Chapter 1 – Introduction to accounting

Concepts and Principles

Monetary Principle - The monetary assumption requires that only those things that can be expressed
in money are included in the accounting records.

Accounting Entity Concept - The accounting entity assumption states that every entity can be
separately identified and accounted for. That is, we don't confuse the company’s performance with
personal transactions.

Accounting Period Concept – The accounting period concept states that the life of a business can be
divided into artificial periods and that useful reports covering those periods can be prepared for the
business.

Going Concern Principle - The going concern assumption states that the business will remain in
operation for the foreseeable future. Of course many businesses do fail, but in general, it is
reasonable to assume that the business will continue operating.

Cost Principle -The historical cost measurement is the recording of assets at their cost. This is applied
not only at the time the asset is purchased, but also over the time the asset is held.

The Conservatism Principle – The conservatism principle serves as not to overstate amounts when
reporting the assets and income or not to understate the liabilities and expenses of a business.

Full Disclosure Principle – The full disclosure principle requires that all circumstances and events that
could make a difference to the decisions financial users might make, be disclosed.

Qualitative Characteristics

Relevance - Information of any sort is relevant if it would influence a decision, or provides a basis for
forecasting future profits. The relevance of the information is affected by its materiality.

Reliability - Information that can be depended upon. The information must be a faithful
representation of what is purport to be. To be reliable, information must also be complete.

Comparability - Comparability results when different entities use the same accounting principles.
Comparability is not satisfied unless an entity uses the same accounting principles and methods from
year to year.

Understandability - Preparers should be mindful of users of general - purpose financial reports who
have the proficiency to comprehend the significance of accounting practices.

Constraints

Timeliness - Financial information may lose its relevance if it is not reported in a timely manner.

Costs vs benefits - Costs of preparation don't exceed benefits derived from the information.

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Financial Statements

Income statement
- ‘For the month ended 31 October’ (period of time)
- Revenues – Expenses = PBIT (- tax expense) = PAT

Balance sheet
- ‘As at 31 October’ (point in time)
-A=L+E
- Equity – Share Capital, Retained earnings

Statement of changes in equity

- As at 31 October’ (point in time)
- Profit (as derived from income statement)
- Retained earnings as of beginning of period
- Dividends (minus)
- Retained earnings as of end of period

Profitability, Liquidity & Solvency

Profitability – measures operating success of an entity for a given time period

Liquidity – measures short term ability of entity to pay its maturing obligations and to meet
unexpected needs for cash

Solvency – measures ability of an entity to survive over a long period of time

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Chapter Two – The accounting information system
Debits & Credits

ACCOUNT NORMAL BALANCE

Asset
Expense DR
Dividend
Liability
Retained earnings CR
Income

Issues share for cash – Increase in cash and equity: DR Cash, CR Share capital

Borrow money from bank – Increase in assets and liabilities: DR Cash CR Bank loan

Purchase of office equipment for cash – Decrease in assets, increase in assets: CR Cash DR Office
equipment

Receipts of cash in advance from customer – Increase in assets and liabilities: DR Cash CR Revenues
received in advance

Renders services for cash – Increase in assets and revenue (equity): DR Cash CR Service revenue

Payments for rent in cash – Decrease in assets, increase in expense: CR Cash DR Retained earnings

REVENUE increases EQUITY and EXPENSES decrease EQUITY

Payment of insurance in cash – Decrease assets, increase assets: CR Cash DR Pre-paid insurance

Purchases of supplies on credit – Increase assets, increase liabilities: DR Cash CR Accounts payable

Payment of dividend – Decrease assets and equity CR Cash DR Retained earnings

Payment of cash for employee salaries - Decrease assets and equity CR Cash DR Retained earnings

Contra Asset Account - An account that is offset against another account on the balance sheet (i.e.
Accumulated Depreciation Office Equipment is used to offset against Office Equipment, on the
Balance Sheet) In this case it is to show the original cost of the equipment and the total cost to date.
Its normal balance is a credit (opposite to that of a normal asset account).

