Principles of Accounting

Diploma in Business Management ACC001
Principles of Accounting
and Finance
ACC001
Principles of Accounting and Finance
Page 1
Introduction to
Accounting
Page 2
INTRODUCTION TO FINANCIAL ACCOUNTING

Definition of Accounting
The process of identifying, measuring and communicating economic
information to permit informed judgments and decisions by users of the
information.
Information provided by accounting
The information provided by accounting is normally found in the

Financial Statements of the business. The Financial Statements,
sometimes called Final Accounts generally consists of:
1.
Trading Account
2.
Profit and Loss Account
3.
Balance Sheet
4.
Cash Flow Statement
Trading Account
The Trading account provides information regarding the total revenue
that the business has obtained or received over the accounting period. It
also shows the users the cost of the products that was sold and the gross
profit or loss on trading activities.
Page 3

This is normally a continuation of the Trading Account for a business that
conducts trading activities. But for a business whose main activities is
providing services, then the Profit and Loss Account is used without the
Trading Account. In general the Profit and Loss Account provides
information regarding the income received from other business activities
and expenses that has been incurred by the business during the
accounting period. The business Net Profit or Loss is shown at the end of
the account.
Balance Sheet
The Balance Sheet is used to show a summary of the business assets,
liabilities and capital invested of the business. The information is
classified according to the class and/or length of time the items are kept
by the business.
Cash Flow Statement

Cash Flow Statement is intended to disclose information that is not
available from inspection of the Profit and Loss account and the Balance
Sheet alone. The Cash Flow Statement provides information about one of
the most important aspects of a business what cash was received by the
business and how it was spent during the period.
Page 4
Users of the Information

The following are the main users of published accounting information:
1.
Shareholders of the business both existing and potential, will

want to know how effectively the directors are performing their
stewardship function. They will use the accounts as a base for
decisions to dispose of some or all of their shares, or to buy some.
2.
The Loan/Creditor Group this consists of existing and potential

debenture and loan stock holders, and providers of short-term
secured funds. They will want to ensure that their interest payments
will be made promptly and capital repayments will be made as
agreed.
3.
Employee Groups including existing, potential and past

employees. There can include trade unions whose members are
employees. Past employees will be mainly concerned with ensuring
that any pensions etc. paid by the company are maintained. Present
employees will be interested in ensuring that the company is able
to keep on operating, so maintaining their jobs and paying them
acceptable wages.
4.
The business contact group this includes trade creditors and

suppliers, who will want to know whether or not they will continue
to be paid, and the prospects for a profitable future association.
Customers are included, since they will want to know whether or
not the company is a secure source of supply. Business rivals in
this group will be trying to assess their own position compared
with the firm.
Page 5
5.
The analyst/adviser group these will need information for their

clients or their readers. Financial journalists need information for
their readers. Stockbrokers need it to advise investors. Credit
agencies want it to be able to advise present and possible suppliers
of goods and services to the company as to its credit worthiness.
6.
The inland revenue will need the accounts to assess the tax
payable by the company.
7.
Other official agencies various organizations concerned with the

supervisions of industry and commerce may want the accounts for
their purposes.
8.
Management in addition to the internally produced management

accounts the management is also vitally concerned with any
published accounts. It has to consider the effect of such published
accounts on the world at large.
9.
The general public this consists of groups such as ratepayers,

taxpayers, political parties, pressure groups and consumers. The
needs of the groups will vary accordingly.
Page 6
The Accounting Equation
Page 7
The Accounting Equation
ASSETS
LIABILITIES + CAPITAL
(External)
Resources available in the business
(Internal)
Providers of the resources
Assets
Assets are actual resources that are in the business. Assets are divided
into two types Fixed Assets and Current Assets.
Fixed Assets are assets that are purchased for use in the business and kept
for a long time. Example of fixed assets are land, buildings, fixtures and
fittings, and vehicles.
Current Assets are assets that are used in business but kept for less than
the accounting period (one year). Some examples of current assets are
stocks, debtors and cash.
Liabilities
Resources that are supplied to the business by others are classified as
liabilities. Examples of liabilities are creditors, bank overdraft, accrued
expenses, and loans. The liabilities are also divided into two categories
Current Liabilities and Long Term Liabilities.
Current liabilities are liabilities that must be paid within the same
accounting period, whereas Long Term Liabilities are liabilities that
covers more than one accounting period.
Page 8
Capital
Investment made by the owner of the business. The investment may not
necessarily be in the form of cash. It may be in other forms such as fixed
assets (building, vehicles) or stock of goods.
As such the equation must always remain equal no matter how many
transaction takes place. The accounting equation will be expressed or
represented as one of the Financial Statements known as the Balance
Sheet.
Page 9
The Balance Sheet
Page 10
Balance Sheet
The accounting equation is expressed in the final statements as the
Balance Sheet
Balance Sheet
Assets
Liabilities
Capital
Example 1
May 1
Bahrum started in business and deposited $60,000 into a bank

account opened specially for the business.
May 3
Bahrum buys a small shop for $32,000, paying by cheque.
May 6
Bahrum buys some goods for $7,000 from Samad, and agrees
to pay for them some time within the next two weeks.
May 10
Goods which cost $600 were sold to Janice for the same
amount, the money to be paid later.
May 13
Goods which cost $400 were sold to Derek for the same
amount. Derek paid for them immediately by cheque.
May 15
Bahrum pays a cheque for $3,000 to Samad in part payment

