BBFA2103 financial accounting and reporting 1 OUM

OUM Business School

BBFA2103

Financial Accounting and Reporting I

Copyright © Open University Malaysia (OUM)

BBFA2103 FINANCIAL ACCOUNTING AND REPORTING I Prof Dr Ong Tze San Rosila Abu Zarin


Project Directors:

Prof Dato’ Dr Mansor Fadzil Prof Dr Wardah Mohamad Open University Malaysia

Module Writers:

Prof Dr Ong Tze San Universiti Putra Malaysia Rosila Abu Zarin Open University Malaysia

Moderator:

Baldev Singh Pertab Singh Open University Malaysia

Developed by:

Centre for Instructional Design and Technology Open University Malaysia

First Edition, December 2014 Second Edition, December 2016 (rs) Copyright © Open University Malaysia (OUM), December 2016, BBFA2103 All rights reserved. No part of this work may be reproduced in any form or by any means without the written permission of the President, Open University Malaysia (OUM).


Table of Contents Course Guide

xiii–xviii

Topic 1

Overview of Accounting 1.1 The Importance of Accounting 1.2 Definition of Accounting 1.3 Users of Accounting Information 1.3.1 Internal Users 1.3.2 External Users 1.4 Branches of Accounting 1.5 Forms of Business 1.5.1 Types of Business 1.5.2 Types of Ownership of Business 1.6 Functions or Roles of Accounting 1.6.1 Accounting as the Language of Trade 1.6.2 Accounting Creating Accountability and Control 1.6.3 Accounting is Information Systems 1.6.4 Accounting as a Decision-making Tool Summary Key Terms Self-Test 1 Self-Test 2 Self-Test 3

1 2 4 6 6 7 9 10 10 12 16 16 16 17 19 20 21 21 22 23

Topic 2

Accounting Principles and Concepts 2.1 Regulatory and Conceptual Framework for Corporate Reporting 2.2 Financial Statements 2.2.1 The Purpose of Financial Statements 2.3 The Components of Financial Statements 2.4 Elements of Financial Statements 2.5 Qualitative Characteristics of Accounting Information 2.5.1 Relevant 2.5.2 Reliable 2.5.3 Comparable 2.5.4 Consistent 2.5.5 Materiality 2.5.6 Understandable 2.5.7 Timely

24 25


26 27 28 36 38 39 40 41 42 42 43 43

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Topic 3

TABLE OF CONTENTS

2.6

Accounting Assumptions 2.6.1 Assumption 1: Separate Entity 2.6.2 Assumption 2: Going Concern 2.6.3 Assumption 3: Monetary Unit 2.6.4 Assumption 4: Accounting Period 2.7 Basic Accounting Principles 2.7.1 Principle 1: Historical Cost 2.7.2 Principle 2: Revenue Recognition 2.7.3 Principle 3: Matching 2.7.4 Principle 4: Full Disclosure 2.8 Accounting Standards Summary Key Terms Self-Test 1 Self-Test 2 Self-Test 3 Self-Test 4

43 43 44 45 45 45 46 46 47 47 47 49 50 50 51 51 52

Accounting Cycle 3.1 The Accounting Cycle 3.1.1 Source Documents 3.1.2 Transactions Analysis 3.1.3 Journalising 3.1.4 Posting to Ledgers 3.1.5 Preparing of Unadjusted Trial Balance 3.1.6 Adjusting Entries 3.1.7 Preparing of Adjusted Trial Balance 3.1.8 Preparing of Financial Statements 3.1.9 Closing Entries 3.2 Accounting Equation 3.3 Transaction Analysis 3.3.1 Transaction 1: Initial Investment by Owner 3.3.2 Transaction 2: Purchase of Non-current Asset 3.3.3 Transaction 3: Withdrawals by Owners 3.3.4 Transaction 4: Borrowing Money 3.3.5 Transaction 5: Repayment of Borrowings 3.3.6 Transaction 6: Earning Revenues 3.3.7 Transaction 7: Paying for Expenses 3.4 Presentation of Financial Statement (MFRS 101) 3.4.1 Statement of Financial Position (Balance Sheet) 3.4.2 Income Statement 3.4.3 Statement of Changes in Equity 3.4.4 Cash Flow Statements

53 54 55 55 55 55 55 56 56 56 56 58 61 62 63 63 64 65 66 67 70 70 70 70 71


TABLE OF CONTENTS

3.4.5 Notes to the Accounts Summary Key Terms Self-Test 1 Self-Test 2 Self-Test 3 Self-Test 4 References

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v

71 71 72 72 73 75 76 76

Topic 4

Adjusting Entries and Closing Entries 4.1 Accounting Basis 4.1.1 Cash Basis Accounting 4.1.2 Accrual Basis Accounting 4.2 Adjusting Entries 4.2.1 Prepaid Expenses 4.2.2 Unearned Revenue 4.2.3 Accrued Expenses 4.2.4 Accrued Revenues 4.2.5 Depreciation 4.2.6 Bad Debts 4.2.7 Provision for Doubtful Debts 4.3 Adjusted Trial Balance 4.4 Closing Entries 4.4.1 Temporary Accounts 4.4.2 Permanent Accounts 4.4.3 Recording Closing Entries Summary Key Terms Self-Test 1 Self-Test 2

77 78 78 79 81 82 85 86 87 88 90 96 102 103 103 103 103 109 110 110 112

Topic 5

Accounting for Current Assets 5.1 Assets 5.1.1 Internal Control for Assets 5.1.2 Current Assets 5.2 Accounting for Cash 5.3 Bank Reconciliation 5.3.1 Types of Bank Accounts 5.3.2 Purposes of Preparing Bank Reconciliation 5.3.3 Preparation of Bank Reconciliation Statement 5.4 Petty Cash 5.4.1 Creating the Petty Cash Fund 5.4.2 Using the Petty Cash Fund

115 116 116 118 119 120 120 123 124 131 131 132


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5.4.3 Reimbursement of the Petty Cash Fund 5.5 Receivables 5.5.1 Credit Control 5.5.2 Reliability Values of Accounts Receivables Collection 5.5.3 Loan Loss Provisioning 5.5.4 Notes to Increase and Decrease in the Provision for Doubtful Debts 5.5.5 Bad Debt Write Off 5.5.6 Reporting of Accounts Receivable in the Financial Statements 5.6 Inventories 5.6.1 Management and Stock Control 5.6.2 Recording System (Periodic and Continuous) 5.6.3 Calculation Method for StocksÊ Value 5.6.4 Effect of Different Flow Assumptions – Practice in Inflation and Deflation 5.6.5 Stock Reported in the Financial Statements 5.6.6 Under First Real Impact and Value Stocks Summary Key Terms Self-Test 1 Self-Test 2 Topic 6

Accounting for Non-current Assets 6.1 Definition of Non-current Assets 6.2 Accounting for Tangible Non-current Assets 6.3 Intangible Assets 6.3.1 Types 6.3.2 Evaluation 6.4 Presentation in the Balance Sheet 6.5 Depreciation 6.5.1 Straight Line Method 6.5.2 Reducing Balance Method 6.5.3 Units-of-production Method 6.6 Disposal of Non-current Assets 6.6.1 Retiring or Discarding the Non-current Asset 6.6.2 Selling the Non-current Asset 6.6.3 Exchanging the Non-current Asset for Another Non-current Asset 6.7 Non-current Assets Held for Sale (FRS 5) 6.7.1 The Concept of Provisions of Depreciation 6.7.2 Factors Affecting the Useful Lives Copyright © Open University Malaysia (OUM)

133 135 135 136 136 137 138 139 139 140 140 142 146 147 148 148 149 150 151 152 153 154 156 156 157 157 158 160 162 163 165 165 167 173 175 175 176

TABLE OF CONTENTS

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6.7.3 Methods of Calculating Depreciation 6.7.4 Disposal of Fixed Assets 6.8 Government Grants (FRS 120) 6.8.1 Categories of Grants 6.8.2 Disclosure 6.9 Investments Summary Key Terms Self-Test 1 Self-Test 2 References

176 180 182 182 183 183 185 186 186 187 188

Topic 7

Property, Plant and Equipment (MFRS 116) 7.1 Property, Plant and Equipment 7.2 Recognition of Fixed Assets 7.3 Initial Measurement 7.3.1 Acquired Assets for Cash or Cash Equivalent 7.3.2 Self-constructed Fixed Asset 7.3.3 Exchange Fixed Asset 7.4 Subsequent Expenditure 7.5 Subsequent Measurement 7.6 Impairment, Retirement and Disposal 7.6.1 Impairment 7.6.2 Retirement and Disposal 7.7 Disclosure Requirements Summary Key Terms Self-Test 1 Self-Test 2 References

189 190 191 192 192 195 197 199 202 207 207 209 211 213 214 214 216 217

Topic 8

Accounting for Liabilities and Equity 8.1 Definition of Liabilities 8.2 Current Liabilities 8.2.1 Bank Overdraft 8.2.2 Dividend Payable 8.2.3 Bank Loans 8.2.4 Bill Payable 8.3 Long-term Liabilities 8.3.1 Long-term Bank Loans 8.3.2 Bonds and Debentures 8.3.3 Mortgage Loans 8.4 Provisions and Contingencies

218 219 220 221 222 222 223 225 226 226 227 227


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8.4.1 8.4.2 8.5 Equity 8.5.1 8.5.2 8.5.3 Summary Key Terms Self-Test 1 Self-Test 2 Self-Test 3 Self-Test 4 Self-Test 5 Self-Test 6 References Topic 9

Topic 10

Provisions Contingencies The Equity of a Single Proprietorship The Equity of a Partnership The Equity of a Company

228 229 230 230 232 233 243 243 244 244 246 246 247 247 248

Integrity and Ethics in Preparing and Reporting Financial Information 9.1 Ethical Code 9.2 Ethical Behaviour 9.2.1 Integrity 9.2.2 Objectivity 9.2.3 Competence 9.2.4 Independence 9.2.5 Confidentiality Summary Key Terms Self-Test 1 Self-Test 2

249

Comprehensive Cases (Partnership: Changes in Ownership) 10.1 Changes of Ownership in a Partnership 10.2 Goodwill 10.3 Admission of New Partners in a Partnership 10.4 Withdrawal of Partners in a Partnership 10.5 Revaluation of Assets Summary Key Terms Self-Test 1 Self-Test 2

256 257 258 261 264 265 269 270 270 272


250 251 251 252 252 253 253 253 254 254 255

TABLE OF CONTENTS

Topic 11

Comprehensive Cases (Dissolution of a Partnership) 11.1 Reasons for Dissolution of a Partnership 11.2 Disposal of Assets and Settlement of Liabilities 11.3 The Garner versus Murray Rule 11.4 The Piecemeal Realisation Summary Key Terms Self-Test 1 Self-Test 2

Answers

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ix

276 277 280 283 286 288 289 289 291 294


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TABLE OF CONTENTS


COURSE GUIDE



COURSE GUIDE

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COURSE GUIDE DESCRIPTION You must read this Course Guide carefully from the beginning to the end. It tells you briefly what the course is about and how you can work your way through the course material. It also suggests the amount of time you are likely to spend in order to complete the course successfully. Please keep on referring to the Course Guide as you go through the course material as it will help you to clarify important study components or points that you might miss or overlook.

INTRODUCTION BBFA2103 Financial Accounting and Reporting I is one of the courses offered by OUM Business School at Open University Malaysia (OUM). This course is worth 3 credit hours and should be covered over 8 to 15 weeks.

COURSE AUDIENCE This is a core major course for all learners taking the Bachelor of Accounting programme. As an open and distance learner, you should be acquainted with learning independently and being able to optimise the learning modes and environment available to you. Before you begin this course, please ensure that you have the right course material, and understand the course requirements as well as how the course is conducted.

STUDY SCHEDULE It is a standard OUM practice that learners accumulate 40 study hours for every credit hour. As such, for a three-credit hour course, you are expected to spend 120 study hours. Table 1 gives an estimation of how the 120 study hours could be accumulated.


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Table 1: Estimation of Time Accumulation of Study Hours Study Activities

Study Hours

Briefly go through the course content and participate in initial discussion

3

Study the module

60

Attend 3 to 5 tutorial sessions

10

Online participation

12

Revision

15

Assignment(s), Test(s) and Examination(s)

20

TOTAL STUDY HOURS ACCUMULATED

120

COURSE OUTCOMES By the end of this course, you should be able to: 1.

Distinguish between the different forms of businesses and their reporting environments;

2.

Describe the issues in the conceptual framework for financial accounting and reporting;

3.

Prepare the balance sheet and income statement;

4.

Analyse the approved accounting standards to account for cash, receivables, inventories and property, plant and equipment as well as intangibles and investments;

5.

Distinguish between the current and non-current liabilities, provisions and contingencies;

6.

Describe the different types of share capital and reserves; and

7.

Evaluate the importance of ethics in the financial reporting process.

COURSE SYNOPSIS This course is divided into 11 topics. The synopsis for each topic can be listed as follows: Topic 1 begins with an overview of accounting. It introduces the various forms of business and different reporting requirements. The functions and roles of accounting are also presented at the end of this topic. Copyright © Open University Malaysia (OUM)

COURSE GUIDE

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Topic 2 discusses the regulatory and conceptual framework for corporate reporting. These cover objectives of financial statements, components of financial statements, elements of financial statements, qualitative characteristics and accounting principles as well as concepts. The next part reveals the general purpose of financial statements. Lastly, the topic ends with the description of users of financial statements. Topic 3 briefly explores the various stages of accounting cycles. It starts with the accounting equation; introduction of journals, ledges and trial balance; adjustments such as accruals and prepayments; and financial statements. The presentation of financial statements based on MFRS101 is shown in this topic which covers balance sheets; income statements; statements of changes in equity; cash flow statements; and notes to the accounts. Topic 4 differentiates cash and accrual basis of accounting. This topic also explains the types and purposes of adjusting entries. Discussion on adjusting entries: prepaid expenses, unearned revenues, accrued expenses, accrued revenues, depreciation, bad debts and doubtful debts will be covered. Lastly, the preparation of adjusted trial balances and closing entries will be illustrated. Topic 5 deals with accounting for current assets. It explains the various components of current assets, that is, cash, receivables and inventories. Topic 6 explores the accounting for non-current assets. It looks at the definition of non-current assets. Other non-current assets such as non-current assets held for sale; intangible assets, presentation in the balance sheet, depreciation, government grants and investments are also discussed. Topic 7 discusses the accounting for property, plant and equipment (PP&E), which covers the recognition of fixed assets, measurement, subsequent expenditure and measurement, impairment, retirement, disposal and disclosure requirements of PP&E. Topic 8 deals with accounting for liabilities. It provides the definition of liabilities. It explains the various components of current and non-current liabilities and provisions as well as contingencies. This topic also deals with accounting for equity. It further explains the different types of share capitals and reserves. Topic 9 elaborates the issues of integrity and ethics in preparing and reporting financial information.


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 COURSE GUIDE

Topic 10 and Topic 11 include a comprehensive case study so that learners can encapsulate their learning from the earlier topics for this course. This topic is designed to enable learners to answer comprehensive examination questions.

TEXT ARRANGEMENT GUIDE Before you go through this module, it is important that you note the text arrangement. Understanding the text arrangement will help you to organise your study of this course in a more objective and effective way. Generally, the text arrangement for each topic is as follows: Learning Outcomes: This section refers to what you should achieve after you have completely covered a topic. As you go through each topic, you should frequently refer to these learning outcomes. By doing this, you can continuously gauge your understanding of the topic. Self-Check: This component of the module is inserted at strategic locations throughout the module. It may be inserted after one sub-section or a few subsections. It usually comes in the form of a question. When you come across this component, try to reflect on what you have already learnt thus far. By attempting to answer the question, you should be able to gauge how well you have understood the sub-section(s). Most of the time, the answers to the questions can be found directly from the module itself. Activity: Like Self-Check, the Activity component is also placed at various locations or junctures throughout the module. This component may require you to solve questions, explore short case studies, or conduct an observation or research. It may even require you to evaluate a given scenario. When you come across an Activity, you should try to reflect on what you have gathered from the module and apply it to real situations. You should, at the same time, engage yourself in higher order thinking where you might be required to analyse, synthesise and evaluate instead of only having to recall and define. Summary: You will find this component at the end of each topic. This component helps you to recap the whole topic. By going through the summary, you should be able to gauge your knowledge retention level. Should you find points in the summary that you do not fully understand, it would be a good idea for you to revisit the details in the module.


COURSE GUIDE

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Key Terms: This component can be found at the end of each topic. You should go through this component to remind yourself of important terms or jargon used throughout the module. Should you find terms here that you are not able to explain, you should look for the terms in the module. References: The References section is where a list of relevant and useful textbooks, journals, articles, electronic contents or sources can be found. The list can appear in a few locations such as in the Course Guide (at the References section), at the end of every topic or at the back of the module. You are encouraged to read or refer to the suggested sources to obtain the additional information needed and to enhance your overall understanding of the course.

PRIOR KNOWLEDGE Learners of this course are required to pass the BBFA1103 Introduction to Financial Accounting course.

ASSESSMENT METHOD Please refer to myINSPIRE.

REFERENCES Kean Kok, N., Weina, Z., Marimuthu, M., & Bhattacharya, S. (2010). Financial management. Oxford Fajar. Larson, K. D., Wild, J. J., & Chiappetta, B. (Omar, R., Hassan, H., Sulaiman, A.J., & Mohamad, L.) (2005). Accounting principles. Malaysia: McGraw-Hill. Lazar, J., Roshayani Arshad., & Huang Ching Choo. (2006). Financial reporting: An introduction. Malaysia: McGraw-Hill. Lerner, J. L., & Cashin, J. M. (1998). SchaumÊs outline of theory and problems of principles of accounting I (5th ed.). Black Lick, OH: McGraw-Hill. Loh, B. F., & Ng., K. H. (2006). Principles of accounts. Singapore: Longman/ Pearson Education Asia. Ng, E. (2006). A practical guide to financial reporting standards (Malaysia). Singapore: CCH Asia. Ng, E. (2009). A practical guide to financial reporting standards (Malaysia). Singapore: CCH Asia. Copyright © Open University Malaysia (OUM)

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Serway, R. A., & Jewett Jr, J. W. (2002). Principles of physics, A calculus-based text (3rd ed.). Fort Worth, TX: Harcourt College. Stice, E. K., Stice, J. D., & Skousen, K. F. (2004). Intermediate accounting (15th ed.). Mason, OH: Thompson South-Western. Tan, L. (2000). Financial accounting & reporting in Malaysia, volume 1 (2nd ed.). Malaysia: PAAC. Tan, L. (2000). Financial accounting & reporting in Malaysia, volume 2 (2nd ed.). Malaysia: PAAC. Thomson, A. (2006). Introduction to financial accounting (5th ed.). McGraw Hill Education, Asia. Wood, F., & Sangster, A. (2002). Business accounting 1 (9th ed.). England: Financial Times/Pearson Education.

TAN SRI DR ABDULLAH SANUSI (TSDAS) DIGITAL LIBRARY The TSDAS Digital Library has a wide range of print and online resources for the use of its learners. This comprehensive digital library, which is accessible through the OUM portal, provides access to more than 30 online databases comprising e-journals, e-theses, e-books and more. Examples of databases available are EBSCOhost, ProQuest, SpringerLink, Books24x7, InfoSci Books, Emerald Management Plus and Ebrary Electronic Books. As an OUM learner, you are encouraged to make full use of the resources available through this library.


Topic

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1

Overview of Accounting

LEARNING OUTCOMES By the end of this topic, you should be able to: 1.

Explain the importance of accounting;

2.

Define accounting and its four components;

3.

Describe the users and branches of accounting;

4.

Discuss the qualitative characteristics of accounting information;

5.

Describe the purpose of financial statements;

6.

Describe the four components of financial statements; and

7.

Distinguish between the roles of external and internal users of accounting.

 INTRODUCTION Accountancy is the process of communicating financial information on a business entity to users such as shareholders and managers. Accounting information helps users to make better financial decisions. Users of financial information may be both internal and external to the organisation. Accounting is a very dynamic profession which is constantly adapting itself to varying needs of its users. Did you know that the movie „Forrest Gump‰ starring Tom Hanks made over USD329.7 million in gross domestic revenue, and yet it was reported as having a net loss? Tom Hanks made millions from his fees which included certain shares of the gross revenue, and yet the original author, Winston Groom, who sold the screenplay rights to his novel for a price plus a share of the movie profit, received none.


2

 TOPIC 1 OVERVIEW OF ACCOUNTING

Had Mr Groom known the accounting language, he would have understood the difference between revenue and profit, and this situation could have been avoided. The movie might have made millions but the expenses which included production costs, marketing and distribution costs and even the fees (based on revenue sharing) paid to Tom Hanks, the directors, etc., reduced the millions of revenue to a net loss. The mentioned case is a good example of how accounting plays an important role in making the right decision. It enables us to make informed and better economic decisions. But how or where can you obtain this accounting information? This information is provided through the financial statement of a business. Now, it is common for public listed companies to publish their financial statements in the newspapers. After you have completed this module, the financial statements will not look so strange after all as you would have understood the language of accounting. This topic introduces accounting, its importance and definition. We will then look at who the users of accounting information are, and we will also look at the qualitative characteristics that must exist in order to generate valuable information for the users. You will later learn the purpose of preparing financial statements and the components of financial statements.

ACTIVITY 1.1 Do you think accounting is assumed as a language? Discuss.

1.1

THE IMPORTANCE OF ACCOUNTING

Accounting plays an important role in our daily lives, directly or indirectly. The views that accounting is only important for businesses and accountants are not true. Accounting provides valuable financial information that enables us to make informed and better decisions. An example of making this economic decision in our daily lives is the handling of our monthly income. You need to know your financial position in order to spend wisely. You need some accounting knowledge to plan or budget for your spending. You need to determine your net income which is gross pay minus all expenses. Copyright © Open University Malaysia (OUM)

TOPIC 1 OVERVIEW OF ACCOUNTING 

3

In deciding whether to purchase your dream car, you need to know if you can afford it. This is where accounting knowledge plays an important role, providing you with the necessary financial information to make decisions. In The Life of Mahatma Gandhi, the author quoted that Gandhi once wrote a letter to his son saying, „You should keep an account of every penny you spend‰. Gandhi used to keep daily records of whatever he spent! According to him, you will be able to manage your money by keeping track of it. Similarly for businesses, they need accounting information to help them run their business effectively and efficiently. They need to know whether the business is profitable or not, whether they have enough cash to pay their workersÊ salaries and more. If they know that their business is not profitable, they could do something about it, like selling it or try to improve the situation by changing their operations. Only with proper financial information will businesses be able to make the right decisions. So what is accounting? Before we go on to discuss the definition of accounting, let us look at the history of accounting. Luca Pacioli (see Figure 1.1), who is regarded as the „Father of Accounting‰ did not invent the accounting system, but in 1494 described the methods used by Italian merchants to record their business transactions in his book Summa de Arithmetica, Geometria, Proportioni et Proportionalita (Everything About Arithmetic, Geometry and Proportion). He described most importantly the double entry accounting system, emphasising that debit must equal credit. The system described by Pacioli changed little over the next four centuries, and you will soon learn the systems throughout this module.

Figure 1.1: Luca Pacioli Source: http://acct.tamu.edu/smith/ethics/pacioli.htm Copyright © Open University Malaysia (OUM)

4


ACTIVITY 1.2 In your own words, try to reason out the need for us to study accounting.

1.2

DEFINITION OF ACCOUNTING

Accounting is described as a system or a process that provides reports on an entityÊs economic transactions to users. Accounting can be defined as a process of collecting, identifying, measuring, recording, summarising and communicating the results of business or economic transactions to users in order for them to make informed or better decisions. Refer to Figure 1.2 for the information flow in an accountancy system.

Figure 1.2: The information flow in an accountancy system



5

There are four components in accounting: (a)

Recording – written records of journalising and posting business transactions;

(b)

Summarising – preparing the financial statements;

(c)

Analysing – examining the results to determine the financial position and performance; and

(d)

Interpreting – using the financial statements to make judgments and decisions.

Accounting systems process inputs which are business transactions (making sales, paying expenses, buying assets, borrowing money etc.) into outputs of financial statements (for example, income statements and balance sheets). This module will teach you the recording and summarising processes in detail. The final topic of the module will introduce basic techniques that are used to analyse and interpret financial statements. From these outputs, information such as how much resources the business owns, how much is owed and its business performance are known. The process is shown in Figure 1.3.

Figure 1.3: The accounting system


6


ACTIVITY 1.3 Imagine running a business with no knowledge of accounting. In my opinion, it is really necessary to have at least some basic knowledge of preparing accounts. What is your opinion? Can you think of ways how accounting helps a business?

1.3

USERS OF ACCOUNTING INFORMATION

Accounting information is useful to anyone who makes decisions that have an economic result. Think about this; we as users have scarce resources (capital, cash) and want to allocate these resources so that they give a maximum return to us. Somehow you need information to enable you to make the right decisions. Users of accounting information can be classified into several categories and groups. Each group makes a different decision and requires different accounting information to aid its decision making. This is very complicated but it is not impossible to provide accounting information that meets the needs of all types of users. There are two types of users; internal and external users of accounting information. These users will be discussed in the next subtopic.

1.3.1

Internal Users

Internal users are part of the business entity and they make decisions for the organisation. Examples are: (a)

Directors of companies, in deciding the amount of dividend to pay to shareholders or bonus to employees who need to know the company profit.

(b)

Managers who want to know if a new product will be profitable.

Management accounting is the area of accounting that provides information for internal usage. These among others include areas of costing, budgeting and payroll.



7

Managers are responsible for daily operations. Their role is to plan for the business and then determine how the plan is carried out. Planning and control involves many big decisions. These may include: (a)

Determining what kind of goods or services should be offered by a business.

(b)

Determining sales targets and determining what action to take when the target is not achieved.

(c)

Preparing budgets and what should be done if performance does not meet the budget.

(d)

Choosing the investment opportunities available.

(e)

Determining how much money you have borrowed and from where to borrow.

(f)

Determining the selling price of the goods or services offered by the business.

To make these decisions, managers need information related to the past and current activities together with forecast predictions. On the other hand, financial accounting provides the financial statements to be used by mainly external users and to some extent the internal users.

1.3.2

External Users

External users are those outside of the organisation and they make decisions about the organisation. Examples are shown in Table 1.1. Table 1.1: External Users External Users Owners

Description 



Owners have some economic decisions to be made among others: –

To decide whether to proceed, sell or close their businesses.

–

To decide whether to invest more or not.

–

To decide how much money can be taken out of the business without jeopardising the financial stability of the business.

When you want to make these decision, owners may find the following information: –

Information about the financial performance of the business, to show how good or if the business has failed. Copyright © Open University Malaysia (OUM)

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–

Information about the current financial position, showing the assets (property owned) and liabilities (external claims payable) as well as business ownerÊs equity claims that can be made on the business property.

Investors

Before buying a companyÊs shares, they will want to know the companyÊs profitability and the amount of dividends paid out to shareholders. Shareholders holding shares in a company might want to decide whether to buy more shares or dispose the shares they have.

Creditors

Suppliers and bankers who want to know if they should extend credit to the business, how much to extend and for how long. They will assess the ability of the business to repay the loan.

Government agencies



For example, Lembaga Hasil Dalam Negeri (LHDN) needs to know the income of a business entity in order to determine the amount of tax to be collected by them.



The most obvious purpose is the tax that should be imposed (the role played by the Inland Revenue Board), other purposes include complying with business laws and statistical output for the economy.



The main decision to be made by the bank and the borrower is whether or not to lend to businesses. The bank and the borrower would also like to know the ability of the company to repay interest and the whole loan amount at the end of the loan period.



In the case of short-term loans, accounting information required is the current financial position of the business and expected financial position in the near future. For long term, a more general analysis is needed on the financial prospects in the long run.

Banks and other lenders

Suppliers

They decide whether they will offer a credit period or not and whether they want to be suppliers. Information about financial position is required.

Customer

Customers want to know the source provider before signing a contract. Customers are offered a guarantee by the suppliers and are also interested in information about the continued existence of the supplier.

Employees

The main thing for employees is job security and payment in kind for their work. Information on the performance and financial position of the employer will help them to decide whether they will continue to work or look for other alternatives.



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ACTIVITY 1.4 Can you consider the internal and external users as the stakeholders of a company? Discuss.

1.4

BRANCHES OF ACCOUNTING

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

Figure 1.4: Accounting disciplines

This introductory accounting course will cover financial accounting only. However, it is important for you to understand the differences between financial accounting and management accounting. A summary of differences is shown in Table 1.2. Table 1.2: Comparison between Financial Accounting and Management Accounting Comparison

Financial Accounting

Management Accounting

Users

External users and internal users.

Internal users only.

Reports

Provides financial statements of an entity.

Provides financial and non-financial information required by an entity to plan, evaluate and control its operations.


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Format of reports

1.5

Financial reports are produced periodically according to a specific format or standards.

Reports are produced at any time according to needs and are not subjected to a specific format or standards.

FORMS OF BUSINESS

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

1.5.1

Types of Business

Business organisations can be categorised into several types according to their main activities (refer to Figure 1.5).

Figure 1.5: Types of business organisations



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Now, let us discuss the types one by one. (a) Merchandising/Retailing/Trading The businessÊ main activities involve purchasing goods which are then sold to customers. Examples are supermarkets, departmental stores, wholesalers and grocery stores. These merchandisers buy various goods at a price (cost or purchase price) and sell them to customers at a higher price (sale price). One such example is Giant, a leader in MalaysiaÊs retail sector (see Figure 1.6). You will learn in detail the accounting for a merchandiser in Topic 6.

Figure 1.6: Giant, a well-known retailer for its cost effective goods

(b)

Manufacturing Manufacturing firms convert raw materials into finished goods. Examples are an oil refinery, a car manufacturing company and a toy manufacturing company. A car manufacturing company purchases tyres and windshields as their raw materials (parts) and hires labour to assemble these materials into finished products (cars). The cost of all materials, labour and other expenses used to manufacture the car is the cost of manufacturing. The finished product is then sold at a higher price than the manufacturing cost. One example of a local car manufacturer is Perodua. Its subsidiary, Perodua Manufacturing Sdn Bhd, is responsible for the manufacturing of the Perodua vehicles and selected vehicle component parts. You will learn the accounting for manufacturing in the management accounting subject. Copyright © Open University Malaysia (OUM)

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(c)

Services This business provides services to its customers. Examples are lawyers, photocopying services, hotels, car rentals and education. Lawyers provide legal services or consultation services, they earn fees for services rendered to customers.

SELF-CHECK 1.1 Can you name a specific business that you have encountered in the following sectors? (a)

Services;

(b)

Merchandising; and

(c)

Manufacturing.

1.5.2

Types of Ownership of Business

Types of ownership will have an impact on the accounting practices and procedures of an organisation. Formats and information contained in the financial statements are slightly different. Therefore you must understand the different characteristics among the three types of ownership. There are three basic forms of ownership, which are shown in Figure 1.7:

Figure 1.7: Types of business ownership



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Let us now discuss the types in greater detail. (a)

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

The advantages of sole proprietorship are as follows: (i)

Sole proprietorship is easy to set up;

(ii)

Owner has full control over the business decisions and activities;

(iii) Income of the business belongs to owner, and not shared with other people; and (iv) Compared to other form of business organisations, it has less legal requirement.

The disadvantages of sole proprietorship: (i)

Difficult to expand as expertise and capital might be limited;

(ii)

Owner bears all the risks; and

(iii) Unlimited liabilities. (b)

Partnership This type of business is owned by two or more individuals, called partners. Just like the sole trader the formation requires no or little legal requirements. The „pisang goreng‰ seller might want to expand his business to include „nasi lemak‰. As such, he might invite an expert in making „nasi lemak‰ to become his partner. However, an agreement must exist between partners normally on how the profit or losses should be shared. Similar to the sole trader, no distinction is made between partners and business for legal purposes. Therefore, all partners are responsible for business liabilities.


14


The advantages of a partnership are as follows: (i)

Higher sources of capital as owners are more than one;

(ii)

Partners might have additional skills and expertise to strengthen the business partnership; and

(iii) Unlike companies, a partnership is not required to disclose business information to an external party.

The disadvantages of sole partnership: (i)

Unlimited liabilities;

(ii)

Conflicts among partners will lead to instability in the management of business; and

(iii) Lack of continuity; a partnership will dissolve if one partner dies, or pulls out of the partnership, or is declared bankrupt. (c)

Company (Corporation) Companies like Coca Cola and Maxis are owned by many people called shareholders. Shareholders are people who own shares in the company. A company is a separate legal entity from the owners, in other words an „artificial person‰ that can conduct business in its own name, unlike sole traders and partnerships.

The advantages of companies are as follows: (i)

Limited liabilities;

(ii)

Easy to expand as they can issue shares and debentures to generate funds as capital;

(iii) Continuity; and (iv) Shares can be transferred from one person to another easily.



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The disadvantages of companies are as follows: (i)

Subjected to rules and regulations of the government;

(ii)

Ownership is separate from the management; and

(iii) Set up cost is high compared to other forms of business. Table 1.3 summarises the differences between the various types of ownership in a business entity. Table 1.3: Comparison of Types of Ownership in a Business Entity Comparison

Proprietorship

Partnerships

Company

Owner (s)

Proprietor

Partners

Shareholders

Life of organisation

Limited

Limited

Indefinite

Liabilities

Unlimited

Unlimited

Limited

Accounting status

Business is separate from the proprietor

Business is separate from the partners

Business is separate from the shareholders

Legal status

None

None

A separate legal entity

Formation

Relatively easy

Relatively easy

Complex

Management

Normally by the owner

Normally by the partners

Managers or directors

Tax

Proprietor pays tax on business profit

Each partner pays tax on his share of the profits

Companies pay tax on the business profit and shareholders pay tax on the amount of dividend they receive (double taxation)

ACTIVITY 1.5 If you plan to open up a gift store in Mid Valley Megamall, what form of business and type of ownership will you choose? Give your reasons.


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1.6

FUNCTIONS OR ROLES OF ACCOUNTING

Accounting contains elements of science and art. It is a term used to reflect some of the techniques and a wide field of study and most importantly, it is not only a collection of arithmetic techniques but is a complex process that is prepared for the public as consumers. The need to have the knowledge of accounting is not only limited to those directly involved in business management. Those who are about to enter a business career or any career which involves a relationship with a business organisation should understand the basic concepts of accounting so that they can communicate with the accountant or interpret the reports containing accounting data. As individuals, we are always confronted with the operation of business enterprises that make a big impact in daily life.

1.6.1

Accounting as the Language of Trade

Accounting is deemed to be the language in world trade. This is because accounting has become common in the delivery of system information pertinent to managers and administrators. This information is then used for making business decisions. Accounting systems not only provide information that is essential for business managers, it also provides the decision of whether to lend or not in the firm. The other creditors will also need to know the information about the financial position of the firm to ensure that the firm has sufficient funds to repay its debts.

1.6.2

Accounting Creating Accountability and Control

The following are the explanations for the accountability and control in accounting: (a)

Accountability Accountability is usually the term used to describe two ideas associated with the provision of trust (stewardship) and the related performance evaluation. Granting trust refers to entrusting a person to manage a property. Performance evaluation is a comparison between actual performance and the expected results.



(b)

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Control Knowledge of the past may help in anticipating the future state. For example, a manager wants to anticipate manufacturing costs for new products; it is easier if he knows the cost of manufacturing for the same product in the last year based on the experience of other firms or from any other source that is available. Other aspects of the past to measure the condition are controlled. Here the last result compared with a target or standard and the difference between actual and target is used in various ways to improve performance, including: (i)

(ii)

1.6.3

If past results are not as good as expected (assumed to be an expected finding and reasonably achievable), appropriate action should be taken and this will involve the planning and current decision. The difference between the previous findings and the results showed that the target may have made mistakes in the past, and this will not be repeated again.

Accounting is Information Systems

The accounting system covers the entire joint procedure, personnel, equipment, records and report documents used to collect, summarise and report financial and accounting information about the business. Generally, factors in accounting information systems can be described as follows (refer to Table 1.4): Table 1.4: Factors in Accounting Information Systems Factor

Description

Employees

Covers staff who are directly involved with accounting activities such as working in the activity of buying, selling, receiving materials and use of materials.

Documents

Include all documents in business activities such as invoices, vouchers, sales order, purchase order, agreements, receipts and so on.

Records

All books of account kept by the business such as accounting books (journals and ledgers).

Procedure

Refers to the narrative that is followed to do the work. For example the procedure of receiving money from buyers in the supermarket. The cashier records the price of each item based on the price of the goods on a slip. Prices of all items purchased will be aggregated and claimed from the customer.


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Equipment

The equipment used for accounting jobs such as storage devices and separate ledger card, cash registers, hardware and software computer.

Knowledge

To solve a problem, knowledge is needed in various fields such as the field of statistical analysis, mathematics, finance and so on. Use of knowledge in accounting can improve the quality of information produced.

Report

Accounting systems should strive to provide reports to meet the needs of every consumer for information.

The accounting system is a subset of the management information system and it contains a common set of basic functions of collecting, recording (processing), reporting (presentation) and evaluating data: (a)

Collecting data – all data processed by the system must be collected at a certain time.

(b)

Recording data – data must be recorded in some form before it can be used.

(c)

Reporting data – the system is divided into two subsystems for the calculation and presentation. The calculation system changes data input to output.

(d)

Assessing/evaluating data – this system involves the comparison of parameters in real output and the expected output.

Characteristics of Accounting Information In most accounting books, the following characteristics are considered important to ensure the quality of accounting information. (a)

Relevant or appropriate Information may not be used if it is not relevant to users in helping them to make economic decisions. Relevant information has predicted values that help users make decisions in the future. Information relevant to the setting (confirmatory value) helps users evaluate past decisions.

(b)

Reliable (reliability) Reliable information must be complete and free of significant errors. It is also unbiased and has valid proof.

(c)

Comparability Users may need to compare financial information issued by businesses with: (i)

The information produced by the same firm in the last year; and Copyright © Open University Malaysia (OUM)


(ii) (d)

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The information produced by other businesses.

Can be understood (understandability) Users must understand the information provided. This level of understanding must also be taken into account in preparing the financial statements.

1.6.4

Accounting as a Decision-making Tool

We can say that accounting emphasises the provision of information in the form of finance that can help in making decisions about the allocation of resources and providing reports on financial forms explaining the effect of resource allocation decisions of the past. Examples of resource allocation decisions are: (a)

Should investors buy or sell shares?

(b)

Will bankers lend money to the firm?

(c)

How much tax should be paid by the company or firm?

Accountants and their interpretations emphasise the provision of financial information. Many accountants will be directly involved in decision making but the functions performed are different (only supply the relevant information). Accounting reports prepared by accountants influence fundamental decisions and actions that will be taken by the individual. Information Flow and Information Users The main purpose of accounting is to help users of accounting information to make better decisions. To meet this goal, we have to answer the following questions: (a)

Who are users of accounting information?

(b)

What kind of decisions must they make?

(c)

What is the accounting information necessary to help them in making the decisions?



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•

Accounting can be defined as a process of collecting, identifying, measuring, recording, summarising and communicating the results of business or economic transactions to users in order for them to make informed or better decisions.

•

Accounting information is important as it helps users to make decisions.



Financial accounting provides financial information for external users and also internal users while management accounting provides financial and nonfinancial information for internal users.

•

For accounting information to be useful and valuable to decision makers, it must be relevant, reliable, comparable and consistent. Useful information should also be understandable, material and timely.

•

The main function of financial statements is to provide information of the business financial position and financial performance to users.

•

The four main components of financial statements are as follows: –

Income statement;

–

Balance sheet;

–

Statement of changes in ownerÊs equity; and

–

Cash flow statement.

•

Income statements report the financial performance of a business entity.

•

Balance sheets report the financial position of a business entity.

•

Statements of changes in ownerÊs equity report how the ownerÊs equity has changed over the reporting period.

•

Cash flow statements show the in-flow and out-flow of cash of an organisation from three main activities; operating, investing and financing.



Internal users and management are the parties involved with accounting in the company. They cope with the daily operations of a company.



External users are those involved with a companyÊs accounting externally. They are: –

Owners; Copyright © Open University Malaysia (OUM)


–

Investors;

–

Creditors;

–

Government agencies;

–

Banks and other lenders;

–

Suppliers;

–

Customers; and

–

Employees.

Accountability

Internal users

Accounting

Materiality principle

Control

Relevance concept

Decision making

Reliability concept

External users

True and fair view

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Financial statement

1.

Define accounting and explain the four components of accounting.

2.

List the qualitative characteristics of accounting information.

3.

What are the items reported in the income statement?

4.

For each of the following users, can you identify the type of accounting information they require? External Users •

Lenders

•

Suppliers

•

Government agencies

•

Customers

Type of Information Required


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Internal Users •

Employees

•

Sales Managers

•

Production Managers

•

Budget Officers

1.

Explain the comparability concept and its role in making accounting information useful.

2.

What are the items reported in the balance sheet?

3.

What are the items reported in the statement of changes in ownerÊs equity?

4.

What are the items reported in the cash flow statement?

5.

The following are the accounts balances of Smart Tuition Centres as at 31 December 2013. RM Accounts receivable Accounts payable Bank loan Supplies Supplies expenses Advertising expense Salaries expenses General expenses Rent expenses Utilities expenses Tuition fees Computer equipment Cash RM20,000 Capital (1/1/2012) Drawings

8,855 2,200 15,000 8,480 6,300 4,200 18,000 1,265 14,400 7,350 75,750 17,800 20,000 23,700 10,000



23

You are required to prepare: (a)

An income statement for Smart Tuition Centres for the year ended 31 December 2013;

(b)

A statement of changes in ownerÊs equity for Smart Tuition Centres for the year ended 31 December 2013; and

(c)

A balance sheet for Smart Tuition Centres as at year ended 31 December 2013.

What are the differences between financial and management accounting?


Topic



2

Accounting Principles and Concepts


Describe regulatory and conceptual framework for corporate reporting;

2.

Explain the components of financial statements;

3.

Identify the elements of financial statements;

4.

Discuss the qualitative characteristics of accounting information;

5.

Describe the accounting assumptions and principles; and

6.

Assess the accounting standards.

 INTRODUCTION Accounting concepts and principles are built to measure the economic activities of a company. Accounting systems in each country are different depending on their influences of the economic structure and legal systems. Imagine the world without traffic laws and enforcement! There will be havoc, as people will drive as fast as they want, beat traffic lights as they please or park their cars anywhere they like. To ensure our safety on the road, we have rules and drivers need licenses before they can drive. Now, can you imagine the accounting profession without rules and regulations? You have learned earlier that external users rely on accounting information produced by businesses to make decisions. How can users be assured that the Copyright © Open University Malaysia (OUM)

TOPIC 2 ACCOUNTING PRINCIPLES AND CONCEPTS 

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information presented is reliable? After all, the financial statements are prepared by the companyÊs accountant. Knowing that to prepare financial statements, accounting professionals have to follow certain rules and regulation increases the reliability of information provided by the financial statement. But who regulates the accounting profession? This topic begins with the introduction to the various accounting bodies in Malaysia that govern the accounting profession. The main functions of these bodies will be described. We have to follow certain guidelines called the accounting standards in preparing the financial statements. You will learn why it is important to have such standards; the following article proves the consequence of not doing so! Accountant Held Liable for Interest Expense from Tax Error Accounting WEB.com - 26th June 2006 - The South Dakota Supreme Court last week upheld a Circuit Court decision allowing a jury to award damages to Doug OÊBryan Contracting Inc. for interest expense on underpayment of taxes that resulted from an error made by his accountant. The stateÊs high court had not previously allowed recovery of interest expense in lawsuits against tax advisers, the Associated Press reports. Bruce Ashland, a certified public accountant, understated OÊBryanÊs income for 1995. The well-drilling company, located in Martin, South Dakota, incorporated in April 1995, and Ashland used the wrong method to calculate income for the first quarter of the year. When the error was discovered several years later, OÊBryan owed an additional $239,933 in taxes and about $50,000 in interest. Source: http://www.accountingweb.com/tax/irs/accountant-held-liable-for-interestexpense-from-tax-error

2.1

REGULATORY AND CONCEPTUAL FRAMEWORK FOR CORPORATE REPORTING

Framework is the basic requirement. The proposed framework by the Malaysian Accounting Standards Board (MASB) for the preparation and presentation of financial statements is similar with the one issued by the International Accounting Standards Board (IASB) which deals with: Copyright © Open University Malaysia (OUM)

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 TOPIC 2 ACCOUNTING PRINCIPLES AND CONCEPTS

(a)

Definition of financial statements;

(b)

Purpose of financial statements;

(c)

Qualitative characteristics of financial information;

(d)

Definition, identification and recognition of the elements of financial statements;

(e)

Concepts of capital and capital maintenance; and

(f)

Basis for the measurement of the elements of financial statements.