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The Journal

Journalising
- Journalising is entering the transaction data in the journal
- Provides a chronological record of all transactions
- Discloses in one place the complete effect of a transaction

Recording transactions in 'journal form' requires:

- The date of the transaction
- The accounts and amounts to be debited and credited
- A brief explanation of the transaction (narration)

Ledger Accounts

Posting
- Using the account number in the posting reference column, locate in the ledger the account to be
debited and enter the date the transaction occurred
- To the right of the date, enter the name of the ledger account to which the credit entry will be
posted (Cross - referencing)
- Enter the amount to be debited to the debit side of the ledger account
- In the general journal, place a tick beside the account number in the posting reference column

Trial Balance

Trial balance – a list of all the accounts and their balances at a given time listed in order as they
appear in the general ledger

Limitations of trial balance – errors not detected when:

- a transaction isn’t journalised
- a correct journal entry is not posted
- a journal entry is posted twice
- incorrect accounts used in journalising or posting
- offsetting errors made in recording the amount of transaction

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Chapter Three – Accrual accounting concepts

Accrual vs Cash basis of accounting

ACCRUAL CASH
Revenue When goods and services are When the cash is received
provided
Expense When assets are consumed or When the cash is paid
liabilities are incurred
Net Profit Revenue earned – Expenses Cash inflows – Cash outflows
incurred

Accrual basis - described as recording the effects of transactions and other events when they occur,
rather than when cash is received or paid, and reporting them in the periods to which they relate.
- Merchandising business - recording revenues when goods are sold rather than when the cash is
received
- Service businesses - when the service is performed rather than when the customer / client pays for
the service

Cash basis – revenue is recorded only when the cash is received, and an expense is recorded only
when cash is paid

Adjusting entries

Adjusting entries - are needed to ensure that the recognition criteria are followed for assets,
liabilities, revenues and expenses. Adjusting entries can be classified as either prepayments or
accruals.

Prepayments
- Prepaid Expenses - amounts paid in cash and recorded as assets until the economic benefits are
used or consumed.
- Revenues Received in Advance - amounts received from customers and recorded as liabilities until
the services are performed or the goods are provided and revenue is recognised

Prepaid Expenses - payments of amounts that will provide economic benefits for more than the
current accounting period. When such a cost is incurred an asset account is increased (DR) to show
the service or benefit that will be received in the future. At each balance date, adjusting entries are
made to record the expenses applicable to the current accounting period and to show the remaining
amounts in the asset accounts. Before adjustment, assets are overstated and expenses are
understated. An adjusting entry for prepaid expenses: DR Expense CR Asset

Examples of accounts requiring adjusting entries (to illustrate consumption, partially or wholly, of an
asset):

- Supplies (e.g. Advertising Supplies Expense)

- Insurance (e.g. Insurance Expense)

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- Depreciation (e.g. Depreciation Expense)

N.B - Accumulated Depreciation - Office Equipment is a contra asset account (CR)

Revenues Received in Advance - when payment is received for services to be provided in a future
accounting period, it is recorded by increasing (CR) a liability account called Revenues Received in
Advance to recognise the obligation that exists. Revenues received in advance are subsequently
recognised as revenue when the service is provided to a customer. Before adjustment liabilities are
overstated which should result in a decrease (DR) to a liability account and revenues are understated
which should result in an increase (CR) to a revenue account.

Accruals
- Accrued Revenues - Amounts not yet received and not yet recorded for which the goods or services
have been provided.
- Accrued Expenses - Amounts not yet paid and not yet recorded for which the consumption of
economic benefits has occurred.

Adjusting entries for accruals are required in order to record revenues and expenses in the current
accounting period that have not been recognised through daily entries and thus are not yet reflected
in the accounts. Accruals will increase the balances of accounts in both the balance sheet and the
income statement.

Accrued Revenues
- Revenues that are recorded as adjusting entries because they have not been recorded in the daily
recording of transactions. May include things such as rent revenue and interest revenue, or services
that have been performed but neither invoiced nor collected (commissions or fees). Thus, both
assets and revenues are understated.
- An adjusting entry for accrued revenues results in an increase (DR) to an asset account and an
increase (CR) to a revenue account (both increase).

Accrued Expenses
- Expenses not yet paid or recorded at balance date are called accrued expenses. Interest, rent, taxes
and salaries are common examples.
- An adjusting entry for an accrued expense results in an increase (DR) to an expense account (e.g.
Interest Expense or Salaries Expense) and an increase (CR) to a liability account (e.g. Interest Payable
or Salaries Payable).

