cs-152 computerized accounting

CS-152COMPUTERIZED ACCOUNTING

CHAPTER 1: ACCOUNTING: IT'S ROLE IN SOCIETY

Chapter Objectives

At the completion of this chapter, you would have learnt the concepts of:

what do we mean by "Accounting"?;

accounting and "Stewardship";

qualities required of Accounting Information;

accounting as Business Information;

who needs the information?;

how does the Accountant satisfy all these people?

Introduction"Accounting", as used in a general sense rather than its direct relation to financial reporting, is but one of the many forms of communication that we have in this world of ours. But it has a unique quality; it derives from the particular relationship that exists between the parties involved in the communication process. To be "Accountable" is to have a responsibility to another party for one's actions or performance.

Whenever there is responsibility, there is also accountability. Just as a politician (in a democracy) is accountable for his actions to his electorate or constituency, or a doctor is accountable to his patient for his advice and treatment, so is the manager of an enterprise or business accountable to its owners for the conduct and profitability of that enterprise or business.

1.1 Accounting and "Stewardship"

The term "stewardship" is sometimes used to describe the role of those responsible for managing an enterprise. Deriving from historical times, the word "steward" was the title given to a person appointed to look after estates on behalf of owners who were either too distant from the scene to manage themselves, or perhaps had other priorities for their energy and talents than spending their time on administration. We find the equivalent of the "steward" of other days is now termed a "Manager" or a "Director".

Accounting as financial reporting is the vehicle which enables directors and managers to report their "stewardship" to the owners of business. The financial element is essential; without this, reports of "stewardship", while no doubt still be containing some interesting features, would be of little practical use to an owner who actually wanted to know what was going on.

1.2 Qualities Required of Accounting InformationAccounting therefore, as we speak of it in this Course, is the reporting of financial information by a person who bears responsibility for what is conveyed by that information. Like all information, of course, it must also have the six(6) qualities of:

accuracy

timeliness

completeness

relevance

conciseness

unambiguousness (sound presentation)

1.3 Accounting as Business Information

Our special concern is with Financial Accounting as Business Information, and it has been said that Accounting is the "Language" of Business. This is because no transaction could be conducted without financial information (you may accept Barter, but even then, the value of the goods transacted remains a fundamental consideration, even if it is not explicitly stated). Furthermore, no calculation of the results or of the worth of a business, or of its future expectations could be possible without Financial Information expressed through Accounting.

1.3.1 What does Accounting Information Tell Us?

Below are the broad categories of the specific information that Accounting Information provides:

whether or not the business continues to be profitable;

what dividends it can afford to pay;

what funds are available from it for other investments or expansion, or conversely;

what funds is it likely to need for its future viability and survival, and finally;

a background against which alternatives for the future direction of the business can be weighed, and for forecasting the likely outcome of the range of available decisions.

1.4 Who Needs the Information?

1.4.1 Managers / Directors

First, as indicated, those who need the information are the Directors and Managers, under the concept of stewardship.Accounting information can be gathered from any part of an enterprise. It makes it possible for Management to:

Look into every detailed aspect of operations within the organization as an integrated part of the whole under taking, and

exercise its function of controlling and operating the business, and taking corrective action where this is indicated by the results reported.

The Directors of a Company are accountable to the Shareholders for policy formulation and the overall control and direction of the Company. They recommend the level of dividend payable from profits to the Shareholders, and also ensure that Management is performing as it should. Like Managers, they use the Accounts to monitor the progress and profitability of their Company and to guide them in their decisions; however, their function being what it is, they take a broader and a longer term view of Company operations.

1.4.2 Proprietor / Partners / Owners / Shareholders

This category includes:

the sole proprietor (in a one-man business) and

Partners (for a partnership).

These people have their personal resources tied up in the business, in that the funds they have provided to finance the business remain part of their private assets. If the business goes bankrupt, so may they. Their interest in the Accounting Information is that of Owners.

Example: Shareholders use the accounts to identify the future growth of their

investment.

1.4.3 Creditors / Suppliers

"Creditor" is a broad term. The Oxford Dictionary defines it simply as "someone to whom money is owed". In practice it comes under two main classifications:

Suppliers of goods and services to whom money is owing in the normal course of business. In Accounting terms these are called "Sundry Creditors" or "Account Payable".

Lenders

These are in two sub-categories:.

Short term

- It is an Accounting Convention to classify any party who has lent money for a term of less than twelve months in this category, which includes finance provided by way of Bank Overdraft.

Long term

- Lenders for terms beyond twelve months are in this category, examples are lenders on mortgage (i.e. Mortgagees), debenture holders, bond holders etc.

A mortgage is an instrument giving the lender security over an asset of the borrower, not necessarily land - it could be buildings, or certain plants, or

even stock in trade. Debentures and bonds may be issued that give a security, or they may not, in which case they are called "unsecured".

1.4.4 Debtors / Customers

Although they are on the other side of the Balance Sheet (when involved as Debtors) and are "borrowing" ("owing") rather than "lending" funds, Customers, like Creditors, have an interest in the continued viability of a business. Its financial health may be vital to their assurance of continued supply of materials and services. And as can be the case with Suppliers they could well become involved in a closer relationship as investors or trading partners, etc.If the business as their suppliers is making excessive profits and thus putting up their own costs, customers in their role of consumers will have a common interest with the general public if these profits are the results of Government protectionist policies, or a monopoly situation.

1.4.5 Employees and Trade Unions

In the past, the individual employee's interest in the financial affairs of his employer may not have gone much beyond the contents of his weekly pay packet, and perhaps also, in whether the Annual Accounts indicated that his employer would continue to be able to hold him in a job. Many still limit their interest in this way. But with the growth of organized labour into Trade Unions, the accounts of employees have come under increasing scrutiny and the information in them used with effect in wage negotiations.

Of greatest interest as a bargaining point for such organizations is the profit figure, and the more millions, the better. What it represents as a return on the funds employed or whether it is but a temporary fluctuation in the fortunes of the enterprise is immaterial to the argument. If dividends are high, they will be mentioned. So employer's representatives involved in Collective Bargaining do have to be as skilled in the art of interpreting these figures to their advantage as are the employees' representatives.

Sometimes the downfall of a business can be attributed to the shortsightedness of Boards of Directors in pursuing accounting policies that put a good light on their work for the benefit of shareholders, only to find that Union claims based on this information have eventually pushed costs to a level that is fatal to the enterprise.

1.4.6 Government and Economists

Company results, particularly those of industry leaders, are a good indicator to the Government and the business community as a whole, as to the state of economic health of a nation. But the compilers of economic surveys cannot wait until the end of a Company's financial year. Simple surveys are done at regular (usually 3 months) intervals, to obtain key information on such matters as order levels, stocks, employment levels etc. Some of this information may come from the same records as do the regular financial reports being given to management.

Government Tariff and Protection Policies are influenced by such factors as the amount of local employment offered by protected industries; however, if the accounts of these industries begin to indicate that their profit and investment returns are becoming excessive, protection may be reduced, particularly if there have been complaints from the general public about price levels or monopoly situations. Government will take note of the profit level of the particular

enterprise involved, often comparing its accounts with results summarized from other industry groups.

Government are also vitally interested in the tax revenue being generated by businesses; properly certified accounts must be supplied with annual Tax Returns, and a tax inspection may be carried out on the books and records of a business if the Taxation Authorities are not satisfied with this information. Such inspections can go back over a number of years, particularly if the results shown do not reconcile with what is known to be typical in the particular business sector involved. The use of computers by the tax authorities to obtain sector results for comparison purposes, and so isolate possible tax avoiders whose business results do not fit the general pattern, is a relatively recent development in tax collection techniques.

Over the past fifty years or so, Government have, in addition to collecting taxation, made increasing use of employers as collection agents for obligations that properly belong to the employee, for example P.A.Y.E Tax, CPF Deductions, Court Maintenance Orders, etc. All of these, while being a logical development that may meet the needs of convenience, involve employers in considerably more in record-keeping than the mere payment of wages would involve, and require properly designed and managed accounting systems.

Local authorities are interested in financial information for measuring the progress of industries and businesses within their area, so that they may gauge likely requirements for such matters as housing, roads and reticulation services, and, of course, how they are likely to be able to obtain from Rates Revenue.

1.4.7 The General Public

Public companies in particular, have found over time that they are becoming accountable to a much wider section of the community than simply their shareholders. Interest groups will seize on the results of companies that are for example involved in a pollution or other environment changing processes, operating in countries with unacceptable political regimes, allegedly involved in cruelty to animals, or selling unsafe products etc. These companies' "ill-gotten" profits will be paraded before the public in an endeavour to shame the enterprise concerned into more enlightened practices. Often such groups will buy up a few shares simply for the purpose of gaining a platform for themselves at Annual Meetings.

And as mentioned earlier, the general public as consumers may also complain if they are being forced through Government protectionism to buy inferior or unduly expensive locally made products while they perceive the industry concerned to be making excessive profits.

1.4.8 How does the Accountant Satisfy all these People?

The short answer is - he cannot. Each individual and each group has its own special needs. Reporting of any type - and this includes the reporting of Financial Information - can be regarded as an Art as much as a Science. The essence of it all is knowing how to tell the party concerned what he/she needs to know, and at the same time avoid undue risk to the interests of other parties.

There is much Accounting Information that can be classified as "Confidential" or "Commercially Sensitive" and of necessity required the use of fine judgment in its dissemination. What you tell a line manager will be different from what you

tell a department supervisor; and these two will differ from what you will have to tell the Managing Director!

The Accountant in any organization has to be aware that he/she is above all an employee, and must follow the lines of communication laid down for him/her, both inside and outside that organization. For he/she could well become the person in an organization who is in possession of a very large part of the important facts relating to the administrative and financial operations of the enterprise; if so, he/she is in a situation of considerable responsibility and consequence.

What the Accountant can do is to consistently give his/her best information and advice to those persons in the enterprise who actually have the responsibility for taking action on it, and ensure that it is properly understood. Should he/she find himself/herself being compromised, or manipulated to provide information for purposes that are doubtful or even dishonest, all he/she can do is make the situation clear to those that need to know – his/her superiors. His/her duty beyond that is to his/her profession, in upholding its standards.

1.5 Accounting Today

In less than a hundred years, Accounting has come an immense distance. Not only is the equipment now available to aggregate, sort and summarize the information and beam it across the globe in a few seconds; more important and more significant perhaps, is the way that techniques and standards for gathering and preparing accounting information have become refined and regularized; both for management and owners, it provides an awareness of how their businesses operate that ranges from the closest operational detail, to useful and credible forecasts of future trends. For in addition to its traditional role of reporting on events that are past, it now projects into the future, and provides the navigational aids both for Investors and for the Captains of Enterprise.

1.6 Exercises1. The Government requires that all firms submit their annual financial reports.

Describe at least five reasons why the government requires such reports.

2. Differentiate between internal and external users of accounting information. Outline some reasons for these internal users.

3.

a) Define the term "stewardship"?

b) List five categories of items that can be obtained from accounting information.

c) Why do employees and/or trade unions require accounting information?

CHAPTER 2: ACCOUNTING

Chapter Objectives

At the completion of this chapter, you would have learnt the concepts of :

book keeping and accounting;

terms used in the financial position;

presentation of the financial position;

accounting concepts and conventions.

2.1 Book Keeping and AccountingWe have seen in chapter one those groups of people that require accounting information for various reasons. How do we go about preparing all these reports? The process goes through the following two stages:

Stage 1 - Book keeping The recording of all business transactions in proper books of accounts.

Stage 2 – Accounting The making use of these financial data contained in the books to produce financial information.

The keyword to this process is "financial" data/information. What is meant by this term? It is all the data that are stated in money terms. So in the book keeping stage, we record into the books all transactions stated in terms of money figures - that is financial data. If everything that happened in the business can be recorded in this way, then the books will show the financial position of the firm at all times. Whenever there is any additional transaction, it will affect the totals in the books. This means that the financial position will change. In fact we can make two important assumptions.

1. That the books of accounts will reflect the financial position of the firm at all times.

2. That every transaction will affect the financial position.

2.2 Financial Position

What do we mean by the term "financial position"? It means that the data will show what belongs to the firm and what is due to be paid out by the firm. This leads us to identify the official terms that we normally use in this statement.

2.2.1 Assets

All those items that belong to the firm are termed assets and they fall into two categories:

fixed assets and

current assets.

Current assets are items of value owned by the firm. These items may be acquired in the course of the business. Current assets will change within the next twelve months. Some assets may not exist in physical form but in the form of a

CS152 CHAPTER 2: ACCOUNTING

legal tender or legal rights. Examples are debtors, bank balance, prepayments etc. Other assets may exist in a physical form such as stock - which are goods or materials balance in the store.

Fixed assets are those items of high value that are owned by the firm. These assets will last for a few years and are not for purposes of resale. These assets must also be held for use in the business. Examples of such assets are motor vehicles, premises, machinery etc.

2.3 Presentation of Financial Position

The Balance Sheet

This is a financial report prepared from the books of accounts. The Balance Sheet will show the financial position of the firm at a given point in time. Being one of the financial reports it is worthwhile to study the form of report that must be presented. Every report must have a three item header.

3. 1. Name of the firm,

2 Title of the report, and

4. The date it refers to.

The balance sheet will show clearly what the firm owns and what it owes.

These three groups of items shown in the balance sheet reflects the accounting equation:

Assets = Capital + Liabilities

How do we get this equation? It is a series of transaction that will increase or decrease these items in the accounting equation.

2.3.1 Illustration of Changes in the Financial Position

Table 2-1 :

Example table

1 June Jimmy Lim invested $50,000 into the business bank account2 June Bought stock for $7,500 paying by cheque3 June Took $2,000 from the bank for use in the cash till4 June Bought a motor vehicle for $20,000 on credit from Borneo Motors5 June Sold goods, originally costing $200 for $650 cash6 June Bought more goods from Sea Supplies Ltd for $3,0007 June Sold goods to ALEC Traders for $3,000 original cost $1,0008 June Jimmy Tan took stock costing $2,000 for his own use. At the same

time he drew out cash $500 for personal expenses


Jimmy Lim (Balance Sheet)

As at 1st June 1993Bank $50,000 Capital $50,000

$50,000 $50,000As at 2nd June 1993Stock $7,500 Capital $50,000Bank $42,500

$50,000 $50,000As at 3rd June 1993Stock $7,500 Capital $50,000Bank $40,500Cash $2,000

$50,000 $50,000As at 4th June 1993Motorvehicle $20,000 Capital $50,000Stock $7,500 Creditors $20,000Bank $40,500Cash $2,000

$70,000 $70,000As at 5th June 1993Motorvehicle $20,000 Capital $50,000Stock $7,300 Add Profit $450 Bank $40,500 $50,450Cash $2,650 Creditors $20,000

$70,450 $70,450As at 6th June 1993Motorvehicle $20,000 Capital $50,000Stock $10,300 Add Profit $450 Bank $40,500 $50,450Cash $2,650 Creditors $23,000

$73,450 $73,450As at 7th June 1993Motorvehicle $20,000 Capital $50,000Stock $9,300 Add Profit $2,450 Debtors $3,000 $52,450Bank $40,500 Creditors $23,000Cash $2,650

$75,450 $75,450As at 8th June 1993Motorvehicle $20,000 Capital $50,000Stock $7,300 Add Profit $2,450 Debtors $3,000 $52,450Bank $40,500 Less Drawings $2,500 Cash $2,150 $49,950

Creditors $23,000$72,950 $72,950


2.4 Accounting Concepts and ConventionsHow do we make all these changes in the financial position? You should notice that we have to follow certain accounting rules when producing these figures. In addition, these reports that are produced from the accounting activities have to meet the needs of different users. All these users are expected to see a universal and standardized accounting information that is comparable amongst business. Therefore, accounting activities today has been evolved through the process of taking into consideration the different users and their needs. The magic number that most users look at is the "bottom line" - that is the net profit. You can imagine a situation where there are no accounting rules. The result will be that different people get different figures from the accounts.

Profit Figures when no Accounting Rules are followed :

Profits

Employees Government Owners Lenders$10,000 $100,000 $1,000,000 $10,000,000

These accounting rules are known as concepts and conventions. In this context we identify seven concepts and three conventions.

2.4.1 Business Entity Concept

The business entity concept is to ensure that we treat the owners as a separate person from the business. In practice, all transactions are treated from the view point of the business. The only transactions that affect the owners will only be capital, profits and drawing.

2.4.2 Going Concern Concept

The going concern concept refers to the continued existence of the business. It is assumed that the business when set up will not close down or terminated. This is closely linked to the cost concept.

2.4.3 Cost Concept

The cost concept states that items to be recorded in the books would be the amount actually paid for and not its value to the firm. The amount paid for would be the figure that everybody can agree upon.


2.4.4 Dual Aspect Concept

The dual aspect concept is being applied whenever a transaction takes place. This means that every transaction will affect two items - which is the application of the accounting equation,


2.4.5 Money Measurement Concept

The money measurement concept is concerned with the entries to be included in the accounts. This concept means that only items with a clear monetary value are entered in the accounts. In this instance, the accounting records can show the value of goods held but not the value of its employees.

2.4.6 Accruals Concepts

The accruals concept governs when the transaction should be recorded. In other words, we should record the items when used and not only when it is paid for. This also means that we bring into account items that are used but not yet paid for or recorded in the books.

2.4.7 Realization Concept

The realization concept means that a transaction is recognized whenever title to the goods changed hands and not dependent on receipts/payments of money. This concept is similar to the accruals concept though it only applies to the recognition of a "sales" made.

2.5 Accounting Conventions

2.5.1 The Materiality Convention

The term materiality refer to the relative importance of an item or event. When the accountants prepare financial information for the users, the materiality of the information to be disclosed is the question to be considered. For example, should a calculator costing $20, be included as an asset to be depreciated yearly or written off as an expense in the year of purchase. Therefore, it can be stated that an item is material if there is reasonable expectations that knowledge of it will influence the decisions of the users of financial statements. Internally, when doing accounting duties, the firm should not waste time looking for the reasons for small errors - it is not material.


2.5.2 The Prudence or Conservatism Convention

This convention derives from the principle of being cautious and careful. In accounting, there is always a degree of uncertainty relating to the future. Being prudent means to assume that we expect the worst to happen. So the practice of this convention is that we should understate profits rather than underestimate expenses.

2.5.3 The Consistency Convention

This convention requires that there is a consistency in accounting treatment of the same item within each accounting period. This implies that our accounting methods should not change from one period to the next.

2.6 Exercises

5. 1. Complete each of the following statement with a word or phrase.

d) The _________________ concept states that all items should be recorded at their original cost price.

e) The accounts of a business should not include the personal transactions of the owner. This is known as the ________________ concept.

f) The balance sheet equation is ________________.

g) A loan repayable in five years time is a _______________ liability.

h) The _________________ concept states that profit should not be taken until a sale is made.

i) Stock is an example of a _______________ asset.

j) The ____________________ concept demands that there should be both a credit and a debit entry for every transaction.

k) Motor vehicles are usually classed as ________________ assets.

l) The tendency to understate profits or overstate losses is known as the _________________ convention.

m) The ruling that the firm should not change its accounting practice or system each year is known as __________________ convention.

6. 2. Briefly describe what is meant by:

a) the cost concept.

b) the business entity concept

c) the realization concept

d) the materiality convention

e) the prudence convention


3. Complete the columns with the word increase, no effect or decrease to show the

effects of the following transactions.

Assets Liability Capital

a a) Buy a motor van on credit.

b b) The owner invests more money into the business.

c c) Receive cash from debtor.

d d) Buy stock paying by cheque.

e e) Pay creditor by cheque.

f f) Sell stock for cash at a profit.

7. State which of the following have been recorded correctly, and which incorrectly and identify, in each case, the relevant concept, convention or type of error:

n) a) Computer printout paper has been recorded under Office Equipment;

b) Lawyers fees relating to the purchase of new offices have been recorded under Premises;

c) A purchase of raw materials has been recorded as a Credit entry in the Purchases account and a Debit entry in the suppliers account;

d) A purchase of clothes for the owners has been left out of the accounts altogether;

e) A sale to A. Ahmed has been entered in the account for A.A. Ahmed;

f) A new machine costing $1,000 has been recorded at this value in the Machinery account even though the resale value is now only $750;

g) An invoice for $740 has been recorded as $470;

h) A pocket calculator costing $9.99 has been recorded as General Office expenses.