of the amount owing.
May 31
Janice who owed Bahrum $600, makes a part payment of

$200 by cheque.
Page 11
Bahrum
Balance Sheet as at 1 May 2007
Assets
Cash in bank
60,000
Capital
60,000
Bahrum
Assets
Shop
32,000
Cash in bank
28,000
Capital
60,000
60,000
60,000
Bahrum
Assets
Liabilities
Shop
32,000
Stock of goods
Creditor
7,000
Capital
60,000
7,000
Cash in bank
28,000
67,000
67,000
Bahrum
Assets
Shop
Stock of goods
Debtor
Cash in bank
Liabilities
32,000
7,000
Capital
60,000
6,400
600
28,000
67,000
Creditor
67,000
Page 12
Bahrum
Assets
Liabilities
Shop
32,000
Stock of goods
Creditor
7,000
Capital
60,000
6,000
Debtor
600
Cash in bank
28,400
67,000
67,000
Bahrum
Assets
Liabilities
Shop
32,000
Stock of goods
Creditor
4,000
Capital
60,000
6,000
Debtor
600
Cash in bank
25,400
64,000
64,000
Bahrum
Assets
Shop
Stock of goods
Debtor
Cash in bank
Liabilities
32,000
4,000
Capital
60,000
6,000
400
25,600
64,000
Creditor
64,000
Page 13
Double Entry System
Page 14
Double Entry System

From the previous example, it can be seen that every transactions effects
to items. When an item is increased another item is decreased and vice
versa. Double entry system is used as a rule in book keeping. This is to
ensure that the accounting work that is being done is accurate and correct.
The T Account
For every item of transaction, an account is created to record it. One of
the basic method to record the transaction is to use the T account.
Title of Account
Debit side
Credit side
Dr.
Cr.
Double entry rule states that:

For every debit entry there must be a corresponding credit entry, and for
every credit entry there must be a corresponding debit entry.
Assets to increase assets the account must be debited and to reduce the
assets the account must be credited.
Liabilities and Capital to increase capital or liabilities the account must
be credited and to reduce capital or liabilities the account must be
debited.
Page 15
Assets
Increases
Decreases
Liabilities
Decreases
Increases
Capital
Decreases
Increases
Page 16
Using Example 2 below, the transactions are now recorded in their

respective accounts as compared to recording using the accounting
equation.
Example 2
Write up the assets, liabilities and capital accounts to record the following
transactions in the records of Kumar.
2007
July 1
Started business with $2,500 in the bank.
July 2
Bought office furniture by cheque $150.
July 3
Bought machinery $750 on credit from OBS Sdn Bhd.
July 5
Bought motor van paying by cheque $600.
July 8
Sold some of the office furniture (not suitable for the business)
for $60 on credit to Junk Shop.
July 15 Paid the amount owing to OBS Sdn Bhd $750 by cheque.
July 23 Received the amount due from Junk Shop $60 in cash.
July 31 Bought more machinery by cheque $280.
Page 17
July 1
Capital
Bank
2,500 July 2
July 3
July 15
July 31
Office furniture
Motor van
OBS Sdn Bhd
Machinery
150
600
750
280
Office Furniture
150
July 8
Junk Shop
60
July 2
Bank
July 3
July 31
OBS Sdn Bhd

Bank
Machinery
750
280
July 5
Bank
Motor Van
600
Bank
OBS Sdn Bhd

750
July 3
Machinery
750
Office Furniture
Junk Shop
60
July 23
Cash
60
Bank
2,500
July 15
July 8
Capital
July 1
Cash
July 23
Junk Shop
60
Page 18
Exercise 1
Complete the gaps in the following table:
Assets
Liabilities
Capital
(a)
12,500
1,800
(b)
28,000
4,900
(c)
16,800
12,500
(d)
19,600
16,450
(e)
6,300
19,200
(f)
11,650
39,750
Exercise 2
Complete the gaps in the following table:
(a)
Assets
Liabilities
55,000
16,900
(b)
17,200
(c)
36,100
(d)
119,500
(e)
88,000
(f)
Capital
34,400
28,500
15,400
62,000
49,000
110,000
Page 19
Exercise 3
Betty is setting up a new business. Before actually selling anything, she
bought a van for $4,500, a market stall for $2,000 and a stock of goods
for $1,500. She did not pay in full for the stock of goods and still owes
$1,000 in respect of them. She borrowed $5,000 from Fatimah. After the
events just described, and before trading starts, she has $400 cash in hand
and $1,100 cash at bank. Calculate the amount of her capital.
Exercise 4
Write up the asset, capital and liability accounts in the books of Ganesh to
record the following transactions:
June 1
June 2
Bought van paying by cheque $6,400.
June 5
Bought office fixtures $900 on credit from OKT Sdn Bhd.
June 8
Bought van on credit from Carton Cars Sdn Bhd $7,100.
June 12
Took $180 out of the bank and put it in cash register.
June 15
Bought office fixtures paying by cash $120.
June 19
Paid Carton Cars Sdn Bhd a cheque for $7,100.
June 21
A loan of $500 cash is received from Bahrin.
June 25
Paid $400 of the cash into the bank account.
June 30
Bought more office fixtures paying by cheque $480.
Page 20
Exercise 5
Write up the accounts to record the following transactions:
Mar 1
Started business with $750 cash and $9,000 in the bank.
Mar 2
Received a loan of $2,000 from Baldev by cheque.
Mar 3
Bought a computer for cash $600.
Mar 5
Bought display equipment on credit from OS Furniture $420.
Mar 8
Took $200 from the bank and put in cash register.
Mar 15
Repaid part of Baldevs loan by cheque $500.
Mar 17
Paid amount owing to OS Furniture $420 by cheque.
Mar 24
Repaid part of Baldevs loan by cash $250.
Mar 31
Bought a printer on credit from Harvey for $200.
Page 21
Asset of Stock
Page 22
Stock
Stock are goods that are purchased by the business with the intention of
reselling the goods or using it in the manufacture of another product.
Since stock is considered as an asset of the business it would require an
account specifically for it. This account is normally used to record the
value of stocks at the end of the accounting period only and not the
increase or decrease in stock. This is because stocks that are purchased
are normally sold at a higher price than its cost. Thus the account will not
be used to record the increase or decrease in stock, but several accounts
will be used to show or record the movements.
Increases in Stock
Stock may increase because of two reasons:
1.
The purchase of additional stock;
2.
The returns of goods, that was previously sold, back to the

business.
In order to differentiate between the two, two accounts are prepared:

