Chart of Accounts( Nature of accounts)

Asset Accounts Liability Accounts

 100 Bank/Cash at Bank - (Cash)  201 Accounts Payable (Creditors)

 101 Petty Cash  206 Credit Cards
 210 Tax Payable
 102 Accounts Receivable
 220 Employment Expenses
 105 Inventory (Stock On Hand) Payable
 106 Prepaid Expenses/Prepayment  270 Accrued Expense
 107 Income Receivable (also known as Income Accrued)
[2]

 108 Deferred Expense

 110 Other Assets
Equity Accounts (for sole proprietorships and partnerships)[edit]

 300 Owner's capital

 330 Capital contributions
 360 Drawings
Equity Accounts (for corporations)[edit]

 300 Preferred stock

 310 Common stock
 320 Additional paid-in capital (Capital in excess of par)
 330 Retained earnings
 350 Treasury stock

Profit & Loss accounts
Revenue Accounts

 400 Sales Revenue

 420 Interest Income (Non-Operating Revenue)
 430 Intercompany

Cost of Goods Sold Accounts

 500 Purchases (note: COGS = Beginning Inventory + Purchases - Ending Inventory)

Expense Accounts

.Increase in Provision for bad dept

Provision for Depreciation

Discoust allowned

 670 Office Expense

 685 Legal Expense
 690 Personnel Benefits' Expenses
 695 Communication Expense
 696 Traveling & Conveyance
 697 Labour & Welfare Expenses
 698 Advertising Expenses
 699 Printing & Stationery Expenses
 670 Carriage Outward
 octrai & freight charges
Adjusting entries are journal entries recorded at the end of an accounting period to
adjust income and expense accounts so that they comply with the accrual concept of accounting.
Their main purpose is to match incomes and expenses to appropriate accounting periods.
The transactions which are recorded using adjusting entries are not spontaneous but are spread over a
period of time. Not all journal entriesrecorded at the end of an accounting period are adjusting entries.
 For example, an entry to record a purchase on the last day of a period is not an adjusting entry. An
adjusting entry always involves either income or expense account.

Types

There are following types of adjusting entries:

 Accruals:
These include revenues not yet received nor recorded and expenses not yet paid nor recorded. For
example, interest expense on loan accrued in the current period but not yet paid.
 Prepayments:
These are revenues received in advance and recorded as liabilities, to be recorded as revenue and
expenses paid in advance and recorded as assets, to be recorded as expense. For example,
adjustments to unearned revenue, prepaid insurance, office supplies, prepaid rent, etc.
 Non-cash:
These adjusting entries record non-cash items such as depreciation expense, allowance for doubtful
debts etc.

Example

This example is a continuation of the accounting cycle problem we have been working on. In the
previous step we prepared an unadjusted trial balance. Here we will pass adjusting entries.
Relevant information for the preparation of adjusting entries of Company A

Office supplies having original cost $4,320 were unused till the end of the period. Office supplies
having original cost of $22,800 are shown on unadjusted trial balance.

Prepaid rent of $36,000 was paid for the months January, February and March.

The equipment costing $80,000 has useful life of 5 years and its estimated salvage value is $14,000.
Depreciation is provided using the straight line depreciation method.

The interest rate on $20,000 note payable is 9%. Accrue the interest for one month.

$3,000 worth of service has been provided to the customer who paid advance amount of $4,000.

The adjusting entries of Company A are:

Date Account Debit Credit

Jan 31 Supplies Expense 18,480

Office Supplies 18,480

Supplies Expense = $22,800 − $4,320 = $18,480

 Date Account Debit Credit

Jan 31 Rent Expense 12,000

Prepaid Rent 12,000

Rent Expense = $36,000 ÷ 3 = $12,000

Jan 31 Depreciation Expense 1,100

Accumulated
1,100
Depreciation

Depreciation Expense = ($80,000 − $14,000) ÷ (5 × 12) = $1,100

Jan 31 Interest Expense 150

Interest Payable 150

Interest Expense = $20,000 × (9% ÷ 12) = $150

Jan 31 Unearned Revenue 3,000

Service Revenue 3,000

An adjusted trial balance is prepared in the next step of accounting cycle.

 Control Accounts :(to check credit accounts arithmetical
accuracy)

Sales Ledger Control accounts

or

Purchase laedger control accounts

or

Subscriptions Account : (Normally we are an organization who

sells tickets and receive fee/subscription)
Example 1 – Calculating amount received
A club has 50 members. Each member is supposed to $50 as his yearly subscription.
At 1 January 2011, 5 members still owed their subscription for 2010 while 7 members have
already paid their 2011subscriptions.
At 31 December 2011, no subscriptions were due for 2010. However, 3 members still had to pay
their 2011subscriptions while 4 members have already paid their 2012 subscriptions.
Prepare the subscriptions account.