Conceptual framework is the guidance in preparing and presenting financial statements instead of an accounting standard. Four aspects should be dealt with by the preparers of financial statements. The four aspects are: (i)

Recognition – Whether the transactions concerning elements of financial statements had taken place, relates to the timing of when the transactions were taken place.

(ii)

Measurement – The amounts of the elements which need to be recorded.

(iii) Recording – Procedure of debiting and crediting the relevant accounts. (iv) Presentation – Transactions are disclosed in financial statements.

2.2

FINANCIAL STATEMENTS

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



2.2.1

27

The Purpose of Financial Statements

MFRS 101 states the purpose of financial statement as the following:

Figure 2.1: MFRS 101 Source: MASB – MFRS 101 – Presentation of Financial Statements

In other words, the objective of preparing financial statements is to provide useful information with regards to the financial position, performance and cash flow of a business to all types of users in order for them to make an economic decision. The result of the financial statements shows how the manager of a business entity manages resources contributed by owners. The information provided by the financial statements together with other information provided in the explanatory notes will be used by users to understand and make decisions.


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SELF-CHECK 2.1 Users depend not only on financial information provided by the financial statements but also on non-financial information to make investment decisions. Can you identify the qualitative information that users need to make decisions?

2.3

THE COMPONENTS OF FINANCIAL STATEMENTS

Financial statements of listed public company can be obtained by the public easily. Kuala Lumpur Stock Exchange (KLSE) provides access to the annual reports of listed companies at its website.

ACTIVITY 2.1 You may visit KLSEÊs website for http://www.bursamalaysia.com/market/

further

information,

Please take note that the following illustrations of financial statements are of a sole proprietorship (single ownership). There are slight differences in reporting requirement and format for a partnership and also a company. (a)

Income Statement Income statement reports the financial performance of an entity. It contains information on revenues and expenses including the profit and loss of the business entity. It is also known as revenue statements or profit and loss statements.



29

There are several formats in reporting the revenue and expenses depending on the nature of business run by the entity. Figure 2.2 is an example of an income statement for service providers. Service providers such as travel agents, hotels and colleges earn their revenues by performing or providing services to customers.

Figure 2.2: Income statement for a service provider


30


Meanwhile Figure 2.3 is an example of a merchandiser income statement. A merchandiserÊs (or traderÊs) revenues come from selling goods to customers.

Figure 2.3: Income statement for a merchandiser

(b)

Balance Sheet A balance sheet reports the financial position of a business entity. It contains information on the entityÊs assets, liabilities and ownerÊs equity. Assets are categorised into two: (i)

Current assets are those assets that are expected to provide benefits for twelve months or less from the reporting date. Examples are cash, account receivables, inventories, prepaid expenses and short-term investments.



(ii)

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Non-current assets are those assets that will provide benefits for a period longer than twelve months from the reporting date, which include land and building, motor vehicles, furniture and fittings, equipment and long-term investments.

Liabilities are also categorised into two: (i)

Current liabilities are liabilities that are due within twelve months from the reporting date. Examples are account payables and short term loans.

(ii)

Non-current liabilities are expected to be settled in a period longer than twelve months from the reporting date, such as a long term bank loan.

There are several formats of balance sheets, in „T‰ format (see Figure 2.4) or in a statement format (see Figure 2.5). There are also differences in reporting the ownerÊs equity depending on the form of business; whether it is a sole proprietorship, a partnership or a company. However, at this level the focus will be on a sole proprietorshipÊs balance sheet.


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Figure 2.4: Balance sheet – „T‰ Format



Figure 2.5: Balance sheet – Statement Format


33

34


There are several different formats available for preparing balance sheets. You might read one textbook showing one format and another textbook showing another format. One format might show the working capital which is current assets minus current liabilities while another lists current assets first and then only non-current assets are listed. At first you might find that this is confusing as one format is slightly different than the next. Do take note that whichever format is used, all assets, liabilities and ownerÊs equity, whether they are current or noncurrent, will be categorised accordingly. (c)

Statement of Changes in OwnerÊs Equity Statement of changes in ownerÊs equity reports how the ownerÊs equity has changed over the reporting period. It reports how opening capital has increased through net income, and how it decreased through net losses and drawings. Refer to Figure 2.6 for an example.

Figure 2.6: Statement of changes in ownerÊs equity

(d) Cash Flow Statement Cash flow statement shows the in-flow and out-flow of cash of an organisation according to three main activities which are operating, investing and financing. The format is shown in Figure 2.7, however, as stated earlier preparing a cash flow statement is not part of the syllabus. Copyright © Open University Malaysia (OUM)


Figure 2.7: Cash flow statement

ACTIVITY 2.2 Do you know your net worth? Let us calculate your net worth. 1.

List all your assets. These will be items that you own, house, car, computer etc. Estimate how much they are worth in the market. In other words you might have spent RM5,000 to buy your computer, but now, if you were to sell your computer, the shop is willing to pay RM300 for it. RM300 is the value of your computer.

2.

List all your liabilities. These include any loans you have outstanding on your house, education and even credit card.

3.

Determine the difference (Total Assets minus Total Liabilities). This is your net worth or capital.


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ACTIVITY 2.3 Many online resources for accounting glossary and terms are available on the net. If you need to look up certain accounting terms, do visit: http://www.ventureline.com/accounting-glossary/A/

2.4

ELEMENTS OF FINANCIAL STATEMENTS

The financial statements reflect the financial position and performance as a result of transactions carried out by the business. The primary objective of financial statements is to provide information about the financial position, performance and cash flows of the business that can be used by each user to make economic decisions. The financial statements show the results from the completion of the monitoring task (stewardship), and management must account for every action related to the asset. To meet this objective, the financial statements provide elements as shown in Figure 2.8:

Figure 2.8: Elements of financial statements Copyright © Open University Malaysia (OUM)


37

The following are the details of the elements. (a)

(b)

(c)

Asset Assets are economic resources owned or controlled by a firm whether it was paid or not. Asset is something that is used to assist in the conduct of business operations. Assets are divided into two groups, fixed assets and current assets. (i)

Fixed Assets Fixed assets are assets that are not easily changed in shape and there is more than one financial period. Fixed assets are divided into two, namely tangible assets and intangible assets. Tangible assets are assets that can be seen physically such as machinery, cars and equipment. Intangible assets are fixed assets that exist but cannot be seen physically such as goodwill, patents, copyrights and trademarks.

(ii)

Current Assets Current assets are assets that exist for accounting periods and are highly liquid. Examples of current assets are cash, receivables, prepaid expenses and proceeds receivable.

Liability Liability is a debt to people outside the business. Liabilities are divided into two groups, current liabilities and long-term liabilities. (i)

Current Liabilities Current liabilities are liabilities that exist for an accounting period and the borrower must pay off or settle the debt within one year. Examples of current liabilities are accounts payable, payables, notes payable, short-term loans and bank overdrafts.

(ii)

Long-Term Liabilities Long-term liabilities are debts that must be paid within a period exceeding one year. Examples of long-term liabilities are long-term loans and notes payable where the payment is more than a year.

OwnerÊs Equity Equity is the owner's intended claim against the assets of business to business owners. Owners' equity is the amount of surplus assets over business liabilities.


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Owners' equity for each business structure is different where: (i)

Equity in a company consists of the owners of the paid-up capital, share premium, retained earnings and reserves (over isolated);

(ii)

Equity in partnerships comprise the owners of partner capital accounts; and

(iii) Equity in sole business owners comprise capital contributed by the owners. (d)

Revenue This is the increase in gross value of assets as a result of the sale of goods or provision of services by businesses to customers. Examples of revenue are sales, discounts received, interest received and rent received.

(e)

Expense Expense is cost of services or goods used in the process to get revenue. Expense is also known as part of the cost of assets that have been writtenoff. Examples of expenses are rent, interest, electricity and water, salaries and other expenses.

These elements together with other information (notes to the accounts) help users predict the cash flow of a business in the future.

2.5

QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION

We will now discuss the characteristics that must exist in accounting information in order to make it useful as listed in Figure 2.9:



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Figure 2.9: Seven characteristics of accounting information

These characteristics will be discussed further in the next subtopics.

2.5.1

Relevant

The relevance principle stipulates that all relevant information should be included in the financial statements. Information is considered relevant if it can assist users in making decisions. Copyright © Open University Malaysia (OUM)

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Let us assume that you have extra money and want to buy shares in one of the companies listed in Bursa Malaysia. What type of information might be useful for your needs? You might want to know: (i)

The companyÊs performance for the past five years;

(ii)

What are future projects or new products of the company?; and

(iii) Who managed the company? All the mentioned information, quantitative and/or qualitative, is relevant as it will assist you in deciding whether to buy the company shares or not. For example, the company has made a good profit of RM2,000,000 for the current year. You should not rely on this information only. You must look at the past trend. Assume you find out that the company has been making big losses for three years before the current year. Will you invest your money in the company? Knowing how the company performed in the past years is relevant to your decision. Big losses for three consecutive years might indicate it is risky to invest in the company even though it has been profitable in the current year.

2.5.2

Reliable

Reliable information is information that can be trusted by users. Information must be objective, free from bias and significant errors. Only reliable information will enable users to make better decisions. How are external users of a financial statement ensured of the reliability of information provided? After all, this statement is prepared by the companyÊs accountant. The comic strip (refer to Figure 2.10) proves us the actual scenario in the accounting profession.



41

Figure 2.10: How reliable is the accounting practice?

The accountant and the companyÊs management are bound by law to follow the rules and regulations in preparing the financial statements. It is assumed that if accountants follow the rules and regulations, the information that is reported in the financial statements show a true and fair view of the companyÊs financial performance and position and hence is reliable to users. External users, to some extent are assured of the trustworthiness of the information presented in the financial statement. Public listed companies are required to have their financial statements audited by external auditors to ensure the financial statement has been prepared according to accounting rules and principles and it provides a true and fair view.

2.5.3

Comparable

Comparability refers to the quality of the information that enables users to make comparison in evaluating similarities or differences between companies, industries or over time. This characteristic is important as comparable information is more useful. Consider this example. You are only given this information on Syarikat Along; Syarikat Along made RM10 million profit last year. Is this information enough for you to decide whether you want to invest in the company or not? Will your Copyright © Open University Malaysia (OUM)

42


decision change if you had known that the company has made RM20 million in the previous year? Comparing the companyÊs performance over two periods can lead to a better decision as you can see that there has been a 50 per cent drop in profit. It is a requirement that a company must provide the previous yearÊs information to enable comparison to be made by users.

2.5.4

Consistent

For information to be comparable across industries or over time, information needs to be consistent from one company to another and also over time. Consistency refers to the requirement that companies maintain consistency in the treatment of various items for all accounting periods. In other words, companies should not change the accounting procedures or methods used each year. An example is methods for depreciating non-current assets. There are several acceptable methods to recognise depreciation expense; among them are the straight line method and the reducing balance method. If a company had used the straight line method in one period, they ought to use the same method in the next accounting period. For your information, a company may change accounting methods they use. However, a full disclosure is required in the notes to financial statements to explain why the changes are made and the effects of the changes to the financial statements.

2.5.5

Materiality

Materiality is another important concept, which states that an entity must account for items that are significant to the entityÊs financial statements. In other words, an amount can be ignored if the effect on the financial statements is unimportant to usersÊ business decisions. The materiality of an item depends on the size or value of the items according to the main activities of the business and the nature of the items involved. For example, a separate account for postage expenses for a grocery store is not required to be kept, as the amount is small and not significant for the grocery store. It is sufficient to lump this expense with other expenses under a miscellaneous expense account. However, for a courier company, postage expenses are material and must be disclosed separately. Copyright © Open University Malaysia (OUM)


2.5.6

43

Understandable

The understandability principle requires information to be presented in a format that can be easily understood. The information reported should be understood by users, who are generally assumed to have reasonable knowledge of business and economic activities.

2.5.7

Timely

Relevant and reliable information will be useless if you do not get the information on time. Hence, it is extremely important to prepare the financial statements on time.

ACTIVITY 2.4 You just read on the seven qualitative characteristics of accounting. Based on your experience, which one quality is the most difficult to comply with? Try to justify your claim.

2.6

ACCOUNTING ASSUMPTIONS

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

2.6.1

Assumption 1: Separate Entity

For accounting purposes, the business is considered as a separate entity from the owner. Both the owner and the business are two separate accounting entities. An accounting entity is an economic unit that controls its own resources. Activities of each entity must be separated from its owner. For example, Kak Long owns three different businesses; a restaurant, a laundrette and a grocery store. Imagine, if only one account is prepared for all businesses, would she be able to identify which business is profitable or not? For accounting purpose there are four separate accounting entities; Kak LongÊs personal entity, the restaurant, the laundrette and the grocery store (see Figure 2.11). It means each entity will need to have a separate accounting record. Separation of accounts will enable the owner to know the financial position and performance of each entity. Copyright © Open University Malaysia (OUM)

44


Figure 2.11: Separate entity

It is important to note that accounting entity is not the same as legal entity. A business that is registered as a company is recognised as a legal entity. While for a sole proprietorship and partnership the law does not differentiate the business and its owner.

2.6.2

Assumption 2: Going Concern

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



45

ACTIVITY 2.5 Syarikat Jojo has been making big profits for the past 10 years of operation. However, it will only continue to exist for the next two years. Will you consider investing your money in Syarikat Jojo? Justify your claim.

2.6.3

Assumption 3: Monetary Unit

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

2.6.4

Assumption 4: Accounting Period

This assumption states that the life of a business entity can be divided into periodic intervals. This enables financial statements to be prepared periodically. The accounting year of a 12 month period has been established as the normal period for reporting. This enables the comparison of present and past performance to be made for each accounting period. Accounting year or fiscal year can start at any period but normally it is from 1st January until 31st December, or it starts from 1st July and ends on 30th June the next year. Interim reports can be produced for a period of less than a year; monthly, quarterly and semi-annually reports. These reports are produced to meet the requirements of users for timely information.

2.7

BASIC ACCOUNTING PRINCIPLES SELF-CHECK 2.2

You purchased a new Ferrari for RM500,000 to be used in your business. The day after, a tree fell onto your new Ferrari. Once repaired, the insurance company valued the Ferrari at RM300,000. Can you record the value of the Ferrari at RM300,000? Why?


46


The four basic assumptions have resulted in the following principles:

2.7.1

Principle 1: Historical Cost

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

2.7.2

Principle 2: Revenue Recognition

This principle states that revenue must be recognised when it is earned. Earned revenue commonly refers to the act of providing goods or services to customers. Recognising revenue means the amount is recorded in the account. This principle indicates that although cash has not been received, goods have been delivered or services have been performed and, thus, revenue should be recognised. The opposite also applies, if you have received cash in advance but have not performed any service or provided any goods to your customer, you cannot record the amount of cash received as revenue. In other words, revenue is recognised when earned rather than when cash is received. This notion of recognising revenue when it is earned and not when cash is received is called accrual accounting. The same applies to the recognition of expenses, where expenses should be recognised when it is incurred not when cash changes hand. If you have received the goods or services, although payments are to be made in the future, expense must be recognised at that time (refer to Figure 2.12).

Figure 2.12: Relationship between revenues and expenses



2.7.3

47

Principle 3: Matching

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

Year 1

Year 2

All Expenses for Year 1 Profit for Year 1 = Total Revenue in Year 1 - Total Expenses in Year 1

2.7.4

Principle 4: Full Disclosure

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

2.8

ACCOUNTING STANDARDS

Accounting standards are guidelines that need to be adhered by the accounting profession in preparing and reporting of the financial statements. Rules and guidelines will definitely increase the work quality of accounting professionals. How can we be assured that companies will follow the prescribed guidelines? The Companies Act 1965 requires companies to comply with approved accounting standards. Section 166A of the Companies Act 1965 requires directors Copyright © Open University Malaysia (OUM)

48


of companies incorporated under the Act to ensure accounts are prepared in accordance with the applicable accounting standards to the extent that the accounts give a true and fair view. In Malaysia, the approved accounting standards comprise the following: (a)

Financial reporting standards issued by MASB;

(b)

International accounting standards issued by International Accounting Standard Board (IASB); and

(c)

Technical pronouncements published by MASB.

These accounting standards are developed from guidelines, practices and rules that are acceptable by the accounting profession and known as Generally Accepted Accounting Principles (GAAP). The standards are established so that the accounting practised is standardised and this increases the reliability and comparability of financial statements. Generally Accepted Accounting Principles (GAAP) In preparing the financial statements, accountants have to follow certain standards, guidelines, practices and rules which are known as Generally Accepted Accounting Principles (GAAP). This is to ensure that the financial information provided to external parties to the business is prepared according to a uniform set of assumptions and principles. To prepare, use and interpret financial statements effectively we need to understand these assumptions and principles. There are a number of assumptions and principles. However, this module will only introduce selected assumptions and principles.

GAAP is the common set of accounting principles, standards and procedures that companies use to compile their financial statements. GAAP is a combination of authoritative standards (set by policy boards) and is simply the commonly accepted ways of recording and reporting accounting information (http://www.investopedia.com/terms/g/gaap.asp)

ACTIVITY 2.6 Even though GAAP principles have been in practice for a long time, why do you think that unscrupulous accountants still distort figures? Discuss.



49

•

The accounting profession has to follow standards, rules and guidelines known as the Generally Accepted Accounting Principles (GAAP) to ensure uniformity in preparing and reporting the accounting information.

•

The standards are established so that the accounting practised is standardised and comparability of financial statements is increased.



The proposed framework is a guide and is useful when confronted with issues for which there are no pronouncements.



The objective of the financial statement is to present information about the financial position and performance of a company.



Principal characteristics are relevant, reliable, comparable, consistent, materiality, understandable and timely.

•

There are four assumptions used to facilitate the preparation of financial statements.



–

Separate entity assumption;

–

Going concern assumption;

–

Monetary unit assumption; and

–

Time period assumption.

The basic principles in accounting are: –

Historical cost principle;

–

Revenue recognition principle;

–

Matching principle; and

–

Full disclosure principle.


50


Accounting assumption Accounting entity assumption

Generally Accepted Accounting Principles (GAAP)

Accounting principle

Maturation

Behaviourism

Reflex arc

Constructivism

1.

Match the following accounting bodies with the main function listed as follows: MIA

MICPA

MASB

(a)

________________

publishes accounting standards.

(b)

________________

provides training to accountants.

(c)

________________

controls the accounting practice in Malaysia.

(d)

________________

issues statements of principles for financial reporting.

2.

Can a company ignore the accounting standards in the preparation and reporting of its financial statements?

3.

Malaysian AirlinesÊ (MAS) revenues come from a number of different sources: ticket sales, holiday packages, rentals of planes and advertising. Take for example, ticket sales; normal tickets sold are fully refundable until 24 hours of flight cancellation. However, tickets sold on super saver plan are not refundable. At what point of time will MAS recognise the revenue from these situations?

4.

Classify the following businesses according to their type of business. Business

• •

Type of Business

Car Rental Car Dealership Copyright © Open University Malaysia (OUM)


• • • •

1.

2.

51

Tuition Centres Batik Factory Tailor Clothing Stores

Explain the following accounting assumptions: (a)

Separate entity;

(b)

Going concern;

(c)

Monetary units; and

(d)

Accounting period.

Explain the following accounting principles: (a)

Historical cost;

(b)

Revenue recognition;

(c)

Matching; and

(d)

Full disclosure.

3.

Identify three types of business ownerships.

4.

Explain the characteristics of each of the business ownership identified in Question 3.

1.

Which of the items in the following list are liabilities and which are assets? (a)

Loan to Permata SB

(b)

Bank overdraft

(c)

Fixtures and fittings

(d)

Computers

(e)

We owe a supplier for goods

(f)

Warehouse we own


52


1.

Classify the following items into liabilities and assets: (a)

Motor vehicles

(b)

Premises

(c)

Creditors for goods

(d)

Stock of goods

(e)

Debtors

(f)

Owing to bank

(g)

Cash in hand

(h)

Loan from Mr. JS

(i)

Machinery


Topic



3

Accounting Cycle


Describe the steps involved in the accounting cycle;

2.

Explain the basic accounting equation;

3.

Analyse transactions;

4.

Demonstrate the effect of transactions on the accounting equation; and

5.

Explain the financial statement (MRFS 101).

 INTRODUCTION By now, you would be wondering how to prepare the financial statements discussed earlier. Can you recall the definition of accounting or recall the four components of the accounting process? You need to be able to collect, identify, measure and record before communicating the information to users in the form of financial statements. This process describes the accounting cycle of a business. In this topic, we will begin by introducing the accounting cycle to you. These are the steps that will be repeated at every accounting period. We will then look at the accounting equation, which is Assets equal Liabilities plus OwnerÊs Equity. This equation will always remain in balance at all times. This is the basis of all accounting as every transaction will have certain effects on the accounting equations. MYOB (Mind Your Own Business) is one of the many computer-based accounting systems available in Malaysia. Many companies rely on an Copyright © Open University Malaysia (OUM)

54

 TOPIC 3

ACCOUNTING CYCLE

accounting system to generate reports. An accounting package is an integral part of a business in completing an accounting cycle, as highlighted by a chartered accountant: „Having the right accounting system is essential for any business. It can save time and money. Having the wrong one, however, can cost you hours in inefficiencies and eat into your profits‰. (Tania Parkyn) Chartered Accountant and the Director of Innovative Accounting Systems

3.1

THE ACCOUNTING CYCLE

The accounting process begins with a transaction and ends with closing the books at the end of a period. These steps are repeated at every accounting period and are called the accounting cycle. It begins with the occurrence of the transaction itself, analysing and recording the transactions in journals, posting it to the ledgers and then preparing a trial balance. At the end of the period, adjusting entries are made, adjusted trial balances and financial statements are prepared and then closing entries are done to prepare the temporary accounts for the next periodÊs accounting cycle (refer to Figure 3.1).

Figure 3.1: The accounting cycle

In the following subtopics, we will look at all the steps in the accounting cycle briefly. Copyright © Open University Malaysia (OUM)

TOPIC 3

3.1.1

ACCOUNTING CYCLE 

55

Source Documents

At this stage, information is gathered, generally in the form of source documents, about transactions or events. Source documents are documents that provide proof that a transaction had actually occurred, and this is the basis of accounting records. Examples of source document are sales invoice, purchase invoice, debit note, credit notes, cheques and receipts. Controls on source documents are important to ensure accounting information is accurate and reliable. At a minimum, each source document should include the data, the amount and a description of the transaction. During an audit, source documents are used as evidence that a particular business transaction occurred.

ACTIVITY 3.1 Look at a sample of a sales or purchase invoice. Can you list down the information documented in this source document?

3.1.2

Transactions Analysis

Transactions are analysed; how each transaction affects the accounting equation is looked into. At this stage the accounts affected by the transaction and how it is affected (increased or decreased) will be identified.

3.1.3

Journalising

These transactions are then recorded in journals. A journal is also known as the book of prime entry. It is a chronological record of transactions. Journal entries will facilitate the posting of transactions to ledgers.

3.1.4

Posting to Ledgers

Records from the journal are then posted (transferred) to ledgers. Posting should be done on a timely basis, to ensure the ledger is up to date.

3.1.5

Preparing of Unadjusted Trial Balance

At the end of an accounting period, the balance of all accounts of a business will be listed in the trial balance. Copyright © Open University Malaysia (OUM)

56

 TOPIC 3

3.1.6

ACCOUNTING CYCLE

Adjusting Entries

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

3.1.7

Preparing of Adjusted Trial Balance

Listing of all businessÊ accounts balances after adjustment entries are made.

3.1.8

Preparing of Financial Statements

The result of the business is communicated to users through financial statements. Can you recall the financial statements that you have learned in Topic 1 earlier? An income statement is prepared in order to report the financial performance of the business. The balance sheet is prepared to report the financial position of the business.

3.1.9

Closing Entries

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


TOPIC 3


57

Figure 3.2: The stages involved in preparing the financial statement Source: Horngren (2004)

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


58

 TOPIC 3

3.2

ACCOUNTING CYCLE

ACCOUNTING EQUATION

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

The accounting equation is the fundamental of accounting. The equation presents the resources of a business and the claim against those resources.


TOPIC 3


59

Can you see the relationship between the assets of the business with liabilities of the business and the ownerÊs equity interest? The relationships are presented in the following basic accounting equation (see Figure 3.3).

Figure 3.3: The basic accounting equation

All economic transactions in an entity will affect the equation, meaning they will affect assets, liabilities or ownerÊs equity. Although the items in the equations are affected (increased or decreased), the equation will remain in balance at all times. The basic accounting equation can be expanded to include items of ownerÊs equity.


60

 TOPIC 3

ACCOUNTING CYCLE

There are four items that can affect the ownerÊs equity, and they are shown in Figure 3.4:

Figure 3.4: Transactions effect on ownerÊs equity

The following are the explanation for the items: (a)

Capital investments – they will increase ownersÊ equity;

(b)

Drawings – they will decrease ownersÊ equity;

(c)

Revenues – they will increase the ownersÊ equity; and

(d)

Expenses – they will decrease the ownersÊ equity.

Hence the equations can be rewritten as shown in Figure 3.5:

Figure 3.5: The expanded accounting equation


TOPIC 3


61

The next subtopic will look at the second step in the accounting cycle: analysing a transaction to determine how it affects the accounting equation.

ACTIVITY 3.2 1.

You have a personal wealth of RM100,000, comprising RM10,000 cash and a car worth RM90,000. You had borrowed RM40,000 from your parents to purchase the car. Can you write your accounting equation?

2.

Without looking back, write down the commonly used form of the accounting equation.

3.3

TRANSACTION ANALYSIS

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

Read and think about the transaction.

STEP 2:

Identify components in the equations that are affected. Is it asset, liability or ownerÊs equity?

STEP 3:

Identify the accounts and the effects. Decreased? Increased?

STEP 4:

Check the equation; it has to be balanced.

It is important for you to understand this analysis as it is the basis for preparing journal entries for all transactions. You will need to spend more time learning this before proceeding to the next level. We will see in detail how transaction analysis works by looking into the following transactions of a service based business (refer to Table 3.1).


62

 TOPIC 3

ACCOUNTING CYCLE

Table 3.1: Transactions of a Company Date

Transactions

1 Sept. 2013

Sonic invested RM50,000 cash to start a photography business.

3 Sept. 2013

Sonic purchased a photo processing machine costing RM1,000 cash.

5 Sept. 2013

Sonic withdrew RM10,000 cash for personal use.

6 Sept. 2013

Sonic borrowed RM20,000 cash from Digi Bank.

25 Sept. 2013

Sonic paid off RM5,000 of the bank loan.

26 Sept. 2013

Sonic provided professional photography service for a wedding; RM2,000 cash was received and another RM1,000 will be received within 14 days.

28 Sept. 2013

Sonic paid RM500 cash for his employeeÊs salary, RM300 cash for utilities and RM200 cash for shop rental.

3.3.1

Transaction 1: Initial Investment by Owner

An owner can contribute cash or other assets to the business as capital. For example, the owner can bring his own motor vehicle into the business and this will be considered as capital contribution by the owner to the business. Capital contributions by the owner will increase both the business assets and ownerÊs equity. These are shown in Table 3.2. Table 3.2: Transaction 1 Equation

Description

Transaction

1 Sept 2013, Sonic invested RM50,000 cash to start a photography business Sonic Enterprise.

Basic Analysis

The asset (cash) has increased by RM50,000. The ownerÊs equity (capital) has increased by RM50,000.

Accounting Equation

Assets

Accounting Equation after Transaction 1

Assets

=

Liabilities

+

Cash RM50,000 =

Liabilities

OwnerÊs Equity Capital RM50,000

+

OwnerÊs Equity

The equation remains in balance. Copyright © Open University Malaysia (OUM)

TOPIC 3

3.3.2


63

Transaction 2: Purchase of Non-current Asset

To operate, most business must have non-current assets (fixed assets) that will be used to generate revenues. For example, a delivery van is needed to deliver goods; a machine to produce products and so on. The purchase of such items can either be on cash terms or credit terms. Paying cash for your purchase of noncurrent asset will see your cash asset decreases and your non-current asset increases. Purchasing non-current assets on credit will see your non-current assets increased and your liabilities increased. Refer to Table 3.3 for the explanation of the Transaction 1 to 2. Table 3.3: Transaction 1 to 2 Equation

Description

Transaction

3 Sept. 2013, Sonic purchased a photo processing machine costing RM1,000 cash.

Basic Analysis

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

Accounting Equation

Assets

=

Liabilities

+

 Cash RM 1,000 Accounting Equation after Transaction 1 and 2

Assets

=

Liabilities

OwnerÊs Equity  Equipment 1,000

+

OwnerÊs Equity

Cash + Equipment

Capital

49,000

50,000

1,000

The equation remains in balance.

3.3.3

Transaction 3: Withdrawals by Owners

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

64

 TOPIC 3

ACCOUNTING CYCLE

recorded as drawings. Refer to Table 3.4 for the explanation of the Transaction 1 to 3. Table 3.4: Transaction 1 to 3 Equation

Description

Transaction

5th Sept. 2013, Sonic withdrew RM10,000 cash for personal use.

Basic Analysis

The asset (cash) has decreased by RM10,000. The ownerÊs equity (capital*) has decreased by RM10,000.

Accounting Equation

Assets

=

Liabilities

+

Cash 10,000 Accounting Equation after Transaction 1, 2 and 3

Assets

=

Liabilities

OwnerÊs Equity Capital * 10,000

+

OwnerÊs Equity


Note: * Withdrawals by owners are not recorded in the capital account directly but will be recorded in an account called drawings. Drawings represent a reduction in ownerÊs equity.

3.3.4

Transaction 4: Borrowing Money

To finance business operations such as buying non-current assets, office supplies, and paying employees, sometimes the cash capital from the owner is not enough. Business can borrow money from another company, a person or a financial institution to increase its available funds. This borrowing represents an obligation to business to pay the principle amount plus interest charges. Borrowing increases both assets (cash) and liabilities of a business. Refer to Table 3.5 for the explanation of Transaction 1 to 4.


TOPIC 3


65

Table 3.5: Transaction 1 to 4 Equation Transaction

Description 6 Sept. 2013, Sonic borrowed RM20,000 cash from Digi Bank. (In this example we will ignore the interest charges)

Basic Analysis

The asset (cash) has increased by RM20,000. The liability (loan) has increased by RM20,000.

Accounting Equation

Assets

=

Liabilities

+

OwnerÊs Equity

Cash 20,000 Accounting Equation after Transaction 1, 2, 3 and 4

Assets

=

Liabilities

Loan 20,000 +

OwnerÊs Equity

The equation remains in balance

3.3.5

Transaction 5: Repayment of Borrowings

Borrowings must be paid off. Repayment methods and amount varies according to the loan agreement. For example a borrower might pay only monthly interest charges over the period of the loan and the whole principle at the end of the loan term or a borrower might pay equal monthly sum which includes interest and principle amount over the period of the loan. Repayment of borrowing will reduce both assets (cash) and liabilities of the business. Refer to Table 3.6 for the explanation of Transaction 1 to 5.


66

 TOPIC 3

ACCOUNTING CYCLE

Table 3.6: Transaction 1 to 5 Equation

Description

Transaction

25 Sept. 2013, Sonic paid off RM5,000 of the bank loan.

Basic Analysis

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

Accounting Equation

Assets

=

Liabilities

+

OwnerÊs Equity

Cash 5,000 Accounting Equation after Transaction 1, 2, 3, 4 and 5

Assets

=

Liabilities

Loan 5,000 +

Cash + Equipment 54,000

1,000

OwnerÊs Equity Loan Capital 15,000

40,000


3.3.6

Transaction 6: Earning Revenues

The main objective of business is to make profit. In order to make profit, businesses must earn revenues. Revenues can be in many forms, a service provider provides services to customers, a merchandiser sells goods to customers and a manufacturer sells manufactured goods to a wholesaler. A business can earn sales commission revenues, interest revenues from cash deposits in bank or event rental revenues for renting out office space to clients. Most of the time, customers will pay cash for service rendered or goods delivered to them, but some will pay later (credit term). Regardless whether cash has been received or not, as long as you have earned the revenue it should be recorded as such. Revenues will increase assets (cash or receivables) and ownerÊs equity. Refer to Table 3.7 for the explanation of Transaction 1 to 6.


TOPIC 3


67


Description

Transaction

26 Sept. 2013, Sonic provided professional photography service for a wedding, RM2,000 cash was received and another RM1,000 will be received within 14 days.

Basic Analysis

The asset (cash) has increased by RM2,000. The asset (accounts receivable) has increased RM1,000. The ownerÊs equity (photography fees) has increased by RM3,000.

Accounting Equation

Assets

=

Liabilities

+

Cash 2,000

OwnerÊs Equity OE through

Accounts Receivable 1,000 photography fees 3,000 Accounting Equation after Transaction 1, 2, 3, 4, 5 and 6

Assets

=

Liabilities

+

OwnerÊs Equity

Cash + AR

Loan

Capital

56,000

15,000

43,000

1,000 +

Equipment 1,000


3.3.7

Transaction 7: Paying for Expenses

In generating sales, business will incur expenses. Examples of such expenses are paying for shop rentals, wages and salary, utilities, insurance, advertising, office supplies, motor vehicle maintenance, repairs and many more. You might pay the expenses with cash as they incurred or you pay it later. Nonetheless, expenses will reduce your assets (cash) if paid by cash, or increase your liabilities (if no cash is paid) and reduce ownerÊs equity. Refer to Table 3.8 for the explanation of Transaction 1 to 7.


68

 TOPIC 3

ACCOUNTING CYCLE


Description

Transaction

28 Sept 2013, Sonic paid RM500 cash for his employeeÊs salary, RM300 cash for utilities and RM200 cash for shop rental.

Basic Analysis

The asset (cash) has decreased by RM1,000. The ownerÊs equity (expense) has decreased by RM1,000.

Accounting Equation

Assets

=

Liabilities

+

Cash 1,000

OwnerÊs Equity OE by 1,000 through in expenses

Accounting Equation after Transaction 1, 2, 3, 4, 5, 6 and 7

Assets

=

Liabilities

+

Cash 55,000

OwnerÊs Equity

Loan 15,000

Capital 42,000

+ Equipments 1,000 + AR 1,000


There are many transactions other than the examples given earlier. All will have an effect on the accounting equation. However, the accounting equation will always remain balanced.


TOPIC 3


69

SELF-CHECK 3.1 Can you give examples of a business transaction that will have the following effects to the accounting equation? 1.

Increase in an asset and increase in a liability.

2.

Increase in an asset and decrease in another asset.

3.

Decrease in an asset and increase in a liability.

4.

Increase in an asset and increase in ownerÊs equity.

5.

Decrease in an asset and decrease in ownerÊs equity.

Summaries of how each of the mentioned transaction affects the accounting equation are given in the following Table 3.9. Go through this again to check your understanding. Table 3.9: Transaction Analysis

Cash

1st Balance 3rd Balance

50,000 50,000 (1,000) 49,000

5th

(10,000)

Balance 6th Balance 25th Balance 26th

39,000 20,000 59,000 (5,000) 54,000

Balance

56,000

28th

(1,000)

Balance

=

LIABILITIES

+

OwnerÊs Equity

Equipment

=

Loan

+

Capital

1,000 1,000

= = = =

ASSETS

Date (Sept. 2013)

+

+

+ +

50,000 50,000 50,000 (10,000) Drawings 40,000

= +

1,000

+

1,000

+

1,000

2,000

55,000

Accounts Receivable

1,000 +

= = = = =

20,000 20,000 (5,000) 15,000

+

40,000

+

15,000

+

40,000 3,000 Revenues 43,000 (500) salaries (300) utilities (200) rentals 42,000

=

1,000

1,000

=

=

+

1,000

+

1,000

=

15,000


+

70

 TOPIC 3

3.4

ACCOUNTING CYCLE

PRESENTATION OF FINANCIAL STATEMENT (MFRS 101)

You can refer to the MASB website (http://www.masb.org.my/) for more information on the format for presentation of financial statements.

3.4.1 Statement of Financial Position (Balance Sheet) Statements of financial position or balance sheets of the organisation on a specific date provide information about: (a)

Tangible fixed assets – such as plant, land, machinery, vehicles and equipment.

(b)

Intangible fixed assets such as goodwill.

(c)

Current assets which are assets that can be converted to cash within one year.

(d)

Liability of current liabilities (debt due within one year and long-term liabilities.

(e)

Equity of owner(s) (owner claims on business).

(f)

Working capital surplus of current assets over current liabilities (current assets – current liabilities).

3.4.2

Income Statement

Income statements are reports on the financial performance and results of the organisation for a certain period of time.

3.4.3

Statement of Changes in Equity

Statement of changes in equity shows: (a)

All changes in equity; and

(b)

Changes in either equity from capital transactions with owners or distributed to owners.


TOPIC 3

3.4.4


71

Cash Flow Statements

Cash flow statements report cash inflows and cash outflows for the period. This is influenced by: (a)

Operating activities (sales, collection, receivables, purchases and pay creditors);

(b)

Investing activities (contribution of investment funds and dividend payments);

(c)

Financing activities (loans and loan payments); and

(d)

Cash flow is important to know the level of survival of the organisation's ability to generate cash and cash needs of the organisation to be used.

3.4.5

Notes to the Accounts

Notes to the accounts should be as follows: (a)

Present information about the basis of preparation of the financial statements and the specific accounting policies selected and applied for significant transactions and details.

(b)

Disclose the information required by MASB Standards that is not presented in any place in the financial statements.

(c)

Provide additional information that is not presented on the face of the financial statements, but it is necessary for a fair presentation.

Notes to the accounts are presented in an orderly manner. Each item of the balance sheet, income statement and cash flow statement should be referenced to any related information with explanatory notes.

•

The accounting cycle begins with the occurrence of the transaction itself, analysing and recording the transactions in journals, posting them to ledgers and then preparing a trial balance. At end of the period, adjusting entries are made, adjusted trial balance and financial statements are prepared and then closing entries are done to prepare the temporary accounts for the next periodÊs accounting cycle.

•

The basic accounting equation is Assets equal Liabilities plus OwnerÊs Equity. Copyright © Open University Malaysia (OUM)

 TOPIC 3

72

•

ACCOUNTING CYCLE

There are four items that can affect the ownersÊ equity, they are: –

Capital investments; they will increase ownerÊs equity;

–

Drawings; they will decrease ownerÊs equity;

–

Revenues; they will increase the ownerÊs equity; and

–

Expenses; they will decrease the ownerÊs equity.

•

The expanded accounting equation can be written as Assets equal Liability plus OwnerÊs Equity plus Revenues minus Expenses and minus Drawings.

•

All transactions will have an effect on the accounting equation; however, the accounting equation will remain in equilibrium at all times.

•

Transactions are analysed to see the accounts affected and the effects they have on the accounting equation.

Accounting equation

Liability

Adjustment

Presentation

Asset

Statement

Equation

1.

Calculate the missing figures. Assets

Liabilities

Owner's Equity

Business A

79,500

45,000

?

Business B

?

23,000

45,600

Business C

163,700

?

104,500


TOPIC 3

2.

(a)

(b)


73

Indicate whether the following items are A (Assets), L (Liabilities), R (Revenues) or E (Expenses). (i)

Cash

(viii) Accounts payable

(ii)

Bank loan

(ix)

Accounts receivable

(iii) Equipment

(x)

Sales

(iv) Notes payable

(xi)

Supplies

(v)

(xii) Advertising

Insurance

(vi) Salaries

(xiii) Salaries payable

(vii) Furniture and fittings

(xiv) Motor vehicle

Explain how the following transactions will affect the accounting equation. Identify the account affected. (i)

Pay cash for postage.

(ii)

Buy furniture and fittings on credit.

(iii) Bring own motor vehicle to be used for business purposes. (iv) Pay salaries to workers. (v)

1.

(a)

Date

Receive rentals from tenants.

Based on the following transaction analysis worksheet of Azwan Enterprise, describe the nature of each transaction (1-9). Azwan Enterprise provides printing services to its clients. Cash

Opening Balance 1/1/2013

7,500

Trans 1

-1,000

Trans 2

2,000

Trans 3

-4,000

Trans 4

-1,000

Accounts Receivable

Supplies

Land

Accounts payable

Bank Loan

3,800

400

38,000

3,700

10,000

Capital 36,000

1,000 -2,000 -4,000 -1,000 (Rent) Copyright © Open University Malaysia (OUM)

74

 TOPIC 3

ACCOUNTING CYCLE

Trans 5

2,000

-2,000 (Wages)

Trans 6

7,000

7,000 (Revenue)

Trans 7

1,500

Trans 8

1,500

3,500

Trans 9

3,500 (Revenue) -1,200

Cash

Accounts Receivable

Supplies

-1,200 Land

Accounts payable

Bank Loan

Capital

Ending Balance, 31/1/2013

2.

(b)

Determine the balance of each account in the worksheet.

(c)

Show the accounting equation for Azwan Enterprise.

(d)

Based on information provided in the transaction analysis worksheet earlier, calculate Azwan EnterpriseÊs income.

Che Wan opens a beauty salon on 1 February 2013. During the first month of operation the following transactions occurred: February 1

Che Wan invested RM150,000 of her own cash in the business and borrowed RM100,000 from a bank

2

She paid cash for furniture and fittings for the shop costing RM25,000.

5

Purchased on credit beauty supplies worth RM4,000.

7

Performed makeup service for a wedding and billed the customer for RM5,000.

10 Che Wan withdrew RM20,000 and invested it in a restaurant business. 12 Che Wan renovated her apartment, paying RM10,000 from her own funds. 15 Provided beauty consultation for a client and received RM3,000 cash for her service. 16 Purchase a second hand car for business use. She paid RM5,000 cash and borrowed another RM15,000 from a bank. Copyright © Open University Malaysia (OUM)

TOPIC 3


75

17 Received RM3,000 cash as partial payment for service rendered on 7th February. 25 Paid the full amount owed for beauty products purchased on 5 February. 27 Purchased beauty supplies worth RM5,000 for cash. 28 Paid the following expenses for cash: Electricity – RM100 Rental – RM1,500 WorkersÊ salaries – RM2,000 You are required to:

1.

(a)

Analyse the effects (increase and decrease) that the mentioned transactions have on the accounting equations and identify the specific accounts affected; and

(b)

Analyse the effects of the above transactions to the accounting equation, by using the format similar to Table 3.1.

Draw up PurupuruÊs balance sheet from the following information as at 31 December 2013. RM Capital

7,200

Debtors

1,200

Van

3,800

Creditors

1,600

Fixtures

1,800

Stock of goods

4,200

Cash at bank

300


76

 TOPIC 3

ACCOUNTING CYCLE

1.

You are required to open the asset, liability, capital accounts and record the following transactions for June 2013 in the records of BerryCo.

2013 June 1

Started business with RM1,200.

2

Paid RM11,700 of the opening cash into a bank account for the business.

5

Bought office furniture on credit from OrangeCo for RM1,900.

8

Bought a van paying by cheque RM5,250.

12

Bought equipment from PineappleCo on credit RM2,300.

18

Returned faulty office furniture costing RM120 to OrangeCo.

25

Sold some of the equipment for RM200.

26

Paid amount owing to OrangeCo RM1,780 by cheque.

28

Took RM130 out of the bank and added to cash.

30

KiwiCo lent RM4,000 – giving the money by cheque.

Horngren, C. T. (2004). Management accounting: Some comments. Journal of Management Accounting Research, 16 (1), 207-211.


Topic



4

Adjusting Entries and Closing Entries


Distinguish cash basis accounting from accrual basis accounting;

2.

Identify the types and purpose of adjusting entries;

3.

Prepare adjusting entries;

4.

Prepare an adjusted trial balance;

5.

Prepare closing entries; and

6.

Prepare the financial statements from the adjusted trial balance.

 INTRODUCTION In Topic 3 you have learned how to analyse, journalise, post, prepare transactions and trial balances and the basic financial statements for a business that provides services. However, you are not done yet! The transactions that you have previously recorded occurred in the same accounting period (you recorded the transactions as they occur). However, not all transactions have been recorded, as there are internal transactions and events that need adjustment at the end of the accounting period. This is due to the accrual accounting principles that recognise revenues when they are earned and match these revenues with expenses that are incurred in the same accounting period.


78

 TOPIC 4 ADJUSTING ENTRIES AND CLOSING ENTRIES

It is most important to understand the difference between cash basis accounting and accrual basis accounting. In this topic, you will also learn how to record adjusting entries and prepare an adjusted trial balance before preparing the financial statements and close temporary accounts. „Many small construction firms find the option of utilising cash basis accounting to be a practical method of bookkeeping. The cash basis method allows deductions for expenses to be taken in the year that they are paid and reporting of income in the year received. For businesses, however, where merchandise is an income-producing factor, the Internal Revenue Service (IRS) strongly favours the „accrual method‰.⁄⁄⁄⁄..In April 2002, the IRS issued regulation 2001-76, which expands the number of businesses that are permitted to use the cash accounting method. Specifically, the rule states that qualifying businesses with less than $10 million in annual revenues can use cash accounting for tax purposes⁄⁄The rule change will benefit more than 500,000 small businesses by reducing administrative cost allowing deduction⁄..‰ Associated Builders and Contractors (2014)

4.1

ACCOUNTING BASIS

In order to understand adjusting entries it is best for us to understand and differentiate accrual and cash basis accounting.