1.
Purchases account this account is used to record the increase

in stock when goods are purchased.
2.
Returns Inwards account goods that are returned by the

customer.
Page 23
Decreases in Stock
Stock will decrease when:
1.
It is sold;
2.
It is returned to the supplier
Two accounts will be prepared to differentiate between the two

transactions.
1.
Sales account used to record when stocks are sold, either by

cash or credit.
2.
Returns Outwards account when goods are returned to the

supplier.
Since stock is an asset of the business the four accounts mentioned above
should be treated as assets accounts in dealing with the double entry rule.
Example 3
Write up the accounts necessary to record the transactions below:
May 1
Bought goods on credit $68 from Daniel.
May 2
Bought goods on credit $77 from Azman.
May 5
Sold goods on credit to Hafizah for $60.
May 6
Sold goods on credit to Muthu for $45.
May 10
Returned goods $15 to Daniel.
May 12
Goods bought for cash $100.
May 19
Muthu returned $16 goods to us.
May 21
Goods sold for cash $150.
May 22
Paid cash to Daniel $53.
May 30
Hafizah paid the amount owing by her $60 in cash.
May 31
Bought goods on credit $64 from Azman.
Page 24
May 1
May 2
May 12
May 31
Daniel
Azman
Cash
Azman
Purchases
68
77
100
64
Sales
May 5
May 6
May 21
Hafizah
Muthu
Cash
60
45
150
Daniel
15
Purchases
68
Azman
May 2
May 31
Purchases
Purchases
77
64
Hafizah
May 30
Cash
60
Returns inwards
16
Purchases
Daniel
100
53
Returns Outwards
May 10
May 19
May 10
May 22
May 5
Muthu
Returns outwards
Cash
Returns Inwards
16
Daniel
15
May 1
53
Sales
60
May 6
Sales
Muthu
45
May 19
May 21
May 30
Sales
Hafizah
150
60
Cash
May 12
May 22
Page 25
From the above example it can be seen that the accounts for Purchases,
Sales, Returns Inwards and Returns Outwards only has entries on either
the debit side or the credit side. This is due to the fact that the accounts
can only be increased and not decreased (except for Purchases when it
involves Drawings). In order to decrease the accounts another account is
used. For example the Sales account will be decreased by the Returns
Inwards account in the Final Statements and not in the account itself.
When the owners of the business takes goods from the business for his
own use this will reduce the purchases.
NOTE:
The Sales and Purchases account is specifically used for the sales and
purchases of stock. The sales and purchases of items other than stocks
should be recorded in other accounts.
Page 26
Expenses, Income and

Drawings
Page 27
Expenses, Income and Drawings
The three remaining classes of accounts that must be looked at are the
Expenses, Income/Revenue and Drawings. Expense class is all expenses
incurred by the business inclusive of Purchases and Returns Inwards. The
Income/Revenue class is all income received inclusive of Sales and
Returns Outwards. Drawings are anything that the business owner takes
out from the business for their own personal use. This transaction will
reduce Capital. Examples of drawings are taking cash out from the
business for personal use, expenses incurred by the owners on personal
business was paid by the business and goods that was meant for sale by
the company was taken out for the owners personal use.
Expenses
Increases
Decreases
Income
Decreases
Increases
Drawings
Increases
Decreases
Page 28
Example 4
Open the accounts necessary to record the following transactions:
June 1
Paid for postage stamps by cash $50.
June 2
Paid for electricity bill by cheque $229.
June 3
Received rent in cash $138.
June 4
Paid insurance by cheque $142.
June 25
Owner takes out $50 cash from the business for personal use.
June 3
Rent Income
Cash
138
June 1
June 25
Bank
June 2
June 4
June 2
Bank
Electricity
229
June 4
Bank
Insurance
142
Postage
Drawings
50
50
Electricity
Insurance
229
142
Cash
138
Postage
June 1
Cash
50
Rent Income
June 3
June 25
Cash
Drawings
50
Page 29
Exercise 6
Enter the following transactions in the accounts:
July 1
Started business with $750 cash.
July 3
Bought goods for cash $110.
July 7
Bought goods on credit $320 from Heidi.
July 10
Sold goods for cash $64.
July 14
Returned goods to Heidi $46.
July 18
Bought goods on credit $414 from Daud.
July 21
Returned goods to Daud $31.
July 24
Sold goods to Susan $82 on credit.
July 25
Paid Heidis account by cash $274.
July 31
Susan paid us her account in cash $82.
Exercise 7
Enter the following transactions in the appropriate accounts:
Aug 1
Started business with $7,400 cash.
Aug 2
Paid $7,000 of the opening cash into the bank.
Aug 4
Bought goods on credit $410 from Watson.
Aug 5
Bought a van by cheque $4,920.
Aug 7
Bought goods for cash $362.
Aug 10
Sold goods on credit $218 to Lokman.
Aug 12
Returned goods to Watson $42.
Aug 19
Aug 22
Bought fixtures on credit from Apple Furniture $820.
Aug 29
We paid Watson his account by cheque $368.
Aug 31
We paid Apple Furniture by cheque $820.
Page 30
Exercise 8
Enter the following transactions, completing the double entry in the
books for the month of May.
May 1
May 2
Purchased goods $290 on credit from James.
May 3
Bought fixtures $1,150 paying by cheque.
May 5
May 6
Bought goods on credit $325 from Muthu.
May 10
Paid rent by cash $200.
May 12
Bought stationery $45, paying by cash.
May 18
Goods returned to James $41.
May 21
Received rent of $25 by cheque for sublet of premises.
May 23
Sold goods on credit to Ganesh for $845.
May 24
Bought a van paying by cheque $4,100.
May 30
Paid the months wages by cash $360.
May 31
The proprietor took cash for personal use of $80.
Page 31
Balancing Off Accounts
Page 32
Balancing Off Accounts
At the end of each period we will have to look at each account to see
what is shown by the entries. This is to find out how much our customers
owe us for goods we have sold to them and to find out how much we still
owe our supplier for goods purchased. And also to identify the balances
of the other assets and liabilities in the business.
In order to identify the balances we must balance off the accounts. To
balance off the account the following steps are to be followed.
1.
Add up both sides of the account to find the totals of each side.
2.
Both sides must have an equal amount.
3.
To ensure that both side have an equal amount, the balancing

