Chapter 1-1

Chapter 1: Incomplete Records and Single Entry

Learning Objectives (LO)
LO 1: Apply Accounting and Business Equations
LO 2: Apply Capital Comparison method & Statement of Affairs
LO 3: Calculate Sales FTY based on Trade Receivables Control A/C
LO 4: Calculate Purchase FTY based on Trade Payables Control A/C
LO 5: Apply Accruals & Prepayments
LO 6: Differentiate principles of Mark-up and Margin
LO 7: Determine inventories loss due to damage by fire/theft
LO 8: Prepare financial statements from incomplete records for sole proprietorships

1 Introduction
Incomplete records occur when a business does not have a full set of accounting records
because: -
a. The proprietor of the business does not keep a full set of accounts. The owner or
bookkeepers do not observe the principles of double entry book keeping system and
accounts are kept under single entry.
b. Some of the business accounts are accidentally lost or destroyed.

2 Accounts kept under Single Entry System

Many small firms, especially retail shops may not know how to write up double entry
records of all business transactions even if they want to. As such, these business owners
may only keep a cash book to record money received and money paid, and some form of
records, (not in double entry form) of their receivables and payables. Information that is
considered not important will not be recorded. Consequently, incomplete records are kept.

3 Preparing financial statements from incomplete records

Several ways / methods are used to calculate missing figures and balances that are required
for the preparation of financial statements:

 Capital Comparison / Statement of Affairs

 Balancing Figure / Analysis method

 Ratios - Mark Up and Margin

 Lost Inventory method

 Chapter 1-2

a. Capital Comparison
This method is used when opening and closing capital are known. This involves using the
formula from the SOFP: -

Equity
Capital as at 1st Jan X
Add: Additional capital X
Add: Profit for the year P/(L)
XX
Less: Drawings (X)
Capital as at 31st December XXX

Capital as at 31st December XXX

Add: Drawings X
XX
Less: Additional capital (X)
Less: Capital as at 1st Jan (X)
Profit or (Loss) P/(L)

The Business Equation:

Closing net assets = Opening net assets + Capital Introduced + Profit – Drawings

Closing capital = Opening capital + Additional Capital + Profit / (Loss) - Drawings

b. Statement of Affairs
This method involves identifying profits/capital when you only have a list of opening and
closing assets and liabilities.

In practice, there should not be any missing item in the opening balance of the business
because it should be available from financial statements of previous year. However,
capital figures are sometimes not available when proper books are not kept, therefore, to
find the profit or loss, it is necessary to determine the capital first by preparing the
Statement of Affairs as follow: -

Statement of Affairs as at 1st January

Debit Credit
RM RM
Assets A
Liabilities L
Capital as at 1 Jan
st
Bal
XX XX

The Accounting Equation:

Assets = Capital + Liabilities
 Chapter 1-3

4 Balancing Figure / Analysis method

a. Trade receivables control account (Credit sales)

If a business does not keep a record of its sales on credit, the value of these sales can be
derived from the opening balance of trade receivables, the closing balance of trade
receivables and the payments received from trade receivables during the period.

Trade Receivables Control A/C

RM RM
Bal b/d X Sales return X
Credit Sales X Bad debts X
Bank (Dishonoured cheque) X Cash / Bank X
Cash / Bank (Refund to TR) X Discount allowed X
Bal c/d X
XX XX
Bal b/d X

Total Sales (SOPL) = Credit Sales + Cash Sales

Trade payables control account (Credit purchases)

A similar relationship exists between trade purchases during a period, the opening and
closing balances for trade payables and amount paid to trade payables during the period.

Trade Payables Control A/C

RM RM
Purchase return X Bal b/d X
Cash / Bank X Credit Purchases X
Discount Received Cash / Bank (Refund from TP) X
Bal c/d X
XX XX
Bal b/d X

Total Purchases (SOPL) = Credit Purchases + Cash Purchases

 Chapter 1-4

b. Income & Expenses Account (Accruals / Prepayments)

The relevant T a/c for calculating expenses during the year: -

Expenses Account
RM RM
Prepayment b/d x Accruals b/d x
Expense paid x SOPL (balancing) x
Accruals c/d x Prepayment c/d x
x x

Illustration 1: Rent Expense

Two businesses pay rent for building in Dec 20x1.
The rent for building is RM 6,000 per year.

Scenario 1. Business A pays RM 5,000 in the year.

At the year-end 20x1, it owes RM 1,000 for rent.

Journal Entry

(1) DR (2) DR

CR CR

Scenario 2. Business B pays RM 6,500 in the year.

It includes RM 500 paid in advance for the following year 20x2.

Journal Entry

(1) DR (2) DR

CR CR

Let’s say both businesses A & B belong to you and rental expenses incurred:

Rental Expenses Account

RM RM
Prepayment b/d Accruals b/d
Expense paid SOPL
Accruals c/d Prepayment c/d
 Chapter 1-5

The relevant T a/c for calculating income during the year: -

Income Account
RM RM
Accruals b/d x Prepayment b/d x
SOPL (balancing) x Income received x
Prepayment c/d x Accruals c/d x
xx xx

Illustration 2: Rental Income

The rent income for a house is RM 10,000 per year.
Received rental from 2 tenants below in Dec 20x1.

Scenario 1. Tenant A pays RM 8,000 in the year.

At the year-end 20x1, balance RM 2,000 rental has not yet received.

Journal Entry

(1) DR (2) DR

CR CR

Scenario 2. Tenant B pays RM 10,800 in the year.

It includes RM 800 received in advance for the following year 20x2.

Journal Entry

(1) DR (2) DR

CR CR

Let’s say you own 2 houses and earn rental income:

Rental Income Account

RM RM
Accruals b/d Prepayment b/d
SOPL Income received
Prepayment c/d Accruals c/d
 Chapter 1-6

c. Cash/Bank Account

Cash Book is re-construct with information available to deduce:

• Closing cash balance
• Cash purchases/sales
• Cash drawings

Bank or Cash Account

RM RM
Bal b/d x Bal b/d (overdraft) x
Cash sales x Cash purchases x
Collection from receivables x Payment to payables x
Additional capital x Cash drawings x
Income received x Expenses paid x
Sale of NCA x Purchases of NCA x
Bal c/d (overdraft) x Bal c/d x
xx xx

d. Non-Current Assets account

A simplified non-current assets account is drawn to deduce:

a. Depreciation charges
b. Acquisition cost of NCA
c. Disposal charges of NCA

Non-Current Asset account (NBV)

RM RM
Bal b/d x Disposal x
Acquisition x Depreciation x
Bal c/d x
xx xx

Note: This is NOT a proper non-current assets account. The simplified account meant for
calculation of depreciation / cost / disposal of assets.
 Chapter 1-7

Illustration 3: Non-Current Asset (NBV)

Alex asked you to compute the NBV of a motor vehicle disposed in the year.
NBV at the beginning and end of the year 20x1 are RM175,000 and RM150,000 respectively.
His accounts executive told him the depreciation for the year was RM50,000 and the cost of
new vehicle acquired with cash in the year was RM55,000.

Non-Current Asset – Motor Vehicle Account (NBV)

RM RM
Bal b/d Disposal (NBV)
Bank (Acquisition) Depreciation
Bal c/d

5 Gross Profit Margin and Mark-up method

When the gross profit percentage is given, it can be used to calculate the gross profit and be
inserted into trading account, thus enabling another missing information, e.g. sales, purchases,
opening and closing inventory to be deduced.

Formulae:
(i) Profit expressed as a % of the selling price is known as margin.

Margin = Gross Profit x 100%

Sales

(ii) Profit expressed as a % of the cost price is known as mark-up.

Mark-up = Gross Profit x 100%

Cost of Sales

Example of Margin and Mark-up

RM
Sales 125
Cost of goods (100)
Gross profit 25

The margin is The mark-up is

Gross Profit Gross Profit

--------------- x 100 = -------------- x 100% ----------------- x 100 = ----------- x 100%
Sales Cost of sales

= ------------ = ------------

= =
 Chapter 1-8

6 Loss Inventory Method

The cost of any lost inventory can be derived by completing the trading account
from the information given and then calculating the lost inventory as a balancing
figure.

Illustration 4 (Margin)
Chong provides the following information about his business for 12 months after
a fire in November:

Margin 20% RM
Sales 98,000
Opening inventory 10,000
Purchases 82,000
Closing inventory after fire 3,000

What is the cost of inventory lost in the fire?

Suggested solution (20% Margin):

RM %
Sales 98,000 100
Less : Cost of sales
Opening inventory 10,000
Add : Purchases 82,000
steps Less : Closing inventory (3,000)
(iii) Inventory lost in fire (10,600)

(ii) Cost of sales 78,400 80%

(i) Gross profit 19,600 20%

Illustration 5 (Mark-up)
Let’s say Chong adopts mark-up of 30% while all other information of sales, purchases
and inventories amount remain the same, what is the cost of inventory lost in the fire?

Suggested solution (30% Mark-up):

RM %
Sales 98,000 100
Less : Cost of sales
Opening inventory 10,000
Add : Purchases 82,000
steps Less : Closing inventory (3,000)
(iii) Inventory lost in fire (10,600)

(ii) Cost of sales 78,400 80%

(i) Gross profit 19,600 20%

 Chapter 2-1

Chapter 2: Partnerships vs Joint Ventures

Learning Objectives (LO)

Partnerships
LO 1: Define the term ‘partnership’ and explain partnership agreement
LO 2: Prepare accounting procedures for partnerships (capital account and current account)
LO 3: Calculate appropriation of profit and loss
LO 4: Prepare partnership financial statements

Joint Venture
LO 5: Explain the term and purpose of joint venture
LO 6: Distinguish between joint venture and partnerships
LO 7: Identify joint venture items in the financial statements

1 Introduction
There are 3 major forms of business – sole proprietor business, partnership and company.

Partnership is established by a minimum of 2 members and a maximum of 20 members.

Partnership receives capital contributions from its members. Each partner has the right to
give ideas and share profit and loss according to the terms in the partnership agreement.

Important details to be mentioned in the Partnership Agreement are:

a. Name of firm/partnership together with partners’ names
b. Type of business and business address
c. The amount of capital contributed by each partner
d. Ratio of profit/loss allocation between partners
e. Salary for active partners
f. Interest on capital and loan allowed to each partner
g. Interest on drawing and the allowed amount of drawings

All partnerships are established under the provision of Partnership Act 1961 (Revised
1974). If partners do not make any partnership agreement, all partners are to observe the
provisions under the Act as follows:
a. Equal profit and loss allocation between partners
b. No partner has the right to be compensated (salary) while doing business
c. Interest on capital and drawings is not charged
d. Solution to misunderstanding must be based on majority votes
e. All partners have the right to conduct partnership
f. New partner acceptance must receive approval from all partners
g. All partners have the right to look at the account books

The Partnership Act 1961 (Revised 1974) defines partnership as a relationship that exists
between individuals who carry out a business together with the purpose of making profit.

While a partnership to establish a bank or share brokerage should not have members
exceeding 10 persons, professional partnerships such as law, accounting, engineering and
medical firms can have an unlimited membership.
 Chapter 2-2

2 Accounting procedures

The accounting procedures for partnerships involve a number of important accounts,

which are capital account, current account, worker salary account, interest on capital
account and interest on drawings account.

a. Capital Account
Each partner must contribute capital into a partnership. Total contributed capital is
determined in the agreement and this amount will remain during the partnership business
period. Contributed capital consists of cash or assets.

The following are entries for capital contribution

i. Cash:
Dr Cash account xx
Cr Partners’ capital account xx

ii. Assets:
Dr Assets account xx
Cr Partners’ capital account xx

Illustration 1:

Alan and Brian agreed to establish a partnership on 1 January 20x2 with the following capital
contributions:

Alan (RM) Brian (RM)

Furniture 25,000 -
Office equipment 15,000 30,000
Motor vehicle - 50,000
Cash 100,000 60,000

Journal Entry

Dr Furniture 25,000
Office equipment 15,000
Cash 100,000
Cr Capital - Alan 140,000
(Cash and assets contributed by partner – Alan)

Dr

Cr
(Cash and assets contributed by partner – Brian)
 Chapter 2-3

Ledger

Furniture Account
20x2 RM 20x2 RM
Jan 1 Alan – Capital a/c 25,000 Dec 31 Balance c/d 25,000

Office Equipment Account

20x2 RM 20x2 RM
Jan 1 Alan – Capital a/c 15,000 Dec 31 Balance c/d 45,000
Brian – Capital a/c 30,000
45,000 45,000

Motor Vehicle Account

20x2 RM 20x2 RM
Jan 1 Brian – Capital a/c 50,000 Dec 31 Balance c/d 50,000

Cash Account
20x2 RM 20x2 RM
Jan 1 Alan – Capital a/c 100,000 Dec 31 Balance c/d 160,000
Brian – Capital a/c 60,000
160,000 160,000

Capital Account
Alan Brian Alan Brian
Balance c/d 140,000 140,000 Furniture 25,000 -
Office equipment 15,000 30,000
Motor vehicle - 50,000
Cash 100,000 60,000
140,000 140,000 140,000 140,000
 Chapter 2-4

Statement of Financial Position as at 31 December 20x2

RM
Assets
Furniture
Office Equipment
Motor Vehicle
Cash and Cash Equivalents
Total Assets

Equities and Liabilities

Capital:
Alan
Brian
Total Equities

b. Current Account
Contributed capital will remain in the business for as long as the partnership continues.
Profit will not be recorded in the capital account; therefore, a current account needs to be
prepared to record profit or loss, accrued salary, interest from capital and interest on
drawing.

The credit column in the current account shows benefit or profit stated under owner’s
equity; while the debit column shows reduction in equity such as drawings.

Illustration 2:

Iris, Shaun and Margaret are three partners who set up a partnership selling apparels named
Dynamic Enterprise. Establish on 1 March 20x2, they agreed to share equal profit and loss.
Their partnership agreement stated the following:

(i) Capital contributed by each partner:

Iris RM 60,000
Shaun RM 30,000
Margaret RM 60,000

(ii) Interest on capital is paid at 8% per year.

(iii) Shaun is to be paid salary of RM2,000 per month.

(iv) On 31 December 20x2, the profit earned was RM78,000 and total drawing of partners
were: Iris RM16,000, Shaun RM 18,000 and Margaret RM14,000.

You are required to prepare these accounts on 31 December 20x2:

(a) Statement to show how partnership profit is distributed
(b) Current account for each partner
 Chapter 2-5

Solution

(a) Statement of Partners’ Profit Appropriation

RM
Net profit 78,000
Less: Shaun’s salary (10 months) 20,000
Interest on capital: Iris 4,000
Shaun 2,000
Margaret 4,000 (30,000)

48,000

Appropriation profit: Iris 16,000 (48,000 /3)

Shaun 16,000 (48,000 /3)
Margaret 16,000 (48,000 /3)

48,000

(b) Ledger

Partners’ Current Account

Iris Shaun Margaret Iris Shaun Margaret
Drawing 16,000 18,000 14,000 Salary - 20,000 -
Balance c/d 4,000 20,000 6,000 Interest of capital 4,000 2,000 4,000
Profit & loss
appropriation 16,000 16,000 16,000

20,000 38,000 20,000 20,000 38,000 20,000

c. Partner Salary
Active partners will be paid salary. The salary paid to partners should be differentiated
from salary paid to employees. Employee’s salary will be charged as expenses while
partner’s salary is not charged to profit account but is itself profit appropriation.

