Financian Accounting Module

BBAW2103
FINANCIAL
ACCOUNTING
Noor Asma Jamaludin
Nor Asma Lode
Junaidah Hanim Ahmad
Azlan Zainol Abidin
Amin Ali
Norazita Marina Abd Aziz
Project Directors: Prof Dr Mansor Fadzil
Prof Dr Zakaria Ismail
Open University Malaysia
Module Writers: Noor Asma Jamaludin

Nor Asma Lode
Junaidah Hanim Ahmad
Azlan Zainol Abidin
Amin Ali
Norazita Marina Abd Aziz
Universiti Utara Malaysia
Moderators: Assoc Prof Dr Arfah Salleh

Assoc Prof Hashanah Ismail
Universiti Putra Malaysia
Azlina Abdul Aziz

Loo Sze Wei
Rosila Abu Zarin
Translated & Edited: Pearson (M) Sdn. Bhd.
Developed by: Centre for Instructional Design and Technology

Printed by: Meteor Doc. Sdn. Bhd.

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First Printing, April 2008

Second Printing, May 2009
Third Printing, November 2009
Fourth Printing, March 2010
Fifth Printing, October 2010
Copyright © Open University Malaysia (OUM), October 2010, BBAW2103
All right reserved. No part of this work may be reproduced in any form or by any means without
the written permission of the President, Open University Malaysia (OUM).
Version March 2010

Table of Contents
Course Guide ix – xiii
Topic 1 Accounting Environment 1

1.1 Introduction to Accounting 2
1.1.1 Definition of Accounting 2
1.1.2 Users of Accounting Information 2
1.1.3 Branches of Accounting 3
1.1.4 Professional Accounting Bodies in Malaysia 4
1.2 Fundamental Accounting Concepts 6
1.2.1 Qualitative Characteristics of Accounting
Information 6
1.2.2 Accounting Assumptions 10
1.2.3 Basic Principles of Accounting 13
1.2.4 Accounting Constraints 16
1.3 Accounting Equation 17
1.3.1 Analysis of Transaction 18
1.3.2 Summary of Analysis 23
1.4 Types and Objectives of Financial Statement 25
1.4.1 Income Statement 26
1.4.2 Statement of Changes in Owner’s Equity 26
1.4.3 Balance Sheet 27
1.4.4 Cash Flow Statement 28
Summary 34
Key terms 35
Topic 2 Recording Process 36

2.1 Chart of Accounts 37
2.2 Format of Account 39
2.3 Rules of Debit and Credit 41
2.3.1 Normal Balance 42
2.4 Steps in Recording Process 43
2.4.1 Journal 43
2.4.2 Journalising and Posting of Entry 45
2.4.3 Example of Analysis and Summary
of Transaction 51
2.4.4 Trial Balance 77
Summary 83
Key Terms 83
iv X TABLE OF CONTENTS
Topic 3 Completing the Accounting Cycle 84

3.1 Adjusting Entries 85
3.1.1 Prepaid Expenses 86
3.1.2 Depreciation Expenses 88
3.1.3 Unearned Revenue (Unearned Income) 89
3.1.4 Accrued Expenses 91
3.1.5 Accrued Revenue 91
3.2 Preparation of Adjusted Trial Balance 93
3.3 Preparation of Financial Statements 100
3.3.1 Income Statement 100
3.3.2 Statement of Changes in Owner’s Equity 105
3.3.3 Balance Sheet 107
3.3.4 Cash Flow Statement 117
3.4 Preparation of Closing Entries 121
3.4.1 Steps In Preparation of Closing Entries 121
3.5 Preparation of Reversing Entries 124
Summary 128
Key Terms 128
Topic 4 Financial Reporting 129

4.1 Statutory Requirement 129
4.2 Financial Report 132
4.2.1 Non-financial Information 133
4.3 Main Financial Statements 135
Summary 138
Key Terms 138
Topic 5 Trading Business Environment 129

5.1 Trading Business Environment 142
5.2 Important Transactions in Trading Firms 144
5.2.1 Purchases 144
5.2.2 Sales 144
5.2.3 Discounts 145
5.2.4 Returns and Allowances 148
5.2.5 Transportation Cost 150
5.3 Accounting for Inventory 152
5.4 Journal Entry for Periodic and Perpetual
Inventory System 155
5.5 Examples of Recording Journal Entries 160
5.6 Format of Income Statement for Trading Firms 163
5.6.1 Single Level of Income Statement 163
5.6.2 Multiple Levels of Income Statement 164
5.7 Closing Entries 168
Summary 175
Key Terms 175
TABLE OF CONTENTS W v
Topic 6 Financial Statement Analysis 176

6.1 Purpose of Financial Statement Analysis 177
6.2 Sources of Information 178
6.3 Basis of Comparison 179
6.4 Techniques of Analysis 180
6.5 Horizontal Analysis 181
6.5.1 Comparison of Horizontal Analysis
for 2 Years 181
6.5.2 Comparison of Horizontal Analysis
for A Sequential Period (Trend Analysis) 185
6.6 Vertical Analysis 186
6.6.1 Vertical Analysis for Balance Sheet 186
6.6.2 Vertical Analysis for Income Statement 188
6.7 Financial Ratio Analysis 190
6.8 Liquidity Ratio 191
6.9 Efficiency Ratio 194
6.10 Profitability Ratio 194
6.11 Debt Management Ratio 194
6.12 Sample of Ratio Calculations 200
Summary 214
Key Terms 214
Answers 215
Reference 265
COURSE GUIDE
COURSE GUIDES W ix
COURSE GUIDE DESCRIPTION

You must read this Course Guide carefully from the beginning to the end. It tells
you briefly what the course is about and how you can work your way through
the course material. It also suggests the amount of time you are likely to spend
in order to complete the course successfully. Please keep on referring to Course
Guide as you go through the course material as it will help you to clarify
important study components or points that you might miss or overlook.
INTRODUCTION
BBAW2103 Financial Accounting is one of the courses offered by the Faculty of
Business and Management at Open University Malaysia (OUM). This course is
worth 3 credit hours and should be covered over 15 weeks.
COURSE AUDIENCE
This is a core course for students undergoing Bachelor of Management, Bachelor
of Business Administration, Bachelor of Tourism Management and Bachelor of
Hospitality Management. For students undergoing Bachelor of Human Resource
Management, this is basic major course.
As an open and distance learner, you should be able to learn independently and
optimise the learning modes and environment available to you. Before you begin
this course, please confirm the course material, the course requirements and how
the course is conducted.
STUDY SCHEDULE
It is a standard OUM practice that learners accumulate 40 study hours for every
credit hour. As such, for a three-credit hour course, you are expected to spend
120 study hours. Table 1 gives an estimation of how the 120 study hours could be
accumulated.
x X COURSE GUIDES
Table 1: Estimation of Time Allocation of Study Hours
LEARNING OUTCOMES
By the end of this course, you should be able to:
1. Discuss the fundamental concepts of accounting and classify types of
financial statements;
2. Describe the meaning of accounting information, its role and importance;
3. Compute journal entry and illustrate the process of preparing accounting
information and completion of the accounting cycle;
4. Apply management accounting techniques or analyses to assist the
management in decision-making; and
5. Propose and plan an accounting information.
COURSE SYNOPSIS
This course is divided into 6 topics. The synopsis for each topic is presented
below:
Topic 1 discusses the Accounting Environment. Topic 1 introduces you to

accounting fundamentals, involving the definition of accounting, users of
accounting information, branches of accounting, professional accounting bodies
in Malaysia as well as the fundamental concepts found in accounting. Also
discussed are the accounting assumptions and the four main types of financial
statements in financial reporting, namely Income Statement, Statement of
Changes in Equity, Balance Sheet and Cash Flow Statement.
COURSE GUIDES W xi
Topic 2 discusses the Recording Process. It revolves around the usage of accounts
as well as the rules of debit and credit for each type of accounts (asset, liability
and owner equity accounts). The rule of debit and credit will also include the
normal balance for each type of accounts.
The last section in this unit tracks the steps taken in the recording process,
which include the journal entry, transfer of entries to ledger and consequently
the preparation of balance sheet. A complete example of the whole process is
included to provide better understanding.
Topic 3 discusses the types of adjustments entry that affect the accounts in the
income statement and balance sheet. An adjusted trial balance is prepared after
the adjustment entries had been recorded and transferred. Following this, four
types of financial statements will be discussed in detail. The closing entries and
reversal entries will also be covered in this topic.
Topic 4 will discuss the requirements to prepare financial report or annual report
by registered business entities, statutory requirement on financial reporting, main
financial statements and accounting concepts as well as notes to the accounts.
Topic 5 covers accounting for trading, comprising preparation of journal entries

as well as income statement. Emphasis will be given on accounting for inventory
using the perpetual and periodic inventory systems. The preparation of income
statement involving single and multiple levels will also be focused on.
Topic 6 introduces us to financial statement analysis using the horizontal and

vertical analysis and financial ratio analysis. Financial ratio analysis that will be
discussed includes the liquidity, efficiency, profitability and debt management
ratios. These financial analyses are important in decision-making.
TEXT ARRANGEMENT GUIDE

Before you go through this module, it is important that you note the text
arrangement. Understanding the text arrangement should help you to organise
your study of this course to be more objective and more effective. Generally, the
text arrangement for each topic is as follows:
Learning Outcomes: This section refers to what you should achieve after you
have completely gone through a topic. As you go through each topic, you should
frequently refer to these learning outcomes. By doing this, you can continuously
gauge your progress of digesting the topic.
Self-Check: This component of the module is inserted at strategic locations

throughout the module. It is inserted after you have gone through one sub-section
xii X COURSE GUIDES
or sometimes a few sub-sections. It usually comes in the form of a question that

may require you to stop your reading and start thinking. When you come across
this component, try to reflect on what you have already gone through. When you
attempt to answer the question prompted, you should be able to gauge whether
you have understood what you have read (clearly, vaguely or worse you might
find out that you had not comprehended or retained the sub-section(s) that you
had just gone through). Most of the time, the answers to the questions can be
found directly from the module itself.
Activity: Like Self-Check, activities are also placed at various locations or

junctures throughout the module. Compared to Self-Check, Activity can appear
in various forms such as questions, short case studies or it may even ask you
to conduct an observation or research. Activity may also ask your opinion and
evaluation on a given scenario. When you come across an Activity, you should
try to widen what you have gathered from the module and introduce it to real
situations. You should engage yourself in higher order thinking where you might
be required to analyse, synthesise and evaluate instead of just having to recall
and define.
Summary: You can find this component at the end of each topic. This component
helps you to recap the whole topic. By going through the summary, you should
be able to gauge your knowledge retention level. Should you find points inside
the summary that you do not fully understand, it would be a good idea for you
to revisit the details from the module.
Key Terms: This component can be found at the end of each topic. You should
go through this component to remind yourself of important terms or jargons
used throughout the module. Should you find terms here that you are not able to
explain, you should look for the terms from the module.
References: References is where a list of relevant and useful textbooks, journals,

articles, electronic contents or sources can be found. This list can appear in a
few locations such as in the Course Guide (at References section), at the end of
every topic or at the back of the module. You are encouraged to read and refer
to the suggested sources to elicit the additional information needed as well as to
enhance your overall understanding of the course.
ASSESSMENT METHOD
Please refer to myVLE
COURSE GUIDES W xiii
REFERENCES
Horngren C. T., Harrison W. T. Jr. & Bamber L. S. (2002), Accounting (5th ed.),
Prentice Hall, New Jersey.
Larson Kermit D., Wild John J., & Chiappetta Barbara, (2004) Fundamentals
accounting principles, (17th ed.), McGraw Hill.
Roger, H. H et al. (1997), Accounting: A business perspective, (7th ed.), Irwin US.
Warren et. Al (2001), Accounting: Customized by school of accountancy UUM for

business accounting students, Thompson Learning.
Warren C. S., Reeve J. M., & Fess P. E. (2004), Accounting (21st ed.), International
Thompson Publishing, Ohio, USA.
Weygandt Jerry J., Keiso Donald E., & Kimmel Paul D., (2004) Accounting
principles, (7th ed.), John Wiley & Sons, Inc.
Topic  Accounting
Environment
1
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Explain the meaning, role and importance of accounting;
2. Identify the users and branches of accounting;
3. Describe the main functions of professional accounting bodies in
Malaysia;
4. Assess the qualitative characteristics of financial information,
assumptions, principles and constraints in accounting;
5. Apply the accounting equations; and
6. Analyse transactions based on the accounting equation.
 INTRODUCTION
Accounting plays an important role in our daily lives without us realising it.
Accounting is a financial information system that helps us make better economic
decisions.
We might assume that accounting is only important to businessmen or

accountants. In fact, we also need accounting in our daily lives. We need financial
information to make economic decisions. For example, when making a decision
on buying a new car, we need to know the total net revenue in a month (gross
revenues minus all expenses) to know whether we can afford to buy the car. We
also need to estimate other costs that might be involved in having a car.
This example is only a decision at an individual level. For a business entity, it

might need to make a decision on whether to buy a new building or just rent it
for operational purposes. Even though it is a higher level decision, the decision-
maker still requires the necessary financial information.
2  TOPIC 1 ACCOUNTING ENVIRONMENT
In this topic, you will be introduced to the basics of accounting. Among them
are the definition and branches of accounting, users of accounting information,
professional accounting bodies in Malaysia as well as the fundamental concepts
in accounting.
1.1 INTRODUCTION TO ACCOUNTING

1.1.1 Definition of Accounting
Accounting is an information system that prepares reports on the economic
activities of an entity for users to help them make better decisions. More
accurately:
Accounting is a process to identify, measure, record and present the

economic information of an entity to the users in order to help them make
evaluations or economic decisions.
Economic information are information related to economic activities; whereas an

entity refers to a business unit.
1.1.2 Users of Accounting Information

Users of accounting information are parties that use the accounting information
for specific purposes. The information required by the users might differ between
one group and another. Users of accounting information can be divided into two
groups - internal users and external users.
Internal users are parties that have direct access to the resources of an
entity and usually involved in the management of the entity, for example
the management of the company.
External users would be the parties who do not have direct access to the
resources of the company and do not involved in the management of the
company.
TOPIC 1 ACCOUNTING ENVIRONMENT  3
The other differences between these two groups are summarised in Table 1.1.
Table 1.1: Differences between Internal Users and External Users
Internal Users External Users

Types of information Information that can help Information required are
required them make planning and different depending on the
exercise control over the type of decisions made.
entity.
Example:
Investor:
Require information on
the profitability of the
company before making
decision to invest.
Loan providers:
Require information on
the stability and liquidity
of the company before
making decision on giving
out credit.
How does the information Using the status or Limited to what is made
been obtained position in the company. available by the company.
Example
Annual report published
by the company.
1.1.3 Branches of Accounting

Accounting is divided into several different branches or other specialised fields.
Among them are:
(i) Financial Accounting;
(ii) Management Accounting;
(iii) Taxation; and
(iv) Auditing.
These branches are not static as they evolve in time and requirement. This
financial accounting course will combine two of the most basic and important
accounting branches; that are financial accounting and management accounting.
Therefore, it is important for you to know some of the differences between these
two branches. Let’s look at Figure 1.2.
Table 1.2: Differences between Financial Accounting and Management Accounting
Financial Accounting Management Accounting

Preparation of report Preparation of financial Preparation of financial
reports of an entity for and non-financial
external and internal users information that are
but focus is given to the required by parties in the
external users. company for planning,
evaluating and controlling
purposes of the operations
of an entity.
Standard or Format Financial reports produced Report is produced at any
are periodically and in time based on requirement
accordance to specified and is not subject to any
standard or format. standard or format.
1.1.4 Professional Accounting Bodies in Malaysia

We also need to familiarise ourselves with the organisations that are involved in
the accounting profession in Malaysia. The organisations are:
(a) Malaysian Institute of Accountants (MIA)

MIA was established under the Accountants Act 1967 as the main
accounting body in the country. Overall, it functions as the core body in
regulating the accounting profession. Other major functions of MIA as
discussed in the Accountants Act 1967 are:
(i) to set the required qualification in order to become a member;
(ii) to provide training and education for practitioners or those who are
interested in becoming accounting practitioners;
(iii) to control the accounting practices in Malaysia; and
(iv) to protect the accounting interest in Malaysia.
(b) The Malaysian Institute of Certified Public Accountants (MICPA)

MICPA, formally known as “The Malayan Association of Certified Public
Accountants”, was established in 1958 under the Companies Ordinances.
On 6 July 1964, the name was changed to “The Malaysian Association of
Certified Public Accountants” to reflect the change of name from Malaya to
Malaysia. Since February 2002, it is known as “The Malaysian Institute of
Certified Public Accountants”. Among the main objectives and functions of
MICPA are:
(i) to advance the accounting theories and practices in all aspects;
(ii) to train and evaluate the competent members;

(iii) to ensure the independence of professional accountants; and
(iv) to oversee the practices and professional conducts of its members.
(c) Malaysian Accounting Standards Board (MASB)

MASB was established under the Financial Reporting Act 1997. Among the
main functions of MASB are:
(i) to set and approve new accounting standards;
(ii) to revise or accept the usage of existing standards as approved
accounting standards; and
(iii) to develop the conceptual accounting framework.
(d) Financial Reporting Foundation (FRF)

FRF was established under the Financial Reporting Act 1997 together with
MASB. Among the main functions of FRF are:
(i) to provide opinion to MASB on matters to be implemented;
(ii) to evaluate the performance of MASB; and
(iii) to be responsible for the overall funding of the operation of MASB,
including to approve its budget.
EXERCISE1.1
EXERCISE 1.1
1. Provide examples of common decisions made by both internal and
external users.
2. How does Financial Accounting and Management Accounting assist
users in making decision?
WEBSITE
Further information regarding the professional accounting bodies in
Malaysia can be obtained from the following websites:
• Malaysian Institute of Accountants (MIA) www.mia.org.my
• The Malaysian Institute of Certified Public Accountants (MICPA)
www.micpa.com.my
• Malaysian Accounting Standards Board (MASB) www.masb.org.my
• Financial Reporting Foundation (FRF) www.masb.org.my
1.2 FUNDAMENTAL ACCOUNTING CONCEPTS

1.2.1 Qualitative Characteristics of Accounting
Information
In this section, you will be exposed to the qualitative characteristics of accounting
information.
Qualitative characteristics of accounting information refer to the

characteristics that must be present in the accounting information to make
it useful.
These characteristics are divided into two categories; primary and secondary
qualities. The primary qualities of accounting information are relevant and
reliability, while the secondary qualities are comparability and consistency.
In summary, accounting information is only useful if it has relevant, reliability,
comparability and consistency qualities.
Figure 1.1 shows the summary for qualitative characteristics of accounting

information.
Figure 1.1: Qualitative characteristics of accounting information
(a) Relevant
In everyday terms, we might describe relevant as important or being related.
In accounting, relevant is described as something that makes a difference
in arriving at a decision. In other words, something is said to be relevant if
it influences or affects the decision being made.
The extent to which information is considered relevant depends on its

importance in decision making and may differ between one decision maker
to another. Information that is relevant to you might not be relevant to
another person and vice versa.
For example, suppose you are an investor and you intend to buy shares
of a public listed company. What kind of information might be relevant to
your needs? You might want to know the profitability and performance of
the said company for the past five years, including new projects or products
for the company that will be profitable in the future. This information is
relevant as it will influence your decision. Suppose the information that you
obtained showed that the company is experiencing continuous losses for the
past five years and it does not have any new projects. Will you still proceed
with the proposal to invest in the company? Probably not.
Figure 1.2 shows an example of performance information of a company in

order to assist investors in decision making.
Figure 1.2: Performance information of a company to assist investor in decision making.
After knowing the meaning of relevant, you must also know how certain
information are said to be relevant. To become relevant, the information
must have three characteristics, namely feedback value, forecast value and
timeliness.
(i) Feedback Value
Relevant information must be able to assist users in substantiating or
correcting early expectations matters at hand.
(ii) Forecast Value

Relevant information must be able to assist users in forecasting.
(iii) Timeliness
Relevant information must be obtained before it becomes obsolete or
unusable.
(b) Reliability
Reliability means that users can rely or depend on the said information to
make good decisions. This characteristic is important because users might
not have the time or expertise to evaluate some information. Generally,
users simply depend on the information presented by the related entity and
assume it to be true. This information is then used in decision making.
Reliability does not mean that the said information must be precise. This is
because in accounting there are a lot of information that involves estimation
and approximation that might not be precise. What is important is that the
estimation and approximation made must be reliable.
Reliable information must have the following characteristics:

(i) Verifiable
This means that the accounting information could be verified
objectively by another person using the same method.
(ii) Objective
Objective in this case means that the information is not biased.
Information contained in the financial statements must be able to fulfil
the requirements of various users and not concentrating on certain
groups only.
(iii) Trustworthy
Information presented is based on the actual result of economic
activities using specified methods.
(c) Comparability
Comparability means that the information can be compared whether among
companies, industries or different periods. This will enable users to identify
the similarities or differences that might exist in the said information. This
characteristic is important because information that can be compared is
more useful.
Let’s look at an example. Assume that you were told that the net profit of a
business in the year 2009 was RM5 million. Is this information useful? This
information would only be meaningful if you can compare it with the net
profit of the business in the year 2008 or the net profit of other businesses
in the same industry as shown in Figure 1.3. Thus, financial statements
contained in the Annual Report also include information on the previous
year in addition to the current year for comparison purposes.
Figure 1.3: Profitability comparison
(d) Consistency
Consistency means that an entity must use the same accounting procedures
in every period. It is for the purpose of enabling comparison to be made
more effectively. In other words, a company cannot change their accounting
procedure every year. This does not mean that the company cannot change
the accounting procedure at all. Changes can still be made, but the company
must make complete disclosure in the financial statement to explain to
the users why they are making the changes and the effect of the changes
towards the financial statements.
SELF-CHECK 1.1
What are the important qualitative characteristics of accounting

information?
ACTIVITY 1.1
In your opinion, what will happen to a business entity if it only

presents the qualitative characteristics of main accounting information
in its annual report?
EXERCISE 1.2
1. State the qualitative characteristics of accounting information.

2. Explain the meaning of comparability provide an example to
show its role in making accounting information useful.
1.2.2 Accounting Assumptions

In this section you will be exposed to accounting assumptions. There are four
accounting assumptions, created to aid the reporting entity and the users, which
are generally accepted. They are:
(a) Assumption of Separate Entity

For the purpose of accounting, an entity is assumed to be separate from its
owner and also other entities. An accounting entity is an economic entity
in its own right which controls resources involving economic activities.
All activities relating to the accounting entity must be separated from the
owner’s activities or other accounting entities’ activities. The examples
below should explain this concept clearly.
Example 1:
Assume that you own a business, your personal economic activities must
be kept separate from the business’ economic activities. If you wish to
buy products for personal use, you cannot take the business’ money and
assume that as part of the business activities. Instead, you must record it as
drawings. The Drawings Account shows the money or products from the
business taken by the owner for personal use.
Example 2:
Supposing you have just set up a business which offers computer repair
services. As it is a small business and you are the sole proprietor, the
business’ cash is deposited into your private account. Assume that on 31
December 2008, the bank balance of your account is RM5,000. Based on
your record, RM1,000 is the money from your business and the balance of
RM4,000 is funds for your studies.
If you did not comply with the assumption of separate entity and assume
RM5,000 is the money from your business, you might make an inaccurate
business decision. You might feel that your business has adequate funds
while in fact only RM1,000 is the business’ cash. Although all the money
belongs to you, from the accounting perspective, RM1,000 is for the
business funds and the balance of RM4,000 is the money for your education
purposes.
Segregation would enable you to evaluate the financial status of the business
much better and to make accurate decisions to enhance the performance
of the business. If an owner has more than one business entity, each entity
must be assumed as separate entity from the others.
Let’s look at an example

Assuming that Mr. Ali owns three different businesses, all three are
considered to be separated from accounting perspective. Accounting records
must be maintained separately; assets and liabilities for each business
cannot be mixed together. Segregation would enable the owner to know the
performance for each business.
As a simple example, suppose that Mr. Ali’s businesses show the following
result on 31 December 2008:
Table 1.3: Mr Ali’s Business
Business Transaction (RM)

Business 1 Profit 6,000
Business 2 Loss 8,000
Business 3 Profit 12,000
If the assumption of separate entity is not complied with and all the entities
are assumed as one, Mr. Ali will have an overall business profit of RM10,000
[RM6,000 + (-8,000) + RM12,000]. Based on this result, Mr. Ali might be
satisfied and might not take any measures for improvement.
However, by preparing separate accounts, Mr. Ali will know that Business
2 is facing problems as it is suffering a loss of RM8,000, while Business 3 is
performing very well with a profit of RM12,000.
(b) Assumption of Going Concern

According to this assumption, an entity is assumed to continue to exist and
in operation in the future. This assumption is important because it enables
the principle of historical cost to be applied. According to the historical cost
principle, all assets and liabilities must be recorded at the purchase price
(original cost). For most assets, this cost would be depreciated throughout
the life span of the assets to depict its usage. However, asset of property
would not be depreciated as its value would always appreciate.
As an example, a machine with a life span of 25 years will be depreciated for

25 years based on the assumption of going concern. With this assumption,
the entity would continue to exist for a period of more than 25 years. If we
assume that the entity would exist only for another 10 years in absence
of this assumption, we obviously cannot use 25 years as the basis for
calculating the depreciation.
The assumption also enables users to make decisions without any doubt
or worries. Suppose you are interested to invest in a company that has
consistently achieved high profits in the past few years. However, you were
informed that the company would exist only for another five years. Would
you still continue with your plan to invest in the said company? Generally,
we will only invest when we believe the company will continue to exist in
the future.
(c) Assumption of Monetary Unit

According to this assumption, all economic activities are measured and
valued in currency unit. In Malaysia, the currency unit used is Malaysian
Ringgit (RM). Only transactions that can be stated in currency unit will be
recorded for accounting purposes. Currency unit enables the transactions
to be summarised, reported and compared. Before the existence of currency,
transactions were conducted by way of exchanging goods (barter system).
The non-existence of currency unit had created difficulties in ascertaining
the value of transactions. With a country’s standard currency unit, we
would be able to value every product.
However, this assumption has two weaknesses, that are:

(i) It restricts the scope of accounting. Only transactions that can be
measured in monetary terms will be taken into account, neglecting
other factors that have impact on the business.
(ii) It assumes that the value of currency is constantly stable, whereas we
know that the currency value is always changing.
(d) Assumption of Accounting Period

In the assumption of going concern, we assumed that the entity will
continue to operate for an unlimited period. However, users (whether
manager, shareholders, loan providers or other parties) require periodical
measurements to help them making decisions. With this assumption, the
lifetime of the entity is divided into a certain period for the purpose of
reporting its economic activities. Normally the period selected is one year.
Financial reports must be produced every accounting year.
The selected accounting period can start from 1 January and ends on 31
December, or starts from 1 July and ends on 30 June the following year,
and so on depending on the operation of the company. For example, if an
entity is established on 1 March, it might choose an accounting period that
starts from 1 March and ends on 28 February of the following year. This
accounting period can be changed if the entity feels that there is a need to do
so.
Figure 1.4 shows examples of accounting period.
Starting Date Ending Date

1 January 2008 31 December 2008
1 July 2008 30 June 2009
1 March 2008 28 February 2009
Figure 1.4: Examples of accounting period
There are also companies which produce reports within a period of less than a
year, for example monthly, quarterly or half yearly. These reports are known as
interim reports. Interim report is normally produced to fulfil the requirement of
users that might need a more up-to-date report.
ACTIVITY 1.2
There is a company that has obtained high profits consistently for the
past 5 years and would exist for a period of another 10 years. Would
you invest in the company? Explain your decision.
1.2.3 Basic Principles of Accounting

After understanding the qualitative characteristics of information and accounting
assumptions, you will be exposed to the basic principles of accounting, which
are the principles used in the process to identify, measure, evaluate and report
financial information. There are four basic principles that you must know:
(a) Principle of Historical Cost

According to this principle, all business resources will be recorded based
on historical cost, which is the original cost at time of purchase. Although
the value of the resources might change in the future, no adjustment will be
made to recognise the changes in the value.
For example, you want to buy a piece of land for your business site. The
seller set the price at RM80,000. You do not agree with the price and ask
the seller to sell it RM70,000. After negotiation, the seller agreed with the
price of RM72,000. In this case, the land would be recorded at the value
of RM72,000 in your financial statement. Five years later, you wish to

revalue the land. The assessor informed you that the value of the land had
appreciated to RM120,000. Although there is a high appreciation in value,
you must still record it at the value of RM72,000, which is the original cost of
the land during the purchase.
The principle of historical cost is justified by its high reliability. The value
recorded in the financial statement is based on the original cost at the time
of purchase supported by documentation. This advantage is also a weakness
for certain parties. These parties criticised the failure of the principle to
recognise any possible changes in asset value. Regardless, this principle is
still adopted.
(b) Principle of Income Recognition

Principle of income recognition provides guidance regarding when and how
to recognise income. The three conditions that must be complied with before
income is recognised are:
• The seller had performed the necessary actions to obtain the income (for
example, providing the goods for trade or rendering services);
• The amount of income can be measured objectively; and
• The income can be collected.
Normally, income is recognised at the point of sale. The point of sale refers
to a situation whereby ownership has been transferred from the seller to
the buyer, notwithstanding whether the cash has been received or not. For
an entity that offers services, the point of sale is when the service has been
provided to the customer.
However, in certain cases, the point of sale method is inappropriate. There

are several different methods that can be used, for instance the percentage of
completion and cash basis methods.
(i) Percentage of Completion Method is normally used by companies

involved in the construction industry which takes a long time to
complete. For example, a housing project might take three years to
complete. It would be inappropriate to recognise the revenue only after
the project is completed. This is because revenue and expenses accrued
throughout the duration of the project that could be determined
periodically based on the degree of completion. This method is more
appropriate because it complies with the accounting period principle
and provides a true picture of the project development.
(ii) Cash Basis Method complies with the basis of cash accounting.
According to this method, revenue is only recognised when cash is
received. This method is applied in credit transactions when cash
receipts are not assured.
(c) Principle of Matching

This principle matches the expense (effort) with the revenue (benefit
obtained from the effort). The matching of the revenue with the expense will
be done when the transaction has completed. To comply with this principle,
two steps will be involved, which are:
(i) First Step
Recognition of the revenue for a specific period.
(ii) Second Step
Recognition of all the expenses involved in ascertaining the revenue.
For example, when we provide services to customers, we will recognise

the revenue according to the principle of income recognition. Then, we will
recognise all the expenses involved in generating the revenue and match
them with the revenue. The difference between the revenue and the expense
will be either profit or loss. If revenue is more than expense, the difference
will be net profit. However, if the revenue is less than expenses, the
difference will be recognised as net loss. Figure 1.5 summarises the concept
of profit and loss.
Income – Expenses = Profit or Loss
Income > Expenses = Net Profit

Income < Expenses = Net Loss
Figure 1.5: The relationship between revenue and expense
(d) Principle of Full Disclosure

The principle stresses for the full disclosure of all relevant information and
material in the financial statement whether in the statement itself or in
the notes to the accounts. This is to ensure that the users can make proper
decisions. The disclosure of financial statements will be explained in detail
in Topic 4.
ACTIVITY 1.3
1. Explain the weaknesses exist in the assumption of monetary unit.

