2 BACHELOR OF MANAGEMENT STUDIES DEGREE PROGRAMME FINANCIAL & COST ACCOUNTING MCU 1206 DAY SCHOOL 01 15/08/2015
3 Content Unit Slides Time (hrs.) UNIT 01 INTRODUCTION TO ACCOUNTING 1 15 (15) 1/2 UNIT 02 - BASICS OF ACCOUNTING (8) 1/2 UNIT 03 - BOOK KEEPING AND ACCOUNTING (32) 2 UNIT 04 - ACCOUNTING CONCEPTS (16) 1/2 UNIT 05 - FINANCIAL STATEMENTS WITH ADJUSTMENTS (32) 2 1/2
4 UNIT 01 INTRODUCTION TO ACCOUNTING
5 Accounting Entity A person, an institute, a business organization (profit & nonprofit organizations, a nation or a government is called as an accounting entity. Definition of Accounting Accounting is the process of assembling, recording, classification, summarizing, analyzing, interpretation & communication of financial information to the internal & external users (Stakeholders) for decision making on an accounting entity. The Purpose (Objectives) of Accounting Providing the accounting information to the stakeholders (internal & external) through financial statements
7 Assembling & Recording Assembling This is emphasis on collecting the source documents of day today transactions. The source documents are used to prove that the transaction happened. Recording This is emphasis on recording the transactions according to accounting rules & regulations & principles. There are seven books which are used to record the transactions. The following diagram shows that. Transaction Book Source of Document Goods purchase for credit Purchase Book Purchase Invoice Goods sell for credit Sales Book Sales Invoice Return inwards Return inwards Book Credit Note Return outwards Return outwards Book Debit Note Cash receipts & payments Cash Book Receipt & Voucher Petty cash payment Petty cash Book Petty cash Voucher Opening & Closing entries, Corrections, Adjustments & Other Common Journal Journal Voucher
8 2. Classification Main Classification Sub Classification Examples Assets Current Assets Stock, Debtors, & Receivable bills Non-Current Assets Land, Building, Equipment Liabilities Current Liabilities Creditors. Bank OD, Payable bills Non-Current Liabilities Mortgage & Bank Loans Equity Equity Capital & Drawings Income Capital Income Machinery sales, Revaluation Profit Operational Income Sales, Received commission Expenditure Capital Expenditure Purchase fixed assets Revenue Expenditure Purchase goods, paid salary & bills
9 Summarizing This is emphasis on summarizing accounting information. There are three ways can be identified, Control Accounts Trial Balance Financial Statements Analyzing, Interpretation & Communication Analyzing - This is emphasis on well understanding the financial information. Interpretation - This is emphasis on decision making by using the accounting information by managers. Communication - This is emphasis on providing accounting information to internal & external users (Stakeholders).
10 Book Keeping, Accounting & Accountancy Book Keeping This is the primary stage of accounting. This is emphasis on entering the transactions & events to the accounting books according to accounting rules, regulations & principles. The book keeping activities includes observation, identification, monetary, recording, classification & summarizing. Book keepers involve in book keeping. Accounting This is emphasis on preparing the financial statements & providing to the stakeholders. This is the secondary stage at the accounting process Accountancy This is emphasis on the philosophical side of accounting. This is based on the accounting rules, regulations, principles & practices in accounting.
11 Stakeholders & Accounting Environment Economic & Political Env. Technical Env Public Customers Legal Env Financial org Busi ness Owners Managers Employees Gov Competitors Investors Creditors Social & Cultural Env. Vocational & Professional Env.
12 Changes & Trends in Accounting Using in computers & software in accounting process for manual accounting process Considering the inflation effects to the financial statements Social Responsibility Accounting - Considering the social responsibility in accounting process E.g. Contribution in community & Natural assets Environmental Accounting - The environmental favorable & unfavorable effects are disclosed in financial statements Human Resources Accounting Evaluating the technical & professional skills of the human resources & disclosing it in the financial environment
13 Accounting Information The information which can be measured in monetary terms is called as accounting information. (Money Measurement Concept). E.g. - Paid salaries Rs.3, 000 Sales Rs.400, 000 The Characteristics of Accounting Information Accuracy Verifiability Up to date/timeliness Reliability Relevance Consistency Comparability Understandability/Simplicity
14 Business Transactions This is emphasis on the economic activities which are changed the assets & liabilities of the business. This is the input of the accounting process. E.g. - Paid bills Rs Purchased goods Rs Input Process Output Transactions Events Assembling & Recording Classification Summarizing Analyzing, Interpretation & Communication Accounting Information
15 Activity 01 Text Book Accounting Information 1) Starting a business by investing Rs ) The value of land & building is Rs ) The value of motor vehicle is Rs ) The total salary amount is paid to the workers Rs ) The monthly sales income of the business is Rs Non-Accounting Information 1) The company has 10 buildings 2) 100 workers are working at the company 3) The company follows the methods of reduce environment pollution 4) The owner of the business is an artist 5) The company is 10km far to the airport
16 Activity 02 & 03 Text Book The primary qualitative characteristic of accounting information that is not given sufficient attention owing to the preparation of financial statements on historical cost basis is, 1. Reliability 2. Relevance 3. Comparability 4. Consistency 5. Neutrality Discuss - Activity 03
17 UNIT 02 BASICS OF ACCOUNTING
18 Business Entity Concept This is emphasis on business is an independent unit which is separate from its owners & other stakeholders. Therefore the owner s investment is called as capital & withdrawal goods & services are called as drawings.
