty Cashier will start every time with an amount equal to Imprest Cash. In other
words, the amount lying with the Petty Cashier will never exceed Imprest Cash. Generally a columnar
Petty Cash Book is used in which different columns are provided for different petty expenses.

The balance of the Petty Cash Book will be shown on the asset side of balance sheet as "Cash in
hand" at the end of the year.

Example:

From the following particulars prepare a Petty Cash Book under Imprest System. 2005

Jan. 1. Received from the Chief Cashier as imprest cash $400.

Jan. 2. Paid Taxi hire $20.

Jan. 3. Paid postage $28 and stationery $60.

Jan. 4. Purchased stationery $48.

Jan. 5. Paid telegram charges $28 and bus fare $4.

Jan. 6. Bought postage stamps $96.

Jan. 7. Paid $72 for repairs of typewriter.

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Solution:Petty Cash Book

V. Traveling Office Misc.
Amount Dat Particu Postages Stationery
N Total $ Expenses Expenses Expenses
Received $ e lars $ $
o. $ $ $

400 20 Cash              
05 Receiv
ed

  Jun                
.1

  Jun Taxi   20 20        
. 2 hire
A/c

  Jun Postag   28   28      
. 3 e A/c

  Jun Station   60     60    
. 3 ery A/c

  Jun Station   48     48    
. 4 ery A/c

  Jun Telegr   28   28      
. 5 am A/c

  Jun Bus   4 4        
. 5 fare
A/c

  Jun Postag   96   96      
. 6 e A/c

  Jun Repair   72       72  
. 7 s A/c

       

        356 24 152 108 72  

    Balanc   44          
e c/d

     

400       400          

               

44 Jun Balanc              
. 8 e b/d

356   Cash              
receive

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LIFO , FIFO AND AVERAGE COST

FIFO stands for first-in, first out. A valuation method in which the assets/ inventory items produced or
acquired first, are sold, consumed used or disposed first.

LIFO stands for last-in, first-out, A valuation method in which the assets/Inventory items produced or
acquired most recently (last) are sold, consumed used or disposed first.

AVERAGE COST:A representative measure of a range of cost that is calculated by taking the sum of the
values and dividing it by the number of costs being examined. The average cost reduces the range into a
single value, which can then be compared to any point to determine if the value is higher or lower than
what would be expected.

The Delta company uses a periodic inventory system. The beginning balance of inventory and purchases
made by the company during the month of July, 2016 are given below:

 July 01: Beginning inventory, 500 units @ $20 per unit.

 July 18: Inventory purchased, 800 units @ $24 per unit.
 July 25: Inventory purchased, 700 units @ $26 per unit.

The Delta company sold 1,400 units during the month of July.

Required: Compute inventory on July 31, 2016 and cost of goods sold for the month of July using
following inventory costing methods:

1. First in, first out (FIFO) method

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2. Last in, first out (LIFO) method

3. Average cost method

 Solution:

Number of units in ending inventory:

Ending inventory = Beginning inventory + Purchases made during the month – Units sold during the
month

= 500 units + *1,500 units – 1,400 units

= 600 units

*800 units + 700 units = 1,500

(1) First in, first out (FIFO) method:

a. Computation of inventory on July 31, 2016 ( i, e., ending inventory) under FIFO:

b. Computation of cost of goods sold (COGS) for July 31, 2016 under FIFO:

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Alternatively, we can compute cost of goods sold (COGS) using earliest cost method as follows:

(2) Last in, first out (LIFO) method:

a. Computation of inventory on July 31, 2016 ( i, e., ending inventory) under LIFO:

b. Computation of cost of goods sold (COGS) for July 31, 2016 under LIFO:

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Alternatively, we can compute cost of goods sold (COGS) using most recent cost method as follows:

 (3) If average cost method is used:

[(500 units × $20) + (800 units × $24) + (700 units × $26)]/500 units + 800 units + 700 units

= $47,400/2,000 units

= $23.70

a. Computation of inventory on July 31, 2016 ( i, e., ending inventory) under average cost method:

