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OUM Business School
BBFA1103
Introductory Accounting
Copyright © Open University Malaysia (OUM)

BBFA1103
INTRODUCTORY
ACCOUNTING
Rosila Abu Zarin
Assoc Prof Dr Ong Tze San

Project Directors: Prof Dato’ Dr Mansor Fadzil
Prof Dr Wardah Mohamad
Open University Malaysia
Module Writers: Rosila Abu Zarin

Assoc Prof Dr Ong Tze San
Moderators: Dr Sofiah Md Auzair

Universiti Kebangsaan Malaysia
Baldev Singh Pertab Singh

Liana Mohamad
Developed by: Centre for Instructional Design & Technology

First Edition, September 2006

Second Edition, August 2014
Copyright © Open University Malaysia (OUM), August 2014, BBFA1103
All rights 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).

Table of Contents
Course Guide xi ă xvi
Topic 1 Accounting Environment 1

1.1 The Importance of Accounting 2
1.2 Definition of Accounting 3
1.3 Users of Accounting Information 5
1.3.1 Internal Users 6
1.3.2 External Users 6
1.4 Branches of Accounting 7
1.5 Qualitative Characteristics of Accounting Information 8
1.5.1 Relevance 8
1.5.2 Reliability 9
1.5.3 Comparability 10
1.5.4 Consistency 10
1.5.5 Materiality 11
1.5.6 Understandability 11
1.5.7 Timeliness 11
1.6 Financial Statements 12
1.6.1 The Purpose of Financial Statements 12
1.6.2 The Components of Financial Statements 13
Summary 20
Key Terms 21
Self-Test 1 21
Self-Test 2 21
Topic 2 Accounting Standards, Assumptions and Principles 23

2.1 Accounting Bodies in Malaysia 24
2.1.1 Malaysian Institute of Accountants (MIA) 24
2.1.2 The Malaysian Institute of Certified Public
Accountants (MICPA) 25
2.1.3 Malaysian Accounting Standard Board (MASB) 25
2.1.4 Financial Reporting Foundation (FRF) 26
2.2 Accounting Standards 26
2.2.1 Generally Accepted Accounting Principles (GAAP) 27
2.3 Accounting Assumptions 27
2.3.1 Assumption 1: Separate Entity 28
2.3.2 Assumption 2: Going Concern 29
2.3.3 Assumption 3: Monetary Unit 29

iv  TABLE OF CONTENTS
2.3.4 Assumption 4: Accounting Period 29

2.4 Basic Accounting Principles 30
2.4.1 Principle 1: Historical Cost 30
2.4.2 Principle 2: Revenue Recognition 30
2.4.3 Principle 3: Matching 31
2.4.4 Principle 4: Full Disclosure 31
2.5 Forms of Business 32
2.5.1 Types of Business 32
2.5.2 Types of Ownership of Business 34
Summary 37
Key Terms 38
Self-Test 1 38
Self-Test 2 39
Topic 3 Accounting Equation 40

3.1 The Accounting Cycle 41
3.1.1 Source Documents 41
3.1.2 Transactions Analysis 42
3.1.3 Journalising 42
3.1.4 Posting 42
3.1.5 Preparation of Unadjusted Trial Balance 42
3.1.6 Adjusting Entries 43
3.1.7 Preparation of Adjusted Trial Balance 43
3.1.8 Preparation of Financial Statements 43
3.1.9 Closing Entries 43
3.2 Accounting Equation 45
3.3 Transaction Analysis 48
3.3.1 Transaction 1: Initial Investment by Owner 49
3.3.2 Transaction 2: Purchase of Non Current Asset 49
3.3.3 Transaction 3: Withdrawals by Owners 50
3.3.4 Transaction 4: Borrowing Money 51
3.3.5 Transaction 5: Repayment of Borrowings 52
3.3.6 Transaction 6: Earning Revenues 53
3.3.7 Transaction 7: Paying For Expenses 54
Summary 57
Key Terms 57
Self-Test 1 58
Self-Test 2 58
Topic 4 Recording Transactions 61

4.1 Account 62
4.1.1 Chart of Accounts 63
4.1.2 Format of Account 64

TABLE OF CONTENTS  v
4.1.3 Rules of Debit And Credit 65

4.2 Journals 67
4.2.1 General Journal 67
4.2.2 Special Journal 68
4.3 Journalising and Posting 71
4.3.1 Transaction 1: Initial Investment by Owner 72
4.3.2 Transaction 2: Purchase of Non Current Asset 73
4.3.3 Transaction 3: Withdrawal by Owner 73
4.3.4 Transaction 4: Borrowing Money 74
4.3.5 Transaction 5: Repayment of Borrowings 74
4.3.6 Transaction 6: Earning Revenues 75
4.3.7 Transaction 7: Paying for Expenses 76
4.4 Journalising and Posting 77
4.4.1 Errors in Trial Balance 78
4.4.2 Balancing of Accounts 78
4.5 Preparation of Financial Statements 81
4.5.1 Income Statement 82
4.5.2 Statement of Changes in OwnerÊs Equity 83
4.5.3 Balance Sheet 83
Summary 85
Key Terms 86
Self-Test 1 86
Self-Test 2 87
Topic 5 Adjusting Entries and Closing Entries 89

5.1 Accounting Basis 90
5.1.1 Cash Basis Accounting 90
5.1.2 Accrual Basis Accounting 91
5.2 Adjusting Entries 93
5.2.1 Prepaid Expenses 94
5.2.2 Unearned Revenue 97
5.2.3 Accrued Expenses 98
5.2.4 Accrued Revenues 99
5.2.5 Depreciation 100
5.2.6 Bad Debts 102
5.2.7 Provision for Doubtful Debts 106
5.3 Adjusted Trial Balance 112
5.4 Closing Entries 113
5.4.1 Temporary Accounts 113
5.4.2 Permanent Accounts 113
5.4.3 Recording Closing Entries 113
Summary 119
Key Terms 120

vi  TABLE OF CONTENTS
Self-Test 1 120
Self-Test 2 121
Topic 6 Accounting for Merchandising Operations 125

6.1 Merchandising (Retailing/Trading) 126
6.2 Accounting for Merchandising Purchases 127
6.2.1 Purchase of Goods 127
6.2.2 Trade Discounts 128
6.2.3 Purchase Discounts (Discount Received) 129
6.2.4 Purchase Returns and Allowance 131
6.2.5 Transportation Costs 133
6.3 Accounting for Merchandising Sales 134
6.3.1 Sales of Goods 134
6.3.2 Sales Discounts (Discount Allowed) 135
6.3.3 Sales Returns and Allowance 136
6.3.4 Transportation Cost 137
6.4 Preparing Financial Statements for Merchandising
Operations 138
6.4.1 Calculate Net Sales 139
6.4.2 Calculate Cost of Goods Sold 140
6.4.3 Calculate Gross Profit 142
6.4.4 Calculate Net Income 142
6.5 Closing Entries for Merchandising Operations 144
Summary 150
Key Terms 150
Self-Test 1 151
Self-Test 2 152
Topic 7 Internal Control and Cash Management 154

7.1 Assets 155
7.1.1 Internal Control for Assets 155
7.1.2 Current Assets 157
7.2 Accounting for Cash 158
7.2.1 Internal Control for Cash 158
7.3 Bank Reconciliation 159
7.3.1 Types of Bank Accounts 159
7.3.2 Purposes of Preparing Bank Reconciliation 162
7.3.3 Preparation of Bank Reconciliation Statement 163
7.4 Petty Cash 169
7.4.1 Creating the Petty Cash Fund 169
7.4.2 Using the Petty Cash Fund 170
7.4.3 Reimbursement of the Petty Cash Fund 171

TABLE OF CONTENTS  vii
Summary 173
Key Terms 174
Self-Test 1 174
Self-Test 2 175
Topic 8 Accounting for Partnership 177

8.1 Setting Up a Partnership 178
8.2 Basic Characteristics of a Partnership 179
8.2.1 The Partnership Act 180
8.2.2 Types of Partnerships 180
8.2.3 Advantages and Disadvantages of a Partnership 181
8.3 Conversion of Sole Proprietorship to Partnership 182
8.4 Partnership Accounts 182
8.4.1 Capital Account of a Partnership 183
8.4.2 Current Account of a Partnership 185
8.4.3 Profit And Loss Appropriation Account of a
Partnership 188
8.4.4 Final Account of a Partnership 190
Summary 192
Key Terms 192
Self-Test 1 193
Self-Test 2 193
Topic 9 Accounting for Companies 194

9.1 Definition of Liabilities 195
9.2 Current Liabilities 196
9.2.1 Bank Overdraft 197
9.2.2 Bank Loans 198
9.2.3 Bill Payable 199
9.2.4 Dividend Payable 200
9.3 Long Term Liabilities 200
9.3.1 Long Term Bank Loans 201
9.3.2 Mortgage Loans 201
9.3.3 Bonds and Debentures 202
9.4 Equity 202
9.4.1 The Equity of a Single Proprietorship 202
9.4.2 The Equity of a Partnership 204
9.4.3 Company Formation 205
9.4.4 The Equity of a Company 207
Summary 214
Key Terms 215
Self-Test 1 215
Self-Test 2 216

viii  TABLE OF CONTENTS
Topic 10 Financial Statement Analysis 218

10.1 The Purpose of Financial Statement Analysis 219
10.2 Comparative Analysis 221
10.2.1 Intra Company Comparison 221
10.2.2 Inter Company Comparison 221
10.2.3 Industry Comparison 222
10.3 Horizontal Analysis 222
10.4 Vertical Analysis 225
10.5 Financial Ratio Analysis 228
10.5.1 Profitability Ratios 228
10.5.2 Liquidity/Solvency Ratios 230
10.5.3 Asset Management/Activity Ratios 232
10.5.4 Financial Leverage/Gearing Ratios 235
Summary 237
Key Terms 238
Self-Test 1 238
Self-Test 2 239
Topic 11 Comprehensive Cases 240

11.1 Preparation of Financial Statements 240
11.2 Financial Statement Analysis 243
Answers 249

COURSE GUIDE

COURSE GUIDE  xi
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 the 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
BBFA1103 Introductory Accounting is one of the courses offered by the OUM
Business School 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 major course for all students undergoing the Bachelor of
Accounting programme.
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.

xii  COURSE GUIDE
Table 1: Estimation of Time Accumulation of Study Hours
Study
Study Activities
Hours
Briefly go through the course content and participate in initial discussion 3
Study the module 60
Attend 3 to 5 tutorial sessions 10
Online participation 12
Revision 15
Assignment(s), Test(s) and Examination(s) 20
TOTAL STUDY HOURS ACCUMULATED 120
COURSE OUTCOMES
By the end of this course, you should be able to:
1. Explain what accounting is and its importance;
2. Describe the accounting standards, assumptions and principles;
3. Record transactions in the journals;
4. Post journal entries into appropriate accounts;
5. Account for the adjusting entries;
6. Analyse the elements in Income Statements and Balance Sheets;
7. Prepare financial statements; and
8. Interpret selected ratios for financial statements analysis.
COURSE SYNOPSIS
This course is divided into 11 topics. The synopsis for each topic is presented as
follows:
Topic 1 introduces accounting, its role and importance. It describes the users of
accounting information, branches of accounting and the qualitative
characteristics of accounting information. Lastly, the four financial statements are
presented: (i) Income statement; (ii) Balance sheet; (iii) Statement of changes in
ownersÊ equity; and (iv) Cash flow statement.

COURSE GUIDE  xiii
Topic 2 details the various accounting bodies in Malaysia: (i) MIA; (ii) MICPA;
(iii) MASB; and (iv) FRF by describing their objectives and functions. It then
presents the accounting standards, accounting assumptions, accounting
principles and the various forms of businesses.
Topic 3 discusses the accounting equation and financial statements. This topic
will also explain the effect of business transactions on accounting equation.
Topic 4 discusses the use of accounts and journals. Next, it illustrates the step-by-
step process of journalising and posting of transactions into the appropriate
accounts. Finally, the preparation of trial balance and financial statement will be
demonstrated.
Topic 5 differentiates between cash and accrual basis of accounting. It also

explains the needs for adjusting entries. Discussion on adjusting entries: (i)
Prepaid expenses; (ii) Unearned Revenues; (iii) Accrued Expenses; (iv) Accrued
Revenues; (v) Depreciation; (vi) Bad Debts; and (vii) Doubtful Debts will be
made. Lastly, the preparation of adjusted trial balance and closing entries will be
illustrated.
Topic 6 covers the concept of sales and purchase in a merchandising company.

Topics such as trade discounts, cash discounts, returns and transportation cost
and their accounting treatments will be discussed further. It also explains the
process of preparing adjusting entries and closing entries and lastly constructs
Income Statement and Balance Sheet of a merchandising company.
Topic 7 discusses the importance of internal control for assets especially cash.
The preparation of bank reconciliation statement and the purpose of preparing
them will be discussed too. Lastly, accounting for petty cash will be covered.
Topic 8 provides the characteristics of partnership. This topic will also discuss
financial statements for partnership.
Topic 9 shows the classification of companies. It also discusses company

formation, structure of companyÊs capital and types of shares and debentures.
Topic 10 discusses the basic concepts in financial statement analysis. It explains

comparative analysis, horizontal analysis, and vertical analysis. Finally, selected
ratios calculation under financial ratio analysis: (i) Profitability ratios; (ii)
Liquidity (solvency) ratio; (iii) Efficiency ratio; and (iv) Financial leverage
(gearing) ratio will be explained.

xiv  COURSE GUIDE
Finally, Topic 11 will discuss comprehensive cases where students can recap
what they have studied. Here, they will also experience and practice the
comprehensive sample exam questions.
TEXT ARRANGEMENT GUIDE

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

throughout the module. It may be inserted after one sub-section or a few sub-
sections. It usually comes in the form of a question. When you come across this
component, try to reflect on what you have already learnt thus far. By attempting
to answer the question, you should be able to gauge how well you have
understood the sub-section(s). Most of the time, the answers to the questions can
be found directly from the module itself.
Activity: Like Self-Check, the Activity component is also placed at various

locations or junctures throughout the module. This component may require you
to solve questions, explore short case studies, or conduct an observation or
research. It may even require you to evaluate a given scenario. When you come
across an Activity, you should try to reflect on what you have gathered from the
module and apply it to real situations. You should, at the same time, engage
yourself in higher order thinking where you might be required to analyse,
synthesise and evaluate instead of only having to recall and define.
Summary: You will 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 in the
summary that you do not fully understand, it would be a good idea for you to
revisit the details in 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 jargon used

COURSE GUIDE  xv
throughout the module. Should you find terms here that you are not able to
explain, you should look for the terms in the module.
References: The References section is where a list of relevant and useful

textbooks, journals, articles, electronic contents or sources can be found. The list
can appear in a few locations such as in the Course Guide (at the References
section), at the end of every topic or at the back of the module. You are
encouraged to read or refer to the suggested sources to obtain the additional
information needed and to enhance your overall understanding of the course.
PRIOR KNOWLEDGE
There is no prerequisite requirement for learners prior taking this subject.
ASSESSMENT METHOD
Please refer to myINSPIRE.
REFERENCES
John Balachandran, M. Iqbal Khadaroo, Kevin Low, & Subramaniam. (2002).
Fundamentals of financial accounting. Selangor: Prentice Hall.
Larson, K. D., Wild, J. J., & Chiappetta, B. (2005). Principles of financial
accounting (17th ed.). New York: McGraw-Hill.
Lerner, J.L. & Cashin, J. M. (1998). SchaumÊs outline of theory and problems of
principles of accounting I (5th ed.). Black Lick, OH USA: McGraw-Hill. In
ebrary (OUM Digital Collection).
Loh, B. F. & Ng, K. H. Principles of accounts. Singapore: Longman/Pearson
Education Asia.
Wood, F., & Sangster, A. (2002). Business accounting 1 (9th ed.). Great Britain:
Financial Times/Pearson Education.
TAN SRI DR ABDULLAH SANUSI (TSDAS) DIGITAL

LIBRARY
The TSDAS Digital Library has a wide range of print and online resources for the
use of its learners. This comprehensive digital library, which is accessible
through the OUM portal, provides access to more than 30 online databases

xvi  COURSE GUIDE
comprising e-journals, e-theses, e-books and more. Examples of databases

available are EBSCOhost, ProQuest, SpringerLink, Books24x7, InfoSci Books,
Emerald Management Plus and Ebrary Electronic Books. As an OUM learner,
you are encouraged to make full use of the resources available through this
library.

Topic  Accounting
1 Environment
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Define accounting and its four components;
2. Explain the importance of accounting;
3. Identify users and branches of accounting;
4. Discuss the qualitative characteristics of accounting information;
5. Describe the purpose of financial statements; and
6. Recognise the four components of financial statements.
 INTRODUCTION
Did you know that the movie „Forest Gump‰ starring Tom Hanks made over
US$329.7m in gross domestic revenue, and yet it was reported as having a net loss?
Tom Hanks made millions from his fees which include certain shares of the gross
revenue, and yet the original author, Winston Groom, who sold the screenplay
rights to his novel for a price plus a share of the movie profit, received none.
Had Mr. Groom known the accounting language, he would have understood the
difference between revenue and profit, and this situation could have been
avoided. The movie might have made millions but the expenses which included
production cost, marketing and distribution cost and even the fees (based on
revenue sharing) paid to Tom Hanks, directors etc, reduced the millions of
revenue to a net loss.
The above case is a good example of how accounting plays an important role in
making the right decision. It enables us to make informed and better economic
decisions. But how or where can you obtain this accounting information from?
This information is provided through the financial statement of a business. Now it is
common for public listed companies to publish their financial statements in the

2  TOPIC 1 ACCOUNTING ENVIRONMENT
newspapers. After you have completed this module, the financial statements will not
look so strange after all as you have understood the language of accounting.
This topic introduces accounting, its importance and definition. We will then
look at who are the users of accounting information, and we will also look at the
qualitative characteristics that must exist so that the information will be valuable
to the users.
You will later learn the purpose of preparing financial statements and the
components of financial statements.
1.1 THE IMPORTANCE OF ACCOUNTING

Accounting plays an important role in our daily life, directly or indirectly. The
views that accounting is only important for businesses and accountants are not
true. Accounting provides valuable financial information that enables us to make
informed and better decisions.
An example of making this economic decision in our daily life is the handling of
our monthly income. You need to know your financial position before you would
be able to spend wisely. You need some accounting knowledge to plan or budget
for your spending. You need to determine your net income which is gross pay
minus all expenses.
In deciding whether to purchase your dream car, you need to know whether you
can afford it. This is where accounting knowledge play an important role,
providing you with the necessary financial information to make decision.
In „The life of Mahatma Gandhi‰, the author quoted that Gandhi once wrote a
letter to his son saying, „You should keep an account of every penny you spend‰.
Gandhi used to keep daily record of whatever he spent! According to him, you
will be able to manage your money by keeping track of it.
Similarly for business, they need accounting information to help them run their
business effectively and efficiently. They need to know whether the business is
profitable or not, whether they have enough cash to pay their workers salary and
more. If they know that their business is not profitable, they could do something
about it, like selling it or try to improve the situation by changing their
operations. Only with proper financial information will business make the right
decisions.

TOPIC 1 ACCOUNTING ENVIRONMENT  3
So what is accounting? Before we go on to discuss the definition of accounting,

let us look at some history of accounting.
Luca Pacioli who is regarded as „Father of Accounting‰ did not invent the
accounting systems, but in 1494 described the methods used by Italian merchants
to record their business transactions in his book Summa de Arithmetica,
Geometria, Proportioni et Proportionalita (Everything About Arithmetic,
Geometry and Proportion). He described most importantly the double entry
accounting systems, emphasising debit must equal credit.
The system described by Pacioli has changed little over the next four centuries,
and you will soon learn the systems throughout this module.
Figure 1.1: Luca Pacioli

Source: http://acct.tamu.edu/smith/ethics/pacioli.htm
ACTIVITY 1.1
In your own words, try to reason out the need for us to study
accounting?
1.2 DEFINITION OF ACCOUNTING
Accounting is described as a system or a process that provides reports on an

entityÊs economic transactions to users.

Accounting can be defined as a process of collecting, identifying, measuring,

recording, summarising and communicating the results of business or economic
transactions to users in order for them to make informed or better decisions.
Figure 1.2: The information flow in an accountancy system
There are four components in accounting:

(a) Recording ă written records of journalising and posting business
transactions;
(b) Summarising ă preparing the financial statements;
(c) Analysing ă examining the results to determine the financial position and
performance; and
(d) Interpreting ă using the financial statements to make judgments and
decisions.
The accounting systems process inputs which are business transactions (making
sales, paying expenses, buying assets, borrowing money etc.) into outputs of
financial statements (e.g. Income Statement and Balance Sheet).

This module will teach you the recording process and summarising process in
detail. The final topic of the module will introduce basic techniques that are used
to analyse and interpret financial statements.
From these outputs, information such as how much resources the business owns,
how much is owed and its business performance are known. The process is
shown in Figure 1.3.
Figure 1.3: The accounting systems
ACTIVITY 1.2
Imagine running a business with no knowledge of accounting. In my

opinion, it is really necessary to have at least some basic knowledge in
preparing accounts.
What is your opinion? Can you think of ways how accounting helps a
business?
1.3 USERS OF ACCOUNTING INFORMATION

Accounting information is useful to anyone who makes decisions that have an
economic result. Think about this; we as users having scarce resources (capital,
cash) and wanting to allocate these resources so that they give a maximum return
to us. Somehow you need information to enable you to make the right decisions.
Different users may need different types of information to aid their decision
making. There are two types of users: internal and external users of accounting
information.

1.3.1 Internal Users

Internal users are part of the business entity and they make decisions for the
organisation. Examples are:
Ć Directors of companies, in deciding the amount of dividend to pay to
shareholders or bonus to employees who need to know the company profit.
Ć Managers who want to know if a new product will be profitable.
Management accounting is the area of accounting that provides information

for internal usage. These among others include areas of costing, budgeting
and payroll.
On the other hand, Financial accounting provides the financial statements to

be used by mainly external users and to some extent the internal users.
1.3.2 External Users

External users are those outside of the organisation and they make decisions
about the organisation. Examples are:
(a) Investors
Before buying a companyÊs shares, they will want to know the companyÊs
profitability and the amount of dividends paid out to shareholders.
Shareholders holding shares in a company might want to decide whether to
buy more shares or dispose the shares they have.
(b) Creditors
Suppliers and bankers who want to know if they should extend credit to
the business, how much to extend, and for how long. They will assess the
ability of the business to repay the loan.
(c) Government Agencies
For example, Lembaga Hasil Dalam Negeri (LHDN), needs to know the
income of a business entity in order to determine the amount of tax to be
cosllected by them.

1.4 BRANCHES OF ACCOUNTING

In the earlier section you have learned that internal usersÊ information
requirements are provided by both management accounting and financial
accounting, while external usersÊ information requirements are provided only by
financial accounting. Accounting has expanded and changed in response to
global changes and needs. Accounting has developed into several branches, as
shown in Figure 1.4:
Figure 1.4: Accounting disciplines
This introductory accounting course will cover financial accounting only.

However, it is important for you to understand the differences between financial
accounting and management accounting. A summary of differences is shown in
Table 1.1.
Table 1.1: Comparison between Financial Accounting and Management Accounting
Financial Accounting Management Accounting
Users External users and internal Internal users only.

users.
Reports Provide financial statements of Provide financial and non-financial

an entity. information required by an entity to plan,
evaluate and control itÊs operations.
Format of Financial reports are produced Reports are produced at any time
reports periodically according to a according to needs and are not subjected
specific format or standards. to a specific format or standards.

1.5 QUALITATIVE CHARACTERISTICS OF

ACCOUNTING INFORMATION
WeÊll now discuss the characteristics that must exist in accounting information in
order to make it useful. In order for accounting information to be useful to
decision makers, it must be relevant, reliable, comparable and consistent. Useful
information should also be understandable, material and timely.
Figure 1.5: Six characteristics of accounting information
1.5.1 Relevance
The relevance principle stipulates that all relevant information should be
included in the financial statements. Information is considered relevant if it can
assist users in making decisions.

LetÊs assume that you have extra money and want to buy shares in one of the
companies listed in Bursa Malaysia. What type of information might be useful for
your needs? You might want to know:
Ć the companyÊs performance for the past five years;
Ć what future projects or new products of the company are; and
Ć who managed the company.
All the above information, quantitative and/or qualitative, is relevant as it will

assist you in deciding whether to buy the company shares or not. For example
the company has made a good profit of RM2,000,000 for the current year. You
should not rely on this information only. You must look at the past trend.
Assume you find out that the company has been making big losses for three
years before the current year. Will you invest your money in the company?
Knowing how the company performed in the past years is relevant to your
decision. Big losses for three consecutive years might indicate it is risky to invest
in the company even though it has been profitable in the current year.
1.5.2 Reliability
Reliable information is information that can be trusted by users. Information
must be objective, free from bias and significant errors. Only reliable information
will enable users to make better decisions.
How do external users of a financial statement are ensured of the reliability of

information provided? After all, this statement is prepared by the companyÊs
accountant. The comic strip below proves us the actual scenario in the accounting
profession.
Figure 1.6: How reliable is the accounting practice?

The accountant and the companyÊs management are bound by law to follow the
rules and regulations in preparing the financial statements. It is assumed that if
accountants follow the rules and regulations, the information that is reported in
the financial statements show a true and fair view of the company financial
performance and position and hence is reliable to users.
External users, to some extent are assured of the trustworthiness of the

information presented in the financial statement. Public listed companies are
required to have their financial statements audited by external auditors to ensure
the financial statement has been prepared according to accounting rules and
principles and it provides a true and fair view.
1.5.3 Comparability
Comparability refers to the quality of the information that enables users to make
comparison in evaluating similarities or differences between companies,
industries or over time. This characteristic is important as comparable
information is more useful.
Consider this example. You are only given this information on Syarikat Along;
Syarikat Along made RM10 million profit last year. Is this information enough
for you to decide whether you want to invest in the company or not? Will your
decision change if you had known that the company has made RM20 million in
the previous year? Comparing the companyÊs performance over two periods can
lead to a better decision as you can see that there has been a 50% drop in profit.
It is a requirement that a company must provide the previous yearÊs information

to enable comparison to be made by users.
1.5.4 Consistency
For information to be comparable across industries or over time, information
needs to be consistent from one company to another and also over time.
Consistency refers to the requirement that companies are required to maintain
consistency in the treatment of various items for all accounting periods. In other
words, companies should not change the accounting procedures or methods
used each year.
An example is methods for depreciating non-current assets. There are several

acceptable methods to recognise depreciation expense; among them are the
straight line method and the reducing balance method. If a company had used

straight line methods in one period, they ought to use the same method in the
next accounting period.
For your information, a company may change accounting methods they use.
However, a full disclosure is required in the notes to financial statements to explain
why the changes are made and the effects of the changes to the financial statements.
1.5.5 Materiality
Materiality is another important concept which states that an entity must account
for items that are significant to the entityÊs financial statements. In other words,
an amount can be ignored if the effect on the financial statements is unimportant
to usersÊ business decisions.
The materiality of an item depends on the size or value of the items according to
the main activities of the business and the nature of the items involved.
For example, a separate account for postage expenses for a grocery store is not
required to be kept, as the amount is small and not significant for the grocery
store. It is sufficient to lump this expense with other expenses under a
miscellaneous expense account. However, for a courier company, postage
expenses are material and must be disclosed separately.
1.5.6 Understandability
The understandability principle requires information to be presented in a format
that can be easily understood. The information reported should be understood
by users whom are generally assumed to have reasonable knowledge of business
and economic activities.
1.5.7 Timeliness
Relevant and reliable information will be useless if you do not get the information on
time. Hence, it is extremely important to prepare the financial statements on time.
ACTIVITY 1.3
You had just read on the six qualitative characteristics of accounting.
Based on your experience, which one quality is the most difficult to
comply? Try to justify your claim.

1.6 FINANCIAL STATEMENTS

The final output of an accounting system is the financial statements. The main
function of financial statements is to provide information of the business
financial position and financial performance to users.
This information is normally obtained from the income statement, balance sheet,
statement of changes in ownerÊs equity and cash flow statement. The information
provided will give a picture of how the resources are used by the business entity.
This module covers the steps required in the preparation of the income
statement, statement of changes in ownerÊs equity and balance sheet. You will
learn how to prepare the cash flow statement in another module.
The Malaysian accounting standard, FRS 101, provides the guides on the
presentation of financial statements.
1.6.1 The Purpose of Financial Statements

FRS 101 (para. 6) stated the purpose of financial statement as the following:
Financial statements are a structured financial representation of the financial

position of and the transactions undertaken by an enterprise. The objective of
general purpose financial statements is to provide information about the
financial position, performance and cash flows of an enterprise that is useful
to a wide range of users in making economic decisions. Financial statements
also show the results of managementÊs stewardship of the resources entrusted
to it. To meet this objective, financial statements provide information about an
enterprisesÊ:
(a) assets;
(b) liabilities;
(c) equity;
(d) income and expenses, including gains and losses; and
(e) cash flows.
Figure 1.7: FRS 101 (para. 6)

Source: MASB ă FRS 101 ă Presentation of Financial Statements

In other words, the objective of preparing financial statement is to provide useful

information with regards to the financial position, performance and cash flow of
a business to all types of users in order for them to make an economic decision.
The result of the financial statements shows how the manager of a business entity
manages resources contributed by owners.
The information provided by the financial statements together with other

information provided in the explanatory notes will be used by users to
understand and make decisions.
SELF-CHECK 1.1
Users depend not only on financial information provided by the

financial statements but also on non-financial information to make
investment decisions. Can you identify the qualitative information that
users need to make decisions?
1.6.2 The Components of Financial Statements

Financial statements of listed public company can be obtained by the public
easily. Kuala Lumpur Stock Exchange (KLSE) provides access to the annual
reports of listed companies at its website.
You may visit KLSEÊs website for further information,

http://announcements.bursamalaysia.com/linkwebmainpage.nsf/lca.htm.
Please take note that the following illustrations of financial statements are of sole
proprietorship (single ownership). There are slight differences in reporting
requirement and format for partnership and also company.
(a) Income Statement

Income statement reports the financial performance of an entity. It contains
information on revenues and expenses including the profit and loss of the
business entity. It is also known as revenue statements or profit and loss
statement.
There are several formats in reporting the revenue and expenses depending
on the nature of business run by the entity. Below is an example of income
statement for service providers. Service providers such as travel agents,
hotels and colleges earn their revenues by performing or providing services
to customers.

KAK LONG DENTAL CARE

Income Statement
for the year ended 30 June 2008
RM RM
Revenues
Dental fees 15,000
Surgery consultancy fees 4,000 19,000
less Expenses
Salaries expenses 5,000
Dental supplies expenses 2,000
Rental expenses 1,500 8,500
Net income 10,500
Figure 1.8: Income statement for a service provider
The following is an example of a merchandiser income statement.

MerchandiserÊs (or traders) revenues come from selling goods to customers.
You will learn in detail how to prepare income statement for merchandiser
in Topic 6.

KEDAI RUNCIT AZMALINA

Income Statement
RM RM
Net Sales* 30,000
less Cost of Goods Sold
Opening stock 4,000
+ Net purchases* 12,000
Cost of goods available for sale 16,000
ă Closing stock (5,000) 11,000
Gross Profit 19,000
less Operating Expenses
Advertising 1,000
Rental expenses 3,000 8,000
Net income 11,000
* Net sales = [Sales ă sales return]
Net purchases = [Purchases ă
purchase return]
Figure 1.9: Income statement for a merchandiser
(b) Balance Sheet

Balance Sheet reports the financial position of a business entity. It contains
information on the entityÊs assets, liability and ownerÊs equity.
Assets are categorised into two:

(i) Current assets are those assets that are expected to provide benefits
for twelve months or less from the reporting date. Examples are cash,
account receivables, inventories, prepaid expenses and short-term
investments.
(ii) Non current assets are those assets that will provide benefits for a
period longer than twelve months from the reporting date, which
include land and building, motor vehicles, furniture and fittings,
equipment and long term investments.

Liabilities are also categorised into two:

(i) Current liabilities are liabilities that are due within twelve months
from the reporting date. Examples are account payables and short
term loans.
(ii) Non current liabilities are expected to be settled in a period longer
than twelve months from the reporting date, such as long term bank
loan.
There are several formats of balance sheet, in ÂTÊ format or in statement

format. There are also differences in reporting the ownerÊs equity
depending on the form of business; whether it is a sole proprietorship, a
partnership or a company. However, at this level the focus will be on sole
proprietorshipÊs balance sheet.

Balance Sheet
as at 30 June 2008
Non Current Assets RM RM OwnerÊs Equity* RM RM
Premise 20,000 Opening Capital 15,000
ă accumulated + net income 11,000
depreciation (5,000) 15,000 26,000
Motor Vehicle 10,000 ă drawings (5,000)
ă accumulated Closing Capital 21,000
depreciation (2,500) 7,500
22,500
Current Assets Non Current
Liabilities
Inventory 11,000 Bank Loan 17,000
Supplies 1,000
Account 4,500 Current Liabilities
Receivables
Cash 2,500 19,000 Account Payables 3,500
41,500 41,500
* If statement of changes in ownerÊs equity is prepared, then only the closing capital is
disclosed in the balance sheet
Figure 1.10: Balance sheet - ÂTÊ Format

Balance Sheet
as at 30 June 2008
Non Current Assets RM RM RM
Premise 20,000
ă accumulated depreciation (5,000) 15,000
Motor Vehicle 10,000
ă accumulated depreciation (2,500) 7,500 22,500
Current Assets
Inventory 11,000
Supplies 1,000
Account Receivables 4,500
Cash 2,500 19,000
Total Assets 41,500
Non Current Liabilities
Bank Loan 17,000 17,000
Current Liabilities
Account Payables 3,500 3,500
Total Liabilities 20,500
Net Assets 21,000
OwnerÊs Equity*
Opening Capital 15,000
+ net income 11,000
26,000
ă drawings (5,000)
Closing Capital 21,000
* If statement of changes in ownerÊs equity is prepared, then only the closing capital is
disclosed in the balance sheet
Figure 1.11: Balance sheet ă Statement Format
There are several different formats available for preparing balance sheet.
You might read one textbook showing one format, and another textbook

showing another format. One format might show the working capital
which is current assets minus current liabilities while another lists current
assets first and then only non current assets are listed.
At first you might find that this is confusing as one format is slightly
different than the next. Do take note that whichever format is used, all
assets, liabilities and ownerÊs equity, whether they are current or non
current, will be categorised accordingly.
(c) Statement of Changes in OwnerÊs Equity

Statement of changes in ownerÊs equity reports how the ownerÊs equity has
changed over the reporting period. It reports how opening capital has
increased through net income, and how it decreased through net losses and
drawings.

Statement of Changes in OwnerÊs Equity
RM
Opening Capital 15,000
+ net income 11.000
26,000
ă drawings (5,000)
* Closing balance of capital is disclosed in the balance sheet
Figure 1.12: Statement of changes in ownerÊs equity
(d) Cash Flow Statement

Cash flow statements show the in-flow and out-flow of cash of an
organisation according to three main activities which are operating,
investing and financing. The format is shown below, however, as stated
earlier preparing cash flow statement is not part of the syllabus.


Cash Flow Statement
Cash flow from operating activities RM RM
Cash receipts from customers 25,000
Cash payment to suppliers (8,000)
Cash payment for expenses (5,000)
Net cash flow from operating activities 12,000
Cash flow from investing activities
Purchase of land and building (13,000)
Net cash flow used for investing activities (13,000)
Cash flow from financing activities
Owner investment 6,000
Drawings (3,000)
Net cash flow from financing activities 3,000
Net cash inflow 2,000
Add opening cash balance - 1 July 2007 500
Closing cash - 30 June 2008 2,500
Figure 1.13: Cash flow statement
ACTIVITY 1.4
Do you know your net worth? LetÊs calculate your net worth.
1. List all your assets. These will be items that you owned, house,
car, computer etc. Estimate how much it worth in the market. In
other words you might have spend RM5,000 to buy your
computer, but now, if you were to sell your computer, the shop is
willing to pay RM300 for it. RM300 is the value of your computer.
2. List all your liabilities. These include any loan you have
outstanding on your house, education and even credit card.
3. Determine the difference (Total Assets minus Total Liabilities).
This is your net worth or capital.
Many online resources for accounting glossary and terms are available on the
net. If you need to look up certain accounting terms, do visit:
http://www.ventureline.com/accounting-glossary/A/

Ć Luca Pacioli describes the methods used by Italian merchants to record their
business transactions in his book „Everything about Arithmetic, Geometry
and Proportion‰.
Ć Accounting can be defined as a process of collecting, identifying, measuring,

recording, summarising and communicating the results of business or
economic transactions to users in order for them to make informed or better
decisions.
Ć Accounting information is important as it helps users to make decisions.
Ć Financial accounting provides financial information for external users and

also internal users while management accounting provides financial and non-
financial information for internal users.
Ć For accounting information to be useful and valuable to decision makers, it

must be relevant, reliable, comparable and consistent. Useful information
should also be understandable, material and timely.
Ć The main function of financial statement is to provide information of the

business financial position and financial performance to users.
Ć The four main components of financial statement are as follows:

(i) Income statement;
(ii) Balance sheet;
(iii) Statement of changes in ownerÊs Equity; and
(iv) Cash flow statement.
Ć Income statement reports the financial performance of a business entity.
Ć Balance sheet reports the financial position of a business entity.
Ć Statement of changes in ownerÊs equity reports how the ownerÊs equity has
changed over the reporting period.
Ć Cash flow statements show the in-flow and out-flow of cash of an

organisation from three main activities; operating, investing and financing.

Accounting Relevance Concept

Financial Statement Reliability Concept
Materiality Principle True and Fair View
1. Define accounting and explain the four components of accounting.
2. List the qualitative characteristics of accounting information.
3. What are the items reported in the income statement?
4. For each of the following users, can you identify the type of accounting
information they require?
External Users Type of information required

Ć Lenders
Ć Suppliers
Ć Government agencies
Ć Customers
Internal Users
Ć Employees
Ć Sales Managers
Ć Production Managers
Ć Budget Officers
1. Explain the comparability concept and its role in making accounting

information useful.
2. What are the items reported in the balance sheet?
3. What are the items reported in the statement of changes in ownerÊs equity?

4. What are the items reported in the cash flow statement?
5. The followings are the accounts balances of Smart Tuition Centres as at 31

December 2008.
RM
Accounts receivable 8,855
Accounts payable 2,200
Bank Loan 15,000
Supplies 8,480
Supplies expenses 6,300
Advertising expense 4,200
General expenses 1,265
Rent expenses 14,400
Utilities expenses 7,350
Tuition fees 75,750
Computer equipments 17,800
Cash 20,000
Capital (1/1/2007) 23,700
Drawings 10,000
You are required to prepare:

(a) Income statement for Smart Tuition Centres for the year ended 31
December 2008;
(b) Statement of changes in ownerÊs equity for Smart Tuition Centres for
the year ended 31 December 2008; and
(c) Balance sheet for Smart Tuition Centres as at year ended 31
December 2008.

2 Standards,
Assumptions
and Principles
LEARNING OUTCOMES
1. Describe the main functions of the accounting bodies in Malaysia;
2. Discuss the purpose of accounting standards;
3. Explain the assumptions and principles in accounting;
4. Apply the concepts and principles in accounting; and
5. Differentiate between types of business and ownership;
 INTRODUCTION
Imagine the world without traffic law and enforcement! There will be havoc, as
people will drive as fast as they want, beat traffic lights as they please or park
their car anywhere they like. To ensure our safety on the road, we have rules and
drivers need license before they can drive. Now, can you imagine the accounting
profession without rules and regulations?
You have learned earlier that external users rely on the accounting information
produced by business to make decisions. How can users be assured that the
information presented is reliable? After all, the financial statements are prepared
by the companyÊs accountant. Knowing that to prepare financial statements, the
accounting profession have to follow certain rules and regulation increased the
reliability of information provided by the financial statement. But who regulates
the accounting profession?

