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Monday, November 30, 2009

Accounting For Fixed Asset Disposals

Fixed assets are not purchased by a business with the intention of reselling them in the normal course of trade. However they might be sold off at some stage for example a business may sell fixed assets when their useful life is over.

Whenever a business sells something it makes a profit or loss. So when fixed assets are disposed of there is a profit or loss on disposal. This is a capital gain or a capital loss.

These gains or losses are reported in the profit and loss account of the business but not as a trading profit. They are commonly referred to as profit on disposal of fixed assets or loss on disposal.

The profit or loss on the disposal of a fixed is the difference between,
  • The net book value of the asset at the time of its sale.
  • Its net sale price which is the price minus any costs of making the sale.

A profit is made when the sale price exceeds the net book value and a loss is made when the sale price is less than the net book value.


Sunday, November 29, 2009

Provision for Depreciation

A provision for depreciation is the amount written off for the wearing out of fixed assets.
There are two basic aspects of the provision for depreciation to remember,

  • A depreciation charge (provision) is made in the profit and loss account in each accounting period for every depreciable fixed asset. Nearly all fixed assets are depreciable, the most important exceptions being freehold land and long term investments.
  • The total accumulated depreciation on a fixed asset builds up as the asset gets older. Unlike a provision for doubtful debts, therefore, the total provision for depreciation is always getting larger, until the fixed asset is fully depreciated.

The similarly in the accounting treatment of the provision for doubtful debts and the provision for depreciation may become apparent.

The ledger accounting entries for the provision for depreciation are as follows.

  • There is a provision for depreciation account for each separate category of fixed assets, for example land and building, furniture and fittings.
  • The depreciation charge for an accounting period is a charge against profit. It is an increase in the provision for depreciation and is accounted as follows, with the depreciation charge for the period.
    Profit and loss account-- Debit
    Provision for depreciation account --Credit
  • The balance on the provision for depreciation account is the total accumulated depreciation. This is always a credit balance brought forward in the ledger account for depreciation.
  • The fixed asset accounts are unaffected by depreciation. Fixed assets are recorded in these accounts at cost or at their re valuated amount.
  • In the balance sheet of the business, the total balance on the provision for depreciation account is set against the value of fixed asset accounts to derive the net book value of the fixed assets.



Saturday, November 28, 2009

Applying a depreciation method consistently

It is up to the business concerned to decide which method of depreciation to apply to its fixed assets. Once that decision has been made, however it should not be charged the chosen method of depreciation should be applied consistently from year to year.

Similarly it is up to the business to decide what a sensible life span for a fixed asset should be. Again once that life span has been chosen, it should be charged unless something unexpected happens to the fixed asset.

It is permissible for a business to depreciate different categories of fixed assets in different ways. For example, if a business owns three cars, then each car would normally be depreciated in the same way; but another category of fixed asset, say, photocopiers can be depreciating using a different method.


Friday, November 27, 2009

Methods of Depreciation

There are several different methods of depreciation. Of these the ones are,
  • Straight line method.
  • Reducing balance method.
  • Sum of the digits method.

Straight line method

The total depreciable amount is charged in equal installments to each accounting period over the expected useful life of the asset. So the net book value of the fixed declines at a steady rate, or in a straight line over time.

The annual depreciation charge = (cost of asset – Residual value) / Expected useful life of the asset

Reducing balance method

The reducing balance method of depreciation calculates the depreciation charge as a fixed percentage of the net book value of the asset, as at the end of the accounting period.

The annual depreciation charge = (cost of asset – accumulated depreciation) x Percentage

Sum of the digits method

This is a variant of the reducing balance method, based on the estimated useful life of an asset.
If an asset has an estimated useful life of three years, then the digits 1, 2 and 3 are added together, giving a total of 6. Depreciation of 3/6 for first year, 2/6 for second year, 1/6 for third year of the depreciable amount is charged in the respective years.