There are two situations in which salary is paid to partners:

Scenario 1: Salary Paid in Accounting Period

Dr Partners’ salary account xx

Cr Cash account xx
 Chapter 2-6

Illustration 3:

Melvin and Audra are two partners who founded a business on 1 January 20x2, and
shared profit equally. According to the agreement between them, Melvin will be paid
salary which totalled RM 24,000 per year. Melvin is paid all salary that he rightfully
earned on 31 December 20x2.

Journal:

Dr Salary account - Melvin 24,000

Cr Cash account 24,000

Salary Account - Melvin

20x2 RM 20x2 RM

Dec 31 Cash 24,000 Dec 31 P&L appropriation 24,000

Cash Account
20x2 RM

Dec 31 Salary - Melvin 24,000

Scenario 2: Accrued Salary

Dr P&L appropriation account xx

Cr Partners’ current account xx

Illustration 4:

Tan and Ryan are two partners who established a business on 1 January 20x2, and shared
profit equally. According to the agreement between them, Ryan will be paid RM 1,500
per month as salary. Ryan’s salary was payable on 31 December 20x2.

Journal:

Dr P&L appropriation account 18,000

Cr Current account - Ryan
18,000
 Chapter 2-7

Profit & Loss Appropriation Account

20x2 RM

Dec 31 Current a/c - Ryan 18,000

Current Account - Ryan

20x2 RM

Dec 31 P&L appropriation a/c 18,000

d. Interest on Capital

Interest on capital is compensation given to partners on the capital that they have
contributed. The partnership agreement will state the interest rate for each partner.

Interest on capital will be deducted from net profit before it is distributed among
partners.

Dr P&L appropriation account xx

Cr Partners’ current account xx

e. Interest on Drawings

Interest on drawings is charged on partners who withdraw money or goods from

partnership business for personal use. Interest on drawings is revenue for business
partnership and it increases profit before profit distribution among partners.

Dr Partners’ current account xx

Cr P&L appropriation account xx

3 Appropriation of Profit and Loss

If the capital contribution from partners is equal, it is fair for the profit to be distributed
equally.
However, in cases where some of the partners are not actively involved in the partnership,
equal profit appropriation or division should be unfair. Thus, profit and loss appropriation
must be done with profit and loss appropriation account / statement to show the actual
view on contributed capital and active partner involvement in partnership business.

Profit and loss appropriation involves interest on capital, salaries and commission, interest
on drawings and profit or loss balance.
 Chapter 2-8

a. Interest on Capital

Interest on capital is compensation given to partners based on the capital they have
contributed. The partnership agreement will state the interest rate of each partner.
Interest on capital is deducted from net profit before the profit is distributed among
partners.

b. Salaries and Commission

It is compensation for the partners’ service contribution in partnership business.

Salaries and commission for partners are deducted from net profit before being
distributed among partners.

c. Interest on Drawings

Interest on drawings is charged on partners who withdraw money or goods from

partnership business for personal use. Interest on drawings is revenue for partnership
business and is added to profit before distributing the profit among partners.

d. Profit or Loss Balance

Balance of profit or loss after appropriation is known as residual profit/loss.

Residual profit/loss = Net profit + Interest drawings – Interest on Capital - Salaries

Illustration 5:

Sarah, Lena and Victor have been partners since 1 July 20x2. They agreed to share
profit and loss equally. Their agreement stated the following:
(i) Salary of RM 19,200 per year is paid to Sarah.
(ii) Interest on capital is given at the rate of 5% per year.

Capital account and Partnership current account show the following balances as at 1
January 20x7.

Capital Account Current Account

Drawings (RM)
(RM) (RM)
Sarah 40,000 9,600 16,000
Lena 60,000 12,400 20,000
Victor 80,000 13,200 28,000

Profit earned in year 20x7 is RM 112,200

You are required to prepare:

(a) Appropriation of profit & loss account
(b) Partnership current account
(c) Extract of statement of financial position as at 31 December 20x7
 Chapter 2-9

Solution
(a)

Appropriation of Statement of Comprehensive Income

RM RM
Salary: Sarah 19,200 Profit & Loss c/d 112,200
Interest on Capital: Sarah 2,000
Lena 3,000
Victor 4,000
Share profit: Sarah 28,000
Lena 28,000
Victor 28,000
112,200 112,200

(b)

Partners’ Current Account

Sarah Lena Victor Sarah Lena Victor
Drawings 16,000 20,000 28,000 Balance b/d 9,600 12,400 13,200
Balance c/d 42,800 23,400 17,200 Salary 19,200

Interest on capital 2,000 3,000 4,000

Share profit 28,000 28,000 28,000

58,800 43,400 45,200 58,800 43,400 45,200

(c) Extract of Statement of Financial Position as at 31 December 20x7

Financed by:
Capital account: Sarah 40,000
Lena 60,000
Victor 80,000
Current account: Sarah 42,800
Lena 23,400
Victor 17,200
 Chapter 2-10

4 Joint Venture Introduction

A joint venture is a business agreement between two or more businesses to carry out a
business temporarily. It is suitable for business which are facing difficulties in capital or
skill. It could solve a problem through cooperation with other business that can provide
the skill or additional capital.

For e.g.: 2 traders, A & run a baby store together. A contributes capital and does the
business marketing while B provides the workforce and manages the distribution of
goods.

Apart from sharing capital, skills, goals and objectives, businesses are also able to reduce
competition. Profits or losses will be divided according to an agreed ratio between the
parties involved.

The similarities between Joint Ventures and Partnerships are:

(a) Profit distribution will be based on mutual agreement after deducting all income and
expenses.
(b) The business corporation could reduce risks and enable the sharing of capital and
skills.

5 Differences between Joint Ventures and Partnerships

Joint Ventures Partnerships

A cooperation agreement between 2 or A combination of a few individuals
more business parties with a specific running a business together.
business purpose.

Involves a certain period of time until Involves a long period of time

the joint venture goals are achieved. depending on the business and the
partners’ capabilities.

Sharing of skills, technology etc. that Comprises business partners who share
can be used to develop/expand the the goal of making profits.
business or cost management.

Owners can maintain their Owners in a partnership are bound to

organisation’s identity and can make make decisions together.
their own decisions as it involves 2 or
more separate businesses.
 Chapter 2-11

6 Identify joint venture items in the financial statements

• Typically, companies with a 20%-50% stake in a joint venture utilise equity method
accounting to account for such investments.
• Equity method accounting is different from full consolidation where the financials of
the subsidiary are fully consolidated in the parent’s financial statement.
• Under this equity method accounting, the investor includes the profits of the investee
as a single line in its income statement, reflecting the investor’s share of the investee’s
net income.
• The investor also shows dividends received from the investee as a single line in its
cash flow statement.
• The investor includes the investment as a single line in its balance sheet, reflecting the
original cost of the investment adjusted for the investor’s share of profits net of
dividends received.

Example: Finding Joint Ventures in Financial Statements

Below is an extract from the 2019 annual report of Shell.

Income Statement

The company has reported its share of profit joint ventures and associates in its consolidated
statement of income. Note that this is a profit figure, net of expenses incurred by the joint
venture, but it is shown beneath Shell’s own revenue figure and included within the group’s
‘Total revenue and other income’.
 Chapter 2-12

Balance Sheet
Equity method investments such as joint ventures and associates are reported in the company’s
balance sheet under non-current assets.
 Chapter 2-13

Statement of Cash Flows

The company has shown many transactions related to joint ventures in its cash flow statement.
For example, they have deducted the investments in joint ventures and associates, and added
proceeds from the sale of joint ventures and associates to arrive at the cash flow from investing
activities.
 Chapter 2-14

Notes to Consolidated Financial Statements

The company has included the details of its income from joint ventures and associates in a
separate note (note 9) within the notes to consolidated financial statements. The notes also
include the carrying amount or the net book value of these investments.
 Chapter 3-1

Chapter 3: Manufacturing Accounts

Learning Objectives (LO)
LO 1: Introduction of manufacturing accounts
LO 2: Classification of Cost division
LO 3: Distinguish Direct and Indirect cost
LO 4: Apportionment of expenses to various divisions
LO 5: Prepare financial statements for manufacturing business
LO 6: Market Value of goods manufactured
LO 7: Calculate Transfer pricing
LO 8: Differentiate Realised and Unrealised Profits
LO 9: Prepare Allowance for UnRealised Profits account (AURP)
LO 10: Prepare financial statements with transfer pricing and unrealised profits

1 Introduction

In a manufacturing enterprise, raw materials are converted into finished goods for resale.
As such, a manufacturing company is involved in production activities other than the
normal marketing, selling, distribution and administrative activities.

For a manufacturing enterprise, we need to calculate the total factory cost of goods
manufactured / produced. This cost will then be transferred from the “Manufacturing
Account” to the “Trading Account” (i.e., the first part of the Statement of Profit or Loss,
SOPL).

Apart from the differences mentioned above, the SOPL for a manufacturing company is
the same as that of a trading company.

The Statement of Financial Position of a manufacturing company is slightly different in

its contents only as its inventories will comprise raw materials, work-in-progress (i.e.,
partly finished goods) and finished goods. In a trading company, there is only inventory
of finished goods.

2 Classification of Costs
In a manufacturing business, costs are usually classified as either Direct Costs or Indirect
Costs/Overheads.

Direct Costs These are costs which can be traced, attributed to or identified to a
particular work-in-progress or finished goods.

Direct These are costs of raw materials and other components used to
Materials produce the finished goods and which can be identified to the
individual units of production. For example, at Gardenia Bhd., the
flour, eggs, yeast and butter are the direct materials used to make its
breads, cakes and pastries.
 Chapter 3-2

Direct This comprises the wages of employees who are directly involved in
Labour manufacturing the products or in operating the machinery that are used to produce
the finished goods.
Direct These are expenses that are directly related and traceable to a specific supply.
Expenses
Examples: the cost of hiring a special machine to produce a particular product and
the royalties paid for the right to produce the finished goods etc.

Indirect These are also known as “Production Overheads”. These costs are not directly
Costs related to the actual production of the finished goods. Hence, they do not vary
with output volume and are normally fixed.
Indirect These include wages and salaries paid to workers who are not directly involved in
Labour the production process.

Examples are wages paid to factory supervisors, factory cleaners, factory

managers, etc.
Indirect These are expenses that cannot be traced, attributed to or identified to a particular
Expenses finished goods.

Examples are repairs and maintenance of plant and machinery, depreciation of

plant and machinery, factory light and power, factory rent and insurance, etc.

3 Categories of Inventories
A manufacturing company differs from a trading company in that it has the following
categories of inventories:

(a) Raw Materials

These are raw materials that have been purchased but have not been used for
production at the reporting date.

(b) Work-in-Progress (WIP)

This refers to goods that are partially completed at the end of the accounting year.
The value of this WIP is the cost of the raw materials, the wages of workers who have
worked on the raw materials plus a share of factory overheads.

(c) Finished Goods

This refers to goods that have been fully completed but remain unsold at the reporting
date.
 Chapter 3-3

4 Format of Manufacturing Accounts

Morning Star Sdn. Bhd.

Manufacturing Account for the year ended 31 December
RM RM
Opening inventory - raw materials 12,000
Purchases of raw materials (net of returns) 258,000
Carriage inwards of raw materials 5,000
Import taxes on raw materials 8,000
283,000
Less: Closing inventory - raw materials (110,000)
Cost of raw materials consumed 173,000
Direct labour/wages 98,000
Direct expenses 12,000
Prime cost 283,000

Production/factory/manufacturing overheads:
Factory power 9,000
Depreciation - Factory building 25,000
Depreciation - Plant 80,000
Plant maintenance 2,000
Rent and insurance 1,000
Water and electricity 7,000
Factory manager's salary 45,000
Wages for supervisors 58,000
Other manufacturing overheads 8,000 235,000
Total manufacturing cost 518,000

Opening inventory - work in progress 19,000

Less : Closing inventory - work in progress (22,000)
Production cost of finished goods 515,000

Note: For the scenario NO factory profit added to Production cost of FG

The “Production cost of finished goods” will then be transferred to the Statement of Profit
or Loss, as shown below:
 Chapter 3-4

Morning Star Sdn. Bhd.

Statement of profit or loss for the year ended 31 December
RM RM
Sales 1,520,000
Less : Cost of goods sold
Opening inventory - finished goods 35,000
Production cost of finished goods 515,000
Less: Closing inventory – fin. goods (23,000) (527,000)
Gross profit 993,000

Note: For the scenario NO factory profit added to Production cost of FG

If for the scenario with factory profit:

Production cost of FG + Factory profit = Transfer price of FG manufactured

5 Other Operating Expenses

There are also other operating expenses incurred which are not related to the
manufacturing process. These other operating expenses are charged to the Statement of
Profit or Loss and not the Manufacturing Account.

These other operating expenses include:

(a) Administrative Expenses

Administrative expenses consist of items such as:
• managers’ salaries,
• legal and accountancy charges,
• depreciation of office fittings, and
• secretaries’ salaries.
• bad debts
• increase in allowance for doubtful debts

(b) Selling and Distribution Expenses

Selling and distribution expenses are items such as:
• marketing staff’s salaries,
• commissions for salesmen,
• carriage outwards,
• depreciation of delivery vans, and
• advertising expenses

(c) Finance Costs

Finance costs are expenses such as:
• bank charges, and
• loan interest
 Chapter 3-5

6 Apportionment of Costs/Expenses
Very often in a manufacturing company, costs or expenses incurred have to be
apportioned to the various departments or divisions that have benefited from the facilities
that have given rise to those costs/expenses. For example, water and electricity expenses
are incurred for both the factory and the administrative office. Rental expenses are paid
for the whole building, which consists of the factory, the warehouse, the administrative
office, etc.

Hence, we need to split the expenses. The objective is to achieve a fair reflection of the
total cost incurred by each department/division in the company so that performance of
each could be evaluated or assessed. The apportionment basis which can be used can be
by floor area, percentage, production volume, headcount, etc.

Example

7 Factory Profit
 Introduction
The manufacturing cost of completed goods is transferred to the statement of profit or
loss at production cost. In some businesses, the value at which the manufactured goods
are transferred from the factory floor to the income statement is based on certain
predetermined transfer price. Such transfer price may be based on market price or at
cost plus a percentage of profit. This would allow the performance of the production
department to be assessed.

The market price used would be the price the manufacturer would have to pay if the
manufactured goods were to be purchased in the open market from outside suppliers.

Information on the factory profit will indicate whether it is more profitable to

manufacture the said goods or to buy them from external suppliers. This will enable
managers in the factory and warehouse to be more aware of the impact of market forces,
increase their motivation to be as efficient as possible and facilitate the evaluation of
their performance as a production facility.

* Transfer price = Production cost of FG + Factory profit

 Calculation of Factory Profit

The factory profit may be based on either of the following bases:
1. Percentage of the production cost.
2. Transfer price - the principle used is the same as for Mark-Up and Margin.
 Chapter 3-6

8 Allowance for Unrealised Profit

At the end of the accounting period, there will normally be inventory of unsold finished
goods.

The finished goods inventories will have been valued at the transfer price, which means
the manufacturing profit reported includes unrealised profits contained in any increase in
finished goods inventories during the year

The balance in the Allowance for Unrealised Profit account represents the manufacturing
profit contained in the finished goods inventory at the end of the accounting year.
According to IAS2 Inventories, inventories should be valued at the lower of cost and net
realisable value. The cost should not include any unrealised profit. This unrealised profit
amount must be deducted from the finished goods inventory value so as to reduce the
inventory valuation to cost price.