Accrued Interest - Calculating amount of interest accumulation is determined by three factors:

1. Loan (principal borrowed)
2. Interest Rate (always expressed as an annual rate)
3. The length of time the loan is outstanding

Loan (Principal Borrowed) x Annual Interest Rate x Time in terms of 1 year

$5000 12% 1 / 12
= INTEREST

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N.B - that the time period is expressed as a fraction of a year

Summary of adjusting entries:

Type of Adjustment Accounts Before Adjusting Entry

Adjustment
Prepaid Expenses
If amount paid is Assets overstated Dr Expenses
initially recorded as an Expenses understated Cr Assets
asset

If amount paid is Expenses overstated Dr Assets

initially recorded as an Assets understated Cr Expenses
expense
Revenues received in
Advance
If amount received is Liabilities overstated Dr Liabilities
initially recorded as Revenues understated Cr Revenues
liability

If amount received is Revenues overstated Dr Revenues

initially recorded as Liabilities understated Cr Liabilities
revenue

Accrued Revenues
not previously stated Assets understated Dr Assets
Revenues understated Cr Revenues
Accrued Expenses
not previously stated Expenses understated Dr Expenses
Liabilities understated Cr Liabilities

Closing entries

Temporary accounts:

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- All revenue accounts
- All expense accounts
- Dividends

Permanent accounts:
- All asset accounts
- All liability accounts
- Equity accounts

At the end of the financial year, the temporary account balances are transferred to the permanent
equity account - Retained Earnings - through the preparation of closing entries. Closing entries
formally recognise in the ledger the transfer of profit (or loss) and dividends to retained earnings,
which will be shown in the retained earnings sections of the statement of changes in equity.

All temporary accounts must be totalled to 'nil' so they are ready to accumulate data in the next
accounting period.

Process:
- All revenue accounts are closed to the Income Summary (DR Revenues CR Income summary).
- All Expenses are then closed to the Income summary (CR Expenses DR Income summary).
- THE BALANCE (Revenue - Expenses) IS EITHER A PROFIT OR LOSS
- Income Summary is closed off to Retained Earnings (DR Income summary CR Retained Earnings)
- Dividends are closed off to Retained Earnings (DR Retained earnings CR Dividends).

Post-Closing Trial Balance - A post-closing trial balance is a list of all permanent accounts and their
balances after closing entries are journalised and posted. The purpose of this trial balance is to prove
the sum of the debit balances equals the sum of the credit balances that are carried forward into the
next account period. Therefore, the post-closing trial balance will only contain balance sheet
accounts.

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Chapter Five – Reporting & Analysing Inventory

Recording purchases of inventory

Purchase of inventory – Increase liabilities, decrease equity: DR Purchases CR Accounts Payable

Purchase returns and allowance – Decrease liabilities, increase equity: DR Accounts Payable CR
Purchase returns and allowance

Freight costs – Decrease assets, decrease equity: DR Freight-in CR Cash

Purchase discounts – Increase equity, decrease liabilities and assets: DR Accounts Payable CR Cash &
CR Discount received (full amount x %)

Recording sale of inventory

Sales of inventory – Increase assets, increase equity: DR Accounts Receivable CR Sales

Sales returns and allowances – Decrease assets and equity: DR Sales returns and allowances CR
Accounts receivable

Sales discount – Increase/Decrease assets, decrease equity: DR Cash & DR Discount allowed (full
amount x %) CR Accounts Receivable

COGS (Cost of Goods Sold)

To determine the COGS under a periodic inventory system, it is necessary to:

- Record purchases of inventory
- Determine the cost of goods purchased
- Determine the cost of goods on hand at the beginning and end of the accounting period by physical
inventory count

Calculation of net purchases and cost of goods purchased:

Purchases
Less: Purchase returns and allowances
= Net purchases
Add: Freight - in
= Cost of goods purchased

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Calculation of COGS:
Beginning inventory
Add: Cost of goods purchased
= Cost of goods available for sales
Less: Ending inventory
= COGS

Determining ownership of goods

Goods in transit (on board a truck, train, ship or plane) at the end of the period. A business may have
purchased goods that have not yet been received, or it may have sold goods that have not been
delivered.

- FOB shipping point - ownership of the goods passes to the buyer when the delivery entity accepts
the goods from the seller.

- FOB destination - ownership of the goods remains with the seller until the goods reach the buyer.

Inventory cost flow methods – Periodic system

Purchases, purchase returns and allowances, and freight-in are all costs included in the cost of goods
available for sale.

Methods:

- Specific Identification Method - If the business can positively identify which particular units were
sold and which are still in ending inventory, this method can be applied. It is possible when a
business sells a limited variety of high-unit-cost items that can be indentified clearly from the time of
purchase to the time of sale.

- First-in, first-out (FIFO) - cost of the ending inventory is obtained by taking the unit cost of the most
recent purchase and working backwards until all units of inventory have been costed. (COG available
for sale – ending inventory = COGS)

- Last-in, last-out (LIFO) – cost of the beginning inventory is obtained by taking the unit cost of the
earliest purchase and working forwards until all units of inventory have been costed. (COG available
for sale – ending inventory = COGS)

- Average cost - The average cost method allocates the cost of goods available for sale on the basis
of the weighted average unit cost incurred. The average cost method assumes that goods are similar
in nature. (COG available for sale / total units available for sale = weighted average unit cost). The

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weighted unit cost is then applied to the units on hand to determine the cost of the ending
inventory.

