FINANCIAL ACCOUNTING

Advanced Diploma in Business Management

Table of Contents
1. Introduction to Accounting ................................................................................................. 2

2. The Accounting Equation .................................................................................................... 9

3. Double entry book keeping system.................................................................................. 11

4. Preparation of Trial Balance .............................................................................................. 13

5. Bank Reconciliation Statement ......................................................................................... 17

6. Preparation of financial statements for sole traders with adjustments ...................... 19

7. Manufacturing Account ..................................................................................................... 26

8. Accounting for Limited Liability Companies ................................................................. 28

9. Interpretation of financial statements .............................................................................. 41

 1. Introduction to Accounting

Accounting is a process of identifying, recording, summarizing, and reporting economic

information to decision makers in the form of financial statements. Accounting
information is useful to anyone who makes decisions that have economic results.

 Managers want to know if a new product will be profitable.

 Owners want to know which employees are productive.
 Investors want to know if a company is a good investment.
 Creditors want to know if they should extend credit, how much to extend, and for how
long.
 Government regulators want to know if financial statements conform to requirements.

Users of Accounting Information

Elements of Accounting
1. Assets

Assets refer to resources owned and controlled by the entity as a result of past
transactions and events, from which future economic benefits are expected to flow to the
entity.
They may be classified as current or non-current.
Current assets – Assets are considered current if they are held for the purpose of being
traded, expected to be realized or consumed within twelve months after the end of the
period or its normal operating cycle, or if it is cash. Examples of current asset accounts
are:
 Cash and Cash Equivalents – bills, coins, funds for current purposes, checks, cash
in bank, etc.
 Receivables – Accounts Receivable (receivable from customers), Notes Receivable
(receivables supported by promissory notes), Rent Receivable, Interest Receivable,
Due from Employees (or Advances to Employees), and other claims
 Inventories – assets held for sale in the ordinary course of business
 Prepaid expenses – expenses paid in advance, such as, Prepaid Rent, Prepaid
Insurance, Prepaid Advertising, and Office Supplies

Non-current assets – Assets that do not meet the criteria to be classified as current. Hence,
they are long-term in nature – useful for a period longer that 12 months or the company's
normal operating cycle. Examples of non-current asset accounts include:
 Long-term investments – investments for long-term purposes such as investment
in stocks, bonds, and properties; and funds set up for long-term purposes
 Land – land area owned for business operations (not for sale)
 Building – such as office building, factory, warehouse, or store
 Equipment – Machinery, Furniture and Fixtures (shelves, tables, chairs, etc.),
Office Equipment, Computer Equipment, Delivery Equipment, and others
  Intangibles – long-term assets with no physical substance, such as goodwill,
patent, copyright, trademark, etc.

2. Liabilities

Liabilities are economic obligations or payables of the business.

Company assets come from 2 major sources – borrowings from lenders or creditors, and
contributions by the owners. The first refers to liabilities; the second to capital.
Liabilities represent claims by other parties aside from the owners against the assets of a
company.
Like assets, liabilities may be classified as either current or non-current.
Current liabilities – A liability is considered current if it is due within 12 months after the
end of the balance sheet date. In other words, they are expected to be paid in the next
year.
Current liabilities include:
 Trade and other payables – such as Accounts Payable, Notes Payable, Interest
Payable, Rent Payable, Accrued Expenses, etc.
 Current provisions – estimated short-term liabilities that are probable and can be
measured reliably
 Short-term borrowings – financing arrangements, credit arrangements or loans
that are short-term in nature
 Current tax liabilities – taxes for the period and are currently payable
Non-current liabilities – Liabilities are considered non-current if they are not currently
payable, i.e. they are not due within the next 12 months after the end of the accounting
period or the company's normal operating cycle.
 Long-term notes, bonds, and mortgage payables;
 Deferred tax liabilities; and
 Other long-term obligations
 3. Capital

Also known as net assets or equity, capital refers to what is left to the owners after all
liabilities are settled. Simply stated, capital is equal to total assets minus total liabilities.
Capital is affected by the following:
 Initial and additional contributions of owner/s (investments),
 Withdrawals made by owner/s (dividends for corporations),
 Income, and
 Expenses.
Owner contributions and income increase capital. Withdrawals and expenses decrease it.
The terms used to refer to a company's capital portion varies according to the form of
ownership. In a sole proprietorship business, the capital is called Owner's Equity or
Owner's Capital; in partnerships, it is called Partners' Equity or Partners' Capital; and in
corporations, Stockholders' Equity.