24  TOPIC 2 ACCOUNTING STANDARDS, ASSUMPTIONS AND PRINCIPLES
This section begins with the introduction to the various accounting bodies in
Malaysia that govern the accounting profession. The main functions of these
bodies will be described.
We have to follow certain guidelines called accounting standards in preparing

the financial statements. You will learn why it is important to have such
standards; this article below proves the consequence of not doing so!
Accountant Held Liable for Interest Expense from Tax Error
Accounting WEB.com - 26th June 2006 - The South Dakota Supreme Court last
week upheld a Circuit Court decision allowing a jury to award damages to
Doug OÊBryan Contracting Inc. for interest expense on underpayment of taxes
that resulted from an error made by his accountant. The stateÊs high court had
not previously allowed recovery of interest expense in lawsuits against tax
advisers, the Associated Press reports.
Bruce Ashland, a certified public accountant, understated OÊBryanÊs income for

1995. The well-drilling company, located in Martin, South Dakota, incorporated
in April 1995, and Ashland used the wrong method to calculate income for the
first quarter of the year. When the error was discovered several years later,
OÊBryan owed an additional $239,933 in taxes and about $50,000 in interest.
Source: http://www.accountingweb.com/cgibin/item.cgi?id=102293&d=815
&h=0&f=0& dateformat=%o%20%B%20%Y
2.1 ACCOUNTING BODIES IN MALAYSIA

It is important that you know the accounting bodies that exist in Malaysia. The
accounting profession in Malaysia is governed by these bodies. Thus, the accounting
profession has to follow certain guidelines and rules set by the bodies.
2.1.1 Malaysian Institute of Accountants (MIA)

Established under the Accountants Act (1967), MIA is an authoritative body
regulating the accounting profession. The main functions of MIA are to:
(a) Determine the qualifications for members;

TOPIC 2 ACCOUNTING STANDARDS, ASSUMPTIONS AND PRINCIPLES  25
(b) Provide training and continuing professional education to existing and

potential practitioners; and
(c) Control the accounting practice in Malaysia.
(Source: www.mia.org.my, 17/08/06, 12.00pm)
2.1.2 The Malaysian Institute of Certified Public

Accountants (MICPA)
The Malaysian Institute of Certified Public Accountants (MICPA) was formed as
a professional body in 1958 under the Companies Act 1940ă1946. The functions
and objectives of MICPA are to:
(a) Advance the theory and practice of accountancy in all its aspects;
(b) Recruit, educate, train and assess a body of members skilled in these areas;
(c) Preserve at all times the professional independence of accountants;
(d) Maintain high standards of practice and professional conduct by all its
members; and
(e) Develop the accounting profession in relation to public practice, industry,
commerce, education and the public service.
2.1.3 Malaysian Accounting Standard Board (MASB)

Established under the Financial Reporting Act 1997 as an independent authority
to develop and issue accounting and financial reporting standards in Malaysia,
the main functions and authority of MASB are to:
(a) Issue new accounting standards [Financial Reporting Standards (FRS)] as
approved accounting standards;
(b) Review, revise or adopt existing accounting standards;
(c) Issue statements of principles for financial reporting;
(d) Sponsor or undertake development of possible accounting standards;
(e) Conduct public consultation as necessary; and
(f) Develop a conceptual framework for the purpose of evaluating proposed
accounting standards.
Source: www.masb.org.my,17/08/06, 3.00pm

2.1.4 Financial Reporting Foundation (FRF)

The Financial Reporting Foundation (FRF) is established under the Financial
Reporting Act 1997 (Act) together with MASB. The FRF comprises representation
from all relevant parties in the standard setting process, including preparers,
users, regulators and the accountancy profession.
The FRF has responsibility for the oversight of the MASB's performance, financial
and funding arrangements and as an initial source of views for the MASB on
proposed standards and pronouncements. It has no direct responsibility with
regard to standard setting.
You may visit, http://www.mia.org.my and http://www.micpa.com.my to

further enhance your understanding on the role played by these bodies. Further,
for more information on MASB and FRF, you can access
http://www.masb.org.my. If you are keen on financial reporting standards, they
can be found at http://www.masb.org.my/masbstd_appas2.htm.
2.2 ACCOUNTING STANDARDS
Accounting standards are guidelines that need to be adhered by the

accounting profession in preparing and reporting of the financial statements.
Rules and guidelines will definitely increase the work quality of accounting
professionals. How can we be assured that companies will follow the prescribed
guidelines?
The Companies Act 1965 requires companies to comply with approved

accounting standards. Section 166A of the Companies Act 1965 requires directors
of companies incorporated under the Act to ensure accounts are prepared in
accordance with the applicable accounting standards to the extent that the
accounts give a true and fair view.
In Malaysia, the approved accounting standards comprise of the followings:

(a) Financial reporting standards issued by MASB;
(b) International accounting standards issued by International Accounting
Standard Board (IASB); and
(c) Technical pronouncements published by MASB.

These accounting standards are developed from guidelines, practices, and rules
that are acceptable by the accounting profession and known as Generally
Accepted Accounting Principles (GAAP). The standards are established so that
the accounting practised is standardised and this increases the reliability and
comparability of financial statements.
2.2.1 Generally Accepted Accounting Principles (GAAP)

In preparing the financial statements, accountants have to follow certain
standards, guidelines, practices, and rules which are known as Generally
Accepted Accounting Principles (GAAP). This is to ensure that the financial
information provided to external parties to the business is prepared according to
a uniform set of assumptions and principles.
To prepare, use and interpret financial statements effectively we need to

understand these assumptions and principles. There are a number of
assumptions and principles. However, this module will only introduce selected
assumptions and principles.
GAAP, the common set of accounting principles, standards and procedures that
companies use to compile their financial statements. GAAP are a combination of
authoritative standards (set by policy boards) and simply the commonly
accepted ways of recording and reporting accounting information.
Source: http://www.investopedia.com/terms/g/gaap.asp
ACTIVITY 2.1
Eventhough GAAP principles has been in practice for a long time,

why do you think that unscrupulous accountants do still distort
figures?
2.3 ACCOUNTING ASSUMPTIONS

LetÊs now look at the four assumptions used to facilitate the preparation of
financial statements.

2.3.1 Assumption 1: Separate Entity

For accounting purposes, the business is considered as a separate entity from the
owner. Both the owner and the business are two separate accounting entities. An
accounting entity is an economic unit that controls its own resources. Activities
of each entity must be separated from its owner.
For example, Kak Long owns three different businesses: a restaurant, a

laundrette, and a grocery store. Imagine, if only one account is prepared for all
business, would she be able to identify which business is profitable or not? For
accounting purpose there are four separate accounting entities: Kak Long, the
restaurant, the laundrette and the grocery store. It means each entity will need to
keep a separate accounting record. Separation of accounts will enable the owner
to know the financial position and performance of each entity.
Figure 2.1: Separate accounting entity
It is important to note that accounting entity is not the same as legal entity.
Business that is registered as a company is recognised as a legal entity. While for
sole proprietorship and partnership the law does not differentiate the business
and its owner.

2.3.2 Assumption 2: Going Concern

An entity is assumed to be continuing its operations in the foreseeable future and
will not cease operations. This has important implication in valuing assets and
liabilities of a company.
Suppose Mak & Anak Bakery, owned a unique bread making machine costing
RM100,000. If Mak & Anak Bakery decides to close down, the machine is
worthless, as nobody else wants to use the bread making machine.
Therefore in order to report the bread making machine as asset worth

RM100,000, we have to make an assumption that Mak & Anak Bakery will
continue operating.
ACTIVITY 2.2
Syarikat Jojo has been making big profits for the past ten years of
operation. However, it will only continue to exist for the next two
years. Will you consider investing your money in Syarikat Jojo?
Justify your claim.
2.3.3 Assumption 3: Monetary Unit

All transactions can be measured in monetary units. In Malaysia the monetary
unit is Ringgit Malaysia (RM). Items that cannot be measured in monetary unit
will not be reported in the financial statements but disclosed as notes.
Transactions in foreign currency will be converted in RM for recording purposes.
2.3.4 Assumption 4: Accounting Period

This assumption states that the life of a business entity can be divided into
periodic intervals. This enables financial statements to be prepared periodically.
The accounting year of a 12 month period has been established as the normal
period for reporting. This enables the comparison of present and past
performance to be made for each accounting period.
Accounting year or fiscal year can start at any period but normally it is from 1st
January until 31st December, or it starts from 1st July and ends on 30th June the
next year.

Interim reports can be produced for a period of less than a year; monthly,
quarterly and semi-annually reports. These reports are produced to meet the
requirements of users for timely information.
2.4 BASIC ACCOUNTING PRINCIPLES
SELF-CHECK 2.1
You purchased a new Ferrari for RM500,000 to be used in your

business. The day after, a tree fell onto your new Ferrari. Once
repaired, the insurance company valued the Ferrari at RM300,000.
Can you record the value of the Ferrari at RM300,000? Why?
The four basic assumptions have resulted in the following principles:
2.4.1 Principle 1: Historical Cost

This principle states that all transactions must be recorded and accounted for
according to their historical cost, in other words, the original cost incurred at the
time of transactions as agreed by both buyer and seller.
2.4.2 Principle 2: Revenue Recognition

This principle states that revenue must be recognised when they are earned.
Earned commonly refers to the act of providing goods or services to customers.
Recognising revenue means the amount is recorded in the account.
This principle indicates that although cash has not been received, but goods have
been delivered or services have been performed, and thus revenue should be
recognised. The opposite also applies, if you have received cash in advance but
have not performed any service or provided any goods to your customer, you
cannot record the amount of cash received as revenue. In other words, revenue is
recognised when earned rather than when cash is received. This notion of
recognising revenue when it is earned and not when cash is received is called
accrual accounting. You will learn more about this in Topic 5.1.2.
The same applies to the recognition of expenses, where expenses should be

recognised when it is incurred not when cash changes hand. If you have received

the goods or services, although payments are to be made in the future, expense
must be recognised at that time.
Figure 2.2: Relationship between revenues and expenses
2.4.3 Principle 3: Matching

To determine profit for the accounting period, the revenues of that period must
be matched with the expenses for the same period. As long as the revenue is
earned and expenses are incurred during the period, it must be taken into
account.
Take note that revenues can be cash or non cash, and expenses can be cash or
non-cash as well. Hence, profit (revenues minus expenses) is not the same as
cash. You can make a large profit but might have liquidity problem; in other
words you do not have enough cash to pay your creditors.
Use the time line diagram to help you learn the matching concepts and later
the calculation of revenue and expenses.
All Revenues for Year 1
match with Year 2

Year 1
All Expenses for Year 1
Profit for Year 1 = Total Revenue in Year 1 - Total Expenses in Year 1
2.4.4 Principle 4: Full Disclosure

This principle states that all relevant and material information must be
adequately disclosed either in the financial statements or as notes accompanying
the statements.

2.5 FORMS OF BUSINESS
Relationship between Business and Accounting
Business deals with a great numbers of decision making. Decisions include

pricing of products, deciding on investment, borrowing money, hiring
employees and expanding the business. To make decisions properly, managers
need useful information. Accounting information plays an important role in
this decision-making process. Business may be classified according to the types
of activities they are involved in and by the types of ownership. Different types
of business have different reporting requirements.
2.5.1 Types of Business

Business organisation can be categorised into several types according to their
main activities.
(a) Merchandising/Retailing/Trading
The business main activities involve purchasing goods which are then sold
to customers. Examples are supermarkets, departmental stores, wholesalers
and grocery stores. These merchandisers buy various goods at a price (cost
or purchase price) and sold them to customers at a higher price (sale price).
One such example is Giant, the leader in MalaysiaÊs retail sector.
Figure 2.3: Giant, well known retailer for its cost effective goods.
You will learn in detail on the accounting for merchandiser in Topic 6.
(b) Manufacturing
Manufacturing firms convert raw materials into finished goods. Examples
are oil refinery, car manufacturing company and toy manufacturing
company. A car manufacturing company purchased tyres, windshield as
their materials (parts) and hire labours to assemble this material into
finished products (cars). The cost of all materials, labour and other expenses
used to manufacture the car is the cost of manufacturing. The finished
product is then sold at a higher price than the manufacturing cost.
One example of a local car manufacturer is PERODUA. Its subsidiary,

Perodua Manufacturing Sdn Bhd, is responsible for the manufacturing of
the Perodua vehicles and selected vehicle component parts.
You will learn the accounting for manufacturing in the management

accounting subject.
(c) Services
This business provides services to its customers. Examples are lawyers,
photocopying service, hotel, car rental and education. Lawyer provide legal
services or consultation services, they earned fees for services rendered to
customers.
Figure 2.4: Types of business organisations
ACTIVITY 2.3
Can you name specific business that you have encountered in the
following sectors?
(a) Services;
(b) Merchandising; and
(c) Manufacturing.

2.5.2 Types of Ownership of Business

Types of ownership will have an impact on the accounting practices and
procedures of an organisation. Formats and information contained in the
financial statements are slightly different. Therefore you must understand the
different characteristics among the three types of ownership. There are three
basic forms of ownership: sole proprietorship, partnership and company.
(a) Sole Proprietorship/Sole trader

As indicated by the name, the ownership belongs to any one individual.
Think of the „goreng pisang‰ seller at the corner of the street. The
formation of this type of business is relatively easy as there are only a few
legal requirements required before starting the business. For accounting
purposes, the owners are considered a separate entity from the business,
however for legal purposes the owner and the business are one entity.
The advantages of sole proprietorship are as follows:

(i) Sole proprietorship is easy to set up.
(ii) Owner has full control over the business decisions and activities.
(iii) Income of the business belongs to owner, and not shared with other
people.
(iv) Compared to other form of business organisations, it has less legal
requirement.
The disadvantages of sole proprietorship:

(i) Difficult to expand as expertise and capital might be limited.
(ii) Owner bears all the risks.
(iii) Unlimited liabilities.
(b) Partnership
This type of business is owned by two or more individuals, called partners.
Just like the sole trader the formation requires no or little legal
requirements. The „goreng pisang‰ seller might want to expand his
business to include „nasi lemak‰. As such, he might invite an expert in
making „nasi lemak‰ to become his partner. However, an agreement must
exist between partners normally on how the profit or losses should be
shared. Similar to sole trader, no distinction is made between partners and

business for legal purposes. Therefore, all partners are responsible for the
business liabilities.
The advantages of partnership are as follows:

(i) Higher sources of capital as owners are more than one.
(ii) Partners might have additional skill and expertise to strengthen the
business partnership.
(iii) Unlike companies, partnership is not required to disclose business
information to an external party.
The disadvantages of sole partnership:

(i) Unlimited liabilities
(ii) Conflicts among partners will lead to instability in the management
of business
(iii) Lack of continuity; partnership will dissolve if one partner dies, or
pulls out of the partnership, or is declared bankrupt.
(c) Company (Corporation)

Companies like Coca Cola and Maxis are owned by many people called
shareholders. Shareholders are people who own shares in the company. A
company is a separate legal entity from the owners, in other words an
„artificial person‰ that can conduct business in its own name, unlike sole
trader and partnerships.
The advantages of companies are as follows:

(i) Limited liabilities.
(ii) Easy to expand as they can issue shares and debentures to generate
funds as capital.
(iii) Continuity.
(iv) Shares can be transferred from one person to another easily.

The disadvantages of companies are as follows:

(i) Subjected to rules and regulations of the government
(ii) Ownership is separate from the management
(iii) Set up cost is high compared to other forms of business
Figure 2.5: Types of business ownership
ACTTIVITY 2.4
If you plan to open up a gift store in the Midvalley Megamall, what

form of business and type of ownership will you choose? Give your
reasons.
The following tables summarises the differences between the various types of
ownership in a business entity.

Table 2.1: Comparison of Types of Ownership in a Business Entity
Proprietorship Partnerships Company

1. Owner (s) Proprietor Partners Shareholders
2. Life of Limited Limited Indefinite
organisation
3. Liabilities Unlimited Unlimited Limited
4. Accounting Business is Business is Business is separate
status separate from the separate from the from the shareholders
proprietor. partners
5. Legal status None None A separate legal entity
6. Formation Relatively easy Relatively easy Complex
7. Management Normally by the Normally by the Managers/Directors
owner partners
8. Tax Proprietor pays Each partner pays Companies pay tax on
tax on business tax on his share of the business profit and
profit the profits shareholders pay tax
on the amount of
dividend they receive.
(Double Taxation)
Ć The accounting profession has to follow standards, rules and guidelines

known as the generally accepted accounting principles to ensure uniformity
in preparing and reporting the accounting information.
Ć The standards are established so that the accounting practised is standardised

and comparability of financial statements is increased.
Ć There are four assumptions used to facilitate the preparation of financial

statements.
(i) Separate entity assumption;
(ii) Going concern assumption;
(iii) Monetary unit assumption; and
(iv) Time period assumption.

Ć The basic principles in accounting are:

(i) Historical cost principles;
(ii) Revenue recognition principles;
(iii) Matching principles; and
(iv) Full disclosure principles.
Ć Business can be divided into three main categories: merchandising

(retailing/trading), manufacturing and services.
Ć Business organisation can be formed as sole proprietorship (sole trader),

partnerships and companies.
Accounting Entity Assumption Historical cost accounting

Generally Accepted Accounting Matching concept
Principles (GAAP)
Revenue recognition
Going concern concept
1. Match the following accounting bodies with the main function listed below.
MIA MICPA MASB
(a) ________________ publishes accounting standards.

(b) ________________ provides training to accountants.
(c) ________________ controls the accounting practice in Malaysia.
(d) ________________ issues statements of principles for financial
reporting.
2. Can a company ignore the accounting standards in the preparation and

reporting of its financial statements?

3. Malaysian Airline (MAS) revenues come from a number of different

sources: ticket sales, holiday packages, rentals of planes and advertisings.
Take for example, ticket sales; normal tickets sold are fully refundable until
24 hours of flight cancellation. However, tickets sold on super saver plan
are not refundable. At what point of time will MAS recognise the revenue
from these situations?
4. Classify the following businesses according to their type of business.
Business Type of Business

Ć Car Rental
Ć Car Dealership
Ć Tuition Centres
Ć Batik Factory
Ć Tailor
Ć Clothing Stores
1. Explain the following accounting assumptions:

(a) Separate entity;
(b) Going concern;
(c) Monetary units; and
(d) Accounting Period.
2. Explain the following accounting principles:

(a) Historical Cost;
(b) Revenue Recognition;
(c) Matching; and
(d) Full disclosure.
3. Identify three types of business ownership.
4. Explain the characteristics of each of the business ownership identified in 3

above.

3 Equation
LEARNING OUTCOMES
1. Identify the steps involved in the accounting cycle;
2. Explain the basic accounting equation;
3. Analyse transactions; and
4. Demonstrate the effect of transactions on an accounting equation
 INTRODUCTION
By now, you should be wondering how to prepare the financial statements
discussed earlier. Can you recall the definition of accounting or recall the four
components of accounting process? You need to be able to collect, identify,
measure and record before communicating the information to users in the form
of financial statements. This process describes the accounting cycle of a business.
In this topic, we will begin by introducing the accounting cycle to you. These are
the steps that will be repeated at every accounting period. We will then look at
the accounting equation, which is Assets equal Liabilities plus OwnerÊs Equity.
This equation will always remain in balance at all times. This is the basis of all
accounting as every transaction will have certain effects on the accounting
equations.
MYOB (Mind Your Own Business) is one of the many computer-based

accounting systems available in Malaysia. Many companies rely on an
accounting system to generate reports. An accounting package is an integral part
of a business in completing an accounting cycle, as highlighted by a chartered
accountant.

TOPIC 3 ACCOUNTING CYCLE  41
„Having the right accounting system is essential for any business. It can save
time and money. Having the wrong one, however, can cost you hours in
inefficiencies and eat into your profits‰.
Tanya Parkyn
Chartered Accountant and the Director of Innovative Accounting Systems Pty.
Ltd
3.1 THE ACCOUNTING CYCLE

The accounting process begins with a transaction and ends with closing the
books at the end of a period. These steps are repeated at every accounting period
and are called the accounting cycle. It begins with the occurrence of the
transaction itself, analysing and recording the transactions in journals, posting it
to the ledgers and then preparing trial balance. At the end of the period,
adjusting entries are made, adjusted trial balance and financial statements are
prepared and then closing entries is done to prepare the temporary accounts for
the next periodÊs accounting cycle.
Figure 3.1: The accounting cycle
In this section, we will begin by looking at all of the steps in the accounting cycle
briefly.
3.1.1 Source Documents

At this stage information is gathered, generally in the form of source documents,
about transactions or events. Source documents are documents that provide
proof that a transaction had actually occurred, and this is the basis of accounting

42  TOPIC 3 ACCOUNTING CYCLE
records. Examples of source document are sales invoice, purchase invoice, debit
note, credit notes, cheque and receipts. Controls on source document are
important to ensure accounting information is accurate and reliable.
At a minimum, each source document should include the data, the amount and a
description of the transaction. During an audit, source documents are used as
evidence that a particular business transaction occurred.
ACTIVITY 3.1
Look at a sample of sales or purchase invoice. Can you list down the
information is documented in this source document?
3.1.2 Transactions Analysis

Transactions are analysed; how each transaction affects the accounting equation
is looked into. At this stage the accounts affected by the transaction and how it is
affected (increased or decreased) will be identified.
3.1.3 Journalising
These transactions are then recorded in journals. A journal is also known as the
book of prime entry. It is a chronological record of transactions. Journal entries
will facilitate the posting of transactions to ledgers.
3.1.4 Posting
Records from the journal are then posted (transferred) to ledgers. Posting should
be done on timely basis, to ensure ledger is up to date.
3.1.5 Preparation of Unadjusted Trial Balance

At end of accounting period, the balance of all accounts of a business will be
listed in the trial balance.

3.1.6 Adjusting Entries

At the end of an accounting period, adjusting entries are prepared to assign
revenues and expenses to the periods they are earned and incurred.
3.1.7 Preparation of Adjusted Trial Balance

Listing of all businessÊ accounts balances after adjustment entries are made.
3.1.8 Preparation of Financial Statements

The result of the business is communicated to users through financial statements.
Can you recall the financial statements that you have learned in Topic 1.6 earlier?
Income statement is prepared in order to report the financial performance of the
business. Balance sheet is prepared to report the financial position of the
business.
3.1.9 Closing Entries

At the end of an accounting period, all temporary accounts are closed. Revenues
and expenses are closed to income summary. Profit or loss is then transferred to
capital account. Drawings are also closed to capital account too.
The above mentioned stages are depicted in Figure 3.2 for quick reference.

Figure 3.2: The stages involved in preparing the financial statement

Adapted from: Horngren (2004)
You will learn in detail all the steps of the accounting cycle. However, let us first,
look at the accounting equation. This is the most basic concept of the double
entry book keeping.

3.2 ACCOUNTING EQUATION

Before we look at the accounting equation, you need to understand that all
economic events can be classified into three categories which are assets, liabilities
and ownerÊs equity.
Assets are resources that are owned by the entity. Land, properties, equipment,
motor vehicle, cash, receivables (debtors) are examples of assets. These assets are
expected to provide future economic benefits to the entity.
Liabilities are debts or obligation of the entity. Loans, bank overdrafts and
payables (creditors) are examples of liabilities. The liabilities are expected to be
cleared off by sacrificing the entityÊs assets.
OwnerÊs equity is the residual claim (rights) of entity assets. LetÊs say you
purchase a car using your own money and the car belongs to you. You can do
whatever you want with the car, even selling it. However, if you take a loan to
purchase a car, although you have the right to use the car, the ownership is not
yours, and the car is not yours until you pay off your loan. If you sell the car, the
loan amount will be deducted (settled) and the difference (the residual) will be
refunded to you.
To illustrate, let us look at this situation. You have decided to start a new
business. You only have RM5,000. So you asked your friend to lend you
another RM5,000. The business now has an asset (cash) of RM10,000 whereby
only RM5,000 belongs to you, and another RM5,000 belongs to your friend.
If you were to stop your business immediately, the business asset (cash) of
RM10,000 is not yours alone; you have to pay off your borrowings, and only
the balance belongs to you (residual claim).

The accounting equation is the fundamental of accounting. The equation presents

the resources of a business and the claim against those resources.
Can you see the relationship between the assets of the business with liabilities of
the business and the ownerÊs equity interest? The relationships are presented in
the following basic accounting equation.
Figure 3.3: The basic accounting equation
All economic transactions in an entity will affect the equation, meaning they will
affect assets, liabilities or ownerÊs equity.
Although the items in the equations are affected (increased or decreased), the
equation will remain in balance at all times.
The basic accounting equations can be expanded to include items of ownerÊs

equity.
There are four items that can affect the ownerÊs equity, and they are:
Ć Capital investments: they will increase ownersÊ equity.
Ć Drawings: they will decrease ownersÊ equity
Ć Revenues: they will increase the ownersÊ equity.
Ć Expenses: they will decrease the ownersÊ equity.

Figure 3.4: Transactions effect on ownerÊs equity
Hence the equations can be rewritten as:
Figure 3.5: The expanded accounting equation
The next section will look at the second step in the accounting cycle, analysing
transaction to determine how it affects the accounting equation.
ACTIVITY 3.2
You have a personal wealth of RM100,000, comprising of RM10,000 cash
and a car worth RM90,000. You had borrowed RM40,000 from your
parents to purchase the car. Can you write your accounting equation?

3.3 TRANSACTION ANALYSIS

It is important for you to remember that the accounting equation must be in
equilibrium at all times. Business transactions must be analysed to see their
effects on the components of the equation.
The following are the steps that you can use to help you analyse business
transactions.
STEP 1: Read and think about the transaction

STEP 2: Identify components in the equations that are affected. Is it
Asset, Liability or OwnerÊs Equity?
STEP 3: Identify the accounts and the effects. Decreased? Increased?
STEP 4: Check the equation; it has to be balanced.
It is important for you to understand this analysis as it is the basis for preparing
journal entries for all transactions. Spend more time learning this section before
proceeding to another level.
We will see in detail how transaction analysis works by looking into the
following transactions of a service based business.
Table 3.1: Transactions of a Company
Date Transactions
1st Sept. 2008 Sonic invested RM50,000 cash to start a photography business.
3rd Sept. 2008 Sonic purchased a photo processing machine costing RM1,000 cash.
5th Sept. 2008 Sonic withdrew RM10,000 cash for personal use.
6th Sept. 2008 Sonic borrowed RM20,000 cash from Digi Bank.
25th Sept. 2008 Sonic paid off RM5,000 of the bank loan.
26th Sept. 2008 Sonic provided professional photography service for a wedding;
RM2,000 cash was received and another RM1,000 will be received
within 14 days.
28th Sept. 2008 Sonic paid RM500 cash for his employeeÊs salary, RM300 cash for
utilities and RM200 cash for shop rental.

3.3.1 Transaction 1: Initial Investment by Owner

Owner can contribute cash or other assets to the business as capital. For example
owner can bring his own motor vehicle into the business and this will be
considered as capital contribution by owner to the business. Capital
contributions by owner will increase both the business assets and ownerÊs equity.
1st Sept 2008, Sonic invested RM50,000 cash to start a

Transaction photography business Sonic Enterprise.
The asset (cash) has increased by RM50,000.

Basic
Analysis The ownerÊs equity (capital) has increased by RM50,000.
Assets = Liabilities + OwnerÊs Equity

Accounting
Equation  Cash RM50,000  Capital RM50,000

Accounting
Equation after
Transaction 1
The equation remains in balance.
Figure 3.6: Transaction 1
3.3.2 Transaction 2: Purchase of Non Current Asset

To operate, most business must have non current assets (fixed assets) that will be
used to generate revenues. For example, a delivery van is needed to deliver
goods; a machine to produce products and so on. The purchase of such items can
either be on cash term or credit term. Paying cash for your purchase of non
current asset will see your cash asset decreases and your non current asset
increases. Purchasing non current assets on credit will see your non current
assets increased and your liabilities increased.

Transaction 3rd Sept. 2008, Sonic purchased a photo processing machine

costing RM1,000 cash.
The asset (cash) has decreased by RM1,000.

Basic
Analysis The asset (equipment) has increased by RM1,000.

Accounting
Equation  Cash RM 1,000  Equipments 1,000

Accounting
Equation after Cash + Equipment Capital
Transactions 1 49,000 1,000 50,000
&2
Figure 3.7: Transaction 1 to 2
3.3.3 Transaction 3: Withdrawals by Owners

It is normal for owner to take the business cash and use it for their personal
purpose. Business and owners assets are two separate things and need to be
accounted as so. If business cash are used for personal (owner) purposes, it is
considered as drawings by the owner. Drawings will reduce the ownerÊs equity
(capital) and asset (cash). It should be noted too, that any consumption of
business assets such as office supplies or stationeries for personal usages must be
recorded as drawings too.

5th Sept. 2008, Sonic withdrew RM10,000 cash for personal

Transaction
use.

Basic The ownerÊs equity (capital*) has decreased by RM10,000.
Analysis

Accounting
Equation  Cash 10,000  Capital * 10,000

Accounting
Equation after
Transactions 1,
2&3
Note: * Withdrawals by owners are not recorded in the capital account directly but will
be recorded in an account called drawings. Drawings represent a reduction in
ownerÊs equity.
3.3.4 Transaction 4: Borrowing Money

To finance business operations such as buying non current assets, office supplies,
paying employees sometimes the cash capital from owner is not enough.
Business can borrow money from another company, a person or a financial
institution to increase its available funds. This borrowing represents an
obligation to business to pay the principle amount plus interest charges.
Borrowing increases both assets (cash) and liabilities of a business.

6th Sept, Sonic borrowed RM20,000 cash from Digi Bank.

Transaction
(In this example we will ignore the interest charges)
The asset (cash) has increased by RM20,000.

Basic The liability (loan) has increased by RM20,000.
Analysis

Accounting
 Cash 20,000  Loan 20,000
Equation

Accounting
Equation after
Transactions 1, =
2, 3 & 4
The equation remains in balance
3.3.5 Transaction 5: Repayment of Borrowings

Borrowings must be paid off. Repayment methods and amount varies according
to the loan agreement. For example borrower might pay only monthly interest
charges over the period of the loan and the whole principle at the end of loan
term or borrower might pay equal monthly sum which includes interest and
principle amount over the period of the loan. Repayment of borrowing will
reduce both assets (cash) and liabilities of the business.
Transaction 25th Sept. 2008, Sonic paid off RM5,000 of the bank loan.
Basic The asset (cash) has decreased by RM5,000.

Analysis The liability (loan) has decreased by RM5,000.


Accounting
 Cash 5,000  Loan 5,000
Equation
Accounting Assets = Liabilities +OwnerÊs Equity

Equation after Cash + Equipment Loan Capital
Transactions 1, 54,000 1,000 15,000 40,000
2, 3, 4 & 5
3.3.6 Transaction 6: Earning Revenues

The main objective of business is to make profit. In order to make profit, business
must earn revenues. Revenues can be in many forms, a service provider provides
services to customers, a merchandiser sells goods to customer and a
manufacturer sells manufactured goods to a wholesaler. A business can earn
sales commission revenues, interest revenues from cash deposits in bank or event
rental revenues for renting out office space to clients.
Most of the time, customer will pay cash for service rendered or goods delivered
to them, but some will pay later (credit term). Regardless whether cash has been
received or not, as long as you have earned the revenue it should be recorded as
such. Revenues will increase assets (cash or receivables) and ownerÊs equity.
Transaction 26th Sept. 2008, Sonic provided professional photography

service for a wedding, RM2,000 cash was received and
another RM1,000 will be received within 14 days.
Basic The asset (cash) has increased by RM2,000.

Analysis The asset (account receivable) has increased RM1,000.
The ownerÊs equity (photography fees) has increased by
RM3,000.

Accounting Assets = Liabilities + OwnerÊs Equity

Equation  Cash 2,000  OE through
 Account Receivable 1,000 photography fees 3,000
Accounting Assets = Liabilities + OwnerÊs Equity

Equation after Cash + AR Loan Capital
Transactions 1, 56,000 1,000 15,000 43,000
2, 3, 4, 5 & 6
+
Equipment
1,000
3.3.7 Transaction 7: Paying for Expenses

In generating sales, business will incur expenses. Examples of such expenses are
paying for shop rentals, wages and salary, utilities, insurance, advertising, office
supplies, motor vehicle maintenance, repairs and many more. You might pay the
expenses with cash as they incurred or you pay it later. Nonetheless, expenses
will reduce your assets (cash) if pay by cash, or increase your liabilities (if no cash
is paid) and reduce ownerÊs equity.
28th Sept 2008, Sonic paid RM500 cash for his employeeÊs
Transaction
salary, RM300 cash for utilities and RM200 cash for shop
rental.


Basic
Analysis The owner equity (expense ) has decreased by RM1,000.

Accounting
Equation  Cash 1,000  OE by 1,000
through  in expenses

Accounting
Equation after Cash 55,000 Loan Capital
Transactions 1, + 15,000 42,000
2, 3, 4, 5, 6 & 7
Equipments 1,000
+
AR 1,000
There are many transactions other than the examples given above. All will have
an effect on the accounting equation. However, the accounting equation will
always remain balanced at all time.

SELF-CHECK 2.1
Can you give examples of a business transaction that will have the
following effects to accounting equation?
1. Increase in an Asset and increase in a Liability.
2. Increase in an Asset and decrease in another Asset.
3. Decrease in an Asset and increase in a Liability.
4. Increase in an Asset and increase in OwnerÊs equity.
5. Decrease in an Asset and decrease in OwnerÊs equity.
Summaries of how each of the above transaction affects the accounting equation
are given in the following table. Go through this again to check your
understanding.
Table 3.2: Transaction Analysis

Date ASSETS OwnerÊs
= LIABILITIES +
(Sept. Equity
2008) Account
Cash + + Equipment = Loan + Capital
Receivables
1st 50,000 = 50,000
Balance 50,000 = 50,000
3rd (1,000) + 1,000 =
Balance 49,000 + 1,000 = 50,000
(10,000)
5th (10,000) =
Drawings
Balance 39,000 + 1,000 = 40,000
6th 20,000 = 20,000
Balance 59,000 + 1,000 = 20,000 + 40,000
25th (5,000) = (5,000)
Balance 54,000 + 1,000 = 15,000 + 40,000
26th 3,000
2,000 1,000 =
Revenues
Balance 56,000 + 1,000 1,000 = 15,000 + 43,000
(500)
salaries
(300)
28th (1,000) =
utilities
(200)
rentals
Balance 55,000 + 1,000 + 1,000 = 15,000 + 42,000

Ć The accounting cycle begins with the occurrence of the transaction itself,
analysing and recording the transactions in journals, posting them to ledgers
and then preparing a trial balance. At end of the period, adjusting entries are
made, adjusted trial balance and financial statements are prepared and then
closing entries are done to prepare the temporary accounts for the next
periodÊs accounting cycles.
Ć Basic accounting equation is Assets equal Liabilities plus OwnerÊs Equity.
Ć There are four items that can affect the ownersÊ equity, they are:
(i) Capital investments; they will increase ownerÊs equity.
(ii) Drawings; they will decrease ownerÊs equity
(iii) Revenues; they will increase the ownerÊs equity.
(iv) Expenses; they will decrease the ownerÊs equity.
Ć The expanded accounting equation can be written as Assets equal Liability

plus OwnerÊs Equity plus Revenues minus Expenses and minus Drawings.
Ć All transactions will have an effect on the accounting equation; however, the
accounting equation will remain in equilibrium at all times.
Ć Transactions are analysed to see the accounts affected and the effects they
have on the accounting equation.
Accounting Equation Liability

Asset

1. Calculate the missing figures.
Assets Liabilities Owner's Equity

Business A 79,500 45,000 ?
Business B ? 23,000 45,600
Business C 163,700 ? 104,500
2. (a) Indicate whether the following items are A (Assets), L (Liabilities), R

(Revenues) or E (Expenses)
(i) Cash (viii) Accounts Payable
(ii) Bank Loan (ix) Accounts Receivable
(iii) Equipment (x) Sales
(iv) Notes Payable (xi) Supplies
(v) Insurance (xii) Advertising
(vi) Salaries (xiii) Salaries Payable
(vii) Furniture and Fittings (xiv) Motor Vehicle
(b) Explain how the following transactions will affect the accounting
equation. Identify the account affected.
(i) Pay cash for postage.
(ii) Buy furniture and fittings on credit.
(iii) Bring own motor vehicle to be used for business purposes.
(iv) Pay salaries to workers.
(v) Receive rentals from tenants.
1. (a) Based on the following transaction analysis worksheet of Azwan

Enterprise, describe the nature of each transaction (1 - 9). Azwan
Enterprise provides printing services to its clients.

Date Cash Account Supplies Land Account Bank Capital

Receivables payable Loan
Opening 7,500 3,800 400 38,000 3,700 10,000 36,000
Balance
1/1/2003
Trans 1 -1,000 1,000
Trans 2 2,000 -2,000
Trans 3 -4,000 -4,000
Trans 4 -1,000 -1,000
(Rent)
Trans 5 2,000 -2,000
(Wages)
Trans 6 7,000 7,000
(Revenue)
Trans 7 1,500 1,500
Trans 8 3,500 3,500
(Revenue)
Trans 9 -1,200 -1,200
Cash Account Supplies Land Account Bank Capital
Receivables payable Loan
Ending
Balance,
31/1/2003
(b) Determine the balance of each account in the worksheet.

(c) Show the accounting equation for Azwan Enterprise.
(d) Based on information provided in the transaction analysis worksheet
above, calculate Azwan EnterpriseÊs income.
2. Che Wan opens a beauty salon on 1 February 2008. During the first month
of operation the following transactions occurred:
February 1 Che Wan invested RM150,000 of her own cash in the business
and borrowed RM100,000 from a bank
2 She paid cash for furniture and fittings for the shop costing
RM25,000.
5 Purchased on credit beauty supplies worth RM4,000.
7 Performed makeup service for a wedding and billed the
customer for RM5,000.
10 Che Wan withdrew RM20,000 and invested it in a restaurant
business.

12 Che Wan renovated her apartment, paying RM10,000 from

her own funds.
15 Provided beauty consultation for a client and received
RM3,000 cash for her service.
16 Purchase a second hand car for business use. She paid
RM5,000 cash and borrowed another RM15,000 from a bank.
17 Received RM3,000 cash as partial payment for service
rendered on 7th February.
25 Paid the full amount owed for beauty products purchased on
5th February.
27 Purchased beauty supplies worth RM5,000 for cash.
28 Paid the following expenses for cash:
Electricity ă RM100
Rental ă RM1,500
Workers Salaries ă RM2,000
You are required to:

(a) Analyse the effects (increase , decrease ) the above transactions have
on accounting equations and identify the specific accounts affected;
and
(b) Analyse the effects of the above transactions to the accounting
equations, by using the format similar to Table 3.1.

Topic  Recording
4 Transactions
LEARNING OUTCOMES
1. Describe accounts and their formats;
2. Apply the rules of debit and credit;
3. Describe journals and their formats;
4. Record transactions in the journal;
5. Post transactions from the journal to the ledger; and
6. Prepare trial balance, income statement, statement of changes in
ownerÊs equity and balance sheet.
 INTRODUCTION
Have you heard of the word Âbook keepingÊ? Book keeping is the process of
recording the business transactions in a business book (accounts). Book keeping
and accounting are two different things but they are so much related. Book
keeping is a part of accounting process. The person responsible for recording is
called the book keeper while it is the accountant who will summarise and
interpret the information recorded by the book keeper.
The process of journalising and posting (book keeping) is done by the book
keeper manually although now it is common for bigger companies to have this
book keeping process automated. In previous topics, you have learned how to
analyse transactions. The increase and decrease in the items are recorded in the
accounts. In this topic, you will learn what is meant by account and the various
formats available.
Next, you will learn about the debit and credit rule. Debit and credit are
accounting language that you need to master in order to be fluent in the language
of business. The third and fourth steps of the accounting cycles, posting and
62  TOPIC 4 RECORDING TRANSACTIONS
journalising will be discussed in detail using the examples from the previous
topic.
Posting to ledger is crucial in preparing all other account statements. Thus, to

avoid a scenario like below, you have to make sure that all transactions are
captured properly in their respective accounts.
4.1 ACCOUNT
In the previous section we saw how transactions will affect the accounting
information. As a result of these economic transactions, you can see that items in
the accounting equation increase or decrease over time. Imagine a business with
hundreds if not thousands of economic transactions. Using the accounting
equation to keep track of these changes (increase/decrease) will be time
consuming, troublesome and confusing. To overcome these problems,
accounting systems were developed.
Account is used to record the increase and decrease of the specific items in the
accounting equation.