The element of unrealised profits contained in the finished goods inventories at the end of
the accounting year should be eliminated by transferring it to an “Allowance for
Unrealised Profit Account” (AURP Account).

A decrease in the allowance for unrealised profit account is added back to the Statement
of Profit or Loss because such a decrease means some of the previously unrealised profits
have been realised during the year.

An increase in the allowance for unrealised profit, on the other hand, is deducted from
income statement because there is an increase in the unrealised profits in the closing
finished goods inventories.

To account for the allowance for unrealised profit in the closing inventory of finished
goods, the following journal entries will be passed:

DR Allowance for unrealised profit (SOPL) *

CR Allowance for unrealised profit (SOFP)

* “DR AURP (SOPL)” is shown as a deduction from factory profit in SOPL.

In the subsequent year, any increase or decrease in the closing finished goods inventories
would require adjustments to be made to the AURP Account as follows:

Increase
DR Allowance for unrealised profit (SOPL)
CR Allowance for unrealised profit (SOFP)

Decrease
DR Allowance for unrealised profit (SOFP)
CR Allowance for unrealised profit (SOPL)
 Chapter 3-7

9 Financial statements with transfer pricing and unrealised profits

(a) Manufacturing Account

Total manufacturing cost X

 Chapter 3-8

(b) Income Statement (Extract) with Increase in AURP

(b) Income Statement (Extract) with Decrease in AURP

 Chapter 3-9

(b) Income Statement with Increase in AURP

 Chapter 3-10

(c) Balance Sheet

 Chapter 3-11

Illustration 1

The following is the trial balance extracted from the books of Wealthy Equipment
Manufacturer Sdn. Bhd. as at 31 December 20x1.

Prepare manufacturing a/c of the company for the year ended 31 December 20x1

RM RM
Machinery 500,000
Office equipment 40,000
Accumulated depreciation:
Machinery 25,000
Office equipment 10,000
Inventories as at 1 January 20x1:
Raw materials 180,000
Work-in-progress 64,000
Finished goods 610,000
Sales 2,408,900
Purchase of raw materials 945,000
Return outwards 3,100
Indirect materials 53,000
Factory supervisors’ salary 73,000
Direct labour 187,000
Salaries of office staff 31,000
Maintenance of machinery 30,000
Royalty 15,000
Commission of salesmen 47,000
Utilities 36,000
Carriage inwards 8,000
Carriage outwards 18,000
Allowance for doubtful debts 1,000
Rental received 6,000
Allowance for unrealised profit as at 1 January 20x1 30,000
Share capital 330,000
Retained earnings 42,000
Bank 53,000
Loan 42,000
Trade receivables 50,000
Trade payables 42000
2,940,000 2,940,000
 Chapter 3-12

Additional information:
1. The value of inventories as at 31 December 20x1 were as follows:
RM
Raw material 360,000
Work-in-progress 45,000
Finished goods 490,000

2. The depreciation policy of the business is as follows:

Machinery : 10% per annum using the reducing balance method
Office equipment : 20% per annum using the straight-line method

3. Accrual of salaries for office staff amounted RM1,000 as at 31 December 20x1.

4. Rental received in advance was RM800 for the year ended 31 December 20x1.

5. Two third of the utilities cost is apportioned to the factory.

6. Finished goods are transferred from the factory at mark-up of 10%.

Solution
Manufacturing Account for the Year Ended 31 December 20x1
Raw material RM RM
Opening inventory of raw material 180,000
Purchase of raw materials 945,000
Carriage inwards 8,000
953,000
Less: Return outwards (3,100) 949,900
1,129,900
Less: Closing inventory of raw material (360,000)
Cost of raw material consumed 769,900
Direct labour 187,000
Royalty 15,000
Prime cost 971,900
Manufacturing overheads
Indirect materials 53,000
Factory supervisors’ salary 73,000
Maintenance of machinery 30,000
Utilities (36,000 x 2/3) 24,000
Depreciation of machinery (500,000 - 25,000) x 10% 47,500 227,500
Total manufacturing cost 1,199,400
Work-in-progress
Opening work-in-progress 64,000
Less: Closing work-in-progress (45,000) 19,000
Production cost of finished goods 1,218,400
Add: Factory profit
Transfer price of finished goods
 Chapter 4-1

Chapter 4A: Accounts for Limited Company (I) & (II)

Issuance of shares & debenture

Learning Objectives (LO)

LO1: Define the nature, function and capital structure of a limited company
LO2: Distinguish classes of shares and debenture
LO3: Calculate capital and revenue reserves, debenture interest, interim and final dividends
LO4: Prepare P&L appropriation account and balance sheet
LO5: Accounting for issue of shares, shares issued at par and premium, excess application
LO6: Bonus issue and rights issue
LO7: Calculate dividends as distribution of profit, finance costs: interest

1 Introduction
The Companies Act 2016 (CA 2016) repealed the Companies Act 1965 (CA 1965) and
changed the landscape of company law in Malaysia.

All businesses required to be registered with the Companies Commission of Malaysia

(CCM) (Suruhanjaya Syarikat Malaysia SSM)

The Companies Commission of Malaysia is a statutory body formed under the Companies
Commission of Malaysia Act 2001, to regulate corporate and business affairs in Malaysia,
as a result of a merger between the Registrar of Companies (ROC) and the Registrar of
Businesses (ROB).

CA 2016 and Companies Regulations 2017 (“new Act”) have mostly come into force as
of 31 January 2017. The new Act aims to reduce the cost of doing business in Malaysia
while increasing protection for stakeholders of a company.

The Companies Act 2016 classifies companies into three

broad categories as follows:
2 (a) Companies limited by shares,
2 (b) Companies limited by guarantee,
2 (c) Unlimited companies

Liability

Limited Unlimited

Shares Guarantee
 Chapter 4-2

2 Limited Liability Companies

a. Companies limited by shares

In this category, the liability of its shareholders/owners is limited to the amount of their
share capital contribution, that is, their investment.

Example:
A shareholder had subscribed for RM100,000 share capital and has only paid up
RM70,000.

The shareholder’s liability is limited only to the RM unpaid on his capital.

This means that the maximum amount that he will lose is restricted to his
RM investment in the company.

If the shares have been fully paid up, the shareholder has no further liability towards the
company.

b. Companies limited by guarantee (CLBG)

A company limited by guarantee has members or guarantors rather than shareholders.
Such a company will have no share capital.

The members of the company “guarantee” to contribute a predetermined sum to settle the
outstanding liabilities of the company in the event of the company being wound up.

The purpose of CLBG is normally not for profit purpose. E.g.: promoting commerce &
industry, art, science, religion, charity, education etc. that useful for the community or
country, providing recreation or amusement.

c. Unlimited Companies

For unlimited companies, there is no limit to the liability of its shareholders. In the
event a company going into liquidation, the creditors have the right to claim against the
personal assets of the shareholders to settle any outstanding debts.

3 Classification of Companies
Companies are incorporated under Companies Act 2016 (or Companies Act 1965 for
those companies registered with CCM before 31 Jan 2017).

Registered companies may be grouped into the following types:

(a) Public companies;
(b) Private companies;
(c) Exempt private companies;
(d) Foreign companies;
(e) Government-linked companies.
 Chapter 4-3

a. Public Companies (BERHAD)

A public company is a company which is not a private company.
E.g.: The minimum number of shareholders for a public company is one and there is no
limit on the maximum number.

Public companies have the advantage of being allowed to raise capital by offering its
shares and debentures to the public. Public companies which are listed on the stock
exchange (Bursa Malaysia) are called public listed companies.

b. Private Companies (SDN. BHD.)

Under CA 2016, a private company has the following characteristics.
- It is a company limited by shares (s42(1))
- It has at least one shareholder and the maximum number of shareholder is 50 (s42(1))
- It restricts the transfer of its shares (s42(2))
- It cannot offer its shares or debentures to the public (s43(1)).
- It cannot allot shares or debentures with a view of offering them to the public (s43(1)).
It cannot invite the public to deposit money with the company (s43(1)

c. Exempt Private Companies

An exempt private company is a private company with limited liability and has no more
than twenty shareholders. Its shares cannot be held, whether directly or indirectly, by
another company.
The advantage of an exempt private company is that it need not file its full audited annual
financial statements with the Registrar of Companies if the company files an exempt
certificate that states that it is able to meet all its liabilities as and when they fall due.
The certificate must be signed by the company secretary and the external auditor of the
company.

d. Foreign Companies
A foreign company may carry on business in Malaysia by either:
• Incorporating a local company with the CCM, or
• Registering the foreign company in Malaysia with CCM.

e. Government-linked Companies (GLCs)

GLCs are state-owned enterprises (SOE) with the government as the major shareholders
with a primary commercial objective and in which the Malaysian Government has a
direct controlling stake.

Controlling stake refers to the Government’s ability (not just percentage ownership) to
appoint BOD members, senior management, make major decisions (e.g., contract
awards, strategy, restructuring and financing, acquisitions and divestments et cetera.) for
GLCs either directly or through government-linked investment companies (GLICs).
Examples: PETRONAS, Tenaga Nasional Berhad (TNB), Telekom Malaysia Berhad,
Malayan Banking Berhad, POS Malaysia Berhad, Malaysia Airline Berhad (MAB) etc.
 Chapter 4-4

4 Capital Structure of a Limited Liability Company

The capital structure of a limited liability company may comprise of the following:
• Share capital – Equity and/or
• Loan capital – Liability

Terms in Connection with Equity

The share capital of a company can be increased from time to time and when the need to
increase its funds arises. The following is a list of terms used in connection with the capital
structure of a company:

a. Authorised (or legal) Capital

This is the maximum amount of share capital a company is empowered to issue. This
amount must be stated in the company’s Memorandum of Association (MA). The amount
of authorised share capital can change by agreement though.

For example, a company's authorised share capital might be 10,000,000 ordinary shares
of $1 each.

With effective from 31 January 2017, authorised capital has been abolished under the new
Companies Act 2016, all companies will no longer has authorised capital.

b. Issued Capital
This is the total cumulative number of shares that has been issued to date by the company,
regardless of whether it is partly or fully paid. Usually, this amount does not exceed the
value of the authorised capital.

Therefore, the company with authorised share capital of 10,000,000 ordinary shares of
RM1 might have issued 6,000,000 shares.

It may issue more shares at some time in the future.

So, the unissued capital is .

Unissued Capital
This represents the remaining amount of share capital a company may issue to public in
the future.
Unissued Capital = Authorised Capital – Issued Capital

c. Called-up Capital

When shares are issued at a price, a company may not always require the shareholders to
pay the full price of the shares at once. The amount of money that the company has called
up on the issued shares is known as called-up capital. The subscribers (shareholders) are
required to pay within a specified time. It might call up only a part of the issue price and
wait until a later time before it calls up the remainder.
For example, if a company issues 6,000,000 ordinary shares at a price of RM1, it might
call up only, say, 80 cents per share.
 Chapter 4-5

Although the issued share capital would be RM6,000,000, the called-up share capital
would only be . So, the uncalled capital is .

Uncalled Capital
This is the amount of money on the issued capital that has not been called.
Uncalled Capital = Issued Capital – Called Up Capital

d. Paid Up Capital

Paid up capital represents the amount of share capital that has been paid by the
shareholders.

For example, if a company issues 6,000,000 ordinary shares at a price of RM1 each, calls
up 80 cents per share, but only receives payments of RM3,600,000, which means paid up
capital would be .
So, the capital not yet paid up is .

Unpaid Capital

This is the amount of the called-up capital that the subscribers failed to pay. The unpaid
amount is also known as “Call in Arrears”. This amount will be shown under Statement
of financial position, under Current Asset.
Unpaid Capital = Called Up Capital – Paid Up Capital

5 Types of equity instruments

The equity capital of a company consists of shares invested by the owners who are known
as shareholders. There are two main types of shares:
(a) Ordinary shares – holders of these shares receive the remainder of the total profits
available for dividends. There is no upper limit to the amount of dividends they can
receive.

(b) Preference shares – holders of these shares get an agreed percentage rate of dividend
before the ordinary shareholders receive anything.

a. Ordinary Shares
 Shareholders have the right to vote.
 Shareholders are entitled to share in the profits remaining after dividends have been paid
to other classes of shares.
 Shareholders are considered as risk takers because should the business fail, they will lose
their capital. If the business proven to be successful, the rewards can also be remarkably
high.
 The rate of dividends paid is dependent upon the company’s level of profits and dividend
policy.
 The shareholders are effectively the owners of the company.
 Chapter 4-6

b. Preference Shares
 Shareholders do not have any voting rights.
 Shareholders have a priority right to a return of their capital over ordinary shareholders in
the event of liquidation of the company.
 Shareholders are entitled to a normally fixed rate of dividend.
 The types of preference shares are:
(i) Cumulative & Non-Cumulative preference shares
(ii) Participating & Non-participating preference shares
(iii) Convertible & Non-convertible preference shares
(iv) Redeemable & Irredeemable preference shares

i. Cumulative preference shares

The holders are entitled to receive a fixed dividend per annum. If insufficient or the
absence of profits prevent payment of dividend of any year, the arrears will be carried
forward to be payable in the future.

Non-cumulative preference shares

The holders entitled to receive a fixed rate of dividend only when the company has
sufficient profits to declare a dividend. Should the company not have sufficient profits
to declare dividends, the dividends for the year are forfeited and cannot be carried
forward.

ii. Participating preference shares

In addition to the fixed dividend , shareholders are allowed to participate to receive
additional dividends to the extent expressed in the constitution, in any further profits,
after all the other classes of shareholders have received their dividends.

Non-participating preference shares

These shareholders are not allowed to participate in the excess profits after all the other
classes of shareholders have been paid their dividends.

iii. Convertible preference shares (hybrid instrument)

Shareholders are entitled to convert their preference shares to ordinary shares at some
future date and at a predetermined conversion rate as expressed in the constitution.

Non-convertible preference shares

Shareholders do not have the convertible option but has all other normal characteristics
of a preference share.

iv. Redeemable preference shares

Company will redeem (repay) the nominal value of those shares at maturity date.
Redeemable preference shares (PS) are treated like loans and are classified as liabilities
in the SOFP. Dividends paid on redeemable PS are treated like interest paid on loans
and are included in financial costs in the SOPL.
 Chapter 4-7

Irredeemable preference shares

Treated just like other shares, form part of equity and dividends are treated as
appropriation of profit. Also known as perpetual PS capital since no maturity date.

6 Types of debentures
Debt financing involves raising loans from the general public in the form of debenture
issues. According to Malaysian Companies Act 2016, debenture includes debenture stock,
bonds, sukuk, notes.

There are several types of debentures that a company can issue based on security, tenure,
convertibility etc. The types of debentures are:
(a) Secured & Unsecured Debentures
(b) Redeemable & Irredeemable Debentures
(c) Convertible & Non-Convertible Debentures

a. Secured Debentures
These are debentures that are secured against asset(s) of the company. In case of default
in repayment of the debentures, a charge is crated on such asset(s). The said asset will be
sold to pay such a loan.

The charge may be fixed against a specific asset(s) or floating against all assets of the
company.

Unsecured Debentures
These debentures are not secured by any charge against the assets of the company, neither
fixed nor floating.

b. Redeemable Debentures
These debentures are payable at the expiry of their term, either in the lump sum or in
instalments over a time period.

Irredeemable Debentures
These debentures are perpetual in nature and no fixed date at which they become payable.
They are redeemable when the company goes into liquidation process.

c. Convertible Debentures
These debentures can be converted to equity shares at the option of the debenture holders,
either fully or partially converted. If a debenture holder opts for the partial conversion to
shares, he will be both a creditor and a shareholder of the company.
 Chapter 4-8

Non-Convertible Debentures
Non-convertible Debentures holders do not have an option to convert to shares or any kind
of equity. These debentures will remain so till their maturity, no conversion will take place.
These are the most common types of debentures.