4. Income

Income refers to an increase in economic benefit during the accounting period in the form
of an increase in asset or a decrease in liability that results in increase in equity, other than
contribution from owners.
Income encompasses revenues and gains.
Revenues refer to the amounts earned from the company’s ordinary course of business
such as professional fees or service revenue for service companies and sales for
merchandising and manufacturing concerns.
Gains come from other activities, such as gain on sale of equipment, gain on sale of short-
term investments, and other gains.
Income is measured every period and is ultimately included in the capital account.
Examples of income accounts are: Service Revenue, Professional Fees, Rent Income,
Commission Income, Interest Income, Royalty Income, and Sales.
 5. Expense

Expenses are decreases in economic benefit during the accounting period in the form of
a decrease in asset or an increase in liability that result in decrease in equity, other than
distribution to owners.
Expenses include ordinary expenses such as Cost of Sales, Advertising Expense, Rent
Expense, Salaries Expense, Income Tax, Repairs Expense, etc.; and losses such as Loss
from Fire, Typhoon Loss, and Loss from Theft. Like income, expenses are also measured
every period and then closed as part of capital.
Net income refers to all income minus all expenses.

Example: Elements of accounting

Write examples for following accounting elements

1. Assets (5 examples)
2. Liabilities (5 examples)
3. Capital (3 examples)
4. Revenue (3 examples)
5. Expenditure (5 examples)
Accounting Concepts and Conventions

1. Business Entity Concept

A business is considered a separate entity from the owner(s) and should be treated
separately. Any personal transactions of its owner should not be recorded in the business
accounting book, vice versa. Unless the owner’s personal transaction involves adding
and/or withdrawing resources from the business.

2. Going Concern Concept

It assumes that an entity will continue to operate indefinitely. In this basis, assets are
recorded based on their original cost and not on market value. Assets are assumed to be
used for an indefinite period of time and not intended to be sold immediately.

3. Monetary Unit Concept / Money Measurement Concept

The business financial transactions recorded and reported should be in monetary unit,
such as US Dollar, Canadian Dollar, Euro, etc. Thus, any non-financial or non-monetary
information that cannot be measured in a monetary unit are not recorded in the
accounting books.

4. Historical Cost Concept

All business resources acquired should be valued and recorded based on the actual cash
equivalent or original cost of acquisition, not the prevailing market value or future value.

5. Matching Concept
This principle requires that revenue recorded, in a given accounting period, should have
an equivalent expense recorded, in order to show the true profit of the business.
6. Accounting Period Concept
This principle entails a business to complete the whole accounting process of a business
over a specific operating time period. It may be monthly, quarterly or annually. For
annual accounting period, it may follow a Calendar or Fiscal Year.

7. Consistency Concept
This principle ensures consistency in the accounting procedures used by the business
entity from one accounting period to the next. It allows fair comparison of financial
information between two accounting periods.

8. Materiality Concept
Ideally, business transactions that may affect the decision of a user of financial
information are considered important or material, thus, must be reported properly. This
principle allows errors or violations of accounting valuation involving immaterial and
small amount of recorded business transaction.

9. Accrual Concept
This principle requires that revenue should be recorded in the period it is earned,
regardless of the time the cash is received. The same is true for expense. Expense should
be recognized and recorded at the time it is incurred, regardless of the time that cash is
paid.

10. Prudence Concept

Prudence is a key accounting principle which makes sure that assets and income are not
overstated and liabilities and expenses are not understated.
 2. The Accounting Equation

Financial accounting is based upon the accounting equation.

This is a mathematical equation which must balance.

Expanded basic equation

Assets + Expenses = Liabilities + Capital + Income

Example 1: Basic Accounting Equation

Enter the following transactions in the accounting equation.

1. Started a business with Rs. 200,000 in the bank.
2. Bought furniture and fixtures Rs.15, 000 paying by cheque.
3. Purchased goods Rs.1750 on credit from M Mills
4. Sold goods for cash Rs.2750.
5. Bought goods on credit from Rs. 11,400 from S Waites
6. Bought a motor vehicle paying by cheque Rs. 3000.
7. The proprietor took cash for himself Rs. 14,000.
Example 2: Expanded Accounting Equation

Write up the following transactions in the accounting equation

Dec 1 Started a business with cash Rs. 150,000.
Dec 2 Bought goods on credit from A Hanson Rs. 20,500.
Dec 5 Paid rent by cash Rs. 28000.
Dec 7 Paid Rs.10,000 of cash to the firms’ bank account.
Dec 11 Sold goods on credit to E Linton Rs. 50,400. (cost of stocks is 40,000)
Dec 14 Bought stationary Rs. 1500 paying by cheque.
Dec 15 Cash sales Rs.45,000. (cost of stocks is 25,000)
Dec 20 Paid for repairs of building Rs.18,000.
Dec 25 Cash Purchase Rs. 12,500.
Dec 29 Bought motor vehicle paying by cash Rs. 39,500.
Dec 30 Paid motor expenses in cash Rs. 12,000
Dec 31 Bought fixtures Rs. 120,000 on credit from A Webster.
 3. Double entry book keeping system

Every transaction affects two items in the accounting equation. Thus double entry follows
the rules of the accounting equation. It maintains the principle that every debit has a
corresponding credit entry. These double entries are made in accounts in the accounting
books.