4.1.1

Cash Basis Accounting

Under cash basis accounting, transactions are recognised (recorded) when they involve cash. Revenues are recognised when cash is received while expenses are recognised when there are payments of cash (refer to Figure 4.1).

Figure 4.1: Cash basis accounting

This system is simple but at the same time it does not give an accurate picture of the financial performance and financial position of the entity. The information provided by a financial statement prepared under cash basis will be incomplete. Copyright © Open University Malaysia (OUM)

TOPIC 4 ADJUSTING ENTRIES AND CLOSING ENTRIES 

79

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

It does not follow the matching principle if credit transactions exist;

(b)

As a result of understating revenue or overstating expenses, profit or loss calculated under cash basis accounting does not reflect the „true‰ business performance; and

(c)

Since the liabilities and assets are not recognised, the balance sheet does not provide the „true‰ picture of the businessÊ financial position.

Do take note that the cash basis accounting is not consistent with the generally accepted accounting principles and is not allowed to be used in practice.

4.1.2

Accrual Basis Accounting

Accrual accounting recognises revenue after goods are delivered or services provided to customers, regardless of whether cash has been received or not. Let us take the example in subtopic 4.1.1, where a firm provided services worth RM15,000 on credit terms. The RM15,000 will be recognised as revenue under accrual basis accounting as services have been provided to customers even though no cash has been received. It is the same with JanuaryÊs utility expenses; you have used the utilities during January. It is JanuaryÊs expenses and should be recognised as so.


80


Let us look at another example. Suppose Che Ah Enterprise paid for one year insurance in advance for RM1,200 on January 1, 2013. Assuming now it is March 30, 2013 and Che Ah Enterprise wants to calculate its income for the first three months of operation, how much insurance expenses should be recognised? Can you draw the time line for this example? Accrual basis accounting will recognise that only three monthsÊ expenses are matched with the same period revenues. Hence only RM300 (RM1,200  3/12) will be recognised as expenses. Another RM900 will be reported as an asset (prepaid insurance) at the end of that period (March 30, 2013). Cash basis accounting on the other hand will recognise the full amount of RM1,200 as expenses. Accrual basis accounting takes into account all revenues that are earned during the accounting period, and match them with all expenses incurred in generating the said revenues. This in fact, gives a „true‰ picture of the business performance compared to using cash basis accounting, and this is the reason why accrual basis accounting is better than cash basis accounting. The strengths of accrual basis accounting are: (a)

It measures the „true‰ financial performance of a business, through accurate measurement of revenue and expenses for the period;

(b)

It shows the „true‰ financial position of a business, through accurate reporting of liabilities and assets; and

(c)

It matches revenues with expenses for the period.

Accrual basis accounting is used in practice to prepare and report financial statements. Figure 4.2 explains the differences between cash basis and accrual basis.

Figure 4.2: Cash versus accrual basis accounting Copyright © Open University Malaysia (OUM)


81

As explained in the previous subtopics, under accrual basis accounting some transactions need to be adjusted to reflect their true measurement of revenues, expenses, assets and liabilities.

ACTIVITY 4.1 1.

2.

4.2

The difference between cash and accrual basis accounting has to do with the time frame in which revenues and expenses are recorded and reported. These websites offers an explanation of how accrual basis accounting and cash basis accounting differ. (a)

http://accountinginfo.com/study/accrual-101.htm

(b)

http://office.microsoft.com/en-us/support/understandingcash-and-accrual-basis-accounting-HA010164612.aspx

An income statement of a firm that uses the accrual basis accounting shows a profit of RM1 million. Does this mean the firm has RM1 million cash?

ADJUSTING ENTRIES

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


82


Figure 4.3 summarises the adjustment entries that need to be made at the end of a financial year.

Figure 4.3: Adjusting entries that need to be made at the end of a financial year

4.2.1

Prepaid Expenses

Prepaid expenses are items that are paid for before their benefits are received or used.

Prepaid expense is an asset. When the assets are used, consumed or expired, they become expenses and should be recognised. These items include supplies, rentals and insurance. Let us look at this example. Suppose on 1 January 2013 you purchased office supplies worth RM500 for cash. The following entries will be made to record the purchase. 1/1/13

Dr

Office supplies 500 Cr Cash 500 To record purchase office supplies for cash.


83


You will be using these office supplies during the operation of your business like taking a pen, diskettes, paper, etc. from the supplies, but it is very unlikely for you to record this as expense every time you take these items as it is not practical to do so. At the end of the month, you do a stock check and find that the office suppliesÊ worth is RM300. Can you see that you do not have RM500 worth of office supplies anymore, only RM300 are left? You have used up RM200 worth of office supplies and this usage (expense) has never been recorded. Thus, it is necessary to make the following adjusting entry at the end of the month to account for the supplies used. 30/1/13

Dr

Supplies expense Cr Office supplies To record supplies used.

200 200

The effect of the adjusting entry is to recognise the expense of RM200 and reduce the office supplies from RM500 to RM200. See the following accounts: Office Supplies Date

Description

1/1/13

Cash

Amount 500

Date

Description

30/1/13

Supplies expense

30/1/13

Closing Balance

Amount 200



500



300 500

This amount will be reported as an asset (office supplies) in the balance sheet as at 30 Jan 2013. Supplies Expense

Date 30/1/13

Description

Amount

Office Supplies

200

Date 30/1/13

Description Closing Balance

200



Amount



200 200

This amount will be transferred to income summary account as supplies expense for the month.


84


Another example is prepaid insurance. Let us assume Xtrail Enterprise paid for three years of insurance coverage of RM3,600 on 1 January 2013. The transaction will be recorded as the following: 1/1/13

Dr

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

Prepaid insurance account is a current assets account. As at January 1, 2012, Xtrail EnterpriseÊs insurance benefits cover the period of 1 January 2012 until 31 December 2014 (36 months). Xtrail wants to prepare its income statement for the year ended 31 December 2012, or after one year of operation. Has any insurance expense been recorded? Does Xtrail have RM3,600 worth of insurance as asset as at 31 December 2012? The answer to both questions is a NO. In fact, you should realise that Xtrail has used up one year of the insurance; hence, this amount should be recognised and recorded as expense. As XtrailÊs asset has been used up, it should be reduced. Hence, the following adjusting entry should be made. 31/12/12

Dr

Insurance expense 1,200 Cr Prepaid insurance 1,200 To record the insurance expense for the year.

The effect of the adjusting entry is to recognise the insurance expense of RM1,200, and reduce the prepaid insurance from RM3,600 to RM2,400. As at 31/12/2012 your prepaid insurance will provide coverage for two years. See the following account: Prepaid Insurance Date

Description

1/1/12

Cash

Amount

Date

3,600

Description

31/12/12

Insurance expense

31/12/12

Closing Balance

Amount 1,200

 2,400

3,600

3,600

 This amount will be reported as asset (prepaid insurance) in the balance sheet of the business as at 31 Dec 2012.



85

Insurance Expense Date

Description

31/12/12

Prepaid insurance

Amount 1,200

Date

Description

31/12/12

Closing Balance

Amount

 1,200

 This amount will be transferred to the income summary account as the insurance expense for the year ended 31 December 2012.

4.2.2

Unearned Revenue

There are a few situations where you will receive cash in advance before delivering goods or providing services. These include rent received in advanced and subscriptions received in advance. According to the revenue recognition principle, revenue can only be recognised when you have earned it, not when you receive cash for it. In fact, when you receive cash in advance, you have an obligation (a liability) to provide goods or services to the customer. Xtrail Enterprise rents out an office space to Keno. On 1 July 2013, Keno paid three monthsÊ rental of RM4,500. The journal entry to record this in XtrailÊs book is: 1/7/13

Dr

Cash 4,500 Cr Rental Revenue 4,500 To record received three months rentals in advance from

K Assume that Xtrail Enterprise prepares its financial statement at 31 July 2013. If no adjustment is made, the account Rental Revenue will show an amount of RM4,500. In fact, Xtrail has not earned the RM4,500 rental revenue; only RM1,500 is earned and it owes Keno another two monthsÊ rental or RM3,000 worth of rental services. Hence, the following adjusting entries need to be made: 31/7/13

Dr

Rental Revenue 3,000 Cr Unearned Rental Revenue 3,000 To record the earning of one month rental that was received in advance.


86


The entry reduces the Rental Revenue amount to RM1,500 (which is already earned by Xtrail) and creates a liability account, Unearned Rental Revenue of RM3,000. See the following accounts: Rental Revenue Date

Description

31/7/13

Unearned Rental Revenue

31/7/13

Closing balance

Amount

Date

3,000

1/7/13

Description Cash

Amount 4,500

 1,500 4,500

4,500

 This amount will be transferred to the income summary account as the rental revenue for the month ended 31 July 2013.

Unearned Rental Revenue Date

Description

31/7/13

Closing Balance

Amount

Date

 3,000 31/7/13

Description

Amount

Rental Revenue

3,000

 This amount will be reported as current liabilities in the balance sheet as at 31 July 2013.

In all unearned revenue, cash is received before the work is performed or the goods are delivered. Any unearned revenue is a liability.

4.2.3

Accrued Expenses

Accrued expenses refer to expenses that a business incurs before paying them. These include items such as electricity and telephone bills, salaries and wages, and interest on loans. For example, on 30 January 2013, the utility bill for January was received for the amount of RM250, but no payment was made. Adjusting entries on 30 January 2013 will be made to recognise the utility expense of RM250 and the existence of a liability (Utilities Payable) of RM250 as at 30 January 2013.



30/1/13

87

Dr

Utilities expenses 250 Cr Utilities payable 250 To record accrued utilities expenses of RM250.

The related accounts are shown as follows: Utilities Expense Date 30/1/13

Description Utilities Payable

Amount

Date

250

30/1/13

Description Closing Balance

Amount



250

 This amount will be transferred to the income summary account as the utilities expense for the month ended 30 January 2013. Utilities Payable Date

Description

30/1/13

Closing Balance

Amount 250

Date 30/1/13

Description Utilities Expense

Amount



250

 This amount will be reported as current liabilities (Utilities Payable) in the balance sheet as at 30 January 2013.

4.2.4

Accrued Revenues

Accrued revenues refer to revenues that a business has earned but cash has not been received. These include items such as interest, rent and commissions. Xtrail Enterprise provides consulting services to Keno. The contract is from 1 January until 30 June 2013 and payment of RM6,000 will only be made at the end of the contract. Suppose Xtrail prepares its financial statement on 30 January 2013, a month after signing the contract. If no adjusting entries are made, Xtrail Enterprise will not be reporting the consultation revenue of RM1,000 that they have earned. 30/1/13

Dr

Consultation fees receivable 1,000 Cr Consultation fees 1,000 To record accrued revenues for consultation service Copyright © Open University Malaysia (OUM) provided.

88


The related accounts are shown as follows: Consultation fees Date

Description

Amount

Date

Description

Amount

30/1/13

Closing Balance

 1,000

30/1/13

Consultation fees receivables

1,000

 This amount will be transferred to the income summary account as the revenues (Consultation fees) for the month ended 30 Jan 2013.

Consultation Fees Receivable Date

Description

Amount

Date

Description

Amount

30/1/13

Consultation fees

1,000

30/1/13

Closing Balance

 1,000

 This amount will be reported as current asset in the balance sheet as at 30 Jan 2013.

An accrued expense is expensed first and paid later. A prepaid expense is paid first and expensed later. Accruals and prepayments are opposites.

4.2.5

Depreciation

Depreciation is the allocation of non-current assets cost as expense over its estimated useful life. The reason for this allocation is that you use non-current assets to generate revenues; for example, you use a motor vehicle to deliver goods to customers and plants and machinery to produce goods. The matching principle states that revenues must be matched with expenses, and therefore we must allocate the cost of using the non-current assets as expense. There are many ways of calculating depreciation. One method is the straight line method. The rest of the methods will be covered in another topic. Copyright © Open University Malaysia (OUM)

89


As an example, on 1 January 2013, Xtrail Enterprise purchased a delivery van for RM60,000 cash. The expected useful life of this van is 10 years and there is no residual value. Using the straight line method, the assetÊs cost minus its residual value will be allocated evenly over 10 years. As the delivery van has zero residual value, the amount of RM60,000 will be allocated evenly over the 10 year period. This means RM6,000 will be expensed as depreciation annually. The adjusting entry at the end of the first year for depreciation is as the following: 31/12/13 Dr

Depreciation Expense Cr Accumulated Depreciation – Motor Vehicle To record depreciation expense for the period.

6,000 6,000

The related accounts are shown as follows: Depreciation Expense Date

Description

31/12/13

Acc. Depreciation – Motor Vehicle

Amount 6,000

Date

Description

31/12/13

Closing Balance

Amount



6,000

 This amount will be transferred to the income summary account as the depreciation expense for the year ended 31 December 2013.

Accumulated Depreciation – Motor Vehicle Date

Description

Amount

31/12/13

 Closing Balance

6,000

Date 31/12/13

Description Depreciation expense

Amount 6,000

 This amount will be reported as a contra to motor vehicle in the balance sheet as at 31 December 2013. You will not credit the non-current asset account directly but use a contra account called accumulated depreciation account. Copyright © Open University Malaysia (OUM)

90


Depreciation account contains only the depreciation charges for the current year while accumulated depreciation account contains total depreciation charges from the date of purchase. Contra account figure will be deducted from the non-current assetÊs original cost in the balance sheet to get the net value of the non-current assets. An example is shown next: Xtrail Enterprise Extract of Balance Sheet for the year ended 31 December 2013 RM

RM

RM

Non-current Assets Vehicle

60,000

Less Accumulated Depreciation

(6,000)

Other non-current asset

4.2.6

54,000 XXX

XXX

Bad Debts ACTIVITY 4.2

A firmÊs balance sheet shows an accounts receivable balance of RM500,000. Do you believe that the firm will be able to collect all of the RM500,000? Why do you think so? Discuss. It is common for businesses to allow credit sales. If you recall, an account called accounts receivable (an asset) will be debited when such a transaction occurs. This accounts receivable or debtors represent an asset to your business, as in the future you will be able to receive the payment. However, businesses are exposed to risks that some of these accounts receivable will not be able to be collected. For example in the event of a debtorsÊ death, business bankrupt or other reasons, you will not be able to collect from your debtors. When this happens, the debts will be known as bad debts. In other words, if someone owes you money that you cannot collect, you have a bad debt.



91

The accounting for bad debts is as follows:

Date

Dr

Bad debts expense XX Cr Accounts receivable XX To record the write off of accounts receivable as a result of bad debt.

Date

Dr

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

Consider the following transaction. On 1 July 2013, Raz & Partners provide consultancy services to Hamza Stores worth RM1,500 on credit. On 1 March 2014, the debts remained unpaid as Hamza has migrated to Australia and could not be traced. Raz & Partners decides to write off Hamza StoresÊ debt of RM1,500. Raz & Partners closes its account on 30 June every year. The transactions will be recorded as follows: 1/7/13

Dr

Accounts Receivable - Hamza Store Cr Consultancy Fees To record consultancy services on account.

1,500 1,500

Accounts Receivable – Hamza Store Date

Description

1/7/13

Consultancy fees

Amount

Date

Description

1,500


Amount

92


1 March 2014, Raz & Partners will make the following entry to write off the debts as it was determined to be bad (uncollectable). Writing off is the process of eliminating amount owed by Hamza from the business records. 1/3/14

Dr

Bad debts expense Cr Account Receivable - Hamza Store Writing off Hamza StoreÊs debt.

1,500 1,500

This entry brings the Accounts receivable – Hamza Store to zero. The debt that is bad has been eliminated or written off. Accounts receivable – Hamza Store Date 1/7/13

Description Consultancy fees

Amount 1,500

Date 1/3/14

Description

Amount

Bad debts expense

1,500

Bad Debts Expense Date 1/3/14

Description Accounts Receivable – Hamza Store

Amount

Date

Description

Amount

1,500

At the end of the period, bad debts expenses account will be closed to the income summary. 30/6/14

Dr

Income summary 1,500 Cr Bad debts expense 1,500 To record transfer bad debts expense to income summary.


93


Bad Debts Expense Date 1/3/14

Description Accounts Receivable – Hamza Store

Amount 1,500

Date

Description

30/6/14

Income summary

Amount 1,500

Business should never give up on bad debts. You must try to recover the debts by all means, even by going through a court order to demand payments from your debtors. Debts that are recovered after being written off are treated as revenue. The following discusses the accounting treatment for recovery of bad debts.

ACTIVITY 4.3 1.

There are many precautionary measures you can take to avoid the risk of bad debts. One of them is to get new customers who cannot provide a satisfactory credit, to provide a guarantor who is financially sound. What are other ways that can you think of to minimise the risk of bad debts?

2.

To do further reading on how to avoid bad debts, do check out these websites: (a)

http://www.australiamigration.com/page/Bad_Debts/150; and

(b)

https://www.ema.co.nz/resources/EMA%20Guides%20 and%20Templates/Advocacy%20Documents/Bad_Debts. pdf

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


94


Date

Dr

Accounts Receivable Cr Bad debts recovered To record bad debts recovered

Date

Dr

Date

Dr

XX XX

Cash XX Cr Accounts Receivable XX To record cash received from bad debts recovered

Bad debts recovered XX Cr Income summary XX To record transfer of bad debts recovered to income summary

From the Raz & Partners example, assume that on 31 December 2013, Hamza was finally located, and payment for his debts was demanded. He agreed to pay a final sum of RM500 to avoid any legal action, and this was accepted by Raz & Partners.



95

On 31 December 2013, Raz & Partners will record the following: 31/12/13

31/12/13

Dr

Accounts Receivable - Hamza Cr Bad debts recovered To record bad debts recovered from Hamza.

500

Dr

500

Cash Cr Accounts Receivable – Hamza To record cash received from Hamza.

500

500

Accounts receivable - Hamza Store Date 30/12/13

Description

Amount

Bad debts recovered

500

Date

Description

31/12/13

Cash

Amount 500

Bad Debts Recovered Date

Description

Amount

Date 31/12/13

Description Accounts receivable Hamza

Amount 500

Transfer the bad debts recovered to income summary at end of period. 30/6/14

Dr

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

Bad Debts Recovered Date 30/12/13

Description Income summary

Amount 500

Date

Description

31/12/13

Accounts receivable - Hamza


Amount 500

96


4.2.7

Provision for Doubtful Debts

As discussed earlier, not all accounts receivable can be collected. A balance sheet that shows accounts receivable of RM500,000 as their current assets does not necessarily mean that the business will be able to collect the amount in full. Therefore a business needs to make an estimate or provision of how much of the accounts receivable might not be collected in the future. Accounts receivable are reported in the balance sheet less the provision for doubtful debts (shown as follows). Provision of doubtful debts is a contra account to accounts receivable. Normally, provision for doubtful debts is calculated based on a certain percentage of the accounts receivable balance that might not be collected. There are several bases used to estimate the provision of doubtful debts. They can be based on past experience, knowledge of the debtorÊs financial position and ageing analysis. (a)

Creating Provision for Doubtful Debts Doubtful debts are recorded for the first time as the following: Date

Dr

Income summary Cr Provision for Doubtful Debts Providing for uncollectible debts in the future.

XX XX

Assume that Peter Printing Company has been operating for a year, and at end of year 31 December 2012, has accounts receivable balance of RM55,000. Peter estimates that 10 per cent of his debtors will not be able to pay up. On 31 December 2012, the provision of doubtful debts is created. 31/12/12

Dr

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


5,500


97

Provision for Doubtful Debts Date 30/12/13

Description

Amount

Closing balance

5,500

Date

Description

30/12/12

Income summary

1/1/13

Opening balance

Amount 5,500



5,500

 The closing balance of RM5,500 will be the opening balance for the next period stated 1 January 2013. At year end 31 December 2012, the accounts receivable and provision of doubtful debts will be reported as the following: Peter Printing Company Extract of Balance Sheet for the year ended 31 December 2012 RM

RM

RM

Current Assets Accounts Receivable

55,000

Less Provision of Doubtful debts

(5,500)

Other current assets

(b)

49,500 XXX

XXX

Increase or Decrease in Provision for Doubtful Debts In the next accounting period year end, there might be an increase or decrease in the provision of doubtful debts, in this case only the increment or decrement is recorded. An increase in the provision of doubtful debts represents a loss or an expense and thus is reported as one in the income statement. A decrease in the provision of doubtful debts represents a gain or revenue and thus is reported as one in the income statement.


98


Company Name Extract of Income statement For the year ended XX/XX/XXXX RM

RM

RM

Other revenues Provision of doubtful debts (decreased in)

XX

Bad debts recovered

XX

XXX

Operating expenses Bad debts

XX

Provision of doubtful debts ( increased in)

XX

XXX

Assume that Peter Printing Company has an accounts receivable balance of RM90,000 as at 31 December 2013. He estimates that 10 per cent of these accounts are uncollectable. Then the following entry is made to reflect the increase in his estimate from RM5,500 to RM9,000 which is an increase of RM3,500. 31/12/13

Dr

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

Provision for Doubtful Debts Date 31/12/12

31/12/13

Description Closing balance

Closing balance

Amount 5,500

9,000

Date

Description

Amount

31/12/12

Income summary

5,500

1/1/13

Opening balance

5,500

31/12/13

Income summary

3,500

9,000

9,000

Now, let us assume that Peter Printing Company has an accounts receivable balance of RM70,000 as at 31 December 2014. He estimates that Copyright © Open University Malaysia (OUM)


99

10 per cent of these accounts are uncollectable. Then the following entry is made to reflect the decrease in his estimate from RM9,000 to RM7,000, which is a decrease of RM2,200. 31/12/13

Dr

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

Provision for Doubtful Debts Date

Description

Amount

31/12/13

Income summary

2,000

31/12/13

Closing balance

7,000

Date 1/1/13

Description

Amount

Opening balance

9,000

9,000

9,000 1/1/14

Opening balance

7,000

Ask the following questions before you make adjusting entries. (a)

How was the transaction recorded and what is the current balance?

(b)

What should the balance be?

(c)

How much is the adjustment?

To summarise, Figure 4.4 shows the effect of prepayments and accruals on items in the balance sheet and profit and loss (P & L) statement before adjustments are made. In order to report the correct figure the relevant adjusting entries (as shown) must be made. For example, if no adjustments are made to expenses (for example, insurance expense) initially recorded as prepaid expenses (for example, prepaid insurance) at the end of accounting period, the asset (prepaid insurance) will be overstated while expense (insurance expense) will be understated.


100  TOPIC 4 ADJUSTING ENTRIES AND CLOSING ENTRIES

Figure 4.4: Summary of effects and adjustment entries


TOPIC 4 ADJUSTING ENTRIES AND CLOSING ENTRIES  101

ACTIVITY 4.4 This crossword puzzle is for you to test your understanding. Go for it!

Down 1.

We measure expenses when _________.

2.

Which basis of accounting poses lesser ethical challenges?

3.

A _________ expense is paid first and expensed later.

4.

We measure revenues when _________.

Across 1.

Which basis of accounting better measures business profit (revenue-expenses)?

2.

A category of adjusting entries.

3.

Money you cannot recover is called bad ______.



4.3

ADJUSTED TRIAL BALANCE

A trial balance is initially prepared at the end of an accounting period before adjustments are made. This trial balance is known as unadjusted trial balance.

Later after adjusting entries are made, another trial balance is prepared. This is known as adjusted trial balance. Similar to the first unadjusted trial balance, the adjusted trial balance lists all the accounts with their normal balance. However, all accounts created under the adjustment entries are included in the adjusted trial balance such as depreciations, accrued expenses, accrued revenues and unearned revenues. From this adjusted trial balance figure, the financial statements will be prepared. See an example as shown in Figure 4.5. Xtrail Enterprise Adjusted Trial Balance as at 30 June 2013 Account Number 1001 1002 1003 1004 1005 1006 2001 2002 2003 3001 3002 4001 4002 5001 5002 5003 5003

Account

Debit RM

Cash Accounts receivable Prepaid insurance Accrued consultation fees Motor vehicle Accumulated depreciation – motor vehicle Accounts payable Accrued utilities expenses Bank loan Capital – Xtrail Drawings - Xtrail Consultation fees Interest revenues Salaries expenses Utilities expenses Insurance expense Depreciation

Credit RM

45,000 1,000 2,000 2,000 10,000 3,000 2,700 300 14,000 40,000 5,000 13,000 1,000 2,500 3,300 1,700 1,500 74,000

Figure 4.5: Example of adjusted trial balance – Xtrail Enterprise Copyright © Open University Malaysia (OUM)

74,000


4.4

CLOSING ENTRIES

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

4.4.1

Temporary Accounts

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

4.4.2

Permanent Accounts

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

4.4.3

Recording Closing Entries

There are four steps in closing entries as explained next. Using the earlier adjusted trial balance for Xtrail Enterprise as at 30 June 2013, you will learn how to do the closing entries.



The first step is to transfer the credit balance of revenue and gain accounts to the income summary account. This is done through the following entry: Date

Dr

Revenue (or gain) account Cr Income Summary account Closing revenues account to income summary

XX XX

For Xtrail, the following entry should be made: 30/6/13

Dr Dr

Consultation fees 13,000 Interest revenue 1,000 Cr Income Summary account 14,000 Closing revenues account to income summary

The effect of this entry is it will bring the revenues account balance to zero. Consultation fees Date

Description

30/6/13

Income summary

Amount

Date

 13,000 30/6/13

Description

Amount

Balance

13,000

Income Summary Account Date

Description

Amount

Date

Description

30/6/13

Consultation fees

Amount

 13,000

Interest revenue



1,000

This amount will be transferred to the income summary as the revenues (consultation fees) for the month ended 30 June 2013, and the consultation fees account balance is zero.



Interest Revenue Date

Description

30/6/13

Income summary

Amount 1,000

Date

Description

30/6/13

Amount

Balance

1,000

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

Dr

Income Summary account Cr Expense (or loss) account Closing expenses account to income summary.

XX XX


Dr

Income Summary account 9,000 Cr Salaries expenses Utilities expenses Insurance expense Depreciation Closing expenses account to income summary.

2,500 3,300 1,700 1,500

The mentioned entry will effectively bring all the expenses account balance to zero. Salaries expenses Date 30/6/13

Description Balance

Amount 2,500

Date

Description

30/6/13

Income summary


Amount

 2,500


Income Summary Account

Date

Description

30/6/13

Salaries expenses

Amount



2,500

Utilities expenses

3,300

Insurance expense

1,700

Depreciation expense

1,500

Closing balance

5,000

Date 30/6/13

Description

Amount

Consultation fees

13,000

Interest revenue

1,000

14,000



14,000

This amount will be transferred to the income summary as the expense (salaries expenses) for the month ended 30 June 2013, and the salaries expenses account balance is zero.

Can you see that the income summary account only contains revenues and expenses accounts? Can you also see that revenue items are listed on the credit side of the income summary account while expense items are listed on the debit side? If you remember these, you will be able to learn how to prepare an income summary account. An income summary account calculates the income of the business. If revenues are higher than the expenses, the business will record a profit. On the other hand, if expenses are higher than revenues, the business will record a loss.

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

Dr

Income Summary account Cr Capital Transferring profit to capital account.

XX XX



On the other hand, if loss is recorded, the following entry is made: Date

Dr

Capital Cr Income Summary account Transferring loss to capital account.

XX XX


Dr

Income Summary account Cr Capital Transferring profit to capital account.

5,000 5,000

This entry will bring the income summary account balance to zero. Income Summary Account Date 30/6/13

Description

Amount

Salaries expenses

2,500

Utilities expenses

3,300

Insurance expense

1,700


1,500

Capital



Date

Description

30/6/13

Consultation fees

Amount 13,000

Interest revenue

1,000

5,000 14,000

14,000

Capital Date

Description

30/6/13

Closing balance

Amount 45,000

Date 30/6/13

Description

Amount

Balance Income summary

45,000


40,000



5,000 45,000




The profit will be transferred to the capital account and it increases the capital balance.

The last step of the closing process is to close the debit balance of drawing accounts to capital account. The following entry is made: Date

Dr

Capital XX Cr Drawings XX To close drawings account to capital account.


Dr

Capital 5,000 Cr Drawings 5,000 To close drawings account to capital account.

As a result, the entry will bring the drawings account balance to zero. Drawings Date 30/6/13

Description

Amount

Balance

5,000

Date 30/6/13

Description Capital

Amount



5,000

Capital Date 30/6/13

Description

Amount

Drawings



Closing balance

 40,000

5,000

Date 30/6/13

Description

Amount


45,000


40,000 5,000 45,000




The drawing balance will be transferred to capital account and this decreases the capital balance.

 The closing balance of the capital account will be reported in the balance sheet as the balance as at 30 June 2013. Note the distinction between adjusting and closing entries. Adjusting entries are required to update certain accounts in your general ledger at the end of an accounting period. They must be done before you can prepare your financial statements and income tax return. Closing entries are needed to clear out your revenue and expense accounts as you start the beginning of a new accounting period.

ACTIVITY 4.5 There is a simple quiz in this website on closing entries. Have a go! http://school.discoveryeducation.com/quizcenter/info/about.html

•

Cash basis accounting recognises revenue when cash is received and expenses when there are cash payments.

•

Accrual basis accounting recognises revenue when it is earned and expense when it is incurred regardless of whether cash has been received or paid.

•

Adjusting entries are made at the end of an accounting period to assign revenues to the period they are earned and expenses to the period they are incurred.

•

Prepaid expenses refer to items paid in advance before receiving the benefits. Hence, they are reported as current assets in the balance sheet.

•

Depreciation is the cost of allocating cost of non-current assets over its estimated useful life.

•

Unearned revenues refer to cash that is received in advance before services are provided or goods delivered to customers. They are reported as current liabilities in the balance sheet. Copyright © Open University Malaysia (OUM)


•

Accrued expenses are expenses incurred but not paid yet. Recognition of accrued expenses will increase expenses and liability (payables).

•

Accrued revenues are revenues earned but not received yet. Recognition of accrued revenues will increase revenues and asset (receivables).

•

Adjusted trial balance is prepared after recording adjusting entries. The new balances are used to prepare the financial statements.

•

Temporary accounts consist of revenue, expense, income summary and drawings. Accounts will be closed at the end of an accounting period to bring its balance to zero.

•

Permanent accounts consist of assets, liabilities and equity accounts which will not be closed. They will show balances which will be brought forward to the next period.

Accrual basis of accounting

Closing entry

Adjusting entries

Prepaid expenses

Cash basis of accounting

Unearned revenue income

1.

The following is information on Onn & Sons Enterprise for the month of January 2013. (a)

Total revenue from service provided is RM35,000. RM7,500 of these revenues still remain uncollected.

(b)

Onn & Sons has purchased RM5,000 supplies for cash. During January, Sen Ang used RM3,000 worth of supplies.

(c)

Onn & Sons has paid three months rent in advance (Jan, Feb and March 2013) for RM3,000.

(d)

Onn & Sons has not paid his workersÊ salaries for January amounting to RM2,000.

You are required to calculate the profit or loss of Onn & Sons Enterprise for the month of January 2013 under: Copyright © Open University Malaysia (OUM)


2.

(a)

Cash basis accounting; and

(b)

Accrual basis accounting.

Crystal had a balance of RM1,617 in office supplies on hand on January 1, 2013. During the year, more office supplies were purchased amounting to RM3,603 and recorded in the asset account. A physical count of the office supplies on December 31, 2013 revealed that RM526 remained on hand. You are required to calculate the office supplies used and provide the journal entry to record the adjustments that need to be made on December 31, 2013.

3. Bintang Corp. had a RM400 balance in its prepaid insurance account on January 1, 2013 from a three year insurance policy acquired on Sept 1, 2010. This policy was renewed on September 1, 2013 for an additional three years with a payment of RM2,160. Bintang initially records purchase of insurance in the prepaid account. You are required to calculate the insurance expense and provide the journal entry to record the adjustment that needs to be made on December 31, 2013. 4.

Ujang Magazine sells magazines on a subscription basis. On 1 April 2010, cash in the amount of RM1,800 was received for magazine subscriptions for the next 36 months. Ujang made a credit entry to a liability account when the cash is received. You are required to calculate the subscription revenues for 2010 and provide the journal entry to record the adjustment that need to be made on 31 December 2010.



1.

Lyd Enterprise has a RM30,000, 12 per cent note payable due to Malayan Banking on March 30 2013. The money was borrowed on 1 October 2010. The first interest payment of RM900 [(RM30,000  12%) ൈ 3/12] is due on 31 March 2011. You are required to provide the journal entry to record the adjustment that needs to be made on 31 December 2010.

2.

On 1 October 2013, Gigantic Corp deposited RM24,000 in a fixed deposit account at one of the local banks. 12 per cent interest will be paid every six months. As at 31 December 2013 interest earned on the fixed deposit amounted to RM720 (RM2,400  12%)  3/12). You are required to provide the journal entry to record the adjustment that needs to be made on 31 December 2013 by Gigantic Corp.

3.

Read the following information regarding Imran Khan Enterprise. 01.01.2013

–

Balance of a debtor, Star, of RM300 has remained uncollected for six months.

05.01.2013

–

Sold goods on credit to Venus for RM600 and the credit terms are 2/10, n30.

10.02.2013

–

Star was declared bankrupt and unable repay his debt. Imran Khan decides to write off StarÊs debt.

07.10.2013

–

Venus, having difficulty in meeting up payment, offers to pay RM200 as full settlement for his debts. The offer has been accepted and payment of RM200 is received. To write off the remaining balance as bad debts.

01.12.2013

–

After much pursuance, Star pays up RM100 of what he previously owed as full settlement.

You are required to: (a)

Record the transactions in general journal; and

(b)

Show the individual accounts receivable, bad debts expense account and bad debts recovered account. Copyright © Open University Malaysia (OUM)


4.

MKS Accounting firm starts operation on 1 July 2012. They provide accounting and auditing services to businesses. The following is the unadjusted trial balance of MKS Accounting firm as at 30 June 2013. MKS Accounting Firm Trial Balance as at 30 June 2013 Accounts Cash Office supplies

Debit

Credit

RM

RM

13,000 500

Accounts receivable

2,300

Prepaid insurance

4,800

Building

60,000

Motor vehicle

30,000

Accounts payable

5,600

Bank loan

25,000

Capital - MKS

60,000

Drawings - MKS

1,200

Accounting fees

25,700

Rental revenues

2,400

Interest expense

1,000

Salaries expenses

4,500

Utilities expenses

1,400 118,700

118,700

Additional information: (a)

Office supplies used during the year amounted to RM350.

(b)

Insurance was paid on 1 July 2012 for two years (24 months) coverage.

(c)

Building is depreciated at five per cent of original cost.

(d)

Motor vehicle is expected to have five years of useful life.



(e)

The accounting fees include retainer fees received for service to be provided in July and August 2013, amounting to RM3,400.

(f)

Tenant owed RM500 for May and June shop rentals as at 30 June 2013.

(g)

Interest on loan of RM300 is due on 30 June 2013, but this has not been paid.

(h)

Salaries accrued amount to RM600 and utilities expense accrued is RM200.

(i)

Provision of doubtful debts for RM300 is to be created.

(j)

As at 30 June 2013, you are required to: (i)

Prepare the adjusting entries.

(ii)

Prepare the adjusted trial balance.

(iii) Prepare •

Income statement; and

•

Balance sheet of MKS.

(iv) Prepare the closing entries for MKS. (v)

Show the income summary account and capital account of MKS.


Topic



5

Accounting for Current Assets


Discuss the importance of internal control for assets;

2.

Describe the guidelines on the internal control for cash;

3.

Explain the purpose of preparing bank reconciliation;

4.

Prepare bank reconciliation;

5.

Explain the purpose of petty cash fund;

6.

Journalise the creation and reimbursement of petty cash fund; and

7.

Record the inventories.

 INTRODUCTION Is it a good idea to keep your hard earned money under the mattress instead of in the bank? Well, there are several reasons why you should not keep your money under the mattress. First of all, it is for security reasons and imagine all the interest you could have earned if you had deposited your money in the bank. Just as cash is important to you, it is vital for a business to manage not only cash but other assets as well. This topic looks at accounting for current assets. What is current asset? Current assets of a business comprise cash, receivables, inventories, short-term investment and prepayments. These current assets are important to businesses. For example, businesses sell inventories to generate revenues. Sales of inventories can be made in cash or credit terms and credit sales will give rise to Copyright © Open University Malaysia (OUM)

116  TOPIC 5 ACCOUNTING FOR CURRENT ASSETS

accounts receivables. Businesses must manage the cash so as to avoid theft or misappropriation. Accounts receivables must be managed effectively in order to collect the amount owed from debtors. This topic will look at the definition of assets according to MFRS. Focus is given to current assets, in particular, cash. We will discuss the basic internal control procedures to protect businessÊ assets. Then look at the definition of cash and why it is important to control it. You will also learn how to prepare bank reconciliation statements. Finally, you will learn accounting for petty cash funds.

5.1

ASSETS

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

5.1.1

Internal Control for Assets

Internal controls are used to monitor and control business activities. An internal control system comprises policy and procedures used to: (a)

Safeguard the assets used in its operation;

(b)

Ensure accurate and reliable accounting records;

(c)

Promote efficient operation; and

(d)

Encourage adherence to company policy.


TOPIC 5 ACCOUNTING FOR CURRENT ASSETS  117

ACTIVITY 5.1 1.

The Institute of Internal Auditors Malaysia has published a Statement on Internal Control – Guidance for Directors of Public Listed Companies. A copy of this statement can be found at http://www.bursamalaysia.com/market/listed-companies/ This statement provides guidance on the disclosure in the annual report of public listed companies on the state of internal control in accordance to the listing requirements of KLSE.

2.

Visit your favourite departmental store. Can you identify and list the various types of internal controls that are used to protect their assets?

These policies and procedures vary from one organisation to another, depending on the nature of their business and size. Among others, the following procedures must exist to ensure adequate internal control in an organisation. (a)

Maintain adequate records. For example, detailed record of assets should be kept so that it is difficult for assets to be stolen or go missing without detection;

(b)

Insure assets. Protect business property assets and human resources with adequate insurance coverage. For example, assets must be protected (warehouse locked and guarded) and insured against theft and fire;

(c)

Separate bookkeeping from custody of assets. Responsibility for initiating business transactions and custody of business assets must be separated from the responsibility for maintaining accounting records. This is to avoid or minimise the risk of misappropriation of assets. For example, a storekeeper is not the same person initiating the purchase of office supplies;

(d)

Apply technological controls. Use devices designed to protect assets and improve accuracy of the accounting process. For example, the use of electronic tags to protect books in the library from getting stolen;

(e)

Perform regular and independent reviews.



5.1.2

Current Assets

According to Malaysian accounting standard MFRS 101 – Presentation of Financial Statement, an asset is classified as a current asset when it is: (a)

Expected to be realised in, or is held for sale or consumption in, the normal course of the enterpriseÊs operating cycle; or

(b)

Held primarily for trading purposes or for the short term and expected to be realised within twelve months of the balance sheet date; or

(c)

Cash or a cash equivalent asset which is not restricted in its use.

All other assets should be classified as non-current assets. Source: http://www.masb.org.my/

In other words, current assets include cash or cash equivalents and other assets that can be converted into cash, and other assets that can be resold or used in manufacturing goods within a period of one accounting year or less. Current assets are shown in Figure 5.1.

Figure 5.1: Current assets

The following subtopics will look at accounting for cash in detail. Copyright © Open University Malaysia (OUM)


5.2

ACCOUNTING FOR CASH

Cash is the most important asset a business has. Cash is crucial to the survival of a business entity. A business may report high profit, but without cash to run its operations, the business will be faced with a liquidity problem. Cash is defined as cash and bank deposits and any items that are accepted by a bank as deposit. These items include coins, currencies, cheques, bank draft, postal order, money order, travellerÊs cheques and others. Cash is the most liquid asset and thus is easily hidden and moved. Hence a good internal control is required to avoid theft and misappropriation of cash. Internal Control for Cash An effective system of internal control to protect cash should have the following guidelines: (a)

All cash receipts and payments must be accompanied by a document or evidence: a receipt, bill, invoice or cheque butt. The use of pre-numbered receipts and cheques helps internal control for cash;

(b)

All cash receipts must be deposited into the bank account at the end of each day. In the event that cash is kept at the premise of the business, it must be stored in a locked vault at the premise until it is deposited into the bank account;

(c)

All payments must be made through issuing of cheques, except for a smaller amount which uses the petty cash. In many business organisations, a cheque requires two signatories rather than one for tighter cash control;

(d)

Established responsibility – assign tasks that are suited to an individualÊs qualification and experience. This reduces the possibility of errors and when a problem occurs, it is easy to identify the person responsible; For example, at the check-out counter, only the cashier can receive cash from the customer;

(e)

Separation of duties, staff who receive and handle cash should not be involved in recording (book keeping) of cash transactions;

(f)

Rotation of duties. Temptation and fraud can be reduced if employees know that they can be transferred without notice from one department to another. For example, banks rarely allow their employees to work at the same branch for more than three years;



(g) Periodical visits and random checks. Management and supervisors must check on their employees; for example check records and tabulate cash to see if they tally; and (h)

Perform bank reconciliation.

ACTIVITY 5.2 In your opinion, why must a business protect its cash? How do you control your own cash? Discuss with your coursemates.

5.3

BANK RECONCILIATION

Bank reconciliation is a document to explain all differences between a firmÊs own cash records and the bank statement figures on a certain date. It is prepared by the firm (not the bank) to ensure accuracy of financial records. Before we go on to discuss the steps involved in preparing a bank reconciliation statement, we will look at the types of bank accounts available. We will then look at the purposes of preparing a bank reconciliation statement.

5.3.1

Types of Bank Accounts

Businesses will keep their cash in the bank. There are at least three different types of bank accounts (see Figure 5.2).

Figure 5.2: Types of bank accounts



Now, let us see the types in detail. (a)

Savings account – The account holder can withdraw money at any time through a passbook or any automatic teller machine (ATM). The account holder can update the passbook to know the detailed transactions and current balance of account.

(b)

Current account – No passbook is given to account holders although money can be withdrawn through the ATM at any time. An additional feature of a current account is the ability of an account holder to draw cheques to make payments. The account holder will receive a bank statement detailing transactions of a particular month.

(c)

Fixed deposit account – Cash is kept at the bank for a certain period of time. Cash cannot be withdrawn within this period without a penalty. Higher interest rate is earned compared to savings and current accounts.

A business normally owns a few types of bank accounts. However, in this topic, we will assume that business only keeps one type of bank account, which is a current account. Firms will record cash as receipts when they receive cheques from another party. Hence, the firmÊs cash account will record an increment (DEBIT CASH). These cheques are later deposited into the firmÊs bank account. Once the cheques are cleared, the amount will be added to the firmÊs current account balance (CREDIT CURRENT ACCOUNT). The same applies when the firm draws cheques to make payments to another party (suppliers, employees, creditors); it will be recorded as cash payment and hence the firmÊs cash account will record a decrease (CREDIT CASH). The holder of the cheque will later present it to the bank to demand payment. If there are sufficient funds in the account of the drawer (the firm), the bank will honour the cheque and deduct the amount from the firmÊs current account (DEBIT CURRENT ACCOUNT). Did you notice that when we deposit cash or cheque in the bank, the bank statement will show as a credit? When this cash is deposited in a bank, the bank has an obligation to pay the money back to the customer on demand. The deposit represents a liability to banks, and therefore, customersÊ bank accounts have credit balances. Figure 5.3 summarises the flow of bank deposits and payments.



Figure 5.3: Flow of bank deposits and payments

At the end of the month, banks will issue statements detailing transactions to the firm. It is uncommon to see the balance of a firm's cash account exactly equal the cash balance shown on the firm's bank statement. Therefore, the need arises for reconciliation of the firmÊs cash account and the bank statement.

ACTIVITY 5.3 Can you figure out the reasons for the difference in the bank balance and the book balance? Copyright © Open University Malaysia (OUM)


5.3.2

Purposes of Preparing Bank Reconciliation

Bank reconciliation is prepared by a firm in order to: (a)

Reconcile the balance of firmÊs cash account with the balance stated in the bank statement for a particular month; and

(b)

Ensure the accuracy and the validity of items recorded in the cash account. Any omissions and errors can then be corrected.

The balance on the bank statement usually disagrees with the cash account balance according to the firmÊs records because of the following reasons: (a)

Items (transactions) which appear in the bank statement (for example, bank charges, interest, dishonoured cheques and others) but have not yet been recorded by the firm.

(b)

Items recorded in the firm's cash account (for the same period) may NOT be recorded by the bank on the bank statement, for example, unpresented/outstanding cheques drawn by the firm, late deposits and deposits in transit.