5. Identify which Accounting Concept or Convention has been IGNORED in the following transactions.

a) An item costing $200 has been recorded as $300 as this is its current market value.

b) The owner of the business has bought a television for his own use and recorded this as Fixed Asset.

c) A contract is currently being negotiated which should bring the firm a profit of $10,000. This amount has been recorded in the books.

d) A calculator costing $3.00 has been recorded as a Fixed Asset.

e) A bill for electricity was received in the last financial year but has been recorded in the current year as payment was only made recently.


f) A sale of goods worth $250 has only been recorded in the Sales Account.

g) An order has been received for goods worth $890. This has duly been recorded in the Sales Account.

h) The firm has had a bad year and is likely to go bankrupt within the next 12 months. The accounts have not been altered.

6. Which Accounting concept or convention has been ignored in each of the following transactions:

a) Floppy disks costing $10 have been recorded as Office equipment.

b) The owner has bought himself a colour TV for $200 and recorded it under Office equipment.

c) Sales are recorded as soon as an Order form is received.

d) The method used for calculating Stock has been changed first from LIFO to FIFO and then to AVERAGE COST, all in the last three years.

e) Rent for the year was $1,000, of which $750 has been paid. The amount shown in the Profit/Loss Account was $750.

CHAPTER 3: ACCOUNTING SYSTEMS

Chapter Objectives

At the completion of this chapter, you would have learnt the concepts of

introduction to Accounting System;

source documents;

daybooks;

ledgers.

Introduction

In the previous chapter, we reviewed the various accounting concepts and conventions. These rules in accounting are necessary to ensure that the accounting reports are true and fair. Moreover, the figures presented must also be accurate. But, how do we achieve this? There must be an accounting system set up to operate a series of activities that will produce accounting information as and when required. There are three essential elements for any accounting system.

8. The system must provide information.

9. There must be built-in controls to ensure there is no chance of cheating.

10. There must be an audit trail - in other words, the system must have steps for a person to follow.

3.1 A Manual Accounting System

The following should be the stages of activities in a manual accounting system.

1. Source Documents

2. Writing up the daybooks

3. Posting to ledger accounts

4. Balancing the ledger accounts

5. Production of a Trial Balance

6. Adjustments necessary to update accounts

7. Accounting Reports

3.2 Source Documents

These are documents that provide actual proof of business transactions. Accounting entries are not made on the basis of oral instruction or hearsay but on documents produced. They are the initial documents to ensure accuracy and has to be kept in a proper manner for verification by auditors, government etc.

In a typical business environment, we can identify the following types of source documents namely:

Table 3-1: Documents used in business

Document Name Purpose

CS152 CHAPTER 3: ACCOUNTING SYSTEMS

Sales invoices To be sent to customers in respect of credit sales

Purchase invoices Received from suppliers for goods bought / services performed

Credit notes issued Return of goods by customersCredit notes received Return of goods to suppliersBank deposits slip / Credit memo Receipts banked inCheque copies / Debit memo Payments made from bankOther memos, letters etc. All other transactions not classified

above

INVOICEJimmy Lim TradersInternational PlazaSingapore Town

Invoice No.: JL5645Date: 30th June 1994

BOBO EnterpriseParadiz BuildingSingapore City

Your order no. BB4414 Dated: 22nd June 1994 Terms 5% - 31 days

Quantity Description Unit Price $

Total $ GST %

Value $

50 boxes H.D. Diskettes 7.50 375.00 10%18 pieces Hard Unit 210.00 3780.00 10%28 reams Plain Paper A4 5.50 154.00 10%

4309.00Trade Discount 15% 646.35

3662.65 4028.92

Authorized Signature

Figure 3-1 : An example of a sales invoice

CREDIT NOTEJimmy Lim TradersInternational PlazaSingapore Town

C/N. No.: R1200Dated: 15th July 1994

BOBO EnterpriseParadiz BuildingSingapore City

Our invoice no. JL5645 Dated : 30th June 1994

Quantity Description Amoun3 pieces Hard Disks 535.50

GST 10% 53.55589.05

Figure 3-2: An example of credit note


IMMEDIATE BANK PLC Cheque DepositChina Town Point Date _________Sinagpore

Bank Cheque No. Amount

Account Name ____________________________

Account No.

Subject to conditions on the reverse

Figure 3-3: A typical bank deposit slip

IMMEDIATE BANK PLC.

Date ____________

Pay ________________________________________ or bearer

Singapore Dollars ___________________________________

______________________S$ __________________________

Timmy Lim

Authorized Signature

834604-5454-001-12345678

Eample 3-4: Eample of cheque


3.3 Daybooks

In day to day activities of the accounts department, source documents are being distributed to different personnel for recording these transaction. All these documents are written up into special journals set up for this particular type of document. A day book is a simple daily recording of the source documents. All the daybooks are normally totalled up at the end of each month (or more frequently depending on volume). Daybooks are sometimes called books of prime entry or books of original entry.

It should be remembered that these daybooks are a diary of the business.

Table 3-2 : Daybooks used in business

Daybook FunctionSales Daybook Record of all invoices issued to customers each day

(for sales on credit)Purchase Daybook Record of all invoices from suppliers (for purchase

on credit)Returns in Daybook All credit notes issued to customers in respects of

returns inwardReturns out Daybook All the credit notes received from suppliers in

respect of returns outwardBank Receipts Book All the deposits into the bank accountBank Payments Book All the payments made from the bank account

(cheque drawn)General Journal All other transaction that do not fall into the above

categories example correction of errors, adjustments, other unusual transactions

Sales DaybookDate Details Account

No.Invoice No.

Amount GST Total

2nd June BOBO Enterprise

JL4201 1765.00 176.50 1941.50

3rd June Anywhere Lo JL4202 2010.00 301.50 2311.504th June Sorry Store JL4203 370.00 37.00 407.005th June Cancelled JL4204

Figure 3-5: Example of sales daybook

Jimmy LimReturns in Daybook

Date Details C/N No. Account No.

Amount GST Total

5th June BOBO Enterprise

1022 3179 55.00 5.50 60.50

6th June Eastern Computer

1023 5620 100.00 10.00 110.00

Figure 3-6: Example of a return inwards daybook


Purchase DaybookDate Acct

No.Inv. No.

Details Total Purchase Motor Expense

GST Total

3rd June 2281 32668 All Rights Co.

175.00 175.00

4th June 4180 76251 Crosswater 250.00 250.006th June 8116 52109 Highland 78.00 78.007th June 4211 17216 Aoco

Stores250.00 250.00

Figure3-7: Example of a purchase daybook

Returns Outward BookDate Acct

No.Inv. No.

Details Total Purchase Motor Expense

Stationary

Sundry

2nd June 4180 C220 Crosswater 40 403rd June 8116 C7201 Highland 40 206th June 2281 10002 All Right

Co.75 75

Figure 3-8: Example of a returns outward daybook

Bank Receipts BookDate Details Account No. Discount Bank7th June Soisy Stores 5662 12 8510th June BOBO Enterprise 2115 120012th June Anywhere Lo 1062 46 2254

Figure 3-9: An example of bank receipt book

Bank Payments BookDate Details Account No. Cheque No. Discount Bank1st June Coco Store 4211 267625 22 4183rd June All Right Co 2281 207626 - 1504th June Highlught 8116 207627 75 14255th June Crosswater 4180 207628 25 225

Figure 3-10: An example of bank payments book

General JournalDate Details Folio Debit Credit

1st June Bank 50000Capital 50000Investment by Jimmy Lim

2nd June Purchases 7500Bank 7500Bought goods paid by cheque

3rd June CashBank 2000Draw cash from bank 2000

Figure 3-11: An example of general journal


3.4 LedgersIn a typical accounting system there will be three ledgers:

8. 1. Nominal Ledger

- This ledger will contain the accounts of all the business transactions. This is also called the General Ledger.

2. Sales Ledger

- Inside which contained the individual accounts for all the customers in respect of sales on credit. It is termed a subsidiary ledger and sometimes called the Debtors Ledger/Accounts Receivable.

9. Purchase Ledger

- This will contain the individual accounts of all the suppliers from whom we have bought on credit. It is also termed a subsidiary ledger and sometimes called the Creditors Ledger/Accounts Payable.

What is a Ledger?

It is a group or file of accounts stored in pages of a book, cards in a tray or tape on a reel. A manual system is one in which the ledger accounts are individually posted from the daybooks. The following is an example of a Ledger Account.

BankDate Details Folio Debit Credit1st June Capitals 50,0002nd June Purchase 7,5003rd June Cash 2,000

50,000 9,5008th June Balance at this date 40,500

Purchases1st June Bank 7,5002nd June Sea Supplies Ltd 3,0003rd June Drawings 2,000

10,500 2,0008th June Balance at this date 8,500

Cash3rd June Bank 2,0005th June Sales 6508th June Drawings 500

2,650 5008th June Balance at his date 2,150

Figure 3-12: Illustrating ledger accounts

CHAPTER 4: DOUBLE ENTRY ACCOUNTS

Chapter ObjectivesAt the completion of this chapter, you would have learnt the concepts of :

identifying account names;

double entry operations;

journal and ledger accounts;

trial balance.

Introduction

We have seen the flow of the accounting system in the previous section. In order to enter transactions correctly classified, there are various steps in the recording process by asking three questions in respect of every transaction:

10. What are the account names to be used?

11. What type of accounts are they?

12. What accounts are to be debited and credited?

For a start we shall answer Question 1. By first of all understanding the transactions of a trader (the business of buying and selling goods).

4.1 What are the Account Names?

Table 4-1

Account Name PurposePurchases To record the cost of buying goods for the purpose of being

soldReturns Out / Outward / Purchase Returns

An account set up to record the value of goods returned to suppliers that were originally purchased

Sales Record the amount sold to customers from the goods previously recorded as purchases

Returns In / Inward Sales Returns

A record of goods returned by customers in which we had previously made a Sale.

Stock The amount of goods held for resale:Closing stock: - balance at the end of an accounting periodOpening stock – balance at start of an accounting period

Discount Allowed That amount of discount given to customers when they pay their accounts

Discount Received That amount of discount given by suppliers when we pay their accounts

The above illustration gives a brief glimpse of the account names that can be used. It is worthwhile to remember that account names are allocated for the nature of each transaction.

4.2 Double Entry Operations

4.2.1 What Type of Accounts?

We have seen that the financial position of a business can be reflected in a Balance Sheet. Each of these items in the balance sheet is an account name by itself and all these names reflect the accounting equation :

CS152 CHAPTER 4: DOUBLE ENTRY ACCOUNTS


which are the three types of accounts. In addition, from the account names mentioned above, there are a few accounts not found in the balance sheet. Such accounts may be found in the Trading or Profit and Loss accounts. For example, Purchases account is classified as an Expense whereas Sales is classified as an Income account. Both Expense and Income are the two different types of accounts.

In summary, there are five types of accounts broadly identified as Assets, Liabilities, Capital, Income and Expense.

The table that follows would illustrate the account names and their account types.

Table 4-2 :

Account Names Account Types Account NaturesMotor Vehicle Assets DebitPremises Assets DebitOffice Equipment Assets DebitPlant and Machinery Assets DebitLand and Building Assets DebitFurniture and Fittings Assets DebitDebtors Assets DebitCash in Hand Assets DebitCash at Bank Assets DebitPrepayment Assets DebitStock Assets DebitBank Loan Liabilities CreditCreditors Liabilities CreditBank Overdraft Liabilities CreditAccruals Liabilities CreditProvision for bad debts Contra Assets CreditProvision for depreciation Contra Assets CreditCapital Capital CreditProfit Capital CreditDrawings Contra Capital CreditSales Income CreditCommission received Income CreditDiscount received Income CreditInterest received Income CreditBad debts expense Expense DebitDepreciation expense Expense DebitInterest expense Expense DebitCommission allowed Expense DebitRent and rates Expense DebitDiscount allowed Expense DebitPurchases Expense DebitWages and salaries Expense DebitInsurance Expense DebitAdvertising Expense DebitHeat and Light Expense DebitCarriage Inwards Expense DebitCarriage Outwards Expense Debit

4.3 Recording of Transactions : Journals and Ledgers


As mentioned, it is necessary for any firm to record its business transactions. Such responsible practice by the managers is known as stewardship.

This chapter would illustrate the process and method involved for recording the business transaction. The recording process requires answering three questions:

13.

14. 1. What account names to be used?

2. What type of accounts are they?

3. Is it an increase or decrease in the account?

Question one and two have already been briefly touched on in the previous sections. This section would put the puzzles together.

To begin, the following example shows the typical transactions that happens in a day of the business.

Example:

Success company has the following transaction in 1st October. As an accounts clerk you are requested by the manager to record the happenings in the general journal:

1st October 19xx

o) Owner invested $30,000 cash into the business

p) Success company sold $5000 goods to customer Info. Ltd on credit and another $2000 goods by cash.

q) Success Co. bought an office furniture costing $3500 by cash.

r) Success Co. replenished its stock by buying $1500 worth of goods on credit with Sure-Give Co.

To record the transactions in the general journal book, it is absolutely necessary for students to know the double entry system.

The recording of a transaction works on the mechanism of double entry which indicates that for every transaction two entries would be recorded: one debit entry and the other credit entry.

Table 4-3:

Account Types Nature Treatment for Increase Treatment for DecreaseAssets Debit Debit CreditLiabilities Credit Credit DebitCapital Credit Credit DebitIncome Credit Credit DebitExpense Debit Debit Credit


Referring to Example 1 and recalling 3 questions:

For transaction (a) the 2 account names are cash and owner's capital. Cash is a current asset and owner's capital is a capital account. Since when owner invested cash the cash balance increases and since cash is an asset the asset would as a result increase. Referring to Table 4-3 the treatment for increase in Assets would be a Debit entry. According to double entry rules since cash is a debit entry the other account-owner's capital would be a credit entry.

A hint for students : to identify the account names watch out for "nouns" in the transactions.

The recording entries for transaction (a) in the General Journal would be:

Date Accounts Folio Debit ($) Credit ($)1/10/93 Cash 3000

Capital 3000Owner’s investment intoBusiness cash accounts

Now, your turn to figure out how transactions (b) to (d) are recorded in the General Journal Book:

Date Accounts Folio Debit ($) Credit ($)1/10/93 Info. Ltd 5000

Sales 5000Sold goods to Info. Ltd on credit

1/10/93 Cash 2000Sales 2000Sold goods for cash

1/10/93 Office furniture 3500Cash 3500Bought office furniture by cheque

1/10/93 Purchase 1500Sure-give Co. 1500Bought goods on credit with sure-give Co.

Explanations for transaction (b) to (d)

i. Transactions (b) Info. Ltd is the debtor/customer of the company who owes $5000 due to sales of goods to Info. Debtor is classified as asset with debit nature. Since this transaction resulted in an increase in asset Info Ltd is debited. According to the rules of double entry the other account sales would be credited. In the same way, cash is also an asset account with debit nature.

ii. Transactions (c) Office furniture is a fixed asset with debit nature. Since the purchase of office furniture would increase the asset available in the business, the office furniture account would be debited. Accordingly, cash account would be credited.

iii. Transactions (d)Goods or stock can be identified as either Purchases or Sales. If goods are bought, they would be identified as purchases but if they are sold, they would be identified as Sales.By purchasing goods on credit from Sure-Give Co., the business would owe Sure-Give Co. (known as creditor for the amount purchased). Since this transaction resulted in an increase in creditor (which belongs to account types of liabilities), Sure-Give Co. would be credited. Accordingly, purchases would be debited.


Ledger Accounts

In the previous section, students would have learned that transactions occurrences are recorded in the journals.

However, in many instances, the business would like to determine its individual account balances. To determine the individual account balances, it is necessary to post the journals to the ledgers.

Ledgers are books that contain data of individual accounts.

Example 2 :

The following are the transactions recorded in the general journal book of XYZ Co. You are required to post the journals to the general ledger to determine the individual account balances.

XYZ Co.General Journal

Date Accounts Debit Credit1st Jan. 19XX Cash 1000

Capital 10002nd Jan.19XX Cash 5500

Sales 55003rd Jan.19XX AXOB Co. 1000

Sales 10004th Jan.19XX Purchases 200

ABC Co. 2005th Jan.19XX ABC Co. 200

Cash 2006th Jan.19XX Office furniture 1200

Cash 1200

Referring to Example 2, the ledger accounts would be reflected in the General Ledger as follow:

XYZ Co.General LedgerCash Account

Date Accounts Debit Credit1st Jan.19XX Capital 10002nd Jan.19XX Sales 55005th Jan.19XX ABC Co. 2006th Jan.19XX Office Furniture 1200

6500 14001st Feb. 19XX Balance 5100

Capital AccountDate Accounts Debit Credit

1st Jan.19XX Cash 1000


Sales AccountDate Accounts Debit Credit

2nd Jan.19XX Cash 55003rd Jan.19XX AXDB Co. 1000

65001st Feb.19XX Balance 6500

AXDB Co.Date Accounts Debit Credit

3rd Jan.19XX Sales 1000

PurchasesDate Accounts Debit Credit

4th Jan.19XX ABC Co. 200

ABC Co.Date Accounts Debit Credit

4th Jan.19XX Purchases 200Cash 200 200

200 200

Office FurnitureDate Accounts Debit Credit

6th Jan.19XX Cash 1200

From the General Ledger, XYZ Co. would know that it has a cash balance of $5,100 from all cash transactions. Similarly for other individual accounts, their balance could be determined.

As such, students should have observed that the balances of individual accounts could be extracted from the ledger; but difficult to retrieve by looking at journals alone.

4.4 Trial Balance

In the previous section, students should be able to differentiate the different purposes of journals and ledgers and also identify how journals and ledgers are related.

In this section, students should recognize that as the volume of transactions increased in the business, there must be a mechanism that ensures that any errors are highlighted to observe accuracy of accounts. That mechanism that allows first time checking is the trial balance.

The trial balance is simply a listing of all the balances for each account in the ledger.

Referring to the General Ledger prepared for Example 2, the trial balance for XYZ Co. would be as follow.

XYZ Co.Trial balance as at 31st Jan.19XX

Accounts Debit CreditCash 5100Capital 1000Sales 6500AXDB Co. 1000


Purchases 200ABC Co.Office Furniture 1200

7500 7500

The trial balance for XYZ Co. was prepared by extracting the closing balances of all accounts in the general ledgers. If the posting to the ledger is correct, the trial balance would balance. Otherwise, it reflects errors that may occur either in the journals or ledgers, and it is the responsibility of the account clerk to identify the errors.

4.4.1 Errors Disclosed by Trial Balance

15.16. 1. Calculation ErrorsWhen trial balance could not balance, it could be due to calculation 17. errors. (termed casting errors in accounting)

18. 2. Posting ErrorsTrial balance could not balance may be due to errors in posting. This may occur as a result of recording the transactions wrongly in the journal and as a result wrong posting to the ledger. It may occur in the ledger accounts when one account is forgotten in ledger - this is known as single entries.

19. 3. Inconsistent FiguresTrial balance could not balance may also be due to inconsistent figures used in the double entry for the same transaction. For example, debiting cash $1,000 but crediting capital $100. Or it may be due to transcription errors such as debiting cash $5,059 but crediting sales $5,095.

In certain circumstance, a balanced trial balance may not assure accuracy of accounts. Unfortunately, such errors could not be easily detected by a balanced trial balance. To avoid such circumstances, all cares must be exercised during posting.

4.4.2 Errors not Disclosed by Trial Balance

1. Errors of original entry.

20. This error occurs because of wrong figures reflected in the double entry of the same transactions.

2. Errors of Omission

21. This error occurs when the whole transaction and its double entry are forgotten or not recorded at all.

3. Errors of Principle

22. This error occurs when the posting are done into the wrong type of accounts. For example, instead of debiting office furniture account, it was posted to purchase account.

4. Errors of Commission

23. This error occurs due to the posting to wrong accounts of the same nature. For example, debiting to Adam Smith instead to A.Adam Smith when both are debtors.

5. Errors of Reversal

24. This is an error resulted due to reversing the double entry for the same transaction.

6. Compensating Errors

25. This error is due to omission of one account figure which was compensated at a later stage. In other words, there are more than one error but offset each other.

