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SIM MODULE BOOK
PRINCIPLES OF ACCOUNTING &
BUSINESS FINANCE
1
Module Book
PRINCIPLES OF ACCOUNTING & BUSINESS FINANCE
Module Book Developer :
Lin Hui Yee
Production
SIM Global Education
:
Module Book © SIM Global Education 2018
All rights reserved.
No part of this material may be reproduced in any form or by any means without permission
in writing from SIM Global Education
First Version @ July 2018
2
Table of Content
Introduction
4
Session 1:
Introduction to Principles of Accounting and the
Accounting Equation
12
Session 2:
Double Entry Bookkeeping
26
Session 3:
Recording Business Transactions – Ledger Accounts
and Trial Balance
40
Session 4:
Bank Reconciliation
57
Session 5:
Introduction to Managerial Accounting and
Analysis of Cost Behaviour
73
Session 6:
Cost Assignments
85
Session 7:
Pricing System
97
Session 8:
Budgeting
108
Session 9:
Introduction to Business Finance
118
Session 10:
Capital Budgeting
126
Session 11:
Time Value of Money
135
Session 12:
Overview of Financial Markets
146
3
Module Book
PRINCIPLES OF ACCOUNTING & BUSINESS FINANCE
Content
This module will provide students with an overview of the financial accounting, management
accounting and business finance concepts. Main topics include the accounting equation,
recording of business transactions, the preparation of financial statements, cost terminology,
cost behaviour and time value of money. Other topics include bank reconciliation, budgeting
and capital investment decision which equip students with basic accounting and financial
management skills. This module will help students establish a basic foundation for the
Accounting and Finance modules in advance diploma studies.
Module Aims
The aims of this module are to:
1.
2.
Provide students with a fundamental understanding of the nature and purpose of
accounting and finance.
Assist students to acquire knowledge and applications of accounting concepts and
skills within the general framework of the Principles of Accounting and Business
Finance.
Learning Outcomes
On completion of this module, the student should be able to:
1.
Show a detailed knowledge and understanding of:
i)
ii)
iii)
iv)
Basic accounting terms such as assets, liabilities, capital, revenues and expenses.
The accounting equation and effects of transactions on the equation.
The double entry principle.
The main components of the Profit and Loss Account and the Statement of Financial
Position.
Bank reconciliation statement.
The objectives of management accounting.
The elements and classification of costs and various cost behaviours.
Assignment of predetermined overhead rate.
Pricing of raw materials.
The behavioural aspects of budgeting.
Key activities of the financial manager.
Alternative approaches to be used in making investment and financing decisions.
The nature of corporations.
v)
vi)
vii)
viii)
ix)
x)
xi)
xii)
xiii)
4
2.
Demonstrate module specific skills with respect to:
i)
ii)
iii)
iv)
Preparing a simple Profit and Loss Account and Statement of Financial Position of a
service firm.
Preparation of bank reconciliation statements.
The use of budgeting as a planning and control tool.
Evaluating investment decisions.
3.
Show cognitive skills with respect to:
i)
ii)
iii)
Ability to distinguish cash and accruals basis of accounting.
The use of budgets as a managerial control tool.
Applying quantitative methods to analyze data, interpret data and make sound
decision-making.
4.
Demonstrate transferable skills in:
i)
ii)
iii)
iv)
v)
Information retrieval and numerical analysis.
Logical reasoning & decision making.
Effective communication.
Accounting in context.
Working with others.
5
Delivery of Module and Lesson Plan
S/N
1.

Topic
Introduction to
Principles of
Accounting and the
Accounting
Equation
Learning Outcomes
Recommended
At the completion of this session, Text, Readings
students will be able to:
and/or
Activities
1. Define the nature and purpose
of accounting.
Module book
Session 1
2. Describe the types of business
organization.
3. Identify the external and
internal users.
4. Define assets, liabilities and
capital.
5. State the accounting equation.
6. Identify and define each
element of the equation.
7. Prepare a simple Statement of
Financial Position based on the
accounting equation concept.
8. Describe and illustrate how
business transactions result in
changes in the elements of the
equation.
9. Rewrite the accounting equation
with different emphasis.
2.
Double Entry
Bookkeeping
1. State the double entry principle.
Module book
Session 2
2. Understand the double entry
concept and the accounting
rules that govern the asset,
liability and equity account.
3. Define revenue and expense.
4. Understand the accounting rules
6
that govern the revenue and
expense account.
5. Describe and illustrate
journalizing transactions using
the double-entry accounting
system.
3.
Recording Business
Transactions –
Ledger Accounts and
Trial Balance
1. Describe the characteristics of
ledger accounts.
Module book
Session 3
2. Describe and illustrate the
posting of transactions to
accounts.
3. Determine the balances of
accounts to prepare a trial
balance.
4. Prepare a trial balance.
5. Understand the differences
between cash and accrual basis.
6. Prepare a simple Profit & Loss
Statement and a Statement of
Financial Position for service
firm.
4.
Bank Reconciliation
1. State the features of good
internal control over cash.
Module book
Session 4
2. Explain the need to prepare a
bank reconciliation statement.
3. Describe the procedure of
preparing a bank reconciliation.
4. Reconcile the cash book balance
with the bank statement balance
and prepare a bank
reconciliation statement.
7
5.
Introduction to
Managerial
Accounting and
Analysis of Cost
Behaviour
1. Explain the meaning of
managerial accounting.
Module book
Session 5
2. Explain the differences between
management accounting and
financial accounting.
3. Explain the meaning of cost and
how costs are assigned to
products and services.
4. Define the various costs of
manufacturing products.
5. Explain the meaning of cost
behavior.
6. Define and describe fixed,
variable and mixed costs.
6.
Cost Assignments
1. Understand how costs are
assigned to cost objects.
Module book
Session 6
2. Compute the predetermined
overhead rate and use the rate to
assign overhead to units.
7.
Pricing System
1. Describe the materials recording Module book
procedure.
Session 7
2. Explain the First in, First out
(FIFO) method of pricing
materials issued from inventory.
3. Explain the Last in, First out
(LIFO) method of pricing
materials issued from inventory.
4. Explain the Weighted Average
(WAC) method of pricing
materials issued from inventory.
8.
Budgeting
1. Define budgeting and discuss its
role in planning, control, and
decision-making.
Module book
Session 8
8
2. Explain the interlinking of the
various budgets within a
business.
3. Indicate the uses of budgeting
and construct a simple cash
budget.
9.
Introduction to
Business Finance
1. Define business finance.
Module book
Session 9
2. Identify and describe the key
activities of the financial
manager within the firm.
3. Explain why wealth
maximization rather than profit
maximization is the firm’s goal.
4. Discuss the relationship
between risk and return.
10.
Capital Budgeting
1. Explain the importance and
nature of capital budgeting.
Module book
Session 10
2. Calculate, interpret, and
evaluate the Accounting Rate of
Returns (ARR).
3. Calculate, interpret, and
evaluate the Payback Period.
11.
Time Value of
Money
1. Discuss the concept of time
value of money and the use of
computational tools.
Module book
Session 11
2. Calculate, interpret and evaluate
the Net Present Value (NPV).
12.
Overview of
Financial Markets
1. Explain the nature of
corporations.
Module book
Session 12
2. Overview of financial markets
and institutions.
9
3. Understand the process of
raising capital for both new and
established firms.
Teaching and Learning Methods
Delivery comprises lectures to highlight concepts and principles as well as tutorial style
interaction where participants will have opportunities to apply the principles via
illustrations and exercises. Participants will be expected to learn independently by
carrying out reading and directed study beyond that available within taught classes.
Indicative Readings
Prescribed Textbook
SIM PABF Module Book
Supplementary reading
Wood, F & Sangster, A (2015). Frank Wood’s Business
Accounting 1. Harlow, Essex: Financial Times/Prentice Hall.
ISBN-13: 978-1292084664.
Mowen M.M., D.R. Hansen and D.L. Heitger (2016).
Managerial Accounting: The Cornerstone of Business
Decisions (7th Ed.) South-Western Cengage earning.
ISBN-13: 978-1337115773.
Gitman, L. J. (2014). Principles of Managerial Finance (14 th
Ed.) Pearson Education.
ISBN-13: 978-0133507690
Assessment/coursework
All assessments must comply with the SIM Rules and Regulations. To satisfy
module requirements, students must:
1) Satisfactorily complete and present on due dates their completed assignment. A
penalty of 20% of the total marks will be imposed for late submission. A
submission later than 1 calendar day past deadline will receive a zero mark.
2) Complete all assessments and coursework in a satisfactory manner.
3) Reference all their work and observe SIM’s policy on plagiarism. Students found
guilty of plagiarism will be dealt with severely.
4) Adopt either the Harvard or APA (American Psychological Association)
Referencing Styles.
10
Specific for this module are the following requirements:
Weighting between components A and B – A: 60% B: 40%
Element Description
% of Assessment
Component A (Controlled Conditions)
Examination (120 minutes)
60%
Component B (CA: Continuous Assessment)
CA1
CA2
CA3
Total (Component A+B)
40%
100%
11
PRINCIPLES OF ACCOUNTING & BUSINESS FINANCE
SESSION 1
INTRODUCTION TO PRINCIPLES OF ACCOUNTING AND THE ACCOUNTING
EQUATION
At the end of the lecture, students should be able to:
1.
2.
3.
4.
5.
6.
7.
9.
Define the nature and purpose of accounting.
Describe the types of business organizations.
Identify the external and internal users.
Define assets, liabilities and capital.
State the accounting equation.
Identify and define each element of the equation.
Prepare a simple Statement of Financial Position based on the accounting equation
concept.
Describe and illustrate how business transactions result in changes in the elements of
the equation.
Rewrite the accounting equation with different emphasis.
1.1
Nature and Purpose of Accounting
8.
Accounting can be defined as the process of identifying, measuring, recording and
communicating economic information about the business entity to the users of the
information to assist them in making decisions.
Recording refers to the keeping of accurate records of business transactions/financial
activities. The data recorded is summarized and financial information is reported to
management and other interested parties in the form of financial reports. The reports could
show the profit made for a certain period of time or the enterprise’s financial position.
Identification
Measurement
Recording
Communication
12
Activity 1.1
What is the difference between book keeping and accounting?
1.2
Users of Financial Information
The financial reports provide a wealth of financial information that helps various users to
make informed decisions. The users who are interested in financial information include the
following:
•
Owners
They are interested in assessing the returns of their investment such as dividend and their
potential capital gain.
•
Managers
They are concerned with the company’s performance as their performance is measured
based on how well they have made use of the company’s resources to earn profits for the
business.
•
Creditors and Lenders
They have an interest in how well the business performs in terms of its ability to meet
payments for goods and services acquired on credit terms. Lenders such as banks are
concerned with a business’s ability to meet loan and interest payments.
•
Employees
They want to be assured of steady employment and if the business is profitable, they
hope to benefit from an employee profit sharing scheme.
•
Governments
They are interested in the financial data to assess taxes.
•
Prospective Investors
They are interested to invest in a business that is financially stable and solvent.
Activity 1.2
Classify the users mentioned in the above paragraphs under external and internal users of
accounting information. Explain the rationale of your classification.
13
1.3
Types of Business Organisation
Businesses range enormously in size but they all have something in common which is to sell
goods and services for the purpose of making profits. Most types of businesses can be
classified in the following three forms.
•
Sole Trader/Proprietorship
The business is owned by one individual who is entitled to all the profits made by the
business and also suffers all the losses made by the business.
•
Partnership
The business is owned by two or more individuals with a common view to profit. The
partners agree on how the firm should be run and share profits and losses according to
their agreement.
