Google+ COMPUTER TRICKS, TWEAKS AND TUTORIALS: Amazing Short notes of mgt 101 account 23-45.

Amazing Short notes of mgt 101 account 23-45.

Recap

Example 1

• Consider the following data for the month of June of T Company

• Balance as per bank book is Rs. 70,240

• Bank statement showed a favourable balance of Rs. 73,920..

• Examination of bank book and bank statement revealed the following:

nA cheque of Rs. 4,920 paid into bank was not credited by the bank until July 3^rd.

nA standing order for payment of annual payment of Rs. 1,000 had not been entered into bank book.

nOn 27^thJune two customers of T Co. paid directly into bank Rs. 5,500, advice of which was received in July.

nCheques issued but not presented in the bank amounted to Rs. 4,600.

nThe bank had debited the account by Rs. 500 on account of bank charges.

• Lets assume that T Co. has not closed its books.

• You are required to adjust the bank book and then prepare a bank reconciliation statement.

Solution

• Following require adjustment in bank book:

nPayment of an annual subscription Rs. 1,000, not entered in bank book.

Debit Relevant Expense A/c 1,000

Credit Bank 1,000

nReceipts from two customers of directly into bank Rs. 5,500,

Debit Bank 5,500

Credit Customer’s Accounts 5,500

nBank charges Rs. 500

Debit Bank Charges Account 500

Credit Bank 500

Adjustments in Bank Book

Original Balance As Per bank book 70,240

Credit / Less Payment on standing orders (1,000)

Credit / Less bank charges (500)

Add Receipts from customers 5,500

Adjusted balance as per bank book 74,240

Solution

T. Co.

Bank Reconciliation Statement as on June 30, 20—

Balance as per Bank Book 74,240

Add Un presented cheques 4,600

Less Un credited cheques (4,920)

Balance s per bank statement 73,920

Example 2

• Same data as previous example.

• Balance as per bank book is Credit Rs. 56,000

• As per bank statement unfavorable balance of Rs. 52,320

Solution

Adjustments in Bank Book

Original Balance As Per bank book (56,000)

Credit / Less Payment on standing orders (1,000)

Debit / Add Receipts from customers 5,500

Credit / Less bank charges (500)

Adjusted balance as per bank book (52,000)

Solution

T. Co.

Bank Reconciliation Statement as on June 30, 20—

Balance as per Bank Book (52,000)

Add Un presented cheques 4,600

Less Un credited cheques (4,920)

Balance as per bank statement (52,320)

Example 3

• From the following data ascertain the balance as per bank statement of Nasir & Co on March 31, 20--

n Balance as per bank book Rs. 63,000

n Cheques issued but not presented for payment Rs. 12,000.

n Cheques deposited but not cleared Rs. 20,000

n Profit on deposit was credited by bank but not debited in bank book Rs. 2,000.

n A customer paid into bank directly Rs. 15,000 but the same was not recorded in bank book.

nOther receipts in bank that were not recorded in bank book Rs. 8,000.

Solution

Nasir and Co.

Balance as per Bank Book 63,000

Add Un presented cheques 12,000

Less Un credited cheques (20,000)

Add Profit received 2,000

Add amount deposited by customer 15,000

Add other receipts in bank 8,000

Balance as per bank statement 80,000

Solution

Nasir and Co.

Balance as per Bank Statement 80,000

Less Un presented cheques (12,000)

Add Un credited cheques 20,000

Less Interest received (2,000)

Less amount deposited by customer (15,000)

Less other receipts in bank (8,000)

Balance as per bank book 63,000

• Debtors OR Trade Debtors – are the receivables by the organization against the sale of goods.

• Receivables / Other Receivables – are all receivables other than trade debtors e.g. advances to staff, suppliers.

• Creditors OR Trade Creditors – are the payables by the organization against the purchase of stock.

• Payables / Other Payables – are all payables other than trade creditors e.g. advances received from customers.

• Accruals – are the expenses of the business that are payable at the end of the accounting period.

• Payables / Other Payables – are all payables other than trade creditors e.g. advances received from customers.

• Provision – where an expense is incurred but the actual amount is not known at the time of recording at the end of accounting period.

Accounting for Creditors

• Purchase of goods

Debit Stocks Account

Credit Creditors Account

• Goods returned

Debit Creditors Account

Credit Stocks Account

• At the time of payment

Debit Creditors Account

Credit Cash / Bank Account

• Discount received from creditors

Debit Creditors

Credit Stock OR Discount Received

Discounts Allowed to Customers

• Discount allowed to debtors

Debit Sales OR Discounts Allowed

Credit Debtors

Recording of Accrual

• At the time of recording accrual

Debit Relevant expense account

Credit Accrued expenses / Expenses Payable

• At the time of payment

Debit Accrued expenses / Expenses Payable

Credit Cash / Bank

• Recording of rebate

Debit Accrued expenses / Expenses Payable

Credit Expense Account

Recording of Accrual

• At the time of recording accrual

Debit Relevant expense account

Credit Accrued expenses / Expenses Payable

• At the time of payment

Debit Accrued expenses / Expenses Payable

Credit Cash / Bank

• Recording of rebate

Debit Accrued expenses / Expenses Payable

Credit Expense Account

Difference Between Accrual and Provision

• Accrual is made when exact amount of expense is known at the time of recording.