TOPIC 4 RECORDING TRANSACTIONS  63
A business will have a number of accounts for each item of assets, liabilities,
ownerÊs equity, revenues and expenses.
A complete set of accounts for a business is called a ledger.
4.1.1 Chart of Accounts

Chart of accounts is a listing of all accounts used in the accounting systems of a
business entity. Each account will have its own identification number unique to
its categories. Smaller company might use two or three digits code, while a
bigger company will use more digits to code their accounts.
Assets, Liabilities and Revenues and Expenses Accounts

OwnerÊs Equity accounts
1 Assets 4 Revenues
101 Cash 401 Consultation fees
102 Beauty supplies 402 Rental revenues
103 Account receivables 403 Interest revenues
104 Prepaid insurance
105 Land and buildings
106 Motor vehicles
2 Liabilities 5 Expenses
201 Account payables 501 Supplies expenses
202 Bank loan 502 Salaries expenses
203 Unearned revenues 503 Utilities expenses
504 Rental expenses
3 OwnerÊs equity
301 Capital ă Che Wan
302 Drawings
Figure 4.1: Partial list of chart of accounts for Che Wan Beauty Salon

ACTIVITY 4.1
Think of a business of a different nature, maybe a workshop. Try to come

up with the possible chart of accounts for that business.
4.1.2 Format of Account

The basic account used to record transaction is called the ÂTÊ account because it
takes the form of the capital letter „T‰. The following is the format of a basic ÂTÊ
account:
Figure 4.2: Basic ÂTÊ account
The increase and decrease of the specific items will be recorded in the debit or
credit side of the account.
A debit to an account does not mean an increase to the account or a credit to an

account does not mean a reduction.
Type of accounts determines whether the effect is an increase or a decrease. You

will learn the debit and credit rule soon.
Other format of accounts or detailed ÂTÊ account is shown in Figure 4.2 and 4.3.
Debit Account Title Credit
Date Description Ref. Amount Date Description Ref. Amount
Figure 4.3: Detailed ÂTÊ account

Both basic and detailed accounts require balancing in order to determine the
balance of the account. Balancing is the process of footing (totalling) all amounts
recorded on the debit side and credit side. The difference is the balance. An
account which has a higher debit total is said to have a debit balance, and an
account which has a higher credit total is said to have a credit balance.
Now it is common to use three-column format account, as the balance can be

determined after each transaction.
Account Title
Date Description Ref. Debit Credit Balance
Figure 4.4: Three-column format account
4.1.3 Rules of Debit and Credit

Remember the transaction analysis that we covered earlier? All economic
transactions will have an effect on the accounting equation, but the accounting
equation will remain balanced at all time. This is the basis of double entry book
keeping.
Double entry book keeping system records every transaction into at least two
separate accounts. In other words, every transaction will involved a debit and a
credit entry, and the debit amount must be equal to the credit amount.
Now let us look at these rules of debit and credit. First, you need to familiarise
yourself with the terms debit and credit.
A debit entry to an account means an amount is entered on the debit (left) side
of an account. While a credit entry to an account means an amount is entered on
the credit (right) side of an account. Dr. and Cr. are the abbreviations used to
represent debit and credit.
The normal balance of an asset account is debit. While a liability account

normally shows a credit balance. OwnerÊs equity account is affected by ownerÊs
investments, revenues, expenses and drawings. Capital accounts that reflect
ownerÊs investment and revenue accounts normally show credit balances.

Expenses and drawings accounts on the other hand normally show debit
balances.
The rules of debit and credit for items in the financial statements are provided in
Table 4.1.
Table 4.1: Rules of Debit and Credit and Normal Balance
TYPES OF NORMAL
INCREASED DECREASED
ACCOUNTS BALANCE
Assets Debit Credit Debit
Liabilities Credit Debit Credit
OwnerÊs equity Credit Debit Credit
Drawings Debit Credit Debit
Revenues Credit Debit Credit
Expenses Debit Credit Debit
Do you notice that the normal balance for each type of account is the same as the
increased entry for them? You need to understand these rules fully in order to
prepare journal entries and post the journal entries to ledger.
To help you memorise the rules of debit and credit, you might want to see the
following diagram that shows the relationship between the accounting equation
and the debit and credit rules.
Figure 4.5: Accounting equation and debit & credit rules

SELF-CHECK 4.1
Consider a cash purchase of supplies. What is the double-entry for this
transaction? We know the cash at bank decreases, what is increased?
What will be the effect if the purchase was made on credit? Try to figure
it out to grasp the concept of double-entry system.
4.2 JOURNALS
Journal is the book of original entry for all economic transactions. Recording
transaction in a journal according to chronological order is the first step of the
recording process before posting (transferring) to ledgers. Journal can be
categorised into two types: general journal and special journal.
4.2.1 General Journal

A general journal is a common journal used in a business entity. It can be used to
record all types of transactions, sales, purchase, cash receipts and cash payments.
Throughout this module all reference to journal entries will be in the form of
general journal.
The format of general journal is shown at Figure 4.6.
Figure 4.6: General journal format

4.2.2 Special Journal

A business entity will have many repetitive transactions involving cash receipts,
cash payments, credit sales and credit purchases. Special journal is designed to
record one specific type of transactions. This will reduce the time and pages of
general journal used to record transactions.
The most common special journals are as follows:
Special Journal To record

(i) Cash receipt journal All receipts of cash including cash sales
(ii) Cash payment journal All payments of cash including cash purchases
(iii) Purchase journal All credit payments
(iv) Sales journal All credit sales
Figure 4.7: General journal format
In order to avoid confusion, before you look at the following example of special
journal you might want to look at how transactions are recorded using general
journal format first (See Section 4.3).
(a) Cash Receipt Journal

The following cash transactions took place in May 2007 for Syarikat Ravin.
Date Transactions
1-May Ravin received cash borrowed from Digi Bank for RM14,000.
4-May Cash sales of RM5,000.
15-May Received from debtor, Asmahan, RM2,000 for payment of his debt.
15-May Cash sales of RM4,000.
17-May Received from debtor, Chia, RM1,450 for payment of his debts.

The transactions will be recorded in a cash receipt journal as follows:
Cash Receipt Journal

Dr Cr
Accounts Dr Sales Cr Cr Other
Date description Ref Cash Discount Debtors Sales Accounts
1-May Loan - Digi Bank 14,000 14,000
4-May Sales 5,000 5,000
15-May A/R - Asmahan 2,000 2,000
15-May Sales 4,000 4,000
17-May A/R - Chia 1,450 1,450
26,450 3,450 9,000 14,000
(b) Cash Payment Journal

The following cash transactions took place in May 2007 for Syarikat Ravin.
Date Transactions
2-May Ravin purchased motor vehicle for RM25,000 cash.
3-May Purchased office supplies of RM300 cash.
5-May Purchased goods for resale of RM3,300 cash.
7-May Paid Adam, a creditor, RM5,500.
The transactions will be recorded in a cash payment journal as the

following:
Cash Payment Journal

Dr Dr
Accounts Cr Purchase Dr Dr Other
Date description Ref Cash Discount Creditors Purchase Accounts
2-May Motor Vehicle 25,000 25,000
3-May Office Supplies 300 300
5-May Purchase 3,300 3,300
7-May A/P - Adam 5,500 5,500
34,100 5,500 3,300 25,300

(c) Purchase Journal

All credit purchase of goods for resale will be recorded in the purchase
journal. The accounts description column will list the individual creditors
(accounts payable) account name.
Purchase Journal
Cr
Accounts
Date Accounts description Ref Payable
2-Jun A/P - Supplier Tatt Mann 5,600

7-Jun A/P - Kedai L. K. Hong 1,300
8-Jun A/P - Kedai Chu Gain 250

15-Jun A/P - Supplier Tatt Mann 5,500
12,650
(d) Sales Journal

All credit sales will be recorded in the sales journal. The accounts
description column will list the individual debtors (accounts receivable)
account name.
Sales Journal
Dr
Accounts
Date Accounts description Ref Receivable
5-Jul A/R - Kedai Wafy Ehsan 2,500
7-Jul A/R - Makro Iman Enterprise 1,400
7-Jul A/R - Super Ariff Store 2,500
15-Jul A/R - Makro Iman Enterprise 2,300
8,700
In addition to the above special journal, general journal will also be used to
record other transactions. Transactions that are not recorded in the special
journal will be recorded in the general journal. An example of such a transaction
is purchasing a fixed asset machinery on credit from Heavy Machine Company
for RM15,000. The transaction cannot be recorded in cash payment journal as no
cash is involved, and it cannot be recorded in the purchase journal as only credit
purchases of goods for resale are recorded in it.

General Journal
Accounts and
Date Ref. Debit Credit
Description
Machinery 15,000
A/P - Heavy Machine Company 15,000
Purchased machinery on credit from Heavy Machine Company.
In text book and examination, it is common that above journal entries are cited as
follows:
Dr Machinery 15,000
Cr Heavy Machine Company 15,000
Purchase machinery on credit term from Heavy Machine Company
ÂDrÊ is the abbreviation of Debit, comes from Latin word ÂdebereÊ for ÂleftÊ, and
ÂCr‰ stands for credit, comes from Latin word ÂcredereÊ for ÂrightÊ.
When you analyse a transaction, find out the effects (if any) on cash before any
other accounts. Did Cash at Bank increase or decrease? It is easier to identify the
effect of a transaction on cash compared to other accounts.
4.3 JOURNALISING AND POSTING
Figure 4.8: Steps in recording transactions
ACTIVITY 4.2
Using Open University Malaysia (OUM) as an example. Can you list the
business transactions that (OUM) would have?

Steps in analysing and journalising business transactions.

Step 1 ă Determine the type of account(s) the transaction affects. Whether they
are assets, liabilities, capital, revenues or expenses in nature.
Step 2 ă Determine if the transactions has increased or decreased the accounts
balances.
Step 3 ă Apply the debit and credit rule that you have learned in section 4.1.3
After transactions are analysed, they will be recorded in the journal, and later it
will be posted to ledger.
Now, we will look at how the transactions of Sonic Enterprise (the example from
Topic 3) will be recorded in the three-column journal and how they will be
posted to their respective accounts.
4.3.1 Transaction 1: Initial Investment by Owner
Transaction 1st Sept 2008, Sonic invested RM50,000 cash to start a photography
business Sonic Enterprise.
Transaction Assets = Liabilities + OwnerÊs Equity

Analysis  Cash 50,000: debit  Capital 50,000: credit
Journal Date Accounts & Description Reference Debit Credit

Entries Sept 1 Cash 50,000
Capital - Sonic 50,000
Initial cash investment by Sonic
Posting Cash
1 Capital ă Sonic 50,000
Capital - Sonic
1 Cash 50,000

4.3.2 Transaction 2: Purchase of Non Current Asset
3rd Sept. 2008, Sonic purchased a photo processing machine costing

Transaction
RM1,000 cash.

Transaction
Analysis  Cash 1,000: credit
 Equipments 1,000: debit

Entries
Sept 3 Equipment 1,000
Cash 1,000
Purchase of equipment for photo processing
Posting Cash
1 Capital - Sonic 50,000 3 Equipment 1,000
Equipment
3 Cash 1,000
4.3.3 Transaction 3: Withdrawal by Owner
Transaction 5th Sept. 2008, Sonic withdrew RM10,000 cash for personal use.

Transaction
Analysis  Cash 10,000: credit  Capital 10,000
Drawings: debit
Journal Accounts &

Entries Date Reference Debit Credit
Description
Sept 5 Drawings 10,000
Cash 10,000
Cash drawings
Posting
Cash
1 Capital - Sonic 50,000 3 Equipment 1,000
5 Drawings 10,000
Drawings
5 Cash 10,000

4.3.4 Transaction 4: Borrowing Money
Transaction 6th Sept, Sonic borrowed RM20,000 cash from Digi Bank.
Transaction
Analysis  Cash  Loan
20,000: debit 20,000: credit

Entries
Sept 6 Cash 20,000
Bank Loan 20,000
Cash borrowing
Cash
Posting 1 Capital - Sonic 50,000 3 Equipment 1,000
6 Bank loan 20,000 5 Drawings 10,000
Bank Loan
6 Cash 20,000
4.3.5 Transaction 5: Repayment of Borrowings
Transaction 25th Sept. 2008, Sonic paid off RM5,000 of the bank loan.

Transaction
Analysis Cash  Loan
5,000: credit 5,000: debit

Entries
Sept 25 Bank Loan 5,000
Cash 5,000
Repayment of bank loan
Cash
Posting 1 Capital ă Sonic 50,000 3 Equipment 1,000
25 Bank Loan 5,000
Bank Loan
25 Cash 5,000 6 Cash 20,000

4.3.6 Transaction 6: Earning Revenues
Transaction
26th Sept. 2008, Sonic provided professional photography
service for a wedding, RM2,000 cash was received and
another RM1,000 will be received within 14 days.
Transaction  Cash  OE through
Analysis
2,000: debit photography fees 3,000:
 Account credit
Receivable
1,000: debit

Entries Sept 26 Cash 2,000
Accounts Receivable 1,000
Photography fees 3,000
Photography fees earned for a wedding
Cash
Posting 1 Capital-Sonic 50,000 3 Equipment 1,000
6 Bank Loan 20,000 5 Drawings 10,000
26 Photography fees 2,000 25 Bank Loan 5,000
Accounts Receivable
26 Photography fees 1,000
Photography fees
26 Cash 2,000
26 Account Receivables 1,000

4.3.7 Transaction 7: Paying for Expenses
Transaction
28th Sept 2008, Sonic paid RM500 cash for his employeeÊs salaries,
RM300 cash for utilities and RM200 cash for shop rental.
Transaction  Cash 1,000: credit  OE by 1,000
Analysis
through  in expenses
1000: debit
Journal Accounts &

Entries Date Reference Debit Credit
Description
Sept 28 Salaries expenses 500
Utilities expenses 300
Rental expenses 200
Cash 1,000
Expenses paid
Cash
Posting 1 Capital ă Sonic 50,000 3 Equipment 1,000
28 Salaries expenses 500
Rental expenses 200
Salaries expenses
28 Cash 500
Utilities expenses
28 Cash 300
Rental expenses
28 Cash 200
Can you see the relationship between journal entries and posting the entries to
ledgers? Initially, in learning the entries, you will feel there is too much to
memorise. Once you have done enough exercises and mastered the concepts, you
will see that analysing, journalising and posting can be done simultaneously.

4.4 JOURNALISING AND POSTING
Figure 4.9: Steps in preparing financial statements
At the end of an accounting period, trial balance is prepared before preparing the
financial statements.
Trial balance lists all accounts with their balances at the end of an accounting
period. The total debit balances and total credit balances must be equal
The steps to prepare the trial balance are as followings:
Figure 4.10: Steps in preparing trial balance

4.4.1 Errors in Trial Balance

However, even if the totals of debit and credit are equal, it does not mean that no
error has been made in one of the stages of the recording process. Errors can be
made at journalising, posting or even at the preparation of trial balance itself.
Consider the following errors:

(a) Transactions are not Recorded at All in the Journal
This error will not affect the debit and credit total, as the transaction is not
recorded at all in the journal and hence not posted at all. Therefore,
although there is error (amount is less it than what it should be), the trial
balance will still be balanced.
(b) Journal Entries are not Posted to Ledger
This error will not affect the debit and credit total too, as trial balance
figures are determine from the accountsÊ balance. The correct amount of
debit and credit balance of trial balance should be higher too.
(c) Double Posting of Journal Entries to Ledger
Double posting journal entries means twice the transactions are recorded in
accounts. This will affect the final accounts balance but the trial balance
figure will still be balanced.
(d) Using Wrong Accounts in Journalising and Posting to Ledger
This final error is principle error as wrong accounts were used. For
example, purchasing office supplies for cash. Supplies account is supposed
to be debited and cash credited. However, if cash was debited and supplies
credited, OR equipment (instead of supplies) was debited and cash was
credited, the debit and credit totals will be equal even though errors in
using accounts have been made.
4.4.2 Balancing of Accounts

Let us look at Sonic Enterprise accountÊs balance and then prepare its trial
balance. First we need to determine the final balance of all accounts affected
through a process called balancing.

SONIC ENTREPRISE LEDGERS

Cash
1 Capital ă Sonic 50,000 3 Equipment 1,000
2
Rental expenses 200
Balance c/d 4 55,000
1 72,000 3 72,000
28 Balance b/d 55,000
Balancing
1 Draw parallel line (two lines after last entry).

2 Add up total debit (72,000) and credit (17,000) amount.
3 Write the higher amount (72,000) on both sides.
4 Determine the closing balance, which is the difference between debit and
credit total (72,000 ă 17,200).
Capital - Sonic
28 Balance c/d 50,000 1 Cash 1 50,000
Drawings
5 Cash 2
10,000 28 Balance b/d 10,000
Balancing
1 If an account has only one entry, it is not necessary to
calculate the balance.
2 It is sufficient to underline the entry.
Bank Loan
25 Bank Loan 5,000 6 Cash 20,000
28 Balance c/d 15,000
20,000 20,000

Account Receivables
26 Photography fees 1,000 28 Balance c/d 1,000
28 Balanceb/d 1,000
Normal Balance
(a) If debit is more than credit side, then normal balance is debit;
(b) If credit is more than debit side, then norml balance is credit; and
(c) Remember your credit and debit rule!
Photography fees
26 Cash 2,000
28 Balance c/d 3,000 Account Receivables 1,000
3,000 3,000
Equipment
3 Cash 1,000 28 Balance c/d 1,000
Salaries expenses
26 Cash 500 28 Balance c/d 500
28 Balance b/d 500
Utilities expenses
28 Balance b/d 300
Rental expenses
28 Balance b/d 200
Notes
 Closing balance = Balance carried down = Balance c/d.
 Beginning balance = Balance brought down = Balance b/d.

The balance of each account is then transferred to trial balance.
SONIC ENTERPRISE
Trial Balance as at 28 February 2008
Debit Credit
Account Account
RM RM
Number
1001 Cash 55,000
1002 Accounts Receivable 1,000
1003 Equipment 1,000
2002 Bank Loan 15,000
3001 Capital Sonic 50,000
3002 Drawings - Sonic 10,000
4001 Photography fees 3,000
5002 Utilities expenses 300
5003 Rental expenses 200
68,000 68,000
Figure 4.11: Trial balance
Once the trial balance is ready, the financial statements can now be prepared.
4.5 PREPARATION OF FINANCIAL

STATEMENTS
Next, the business financial statements will be prepared using the information
provided in the trial balance. Nonetheless, the above transactions are not
completed as not all expenses have been taken into consideration; for example,
the depreciation of photography equipment for February. You will learn this in
the next topic.
If you can recall, in Topic 1, we have learnt that different types of business have
different reporting formats for income statement and balance sheet. At this stage
we will use the examples of Sonic Enterprise, a service provider. Its financial
statement will be shown as an illustration.

4.5.1 Income Statement

Also known as profit and loss statement, revenue statement, and statement of
financial performance, income statement shows all revenues and expenses for the
business entity for a period of time.
Business Name
Income Statement
for the year ended XX/XX/XXXX
RM RM
Revenues
Details of revenues XX XXX
less Expenses
Details of expenses XX XXX
Net income XXX
Figure 4.12: Format of income statement of a service provider
The following income statement is prepared for Sonic Enterprise, a service

provider.
SONIC ENTERPRISE
Income Statement
for the month ended 28 February 2008
RM RM
Revenues
Photography fees 3,000
Camera rentals 500 3,500
Less Expenses
Salaries expenses (500)
Utilities expenses (300)
Rental expenses (200) (1,000)
Net Income 2,500
Figure 4.13: Income statement of Sonic Enterprise

4.5.2 Statement of Changes in Owner’s Equity

Statement of changes in ownerÊs equity shows the changes in the ownerÊs equity.
The format of the statement of changes in ownerÊs equity is given as follows:
Business Name
for the month ended XX/XX/XX
RM
OwnerÊs Equity
Opening Capital XX
Add Profit XX
XXX
Less Drawings (XX)
Closing Capital XXX
Figure 4.14: Format of statement of changes in ownerÊs equity
SONIC ENTERPRISE
RM
OwnerÊs Equity
Beginning Capital - 1st February 2008 50,000
Add profit 2,000
52,000
Less Drawings (10,000)
Closing capital - 28th February 2008 42,000
Figure 4.15: Statement of changes in ownerÊs equity of Sonic Enterprise
4.5.3 Balance Sheet

Also known as statement of financial position, balance sheet shows all the assets,
liabilities and ownerÊs equity. Balance sheet shows what the business owns and
its obligations.

Business Name
Balance Sheet
as at 30 June 2008
Non Current Assets RM RM
Itemised items XX
Current Assets
Itemised items XX
Total Assets XXX
Itemised items XX
Current Liabilities
Itemised items XX
Total Liabilities XXX
Net Assets XXXX
OwnerÊs Equity* XXXX
Figure 4.16: Format of balance sheet of Sonic Enterprise
SONIC ENTERPRISE
Balance Sheet
RM RM
Non Current Assets
Equipment 1,000 1,000
Current Assets
Cash 55,000
Account Receivables 1,000 56,000
Total Assets 57,000
Bank Loan 15,000 15,000
Net Assets 42,000
OwnerÊs Equity*
Capital - Sonic 42,000
Figure 4.17: Balance sheet of Sonic Enterprise
Remember, accounting is a practical subject and you must practise and do

more exercises in order to understand the subject better.

Ć Account is used to record the increase and decrease of the specific items in
the accounting equation.
Ć A complete set of accounts for a business is called a ledger.
Ć Rules of debit and credit state that an increase of assets is debited, while an
increase in liabilities and ownerÊs equity are credited. A decrease in assets is
credited while a decrease in liabilities and ownerÊs equity are debited.
Ć Transactions are analysed (how they affect the accounting equation), then
journalised before posting to their appropriate accounts.
Ć Journal is a chronological record of business transactions.
Ć There are two types of journal used in recording business transactions

 General journal; and
 Special journal.
Ć Cash receipt journal is used to record transactions involving receipts of cash.
Ć Cash payment journal is used to record transactions involving payments of

cash.
Ć Trial balance is a listing of all accounts with its balances; total debit and credit
balance must be equal.
Ć Trial balance is prepared in order to detect arithmetical errors and to aid the
preparation of financial statements.
Ć The following errors can still occur even if the debit and credit columns of the
trial balance agree.
 Transactions are not recorded at all in the journal;
 Journal entries are not posted to ledger;
 Double posting of journal entries to ledger; and
 Using wrong accounts in journalising and posting to ledger.
Ć Sales journal is used to record credit sales.
Ć Purchase journal is used to record credit purchases.

Ć Posting is the transferring of the information recorded in the journal to

ledgers (accounts).
Double-entry accounting Ledger

Journal Posting
Journal entry Trial balance
1. Describe accounts, ledger and charts of accounts.
2. List the formats of accounts that you have learnt. Which format will show
the closing balance after each transaction?
3. Will the following accounts have a debit or credit balance?

(a) Drawings.
(b) Building.
(c) Office supplies.
(d) Prepaid expenses.
(e) Revenue received in advance.
(f) Interest revenues.
(g) Capital.
4. Based on the transactions of Che Wan Beauty Salon from Test 2, question
number 2 in Topic 3, you are required to:
(a) Provide the journal entries for the above transactions; and
(b) Post all the transactions to ledgers, using three column format
account.
5. Based on answers from question 4, prepare the trial balance for Che Wan
Beauty Salon.

6. Syarikat Janda Baik provides you with the following information regarding
their account balance:
RM
Subscriptions revenue 15,500
Rental revenue 4,300
Utilities expense 250
Interest expense 130
You are required to prepare the income statement for Syarikat Janda Baik
for the month ended 30 April 2007.
1. Complete the following Trial Balance using the figures provided for Mawee
& Associate Consulting as at 30 June 2008:
TRIAL BALANCE
(as at 30 June 2008)
RM Debit Credit
Land and Buildings 20,000

Motor Vehicles 13,000
Salaries Wages 700
Consultation Fees 20,000
Office Supplies 700
Insurance Expense 1,500
Accounts Payable 3,000
Bank Loan 4,000
Advertising Expense 400
Repairs and Maintenance 500
Capital ?
Rental Income 460

2. Based on the trial balance prepared in Test 1 question 5, prepare the income
statement for Che Wan Beauty Salon for the month ended 28 February 2008.
3. Based on the trial balance prepared in Test 1 question 5, and income

statement prepared in Test 2 question 1, prepare the statement of changes
in ownerÊs equity for Che Wan Beauty Salon for the month ended
28 February 2008.
4. Based on the trial balance prepared in Test 1 question 5, the income

statement prepared in Test 2 question 2 and the statement of changes in
ownerÊs equity in Test 2, question 3, prepare the balance sheet for Che Wan
Beauty Salon as at 28 February 2008.
5. You are required to prepare the income statement for Amit & Associates
Architects for the month ended 30 June 2008.
Amit & Associate Architects

Trial Balance as at 30 June 2008
Debit Credit
Accounts
RM RM
Cash 17,500
Building 70,000
Salaries payable 600
Bank Loan 25,000
Capital - Amit 30,000
Drawings-Amit 1,200
Consultation fees 34,500
Interest revenues 2,900
Supplies expense 1600
98,600 98,600

Topic  Adjusting
5 Entries and
Closing Entries
LEARNING OUTCOMES
1. Distinguish cash basis accounting from accrual basis accounting;
2. Identify the types and purpose of adjusting entries;
3. Prepare adjusting entries;
4. Prepare an adjusted trial balance;
5. Prepare closing entries; and
6. Prepare the financial statements from the adjusted trial balance.
 INTRODUCTION
In Topics 3 and 4 you have learned how to analyse, journalise, post, prepare
transactions and trial balance and the basic financial statements for a business
that provides services. However, you are not done yet!
The transactions that you have previously recorded occurred in the same
accounting period (you record the transactions as they occur). However, not all
transactions have been recorded, as there are internal transactions and events
that need adjustment at the end of the accounting period. This is due to the
accrual accounting principles that recognise revenues when they are earned and
match these revenues with expenses that are incurred in the same accounting
period.
It is most important to understand the difference between cash basis accounting

and accrual basis accounting. In this topic, you will also learn how to record

90  TOPIC 5 ADJUSTING ENTRIES AND CLOSING ENTRIES
adjusting entries and prepare an adjusted trial balance before preparing the
financial statements and close temporary accounts.
„Many small construction firms find the option of utilising cash basis
accounting to be a practical method of bookkeeping. The cash basis
method allows deductions for expenses to be taken in the year that
they are paid and reporting of income in the year received. For
businesses, however, where merchandise is an income-producing
factor, the Internal Revenue Service (IRS) strongly favours the
„accrual method‰.⁄⁄⁄⁄..In April 2002, the IRS issued regulation
2001-76, which expands the number of businesses that are permitted
to use the cash accounting method. Specifically, the rule states that
qualifying businesses with less than $10 million in annual revenues
can use cash accounting for tax purposes⁄⁄The rule change will
benefit more than 500,000 small businesses by reducing
administrative cost allowing deduction⁄..‰
http://www.abc.org/ga
5.1 ACCOUNTING BASIS

In order to understand adjusting entries it is best for us to understand and
differentiate between the accrual and cash basis accounting.
5.1.1 Cash Basis Accounting

Under cash basis accounting, transactions are recognised (recorded) when they
involve cash. Revenues are recognised when cash is received while expenses are
recognised when there are payments of cash.
Figure 5.1: Cash basis accounting
This system is simple but at the same time it does not give the accurate picture of
the financial performance and financial position of the entity. The information
provided by financial statement prepared under cash basis will be incomplete.

TOPIC 5 ADJUSTING ENTRIES AND CLOSING ENTRIES  91
To explain this, let us assume a business entity has provided services on

credit term for RM15,000. Under cash basis, no revenue can be recognised
as no cash has been received by the business. If the business prepares
financial statements before the cash is received, the revenues under cash
basis accounting will be understated, resulting in a lower profit (income).
From a financial position point of view, the assets will also be
understated.
The same concept applies to expenses recognition. Take utility bill for
example, January bill is received at the end of the month for RM100 and
will only be paid the following month. Under cash basis accounting, no
utility expenses will be recognised in January; as a result, the amount of
expenses is understated, hence overstating JanuaryÊs profit (income).
From a financial position point of view, JanuaryÊs liabilities are
understated too.
To summarise, the weaknesses of cash basis accounting are:

(a) It does not follow the matching principle if credit transactions exist;
(b) As a result of understating revenue or overstating expenses, profit or loss
calculated under cash basis accounting does not reflect the ÂtrueÊ business
performance; and
(c) Since the liabilities and assets are not recognised, the balance sheet does not
provide the ÂtrueÊ picture of the businessÊ financial position.
Do take note that the cash basis accounting is not consistent with the generally
accepted accounting principles and is not allowed to be used in practice.
5.1.2 Accrual Basis Accounting

Accrual accounting recognises revenue after goods are delivered or services
provided to customers, regardless whether cash has been received or not. LetÊs
take the example in 5.1.1, when a firm provided services worth RM15,000 on
credit term. The RM15,000 will be recognised as revenue under accrual basis
accounting as services have been provided to customers even though no cash has
been received.
It is the same with JanuaryÊs utility expenses; you have used the utilities during
January. It is JanuaryÊs expenses and should be recognised as one.

Let us look at another example. Suppose Che Ah Enterprise paid for one year
insurance in advance for RM1,200 on January 1, 2008. Assuming now it is March
30, 2008 and Che Ah Enterprise wants to calculate its income for the first three
months of operation, how much insurance expenses should be recognised? Can
you draw the time line for this example? See tips in Topic 2.4.3. Try it!
Accrual basis accounting will recognise that only three monthsÊ expenses are
matched with the same period revenues. Hence only RM300 (RM1,200 x 3/12)
will be recognised as expenses. Another RM900 will be reported as an asset
(prepaid insurance) at the end of that period (March 30, 2008). Cash basis
accounting on the other hand will recognise the full amount of RM1,200 as
expenses.
Accrual basis accounting takes into account all revenues that are earned during
the accounting period, and match them with all expenses incurred in generating
the said revenues. This in facts, give a ÂtrueÊ picture of the business performance
when compared to using cash basis accounting, and this is the reason why
accrual basis accounting is better than cash basis accounting.
The strengths of accrual basis accounting are:

(a) It measures the ÂtrueÊ financial performance of a business, through accurate
measurement of revenue and expenses for the period;
(b) It shows the ÂtrueÊ financial position of a business, through accurate
reporting of liabilities and assets; and
(c) It matches revenues with expenses for the period.
Accrual basis accounting is used in practice to prepare and report financial

statements.
Figure 5.2: Cash versus accrual basis accounting

As you have seen from the previous sections, under accrual basis accounting
some transactions need to be adjusted to reflect their true measurement of
revenues, expenses, assets and liabilities.
ACTIVITY 5.1
1. The difference between cash and accrual basis accounting has to do

with the time frame in which revenues and expenses are recorded
and reported. These websites offers an explanation of how accrual
basis accounting and cash basis accounting differ.
(a) http://accountinginfo.com/study/accrual-101.htm
(b) http://office.microsoft.com/en-us/support/understanding-
cash-and-accrual-basis-accounting-HA010164612.aspx
2. An income statement of a firm that uses the accrual basis

accounting shows a profit of RM1 million. Does this mean the firm
has RM1 million cash?
5.2 ADJUSTING ENTRIES

At the end of an accounting period, information obtained from the trial balance is
not sufficient to prepare a complete financial statement of a business entity. This
is due to the need to prepare adjusting entries to match revenues and expenses of
an accounting period in order to obtain an accurate profit or loss for the said
period.
There are items like prepaid expenses, accrued expenses, unearned revenues,
accrued revenues, depreciation, bad debts and doubtful debts that need to be
accounted for at the end of the accounting period.
WeÊll now discuss each of these adjustments in detail.
The following diagram summarises the adjustment entries that need to be made
at the end of a financial year.

Figure 5.3: Adjusting entries that need to be made at the end of a financial year
5.2.1 Prepaid Expenses
Prepaid expenses are items that are paid for before their benefits are received
or used.
Prepaid expense is an asset. When the assets are used, consumed or expired, they
become expenses and should be recognised. These items include supplies, rentals
and insurance.
Let us look at this example. Suppose on 1 January 2008 you purchased office
supplies worth RM500 for cash. The following entries will be made to record the
purchase.
1/1/08 Dr Office supplies 500

Cr Cash 500
Purchase office supplies for cash.
You will be using these office supplies during the operation of your business like
taking a pen, diskettes, paper etc from the supplies, but it is very unlikely for you
to record this as expense every time you take these items as it is not practical to
do so.

At the end of the month, you do a stock check and find that the office suppliesÊ
worth is RM300.
Can you see that you do not have RM500 worth of office supplies anymore, only
RM300 are left? You have used up RM200 worth of office supplies and this usage
(expense) has never been recorded. Thus, it is necessary to make the following
adjusting entry at the end of the month to account for the supplies used.
30/1/08 Dr Supplies expense 200

Cr Office supplies 200
To record supplies used.
The effect of the adjusting entry is to recognise the expense of RM200 and reduce
the office supplies from RM500 to RM200. See the following accounts.
Office Supplies
Date Description Amount Date Description Amount
1/1/08 30/1/08 Supplies 200
Cash 500
expense
30/1/08 Closing Balance 1 300
500 500
1
This amount will be reported as asset (office supplies) in the balance sheet
as at 30 Jan 2008.
Supplies Expense
30/1/08 Office Supplies 200 30/1/08 Closing Balance 1 200
200 200
1
This amount will be transferred to income summary account as supplies
expense for the month.
Another example is prepaid insurance. LetÊs assume Xtrail Enterprise paid for
three years of insurance coverage of RM3,600 on 1 January 2008. The transaction
will be recorded as the following.
1/1/08 Dr Prepaid insurance 3,600

Cr Cash 3,600
Paid cash for a 3 year coverage of insurance policy

Prepaid insurance account is a current assets account. As at January 1, 2008,

Xtrail EntreprisesÊ insurance benefits cover the period of 1 January 2008 until 31
December 2010 (36 months). Xtrail wants to prepare its income statement for the
year ended 31 December 2008, or after one year of operation. Has any insurance
expense been recorded? Does Xtrail have RM3,600 worth of insurance as asset as
at 31 December 2008? The answer to both questions is a NO.
In fact, you should realise that Xtrail has used up one year of the insurance;
hence, this amount should be recognised and recorded as expense. As XtrailÊs
asset has been used up, it should be reduced. Hence, the following adjusting
entry should be made.
31/12/08 Dr Insurance expense 1,200

Cr Prepaid insurance 1,200
To record the insurance expense for the year.
The effect of the adjusting entry is to recognise the insurance expense of

RM1,200, and reduce the prepaid insurance from RM3,600 to RM2,400. As at
31/12/2008 your prepaid insurance will provide coverage for two years. See the
following account.
Prepaid Insurance
1/1/08 Cash 3,600 31/12/08 Insurance expense 1,200
31/12/08 Closing Balance 1
2,400
3,600 3,600
1 This amount will be reported as asset (prepaid insurance) in the balance

sheet of the business as at 31 Dec 2008.
Insurance Expense
31/12/08 Prepaid insurance 1,200 31/12/08 Closing Balance 1 1,200
This amount will be transferred to the income summary account as the

1
insurance expense for the year ended 31 December 2008.

5.2.2 Unearned Revenue

There are a few situations where you will receive cash in advance before
delivering goods or providing services. These include rent received in advanced
and subscriptions received in advance.
According to the revenue recognition principle, revenue can only be recognised

when you have earned it, not when you receive cash for it. In fact, when you
receive cash in advance, you have an obligation (a liability) to provide goods or
services to the customer.
Xtrail Enterprise rents out an office space to Keno. On 1 July 2008, Keno paid
three monthsÊ rental of RM4,500. The journal entry to record this in XtrailÊs book
is:
1/7/08 Dr Cash 4,500

Cr Rental Revenue 4,500
Received three months rentals in advance from Keno.
Assume that Xtrail Enterprise prepares its financial statement at 31 July 2008. If
no adjustment is made, the account Rental Revenue will show an amount of
RM4,500. In fact, Xtrail has not earned the RM4,500 rental revenue; only RM1,500
is earned and it owes Keno another two monthsÊ rental or RM3,000 worth of
rental services. Hence, the following adjusting entries need to be made:
31/7/08 Dr Rental Revenue 3,000

Cr Unearned Rental Revenue 3,000
To record the earning of one month rental that was received in advance.
The entry reduces the Rental Revenue amount to RM1,500 (which is already
earned by Xtrail) and create a liability account, Unearned Rental Revenue of
RM3,000. See the following accounts.
Rental Revenue
31/7/08 Unearned Rental 3,000 1/7/08 Cash 4,500
Revenue
31/7/08 Closing balance 1
1,500
4,500 4,500
1
rental revenue for the month ended 31 July 2008.
Unearned Rental Revenue

31/7/08 Closing Balance 1
3,000 31/7/08 Rental Revenue 3,000
1
This amount will be reported as current liabilities in the balance sheet as at
31 July 2008.
In all unearned revenue, cash is received before the work is performed or the
good are delivered. Any unearned revenue is a liability.
5.2.3 Accrued Expenses

Accrued expenses refer to expenses that a business incurs before paying them.
These include items such as electricity and telephone bills, salaries and wages,
and interest on loan.
For example, on 30 January 2008, the utility bill for January was received for the
amount of RM250, but no payment was made. Adjusting entries on 30 January
2008 will be made to recognise the utility expense of RM250 and the existence of
a liability (Utilities Payable) of RM250 as at 30 January 2008.
30/1/08 Dr Utilities expenses 250

Cr Utilities payable 250
To record accrued utilities expenses of RM250.
The related accounts are shown below.
Utilities Expense
30/1/08 Utilities Payable 250 30/1/08 Closing Balance 1
250

1
utilities expense for the month ended 30 January 2008.

Utilities Payable
30/1/08 Closing Balance 250 30/1/08 Utilities Expense 1
250
This amount will be reported as current liabilities (Utilities Payable) in the

1
balance sheet as at 30 January 2008.
5.2.4 Accrued Revenues

Accrued revenues refer to revenues that a business has earned but cash has not
been received. These include items such as interest, rent and commissions.
Xtrail Enterprise provides consulting services to Keno. The contract is from 1

January until 30 June 2008 and payment of RM6,000 will only be made at the end
of the contract.
Suppose Xtrail prepares its financial statement on 30 January 2008, a month after
signing the contract. If no adjusting entries are made, Xtrail Enterprise will not be
reporting the consultation revenue of RM1,000 that they have earned.
30/1/08 Dr Consultation fees receivable 1,000

Cr Consultation fees 1,000
To record accrued revenues for consultation service provided.
Consultation fees
30/1/08 Closing Balance 1 1,000 30/1/08 Consultation 1,000
fees receivables

1
revenues (Consultation fees) for the month ended 30 Jan 2008.

Consultation Fees Receivable

30/1/08 Consultation fees 1,000 30/1/08 Closing Balance 1
1,000
This amount will be reported as current asset in the balance sheet as at 30

1
Jan 2008.
An accrued expense is expensed first and paid later. A prepaid expense is paid
first and expensed later. Accruals and prepayments are opposites.
5.2.5 Depreciation
Depreciation is the allocation of non-current assets cost as expense over its

estimated useful life.
The reason for this allocation is that you use non current assets to generate
revenues; for example, you use a motor vehicle to deliver goods to customers
and plants and machinery to produce goods. The matching principle states that
revenues must be matched with expenses, and therefore we must allocate the
cost of using the non current assets as expense.
There are many ways of calculating depreciation. One method is the straight line
method. The rest of the methods will be covered in another topic.
As an example, on 1 January 2007, Xtrail Enterprise purchased a delivery van for

RM60,000 cash. The expected useful life of this van is 10 years and there is no
residual value. Using the straight line method, the assetÊs cost minus its residual
value will be allocated evenly over 10 years. As the delivery van has zero
residual value, the amount of RM60,000 will be allocated evenly over the 10 year
period. This means RM6,000 will be expensed as depreciation annually.
The adjusting entry at end of first year for depreciation is as the following.
31/12/07 Dr Depreciation Expense 6,000

Cr Accumulated Depreciation ă Motor Vehicle 6,000
To record depreciation expense for the period.

Depreciation Expense
31/12/07 Acc. Depreciation 6,000 31/12/07 Closing Balance 1
6,000
ă Motor Vehicle

1
depreciation expense for the year ended 31 December 2004.
Accumulated Depreciation ă Motor Vehicle

31/12/07 1
Closing Balance 6,000 31/12/07 Depreciation 6,000
expense
This amount will be reported as a contra to motor vehicle in the balance

1
sheet as at 31 December 2007.
You will not credit the non current asset account directly but use a contra
account called accumulated depreciation account.
Depreciation account contains only the depreciation charges for the current year
while accumulated depreciation account contains total depreciation charges from
the date of purchase.
Contra account figure will be deducted from the non current assetÊs original cost
in the balance sheet to get the net value of the non-current assets. Example is
shown below.
Xtrail Enterprise
Extract of Balance Sheet
for the year ended 31 December 2007
RM RM RM
Non Current Assets
Vehicle 60,000
Less Accumulated Depreciation (6,000) 54,000
Other non current asset XXX XXX

5.2.6 Bad Debts
SELF-CHECK 5.1
A firm balance sheets shown accounts receivable balance of RM500,000.
Do you believe that the firm will be able to collect all of the RM500,000?
Why do you think so?
It is common for business to allow credit sales. If you recall, an account called
account receivable (an asset) will be debited when such transaction occurred.
This account receivables or debtors represent an asset to your business, as in the
future you will be able to receive the payment. However, businesses are exposed
to risks that some of these account receivables will not be able to be collected.
For example in the event of a debtorsÊ death, business bankrupt or other reasons,
you will not be able to collect from your debtors. When this happens, the debts
will be known as bad debts.
In other words, if someone owes you money that you cannot collect, you have
a bad debt.
The accounting for bad debts is as follows:
Date Dr Bad debts expense XX

Cr Account Receivable XX
To record the write off of account receivable as a result of bad debt.
Date Dr Income summary XX

Cr Bad debts expense XX
To transfer bad debts expense to income summary.