•
Limited Company
The business is organized under the country’s laws and the owners are known as
shareholders. The shareholders’ investment in the business is measured in shares and
their liability is limited up to the amount of capital invested. This is unlike the sole
proprietorship and partnership where the owners face unlimited liability as they may
have to make up for the business losses from their personal resources.
Activity 1.3
List the main types of businesses. Identify the different features among them.
1.4
Definition of Assets, Liabilities and Equity
Assets may be defined at this stage as items of value owned by a business. A business’s
assets comprise of items such as cash, motor vehicles, land, buildings, inventories/stock,
debts owing to it (known as accounts receivable or debtors), and so on.
Liabilities are amounts owed by the business. They include amounts owed as a result of the
purchase of goods or services (known as accounts payable or creditors), a bank overdraft or
other loans of money to the business.
Owner’s Equity may be defined as the interests of the owner or owners in the business. It
can arise because the owner has injected cash in the business (known as capital) or it can be
created by the business making profits. On the other hand, when the owner withdraws cash
from the business for personal use (known as drawings), it will cause owner’s equity to
decrease.
14
Activity 1.4
Classify the following items into their correct category as asset, liability or owner’s equity.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
Office equipment
Loan from DBS Bank
Motor vehicles
Bank balance
Mortgage on factory
Account receivables
Inventory of goods held for resale
Accounts payable
Bank overdraft
Capital
Business’s website
1.5
The Accounting Equation
When an entity comes into being it is possible to note two aspects – the source of funds
provided to start the business, and the assets which represent those funds.
Assets of the business = Funds provided
Where the funds are all provided by the owner we can record this as:
Assets of the business
=
Funds provided by the owners
Usually, people other than the owners will also provide some of the funds. Hence, we can
expand the equation to:
Assets of the = Funds provided by
business
the owners
Assets
=
+ Funds provided by
outsiders
Owner’s Equity
+
Liabilities
So, the accounting equation is:
ASSETS
=
OWNER’S EQUITY
+
LIABILITIES
15
Activity 1.5
Complete the following table:
Assets
Liabilities
Owner’s Equity
$
$
$
(a) 55,000
?
36,400
(b) ?
21,200
18,500
(c) 40,000
15,400
?
(d) 121,000
?
62,000
(e) 198,000
?
110,000
1.6
The Balance Sheet or Statement of Financial Position
The balance sheet or statement of financial position is a statement of assets, liabilities and
equity, suitably arranged and classified to reflect the financial position of an accounting entity
at a particular point in time.
Statement of Financial Position of Adam Trading
Assets
Van
Premises
Equipment
Inventories
Cash in hand
Total assets
Liabilities
Payable/ Creditor
Loan
Owner’s Equity
Adam’s capital
Total liabilities and equity
$
20,000
5,000
$
50,000
9,500
1,500
1,000
3,000
65,000
25,000
40,000
65,000
Activity 1.6
Joyce has the following items in her statement of financial position on 30 April 2017:
Capital $22,200; Accounts payable $7,400; Fixtures $11,100; Inventories $4,300; Motor van
$8,600; Accounts receivable $4,100; Cash at bank $1,600; Cash in hand $2,900; Loan
$3,000.
Draw up Joyce’s statement of financial position as at 30 April 2017.
16
1.7
Effect of Transactions on the Accounting Equation
As the business engages in transactions, its assets, liabilities and equity change continually.
However, the relationship in the accounting equation will always hold true. The equality is
always maintained as the assets controlled by the business had to be financed by one or more
sources, such as the owner or lenders.
Illustration 1.1
(a) If the owner decides to invest $1,000 to start a business, then owner’s equity will be
increased by $1,000. At the same time $1,000 in cash will have been added to the
assets, so that the equation would now read:
Assets
Cash + $1,000
=
Liabilities
+
Owner’s Equity
Capital + $1,000
A ($1,000) = L(0) + OE ($1,000)
(b) If $600 is used to buy some furniture, one asset (cash) will be replaced by another asset
(furniture).
Assets
Cash – $600
Furniture +$600
=
Liabilities
+
Owner’s Equity
A ($1,000 – $600 + $600) = L(0) + OE ($1,000)
A ($1,000) = L(0) + OE ($1,000)
(c)
If the furniture had been bought on credit, instead of cash being replaced, there will now
be a liability (payable).
Assets
Furniture +$600
=
Liabilities
Payable +$600
+ Owner’s Equity
Capital + $1,000
A ($1,000 + $600) = L($600) + OE ($1,000)
A ($1,600) = L($600) + OE ($1,000)
17
(d)
If the owner takes out $100 from the business’s cash to pay for his personal expenses,
this will reduce his interests in the business. Hence owner’s equity will be reduced by
$100. At the same time, asset (cash) will also reduce by $100.
Assets
Cash -$100
=
+ Owner’s Equity
Drawings -$100
Liabilities
A ($1,600 – $100) = L($600) + OE ($1,000 – $100)
A ($1,500) = L($600) + OE ($900)
Activity 1.7
Show how the accounting equation is affected with the following transactions:
Transactions
Assets
=
Owner’s
Equity
+ Liabilities
10,000
=
10,000
+ 0
10,000
=
10,000
+ 0
11,500
=
10,000
+ 1,500
10,500
=
10,000
+ 500
13,500
=
10,000
+ 3,500
a) Eve started a small
trading business with
$10,000, deposited
into a bank
b) Purchase a
computer by cheque
$1,500
c) She bought a piece
of furniture for
$1,500 on credit.
d) Make payment to
payable $1,000 by
cheque
e) Business borrowed
$3,000 from the bank
18
f) Eve withdrew
$600 from business
bank for personal use
12,900
=
9,400
+ 3,500
Review Questions
Question 1
Which of the following statements is correct?
A.
B.
C.
D.
Accounting is defined as an information system that provides reports to external
users only.
Financial statements do not provide relevant information to credit suppliers.
All the information required by all users are met by the financial statements.
Financial statements comprise of an Income Statement and a Balance Sheet to
meet the needs of a number of user groups.
Question 2
Potential investors are interested in financial information because they need to
A.
B.
C.
D.
assess the business’s ability to meet loan and interest payments.
decide whether to buy shares in the company.
be assured of steady employment.
assess taxes.
Question 3
Which of the following statements about the accounting equation is correct?
A.
B.
C.
D.
Assets – Liabilities = Owner’s equity
Assets + Liabilities = Owner’s equity
Assets + Owner’s equity = Liabilities
Liabilities – Owner’s equity = Assets
Question 4
Jamie withdrew $9,000 from her business. What is the effect of the transaction on the
business’s accounting equation?
A.
B.
C.
D.
Increase in asset and owner’s equity
Decrease in an asset and decrease in another asset
Increase in assets and liabilities
Decrease in assets and owner’s equity
19
Question 5
Leslie paid $12,900 to trade payables with a personal cheque. What is the effect of the
transaction on the business’s accounting equation?
A.
B.
C.
D.
Increase in asset and owner’s equity
Decrease in an asset and decrease liabilities
Increase in assets and liabilities
Decrease in liabilities and increase in owner’s equity
Question 6
Susan contributed $10,000 into her business. What is the effect of the transaction on the
business’s accounting equation?
A.
B.
C.
D.
Increase in asset and owner’s equity
Increase in an asset and decrease in another asset
Increase in assets and liabilities
Increase in liabilities and owner’s equity
Question 7
Dorcas took a loan from DBS and deposited the money in her business bank account. What
is the effect of the transaction on the business’s accounting equation?
A.
B.
C.
D.
Increase in bank and increase in loan
Decrease in bank and accounts payable
Increase in bank and accounts payable
Decrease in bank and loan
Question 8
Complete the following table:
Assets
$
(i) 89,200
(ii) 47,000
(iii) ?
A.
B.
C.
D.
Liabilities
$
43,000
?
21,789
Capital
$
?
21,350
67,000
(i) Capital $132,200; (ii) Liability $68,350; (iii) Assets $88,789
(i) Capital $ 46,200; (ii) Liability $25,650; (iii) Assets $88,789
(i) Capital $ 46,200; (ii) Liability $68,350; (iii) Assets $88,789
(i) Capital $132,200; (ii) Liability $25,650; (iii) Assets $45,211
20
Question 9
Write down the effects on the accounting equation when
(i) a sole proprietor brought in a printer of $1,050 into the business
(ii) and bought another printer that cost $1,980 on credit
(iii) subsequently returned the newly bought printer to the supplier as it was
defective
Question 10
During the month of April 2017, Ronald Teo entered into the following transactions:
(i) Gave a cheque of $11,280 to a creditor.
(ii) Withdrew $3,000 from his business’s bank account and put it as cash in the till.
(iii) Bought a cabinet for $890 on credit.
(iv) Repaid a loan of $25,000 to the bank.
Show how the accounting equation is affected with the above transactions.
Question 11
The following items are from Jason’s statement of financial position on 31 May 2016:
Trade payable $21,100; Office equipment $20,200; Furniture and fittings $4,800; Inventory
$19,600; Capital $25,650; Trade receivable $24,900; Bank overdraft $10,300; Cash in hand
$550; Bank Loan $13,000.
Draw up Jason’s statement of financial position as at 31 May 2016.
Question 12
Laura Tang provided the following information as at 30 June 2014:
$
Plant and Machinery
152,000
Cash
12,000
Motor vehicle
78,500
Premises
280,000
Trade receivable
45,080
Trade payable
92,340
Inventory
54,000
Office equipment
26,000
Bank loan
150,000
Bank overdraft
12,600
Mortgage Loan
120,000
Required:
Based on the information above, prepare a statement of financial position as at 30 June 2014
and compute the missing Capital amount.
21
Homework Questions (with answers)
Question 1
Which of the following statements is correct?
A.
B.
C.
D.
Financial statements provide forecast information to users.
Financial statements do not provide useful information to lenders.
All the information required by the owner are met by the financial statements.
Financial statements are intended to meet the needs of a number of user groups.
Question 2
Lenders are interested in financial information because they need to
A.
B.
C.
D.
assess the business’s ability to meet loan and interest payments.
decide whether to buy shares in the company.
be assured of steady employment.
assess taxes.
Question 3
Which of the following item is not an asset?
A.
B.
C.
D.
Motor vehicle
Loan from a bank
Tables and chairs
Money in the bank
Question 4
Jeremiah paid $2,060 to a supplier for amount previously owed with a personal cheque. What
is the effect of the transaction on the business’s accounting equation?
A.
B.
C.
D.
Decrease in accounts payable and loan
Decrease in cash and accounts payable
Increase in cash and accounts payable
Decrease in accounts payable and increase in capital
MCQ Answers : D, A, B, D
22
Question 5
Identify three groups of users and explain why they need financial information.
Answer (Any three groups of users)
• Owners
They are interested in assessing the returns of their investment such as dividend and their
potential capital gain.
•
Managers
They are concerned with the company’s performance as their performance is measured
based on how well they have made use of the company’s resources to earn profits for the
business.
•
Creditors and lenders
They have an interest in how well the business performs in terms of its ability to meet
payments for goods and services acquired on credit terms. Lenders such as banks are
concerned with a business’s ability to meet loan and interest payments.
•
Employees
They want to be assured of steady employment and if the business is profitable, they
hope to benefit from an employee profit sharing scheme.
•
Governments
They are interested in the financial data to assess taxes.
•
Prospective Investors
They are interested to invest in a business that is financially stable and solvent.
Question 6
Complete the following table:
(a)
(b)
(c)
Assets
$
?
98,400
63,000
Answer: Assets
$
(a)
116,900
(b)
98,400
(c)
63,000
Liabilities
$
43,000
?
34,400
Liabilities
$
43,000
50,900
34,400
Capital
$
73,900
47,500
?
Capital
$
73,900
47,500
28,600
23
Question 7
During the month of June 2016, Janelle entered into the following transactions:
(v) Received a cheque of $9,700 from a debtor.