Thursday, November 26, 2009

Depreciation in the accounts of a business

When a fixed asset is depreciated, two things must be accounted for,
  1. The charge for depreciation is a cost or expense of the accounting period. Depreciation is an expense in the profit and loss account.
  2. At a same time the fixed asset is wearing out and diminishing in value. So the value of the fixed asset in the balance sheet must be reduced by the amount of depreciation charged. The balance sheet value of the fixed asset will be its net book value which is the value after depreciation in the books of account of the business.

The amount of depreciation will build up or accumulate over time, as more depreciation is charged in each successive accounting period. This accumulated depreciation is a provision because it provides for the fall in value in use of the fixed asset. The term provision for depreciation means the accumulated depreciation of a fixed asset.

The Depreciable Amount

The total amount to be charged over the life of a fixed asset or depreciable amount is usually its cost less any expected residual sales value or disposal value at the end of the asset’s life.

A fixed asset costing 50000$ which has expected life of five years and an expected residual value of 5000$, should be depreciated by 45000$ in total over the five year period.

A fixed asset costing 50000$ which has expected life of five years and an expected residual value of nil, should be depreciated by 50000$ in total over the five year period.


Fixed Assets Depreciation

Depreciation can be described as a means of spreading the cost of a fixed asset over its useful life, and so matching the cost against the full period during which it earns profits for the business. Depreciation charges are an example of the application of the matching concept to calculate profits.

Depreciation has two important aspects.
  1. Depreciation is a measure of the wearing out or depletion of a fixed asset through use, time or obsolescence.
  2. Depreciation charges should be spread fairly over a fixed asset’s life, and so allocated to the accounting periods which are expected to benefit from the asset’s use.

A fixed asset is acquired for use within a business with a view to earning profits. Its life extends over more than one accounting period, and so it earns profits over more than one period. In contrast, a current asset is used and replaced many times within the period. Foe example stock is sold and replaced, debtors increase with sales and decrease with payment received.

When a business acquires a fixed asset, it will have some idea about how long its useful life will be and might decide,

  • To keep on using the fixed asset until it becomes completely worn out, useless and worthless.
  • To sell off the fixed asset at the end of its useful life, either by selling it as a second hand item or as scraps.

Since a fixed asset has a cost, and a limited useful life, and its value eventually declines, it follows that a charge should be made in the trading, profit and loss account to reflect the use that is made of the asset by the business. This charge is called depreciation.


Sunday, November 22, 2009

Accounting for Stocks (Summary)
  • The quantity of stocks held at the year end is established by means of a physical count of stock in an annual stocktaking exercise, or by a continuous stock take.
  • The value of these stocks is then calculated, taking the lower of cost and net realizable value for each separate item or group of stock items.
  • In order to value the stocks, some rule of thumb must be adopted. The possibilities include FIFO, LIFO, and average costs. But in financial accounts FIFO or average cost should normally used.
  • Net realizable value (NRV) is the selling price less all costs to completion and less selling costs.
  • Cost comprises purchase costs and cost of conversion.
  • The value of closing stocks is accounted for in the nominal ledger by debiting a stock account and crediting the trading account at the end of an accounting period. The stock will therefore always have a debit balances at the end of a period, and this balance will be shown in the balance sheet as a current asset for stocks.
  • Opening stocks brought forward in the stock account are transferred to the trading account, and so at the end of the accounting year the balance on the stock account ceases to be the opening stock value brought forward, and becomes instead the closing stock value caught forward.
  • The statutory regulations and accounting standards requires that the balance sheet should show subdivided as follows, Stocks
    1. Raw materials and consumables.
    2. Work in progress.
    3. Finished goods and goods for resale.
    4. Payments on account.


Saturday, November 21, 2009

Statutory Regulations and Accounting Standards Requirements for Stocks

In the most businesses the value put on stock is an important factor in the determination of profit. Stock valuation is however, a highly subjective exercise and consequently there is a wide variety of different methods used in practice.