amount would be recorded on the side that has the smaller
value.
4.
Enter totals on a level with each other.
5.
Enter the balancing amount on the line below the totals. If the
balancing amount is on the debit side then the same amount
would be recorded on the credit side. If the balancing amount is
on the credit side then the same amount would be recorded on
the debit side. This is to satisfy the double entry rule.
Page 33
May 10
May 22
May 31
May 5
Returns outwards
Cash
Balance c/d
Sales
Daniel
15
May 1
53
68
Azman
141
May 2
May 31
141
Jun 1
60
Hafizah
May 30
May 6
Sales
Jun 1
Balance b/d
Muthu
45
May 19
May 31
45
29
May 21
May 30
Sales
Hafizah
150
60
June 1
Balance b/d
210
57
Cash
May 12
May 22
May 31
Purchases
68
68
Purchases
Purchases
Balance b/d
77
64
141
141
Cash
60
Returns inwards
Balance c/d
16
29
45
Purchases
Daniel
Balance c/d
100
53
57
210
Balancing off accounts can only be done on accounts in the Assets,

Liabilities, Capital and Drawings classes. Expenses and Income classes
are not required to be balanced off as above but requires a different
method of balancing off accounts when the Final Statements are
prepared.
Page 34
Trial Balance
Page 35
Trial Balance
A Trial Balance is drawn up to ensure that the accounting entries has

been done according to double entry rule. This is to ensure that the
information recorded in the accounts are accurate and correct.
A Trial Balance is drawn up by totaling the debit entries and totaling the
credit entries. Both total on the debit and credit side must be equal. If the
totals are not equal then an error in the recording of the transaction may
have occurred. At this point investigation will be carried out to rectify the
error before the Final Statements are prepared.
Page 36
Example 5
You are to enter up the necessary accounts for the month of May from the
following information relating to a small business. Then balance of the
accounts and extract a trial balance as at 31 May.
May 1 Started in business with capital in cash of $800 and $2,200 in
the bank.
2 Bought goods on credit from the following persons:
Ward $610
Green $214
Taylor $174
Gemmill $345
Tone $542
4 Sold goods on credit to:
Sharpe $340
Boycott $720
Titmus $1,152
6 Paid rent by cash $180.
9 Sharpe paid us his account by cheque $340.
10 Titmus paid us $1,000 by cheque.
12 We paid the following by cheque:
Taylor $174
Ward $610
15 Paid transport expenses by cash $38.
18 Bought goods on credit from:
Green $291
Gemmill $940
21 Sold goods on credit to Boycott $810
31 Paid rent by cheque $230
Page 37
May 1 Capital
Jun 1 Balance b/d
May 1 Capital
9 Sharpe
10 Titmus
Jun 1 Balance b/d
May 4 Sales
21 Sales
Jun 1 Balance b/d
May 4 Sales
Jun 1 Balance b/d
May 4 Sales
Cash (assets)
800
May 6 Rent
15 Transport
31 Balance c/d
800
582
Bank (assets)
2,200
May 12
340
12
1,000
31
31
3,540
2,526
Taylor
Ward
Rent
Balance c/d
Boycott (assets)
720
May 31 Balance c/d
810
1,530
1,530
Titmus (assets)
1,152
May 10 Bank
31 Balance c/d
1,152
152
Sharpe (assets)
340
May 9 Bank
180
38
582
800
174
610
230
2,526
3,540
1,530
1,530
1,000
152
1,152
340
Page 38
May 12 Bank
May 31 Balance c/d
May 12 Bank
May 31 Balance c/d
May 2 Balance c/d
Ward (liabilities)
610
May 2 Purchases
610
Green (liabilities)
505
May 2 Purchases
18 Purchases
505
Jun 1 Balance b/d
214
291
505
505
Taylor (liabilities)
174
May 2 Purchases
174
Gemmill (liabilities)
1,285
May 2 Purchases
18 Purchases
1,285
Jun 1 Balance b/d
345
940
1,285
1,285
Tone (liabilities)
542
May 2 Purchases
Jun 1 Balance b/d
542
542
Page 39
Sales (Income)
May 4
4
4
21
May 2
2
2
2
2
18
18
Ward
Green
Taylor
Gemmill
Tone
Green
Gemmill
May 6 Cash
31 Bank
May 15 Cash
Sharpe
Boycott
Titmus
Boycott
Purchases (Expenses)
610
214
174
345
542
291
940
3,116
Rent (expenses)
180
230
410
Transport (expenses)
38
Capital
May 1 Cash
1 Bank
340
720
1,152
810
3,022
800
2,200
3,000
Page 40
Trial Balance as at 31 May

Debit
Cash
582
Bank
2,526
Boycott
1,530
Titmus
Credit
152
Green
505
Gemmill
1,285
Tone
542
Sales
3,022
Purchases
Rent
Transport
3,116
410
38
Capital
3,000
8,354
8,354
Page 41
Exercise 9
Enter the following transactions of a furniture shop in the accounts and

extract a trial balance as at 31 March.
Mar 1 Started in business with $8,000 in the bank.

