DISPOSAL OF FIXED ASSETS

1.        Gain or loss on disposal of a non-current asset
   Property, plant and equipment are eventually disposed of:
   •  by sale, or
   •  if they have no sale value, through disposal as scrap.
   Disposal can occur at any time and need not be at the end of the asset’s expected useful life.
   The effect of a disposal on the statement of financial position (or accounting equation) is that:
   •  the asset (at cost or valuation) is no longer in the statement of financial position, and
   •   the accumulated depreciation on the asset is also no longer in the statement of financial position.
   The carrying amount of the asset is therefore removed from the accounting equation.
   There is a gain or loss on disposal of the asset, as follows:
    

   

   Gain or loss on disposal

METHODS OF CALCULATING DEPRECIATION

1. 1.      Straight-line method
   Definition: Straight line depreciation
   Where the depreciable amount is charged in equal amounts to each reporting period over the expected useful life of the asset.
   Formula: Straight-line depreciation

   

   Straight-line depreciation

   
   

DEPRECIATION AND CARRYING AMOUNT

1.      Definition of depreciation

Depreciation is a method of spreading the cost of a non-current asset over its expected useful life (economic life), so that an appropriate portion of the cost is charged in each accounting period.

Definitions (from IAS 16)
Depreciation: The systematic allocation of the depreciable amount of an asset over its useful life.

NON-CURRENT ASSETS

1.      Introduction
The assets of a business are classified as current assets or non-current assets.
IAS 1 (Presentation of financial statements) defines current assets and then states that all other assets should be classified as non-current assets.
Current assets include, cash, receivables, prepayments (see chapter 7) and inventory. They are all items that will be used or recovered in the short term.
A non-current asset is an asset which is used by the business over a number of years.
Non-current assets may be:

END OF YEAR ADJUSTMENTS

1. 1.      The need for end-of-year adjustments
   
   
   Start of a financial year
   At the start of a financial year the asset, liability and capital accounts in the general ledger contain the balances brought forward at the end of the last year as set out in last year’s statement of financial position.
   The income and expense accounts in the general ledger are empty as they will have been transferred to the income and expense account for the calculation of profit.

ACCOUNTING FOR CASH

1.      The cash book
The cash book is often a book of prime entry. It is used to record receipts and payments of cash into the business bank account.
The cash book has two sides, a side for receipts of money and a side for payments. Both sides have a number of columns so that cash receipts and payments can be analysed to make it easier to construct journals for double entry.

ACCOUNTING FOR PURCHASES

• 1.      Documents in the purchases cycle
  Businesses make purchases from suppliers. Purchases are similar in many respects to sales, except that the business is buying from a supplier rather than selling to a customer.
  The following documents might be used in a system designed to account for purchases.
  
  
  Purchase invoice: A request for payment from the supplier for goods delivered.
  
  
  
  
  2.      Recording purchases
  Purchases day book
  

Accounting For Sales

1.      Documents in the sales cycle
A business tries to make a profit by selling goods or services to customers. This creates revenue or income for the business.
Sales might be for cash or (coin, by debit card, credit card, cheque or by some less common method such as banker’s draft) or on credit.
The following documents might be used in a system designed to account for sales.
Sales invoice: A request for payment from the customer for goods delivered. Invoices normally show a date, details of transaction and payment terms.
Credit note: Issued when a customer returns goods and the business agrees to this. The business issues a credit note to acknowledge that the amount specified is no longer owed to them by the customer.
 

BOOKS OF PRIME ENTRY

The role of books of prime entry

Book-keeping is the process of recording financial transactions in the accounting records (the ‘books’) of an entity. Transactions are recorded in accounts, and there is a separate account for each different type of transaction.

It is often the case that individual transactions are not recorded in the ledger accounts as they occur. Instead, they are recorded initially in records called books of prime entry (also known as books of original entry). Each of these ‘books’ or ‘journals’ is used to record different types of transaction. Periodically the totals of each type of transaction are double entered into the appropriate ledger accounts in the general ledger.

Books of prime entry include the following:

GENERAL LEDGER

Introduction

The general ledger is a document which contains all of the individual accounts which are used to record the double entries of a business. It may have physical form as a book or it may be a software application.

All of the financial transactions of a business are entered into appropriate accounts in the general ledger. The balances on these individual accounts can be extracted as a trial balance as a step in preparing financial statements for the business.