(c)

Errors made by the firm or bank in their respective accounts.

Figure 5.4 shows an example of bank statement.



Figure 5.4: Bank statement

5.3.3

Preparation of Bank Reconciliation Statement

The following are the steps that you should follow in order to prepare bank reconciliation:



(a)

If items appear in cash account and bank statement, tick (√) the items off.

(b)

Check also for errors in figures recorded in the cash accounts. We always assume the figures shown in the bank statements are correct unless stated otherwise.

(c)

Items that are not ticked in the debit side of cash account are deposit in transit or deposit not yet credited (cash receipts that a firm has deposited into the bank but not yet credited into the firmÊs current account by the bank).

(d)

Items that are not ticked in the credit column of the bank statement, are items that the firm has not recorded as receipt in the firmÊs cash account. (Bank has recorded receipts of cash in the firmÊs current account).

(e)

If items appear in the cash account and bank statement, tick (√) the items off.

(f)

Check also for errors in figures recorded in the cash accounts. We always assume the figures shown in the bank statements are correct unless stated otherwise.

(g)

Items that are not ticked in the credit side cash account are unpresented cheques (Cheques that have been issued to creditors, but the amount has not been deducted by the bank from the firmÊs current account).

(h)

Items that are not ticked in the debit column of the bank statements are items that the firm has not recorded as payments in the firmÊs cash account. (Bank has deducted payments of cash in the firmÊs current account)

(i)

Examples of items that appear in the bank statement but not yet recorded in the firmÊs cash account and their treatment are as follows (see Table 5.1):



Table 5.1: Items in Bank Statement Debit FirmÊs Cash Account

Credit FirmÊs Cash Account

Dividend received

Bank charges or fees

Direct credit

Stamp duty and taxes

Interest on deposit

Dishonoured cheques Direct debit

(j)

Dishonoured cheques are cheques that are received by a firm, and are recorded as receipts in the cash book. However, due to several factors such as insufficient funds in the drawerÊs account, wrong signatures, errors or expired dates; the cheques will not be honoured by the paying bank. In this case, firm must correct the entry first made to record the receipt. Therefore, credit the bank account and debit the related account, for example, debit accounts receivable.

(k)

Amend errors made in the firmÊs cash account.

(l)

Normally, journal entries are required to be made before the cash book is updated. In the illustration, you will be shown the journal entries.

After taking into account all of the adjustment from the above, you need to determine the new cash account balance (Important! This will be the starting figure for your bank reconciliation statement). Cash accounts can have credit balances, when it means the firm has drawn more funds than it has. If firms have arranged for overdraft facilities with the bank, the bank will allow an overdraft. Firm will need to pay interest on the overdraft facilities, as well as paying off the overdraft. Overdraft will be reported as current liabilities in the balance sheet.



Cash Account Date

Description

Amount

Opening bank balance

Date

XX

Cash receipts

Description

Amount

Cash payments

XX

XX

Bank fees and charges

XX

Dividend received

XX

Stamp duties

XX

Interest on deposit

XX

Direct debit

XX

XX

Dishonoured cheque

XX

Direct credit Correction of errors

XXX

Correction errors Balance c/d

XXX

of

XX

 XXX XXX

FirmÊs Name Bank Reconciliation as at 31 December 2013 RM Balance as per cash account

RM XXX

Add Unpresented cheques (list all items) Cheque no 10##

XX

Cheque no 11##

XX

 Bank errors in crediting current account

XX

XXX XXX

Less Deposit in transit Deposit not yet credited

XX

 Bank errors in debiting current account

XX

Balance as per bank statement


XXX

 XXX


*



This balance will be the balance used in the bank reconciliation statement



Bank can make errors through crediting (adding) funds that do not belong to customers or debiting (deducting) funds.



This figure should be the same as the balance stated in the bank statement. An overdraft will be shown as DEBIT balance in the bank statement. Note: If the cash account balance is credit, the figure will be shown in brackets (XX)

To help you learn the preparation of bank reconciliation, let us look at this illustration. You were asked to prepare a bank reconciliation for Syarikat Kejora for the month ended 30 March 2013. The bank showed a balance of RM9,750 while the bank statement showed a balance of RM9,812. Example 5.1 Assuming that you have completed step 1 and step 2, whereby you compare the cash account and bank statements, you must have ticked items that appeared in both accounts. The cash account and bank statement will look like the following: Step 1 and 2: Compare cash account and bank statement Cash Account Date

Description

1/3

Balance b/d

2/3

A/R – Ali

13/3

A/R – Zack

23/3

Rental revenue – burn

25/3

Sales

Amount

Date

Description

5,700

4/3

A/P – Eda (1008)

1,500

10/3

A/P – Loo (1009)

 2,600

15/3

Salaries (1010)

300

27/3

Purchase (1011)

3,300

30/3

Insurance (1012)

30/3

Balance b/d

Amount 300



150 400

1,200

 1,600

13,400 Copyright © Open University Malaysia (OUM)

9,750 13,400


Syarikat Kejora Bank Statement as at 30 March 2013 DEBIT

CREDIT

BALANCE

1/3

Balance b/d

5,700

3/3

Deposits

6/3

Cheque 1008

300

6,900

10/3

Standing instruction to pay subscription fees

 450

6,450

15/3

Cheque 1010

400

6,050

17/3

Deposits (for A/R - Alin)

23/3

1,500

7,200

 2,300

8,350

Deposits

300

8,650

25/3

Deposits

3,300

11,950

27/3

Cheque 1011

 2,100

9,850

30/3

Bank charges

40

9,810

30/3

Stamp duties

8

9,802

30/3

Interest

 10

9,812



Deposit in transit.



Unpresented cheques.



Error has been made in recording purchase as RM1,200, the correct amount should be RM2,100.



Item not yet recorded in the cash book.



Step 3: Update cash account Cash Account Date 30/3

Description

Amount

Balance b/d

9,750

A/R-Wan

2,300

Interest

10

Date 30/3

Description

Amount

Bank charges

40

Stamp duties

8

Purchase

900

Subscription fees

450

Balance c/d

10,662

12,060

12,060

Remember the accounting cycle? Journal first, then only post to accounts. The following are journal entries required to record the unrecorded transactions and correct errors: Dr

Cash Cr Accounts Receivable – Wan To record receipt of payment into bank account from AR-Wan Dr

Debit 2,300

Credit 2,300

Cash Cr Interest Revenue To record interest on cash deposit

10

Dr

Bank Charges Cr Cash To record bank charges

40

Dr Stamp duties Cr Cash To record stamp duties

8

10

40

8

Dr Purchase Cr Cash To correct amount of purchases recorded

900

Dr

450

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

900


450


Step 4: Prepare the bank reconciliation statement Syarikat Kejora Bank Reconciliation as at 30 March 2013 RM Balance as per cash account Unpresented cheques Cheque 1009 Cheque 1012

Add

150 1,600

RM 10,662

1,750 12,412

Less



Deposit in transit A/R – Zack Balance as per bank statement

2,600

 9,812

This figure must equal the balance as per the bank statement of Syarikat Kejora.

5.4

PETTY CASH

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

5.4.1

Creating the Petty Cash Fund

A specific individual is appointed to handle the petty cash. He will be responsible for all payments made using the petty cash. To create the petty cash, an estimate of cash required for a specific period must be made. This amount is then withdrawn from the bank account and given to the person in charge of the petty cash, known as the petty cashier (custodian). Copyright © Open University Malaysia (OUM)


The petty cashier will keep the petty cash in a safe place (safe deposit or vault). Another control practice is to set the maximum amount for payment. For example, any payment exceeding RM50 must not be made using petty cash. Or conditions or terms of usage; only payment for postage, stationeries or fares shall be allowed from the petty cash. Assume that on 1 January 2013, Segar Berhad agreed to create a petty cash fund of RM500. It was also agreed that the funds will be reimbursed at the end of every month or whenever the amount used reaches RM400, whichever comes first. The journal entry to create the petty cash fund for Segar Berhad on 1 January 2013 is as follows: Dr

Petty cash Cr Cash To record the establishment of petty cash fund of RM500.

5.4.2

500 500

Using the Petty Cash Fund

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


5.4.3

Reimbursement of the Petty Cash Fund

As mentioned earlier, no records are made at the times of reimbursing the amount claimed by employees or other parties. Petty cash will decrease as more and more reimbursement is made. For illustration purposes, let us assume that for the month of January 2013, payments using the petty cash fund comprise the following: stationeries RM46; postage RM15; newspaper RM33, petrol RM45; taxi fare RM5 and magazines RM12. The journal entries to record the expenses and the reimbursement of petty cash fund are the following: Dr Dr Dr

Stationeries 46 Transportation expense* 50 Miscellaneous expense** 60 Cr Cash 156 To record expenses using the petty cash fund and the reimbursement of petty cash fund *

Expenses of the same nature are added together.

** Depends on company size, bigger companies will have separate individual expenses account for postage and subscriptions of newspapers and magazines.

The earlier entry will bring the petty cash amount to the original amount of RM500. Did you notice that there is no entry made to petty cash account? Entry to petty cash account is only made only for the following situations: (a)

The creation of petty cash fund; and

(b)

The petty cash amount is to be reduced or increased. Assume Segar Berhad decides to reduce its petty cash fund to RM400 from RM500. The following entry will be made:

Dr

Cash Cr Petty cash To record decrease amount of petty cash fund

100


100


If Segar Berhad decides to increase its petty cash fund from RM500 to RM700, the following entry will be made: Dr

Petty cash Cr Cash To record increase amount of petty cash fund (c)

200 200

The petty cash account is to be eliminated If for some reason, Segar Berhad decides to close its petty cash fund of RM700, the following entry will be made:

Dr

Cash Cr Petty cash To close off petty cash fund.

700 700

In some instances, the balance of petty cash fund added to the total expenses do not tally (amount different than the original amount of petty cash fund). This is probably due to errors where we have overpaid or underpaid claims for reimbursement, or even fraud or theft. How would we record this short of petty cash or over of petty cash? To illustrate, the following entries are made to reimburse a RM100 petty cash fund when its payments receipts show RM75 and only RM15 cash remains. This indicates a shortage of RM10. Dr Dr

Miscellaneous expense Cash short and over Cr Cash To record shortage of petty cash of RM10.

75 10 85

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



Dr

Miscellaneous expense Cr Cash short and over Cr Cash To record revenue (over) of petty cash of RM30.

185 30 155

Cash short and over will be reported as revenue or expense in the income statement depending on the balance of the account at the end of the accounting period. A debit balance is expense (shortage), while credit balance is revenue (over).

5.5

RECEIVABLES

Receivables are one item of current assets. Receivables consist of two types, which are: (a)

Trade receivables – receivables from the sale of goods is common; and

(b)

Non-trade receivables – receivables other than the above example is from the sale of assets of the debtor.

Some of the purposes in the extension of credit are: (a)

To increase sales to increase profit;

(b)

Compete with other competitors; and

(c)

Provide convenience to buyers who buy in bulk. They do not have to pay a lump sum amount.

However, credit (debt) must be controlled so that there is no fraud and opportunism.

5.5.1

Credit Control

Credit control measures commonly performed are: (a)

Approval of credit where the background should be investigated on the previous performance of the debtor, measuring the ability to repay other important documents to avoid high bad loans.

(b)

Credit policy to be utilised will determine the minimum requirements: that allow credit purchase to be made, that the credit should be given, the value Copyright © Open University Malaysia (OUM)


of the discount that should be granted, interest that will be charged for late payment of debts and the sending of a statement to the debtor. (c)

Keep complete records of the debtor through subsidiary ledgers and accounts receivable and accounts – regulation is to be constantly updated.

5.5.2

Reliability Values of Accounts Receivables Collection

This is commonly made through aging reports, and uncollectible debt can be estimated. Example: Aging Report Debtors/Time Payment

Credit limit

Total debt

Ali

6000

4000

2500

Baba

5000

4000

3000

Caca

9000

8000

2000

Duda

3000

2500

Duration

30 days

60 days

90 days

>90 days

1500 1000 4000

2000 1500

1000

Conclusion: From the report on aging, most likely Duda could not pay the debt.

5.5.3

Loan Loss Provisioning

Bad loans are uncollectible debt while provision for doubtful debts is estimated as uncollectible debt. This is because of the following reasons: (a)

Debtors died;

(b)

Bankruptcy of debtors;

(c)

Debtors giving false information; and

(d)

The problem with the overall economy.



An example of the recording of bad debt is: Dr. Bad debt Expense Cr. Provision for doubtful debts (record of bad debts)

XX XX

But if the debtor has made a purchase and was recognised earlier than when he declared bankruptcy (such as purchases made in 2013 and declared bankruptcy in the next year, 2014), the recognised revenue would have declined and would not comply with the matching concept (which has been studied previously). To address this problem, the provision for doubtful debts is made to estimate the possibility that it cannot be collected. It can be done on the revenue recognised (from the mentioned example, the provision for doubtful debts can be made in 2013). Steps to be taken to estimate doubtful debts can be done: (a)

Based on past experience;

(b)

Based on the aging report; and

(c)

Based on the percentage of net credit sales.

The following is an example of recording provision for doubtful debts: Sample questions 1: If the debtor balance is RM10,000 and the provision for doubtful debts at 2 per cent of the remaining debtors. Dr. Bad debt expense 200 Cr. Provision for doubtful debts 200 (provision for doubtful debts of 2 per cent of outstanding receivables)

5.5.4

Notes to Increase and Decrease in the Provision for Doubtful Debts

When an allowance account already exists, it just needs to be increased or decreased according to a predetermined budget. Notes to add the provision for doubtful debts is the same as before: Dr. Bad debt expense Cr. Provision for doubtful debts



While if we want to reduce the allowance for doubtful debts, the notes are as follows: Dr. Provision for doubtful debts Cr. Over provision for doubtful debts *

XX XX

*is a kind of new account opened and will be reported as other revenue in the income statement Sample question 2: If the balance of receivables increased from Sample question 1 to RM12,000 and the provision for doubtful debts is at 2 per cent of the remaining debtors, then, the allowance will increase from RM200 to RM240. We just need to add another RM40 in the allowance for doubtful debts. Notation is as follows: Dr. Of bad debt expense 40 Cr. Provision for doubtful debts/obsolete 40 (provision for doubtful debts of 2 per cent of outstanding receivables) Sample question 3: If the remaining debtors from Sample question 1 were reduced to RM9,000 and provision for doubtful debts is at 2 per cent of the remaining debtors, the allowance will be reduced from RM200 to RM180. We just need to cut RM20 from the allowance for doubtful debts. Notation is as follows: Dr. Provision for doubtful debts / obsolete 20 Cr. Doubtful debts / obsolete Over provision 20 (provision for doubtful debts of 2 per cent of outstanding receivables)

5.5.5

Bad Debt Write Off

When an account receivable has been determined to be uncollectible, it is no longer classified as current assets and should be eliminated. Recording of bad debts are: Dr. Provision for bad/doubtful Cr. receivables

XX XX

Sometimes customers will come back after a long time to pay back the debt. Should this happen, we must first create the account debtors with a record. Copyright © Open University Malaysia (OUM)


Dr. receivables Cr. Bad debts recovered *

XX XX

* created a new account and will be reported as other revenue in the current period income statement. Once the cash payment is made by the debtor then we need to record it with the following entry: Dr. cash

XX Cr. Receivables

5.5.6

XX

Reporting of Accounts Receivable in the Financial Statements

Accounts receivable is a current asset – a diluted net of cash and cash in banks. In the balance sheet current assets are shown as follows: Excerpt of Balance Sheet In 31/12/200X Current assets Cash Cash in bank Receivables - Provision for doubtful debts Total current assets

5.6

XX XX XX XX (XX) XX

INVENTORIES

According to MASB 2, inventories are: (a)

Assets held for resale in the ordinary business operations;

(b)

Assets that are in the process of reselling; and

(c)

Assets in the form of raw materials or supplied for use in the production process or in the conduct of service.



5.6.1

Management and Stock Control

Inventory or stock is important in the calculation of profit and loss. Hand inventory items are usually the biggest items in current assets. These assets must be controlled to prevent theft or damage to minimise losses. Stock turnover must also be fast because the faster it is, the higher the profit to be gained. But the stock must be controlled by means of the following actions commonly performed by most businesses: (a)

Physical stock is recorded regardless of the system or method of calculation that used stock;

(b)

Stock is kept in a safe place away from any theft or damage (depending on the type of stock);

(c)

Give responsibility for keeping inventory to employees who are unrelated to inventory recording (storing and recording are different people); and

(d)

Keep continuous records for the expensive goods such as jewellery and other luxury goods.

5.6.2

Recording System (Periodic and Continuous)

The recording system is divided into two types, which are: (a)

Periodic Inventory System (i)

Inventory balances in the balance sheet are available from the calculation of physical residual;

(ii)

Stock account is not updated every time a transaction involving inventory is made;

(iii) Cost of goods sold is calculated as the initial stock + Net Purchases Closing stock; and (iv) Inventories are measured at each period (such as once a month or once a year depending on the type of stock). (b)

Continuous Inventory System (i)

Account stock is updated every time a transaction involving inventory is made.

(ii)

Each time the sale of goods is made, the cost of goods sold will be calculated. Copyright © Open University Malaysia (OUM)


(iii) A physical calculation is also made as a control measure to have a separate record for comparison. (iv) Loss of stock can be easily detected and recorded as: Dr. Loss on stock loss Cr. stock (recording stock loss)

XX XX

Table 5.2 explains the comparison of general journal entries for a periodic inventory system and continuous inventory system. Table 5.2: Comparison of General Journal Entries for Periodic Inventory System and Continuous Inventory System Continuous Inventory System

Periodic Inventory System 1

Dr. Purchases Cr. Creditors

6000

1.

6000

Cr. Creditors

(recording credit purchases) 2.

Dr. Goods transported

120

Cr. Cash

Dr. Debtors Cr. Sales

6000 6000

(recording credit purchases) 2. 120

Dr. Stock

120

Cr. Cash

(recording goods in transport) 3.

Dr. Stock

120

(recording goods in transport) 1600

3.

1600

Dr. Debtors Cr. Sales

1600 1600

(recording credit sales) Dr. COGS Cr. Stock (recording credit sales) 4.

Dr. Debtors Cr. Purchase return (recording purchase return)

220 220

4.

Dr. Debtors Cr. Stock (recording purchase return)


800 800 220 220


5.

Dr. Sales return

300

Cr. Debtors

5.

300

Dr. Sales return

300

Cr. Debtors

300

(recording sales return) Dr. Stock

150

Cr. COGS

150

(recording sales return)

5.6.3

Calculation Method for Stocks’ Value

Generally, there are two calculation methods for stocksÊ value, which are: (a)

The actual method The actual method is also known as identification method. It is used for items that are easily identifiable with the total cost easily identifiable or easily calculated. Examples are the items that are requested or ordered.

(b)

Method assumptions The method assumptions are FIFO method (first in first out), LIFO (Last In First Out) and Weighted Average. In addition to identifying the method you want to use, the system used must be determined (either periodic or continuous systems).

A sample solution is as follows: Example 1 (periodic inventory system) The following data is related to Mariah Sdn Bhd for the month of April 2013. Stocks on 1 April 2013 were 100 units at a cost of RM4 each. April purchases are as follows: 2 April

200 units

4.15

830

7 April

200 units

4.20

840

15 April

300 units

4.30

1,290

22 April

100 units

4.40

440

28 April

200 units

4.65

930

Total

1000 units


4,330


Throughout the month of April the company sold 800 units with a unit price of RM8 Required: Calculate stocks end, cost of goods sold and gross profit using the assumption 1. FIFO 2. LIFO 3. Weighted Average Solution: FIFO Stocks end (in units) = 1100 units  800 units = 300 units Calculated as the closing costs: 100 units @4.40 + 200 units @ 4.65 = RM1370 Cost of Goods Sold is calculated as; COGS = Opening stock + Purchases  Closing stock 400 + 4330  1370 = 3360 LIFO Stocks end (in units) = 1100 units – 800 units = 300 units

Closing cost is calculated as: 100 units @4.00 + 200 units @ 4.15 = RM400 + RM830 = RM1230 Cost of Goods Sold is calculated as: COGS = Opening stock + Purchases – Closing stock 400 + 4330 – 1230 = 3500 Weighted Average (Opening stock + Purchases)/ Quantity = (400 + 4330)/1100 = RM4.30 per unit Closing stock = 300 units @ RM4.30 = RM1,290 Cost of goods sold is calculated as: COGS = Opening stock + Purchases – Closing stock 400 + 4330 – 1290 = 3440 No gross profits were calculated Copyright © Open University Malaysia (OUM)


Example 2 (Continuous Inventory system) Here we use Example 1 but the sales made according to dates are as follows: April 3

250 units

April 10

200 units

April 16

250 units

April 23

100 units

Required: Calculate stocks end, cost of goods sold and gross profit using the assumption 1. FIFO 2. LIFO 3. Weighted Average. Solution for FIFO: Date

In (Purchases) Quantity

Costs

Out (Sales) Quantity

Costs

April 1 April 2

200

4.15

April 3

April 7

250 ; 100 150 200

4.20

April 10

April 15

200; 50 150 300

250; 50 200 100

100 200

4.20 4.30

4.40

April 23 April 28

4.15 4.20

4.30

April 16

April 22

4 4.15

4.65

4.30

Balance Quantity

Costs

100

4

100 200

4 4.15

50

4.15

50 200

4.15 4.20

50

4.20

50 300

4.20 4.30

100

4.30

100 100

4.30 4.40

100

4.40

100 200

4.40 4.65



Cost of goods sold = 3360 Closing stock = 1370 Solution for LIFO: Date

In (purchases) Quantity

Out (sales)

Costs

Quantity

Costs

April 1 April 2

200

4.15

April 3

April 7

200

200

4.15

50

4.00

4.20

300

4.20

4.30

April 16

100

4

100

4

200

4.15

50

4.00

50

4.00

200

4.20

50

4.00

50

4.00

300

4.30

50

4.00

50

4.30

50

4.00

50

4.30

100

4.40

250; 250 100

100 200

4.30

4.40

April 23 April 28

Costs

200; 200

April 22

Quantity

250 ;

April 10 April 15

Balance

4.65

4.40

50

4.00

50

4.30

50

4.00

50

4.30

200

4.65

Cost of goods sold = 3385 Closing stock = 1345



Solution for Weighted Average: Date

In (purchases) Quantity

Costs

Out (sales) Quantity

Costs

April 1 April 2

200

4.15

April 3 April 7

250 200

4.20

April 10 April 15

200 300

250 100

100 200

4.65

*

Cost of goods sold =3365

**

No gross profits calculated

5.6.4

4.28

4.40

April 23 April 28

4.18

4.30

April 16 April 22

4.10

4.34

Balance Quantity

Costs

100

4

300

4.10

50

4.10

250

4.18

50

4.18

350

4.28

100

4.28

200

4.34

100

4.34

300

4.55

Closing stock =1365

Effect of Different Flow Assumptions – Practice in Inflation and Deflation

In the event of inflation FIFO generally produces higher profits than LIFO. But when viewed in terms of a more accurate profit reports, with each level of inventory purchase in the event of inflation, profit should decline as the cost of goods increases. If the sales price is fixed, then the gain will be less and less as the cost of goods goes up. If the LIFO method is used, the profit will increase as ending inventory is the most expensive inventory compared with that previously purchased. While in the FIFO method of inventory, purchased first are issued first, the initial inventory purchase when the price is cheap will be sold first. Thus, fortunately the cost is becoming less and the latest inventory value is more. In the event of deflation In the event of sustained deflation, it is the opposite of the current state of inflation mentioned. Copyright © Open University Malaysia (OUM)


The concept of the lower of cost and market value: This method will compare the cost price to the market price of each item in inventory. The added lowest value will then be the value of the cost of goods sold reported. Example: Inventory Types

Cost Price

Market Price

Lowest Value

Shirts

20

23

20

T-shirts

10

8

8

Total

30

31

28

5.6.5

Stock Reported in the Financial Statements

Closing stock items will be shown in both the income statement and balance sheet. In the income statement it is one of the items to calculate the cost of goods sold. It is shown as follows: Excerpts income statement for the year ended 31/12/200X Cost of goods sold: initial stock + Net purchases -Stocks end COGS

XX XX (XX) XX

In the balance sheet it is shown in the current assets after more liquid current assets thereof or otherwise as follows: Balance Sheet as at 31/12/200X Current assets Cash Cash at bank Receivables -Provision for doubtful debts Stock or inventory Total current asset

XX XX XX XX (XX) XX



5.6.6

Under First Real Impact and Value Stocks

If the closing is overstated, then the consequences are as follows: (a)

Cost of goods sold will be reduced significantly;

(b)

Gross profit/net will be overstated; and

(c)

Overstatement of owners' equity.

If the closing is significantly reduced, then the consequences are as follows: (a)

Cost of goods sold will be overstated;

(b)

Gross profit/net will be significantly reduced; and

(c)

Significantly reduced shareholders' equity.



Assets are defined as resources controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity.



Current assets include cash or cash equivalent and other assets that can be converted into cash, and other assets that can be resold or used in manufacturing goods within a period of one accounting year or less.



Internal controls are used to monitor and control business activities. An internal control system comprises policy and procedures used to: –

Safeguard the assets the business uses in its operation;

–

Ensure accurate and reliable accounting records;

–

Promote efficient operation; and

–

Encourage adherence to company policy.



Cash includes coins, currencies, cheques, bank drafts, postal orders, money orders, travellerÊs cheques and others.



Bank reconciliation is prepared to check the accuracy of the firmÊs cash account with the bankÊs record.





Bank reconciliation is prepared by a firm in order to: –

Reconcile the balance of firmÊs cash account with the balance stated in the bank statement for a particular month; and

–

Ensure the accuracy and the validity of items recorded in the cash account.

Bank reconciliation

First In First Oot (FIFO)

Bank statement

Internal control

Cash and equivalents

Inventories

Cash on hand

Last In First Out (LIFO)

Cash short/over account

Receivables

Deposits in transit

Stock

1.

The following is information regarding Syarikat Kampung as at 31 May 2013. RM Cash account balance 1/5/2013

4,650

Total cash receipts in May 2013

7,600

Total cash payments in May 2013

3,670

Bank statement as at 31/5/2013 shows closing balance of RM6,675

A reconciliation exercise found the following: (i)

A cash deposit made on 31 May 2013 of RM2,460 does not appear in the bank statement.

(ii)

Bank has erroneously deducted a cheque (cheque number 20345) of RM1,200 drawn by another company, Syarikat Lampong.



(iii) Three cheques drawn in May remains unpresented: •

Cheque 10345

450

•

Cheque 10347

590

•

Cheque 10348

430

(iv) Bank has recorded a receipt of RM3,300; Jaya Holding paid its debts directly to Syarikat KampungÊs current account. (v)

Bank service charge for May is RM20

(vi) Interest revenue for May is RM15 (vii) Syarikat Kampung has a standing instruction to pay insurance though auto debit. RM2,400 was deducted in May. (viii) The bank statement shows a dishonoured cheque from A/R - Sukar of RM700. (ix) Cheque drawn as payment to A/P-Anita was recorded in the cash account as RM540; the correct amount should be RM450. You are required to: (i)

Update the cash account of Syarikat Kampung.

(ii)

Provide the journal entries for the adjustment made in the cash account.

(iii) Prepare a bank reconciliation statement for Syarikat Kampung as at 31 May 2013. 2.

In your opinion, why must businesses prepare bank reconciliations?

3.

Some items in the bank statement must be journalised. What are examples of items that need to be journalised? What will happen if a business does not make the journal entry?

4.

Explain why the amount of dishonoured cheques due to insufficient fund will be deducted from the cash account when preparing a bank reconciliation.



1.

The following is information regarding the petty cash fund of Mushy Enterprise as at 28 February 2013. RM Petty cash fund amount as at 1 February 2013 Petty cash fund amount as at 28 February 2013

250.00 46.70

Bills and receipts details for the months of February 2013 are the following: RM Stationeries

73.50

Postage

15.60

Taxi fare

12.60

Minor repairs on office printer

45.00

Bus fare

5.50

Newspaper

30.00

Mushy also planned to increase the petty cash fund to RM300. You are required to provide the journal entries for the mentioned transactions.


Topic



6

Accounting for Non-current Assets


Define non-current assets;

2.

Determine the cost of a tangible non-current asset;

3.

Differentiate between the concepts of revenue expenditures and capital expenditures;

4.

Describe the concept of depreciation;

5.

Prepare the account for the disposal of non-current assets;

6.

Explain government grants; and

7

Analyse intangible assets and investments.

 INTRODUCTION Imagine that you have just purchased a brand new red Ferrari for RM500,000. As a strong believer of Feng Shui, you were told that the colour red is not auspicious for you. You had only used the car for a month and plan to sell it. Can you sell the Ferrari for RM500,000? One should not expect to be able to sell the Ferrari at the original price paid. After all, you have used it and therefore, the value of the Ferrari has depreciated. A buyer might be willing to pay RM450,000. The difference of RM50,000 is a loss to you.


TOPIC 6 ACCOUNTING FOR NON-CURRENT ASSETS 

153

Businesses own various non-current assets such as buildings, equipment, motor vehicles and machinery to generate sales. These assets will depreciate, sometimes businesses sell their non-current assets or replace them with another. How does a business account for these transactions? Just to give you an idea of how much money is allocated for depreciation, let us look at the excerpt of this article. MaxisÊ Third Quarter Revenue Up 11% To RM1.23 Billion Net Profit Up 2% To RM234 Million Profit after tax („PAT‰) was up 2% to RM234 million from RM229 million in the preceding quarter. This improvement in net profit was achieved despite the higher depreciation and amortisation expense of RM241 million for the current three months compared to the RM200 million charged in the preceding quarter. This topic will discuss accounting for non-current assets. You will learn how to calculate depreciation for non-current assets under different methods. You will also learn how to account for the disposal (sales) of non-current assets. This topic will also explain why depreciation must be provided and how to calculate it employing the most widely used methods, in the year of acquisition and the year of disposal, and all the years in between.

6.1

DEFINITION OF NON-CURRENT ASSETS

MFRS 101 defined non-current asset as assets other than current assets. Noncurrent assets provide benefits for a period longer than twelve months. Non-current assets are used to generate revenue and not for resale. Non-current assets include items such as land, building, plant, equipment, machinery, motor vehicles, fixtures and fitting and long-term investments (see Figure 6.1).


154  TOPIC 6 ACCOUNTING FOR NON-CURRENT ASSETS

Figure 6.1: Types of non-current assets

These non-current assets are normally classified into the following groups: (a)

Tangible non-current equipment);

assets

(property,

land,

building,

plant

and

(b)

Intangible non-current assets (copyrights, goodwill, patterns, franchises and trademarks); and

(c)

Long-term investments (shares in another company).

For intangible assets such as brands and intellectual property, the process of allocating costs over time is called amortisation.

ACTIVITY 6.1 Take a look at all your assets and categorise them into current and non-current.

6.2

ACCOUNTING FOR TANGIBLE NON-CURRENT ASSETS

The financial reporting standard, MFRS 116 – Property, Plant and Equipment prescribes the accounting treatment for property, plant and equipment. MFRS 116 defines property, plant and equipment as tangible assets that:



155

(a)

Are held by an enterprise for use in the production or supply of goods or services, for rental to others, or for administrative or maintenance purposes; and

(b)

Are expected to be used during more than one reporting period.

MFRS 116 also states that these assets must be recorded at cost. This cost includes the purchase price and any directly attributable cost in bringing the asset to working condition. Examples of directly attributable costs are: (a)

The cost of site preparation;

(b)

Initial delivery and handling costs;

(c)

Installation costs;

(d)

Professional fees such as for architects and engineers; and

(e)

The estimated cost of dismantling and removing the asset and restoring the site, to the extent that it is recognised as a provision.

Example 6.1 For example, you purchase an office building. The selling price of the building is RM100,000. You also incurred additional fees – agent fees of RM5,000 and legal fees and stamp duty of RM10,000. You will record the cost of building as RM115,000. Capital Expenditures versus Revenue Expenditures After purchasing the non-current assets, there are additional costs incurred in maintaining and repairing assets in order to enable the asset to be used effectively and efficiently. For example, buildings need to be repainted and broken windows replaced. Should the cost be added to the cost of the asset or be written off as expense? In general, any cost that increases the estimated useful life and the capability of the non-current assets shall be capitalised (added to the cost of assets). This type of expenditure is called capital expenditure. For example, you incurred expenses of RM50,000 for renovating your shop to extend the show room. Renovating the show room will definitely increase the estimated useful life and capability of Copyright © Open University Malaysia (OUM)


your shop, and hence the cost of renovating the shop will be added to the cost of the shop. In this example, the following journal entry will be made: Date

Dr

Shop Building Cr Cash (renovating show room for RM50,000 cash.)

50,000 50,000

Expenditures like repairs and maintenance do not extend the estimated useful life or capability of the asset. These expenditures only provide benefit for the current accounting period. This type of expenditure is called revenue expenditures and will be charged as expense in the period incurred. For example, you incurred expenses of RM10,000 to replace the window glass that was broken. You cannot add the cost of this repair to the cost of shop, but rather treat it as expenses for the period. The following journal entry will be made. Date

6.3

Dr

Repairs Expenses 10,000 Cr Cash (replacing window glass of shop for RM10,000 cash.)

10,000

INTANGIBLE ASSETS

Intangible fixed assets are assets that essentially have no monetary value and do not have a physical form. Its value is determined by the law or the rights or benefits to the owners or businesses.

6.3.1

Types

One example of an intangible asset that is often found or used is goodwill. Goodwill is the amount of intangible assets that contribute to the success of a business such as location, reputation or good image, skills as well as competencies of employees or management or close contacts between the debtors, customers and suppliers. There are two types of goodwill in the business, which are: (a)

Goodwill inherited (inherent goodwill); and

(b)

Goodwill purchased (purchased goodwill).



157

Inherited goodwill has to be recorded in the business because there are no documents that can prove it (the concept of objectivity). Goodwill bought occurs when a company purchases another business. This value should be shown in the balance sheet.

6.3.2

Evaluation

Goodwill acquired for the maximum amortisation period is 25 years. Useful lives commence on the date it is purchased and amortisation is on a straight-line basis.

6.4

PRESENTATION IN THE BALANCE SHEET

Assets are reported in the balance sheet according to their categories, current or non-current. The following is example how current and non-current assets are reported in the balance sheet (refer Figure 6.2).

Figure 6.2: Assets presentation in the balance sheet Copyright © Open University Malaysia (OUM)


6.5

DEPRECIATION

We expect the benefits (service potential) of assets will decline as the assets are used to generate revenue. Non-current asset value (benefits) will depreciate through: (a)

Physical wear and tear – non-current assets can lose their value by physical deterioration.

(b)

Normal usage – think of buildings deteriorating from weather effects.

(c)

Technical and commercial obsolescence – old models will lose their value when a latest model that is more effective and efficient is available in the market. Think of computers!

(d)

Time factor – assets that are leased, patterns and copyrights have a set time limit. The values of these assets decrease as time goes by.

(e)

Depletions – natural resources like ores and oil will deplete as production continues.

MFRS 104 – Depreciation accounting defines depreciation as the allocation of the depreciable amount of an asset over its estimated useful life. In other words, the cost of assets less its residual value (depreciable amount) will be depreciated over its estimated useful life.

To measure depreciation of an asset, the following information is required: (a)

Original cost of the assets

(C)

(b)

The estimated useful life of the asset

(n)

(c)

The estimated residual value of the asset at the end of estimated useful life

(R)

There are three main methods in calculating depreciation as shown in Figure 6.3.



159

Figure 6.3: Methods to calculate depreciation

There are many other methods that can be adopted to calculate depreciation; for example, double declining balance and sum-of-year digit methods. Readings on this topic can be found in many of the accounting text books. Earlier, you have learned how to journalise the adjusting entries to recognise depreciation and report the related items in income statements and balance sheets. Using the following data, we will learn the various methods of calculating depreciation (refer to Figure 6.4). Take note that land does not wear out so it appreciates (not depreciate).



Figure 6.4: Data to calculate depreciation

6.5.1

Straight Line Method

Straight line method assigns equal amount of depreciation over the assetÊs estimated useful life.



161

The depreciation charges for AMT lorry is calculated as the following:

The entry to record one year depreciation on 31/12/2011 will be as follows: 31/12/11

Dr

Depreciation expense Cr Accumulated depreciation - lorry To record one year depreciation expense of lorry.

10,000 10,000

Depreciation account is an expense account and will be closed to the income summary. Accumulated depreciation-lorry is a contra account to lorry and contains the total depreciation charges since the assets were acquired. The following is the depreciation schedule for AMTÊs lorry under the straight line method. Date

Asset Cost

Depreciation Rate

RM 01/01/2011

Depreciable Amount

Depreciation Expense

Accumulated Depreciation

Carrying Amount

RM

RM

RM

RM

52,000

31/12/2011

20%



50,000

10,000

10,000

42,000

31/12/2012

20%



50,000

10,000

20,000

32,000

31/12/2013

20%



50,000

10,000

30,000

22,000

31/12/2014

20%



50,000

10,000

40,000

12,000

31/12/2015

20%



50,000

10,000

50,000

2,000

Carrying amount is also known as net realisable value, net book value and this is the amount reported in the balance sheet.



6.5.2

Reducing Balance Method

The reducing balance method allocates more of the assetÊs depreciable amount in the earlier life of the asset. The assetÊs original cost is multiplied with a set depreciation rate. The depreciation rate can be calculated with the following formula. n

n is the estimated useful life

1 –

Residual value (R) Cost (C)

However, this formula cannot be used if the residual value is zero. For AMTÊs lorry, the depreciation rate is calculated as follows:

1 5

2, 000  1  0.52  0.48  48% 52, 000

Depreciation expenses under reducing balance are determined by the following formula. At the end of the first and second year, depreciation expenses are calculated as follows. Reducing balance depreciation 1st year

= RM52,000



48%

= RM24, 960

Original cost – Accumulated depreciation; RM52,000 – 0

Reducing balance depreciation 2nd year

= RM27,400



48%

= RM12,979

Original cost – Accumulated depreciation; RM52,000 – RM24,960



163

The following is the depreciation schedule for AMTÊs lorry under the reducing balance method. Asset Cost

Date

Depreciation Rate

RM 1/1/2011

Carrying Amount

Depreciati on Expense


Carrying Amount

RM

RM

RM

RM

52,000

31/12/2011

48%



52,000

24,960

24,960

27,040

31/12/2012

48%



27,040

12,979

37,939

14,061

31/12/2013

48%



14,061

6,749

44,688

7,312

31/12/2014

48%



7,312

3,510

48,198

3,802

3,802

 1,802

50,000

2,000

31/12/2015



Depreciation for 2015 is RM1,802 (RM3,892 – RM2,000). You cannot depreciate the asset more than its depreciable value (C–R).

6.5.3

Units-of-production Method

Unit-of-production method calculates the depreciation rate per unit of production. The following formula is used.

For AMTÊs lorry the depreciation rate is:

Depreciation expense is then determined through the actual usage per annum.



The depreciation expense based on the actual usage for the first year is as follows:

The following is the depreciation schedule for AMTÊs lorry under the unit-ofproduction method. Date

Asset Cost

Depreciation Rate

RM 01/01/2011

Carrying Amount



Carrying Amount

RM

RM

RM

RM

52,000

31/12/2011

50 cent



33,000

16,500

16,500

35,500

31/12/2012

50 cent



27,000

13,500

30,000

22,000

31/12/2013

50 cent



20,000

10,000

40,000

12,000

31/12/2014

50 cent



15,000

7,500

47,500

4,500

31/12/2015

50 cent



5,000

2,500

50,000

2,000

Microsoft Excel has a built-in function to auto calculate depreciation. Open up an Excel file, go to Function, and select to view the financial category. They have functions to calculate straight line, double declining balance and sum-ofyear digit depreciation. Figure 6.5 explains the depreciation patterns through time:

Figure 6.5: Depreciation patterns through time Source: Horngren & Harrison (2001) Copyright © Open University Malaysia (OUM)


165

ACTIVITY 6.2 Investors need to exercise judgment when examining numbers on financial statements. The article titled Appreciating Depreciation in this website will help you achieve this awareness on depreciation: http://www.investopedia.com/articles/fundamental/04/090804.asp

6.6

DISPOSAL OF NON-CURRENT ASSETS

Non-current assets are disposed when they are not able to provide services or benefits to the businesses due to: (a)

Normal wear and tear;

(b)

Obsolescence;

(c)

Unproductivity; and

(d)

Inefficiency.

Non-current assets can be disposed through the retirement or discarding the non-current asset; selling the non-current asset or exchanging the non-current asset for another non-current assets. We will now look at each method of disposal in detail. You need to know the journal entries to record the disposal of non-current assets.

SELF-CHECK 6.1 Malaysian Airlines has decided to sell their headquarters building to cut down its losses. How would they account for this sale?

6.6.1

Retiring or Discarding the Non-current Asset

This method is used when the asset is no longer useful to the business and it has no market value.



Example 6.2 As an example, take a machine with an original cost of RM5,000 and accumulated depreciation of RM5,000 and no resale value at the end of its five year estimated useful life. The machine cannot be used and is therefore The following entry will be made to account for the retirement of the machine: Dr

Accumulated depreciation 5,000 Cr Machinery To record the retirement of machinery that has been fully depreciated

5,000

The entry in effect has written off the machinery from the business record, as shown by the following ledger. Machinery Description Balance b/d

Amount 5,000

Date

Description Accumulated Depreciation

Amount

 5,000

Accumulated Depreciation - Machinery Description Machinery

Amount

 5,000

Date

Description

Amount

Balance b/d

5,000

 This entry writes off both machinery and its contra account from the business ledger, that is, the balance becomes zero. There are cases when the asset is discarded (retired) before the end of its estimated useful life. For example, a motor vehicle that originally costs RM50,000 with an estimated useful life of 10 years. At the end of the sixth year, with an accumulated depreciation of RM30,000, the vehicle gets involved in a very bad accident and cannot be used anymore. When this happens, loss on disposal has occurred. Loss on disposal will be reported as operating expenses (losses) in the income statement.



167

Using the given example as an illustration, the following journal entry is made when the motor vehicle is discarded before it is fully depreciated. Dr Accumulated depreciation Dr Loss on disposal of vehicle Cr Motor vehicle To record the retirement of vehicle due to accident.

30,000 20,000

Motor Vehicle Description Balance b/d

Amount

Date

50,000

Description Accumulated depreciation Income summary

50,000

Amount 30,000

 20,000 50,000

 The amount is transferred to income summary as loss on disposal of motor vehicle

Accumulated Depreciation – Motor Vehicle Description Motor vehicle

6.6.2

Amount 30,000

Date

Description Balance b/d

Amount 30,000

Selling the Non-current Asset

In the event that a business sells its non-current assets, the consideration received might be higher or lower than its carrying amount (original cost minus accumulated depreciation). If selling price is higher than the assetÊs carrying amount, a gain on disposal will be recorded, while a loss on disposal will be recorded if the selling price is lower than the assetÊs carrying amount.



In order to learn how to record the disposal of asset through selling, we will look at the following example: Example 6.3 Omni Express has sold one of its machineries on 1 July 2014 for RM10,000 cash. The machine was originally purchased on 1 January 2011 for RM20,000, with an estimated useful life of five years and no residual value. The accumulated depreciation as at 1 January 2014 is RM12,000. Omni Express uses the straight line method to calculate depreciation at the end of the year. It will be useful to draw a timeline diagram to help you understand the problem (see Figure 6.6).

Figure 6.6: Timeline diagram

Firstly, it is important to know the exact accumulated depreciation until the date of disposal. You might be required to calculate the accumulated depreciation depending on the information given in the problem. From the given example, the last depreciation was recorded on the 31/12/2013, and total accumulated depreciation was RM12,000 (RM4,000  3 years). No depreciation has been recorded for the period of 1/1/14 until 1/7/14 (disposal date). In other words, you have used the machine for six months and therefore depreciation expense of RM2,000 (RM4,000  6/12) must be recorded. Hence, the following entry must be made to record the depreciation expenses. 1/7/14

Dr

Depreciation Expense Cr Accumulated Depreciation (recording the six months depreciation expense of machinery.)

2,000


2,000


169

This will bring the accumulated depreciation balance of the machinery to RM14,000 (RM12,000 + RM2,000), and therefore the carrying amount of the machinery is RM6,000 (RM20,000 – RM14,000). The cash received from the sales is RM10,000; therefore, there is gain on disposal of RM4,000. The following entries are made to record the disposal. 1/7/14

Dr Dr

Cash Accumulated depreciation Cr Income summary Cr Machinery (recording the disposal of machinery)

10,000 14,000 4,000 20,000

The effect of the above journal entry to the machinery account is as follows: Machinery Date

Description

Amount

Date

Description

1/7/14

Balance b/d

20,000

1/7/14

Cash

1/7/14

Income summary

4,000

1/7/14

Accumulated depreciation

24,000

Amount 10,000 14,000 24,000

The next step is to transfer the gain or losses to income summary. 1/7/14

Dr

Machinery 4,000 Cr Income summary 4,000 (recording the transfer of gain on disposal of asset to income summary) Gain on disposal will be recorded in the income statement as other revenues (gains).