2 Bought goods on credit from the following persons: Frank
$550, Byers $290, Lee $610.
5 Cash sales $510.
6 Paid wages in cash $110.
7 Sold goods on credit to: Snow $295, Park $360, Tyler $640.
9 Bought goods for cash $120.
10 Bought goods on credit from Byers $410, Lee $1,240.
12 Paid wages in cash $110.
13 Sold goods on credit to Park $610, Tyler $205.
15 Bought shop fixtures on credit from Stop Sdn Bhd $740.
17 Paid Byers by cheque $700.
18 We returned goods to Lee $83.
21 Paid Stop Sdn Bhd a cheque for $740.
24 Tyler paid us his account by cheque $845.
27 We returned goods to Frank $18.
30 Prince lent us $1,000 by cash.
31 Bought a van paying by cheque $6,250.
Page 42
Financial Statements
Page 43
After the accounts have been prepared and a trial balance extracted and
there are no errors in the process of recording the transactions, the next
step is the preparation of the financial statements.
Trading and Profit and Loss Account

Trading Account
The Trading account is an account that is used to calculate the profit or
loss from selling products. Accounts that are related to the increase and
decrease in stock Sales, Purchases, Returns Inwards and Returns
Outwards are balanced off or transferred or posted to the Trading
Account. A problem that arises in the preparation of the Trading Account
is the balance of stock that remains unsold at the end of the accounting
period. From the previous exercises, the stock that was not sold was never
stated or recorded in any accounts. As such the example below will
illustrate the recognition of closing stock.
May 31 Trading Account
May 2
2
2
2
2
18
18
Ward
Green
Taylor
Gemmill
Tone
Green
Gemmill
Sales (Income)
3,022
May 4
4
4
21
3,022
Sharpe
Boycott
Titmus
Boycott
Purchases (Expenses)
610
214
174
345
542
291
940
3,116
340
720
1,152
810
3,022
3,116
3,116
Page 44
From the Sales and Purchases account it is obvious that all the stocks that
was purchased was not sold. Lets assume that the stock that is still
available at the end of the month was $2,209. The stock that remains is an
asset of the business and yet there is no account for it. Therefore at the
end of the accounting period, stock that remains unsold closing stock
will be recorded in the Stock Account.
Stock (assets)
2,209
Now lets look at the Trading Account

May 31 Purchases
31 Gross Profit c/d
Trading Account
3,116
May 31 Sales
2,115
31 Stock
5,231
May 31 Gross Profit b/d
3,022
2,209
5,231
2,115
Based on double entry rule, the Sales account is closed by transferring the
total to the Trading Account. The Purchases account is closed by
transferring the total to the Trading Account, and the Stock account
which was just created to recognize the closing stock would have a debit
entry since stock is an asset and the corresponding credit entry is to the
Trading Account. The Trading account is then closed or balanced off and
the balancing amount on the debit side is considered as the Gross Profit.
Page 45
Trading Account T Account method

May 31 Purchases
31 Gross Profit c/d
Trading Account
3,116
May 31 Sales
2,115
31 Stock
5,231
3,022
2,209
5,231
2,115
Trading Account Vertical format

Trading Account for the month ending 31 May
Sales
3,022
Less Cost of Goods Sold

Purchases
3,116
Less Closing Stock
2,209
Gross Profit
907
2,115

After the Gross Profit has been calculated the next step is to calculate the
profit or loss from running the business. This profit or loss is calculated in
the Profit and Loss Account. Other Income and Expense class accounts
are closed or balance off or posted to the Profit and Loss Account in order
to calculate the Net Profit or Net Loss. Usually the Profit and Loss
Account is continued from the Trading Account.
Page 46
May 6 Cash
31 Bank
May 15 Cash
Rent (expenses)
180
May 31 Profit and Loss
230
410
Transport (expenses)
38
May 31 Profit and Loss

May 31 Purchases
3,116
May 31 Sales
31 Gross Profit c/d
2,115
31 Stock
5,231
May 31 Rent
410
Transport
38
Net Profit
1,667
2,115
410
410
38
3,022
2,209
5,231
2,115
2,115
Trading and Profit and Loss Account for the month ending 31 May
Sales
3,022

Purchases
3,116
Less Closing Stock
2,209
Gross Profit
907
2,115
Less Expenses:
Rent
Transport
Net Profit
410
38
448
1,667
Therefore the closing stock at the end of the accounting period will not be
recorded or stated in the Trial Balance. The closing stock at the end of the
accounting period will be the opening stock for the next accounting
period, therefore it will be stated in the Trial Balance of the next period.
Page 47
Exercise 10
From the following trial balance extracted after one years trading,
prepare the Trading and Profit and Loss account for the year ended 31
December 2006.
Trial Balance as at 31 December 2006

Debit
Sales
Purchases
Salaries
190,576
119,832
56,527
Motor expenses
2,416
Rent
1,894
Insurance
General expenses
372
85
Premises
95,420
Motor vehicles
16,594
Debtors
26,740
Creditors
16,524
Cash at bank
16,519
Cash in hand
342
Drawings
Credit
8,425
Capital
345,166
345,166
Note: Stock at 31 December 2006 was $12,408
Page 48
Exercise 11
From the following trial balance of Nadya after her first years trading,
you are required to draw up the trading and profit and loss account for the
year ended 30 June 2006.
Trial Balance as at 30 June 2006

Debit
Sales
Purchases
Rent
Lighting and heating expenses
Salaries and wages
265,900
154,870
4,200
530
51,400
Insurance
2,100
Buildings
85,000
Fixtures
1,100
Debtors
31,300
Sundry expenses
412
Creditors
15,910
Cash at bank
14,590
Drawings
30,000
Vans
16,400
Motor running expenses
Credit
4,110
Capital
114,202
396,012
396,012
Note: Stock at 30 June 2006 was $16,280.
Page 49
Balance Sheet
The last Financial Statement is the Balance Sheet. Balance Sheets shows
the financial standing of the business at one point in time. As was
previously discussed the accounting equation is expressed as a Balance
Sheet, but the equation is classified into specific assets and liabilities so
that it is easier to make judgments and decisions.
Example 6
The following is the trial balance of Susan after the first year of trading
on 31 December 2005. The final statements are required to be prepared
for the year.
Trial Balance as at 30 December 2005

