Accounting chapter-10

This presentation is owned by
ABUL KALAM AZAD PATWARY
“for class 9-10[accounting]”

Every business organization needs to know the
exact financial position at the end of the definite
period. There are two aspects of financial
condition- (i) ascertainment of profit or loss of
the business and (ii) value of different assets and
liabilities-debt of business.
The statement which is prepared to ascertain the
profit and loss of the business is known as the
Statement of Comprehensive Income (it was
previously known as Income
Statement) and the Statement prepared to
ascertain the assets, liabilities-debts is called
statement of Financial Position. It was previously
known as Balance Sheet. Statement
of Comprehensive Income and the Statement of
Financial Position are known as financial
statement

Financial Statement of Sole Proprietorship:
Financial statement is a structured, disciplined and continuous
process of knowing the financial results and the state of affairs
of an organization. Financial statements help the users make
economic decision by providing of accounting information of
financial results, the state of affairs and cash flow, etc.
Financial statement is an important base to evaluate
managerial efficiency and overall condition of the organization.
According to the International Accounting Standard-01 (IAS-
01), we are to prepare a financial statement of which is divided
into 5 (Five) parts; the five parts are-
1. the Statement of Comprehensive Income
2. the Statement of Changes in Equity
3. the Statement of Financial Position
4. the Statement of Cash Flows
5. Notes, comprising a summery of significant accounting
policies and other
explanatory information provided in the financial statement.

PICTURE INDICATOR OF PROFIT AND LOSS
The Statement of Comprehensive Income:
Revenue type income and expenditures are recorded
in the Statement of Comprehensive Income. In case
of, service organizations which do not get involved
in trading rather providing services (advertising
firm), net profit can be ascertained through
deduction of costs of service from income. On the
other hand, gross profit of a trading concern can be
ascertained by deducting costs of goods sold from
earnings from sales. For ascertaining net profit we
are to add all indirect income with gross profit get
total income and deduct all indirect expenses from
that total income.

Objectives of the Statement of Comprehensive
Income:
1) We can know net profit and loss from
comprehensive income statement. By doing so an
important message is sent to the owner that he/she
can’t claim up over the net profit. Because claiming
over net profit means the break down of capital
structure which may lead to severe interruption of
future business activities of the firm.
2) By analyzing different income and expenditures
of the Statement of
Comprehensive Income, we can know how to
increase net profit of a firm by
increasing future income and decreasing
expenditures.

Preparation of the Statement of Comprehensive Income (service providing
business):
The Statement of Comprehensive Income is prepared in each year for
particular period
of time. Net income is ascertained by deducting the expenditures from the
income of
that year.

For a trading concern, main source of income is earnings from
sales. It is the main source of operating income. There are some non
operating income too, such as, commission received, rent received,
interest received from bank etc. Operating expenses are purchase,
wages, manager salaries, travelling expenses, repairing expenses,
bad debt, depreciation etc. Statement of Comprehensive Income is
prepared mainly in three stages.
In first stage, gross profit can be determined by deducting cost of
goods sold from sales revenue.
In second stage, operating profit can be determined by adding
indirect operating incomes with gross profit and then deducting
operating expenses from that total.
In third stage, net profit can be calculated by adding net non-
operating incomes/expenses (non-operating income – less non
operating expenses) with operating profit.

Some expenditure is discussed below:
1)Cost of goods sold:
Total of the expenses incurred on the goods sold during a
period to bring them into saleable condition is called cost of goods
sold. Cost of goods sold = opening stock + (net purchase + other
expenses related with purchase) – closing stock. Here other expenses
related with purchase means carriage inward, wages, import duty etc.
2) Insurance: Assets of business like Building, Machinery, and Stock-
in-trade are insured against their destruction in any accident.
Premium is to be paid to Insurance Companies at regular intervals.
This Premium is treated as insurance expense.
3) Depreciation: Reduction of fixed asset arises from continuous use.
This reduction is called depreciation. On the other hand, depreciation
of assets can be formed back dated of assets.