2. Describe three conditions that must be fulfilled before revenue
can be recognised.
1.2.4 Accounting Constraints

We have seen the principles that must be complied with in accounting. However,
there are constraints or obstructions that might result in these principles not being
complied with. The main constraints in accounting are:
(a) Cost-Benefit Relationship

Before deciding on obtaining specific information, a company would
normally analyse the cost involved and the benefit that may be gained
from the information. If the cost of obtaining the information is very high
but the benefit generated is not so much, the company might not reveal the
information even though all information must be completely disclosed in
accordance with the principle of full disclosure.
(b) Materiality
Materiality refers to the effect of an item towards the overall operation of
the entity. An item is considered immaterial if it does not affect the decision
that will be made. Materiality is often measured based on size. A transaction
that involves a huge amount is normally treated as material. A material
transaction must be disclosed in detail, while immaterial transactions are
sometimes combined or not disclosed in detail.
For example, a small amount of expense like a purchase of stamps and

fares are combined into one account known as sundry expenses. Another
example will be the practice of approximation. You can see examples in the
annual report published by companies. Generally, companies would not
record the cents value, but instead will round the figures up to the nearest
ringgit (example: RM471.20 is recorded as RM471). For larger companies,
it might make the approximation to the nearest hundred ringgit (example:
RM525,795 is recorded as 525,800).
1.3 ACCOUNTING EQUATION

Accounting equation is the basis of accounting that will always be used each time
we record a transaction. It consists of three components or basic elements, which
are asset, liability and owner’s equity.
What is asset? Asset is the resources that can bring economic benefit, owned by
the entity. For example, cash, building and fittings.
For each resource, there must be a claim or rights on it. A simple example, if you
own some money, the money belongs to you. If you buy a vehicle with bank loan,
the ownership of the vehicle is claimed by the bank until you have settled your
loan. In other words, the vehicle is not owned by you (but is owned by the bank)
until you have settled your entire loan.
It is the same in business. Every asset owned by the business can be claimed
either by the owner itself, or loan providers. Rights or claims made by the loan
providers are known as liabilities, whereas the rights or claims made by the
owner itself are known as equities.
Loan providers have priority over the rights to the business assets. If the entity is
facing problems, it must first settle its loans. The owner can only claim his rights
if there are assets left. Therefore, liability is put ahead of owner’s equity in the
accounting equation as shown below:
ASSET = LIABILITY + OWNER’S EQUITY
SELF-CHECK 1.3
A business has assets of RM120,000. RM50,000 is the owner’s capital

and the balance is bank loan. What is the accounting equation?
1.3.1 Analysis of Transaction

You must always remember that the accounting equation is always equal
regardless of the transaction that has transpired. All transactions can be stated by
changes in the three components of the accounting equation. Now we will look at
a few common transactions and analyse the results on the accounting equation.
We will use the example of a sole proprietor business owned by Reen. Reen, who
is skilled in the computer field, has established her own company on 1 November
2008. For a start, the business (Reen Cyber Service) offers services in computer
consultancy. If successful, Reen intends to expand her business to selling
computers. The following is a list of transactions incurred by Reen Cyber Service
throughout the month of November 2008:
Table 1.3: List of Transactions for Reen Cyber Service, November 2008
No. Date (Nov) Transactions

1 1 Reen invested cash of RM30,000 into Reen Cyber Service.
2 2 Purchased a piece of land valued at RM20,000. The business
paid cash RM5,000 and the balance is financed by bank loan.
3 4 Purchased office supplies valued at RM2,700 on credit.
4 15 Received revenue from consultancy services provided to
customer. The customer paid RM15,000 cash.
5 30 Paid staff salary expense RM4,250; rental expense RM1,600;
utility expense RM900 and other expenses RM550.
6 30 Made payment for account payable of RM1,900.
7 30 Unused office supplies valued at RM1,100.
8 30 Reen withdrew money from the business amounting to
RM4,000 for her personal use.
All the transactions above are pertaining to Reen Cyber Service. The personal
transactions of the owner (Reen) will not be taken into account if it does not
involve the business. Now we have to analyse each transaction to see their effects
on the accounting equation.
Transaction 1:
Reen invested cash of RM30,000 into Reen Cyber Service. Again, it needs to be
emphasised that we are only interested in transactions involving Reen Cyber
Service, and not Reen’s personal transactions. Therefore, even though the cash
owned by Reen was reduced by RM30,000, the cash owned by Reen Cyber
Service has increased by RM30,000. This capital was contributed by Reen.
Therefore, owner’s equity will increase by RM30,000.
Transaction ASSET = LIABILITY + OWNER’S EQUITY

Cash Capital, Reen
1 30,000 = 30,000
Transaction 2:
The business entity purchased a piece of land valued at RM20,000, paying
RM5,000 by cash and the balance of RM15,000 being financed by bank loan.
From this transaction, the business will have a new asset (land) valued at
RM20,000. The business’ cash is reduced by RM5,000 while a new liability of
RM15,000 is created. Bank loan is always represented by the account Notes
Payable (NP). Note that the equation still holds true. The asset section increased
by RM15,000 and the liability section also increased by RM15,000.
“Balance” shows the final balance for each item after every transaction.
OWNER’S
Transaction ASSET = LIABILITY +
EQUITY
Cash + Land NP Capital, Reen
Balance 30,000 = 30,000
2 (-5,000) + 20,000 = 15,000
Balance 25,000 20,000 = 15,000 30,000
Transaction 3:
Purchased office supplies valued at RM2,700 on credit. The asset will increase
by RM2,700. The purchase by credit will create a new liability, which is Account
Payable (AP).
OWNER’S
EQUITY
Cash + Land + Supplies NP + AP Capital,
Reen
Balance 25,000 + 20,000 = 15,000 + 30,000
3 2,700 = 2,700
Balance 25,000 20,000 2,700 = 15,000 2,700 30,000
Normally, office supplies bought are not only used in the current accounting
period. The purchase of office supplies are prepaid expenses. The usage of
office supplies for the specific period is recorded by using the account Supplies
Expenses.
Transaction 4:
Received revenue from consultancy services provided to customer. The customer
paid RM15,000 cash.
OWNER’S
EQUITY
Reen
Balance 25,000 + 20,000 + 2,700 = 15,000 + 2,700 + 30,000
4 15,000 = 15,000
service
revenue
Balance 40,000 20,000 2,700 = 15,000 2,700 45,000
Service revenue is one of the components in owner’s equity. The other

components are expenses and drawings. Revenue will increase the owner’s
equity while expenses and drawings will reduce it.
Figure 1.6 shows the effect of revenue, capital, expenses and drawings on owner’s
equity.
Revenue ↑ = Owner’s equity ↑

Capital ↑ = Owner’s equity ↑
Expenses ↑ = Owner’s equity ↓
Drawings ↑ = Owner’s equity ↓
Figure 1.6: Analysis of transaction
Transaction 5:
Paid salary expense RM4,250; rental expense RM1,600; utility expense RM900
and other expenses RM550.
OWNER’S
EQUITY
Reen
Balance 40,000 + 40,000 + 2,700 = 15,000 + 2,700 + 45,000
5 (-4,250) = (-4,250)
paid salary
(-1,600) (–1,600)
paid rental
-900 (-900)
paid utility
-550 (-550)
paid
sundry
Balance 32,700 + 20,000 + 2,700 = 15,000 + 2,700 + 37,700
In this transaction, all the expenses were paid by cash. Therefore, cash will
decrease according to the amount involved. Each expense item has to be recorded
separately and cannot be combined. As explained in transaction 4, expenses will
reduce owner’s equity.
Transaction 6:
Made payment for account payable of RM1,900. When the business paid
RM1,900, cash will decrease by RM1,900 and liability will also decrease by
RM1,900.
OWNER’S
EQUITY
Reen
Balance 32,700 + 20,000 + 2,700 = 15,000 + 2,700 + 37,700
6 (-1,900) = -1,900
Balance 30,800 + 20,000 + 2,700 = 15,000 + 800 + 37,700
Transaction 7:
At the end of the month, the unused office supplies were valued at RM1,100. The
office supplies was originally bought for RM2,700. The value of office supplies
used up during the period is RM1,600 (RM2,700 – RM1,100)
OWNER’S
EQUITY
Reen
Balance 30,800 + 20,000 + 2,700 = 15,000 + 800 + 37,700
7 -1,600 = -1,600
Supplies
expenses
Balance 30,800 + 20,000 + 1,100 = 15,000 + 800 + 36,100
Transaction 8:
Reen withdrew money from the business amounting to RM4,000 for her personal
use.
OWNER’S
EQUITY

Reen
Balance 30,800 + 20,000 + 1,100 = 15,000 + 800 + 36,100
8 (-1,600) = (-4,000)
cash
drawings
Balance 26,800 + 20,000 + 1,100 = 15,000 + 800 + 32,100
Drawings is the reverse of capital investment. Capital investment will increase

the capital (example in the form of cash) of the business. Drawings will reduce the
capital. At the end of the accounting period, the drawings account will be closed
and the balance will be transferred to the capital account. Therefore, drawings
will be recorded as a reduction in capital account. Although both drawings and
expenses reduced capital, there is a clear difference between these two types of
accounts. Drawings are not for the purpose of generating revenue, but for the
owner’s personal use.
1.3.2 Summary of Analysis

Some important items that we must be aware of during the analysis of
transaction:
(a) Each transaction will affect, either as an increase or decrease, one or more
components in the accounting equation. However, each transaction will
definitely involve more than one item in the financial statements;
(b) The accounting equation explained at the earlier stage will always be equal.
You can examine this yourself by looking into the “Balance” section after
every transaction analysis; and
(c) Owner’s equity will increase with investment from the owner and revenue,
while drawings by the owner and expenses will reduce owner’s equity.
Table 1.4 is a summary of analysis for all the transactions of Reen Cyber Service.
After all the transactions have been recorded, we will discover that the accounting
equation will still be equal.
Table 1.4: Analysis of Transaction for Reen Cyber Service, November 2008
OWNER
EQUITY
Reen
1 30,000 = 30,000
investment
by Reen
Balance 30,000 = 30,000
2 -5,000 20,000 = 15,000
Balance 25,000 20,000 = 15,000 + 30,000
3 + 2,700 = 2,700
Balance 25,000 + 20,000 + 2,700 = 15,000 + 2,700 + 30,000
4 15,000 = 15,000
service
revenue
Balance 40,000 + 20,000 + 2,700 = 15,000 + 2,700 + 45,000
5 (-4,250) = (-4,250)
paid salary
(-1,600) (-1,600)
paid rental
(-900) (-900)
paid utility
(-550) (-550)
paid sundry
Balance 32,700 + 20,000 + 2,700 = 15,000 + 2,700 + 37,700
6 (-1,900) = -1,900
Balance 30,800 + 20,000 + 2,700 = 15,000 + 800 + 37,700
7 -1,600 = (-1,600 )
expenses
supplies
Balance 30,800 + 20,000 + 1,100 = 15,000 + 800 + 36,100
8 (-4,000) = (-4,000) cash
drawings
Balance 26,800 + 20,000 + 1,100 = 15,000 + 800 + 32,100

47,900 = 15,800 + 32,100
47,900 = 47,900
1.4 TYPES AND OBJECTIVES OF FINANCIAL

STATEMENT
After the transactions have been identified, analysed and recorded, we need to
prepare a report for the users. This report is the final product of the accounting
process and is known as financial statement. There are four types of financial
statement that you need to know:
(a) Income Statement;
(b) Statement of Changes in Owner’s Equity;
(c) Balance Sheet; and
(d) Cash Flow Statement.
These statements are interconnected with one another. The title for each statement
must contain the reporting entity’s name, type of statement and the reporting
period covered. In this section, we will see in summary, the format for each of the
four statements based on the transactions for Reen Cyber Service. We will learn
about the preparation of each statement in detail in Topic 3.
Figure 1.7: Types of business
Let us take a look at Figure 1.7. Generally, businesses are divided into three types,
which are sole proprietorship, partnership and company. Sole proprietorship is
owned by a single owner while partnership is owned by 2 to 20 owners. Financial
statements for these two types of business are not subject to the standards
released by MASB. Therefore, there might be several formats used by these two
types of business.
Companies are divided into private limited and public listed companies. Private
limited companies can be owned by 2 to 50 owners. However, there are unlimited
number of owners for public listed companies. The preparation of financial
statements for companies is subject to the standards released by MASB, whether
in the form of accounting method, disclosure and reporting format.
1.4.1 Income Statement

This statement is also known as Profit and Loss statement which lists all
the revenues and expenses incurred by the entity for a specific period. The
difference between the revenue and expense will result in either net profit or
net loss. Excess of revenue over expense will give us net profit, while expense in
excess of revenue will give us net loss. Figure 1.8 shows the income statement for
Reen Cyber Service for the month ended 30 November 2008.
Reen Cyber Service

Income Statement
for the month ended 30 November 2008
RM RM
Service revenue 15,000
Expenses:
Salary expenses 4,250
Rental expenses 1,600
Utility expenses 900
Supplies expenses 1,600
Sundry expenses 550 (8,900)
Net profit 6,100
Figure 1.8: Income statement
1.4.2 Statement of Changes in Owner’s Equity

This statement shows the changes in owner’s equity for a specific accounting
period. Owner’s equity will increase when the owner makes a capital investment
or when the entity gains net profit. Owner’s equity will decrease when the
owner makes drawings or when the entity incurs net loss. Figure 1.9 shows the
statement of changes in owner’s equity for Reen Cyber Services.
Reen Cyber Service

Statement of Changes in Owner’s Equity
RM
Opening Capital – 1 November 30,000
(+) Net profit 6,100
36,100
(-) Drawings (4,000)
Closing Capital – 30 November 32,100
Figure 1.9: Statement of changes in owner’s equity
1.4.3 Balance Sheet

This statement is also known as the financial position statement, listing all the
assets, liabilities and owner’s equity of the entity on a specific date. The purpose
of this statement is to show the financial status of the entity on a specific date.
There are two formats normally used, which are the statement format and
accounts format. The accounts format places the asset on the left side with
liability and owner’s equity on the right side (refer to Figure 1.10 and Figure 1.11)
Reen Cyber Service

Balance Sheet as at 30 November 2008
ASSETS RM LIABILITIES AND OWNER’S EQUITY RM
Current Assets: Liabilities:
Cash 26,800 Current Liability:
Supplies 1,100 Account payable 800
27,900 Non-current liability:
Non-current Notes payable 15,000
Assets:
Land 20,000 Total liabilities 15,800
Owner Equity:
Capital 32,100
TOTAL LIABILITIES AND
TOTAL ASSETS 47,900 OWNER’S EQUITY 47,900
Figure 1.10: Balance Sheet in accounts format

In the statement format, the asset, liability and owner’s equity are listed
vertically.
Reen Cyber Service

Balance Sheet
as at 30 November 2008
RM RM
Non-current Assets:
Land 20,000
Current Assets:
Cash 26,800
Supplies 1,100
27,900
Less: Current liability:
Account payable (800)
27,100
Net current assets 47,100
Financed by:
Owner’s equity: 32,100
Capital, Reen
Non-current liability:
Notes payable 15,000
47,100
Figure 1.11: Balance Sheet in statement format
1.4.4 Cash Flow Statement

This statement reports all the cash receipts and payments of the entity in a specific
period. Through this statement, the users will know the sources of cash received
and why cash is paid. The difference between cash inflows and outflows will
provide the final cash account balance of the entity. This balance will be the same
as the cash amount shown in the Balance Sheet. In the cash flow statement, cash
transactions are divided according to the type of activities, which are operating,
investing and financing activities. Figure 1.12 shows the cash flow statement for
Reen Cyber Services.
Reen Cyber Services

Cash Flow Statement
RM RM RM
Cash from operating activities:
Cash received from customers 15,000
(–) Expenditure paid 7,300
Payment to supplier 1,900 (9,200)
Net cash flow from operating activities 5,800
Cash from investing activities:

Payment for purchase of land (5,000)
Net cash flow from investing activities (5,000)
Cash flow from financing activities:

Investment by owner 30,000
(–) Drawings by owner (4,000)
Net cash flow from financing activities 26,000
Net cash flow for entity and cash account balance as at 26,800
30 November
Figure 1.12: Cash flow statement
ACTIVITY 1.3
Discuss the issues that might arise if a business entity did not disclose
the relevant information in its financial statement. Present in your
tutorial.
EXERCISE 1.4
Fill the blanks with the most accurate answer:
(a) Financial statement prepared on a yearly basis complies with the

assumption of ______________.
(b) The principle that requires the economic resources of the entity to be
recorded at the original cost at time of purchase is the principle of
___________.
(c) _____________ information must have feedback value, forecast value

and is presented on a timely basis.
(d) The professional body responsible for setting the accounting

standards in Malaysia is ______________.
(e) The qualitative characteristic that enables users to depend or rely on

the information presented is _____________.
(f) The principle that matches the revenue with the expenses in the
specific accounting period is ___________________.
(g) Not all accounting information can be disclosed in detail due to

constraints of ___________________ and __________________.
(h) The branch of accounting that prepares specialised information

for internal users and not subject to specified standard or format is
______________.
(i) According to the assumption of _____________, the entity is

assumed to continue to exist and in operation in the future.
(j) Revenue is normally recognised when ________________.
(k) The statement that shows the cash flow of an entity for a specific
period is _______________.
(l) ____________________ lists all the assets, liabilities and owner’s

equity of an entity in a specific period.
EXERCISE 1.5
1. If revenue = RM12,000; expense = RM8,400 and drawings by owner

= RM2,000; how much is the net profit or net loss for that period?
A. Net profit RM5,600
B. Net loss RM3,600
C. Net profit RM1,600
D. Net profit RM3,600
2. Which of these is NOT a qualitative characteristic of accounting

information?
A. Materiality
B. Reliability
C. Relevant
D. Comparability
3. One example of internal user is:

A. Inland Revenue Board
B. Investor
C. Creditors
D. Management
4. If the total assets increased by RM15,000 and the total liabilities

decreased by RM10,000; owner’s equity had:
A. increased by RM5,000
B. decreased by RM5,000
C. increased by RM25,000
D. decreased by RM25,000
5. For the purpose of simplifying accounting, the business owner and

business entity are assumed as the same.
True False
6. The accounting period for all businesses must start from 1 January
and ends at 31 December each year.
True False
7. Income statement shows the net profit or loss of a business entity at

a specific date.
True False
EXERCISE 1.6
Answers the questions below.
1. Determine the appropriate amount in the spaces marked “?”

(a) 84,000 = ? + 38,000
(b) ? = 72,000 + 28,000
(c) 125,000 = 50,000 + ?
2. State the effects of the following transactions on the asset, liability

and owner’s equity. An example is shown in transaction (a):
Transaction Effect
(a) Paid debts to supplier. Asset decreased, Liability
decreased.
(b) Purchased office equipment
by cash.
(c) Owner took cash from the
business for personal use.
(d) Paid staff salary for the
current period.
(e) Received cash from customer
to settle his account
receivable.
(f) Owner contributed office
equipment for business use.
3. Mr. Ashwin established a tour agency on 1 June 2007. The

transactions for the month are as follows:
(a) Deposited cash into the business account totalling RM20,000.
(b) Purchased supplies on credit for RM800.
(c) Made payment to supplier for RM620.
(d) Received cash on the services provided for RM4,200.
(e) Paid staff salary of RM1,000.
(f) Paid transportation of RM700 and sundry expenses of RM150.
(g) Paid office rental of RM1,200.
(h) Charged customer RM2,500 for services provided.
(i) Supplies unused at the end of the period is valued at RM250.

(j) Mr. Ashwin took cash from the business totalling RM750 for his
personal use.
Required:
(a) State the effect of each transaction and the balance after each
transaction using the accounting equation format that you have
learned.
(b) Create the accounting equation for Mr. Ashwin business after
the last transaction for that month.
4. Below are the assets and liabilities accounts balances for Seri
Consultation Services as at 31 December 2008 including the revenue
and expense incurred throughout the year 2008. On 1 January 2008,
the capital of Miss Seri Devi (the owner) is RM22,200. Throughout
the year, she made a cash drawings of RM6,000 but no records of it
has been made.
Account Amount (RM)

Accounts payable 1,200
Accounts receivable 18,755
Supplies 8,480
Tax expenses 4,200
Sundry expenses 1,265
Utility expenses 7,350
Service income 78,750
Cash 23,300
Required:
Based on the information given, prepare:
(a) Income statement for the year ended 31 December 2008.
(b) Statement of Changes in Owner’s Equity for the year ended 31
December 2008.
(c) Balance Sheet as at 31 December 2008.
SUMMARY
In this topic, you have learned and discovered:

• The users of accounting information consist of internal users and external
users.
• The difference between financial accounting and management accounting
are:
– Financial accounting prepares the financial report for external users
while management accounting prepares the monetary and non-financial
information for internal users.
– The financial reports in financial accounting is produced periodically and
subject to specified format while the report for management accounting
is produced according to specific needs and not subject to specified
standards.
• The professional bodies involved in the accounting profession are Malaysian
Institute of Accountants (MIA), The Malaysian Institute of Certified Public
Accountants (MICPA), Malaysian Accounting Standards Board (MASB) and
Financial Reporting Foundation (FRF).
• The assumptions and fundamental principles of accounting consist of:
– assumption of separate entity;
– assumption of going concern;
– assumption of monetary unit;
– assumption of accounting period;
– principle of historical cost;
– principle of income recognition;
– principle of matching; and
– principle of full disclosure.
• The accounting equation is fundamental in accounting and it consists of
three components, namely asset, liability and owner’s equity.
• Financial statement is the final product of the accounting process and it
consists of Income Statement, Statement of Changes in Owner’s Equity,
Balance Sheet and Cash Flow Statement.
Accounting Management Accounting

Auditing Monetary Unit
External Users Qualitative Characteristics
Financial Accounting Taxation
Internal Users
Topic  Recording
Process
2
LEARNING OUTCOMES
1. Describe the chart of accounts for recording and summarise the effect
of transactions on financial statement;
2. Explain the format of accounts used;
3. Assess the rule of debit and credit for each type of accounts;
4. Prepare journal entries;
5. Post journal entries to ledger; and
6. Prepare trial balance.
 INTRODUCTION
After studying how to analyse transactions, we will now learn about recording.
Recording is the most important step in accounting for a business entity.
However, before recording, we must identify the event that had occurred. Only
events that occur to the business entity will be recorded in the entity’s book. Not
all events are transactions, for example, recruitment of staff. Although it will
affect the entity economically, this event is not considered as a transaction.
TOPIC 2 RECORDING PROCESS  37
2.1 CHART OF ACCOUNTS

When we analysed the transactions in the example of Reen Cyber Service,
we have recorded and summarised the transactions that occurred using the
accounting equation format. Although this format is easy to understand, it will
become difficult to use when there are a lot of transactions to be recorded daily.
In the example in Topic 1, we have analysed 8 transactions in a period of one

month. In an actual situation, a medium-sized service firm may have several
transactions in a day. If we use that accounting equation format, we will need a
huge amount of space. Whenever there is a new item, we must add it into the
limited columns available. We need to reshuffle the whole original format to
accommodate this change. This also applies if errors are detected. It would be
difficult for us to make any alteration without re-arranging the whole original
format.
As a result, the accounting system was created to show the increase or decrease
of each item in the financial statement separately. The separate recording of each
item is known as account. As an example, cash account is a separate recording
especially to show the increase or decrease in the cash item. This also applies to
other items like account payable, service revenue and salary expense.
The group of accounts in a business entity is known as ledger. The list of

accounts in the ledger is known as a chart of accounts. Chart of accounts was
created particularly to enable the users of financial statements to refer to specific
accounts. Each account is given a special number as reference. These accounts are
normally listed systematically in the financial statement. Normally in the chart of
accounts, balance sheet items (asset, liability and owner’s equity) are put in front,
followed by income statement items (revenue and expense).
SELF-CHECK 2.1
Why must transactions be recorded in accounts and not some other

format?
38  TOPIC 2 RECORDING PROCESS
Figure 2.1 summarises the concept of ledger and chart of accounts.
Figure 2.1: Ledger and chart of accounts
Figure 2.1 explains the chart of accounts clearly. This chart will be used as an
example in this topic. New accounts will be introduced in the following units
when the entity increases its business scope. The chart is created by the entity
itself. Therefore, the chart of accounts between one entity and another entity
might be different.
Table 2.1 shows the chart of accounts for Reen Cyber Service. Its chart of accounts
consists of only two digits. The first digit will show the type of account (example:
1 for asset account, 2 for liability account, 3 for owner’s equity account, 4 for
revenue account and 5 for expense account). The second digit will show the
account itself. For larger businesses, the chart might consist of three to four digits.
If the entity has a branch at different location, the first digit might be used to
show the branch location.
Table 2.1: Chart of Accounts for Reen Cyber Service
Accounts in Balance Sheet Accounts in Income Statement
1 ASSETS 4 REVENUE
11 Cash 41 Service revenue
12 Account receivable
14 Supplies
15 Insurance prepayment
17 Land
18 Office equipment
2 LIABILITIES 5 EXPENSES
21 Account payable 51 Salary expenses
22 Notes Payable 52 Rental expenses
23 Deferred Rental 53 Utility expenses
54 Supplies expenses
3 OWNERÊS EQUITY
55 Sundry expenses
31 Capital, Reen
32 Drawings, Reen
EXERCISE 2.1
Which of these events can be considered as a transaction and must be

recorded? Explain.
(a) The death of a branch manager.
(b) The capital contribution of the owner into the business.
2.2 FORMAT OF ACCOUNT

Each account has three sections:
(a) Title or name of the account, which is the name of the items recorded in that
particular account.
(b) Debit section on the left side.
(c) Credit section on the right side.
The debit and credit section are used to record either the increase or decrease in
the specific account. However, do remember that, debit does not necessarily show
an increase and that credit does not necessarily show a reduction. It depends on
the type of account. This subject will be explained in detail later under the rule of
debit and credit.
Accounts are also known as T-accounts due to their shapes that look like the
letter T.
Account Title
Debit Credit
(left) (right)
Figure 2.2: T-Account (simple format )
Each section of the T-account should have four columns in the debit section and
four columns in the credit section.
Debit Account Title Credit
Date Description Reference Amount Date Description Reference Amount
Figure 2.3: T-Account (detailed format )
There is another format of account known as the three column account. Although
in fact there are actually six columns in this account’s format, the three columns
refer to the debit, credit and balance columns. An advantage of this format is that
it can show the latest account balance at any particular time.
Date Description Reference Debit Credit Balance
Figure 2.4: Three column account format

2.3 RULES OF DEBIT AND CREDIT

We have previously stated that asset, liability and owner’s equity are the three
main components in the accounting equation. Other items that are involved
include drawings, revenue and expense. Every transaction that occurs will
involve debit and credit and every transaction will affect at least two accounts.
For every transaction, the total debit must be equal to the total credit. This is the
basis of the double entry system. This rule of debit and credit is important to
ensure that we make accurate recording. Table 2.2 shows the rules of debit and
credit for each type of accounts.
Table 2.2: Rules of Debit and Credit
Type of Account Increase Decrease
Asset Debit Credit
Liability Credit Debit
Capital Credit Debit
Drawings Debit Credit
Revenue Credit Debit
Expense Debit Credit
Do you understand the rules listed in Table 2.2? Table 2.2 shows that when the
asset account increases, we will debit the said account. For example, when the
entity receives cash, we will debit cash account.
When the asset account decreases, we will credit the said account. For example,
when the entity made cash payment, we will credit the entity’s cash account.
Referring to Table 2.2, we will discover that the nature of the asset account is
opposite to that of the liability and owner’s equity accounts. To observe this more
clearly, please refer back to the accounting equation we had learned:
The asset item is on the left side while the liability and owner’s equity are on the
right side. Asset is the economic resources owned by the entity while liability and
owner equity are parties claiming ownership on the asset. Therefore, asset is the
opposite of liability and owner’s equity.
SELF-CHECK 2.2
Identify the characteristics that allow an event to be viewed as a

transaction and therefore must be recorded?
2.3.1 Normal Balance

Normal balance is included in the rule of debit and credit. This refers to the
balance ordinarily shown in the account.
Let us take the asset account as an example. When asset increases, the account
is debited. When asset decreases, the account is credited. Therefore, the normal
balance for asset account is debit. This is because the reduction in asset normally
would not exceed the increase that had occurred. As a simple example, if we have
cash of RM1,000 in the bank, normally we cannot withdraw more than the said
value. Table 2.3 shows the rules of debit and credit including the normal balances
for each type of accounts.
Table 2.3: The Rules of Debit and Credit Including Normal Balances
Type of Account Increase Decrease Normal Balance
Asset Debit Credit Debit
Liability Credit Debit Credit
Capital Credit Debit Credit
Drawings Debit Credit Debit
Revenue Credit Debit Credit
Expense Debit Credit Debit
Note that the normal balance for each account is the same as the increase in the
said account.
The rule of normal balance is important as it may help you to identify errors.
For example, if the land account has a credit balance, you might have made a
mistake in recording. However, you must also remember that normal balance
is the balance that is ordinarily shown. The cash account that normally has a
debit balance can also have a credit balance. This occurs when a company has
withdrawn more cash than what is available. This might occur if the company
has an overdraft agreement with the bank. When an entity has an overdraft
agreement with the bank, it will be allowed to withdraw more money than what
it is available in its account. The amount that can be withdrawn is subject to
agreement.
ACTIVITY 2.1
Identify the characteristics that allow an event to be viewed as a

transaction and therefore must be recorded? Discuss.
2.4 STEPS IN RECORDING PROCESS

Once the entity’s transactions are identified, they must be recorded according
to the accounting procedure specified. Recording begins with journal entry,
then post to ledger and finally preparation of trial balance. This process can be
illustrated in Figure 2.5.
Figure 2.5: Steps in recording process
2.4.1 Journal
Journal is the first book to be used in the recording process. Recording in
journals (journalising) is the first process of recording. Transactions are recorded
chronologically in the journal before been transferred to ledger. There are two
main types of journal, the general journal and special journal.
(a) General Journal

General journal is the journal normally owned by all entities. This journal
can be used to record all kinds of transaction like sales, purchases, cash
receipts and cash payments.
(b) Special Journal

Large businesses normally have many transactions. Special journals are
created to avoid confusion due to many entries made in the general journal.
The type of special journal created depends on the needs of the entity.
For example, an entity that have numerous cash transactions might want to
create Cash Receipts Journal and Cash Payment Journal that will be specially
used for cash transactions. All the other transactions can still be recorded in
the General Journal. This segregation will simplify recording and control.
Among the special journals that are commonly used are:
(i) Purchase Journal: particularly for recording purchases of goods on
credit.
(ii) Sales Journal: particularly for recording sales of goods on credit.
(iii) Cash Receipt Journal: particularly for recording all cash received.
(iv) Cash Payment Journal: particularly for recording all cash payment.
However, this course will only emphasise to the general journal. The format of
general journal is shown in Figure 2.6.
Figure 2.6: Format of general journal

It is important to ensure that journalising is done correctly. This is because

these information will be transferred to ledger for the purpose of preparing the
financial statement. Errors made in the journal will result in errors in the financial
statement. The name of accounts used must be specified in the beginning and
used consistently in order to avoid confusion.
ACTIVITY 2.2
In your opinion, what are the appropriate journals for a book shop in a
school? Please discuss.
2.4.2 Journalising and Posting of Entry

After the transactions have been recorded in the journal, it will be posted to the
ledger. This process is known as transfer of entry or posting. We will now record
the transactions of Reen Cyber Service in the General Journal and then post them
to the ledger using the T-account format.
Transaction 1:
On I November, Reen invested RM30,000 as capital for Reen Cyber Service
business. From our analysis in Topic 1, we know that this transaction will increase
the cash and owner’s equity by RM30,000. According to the rules of debit and
credit, the increase in asset account (cash) will be debited and increase in owner’s
equity account (capital) will be credited.
When recording, note that the name of the account to be debited is listed first,
followed by the name of account to be credited. The name of the credited
account will be aligned slightly to the right to differentiate it from the account to
be debited.
Journal entry:
General Journal pg 1
Date Description Reference Debit (RM) Credit (RM)
Nov 1 Cash 30,000
Capital, Reen 30,000
(Cash invested by Reen)
Journal 1: General Journal for Transaction 1

Post to ledger:
Cash
RM
Nov 1 Capital, Reen 30,000
Capital, Reen
RM
Nov 1 Cash 30,000
Ledger 1: Ledger for Transaction 1
Transaction 2:
On 2 November, the business purchased a piece of land valued at RM20,000. A
total of RM5,000 cash had been paid while the balance is financed by bank loan
(notes payable).
Note that even though this transaction involves more than two accounts, the total
amount of debit is still equal to the total amount of credit.
Journal entry:
Nov 1 Land 20,000
Cash 5,000
(Purchased land by cash
and bank loan)
Post to ledger:
Land
RM
Nov 2 Cash 5,000
Notes Payable 15,000
Cash
RM RM
Nov 1 Capital, Reen 30,000 Nov 2 Land 5,000
Notes Payable
Nov 2 Land RM
15,000
Transaction 3:
On 4 November, the business bought office supplies valued at RM2,700 on credit.
Journal entry:
Nov 4 Supplies 2,700
Accounts Payable 2,700
(Purchased office
supplies by credit)
Post to ledger:
Supplies
RM
Nov 4 Account Payable 2,700
Accounts Payable
RM
Transaction 4:
On 15 November, the business received revenue from consultancy services
provided to a customer. The customer paid cash of RM15,000.
Journal entry:
Nov 15 Cash 15,000
(Cash received for
services provided)
Post to ledger:
Cash
RM RM
15 Service revenue 15,000
Service revenue
RM
Nov 15 Cash 15,000
Transaction 5:
On 30 November, the business paid salary expenses (RM4,250), rental expenses
(RM1,600), utility expenses (RM900) and sundry expenses (RM550).
Journal entry:
Nov 30 Salary expenses 4,250
Sundry expenses 550
Cash 7,300
(Cash payment for the
said expenses)
Post to ledger:
Cash
RM RM
15 Service revenue 15,000 30 Salary expenses 4,250
Sundry expenses 550
Salary expenses Rental expenses

RM RM
Nov 30 Cash 4,250 Nov 30 Cash 1,600
Utility expenses Sundry expenses

RM RM
Nov 30 Cash 900 Nov 30 Cash 550
Transaction 6:
On 30 November, the business paid its debt to the supplier of supplies purchased
on 4 November for RM1,900.
Journal entry:
Nov 30 Accounts Payable 1,900
Cash 1,900
(Payment to accounts
payable)
Post to ledger:
Cash
RM RM
Sundry expenses 550
30 Accounts payable 1,900
Accounts Payable
RM RM
Nov 30 Cash 1,900 Nov 4 Supplies 2,700
Transaction 7:
Unused office supplies on 30 November were valued at RM1,100.
Journal entry:
Nov 30 Supplies expenses 1,600
Supplies 1,600
(Recording usage of
supplies)
Post to ledger:
Supplies
RM RM
Nov 4 Accounts payable 2,700 Nov 30 Supplies 1,600
Supplies expenses
RM
Transaction 8:
On 30 November, Reen took RM4,000 cash from the business for her personal use.
Journal entry:
Nov 30 Drawings, Reen 4,000
Cash 4,000
(Cash drawings by
owner)

Post to ledger:
Cash
RM RM
Sundry expenses 550
30 Drawings, Reen 4,000
Drawings, Reen
RM
Nov 30 Cash 4,000
How are you doing so far? Can you understand the recording process at this
stage? By using the same transactions, we have prepared the journal entries and
transferred them to ledger. The journalising and posting process that we have
done is a very simple example for you to better understand the basic process,
emphasising only on the date, accounts and amounts involved. In the next
example, we will perform postings in detail involving reference column.
2.4.3 Example of Analysis and Summary of

Transaction
The double entry system is very useful for analysing the effects of transactions.
According to the system, every transaction will affect at least two items in the
financial statements. In analysing the transactions, three important things that
must be dealt with:
(a) Determine whether the transaction will affect the asset, liability, owner’s
equity, revenue or expense accounts.
(b) For every account involved, determine whether the account will increase or
decrease.
(c) Decide whether the increase or decrease should be recorded as debit or
credit.
You might feel difficult at this stage to make an analysis, or feel there are too
many things to remember. However, with familiarisation and frequent practice,
you will find that these three things can be done simultaneously.
We will now continue with the example of Reen Cyber Service by extending
the transactions to December. In December, we will see more transactions.
We will analyse the transactions one by one with emphasis given on the types
of transaction that have not been analysed before. The transactions throughout
December are listed in Table 2.4.
Table 2.4: Transactions for the month of December
Date
No. Transactions
(Dec 2008)
1 1 Paid insurance premium of RM4,800 for coverage against losses

due to fire and burglary for a period of 24 months.
2 1 Paid office rental for the month of December of RM1,600.
3 1 A company planned to rent the land owned by Reen Cyber

Service. The business rented the land for three months for RM720.
The tenant paid the amount in cash.
4 4 Purchased office equipment on credit from Office Equipment Sdn.