Debit
Sales
Purchases
38,500
29,000
Rent
2,400
Lighting expenses
1,500
General expenses
600
Fixtures and fittings
5,000
Debtors
6,800
Creditors
9,100
Bank
15,100
Cash
200
Drawings
Credit
7,000
Capital
20,000
67,600
67,600
Note: Closing stock was $3,000.
Page 50
Trading and Profit and Loss Account for the period ending 31 Dec 2005
Sales
38,500

Purchases
Less Closing Stock
29,000
3,000
26,000
Gross Profit
12,500
Less Expenses:
Rent
2,400
Lighting expenses
1,500
General expenses
600
4,500
Net Profit
8,000
Balance Sheet as at 31 December 2005

Fixed Assets
Fixtures and fittings
5,000
Current assets
Stock
3,000
Debtors
6,800
Bank
15,100
Cash
200
25,100
Less Current liabilities

Creditors
Working capital
9,100
16,000
21,000
Capital
Cash introduced
Add Net profit for the year
20,000
8,000
28,000
Less Drawings
7,000
21,000
Page 51
Accounting Concepts
Page 52
Accounting Concepts
Fundamental Accounting Concepts
Going Concern Concept

This concept implies that the business will continue to operate as usual
for the foreseeable future.
Consistency Concept
There are several method of recording items in the accounts. Each
business should try to choose the methods which give the most reliable
picture of the business. In order to provide the most reliable picture a
method would be used in every accounting period.
Prudence Concept
Assets of the business should be understated but not deliberately and
liabilities should be overstated but not deliberately.
Matching Concept
Income and expenses should be matched against each other in the same
period it is earned and incurred. This is to ensure proper calculation of
profits or losses in the period.
Accruals Concept
Income can only be recognized when it is earned and expenses must be
recognized when it is incurred.
Page 53
Adjustments to
Page 54
Adjustments to the Financial Statements
Before the Financial Statements can be finalized or completed, there are

adjustments needed to be done to the accounts. The adjustments are
necessary in order to comply with the Accounting Concepts.
Adjustments that are needed are:

1.
Accruals and Prepayments
2.
Depreciation of fixed assets.
Accruals
Accruals are expenses that are already incurred but remains unpaid at the
end of the accounting period.
Example 7
Rent for the year is $1200 and payable in equal installments every 4
months.
Mar 31
July 2
Oct 4
Dec 31
Amount
Rent due
Rent paid
$300
31 March 2006
31 March 2006
$300
30 June 2006
2 July 2006
$300
30 September 2006
4 October 2006
$300
31 December 2006
5 January 2007
Bank
Bank
Bank
Balance c/d
300
300
300
300
1,200
Rent
Dec 31 Profit and Loss
Jan 1 Balance b/d
1,200
1,200
300
Page 55
The total rent that must be recognized for the year is $1,200 even though
the actual amount paid was only $900. This is to apply the matching
concept and the accruals concept. The balance of $300 that is unpaid will
be listed as a liability in the Balance Sheet.
Prepayments
Prepayments are expenses that are already paid but still not incurred yet
at the end of the accounting period.
Example 8
Insurance of $4,000 per year is to be paid over 4 equal installments every
3 months.
Amount
Insurance due
Insurance paid
$1,000
31 March 2006
$1,000 28 Feb 2006
$1,000
30 June 2006
$1,000
30 September 2006
$1,000
31 December 2006
Feb 28 Bank
Aug 31 Bank
Nov 18 Bank
Jan 1 Balance b/d
$2,000 31 Aug 2006

$2,000 18 Nov 2006
Insurance
1,000
Dec 31 Profit and Loss
2,000
31 Balance c/d
2,000
5,000
1,000
4,000
1,000
5,000
The insurance expense that can be recognized for the year is $4,000. Even
though $5,000 has already been paid, only $4,000 can be transferred to
the Profit and Loss account. The balance of $1,000 will be recorded as an
asset in the Balance Sheet.
Page 56
Depreciation of Fixed Assets

Depreciation is the reduction in the value of fixed assets caused by
physical deterioration, economic factor, time factor or depletion.
Methods of calculating depreciation

1.
Straight Line Method
2.
Reducing Balance Method
Straight Line Method

Formula =
Cost of Fixed Assets Scrap Value

Estimated Useful life
= Depreciation/year
Example 9
A machine was purchased on 1 January 2001 for $10,000 and it was
estimated that this machine will be used for 4 years. The machine will
have a scrap value of $256 at the end of 4 years.
Depreciation = ($10,000 - $256) / 4 = $2,436
1 January 2001
Cost
$10,000
31 December 2001
Depreciation
$ 2,436
1 January 2002
Net Book Value
$ 7,564
31 December 2002
Depreciation
$ 2,436
1 January 2003
Net Book Value
$ 5,128
31 December 2003
Depreciation
$ 2,436
1 January 2004
Net Book Value
$ 2,692
31 December 2004
Depreciation
$ 2,436
1 January 2005
Net Book Value
256
Page 57
Reducing Balance Method

Formula: 1 - n(s/c) = depreciation rate
Example 10
(the same information as in Example 9)
Depreciation rate = 1 - 4(256/10,000) = 0.6 or 60%
1 Jan 2001
Cost
$10,000
31 Dec 2001
Depreciation (10,000 x 60%)
$ 6,000
1 Jan 2002
Net Book Value
$ 4,000
31 Dec 2002
$ 2,400
1 Jan 2003
Net Book Value
$ 1,600
31 Dec 2003
960
1 Jan 2004
Net Book Value
640
31 Dec 2004
Depreciation (640 x 60%)
384
1 Jan 2005
Net Book Value
256
Page 58
Recording of Depreciation
It does not matter which method of depreciation is adopted by the
business, the recording of the depreciation in the accounts is still the
same. Using the Straight Line Method of depreciation in Example 9 the
accounts would be as follows:
1/1/2001
1/1/2002
1/1/2003
1/1/2004
1/1/2005
Machinery
10,000 31/12/2001
10,000 31/12/2002
10,000 31/12/2003
10,000 31/12/2004
10,000
Bank
Balance b/d
Balance b/d
Balance b/d
Balance b/d
31/12/2001
31/12/2002
31/12/2003
31/12/2004
31/12/2002 Balance c/d
31/12/2004
Depreciation Expense
2,436 31/12/2001
2,436 31/12/2002
2,436 31/12/2003
2,436 31/12/2004
Prov. For Depre