26. In summary, a good practice in accounting is to record all transactions and ensuring its accuracy. This is handled by the process of recording all


transactions in the relevant journal books, posting of accounts in the relevant ledgers and ensuring accuracy by preparing trial balance.

27.

4.5 Exercises28.

29. 1. Record the following transaction of Sure-Succeed in the general journal.

6th Oct 19XX Owner invested $3,000 cash and $2,000 worth of office furniture into business.

7th Oct 19XX Business sold $2,000 worth of goods on credit to ABC Ltd and another $1,000 worth of goods by cash.

8th Oct 19XX Business purchased $1,500 worth of goods on credit from XYZ Co.

9th Oct 19XX ABC Ltd returned to Sure-Succeed $200 worth of goods because the quality is lousy.

10th Oct 19XX ABC Ltd paid Sure-Succeed $1,620 and the remainder are taken as discount given by Sure-Succeed.

11th Oct 19XX Sure-Succeed paid $1,450 to XYZ Co. The remaining balance is the discount received from XYZ Co.

12th Oct 19XX Business sold $10,000 worth of goods to Data Co.13th Oct 19XX Cash sale of $15,000 was transacted.14th Oct 19XX Owner withdrew $2,000 stock for his own personal use.15th Oct 19XX Business paid for wages $300, stationery $200 and rent of $1,000

by cash.16th Oct 19XX Sure-Succeed purchased $4,000 goods from XYZ Co.

17th Oct 19XX Sure-Succeed returned $200 goods to XYZ Co due to poor quality.

18th Oct 19XX Business expanded by purchasing $1,000 office furniture and $3,000 machinery.

19th Oct 19XX Business borrowed from the bank a loan of $4,000 for its expansion.

20th Oct 19XX An overdraft of $2,000 was arranged with the bank.24th Oct 19XX Sure-Succeed returned the amount it borrowed with an interest of

7%.26th Oct 19XX Business paid for electricity charges of $200 by cheque.27th Oct 19XX Business paid XYZ Co. for the amounts owned.28th Oct 19XX Business transacted cash purchases of $3,000.30th Oct 19XX Business received commission of $500 as a result of selling goods

on behalf of Visa Pte Ltd.

30. 2. Prepare the ledger accounts of question 1 and check the accuracy of posting by preparing the trial balance.

31. 3. Explain the purpose of preparing journals and ledgers.

4. Identify and explain errors that are not disclosed and errors that are disclosed by the trial balance. Use examples to aid in your explanation.

CHAPTER 5: FINANCIAL STATEMENTS

Chapter Objectives


trading, profit or loss statement;

balance sheet;

adjustment entries.

Introduction

In the previous chapter, students would have learned how transactions are recorded and how transactions accounts balances could be checked to ensure its accuracy.

However, this practice is not enough. Very often, accounting information is required by many users. The firm would like to know its balance sheet status and its profit or loss for its financial period.

This chapter is a continuation from the previous chapter. It illustrates how after preparing the trial balance, the firm could make use of accounts in the trial balance to prepare its Trading, Profit or Loss Statement and Balance Sheet.

5.1 Trading, Profit or Loss Statement

The trading, profit or loss statement reflects on the company's profit earned or loss incurred due to its business activities.

Example 1 would illustrate how profit or loss could be determined.

Example 1

The following trial balance was prepared by Sure-Succeed after posting accounts to the general ledger. You are required to draw the Trading, Profit or Loss Statement of Sure-Succeed for the year ended 30/06/19xx.

Debit ($) Credit ($)Sales 50000Purchases 10000Returns-Out 4200Opening Stock 31000Returns In 500Discount Allowed 340 210Discount Received 280Carriage Inwards 350Carriage Outwards 470Rent 710Interest 1230Wages and Salaries 230Lighting and Heating 170Motor Expenses 4000Stationary 5130Insurance

54410 54410

Notes: Closing stock is $30,000

CS152 CHAPTER 5: FINANCIAL STATEMENTS

Sure-SucceedTrading, Profit or Loss Statements for the year ended 30/6/19XX

$ $ $Sales 50,000Less: Returns In 500

49,500Cost of goods sold:Opening Stock 31,000Purchases 10,000Carriage Inwards 280

1,0280Less: Returns Out 4,200

6,080 37,080

Less: Closing Stock 30,000 7,080 Gross Profit 42,420Discount Received 210

42,630Expenses:Discount Allowed 340Carriage Outward 350Rent 470Interest 710Wages and Salaries 1,230Lighting and Heating 230Motor Expenses 170Stationary 4,000Insurance 5,130 Total Expense 12630 Profit / (Loss) 30,000

In example 1, after preparing the Trading, Profit or Loss Statement, Sure-Succeed would know that for the financial period, it has earned a profit of $30,000.

There are two parts to the Trading, Profit or Loss Statement:

Trading Account; and

Profit or Loss Account.

The Trading Account determines the gross profit earned due to the firm's trading activities. However, this gross profit does not determine the net earning of the firm. This explains why expenses incurred by the firm have to be deducted from the gross profit to determine the profit earned. This is the profit or loss account.

A few formulae to remember to determine the net profit:

32. Net Profit = Gross Profit + Additional Revenue – Expenses

33. Gross Profit = Net Sales - Cost of Goods Sold

34. Net Sales = Sales - Returns In

35. Cost of Goods Sold = Opening Stock + Purchases + Carriage Inward - Returns Out - Closing Stock

5.2 Balance Sheet


Knowing the profit of the firm is not sufficient. It is important for a firm to know its financial position in the market. This could be reflected by referring to the net assets owned by the firm in the balance sheet.

Example 2

The following information is provided by Sure-Succeed. You are required to prepare the balance sheet as at 30/06/xx.

$Premises 300,000Stock 2,000Debtors 1,800Creditors 3,400Cash 2,100Bank Overdraft 2,300Drawings 368Fixtures and Fittings 2,800Profit 4,700Sales 2,800Purchases 1,800Capital 25,268Bank Loan 3,400

Sure-SucceedBalance Sheet as at 30/6/XX

$ $ $Fixed Assets: Cost Acc. Depre NBVPremises 30,000 - 30,000Fixtures and Fittings 2,800 - 2,800

32,800 - 32,800

Current Assets:Stock 2,000Debtor 1,800Cash 2,100

5,900

Current Liabilities:Creditors 3,400Bank Overdraft 2,300

5,700Networking Capital 200 Net Assets Employed 33,000

Financed By:Owner’s Equity:Capital 25,268Profit 4,700 29,968Less Drawings 368

29,600Long term Liabilities:Bank Loan 3,400

33,000

5.3 Adjustment Entries

5.3.1 Prepayment and Accruals

In the previous section, it was reflected that items incurred are paid in full. But in many occasions, items may not be paid in full. The business may have situations whereby it


pays in advance but in other situations, the items are not fully paid for. When items are paid in advance, they are known as prepayment but when items are not fully paid for they are known as accruals.

To adjust for such entries, the double entry would be:

s) Prepayment:

Debit Prepayment (of expense) xxCredit Expense xx

t) Accruals:

Debit Expense xxCredit Accruals (of expense) xx

The amount reflected would be the amount prepaid or accrued.

Whenever there are adjustment entries, it is necessary to reflect the adjustment required in the Profit or Loss Statement and Balance Sheet.

Treatment under Profit or Loss Statement:

a) Prepayment

- The amount of expense prepaid will be deducted from the expense in the profit or loss.

- For example, if in the trial balance Rent is reflected as $3,000 and it was discovered that $250 was prepaid.

- Extract of Profit & Loss Statement :

Rent = 3,000Less Prepaid = 250

2,750

b) Accruals

- The amount accrued implies that the firm does not pay enough. This would require the firm to adjust its expense by adding the amount accrued in the Profit & Loss Statement.

- For example, the firm only pays for three quarters of Rent where each quarter is $300. At the end of the year when preparing for Profit & Loss, the adjustment entries would be:

- Extract of Profit & Loss Statement :

Rent = 900Add Accruals = 300

1,200


Treatment under Balance Sheet

c) Prepayment

- Extract of Balance Sheet

- Current Assets

- Prepayment - Rent = $250

d) Accruals

- Extract of Balance Sheet:

- Current Liabilities

- Accruals - Rent = $300

5.3.2 Depreciation

It should appear obvious that it is unlikely that the value of fixed asset would remain consistent at its cost :

as the fixed assets were used throughout its useful life,

or wear and tear through use,

or as a result of economic factors such as obsolescence,

or due to its age that was predetermined,

or when it is depleted,

the value of assets decreased or depreciated.

The decline in value has to be taken into consideration. However, the value would not be directly adjusted due to avoidance of violating the cost concept. As such separate adjustment entries are taken into consideration by adjusting for depreciation.

The difficulty arises in depreciation is due to the fact that the actual amount of depreciation can only be determined when the fixed assets are sold. The difference between the original price to the price the assets can be sold determines the amount depreciated. This is not a practical approach to determine depreciation for no one firm would like to sell its fixed assets in order to determine how much the asset has been depreciated. For this reason, to overcome this difficulty, depreciation has to be estimated using methods such as straight-line or reducing balance method. Whichever method was used, the firm has to ensure that it observed the consistency convention.

Straight-line Methods

This is the easiest among all methods. To determine the amount to depreciate, the firm has to first estimate scrap value/residual value and the assets estimated useful life.

For example, if a machinery was purchased at $10,000 and the firm estimates that the machinery could have a residual value of $2,000 and a useful life of 5 years, then the depreciation amount each year would be:

Depreciation = Cost – Residual ValueValue


= 10,000 – 2,0005

= 8,0005

= $1,600/year

This implies that machinery would depreciate at $1,600 each year.

Reducing Balance Method

This method is not as straight-forward as in straight line method. It is usually applied when the firm could not identify how long the asset would be kept or what its disposal value would be. This method estimates its annual depreciation by applying a certain depreciation rate on the net book value (NBV) of the asset.

For example, if the machinery of $10,000 is to be depreciated at 25% p.a. for 4 years, the depreciation amount calculated would be as follow:

Cost $ AccumulatedDepreciation

NBV DepreciationAmount

Year 1 Machinery 10,000 2,500 7,500 2,500Year 2 Machinery 10,000 4,375 5,625 1,875Year 3 Machinery 10,000 5,781 4,219 1,406Year 4 Machinery 10,000 6,836 3,164 1,055

As observed, the depreciation amount each year was different and it was calculated by multiplying 25% to its NBV.

After calculating the depreciation amount, the firm has to ensure that it was correctly adjusted for in the Profit and Loss Statement and Balance Sheet. All adjustments must be recorded in the journal, where the firm possessed many types of fixed assets, a fixed assets register would be set up to keep track of all the fixed assets in use. This register would contain at least some of the following details:

Contents of a Fixed Assets Register

Description of the asset

Date of Acquisition / Purchase date

Original cost and estimated disposal value

Depreciation method

Accruals depreciated

Total depreciation to date / accumulated depreciation

Net Book Value (NBV)

Supplier's name and address

Location in the premises

Category of the fixed asset / reference number

Maintenance / servicing history


Using the figure calculated on the reducing Balance Method:

Double-Entries (in 2nd Year)

Debit Depreciation of Machinery $1875Credit Provision for Depreciation of Machinery $1875

Treatment under Profit & Loss (ended 2nd Year)

Extract of Profit & Loss:

Less ExpensesDepreciation of Machinery $1875

Treatment under Balance Sheet (as at 2nd Year)

Fixed Assets: Cost Acc Dep NBVMachinery 10,000 4,375 5,625

5.3.3 Bad Debts and Provision for Bad Debts

In certain occasions, customers may not be able to pay for their debts. Debts that cannot be collected back from Debtors are considered "bad".

Firms have to recognize that some debtors' accounts could not be fully collected and as such there is a need to create a bad debts accounts.

When a named debtor is confirmed that a certain amount of debt is bad the amount is reflected as bad debts in Profit & Loss. But if the firm tries to be conservative by predicting that on general basis a certain percentage of debts from its overall debtors would be bad, it would create a provision for bad debts. A more appropriate term for provision for bad debts is Provision for doubtful debts as the debt is doubtful and not bad as yet.

The provision for bad debts reflects an estimation of any future bad debts. At the end of the financial period, some debtors may have become "bad" but this should not affect the provision for doubtful debts as the figures is always an estimate for the future years. Any increase or decrease in the provision for doubtful debts only needs to be entered in the Profit & Loss. Otherwise no other entries is needed in the Profit & Loss as it may have been written off in earlier year.

For example, if Michael who owes the firm $300 died, his debt is termed as "bad".

The double-entry would be:

Debit Bad debts $300Credit Michael $300

Treatment in Profit & Loss:

Extract of Profit & Loss = bad debt = $300

For example, to differentiate the treatment for provision for Doubtful debts, total debtors of $20,000 where provision are to be increased from 10% to 20%:

Treatment in Profit & Loss : bad debt = $2000

Increase in Provision for doubtful debts


(20% x $20,000 - 10% x $20,000)

Treatment in Balance Sheet :

Debtors 20,000Less provision for bad debts 4,000

16,000

Double Entries:

Provision for Doubtful Debts Account

A/C DR CR1 Jan ’89 Bal at this date 2,00031 Dec ’89 Profit or Loss A/C 2,0001 Jan ’90 Bal at this date 0 4,000

Example

The following trial balance at 31 Dec. 19xx was provided by Sure-Succeed. You're required to prepare a Trading, Profit & Loss account and Balance Sheet at that date.

Sure SucceedTrial Balance As At 31 Dec 19XX

Details DR $ CR $Drawing 116 18,000Capital 23,000Premises 3,000Furniture and Fittings 280Cash at bank 780Cash in hand 5,000Motor Vehicles 2,800Wages 4,500Rent and Rates 30,000 52,000Purchases and Sales 7,600 6,200Debtors and Creditors 2,800Opening Stock 250Lighting and Heating 2,178Discounts Received 2,300Discounts Allowed 1,000Provision for bad debts 2,800Bank Loan 1,180Returns In 1,128Returns OutAccumulated Depreciation:Furniture and Fittings 300

83,606 83,606

Notes and Adjustments:

Provision for bad debts is to be increased to 20% for debtors.

Furniture and Fittings is to be depreciated at 10% on NBV using the reducing balance method.

Amounts owing: Wages $200 and rent $150.

Lighting and heating prepaid is $50.


Sure-SucceedTrading, Profit or Loss Account for the year ended 31/12/19XX

$ $ $Sales 52,000Less: Returns –In 1,180 50,820

Cost of goods sold:Opening stock 2,800Purchases 30,000

32,800Less: Returns -Out 1,128

31,672Less: Closing Stock 3,800

27,872Gross Profit 22,948Discounts Received 2,178

25,126Expenses:Wages 30,000Rent and Rates 4,650Lighting and Heating 200Discounts Allowed 2,300Depreciation for furniture and fittings

270

Increase in Provision for bad debts

520 10,940

Net Profit / (Loss) 14,186


Sure-SucceedBalance Sheet as at 31/12/19XX

Cost$

Acc. Depre.$

NBV$

Fixed AssetsPremises 23,000 - 23,000Furniture and Fittings 3,000 570 2,430Motor Vehicles 5,000 - 5,000

31,000 570 30,430Current AssetsStock 3,800Cash at bank 280Cash in hand 780Debtors 7,600Provision for bad debts 1,520 6,080Prepayments 50

10,990Current LiabilitiesCreditors 6,200Accruals 350 6,550 Net working capital 4,440 Net assets employed 34,870Financed by:Capital 18,000Added net profits 14,186 32,186Less Drawings 116 Long-terms Liabilities: 32,070Bank Loan 2,800

34,870


5.4 Exercises

36. 1. The following information is provided by Sure-Succeed. You are required to prepare

a trial balance, trading, profit and loss statement and balance sheet.

$Sales 63,000Fixtures and Fittings 42,000Office Equipment 18,000Purchases 2,500Returns-In 477Returns-Out 398Carriage-In 1,120Debtors 1,428Creditors 1,876Capital 2,852Opening Stock 2,960Cash in hand 1,880Bank overdraft 2,740Bank loan 2,916Rent 384Stationery 782Discount Allowed 567Discount received 789Wages and Salaries 1,012Motor Expenses 234Insurance 258Drawings 969


2. The following transactions happened in the month of July. You're required to prepare the journal entries and post the entries to the ledgers. Also prepare a trial balance, trading, profit and loss statement and balance sheet.

July 1 Owner invested $30,000 of cash into business and $12,500 of fixtures and fittings.

July 2 Bought office furniture of $5,000 from ABC Ltd.July 3 Bought goods from XYZ traders worth $5,000.July 7 Bought another $3,800 worth of goods. Made payment of

$3,600 and the remaining balance given as discount.July 8 Sold goods to Michael Tan worth$7,300 and cash sales of

$2,600. Michael paid $7,100 as the remaining is offered as discount due to his earlier settlement.

July 10 Sold goods worth $3,600 to XYZ Ltd but due to poor quality, XYZ Ltd returned $180 worth of goods to business.

July 12 Bought $1,300 worth of goods from ABC Ltd but returned $100 worth of goods to ABC Ltd.

July 15 Paid for wages $300, stationery $500, rent $800 and utilities of $700 by cheque.

July 18 Owner withdraw $350 cash from business for his personal use.

July 21 Business borrowed $3,800 from bank.July 22 Paid interest of 10% on bank loan borrowedJuly 25 Bought goods from ABC Ltd $32,500 and paying $300 for

carriage inward.July 29 Sold goods to DBC Ltd $48,000.July 30 Received commission from Xanadu for goods sold on their

behalf $3,000.July 31 Owner withdrew $200 worth of goods from business for his

own personal use.


3.

$ $Bank 1,000Rent and Rates 270Debtors and Creditors 2,580 1,870Wages and Salaries 224Insurance 231Discounts Received 510Fixtures and Fittings at cost 23,000Motor vehicles at cost 48,000Sales and Purchases 5,400 66,016Capital 9,870Stock (as at 1/1/19XX) 1,700Returns-OutCarriage Inwards 214 119Carriage Outwards 160Loan 1,100Motor vehicles expenses 3,450Commission received 217Drawings 275Lighting and Heating 348Accumulated depreciation:Motor Vehicles 4,800Fixtures and Fittings 2,300Provision for bad debts 50

86,852 86,852

Givena) Stock at 31/12/19xx $9,900.

b) Lighting and heating paid in advance $210.

c) Rents owing $455.

d) Depreciation is to be calculated at 20% of cost for fixtures and fittings and 10% net book value for Motor Vehicles.

e) Provision of Bad Debts are to be increased to 5% of Debtors.

The above trial balance was produced by a firm. You are required to draw up a Trading and Profit or Loss account for the year ended 31/12/19xx and a Balance Sheet as at 31/12/19xx.


3. The following trial balance was prepared by Sure-Succeed. You are required to prepare the Trading and Profit or Loss Account and Balance Sheet.

$ $Stock 2,800Returns Out 1,700Returns In 1,600Capital 2,800Creditor and Debtors 2,580 2,680Sales and Purchases 11,000 24,000Fixtures and fittings 21,000Motor Vehicles 24,000Wages 2,518Discounts Received 248Bank Loan 21,000Cash at bank 1,400Rents and Rates 4,000Premises 6,790Lighting and Heating 1,100Cash in Hand 2,500Provision for bad debts 120Insurance 510Motor vehicle expenses 450Accumulated depreciation:Motor vehicles 2,400Fixtures and Fittings 2,100

82,248 82,248

Notes and Adjustments:

e) Closing Stock is $6,500.

f) Insurance owing is $350 and Rent is $750.

g) Lighting and Heating is $500 paid in advance.

h) Motor Vehicles and fixtures and fittings are to be depreciated at 10% on NBV using reducing balance method.

i) Provision for bad debts is to be increased to 5% of debtors.

37.

CHAPTER 6: COMMON FINANCIAL RATIOS

Chapter Objectives


profitability ratio;

liquidity ratio;

performance ratio;

how to interpret the accounts?

Introduction

Previously, we have seen how Trading, Profit and Loss Accounts and Balance Sheet are prepared to provide information for users.

However, users would often demand more than Trading, Profit and Loss A/C and Balance Sheet. Many of the users would examine the accounts of the firm to measure the firm's relative performance with its subsidiaries, of its competitors and its industry.

In this chapter, students would be taught on how to use formula to measure the profitability, liquidity and efficiency of the firm. It is also of utmost importance that students know the interpretation of accounts.

