The accounting equation ,CFABAccountingChapter3.Recordingfinancialtransactions, CFABAccountingChapter4.Ledgeraccoutinganddoubleentry, CFABAccountingChapter5.Preparingbasicfinancialstatements, CFABAccountingChapter6.ErrorsandcorrectionstoacrecordsandFSs, CFABAccountingChapter7. Costofsalesandinventories
ACCOUNTING CHAPTER THE ACCOUNTING EQUATION 2 TOPIC LIST Assets, liabilities and the business entity concept The accounting equation Credit transactions The statement of financial position Preparing the statement of financial position The statement of profit or loss 3 1 ASSETS, LIABILITIES AND THE BUSINESS ENTITY CONCEPT 1.1 Assets and liabilities Asset: a resource controlled by the entity as a result of past events from which future economic benefits are expected to flow to the entity 4 ASSETS, LIABILITIES AND THE BUSINESS ENTITY CONCEPT 1.1 Assets and liabilities Asset: non-current assets v current assets Land and buildings Motor vehicles Plant and machinery Fixtures and fittings Cash Inventory Receivables 5 ASSETS, LIABILITIES AND THE BUSINESS ENTITY CONCEPT 1.1 Assets and liabilities Liability: a present obligation arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits 6 2 ASSETS, LIABILITIES AND THE BUSINESS ENTITY CONCEPT 1.1 Assets and liabilities Examples: Bank loan or overdraft Payables Taxation 7 ASSETS, LIABILITIES AND THE BUSINESS ENTITY CONCEPT 1.2 The business as a separate entity Business entity concept: a business is a separate entity from its owner (strict legal position v convention adopted by accountants) 8 ASSETS, LIABILITIES AND THE BUSINESS ENTITY CONCEPT 1.2 The business as a separate entity Capital: (equity in the context of company) residual interest in the assets of the entity after deducting all its liability 9 3 THE ACCOUNTING EQUATION 2.1 What is the accounting equation Accounting equation: ASSETS = CAPITAL + LIABILITIES In other words: the rule that the assets of a business will at all time equal its liabilities plus capital (balance sheet equation) 10 10 THE ACCOUNTING EQUATION 2.2 Assets = capital + liabilities Worked examples p.40: 11 11 THE ACCOUNTING EQUATION 2.2 Assets = capital + liabilities Historical cost: transactions are recorded at their cost when they were incurred 12 12 4 THE ACCOUNTING EQUATION 2.3 Where profits/losses fit into the accounting equation? Worked example p.41: Assets = capital + profit Profit: the excess of income over expenses Loss: the excess of expenses over income 13 13 THE ACCOUNTING EQUATION 2.3 Where profits/losses fit into the accounting equation? Income: Increases in economic benefits over a period in the form of inflows or increases of assets, or decreases of liabilities, resulting in increases in equity/capital (CF) It can include both revenue and gains Expenses: Decreases in economic benefits over a period in the form of outflows or depletion of assets, or increases in liabilities, resulting in decreases in equity/capital (CF) 14 14 THE ACCOUNTING EQUATION 2.4 Appropriation of profits: sole trader drawings Drawings: Money and goods taken out of a business by its owner (Important: withdrawals or appropriations of profit and not as expenses) Worked example p.39 (S/M) 15 15 5 THE ACCOUNTING EQUATION 2.4 Appropriation of profits: sole trader drawings Drawings: Money and goods taken out of a business by its owner (Note: withdrawals or appropriations of profit and not as expenses) Worked example p.39 (S/M) £ Net profit earned by the business 250 Less profit withdrawn by Liza (180) Net profit retained in the business 70 16 16 CREDIT TRANSACTIONS 3.1 Trade payables Creditor: Person to whom a business owes money (A trade creditor is a person to whom a business owes money for trading debts) Trade payables: The amounts due to credit suppliers 17 17 CREDIT TRANSACTIONS 3.2 Trade receivables Debtor: Person who owes money to the business Trade receivables: The amounts owed by credit customers Worked example p.45 18 18 6 CREDIT TRANSACTIONS 3.3 Accruals concept The accruals (or matching) concept requires that income earned is matched with the expenses incurred in earning it (*) 19 19 CREDIT TRANSACTIONS 