Ending inventory = 600 units × $23.70

= $14,220

b. Computation of cost of goods sold (COGS) for July 31, 2016 under average cost method:

Cost of goods sold (COGS) = 1,400 × $23.70

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= $33,180

Alternatively, we can compute cost of goods sold (COGS) by deducting ending inventory from cost of
goods available for sale:

Cost of goods sold (COGS) = Cost of goods available for sale – Ending inventory

Cost of goods sold (COGS) = [{(500 units × $20) + (800 units × $24) + (700 units × $26)} – $14,220*]

= $47,400 – $14,220

= $33,180

SHORT QUESTION AND ANSWERS

Manufacturing accounts – Short Question and Answers

1. What do you mean by manufacturing concern? 

Manufacturing concern means those business organisations which manufacture goods. These
organisations purchase raw material and make finished goods. For example, sugar mills purchase
sugarcane and sale sugar.

2. Define trading concern. 

Those merchants who sale goods in the smae shape and condition in which they had purchased them
such as general store, medical store etc.

3. Define direct material. 

The material used in the course of manufacturing which enters into and becomes part of the product
i.e. wheat used in milling flour is direct material.

4. Define direct labour cost. 

The labour force employed by an enterprise will generally fall in two categories i.e. direct labour and
indirect labour.

5. Explain direct labour. 

The labour employed is performing work directly upon a saleable article is called direct labour.

7. Define factory overhead. 

Factory overhead may be defined as those costs which are indirectly related with production and are
incurred before the goods are put in to finished goods store room or supplied to customers.

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8. What is prime cost? 

According to some cost accountants the prime cost is the sum of direct materials, direct labour and
direct factory overhead costs.

9. What is conversion cost? 

It is the cost of converting raw materials into prepared material or finished goods exclusive of the cost
of raw materials. The direct labour and factory overhead.

10. What is factory cost? 

It is the figure by which completed goods are shown in the factory. This is also known as total work
cost, or total manufacturing cost.

Depreciation – Short Question and Answers

Test your learning about ‘Depreciation’ chapter by answering 10 short questions given below. I
suggest you try to answer each question yourself

1. Define depreciation? 

When the value of assets gradually reduces due to use and wear and tears, it is called depreciation.

2. Give any three objects of providing depreciation? 

1- To found out net profit or loss for a specific period.

2- To present a true and fair view of the state of afairs of the business.
3- To replace the asset.

3. Name the methods of calculating depreciation? 

1- Straight line method.

2- Disminishing balance method.
3- Sum of years digits method.
4- Revalution method.

4. What do you mean by scrap value? 

The amount which will be realized at the end of useful life of a asset is called scrap value.

5. What do you mean by depletion? 

The process of measuring and recording the exhaustion of natural resources due to their use is called
depletion.

6. Define the term "Amortization"? 

The term amortization is used in respect of intangible assets like goodwill copy right, patents etc. The
process of writing off their calue is called Amortization.

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7. Explain the term "Tangible plant Assets"? 

The term tangible denotes physical substance, such as machinery, furniture, motor car, building etc.

8. Explain the term "Intangible assets"? 

The assets which are used in the operation is called intangible assets such as goodwill, copy right,
patents etc.

9. Define "original cost method" of depreciation? 

When depreciation is calculated under equal portion of the asset's cost as depreciation expenses in
each period of the asset's useful life is called original cost method or straight line method

10. Explain diminishing balance method of depreciation? 

Under this method the amount of depreciation is calculated as fixed percentage of the reducing or
diminishing value of the asset standing in the book at the beginning of the year, so as to bring down
the book value of asset to its resdual value. The amount of depreciation is decreasing every year.

General journal – Short Question and Answers

1. What is a journal?. 

Journal is a book in which business trnsactions are recorded in chronological order (in order in which
they occur).

2. What is meant by a journal entry? 

Journal entry means recording business transactions in general journal strictly in accordance with the
rules of double entry system of book-keeping.

3. What is meant by narration of the journal entry? 

The explanation or detail which is written under each journal entry to explain the transaction is known
as narration.