6.1 Profitability

These are the main group of formula to measure the profitability of a firm. A few of the formula that would be discussed in the following sections include:

j) Return on Capital Employed

k) Net Profit Margin

l) Gross Profit Margin

m) Profit Markup

6.1.1 Return on Capital Employed

This ratio measures the return of the owner's capital investment. Under normal circumstances, the higher the return on capital employed, the better.

Formula :ROCE = Net Profit x100%

Capital Employed

Capital Employed = Fixed Assets + Current Assets - Current Liabilities

For example, Jane Lim of Sure-Succeed Ltd obtained the following information and she would like to know return on capital employed.

Net Profit : $30,000Fixed Assets : $65,000Current Assets : $35,000

CS152 CHAPTER 6: COMMON FINANCIAL RATIOS

Current Liabilities : $20,000

Henceforth, ROCE = 30,000 x 100%80,000

= 37.5%

6.1.2 Net Profit Margin

This formula reflects how effective the firm has been in its operation and how it managed to keep the expenses down. This formula calculates net profit as a percentage of total sales.

Formula : Net Profit Margin = Net Profit x 100%Sales

For example, Sure-Succeed sold a net sales of $100,000 and it obtains a net profit of $10,000.

Henceforth, Net Profit Margin = 10,000 x 100%100,000

= 10%

6.1.3 Gross Profit Margin

This formula reflects how effective it is in its trading activities. This formula could be used for control purposes to ensure compliance of standard pricing and to avoid fraud.

Formula : Gross Profit Margin = Gross Profit x 100%Sales

For example, Sure-Succeed determines that its sales has been $80,000 and it also earns a gross profit of $20,000, then its gross profit margin is

Gross Profit Margin = 20,000 x 100%80,000

= 25%

6.1.4 Profit Markup

In part (c), knowing the margin would ensure compliance of standard pricing policy.

For example, if the cost of goods is $10 and the firm seeks to achieve a gross profit margin of 10%, then the firm's and its subsidiaries would have to observe its pricing policy by selling at $11.11, not more nor less. How was $11.11 obtained? By margin, it is based on the selling price expressed as 100%. In this example, if the firm determines to achieve 10% profit margin then it implies that cost of goods at $10 is expressed as 90%.


However, in certain circumstance, the firm may prefer to achieve markup on its cost. By markup, it is based in the cost price expressed as 100%.

For example, if the costs of goods is $10 and the firm seeks to achieve 10% markup, then its selling price would be $11.

6.2 Liquidity

This ratio measures the firm's ability to meet its debts. A firm which has plenty of cash to meet its current liabilities is termed as a "liquid" firm.

To determine the liquidity of a firm, users need to compare the firm's current assets with its current liabilities.

These are three formulae used to measure a firm's liquidity position:

n) Current Ratio

o) Working Capital

p) Acid Test or Quick Ratio

6.2.1 Current Ratio

This ratio compares the current assets to current liabilities.

Formula: Current Asset : Current Liabilities

For example, if the current assets of Sure-Succeed amounted to $30,000 and its total current liabilities amounted to $10,000, then current ratio would be 3 : 1. This ratio measures the financial health of the firm. We can identify if there is sufficient assets to meet liabilities.

6.2.2 Working Capital

This formula measures the difference in absolute monetary amount between current assets and current liabilities.

Formula : Working Capital = Current Assets - Current Liabilities

As in the previous example, if current assets remain as $30,000 and current liabilities at $10,000, then the firm's net working capital would be $20,000.

6.2.3 Acid Test or Quick Ratio

This ratio takes a more pessimistic view by assessing the firm's liquidity under the worst possible situations. Only those assets that can be quickly converted into "cash" would be taken into consideration. As such, stock which is most difficult to convert to "cash" is excluded.

Formula : Acid Test Ratio = (Current Assets - Stock) : Current Liabilities


In previous example, if in the amount of current assets, $2,000 refers to stock, then Acid Test would indicates (30,000 - 2000) : 10,000 or 2.8 : 1.

Note: Stock refers to Closing Stock

6.3 Performance

The last group of formulae is used to determine the effectiveness of management.

A few of the formulae that will be discussed are:

q) Stock Turnover

r) Debtors Payment Period

s) Creditors' Payment Period

6.3.1 Stock Turnover

This formula calculates how long it takes for stock to turnover or to be replaced. If the turnover period is long, it may not be healthy as it may cause the firm in losing any bulk discounts offered by suppliers. This will measure the efficiency of stock management by the firm - though the interpretation will depend on what type of stocks are involved. For example, 92 days is too long for fresh food but not for furniture.

Formula : Stock Turnover = Cost of goods sold = x timesAverage stock

Average stock = Opening stock + Closing stock2

For example, if Sure-Succeed has cost of goods sold of $10,000, opening stock of $2,000, and closing stock is $3,000, then Sure-Succeed's stock turnover would be: 4 times or 92 days.

6.3.2 Debtors' Payment Period

This formula determines how long it takes for a firm to receive payments from debtors. This formula would thus reflect on how effective a firm is in exercising its credit control procedures.

Formula : Debtors x 365 days = x daysSales

For example, Sure-Succeed's Debtors are $25,000 and credit sales for the period is $250,000 then it implies that Sure-Succeed would take 37 days to collect payments from debtors. Generally, if debtors pay earlier, the firm would have more liquid funds. The conclusion is dependent on terms of credit offered. 37 days are not services for granted TOC (term of credit) of 30 days, although it could be improved.

Note: Days must be rounded up.

6.3.3 Creditors Payment Period


This formula calculates the average time taken to pay off creditors. Generally, if firm pays later, it would have more liquid funds retained to deal with its transactions.

Formula : Creditors x 365 = x daysPurchase

For example, if Sure-Succeed has credit purchases of $10,000 and creditors of $3,000, it implied that it takes 110 days to settle its debts with its suppliers.

This measures the extent to which credit terms are obtained from suppliers. 110 days is advantageous but must be considered in context of whether suppliers might face liquidity problems.

Note: Days must be rounded up.

6.4 How to Interpret the Accounts?

By using the formula, users would be able to measure the firm's profitability, liquidity and efficiency.

Under general situation, the higher the profitability ratio, the better. If liquidity ratio is more than 2, the firm is termed to be liquid. However, be cautioned that it may not be too healthy for a firm if it becomes too liquid.

For performance ratio, a general guide would be the lower the stock turnover ratio, the better. However, be cautioned that the formula should be used with care when comparing different firms. For debtors' payment period, a general guide would be the shorter the better. For creditors payment, the converse would be true. But, firms have to exercise care that credit control should not be too tight till customers are scared off. Similarly, firms should not delay payment to supplier otherwise suppliers would be very hesitant in giving future support to firms.


6.5 Exercises38. The following is the Trading, Profit or Loss Account and Balance Sheet of Sure-Succeed. You are required to state the formulae and calculate the following.

t) Return on Capital Employed

u) Net Profit Margin

v) Gross Profit Margin

w) Current Ratio

x) Working Capital

y) Quick Ratio

z) Stock Turnover

aa) Debtors' Payment Period

bb) Creditors' Payment Period

Trading, Profit or Loss Account$ $

Sales 200,000Opening Stock 15,000Purchase 93,000

108,000Less: Closing Stock 8,000 Cost of goods sold 100,000Gross profit 100,000Less: Expense 85,000 Net profit 15,000

Balance SheetFixed Assets 182,000 Current Liabilities 33,000Current Assets 51,000 Capital 200,000

233,000 233,000* Debtors = $12,000,,,* Creditors = $20,000

39. Calculate the following ratios by referring to the Trading, Profit or Loss and Balance Sheet you have prepared in Chapter 5 Exercise Q1 and Q2.

cc) Two accounting ratios that might be used by the firm's managers.

dd) Two accounting ratios that might be used by the shareholders.

ee) Two accounting ratios that might be used by the firm's suppliers.

ff) Compare the ratios of (a), (b) and (c) of the firms and comment on their relative performance.

CHAPTER 7: AUDIT AND CONTROL

Chapter Objectives


necessity to have checking and controlling procedures in an accounting system;

the different methods used in internal controls;

what is external control and audit evidence.

Introduction - Why the Need for Controls

An effective accounting system should be able to produce necessary information efficiently. In other words, these information generated should be accurate and up to date. Recall the concept of the separation of control and ownership of a business.

Some of the reasons are:

Employees will be handling monetary transactions and the management is held to be accountable for the employees actions. Therefore, there must be effective and careful controls to make sure that accounting jobs are carried out properly.

Controls are also required so that the chances for fraud and theft can be prevented.

Many groups of people use accounting reports to make decisions. Some of these users like future investors and lending banks, will make use of these accounting reports to decide whether to invest in the business or lend money to the business.

In this respect, they will assume that figures are true and correct - this can only be produced from an accounting system that practice proper control and checking procedures. However, checks and controls can fall into two categories.

gg) Internal controls - procedures implemented by management to ensure that an effective system is in operation.

hh) External controls - carried out by the auditors who will be working on behalf of the owners.

7.1 Internal Controls

Internal controls are those checking and controlling procedures that are implemented by the management to prevent any errors or fraudulent practices.

These procedures can normally be divided into seven areas.

7.1.1 Checks on Numerical Accuracy

Mainly serves as a control tool to detect errors in double entry and casting mistakes. Frequent preparation of a Trial Balance and the use of Control Accounts are the usual tools.

7.1.2 A Well Defined Organization Structure should be Set Up

CS152 CHAPTER 7: AUDIT AND CONTROL

Employees should be given clearly defined responsibilities and scope of authority. An organization chart should be drawn up and this will enable employees to see what they are responsible for. An example, would be to state clearly who can receive an order, who can approve the order, who to receive payment.

7.1.3 Segregation of Duties

Segregation of duties is another policy to be implemented for internal controls. This means that no one person should be solely responsible for recording and processing a transaction. The practice of having different persons for receiving an order, approving an order, recording the order etc., will reduce the occurrence of intentional manipulation of records and the chances of errors. In particular, the function of authorization, execution, custody and recording should be separated if this procedure is to be followed properly.

7.1.4 Physical Controls

Physical controls would mean the use of locks and keys and restriction of access to assets of the company. Where accounting information are concerned, there must be procedures and security measures designed to ensure that access to information is limited to authorized personnel only. Restriction to books of accounts will prevent any unauthorized entries being made. For instance, important documents should be kept properly and the keys should be retained by the manager. By restricting access to information, the chances of information being lost or tampered with will be much reduced. Fraud will also be less likely.

7.1.5 Authorization and Approval

Authorization and approval should cover all types of transactions. The system should set limits for transactions especially where large sums of money are involved. In issuing purchase orders, for instance, any amounts over certain level must have the signature of the manager as the approving authority - in addition to the authorized signature of the purchasing officer. The same manner can be implemented for any cheque paid out, in which any amount over a certain sum must require an additional signature.

7.1.6 Personnel

As accounting is a specialized skill, employees should be competent in the basic skills for the work to be done. In addition the employees should be well motivated as well as honest and reliable. This will reduce errors and fraud.

7.1.7 Supervision

There must be adequate supervision to ensure that there are no errors. Modern techniques such as remote video cameras can be supplemented.


7.2 External Control

External checks are being undertaken by the owners of the business. The auditors play the role of checking on behalf of the owners.

They have to verify that proper books of account are kept and that the final accounts tally with the books.

They are responsible for reporting on the accuracy of the final accounts issued to shareholders and that is the auditors report.

Audited financial statements must be prepared for all registered companies (in accordance with the Companies Act).

The auditor is particularly concerned with the adequacy of the underlying records and the detection of major distortions in the accounts arising from improperly kept records. They will check on the possibility of the biased use of accounting standards and methods.

Their main purpose is to detect any fraud or errors.

The auditors have the right to examine all records and documents. Audit tests are being performed to check on the effectiveness of controls in the accounting system. The test will also prove the accuracy and validity of data produced by the accounting system.

All these checking by the auditors are carried out by means of audit evidence. We can break down the audit evidences into different activities as follows:

7.2.1 An Audit Trail

When designing any accounting system the analyst should bear in mind that the system should maintain an audit trail, produce necessary information and enable adequate control measures to be implemented. An audit trail is actually a sequence or path by which an auditor can follow the documentation of a transaction from source document through all the books up to its presentation in the final accounts. This trail can also be followed backwards by picking up a figure from the final accounts and working backwards to the source documents. This flow of evidence will help the auditor to confirm whether accounting records are properly maintained though it will not confirm that the accounts are correct.

An audit trail will only demonstrate the possibility of fraud if there is no source document found at the start of the trail. However the trail will enable the auditor to confirm that all items have been recorded properly and that there is no fraud or error. This form of checking is also referred to as a "walk through" test. The figure below illustrates the audit trail for a typical purchasing system.


7.2.2 Documentation

Purchase Requisition

Purchase Order

Goods Received Note (GRN) /Delivery note

Purchase Invoice

Purchase Day Book

Purchase Ledger Nominal Ledger

Cheque Requisition / Payment Voucher

Bank Daybook

Ledger Account

Reports

Figure 7-1: An audit trail for purchase on credit

The sighting of various documents will enable the auditors to follow the audit trail and to ensure that information is processed correctly. It is also used to check whether there is any possibility of fraud.

7.2.3 Flowcharts for Reviewing System

The use of accounting flowcharts provide another means of checking whether the accounting system is effective. The flowcharts will show the stages in the processing function and who is responsible at each stage.

7.2.4 Directors' Minutes

Resolutions by the Board of Directors are required for major business decisions. The minutes will form the authorization of major purchases, for example buying fixed assets or the acquisition (take-over of other companies). Minutes can also enable the auditors to discover any plans for future changes.


7.2.5 Debtors and Creditors Circulation

An important source of independent third party confirmation of balances can be obtained from the firm's debtors and creditors. They will be requested to confirm outstanding balances directly to the auditors from the figures obtained from the books.

7.2.6 Physical Inspection

The sighting of items of material values such as fixed assets are also an integral part of gathering audit evidence. The auditors may insist on the indexing of fixed assets to ascertain that the total items tally with the books.

7.2.7 Meetings and Discussions

Holding meetings with management and discussion with system operators (the employees) will provide invaluable feedback to the auditors concerning the adequacy of the system.

7.2.8 Reports from Mass Media

Reports on television; radio and articles in newspapers may also confirm the validity of any rumours whether positive or negative.

Summary

Remember any accounting system should have checks and control in order to prevent the occurrence of errors and the possibility of fraud being committed. We have suggested seven internal control areas, namely:

checks on calculation;

proper organizational structure;

segregation of duties;

physical control;

authorization and approval;

qualified personnel and

close supervision.

Internal controls are set up by the management. External controls are carried out on behalf of owners/shareholders. Auditors carry out their work by obtaining audit evidence. A total of eight audit evidences have been listed.


7.3 Exercises

Write the word or phrase needed to complete each of the following:

40.

ii) An ________________ means that a document can be traced from source to final accounts.

jj) The _______________ is a person employed by the shareholders to check the accounts.

kk) A person who checks the truth and fairness of the accounts is known as __________________.

ll) The simplest way to avoid fraud and prevent errors is to ensure that there is a _________________.

mm) Explain briefly the roles and duties of an External Auditor.

nn) The auditor checks the accounts of a firm gathering _______________.

41. What is the purpose of an audit trail?

42. Explain, briefly, the meaning of the term "audit trial".

43. What evidence might an auditor use to confirm the following:

i) A decision by the Board of Directors to issue more shares.

ii) A debt of $250 owned by ABC & Co.

iii) The purchase of new factory premises in a neighbouring town.

iv) The existence of standard procedures for processing data.

v) The take over of a very large competitor.

vi) The purchase of a random sample of raw materials.

44. By referring to documents/accounts/statements etc. Describe briefly, an audit trial for purchases made on credit.

45. What evidence might an auditor examine in order to verify the Creditors figure on a balance sheet?

46. What is meant by segregation of duties?

CHAPTER 8: CONTROL ACCOUNTS AND SUSPENSE ACCOUNTS

Chapter Objectives


control accounts;

data flow in control accounts;

control account exercise;

suspense accounts;

step by step procedure.

8.1 What is a Control Account

This is a ledger account set up in the nominal ledger to control the total of all entries for a set of individual accounts maintained in subsidiary ledgers.

Examples

Stock Control Account

Set up to keep a running balance of goods/materials held in stock

Entries to this account would include :

- stock purchases value / total (from suppliers)

- requisitions value / total(issued out to production)

- opening stock values / totals

- closing stock values / current stock

Bank Control Account

- For all the individual bank transactions

Sales Ledger Control Account

- For all the debtors accounts kept in the Sales Ledger

Purchase Ledger Control Account

- For all the individual creditors accounts kept in the Purchase Ledger

Control Accounts are necessary in manual accounting systems because it can check the accuracy of the accounting reports. Control accounts can enable the users to highlight in which ledger an error occurs. Where more than one user of the accounts are making use of the system, there is minimum delay. This will mean that each user can work on one part of the ledger at the same time. Especially so in manual accounting systems, the trial balance will be shorter if there are control accounts being set up. A diagrammatic illustration of the flow of data in a system for Control Accounts is shown below.

Source Documents

Daybooks

Sales Ledger Purchase Ledger Nominal Ledger

CS152 CHAPTER 8: CONTROL ACCOUNTS AND SUSPENSE ACCOUNTS

Legend = Single Entry= Double Entry

Figure 8-1: Simplified diagram for division of the ledger


In the system for the Division of the Ledger, three ledgers are being maintained. The two subsidiary ledgers are:

47. Sales Ledger containing the individual accounts of the various debtors.

48. Purchase Ledger containing the accounts of the individual creditors.

And a Nominal Ledger (General Ledger) containing the accounts for assets, liabilities, income, capital and expenses. No personal names are being used as accounts in this ledger.

8.1.1 Sales Ledger Control Account

All transactions concerning the accounts of the debtors will be updated individually in the sales ledger (one account for each customer). At the same time, the double entry posting will be made in the nominal ledger, the totals involving debtors being posted to the Sales Ledger Control Account (SLC A/C). This can be summarised below.

Transaction Daybook Sales Ledger

Nominal Ledger

Sales Invoice Sales Daybook Debit Debit SLC A/CCredit Sales

Credit Notes Issued Returns in Daybook Credit DR. Returns in CR. SLC A/C

Receipts(Payments by Debtors)

Bank Receipts Book Credit DR BankCR. SLC A/C

Discount Allowed General Journal Credit DR. Discount AllowedCR. SLC A/C

Dishonoured Cheque General Journal Debit DR. SLC A/CCR. Bank

Bad Debts Written off General Journal Credit DR. Bad Debts CR SLC A/C

Interest Overdue A/Cs General Journal Debit DR. SLC A/CCR. Interest Recd.

8.1.2 Purchase Ledger Control Account

For this system, all transactions involving the creditors will be updated to the individual accounts kept in the Purchase Ledger. At the same time, the double entry records will be updated in the nominal ledger whereby the total affecting the creditors will be posted to the Purchase Ledger Control Account (PLC A/C). This can be summarized as follows.

Transaction Daybook Purchase Ledger Nominal LedgerPurchase Invoice Purchase

DaybookCredit DR. Expenses

CR. LC A/CCredit Notes Received / Debit Note Issued

Returns Out Daybook

Debit DR. PLC A/CCR. Returns Out

Payment to Creditor Bank Payments Daybook

Debit DR. PLC A/CCR. Bank

Discount Received General Journal Debit DR PLC A/CCR. Discount Recd


8.1.3 Account Balances

The sales ledger control account and the purchase ledger control account, normally will have a Debit and Credit balances respectively. In certain systems, we also show at the same time a credit balance in the sales ledger control account and a debit balance in the Purchase Ledger Control Account. The purpose of these abnormal balances is to reflect outstanding deduction from the balances due to - Returns Inwards and Return Outwards. As settlement have not been made, it is more effective to show these balances as a separate figure.

In cases where the Control Accounts do not agree to the total of the subsidiary ledger, the following actions are recommended.

49. Check additions in Daybooks, Ledger Accounts, control accounts, and/or listing of debtors/creditors.

50. Check posting from Daybook to ledger accounts, as well as total amounts posted to Control Accounts.

8.2 Advantages of Control Accounts

With this system in operation, errors are more likely to be spotted as more than one person will be entering data. This will also be a deterrent against fraud (since collusion is needed to commit this crime). Apart from having a shorter trial balance, the use of control accounts will result in savings in time and effort for correcting any errors.