4) Bad Debt: In case of credit
sales the amount not to be
realized from debtors is
called bad debt. The reason of
bad debt is death, bankruptcy
and/ or absconding
of debtors.
5) Provision for Doubtful
Debt: The amount of debts
which may not be realized is
called doubtful debt, which is
a probable loss and will be
included in operating
expenses.

Some incomes are discussed below:
1) Dividend received: Excess of necessary
income is sometimes invested as shares at
other companies. Earning from shares is
known as dividend.
2) Interest received: Additional incomes
which are deposited at bank or invested at
profitable ventures and get some benefit is
called interest.

Procedure of preparing
Statement of Changes in
Equity for Sole
Proprietorship:
Statement of Changes in
Equity is prepared to
ascertain the closing balance
of owner’s equity at the end
of the accounting period. To
ascertain so the additional
amount of capital, net profit/
loss and drawings are
adjusted with the opening
balance of owner’s equity. A
pro-forma of Statement of
Changes in Equity for Sole
Proprietorship is shown
below:

Procedure of preparing the Statement of Financial Position:
Information is recorded in the Statement of Financial Position in two
stages. First stage consists of assets. Assets are of two types- A) fixed
assets e.g. land, buildings and current assets e.g. B) cash, debtors and
stock-in-trade. Capital and liabilities are shown in second stage.
Liabilities are mainly of two types- A) current liabilities e.g. creditors,
outstanding expenses and B) long term liabilities such as loan from bank.
Closing Balance of Owner’s Equity is shown after total liabilities.
Summation of closing balance of owner’s equity and total liabilities will
be equal to the amount of total assets.
Assets and liabilities are arranged generally, in Liquidity Preference
Method, that is
assets are arranged in order of easy and quick conversion into cash and
liabilities are
arranged in order of prompt payment. That’s why current assets are
shown first then
fixed assets are shown in the statement of financial position. Similarly
current liabilities are shown earlier than long term liabilities. There is
another method of arranging balances known as Permanence Preference
Method. This method is reverse to liquidity preference method. Under
this method the most permanent asset and liabilities are shown first,
then current asset, and liabilities are shown. That is fixed assets shown
first then current assets, in the same way long term liabilities are shown
first then are current liabilities.

Importance of classification of assets and liabilities:
Different assets are of different nature and they have varieties of objectives
in business.
Necessity of knowing how quickly an asset will be encashed, how quickly a
liability will be paid for the sake of efficient management of assets. And thus
it will be easier to put emphasis on individual assets and liabilities.
Current Assets: Current assets are those assets which can be converted into
cash within one accounting period e.g. Stock-in-trade, Debtors, cash in
hand, cash at bank etc.
Fixed Assets: Fixed Assets are those which are used in the business for long
time and bought not for selling again, such as, land and buildings, plant and
machinery, furniture,
etc.
Current Liabilities: Liabilities which are payable within one accounting
period is called current liabilities e.g. sundry creditors, outstanding
expenses etc.
Long Term Liabilities: liabilities which are taken for a long period of time is
called long term liabilities e.g. Bank loan, mortgage etc.

Application of accounting principles in preparation of statement of
financial position:
In preparation of the Statement of Comprehensive Income and the
Statement of Financial Position certain accounting principles are
followed. In order to ascertain accurate profit or loss and to determine
the accurate value of assets and liabilities following principles must
doing activity.
1) Business entity concept: Under this concept the business is said to be
quite distinct from its proprietors. Only for this reason all accounts are
kept in the name of the business are not in the name of the proprietors.
That’s why, capital supplied
by the proprietor is the liability of the business and
drawings by the proprietor are his own expense and
reduce the value of capital.