4. What is a compound journal entry? 

A journal entry that involves more than two accounts is called compound entry or compound journal
entry. Whenever two or more transactions of the same nature take place on the same date, a
compound entry, instead of two or more separate entries, may be made to record such transactions

6. How trade discount is recorted in the journal? 

No entry is made for the trade discount. Merchandise are priced net of trade discount so it is not
recorded in books.

7. Why journal is called the book of original entry? 

Journal is a book in which business transactions are recorded at first instance as they occur, so
journal is called the book of original entry.

8. $950 cash is received from Mr. Z (an account receivable) in full settlement of his account of $1,000.
How would you record this transaction in general journal? 

This transaction would be journalized as follows:

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Cash $950--Dr.
Discount allowed $50--Dr.
Accounts receivable - Mr. Z $1,000--Cr.

9. $480 cash is paid to Mr. Y (an account payable) in full settlement of his account of $500. How
would you journalize this transaction? 

This transaction would be journalized as follows:

Accounts payable - Mr. Y $450--Dr.
Cash $480--Cr.
Discount received $50--Cr.

10. What is the purpose of posting reference column of journal? 

Posting reference column shows the page number where a particular account resides in general
ledger. For example, if we see 12 written with the sales account in general journal, the sales account
would be found on page 12 in the general ledger.

Non-trading concern – Short Question and Answers

1. Define non-trading concern?. 

Non-trading concerns are those operated for the benifit of the society as a whole rather than for the
benefit of a individuals or group or partners. Such as libraries, govr. hospital, govt. educational
institutions, athletic clubs etc.

2. Give any four characterstics of non-trading concerns? 

1. Non-profit making. (2). Provide goods or services to fulfil a social need. (3). Main source of income
are fees, subscriptions, donations etc. (4). Prepare receipts and payment account instead of cash
book.

3. Explain receipts and payments account. 

It is a consolidated summary of cash book. All cash receipts are recorded on the debit side and all
cash payments are recorded on the credit side. It starts with the opening balance and ends with
closing balance. It is prepared at the end of the accounting period.

4. Explain income and expenditure account? 

Trading concers prepare profit and loss account where as non-trading concerns prepare income and
expenditure account. All expenses paid or payable of the current year are recorded on the debit side
and all incoms received or receivable are recorded on the credit side. It excludes all the capital items
and also revenue items of the previous or subsequent period.

5. Describe the main points for conversion of receipts and payment account to an income and
expenditure account? 

(1). Exclude the opening and clasing balance of cash and bank. (2). Exclude all items of capital
nature. (3). Exclude income of the previou$ year and incoming year. (4). Exclude expenditures of
previous year and incoming year. (5). Include income of the current period, but not recorded. (6).
Include expenditure of the current period, but not paid. (7).Provisiorvfor bad debits and depreciation
on fixed assets of the current year should be included.

6. Define capital fund? 

The excess of assets over the liabilities will indicate the capital found. It will be found out by prepering
a statement of assets and liabilities at the beginning of the year .

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7. What is the treatment Of new asset? 

If any new asset is acquired its payment appears is the credit side of receipts and payment account.
Such asset will also appear in balance sheet

8. What do you means by "LEGACY"? 

It is the account given to a non-trading concerns as per the will of deceased persons. It is like
donations. It is capital recept and appear in receipts and payment account.

9. What is the accounting treatment of deficit? 

It is treated as liability in the balance sheet.

10. What do you mean by"Special. subscription"? 

Any member of the non-trading concerns participate in a particulars activity and pay/contribute
subscription for it, is called special subscription.

Cash Book – Short Question and Answers

1. What is Cash Book? 

The Cash Book is a book of original entry in which all cash receipts and payments are recorded.

3. What is three column Cash Book? 

A cash book of three columns on both receipt and payment side, these are cash, bank and discount
columns.

4. What is contra entry? 

An entry which is recorded on both sides of cash book at the same time. The example of contra-entry
is depositing of cash in bank and withdrawing of cash from bank for business use.