Dr Subscriptions Account Cr
Date Details Amount Date Details Amount
$ $
1 Jan 11 Balance b/d – arrears 250 1 Jan 11 Balance b/d – advance 350
31 Dec 11 Income andexpenditure 2500 31 Dec 11 Receipts 2450
31 Dec 11 Balance c/d – advance 200 31 Dec 11 Balance c/d – arrears 150
2950 2950
1 Jan 12 Balance b/d – arrears 150 1 Jan 12 Balance b/d – advance 200
Partnership – Example of Income Statement and Balance
Sheet, Part 1 of 3
• Fluctuating Capital Accounts (it Means combine current+fixed capital
accounts)
Since the capital account balances changes (fluctuates) with the regular transactions relating to capital, the
Capitals accounts maintained under this method are known as "Fluctuating Capital Accounts".

By convention this is the normal method adopted for maintaining capital accounts in problem solving, unless there
is an instruction to the contrary.
Dr Partners Current Capital a/c's Cr
A B C A B C
Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs) (in Rs) (in Rs)
To Int on Draw 1,000 100 750 By Bal b/d (fixed
To Drawings 20,000 2,000 15,000 capital) 2,00,000 75,000 1,00,000
By Int on Cap 10,000 3,750 5,000
To Bal c/d 2,82,700 1,94,350 2,34,950 24,000
By Salary 52,000
By Commission 93,700 93,700 93,700
By Profit Share
3,03,700 1,96,450 2,50,700 3,03,700 1,96,450 2,50,700
By Bal b/d 2,82,700 1,94,3500 2,34,950

Dr Partners Fixed Capital a/c's Cr

A B C A B C
Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs) (in Rs) (in Rs)
If Good will 1,000 100 750
Decrease. 20,000 2,000 15,000 By Bal b/d
By introduction 2,00,000 75,000 1,00,000
New partner 10000 3,750 5,000
2,82,700 1,94,350 2,34,950
To Bal c/d Good will if increase 24,000
revaluation if increase 52,000
in assets 93,700 93,700 93,700

3,03,700 1,96,450 2,50,700 3,03,700 1,96,450 2,50,700

By Bal b/d 2,82,700 1,94,3500 2,34,950

On dissolution of a firm, all the books of account are closed, all assets are sold and all liabilities
are paid off. In order to record the sale of assets and discharge of liabilities, a nominal account is
opened named Realisation Account. The main purpose to open Realisation Account is to
ascertain the profit or loss due to the realisation of assets and liabilities. Realisation profit (if
credit side > debit side) or realisation loss (if debit side > credit side) are transferred to the
Partner's Capital Account in their profit sharing ratio.

Concisely, following are the important objectives of preparing Realisation Account.

1) To close all the books of account.
2) To record transactions relating to the sale of assets and discharge of liabilities.
3) To determine profit or loss due to the realisation of assets and liabilities.
Accounting treatment of items related to Realisation Account

1) For transfer of assets

Realisation A/c Dr.

To Sundry Assets A/c (Individually)
(All Assets transferred to realisation account, except
Cash/Bank, P and L debit balance, Loan to a Partner)

2) For transfer of liabilities

Sundry Liabilities A/c (Individually) Dr.

To Realisation A/c
(All Liabilities transferred to Realisation account except
Partner's Capitals, P and L credit balance, Loan from Partner)

3) For sale of assets

Bank A/c (Amount received) Dr.

To Realisation A/c
(Assets sold for cash)

4) For payment of liabilities

Realisation A/c Dr.

To Bank A/c
(Liabilities paid in cash)

5) For payment of realisation expenses

Realisation A/c Dr.

To Bank A/c
(Expenses paid)

6) For transfer of profit on realisation

Realisation A/c Dr.

To Partner's Capital A/c
(Profit on realisation transferred to partner 's capital account)

7) For transfer of loss on realisation

Partner's Capital A/c Dr.

To Realisation A/c
(Loss transferred to partner's capital account)
Incomplete record solution steps:
1) find total sales and total purchase by trade recievable and trade payble t- accounts
2) find opening capital ( Capital= opening Assets –opening liabilities)
3) Closing Cash (All receipts – All payments)

Ratios and Formulas in Customer Financial Analysis

Financial statement analysis is a judgmental process. One of the primary objectives is
identification of major changes in trends, and relationships and the investigation of the
reasons underlying those changes. The judgment process can be improved by
experience and the use of analytical tools. Probably the most widely used financial
analysis technique is ratio analysis, the analysis of relationships between two or more
line items on the financial statement. Financial ratios are usually expressed in
percentage or times. Generally, financial ratios are calculated for the purpose of
evaluating aspects of a company's operations and fall into the following categories:

 liquidity ratios measure a firm's ability to meet its current obligations.

 profitability ratios measure management's ability to control expenses and to
earn a return on the resources committed to the business.
 leverage ratios measure the degree of protection of suppliers of long-term
funds and can also aid in judging a firm's ability to raise additional debt and its
capacity to pay its liabilities on time.
 efficiency, activity or turnover ratios provide information about management's
ability to control expenses and to earn a return on the resources committed to
the business.