Consider the following transaction. On 1 July 2007, Raz & Partners provide
consultancy services to Hamza Stores worth RM1,500 on credit. On 1 March 2008,
the debts remained unpaid as Hamza has migrated to Australia and could not be
traced. Raz & Partners decides to write off Hamza StoresÊ debt of RM1,500. Raz &
Partners closes its account on 30 June every year.
The transactions will be recorded as follows:
1/7/07 Dr Account Receivable - Hamza Store 1,500

Cr Consultancy Fees 1,500
Provided consultancy services on account.
Account Receivable ă Hamza Store

1/7/07 Consultancy fees 1,500
1 March 2008, Raz & Partners will make the following entry to write off the debts
as it was determined to be bad (uncollectable). Writing off is the process of
eliminating amount owed by Hamza from the business records.
1/3/08 Dr Bad debts expense 1,500

Cr Account Receivable - Hamza Store 1,500
Writing off Hamza StoreÊs debt.
This entry brings the Account Receivable ă Hamza Store to zero. The debt that is
bad has been eliminated or written off.
Account Receivable ă Hamza Store
1/7/07 Consultancy fees 1,500 1/3/08 Bad debts expense 1,500
Bad Debts Expense

1/3/08 Account 1,500
Receivable ă
Hamza Store
At the end of the period, bad debts expenses account will be closed to the income
summary.

30/6/08 Dr Income summary 1,500

Cr Bad debts expense 1,500
Transfer bad debts expense to income summary.
Bad Debts Expense

1/3/08 Account 1,500 30/6/08 Income summary 1,500
Receivable ă
Hamza Store
Business should never give up on bad debts. You must try to recover the debts
by all means, even by going through court order to demand payments from your
debtors. Debts that are recovered after being written off are treated as revenue.
The following discuss the accounting treatment for recovery of bad debts.
ACTIVITY 5.2
1. There are many precautionary measures you can take to avoid the risk of
bad debts. One of them is to get new customers who cannot provide a
satisfactory credit, to provide a guarantor who is financially sound.
What are other ways that can you think of to minimise the risk of bad
debts?
2. To do further reading on how to avoid bad debts, do check out these

websites:
(a) http://www.australia-migration.com/page/Bad_Debts/150;
and
(b) http://www.ema.co.nz/Bad_Debts.pdf#search='bad%20debts'
Recovery of Bad Debts

In the event that the debts can be recovered after they have been written off, the
debts recovered will be recognised as gain and will be reported as other
revenues. When an account receivable is recovered, the following accounting
treatment is applicable.

Date Dr Account Receivable XX

Cr Bad debts recovered XX
To record bad debts recovered
Date Dr Cash XX
Cr Account Receivable XX
To record cash received from bad debts recovered
Date Dr Bad debts recovered XX

Cr Income summary XX
Transferring bad debts recovered to income summary
From the Raz & Partners example, assume that on 31 December 2008, Hamza was
finally located, and payment for his debts was demanded. He agreed to pay a
final sum of RM500 to avoid any legal action, and this was accepted by Raz &
Partners.
On 31 December 2008, Raz & Partners will record the followings.
31/12/08 Dr Account Receivable - Hamza 500

Cr Bad debts recovered 500
To record bad debts recovered from Hamza.
31/12/08 Dr Cash 500

Cr Account Receivable ă Hamza 500
To record cash received from Hamza.

Account Receivable - Hamza Store

30/12/08 Bad debts recovered 500 31/12/08 Cash 500
Bad Debts Recovered

31/12/08 Account Receivable - 500
Hamza
Transfer the bad debts recovered to income summary at end of period.
30/6/09 Dr Bad debts recovered 500

Cr Income summary 500
To transfer bad debts recovered to income summary
Bad Debts Recovered

30/12/08 Income summary 500 31/12/08 Account 500
Receivable -
Hamza
5.2.7 Provision for Doubtful Debts

As discussed earlier, not all account receivable can be collected. A balance sheet
that shows accounts receivable of RM500,000 as their current assets does not
necessarily mean that the business will be able to collect the amount in full.
Therefore a business need to make an estimate or provision of how much of the

accounts receivable might not be collected in the future. Accounts receivables are
reported in the balance sheet less the provision for doubtful debts (shown
below). Provision of doubtful debts is a contra account to accounts receivable.
Normally, provision for doubtful debts is calculated based on a certain

percentage of the account receivable balance that might not be collected. There
are several basis used to estimate the provision of doubtful debts. They can be
based on past experience, knowledge of the debtorÊs financial position, and
ageing analysis.

(a) Creating Provision for Doubtful Debts

Doubtful debts are recorded for the first time as the following:
Date Dr Income summary XX

Cr Provision for Doubtful Debts XX
Providing for uncollectible debts in the future.
Assume that Peter Printing Company has been operating for a year, and at
end of year 31 December 2008, has accounts receivable balance of
RM55,000. Peter estimates that 10% of his debtors will not be able to pay
up.
On 31 December 2008, the provision of doubtful debts is created.

Cr Provision for Doubtful Debts 5,500
Creating provision for doubtful debts
Provision for Doubtful Debts

30/12/08 Closing 30/12/08 Income
5,500
balance 5,500 summary
1/1/09 Opening 1 5,500
balance
1
The closing balance of RM5,500 will be the opening balance for the
next period stated 1 January 2006.
At year end 31 December 2008, the accounts receivable and provision of

doubtful debts will be reported as the following.
Peter Printing Company

RM RM RM
Current Assets
Accounts Receivables 55,000
Less Provision of Doubtful debts (5,500) 49,500
Other current assets XXX XXX

(b) Increase or Decrease in Provision for Doubtful Debts

In the next accounting period year end, there might be an increase or
decrease in the provision of doubtful debts, in this case only the increment
or decrement is recorded. An increase in the provision of doubtful debts
represents a loss or an expense and thus reported as one in the income
statement. While a decrease in the provision of doubtful debts represents a
gain or revenue and thus reported as one in the income statement.
Company Name
Extract of Income statement
For the year ended XX/XX/XXXX
RM RM RM
Other revenues
Provision of Doubtful Debts (decreased in) XX
Bad debts recovered XX XXX
Operating
expenses
Bad debts XX
Provision of Doubtful debts ( increased in) XX XXX
Assume that Peter Printing Company has an accounts receivable balance of

RM90,000 as at 31 December 2009. And he estimates that 10% of these
accounts are uncollectable. Then the following entry is made to reflect the
increase in his estimate from RM5,500 to RM9,000 which is an increase of
RM3,500.

Cr Provision for Doubtful Debts 3,500
To record an increase in the provision of doubtful debts.

5,500 5,500
balance summary
1/1/09 Opening
5,500
balance
9,000 3,500
balance summary
9,000 9,000
Now letÊs assume that Peter Printing Company has an accounts receivable
balance of RM70,000 as at 31 December 2010. He estimates that 10% of these
accounts are uncollectble. Then the following entry is made to reflect the
decrease in his estimate from RM9,000 to RM7,000, which is a decrease of
RM2,200.
31/12/09 Dr Provision for Doubtful Debts 2,000

Cr Income summary 2,000
To record a decrease in the provision of doubtful debts.

31/12/10 Income 1/1/10 Opening
2,000 9,000
summary balance
31/12/10 Closing balance
7,000
9,000 9,000
1/1/11 Opening
7,000
balance
Ask the following questions before you make adjusting entries.

(a) How was the transaction recorded and what is the current balance?
(b) What should the balance be?
(c) How much is the adjustment?
To summarise, the following diagram shows the effect of prepayments and

accruals on items in the balance sheet and profit and loss statement before
adjustments are made. In order to report the correct figure the relevant adjusting
entries (as shown) must be made. For example, if no adjustments are made to
expenses (e.g. insurance expense) initially recorded as prepaid expenses (e.g.
prepaid insurance) at the end of accounting period, the asset (prepaid insurance)
will be overstated while expense (insurance expense) will be understated.

Figure 5.4: Summary of effects and adjustment entries

ACTIVITY 5.3
This crossword puzzle is for you to test your understanding. Go for it!
D E B T S
Down
1. We measure expenses when _________.
2. Which basis of accounting poses lesser ethical challenges?
3. A _________ expense is paid first and expensed later.
4. We measure revenues when _________.
Across
1. Which basis of accounting better measures business profit (revenue-
expenses)?
2. A category of adjusting entries.
3. Money you cannot recover is called bad ______.

5.3 ADJUSTED TRIAL BALANCE
A trial balance is initially prepared at the end of an accounting period before

adjustments are made. This trial balance is known as unadjusted trial balance.
Later after adjusting entries are made, another trial balance is prepared. This is
known as adjusted trial balance. Similar to the first unadjusted trial balance, the
adjusted trial balance lists all the accounts with their normal balance. However,
all accounts created under the adjustment entries are included in the adjusted
trial balance such as depreciations, accrued expenses, accrued revenues, and
unearned revenues.
From this adjusted trial balance figure, the financial statements will be prepared.
Xtrail Enterprise
Adjusted Trial Balance as at 30 June 2008
Account
Account Debit RM Credit RM
Number
1001 Cash 45,000
1002 Accounts Receivable 1,000
1003 Prepaid insurance 2,000
1004 Accrued consultation fees 2,000
1005 Motor Vehicle 10,000
Accumulated depreciation ă Motor 3,000
1006
Vehicle
2001 Accounts Payable 2,700
2002 Accrued utilities expenses 300
2003 Bank Loan 14,000
3001 Capital ă Xtrail 40,000
3002 Drawings - Xtrail 5,000
4001 Consultation fees 13,000
4002 Interest revenues 1,000
5001 Salaries expenses 2,500
5002 Utilities expenses 3,300
5003 Insurance expense 1,700
5003 Depreciation 1,500
74,000 74,000
Figure 5.5: Example of adjusted trial balance ă Xtrail Enterprise

5.4 CLOSING ENTRIES

At the end of an accounting period, a closing process is required to prepare
accounts for recording transactions in the next period.
Before we go on to discuss the steps in closing accounts, weÊll look at the types of
accounts in a business. There are two types of accounts; temporary and
permanent accounts. Only temporary accounts are closed at the end of an
accounting period.
5.4.1 Temporary Accounts

Also known as nominal account, temporary accounts are used to record
expenses, revenues, drawings and income summary account. These accounts are
temporary because they are opened at the beginning of an accounting period,
record related transactions for the period, and later closed at the end of the
accounting period.
Accounts are closed so that their balance will be zero at the end of the accounting
period. In the next period, the account will record the amounts incurred in the
next period only. This enables revenues, expenses, drawings and income for the
period to be measured accurately.
5.4.2 Permanent Accounts

Also known as real account, permanent accounts are used to report assets,
liabilities and capital. They record transactions related to more than one
accounting period. Their balance at the end of an accounting period will be
carried forward to the next period. These are items that are reported in the
balance sheet.
5.4.3 Recording Closing Entries

There are four steps in closing entries as explained below. Using the above
adjusted trial balance for Xtrail Enterprise as at 30 June 2008, you will learn how
to do the closing entries.

The first step is to transfer the credit balance of revenue and gain accounts to the
income summary account. This is done through the following entry.
Date Dr Revenue (or gain) account XX

Cr Income Summary account XX
Closing revenues account to income summary
For Xtrail, the following entry should be made.
30/6/08 Dr Consultation fees 13,000

Dr Interest revenue 1,000
Cr Income Summary account 14,000
Closing revenues account to income summary
The effect of this entry is it will bring the revenues accountsÊ balance to zero.
Consultation fees
30/6/08 Income summary 1
13,000 30/6/08 Balance 13,000
Income Summary Account

30/6/08 Consultation fees 1
13,000
Interest revenue 1,000
1 This amount will be transferred to the income summary as the revenues

(consultation fees) for the month ended 30 June 2008, and the consultation
fees account balance is zero.
Interest Revenue
30/6/08 Income summary 1,000 30/6/08 Balance 1,000

The second step is to transfer the debit balance of expense and loss accounts to
the income summary account. This is done through the following entry.
Date Dr Income Summary account XX

Cr Expense (or loss) account XX
Closing expenses account to income summary.
30/6/08 Dr Income Summary account 9,000

Cr Salaries expenses 2,500
Insurance expense 1,700
Depreciation 1,500
Closing expenses account to income summary.
The above entry will effectively bring all the expenses accountsÊ balance to zero.
Salaries expenses
30/6/08 Balance 2,500 30/6/08 Income summary 1
2,500

30/6/08 Salaries expenses 1
2,500 30/6/08 Consultation fees 13,000
Utilities expenses 3,300 Interest revenue 1,000
Depreciation
1,500
expense
Closing balance 5,000
14,000 14,000
This amount will be transferred to the income summary as the expense

1
(salaries expenses) for the month ended 30 June 2008, and the salaries
expenses account balance is zero.

Can you see that the income summary account only contains revenues and
expenses accounts? Can you also see that revenue items are listed on the credit
side of the income summary account while expense items are listed on the debit
side? If you remember these, you will be able to learn how to prepare income
summary account.
Income summary account calculates the income of the business. If revenues are
higher than the expenses, the business will record a profit. On the other hand, if
expenses are higher than revenues, the business will record a loss.
The third step is to transfer the balance (profit or loss) of the income summary
account to capital account.
If profit is recorded, the following entry is made.
Date Dr Income Summary account XX

Cr Capital XX
Transferring profit to capital account.
On the other hand, if loss is recorded, the following entry is made.
Date Dr Capital XX
Cr Income Summary account XX
Transferring loss to capital account.

Cr Capital 5,000
Transferring profit to capital account.
This entry will bring the income summary account balance to zero.


30/6/08 Salaries 2,500 30/6/08 Consultation 13,000
expenses fees
Utilities 3,300 Interest 1,000
expenses revenue
Insurance 1,700
expense
Depreciation 1,500
expense
Capital 1
5,000
14,000 14,000
Capital
30/6/08 Closing balance 45,000 30/6/08 Balance 40,000
Income summary 1
5,000
45,000 45,000
1 The profit will be transferred to the capital account and it increases the
capital balance.
The last step of the closing process is to close the debit balance of drawing
accounts to capital account. The following entry is made.
Date Dr Capital XX
Cr Drawings XX
To close drawings account to capital account.

30/6/08 Dr Capital 5,000

Cr Drawings 5,000
To close drawings account to capital account.
As a result, the entry will bring the drawings accountÊs balance to zero.
Drawings
30/6/08 Balance 5,000 30/6/08 Capital 1
5,000
Capital
30/6/08 Drawings 1
5,000 30/6/08 Balance 40,000
Closing balance 2 40,000 Income summary 5,000
45,000 45,000
1 The drawing balance will be transferred to capital account and this

decreases the capital balance.
2 The closing balance of the capital account will be reported in the balance
sheet as the balance as at 30 June 2008.
Note the distinction between adjusting and closing entries. Adjusting entries
are required to update certain accounts in your general ledger at the end of an
accounting period. They must be done before you can prepare your financial
statements and income tax return. Closing entries are needed to clear out your
revenue and expense accounts as you start the beginning of a new accounting
period.
ACTIVITY 5.4
There is a simple quiz in this website on closing entries. Have a go!
http://school.discovery.com/quizzes20/davidsonm/ClosingEntriesQui.
html

Ć Cash basis accounting recognises revenue when cash is received and

expenses when there are cash payments.
Ć Accrual basis accounting recognises revenue when it is earned and expense

when it is incurred regardless whether cash has been received or paid.
Ć Adjusting entries are made at the end of an accounting period to assign

revenues to the period they are earned and expenses to the period they are
incurred.
Ć Prepaid expenses refer to items paid in advance before receiving the benefits.
Hence, they are reported as current asset in the balance sheet.
Ć Depreciation is the cost of allocating cost of non-current assets over its

estimated useful life.
Ć Unearned revenues refer to cash that is received in advance before services

are provided or goods delivered to customers. They are reported as current
liability in the balance sheet.
Ć Accrued expenses are expenses incurred but not paid yet. Recognition of
accrued expenses will increase expenses and liability (payables).
Ć Accrued revenues are revenues earned but not received yet. Recognition of
accrued revenues will increase revenues and asset (receivables).
Ć Adjusted trial balance is prepared after recording adjusting entries. The new
balances are used to prepare the financial statements.
Ć Temporary accounts consist of revenue, expense, income summary and

drawings. Accounts will be closed at the end of an accounting period to bring
its balance to zero.
Ć Permanent accounts consist of assets, liabilities and equity accounts which

will not be closed. They will show balances and brought forward in the next
period.

Accrual basis of accounting Closing entry

Adjusting entries Prepaid expenses
Cash basis of accounting Unearned revenue income
1. The following are information of Onn & Sons Enterprise for the month of
January 2008.
(a) Total revenue from service provided is RM35,000. RM7,500 of these
revenues still remain uncollected.
(b) Onn & Sons has purchased RM5,000 supplies for cash. During
January, Sen Ang used RM3,000 worth of supplies.
(c) Onn & Sons has paid three months rent in advance (Jan, Feb and
March 2008) for RM3,000.
(d) Onn & Sons has not paid his workersÊ salaries for January amounting
to RM2,000.
You are required to calculate the profit or loss of Onn & Sons Enterprise for
the month of January 2008 under:
(a) Cash basis accounting; and
(b) Accrual basis accounting.
2. Crystal had a balance of RM1,617 in its Office Supplies on Hand account on

Jan 1, 2008. During the year, more office supplies were purchased
amounting to RM3,603 and recorded in the asset account. A physical count
of the office supplies on December 31, 2008 revealed that RM526 remained
on hand.
You are required to calculate the office supplies used and provide the
journal entry to record the adjustment that needs to be made on December
31, 2008.
3. Bintang Corp. had a RM400 balance in its Prepaid Insurance Account on

January 1, 2008 from a 3 year insurance policy acquired on Sept 1, 2005.

This policy was renewed on September 1, 2008 for an additional 3 years

with a payment of RM2,160. Bintang initially records purchase of insurance
in the prepaid account.
You are required to calculate the insurance expense and provide the journal
entry to record the adjustment that needs to be made on December 31, 2008.
4. Ujang Magazine sells magazines on a subscription basis. On 1 April 2007,

cash in the amount of RM1,800 was received for magazine subscriptions for
the next 36 months. Ujang made a credit entry to a liability account when
the cash is received.
You are required to calculate the subscription revenues for 2007 and
provide the journal entry to record the adjustment that need to be made on
31 December 2007.
1. Lyd Enterprise has a RM30,000, 12% note payable due to Malayan Banking
on March 30 2013. The money was borrowed on 1 October 2008. The first
interest payment of RM900 [(RM30,000 x 12%) x 3/12] is due on 31 March
2009.
You are required to provide the journal entry to record the adjustment that
needs to be made on 31 December 2008.
2. On 1 October 2008, Gigantic Corp deposited RM24,000 in a fixed deposit

account at one of the local bank. 12% interest will be paid every six months.
As at 31 December 2008 interest earned on the fixed deposit amounted to
RM720 (RM2,400 x 12%) x 3/12).
You are required to provide the journal entry to record the adjustment that
need to be made on 31 December 2008 by Gigantic Corp.
3. Read the following information regarding Imran Khan Enterprise.
01.01.2007 ă Balance of a debtor, Star, of RM300 has remained

uncollected for 6 months.
05.01.2007 ă Sold goods on credit to Venus for RM600 and the credit
term is 2/10, n30.

10.02.2007 ă Star was declared bankrupt and unable repay his debt.
Imran Khan decides to write off StarÊs debt.
07.10.2007 ă Venus, having difficulty in meeting up payment, offers to

pay RM200 as full settlement for his debts. The offer has
been accepted and payment of RM200 is received. To write
off the remaining balance as bad debts.
01.12.2007 ă After much pursuance, Star pay up RM100 of what he

previously owed as full settlement.

(a) Record the transactions in general journal; and
(b) Show the individual account receivable, bad debts expense account
and bad debts recovered account.
4. MKS Accounting firm starts operation on 1 July 2007. They provide
accounting and auditing services to businesses. The following is the
unadjusted trial balance of MKS Accounting firm as at 30 June 2008.

MKS Accounting Firm

Debit Credit
Accounts
RM RM
Cash 13,000
Office supplies 500
Prepaid insurance 4,800
Building 60,000
Bank Loan 25,000
Capital - MKS 60,000
Drawings - MKS 1,200
Accounting fees 25,700
Rental revenues 2,400
Interest expense 1,000
118,700 118,700
Additional information;
(a) Office supplies used during the year amounted to RM350.
(b) Insurance was paid on 1 July 2007 for two years (24 months) coverage.
(c) Building is depreciated at 5% of original cost.
(d) Motor vehicle is expected to have 5 years of useful life.
(e) The accounting fees include retainer fees received for service to be
provided in July and August 2008, amounting to RM3,400.
(f) Tenant owed RM500 for May and June shop rentals as at 30 June 2008.

(g) Interest on loan of RM300 is due on 30 June 2008, but this has not been
paid.
(h) Salaries accrued amount to RM600 and utilities expense accrued is
RM200.
(i) Provision of doubtful debts for RM300 is to be created.
(j) As at 30 June 2008, you are required to:
(i) Prepare the adjusting entries.
(ii) Prepare the adjusted trial balance.
(iii) Prepare
Ć Income statement and
Ć Balance sheet of MKS.
(iv) Prepare the closing entries for MKS; and
(v) Show the income summary account and capital account of
MKS.

Topic  Accounting for
6 Merchandising
Operations
LEARNING OUTCOMES
1. Explain the difference between services and merchandising
operations;
2. Journalise and post transactions of a merchandiser;
3. Calculate net sales, net purchase, cost of good sold, gross profit and
net income of a merchandiser using periodic inventory systems;
4. Prepare the income statement and the balance sheet of a
merchandiser; and
5. Prepare closing entries of a merchandiser using periodic inventory
systems.
 INTRODUCTION
In Topic 2, you have been introduced to different types of business activities.
They are merchandising (trading/retailing), manufacturing and services. This
topic will discuss in detail the nature of merchandising operations.
In the previous topics all of the examples used were that of a service provider.
You have learned how to prepare a basic income statement and balance sheet of a
business in the service industry. In this topic, you will learn how to prepare the
financial statement of a merchandiser and know the differences in the formats in
reporting revenues and expenses for merchandisers.
In contrast to businesses offering services, a merchandising business involves

purchasing goods which will later be sold to customers. Other than sales and
purchases, there are other transactions that are specific to merchandising, like
126  TOPIC 6 ACCOUNTING FOR MERCHANDISING OPERATIONS
giving or receiving discounts, returning goods and paying for deliveries of

goods. You will also learn how to record these merchandising related
transactions.
In this topic, we will make the assumption that the business uses periodic
inventory systems, where cost of goods sold will only be calculated at the end of
an accounting period.
6.1 MERCHANDISING (RETAILING/TRADING)

Merchandising business can be categorised into two types as shown in the
following diagram. It involves buying goods from one party (suppliers,
manufacturers and wholesalers) and selling it to another party (resellers and
customers).
Figure 6.1: Merchandising
The goods purchased by a business to be sold to another party is called

inventory. Inventory for one business will differ from another business
depending on its trading activities. For a business which sells cars, the cars
become its inventory; while another company that sells clothing, clothing
becomes its inventory; and the delivery van is its non current assets. For a
manufacturing company, its inventory consists of raw material, work in process
and also finished goods. You will learn about this in the cost management
module.
Inventory is reported as current asset in the balance sheet. The cost of inventory
sold, which is known as cost of goods sold will be reported as expenses in the
income statement.

TOPIC 6 ACCOUNTING FOR MERCHANDISING OPERATIONS  127
All other transactions like recording capital contribution, purchasing non current
asset, obtaining loans and paying for expenses are recorded similar to what you
have learned earlier in previous topics.
At the end of an accounting period, adjusting entries still need to be made before
adjusted trial balance is prepared. Financial statements are then prepared and
then closing entries are made. The closing entries for merchandising operation
are slightly different from the service provider.
SELF-CHECK 6.1
Think of a big retailing firm, like Carrefour, Tesco or Makro. Can you
list out their business activities? Compare their activities to the kedai
runcit in your area.
6.2 ACCOUNTING FOR MERCHANDISING

PURCHASES
We will begin this section by look at how business will record its purchases of
inventory. Later we will learn how to account for purchase discounts, purchase
returns & allowances and transportation charges.
6.2.1 Purchase of Goods

Under periodic inventory systems, purchases are recorded in a purchase account,
and only at the end of an accounting period the purchase accountÊs balance will
be added to the inventory beginning balance to determine the cost of goods
available for sales. Inventory refers to the goods a company owns and expects to
sell.
When a business purchases goods for resale, the following entry is to be made.
Date Dr Purchases XX
Cr Cash/Accounts Payable XX
Purchase goods for resale.

1 Jan 2008, ABD Cycles purchased 10 bicycles for RM250 each from Raleigh & Co
on account. This transaction will be recorded as follows:
1/1/08 Dr Purchases 2,500

Cr Account Payable ă Raleigh & Co. 2,500
Purchased 10 bicycles @ RM250 each on credit from Raleigh & Co.
Accounts payable is also known as creditor. Accounts payable will be reported in

the balance sheet as current liabilities; it represents an obligation to pay the
creditors. Accounts payable balance that appears in the trial balance and
subsequently in the balance sheet is actually the total sum of individual accounts
payables. In practice, individual or personal account payable is credited for each
credit transaction. These individual accounts are grouped together and are also
known as creditor subsidiary ledger or purchase ledger.
The relationship between individual accounts payable and the amount shown in
the balance sheet is shown in the following diagram.
Figure 6.2: Accounts payable
6.2.2 Trade Discounts

You might have seen this poster in MAKRO: „Purchase ten items and get 5%
discount.‰ Trade discounts are discounts offered by sellers to encourage buyers
to buy in bulk. The price listed will be deducted against the discount offered if
buyers buy in larger quantities. For recording purposes only the net price after
trade discount is recorded.

On 15 Jan 2008, ABD Cycles purchased 10 tricycles, with a listed price of RM330
each on credit terms. The seller offered RM30 discounts for each tricycle if more
than 5 tricycles were purchased. This transaction will be recorded as follows:
15/1/08 Dr Purchases 3,000

Cr Accounts Payable 3,000
Purchased 10 bicycles for RM300 each (after discount) on credit.
6.2.3 Purchase Discounts (Discount Received)

Goods purchased on credit must be paid according to the term of purchase. This
can be obtained from the invoice. The seller, in order to induce early settlement
of debts, might offer cash discounts. The seller might state the following
discount terms:
(a) 2/10, n/30

This term means if we pay within ten days of the invoice date, we will get a
2% discount. In other words, we will pay our creditor 2% less than the
stated amount. Otherwise, the full amount is due to be paid 30 days after
the invoice date with no discount received. For example for a credit
purchase of Rm200,000 on 5 Dec 2008, (if you pay by 15 Dec 2008), you will
pay only RM196,000. Otherwise, the whole amount is due to be paid by 20
January 2009.
(b) 5/5,eom
Eom refers to end of month. This term means if we pay within five days of
the invoice date, we will get a 5% discount. In other words, we will pay our
creditor 5% less than the stated amount. Otherwise, the full amount is due
to be paid at the end of the current month of the invoice date. For example,
a credit purchase of RM100,000 on 5 Dec 2008 terms 5/5,eom. If you pay by
10 Dec 2008, you will pay only RM95,000. Otherwise, the full amount is due
by 31 December 2008.
(c) n/eom or n/30

In this situation, no discount is offered for early settlement of debts. The
whole amount is due by the end of the month or within 30 days.
Purchased discount (discount received) is recorded when payment is made

to reflect the saving you made by not paying the full amount. Purchase
discount reduces the net purchases.

When a business pays its creditors within the discount period and receives cash
discounts the following entry is to be made.
Date Dr Accounts Payable XX

Cr Cash XX
Purchase discounts
(Discount Received) XX
On 15 January 2008, the credit purchase term was 10/15, n/eom. ABD Cycles
paid the amount due on 20 January 2008. As they paid within the discount
period, the transactions will be recorded as follows.
15/1/08 Dr Accounts Payable 1 3,000

Cr Cash 2 2,700
Purchase discounts 3 300
Paid RM3,000 accounts payable balance and received a 10% discount.
1 Total amount due from the credit purchase on 15/1/08.
2 Amount paid for early settlement 20/1/08.
3 Discount received for early settlement.

Figure 6.3: Discounts
6.2.4 Purchase Returns and Allowance

Purchase returns refer to goods that are returned by purchaser to seller to get full
refunds. Goods are returned for several reasons:
(a) Defective;
(b) Items received are not what was ordered; or
(c) Wrong specifications.
This refund can either be in the form of cash (if goods were purchased by cash)
or a reduction in the amount to be paid (if goods were purchased on credit).
ACTIVITY 6.1
Why would purchasers return their purchase to suppliers?
Purchase returns are recorded by the following entry.
Date Dr Cash/Accounts Payable XX

Cr Purchase returns and allowance XX

On 4 Jan 2008, ABD Cycles found out that 2 of the bicycles purchased were
defective, and these bicycles were returned. The transactions will be recorded as
follows.
4/1/08 Dr Accounts Payable 500

Cr Purchase returns and allowance 500
Returned two defective bicycles, RM250 each to seller.
As an incentive for buyers to keep defective or wrong specification instead of

returning it, seller might offer purchase allowances. Purchase allowances refer to
the reduction in the cost of the goods purchased.
The seller might offer ABD Cycles an allowance of RM200 of the purchase price if
ABD keeps the defective bicycles. If ABD Cycles accepts the allowance, the
following will be recorded.
4/1/08 Dr Accounts Payable 200

Cr Purchase returns and allowance 200
Accepted RM200 allowance for defective bicycles from seller.
Purchase returns and allowance (also known as returns outwards) reduce the
purchase amount. Net purchase is obtained by deducting purchase returns and
allowance from purchase balance.
Figure 6.4: Returns and allowances

6.2.5 Transportation Costs

Seller and purchaser must determine who bears the transportation (freight) cost.
This is reflected in the invoice.
(a) FOB Destination
FOB (free on board) destination means the seller pays for all the cost
related to the deliveries of goods from sellerÊs premise to purchaserÊs
premise (destination).
The accounting of this freight charges will be covered in the next section.
This outwards delivery charges is also known as freight/carriage
outwards.
(b) FOB Shipping Point
FOB shipping point or FOB factory means buyer pays all the costs related
to the goods purchased the moment the goods left the sellerÊs premise.
The ownership of the goods is passed to purchaser once the goods leave the
sellerÊs premise.
The cost principle requires that the freight charges (freight inwards)
incurred in bringing goods to purchaserÊs premises must be added to the
cost of purchased good.
As a result of the increase in cost of net purchase, the cost of goods available for
sales will increase too.
This inwards delivery charges is also known as freight inwards or carriages

inwards.
Inward freight charges are recorded by the following entry.

Date Dr Freight Inwards (Carriages Inwards) XX

Cr Cash/Accounts Payable XX
To record freight inwards expense.
On 15 Jan 2008, ABD Cycles paid a for transportation cost of RM150 cash to bring
20 bicycles purchased on to their premise.
15/1/08 Dr Freight Inwards (Carriages Inwards) 150

Cr Cash 150
Paid transportation cost of RM150 on bicycles purchased.
Figure 6.5: Transportation costs
6.3 ACCOUNTING FOR MERCHANDISING

SALES
Now we will look at how business will record their sales transaction. We will
also be looking at sales discounts and sales returns & allowances.
6.3.1 Sales of Goods

Under periodic inventory systems, sales will recorded in a sales account. When a
business sells its goods, the following entry is to be made.
Date Dr Cash/Accounts Receivables XX

Cr Sales XX
To record sales.

On 6 Jan 2008, ABD Cycles sold 5 bicycles for RM400 each on account to Kedai
Basikal Ali. This transaction will be recorded as follows:
1/1/08 Dr Accounts Receivable ă Kedai Basikal Ali 2,000

Cr Sales 2,000
Sold 5 bicycles for RM400 each on account to Kedai Basikal Ali.
Accounts receivable is also known as debtor. Just like credit purchase, in

recording credit sales, the individual or personal account receivable is to be
debited. These individual accounts are known as debtor subsidiary ledger or
sales ledger. The figure reported in the trial balance is the total sum of individual
accounts of receivables. Account receivable will be reported as current assets in
the balance sheet of the business.
The relationship between the individual accounts receivable and the amount
shown in the balance sheet is shown by the following diagram.
Figure 6.6: Accounts receivable
6.3.2 Sales Discounts (Discount Allowed)
ACTIVITY 6.2
Can you suggest ways to get debtors to pay their debts earlier?
As stated in the earlier section, cash discount is offered to encourage early

settlement of debts. To the seller it means less payment will be received for the
amount owed. Sales discount (discount allowed) is recorded to reflect the loss
made through not receiving the full amount due. Sales discount reduces the net
sales.
When a business receives payment from account receivables and allows cash
discounts, the following entry is to be made.
Date Dr Cash XX
Sales Discount (Discount Allowed) XX
Cr Accounts Receivables XX
To record receipt of payment from debtor.
The term of 6 Jan 2008 sales is 10/5, eom. ABD Cycles received the amount due
from customer on 11 January 2008. This transaction will be recorded as follows:
1
Date Dr Cash 1,800
Sales Discount 2 200
Cr Accounts Receivables ă Kedai Basikal Ali 3 2,000
To record cash received from Kedai Basikal Ali.
1 Amount received from early settlement of accounts receivable
2 Discount allowed for early settlement.
3 Amount originally owed by purchaser.
6.3.3 Sales Returns and Allowance

Sales returns refer to goods returned to suppliers. Cash will be refunded to
customer if cash sales were involved, while a reduction in amount to be paid by
customer will be made if credit sales were involved.

Sales returns are recorded by the following entry.
Date Dr Sales returns and allowance XX

Cr Cash/Accounts Receivable XX
To record returns by customer.
On 10 Jan 2008, Kedai Basikal Ali returned 1 defective bicycle to ABD Cycles. The
transactions will be recorded as follows.
10/1/08 Dr Sales returns and allowance 400

Cr Accounts Receivable - Kedai Basikal Ali 400
A customer returned 1 defective bicycle costing RM400.
As an incentive for buyers to keep defective or wrong specifications, instead of

returning it, the seller might offer sales allowances. Sales allowances refer to the
reduction in the amount the purchasers have to pay for their purchases.
Now, letÊs assume ABD Cycles offers RM50 allowance if the Kedai Basikal Ali
keep the defective bicycle. The customer accepts the allowance, as the defect is
minor and can be repaired at no cost. The following entry will be made.
10/1/08 Dr Sales returns and allowance 50

Cr Account Receivable - Kedai Basikal Ali 50
Gave RM50 allowance for defective bicycle sold to ABD Cycle.
Sale returns reduce the sales amount. Net sales are obtained by deducting sales
returns and allowance from sales balance.
6.3.4 Transportation Cost

If seller pays for the transportation charges for delivery of goods from seller to
purchasersÊ premise (FOB destination), the transaction will be recorded as
follows.

Date Dr Freight outwards XX

Cr Cash/Payables XX
To record freight outwards.
On 9 Jan 2008, ABD Cycles incurred delivery charges of RM45 in delivering

bicycles to customer. The amount will be paid on 10 January 2008. The following
entry will be made.
9/1/08 Dr Freight outwards 45

Cr Freight Payables 45
To record freight outwards.
Freight outwards will be reported as operating expenses in the income statement

of ABD Cycles at the end of an accounting period.
6.4 PREPARING FINANCIAL STATEMENTS FOR

MERCHANDISING OPERATIONS
The accounting cycle of a merchandiser is similar to the one of a service provider.
Before financial statements are prepared, the adjustment entries need to be made.
Under the periodic accounting system, Inventory account will be adjusted at the
end of an accounting period, as part of closing entries to bring the inventory
accountÊs balance to its correct amount.
After adjustments are made for prepaid expenses, depreciation, unearned

revenues, accrued expenses and accrued revenues, the adjusted trial balance will
be prepared. The adjusted trial balance will provide the information required to
prepare income statement and balance sheet.
The balance sheet of a merchandiser is similar to what you have learned earlier.
Additional items that appear in the current asset of a merchandiser are
inventory.
Reporting of revenues and expenses of merchandising operation is slightly

different than the service industry as previously covered in Topics 2 and 3.

The following diagram summarises the differences.
Figure 6.7: Differences in reporting income
6.4.1 Calculate Net Sales
Figure 6.8: Net sales

The following information is given for Meme Trading for the year ended 31
December 2008:
(a) Sales Revenue RM15,500.
(b) Sales returns and allowance RM700.
(c) Sales discounts RM400.
Determine the net sales for Meme Trading.
Net Sales RM RM
Sales revenues 15,500

(ă) Sales returns and allowance (700)
(ă) Sales discounts (discount allowed) (400) (1,100)
(=) Net Sales 14,400
6.4.2 Calculate Cost of Goods Sold

Cost of goods sold is the cost associated with sales. Under periodic inventory
systems, cost of goods sold is determined at the end of an accounting period.
Physical stock take is held at the end of an accounting period to determine the
amount of inventory on hand. This information together with opening inventory
balances, purchases, purchases returns, inwards charges and others will be used
to calculate the cost of goods sold.
Net purchases are calculated as follows.
Figure 6.9: Net purchases
Freight cost (inwards), insurance premiums, handling costs, and other costs
incurred in preparing the goods for sales are included in the cost of inventories.

The following information is given for Meme Trading for the year ended 31
December 2008:
(a) Purchases RM7,300.
(b) Purchase returns and allowance RM400.
(c) Purchase discounts RM200.
(d) Freight inwards RM100.
Calculate net purchase.
Net Purchases RM RM
Purchases 7,300
(ă) Purchases returns and allowance (400)
(ă) Purchases discounts (discount allowed) (200)
(+) Freight inwards 100 (500)
(=) Net Purchases 6,800
Cost of goods sold is calculated as follows.
Figure 6.10: Cost of goods sold
At the start of trading, inventory on hand for Meme Trading is RM1,500. At the
end of the period, physical count of inventory found that RM2,700 remained
unsold. Calculate cost of goods sold for Meme Trading.
Cost of Goods Sold RM RM
Opening inventory 1,500

(+) Net Purchases 6,800
(=) Cost of Goods Available for Sales 8,300
(ă) Closing Inventory (2,700)
(=) Cost of Goods Sold 5,600

6.4.3 Calculate Gross Profit

Gross profit is calculated as follows.
Figure 6.11: Gross profit
Gross profit of Meme Trading is calculated as follows.
Gross Profit RM RM
Net Sales 14,400

(ă) Cost of Goods Sold (5,600)
(=) Gross Profit 8,800
6.4.4 Calculate Net Income

Net income is calculated as follows.
Figure 6.12: Net income
Meme Trading incurred the following expenses during the year:

(a) Salaries expense RM3,300.
(b) Rental expense RM1,200.
(c) Utilities expense RM200.

Net income of Meme Trading is calculated as follows.
Net Income RM RM
Gross Profit 8,800

(ă) Salaries expense (3,300)
Rental expense (1,200)
Utilities expense (200) (4,700)
(=) Net Income (Profit) 4,100
If the income statement of Meme Trading is to be prepared for the year ended 31
December 2008, then it will look like the following.
Meme Trading
Income Statement for the year ended 31 December 2008
RM RM RM
Net Sales 14,400
(ă) Sales discounts (discount allowed) (400) (1,100)
Less Cost of Goods Sold 5,600
Add Net Purchases 6,800
Purchases 7,300
(ă) Purchases discounts (200)
(+) Freight inwards 100
Cost of Goods Available for Sales 8,300
Less Closing inventory (2,700)
Gross Profit 8,800
Less Operating Expenses (4,700)
Salaries expense (3,300)
Rental expense (1,200)
Utilities expense (200)
Net Income (Profit) 4,100

6.5 CLOSING ENTRIES FOR MERCHANDISING

OPERATIONS
Recall what you have learned earlier regarding closing entries. Closing entries
are entries made to close temporary accounts at the end of an accounting period.
For merchandisers, there are extra temporary accounts that need to be closed.
These additional accounts include sales, purchases, returns and discounts.
Therefore, the closing entry for merchandisers is slightly different than that of the
service provider. The inventory accounts will be adjusted during this closing
process, where the opening balance of inventory account will be transferred out
to income summary and the closing balance of inventory will be recorded.
We will look at how closing entries for merchandisers will be made using the
following examples of Meme Trading.
MEME Trading
Adjusted Trial Balance as at 31 December 2008
Debit Credit
Account
RM RM
Cash 3,000
Inventory 1,500
Land 40,000
Bank Loan 10,000
Capital ă MEME 30,000
Drawings - MEME 600
Sales revenue 15,500
Sales returns and allowance 700
Sales discounts 400
Purchases 7,300
Purchases returns and allowance 400
Purchases discounts 200
Freight inwards 100
Rental expenses 200
59,300 59,300
Additional information:
Physical count of inventory on hand at the end of year is valued at RM2,700.