(vi) Deposited $20,000 of her own money into the business’s bank account.
(vii) Bought a computer for $1,000 by paying cash.
(viii) Took up a loan of $35,000 from the bank.
Show how the accounting equation is affected with the above transactions.
Answer:
(i) Asset (Bank) + $9,700; Asset (Debtor) – $9,700.
(ii) Asset (Bank) + $20,000; Equity (Capital) + $20,000.
(iii) Asset (Equipment) + $1,000; Asset (Cash) – $1,000.
(iv) Asset (Bank) + $35,000; Liability (Bank Loan) + $35,000.
Question 8
Thomas has the following items in his statement of financial position on 31 January 2017:
Accounts payable $17,100; Furniture and fittings $20,800; IT equipment $19,800; Capital
$28,600; Accounts receivable $24,700; Bank overdraft $11,300; Cash in hand $3,700; Bank
loan $12,000.
Draw up Thomas’s statement of financial position as at 31 January 2017.
Answer:
Statement of Financial Position of Thomas as at 31 January 2017
Assets
Furniture and fittings
IT equipment
Accounts receivable
Cash in hand
Total assets
Liabilities
Accounts payable
Bank overdraft
Bank loan
Owner’s Equity
Thomas’s capital
Total liabilities and equity
$
17,100
11,300
12,000
$
20,800
19,800
24,700
3,700
69,000
40,400
28,600
69,000
24
Question 9
Joy Factory provided the following information as at 30 June 2016:
$
Machinery
148,000
Cash
12,000
Delivery trucks
72,500
Buildings
212,000
Trade receivables
47,000
Trade payables
41,300
Inventory
24,000
Equipment
37,000
Long-term loan
62,300
Bank overdraft
48,600
Mortgage
174,000
Required:
Based on the information above, compute the missing capital amount and prepare a statement
of financial position as at 30 June 2016.
Answer:
Statement of Financial Position of Joy Factory as at 30 June 2016
Assets
Machinery
Cash
Delivery trucks
Buildings
Trade receivables
Inventory
Equipment
Total assets
Liabilities
Trade payables
Long-term loan
Bank overdraft
Mortgage
Owner’s Equity
Capital (552,500 – 326,200)
Total liabilities and equity
$
41,300
62,300
48,600
174,000
$
148,000
12,000
72,500
212,000
47,000
24,000
37,000
552,500
326,200
226,300
552,500
25
PRINCIPLES OF ACCOUNTING & BUSINESS FINANCE
SESSION 2
DOUBLE ENTRY BOOKKEEPING
At the end of the lecture, students should be able to:
1.
2.
3.
4.
5.
2.1
State the double entry principle.
Understand the double entry concept and the accounting rules that govern the asset,
liability and equity account.
Define revenue and expense.
Understand the accounting rules that govern the revenue and expense account.
Describe and illustrate journalizing transactions using the double-entry accounting
system.
Dual Aspect Rule
The dual aspect rule states that every business event will always have a twofold effect. The
recognition of the twofold effect of all transactions gave rise to the double-entry bookkeeping
system.
2.2
Double Entry
It is a debit entry to at least one account and a credit entry to at least one account. The total
debits and total credits of each double entry must be equal.
Rules of Double Entry
– Every transaction affects at least 2 accounts.
– At least one account is debited and one account is credited.
– Total Debits == Total Credits
Accounts to Debit and Credit
Every account is deemed to have a nature, either debit or credit. Whether an account is to be
debited or credited depends on the nature of the account. Increases to the account are
recorded on the same side as the nature of the account. Decreases are recorded on the
opposite side to the nature of the account.
26
Hence, the accounting rules that govern asset, liability and equity accounts are as follows:Categories
Nature
Increase
Decrease
Assets
Debit
Dr
Cr
Liabilities
Credit
Cr
Dr
Equity
Credit
Cr
Dr
Steps to record a transaction
(i)
( ii )
( iii )
( iv )
Identify the two items(accounts) that are affected by the transaction.
Determine if they are being increased or decreased.
Decide whether each account should be debited or credited based on the nature.
Check that total debit amount is equal to total credit amount.
Activity 2.1
Transaction
1
Owner contributed
cash to the entity
2
Bought motor vehicle
on credit from Auto Ltd
3
Bought furniture paying
by cash
4
Business borrowed cash
from the bank
5
Paid amount owing to
Auto Ltd
6
Personal drawings of
cash by owner
Accounts
Affected
Category
Increase OR
Decrease
Dr OR
Cr
27
Transaction
7
Paid off bank loan in
cash
8
A debtor (accounts
receivable) paid his
account by cash
2.3
Accounts
Affected
Category
Increase OR
Decrease
Dr OR
Cr
Definition of revenue, expenses and profit
Revenue may be defined as the income that a business earns from its normal business
activities, usually from the sale of goods and services* to customers. An increase in revenue
results in an inflow of resources; hence, it will cause owner’s equity to increase. *For this
course, we will only focus on sale of services.
Expenses are amounts incurred by a business when it accepts goods or consumes services
provided by another entity. An increase in expense results in an outflow of resources; hence,
it will cause owner’s equity to decrease.
Profit is the difference between revenue and expenses. When a business makes profit from
its transactions, the profit becomes part of the owner’s equity.
2.4
Accounting Rules for Revenue and Expenses account
When the business makes profit, profit goes to the owner. Since equity is credit in nature,
profit which increases capital is also credit in nature.
Profit = Revenue – Expenses
Revenue increases profit which is credit in nature, hence revenue accounts are credit in nature
while expenses which decrease profit will then be debit in nature.
A summary on the accounting rules that govern revenue and expense accounts are as
follows:-
Categories
Nature
Increase
Decrease
Expenses
Debit
Dr
Cr
Revenue
Credit
Cr
Dr
28
Activity 2.2
Transaction
1
Paid wages to staff in
cash
2
Billed client-Peter for
services rendered
3
Received commission
by cash
4
Paid rent in cash
5
Collected cash from
Peter for amount owed
Accounts
Affected
Category
Increase OR
Decrease
Dr OR
Cr
Activity 2.3
For each of the following transactions which relates to the business of Max:
i) Identify the accounts that are affected.
ii) Classify the account as an asset(A), liability(L), owner’s equity(OE), revenue(R) or
expense(E).
iii) Indicate whether each account will be increased or decreased.
iv) Decide whether the account should be debited or credited based on the nature.
Transaction
1
Bought shelves to be
used in the office on
credit from Roma
2
Max brought in more
cash as capital
3
Received interest
income by cheque
Accounts
Affected
Category
Increase OR
Decrease
Dr OR
Cr
29
Transaction
4
Paid cheque to Roma
for amount owed
5
Paid rent expense by
cheque
6
Bank in office cash
7
Paid wages and salaries
by cheque
8
Max issued a business
cheque to pay off a
personal loan
9
Billed a client Jill for
service rendered
10
Took up a bank loan
and received cheque
for it
11
Received cash from Jill
for amount owing
12
Paid off bank loan in
cheque
13
Max transferred a sum
of money from his
personal bank account
to the business’s bank
account
14
Transfer from the
business bank account
to cash in hand
Accounts
Affected
Category
Increase OR
Decrease
Dr OR
Cr
30
Review Questions
Question 1
Susan received $10,000 of commission income. What is the effect of the transaction on the
business’s accounting equation?
A.
B.
C.
D.
Increase in cash and capital
Increase in cash and income
Decrease in cash and increase in expense
Decrease in cash and income
Question 2
John paid his worker $9,000 of wages. What is the effect of the transaction on the business’s
accounting equation?
A.
B.
C.
D.
Increase in expense and capital
Increase in cash and income
Decrease in cash and increase in expense
Decrease in cash and income
Question 3
A debit entry is recorded when
A.
B.
C.
D.
asset increases and liability decreases
asset increases and equity increases
equity increase and liability increases
expense decreases and revenue decreases
Question 4
A credit entry is recorded when
A.
B.
C.
D.
asset decreases and liability decreases
asset increases and capital increases
expense decrease and liability increases
drawings increase and revenue decreases
Question 5
Daryl bought a pick up that cost $45,000 paying by cheque. What is the effect of the
transaction on the business’s accounting equation?
A.
B.
C.
D.
Increase in expense and capital
Increase in vehicle and decrease in bank
Increase in vehicle and increase in other payable
Increase in cash and increase in income
31
Question 6
When motor vehicles are bought on credit, the accounting entries are
A.
B.
C.
D.
Debit
Motor vehicles
Other payable
Motor vehicles
Cash
Credit
Other payable
Motor vehicles
Cash
Motor vehicles
Question 7
Toby received $7,000 from a trade debtor. What is the correct double entry to record this
transaction?
A.
B.
C.
D.
Dr Cash account
Dr Cash account
Dr Expense account
Dr Cash account
Cr Capital account
Cr Income account
Cr Cash account
Cr Trade debtor account
Question 8
Daisy paid $11,000 for advertising her product. What is the correct double entry?
A.
B.
C.
D.
Dr Expense account
Dr Cash account
Dr Expense account
Dr Cash account
Cr Drawings account
Cr Expense account
Cr Cash account
Cr Income account
Question 9
Consider the following transactions of Jill’s facial and spa firm, indicate the effects upon
assets, liabilities, owner’s equity, revenue and expense, i.e. whether the element will increase
or decrease, and write down the double entries to record the transactions.
Transaction
1
Jill contributed $25,000
cash and beauty
equipment that costs
$70,000 to begin her
business.
2
Bought a computer
from Lee’s, $3,100 on
account.
Accounts
Affected
Category  OR

Double Entries
32
Transaction
3
Paid $2,500 for rental
of shop space by cash.
4
Withdrew $890 in cash
to pay home utilities.
5
Took up a loan of
$10,000 from Citibank,
receiving a cheque for
it.
6
Banked in office cash
$1,000.
7
Paid amount owing to
Lee’s with a cheque
8
Received cash $2,500
for service rendered to
a client
9
Billed a client Jane
$3,200 for service
rendered. Client agreed
to pay the following
week.
10
Paid interest for the
Citibank loan in cash
$100.
11
Client Jane paid up the
amount owing in
cheque.
Accounts
Affected
Category  OR

Double Entries
33
Transaction
12
Accounts
Affected
Category  OR

Double Entries
Debit
Credit
Bought a cabinet $900
from Norman, paying
half in cash, the
remainder to be paid by
the end of the month.
Question 10
Complete the following table:
a)
Owner brought in her car for business
use
b)
Bought a cabinet paying by cheque
c)
Bought a truck from MX Ltd on
account
d)
Returned the truck bought on credit
from MX Ltd.
e)
Received commission income in cash
f)
Issued a cheque to pay rent expense
g)
Bought furniture on credit from
Harvey
h)
Billed client Martha for service
rendered
i)
Paid the amount owing to Harvey by
cheque
j)
Owner issued a business cheque to
pay for his son’s tuition fee
k)
Owner brought in more cash into the
business
34
Debit
l)
Credit
Received a cheque from Martha for
the amount owing
m) Paid staff wages in cash
Homework Questions (with solutions)
Question 1
Peter withdrew $3,000 from the business’s bank account to pay for his personal income tax.
What is the effect of the transaction on the business’s accounting equation?
A.
B.
C.
D.
Decrease in bank and increase in expense
Decrease in bank and increase in drawings
Decrease in bank and increase in cash
Increase in bank and increase in drawings
Question 2
Stephen bought an equipment that cost $12,000 on credit. What is the effect of the transaction
on the business’s accounting equation?
A.
B.
C.
D.
Increase in expense and capital
Increase in equipment and decrease in cash
Increase in equipment and increase in other payable
Increase in cash and increase in sales
Question 3
Which of the following requires a debit entry?