3.3 Accruals concept Interactive question 2: How would each of these transactions affect the accounting equation in terms of increase or decrease in asset, capital or liability? (a) Purchasing £800 worth of goods on credit (b) Paying the telephone bill £25 (c) Selling £450 worth of goods for £650 (d) Paying £800 to a supplier 20 20 THE STATEMENT OF FINANCIAL POSITION 4.1 What is a statement of financial position? The business's SFP shows its financial position at a given moment in time 03 key elements of SFP: liabilities, capital and assets A SFP is very similar to the accounting equation - 02 differences: The manner or format The extra detail in SFP Net assets: Assets less liabilities 21 21 7 THE STATEMENT OF FINANCIAL POSITION 4.1 What is a statement of financial position? (In accordance to IAS 1, Presentation of F/Ss) Name of business Statement of financial position as at (date) £ Assets (item by item) X Capital X Liabilities X X 22 22 THE STATEMENT OF FINANCIAL POSITION 4.2 Capital (Sole trader) Capital is usually analysed into its component parts £ £ Beginning capital (ie, capital b/f or b/d) X Add additional capital introduced X X Add profit earned (or less losses incurred) X Less drawings (X) Retained profit for the period X Capital as at the end (ie, capital c/f or c/d) X 23 23 THE STATEMENT OF FINANCIAL POSITION 4.2 Capital (Sole trader) 'Brought forward' means that the amount is brought forward from the previous period ‘Carried forward' means carried forward to the next period The carried forward amount at the end of one period is therefore the brought forward amount of the next period 24 24 8 THE STATEMENT OF FINANCIAL POSITION 4.2 Capital (Sole trader) 4.2.1 Equity (company) The capital or equity side of a company's statement of financial position is more complicated than a sole trader's We shall look at it in detail in Chapter 11 25 25 THE STATEMENT OF FINANCIAL POSITION 4.3 Liabilities IAS requires distinction between non-current liabilities and current liabilities Current liabilities are debts which are payable within one year Non-current liabilities are debts which are payable after one year 26 26 THE STATEMENT OF FINANCIAL POSITION 4.3 Liabilities Examples of non-current liabilities: Loans which are not repayable for more than one year, such as a bank loan or a loan from an individual to a business Loan stock or debentures 27 27 9 THE STATEMENT OF FINANCIAL POSITION 4.3 Liabilities Examples of current liabilities: Loans repayable w/i one year, incl the element of a long term loan that is repayable w/i one year A bank overdraft Trade payables Other payables Taxation payable to HMRC with respect to CT Accruals 28 28 THE STATEMENT OF FINANCIAL POSITION 4.4 Assets IAS requires distinction between non-current assets and current assets Non-current assets are acquired for long-term use within the business They are normally valued at cost less accumulated depreciation Current assets are expected to be converted into cash within one year 29 29 THE STATEMENT OF FINANCIAL POSITION 4.4 Assets 4.4.1 Non-current assets Components of non-current assets Property, plant and equipment (PPE) (ie, 'Tangible' assets) Intangible non-current assets (patent, goodwill) Long-term investments 30 30 10 10 ACCOUNTING CHAPTER COST OF SALES AND INVENTORIES 2 TOPIC LIST IAS 2, Inventories (FRS 102 s13) Cost of sales Accounting for opening and closing inventories Adjusting the TB Counting inventories Using mark-up/margin percentage to establish cost Inventory drawings 3 55 1 IAS 2, INVENTORIES (FRS 102 S13) 1.1 Objective: Objective of IAS 2: Accounting treatment for inventories: Guidance on determination of cost Subsequent recognition as an expense Net realisable value 4 IAS 2, INVENTORIES (FRS 102 S13) 1.2 Inventoris: Definition: Inventories – assets: Held for sale in the ordinary course of business (finished goods (purchased or produced inhouse)) In the process of production for such sale (WIP) In the form of materials or supplies to be consumed in the production process or in the rendering of services (MAT) 5 COST OF SALES Cost of sales: Opening inventory + purchases + carriage