• Provision is made when it is known that an expense will arise but the exact amount is not known.

Recording of Provision for Doubtful Debts

• At the time of creating the provision

Debit Profit and Loss Account

Credit Provision for Doubtful Debts

• At the time of actual bad debt

Debit Provision for Doubtful Debts

Credit Trade Debtors

• In case of bad debt where no provision was made

Debit Profit and Loss Account

Credit Trade Debtors

Provision for Expenses (e.g. Electricity)

• At the time of creating the provision

Debit Relevant Expense Account

Credit Accrued Expenses

• At the time actual amount is known

n Where actual bill is less than the provision

Debit Accrued Expenses

Credit Expense Account

• Recording of payment

Debit Accrued Expenses

Credit Cash / Bank

Presentation of Provision

• Provisions are presented as current liabilities in the balance sheet.

• Exceptions

nDepreciation

nProvision for doubtful debts

• Provision for Doubtful Debts is shown as a reduction from debtors in the balance sheet.

Recording of Debtors

• At the time of sale

Debit Debtors

Credit Sale

• At the time of receipt

Debit Cash / Bank

Credit Debtors

Recording of Debtors

• Return of goods by debtors

Debit Sale

Credit Debtors

Debit Stock

Credit Cost of Sales

Recording of Provision

Extract of Profit and Loss Account

• Extract of Profit and Loss to show the Provision for Doubtful Debts

Profit and Loss Account

For the year ended --—

Gross Profit 90,000

Less: Expenses

Provision for bad debts (5,000)

Extract of Balance Sheet

• Extract of Balance Sheet to show the Provision

Balance Sheet

As At ----------

Current Assets

Debtors 100,000

Provision for Bad Debts (5,000) 95,000

Recording of Bad Debt

• Where provision has already been made for that debt:

Debit Provision for Bad and Doubtful Debts

Credit Debtors

• No expense will be charged.

Recording Change in Provision

• Reducing the provision

Debit Provision for Bad and Doubtful Debts

Credit Profit and Loss Account

• Increasing the provision

Debit Profit and Loss Account

Credit Provision for Bad and Doubtful Debts

Example

• Following information is available for A Ltd. For the year ended June 30, 20--.

n Bad Debts During the year

November 1,100

January 640

April 120

n At the year end total debtors amounted to Rs. 68,000 out which Rs. 2,200 is considered to be doubtful / bad.

• Show the relevant accounts and extracts from Profit and Loss and Balance Sheet.

Example

Presentation

A Ltd.

• Profit and Loss Account for the year ended June 30, 20—

Gross Profit -------

Less: Expenses

Bad Debts (1,860)

Provision for bad debts (2,200)

• Extract of Balance Sheet As On June 30, 20--

Current Assets

Debtors 68,000

Provision for Bad Debts (2,200) 65,800

Example 2

• A business creates a provision for bad debts @ 5% of its debtors on balance sheet date.

• On Jan 01, 20-- the balance of Provision was 6,600.

• During the year debts written off amounted to Rs. 5,400.

• On December 31, 20--, debtors totaled Rs. 62,000.

• Show Bad debts Account and provision for bad debts account.

Solution

• Required closing balance of Provision

62000 x 5% = 3,100

Example 2

Presentation

• Extract of Balance Sheet

Current Assets

Debtors 62,000

Provision for Bad Debts (3,100) 58,900

Control Accounts

• In general ledger summarized record is maintained in the account called “Control Account”. Separate control account is used for Debtors and Creditors.

• Details of individual accounts are kept in a separate Register / Ledger called subsidiary ledger.

Control Accounts

• Control accounts are part of Double Entry recording.

• Entries in Subsidiary Accounts are not part of double entry.

• Total of transactions in subsidiary ledger should match with the transactions in control accounts.

Information for Control Accounts - Debtors

Control Accounts

• Cash sales are usually not recorded in control accounts.

Example

• Prepare a Debtors control Account from the following data and work out the closing balance on May 31, of debtors.

n May 1 Opening Balance 55,000

Totals for May

Total Credit Sales 45,000

Returns Inward 8,000

Cheques and Cash received 40,000

Discounts allowed 4,500

Example 2

• Prepare a Creditors Control Account from the following data and work out the closing balance on April 30, of creditors.

n Apr. 1 Opening Balance 44,500

Totals for May

Total Credit Purchases 32,000

Purchase Return 6,200

Cheques and Cash paid 28,800

Discounts received 2,500

Recap

• With the increase in business, it becomes difficult to maintain separate accounts for every Debtor and every Creditor.

• Control Accounts are opened in the ledger for both Debtors and Creditors.

• Control Accounts are part of double Entry system.

• Subsidiary ledgers are not part of double entry system.

• Control Account system is used only for credit sale and credit purchase.

Subsidiary Books

• To reduce the volume of general ledger, number of books are opened that are called Subsidiary books.

Subsidiary Books- Debtors

• Three subsidiary books are maintained in case of sales / debtors.

n Sales Journal / Sales Day Book – individual invoice wise sales are recorded in this Journal.

n Sales Return / Return Inward Journal – in case the volume of returns is also high then these are also recorded in a separate register.

n Debtors Ledger – this ledger maintains record of individual debtor.