Why Issue Debentures?

o The funds involved may be required for a definite span of time only. For instance, the
company intends to use the funds for 10 years only. So, the company will issue a debenture
with a maturity date in 10 years’ time.

o Interest is a tax allowable expense in company income tax calculation, while dividend on
share is not a tax allowable expense.

o The company does not want to dilute the control of existing ordinary shareholders. Since
debenture holders do not have voting rights, the control of the existing shareholders will
not be affected.
 Chapter 4-9

7 Differences between Ordinary Shares and Debentures

Ordinary Shares Debentures

(1) Identity Shareholders Debenture holders

SFP – SFP –
(2) Classification
Capital and reserves Non-current liabilities
Interest. This interest payable
(3) Returns Dividend. The dividend
is fixed at a predetermined
payable is not fixed.
rate.

(4) Accounting Internal reporting Internal or External

Treatment for =Appropriation Account reporting
Returns
External reporting Statement of Profit or Loss under
= Statement of Changes in “Finance cost”.
Equity

(5) Enforcement of Dividend payment is not Interest payment is mandatory.

returns mandatory. Interest must be paid to debenture
holders regardless of the
Shareholders cannot demand performance of the company.
the payment of dividends.
Legal action can be taken by
debenture holders against the
company for non-payment of
interest due.

May be redeemable (i.e.,

(6) Redemption Depends on the constitution of
repayable) or convertible (i.e.,
the company.
converted into ordinary shares) at
or by a specified future date.
The terms are stated when the
debentures are issued.

Yes.
(7) Transfer of Yes.
Ownership
 Chapter 4-10

Ordinary Shares Debentures

Debentures are secured against

(8) Security of Assets Ordinary shares are not secured
the company’s assets through
against the company’s assets.
either fixed or floating charge).

Fixed charge:
A specified asset is charged to the
debenture. The company may use
the asset but cannot dispose of it.

Floating charge:
A group of assets are charged to
the debenture. This group of
assets can vary from time to time.

The specific assets against which

(9) Repayment of Ordinary shareholders are paid
the debenture is secured will be
Capital due to last, after all creditors and the
sold to repay the debenture
Liquidation preference shareholders have
holders.
been repaid.

8 Capital and Revenue Reserves

Reserves are ‘owned’ by the shareholders. Share capital and reserves are known
collectively as shareholders’ equity.

Capital reserves Revenue reserves

Share premium * General reserve

Capital redemption reserve * Retained earnings
Asset revaluation reserve

* The Companies Act 2016 abolishes the concept of nominal value in shares.
Effectively, share premium account and capital redemption reserves of a company
no longer relevant.

a. Capital Reserves
Also known as Statutory reserves which a company is required to set up by law, and
which are NOT available for the distribution of dividends.

ai. Share premium account

Premium means the additional amount received above the par value of shares issued. The
account can be used only in certain limited ways. One common use is to ‘finance’ the
issue of bonus shares.
 Chapter 4-11

aii. Capital redemption reserve

A reserve fund into which profits are allocated for the purpose of redeeming or buying
back shares in the company.

aiii. Revaluation reserve

This reserve is created when an asset is revalued to reflect an increase in value. The
increase in revaluation value of a non-current asset is a ‘revaluation surplus’. The
revaluation surplus may fall if such NCA decrease in value. This reserve is non-
distributable since it represents unrealised profits on the revalued assets.

b. Revenue Reserves
Also known as Non-statutory reserves, which are reserves consisting of profits which are
distributable as profits.

bi. General reserve

General reserve is the amount kept aside from the profit earned by the company during its
normal course of the operation to meet future general needs, i.e.: to strengthen the
company’s financial position, increase working capital etc. which are not for specific
purpose (i.e.: plant and machinery replacement reserve). It is considered to be part of the
profit and loss appropriation account.

bii. Retained earnings

This is the most significant reserve. Provided that a company is earning profits, this reserve
increases from year to year, as most companies do not distribute all their profits as
dividends.

9 Debenture Interest
The rate of interest is a prefix value to the debenture, say 9% Debentures and, therefore,
is payable even if the company incurs a loss. It is a charge against profit, by presenting
Interest on Debentures as Finance Cost in SOPL.

 Debenture interest paid by the company to its debenture holders

Dr Debenture interest (SOPL Expenses)

Cr Bank (interest paid)

 Debenture interest accrued by the company as outstanding to its debenture holders:

Dr Debenture interest (SOPL Expenses)

Cr Debenture interest payable (SOFP Liability)
 Chapter 4-12

10 Interim and final dividends

Dividends are appropriations of profit after tax.
Many companies pay dividends in two stages during the course of their accounting year.

Interim dividends
After the half-year financial results are known, interim dividends might be paid during the
financial year.

Dr Retained profits (appropriation of profit)

Cr Bank (dividend paid)

If not yet paid,

Dr Retained profits (appropriation of profit)
Cr Dividend payable (SOFP: CL)

Final dividends
After finalising the year-end financial accounts, final dividends might be proposed and
declared usually after year end. It will not be recognised in current year financial
statements but disclosed in the note to accounts.

11 Profit and loss appropriation account & balance sheet

This is merely an extension of the profit and loss account and is prepared to show how
retained profit is appropriated, i.e.: transfer to general reserves, dividends paid and
payable.
 Chapter 4-13

12 Accounting for Issue of Shares

Before CA2016, under par value regime, a company can issue its shares:
(a) At par/nominal value

(b) At a premium ( above their par value)

The amount collected in excess of the par value is recorded in the “Share Premium
Account”.
For e.g.: If A Co issues 1,000 units of ordinary shares with par value of $1 at $2.60 each
and receives full amount.
$ $
DR Bank 2,600
CR Ordinary shares 1,000
CR Share premium account ?

(c) At a discount (below their par value)

The difference between par value and the lower issue price is recorded in the “Discount
on Shares Account”.

For e.g.: If B Co issues 1,000 units of ordinary shares with par value of $1 at $0.80 each
and receives full amount.
$ $
DR Bank 800
DR Discount on Shares ?
CR Ordinary shares 1,000

Balance on the Discount on Shares Account may be written off against the Share Premium
Account or SOPL.
 Chapter 4-14

After implementation of CA2016, one of key changes is the abolition of the par value regime.
Consequently, related concepts to the par value regime such as authorised capital, share
premium accounts and capital redemption reserve are abolished too. All proceeds from the
shares issuance are credited to ordinary share capital account.

Illustration 1

Upon receipt of money for issuance of 100,000 units of ordinary shares at RM 1.20 each:

DR Bank
CR Ordinary shares capital
(Being payment for 100,000 number of shares issued at RM1.20 per share)

Illustration 2

(a) Upon receipt of share application money

Issue of 10m shares at RM1.20 each and applications received is 15m shares

DR Bank
CR Share application
(Being the amount received on share application)

(b) Upon allotment of shares to shareholders

DR Share application
CR Ordinary shares capital
(Being allotment of shares to successful applicants)

(c) Refund of excess application money

DR Share application
CR Bank
(Being refund of excess/money to unsuccessful applicants)

13 Bonus issues
The issuance of bonus shares is given free-of-charge (FOC) to the existing shareholders
of a company and is normally recommended when the company has large accumulated
profit or capital reserves but does not want to or is unable to distribute them in the form
of cash dividends due to the company’s dividend policy or due to statutory restrictions.

Both revenue reserves and capital reserves can be utilised to issue bonus shares. The issue
of bonus shares is also known as the capitalisation of reserve. Following CA2016
implementation, companies were given 24 months of grace period to utilising share
premium account and capital redemption reserve, one of which was to finance the issuance
of bonus shares.
 Chapter 4-15

Bonus issue is made to the existing shareholders in proportion to their shareholdings.

For example, if a company declares a “1 for 7” bonus issue, a holder of 7 existing shares
will receive 1 bonus share.
The issue of bonus shares does not involve any inflow or outflow of funds. However, there
is a dilution in the net asset value per share after the bonus issue due to an increase in the
number shares.
Under the Companies Act 2016, a bonus issue can be undertaken either:
i. by way of capitalisation of the retained earnings/reserves of a company, or
ii. without capitalisation, where a company may issue and allot the bonus shares at nil
consideration

Accounting for Bonus Issue

(i) Bonus Issue with Capitalisation of Reserves

Bonus issue from retained profit

DR Retained profit/reserve
CR Ordinary share capital
(Issue of xxx units of bonus shares by capitalisation of retained profit/reserve)

Example: QL proposed “3 for 10” bonus issue wholly capitalised from the reserve

(ii) Bonus Issue Without Capitalisation of Reserves

Bonus shares issued as fully paid shares at no consideration and without any capitalisation
from the Company’s reserves. As a safeguard, share price adjusted for the Proposed Bonus
Issue shall not be less than a certain limit.

Example: PCB proposed “1 for 2” bonus issue

 Chapter 4-16

14 Right issues
A company may raise additional capital to finance its expansion programme or to repay its
borrowings. A rights issue is an invitation to existing shareholders to purchase
additional shares in the company.

Right shares mean the shares where the existing shareholders have the first right to
subscribe the shares. Usually, the price of a rights issue offered to existing shareholders
is lower than the market price of the existing shares. The shareholders are
offered based on their existing shareholdings. For company listed in Bursa Malaysia, the
discount shall not be more than 10% of the market price.

Let’s say an investor owns 100 shares of ABC Group and the shares are trading at RM10
each. The company announces a rights issue in the ratio of 2 for 5. It means each investor
holding 5 shares will be eligible to buy 2 new shares. The company announces a discounted
price of, for example, RM9 per share.
It means that for every shares held by an existing shareholder, the company will
offer shares at a discounted price of RM each.

Accounting for Rights Issue

Illustration 1:
Right Issue of 2 for 10 held at a price of RM1.20 each. The existing number of issued
shares is 100,000 units before the right issue. The market value is RM1.50 each.

DR Bank
CR Ordinary share capital
(Proceeds from rights issue of unit at RM per share)

This is applicable for private company companies where there is unlikely to be excess
application for rights.

Illustration 2:
Rights issue of 1 for 10 held RM0.80 each. The existing number of shares issued is
10,000,000 at total RM 10m before the right issues. Applications received is 1.1m shares.
The excess shall be refunded to the unsuccessful applicants.

Dr Bank
Cr Rights issue application
(Being amount of share application money received)

Dr Rights issue application

Cr Ordinary share capital
(Being allotment of shares to successful applicants)

Dr Rights issue application

Cr Bank
(Being refund of excess / rights issue money to unsuccessful applicants)

This is applicable for public companies with large scale right issues involving the public
and when excess application for rights arises.
 Chapter 4-17

Difference Between Limited Companies with Other Entities (Additional Reference)

Limited Liability
Sole Proprietor Partnership Partnership Limited Companies
1 Key Registration of Partnership Act Limited Liability Companies Act 2016
governing Business Act 1961 (Revised Partnerships Act
legislations 1956 (Revised 1974) 2012
1978)
2 Number of One 2 to 20 partners Minimum 2 Private – 1 to 50
owners partners members
Public – 1 to unlimited
3 Owner of Sole proprietor Partners PLT Company
business
4 Financial Unlimited Unlimited Limited Limited
liability (Perkongsian
Liabiliti
Terhad)
5 Separate No No Yes Yes
legal entity
6 Succession Ceased at the No perpetual Yes. Perpetual Yes. Perpetual
demise of the sole succession succession succession
proprietor
7 Profit or loss Owner takes all Shared according All partners of an Profit is distributed as
the profit or bear to agreed profit- LLP are entitled dividend to the
all the losses sharing ratio to share equally in shareholders subject to
the capital and approval by the board
profits of of directors and / or
the LLP. shareholders.
8 Management Owner manages Partners may Every partner may Shareholders and
of business everything or share different take part in the management of
engage employees roles and assisted management of business are separated
to work for them by employees the LLP
9 Funding Owner contributes Partners Partners Funded by shares
all the capital contribute agreed contribute agreed issued to shareholders.
needed by the amount of capital capital in
business accordance with Public Listed
the limited Companies – Fund is
liability raised from the public
partnership and the shares are
agreement. traded in stock
exchange.

Private company –
Shares are transferable
subject to constitution
of the company.
10 Reporting Not mandatory Not mandatory Not mandatory CA2016 – Director’s
requirement report and audited
financial statements
11 Financial Not mandatory Not mandatory Mandatory - CA2016 and MFRSs
reporting S69(1) Limited & IFRSs or MPERSs
framework Liability
Partnership Act
2012
12 Audit of F/S Not mandatory Not mandatory Not mandatory Mandatory
 Chapter 4-18

Chapter 4B: Accounts for Limited Company (III) & (IV)

IAS 1/ MFRS 101 External Reporting

Learning Objectives (LO)

LO1: Explain users of financial statements and regulatory framework for published financial
statements (Introduction)
LO2: Read annual reports
LO3: Prepare income statement (by nature & by function format)
LO4: Prepare statement of profit or loss and other comprehensive income
LO5: Prepare statement of financial position
LO6: Prepare statement of changes in equity
LO7: Disclose notes to the financial statements
LO8: Explain accounting irregularities

1 Introduction
A limited liability company prepares financial statements for both internal and external users
besides compliance with requirements of Companies Act 2016 (CA2016).

Examples of internal users are:

Board of directors (BOD)
Management

Examples of external users are:

Investors / shareholders
Lenders
Creditors
Customers
Certain regulatory bodies such as Inland Revenue Board (IRB)

2 Financial Reporting Framework

The financial reporting framework determines the format and contents of the financial
statements prepared by a limited company. For companies incorporated in Malaysia, the
contents of financial statements are governed by:

(a) Companies Act 2016

(b) Malaysian Financial Reporting Standards approved by Malaysia Accounting Standards
Board.

MFRS 101/ IAS 1 Presentation of Financial Statements prescribed the formats of financial
statements.
 Chapter 4-19

3 Companies Act 2016

Limited liability companies are required to comply with more regulations and rules in the
presentation of financial statements compared to sole proprietors and partnership.

In relation to the keeping of accounts of a limited company, key requirements of CA2016

are:
(a) Keep accounting records and other records to sufficiently explain the transactions and
financial position of the company and enable true and fair profit and loss accounts and
balance sheets and any documents required.
(b) Keep accounting and other records in a manner as to enable the accounting and other
records to be conveniently and properly audited; and
(c) Appropriate entries must be made in the accounting and other records within 60 days of
completion of the transactions.
Besides accounting books and records, a limited company is also required to keep books and
registers which must be maintained and make available for inspection upon request, such as:
• Register of Members
• Register of Directors
• Register of Directors’ Shareholdings
• Register of Debenture Holders
• Register of Charges

A company is required circulate financial statements and reports to its members, auditors,
debenture holders.
(a) For a private company, it must be circulated within 6 months of its financial year end;
and
(b) For a public company, it must be at least 21 days before its Annual General Meeting.

4 Contents of Financial Statements and Reports

The contents of financial statements are:
(a) Directors’ Report
(b) Statements of financial position (Balance sheet)
(c) Statement of profit or loss and other comprehensive income (Income statement) either
by function or by nature
(d) Statement of changes in Equity
(e) Statement of Cash Flow; and
(f) Notes to the Accounts comprises of a summary of significant accounting policies and
other explanatory notes on material figures presented in the financial statements.
 Chapter 4-20

5 Annual General Meeting

Public company is required to hold an Annual General Meeting (AGM) within 6 months of
the company’s financial year end or not more than 15 months after the last preceding AGM.