1.
2.
3.
4.
Expense increases and liability increases
Asset increases and drawings increase
Revenue decreases and liability increases
Expense increases and revenue decreases
A.
B.
C.
D.
1 and 2
2 and 4
2 and 3
3 and 4
35
Question 4
When a lap top is bought on credit, the accounting entries are
A.
B.
C.
D.
Debit
Office equipment
Payable
Cash
Office equipment
Credit
Cash
Office equipment
Office equipment
Payable
MCQ answers: B, C, B, D
Question 5
Explain the dual aspect rule and provide an example to illustrate the rule.
Answer:
The dual aspect rule states that every business event will always have a twofold effect. The
recognition of the twofold effect of all transactions gave rise to the double-entry bookkeeping
system.
For example, when the owner makes cash investment into the business, there is an increase in
asset called cash, followed by an increase in capital.
Question 6
Explain why an increase in revenue causes owner’s equity to increase while an increase in
expense has an opposite effect on owner’s equity.
Answer:
Revenue or turnover may be defined as the income that a business earns from its normal
business activities, usually from the sale of goods and services to customers. An increase in
revenue results in an inflow of resources; hence, it will cause owner’s equity to increase.
Expenses are amounts incurred by a business when it accepts goods or consumes services
provided by another entity. An increase in expense results in an outflow of resources; hence,
it will cause owner’s equity to decrease
36
Question 7
Complete the following table:
a)
Invested cash in business
b)
Bought motor van by cheque
c)
Returned furniture to Courts Ltd.
d)
Machinery bought on credit from Saw Ltd.
e)
Paid creditor Saw Ltd. By cheque
f)
A debtor, Lynn, paid us in cash.
Debit
Credit
Debit
Credit
Capital
Bank
Furniture
Payable-Saw
Ltd
Bank
Answer:
a)
b)
c)
d)
Invested cash in business
Bought motor van by cheque
Returned furniture to Courts Ltd.
Machinery bought on credit from Saw Ltd.
Cash
Motor vehicle
Payable-Courts
Machinery
e)
Paid payable Saw Ltd. By cheque
f)
A receivable, Lynn, paid us in cash.
Payable-Saw
Ltd
Cash
Accounts
receivable-Lynn
Question 8
Write down the double entries when a business
(i) bought some furniture for $14,000 on credit
(ii) subsequently returned some damaged furniture that cost $3,000
(iii) repaid the furniture supplier for the balance owed
Answer:
(i)
Dr Furniture $14,000
(ii)
Dr Payable $3,000
(iii) Dr Payable $11,000
Cr Payable $14,000
Cr Furniture $3,000
Cr Cash $11,000
37
Question 9
Complete the following table:
Transactions
(a) We pay creditor $120 by cheque
Dr $
Cr $
(b) The owner takes out $1000 cash for his
personal use
(c) The owner puts a further $5,000 cash into
the business
(d) Bought fixtures $200 paying by cheque
(e) John lends the firm $200 in cash
(f)
Paid staff salaries $700
(g) Received $1500 from client for service
rendered
(h) Paid John the amount owing by cash
(i)
Billed client $5600 for taxation services
rendered
(j)
Received $2800 cheque from a receivable
Answer:
Transactions
(a) We pay creditor $120 by cheque
Dr $
Creditor 120
Cr $
Bank 120
(b) The owner takes out $1000 cash for his Drawings
personal use
1000
Cash 1000
(c) The owner puts a further $5,000 cash into Cash 5000
the business
Capital 5000
(d) Bought fixtures $200 paying by cheque
Bank 200
Fixtures 200
38
(e) John lends the firm $200 in cash
Cash 200
Loan 200
(f)
Salaries 700
Cash 700
Paid staff salaries $700
(g) Received $1500 from client for accounting Cash 1500
service rendered
Accounting
revenue 1500
(h) Paid John the amount owing by cash
Cash 200
Loan 200
(i)
Billed client $5600 for taxation services Debtor 5600
rendered
Taxation
revenue 5600
(j)
Received $2800 cheque from a receivable
Receivable
2800
Bank 2800
39
PRINCIPLES OF ACCOUNTING & BUSINESS FINANCE
SESSION 3
RECORDING BUSINESS TRANSACTIONS – LEDGER ACCOUNTS AND THE
TRIAL BALANCE
At the end of the lecture, students should be able to:
1.
2.
3.
4.
5.
6.
Describe the characteristics of ledger accounts.
Describe and illustrate the posting of transactions to accounts.
Determine the balances of accounts to prepare a trial balance.
Prepare a trial balance.
Understand the differences between cash and accrual basis.
Prepare a simple Profit & Loss Statement and a Statement of Financial Position for
service firm.
3.1
Ledger Accounts
We have learnt that every business transaction has an effect on the elements of the accounting
equation. It is necessary to have a mechanism to record the changes in each of these
individual items. In the double entry bookkeeping system, transactions are recorded in
accounts. Accounts are kept for each asset item, liability item, capital and drawings item and
each item of revenue and expenses.
An account is therefore a record, built up over time, of all the economic transactions that
have occurred. These accounts are collected and kept together in a ledger called the nominal
or general ledger.
The Account, which in its simplest form, is a page, sheet or card for each item. The left-hand
side of an account is known as Debit (Dr) and the right-hand side of the account is known as
Credit (Cr).
Format:
Dr.
Date Particulars
Name of Account
$
Date Particulars
Cr.
$
When we say “Debit Account A”, it means we are recording on the left side of Account A.
When we say “Credit Account A”, it means we are recording on the right side of Account A.
40
3.2
Posting of Transactions to ledger accounts
The recording of transactions into ledger accounts can be illustrated using the following
examples.
Illustration 3.1
On 1 Jan 2017, owner contributed $10,000 cash into the business’s bank account.
Double entries: Dr Bank $10,000
Cr Capital $10,000
Bank
2017
1 Jan Capital
$
10,000
Capital
2017
1 Jan
Bank
$
10,000
Activity 3.1
Write up the ledger accounts to record the following transactions of Ezra. All monies
received and paid are recorded in the bank account.
June
1 Started business with $10,500 cheque from the owner.
2 Received a $1,500 cheque for services rendered.
4 Bought office equipment on credit from Homes $1,000.
7 Bought a computer paying by cheque $1,200.
12 Billed a client Matt $2,000 for services rendered.
18 Paid the amount owing to Homes $1,000 by cheque.
25 Received the amount due from client Matt $1,500.
29 Paid office rental $1,000.
41
Bank
Capital
Service Revenue
Office Equipment
Payable – Homes
Receivable – Matt
Rent Expense
42
3.3
The Account Balances
The balance on an account is the amount by which the total value of debit entries and the total
value of credit entries in the account are different.
•
When the total debits exceed the total credits, the account has a debit balance.
Bank
July 1
July 15
Capital
Receivable
$
15,000
4,000
July 5
Office furniture
$
3,000
Debit balance $16,000
Furniture
April 5
Payable
$
32,000
Debit balance $32,000
•
When the total credits exceed the total debits, the account has a credit balance.
Payable – Wong
May 16
Bank
$
18,000
May 2
Office furniture
$
28,000
Bank
$
10,000
Credit balance $10,000
Loan
Jan 16
Credit balance $10,000
43
•
When the total debits equal to the total credits, the account has no balance.
Payable – Toyo
Sep 17
Sep 30
Bank
Bank
$
35,000
20,000
Sep 9
Motor van
$
55,000
No balance
Activity 3.2
State whether the following accounts have a debit or credit balance and calculate the amount
of the balances.
Bank A/C
2017
Jan 1 Capital
15 Receivable
$
2017
$
10,000
Jan 5 Advertising
2,000
3,900
6 Repairs
4,300
25 Wages
1,000
Payable A/C
2017
$
Jan 22 Bank
3.4
2,000
2017
Jan 10 Furniture
$
5,000
Trial Balance
A trial balance is a list of all the accounts in the ledger with their current balances. It is a
check on the arithmetical accuracy of the work (i.e. to check that for every debit entry made,
an equal credit entry has been made) but not by any means an accurate check of the
accounting entries.
44
However, if the trial balance figures do not agree it is obvious an error has been made. The
trial balance is thus a form of control over the recording process.
The trial balance also forms as a first step for preparing a set of financial statements, the
statement of profit or loss and a statement of financial position. The statement of financial
position, introduced in session 1, shows the assets, liabilities and owner’s equity at a
particular point in time. The statement of profit or loss will be covered on the next page.
Format of a trial balance
Trial Balance as at 31 December 2016
Dr $
Expenses
X
Assets
X
Drawings
X
Cr $
Revenue
X
Liabilities
X
Capital
X
X
X
Activity 3.3
Prepare a trial balance from the following balances that were extracted from the ledgers of
Ezra on 30 June 2016.
Bank
Capital
Service Revenue
$
10,300
10,500
3,500
Office Equipment
Receivable – Matt
Rent Expense
$
2,200
500
1,000
Trial Balance as at 30 June 2016
Dr ($)
Cr ($)
Bank
Capital
Service Revenue
Office Equipment
Receivable – Matt
Rent Expense
45
3.5
Cash Basis & Accrual Basis
Cash Basis of Accounting states that revenue is recognized when cash is received and
expense is recognized when cash is paid.
Accrual Basis of Accounting, on the other hand, recognizes revenue only when it is earned
in an accounting period and expenses only when incurred. This is to ensure that there is
proper matching of revenue and expenses to determine profit.
Hence,
Profit = Revenue earned – Expenses incurred
Profit represents an increase in owners’ equity while loss reflects a drop in owners’ equity.
3.6
Statement of Profit or Loss of a Service Business
A service business is one that sells services directly to consumers or other businesses. Some
examples of service business include accounting, banking, consultation, cleaning, education,
insurance and transportation services.
Sometimes called the income statement, the statement of profit or loss is a summary of the
revenue and expenses of a business for a period of time, usually one year. The last line in the
statement indicates the net profit or loss of the business, hence the reference to the “bottom
line”.
Example of a Statement of Profit or Loss of a Service Business
Statement of Profit or Loss
For the year ended 31 December 2016
$
$
Revenue
Accounting fee
Taxation fee
Less: Operating Expenses
Advertising
Motor van expenses
Salaries
Office Expenses
Rent
Utilities
Net Profit
260,000
40,000
10,000
3,000
10,000
5,000
12,000
5,000
300,000
(45,000)
255,000
46
Activity 3.4
The following balances were extracted from the Trial Balance of Sarah’s Tuition Services on
30 June 2016:
Advertising
Interest paid
Light and power
Postage and stationery
Rent received
Salaries
Tuition fee
Dr $
310
85
92
124
Cr $
224
5,620
15,074
Required:
Prepare a Statement of Profit or Loss for the year ended 30 June 2016.
Statement of Profit or Loss for the year ended 30 June 2016
$
$
Revenue
Less: Operating Expenses
Net Profit
47
Activity 3.5
Below is the trial balance of Shawn as at 30 June 2017:
Insurance
Motor expenses
Salaries and wages
Service revenue
Commission received
Sundry expenses
Motor vans
Payables
Receivables
Fixtures
Buildings
Cash at bank
Drawings
Capital
Dr
$
1,650
2,960
5,850
Cr
$
25,600
1,830
1,806
4,500
3,240
7,810
4,960
27,000
2,134
2,000
60,670
30,000
60,670
Required:
Prepare a Statement of Profit or Loss for the year ended 30 June 2017 and a Statement of
Financial Position as at that date.
Statement of Profit or Loss for the year ended 30 June 2017
$
$
Revenue
Less: Operating Expenses
Net Profit
48
Statement of Financial Position as at 30 June 2017
$
$
Assets
Liabilities
Owner’s Equity
49
Review Questions
Question 1
What items are shown on the statement of financial position?