Step 1: Close accounts with credit balance to income summary
The first step is to transfer the credit balance of sales revenue and other revenues
or gain accounts to the income summary account. Other temporary accounts
with credit balance like purchase returns and allowance and purchase discounts
will be closed too.
The value of closing inventory from the physical count at the end of the period is
adjusted at this stage. This is done through the following entry.
Date Dr Sales revenue XX

Other revenue (or gain) account XX
Inventory (closing value) XX
Other temporary accounts with credit balance XX
Cr Income summary account XX
For Meme Trading, the following entry should be made.
31/12/08 Dr Sales revenue 15,500

Inventory (closing) 2,700
Purchases returns and allowance 400
Cr Income summary account 18,800
The effect of this entry will bring the revenues accountsÊ balance to zero.
Sales Revenue
31/12/08 Income 15,500 31/12/08 Balance 15,500
summary

Date Sales Revenue 1 15,500
31/12/08 Inventory (closing) 2 2,700
Purchases returns and
allowance 400

Inventory
31/12/08 Beginning balance 1,500
31/12/08 Income summary 2,700
2
1 This amount will be transferred to income summary, and balance
becomes zero.
2 The closing inventory (what is left on hand) is RM2,700. The beginning

inventory will be transferred to income summary in the next step.
Step 2: Close accounts with debit balance to income summary
The second step is to transfer the debit balance of opening inventory purchases,
expenses and loss accounts and other temporary accounts with debit balance to
the income summary account. Freight inwards, sales discounts and sales returns
and allowance and all other expenses will be closed in this step. This is done
through the following entry.
Date Dr Income summary account XX

Cr Inventory (opening balance) XX
Purchases XX
Expense (or loss) account XX
Temporary account with debit balance XX
31/12/08 Dr Income summary account 14,700

Cr Inventory opening 1,500
Purchases 7,300
Sales returns and allowance 700
Sales discount 400
Freight inwards 100
Rental expense 1,200

The effect of this entry will bring all the temporary accountsÊ balance to zero.
Purchases
31/12/08 Balance 7,300 31/12/08 Income
7,300
summary

31/12/08 Inventory 31/12/08 Sales Revenue
1,500 15,500
opening
Purchases Inventory
7,300 2,700
(closing)
Sales returns and Purchases returns
700 400
allowance and allowance
Sales discount Purchases
400 200
discounts
Freight inwards 100
Closing balance 3 4,100
18,800 18,800
Inventory
31/12/08 Beginning 31/12/08 Income summary 1 1500
1,500
balance
31/12/08 Income 1/12/08 Closing balance 2 2,700
2,700
summary
4,200 4,200
1
This adjustment transfers the beginning inventory to income summary
leaving the correct amount of inventory at the end of the period as per
the physical count of RM2,700.
2 This amount will be reported as current asset in the balance sheet.
3 This amount will be transfered to capital account in the next step.

Step 3: Close income summary account to capital account
The third step is to transfer the balance (profit or loss) of the income summary
account to capital account.
If profit is recorded, the following entry is made.
Date Dr Income summary account XX

Cr Capital XX
On the other hand, if loss is recorded, the following entry will be made.
Date Dr Capital XX
Cr Income summary account XX
30/6/05 Dr Income summary account 4,100

Cr Capital 4,100
The effect of this entry will bring the income summary account balance to zero.

31/12/08 Inventory 1,500 31/12/08 Sales Revenue 15,500
opening
Purchases 7,300 Inventory 2,700
(closing)
Sales returns and 700 Purchases 400
allowance returns and
allowance
Sales discount 400 Purchases 200
discounts
Freight inwards 100
Income summary 1 4,100
18,800 18,800

Drawings
30/6/08 Closing Balance 34,100 30/06/08 Balance 30,000
Income 4,100
summary
34,100 1 34,100
1 Net profit transferred from the income summary increases the capital
balance.
Step 4: Close drawing account to capital account
The last step of the closing process is to close debit balance of drawing accountÊs
to capital account. The following entry is made.
30/6/08 Dr Capital XX
Cr Drawings XX
30/6/08 Dr Capital 600

Cr Drawings 600
The effect of this entry will bring the drawings accountsÊ balance to zero.
Drawings
31/12/08 Balance 600 31/12/08 Capital 600
Capital
31/12/08 Drawings 1 600 31/12/08 Balance 30,000
Closing 2 33,500 Income summary
4,100
balance
34,100 34,100

The drawing balance will be transferred to capital account and this

1
decreases the capital balance.
2 The closing balance of the capital account will be reported in the balance
sheet as the balance as at 31 December 2008.
Ć A merchandiser purchases goods to be resold to customers.
Ć Inventories are goods owned by a business for resale to customers.

Inventories are the current asset of a business.
Ć Cost of goods sold of a merchandiser using periodic inventory systems is

calculated at the end of an accounting period.
Ć Freight inwards contribute to the cost of purchases, and increases the cost of
goods sold.
Ć Gross profit is Net sales minus Cost of Goods Sold.
Ć Net income or net loss is determined after deducting operating cost from
gross profit.
Ć The income statement of a merchandiser reports additional items such as cost

of goods sold and gross profit, compared to a service provider.
Gross profit Net sales

Net profit Physical stock take
Net purchases Trade discount

1. Naruto operates a shop selling electrical goods. It uses periodic inventory

systems. The following are transactions for the month ended 30 April 2008.
1 April Sold 10 television sets to Ninja on credit. The list price is

RM550 each. No trade discount was offered. The term is
10/10, n/30. FOB destination.
4 Paid RM50 transportation cost for April 1 transaction.
5 Ninja returned 1 faulty television.
6 Purchase various electrical products from Syarikat Xmen on
account. Total purchase price is RM7,500, Term 5/10,n30.
9 Sold 20 washing machines to Cross Ltd. on account. The list
price is RM500. A discount of 10% will be given for purchase
of a minimum of 20 washing machines. Term 5/15, eom. FOB
shipping point.
10 Ninja paid half of the amount owed for April 1 transaction.
11 Received allowance of RM400 for defective electrical goods
purchased from Syarikat Xmen.
15 Cross paid the amount due for transaction on April, 9.
20 Purchased electrical goods from Star Ltd. worth RM1,400 on
credit. Term 2/10,n30. FOB shipping point.
21 Paid the transportation cost incurred for April 20 purchase,
RM70.
24 Sold electrical products for RM14,500 cash.
29 Paid amount owed to Star Ltd for transaction on April,20.
30 Ninja paid the remaining balance due from April 1
transaction.
2. The following is the additional information for Naruto Electrical Shop from
previous question 1:
(a) Beginning inventory as at 1 April 2008 is RM4,700.
(b) Closing inventory as at 31 April 2008 is RM1,400.
(c) Operating expenses:
(i) Salaries expense RM2,300.
(ii) Utilities expense RM500.

(iii) Motor vehicle depreciation RM1,200.

(iv) Advertising expense RM700.
You are required to prepare the income statement for Naruto Electrical
Shop for the month ended 30 April 2008.
1. Use the information in Self-Test 1 to provide the closing entries for Naruto
Electrical Shop for the month ended 30 April 2008.
2. Turbo Trading accountsÊ balance as at 30 June 2008 is as the following:
Turbo Trading
Debit Credit
Accounts
RM RM
Cash 15,900
Inventory 2,800
Accounts Receivable & Payable 2,300 4,300
Capital - Turbo 66,000
Drawings - Turbo 2,400
Sales and Purchases 11,200 25,700
Sales and Purchase Returns 400 700
Rental revenue 1,400
Sales and Purchase Discounts 1,200 900
Freight expense 900
Advertising Expenses 1,500
99,000 99,000

Additional information;
(a) Closing inventory at 30 June 2008 is RM1,400.
(b) Insurance was paid on 1 January 2008 for a three year (36 months)
coverage.
(c) Motor vehicle was purchased on 1 July 2007 and is expected to have
10 years of useful live. Straight line method is used to calculate
depreciation charges.
(d) Tenant owed RM400 for June rentals as at 30 June 2008.
(e) Turbo estimates 10% of the account receivables will be uncollectible.
(f) Salaries accrued amounted to RM600 and utilities expense accrued is
RM200.
(g) Advertising in the local magazine for July 2008 of RM500 has been
paid and included in the advertising expense.
(h) One third (1/3) of freight charges is transportation cost related to
purchases.
(i) As at 30 June 2008, you are required to prepare:
(i) income statement of Turbo Trading for the year ended 30 June
2008; and
(ii) balance sheet of Turbo Trading as at 30 June 2008

Topic  Internal
7 Control and
Cash
Management
LEARNING OUTCOMES
1. Discuss the importance of internal control for assets;
2. Define cash;
3. Describe the guidelines on the internal control for cash;
4. Explain the purpose of preparing bank reconciliation;
5. Prepare bank reconciliation;
6. Explain the purpose of petty cash fund; and
7. Journalise the creation and reimbursement of petty cash fund.
 INTRODUCTION
Is it a good idea to keep your hard earned money under the mattress instead of
in the bank? Well, there are several reasons why you should not keep your
money under the mattress. First of all, for security reasons and imagine all the
interest you could have earned if you deposited your money in the bank. Just as
cash is important to you, it is vital for business to manage not only cash but other
assets as well.
This topic looks at the accounting for current assets. What is current asset?
Current assets of a business comprise of cash, receivables, inventories, short term
investment and prepayments. These current assets are important to business. For
TOPIC 7 INTERNAL CONTROL AND CASH MANAGEMENT  155
example, business sells inventories to generate revenues. Sales of inventories can

be made in cash or credit term and credit sales will give rise to accounts
receivables. Business must manage the cash so as to avoid theft or
misappropriation. Accounts receivables must be managed effectively in order to
collect the amount owed from debtors.
This topic will look in detail at the definition of assets according to FRS. Focus is
given to current assets, in particular cash. We will discuss the basic internal
control procedures to protect businessÊ assets. Then look at the definition of cash
and why it is important to control it. You will also learn how to prepare bank
reconciliation statement. Finally, you will learn the accounting for petty cash
fund.
7.1 ASSETS
Financial Reporting Standard (FRS) defines assets as resources controlled by an

entity as a result of past events and from which future economic benefits are
expected to flow to the entity.
The definition states control rather than ownership. In other words, an entity
may not own the resources; as long as it has the control over the use of the assets,
the item will be reported as assets. LetÊs say you had purchased a car with 100%
financing from the bank; the car ownership will be transferred to you only when
you settle the loan. The bank owns the car, but you will have to report the car as
your asset as you have full control of the car (resources). You will also report the
liability (the loan) in your balance sheet.
Assets are used to generate revenue for an entity. Hence it is important to protect
the assets. Good internal control must exist to ensure assets are safe.
7.1.1 Internal Control for Assets

Internal controls are used to monitor and control business activities. An internal
control systems comprise of policy and procedures used to:
(a) safeguard the assets used in its operation;
(b) ensure accurate and reliable accounting records;
(c) promote efficient operation; and
(d) encourage adherence to company policy.

156  TOPIC 7 INTERNAL CONTROL AND CASH MANAGEMENT
ACTIVITY 7.1
1. The Institute of Internal Auditor Malaysia has published a

Statement on Internal Control ă Guidance for Directors of Public
Listed Company. A copy of this statement can be found at
http://www.klse.com.my/website/documents/intcontguid.pdf.
This statement provides guidance on the disclosure in the
annual report of public listed company on the state of internal
control in accordance to the listing requirements of KLSE.
2. Visit your favourite departmental store. Can you identify and

list the various types of internal control that are used to protect
their assets?
These policies and procedures vary from one organisation to another, depending
on the nature of their business and size. Among others, the following procedures
must exist to ensure adequate internal control in an organisation.
(i) Maintain adequate records. For example, detailed record of assets should
be kept so that it is difficult for assets to be stolen or go missing without
detection.
(ii) Insure assets. Protect business property assets and human resources with
adequate insurance coverage. For example, assets must be protected
(warehouse locked and guarded) and insured against theft and fire.
(iii) Separate bookkeeping from custody of assets. Responsibility for initiating
business transactions and custody of business assets must be separated
from the responsibility for maintaining accounting records. This is to avoid
or minimise the risk from misappropriation of assets. For example, a
storekeeper is not the same person initiating the purchase of office supplies.
(iv) Apply technological controls. Use devices designed to protect assets and
improve accuracy of the accounting process. For example, the use of
electronic tag to protect books in the library from getting stolen.
(v) Perform regular and independent reviews.

7.1.2 Current Assets

According to Malaysian accounting standard FRS 101 ă Presentation of Financial
Statement, an asset is classified as a current asset when it is:
(a) expected to be realised in, or is held for sale or consumption in, the
normal course of the enterpriseÊs operating cycle; or
(b) held primarily for trading purposes or for the short term and expected to
be realised within twelve months of the balance sheet date; or
(c) cash or a cash equivalent asset which is not restricted in its use.
All other assets should be classified as non-current assets.
Source:http://www.masb.org.my/MASB_Std_Eng/masb1a.htm (para. 57).
In other words, current assets include cash or cash equivalent and other assets
that can be converted into cash, and other assets that can be resold or used in
manufacturing goods within a period of one accounting year or less.
Current assets are shown in Figure 7.1.
Figure 7.1: Current assets
You have learned how to record transactions related to accounts receivable, i.e.
recording and reporting bad debts and provision for bad debts in Topic 5,

prepaid expenses was also explained in detail in Topic 5, and the recording of
inventory under periodic inventory systems was covered in Topic 6.
The following sections will look at accounting for cash in detail.
7.2 ACCOUNTING FOR CASH

Cash is the most important assets a business has. Cash is crucial to the survival of
a business entity. A business may report high profit, but without cash to run its
operation, the business will be faced with liquidity problem.
Cash is defined as cash and bank deposits and any items that are accepted by
bank as deposit. These items include coins, currencies, cheques, bank draft,
postal order, money order, travellerÊs cheques and others.
Cash is the most liquid asset and thus is easily hidden and moved. Hence a good
internal control is required to avoid stolen and misappropriate of cash.
7.2.1 Internal Control For Cash

An effective system of internal control to protect cash should have the following
guidelines:
(a) All cash receipts and payments must be accompanied by a document or

evidence: a receipt, bill, invoice or cheque butt. The use of pre-numbered
receipts and cheque helps internal control for cash.
(b) All cash receipts must be deposited into the bank account at the end of each
day. In the event that cash are kept at the premise of business, it must be
stored in a locked vault at the premise until it is deposited into the bank
account.
(c) All payments must be made through issuing of cheques, except for a
smaller amount which uses the petty cash. In many business organisations,
a cheque requires two signatories rather than one for tighter cash control.
(d) Established responsibility ă assigned task that is suitable to an individualÊs

qualification and experience. This reduces the possibility of errors and
when a problem occurs, it is easy to identify the person responsible.

For example, at the check out counter, only the cashier can receive cash
from the customer.
(e) Separation of duties, staff who receive and handle cash should not be
involved in recording (bookkeeping) of cash transactions.
(f) Rotation of duties. Temptation and fraud can be reduced if employees

know that they can be transferred without notice from one department to
another. For example, banks rarely allow their employees to work at the
same branch for more than three years.
(g) Periodical visits and random checks. Management and supervisors must
check on their employees; for example check records and tabulate cash to
see if they tally.
(h) Perform bank reconciliation.
ACTIVITY 7.2
In your opinion, why must a business protect its cash? How do you
control your own cash? Discuss with your friends.
7.3 BANK RECONCILIATION
Bank reconciliation is a document to explain all differences between a firmÊs

own cash records and the bank statement figures on a certain date. It is
prepared by the firm (not the bank) to ensure accuracy of financial records.
Before we go on to discuss the steps involved in preparing bank reconciliation

statement, weÊll look at the types of bank accounts available. We will then look at
the purposes of preparing bank reconciliation statement.
7.3.1 Types of Bank Accounts

Businesses will keep their cash in the bank. There are at least three different types
of bank accounts.

Figure 7.2: Types of bank accounts
(a) Savings account ă Account holder can withdraw money at any time
through a passbook or any automatic teller machine (ATM). Account
holder can update the passbook to know the detailed transactions and
current balance of account.
(b) Current account ă No passbook is given to account holder although money
can be withdrawn through the ATM at any time. An additional feature of a
current account is the ability of account holder to draw cheques to make
payments. Account holder will receive a bank statement detailing
transactions of a particular month.
(c) Fixed deposit account ă Cash is kept at the bank for a certain period of time.
Cash cannot be withdrawn within this period without a penalty. Higher
interest rate is earned compared to saving and current accounts.
A business normally owned a few types of bank accounts. However, in this topic,
we will assume that business only keeps one type of bank account, which is
current account.
Firms will record cash as receipt when they receive cheques from another party.
Hence, the firmÊs cash account will record an increment (DEBIT CASH). These
cheques are later deposited into the firmÊs bank account. Once the cheques are
cleared, the amount will be added to the firmÊs current account balance (CREDIT
CURRENT ACCOUNT).
The same applies when the firm draws cheques to make payments to another
party (suppliers, employees, creditors); it will be recorded as cash payment and
hence the firmÊs cash account will record a decrease (Credit Cash). The holder of
these cheques will later present the cheque to the bank to demand payments. If
there is sufficient fund in the account of the drawer (the firm), the bank will
honour the cheque and deduct the amount from the firmÊs current account (Debit
Current Account of the firm).

Did you notice that when we deposit cash or cheque in the bank, the bank
statement will show as a credit? When this cash is deposited in a bank, the bank
has an obligation to pay the money back to the customers on demand. The
deposits represent a liability to banks, and therefore customers` bank accounts
have credit balances.
Figure 7.3: Flow of bank deposit and payments

At the end of the month, banks will issue statements detailing transactions to the
firm. It is uncommon to see the balance of a firm's Cash account exactly equal the
cash balance shown on the firm's bank statement. Therefore, the need arises for
reconciliation of firmÊs cash account and the bank statement.
ACTIVITY 7.3
Can you figure out the reasons for the difference in the bank balance
and the book balance?
7.3.2 Purposes of Preparing Bank Reconciliation

Bank reconciliation is prepared by a firm in order to:
(a) reconcile the balance of firmÊs cash account with the balance stated in the
bank statement for a particular month; and
(b) ensure the accuracy and the validity of items recorded in the cash account.
Any omissions and errors can then be corrected.
The balance on the bank statement usually disagrees with the cash account
balance according to the firmÊs records because of the following reasons:
(i) Items (transactions) which appear in the bank statement (e.g. bank charges,
interest, dishonoured cheques, etc...) but have not yet been recorded by the
firm.
(ii) Items recorded in firm's cash account (for the same period) may NOT be
recorded by bank on bank statement, e.g. unpresented/outstanding
cheques drawn by the firm, late deposits, deposits in transit.
(iii) Errors made by the firm or bank in their respective accounts.

Figure 7.4: Bank statement
7.3.3 Preparation of Bank Reconciliation Statement

The following are the steps that you should follow in order to prepare bank
reconciliation.
Ć If items appear in cash account and bank statement, tick ( ) the items off.
Ć Check also for errors in figures recorded in the cash accounts. We always
assume the figures shown in the bank statements are correct unless stated
otherwise.

Ć Items that are not ticked in the debit side of cash account are deposit in
transit or deposit not yet credited. (Cash receipts that a firm has deposited
into bank but, not yet credited into firmÊs current account by the bank).
Ć Items that are not ticked in the credit column of the bank statement, are items
that the firm has not recorded as receipt in the firmÊs cash account. (Bank has
recorded receipts of cash in the firmÊs current account).
Ć If items appear in cash account and bank statement, tick ( ) the items off.
Ć Check also for errors in figures recorded in the cash accounts. We always
assume the figures shown in the bank statements are correct unless stated
otherwise.
Ć Items that are not ticked in the credit side cash account are unpresented
cheques (Cheques that have been issued to creditors, but the amount has not
been deducted by the bank from firmÊs current account).
Ć Items that are not ticked in the debit column of the bank statements are items
that the firm has not recorded as payments in the firmÊs cash account. (Bank
has deducted payments of cash in the firms current account)
Ć Examples of items that appear in the bank statement but not yet recorded in
the firmÊs cash account and their treatment are as follows:
DEBIT FIRMÊS CASH ACCOUNT CREDIT FIRMÊS CASH ACCOUNT

Dividend received Bank charges/fees
Direct credit Stamp duty & taxes
Interest on deposit Dishonoured cheques
Direct debit
Ć Dishonoured cheques are cheques that are received by a firm, and are
recorded as receipts in the cash book. However, due to several factors such as
insufficient funds in the drawerÊs account, wrong signatures, errors or
expired dates; the cheques will not be honoured by the paying bank. In this
case, firm must correct the entry first made to record the receipt. Therefore

credit the Bank account, and debit the related account for example, debit
Accounts Receivable.
Ć Amend errors made in the firmÊs cash account.
Ć Normally, journal entries are required to be made before cash book is
updated. In the illustration, you will be shown the journal entries.
After taking into account all of the adjustment from the above, you need to
determine the new cash account balance (Important! This will be the starting
figure for your bank reconciliation statement).
Cash account can have credit balance, when it means the firm has drawn more
funds than it has. If firms have arranged for overdraft facilities with the bank, the
bank will allow an overdraft. Firm will need to pay interest on the overdraft
facilities, as well as paying off the overdraft. Overdraft will be reported as
current liabilities in the balance sheet.
Cash Account
Opening bank Cash payments
XX XX
balance
Cash receipts Bank fees &
XX XX
charges
Dividend Received XX Stamp duties XX
Interest on deposit XX Direct debit XX
Direct credit Dishonoured
XX XX
cheque
Correction of errors Correction of
XXX XX
errors
Balance c/d 1 XXX
XXX XXX

FirmÊs Name
Bank Reconciliation as at 31 December 2008
RM RM
Balance as per cash account XXX
Add Unpresented cheques (list all items)
Cheque no 10## XX
Cheque no 11## XX
2 Bank errors in crediting current account XX XXX
XXX
Less Deposit in transit
Deposit not yet credited XX
2 Bank errors in debiting current account XX XXX
Balance as per bank statement 3 XXX
1 This balance will be the balance used in the bank reconciliation

statement
2 Bank can make errors through crediting (adding) funds that do not
belong to customers or debiting (deducting) funds.
3 This figure should be the same as the balance stated in the bank
statement. An overdraft will be shown as DEBIT balance in the bank
statement.
* Note: If the cash account balance is credit, the figure will be shown in brackets (XX)
To help you learn the preparation of bank reconciliation, let us look at this
illustration. You were asked to prepare bank reconciliation for Syarikat Kejora for
the month ended 30 March 2008. The balance in the cash at bank shown a balance
of RM9,750 while the bank statement show a balance of RM9,812.
Example 7.1
Assuming that you have completed step 1 and step 2, whereby you compare
the cash account and bank statements, you must have ticked items that
appeared in both cash account. The cash accounts and bank statement will look
like the following.

Step 1 and 2: Compare cash account and bank statement
Cash Account
1/3 Balance b/d 5,700 4/3 A/P ă Eda (1008) 300
2/3 A/R ă Ali 1,500 10/3 A/P ă Loo (1009) 2 150
13/3 A/R ă Zack 1 2,600 15/3 Salaries (1010) 400
23/3 Rental Revenue ă 300 27/3 Purchase (1011) 1,200
Burn
25/3 Sales 3,300 30/3 Insurance (1012) 2 1,600

30/3 Balance b/d 9,750
13,400 13,400
Syarikat Kejora
Bank Statement as at 30 March 2008
DEBIT CREDIT BALANCE
1/3 Balance b/d 5,700
3/3 Deposits 1,500 7,200
6/3 Cheque 1008 300 6,900
Standing instruction to pay 4 450
10/3 6,450
subscription fees
15/3 Cheque 1010 400 6,050
17/3 Deposits (for A/R - Alin) 4 2,300 8,350
23/3 Deposits 300 8,650
25/3 Deposits 3,300 11,950
27/3 Cheque 1011 3 2,100 9,850
30/3 Bank Charges 40 9,810
30/3 Stamp duties 4 8 9,802
30/3 Interest 4 10 9,812
1 Deposit in transit.
2 Unpresented cheques.
3 Error has been made in recording purchase as RM1,200, the correct amount
should be RM2,100.

4 Item not yet recorded in the cash book.
Step 3: Update cash account
Cash Account
30/3 Balance b/d 9,750 30/3 Bank charges 40
A/R-Wan 2,300 Stamp duties 8
Interest 10 Purchase 900
Subscription fees 450
Balance c/d 10,662
12,060 12,060
Remember the accounting cycle? Journal first, then only posting to accounts. The
following are journal entries required to record the unrecorded transactions and
correct errors.
Debit Credit
Dr Cash 2,300
Cr Account Receivable ă Wan 2,300
To record receipt of payment into bank account from AR-Wan
Dr Cash 10
Cr Interest Revenue 10
To record interest on cash deposit
Dr Bank Charges 40
Cr Cash 40
To record bank charges
Dr Stamp duties 8
Cr Cash 8
To record stamp duties
Dr Purchase 900
Cr Cash 900
To correct amount of purchases recorded
Dr Subscription fees 450

Cr Cash 450
To record payment of subscription fees through standing instruction

Step 4: Prepare the bank reconciliation statement
Syarikat Kejora
Bank Reconciliation as at 30 March 2008
RM RM
Balance as per cash account 10,662
Add Unpresented cheques
Cheque 1009 150
Cheque 1012 1,600 1,750
12,412
Less Deposit in transit
A/R ă Zack 2,600
Balance as per bank statement 1 9,812
1 This figure must equal with the balance as per the bank statement of
Syarikat Kejora.
7.4 PETTY CASH

Although we emphasise the use of cheques for all cash transactions of business to
enhance control of cash, it is unavoidable but to use cash in certain transactions.
It is inconvenient to use cheques to make payments for small amount, for
example, such as stamps, drinks, provisions or taxi fare.
The cash kept at the business premise is known as petty cash. This cash is used to
pay for items of smaller amounts. Although the amount involved is small,
frequent transactions can lead to a bigger amount. This petty cash must be
controlled in order to avoid misappropriation and fraud.
The imprest petty cash system is used to operate the petty cash book. We will
look at how the system is used to control petty cash.
7.4.1 Creating the Petty Cash Fund

A specific individual is appointed to handle the petty cash. He or she will be
responsible for all payments made using the petty cash. To create the petty cash,
an estimate of cash required for a specific period must be made. This amount is

then withdrawn from the bank account and given to the person in charge of the
petty cash, known as petty cashier (custodian).
The petty cashier will keep the petty cash in a safe place (safe deposit/vault).
Another control practice is to set the maximum amount for payment. For
example, any payment exceeding RM50 must not be made using petty cash. Or
conditions or terms of usage; only payment for postage, stationeries or fares shall
be allowed from the petty cash.
Assume that on 1 January 2007, Segar Berhad agreed to create a petty cash fund
of RM500. It was also agreed that the funds will be reimbursed at the end of
every month or whenever the amount used reaches RM400, whichever comes
first.
The journal entry to create the petty cash fund for Segar Berhad on 1 January
2007 is as follows.
Dr Petty cash 500

Cr Cash 500
To record the establishment of petty cash fund of RM500.
7.4.2 Using the Petty Cash Fund

Employees or other parties that demand payment from the business must
provide bills or receipts as evidence of payment to the petty cashier. These bills
and receipts must be kept together with the petty cash. The petty cashier must
ensure that all conditions set earlier (e.g. amount not exceeding RM50) must be
met before reimbursement is made. The petty cashier will issue a receipt to the
employees or other parties that demand payments.
At all times, the petty cash amount and the total of claimed payments (based on
the bills or receipts collected) must be equal to the amount originally set as petty
cash fund.
Do take notes that no records are made when payments are made by the petty
cashier. These transactions (expenses) will be recorded only when the petty cash
fund is reimbursed again. For control purposes, the person responsible to record
the transaction must not be the same as the petty cashier; this is to avoid
misappropriation or fraud by the petty cashier. The petty cashier will submit the
receipts or bills of payment to the person responsible to make the journal entries
and receive the amount to reimburse its petty cash.

No journal entries are made for petty cash payments until the fund is
replenished. This system avoids the need to journalise many small payments.
7.4.3 Reimbursement of the Petty Cash Fund

As mentioned earlier, no records are made at the times of reimbursing the
amount claimed by employees or other parties. Petty cash will decrease as more
and more reimbursement are made.
For illustration purposes, letÊs assume that for the month of January 2004,
payments using the petty cash fund comprise the following: stationeries RM46;
postage RM15; newspaper RM33, petrol RM45; taxi fare RM5 and magazines
RM12.
The journal entries to record the expenses and the reimbursement of petty cash
fund is a the following:
Dr Stationeries 46
Dr Transportation expense* 50
Dr Miscellaneous expense** 60
Cr Cash 156
To record expenses using the petty cash fund and the reimbursement of petty
cash fund
* Expenses of the same nature are added together.

** Depends on company size, bigger companies will have separate individual expenses account
for postage and subscriptions of newspapers and magazines.
The above entry will bring the petty cash amount to the original amount of
RM500.
Did you notice that there is no entry made to petty cash account? Entry to petty
cash account is only made only for the following situations:
(a) The creation of petty cash fund
(b) The petty cash amount is to be reduced or increased
Assume Segar Berhad decides to reduce its petty cash fund to RM400 from
RM500. The following entry will be made.

Dr Cash 100
Cr Petty cash 100
To decrease the amount of petty cash fund
If Segar Berhad decides to increase its petty cash fund from RM500 to
RM700, the following entry will be made.
Dr Petty cash 200

Cr Cash 200
To increase the amount of petty cash fund
(c) The petty cash account is to be eliminated

If for some reason, Segar Berhad decides to close its petty cash fund of
RM700, the following entry will be made:
Dr Cash 700
Cr Petty cash 700
To close off petty cash fund.
In some instances, the balance of petty cash fund added with the total expenses
did not tally (amount different than the original amount of petty cash fund). This
is probably due to errors where we have overpaid or underpaid claims for
reimbursement, or even fraud or theft. How would we record this short of petty
cash or over of petty cash?
To illustrate, the following entries are made to reimburse a RM100 petty cash
fund when its payments receipts only show that RM75 and only RM15 cash
remains. This indicates a shortage of RM10.
Dr Miscellaneous expense 75
Dr Cash short and over 10
Cr Cash 85
To record shortage of petty cash of RM10.

In the even that there balance of petty cash fund is more than what it should be,
the amount then will be credited to Cash Short and Over account.
To illustrate, the following entries are made to reimburse a RM200 petty cash
fund when its payments receipts shows RM185 and only RM45 cash remains.
This indicates a cash over of RM30.
Dr Miscellaneous expense 185

Cr Cash short and over 30
Cr Cash 155
To record over of petty cash of RM30.
Cash short and over will be reported as revenue or expense in the income
statement depending on the balance of the account at the end of the accounting
period. A debit balance is expense (shortage), while credit balance is revenue
(over).
 Assets are defined as resources controlled by an entity as a result of past

events and from which future economic benefits are expected to flow to the
entity.
 Current assets include cash or cash equivalent and other assets that can be
converted into cash, and other assets that can be resold or used in
manufacturing goods within a period of one accounting year or less.
 Internal controls are used to monitor and control business activities. An

internal control systems comprise of policy and procedures used to:
- safeguard the assets the business used in its operation;
- ensure accurate and reliable accounting records;
- promote efficient operation; and
- encourage adherence to company policy.
 Cash includes coins, currencies, cheques, bank draft, postal order, money
order, travellerÊs cheques and others.

 Bank reconciliation is prepared to check the accuracy of the firmÊs cash

account with the bankÊs record.
 Bank reconciliation is prepared by a firm in order to:

- reconcile the balance of firmÊs cash account with the balance stated in the
bank statement for a particular month; and
- ensure the accuracy and the validity of items recorded in the cash
account.
Bank reconciliation Cash on hand

Bank statement Cash short/over account
Cash and equivalents Deposits in transit
1. The following is information regarding Syarikat Kampung as at 31 May 2008.
RM
Cash account balance 1/5/2008 4,650
Total cash receipts in May 2008 7,600
Total cash payments in May 2008 3,670
Bank statement as at 31/5/2008 shows closing balance of RM6,675
Reconciliation exercise found the following:

(i) A cash deposit made on 31 May 2008 of RM2,460 does not appear in
bank statement.
(ii) Bank has erroneously deducted a cheque (cheque number 20345) of
RM1,200 drawn by another company, Syarikat Lampong.
(iii) Three cheques drawn in May remains unpresented
Ć Cheque 10345 450
Ć Cheque 10347 590
Ć Cheque 10348 430

(iv) Bank has recorded a receipt of RM3,300; Jaya Holding paid its debts
directly to Syarikat KampungÊs current account.
(v) Bank service charge for May is RM20
(vi) Interest revenue for May is RM15
(vii) Syarikat Kampung has a standing instruction to pay insurance though
auto debit. RM2,400 was deducted in May.
(viii) The bank statement shows a dishonoured cheque from A/R - Sukar of
RM700.
(ix) Cheque drawn as payment to A/P-Anita was recorded in the cash
account as RM540; the correct amount should be RM450.
(a) Update the cash account of Syarikat Kampung.
(b) Provide the journal entries for the adjustment made in the cash
account.
(c) Prepare a bank reconciliation statement for Syarikat Kampung as at
31 May 2008.
2. In your opinion, why must businesses prepare bank reconciliation?
3. Some items in the bank statement must be journalised. What are examples
of items that need to be journalised? What will happen if a business does
not make the journal entry?
4. Explain why the amount of dishonoured cheques due to insufficient fund

will be deducted from the cash account when preparing bank
reconciliation?
1. The following is information regarding petty cash fund of Mushy

Enterprise as at 28 February 2008.
RM
Petty cash fund amount as at 1 February 2008 250.00
Petty cash fund amount as at 28 February 2008 46.70

Bills and receipts details for the months of February 2005 are the following:
RM
Stationeries 73.50
Postage 15.60
Taxi fare 12.60
Minor repairs on office printer 45.00
Bus fare- 5.50
Newspaper 30.00
Mushy also planned to increase the petty cash fund to RM300.
You are required to provide the journal entry for the above transactions.

8 Partnership
LEARNING OUTCOMES
1. Describe the provisions in The Partnership Act 1961;
2. Explain the characteristics of a partnership;
3. Differentiate between partnerships and sole proprietorships;
5. Prepare accounting entries for partnerships; and
6. Identify differences between current accounts and capital accounts.
 INTRODUCTION
It has become a trend for big companies around the world to form partnerships
to enhance their profiles. Sometimes, launching products or services produced by
two big corporations can attract more customers. The Maxis Microsoft
partnership programme in the advertisement below (http://p0.com.my/
maxis/m2/) is a good example of a partnership that encourages the development
of commercial mobility solutions in mobile technology. However, there are
several fundamental concepts for partners to look at prior to planning a
partnership.
Maxis and Microsoft Malaysia are proud to be partners in

launching the M2 Collaboration Programme which aims to
encourage the development of commercial mobility solutions
and empower solution providers with Microsoft's cutting-edge
development tools and platform. The M2 Collaboration
Programme lasts from 1November 2004 to 30 October 2005.
In this topic, we will introduce some fundamental concepts and basic accounting
entries for partnerships. A proper book record is essential for any business. It is
even more important for a partnership because of its complexities, compared to a
178  TOPIC 8 ACCOUNTING FOR PARTNERSHIP
sole proprietorship, as the management of the partnership involves more than

one individual. Therefore, good accounting records are essential, in case of any
disputes among partners. Businesses of any type, ranging from groceries shops
to supermarkets, can be established in the form of partnerships.
8.1 SETTING UP A PARTNERSHIP

A sole proprietorship is a business run mainly by one person. When it grows, it
requires additional capital and manpower to manage the day-to-day operations
in order to be competitive. In such a case, the business of a sole proprietor can be
converted into a partnership. This is done by inviting suitable candidates to
become partners in the business. By doing so, the business will have additional
capital and manpower for the purpose of expansion.
SELF-CHECK 8.1
What is the main difference between a partnership and a sole

proprietorship?
In todayÊs knowledge-based economy, a business can be successful if a group of

individuals with the necessary knowledge and skills works towards a common
goal. By combining all the required resources, the partnership becomes a viable
option for individuals to succeed in the world of commerce.
A partnership is usually managed by partners who differ in character and

management styles. Such differences or diversity in handling the business
operation can easily complicate the partnership. Therefore, there are some things
to consider before entering into a partnership.
In the following section, we will examine the basic characteristics of a

partnership and introduce you to the unique accounts which appear only in
partnerships.
SELF-CHECK 8.2
What are the problems that may arise upon setting up a partnership?

TOPIC 8 ACCOUNTING FOR PARTNERSHIP  179
8.2 BASIC CHARACTERISTICS OF A

PARTNERSHIP
A partnership is a business entity which exists when two or more people carry on
a business with the aim of making money. Partnerships are governed by the
Partnership Act 1961.
Students should take note that a partnership is established when a group of

individuals agree to share management as they have very limited capital resources
to start a business on their own. That a partnership should have two or more
partners is a fundamental concept. It is common in a partnership for each partner to
contribute an agreed amount of money and time to make the business profitable.
SELF-CHECK 8.3
What are the main characteristics of a partnership?
A partnership can be established by verbal agreements, written agreements or

under seal. The partnership agreement is a binding contract that stipulates the
rights, liabilities and duties of the individual partners. However, it is not
uncommon for a partnership to be set up without an expressed agreement
among the partners. However, it is advisable for a partnership to have a written
agreement. This is to avoid unnecessary conflict that may arise in the future. It is
important to have a mutual agreement on such matters, as shown in Figure 8.1.
Figure 8.1: The importance of having a mutual agreement among partners

8.2.1 The Partnership Act

The Partnership Act plays an important role if there is no formal partnership
agreement drawn up by the partners. The major provisions in the Act relating to
the partnership arrangement are as shown in Figure 8.2.
Figure 8.2: Major provisions in the Partnership Act
Under the Partnership Act, each partner has unlimited liabilities. This implies
that all partners are jointly-liable for the debts of the partnership. In other words,
creditors have the right to claim the private property of the individual partner in
the event of a lawsuit against the partnership. This is a critical issue to consider
before an individual decides to enter into a partnership business.
SELF-CHECK 8.4
List the provisions in the Partnership Act.
8.2.2 Types of Partnerships

As can be seen in Figure 8.3, there are three main types of partners in a
partnership, namely active partners, sleeping partners and limited partners.

Figure 8.3: Three main types of partners in a partnership
ACTIVITY 8.1
What is your opinion regarding the statement „partnership means

profit‰? Discuss with your classmates and present your findings in the
classroom.
8.2.3 Advantages and Disadvantages of a Partnership

Balachandran, Low, Khadaroo and Subramaniam (2002) list the advantages and
disadvantages of a partnership in Table 8.1.

Table 8.1: Advantages and Disadvantages of a Partnership
Advantages Disadvantages
 More resources for the business;  Unlimited liabilities;
 Sharing of technical and  Subject to restriction imposed by the
managerial skills; agreement; and
 Sharing of losses; and  Profit must be shared according to the
 Tax incentives may be available. profit-sharing ratio of the partnership
agreement.
8.3 CONVERSION OF SOLE PROPRIETORSHIP

TO PARTNERSHIP
As mentioned above, when a business grows and additional capital is needed, a
sole proprietor may form a partnership. This can also take place when two or
more sole traders agree to combine their business activities into one enterprise.
It should be noted that running a partnership is different from running a sole

proprietorship. It is always important to have a proper partnership agreement in
place, so that future disputes can be better resolved. When a sole proprietor
intends to convert his business into a partnership, he has to be fully aware of all
the advantages and disadvantages of a partnership, as outlined above.
ACTIVITY 8.2
1. What are the clauses normally included in a partnership
agreement?
2. How can the expressed partnership agreement protect the partners
should there be any legal dispute?
3. What are the benefits of a partnership business?
4. What are the disadvantages of a partnership business?
8.4 PARTNERSHIP ACCOUNTS

The recording of the daily transactions of a partnership business is no different
from that of a sole trader. Recording these transactions properly is essential to
ensure that the partners can easily access relevant information. Such information

is important to help businessmen make good decisions to make their business

thrive.
To keep a record of the share equity of each partner, it is common to keep two
accounts in a partnership account: capital account and current account. We will
discuss in detail these special accounts in the following sections.
8.4.1 Capital Account of a Partnership

Capital injection is needed to start up commercial activity. In a partnership, it is
very common for each partnerÊs capital contribution to be spelt out clearly in the
partnership agreement. The amount of capital brought into the business by the
partner will be recorded in the capital account in the partnership book.
Figure 8.4: Adjustment on the capital account when the above event takes place
This account will normally remain the same (initial amount) throughout the
partnership, unless there is an adjustment to the account balance as shown above
in Figure 8.4. Capital injection is not limited to cash. It can be fixed assets
contribution, such as motor vehicles, furniture and fittings, equipment,
computers etc.