The Double Entry rule for Bookkeeping

Example: Preparation of ledger accounts

Write up the following transactions in the accounts of L Thompson.

2019
Dec 1 Started a business with cash Rs. 150,000.
Dec 2 Bought goods on credit from A Hanson Rs. 20,500.
Dec 5 Paid rent by cash Rs. 28000.
Dec 7 Paid Rs.10,000 of cash to the firms’ bank account.
Dec 11 Sold goods on credit to E Linton Rs. 50,400.
Dec 14 Bought stationary Rs. 1500 paying by cheque.
Dec 15 Cash sales Rs.45,000.
Dec 17 Goods returned by us to A Hanson Rs. 5000.
Dec 20 Paid for repairs of building Rs.18,000.
 4. Preparation of Trial Balance
Trial Balance is a list of closing balances of ledger accounts on a certain date and is the
first step towards the preparation of financial statements. It is usually prepared at the end
of an accounting period to assist in the drafting of financial statements.

Ledger balances are segregated into debit balances and credit balances. Asset and
expense accounts appear on the debit side of the trial balance whereas liabilities, capital
and income accounts appear on the credit side.

If all accounting entries are recorded correctly and all the ledger balances are accurately
extracted, the total of all debit balances appearing in the trial balance must equal to the
sum of all credit balances.

Purpose of a Trial Balance

1. Trial Balance acts as the first step in the preparation of financial statements. It is a
working paper that accountants use as a basis while preparing financial
statements.
2. Trial balance ensures that for every debit entry recorded, a corresponding credit
entry has been recorded in the books in accordance with the double entry concept
of accounting.
3. Trial balance ensures that the account balances are accurately extracted from
accounting ledgers.
4. Trial balance assists in the identification and rectification of errors.
Format for the Trial Balance
Luck Traders
Trail Balance as at 31st March 2015
Rs. Rs.
Description Debit Credit
Sales 18,642
Purchases 14,629
Salaries 2,150
Motor expenses 520
Rent 670
Insurance 111
General expenses 105
Motor Vehicles 1,200
Debtors 1,950
Creditors 1,538
Cash at bank 1,654
Cash in hand 40
Drawings 895
Capital 5,424
Total 25,424 25,424

Limitations of a trial balance

Trial Balance only confirms that the total of all debit balances match the total of all credit
balances. Trial balance totals may agree in spite of errors. An example would be an
incorrect debit entry being offset by an equal credit entry.
Example: Preparation of trial balance

Record following transactions to ledger using double entries and prepare trial
balance.
The transactions of the Sunil Traders for the month of January are given below.

01 - Sunil invested Rs.80,000 and started the business in the name of “Sunil Traders”
01 - Sunil obtained a loan from Piyal amounting to Rs.10,000 with a promise of
paying it back after 3 months
02 - Purchased a lorry for Rs.10,000
02 - Purchased furniture from Lal and Company for Rs.5,000 to use in the business
on credit basis
02 – Opened a current account in Sampath Bank by depositing Rs.25,000
03 – Purchased stock Rs.30,000
04 – Cash Sales Rs.50,000, Credit Sales Rs.20,000 to Aravinda
05 – Set off the full payment due to Lal and Company
05 - Sunil withdrawn Rs.7,000 for his personal use
06– Sunil and Company earned Rs.10,000 by transporting goods from Galle to
Colombo
07– Paid salaries amounting to Rs.2,000 to the driver of the lorry in cash
08 – Purchased office furniture Rs.5,000 from Dayal Company Rs.5,000 on credit
09 – Received a cheque for Sales Rs.2, 000
Credit Sales to Piyadasa Rs.3,500
10 – Purchased stock by issuing a cheque Rs.5,000
11 – Deposited the cheque received on 09th
12 – Withdrawn from the bank Rs.5,000
13 – Obtained a bank loan Rs.25,000
14 – Paid telephone bill by a cheque Rs. 3,000
15 – Paid salaries Rs.6,000
16 – Purchased office furniture Rs.10,000
17 – Purchased stock for Rs.15,000 by issuing a cheque
18 – Cash sales Rs.15,000
19 – Credit sales to Piyadasa Rs.18,000
20 – Received a cheque from Piyadasa Rs.8,000; deposited the cheque
21 – Obtained a loan from Jayasena Rs.50,000 and deposited Rs.30,000 from it in the
bank
22 – Cash Sales Rs.100,000
23 – Purchased stock for Rs.16,000 by issuing a cheque
24 – Bank informed that Piyadasa’s cheque was dishonored
25 – Credit Sales to Ranasinghe Rs.1,000
26 – Paid telephone bill Rs.800 in cash
27 – Paid salaries Rs. 5,000 by issuing a cheque
29 –Withdrawn money for his personal use Rs.2,000 from the business