• Cash sale is not included in the debtors control accounts.

Information for Control Accounts

Opening balance of debtors List of debtors balances drawn up to the end of previous period confirms with the aggregate balance of the Control Account.

Credit Sales Periodically total of sales journal is posted into the debtors control account.

Sales Return In case the transaction volume of sales return is high then these are recorded in the sales return journal. Periodically the total is posted in the debtors control a/c.

Cheques / Cash Received List of receipts is extracted from cash and bank book. Or a separate column is maintained in cash and bank books for this purpose

Closing Balance This is the balancing figure. It can also be checked with the total of balances in

debtors Control Account.

• Again if we total the balance of three accounts of the debtors ledger on Jan 30,:

n A 8,500

n B 10,000

n C 15,000

n Total 33,500

• It will be the same as the balance in the debtors control account of the general ledger.

Receipts From Debtors

• When control accounts are used we maintain cash and bank books with separate pages for receipts and payments i.e. two column cash/bank books are not used.

• On the receipts side of the cash and bank book a column is added in which receipts from debtors are separately noted.

• This type of cash / bank book is also called multi column cash / bank book.

Recording of Receipts – Multi Column Cash Book

Subsidiary Books- Creditors

• The recording of creditors is similar to debtors. The subsidiary books maintained in case of purchases / creditors are:

n Purchase Journal / Purchase Day Book – individual purchases are recorded in this Journal.

n Purchase Return / Return outward Journal – in case the volume of returns is also high then these are also recorded in a separate register.

n Creditors Ledger – this ledger maintains record of individual creditors.

• Cash purchase is not included in the creditors control accounts.

Subsidiary Books - Creditors

Opening balance of Creditors List of creditors balances drawn up to the end of previous period confirms with the aggregate balance of the Control Account.

Credit Purchases Periodically total of purchase journal is posted into the creditors control account.

Purchase Return In case the transaction volume of purchase return is high then these are recorded in the purchase return journal. Periodically the total is posted in the creditors control a/c.

Cheques / Cash Paid List of payments is extracted from cash and bank book. Or a separate column is maintained in cash and bank books for this purpose

Closing Balance This is the balancing figure. It can also be checked with the total of balances in creditors Control Account.

Recording of Payments – Multi Column cash book

Recap

n The need for maintaining control accounts

n Subsidiary record maintained, and

nControl Accounts when a person is both Debtor & Creditor.

nNumerical Examples of Control Accounts.

When a person is both debtor and creditor

• When a person is both debtor & creditor, that means you are purchasing one thing from him and at the same time selling another thing to him.

• In the absence of written agreement, the way of settling the payable and receivable is that you pay him full and ask him to pay you full amount.

• If the agreement exists, the way and may be the wiser way is that you pay or receive from him, the net amount of payables and receivables.

When a person is both debtor and creditor

• For example, you purchase item A from Mr. ABC for Rs. 100,000 and sell him item B for Rs. 65,000.

o One way of settling the payable and receivable is that you can pay Mr. A 100,000 and ask him to pay Rs. 65,000.

o The other and may be the wiser method is that you pay him Rs. 35,000 and both the transactions are settled. And this is how such transactions are handled in real life.

When a person is both debtor and creditor

Normally where no control accounts are maintained, following entries will be passed:

Debit A (payable/creditor) account 65,000

Credit A (receivable/debtor) account 65,000

The other entry will be:

Debit A (payable/creditor) account 35,000

Credit Cash / Bank 35,000

This will settle the payable account fully.

When a person is both debtor and creditor

• Where control accounts are being maintained the above two entries are still passed but with slight modification:

Debit Creditors Control account 65,000

Credit Debtors Control account 65,000

The other entry will be:

Debit A (payable/creditor) account 35,000

Credit Cash / Bank 35,000

This entry comes from the creditors column of cash / bank book payment side as usual.

Bad Debts

• Provision does not effect debtors account in simple books. It will therefore, have no effect either on debtor control account or debtors ledger.

• At the time of actual bad debt, the journal entry

Debit Provision / Bad Debts

Credit Debtors Control Account

• In subsidiary ledger, the debit entry will be same but the credit effect will go to Individual Debtors Account in Debtors Ledger.

• Similar treatment is given to discounts received and allowed.

Example 1

• You are required to prepare the Creditors Control account for the month of March and calculate the closing balance from the following data.

n March 1 Opening balance Dr. 50,390

n Totals for the month

Sales from Sales Register 60,500

Sales Return (Sales Return Register) 1,550

Cheques and cash received 75,500

Discounts Allowed 2,000

Bad debts written off 1,800

n No provision for bad debts was made previously.