Example 1
Sea and Lion entered into a partnership on 31 December 2009, selling T-shirts
and jeans at KLSS shopping mall. To start up the business, Sea and Lion each
made an initial capital contribution of RM84,000 and RM105,000,
respectively.The partnership commenced on 1 January 2010. In addition to the
cash contribution of each partner, Sea brought a van worth RM187,500 into the
business.
Required
Prepare the capital account of each partner in the partnership.
Solution
Capital ă Sea
2010 RM 2010 RM
31 Dec Balance c/f 171,500 1 Jan Cash 84,000
171,500 171,500
Capital ă Lion
2010 RM 2010 RM
It can be seen in the above example that the capital introduced by the partners
is credited into capital accounts. The same amount would be carried forward to
the next financial year in the event there is no additional adjustment to the
accounts during the year. Should there be an adjustment during the year, the
total capital to be carried forward will need to reflect such an adjustment.
Using the above example, if we assume Lion decided to increase his capital by
adding another RM70,000 on 30 June 2010, the capital account for Lion will be
as follows:
Capital ă Lion
2010 RM 2010 RM
30 June Cash ă injection 70,000
175,000 175,000

8.4.2 Current Account of a Partnership

Apart from the partnersÊ capital accounts, a current account is used to keep the
record of the balance of retained profit attributable to each partner.
This account is prepared to record the following:
(a) Share of profit for each partner;
(b) Drawings of money or goods taken by the partners;
(c) Interest on loans to the partnership; and
(d) PartnersÊ salaries.
In this account, a debit balance implies that the partner has withdrawn from the
business more than his share of profit.
A partnerÊs current account is shown as follows:

Current Account
RM RM
Interest on drawings XX Balance b/f XX
Drawings XX Interest on capital XX
Balance c/f XX Interest on loan XX
Partner salary XX
Share of profit XX
XX XX
They may also have a separate drawings account which records all goods or
money taken out by the partners during the year. However, the balance of this
account will need to be transferred to the partnersÊ current accounts at the end of
the year. Therefore, sometimes current accounts are labelled as drawings
accounts.
Current accounts = Drawings accounts
By looking at the following example, you should be able to maintain proper

capital and current accounts for the partners in a partnership. You can apply the
concept mentioned above to help you comprehend the accounting entries of a
partnership.

Example 2
Sean and Steven are in a partnership selling second-hand books and

magazines in Kuala LumpurÊs Chinatown.
As at 1 January 2010, the capital and current account balances of the business
were as follows:
Sean Steven
Capital RM48,000 RM32,000
Current RM4,800 RM2,400
Sean took RM800 worth of books for his daughter on 1 April 2010, while
Steven withdrew RM480 from the business on 1 June 2010. Interest of 2% on
the drawings is charged under their partnership agreement. Based on the
agreement, profit and loss are to be shared equally.
Required
Prepare proper capital and current accounts for Sean and Steven as at
31 December 2010.
Solution
Capital ă Sean
2010 RM 2010 RM
31 Dec Balance c/f 48,000 1 Jan Balance b/f 48,000

Capital ă Steven
2010 RM 2010 RM
Current Account ă Sean

2010 RM 2010 RM
1 Apr Drawings 800 1 Jan Balance b/f 4,800
31 Dec Interest on 12
drawings
31 Dec Balance c/f 3,988
4,800 4,800
Current Account ă Steven

2010 RM 2010 RM
1 Jun Drawings 480 1 Jan Balance b/f 2,400
31 Dec Interest on 5.6

drawings
31 Dec Balance c/f 1,914.4
2,400 2,400
Table 8.2 summarises the differences between a capital account and a current
account.

Table 8.2: Capital Account versus Current Account
Capital Account Current Account

To record the initial capital contribution of To record the balance of retained profit
each partner. distributable to each partner.
The capital amount will remain the same, To record:
unless adjustments are made to the (a) Share of profit for each individual;
accountÊs balance, such as new injection of
(b) Drawings of the partners;
capital into the business.
(c) Interests on loans and capital; and
(d) Salaries of partners.
Capital injection is not limited to cash. It Sometimes, it is also labelled as drawings
includes items such as furniture and account.
fittings, equipment, car and computers.
ACTIVITY 8.3
Compare and contrast current accounts and capital accounts. Discuss
with your classmates and present your findings in the classroom.
8.4.3 Profit and Loss Appropriation Account of a

Partnership
The profit and loss account of a partnership is prepared in a similar way to that
of a sole proprietor. It includes the income and expenses of the partnership.
Income such as sales and interest received are credited to the profit and loss
account. Cost of goods sold and expenses such as rental and salary are debited to
this account.
In the partnership account, after the normal profit and loss account has been
prepared, there is an additional account, known as the appropriation account,
which has to be prepared as well. This account shows the profit and loss sharing
among the partners.
The net profit in the profit and loss account is carried down to the appropriation
accounts followed by:
(a) Interest on capital;
(b) Interest on drawings; and
(c) PartnersÊ salaries.

The balance of the appropriation account will be shared among the partners
based on the agreed profit and loss sharing ratio. You will get a better
understanding of the appropriation account from Example 3 shown below.
Example 3
Mimi and Sue are in a partnership that has provided packed lunches for
secondary schools in Sungai Long since 2000. For the year ended 31 December
2010, their partnership recorded a profit before appropriation of RM60,000. Sue
received a salary of RM12,000 as she worked full-time in the business. Mimi, on
the other hand, received a salary of RM7,200 as she only worked part-time. In
addition, during the year Mimi took out some goods worth RM2,400 for personal
use. Based on the partnership, interest on drawings is agreed at 5% per annum.
Under the partnership agreement, profit and loss are to be shared between Mimi
and Sue in the ratio of 2/3 and 1/3 respectively.
Required
Prepare a profit and loss appropriation account.
Solution
Mimi and Sue
Profit and Loss Appropriation Account
For the Year Ended 31 December 2010
RM RM
Salary: Net Profit b/f 60,000
Mimi 12,000
Sue
7,200
Interest on drawings: 120
Mimi ă 5%  RM2,400
Profit-sharing:
Mimi (2/3) 27,280
Sue (1/3) 13,640
60,120 60,120

8.4.4 Final Account of a Partnership

By now you should have a general understanding of partnership accounts and be
quite familiar with the additional accounts to be prepared in a partnership business.
To recap, in a partnership account, capital and current accounts for individual

partners are important. Besides, by using the same method of preparing a profit and
loss account as in a sole proprietorship, an additional profit and loss appropriation
account has to be prepared to recognise the sharing of profit among the partners.
Subsequently, the allocated profit and loss for each partner will be transferred to
their individual current accounts to show their entitlements.
The following example enables you to understand the complete accounting

entries for a partnership, from the maintaining of the partnersÊ capital accounts
and current accounts to the closing of the final accounts for a partnership.
SELF-CHECK 8.5
What is the main purpose of maintaining the extra accounts (for
example, current accounts profit and loss appropriation account) in a
partnership business?
Example 4
Chee Seng and Moonty contributed RM14,000 and RM7,000 respectively to
set up a computer hardware business 10 years ago. As at 31 December 2010,
the current accounts of Chee Seng and Moonty stood at RM12,600 and
RM10,500 respectively.
Based on the partnership agreement, interest on capital and drawings is
calculated at 3% per annum. Since Chee Seng is actively involved in the
business, he gets a salary of RM28,000 per annum. In the year ended 31
December 2010, the net profits before appropriation were RM63,385. Based on
the agreement, Chee Seng and Moonty share profits and losses on a 2:1 basis.
During the year, Chee Seng took out goods worth RM4,200 from the business
for personal use. On 1 April 2010, Moonty also took out goods, worth
RM1,400, for personal use.
Note:
Interest on drawings is to be calculated on a monthly basis.

Required
Prepare Profit and Loss Appropriation Account, and PartnerÊs Current and
Capital Accounts for the year ended 31 December 2010.
Solution
Chee Seng and Moonty
Profit and Loss Appropriation Account
For the Year Ended 31 December 2010
Salary: RM RM
Chee Seng Net Profit b/f 63,385
28,000
Interest on capital Interest on drawings:
Chee Seng ă 3%  RM4,200  63
Chee Seng ă 3%  RM14,000 6/12
420 31.5
Moonty ă 3%  RM7,000 Moonty ă 3%  RM1,400  9/12
210
Profit-sharing:
Chee Seng (2/3)
Moonty (1/3) 23,233
11,616.5
63,479.5 63,479.5
Capital ă Chee Seng

2010 RM 2010 RM
Capital ă Moonty
2010 RM 2010 RM
Current Account ă Chee Seng

2010 RM 2010 RM
31 Dec Drawings 4,200 1 Jan Balance b/f 12,600
Interest on 63 31 Dec Interest on capital 420
drawings
Balance c/f 59,990 Salary 28,000
Profit 23,233
64,253 64,253

Current Account ă Moonty

2010 RM 2010 RM
1,400
31 Dec Drawings 1 Jan Balance b/f 10,500
210
Interest on drawings 31.5 31 Dec Interest on capital
Balance c/f 20,895.5 Profit 11,616.5
22,326.5 22,326.5
Ć In view of the highly competitive business environment, a large capital outlay

is normally needed in order to start a business.
Ć A partnership has become one of the best choices which enables individuals
to participate in a commercial activity with smaller capital contribution.
Ć In accounting, a partnership has a similar accounting treatment to that of a

sole trader in its book of records.
Ć In a partnership, the additional accounts that need to be maintained include

partnersÊ capital accounts, partnersÊ current accounts, profit and loss
appropriation accounts and drawings accounts.
Ć Also, the profits and losses are divided among the partners in accordance
with the partnership agreement.
Appropriation account Partnership

Capital account Partnership Act
Current account Sole proprietorship
Drawings accounts

1. Holmes, Watson and Lupin are partners. They share profits and losses in
the ratios of 2/9, 1/3 and 4/9 respectively. For the year ended 31 July 2013,
their capital accounts remained fixed at the following amounts:
RM
Holmes 60,000
Watson 40,000
Lupin 20,000
They have agreed to give each other 6 percent interest per annum on their
capital accounts. In addition to the above, partnership salaries of RM30,000
for Watson and RM18,000 for Lupin are to be charged. The net profit of the
partnership, before taking any of the above into account was RM111,000.
You are required to draw up the appropriation account of the partnership

for the year ended 31 July 2013.
1. Draw up a profit and loss appropriation account for the year ended 31
March 2013 and balance sheet extracts at that date, from the following:
(a) Net profit RM111,100.
(b) Interest to be charged on capitals: Black RM3,000, Blue RM2,000 and
Purple RM1,500.
(c) Interest to be charged on drawings: Black RM400, Blue RM300 and
Purple RM200.
(d) Salaries to be credited: Blue RM20,000 and Purple RM25,000.
(e) Profits to be shared: Black 70%, Blue 20% and Purple 10%
(f) Current accounts: balance b/d Black RM18,600; Blue RM9,460; Purple
RM8,200
(g) Capital accounts: balance b/d Black RM 100,000, Blue RM 50,000 and
Purple RM25,000.
(h) Drawings: Black RM39,000, Blue RM27,100 and Purple RM16,800.

9 Companies
LEARNING OUTCOMES
1. Describe current and long term liabilities;
2. Differentiate the equity components of a single proprietorship,
partnership and company;
3. Calculate the amount of dividend entitled to shareholders based on
the different types of shares;
4. Calculate earning before tax of company and amount; and
5. Prepare a balance sheet of a company and statement of retained
earnings.
 INTRODUCTION
You have a great idea for a business that will guarantee a big profit. To start this
business you need RM1,000,000 cash. You managed to raise RM600,000 cash after
selling all your personal assets and belonging. How can you get the remaining
RM400,000 cash needed to start the business? You might be able to find a partner
who is willing to invest RM400,000 cash in the business or you can borrow the
amount needed from your friend or a financial institution. There are several
ways to raise capital (money) needed for a business. This can be done through
borrowing (liability) or through equity financing.

TOPIC 9 ACCOUNTING FOR COMPANIES  195
Companies borrow to finance operations and to expand their businesses.

But borrowing can be dangerous. Pasminco Limited was world-class zinc
and lead producer. It borrowed heavily to take over other businesses.
Then the price of zinc dropped to historic lows. Pasminco crashed in
September 2001 with $800 million in currency hedging losses and 1.8
billion in debt⁄⁄.but many companies are able to mange their
borrowings quite successfully. PaperlinX Ltd, reported that its financial
position is solid. Another gas company also felt comfortable with its level
of debt⁄⁄These statements show how important the levels of
borrowings,⁄⁄⁄
Adapted from Horngren (2004)
We will start by looking at the definition of current liabilities as defined by

Malaysian accounting standards. The components of selected current liabilities and
long term liabilities will be explained. Then, we will look at the ownerÊs equity and
the different components of equity for single proprietorship, partnership and
company. Emphasis is made to explain the equity component of a company.
Comparison of how equity will be reported by each form of business will be made
too. It is important to understand the equity component of a company, as in the next
topic financial statements analysis, company financial statements will be used.
9.1 DEFINITION OF LIABILITIES
SELF-CHECK 9.1
Try to list down all your liabilities and identify the years you need to
settle them.
Do you plan to settle any of them sooner? Why?
Funds or money to finance business activities (buying fixed assets, paying

expenses etc) comes either from borrowing (liabilities) or from ownerÊs
contribution (ownerÊs equity). You have learned earlier how to record borrowing
from banks and also the purchase of goods on credit. All these transactions gave
rise to liabilities.

196  TOPIC 9 ACCOUNTING FOR COMPANIES
Liabilities represent an obligation of an entity. This obligation needs to be

satisfied by the entity through payment of cash or the surrendering of entityÊs
assets or services.
To illustrate further, assume you received cash today for two cakes to be
delivered to your client in two weeks time. Have you earned your revenue? Did
you deliver goods or services? The fact is that you have received cash in
advanced for goods that will be delivered later, hence no revenue is earned.
Upon receiving the cash, you have the obligation to deliver the cakes in two
weeks time, thus you should record the receipts of cash (unearned revenue) as a
liability.
In Topic 1, you were told that liabilities can be categorised as current or non
current. Now let us look at how the Malaysian accounting standard defines
current liabilities.
According to Malaysian accounting standard FRS 101-Presentation of Financial

Statement, a liability shall be classified as current when it satisfies any of the
following criteria:
(a) it is expected to be settled in the entity's normal operating cycle;

(b) it is held primarily for the purpose of being traded;
(c) it is due to be settled within twelve months after the balance sheet date;
or
(d) the entity does not have an unconditional right to defer settlement of
the liability for at least twelve months after the balance sheet date.
All other liabilities shall be classified as non-current.
Source: http://www.masb.org.my/MASB_Std_Eng/masb1a.htm ( para. 60)
9.2 CURRENT LIABILITIES
Current liabilities are obligations by an entity that need to be settled using

current assets or by creating another current liability within a period of one
year.

Current liabilities comprise of the followings, as shown in Figure 9.1.
Figure 9.1: Current liabilities
You have learned how to record transactions related to accounts payable,

borrowings, and accrued expenses in the earlier topic.
Now you shall learn about the other form of current liabilities.
9.2.1 Bank Overdraft

Bank overdraft is a facility given by banks to current account holders that enable
the holder to draw cheques larger than the holderÊs bank balance. An overdraft is
indicated by a credit balance in a firmÊs cash account. Bank will charge firm a
fixed interest rate for the overdraft amount. The original amount plus the interest
must be paid by the current accountÊs holder.

9.2.2 Bank Loans

Bank loan is also refers to as notes payable represent borrowing made by
businesses. Borrowings can be long term or short term. Short term refers to
borrowing that needs to be paid within a period of one year. Borrowings are
subjected to interest. Interest rate is normally quoted per annum.
Example 9.1
For example if you borrow RM10,000 from Giant Bank and the interest rate is
10%, you are required to pay back the original amount borrowed plus the
interest in six monthsÊ time. How much will you pay back? RM10,000 the
original amount plus interest of RM500 (RM10,000 x 10% x 6/12) . Not
RM1,000 as you only borrow the money for six months.
The journal entry to be recorded at the date of payment is:
Date Dr Bank Loan 10,000
Dr Interest expense 500
Cr Cash 10,500
To record repayment of bank loan plus interest charges.
If you have long term borrowing, for reporting purposes, you will need to
identify the amount that is due within the next twelve months period and
separate this from the amount that is due after the twelve months. The amount
that is due within twelve months will be reported as current portion of long term
liabilities under current liabilities and the remaining balance will be reported as
non current liabilities.
Example 9.2
For example, on 31 December 2008 you borrow RM1,000,000 from Giant Bank
and the interest rate is 10%. You are required to pay back the original amount in
ten instalments (at the end of every year) plus the annual interest. What will be
reported in the balance sheet as at 31 December 2008?
You will report RM100,000 as the current portion of long term liabilities (as the
first instalment is due on 31 December 2009 within 12 months). For your
information no accrued interest will be recorded on 31 December 2008 as it is
the first day of borrowing (refer to Topic 5 - accrued expenses).
The remaining RM900,000 will be reported as long term liabilities in the balance
sheet.

9.2.3 Bill Payable
Bill payable is a note issued by one entity, promising to pay another entity. It is
usually issued when you as the debtor are unable to pay for your account payable
balance to your supplier (creditor).
You will issue bill payable, a note promising to pay the amount within a certain
period at a certain interest. In other word, your account payable balance will be
zero, but you have created another liability called bill payable. The amount plus
interest will need to be paid within the promised time period.
Example 9.3
For example, you purchased goods on credit from Paris Trading for RM6,000 on 1
June 2008. Credit term was n30. If after thirty days you are unable to pay for the
amount, you can issue a bill payable to Paris Trading. The note promises to pay
the amount in three monthsÊ time, and at a 10% interest.
You will record the issue of bill payable as the following:
1 July 2008 Dr Account Payable 6,000

Cr Bill Payable 6,000
To record the issue of bill payable, term three months and 10%
interest.
On the date of settlement of the bill payable (you can pay earlier, which mean the
interest charges will be lower!) Assume payment is made on 1 September 2008
(two months instead of the promised three months). Interest of RM100 (RM6,000
x 10% x 2/12). The following entries will be made:
1 Sept 2008 Dr Bill Payable 6,000

Dr Interest expense 100
Cr Cash 6,100
To record the settlement of bill payable and the interest charged.
The receiver of bill payable will record this as bill receivable and will report this
as current assets.

Example 9.4
To illustrate, we will look at how the above example will be recorded in Paris
Trading.
Paris Trading will record the receipt of bill payable from you in his book as the
following:
1 July 2008 Dr Bill Receivable 6,000

Cr Account Receivable 6,000
To record the bill receivable term three months and 10% interest.
When payment is received on 1 Sept 2008, the following will be recorded:
1 Sept 2008 Dr Cash 6,100

Cr Bill Receivable 6,000
Cr Interest revenue 100
To record the receipts of bill receivable and interest received.
9.2.4 Dividend Payable
Dividends payable is liability unique to companies. It arises as a result of the

difference in the date when dividend is declared and the date dividend is
paid.
Dates of dividends declared and dates of payments might be months apart. For
example, final dividends are declared at the end of accounting period, while the
payment will be made two or three months later in the next period. This
represents a liability for the company to pay the amount in the next period. You
will learn more about dividends in the equity section of this topic.
9.3 LONG TERM LIABILITIES
Long term liabilities are obligations of an entity that need to be settled in a

period of more than twelve months than the date of reporting. The obligation
is settled by giving up (sacrificing) the entityÊs current assets.

Long term liabilities are as shown in Figure 9.2.
Figure 9.2: Long term liabilities
9.3.1 Long Term Bank Loans

Long term bank loans (notes payable) are borrowings that needs to be paid
within a period of more than twelve months. As we learned earlier, long term
loans can be classified partially as current and partially as a long term liability.
9.3.2 Mortgage Loans

Mortgage loans refer to borrowings made by an entity (for example bank), that
involves securing loan against an asset. In other word the amount of borrowing
is tied against the entity assets (building, vehicle or land). For this type of
liabilities, in the event that the borrower cannot pay the amount, the lender can
sell off the assets secured, and the payment received will be used to pay off the
debts. Your housing loan is an example of a secured loan. If you are unable to
pay off the loan, the bank can take control of your house, sell it and the money
will be used to pay off the amount borrowed and any difference is returned to
the borrower.

9.3.3 Bonds and Debentures
ACTIVITY 9.1
The government has issued several bonds for the public.
Can you identify and list down the reasons as to why these bonds are
offered to the public?
Bonds and debentures are issued by an entity in order to finance its activities.
Normally big corporations and government will issue bonds. You might have
read about the WAWASAN Islamic bond issued by the World Bank in Malaysia,
amounting to RM760 million and due in 2010. The issuer will have an obligation
to pay the interest payment to the bond holder, normally semi annually until the
bond matures. The face value or bond will be paid by the issuer on maturity.
ACTIVITY 9.2
Can you try to categorise all obligations that you have into current
and non-current?
9.4 EQUITY
Remember equity or ownerÊs equity from Topic 1? It is the ownerÊs residual
claims of the business assets after paying off liabilities. You now learn the
different in reporting equity for single proprietorship, partnership and company.
SELF-CHECK 9.2
Can you explain the difference in reporting equity for single
proprietorship, partnership and company?
9.4.1 The Equity of a Single Proprietorship

For a single proprietorship the equity section of a balance sheet will have only
one account i.e. Capital account. The balance of capital account represents:

(a) the original amount contributed by the owner;

(b) any increase or decrease as a result of profits or losses;
(c) any increase as a result of additional contribution by owner; and
(d) any decrease as a result of drawings made by owner.
Figure 9.3: Capital account
Let us look at an extract of a balance sheet of a single proprietorship, Perniagaan

Runcit Tunggal owned by Ammar.
Perniagaan Runcit Tunggal

OwnerÊs Equity RM
Opening Capital ă Ammar 20,000
+ Net income 6,000
26,000
ă Drawings (5,000)
Closing Capital ă Ammar 21,000
Figure 9.4: OwnerÊs equity of a single proprietorship

The closing balance of RM21,000 shows the equity of the proprietorship; the
owner, Ammar, claims against the businessÊ net assets.
9.4.2 The Equity of a Partnership

For the purpose of comparison let us look at partnership, where we know there
are at least two owners. These owners might not contribute capital in equal
amounts, make equal amounts of drawings; and nor do they share profits the
same way. Therefore, it is necessary to separate the capital and drawings
accounts of partners.
Under partnership, the capital account only records the amounts originally
contributed by partners, while another account called Current Account is used to
record the profit or loss made by the partnership and also the drawings made by
them.
Figure 9.5: Equity component of a partnership
In other words, when comparing the reporting of equity of a proprietorship in

the balance sheet, the equity of partnership will be reported as the following.

Perniagaan Runcit Tunggal

RM RM RM
OwnerÊs Equity Ali Amir
Capital 50,000 100,000 150,000
Current account ă opening

30,000 45,000
balance
+ share of net income 20,000 30,000
50,000 75,000
- drawings by partners 8,000 12,000
Current account ă closing
42,000 63,000 105,000
balance
255,000
Figure 9.6: Reporting equity of a single proprietorship
From the above example you can see that the total owner equity is RM255,000,
which is the total of capital and the current account of both partners, Ali and
Amir.
How net income is shared or allocated to partners will be taught in another

module.
9.4.3 Company Formation

Company formation in Malaysia is a more complex process than those of sole
proprietorships and partnerships. The Commision of Companies Malaysian
(CCM) at www.ssm.com.my has drafted all incorporation procedures and all
companies are required to follow the following procedures in order to form a
company.
(a) Application of Name Search

The company is required to perform a name search. This is to make sure the
proposed name of the company is available for use. First, Form 13A CA
(Request for Availability of name) needs to be completed and submitted to
SSM. Next, a fee of RM30 for each name applied is payable to SSM. In the
case where the companyÊs name is approved by SSM, a three month
reservation period from the date of approval will be given.

(b) Lodgement of Incorporation Documents

Within the three months reservation period above, incorporation
documents such as, are lodged:
(i) Memorandum and Article of Association;
(ii) Form 48A (Statuary Declaration By A Director Or Promoter Before
Appointment);
(iii) Form 6 (Declaration of Compliance); and
(iv) Additional Documents (Original copy of Form 13A, A copy of the
letter from SSM approving the name of the company, and A copy of
the identity card of each director and company secretary).
(c) Registration Fees

The registration fees chargeable by SSM are listed as below:
Authorised Share Capital (RM) Fees (RM)

Up to 400,000 1,000
400,001 ă 500,000 3,000
500,001 ă 1 million 5,000
1,000,001 ă 5 million 8,000
5,000,001 ă 10 million 10,000
10,000,001 ă 25 million 20,000
25,000,001 ă 50 million 40,000
50,000,001 ă 100 million 50,000
100,000,001 and above 70,000
(d) Certificate of Corporation

A Certificate of Incorporation will be issued by SSM upon compliance with
the incorporation procedures and submission of the duly completed
Incorporation Documents.
Source: www.ssm.com.my

9.4.4 The Equity of a Company
SELF-CHECK 9.3
Can you suggest ways for a company to raise money to increase its
capital?
In the next topic, we will look at the financial analysis of an income statement
using a company balance sheet and income statement. Hence it is important for
you to understand the composition of ownersÊ equity of company and the
difference in reporting ownersÊ equity for a company.
Equity component of a company comprises of:

(i) shareholderÊs fund;
(ii) retained earnings; and
(iii) reserves.
Before we look at these components in detail, let us learn the types of shares
available.
For a company, the owners comprise of many individuals called shareholders.

Thus it is impractical to have capital account for each shareholder. Shareholders
own shares of the company. Shareholders (owners) cannot withdraw profits from
the company whenever they like; however companies will give shareholders
dividends.
A company will initially offer shares (stocks) to the public. You have probably
seen a prospectus in the newspaper inviting the public to purchase shares in a
listed company. In general there are two types of shares: common or ordinary
shares and preference shares. Shares will be issued at a fixed face value or par
value. The face value is also called the nominal value. The par value of a share
can be 50 cents, RM1 or any other value.
Shares are first issued by a company to the public at a price that is normally
different than the par value of shares. For example, a share with par value of
RM1 can be issued at RM2 or any other value when it is first offered to the
public. Primary market is where the company issues the share trade with the
public.

After shares are issued to the public, the shareholders can sell their shares to
other buyers in the Kuala Lumpur Stock Exchange, or they can buy more shares
from other shareholders in the Bursa Malaysia. In other words, Kuala Lumpur
Stock Exchange is a secondary market for shares.
Figure 9.7: Primary and secondary market
Now let us look at the composition of shareholder funds.
(a) Shareholder funds

Shareholder funds are the par value of shares times the number of shares
issued by a company. For example, if a company issues 3 million ordinary
shares of RM1 par value each, then the shareholder fund is RM3 million.
Let us look at the characteristics of these shares.
(i) Ordinary or Common Shares
Ć Holders of common shares are the true owner of a company. They
have the rights to vote.
Ć Ordinary shareholdersÊ right to dividend is after preference
shareholders.
Ć Ordinary shareÊs dividend amount is not fixed.
Ć In the event that a business turns bad, company do not have an
obligation to declare dividends for ordinary shares. However,

once a company declares its dividend, the company must fulfil its
obligation to pay.
(ii) Preference Shares

Ć Holders of preference share do not have the rights to vote.
Ć Preference shares have special rights attached to them, i.e. rights
to receive dividends before ordinary shareholders and also rights
to the residual assets before ordinary shareholders if the company
wind up.
Ć The preference sharesÊ dividend amount is fixed. Preference
shares will be issued with fixed dividend rates.
Ć A company has the obligation to pay this dividend regardless
whether business is good or bad. Hence, in ratio analysis,
preference shares are treated as liabilities rather than equity.
For your information, there are many types of preference shares in the
market. For this moduleÊs purpose, we will only look at the general
characteristic of preference shares.
Figure 9.8: Reporting equity of a single proprietorship
(b) Retained Earnings

The second component of equity for company is retained earning. Retained
earning account is the accumulation of companyÊs net earnings (profit) after
tax after distributions to shareholders and/or reserves. Earning after tax
will increase retained earnings, while net losses will decrease the retained
earningsÊ balance.
For single proprietorship and partnership, the business is not taxed for the
profit it makes; the individual will need to report the profit of the business
as its income, and will be taxed individually. However, for a company, the
company will have to pay tax on their income or profit. Therefore, the
income statement of company will include an additional item of expense
which is tax expense.

Company Name
Income Statement
for the year ended XX/XX/XX
RM RM
Sales revenue* XX
Minus Cost of Goods Sold* XX
Gross profit XXX
Less Operating Expense**
Selling and distribution expenses XX
General and administrative expenses XX
Financial expenses XX XXX
Earnings before tax XXX
Less Tax expenses XX
Earnings after tax XXX
* Details of the calculation of sales revenues and cost of goods sold is

shown through note to the financial statements.
** Operating expenses are categorised into three types: (i) selling and
distribution; (ii) general and administrative and (iii) financial expenses.
Figure 9.9: Income statement of a company
Unlike proprietorship and partnership, where the owner can withdraw his
profits at any time, shareholders cannot do the same. However, a company will
pay dividends out of net income after tax (profits/earnings). This dividend will
reduce the balance of retained earnings.
The retained earning balance reported in the balance sheet is net after deducting
dividend and transfer of earnings to reserves. Normally two types of dividend
are paid to shareholders:
(i) Interim dividend. Interim dividend is declared and paid during the current
financial year,
(ii) Final dividend. Final dividend is declared at the end of the current financial
year and will be paid in the next financial period.

ACTIVITY 9.2
Surf the web for the Balance Sheet of companies. You can also go to
the Bursa Malaysia website http://www.klse.com.my. You can see
how these corporations report their assets, liabilities and equity. Do
take note of the types of reserves being reported.
Dividends are always quoted based on the nominal value of shares, not the
current market price (quoted in Bursa Malaysia) or the issue price of the shares.
For example, a company has issued 2 million ordinary share par value 50 cents
each, at a price of RM2 and currently the shares are traded at RM3.50 each.
Assuming that at the end of year the company declares a 5% dividend for
ordinary shares. What is the amount of dividend that will be paid by the
company?
The amount of dividend is RM50,000 which is 5% times RM1 million (the

nominal value of the ordinary shares).
(c) Reserves
A company might also create reserves to set aside funds from earnings for
the following purposes:
(i) to cover themselves from future loses;
(ii) to buy fixed assets;
(iii) to repay liabilities; and
(iv) to buy back their shares.
The most common reserve created is the general reserves, and this will be
reported in the equity section of the balance sheet.

Figure 9.10: Equity component of a company
After learning about retained earnings, dividends and reserves let us look at the
Statement of Retained Earning. Statement of retained earnings shows the changes
in retained earnings of a company over a period.
Company Name
Statement of Retained Earnings
for the year ended XX/XX/XX
RM RM
Opening Retained Earnings XX
Add Earnings after tax XX
Earnings available for distribution XXX
Less
Ordinary Shares Dividends XX
Preference Shares Dividends XX XXX
Transfer to Reserves XX
Closing Retained Earnings XXX
Figure 9.11: Format of statement of retained earnings
Let us look at the following example, in order to learn how to prepare statement
of retained earning and the equity portion of balance sheet of a corporation.

Example 9.5
Cyber Corporation has issued 5 million ordinary shares par value RM1 each
and 2 million 10% preference shares par value RM2 each. Earnings after tax
for the year ended 31 December 2008 is RM23,000,000. Balance of retained
earning as at 1 January 2008 is RM123,000,000. No dividends have been paid
during the year. The Director decided to pay 20 cents dividend per share to
ordinary shareholders and the amount due to preference shareholders. The
directors also decided to transfer RM10,000,000 of earnings to general
reserves. General reserves balance as at 1 January 2008 is RM35,000,000.
Dividend to ordinary shareholders is 20 cents per share and there are 5

million shares; therefore, the total dividend for ordinary shareholder is
RM1,000,000. (5 million shares x 20 cents)
For preference shares, the dividend rate is 10% (as stated 10% preference
share), and the amount of preference share is RM4,000,000 (2 million shares x
RM2 par value), and therefore the dividend is RM400,000 (RM4,000,000 x
10%).
The statement of retained earnings of Cyber Corporation will look like the
following:
Cyber Corporation
for the year ended 31/12/2008
RM RM
Opening Retained Earnings 123,000,000
Add Earnings after tax 23,000,000
Earnings available for distribution 146,000,000
Less
Ordinary Shares Dividends (1,000,000)
Preference Shares Dividends (400,000) (1,400,000)
Transfer to General Reserves (10,000,000)
Closing Retained Earnings 134,600,000
Figure 9.12: Statement of retained earning of cyber corporation

If the extract of a balance sheet is to be prepared (equity) for Cyber Corporation,

it will look like as the following:
Cyber Corporation
RM RM
Equity
ShareholdersÊ funds
Ordinary shares 5,000,000
Preference shares 4,000,000 9,000,000
Retained earnings 134,600,000
General Reserves 45,000,000
Total equity 188,600,000
* The balance sheet of a company is similar to the balance sheet

prepared by proprietorship and partnership, meaning all the assets
and liabilities will be reported either as current or non current. The
only difference is the way equity is reported. This is due to the
different component of equity for different forms of business. Do
remember this, at all time the total equity will equal the total assets
minus total liabilities = net assets = equity = A ă L.
Figure 9.13: Balance sheet extract of cyber corporation
 Current liabilities are obligations by an entity that need to be settled using

current assets or by creating another current liability within a period of one
year.
 Bank overdraft is a facility given by banks to current account holders that

enable the holder to draw cheques larger than the holderÊs bank balance.
 Bill payable is a note issued by one entity, promising to pay another entity.
 Long term bank loans (notes payable) are borrowing that needs to be paid
within a period of more than twelve months.

 Equity component of a company comprises (i) shareholderÊs fund; (ii)

retained earnings and (iii) reserves.
 Shareholder funds are the par value of shares times the number of shares
issued by a company.
 Retained earning account is the accumulation of companyÊs net earnings

(profit) after tax after distributions to shareholders and/or reserves.
Bills payable Preferred stock or preference shares

Bills receivable Reserve accounts
Common stock or ordinary shares Retained earnings
1. Syarikat Demo borrowed RM500,000 from Putrajaya Bank on 1 July 2008.

Interest rate is 5% of the original loan amount and is to be paid semi-
annually. The first interest payment is due on 1 January 2009. The loan
principle is to be paid over 10 instalments, to be made annually, and the
first instalment is due on 1 July 2009.

(a) prepare the extract of a balance sheet as at 31 December 2008;
(b) provide the journal entries to record the first interest payment;
(c) provide the journal entries to record the payment of the first
instalment of the principle amount; and
(d) prepare the extract of a balance sheet as at 31 December 2010.
2. Calculate the amount of dividend for the following situations.

(a) Exxone Corporation issued 300,000 8% preference shares par value
RM1 each.
(b) Shellex Corporation issued 400,000 9% preference share par value
RM2 each.

(c) Dividend of 15% for 500,000 ordinary shares, par value 50 cents each.
(d) Dividend of 10% for 200,000 ordinary shares, par value RM1 each.
(e) Dividend of 5 cents each for 500,000 ordinary shares, par value 50
cents each.
1. Fill in the blanks

(a) Equity of a partnership comprises ______________ and
______________ accounts.
(b) Equity of a company comprises ______________, ______________ and
______________accounts.
(c) There are two main types of shares: ______________ share and
_____________ shares.
(d) Instead of making drawings, shareholders are paid ______________.
(e) ______________ and ______________ will decrease the retained
earnings balance, while ______________ will increase the retained
earnings.
2. The following information is obtained from M&S Corporation as at 31

December 2005.
Ordinary shares par value 70 cents 3,000,0000 shares issued
5% Preference shares par value 50 cents 5,000,0000 shares issued
Sales revenues RM57,500,000
Cost of goods sold RM15,000,000
Operating expenses RM18,000,000
Company tax rate is 30%
Retained earnings 1/1/2008 RM25,600,000
General reserves 1/1/2008 RM12,000,000
On 31 December 2008, The Director declared the following final dividend:

(i) 10% to ordinary share to ordinary shareholders; and
(ii) the due amount to preference shareholders.
The directors also decided to transfer RM3,500,000 of retained earnings to

general reserves.


(a) calculate the earning after tax for M&S Corporation for the year
ended December 2008;
(b) prepare the statement of retained earnings for M&S Corporation for
the year ended December 2008; and
(c) prepare the extract of balance sheet for M&S Corporation as at 31
December 2008.

Topic  Financial
10 Statement
Analysis
LEARNING OUTCOMES
1. Define the financial statement analysis;
2. Discuss the importance of the statement of analysis;
3. Calculate the profitability ratios, liquidity ratios, efficiency ratios
and financial leverage ratios; and
4. Interpret the ratios.
 INTRODUCTION
Syarikat RAZ makes RM5,000,000 profit while another company, Syarikat Ummi
& Sons makes RM2,000,000 profit. Based on this information only, can you make
a decision to invest your money in Syarikat RAZ as its profit is higher than
Syarikat Ummi & Sons? What will be your decision if you know that Syarikat
RAZ made RM20,000,000 in the previous year while Syarikat Ummi & Sons
made only RM400,000? What will your decision be if you know that Syarikat
RAZ had issued 50,000,000 shares, while Syarikat Ummi & Sons only has 100,000
shareholders?
You should not rely on single information or the absolute profit figures reported
in the financial statement to make decision, they can be misleading. You need to
compare the companyÊs performance or financial position with their performance
in the past, with another company or with the industry average. Financial
statements analysis is the tool used by users, accountants, financial analysts and
others to interpret the results of a company before making their decisions.

TOPIC 10 FINANCIAL STATEMENT ANALYSIS  219
Adapted from: www.grantland.net
Is this the kind of statement we get from companies?
We will begin this topic by looking at the purpose of financial statement analysis.
We will then look at three financial analyses in detail.
10.1 THE PURPOSE OF FINANCIAL

STATEMENT ANALYSIS
Do you still remember, in Topic 1, for accounting information to be useful, it has
to have the comparability characteristic? To compare whether a person is a better
cook than another, we can ask both to cook the same food using the same
ingredients, and then we can decide on the result. However, to make a
comparison between two companies that are different in sizes, have different
business activities and different management, will be difficult because of the
dissimilarities. In other words, how can you compare apples and pineapples?

220  TOPIC 10 FINANCIAL STATEMENT ANALYSIS
ACTIVITY 10.1
1. You have inherited RM1,000,000. You planned to invest this

money in the share market. What would you look for in a
company before you buy their shares?
2. Is it important for a firm to compare its financial performance or

financial position? Discuss.
Profitability, liquidity, efficiency and financial stability are the criteria that users look
for in a business before making their economic decisions. Their decisions whether to
invest, lend money, buy, supply lies on the company strengths. How do users assess
a company profitability liquidity, efficiency and financial stability?
Financial statements are prepared by companies to provide financial

information for multi users who use the information provided to make
decisions. These users can be external and internal users. The information
provided are only absolute numbers that must be analysed further in order to
Financial statement analysis is a tool used by accountants to interpret the

financial performance or position of a business entity. Through analysis, the
strengths and weaknesses of a business entity can be measured according to past
financial performance and position.
The main purpose of financial analysis is to enable users make better or informed
decisions. It also helps to predict the future performance of a business entity
based on the past performance.
The two techniques available for use are:

(a) comparative analysis; and
(b) ratio analysis.
We will discuss each in detail in the following sections using the financial
statements of a public listed company, Syarikat Abuza that sells computer goods.