You are required to

a. Record the transactions in to relevant ledger accounts
b. Prepare trial balance as at 31th January 2020
 5. Bank Reconciliation Statement
A statement known as Bank reconciliation Statement is therefore prepared usually every
month with a view to reconciling the two balances shown by the Cash book and the Bank
statement on a particular date. It should be prepared regularly as part of the internal
control system of the business to check:
 the accuracy of the cash book
 the accuracy of the bank statement
 that undue delay is not occurring between payments, receipts and their clearance
by the bank
 to discover payments made and items received by the bank not entered in the cash
book
The cash book (bank column) balance at the end of the month may not agree with the
balance shown in the Bank statement issued by the bank. This is due to delay in
transmission of information between the company and the bank.

Reasons for the difference between two balances

1. Cheques deposited into bank but not yet collected by the bank

2. Cheques issued but not yet presented for payment

3. The bank usually makes charges for the collection and for the various services
rendered by it to the traders. Collection charges, service charges and interest on
overdraft charged by the banker. The business can ascertain the exact amount of
charges and record them in the cash book only after the receipt of the bank
statement.

4. Interest or dividend on investments and rent on property collected by the bank

on behalf of the client.

5. Insurance Premium, Subscriptions to periodicals and other payments made by

the bank on behalf of the client.
 6. Dishonour of bills discounted with the bank might not have been adjusted in the
cash book.

7. Payment by customers direct into businessman’s account with the banker.

8. Wrong debit or credit given in the bank statement or the cash book.

Example: Preparation of bank reconciliation statement

The following cash book extract and bank statement of ALL THE BEST business has
been presented to you.
Cash Book
Dr(RS) Cr (Rs)
Balance B/F 01/07/20 5000 Cheque 001 400
Cheques/ cash 400 Cheque 002 600
deposited
Cheques/ cash 800 Cheque 003 700
deposited
Cheques/ cash 2000 Bal C/F 31/07/20 6500
deposited
8200 8200

Bank Statement
Dr Cr Balance
Balance1/07/20 5000 Cr
Cheque001 400 4600 Cr
Cash/ Cheques 400 5000 Cr
Cheque 002 600 4400 Cr
Bank Charges 150 4250 Cr
Cash/Cheques 800 5050 Cr
Direct deposit by a 300 5350 Cr
customer
Balance31/07/20 5350 Cr

You are required to prepare Bank reconciliation statement as at 31 July 2020 after
adjusting the cash book.
 6. Preparation of financial statements for sole
traders with adjustments
The calculation of such profits and losses is probably the most important objective of the
accounting function. In the case of a sole trader the profits are calculated by drawing up
a special account called a Trading and Profit and Loss Account. Nowadays this is often
simply called the Income statement or Statement of Comprehensive income.
That all balances remaining on a trial balance after the trading and profit and loss account
for a period has been drawn up are displayed in a balance sheet dated ‘as at’ the last day
of the period. Thus, the balance sheet is not part of double entry.
Example 1: Preparation of financial statements
From the following trial balance of Good Luck Co., extracted at the end of the year
trading, prepare a trading and profit and loss account and balance sheet for the year
ended 31st March 2020.
Trail Balance as on 31st March 2020
Rs. Rs.
Description Dr Cr
Sales 28,794
Purchases 23,803
Opening Stock as at 01.04.2019 854
Lighting and heating expenses 422
Salaries and wages 3,164
Insurance 105
Buildings 50,000
Fixtures 1,000
Debtors 3,166
Sundry expenses 506
Creditors 1,206
Cash at bank 3,847
Drawings 2,400
Motor van 5,500
Motor running expenses 1,133
Capital 65,900
Total 95,900 95,900

Stock at 31st March 2020 was Rs.4, 166

Adjustments needed in the Financial Statements
1. Adjustment for accruals and prepayments

Accrued expense is expense which has been incurred but not yet paid. Expense must be
recorded in the accounting period in which it is incurred. Therefore, accrued expense
must be recognized in the accounting period in which it occurs rather than in the
following period in which it will be paid.