6 Annual Reports
The annual report of a public listed company listed in Bursa Malaysia Securities Berhad
contains various reports and audited financial statements as prescribed by Listing
Requirement of Bursa Malaysia. The annual report must be distributed to the shareholders at
21 days before the date of AGM.

The annual report may consist of the following:

(a) Chairman’s Statement
(b) Statement on Management Discussions and Analysis
(c) Corporate Governance Overview Statement
(d) Audit Committee Report
(e) Statement on Risk Management and Internal Control
(f) Sustainability Statement
(g) Directors’ Report
(h) Audited Financial Statements etc.

7 Financial Statements (Illustrating samples)

(A) Statement of Profit or Loss and Other Comprehensive Income For The Year
Ended 31 December 20x1

(i) By function format

20x1 20x0
RM RM
Revenue x x
Cost of sales (x) (x)
Gross profit x x
Other income x x
Distribution costs (x) (x)
Administrative expenses (x) (x)
Profit from operations x x
Finance costs (x) (x)
Profit before tax x x
Income tax expense (x) (x)
Profit for the year x x

Other comprehensive income:

Gains on property revaluation x x
Total comprehensive income for the year x x
 Chapter 4-21

(ii) By nature format

20x1 20x0
RM RM
Revenue x x
Other income x x
Changes in inventories of finished goods and
(x) (x)
work in progress
Raw materials & consumable used (x) (x)
Employee benefits expense (x) (x)
Depreciation & amortisation (x) (x)
Other operating expenses (x) (x)
Profit from operations x x
Finance costs (x) (x)
Profit before tax x x
Income tax expense (x) (x)
Profit for the year x x

Other comprehensive income:

Gains on property revaluation x x
Total comprehensive income for the year x x

B) Statement of Financial Position as at 31 December 20x1

 Chapter 4-22

(C) Statement of Changes in Equity for the year ended 31 December 20x1

(D) Notes to the financial statements

Disclosure notes are included in a set of financial statements to give users additional information.
 Chapter 4-23

(D) Notes to the financial statements

The notes to the financial statements should state:
(1) general information about the company with its registered office and principal activities
of the company
(2) basis of preparation of the financial statements (Statement of Compliance in accordance
with financial reporting standards, Basis of measurement, Function currency, accounting
policies selected etc.
(3) Significant accounting judgements and estimate

The company should disclose all information required by IFRS not disclosed elsewhere in the
financial statements.

In addition, the company should disclose any additional information not disclosed on the face
of the financial statements, but which is necessary for a true and fair view.

Illustrating sample of Property, Plant and Equipment Note

Land and Plant and
buildings equipment Total
RM RM RM
Cost or valuation
At 1 January 20x1 40,000 10,000 50,000
Revaluation surplus 12,000 - 12,000
Additions - 4,000 4,000
Disposals - (1,000) (1,000)
At 31 December 20x1 52,000 13,000 65,000

Accumulated Depreciation
At 1 January 20x1 10,000 6,000 16,000
Depreciation charge for year 1,000 3,000 4,000
Eliminated on disposals - (500) (500)
At 31 December 20x1 11,000 8,500 19,500

Carrying amount
At 31 December 20x1 41,000 4,500 45,500
At 1 January 20x1 30,000 4,000 34,000
 Chapter 4-24

8 Accounting Irregularities
Accounting irregularities are at the heart of frauds that hit financial statements and include
misstatement, misclassification as well as misrepresentation. Manipulation of accounting
data, description or disclosure are involved in order to distort the true financial picture of the
company.

Main categories of accounting irregularities:

(a) overstatement of sales revenue (Selling More)

Revenue is usually the largest item in P&L account of most companies and has a direct impact
on the net profit. The figure appears in the first row of P&L tends to attract a significant level
of attention from the readers of financial statements. Therefore, it is often regarded as one of
the most sensitive reported amounts as far as the financial statements are concerned.

Examples of scenarios when overstatement of sales occur

• The company creates fictitious sales invoices.
• Revenue from future period is recognized in current period.
• Revenue is recognized for goods sold with rights of return; and
• Sending goods to customer before year end though customers did not order them. The
financial statements were not adjusted to reflect the returns by customers after year end.

(b) understatement of expenditure (Costing Less)

This will lead to higher profits or lower losses reported. It involves suppressing and/or hiding
expenditure or disguising its intent or purpose. It also covers any concealments or
understatements of an obligation to pay. Expenses should be recorded as soon as they are
incurred, regardless as to when the cash is spent (Accrual / matching concept).

Examples of scenarios when understatement of expenditure occurs

• Deferring current period expenses
• Allocating more costs to inventory than cost of goods sold
• Classifying operating expenses as non-current assets.

(c) overstatement of asset (Owning More)

Common asset items include accounts receivables, inventories, cash and cash equivalents,
tangible, and intangible assets, etc. Asset is overstated when the carrying amount > NRV.
Assets maybe overstated by some companies for the potential use of collateral when in need
of debt financing.

Examples of scenarios when overstatement of asset occurs

• Impairment of the asset and depreciation/amortisation are not provided for PPE/intangible
assets.
• Inventories is not written down to net realisable value or contains damaged/obsolete goods.
• Bad debts / allowance for doubtful debts are not recognised.
 Chapter 4-25

(d) understatement of liabilities (Owing Less)

A company’s Net assets = Total Assets – Total Liabilities
These would portray illusion of having more net assets than the company actually has.
Liabilities may be overstated by some companies to make financial statement appear stronger
or to comply with its loan covenants.

Examples of scenarios when understatement of liabilities occurs

• Unrecorded liabilities such as warranties, lawsuits compensation
• Accruals / matching not applied

(e) manipulation of classification and disclosure

Revenue could be irregularly manipulated, as could assets; while expenditure and liabilities
could be irregularly mis-stated.
For example: Classifying expenses as assets

Purposeful omissions and not disclosed in notes to accounts.

For examples:
(a) Contingent liabilities: legal action against company
(b) Significant events after reporting period - obsolete product due to new competing
product/substitute
(c) Related party transactions - a director who holds an undisclosed financial interest in
another entity and there were transactions between the two entities.
 Chapter 5-1

Chapter 5: IAS 23 / MFRS 123 Borrowing costs

LO 1: Define borrowing costs and qualifying assets
LO 2: Compute the borrowing costs eligible for capitalisation
LO 3: Explain commencement, suspension and cessation for capitalisation of borrowing costs

1.0 Definitions

Borrowing costs are interests and other costs incurred by an entity in connection with the
borrowings of funds. Borrowing costs include:

(a) Interest expense calculated using the effective interest method as described in IFRS 9
Financial Instruments;
(b) finance charges in respect of leases recognised in accordance with IFRS 16 Leases ;
and
(c) exchange differences arising from foreign currency borrowings to the extent that they
are regarded as an adjustment to interest costs.

The borrowing costs may be based on specifically borrowed funds or on the weighted
average cost of a pool of funds.

Qualifying asset is an asset that necessarily takes a substantial period of time to get ready
for its intended use or sale.

Depending on the circumstances, any of the following may be qualifying assets::

(a) Inventories that require a substantial period of time to bring them to a saleable condition.
E.g. the construction of building, long-term construction etc.
(b) Manufacturing plants
(c) Power generation facilities
(d) Investment properties
(e) Intangible assets (during development period)

Inventories produced in bulk over short periods and on a regular basis are not qualifying assets
nor are asset ready for sale or their intended use when purchased.
 Chapter 5-2

2.0 Accounting treatment

2.1 Benchmark treatment

Prior to the revision of IAS 23, the benchmark treatment was to recognise borrowing costs as
expenses. This benchmark/allowed treatment has now been removed (effective 1 January
2009).

2.2 IAS 23 revised: capitalisation

Under this revised treatment, all eligible borrowing costs must be capitalised.

Borrowing costs eligible for capitalisation

Only borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset can be capitalised as part of the cost of that asset.
The borrowing costs may be based on specifically borrowed funds or on the weighted
average cost of a pool of funds.

(A) Funds borrowed specifically for the purpose of obtaining a qualifying asset

Where funds are borrowed specifically for the purpose of obtaining a qualifying asset, the
amount of borrowing costs eligible for capitalisation will be the actual borrowing costs
(based on effective rate of interest) incurred on that borrowing during the period less any
investment income on the temporary investment of those borrowings.

Borrowing costs capitalised

= Borrowing costs incurred
less investment income on temporary investment of those borrowings.

Illustration 1
An entity borrowed RM39 million for the construction of a building. However, only RM10
million was used and the balance of RM29 million was invested temporarily. If the actual
borrowing costs were RM2 million and the investment income was RM400,000. How much
the amount would be capitalised?

Solution:
Borrowing costs capitalised
= Borrowing costs incurred
less investment income on temporary investment of those borrowings.
 Chapter 5-3

Illustration 2
On 1 January 20x6, ABC Sdn Bhd borrowed RM1.5 million to finance the production of two
assets, both of which were expected to take a year to build. Work started on 1 January 20x6.
The loan facility was drawn down and interest was incurred on 1 January 20x6 and was utilised
as follows, which the remaining funds invested temporarily.
Asset A Asset B
RM’000 RM’000
1 January 20x6 250 500
1 July 20x6 250 500

The loan rate was 9% and ABC Sdn Bhd can invest surplus funds at 7%.

Required:

Ignoring compound interest, calculate the borrowings costs which may be capitalised for each
of the assets and consequently the cost (carrying amount) of each asset as at 31 December 20x6.

Solution: Asset A Asset B

RM RM
Borrowing costs incurred

Less: Investment income

Borrowing costs capitalised

Cost (carrying amount) of assets

Expenditure incurred
Borrowing costs capitalised
 Chapter 5-4

(B) Funds borrowed generally and used for the purpose of obtaining a qualifying asset

In a situation where borrowings are obtained generally but are applied in part to obtaining
a qualifying asset, the entity shall determine the amount of borrowing costs eligible for
capitalisation by applying a capitalisation rate to the expenditures on that asset.

Capitalisation rate
The capitalisation rate shall be the weighted average of the borrowing costs applicable to
the borrowings of the entity that are outstanding during the period, other than
borrowings made specifically for the purpose of obtaining a qualifying asset. The amount
of borrowing costs that an entity capitalises during a period shall not exceed the amount of
borrowing costs it incurred during that period.

Illustration 3
On 1 January 20x3, Jay Bhd raised finance amounting to RM400,000. The borrowing costs
were to finance both a construction of a plant and for operations. On 31 Dec 20x5, The
borrowings were RM400,000 with no capital repayment in year 20x5. The borrowings were
mainly used for the construction of the plant at a cost of RM300,000. The details of the
borrowing were as follows:

31.12.x5 RM
12% Loan stock 100,000
10% Term loan 220,000
8% Redeemable preference shares 80,000

Required:
Compute the capitalisation rate, the amount of total interest, the interest charged to the
statement of profit or loss and the amount of interest that qualifies for capitalisation for the year
ended 31.12.x5.
 Chapter 5-5

Solution:

Capitalisation rate (CR)

Principal Weighted Interest
RM average (a) rate (b) (a) x (b)
%
12% loan stock
10% term loan
8% redeemable preference shares

Capitalisation rate =

Interest can be capitalised = Exp. incurred on construction x CR

Total interest p
(a) rate (b) (a) x (b)
RM % RM
12% loan stock
10% term loan
8% redeemable preference shares

RM
Interest qualified for capitalisation
Interest charged to SOPL
 Chapter 5-6

3.0 Carrying amount exceeds recoverable amount

A situation may arise whereby the carrying amount (or total cost of the asset) of the qualifying
asset exceeds its recoverable amount or net realisation value. In these cases, the asset has to be
written down accordingly.

4.0 Commencement of capitalisation

Three events or transactions must be taking place for capitalisation of borrowing costs to be
started.

(a) Expenditure on the asset is being incurred. (e.g. commencement of construction).

(b) Borrowing costs are being incurred.
(c) Activities that are necessary to prepare the asset for its intended use or sale are in
progress.

Activities necessary to prepare the asset for its intended use or sale include technical and
administrative work prior to physical construction work e.g. obtaining permits.

5.0 Suspension of capitalisation

If active development is interrupted for extended periods, capitalisation of borrowing costs

should be suspended for those periods.

The situations which are not considered as interruption of construction:

(a) A temporary delay which is necessary as part of the process of getting an asset ready
for its intended use or sale.
(b) Substantial technical or administrative work is taking place

6.0 Cessation of capitalisation

Once substantially all the activities necessary to prepare the qualifying asset for its intended
use or sale are complete, the capitalisation of borrowing costs should cease. This is normally
when physical construction of the asset is completed, although minor modifications may still
be outstanding.
 Chapter 5-7

Illustration 4
Everywhere Bhd constructed a building on 1.1.x1. The building was completed on 31.12.x3.
Construction costs (excluding interest) incurred on the building was RM1,500,000.

1 January 20x1, Everywhere Bhd secured a loan of RM1,000,000 from Rich Finance Bhd to
finance the construction costs. Interest on the loan was charged at 10% per annum. Repayment
period of the loan was 5 years. Since Everywhere Bhd did not need the full amount of the loan
in the beginning of first year of the construction, it deposited RM600,000 in fixed deposit which
yielded an interest of 8% p.a. The deposit matured on 31 December of year x1. The useful life
of the building was estimated to be 50 years.

Required:

(a) Calculate the cost (carrying amount) of the building as at 31 December 20x3 and
(b) Prepare the statement of profit or loss (extract) for the years ended 31 December x1
until x4.

Solution:

(a) RM
Borrowing costs incurred

Less: Investment income

Borrowing costs capitalised

Carrying amount of building as at 31 December 20x3

Expenditure incurred
Borrowing costs capitalised

(b) Everywhere Berhad

Statement of profit or loss (extract) for the years ended 31 Dec
x1 x2 x3 x4
Expenses: RM RM RM RM
Interest expense
Depreciation
 Chapter 6-1

Chapter 6: IFRS / MFRS 16 Leases

Learning Objectives (LO)
LO 1: Identify a lease
LO 2: Account for right-of-use assets and lease liabilities in the records of the lessee
LO 3: Prepare extract of financial statements
LO 4: Explain recognition exemptions

1.0 Definition
Under the new standard, a lease is a contract, or part of a contract, that conveys the right to
use an asset (the underlying asset) for a period of time in exchange for consideration.

To be a lease, a contract must convey the right to control the use of an identified asset, which
could be a physically distinct portion of an asset such as a floor of a building.

Convey the right to use the asset

Lessor ------------------------------------- > Lessee
<-------------------------------------
Consideration: A payment or series of payment

A contract conveys the right to control the use of an identified asset if, throughout the period
of use, the customer has the right to:
(a) obtain substantially all of the economic benefits from the use of the identified asset;
and
(b) direct the use of the identified asset (i.e., direct how and for what purpose the asset is
used).

A lessee does not control the use of an identified asset if the lessor can substitute the
underlying asset for another asset during the lease term.

2.0 Lessee accounting

Initial recognition and measurement

Lessees are required to initially recognise a lease liability for the obligation to make lease
payments and a right-of-use asset for the right to use the underlying asset for the lease term.