Example

• Prepare the Creditors Control account for the month of June and calculate the closing balance from the following data.

n June 1 Opening balance Cr. 35,500

n Totals for the month

Purchases from Purchase Register 50,000

Purchase Return (Purch. Return Register) 1,550

Payments made 45,500

Discounts received 1,500

Example

• The financial year of ABC Co. ended on June 30, 2002. You have been asked to prepare the Debtors and Creditors Control Account from the information extracted form subsidiary books. NOTE

n Sales Cash 140,500 1

Credit 255,000

n Purchases Cash 95,000 1

Credit 199,500

n Total Receipts 405,000 2

n Total Payments 275,000 2

n Discounts allowed(all credit cust.) 12,000

n Discounts received(all credit supp.) 9,500

Example 3

NOTE

n Bad debts written off 800

n Increase in prov. Doubtful debts 2,000 3

n Last year closing balances were

Debtors 285,000

Creditors 194,000

NOTES

1 Cash Sales and Purchases don’t effect debtors/creditors control accounts.

2 Total receipts and payments include cash sale and purchases.

3 Change in provision does not effect debtors actual write off .

Subsidiary Ledgers

• Subsidiary ledgers contain the record of all individuals Debtors and Creditors.

• Subsidiary ledgers give information about the main clients and slow moving clients which is helpful for the management in decision making.

• If the business has distributors in different areas, subsidiary ledger give information about sale of different distributors in different areas which is helpful for the management in decision making.

Recording of Bad Debts in Control Accounts

• In case no provision was created for doubtful debts:

Debit Bad Debts

Credit Debtors Control Account

• In case provision was created for doubtful debts:

Debit Provision for Doubtful Debts

Credit Debtors Control Account

• Recording is also made in the respective account of the debtor in subsidiary ledger.

Recording of Discounts Received in Control Accounts

Debit Creditors Control Account

Credit Discount Received Account

Recording is also made in the respective account of the creditor in subsidiary ledger.

Recording of Discounts Allowed in Control Accounts

Debit Discount Allowed Account

Credit Debtors Control Account

Recording is also made in the respective account of the debtor in subsidiary ledger.

Rectification of errors

• In recording transactions, there is always a chance of error.

• There can be clerical errors in the books of Accounts.

• Whatever the reason may be, there may be an error or two in the accounting process.

• Which means that we need a procedure to rectify those errors.

Rectification of errors

• One way is that we can simply erase or overwrite the incorrect entry and replace it with the correct one but this practice is not allowed in accounting.

• We have to Rectify / Correct the mistake by passing another entry.

Types of errors

ERRORS OF OMISSION.

n This means that an event occurred but we did not record it.

ERRORS OF COMMISSION.

n Event is classified and recorded correctly but classification of account is wrong.

ERRORS OF PRINCIPLE

n Entry is recorded in the wrong class of account.

ERRORS OF ORIGINAL ENTRY

n Recording of transaction is in correct account but incorrect figure is recorded.

Types of errors

REVERSAL OF ENTRY

n Entry is reversed by mistake. This means that the account that should have been Debited is Credited and vice versa.

Rectifying the errors

ERRORS OF OMISSION.

nYou have to record the entry that was omitted by mistake.

Example

A sale of Rs. 15,000 made to XYZ on Apr 15, was omitted by mistake

Rectification Entry on the date of discovery

Debit XYZ Account 15,000

Credit Sales 15,000

Narration: Rectification of omission of recording sale to XYZ on Apr 15.

Rectifying the errors

ERRORS OF COMMISSION / ERROR OF PRINCIPLE

nIn both these cases the effect given to incorrect account is reversed and effect is given to the correct account.

Example

Purchase of an asset for Rs. 50,000 is recorded in the expense account.

Rectification

Debit Asset Account 50,000

Credit Relevant Expense Account 50,000

Narration: Rectification of purchase of asset incorrectly recorded as expense.

Rectifying the errors

ERROR OF ORIGINAL ENTRY

nIf the entry recorded is of lesser amount than the required amount, then an entry of the balance amount is passed. On the other hand if the entry recorded is of a greater amount than the required amount, a reverse entry is passed that cancels the effect of the error.

Example

1) A receipt of cash Rs. 5,000 from B is recorded as Rs 500

2) A receipt of cash Rs. 5,000 from B is recorded as Rs 50,000

Rectifying the errors

Rectification

nIn the first instance the recorded figure is less by Rs. 4,500. The rectification entry will therefore be:

Debit Cash Account 4,500

Credit B Account 4,500

nIn the second instance the recorded figure exceeds by Rs. 45,000 from the desired figure. The rectification will, therefore be a reverse entry by Rs. 45,000

Debit B Account 45,000

Credit Cash Account 45,000

Rectifying the errors

• REVERSAL OF ENTRY

nIf a reverse entry is passed by mistake then two entries are required to rectify it, one to reverse the effect of mistake and the other to record correct entry. we can also pass one entry with double amount that serves the purpose of both the entries.

Example

nA payment of Rs. 10,000 made to Mr. D is recorded on the receipt side of the cash book and credit is given to D’s account.

Rectifying the errors

Rectification

nWe can correct this mistake by two entries

Debit Mr. D Account 10,000

Credit Cash Account 10,000

This will reverse the effect of mistake.

Debit Mr. D Account 10,000

Credit Cash Account 10,000

And this will record the transaction correctly.

Or we can record it through one entry.

Debit Mr. D Account 20,000

Credit Cash Account 20,000

Rectification of Errors – Example 2

• Assume that we received cash Rs. 50,000 from a debtor and instead of Debiting the Cash Book / Cash Account we Debited the Bank Book whereas the credit was given to the correct account.