8.3 Fully Worked Example

Prepare the Sales Ledger Control Account and the Purchase Ledger Control Account at 31/12/92 from the following information.

Purchase ledger credit balances 01/01/92 $ 10872Sales ledger debit balances 01/01/92 $ 11345Credit sales for 1992 $ 123400Credit purchases for 1992 $ 65986Returns Inwards for 1992 $ 4854Returns Outwards for 1992 $ 2834Discounts received in 1992 $ 2103Discounts allowed in 1992 $ 1563Payment received from debtors in 1992 $ 105503Payments to creditors in 1992 $ 58378

Steps in writing up the control accounts:

51. The Sales Ledger Control and Purchase Ledger Control accounts opening balances must be entered first.

52. Any increases in the Sales Ledger Control account will be debits and decreases will be credits. The opposite situation will apply to the Purchase Ledger Control account.

53. Enter any abnormal balances in the control accounts, from the figures given. Then total both sides to identify the year end balances.


Sales Ledger Control AccountDate Details Folio DR CR

01/01/92 Balance at this date 11,34521/12/92 Credit sales 123,400

Returns Inwards 4854Discounts Allowed 1563Payments Received 105503

134,745 111,92001/01/93 Balance at this date

Purchase Ledger control AccountDate Details Folio DR CR

01/01/92 Balance at this date 10,87231/12/92 Credit purchases 65,986

Returns Outwards 2,834Discounts Received Payments to Creditors

2,103

58,37863,315 76,858

Balance at this date 13,54301/01/93

8.4 Suspense Account

A suspense account is a ledger account set up in nominal ledger to insert the amount of difference in a Trial Balance totals. A trial balance can go out of balance due to :

incorrect addition (casting errors)

entering an item on one side of the books without a corresponding entry on the other side

there could also be an insertion of incorrect figures on either side of the accounts

The suspense account is a temporary account set up to balance the trial balance. Then all the errors identified should be cleared via the suspense account. Errors identified must be entered into the books via journal entries. These journal entries would then be posted to the relevant ledger accounts. It should be noted that suspense account must be cleared - i.e. zero balance - before final accounts are prepared.

The following steps should be followed in this procedure:

54. If a trial balance total disagree, insert the difference in the lesser side to balance the total. This "difference" will be the opening balance in the suspense account.

55. Locate the errors and enter into the journal.

56. Post the journal entries to the relevant ledger accounts (including the suspense account where necessary).

57. If there is no balance in the Suspense Account, then it is presumed that all errors are discovered and you can proceed to prepare final accounts.

58.

8.4.1 Suspense Account - a Fully Worked Example (NCC 1/91 - Q3)

A firm has extracted a Trial Balance which does not agree, the Debit total is $97,540 and the credit total is $98,320.59.


60. 1. Create a suspense account for the difference at 31st March 1991.

2. During the next few weeks, the following errors were discovered:

vii) A Cheque for motor expenses of $410 had not been entered in the motor expenses account.

viii) The total of the Returns Out daybook $120 had not been posted to the nominal ledger.

ix) A cheque received from T. Woo for $85 had not been recorded in the cash book.

x) The discount received of $305 from Creditors had not been recorded in the creditors accounts.

xi) A payment to R. Nail for $210 had been recorded in their account as $120.

xii) The petty cash float had been restored by transferring $10 but this has not been recorded in the Petty Cash Account.

Enter the above in the suspense account and balance it off at the end of the months.61.62. 1. Identify the difference in the total of the trial balance in order to set up the 63. suspense account.

64.

65. DR CR

66. Trial Balance 97540 98320

67. Suspense Account 780 _____68. 98320 98320

Therefore the Suspense Account will start off with a debit balance of $780.69.

70. 2. All the errors identified must be entered into the books via journal entries.

71. 3. Finally the journal entries will be posted to the ledger accounts. The 72. suspense account will be:

73.

Suspense A/CDate Details Folio DR CR

Trial Balance 780Motor Expenses 410Returns Out 120Bank 85Creditors 305R.Nails 90Petty Cash 10

900 900

JournalDate Details Folio DR CR

i Motor Expenses 410Suspense A/C 410

ii Suspense S/C 120Returns Out 120


iii Bank 85Suspense A/C 85

iv Creditors 305Suspense A/C 305

v R.Nail 90Suspense A/C 90

vi Petty Cash 10Suspense A/C 10

8.5 Exercises74.75. 1. A firm has the following details in its accounts at 30 September 1990. Prepare the 76. sales ledger control account and the purchase ledger control account. The balance in 77. the sales ledger at 1st September was $1200 and in the purchases ledger was $3,450.

Credit purchases from suppliers $ 21345Credit sales to customers $ 28900Cash paid to creditors $ 13480Receipts from trade debtors $ 21010Discounts received $ 1100Discounts allowed $ 825Purchases returns $ 3100Sales returns $ 980Bad debts written off $ 310

78.79. 2. a) Prepare from the following list of balances, a Sales Ledger Control Account for 80. the year ended 30/9/91.

Returns Inwards $ 451Returns Outwards $ 1088Discount Allowed $ 11090Credit Sales $ 231355Cash from debtors $ 214567Discounts received $ 13750Bad Debts Written off $ 5177Sales Ledger Debit balances 1/10/90 $ 24134

b) List four actions which an accountant might take in order to find the error(s) if,in a manual accounting system, a Sales Ledger Control Account does not balance.


3 a) A firm has obtained the following data from its records. You are required to draw up the Sales Ledger and Purchases Ledger Control Accounts:

Opening balance : Debtors $ 10450Opening balance : Creditors $ 7346Cash Sales $ 804Cheque Received $ 34892Cheque Paid $ 29428Discount Received $ 1440Discount Allowed $ 2862Bad Debts Written Off $ 925Increase in Provision for bad debts $ 704Credit Notes Issued $ 1105Debit Notes Issued $ 1207Sales Invoices $ 36858Purchase Invoices $ 32324Purchase IncorrectlyRecorded as a sale $ 1549

b) Explain why control accounts are used in Manual Accounting Systems.

4 A firm has extracted a Trial Balance which does not agree. The debit side is $64,230 and the credit side is $65,650. Create a suspense account for the difference, allowing for the errors listed below, which were discovered during the next few weeks.

i) Sales worth $755 have not been entered in the debtors accounts.

ii) The balance for H. Lau, a creditor, has been recorded as $185 instead of $158.

iii) A cheque received for $780 has not yet been entered in the Bank Account.

iv) The owner took drawings $142 from stock which has not been entered in the stock account.

5 The debit side of a trial balance exceeded the credit side by $860 and after checking the accounts the following discrepancies were found:

v) A debit balance of $950 on the rent account had been omitted.

vi) An invoice for $96 in the sales daybook was entered in the Debtors' Account as $69.

vii) A bill for $150 had been credited to the electricity account instead of debited.

viii) A purchase invoice for $230 has been posted to J.J. Tall's account instead of A.A. Small's.

ix) The sales daybook had been incorrectly totalled and $11476 entered to the sales account instead of $12613.

x) A credit balance of $627 on the Interest Received Account had been omitted.

xi) The wages account had been overcast (the total was overstated) by $373.


81.82. 6 A business extracted a trial balance at the end of the financial year. Because of an 83. imbalance, a suspense account had to be created. After various investigations the following errors were discovered:

xii) The sales daybook total had been entered in the sales account as $152,700 instead of $157,200.

xiii) The motor expenses account, totalling $2,100 had been omitted from the trial balance.

xiv) A purchase invoice for $635 had been wrongly entered on to the debit side of the individual creditor's account.

xv) A credit balance of $657 on the sales ledger account had been omitted when calculating the debtors figure.

xvi) An item in the cash book, wages $5,700, had been incorrectly entered in the wages account as $7,500.

Enter the above transactions to clear the suspense account, showing clearly the original trial balance difference.

oo)

CHAPTER 9: COST ACCOUNTING

Chapter Objectives


classification of costs;

operating statement.

Introduction

In the previous chapters we have seen how financial transactions are recorded in their respective books and how they are eventually transformed into useful information.

With financial accounting the firm would have a more systematic control to ensure the healthy operation of a company. It provides a good record of the company's past undertakings.

But to be a viable company it is not enough to exercise care by recording the company's undertakings. Planning is equally important to assist management in deciding what is better and how to deal well with the company's future.

This explains the need to understand this chapter : Costing and Management Accounting.

To appreciate the topics on Costing and Management Accounting, it is necessary for students to establish a clear understanding of the various types of cost before proceeding to appreciate how costing assists management for the future.

9.1 Classification of Cost

Costing and management accounting as its name implies concerns costs and its impact on management of costs.

To begin with, it is important to understand the various classification of costs.

9.1.1 Variable Costs

This cost relates in direct proportion to the per unit of output generated. This implies that if a company does not produce any output there will not be any variable costs incurred. The variable costs would increase in accordance to the increase in quantities of output.

Examples of variable cost are Direct Materials, Direct Labour and Direct Expenses.

Direct Materials cost are materials cost incurred to produce each unit of output. Cost of factory worker whose wages depend on the number of outputs produced contribute the direct labour costs. Direct Expenses refer to cost incurred such as royalties.

CS152 CHAPTER 9: COST ACCOUNTING

9.1.2 Fixed Cost

It is the name given to various expenses incurred in the cost of manufacture and other functions. It is also known as fixed overheads. Such costs would remain consistent regardless of the number of output generated. It may still incur when there is zero output.

Since it does not vary directly to the output it is also identified as indirect costs. Examples of fixed costs are supervisor's salaries and rent.

9.1.3 Total Cost

This cost comprises of total variable costs and total fixed costs. It determines the overall cost incurred to produce a certain quantity of outputs.

Total Costs = Total Variable Costs + Total Fixed Costs

9.2 The Operating Statement

An operating statement displays the profit earned by the organization after detailing its revenue and costs.

Table 9-1 : Operating Statement

$ $Revenue 100,000

Direct Materials Cost 25,500Direct Labour Cost 12,500Direct Expenses 2,000

Prime Cost 4,000

Factory Costs:Indirect Labour 3,000Indirect Materials 2,500Depreciation of Machinery 1,500Lighting and Heating 1,750Rent and Rates 2,250

11,000Total Manufacturing Costs 51,000

Administration Costs:Wages and Salaries 10,000Rent and Rates 2,000Lighting and Heating 250Depreciation Equipment 1,250

13,500

Sales and Distribution Costs:Salesmen Salaries 5,000Advertising 1,500Depreciation: Shoe Fittings 2,750Depreciation: Delivery Van 750

10,000

CS152 CHAPTER 9: COST ACCOUNTING

Finance Costs:Audit Fees 3,000Bank Interest 4,500

7,500Total Cost 82,000Profit 18,000

In table 9-1, the profit figure of $18000 is obtained from the difference of revenue and total costs. To facilitate the students' understanding on operating statement, the following equations would be useful.

Profit = Revenue - Total Costs

Total Costs = Manufacturing Costs + Administration Costs+ Sales and Distribution Costs + Finance Costs

Manufacturing Costs = Prime Cost + Factory Costs

Prime Costs = Direct Material Cost + Direct Labour Cost+ Direct Expenses

Factory Costs = Indirect Labour + Indirect Materials+ Depreciation of Machinery + Lighting and Heating + Rent and Rates (all indirect costs relating to Factory)

Further explanation on some terms:

Administration Costs

- These costs concerns the cost incurred due to administrative activities (usually called the office).

Sales and Distribution Cost

- These costs has incurred as a result of sales and distribution activities (the cost of money).

Finance Cost

- These costs has incurred as a result of financing the business.

In summary, unlike the profit and loss statement in financial accounting, operating statement could be expanded to reflect a detailed analysis on the profit generated by each product. It provides a detailed breakdown on the different types of costs and revenue incurred that contributed to the profit of a product.

CHAPTER 10: COST OF RAW MATERIALS

Chapter Objectives


cost calculation for raw materials;

inventory control;

formula for calculating stock levels.

Introduction

In the previous chapter we have seen an example of an operating statement which illustrates the breakdown of cost and revenue items. In this chapter students will be taught on how to perform job costing. This chapter will start off to illustrate the three basic methods on the costing of raw materials or stock taken for sale/used in production.

10.1 Cost Calculation for Raw Material

To determine the cost of raw materials of a product may not be as simple as it appears in the equation of cost = quantity x unit price. To ensure continuity in production and that sales are not lost because of lack of finished goods, many firms would prefer to store sufficient stocks of raw materials. New stock of raw materials may be purchased at a price and then issued to the production factory at a different price. The variation in purchase and issue price may be due to inflation, natural phenomena and other factors. As such, monitoring on the cost of raw materials becomes an important task to ensure proper control. Three methods have been developed to record the purchase and issue status of raw materials. The three methods are

First In First Out (FIFO),

Last In First Out (LIFO) and

Average Cost (AVCO).

To illustrate how the cost of raw material are determined under the above methods, the following information and a stock record card are used;

Table 10-1 : List of transactions

Date Receipt (Units) Per Unit Cost Issues (Units)January 10 $2.00February 8March 20 $4.00April 14May 30 $6.00June 10

CS152 CHAPTER 10: COST OF RAW MATERIALS

10.1.1 FIFO : First In First Out

This method states that the oldest stock of raw materials to be received should be the first to be issued.

Table 10-2 : Stock Record Card : FIFO Method

Receipts Issues BalanceDate Units Per Unit Total Units Per Unit Total Units Per Unit TotalJan 10 2 20 10 2 20Feb 2 2 4Mar 20 4 80 2 2 4

20 4 8022 84

Apr 2 2 412 4 48 8 4 32

May 30 6 180 8 4 3230 6 18038 212

June 8 4 322 6 12 28 6 16832 112

With reference to Table 10-2:

Jan 10 units @ $12 are received and this contributed to the total starting available balance of 10 units @ $2 = $20

Feb 8 units need to be issued to the production factory. The issued price for the 8 units charged to the production factory according to FIFO method would be the price of the earliest available stock (Jan price). Henceforth, in Feb, 8 units are issued at $2 each. After its issue of 8 units, the available stock balance would be left with 2 units at $2 each.

March 20 more units are received at $4 each and that contributes to the available stock balance of : 2 units @ $2 and 20 units @ $4 Total = 22 units. Remember : the first stock received would be shown first in the balance like old stock new stock

April 14 units need to be issued. Since there are 2 units left from Jan and it is an earlier stock before those of March. 2 units will first be issued at $2 each, followed by the remaining required 12 units from March stock at $4 each. This would leave the available balance of 8 units at $4 each.

May 30 more units at $6 each is received. This resulted in the available balance of 8 units @ $4 (March) and 30 units @ $6 (May)

June 10 units need to be issued. Since the earlier stock balance comes from March the 8 units at $4 will be issued first followed by the two more units required obtained from May receipts.

With the stock record card, the cost accountant could extract a few important results. Firstly, the total cost of $112 in the issue column reflects the cost of sales for the stock or raw materials. Secondly, the balance column will reflect to the cost accountant that they are left with 28 units of closing stock at $6 each. Thirdly, the gross profit could be derived given the cost of sales, and if selling price per unit are given, say at $10 each, the gross profit would then be:

Sales (32 units @ $10) = $320Less cost of sales = $112Gross profit = $208


10.1.2 LIFO : Last In First Out

This method is just the opposite to FIFO as it states that the newest stock to the received should be the first to be issued.

Table 10-3 : Stock Record Card : LIFO Method

Receipts Issues BalanceDate Units Per Unit Total Units Per Unit Total Units Per Unit TotalJan 10 2 20 10 2 20Feb 8 2 16 2 2 4Mar 20 4 80 2 2 4

20 4 8022 84

Apr 14 4 56 2 2 46 4 248 282 2 4

May 30 6 180 6 4 2430 6 18038 208

June 10 6 60 2 2 26 4 1246820 6 12028 148

32 132

As in this example, until March there is no difference for FIFO and LIFO methods. But the difference between the 2 methods should be closely observed from April to June.

April 14 units need to be issued. Since the newest available stock balance is March with 20 units @ $4, 14 units will be issued at $4 each. This would leave the available stock balance in April with: 2 units @ $2 (Jan) and 6 units @ $4 (March)

June 10 units need to be issued. Since the newest available stock is May with 30 units at $6 each, 10 units will be issued from the 30 units at $6 each. This would leave the available stock balance in June with:2 units @ $2 (Jan), 6 units @ $4 (Mar) and 10 units @ $6 (May)

Similar to the FIFO method, the cost accountant could derive the gross profit at a selling price of $10 each:

Sales (32 units @ $10) = $320Less Cost of Sales = $132Gross Profit = $188


10.1.3 AVCO : Average Cost Methods

This method finds the average cost of goods received and applies this price to the materials issued. Whenever new stock is received, a revised unit price will be calculated and use for subsequent issues until new stock is received. The process then continues.

Table 10-4 : Stock Record Card - AVCO Method

Receipts Issues BalanceDate Units Per Unit Total Units Per Unit Total Units Per Unit TotalJan 10 2 20 10 2 20Feb 8 2 16 2 2 4Mar 20 4 80 22 3.82 84.04Apr 14 3.82 53.48 8 3.82 30.56May 30 6 180 38 5.54 210.52June 10 5.54 55.40 28 5.54 155.12

32 124.88

Note: Preference is for unit price to use a maximum of two-decimal points (for currency).

Using this method the Gross Profit would be:

Sales (32 units @ $10) $320.00Less Cost of Sales $124.88Gross Profit $195.12

As observed the three methods of valuation gave three different gross profit figures. This explains why it is important to observe the consistency convention - that is the valuation methods should not change from year to year.

10.1.4 Two Types of Inventory System

The stock valuation methods using the stock record card is known as the perpetual inventory system. This system states that whenever there is a movement in stock, the cost of receipts, issues and balances must be identified.

The periodic inventory system states that at the end of each period, the total receipts and total issues are then identified and the stock balances are then calculated.

From the previous examples, the cost of goods sold would be calculated as follows:

FIFO Method

10 units @$2 = $ 20.0020 units @$4 = 80.00 2 units @$6 = 12.0032 = $112.00


CIFO Method30 units @$6 = $180.00 2 units @$4 = 8.0032 = $188.00

AVCO Method

AVCO of Goods received = = 4.67 per unit

Cost of Goods Sold : 32 units @$4.67 = $149.44

Table 10-5

Method FIFO LIFO AVCOSales $320 320 320.00Cost of Sales 112 188 149.44Gross Profit $208 132 170.56

10.1.5 Some Situation for Using Each Method

FIFO will be used when prices are falling and the firm wants to avoid potential losses through over-pricing later. This method is also used where products have a limited shelf life, e.g. perishable products like vegetables etc.

LIFO is used if the cost figures are to reflect current material prices. When prices are rising, this method will result in older stocks remaining at the lower prices. However, this method can easily respond to changing market prices.

AVCO - this is an intermediate figure between LIFO and FIFO. It is normally used when prices fluctuate between highs and lows. This method is suitable for stocks in bulk storage like liquids, furniture etc.

10.2 Inventory Control

The three valuation methods covered above have illustrated the recording process on the receipts and issue of goods. Such recording process is an important means to effective stock control. But this is not at all about materials. Another aspect is the quantities which should be ordered and kept in stock. Inventory control would be the techniques used to calculate the stock levels to ensure that stocks are kept at an economic level.

To determine the most economic levels of stock, the following formulae will be used. The formula involves some terms and it is necessary to understand the meaning of the various terms.

Definition of terms :

Lead Time This is the time period that elapses between the placing of order and receiving of goods.

Minimum Stock


It is also known as buffer stock. It refers to the amount of stock that will be needed to satisfy demand while waiting for delivery of stock during lead time.

Maximum Stock

The highest level of stock required for each item.

Re-order Quantity

The quantity of stock further orders should be placed.

Economic Order Quantity

The quantity to be ordered each time that provides best saving after considering balances between costs of keeping and ordering.

Re-order Level

The level of stock that determines a further order should be placed.

10.3 Formula for Calculating Stock Levels

10.3.1 Reorder level

Reorder Level = Maximum Usage X Maximum Lead Time

For example, if a company has a daily maximum usage of 25 units and it takes 10 days maximum lead time then the re-order level would be

25 units x 10 days = 250 units

This implied that if stock falls as low as 250 units, a further order should be made.