Dr Right-of-use asset
Cr Lease liability
Cash/Bank (e.g. initial payment and initial costs less incentive received)

Lease liability. The lease liability is measured at the present value of the future lease payments
(including the residual value guarantees) to be made over the lease term i.e. discounted at the
interest rate implicit in the lease. If that rate cannot be readily determined, the lessee’s
incremental borrowing rate should be used.
 Chapter 6-2

Right-of-use asset. The right-of-use asset is initially measured at the amount of the lease
liability, adjusted for lease prepayments (initial payment), lease incentives received, the
lessee’s initial direct costs (e.g., commissions) and an estimate of restoration, removal and
dismantling costs.

Initial measurement of the right-of-use asset =

(a) Initial measurement of lease liability
(b) Add: Lease prepayments (initial payment before the commencement date)
Less: Lease incentives received
(c) Add: Initial direct costs
(d) Add: an estimate of restoration, removal and dismantling costs.

An accounting policy election: A lessee may elect not to apply the above requirements to:
(a) short-term leases (leases with a lease term of 12 months or less); and
(b) leases for which the underlying asset is of low value (i.e. low value assets)

If a lessee elects not to apply the above requirements to either short-term leases or leases for
low value assets, the lessee shall recognise the lease payments associated with those leases as
an expense on either a straight-line basis over the lease term or another systematic basis.

Subsequent measurement
Lease liability. The lease liability will increase with the interest (finance costs) and decrease
by the lease payments made.

Right-of-use asset. The related right-of-use asset is depreciated over the shorter of the lease
term and the useful life of the underlying asset. If the lease transfers ownership of the
underlying asset to the lessee by the end of the lease term, the lessee shall depreciate the right-
of-use asset over the useful life of the underlying asset.

Apportionment of rental payments

When the lessee makes a rental payment, it will comprise two elements:
(i) An interest charge on the finance provided by the lessor.
(ii) The capital cost of the asset
The apportionment between interest portion and capital portion is done by the actuarial method.

Illustration 1 (Payment in arrears with initial payment-deposit)

On 1 January 20X0, B Co, wine merchants, buys a small bottling and labelling machine from
Silenus Co under a lease. The present value of future lease payments was RM5,710. The
agreement required the immediate payment (initial payment) of a RM2,000 deposit with the
balance being settled in four equal annual instalments of RM2,000 each commencing on 31
December 20X0. The interest implicit in the lease is 15% per annum. Depreciation on the
machine is to be provided for over four years on a straight line basis.

Required:

(a) Show the calculation of initial measurement of the lease liability (present value of future
lease payments), initial measurement of the right-of-use asset and journal entries for
initial measurement.
(b) Calculate/show the outstanding balance at end of each year.
 Chapter 6-3

(c) Prepare the financial statement extracts for B Co for the years ending 31 December
20x0 to 20x3.

Solution:
(a)
Lease liability at commencement date = present value of future lease payments
RM

Right-of-use asset = Initial payment + initial measurement of lease liability

=
=

Journal entries

Dr Right-of-use asset
Cr Lease liability
Cr Cash/Bank

(b) Outstanding balance

20X0 20X1 20X2 20X3

RM RM RM RM
Balance 1 Jan
(+) Interest 15%
(-) Instalment
Balance
outstanding
31 Dec
 Chapter 6-4

(c)
B Co
Statement of profit or loss extracts for the year ended 31 December

X0 X1 X2 X3
RM RM RM RM
Expenses
Depreciation
Interest / Finance costs

B Co
Statement of financial position extracts as at 31 December

X0 X1 X2 X3
RM RM RM RM
Non-current assets
Right-of-use asset
Accumulated dep.

Non-current liabilities
Lease liability

Current liabilities
Lease liability

Illustration 2 (payment in arrears without initial payment-deposit)

On 1 January 20X0, a lessee enters into a four-year lease of a building which has a remaining
useful life of ten years. Lease payments are RM50,000 per annum payable at the end of each
year. The interest rate implicit in the lease is 5%.

Calculate the lease liability at the commencement date and calculate/show the outstanding
balance at end of each year.
 Chapter 6-5

Solution:

Lease liability at commencement date = present value of future lease payments

RM

20X0 20X1 20X2 20X3

RM RM RM RM
Balance 1 Jan
(+) Interest 15%
(-) Instalment
Balance
outstanding
31 Dec

Illustration 3 (payment in advance)

B Co has leased an item of plant under the following terms:

(a) Commencement of the lease was 1 February 20X2

(b) Term of lease 5 years
(c) Annual payments in advance RM12,000 (first payment on 1 February 20X2, second
payment on 1 February 20X3)
(d) Implicit interest rate within the lease is 8% per annum

Depreciation on the plant is to be provided for over five years on a straight-line basis.

Required:

Prepare extracts of the statement of profit or loss and statement of financial position for B Co
for the year to 31 January 20X4 for the above lease.
 Chapter 6-6

Solution:

Lease liability at commencement date = present value of future lease payments

RM

Movement on the lease liability / Outstanding balance

20X2 – 20X3 – 20X4 – 20X5 – 20X6 –

20X3 20X4 20X5 20X6 20X7
RM RM RM RM RM
(-) Instalment -
Balance 1 Feb
(+) Interest
Balance
outstanding 31 Jan

B Co
Statement of profit or loss extracts for the year ended 31 January 20X4
RM
Expenses
Depreciation charge
Interest / Finance cost

B Co
Statement of financial position extracts as at 31 January 20X4
RM
Non-current assets
Right-of-use asset
Accumulated dep.

Non-current liabilities
Lease liability

Current liabilities
Lease liability
 Chapter 6-7

3.0 Recognition exemptions

IFRS 16 provides optional exemptions from applying the full requirements of IFRS 16 on the
following types of lease:

(a) Short-term leases

These are leases with a lease term of 12 months or less. This election is made by class
of underlying asset. A lease that contains a purchase option cannot be a short-term lease.

(b) Low-value leases

These are leases where the underlying asset has a low value when new. An underlying
asset qualifies as low value only if two conditions apply:

(i) The lessee can benefit from using the underlying asset.
(ii) The underlying asset is not highly dependent on, or highly interrelated with
other assets.

Lease payments are recognised as an expense in P&L on a straight-line basis over the lease
term unless some other systematic basis is representative of the time pattern of the user’s
benefit.

Illustration 4
Chloe Co is preparing its financial statements for the year ended 30 June 20x6.
On 1 May 20x6, Chloe made a payment of RM 32,000 for an eight-month lease of a milling
machine. Chloe has elected to utilise any lease exemptions available.

Required
Explain what amount would be charged to Chloe Co’s statement of profit or loss for the year
ended 30 June 20x6 in respect of this transaction?

Solution
The lease is for eight months, which counts as a lease, and so it does not
need to be recognised in the statement of financial position.

The amount charged to FTYE 30 June 20x6 is therefore

.
 Chapter 7-1

Chapter 7: Statement of Cash Flow IAS 7 / MFRS 107

Learning Objectives (LO)

LO1: Define scope & purpose of the Statement of Cash Flows
LO2: Distinguish types of activities in Statement of Cash Flows (SOCF)
LO3: Prepare SOCF using Direct method and Indirect method
LO4: Prepare reconciliation of net income to cash flows from operating activities
LO5: Prepare reconciliation of opening and closing cash and cash equivalents
LO6: Analyse/Comment Statement of Cash Flow

1 Objective of IAS7
To provide users of financial statements with information about the historical changes in
cash and cash equivalents of a reporting entity which are necessary for the evaluation of:

(a) a reporting entity's ability to generate cash and cash equivalents and
(b) the timing and certainty of their generation
(c) gives indication of the relationship between profitability vs cash generating ability of
the entity.
(d) to provide information to the user of the financial statement about the entity’s ability
to generate cash & cash equivalent, as well as indicating the cash needs of the entity.

Statement of Cash Flows enhance comparability as they are not affected by differing
accounting policies used for the same type of transactions or events.

2 Profitability vs Liquidity (Profit vs Cash)

Accrual concept
Cash flow is not the same as profit in short term due to timing differences in

(a) Profit earned vs $ received

(b) Expenses incurred vs $ paid

Effect of Accruals - Cash Flows & Profit are not equal

Profit earned is not the amount of cash inflow to the business because:

• SOPL & SOFP are prepared on basis, while

• Statement of cash flow (SOCF) is prepared on basis. SOCF reports cash

movements of the business.
 Chapter 7-2

Illustration 1
Company A - Cash Sales
Started business with cash capital of RM10,000. Purchased goods for RM5,000 and sold
it for cash at the price of RM12,000.

Company B - On Credit
Started business with cash capital of RM10,000. Purchased goods for RM5,000 and sold
it on credit terms of 30 days at a price of RM12,000.

Company A Company B
On Cash On Credit
SOFP Before Sales of Inventories
Capital 10,000 10,000
Cash 10,000 10,000

SOFP After Sales of Inventories

Capital 10,000 10,000
Profit 7,000 7,000
17,000 17,000

Trade receivables - 12,000

Cash 17,000 5,000
17,000 17,000

Company’s performance and prospects depend not so much on the “profit” earned in the
period, but more realistically on liquidity or cash flows. E.g.:

(i) The payment of dividend in a company does not depend on the profit earned during
the period but depends on whether the company has sufficient cash available to stay
in the business and to pay the dividend.

(ii) Employees believe that if a company make profits, it can afford to pay higher salary
next year. The ability of the company to pay higher salary depends on the availability
of cash.

(iii) Survival of a company depends not so much on their profit as on its ability to pay its
debts when they fall due.
 Chapter 7-3

3 IAS7 – Definition of terms

(a) Cash
Cash in hand & demand deposit.

(b) Cash equivalent

ST, highly liquid investments that are readily convertible to known amounts of cash
& which are subject to an insignificant risk of changes in value.

Cash & Cash Equivalents (C&CE)

C&CE consist of cash on hand and at bank, overdraft and ST investments

20x9 20x8
RM RM
Cash at bank and at hand xxx xxx
Short Term Investments xx xx
Bank Overdraft (xx) (xx)
Cash and cash equivalents G F

They are not held for investment or long-term purposes, but rather to meet short-term cash
commitments. An investment’s maturity date should be normally within 3 months from its
acquisition date.

Equity investments (i.e. share in other company) are not CE. An exception would be
preferred shares were acquired with a very close maturity date.

Loans & other borrowings from banks are classified as financing activities.

In some countries, bank overdrafts are repayable on demand and are treated as part of total
cash management system.

4 The purpose : Statement of Cash Flows

(a) To aid the users of financial statement to assess the effectiveness of management to
provide and utilise the C&CE during a reporting period.

(b) To disclose the inflow and outflow of cash during a financial period and identify the
activities that generated cash and the activities that used cash.

(c) To evaluate whether the company able to meet the future commitments such as tax
payments, loan repayments, interest payment etc.

(d) To identify the likely future financing needs, for example, the future share issue or
loan may be needed.
 Chapter 7-4

5 The advantages: Statement of Cash Flows

(a) It assists users in making judgments on the amount, timing and degree of certainty of
future cash flow.

(b) It gives an indication of the relationship between profitability and cash-generating

ability, and thus the quality of profit earned.

(c) Analysts often develop models to assess and compare present value of the future CF
of the entities.

(d) A SOCF in conjunction with a SOFP provides information on liquidity, viability and
adaptability.

(e) CF is more comprehensive the “profit” which dependent on accounting conventions &
concepts. CF cannot easily be manipulated and not affected by judgment or
accounting policies.

(f) Survival in business depends on the ability to generate cash. SOCF directs attention
towards this critical issue.

(g) Payables (short & long term) are more interested in an entity’s ability to repay them
than its profitability.

6 The disadvantages: Statement of Cash Flows

(a) SOCF are based on historical information and therefore do not provide complete
information for assessing future cash flows.

(b) There is some scope for manipulation of cash flows. For example, a business may
delay paying suppliers until after year end.

(c) CF is necessary for survival in the ST, but in order to survive in the LT a business
must be profitability. A huge cash balance is not a sign of good management if the
cash could be invested elsewhere to generate profit.

7 Actions should be taken by a company when facing cashflow problem:-

(a) Increase O/D (if not already at the limit).

(b) Increase LT borrowings.

(c) Raise $ through share issue (company must have a good record of profitability and of
dividend growth, and the share price must be high).

(d) Tightening credit and inventory control, paying suppliers later.

(e) Limiting capital expenditure.

(f) Entering into sale & leaseback agreement.

 Chapter 7-5

(g) Selling some assets (for example investments, or part of the business which are less
related to the main trade).

(h) Purchasing a cash-rich company by issuing shares in consideration.

(i) Reducing dividend payment.

(j) Reducing its level of activities.

8 Three types of activities

(a) Operating activities

Principal revenue producing activities & other activities excluding investing or
financing activities.

(b) Investing activities

Acquisitions and disposal of non-current assets and other investments not included in
cash equivalent.

(c) Financing activities

Transactions which involve the obtaining and repaying of financial resources from
the owners and providers of non-current capital in which the providers receive a
return.

Operating, Investing & Financing Activities and the SOFP

 Chapter 7-6

9 Presentation – Statement of Cash Flows Direct vs Indirect method

Direct method is the preferred method because it discloses information not available
elsewhere in the FS, which could be of use in estimating future CF.

In practice, the indirect method is more commonly used since it is quicker and easier.

(A) Direct Method (Illustrating Sample)

Twinker-bell Bhd.
Statement of Cash Flows For the year ended 31/12/20x1
RM RM
Cash Flows from Operating Activities
Cash receipts from customers X
Cash paid to suppliers (X)
Cash paid to employees (X)
Other operating expenses paid (X)

Cash generated from operations A

Interest paid (X)
Income taxes paid (X)

Net cash from/(used in) operating activities B/(B)

Cash Flows from Investing Activities
Purchase of property, plant & equipment (X)
Proceeds from disposal of property, plant & equipment X
Purchase of equity investment (X)
Interest received X
Dividends received X
Net cash from/(used in) investing activities C/(C)
Cash Flows from Financing Activities:
Proceeds from issuance of share capital X
Proceeds from long term borrowings / bonds X
Repayment of long-term borrowings (X)
Redemption of preference shares (X)
Payment to redeem the debenture (X)
Payment of finance lease obligations (X)
Dividends paid * (X)
Net cash from/((used in) from financing activities D/(D)
Net increase in cash and cash equivalents E
Cash & cash equivalents at beginning of period (Note A) F
Cash & cash equivalents at end of period (Note A) G

* could also be shown as an operating CF

 Chapter 7-7

B) Indirect Method (Illustrating sample)

Twinker-bell Bhd.
Statement of Cash Flows For the year ended 31/12/20x1
RM RM
Cash Flow From Operating Activities:
Net profit before taxation X

Adjustments for:
Depreciation X
Loss/(Gain) on disposal of investments X/(X)
Loss/(Gain) on disposal of property, plant & equipment X/(X)
Bad debt written off X
Increase/(Decrease) in AFDD X/(X)
Investment income / Interest income (X)
Interest expenses X
Operating profit before working capital changes X
(Increase)/decrease in receivables (X)/X
Decrease/(increase) in inventories X/(X)
(Decrease)/increase in payables (X)/X
Cash generated from operations A
Interest paid (X)
Income taxes paid (X)
Net cash from/(used in) operating activities B/(B)
Cash Flow From Investing Activities:
Purchase of property, plant & equipment (X)
Proceeds from disposal of property X
Interest received X
Dividends received X
Net cash from/(used in) investing activities C/(C)

Cash Flow From Financing Activities:

Proceeds from issuance of share capital X
Proceeds from long term borrowings / bonds X
Repayment of long-term borrowings (X)
Redemption of preference shares (X)
Payment to redeem the debenture (X)
Dividends paid * (X)
Net cash from/(used in) financing activities D/(D)
Net increase in cash and cash equivalents E
Cash & cash equivalents at beginning of period (Note A) F
Cash & cash equivalents at end of period (Note A) G

* could also be shown as an operating CF

International Accounting Standards (IAS) 7, Statement of Cash Flows

Dividends and Interest are disclosed separately, and they should be classified in a consistent
manner from period to period (IAS 7, para. 31).
Cash flows from dividend and interest paid can be categorised either as Operating or Financing
activities:
 Chapter 7-8

Dividend paid (Operating / Financing activity)

Dividend received (Investing activity)

Interest paid (Operating / Financing activity)

Interest received (Investing activity)

Dividends paid may be classified as a component of cash flows from operating activities in
order to assist users to determine the ability of an entity to pay dividends out of operating cash
flows.
Dividends paid may be classified as a financing cash flow because they are a cost of obtaining
financial resources.