Debit Expense (Income Statement)

Credit Expense Payable (Balance Sheet)

Accrued income is income which has been earned but not yet received. Income must be
recorded in the accounting period in which it is earned. Therefore, accrued income must
be recognized in the accounting period in which it arises rather than in the subsequent
period in which it will be received.
Debit Income Receivable (Balance Sheet)
Credit Income (Income Statement)

Prepaid Expense Prepaid expense is expense paid in advance but which has not yet been
incurred. Expense must be recorded in the accounting period in which it is incurred.
Therefore, prepaid expense must be not be shown as expense in the accounting period in
which it is paid but instead it must be presented as such in the subsequent accounting
periods in which the services in respect of the prepaid expense have been performed.
Debit Prepaid Expense (Asset)
Credit Expenses

Prepaid income is revenue received in advance but which is not yet earned. Income must
be recorded in the accounting period in which it is earned. Therefore, prepaid income
must be not be shown as income in the accounting period in which it is received but
instead it must be presented as such in the subsequent accounting periods in which the
services or obligations in respect of the prepaid income have been performed.
Debit Income
Credit Prepaid Income (Liability)

2. Adjustment for depreciation

All property, plant and equipment that are in use for carrying out the business have to
be depreciated in line with the useful economic life. As per SLAS 18, depreciation is a
systematic distribution of the cost of the asset according to the life time. Depreciation is
not an actual cost. It is only a cost component in the books. Mainly there are three
methods for calculating depreciation as per LKAS 16;
 Straight line method
 Reducing balance method
 Production unit method

Debit Depreciation
Credit Accumulated Depreciation

3. Bad debts and provision for doubtful debts

After selling goods and services on credit terms, a debtor is appeared in our books and,
if the debts are not recoverable it is treated as bad debts. If the amount not receivable can
be ascertained accurately it is treated as bad debts. If there is a doubt in the receipt of a
particular percentage from the debtors it is prudent to make a provision from the current
year profit.
Example 2: Preparation of financial statements with adjustments

The following is the schedule of balances on 31st March, 2020 extracted from the books
of “All the Best” business owned by Dinesh.

Dr Cr
Rs. Rs.
Cash at bank 2,600
Debtors 86,000
Stock as on 1st April, 2019 62,000
Furniture and fixtures 21,400
Office equipment’s 16,000
Buildings 60,000
Motor car 20,000
Creditors 43,000
Loan 30,000
Provision for doubtful debts 3,000
Purchases 140,000
Purchases return 2,600
Sales 230,000
Sales return 4,200
Salaries 12,400
Rent 5,500
Interest on loan 2,700
Rates and taxes 2,100
Discount allowed to debtors 2,400
Discount received from creditors 1,600
Freight on purchases 1,200
Carriage outwards 2,000
Drawings 12,000
Printing and stationery 1,800
Electric charges 2,200
Insurance premium 5,500
General office expenses 3,000
Bad debts 2,000
Bank charges 1,600
Motor car expenses 3,600
Capital account 162,000

472,200 472,200

Additional Information:
(i) Provide depreciation on
(a) Building at 5%;
(b) Furniture and fixture at 10%;
(c) Office equipments at 15%; and
(d) Motor car at 20%.
(ii) Value of stock at the close of the year was Rs.44, 000.
(iii) Increase bad debts by Rs.6, 000 due to death of one of the customers, on the year
end debtor balance it is required to maintain 5% as provision for doubtful debts.
You are required to prepare the Income statement for the year ended 31 st March 2010
and the balance sheet as at 31 March 2020.
Format for the Financial Statement of Sole Trader
Asoka Traders
Income Statement/ Statement of Comprehensive Income for the
year ended 31st March 2020 (Rs.)
Revenue XXXXX
Les: Sales Returns (XXX)
XXXXX
Cost of Goods Sold
Opening Stock XXX
Add:Purchases XXXX
XXXX
Less: Purchase returns (XX)
Inward Charges XXX
XXXX
Less: Closing Stock (XXX) XXXX
Gross Profit XXXXX
Other Income XXX
XXXXX

Administration Expenses
Salaries XXX
Wages XX
EPF Expense XXX
ETF Expense XXX
Electricity XXX
Water XXX
Depreciation XX
Telephone XX
Rent & Rates XX
XX (XXX)
Selling & Distribution Expenses
Storage Charges XX
Selling Expenses XX
Distribution Vehicle Depreciation XXX
Distribution Expenses XX
Marketing Staff Salaries XXX
XXX (XXX)
Finance & Other Expenses
Bank Charges
Interest on loan XX
Overdraft Interest XXX (XXX)
Net Profit XXX
Asoka Traders
BALANCE SHEET / STATEMENT OF FINANCIAL POSITION
AS AT 31ST MARCH 2020
(All Amounts Are In Sri Lanka Rupees)
Cost Acc.Dep WDV
ASSETS
Non-Current Assets
Land XXXX - XXX
Buildings XXXX XX XXX
Machinery XXXX XX XXX
Office Equipment XXXX XX XXX
Total XXXXX XXX XXXXX
Fixed Deposit XXX

Current Assets XXXX

Stocks XXXX
Trade & Other Receivables XXXX
Short-term Investments XXXX
Cash & Cash Equivalents XXXX XXXX
Total Assets XXXXXX
EQUITY & LIABILITIES
Capital XXXXXX
Add: Profit for the year XXXX
xxxxx
Less: Drawings (XXX) XXXX
Owner's Equity XXXX

Non Current Liabilities

Bank Loan XXXXX
Loan from-Mr.Fonseka XXXXX XXXXX
Total
Current Liabilities
Trade Payables XXXX
Other Payables XXXX
Bank Overdrafts XXXX XXXXX
Total Equity & Liabilities XXXXXX
 7. Manufacturing Account

For businesses which are manufacturers, a manufacturing account is prepared in

addition to the trading and profit and loss accounts. If a business is using manufacturing
accounts, instead of a figure for purchases (of finished goods) the trading account will
contain the cost of manufacturing the goods that were manufactured during the period.
The manufacturing account is used to calculate and show the cost of manufacturing those
goods. The figure it produces that is used in the trading account is known as the
production cost.