Bhd. totalling RM3,600.
5 6 Paid RM360 to advertise the business in the newspaper.
6 11 Paid RM800 for the transaction on 4 December.
7 13 Paid salary of temporary staff for RM1,900 for the first two weeks
of December.
8 16 Received RM6,200 cash from customer for services provided.
9 16 Provided services valued at RM3,500 to a customer. The customer

promised to pay next month.
10 20 Made another payment of RM1,800 for transaction on 4 December.
11 21 Customer made payment for account receivable of RM1,300.
12 23 Purchased supplies by cash for RM2,900.
13 27 Paid salary of temporary staff for RM2,400 for the last two weeks
of December.
14 31 Paid telephone and electricity bill for the month December for
RM620 and RM450 respectively.
15 31 Received cash of RM5,740 from customer on the services

provided.
16 31 Billed customer for the services provided of RM2,240.
17 31 Reen made cash drawings of RM4,000.

Transaction 1:
Paid insurance premium for 24 months totalling RM4,800.
Have you ever paid insurance premium? If you own a vehicle, you will be
familiar with paying insurance premium. Insurance premium must be paid at the
beginning of the coverage period. Payment made in advance is known as prepaid
expenses and it is an asset. The asset you get is the insurance coverage for 24
months starting from 1 December 2008.
Analysis 1 and 2: Prepaid insurance account (asset) increased by RM4,800.

Accounts involved and Cash account (asset) reduced by RM4,800.
effects of transaction
Analysis 3: Prepaid insurance account (asset) increased: debit

Rule of debit and credit Cash account (asset) reduced: credit
Journal entry:
Dec 1 Prepaid insurance L15 4,800
Cash L11 4,800
(Paid insurance premium
for 24 months)
Post to ledger:
Prepaid Insurance Account No: 15

Date Description Reference Debit (RM) Credit (RM) Balance
Dec 1 Cash J2 4,800
Cash Account No: 11

Dec 1 Prepaid insurance J2 4,800
In this example, we did not use the T-account format. Instead, we used the three
column account format to make you more familiar with the different types of
accounting format available. This format is better as it can show the balance after
each transaction. The balance column is supposed to show final balance after
each transaction including the previous transactions in November. However, in
this section, the column is left blank to avoid confusion. After completing all the
transactions, we will combine all the processes of journal entries and entry post
to ledger. After that, you will be able to understand better the function of the
balance column in this three column account format.
Note that for reference purposes, the account number (refer to the chart of
accounts in section 1) must be recorded in the Reference column in the journal,
while the page of general journal is recorded in the Reference column in the
accounts.
Transaction 2:
Paid RM1,600 rental for the month of December .
This transaction is prepaid expense as the rental expenses was paid at the
beginning of December. However, it is different from transaction 1 in terms of the
coverage period.
In transaction 1, the premium paid was for a period of 24 months. In this

transaction, the rental paid was only for one month. For such a short period, we
normally do not use the prepaid rental account. This is easier as we need not
make any adjustments at the end of the period. The adjustments will be taught in
detail in Topic 3.
Analysis 1 and 2: Rental expenses account (expense) increased by RM1,600.

Accounts involved and Cash account (asset) reduced by RM1,600.
Analysis 3: Rental expenses account (expense) increased: debit

Rule of debit and credit Cash account (asset) reduced: credit
Journal entry:
Dec 1 Rental expenses L52 1,600
Cash L11 1,600
(Paid rental expenses for
December month)
Post to ledger:
Rental expenses Account No: 52

Dec 1 Cash J2 1,600
Cash Account No: 11

Dec 1 Rental expenses J2 1,600
ACTIVITY 2.3
Do you still remember the accounting constraints on materiality that we

had studied earlier? Can you relate it to the recording of transaction 2?
Discuss with your classmates.
Transaction 3:
Received RM720 from the land’s tenant for rental of three months.
In this transaction, the business received payment in advance of the specific

period. This created an obligation or commitment on the business. By receiving
three months rental in advance, Reen Cyber Service is responsible to supply land
for rental in that three months period.
This is a liability (the business ‘owes’ services to the tenant) and the account
created is deferred rental account. The deferred rental will be recognised as rental
revenue at the end of the period when the services have been provided.
Analysis 1 and 2: Cash account (asset) increased by RM720.

Accounts involved and Deferred rental account (liability) increased by RM720.
Analysis 3: Cash account (asset) increased: debit

Rule of debit and credit Deferred rental account (liability) increased: credit
Journal entry:
Dec 1 Cash L11 720
Deferred rental L23 720
(Cash received for three
months rental)
Post to ledger:
Cash Account No: 11

Dec 1 Deferred rental J2 720
Derferred rental Account No: 23

Dec 1 Cash J2 720

Transaction 4:
Purchased office equipment on credit for RM3,600.
Analysis 1 and 2: Office equipment account (asset) increased by RM3,600.

Accounts involved and Accounts payable (liability) increased by RM3,600.
Analysis 3: Office equipment account (asset) increased: debit

Rule of debit and credit Accounts payable (liability) increased: credit
Journal entry:
Dec 4 Office equipment L18 3,600
Accounts payable L21 3,600
(Purchased office
equipment on credit)
Post to ledger:
Office Equipment Account No: 18

Dec 4 Accounts payable J2 3,600
Account Payable No: 15

Dec 4 Office equipment J2 3,600
Transaction 5:
Paid RM360 for advertisement in newspaper.
For large businesses that always advertise their products or services. For
advertisement that involves large sums, a specific account (Advertisement
expenses) will be created for this purpose. However, if the advertisement
expenses seldom occur and immaterial, it is often recorded as sundry expenses.
In the example of Reen Cyber Service, we will use the sundry expenses account
to record this expense.
Analysis 1 and 2: Sundry expenses account (expense) increased by RM360.

Accounts involved and Cash account (asset) decreased by RM360
Analysis 3: Sundry expenses account (expense) increased: debit

Rule of debit and credit Cash account (asset) decreased: credit
Journal entry:
Dec 6 Sundry expenses L55 360
Cash L11 360
(Payment for
advertisement expenses)
Post to ledger:
Sundry Expenses Account No: 55

Dec 6 Cash J2 360
Cash Account No: 11

Dec 6 Sundry expenses J2 360

Transaction 6 :
Paid supplier (for transaction on 4 December) amounting to RM800.
Analysis 1 and 2: Accounts payable (liability) decreased by RM800.

Accounts involved and Cash account (asset) decreased by RM800.
Analysis 3: Accounts payable (liability) decreased: debit

Journal entry:
Dec 11 Accounts payable L21 800
Cash L11 800
(Payment for accounts
expenses)
Post to ledger:
Accounts payable No: 21

Dec 11 Cash J2 800
Cash Account No: 11

Dec 11 Accounts payable J2 800
Transaction 7:
Paid salary of temporary staff for the first two weeks of December totalling
RM1,900.
Analysis 1 and 2: Salary expenses account (expense) increased by RM1,900.

Accounts involved and Cash account (asset) decreased by RM1,900.
Analysis 3: Salary expenses account (expense) increased: debit

Journal entry:
Dec 13 Salary expenses L51 1,900
Cash L11 1,900
(Salary payment for
temporary staff)
Post to ledger:
Salary expense Account No: 51

Dec 13 Cash J2 1,900
Cash Account No: 11

Dec 13 Salary expenses J2 1,900
Transaction 8:
Received RM6,200 cash for services provided:
Analysis 1 and 2: Cash account (asset) increased by RM6,200.

Accounts involved and Service revenue account (revenue) increased by RM6,200.

Rule of debit and credit Service revenue account (revenue) increased: credit
Journal entry:
Dec 16 Cash L11 6,200
Service revenue L41 6,200
(Received cash for
services provided)
Post to ledger:
Cash Account No: 51

Dec 16 Service revenue J2 6,200
Service revenue Account No: 41

Transaction 9:
Billed customer for RM3,500 for services provided.
Analysis 1 and 2: Accounts receivable (asset) increased by RM3,500.

Analysis 3: Accounts receivable (asset) increased: debit

Journal entry:
Dec 16 Accounts receivable L12 3,500
(Billed customer for
services provided)
Post to ledger:
Accounts receivable No: 12


Dec 16 Accounts receivable J2 3,500
Transaction 10:
Payment of RM1,800 to supplier (for transaction on 4 December).
Analysis 1 and 2: Accounts payable (liability) decreased by RM1,800.

Analysis 3: Accounts payable (liability) decreased: debit

Journal entry:
Dec 20 Accounts payable L21 1,800
Cash L11 1,800
payable)
Post to ledger:
Accounts payable No: 12

Cash Account No: 11

Dec 20 Accounts payable J3 1,800
Transaction 11:
Customer paid cash RM1,300 as payment on its accounts receivable.
Analysis 1 and 2: Cash account (asset) increased by RM1,300

Accounts involved and Accounts receivable (asset) decreased by RM1,300

Rule of debit and credit Accounts receivable (asset) decreased: credit
Journal entry:
Dec 21 Cash L11 1,300
Accounts receivable L12 1,300
(Payment received for
accounts receivable)
Post to ledger:
Cash Account No: 11

Accounts Receivable No: 12

Transaction 12:
Purchased supplies by cash for RM2,900.
Analysis 1 and 2: Supplies account (asset) increased by RM2,900.

Analysis 3: Supplies account (asset) increased: debit

Journal entry:
Dec 23 Supplies L14 2,900
Cash L11 2,900
(Purchase supplies by cash)
Post to ledger:
Supplies Account No: 14

Cash Account No: 11

Dec 23 Supplies J3 2,900
Transaction 13:
Paid salary of temporary staff for the last two weeks of December totalling
RM2,400.
Analysis 1 and 2: Salary expenses account (expense) increased by RM2,400.

Analysis 3: Salary expenses account (expense) increased: debit

Journal entry:
Dec 27 Salary expenses L51 2,400
Cash L11 2,400
(Payment for salary of
temporary staff)
Journal 21: Ledger for Transaction 13
Post to ledger:
Salary expenses Account No: 51

Cash Account No: 11

Dec 27 Salary expenses J3 2,400

Transaction 14:
Made payment for telephone and electricity bill for RM620 and RM450,
respectively.
The payment of bills like electricity, water and telephone are normally grouped
into the utility expenses account. This is because the expenses incurred are
normally immaterial in terms of amount and significance until the entity has to
open a separate account for each type of bill. Therefore, the total utility expenses
paid on this date is RM1,070.
Analysis 1 and 2: Utility expenses account (expense) increased by RM1,070.

Analysis 3: Utility expenses account (expense) increased: debit

Journal entry:
Dec 31 Utility expenses L53 1,070
Cash L11 1,070
(Payment for telephone
and electricity bill for
December)
Post to ledger:
Utility expenses Account No: 53

Cash Account No: 11

Dec 31 Utility expenses J3 1,070
Transaction 15:
Received cash RM5,740 for services provided.
Analysis 1 and 2: Cash account (asset) increased by RM5,740.


Journal entry:
Dec 31 Cash L11 5,740
(Received cash for
services provided)
Post to ledger:
Cash Account No: 11


Transaction 16:
Billed customer for RM2,240 for services provided.
Analysis 1 and 2: Accounts receivable (asset) increased by RM2,240

Accounts involved and Service revenue account (revenue) increased by RM2,240
Analysis 3: Accounts receivable (asset) increased: debit

Journal entry:
Dec 31 Accounts receivable L12 2,240
(Billed customer for
services provided)
Post to ledger:
Account Receivable No: 12


Transaction 17:
Owner made cash drawings of RM4,000.
Analysis 1 and 2: Drawings account (contra owner equity) increased by

Accounts involved and RM4,000
effects of transaction Cash account (asset) decreased by RM4,000.
Analysis 3: Drawings account (contra owner equity) increased: debit

Notes: Although the drawings account is a type of owner equity account, it has
an opposite feature against the owner’s equity. Therefore, we will put the word
‘contra’ to show the difference.
Journal entry:
Dec 31 Drawing, Reen L32 4,000
Cash L11 4,000
(Cash drawing by Reen).
Post to ledger:
Drawings, Reen Account No: 32

Cash Account No: 11

Dec 31 Drawings, Reen J3 4,000
After analysing all the transactions one by one, we will now combine all the
journal entries and entries posting involved throughout the month of November
and December 2008.
The following are the general journal entries and postings throughout November
and December 2008.
GENERAL JOURNAL pg 1
Date Account and Description Reference Debit (RM) Credit (RM)
Nov 1 Cash L11 30,000
Capital, Reen L31 30,000
(Investment by Reen)
2 Land L17 20,000
Cash L11 5,000
Notes payable L22 15,000
(Purchase of land by cash and
bank loan)
4 Supplies L14 2,700
(Purchase of supplies on credit)
15 Cash L11 15,000
(Received cash for services
provided)
30 Salary expenses L51 4,250
Rental expenses L52 1,600
Utility expenses L53 900
Sundry expenses L55 550
Cash L11 7,300
(Payment of expenses by cash)
30 Account payable L21 1,900
Cash L11 1,900
(Payment to accounts payable)
30 Supplies expenses L54 1,600
Supplies L14 1,600
(Recording of supplies usage)
30 Drawings, Reen L32 4,000
Cash L11 4,000
(Cash drawings by owner)
Dec 1 Prepaid Insurance L15 4,800
Cash L11 4,800
(Paid insurance premium for
24 months)
1 Rental expenses L52 1,600
Cash L11 1,600
(Paid rental for December)
1 Cash L11 720
Deferred rental L23 720
(Cash received for three
months rental)
4 Office equipment L18 3,600
(Purchased office equipment
by credit)
6 Sundry expenses L55 360
Cash L11 360
(Payment for advertisement
expenses)
11 Accounts payable L21 800
Cash L11 800
Cash L11 1,900
temporary staff)
16 Cash L11 6,200
provided)
16 Accounts receivable L12 3,500
(Billed customer for services
provided)
Dec 20 Accounts payable L12 1,800
Cash L11 1,800
21 Cash L11 1,300
(Received payment for
accounts receivable)
23 Supplies L14 2,900
Cash L11 2,900
(Purchased of supplies by
cash)
Cash L11 2,400
temporary staff)
31 Utility expenses L53 1,070
Cash L11 1,070
(Payment of telephone and
electricity bill)
31 Cash L11 5,740
provided)
31 Accounts receivable L12 2,240
(Billed customer for services
provided)
31 Drawings, Reen L32 4,000
Cash L11 4,000
Journal 26: General Journal for Reen Cyber Service for the month of November and
December 2008.
GENERAL LEDGER
Cash Account No: 11
Date Debit Credit Balance

Description Reference
(RM) (RM) (RM)
Nov 1 Capital, Reen J1 30,000 30,000
2 Land J1 5,000 25,000
15 Service revenue J1 15,000 40,000
30 Salary expenses J1 4,250 35,750
Rental expenses J1 1,600 34,150
Utility expenses J1 900 33,250
Sundry expenses J1 550 32,700
30 Accounts payable J1 1,900 30,800
30 Drawings, Reen J1 4,000 26,800
Dec 1 Prepaid insurance J2 4,800 22,000
Rental expenses J2 1,600 20,400
Deferred rental J2 720 21,120
6 Sundry expenses J2 360 20,760
11 Accounts payable J2 800 19,960
21 Accounts receivable J3 1,300 23,760
23 Supplies J3 2,900 20,860
31 Utility expenses J3 1,070 17,390
31 Drawings, Reen J3 4,000 19,130
* It was previously explained that the ‘Balance’ column will show the updated
balance after each transaction. Can you relate to it now?

(RM) (RM) (RM)
Dec 16 Service revenue J2 3,500 3,500
21 Cash J3 1,300 1,100

Debit Credit Balance
Date Description Reference
(RM) (RM) (RM)
Nov 4 Accounts payable J1 2,700 2,700
30 Supplies expenses J1 1,600 1,100
Dec 23 Cash J3 2,900 4,000
Prepaid insurance Account No: 15

(RM) (RM) (RM)
Dec 1 Cash J2 4,800 4,800
Land Account No: 17

(RM) (RM) (RM)
Nov 2 Cash J1 5,000 5,000
Notes payable J1 15,000 20,000

(RM) (RM) (RM)
Dec 4 Accounts payable J2 3,600 3,600
Accounts Payable No: 22

(RM) (RM) (RM)
Dec 4 Supplies J1 2,700 2,700
30 Cash J1 1,900 800
Dec 4 Supplies J2 3,600 4,400
11 Cash J2 800 3,600
20 Cash J3 1,800 1,800
Notes Payable Account No: 22

(RM) (RM) (RM)
Nov 2 Land J1 15,000 15,000
Deferred Rental Account No: 23

(RM) (RM) (RM)
Dec 1 Cash J2 720 720
Capital, Reen Account No: 31

(RM) (RM) (RM)
Nov 1 Cash J1 30,000 30,000
Drawings, Reen Account No: 32

(RM) (RM) (RM)
Nov 30 Cash J1 4,000 4,000
Dec 31 Cash J3 4,000 8,000
Service Revenue Account No: 41

(RM) (RM) (RM)
Nov 15 Cash J1 15,000 15,000
Dec 16 Cash J2 6,200 21,200
Accounts receivable J2 3,500 24,700
31 Cash J3 5,470 30,440
Account receivable J3 2,240 32,680
Salary Expenses Account No: 51

(RM) (RM) (RM)
Nov 30 Cash J1 4,250 4,250
Dec 13 Cash J2 1,900 6,150
27 Cash J3 2,400 8,550
Rental Expenses Account No: 52

(RM) (RM) (RM)
Nov 30 Cash J1 1,600 1,600
Dec 1 Cash J2 1,600 3,200
Utility Expenses Account No: 53

(RM) (RM) (RM)
Nov 30 Cash J1 900 900
Dec 31 Cash J3 1,070 1,970
Supplies Expenses Account No: 54

(RM) (RM) (RM)
Nov 30 Supplies J1 1,600 1,600

Description Debit Credit Balance
Date Reference
(RM) (RM) (RM)
Nov 30 Cash J1 550 550
Dec 6 Cash J2 360 910
2.4.4 Trial Balance

Trial balance is a list of all the accounts used including the corresponding balances
at a specific date. Normally the trial balance would be prepared at the end of the
specific accounting period and the debit and credit totals need to be equal.
The main purpose of preparing the trial balance is to ensure that the total debit
and credit balances are the same. Unequal amount of total balances indicate that
errors had happened in any one of the stages in the recording process, whether
during the journal entry, posting to ledger or the preparation of the trial balance
itself.
However, it must always be kept in mind that a balanced trial balance does not
necessarily mean that there are no errors. Examples of errors that can occur even
though the trial balance is balanced are:
(a) the transaction has not been recorded at all in the journal;
(b) the transaction entry has not been posted to the ledger;
(c) the transaction of entry posted to ledger had been done twice; and
(d) the usage of wrong account during journalising or posting.
In the first case, the transaction was not recorded at all. Both the debit and credit
sections were not affected. Therefore, the trial balance will be balanced, only
the total would be less than what it should have been. In the second case, the
transaction had been recorded in the journal without being posted to ledger. The
result is the same as with the first case because the trial balance is prepared based
on the ledger balance.
In the third case, the entry was posted correctly, but twice. The trial balance will
be balanced, only the total would be more than what it should have been. In the
final case, the debit and credit amount is equal, only that they have been recorded
on the wrong side of the accounts. The final balance of the trial balance would
be the same as it should be, but there will be errors in the last balance of the
individual accounts. For example, when a business purchased supplies by cash,
the correct entry should be to debit the supplies account and to credit the cash
account. However, a mistake was made by debiting cash and crediting supplies.
Although the accounts have been recorded wrongly, the trial balance will still be
balanced. Only the individual balances in the cash account and supplies account
will be incorrect. This error is quite difficult to detect as the final amount in the
trial balance is still equal.
The following is the trial balance for Reen Cyber Service as at 31 December 2008.
The balances of the accounts were derived from the previous general ledger.
ACTIVITY 2.4
Can you explain the consequences of each error that had occured in the
trial balance by referring to examples on page 52?
Reen Cyber Service

Trial Balance
as at 31 December 2008
Account Debit Credit
Accounts
Number (RM) (RM)
11 Cash 19,130
12 Accounts receivable 4,440
14 Supplies 4,000
15 Prepaid insurance 4,800
17 Land 20,000
18 Office equipment 3,600
22 Notes payable 15,000
23 Deferred rental 720
31 Capital, Reen 30,000
41 Service revenue 32,680
51 Salary expenses 8,550
52 Rental expenses 3,200
53 Utility expenses 1,970
54 Supplies expenses 1,600
55 Sundry expenses 910

TOTAL 80,200 80,200
Figure 2.7: Trial balance

EXERCISE 2.2
1. What is meant by account, ledger and chart of accounts?
2. State two account format of that you have learned. Which is the
easier format? Which format will show the latest balance after each
transaction?
3. Drawings and expense will reduce owner’s equity. Discuss the

difference between these two terms.
4. Which of the following accounts have a normal debit balance?

A. Owner’s capital
B. Deferred rental
C. Prepaid expense
D. Service revenue
5. A credit balance in which account might indicate an error?

A. Rental revenue
B. Accounts payable
C. Drawings
D. Capital
6. Group the following accounts according to its type (asset, liability,

owner’s equity, revenue or expense):
(a) Vehicle
(b) Insurance expenses
(c) Prepaid insurance
(d) Rental revenue
(e) Deferred rental
(f) Supplies
(g) Supplies expenses
(h) Accounts receivable
EXERCISE 2.3
1. Cindy established Cindy Insurance Agency on 1 April 2008. The

effects of all transactions throughout April 2008 are summarised in
the following schedule:
Owner’s
Asset = Liability +
Equity
Capital,
Trans. Cash + AR + Supplies = AP +
Cindy
a. +5,000 +5,000
Capital,
Cindy
b. +275 +275
c. +3,250 +3,250
Service
revenue
d. -750 -750
Paid rental
expense
e. -125 -125
f. +1,875 +1,875
Service
revenue
g. -577 -390
Paid utility
expense
-187
Paid sundry
expense
h. -1,250 -1,250
Paid salary
expense
i. -162 -162
Paid
supplies
expenses
j. -500 -50 -550
Drawings,
Cindy
Required:
(a) Prepare the journal entries for all the above transactions.
(b) Transfer the entries to ledger using the 3 column account format.
(c) Prepare the trial balance as at 30 April 2008.
EXERCISE 2.4
1. The following are the chart of accounts and accounts balances for
Edlin Enterprise on 1 February 2007:
Account Balance as at 1/2/07
Accounts
No (RM)
101 Cash 15,238
104 Supplies 427
301 Capital, Edlin 26,910
302 Drawings, Edlin ă
401 Service revenue ă
501 Rental expenses ă
502 Advertisement expenses ă
503 Utility expenses ă
509 Sundry expenses ă
Transactions involving Edlin Enterprise throughout the month of

February 2007 are:
Date Transaction
Feb 1 Purchased office supplies by cash RM274.
2 Edlin withdrew cash from business totalling RM2,000 for personal
use.
5 Received RM2,740 cash from customer for payment on accounts
receivable.
9 Purchased office equipment valued at RM4,000 on credit. The seller
agreed to give a discount of RM150 from the amount.
15 Made payment to accounts payable for RM1,200.
18 Received cash for services provided for RM580.
25 Paid RM420 to advertise its business in the newspaper.
28 Paid telephone bills (RM75 for EdlinÊs house and RM135 for business)
and electricity bills (RM42 for EdlinÊs house and RM80 for business).
All the payments had been made using money from his savings.
29 Paid RM1,200 for rental of business premises.
30 Paid RM220 to repair the office equipment.
Required:
(a) Prepare the journal entries to record all the above transactions by
using the accounts listed in the chart of accounts for Edlin Enterprise.
(b) Post the entries to ledger by using the three column account format.
(c) Prepare the trial balance as at 28 February 2007.
SUMMARY
The important matters discussed in this topic were:

• The chart and format of accounts used to present the financial report of an
organisation.
• The rules of debit and credit are fundamental to the double entry system.
• The rules of normal balance for each type of account are used to assist in
identifying errors in recording.
• Steps in recording beginning from journal entry, posting entries to ledger
and preparation of the trial balance.
Assets Journal
Chart of Accounts Ledger
Credit Liabilities
Debit Revenue
Expenses Trial Balance
Topic  Completing
the
3 Accounting
Cycle
LEARNING OUTCOMES
1. Describe the types of adjusting entries;
2. Prepare the Adjusted Trial Balance;
3. Prepare the financial statements consist of income statement,
statement of changes in owner’s equity, balance sheet statement and
cash flow statement;
4. Prepare the closing entries; and
5. Prepare the reversing entries.
 INTRODUCTION
This topic is the continuation of Topic 2, where you have come across the
unadjusted trial balance. This topic will also discuss the preparation of adjusting
entries for the purpose of preparing the adjusted trial balance. The adjusted
trial balance is prepared after the adjusting entries have been recorded and
transferred.
The four main components of financial statements, comprising the income

statement, statement of changes in owner’s equity, balance sheet and cash flow
statement; are prepared based on the information from the adjusted trial balance.
The preparation of cash flow statement also requires all information related to
cash that can be found in the records.
TOPIC 3 COMPLETING THE ACCOUNTING CYCLE  85
At the end of Topic 3, you will be exposed to closing and reversal entries to
complete the accounting cycle.
3.1 ADJUSTING ENTRIES

You might be wondering why adjusting entries need to be discussed before
completing the accounting cycle. The answer becomes clearer once you know
what adjusting entries are.
Adjusting entries are additional accounting information recorded at the

end of the accounting period to accurately match revenues with expenses.
It is the main element in accrual-basis accounting. The accrual basis refers to

revenues or expenses which are recognised in the current period irrespective of
whether cash has been received. It is different from cash basis accounting, where
revenues or expenses are only recognised when they involve cash receipts or
payments.
Adjusting entries will affect at least one income statement account (revenue or
expense) and one balance sheet account (asset or liability). After the adjustments,
the accounts in the trial balance will show the updated balances, which will then
be used to prepare the financial statements.
Prepaids and accruals are the basis for making adjusting entries. Prepaid refer to
cash received or paid before revenues or expenses are recorded, while accruals
are revenues or expenses which are recorded before cash is received or paid.
Adjusting entries are divided into 5:

(a) prepaid expenses;
(b) depreciation expenses;
(c) unearned revenue;
(d) accrued expenses; and
(e) accrued revenue.
86  TOPIC 3 COMPLETNG THE ACCOUNTING CYCLE
3.1.1 Prepaid Expenses
Prepaid expenses refer to all expenses that have been paid in advance by
cash but the benefit from the expenses has not been received or obtained.
It is an asset to the business and will be written off after it has been used or when
it expires. Adjusting entries must be made at the end of the accounting period to
recognise assets that have been written off as expenses.
Examples of prepaid expenses are prepaid rental and prepaid insurance.
Example 3.1
On 1 April 2006, Encik Zaini rented a house and paid a total of RM900 for the
first 3 months. The landlord had set the rental at RM300 per month. The journal
entries are as follows:
1 April 2006 Dr. Rental Prepaymewnt RM900

Cr. Cash RM900
When the entry is transferred to ledger, the accounts involved will be:
Rental Prepayment Account Cash Account

RM RM
April 1 2006 900 April 1 2006 900
The trial balance on 30 April 2006 before adjustment shows the rental prepayment
account with a normal debit balance of RM900. This amount is incorrect if used
for the purpose of preparing the financial statement.
Therefore, an adjusting entry is needed to update and match the expenses

accurately so that the correct total is reported in the financial statements.
The adjusting entry is as follows:
30 April 2006 Dr. Rental expenses RM300*

Cr. Rental prepayment RM300
Rental paid for 3 months is RM900, which is rental prepayment.

*One third of the total rental prepayment for a period of one month (April) is:
1/3 x 900 = 300
When the adjusting entry is transferred to ledger, it would involve one account
from the income statement (rental expenses account) and one account from the
balance sheet (rental prepayment account).
Figure 3.1: Process of transferring adjusting entries to ledger
The adjusting entries that had been transferred to ledger are as follows:
Rental Prepayment Expenses

RM RM
April 1 2006 900 April 30 2006 300
Balance 600
Rental Expenses Account

RM
April 30 2006 300
The adjusting entries had recognised the rental expenses for a period of one
month in April, which is RM300. The rental prepayment account had been
credited by RM300, causing the balance in the account to decrease by RM300.
Therefore, the rental prepayment account has been updated from RM900 to
RM600.
3.1.2 Depreciation Expenses
Depreciation expenses are provisions against the cost of fixed assets like
plant, equipment and vehicle.
It is an expense throughout the lifespan of the asset. The concept used for asset
and depreciation is the same as with prepaid expenses.
Cash paid by the business to acquire the asset is viewed as a prepaid expense.
In other words, the cash is paid in advance before the asset is used. Adjusting
entries must be recorded as the asset expires or when the asset has been used
by the business. The entry is made at the end of the accounting period and
acknowledges the usage of the asset as expenses.
Example 3.2
On 1 Jan 2007, Mazni Enterprise purchased a vehicle for office usage valued at
RM60,000 by cash. This vehicle is estimated to have a lifespan of 10 years. The
journal entries for this transaction are as follows:
1 Jan 2007 Dr.Vehicle 60,000

Cr. Cash 60,000
Vehicle Account Cash Account

RM RM
1 Jan 2007 60,000 1 Jan 2007 60,000
An adjusting entry is required at the end of the accounting period to record the
expenses for the use of the vehicle, which will be as follows:
31 December 2007 Dr. Depreciation expenses 6,000*

Cr. Accumulated Depreciation – Vehicle 6,000
*The straight line method was used to calculate the depreciation expenses.
Formula:
(Cost of Assest - Scrap Value)

––––––––––––––––––––––––––
Useful Life
(RM60,000 – 0/10 year) = RM6,000 per year
The adjusting entry is then transferred to ledger and will involve one account
from income statement (depreciation expenses account) and one account from
balance sheet (accumulated depreciation of vehicle account, which is a contra
account for asset).
Depreciation Expenses Account

RM
31 Dec 2007 6,000
Accumulated Depreciation Account

RM
31 Dec 2007 6,000
The debit entry of RM6,000 in the depreciation expenses account reflects the
business’ use of the asset for the one year period, while the credit balance in the
accumulated depreciation account for vehicle shows the total depreciation on the
asset to date. The total accumulated depreciation will be deducted from the total
asset to provide the book value or carrying value of the asset:
RM
Vehicle’s cost as at 1 Jan 2007 60,000
(-) Accumulated depreciation – vehicle (6,000)
Vehicle’s book value as at 31 December 2007 54,000
3.1.3 Unearned Revenue (Unearned Income)

Unearned revenue refers to cash which is received in advance before goods
or services has been provided.
This is an obligation or liability to the business entity. Cash received cannot be

recognised as revenue for that period because the goods or services will only be
provided at a future date.
Example 3.3
On 1 December 2007, Ayu Beauty Company received RM800 cash from a

customer. This payment was for services that the Company will provide on 1
January 2008. The journal entry is as follows:
1 December 2007 Dr. Cash 800

Cr. Unearned revenue 800
Cash Account Unearned Revenue

RM RM
1 Dec 2007 800 1 Dec 2007 800
On 31 December 2007, a liability of RM800 was created for Ayu Beauty Company
because cash was received while the services had not yet been provided. The
liability will cease to exist and the revenue can be recognised once the company
had provided the services on 1 January 2008. The adjusting entry to recognise the
revenue is as follows:
1 January 2008 Dr. Unearned revenue 800

Cr. Service revenue 800
from income statement (service revenue account) and one account from balance
sheet (unearned revenue account).
Unearned Revenue Account

RM RM
1 Jan 2008 800 31 Dec 2007 800
Service Revenue Account

RM
1 Jan 2008 800
When unearned revenue account is debited, the business entity ceases to have
the liability and the revenue is recognised as the services which is now being
provided.
3.1.4 Accrued Expenses
Accrued expenses refer to all expenses incurred but have not yet been paid
or recorded because there was no cash outflow from the business entity.
Accrued expenses are a liability as an obligation exists that must be settled by the
business. At the end of the accounting period, the business entity must record/
recognise all expenditure even though no cash outflow occurred. Examples of
accrued expenses are salary payable, rental payable, interest payable and tax
payable.
Example 3.4
Haruman Company has not paid its staff salary for the month of December 2006
totalling RM4,500 due to financial problems. However, the company promised to
pay the salary in January 2007. On 31 December 2006 the adjusting entry will be
as follows:
31 December 2006 Dr. Salary Expenses 4,500

Cr. Salary Payable 4,500
from income statement (salary expenses account) and one account from balance
sheet (salary payable/ salary accrued account).
Salary Expenses Account Salary Payable Account

RM RM
31 Dec 2006 4,500 31 Dec 2006 4,500
This adjusting entry will recognise the salary expenses for the period even though
cash outflow from the business has not occurred while the salary payable/salary
accrued is a liability to the business entity at that date.
3.1.5 Accrued Revenue
Accrued revenue refers to the revenue that had been obtained but there is
no cash inflow into the business entity.
This happens when the goods or services were provided to the customer but the
customer has not paid for it yet.
Accrued revenue is an asset as the benefit in the form of cash will be obtained by
the business entity in the future. Examples of accrued revenue are rental revenue
receivable, service revenue receivable and interest receivable.
Example 3.5
Geelang Company rented out a section of its building at the monthly rate of
RM1,200 which must be paid at the end of the month. However, the tenant failed
to pay the rental for the month of December 2008 but promised to settle the rental
in the month of January 2009. The adjusting entry required for Geelang Company
would be:
31 December 2008 Dr. Rental receivable 1,200

Cr. Rental revenue 1,200
from income statement (rental revenue account) and one account from balance
sheet (rental receivable or rental revenue accrued account).
Rental Receivable Account

RM
31 Dec 2008 1,200
Rental Revenue Account

RM
31 Dec 2008 1,200
At the end of the accounting period, revenue that has been recorded or recognised
totalled RM1,200 even though there is no cash inflow while asset increased by
RM1,200 when rental receivable was debited.
If there is no adjustment, the account balances presented in the financial

statements will not comply with the principle of revenue recognition and
principle of matching. Therefore the financial statements published were
presented without complying with the GAAP (Generally Accepted Accounting
Principles).
All the adjustments made to the account balances in the trial balance will produce
the Adjusted Trial Balance. The Adjusted Trial Balance will be used as the basis
in the preparation of the financial statements. The Adjusted Trial Balance will be
discussed next. To ensure that you understand what you have learned, answer
the following questions:
EXERCISE 3.1
Explain the meaning for each of the following:

(a) Accrued Revenue
(b) Accrued Expenses
(c) Prepaid Expenses
(d) Unearned Revenue
3.2 PREPARATION OF ADJUSTED TRIAL

BALANCE
This section will expose you to the process of preparing the Adjusted Trial
Balance. The Adjusted Trial Balance is a trial balance which is prepared after
taking into account all the adjusting entries that have been journalised and
transferred. The Adjusted Trial Balance will also show the balance of all the
accounts irrespective of whether they were involved in the adjustment. The
accounts involved in the adjustment will show the updated or adjusted balance.
The purpose of preparing the Adjusted Trial Balance is to show the effect of
all financial events that had occurred in the accounting period. The Adjusted
Trial Balance is to verify that the total debit and total credit are equal for all the
accounts in the ledger after the adjustments.
You must refer to the information in the Unadjusted Trial Balance for Reen Cyber
Service in Topic 2 (Figure 2.7: Trial Balance) for the preparation of this Adjusted
Trial Balance. For students’ reading convenience, the unadjusted balance had
been included in Table 3.2.
Additional information relating to adjustments for Reen Cyber Service are as

follows:
(a) The supplies in hand at 31 December 2008 totalled RM1,520.
(b) The insurance premium that had expired throughout the year totalled
RM200.
(c) Unearned rental revenue at 31 December 2008 totalled RM480.
(d) Salary accrued but not yet paid at 31 December 2008 totalled RM500.
(e) Interest revenue accrued but not yet recorded for the month of December
totalled RM1,000.
(f) Depreciation for office equipment for the month of December totalled
RM100.
The adjustment entries that must be recorded by Reen Cyber Service as at 31

December 2008 are as per Table 3.1 below:
Table 3.1: Adjustment Entries
Date Description Reference Debit Credit

(RM) (RM)
31 December Supplies expenses 2,480
Supplies 2,480
31 December Insurance expenses 200
Insurance prepayment 200
31 December Unearned rental revenue 240
Rental revenue 240
31 December Salary expenses 500
Salary accrued 500
31 December Accounts receivable 1,000
Interest revenue 1,000
31 December Depreciation expenses 100
Accumulated 100
depreciation for office
equipment
Table 3.2: Unadjusted Trial Balance

Reen Cyber Service
Trial Balance

Accounts
Number (RM) (RM)
11 Cash 19,130
14 Supplies 4,000
15 Insurance prepayment 4,800
17 Land 20,000
22 Notes payable 15,000
23 Unearned rental revenue 720
31 Capital, Reen 30,000
41 Interest revenue 32,680
51 Salary expenses 8,550
53 Utility expenses 1,970
54 Supplies expenses 1,600
TOTAL 80,200 80,200
The treatment for each additional item of information are as follows:
(a) The supplies account shown in the Unadjusted Trial Balance is the opening
balance at 1 January 2008 which is RM4,000. The additional information
stated the current balance, which is the balance at 31 December 2008 totalling
RM1,520.
Therefore, the difference between both the balances is the supplies expenses
that must be recognised/recorded, which is RM2,480.
Supplies Account – Supplies Account = Supplies Expenses

(Opening Balance) (Current Balance)
RM4,000 – RM1,520 = RM2,480
This adjusting entry affects one account in Income Statement (supplies

expenses) and one account in Balance Sheet (supplies account).
The current balance for supplies account is RM1,520, which is RM4,000

(opening balance) – RM2,480 (credit entry from adjustment) which resulted
in the same total as stated in the additional information.
(b) Insurance prepaid account with debit balance totalling RM4,800 showed
insurance prepaid for a period of 24 months starting 1 December 2008.
Therefore, the insurance expenses at 31 December 2008 that must be
recognised total RM4,800 ÷ 24 = RM200.
This adjusting entry causes the insurance prepayment account in the Balance
Sheet to have a current balance of RM4,600 (RM4,800 – RM200) while
insurance expenses of RM200 will be recognised in the income statement for
the period.
(c) Unearned rental revenue account has a normal credit balance of RM720
which showed total cash for the rental received in advance for three months.
Therefore, the rental revenue that need to be recognised for the month of
December is 1/3 x RM720 = RM240.
The effect of this adjusting entry is the unearned rental revenue account
in the Balance Sheet which will be reduced by RM240 to RM480 while the
rental revenue of RM240 will be reflected in the Income Statement .
(d) Salary accrued or unpaid for the month of December totalled RM500. The
salary accrued will increase the total expenditure and is a liability to the
business entity. The adjusting entry will recognise this salary expense as an
item in the Income Statement and the salary payable/accrued as a balance
sheet item totalling RM500 for the period.
(e) Interest revenue accrued for the business entity but yet to be recognised or
recorded totalled RM1,000. This amount is an asset and will increase the
total revenue of the business entity. The adjusting entry will recognise the
interest revenue as an item in the Income Statement and accounts receivable
account in Balance Sheet will show a total of RM1,000 for the period.
(f) Depreciation of office equipment for the month of December totalling

RM100 will increase the total expenditure for that business entity. The
adjusting entry will recognise the depreciation as an expenses item in
the income statement and will affect one account in balance sheet, the
accumulated depreciation account which is a contra account for asset.
The worksheet as per Table 3.3 is used to prepare the Adjusted Trial Balance for
Reen Cyber Service for two months ending at 31 December 2008.
Table 3.3: Worksheet
Adjusted Trial
Trial Balance Adjustment
Balance
Name of Account Dr. Cr. Dr. Cr. Dr. Cr.
(RM) (RM) (RM) (RM) (RM) (RM)
Cash 19,130 19,130
Accounts receivable 4,440 (5) 1,000 5,440
Supplies 4,000 (1) 2,480 1,520
Insurance prepayment 4,800 (2) 200 4,600
Land 20,000 20,000
Office equipment 3,600 3,600
Accounts payable 1,800 1,800
Unearned rental revenue 720 (3) 240 480
Notes payable 15,000 15,000
Capital, Reen 30,000 30,000
Drawings, Reen 8,000 8,000
Interest revenue 32,680 (5) 1,000 33,680
Salary expenses 8,550 (4) 500 9,050
Rental expenses 3,200 3,200
Utility expenses 1,970 1,970
Supplies expenses 1,600 (1) 2,480 4,080
Sundry expenses 910 910
Insurance expenses (2) 200 200
Rental revenue (3) 240 240
Salary accrued (4) 500 500
Depreciation expenses (6) 100 100
Accumulated depreciation – (6) 100 100
equipment
80,200 80,200 4,520 4,520 81,800 81,800
You can also prepare the Adjusted Trial Balance for Reen Cyber Service without
using the sheet by:
(a) preparing the adjusting entries.
(b) updating all the account involved with the adjusting entries
(c) entering the current balance that had been adjusted into the Adjusted Trial
Balance as below:
Table 3.4: Adjusted Trial Balance

Reen Cyber Service
Adjusted Trial Balance
RM RM
Cash 19,130
Accounts receivable * 5,440
Supplies * 1,520
Insurance prepayment * 4,600
Land 20,000
Office equipment 3,600
Unearned revenue * 480
Drawings, Reen 8,000
Interest revenue * 33,680
Salary expenses * 9,050
Supplies expenses * 4,080
Sundry expenses 910
Insurance expenses ** 200
Rental revenue ** 240
Salary accrued ** 500
Depreciation expenses ** 100
Accumulated depreciation – 100
equipment **
81,800 81,800
* Updated accounts
** New accounts created after the adjusting entries.
After the adjustments are made, you will find that the ledger accounts in the
Adjusted Trial Balance show the same total debit and total credit. This Adjusted
Trial Balance will be used in the preparation of the financial statements, which
will be discussed next.
ACTIVITY 3.1
In your opinion, what are the uses of the Adjusted Trial Balance for
small businesses? Discuss.
SELF-CHECK 3.1
When is the right time to prepare the Adjusted Trial Balance?
Before we proceed to the next topic, answer the following exercise to test your
understanding.
EXERCISE 3.2
Information for adjustments is as follows:

1. Supplies in hand at 31 December 2007 amounted to RM750.
Supplies at 1 January 2007 totalled RM1,000.
2. Depreciation of equipment for the year 2007 totalled RM400.
3. Interest accrued on notes payable totalled RM300.
4. Insurance expired throughout the year 2007 totalled RM1,500.
5. Revenue accrued at 31 December 2007 totalled RM750.
6. Unearned revenue received throughout the year 2007 totalled
RM5,000.
Prepare the adjusting entries at 31 December 2007.
3.3 PREPARATION OF FINANCIAL

STATEMENTS
After studying the preparation of Adjusted Trial Balance, you will now learn how
to prepare Financial Statements. The financial statements are prepared after all
transactions are recorded or journalized, transferred and summarised in the trial
balance. The financial statements are also known as the accounting report that
reports the financial status at the end of the accounting period.
This topic will only discuss on the preparation of the financial statements for
service-oriented businesses. As you know, the financial statements consist of 4
statements, which are:
• Income Statement;
• Statement of Changes in Owner’s Equity;
• Balance Sheet Statement; and
• Cash Flow Statement.
3.3.1 Income Statement
Income Statement refers to the financial statement which presents the

operational results of the business entity for a specific period.
It is also known as the summary of revenue and expense for a specific period
whether it is one month, three months, six months or a year. If the business
entity’s total revenue is more than total expenditure, then net profit will be
reported in its income statement.
Total Revenue > Total Expense = Net Profit
If the total expense exceeds total revenue, the business entity will report a net
loss.
Total Expense > Total Revenue = Net Loss

The matching process is used to determine the net profit or net loss. The contents
in the Income Statement comprise of 5 main elements:
(a) Name of business entity
Example: Noora Jaya Company
(b) Title of statement, which is Income Statement
(c) Report period and date.
Example: For the month/year ended 31 December 2008.
(d) Revenue and expenditure items
(e) Net profit/loss
Figure 3.2 shows the format for Income Statement:
Figure 3.2: Format of income statement for service firms
The revenue and expense items are the main components in the income
statement. Revenue is the gross revenue obtained from business activities that
were conducted for the purpose of generating revenue. Normally revenue is
derived from sales of goods, provision of services, rental of land and loans.
Figure 3.3 shows examples sources of revenue.
Figure 3.3: Examples of sources of revenue
Revenue obtained will increase the total asset and owner equity for a business
entity. For example, the main revenue for a car wash business is revenue from
the car wash services provided. Other examples of revenue are fees, commission,
interest, dividend, royalty and rental.
Expenses are costs to the assets or services used or provided in the process
to generate the revenue.
Expense will reduce the total asset and owner equity. Examples of expense for a
car wash business are water, cleaning materials and staff salary.
The steps involved in preparing the Income Statement for Reen Cyber Service are
as follows:
(a) You must analyse the information reported in the following Adjusted Trial
Balance:
Reen Cyber Service

RM RM
Cash 19,130
Supplies 1,520
Insurance prepayment 4,600
Land 20,000
Unearned interest revenue 480
Drawings, Reen 8,000
Sundry expenses 910
Insurance expenses 200
Rental revenue 240
Salary payable 500
Depreciation expenses 100
Accumulated depreciation 100
81,800 81,800
(b) Extract all the revenue and expense items only because these are the main
components in the preparation of Income Statement.
The following are all the revenue and expense items found in the Adjusted
Trial Balance for Reen Cyber Service.

Rental revenue 240
Sundry expenses 910
19,510 33,920
(c) Calculate the net profit or loss by adding all the revenue items and deducting
all the expense items. If the total revenue exceeds total expenditure, then
net profit is obtained. If total expense exceeds total revenue then net loss is
obtained.
Total revenue is RM33,920, which includes interest revenue of RM33,680 and

rental revenue of RM240. Total expense, which is RM19,510 will be deducted
from the total revenue of RM33,920 to generate the net profit of RM14,410.
RM
Total revenue 33,920
Total expense (19,510)
Net Profit 14,410
(d) Finally, you must enter all the items involved (revenues, expense and net
profit) into the income statement format.
Reen Cyber Service

Income Statement
For two months ended 31 December 2008
RM RM
Revenue:
Rental revenue (240)
33,920
Less expenses:
Sundry expenses 910
(19,510)
Net Profit 14,410
This total will be reported in the

statement of changes in owner’sequity
3.3.2 Statement of Changes in Owner’s Equity
Statement of changes in owner’s equity is a summary of changes in the

owner equity that occurred in a specific period.
This statement is related to Income Statement and Balance Sheet (which will be
discussed after this) and is prepared at the end of the accounting period.
Equity is the owner’s claim on the total asset. It equals to the total assets
after deducting all the liabilities.
Equity is comprised of the following items:

(a) opening capital;
(b) the yearly retained profit or loss;
(c) drawings; and
(d) closing capital.
Drawings refer to the total cash or goods taken by the business entity’s owner for
personal use.
Statement of Changes in Equity for Reen Cyber Service:
Reen Cyber Service

For two months ended 31 December 2008
RM
Capital Reen, 1 November 2008 30,000* from income statement
Net profit 14,410
Drawings (8,000)*
Capital Reen, 31 December 2008 36,410 will be reported in the
balance sheet
* Total opening capital and drawings were taken from the Adjusted Trial Balance.
Normally this statement is not prepared and is only shown in the notes to the
accounts (which will be discussed at the end of this unit). Items in this statement
will be shown either in the income statement or in the balance sheet. For example,
the yearly retained profit/loss is shown in the income statement while the total
closing capital is shown in the balance sheet.
The statement of changes in equity contains the total net profit taken from the
income statement that had been prepared previously. From the statement of
changes in equity thus prepared, the closing capital is obtained. This total will be
reported in the balance sheet statement. Therefore, the statement of changes in
equity has linked the income statement with the balance sheet.
3.3.3 Balance Sheet

Balance sheet or statement of financial position is a statement which reports the
financial status of the business at a point of time. The financial status of a business
entity covers the control on its economic resources, financial structure and
sustainability in the long-term. Balance sheet contains three main components,
which are:
Self Check 3.4
(a) Asset
Asset is an economic resource owned by a business entity that can bring
benefit to the business entity in the future. Asset exists in a business due
to past occurrences and transactions. Asset is a valuable resource to the
company as it can be used or exchanged to generate products or provide
services.
Asset is recorded in the balance sheet based on historical cost, which is the
original cost of purchase. Three characteristics that enable a resource to be
classified as an asset are:
• The resource can help the business entity to generate cash inflow in the
future, whether directly or indirectly.
• The resource must benefit the business entity in the future and the
entity has controlling power on the said resource. Controlling power
means that the entity can prevent other people from using the said
resources.
• Transaction or event that gives the rights to the business entity to control
the said resource had occurred. If the transaction of purchasing the
resource had not occurred then the resource cannot be considered as an
asset to the entity.
Asset consists of current asset and long-term asset.

(i) Current Asset

Current asset is an asset that is expected to be exchanged for cash or sold or
used in a period of one year or in the operating cycle period (whichever is
longer).
Operating cycle refer to the time frame taken by the business entity to
process as well as to sell the inventory, to collect accounts receivable
(AR) as well as to transform the accounts receivable into cash as
shown in Figure 3.4.
Figure 3.4: Operating cycle
Current assets include:

• Cash;
• Trading securities/Short-term investment;
• Items receivable;
• Inventories; and
• Prepayment expenses.
Cash includes cash in hand and cash in saving/current accounts in the bank.
Cash that cannot be used immediately is known as cash equivalents. It is
also classified under cash items.
Marketable securities or short-term investment comprise of investment

in the equity securities (example: investment in stocks) and investment in
debt security (example: investment in bonds). Investments in both of these
securities are considered current assets because these investments are ready
to be sold or traded. These two types of investments can be exchanged for

cash by the business entity in a period of a year or in the operating cycle
period, whichever is longer.
Items receivable is created when the business entity has provided services
or sold goods but the cash is yet to be received. Items receivable are
accounts receivable (AR), notes receivable, interest receivable and fees
receivable.
Prepaid expenses can also be classified as item receivable, for example

rental prepayment, salary prepayment, insurance prepayment.
Inventory for a business entity is different according to the type of business.

A business entity which provides services do not have inventory. This is
different from a business entity that produces/manufactures its goods. It
will have raw material inventories, work in process inventories and finished
goods inventory (all these types of inventories will be discussed in Topic 5).
Similarly, businesses that buy and sell goods (trading firms) have inventory
for retail stocks.
(ii) Long-Term Asset/Non-curent Asset

Long-term asset is an asset that can be used in the business or held for a
longer period, usually more than a year. Long-term asset comprises non-
current asset, other long-term asset and intangible asset.
• Long-Term Asset
Land, plant, building and equipment are examples of long-term assets.
It has physical form and is used in the operation of the business entity.
All these assets must be depreciated, except for land. Land need not be
depreciated as its value is always appreciating while plant, equipment
and building must be depreciated as the value of the assets will reduce
as they get older.
Long-term asset is also known as non-current asset or tangible

asset.
In the balance sheet, non-current assets are presented at their original or

historical cost less the corresponding accumulated depreciation.
• Other Long-Term Asset
Other long-term assets include long-term investment, deferred
expenditure and amounts that are involved in the long-term such as
item receivable.
These investments consist of investment in securities such as investment

in stocks and bonds that would not be exchangeable for cash in the short
period. Other long-term investments include investment in property
that is held for speculation purposes or for use in future operation and
investment in special funds such as pension funds.
Long-term investments are investment held by the business entity

for a period of more than one year.
The amount involved in the long-term is amount which is expected to

be received after a year. It includes accounts receivable, notes receivable,
receivable from director, receivable from transaction between companies
and other item receivables.
Deferred expenses are prepaid expenses for a long-term period

like deferred tax, companies’ restructuring expenses and business’
preliminary expenses.
• Intangible/Non-physical Asset
Goodwill, patent, copyright and trademark are intangible assets because
they lack physical substance. The economic benefits that can be provided
by the intangible assets to the business entity in the future are difficult to
evaluate. Examples of other intangible assets are franchise, trade names
and computer software’s cost. Generally intangible assets are amortised
in a period of 5 to 40 years. The intangible asset will be reported in the
balance sheet at book value, which is cost less accumulated amortisation
expenses. Figure 3.5 shows the types of long-term assets.
Figure 3.5: Long-term assets
The following is a summary on assets.
Asset
Economic resources that can generate benefit to the entity in the future.
Current Assets Long-Term Assets/Non-current Assets

1. Expected usage within 1 year or 1. Can be used or held by the business for
operating cycle period more than 1 year.
2. Comprises: 2. Comprises:
(a) Cash (a) Long-term asset/non-current asset
(b) Trading securities/Short-term (land, plant, building, equipment)
(c) Item receivables (b) Other long-term assets (long-term
(d) Inventory investment, deferred expenditure).
(e) Prepayment expenses Intangible asset (patent, copyright,
trademark)
Figure 3.6: Summary of assets
SELF-CHECK 3.2
Describe the difference between current assets and long-term assets.

State the items contained in these two types of assets.
(b) Liability
Liability is an obligation or responsibility of a business entity to external
parties like creditors or other business entities that have claims on the said
business. Liability is presented in the balance sheet to help users of financial
statements to measure the extent of the claims of other entities toward the
business entity’s resources. Liability is divided into two, which are current
liability and long-term liability (non-current liability).
(i) Current Liability

Current liability is a responsibility or obligation that is expected to be
paid using the current asset or by creating another current liability
within the period of one year. Current liabilities include:
• Bank loan or overdraft;
• Item payable;
• Portion of current long-term liability; and
• Deferred revenue.
Bank loan exists when a business entity applies for loan from the bank,
which must be settled within a year. Meanwhile, overdraft is a facility
given to current account holders to make withdrawal in excess of the
savings available.
Item payable consists of accounts payable (AP) and notes payable.

It exists when a business entity makes credit purchase from another
business entity. AP exists without any written agreement between the
two business entities but only via verbal agreement. It is different from
notes payable which has written agreement between the two business
entities.
Other items payable are salary payable, rental payable, interest payable,
which are expenses accrued or payable by the business entity. The
service is already received by the business entity but the payment is
still outstanding or there is no cash outflow from the business entity.
Portion of current long-term liability occurs when there is a portion

from the long-term liability that must be settled in a year’s period. The
total is classified as current liability and not long-term liability. The
balance will be classified as long-term liability.
The cash received will be the current liability to the business entity
as long as the services have not been provided. Examples of deferred
revenue are unearned fees, unearned revenue and deposit from
customers.
Deferred revenue refers to the cash received from the customer

but the services have not provided yet.
(ii) Long-term Liability/Non-current Liability

Compared with current liability, long-term liability is a responsibility or
obligation that would not be settled or paid within the period of one
year. Long-term liabilities include:
• Bonds payable
• Notes payable
• Inter-company loan
• Secured loan
Bonds payable are long-term liabilities or obligation to a business

entity. The entity must settle the total cash received from the bonds
issued within a period which may exceed one year, that is upon
maturity of the bonds.
Notes payable are transactions involving credit with written agreement

between the two business entities. The business entity which received
the notes payable with maturity date exceeding one year means that it
has a liability/responsibility that must be settle in that period.
Inter-company loan involved obligation or responsibility between

companies that must be settled within the specific period which
exceeds one year.
Secured loan is a liability to a business company towards another

party, for example bank or financial institution. The institution will
get the business entity’s asset (such as land and building) as security
for the loan provided to the company. Figure 3.6 shows a summary of
liabilities.
Table 3.5: Summary of Liabilities
Liabilities
Economic benefit that must be sacrificed by transferring the asset or providing
services/goods to another business entity.
Current Liability Long-Term Liability/Non-current Liability
1. Expected to be paid within a period 1. Expected to be settled within the
of one year period > one year.
2. Comprises: 2. Comprises:
• Bank loan • Bonds payable
• Item payable • Notes payable
• Portion of current long-term • Inter-company loans
liability • Secured loan
• Deferred revenue • Contingent liability
(b) Owner’s Equity

Owner’s equity means rights or claims against the assets of the business by
the owner. Owner’s equity is the excess of total asset against total liability of
the business. Owner’ equity for each ownership business structure differ:
• For company, owner’s equity consist of paid-up capital, premium shares,
retained earnings and reserve.
• For partnership, owner’s equity consist of total capital account for all
partners.
• For sole proprietorship, owner’s equity consist of capital account
contributed by its sole owner.
You have know all the items that need to be reported in the balance sheet:
namely asset, liability and owner’s equity.
ACTIVITY 3.1
How may a debt be considered as a bad debt? If you have your own
business, what is your interpretation on the term of bad debt? Discuss.
Activity 3.2
The following balance sheet statement reports all items of asset, liability and
owner’s equity found in the Adjusted Trial Balance and Statement of Changes in
owner’s equity for Reen Cyber Service:
Reen Cyber Service

Balance Sheet
RM RM RM
Non-current assets:
Land 20,000
Accumulated depreciation (100)
3,500 23,500
Current assets:
Cash 19,130
Suppliers 1,520
Insurance prepayment 4,600 30,690
Less: Current Liabilities:

Account payable 1,800
Salary payable 500
Unearned revenue 480
(2,780)
Net current assets 27,910
51,410
Finance by:
Owner’s Equity
Capital, Reen 36,410*
Non-curent liability:
51,410
From the statement of changes in owner’s equity
• If the statement of changes in equity has not been prepared, all the items
in that statement would be shown in the balance sheet for the purpose of
reporting the closing capital as at 31 December 2008.
Net assets refer to the difference between net current assets and net current
liabilities. This item must be reported according to the regulation and standards
approved by the Malaysian Accounting Standards Board (MASB) 1: Presentation of
Financial Statements.
To ensure that you have understood what you have learned, complete the
following exercise.
EXERCISE 3.3
Information in the adjusted trial balance for Khairunnisa’ Consulting

Services at 30 June 2007 are as follows:
Khairunnisa’ Consulting Services

as at 30 June 2007
Debit Credit
Cash 56,350
Office supplies 12,300
Rental prepayment 4,400
Accumulated depreciation – office equipment 10,725

Unearned Fees 10,980
Notes payable – long-term 100,000
Salary payable 7,100
Capital, Khairunnisa’ 51,990
Fees revenue 119,280
Insurance expenses 3,500
Total 317,675 317,675
From the information above,

1. Prepare the income statement for the period ended 30 June 2007 for
Khairunnisa’ Consulting Services.
2. Prepare the balance sheet as at 30 June 2007.
3.3.4 Cash Flow Statement

You will next be exposed to the fourth financial statement, the cash flow
statement which summarises the cash received and cash payment for the period.
It presents the basic cash information for operating, investing and financing
activities. The cash flow statement can help users of accounting information to:
(i) evaluate the capability of the company to generate positive cash flow in the
future; and
(ii) evaluate the capability of the company in settling its debts, paying
dividends and providing loans to external parties.
Cash flow statement can be classified under three activities, which are operating
activities, investing activities and financing activities.
Figure 3.7: Cash flow statement
(a) Operating Activities

Operating activities involve cash transactions that affect the business’ net
profit, which are any cash received, such as cash from sales, and any cash
payments, such as payment for purchases. Only cash received and payment
related to the operation of the company are taken into account. MASB 5 also
specified interest and dividend received as part of items from operating
activities. However, both these items can also be classified as investing or
financing activities, which will be discussed later.
(b) Investing Activities

The second activity is investing activities, and would normally involve
long-term asset items, such as purchase and sale of non-current asset. Any
profit or loss from the sale of non-current asset will not be included in the
calculation of net cash flow from investing activities.
(c) Financing Activities

This activity normally involves long-term liability and equity items such as
issuance of share and payment of all debts. If there is profit or loss during
the payment of all debts, it will not be taken into account while generating
the net cash flow from financing activities.
Examples of Cash Received and Payments for each of the activities are as follows:
Operating Activities
Cash Received From: Cash Payment For:
Sale of goods Purchase of goods
Service revenue Staff wages and salary
Fees revenue Utility expenses
Rental revenue Rental expenses
Investing Activities
Sale of non-current asset Purchase of non-current asset
Sale of investment Purchase of shares (invest)
Collection of loan provided to Provision of loan to other entities
other entities
Financing Activities
Loan or debt of the company Repayment of loan/debt
from external parties
Issuance of shares Share buyback
Examples for each activity above are reported in the Cash Flow Statement shown
as follows:
Cash balance as at 1 January 2007 is zero as the business is newly established.

Air Molek Enterprise

Cash Flow Statement
for the Period Ended 31 December 2007
Operating Activities RM RM
Received:
Collection from customer 6,500
Payment:
Staff salary (1,200) (1,200)
Net cash flow from operation 5,300
Sale of land 22,000
Sale of shares 18,000
Net cash flow from investment 40,000
Investment by owner 50,000 50,000
Total increase in cash 95,300
Cash balance as at 1 January 2007 0

Cash balance as at 31 December 2007 95,300
For your information, the Cash Flow Statement must take into account all cash
related transactions. This means that you must refer to Topic 2, which is the
recording of information related to incoming or outgoing cash flow.
Cash Flow Statement for Reen Cyber Service is as follows:

Notes to Solution:
Reen Cyber Service

Cash Flow Statement
For the Period Ended 31 December 2008
Operating Activities RM RM
Received:
Cash from customers 13,960
Payment:
Cash to suppliers (2,600)
Expenditure (15,030) (17,630)
Net cash flow from operation (3,670)
Drawings by owner (4,000)
Total increase/(decrease) in cash (7,670)
Cash balance 1 December 2008 26,800
Cash balance 31 December 2008 19,130
Cash total is the same as the total reported in balance sheet.
(i) Cash from customer total RM13,960, which is the total cash received
throughout the month of December. You can refer to the journal entry done
in Topic 2 relating to accounts receivable. RM13,960 was total cash received
for 1 December for RM720; 16 December for RM6,200; 21 December for
RM1,300 and 31 December for RM5,740.
(ii) Payment to suppliers totalling RM2,600 was for transaction on 11 December
2008 for RM800 and 20 December for RM1,800.
(iii) Cash for payment of expenditure was from all transactions related to
expenses and outgoing cash flow. Examples of expenses involved are rental
expenses, insurance expenses, sundry expenses and utility expenses. You can
try by using the same way we had derived the total cash from customers.
You will find that total for all expenses are RM15,030. Therefore, the net cash
flow from the operating activities totalled (RM3,670), which is (RM13,960 –
RM17,630).
(iv) What had happened to the overall cash flow? The cash flow had decreased
by RM7,670 throughout the month of December. This is different from the
one reported in the income statement for the period ended 31 December,
that is the net profit of RM14,410. This is because the entity had used the
accrual basis in recognising the revenue and expenditure, without taking
into account the incoming or outgoing cash.
(v) Total cash balance as at 1 December 2008 which is RM26,800 refer to the cash
transaction throughout the month of November 2008.
SELF-CHECK 3.3
Briefly explain the four financial statements which are included in the
preparation of financial reports.
3.4 PREPARATION OF CLOSING ENTRIES

In the next section, you will learn how to prepare the closing entry. Drawings
account will be closed directly to the capital account.
Closing entry refers to the temporary closing of accounts, where all the
accounts in the income statement (revenue and expenses accounts) will be
transferred to the revenue summary account.
The purpose of closing entry is to measure the profit accurately. It is also for the
purpose of making the temporary accounts into zero balance for the next period.
3.4.1 Steps in Preparation of Closing Entries

Temporary accounts are accounts related only to the current accounting period
which will be closed, for example expenses accounts and drawings account. The
fixed accounts (such as asset, liability and owner equity), however, will not be
closed. These accounts are related to one or more accounting periods in the future
with its balance reported in the balance sheet. Closing entry is done at the end of
the accounting period.
The steps for making closing entries are as follows:

(a) All revenue accounts will be debited and revenue summary account will be
credited.
(b) All expenses accounts will be credited and revenue summary account will
be debited.
(c) Transfer balance from revenue summary account into capital account.
(d) Drawings account will be credited and capital account will be debited.
Figure 3.8 shows the summary of preparing the closing entry.
Figure 3.8: Summary for preparation of the closing entry.