A ratio can be computed from any pair of numbers. Given the large quantity of
variables included in financial statements, a very long list of meaningful ratios can be
derived. A standard list of ratios or standard computation of them does not exist. The
following ratio presentation includes ratios that are most often used when evaluating
the credit worthiness of a customer. Ratio analysis becomes a very personal or
company driven procedure. Analysts are drawn to and use the ones they are
comfortable with and understand.

Liquidity Ratios

Working Capital
Working capital compares current assets to current liabilities, and serves as the liquid
reserve available to satisfy contingencies and uncertainties. A high working capital
balance is mandated if the entity is unable to borrow on short notice. The ratio
indicates the short-term solvency of a business and in determining if a firm can pay its
current liabilities when due.

 Formula
Current Assets
- Current Liabilities

Acid Test or Quick Ratio

A measurement of the liquidity position of the business. The quick ratio compares the cash plus
cash equivalents and accounts receivable to the current liabilities. The primary difference
between the current ratio and the quick ratio is the quick ratio does not include inventory and
prepaid expenses in the calculation. Consequently, a business's quick ratio will be lower than its
current ratio. It is a stringent test of liquidity.

 Formula
Cash + Marketable Securities + Accounts Receivable
Current Liabilities

Current Ratio
Provides an indication of the liquidity of the business by comparing the amount of current assets
to current liabilities. A business's current assets generally consist of cash, marketable securities,
accounts receivable, and inventories. Current liabilities include accounts payable, current
maturities of long-term debt, accrued income taxes, and other accrued expenses that are due
within one year. In general, businesses prefer to have at least one dollar of current assets for
every dollar of current liabilities. However, the normal current ratio fluctuates from industry to
industry. A current ratio significantly higher than the industry average could indicate the
existence of redundant assets. Conversely, a current ratio significantly lower than the industry
average could indicate a lack of liquidity.

 Formula
Current Assets
Current Liabilities

Cash Ratio
Indicates a conservative view of liquidity such as when a company has pledged its receivables
and its inventory, or the analyst suspects severe liquidity problems with inventory and
receivables.

 Formula
Cash Equivalents + Marketable Securities
Current Liabilities

Profitability Ratios

Net Profit Margin (Return on Sales)

A measure of net income dollars generated by each dollar of sales.

 Formula
Net Income *
Net Sales

* Refinements to the net income figure can make it more accurate than this ratio computation.
They could include removal of equity earnings from investments, "other income" and "other
expense" items as well as minority share of earnings and nonrecuring items.
Return on Assets
Measures the company's ability to utilize its assets to create profits.

 Formula
Net Income *
(Beginning + Ending Total Assets) / 2

Operating Income Margin

A measure of the operating income generated by each dollar of sales.

 Formula
Operating Income
Net Sales

Return on Investment
Measures the income earned on the invested capital.

 Formula
Net Income *
Long-term Liabilities + Equity

Return on Equity
Measures the income earned on the shareholder's investment in the business.

 Formula
Net Income *
Equity

Du Pont Return on Assets

A combination of financial ratios in a series to evaluate investment return. The benefit of the
method is that it provides an understanding of how the company generates its return.

 Formula
Net Income * Sales Assets
x x
Sales Assets Equity

Gross Profit Margin

Indicates the relationship between net sales revenue and the cost of goods sold. This ratio should
be compared with industry data as it may indicate insufficient volume and excessive purchasing
or labor costs.

 Formula
Gross Profit
Net Sales

Financial Leverage Ratio

Total Debts to Assets
Provides information about the company's ability to absorb asset reductions arising from losses
without jeopardizing the interest of creditors.

 Formula
Total Liabilities
Total Assets

Capitalization Ratio
Indicates long-term debt usage.

 Formula
Long-Term Debt
Long-Term Debt + Owners' Equity

Debt to Equity
Indicates how well creditors are protected in case of the company's insolvency.

 Formula
Total Debt
Total Equity

Interest Coverage Ratio (Times Interest Earned)

Indicates a company's capacity to meet interest payments. Uses EBIT (Earnings Before Interest
and Taxes)

 Formula
EBIT
Interest Expense

Long-term Debt to Net Working Capital

Provides insight into the ability to pay long term debt from current assets after paying current
liabilities.

 Formula
Long-term Debt
Current Assets - Current Liabilities

Efficiency Ratios

Cash Turnover
Measures how effective a company is utilizing its cash.