Example: Preparation of manufacturing account

Stocks at 1 January
Raw material 12000
WIP 6000
Finished Goods 15000
Sales 150000
Purchases of Rawmaterials 65000
Carriage inwards 2000
Wages 10000
Direct Material 4000
Direct Expences 3500
Factory Salaries 12500
Depreciation- Factory machine 2500
Facory expenditure 5000
Purchases returned 1000
Stocks at 31 December
Raw material 10000
Work in Progress 4000
Finished Goods 5000

Prepare Manufacturing account for the year ended 31 December2015 for ABC Business.

Format for the manufacturing account

ABC Company
Manufacturing Account for the year ended 31st March 2020
(Rs.)
Raw Materials
Opening Stock XXX
Purchases XXX
Add
Custom duties XX
Carriage Inwards XXX XXX
XXX
Less: Closing Stock (XXX)
Cost of raw materials
consumed XXX
Direct wages XXX
Other direct expenditure XXX
XXXX
Work-In-Progress
Opening WIP XXX
Closing WIP (XXX) XXX
Prime cost XXXX

Factory Overheads
Salaries XXX
Electricity & Power XXX
Machinery Depreciation XXX
Machinery Maintenance XXX
Depreciation on tools &
equipment XXX
Factory Rent XXX
Factory Rates XXX
Factory Insurance XXX
Factory General Expenditure XXX XXXX
Total Production Cost XXXX
 8. Accounting for Limited Liability Companies
Key factors distinguishing companies:
 Separate legal entity concept: the company is a separate entity in law
 Separation of the ownership (shareholders) from the management (directors) of
the company
 Limited liability of shareholders for the debts of a company. Generally speaking,
their liability will be limited to any portion of the nominal value of shares which
is unpaid.
 Formalities required. These are varying from country to country but frequently
require public availability of financial statements an annual audit by qualified
auditors.

Sole Traders and Companies Compared:

Item Sole trader Company
Capital introduced Capital account Issued share capital
by proprietors
Loans from third Loan account Loan notes and
parties bonds
Profits withdrawn Drawings Dividends
by proprietors
Profits retained in Capital account Reserves
the business

Advantages of Operating as Limited Company:

 Liability of the shareholders is limited to the capital already introduced by them.
 Formal separation of the business from owners of the business, which may be
helpful to the running of the business.
 Ownership can be shared between people more easily than other forms of business
organization, e.g. a partnership
 Shares in the business can be transferred relatively easily.
Disadvantages of Operating as a Limited Company:
 Costs of formation of the company.
 Costs of compliance with company’s legislation, including the audit requirement,
if any.
 Directors’ duties: company directors are subject to greater legislative duties than
others running an unincorporated business.
 It is difficult/ expensive to return surplus capital to the shareholders.

Company finance
Principal sources of company finance:
(a) Ordinary shares (equity capital)
Share
Capital

(b) Preference shares

Debt (c) Bonds/ Debentures
Capital
(d) Bank Loans
(e) Loan Notes
We called this as “Capital Structure”

Share capital
Share capital represents part of the capital invested in the company by its shareholders.
It may also represent past reserves of the company which have been ‘capitalized’ by a
bonus issue of shares.
Reserves represent the balance of net assets accruing to the shareholders. They may
include accumulated profits which have not been distributed and revaluation gains on
the revaluation of non- current assets.
The total of share capital and reserves represents the book value of the net assets of the
company.
Types of share capital
Ordinary or equity shares are the normal shares issued by a company.
Right of ordinary shareholders,
 to vote at company meetings
 to receive dividends from profits, often an interim dividend during an accounting
year and a final dividend after the balance sheet date when the company’s profit
for the year is known.
Preference or preferred shares carry a fixed rate of dividend, the holders of which have a
prior claim to ant company profits available for distribution.
 Convertible preference shares-where shareholder get the option of converting
their preference shares to predetermined number of ordinary shares
 Redeemable preference shares-the term of issue specify that they are repayable by
the company after a specific period of time.

Aspect Ordinary shares Preference shares

Distribution of A dividend which may vary from A fixed dividend (percentage of

profits one year to the next after the nominal value) in priority to
( dividends) preference shareholders have ordinary dividend.
received their dividend.