19 5 Major Classification 1. Assets The characteristics of assets are having a legal ownership, an economical value & useful resources of internal & external parties of the business. 2. Equity This is emphasis on everything which belongs to the owner of the business. This is a liability of the business because according to business entity concept, the owner & the business are two parties.
20 3. Liabilities This is emphasis on everything which is liable to pay to the external parties of the business. The Similarities of Equity & Liability Both of them give the resources to the business. Both of them have the interested to the business. Both of them belong to liability accounts of the business. The Difference between of Equity & Liability Equity Liability 1 Obligation of the internal party of the business Obligation of the external party of the business 2 The Profit/Loss is the return. The Interest is the return. 3 Participates in management the business. Dose not Participate in management the business. 4 Secondly released when close the business. Firstly released when close the business.
21 4. Income - This is emphasis on earnings of the business 5. Expenditure This is emphasis on resource consumption of a business. On the other words, the dedicated value of goods & services for earning an income. Difference between Capital & Revenue Expenditure Capital Expenditure Revenue Expenditure 1 Spends for acquiring the long term benefits. 2 Not Spends for continuing in daily business operation. 3 Reduces parts by parts from the income statement. Spends for daily to continue the operations of the business. Spends for continuing in daily business operation. Reduces whole expenditure from the income statement. 4 Helps to generate income at long term. Helps to generate income at short term.
22 Exercise 01 - Capital/ Revenue Expenditure & Exercise 02 - Classify the Transactions in to 5 Categories in Accounting
23 Accounting Equation Accounting equation shows the ways of getting the resources to the business & utilizing them. Assets = Equity + Liabilities A = E + L Income Expenditure = Profit/Loss. Profit & Loss are finally bared by the owner of the business. Therefore it is relevant for the Equity.
24 Double Entry System - This is emphasis on every transaction is recorded as debit & credit in accounting books according to the dual aspect of the transaction. Balance Increasing Decreasing Accounts Assets, Expenditures & Losses Liabilities, Equity, Income & Profit Debit Debit Credit Credit Credit Debit This is emphasis on a proper structure of recording the transactions according to the dates. Date Description Amount Date Description Amount Debit Side of The Account Credit Side of The Account
25 Exercise 03 How Transactions Effects to Accounting Equation
26 UNIT 03 BOOK KEEPING AND ACCOUNTING
27 Balance Increasing Decreasing Assets, Expenditures & Losses Debit Debit Credit Liabilities, Equity, Income & Profit Credit Credit Debit Exercise 01- Identify Debit/Credit & Exercise 02- Record in ledger
28 Book Keeping Process Transaction Double Entry Primary Book Balance is taken to Ledger Trail Balance Financial Statements
29 The every transaction & event is recorded in the primary books & ledger accounts. Ledger This is emphasis on a book or books which has accounts. In accounting process, one entry is recorded in the ledger & the other entry is recorded in the primary books and after end of the period the balance of the every primary book is moved to the ledger account. Therefore there are two ways which are recorded in the ledger The Functions of the Ledger This is the first stage of book keeping. This helps to summarize the transactions. This helps to prepare financial statements.
30 Primary Books Every transaction is recorded in the primary book according to the date. This is the primary entry of the accounting process. After end of the period the balance of every primary book is moved to the ledger accounts. The document sources are used to record the transactions. The Functions of the Primary Books Helps to prepare the ledger Able to summarize lots of similar transactions Able to record the transactions according to the time period
31 Transaction Primary Book Source of Document 1. Records Cash Receipts & Cash Payments Cash Book Receipt & Voucher 2. Petty cash payment Petty cash Book Petty cash Voucher 3.Goods purchase for credit Purchase Book Purchase Invoice 4.Return outwards Return outwards Book Debit Note 5.Goods sell for credit Sales Book Sales Invoice 6.Return inwards Return inwards Book Credit Note 7.Opening & Closing entries, Corrections, Adjustments & Other Common Journal Journal Voucher
32 Cash Book Record transactions Cash receipts & cash payment from the business and the bank account. Dual Functions of Cash Book Acts as a primary book Acts as a ledger account Classification of Cash Book Single column cash book Record only Cash receipts & Cash Payment, directly coming to the business Double column cash book - Record only Cash receipts & Cash Payment, directly coming to the business & to the bank Triple column cash book - Record only Cash receipts & Cash Payment, directly coming to the business & to the bank & Discounts. Double Entry of Cash Book Cash Receipts Cash Account - Debit Other Account - Credit Cash Payments Other Account - Debit Cash Account - Credit
33 Discounts This is emphasis on the reduction amount of the marked price at the economical transaction between two parties. This is used to encourage the purchase and encourage the early settlement of the business. Trade Discount Cash Discount Allowed Discount Received Discount Allowed Discount Received Discount Trade Discount This is emphasis on the reduction amount of the marked price in the both situations, purchase on cash & purchase on credit. Trade discount is not recorded in the books. Therefore the total spent amount is debit & credit to the relevant accounts & not separately showing the discount. Cash Discount This is emphasis on the reduction amount when settle the creditors & receive money from debtors. Cash discount is recorded in the ledger. In cash book, it shows as only the memory record (just for reminding).