2) Going concern concept: Under this concept, it is taken into
consideration that the business will continue for an indefinite
period of time and is not organized for a limited period. That is
a business will run for unlimited period and there is no plan to
stop business. In the light of this concept, the incomes and
expenses are divided into capital and revenue nature. Capital
items are used to prepare the Statement of Financial Position.
According to this concept, depreciation is calculated over the
life span of fixed assets. If this concept does not exist it is not
possible to prepare financial position and no need of charging
depreciation.
3) Periodicity concept: According to going concern concept there
is no specific period of business. But we can’t wait for
unlimited period to know the financial position of business.
For that reason, to know the financial condition of each year
we have to prepare comprehensive income statement and
statement of financial position. Unlimited period of business
can be divided into equal small parts. This small part is called
periodicity. Generally periodicity indicates for one year.

4) Accrual concept: According to this concept, at the time
of preparing Statement of Comprehensive Income
outstanding references are added to the related expenses
which have been paid and outstanding incomes are
added to related incomes which are already received
during the concerned accounting year. Over and above,
unearned incomes and prepaid expenses are shown as
deduction from respective
account head.
5) Conservatism principle: According to this principle, to
calculate profit you have to conservatism, that is anticipating
no profit but provide for all possible losses. It means provision
should be created if there is any possibility of loss in future,
but anticipated profit should not be taken into consideration
unless and until it is realized. If profit or dividend is
distributed from anticipation, then it is as if the break down of
capital of the business which is not only ultra vires to the
company act but also harmful for the concern. Such as,
provision for bad and doubtful debt
is though probable losses, they are shown in the financial
statement. Closing stock is valued at cost or market price
whichever is lower.

6) Cost price principle: Under this principle, fixed assets are shown in the
financial statement based on their historical cost that is at the price when
they were purchased. Fixed assets are not shown at the current market
price because they are not purchased for trading rather for long term use
in business. Cost price means amount sacrificed for acquiring respective
asset and other necessary expenses made to make the asset usable for the
business.
7) Consistency principle: According to this principle, books of accounts
are prepared and maintained following the same methodology each and
every year. It is so because of comparison and analysis between the years
and inter-organization. Otherwise, true financial picture can not be
gained.
8) Materiality convention: Under this convention, recording of
transactions is done through using knowledge, experience and
intelligence of the accountant. Accountant himself considers the
materiality or immateriality at the time of recording the transaction.
For example, stationeries such as calculators, staple machine and
punch machine are bought to use long span of time in business but
since they are of small price they are not treated as assets and price is
not distributed over the useful life rather they are treated as the
expenses of the respective year and shown in comprehensive income
statement.

Adjustments to be considered at the time of preparing statement of
financial Position:
Outstanding Expenses:
After preparation of trial balance it will be found that wages are due Tk.
500. Then according to the accrual concept Tk. 500 will be at Statement
of Comprehensive Income because this expense is relating to current
accounting period. The same amount will be shown in the Statement of
Financial Position as current liability because it needs prompt payment.
Expenses paid in Advance/Prepaid Expenses:
At the end of year it is found that house rent for Tk. 800 paid in advance.
According to periodicity concept this prepaid rent will be deducted from
the total house rent and shown in the Statement of Comprehensive
Income because this expense is not relating to current accounting
period. The same amount will be shown in the Statement of Financial
Position on assets side because it will give benefit in future as like other
asset.

Accrued Income:
At the end of it is found that interest on investment of Tk. 600 has
been earned but not yet received. According to periodicity concept
Tk. 600 will be shown in the Statement of Comprehensive Income
as income. This interest receivable will be shown in the Statement
of Financial Position as current asset.
Accrued Income:
At the end of it is found that interest on investment of Tk. 600 has been
earned but not yet received. According to periodicity concept Tk. 600
will be shown in the Statement of Comprehensive Income as income.
This interest receivable will be shown in the Statement of Financial
Position as current asset.