Chapter Seven – Internal control, cash and receivables

Principles of internal control

Internal Control - consists of all the processes used by management and staff to provide effective
operations, and compliance with laws, regulations and internal policies. Internal control is an
essential part of risk management. Its main functions are to:

- Safeguard its assets (from theft, robbery and unauthorised use)

- Enhance the completeness, accuracy and reliability of its accounting records by reducing risk of
errors

Establishment of Responsibility - Assignment of responsibility to specific individuals and the

appointment of supervisors to monitor compliance with procedures. When assigning responsibility
to individuals, management should ensure that staff are appropriately qualified or trained.

Segregation of Duties - The responsibility for related activities should be assigned to different
individuals. The responsibility for keeping the records for an asset should be separate from the
physical custody of that asset.

Documentation Procedures - Documents provide evidence that transactions and events have
occurred. Procedures must be established for documents. Documents should be pre-numbered
(stops a transaction being recorded more than once). It facilitates an audit trial.

Physical, mechanical and electronic controls - Physical controls, such as safes, alarms and locks relate
mainly to safeguarding of assets. Mechanical and electronic controls safeguard assets and enhance
the accuracy and reliability of the accounting records. Programmed computer systems are built in
controls that limit unauthorised or unintentional tampering.

Independent internal verification - Most systems of internal control provide for independent internal
verification. This principle involves the review, comparison and reconciliation of data prepared by
employees.

- Independent verification should be made both routinely and on a surprise basis.

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- The verification should be done by an employee who is independent of the personnel responsible
for the information.
- Discrepancies and exceptions should be reported to a management level that can take appropriate
corrective action.

Limitations of internal control

The concept of reasonable assurance rests on the premise that the costs of establishing control
procedures should not exceed their expected benefit. The human element is an important factor in
every system of internal control. A good system can become ineffective as a result of employee
fatigue, carelessness or indifference. Collusion is also a limitation.

Internal control over cash

Cash consists of 'cash on hand', 'cash at bank', 'cheque account' and 'cash equivalents' (bank
overdrafts, deposits on the money market and 90 day bank acceptance bills). Cash receipts result
from a variety of sources: cash sales; collections of accounts receivable; the receipt of interest, rents
and dividends; investments by owners; bank loans; and proceeds from the sale of non - assets.

- Establishment of Responsibility - Only designated personnel (cashiers) are authorised to handle

cash receipts

- Segregation of Duties - Different individuals receive cash, record cash receipts and hold the cash
Documentation Procedures Use remittance advice (mail receipts) cash register tapes and deposit
slips, or sequentially ordered electronic receipt numbers

- Physical, mechanical and electronic controls - Store cash in safes and bank vaults; limit access to
storage areas; bank cash frequently; use cash registers or have customers use direct deposits to the
bank account or electronic fund transfer

- Independent Internal Verification - Supervisors count cash receipts daily; banking clerk compares
total receipts with bank deposits daily. Compare accounting records with bank records on a regular
basis (bank reconciliation).

Bank reconciliation

Bank reconciliation involves a comparison between the bank's records and the business's cash
receipts journal, cash payments journal and Cash at Bank ledger account. The lack of agreement
between these accounts/ledgers and the bank statement is due to:

Timing Differences - When one of the parties records the transaction in a different period from the
period used by the other party. E.g. Unrepresented Cheques - a cheque that has been drawn by the
payer but not yet paid by the bank. Outstanding Deposit - business deposits that do not yet appear
in the bank records.

Errors - By either party when recording transactions.

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Steps in bank reconciliation:

1. Start with bank statement balance for reconciliation date – compare cash receipts journal to
deposits on statement, compare cash payments journal to withdrawals on statement. Tick items that
match, correct errors in cash books, bank statement errors added to bank reconciliation statement.

2. Identify ‘unticked’ items on bank statement – adjust cashbook for dishonoured cheques and direct
deposits, outstanding deposits and unpresented cheques recorded in bank reconciliation statement,
outstanding items carried forward to next bank reconciliation

3. Total cash journals and post to Cash at Bank ledger

4. Complete bank reconciliation statement – outstanding deposits increase the bank account,
unpresented cheques decrease the bank account

Managing and monitoring cash

The objective is to ensure that a business has sufficient cash to meet payments as they come due,
yet minimise the amount of surplus cash on hand because the money could be invested more
profitably in operations.