34 Allowed Cash Discount This is the given discount to the trade debtors when they are settling their accounts on time. This is an expense. Therefore allowed cash discount account is debit. Discount reduces the debtor value. Therefore it is credited to debtor A/C. Allowed Cash Discount Debit Debtor s Account Credit Received Cash Discount This is emphasis on the received discount when settling the trade creditors within the given period of time. This is an income. Therefore received cash discount account is credit. Discount reduces the creditor s value. Therefore it is debited to creditor A/C. Creditor s Account Debit Received Cash Discount Credit
35 Exercise 03 (1) Preparing cash Book & Ledger Accounts
36 Bank Reconciliation This is emphasis of the statement which is prepared to reconcile the bank balance in cash book and the balance of bank statement. The bank statement is sent by the bank once a month and it displays all the transactions of the bank current account in a particular period (in a month). Bank reconciliation is a statement with additions and deductions to the adjusted balance of cash book and finding the bank statement balance. Purpose of Reconciliation Statement This can be used to minimize the errors which are arisen from bank transactions. It helps to examine the accuracy of the cash and bank transactions. The reasons for bank statement balance is differ with the cash book balance. Not realized cheque. Not presented cheque. The bank charges and other debit taxes. Standard orders. Direct receivable income. Disordered deposited cheque. Disordered issued cheque. Bank errors. Cash book errors. The cash book should be corrected
37 Exercise 01 Preparing Bank Reconciliation
38 Petty Cash Book The business has lots of transactions, both large & small amount. If all transactions are recorded in cash book, it will be more complex and unable to maintain internal control in the business. Therefore the separate book is maintained to record small amount of transactions. This is called as petty cash book & this system is called petty cash imprest system. The Main Differences of Cash Book and Petty Cash Book In petty cash book has the analytical columns of expenditure All transactions are expenditures except only on receipt from main cashier Petty Cash Imprest & Petty Cash Imprest System Petty cash imprest is emphasis on the fixed cash amount which is given to petty cashier for spending the petty cash expenses by the main cashier. The fixed amount depends on the petty cash transactions. It is decided by the main cashier of the business. Petty cash imprest system is the process of reimburse of petty cash expenses in the same amount by the main cashier. The Factors of Deciding the Petty Cash Imprest The volume of transactions in the main cash book The value of transactions in the main cash book The volume of transactions in the petty cash book The value of transactions in the petty cash book The time period of exchanging cash between main cashier & petty cashier
39 Exercise 05 Preparing Petty Cash Book
40 Purchase Journal This is a primary book. This is recorded on the purchased goods for credit. The goods is emphasis on expect to sell again. As the example, a grocery shop purchased, sugar, rice & milk powder are recorded in the purchase journal. But if it purchased furniture is not recorded in the purchase journal because it purchases not for selling. Purchase is an expense. Therefore it is debit to purchase account. It is credited to the creditors account because the liability is created. Purchase Account Dr. Creditor s Account Cr. At the end of the period, the total amount is taken to the purchase account at the ledger.
41 Exercise 06 (1) Preparing Purchase Journal
42 Purchase Return Journal / Return Out-Ward Journal This is a primary book. This is recorded on the returned purchased goods for credit. Returning the purchase goods causes to reduce the expense of purchase. Therefore this has a credit balance. At the end of the period, the total amount is taken to the purchase return account at the ledger as a credit balance. This causes to reduce the creditors value. Therefore it is debited to creditor s account. Creditor s Account Dr. Purchase Return Account CR.
43 Exercise 07 Preparing Purchase Return Journal
44 Sales Journal This is a primary book. This is recorded on the sold goods for credit. The goods is emphasis on expect to sell in the business operations. As the example, a grocery shop sold, sugar, rice & milk powder are recorded in the sales journal. But if it sold furniture is not recorded in the sales journal because it is external thing from the business operation. Sales are an income. Therefore at the end of the period, the total amount is taken to the sales account at the ledger as a credit balance. It is debited to the debtor s account because the asset is created. Debtor s Account Dr. Sales Account Cr.
45 Exercise 08 (1) Preparing Sales Journal
46 This is a primary book. This is recorded on the returned sold goods for credit. Returning the sold goods causes to reduce the sales income. Therefore at the end of the period, the total amount is taken to the sales return account at the ledger as a debit balance. This causes to reduce the debtors value. Therefore it is credited to debtor s account. Sales Return Account Dr. Debtor s Account CR.