Rectification of Errors

Step 1 Note down the correct entry

Debit Cash 50,000

Credit Debtors 50,000

Step 2 Note down the incorrect entry

Debit Bank 50,000

Credit Debtors 50,000

Step 3 See that Credit affect is correct. In case of Debit, affect has been given to Bank instead of cash. Therefore we will give the due affect to Cash by debiting it and Remove the incorrect affect from bank by crediting it.

Debit Cash Account 50,000

Credit Bank Account 50,000

Examples

Rectify the following errors

• Additional Capital paid in bank Rs. 100,000 credited to sales account.

• Purchase of goods of Rs. 5500 from Mr Amir recorded in books at Rs 5050

• Cash deposited in bank Rs. 20,000 credited to bank and debited to cash

• A purchase of Computer Rs. 25,000 recorded as maintenance expense.

• Completely omitted a payment of bank charges of Rs. 500

Solution

Rectify the following errors

• Additional Capital paid in bank Rs. 100,000 credited to sales account.

• Correct Entry

• Debit Bank 100,000

• Credit Capital 100,000

• Entry recorded

• Debit Bank 100,000

• Credit Sales 100,000

• Rectification

• Debit Sales 100,000

• Credit Capital 100,000

Solution

Rectify the following errors

• Purchase of goods of Rs. 5500 from Mr Amir recorded in books at Rs 5050

• Correct Entry

• Debit Stock 5,500

• Credit Amir 5,500

• Entry recorded

• Debit Stock 5,050

• Credit Amir 5,050

• Rectification

• Debit Stock 450

• Credit Amir 450

Solution

Rectify the following errors

• Cash deposited in bank Rs. 20,000 credited to bank and debited to cash

• Correct Entry

• Debit Bank 20,000

• Credit Cash 20,000

• Entry recorded

• Debit Cash 20,000

• Credit Bank 20,000

• Rectification

• Debit Bank 40,000

• Credit Cash 40,000

Solution

Rectify the following errors

• A purchase of Computer Rs. 25,000 recorded as maintenance expense.

• Correct Entry

• Debit Computers 25,000

• Credit Bank / Cash 25,000

• Entry recorded

• Debit Maintenance 25,000

• Credit Bank / Cash 25,000

• Rectification

• Debit Computers 25,000

• Credit Maintenance 25,000

Solution

Rectify the following errors

• Completely omitted a payment of bank charges of Rs. 500

• Correct Entry

• Debit Bank Charges 500

• Credit Bank 500

• Entry recorded

• -------

• Rectification

• Debit Bank Charges 500

• Credit Bank 500

Profit and Loss Account

Profit and Loss Account

• Sales

n Sales are the revenue against the sale of the product in which the organization deals.

n In case of a service organization, there will be Income Against Services Rendered instead of Sales and there will be no Cost of Sales or Gross Profit.

• Cost of Goods Sold / Gross Profit

n It is the direct cost incurred to manufacture the goods that are sold during the period.

n Gross Profit = Sales – Cost of Goods Sold

Profit and Loss Account

• Other Income

n Other income includes revenue from indirect source of income, such as return on investment, profit on PLS account, Sale of scrap etc.

• Administrative and Selling Expenses

n All costs that are incurred for the purpose of business but are not directly related to production are classified in Admin and Selling Expenses.

• All expenses should be distributed properly among the three classifications i.e. Cost of Goods Sold, Administrative Expenses and Selling Expenses to present the financial statements fairly.

Profit and Loss Account

• Financial Expenses

n Financial expense are the cost / interest paid on loans taken by the organization. These are shown separately in the Profit and Loss Account

Profit and Loss Account

• Income Tax

n Income Tax is paid on Net Profit.

n At the time of preparing annual financial statements, an estimate of expected tax liability is made.

n A provision is then created equal to that estimate.

n The treatment of Provision for tax is same as that of provision for Doubtful debts. i.e. provision is made at the time of preparing accounts which then adjusted accordingly at the time actual tax expense is known.

Balance Sheet (Assets)

• Fixed Assets

n Assets purchased not for resale are called fixed assets and these are presented at cost less accumulated depreciation OR revalued amount.

• Capital Work in Progress

n A fixed asset under completion is shown under this head. At the time of completion it is transferred to fixed assets.

• Deferred Costs

n These are revenue expenditures that benefit the organization for a period longer than one year.

n These are, therefore, initially shown in balance sheet and then charged to profit and loss (amortized) over the period they are expected to provide benefit to the organization.

Balance Sheet (Assets)

• Long Term and Short Term Investments

n Investments made with the intention that they will be held for a period longer than twelve months are classified as long term and those made for a period shorter than 12 months are classified as short term.

Balance Sheet (Assets)

n Following things are important to note here:

o Classification is to be made every time a balance sheet is prepared and the period is to be calculated from the date of balance sheet.

o An investment may initially be made as a current investment. Subsequently, if it is decided to hold it for a longer period. Then, its classification will have to be changed accordingly and vice versa.

n Therefore, investments are checked for classification every time a balance sheet is prepared and presented accordingly.