The statutory regulations and accounting standards requirements have been developed to achieve greater uniformity in the valuation methods used and in the disclosure in financial statements prepared under the historical cost convention.

Accounting standards defines stocks and work in progress as,
  • Goods or other assets purchased for resale.
  • Consumable stores.
  • Raw materials and components purchased for incorporation into products for sale.
  • Products and services in intermediate stages of completion.
  • Long term contract balances.
  • Finished goods.

In published accounts the companies act requires that these stock categories should be grouped and disclosed under the following heading,

  • Raw materials and consumables stocks.
  • Work in progress stocks.
  • Finished goods and goods for resale.
  • Payments on account. This is presumably intended to cover the case of a company which has paid for stock items but not yet received them into stock.

Determination of the cost of stock

To determine profit costs should be matched with related revenues. Since the cost of unsold stock and work in progress at the end of an accounting period has been incurred in the expectation of future sales revenue, it is appropriate to carry these costs forward in the balance sheet and charge them against the profits of the period in which the future sales revenue is eventually earned.

As the explanatory note to accounting standards expresses;

“If there is no reasonable expectation of sufficient future revenue to cover cost incurred the irrecoverable cost should be charged to revenue in the year under review. Thus stocks normally need to be stated at cost or if lower at net realized value”


Friday, November 20, 2009

Valuing Stocks

Determining the purchase cost

Stock may be raw materials or components bought from suppliers, finished goods which have been made by the business but not yet sold, or work in the process of production, but only part completed. It will simplify matters however if we think about the historical cost of purchased raw materials and components which ought to be their purchase price.

When the storekeeper issues components to production he will simply pull out from the bin the nearest components to hand, which may have arrived in the latest consignment or in an earlier consignment or in several different consignments. Our concern is to devise a pricing technique, a rule of thumb which we can to attribute a cost to each of the components issued from stores.

There are several techniques which are used in practice,
  1. First in first out (FIFO)
    This assumes that materials are issued out of stock in the order in which they were delivered into stock. The components issued are deemed to have formed part of the oldest consignment still unused and are cost accordingly.
  2. Last in first out (LIFO)
    This involves the opposite first in first out system; the components issued to production originally formed part of the most recent delivered.
  3. Average cost
    As purchase prices change with each new consignment, the average price of components in the bin is constantly changed. Average cost may be simple average cost or weighted average cost.


Thursday, November 19, 2009

Valuing Stocks

There are several methods which in theory might be used for the valuation of stock items.
  1. Stocks might be valued at their historical cost – The cost at which they were originally bought.
  2. Stock might be valued at net realizable value – Valued at their selling price less any costs still to be incurred in getting them ready for sale and then selling them.
  3. Stock might be valued at their expected selling price – The use of selling prices in stock valuation is ruled out because this would create a profit for the business before the stock has been sold.
  4. Stock might be valued at the amount it would cost to replace them – This amount is referred to as the current replacement cost of stocks.

The argument developed above suggests that the rule to follow is that stocks should be valued at cost, or if lower, net realizable value. The accounting treatment of stock is governed by an accounting standard that stats stock should be valued at the lower of cost and net realizable value.


Wednesday, November 18, 2009


Business trading is continuous activity, but accounting statements must be drawn up at a particular date. In preparing a balance sheet it is necessary to summarize the activity of a business so as to determine its assets and liabilities at a given moment. This includes establishing the quantities of stocks on hand, which can create problems.
  • A business buys stocks continually during its trading operations and either sells the goods onwards to customers or incorporates them as raw materials in manufactured products. This constant moment of stocks makes it difficult to establish what exactly is held at any precise moment.
  • In simple cases, when a business holds easily counted and relatively small amounts of stock, quantities of stock on hand at the balance sheet date can be determined by physically counting in a stock take.
  • The continuous nature of trading activity may cause a problem in that stock movements will not necessarily cease during the time that the physical stock take is in progress. To close down the business while the count takes place, or to keep detailed records of stock movements during the course of the stock take.
  • Closing down the business for a short period for a stock take is considerably easier than trying to keep detailed records of stock movements during a stock take.
  • One obstacle is overcome once a business has established how much stock is on hand. But another of the problems noted in the introduction immediately raises its head.