A.
B.
C.
D.
Assets and expenses
Drawings and expenses
Revenue and liabilities
Capital, Assets and liabilities
Question 2
What items are shown on the statement of profit or loss?
A.
B.
C.
D.
Assets and liabilities
Drawings and expenses
Revenue and expenses
Capital and drawings
Question 3
At 30 December 2016 Sharmila’s trial balance included the following balances:
Debit
$
Beauty treatment revenue
Wages and salaries
Postage
Rent
Commission revenue
Advertising
Other expenses
Credit
$
45,000
15,500
340
6,000
12,700
1,900
2,500
What is Sharmila’s net profit?
A.
B.
C.
D.
$18,760
$26,240
$31,460
$57,700
50
Question 4
The following Trial Balance has a number of errors. Prepare a corrected trial balance.
Trial Balance as at 31 May 2017
Dr.
$
Capital
Cash at bank
Loan from UOB
Premises
Consultation Revenue
Sundry debtors
Sundry creditors
Repairs & Maintenance
Wages and salaries
Utilities
Drawings
Total
Cr.
$
51,000
16,800
50,000
116,000
54,000
12,000
178,000
23,000
7,000
22,000
3,500
700
178,000
Answer:
Trial Balance as at 31 May 2017
Dr.
$
Cr.
$
Capital
Cash at bank
Loan from UOB
Premises
Consultation Revenue
Sundry debtors
Sundry creditors
Repairs & Maintenance
Wages and salaries
Utilities
Drawings
Total
51
Question 5
Below is the information of Lily Woo, a sole proprietor for the year ended 31 July 2017:
Capital
Motor van
Cash at bank
Furniture and fixtures
Service revenue
Transportation expenses
Interest expense
Salaries & wages
Commission received
Utilities
Rental expense
Receivables
Payables
Loan
Drawings
$
61,000
33,400
11,700
18,290
13,850
1,250
400
7,000
6,000
4,000
9,300
9,710
2,200
15,000
3,000
Required:
Prepare a Statement of Profit or Loss for the year ended 31 July 2017 and a Statement of
Financial Position as at that date.
Homework Questions (with solutions)
Question 1
Explain how revenue and expenses are recorded under
(i) cash accounting
(ii) accrual accounting.
Answer:
Cash Basis of Accounting states that revenue is recognized when cash is received and
expense is recognized when cash is paid.
Accrual Basis of Accounting, on the other hand, recognizes revenue only when it is earned
in an accounting period and expenses only when incurred.
52
Question 2
Write up the ledger accounts to record the following transactions in the records of Felicia.
Determine the balance of the accounts at the end of the month and extract a trial balance. All
monies received and paid are recorded in the bank account.
July
1
5
6
10
11
12
15
Started business with $15,000 in the bank.
Bought office furniture by cheque $1,200.
Received a cheque $850 for commission revenue.
Bought a motor van $1,400 on credit from Mac Ltd.
Billed a client Tim $2,600 for transportation services rendered.
Received a cheque $330 for transporting goods for a client.
Sold some of the office furniture – not suitable or the business – for $150
cash.
17 Paid rent $580.
22 Paid the amount owing to Mac Ltd $1,400 by cheque.
31 Bought more furniture by cheque $650.
Answer:
Cash at Bank
1 Jul Capital
6 Jul Commission revenue
12 Jul Transportation revenue
15 Jul Office furniture
15,000
850
330
150
5 Jul Office furniture
17 Jul Rent
22 Jul Payable – Mac Ltd
31 Jul Office furniture
1,200
580
1,400
650
Debit balance $12,500
Capital
1 Jul Cash at bank
15,000
Credit balance $15,000
Office Furniture
5 Jul Cash at bank
Cash at bank
1,200
650
15 Jul Cash at bank
150 31 Jul
Debit balance $1,700
53
Commission Revenue
1 Jul Cash at Bank
850
Credit balance $850
Motor Van
10 Jul Payable – Mac Ltd
1,400
Debit balance $1,400
Payable – Mac Ltd
22 Jul Cash at bank
1,400
10 Jul Motor van
1,400
No balance
Receivable – Tim
11 Jul Transportation revenue
2,600
Debit balance $2,600
Transportation Revenue
11 Jul Receivable – Tim
12 Jul Cash at bank
2,600
330
Credit balance $2,930
Rent
17 Jul Cash at bank
580
Debit balance $580
54
Trial Balance as at 31 July
Cash at Bank
Capital
Office Furniture
Commission Revenue
Motor van
Receivable – Tim
Transportation Revenue
Rent
Dr ($)
12,500
Cr ($)
15,000
1,700
850
1,400
2,600
2,930
580
18,780
18,780
Question 3
Beatrice
Trial Balance as at 30 April 2017
DR
$
235
1,500
Bank
Capital
Equipment
Accounts payable
Utilities
Commission revenue
Accounts receivable
Wages and salaries
Drawings
CR
$
1,240
730
135
1,827
845
967
3,547
635
4,567
List the above balances under the correct debit and credit columns in order to balance the trial
balance.
Answer:
Beatrice
Trial Balance as at 30 April 2017
Bank
Capital
Equipment
Accounts payable
Utilities
Commission revenue
Accounts receivable
Wages and salaries
Drawings
DR
$
235
CR
$
1,500
1,240
730
135
1,827
845
967
635
4,057
4,057
55
Question 4
Below is the information of Lawrence, a sole trader for the year ended 31 July 2016:
$
Capital
20,000
Receivables
7,072
Cash at bank
12,900
Payables
3,300
Office equipment
22,700
Service revenue
37,000
Transportation
480
Salaries & Wages
12,000
Interest received
3,220
Heating and lighting
1,768
Rental expense
6,600
Required:
Prepare a Statement of Profit or Loss for the year ended 31 July 2016 and a Statement of
Financial Position as at that date.
Answer:
Statement of Profit or Loss for the year ended 31 July 2016
Revenue
Service revenue
Interest received
Less: Operating Expenses
Transportation
Salaries & wages
Heating and lighting
Rental expenses
Net Profit
$
$
37,000
3,220
40,220
480
12,000
1,768
6,600
20,848
19,372
Statement of Financial Position as at 31 July 2016
$
Assets
Receivables
Cash at bank
Office equipment
7,072
12,900
22,700
42,672
Liabilities
Payables
Owner’s Equity
Capital
Add: Net profits
$
3,300
20,000
19,372
39,372
42,672
56
PRINCIPLES OF ACCOUNTING & BUSINESS FINANCE
SESSION 4
BANK RECONCILIATION
At the end of the lecture, students should be able to:
1.
2.
3.
4.
State the features of good internal control over cash.
Explain the need to prepare a bank reconciliation statement.
Describe the procedure of preparing a bank reconciliation.
Reconcile the cash book balance with the bank statement balance and prepare a bank
reconciliation statement.
4.1
Internal Control over Cash
As cash is a tempting target for fraud and can easily be misappropriated, there is a need for
firms to put in place good control practices over cash. Some of the control practices include:
•
Ensuring that no one person has access to both the physical assets and the related
accounting records so that the separate parties can check on each other independently.
•
Periodic reconciling of the bank accounts with the bank statements by someone
independent of the cash recording. These bank reconciliations should be reviewed by
the owner(s) along with the review of the bank statements.
Activity 4.1
State one more feature of good internal control over cash.
4.2
Relationship between Business and Bank
If a business deposits $1,000 into the bank, the business now has $1,000 asset in the form of a
bank account. It is reflected as a debit balance in the business’s books.
From the bank’s point of view, the $1,000 kept with them represents the amount owing to the
business. Hence, the $1,000 will be reflected as a credit balance in bank’s records.
4.3
Bank Reconciliation Statement
Firms will normally open a current account with the bank. All deposits or withdrawals of
cash made at the bank are recorded in the cash book. With cheques and bank transfers, there
are timing differences between recording the receipt or payment in the cash book and the
actual transfer of money into or out of the bank account.
57
Therefore, at any given date, the cash book balance of the firm may differ from the bank
statement balance.
Bank Statement
At month-end, the bank will send the firm a bank statement, which gives details of money
drawn out and deposits made by the firm. It is used to check that the cash book details are
correct.
Bank Reconciliation Statement
The details in the bank statement are checked against the details in the cash book to make
sure that they are in agreement with each other. When the balance in the bank statement and
the balance in the cash book are different, a bank reconciliation is needed to check the
differences in the balances and make sure that the differences can be explained.
Bank reconciliation is an important control practice as it provides a check on the accuracy of
the cash book. Errors in the cash book would be identified and corrected. The cash book
would also be updated with items found in the bank statement but not previously entered on
the cash book such as, bank charges, interest on deposits etc.
4.4
Preparation of Bank Reconciliation Statement
Procedures of preparing a bank reconciliation
Step 1
Look for individual transactions in the cash book that can be matched with the same
transactions in the bank statement. When transactions are matched, it is a common practice
to mark it in both the cash book and the bank statement with a tick.
Step 2
The difference in the two ending balances must be explained by those transactions in the
bank statement and cash book that are not ticked.
Transactions not ticked in bank statement
– Items in the bank statement not entered on the firm’s cash book (Unrecorded items)
(i)
Withdrawals from the firm’s bank account for items such as bank charges, standing
orders and dishonoured cheques.
(ii)
Deposits into the firm’s bank account for items such as credit transfer from the firm’s
customers, dividends on investment and interest on deposits.
For these transactions, pass a double entry to record them in the cash book. Once done, tick
them off in the bank statement to show that they have been dealt with.
58
Step 3
After updating the cash book, there will be a new balance on the cash book, though it would
likely to be still different from the bank statement balance. This is due to items in the cash
book that have not been ticked because they are not in the bank statement.
Transactions not ticked in cash book
– Items in the firm’s cash book not recorded in the bank statement (Timing Differences)
(i)
Unpresented cheques
These are cheques paid out by the firm recorded in the cash book at the date drawn out
but not yet presented to the bank for payment.
(ii)
Uncredited deposits
These are cheques received by the firm recorded in the cash book but still passing
through the bank clearing system. They will not be recorded by the bank until money is
received from the drawer’s bank.
For these transactions, include them in the bank reconciliation statement to explain the
difference between the updated cash book balance and bank statement balance.
Summary of the Steps
Step 1 & 2
Update cash book
Unrecorded items
cash book updated balance
Step 3
Prepare the bank reconciliation statement
XYZ Ltd
Bank Reconciliation Statement
as at 31 Dec 2016
Balance per bank statement
XX
Less: Unpresented cheques
– Cheque no 123
– Cheque no 125
(XX)
(XX)
Add: Uncredited deposits
XX
Updated balance per cash book
XX
NOTE: Bank overdraft will be denoted by a ( ) to indicate its negative balance.
59
Follow up actions in the following month
Step 1
Check that previous month’s reconciling items are updated by the bank.
Step 2
Reconciling items not updated will remain in bank reconciliation statement till they are
finally updated by the bank.
Activity 4.2
The following shows the cash book and bank statement of a certain firm:
Dr.
2017
Mar
1
2
10
15
31
Balance
Johnny
Sales
Sales
Dawn
Cash Book (Bank Entries only)
$
2017
2,840 Mar 7 Toni Ltd
400
11 Tanlin
550
20 Jamie
600
26 Sansan
191
27 Felicia
Cr.
$
370
200
150
187
212
Debit balance $3,462
Bank Statement
2017
Mar
1
4
9
10
14
15
22
27
28
Balance
Deposit: Johnny
Cheque: Toni Ltd
Deposit
Cheque: Tanlin
Deposit
Cheque: Jamie
Lee Ltd (Dividend)
Bank charges
Dr.
$
Cr.
$
400
370
550
200
600
150
90
50
Balance
$
2,840
3,240
2,870
3,420
3,220
3,820
3,670
3,760
3,710
Required:
(i) Update the cash book.