Figure 10.1: Financial statement analysis techniques
10.2 COMPARATIVE ANALYSIS

When you compare financial statements of a business, the result can be
compared against the companyÊs past performance, against another companyÊs
performance or against the industry average. Comparison against a benchmark
will enable users to make an informed and better decision.
10.2.1 Intra Company Comparison

Items in the financial statements of a company are compared against the
companyÊs result of the selected base year. Comparison can be done for two
years or more for the same company. The result of the comparison can show the
companyÊs trend and this can be used to predict future financial performance or
financial position. For example, comparing last yearÊs profitability and the
current yearÊs profitability will show whether the profitability has increased or
decreased.
10.2.2 Inter Company Comparison

Results for the current year are compared against the results of another company.
Both companies should be in the same industry. A company might want to
compare its performance against its competitor. This comparison will provide
useful information regarding the companyÊs financial performance and position
against the competitor. Companies of different activities can also be compared
provided both companies are in the same groups (subsidiaries).
10.2.3 Industry Comparison

Results for the current year are compared against the industry average. Industry
average comprises the average result of all companies within the same industry.
For example, a transportation company can compare its profit level against the
transportation industry profit level. This comparison will provide useful
information regarding a companyÊs performance against the industry.
Comparative analysis can be divided into two categories: horizontal analysis and
vertical analysis.
10.3 HORIZONTAL ANALYSIS

Horizontal analysis involves the comparison of items in the financial statements
over a two year period or more. The changes are presented in Ringgit Malaysia
(RM) and also in percentages. Comparison can be made against last yearÊs
performance or against a few years (trend analysis).
The base year is identified, usually the earliest of years compared. The amount of
changes will be divided against the amount of the base year to get the percentage
of changes.
Changes in RM = Current Year Amount ă Base Year Amount
Changes in RM
Percentage in Changes  x100%
BaseYearAmount

The following Figure 10.2 shows an example of horizontal analysis for an income
statement.
SYARIKAT ABUZA
Comparative Income Statement - Horizontal Analysis
for the year ended December
Increased
2008 2007 Percentage
(Decreased)
RM RM RM %
Sales Revenue 15,560,000 13,507,000 1 2,053,000 2 15.20
Less Cost of goods sold 6,504,500 5,804,500 700,000 12.06
Gross Margin 9,055,500 7,702,500 1,353,000 17.57
Less Operating Expenses 4,050,500 4,550,500 (500,000) ă10.99
Earnings before tax 5,005,000 3,152,000 1,853,000 58.79
Tax expenses 1,501,500 945,600 555,900 58.79
Earnings after tax 3,503,500 2,206,400 1,297,100 58.79
1 This figure is the difference between 2008 revenue and the base year revenue
(in this case, year 2007 is the base year)
(15,560,000 ă 13,507,000) = RM2,053,000
2 Figure is the percentages of change from the base year.

(2,053,000/13,507,000) x 100% = 15.20%
Figure 10.2: Comparative Income Statement - Horizontal Analysis
Horizontal analysis compares the results of the current year with the result of a
base year. The results whether an increase or decrease can now be seen clearly in
this format. Any alarming decrease in revenues and profit or increase in expenses
should be investigated and corrected.
SELF-CHECK 10.1
Can you think of reasons for the increase in expenses or decrease in
revenues from one period to another? Can you suggest ways to
correct them?
The following Figure shows an example of horizontal analysis for a balance sheet.

SYARIKAT ABUZA
Comparative Balance Sheet - Horizontal Analysis as at 31 December
Increased
2008 2007 Percentage
(Decreased)
RM RM RM %
Current Assets
Cash 7,805,000 6,605,000 1,200,000 18.17
Accounts Receivable 567,800 867,800 (300,000) ă34.57
(net)
Inventory 3,450,000 3,046,500 403,500 13.24
Total Current Assets 11,822,800 10,519,300 1,303,500 12.39
Non Current Assets
Land and buildings (net) 50,500,000 52,000,000 (1,500,000) ă2.88
Motor Vehicle (net) 20,000,000 15,000,000 5,000,000 33.33
Total Non Current 70,500,000 67,000,000 3,500,000 5.22
Assets
Total Assets 82,322,800 77,519,300 4,803,500 6.20
Current Liabilities
Accounts Payable 3,800,000 2,500,000 1,300,000 52.00
Bill Payables 5,000,000 1,000,000 4,000,000 400.00
Total Current 8,800,000 3,500,000 5,300,000 151.43
Liabilities
Long Term Liabilities
Long Term Loan 15,000,000 20,000,000 (5,000,000) ă25.00
Debentures 5,000,000 5,000,000 ă 0.00
Total Long Term 20,000,000 25,000,000 (5,000,000) ă20.00
Liabilities
Total Liabilities 28,800,000 28,500,000 300,000 1.05
Net Assets 53,522,800 49,019,300 4,503,500 9.19
Equity
Shareholders funds
Ordinary shares 10m 20,000,000 20,000,000 ă 0.00
shares
Preference shares 5m shares 5,000,000 5,000,000 ă
Retained earnings 14,522,800 11,019,300 3,503,500 31.79
General Reserves 14,000,000 13,000,000 1,000,000 7.69
Total equity 53,522,800 49,019,300 4,503,500 9.19
Figure 10.3: Comparative Balance Sheet - Horizontal Analysis

10.4 VERTICAL ANALYSIS

Not all companies are of the same size, and comparing the absolute results of
different businesses of dissimilar sizes will not provide an adequate picture. By
turning the absolute figures into percentages, we could make a more meaningful
interpretation of the data. Another name for vertical analysis is common-size
analysis. In vertical analysis, we will compare percentages rather than the
absolute figure; this will overcome the problem of comparing companies of
different sizes.
In this analysis, all the components of income statement are expressed as

percentages based on net sales.
Current Year Amount of COGS

Percentage of Cost of Goods Sold   100%
Total Sales
Current Year Amount of Gross Profit

Percentage of Gross Profit   100%
Total Sales
All the components of balance sheet are expressed as percentages based on the
total assets.
Current Year Amount of COGS

Percentage of Cost of Goods Sold   100%
Total Sales
Current Year Amount of Gross Profit

Percentage of Gross Profit   100%
Total Sales

SYARIKAT ABUZA
Comparative Income Statement - Horizontal Analysis
for the year ended December
2008 2007
RM % RM %
Sales Revenue 15,560,000 100.00 13,507,000 100.00
Less Cost of goods sold 6,504,500 41.80 5,804,500 42.97
Gross Margin 9,055,500 58.20 7,702,500 57.03
Less Operating 4,050,500 26.03 4,550,500 33.69
Expenses
Earnings before 5,005,000 32.17 3,152,000 23.34
tax
Tax expenses 1,501,500 9.65 945,600 7.00
Earnings after tax 3,503,500 22.52 2,206,400 16.34
Figure 10.4: Comparative Income Statement ă Vertical Analysis

SYARIKAT ABUZA
Comparative Income Statement - Horizontal Analysisas at 31 December
2008 2007
RM % RM %
Current Assets
Cash 7,805,000 9.48 6,605,000 8.52
Accounts Receivable (net) 567,800 0.69 867,800 1.12
Inventory 3,450,000 4.19 3,046,500 3.93
Total Current Assets 11,822,800 14.36 10,519,300 13.57
Non Current Assets
Land and 50,500,000 61.34 52,000,000 67.08
buildings(net)
Motor Vehicle (net) 20,000,000 24.29 15,000,000 19.35
Total Non Current 70,500,000 85.64 67,000,000 86.43
Assets
Total Assets 82,322,800 100.00 77,519,300 100.00
Current Liabilities
Accounts Payable 3,800,000 4.62 2,500,000 3.23
Bill Payables 5,000,000 6.07 1,000,000 1.29
Total Current 8,800,000 10.69 3,500,000 4.52
Liabilities
Long Term Liabilities 0.00
Long Term Loan 15,000,000 18.22 20,000,000 25.80
Debentures 5,000,000 6.07 5,000,000 6.45
Total Long Term 20,000,000 24.29 25,000,000 32.25
Liabilities
Total Liabilities 28,800,000 34.98 28,500,000 36.77
Net Assets 53,522,800 65.02 49,019,300 63.23
Equity
Shareholders funds
Ordinary shares 10m 20,000,000 24.29 20,000,000 25.80
shares
Preference shares 5m 5,000,000 6.07 5,000,000 6.45
shares
Retained earnings 14,522,800 17.64 11,019,300 14.21
General Reserves 14,000,000 17.01 13,000,000 16.77
Total equity 53,522,800 65.02 49,019,300 63.23
Figure 10.5: Comparative Balance Sheet ă Vertical Analysis

Horizontal and vertical analyses are one way to study the relationships
among the numbers on a financial statement. Ratios are another way.
10.5 FINANCIAL RATIO ANALYSIS

Financial ratio analysis shows the relationship between an item in the income
statement or balance sheet with another item. This ratio analysis can provide a
meaningful data and will enable users to understand the financial statements.
However, please take note that ratio (the figure) on its own has little or no
meaning at all. You need to do ratio comparison against a companyÊs past
performance, another company or industry average.
Although there are many ratios available, we will look at only four main
categories of financial ratios. They are:
(a) Profitability ratios
(b) Liquidity ratios
(c) Assets management/activity ratios
(d) Financial leverage/gearing ratios
These ratios will be discussed in detail next.
10.5.1 Profitability Ratios

Profitability ratios measure the ability of a business entity to earn profits. It is
used as an indicator of how efficient and effective a company is in achieving its
profit. There are many ratios that are categorised under profitability ratios but
we will look at the following three ratios only.
(a) Gross Profit Margin (Ratio)

The ratio measures the gross profit earned for every Ringgit sales. Higher
gross profit ratio indicates strong performance as the company has more
profit to pay for its sales and administrative expenses. The formula is:
 Gross Profit 
Gross Profit Ratio     100%
 Net Sales 

Syarikat AbuzaÊs 2008 and 2007 gross profit margin is calculated as follows:
2008 2007
Gross profit  9,055,500   7,702,500 

ratio  15,560,000   100%  58.20%  13,507,000   100%  57.03%
   
This means that in 2008, for every RM1 of sales, Syarikat Abuza has
managed to obtain 58.2 cents gross profit. 2008 gross margin has improved
by more than 1% compared to 2007.
(b) Net Profit Margin (Ratio)

The ratio measures the net profit earned for every Ringgit sales. Higher net
profit ratio indicates strong performance as the company has more profit to
pay dividends to shareholders. The formula is:
 Net Profit 
Net Profit Margin     100%
 Net Sales 
Syarikat AbuzaÊs 2008 and 2007 gross profit margin is calculated as follows:
2008 2007
Net profit  5,005,500   3,152,000 

margin  15,560,000   100%  32.17%  13,507,000   100%  23.34%
   
In 2008 for every RM1 of sales, Syarikat Abuza has managed to obtain 32.17
cents net profit compared to 23.34% net profit in 2007 Syarikat Abuza has
improved its profitability by 8.83% over the current financial year.
(c) Earning Per Share (EPS)

Earning per share measures the earning that is earned by each ordinary
share after paying for tax and preference shares dividend. The higher the
earning per share the better it is. The formula is:
 Earning after Tax – Dividend for Preference Share 

Earning Per Share   
 Total Number of Ordinary Shares 
Let us assume that Syarikat Abuza paid 10% dividend for preference
shareholders annually. With RM5,000,000 preference share issued, total

dividend for preference shares is RM500,000 per annum. Hence, earning

per share for Syarikat Abuza can be calculated as follows:
(RM3,503,500RM500,000)

Earning Per Share =   15.02centspershare
 20,000,000ordinaryshares
 (RM2,206,400  RM500,000) 
Earning Per Share =    8.53 cents per share
 20,000,000 ordinary shares 
In 2008 for every share held by ordinary shareholders, it managed to earned

15.02 cents earnings after tax and preference shares dividend. This has improved
significantly from 2007 whereby it was only 8.53 cents earnings per share.
Shareholders might continue holding Syarikat Abuza shares knowing that the
EPS has improved over the financial year or they can dispose the shares if there
are other shares that have higher EPS than 15.17 cents per share.
10.5.2 Liquidity/Solvency Ratios
SELF-CHECK 10.2
What do you understand about the term ÂliquidityÊ and ÂsolvencyÊ?
Liquidity and solvency are two different concepts; however, they are closely
related. Liquidity refers to the ability to generate or raise cash while solvency
refers to a companyÊs ability to pay its debts.
Knowing these ratios will enable us to measure the ability of a company to meet
short term obligations or debts that might be unexpectedly demanded to be paid
before its maturity dates. If a company fails to pay its debts, it could mean an end
to the business.
We will look at the following two ratios:
(a) Current Ratio

If a short term creditor demands a business to pay off its debts
immediately; how can a firm raise its cash to pay this creditor? The business
will have to immediately convert current assets into cash and settle these
obligations. Current ratio measures the ability of a business entity to pay
up current liabilities in the above situation. The following formula

calculates current ratio.
Current Assets
Current ratio 
Current Liabilities
Using Syarikat AbuzaÊs Balance Sheet for 2008 as an illustration, letÊs

calculate Syarikat AbuzaÊs current ratio for 2008.
11,822,800
Current ratio   1.34:1
8,800,000
A current ratio of 1.34:1 means that Syarikat AbuzaÊs current assets are 1.34
times as large as its current liabilities. As a rule of thumb, a current ratio of
2:1 indicates strong ability to meet short term debts. The higher the current
ratio, the more liquid the company is said to be. As Syarikat AbuzaÊs
current ratio is less than 2:1, we can say that Syarikat Abuza might face
difficulties in meeting short term obligations if short term creditors demand
payments immediately.
(b) Quick Ratio

Quick ratio is also known as acid test ratio. It measures how many quick
assets there are to cover quick liabilities. Quick assets comprise cash,
receivables and marketable securities. Not all current assets can easily be
converted into cash. For example, a company inventory might comprise old
stock that cannot be sold in order to be converted into cash. Another item
that cannot be converted into cash is prepayments. In order to correctly
measure the liquidity of a business entity, quick ratio is used. The following
formula calculates quick ratio.
Current Assets  (Inventories  Prepayment)

Quick ratio 
Current Liabilities
Using Syarikat AbuzaÊs Balance Sheet for 2008 as illustration, letÊs calculate
Syarikat AbuzaÊs quick ratio for 2008.
(11,822,800  3,450,000)
Current ratio   0.95:1
8,800,000
A quick ratio of 0.95:1 indicates that for every RM1 quick liabilities, Syarikat
Abuza only has RM0.95 quick assets. As a rule of thumb, a ratio of at least
1:1 is desirable. As Syarikat AbuzaÊs quick ratio is less than 1:1, we can then

say that Syarikat Abuza might face serious difficulties to generate cash to
meet short term obligations if short term creditors demand payments
immediately.
10.5.3 Asset Management/Activity Ratios
ACTIVITY 10.2
In your opinion, why it is important to know the efficiency and
activity ratio?
A company has to manage its assets effectively; otherwise the shareholders might
sell their shares and buy other companiesÊ shares that manage their assets more
effectively and productively.
The asset management and activity ratios measure the effectiveness and ability of
a company in managing its resources. For example, it can indicate how effective a
companyÊs inventory is being used to generate sales or how efficient is the
collection of debts by a company.
We will look at the following three ratios:
(a) Accounts Receivable Turnover

Accounts receivable turnover measures how fast accounts receivable is
collected. It indicates the effectiveness of a business entity in managing its
accounts receivables. A company must collect its debts promptly in order to
avoid a liquidity problem. Hence, measuring accounts receivable turnover
is important for a company as corrective actions can be taken if the
company is found to be ineffective in collecting its debts.
The following formula calculates accounts receivable turnover.
Net Credit Sales

Account Receivable Turnover 
Average Account Receivables*
(Opening Acct. Receivable  Closing Acct. Receivable)

* Average Account Receivable 
2
Assuming 70% of sales of Syarikat Abuza is credit sales, the accounts

receivable turnover can be calculated as follows:

(70%  15,560,000) 10,892,000

Account Receivable Turnover    15.17 times
 567,800  867,800  717,800
 2 
 
Account receivable turnover of 15.17 indicates the number of times

accounts receivables is being collected. The higher the turnover rate, the
better it is. It is an indicator that the company has the ability to collect its
debts. How fast they can collect their account receivable can be measured
through the average collection period.
The average collection period can be determined through the following

formula:
365 days 365

Average Collection Period    24.06 days
Average Receivable Turnover 15.17
It indicates that Syarikat Abuza, on average, collects its accounts receivable

every 24 days. Is this good or bad? It depends on the credit policy of a
company. Assuming that Syarikat Abuza extends credit sales over 30 days,
then an average collection period of 24 days is good. In general, the shorter
the period of collection, the better it is, as it indicates effective debt
collection effort by the company.
(b) Inventory Turnover

Inventory turnover measures the ability of a business entity to sell its
inventory. It indicates the number of times inventory is sold.
Cost of Goods Sold

Inventory Turnover 
Average Inventory*
(Opening Inventory  Closing Inventory)

* Average Inventory 
2
Syarikat AbuzaÊs inventory turnover for 2008 is as follows:
6,504,500
Inventory Turnover   2.00 times
 3,450,000  3,046,500 
 2 
 

You need to compare this ratio in order to get a meaningful analysis. In

general, higher turnover to a certain extent indicates effective management
of inventory.
On its own, an inventory turnover of 2.00 indicates that Syarikat Abuza has
only managed to sell its average inventory twice over the year. This
indicates that Syarikat Abuza has a slow inventory turnover. Slower
inventory turnover can be dangerous for companies, as the chances that
stocks become spoilt or obsolete is increased.
Syarikat Abuza trades IT goods where technology changes fast; therefore, a

low turnover of 2.0 might probably mean Syarikat AbuzaÊs inventory
comprises old and obsolete stocks that are hard to sell. To correct this,
Syarikat Abuza should sell the old stock at a lower price. This will move the
stock faster and improve turnover.
(c) Total Assets Turnover

Total assets turnover measures the relationship between sales levels against
the average total assets. It measures the effectiveness of total assets which
are used in generating sales. Higher turnover indicates a positive outlook to
the analyser.
Net Sales
Total Assets Turnover =
Average Total Assets
Syarikat AbuzaÊs total assets turnover for 2008 and 2007 is as follows:
2008 2007
Total Assets  15,560,000   13,507,000 

    = 0.1742 times
Turnover  82,322,800 + 77,519,300   77,519,300 * 
2
* 2006 asset figure was not given
Comparing 2008 total assets turnover with 2007 ratios indicates a slight
improvement in the management of total assets.

10.5.4 Financial Leverage/Gearing Ratios
SELF-CHECK 10.3
Why is it important to know the debt ratios of a company?
Company assets are financed either by borrowing or by shareholdersÊ funds.

Financial leverage ratios look at how much the assets of a company is financed
by creditors rather than the owners. High proportion of shareholders funds
indicates financial strength. Heavy reliance on borrowing indicates the risk to the
investors as debts require repayments of loan principal amount and the interest
expenses. If these obligations are not met, the business will wind up and
shareholders will lose their investment. This is because if a company is
liquidated, the creditors have the first right to be paid before the shareholders.
The following two ratios are used to identify the financial strength and risk of a
company.
(a) Equity Ratios

Equity ratio measures the financial structure of a company. Higher equity
ratios indicate stability. Equity ratio can be calculated as follows:
Total Ordinary Shareholders' Fund*

Equity ratio   100%
Total Assets
* Ordinary shareholders fund include retained earnings and reserves but exclude
the preference shares
Syarikat AbuzaÊs equity ratio for 2008 and 2008 is as follows:
2008 2007
 48,522,800   44,019,300 
Equity ratio  82,322,800   100%  58.9%  77,519,300   100%  56.8%
   
In 2008, for every RM1 total assets, only 58.9 cents is financed by ordinary
shareholders funds. This figure indicates high borrowing by Syarikat
Abuza and it represents a high risk to investors. The equity ratio has
increased from 56.8% in 2007 to 58.9% in 2008, showing slight improvement

in the equity composition of the business. Syarikat Abuza should settle

some of its debts to improve its equity ratios.
(b) Debts Ratios

Total debts include preference shareholders funds. The debts ratio
measures the financial structure of a company. Higher debts ratios indicate
that a company face a higher risk in its ability to settle its debts obligation.
The following formula is used to calculate debts ratios:
Total Debts*
Debts ratio   100%
Total Assets
 Total debts = Total liabilities + Preference ShareholdersÊ fund
Syarikat AbuzaÊs debt ratio for 2008 and 2007 is as follows:
 (28,800,000  5,000,000) 
Debts ratios for 2008  82,322,800   100%  41.1%
 
 (28,800,000  5,000,000) 
Debts ratios for 2007  77,519,300   100%  43.2%
 
In 2008, for every RM1 total assets, 41 cents is financed by borrowing. This
indicates high borrowings by Syarikat Abuza, and represents high risks to
investors. The debts ratio decreased from 43.2% in 2007 to 41.1% in 2008.
Syarikat Abuza should try to reduce this debts ratio.
(c) Debts to Equity Ratios

The ratio measures how much of total debts are covered by equity. The
lower the ratio the better it is as it indicates the amount owned by equity is
more than liabilities.
Total Debts*
Debts to equity ratios 
Total Shareholder Equity
* Total debts = Total liabilities + Preference ShareholdersÊ fund

Syarikat AbuzaÊs debt to equity ratio for 2008 and 2007 is as follows:
2008 2007
Debts to  (28,800,000  5,000,000)   (28,800,000  5,000,000) 
equity  53,522,800   0.63:1    0.68:1
   49,019,300 
ratio
In 2008, for every RM1 Syarikat Abuza equity there is 63.1 cents liabilities.
This ratio is considered high; however, the ratio has decreased by 5 cents
from 2007, hence showing a slight improvement.
Figure 10.6: Financial ratios analysis
 Financial statement analysis is a tool used by accountants to interpret the

financial performance or position of a business entity. The analysis provides a
meaningful data that can be used by users to make informed and better
decisions.
 Financial information from the balance sheet and income statement of a

company can be compared using three benchmarks: intra company, inter
company and industry average.
 There are three techniques used to analyse financial statements:

(i) horizontal analysis
(ii) vertical analysis
(iii) financial ratios analysis

 Horizontal analysis compares items in the financial statements over a two

year period or more, to see the decreases or increases.
 Vertical analysis converts items in the financial statements in terms of

percentages and compare them.
 Financial ratio analysis shows the relationship between an item in the income
statement or balance sheet with another item.
Benchmark Ratio
Financial Gearing or Leverage Ratio Analysis
Profitability Ratios
1. Differentiate among the following comparative analysis for a company:

(a) Intra company;
(b) Inter company; and
(c) Industry average.
2. The following net profit figures are obtained from Syarikat Hazim.
Syarikat Hazim
2008 2007 2006 2005 2004
Net Income 49,670 44,890 40,456 37,657 35,829
Percentage ? ? ? ? 100%
Increment/Decrement ? ? ? ? ă
Using 2007 as the base year; calculate the increase or decrease in net income
of Syarikat Hazim. What can you say about Syarikat HazimÊs profitability?

1. The following is the condensed Statement of Financial Performance for

Intan Holding in 2008.
RM %
Net Sales 400,000
Less Cost of Goods Sold 240,000 0
Gross Profit 160,000 ?
Less Operating Expenses 100,000
Net Profit 40,000 ?
Required:
(a) Calculate the gross profit margin and net profit margin.
(b) Intan Holding has only 20,000 ordinary shares issued. Company tax
rate is 30%. Calculate the earning per share.
(c) Interpret the profitability of Intan Holding based on your answers
provided in (a) and (b).

Topic  Comprehensive
11 Cases
LEARNING OUTCOMES
1. Recap the learning from earlier topics; and
2. Experience and practice the comprehensive sample exam
questions.
 INTRODUCTION
This topic is designed so that students can encapsulate their learning from the
earlier topics. Various samples of exam questions and suggested answers will be
presented in this topic.
11.1 PREPARATION OF FINANCIAL

STATEMENTS
Let us go through on the preparation of financial statements.
Case 1:
The following trial balance was taken from the book of a sole trader, Syarikat
Shine on 30 April 2013:

TOPIC 11 COMPREHENSIVE CASES  241
Particulars Debit (RM) Credit (RM)

Motor vehicles 48,400
Provision for depreciation of motor vehicles 24,200
Fixtures and fittings 11,800
Cash 3,500
Bank 4,800
Inventory 1/5/2012 30,240
Loan ă Joshua 17,680
Accounts Receivable and Accounts Payable 26,400 26,276
Capital 13,484
Provision for doubtful debts 1,500
Sales and purchase 123,220 196,740
Discount 2,600 600
Returns 600
Freight 1,008
Utility expenses 1,492
Salary expenses 24,140
Drawings 1,340
Insurance 420
Motor vehicles repair expenses 520
Total 280,480 280,480
Additional information:
(a) Inventory on 30 April 2012 is RM20,952.
(b) The depreciation rate for motor vehicles is 25% on cost, while for fixtures
and fittings is 10% on reducing balance.
(c) Bad debts of RM600 were written off and the provision for doubtful debts is
5% of debtors.
(d) 2/3 of freight charges is for freight outwards.
(e) Interest 5% per annum on JoshuaÊs loan is still outstanding.
(f) Insurance paid includes personal insurance of RM100.
(g) Utility bill for the month of April of RM92 was still not paid.
(h) Advanced discount received of RM100.

242  TOPIC 11 COMPREHENSIVE CASES
You are required to prepare an Income Statement and a Balance Sheet for
Syarikat Shine as at 30 April 2013.
Question 2:
The following account balances were extracted from the records of Syarikat
Ameer as at 31 December 2013:
RMÊ000
Office equipment 260

Accumulated depreciation 46
Accounts receivable 971
Cash at bank 50
Inventory 96
Accounts payable 722
Capita Ameer 250
Goodwill 60
Retained profits as at 31/12/13 419
The following transactions are not recorded in the books of Syarikat Ameer:
(a) As at year end, the firm received cash amounting to RM70,000 from
customers but services would only be delivered in the month of January
2014.
(b) The proprietor has withdrawn RM9,000 cash from the company bank
account for private use.
(c) Depreciation of 15% is to be provided for office equipment using the
straight line method.
(d) At 30 December, the company signed the sales and purchase agreement to
acquire a piece of land valued at M230,000. This acquisition is financed by a
bank loan.
You are required to prepare a Balance Sheet for Syarikat Shine as at 31 December
2013.

11.2 FINANCIAL STATEMENT ANALYSIS

Case 1:
The following are CIMB CorporationÊs income statement and balance sheet, in
RM millions.
Income Statements
2012 2013
Net Revenue 49,205 41,444
Cost of revenue (40,190) (33,892)
Gross profit 9,015 7,552
Selling, general and administrative
expense (4,298) (3,544)
Depreciation and amortisation (463) (464)
Operating income (EBIT) 4,254 3,544
Interest and other income 191 180
Interest expenses (100) (100)
Earning before incomes tax 4,345 3,624
Income taxes (50) (50)
Net Income 4,295 3,574
Balance
Sheet
2011 2012 2013
Assets
Cash and cash equivalents 4,747 4,317 3,317
Short-term investments 988 835 715
Accounts receivable, net 2,000 1,500 1,500
Inventories 7,500 8,000 8,300
Total current assets 15,235 14,652 13,832
PP&E, net 1,691 1,517 1,600
Investment 4,319 3,000 3,368
Other non-currents assets 308 391 400
Total assets 21,553 19,560 19,200

Liabilities and Stockholders Equity

Accounts payable 8,895 7,316 7,400
Accrued and other current liabilities 3,241 3,580 3,500
Total current liabilities 12,136 10,896 10,900
Long term debt 505 505 600
Other non-current liabilities 2,089 1,630 1,700
Total liabilities 14,730 13,031 13,200
StockholdersÊ equity: 6,823 6,529 6,000
Total liabilities & stockholdersÊ equity 21,553 19,560 19,200
(a) Using the above information, calculate the following ratios for 2012 and
2013:
Current ratio
Quick ratio
Acc receivable turnover
Receivable collection periods
Acc inventory turnover
DaysÊ sales in inventory
Acc payable turnover
Acc payable period
Conversion period
Net Trading cycle
(b) Comment CIMB's liquidity risk over the period.
Case 2:
The following are Seri Sentiasa CorporationÊs income statement and balance
sheet, in RM millions.
Income Statement
2012 2013
Net Revenue 50,000 42,000
Cost of revenue (40,190) (33,892)
9,810 8,108

Gross profit
Selling, general and
administrative expense (4,298) (3,544)
Depreciation and
amortisation (463) (464)
Operating income (EBIT) 5,049 4,100
Interest and other income 191 180
Interest expenses (100) (100)
Earning before income tax 5,140 4,180
Income taxes (50) (50)
Net Income 5,090 4,130
Balance Sheet
2011 2012 2013
Assets
Cash and cash equivalents 4,847 4,317 3,317
Short-term investments 988 835 715
Accounts receivable, net 2,000 1,500 1,500
Inventories 5,500 7,000 7,300
Total current assets 13,335 13,652 12,832
PP&E, net 1,691 1,517 1,600
Investment 4,319 3,000 3,368
Other non-currents assets 308 391 400
Total assets 19,653 18,560 18,200
Liabilities and StockholdersÊ

Equity
Accounts payable 8,895 7,316 7,400
Accrued and other current
liabilities 1,341 2,580 2,500
Total current liabilities 10,236 9,896 9,900
Long term debt 505 505 600
Other non-current liabilities 2,089 1,630 1,700
Total liabilities 12,830 12,031 12,200
StockholdersÊ equity: 6,823 6,529 6,000
Total liabilities and
stockholdersÊ equity 19,653 18,560 18,200

Using the above information, calculate the following ratios for 2012 and 2013:
Current ratio
Quick ratio
Acc receivable turnover
Receivable collection periods
Acc inventory turnover
DaysÊ sales in inventory
Acc payable turnover
Acc payable period
Conversion period
Net Trading cycle
Case 3:
The following are Comparative Income Statement and Balance Sheet and Income
Statement of Teratai Sdn. Bhd.
Teratai Sdn. Bhd. Income Statement

for the Year Ended 31 December
2010 (RM) 2009 (RM)

Sales 650,000 520,000
Less: Cost of goods sold (415,000) (354,000)
Gross profit 235,000 166,000
Sales and administrative expenses (150,000) (114,800)
Interest expenses (7,200) (6,000)
Taxation (18,000) (14,000)
Less: Total expenses (175,200) (134,800)
Net Income 59,800 31,200

Teratai Sdn. Bhd. Balance Sheet

as at 31st December
Asset 2010 (RM) 2009 (RM)

Current assets:
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 assets 235,000 177,000
Equipment (Net) 403,000 383,000
Total assets 638,000 560,000
Liabilities and Owners Equity
Current liabilities:
Accounts payable 112,000 110,000
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
Retained earnings 223,000 200,000
Total owner's equity 373,000 350,000
Total liabilities and ownerÊs equity 638,000 560,000
Required:
(a) Calculate the following financial ratios for the year 2010:
(i) Current ratio;
(ii) DaysÊ sales in receivable;
(iii) DaysÊ purchase in acc payable;
(iv) Net trading cycle;
(v) Return on assets;
(vi) Return on common equity;
(vii) Earnings per share;
(viii) Debt to equity ratio;

(ix) Dividend payout ratio; and

(x) Interest coverage ratio.
(b) Comments in detail about the companyÊs following financial ratio

(i) Net trading cycle;
(ii) Return on assets; and
(iii) Return on common equity.

ANSWERS  249
Answers
TOPIC 1: ACCOUNTING ENVIRONMENT
Self-test 1
1. Accounting can be defined as a process of collecting, identifying,
measuring, recording, summarising and communicating the results of
businesses or economic transactions to users in order for them to make
informed or better decisions.
There are four components in accounting:
(a) Recording ă written records of journalising and posting business

transactions;
(b) Summarising ă preparing the financial statements;
(c) Analysing ă examining the results to determine the financial position
and performance; and
(d) Interpreting ă using the financial statements to make judgments and
decisions.
2. To be useful, accounting information has to have the following qualitative

characteristics
(a) Relevance;
(b) Reliability;
(c) Comparability; and
(d) Consistency.
3. An income statement reports the financial performance of an entity. It

contains information on revenues and expenses including the profit and
loss of the business entity.

250  ANSWERS
4. Answers are not limited to this.
External Users Type of Information Required
Ć Lenders Cash flow - They are interested to know if the business will have
enough cash to pay back the loan
Ć Suppliers Profitability - They are interested to know if the business is

profitable and will continue operating before selling goods on
credit.
Ć Government Profitability - Government agencies, such as Lembaga Hasil

agencies Dalam Negeri (LHDN), need to know the profit in order to
determine the amount to be taxed.
Ć Customers Profitability - They are interested to know if the business is

profitable and will continue operating before committing to a
long term relationship.
Internal Users
Ć Employees Profitability - They are interested to know if they will get

bonuses or increments.
Ć Sales Managers They need to know what, when and how much to sell.
Ć Production They need to know what, when and how much to produce.
Managers
Ć Budget Officers They need the information to monitor cost and performance
Self-test 2
1. Comparability refers to quality of the information that enables users to
make comparison in evaluating similarities or differences between
companies, industries or over time.
Decision making always involved comparing at least two pieces of

information. A single information, for example Syarikat XÊs profit of RM5
million, is not useful to a decision maker. They need to compare it to other
companiesÊ profits, last yearÊs profit or the industry average in order to
make a decision.

ANSWERS  251
2. The Balance Sheet reports the financial position of a business entity. It

contains information on the entityÊs assets, liabilities and ownerÊs equity.
3. The Statement of changes in ownerÊs equity reports how the ownerÊs equity
has changed over the reporting period. It reports how opening capital has
increased through net income, and how it decreased through net losses and
drawings.
4. Cash flow statements show the in-flow and out-flow of cash of an

organization according to three main activities which are operating,
investing and financing.
5 (a) Income Statement
SMART TUITION CENTRE

Income Statement
RM RM
Revenues
Tuition fees 75,750 75,750
less Expenses
Supplies expenses 6,300
Advertising expense 4,200
General expenses 1,265
Rent expenses 14,400
Utilities expenses 7,350 51,515
Net income 24,235

252  ANSWERS
(b) Statement of changes in ownerÊs equity

RM
Opening Capital (1/1/2008) 23,700
+ net income 24,235
47,935
ă drawings (10,000)
Closing Capital (31/12/2008) 37,935
(c) Balance sheet

Balance Sheet as at 31 December 2008
RM RM RM
Non Current Assets
Computer equipments 17,800 17,800
Current Assets
Supplies 8,480
Accounts Receivables 8,855
Cash 20,000 37,335
Total Assets 55,135
Bank Loan 15,000 15,000
Current Liabilities
Accounts Payables 2,200 2,200
Total Liabilities 17,200
Net Assets 37,935
OwnerÊs Equity*

ANSWERS  253
TOPIC 2: ACCOUNTING STANDARDS, ASSUMPTIONS

AND PRINCIPLES
Self-test 1
1. (a) MASB publishes accounting standards.
(b) MICPA and MIA provide training to accountants.
(c) MIA controls the accounting practice in Malaysia
(d) MASB issues statements of principles for financial reporting.
2. NO. The Companies Act 1965 requires companies to comply with approved
accounting standards. Section 166A of the Companies Act 1965 requires
directors of companies incorporated under the Act to ensure accounts are
prepared in accordance with the applicable accounting standards to the
extent that the accounts give a true and fair view.
3. Ticket sales, holiday package, rentals of planes and advertising are

subjected to full or partial refund if customers cancel their booking. For this
type of transaction when the seller has an obligation to refund money upon
cancellation, it is normal to recognise revenue only at the date which the
service is provided or on the date that cancellations will not be refunded at
all.
For sales of tickets for super saver flights which are non-refundable, the
airline can recognise them as revenue at the point of sale as they do not
have any obligation to refund the fares.
4.
Business Type of Business
Ć Car Rentals Service
Ć Car Dealerships Merchandising (trading/retailing)
Ć Tuition Centres Service
Ć Batik Factory Manufacturing
Ć Tailor Service
Ć Clothing Stores Merchandising (trading/retailing)

254  ANSWERS
Self-test 2
1. Explain the following accounting assumptions:
(a) Separate Entity

For accounting purposes, the business is considered as a separate
entity from the owner. Both the owner and the business are two
separate accounting entities. An accounting entity is an economic unit
that controls its own resources.
(b) Going Concern

An entity is assumed to be continuing its operations in the foreseeable
future and will not cease operations.
(c) Monetary Units

All transactions can be measured in monetary units. In Malaysia the
monetary unit is Ringgit Malaysia (RM). Items that cannot be
measured in monetary unit will not be reported in the financial
statements but disclosed as notes.
(d) Accounting Period

This assumption states that the life of a business entity can be divided
into periodic intervals. This enables financial statements to be
prepared periodically.
2. Explain the following accounting principles:
(a) Historical Cost

This principle states that all transactions must be recorded and
accounted for according to their historical cost.
(b) Revenue Recognition

This principle states that revenues must be recognised when they are
earned. Earned commonly refers to the act of providing goods or
services to customers.
(c) Matching
To determine profit for the accounting period, the revenues of that
period must be matched with the expenses for the same period.

ANSWERS  255
(d) Full Disclosure

This principle states that all relevant and material information must be
adequately disclosed either in the financial statements or as notes
accompanying the statements.
3. (a) Sole Proprietorship

(b) Partnership
(c) Company
4. Characteristics of sole proprietorship, partnership and company
Sole Proprietorship Partnership Company

1. Owner (s) Proprietor Partners Shareholders
2. Life of Limited Limited Indefinite
organisation
3. Liabilities Unlimited Unlimited Limited
4. Accounting status Business is separate Business is Business is separate
from the proprietor. separate from from the
the partners shareholders.
5. Legal status None None A separate legal
entity
6. Formation Relatively easy Relatively easy Complex
7. Management Normally by the owner Normally by the Managers/Directors
partners
8. Tax Proprietor pays tax on Each partner Companies pay tax
business profit. pays tax on his on the business
share of the profit and
profits. shareholders pay
tax on the amount
of dividend they
receive. (Double
Taxation)

256  ANSWERS
TOPIC 3: ACCOUNTING EQUATION
Self-test 1
1.
Assets Liabilities Owner's Equity
Business A 79,500 45,000 34,500
Business B 68,600 23,000 45,600
Business C 163,700 59,200 104,500
2 (a) Indicate whether the following items are A (Assets), L (Liabilities), R

(Revenues) or E (Expenses)
(i) Cash (A) (viii) Accounts Payable (L)
(ii) Bank Loan (L) (ix) Accounts Receivable (A)
(iii) Equipment (A) (x) Sales (R)
(iv) Notes Payable (L) (xi) Supplies (A)
(v) Insurance (E) (xii) Advertising (E)
(vi) Salaries (E) (xiii) Salaries Payables (L)
(vii) Furniture and Fittings (A) (xiv) Motor Vehicle (A)
(b) Explain how the following transactions will affect the accounting
equation. Identify the account affected.
(i) Pay cash for postage.
Decrease in asset (cash) and decrease in ownerÊs equity
through increase in expense (postage)
(ii) Buy furniture and fittings on credit.
Increase in assets (furniture and fittings) and increase in
liabilities (accounts payable)
(iii) Bring own motor vehicle to be used for business purposes.
Increase in assets (motor vehicle) and increase in ownerÊs
equity (capital)
(iv) Pay salaries to workers.
Decrease in asset (cash) and decrease in ownerÊs equity
through increase in expense (salaries)

ANSWERS  257
(v) Receive rentals from tenants.

Increase in asset (cash) and increase in ownerÊs equity through
increase in revenue (rental income)
Self-test 2
1. (a) Transactions of Azwan Enterprise.
Transactions Descriptions
1 - Purchased supplies worth RM1,000 for cash.
2 - Received RM2,000 cash from debtor.
3 - Paid off bank loan for the amount of RM4,000 cash.
4 - Paid rental RM1,000 cash.
5 - Paid wages RM2,000 cash.
6 - Received RM7,000 cash for work performed (printing service).
7 - Purchased supplies worth RM1,500 on credit.
8 - Provided printing services to client but payment will be received later.
9 - Supplies used.
(b) Balance of the account as at 31/1/2006.
Accounts Account Bank

Date Cash Supplies Land Capital
Receivable Payable Loan
Ending
balance, 8,500 5,300 1,700 38,000 5,200 6,000 42,300
31/1/2006
(c) Accounting equation of Azwan Enterprise.

Cash + A/R + Supplies + Land = A/P + Bank Loan + Capital
8,500 + 5,300 + 1,700 + 38,000 = 5,200 + 6,000 + 42,300
53,500 = 11,200 + 42,300

258  ANSWERS
(d) Total Revenue minus Total Expense = Income

(i) (Service Revenue) minus (rental expense + wages expense +
supplies used) = Income
(ii) RM10,500 ă (RM1,000 + RM2,000 + RM1,200) = Income
(iii) Therefore income (profit) is RM6,300.
Did you notice that the difference between opening capital balance
(RM36,000) and closing capital balance (42,300) is exactly RM6,300, which is
the profit made by Azwan Enterprise?
Can you see the relationship between them?
Profit is revenue minus expense, and you have learned earlier that revenue
will increase ownerÊs equity while expense will decrease ownerÊs equity.
Therefore, if you know the opening capital balance and closing capital
balance (assuming there is no drawing made by owner) you can determine
the profit.
2. (a) Transactions analysis: Effects on accounting equation.