Liquidation of the Entitled to surplus assets on Priority of repayment over

company liquidation after liabilities and ordinary shares but not usually
preference shares have been repaid. entitled to surplus assets on
liquidation.

Company borrowing
 Notes :debt issued to a single investor
 Bonds :issue in units to a number of investors.
 Holders of notes or bonds are in no way owners of the business, they receive
interest which is an expense of the company.
  Notes or bonds may be secured on one or more assets of the company. If the
company defaults on its payment obligations, those assets can be sold to raise the
required money for the holders of the notes or bonds.
The shareholders’ interest in the company consists of the share capital plus reserves and
not merely the equity capital figure.
 Equity capital is held in the balance sheet at the same figure year after unless new
shares are issued.
 Accumulated profit: the company’s profit for the year minus dividends paid to the
members.
Format for the financial statements

………….. COMPANY LTD

COMPREHENSIVE INCOME STATEMENT
FOR THE YEAR ENDED 31ST MARCH 2020
Note Rs'000

Revenue 01 xxx

Cost Of Sales 02 (xxx)

Gross Profit For The Year xxx

Other Operating Income 03 xxx

Distribution Expenses 04.1 (xxx)

Administration Expenses 04.2 (xxx)

Other Operating Expenses 04.3 (xxx)

Profit/(Loss) From Operating Activities xxx

Finance Expenses 05 (xx)

Net Profit/(Loss) Before Taxation xxx

Income Tax 06 (xxx)

Net Profit/(Loss) After Taxation xxx

………….. COMPANY LTD
STATEMENT OF FINANCIAL POSITION/BALANCE SHEET
AS AT 31ST MARCH 2020
Note Rs'000

ASSETS
Non Current Assets
Property, Plant & Equipment 08 x
Intangible assets 09 x
Long term
Investments 10 x
Investment in
associates 11 x
Investments in other financial assets 12 x
xx
Current Assets
Inventories 13 x
Trade & Other
Receivables 14 x
Current Investment 15 x
Cash & Cash
Equivalents 16 x
xx
TOTAL ASSETS xxx
EQUITY & LIABILITIES
Stated Capital & Reserves
Stated/ Share Capital 17 x
Reserves 18 x
Accumulated
profits/loss x
Total Equity xx
Non Current Liabilities
Amount Payable(not interest bearing) 19 x
Interest bearing
Loans 20 x
Deferred Tax Liability 21 x
Provisions and Other Liabilities 22 x
xx
Current Liabilities
Trade & Other
Payables 23 x
Dividend Payable x
Income Tax Liability x
 Current Part of the Interest Bearing Loan x
xx
TOTAL EQUITY & LIABILITIES xxx

………….. COMPANY LTD

STATEMENT OF CHANGES IN
EQUITY
FOR THE YEAR ENDED 31ST MARCH 2020
Rs'000
Preference
Stated Share Revaluation Accumulated Total
Capital Capital Reserve Profit

Balance As At 31.03.2019 xx xx xx xx xxx

Effect of changes in accounting
policies (x) (x)

Balance xx xx xx xx xxx

Surplus on revaluation of fixed assets x x

Deficit on revaluation of other assets (x) (x)

Issues of shares for cash x x x

Bonus issue x x

Profit/(Loss) For The Year xx xx

Dividends Paid Note 07 (x) (x)

Balance As At 31.03.2020 xx xx xx xx xxx

………….. COMPANY LTD
NOTES TO THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED 31ST MARCH 2020
Rs'000

NOTE 01 - REVENUE
Exports Sales xx
Local Sales xx
xxx
Return inwards (x)
Net Sales xxx

NOTE 02 - COST OF SALES

Opening Stock xx
Add: Purchases xxx
Purchase expenses xxx
Less: Return outwards (xx) xxx
Closing Stock (xx)
xxx

NOTE 03 - OTHER OPERATING INCOME

Interest Income x
Insurance Commission x
Dividend Income x
Sundry Income x
Profit on sale of Property, Plant & Equipment x
Total xxx

NOTE 04.1 - DISTRIBUTION EXPENSES

Transport x
Advertising x
Bad Debts x
Hire Charges for Plant & Machinery x
Other Distribution Expenses x
xxx

NOTE 04.2 - ADMINISTRATIVE EXPENSES

Directors' Emoluments x
Auditors' Remuneration x
Depreciation x
Staff Cost x
Management Fee x
Legal Fee x
Others x
xxx
NOTE 04.3 - OTHER OPERATING EXPENSES
Losses on sale of Property, Plant & Equipment x
Losses on disposal of investment x
Changes in the value of short term investment x
Exchange Losses x
Donations x
xxx
xxx