47 Exercise 09 Preparing Sales Return Journal
48 General Journal This is a primary book. The other primary books are recorded transactions which are inherent of each book. But for general journal is recorded any other transaction except that. There are five transactions can mainly be identified, Opening Entries Entries for Fixed Assets Entries for Correction of Errors Adjustment Entries Closing Entries The document source is the Journal vouchers. Recording in the general journal is called as the journalizing.
49 Trial Balance This is emphasis on summarized statement which is prepared to inspect the accuracy of the recording in the ledger accounts & the primary books. The every balance of the ledger account is taken to the trail balance. Importance of Trial Balance Helps to summarize the transactions Helps to prepare the financial statements Ensures the numerical accuracy of the accounting information. The Errors Disclosed in Trail Balance Only one entry of the transaction is recorded. E.g. Paid salary of Rs is recorded only the salary account. Addition errors of the accounts. Record the transactions on the same side E.g. both in debit side Recording the different amount E.g. one entry is recorded as Rs.1000 & other entry is recorded as Rs.100 Errors in coping balances to the trail balance.
50 The Errors Not Disclosed in Trail Balance Errors of omission This is emphasis on completely omitted the transaction from the books. Errors of duplication This is emphasis on the same transaction is recorded twice in the books Errors of commission This is emphasis on the transaction value understated or overstated in both sides. Errors of principle This is emphasis on breaking the accounting principle in recording the transactions. E.g. Purchasing equipment is recorded in equipment expenditure account. This is violating the accounting principle by recognizing purchasing equipment as an expense. It is an asset. Compensating errors This is emphasis on the errors set off each other. In one transaction recording the value is understated; this is set off from overstated another transaction in the same amount. E.g. In recording purchase Rs.3000 understated only in the purchase account. This sets off by overstated the water bill expense account Rs Suspense Account When the trial balance unbalances the both sides of credit and debit, open a suspense account as a temporary solution to balance the trial balance. After identifying the errors, it is corrected through the general journal and the suspense account. The suspense account displays only the errors which are disclosed through the trial balance. The suspense account shows in the balance sheet; the debit balance of the suspense account under current asset & the credit balance under current liabilities.
51 Exercise 11 (1 & 2) Identifying Errors & Impact to the Profit
52 Exercise 12 Whole Process of Book Keeping Required, Primary Books Ledger Accounts Trial balance
53 Subsidiary Ledger This is emphasis on a book which has similar types of accounts. This can be divided into two parts; sales ledger & purchase ledger. The Purpose of the Subsidiary Ledger This reduces the volume of common ledger. This reduces the unnecessarily long the trial balance. This provides the internal control and minimizes the errors and frauds. This facilitates the division of works. This is kept in addition to common ledger. Some businesses keep only common ledger and some keep both ledgers. The businesses which are maintained both ledgers, at the end of the period the balances of the subsidiary ledgers are taken to the common ledger through Control Accounts.
54 Control Accounts Control accounts are prepared a bridge to bring the balances of subsidiary ledgers to the common ledger. Therefore the values are taken from the primary books. There are two types of control accounts, debtors ledger (sales ledger) control account and creditors ledger (purchase ledger) control account. If there is the same person in both debtors ledger and creditors ledger, it can be set off and the balance is shown in the control account. At the end of the period the balances of primary books are taken to the control accounts. The format of control account is similar to normal account. The debit balances are debit to the control account and vice versa. It can be created the credit balances in the debtors accounts and debit balances in creditors accounts. The reasons are After closing the accounts, the return inwards and outwards are created. When closing the accounts, it is neglected the discounts. Received the bad debts. Set off the debtor and creditor balance of the same person. The errors of balancing the accounts.
55 List of Balances The list of balances of subsidiary accounts is prepared to identify the errors and maintained the control. This is prepared by using the balances of subsidiary ledger accounts. Therefore the balance of control account and the list of balance should be tallied with each other. There are two main reasons which can be identifying not tallying both control account and list of balances. They are, The errors of preparing control accounts The errors of preparing list of balances
56 The Errors of Preparing Control Accounts The errors of adding primary books. The errors of copying to the control account from the primary books. Avoiding the transactions from primary books. Avoiding set off balances. It is not concerned the ad normal balances in primary books. The errors of balancing the control accounts. The Errors of Preparing List of Balances Avoiding the transactions from the ledger. Avoiding the balances from list of balances. Recording twice some balances in list of balances. The numerical mistakes in list of balances. Avoiding set off balances. It is not concerned the ad normal balances in list of balances. The errors of adding list of balances.
57 Exercise 13 Control Accounts & The Reconciliation Statement of Control Account
59 UNIT 04 ACCOUNTING CONCEPTS
60 Conceptual Framework of Accounting There should be a common framework to present the financial information to the external parties. It should not give an advantage to one party and a disadvantage to another party. This common framework is maintained by accounting concepts. This facilitates the comparison among the businesses and the accounting years. Accounting Concepts This is the basic principles which are used to prepare the financial statements. This helps to create the common practice in the accounting process. The Importance of Conceptual Framework of Accounting This makes common framework in accounting process. This acts as the principles of accounting. This increases the usefulness of accounting because it maintains the standards. This increases the quality of financial statements.