10.3.2 Minimum level

Minimum Level = Reorder Level - Average usage x average lead time

For example, if on a daily average, 20 units are used and it takes a lead time of 6 - 10 days, then the minimum level would be

250 units - (20 units x 6+10 days) = 90 units2

This implies that stock should be kept at a minimum of 90 units and not less.

10.3.3 Economic Order Quantity


2 x Order x annual demandCarrying cost per item per annum

For example, if it requires an ordering cost of $5 per order, carrying cost is 10% each unit of stock, cost per unit is $100 and daily average usage is 20 units then the EOQ would be :

2 x 2 x (20 x 365)10% x $100

= 86 units

This implied that a company has the best saving with 86 units ordered each time.

10.3.4 Maximum Level

Maximum level = Reorder level + EOQ - Minimum usage x Minimum lead time

For example, with the data as obtained above where Reorder level = 250 units, EOQ = 86 units and if minimum usage is 10 units per day with a lead time of 6 - 10 days, then the maximum level of stock would be

250 + 86 - (10 x 6) = 276 units

This implies that the company should not hold more than 276 units of stock.

10.3.5 Reorder Quantity

Reorder Quantity = Maximum stock - (Reorder-Level- Minimum usage in minimum lead time)

Besides EOQ this is another method to determine the quantity of stock to order. However, the company must first decide what is the maximum stock level it should be. For example, if the company has decided that its maximum stock is 280 units, reorder level as calculated is 250 units, minimum usage is 10 units per day with lead time of 6 - 10 days, then reorder quantity is

280 - (250 - (10 x 6)) = 90 units

10.3.6 Average Stock

Average stock = Minimum level + 1/2 reorder quantity

This formula determines the average quantity in stock on lead times. For example, if the minimum level is 50 units and reorder quantity as calculated is 90 units, then the average stock is 50 + 1/2(90) = 95 units.

10.4 Exercises84.

85. 1. Identify whether the following costs are variable, semi-variable or fixed costs.

pp) wages for machine operators


qq) carriage cost for raw material

rr) foremen's wages

ss) cost of raw materials

tt) royalties f

uu) storekeeper's wages in factory

vv) depreciation on production machinery

2. The stock card for a certain item of stock showed a balance at 31st December 1991 of 86. 100 units at $0.50 per unit.

Purchases for the month of January 1992:

January 8 : 30 units at $0.60 per unitJanuary 18 : 90 units at $0.70 per unit

Sales for the month of January 1992:

January 10 : 10 unitsJanuary 20 : 70 unitsJanuary 30 : 60 units

Show these entries on stock card (including values) under the FIFO, LIFO and AVCO methods. Also calculate the gross profit if the sales price is $4.00 per unit under all the three methods.

3. From the following data calculate the cost of raw materials issued using 87. Perpetual/Periodic style under

xvii) the FIFO method

xviii) the LIFO method

xix) the Average Cost methods

Month Receipts Month Issues (Units)Jan 20@ 10.00 March 10Feb 10@ 10.50 April 10May 8@ 11.00 June 13July 20@ 12.00

The goods were later on sold for $25 per unit. Calculate the gross profit under the three methods separately.


4. Calculate REORDER LEVEL, MINIMUM and MAXIMUM LEVEL based on the allowing information:

Average usage 4000 units per weekMinimum Usage 3200 units per weekMaximum usage 5200 units per weekLead Time 10 - 14 units per weekEOQ 40000 units

88. 5. Calculate the following information using the formulae:

ww)Reorder level

xx) Reorder Quantity

yy) Minimum Level

zz) Average stock held

aaa) Maximum stock level 18000 units

Expected consumption per month Max 400 units

Min 160 units

Estimated delivery time Max 6 months

Min 2 months

89. 6. Tomboy Enterprises has recently finished a job and the following data has been collected for the respective job. Calculate the prime costs.

Direct Materials $25.00

Direct LabourAssembly 4 hoursFinishing 2 hoursPacking 2 hours

Machine Hours Finishing 3 hours

xx) The rate of payment of direct labour are:

Assembly $3.00 per hourFinishing $4.00 per hour

Packing $5.00 per hour

7. Waveline Computer System (Pte) Ltd has the following costs :

90.

91. Analyst Programmers wages are $10.50 per hour, Overhead $4.00 per computer hour. Recently a job for a company was done and it involved the following costs/times : diskettes $2.00, Photocopying and Stationary $4.50, Programming and computer hours 5 and 4 respectively.

Calculate the cost of the job and work out a selling price assuming that the firm has a 30% markup for profitability.


8. Draw up an operating statement from the following information:

92.

Revenue 500000Purchases 30000Returns outwards 200Carriage 100Royalties 1200

Depreciation : Plant and Machinery 4000Office Equipment 2000Delivery Vans 3000Shop Fittings 1500

Finance Costs :Audit Fees 10000Bank Interest 5000Advertising 6000

Labour Costs :Production wages 40000Foreman's Wages 13000Office Salaries 28000Salesman Salaries 14000

Lighting and Heating :Factory 5000Offices 3000Shop 2000

Rent and Rates :Factory 7000Offices 200093. Shop 1000


94. 9. Draw up an Operating Statement from the following budgeted figures:

xxi) Revenue400000Materials :

Direct Materials 50000Carriage inwards 1200Carriage outwards 1500Indirect Materials 2000

Wages and Salaries :Direct labour 45000Factory supervisor 25000Foreman 10000Office staff 12000Sales force 10000Patents 13000

Lighting and Heating :Office 4000Shop 1000

Others Insurance for shop 1500Loan interest 3000

CHAPTER 11: JOB COSTING - AN ABSORPTION APPROACH

Chapter Objectives


direct labour cost and overhead absorption rate;

job cost card.

Introduction

In the previous chapter, students should have established sufficient understanding on using the three methods to determine the cost of material taken from stock.

To perform job costing, it is not sufficient to know the materials cost. There are other cost elements that must be taken into account.

This chapter will illustrate how to calculate direct labour cost and overheads absorption rate. It will conclude with an example of job costing.

11.1 The Cost of Direct Labour

Direct Labour cost is defined as the cost incurred and paid to workers directly involved in making a product.

This will involve recording the time taken by individual workers in producing the product.

To calculate direct labour cost, it involves multiplying the hours worked to the hourly wage rate paid to workers in that department.

For example, a manufacturing company has three departments involved in the production of an item: Assembly, finishing and packing.

The hourly wage rates paid for these departments are:

$/HourAssembly 50Finishing 20Packing 10

Recently, the company has just received an order for product A. To produce product A, it requires labour of 4 hours, 3 hours and 1 hour for assembly, finishing and packing respectively.

To calculate the cost of direct labour :

Product A

Assembly : 50 x 4 $200Finishing : 20 x 3 $ 60Packing : 10 x 1 $ 10 Total direct Labour Cost $270

11.2 The Cost of Overheads

CS152 CHAPTER 11: JOB COSTING - AN ABSORPTION APPROACH

Overheads is defined as the indirect and fixed expenses which cannot be attributed to any specific job. However, such cost should not be ignored in calculating the costs of a job since it is incurred as part of the total costs.

It is therefore necessary that the company develop some ways of "absorbing" the cost of overheads. One common approach is to absorb overhead costs on an hourly basis such as labour hours or machine hours.

The choice of the hours selected to absorb the overheads depends very much on the operational needs of the company. If the company is machine-oriented, absorbing overheads on machine hours would be an appropriate choice. Otherwise, labour hours would be selected instead.

It is not uncommon to see different departments involve in the completion of a job. Therefore, it is necessary to calculate what proportion of overheads needs to be absorbed by each department.

Before an example is used to illustrate overhead absorption, it is useful for students to follow closely the steps.

1. Determine the basis used for apportionment for each overheads.

2. Apportionment of overheads to the different departments.

3. Calculate the total overheads for each department.

4. Decide on the basis of absorption. (Labour hours or machine hours)

5. Calculate the Hourly Absorption Rate for each department.

An example:

A company estimates that it has the following overheads for the coming year.

Rent and Rates $10,000Lighting and Heating $ 5,000Foremen's Wages $20,000Depreciation $ 3,000Canteen Costs $ 1,500

Other information relating to the three sections are :

Assembly Finishing Packing TotalFloor Area (m2) 3,000 5,000 2,000 10,000Cost of Machine ($) 20,000 10,000 10,000 40,000Use of Machine (Hours) 5,000 3,000 2,000 10,000No. of Employees 10 6 4 20


11.2.1 Determining the Overhead Absorption Rate

Cost Step 1Basis Used

Step 2aAssembly

Step 2bFinishing

Step2cPacking

Total

Rent and rates Floor Area $3,000 $5,000 $2,000 $10,000Lighting and Heating

Floor Area 1,500 2,500 1,000 5,000

Foreman’s wages Employees 10,000 6,000 4,000 20,000Depreciation Cost of

machine1,500 750 750 3,000

Canteen costs Employees 750 450 300 1,500Step 3Total:

16,750 14,700 8,050 39,500

Step 4:Machine hours

5,000 3,000 2,000

Step 5:Hourly overhead absorption rate

$3.35 / hr $4.90 / hr $4.03 / hr

This means that Assembly will be charged $3.35/hr, finishing $4.90/hr and Packing $4.03/hr.

The charges will be in addition to materials cost and labour cost. Such charges are intended to recover the overheads in the 3 departments.

Explanation:

Step 1. Decide on the basis of apportionment for each cost.

Step 2a. To obtain $3,000 in Assembly Rent and Rates:

Basis : floor area for assembly = 3000m2 / 10000m2= 0.3

Rent and Rates cost = $10,000Hence, assembly would absorb = 0.3 x $10,000

= $3,000

Step 2b. To obtain $2,500 in finishing Lighting and Heating:

Basis : Floor area for finishing = 5000m2/10000m2= 0.5

Lighting and Heating Cost = $5,000Hence, finishing would absorb = 0.5 x $5,000

= $2,500

Step 2c. To obtain $4,000 in Packing foremen's wages:Basis : Employee for Packing = 4/20

= 0.2Foremen's Wages = $20,000Hence, Packing would absorb = 0.2 x $20,000

= $4,000


11.3 Job Costing

The total costs of a job could be calculated and recorded using a job cost card.

Example:

The following data concerning the job : JBOOT has been obtained:

Direct Materials : Assembly = $40Finishing = $40Packing = $32

= 112Direct Labour : Hourly Wage Rate :

Assembly = $50Finishing = $20Packing = $10

Labour Hours Worked : Assembly = 4Finishing = 3Packing = 1

Machine Hours used : Assembly = 4Finishing = 3Packing = 2

Hourly overhead Absorption Rate :Assembly = $3.35/hrFinishing = $4.90/hrPacking = $4.03/hr

Other costs :Selling and Distribution = $5.10Administration = $4.20

Profit mark-up required = $20


To calculate the total charges to customers, the following job cost card would be used.

Job Cost Card

Job number : JB007 Special features :Start Date: 30/6/xx Blue facie requiredCompletion Date: 30/7/xx

Customer Name and Address :Informatics Holdings Ltd

Materials Labour Cost Overheads Total

Hrs Rate Total Hrs Rate TotalAssembly 40 4 50 200 4 3.35 13.40Finishing 40 3 20 60 3 4.90 14.70Packing 32 1 10 10 2 4.03 8.06

112 270 36.15 418.16

Total costs of job = $418.16Selling and distribution = 5.10Administration cost = 4.20 Total 427.46Profit mark-up 20.00Amount chargeable 447.46

In the example, the total costs of the job would be calculated as $427.46. The total charges to customers would be $447.46.

In conclusion, with the job cost card and a clear understanding of the various costs, the total costs of the job could be determine and the total charges to customers could be calculated.

Such knowledge is deemed to be desirable to the management in ensuring that not only all costs are covered but also to ensure the company earns its desirable profit margin.

11.4 Exercises95. 1. Tanamara Pte Ltd would like to determine the total cost incurred for its direct labour. The following information is provided and it seeks your expertise to calculate its direct labour costs for the three products. What would be Tanamara's total direct labour costs incurred?

Department A : 20 workers @ $1.50/hourDepartment B : 15 workers @ $6.20/hourDepartment C : 5 workers @ $1.80/hour

Product A : Requires support from Department A and Department B.

: Utilizes 10 man-hours for department A and 20 man-hours for department B.

Product B : Uses 15 workers of Department A and 4 workers of Department C.

: Uses 15 man-hours for Department A and 2 man-hours for department C.

Product C : Requires support from department B and department C.

: Utilizes 15 man-hours each for department B and 12 man-hours each for department C.


96.97. 2. Kwee Lee estimates that they will have the following overheads for their TV 98. Plant at Singapore:

Rent and Rates $12,000Salaries 26,000Depreciation 12,000Insurance 4,000Maintenance 16,000Lighting 4,000Canteen Costs 6,000

$80,000

The plant has three departments and the chief executive would like to calculate an overhead absorption rate for each section:

Department Dept A$

Dept B$

Dept C$

Total

Floor area (sqm2) 10,000 10,000 5,000 25,000Cost of equipment 50,000 160,000 20,000 130,000Use of equipment(in terms of hours)

40,000 5,000 5,000 50,000

No. of employees:Supervisors 6 8 6 20Operators 10 50 30 90Labour hours:Direct 15,000 90,000 50,000 155,000Indirect 20,000 20,000 30,000 70,000

With the help of the supplied information to apportion costs between the different sections and then calculate the hourly absorption rate for each department separately.

99. 3. A production firm produces a wide range of products and it uses the job cost card to determine the costs of its products produced.

Currently, the firm plans to produce Job Number: 1234 and it seeks your expertise to calculate:

bbb) Cost of material used

ccc) Cost of Direct Labour

ddd) Overheads absorbed

eee) Total manufacturing cost

fff) Total Cost

ggg) Selling Price

To facilitate the understanding, you are required to present your answers using a job cost card.

Information available:

Materials used Hours Kg Department Labour OverheadsDongles $2/kg 10 10 A $4.20/hour $1.80/hour


Sprockets $5/kg 15 7 B $5.00/hour $2.10/hour

Other information:

- An additional 20% is added onto the manufacturing cost to cover the cost of overheads in Selling and Distribution, and the selling price is mark-up 30% on the total cost.

CHAPTER 12: MARGINAL COSTING: BREAK-EVEN ANALYSIS

Chapter Objectives


what is break-even?

other facts concerning break-even.

Introduction

In the earlier chapters students are given description on the behaviour of costs and how costs are classified.

Such knowledge is important in many aspects of costing and management. This chapter will illustrate to students one of the applications : Break-even Analysis.

12.1 What is Break-even?

Many organizations, before the launch of any new product would conduct market research to determine the market potential. One area of considerations is to determine the number of units they can expect to sell and to make any profit.

Break even analysis is the technique used to enable management to quickly determine the worthiness of launching the new product.

By break even, it refers to a situation whereby it requires management to be able to sell a minimum number of units to ensure that all costs are covered. Henceforth, avoiding making a loss inspite of no profit earned. The basic formula to determine the number of units required to ensure at least a no-gain no-loss situation is:

Break-even = = x units

Looking at the formula, students would observe that total fixed costs and unit contribution must be determined.

The term "unit contribution" simply means the unit selling price less the unit variable costs.

Example :

Suppose a manufacturing firm: Sure-Succeed plans to launch a product X which is estimated to sell at $20.00 each. The production of product X would cost the firm the following :

Direct Materials $2/unitDirect Labour $3/unitDirect Expenses $5/unitFixed Costs $20,000

As a consultant employed by the manufacturing firm, you are to advise the management on the following:

The number of units needed to break-even.

CS152 CHAPTER 12: MARGINAL COSTING: BREAK-EVEN ANALYSIS

The sales dollars required to break-even.

Using a break-even chart as an alternative to illustrate your answers.


To answer the question, the following information must be determined.

Fixed Costs = $20,000Variable Costs = $2 + $3 + $5 = $10/unitUnit Selling price = $20/unit

Break-even formula = Total fixed costUnit contribution

hhh) Break-even (units) = 20,000220 – 10

= 2,000 units

iii) Break-even ($) = 2,000 units x Selling price

= 2,000 x 20

= $40,000

c)

0 2000Variable cost 0 x $10 2000 x $10

=$0 = $20,000Unit : x

$ : y $0 + $20,000 $20,000 + $20,000Total cost = $20,000 = $40,000= Variable cost + fixed cost

Sales 0 x $20 2,000 x $20= $0 = $40,000

Given the x and y Coordinates:

SalesProfit

Break-even

40,000 LossesTotal Cost

(2,000 , 40,000)Fixed Cost

20,000(0 , 20,000) (2,000 , 20,000)

(0,0) Units2,000

Figure 12-1: Break-Even Chart


The break-even chart reflects an alternative method to calculate break-even. To break-even, total sales must equal total costs.

As illustrated in the above break-even chart, for the manufacturing firm to break-even for product X, it must sell at 2,000 units or to generate at least $40,000 of sales to ensure that total costs are covered. This is reflected by the intersecting point where the Sales meet the Total costs line.

12.1.1 What-if More than Break-even?

Very often than not, it is not too realistic for any organization to survive by only breaking-even.

On a longer term basis, profits are expected for owners or shareholders who invested their capital into the firm, they would expect a return on their capital invested.

Under such circumstances, it is no longer feasible for any firm to cover only their total costs. They would need to ensure that the expected profit are earned and their shareholders deserved their return on capital employed (ROCE).

With further expectation, break-even would take an additional role.

New Break-even Formula:

Units Required = Fixed Cost + Profit or Fixed Cost + ROCEUnit Contribution Unit Contribution

= x units

Example :

Supposing Sure-Succeed manufacturing firm, which produces product X, decides that it expects an estimated profit of $20,000. Cost and sales figures remain the same. Calculate the units required to be sold and the sales value.

jjj) Given: Profit expected = $20,000

Fixed Cost = $20,000

Unit Contribution = $20 - $10= $10

Units Required = 20,000 + 20,00010

= 4,000 units

b) Sales Value = 4000 x $20

= $80,000

In this example, it implies that the manufacturing firm needs to sell 4,000 units or generate $80,000 to cover the total costs to assure an estimated profit of $20,000 to the shareholders.


12.2 Other Facets of Break-even

Break-even could be used in another approach to determine the level of profit/loss sustained.

For instance, using the information given in example 1 and 2, Sure-Succeed manufacturing firm estimated that it could sell 5,500 units of Product X. However, it is concerned if this quantity of product X is going to be a lucrative business. How could this concern be addressed?

In the previous example, it was calculated that the break-even units was 2,000 units.

If Sure-Succeed sells 5,500 units of product X, this imply that Sure-Succeed has additional 3,500 units above its break-even. Any units above its break-even point imply profit earned but if the converse is true, a loss would be incurred.

In this case, the profit earned would be:

Sales : 5,500 unitsLess Break-even : 2,000 unitsMargin of safety 3,500 unitsUnit Contribution : $10Profit earned : $35,000

In this situation, it was identified that the firm would earn a profit of $35,000. The difference of 3,500 units between the sales level and break-even point is termed as the Margin of Safety.

Margin of Safety reflects how close the management is to break-even. The smaller the margin of safety, the firm will more likely be dangerously close to making a loss.

In conclusion, with a good understanding on break-even analysis, management would have a better control to avoid situation of making any loss and ensuring the potential of the new product before launching it in the market.


12.3 Exercises100.101.1. A leading computer firm in United Kingdom intends to produce a notebook for

102.marketing in Singapore. It estimates that the selling price per unit is S$4,000 and the variable cost is S$2,000 per unit, the firm is having a fixed cost of $1,600,000. From the information provided calculate the following:

kkk) The break-even point in terms of units.

lll) The break-even point in terms of dollars.

mmm) Draw a break-even chart/graph and indicate the break-even point, shade the area of profit and the area of loss clearly on the graph.

nnn) If the variable costs go up by 10% recalculate the new break-even point in terms of dollars and units. (Do not plot this one).

103.2. Alfa Technologies is considering whether to introduce a new product and it has estimated that the item will spend $25 on direct materials, $15 dollars on the direct labour and $40,000 of fixed costs. The firm wants to make a profit hence it sets its price at $60 but on conducting survey it reflected that it can sell only 1400 units.

ooo) Calculate the break-even point.

ppp) Would the firm be wise to sell at this price?

qqq) If the price were to be reduced to $50 what would be the new break-even point?

rrr) How many units need to be sold at the new price to make a profit of $10,000?