 Formula
Net Sales
Cash
Sales to Working Capital (Net Working Capital Turnover)
Indicates the turnover in working capital per year. A low ratio indicates inefficiency, while a
high level implies that the company's working capital is working too hard.

 Formula
Net Sales
Average Working Capital

Total Asset Turnover

Measures the activity of the assets and the ability of the business to generate sales through the
use of the assets.

 Formula
Net Sales
Average Total Assets

Fixed Asset Turnover

Measures the capacity utilization and the quality of fixed assets.

 Formula
Net Sales
Net Fixed Assets

Days' Sales in Receivables

Indicates the average time in days, that receivables are outstanding (DSO). It helps determine if a
change in receivables is due to a change in sales, or to another factor such as a change in selling
terms. An analyst might compare the days' sales in receivables with the company's credit terms
as an indication of how efficiently the company manages its receivables.

 Formula
Gross Receivables
Annual Net Sales / 365

Accounts Receivable Turnover

Indicates the liquidity of the company's receivables.

 Formula
Net Sales
Average Gross Receivables

Accounts Receivable Turnover in Days

Indicates the liquidity of the company's receivables in days.

 Formula
Average Gross Receivables
Annual Net Sales / 365
Days' Sales in Inventory
Indicates the length of time that it will take to use up the inventory through sales.

 Formula
Ending Inventory
Cost of Goods Sold / 365

Inventory Turnover
Indicates the liquidity of the inventory.

 Formula
Cost of Goods Sold
Average Inventory

Inventory Turnover in Days

Indicates the liquidity of the inventory in days.

 Formula
Average Inventory
Cost of Goods Sold / 365

Operating Cycle
Indicates the time between the acquisition of inventory and the realization of cash from sales of
inventory. For most companies the operating cycle is less than one year, but in some industries it
is longer.

 Formula
Accounts Receivable Turnover in Days
+ Inventory Turnover in Day

Days' Payables Outstanding

Indicates how the firm handles obligations of its suppliers.

 Formula
Ending Accounts Payable
Purchases / 365

Payables Turnover
Indicates the liquidity of the firm's payables.

 Formula
Purchases
Average Accounts Payable

Payables Turnover in Days

Indicates the liquidity of the firm's payables in days.
 Formula
Average Accounts Payable
Purchases / 365

Fixed Assets Accounting/ Depreciation

Suspense accounts and error correction are popular topics for examiners because
they test understanding of bookkeeping principles so well

A suspense account is a temporary resting place for an entry that will end up somewhere else once its final
destination is determined. There are two reasons why a suspense account could be opened:
1. a bookkeeper is unsure where to post an item and enters it to a suspense account pending instructions
2. there is a difference in a trial balance and a suspense account is opened with the amount of the difference so
that the trial balance agrees (pending the discovery and correction of the errors causing the difference). This
is the only time an entry is made in the records without a corresponding entry elsewhere (apart from the
correction of a trial balance error - see error type 8 in Table 1).
Types of error
Before we look at the operation of suspense accounts in error correction, we need to think about types of error - not
all types affect the balancing of the records and hence the suspense account. Refer to Table 1.

Note :Suspense account is not maintained for following errors because they are two
sides arrors

Table 1: Types of error

Suspense
account
Error type involved?

1 Omission - a transaction is not recorded at all No

2 Error of commission - an item is entered to the correct

side of the wrong account (there is a debit and a credit here,
so the records balance) No

3 Error of principle - an item is posted to the correct side of

the wrong type of account, as when cash paid for plant
repairs (expense) is debited to plant account (asset)
(errors of principle are really a special case of errors of
commission, and once again there is a debit and a credit) No

4 Error of original entry - an incorrect figure is entered in the

records and then posted to the correct account
Example: Cash $1,000 for plant repairs is entered as $100;
plant repairs account is debited with $100 No

5 Reversal of entries - the amount is correct, the accounts

used are correct, but the account that should have been
debited is credited and vice versa
Example: Factory employees are used for plant maintenance:
Correct entry:
Debit: Plant maintenance
Credit: Factory wages
Easily done the wrong way round No

6 Addition errors - figures are incorrectly added in a ledger

account Yes
7 Posting error
a an entry made in one record is not posted at all
b an entry in one record is incorrectly posted to another
Examples: cash $10,000 entered in the cash book for the
purchase of a car is:
a not posted at all
b posted to Motor cars account as $1,000 Yes

8 Trial balance errors - a balance is omitted, or incorrectly

extracted, in preparing the trial balance Yes

9 Compensating errors - two equal and opposite errors

leave the trial balance balancing (this type of error is rare, and
can be because a deliberate second error has been made to
force the balancing of the records or to conceal a fraud) Yes,
to correct each of the errors as discovered

Good Luck