Classification of Investments

• Long term investments are those investments that are meant to be held for a long term period.

• If it is decided to dispose off a long term investment, then its classification is changed to current investment from long term.

Balance Sheet (Liabilities)

• Capital

n It is the total of resources supplied to a business by its owners.

n Capital is termed as “Share Capital” in case of Limited Companies.

• Capital Introduced By Owner In form of Assets

Debit Fixed Assets Account

Credit Capital Account

• Reserves

nReserve is the portion of profit set aside for use in future years for a specific purpose.

• Profit and Loss / Accumulated Profit and Loss Account

n It is that portion of the profit that is reemployed in the business.

OR

n This is the accumulated balance of undistributed profit.

• Accumulated Profit and Loss Account

n In the first year of business this account shows following figure:

Profit for the year X

Less: Transferred to Reserve X

Less: Profit distributed X

Balance carried to Balance Sheet X

n In Subsequent years balance brought forward from previous years and profit for the year is added and distributed as above and the balance is carried to next year.

• Long Term Loans

nLoans that are payable later than a period of more than twelve months from the balance sheet date.

Short Term Loans

nLoans that are payable within twelve months of the balance sheet date.

• Current Portion of Long Term Loans

nIt is that portion / installment of the long term loan that is payable with in next twelve months.

Other Long Term Liabilities

n These include all other liabilities that are payable after a period of one year of balance sheet date.

nFor example staff gratuity and other benefits, liability against lease finance and other liabilities that become payable after a period of one year.

• Provision

nProvision is charge created for an expected expense or loss whose actual amount is not known.

nIt is usually shown as a reduction in the asset to which it relates

• Reserves

nReserve is the portion of profit set aside for use in future years for a specific purpose.

nIt is usually created at the discretion of the owners an is shown as a liability.

• Current Liabilities

n Trade Creditors

n Short Term Borrowings

n Other Short Term Liabilities

o Salaries Payable

o Accrued Expenses

o Bills payable

o Advances From Customers

n Current Portion of Long Term Liabilities

Different Business Entities

• Commercial Organizations

n Sole proprietorship

n Partnership, and

n Limited Company

• In commercial organizations profit is distributed among the owners of the business.

Different Business Entities

• Non-Commercial Organizations

n Co-operative institutions

n NGO’s

n Trusts

• In non-commercial organizations profit is not distributed but is used for the objective of the organization.

Sole Proprietorship

• Sole Proprietorship is a business owned and run by an Individual called Proprietor / Sole Proprietor.

• It is the simplest form of business.

Partnership

• Partnership is a business owned and run by more than one persons called Partners.

• There can be a maximum of 20 partners.

Partnership

• Partners in a partnership business are Jointly and Severally liable for repayment of partnership’s liabilities.

• The liability of the partners is Unlimited.

Limited Companies

• The liability of the owners is limited to the extent of funds invested by them in the company.

Journal Entries for Drawings Account

• Cash Drawn by Proprietor

Debit Proprietor’s Drawing

Credit Cash

• The balance in drawings account is transferred to Capital Account at the year end.

Sole Proprietor – Capital Account

Balance Sheet - Sole Proprietor

Partnership – Capital Accounts

• Fixed Capital Account

n In this case capital account shows movement in capital only i.e. actual increase or decrease in capital, by partners.

n Other transactions such as Drawings and Profit etc. are not recorded in capital account

• Fluctuating Capital Account

n In fluctuating capital account all transactions relating to partners are recorded in capital account.

Partnership – Current Accounts

• Fixed Capital Account

n In case of fixed capital accounts other transactions such as Drawings and Profit etc. are recorded in a separate account called Current Account.

Partnership – Journal Entries

• Capital Introduced by Partner

Debit Cash / Bank

Credit Partner’s Capital Account

Separate capital account is opened in general ledger for each partner.

Partnership – Journal Entries

• Drawing by Partner

Debit Individual Partner’s Current Account

Credit Cash / Bank

• Excess Drawn Amount Returned by Partner

Debit Bank / cash

Credit Individual Partner’s Current Account

• Profit Distribution

Debit Profit and Loss Appropriation Account

Credit Partner A’s Current Account

Credit Partner B’s Current Account

Credit Partner C’s Current Account

Balance Sheet - Partnership

Limited Companies – Number of Shareholders

• Private Limited Company

n Two to fifty persons can form a private limited company.

n Minimum two members are elected to form a board. This board is given the responsibility to run day to day business of the company.

Limited Companies – Number of Shareholders

• Public Limited Company

n Minimum Seven persons can form a public limited company.

Limited Companies – Shareholders

• Capital of the company is divided into small units / denominations. These units / denominations are called shares.

• Owners purchase these shares and are therefore called shareholders.

Limited Companies – Shareholders

• Capital of the company is divided into small units / denominations. These units / denominations are called shares.

• Owners purchase these shares and are therefore called shareholders.

Distribution of Profits

• The profit of company is distributed in the form of Dividend.