inwards – closing inventory = cost of sales Cost of sales comprises: Opening inventory X Purchases X Carriage inwards X Closing inventory (X) Cost of sales X 6 56 2 COST OF SALES Question: Where is inventory account held in FSs? Reality (so far may be interesting for you): Inventory, both opening and closing, features in the statement of profit or loss whereas you might expect it to feature only in the statement of financial position, as an asset How is this so? 7 COST OF SALES 2.1 Unsold goods at the end of reporting period Unsold goods are held in inventory Question: should this value be included in COS? Worked eample p.168/169 8 COST OF SALES 2.2 Cost of sales Opening inventory value X Add cost of purchases (or, for a manufacturing company, the cost of production) X Add cost of carriage inwards X Less closing inventory value (X) Equals cost of sales X Interactive question p.170 9 57 COST OF SALES 2.3 Delivery costs The cost of delivery inwards is added to the cost of purchases (and is therefore included in the calculation of cost of sales and gross profit) The cost of delivery outwards is a distribution cost deducted from gross profit in the statement of profit or loss Worked example p.170 10 10 COST OF SALES 2.4 Inventory written off and written down Inventories might: Be lost or stolen Be damaged and become worthless Become obsolete and be sold at low price Value of inventories? Question: Gross profit? Worked example p.171 11 11 COST OF SALES 2.4 Inventory destroyed or stolen Where material amount of inventory stolen/destroyed? (including them in COS?) Solution: taking the cost of goods stolen/destroyed out of purchases and including in expenses Insurance claim: other income (offsetting!) Worked example p.173 12 12 58 ACCOUNTING FOR OI AND CI OI: expense in the SPL: DEBIT Cost of sales £X CREDIT Inventory account (SFP-OI) £X CI: deducted from COS in the reporting period DEBIT Inventory account (SFP-CI) £X CREDIT Cost of sales (SPL) £X 13 13 ADJUSTING THE TB CI is entered into both adjustment columns of the ETB for inventory The DEBIT is taken across to the SFP (?); the CREDIT is taken to the SPL (?) OI is taken straight to the SPL as a DEBIT (what about the opposite entry?) 14 14 COUNTING INVENTORIES The inventory count establishes quantities held in inventory at the end of the reporting period 15 15 59 VALUING INVENTORIES Inventory is valued at the lower of (historical) cost of purchase, and net realisable value (NRV) NRV is the expected selling price less any costs to be incurred in achieving that sale Cost comprises: purchase price, carriage, duties and conversion costs to bring item to its present location and condition 16 16 VALUING INVENTORIES 6.1 Basic valuation: lower of cost and NRV IAS2: Inventory should be valued at the lower of cost and net realisable value 17 17 VALUING INVENTORIES 6.2 Applying the lower of cost and NRV If a business has many inventory items on hand the comparison of cost and NRV should be carried out for each item separately It is not sufficient to compare the total cost of all inventory items with their total NRV 18 18 60 6 VALUING INVENTORIES 6.3 Determining the cost of inventory Cost of inventories: All costs of purchase, of conversion (eg, labour) and of other costs incurred in bringing the items to their present location and condition Cost of purchase: The purchase price, import duties and other non-recoverable taxes, transport, handling and other costs directly attributable to the acquisition of finished goods and materials 19 19 VALUING INVENTORIES 6.3 Determining the cost of inventory Conversion costs: Any costs involved in converting raw materials into final product, including labour, expenses directly related to the product and an appropriate share of production overheads (but not sales, administrative or general overheads) 20 20 VALUING INVENTORIES 6.3 Determining the cost of inventory 6.3.1 What is included in the total cost of an item? The total cost of an item includes all costs incurred in bringing the item to its present location and condition This consists of the purchase cost of raw materials carriage