Feb 1 Asset (cash) increased, liability (loan) increased and owner's
equity (capital) increased
2 Asset (cash) decreased and another asset (furniture and fittings)
increased
5 Asset (beauty supplies) increased, liability (accounts payable)
increased
7 Asset (accounts receivable) increased, owner's equity (revenue)
increased
10 Asset (cash) decreased, owner's equity (drawings) decreased
12 Not a transaction for the beauty salon.
15 Asset (cash) increased, owner's equity (consultation fees) increased
16 Asset (cash) decreased, another asset (motor vehicle) increased
and liability (loan) increased
17 Asset (cash) increased and another asset (accounts receivable)
decreased
25 Asset (cash) decreased, liability (accounts payable) decreased
27 Asset (beauty supplies) increased and another asset (cash)
decreased

ANSWERS  259
28 Asset (cash) decreased, ownerÊs equity (expenses) decreased
(b) Transaction analysis.

Transa Owner’s
ASSETS = LIABILITIES +
ctions Equity
(Feb.
2005) Furniture Account
Beauty Motor Account
Cash + + and + + Receivab = Loan + + Capital
Supplies Vehicle Payables
fittings les
1 250,000 = 100,000 + 150,000

Bal. 250,000 = 100,000 + 150,000
2 (25,000) + 25,000 =
Bal. 225,000 + 25,000 = 100,000 + 150,000
5 4,000 = 4,000
Bal. 225,000 + 4,000 + 25,000 = 100,000 + 4,000 + 150,000
5,000
5,000 =
7 Revenues
Bal.e 225,000 + 4,000 + 25,000 5,000 = 100,000 + 4,000 + 155,000
(20,000)
(20,000) =
10 Drawings
Bal. 205,000 + 4,000 + 25,000 5,000 = 100,000 + 4,000 + 135,000
12 Not a transaction for the beauty salon
Bal. 205,000 + 4,000 + 25,000 5,000 = 100,000 + 4,000 + 135,000
3,000
3,000 =
15 Revenues
Bal. 208,000 + 4,000 + 25,000 5,000 = 100,000 + 4,000 + 138,000
16 (5,000) + 20,000 = 15,000
Bal. 203,000 + 4,000 + 25,000 + 20,000 5,000 = 115,000 + 4,000 + 138,000
17 3,000 + (3,000) =
Bal. 206,000 + 4,000 + 25,000 + 20,000 + 2,000 = 115,000 4,000 138,000
25 (4,000) = (4,000)
Bal. 202,000 + 4,000 + 25,000 + 20,000 + 2,000 = 115,000 + 0 + 138,000
27 (5,000) + 5,000 =
Bal. 197,000 + 9,000 + 25,000 + 20,000 2,000 = 115,000 + 0 + 138,000
(100)
(3,600) =
28 electricity
(1,500)
+
rentals
(2,000)
+
salaries
Bal. 193,400 + 9,000 + 25,000 + 20,000 + 2,000 = 115,000 + 0 + 134,400
TOPIC 4: RECORDING TRANSACTIONS
Self-Test 1
1. Describe accounts, ledger and charts of accounts.
(a) Accounts are used to record the increase and decrease of the specific
items in the accounting equation.
(b) A complete set of accounts for a business is called a ledger.

260  ANSWERS
(c) A chart of accounts is a listing of all accounts used in the accounting

system of a business entity.
2. List the format of accounts that you have learned? Which format will show
the closing balance after each transaction?
(a) simple T account
(b) detailed T account
(c) three column account (shows the balance after each transaction)
3. Debit or credit balance

(a) Drawings: debit balance
(b) Building: debit balance
(c) Office supplies: debit balance
(d) Prepaid expenses: debit balance
(e) Revenue received in advance: credit balance
(f) Interest revenues: credit balance
(g) Capital: credit balance
4. (a) Journal Entries
Feb 1 Cash 150,000

Capital - Che Wan 150,000
Contributed RM150,000 cash as initial capital.
1 Cash 100,000
Bank Loan 100,000
Borrowed RM100,000 from bank for the business.
2 Furniture & Fittings 25,000

Cash 25,000
Purchased furniture and fittings for cash.
5 Beauty supplies 4,000

Accounts payable 4,000
Purchased beauty supplies on credit.

ANSWERS  261
7 Accounts receivable 5,000

Service revenues* 5,000
Billed customer for makeup service provided.
10 Drawings 20,000
Cash 20,000
Withdrew cash for personal use.
12 Not a transaction for the beauty salon.
15 Cash 3,000
Service revenues 3,000
Provide beauty consultation service for cash.
16 Motor vehicle 20,000
Cash 5,000
Bank loan 15,000
Purchased motor vehicle, paying partially by cash and taking
out loan.
17 Cash 3,000
Received payment from customer for service rendered.
25 Accounts payable 4,000

Cash 4,000
Paid accounts payable.
27 Beauty supplies 5,000

Cash 5,000
Purchased beauty supplies for cash.
28 Electricity expenses 100

Rental expenses 1,500
Cash 3,600
Paid expenses for cash.
* Depending on the firm, different names can be used to record their

revenues. In this case service revenue account was used. Other names
for this nature of business could be Consultation fees, Makeup Fees,
Makeup Service etc.

262  ANSWERS
(b) Posting journal entries to ledger using three column format account.
Cash
Date Account Name Ref Debit Credit Balance

1 Feb Capital-Che Wan 150,000 150,000
1 Feb Bank Loan 100,000 250,000
2 Feb Furniture & Fittings 25,000 225,000
10 Feb Drawings 20,000 205,000
15 Feb Service revenues 3,000 208,000
16 Feb Motor vehicle 5,000 203,000
17 Feb Accounts receivable 3,000 206,000
25 Feb Accounts payable 4,000 202,000
27 Feb Beauty supplies 5,000 197,000
28 Feb Electricity expenses 100 196,900
28 Feb Rental expenses 1,500 195,400
28 Feb Salaries expenses 2,000 193,400
Accounts Receivable
7 Feb Service revenues 5,000 5,000
17 Feb Cash 3,000 2,000
Beauty Supplies
5 Feb Accounts payable 4,000 4,000
27 Feb Cash 5,000 9,000
Motor Vehicle
16 Feb Cash 5,000 5,000
Bank loan 15,000 20,000

ANSWERS  263
Furniture and Fittings

2 Feb Cash 25,000 25,000
Bank Loan
1 Feb Cash 100,000 100,000
16 Feb Motor vehicle 15,000 115,000
Accounts Payable
5 Feb Beauty supplies 4,000 4,000
25 Feb Cash 4,000 0
Capital - Che Wan

1 Feb Cash 150,000 150,000
Drawings
10 Feb Cash 20,000 20,000
Service Revenues
7 Feb Accounts receivable 5,000 5,000
15 Feb Cash 3,000 8,000

264  ANSWERS
Electricity Expenses
28 Feb Cash 100 100
Rental Expenses
28 Feb Cash 1,500 1,500
Salaries Expenses
28 Feb Cash 2,000 2,000
5.
Che Wan Beauty Salon
Trial Balance as at 28 February 2008
Account Debit RM Credit RM
Cash 193,400
Accounts 2,000
receivable
Beauty 9,000
supplies
Motor vehicle 20,000
Furniture & 25,000
Fittings
Bank Loan 115,000
Capital - Che 150,000
Wah
Drawings 20,000
Service 8,000
revenues

ANSWERS  265
Electricity 100
expenses
Rental 1,500
expenses
Salaries 2,000
expenses
273,000 273,000
Accounts payable is not listed in the trial balance as the balance of the account is zero.
6.
Syarikat Janda Baik
Income statement
for the month ended 30 April 2007
RM RM
Revenues
Subscription 15,500
revenues
Rental revenues 4,300 19,800
Expenses
Salaries 2,500
expenses
Utilities 250
expenses
Interest 130 2,880
expenses
Net Income 16,920

266  ANSWERS
Self-test 2
1.
Mawee & Associates Consulting
Debit (RM) Credit (RM)

Land and Buildings 20,000
Motor Vehicles 13,000
Salaries Wages 700
Consultation fees 20,000
Office Supplies 700
Bank Loan 4,000
Advertising expense 400
Repairs and 500
Maintenance
Capital 14,000*
Rental Income 800
41,800 41,800
* Capital figure is obtained from deducting Total Assets (RM41,800)

against Total Liabilities (RM27,800) = RM14,000.

ANSWERS  267
2.
Income Statement
RM RM
Revenues
Service Revenues 8,000
Expenses
Electricity expenses 100
Rental expenses 1,500
Salaries expenses 2,000 3,600
Net Income 4,400
3.
RM
OwnerÊs Equity
Beginning Capital 1st February 150,000
2008
Add profit 4,400
154,400
Less Drawings (20,000)
Closing capital - 28th February 134,400
2008

268  ANSWERS
4.
Balance Sheet
RM RM
Assets
Cash 193,400
Beauty supplies 9,000
Furniture & Fittings 25,000
249,400
Liabilities
Bank Loan 115,000 115,000
Net Assets 134,400
OwnerÊs Equity
Capital - Che Wan 134,400

ANSWERS  269
5.
Amit & Associates Architects
Income Statement
for the month ended 30 June 2008
RM RM
Revenues
Consultation 34,500
fees
Interest 2,900 37,400
revenues
Less Expenses
Salaries 5,700
expenses
Utilities 2,600
expenses
Supplies 1,600 9,900
expense
Net Income 27,500

270  ANSWERS
TOPIC 5: ADJUSTING ENTRIES AND CLOSING ENTRIES
Self-Test 1
1. (i) Cash basis accounting
Onn & Sons Enterprise

Income Statement for the month ended 31 January 2008
RM RM
Revenues
less Expenses
Supplies expense (5,000)
Rental expenses (3,000) (8,000)
Net income 19,500
(ii) Accrual basis accounting
Onn & Sons Enterprise

Income Statement for the month ended 31 January 2008
RM RM
Revenues
less Expenses
Salaries expenses (2,000)
Supplies expense (3,000)
Rental expenses (1,000) (6,000)
Net income 29,000

ANSWERS  271
2. Working
Total office supplies ă supplies on hand at the end of period = office used
supplies
(RM1,617 + RM3,603 ă RM526) = RM4,694
Journal entry
Dr Office Supplies Expense 4,694

Cr Office Supplies 4,694
To record office supplies used
3. This exercise will be easier to see if you draw the timeline diagram.
Working
1/1/2008 31/8/2008 31/12/2008
Prepaid insurance = RM400 1 Renewed 3 years policy RM2,160 2 2008

Expenses ?
1 This will expire (used up) by 1/9/2008 and will be expensed for 2008.
2 This will provide coverage until 31/8/20011, however until 31/12/2008 it

provides four months coverage to the business and hence need to be
expensed.
1 January to 31 August 2008 insurance expense = RM400 + 1 Sept to 31

December 2008 insurance expense = RM240 (RM2,160 x 4/36)
Journal entry
Dr Insurance Expense 640

Cr Prepaid Insurance 640
To record insurance expired.
4. Working
For only nine months (April to September) magazine has been sent to client
therefore Ujang only earned RM450 revenue (RM1,800 x 9/36).

272  ANSWERS
Dr Subscription Received in Advanced 450

Cr Subscription Revenue 450
To record subscription revenue earned (9 months)
Self-test 2
1. Interest on note payable = (RM30,000 X 12%) x 3/12) = RM900.
Journal entry
Dr Interest Expense 900

Cr Interest Payable 900
To record interest expense accrued.
2. Interest earned on the fixed deposit = (RM24,000 X 12%) x 3/12) = RM720.
This will not be received until 31 March 2009, but you have earned the
interest revenue and will be receiving it later. Hence, revenues should be
recognised.
Journal entry
Dr Interest receivables 720

Cr Interest income 720
To record interest income earned.
3. (a) Journal entries

ANSWERS  273
01/01/2007 ă Not a transaction. Balance is shown in the Accounts

Receivable
05/01/2007 ă Dr Accounts Receivable - Venus 600

Cr Sales 600
Sold goods on credit to Venus
10/02/2007 ă Dr Bad Debts Expenses 300

Cr Account Receivable - Star 300
Writing off Star accounts as bad due to bankruptcy.
07/10/2007 ă Dr Cash 200

Cr Accounts Receivable - Venus 200
Venus paid RM200 as full settlement of his account
Dr Bad Debts Expenses 400

Cr Accounts Receivable - Venus 400
Writing off balance of Venus account RM400 as bad
01/12/2007 ă Dr Accounts Receivable - Star 100

Cr Bad debts recovered 100
Bad debt recovered from Star RM100
Dr Cash 100
Cr Accounts Receivable - Star 100
To record the receipt of RM100 from Star.

274  ANSWERS
(b) Ledger
Bad Debts Expense

10/2 Accounts Receivable ă 300 Year end P&L 600
Star
10/2 Accounts Receivable ă 300
Venus
600 600
Bad Debts Recovered

Year end 100 1/6 Account Receivable ăStar 100
P&L
Accounts Receivable- Star

1/1 b/d 300 10/2 Bad Debts Expense 300
1/6 Bad Debts 100 1/6 Cash 100
Recovered
Accounts Receivable- Venus

5/1 Sales 500 10/5 Cash 200
10/5 Bad Debts Expense 300
500 500
4. (a) Journal entries Debit Credit

(i) Dr Supplies expense 350
Cr Supplies 350
(ii) Dr Insurance expense 2,400

Cr Prepaid insurance 2,400
(RM4,800 / 2 years) = RM 2,400 p.a.)
(iii) Dr Depreciation expense 3,000

Cr Accumulated Depreciation - Building 3,000
(RM60,000 x 5%)
(iv) Dr Depreciation expense 6,000

Cr Accumulated Depreciation - Motor Vehicle 6,000
(RM30,000 / 5 years = RM6,000 p.a.)

ANSWERS  275
(v) Dr Accounting fees 3,400

Cr Unearned accounting fees 3,400
(vi) Dr Rental receivables 500

Cr Rental Revenues 500
(vii) Dr Interest expense 300

Cr Interest payable 300
(viii) Dr Salaries expenses 600

Cr Salaries payable 600
Dr Utilities expense 200

Cr Utilities payable 200
(ix) Dr Income summary 300

Cr Provision for doubtful debts 300
(b) Adjusted trial balance
MKS Accounting Firm

Adjusted Trial Balance as at 30 June 2008
Accounts Debit (RM) Credit (RM)
Cash 13,000
Office supplies 150
Provision for doubtful 300
debts
Rental receivables 500
Building 60,000
Accumulated Depreciation 3,000
- Building
Accumulated Depreciation 6,000
- Motor Vehicle
Unearned accounting fees 3,400
Utilities payable 200
Interest Payable 300

276  ANSWERS
Bank Loan 25,000

Capital - MKS 60,000
Drawings - MKS 1,200
Rental revenues 2,900
Interest expense 1,300
Doubtful debts 300
Depreciation expense 9,000
129,600 129,600
The adjusting entries and adjusted trial balance can also be combined as
worksheet, (see the following worksheet).
MKS Accounting Firm

Worksheet as at 30 June 2008
Unadjusted T.B. Adjustment Adjusted T.B.
Account
Dr Cr Dr Cr Dr Cr
Cash 13,000 13,000
Office supplies 500 350 150
Accounts Receivable 2,300 2,300
Prepaid insurance 4,800 2,400 2,400
Building 60,000 60,000
Motor Vehicle 30,000 30,000
Accounts Payable 5,600 5,600
Bank Loan 25,000 25,000
Capital - MKS 60,000 60,000
Drawings - MKS 1,200 1,200
Accounting fees 25,700 3,400 22,300
Rental revenues 2,400 500 2,900
Interest expense 1,000 300 1,300
Salaries expenses 4,500 600 5,100
Utilities expenses 1,400 200 1,600
Supplies expense 350 350
Insurance expense 2,400 2,400

ANSWERS  277
Depreciation expense 9,000 9,000

Accumulated Depreciation 3,000 3,000
- Building
Accumulated Depreciation 6,000 6,000
- Motor Vehicle
Unearned accounting fees 3,400 3,400
Rental receivables 500 500
Utilities payable 200 200
Interest payable 300 300
Salaries payable 600 600
Doubtful Debts 300 300
Provision for Doubtful 300 300
Debts
118,700 118,700 17,050 17,050 129,600 129,600
It is common for a business not to record adjusting entries in a journal but

show it in a ten column worksheet. The above is a partial worksheet, as it
does not include the income summary and balance sheet column. Can you
see the effect of adjustment entries to the unadjusted trial balance figure?
Some adjustments will increase the balances, while others decrease the
balance. And this increase or decrease is according to the normal balances
rules.
Can you see that additional accounts are created after adjustments are
made? Did you notice how there are no adjustment entries that involve
cash? And for each adjustment entry there will be one item of balance sheet
and another item of income statement affected.

278  ANSWERS
(c) (i) Income statement for MKS Accounting Firm
MKS Accounting Firm

Income statement for the year ended 30 June 2008
RM RM
Revenues
Rental revenues 2,900 25,200
Less Operating expenses
Interest expense (1,300)
Salaries expenses (5,100)
Utilities expenses (1,600)
Supplies expense (350)
Insurance expense (2,400)
Doubtful Debts (300)
Depreciation expense (9,000) (20,050)
Net Income 5,150

ANSWERS  279
(c) (ii) Balance Sheet for MKS Accounting Firm
MKS Accounting Firm

Balance Sheet as at 30 June 2008
RM RM RM
Current Assets
Cash 13,000
Office supplies 150
Less Provision for doubtful 300 2,000
debts
Total current assets 18,050
Non Current Assets
Building 60,000
Accumulated Depreciation - (3,000) 57,000
Building
Accumulated Depreciation - (6,000) 24,000
Motor Vehicle
Total non current assets 81,000
TOTAL ASSETS 99,050
Current Liabilities
Unearned accounting fees 3,400
Interest payable 300
Total current liabilities 10,100
Bank Loan 25,000
Total non current liabilities 25,000
TOTAL LIABILITIES 35,100
NET ASSETS 63,950

OwnerÊs Equity
Beginning capital 1/7/07 60,000

280  ANSWERS
Add net income 5,150

65,150
Less drawings 1,200
Closing capital 30/6/08 63,950
(d) Closing entries
Dr Accounting fees 22,300

Dr Rental revenues 2,900
Cr Income summary 25,200
To close revenue accounts to income summary account
Dr Income summary 20,050

Cr Interest expense 1,300
Cr Salaries expenses 5,100
Cr Utilities expenses 1,600
Cr Supplies expense 350
Cr Insurance expense 2,400
Cr Doubtful Debts 300
Cr Depreciation expense 9,000
To close expense accounts to income summary account
Dr Income summary 5,150

Cr Capital 5,150
To close income summary to capital account
Dr Drawings 1,200
Cr Capital 1,200
To close drawings account to capital account

ANSWERS  281
(e) (i) Income summary account
Income Summary
30/6/08 Interest expense 1,300 30/6/08 Accounting fees 22,300
Salaries expenses 5,100 Rental revenues 2,900
Doubtful Debts 300
Depreciation expense 9,000
Capital 5,150
25,200 25,200

282  ANSWERS
(e) (ii) Capital account
Capital
30/6/08 Drawings 1,200 30/6/08 Balance 60,000
Closing balance 63,950 Income 5,150
summary
65,150 65,150
Can you see the relationship between the capital account and the statement of
changes in ownerÊs equity? Statement of changes in ownerÊs equity (or the
ownerÊs equity component in the balance sheet) is actually the statement format
of capital account. See the following statement of ownerÊs equity for MKS.
MKS Accounting Firm

Statement of Changes in OwnersÊ Equity as at 30 June 2008
RM RM RM
Add net income 5,150
65,150
Less drawings (1,200)
TOPIC 6: ACCOUNTING FOR MERCHANDISING

OPERATIONS
Self-test 1
1.
(a) Journal entries
Apr 1 Accounts Receivables ă Ninja 5,500
Sales 5,500
Sold 10 television sets @RM550 each on credit, term 10/10, n30 FOB
Destination.

ANSWERS  283
4 Freight outwards 50
Bank 50
Paid for freight outwards RM50.
5 Sales returns & allowance 550

Accounts Receivables - Ninja 550
Ninja returned faulty television
6 Purchase 7,500
Accounts Payable ă Syarikat Xmen 7,500
Purchase goods on credit, term 5.10, n30
9 Accounts Receivable - Cross Ltd. 9,000

Sales 9,000
Sold 20 washing machines @RM500 each less 10% trade discount.
Term 5/15, eom
10 Bank 2,475
Sales Discount 275
Accounts Receivables ă Ninja 2,750
Ninja paid half of amount due within the discount period and
received 10%
discount.
11 Accounts Payable - Syarikat Xmen 400

Purchase returns and allowance 400
Received allowance from Syarikat Xmen electrical.
15 Bank 8,550
Sales Discount 450
Accounts Receivable - Cross Ltd. 9,000
Cross Ltd paid within the discount period and was allowed 5%
discount.
20 Purchase 1,400
Accounts Payable - Star Ltd. 1,400
Purchased electrical goods on account term 2/10, n30, FOB shipping
point.
21 Freight inwards 70
Cash 70
Paid for freight inwards for April, 20 purchase.

284  ANSWERS
24 Cash 14,500
Sales 14,500
Cash sales
29 Accounts Payable - Star Ltd. 1,400

Bank 1,372
Purchase discount 28
Paid Star Ltd. within the discount period and paid 2% less.
30 Bank 2,750
Accounts Receivables ă Ninja 2,750
Ninja paid remaining amount owed from April 1 transaction.

ANSWERS  285
2.
Naruto Electrical Shop
Income Statement for the year ended 30 April 2008
RM RM RM
Net Sales
(-) Sales returns and (550)
allowance
(-) Sales discounts (discount (725) (1,275) 27,725
allowed)
Less Cost of Goods Sold
Purchases 8,900
(-) Purchases returns and (400)
allowance
(-) Purchases discounts (28)
(+) Freight inwards 70
Cost of Goods Available for 13,242
Sales
Less Closing inventory (1,400) 11,842
Gross Profit 15,883
Less operating expenses (4,750)
Freight outwards (50)
Salaries expense (2,300)
Utilities expense (500)
Motor vehicle depreciation (1,200)
Advertising expense (700)
Net Income (Net Profit) 11,133

286  ANSWERS
Self-test 2
1. Closing entries
31/12/08 Dr Sales revenue 29,000

Dr Inventory (closing) 1,400
Dr Purchases returns and allowance 400
Dr Purchases discounts 28
Cr Income Summary account 30,828
To close temporary accounts with credit balances.

Cr Inventory opening 4,700
Cr Purchases 8,900
Cr Sales returns and allowance 550
Cr Sales discount 725
Cr Freight inwards 70
Cr Freight outwards 50
Cr Salaries expense 2,300
Cr Utilities expense 500
Cr Motor vehicle depreciation 1,200
Cr Advertising expense 700
To close temporary accounts with debit balances.

Cr Capital 11,133
To transfer net profit to capital account.

ANSWERS  287
2. (a)
Turbo Trading
Income Statement for the year ended 30 June 2008
RM RM RM
Net Sales 24,100
(ă) Sales discounts (discount allowed) (1,200) (1,600)
Less Cost of Goods Sold 11,300
Purchases 11,200
(ă) Purchases discounts (900)
(+) Freight inwards (1/3 x 900) 300
Cost of Goods Available for Sales 12,700
Less Closing inventory (1,400)
Gross Profit 12,800
Add Other Income
Rental Revenues (1,400 + 400) 1,800
14,600
Less Operating Expenses 15,030
Freight outwards (2/3 x 900) 600
Advertising Expenses (1,500 ă 500) 1,000
Salaries expenses (5,400 + 600) 6,000
Utilities expenses (1,400 + 200) 1,600
Insurance expense (3,600 x 6/36 ) 600
Depreciation (50,000 / 10 years) 5,000
Doubtful debts (10% x 2,300) 230
Net loss (430)

288  ANSWERS
Did you notice that the balance of sales and purchase, discounts and returns are
given within the same row, but different figures appear in the Debit and Credit
columns? Purchases always have a debit balance and Sales will have a credit
balance. Their respective discounts and returns are of opposite balances.
2. (b)
Turbo Trading
Balance Sheet as at ended 30 June 2008
RM RM RM
Current Assets
Cash 15,900
Inventory 1,400
Less Provision for doubtful debts (230) 2,070
Prepaid advertising 500
Total current assets 23,270
Non Current Assets
Accumulated Depreciation - Motor (5,000) 45,000
Vehicle
Total non current assets 45,000
TOTAL ASSETS 68,270
Current Liabilities
Total current liabilities 5,100
NET ASSETS 63,170
Owners Equity
Less loss (430)
65,570
Less drawings (2,400)

ANSWERS  289
TOPIC 7: INTERNAL CONTROL AND CASH

MANAGEMENT
Self-test 1
1. To economic on space, all narratives for journal entries are omitted.
(a) More Dr 412 : More Cr 412
(b) Machinery Dr 619 : Frankie Cr 619
(c) Computer Dr 550 : Office expenses Cr 550
(d) Woody Dr 18 : Sales Cr 18
(e) Sales Dr 164 : Communication recÊd Cr 164
(f) Cash (double) Dr 136 : Blair Cr 136
(g) Purchases Dr 372 : Drawings Cr 372
(h) Discount allowed Dr 48 : Discount received Cr 48
Self-test 2
1.
Suspense Account
(i) Purchases 20 Balance b/d 40
(ii) Creditors 9
(iii) Sales 11
40 40

290  ANSWERS
TOPIC 8: ACCOUNTING FOR PARTNERSHIP
Self-Test 1
1. (a) Extract of balance sheet as at 31 December 2008
Syarikat Demo
as at 31/12/2008
RM RM
Current Liabilities
Accrued Interest 12,500
Current portion of long term loan - Putrajaya Bank 50,000 62,500
Long Term Loan

Long term loan - Putrajaya Bank 450,000
512,500
Working:
Accrued interest of the loan is RM500,000 x 5% x 6/12 = RM12,500.
First instalment due within twelve months is RM50,000.
(b) Journal entries to record payment of interest on 1 January 2006
Dr Interest Payable 12,500

Cr Cash 12,500
To record the payment of accrued interest.
(c) Journal entries to record payment of interest on 1 July 2006
Dr Interest Expense 12,500

Dr Bank Loan - Putrajaya 50,000
Cr Cash 62,500
To record the payment of first instalment and the interest charges.

ANSWERS  291
(d) Extract of balance sheet as at 31/12/2010
Syarikat Demo
as at 31/12/2010
RM RM
Current Liabilities
Accrued Interest 12,500
Current portion of long term loan - Putrajaya Bank 50,000 62,500
Long Term Loan

Long term loan - Putrajaya Bank 350,000
412,500
Working:
From 31/12/ 2008 until 31/12/2010, two instalments of principles were
made, meaning the balance of the loan is RM400,000. And out of this
amount, RM50,000 is due within the next twelve months (1 June 2011). As at
31/12/2010, Syarikat Demo has accrued RM12,500 (original loan amount of
RM500,000 x 5% x 6/12) interest and this to be paid on 1 January 2011.
2. (a) Nominal value of preference share is RM300,000

(300,000 shares x RM1 par value)
Dividend is RM24,000 (8% x RM300,000)
(b) Nominal value of preference share is RM800,000

(c) Nominal value of ordinary share is RM250,000

(500,000 shares x 50 cents par value)
(d) Nominal value of ordinary share is RM200,000

(e) Nominal value of ordinary share is RM250,000

(500,000 shares x RM0.50 par value)

292  ANSWERS
However dividend is paid 5 cents per share, therefore dividend paid

is RM25,000 (500,000 shares x 5 cents)
Self-test 2
1. (a) Equity of a partnership comprises capital and current accounts.

(b) Equity of a company comprises shareholdersÊ fund, retained earnings
and reserves accounts.
(c) There are two main types of shares: ordinary share and preference
shares.
(d) Instead of making drawings, shareholders are paid dividends.
(e) Dividends and transfer to reserves will decrease the retained earnings
balance, while earning after tax will increase the retained earnings.
2. (a) Calculate earnings after tax
M&S Corporation
Income Statement
RM
Revenue 57,500,000
Less Cost of goods sold (15,000,000)
Gross Margin 42,500,000
Less Operating Expenses (18,000,000)
Earnings before tax 24,500,000
Less Tax expenses (7,350,000)
Earnings after tax 17,150,000

ANSWERS  293
(b) Prepare statement of retained earnings
M&S Corporation
RM RM
Opening Retained Earnings 25,600,000
Add Earnings after tax 17,150,000
Earnings available for distribution 42,750,000
Less
Ordinary Shares Dividends (210,000)
Preference Shares Dividends (125,000) (335,000)
Transfer to General Reserves (3,500,000)
Closing Retained Earnings 38,915,000
(c) Extract of balance sheet
M&S Corporation
as at 31/12/2008
RM RM
Equity
Shareholders funds
Ordinary shares 3 million shares 2,100,000
Preference shares 5 million shares 2,500,000 4,600,000
Retained earnings 38,915,000
General Reserves 15,500,000
Total equity 59,015,000

294  ANSWERS
TOPIC 9: ACCOUNTING FOR COMPANIES
Self-test 1
1.
Holmes, Watson and Lupin
Appropriation Account for the year ended 31 July 2012
Net profit b/d 111,000
Less salaries: Watson 30,000
Lupin 18,000 48,000
Interest on capitals: Holmes 3,600
Watson 2,400
Lupin 1,200 7,200 55,200
Balance of profits 55,800
Shared: Holmes 2/9 12,400
Watson 1/3 18,600 ______
Lupin 4/9 24,800 55,800
Self-test 2
1.
Black, Blue and Purple
Appropriation Account for the year ended 31 December 2013
Net profit b/d 111,100
Add interest on drawings: Black 400
Blue 300
Purple 200 900
112,000
Less Interest on capitals: Black 3,000
Blue 2,000
Purple 1,000 6,500
Salaries: Blue 20,000
Purple 25,000 45,000 51,500
Balance of profits 60,500
Shared: Black 70% 42,350

ANSWERS  295
Blue 20% 12,100

Purple 10% 6,050 60,500
Balance sheet as at 31 March 2013 (extracts)
Capital account: Black 100,000
Blue 50,000
Purple 25,000 175,000
Current Accounts: Black Blue Purple

Balances 1.4. 2012 18,600 9,460 8,200
Add Interest on capital 3,000 2,000 1,500
Salaries 20,000 25,000
Share on profits 42,350 12,100 6,050
63,950 43,560 40,750
Less: Interest on drawings 400 300 200
Drawings 39,000 27,100 16,800
24,550 16,160 23,750 64,460
TOPIC 10: FINANCIAL STATEMENT ANALYSIS
Self-test 1
1. (a) Intra company is where items in the financial statements of a company
are compared against the companyÊs result in the selected base year;
(b) Inter company is where items in the financial statements of a company
are compared against a competitorÊs (another company in the same
industry); and
(c) Industry average is where items in the financial statements of a
company are compared against the industry average.
2.
Syarikat Hazim
2008 2007 2006 2005 2004
Net Income 49,670 44,890 40,456 37,657 35,829
Percentage 138.63 125.29 112.91 105.10 100
Increment/Decrement 13.34 12.38 7.81 5.10 ă

296  ANSWERS
The profit (net income) of Syarikat Hazim has increased over time. In 2007,
there was a big jump in profit by 12.38% from the 2006 profit.
In 2005, an increase of 5.10%
n 2008, an increase of 13.34%
Self-test 2
160,000
1. (a) (i) Gross Profit Ratio   100%  40%
400,000
40,000
(ii) Net Profit Ratio   100%  10.00%
400,000
(b) Earning after tax = RM40,000 ă (30% x RM40,000) = RM28,000
Only 20,000 ordinary shares has been issued and no preference shares
was issued by the company.
28,000
Therefore Earning Per Share   RM1.40 per share
20,000 ordinary shares
(c) For every RM1 sales, Intan Holding has managed to earn 40 cents
gross profit.
Intan Holding also managed to earn 10 cents net profit for every
Ringgit sales.
This means 30% of sales is used to pay off operating expenses (sales and
administrations expenses). Is this ratio good or bad? We need more
information; for example, what were the ratios last year, what are the
competitorsÊ ratios or industry average. Then only can we conclude whether
Intan Holding has performed better or is worse off.
2. First you need to know the grouping of assets and liabilities; whether they
are current or long term. You also need to know what comprises
shareholders funds. In this case, only two items are given: Ordinary
Shareholder funds and retained earnings.
365,000
(a) Gross Profit Ratio   100%  40.09%
910,500

ANSWERS  297
152,500
(b) Net Profit Ratio   100%  16.75%
910,500
 152,500  (30%  152,500) 

(c) Earnings Per Share     RM1.0675 per share
 100,000 shares 
 (75,500  125,000) 
(d) Current Ratio     2.66:1
 (60,500  15,000) 
 125,000 
(e) Quick Ratio     1.66:1
 (60,500  15,000) 
 
 
(910,500  365,000) 
(f) Inventory Turnover Ratio    7.50 times
  (70,000  75,500)  
 2 
 
Cost of goods sold (COGS) is not given but if you know the gross profit and
sales figure, you can find out the COGS. Sales minus COGS = Gross Profit.
Work backward to find the COGS.
 
 
910,500
(g) Account Receivable Turnover Ratio     7.92 times
  (125,000  105,000)  
 2 
 
accounts receivable
 365 days 
(h) Average Collection Period     46.09 days
 7.95 times 
 
 
910,500
(i) Total AssetsTurnover     1.48 times
  (675,500  555,000)  
 
 2 
æ (200,000 + 60,500 + 15,000) ö÷

(j) Debts Ratio = çç ÷´100% = 40.78%
çè 675,500 ø÷

298  ANSWERS
æ (100,000 + 300,000) ö÷
(k) Equity Ratio = çç ÷÷´100% = 59.26%
çè 675,500 ø
æ (200,000 + 60,000 + 15,000) ö÷

(l) Debts to Equity Ratio = çç ÷ = 0.69 :1
çè (100,000 + 300,000 ø÷
TOPIC 11: COMPREHENSIVE CASES

11.1 ă Preparation of Financial Statements
Case 1:
Syarikat Shine
Income Statement
for the year ended 30 April 2013
RM RM RM
Sales 196,740
Less: Return inwards (600)
Net sales 196,140
Less: Cost of Sales
Beginning Inventory 30,240
Purchases 123,220
Add: Freight inwards(l/3x RMl,008) 336
Net Purchases 123,556
Cost of goods available for sales 153,796

Less: Ending Inventory (20,952)
Cost of Sales (132,844)
Gross Profit 63,296
Add: Revenues 500

Discount Received (RM600-RM100) 710
Provision for Doubtful Debts 210
( 1,500 - (5% x RM25,800) 64,006
Less: Expenses

ANSWERS  299
Discount allowed 2,600

Freight Outwards (2/3 x RM1,008) 672
Utilities (RM1,492 + RM92) 1,584
Salary 24,140
Insurance (RM420 - RM100) 320
Motor vehicles repair expense 520
Bad debts 600
Depreciation Expense ă Motor
Vehicles 12,100
Depreciation Expense ă Fixtures & fittings
(RM11,800 x 10%) 1,180
Interest on Loan 884 44,600
Net Profit 19,406
Syarikat Shine
Balance Sheet
as at 30 April 2013
RM RM RM
Non-current Assets
Less: Accumulated Depreciation ă motor
vehicle (RM24,200 + RM12,100) (36,300) 12,100
Fixtures and fittings 11,800

Less: Accumulated depreciation ă
fixtures and fittings (RM11,800 x 10%) (1,180) 10,620
Current assets 22,720

Cash 3,500
Bank 4,800
Ending Inventory 20,952
Accounts Receivable (RM26,400 - 25,800
RM600)
Less: Provision for doubtful debts (1,290) 24,510
53,762
Less: Current Liabilities


300  ANSWERS
Accrued utilities 92
Advanced discount received 100
Interest Payable 884
26,410
WORKING CAPITAL (RM53,762 - (27,352)
RM27,352) 49,130
Financed by: OwnerÊs Equity 13,484

Capital 19,406 31,450
Add: Net Profit 32,890 17,680
Less: Drawings (RMl,340 + RM100) (1,440) 49,130
Loan ă Joshua
Case 2:
Syarikat Ameer
Balance Sheet as at 31 December 2013
RMÊ000 RMÊ000 RMÊ000

Non-current assets:
Land 230
Office equipment 260
Accumulated depreciation(RM46 85 175 405
+ RM39)
Intangible asset:
Goodwill 60
Current assets:
Inventory 96
Accounts receivable 871
Cash at bank (RM50 + RM70 - 111 1178
RM9)
Current liabilities:
Accounts payable 722
Unearned revenue 70 882
Net current assets 296
851

ANSWERS  301
Financed by:
Capital 250
Retained profits 380
Less: Drawings 9 621
Non-current liability:
Bank loan 230
851
11.2 ă Financial Statement Analysis

Case 1:
(a)
2012 2013
Current ratio 1.26 1.34
Quick ratio 0.64 0.61
Acc receivable turnover 27.63
Receivable collection periods 12.80 13.03
Acc inventory turnover 5.19 4.16
DaysÊ sales in inventory 69.42 86.57
Acc payable turnover 4.96 4.61
Acc payable period 72.60 78.16
Conversion period 82.22 99.60
Net Trading cycle 9.62 21.44
(b) Over the period

(i) Current ratio = reasonable above 1 but below 2 (industry overall
standard).
(ii) Quick ratio = critical, too much stocks and inventory period.
(iii) Conversion period slightly long but improving.
(iv) Net trading cycle at comfortable zone and improving.

302  ANSWERS
Case 3:
2012 2013
Current ratio 1.30 1.38
Quick ratio 0.77 0.67
Acc receivable turnover 28.57 28.00
Receivable collection periods 12.60 12.86
Acc inventory turnover 6.43 4.74
DaysÊ sales in inventory 55.98 75.95
Acc payable turnover 4.96 4.61
Acc payable period 72.60 78.16
Conversion period 68.58 88.80
Net Trading cycle -4.02 10.65

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OUM Business School

Copyright © Open University Malaysia (OUM)

Copyright © Open University Malaysia (OUM)

Module Writers: Rosila Abu Zarin

Moderators: Dr Sofiah Md Auzair

Baldev Singh Pertab Singh

Developed by: Centre for Instructional Design & Technology

First Edition, September 2006

Copyright © Open University Malaysia (OUM)

Topic 1 Accounting Environment 1

Topic 2 Accounting Standards, Assumptions and Principles 23

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2.3.4 Assumption 4: Accounting Period 29

Topic 3 Accounting Equation 40

Topic 4 Recording Transactions 61

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4.1.3 Rules of Debit And Credit 65

Topic 5 Adjusting Entries and Closing Entries 89

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Topic 6 Accounting for Merchandising Operations 125

Topic 7 Internal Control and Cash Management 154

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Topic 8 Accounting for Partnership 177

Topic 9 Accounting for Companies 194

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Topic 10 Financial Statement Analysis 218

Topic 11 Comprehensive Cases 240

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Copyright © Open University Malaysia (OUM)

COURSE GUIDE DESCRIPTION

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Table 1: Estimation of Time Accumulation of Study Hours

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Topic 5 differentiates between cash and accrual basis of accounting. It also

Topic 6 covers the concept of sales and purchase in a merchandising company.

Topic 9 shows the classification of companies. It also discusses company

Topic 10 discusses the basic concepts in financial statement analysis. It explains

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TEXT ARRANGEMENT GUIDE

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

Activity: Like Self-Check, the Activity component is also placed at various

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References: The References section is where a list of relevant and useful

TAN SRI DR ABDULLAH SANUSI (TSDAS) DIGITAL

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comprising e-journals, e-theses, e-books and more. Examples of databases

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Copyright © Open University Malaysia (OUM)

1.1 THE IMPORTANCE OF ACCOUNTING

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So what is accounting? Before we go on to discuss the definition of accounting,

Figure 1.1: Luca Pacioli

1.2 DEFINITION OF ACCOUNTING

Accounting is described as a system or a process that provides reports on an

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Accounting can be defined as a process of collecting, identifying, measuring,

Figure 1.2: The information flow in an accountancy system

There are four components in accounting:

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Figure 1.3: The accounting systems

Imagine running a business with no knowledge of accounting. In my

1.3 USERS OF ACCOUNTING INFORMATION

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