62 Business Entity Concept This is emphasis on engaging all the accounting activities by considering a business is a separate entity from its owners and the other internal and external parties. Therefore it is recorded only the transactions which are relevant to the business when preparing the financial statements. Appling of Business Entity Concept The financial statements are prepared the name of the business, not the name of the owner. It displays the owners equity through capital accounts. It considers as drawings, all withdrawing things by the owner. It is not recorded the private properties of the owner in accounting books.
63 Going Concern Concept This is emphasis on engaging all the accounting activities by assuming that the business will carry in for a foreseeable long period without a break. The purpose of introducing this concept is if the business will end within the short period of time, no point to follow accounting process. Therefore it assumes the business will be continuing up to uncertain future when preparing the financial statements. But this is against with periodic concept because according to going concern concept, the final result of the business is measured at the end of the business and in periodic concept at the end of the accounting year. Appling of Going Concern Concept It classifies the assets as current assets and non-current assets. It classifies the liability as current liability and non-current liability. It classifies the expenditure as prepaid expenditure and accrual expenditure. It makes any other classifications. The accounts are balanced and forwarded to the next period.
64 Period Concept This is emphasis on the long life time of the business is divided in to similar periods and engaging the accounting activities. Therefore the financial statements are prepared for a particular time period. Normally the businesses use one year as the time period to present the financial statements to external parties. But the different time period are used to present the financial statements for internal users. Appling of Period Concept It is recorded the fixed assets depreciation for an accounting year. It is prepared the trade, profit and loss account for a particular period of time. It is prepared the balance sheet as at the date of ending the time period. Recruitments and Departures of the partners are recorded for a particular period of time.
65 Money Measurement Concept This is emphasis on the every transaction should be measured in a monetary value. Therefore every asset, liability, equity income and expenditure is recorded in a monetary value. The type of money can be different according to the country. As examples, Rupees and Cents are used by Sri Lanka. American Dollars are used by America. The Weakness of Money Measurement Concept It is considered that the value of money is fixed. But the value of money is reduced by inflation. It is unable to record information which is unable to measure in monetary value. Appling of Money Measurement Concept Accounting information is measured in monetary value. Inventories are measured in monetary value. It is given the estimate monetary value which cannot be directly measured in monetary value.
66 Historical Cost Concept Historical cost is the basic cost which spends to acquire the fixed assets or the first value of the transaction. Historical cost concept is emphasis on that historical cost is considered at present for all accounting activities. According to this concept the market value of fixed assets is not considered. Therefore all the activities of fixed assets such as purchase, sell, disposing exchanging and depreciation are done based on historical cost. The Weakness of Historical Cost Concept Balance sheet does not reflect the real condition of the fixed assets. The depreciation amount which is ascertained for a particular time period is not accurate. The earnings of the fixed assets do not reflect correctly.
67 Accrual Concept This is emphasis on when preparing the income statement, the income is considered as received and receivable and the expenditure is considered as paid and payable. Therefore if it is received or not and paid or not, the whole revenue and expenditure which are relevant for the year are considered to make the income statement. According to this concept, the basis of accounting can be divided into two parts, Cash basis accounting - This is emphasis on considering only received income and paid expenditure when preparing the financial statements. Accrual basis accounting This is emphasis on the accrual concept.
68 Matching Concept This is emphasis on when preparing the income statement, the income and the expenditure are compared each other. This clearly says that income is based on the expenditure of a particular period of time or the income generates through the expenditure. Applying Matching Concept Recognizing the prepaid expenses. This is relevant to generate income for next period of time. Recognizing bad debts. This is the expenditure which is spent to generate sales income. The depreciation. This is the usage of fixed assets to generate an income.
69 Materiality Concept This is introduced to identify the capital expenditure and the revenue expenditure. It depends on the nature and relativeness of the transaction. As example, Paper clips and Computers are both long term expenditures. But paper clips are relatively small expense. Therefore it is considered as revenue expenditure. Purchase a refrigerator for a refrigerator business is revenue expenditure because they want to sell it. But Purchase a refrigerator for a grocery business is capital expenditure because they want to use it. Destroying 5kg of wheat meal from 10 kg using per day is relatively higher amount for that business than destroying 5kg of wheat meal from Prima Factory.
70 Realization Concept This concept decides the time of recording income to the financial statements. Therefore this is called as the revenue principle. According to this concept, sales on credit are recognized as revenue if it is received the cash or not. But this is against the prudence concept; it says income is recognized after receiving cash. Appling Realization Concept Recognizing sales on credit as an income. Recognizing long term contracts values as income. Recognizing sales orders for next year as income.