CHAPTER 13: MARGINAL COSTING: OPERATING STATEMENTS

Chapter Objectives


what is marginal costing?

marginal costing and decision makings.

Introduction

In the earlier chapter on Break-even Analysis, students are introduced the term "contribution".

Understanding contribution is important in another accounting technique called marginal costing for decision making.

13.1 What is Marginal Costing?

Marginal costing assumes that fixed costs remain constant regardless of the output. So the considerations for decision making lies with the marginal cost and sales.

13.2 Marginal Costing and Decision Makings

13.2.1 Decision on to Produce or not to Produce?

Sure-Succeed produces 3 products : X, Y and Z and their profit statements are as follow :

X ($) Y ($) Z ($) Total ($)Sales 10,000 20,000 30,000 60,000

Variable Costs

6,000 3,000 4,000 13,000

Fixed Costs

8,000 4,000 5,000 17,000

Total Costs 14,000 7,000 9,000 30,000Profit / (Loss)

(4,000) 13,000 21,000 30,000

Looking at the loss for X, the management expressed concern that perhaps the production for X should stop.

As a consultant, you are invited to advise the management should the firm continue producing X or stop producing X.

To answer the question, student must understand that marginal costing assumes that fixed cost remains constant regardless of the level of output. The decision on whether to continue producing X lies on the contribution.

Comparing the situation with and without X:

CS152 CHAPTER 13: MARGINAL COSTING: OPERATING STATEMENTS

Situation with Product X:

X ($) Y ($) Z ($) Total ($)Sales 100,000 20,000 30,000 60,000Variable Costs

6,000 3,000 4,000 13,000

Contribution 4,000 17,000 26,000 47,000Fixed costs 17,000Profit / (Loss)

30,000

Situation without Product X:

X ($) Y ($) Total ($)Sales 20,000 30,000 50,000Variable Costs 3,000 4,000 7,000Contribution 17,000 26,000 43,000Fixed costs 17,000Profit / (Loss) 26,000

Without product X, the firm has to forego the contribution of $4,000 from product X while total fixed cost remains at $17,000.

This leads to a lower profit figure of $26,000 without product X. The firm should thus be advised to continue producing X because it would earn a higher total profit of $30,000.

13.2.2 Decision Whether to Produce or to Buy from Supplier?

Sure-Succeed is currently producing 10000 units of product X but a supplier : Wholesale Pte Ltd offers to sell product X to Sure-Succeed at $0.95/unit.

The firm is considering this offer as it would mean that it does not need to spend time producing X. Once again, they approach you for your advice.

To answer this question, students need to compare the situation of producing X or buying X from the supplier.

Producing X Buying XSales $10,000 $10,000Variable Costs $6,000 $9,500Contribution $4,000 $500


In this example, since producing product X offers a higher contribution, it will be more advisable for Sure-Succeed to produce product X than to accept Wholesale Pte Ltd's offer.

13.2.3 Decision on Whether to Accept an Additional Contract

Sure-Succeed is currently producing 2000 units of product Y. The maximum utilization for product Y is 2500 units.

A customer, Abraham approached Sure-Succeed for a contract of 500 units of product Y and he is willing to pay Sure-Succeed at $8/unit.

Sure-Succeed would very much like to accept Abraham's offer but it is hesitant also because it is worried that it could not have the capacity to accept an additional 500 units. In addition, Sure-Succeed is also concerned about the lower selling price of $8/unit.

Once again, as an advisor, you are asked to advise the management whether Sure-Succeed should accept the additional contract.

To answer this question, a comparison of without the additional contract or with the additional contract has to be taken into consideration.

Without Contract With ContractSales 2,000 units 2,500 unitsVariable costs

$20,000 $2,400

Contribution

$3,000 $3,750

$17,000 $20,250

Working : (2000 units x $10) + (500 x $8) = $24000

By accepting the additional contract, Sure-Succeed would earn a much higher contribution. Even though, the selling price for the additional contract is only $8/unit, it does not incur any further increase in fixed cost since Sure-Succeed is producing within the 2500 units of maximum utilization. Moreover, the variable cost at $1.50/unit remains and this would result in additional contribution of $6.50/unit ($8 - $1.50).

Thus, it is advisable for Sure-Succeed to accept the additional contract.


13.3 Exercises104.105.1. Sure-Succeed was shocked to see that product A is making a loss and it 106. plans to drop the production for product A. As an advisor, you are to give 107. your advice to Sure-Succeed to determine whether product A should be 108. terminated.

Information Available

Product A $

Product B $

Product C $

Total $

Sales 120,000 140,000 160,000 420,000Variable Costs:Direct Materials

100,000 100,000 75,000 275,000

Direct Labour

10,000 10,000 25,000 45,000

Fixed Costs 15,000 14,000 30,000 59,000Profit / (Loss)

(5,000) 16,000 30,000 41,000

2. Tanamara Pte Ltd produces product X at $6.50 each. The current capacity 109.Tanamara is producing is 2000 units for Product X at a selling price of $7.00 each. On one occasion, Samurai Pte Ltd approached Tanamara and it offers to produce product X for Tanamara. The charges incurred would be $6.80 per unit. As an advisor, Tanamara approached you to determine whether it should accept Samurai's offer.

110.

CHAPTER 14: BUDGETS AND BUDGETARY CONTROL

Chapter Objectives

At the completion of this chapter, you would have learnt the concepts of :an example on budgeted profit and loss statement;

cash budget;

variance analysis.

Introduction

In the chapter on Break-even Analysis, it was known that the firm needs to estimate its costs and selling prices. Thus, it is not uncommon to see firms carrying out various exercises to predict its future costs and selling prices. Such exercises of predicting for future is known as budgeting.

Budgeting is usually done with reference to the previous years' figures and trend. A few of the common budgets prepared are budgeted profit/loss statement and cash budgets. It is important that managers co-ordinate with one another when preparing the budgets so as to ensure the interests of the overall organization.

An effective budget prepared is one that ensures control over expenditure and to indicate any evasive action that can be planned. One good application of budgetary control is the techniques known as variance analysis.

14.1 An Example on Budgeted Profit and Loss Statement

Imagine that the budgeting exercise has been carried out. Managers from the various department met and submitted their estimates for the coming year. The estimates are :

Sales DepartmentEstimated Sales Revenue $500,000Selling Overheads $30,000Production DepartmentEstimated purchase of raw materials

30% of sales revenue

Estimated direct labour 10% of sales revenueProduction overheads $10,000Admiration DepartmentPersonnel overheads $5,000General office expenses $2,000 Canteen costs $1,000Finance DepartmentFinance interest $1,000Audit fees $4,000Overheads and salaries $3,000

CS152 CHAPTER 14: BUDGETS AND BUDGETARY CONTROL

Consolidating all the departments' budgets, the following budgeted profit/loss statement was prepared :

Budgeted Profit & Loss Statement$ $ $

Sales Revenue 500,000

Direct Costs:Purchase of raw materials

150,000

Direct Labour 50,000Prime Costs 200,000

Overheads:Selling Overheads 30,000Production Overheads 10,000Personnel Overheads 5,000General Office Expenses 2,000Canteen Costs 1,000Finance Interests 1,000Audit Fees 4,000Finance Overhead and Salaries

3,000

56,000Total Costs 256,000

Estimated Net Profit 244,000

The example has clearly indicated that if the firm could keep its estimated sales and cost under control, it would generate an estimated net profit of $244,000. The reasons why companies prepare budgeted profit and loss statements can be summarized as:

to forecast expected income and expected expenditure

to forecast expected profit or loss

to allow the company to identify areas where savings could be made

to allow the company to compare actual results with the budget to identify and explain any deviations.

14.2 Cash Budget

One of the shortcoming of budgeted profit and loss statement is its inability to reflect the flow of cash into and out of the business. Such shortcoming is overcome with the cash budget.

Cash budget is another useful "tool" where it aids management in determining its cash flow status. It reflects any possible cash that may be received that may have been used to settle its cash payments. Any surplus or deficit would then be appropriately dealt with.


14.2.1 Cash Budget

Imagine the different departments have come together again to submit their estimates for the coming year.

The estimates are:

Sales Department:

This department states that sales for the coming year would be as follow:

Dec Jan Feb Mar Apr May Jun JulyUnits 200 200 300 300 300 400 400 400

All the units are sold for $10 each. 90% of sales are on credit whereby debtors pay one month after the month of sales. The remaining 10% are cash sales.

Purchases Department:

In order to fulfill the customers' orders, it is necessary for the department to purchase the following quantities of goods.

Dec Jan Feb Mar Apr May Jun JulyUnits 50 50 60 60 60 70 70 70

All units are purchased at $5 each. Purchases are on credit and creditors are paid one month after the purchase.

Other Departments:

In addition, the other departments also contributed their estimates for their overheads.111.

112.1. Wages will be $500 per month.

2. Overhead will be $100 per month.

3. Rent and Rates will be $150 per month for January to March and $200 per month subsequently.

4. A new equipment will be bought in the month of March costing $900. This will be paid for in 3 equal instalments in April, May and June.

5. Opening cash balance in January is $300.

113.


114.

Based on the estimates submitted by the various departments, prepare a cash budget for the period of January to June. Analysing your budget, determine what actions should the firm take if there is positive closing cash balance or if there is negative closing cash balance.

Cash Budget for January to JuneJan Feb Mar Apr May June

Cash Sales 300 300 300 300 400 400Debtors 1,800 1,800 2,700 2,700 2,700 3,600Total Cash Received

2,000 2,100 3,000 3,000 3,100 4,000

Purchases 250 250 300 300 300 350Wages 500 500 500 500 500 500Overheads 100 100 100 100 100 100Rents and Rates 150 150 150 200 200 200Purchase of newEquipment - - - 300 300 300Total Cost 1,000 1,000 1,050 1,400 1,400 1,450Surplus / (Deficit)

1,000 1,100 1,950 1,600 1,700 2,550

Opening Bal. 300 1,300 2,400 4,350 5,950 7,650Bal. C/F 1,300 2,400 4,350 5,950 7,650 10,200

In the above example, it was observed that the period from January to June have positive cash balance c/f. Also note that the closing cash balance would be the opening cash balance for the next accounting period.

For positive cash balance, the management may like to consider investing in short-term deposits. However, if the situation is conversed (negative cash balance), management may have to arrange for overdraft with the bank.

With cash budget, the firm is able to "receive" prior warnings of any cash flow problems or opportunities. Such warnings would allow the firm to have a considerable period to make arrangements to avert any crisis or to better utilize the cash balance.

14.3 Variance Analysis

With the budgets prepared, the firm can check whether the managers of different departments performed as expected by comparing the budget figures with the actual results. This practice involves variance analysis.

Whenever managers do not perform according to budget, they would be asked to explain the reasons for the variances.

Therefore, variance analysis is a useful budgetary control technique used to evaluate a firm's efficiency.

To perform variance analysis, a flexible budget has to be prepared. This is a budget adjusted to the actual level of sales. Flexible budget shows what the budgeted figures would have been at the actual level of sales.


14.3.1 An Example on Variance Analysis

Budgeted (10,000 units)

Actual (11,000 units)

Sales Revenue $500,000 $510,000Direct Costs:Purchases (Raw Materials)

15,000 16,000

Direct Labour 50,000 51,000

Overheads:Selling Overheads 30,000 32,000Production Overheads 10,000 10,000Personnel Overheads 5,000 5,000General Office Expenses 2,000 2,000Canteen Costs 1,000 1,000Finance Interests 1,000 1,200Audit Fees 4,000 4,000Finance Overheads and Salaries

3,000 3,000

Profit $244,000 $384,800

The above budgeted profit and loss statement was extracted from the previous section : An example on Budgeted Profit and Loss Statement. At the end of the year, the firm would measure its performance by comparing budget to actual results.

However, an invalid comparison would have happened if the above budget is not adjusted for the actual level of sales. There is a need for a like-to-like comparison and this indicates a need to prepare the flexible budget.

The following is an illustration of how the figures can be compared using the flexible budget and actual results. Take note that the last column shows the variance amount with comments in brackets as "A" or "F". "F" stands for a favourable variance and "A" stands for adverse.


14.3.2 An Example on Budgetary Control Worked Example

Budgeted(10,000 units)

Unit

Cost

Flexible Budget

(11,000 units)

Actual Variance

Sales $500,000 $50 $550,000 $510,000

$40,000(A)

Direct Costs:Purchases 15,000 1.5 16,500 16,000 500(F)Direct Labour 50,000 5 55,000 51,000 4,000(F)

Overheads:Selling Overheads

30,000 30,000 32,000 2,000(A)

Production Overheads

10,000 10,000 10,000 -

Personnel Overheads

5,000 5,000 5,000 -

General Office Expenses

2,000 2,000 2,000 -

Canteen Costs 1,000 1,000 1,000 -Finance Interest 1,000 1,000 1,200 200(A)Audit Fees 4,000 4,000 4,000 -Finance Overheads and Salaries

3,000 3,000 3,000 -

Total Cost $121,000 $127,500 $125,200

$2,300(F)

Profit $379,000 $422,500 $384,800

$37,700(A)


Take note that overhead costs are fixed and hence they will not vary with the level of sales. As such, all the overhead figures remain consistent in flexible budget. However, purchases of raw materials and direct labour are variable costs. Therefore, they vary with the actual level of sales.

To perform variance analysis, statements must be clear that it is not always true that when actual results is greater than budgeted figure, it is deemed as favorable, students must identify that sales revenue and actual profits are earnings of the company. The variance will be termed as favourable when actual sales revenue and actual profits are greater than budgeted. This implies a situation whereby the firm earns more than what it expected.

On the other hand, for cost items, the variance will be identified as adverse if the actual costs are greater than budgeted. This implies a situation whereby the firm overspend than it is expected.

Referring to the above example actual sales revenue is less than its expected sales by $40,000. This indicates an adverse variance. On the other hand, the actual costs incurred for purchasing the raw materials is less than what is budgeted. This indicates a favourable variance as the firm spends lesser than it expected.

This is not all for variance analysis. Very often, the managers are required to explain any factors that lead to the variances.

Referring to the example again, some of the factors that may lead to the various variances are:

Sales Variance : Reduction in selling price

Materials Variance : Reduction in materials wastage

Labour Variance : Improvement in labour productivity

Selling Overheads Variance : Increase in salesman commission

Finance Interest Variance : Increase in interest rate

In summary, knowing the technique Variance Analysis would enable the management to be more efficient and effective in their planning and control.


14.4 Exercises115.116.1. A firm has come up with the following figures for their electronic components plant 117. at Singapore :

Units Budget Figures 20,000 Units

Actual Figures21,500 Units

Sales 80,000 82,775Direct Materials 10,000 11,825Direct Labour 25,000 23,650Direct Expenses 5,000 ,4945Fixed Costs 12,000 12,900Profit 28,000 29,455

118.

119.Flexible budget to be prepared at 21,500 units and state your reasons for the different variances.

120.

2. Kwee Lin Pte(s) has come up with the following figures for their diskette manufacturing division at Taiwan:

121.

Details Budget Figures4,000 Units

Actual Figures4,000 Units

Revenue 30,000 32,500Direct:Materials 10,450 10,000Labour 10,000 10,000Fixed Overheads 3,000 3,500

Net Profit 6,550 9,000122.

123.Simply calculate the different variances.

124.

125.3. You as the finance manager of a manufacturing firm is required to present a cash budget for your forthcoming performance review meeting of your firm for the period Jan to June.

sss) The opening balance of cash is $10,000.

ttt) Sales are 1000 units for the months starting from December up to July.

uuu) The selling price per product is $6.00.

vvv) Sales comprise of 75% as one month credit and 25% cash.

www) Direct Labour is paid $500 per month.

xxx) The firm buys goods from various suppliers as follows:

xxii) 500 units in November and December.

xxiii) 1,500 units for the remaining months, the purchase price is $2.00 per unit

and it is paid after 60 days.

yyy) The office rent is paid every month @$200.

zzz) The corporate taxes are paid quarterly in advance @$4,000 p.a.


aaaa) Office expenses of $200 are incurred every month.

4. Prepare a sales, purchase budget and cash budget for six months starting from Jan and ending June based on the information provided to you:

bbbb) Sales for the months of Dec to June shall be 1,000 units and each sold for $20. Debtors are given one month's credit.

cccc) Purchases are made one month before they are sold and each unit cost $2. Creditors are paid after two months. Purchases in November was 900 units.

dddd) Direct labour is paid $3 per unit purchased for converting the raw materials and paid in the same month they are used.

eeee) Other costs are Factory Overheads $700 per month, Office expenses $250 per month. Purchases of machinery $5,000 made in the month of February.

CHAPTER 15: COMPUTERIZED ACCOUNTING SYSTEMS

Chapter Objectives


how a computerized accounting system will create problems for the auditors;

what are the control procedures necessary for a computerized accounting system;

understand the needs for computerized accounting system;

understand the accounting cycle in both the manual and computerized system;

identify the 2 common types of computerized accounting system : Integrated vs stand-alone;

identify features to consider when selecting an accounting package;

understand the various accounting systems existing and used by the market;

understand how to use spreadsheets to handle accounting requirements;

understand by gaining hands-on experience on the various accounting packages : their menus, their functions and their printouts.

Introduction

In the previous sections, students have acquired sufficient knowledge on financial accounting and cost accounting. These topics are discussed more on the manual accounting systems. However, given the keen competition in today's world market, getting information faster than competitors becomes important. This would explain why there is now so much emphasis for computerized accounting systems.

15.1 Auditing Computerized Accounting Systems

When firms are using computerized systems, the role of the auditor is basically the same as that of a manual accounting system. The auditors have to report on the truth and fairness of the accounts. However, there are problems that the auditors need to overcome, especially when gathering audit evidence. Some of these problems are:

1. The loss of an audit trail - where the firm delete previous transactions in order to increase storage space.

2. Source documents are not sorted into any order or they may be filed haphazardly.

3. It would be difficult to check which employee entered a particular data, unlike in a manual system when we can recognize the handwriting.

4. Fraud can be easily committed since the computer may not query large transactions.

5. In order to carry out their task efficiently, the auditors need to acquire knowledge of computer operations and system analysis.

6. It would be difficult to view data as they are stored on disk.

15.2 Audit and Controls

CS152 CHAPTER 15: COMPUTER ACCOUNTING SYSTEMS

In view of the above, there are various solution available to the auditor. As auditing a computerized system will be different from a manual approach - the auditors will need to concentrate more on the systems rather than on documentation. For testing the systems, the auditors would use an audit test pack or computer assisted audit programs/technique. The computer can be used to perform some of the audit tests such as:

Dead tests

Whereby a sample data that had already being processed is re-checked and compare with original results.

Live Tests

A set of test data is created for processing and the results is compared to a model answer.

As for documentation, the auditors can verify input by checking the serial numbering of documents and validation checks. Auditors who have difficulty in auditing computerized systems may also obtained procedures from books bought off the shelf. These books are specially written for auditors. Finally, the main task is for the firm to practise computer controls - these fall into Administrative controls, system development controls, and procedural controls.

15.2.1 Administrative Controls

DP Manager

System Data Data Operators Libraryand Programming Conversion Control

System Analysts Programmers

Figure 15-1: An organization chart of a typical DP department

Refer to the organization chart for a typical DP Department which shows the clear division of duties in the department.

No one person should be responsible for a complete transaction. This should apply to system design and development especially at the operational level. This will reduce the chances of fraud and also act as a check on people's work.

Included in this area are operational controls. Only a few authorized personnel should have access to the system. This can be done through the use of passwords - which should be made difficult for other users to discover. It should be something that only the user can make sense of. Car registration numbers are poor choice of passwords as they can be easily discovered by other users and also should avoid names of wife, children etc.

An operations logbook should also be kept by the system. This logbook will record


the activities of the computer as well as the people who use the system.

Another example of such control will be cases where transfer of funds over a certain limit should require another password from a higher ranking manager.

File controls is another area that should be implemented. The file librarian should be a skilled and well trained person. There should be proper procedures for issuing and returning of data files as well as program files. There should be proper labelling and indexing for all files. The purpose of proper labelling is to minimize the risk of issuing certain files to unauthorized personnel by mistake.

Proper maintenance of files will also prevent unauthorized deletion/altering of data on files or to prevent any accidental erasures.

In addition there must be proper procedures set up for file reconstruction. The system should call for files back up frequently and dumping hard copies.Dumping ensures that information which is needed for audit trail purposes willnot be lost to overwriting (this is sometimes carried out due to lack of space).