Closing entries for Reen Cyber Services as at 31 December 2008 are as follows:
31 December 2008
Dr. Interest revenue 33,680
Rental revenue 240
Cr. Revenue Summary 33,920
(Closing of all revenue accounts)
Dr. Revenue Summary 19,510
Cr. Salary expenses 9,050
Sundry expenses 910
Depreciation 100
(Closing of all expenses accounts)
Dr. Revenue Summary 14,410

Cr. Capital, Reen 14,410
(Closing of revenue summary account)
Dr. Capital, Reen 8,000

Cr. Drawings 8,000
(Closing of drawings account)
Notes to Solutions:
(i) All revenue accounts will be closed by debiting the specific accounts and
creating an revenue summary account. With this all the revenue accounts
will have a zero balance while the revenue summary account will have
RM33,920 credit balance.
(ii) All expenses accounts will be closed by crediting the said accounts. With this
all the expenses accounts for that period will have a zero balance. Meanwhile
the current balance of revenue summary account will become RM14,410 after
taking into account the expenses transferred over to this account.
(iii) Balance in the revenue summary account of RM14,410 will be transferred to
the capital account. If it is a credit balance, it would be net profit, while if
it has a debit balance, it will be net loss. This balance will be the same net
profit reported in the income statement prepared in the previous topic.
SELF CHECK 3.4
What are the steps required to prepare a closing entry?
3.5 PREPARATION OF REVERSING ENTRIES
Reversing entry is a reversal to the adjusting entry from the previous

period but only related to accruals, which are accrued revenue and accrued
expenses.
Reversing entry is usually prepared on the first day of the next accounting
period. It is to simplify the accounting process because it separates the expenses
or revenue for the two accounting periods. However, business entity has a choice
on whether to prepare this reversal entry or not.
Example 3.7
At the end of year 2005, Mas Merah Company has accrued salary expenses of
RM800. The adjusting entry recorded was:
31 December 2005 Dr. Salary Expenses 800

Cr. Salary Payable 800
At 31 December, closing entry must be made to close the salary expenses account
as this account is temporary. The entry needed is:
31 December 2005 Dr. Revenue Summary 800

Cr. Salary expenses 800
If Mas Merah Company prepares the reversal entry on the first day of the next
accounting period, the reversal entry would be:
1 January 2006 Dr. Salary payable 800

Cr. Salary expenses 800
At 15 January 2006, Mas Merah Company made an actual salary payment of

RM2,000. The journal entry involved would be:
15 January 2006 Dr. Salary expenses 2,000

Cr. Cash 2,000
After all the journal entries had been transferred to the ledger, the accounts
involved are:
Salary Expenses Account

RM RM
31 Dec 2005 Adjustment 800 31 Dec 2005 Closing 800
15 Jan 2006 Payment 2,000 1 Jan 2006 Reversal 800
Salary Payable Account

RM RM
31 Dec 2005 Balance c/f 800 31 Dec 2005 Adjustment 800
1 Jan 2006 Reversal 800 1 Jan 2006 Balance b/d 800
Revenue Summary Account

RM
31 Dec 2005 Closing 800
Cash Account
RM
1 Jan 2006 Payment 2,000
Salary expenses account as at 15 January 2006 has a debit balance of RM1,200

(RM2,000 – RM800). This means that this total will be recognised as salary
expenses for the accounting period of 2001. Therefore, the role of reversal entry is
to separate the expenses for the two accounting period, that is for the years 2006
and 2005.
As at 15 January 2006, the balance for salary payable account will be 0 that is after
the reversal entry had been transferred to salary payable ledger. The revenue
summary account will be closed by debiting the capital account while cash
account will be permanently reported in the balance sheet.
EXERCISE 3.4
1. The trial balance for Berkat Enterprise as at 30 June 2008 is as

follows:
Debit Credit
Cash 3,425
Supplies 1,270
EXERCISE
Insurance prepayment 3.4 620
Accumulated depreciation – Office 9,700
equipment
Salary payable 925
Unearned revenue 1,250
Capital 29,000
Drawings 5,200
Total 100,000 100,000
Adjustment information:
(i) Supplies in hand as at 30 June 2008 totalled RM380.
(ii) Insurance premium expired for the year totalled RM315.
(iii) Yearly depreciation for office equipment totaled RM4,950.
(iv) Salary accrued but yet to be paid as at 30 June is RM440.
(v) Service revenue accrued but yet to be recorded totaled RM1,000.
(vi) Unearned revenue as at 30 June totaled RM750.
From the information provided, you are required to:

(a) Prepare the journal entries to record all the adjustments.
(c) Prepare the Income Statement and Balance Sheet at the end of
the accounting period.
(d) Prepare the closing entries.
2. Mekar Serumpun Company paid salary to its workers once in

every six days (the salary for Saturday until Thursday will be paid
on Thursday). Friday is a holiday for Mekar Serumpun Company.
The company pays a daily rate of RM20 as salary to its workers.
The company had decided that 31 December is the last day for its
accounting period and 31 December 2008 falls on a Wednesday.
Based on the above information, prepare the reversing entries and
transfer the entries to the corresponding ledgers for the final week of
year 2008.
3. Information in the Adjusted Trial Balance of Moiz Real Estate
Company as at 31 December 2008 are as follows:
Moiz Real Estate Company

Trial Balance
31 December 2008
RM RM
Cash 6,850
Supplies 2,540
Accumulated depreciation – office equipment 19,400
Unearned revenue 2,500
Capital, Moiz 58,000
Drawings, Moiz 10,400
Depreciation expenses 5,430
Total 200,000 200,000
From the information above, you are required to:

(a) Prepare the income statement, statement of changes in equity and
balance sheet statement.
(b) Prepare the closing entries.
SUMMARY
• In this topic, you have been introduced to the following items:

– Prepaid expenses
– Depreciation expenses
– Unearned revenue
– Accrued expenses
– Accrued revenue
• The preparation of Adjusted Trial Balance is for the purpose of showing
the effect of all financial events that had occurred in the specific accounting
period.
• The preparation of Financial Statements is done after the transactions have
been recorded, journalised, transferred and summarised in the Trial Balance.
• The Financial Statements prepared for an entity include:
– Income Statement
– Statement of Changes in Equity
– Balance Sheet Statement
– Cash Flow Statement
• The preparation of closing entries must be done for the purpose of
measuring the profit accurately and to make the temporary accounts into
zero balance for the next accounting period.
• The preparation of reversing entries must be done on the first day of the
next accounting period. This is a reversal to the adjusting entries made in
the previous period and is related only to accruals (accrued revenue and
accrued expenses).
Accrued Expenses Depreciation Expenses

Adjusted Trial Balance Long-term Asset
Adjusting Entries Long-term Liability
Current Asset Prepaid Expenses
Current Liability Unearned Revenue
Topic  Financial
Reporting
4
LEARNING OUTCOMES
1. Explain the purpose of the financial report;
2. Describe the statutory requirements for the preparation of financial
report or annual report;
3. Examine the contents in the annual report comprising financial
information and non-financial information; and
4. Prepare the financial statements that must be presented in the key
financial statements according to MASB1.
 INTRODUCTION
This topic discusses the statutory requirements that necessitate business entities
to prepare the financial report or annual report.
The contents in the financial reports released by business entities comprise

financial information and non-financial information, which will be discussed at
the end of the topic.
4.1 STATUTORY REQUIREMENT

Before further discussion on financial reporting, it is better we analyse in advance
the statutory requirements for the preparation of this report.
Business entities are required to report their financial status at the end of each
accounting period in a formal report known as the financial report or annual
report. The purpose of the report is to present the financial status of the business
entity for a specific accounting period.
130  TOPIC 4 FINANCIAL REPORTING
Financial reports are very useful and important for users of accounting
information such as investors, creditors, government, economic analysts and
other interested users as they help them to conclude on the performance and
financial status of a business entity. In addition, these financial reports are also
prepared to fulfil statutory requirements.
The regulations that must be complied with in the preparation of financial report
are Companies Act 1965, Securities Commission 1995, Financial Reporting Act
1997 and Income Tax Act 1967, whilst organisations such as Bursa Malaysia
Berhad and Central Bank of Malaysia require business entities to submit financial
reports.
Figure 4.1 shows the summary of statutory bodies that require annual reports.
Figure 4.1: Statutory bodies that require annual report prepared by business entity
(a) Companies Act 1965

You will now be introduced to the first regulation that requires the
preparation of annual report, which is the Companies Act 1965. Business
institutions formed as companies are bound by the Companies Act 1965
with regards to the aspect of preparation of financial and accounting report.
It is stated clearly under Schedule VI: Account and Audit of the Companies
Act 1965.
Sections 169 (1), (2), (3), (4) and (5) of the Companies Act 1965 require
a newly incorporated business entity registered with the Registrar of
Companies to prepare the annual report not later than 18 months from the
date of its incorporation. For the following years, the annual report must
be prepared at the end of each accounting period. A business entity will be
fined or its registration be annulled by the Registrar of Companies if it failed
to prepare the annual report.
TOPIC 4 FINANCIAL REPORTING  131
To enhance your understanding on the companies’ rules and regulations

stated above, you can refer to Section 169 of the Companies Act 1965.
(b) Securities Commission 1995

Securities Commission 1995 is a statutory body established under the
Securities Commission Act 1993. This commission emphasises the
importance of standard financial reporting. It also has statutory power that
requires business entities to comply with its regulation.
Regulation 8 of the commission requires all companies that are listed on

the Stock Exchange to prepare their accounts according to the approved
accounting standards. Companies can be imposed with disciplinary actions
or fine if they failed to comply with this regulation.
(c) Financial Reporting Act 1997

The Financial Reporting Act 1997 had established an accounting standards
setting body that is the Malaysian Accounting Standards Board (MASB) on 1
July 1997.
Companies registered in this country must observe the stipulated

regulations, by complying with the accounting standards approved by
MASB. MASB 1 lists the minimum accounting information that must be
reported by a company for the purpose of preparing a report.
Please refer to the Financial Reporting Act 1997 for further information.
(d) Income Tax Act 1967

Compliance with the Income Tax Act 1967 is legal requirement. This Act
is important as it includes specific provisions relating to the retention of
accounting records of business entities for the purpose of tax calculations
(Sections 82, 108 and 110).
(e) Bursa Malaysia Berhad

Next is Bursa Malaysia Berhad. Bursa Malaysia Berhad requires all business
entities listed on its exchange to comply with several conditions as follows:
(i) Printed financial report must be distributed within six months from the
last financial date to the shareholders and Bursa Malaysia Berhad;
(ii) Annual audited accounts must be in the form of Consolidated*
Financial Statement; and
(iii) Annual audited accounts must be prepared according to the standards
approved by MASB and the Companies Act 1965
*Consolidated accounts are the accounts of a parent company combined

with the accounts of its subsidiaries.
(f) Central Bank of Malaysia

The Central Bank of Malaysia or Bank Negara Malaysia had prepared a
guideline relating to financial reporting for financial institutions of this
country under the Banking and Financial Institutions Act 1989.
This guideline deals with general disclosure in the preparation of financial

statement, and detailed disclosures are highly encouraged.
SELF-CHECK 4.1
Why is it important for business entities to comply with the

regulations as set by the statutory bodies in this country?
EXERCISE 4.1
List the regulations and organisations that require financial reporting.
To test your understanding, answer the following question.
4.2 FINANCIAL REPORT

Let us take a look at the information contained in the financial report in detail.
The Companies Act 1965 (Section 169) had stipulated the contents that must be
reported in the financial report/annual report. Most of the business entities also
include additional information such as corporate information and structure.
The contents and presentation format of the annual reports prepared by
business entities are normally different depending on the policy adopted by the
management.
Financial and non-financial information are the main components in financial

report/annual report for a business entity.
4.2.1 Non-Financial Information

Non-financial information comprise the following:
(a) Chairman’s Report

Report on financial performance or financial status of the company. A
chairman’s report also specifies future planning and prospects including
dividend payout to shareholders based on available proof, such as the profit
or loss status and the current economic situation.
(b) Notice of Annual General Meeting

This notice is an invitation to the annual general meeting which is
distributed to all members or shareholders. It usually states the date, time,
meeting venue, meeting agenda and other related matters. The notice is
normally prepared by the company secretary.
(c) Corporate Information and Structure

Corporate information relates to information on members of the board of
directors, company secretary, audit committee, registered office, principal
bankers, auditors and corporate lawyers. The company structure states
information relating to subsidiaries and associated companies* including
percentage of share ownership on subsidiaries and associated companies
within the group’s structure.
*Associated company – when a business entity has a percentage share

ownership of 20 - 50% in another business entity.
(d) Summary of Financial Information

This report compares a summary of the company’s past financial results,
usually for the past five to ten years. The information is normally presented
in the form of graphs or charts to show comparison between the previous
and the current results.
(e) Auditors’ Report

Auditors’ report is the opinions given by Auditors as an independent
external party who are appointed by the company. The auditors provide
opinion after checking and auditing all the accounts and financial report,
according to the standards and procedure.
Figure 4.2: Non-financial information
ACTIVITY 4.1
If you intend to invest by buying shares in a company, is it important

for you to evaluate or read the company’s prospectus yourself?
SELF-CHECK 4.2
State the contents of non-financial information.

This report is for the purpose of verifying that all the information prepared and
reported in the annual financial statements had given a true and fair view.
Non-financial information discussed earlier can be seen in Figure 4.2.
4.3 MAIN FINANCIAL STATEMENTS

In sub-topic 4.2.1, you were exposed to the non-financial information. In this
topic, the discussion will revolve on financial information which forms the
most important part in the annual report which will be presented in the form
of Key Financial Statements. MASB 1 lists the financial statements that must be
presented in the Key Financial Statements as follows:
(a) Income Statement

The first financial statement discussed here is the income statement. The
income statement reports the financial performance by showing loss or
profit during the accounting period. All related accounting information
must be disclosed in the income statement. The following are the minimum
accounting information required by MASB 1 for reporting purposes:
(i) Turnover
(ii) Profit from operating
(iii) Profit/Loss in associate companies
(iv) Tax
(v) Operating Profit/Loss
(vi) Extraordinary items
(vii) Minority interest
(viii) Net profit/loss
MASB 1 also requires business entities to report the dividend per share
either in the income statement or in the notes to the accounts.
(b) Balance Sheet Statement

Balance sheet is the statement that shows the financial status of a business
entity at any one time. This statement reports the status of assets, liabilities
and owner’s equity.
MASB 1 requires business entities to report the following items, which are
the minimum disclosure in the balance sheet:
(i) Land, plant and equipment
(ii) Intangible asset

(iii) Investment
(iv) Item receivable
(v) Cash
(vi) Item payable
(vii) Tax liability
(viii) Minority interest
(ix) Share issued and reserves
However, several of the above items will only be studied in the more
advanced accounting curriculum.
(c) Statement of Changes in Owner’s Equity

Statement of changes in Owner’s equity is the statement that reports the
changes in the equity for the accounting period. The disclosures required by
MASB 1 in this statement are as follows:
(i) Net profit/loss for the current period.
(ii) Revenue and expenditure items.
(iii) Effect of changes in accounting policy and correction of any significant
errors.
Apart from the above, MASB 1 also requires additional information that
are to be reported in either the statement of changes in equity or in the
notes to the accounts. This information include:
(i) Transactions involving owners and distribution to owners.
(ii) Opening and closing balance of accumulated profit/loss for the period
and changes that occurred during that period.
(iii) Reconciliation between the carrying value of each equity items, share
premiums, and reserves as at the opening and closing period.
(d) Cash Flow Statement

As the name implies, cash flow statement involves cash transactions. The
cash flow statement shows the changes in cash that occurred for the business
entity during a specific period. Information from this statement is very
important to users of financial information as it reports the ability of the
business entity to generate cash in the future.
MASB 5 requires business entities to report the net cash flow from the
following activities:
(i) Operating activities

(ii) Investing activities
(iii) Financing activities
All the statements discussed above must be reported in the annual report
by comparing two accounting periods which is the current period and the
previous period.
(e) Notes to the Accounts and Accounting Policies

(i) Notes to the Accounts
Notes to the accounts refer to the detailed descriptions relating to the
accounts reported in the balance sheet and income statement. MASB 1
defines notes to the accounts as part of the financial report. Among the
notes to the accounts reported in the financial report are in relation to:
• Accounting policy
• Debtors Account/Account Receivable
• Inventory Account
• Investment
• Share capital
• Reserves
The function of notes to the accounts is to provide an explanation to

the users of accounting information on how the total of the accounts
reported in the financial statements are derived.
(ii) Accounting Policies

Accounting policies for a business entity refer to the accounting policies
practised by the entity in preparing and presenting the financial
statement. These accounting policies are subject to the standards
released by MASB and the accounting bodies. Examples of accounting
policy that must be disclosed by a business entity are:
• Basis of accounting used, either historical cost or revaluation.
• Basis of consolidation for consolidated accounts.
• Meaning of consolidated companies.
• Meaning of associated companies
• Basis of accounting for fixed asset and the methods used for
calculation of depreciation.
EXERCISE 4.2
1. What are the differences between financial and non-financial

information?
Financial Information Non Financial Information
2. Why are notes to the accounts being prepared?
SUMMARY
Several important points that were discussed in this topic are:

• Financial report prepared by business entities shows the financial status
of the business which is useful to the investors, creditors, government,
economic analysts and other interested users.
• Financial and non-financial information are the main components in the
financial/annual report of a business entity.
• MASB 1 lists the financial statements that must be presented in the key
financial statements:
– Income Statement
– Balance Sheet Statement
– Statement of Changes in Equity
– Cash Flow Statement
– Notes to the Accounts and Accounting Policies
Financial Information Non-financial Information

Financial Report Statutory Requirement
Financial Statements
Topic  Trading
Business
5 Environment
LEARNING OUTCOMES
1. Explain the difference between services business activities and trading
business activities;
2. Prepare the journal entries for trading transactions relating to:
(a) purchases;
(b) sales;
(c) transportation costs; and
(d) transactions that involves buyer and seller.
3. Differentiate between periodic and perpetual inventory systems; and
4. Prepare the income statement for trading business.
 INTRODUCTION
Topic 1 - 4 had discussed the accounting environment and recording process, as
well as the way to complete the accounting cycle, including the types of adjusting
entries that will affect the accounts in the income statement. Topic 5 - 6 will
discuss on the different types of firms, with more emphasis placed on trading
firms.
There are two types of firms: trading firms and service firms. However, this topic
will only focus on trading firms. Trading firms are businesses that buy goods
which will be resold to its buyers. Trading firms usually have inventories of
goods to be resold. Service firms do not have these inventories.
140  TOPIC 5 TRADING BUSINESS ENVIRONMENT
The difference between trading firms and service firms can be narrowed down
to the revenue and expense items which appear in the Income Statement (refer to
Figure 5.1)
Service Firms Trading Firms

RM RM
Fees earned XXX Sales XXX
Operating expense (XX) Cost of goods sold (XX)
XXX Gross profit XXX
Operating expense (XX)
Net operating income XXX
Figure 5.1: Difference in income statement for service firms and trading firms
Service firms derive their revenue from services which they provide to customers.
For example, the revenue of accounting firms relate to fees from conducting
audits in organisations. For income statement of service firms, revenue from these
services is reported as fees earned (or service revenue). Net operating revenue for
service firms is the difference between the fees earned and the operating expense
involved in offering the services. This can be clearly seen in Figure 5.1.
However, the situation is different for trading firms. For trading firms, revenue
is generated from buying and selling goods. Trading firms buy goods and then
sell it to customers. When goods are sold, the revenue received is reported as
sales revenue. What about the cost of buying the goods? The trading firms
would, of course, purchase their goods from suppliers and the cost of buying the
merchandise will be recorded as an expense item known as cost of goods sold.
The difference between sales revenue and cost of goods sold is known as gross
profit. Gross profit is the profit before deducting the operating expense involved
in buying and selling these goods.
You must be thinking that not all goods bought can be sold. What will happen?
Goods which are unsold by the end of the accounting period will be kept as
inventory. This inventory will be reported in the current asset section of the
company’s balance sheet. As a note, you have now started to identify the
transactions involved in the income statement (sales, cost of goods sold and gross
profit) and balance sheet (trading goods inventory).
Trading transactions will be recorded in the accounts using the rules of debit and
credit as explained in Topic 1 until Topic 4.
TOPIC 5 TRADING BUSINESS ENVIRONMENT  141
5.1 TRADING BUSINESS ENVIRONMENT

Income statements for trading and service firms are different as both involve
different activities. Trading firms buy goods from supplier and then resell the
goods to generate profit. There are two types of trading firms; retailers and
wholesalers.
Example of retailers are supermarkets (large scale retailers) and retail shops such
as electrical and furniture (small scale retailer).
Retailers are trading firms that buy goods from wholesalers and resell it
directly to consumers.
Wholesalers do not sell the goods directly to consumers but instead sell it to
retailers.
Wholesalers are trading firms that buy goods directly from manufacturers
in large quantities.
The characteristics of trading firms are:

(a) buy goods for resale.
(b) goods sold will be reported as sales revenue and cost of goods sold is the
cost of inventory sold;
(c) Cost of goods sold will be deducted from sales revenue to obtain gross
profit;
Gross Profit = Sales revenue – Cost of goods sold
(d) Operating expense will be deducted from gross profit to obtain Net
Operating Revenue; and
Net Operating Income = Gross profit – Operating expense

(e) Goods or inventory that is not sold by the end of the accounting period will
become the closing inventory and will be reported as current asset in balance
sheet.
As trading firms deal in goods, a trading entity must have an inventory system
which is efficient and effective to value the opening inventory and closing
inventory of the trading firm. There are two types of inventory management
system, periodic inventory system and perpetual inventory system.
ACTIVITY 5.1
Kamdar and Mydin are two companies that are successful and famous
in Malaysia as they can afford to offer various goods at low prices. What
are their success factors?
Test your understanding by answering the exercise below.
EXERCISE 5.1
Tick () at the correct column.

1. Gross profit is: True False
(a) operating expense deducted from net
operating revenue.
(b) sales revenue is more than operating
expenses.
(c) sales revenue is more than cost of
goods sold.
(d) operating expenses more than cost of
goods sold.
2. Berjaya Sdn. Bhd. recorded sales revenue of RM110,000, cost of

goods sold totalled RM70,000 and operating expense is RM20,000
Calculate:
(a) gross profit;
(b) net operating revenue
5.2 IMPORTANT TRANSACTIONS IN

TRADING FIRMS
For trading firms that sell on credit, the business’ operating cycle include the
following transactions:
(a) purchase of goods;
(b) sale of goods; and
(c) collection of accounts receivable.
For cash sales, however, the operating cycle is related only to buying and selling
goods involving cash. This operating cycle will be repeated throughout the
lifetime of the business.
There are 5 important types of transactions in a trading firm, these are:

(a) Purchases
(b) Sales
(c) Discounts
(d) Returns and Allowances
(e) Transportation Cost
5.2.1 Purchases
Purchase transactions involve purchasing goods to be resold. Any item bought
for use in the business, such as purchase of asset, is not regarded as purchases.
Purchases can be made by cash or credit. Credit purchases will be supported
by purchase invoices. Copies of sales invoices from the seller are regarded as
purchase invoices. The buyer can only recognise the purchase or inventory in its
business when the ownership of the goods purchased has been transferred from
the seller to the buyer.
5.2.2 Sales
Sales involve goods or inventories. Based on the principle of income recognition
as stated in the Malaysian Accounting Standard Board 9, sales revenue will be
recorded when the goods had changed hands from the seller to the buyer. For
credit sales, the duration taken to transfer the goods from the seller to the buyer
depends on the delivery terms stated. Sales can be made by cash or credit. Credit
sales may include cash discount, depending on the credit payment period.
5.2.3 Discounts
Discounts are price reductions given by the seller to the buyer.
There are two types of discount:

• Quantity discount; and
• Cash discount.
Quantity discounts are discounts given for purchases made in bulk.
The purpose of giving quantity discounts is to encourage the buyer to buy at

higher quantities. No journal entry is needed to record the quantity discount
as the quantity discount amount will be deducted directly from the invoice.
Example of quantity discount:
If quantity purchased is between:

(i) 3000 – 4000 units, then a 10% discount will be given.
(ii) 4001 – 5000 units, then a 20% discount will be given.
This shows that as more units are purchased, the higher the discount obtained.
Cash discounts are offered for credit purchases.
Cash discounts are price reductions given if payment is made within the
discount period.
If quantity discount is given together with cash discount, the cash discount will
be calculated after deducting the quantity discount amount. Cash discount is
given to encourage early payment.
Credit terms are the terms given by the seller to the buyer on the period
for payment.
Several credit terms are commonly used:
(i) 2/10, n/30

This credit term means that a discount of 2% will be given if payment is
made within 10 days from the date of invoice, while the payment period
(without discount) is for a period of 30 days. If purchases were made on 5
January, the expiry period for cash discount is on 15 January (5 January +
10 days = 15 January). This means that a 2% discount will be obtained if
payment is made on or before 15 January.
(ii) n/30
No discount was offered but the total purchase amount must be settled
within 30 days.
(iii) 4/15, n/eom

4% discount will be given if payment is made within 15 days and the
payment period is at the end of the current month. EOM as stated above
means end of month.
Cash discount can be categorised into two: purchase discount and sales discount.
(a) Purchase Discount

Cash discount is known as purchase discount by the buyer if the buyer pays
within the discount period for the purchase transaction made.
Purchase discounts or discounts received are price reductions given by the

seller to the buyer if the buyer pays his debt within the discount period.
If the buyer pays within the discount period, the price paid will be less than
the price stated in the purchase invoice. In the periodic system, the purchase
discounts account with credit balance will be set-off (contra) against the
purchases account.
(b) Sales Discount

Cash discount is known as sales discount to the seller if the buyer pays
within the discount period for the purchase transaction made.
Sales discounts or discounts given are price reductions given to credit

sales if the customer pays up within the discount period.
Cash payable by the customer or debtor will be less compared to the price
stated in the invoice. Sales discounts are offered to encourage customer to
make early payment.
Example of purchases and sales involving sales discount and purchase

discount are shown in Figure 5.2:
Figure 5.2: Example of purchases and sales involving sales discount

and purchase discount
ACTIVITY 5.2
Why would business entities provide discounts to its buyers? Discuss.
EXERCISE 5.2
1. Explain the meaning of the credit term 2/10, n/30.

2. Explain the meaning of sales discount.
3. Explain the meaning of purchase discount.
5.2.4 Returns and Allowances

Returns and allowances are known as Purchase Returns and Purchase Allowances
by buyers, and as Sales Return and Sales Allowances by sellers. As an example:
Besta Sdn. Bhd. sold goods to Ali Company. Therefore, Besta Sdn. Bhd. is the
seller and Ali Company is the buyer.
Besta Sdn. Bhd. Ali Company

(seller) (buyer)
Assuming Ali Company had returned goods to Besta Sdn. Bhd. as the goods were
not as per specifications.
For Ali Company (buyer), goods returned is known as purchase return as they
relate to purchases that had occurred earlier. However, the returned goods
received by Besta Sdn. Bhd. (seller) will be viewed as sales return as they relate to
their earlier sales. Further details on sales returns and allowances and purchase
returns and allowances are explained below.
(a) Purchase Returns and Allowances

When businesses purchase goods, and then they are not satisfied with the
goods, they are allowed to return the goods to the supplier. They can also
choose to keep the goods.
When a buyer returns the goods, it is known as purchase return from the
buyer’s perspective. For credit purchases, the return made will reduce the
amount in the accounts receivable balance. For cash purchases, cash will be
refunded to the buyer.
Purchase allowances exist when the buyer does not return the goods that
did not fulfil the specification and the seller agreed to reduce the purchase
price. In this case, the buyer will send a debit memo to the seller to remind
the seller to reduce the buyer’s account balance. Example of debit memo is
as shown in Figure 5.3.
Purchase returns and allowances account is the contra account for purchases
account and the normal balance is on the credit side.
Figure 5.3: Example of debit memo
(b) Sales Returns and Allowance

From the seller’s perspective, sales returns occur when a buyer or customer
returns goods which are damaged or for other reasons. Sales allowances
exist when a buyer chooses to keep the damaged goods. The seller must
adjust the invoice price to enable the outstanding balance to be reduced. The
seller will send a credit memo to the buyer when this happens. Example of a
credit memo is shown in Figure 5.4.
Figure 5.4: Example of credit memo

SELF-CHECK 5.1
Why do companies provide sales return allowances to their

customers?
ACTIVITY 5.3
Discuss the importance of having return allowances to the buyer and

seller.
EXERCISE 5.3
1. Choose the most accurate answer. The account which is related to

sales and has a normal debit balance is:
(a) sales discounts;
(b) sales returns and allowances; and
(c) both (a) and (b).
2. Explain the meaning of purchase returns and allowances.
3. Describe sales returns and sales allowances.
5.2.5 Transportation Cost

In general, transportation terms are specified in trade.
The transportation term will decide who will pay for the transportation
cost (either the buyer or the seller) and the time frame for the goods to be
transferred from the seller to the buyer.
Transportation costs can be classified into two:

(a) Free on Board (FOB) shipping point; and
(b) Free on Board (FOB) destination.
(a) FOB Shipping Point

In the FOB shipping point term, the goods will be transferred from the
seller to the buyer when the goods are sent by the seller to the transport
company: lorry, ship and others. The goods will belong to the buyer and can
be recorded as buyer’s inventory at the time of purchase. The transportation
cost would be borne by the buyer. The transportation cost paid by the
buyer will be recorded as carriage inwards. Carriage inwards account
would normally have a debit balance and will be added to the purchase cost
to obtain the cost of goods sold in the income statement.
Figure 5.5: FOB shipping point
(b) FOB Destination

The ownership of the goods will be transferred from the seller to the
buyer when the goods reach the buyer’s destination, which is the buyer’s
warehouse. The goods purchased will be owned by the buyer and can be
recorded as buyer’s inventory when the buyer received the goods. The buyer
cannot record the goods in its inventory during purchase. Entry will only be
made when the goods are received. The seller will bear the transportation
cost and record it as carriage outwards after the transportation cost had
been paid. This carriage outwards will be included in the income statement
as a part of the operating expenditure.
Figure 5.6: FOB destination
ACTIVITY 5.4
Which FOB term is suitable for business selling computers?
EXERCISE 5.4
Describe the difference between FOB shipping point with FOB destination.
5.3 ACCOUNTING FOR INVENTORY

As you know, trading firms buy goods for the purpose of resale. The goods
purchased will become inventory for the business entity. There are two methods
of recording inventory:
(a) Periodic Inventory System

Under the Periodic Inventory System, the amount of the inventory will only
be known by calculating the inventory physically. The stock count is made
at the end of the accounting period, when the total closing inventory is
needed to calculate the cost of goods sold. Companies do not have updated
information on the total inventory in the store. The characteristics of Periodic

Inventory System are:
(i) Goods purchased would be recorded in the Purchases Account.
(ii) Transportation cost would be recorded in the Carriage Inwards
Account.
(iii) Purchase returns and allowances will be recorded in the Purchase
Returns and Allowances Account.
(iv) Purchase Discounts obtained will be recorded in the Purchase Discounts
Account.
(v) Inventories (in record) would not be reduced when goods were sold.
(vi) The calculation of inventories physically is done once a year.
(vii) This system is used by businesses selling low-priced items which may
not derive any significant benefit from the preparation of inventory
records.
In Periodic Inventory System, companies must calculate the cost of goods

sold at the end of the accounting period. The calculations for cost of goods
purchased and the cost of goods sold are done in the income statement. The
calculation for cost of goods purchased is shown:
The opening inventory amount for the current year will be the closing
inventory for the previous year. This closing inventory amount will be
determined by physical calculation.
(b) Perpetual Inventory System

Under the Perpetual Inventory System, an inventory account will be created
and the inventory records will always be updated. The usage of this method
enables the company to know the inventory account balance at any time
by checking the balance of the said account. Every transaction affecting the
inventory will be recorded into the inventory account. The characteristics of
Perpetual Inventory System are:
(i) Inventory purchased will be recorded in the Inventory Account.
Therefore the inventory account will increase when purchases are
made.
(ii) Transportation cost will be recorded in the Inventory Account. The
transportation cost will increase the balance in the Inventory Account.
(iii) Purchase returns and allowances including purchase discounts will be
recorded in the Inventory Account.
(iv) Sales of inventory will be recorded at two prices, sales price and cost
price. The sales recorded at selling price will show the total sales
revenue, while the recording at cost price will show the total cost of
goods sold.
In the Perpetual Inventory System, there is no need to calculate the cost of

goods purchased and the cost of goods sold. Companies can know the value
of cost of goods sold directly by checking the balance in the cost of goods
sold account. This is because each time goods or inventories are sold, it will
be recorded in the Cost of Goods Sold Account at cost value.
SELF-CHECK 5.2
What are the usages of inventory recording for business entities?

5.4 JOURNAL ENTRY FOR PERIODIC AND

PERPETUAL INVENTORY SYSTEM
As a continuation from Section 5.3, the differences in the journal entries for
Periodic Inventory System and Perpetual Inventory System are shown in this
section.
(a) Cash and Credit Sales

If cash or credit sales were made, journal entries are needed to record the
sales at sales price. In Periodic Inventory System, the journal entry is only
recorded for sales at the sales price without any entry for cost price. In
Perpetual Inventory System, journal entries must be made to record the
sales at both the sales and cost price. Cash or credit sales at cost are made by
debiting the cost of goods sold account.
(b) Sales Returns and Allowances (Cash and Credit)

In the Periodic Inventory System, the journal entries for sales returns
and allowances are recorded at sales price only. However, for Perpetual
Inventory System, the sales returns and allowances made on cash sales or
credit sales must be recorded at sales and cost price. The journal entry to
record the returns at cost price can be done by crediting the cost of goods
sold account.
Table 5.1 shows the different journal entries between the two inventory systems
while Table 5.2 shows the journal entries for the related transactions, from the
view of the buyer and seller.
Table 5.1: Differences in Journal Entries for Periodic Inventory System and Perpetual Inventory System
TOPIC 5 TRADING BUSINESS ENVIRONMENT

155
156

Table 5.1: Differences in Journal Entries for Periodic Inventory System and Perpetual Inventory System (continuation)
Table 5.2: Illustration of Journal Entries for Buyer and Seller

157
158

Table 5.2: Illustration of Journal Entries for Buyer and Seller (continuation)
Before proceeding with our discussion, test your understanding by completing

the following exercise.
EXERCISE 5.5
1. Inventory was purchased at cost of RM2,000 on 15 July, with credit term
2/10, n/30. On 18 July, a credit memo had been received from supplier
due to damage to goods for RM100. Prepare the journal entries for
payment made on 24 July, using the perpetual inventory system.
2. A credit sale had been made on 10 July totalling RM800 with credit
term of 2/10, n/30. On 12 July, RM100 goods had been returned.
Prepare the journal entry on 19 July to record the cash received from
customer.
5.5 EXAMPLES OF RECORDING JOURNAL

ENTRIES
The following are the transactions for Selasih Sdn. Bhd. throughout the month of
December 2009. The company adopts the Perpetual Inventory System.
December 3 Purchased goods from Firdaus Sdn. Bhd. for RM4,000, FOB shipping point
term, 2/10, n/30 with prepayment of carriage for RM120.
December 5 Purchased goods from Kenari Sdn. Bhd. for RM8,500, with FOB destination
term 1/10, n/30.
December 6 Sold goods bought on 3 December to Hijrah Sdn. Bhd. at the price of RM5,800.
December 8 Purchased office supplies by cash for RM150.
December 10 Returned RM1,300 of goods purchased on 5 December from Kenari Sdn. Bhd.
December 13 Paid Firdaus Sdn. Bhd. for purchases made on 3 December, after discount.
December 14 Purchased goods by cash of RM10,500.
December 15 Paid Kenari Sdn. Bhd. for the purchases made on 5 December, after deducting
returns on 10 December and discount.
December 16 Received cash for sales made to Hijrah Sdn. Bhd. on December 6, after
deducting discount.
December 19 Sold goods, payment made via American Express credit card for RM2,450. Cost
of goods sold is RM980.
December 22 Sold goods to Cerating Sdn. Bhd. total RM3,480, credit term 2/10, n/30. Cost of
goods sold is RM1,400.
December 24 Purchased goods by cash for RM4,350. Cost of goods sold is RM1,750.
December 25 Received returns from Cerating Sdn. Bhd. for sales made on 22 December,
RM1,480. Cost of goods returned is RM600.
December 31 Received cash from American Express for sales made on 19 December and the
service charges is RM140.
Required:
Prepare the journal entries for the transactions above.
Solution:
Debit Credit
Date Descriptions
(RM) (RM)
Dec 3 Inventory 4,120
Accounts payable – Firdaus SB 4,120
Accounts payable – Kenari SB 8,500
Dec 6 Accounts receivable – Hijrah SB 5,800
Sales [4,000 - (30% x 4,000)] 5,800
Cost of goods sold 4,000
Inventory 4,000
Dec 8 Office supplies 150
Cash 150
Dec 10 Accounts payable – Kenari SB 1,300
Inventory 1,300
Dec 13 Accounts payable – Firdaus SB 4,120
Inventory 80
Cash [4,000 – (2% x 4,000) + 120] 4,040
Cash 10,500
Dec 15 Accounts payable – Kenari SB 7,200
Inventory [(8,500 – 1,300) x 1 %] 72
Cash [8,500 – 1,300 – 72] 7,128
Dec 16 Cash 5,684
Sales discount 116
Accounts receivable – Hijrah SB 5,800
Dec 19 Accounts receivable – American Express 2,450
Sales 2,450
Cost of goods sold 980
Inventory 980
Dec 22 Accounts receivable – Cerating SB 3,480
Sales 3,480
Inventory 1,400
Dec 24 Cash 4,350
Sales 4,350
Inventory 1,750
Dec 25 Sales returns and allowances 1,480
Accounts receivable – Cerating SB 1,480
Inventory 600
Dec 31 Cash 2,310
Credit card expenses 140
Accounts receivable – American Express 2,450
EXERCISE 5.6
Cempaka Sdn. Bhd. conducts trading activities for the month of May.
At the start of the month of May, Cempaka Sdn. Bhd. has a cash total
RM5,000 and the capital contributed by Abu Bakar totalled RM5,000.
May 1 Purchased trading goods for RM6,000 from Depot