(ii)
Prepare a statement to reconcile the difference between the updated cash book balance
and the bank statement balance on 31 March 2017.
(iii) Which cash balance do we reflect in the statement of financial position – the adjusted
balance of the cash book or the closing balance in the bank statement?
60
(iv) The following are the cash book and bank statement for the following month. What
must you do with the previous month’s reconciling items?
Dr.
2017
Apr
1
9
14
28
30
Cash Book (Bank Entries only)
$
2017
Balance
3,502 Apr 5 Yeo
Commission
800
16 May
Sales
750
20 Jean
Matt
360
Tom
900
Bank Statement
2017
Apr
1
2
6
10
10
11
17
19
30
30
Balance
Deposit: Dawn
Cheque: Felicia
Deposit
Cheque: Sansan
Cheque: Yeo
Deposit
Interest
Deposit
Bank charges
Dr.
$
Cr.
$
710
40
520
Cr.
$
191
212
800
187
710
750
60
360
50
Balance
$
3,710
3,901
3,689
4,489
4,302
3,592
4,342
4,402
4,762
4,712
61
Activity 4.3
Lee’s cash cook (bank columns only) for the month of August 2016 was as follows:
Dr
Cheque
No.
2016
Aug
1 Balance
9 Cash
31 Lee Pte Ltd
$
2016
600 Aug
420
720
5 Beano
24 Tan Ltd
30 Drawings
110
111
112
Cr
$
410
290
250
Debit balance $790
He received the following statement from his bank at the beginning of September 2016:
2016
Aug
Details
1
7
9
9
15
30
31
Bal
Cheque 110
Cheque 109
Cash
Banker’s Order – Insurance
Cheque 112
Deposit Interest
Payments
$
Receipts
$
410
100
420
140
250
80
Balance
$
700
290
190
610
470
220
300
You are required to:
(i)
Update the cash book.
(ii)
Prepare a statement, to reconcile the difference between your updated cash book
balance and the balance in the bank statement on 31 August 2016.
62
Review Questions
Question 1
What are unpresented cheques?
A.
B.
C.
D.
Cheques recorded and sent to suppliers but not yet presented for payment
Cheques received and recorded but not credited by the bank .
Cheques received and recorded but dishonoured by the bank
Cheques recorded and sent to suppliers and presented for payment
Question 2
Listed below are some possible reasons for the differences between the cash book balance
and the bank statement balance when preparing a bank reconciliation.
1. Bank charges
2. Dividend income
3. Unpresented cheques
4. Uncredited receipts
5. Dishonoured cheques
Which of these items will be shown in bank reconciliation statement?
A.
B.
C.
D.
1, 2 and 3
3,4 and 5
3 and 4 only
All of the items
Question 3
For Question 2, what are the items to be credited to the cash book?
A.
B.
C.
D.
1, 2 and 5
3 and 4
3, 4 and 5
1 and 5
Question 4
What is a bank statement?
A.
B.
C.
D.
Statement by the bank showing deposits made by the firm
Statement by the bank showing money drawn out by the firm
Statement by the firm showing money drawn out and deposits made by the firm
Statement by the bank showing money drawn out and deposits made by the firm
63
Question 5
Uncredited deposits refer to
A.
B.
C.
D.
cheques received by the firm that had been recorded in the cash book but had not
passed through the bank clearing system at month end.
cheques paid out by the firm that had been recorded in the cash book but not yet
presented to the bank for payment at month end.
cheques that were not cleared by the bank due to insufficient funds in the payers’ bank
accounts
cancelled cheques
Question 6
Felicia’s cash book (bank columns only) for the month of July 2016 was as follows:
Dr.
2016
Jul 1
4
16
24
25
31
Cr.
Balance
Cash
Suyin
Cash
Don
Susan
$
2016
800 Jul 2
300
10
220
23
70
26
80
100
$
120
825
360
50
Edwin
Thomas
Morgan
Petty Cash
Debit balance $215
The following bank statement was received in early August 2016:
Bank Statement
2016
Jul 1
4
8
10
16
17
24
25
26
28
31
Balance
Cash
Edwin
Banker’s Order – Fire Insurance
Cheque
Thomas
Cash
Cheque
Petty Cash
Dishonoured Cheque – Don
Interest on Deposit a/c
Dr.
$
Cr.
$
300
120
105
220
825
70
80
50
80
80
Balance
$
800
1,100
980
875
1,095
270
340
420
370
290
370
Required:
(i) Adjust the cash book.
(ii)
Prepare a statement to reconcile the difference between the amended cash book balance
and the bank statement balance on 31 July 2016.
64
Question 7
Laura’s cash book (bank columns only) for the month of June 2017 was as follows:
Dr.
2017
June
Cheque No
1
5
16
25
26
30
Balance
Cash
Jix
Cash
Sanuti
Cash
$
2017
1,200 June
660
1,390
2,070
480
200
1
15
24
27
Dawn
Terence
Amy
Petty Cash
991
992
995
999
Cr.
$
680
415
4,760
90
Debit balance $55
The following bank statement was received in early July 2017:
Bank Statement
2017
June
1
1
7
9
10
18
18
27
29
29
30
30
Bal
Error corrected – contra 31 May
Cheque No: 989
Cash
Dawn
Banker’s Order – Fire Insurance
Cheque
Terence
Cash
Cheque
Petty Cash
Unpaid Cheque – Sanuti
Interest on Structural Deposit a/c
Dr.
$
Cr.
$
230
110
660
680
919
1,390
415
2,070
480
90
480
114
Balance
$
1,080
1,310
1,200
1,860
1,180
261
1,651
1,236
3,306
3,786
3,696
3,216
3,330
Required:
(i)
Bring the cash book up to date.
(ii)
Prepare a statement to reconcile the difference between your amended cash book
balance and the balance in the bank statement on 30 June 2017.
(iii)
State the amount for the bank balance which would appear in Laura’s Statement of
Financial Position for 30 June 2017.
65
Question 8
Daryl’s cash book on 30 April 2017 showed a debit balance at the bank of $6,320 while the
bank statement of the same date had a debit balance of $849.
Subsequently the following discoveries were made:
a) Amounts received in the last few days of April 2017 totaling $5,478 and recorded in
the cash book have not been included in the bank statements until 3 May 2017.
b) The bank had made a standing order payment on 24 April 2017 to AIA for office
insurance of $1,125. It has been recorded in the bank statement but is not recorded in
the cash book.
c) Cheque number 1113 for $510.30 in favour of Eugene has been correctly recorded in
the bank statement, but included in the cash book as $105.30.
d) Bank commission of $57 and interest on overdraft of $102 had been charged by the
bank.
e) Cheques paid according to the cash book during April 2017 and totaling $225 were
not presented for payment to the bank till May 2017.
f) The bank statement shows that a cheque for $427 received from Colin was returned
by the bank due to insufficient funds.
g) The bank had received by direct credit transfer (bank Giro) a payment of $200 due to
Daryl from debtor Pamela.
Required:
(i) Bring the cash book up to date.
(ii) Prepare a statement to reconcile the difference between your amended cash book balance
and the balance in the bank statement on 30 April 2017.
66
Homework Questions (with solutions)
Question 1
Bank reconciliations must be performed by someone who is
A.
B.
C.
D.
responsible for cash receiving and recording
from the bank
not involved in cash recording
the owner
Question 2
Listed below are some possible reasons for the differences between the cash book balance
and the bank statement balance when preparing a bank reconciliation.
1.
2.
3.
4.
5.
Bank charges
Dividend income
Unpresented cheques
Uncredited receipts
Dishonoured cheques
Which of these items require an entry in the cash book?
A.
B.
C.
D.
1, 2 and 5
3 and 4
3, 4 and 5
All of the items
Question 3
Listed below are some possible reasons for the differences between Joyce’s cash book
balance and the bank statement balance as at 31 March 2017.
1.
2.
3.
4.
5.
Cheques recorded and sent to suppliers before 31 March 2017 but not yet presented for
payment.
Interest income
Cheques received and recorded before 31 March 2017 but not credited by the bank until
3 April 2017.
Standing order
Cheques received and recorded before 31 March 2017 but dishonoured by the bank
Which of the following options correctly classify the items into those that require a correction
of the cash book and those that would appear in the bank reconciliation?
A.
B.
C.
D.
Cash book entry
1, 3, 5
2, 4
2, 5
2, 4, 5
Bank reconciliation
2, 4
1, 3, 5
1, 3, 4
1, 3
67
Question 4
What are the details that can be found on the bank statement?
A.
B.
C.
D.
money received by the firm only
money that the firm owes
money drawn out by the firm only
money drawn out and deposits made by the firm
MCQ Answers: C,A,D,D
Question 5
What is the purpose of preparing bank reconciliation statement?
Answer:
Bank reconciliation is an important control practice as it provides a check on the accuracy of
the cash book. Errors in the cash book would be identified and corrected. The cash book
would also be updated with items found in the bank statement but not previously entered on
the cash book such as, bank charges, interest on deposits etc.
Question 6
Ray’s cash book for the month of May 2016 was as follows:
Dr
2016
May 1
4
11
17
23
30
Cheque No.
Balance
Cash
A. Hill
Zakaria
Cash
B. John
$
2016
900 May 19
200
15
94
22
71
25
100
90
Ruth Chan
Terri
Carol Koh
Petty Cash
1001
1002
1003
1004
Cr
$
130
206
315
25
Debit balance $779
68
The following bank statement was received at the beginning of June 2016:
Details/Cheque Number
2016
May 1
4
11
12
13
17
17
21
23
25
25
29
Payments
$
Balance
Cash
Cheque
1001
995
Cheque
Bankers’ Order – Fire Insurance
Dishonoured cheque – Zakaria
Cash
1003
1004
Interest
Receipts
$
200
94
130
110
71
98
71
100
315
25
42
Balance
$
1,010
1,210
1,304
1,174
1,064
1,135
1,037
966
1,066
751
726
768
Required:
(i)
Correct the cash book.
(ii)
Prepare a statement to reconcile the difference between the amended cash book
balance and the bank statement balance on 31 May 2016.
Answer:
(i)
Bank A/C
$
$
Balance
779 Fire insurance
98
Interest income
42 Zakaria (dishonoured chq)
71
Debit balance $652
(ii) Bank Reconciliation Statement as at 31 May 2016
Balance per bank statement
$
768
Less: Unpresented cheques
Cheque no. 1002
(206)
Add: Uncredited deposits
B. John
90
Updated balance per cash book
652
69
Question 7
This is the bank account of a firm as shown in its cash book for the month of January.
Dr.
2017
Jan 1
6
7
18
29
30
Balance
Sales
Rent received
York
Sales
Otter
Cash Book
$ 2017
910 Jan 3 Wages
505
7 Purchases
40
10 Amanda
80
15 Foo
407
30 Rates
110
Cheque No.
2000
2001
2002
2003
2004
Cr.
$
60
312
141
114
20
Debit balance $1,405
On 3 February 2017, the firm received the following bank statement:
Bank Statement
2017
Jan 1
2
4
9
10
12
15
20
31
Balance
Deposit
Cheque No. 1999
Cheque No. 2000
Deposit
Deposit
Credit transfer: Denise
Cheque No. 2001
Cheque No. 2003
Deposit: York
Service charge
Dr.
$
Cr.
$
265
100
60
505
40
200
312
114
80
30
Balance
$
745
1,010
910
850
1,355
1,395
1,595
1,283
1,169
1,249
1,219
Required:
(i)
Update the cash book.
(ii)
Prepare a statement to reconcile the difference between the amended cash book balance
and the bank statement balance on 31 January 2017.