Monday, November 16, 2009

Accounting for Stocks

To calculate gross profit it is necessary to work out the cost of goods sold, and in order to calculate the cost of goods sold it is necessary to have value for the opening stock and closing stock.
  • Normally purchases are introduced to the trading account.
    Trading account - Debit
    Purchases account - Credit
  • When a stock take is made the business will have a value for its closing stock and the double entry is,
    Stock account - Debit
    Trading account - Credit
  • Closing stock at the end of one period becomes opening stock at the start of the next period. The stock account remains uncharged until the end of the next period when the value of opening stock is taken to the trading account,
    Trading account - Debit
    Stock account - Credit

This stock account is only ever used at the end of an accounting period, when the business counts up and values the stock in hand in a stock take. The debit balance of on stock account represents an asset, which will be shown as part of current assets in the balance sheet.


Sunday, November 15, 2009

Accounting Entries for Provision for Doubtful Debts

For this provision a business might know from past experience that say 5% of debtors balances are unlikely to be collected. It would then be considered prudent to make a general provision of 5%.

It may be that no particular customers are regarded as suspect and so it is not possible to write off any individual customer balances as bad debts. The procedure is then to leave the total debtors balances completely untouched, but to open up a provision account by the following entries,

Doubtful debts account - Debit
Provisions for doubtful debts - Credit

When preparing a balance sheet the credit balance on the provision account is deducted from the total debts balances in the debtors’ ledger.

In subsequent years adjustments may be needed to the amount of the provision. The procedure to be followed then is as follows.
  • Calculate the new provisions required.
  • Compare it with existing balance on the provision account.
  • Calculate increase or decrease required.
  • If a higher provision is required
    Provision of doubtful debts - Credit
    Profit and loss account - Debit
  • If a lower provision is needed now than before
    Profit and loss account - Credit
    Provision for doubtful debts - Debit


Friday, November 13, 2009

Accounting entries for bad debts write off

For bad debts written off there is a bad debts account. The double entry bookkeeping is fairly straightforward, but there are two separate transactions to record.
  • When it is decided that a particular debt will not be paid, the customer is no longer called an outstanding debtor, and becomes a bad debt.
    Bad debts account (expense) - Debit
    Debtors account - Credit
  • At the end of the accounting period, the balance on the bad debts account is transferred to the profit and loss account.
    Profit and loss account - Debit
    Bad debts account - credit

Where a bad debt is subsequently recovered in the same accounting period, you simply reverse the entries in above and so there will be no need to carry out the entries in above.
Debtors account - Debit
Bad debts account - Credit

However, where a bad debt is subsequently recovered in a later accounting period the accounting entries will be as follows.
Debtors account - Debit
Bad debts recovered - Credit

Bad debts recovered account identifying as income in the profit and loss account.


Thursday, November 12, 2009

Provisions For Doubtful Debts
When bad debts are written off, specific owed to the business are identified as unlikely ever to be collected, however because of the risks involved in selling goods on credit, it might be accepted that a certain percentage of outstanding debts at any time are unlikely to be collected.
But although it might be estimated that, say 10% debts will turn out bad the business will not know until later which specific debts are bad.
A general provision for doubtful debts is an estimate of the percentage of debt which are not expected to be paid.
  • When a provision is first made the amount of this initial provision is charged as an expense in the profit and account of the business.
  • When a provision already exists but subsequently increased in size, the amount of the increase in provision is charged as an expense in the profit and loss account for the period in which the increase provision is made.
  • When a provision already exits but subsequently reduce in size, the amount of the decrease in provision is provision is recorded as an item of income in the profit and loss account.