Prov. For Depre
Prov. For Depre
Prov. For Depre
Balance c/d
Balance c/d
Balance c/d
Balance c/d
Provision for Depreciation

2,436 31/12/2001
2,436
4,872
1/1/2002
31/12/2002
4,872
7,308
1/1/2003
31/12/2003
7,308
9,744
1/1/2004
31/12/2004
9,744
1/1/2005
10,000
10,000
10,000
10,000
Profit and Loss

Profit and Loss
Profit and Loss
Profit and Loss
2,436
2,436
2,436
2,436
Depre. Exp.
2,436
2,436
2,436
2,436
4,872
4,872
2,436
7,308
7,308
2,436
9,744
9,744
Balance b/d
Depre. Exp.
Balance b/d
Depre. Exp.
Balance b/d
Depre. Exp
Balance b/d
Page 59
Example 11 (Fully Worked Example)

From the following trial balance, prepare the financial statements of the
business at 31 August 2006.
Debit
Stock at 1 September 2005
Purchases and Sales
8,200
26,000
Rent
4,400
Business rates
1,600
Sundry expenses
40,900
340
Motor vehicles at cost
9,000
Debtors and creditors
1,160
Bank
1,500
Provision for depreciation
2,100
1,200
Capital at 1 September 2005

Drawings
Credit
19,700
11,700
63,900
63,900
Notes: At 31 August 2006 there was:

1.
Stock value at cost price $9,100
2.
Accrued rent of $400
3.
Prepaid business rates $300
4.
Motor vehicle is to be depreciated at 20% on cost
Page 60
Trading and Profit and Loss account

for the period ending 31 August 2006
Sales
40,900
Less Cost of Sales

Opening stock
8,200
Add Purchases
26,000
34,200
Less Closing stock
9,100 25,100
Gross Profit
15,800
Less Expenses:
Rent (4,400 + 400)
4,800
Business rates (1,600 300)
1,300
Sundry expenses
340
1,800
Net Profit
8,240
7,560
Balance Sheet as at 31 August 2006

Fixed Asset
Cost
Depre
NBV
Motor vehicles
9,000
3,000
6,000
Current Assets
Stock
9,100
Debtors
1,160
Prepaid rates
300
Bank
1,500
12,060
Current Liabilities
Creditors
Accrued rent
Working Capital
2,100
400
2,500
9,560
15,560
Capital
As at 1 September 2005
Add Net Profit for the year
19,700
7,560
27,260
Less Drawings
11,700
15,560
Page 61
ASSIGNMENTS
QUESTION 1
James, a sole trader, extracted the following trial balance from his books at the close of
business on 31 March 2009.
Debit
Credit
Purchases and Sales
61,420
127,245
Stock at 1 April 2008
7,940
Capital at 1 April 2008
25,830
Bank Overdraft
Cash
2,490
140
Discounts allowed
62
Discounts received
2,480
Returns inwards
3,486
Returns outwards
1,356
Transportation
3,210
Rent and insurance
8,870
Fixtures and Fittings
1,900
Van
5,600
12,418
Drawings
21,400
Wages and Salaries
39,200
General office expenses
11,400
319
168,383
168,383
Notes:
1.
Stock at 31 March 2009 $6,805
2.
Wages and salaries accrued at 31 March 2009 $3,500; Office expenses owing $16.
3.
Rent prepaid at 31 March 2009 $600
4.
Provide for depreciation as follows: Fixtures and Fittings $190; Van $1,400
Page 62
Question 2
From the following trial balance of Brian, store owner, prepare a trading account and profit
and loss account for the year ended 31 December 2007, and a balance sheet as at that date,
taking into consideration the adjustments shown below:
Debit
Sales
Credit
400,000
Purchases
350,000
Sales returns
5,000
Purchases returns
Opening stock at 1 January 2007
Wages and salaries
6,200
100,000
30,000
Rates
6,000
Telephone
1,000
Shop fittings at cost
40,000
Van at cost
30,000

Bad Debts
9,800
7,000
200
Capital
179,800
Bank balance
Drawings
3,000
18,000
593,000
593,000
Notes:
1.
Closing stock at 31 December 2007 $120,000
2.
Accrued wages $5,000.
3.
Rates prepaid $500.
4.
Telephone account outstanding $220.
5.
Depreciate shop fittings at 10% per annum and van at 20% per annum, on cost.
Page 63
Accounts of
Limited Companies
Page 64
Accounts of Limited Companies
The financial statements of a limited company, is similar to that of a sole

trader, except that after the net profit or loss is calculated, the amount
available is appropriated to pay for taxes, transferred to reserves and
payment of dividends. Any balance of profit that is left would be
recognized as retained profits, and it would be used in the future.
ABC Sdn Bhd

For the year ended 31 December 2006
Sales
100,000
Less Cost of Sales
54,000
Gross Profit
46,000
Expenses (Note 1)
Selling and Distribution
Administration
Financing
5,300
31,500
400
37,200
Net Profit
8,800
Less Taxation
2,500
Profit after Tax
6,300
Less Transfer to Reserves (Note 2)
2,000
4,300
Less Dividends (Note 3)
2,600
Retained Profit (Note 4)
1,700
Retained Profit b/d
1,500
Retained Profit c/d
3,200
Page 65
ABC Ltd
Balance Sheet as at 31 December 2006
Fixed Assets
102,000
Current Assets
Stock
4,000
Debtors
16,800
Bank
17,400
38,200
Current Liabilities
Creditors
26,400
Taxation
2,500
Dividends
1,600
30,500
7,700
109,700
Long Term Liabilities