Wholesaler, with terms 2/10, n/30.
May 2 Sold goods worth RM4,500 to Rahmat, credit terms 2/10,
n/30. Cost of goods is RM3,000.
May 5 Returned goods worth RM200 to Depot wholesaler.
May 9 Received full payment, after deducting discount, from
Rahmat for the sales of RM4,500 made on 2 May.
May 10 Paid Depot Wholesaler.
May 11 Purchased supplies from supplier by cash for RM900.
May 12 Purchased goods by cash for RM2,400.
May 15 Received refund of RM230 for goods purchased
on 12 May from supplier due to the goods being of
unsatisfactory quality.
May 17 Purchased goods from Harrods Sdn. Bhd. for RM1,900,
FOB shipping point, with terms 2/10, n/30.
May 19 Paid carriage of RM250 for purchases made on 17 May.
May 24 Sold goods by cash for RM6,200. Cost of goods sold is
RM4,340.
May 25 Purchased goods from Horizon Sdn. Bhd. for RM1,000,
FOB destination, terms 2/10, n/30. Goods were only
received on 28 May.
May 27 Paid Harrods Sdn. Bhd. for the purchases made on 17
May.
May 29 Refunded RM100 for damaged goods. The cost of goods
returned is RM70.
May 31 Sold goods of RM1,600 to Rahmat, with term n/30. The
cost of goods sold is RM1,120.
Required:
(a) Prepare the journal entries for the above transactions by using the
Perpetual Inventory System.
(b) Prepare the ledgers for each of the entries.
(c) Prepare the Income Statement for the month ended 31 May 2009.
5.6 FORMAT OF INCOME STATEMENT FOR

TRADING FIRMS
Income statements for trading firms contain three items which are not found on
income statements of service firms:
(a) sales revenue from trading goods;
(b) cost of goods sold;
(c) gross profit.
Two types of statement normally used are:

(a) single level of income statement; and
(b) multiple level of income statement.
5.6.1 Single Level of Income Statement

In the Single Level Income Statement, all the expenditures are deducted in
only one step as shown in the next page, inclusive of cost of goods sold. In the
income section, companies would not report the gross sales, sales returns and
allowances and sales discounts individually but will only report overall net
sales. Single Level Income Statement emphasises more on the total revenue and
total expenditure to determine the net profit. The Single Level Income Statement
also does not show directly the information on gross profit and revenue from
operations for analysis purposes.
5.6.2 Multiple Levels of Income Statement

Generally, Multiple Level Income Statement comprises several sections and
sub-totals of those sections. Multiple Level Income Statement can be prepared
according to the Periodic Inventory System and Perpetual Inventory System, as
explained in Section 5.3.
In the Perpetual Inventory System, the closing balance of cost of goods sold
can be obtained directly from the account. This is because sales or sales returns
and allowances are recorded at sales and cost price. In comparison, information
on cost of goods sold for the Periodic Inventory System can only be obtained
through calculation which must be done physically. This had been explained in
Section 5.3 (a).
Figure 5.7 shows the format for Multiple Level Income Statement using the
Periodic Inventory System, while Figure 5.8 illustrates the format for Multiple
Level Income Statement using the Perpetual Inventory System.
Angsana Berhad
Income Statement for the year 30 June 2007
RM RM RM RM
Revenue:
Sales XX
(–) Sales returns and allowances XX
Sales discount XX (XX)
Net sales XX
Less: Cost of goods sold
Opening inventory XX
Purchases XX
(–) Purchases returns and allowances XX
* Purchases discount XX (XX)
Net purchases XX
(+) Carriage inwards XX
Cost of goods purchased XX
Cost of goods ready for sale XX
(–) Closing inventory (XX)
Cost of goods sold XX
Gross profit XX
Add: Other income
Interest revenue
Rental revenue XX
Less: Operating expenditures XX
Sales expenses XX
Sales salary expenses
Advertisement expenses
Sales maintenance expenses XX
Store depreciation expenses
Total sale expenses XX
Administrative expenses XX
Administrative salary expenses XX
Equipment depreciation expenses
Insurance expenses XX
Rental expenses
Total administrative expenses XX
Total sale and administrative expenses XX
Revenue from operating XX
Total sales and administrative expenses (XX)
Add: Other revenue
Interest revenue XX
Rental revenue XX XX
Less: Other expenditures
Interest expenses (XX) XX
Net profit XX
* Cost of goods sold must be calculated according to the calculation explained in Section 5.3.1
Figure 5.7: Multiple level income statement – periodic inventory system
Angsana Berhad
Income Statement for the Year 30 June 2007

RM RM RM
Revenue:
Sales XX
(-) Sales returns and allowances XX
Sales discount XX (XX)
Net sales XX
(-) Cost of goods sold XX
Gross profit XX
Add: Other income
Interest revenue
Rental revenue XX
Less: Operating expenditures XX
Sales expenses XX
Sales salary expenses
Advertisement expenses
Sales maintenance expenses XX
Store depreciation expenses
Total sale expenses XX
Administrative expenses XX
Administrative salary expenses XX
Equipment depreciation expenses
Insurance expenses XX
Rental expenses
Total sale and administrative expenses XX
Total sales and administrative expenses (XX)
Add: Other revenue
Interest revenue XX
Rental revenue XX XX
Less: Other expenditures
Interest expenses (XX) XX
Net profit XX
* Cost of goods sold can be determined by looking at the closing balance of the cost of goods sold
account. Please see Section 7.3 (b) for further information.
Figure 5.8: Multiple level income statement – perpetual inventory system
The major difference between these two formats is the total cost of goods sold
(COGS). In the Perpetual Inventory System, the cost of goods sold account was
created to record the credit sales or cash sales at cost. It is the same for returns.
For credit sales or cash sales, the returns will be recorded at sales price and cost
price. Therefore, the closing balance for the cost of goods sold can be determined
from the cost of goods sold account balance. As the accounting method for
Perpetual Inventory System records the credit sales and cash sales at the sales
price and cost price, cost of goods sold closing balance can be determined from
the balance of the cost of goods sold account. The accounting method for Periodic
Inventory System only records the credit sales and cash sales at sales price,
therefore numerical calculation must be done to obtain the cost of goods sold.
EXERCISE 5.7
The Trial Balance for Melati Sdn. Bhd. involved the following accounts
for the year ended as at 31 December 2008.
Melati Sdn. Bhd.
Trial Balance
31 December 2008
Debit (RM) Credit (RM)
Cash 23,400
Trading goods inventory 90,000
Land 92,000
Building 197,000
Accumulated depreciation – building 54,000
Equipment 83,500
Accumulated depreciation – equipment 42,400
Capital – Aminah 267,800
Drawings – Aminah 10,000
Sales 902,100
Sales discount 4,600
Repair expenses 5,900
Maintenance expenses 7,200
1,353,800 1,353,800
Additional information:
1. Depreciation for building is RM10,000 and equipment RM9,000
(both are administrative expenses).
2. Interest payable RM7,000 and notes payable still outstanding as at
31 December 2008.
3. Salary expenses are 80% for sales and 10% for administration.
4. Utility expenses, repair expenses and insurance expenses are 100%
for administration.
5. RM15,000 from the notes payable will mature this year.
6. Maintenance expenses are for sales expenses.
Required:
(a) Prepare the journal for adjusting entries.
(b) Prepare the Income Statement for the year ended 31 December 2008.
(c) Prepare the balance sheet as at 31 December 2008.
(d) Prepare the closing entries.
5.7 CLOSING ENTRIES

Closing Entries are made at the end of the accounting period of a company. It
is the last process in preparation of accounts for the period. For trading firms,
the closing entries are made to close all the temporary accounts. The accounts
involved are revenue accounts, expenses accounts and drawings account. This is
in accordance to the principle of matching and principle of revenue and expenses
recognition. By this action, the accounts involved will not be added to the revenue
and expenses of other periods. All accounts involved in calculating net profit will
be closed to the revenue summary account.
Drawings account will be closed and included in the capital account. Accounts
for assets and liabilities will be maintained and will not be closed. Assets and
liabilities account balances will be carried forward to the next accounting period.
The format of closing entries for Periodic Inventory System is shown in Figure
5.9, while the format of closing entries for Perpetual Inventory System is shown
in Figure 5.10.
1. Closing accounts with credit balances.

RM RM
Dr Sales XX
Dr Interest revenue XX
Cr Revenue summary XX
2. Closing accounts with debit balances
RM RM
Dr Revenue summary XX
Cr Sales returns and allowances XX
Cr Sales discount XX
Cr Cost of goods sold XX
Cr Carriage outwards XX
Cr Insurance expenses XX
Cr Salary expenses XX
Cr Other expenses XX
3. Closing revenue summary account – net profit or loss
RM RM
Dr Revenue Summary XX
Cr Capital XX
4. Closing drawings account to capital account
RM RM
Dr Capital XX
Cr Drawings XX
Figure 5.9: Closing entries for trading firms using periodic inventory system
1. Closing accounts with credit balances.

RM RM
Dr Inventory (closing) XX
Dr Sales XX
Dr Interest revenue XX
Dr Purchase returns and allowances XX
Cr Revenue summary XX
2. Closing accounts with debit balances
RM RM
Dr Revenue summary XX
Cr Inventory (closing) XX
Cr Sales returns and allowances XX
Cr Purchases XX
Cr Sales discount XX
Cr Carriage inwards XX
Cr Carriage outwards XX
Cr Insurance expenses XX
Cr Salary expenses XX
Cr Other expenses XX
3. Closing revenue summary account
RM RM
Dr Revenue Summary XX
Cr Capital XX
4. Closing drawings account to capital account
RM RM
Dr Capital XX
Cr Drawings XX
Figure 5.10: Closing entries for trading firms using perpetual inventory system
Example:
Sejahtera Company has just started its retail business on 1 September 2009. The
following are the transactions made by Sejahtera Company Sdn Bhd throughout
the month of September 2009:
Sept 1 Owner of Sejahtera Company, Farid invested cash of RM50,00 into

the business.
Sept 1 Purchased and received inventory of RM10,000 bought on credit
from Azlan Company with the terms 2/10, n/30, FOB destination.
Sept 2 Sold inventory for RM8,000 on credit to Indah Company with
terms 2/10, n/30, FOB shipping point. Cost of inventory sold total
RM3,200.
Sept 5 Returned RM500 of inventory purchased on 1 September from

Azlan Company as the inventory was found to be damaged.
Sept 9 Received cash from Indah Company for the sales made on 2
September.
Sept 10 Settled all debts to Azlan Company for purchase made on 1
September after deducting returns on 5 September.
Sept 11 Purchased inventory totalling RM4,800 by cash.
Sept 15 Purchased inventory totalling RM4,000 on credit from Huda
Company with terms 1/10, n/30, FOB shipping point.
Sept 17 Paid carriage expenses of RM300 for purchases on 15 September.
Sept 22 Sold inventory totalling RM12,500 by cash to Cahaya Company.
Cost of goods sold totalled RM6,250.
Sept 25 Received inventory returned of RM200 from Cahaya Company for
sales on 22 September. The cost of the inventory is RM100.
Sept 28 Sold inventory for RM3,500 on credit to Umi Company with term
n/30. Cost of inventory sold is RM1,500.
Sept 30 Paid building rental for the month of September total RM2,000 and
salary for the month of September for RM6,000.
Required:
(a) Prepare the journal entries for the above transactions, assuming Sejahtera
Company adopts the Perpetual Inventory System.
(b) Prepare the Single Level of Income Statement for the month ended
30 September 2009.
(c) Prepare the closing entries for Sejahtera Company.
Answer (a)
Sept 1 Cash 50,000
Capital, Farid 50,000
Sept 1 Inventory 10,000
Accounts payable – Azlan 10,000
Company
Sept 2 Accounts receivable – Indah 8,000
Company
Sales 8,000
Inventory 3,200
Sept 5 Accounts payable – Azlan Company 500
Inventory 500
Sept 9 Cash 7,840
Accounts receivable – Indah 7,840
Company
Sept 10 Accounts payable – Azlan Company 9,500
Cash 9,310
Inventory (2% x 9,500) 190
Cash 4,800
Accounts payable – 4,000
Huda Company
Sept 17 Inventory 300
Cash 300
Sept 22 Cash 12,500
Sales 12,500
Inventory 6,250
Sept 25 Sales returns and allowances 200
Cash 200
Inventory 100
Sept 28 Accounts receivable – Umi Company 3,500
Sales 3,500
Inventory 1,500
Sept 30 Salary expenses 6,000
Cash 6,000
Sept 30 Rental expenses 2,000
Cash 2,000
Answer (b)
Sejahtera Company
Income Statement
for the Month Ended 30 September 2009
RM RM
Revenue:
Net sales (8,000-160+12,500-200+3,500) 23,640
Less: Expenditure
Cost of goods sold (3,200+6,250-100+1,500) 10,850
Total expenditure (18,850)
Net profit 4,790
Answer (c)
Sep 30 Sales (8,000+12,500+3,500) 24,000
Revenue summary 24,000
Sales return and allowance 200
Sales discount 160
Revenue summary
Capital, Farid 4,790
4,790
WEBSITE
Visit the following websites to obtain additional information on the topics

discussed.
http://www.ameritrade.com/educationv2/fhtml/learning/uincomestates.fhtml
Description: Information on Income Statement.
http://management.about.com/cs/adminaccounting/ht/readincomestmt.htm
Description: Guide to understanding Income Statement.
http://www.ibm.com/investor/financialguide/
Description: Introduction to identifying Financial Statement.
EXERCISE 5.8
1. Prepare journal entries to record the following transactions for

Kelana Sdn. Bhd. by using the Perpetual Accounting System.
(a) On 2 March, Kelana Sdn. Bhd. sold RM800,000 goods to Kenari
Sdn. Bhd., with credit terms 2/10, n/30. Cost of goods sold is
RM600,000.
(b) On 6 March, Kenari Sdn. Bhd. returned RM120,000 of goods
sold on 2 March due to damage. Cost of goods returned is
RM90,000.
(c) On 12 March, Kelana Sdn. Bhd. received payment from Kenari
Sdn. Bhd.
2. Merlimau Sdn. Bhd. has trading account balances as follows:
Sales RM 180,000
Discount RM 2,000
Cost of goods sold RM 100,000
Goods inventory RM 40,000
Prepare the closing journal entries by recording the above items in

the revenue summary.
3. Information reported by Olen Sdn. Bhd. are as follows:

(a) On 5 April, Olen purchased trading goods from Danau Sdn.
Bhd. totalling RM16,000, credit terms 2/10, n/30, FOB shipping
point.
(b) On 6 April, Olen paid transportation cost of RM900 for goods
sold to Danau Sdn. Bhd.
(c) On 7 April, Olen purchased equipment for RM26,000.
(d) Olen returned damaged goods of RM3,000 to Danau Sdn. Bhd.
(e) On 15 April, Olen settled the outstanding amount to Danau
Sdn. Bhd.
(i) Prepare the journal entries to record the transactions for
Olen Sdn. Bhd. using the perpetual inventory system.
(ii) Assume payment was made on 4 May instead of 15 April.
Prepare the journal entries to record this payment.
4. On 1 September, Pertama Sdn. Bhd. had 30 calculators costing RM20

each. The company adopts the perpetual inventory system. The
following transactions occurred throughout the month of September.
September 6 Purchased 80 calculators at the price of RM19
each from Digital Sdn. Bhd. by cash.
September 9 Paid transportation RM80.
September 10 Returned 2 calculators, valued at RM40, as they
did not meet specifications.
September 12 Sold 26 calculators at the price of RM20 per
unit, or RM30 per unit if transportation cost is
included.
September 14 A calculator priced at RM30 was returned to the
company as the customer had ordered in excess.
September 20 Sold 30 calculators at a selling price of RM30
each. These calculators cost RM20 each.
Required: Prepare the journal entries for the transactions throughout

the month of September.
5. The following are the transactions for Selasih Sdn. Bhd.

December 3 Selasih Sdn. Bhd. sold goods totalling
RM480,000 to Desaru Sdn. Bhd., with terms
2/10, n/30, FOB shipping point. Cost of goods
sold amounted to RM320,000.
December 8 Desaru Sdn. Bhd. received allowances worth
RM20,000 for the goods purchased on December
3.
December 13 Selasih Sdn. Bhd. received payment from
Desaru Sdn. Bhd.
Required:
(a) Prepare the journal entries to record the transactions for Selasih Sdn.
Bhd., using the perpetual inventory system.
(b) Assume that Selasih Sdn. Bhd. had received the payment from
Desaru Sdn. Bhd. on 2 January instead of 13 December. Prepare the
journal entries for the payment received on 2 January the following
year.
SUMMARY
This topic emphasised on the following:

• Income statement for trading and service firms are different due to the
different activities involved. There are two types of trading business which
are:
– Retailers
– Wholesalers
• Main characteristics of trading firms are:
– Purchased goods for resale.
– Goods sold are treated as sales revenue, while cost of goods sold relate
to the cost of inventories which have been sold.
– Gross profit can be calculated by deducting cost of goods sold from sales
revenue.
– Net operating revenue can be calculated by deducting operating
expenditure from gross profit.
– Goods unsold by the end of the accounting period will become closing
inventory, which will be reported as current asset.
• Important transactions for trading firms are:
– Purchases
– Sales
– Discounts
– Returns and allowances
– Transportation cost
• Two important methods to record inventory are:
– Periodic Inventory System
– Perpetual Inventory System
• There are two types of income statement for trading firms:
– Single level income statement
– Multiple level income statement
• The closing entries must be made at the end of the accounting period to
close all the temporary accounts for trading firms.
Cash discounts Purchases

Cash sales Quantity discounts
Credit sales Sales
Credit terms Sales Returns and Allowance
Discount
Topic  Financial
Statement
6 Analysis
LEARNING OUTCOMES
1. Explain three techniques that can be used to analyse the financial
statement;
2. Discuss the basis of item comparison in financial statement;
3. Differentiate between Horizontal Analysis and Vertical Analysis in
evaluating financial statement;
4. Explain the importance of financial ratio in analysing and interpreting
the accounting infomation;
5. Calculate and interpret the financial ratio that can be used to measure
profitability, liquidity, efficiency and debt management; and
6. Explain the purposes as well as the effectiveness of financial ratios to
evaluate the liquidity, profitability and debt management.
 INTRODUCTION
Topic 6 will explain financial statement analysis in more detail. Financial
statement analysis provides useful information to internal users for decision-
making. This topic will discuss financial statement information that will be used
to evaluate the performance and financial status of a company. The main reasons
for comparison and analysis techniques used are emphasised in this topic. There
are three types of analysis techniques:
(a) horizontal analysis;
(b) vertical analysis; and
(c) ratio analysis.
TOPIC 6 FINANCIAL STATEMENT ANALYSIS  177
6.1 PURPOSE OF FINANCIAL STATEMENT

ANALYSIS
The main function of financial statement analysis is to help users make better
decisions, whether for internal or external users of the company concerned.
Internal users of accounting information are individuals involved in the

management and operations of the organisations.
They include the management, internal auditors, other employees, consultants

and parties involved in decision-making in an organisation. Figure 6.1 shows an
illustration of internal users.
Figure 6.1: Internal users of accounting information
Internal users are responsible for planning strategies and executing the
company’s operations. The purpose of financial analysis is to provide them with
information in order to improve the efficiency and effectiveness in producing
output or services of the organisation.
External users of accounting information are not directly involved in the

operation of the organisation.
They comprise shareholders, creditors, non-executive directors, customers,

suppliers, legislators, lawyers, brokers, media and others. Figure 6.2 illustrates a
summary of external users.
178  TOPIC 6 FINANCIAL STATEMENT ANALYSIS
Figure 6.2: External users of accounting information
External users utilise accounting information to determine the financial status of

the company for their own purposes. Shareholders and creditors will evaluate
the investment and financing prospects of the company. Members of the board
of directors will analyse the financial statement for the purpose of monitoring the
effectiveness of decisions which have been made. Suppliers will use the financial
information to evaluate the credit standing of the organisations.
Generally, financial statement analysis is done to:

(a) make the information more meaningful to enable users to make decisions;
and
(b) assist users to measure the performance level and financial status of the
business.
SELF-CHECK 6.1
Do internal users need to obtain prior approval from external users

before implementing specific financial decisions? Why?
6.2 SOURCES OF INFORMATION

Financial statement analysis requires information for analysis. Financial statement
analysis can be done using the annual report of organisations. The annual report
contains information in the form of:
(a) Income Statement;
(b) Balance Sheet;
(c) Cash Flow Statement;
(d) Statement of Changes in Equity;
(e) Notes to the financial statement;
(f) Summary of accounting methods used;

(g) Management’s discussion and analysis of operating revenue;
(h) Auditors’ report; and
(i) Financial data comparison for several years.
6.3 BASIS OF COMPARISON

Financial information can be compared using three bases:
• within the company (intra-company);
• between companies (inter-company); and
• industry average.
(a) Within the Company

Using this basis, the company will compare the items in its financial
statements relating to two different years, or more. The comparison of
current year’s financial statement with previous years will show the trend
of the company that can be used for future prediction. For example, the
comparison of cash item for the current year with previous years will show
its increase or decrease within the company.
(b) Between Companies

Using this basis of comparison, the items in the financial statement of one
particular company are compared with those of other companies, all of
which are operating the same type of business. The comparisons are made
based on the financial statement published by the companies. Comparisons
between companies provide useful information on the specific company’s
status as compared to its competitors.
(c) Industry Average

This basis of comparison compares items in the financial statement of the
specific company with other companies in the related industry in general.
Comparison made between the company and industry average will provide
information on the company’s performance within the industry.
ACTIVITY 6.1
How can the basis between comparison for financial information be useful
for a printing company that has operated for the past 40 years? Discuss.
EXERCISE 6.1
State the differences between the following basis of comparison:

(a) Within company;
(b) Between companies; and
(c) Industry average.
6.4 TECHNIQUES OF ANALYSIS

Three techniques may be used in evaluating financial statement data: Horizontal
Analysis, Vertical Analysis and Ratio Analysis.
Horizontal analysis is especially used for comparison within the company.

Vertical analysis can be used either for comparison within the company or
between companies, while ratio analysis can be used for all the three bases
of comparison, which are within company, between companies and industry
average. Figure 6.3 summarises the analysis techniques mentioned.
Figure 6.3: Techniques of Analysis
SELF-CHECK 6.2
Explain the three techniques of analysis in evaluating financial

statement data.
ACTIVITY 6.2
Which analysis technique is suitable for a business selling sports cars?

6.5 HORIZONTAL ANALYSIS
Horizontal analysis is a technique used to assess the trend of the items in

the financial statement (increasing or decreasing) in terms of amount or
percentage of fluctuation.
There are two characteristics of horizontal analysis. First, the comparison is

made on every item in the financial statement for at least two accounting period
or years. The basis of comparison for these two years (the current year and the
previous year) will be set by using the financial statement of the previous year
as the base to determine an increase or decrease. Second, the comparison for
sequential financial data is normally for 5 to 10 years or more. This comparison is
also known as trend analysis.
Horizontal analysis is classified into:

(a) Period of at least 2 years; and
(b) Period of more than 2 years – also known as trend analysis.
6.5.1 Comparison of Horizontal Analysis for 2 Years

The calculation for percentage of increase or decrease in horizontal analysis for a
period of 2 years is made using the following steps:
(a) First, calculate the amount of change for the base year (previous year) and
the following year (current year), for every item in the financial statement.
(b) Second, divide the amount of change, as calculated above, with the amount
in the base year for every item in the financial statement, to obtain the
percentage of change.
Change in Ringgit = Current year amount - Base year amount
Current year amount - Base year amount

Percentage of change = ––––––––––––––––––––––––––––––––––––  100
Base year amount
Percentage of change for the Cash item in the Balance Sheet (Refer Table 6.2)
Current year amount - Base year amount  100

Percentage of change = –––––––––––––––––––––––––––––––––––––––––
Base year amount
RM90,500 - RM64,700
Percentage of change = –––––––––––––––––––––  100
RM64,700
= 39.9%
The calculation above must be repeated for each item in the balance sheet, income
statement and retained earnings statement.
The next examples are on marketable securities and non-current liability as

shown in Table 6.1:
Table 6.1: Percentage change for Marketable Securities and non-current Liability
Item Year Increase (Decrease)

2009 2008 Amount (RM) Percentage (%)
Marketable 75,000 60,000 75,000 – 60,000 15,000
Securities = 15,000 –––––––  100
60,000
= 25
Non-current Liability 100,000 200,000 100,000 – 200,000 (100,000)
= (100,000) ––––––––  100
200,000
= (50)
First step calculation
Second step calculation
Table 6.2 shows the horizontal analysis for the entire Balance Sheet based on the
format set by the Malaysian Accounting Standards Board in MASB 1, which is
‘Presentation of Financial Statements’ and in MASB 3 titled ‘Net Profit or Loss for
the Period, Fundamental Errors and Changes in Accounting Policies’.
Table 6.2: Anggerik Sdn. Bhd.: Comparison Balance Sheet
Anggerik Sdn. Bhd.

Comparison Balance Sheet
as at 31 December 2006 and 2007
Increase (Decrease)
2007 2006 Amount Percentage
(RM) (RM) (RM) (%)
Non-current Assets:
Long-term investment 95,000 177,500 (82,500) (46.5)
Building and Equipment (net) 444,500 470,000 (25,500) (5.4)
Intangible assets 50,000 50,000 – –
Total non-current assets 589,500 697,500 (108,000) (15.5)
Current Assets:
Cash 90,500 64,700 25,800 39.9
Marketable securities 75,000 60,000 15,000 25.0
Accounts receivable 115,000 120,000 (5,000) (4.2)
Inventory 264,000 283,000 (19,000) (6.7)
Expenses pre-payment 5,500 5,300 200 3.8
Total current assets 550,000 533,000 17,000 3.2
Current liability:
Accounts payable 210,000 243,000 (33,000) (13.6)
Total net current assets 340,000 290,000 50,000 17.2
929,500 987,500 (58,000) 5.9
Financed by owner and long-term
liability:
Owner’s equity:
6% Preference shares, RM100 150,000 150,000 – –
Ordinary shares, RM10 500,000 500,000 – –
Retained earnings 179,500 137,500 42,000 30.5
Non-current liability 100,000 200,000 (100,000) (50.0)
Total owner’s equity and long-term 929,500 987,500 (58,000) 5.9
liability
Table 6.3 shows the horizontal analysis for Income Statement.
Table 6.3: Anggerik Sdn. Bhd.: Comparison Income Statement
Anggerik Sdn. Bhd.

Comparative Income Statement
for the Year Ended 31 December, 2007 and 2006
Increase (Decrease)
(RM) (RM) (RM) (%)
Sales 1,530,500 1,530,500 296,500 24
(–) Sales return and allowance 32,500 34,000 (1,500) (4.4)
Net sales 1,498,000 1,200,000 298,000 24.8
(–) Cost of goods sold 1,043,000 820,000 223,000 27.2
Gross profit 455,000 380,000 75,000 19.7
(–) Sales expenses 191,000 147,000 44,000 29.9
(–) Adminis-trative expenses 104,000 97,400 6,600 6.8
Net operating revenue 160,000 135,600 24,400 18.0
(+) Other revenue or profit 8,500 11,000 (2,500) (22.7)
(–) Other expenses and loss 6,000 12,000 (6,000) (50.0)
Profit before tax 162,500 134,600 27,900 20.7
Taxation 71,500 58,100 13,400 23.1
Profit after tax 91,000 76,500 14,500 19.0
Horizontal analysis for Retained Earnings Statement is shown in Table 6.4.
Table 6.4: Anggerik Sdn. Bhd.: Comparative Retained Earnings Statement
Anggerik Sdn. Bhd.

Comparative Retained Earnings Statement
as at 31 December, 2007 and 2006
Increase (Decrease)
(RM) (RM) (RM) (%)
Retained earnings, 1 Jan 137,500 100,000 37,500 37.5
Current year profit 91,000 76,500 14,500 19.0
228,500 176,500 52,000 29.5
(–) Dividend
Preference shares 9,000 9,000 – –
Ordinary shares 40,000 30,000 10,000 33.3
49,000 39,000 10,000 25.6
Retained earnings, 31 December 179,500 137,500 42,000 30.5
6.5.2 Comparison of Horizontal Analysis for a

Sequential Period (Trend Analysis)
Horizontal Analysis for a sequential period or Trend Analysis is a

technique to evaluate the financial data for specific periods.
Trend analysis is a horizontal analysis involving the income statement and

balance sheet for three years or more. In trend analysis, the item from the first
statement or initial period will be used as the base for comparison.
Example:
Information obtained from Balance Sheet of Angsana Sdn. Bhd., the Net Sales
item for 2003-2007, is shown in Table 6.5.
Table 6.5: Angsana Sdn. Bhd. – Net Sales Data for a Period of 5 Years
Angsana Sdn. Bhd.

2007 2006 2005 2004 2003
Net sales (RM) (RM) (RM) (RM) (RM)
41,296 38,064 34,835 33,110 30,518
By using 2003 as the base year for comparison, calculation of increase or decrease
of the financial data for the following years can be done.
Amount for a specific year – Base year amount

Change from base year = ––––––––––––––––––––––––––––––––––––––––––  100
Base year amount
Example:
Increase in net sales for year 2004:
RM33,110 – RM30,518
= ––––––––––––––––––––  100
RM30,518
= 8.5%
Therefore, net sales have increased by 8.5% in 2004 from the base year of 2003.
By using the sales figure for 2003 – 2007, a sequential period analysis can be
obtained (refer Table 6.6).
Table 6.6: Angsana Sdn. Bhd. – Net Sales Data for a Period of 5 Years
Angsana Sdn Bhd

2007 2006 2005 2004 2003
(RM) (RM) (RM) (RM) (RM)
Net sales
41,296 38,064 34,835 33,110 30,518
135% 125% 114% 108% 100%
6.6 VERTICAL ANALYSIS
Vertical Analysis is a technique to evaluate items in the financial statement

by stating each of the items in the form of percentage as compared to the
base amount.
Vertical analysis shows the relationship of every item in the financial statement
with one item which is being used as the base. The base item for balance sheet is
Total Asset, and base item for Income Statement is Net Sales.
6.6.1 Vertical Analysis for Balance Sheet

To perform the vertical analysis, items found in the financial statement as stated
in MASB 1 must be presented according to the format shown in Table 1. This is to
facilitate the calculation of the percentages in the vertical analysis.
The vertical analysis can be performed more easily if (Total Asset) and (Total
Liability and Owner Equity) is shown in the analysis. The basis of comparison in
vertical analysis is based on (Total Asset) or (Total Liability and Owner Equity).
This can be illustrated based on the accounting equation:
Asset = Liability + Owner’s equity
Table 6.7 shows examples of the calculation for Cash and Accounts payable items
for 2007 and 2006.
Table 6.7: Percentage Calculation Examples of Vertical Analysis for Balance Sheet
2007 2006
Cash Percentage:
Cash RM90,500 RM64,700
––––––––––––  100 = ––––––––––––  100 = ––––––––––––  100
Total assets RM1,139,500 RM1,230,500
= 7.9% = 5.3%
AP Percentage:
Total Liability RM210,000 RM243,000
–––––––––––––––––––––––––––––  100 = ––––––––––––  100 = ––––––––––––  100
Total Liability and Owner Equity RM1,139,500 RM1,230,500
= 18.4% = 19.7%
The vertical analysis for the entire Balance Sheet of Anggerik Sdn. Bhd. as at 31
December 2007 and 2006 is shown in Table 6.8.
Table 6.8: Anggerik Sdn. Bhd.: Comparative Balance Sheet

Anggerik Sdn. Bhd.
Comparative Balance Sheet
2007 2006
Total Percentage Total Percentage
(RM) (%) (RM) (%)
Current Assets:
Cash 90,500 7.9 64,700 5.3
Marketable Securities 75,000 6.6 60,000 4.9
Accounts receivable 115,000 10.1 120,000 9.8
Inventory 264,000 23.2 283,000 23.0
Expenses Prepayment 5,500 0.48 5,300 0.4
Total Current Assets 550,000 48.3 533,000 43.3
Non-current Assets:
Long-term Investment 95,000 8.3 177,500 14.4
Building and Equipment (Net) 444,500 39.0 470,000 38.2
Intangible Asset 50,000 4.4 50,000 4.1
Total Non-current Assets 589,500 51.7 697,500 56.7
Total Assets 1,139,500 100 1,230,500 100
Current Liability:
Accounts payable 210,000 18.4 243,000 19.7
Non-current Liability 100,000 8.8 200,000 16.3
Total Liabilities 310,000 27.2 443,000 36.0
Owner’s Equity:
6% Preference Shares, RM100 150,000 13.2 150,000 12.2
Ordinary Shares, RM10 500,000 43.9 500,000 40.6
Retained Earnings 179,500 15.8 137,500 11.2
Total Owner’s Equity 829,500 72.8 787,500 64.0
Total Liabilities and Owner’s Equity 1,139,500 100 1,230,500 100
The analysis can also be done by comparing the percentage of an item for one
year with its percentage for another year. For example, in 2006, total liabilities
form 36% of the total liabilities and owner’s equity. The corresponding figure for
2007 is only 27.2%, implying that the usage of debts in year 2007 had decreased
as compared to 2006. The same approach can be used to analyse the other items.
6.6.2 Vertical Analysis for Income Statement

In vertical analysis for income statement, the item used as the base for comparison
is Net Sales.
Table 6.9: Percentage Calculation Example of Vertical Analysis for Income Statement
2007 2006
Sales percentage:
Sales RM1,530,500 RM1,234,000
––––––––––  100 = ––––––––––––  100 = ––––––––––––  100
Net assets RM1,498,000 RM1,200,000
= 102.2% = 102.8%
Administrative expenses percentage:

RM104,000 RM97,400
Administrative expenses = ––––––––––––  100 = ––––––––––––  100
–––––––––––––––––––––––  100 RM1,498,000 RM1,200,000
Net sales = 6.9% = 8.1%
The calculation results of vertical analysis for the entire Income Statement are
shown in Table 6.10.
Table 6.10: Anggerik Sdn. Bhd.: Comparative Income Statement
Anggerik Sdn. Bhd.

for 31 December 2007 and 2006
2007 2006
Total Percentage Total Percentage
(RM) (%) (RM) (%)
Sales 1,530,500 102.2 1,234,000 102.8
(–) Sales return and allowance 32,500 2.2 34,000 2.8
Net sales 1,498,000 100.0 1,200,000 100.0
(–) Cost of goods sold 1,043,000 69.6 820,000 68.3
Gross profit 455,000 30.4 380,000 31.7
(–) Sales expenses 191,000 12.8 147,000 12.3
(–) Administrative expenses 104,000 6.9 97,400 8.1
Total operating revenue 160,000 10.7 135,600 11.3
(+) Other revenue or profit 8,500 0.6 11,000 0.9
(–) Other expenses or loss 6,000 0.4 12,000 1.0
Profit before tax 162,500 10.9 134,600 11.2
Taxation 71,500 4.8 58,100 4.8
Profit after tax 91,000 6.1 76,500 6.4
As explained in section 6.6.1 regarding the Balance Sheet, analysis can be done by
comparing the percentage of an item for one year with its percentage for another
year. For example, in 2006, profit after tax (as percentage of net sales) is 6.4%. The
corresponding figure in 2007 is only 6.1%.
It is possible to identify the reason for the decrease by making the same
comparison for the other items. For example, in 2006, cost of goods sold (as
percentage of net sales) is 68.3%. The corresponding figure in year 2007 had
increased to 69.6%. This increase might be the reason for the decrease in the
percentage of profit after tax.
After studying the methods for analysing financial statement, complete the
following exercise to test your understanding.
EXERCISE 6.2
1. The two methods of analysing financial statement are Horizontal

Analysis and Vertical Analysis. Describe the differences between
these two methods.
Horizontal Analysis Vertical Analysis
2. The data shown below are extracted from the Comparative Balance
Sheet of Bidara Sdn. Bhd. for the year ended 31 December 2006 and
2007.
31 December 2006 31 December 2007
Accounts receivable 500,000 400,000
Inventory 840,000 600,000
Total current assets 3,220,000 2,800,000
Prepare the horizontal and vertical analysis by using the above data.
6.7 FINANCIAL RATIO ANALYSIS

We will now go on to discuss financial ratio analysis. The classifications of
financial ratios are shown in Figure 6.4 below:
Figure 6.4: Classifications of financial ratios

(a) Liquidity
Liquidity ratio measures the business’s short term capability to discharge
its obligations or debts upon maturity and to fulfil unforeseen cash
requirements. This ratio is often used by short-term creditors.
(b) Efficiency
Efficiency ratio is for the purpose of measuring the level of efficiency and
capability of the management to operate its business, especially in the usage
of assets to generate sales.
(c) Profitability
Profitability ratio measures the ability of the business to generate profit
within a specific period. It is used as an indicator to analyse the efficiency
and effectiveness level of the business in achieving its profit objective.
(d) Debt Management

This ratio measures the ability of the business to continue its operation.
The ratios that can be classified under debt management ratios are interest
coverage ratio, debt ratio, equity ratio and debt to equity ratio.
ACTIVITY 6.4
How are financial ratios important to service firms? Give an example of

service firm.
6.8 LIQUIDITY RATIO

Liquidity ratio measures the business’s capability to discharge its short-term
financial obligation. However, long-term creditors also place importance on the
evaluation of the company’s liquidity.
This liquidity can be used by the company to determine its debt repayment
capability in the short-term. Ratios that can be classified as liquidity ratios are:
(a) Working capital;
(b) Current ratio; and
(c) Quick ratio.
Table 6.11 explains each of the liquidity ratios.