71 Prudence Concept This concept is presented to get the protection to the accountant of the business when preparing the financial statements. This clearly says to minimize the profit of the business and keep more savings within the business for future protection. This is not clearly emphasis on creating lie expenditure or hiding income. There are three methods can be used to minimize the profit. Recording more expenditure This is emphasis on provision of more bad debts and depreciation. Recording less Revenue This is emphasis on revenue recognition after received cash. Recording inventories in a small amount It is recorded the lower amount among the cost of inventories and net realization value. Appling Prudence Concept Provision of depreciation for fixed assets. Provision of bad debts. Provision of discounts. Provision of un-realization profit. The valuation of inventories.
72 Substance Over Form Concept This is emphasis on disclosure every information of all economical transactions through the financial statements. This concept ensures the rights of knowing the information to the external parties of the business. If there is any information which cannot be showed by financial statements, it should be presented as a note after the balance sheet. E.g. Estimates of future capital Market value of investments Uncertainties Conditions of after the balance sheet date
73 Consistency Concept This is emphasis on consistency in following accounting rules and regulations, principles, basis and practices when preparing financial statements. It should not be changed. It should be consistency in every accounting year. Applying Consistency Concept Depreciation of fixed assets Value the inventories Recognize of income Recognize of expenditure
74 The Weakness of Accounting Concepts It considers the value of money is fixed when preparing financial statements. It considers historical cost at present. Some concepts are against the other concepts. It has to be waited up to closure of the business to identify the results. Against Concepts Realization Concept and Prudence Concept Prudence Concept and Substance over form Concept Going Concern Concept and Periodic Concept
75 The Concepts which is Relevant for Depreciation Historical cost concept Matching concept Periodic concept Prudence concept Going concern concept The Concepts of LKAS 01 Going concern concept Consistency concept Realization concept Concepts in Trade Account Business entity concept The Name of the Business Periodic concept Preparing for particular time (year) Money measurement concept All information in financial values Realization concept - Sales Matching concept Comparing the sales with the cost of sales
76 Discuss Questions
77 UNIT 05 FINANCIAL STATEMENTS WITH ADJUSTMENTS
78 Adjustment Entries This is emphasis on the transactions which happened at the particular time period, but still it is not recorded until going to preparing financial statements. The general journal is used as the primary book of these adjustment entries. The adjustments are, Adjustments for Inventories. Adjustments for Property, Plant and Equipment. Adjustments for Accrual Expenditure and Accrual Income. Adjustments for Prepaid Expenditure and Pre-received Income. Adjustments for Bad Debts and the Provision of Doubtful Debts.
79 Inventory Adjustments - LKAS No: 02 Inventories are very important assets to the business because there is a direct relationship between the profit and the inventories. LKAS No 02 is governed the accounting process of inventories. Therefore all definitions and treatments are based on LKAS No 02. The stock is recorded as debited to stock account because it is an asset and credited to trading account (financial statement). It is showed by deducting from the debit side of trade account. Definition of Inventories Inventories consist of three parts; raw materials, work in progress and finished goods. Raw materials The inventories hold for continue the production process. Still these are not used for the production. Work in Progress The inventories in the process. These are in middle raw materials and finished goods. Finished Goods - The inventories hold for send to the market, the final product.
80 Measurement of Inventories The inventories are measured at the lower of cost and net realizable value. Methods of Calculate Measurement of Inventories There are mainly two methods are used. Item Method This is emphasis of get the lower of cost and net realizable value in item wise. Batch Method - This is emphasis of get the lower of cost and net realizable value in batch wise. Cost of Inventories This consists of three parts, Cost of Purchase This includes purchase price plus all other direct expenses of purchase such as carriage inwards, custom duties, transport and handlings and deduct the trade discounts and any other reductions. Conversion Cost This is the total of all direct and overhead costs which spend for converting materials into finished goods. E.g. direct labour, and fixed and variable production overhead cost. Other Cost This is any other costs which are incurred in bringing to the inventories to the present location and condition. Net Realizable Value This is the reduction amount of estimated selling price from estimated cost of completion and the estimated costs necessary to make sales.
81 Discuss Exercise 01
82 Measurement of Inventories This is emphasis on the time of valuing inventories. This can be divided in to two parts. Continuous Measurement of Inventories This is emphasis on valuing inventories at the day today transactions happening. There should be a proper system like computerized system to do this. Large companies like keels super and food city use this methods to reduce the complexity of measuring inventories and make sure the availability of the inventories for ensuring customer satisfaction. Physical Measurement of Inventories This is emphasis on physically valuing the inventories at the end of the period. There are main two weaknesses in this method. This may not consider the inventories which are not physically available, but owning to the business. This may consider the inventories which are physically available, but not owning to the business. Reasons for both, The inventories of on the way or not deliver to the customer. The inventories which are given to the agents or taken from the agents on the basis of sales or return and still not expired. The inventories which is given or kept as pledge and securities of loans. The inventories at external stocks or given the stock to external users.