Notes to Statement of Cash Flows

Note A: Cash and cash equivalents
C&CE consist of cash on hand and at bank, overdraft and ST investments.

20x1 20x0
RM RM
Cash at bank and at hand xx xx
ST investments xx xx
Bank O/D (xx) (xx)
Cash and cash equivalents G F

Note B: Reconciliation of cash flows from operations with the NP for the period
RM
Cash from Operating Activities:
Net profit before taxation X
Adjustment for:
Depreciation X
Loss/(Gain) on disposal of property, plant & equipment X/(X)
Loss/(Gain) on disposal of investments X/(X)
Bad debt written off X
Increase/(Decrease) in AFDD X/(X)
Impairment loss in goodwill X
Investment income / Interest income (X)
Interest expenses X
Operating profit before working capital changes X
(Increase)/decrease in receivables (X)/X
(Increase)/decrease in inventories (X)/X
(Decrease)/increase in payables (X)/X
Cash generated from operations A
 Chapter 7-9

10 Analyse Statement of Cash Flow

(a) Operating Activities

• The first key figure to address is likely to be cash generated from operation. It shows
how much cash the business can generate from its core activities. The “Cash generated
from operation” figure should be compared to the “Profit from operations” in SOPL to
show the quality of the profit.

• The cash generated from operations figure should be positive to ensure that the business
generates sufficient cash to cover the day to day running of the company, interest and
tax payments.

• Examine the movements in working capital. For instance:

(i) Significant increases in receivables may potentially lead to irrecoverable debts and
cash flow issue; or it may indicate the increased payment terms and credit limit
extended for large customers.

(ii) Significant increases in inventories may potentially lead to higher provision for
obsolete inventories and cash flow issue; or it may indicate lower inventory
turnover and cash flow is tied up to inventory.

(iii) Significant increases in payables despite of a positive cash generated from

operations may indicate a company is delaying paying its suppliers in order to
improve its cash flow position at the end of the year.

• Net cash generated from operating activities is “free cash”, attention should be paid as
to how this is spent. For instance:

(i) Ideally, dividend would be paid out of this free cash, so that a company does not
need to raise additional fund to pay dividend to shareholders.

(ii) Using this free cash to invest in non-current assets as this should generate more
returns in the future.

(iii) Using this free cash to pay back loans as this will reduce further interest payments.
 Chapter 7-10

(b) Investing activities

• Received cash generated from its investment, such as dividend / interest received.

• Focuses on the cash flows relating to non-current assets. For instance:

(i) Acquisition of new assets to expand capability and generate more returns.

(ii) Replacement of old assets to improve productivity/cost competitiveness.

(iii) Disposal of non-current assets to resolve cash flow problems / manage short-term
liquidity requirements make the financial position significantly weaker.

(c) Financing activities

• Raising capital by issuing shares or borrowings for:-

(i) Financing market expansion / business growth.

(ii) Investment in non-current assets (long-term finances are appropriate to use for
long-term assets).

(iii) Funding working capital.

• Need to consider the future consequences when raising long-term finance, for instance:

(i) Loans will lead to higher interest payments going forward and higher gearing level.

(ii) Raising funds from issuing shares will possibly lead to higher dividend payments
in the future and more shareholders.
 Chapter 8-1

Chapter 8: Financial Ratio Analysis

Learning Objectives (LO)
LO 1: Explain the importance and purpose of analysis of financial statements
LO 2: Calculation of accounting ratios
LO 3: Explain categories and purposes of ratios
LO 4: Interrelationships between ratios
LO 5: Define users of accounting ratios
LO 6: Interpretation of ratios
LO 7: Calculate and interpret the relationship between the elements of the financial statements.
LO 8: Draw valid conclusions from the information contained within the financial statements
and present these to the appropriate user of the financial statements.

1 Purpose of Ratio Analysis

Ratio analysis is also known as “Interpretation of financial statements”. Generally, the
users of financial statements need information about companies to make comparisons.
Most of the time, the comparisons made include: -

(a) Compare performance of a company to another company in the same industry.

(b) Compare performance of a company between different accounting periods.

Current year ratio analysis

The ratios themselves provide additional information. It is more useful when the current
year’s ratios are used to evaluate the company’s relative performance compared
against:

- The same company’s results of previous years. i.e. trend analysis

- Compare with the results of other companies within the same industry, i.e. inter-firm
comparison
- Comparison against the predetermined industry standards
- Compare with budgets
- Compare with the company’s predetermined standards.

The ratios are derived from the statement of financial position, statement of profit or loss
OR from both these statements.

The analysis of current year results against the above benchmark would assist the company
identify its strengths, weaknesses and the underlying trend of business.

2 Techniques of interpretation
In order to appreciate the results calculated from the ratios, it is important to understand
the environment in which business operate:

(a) Market in which business operate.

(b) General economic conditions.
(c) Size of business in relation to competitors.
(d) Location of the business.
(e) Age of net current assets.
 Chapter 8-2

The key to obtaining meaningful information from ratio analysis is the comparison
which involves:
(i) comparing ratios over time within the same business to establish whether things are
improving or declining, and
(ii) comparing ratios between similar business to see whether the company you are
analyzing is better or worse than average within its specific business sector.

Ratio analysis on its own is not sufficient for interpreting company accounts, and that there
are other items of information which should be linked at, for example:
(a) The content of any accompany commentary on the accounts and other statements.
(b) The age & nature of the company’s assets.
(c) Current & future developments in the company’s markets, at home & overseas, recent
acquisitions or disposal of subsidiary by the company.

3 Users of accounting ratios

(1) Management (who are interest with the trend of profit, cost control, salaries, etc.)
(2) Bank manager & financial institution (who are interested with the liquidity, profit
potential, ownership of the business)
(3) Shareholders & investment analysts (who are interested with return on investment,
security, liquidity, buy/sell shares).
(4) Creditors/Payables (who are interested with the security of their debt/loan, liquidity,
amount & period of credit)

4 Types of financial ratios

(a) Profitability & Return on Capital
Level of returns the owner is getting on his sales/capital.

(b) Level of efficiency of business activities (Turnover ratios)

Considers the way the business uses its assets and the relationship between the Gross
Profit and Net Profit.

(c) Short-term solvency and Liquidity

To assess the business’s ability to settle short-term debts.

(d) Long-term solvency and Stability (Capital structure / Position ratios)

To assess the business’s ability to meet its long-term obligations.
Relationship between Equity capital and Long-term sources of finance
(e.g. preference shares and Non-current loans).

* Equity Capital = Capital of the Owner (Ordinary Share Capital)

(e) Shareholders’ investment ratios

To assess return on equity shareholders’ investment.
 Chapter 8-3

5 a. Profitability Ratios
Profitability ratios measure the company’s use of its assets and control of its expenses to
generate an acceptable rate of return.

i. Gross profit margin

This represents the gross profit before deducting any expenses, for every sale earned.
A higher ratio shows a better financial performance.

o The gross profit margin measures how well a company is running its core
operations.

o A significant change may be due to a change in sales price, a change in product

mix, an incorrect inventory valuation, a change in cost of sales due to efficiency or
price movements.

ii. Operating profit margin

This represents the net profit after deducting expenses for every RM1 of sales. A higher
ratio shows a better financial performance.

o PBIT is used to avoid distortions when comparisons are made between 2 different
companies where one is mainly debt financing, and the other one is entirely equity
financing.

o The extra consideration for the operating profit margin over the gross profit margin
is how well the company is controlling its overheads.

o A significant change (especially a drop) may be due to the reasons for the
movement in the gross profit margin, changes in control over administration and
distribution costs, one off expenses e.g.: advertising.

iii. Return on capital employed (ROCE)

It measures how efficiently the capital has been used by the business to generate
income. ANALYSE the breakdown: ROCE = Profit Margin x Asset Turnover

* Capital employed = Total Equity + Non-current liabilities OR

Total Assets – Current liabilities (TALCL)

o ROCE for a manufacturing company is likely to be lower than that of a service

company as a manufacturing company has higher assets.

o A significant change may be due to new assets acquired during the year which are
not yet running at capacity, assets aging and revaluations.
 Chapter 8-4

iv. Return on Equity (ROE)

It measures the profitability of the business in relation to equity.
ROE is not a widely used ratio, because there are more useful ratios that give an
indication of the return to shareholders, i.e.: earnings per share, dividend yield et
cetera.

o Shareholders’ funds also referred to total equity.

o Whilst the ROCE looks at the overall return on the long-term sources of finance,
ROE focuses on the return for the ordinary shareholders.

o Reasons for changes in the ROE will be similar to the ROCE with the extra
consideration of changes in interest paid and gearing. This is because ROCE uses
PBIT whereas ROE uses PAT.

v. Asset Turnover Ratio

It measures the efficiency of the use of net assets in generating revenue.

* Capital employed = Total Equity + Non-current liabilities OR

Total Assets – Current liabilities (TALCL)

o Ideally, the ratio should be increasing, but need to be careful when making
assessment based on the ratio, because the company could have bought lots of
assets late in the year and simply have not had much time to start generating
revenue. If this is the case, the ratio will almost certainly fall, but this is not a
reflection on the ability of the assets to generate revenue; it is simply a timing issue.
 Chapter 8-5

b. Efficiency Ratios
Efficiency ratios measure how well the company uses its assets to generate profit, revenue
and cash.

i. Inventory turnover
Inventory turnover ratio (in times)
It indicates the number of times in a year the average inventory can be sold off.

*Average inventory = (Opening inventory + Closing inventory) / 2

Inventory turnover period (in days)

It measures on average, how many days the goods are held before sales.

This ratio can be expressed in terms of months, weeks or days.

If information on opening inventory is not available, using closing inventories in the
calculation is acceptable.

o Inventory turnover depend on the type of goods sold by the company. For eg: fresh
fruit and vegetables should have a low inventory holding period whereas aged wine
will have a very long inventory holding periods.

o A significant change may be due to a change in type of inventory held, improved

or worsened inventory controls or changes in the popularity of certain inventory
items.

ii. Trade receivable collection period

It measures on average how long it takes for the company to collect debts from TR.

This ratio can be expressed in terms of months, weeks or days.

o The average credit term granted to customers should be considered as well as the
efficiency of the credit control function within the company.

o A significant change may be due to increased/decreased credit terms offered to

customers, change in mix between cash cand credit sales, better/worse credit
control.
 Chapter 8-6

iii. Trade payable payment period

It measures the time it takes the company to settle its trade payable balances.

* If purchases are not provided in the accounts, use Cost of Sales.

o Trade payables provide the company with a valuable source of short-term finance,
but delaying payment for too long a period of time can cause operational problems
as suppliers may stop providing goods and services until payment is received.

o A significant change may be due to increased/decreased credit term from suppliers,

increase/decrease in cash, better/worse management of the payables ledger.

c. Liquidity Ratios
Liquidity ratio measures the ability of a company to pay its short-term debts.

i. Current ratio (Working Capital Ratio)

The current ratio is an indication of the business ability to pay its CL out of its CA.

o Sufficient working capital enables a company to hold adequate inventories, allow

a measure of credit to customers, and pay suppliers on the due date.

o The ideal ratio in general is 2:1. A company should not operate at a level that is
too low as will not have sufficient current assets to cover short-term debts as they
fall due. However, a company should not operate at a level that is too high as this
may suggest that the company has too much inventory, receivables or cash.

o Should consider of the specific industry the company operates in as well. For eg:
a supermarket holds relatively low levels of perishable inventories, few receivables
due to major cash sales, and high payables as supermarkets typically have superior
bargaining power to their smaller suppliers.

ii. Quick Ratios (also called Liquid or Acid Test Ratio)

The quick ratio shows the ability of the business to pay its current debts with current
assets that are easily convertible into cash.

o Inventories are the least liquid current assets that a company has, as it has to be
sold, turned into receivables and then cash has to be collected.

o A ratio of less than 1:1 could indicate that the company would have difficulty
paying its short-term debts as they fall due.
 Chapter 8-7

d. Capital Structure / Position Ratios

Capital structure ratios measures a company’s long-term solvency and its capital structure,
how a company funds the overall operations and growth.

i. Gearing or Leverage ratio

The gearing ratio measures how risky a business is perceived to be based on its level
of borrowing.

o Gearing is concerned with the long-term financial stability of the company. It is

looking at how much the company is financed by debt.

o Debt is cheaper than equity as interest is tax deductible but, the higher the gearing
ratio, the less secure the financing of the company will be.

ii. Interest cover

It measures the number of times interest payment is covered by profit.

o Interest cover ratio considers the number of times a company could pay its interest
payments using its profits from operations.

o The main concern is not a company does not have so much debt finance that it
risks not being able to settle the debt as it falls due.
 Chapter 8-8

e. Investors’ ratios
Investors’ ratios measure the ability of the company to maintain profitability and continue
generating positive returns against their investment.

i. Earnings per share (Basic EPS)

It measures the company’s profit attributed to each ordinary share.

o A significant change in basic EPS may be due to issuance of new shares that
increase the number of shares outstanding, which can dilute EPS if net
income/earnings does not increase proportionately.

o Any significant changes in net income, whether due to higher sales, lower costs,
or non-operating income will directly affect EPS.

ii. Dividend cover

It measures the number of times ordinary dividend is covered by profit.

o Dividend cover shows the proportion of profit for the year that is available for
distribution to shareholders that has been paid (or proposed) and what proportion
will be retained in the business to finance future growth.

o A dividend of 2 times would indicate that the company had paid 50% of its
distributable profits as dividends, and retained 50% in the business to help to
finance future operations. Retained profits are an important source of funds for
most companies, and so the dividend cover can in some cases be quite high.

o A significant change in the dividend cover from one year to the next would be
worth looking at closely. For eg: if a company’s dividend cover were to fall sharply
between one year the a d the next, it could be that its profits had falledn, but the
directors wished to pay at least the same amount of dividends as in the previous
year, so as to keep shareholder expectations satisfied.
 Chapter 8-9

iii. Dividend Yield

It measures the return a shareholder is currently expecting on the shares of a
company.

o Shareholders look for both dividend yield and capital growth.

iv. Price / Earnings (P/E) ratio

It measures shareholder confidence in the company and its future, e.g. in profit
growth.

Investors use this ratio to assess the company and to determine number of years to
earn the market price of the share.

o A high P/E ratio indicates strong shareholder confidence in the company and its
future, eg in profit growth, and a lower P/E ratio indicates lower confidence.

o The P/E ratio is often used in stock exchange reporting where prices are readily
available.
 Chapter 8-10

6 Usefulness or Advantages of Ratio Analysis

(a) Compare performance of a company to another company in the same industry.

(b) Compare performance of a company between different accounting periods.

(c) Evaluate on liquidity and going concern position of a company.