70
Answer:
(i)
Bank A/C
$
Balance
Denise
$
1,405 Service charge
30
200
Debit balance $1,575
(ii) Bank Reconciliation Statement as at 31 January 2017
Balance per bank statement
$
1,219
Less: Unpresented cheques
Cheque no. 2002
Cheque no. 2004
(141)
(20)
Add: Uncredited deposits
Sales
Otter
407
110
Updated balance per cash book
1,575
Question 8
Kim Song’s cash book at 30 September 2016 showed a debit balance at the bank of $512 but
the bank statement of the same date had a credit balance of $131.
After comparing the cash book with the bank statement, the following differences were
noted:
(a) An amount of $71 paid into the bank had not yet appeared on the statement.
(b) Bank interest $30 in respect of an earlier overdraft had been charged by the bank.
(c) Cheques issued for $280 had not been presented for payment.
(d) A cheque for $400 which had been paid into the bank had been returned unpaid because
of lack of funds. No action has been taken by Kim Song to deal with this item.
(e) Funds of $560 paid into the bank had been entered in the Cash Book as $500.
71
(f) The bank had made a banker’s order payment for insurance of $240 which had not been
recorded by Kim Song.
(g) The bank had received by direct credit transfer (bank Giro) a payment of $20 due to Kim
Song from Joshua.
Required:
(i)
Correct the cash book.
(ii)
Prepare a statement to reconcile the difference between the amended cash book balance
and the bank statement balance 30 September 2016.
(iii) State the amount for the bank balance which would appear in Kim Song’s Balance
Sheet for 30 Sep 2016.
Answer:
(i)
Bank A/C
$
$
Balance
512 Interest charge
30
Funds
60 Dishonoured chq
400
Joshua
20 Insurance
240
Credit balance $78
(ii) Bank Reconciliation Statement as at 30 Sep 2016
Balance per bank statement
$
131
Less: Unpresented cheques
(280)
Add: Uncredited deposits
71
Updated balance per cash book
(78)
(iii)The amount for the bank balance which would appear in Kim Song’s Balance Sheet for
30 Sep 2016 is a bank overdraft of $78
72
PRINCIPLES OF ACCOUNTING & BUSINESS FINANCE
SESSION 5
INTRODUCTION TO MANAGERIAL ACCOUNTING AND ANALYSIS OF COST
BEHAVIOUR
At the end of the lecture, students should be able to:
1.
2.
3.
4.
5.
6.
Explain the meaning of managerial accounting.
Explain the differences between managerial accounting and financial accounting.
Explain the meaning of cost and how costs are assigned to products and services.
Define the various costs of manufacturing products.
Explain the meaning of cost behaviour.
Define and describe fixed, variable and mixed costs.
5.1
The Meaning of Managerial Accounting
Management accounting is the provision of accounting information for a company’s internal
users. It is concerned with providing information to internal managers to help them in
planning, controlling and decision-making within an organisation.
Planning
Planning involves coming out with action plans to achieve a particular end. It is often
forward looking and includes long-term and short-term planning.
Planning requires:
– setting objectives/goals for the organisation
– establishing the resources required
– identifying methods to use the resources to achieve the objectives
Example: preparation of annual budgets.
Controlling
Controlling ensures the plan developed from the planning stage is being carried out
accordingly, taking corrective actions as and when required. Control is usually achieved by
comparing actual performance with expected performance.
Example: comparing actual and budgeted results.
Decision-making
Decision-making is the process of choosing among competing alternatives. It is required in
both the planning and controlling phase as a manager cannot successfully plan or control the
organisation’s actions without making decisions regarding competing alternatives.
Example: Producing product A or product B.
73
5.2
Differences between Managerial Accounting and Financial Accounting
The data used to prepare financial accounts and management accounts are the same though
the difference lies in the way the data is analysed.
Managerial Accounting
Financial Accounting
➢
No legal requirement
➢
Legal requirement for limited
companies
➢
Focus on internal management
➢
needs i.e. prepared for management
Focus mainly on external users
needs e.g. shareholders
➢
Past and projected data (budgets)
➢
Past data
➢
Information used for planning,
controlling and decisions-making
over relevant periods
➢
Information is used for reporting of
financial information over a
predefined period
➢
May be approximate
➢
Accurate
➢
There are no mandatory rules
➢
Has to comply with Accounting
Standards (FRS)
5.3
The Meaning of Cost
One of the most important tasks of managerial accounting is to determine the cost of products
and services or any other items deemed necessary to managers.
Cost can be defined as the amount paid for the goods supplied or the service provided. Cost is
important as it helps an organisation to determine the selling price, after a profit element is
added.
Selling Price =
5.4
Cost +
Profit
Assigning Costs to Products and Services
There is a number of ways to assign costs to products and services; some are accurate but
require more work while others can be quick and easy but less accurate. The method chosen
will thus depend on the management’s need for accuracy.
To assign costs, one needs to know the nature of costs.
74
Direct Costs
Direct costs are costs that can be accurately and easily traced to a cost object. A cost object is
something for which the organisation wants to know the cost. It can be a product, a
department, a project, service etc. Direct costs are also known as prime costs.
Direct materials – materials that form an integral part of the finished product. Example:
cloth in shirts, wood in furniture.
Direct labour – labour directly involved in making the product. Example: wages of workers
on an assembly line.
Indirect Costs
Indirect costs are costs that cannot be easily and accurately traced to a cost object. They
normally benefit multiple cost objects and it is not practical to accurately trace them to
individual products, departments etc. Indirect costs are also known as production
overheads.
Indirect materials – materials used that do not form part of the final products. Example:
lubricants used for machine that produce the final product.
Indirect labour – labour not directly involved in production but essential to the
manufacturing process. Example: salary of supervisors.
Other indirect costs – factory insurance, factory rent, factory utilities etc
It is important to note that all costs in the factory are either direct materials, direct labour or
production overhead. No product cost can be omitted; no matter how remotely related it is to
the actual manufacturing process.
Total Product Costs
Direct Materials
Direct Labour
Partially
Finished
Completed
Sold
Work in
Process
Finished
Goods
Cost of
Goods Sold
Production
Overheads
75
Period Costs
Besides production cost, there are other costs of running a business, referred to as period
costs. Thus, period costs are all costs that are not production costs, e.g. advertising, research
and development, CEO’s salary and salesman commission.
Total Cost
=
Production Cost
+
Period Cost
Activity 5.1
A company manufactures and sells t-shirts.
Classify the following items into their correct category as direct materials, direct labour,
production overheads and period costs.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
Paper for office printer
Buttons for t-shirts
Lubricant for sewing machines
Interest on loan
Market research undertaken before launching a new product
Cost of advertising products on newspaper
Wages of workers in the cutting department
Factory rental
5.5
Cost Behaviour
Cost behaviour refers to the way a cost changes as volume of output rises. Costs can be
variable, fixed or mixed. Understanding how costs change as output rises helps managers in
planning, controlling and decision making.
Specifically, a distinction between fixed and variable cost might be used:
(a)
(b)
To help managers make decisions about increasing or decreasing output.
To estimate future costs for the purpose of forecasting and budgeting.
Fixed Costs
Fixed costs are costs that do not vary with the level of output within the relevant range.
An example of fixed cost is the rent of a factory, which remains the same regardless of how
much is produced inside it.
76
Cost $
Total Fixed Cost
Level of Output
In reality, there must be a level of output so large that the business will need to rent more than
1 factory and in this instance, rent will no longer be a fixed cost. However, as long as we are
looking at a reasonable range of output, rent can be considered a fixed cost. This reasonable
range of output is known as the relevant range.
If a cost is fixed within a relevant range, then the cost per unit must fall as the level of output
rises.
Cost $
Fixed cost per unit
Level of Output
Committed Fixed Costs
They are fixed costs that cannot be easily changed. Such costs will continue to be incurred
even when production level drops to zero. Often, committed fixed costs are those that
involve a long term contract, e.g. leasing of warehouse space, purchase of plant and
equipment, insurance and salaries of important personnel.
Discretionary Fixed Costs
They are fixed costs that can be changed or avoided easily by management decisions. Usually
such costs will be increased in better times and reduced during difficult period, e.g.
advertising, research and development costs.
Activity 5.2
Suggest some examples of fixed costs for a hairdressing business.
77
Variable Costs
Variable costs are costs that vary directly with the level of output. This means that the higher
the output, the higher the level of total variable cost. An example will be the direct material
like the cost of a screen installed in each computer.
Cost $
Total Variable Cost
Level of Output
However, variable cost per unit is a constant amount.
Cost $
Variable Cost per unit
Level of Output
Activity 5.3
Suggest some examples of variable costs for a hairdressing business.
Step Costs
Step costs are costs which are fixed for a range of output and then jump to a higher level and
are fixed again for another range. Example of a step cost is the factory supervisor’s salary.
For production up to a certain level, just one supervisor is sufficient. However, beyond this
level and up to the next level of production, two supervisors will be required and so on.
Cost $
Level of Output
78
Mixed Costs
Mixed costs are costs that have both a fixed and variable component. For example,
salesman’s salaries normally include a base salary and commission that increases with
volume of sales.
Cost $
Variable cost
Fixed cost
Units sold
79
Review Questions
Question 1
Which of the following statements is NOT correct?
A.
B.
C.
D.
Management accounting focus mainly on internal users needs
Management accounting can assist in providing estimates for the future
Management accounting must comply with accounting standards
Management accounting can assist with budgeting
Question 2
The board of directors is looking into the most profitable product to manufacture. The
management accountant has prepared a report that compares the profitability of Product Mint
and Product Spice. This report will primarily help management in:
A.
B.
C.
D.
Planning
Controlling
Decision-making
Implementing
Question 3
Which of the following best describes the control process?
A.
B.
C.
D.
Making a choice between alternatives
Establishing a plan for a future period
Developing strategies to achieve objectives
Monitoring something to keep it on course
Question 4
Which of the following would be classified as direct expenses for a company producing
tables and chairs?
(i)
(ii)
(iii)
(iv)
The hire cost of maintenance tools and equipment
The cost of overtime worked by the carpenters to complete a specific customer order.
The wood used in making the tables and chairs
The carpenter’s wages
A.
B.
C.
D.
(i) and (iii)
(i), (ii) and (iv)
(ii), (iii) and (iv)
(iii) and (iv)
80
Question 5
Which of the following should be classified as indirect costs?
A.
B.
C.
D.
The repairs cost of equipment
The labour costs incurred in the production line
The hire of a machinery for a specific job
The material costs of a product
Question 6
A production worker is paid a salary of $900 per month, plus an amount of 50 cents for each
unit produced during the month. This labour cost is best described as
(a)
(b)
(c)
(d)
A variable cost
A fixed cost
A mixed cost
A step cost
Question 7
The following shows the unit cost of an expense at different production levels:
Level of Production (units)
1
50
100
150
Unit Cost ($)
10,000
200
120
80
What is the correct behavioural classification for the expense?
A.
B.
C.
D.
Variable cost
Fixed cost
Mixed cost
Step cost
Question 8
A certain cost is classified as a fixed cost. If level of output increases by 10%, what will
happen to the cost per unit?
A.
B.
C.
D.
Remains the same
Increases
Reduces in proportion to the change in output level
Reduces but not in proportion to the change in output level
81
Question 9
Which chart shows the unit cost behaviour of factory rent?
Cost/unit
($)
Cost/unit
($)
Qty
Qty
A
B
Cost/unit
($)
Cost/unit
($)
Qty
C
Qty
D
Question 10
A company bakes and sells butter cookies.