Sometimes accounts have to be reconstructed if computer records are lost or damaged - so hard copies can be made available to ease the difficulty.

Hardware security is another administrative control procedure for computerized accounting system. The machines or equipment used by the system should be placed in a separate room where only authorized personnel can have access. This can also be reinforced by locking up the machines when not in operation.

A logbook should be kept for those who go into the terminal room for the day.

A maintenance contract should be drawn up to ensure that there is a constant servicing of the machines - to prevent any shutdowns.

15.2.2 System Development Controls

When developing accounting systems, there must be procedures designed to ensure that the system to be implemented will meet standards expected by the auditors. Whenever, possible and especially when buying a new computerized accounting system, the auditors should be consulted. The auditor's experience may help in such areas as special printouts, dumping procedures or maintaining the audit trail. It is easier to build in requirements at the design stage rather than later. Therefore, system development control procedures have to be followed.

First of all there must be standardization. Programs to be developed should be properly documented to acceptable standards. There should be division

of duties rather than one programmer writing out the whole suite of programmes.

The use of standards laid down by management would be the starting point in the process. Such standards would be proper documentation of the system being developed, including flow charts.

Programs should not allow single entry to be entered into the accounts. The process can proceed only until a double entry is made. The program would not allow any entries made previously to be erased.

At all stages of the development cycle management must be kept informed and their support solicited. The preparation of feasibility studies, the use of budget for capital and revenue expenditure should be properly authorized.


There should be regular evaluation of performance to ensure that each project is viable and cost effective.

There should be thorough testing of programs before the system becomes operational. This should include the use of "benchmark" to determine the optimum time taken by a program. These "benchmark" can later be used to check whether the programs have subsequently been tampered with.

Proper training should be provided for staff involved in this system to ensure that there is reduction in the risk of errors. This is important because if funds are transferred in error, it would be difficult to retrieve it back.

When the new system is ready to run, there should be a planned implementation programme. The new system should run concurrently with the old system so that results can be validated - this is known as parallel run. This should carry on for some time until it is absolutely certain that the new system can run correctly and efficiently.

15.2.3 Procedural Controls

The other area for controls to be carried out would be the processing cycle - these are known as procedural controls and will cover the day to day running of the system.

The first step would be the control of the input material which should be practiced both by the user department as well as the DP department. When sending documents for key punching (input to the computer) the user department should number serially all the documents to be transmitted.

There should be validation checks on the documents to ensure correct data are fed into the system.

When transmitting documents to the DP department there must be proper authorization to certify that the correct type of documents are sent.

It would also be necessary to record batch totals to ensure that all the documents will be sent for processing.

On receiving these input materials, the DP department should check the batches to ensure contents are complete. A register should be kept, showing when it was received and proper identification number allocated.

There must be proper scheduling of work to ensure all inputs are keyed in on time with procedures for checking data conversion.

During processing there are other control practice that should be carried out. Check digit verification would ensure the correct amounts are input.

Other checks would be made on the size of the field and/or record. Consistency checks, range tests on quantities or values should be practiced.

There should be feasibility test on quantities, cash totals for balances and control / record total checks.

Checking should be made on the files used such as header labels for identifying files, the use of trailer labels to ensure completeness of "read", control totals to check on "arithmetic proof" in master files.

In case of any unusual changes in values/totals, exception reports should be made out.

The next type of controls affects the output - which is implemented mainly


for user checks.

All hard copies should be vetted for completeness of output and despatch to relevant user department.

Controls do not end at this stage. Both hard copy (printouts) electronic materials (disks, diskettes and pages), and input documents need to be

stored away safely.

There must be an easy retrieval of all material in the future.

Storage controls begin with source documents such as payment vouchers and invoices etc. They should be retained and kept properly in a safe place.

If a computer disk is damaged, then these source documents can be used to recreate the files.

The working diskettes should be backed up constantly to prevent any loss of data and the back up copy should be kept in a safe place.

There should be improved library facilities by using a skilled file librarian, proper procedures for file control with adequate protection against dust, humidity, magnetic fields etc.

Disks should be kept in a secured locked room to prevent illegal access and damage to the disks.

There should be a minimum storage period before the materials can be disposed off.

Finally, for program, back up files must be kept secure and with access only to authorized person.

No programs can be altered without proper authorization and all changes must be fully documented.

Proper backup copies should be made and especially vital records would be stored at a distance away from the premises.

15.3 Advantages of Computer Systems

Computerized accounting systems offer many advantages over manual system.

15.3.1 More Accuracy

Very often, when accounting data became voluminous, there is always a high tendency for human errors to occur. By computerizing the accounting systems, additions and entries are more accurate.

15.3.2 Speed and Volume

A computerized accounting system can provide information quicker than a manual system.


The reason being it can overcome the problem of time consumed when done manually. With computerized accounting system, a larger volume of transactions can be handled due to its speed of processing.

15.3.3 Automatic Posting

With computerized accounting system, posting can be done automatically. This allows enormous savings in time and ensuring that each and every entry is posted accurately.

Errors such as double posting, posting to the wrong account, wrong entries and wrong amount could be avoided.

15.3.4 Automatic Reports Preparation

Reports such as journals, ledgers, special reports and financial statements can be generated automatically in a computerized accounting system when called for. Such reports would definitely aid management in decision making.

15.3.5 Automatic Document Printing

Computerized accounting system can generate business documents such as invoices, monthly statements for customers, payroll cheques and many others.

15.4 Comparison of the Accounting Cycle

Comparison of the accounting cycle in a manual system and in a computerized system.

Table 15-1:

Manual System Computerized System1. Begin with account balances in

the Ledgers.

1. Same

2. Post journal entries to the ledger

accounts.

2.Computer automatically posts from journals to ledgers.

3. Enter trial balance on the Worksheet and complete the

worksheet.

3. Computer prepares a trial balance and enter adjusting entries into the computer.

4. With worksheet, prepare financial

statements, journalise and post the adjusting entries and closing entries.

4. Computer automatically prepares all.

5. Prepare post closing trial 5. Computer automatically


balance. prepares it.

As observed from the above comparison, there is indeed no difference in the accounting cycle regardless of whether it is processed in the manual system or computerized system. The main difference lies in that computerized system could automate the process thereby resulting in quicker information.

15.4.1 Account Classification

In a manual system, account names are used to identify items involved in a transaction. In a computerized system, the data is often classified by using account codes which may be set up as follows:

Prefix - Main code - Suffix

Usually in a large computerized system.

In a typical accounting system, there are four types of codes commonly used:

Sequential codes - usually numerical codes allocated in sequence by the system

Block codes - usually sequential codes allocated in block numbers

Mnemonic codes - alphanumeric codes allocated in a way that is meaningful in name to the account which it refers

Section codes - alphanumeric codes which refer to usually, a product classification system


15.5 Integrated Packages versus Stand-alone Packages

An accounting package might have separate modules for:

Invoicing

Stock

Sales Ledger

Purchase Ledger

Nominal Ledger

Payroll

Cash Book

Job Costing

Fixed Asset Register

Report Generator

and so on.

Each module may be integrated with the others, so that data entered in one module will be passed automatically to others where the data is of some relevance. Such accounting package is known as the integrated package.

Integrated package would ensure that any update in one module would ensure an automatic update in another.

However, in many situations, most firms would prefer the stand-alone packages. Reasons being not all firms need all the modules in a single package. It would be both a waste of money and resources if the modules are not used yet they are included in the integrated package.

Stand-alone packages or division of ledgers have the advantages of restricting the opportunity for fraud and allowing multi-users.

15.6 Computerized Accounting Systems and Audit Trail

With computerized accounting systems, certain inconveniences and difficulties would be anticipated during audit trial.

One of the main problems is the difficulty to ascertain who to be accountable for errors committed. There may be problem in identifying who to be held answerable: the person who entered a particular transaction or the person who altered the details in an account. This problem could be solved with logbooks.

Another problem is that data may have been deleted from the account if the transaction is too old. But very often when performing audit trail, there is always possibility for auditors to demand the old accounts to be checked. If the data has been deleted, audit trail would be a troublesome process for the auditors. This may require the auditor to refer to the various daybooks.


15.7 What to Consider in Selecting an Accounting Package?

To suit the specific needs of the users, when choosing an accounting package, the data user should look at the following features of the package.

Integration

Determine the degree of integration between the various modules.

Data Volumes and Master File Sizes

Identify whether the system can handle the data volumes and the master file sizes that the user will have.

Sufficient Fixed Field length for Account Codes

Identify if the accounting package has sufficient fixed field length for the account codes.

Reference Number

Determine if the program allows more than one reference number for a single transaction. For example, reference number for sales invoice, order and job for a single transaction.

Price Ranges

Determine the currency accommodated and the minimum and maximum price range.

Discounts

Determine if the system accommodates or deals with discounts that is suitable for the company.

Reports

Determine if and what standard reports are produced by the system. If these reports could be redesign by the users.

User Friendly

Determine if the system provide "help" facilities or/and menus. Are the screens formatted clearly and easy to read?

Speed

Determine if the system is fast enough in its operation and to deal with the transactions.


Security

Identify the various security features which the package offers to prevent unauthorized access.

System Documentation

Determine if the system documentation for the user is well written and readable. Also determine whether the operating manuals are easy to understand and well indexed for easy reference.

Expansion

Determine if the system could expand according to the expansion plans of the company.

Multi-user Facility

Determine if the system can support multi-users.

Audit Trails

Determine if the package provide adequate audit trails.

15.8 Configuration Features

Determine whether the system allows other configurations to the system. The system configuration considerations would include:

Company name and address

Computer Hardware Configuration (Compatible model)

Printer Hardware Configuration (Printer control codes)

Operational Configuration (Account Codes)

Page Format Configuration

Tax Rates (GST / VAT)

Alter User Table (Password to enter system)


15.9 Sales Ledger Package

The purpose of the sales ledger package is to maintain customer accounts and ensuring it reflects accurate and updated information about the transactions made with the customers.

Similar to all computerized system, the sales ledger package works on the principle of:

The data of the sales ledger package are the details of the customers and it includes the standing data (i.e. it will change infrequently) and the variable data.

Input Process Output

Typical standing data found in a sales ledger package include:

Customer account number

Customer name

Address

Credit Limit

Account Sales Analysis Code

Account Type

Typical items of variable data includes:

Transaction Data

Transaction Description

Transaction Code

Debits

Credits

Balance

Typical inputs into the sales ledger system involve amendment made to customer details, insertion of new customers and deletion of old "non-active" customers. It also includes any transaction data relating to invoicing, customer payments, credit notes and any adjustment made to the debit or credit items.

The primary process involved in the sales ledger package is the modification made to the amount outstanding on the customer's account.

Typical outputs in a computerized sales ledger package are:

Day book listing

A list of all transactions posted each day.

Invoices


Customers' Statements

Aged Debtor Analysis

A printout that shows the current balance and old balance outstanding from the customers.

Sales Analysis Reports

A printout that analyses sales according to the sales analysis codes on the sales ledger file.

Debtors Reminder Letters

Letters produced to chase late payers.

Mailing lists of customers

Lists of customers accounts

A summary of all debtors' accounts held in the ledger.

Examination of customers' Accounts

Special Operations Logbook

15.10 Purchase Ledger Package

The purpose of the purchase ledger package is to maintain suppliers accounts and ensuring it reflects accurate and updated information about all transactions made with suppliers.

Similar to the Sales Ledger package, it works on the same principle of:

Input Process Output

The data of the Purchase Ledger Package are the details of the suppliers which includes the standing data and the variable data.

Typical standing data found in a purchases ledger package include:

Suppliers' account number

Suppliers' Company Name

Suppliers' address and contact details

Credit details

Bank details (e.g.: Method of Payment)

Cash discounts applicable

Typical items of variable data include:


Transaction date

Transaction Description

Transaction Code

Debits

Credits

Balance

Typical inputs into the purchase ledger system involve details of purchases recorded on invoices, details of returns to suppliers for which credit notes are received, payments to suppliers and any adjustments.

The primary process for the purchase ledger package is the adjustment made to the amounts outstanding on the supplier accounts.

A few of the typical outputs generated by the purchase ledger package are:

Lists of transactions posted (Daybook Listing)

Analysis of expenditure for nominal ledger purposes

List of creditors balances

Copies of detailed creditors' accounts

Details of payments such as remittance advises, cheque and credit transfer listings

Other special reports for costing purposes, updating records about fixed assets and comparison with budget

Aged creditors' listing

Mailing lists of supplier

15.11 Payroll Package

The purpose of a payroll package is to compute the gross wages and salaries of employees and produce payslips, cheque and/or listings sent to various banks instructing them to make payments.

The payroll system would carry out the above tasks by "looking" at how much employees should receive, how they should receive and when should they be paid. It must calculate tax to deduct, any national insurance deductions, CPF contributions, savings, loan repayments, profit sharing allocated, bonus given, overtime claims etc. that are connected with employees' pay.

The data of the payroll package will consist of the standing and variable data of individual employee's record.

The standing data of the employee will include:

Personal details

Rate of pay

Details of deductions


Department

The variable data of the employee will include:

Gross pay to date

Tax to date

CPF contributions

Net Pay

Overtime

Commission etc.The typical inputs into the payroll system include all records that determine the employees' final pay packets. This may be time sheets, clock cards etc.

The primary action involved in processing a payroll is determining the employee's gross pay, performing calculation and implementing various deductions or additions in order to find net pay.

A few of the typical outputs in a payroll system are:

Payslips

Payroll Summary

Payroll Analysis of deductions and all details for costing purposes

Coin analysis, cheque, credit transform forms

Magnetic, cassette or floppy disk with payment details for despatch to the bank and payment through the BACS (Bankers Automated Clearing System)

Cheques (if paid individually)

End of year taxation documents

Employee details

15.12 Nominal Ledger Package

The nominal ledger summarizes the financial affairs of a business. It contains the details of assets, liabilities and capital, income and expenditure and profit or loss.

Postings of the computerized nominal ledger depend on whether the accounting system is integrated or not.

If the system is integrated, data is put into the relevant nominal ledger accounts and updated. But if it is not integrated then the output from the stand-alone package would have to be input into the nominal ledger through journal entries.

Similar to the manual accounting system, the typical outputs or printouts of the computerized nominal ledger system include:

Profit and loss account


Balance Sheet

Trial Balance

Examination of accounts details

List of accounts

Daybooks/Journals

Regardless of whether the system is integrated or not, the data required by the nominal ledger package to update any relevant ledger accounts includes:

Date

Description

Amount

Account Codes

15.13 Stock Control Systems

The purpose of a stock control system is to track the movements and balances of different categories of stock. A good stock control system should reduce the working capital otherwise tied up in stock.

The data found in the file of stock control system include:

Stock number

Stock description

Standard cost

Quantity in stock

Typical inputs into the stock control system include goods received notes, issues to production, production to finished goods store, despatch notes and any adjustment entries.

A good stock control system would be able to process the input data quickly so as to minimize warehouse stock holding, achieve optimum distribution of available stock to retail outlets and generates reports quickly and accurately.

A few typical outputs generated from the stock control include:

Stock Daybook

Daybook that shows details of all items of stock that are issued, ordered, reserved and received during the period.

Stock Lists

This printout provides a lists of all items currently in stock. With the list is the description, prices and analysis codes of each item.

Stock Movement Reports

An important report that shows what quantity of stock for each item has been received and issued. This report would then allow management to identify


slow-moving stock, analyses the movements of the stock in order to produce projected movements for future months and identify future stock requirements.

Stock Levels and Availability

This report details information on items of stock that are currently reserved, on order, are available and sold. It also reflects on the minimum level required for each item of stock and indicates stock that has fallen below the minimum level.

Stock Price List

A printout on the prices of each item of stock sent to customers.

Stock Valuation

This report shows the total value for each item held in stock and the total value of all stock by adopting one of the methods used for valuation: FIFO, LIFO or AVCO.

Outstanding Orders Report

Reorder Report

Often than not, the stock system is often linked to the purchases and/or sales system. As such, other inputs/outputs are necessary and they include:

Inputs:

Changes in reorder levels, quantities etc.

Orders placed with suppliers

Customers orders

Notification of despatch to customers.

Outputs:

Purchase order or reorder schedules

Overdue purchase order

Production requirements

Unmatched customer orders over a predetermined age.

Finally, it is worth for management to continue performing physical stock counts. This would enable differences to be identified so that wastage, pilferage could be determined and to allow the stock files to be corrected.

15.14 Spreadsheets

Spreadsheets are integrated software programs that could be used to solve accounting problems. Typical accounting applications on spreadsheets would include budgets, depreciation schedules, debt amortization schedules, cost-volume profit analysis, stock control, job costing, forecasting and variance analysis.


Spreadsheets like Lotus 1-2-3 is organized into a matrix of rows labelled by alphabets and columns labelled by numbers. The intersection of a row and a column is known as the cell would contain numbers, text or formulae. If a formulae is used, the spreadsheet will carry out any calculations required and any figures adjusted for would automatically be recalculated. It also includes sophisticated graphics capabilities which are especially useful for management presentations.

An example on how spreadsheet could be used to handle variance analysis is given below. However, students are advised to allow themselves enough exposures of the software. Nothing could be as practical as having hands-on experience with the software to understand the wonders of spreadsheets.


1 A B C D E F G H2 Budgeted Actual Variances3 1,000 1,2004 Units Units5 $ $6 Sales 100,000 120,00

020,000

7 Cost of goods sold

600,000 72,000 12,000

8 40,000 48,000 8,0009 Gross Profit1011 Expenses:12 Salaries 22,500 27,000 4,50013 Rent 4,000 4,800 80014 Depreciation 2,500 3,000 50015 Utilities 2,000 2,400 40016 Interest 1,000 1,200 20017 Total Expense 32,000 38,400 6,4001819 Net Profit 8,000 9,600 1,60020

1 A B C D E F G H2 Budgeted Actual Variances3 1,000 1,2004 Units Units5 $ $6 Sales 100,000 120,00

020,000

7 Cost of goods sold

600,000 72,000 12,000

8 +D6-D7 +F6-F7

+F9-D9

9 Gross Profit1011 Expenses:12 Salaries 22,500 +C12 /

D3*F3+C12-E12

13 Rent 4,000 +C13 / D3*F3

+C13-E13

14 Depreciation 2,500 +C14 / D3*F3

+C14-E14

15 Utilities 2,000 +C14 / D6*F3

+C15-E15

16 Interest 1,000 +C16 / D7*F3

+C16-E16

17 Total Expense @SUM(C12.C16)

@SUM(E12.E16)

+C17-E17

18


19 Net Profit =D9-D17 +F9-F17

+F19-D19

20


15.15 Exercises126.

127.1. Describe five advantages of using computerized accounting system.

2. Under what situations should end-users select integrated accounting packages rather than stand-alone packages?

3. What are some of the difficulties encountered when performing audit trail in a computerized accounting systems?

4. Name six considerations when selecting an accounting package.

5. Identify the inputs, process and outputs for the following accounting packages:

ffff) Sales Ledger

gggg) Purchases Ledger

hhhh) Payroll

iiii) Nominal Ledger

jjjj) Stock Control

128.

129.6. Design the main menu for the following accounting packages:

kkkk) Sales Ledger

llll) Purchases Ledger

mmmm) Payroll

nnnn) Nominal Ledger

130.

131.7. Explain what is spreadsheet and identify some of its uses.

132.8. Using a spreadsheet program which you are familiar with, solve these accounting problems.

oooo)

Budget Actual100,000 units 120,000 units

$ $Sales Revenue 800,000 900,000

Materials 200,000 300,000Labour 160,000 170,000

Production Overheads

100,000 110,000

Selling Overheads 45,000 48,000Admin. Overheads 35,000 38,000

Profit 260,000 234,000


pppp) Prepare a cash budget from the following for the six months January to June:

- Opening Balance $5,000.00.

- Sales are 500 units per month for the months December, January, February and March, and 2500 units for subsequent months.

- Selling per unit is $500.00. 20% of sales are for cash and the remainder are on credit; debtors pay in one month.

- Purchases for materials are bought one month before sales and they are paid one month after sales.

- Rent is 10% of sales of that month.

- is 15% of total receipts of that month.

- A machine is going to be purchased in March for $3000.00 and would be paid in 3 monthly equal instalments.