Basic principles of cash management:

- Increase the speed of collection of receivables
- Keep inventory levels low
- Don't pay earlier than necessary
- Plan the timing of major expenditures
- Invest idle cash

Receivables – The term receivables refer to amounts due from individuals and businesses.
Receivables are claims that are expected to be collected in cash.

- Accounts Receivables - are amounts owed by the customers on account. They result from the sales
of goods and services.
- Notes Receivables - represent claims for which formal instruments of credit are issued as evidence
of the debt.
- Other Receivables - include non-trade receivables such as interest receivable, loans to officers,
advances to employees, and GST receivable.

Direct write-off method for uncollectable accounts – DR Bad Debts Expense CR Accounts Receivable
– (specific account name)

Allowance method for uncollectable accounts:

- Estimated uncollectables - are recorded as an increase (DR) to Bad Debts Expenses and an increase
(CR) to Allowance for Doubtful Debts (a contra asset account through an adjusting entry at the end
of each period)

- Actual uncollectables - DR to Allowance for Doubtful Debts and CR to Accounts Receivable at the
time at the specific account is written off as uncollectable.

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 Current Assets
Cash XX
Accounts Receivable XX
Less: Allowance for doubtful debts XX
Inventory XX
Prepaid Expense XX
Total current assets XX

Recording the write off of an uncollectable amount - Allowance for Doubtful Debts is not closed at
the end of the financial year because it is a permanent account. Bad Debts Expense is closed to
Income Summary at the end of the financial year. DR Allowance for Doubtful Debts CR Accounts
receivable

Recovery of an uncollectable amount - Two entries are required to record the recovery of bad debt:
(1) the entry made in writing off the account is reversed to reinstate the customer's account; (2) the
collection is journalised in the usual manner.

1. DR Accounts Receivable CR Allowance for Doubtful Debt – (specific account name)

2. DR Cash CR Accounts Receivable

Notes receivable - Notes receivables gives the holder a more expedient legal claim to assets than
accounts receivable. Notes receivable can be readily sold to another party. Promissory notes are
negotiable instruments (as are cheques), which means that, when sold, they can be transferred to
another party by endorsement.

Recognising notes receivable – DR Notes Receivable (at face value) CR Accounts Receivable

Honouring of notes receivable – A note is honoured when it is paid in full at its maturity date. DR
Cash CR Notes Receivable

Exchange notes receivable - If the business does not wish to wait until the due date to receive the
face value of the note, it may exchange the note. This is referred to 'discounting the not' because,
when a holder exchanges a note before maturity, the amount of cash received is the face value - a
discount.

Cash (DR) 990

Interest Expense (DR) 10
Notes Receivable (CR) 1000
(To record discounting the note at 1%)

Managing receivables:

- Determine who to extend the credit

- Establish a payment period
- Monitor collections
- Evaluate the receivables balance

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- Accelerate cash receipts from receivables when necessary

Chapter Eight – Reporting and analysing non-current assets

Property, Plant and Equipment (PPE)

PPE are assets that have physical substance (a definite size or shape), are used in the operations of
an entity for more than one period, and are not intended for sale to customers

Determining the cost of PPE - PPE are initially recorded at cost in accordance with the historical cost
method of accounting. Fair Value is the amount for which an asset could be exchanged between
knowledgeable willing parties in an arm's - length transaction. If a cost is not included in a PPE
account then it must be expensed immediately. On the other hand, costs that are not expensed
immediately are included in a PPE asset account and are referred to as capital expenditures.

Property – the cost of lands includes:

- The cash purchase price
- Settlement costs such as solicitors fee
- Stamp duty
- Accrued property taxes on the land assumed by the purchaser

DR Land CR Cash

Plant and Equipment – the cost of equipment includes:

- The cash purchase price
- Freight charges and insurance during transit
- Expenditures in assembling, installing and testing the unit.

Accounting for PPE

Depreciation - is the process of allocating to expense the cost of a PPE asset over its useful life in a
rational and systematic manner. It is important to understand that depreciation is a process of cost
allocation, not, a process of asset valuation. Depreciation applies to land improvements, buildings,

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and plant and equipment. Each of these is considered to be a depreciable asset because its
usefulness to the entity and its revenue-generating ability decline over the asset's useful life.

Factors in calculating depreciation:

- Cost - Considerations that affect the cost of a depreciable asset have been explained earlier in this
chapter.
- Useful life - is an estimate of the expected productive life of the asset to the entity.
- Residual value - is an estimate of the asset's value at the end of its useful life.