NOTE 05 - FINANCIAL EXPENSES

Bank Charges x
Interest On Overdraft x
Loan Interest x
Lease Interest x
Debenture Interest x
 xxx

NOTE 06 - INCOME TAX

Tax on profit for the period x
(+/-) Adjustment for prior year x
xx

NOTE 07 - DIVIDENDS
Interim dividends
Preference shares x
Ordinary shares x
Proposed dividends
Preference shares x
Ordinary shares x
xx
NOTE 08 - PROPERTY, PLANT &
EQUIPMENT

Cost
Additions Revaluation Disposal
Opening Closing
Description
Balance Balance
(Acquisition)

Freehold Land x x x xx
Leasehold
Lands x x xx
Buildings x x x (x) xx
Motor Vehicles x x x (x) xx
Plant &
Equipment x x x (x) xx
Furniture &
Fittings x x x (x) xx
xx xx xx xx xx

Accumulated
Depreciation

Opening Depreciation Depreciation Transfer in Closing

Description
Balance for the year on assets revaluation Balance
disposal
Buildings x x (x) (x) xx
Motor Vehicles x x (x) (x) xx
Plant &
Equipment x x (x) (x) xx
Furniture &
Fittings x x (x) (x) xx
xx xx xx xx xx
Example

Following trial balance has obtained from Ceylon PLC as at 31st March 2013.
Dr Cr
Description (Rs.'000) (Rs.'000)
Stated capital- Ordinary Shares 265,000
General Reserves 102,500
Retained earnings 60,000
Stocks on 01.04.2012 52,000
Purchases & Sales 650,000 1,162,000
Return inwards & outwards 6,200 39,000
Lands at cost 298,000
Building at cost 60,000
Furniture & fittings at cost 9,200
Motor Vehicles at cost 180,000
Equipment at cost 8,000
Provision for depreciation at
01.04.2012
Buildings 35,000
Furniture & fittings 3,500
Motor Vehicles 85,000
Equipment 2,500
Provision for doubtful debt 2,000
Trade debtors & creditors 80,000 70,000
Bank loan 50,000
Investments 125,000
Accrued expenses 200
Prepayments and sundry deposits 800
Call deposits 300,000
Bank Overdrafts 1,000
Bank Balance & cash in hand 7,000
Interest on investments received 30,000
Interest on bank overdraft 1,800
Administrative costs 81,000
Distribution cost 16,640
Other costs 32,060
1,907,700 1,907,700
Additional information;
1. Closing stock as at 31.03.2013 is valued for Rs.60, 000,000. Stock is being valued at
the lower of cost and estimated Net Realizable Value after making adjustment for
obsolete and slow moving items.
2. Depreciation will be done on straight line method to the cost and rates are as
follows.
Buildings 2.5%
Furniture & Fittings 10%
Motor Vehicles 20%
Equipment 12.5%
3. Bank loan interest is at the rate of 16% on year end loan balance.
4. Composition of the Administrative cost is as follows
Directors’ fees 8,480,000
Audit fees 325, 000
Gratuity payment 275, 000
Salaries 48,000,000
EPF 1,440, 000
ETF 360, 000
Maintenance 1,000,000
Training & development costs 2,400,000
Legal fees 6,000,000
Promotional expenses 9,000,000
Sales commissions 3,720,000
81,000,000

Required: Prepare the following for the purpose of publication

a. Comprehensive Income Statement/ Income Statement for the year ended 31.03.2013
b. Statement of Financial Position/ Balance sheet as at 31.03.2013
c. Statement of changes in equity
d. Relevant notes to the financial statements
 9. Interpretation of financial statements
Ratios are considered to be the best guides for the efficient execution of basic
managerial functions like planning, forecasting control etc. The most valuable way to
use them is generally to compare them with the corresponding ratios of earlier
accounting periods and study the trends disclosed.

Purposes of Financial Ratio Analysis

 Standardize financial information for comparisons
 Evaluate current operations
 Compare performance with past performance
 Compare performance against other firms or industry standards
 Study the efficiency of operations
 Study the risk of operations

Example

The following is a simple example of firm comparison. Here are the ratios Identify the
Period in which company is performing well

Ratio 2013 2014 2015

Net Profit
Assets Employed 45% 69% 60%
Net Profit %
Sales 49% 55% 52%
Sales %
Assets Employed 47% 53% 55%
Distribution & Marketing Expenses
Sales 36% 32% 34%
Average Stocks x 365 days
Net Cost of Sales 26 days 21days 28 days

Debtors x 365 days

Net Sales 32 days 25days 27 days

Creditors x 365 days

Average Purchases 52 days 58days 51days
Current Assets
Current Liabilities 1.8:1 2:1 1.5:1
Quick Assets
Current Liabilities .8:1 1.3:1 1.1:1

ROCE % 43% 49% 53%

Interest Cover 4 times 8 times 7 times

EPS 5.5 7.1 7.3