EXERCISE 6.3
1. Explain the meaning of current ratio and quick ratio, including the
formulae for both.
2. The following is part of the data extracted from the Balance Sheet of
Kenari Sdn. Bhd.
Kenari Sdn. Bhd.

Balance Sheet extract
CURRENT ASSETS RM
Cash 8,241,000
Marketable securities 1,947,000
Accounts receivable 12,545,000
Inventory 14,814,000
Expenses prepayment 5,371,000
TOTAL CURRENT ASSETS 42,918,000
CURRENT LIABILITY:
Total current liability 45,844,000
Calculate the:
(a) Working Capital
(b) Current Ratio
(c) Quick Ratio
Table 6.11: Classification of Liquidity Ratio
TOPIC 6 FINANCIAL STATEMENT ANALYSIS

193
6.9 EFFICIENCY RATIO

Efficiency ratio measures the level of efficiency and capability of the management
to operate its business, especially in the usage of assets to generate sales. Ratios
that can be classified as efficiency ratios are shown in Table 6.12.
6.10 PROFITABILITY RATIO

Profitability ratio measures the ability of the business to generate profit within
a specified period. It is used as an indicator to analyse the efficiency and
effectiveness level of the business in achieving its profit objective. This ratio is a
favourite among creditors, investors and owners. The ratios that can be classified
as profitability ratio as well as their purposes and descriptions are explained in
Table 6.13.
6.11 DEBT MANAGEMENT RATIO

Finally, the debt management ratio measures the ability of the business to
continue its operation. The ratios that can be classified as debt management ratio
are:
(a) interest coverage ratio;
(b) debt ratio;
(c) equity ratio; and
(d) debt to equity ratio.
The purposes and summary to calculate the debt management ratio are shown in
Table 6.14.
ACTIVITY 6.5
Suppose you run a business selling computers. How can the debt
management ratios be able to help you in developing your business?
Table 6.12: Classification of Efficiency Ratio

195
196

Table 6.12: Classification of Profitability Ratio (Continuation)

Table 6.13: Classification of Profitability Ratio

197
198

Table 6.13: Classification of Profitability Ratio (Continuation)

Table 6.14: Classification of Debt Management Ratio

199
Before proceeding, answer the following exercise to test your understanding of

financial ratios.
EXERCISE 6.4
The following are data extracted from Income Statement of

Keris Sdn. Bhd.
2006 (RM) 2005 (RM)

Net sales 6,420,000 6,420,000
Opening inventory 980,000 860,000
Purchases 4,440,000 4,661,000
Closing inventory 1,020,000 980,000
By using the information above, calculate the:

(a) Inventory turnover ratio for year 2006.
(b) Asset turnover for year 2006.
6.12 SAMPLE OF RATIO CALCULATIONS

The following is the Financial Statement for Kenanga Sdn. Bhd. This company
operates a plastics-related business. The information on industry averages is also
enclosed.
Kenanga Sdn. Bhd.

Comparative Income Statement with Industry Average
for the Year Ended 31 December 2007
Kenanga Sdn. Bhd. Industry
(RM) Average (%)
Net sales * 600,000 100
(Cash sales RM330,000)
Cost of goods sold 384,000 74.2
Gross profit 216,000 25.8
Sales and administrative expenses 194,000 22.5
Operating profit 22,000 3.3
Other expenses (4,000) 0.2
(Interest expenses RM3,000)
Profit before tax 28,000 3.1
Income tax expenses (5,000) 0.7
Net profit 13,000 2.3
Kenanga Sdn. Bhd.

2007 (RM) 2006 (RM)
Current assets:
Cash 15,000 10,000
Marketable securities 10,000 15,000
Accounts receivable (net) 35,000 25,000
Inventory 55,000 40,000
Expenses pre-payment 5,000 5,000
Total current asset 120,000 95,000
Non-current asset 80,000 45,000
Total asset 200,000 140,000
Liabilities and owner equity:
Current liability 60,000 50,000
Non-current liability 15,000 10,000
Owner’s equity 125,000 80,000
Total liabilities and owner’s equity 200,000 140,000
The average ratios for the plastics industry are as follows:
Ratio Industry Average

Current ratio 1.8 : 1.0
Quick ratio 1.1 : 1.0
Accounts receivable turnover 9.5 times
Average collection period 38 days
Inventory turnover 4.8 times
Asset turnover 2.3 times
Gross profit margin 25.8%
Net profit margin 3.1%
Return on asset 4.0%
Return on owner equity’s ordinary shares 11.4%
Interest coverage ratio 2.8 times
Debt ratio 44.1%
Debt to equity ratio 120.2
Required:
(a) Prepare the vertical analysis for Kenanga Sdn. Bhd’s Income Statement.
Compare it with the industry average and explain briefly the result of the
analysis.
(b) Calculate the following financial ratios and compare it with industry
average for 2007 for Kenanga Sdn. Bhd. Explain your analysis results.
(i) Current ratio
(ii) Quick ratio
(iii) Accounts receivable turnover
(iv) Average collection period
(v) Inventory turnover
(vi) Asset turnover
(vii) Gross profit margin
(viii) Net profit margin
(ix) Return on asset
(x) Return on owner equity’s ordinary shares
(xi) Interest coverage ratio
(xii) Debt ratio
(xiii) Debt equity ratio
Solution:
(a) Vertical Analysis
Kenanga Sdn. Bhd.

Comparative Income Statement with Industry Average
Kenanga Kenanga Sdn. Bhd. Industry
Sdn. Bhd. Average
(RM) RM’000 % (%)
Net sales *
(Cash sales RM330,000) 600,000 600/600 100 100
Cost of goods sold 384,000 384/600 64 74.2
Gross profit 216,000 216/600 36 25.8
Sales and administrative 194,000 194/600 32.3 22.5
expenses
Profit from operating 22,000 22/600 3.7 3.3
Other expenses
(Interest expenses RM3,000) (4,000) 4/600 0.7 0.2
Profit before tax 18,000 18/600 3.0 3.1
Income tax expenses (5,000) 5/600 0.8 0.7
Net profit 13,000 13/600 2.2 2.3
(b) Ratio Analysis

Industry
No Ratio Kenanga Sdn. Bhd.
Average
(i) Current ratio Current asset 1.8 : 1.0
––––––––––––––
Current liability
120,000
= –––––––
60,000
= 2.0 : 1.0
(ii) Quick ratio Quick asset 1.1 : 1.0
––––––––––––––
Current liability
15,000 + 10,000 + 35,000
= –––––––––––––––––––––
60,000
= 1.0 : 1.0
Analysis result:
Quick ratio of the company is just enough to pay
the short-term debts quickly. This quick ratio is
less by 0.1 from the industry average
(iii) Accounts Net credit sales 9.5 times

receivable –––––––––––––––
Average Net AR
turnover
600,000 – 330,000
= –––––––––––––––––––––
(25,000 + 35,000)/2
= 9.0 times
Analysis result:
The AR turnover for year 2001 is 9 times. This
shows that the business is able to collect its debts
quickly. The industry average is 0.5 times more
than the company.
(iv) Average 365 days 38 days

collection ––––––––––––––
*AR turnover
period
365
= –––––––
9
= 41 days
Analysis result:
The company is able to collect debts within 41
days. The efficiency of the company in debt
collection is late by 3 days compared to industry
average of 38 days.
* AR = Account Receivable
Industry
Average
(v) Inventory Cost of goods sold 4.8 times
turnover –––––––––––––––––––––
Average inventory
384,000
= –––––––––––––––––
(40,000 + 55,000)/2
= 8.1 times
Analysis result:
The higher the inventory turnover the better.
This shows the business is good in selling its
inventory and reduces the chances of obsolete
inventory. The company’s inventory turnover of
8.1 times is twice as fast as the industry average
of 4.8 times.
(vi) Asset Net sales 2.3 times
turnover –––––––––––––––––
Average total asset
RM600,000
= –––––––––––––––––––––––––
(RM140,000 + RM200,000)/2
= 3.5 times
Analysis result:
The higher the ratio, the better. Asset turnover
for the company is better compared to industry
average of 2.3 times.
(vii) Gross profit 25.8%

Gross profit
margin ––––––––––––
Net sales
RM216,000
= ––––––––––
RM600,000
= 36%
Analysis result:
The higher the gross profit margin the better.
This indicates good purchasing management and
lower purchasing cost. The gross profit margin
of this company is better compared to industry
average. This shows the purchasing management
and cost of the company is 10.2% better than
industry average.
Industry
Average
(viii) Net profit Net profit
margin ––––––––––––
Net sales
3.1%
RM13,000
= ––––––––––
RM600,000
= 2.2%
Analysis result:
The lower the sales price, the higher the sales
revenue generated is being used for other
activities. The higher the ratio, the better as
it shows lower expenditure or cost needed to
generate sales.
The percentage of net profit margin for the
company is less than the industry average.
(ix) Return on Net profit
asset ––––––––––––––––– 4.0%
Average total asset
RM13,000
= –––––––––––––––––––––––––
(RM140,000 + RM200,000)/2
= 7.6%
Analysis result:
This shows that profit return is 7.6% as relates
to management efficiency in using the asset
regardless of resources to finance the asset. Return
on the company’s asset is much better compared to
the industry average that only contributes 4.0%.
(x) Return Net profit – Dividend for preference shares 11.4%

on owner ––––––––––––––––––––––––––––––––––––––
Average owner’s equity
equity’s
ordinary RM13,000 – 0
= –––––––––––––––––––––––––
shares (RM80,000 + RM125,000)/2
= 12.68%
Analysis result:
The higher the ratio the better as it shows the
business is capable of generating higher profit
for the shareholders. The company is able to give
12.68% profit to the ordinary shareholders. The
return for the company’s ordinary shareholders is
1.28% higher than industry average, only a slight
difference as compared to the industry average.
Industry
Average
(xi) Interest Net profit – Taxation + Interest expenses 2.8 times
coverage ––––––––––––––––––––––––––––––––––––––
Interest expenses
ratio
RM13,000 + RM5,000 + RM3,000
= –––––––––––––––––––––––––––––
RM3,000
= 7 times
Analysis result:
The higher the ratio, the better as it shows the
business is capable to pay the interest expenses.
This shows the company is able to obtain adequate
funds to pay interest upon the maturity date. The
company is able to use net profit after tax to pay
the interest expenses 7 times. The interest coverage
ratio is much better compared to industry average
that is only able to use 2.8 times from the profit
after tax to pay interest.
(xii) Debt ratio Total liability
––––––––––––
Total asset 44.1%
RM75,000
= ––––––––––
RM200,000
= 37.5%
Analysis result:
To measure the percentage of total assets financed
by creditors. This shows that 37.5% from the
company’s asset are financed by creditors. The
total percentage debt ratio of company is lower
compared to industry average. This shows the
company’s asset management is better at 37.5%
compared to 44.1% for industry average.
(xiii) Debt to Total liability
equity ––––––––––––––––––– 120.2%
Total owner’s equity
ratio
RM75,000
= ––––––––––
RM125,000
= 60.0%
Analysis result:
To measure the percentage of liability covered by
owner equity. The lower the ratio, the better as it
shows the company is able to increase liability
whenever needed. The company’s debt equity
ratio is much better compared to the industry
average.
Test your understanding by answering the following questions.
EXERCISE 6.5
The following shows the Comparative Balance Sheet for Delima Sdn.
Bhd.
Delima Sdn. Bhd.

Comparison Balance Sheet
as at 31 December, 2008 and 2007
2008 (RM) 2007 (RM)

Cash 20,000 30,000
Inventory 60,000 50,000
Equipment (net) 200,000 180,000
345,000 320,000
Mortgage (15%) 100,000 100,000
Ordinary shares @ RM10 140,000 120,000
Retained earnings 55,000 40,000
345,000 320,000
Additional information for the year 2008:

1. The sales account total is RM420,000. Sales return and allowance
totalled RM20,000.
2. Cost of goods sold is RM198,000.
3. Net income from operating activities totalled RM44,000.
Required:
Calculate the ratios listed below for 2008.
(a) current ratio;
(b) quick ratio;
(c) accounts receivable turnover;
(d) inventory turnover; and
(e) return on sales.
Table 6.15: Summary of Financial Ratios

Table 6.15: Summary of Financial Ratios (Continuation)

209
210

Table 6.15: Summary of Financial Ratios (Continuation)

EXERCISE 6.6
1. The financial information for Desa Sdn. Bhd. is shown below:
31 December 31 December
2005 2004
Current asset 125,000 100,000
Equipment (net) 400,000 330,000
Current liability 91,000 70,000
Long-term liability 144,000 95,000
Ordinary shares @ RM1 155,000 115,000
Required:
Prepare the Horizontal Analysis for year 2005 by using year 2004 as
the base year.
2. The following is the comparative financial information for Sentosa

Sdn. Bhd. The Balance Sheets are dated 31 December 2007 and 2006.
2007 2006
(RM) (RM)
Net Sales 800,000 720,000
Cost of sales 480,000 40,000
Interest expenses 7,000 5,000
Net revenue 64,000 42,000
Account receivables 120,000 100,000
Inventory 85,000 75,000
Total asset 600,000 500,000
Total owner equity 450,000 310,000
Required:
Calculate the following ratios for year 2007.

(a) profit margin;
(b) asset turnover;
(c) return on asset; and
(d) return on owner equity.
3. The information given relate to the Comparative Income Statement

and Balance Sheet for Teguh Sdn. Bhd.
Teguh Sdn. Bhd.
as at 31 December 2001, 2000 and 1999
2001 (RM) 2000 (RM) 1999 (RM)
Cash 25,000 20,000 18,000
Accounts receivable (net) 50,000 45,000 48,000
Expenses prepayment 90,000 85,000 64,000
Investment 75,000 70,000 45,000
Equipment (net) 400,000 370,000 358,000
640,000 590,000 533,000
Current liability 75,000 80,000 70,000
Long-term liability 80,000 85,000 50,000
Ordinary share @ RM10 340,000 300,000 300,000
Retained earnings 145,000 125,000 113,000
640,000 590,000 533,000
Teguh Sdn. Bhd.
for the year ended 31 December 2001
2001 (RM) 2000 (RM)
Sales 740,000 700,000
Less: Sales return allowance 40,000 50,000
Net sales 700,000 650,000
Cost of goods sold 420,000 400,000
Gross profit 280,000 250,000
Operating expenses 230,000 215,000
Net Revenue 50,000 35,000
Additional Information:
1. The market values of ordinary shares for Teguh Sdn. Bhd. are RM4
for year 1999, RM5 for year 2000 and RM7.95 for year 2001.
2. All dividends were paid by cash.
3. At 1 July 2001, 4,000 units of new ordinary shares were issued.
Required:
Calculate the following ratios for 2001 and 2000.
(a) profit margin;
(b) asset turnover;
(c) earnings per share;
(d) price earnings ratio;
(e) dividend payout ratio; and
(f) debt ratio.
4. The following are Comparative Income Statement and Balance Sheet

of Teratai Sdn. Bhd.
Teratai Sdn. Bhd.

Income Statement
2006 (RM) 2005 (RM)
Sales 650,000 520,000
Less: Cost of goods sold 415,000 354,000
Gross profit 235,000 166,000
Sales and administrative 150,000 114,800
expenses
Interest expenses 7,200 6,000
Taxation 18,000 14,000
Les: Total expenses 175,200 134,800
Net Revenue 59,800 31,200
Teratai Sdn. Bhd.

2006 (RM) 2005 (RM)
ASSET
Current asset:
Cash 41,000 18,000
Marketable securities 18,000 15,000
Accounts receivable (net) 92,000 74,000
Inventory 84,000 70,000
Total current asset 235,000 177,000
Equipment (Net) 403,000 383,000
Total asset 638,000 560,000
LIABILITIES AND OWNERS EQUITY
Current liabilities:
Tax payable 23,000 20,000
Total current liabilities 135,000 130,000
Long-term liability:
Bond payable 130,000 80,000
Total liabilities 265,000 210,000
Owner’s equity:
Ordinary share@RM5 150,000 150,000
Total owner’s equity 373,000 350,000
Total liabilities and owners equity 638,000 560,000
Additional information:
1. Ordinary shares are sold at RM19.50 per share.
Required:
Calculate the following ratios for the year 2006:
(a) current ratio; (h) return on owner’s equity;
(b) quick ratio; (i) earnings per share;
(c) accounts receivable turnover; (j) price earnings ratio;
(d) inventory turnover; (k) dividend payout ratio;
(e) gross profit margin; (l) debt to equity ratio; and
(f) asset turnover; (m) interest coverage ratio.
(g) return on asset;
SUMMARY
This topic covered several important areas:

• Financial statement analysis is prepared for the purpose of helping internal
and external users make better decisions.
• Financial information can be compared by using three basis of comparison.
– Within the company (intra-company)
– Between companies
– Industry average
• Three analysis techniques normally used to evaluate financial statement data
are:
– Horizontal analysis
– Vertical analysis
– Financial ratio analysi
Debt Management Ratio Internal Users

Efficiency Ratio Liquidity Ratio
External Users Profitability Ratio
Financial Statement Ratio Analysis
Financial Statement Analysis Trend Analysis
Horizontal Analysis Vertical Analysis
Answers
TOPIC 1: ACCOUNTING ENVIRONMENT
Exercise 1.1
1. Internal users are people who have direct access to the resources of an entity
and are normally involved in the management of the company; an example
being the company’s management. These people are involved in planning
and controlling the activities of the company to enable it to achieve specified
objectives. Examples of common decision making are:
(a) does the company require additional capital or not; if the company
requires additional capital, would the company be applying for loan or
issue shares.
(b) does the company require additional asset; if the company requires
additional asset, would the company be buying or renting it.
(c) how much is the company’s excess cash, if any, should be utilised.
(d) how the company is going to overcome insufficient cash flow problems
it might be facing.
(e) the company’s strategy to expand the market for its products
External users are people who do not have direct access to the resources
of the company and to not involved in the management of the company.
Examples of external users are investors, loan providers, Inland Revenue
Board, government agencies and the public. The types of decision made are
different according to user groups. For example, investors make decisions on
whether to invest in a company, loan providers make decisions on whether
to approve loans while the Inland Revenue Board decide on the total tax to
be imposed.
2. Financial accounting helps decision makers by preparing the entity’s

financial reports for external and internal users; but is focused more on
external users. The financial report is released periodically and is subject to
specific standards and formats. The users are able to make decisions on the
performance and status of the company through this report.
Management Accounting provides the financial and non-financial

information required by the management of the company for planning,
evaluating and controlling the operations of the entity. Reports may be
216  ANSWERS
issued at any time according to requirement and are not subject to any
standards and formats. Through this report, the users are able to take the
necessary measures required for improvement in order to ensure that the
company achieves its objectives.
Exercise 1.2
1. The characteristics of accounting information can be divided into two
categories, primary characteristics and secondary characteristics. The
primary characteristics are comprised of relevant and reliability, while the
secondary characteristics are comparability and consistency.
2. Comparability means that the information can be compared; whether among

companies, among industries or across different periods. Let us assume that
you are interested in investing in a company. You were informed that the net
income of the company in year 2000 was RM10 million. Is this information
useful?
Actually, it is only useful if you have other information that can be compared
with that figure. For example, the net income in 1999 for the company was
RM3 million. This information enables you to conclude that the company
has gained a huge increase in net income. What if you were told that the net
income of the company in 1999 was RM19 million? You might not want to
proceed with the investment because the company has experienced a huge
decline in net income. You would not be able to come to this conclusion by
only referring to the RM10 million figure.
Exercise 1.3
1. The weaknesses in the assumption of monetary unit:
(a) Limiting the scope of accounting. This is because only transactions that
can be measured in monetary unit will be taken into consideration in
accounting, whereas there are many other factors that will also affect
the business. For example, the death of the company’s manager,
termination of staff, recognition by specific bodies on the business
achievements and other factors. All these cannot be recorded in the
financial statements as it cannot be stated in monetary terms.
(b) Assuming the value of money is stable at all times; when we know that
the currency value fluctuates. You have often heard the grumblings or
even experienced the fluctuation in currency value. We used to be able
to buy several items with RM10 but not so presently. In the early days,
school children only took 20 cents to school, now they bring RM2. All
ANSWERS  217
these examples show that the currency value has changed. In other
words, the RM1 you have today will not have the same value as the
RM1 you will receive in a couple of months’ time. The fluctuation in the
currency value should have been taken into account when recording
transactions but was ignored.
2. Three conditions that must be fulfilled before revenue can be recognised are:
(a) The seller had done the necessary action to obtain the revenue (for
example, had supplied the goods for trade or rendered its services to
customer). The revenue cannot be recognised if the goods or services
are not supplied or rendered to the customer, even though the customer
had paid cash.
(b) The amount of revenue can be measured objectively. If the seller
had handed over the goods or provided the services, but have not
determined the amount that must paid by the customer, then the
revenue cannot be recognised.
(c) For credit transactions, the revenue can be collected. The seller had
handed over the goods or provided the services and had stated the
amount to be paid by the customer. If the seller is confident that cash
is collectable from the customer, then the revenue will be recognised at
the point of sale. However, if the seller is uncertain, then the revenue
will only be recognised when cash is received.
Exercise 1.4
1. (a) accounting period
(b) historical cost
(c) relevant
(d) Malaysian Accounting Standards Board
(e) reliability
(f) principle of matching
(g) cost benefit relation, materiality
(h) management accounting
(i) going concern
(j) point of sale
(k) Cash Flow Statement
(l) Balance Sheet
218  ANSWERS
Exercise 1.5
1. D
2. A
3. D
4. C
5. False
6. False
7. False
Exercise 1.6
1. (a) 46,000
(b) 100,000
(c) 75,000
2. (a) Asset increased, Asset decreased or has no effect on the Asset

(b) Asset decreased, Owner’s Equity decreased
(c) Asset decreased, Owner’s Equity decreased
(d) Asset increased, Asset decreased or has no effect on the Asset
(e) Asset increased, Owner’s Equity increased
ANSWERS  219
3.
ASSET = LIABILITY + O.EQUITY
Trans + Capital,
Cash + AR + Supplies = AP
action Ashwin
a. +20,000 +20,000
Investment by
Ashwin
Balance 20,000 = 20,000
b. +800 +800
Balance 20,000 800 = 800 20,000
c. -620 -620
Balance 19,380 800 = 180 20,000
d. +4,200 +4,200
Service revenue
Balance 23,580 800 180 24,200
e. -1,000 -1,000
Salary expenses
Balance 22,580 800 = 180 23,200
f. -700 -700
Transportation
expenses
-150 -150
Sundry expense
Balance 21,730 800 = 180 22,350
g. -1,200 -1,200
Rental expenses
Balance 20,530 800 = 180 21,150
h. +2,500 +2,500
Service revenue
Balance 20,530 2,500 800 = 180 23,650
i. -550 -550
Supplies
Balance 20,530 2,500 250 = 180 expenses
23,100
j. -750 -750
Drawings,
Ashwin
Balance 19,780 2,500 250 180 22,350
220  ANSWERS
4. (a)
Seri Consultation Services
Income Statement
For the year ended 31 December 2008
RM RM
Service Revenue 78,750
(-) Expenses:
Tax expenses 4,200
Sundry expenses 1,265 (51,515)
Net income 27,235
(b)
For the year ended 31 December 2008
RM
Capital, Seri Dewi – 1 Jan 22,200
(+) Net income 27,235
49,435
(-) Drawings (6,000)
Capital, Seri Dewi – 31 Dec 43,435
(c)
Balance Sheet
As at 31 December 2008
RM
ASSETS
Cash (23,300 – 6,000) 17,300
Supplies 8,480
TOTAL ASSETS 44,635
LIABILITIES
Accounts Payable 1,200
OWNER’S EQUITY
Capital, Seri Dewi 43,435
TOTAL LIABILITIES AND O.EQUITY 44,635
ANSWERS  221
TOPIC 2: RECORDING PROCESS

Exercise 2.1
1. (a) It is not a transaction and must not be recorded. This is because it will
not affect the entity’s financial position (will not affect the asset, liability
or owner equity) and cannot be measured in currency unit.
(b) It is a transaction and must be recorded. This will affect the entity’s
financial position (increase asset and owner’s equity) and can be
measured in currency unit.
Exercise 2.2
1. Account is a specific and separate accounting record for each item in the
financial statement. All transactions that affect the items will be recorded in
the accounts. Ledger is a group of accounts for a business entity. Chart of
accounts is the list of accounts in the ledger.
2. T-Account and three column account. T-account is easier but the three
column account enables us to know the last balance after each transaction.
3. Drawings are made by the owner for personal use while expenses are
incurred by the entity for the purpose of generating income. Drawings
are not considered in the calculation of net profit or loss, but are deducted
directly from owner’s equity. Expenses will be matched against income. The
difference between income and expenses will be either net profit or net loss.
This difference will be added or deducted from owner’s equity.
4. C
5. C
6. (a) Asset
(b) Expense
(c) Asset
(d) Income
(e) Liability
(f) Asset
(g) Expense
(h) Asset
222  ANSWERS
Exercise 2.3
1. (a)
Apr 2008
a. Cash 5,000
Capital, Cindy 5,000
(Cash investment by Cindy)
b. Supplies 275
Accounts payable 275
(Purchase of supplies on credit)
c. Cash 3,250
(Cash received for services provided)
d. Rental expenses 750
Cash 750
(Payment of rental by cash)
e. Accounts payable 125
Cash 125
f. Accounts receivable 1,875
Service revenue 1875
( Customer has not paid for services
provided)
g. Utility expenses 390
Sundry expenses 187
Cash 577
(Payment for expenses by cash)
h. Salary expenses 1,250
Cash 1,250
(Payment for salary by cash)
i. Supplies expenses 162
Supplies 162
(Usage of supplies)
j. Drawings 550
Cash 500
Supplies 50
(Cash and supplies drawings by
owner)
ANSWERS  223
1 (b) Post to ledger
Cash Account
(RM) (RM) (RM)
Apr 2008 Capital, Cindy 5,000 5,000
Service revenue 3,250 8,250
Rental expenses 750 7,500
Accounts payable 125 7,375
Utility expenses 390 6,985
Sundry expenses 187 6,798
Salary expenses 1,250 5,548
Drawings, Cindy 500 5,048
Account Receivable
(RM) (RM) (RM)
Apr 2008 Service revenue 1,875 1,875
Supplies Account
(RM) (RM) (RM)
Apr 2008 Accounts payable 275 275
Supplies expenses 162 113
Drawings, Cindy 50 63
Accounts Payable
(RM) (RM) (RM)
Apr 2008 Supplies 275 275
Cash 125 150
Capital Account, Cindy

(RM) (RM) (RM)
Apr 2008 Cash 5,000 5,000
Drawings Account, Cindy

(RM) (RM) (RM)
Apr 2008 Cash 500 500
Supplies 50 550
224  ANSWERS
Service Revenue Account

(RM) (RM) (RM)
Apr 2008 Cash 3,250 3,250
Rental Expenses Account

(RM) (RM) (RM)
Apr 2008 Cash 750 750
Utility Expenses Account

(RM) (RM) (RM)
Apr 2008 Cash 350 350
Sundry Expenses Account

(RM) (RM) (RM)
Apr 2008 Cash 187 187
Salary Expenses Account

(RM) (RM) (RM)
Apr 2008 Cash 1,250 1,250
Supplies Expenses Account

(RM) (RM) (RM)
Apr 2008 Cash 162 162
1 (c) Trial Balance

ANSWERS  225
Cindy Insurance Agency

Trial Balance
as at 30 April 2008
Accounts Debit (RM) Credit (RM)

Cash 5,048
Supplies 63
Accounts payable 150
Capital, Cindy 5,000
Drawings, Cindy 550
Salary expenses 750
Rental expenses 390
Sundry expenses 162
TOTAL 10,275 10,275
226  ANSWERS
Exercise 2.4
1. (a) GENERAL JOURNAL
Date Account and Description Reference Debit Credit

(RM) (RM)
Feb 1 Supplies L104 274
Cash L101 274
(Purchased supplies by cash)
2 Drawings, Edlin L302 2,000
Cash L101 2,000
5 Cash L101 2,740
(Received cash from customer
for payment of accounts
receivable)
9 Office equipment L108 3,850
(Purchased office equipment
on credit)
15 Accounts payable L201 1,200
Cash L101 1,200
payable)
18 Cash L101 580
Service revenue L401 580
(Received for services
provided)
25 Advertisement expenses L502 420
Cash L101 420
(Payment for advertisement)
ANSWERS  227
28 Utility expenses L503 215

Cash L101 215
(Payment for business’s
telephone and electricity bill)
28 Drawings, Edlin L302 117

Cash L101 117
(Payment for telephone and
electricity bill of owner’s
house by cash from the
business)
28 Rental expenses L501 1,200
Cash L101 1,200
(Payment for rental of
business premises)
28 Sundry expenses L509 220
Cash
(Repair of office equipment L101 220
by cash)
1 (b) Post of entries to ledger
Cash Account No: 101

(RM) (RM) (RM)
Feb Cash 15,238
1 Supplies J1 274 14,964

2 Drawings, Edlin J1 2,000 12,964
228  ANSWERS
5 Accounts receivable J1 2,740 15,704

18 Service revenue J1 580 15,084
25 Advertisement J1 420 14,664

expenses
28 Utility expenses J1 215 14,449
28 Drawings, Edlin J1 117 14,332
28 Rental expenses J1 1,200 13,132
28 Sundry expenses J1 220 12,912

(RM) (RM) (RM)
Feb 1 Balance 4,575
5 Cash J1 2,740 1,835

(RM) (RM) (RM)
Feb 1 Balance 427
1 Cash J1 274 701

Date Reference Debit Credit Balance
Description
(RM) (RM) (RM)
Feb 1 Balance 8,400
9 Account payable J1 3,850 12,250
Accounts Payable No: 201

(RM) (RM) (RM)
Feb 1 Balance 1,730
9 Office equipment J1 3,850 5,580
15 Cash J1 1,200 4,380
Capital Account, Edlin No: 301

(RM) (RM) (RM)
Feb 1 Balance 26,910
ANSWERS  229
Drawings Account, Edlin No: 302

(RM) (RM) (RM)
Feb 2 Cash J1 2,000 2,000
28 Cash J1 117 2,117
Service Revenue Account No: 401

(RM) (RM) (RM)
Feb 18 Cash J1 580 580
Rental Expenses Account No: 501

(RM) (RM) (RM)
Feb 28 Cash J1 1,200 1,200
Advertisement Expenses Account No: 502

(RM) (RM) (RM)
Feb 25 Cash J1 420 420
Utility Expenses Account No: 503

(RM) (RM) (RM)
Feb 28 Cash J1 215 215

(RM) (RM) (RM)
Feb 28 Cash J1 220 220
1. (c) Trial Balance

230  ANSWERS
Edlin Enterprise
Trial Balance
as at 28 February 2007
Accounts
Number (RM) (RM)
101 Cash 12,912
104 Utilities 701
301 Capital, Edlin 26,910
302 Drawings, Edlin 2,117
401 Service revenue 580
502 Advertisement expenses 420
503 Utility expenses 215
TOTAL 31,870 31,870
ANSWERS  231
TOPIC 3: COMPLETING THE ACCOUNTING CYCLE