Depreciation methods - Depreciation is generally calculated using one of the three methods:
- Straight-line
- Diminishing-balance
- Units-of-production

Information such as this is usually provided:

- Cost $13 000
- Expected residual value $1000
- Estimated useful life (in years) 5
- Estimated useful life (in kilometres) 100 000
Straight line method - Under the straight-line method, depreciation is the same for each year of the
asset's useful life.

Cost ($13000) – Residual value ($1000) = Depreciable amount ($12000)

Depreciable amount ($12000) / Useful life (5 years) = Depreciation expense ($2400)

Annual rate = 20% (100%/5 years) x Depreciable amount ($12000)

DR Depreciation expense – (specific account) CR Accumulated Depreciation – (specific account)

Diminishing-balance method - This method is called an 'accelerated method' because it results in

more depreciation in the early years of an asset's life than does the straight-line method.

1 – n √r/c

n = estimated useful life (in years)

r = estimated residual value (in dollars)
c = original cost of the asset (in dollars)

Units-of-production method - useful life is expressed in terms of the total units of production or the
use expected from the asset.

Depreciable amount ($12000) / Total units of production (100000km) = Depreciation cost ($0.12)
Depreciation amount p/unit ($0.12) x Units of production during year (15000km) = Depreciation
expense ($1800)

Subsequent expenditure:

- Ordinary repairs - are expenditures to maintain the operating efficiency and expected productive
life of the asset. They are an expense in the income statement. DR Repair and Maintenance

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- Additions and improvements – are costs incurred to increase the operating efficiency, productive
capacity, or expected useful life of PPE assets.

Disposal of PPE assets:

- Sale (equipment is sold to another party)

- Scrapping (equipment is scrapped or discarded)
- Exchange (existing equipment is traded for new equipment)

Whatever the method, the entity must determine the carrying amount of the PPE asset at the time
of disposal. The carrying amount is the difference between the cost of the PPE asset and the
accumulated depreciation to date.

The carrying amount is then eliminated by increasing (DR) Accumulated Depreciation for the total
depreciation associated with that asset to the date and reducing (CR) Asset Account (e.g. Office
Furniture).

Sale of PPE assets - In disposal by sale, the carrying amount of the asset is compared with the
proceeds received from the sale. If the proceeds from the sale exceed the carrying amount of the
asset, a gain on disposal occurs. If the proceeds from the sale are less than the carrying amount of
the asset sold, a loss on disposal occurs.

E.g. – Gain on disposal:

On the 1st of July 2007 Wright Ltd sells office furniture for $16000 cash. The office furniture
originally cost $60000 and as of 1st Jan 2007 had accumulated depreciation of $41000. Depreciation
for the first 6months is $8000.

STEP 1
Depreciation Expense (debit) 8000
Accumulated Depreciation - Office Furniture (credit) 8000

(This entry is to record depreciation expense and update accumulated depreciation to 1st July)

STEP 2
After the accumulated depreciation balance is updated, a gain on disposal of $5000 is calculated:

Cost of Office Furniture 60000

Less: Accumulated Depreciation 49000
Carrying amount at date disposal 11000
Proceeds from sale 16000
Gain on disposal 5000

The entry to record the sale and the gain on sale of the PPE asset is as follows:

DR Cash 16000
DR Ac. Dep'n 49000 (decrease)

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CR Office Furniture 60000
CR Gain on Disposal 5000

Chapter Nine – Reporting and analysing liabilities

Liabilities are defined as obligations for future sacrifices of economic benefits resulting from a past
transaction or other past event. A current liability is an obligation that can reasonably be expected to
be paid within 1 year or within the operating cycle, whichever is the longer.

Current liabilities

Notes payable - Notes payable are sometimes used instead of accounts payable because they give
the lender written documentation of the obligation in case legal avenues are needed.

Notes payable usually require the borrower to pay interest and frequently are issued to meet short-
term financing needs. When the note is issued to the business, the receiver records the face value
(the principal amount payable at maturity) as follows (i.e. receives a note for $100000)

DR Cash $100000
CR Notes Payable $100000

Depending on the length (i.e. 4month note) and the percentage (i.e 12%) an adjusting entry
(depending on the business balance date) is required to recognise interest expense and interest
payable (i.e. $100000x12%x4/12)

DR Interest Expense $4000

CR Interest Payable $4000

In the 30th June financial statement, the current liabilities section of the balance sheet will include
Notes Payable ($100 000) and Interest Payable ($4000). In addition, Interest Expense ($4000) will be
reported.

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At maturity, that is, when the principal payment is due the business must pay the face value of the
note plus $4000 interest

DR Notes Payable $100000

DR Interest Payable $4000
CR Cash $104000

Payroll and Payroll deductions payable - Every employer incurs liabilities relating to employees'
salaries and wages. The employer deducts amounts from employees' wages if they are required to
be paid to other parties (i.e. Tax).