5. What is Petty Cash Book? 

The book, in which small payments are recorded is called petty cash book.

6. What is meant by imprest system of petty cash book? 

A system in which a fixed sum of money is given to cashier in advance to meet petty expenses is
called imprest system.

1) The fundamental accounting equation states that:

a) assets = liabilities + owner’s equity
b) assets = liabilities + drawings
c) assets = liabilities + net income
d) assets = liabilities + net income – owner’s equity
e) assets = liabilities - owner’s equity

2) If Net Income is $25,600, Gross Income is $32,505, and Revenue is $45,500 then:

a) Cost of Goods Sold is $19,900 and expenses is $6,905

b) Cost of Goods Sold is $12,995 and expenses is $6,905
c) Cost of Goods Sold is $12,995 and expenses is $16,448
d) Cost of Goods Sold is $19,900 and expenses is $16,448

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e) Cost of Goods Sold is $6,905 and expenses is $12,995

Explanation: COGS=Revenue- Gross Income
Expenses=Gross Income – Net Income

3) Calculate the amount of simple interest that would be charged if $5,500 is borrowed for 3 years at
an interest rate of 6%.

a) $860
b) $900
c) $990
d) $1,080
e) $1,170
Explanation: $ 5,500*0.06= $330/year
$330*3= $990

4) When Business X owes money to Business Y for supplies or materials purchased on credit,
Business X calls this an:

a) accounts receivable
b) accounts payable
c) asset
d) interest account
e) expense

5) An asset loses value over time through the process of:

a) depreciation.
b) deprecation.
c) capitalization.
d) appreciation.
e) depression.

14) The financial statement that indicates how well the business has been doing over a period of time
is called the

a) balance sheet
b) inventory sheet
c) ledger statement
d) income statement
e) journal sheet

15) The amount that an asset is worth at the end of the lease is referred to as the
a) face value
b) operating value
c) residual value
d) lease value
e) gross value

16) The financial statement that best demonstrates that a business has enough funds to meet its
current obligations is
a) a balance sheet
b) an income statement
c) a statement of shareholder's equity
d) a statement of cash-flow
e) these are all equally good

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17) If assets total $375,000 and owner’s equity equal $125,000, then liabilities would total
a) $500,000
b) $250,000
c) $225,000
d) $375,000
e) $125,000
Explanation: Liabilities= Assets-Owner’s Equity

18) What effect does a low inventory turnover have on a company?

a) None, only the level of sales is important.
b) Negative, inventory that moves slowly costs money
c) Positive, low levels of inventory turnover indicates less holding costs
d) Positive, low turnover indicates increased cash flow
e) None, low turnover indicates lower assets on the balance sheet only

Explanation: If a company has a low inventory turnover, this means that the company is not getting
rid of their inventory fast enough. This will cost the company money due to holding costs. In addition,
it might lead to possible write- offs of inventory due to obsolescence.

19) Pick the valid formula.

a) Revenue – Fixed Cost = Profit
b) Fixed Cost + Variable Cost = Gross Sales
c) Revenue – Expenses = Profit
d) Expenses – Profit = Revenue
e) Revenue – Variable Cost + Fixed Cost = Profit

20) Business owners use income statements in order to:

a) Increase assets
b) Decrease liabilities
c) Determine the amount of profit or loss
d) Calculate the original owner’s equity
e) Calculate if they should expand the business

21) The length of a fiscal period may be:

a) 3 months
b) a year
c) 6 months
d) a month
e) any length of time

Explanation: There are no regulations regarding to the length of a fiscal period. However, most
companies’ fiscal period are either quarterly or yearly.
22) An item that will be used up or converted to cash during the fiscal year is:
a) a current liability
b) an expense
c) a fixed asset
d) a plant asset
e) a current asset

23) The shareholders of a corporation elect:

a) the executives
b) the Board of Directors
c) the employees
d) the proxy
e) the CEO

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Explanation: The shareholders of a company can only elect members of the Board of Directors. The
Board of Directors represents the shareholders of the company. The Board of Directors has the power
to appoint CEO of the company.

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