Debentures (Note 5)
4,000
105,700
Share Capital and Reserves

Ordinary Shares of $1 each (Note 6)
55,000
Share premium (Note 7)
22,500
General Reserve
25,000
Retained Profits
3,200
105,700
Page 66
Note 1:
The expenses of the business is classified into 3 groups

Selling and Distribution, Administration and Financing.
Note 2:
Transfer to Reserves are created to strengthen the financing

of a company by ploughing profits back into the business.
Note 3:
Dividends are actually the profits that the shareholders are

allowed to receive. The amount is decided by the directors of
the company.
Note 4:
The balance on the profit and loss appropriation account

after transfers to reserves and dividends is the retained profit
for the year. It is added to retained profit brought forward
from the previous year to provide the retained profit carried
forward to the next year.
Note 5:
A debenture is a loan made to a company, which is stated in

a document called Debentures.
Note 6:
The amount of share capital invested by share holders.
Note 7:
Share premium is the amount above the par value of the

shares that was invested by the shareholders.
Page 67
Interpretation of Accounts
Page 68
Interpretation of Accounts
The purpose of accounting is to convey information, but absolute
numbers are generally meaningless. For example it is only possible to
make a judgment about profit if it can be related to some other figures
such as the amount of money invested in the business.
Profitability Ratios
1.
Return On Capital Employed
2.
Net Profit to Sales
3.
Gross Profit to Sales
4.
Expenses to Sales
Utilization of Resources
1.
Utilization of Capital Employed
2.
Utilization of Total Assets
3.
Utilization of Fixed Assets
4.
Utilization of Current Assets
Financial Ratios
1.
Current Ratio
2.
Liquid Ratio
3.
Stock turn
4.
Debtors Ratio
5.
Creditors Ratio
Investment Ratios
1.
Earnings per share
2.
Price Earnings Ratio
Page 69
ABC Sdn Bhd

Trading and Profit and Loss Account for the Year ended
2001
Sales
1,000
Less Cost of Sales
Opening Stock
60
Purchases
710
770
Closing Stock
68
702
Gross Profit
298
Expenses
Selling and Distribution
60
Administration
105
Financial
5
170
Profit before taxation
128
Taxation
47
Profit after tax
81
Transfer to reserves
30
51
Dividends
29
Retained Profit
22
Retained Profit b/d
4
Retained Profit c/d
26
ABC Sdn Bhd
Trading and Profit and Loss Account for the Year ended
2001
Fixed Assets (NBV)
316
Current assets
Stock
68
Debtors
83
Bank
85
236
Current Liabilities
Creditors
80
Taxation
47
Dividends
29
156
80
396
Long Term Liabilities
Debentures
40
356
Share capital and reserves
Ordinary shares of $1
300
General reserves
30
Retained Profit
26
356
2002
1,220
68
812
880
72
808
412
78
134
15
227
185
57
128
50
78
54
24
26
50
2002
520
72
112
77
261
120
57
54
231
30
550
120
430
300
80
50
430
Page 70
Return On Capital Employed

Profit before Interest
Capital Employed
x 100
2001
(128 + 5)
(356 + 40)
X 100
= 33.6%
2002
(185 + 15)
(430 + 120)
X 100
= 36.4%
Net Profit To Sales

Profit before tax
Sales
x 100
2001
128
1,000
X 100
= 12.8%
2002
185
1,220
X 100
= 15.2%
2001
298
1,000
X 100
= 29.8%
2002
412
1,220
X 100
= 33.8%
2001
170
1,000
X 100
= 17%
2002
227
1,220
X 100
= 18.6%
Gross Profit to Sales

Gross Profit
Sales
x 100
Expenses to Sales
Expenses
Sales
x 100
Page 71
Utilization of Capital Employed

Sales
Capital Employed
= times
2001
1,000
396
= 2.53
times
2002
1,220
550
= 2.22
times
2001
1,000
(316 + 236)
= 1.81
times
2002
1,220
(520 + 261)
= 1.56
times
2001
1,000
316
= 3.16
times
2002
1,220
520
= 2.35
times
2001
1,000
236
= 4.24
times
2002
1,220
261
= 4.67
times
Utilization of Total Assets

Sales
Total Assets
Utilization of Fixed Assets

Sales
Fixed Assets
Utilization of Current Assets

Sales
Current Assets
Page 72
Current Ratio
Current Assets : Current Liabilities
2001
236
156
= 1.50 : 1
2002
261
231
= 1.13 : 1
Liquid Ratio
Current Assets Stock : Current Liabilities
2001
236 - 68
156
= 1.08 : 1
2002
261 - 72
231
= 0.82 : 1
Stock turn
Cost of Sales
Average Stock
Avg Stock=
Opening Stock + Closing Stock
2001
702
(60 + 68)/2
= 10.97
times
2002
808
(68 + 72)/2
= 11.54
times
Debtors Ratio
Debtors
Sales
x 365
2001
83
1,000
X 365
= 30.3 days
2002
112
1,220
X 365
= 33.5 days
= days
Page 73
Creditors Ratio
Creditors
Purchases
x 365
2001
80
710
X 365
= 41.1 days
2002
120
812
X 365
= 53.9 days
= days
Earnings Per Share

Profit after tax
Number of shares
2001
81
300
= $0.27
2002
128
300
= $0.427
2001
$2.50
$0.27
= 9.23
2002
$4.50
$0.427
= 10.54
Price Earnings Ratio

Market Price of Share
Earnings Per Share
Page 74

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Diploma in Business Management ACC001