To illustrate loss on disposal, let us assume the above machinery is sold below its carrying amount value, at RM1,000, while other information remains the same. RM 20,000 14,000 6,000 1,000 5,000

Original cost of machinery Accumulated depreciation as at 1/7/14 Carrying amount of the machine Selling price of the disposed asset Loss on disposal

The following journal entry is made to record the disposal of machinery: 1/7/14

Dr Dr Dr

Cash Accumulated depreciation Income summary Cr Machinery (recording the disposal of machinery.)

1,000 14,000 5,000 20,000

The next step is to transfer the losses to the income summary. 1/7/14

Dr

Income summary 5,000 Cr Machinery 5,000 (recording the transfer of gain on disposal of asset to the income summary.)

Loss on disposal will be recorded in the income statement as other expenses (losses). Machinery Date 1/7/14

Description Balance b/d

Amount

Date

Description

20,000

1/7/14

Cash

1/7/14


1/7/14

Income summary

Amount

20,000

1,000 14,000 5,000 20,000



171

It is common accounting practice to use a disposal account to record gains or losses on disposal of assets. We will look at this method next.

Under this method, the receipt of cash from the disposal is recorded through the following entry: 1/7/14

Dr

Cash 10,000 Cr Disposal 10,000 (recording the receipt of cash from the disposal of machinery) Write off the assets and their accumulated depreciation to Disposal Account. 1/7/14

Dr

Disposal Cr Machinery To record the selling of machinery.

20,000

1/7/14

14,000

20,000

Dr

Accumulated depreciation Cr Disposal (recording the selling of machinery.)

14,000

Let us look at the following accounts after the previous entries are made: Machinery Date

Description

Amount

1/7/14

Balance b/d

20,000

Date 1/7/14

Description Disposal

20,000


Amount 20,000 20,000


Accumulated Depreciation - Machinery Date 1/7/14

Description Disposal

Amount

Date

14,000

Description

Amount

1/1/14

Balance b/d

12,000

1/7/14


2,000

14,000

14,000

Disposal - Machinery Date 1/7/14

Description

Amount

Date

Description

Amount

Machinery

20,000

1/7/14

Cash

10,000

Income summary

4,000

1/7/14


14,000

24,000

24,000

The last step is to transfer the gain or losses to the income summary. 1/7/14

Dr

Disposal 4,000 Cr Income summary (recording the transfer of gain on disposal to income summary.)

4,000

Gain on disposal will be recorded in the income statement as other revenues (gains). Steps to record disposal of assets for cash using disposal account Step 1: Ensure depreciation of the disposed asset is up to date. The following journal entry is necessary: Date

Dr

Depreciation expense Cr Accumulated Depreciation (recording the depreciation expense of non-current asset)

XX


XX


173

Step 2: Record the cash receipts. Date

Dr

Cash Cr Disposal (recording the cash receipt from selling of non-current asset)

XX XX

Step 3: Record the written off of assets and its contra account Date

Disposal Cr Non-current assets To record the selling of non-current asset Date

Dr

Accumulated depreciation – non-current assets Cr Disposal (recording the selling of non-current asset)

XX XX

Dr

XX XX

Step 4: Transfer the gain or losses to income summary For gain: Date

Dr

Disposal Cr Income summary (recording the transfer gain on disposal to income summary)

XX XX

or loss: Date

Income summary Cr Disposal (recording the transfer loss on disposal to income summary)

6.6.3

Dr

XX XX

Exchanging the Non-current Asset for Another Non-current Asset

It is normal for businesses to exchange a non-current asset for another. Normally the seller will receive a trade in value for the asset exchanged. In other words, the buyer will only pay the difference between the costs of the new asset less the trade in value of the old asset. Copyright © Open University Malaysia (OUM)


To illustrate, let us look at the following example: Example 6.4 Tamka Tech Enterprise owned a delivery van, purchased on 1 January 2010 for RM60,000. The estimated useful life of the van is 10 years with no residual value; it used the straight line method to depreciate motor vehicle. In July 2014, Tamka Tech Enterprise traded in the delivery van for a latest model costing RM100,000. Tamka Tech Enterprise received RM35,000 trade in for the old delivery van and paid the difference in price in cash. Again, let us use time a diagram for the given example (see Figure 6.7).

Figure 6.7: Timeline diagram

The calculation of gain or loss on trade-in is as the following: RM Original cost of delivery van Accumulated depreciation as at 1/7/14 Carrying amount of the machine Trade in value of delivery van Gain on trade in of delivery van

60,000 27,000 33,000 35,000 2,000

The exchange will be recorded by the following journal entries: 1/7/14 Dr Dr

Motor vehicle (new delivery van) 100,000 Accumulated depreciation 27,000 Cr Income summary (gain on trade in) 2,000 Cr Motor vehicle (old delivery van) 60,000 Cr Cash 65,000 (recording the acquisition of new delivery van and trade in of old delivery van)



175

The motor vehicle account after the entry has been made looks like the following: Motor Vehicle Date 1/7/14

Description

Amount

Date

Description

Balance b/d

60,000

1/7/14


Cash

65,000

1/7/14

Balance c/d

Income summary

27,000 100,000

2,000 127,000

6.7

Amount

127,000

NON-CURRENT ASSETS HELD FOR SALE (FRS 5)

Fixed assets are assets that can be seen physically and stay long in the business. It is used to operate the business but not for sale as stock. Capital Expenditure Concept Capital expenditure is expenditure incurred to acquire assets or increase the capacity and value of the asset. These expenses are included in the cost of the asset. Capital Revenue Concept Revenue expenditure is expenditure other than capital expenditure. These include selling expenses and financial expenses and administrative expenses. This expenditure will be debited to the income statement.

6.7.1

The Concept of Provisions of Depreciation

Depreciation is defined as the process of allocating the depreciable amount of the assets over their useful lives. It is considered a business expense on fixed assets purchased for use in business operations The availability of fixed asset depreciation costs are divided into a number of accounting periods. No cash is involved. The depreciable amount is the cost (value at purchase) subtracted by the salvage value (estimated value is set to sell for end of life of the asset). Copyright © Open University Malaysia (OUM)


6.7.2

Factors Affecting the Useful Lives

The useful life is how long the expected value of an asset can be utilised. The useful life is influenced by several factors including (refer to Figure 6.8):

Figure 6.8: Factors affecting the useful lives

6.7.3

Methods of Calculating Depreciation

The commonly used depreciation methods are: (a)

Straight-line Method The formula used is: Depreciation = (Cost – Salvage Value) / Useful life



177

Example 6.5: On January 1, 2014, Rose bought a machine for business priced at RM31,500 on credit from Takar Sdn Bhd. Other payments involved are: •

Goods in transport = RM500

•

Installation expenses = RM200

•

Import tax = RM300

•

Travelling Insurance = RM500

•

Fire insurance = RM150

Other information: •

The estimated useful life is four years

•

The estimated salvage value is RM3,000

Required: Calculate the depreciation on a straight line basis. Solution: Depreciation expense = Costs – Salvage value/ Useful life = 33,000 – 3,000 = 7,500 4 Recording depreciation: 31/12/2014 Dr Depreciation expense 7,500 Cr Provisions for depreciation 7,500 (recording depreciation charge for one year) For half year: 30/6/2014 Dr Depreciation expense 3,750 Cr Provisions for depreciation 3,750 (recording depreciation charge for half-year)



(b)

Reducing Balance Method In this method the rate (per cent to less depreciable value) is determined in advance. The formula used: r = 1 – n√ s/c where; r= depreciation rate used n= total useful life s= salvage value c= asset cost Based on Example 6.5, solution by the reducing balance method is as follows: Depreciation = Rate  Book value Year

Book Value Year Beginning

Depreciation Rate


Book Value Year End

1

33,000

45%

14,850

18,150

2

18,150

45%

8,165

9,982

3

9,982

45%

4,492

5,490

4

5,490

Less balance

2,490

3,000

Net book value = Book value – Depreciation (c)

Number of Years Method This method assumes that the asset is used more in the early years from next year. Depreciation is charged much more in the early years than in the subsequent ones. The method of calculation is as follows: (i)

Calculate the number of digits plus years; and

(ii)

Increase the number of lifetime.

(iii) To calculate the depreciation for each period, cost less residual values and useful lives are multiplied by the balance divided by the number of digits added.



179

Based on Example 6.5, solution on a straight-digit number plus the year are as follows: Plus the sum of digits = 1 +2 +3 +4 = 10

Year

(d)

Remaining Useful Lives / Total Digits Plus Years

Depreciable Cost

Depreciation Charge

1

4/10

33,000-3,000

12,000

2

3/10

33,000-3,000

9,000

3

2/10

33,000-3,000

6,000

4

1/10

33,000-3,000

3,000

Units of Production Method Depreciation is calculated based on the annual production capacity. The method of calculation requires two steps: (i)

Calculation of depreciation rate per unit of production Rate = {Cost – Salvage Value}/Estimated production unit

(ii)

The annual count Depreciation = Rate  Actual production

Example 6.6: A business purchased a machine at a cost of RM50,000. Estimated residual value is 5,000 and the expected use of the machine is 90,000 hours. Calculate: (i)

Depreciation rates; and

(ii)

If the first year of depreciation for the first year of production is 6,000 hours.

Solution: Depreciation rate = {50,000-5,000}/90,000= 50 cents/unit Depreciation = 0.5  6000 = RM3,000



6.7.4

Disposal of Fixed Assets

Generally, there are three ways to dispose the assets: (a)

Sales of assets;

(b)

Asset swap with the same type or different types of; and

(c)

Dispose of immediately.

The gain or loss on disposal will be recorded as other revenue (revenue from sale of assets) or loss from the sale of assets in the income statement. Example 6.7: Perniagaan Mawar had bought a machine on 1/7/2011 and the cost is RM33,000 where the salvage value is RM3,000 and useful life is four years. Method to use is straight line method. Show the solution for each disposal assumptions as follows: (i)

Assume the machine is sold at the price of RM19,000 by cash. Sales was made on 1/7/2013.

(ii)

Assume the machine is sold to Hong Enterprise at RM16,000 on credit on 1/7/2013.

(iii) Assume on 1/7/2013, the old machine was replaced with a new machine at a price of RM40,000. Perniagaan Mawar has paid the supplier RM20,000 to own the machine. (iv) Assume on 1/7/2013, the old machine was replaced with a new machine at a price of RM40,000. Replacing allowances given by supplier is RM15,000. Perniagaan Mawar settles the balances to the supplier in three months. (v)

Assume on 1/7/2013, the machine is repaired. Repairing expenses amounted to RM7,000 has increased the useful life of the machine by another THREE years.

Solution: Calculation (i): Sale price = 19,000 Book value = 33,000-15,000 (PSN) = 18,000 Profit = RM1,000



Dr (RM)

Cr(RM)

Recording: Dr. Depreciation Cash Cr. Machine

15,000 19,000 33,000

Gain on disposal Calculation (ii):

1,000

Sale price = 16,000 Book value = 33,000 – 15,000 (PSN) = 18,000 Loss = RM2,000 Recording: Dr. Depreciation Hong Enterprise Loss Cr. Machine

15,000 16,000 2,000 33,000

Calculation (iii): Book value = 33,000 – 15,000 (PSN) = 18,000 Replacement allowance = 40,000-20,000=20,000 Gain = RM2,000 Recording: Dr Depreciation New machine Cr Cash Machine Revenue

15,000 40,000 20,000 33,000 2,000

Calculation (iv): Book value = 33,000 – 15,000 (PSN) = 18,000 Replacement allowance = 15,000 Loss = RM3,000 Recording: Dr

Depreciation New machine Loss Cr Creditor Machine

15,000 40,000 3,000 25,000 33,000


181


(d)

The resolution of this question does not involve the disposal but only requires adjustment of depreciation. If the salvage value is not changed then the depreciation for the next year is: (Value of the new machine – Depreciation for the previous two years – The salvage value)/(The age of the machine + extension of useful life) = (40,000 – 15,000 – 3,000) / (2 + 3) = 4,400 per year

Adjusting entries for depreciation on 31.12.2000 (meaning, the amount of amortisation is only for half of the year)

Dr Depreciation expense Cr Provisions for depreciation – machinery

Dr (RM) 2,200

Cr (RM)

2,200

ACTIVITY 6.3 State two characteristics that you know can differentiate fixed assets from current assets.

6.8

GOVERNMENT GRANTS (FRS 120)

FRS 120 defines government grants as the assistance in the form of transfers of resources to an enterprise in return for past or future compliance with certain conditions relating to the operating activities of the entity.

6.8.1

Categories of Grants

Categories of grants are: (a)

Grants related to assets (grants are given on the condition that the enterprise purchases, constructs or otherwise acquires long-term assets); and

(b)

Grants related to income (any grant not related to assets).



183

Complying with the prudence concept, government grants should not be recognised until there is reasonable assurance that the enterprise will: (i)

Comply with any conditions attached to the grant; and

(ii)

Actually receive the grants.

Two approaches to accounting for government grants are shown in Figure 6.9:

Figure 6.9: Two approaches to accounting for government grants

6.8.2

Disclosure

The following matters regarding government grants should be disclosed: (a)

The accounting policy adopted for government grants, including the methods of presentation adopted in financial statements;

(b)

The nature and extent of government grants recognised in the financial statements and other forms of government assistance received; and

(c)

Unfulfilled conditions and other contingencies attached to government assistance that has been recognised.

6.9

INVESTMENTS

Investments refer to assets that can increase wealth (through the distribution of royalties, dividends and rental income). In conclusion, investments provide economic benefits to businesses in the form of interest received, dividends, royalties or capital appreciation.



Examples of investments are: (a)

Investing in a company or other business;

(b)

Investing in the stock exchange; and

(c)

Purchase of fixed assets with the purpose of price speculation.

Investments consist of two types, which are explained in Figure 6.10:

Figure 6.10: Types of investments

How to Record in the Financial Statements? If it is the current investment, this investment will be shown in the balance sheet under current assets as follows: Balance Sheet as at 31/12/200X Current Assets Cash Cash at bank Investment Receivables -Provision for doubtful debts Stock/Inventory Total current assets

XX XX XX XX (XX) XX XX



185

However, if it is a long-term investment, these investments will be reflected in the balance sheet as follows: Balance Sheet as at 31/12/200X Non-current Assets Land Furniture Vehicle Equipment Investment Long-term investment Total non-current asset

XX XX XX XX XX XX XX



Non-current assets are used to generate revenue and are not for resale.



Capital expenditures that increase the estimated useful life and the capability of the non-current asset shall be capitalised.



Revenue expenditure does not extend the estimated useful life or capability of the assets, they only provide benefits for the current accounting period, and will be treated as expense for the current period.



Depreciation accounting defines depreciation as the allocation of the depreciable amount of an asset over its estimated useful life.



The three main methods to calculate depreciation are:



–

Straight line;

–

Reducing balance; and

–

Unit-of-production.

Non-current assets can be disposed through discarding at scrap value, selling, and exchanging the old asset for another asset. Any gain and loss on disposal will be reported in the income statement.



Capital expenditure (Capex)

Depreciation allocation

Capital improvement

Revenue expenditure

Depreciation

1.

Mega Enterprise purchased a delivery van on 1 July 2013. RM 65,700 6,500 2,000 1,200

Purchase price Sales tax Road tax Insurance

You are required to calculate the amount that should be recorded as the cost of the delivery van. 2.

During the year ended 30 June 2013, Mega Enterprise incurred the following expenditures with regards to the delivery van purchased in Question 1. RM Repairs (replaced two punctured tyres) Installed roof top carrier Replaced front windshield Petrol

1,500 2,000 1,000 2,200

Required: Identify the mentioned expenditures as capital or revenue expenditures.



1.

187

The following information is provided from Azie Printing. On 1 Jan 2009, Azie Printing purchased a printing machine to increase its production output. Cost of Machine

RM66,000

Estimated residual value at the end of estimated useful life

RM6,000

Estimated useful life Years

10 years

Total Unit of production (printing pages)

100,000,000 pages

Actual usage For the year ended of December 2009

15,400,000 pages

For the year ended of December 2010

13,600,000 pages


11,200,000 pages


12,500,000 pages


12,500,000 pages

You are required to calculate and show the depreciation table for the first five years of operation of the machine using the following methods: (a)

Straight line method;

(b)

Reducing balance method; and

(c)

Unit-of-production method.



2.

As at 31 December 2013, Stargazer Limited owns a machine that originally cost RM77,000. The accumulated depreciation as at 31 December 2013 is RM64,000. Provide the journal entries for the disposal of the machine under the following circumstances: (a)

It is discarded as scrap without any value

(b)

It is sold at its carrying amount, RM13,000

(c)

It is sold for RM20,000

(d)

It is sold for RM10,000

(e)

It is exchanged with another machine. The trade-in value of the old machine is RM23,000 and the cost of the new machine is RM55,000.

(f)

It is exchanged with another machine. The trade-in value of the old machine is RM9,000 and the cost of the new machine is RM65,000.

Horngren, C. T., & Harrison, W. T. (2001). Financial accounting (4th ed.). Upper Saddle River, NJ: Prentice Hall.


Topic  Property,

7

Plant and Equipment (MFRS 116)

LEARNING OUTCOMES By the end of this topic, you should be able to:



1.

Define the term „assets‰;

2.

Explain the criteria for the recognition of fixed assets;

3.

Identify the components of the costs for initial measurement;

4.

Demonstrate expenditure;

5.

Apply the techniques for impairment, retirement and disposal of tangible property, plant and equipment; and

6.

Discuss the disclosure requirements for property, plant and equipment.

the

techniques

for

measuring

subsequent

INTRODUCTION

Let us look at our own lives. Perhaps, after working for several years, we will have some money to buy a car. Then, later on, we might buy a house. These are two examples of non-current assets an individual may own, instead of cash. In this topic, we will discuss property, plant and equipment, which are referred to as non-current assets or fixed assets. Non-current assets have a relatively long economic life and can be classified according to their „tangibility‰. A tangible


190  TOPIC 7 PROPERTY, PLANT AND EQUIPMENT (MFRS 116)

item is something we can touch. Thus, property, plant and equipment are tangible non-current assets. Examples of tangible non-current assets are those with physical forms such as land, warehouse, factory, motor vehicles, machinery, delivery equipment, cash registers, office furniture, fittings, etc. Accounting for property, plant and equipment has a significant impact on an enterpriseÊs operations because an item of expenditure can either represent an asset or an expense. The accounting standards for property, plant and equipment are covered in MFRS 116. MFRS 116 is applied for annual periods from or after 1 January 2006. MASB 15 is applied in private entities and MFRS 116 is applied in all other entities.

7.1

PROPERTY, PLANT AND EQUIPMENT

MFRS 116 defines property, plant and equipment as follows: „The assets that are held by an enterprise for use in the production of goods and services, for rental to others, or for administrative or maintenance purposes; and are expected to be used during more than one reporting period‰.

Based on the given definition of property, learners should understand that plant and equipment are tangible assets used in normal business operations. They are also reminded that tangible assets come in physical forms and are expected to provide services over several accounting periods.

ACTIVITY 7.1 1. You have learnt what the term „tangible asset‰ means. What about „intangible assets‰? List two examples of intangible assets. 2. Give an example for each of the following: (a)

Property;

(b)

Plant; and

(c)

Equipment.


TOPIC 7 PROPERTY, PLANT AND EQUIPMENT (MFRS 116) 

7.2

191

RECOGNITION OF FIXED ASSETS

An item of property, plant or equipment should be recognised as an asset when: (a)

It is probable that future economic benefits associated with the asset will flow to the enterprise; and

(b)

The cost of the asset to the enterprise can be measured reliably.

Property, plant and equipment are often a major portion of the total assets of an enterprise. Therefore, they are important in the presentation of its financial position. As can be seen in Figure 7.1, let us look at the two distinct criteria needed for recognition of fixed assets:

Figure 7.1: Criteria for recognition of fixed assets

(a)

Future Economic Flow to the Enterprise The first criterion for recognition is met when future economic benefits to the enterprise can be determined with a degree of certainty. Therefore, risks and rewards in relation to the ownership of the assets are passed to the enterprise from the onset.

(b)

The Existence of an External Transaction The second criterion for recognition of acquired assets is easily met because of the existence of an external transaction. In the case of a self-constructed asset, a reliable measurement of the cost of construction is readily available.

In the next subtopics, we will look at the measurement of cash, cash equivalents and fixed assets.



7.3

INITIAL MEASUREMENT

According to MFRS 116, an item of property, plant or equipment which qualifies for recognition as an asset should initially be measured at cost.

SELF-CHECK 7.1 Why do we record asset initially at cost?

7.3.1

Acquired Assets for Cash or Cash Equivalent

The initial cost of a fixed asset should comprise: (a)

Import duties;

(b)

Purchase price;

(c)

Taxes; and

(d)

Any directly attributable costs incurred to bring the asset to working condition for its intended use.

Purchase price should deduct any trade or cash discount, irrespective of whether or not the discount is taken. Therefore, only cash price equivalent is recorded. Examples of directly attributable costs are listed in Figure 7.2.



Figure 7.2: Directly attributable costs


193


Example 7.1 Zazy Sdn. Bhd. bought specialised machinery from Taiwan. The invoice price was RM350,000. Zazy Sdn. Bhd. is given a discount of 2 per cent by the seller if the company manages to pay within 45 days. The company has incurred the following payments for the machinery: Machinery-related expenses Import duties and taxes Delivery charges Installation charges Inspection costs Pre-production costs

RM 7,000 3,000 12,000 4,000 8,000

Required Determine the initial historical cost of the machinery. Solution The components of the historical initial cost of the machinery are tabulated in Table 7.1. Table 7.1: Components of the Historical Initial Cost of the Machinery Items Invoice price of machinery

RM 350,000

Less 2 per cent cash discount (irrespective of whether the discount is taken)

(7,000) 343,000

Import duties and taxes

7,000

Delivery charges

3,000

Installation charges Historical cost of the machinery

12,000 365,000



195

ACTIVITY 7.2 Discuss with your coursemates the following questions: (a)

What do you understand by the term „maintenance costs‰?

(b)

Can maintenance charges be part of the cost of an asset? Give your reasons.

However, we should not include administrative and general overhead expenses in the cost of a fixed asset. Similarly, start-up and related pre-production costs should be excluded, unless they are necessary to bring the asset to its working condition.

7.3.2

Self-constructed Fixed Asset

The cost of a self-constructed fixed asset is determined using the same principles for an acquired asset. A self-constructed fixed asset is property, plant or equipment constructed or built by an enterprise for its own use instead of buying a ready-made asset.

The cost of a self-constructed fixed asset includes all expenses necessary to bring it to good working condition. The normal costs incurred are: (a)

Direct materials;

(b)

Direct labour; and

(c)

Overheads.

Material and labour costs are directly related to the asset, while overheads incurred are based on the amount allocated to the asset. The cost of a self-constructed fixed asset should not include internal profit, and costs arising from delays, idle capacity or industrial disputes in the course of its construction. In any situation, we have to ensure that the initial cost capitalised for a selfconstructed fixed asset does not exceed its estimated recoverable amount.



Example 7.2 Mega Sdn. Bhd. built a factory. The costs incurred were as follows: Items ContractorsÊ costs

RM 1,000,000

Direct materials purchased

800,000

Labour used in construction

600,000

Architects and engineers fees

400,000

General administrative costs allocated

300,000

Overheads – directly attributable

460,000

Estimated amount of unused materials at the construction site worth RM200,000 will be used in the construction of a warehouse next to the factory. 10 per cent of the direct labour used was attributable to the cost inefficiencies caused by a labour strike. The contractorsÊ costs include RM100,000 spent on rectification. It is determined by the accountant of the company that the recoverable amount of the factory could be RM10,000,000. Required Determine the historical cost of the factory building. Solution Items Direct materials Less: Unused material

RM

RM

800,000 (200,000)

Labour

600,000

Less: Cost inefficiencies

(60,000)

600,000 540,000

Overheads – directly attributable

460,000

Architects and engineers fees

400,000

ContractorsÊ cost

1,000,000

Less: Rectification costs

(100,000)

Total cost

900,000 2,900,000

Now, let us compare the asset costs (RM2,900,000) with the recoverable amount (RM10,000,000). Therefore, only RM10,000,000 will be capitalised and the balance of RM1,000,000 will be expensed off in the income statement.



7.3.3

197

Exchange Fixed Asset

The company may acquire property, plant and equipment via non-monetary consideration, by giving one or more assets in exchange for another. For example, you trade in your old car for a new one. When we exchange one asset for another, the asset we acquire may or may not be similar to the one we had. (a)

Similar Asset A similar asset is used for the same purpose in the same line of business and has similar fair values. In this situation, we should measure the asset acquired based on the carrying amount of the asset given up, so there is no gain or loss recognised.

Example 7.3 Speed Sdn. Bhd. trades in a used Nissan Serena, a multipurpose van, for a new Proton Waja. The Nissan Serena was bought at RM140,000; the carrying amount is RM56,000 and the market value is RM64,000 at the time of the trade-in. The new Proton Waja has a market value of RM60,000. Required (a)

Determine the cost of the Proton Waja; and

(b)

Show the journal entry to record the transaction.

Solution (a)

This is a case of exchanging „similar assets‰. In accordance with the provision of MASB 15, we measure the new Proton Waja car based on the carrying amount of the used Nissan Serena multipurpose van, that is RM56,000.

(b)

The journal entry: Dr (RM) Dr Dr

Motor vehicle (Proton Waja) Accumulated Depreciation Cr Motor vehicle (Nissan Serena)

Cr (RM)

56,000 84,000


140,000


(b)

Dissimilar Asset If we acquire an item of property, plant or equipment of a dissimilar item, we should measure the asset acquired at its fair value. This is equivalent to the fair value of the asset given up adjusted by the amount of any cash or cash equivalent transferred.

Example 7.4 In line with its business expansion, Sunshine Transport Sdn. Bhd. trades in a used lorry for a new BMW. The lorry was bought for RM100,000; the carrying amount is RM40,000 and the market value of RM54,000 at the time of the trade-in. The new BMW has a market value of RM150,000. Required (a)

Determine the cost of the BMW; and

(b)

Show the journal entry to record the transaction.

Solution (a)

This is a case of exchanging „dissimilar assets‰. In accordance with the provision of MASB 15, the new BMW should be measured based on the fair value of the asset received, that is RM150,000.

(b)

The journal entry: Dr (RM) Dr Dr

Motor vehicle (BMW) Accumulated depreciation Cr Motor vehicle (Lorry) Cr Gain on disposal Cr Cash

Cr (RM)

150,000 60,000 100,000 14,000 96,000

In the next subtopic, we will discuss subsequent expenditure. Let us take a short break by examining the following quote: „Some folks go through life, pleased that the glass is half full. Others spend a lifetime lamenting that it is half-empty. The truth is that there is a glass with a certain volume of liquid in it. From there, it is up to you!‰ Dr. James S. Vuocolo (as cited in Klein, 2014)



199

SELF-CHECK 7.2 Why should capitalised costs not exceed the recoverable amount of the asset?

7.4

SUBSEQUENT EXPENDITURE

Please be reminded that subsequent expenditure is expenditure incurred on an asset after the date of acquisition/exchange/construction. In fact, we will incur subsequent expenditure throughout the lifespan of such assets, as illustrated in Figure 7.3.

Figure 7.3: Things to consider after purchasing a new car

Questions we need to ask ourselves: (a)

Should we capitalise the expenditure as part of the cost of the asset?

(b)

Should we treat it as revenue expenditure and charge against revenue as and when incurred?



ACTIVITY 7.3 Do the following: Take out a piece of paper. (a)

Jot down expenditures you will incur after purchasing a car.

(b)

Identify the more important ones and compare them with the others. Explain.

The rule of thumb that we should apply here is that: Subsequent expenditure on property, plant and equipment is recognised as an asset when the expenditure improves the condition of the asset beyond its originally-assessed standard of performance. According to MASB 15 [para 28], examples of improvements which result in increased future economic benefits include: (a)

Modification of an item of plant to extend its useful life, including an increase in its capacity;

(b)

Upgrading machine parts to achieve a substantial improvement in the quality of output;

(c)

Adoption of new production processes to enable a substantial reduction in previously-assessed operating costs; and

(d)

Upgrading of a component of the asset that has been treated separately for depreciation purposes such as hotel furniture and fixtures, as well as fittings. Under this situation, the expenditure incurred in replacing or renewing the component is accounted for by the acquisition of a separate asset and the replaced asset is written off.

We should assess the expenditure on repairs or maintenance of property, plant and equipment since these are made to restore or maintain the asset. If the subsequent expenditure is recognised as an asset, this will affect the amount of depreciation. Students are reminded of the following formula to calculate the depreciation of an asset after the subsequent expenditure: *Net Carrying Amount + Subsequent Expenditure – Residual Value Remaining Useful Life (*Net Carrying Amount = Book value – Accumulated depreciation)



201

Example 7.5 Peach Tree Sdn. Bhd., a manufacturer in Klang, bought machinery at a cost of RM210,000 from Korea in 2008. The residual value was estimated at RM10,000. It is the companyÊs policy to depreciate the machinery on the straight line method over 10 years and charge full year depreciation in the year of purchase and none in the year of disposal. The following subsequent expenditures were incurred in 2013: (a)

In view of excessive usage, an important component of the machinery was damaged and the company replaced it with a similar component at a cost of RM25,000;

(b)

The machine requires annual servicing and the cost in 2013 was RM15,000; and

(c)

The company incurred RM50,000 for a major overhaul, which increased the output capacity by 40 per cent.

Required (a)

How should each of the subsequent expenditures be accounted for?

(b)

Calculate the depreciation for the year ended 31 Dec 2013.

Solution (a)

The cost of replacing a similar component and annual service should be expensed. The cost of major overhaul should be capitalised as an asset.

(b)

Depreciation = =

Net carrying amount + Subsequent expenditure - Residual value Remaining useful life RM110,000 + RM50,000 – RM10,000 10 – 5

=

RM30,000

Net carrying amount

= Book value – Accumulated depreciation = RM210,000 – (RM200,000/10 – 5) = RM110,000



SELF-CHECK 7.3 Why does a company prefer to record assets at market value?

7.5

SUBSEQUENT MEASUREMENT

Normally, property, plant and equipment are recorded at historical costs and depreciate over their useful life. However, there is one exception to this; no depreciation is charged for freehold land. As the net book value of the noncurrent asset may be different from the fair value, the non-current asset will not reflect the true value or market value of the business. For example, a building which is five years old may have a carrying value of RM800,000, whereas the market value might be RM1,600,000 due to its strategic location and regular maintenance. As such, should this company disclose the building at the market value or continue to record at cost less accumulated depreciation? If we follow strictly historical cost accounting, the building should be disclosed at cost less accumulated depreciation. However, many enterprises would prefer to disclose at market value less depreciation. For decision-making purposes, we should use the fair value. With reference to MASB 15: Property, Plant and Equipment, the benchmark treatment is that property, plant and equipment should be recorded at cost less accumulated depreciation. Similar treatment is also applied in MFRS 116. It is referred to as the „Cost Model‰ [para 30].

ACTIVITY 7.4 The price for renting a house in Damansara Utama usually is about twice that for a house in Rawang. In your opinion, why is this so?

MASB 15 also provides that revaluation should be made with sufficient regularity such that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet [para 34]. Copyright © Open University Malaysia (OUM)


203

Under MFRS 116, it is regarded as the „Revaluation Model‰. If the enterprise wants to revalue its property, plant or equipment, then the following rules are applicable: (a)

The non-current assets are shown at fair value, which for: (i)

Land and building is normally at the market value; and

(ii)

Plant and equipment at their market value or depreciated replacement cost (para 35).

(b)

Once revaluation has been done by an appraiser, regular revaluation should be carried out every three or five years (para 35).

(c)

When an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs should be revalued (Para 39).

Upon an initial revaluation, increase in net carrying amount (revaluation surplus) should be credited directly to equity and a decrease in net carrying amount should be charged directly as an expense. However, upon a subsequent revaluation, a revaluation increase should be recognised as income to the extent that it reserves a revaluation decrease of the same asset previously recognised as an expense [para 43]. Conversely, a decrease in revaluation should be charged directly against any related revaluation surplus to the extent that decreases do not exceed the amount held in the revaluation surplus in respect of the same asset. Only upon disposal of the asset, can the revaluation surplus be transferred to the income statement as realised gain.



Example 7.6 SSL Sdn. Bhd., a developer in Kuala Selangor, bought three blocks of commercial buildings in Kuala Lumpur and Selangor on 1 January 2010. They are situated in Kepong, Selayang and Rawang. In compliance with the accounting standard, it is the companyÊs practice to revalue the buildings every five years. The following data relate to the three blocks of buildings: Building

Cost

Revalued Amount

1.1.2010

1.1.2011

1.1.2016

1.1.2021

RM (Â000)

RM (Â000)

RM (Â000)

RM (Â000)

Kepong

800

1,000

1,300

960

Selayang

800

600

570

970

Rawang

600

900

700

Sold for 740

Required Show the journal entries to record the above transactions. Solution Building in Kepong Date 1.1.2011

Item Dr Building A

Debit

Credit

RM(Â000)

RM (Â000)

200

Cr Revaluation surplus

1.1.2016

Dr Building A

200

300


1.1.2021

Dr Revaluation surplus Cr Buildings A

300

340 340



Building in Selayang Date 1.1.2011

Item Dr Income statement

Debit

Credit

RM(Â000)

RM (Â000)

200

Cr Building B

1.1.2016

200

Dr Income statement

30

Cr Building B

1.1.2021

30

Dr Building B

400

Cr Income statement

230


170

Building in Rawang Date 1.1.2011

Item Dr Building C

Debit

Credit

RM(Â000)

RM (Â000)

300


1.1.2016

Dr Revaluation surplus

300

200

Cr Building C

1.1.2021

200

Dr Bank

740

Cr Building C

700

Cr Income statement (gain on disposal)

Dr Revaluation surplus

40

100

Cr Income statement


100

205


To record the effects of the revaluation, MFRS 116 provides the following two methods: (a)

Restated proportionately with the change in the gross carrying amount of the asset so that the carrying amount of the asset after revaluation equals its revalued amount; and

(b)

Eliminated against the gross carrying amount of the asset and the net amount restated to the revalued amount of the asset.

Example 7.7 On 1 May 2013, Superman Sdn. Bhd. had machinery costing RM250,000 and accumulated depreciation of RM50,000. The machinery was purchased two years ago and was depreciated on the straight-line method over 10 years. On that date, the machinery was revalued upward because current prices had increased substantially. The basis of the revaluation was based on the replacement cost and the relevant data were as follows: Descriptions

RM

Replacement cost of a similar or equivalent new machine

400,000

Less depreciation for two years

(80,000)

Depreciated replacement cost

320,000

Required: (a)

Calculate the surplus arising on the revaluation and show the journal entry under each of the two methods of recording revaluation of assets.

(b)

Present the machinery account under each of the two methods.

Solution (a)

Revaluation surplus = Net revalued amount – Net book value = RM320,000 – RM200,000 = RM120,000



207

Journal entry: Method 1 Dr (RM) Dr

Machinery account Cr Accumulated depreciation Cr Revaluation reserve

Cr (RM)

150,000 30,000 120,000

Method 2 Dr (RM) Dr

(b)

Accumulated depreciation Cr Machinery account Cr Revaluation reserve

Cr (RM)

50,000 70,000 120,000

Presentation of machinery Items

7.6

Method 1

Method 2

Machinery, at valuation

400,000

320,000

Less: Accumulated depreciation

(80,000)

–

Net carrying amount

320,000

320,000

IMPAIRMENT, RETIREMENT AND DISPOSAL

In the following subtopics, we will discuss in details the three important elements; impairment, retirement and disposal.

7.6.1

Impairment

Various factors, such as those internal (obsolescence or physical damage to assets) or external (economic or legal environment), can cause diminution in the value of an asset. This drastic change in value is an impairment loss. Diminution = The process of decreasing or diminishing.



Impairment loss arises when the carrying amount of an asset exceeds its recoverable amount. Paragraph 64 – 72 of MFRS 136 deal with issues in connection with impairment loss. Let us look at the descriptions of a few important terms, shown in Table 7.2 which will be used later in this course. Table 7.2: A Few Important Terms and Their Descriptions Terms

Descriptions

Recoverable Amount

Recoverable amount is the higher of an assetÊs net selling price and its value in use.

Value in use

The present value of estimated future cash flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life.

Net selling price

The amount obtainable from the sale of an asset in an armÊs length transaction between knowledgeable, willing parties, less the costs of disposal.

When there are indications of impairment, we should compare the carrying value of the asset with its recoverable amount. There are times when the recoverable amount of the property, plant or equipment is below the net carrying amount. When this happens, the asset should be assessed on its recoverable amount. We need to immediately recognise the amount of reduction as an expense, and charge it in the current yearÊs profit and loss account. When do we need to do the impairment test? Paragraph 64 of MASB 15 states that: „An enterprise should assess at each balance sheet date whether there is any indication that an asset may be impaired. If any such indication exists, the enterprise should estimate the recoverable amount of the asset.‰ The accounting treatment of an impairment loss will depend on whether the asset value is carried at cost or revalued amount: (a)

Assets Carried at Cost The impairment loss should be recognised as an expense in the income statement immediately.

(b)

Assets Carried at Revalued Amount The impairment loss should be treated as a decrease in revaluation surplus to the extent the impairment loss does not exceed the amount held in the revaluation reserve of that asset. Copyright © Open University Malaysia (OUM)


209

Example 7.8 A machine has carrying amount of RM100,000. Its realisable value is RM60,000 and the value in use is RM75,000. Determine any impairment loss. Solution The recoverable amount is RM75,000 and the machine is considered impaired. The impairment loss of RM25,000 (RM100,000 – RM75,000) should be recognised immediately by writing down the carrying amount to RM75,000. An impairment loss should be recognised in the income statement for assets carried at cost and treated as a revaluation decrease for assets carried at revalued amount.

7.6.2

Retirement and Disposal

We should eliminate the property, plant and equipment from the account upon the disposal or retirement of an asset. For fully depreciated property, plant and equipment which continue to be in use, we should retain these assets in their accounts with RM1 to show their benefit to the enterprise. When we dispose of property, plant and equipment, one of the following situations shown in Figure 7.4 will arise:

Figure 7.4: Situations which arise after disposing of property, plant and equipment



Gain or loss upon disposal should be recognised in the income statement in the year of disposal. When property, plant and equipment retire from active use, the assets held should be valued lower than the net carrying amount and net realisable value, and any loss should be recognised immediately in the income statement. Example 7.9 On 1 January 2013, Streamline Sdn. Bhd. acquired machinery costing RM300,000. It is the company policy to depreciate the machine on the straight line method over 10 years. It is also the company policy to charge full year depreciation in the year of purchase and none in the year of disposal. There was no residual value at the end of the useful life. The company sold the machine for RM120,000 in 2013. In 2013, a machine retired from active use. It has a net book value of RM10,000. The estimated net realisable value of the equipment is RM2,000. Required (a)

Calculate the disposal gain or loss for the machinery; and

(b)

Show the journal entries to record the transactions.

Solution (a)

(b)

Net carrying amount = =

RM300,000 – [(RM300,000/ 10)  5 years] RM150,000

Disposal Loss

RM120,000 – RM150,000 RM30,000

= =

The journal entry Dr Dr Dr

Bank Accumulated Depreciation Income Statement – Loss on disposal Cr Machinery (Disposal of machinery)

Dr (RM) 120,000 150,000 30,000

Cr (RM)

300,000



Dr

Income Statement – written down value Cr Equipment (Retirement of equipment from active use)

7.7

Dr (RM) 8,000

211

Cr (RM) 8,000

DISCLOSURE REQUIREMENTS

Based on MFRS 116, the financial statements shall disclose, for each class of property, plant and equipment: (a)

The measurement bases used for determining the gross carrying amount;

(b)

The depreciation methods used;

(c)

The useful lives or the depreciation rates used;

(d)

The gross carrying amount and the accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period; and

(e)

A reconciliation of the carrying amount at the beginning and end of the period showing: (i)

Additions;

(ii)

Disposals;

(iii) Acquisitions through business combinations; (iv) Increases or decreases during the period resulting from revaluations under paragraphs 34, 43 and 44 and from impairment losses recognised or reversed directly in equity as required under paragraphs 64 to 58 (if any); (v)

Impairment losses recognised in income statement during the period (if any);

(vi) Impairment losses reversed in income statement during the period (if any); (vii) Depreciation; (viii) The net exchange differences arising from the translation of the financial statements of a foreign entity; and Copyright © Open University Malaysia (OUM)


(ix) Other movements. Comparative information is not required for the reconciliation in (e) mentioned. (f)

Monetary or non-monetary compensation recognised for impairment or lost items of property, plant and equipment, which should be disclosed separately.

ACTIVITY 7.5 Find out how property, plant and equipment are presented and disclosed in annual audited accounts from the website of Bursa Malaysia at http://www.bursamalaysia.com/market/ The following example is taken from the notes of the accounts of an annual report of a Malaysian company. It illustrates the accounting policy for property, plant and equipment and the disclosure practice based on MFRS 116 for property, plant and equipment. Example 7.10 CAB CAKARAN CORPORATION BERHAD Year ended 30 September 2009 Extract from notes to accounts Significant accounting policies Property, plant and equipment are stated at cost or valuation less accumulated depreciation and accumulated impairment. Land and buildings stated at valuation are revalued at regular intervals of at least once every five years by the directors based on the valuation reports of independent professional valuers. This is based on market value using comparison and cost methods of valuation with additional valuations in the intervening years where market conditions indicate that the carrying value of revalued assets differ materially from the market values. An increase in the carrying amount arising from revaluation of property, plant and equipment is credited to the revaluation reserve account as revaluation surplus. Any deficit arising from revaluation is charged against the revaluation reserve account to the extent of a previous surplus held in the revaluation reserve account for the same asset. In all other cases, a decrease in carrying amount is charged to the income statement. An increase in revaluation directly related to a previous decrease in the carrying amount for that same asset that was recognised as an expense, is credited to income statements to the extent that it offsets the previously recorded decrease. Upon disposal of revalued assets or crystallisation Copyright © Open University Malaysia (OUM)


213

of deferred tax liabilities on revalued assets, the amounts in revaluation reserve accounts relating to such assets are transferred to retained profit accounts. The carrying amount of property, plant and equipment is reviewed at each balance sheet date to determine whether there is any indication of impairment. An impairment loss is recognised whenever the carrying amount of an item of property, plant and equipment exceeds its recoverable amount. The impairment loss is charged to the income statement unless it reverses a previous revaluation, in which case it is treated as a revaluation decrease. Freehold land and construction-in-progress are not depreciated. Leasehold land is amortised over the lease period of 12, 52, 54, 63, 66, 96 and 880 years. All other property, plant and equipment are depreciated on the straight-line method in order to write off the cost of each asset to its residual value over its estimated useful life. The annual depreciation rates are as follows: Buildings Plant, machinery and equipment

5 to 96 years 2%–50%

Electrical installation

10% & 12%

Office equipment

10%–50%

Furniture, fixtures and fittings

10%–50%

Motor vehicles

10%–50%

Renovation

2% - 15% 10% 10%

Pasaraya equipment Warehouse

Learners are advised to refer to the disclosure of property, plant and equipment from the annual report on the website above. Source: http://www.bursamalaysia.com/market/listed-companies/companyannouncements/#/?category=all



MASB 15 and MFRS 116 prescribe the accounting treatment for property, plant and equipment.



An item of property, plant and equipment should be recognised as an asset when it is probable that future economic benefits associated with the asset Copyright © Open University Malaysia (OUM)


will flow to the enterprise and the cost of the asset to the enterprise can be measured reliably. 

The property, plant or equipment which qualifies for recognition as an asset should initially be measured at its cost.



Subsequent expenditure can only be capitalised when it is probable that future economic benefits, in excess of the originally assessed standard of performance of the existing asset, will flow to the enterprise.



All other subsequent expenditure should be recognised as an expense in the period in which it incurred.

Carrying amount

Property, plant and equipment

Cost

Recoverable amount

Depreciation

Residual value

Equipment

Revaluation

Fair value

Useful life

Impairment loss

Value in use

Net selling price

1.

Florida Sdn. Bhd. acquired machinery from Taiko Bhd, a Japanese subsidiary in Malaysia. The following expenditures were incurred: Items Invoice price of machinery

RM 150,000

Trade discount given

3%

Delivery and handling costs

7,000

Maintenance charges per year

2,000

Installation charges

10,000

General administrative costs



215

Required Calculate the initial amount at which this machinery should be valued. 2.