(d) Evaluate the efficiency of management by calculating profitability and efficiency

ratios.

(e) Analyse the financial position of the company.

(f) Show the key success factors e.g. profitability and efficiency.

7 Limitations of Ratio Analysis

(a) Where the size of the companies compared is different, it will not be a fair
comparison.

(b) Comparison of an established business with a new business is not fair.

(c) A comparison of results among companies having different accounting year-end is

not accurate.

(d) Accounting information can be manipulated,

(e) Different accounting policies are used between companies.

(f) Difficulty in comparing results among companies of different industries.

 Chapter 9-1

Chapter 9: Accounting policies, changes in accounting estimates

and errors IAS 8

Learning Objectives (LO)

LO1: Account for changes in accounting policies
LO2: Account for changes in accounting estimates
LO3: Account for correction of prior period errors

1.0 Overview

IAS 8 prescribes the rules for three specific areas:

Rules for 3 specific areas

Changes in accounting Changes in accounting Correction of material errors

policies estimates (of prior period)

2.0 Accounting policies

2.1 Definition

Accounting policies are the specific principles, bases, conventions, rules and practices adopted
by an entity in preparing and presenting financial statements.

Examples

FIFO method Revaluation model/cost model

to value inventory. for subsequent measurement of PPE

2.2 Selection and application of accounting policies

Accounting policies are determined by applying the relevant IAS, IFRS or IFRS Interpretation.
IAS 8 requires an entity to determine the accounting policy to a transaction or event by
reference to any IFRS specifically applying to that transaction or event.

For example, when an entity acquires an item of inventory, then it applies the requirements of
IAS 2 Inventories.

1
 Chapter 9-2

In the absence of a standard or interpretation, management should use its judgement in

developing and applying an accounting policy that results in information that is relevant and
reliable. In this, management should refer to:

(a) The requirements and guidance in IFRSs and IFRSICs dealing with similar and related
issues
(b) The definitions, recognition criteria and measurement concepts for assets, liabilities,
income and expense in the Conceptual Framework.

2.3 Consistency of accounting policies

An entity shall select and apply its accounting policies consistently for similar transactions,
other events and conditions, unless an IFRS specifically requires or permits categorisation of
items for which different policies may be appropriate.

3.0 Changes in accounting policies

A change in an accounting policy usually relates to a change of principle, basis, convention,

rule or practice being applied by an entity.

The same accounting policies are usually adopted from period to period, to allow users to
analyse trends over time in profit, cash flows and financial position.

Changes in accounting policy will therefore be rare and should be made only if it:
(a) is required by an IFRS; or
(b) results in the financial statements providing more reliable and relevant information
about the effects of transactions, other events or conditions on the entity’s financial
position, financial performance or cash flows.

An example of a change in accounting policies.

(a) Inventory valuation basis: from FIFO method to weighted average method.
(b) Reclassification of depreciation charge from administrative expenses to cost of sales

The following are not changes in accounting policies:

(a) the application of an accounting policy for transactions, other events or conditions that
differ in substance from those previously occurring; and
(b) the application of a new accounting policy for transactions, other events or conditions
that did not occur previously or were immaterial.

Accounting treatment for changes in accounting policies

Retrospective application (Retrospective method)

A change in accounting policies must be applied retrospectively. Retrospective application
means that the new accounting policy is applied to transactions and events as if it had always
been in use.

2
 Chapter 9-3

The retrospective method

Retrospective application requires the entity:
(a) to adjust opening balance of each affected component of equity for the earliest
period presented and;
(b) to present other comparative amounts disclosed for each prior period presented as if
the new accounting policy had always been in use. This is to limit the problem of
reduced comparability caused by a change in accounting policy.

Illustration 1
A company has always valued inventory on a FIFO basis. In 20x9, it decides to switch to the
weighted average method of valuation. You are given the following information which is
before the adoption of the new accounting policy.

Statement of profit or loss for the year ended 31 December

20x9 20x8
RM RM
Revenue 900,000 869,000

Cost of sales
Opening inventory 174,000 135,000
Purchases 250,000 246,000
Closing inventory (150,000) (174,000)
274,000 207,000

Gross profit 626,000 662,000

Operating expenses (120,000) (100,000)
Profit before tax 506,000 562,000
Income tax expense (126,500) (140,500)
Profit for the year 379,500 421,500

Retained earnings (before the inventory adjustments) at 1 January 20x8 and 20x9 were
RM130,000 and RM551,500 respectively.

The inventories based on the weighted average method would be as follows:

20x9 20x8
RM RM
Opening inventory 143,000 135,000
Closing inventory 145,000 143,000

Required:

By reference to IAS 8, prepare the statement of profit or loss for the year ended 31 December
20x9, with the 20x8 comparative, and retained earnings.

(Note: ignore the effects of tax)

3
 Chapter 9-4

Solution:

YE YE
31.12.x9 31.12.x8
Workings:
Cost of sales RM RM
Opening inventory
Purchases
Closing inventory

Statement of profit or loss for the year ended 31 December

20x9 20x8
RM RM
Revenue
Cost of sales
Gross profit
Operating expenses
Profit before tax
Income tax expense
Profit for the year

Statement of retained earnings for the year ended 31 Dec

20x9 20x8
RM RM
Balance at 1 January
Prior period adjustments
Changes in accounting policy
-Decrease in 20x8’s CI
Restated balance
Profit for the year
Balance at 31 December

4
 Chapter 9-5

4.0 Changes in accounting estimates

A change in accounting estimate is an adjustment of the carrying amount of an asset or a

liability, or the amount of the periodic consumption of an asset, that results from the assessment
of the present status of, and expected future benefits and obligations associated with, assets and
liabilities. Changes in accounting estimates result from new information or new developments
and, accordingly, are not corrections of errors.

In applying an accounting policy, it is often necessary to make estimates because of the

uncertainties inherent within business activities. A change in accounting estimate is a
change in the way in which an accounting policy is applied.

For example, in relation to PPE, the accounting policy is PPE are carried either at cost less
accumulated depreciation (cost model) or at revalued amount less accumulated
depreciation (revaluation model). The accounting estimate is how that depreciation is
calculated e.g., straight line method or reducing balance method.

Here are some examples of accounting estimates:

(a) Expected level of doubtful debts (Allowance for doubtful debts)

(b) Expected useful lives of depreciable assets
(c) Provision for obsolescence of inventory
(d) Provision for warranty obligations
(e) Changes in fair value of financial assets/liabilities

Accounting treatment for changes in accounting estimates

The prospective method

The rule here is that the effect of a change in an accounting estimate should be included in the
determination of net profit or loss in one of:

(a) The period of the change, if the change affects that period only (e.g., doubtful debts).
(b) The period of the change and future periods, if the change affects both (e.g.,
economic life of depreciable asset).

The carrying amounts of affected assets, liabilities and equity are adjusted for the change in
accounting estimates in the period of the change.

No attempt is made to account for the cumulative effect of change and the financial statements
of the prior period presented as comparative figures are not restated.

5
 Chapter 9-6

Illustration 2

A plant was purchased for RM120,000 one year ago. Expected economic life is 6 years with
no residual value. Depreciation policy is a straight-line method. A review on the plant at the
beginning of year 2 revealed that due to recent technological developments, the remaining
useful life of the asset is now four more years (Five years in total from the date of purchase).

Required:
Calculate depreciation for year 1 and year 2.

Solution:
RM
Cost
Depreciation – year 1
CA
Depreciation – year 2
CA

5.0 Errors (Correction of prior period errors)

Prior period errors are omissions from, and misstatements in, the entity’s financial statements
for one or more prior periods arising from a failure to use, or misuse of, reliable information

Errors of prior periods may be discovered during a current period. Error may arise in respect
of recognition, measurement, presentation and disclosure of the elements of the financial
statements.

Examples of errors:

(a) Mathematical mistakes

(b) Mistakes in the application of accounting policies
(c) Misinterpretation of facts
(d) Fraud
(e) Oversights

Accounting treatment for prior period errors

Prior period errors: correct retrospectively

Material prior period errors are corrected retrospectively by:

(i) Restating the comparative amounts for the periods presented in which the error
occurred or
(ii) If the error occurred before the earliest prior period presented, restating the opening
balances of assets, liabilities and equity for the earliest prior period presented.

6
 Chapter 9-7

Illustration 3

Alpha Bhd. has in issue RM2 million ordinary shares of RM1 each. During year 20x2, it
discovered that some products costing RM100,000 that had been sold in year 20x1 were
incorrectly included in closing inventory of year 20x1. Alpha Bhd.’s summarised statement of
profit or loss (before adjusting the error) was as follows:

20x2 20x1
RM RM
Revenue 1,000,000 900,000
Cost of sales (720,000) (450,000)
Gross profit 280,000 450,000
Operating expenses (110,000) (100,000)
Profit before tax 170,000 350,000
Income tax expense @ 25% (42,500) (87,500)
Profit for the year 127,500 262,500

Retained earnings (before the adjustment) as at 1.1.20x1 were RM230,000.

Required:

Prepare the statement of profit or loss for the year ended 31 December 20x2, with the 20x1
comparative, and retained earnings.

Solution:

Workings:
20x2 20x1
1. Cost of sales RM RM
As per question
Inventory adjustment

2. Income tax
As per question
Tax effect on inventory adjustment

7
 Chapter 9-8

Alpha Bhd.
Statement of profit or loss for the year end 31 December
20x2 20x1
RM RM
Revenue
Cost of sales
Gross profit
Operating expenses
Profit before tax
Income tax expense @ 25%
Profit for the year

Statement of retained earnings for the year ended 31 Dec

20x2 20x1
RM RM
Balance at 1 January (as previously reported)
Prior period adjustments
Correction of prior period error

Restated balance
Profit for the year
Balance at 31 December

8
 Chapter 10-1

Chapter 10: Islamic financial accounting

Learning Objectives (LO)
LO 1: Know introduction to conventional accounting (IFRS / MFRS)
LO 2: Know the history and implementation of Islamic financial accounting
LO 3: State differences for Islamic and conventional banking

1 Introduction to conventional accounting (IFRS / MFRS)

The history of standard setting function in Malaysia

1958 Establishment of MICPA (MACPA) as an accountancy body.

1965 Introduction of the Companies Act, including Ninth Schedule.

1967 Establishment of MIA to maintain adequate control of accountancy

profession and establish a register of qualified accountants in
Malaysia.

1968 • MICPA issued the first accounting guidance.

• Included a specimen of company account.

1978 MICPA adopted IASs.

1984 The first Malaysian Accounting Standard 1 Earnings per Share

(MAS 1) was issued.

1985 Amendments to Companies Act 1965 which requires financial

statements to include P&L account, balance sheet, statement of
source and application of funds and notes to account.

1987 MIA and MICPA jointly issued MASs accounting standards.

1997 • Establishment of FRF and MASB.

• MASB adopted all accounting standards issued by MIA and
MICPA and renamed it to MASB standards.
• Amendments to Companies Act 1965 for companies to assert
compliance to approved accounting standards.
 Chapter 10-2

Development of IFRS and MFRS

1973 Formation of IASC

1996 Formation of SIC

2000 Restructuring of IASC to IASB

2001 IASB adopts IASC Standards

2003 Issuance of IFRS 1 as preparation of convergence by major

jurisdictions

2004 MASB initiated a direction to align its accounting standards to the

IASB

2008 MASB announced for Malaysia full convergence with IFRSs

2011 Issuance of MFRS Framework

2012 Effective date to apply MFRS Framework, except for TE*

2018 Effective date to apply MFRS Framework for TE*

TE * Transitioning entities are entities that are subject to the application of MFRS 141
Agriculture and/or IC Interpretation 15 Agreements for the Construction of Real Estate

Financial Reporting Framework in Malaysia

Malaysian Financial Reporting

Entities other than
Standards (MFRS)
private entities Beginning on or after 1 January 2012

Financial Reporting Standards

Entities other than (FRS)
private entities that are Shall comply with MFRS for annual
transitioning entities* periods beginning on or after 1 January
2018

Malaysian Private Entities

Reporting Standards (MPERS)
Private entities Beginning on or after 1 January 2016
 Chapter 10-3

2 The history and implementation of Islamic financial accounting

The MASB’s initiative on Islamic financial reporting started since its establishment in
1997 with the initial thought or view to issue a separate and stand-alone set of Islamic
standards to reflect and report on Islamic transactions and events. Based on that initial
view, MASB issued MASB i-1 Presentation of Financial Statements of Islamic Financial
Institutions (the Standard was then renamed as FRS i-1 following the convergence
initiative).

Extensive research and consultation were conducted since then and it appeared that
conventional accounting concepts and generally accepted accounting principles could also
be applied to Islamic financial transactions and events. Following that, MASB decided to
cease its policy of issuing Islamic accounting standards on Islamic financial transactions
and focused on issuing other technical documents that discuss the application of MASB
approved accounting standards to Islamic transactions or events.

The decision on the applicability of MASB approved accounting standards to Shariah

compliant financial transactions and events was then reaffirmed through the issuance of
Statement of Principles i-1 Financial Reporting from an Islamic Perspective (SOP i-1).
The SOP i-1 states that the following factors had been considered by MASB in its
assessment to derive to the stand that conventional accounting concepts and generally
accepted accounting principles could also be applied to Islamic financial transactions and
events:
(a) Users and their information need.
(b) Objective of financial statements.
(c) The underlying assumptions and qualitative characteristics of financial statements.
(d) The elements of financial statements and their recognition and measurement.
(e) The concept of capital and capital maintenance.

From the assessment of the factors above, MASB then decided to apply the framework for
Islamic reporting using the established principles in conventional accounting thought
except for those that violate Shariah principles. This decision is consistent with Shariah
legal maxim of “permitted unless prohibited”.

MASB however, acknowledges that the conventional framework is lacking in dealing with
the treatment of Shariah compliant financial transactions and events as well as on the
display of information which are deemed important from an Islamic perspective. As such,
MASB had decided to provide complementary guidance in compliance with Shariah
precepts in addition to the conventional framework when there is a need to do so.

By definition, Shariah means to lead to water, which implies that Shariah promotes the
right way of Muamalat. Muamalat is the code of conduct amongst men, which includes
business dealings.

For Islamic financial institutions, rules that prohibits usury (Riba’) either marginally or
excessively, plays an important influence on how Islamic economic policies are structured.
Business practices that adopt rules such as avoidance of uncertainty (Gharar) provide
enhanced transparency on products and services. Equally, businesses that avoid excessive-
risk elements akin to gambling (Maisir) encourage products to be designed with the
protection of consumer rights in mind.
 Chapter 10-4

3 Major differences for Conventional and Islamic banking

Conventional Banking Islamic Banking

Medium of Exchange Financier gives money as an Purchases the commodity.
interest-bearing loan.

Base of Profits Charges interest on capital. Profits are earned through

Interest depends on the exchange of goods and
‘time-value’. services.

Time Value of Money Conventional loan amount Selling price once agreed
keeps on increasing. remains fixed.

Deficit Financing Expanded money without the Balance budget, outcome of

backing of real assets. no expansion of money.

Sharing in Loss Lender suffers losses, not Loss is shared as an

shared by the bank. investment partner.

Disbursing Funds No agreement for exchange Execution of agreements for

of goods and services. the exchange of goods and
services.

Inflation Expansion of money creates No expansion of money. No

inflation. inflation is created.

Existence of Capital Goods Bridge financing and long Musharakah and

term loans, without the Diminishing Musharakah
existence of capital goods. agreements.
• After Capital goods exists
• Before disbursing funds