• (5) Fixed Assets at WDV

Cost Rate Dep. WDV

Furniture 72,000 12.5% 9,000 63,000

Vehicle 120,000 20% 24,000 96,000

33,000 159,000

Solution

• Working

• (6) Debtors

Debtors 246,000

Less: Provision for Doubtful

Debts (note 4) (16,500)

229,500

Solution

• Working

• (7) Expenses Payable

Question

• Following trial balance has been extracted from the books of Javed Furniture Manufacturers on June 30, 2002.

Notes:

• Stocks on June 30, 2002

n Raw Material Rs. 60,000

n Finished Goods Rs. 100,000

n Work in Process Rs. 37,500.

• Out of total wages Rs. 450,000 is direct and balance indirect.

• 80% of Rent and Insurance are to be apportioned to factory and balance to administrative office.

• Depreciation to be charged on Machinery at 20% and Office Equipment at 10% on cost.

• Required

You are required to prepare profit and loss account for the year and balance sheet as on june30, 20-2

Solution

Working 1 – Cost of Goods Sold

Cost of Goods Sold Statement

Stock of Raw Material Jul 01, 2001 52,500

Add. Purchases 925,000

Add. Carriage Inward 8,750

986,250

Less: Closing Stock of Raw Material (60,000)

Raw Material Consumed 926,250

Direct labour 450,000

Factory Overheads

General Factory Overheads 77,500

Power 34,250

Rent (80% of 30,000) 24,000

Insurance (80% of 10,500) 8,400

Plant dep. (Note 5) 140,000

Indirect Labour 362,500 646,650

Total Factory Cost 2,022,900

Add: Work in Process Jul 01, 2001 33,750

Less: Work in Process Jun 30, 2002 (37,500)

Cost of Goods Manufactured 2,019,150

Add: Finished Goods Stock Jul 01, 2001 97,250

Less: Finished Goods Stock Jun 30, 2002 (100,000)

Cost of Goods Sold 2,016,400

Cost of Goods Sold Statement

Stock of Raw Material Jul 01, 2001 52,500

Add. Purchases 925,000

Add. Carriage Inward 8,750

986,250

Less: Closing Stock of Raw Material (60,000)

Raw Material Consumed 926,250

Direct labour 450,000

Raw Material Consumed 926,250

Direct labour 450,000

Factory Overheads

General Factory Overheads 77,500

Power 34,250

Rent (80% of 30,000) 24,000

Insurance (80% of 10,500) 8,400

Plant dep. (Note 5) 140,000

Indirect Labour 362,500 646,650

Total Factory Cost 2,022,900

Working 1 – Cost of Goods Sold

Total Factory Cost 2,022,900

Add: Work in Process Jul 01, 2001 33,750

Less: Work in Process Jun 30, 2002 (37,500)

Cost of Goods Manufactured 2,019,150

Add: Finished Goods Stock Jul 01, 2001 97,250

Less: Finished Goods Stock Jun 30, 2002 (100,000)

Cost of Goods Sold 2,016,400

Working 2 – Administrative Expenses

Administrative Salaries 110,000

Rent (20% of 30,000) 6,000

Insurance (20% of 10,500) 2,100

General Admin Expenses 33,500

Office Electricity 18,750

Depreciation Office Equip. (Note5) 5,000

Administrative Expenses 175,350

Working 3 – Selling Expenses

Salesman’s Salary 75,000

Commission on Sales 28,750

Carriage Outward 14,750

Administrative Expenses 118,500

Working 4 – Financial Expenses

Bank Charges 5,750

Discount Allowed 12,000

Administrative Expenses 17,750

Working 5 – Fixed Assets at WDV

Acc. Depreciation WDV

Cost Rate Opening For the Closing

Year

Plant and Mach. 700,000 20% 125,000 140,000 265,000 435,000

Office Equip. 50,000 10% 20,000 5,000 25,000 25,000

145,000 460,000

Working 6 – Current Assets

Stock

Raw Material 60,000

Work in Process 37,500

Finished Goods 100,000

Debtors 355,750

Bank 142,000

Cash 21,250

Current Assets 716,500

Working 7 – Current Liabilities

Creditors 312,500

Mark up on Capital

n A partner may be given markup on the capital invested by him.

n Markup can be calculated on the whole amount or an amount exceeding a specific limit depending upon the terms of the agreement.

Mark up on Drawings

n Markup may also be charged on drawings, depending upon the partnership agreement.

n Markup on capital and drawing do not become part of Profit and Loss Account. They are treated in the appropriation account.

Recording

• Mark up on Capital

Debit Profit and Loss Appropriation Account

Credit Partner A’s Current Account

Credit Partner B’s Current Account

Credit Partner C’s Current Account

Recording

• Mark up on Drawings

Debit Partner A’s Current Account

Debit Partner B’s Current Account

Debit Partner C’s Current Account

Credit Profit and Loss Appropriation Account

Calculation – Mark up on Capital

EXAMPLE

• Mr. Ali is a partner in AB Partnership.

• He is given mark up on capital @ 5 % on the proportionate amount of capital invested during the year.

• The details of his capital account are as follows:

n Opening balance as on July 01, Rs. 150,000

n Further capital invested on December 01, Rs. 75,000

• Calculate the markup on his capital.

Calculation – Mark up on Capital

SOLUTION

• From July 1 to November 30 capital was Rs. 150,000 and From December 1 to June 30 it increased to Rs. 225,000.