Exercise 3.1
(a) Accrued Revenue
Accrued revenue refers to the revenue that has been obtained but there
is no incoming cash flow into the business entity. This happens when the
goods or services have been supplied to the customer but the customer has
not paid for it yet. Accrued revenue is an asset as the benefit in the form
of cash will be obtained by the business entity in the future. Examples of
accrued revenue are rental revenue receivable, service revenue receivable
and interest receivable.
(b) Accrued Expenses

Accrued expenses refer to all the expenditure that has incurred but has
not been paid or recorded because there is no outgoing cash flow. Accrued
expense is a liability as an obligation exists that must be settled by the
business. At the end of the accounting period, the business entity must
record/recognise all the expenditure even though no cash flow has occurred.
Examples of accrued expenses are salary payable, rental payable, interest
payable and tax payable.
(c) Prepaid Expenses

Prepaid expenses refer to all expenses that have been paid in advance by
cash but the benefit from the expenses has not been received or obtained.
It is an asset to the business and will be written off after it has been used
or when it has expired. Therefore, at the end of the accounting period,
adjusting entries must be made to recognise the asset that had been written
off as expense.
(d) Unearned Revenue

Unearned revenue refers to the cash received in advance but the goods
or services have not been supplied. This is an obligation or liability to the
business entity. Cash received cannot be recognised as an revenue for that
period because the goods or services will only be provided in the future.
Exercise 3.2
1. Supplies Expenses RM250
Supplies RM250
2. Depreciation Expenses RM400
Accumulated Depreciation RM400
3. Interest Expenses RM300
Interest payable RM300
232  ANSWERS
4. Insurance Expenses RM1,500

Insurance Prepayment RM1,500
5. Accrued Revenue/Revenue Receivable RM750
Service Revenue RM750
6. Cash RM5,000
Unearned revenue RM5,000
Exercise 3.3
Income Statement
For the Period Ended 30 June 2007
RM RM
Fees Revenue 119,280
Less Expenditure:
Total expenditure (88,925)
Net revenue 30,355
ANSWERS  233

Balance Sheet
as at 30 June 2007
RM RM
Current Assets Current Liabilities
Cash 56,350 Accounts Payable 17,600
Accounts Receivable 41,600 Salary Payable 7,100
Office supplies 12,300 Unearned fees 10,980
Rental prepayment 4,400 35,680
129,750 Non-current Liabilities
Notes Payable 100,000
Total liabilities 135,680
Non-current Assets
Office equipment 99,000 Owner’s Equity
Less: Accumulated 10,725 Opening capital, 51,990
Depreciation Khairunnisa’
Net book value 88,275 Net revenue 30,355
Closing capital,
82,345
Khairunnisa’
Total Assets 218,025 Total Liabilities & Equity 218,025
The balance sheet is presented according to the account format. You can also use
the report format as suggested by MASB1. If the report format is used, the net
assets reported are RM94,070. Therefore, the total assets will be RM182,345. Total
non-current liabilities and equity are the same at RM182,345.
234  ANSWERS
Exercise 3.4
1. (a) Adjusting Entries RM RM
Supplies expenses 890
Supplies 890
Accumulated depreciation 4,950
Salary Expenses 440
Salary payable 440
Accounts Receivable 1,000
Unearned revenue 500
Service revenue 500
(b) Financial Statement
Berkat Enterprise
Income Statement
For the Period Ended 30 June 2006
RM RM
Depreciation expenses 4,950 (37,430)
Net profit (23,195)
ANSWERS  235
Berkat Enterprise
Balance Sheet
30 June 2006
RM RM RM
Non-current Asset:
Accumulated Reprediation (14, 650) 37,000
Curent assets:
Cash 3,425
Account receivable 8,000
Supplies 380
Insurance prepayment 305 12,110
Current liablities:
Salary payable 1,365
Unearned revenue 750 2,115
Total current assets 9,995

46,995
Financed by:
Owner’s Equity 29,000
Capital 23,195
Add: Net profit (5,200)
Less: Drawings 46,995
236  ANSWERS
(c) Closing entries

RM RM
Service Revenue 60,625
Revenue Summary 60,625


Capital 23,195
Capital 5,200
Drawings 5,200
2. Adjusting entries
RM RM
Salary expenses 100
Accrued/Payable Salary 100
Closing entry
Revenue summary 100
Salary expenses 100
Reversing entry
Accrued salary 100
Salary expenses 100
Entry for salary payment

Salary expenses 120
Cash 120
ANSWERS  237
Salary expenses
RM RM
31/12/00 Adjusting 100 31/12/00 Closing 100
100 100
01/01/01 Payment 120 01/01/01 Reversing 100
Accrued Salary
RM RM
31/12/00 Balance 100 31/12/00 Adjusting 100
100 100
01/01/01 Reversing 100 01/01/01 Balance 100
Revenue Summary
31/12/00 Closing RM100
Cash
01/01/01 Payment RM120
3. (a) Moiz Real Estate

Income Statement
RM RM
Revenue:
Less Expenditure:
Total expenditure 61,670
Net revenue 56,580
238  ANSWERS
Moiz Real Estate

Statement of Changes in Equity
RM
Capital, Moiz, 1 January 2004 85,000
Add: Net revenue 56,580
114,580
Less: Drawings (10,400)
Capital, Moiz, 31 December 2004 104,180
Moiz Real Estate

Balance Sheet
RM RM RM
Current Assets Current Liabilities
Cash 6,850 Accounts Payable 1,850
Accounts Receivable 14,000 Unearned revenue 2,500
Supplies 2,540 Total current 4,350
liabilities
Total current assets 24,630 Owner’s Equity
Capital, Moiz 104,180
Non-current Assets
Equipment 103,300
Acc Dep (19,400)
Net book value 83,900
Total Assets 108,530 Total Liabilities & 108,530
Equity
ANSWERS  239
The above Balance Sheet was reported using the account format. If the statement
format is used, the total net assets would be RM20,280 and the total assets would
be RM104,180. The total equity would also be RM104,180.
3.(b)
Closing Entries
RM RM


Capital 56,580
Capital 10,400
Drawings 10,400
240  ANSWERS
TOPIC 4: FINANCIAL REPORTING

Exercise 4.1
1. Regulations that are linked with financial reporting
(i) The Companies Act 1965
(ii) The Securities Commission 1995
(iii) The Financial Reporting Act 1997
(iv) The Income Tax Act 1967
2. Organisations that are linked with financial reporting

(i) Bursa Malaysia Berhad
(ii) Central Bank of Malaysia
Exercise 4.2
1. Non-financial information is additional information comprising chairman’s
report, notice of annual general meeting, corporate information and
structure and others. All the information is related to the organisation itself,
while financial information comprises financial statements related to the
organisation’s financial status. Financial information is the main and most
important information in a financial report.
2. Notes to the accounts are prepared for the users of accounting information
to clarify the total of the accounts as reported in the financial statement.
ANSWERS  241
TOPIC 5: TRADING BUSINESS ENVIRONMENT

Exercise 5.1
1. (a) False
(b) False
(c) True
(d) False
2. (a) Gross profit = Sales revenue – Cost of goods sold

= RM 110,000 – RM 70,000
= RM 40,000.
(b) Net operating revenue = Gross profit – operating expenses

= RM40,000 – RM20,000
= RM20,000.
Exercise 5.2
1. 2/10, n/30
2% discount will be given if payment is made within 10 days from the
invoice date and the last payment period (without discount) is within 30
days.
2. Sales Discount
Price reduction will be given on credit sales if customer pays within discount
period.
3. Purchase Discount
Price reduction will be given by seller to buyer if buyer pays within discount
period.
Exercise 5.3
1. C
2. Purchase Allowance
Exists when buyer does not return the goods that do not meet specification
and seller agreed to reduce the purchase price.]
Purchase Return
Exists when buyer return the goods that do not meet specification.
242  ANSWERS
3. Sales Allowance
Exists when buyer chooses to keep the damaged goods.
Sales Return
Exists when buyer returns the damaged goods.
Exercise 5.4
The differences between FOB shipping point with FOB destination are as below:
FOB means Free On Board

FOB shipping point defined that the ownership of the goods will be transferred
from the seller to the buyer when the goods are sent by the seller to the transport
company (lorry, ship and others). The goods will belong to the buyer and can be
recorded as the buyer’s inventory at the time of purchase. The transportation cost
would be borne by the buyer. The transportation cost paid by the buyer will be
recorded as carriage inwards. Carriage inwards account would normally have a
debit balance and will be added to the purchase cost to obtain the cost of goods
sold in the income statement.
FOB destination defined that the ownership of the goods will be transferred from
the seller to the buyer when the goods reached the buyer’s destination, which
is the buyer’s warehouse. The goods purchased will be owned by the buyer or
can be recorded as the buyer’s inventory only when the buyer has received the
goods. The buyer cannot record the goods in its inventory during purchase but
only upon receiving the goods. The seller will bear the transportation cost and
record it as carriage outwards after it had been paid. Carriage outwards will be
included in the income statement as a part of the operating expenditure.
Exercise 5.5
1. Credit terms of 2/10, n/30 means that the company will receive 2% cash
discount if payment is made within 10 days from the date of invoice.
However, the last payment period is 30 days from date of invoice with the
amount to be paid as stated in the invoice.
Journal entry for the payment is as below:
RM RM
July 24 Dr: Accounts receivable 1,900
(RM2,000 – RM100)
Cr: Inventory (RM1,900 x 2%) 38
Cr: Cash (RM1,900 – RM38) 1,862
ANSWERS  243
2. One credit sales was on 10 July totalling RM800 with credit terms 2/10,
n/30. On 12 July, RM100 worth of goods had been returned. Prepare journal
entries on 19 July to record the cash received by customer.
The journal entry for cash receipt is as below:
RM RM
July 19 Dr: Cash (RM700 – RM14) 686
Dr: Sales discount (RM700 x 2%) 14
Cr: Accounts receivable
(RM800 – RM100) 700
Exercise 5.6
(a) Journal
Date Description Debit Credit

May 1 Inventory 6,000 6,000
Accounts payable
(Depot Wholesaler)
May 2 Accounts receivable (Rahmat) 4,500 4,500
Sales
Cost of goods sold 3,000 3,000
Inventory
May 5 Accounts payable 200 200
(Depot Wholesaler)
Inventory
May 9 Cash (RM4,500-RM90) 4,410
Sales discount (4,500 x 2%) 90
Accounts receivable (Rahmat) 4,500
May 10 Accounts payable (6,000 – 200) 5,800
Inventory (5,800 x 2%) 116
Cash 5,684
May 11 Supplies 900
Cash 900
May 12 Inventory 2,400
Cash 2,400
May 15 Cash 230
Inventory 230
244  ANSWERS

Accounts payable (Harrods) 1,900
May 19 Inventory 250
Cash 250
May 24 Cash 6,200
Sales 6,200
Inventory 4,340
Accounts payable (Horizon) 1,000
May 27 Accounts payable (Harrods) 1,900
Inventory (1,900 x 2%) 38
Cash 1,862
May 29 Sales return and allowance 100
Cash 100
Inventory 70
May 31 Accounts receivable (Rahmat) 1,600
Sales 1,600
inventory 1,120
(b) Ledger
Cash
Date Description Debit Credit Balance
May 1 Balance 5,000
9 Accounts receivable 4,410 9,410
10 Accounts payable 5,684 3,726
11 Supplies 900 2,826
12 Inventory 2,400 426
15 Inventory 230 656
19 Inventory 250 406
24 Sales 6,200 6,606
29 Sales return and allowances 100 4,644
ANSWERS  245
Accounts receivable
May 2 Sales 4,500 4,500
9 Cash 4,410 90
9 Sales discount 90 0
31 Sales 1,600 1,600
Inventory

May 1 Accounts payable 6,000 6,000
2 Cost of goods sold 3,000 3,000
5 Accounts payable 200 2,800
12 Cash 2,400 5,084
15 Cash 230 4,854
19 Cash 250 7,004
29 Cost of goods sold 70 3,696
Supplies

Cash 900 900
246  ANSWERS
Accounts payable

5 Inventory 200 5,800
10 Cash 5,684 0
17 Inventory 1,900 1,900
26 Inventory 1,000 2,900
27 Cash 1,862 1,000
Capital – Abu Bakar

May 1 Balance 5,000
Sales
May 2 Accounts receivable 4,500 4,500
24 Cash 6,200 10,700
31 Accounts receivable 1,600 12,300
Sales Return and Allowance

May 29 Cash 100 100
Sales Discount
May 9 Accounts receivable 90 90
Cost of Goods Sold

24 Inventory 4,340 7,340
31 Inventory 1,120 8,390
ANSWERS  247
(c) Cempaka Sdn Bhd

Income Statement Extract
For the Month Ended 31 May 2007
RM RM
Sales revenue:
Sales 12,300
Less: Sales return and allowances 100
Sales discount 90 190
Net sales 12,110
Cost of goods sold (8,390)
Gross profit 3,720
Exercise 5.7
(a) Adjusting Entries
Entries Debit Credit

(i) Depreciation expenses – building 10,000
Accumulated depreciation – building 10,000
(ii) Depreciation expenses – equipment 9,000
Accumulated depreciation – equipment 9,000
(iii) Interest expenses 7,000
Interest payable 7,000
248  ANSWERS
(b) Melati Sdn Bhd

Income Statement
For the Year Ended 31 December 2008
RM RM RM
Sales revenue:
Sales 902,100
Less: Sales Discount (4,600)
Net Sales 897,500
Cost of goods sold (709,900)
Gross profit 187,600
Less: Operating expenses
Sales expenses:
Salary expenses (69,800 x 80%) 55,840
Maintenance expenses 7,200 63,040
Administrative expenses
Salary expenses (69,800 x 20%) 13,960
Depreciation expenses – building 10,000
Depreciation expenses – equipment 9,000
Insurance expenses 3,500 61,760
Total operating cost (124,800)
Operating revenue 62,800
Other expenses – interest expenses (7,000)
Net revenue 55,800
ANSWERS  249
(c) Melati Sdn Bhd

Balance Sheet
RM RM RM RM
Non-current assets:
Land 92,000
Building 197,000
Less: Accumulated depreciation (64,000) 133,000
Equipment 83,500
Less: Accumulated depreciation (51,400) 32,100 257,100
Current Assets:
Cash 23,400
Inventory 90,000 151,000
Current Liabilities:
Notes payable (mature in year 2008) 15,000
Interest payable 7,000 59,500
Net current asset/Working capital 91,500

348,600
Financed by:
Capital (267,800+55,800-10,000) 313,600
Non-current liability 35,000
348,600
250  ANSWERS
(d) Recording Closing Entries

Dec 31 Sales 902,100
Dec 31 Revenue summary 846,300
Maintenance expenses 7,200
Depreciation expenses – building 10,000
Depreciation expenses – equipment 9,000
Interest expenses 7,000
Dec 31 Revenue summary 55,800
Capital – Abu Bakar 55,800
Dec 31 Capital – Abu Bakar 10,000
Drawings 10,000
Exercise 5.8
1.
Mar 2 Accounts receivable 800,000
Sales 800,000
Inventory 600,000
Mar 6 Sales return and allowance 120,000
Inventory 90,000
Mar 12 Cash (680,000 – 13,600) 666,400
Sales discount (680,000 x 2%) 13,600
2.
ANSWERS  251
Description Debit Credit

Sales 180,000
Goods inventory 40,000
3. (i)
April 5 Inventory 16,000
April 6 Inventory 900
Cash 900
April 7 Equipment 26,000
April 8 Accounts payable 3,000
Inventory 3,000
April 15 Accounts payable (16,000-3,000) 13,000
Inventory [(16,000-3,000) x 2%] 260
Cash (13,000-260) 12,740
(ii)
May 4 Accounts payable 13,000
Cash 13,000
252  ANSWERS
4.
Sept 6 Inventory (80 x RM19) 1,520
Cash 1,520
Sept 9 Inventory 80
Cash 80
Sept 10 Accounts receivable (2 x RM20) 40
Inventory 40
Sept 12 Accounts receivable (26 x RM30) 780
Inventory 780
Cost of goods sold (26 x RM20) 520
Inventory 520
Sept 14 Sales return and allowance 30
Accounts receivable 30
Inventory 20
Sep 20 Accounts receivable (30 x RM30) 900
Sales 900
Cost of goods sold (30 x RM20) Inventory 600
600
5. (a)

Dec 3 Accounts receivable 480,000
Sales 480,000
Inventory 320,000
Dec 8 Sales return and allowance 20,000
Dec 13 Cash (460,000 – 9,200) 450,800
Sales discount [(480,000 – 20,000) x 2%] 9,200
(480,000 – 20,000)
(b)

Jan 2 Sales 460,000
(RM480,000 – RM20,000)
ANSWERS  253
TOPIC 6: FINANCIAL STATEMENT ANALYSIS

Exercise 6.1
The bases of comparison for intra-company, inter-company and industry average
can be compared by looking at the financial information aspect.
(a) Intra-company (Within the company)

The basis for intra-company is that it compares the items in the financial
statement for two different years (or more) for the same company. The
comparison of current year’s financial statement with previous years will
show the trend of the company which can be used for future predictions. For
example, the comparison of cash item for Selatan Sdn. Bhd. of the current
year with previous years will show the increase or decrease.
(b) Inter-company (Between companies)

The basis for inter-company is that it compares the items in the financial
statement of one company with one or more companies operating the same
type of business. The comparison made is based on the financial statement
published by the company. Inter-company comparison provides useful
information on the company’s status as compared to its competitors.
(c) Industry Average

This basis compares items in the financial statement of the company with
other companies in the related industry in general. Comparison made
between the company and industry average can provide information on the
company’s performance as compared to the industry.
Exercise 6.2
1. The difference between horizontal analysis with vertical analysis is that
horizontal analysis is used especially for comparison within the company
(intra-company) while vertical analysis can also be used for intra-company
or inter-company comparison. Ratio analysis is used in all three bases of
comparison, which are intra-company, inter-company and industry average.
Horizontal analysis is a technique to evaluate the trend of items in the

financial statement (increase or decrease) in terms of amount or percentage
of change. The basis of comparison for these two years (the current year and
the previous year) will be set by using the financial statement of the previous
year as the base to determine an increase or decrease.
254  ANSWERS
Vertical Analysis is a technique to evaluate the items in the financial

statement by stating each of the items in the form of percentage as compared
with the base amount. It shows the relationship of each item in the financial
statement with another item that is used as the base. In balance sheet, the
amount normally used as the base for calculation is Total Asset for asset
items, while Total Liability and Owner’s Equity will be used as the base for
liability and equity items. For Income Statement, the Net Sales will be used
as the base amount for each of the items in the income statement.
2. Horizontal Analysis
Change in
31 Dec 31 Dec Percentage
Amount Calculation
2006 2007 (%)
(RM)
Accounts 500,000 400,000 100,000 100k/400k 25%*
receivable
Inventory 840,000 600,000 240,000 240k/600k 40%**
Total current 3,220,000 2,800,000 420,000 420k/2,800k 15%***
assets
Vertical Analysis
31 Dec 2006 31 Dec 2007
Accounts 500,000 400,000
receivable
Inventory 840,000 600,000

Total asset 3,220,000 100% 2,800,000 100%
Exercise 6.3
1. The meaning of current ratio and quick ratio, including their formula, are
shown below:
Explanation Formula
Current ratio To measure the adequacy of Current asset
current asset to pay current ăăăăăăăăăăăăăăă
liability Current liability
Quick ratio To measure the business’s Quick asset*

capability to pay short-term ăăăăăăăăăăăăăăă
debt immediately. Current liability
*Quick asset comprise cash,
marketable securities and
accounts receivable.
ANSWERS  255
2. (a) Working Capital = Current Asset – Current liability

= RM42,918,000 – RM45,844,000
= (RM2,926,000)
Current asset
(b) Current ratio = ăăăăăăăăăăăăăăă
Current liability
42,918,000
= ăăăăăăăăăă
45,844,000
= 0.94 : 1
Cash + Marketable security + AR

(c) Quick ratio = ăăăăăăăăăăăăăăăăăăăăăăăăăăăăăă
Current Liability
8,241,000 + 1,947,000 + 12,545,000
= ăăăăăăăăăăăăăăăăăăăăăăăăăăăăăă
45,844,000
= 0.50: 1
Exercise 6.4
Cost of goods sold

Inventory turnover = ăăăăăăăăăăăăăăăăă
Average inventory
Cost of Goods Sold Cost of Goods Sold

(2006) (2005)
Opening inventory 980,000 860,000
Add: Purchases 4,440,000 4,661,000
Cost of goods ready for sale 5,420,000 5,521,000
Less: Closing inventory 1,020,000 980,000
Cost of goods sold 4,400,000 4,541,000
Cost of goods sold

(a) Inventory turnover = ăăăăăăăăăăăăăăăăăăă
2006 Average inventory
4,440,000
= ăăăăăăăăăăăăăăăăăăă
980,000 + 1,020,000
2
= 4.4 times
256  ANSWERS
Cost of goods sold

(b) Inventory turnover = ăăăăăăăăăăăăăăăăăă
2006 Average inventory
4,541,000
= ăăăăăăăăăăăăăăăăăăăă
860,000 + 980,000
2
= 4.9 times
Exercise 6.5
Current Asset
(a) Current ratio = ăăăăăăăăăăăăăăăăăă
Current Liability
20,000 + 65,000 + 60,000

= ăăăăăăăăăăăăăăăăăăăăăă
50,000
= 2.9 : 1
Quick asset
(b) Quick ratio = ăăăăăăăăăăăăăăăă
Current Liability
65,000 + 20,000
= ăăăăăăăăăăăăăă
50,000
= 1.7 : 1
Credit sales (net)

(c) AR turnover = ăăăăăăăăăăăăăăăă
Average AR (net)
400,000
= ăăăăăăăă
62,500*
= 6.4 times
*[AR last year + AR current year]

ăăăăăăăăăăăăăăăăăăăăăăăăăăăăăă
2
60,000 + 65,000
= ăăăăăăăăăăăăăăă
2
= 62,500
ANSWERS  257
(d) Inventory turnover = Cost of goods sold

ăăăăăăăăăăăăăăăăăă
Average inventory
198,000
= ăăăăăăăă
55,000**
= 3.6 times
**[Inventory last year + Inventory current year]

ăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăă
2
50,000 + 60,000
2
= 55,000
(e) Return on sales Net profit

(Profit margin) Sales (net)
44,000
420,000 - 20,000
= 11%
258  ANSWERS
Exercise 6.6
1. Desa Sdn. Bhd.
Balance Sheet
2004 Increase (Decrease)
2005 (RM)
Amount Percentage
(RM) Basis
Year (RM) (%)
Assets:
Equipment (net) 400,000 330,000 70,000 21.2
Current asset 125,000 100,000 25,000 25.0
Total Assets 525,000 430,000 95,000 22.1
Liabilities:
Non-current liability 144,000 95,000 49,000 51.6
Current liability 91,000 70,000 21,000 30.0
Total Liabilities 235,000 165,000 70,000 42.4
Owner’s Equity:
Ordinary shares @ RM1 155,000 115,000 40,000 34.8
Retained earnings 135,000 150,000 (15,000) (10.0)
Total owner’s equity 290,000 265,000 25,000 9.4
Total liabilities and owner’s 525,000 430,000 95,000 22.1
equity
Net profit
2. (a) Profit margin = ăăăăăăăăăă
Sales (net)
64,000
800,000
= 8%
Net sales
(b) Asset turnover = ăăăăăăăăăăăăăăăăă
Average total asset*
800,000
= ăăăăăăăă
550,000
= 1.5 times
ANSWERS  259
*[Total asset last year + Total asset current year]

2
500,000 + 600,000
= ăăăăăăăăăăăăăăăă
2
= 550,000
Net profit
(c) Return on asset = ăăăăăăăăăăăăăăăăă
64,000
= ăăăăăăăă
550,000
= 11.6%

2
500,000 + 600,000
= ăăăăăăăăăăăăăăăă
2
= 550,000
Net profit after tax

(d) Return on owner’s equity = ăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăă
Average ownerÊs equity ordinary shares
64,000
800,000
= 16.8%
3. Ratio analysis for year 2000:
Formula 2000
(a) Profit margin Net profit 35,000
ăăăăăăăăăăăăăăă = ăăăăăăăăă
Sales (net) 650,000
= 5.4%
(b) Asset turnover Net sales 650,000
ăăăăăăăăăăăăăăă = ăăăăăăăăă
Average total asset* 561,500*
= 1.2 times
* [Total asset last year +
Total asset current year] *(533k+590k)/2
ăăăăăăăăăăăăăăăăăăăăă
2 *561,500
260  ANSWERS
Formula 2000
(c) Earnings per Not profit ă Dividend 35,000
share for Preference Shares = ăăăăăăăăăăă
ăăăăăăăăăăăăăăăăăăăăăă 30,000* unit
Average ordinary shares = RM1.17
issued (unit)
*(300,000+300,000/2
RM10
*30,000
(d) Price earnings Market value of ordinary RM5.00
ratio = ăăăăăăăă
shares per unit RM1.17
ăăăăăăăăăăăăăăăăăăăăăăă
Earnings per share = 4.3 times
(e) Dividend payout Cash dividend 23,000**
ratio ăăăăăăăăăăăăăă = ăăăăăăăă
Net profit 35,000
= 65.7%
**revenue year 1999 +
2000 current profit –
2000 retained revenue
**113,000 +
35,000 – 125,000
=** 23,000
(f) Debt ratio Total liability 165,000
ăăăăăăăăăăăăă = ăăăăăăăăă
Total asset 590,000
= 28.0%
Ratio analysis for year 2001:

Formula 2001
(a) Profit margin Net profit 50,000
ăăăăăăăăăă = ăăăăăăăăă
Sales (net) 700,000
= 7.1%
(b) Asset turnover Net sales 700,000
ăăăăăăăăăăăăăăăăă = ăăăăăăăăă
Average total asset* 615,000*
= 1.1times
* [Total asset last year +
*(590k+640k)/2
Total asset current year]
ăăăăăăăăăăăăăăăăă *615,000
2
ANSWERS  261
Formula 2001
(c) Earnings per Net profit - Dividend 50,000
share = ăăăăăăăăăăăă
for Preference Shares 32,000* unit
ăăăăăăăăăăăăăăăăă
Average ordinary shares = RM1.56
issued (unit)
*(300,000+300,000/2
RM10
*32,000
(d) Price earnings Market value of ordinary RM7.95

ratio = ăăăăăăăă
shares per unit RM1.56
ăăăăăăăăăăăăăăăăăăăăăăă
Earnings per share = 5.1 times
(e) Dividend Cash dividend 30,000**
payout ratio ăăăăăăăăăăăăăă = ăăăăăăăă
Net profit 50,000
= 60.0%
**revenue year 2000 +
2001 current profit –
2001 retained revenue
**125,000 +
50,000-145000
= **30,000
(f) Debt ratio Total liability 155,000
ăăăăăăăăăăăăă = ăăăăăăăă
Total asset 640,000
= 24.2%
4. (a) Current Asset

Current ratio = ăăăăăăăăăăăăăăăăăă
Current Liability
235,000
= ăăăăăăăă
135,000
= 1.7 : 1
Quick asset
(b) Quick ratio = ăăăăăăăăăăăăăăăă
Current Liability
41,000 + 18,000 + 92,00

= ăăăăăăăăăăăăăăăăăăăă
135,000
= 1.1 : 1
262  ANSWERS
(c) Accounts receivable turnover =

650,000
= ăăăăăăăă
83,000
= 7.8 times
*[AR last year + AR current year]

ăăăăăăăăăăăăăăăăăăăăăăăăăăăăăă
2
*74,000 + 92,000
ăăăăăăăăăăăăăăă
2
* 83,000
Cost of goods sold
(d) Inventory turnover = ăăăăăăăăăăăăăăăăăă
Average inventory*
415,000
= ăăăăăăăă
77,000
= 5.4 times
*[Inventory last year + Inventory current year]

2
70,000 + 84,000
ăăăăăăăăăăăăăă
2
77,000
Gross profit
(e) Gross profit margin = ăăăăăăăăăăăă
Sales (net)
235,000
= ăăăăăăăă
650,000
= 36.2%
Net sales
(f) Asset turnover = ăăăăăăăăăăăăăăăăăăă
650,000
= ăăăăăăăă
599,000
= 1.1 times
ANSWERS  263

2
560,000 + 638,000
ăăăăăăăăăăăăăăăă
2
599,000
Net profit
(g) Return on asset = ăăăăăăăăăăăăăăăăăăă
59,800
= ăăăăăăăă
599,000
= 10%
2
560,000 + 638,000
ăăăăăăăăăăăăăăăă
2
599,000
Net profit
(h) Return on owner’s equity = ăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăă
Average owners equityÊs ordinary share*
59,000
= ăăăăăăăă
361,500
= 16.3%
*[Total owner equity last year + Total owner equity current year]
ăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăă
2
350,000 + 373,000
ăăăăăăăăăăăăăăăăă
2
361,500
Net profit - Dividend on preference shares
(i) Earnings per share = ăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăă
Average ordinary shares issued (unit)*
59,800
= ăăăăăăăă
30,000
= RM1.99
264  ANSWERS
*RM150,000 / RM5 per share

*30,000 units share
Market value of ordinary shares per unit
(j) Price earnings ratio = ăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăă
Earnings per share
RM19.50
= ăăăăăăăă
RM1.99
= 9.8 times
Cash dividend*
(k) Dividend payout ratio = ăăăăăăăăăăăăăăăă
Net profit
36,000
= ăăăăăăăă
59,800
= 61.5%
*Opening retained earnings + Current net profit - Closing retained earnings

*200,000 + 59,800 – 223,000
= 36,800
Total liability
(l) Debt to equity ratio = ăăăăăăăăăăăăăăăăăăăă
Total ownerÊs equity
265,000
= ăăăăăăăă
373,000
= 71.0%
Net profit + Taxation + Interest expenses*

(m) Interest coverage ratio = ăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăăă
Interest expenses
85,000
= ăăăăăă
7,200
= 11.8 times
*Net profit + Taxation+ Interest expenses

= 59,800 + 18,000 + 7,200
= 85,000
Reference
Akilah Abdullah et al. (1999), Business Accounting, Module PJJ, Centre for
Professional and Continuing Education (PACE), UUM, Sintok.
Che Zuriana et al, (2001) Business Accounting Education Book Series, (3rd ed.),
Publisher UUM.
Che Zuriana Muhammad Jamil, Akilah Abdullah, Noriah Che Adam, Noor
Aziz Ismail & Mohd Azlan Yahya (2001), Education Book Series, (3rd ed.),
University Utara Malaysia.
Larson, K.D., Wild, J.J., and Chiappetta, B., (1999) Fundamentals Accounting
Principles, (5th ed.), McGraw Hill.
Malaysian Accounting Standards Board (Standard 1), Presentation of Financial

Statements.
Malaysian Accounting Standards Board, MASB 2: Inventories.
Malaysian Accounting Standards Board, MASB 3: Net Profit or Loss for the
Period, Fundamental Errors and Changes in Accounting Policies.
Shamsul Nahar Abdullah (2000), Management Accounting, Publisher UUM,

Sintok.
Warren, C.S., Reeve, J.M., and Fess, P.E., (2001). Accounting, Customised by
School of Accountancy UUM for Business Accounting Students, (1st ed.),
International Thompson Publishing.
Weygandt, J.J., Keiso, D.E., and Kimmel, P.D., (1999). Accounting Principles, (5th
ed.), John Wiley & Sons, Inc.

Financian Accounting Module

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BBAW2103

Module Writers: Noor Asma Jamaludin

Moderators: Assoc Prof Dr Arfah Salleh

Azlina Abdul Aziz

Translated & Edited: Pearson (M) Sdn. Bhd.

Developed by: Centre for Instructional Design and Technology

Printed by: Meteor Doc. Sdn. Bhd.

First Printing, April 2008

Version March 2010

Topic 1 Accounting Environment 1

Topic 2 Recording Process 36

Topic 3 Completing the Accounting Cycle 84

Topic 4 Financial Reporting 129

Topic 5 Trading Business Environment 129

Topic 6 Financial Statement Analysis 176

COURSE GUIDE DESCRIPTION

Table 1: Estimation of Time Allocation of Study Hours

Topic 1 discusses the Accounting Environment. Topic 1 introduces you to

Topic 5 covers accounting for trading, comprising preparation of journal entries

Topic 6 introduces us to financial statement analysis using the horizontal and

TEXT ARRANGEMENT GUIDE

Self-Check: This component of the module is inserted at strategic locations

or sometimes a few sub-sections. It usually comes in the form of a question that

Activity: Like Self-Check, activities are also placed at various locations or

References: References is where a list of relevant and useful textbooks, journals,

Warren et. Al (2001), Accounting: Customized by school of accountancy UUM for

We might assume that accounting is only important to businessmen or

This example is only a decision at an individual level. For a business entity, it

1.1 INTRODUCTION TO ACCOUNTING

Accounting is a process to identify, measure, record and present the

Economic information are information related to economic activities; whereas an

1.1.2 Users of Accounting Information

Table 1.1: Differences between Internal Users and External Users

Internal Users External Users

1.1.3 Branches of Accounting

Table 1.2: Differences between Financial Accounting and Management Accounting

Financial Accounting Management Accounting

1.1.4 Professional Accounting Bodies in Malaysia

(a) Malaysian Institute of Accountants (MIA)

(b) The Malaysian Institute of Certified Public Accountants (MICPA)

(ii) to train and evaluate the competent members;

(c) Malaysian Accounting Standards Board (MASB)

(d) Financial Reporting Foundation (FRF)

1.2 FUNDAMENTAL ACCOUNTING CONCEPTS

Qualitative characteristics of accounting information refer to the

Figure 1.1 shows the summary for qualitative characteristics of accounting

Figure 1.1: Qualitative characteristics of accounting information

The extent to which information is considered relevant depends on its

Figure 1.2 shows an example of performance information of a company in

Figure 1.2: Performance information of a company to assist investor in decision making.

(ii) Forecast Value

Reliable information must have the following characteristics:

Figure 1.3: Profitability comparison

What are the important qualitative characteristics of accounting

In your opinion, what will happen to a business entity if it only

1. State the qualitative characteristics of accounting information.

1.2.2 Accounting Assumptions

(a) Assumption of Separate Entity

Let’s look at an example

Table 1.3: Mr Ali’s Business

Business Transaction (RM)

(b) Assumption of Going Concern