import taxes and duties conversion costs 21 21 61 VALUING INVENTORIES 6.3 Determining the cost of inventory 6.3.2 What is the total cost of items left in inventory? FIFO (first in, first out) LIFO (last in, first out) AVCO (average cost) 22 22 VALUING INVENTORIES 6.4 Inventory valuations and profit Different methods of inventory valuations will provide different profit figures 23 23 MARK-UP/MARGIN Mark-up is calculated on cost Margin is calculated on sales Margin and mark-up can help us to establish the cost of an item of inventory 24 24 62 8 WRITING OFF INVENTORIES, INVENTORY DRAWINGS Provided inventory actually held is valued at the lower of cost and NRV, no inventory write-off entries are needed When an owner draws out inventory: debit drawings, credit purchases 25 25 End of Chapter Thank you! 26 26 63 64 ACCOUNTING CHAPTER IRRECOVERABLE DEBTS AND ALLOWANCE FOR RECEIVABLES 2 TOPIC LIST Irrecoverable debts Allowance for receivables Accounting for irrecoverable debts and allowance for receivables Adjusting the TB for irrecoverable debts and allowance for receivables 3 65 1 IRRECOVERABLE DEBTS 1.1 Writing off irrecoverable debts When a business decide that a particular debt will not be paid: Reduce revenue? Increase expense? 4 IRRECOVERABLE DEBTS 1.1 Writing off irrecoverable debts 1.1.1 Irrecoverable debts written off and subsequently paid DEBIT Cash at bank CREDIT Irrecoverable debts expense Question: Do we need to credit trade receivales? Worked example p.206 5 IRRECOVERABLE DEBTS 1.1 Writing off irrecoverable debts 1.1.1 Irrecoverable debts written off and subsequently paid DEBIT Cash at bank CREDIT Irrecoverable debts expense Question: Do we need to credit trade receivales? Worked example p.206 Question: Dishonoured cheques? – write off receivable? 6 66 IRRECOVERABLE DEBTS 1.2 Dishonoured cheques and irrecoverable debts Question: Dishonoured cheques? – write off receivable? No! => Reverse the payment transaction! 7 ALLOWANCE FOR RECEIVABLES IFRS 9: a company required to look forward and estimate expected future losses on trade receivables balance (Question: should they look forward and estimate expected future gains on trade receivables balance???) UK GAAP – FRS 102 – no forward-looking criteria 8 ALLOWANCE FOR RECEIVABLES DEBIT Irrecoverable debts expense (SPL – administrative expense) £X CREDIT Allowance for receivables (SFP) £X Worked example 1,2 p.208 9 67 3 ACCOUNTING FOR IRRECOVERABLE DEBTS AND ALLOWANCE FOR RECEIVABLES 3.1 Irrecoverable debts written off: ledger accounting entries When it is decided that a particular debt will not be paid: DEBIT Irrecoverable debts expense account £X CREDIT Trade receivables £X Question: What else shall we record? 10 10 ACCOUNTING FOR IRRECOVERABLE DEBTS AND ALLOWANCE FOR RECEIVABLES 3.1 Irrecoverable debts written off: ledger accounting entries At the end of the reporting period DEBIT Profit and loss ledger account £X CREDIT Irrecoverable debts £X Where an irrecoverable debt is recovered DEBIT Cash £X CREDIT Irrecoverable debts expense account £X Interactive question p.211 11 11 ACCOUNTING FOR IRRECOVERABLE DEBTS AND ALLOWANCE FOR RECEIVABLES 3.2 Allowance for receivable: ledger accounting entries An allowance account is set up: DEBIT Irrecoverable debts expense CREDIT Allowance for receivables £X £X When preparing the SFP, the credit balance on the allowance account is deducted from the balance on the receivables account (!) 12 12 68 ACCOUNTING FOR IRRECOVERABLE DEBTS AND ALLOWANCE FOR RECEIVABLES 3.2 Allowance for receivable: ledger accounting entries In subsequent reporting periods Carry down the new allowance required Calculate the charge or credit to SPL If the allowance has risen: CREDIT Allowance for receivables £X DEBIT Irrecoverable debts expense £X If the allowance has fallen: DEBIT Allowance for receivables £X CREDIT Irrecoverable debts expense £X 13 13 ADJUSTING THE TB FOR IRRECOVERABLE DEBTS AND ALLOWANCE FOR RECEIVABLES Calculate a/m of irrecoverable debts expense and the required allowance for receivables Prepare journal entries Adjustments columns Cross-cast 14 14 End of Chapter Thank you! 15 15 69