• Markup will be calculated as follows:

150,000 x 5% = 7,500 x 5 / 12 = 3,125.00

225,000 x 5% = 11,250 x 7 / 12 = 6,562.50

TOTAL 9,687.50

Calculation – Mark up on Drawings

EXAMPLE

• Mr. Umer is a partner in a partnership firm. He drew following amounts during the year:

n August 1 Rs. 2000

n October 1 Rs. 2500

n November 1 Rs. 1500

n March 1 Rs. 2000

n June 1 Rs. 3000

• Calculate the markup on his drawing if the rate is 5%.

• Consider a financial year from July to June.

Calculation – Mark up on Drawings

SOLUTION

Aug 1 Rs. 2,000 x 5% = 100 x 11 / 12 = 91.67

Oct 1 Rs. 2,500 x 5% = 125 x 9 / 12 = 93.75

Nov 1 Rs. 1,500 x 5% = 75 x 8 / 12 = 50.00

Mar 1 Rs. 2,000 x 5% = 100 x 4 / 12 = 33.33

Jun 1 Rs. 3,000 x 5% = 150 x 1 / 12 = 12.50

TOTAL 281.25

Admission Of A Partner

• At the time of admission of a partner:

n Assets and liabilities are revalued.

n Value of Goodwill is determined.

• The value (in monetary terms) of the reputation of the business is called GOODWILL. It is an intangible asset.

Dissolution Of A Firm

• When a partnership firm is dissolved, first of all, liabilities of the partnership are paid.

• The remaining amount (if available) is distributed among the partners in their profit/loss sharing ratios.

Maximum Number of Partners in a Partnership

• There can be a maximum of Twenty partners in a partnership firm.

• Exceptions – Partnership firms of professional can have more than twenty partners.

What is the Need to Form a Limited Company?

• Size of Project – The size of project may be so large that it constantly requires more capital and therefore a large number of persons is required to finance it.

• Limited Liability – In a limited company liability of the shareholders is limited to the amount invested in the company through the shares purchased.

• Tax Benefits – There are certain tax benefits that a limited company enjoys as compared to a partnership firm.

Limited Companies

• In Pakistan, affairs of Limited Companies are controlled by COMPANIES ORDINANCE issued in 1984.

• The formation of a company and other matters related to companies are governed by SECURITIES AND EXCHANGE COMMISSION OF PAKISTAN (SECP).

Types of Companies

Types of Companies

• Private Limited Company:

n Can not ask public at large to invest in its shares.

n Can have a Minimum Two and Maximum Fifty members / shareholders.

n In case a shareholder decides to sell his shares, his shares are first offered to existing shareholders. If all existing shareholders decide not to purchase these shares, only then an outsider can buy them.

• Private Limited Company (Management):

n Minimum two persons are elected from the shareholders to run the affairs of the company. These persons are called directors.

n These directors form the Board of Directors of the company.

n Head of the board of the directors is called Chief Executive of the company.

Types of Companies

• Public Limited Company

n Restriction mentioned in case of Private Limited Company do not apply to Public Limited Companies.

n Minimum Seven persons can form a limited company. There is no restriction on the number of maximum shareholders in a public limited company.

n Minimum number of directors is Seven.

Types of Public Companies

• Non Listed Company

n A company whose shares are not traded by general public on a stock exchange.

• Listed company

n Listed companies are those companies whose shares are traded on a stock exchange.

• Name of the Company

n Words and parentheses (Private) Limited are added at the end of the name of a private limited company. Example ABC (Private) Limited.

n Word Limited is added at the end of the name of a public limited company. Example ABC Limited.

Formation of Companies

• Steps in the Formation of a Company:

n Availability of name of the company.

n Memorandum and Articles of Association Memorandum of Association

Formation of Companies

• Memorandum of Association

• Contains Following Information

n Objectives of the company.

n Place of registered office of the company

n Capital of the company.

n Division of capital into shares.

n Name, addresses and N.I.C. numbers of the persons forming the company.

Formation of Companies

• Articles of Association

n A document that contain the policies and procedures to run the company.

n These are also signed by the persons forming the company.

Share Capital

• Authorized Share Capital

n Maximum amount of the capital that a company can raise is called Authorized Capital.

n Authorized Capital can be enhanced with the prior approval of SECP.

n This total capital is divided into smaller denominations called shares.

Preliminary Expenses

n All expenses incurred before the registration (incorporation) of the company are called Preliminary Expenses.

Share Capital

• Issued Capital

n The actual amount of capital raised is called Issued Capital.

n It is also called Paid Up Capital.

n Accounting entry is recorded for Issued / Paid Up Capital and not for Authorized Capital.

Share capital

• Authorized Share Capital is the maximum capital, a company may raise.

• It can be increased with the approval of SECP.

Share capital

• Shares can be issued against cash or assets such as land etc.

• Share certificate is an evidence of ownership of number of shares held by a member.

Share capital

• Shares sold at a price higher than their face value are termed as Shares Issued at Premium.

• Shares sold on a price lesser than their face value are termed as Shares Issued on Discount.

Certificate of incorporation

• Certificate of Incorporation is the evidence of registration (incorporation) of the company.• It is issued by the SECP.