Mika Sdn. Bhd. has incurred the following costs for the construction of a factory: Items Land cost

RM 500,000

Legal fees and stamp duty for purchase of land

14,000

Cost of demolishing old building on the land

50,000

Cost of clearing and levelling the land

50,000

Architect fees

55,000

Piling and foundation works Legal fees for agreement with building contractor

200,000 3,000

Construction cost

480,000

Plumbing and wiring

200,000 1,552,000

Required Determine separately the amount to be recorded as the cost of land and of the factory building. 3.

Super Max Sdn. Bhd. started its business on 1 January 2008. The company bought two machines in 2010, costing RM50,000 each. It is the company policy to depreciate the machinery at the rate of 10 per cent per annum, using the straight-line method. It is also the company policy to provide full year depreciation in the year of purchase and none for the year of disposal. In 2014, one of the machines bought in 2010 was sold for RM15,000 on credit to Wong Sdn. Bhd. At the same time, another machine was modified to increase the quality of its output. The cost of modification was RM20,000. The useful life of this machine after the modification was estimated to be 13 years. Required Prepare the following accounts for 2014: (a)

Machinery account;

(b)

Accumulated depreciation account; and

(c)

Machinery disposal account. Copyright © Open University Malaysia (OUM)


1.

Mikuyo Sdn. Bhd. has a multi-purpose van worth RM270,000. Its policy is to charge full yearÊs depreciation in the year of acquisition and none in the year of disposal. The residual value at the end of its useful life is RM20,000. In 2013, the accumulated depreciation for the van before the current year provision is RM100,000. During the year, major repairs were made costing RM60,000 due to a severe accident. The multi-purpose van was also installed with an advanced alarm system costing RM15,000. The vanÊs remaining useful life is expected to be three years. Required

2.

(a)

How would you treat the expenses incurred in 2013?

(b)

Calculate the depreciation charge for 2013.

Triple A Rice Sdn. Bhd. bought a machine on 1 July 2008 at a cost of RM80,000. The machine had an estimated residual value of RM8,000 and a useful life of eight years. The company sold it for RM25,000 on 31 December 2013, the last day of its accounting year. Triple A Rice Sdn. Bhd. incurred dismantling costs and costs of transporting the machine to the buyerÊs factory, amounting to RM3,000. The company uses the straight-line method of depreciation. Required What was the gain or loss upon disposal of the machine?

3.

SR Medical Centre in Kuala Lumpur bought medical equipment costing RM400,000 on 1 January 2009. The estimated useful life of the equipment was five years. On 1 January 2013, it was revalued at RM300,000. Following an inspection, the equipment is expected to last another three years. On 1 January 2013, the equipment was disposed of for RM120,000. The accumulated depreciation is to be eliminated on revaluation. Required Write up the necessary ledger accounts.



217

Klein, A. (2014). Having the time of your life: Little lessons to live by. Berkeley, CA: Viva Editions.


Topic



8

Accounting for Liabilities and Equity


Describe current and long-term liabilities;

2.

Explain the provisions and contingencies;

3.

Differentiate between the equity components proprietorship, partnership and company;

4.

Record the amount of dividend based on the different types of shares;

5.

Record earnings before tax of company and amount; and

6.

Prepare a balance sheet of a company and statement of retained earnings.

entitled

to

of

a

single

shareholders

 INTRODUCTION You have a great idea for a business that will guarantee a big profit. To start this business you need RM1,000,000 cash. You managed to raise RM600,000 cash after selling all your personal assets and belongings. How can you get the remaining RM400,000 cash needed to start the business? You might be able to find a partner who is willing to invest RM400,000 cash in the business or you can borrow the amount needed from your friend or a financial institution. There are several ways to raise capital (money) needed for a business. This can be done through borrowing (liability) or through equity financing.


TOPIC 8 ACCOUNTING FOR LIABILITIES AND EQUITY  219

Companies borrow to finance operations and to expand their businesses. But borrowing can be dangerous. Pasminco Limited was a world-class zinc and lead producer. It borrowed heavily to take over other businesses. Then, the price of zinc dropped to historic lows. Pasminco crashed in September 2001 with $800 million in currency hedging losses and 1.8 billion in debt⁄⁄.but many companies are able to manage their borrowings quite successfully. PaperlinX Ltd, reported that its financial position is solid. Another gas company also felt comfortable with its level of debt⁄⁄These statements show the importance of the levels of borrowings,⁄⁄⁄ Horngren (2004) We will start by looking at the definition of current liabilities as defined by Malaysian accounting standards. The components of selected current liabilities and long-term liabilities will be explained. Then, we will look at the ownerÊs equity and the different components of equity for single proprietorship, partnership and company. Emphasis is on the equity component of a company. Comparisons of how equity will be reported by each form of business will be made too. It is important to understand the equity component of a company, as in the next topic financial statements analysis, company financial statements will be used.

8.1

DEFINITION OF LIABILITIES

Funds or money to finance business activities (buying fixed assets, paying expenses, etc.) comes either from borrowing (liabilities) or from ownerÊs contributions (ownerÊs equity). You have learned earlier how to record borrowings from banks and also the purchase of goods on credit. All these transactions gave rise to liabilities. Liabilities represent an obligation of an entity. This obligation needs to be satisfied by the entity through payment of cash or the surrendering of the entityÊs assets or services.

To illustrate further, assume you received cash today for two cakes to be delivered to your client in two weeksÊ time. Have you earned your revenue? Did you deliver goods or services? The fact is that you have received cash in advanced for goods that will be delivered later, hence no revenue is earned. Upon receiving the cash, you have the obligation to deliver the cakes in two weeks time, thus you should record the receipts of cash (unearned revenue) as a liability. Copyright © Open University Malaysia (OUM)

220  TOPIC 8 ACCOUNTING FOR LIABILITIES AND EQUITY

Earlier, you were told that liabilities can be categorised as current or non-current. Now let us look at how the Malaysian accounting standard defines current liabilities. According to the Malaysian financial accounting standard MFRS 101Presentation of Financial Statement, a liability shall be classified as current when it satisfies any of the following criteria:

(a)

It is expected to be settled in the entity's normal operating cycle;

(b)

It is held primarily for the purpose of being traded;

(c)

It is due to be settled within twelve months after the balance sheet date; or

(d)

The entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the balance sheet date.

All other liabilities shall be classified as non-current. Source: http://www.masb.org.my/

ACTIVITY 8.1 List all your liabilities and identify the years you need to settle them. Do you plan to settle any of them sooner? Why?

8.2

CURRENT LIABILITIES

Current liabilities are obligations by an entity that need to be settled using current assets or by creating another current liability within a period of one year.

Current liabilities comprise the following, as shown in Figure 8.1.



Figure 8.1: Current liabilities

You have learned how to record transactions related to accounts payable, borrowings and accrued expenses in the earlier topic. Now you shall learn about the other forms of current liabilities.

8.2.1

Bank Overdraft

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



8.2.2

Dividend Payable

Dividend payable is a liability unique to companies. It arises as a result of the difference in the date when dividend is declared and the date dividend is paid. Dates of dividends declared and dates of payments might be months apart. For example, final dividends are declared at the end of the accounting period, while the payment will be made two or three months later in the next period. This represents a liability for the company to pay the amount in the next period. You will learn more about dividends in the subtopic 8.5.

8.2.3

Bank Loans

Bank loans, also referred to as notes payable, represent borrowings made by businesses. Borrowings can be long term or short term. Short term refers to borrowing that needs to be paid within a period of one year. Borrowings are subjected to interest. Interest rate is normally quoted per annum. Example 8.1 For example, you borrow RM10,000 from Giant Bank and the interest rate is 10 per cent. You are required to pay back the original amount borrowed plus the interest in six monthsÊ time. How much will you pay back? RM10,000 the original amount plus interest of RM500 (RM10,000 x 10 per cent x 6/12), not RM1,000 as you only borrowed the money for six months. The journal entry to be recorded at the date of payment is: Dr (RM) Date

Dr

Bank Loan

Dr

Interest expense Cr

Cash

Cr (RM)

10,000 500 10,500

To record repayment of bank loan plus interest charges.



If you have long-term borrowing, for reporting purposes, you will need to identify the amount that is due within the next 12 month period and separate this from the amount that is due after the 12 months. The amount that is due within 12 months will be reported as the current portion of long-term liabilities under current liabilities and the remaining balance will be reported as non-current liabilities. Example 8.2 For example, on 31 December 2013 you borrowed RM1,000,000 from Giant Bank and the interest rate is 10 per cent. You are required to pay back the original amount in 10 instalments (at the end of every year) plus the annual interest. What will be reported in the balance sheet as at 31 December 2013? You will report RM100,000 as the current portion of long-term liabilities (as the first instalment is due on 31 December 2014 within 12 months). For your information no accrued interest will be recorded on 31 December 2013 as it is the first day of the borrowing. The remaining RM900,000 will be reported as long-term liabilities in the balance sheet.

8.2.4

Bill Payable

Bill payable is a note issued by one entity, promising to pay another entity. It is usually issued when you, as the debtor, are unable to pay for your accounts payable balance to your supplier (creditor).

You will issue a bill payable, a note promising to pay the amount within a certain period at a certain interest. In other words, your accounts payable balance will be zero, but you have created another liability called bills payable. The amount plus interest will need to be paid within the promised time period.



Example 8.3 For example, you purchased goods on credit from Paris Trading for RM6,000 on 1 June 2013. Credit terms was n30. If after thirty days you are unable to pay for the amount, you can issue a bill payable to Paris Trading. The note promises to pay the amount in three monthsÊ time, and at a 10 per cent interest. You will record the issue of bill payable as the following:

1 July 2013

Dr

Dr (RM) 6,000

Cr(RM)

Accounts Payable Cr Bills Payable 6,000 To record the issue of bill payable, term three months and 10 per cent interest.

On the date of settlement of the bill payable (you can pay earlier, which means the interest charges will be lower!) Assume payment is made on 1 September 2013 (two months instead of the promised three months). Interest of RM100 (RM6,000 x 10% x 2/12). The following entries will be made:

1 Sept 2013

Dr(RM) Cr(RM) Bills Payable 6,000 Interest expense 100 Cr Cash 6,100 To record the settlement of bill payable and the interest charged. Dr Dr

The receiver of the bill payable will record this as bill receivable and will report this as current assets.



Example 8.4 To illustrate, we will look at how the mentioned example will be recorded in Paris Trading. Paris Trading will record the receipt of bill payable from you in his book as the following:

1 July 2013

Dr(RM) Cr(RM)_ Bills Receivable 6,000 Cr Accounts Receivable 6,000 To record the bill receivable term three months and 10 per cent interest.

Dr

When payment is received on 1 Sept 2013, the following will be recorded:

1 Sept 2013

8.3

Dr(RM) Cr(RM) Dr Cash 6,100 Cr Bills Receivable 6,000 Cr Interest revenue 100 To record the receipts of bill receivable and interest received.

LONG-TERM LIABILITIES

Long-term liabilities are obligations of an entity that need to be settled in a period of more than twelve months from the date of reporting. The obligation is settled by giving up (sacrificing) the entityÊs current assets.

Long-term liabilities are as shown in Figure 8.2.



Figure 8.2: Long-term liabilities

8.3.1

Long-term Bank Loans

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

8.3.2

Bonds and Debentures

Bonds and debentures are issued by an entity in order to finance its activities. Normally big corporations and government will issue bonds. You might have read about the WAWASAN Islamic bond issued by the World Bank in Malaysia, amounting to RM760 million and due in 2014. The issuer will have an obligation to pay the interest payment to the bond holder, normally semi-annually until the bond matures. The face value of the bond will be paid by the issuer on maturity.

ACTIVITY 8.2 The government has issued several bonds for the public. Can you identify and list the reasons as to why these bonds are offered to the public?



8.3.3

Mortgage Loans

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

ACTIVITY 8.3 Can you try to categorise all obligations that you have into current and non-current?

8.4

PROVISIONS AND CONTINGENCIES

MFRS 137 Provisions, Contingent Liabilities and Contingent Assets prescribed the accounting treatment for: (a)

Provisions;

(b)

Contingent liabilities; and

(c)

Contingent assets.

Provisions, contingent liabilities and contingent assets would not be covered by MFRS 137 if: (i)

It results from financial instruments that are carried at fair value;

(ii)

It results from executory contracts, except where the contract is onerous;

(iii) They arise in insurance enterprises from contracts with policyholders; and (iv) They are covered by another MFRS (for example; provision for taxation is covered under MFRS 112 Income Taxes).



8.4.1

Provisions

MFRS 137 defines provision „as a liability of uncertain timing or amount or both‰. Provision is quite different from other liabilities such as accruals and payables. For provision, there is uncertainty as to the timing or amount of the future expenditure. Provision can be recognised when: (a)

An enterprise has a present obligation (legal or constructive) as a result of a past event;

(b)

It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and

(c)

A reliable estimate can be made of the amount of the obligation.

Present Obligations Present obligations are divided into: (a)

Legal obligation For example, an obligation to replace defective parts for cars sold stipulated in the sales agreement is a legal obligation. Legal obligations arise due to legislations, operation of law, or contract.

(b)

Constructive Obligations Constructive obligations derive from an entityÊs action when: (i)

By an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and

(ii)

As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities. For example, the practice of a company paying two monthsÊ bonus to its current employees, even though there is no contract to do so.

Past Events If past event leads to a present obligation, it is called an obligating event. If a company has an obligating event, it has to settle the obligation. If the obligation event is a legal or constructive one, the entity has to accrue the liability. Past events have to be independent of future actions of the entity. For example, if the entity has polluted the environment it has to pay penalties. These penalties entail an outflow of economic resources because of a past event. Copyright © Open University Malaysia (OUM)


However, the entity could install a filtering system to reduce pollutants. It is not an obligation if the entity can avoid future expenditure. On the other hand, a current non-obligating event may become an obligating event in the future.

8.4.2

Contingencies

Contingencies are events, the outcome of which is determined by other events whose outcomes are uncertain. Contingencies are classified into: (a)

Contingent Liabilities Contingent liabilities can be defined as: (i)

A possible obligation that arises from past events and whose existence will be confirmed only on the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or

(ii)

A present obligation that arises from past events but is not recognised because: 

It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation, or



The amount of the obligation cannot be measured with sufficient reliability.

Recognition of contingent liabilities A contingent liability that is probable is considered as a liability. To recognise it, an entity should determine whether the contingency is probable or possible which involves judgement. If the probability is more than 50 per cent, it is probable. If it is less than 50 per cent, it is possible. Less than 30 per cent is remote. For possible contingent liabilities, a disclosure is made in the financial statement by way of a note if the contingent liability is possible but not remote. If it is remote, no disclosure is needed. (b)

Contingent Assets Contingent assets can be defined as: (i)

A possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; and



(ii)

MFRS 137 provides that contingent asset should not be recognised. However, contingent assets should be disclosed where inflow of economic benefits is probable.

When the realisation of income is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate, where a contingent asset is disclosed. But contingent assets are seldom disclosed in financial statements according to MFRS 137 unless in rare cases.

8.5

EQUITY

Do you remember equity or ownerÊs equity from earlier topics? It is the ownerÊs residual claims of the business assets after paying off liabilities. You will now learn the difference in reporting equity for single proprietorship, partnership and company.

SELF-CHECK 8.1 Explain the difference in reporting equity for single proprietorship, partnership and company.

8.5.1

The Equity of a Single Proprietorship

For a single proprietorship the equity section of a balance sheet will have only one account, that is, the capital account. The balance of the capital account represents (see Figure 8.3): (a)

The original amount contributed by the owner;

(b)

Any increase or decrease as a result of profits or losses;

(c)

Any increase as a result of additional contribution by owner; and

(d)

Any decrease as a result of drawings made by owner.



Figure 8.3: Capital account

Let us look at an extract of a balance sheet of a single proprietorship, Perniagaan Runcit Tunggal owned by Ammar (see Figure 8.4).

Figure 8.4: OwnerÊs equity of a single proprietorship



The closing balance of RM21,000 shows the equity of the proprietorship; the ownerÊs (AmmarÊs) claims against the businessÊ net assets.

8.5.2

The Equity of a Partnership

For the purpose of comparison let us look at a partnership, where we know there are at least two owners. These owners might not contribute capital in equal amounts, make equal amounts of drawings; and nor do they share profits the same way. Therefore, it is necessary to separate the capital and drawings accounts of partners. Under partnership, the capital account only records the amounts originally contributed by partners, while another account called Current Account is used to record the profit or loss made by the partnership and also the drawings made by them (see Figure 8.5).

Figure 8.5: Equity component of a partnership

In other words, when comparing the reporting of equity of a proprietorship in the balance sheet, the equity of partnership will be reported as the following (see Figure 8.6).



Figure 8.6: Reporting equity of a partnership

From the given example you can see that the total ownerÊs equity is RM255,000, which is the total of capital and the current account of both partners, Ali and Amir. How net income is shared or allocated to partners will be taught in another module.

8.5.3

The Equity of a Company SELF-CHECK 8.2

Can you suggest ways for a company to raise money to increase its capital?

We will look at the financial analysis of an income statement using a company balance sheet and income statement. Hence, it is important for you to understand the composition of ownersÊ equity of company and the difference in reporting ownersÊ equity for a company.



The components of a companyÊs equity are as follows: (a)

ShareholdersÊ funds;

(b)

Retained earnings; and

(c)

Reserves.

Before we look at these components in detail, let us learn the types of shares available. For a company, the owners comprise many individuals called shareholders. Thus, it is impractical to have a capital account for each shareholder. Shareholders own shares of the company. Shareholders (owners) cannot withdraw profits from the company whenever they like; however companies will give shareholders dividends. CompanyÊs capital comprises of share capital (equity) and loan capital (liability). The issuer (company) will classify the financial instrument as an equity or a liability in accordance with the substance of the contractual arrangement. A company will initially offer shares (stocks) to the public. You have probably seen a prospectus in the newspaper inviting the public to purchase shares in a listed company. In general, there are two types of shares: common or ordinary shares and preference shares. Shares will be issued at a fixed face value or par value. The face value is also called the nominal value. The par value of a share can be 50 cents, RM1 or any other value. Shares are first issued by a company to the public at a price that is normally different from the par value of shares. For example, a share with par value of RM1 can be issued at RM2 or any other value when it is first offered to the public. A primary market is where the company issues the shares to trade with the public. After shares are issued to the public, the shareholders can sell their shares to other buyers or buy more shares from other shareholders in the Kuala Lumpur Stock Exchange (KLSE) or Bursa Malaysia. In other words, the KLSE is a secondary market for shares.



Figure 8.7 explains the primary and secondary market.

Figure 8.7: Primary and secondary market Bursa Malaysia Source: Kean Kok, Weina, Marimuthu & Bhattacharya (2010)

Now let us look at the composition of shareholdersÊ funds. (a)

ShareholdersÊ funds ShareholdersÊ funds are the par value of shares times the number of shares issued by a company. For example, if a company issues three million ordinary shares of RM1 par value each, then the shareholdersÊ fund is RM3 million. Let us look at the characteristics of these shares.

(i)

Ordinary or Common Shares All companies must have ordinary shares and usually the ordinary shares comprise the bulk of the companyÊs equity. They carry the right to vote and the ordinary shareholders are entitled to share in the profits for dividends only after any dividend has been paid to the other classes of shares. Due to this, ordinary shareholders are considered to be risk takers because if the business fails, they can lose their capital. Vice versa, if the business proves to be successful, the reward might be very high. The rate of dividends paid to ordinary shareholders is not fixed. It is dependent on the companyÊs level of profits and the companyÊs dividend policy. The ordinary shareholders are effectively the owners of the company. In the event that a business turns bad, the company does not have an obligation to declare dividends for ordinary shares. However, once a company declares its dividend, the company must fulfil its obligation to pay. Copyright © Open University Malaysia (OUM)


(ii)

Preference Shares Preference shares carry preferential rights, as to the payment of dividends and repayment of capital in the event of liquidation, over the other classes of shares. Preference shareholders receive a fixed rate of dividend which is expressed as a percentage of the nominal value. Preference shares have special rights attached to them, that is, rights to receive dividends before ordinary shareholders and also rights to the residual assets before ordinary shareholders, if the company winds up. A company has the obligation to pay this dividend regardless whether the business is good or bad. Hence, in ratio analysis, preference shares are treated as liabilities rather than equity. The rights attaching to the preference shares are set out in the Memorandum of Articles (MoA) of the company. The MoA of the company will state the rights of the preference shares with respect to repayment of capital, participation in surplus profits, and priority of repayment of capital and dividends as to other classes of capital. Preference shareholders do not have any voting rights and therefore leave the management of the company to the ordinary shareholders. There are five types of preference shares (refer to Table 8.1). Table 8.1: Types of Preference Shares

Types

Description

Cumulative preference shares

The holders of these shares are entitled to receive a fixed dividend per annum. If there is any insufficient or absence of dividend payment in any year, the arrears can be carried forward and become payable in the future.

Non-cumulative preference shares

Holders of this preference shares receive a fixed rate of dividend if the company has sufficient profits to declare dividend. If not, the dividend for that year is forfeited and cannot be carried forward.

Participating preference shares

The holders receive fixed dividends, are allowed to receive additional dividends depending on profits after all other classes of shareholders have received their dividends.

Redeemable preference shares

Redeemable preference shares can be repurchased from the shareholders at a future date as pre-determined at the time of the issue of the redeemable preference shares. This type of shares allows the company to obtain capital of a semipermanent nature at a fixed rate of dividend.



Convertible preference shares

(b)

The holders are entitled to convert their preference shares to ordinary shares as expressed in the Articles. The date and the rate of conversion will be specified.

Retained Earnings The second component of equity for company is retained earnings. Retained earnings account is the accumulation of a companyÊs net earnings (profit) after tax after distributions to shareholders and/or reserves. Earnings after tax will increase retained earnings, while net losses will decrease the retained earningsÊ balance. For a single proprietorship and partnership, the business is not taxed on the profit it makes; the individual will need to report the profit of the business as its income, and will be taxed individually. However, for a company, the company will have to pay tax on its income or profit. Therefore, the income statement of company will include an additional item of expense which is tax expense. See example in Figure 8.8.

Figure 8.8: Income statement of a company Copyright © Open University Malaysia (OUM)


Unlike a proprietorship and partnership, where the owner can withdraw his profits at any time, shareholders cannot do the same. However, a company will pay dividends out of net income after tax (profits/earnings). This dividend will reduce the balance of retained earnings. The retained earning balance reported in the balance sheet is net after deducting dividends and transfer of earnings to reserves. Normally two types of dividends are paid to shareholders: (i)

Interim dividend. Interim dividend is declared and paid during the current financial year,

(ii)

Final dividend. Final dividend is declared at the end of the current financial year and will be paid in the next financial period.

ACTIVITY 8.4 Surf the web for the balance sheets of companies. You can also go to the Bursa Malaysia website http://www.bursamalaysia.com/market/. You can see how these corporations report their assets, liabilities and equity. Do take note of the types of reserves being reported.

Dividends are always quoted based on the nominal value of shares, not the current market price (quoted in Bursa Malaysia) or the issue price of the shares. For example, a company has issued two million ordinary share par value 50 cents each, at a price of RM2 and currently the shares are traded at RM3.50 each. Assuming that at the end of year the company declares a 5 per cent dividend for ordinary shares. What is the amount of dividend that will be paid by the company? The amount of dividend is RM50,000 which is 5 per cent times RM1 million (the nominal value of the ordinary shares). (c)

Reserves A company might also create reserves to set aside funds from earnings for the following purposes: (i)

To cover themselves from future loses;

(ii)

To buy fixed assets;

(iii) To repay liabilities; and (iv) To buy back their shares. Copyright © Open University Malaysia (OUM)


The most common reserve created is the general reserves, and this will be reported in the equity section of the balance sheet. Reserves can be classified into two (see Table 8.2): Table 8.2: Classes of Reserves Classes

Description

Revenue reserves

Revenue reserves are profits arising through trading activities set aside to meet specific or general purposes. They are realised profits and can be distributed in cash form. General reserves and retained profits are common examples of revenue reserves. The retained profits are available for distribution as dividends. If the company wants, it can transfer all or a part of the general reserve to retained earnings to make it available for distribution.

Capital reserves

Increases to the shareholdersÊ equity by non-trading activities are categorised as capital reserves. Capital reserves may be created due to: 

Statutory requirements;



Accounting standard requirements; or



Good accounting practice.

The source of the capital reserves is identified by the title to the account. Asset revaluation reserve identifies the reserve that arises due to an increase in the value of noncurrent assets through a revaluation exercise and the company has adopted the value for that particular noncurrent asset in the accounts. The general rule regarding capital reserve is that the company cannot distribute capital reserve in the form of cash dividends. Even if it is distributed, it can be only in the form of bonus shares. For example, one of the purposes for which the share premium could be utilised is to issue bonus shares.



Figure 8.9 summarises the components of a companyÊs equity.

Figure 8.9: Components of a companyÊs equity

After learning about retained earnings, dividends and reserves let us look at the Statement of Retained Earnings (see Figure 8.10). Statement of retained earnings shows the changes in retained earnings of a company over a period.

Figure 8.10: Format of statement of retained earnings Copyright © Open University Malaysia (OUM)


Let us look at the following example, in order to learn how to prepare the statement of retained earnings and the equity portion of balance sheet of a corporation. Example 8.5 Cyber Corporation has issued five million ordinary shares par value RM1 each and two million 10 per cent preference shares par value RM2 each. Earnings after tax for the year ended 31 December 2013 is RM23,000,000. Balance of retained earnings as at 1 January 2013 is RM123,000,000. No dividends have been paid during the year. The Director decided to pay 20 cents dividend per share to ordinary shareholders and the amount due to preference shareholders. The directors also decided to transfer RM10,000,000 of earnings to general reserves. General reserves balance as at 1 January 2013 is RM35,000,000. Dividend to ordinary shareholders is 20 cents per share and there are five million shares; therefore, the total dividend for ordinary shareholder is RM1,000,000 (five million shares x 20 cents). For preference shares, the dividend rate is 10 per cent (as stated 10 per cent preference share), and the amount of preference shares is RM4,000,000 (two million shares x RM2 par value), and therefore the dividend is RM400,000 (RM4,000,000 x 10%).

The statement of retained earnings of Cyber Corporation will look like the following (see Figure 8.11):



Figure 8.11: Statement of retained earnings of Cyber Corporation

If the extract of a balance sheet is to be prepared (equity) for Cyber Corporation, it will look like the following (see Figure 8.12):

Figure 8.12: Balance sheet extract of Cyber Corporation Copyright © Open University Malaysia (OUM)




There are two categories of liabilities; current liabilities and long-term liabilities.



Current liabilities are obligations by an entity that need to be settled using current assets or by creating another current liability within a period of one year. Example: bank overdraft.



Long-term liabilities are items that have to be paid more than a year after the balance sheet date. Example: bank loans.



Bank overdraft is a facility given by banks to current account holders that enable the holder to draw cheques larger than the holderÊs bank balance.



Bill payable is a note issued by one entity, promising to pay another entity.



Long-term bank loans (notes payable) are borrowings that need to be paid within a period of more than twelve months.



Equity components of a company comprises (i) shareholders funds; (ii) retained earnings; and (iii) reserves.



Shareholders funds are the par value of shares times the number of shares issued by a company.



Retained earnings account is the accumulation of companyÊs net earnings (profit) after tax after distributions to shareholders and/or reserves.

Bills payable

Ordinary share

Bills receivable

Preference share

Common stock or ordinary shares

Preferred stock or preference shares

Contingencies

Reserve accounts

Current liability

Retained earnings

Long-term liability

Share capital



1.

Syarikat Demo borrowed RM500,000 from Putrajaya Bank on 1 July 2012. Interest rate is 5 per cent of the original loan amount and is to be paid semiannually. The first interest payment is due on 1 January 2013. The loan principle is to be paid over 10 instalments, to be made annually, and the first instalment is due on 1 July 2013. You are required to:

2.

1.

(a)

Prepare the extract of a balance sheet as at 31 December 2012;

(b)

Provide the journal entries to record the first interest payment;

(c)

Provide the journal entries to record the payment of the first instalment of the principle amount; and

(d)

Prepare the extract of a balance sheet as at 31 December 2014.

Calculate the amounts of dividends for the following situations. (a)

Exxone Corporation issued 300,000 8 per cent preference shares par value RM1 each.

(b)

Shellex Corporation issued 400,000 9 per cent preference shares par value RM2 each.

(c)

Dividend of 15 per cent for 500,000 ordinary shares, par value 50 cents each.

(d)

Dividend of 10 per cent for 200,000 ordinary shares, par value RM1 each.

(e)

Dividend of 5 cents each for 500,000 ordinary shares, par value 50 cents each.

Fill in the blanks (a)

Equity of a partnership ______________ accounts.

comprises

______________

(b)

Equity of a company comprises ______________, ______________ and ______________accounts.

(c)

There are two main types of shares: ______________ shares and _____________ shares. Copyright © Open University Malaysia (OUM)

and


2.

(d)

Instead of making drawings, shareholders are paid ______________.

(e)

______________ and ______________ will decrease the retained earnings balance, while ______________ will increase the retained earnings.

The following information is obtained from M&S Corporation as at 31 December 2010. Ordinary shares par value 70 cents 3,000,0000 shares issued 5 per cent preference shares par value 50 cents 5,000,0000 shares issued Sales revenues RM57,500,000 Cost of goods sold RM15,000,000 Operating expenses RM18,000,000 Company tax rate is 30 per cent Retained earnings 1/1/2013 RM25,600,000 General reserves 1/1/2013 RM12,000,000 On 31 December 2013, The Director declared the following final dividend: (i)

10 per cent to ordinary share to ordinary shareholders; and

(ii)

The due amount to preference shareholders.

The directors also decided to transfer RM3,500,000 of retained earnings to general reserves. You are required to: (a)

Calculate the earnings after tax for M&S Corporation for the year ended December 2013;

(b)

Prepare the statement of retained earnings for M&S Corporation for the year ended December 2013; and

(c)

Prepare the extract of balance sheet for M&S Corporation as at 31 December 2013.



1.

DJ started a business on 1 July 2013, with RM40,000 capital in cash. During the first year he kept very few records of his transactions. The assets and liabilities of the business at 30 June 2014 were: RM Freehold premises Mortgage on the premises Stock Debtors Cash and bank balances Creditors

76,000 50,000 24,000 2,800 5,400 7,600

During the year, DJ withdrew RM9,000 cash for his personal use but he also paid RM6,000 received from the sale of his private car into the business bank account. From the given information, prepare a balance sheet showing the financial position of the business at 30 June 2014 and indicate the net profit for the year.

1.

From the following items provided, draw up a balance sheet for Lafferty as at 31 December 2014. RM Fixtures and fittings Stock Debtors Bank Cash Creditors Net profit for year Cash introduced Drawings

RM

5,000 3,000 6,800 15,100 200 16,000 8,000 20,000 7,000



1.

The chairman of a public limited company has written his annual report to the shareholders, an extract of which is quoted as follows: „In May 2012, in order to provide a basis for more efficient operations, we acquired REX Warehousing and Transport limited. The agreed valuation of the net tangible assets acquired was RM1.4 million. The purchase consideration, RM1.7 million, was satisfied by an issue of 6.4 million equity shares, of RM0.25 per share, to REXÊs shareholders. These shares do not rank for dividend until 2013.‰ Answer the following questions on the above extract: (a)

What does the difference of RM0.3 million between the purchase consideration (RM1.7m) and the net tangible assets value (RM1.4m) represent?

(b)

What does the difference of RM0.1m between the purchase consideration (RM1.7m) and the nominal value of the equity shares (RM1.6m) represent?

(c)

What is the meaning of the term „equity shares‰?

(d)

What is the meaning of the phrase „do not rank for dividend‰?

Fixed assets: Premises Current assets: Stock Debtor Bank Less: Current liabilities Creditors

Capital

Fujida Balance sheet as at 31 March 2013 RM

RM 190,000

39,200 18,417 828__ 58,445 (23,216) 35,229 225,229 225,229



(a)

The business of Fujida is taken over by Kagawa in its entirety. The assets are deemed to be worth the balance sheet values as shown. The price paid by Kagawa is RM260,000. Show the opening balance sheet of Kagawa.

(b)

Suppose instead that Kenshin had taken over FujidaÊs business. He did not take over the bank balance, and valued the premises at RM205,000 and stock at RM36,100. The price paid by him is also RM260,000. Show the opening balance sheet of Kenshin.

Horngren, C. T. (2004). Management accounting: Some comments. Journal of Management Accounting Research, 16 (1), 207-211. Kean Kok, N., Weina, Z., Marimuthu, M., & Bhattacharya, S. (2011). Financial management. Kuala Lumpur, Malaysia: Oxford Fajar.


Topic  Integrity and

9

Ethics in Preparing and Reporting Financial Information


Describe the ethical code; and

2.

Discuss the factors in ethical behaviour.

 INTRODUCTION Ethics is a term that refers to a code or moral system that provides criteria for evaluating right and wrong. An ethical dilemma is a situation in which an individual or group is faced with a decision that tests this code. Many of these dilemmas are simple to recognise and resolve. For example, have you ever been tempted to call your professor and ask for an extension on the due date of an assignment by claiming a fictitious illness? Temptations like these will test your personal ethics.


250  TOPIC 9 INTEGRITY AND ETHICS IN PREPARING AND REPORTING FINANCIAL INFORMATION

Accountants, like others operating in the business world, are faced with many ethical dilemmas, some of which are complex and difficult to resolve. For instance, the capital marketsÊ focus on periodic profits may tempt a companyÊs management to bend or even break accounting rules to inflate reported net income. In these situations, technical competence is not enough to resolve the dilemma.

ACTIVITY 9.1 Do you know of any real cases happening in the accounting world involving ethical issues? Discuss these cases with your coursemates.

9.1

ETHICAL CODE

All accounting members acting in the public interest have to comply with certain ethical codes. The difference in the accountancy profession is its acceptance of the responsibility to act in the public interest. Thus, an accountantÊs or any accounting memberÊs responsibility is not more than to satisfy the needs of an individual client or employer. Ethical codes consist of fundamental principles of professional ethics for accounting members and provide a conceptual framework that members can apply to: (a)

Identify threats to comply with the fundamental principles;

(b)

Evaluate the significance of the threats identified; and

(c)

Apply safeguards, when necessary, to eliminate the threats or reduce them to an acceptable level.

Safeguards are necessary when the member determines that the threats are not at a level at which a reasonable and informed third party would be likely to conclude, weighing all the specific facts and circumstances available to the member at that time, that compliance with the fundamental principles is not compromised. A member shall use professional judgment in applying this conceptual framework.


TOPIC 9 INTEGRITY AND ETHICS IN PREPARING AND  REPORTING FINANCIAL INFORMATION

9.2

251

ETHICAL BEHAVIOUR

Ethical behaviour is necessary for a society to function in an orderly manner. It can be argued that ethics is the glue that holds a society together. The need for ethics in society is sufficiently important that many commonly held ethical values are incorporated into laws. Ethical behaviour should be practised by all accounting members and is essential in accounting professional practices. Those are listed in Figure 9.1.

Figure 9.1: Essential ethical behaviour in accounting professional practices

Now, let us discuss these ethical behaviours one by one in greater detail.

9.2.1

Integrity

Integrity imposes an obligation on all accountants to be straightforward and honest either in the business or professional relationship. Integrity dealing is fair and truthful. Copyright © Open University Malaysia (OUM)


Accountants shall not be involved in any report, returns, communication or other information if they knew it: (a)

Contains a materially false or misleading statement;

(b)

Contains statements or information furnished recklessly; or

(c)

Omits or obscures information required to be included where such omission or obscurity would be misleading.

If accountants become aware that they have been associated with such information, they shall take steps to be disassociated from that information.

9.2.2

Objectivity

The principle of objectivity imposes an obligation on all members not to compromise their professional or business judgment because of bias, conflict of interest or the undue influence of others. A member may be exposed to situations that may impair objectivity. It is impracticable to define and prescribe all such situations. A member shall not perform a professional service if a circumstance or relationship biases unduly influences the memberÂs professional judgment with respect to that service.

9.2.3

Competence

The principle of professional competence and due care imposes the following obligations on all members: (a)

To maintain professional knowledge and skill at the level required to ensure that clients or employers receive competent professional service; and

(b)

To act diligently in accordance with applicable technical and professional standards when providing professional services.

The maintenance of professional competence requires a continuing awareness and an understanding of relevant technical, professional and business developments. Continuing professional development enables a member to develop and maintain the capabilities to perform competently within the professional environment.



9.2.4

253

Independence

Independence for accounting members refers to behaving professionally. The principle of professional behaviour imposes an obligation on all members to comply with relevant laws and regulations and avoid any action or omission that the member knows or should know may discredit the profession. This includes actions or omissions that a reasonable and informed third party, weighing all the specific facts and circumstances available to the member at that time, would be likely to conclude that they adversely affect the good reputation of the profession.

9.2.5

Confidentiality

The principle of confidentiality imposes an obligation on all members to refrain from: (a)

Disclosing outside the firm or employing organisation confidential information acquired as a result of professional and business relationships without proper and specific authority or unless there is a legal or professional right or duty to disclose; and

(b)

Using confidential information acquired as a result of professional and business relationships, to their personal advantage or the advantage of third parties.

A member shall maintain confidentiality, including in a social environment, be alert to the possibility of inadvertent disclosure, particularly to a close business associate or a close or immediate family member, maintain confidentiality of information disclosed by a prospective client or employer, maintain confidentiality of information within the firm or employing organisation, and take reasonable steps to ensure that staff under the memberÊs control and persons from whom advice and assistance is obtained, respect the memberÊs duty of confidentiality.



Ethical codes consist of fundamental principles of professional ethics for accounting members and provide a conceptual framework to them.



Integrity is being straightforward, honest and truthful in all professional and business relationships. You should not be associated with any information that you believe contains a materially false or misleading statement, or which is misleading by omission. Copyright © Open University Malaysia (OUM)




Objectivity does not allow bias, conflict of interest or the influence of other people to override your professional judgement.



Professional competence and due care are an ongoing commitment to your level of professional knowledge and skill. Base this on current developments in practice, legislation and techniques. Those working under your authority must also have the appropriate training and supervision.



In confidentiality, you should not disclose professional information unless you have specific permission or a legal or professional duty to do so.



Professional behaviour complies with relevant laws and regulations. You must also avoid any action that could negatively affect the reputation of the profession.

Behaviour

Personal

Ethical

Professional

Misconduct

Safeguards

1.

You are the financial director of a large multinational organisation and have been privy to information on a takeover bid to acquire a rival firm. A family friend is considering selling shares in this rival organisation and has asked you, as an expert in the industry, for advice on this matter. What would you do? Which principles are affected and how? Explain based on the categories given: (a)

Integrity;

(b)

Objectivity;

(c)

Professional competence and due care;

(d)

Confidentiality; and

(e)

Professional behaviour.



1.

255

You are a CIMA member who is a non-executive director of a large services company. The board of directors meets on a monthly basis to discuss the quarterly forecast and other business issues. It is the responsibility of the finance director to distribute papers at least two weeks prior to the date of the meeting. These papers should first be signed off by the CEO. Recently documents have only been received a day before the meeting. You have raised this with the finance director who has stated the delay is due to the sign off by the CEO. You do not feel that you are given sufficient time to review the papers and also believe the information that is available is not complete and therefore difficult to fully appraise. The CEO is a dominant character and many members of the board are nervous about broaching the matter. What would you do? Which principles are affected and how? Explain based on the categories given next: (a)

Integrity;

(b)

Objectivity;

(c)

Professional competence and due care;

(d)

Confidentiality; and

(e)

Professional behaviour.


Topic  Comprehensive

10

Cases (Partnership: Changes in Ownership)




1.

Identify the changes in ownership of a partnership;

2.

Explain the methods of valuing goodwill;

3.

Prepare the accounting entries for admission of new partners, retirement and withdrawal of existing partners;

4.

Discuss the reasons why existing partners withdraw from a partnership;

5.

Describe the importance of asset revaluation in a partnership;

6.

Demonstrate accounting entries for asset revaluation; and

7.

Prepare financial statements for a partnership.

INTRODUCTION

In a partnership business, it is very common for changes in ownership to take place. In this topic, we will discuss changes in a partnership including the admission of new partners, retirement and the withdrawal of partners. You will be introduced to the revaluation of a partnershipÊs assets and recognition of Copyright © Open University Malaysia (OUM)

TOPIC 10 COMPREHENSIVE CASES (PARTNERSHIP: CHANGES IN OWNERSHIP)  257

goodwill upon changes in ownership. All these will be discussed in detail in the following subtopics.

10.1

CHANGES OF OWNERSHIP IN A PARTNERSHIP

When you talk about change of ownership in a partnership, the following three questions need to be answered: (a)

When does ownership change take place? Change of ownership in a partnership takes place in the event of the admission of new partners, retirement or death of existing partners.

(b)

What kind of adjustments is needed? Under such circumstances, a new partnership is deemed to be set up. Therefore, adjustments to the profit-sharing ratio must be made. The reason is, part or all of the old partnershipÊs profits or losses could be related to an earlier period when the business was under a different profit-sharing basis.

(c)

What are the processes? Figure 10.1 shows that the outgoing partner may ask for his fair share from the partnership before he leaves. The new partner, on the other hand, may pay a premium upon joining the partnership in view of the business potential. In short, the incoming partner would be expected to bring in new capital, whereas the outgoing partner, owing to either retirement or death, would have to withdraw his share of the business assets.


258  TOPIC 10 COMPREHENSIVE CASES (PARTNERSHIP: CHANGES IN OWNERSHIP)

Figure 10.1: Changes of ownership in partnership

After having an agreed profit-sharing ratio, the old partnership is deemed to be non-existent. A new partnership agreement will become the legal binding document for all the partners in the partnership.

ACTIVITY 10.1 Find the answers to the following questions and discuss with your coursemates: (a)

What would happen to a partnership if one of the owners died?

(b)

Do we need to find a replacement?

Share your thoughts in myINSPIRE.

10.2

GOODWILL

In a partnership, goodwill arises when there is an admission of new partners into the partnership. This is to compensate the existing partners who have put in effort in building up the business over the years. It is important to note that the goodwill at the time of an admission belongs entirely to the existing partners. Copyright © Open University Malaysia (OUM)


Goodwill is the difference between the price that the purchaser pays to buy a business and the fair value of the net assets of the business. For example, Ali paid RM1 million to buy a business where the fair value of the net assets is RM800,000. In this case, the goodwill is RM200,000. Goodwill arises when there is an increase in the perceived value of the business which is not reflected in the books. It is commonly known as a form of intangible assets. Goodwill is an asset which is difficult to quantify as it is a very subjective process. There are several methods of valuing goodwill. The most common methods of valuing goodwill are as illustrated in Figure 10.2: (a)

A given multiple of turnover;

(b)

A given multiple of the annual profit; or

(c)

The excess of the capitalised value of the profit over the current market value of the net tangible assets.

Figure 10.2: Methods of valuing goodwill

SELF-CHECK 10.1 What are the methods used to value goodwill?

Let us look at these three methods of valuing goodwill in the following example. Copyright © Open University Malaysia (OUM)


Example 10.1 Ahmad and Ali have run a cafe under a partnership since 2010. At the end of 2013, Fatimah joined the partnership. The business has the following financial information for the three years prior to FatimahÊs admission. The market value of the net tangible assets of the business was estimated to be RM120,000. 2011 (RM)

2012(RM)

2013 (RM)

48,000 160,000

64,000 240,000

80,000 440,000

Profit Turnover

Required Compute the goodwill of the partnership using the following methods: (a)

Goodwill is valued at two yearÊs average profit for the last three years;

(b)

Goodwill is valued at a half yearÊs average turnover for the last three years; and

(c)

Goodwill is the excess of the capitalised value of the profit over the current market value of the net tangible assets.

Solution (a)

Average profit = (RM48,000 + RM64,000 + RM80,000) / 3 = RM64,000 Goodwill is valued at two yearÊs average profit for the last three years, that is: Goodwill = 2  RM64,000 = RM128,000

(b)

Average turnover

= (RM160,000 + RM240,000 + RM440,000) / 3 = RM280,000

Goodwill is valued at a half yearÊs average turnover for the last three years, that is: Goodwill = 1/2  RM280,000 = RM140,000 (c)

Capitalised value of profit

= (RM48,000 + RM64,000 + RM80,000) = RM192,000

Goodwill is the excess of the capitalised value of the profit over the current market value of the net tangible assets, that is: Goodwill = RM192,000 – RM120,000 = RM72,000



ACTIVITY 10.2 Why is goodwill commonly known as intangible assets?

10.3

ADMISSION OF NEW PARTNERS IN A PARTNERSHIP

Businesses commonly require additional monetary and human capital as expansion takes place. As such, it is necessary for the existing partners to look for new partners. When a new partner enters the partnership, it is always necessary for the partners to draw up a new partnership agreement. This is important because the new agreement can accommodate changes in the ownership of the business. The old partnership will then cease and a new partnership is formed. As mentioned earlier, goodwill will arise when new partners join a partnership. There are three methods of dealing with goodwill upon the admission of new partners, as seen in Figure 10.3.