Income Received in Advance/Unearned Income:
Suppose, in the trial balance of current accounting period, rent received has
been shown as Tk. 10,000. Out of this amount Tk. 3,000 received in advance
for next year. This prepaid rent of Tk. 3,000 will be deducted from rent
received Tk. 10,000, actual rent received for this year Tk. 7,000 will be
shown in the Statement of Comprehensive Income. Again, Tk. 3,000 will be
shown in the Statement of Financial Position because for this income
service is to be rendered or will be adjusted with the income of next year.
Goods drawn by the Proprietors:
At the end of year it is found that the Proprietor has used goods for Tk.
4,000 for his/her private purpose from the business. Such type of
expenditure is personal expenditure for proprietor and not for business
expenditure. So, Tk. 4,000 will be deducted from purchases and will be
shown in the Statement of Comprehensive Income statement. The same
amount of drawings will eventually be deducted from capital in the
Statement of Financial Position.

Depreciation:
Depreciation is the reduction of value of an asset i. e. buildings,
machineries etc. owing
to its use or other causes. Such reduction or loss known as
depreciation and it will be
shown as operating expenses in the Statement of Comprehensive
Income. For example
Plant and machinery is shown in the trial balance at Tk. 80,000.
Depreciation on plant
and machinery is to be charged @ 15% p.a. Here depreciation will be
(80,000 X 15%)=
Tk. 12,000 will be shown as operating expenses in the Statement of
Comprehensive
Income. The same amount will be deducted from plant and
machinery as accumulated
depreciation in the Statement of Financial Position.

Bad Debt:
A bad debt is a loss caused by the failure or bankruptcy of a debtor to pay
the amount due from him. This loss is called bad debt. Suppose, Tk. 50,000
shown as sundry debtors. At the end of the year, it was come to know that
Tk.1,000 is totally irrecoverable from one debtor. This loss will be shown in
the Statement of Comprehensive Income and according to double entry
system of accounting; the same amount will be deducted from debtors as
bad debt in the Statement of Financial Position.
Provisions for Bad and Doubtful Debt:
After deducting the bad debt from debtors, some portion of the amount from rest of the
debtors may not be realized. It is probable loss. Such loss will be shown in the
Statement of Comprehensive Income as reserve for bad debts and according to
Conservatism principle this amount will be deducted from sundry debtors in the
Statement of Financial Position.
Example: Let debtors Tk. 50,000 and opening balance of provision for bad debt Tk.
2,000 in the trial balance. There is information that Tk. 1,000 from a debtor is certainly
irrecoverable, moreover 5% amount of money from rest of the debtors may not be
realized.

Profit ratio:
We can compare net profit to Sales and capital employed. That is, we
can calculate percentage of net profit to sales and net income to capital
employed. Increase of these ratios indicates good capacity of earning
profit. Beside, this profit ratio of business is higher than another
business indicates better capacity of earning profit.
NET PROFIT : (NET PROFIT Divided by NET SALES ) x 100
Net profit to capital employed ratio : (NET PROFIT Divided by
CAPITAL EMPLOYED ) x 100
Capital employed= Total assets-(Intangible assets + investment -
Current Liabilities)

Capacity of loan repayment:
We can know the loan repayment capacity of business from compares of
current assets and current liabilities that is calculation of current assets
and current liabilities ratio. For this reason we have to calculate following
two ratios:
CURRENT RATIO: CURRENT ASSETS DIVIDED BY CURRENT
LIABILITIES.
LIQUID RATIO: CURRENT ASSETS - (STOCK + PREPAID
EXPENSES ) divided by Current Liabilities.
To calculate liquid ratio prepaid expenses should be deducted because
of irrecoverable. Beside this closing stock should be deducted because
of slow liquidity. Standard current assets and current liabilities ratio
will be 2:1, because, for loan repayment purpose collection of 50%
assets is enough. Standard liquid ratio is 1:1.

Accounting chapter-10

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Accounting chapter-10