For example, accrual and payment of a $100 000 payroll on which an entity withholds tax from its
employees' wages and salaries would be recorded as follows:

Salaries and Wages Expense $100 000

Pay-as-you-go Withheld Tax Payable $32036
Salaries and Wages Payable $67 964
(to record payroll and withheld taxes)

Salaries and Wages Payable $67 964

Cash $67 964
(to record payment)
Revenue received in advance - When the advance is received, Cash is increased (DR), and a current
liability account identifying the source of the Revenue Received in Advance is also increased (CR). The
Revenue Received in Advance account is a liability. When the service is performed or the goods are
delivered, the Revenue Received in Advance account is decreased (DR), and a revenue account is
increased (CR).

For example the sale of tickets. A football company sells 100 000 tickets at $50 each for its five home
games.

Cash $500 000

Ticket Revenue Received in Advance $500 000

As each game is completed, this entry is made:

Ticket Revenue Received in Advance $100 000

Football Ticket Revenue $100 000

Non-current liabilities

Non-current liabilities are obligations that are expected to be paid after 1 year or outside the normal
operating cycle.

Unsecured notes - Notes that are not subject to a security over assets of the issuing company

Debentures - Notes that are subject to a secured change over some of the issuer's assets. A security
over assets is the right to have the assets liquidated to recover unpaid amounts of a debt if the
debtor defaults on payment.

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Assume a business issues 1000, 10 year, 10%, $1000 debentures on 30 June 2006 at 100 (100% of
face value). The entry to record the $ 1000 000 ($1000 x 1000) issue is

Cash (DR) $1 000 000

Debentures Payable (CR) $1 000 000

Debentures payable are usually reported in the non-current liabilities section of the balance sheet
because the maturity date is more than 1 year away. They are reclassified as current liabilities when
maturity is within one year.

Over the term (life) of the debentures, entries are required for interest. Interest payable on
debentures is calculated by multiplying the face value of the debenture by the interest rate stated in
the contract.

Assume that interest is payable half-yearly on 31 Dec and 30 June (in the debenture described
above), interest of $50 000 ($1 000 000 x 10% x 6/12) must be paid on 31 Dec. The entry is:

Interest Expense (Borrowing Costs) debit 50 000

Cash credit 50 000

If payments fell outside of balance dates, a balance-day an adjustment must be made to accrue
unpaid interest. CR Interest Payable instead of Cash.

Redeeming unsecured notes at face value - Notes are redeemed when they are purchased (repaid)
by the issuing company. Regardless of the issue price of notes, the carrying amount of the notes at
maturity will equal their face value.

Debentures Payable (DR) 1 000 000

Cash (CR) 1 000 000

Redeeming unsecured notes and debentures before maturity - Notes may be redeemed before
maturity. However, it is necessary to:

- Eliminate the carrying amount of the notes at the redemption date

- Record the cash paid
- Recognise the gain or loss on redemption

Assume, a business issued debentures with a face value of $1 000 000 maturing on 30 June 2010.
After paying interest for the year, the business redeems its debentures at 103 on 30 June 2007. The
carrying amount of the debentures at the redemption date is $1 000 00. The amount that the
business must pay is $1 030 000, being 103% of the face value.

Debentures Payable (DR) 1 000 000

Loss on Redemption of Debentures (DR) 30 000
Cash (CR) 1 030 000

Loans payable by instalment - A mortgage is a loan secured by a charge over property. If the
borrower (mortgagor) is unable to repay the loan, the lender (mortgagee), may sell the property and
use the proceeds to repay the loan.

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The reduction of the mortgage liability is also referred to as the reduction of the principal of the
loan, or just the reduction of the principal. The effect is A(decrease) = L(decrease) + E(decrease).

Interest Expense = $100 000 x 1% = $1000

The payment of $10 000 should be accounted for as an interest expense of $1000 and a $9000
reduction in the principal of the loan.

Interest Expense (DR) 1 000

Loan Payable (DR) 9000
Cash at Bank (CR) 10 000

Provisions and contingent liabilities

Provisions are defined at liabilities for which the amount of the future sacrifice is uncertain.
Provisions appear on the Balance Sheet and could be in the form of warranty provisions, sick leave
provisions etc.

Recording provisions for warranties - warranty is an obligation of the supplier of goods or services to
the purchaser that the product will be functional or that the work performed will remain satisfactory
for a stated period after the sale of goods or the provision of services. The future sacrifice is
conditional upon the customer making a claim and costs of satisfying claims vary with the nature of
the fault.