Classify the following items into their correct category as direct materials, direct labour,
production overheads and period costs.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
Wages of storekeepers in the materials store
Delivery charges for sending the cookies to supermarkets
Wages of workers in mixing department
Chief accountant’s salary
Factory rental
Advertising costs
Butter and flour
Cost of cookies tins
Interest on bank overdraft
82
Question 11
State whether the following items are committed fixed costs, discretionary fixed costs,
variable costs, mixed costs or step costs:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
Cost of raw materials used
Repairs and maintenance costs
Factory rent
Sales representative’s salary and commission
Bottles in soft drink bottling factory
Supervisor’s salary – 1 supervisor for every 20 workers
Advertising costs
Plant and machinery
Research and development costs
Homework Questions (with solutions)
Question 1
Which of the following is a characteristic of managerial accounting?
A.
B.
C.
D.
There is no legal requirement.
There is an internal focus.
Subjective information may be used.
All of these.
Question 2
The process of choosing among competing alternatives is called
A.
B.
C.
D.
planning
controlling
decision-making
None of the above
Question 3
Setting objectives and identifying methods to achieve them is called
A.
B.
C.
D.
planning
controlling
decision-making
None of the above
83
Question 4
Which of the following does not form part of production costs of a product?
A.
B.
C.
D.
Administrative expenses
Production overheads
Raw materials
Direct labour
Question 5
Which of the following is most likely to be classified as a direct cost?
A.
B.
C.
D.
Supervisor costs
Factory rent
Material
Repairs and maintenance
Question 6
Which of the following statements relating to cost behaviour is incorrect?
A.
B.
C.
D.
Variable cost per unit is constant
Total variable costs is constant
Total fixed cost is constant
Fixed cost per unit falls with increased activity
Question 7
A telephone bill has been received with a line rental of $25 per month, and a charge per call
of 5cents. The telephone cost could be best described as:
A.
B.
C.
D.
A fixed cost
A variable cost
A step cost
A mixed cost
MCQ Answers: D, C, A, A, C, B, D
84
PRINCIPLES OF ACCOUNTING & BUSINESS FINANCE
SESSION 6
COST ASSIGNMENTS
At the end of the lecture, students should be able to:
1.
2.
Understand how costs are assigned to cost objects.
Compute the predetermined overhead rate and use the rate to assign overhead to units.
6.1
Definition of Production Overheads
Unlike direct material and labour, overheads are indirect costs incurred which cannot be
easily and accurately traced directly to cost units. This includes:
➢ Indirect materials
➢ Indirect labour
➢ Other indirect expenses like factory rent, factory utilities.
It is necessary to include overheads in the cost of the product so that we can have the
complete production cost of the product. This can then be used as a basis to value inventories
and for decision making, one of which is to arrive at the selling price.
Hence, we need to allocate and apportion the overheads to the cost units.
Total Production Cost = Direct Material + Direct Labour + Production overheads
Directly traceable to
individual unit
Cannot be easily and
accurately traced to
individual unit
Allocate and apportion
to individual unit
85
6.2
Assigning Overheads to Cost Units
Allocation
Allocation is the process of charging a whole item of overhead cost to specific
production departments.
Example: costs of supervision in Production department A → Production department A
costs of supervision in Production department B → Production department B
Apportionment
Apportionment is a procedure whereby general overheads costs are shared between
production departments on a fair basis.
Example: factory rental can be apportioned to the different production departments on
the basis of floor space occupied by each department.
Some examples of typical bases used are:
Overheads
Rent, rates, heating, cleaning, lighting,
Basis of Apportionment
Floor space
Power
Personnel, general administration
Maintenance of machines
Power usage %
Number of employees
Number of machines or machine hours
used in production
Adding up
For each production department:
Total Overhead Costs =
Allocated Costs + Apportioned Costs
Absorption
An absorption rate is the rate at which overheads are added to the costs.
Calculate overhead absorption rate (OAR) for each production department.
OAR =
Total Overhead Costs
————————————————————-Volume of Activity (direct labour hour, machine hour)
86
6.3
Absorption Rates based on Budgeted Figures
Many would believe that overhead absorption rates should be based on the actual overhead
costs and actual volume of activity.
In practice, this is not the case. Overhead absorption rates are based on budgeted figures.
Reasons:
(1)
Using actual overhead costs cannot provide timely information when required. Most
actual overhead costs are not known till end of financial year and waiting for figures
to come in can cause delays in pricing the products and invoicing the customers.
(2)
Actual overhead costs tend to fluctuate from year to year. Using actual costs to
calculate selling price will result in erratic pricing and affect competitiveness.
Hence,
OAR =
6.4
Budgeted Overhead Costs
————————————————————-Budgeted Volume of Activity (direct labour hour, machine hour)
Assigning Overheads to Units
To assign overheads to the total costs of a product, we calculate absorbed overheads using the
OAR determined during the budgeting process.
Absorbed overhead
=
OAR x Actual activity level
87
Activity 6.1 – Overheads
SIM Manufacturing Ltd is preparing its production overhead budgets and determining the
apportionment of these overheads to products.
Production centres expenses and related information have been budgeted as follows:
Total
$
Machine shop A
$
Machine shop B
$
Assembly
$
Indirect wages
33,450
8,586
9,190
15,674
Indirect materials
16,300
6,400
8,700
1,200
Rent and rates
16,700
Building insurance
2,400
Power
8,600
Total
$
Machine shop A
$
Machine shop B
$
Assembly
$
Floor area (sq m)
40,000
10,000
10,000
20,000
Power usage (%)
100
55
40

5
Other information:
Required:
(a) Apportion the overheads to the production centres, showing clearly the basis of
apportionment.
(b)
The Machine Shop A and Machine Shop B are machine intensive while the Assembly
centre is largely labour-based. Information on machine and labour hours for the
production centres is shown below:
Total
Direct labour hours
35,000
Machine shop
A
8,000
Machine hours
25,200
7,200
Machine shop
B
6,200
Assembly
18,000

20,800
Calculate production overhead absorption rates for each of the three production centers
(OAR)
88
(c)
One of the products of SIM Manufacturing Ltd is Info. Cost information to produce
one unit of Info is as follows:
Direct Materials
3 kg at $5.20 per kg
Direct Labour
1.5 hours at $6.50 per hour
Time Spent in:
Machine Shop A
Machine Shop B
Assembly
1.5 machine hours
2 machine hours
4 labour hours
Find the cost per unit of Info.
Answers:
Basis
Total
$
Production Centre
Machine A
Machine B
Assembly
$
$
$
Allocated
Apportionment
Total (a)
Activity Base (b)
OAR = (a)/(b)
89
Review Questions
Question 1
Overhead apportionment is used to
A.
B.
C.
D.
charge whole items of costs to production centers.
charge cost units with an appropriate share of overheads.
spread common costs over production centers equally.
ensure budgeted overheads are not exceeded.
Question 2
Which of the following would be the most appropriate basis for apportioning machinery
maintenance costs to production departments within factory?
A.
B.
C.
D.
The number of machines in each production department
The floor area occupied by the machinery in each production department
The total cost of the machinery in each production department
The operating hours of the machinery in each production department
Question 3
A manufacturing company has two production centres, Cutting and Packing.
The budgeted overheads and operating hours for the two centres for the following year are:
Cutting
$180,000
90,000 machine hours
5,000 labour hours
Packing
$120,000
8,000 machine hours
12,000 labour hours
The overhead absorption rates for the departments should:
A.
B.
C.
D.
both be based on machine hours
both be based on labour hours
be based on machine hours for cutting centre and labour hours for packing centre
be based on labour hours for cutting centre and machine hours for packing centre
Question 4
What is the term associated with charging a specific item of overhead cost to one particular
department?
A.
B.
C.
D.
Absorption
Allocation
Apportionment
None of the above
90
Question 5
Labour hours are used to absorb overheads in a production department. Overheads allocated
and apportioned to the department are:
Allocated
Apportioned
$24,710
$11,890
180,000 units of products are produced at a rate of 60 per labour hour.
What is the overhead absorption rate per labour hour?
A.
B.
C.
D.
$3.96
$8.24
$12.20
$13.50
Question 6
The following information relates to the production of 1,000 units of Product Style.
Dept A
Dept B
Direct materials consumed
Direct labour rate per hour
Direct labour hours
Machine hours
$5,000
$4
400 hrs
680 hrs
$3,000
$5
200 hrs
68 hrs
Budgeted overheads
Budgeted direct labour hours
Budgeted machine hours
$160,000
2,500 hrs
40,000 hrs
$120,000
30,000 hrs
1,000 hrs
What is the total production cost to produce 1,000 units of Product Style?
A.
B.
C.
D.
$15,250
$13,333
$12,500
$14,120
91
Question 7
A manufacturing business has two production centres, assembly and finishing. The following
budgeted expenses are expected to be incurred next year.
$
Indirect materials
Assembly
13,500
Finishing
8,000
Indirect labour
Assembly
14,000
Finishing
9,000
Rent and rates
60,000
Heat and light
15,000
Power
18,000
You are also given the following information:
Floor area (sq m)
Power usage (%)
Assembly
1,000
65%
Finishing
500
35%
Total
1,500
100%
The assembly department is a largely machine based department whereas the finishing
department is largely labour based. The management of the business has decided that the
assembly department overheads should be absorbed on the basis of machine hours and that
the finishing department overheads should be absorbed on the basis of labour hours.
The budgeted machine hours in the assembly department is 100,000 whereas the budgeted
labour hours for the finishing department is 20,000.
Required
(a)
Calculate the overhead absorption rate in each department.
(b)
One of the products of the business is the Maximus. This product has direct material
costs of $14.30 per unit and direct labour costs of $16.50 per unit. Each unit of
Maximus spends 6 machine hours in the assembly department and 3 labour hours in the
finishing department.
What is the final unit cost of the Maximus?
92
Answers:
Basis
Total
$
Production Centre
Assembly
Finishing
$
$
Allocated
Apportionment
Total (a)
Activity Base (b)
OAR = (a)/(b)
93
Homework Questions (with solutions)
Question 1
Overhead allocation is the process of:
A.
B.
C.
D.
the charging of direct labour to cost units.
the allotment of proportions of costs to production centres.
the charging of direct material to cost units.
the allotment of whole item of overhead to production centres.
Question 2
Which of the following would be the most appropriate basis for apportioning factory rental to
production departments within a manufacturing company?
A.
B.
C.
D.
The number of workers in each production department
The floor area occupied by each production department
The number of machinery in each production department
None of the above
Question 3
Glory Ltd has 2 production centres A and B. The budgeted rent for the coming year is
$48,000 and the floor area occupied by each of the centres is as follows
Production centre A
Production centre B
3,750 sqm
8,250 sqm
Calculate the amount of rent to be apportioned to each of the centres
Production Centre
A.
B.
C.
D.
A
B
$16,000
$10,000
$15,000
$15,500
$32,000
$38,000
$33,000
$32,500
Question 4
The overhead absorption rate (OAR) equals
A.
B.
C.
D.
actual overhead divided by actual activity level for a period
estimated overhead divided by estimated activity level for a period
actual overhead minus estimated overhead
actual overhead multiplied by actual activity level for a period
94
Question 5
The following budgeted information is for MIS Co:
Assembly
Finishing
Overheads
$493,200
$216,000
Machine hours (MH)
10,960
1,200
Labour hours (LH)
548
6,750
Calculate the overhead absorption rate for each of the 2 production centres.
A.
B.
C.
D.
Assembly
Finishing
$45/MH
$45/MH
$900/LH
$900/LH
$32/LH
$180/MH
$32/LH
$180/MH
MCQ Answers: D, B, C, B, A
Question 6
GM is a small manufacturing company with two production departments A and B. Budgeted
overhead costs for a period are listed below:
Costs allocated
Costs to be apportioned:
Factory manager’s salary
Building operating costs
Additional information:
Number of staff
Floor area (sqm)
Production Department
A
B
$
$
24,970
22,100
Total
$
47,070
35,80…
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