83 Basis of Sales or Return This is a method of selling goods through agent. Here there is a legal relationship of principle and agent. The principle marks the price and handovers to the agent. But at this occasion it is not recorded in the books because it changes only the guardianship of the goods. Still the ownership of goods is with the principle. There are three occasions basis of sales or return is recorded in the books. They are, The goods are sold by the agent. The goods are consumed by the agent It is expired the time of send back. This is recorded as the sales. Cash/Debtor Account Dr. xxxx Sales Account Cr. xxxx At the end of the period, the cost of not selling goods with agents should be added to the closing inventories because it is still with the business.
84 Discuss Exercise 02
85 Cost Formulas This is emphasis on how to attribute the cost to the inventories. According to SLAS 05, there are two methods. They are First-in-First-Out (FIFO) - First issue the first purchase inventories. Weighted Average Cost (WAC) - Determining the cost based on weighted average of the cost of similar items. Recognition of Inventory as an Expense Written down the inventories up to net realizable value. Damaged inventories. Obsoleted inventories. After selling inventories cost of inventories. Disclosure of Inventories in Financial Statements The accounting policies are used to measure the inventory. The total carrying amount of inventories to the next period. The carrying amount of inventories pledged as security for liabilities. The amount of inventories is considered as expense. Any written down value of inventories with in the period.
86 Adjustments for Property, Plant and Equipment LKAS 16 Property, Plant and Equipment This is emphasis on tangible assets; more than one year life time which are kept for produce goods and services (machines) or for rent (vehicles) or administrative works (computers). Definitions Cost The amount of cash or cash equivalent or any other fair value spends for acquiring or constructing the asset. Carrying Amount The amount displays in the balance sheet after deducting cumulative depreciation. Residual Value This is the amount which can be obtained at the disposal, calculating by deducting selling amount at the end of useful life time of the asset from estimate selling cost. Recoverable Amount The amount expects to earn future usage plus its residual value. Fair Value This is the asset exchanging amount at arm s length transaction among knowledgeable and willing parties. Useful Life Time This is the time period that the asset is expected to use or number of production is expected to be obtained from an asset. Depreciable Amount This is net amount which can be obtained cost of the asset or revaluation value minus residual value. Depreciable Amount = Cost/Revaluation value Residual Value
87 Recognition of Property, Plant and Equipment There should be following characteristics. It should be tangible. It should be used for production or supplying of goods and services of the business. This is expected to use more than one year. It is possible to get the future benefits from this asset. The spent cost for the asset should be measured reliably. It is not consisted with following condition, further it is not an asset. It is an expenditure and written off it by the profit and loss account.
88 The standard specially prescribe the accounting treatments under followings, 1) The accounting treatment for initial cost of assets. 2) The accounting treatment for subsequent cost of assets. 3) The accounting treatment for exchanging assets. 4) The accounting treatment for revaluation of assets. 5) The accounting treatment for depreciation of assets. 6) The accounting treatment for de-recognition of assets. 7) Disclosures of property, plant and equipment.
89 The Accounting Treatment for Initial Cost of Property, Plant and Equipment Initial cost is emphasis on the cost which is incurred at the acquiring of an asset. The following costs are included, Purchase Cost Rs Rs. Purchase Price xxxx Import Duties xxxx Un-repayable Duties xxxx xxxx Cost of Preparing Place xxxx Transport and Carriage inwards xxxx Cost of Fixing xxxx Professional Fees (Engineering and Creations) xxxx Total Cost xxxx
90 The Accounting Treatment for Subsequent Cost of Property, Plant and Equipment This is emphasis on the cost which is incurred for after starting to use the asset such as repairs and maintenance and replacing new parts to increase the efficiency of the asset. If the subsequent cost increases the carrying amount or the efficiency level of the asset, that cost is capitalized under the asset. Unless it is considered as an operational cost and written off from the profit and loss account. The following conditions affect to increases the carrying amount or the efficiency level of the asset, A repair of increasing the useful life of the asset or capacity of the asset. The cost which affects to improve the output quality of asset in a large amount. The repair reduces the estimated operational cost in a large amount.
91 The Accounting Treatment for Exchanging Property, Plant and Equipment It is ascertained the profit or loss when exchanging unequal property, plant and equipment of the business. E.g. Exchanging a motor vehicle for a machine. But It is not ascertained the profit or loss when exchanging equal property, plant and equipment of the business. E.g. Exchanging a machine for another machine.
92 The Accounting Treatment for Revaluation of Property, Plant and Equipment This is emphasis on recognition of the fair value of the assets as at the date. Fair value is the asset exchanging amount at arm s length transaction among knowledgeable and willing parties. According to SLAS 18 property, plant and equipment can be revalued any times. Normally the fair value is based on the market value of the asset. Revaluation is done by professionally qualified estimators. The class of property, plant and equipment can be revalued. Land Land and Buildings Machinery Ships Air craft Motor Vehicle Furniture and Fixtures Office Equipment The accounting treatments for revaluation The following one of the treatment can be used, After revaluation the carrying amount should be equal to the revalued amount. Therefore it is recorded the revalued amount as carrying amount and the cumulate depreciation should be changed proportionally the carrying amount of the asset. The cumulated depreciation is totally removed and the revalued value considered as the fair value of the asset. Revaluation profit and loss Revaluation profit This is emphasis on increasing the net amount of the asset through revaluation. The revaluation profit is taken to revaluation reserves account and showed at the balance sheet under equity because this belongs to the owner. Revaluation loss This is emphasis on decreasing the net amount of the asset through revaluation. The revaluation loss is written off from the profit and loss account.