Figure 10.3: Dealing with goodwill upon admission of new partners

ACTIVITY 10.3 As an incoming partner, would you agree to the assets remaining in the book being valued at their historical costs? If not, why? State your reasons. Copyright © Open University Malaysia (OUM)


The three methods mentioned will be discussed in the following example: Example 10.2 Ali and Ballu are partners in a business that provides transport services in Kuala Lumpur. Each has made a capital contribution of RM30,400 and RM22,400 respectively. Profit-sharing is in the ratio of 3:2. Due to business expansion in the next couple of months, which will require additional capital injection, they decided to admit Cheng on 31 December 2013 as a third partner. Cheng agreed to contribute RM54,400 as his initial capital. The new profits and losses sharing ratio will be 3:2:5. Upon ChengÊs admission, all three have agreed that goodwill is to be calculated at twice the average profits of the last three years. The profits recorded for the last three years were RM4,344, RM7,752 and RM13,104. Required Compute the goodwill for the above partnership. Solution Goodwill = 2  (RM4,344 + RM7,752 + RM13,104) / 3 = RM16,800 After having determined the goodwill and new profit-sharing ratio, the different methods of dealing with goodwill upon the admission of a new partner are as follows: Method 1: Goodwill is recorded in full in the books In this method, a goodwill account is created with a debit entry. The old partnersÊ capital accounts are credited the goodwill based on the old partnersÊ profits and losses sharing ratio. This is because the goodwill, as a result of the admission of a new partner, belongs solely to the old partners. Goodwill Account 2013 31 Dec

Capital – Ali

RM 10,080 6,720

2013 31 Dec

Balance c/f

RM 16,800

Capital – Ballu 16,800

16,800



2013 31 Dec Balance

PartnersÊ Capital Account Ali Ballu Cheng RM RM RM 2013 40,480 29,120 54,400 31 Dec Balance

c/f

c/f Bank Goodwill 40,480 29,120 54,400

Ali Ballu Cheng RM RM RM 30,400 22,400 –

–

– 54,400

10,080

6,720

–

40,480 29,120 54,400

Method 2: Goodwill is not recorded in the books When goodwill is recognised upon the admission of new partners, such an amount will be amortised and written off against the partnersÊ capital accounts. Under this method, the goodwill is credited to the partnersÊ capital accounts based on the old profit and loss sharing ratio (as shown in Method 1). The goodwill is then written off by debiting the partnersÊ capital accounts in their new profit and loss sharing ratio. Such an attempt is to recognise a loss that would otherwise have been charged to future yearsÊ profit and loss accounts. Thus, this amount is to be shared among the partners in their new profitsharing ratio. PartnersÊ Capital Account 2013 31 Dec Goodwill

Balance c/f

Ali RM 5,040

Ballu Cheng RM RM 2013 3,360 8,400 31 Dec Balance c/f

25,360 19,040 46,000

30,400 22,400 54,400

Bank

Ali Ballu Cheng RM RM RM 30,400 22,400 –

–

– 54,400

30,400 22,400 54,400



Goodwill Account 2013 31 Dec 31 Dec

Capital – Ali Capital – Ballu

RM 10,080 6,720

2013 31 Dec

Capital – Ali Capital – Ballu Capital – Cheng

16,800

RM 5,040 3,360 8,400 16,800

As you can see earlier, the goodwill account is no longer kept in the book after it is written off against the partnersÊ capital accounts. The partnersÊ capital accounts will show the effect of goodwill recognition upon the admission of partners. Method 3: Goodwill is paid directly to the old partners and no record is made in the books This method is the least beneficial to the incoming partner because the money which he pays for goodwill is not reflected in the business transaction. Using the same example, after the goodwill is written off based on the new profit-sharing ratio, Cheng is required to debit from his capital account, RM10,500 (as shown in Method 2). Under Method 3, such amount is to be shared between Ali and Ballu based on their old profit-sharing ratio. Effectively, Cheng will pay Ali RM6,300 and Ballu RM4,200, off the record, leaving the actual capital introduced by Cheng to be reduced to RM57,500 (RM68,000 – RM6,300 – RM4,200).

ACTIVITY 10.4 What are the business attributes that are thought to give rise to goodwill?

10.4

WITHDRAWAL OF PARTNERS IN A PARTNERSHIP

The existing partners can withdraw from a partnership for a number of reasons, such as retirement, business disputes, personal advancement or death. When a partner leaves a partnership, the outgoing partner should be rewarded more than the amount recorded in his capital account for the goodwill he has helped to Copyright © Open University Malaysia (OUM)


generate for the business over the years. It is only fair that the compensation should reflect his contributions to the partnership over the years. When a partner leaves a partnership, his capital and current accounts are to be fully repaid. Before the accounts are repaid, it is necessary to make adjustments in order to recognise the value of goodwill that has been created. The three methods of dealing with goodwill mentioned earlier can be applied. After taking into account all the necessary adjustments, including goodwill recognition, and profits and losses arising from asset revaluation (which will be discussed later), the outgoing or deceased partnerÊs current account is to be transferred to his capital account. The remaining balance in the capital account shall, therefore, represent the amount payable to the individual. The balance in the capital account of the deceased partner can be paid to his estate immediately or settled partly and the remaining is to be regarded as loan repayable over a period of time.

SELF-CHECK 10.2 What are the reasons for the withdrawal of an existing partner from a partnership?

10.5

REVALUATION OF ASSETS

Revaluation of the assets of the business is necessary for the following reasons: (a)

Admission of new partners;

(b)

Withdrawal of existing partners; and

(c)

Change in profit-sharing ratio.

Revaluation of assets is needed because some assets may have appreciated in value, while others may have depreciated. If the revaluation of assets is not done, the new partner admitted would have benefited or lost out due to increases or decreases in value before he joined the partnership without paying or giving anything for it. A revaluation account, therefore, is required.



SELF-CHECK 10.3 What are the functions of asset revaluation in a partnership?

Example 10.3 Micky and Donald are in partnership selling water sport equipment in Petaling Street. Donald has been upset over the existing profit-sharing ratio and demanded a revision. With effect from 1 January 2011, they decided to change their profit-sharing ratio from 2:1 to 1:1. Following is the balance sheet of Micky and Donald as at 31 December 2013: Micky and Donald Balance Sheet as at 31 December 2013 RM Fixed assets: Land and building Equipment

RM

208,000 48,000 256,000

Current assets: Stock Debtors Bank

64,000 38,400 25,600 128,000 384,000

Capital: Micky Donald

224,000 160,000 384,000



Following negotiations, they finally agreed to revalue the following assets before the new profit-sharing ratio took effect: (a)

Land and building RM308,000;

(b)

Equipment RM32,000; and

(c)

Other assets remained at the same values.

Required Prepare the following accounts for Micky and Donald to effect the change in the profit-sharing ratio: (a)

Revaluation account;

(b)

Land and building;

(c)

Equipment;

(d)

PartnersÊ capital accounts; and

(e)

Balance sheet as at 1 January 2011.

Solution Revaluation Account 2014 1 Jan Asset reduced in value Equipment Profit on revaluation Micky (2/3) Donald (1/3)

RM 2014 1 Jan Asset increased in value 16,000 Land and building

RM 100,000

56,000 28,000 100,000

100,000

Land and Building 201 4 1 Jan

RM 2014 Balance b/f

208,000 1 Jan Balance c/f

Revaluation

100,000 308,000


RM 308,000

308,000


Equipment 2014 1 Jan Balance b/f

RM 2014 48,000 1 Jan Revaluation Balance c/f

RM 16,000 32,000

48,000

48,000

Capital Account – Micky 2014 1 Jan Balance c/f

RM 2014 280,000 1 Jan Balance b/f Revaluation: Share of profit

RM 224,000

280,000

280,000

56,000

Capital Account – Donald 2014 1 Jan Balance c/f

RM 2014 188,000 1 Jan Balance b/f Revaluation: Share of profit

RM 160,000

188,000

188,000

28,000

Micky and Donald Balance Sheet as at 1 January 2014 RM Fixed assets: Land and building Equipment

RM

308,000 32,000 340,000


64,000 38,400 25,600 128,000 468,000

Capital: Micky Donald

280,000 188,000 468,000



As you can see from the given example, the benefits or profit arising from the assets revaluation are credited to the partnersÊ capital accounts based on the old profit-sharing ratio of 2:1. The new profit-sharing ratio of 1:1 will be in the following financial year. This is because the partnership before revaluation that takes place is still regarded as the old partnership. Once the revaluation of assets is completed, the new sharing ratio will take effect.

•

In the case of an admission of new partners, retirement of old partners or death of an existing partner, the old partnership is deemed to have ceased and a new partnership agreement needs to be created for the continuation of the business.

•

From the accounting perspective, goodwill results from changes in ownership of a partnership.



There are several methods of valuing goodwill: –


–


–

The excess of the capitalised value of the profit over the current market value of net tangible assets.

•

An existing partner can withdraw from a partnership due to a number of reasons, such as retirement, business disputes, personal advancement or death.

•

To capture the fair value of the business before the new owner can take over the business, the revaluation of assets is required.



Revaluation of the assets of the business is necessary for the following reasons:

•

–

Admission of new partners;

–

Withdrawal of existing partners; and

–

Change in profit-sharing ratio.

The apportionment of the benefits or losses resulting from the recognition of goodwill or revaluation of assets must be based on the old partnersÊ profit and loss sharing ratio. This is because the goodwill or revaluation of benefits belongs solely to the old partners in the old partnership agreement. Copyright © Open University Malaysia (OUM)


•

The new agreement reached among partners will only take effect upon the start of the new business.

Asset revaluation

Intangible asset

Changes of ownership

Partnership

Goodwill

1.

Liono and Tigra are partners in a hardware business in Kuala Lumpur. They are sharing profits and losses in the ratio of 3:2 respectively. Their capital contributions were RM21,000 and RM19,600 respectively. After several years of economic downturn, they are of the view that demand for hardware in the country may pick up tremendously in the near future. In view of this, they expanded their business by admitting Pentron as their new partner on 1 January 2014. Pentron agreed to contribute RM33,600 as his share of the capital. The business made profits of RM5,040, RM6,720, RM7,770 and RM8,190 over the last four years. Three of the partners agreed to compute the goodwill by taking three times the net average net profit over the last four years. Required

2.

(a)

Compute the goodwill for the business;

(b)

Prepare the capital accounts for Liono, Tigra and Pentron, assuming goodwill is to be kept in the books of the partnership; and

(c)

If the goodwill is to be written off in the business, compute PentronÊs share of the goodwill, assuming he is to share 1:5 of the goodwill.

Siew Meng and Lily contributed RM36,000 and RM24,000 respectively as initial capital when they started up a partnership three years ago in Kajang. Based on the partnership agreement, Siew Meng and Lily share profits and Copyright © Open University Malaysia (OUM)


losses equally. On 1 January 2014, Adeline was admitted as a new partner in the business. Adeline brought in RM12,000 as capital and paid RM3,600 as premium for the business goodwill. The new profit and loss sharing ratio after admitting Adeline is 1:2, 1:3 and 1:6 for Siew Meng, Lily and Adeline respectively. The partners agreed that goodwill is not to be recorded in the books. Required Show the necessary ledger accounts upon the admission of Adeline as at 1 January 2014. 3.

Proton and Jaguar are in a partnership trading in car accessories in a shopping complex in Kuala Lumpur. They share the profits and losses of the business on the ratio of 3:2 respectively. They intend to expand their business in view of the enforcement of the new automotive policy recently announced by the Federal Territory government. The following is the balance sheet of the business as at 31 December 2013: Proton and Jaguar Balance Sheet as at 31 December 2013 RM Fixed assets: Equipment Furniture

RM

256,000 179,200 435,200


19,200 140,800 12,800 172,800

Less: Current liabilities Creditors

115,200 57,600 492,800

Capital: Proton Jaguar

281,600 211,200 492,800



Proton and Jaguar decided to admit Benz into the partnership effective 1 January 2014 under the following terms and conditions: (a)

The old partners share profits and losses in the same ratios as before;

(b)

Benz contributes RM128,000 in cash as capital;

(c)

Benz receives 1:4 share of the profits and losses;

(d)

The following assets of the old firm are to be revalued as follows; and

(i)

Equipment

RM 288,000

(ii)

Furniture

192,000

(iii) Debtors

128,000

(iv) Stock (e)

25,600

Business goodwill is to be valued at RM64,000.

Note: Goodwill is to be kept in the books for future amortisation. Required

1.

(a)

Prepare a revaluation account;

(b)

Prepare the balance sheet of the new firm after all adjustments have been made; and

(c)

State the partnersÊ new profit-sharing ratios.

Gordon and Gerald run a business selling household products in Klang. To start the business, they each contributed RM304,000 and RM240,000 respectively as initial capital. They share profits and losses in the ratio of 2:1. On 1 January 2014, due to family commitment, Gordon faced some financial difficulty and requested RM64,000 from the partnership. The withdrawal, as a reduction of GordonÊs capital contribution, was agreed to and the partners changed their profit-sharing ratio to 1:1, from 1 January 2014. Upon the cash withdrawal by Gordon, the partners also agreed to revalue the land and building to RM128,000 and motor vehicles to RM37,600. Other assets remained at the same values. Copyright © Open University Malaysia (OUM)


As the accountant for the partnership, you were furnished with the following balance sheet of Gordon and Gerald as at 31 December 2013: Gordon and Gerald Balance Sheet as at 31 December 2013 RM Fixed assets: Land and buildings Motor vehicles Computer

RM

96,000 48,000 32,000


176,000 144,000 118,400 105,600 368,000 544,000

Capital: Gordon Gerald

304,000 240,000 544,000

Required Prepare the following accounts for the partnership to reflect the arrangement made on 1 January 2014: (a)

Revaluation account;

(b)

Motor vehicle;

(c)

Equipment;

(d)

Bank;

(e)

PartnersÊ capital accounts; and

(f)

Balance sheet as at 1 January 2014, immediately after the change in profit-sharing ratio.



2.

Chan, Moseen and Nuzul have been in a partnership business since 2005. The business involves manufacturing a famous solar system brand in Malaysia. Currently, they are sharing profits and losses in the ratio of 4:3:3. The following balance sheet shows the results of the business as at 30 September 2014: CMN Partners Balance Sheet as at 30 September 2014 RM Fixed assets: Premises Furniture

RM

75,600 20,160 95,760


Less: Current liabilities: Creditors

18,480 20,160 31,080 69,720

18,480 51,240

Long-term liabilities: Loan – Moseen

(21,000) 126,000

Capital: Chan Moseen Nuzul

50,400 25,200 25,200 100,800

Current account: Chan Moseen Nuzul

12,600 8,400 4,200 25,200 126,000



Moseen decided to retire on 30 September 2014 when he reached the age of 60. However, Chan and Nuzul are still in their 40s and hope to continue in the partnership without inviting any new partner to replace Moseen. They agreed to share the profit in the ratio of 3:2. MoseenÊs loan was repaid on 1 October 2014 and it was agreed that the remaining balance due to him, other than that on his current account, should remain on loan to the partnership. It was agreed that the following adjustments were to be made to the balance sheet as at 30 September 2014: (i)

Premises to be revalued at RM126,000;

(ii)

Furniture to be revalued at RM21,000;

(iii) Debt to be reduced by RM840; (iv) Credit to be increased by RM1,680; (v)

Stock to be reduced by RM1,260 due to damaged goods;

(vi) Provision of RM420 to be made for professional charges in connection with the revaluation; and (vii) Goodwill to be valued at RM58,800 and no goodwill account to be recorded in the books. Required Prepare the following accounts: (a)

The revaluation account;

(b)

Capital and current accounts for Chan, Moseen and Nuzul;

(c)

Balance sheet of Chan and Nuzul as at 1 October 2014; and

(d)

Discuss briefly the different methods in valuing goodwill.


Topic  Comprehensive

11

Cases (Dissolution of a Partnership)




1.

Explain the reasons for the dissolution of a partnership;

2.

Apply the principles in disposal of assets and settlement of liabilities;

3.

Prepare accounts, including realisation account and partnersÊ capital accounts;

4.

Apply the principle of Garner versus Murray in the event of a dissolution; and

5.

Calculate cash distribution to partners in the disposal of assets.

INTRODUCTION

Consider yourself involved in a partnership. To make a business decision, all partners must come to an agreement. What difficulties do you anticipate when partners are facing a situation similar to that in Figure 11.1?


TOPIC 11 COMPREHENSIVE CASES (DISSOLUTION OF A PARTNERSHIP)  277

Figure 11.1: Partnership and decision-making Source: www.valdosta.edu/spec/20020214/opinion.shtml

In the previous topic, we discussed changes in ownership of a partnership. In this topic, we will learn about the circumstances where all the partners leave the partnership in a cessation of business operations. In this case, all the assets and liabilities of the partnership will be disposed of and settled in full. The accounting treatments in this situation are discussed in the following sections.

11.1

REASONS FOR DISSOLUTION OF A PARTNERSHIP

A partnership agreement is a vital document in ensuring the smooth running of the business. All partners should agree to run the business indefinitely as long as the operation is profitable. However, due to personal reasons or unprofitable trading conditions, a partnership may be terminated. There are many factors that can bring about the dissolution of a partnership, as shown in Figure 11.2.


278  TOPIC 11 COMPREHENSIVE CASES (DISSOLUTION OF A PARTNERSHIP)

Figure 11.2: Reasons for dissolution of a partnership

SELF-CHECK 11.1 List at least five reasons for the dissolution of a partnership.



Apart from the mentioned reasons, certain provisions in the Partnership Act can be applied in court by the partners to wind up the partnership, as illustrated in Figure 11.3.

Figure 11.3: Provisions in the Partnership Act which can be applied to dissolve a partnership

When a partnership is dissolved, all its assets and liabilities should be fully disposed of and settled. Unlike the admission or retirement of partners, the dissolution of a partnership means the business will no longer exist and therefore no new partnership agreement is needed.

ACTIVITY 11.1 Find out other reasons for the dissolution of a partnership, apart from those given earlier. You may refer to a book or to the Internet. Present your findings in the classroom.



11.2

DISPOSAL OF ASSETS AND SETTLEMENT OF LIABILITIES

When a partnership is to be closed down, partners have to look for buyers of their business assets. They are also required to pay off the liabilities of the partnership by using the proceeds or money generated from the disposal of assets, plus the cash available in the partnership. Once this is done, partners can determine the final settlement of their capital and current accounts. Under normal circumstances, the disposal of the business assets will result in either a profit or loss. Such profit or loss is to be shared among the partners based on their profit-sharing ratio.

ACTIVITY 11.2 Imagine you want to wind up your business. Based on your basic business knowledge, list out at least three things you need to do. The basic accounting entries for the dissolution of partnerships are relatively simple. When the dissolution of a partnership takes place, a realisation account is created (refer to Figure 11.4).

Figure 11.4: Items in a realisation account

Upon the full settlement of the liabilities in the partnership, the available cash in hand can then be used in paying the partnersÊ capital accounts. The following, Example 11.1, aims to explain the proper accounting entries upon the dissolution of a partnership. Copyright © Open University Malaysia (OUM)


Example 11.1 Baba and Nyonya have been partners in the floor tiles business for the past 40 years. Despite the wide difference that exists in the partnershipÊs initial capital contribution, they agree to share profit and loss on a 1:1 basis. As at 30 June 2013, their assets and liabilities were as follows: Baba and Nyonya Balance Sheet as at 30 June 2013 RM

RM

Fixed asset: 72,800 Equipment Current assets: Stock Debtors Cash at bank

39,200 128,800 11,200 179,200

Less: Current liabilities Creditors Loan – Baba

56,000 28,000 84,000 168,000

Capital accounts: Baba Nyonya

156,800 11,200 168,000

Over the years, the partners have been arguing a lot over certain business practices. On 30 June 2013, they decided to dissolve the partnership. Baba agreed to take over the stock at a valuation of RM28,000. They managed to sell the equipment for RM56,000. They only received RM112,000 from debtors but agreed to treat the amount as final and full settlement. The realisation expenses were RM11,200. The liabilities had to be paid in full. Nyonya would pay the amount she owed the firm. The dissolution was completed by 31 July 2013.



Required Prepare all relevant accounts, including the realisation account and partnersÊ capital accounts for the purpose of the dissolution. Solution Realisation Account 2013 31 Jul

Equipment Debtors Stock Cash – realisation exp

RM 72,800 128,800 39,200 11,200

2013 31 Jul

Cash (Equipment) Cash (Debtors) Baba – stock Loss on realisation: – Baba – Nyonya

252,000

RM 56,000 112,000 28,000 28,000 28,000 252,000

Creditors 2013 31 Jul

Cash

RM 56,000

2013 1 Jul

Balance b/f

RM 56,000

Realisation

RM 72,800

Realisation

RM 128,800

Balance b/f

RM 28,000

Equipment 2013 1 Jul

Balance b/f

RM 72,800

2013 31 Jul

Debtors 2013 1 Jul

Balance b/f

RM 128,800

2013 31 Jul

Loan – Baba 2013 31 Jul

Cash

RM 28,000

2013 1 Jul

Cash Account 2013 1 Jul 31 Jul

Balance b/f Realisation: Equipment Realisation: Debtors Capital – Nyonya

RM 11,200 56,000 112,000 16,800 196,000

2013 31 Jul

Realisation exp Creditors Loan – Baba Capital – Baba


RM 11,200 56,000 28,000 100,800 196,000


Capital Account – Baba 2013 31 Jul

Realisation: Stock Loss on realisation Cash

RM 28,000 28,000 100,800 156,800

2013 1 Jul

Balance b/f

RM 156,800

156,800

Capital Account – Nyonya 2013 31 Jul

Loss on realisation

RM 28,000

2013 1 Jul 31 Jul

Balance b/f Cash

28,000

RM 11,200 16,800 28,000

ACTIVITY 11.3 Do you agree that the incidence of partnership dissolution among newly-developed companies is higher compared to that in partnerships among well-established companies? If yes, state your reasons. Share your thoughts with your coursemates in the myINSPIRE forum.

11.3

THE GARNER VERSUS MURRAY RULE

The rule of Garner versus Murray is applicable in the case where one partner is unable to repay his debts in the event of dissolution. When the partnerÊs capital account is in debit, this means that the partner owes the firm. He may not be able to repay his debts to the partnership due to lack of funds or bankruptcy. This rule is universally accepted in such a situation. Garner versus Murray stipulates that in the event of a dissolution, where there are three or more partners and one of the partners fails to repay his debts to the partnership, then the solvent partners must take over such debts in the ratio of their capital contributions at the start of the dissolution.



The following example illustrates the application of the rule of Garner versus Murray: Example 11.2 Wilson, Beh and Tee have been in partnership selling toys at Midvalley since 2005. They are sharing profit and loss in the ratio of 3:2:1. Despite its location in a busy mall, business has not been good. Moreover, Tee has been withdrawing goods from the business, leaving a debit balance in his capital account. On 31 December 2013, the partners decided to dissolve the partnership and the following is the balance on that date: WBT Partners Balance Sheet as at 31 December 2013 RM Fixed asset: Furniture Current assets: Stock Debtors Bank Less: Current liability: Creditors

RM 216,000

162,000 54,000 14,400 230,400

72,000 158,400

Capital: Tee

57,600 432,000

Capital: Wilson Beh

288,000 144,000 432,000

Tee was unable to contribute anything towards the debit in his capital account. Wilson and Beh agreed to absorb his share in the ratio of their capitals. Upon the dissolution, they incurred RM7,200 for the realisation of assets. They managed to dispose of all their assets (other than cash) for RM396,000.



Required Prepare all relevant accounts to close the books for the partnership. Solution Realisation Account 2013 31 Dec

RM 216,000 162,000

Furniture Stock Debtors Cash – exp

2013 31 Dec

54,000

Cash Loss on realisation: – Wilson(3/6)

RM 396,000

21,600

realisation 7,200

– Beh (2/6) – Tee (1/6)

14,400 7,200

439,200 Creditors 2013 31 Dec

Cash

RM 72,000

2013 31 Dec

Balance b/f

RM 72,000

Realisation

RM 54,000

Realisation

RM 162,000

Debtors 2013 31 Dec

Balance b/f

RM 54,000

2013 31 Dec

Stock 2013 31 Dec

Balance b/f

RM 162,000

2013 31 Dec

Cash Account 2013 31 Dec

RM Balance b/f Realisation

14,400 396,000

2013 31 Dec

RM Realisation expenses Creditors Capital – Wilson Capital – Beh

410,400

7,200 72,000 223,200 108,000 410,400

Capital Account – Wong 2013 31 Dec

Loss on realisation Capital – Tee (2/3)

Cash

RM 21,600 43,200

2013 31 Dec

Balance b/f

223,200 288,000


RM 288,000

288,000


2013 31 Dec

2013 31 Dec

Loss on realisation Capital – Tee (1/3) Cash

Balance b/f Loss on realisation

Capital Account – Beh RM 2013 14,400 31 Dec Balance b/f 21,600 108,000 144,000

RM 144,000

144,000

Capital Account – Tee RM 2013 57,600 31 Dec Capital – Wilson 7,200 Capital – Beh 64,800

RM 43,200 21,600 64,800

As you can see from the given example, Tee was unable to settle the amount he owed the partnership. Therefore, Wilson and Beh had to absorb TeeÊs deficit in the ratio of their capital contributions, that is, RM288,000: RM144,000 (2:1). TeeÊs deficiency of RM72,000 was shared by Wong and Beh in the ratio of 2:1. Wong was to share 2/3  RM72,000 = RM48,000 whereas, Beh was to share 1/3  RM72,000 = RM24,000.

ACTIVITY 11.4 Do you think the Garner versus Murray rule is important? State your reasons.

11.4

THE PIECEMEAL REALISATION

To dissolve a partnership, partners may take some time to dispose of all their assets before profits or losses can be computed and shared among them. Some partners may want to withdraw cash that is available for distribution among them rather than wait until the last piece of asset is sold. In this case, proper accounting records are vital to avoid overpaying the partner before the dissolution is completed. In a situation where assets are being disposed of over a period of time, each disposal of an asset is treated as the last disposal of the partnership assets. Any profit or loss arising from the disposal is shared among the partners in their profit and loss sharing ratio. If a partner is unable to meet his financial obligation after the distribution of profit and loss, the Garner versus Murray rule is to be Copyright © Open University Malaysia (OUM)


applied. The remaining partners have to share the deficit in the ratio of their capital.

SELF-CHECK 11.2 Answer the following questions: (a)

How long can partnership dissolutions take?

(b)

What are the factors that contribute to the delay of the dissolution process?

The following illustrates the computation mechanism when assets are disposed of over a period of time. Example 11.3 Ahmad, John and Silva are childhood friends. Upon graduation, they enter into a partnership selling nasi lemak in KLSS. They share profit and loss in the ratio of 3:3:2 respectively. Due to some disagreements among them, the partnership is dissolved. The following is the balance sheet as at the date of dissolution: AJS Partners Balance Sheet as at 31 December 2013 RM Fixed assets: Furniture Office equipment Current asset: Stock Less: Current liability: Creditors

RM 64,000 48,000

80,000

(28,800) 51,200 163,200

Capital: Ahmad John Silva

64,000 96,000 3,200 163,200



On 1 January 2014, the partners managed to sell some assets for RM60,800. The creditors and the dissolution cost them RM3,200. The balance of RM28,800 was left for distribution. On 1 March 2014, John sold more assets for RM70,400 and this amount was available for distribution. The last group of assets was sold for RM51,200 on 1 May 2014. Required Compute the cash distribution to the partners upon each disposal. Third and Final Distribution Loss if no further assets sold Assets Proceeds Loss of disposal Dissolution expenses Loss to be shared Cash paid to partners (RM64,000)

RM

RM

RM

RM

(4,800)

(4,800)

3,200

24,320

26,880

–

192,000 205,200 9,600 3,200 12,800

•

The dissolution of a partnership happens when there are issues such as disagreements among partners or the business is no longer profitable.

•

In the event of dissolution, all assets and liabilities of the partnership are to be disposed of and settled in full.

•

The capital contributions of partners are to be repaid at the end of the realisation process.

•

If a partner is insolvent and unable to contribute further financial resources, the rule of Garner versus Murray is applied.

•

The Garner versus Murray rule stipulates that the deficiency of the insolvent partner must be shared by the solvent partners based on their capital contributions ratio.



Assets realisation

Insolvent partner

Dissolution

Realisation account

Garner versus Murray rule

1.

Tip, Top and Ted have been in partnership since 2003. Due to TipÊs poor health, they decided to dissolve their partnership as at 31 December 2013. Upon realisation of the business assets, they made a profit of RM4,480. They were sharing profits and losses in the ratio of 4:3:1. The following information was extracted from the books of the partnership as at 31 December 2013: Capital

– Tip – Top – Ted Cash at bank Sundry creditors

RM 14,000 11,200 8,400 42,280 4,200

Required Prepare the accounts to close the books of the partnership. 2.

Alfa and Beta run a florist and shared profit and loss on a 1:1 basis. Due to the economic downturn and unprofitable trading conditions, they decided to sell off their business as at 31 March 2014 to a local businessman. Their balance sheet as at 31 March 2014 was as follows:



AB Florist & Co. Balance Sheet as at 31 March 2014 RM Fixed assets: Equipment Furniture

RM

81,000 10,800 91,800


5,400 22,950 37,800 66,150

Less: Current liability: Creditors

(76,950) (10,800) 81,000

Capital: Alfa Beta

54,000 27,000 81,000

The expenses of dissolution were RM3,240. Alfa was to take the stock at a valuation of RM1,350. They sold the assets as follows: (a)

Debtors

– RM20,250;

(b)

Equipment – RM108,000; and

(c)

Furniture

– RM2,700.

Beta managed to get RM4,050 in discount from the creditors. Required Prepare the necessary accounts to show the results of the dissolution of the partnership. 3.

May, June and Steven were partners in a catering business in Kajang. In view of poor management, the partners decided to dissolve their partnership on 31 December 2013. They made a profit on assets realisation of RM11,040. The liabilities of the business included sundry creditors of RM3,840. Cash at bank was RM161,600 after taking into account the proceeds from the disposal of assets. The capital accounts of the partners are May – RM64,000 (CR), June – RM96,000 (CR) and Steven – RM13,280 (DR). Copyright © Open University Malaysia (OUM)


Upon the dissolution, Steven claimed that he had no further financial resources to repay the partnership even though the partners were supposed to share profits and losses equally. Required Draw up the final accounts to close the books of the partnership.

1.

Fernandez, Tengku and Ramli were partners selling hand phone gadgets at a shop in Johor Bahru. They were sharing profits and losses on a 1:1:1 basis. Tengku was declared bankrupt recently and wanted to withdraw from the partnership. Fernandez and Ramli felt they would not be able to cope with the workload and decided to dissolve the partnership on 31 December 2013. The balance sheet as at the date of dissolution was as follows: Fernandez, Tengku and Ramli Balance Sheet as at 31 December 2013 RM Fixed assets: Land and building Motor vehicles

RM

144,000 48,000 192,000


2,400 4,800 7,200 14,400


19,200 (4,800)

Long-term liabilities: Mortgage loan Capital Tengku

(48,000) 4,800 144,000

Capital: Fernandez Ramli

96,000 48,000 144,000



They realised their assets at the following valuations: (i)

Land and building – RM120,000;

(ii)

Motor vehicles – RM36,000 (taken by Fernandez);

(iii) Stock – RM1,200 (taken by Fernandez); and (iv) Debtors – RM2,400. The mortgage loan on the land and building was duly discharged and creditors were settled in full for RM18,000. The costs of dissolution amounted to RM1,200. Required Prepare the following accounts

2.

(a)

The realisation account;

(b)

The cash account; and

(c)

The partnersÊ capital accounts.

Anson, Henry and Chris ran a pharmacy in Penang. They were sharing profits and losses on a 1:1:1 basis. As Henry and Chris wanted to do a MasterÊs course in Canada, they decided to dissolve the partnership. After several rounds of negotiations, the partners managed to sell their outlet to a leading pharmaceutical chain in Malaysia at a goodwill of RM52,800. The company would pay the partners RM180,000 (excluding goodwill) in order to take over all their assets and liabilities except cash at bank. The balance sheet as at 31 December 2013, before the buyover was as follows:



AHC Pharmacy Balance Sheet as at 31 December 2013 RM Fixed assets: Equipment Motor vehicles Computer

RM

53,700 50,400 33,480 137,580

Current assets: Stock Bank

59,220 48,000 107,220


(28,800) 78,420 216,000

Capital: Anson Henry Chris

72,000 72,000 72,000 216,000

Required Prepare the following accounts to reflect the dissolution as at 31 December 2013: (a)

Realisation account;

(b)

Cash account; and

(c)

PartnersÊ capital accounts.


294  ANSWERS

Answers TOPIC 1:

OVERVIEW OF ACCOUNTING

Self-Test 1 1.

Accounting can be defined as a process of collecting, identifying, measuring, recording, summarising and communicating the results of business or economic transactions to users in order for them to make informed or better decisions. There are four components in accounting:

2.

3.

(a)

Recording – written records of journalising and posting business transactions;

(b)

Summarising – preparing the financial statements;

(c)

Analysing – examining the results to determine the financial position and performance; and

(d)

Interpreting – using the financial statements to make judgments and decisions.

To be useful, accounting information has to have the following qualitative characteristics (a)

Relevance;

(b)

Reliability;

(c)

Comparability; and

(d)

Consistency.

Income statements report the financial performance of an entity. It contains information on revenues and expenses including the profit and loss of the business entity.


ANSWERS 

4.

295

Answers are not limited to this. External Users

Type of Information Required

•

Lenders

Cash flow - They are interested to know if the business will have enough cash to pay back the loan.

•

Suppliers

Profitability - They are interested to know if the business is profitable and will continue operating before selling goods on credit.

•

Government agencies

Profitability - Government agencies such as Lembaga Hasil Dalam Negeri (LHDN) need to know the profit in order to determine the amount to be taxed.

•

Customers

Profitability - They are interested to know if the business is profitable and will continue operating before committing in a long-term relationship.

Internal Users •

Employees

Profitability - They are interested to know if they will get bonuses or increments.

•

Sales managers

They need to know what, when and how much to sell.

•

Production managers

They need to know what, when and how much to produce.

•

Budget officers They need the information to monitor cost and performance.

Self-Test 2 1.

Comparability refers to quality of the information that enables users to make comparison in evaluating similarities or differences between companies, industries or over time.


296  ANSWERS

Decision making always involves comparing at least two pieces of information. A single information, for example Syarikat X profit of RM5 million, is not useful to a decision maker. They need to compare it to other companiesÊ profits, last yearÊs profits or the industry average in order to make a decision. 2.

Balance Sheet reports the financial position of a business entity. It contains information on the entityÊs assets, liabilities and ownerÊs equity.

3.

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

4.

Cash flow statements show the in-flow and out-flow of cash of an organisation according to three main activities which are operating, investing and financing.

5.

(a)

Income Statement SMART TUITION CENTRE Income Statement for the year ended 31 December 2013 RM

RM

75,750

75,750

Revenues Tuition fees less Expenses Supplies expenses

6,300

Advertising expense

4,200

Salaries expenses

18,000

General expenses

1,265

Rent expenses Utilities expenses Net income

14,400 7,350

51,515 24,235


ANSWERS 

(b)

Statement of changes in ownerÊs equity SMART TUITION CENTRE Statement of Changes in OwnerÊs Equity for the year ended 31 December 2013 RM

Opening Capital (1/1/2013)

23,700

+ net income

24,235 47,935

– drawings

(10,000)

Closing Capital (31/12/2013)

(c)

37,935

Balance sheet SMART TUITION CENTRE Balance Sheet as at 31 December 2013 RM

RM

RM

Non-current assets Computer equipment

17,800

17,800

Current assets Supplies

8,480

Account Receivables

8,855

Cash

20,000

Total Assets

37,335 55,135

Non-current liabilities Bank Loan

15,000

15,000

2,200

2,200

Current liabilities Account Payables Total liabilities

17,200

Net assets

37,935

OwnerÊs equity* Closing Capital


297

298  ANSWERS

Self-Test 3 1. Financial Accounting

Management Accounting

Financial accounting presents a summary view of the financial results of past operations and its reports are generally aimed at external audiences.

Management accounting information is tracked and presented at a much more detailed level, such as by programme or branch.

TOPIC 2: ACCOUNTING PRINCIPLES AND CONCEPTS Self-Test 1 1.

(a)

MASB publishes accounting standards.

(b)

MICPA and MIA provide training to accountants.

(c)

MIA controls the accounting practice in Malaysia

(d)

MASB issues statements of principles for financial reporting.

2.

No. The Companies Act 1965 requires companies to comply with approved accounting standards. Section 166A of the Companies Act 1965 requires directors of companies incorporated under the Act to ensure accounts are prepared in accordance with the applicable accounting standards to the extent that the accounts give a true and fair view.

3.

Ticket sales, holiday package, rentals of planes and advertising are subjected to full or partial refund if customers cancel their booking. For this type of transaction when the seller has an obligation to refund money upon cancellation, it is normal to recognise revenue only at the date which the service is provided or on the date that cancellation will not be refunded at all. For sales of tickets for super saver flight which is non-refundable, the airline can recognise them as revenue at the point of sale as they do not have any obligation to refund the fees.


ANSWERS 

299

4. Business •

Type of Business

Car rentals

Service

•

Car dealerships

Merchandising (trading/retailing)

•

Tuition centres

Service

•

Batik factory

Manufacturing

•

Tailor

Service

•

Clothing stores

Merchandising (trading/retailing)

Self-Test 2 1.

2.

Explain the following accounting assumptions: (a)

Separate Entity For accounting purposes, the business is considered as a separate entity from the owner. Both the owner and the business are two separate accounting entities. An accounting entity is an economic unit that controls its own resources.

(b)

Going Concern An entity is assumed to be continuing its operations in the foreseeable future and will not cease operations.

(c)

Monetary Units All transactions can be measured in monetary units. In Malaysia, the monetary unit is Ringgit Malaysia (RM). Items that cannot be measured in monetary unit will not be reported in the financial statements but disclosed as notes.

(d)

Accounting Period This assumption states that the life of a business entity can be divided into periodic intervals. This enables financial statements to be prepared periodically.

Explain the following accounting principles: (a)

Historical Cost This principle states that all transactions must be recorded and accounted for according to their historical cost.


300  ANSWERS

3.

4.

(b)

Revenue Recognition This principle states that revenues must be recognised when they are earned. Earned commonly refers to the act of providing goods or services to customers.

(c)

Matching To determine profit for the accounting period, the revenues of that period must be matched with the expenses for the same period.

(d)

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

(a)

Sole Proprietorship;

(b)

Partnership; and

(c)

Company.

Characteristics of sole proprietorship, partnership and company. Sole Proprietorship

Partnership

Company

1.

Owner (s)

Proprietor

Partners

Shareholders

2.

Life of organisation

Limited

Limited

Indefinite

3.

Liabilities

Unlimited

Unlimited

Limited

4.

Accounting status

Business is separate from the proprietor.

Business is separate from the partners.

Business is separate from the shareholders.

5.

Legal status

None

None

A separate legal entity

6.

Formation

Relatively easy

Relatively easy

Complex

7.

Management

Normally by the owner

Normally partners

8.

Tax

Proprietor pays tax on business profit.

Each partner pays tax on his share of the profits.

by

the

Managers or directors Companies pay tax on the business profit and shareholders pay tax on the amount of dividend they receive. (Double Taxation)


ANSWERS 

Self-Test 3 1. (a) Liability (b) Liability (c) Asset (d) Asset (e) Liability

(f) Asset

Self-Test 4 1. (a) Asset (b) Asset (c) Liability (d) Asset (e) Asset (f) Liability (g) Asset (h) Liability

(i) Asset

TOPIC 3:

ACCOUNTING CYCLE

Self-Test 1 1. Assets

Liabilities

Owner's Equity

Business A

79,500

45,000

34,500

Business B

68,600

23,000

45,600

Business C

163,700

59,200

104,500


301

302  ANSWERS

2

(a)

(b)

Indicate whether the following items are A (Assets), L (Liabilities), R (Revenues) or E (Expenses). (i)

Cash (A)

(viii) Accounts payable (L)

(ii)

Bank loan (L)

(ix) Accounts receivable (A)

(iii) Equipment (A)

(x)

(iv) Notes payable (L)

(xi) Supplies (A)

(v)

(xii) Advertising (E)

Insurance (E)

Sales (R)

(vi) Salaries (E)

(xiii) Salaries payables (L)

(vii) Furniture and fittings (A)

(xiv) Motor vehicle (A)

Explain how the following transactions will affect the accounting equation. Identify the account affected. (i)

Pay cash for postage Decrease in asset (cash) and decrease in ownerÊs equity through increase in expense (postage).

(ii)

Buy furniture and fittings on credit Increase in assets (furniture and fittings) and increase in liabilities (accounts payable).

(iii) Bring own motor vehicle to be used for business purposes Increase in assets (motor vehicle) and increase in ownerÊs equity (capital). (iv) Pay salaries to workers Decrease in asset (cash) and decrease in ownerÊs equity through increase in expense (salaries). (v)

Receive rentals from tenants Increase in asset (cash) and increase in ownerÊs equity through increase in revenue (rental income).

Self-Test 2 1.

(a)

Transactions of Azwan Enterprise. Transactions

Descriptions

1

-

Purchased supplies worth RM1,000 for cash.

2

-

Received RM2,000 cash from debtor.

3

-

Paid off bank loan for the amount of RM4,000 cash. Copyright © Open University Malaysia (OUM)

ANSWERS 

(b)

303

4

-

Paid rental RM1,000 cash.

5

-

Paid wages RM2,000 cash.

6

-

Received RM7,000 cash for work performed (printing service).

7

-

Purchased supplies worth RM1,500 on credit.

8

-

Provided printing services to client but payment will be received later.

9

-

Supplies used.

Balance of the account as at 31/1/2013.

Date

Cash

Accounts Receivable

Supplies

Land

Account Payable

Bank Loan

Capital

Ending balance,

8,500

5,300

1,700

38,000

5,200

6,000

42,300

31/1/2013

(c)

Accounting equation of Azwan Enterprise. Assets

=

Liabilities

+

OwnerÊs Equity

Cash + A/R + Supplies + Land

=

A/P + Bank Loan

+

Capital

8,500 + 5,300 + 1,700 + 38,000

=

5,200 + 6,000

+

42,300

53,500

=

11,200

+

42,300

(d)

Total Revenue – Total Expense = Income (i)

Service Revenue – (Rental expense + Wages expense + Supplies used) = Income

(ii)

RM10,500 – (RM1,000 + RM2,000 + RM1,200) Income

(iii)

=

Therefore income (profit) is RM6,300.

Did you notice that the difference between the opening capital balance (RM36,000) and closing capital balance (42,300) is exactly RM6,300, which is the profit made by Azwan Enterprise? Can you see the relationship between them?


304  ANSWERS

Profit is revenue minus expense, and you have learned earlier that revenue will increase ownerÊs equity while expense will decrease ownerÊs equity. Therefore, if you know the opening capital balance and closing capital balance (assuming there is no drawing made by owner) you can determine the profit. 2.

(a)

Transactions analysis: Effects on accounting equation. Feb 1

Asset (cash) increased, liability (loan) increased and owner's equity (capital) increased.

2

Asset (cash) decreased and another asset (furniture and fittings) increased.

5

Asset (beauty supplies) increased, liability (accounts payable) increased.

7

Asset (accounts receivable) increased, owner's equity (revenue) increased.

10 Asset (cash) decreased, owner's equity (drawings) decreased. 12 Not a transaction for the beauty salon. 15 Asset (cash) increased, owner's equity (consultation fees) increased. 16 Asset (cash) decreased, another asset (motor vehicle) increased and liability (loan) increased. 17 Asset (cash) increased and another asset (accounts receivable) decreased. 25 Asset (cash) decreased, liability (account payables) decreased. 27 Asset (beauty supplies) increased and another asset (cash) decreased. 28 Asset (cash) decreased, ownerÊs equity (expenses) decreased.


ANSWERS 

(b)

Transaction analysis.

Transa ctions (Feb. 2005)

305

ASSETS

Cash

+

Beauty Supplies

+

Furniture and fittings

=

+

Motor Vehicle

+

Account Receivab les

LIABILITIES

=

Loan

+

Account Payables

+

Owner’s Equity

+

Capital

1

250,000

=

100,000

+

150,000

Bal.

250,000

=

100,000

+

150,000

2

(25,000)

+

Bal.