Preparing accounts from a trial balance

Year-end adjustments

The trial balance provides a foundation for preparing a statement of comprehensive income and a statement of financial position at the end of an accounting period.

•  A trial balance is extracted from the general ledger, and various year-end adjustments are then made to the accounts.

•  These adjustments include adjustments for:

· Depreciation expense (to reflect the use of non-current assets);

· Accruals and prepayments;

· Bad and doubtful debts; and

· Inventory.

Trial balance

The balance extracted for any single account is the net of all of the debit and credit entries in that account.

If double entries have been posted correctly then the total of all debit entries made to all of the accounts in the general ledger must equal the total of all credit entries. It follows that if balances are extracted for every account in the general ledger the sum of the debit balances must equal the sum of the credit balances.

Closing off an account and bringing down the balance

The balance on an account can be established at any time as the difference between the total value of debit entries and the total value of credit entries.

•  If total debit entries in an account exceed total credits, there is a debit balance on the account.
•  If total credit entries in an account exceed total debits there is a credit balance on the account.

BASIC RULES OF DOUBLE ENTRY BOOKKEEPING

Debit and credit entries, and T accounts

Financial transactions are recorded in the accounts in accordance with a set of rules or conventions. The following rules apply to the accounts in the main ledger (nominal ledger or general ledger).

•  Every transaction is recorded twice, as a debit entry in one account and as a credit entry in another account.

•  Total debit entries and total credit entries must always be equal. This maintains the accounting equation.

It therefore helps to show accounts in the shape of a T, with a left-hand and a right-hand side. (Not surprisingly this presentation is known as a T account). By convention:

•  debit entries are made on the left-hand side and

•  credit entries are on the right-hand side.

INTRODUCTION TO ACCOUNTING SYSTEMS

The dual nature of transactions

Every transaction must be entered in two places or the equation would fail.

There is no exception to this rule. Every transaction that affects assets, liabilities, capital, income or expenses must have an offsetting effect to maintain the accounting equation. Every transaction must be recorded (entered) in two places.

The process of doing this is called double entry book-keeping.

The accounting equation is useful to give an overview of the accounting process but it is not very practical as a tool to account for the transactions of a business.

A business might enter into many thousands of transactions and it would be very time consuming to redraft the equation after each of them. A system is needed to allow large numbers of transactions to be recorded and then summarised to allow the production of financial statements on a periodic basis.

Book-keeping

The effect of financial transactions on the accounting equation

The accounting equation

A simple representation of the statement of financial position

The accounting equation is a simplified way of showing a statement of financial position. The equation is:

Formula: Accounting equation

Assets = Equity + Liabilities

A        = E        + L

THE ELEMENTS OF FINANCIAL STATEMENTS

• Introduction
  The objective of financial reporting is to provide useful information. In order to be useful information must be understandable. A large company enters into thousands of transactions so in order for users to be able to understand the impact of these they must be summarised in some way.
  Financial statements group transactions into broad classes according to their economic characteristics. These broad classes are called the elements of financial statements.
  ·          The elements directly related to the measurement of financial position in the statement of financial position are assets, liabilities and equity.
  ·          The elements directly related to the measurement of performance in the statement of comprehensive income are income and expenses.
  
  
  1.      Assets

ACCOUNTING CONCEPTS

• 1.      Accruals basis (matching concept)
  Accruals basis accounting (accruals accounting, the accruals concept) depicts the effects of transactions and other events and circumstances on a reporting entity’s economic resources and claims in the periods in which those effects occur, even if the resulting cash receipts and payments occur in a different period.
  ·          Revenue from sales and other income should be reported in the period when the income arises (which might not be the same as the period when the cash is received).
  ·          The cost of sales in the statement of comprehensive income must be matched with the sales. Income and ‘matching’ expenses must be reported in the same financial period.
  ·          Other expenses should be charged in the period to which they relate, not the period in which they are paid for.
  
   
  Example 1: Accruals basis
  A company prepares its financial statements to the 30 June each year.
  It sells goods for Rs. 50,000 to a customer on 6 June Year 2, but does not receive a cash payment from the customer until 15 August Year 2.
  Accruals basis:
  The sale is recognised as income in the year to 30 June Year 2, even though the cash is not received until after the end of this financial year.