93 The Accounting Treatment for Depreciation of Property, Plant and Equipment Depreciation This is emphasis on distributing the depreciable amount of asset all over its economical useful time in a proper manner. Assets with limited life time are depreciated. The Factors Considered in Determining the Useful Life of an Asset Expected usage of the asset. Expected physical wear and tear. This is based on repair and maintenance. Technical obsolescence. This is based on the improvements in production or any other changes in market. Legal limitations. E.g. Lease assets useful life time is based on expired date of lease agreement. Methods of Depreciation This is emphasis on the pattern of distributing depreciation over asset s economic useful life time. SLAS 18, the standard of property, plant and equipment is identified basically two methods of depreciation. They are, Straight line Method This is emphasis on constantly distribution over the asset s economic useful life time. Reducing balance method This is emphasis on decreasing amount charge over the useful life. Here the percentage of depreciation can be identified. The Factors Considered in Determining the Depreciation The cost of asset or revaluation value Residual value Asset s economic useful life Policies of depreciation
94 The Accounting Treatment for De-recognition of Assets The carrying amount of the asset is de-recognized on disposal. Here gain or loss of de-recognition is identified.
95 Disclosures of Property, Plant and Equipment Disclosures under each class of Property, Plant and Equipment Measurement of carrying amount is based on cost or revaluation value. The method of depreciation. The useful lives or depreciation rate of the asset. The gross carrying amount and the accumulated depreciation at the beginning and at the end of the period. Disclosures under Revaluation The base of revaluation. The effective date of revaluation. Whether an independent estimator was involved or not. The methods and significant assumption are used for revaluation. The movements in revaluation reserves account. Disclosures of Reconciliation at the Beginning and at the End of the Period Additions. Sales or disposal. Acquisition through business combinations. Changes in carrying amount. Impairment loss or other charges. Other Disclosures according to the Situations The amount of pledged assets as security for liabilities. The details of future acquisition assets. The details if there are work in process in construction. If there is any changes in useful life or residual value or method of depreciation. The details of temporary unused assets and over the depreciation amount but still using assets. The details of assets which are expected to sell in near future. Any other information which will be important to prepare the financial statements.
96 Example 03 Property, Plant and Equipment
97 Adjustments for Accrual Expenditure and Accrual Income Accounting is used the accrual basis. Therefore the expenditure paid or not is considered as the expenditure for the period. Income also is recognized as accrual basis, it is received or not the income relevant to the period is recognized as the income. Accrued Expenditure This is a liability because the business has to pay this. Therefore accrual expenditure account is credit and expenditure account is debit. At the end of the year total balance of expenditure account is transferred to the profit and loss account. Accrued Income Accrued Income is a current asset for the business. Therefore it is debited to accrued income account and credited to income account because revenue has a credit balance.
98 Adjustments for Prepaid Expenditure and Pre-received Income According to going concern concept, the business will carry on uncertain future depending on that basis creates the prepaid expenditure and pre-received income. Prepaid Expenditure Prepaid expenditure is an asset to the business because it has paid for unused resources. Therefore prepaid expenditure account is debited and credited to relevant expenditure account. At the end of the period, the expenditure which is relevant for the period is taken to the profit and loss account and forwarded prepaid expenditure to the next period. Pre-received Income Pre-received income is a liability to the business because external party has paid for unused resources. Therefore prereceived income account is credited and debited to relevant income account. At the end of the period, the income which is relevant for the period is taken to the profit and loss account and forwarded pre-received income to the next period.
99 Adjustments for Bad Debts and the Provision of Bad Debts The trade debtors created from selling goods on credit. There is no legal written document on credit sales. Therefore there may be created bad debts or provision of doubtful debts or provision for discounts. Bad Debts This is emphasis on the credit sales which are identified as cannot be recharged. Bad debt is expenditure to the business. Therefore bad debts account is debited and credited to debtor s account because of reducing debtor amount. At the end of the period balance of bad debts account is taken to the profit and loss account under sales and distribution expenses. If received the cut off bad debts, firstly keeping double entries for receiving money, debited to cash account and credited to debtor s account. After that remove the bad debts, debited to debtor s account and credited to bad debts account. The reasons for creating bad debts are the death of debtor, bankruptcy or missing. Before identifying as bad debts or doubtful debts, the business should get the proper actions like reminding letters, stop selling further, giving discounts to encourage, charge expiring chargers and stop given discounts to the debtors. Both bad debts and the provision of doubtful debts are identified based on prudential concept.
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