225,000

+

100,000

+

=

25,000

=

4,000

5 Bal.

25,000

=

225,000

+

4,000

+

25,000

225,000

+

4,000

+

25,000

= 5,000

7 Bal.e 10 Bal.

(20,000) 205,000

15 Bal. 16 Bal. 17 Bal. 25 Bal. 27 Bal. 28

100,000

+

4,000

+

100,000

+

4,000

+

= = =

+

4,000

+

25,000

5,000

=

100,000

+

4,000

+

205,000

100,000

+

4,000

+

+

4,000

+

135,000 3,000 Revenues 138,000

+

4,000

+

138,000

+

4,000

+

25,000

5,000

=

208,000

+

4,000

+

25,000

5,000

=

100,000

(5,000)

+

=

15,000

203,000

+

115,000

3,000

+

206,000

+

3,000

= 20,000 4,000 4,000

+ +

25,000 25,000

+ +

20,000 20,000

+

5,000

=

(3,000)

=

2,000

=

(4,000)

115,000

4,000

=

202,000

+

4,000

(5,000)

+

5,000

197,000

+

9,000

+

25,000

+

20,000

+

2,000

=

138,000

(4,000) 115,000

+

0

+

138,000

115,000

+

0

+

138,000 (100) electricity (1,500) rentals (2,000) salaries 134,400

= +

25,000

+

20,000

2,000

(3,600)

= =

+ + Bal.

150,000 5,000 Revenues 155,000 (20,000) Drawings 135,000

Not a transaction for the beauty salon

12 Bal.

5,000

150,000 4,000

193,400

+

9,000

+

25,000

+

20,000

+

2,000

=

115,000

+


0

+

306  ANSWERS

Self-Test 3 1. Purupuru Balance sheet as at 31 December 2013 Fixed assets: Fixtures Van Current assets: Stock of goods Debtors Cash at bank

RM

RM

1,800 3,800

5,600

4.200 1.200 300 5,700

Less: Current liabilities Creditors

4,100

Capital

1,600 7,200 7,200

Self-Test 4 1. Cash June 1 Capital 25 Equipment 28 Bank

12,000 200 300

June 2 Bank

11,700

Capital June 1 Cash

12,000

Office furniture June 5 OrangeCo

1,900

June 18 OrangeCo

Van June 8 Bank

5,250


120

ANSWERS 

307

Equipment June 12 PineappleCo

2,300

June 25 Cash

200

Bank June 2 Cash 30 KiwiCo

11,700 4,000

June 8 Van 26 OrangeCo 28 Cash

5,250 1,780 130

OrangeCo June 18 Office furniture 26 Bank

120 1,780

June 5 Office furniture

1,900

PineappleCo June 12 Equipment

2,300

KiwiCo June 30 Bank

4,000

TOPIC 4: ADJUSTING ENTRIES AND CLOSING ENTRIES Self-Test 1 1.

(a)

Cash basis accounting Onn & Sons Enterprise Income Statement for the month ended 31 January 2013 RM

RM

Revenues Service revenues

27,500

less Expenses Supplies expense

(5,000)

Rental expenses

(3,000)

Net income

(8,000) 19,500


308  ANSWERS

(b)

Accrual basis accounting Onn & Sons Enterprise Income Statement for the month ended 31 January 2013 RM

RM

Revenues Service revenues

35,000

less Expenses Salaries expenses

(2,000)

Supplies expense

(3,000)

Rental expenses

(1,000)

(6,000)

Net income

2.

29,000

Working Total office supplies – Supplies on hand at the end of period = Office used supplies (RM1,617 + RM3,603) – RM526 = RM4,694 Journal entry Dr

Office Supplies Expense Cr Office Supplies To record office supplies used

3.

4,694 4,694

This exercise will be easier to see if you draw the timeline diagram. Working 1/1/2013

31/8/2013

Prepaid insurance = RM400 1 Renewed 3 years policy RM2,160 2 Expenses?

31/12/2013

2013


ANSWERS 

309

1

This will expire (used up) by 1/9/2013 and will be expensed for 2013.

2

This will provide coverage until 31/8/2016, however until 31/12/2013 it provides four months coverage to the business and hence needs to be expensed. 1 January to 31 August 2013 insurance expense = RM400 + 1 Sept to 31 December 2013 insurance expense = RM240 (RM2,160  4/36) Journal entry Dr

Insurance Expense Cr Prepaid Insurance To record insurance expired. 4.

640 640

Working For only nine months (April to September) the magazine has been sent to client therefore Ujang only earned RM450 revenue (RM1,800  9/36). Journal Entry Dr

Subscription Received in Advanced Cr Subscription Revenue To record subscription revenue earned (9 months)

450 450

Self-Test 2 1.

Interest on note payable = (RM30,000  12%)  3/12) = RM900. Journal entry Dr

Interest Expense Cr Interest Payable To record interest expense accrued. 2.

900 900

Interest earned on the fixed deposit = (RM24,000  12%)  3/12) = RM720. This will not be received until 31 March 2013, but you have earned the interest revenue and will be receiving it later. Hence, revenues should be recognised. Copyright © Open University Malaysia (OUM)

310  ANSWERS

Journal entry Dr

Interest receivables Cr Interest income To record interest income earned.

3.

(a)

720 720

Journal entries

01/01/2013 –

Not a transaction. Balance is shown in the Accounts Receivable

05/01/2013 –

Dr

Accounts Receivable - Venus Cr

600

Sales

600

Sold goods on credit to Venus

10/02/2013 –

Dr

Bad Debts Expenses Cr

300

Accounts Receivable - Star

300

Writing off Star accounts as bad due to bankruptcy.

07/10/2013 –

Dr

Cash Cr

200 Accounts Receivable - Venus

200

Venus paid RM200 as full settlement of his account

Dr

Bad Debts Expenses Cr

400

Accounts Receivable - Venus

400

Writing off balance of Venus account RM400 as bad

01/12/2013 –

Dr

Accounts Receivable - Star Cr

100

Bad debts recovered

100

Bad debt recovered from Star RM100

Dr

Cash Cr

100 Accounts Receivable - Star

To record the receipt of RM100 from Star.


100

ANSWERS 

(b)

311

Ledger Bad Debts Expense

10/2

Accounts receivable –Star

300

10/2

Accounts Venus

300

receivable

–

Year end P&L

600

600

600

Bad Debts Recovered Year P&L

end

100

1/6

Account receivable –Star

100

Accounts Receivable- Star 1/1

b/d

300

10/2

Bad Debts Expense

300

1/6

Bad Debts Recovered

100

1/6

Cash

100

Accounts Receivable- Venus 5/1

Sales

500

10/5

Cash

200

10/5

Bad Debts Expense

300

500

4.

(i)

500

Journal entries  Dr Supplies expense Cr Supplies

Debit 350



2,400



Dr

Insurance expense Cr Prepaid insurance (RM4,800 / 2 years = RM 2,400 p.a.)

Dr


Credit 350

2,400

3,000


312  ANSWERS

Cr Accumulated depreciation - Building (RM60,000 x 5%)       

Depreciation expense 6,000 Cr Accumulated depreciation - Motor vehicle (RM30,000 / 5 years = RM6,000 p.a.) Dr Accounting fees 3,400 Cr Unearned accounting fees

3,000

Dr

Dr

Dr

Dr

Dr

Dr

Rental receivables Cr Rental revenues

500

Interest expense Cr Interest payable

300

Salaries expenses Cr Salaries payable

600

Utilities expense Cr Utilities payable

200

Income summary Cr Provision for doubtful debts

300

6,000

3,400

500

300

600

200


300

ANSWERS 

(ii)

Adjusted trial balance

Accounts

MKS Accounting Firm Adjusted Trial Balance as at 30 June 2013 Debit (RM)

Cash Office supplies Accounts receivable Provision for doubtful debts Rental receivables Prepaid insurance Building Accumulated Depreciation - Building Motor vehicle Accumulated Depreciation - Motor vehicle Accounts payable Unearned accounting fees Salaries payable Utilities payable Interest payable Bank loan Capital - MKS Drawings - MKS Accounting fees Rental revenues Interest expense Salaries expenses Utilities expenses Supplies expense Insurance expense Doubtful debts Depreciation expense

Credit (RM)

13,000 150 2,300 300 500 2,400 60,000 3,000 30,000 6,000

5,600 3,400 600 200 300 25,000 60,000 1,200 22,300 2,900 1,300 5,100 1,600 350 2,400 300 9,000 129,600

129,600


313

314  ANSWERS

The adjusting entries and adjusted trial balance can also be combined as a worksheet (see the following worksheet):

Account Cash Office supplies Accounts receivable Prepaid insurance

MKS Accounting Firm Worksheet as at 30 June 2013 Unadjusted T.B. Adjustment Dr Cr Dr Cr 13,000 500

350

2,300

Adjusted T.B. Dr Cr 13,000 150 2,300

4,800

2,400

2,400

Building

60,000

60,000

Motor vehicle

30,000

30,000

Accounts payable Bank loan Capital - MKS Drawings - MKS Accounting fees Rental revenues Interest expense Salaries expenses Utilities expenses Supplies expense Insurance expense Depreciation expense Accumulated depreciation – Building Accumulated depreciation - Motor vehicle

5,600 25,000 60,000

5,600 25,000 60,000

1,200

1,200 25,700 2,400

1,000 4,500 1,400

3,400 500 300 600 200 350 2,400 9,000

Unearned accounting fees Rental receivables Utilities payable Interest payable Salaries payable Doubtful debts Provision for doubtful Debts

22,300 2,900 1,300 5,100 1,600 350 2,400 9,000

3,000

3,000

6,000

6,000

3,400

3,400

500

500 200 300 600

200 300 600 300

300

300

300

118,700

118,700

17,050

17,050

129,600


129,600

ANSWERS 

315

It is common for a business not to record an adjusting entry in a journal, but instead, show it in a ten column worksheet. The above is a partial worksheet, as it does not include the income summary and balance sheet column. Can you see the effect of adjustment entries to the unadjusted trial balance figure? Some adjustments will increase the balances, while others decrease the balance. This increase and decrease are according to their normal balances rules. Can you see that additional accounts are created after adjustments are made? Did you notice how there are no adjustment entries that involve cash. And for each adjustment entry there will be one item of balance sheet and another item of income statement affected. (iii) Income statement for MKS Accounting Firm MKS Accounting Firm Income statement for the year ended 30 June 2013 RM Revenues Accounting fees Rental revenues Less Operating expenses Interest expense Salaries expenses Utilities expenses Supplies expense Insurance expense Doubtful debts Depreciation expense

RM

22,300 2,900

25,200

(1,300) (5,100) (1,600) (350) (2,400) (300) (9,000)

(20,050)

Net Income

5,150

(iv) Balance Sheet for MKS Accounting Firm MKS Accounting Firm Balance Sheet as at 30 June 2013 RM Current assets Cash Office supplies Accounts receivable

RM 13,000 150

2,300


RM

316  ANSWERS

Less provision for doubtful debts Rental receivables Prepaid insurance Total current assets Non-current assets Building Accumulated depreciation – Building Motor vehicle Accumulated depreciation Motor vehicle Total non-current assets

300

2,000 500 2,400 18,050

60,000 (3,000)

57,000

30,000 (6,000)

24,000 81,000

TOTAL ASSETS Current liabilities Accounts payable Unearned accounting fees Salaries payable Interest payable Utilities payable

99,050 5,600 3,400 600 300 200

Total current liabilities Non-current liabilities Bank loan

10,100 25,000

Total non-current liabilities

25,000

TOTAL LIABILITIES NET ASSETS OwnerÊs Equity Beginning capital 1/7/12 Add net income

35,100 63,950 60,000 5,150 65,150

Less drawings Closing capital 30/6/13

1,200 63,950


ANSWERS 

(v)

317

Closing entries Dr Dr

Accounting fees 22,300 Rental revenues 2,900 Cr Income summary To close revenue accounts to income summary account

Dr

Income summary Cr Interest expense Cr Salaries expenses Cr Utilities expenses Cr Supplies expense Cr Insurance expense Cr Doubtful Debts Cr Depreciation expense

25,200

20,050 1,300 5,100 1,600 350 2,400 300 9,000

To close expense accounts to income summary account Dr

Income summary Cr Capital To close income summary to capital account

5,150

Dr

1,200

Drawings Cr Capital To close drawings account to capital account

5,150

1,200

(vi) Income summary account Income Summary Date

Description

Amount

30/6/13

Interest expense

1,300

Salaries expenses

5,100

Utilities expenses

1,600

Supplies expense

350

Insurance expense

Date

Description

Amount

30/6/13

Accounting fees

22,300

Rental revenues

2,900

2,400

Doubtful debts

300


9,000

Capital

5,150 25,200 Copyright © Open University Malaysia (OUM)

25,200

318  ANSWERS

(v)

Capital account Capital

Date 30/6/13

Description Drawings Closing balance

Amount 1,200

Date 30/6/13

63,950

Description

Amount


65,150

60,000 5,150 65,150

Can you see the relationship between the capital account and the statement of changes in ownerÊs equity? Statement of changes in ownerÊs equity (or the ownerÊs equity component in the balance sheet) is actually the statement format of capital account. See the following statement of ownerÊs equity for MKS. MKS Accounting Firm Statement of Changes in OwnersÊ Equity as at 30 June 2013 RM Beginning capital 1/7/12 Add net income

RM

RM

60,000 5,150 65,150

Less drawings

(1,200)

Closing capital 30/6/13

63,950


ANSWERS 

TOPIC 5:

319

ACCOUNTING FOR CURRENT ASSETS

Self-Test 1 1.

(i)

Update the cash account

Balance b/d Cash receipts A/R - Jaya Holding Interest revenue A/P-Anita

Cash Account 4,650 Cash payments 7,600 Service charge 3,300 Insurance 15 A/R - Sukar 90 Balance c/d

3,670 20 2,400 700 8,865

15,655

(ii)

15,655

Journal entries

Journal Entries 31/5/08 Dr Cash 3,300 Cr A/R - Jaya Holding 3,300 To record receipt of payment into bank account from AR-Jaya Holding Dr

Cash 15 Cr Interest revenue To record interest revenue

15

Dr

Cash 90 Cr AP-Anita To correct error in recording payment to AP-Anita Dr

Service charge Cr Cash To record service charge Dr

Insurance Cr Cash To record insurance

90

20 20

2,400

A/R - Sukar 700 Cr Cash To record dishonoured cheque from AR-Sukar

2,400

Dr


700

320  ANSWERS

(iii) Prepare bank reconciliation statement. Syarikat Kampung Bank Reconciliation as at 31 May 2008 RM

RM

Balance per cash account

8,865

Add Unpresented cheques Cheque 10345

450

Cheque 10347

590

Cheque 10348

430

1,470 10,335

Less Deposit in transit Cash deposit Less Bank error

2,460 1,200

3,660 6,675

2.

Bank reconciliation is prepared to identify and to explain why there are differences in the balance of cash in the cash account and the balance reported by the bank in the bank statement. This also helps businesses to detect mistakes and misappropriation that might have happened.

3.

Items that require adjustments are amounts that have been deducted (debited) by banks before a business makes the entries. Examples are standing instructions to repay loan amounts, and auto debit giro to pay utility bills. Amounts that have been added (credited) to the bank current account also need to be journalised, for example, deposits made directly to the bank by another third party, dividends credited by banks or interests earned on the bank account. The entries are made to ensure the balance of cash account is correct. This is due to the fact that the items have not been recorded in the cash account or items have been recorded in the cash book, but errors have been made and need to be corrected or cancelled.


ANSWERS 

321

If no entries are made, the cash account balance will not reflect the true amount. Certain expenses or revenues will also be understated, as they are not recorded (for example, bank service charges deducted). Certain liabilities or assets will be overstated, for example auto payment of bank loan was not recorded. 4.

A dishonoured cheque will be deducted (credited) from the cash account as originally the amount had been added (debited) when the cheque was received as payment. In fact, as the cheque was dishonoured, the amount of cash balance should exclude the amount of the dishonoured cheque as we would not be able to receive any cash from it. Therefore by crediting (deducting) the amount from cash account, we actually cancel the amount that we had originally debited.

Self-Test 2 1.

There is a shortage of RM21.10. Petty cash on hand of RM46.70 plus payments of RM182.20 is not equal to RM250. Dr Dr Dr Dr Dr

Stationeries Transportation expenses Repairs and maintenance Miscellaneous expenses Cash short and over Cr Cash To record petty cash reimbursement

73.50 18.10 45.00 45.60 21.10 203.30

The journal entry to record the increase in petty cash fund is as follows: Dr

Petty cash 50 Cr Cash To increase the amount of petty cash fund.

TOPIC 6:

50

ACCOUNTING FOR NON CURRENT ASSETS

Self-Test 1 1.

Cost of delivery Van Purchase price Sales tax

RM 65,700 6,500 72,200 Copyright © Open University Malaysia (OUM)

322  ANSWERS

Road tax and insurance are revenue expenditures and you will incur these types of expenses each year in order to be able to use the delivery van. 2. RM Repairs (replaced two punctured tyres) 1,500 - Revenue expenditure. Installed roof top carrier 2,000 - Capital expenditure, the carrier will extend capabilities of the van. Replaced front windshield 1,000 - Revenue expenditure. Petrol 2,200 - Revenue expenditure.

roof the delivery

Self-Test 2 1.

Depreciation table (a) Date

Straight line method Asset Cost

Depreciation Rate

RM 01/01/2008

Depreciable Amount



Carrying Amount

RM

RM

RM

RM

66,000

31/12/2008

10%

X

60,000

6,000

6,000

60,000

31/12/2009

10%

X

60,000

6,000

12,000

54,000

31/12/2010

10%

X

60,000

6,000

18,000

48,000

31/12/2011

10%

X

60,000

6,000

24,000

42,000

31/12/2012

10%

X

60,000

6,000

30,000

36,000

100% / 10 years = 10% per annum or RM60,000 / 10 years = RM6,000 per annum

(b)

Reducing balance 1 – 10

6,600  1  0.79  0.21  21% 66,000


ANSWERS 

Date

Asset Cost

Depreciation Rate

RM 1/1/2008

323

Depreciable Amount



Carrying Amount

RM

RM

RM

RM

66,000

31/12/2008

21%

X

66,000

13,860

13,860

52,140

31/12/2009

21%

X

52,140

10,949

24,809

41,191

31/12/2010

21%

X

41,191

8,650

33,459

32,541

31/12/2011

21%

X

32,541

6,834

40,293

25,707

31/12/2012

21%

X

25,707

5,398

45,691

20,309

Depreciable Amount



Carrying Amount

RM

RM

RM

RM

(c)

Date

Unit-of-production Asset Cost

Depreciation Rate

RM 1/1/2008

66,000

31/12/2008

$ 0.0006 X

15,400,000

9,240

9,240

56,760

31/12/2009

$ 0.0006 X

13,600,000

8,160

17,400

48,600

31/12/2010

$ 0.0006 X

11,200,000

6,720

24,120

41,880

31/12/2011

$ 0.0006 X

12,500,000

7,500

31,620

34,380

31/12/2012

$ 0.0006 X

12,500,000

7,500

39,120

26,880

Depreciation rate per page = (RM60,000 / 100,000,000 pages) = RM0.0006 per page

2.

Journal entries to record the disposal of non-current assets. (a) Dr Dr

Accumulated depreciation 64,000 Income summary 13,000 Cr Machinery To record the retirement of machinery as scrap (no value)

77,000

(b) Dr Dr

Cash Accumulated depreciation Cr Machinery

13,000 64,000


77,000

324  ANSWERS

To record the disposal of machinery at carrying amount.

(c)

Dr

Cash

20,000

Dr


64,000

Dr

Income summary Cr

7,000

Machinery

77,000

To record the loss on disposal of machinery (d)

Dr

Cash

10,000

Dr


64,000

Dr

Income summary Cr

3,000

Machinery

77,000

To record the loss on disposal of machinery (e)

Dr

Machinery (new)

55,000

Dr


64,000

Cr

Income summary

10,000

Cr

Machinery

77,000

Cr

Cash

32,000

To record the gain on trade in of machinery (f)

Dr

Machinery (new)

65,000

Dr


64,000

Dr

Income summary

4,000

Cr

Machinery

77,000

Cr

Cash

56,000

To record the loss on trade in of machinery


ANSWERS 

TOPIC 7:

325

PROPERTY, PLANT AND EQUIPMENT (MFRS 116)

Self-Test 1 1. Invoice price of machinery Less: Trade discount Delivery and handling costs Installation charges Total 2.

RM 150,000 (4,500) 145,500 7,000 10,000 162,500

Cost of land: Land cost Legal fees and stamp duty for purchase of land Cost of demolishing old building on the land Cost of clearing and levelling the land

Cost of Factory: Architect fees Piling and foundation works Legal fees for agreement with building contractor Construction cost Plumbing and wiring

3. 2014

Bal b/f Bank

Machinery Account 100,000 2014 Disposal 20,000 Bal c/f 120,000


RM 500,000 14,000 50,000 50,000 614,000

RM 55,000 200,000 3,000 480,000 200,000 938,000

50,000 70,000 120,000

326  ANSWERS

2014

Machinery Disposal Bal c/f

2014

Machinery

Accumulated Depreciation Account 2014 Bal b/d 30,000 33,077 Depreciation – Income statement 63,077

60,000

3,077 63,077

Machinery Disposal 50,000 2014 Accumulated depreciation Wong Sdn Bhd Loss in disposal 50,000

30,000 15,000 5,000 50,000

Self-Test 2 1.

(a)

Write off RM60,000 and capitalise RM15,000

(b)

Depreciation charge for 2013 =

Net Carrying Amount * + Subsequent Expenditure – Residual Value Remaining Useful Life

RM270,000 – RM100,000 + RM15,000 – RM20,000 3 years = RM55,000

=

2.

RM (80,000 – 8,000) 8 years = RM9,000 It is assumed that in 2008 only a half yearÊs depreciation was charged because the asset was purchased six months into the year. Annual depreciation

=

RM Machine at cost Depreciation – 2008 Depreciation – 2009, 2010, 2011, 2012, 2013 Accumulated depreciation Net carrying amount at the date of disposal (31/12/2013) Sale price Cost incurred in making the sale Net selling price

RM 80,000

4,500 45,000 (49,500) 30,500 25,000 (3,000) (22,000)

Loss on disposal

8,500

This loss will be shown as an expense in the income statement. Copyright © Open University Malaysia (OUM)

ANSWERS 

Medical Equipment 400,000 1.1.2012

3. 1.1.2009 1.1.2013

Cash

Revaluation surplus

140,000 1.1.2014

Accumulated depreciation Disposal

540,000

327

240,000 300,000 540,000

Accumulated Depreciation 1.1.2012

Medical equipment

240,000

31.12.2009 Depreciation 31.12.2010 Depreciation 31.12.2011 Depreciation

240,000 1.1.2014

Disposal

200,000

80,000 80,000 80,000 240,000

31.12.2012 Depreciation 31.12.2013 Depreciation

200,000 Disposal of Medical Equipment 1.1.2014 Medical equipment 300,000 1.1.2014 Accumulated depreciation Gain on disposal 20,000 Cash 320,000

100,000 100,000 200,000

200,000 120,000 320,000

Revaluation Reserve 1.1.2014 Income statement

140,000

1.1.2012

Medical equipment


140,000

328  ANSWERS

TOPIC 8: ACCOUNTING FOR LIABILITIES AND EQUITY Self-Test 1 1.

(a)

Extract of balance sheet as at 31 December 2012 Syarikat Demo Extract of Balance Sheet as at 31/12/2012 RM

RM

Current Liabilities Accrued interest

12,500

Current portion of long term loan - Putrajaya Bank

50,000

62,500

Long Term Loan Long term loan - Putrajaya Bank

450,000 512,500

Working: Accrued interest of the loan is RM500,000 x 5% x 6/12 = RM12,500. First instalment due within twelve months is RM50,000. (b)

Journal entries to record payment of interest on 1 January 2013 Dr

Interest payable Cr Cash To record the payment of accrued interest.

(c)

12,500 12,500

Journal entries to record payment of interest on 1 July 2013 Dr Dr

Interest expense 12,500 Bank Loan - Putrajaya 50,000 Cr Cash 62,500 To record the payment of first instalment and the interest charges.


ANSWERS 

(d)

329

Extract of balance sheet as at 31/12/2014 Syarikat Demo Extract of Balance Sheet as at 31/12/2014 RM

RM

Current Liabilities Accrued interest

12,500

Current portion of long term loan - Putrajaya Bank

50,000

Long Term Loan Long term loan - Putrajaya Bank

62,500

350,000 412,500

Working: From 31/12/ 2012 until 31/12/2014, two instalments of principles were made, meaning the balance of the loan is RM400,000. Out of this amount, RM50,000 is due within the next twelve months (1 June 2015). As at 31/12/2010, Syarikat Demo has accrued RM12,500 (original loan amount of RM500,000 x 5% x 6/12) interest and this to be paid on 1 January 2015. 2.

(a)

Nominal value of preference share is RM300,000 (300,000 shares x RM1 par value) Dividend is RM24,000 (8% x RM300,000)

(b)

Nominal value of preference share is RM800,000 (400,000 shares x RM2 par value) Dividend is RM72,000 (9% x RM800,000)

(c)

Nominal value of ordinary share is RM250,000 (500,000 shares x 50 cents par value) Dividend is RM37,500 (15% x RM250,000)

(d)

Nominal value of ordinary share is RM200,000 (200,000 shares x RM1 par value) Dividend is RM20,000 (10% x RM200,000)

(e)

Nominal value of ordinary share is RM250,000 (500,000 shares x RM0.50 par value) Copyright © Open University Malaysia (OUM)

330  ANSWERS

However dividend is paid 5 cents per share, therefore dividend paid is RM25,000 (500,000 shares x 5 cents)

Self-Test 2 1.

2.

(a)

Equity of a partnership comprises capital and current accounts.

(b)

Equity of a company comprises shareholdersÊ fund, retained earnings and reserves accounts.

(c)

There are two main types of shares: ordinary shares and preference shares.

(d)

Instead of making drawings, shareholders are paid dividends.

(e)

Dividends and transfer to reserves will decrease the retained earnings balance, while earnings after tax will increase the retained earnings.

(a)

Calculate earnings after tax M&S Corporation Income Statement for the year ended 31/12/2013 RM

Revenue Less Cost of goods sold Gross margin Less Operating Expenses Earnings before tax Less Tax expenses Earnings after tax

57,500,000 (15,000,000) 42,500,000 (18,000,000) 24,500,000 (7,350,000) 17,150,000


ANSWERS 

(b)

331

Prepare statement of retained earnings M&S Corporation Statement of Retained Earnings for the year ended 31/12/2013 RM

Opening retained earnings Add earnings after tax Earnings available for distribution Less Ordinary Shares Dividends Preference Shares Dividends

(210,000) (125,000)

RM 25,600,000 17,150,000 42,750,000

(335,000)

Transfer to General Reserves

(3,500,000)

Closing Retained Earnings

38,915,000

(c)

Extract of balance sheet M&S Corporation Extract of Balance Sheet as at 31/12/2013 RM

RM

Equity ShareholdersÊ funds Ordinary shares 3 million shares

2,100,000

Preference shares 5 million shares

2,500,000

4,600,000

Retained earnings

38,915,000

General reserves

15,500,000

Total equity

59,015,000


332  ANSWERS

Self-Test 3 1. DJ Balance sheet as at 30 June 2014 RM Fixed assets: Premises Current assets: Stock Debtors Cash and bank Less: current liabilities Creditors

RM 76,000

24,000 2,800 5,400 32,200 7,600

Mortgage

Capital: Balance at 1/7/2013 Capital introduced Net profit

24,600 100,600 50,000 50,600

40,000 6,000 13,600 59,600 9,000 50,600

Less: Drawings

Self-Test 4 1. Lafferty Balance sheet as at 31 December 2014 RM Fixed assets: Fixtures and fittings Current assets: Stock Debtors Bank Cash

RM 5,000

3,000 6,800 15,100 200 25,100 Copyright © Open University Malaysia (OUM)

ANSWERS 

Less: current liabilities Creditors

333

(9,100) 16,000 21,000

Capital: Cash introduced Add: Net profit for the year

20,000 8,000 28,000 (7,000) 21,000

Less: Drawings

Self-Test 5 1. (a)

The amount paid for goodwill.

(b)

The excess represents share premium.

(c)

Equity shares generally mean ordinary shares.

(d)

That although issued in 2013 a dividend will not be paid in that year. The first year that dividends could be paid is 2014.

Self-Test 6 1.

Goodwill Premises Stock Debtors Bank Less: Creditors

Capital

Balance sheet As at 31 March 2013 (a) Kagawa 34,771 190,000 39,200 18,417 828___ 283,216 (23,216) 260,000 260,000


(b) Kenshin 23,699 205,000 36,100 18,417 -______ 283,216 (23,216) 260,000 260,000

334  ANSWERS

TOPIC 9: INTEGRITY AND ETHICS FINANCIAL STATEMENTS

IN

PREPARING

Self-Test 1 1. (a)

Integrity – This situation has a clear impact on your integrity - fair dealing and truthfulness. Your obligations in this instance are to confidentiality.

(b)

Objectivity – Your objectivity would be at risk if you allow a personal relationship to influence the ethical and legal responsibilities you have to your employer.

(c)

Professional competence and due care – You have a duty to maintain professional knowledge, to act diligently in accordance with professional standards and to uphold legal and regulatory requirements.

(d)

Confidentiality - You have an obligation to refrain from disclosure of information outside the firm or employing organisation.

(e)

Professional Behaviour - You cannot compromise your professional judgment as a result of a personal relationship.

Personal relationships can sometimes compromise your objectivity – it is important that you know what your obligations are and that you act with integrity. In this case, you have obligations of confidentiality both in relation to your organisation and in financial regulation. In advising your family friend, you would not only risk losing your job, but are also compromising your professional judgement, integrity and future career. You should decline to discuss the issue.

Self-Test 2 1. (a)

Integrity - you need to uphold your integrity by addressing the matter–there is a need to be straightforward and honest.


ANSWERS 

335

(b)

Objectivity - Your objectivity is being compromised not only on the basis of lack of full and timely information, but also the perceived threats of the CEOÊs behaviour.

(c)

Professional competence and due care - You need to have full and correct information in a timely manner in order to carry out your role.

(d)

Confidentiality - You would be expected to resolve the issues internally where possible without disclosing confidential information.

(e)

Professional behaviour - Your professional behaviour is being compromised without addressing the issue and you would not be discharging your duties (and nor would your colleagues).

Without sufficient information in good time for the meeting, you will not be able to act with sufficient expertise. In this situation, acting with integrity means that you have to address the matter in a straightforward manner. As suggested by the principles affected earlier, this is an internal matter that you should at first hand try resolve within the organisation. Revisit the issue with the finance director and CEO in writing and be sure if the issue continues to have it on the agenda of the next board meeting. This issue has to be resolved satisfactorily in order for you and your colleagues to be able to carry out your roles in a professional manner.

TOPIC 10: COMPREHENSIVE CASES (PARTNERSHIP: CHANGES IN OWNERSHIP) Self-Test 1 1.

(a)

Goodwill of the partnership = 3  (RM5,040 + RM6,720 + RM7,770 + RM8,190) / 4 = RM20,790

(b)

2014 31 Jan

Balance c/f

L RM 33,474

33,474

PartnersÊ Capital Account T P RM RM 2014 27,916 33,600 31 Jan Balance b/f Bank Goodwill 27,916 33,600

L RM 21,000

T RM 19,600

P RM –

– 12,474 33,474

– 8,316 27,916

33,600 – 33,600


336  ANSWERS

(c)

If the goodwill is to be written off from the accounts, PentronÊs share of goodwill will be: = RM20,790  1/5 = RM4,158

2.

2014 1 Jan Goodwill w/off Balance c/f

36,000

PartnersÊ Capital Account L A RM RM 2014 1,200 600 1 Jan Balance b/f 24,600 11,400 Bank

37,800

25,800

S RM 1,800

Goodwill

2014 1 Jan Capital – S Capital – L

3.

(a)

12,000

S RM 36,000

L RM 24,000

A RM –

–

–

12,000

1,800 37,800

1,800 25,800

– 12,000

Goodwill Account RM 2014 1,800 1 Jan Capital – S 1,800 Capital – L Capital – A 3,600

Revaluation Account RM 2014 Asset increased in 1 Jan Asset reduced in value 1 Jan value Debtors 12,800 Equipment Furniture Profit on revaluation Stock Proton (3/5) 61,440 Goodwill Jaguar (2/5) 40,960 115,200

2014

2014 1 Jan Balance b/f Revaluation

Equipment RM 2014 256,000 1 Jan 32,000 288,000

Balance c/f


RM 1,800 1,200 600 3,600

RM

32,000 12,800 6,400 64,000 115,200

RM 288,000 288,000

ANSWERS 

2014 1 Jan

2014 1 Jan Balance b/f

Furniture RM 2014 179,200 1 Jan 12,800 192,000

Debtors RM 2014 140,800 1 Jan

Balance c/f

2014 1 Jan Balance c/f

Stock RM 2014 19,200 1 Jan 6,400 25,600

RM 192,000 192,000

Revaluation Balance c/f

140,800

2014 1 Jan Balance b/f Revaluation

337

Balance c/f

RM 12,800 128,000 140,800

RM 25,600 25,600

Capital Account – Proton RM 2014 343,040 1 Jan Balance b/f Revaluation: 343,040

RM 281,600 61,440 343,040

Capital Account – Jaguar 2014 1 Jan Balance c/f

RM 2014 252,160 1 Jan

Balance b/f Revaluation:

252,160

RM 211,200 40,960 252,160

Capital Account – Benz 2014 1 Jan Balance c/f

RM 2014 128,000 1 Jan

Cash


RM 128,000

338  ANSWERS

(b)

Proton, Jaguar and Benz Balance Sheet as at 1 January 2014 RM Intangible assets Goodwill

RM 64,000

Fixed assets Equipment Furniture

288,000 192,000 480,000

Current assets Stock Debtors Bank (RM12,800 + RM128,000) Less: Current Liabilities Creditors

25,600 128,000 140,800 294,400

115,200 179,200 723,200

Capital Proton Jaguar Benz

(c)

343,040 252,160 128,000 723,200

New profit sharing ratio Benz is to share 25% of the total profit. The remaining 75% is to be shared by Proton and Jaguar. The profit-sharing ratio between Proton and Jaguar remains as 60%:40%. Therefore, Proton will share 75%  60% = 45% Jaguar will share 75%  40% = 30% Benz will share 25%  of the total profit The new sharing ratio is therefore 45% : 30% : 25% for Proton, Jaguar and Benz respectively.


ANSWERS 

339

Self-Test 2 1.

(a) 2014 1 Jan

Revaluation Account RM 2014 Asset reduced in Asset increased in 1 Jan value value Motor vehicle 10,400 Land and Building Profit on revaluation Micky (2/3) 14,400 Donald (1/3) 7,200 32,000

(b) 2014 1 Jan

Balance b/f Revaluation

(c) 2014 1 Jan

Balance b/f

(d) 2014 1 Jan

Balance b/f

Land and Building RM 2014 96,000 1 Jan Balance c/f 32,000 128,000 Motor Vehicles RM 2014 48,000 1 Jan Revaluation Balance c/f 48,000 Cash at Bank RM 2014 105,600 1 Jan

Capital – Gordon Balance c/f

105,600

(e) 2014 1 Jan

2014 1 Jan

Bank Balance c/f

Balance c/f

Capital Account – Gordon RM 2014 64,000 1 Jan Balance b/f 254,400 Revaluation: share of profit 318,400 Capital Account – Gerald RM 2014 247,200 1 Jan Balance b/f Revaluation: share of profit 247,200


RM

32,000

32,000

RM 128,000 128,00

RM 10,400 37,600 48,000

RM 64,000 41,600 105,600

RM 304,000 14,400 318,400

RM 240,000 7,200 247,200

340  ANSWERS

(f)

Gordon and Gerald Balance Sheet as at 1 January 2014 RM Fixed Assets Land and building Motor vehicles Computer

RM

128,000 37,600 32,000 197,600

Current assets Stock Debtors Bank

144,000 118,400 41,600 304,000 501,600

Capital Gordon Gerald

2.

(a) 2014 1 Oct

2014 1 Oct

254,400 247,200 501,600 Revaluation Account RM 2014 Asset reduced in 1 Oct Asset increased value in value Debtors 840 Premises Creditor 1,680 Furniture Stock 1,260 Professional 420 charges Profit on revaluation Chan (4/10) 18,816 Moseen (3/10) 14,112 Nuzul (3/10) 14,112 51,240


Premises RM 2014 75,600 1 Oct 50,400 126,000

Balance c/f


RM

50,400 840

51,240

RM 126,000 126,000

ANSWERS 

2014 1 Oct

2014 1 Oct


Balance b/f

Furniture RM 2014 20,160 1 Oct 840 21,000 Debtors RM 2014 20,160 1 Oct

Balance c/f

2014 1 Oct

Balance c/f

Creditors RM 2014 20,580 1 Oct


Balance b/f Revaluation Professional charges

20,580

2014 1 Oct

Balance b/f

Stock RM 2014 18,480 1 Oct


18,480

2014 1 Oct

Goodwill written off Balance c/f

Capital Account – Chan RM 2014 35,280 1 Oct Balance b/f 57,456

Revaluation: Share of profit Goodwill

92,736

2014 1 Oct

Goodwill written off Balance c/f

Capital Account – Moseen RM 2014 23,520 1 Oct Balance b/f 33,432

RM 21,000 21,000

20,160

(b)

341

Revaluation Share of profit Goodwill

56,952


RM 840 19,320 20,160

RM 18,480 1,680 420 20,580

RM 1,260 17,220 18,480

RM 50,400

18,816 23,520 92,736

RM 25,200

14,112 17,640 56,952

342  ANSWERS

2014 1 Oct

Balance c/f

(c)

Capital Account – Nuzul RM 2014 56,952 1 Oct Balance b/f Revaluation: Share of profit Goodwill 56,952

RM 25,200 14,112 17,640 56,952

CN Partners Balance Sheet as at 1 October 2014 RM Fixed assets Premises Furniture

RM

126,000 21,000 147,000

Current assets Stock Debtors Bank (RM31,080 – RM21,000 – RM8,400)* Less: Current liabilities Creditors

17,220 19,320 1,680 38,220 20,580 17,640

Long-term liabilities Loan – Moseen Capital Chan Nuzul

(33,432) 131,208 57,456 56,952 114,408

Current Account Chan Nuzul

12,600 4,200 16,800 131,208

* Repayment of MoseenÊs loan and his current accounts


ANSWERS 

(d)

343

Different methods in valuing goodwill Goodwill is an asset which is difficult to quantify as the rule of „beauty is in the eyes of beholder‰ always applies. There are several methods of valuing goodwill. The most common methods are: (i)


(ii)


(iii)

The excess of the capitalised value of the profit over the current market value of the net tangible assets.

TOPIC 11: COMPREHENSIVE CASES (DISSOLUTION OF PARTNERSHIP) Self-Test 1 1.

Share of profit on realisation, Tip = RM4,480  4/8 = RM2,240 Top = RM4,480  3/8 = RM1,680 Ted = RM4,480  1/8 = RM560

2013 31 Dec

2013 31 Dec

Balance b/f

Cash

Cash Account RM 2013 42,280 31 Dec Creditors Capital – Tip Capital – Top Capital – Ted 42,280

RM 4,200 16,240 12,880 8,960 42,280

Capital Account – Tip RM 2013 16,240 31 Dec Balance b/f Profit on realisation

RM 14,000 2,240

16,240

16,240


344  ANSWERS

2013 31 Dec

2013 31 Dec

Cash

Capital Account – Top RM 2013 12,880 31 Dec Balance b/f Profit on realisation 12,880

RM 11,200 1,680 12,880

Cash

Capital Account – Ted RM 2013 8,960 31 Dec Balance b/f Profit on realisation 8,960

RM 8,400 560 8,960

2. 2014 31 Mar

2014 31 Mar

2014 31 Mar

Equipment Furniture Debtors Stock Cash – realisation exp Profit on realisation – Alfa – Beta

Cash Realisation

Balance b/f

Realisation Account RM 2014 81,000 31 Mar Cash – Equipment 10,800 Cash – Furniture 22,950 Cash – Debtors 5,400 Capital – Alfa (stock) 3,240 Creditors

RM 108,000 2,700 20,250 1,350 4,050

6,480 6,480 136,350

136,350

Creditors RM 2014 72,900 31 Mar 4,050 76,950 Debtors RM 2014 22,950 31 Mar

Balance b/f

RM 76,950 76,950

Realisation


RM 22,950

ANSWERS 

2014 31 Mar

2014 31 Mar

Balance b/f

Balance b/f Realisation

RM 5,400

Stock 2014 31 Mar

Realisation

Cash Account RM 2014 37,800 31 Mar Realisation expenses Creditors 130,950 Cash – realisation exp Capital – Alfa Capital – Beta 168,750

345

RM 5,400

RM 72,900 3,240 59,130 33,480 168,750

Capital Account – Alfa 2014 31 Mar

Stock Cash

RM 1,350 59,130 60,480

2014 31 Mar

Balance b/f Profit on realisation

RM 54,000 6,480 60,480

Capital Account – Beta 2014 31 Mar

Cash

RM 33,480

2014 31 Mar


33,480

3.

RM 27,000 6,480 33,480

Share of profit on realisation: May = RM11,040  1/3 = RM3,680 June = RM11,040  1/3 = RM3,680 Steven = RM11,040  1/3 = RM3,680 Cash Account 2013 31 Dec

Balance b/f

RM 161,600

2013 31 Dec

Creditors Capital – May Capital – June

161,600


RM 3,840 63,840 93,920 161,600

346  ANSWERS

Capital Account – May RM 2013

2013 31 Dec

Capital – Steven (2/5)* Cash

3,840 63,840

31 Dec

RM


67,680

67,680

Capital Account – June RM 2013

2013 31 Dec

Capital – Steven (3/5)* Cash

5,760 93,920

31 Dec

RM


99,680

2013 31 Dec

Balance b/f

64,000 3,680

96,000 3,680 99,680

Capital Account – Steven RM 2013 13,280 31 Dec Profit on realisation Capital – May Capital – June 13,280

RM 3,680 3,840 5,760 13,280

* Sharing ratio based on capital contribution i.e. RM64,000 (May): RM96,000 (June) = 2:3

Self-Test 2 1.

(a) 2013 31 Dec

Land and Building Motor vehicle Debtors Stock Cash – realisation exp

Realisation Account RM 2013 144,000 31 Dec Cash – Land and building 48,000 – Debtors 4,800 Capital – F (M/V) 2,400 Capital – F (stock) 1,200 Creditors Loss on realisation F (1/3) T (1/3) R (1/3) 200,400


RM 120,000 2,400 36,000 1,200 1,200

13,200 13,200 13,200 200,400

ANSWERS 

(b) 2013 31 Dec

Cash Account RM 2013 7,200 31 Dec

Balance b/f Land and Building Debtors

120,000 2,400

Realisation expenses Creditors Mortgage loan Capital – F Capital – R

129,600 Capital Account – Fernandez RM 2013 13,200 31 Dec Balance b/f

(c) 2013 31 Dec

2013 31 Dec

2013 31 Dec

Loss on realisation Motor Vehicles Stock Capital – Tengku (2/3)* Cash

Loss on realisation Capital – Tengku (1/3)* Cash

Balance b/f Loss on realisation

347

RM 1,200 18,000 48,000 33,600 28,800 129,600

RM 96,000

36,000 1,200 12,000 33,600 96,000 Capital Account – Ramli RM 2013 13,200 31 Dec Balance b/f

6,000 28,800 48,000 Capital Account – Tengku RM 2013 4,800 31 Dec Capital – F 13,200 Capital – R

18,000

96,000

RM 48,000

48,000

RM 12,000 6,000

18,000

* Sharing ratio based on capital contribution i.e. RM96,000 (F): RM48,000 (R) = 2:1


348  ANSWERS

2.

(a) 2013 31 Dec

Equipment Motor vehicles Computer Stock Profit on realisation Anson (1/3) Henry (1/3) Chris (1/3)

(b) 2013 31 Dec

Balance b/f Realisation Realisation – Goodwill

Realisation Account RM 2013 53,700 31 Dec Creditors 50,400 Cash 33,480 Cash – Goodwill 59,220

21,600 21,600 21,600 261,600

261,600

Cash Account RM 2013 48,000 31 Dec Capital – Anson 180,000 Capital – Henry 52,800 Capital – Chris 280,800

(c) 2013 31 Dec

Cash

31 Dec

Cash

Capital Account – Anson RM 2013 93,600 31 Dec Balance b/f Profit on Realisation 93,600

93,600

31 Dec

Balance b/f Profit on Realisation

93,600

2013 31 Dec

Cash

RM 93,600 93,600 93,600 280,800

Capital Account – Henry RM 2013

2013

RM 28,800 180,000 52,800

Capital Account – Chris RM 2013 93,600 31 Dec Balance b/f Profit on Realisation 93,600


RM 72,000 21,600 93,600

RM 72,000 21,600 93,600

RM 72,000 21,600 93,600

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BBFA2103 financial accounting and reporting 1 OUM

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