Electrobuz Ltd sells electronic equipment with a 12 month warranty. Its balance date is 30 June. At
30 June 2005, warranty contracts for sales made during the year have not expired. Electrobuz
estimates from past experience that the cost of servicing outstanding warranties will be $200 000
(this reflects the percentage of sales resulting in warranty claims and the average cost of servicing
warranty claims in the past).

Warranty Expense (DR) 200 000

Warranty Provision (CR) 200 000

In the following year, the costs of servicing warranty claims are charged against Warranty Provision
account, e.g. on 12 July 2012, Electrobuz replaced goods under warranty at a cost of $1000 using
goods from its own inventory.

Warranty Provision (DR) 1 000

Inventory (CR) 1 000

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Chapter Eleven – Reporting and analysing liabilities

Purpose - to provide information about cash receipts, cash payments and the net change in cash
resulting from the operating, investing and financing activities of an entity during the period.

Classification - Cash Flow Statements classify cash receipts and cash payments into operating,
investing and financing activities.

Operating Activities - are the entity's principal revenue - generating activities (such as the provision
of goods and services and activities which are not classified as investing or operating activities).
Operating activities is the most important category because it shows the cash provided or used by
operations. This source of cash is generally considered to be the best measure of whether an entity
can generate sufficient cash to continue as a going concern and to expand.

Investing Activities - the acquisition and disposal of long - term assets, including activities such as
purchasing and selling of non - current assets, and lending money and collecting the loans.

Financing Activities- are those that affect the size and composition of contributed equity and
borrowing, and include obtaining cash from issuing debt, repaying the amounts borrowed, obtaining
cash from shareholders, and paying them dividends or buying back shares.

Operating Activities Financing Activities Investing Activities

Cash Inflow Sale of Goods of Sale of PPE Issue of the company's

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 Services. Sale of investments own shares
Returns on loans (debt or equity Issue of debt
(interest received) and instruments) (debentures and notes)
on equity securities Collection of principal
on loans to other
entities
Cash Outflow To suppliers for To purchase PPE To shareholders as
inventory To purchase dividends
To employees for investments To redeem (repay) long
services To make loans to other - term debt
To governments for entities To buy back the
taxes company's own shares
To lenders for interest
To others for expenses

NB - significant financing and investing activities that do not affect cash are not reported in the body
of the cash flow statement.

CASH FLOWS FROM OPERATING ACTIVITIES

INFLOW:
1. Cash receipts from customers:

a) Calculate bad debts written off:

Opening allowance for DD + Bad debt expense – Closing allowance for DD

b) Calculate cash receipts from customers:

Opening A/C receivable + Sales – Bad debt written off – Closing A/C receivable

OUTFLOW:
2. Cash paid to suppliers:

COGS + Closing inventory – Opening inventory + Opening A/C payable – Closing A/C payable

3. Cash paid for operating expenses:

Operating expenses (excl. Depreciation) + Closing prepaid expenses – Opening prepaid expenses + Opening accrued
expenses payable – Closing accrued expenses payable

4. Cash payments for income tax:

Income tax expense (seen on income statement) – Increase in income tax payable (seen on comparative b/s)

5. Interest paid:

Normally disclosed in the additional information

6. Net cash provided (used) by operating activities

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INFLOWS – OUTFLOWS = NET CASH

CASH FLOWS FROM INVESTING ACTIVITIES

7. Sale/Purchase of PPE

Normally disclosed in the comparative balance sheet and in additional information

8. Net cash provided (used) by investing activities

INFLOWS – OUTFLOWS = NET CASH

CASH FLOWS FROM FINANCING ACTIVITIES

9. NB: Issuing shares (inflow), Dividends paid (outflow), Debentures redeemed (outflow), Notes payable (inflow)

10. Net cash provided (used) by financing activities

INFLOWS – OUTFLOWS = NET CASH

11. Net increase/decrease in cash

= Net cash provided (used) by operating activities +/- Net cash provided (used) by investing activities +/- Net cash provided
(used) by financing activities

12. Cash at beginning of period

13. Cash at end of period

= Net increase/decrease in cash + Cash at beginning of period

Chapter Thirteen – Management accounting

Manufacturing overhead – indirect costs associated with manufacturing products (eg. Indirect
labour/materials, depreciation, insurance, maintenance)

Product costs – relate directly to finished products. Expensed as COGS when finished products are
sold

Period costs – not directly part of the manufacturing process. Expensed according to time (financial
period costs eg. Selling and admin costs)

Prime costs – directly associated with the manufacture of finished products

Conversion costs – incurred in converting raw materials into finished products

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