The value of debtors in the balance sheet must be shown after deducting the provision for doubtful debts.


Monday, November 9, 2009

Bad Debts

A bad debt is a debt which is not expected to be prepaid.

Customers who buy goods on credit might fail to pay for them, perhaps out of dishonesty or perhaps because they have gone bankrupt and cannot pay. For one or another, a business might decide to give up expecting payment and to write the debt off.

When a business decides that a particular debt is unlikely ever to be repaid, the amount of the debt should be written off as an expense in the profit and loss account. However bad debts written off are accounted for as follows,
  • Sales are shown at their invoice value in the trading account. The sale has been made and gross profit should be earned. The subsequent failure to collect the debt is a separate matter, which is reported in the profit and loss account.
  • Bad debts written off are shown as an expense in the profit and loss account.
  • If bad debts written off and subsequently paid, the amount recovered should be recorded as additional income in the profit and loss account of the period in which the payment is received.

Double entries

  1. Accounting bad debts
    Bad Debts account (Debit)
    Debtors account (Credit)
  2. Writing off bad debts
    Profit and loss account (Debit)
    Bad Debts account (Credit)
  3. bad debts written off and subsequently paid
    Cash account (Debit)
    Bad debts received (Credit)
  4. Recorded bad debts written off and subsequently paid as additional income in the profit and loss account.
    Bad debts received (Debit)
    Profit and loss account (Credit)


Sunday, November 8, 2009

Accounting for Discounts

A discount is a reduction in the price of goods below the amount at which those goods would normally be sold to other customers of the supplier. Discounts can identified as two parts,
  1. Trade Discounts – Trade discounts is a reduction in the catalogue price of an article, given by a wholesaler or manufacturer to a retailer. It is often given in return for bulk purchase orders.
  2. Cash Discounts or settlement discounts – Cash discounts is a reduction in the amount payable for the purchase of goods or services in return for payment in cash rather than taking credit.

Trade Discounts

This is a reduction in the cost of goods owing to the nature of the trading transaction. For example a customer might quoted a price 2$ per unit for a particular item, but lower price of say 0.5$ per unit if the item is bought in quantities of say 200 units or more at a time.

In an accounting trade discounts are recorded in only to the day books, its not transfer to journal.

Cash Discounts or Settlement Discounts

This is a reduction in the amount payable to the supplier, in return for immediate payment in cash, rather than purchase on credit. For example a suppler might charge 2000$ for goods, but offer a discount of, say 10% if the goods are paid for immediately in cash.

In an accounting trade discounts are recorded in cash book first and transfer it into journal.

Trade discounts received

It should be deducted from the gross cost of purchase. It’s recorded as shown below

  • Total creditors (Debit)
  • Discounts received (Credit)
  • Cash account (Credit)

At the end of the accounting period discounts received account is transfer to the profit and loss account

  • Discounts received (Debit)
  • Profit and loss account (Credit)

Trade discounts allowed

It should be deducted from the gross sales price. It’s recorded as shown below

  • Cash account (Debit)
  • Discounts allowed (Debit)
  • Total debtors (Credit)

At the end of the accounting period discounts allowed account is transfer to the profit and loss account

  • Profit and loss account (Debit)
  • Discounts received (Credit)


Saturday, November 7, 2009

Calculating Cost of Goods Sold

Opening stock value -------------------------------------XXX
(+)Cost of Purchase or cost of production -----XXX
(-) Closing stock value -----------------------------------(XX)
Cost of Goods Sold ---------------------------------------XXX

Goods might be unsold at the end of an accounting period and so still be held in stock at the end of the period. The purchase cost or production cost of these goods should not be included therefore in the cost of sales of the period, that’s why we doing stock adjustment like above.

Goods written off or written down

A business might be unable to sell all the goods of purchase or produced, because might be happen to the goods before they sold,
  • Goods might be damaged.
  • Goods might be stolen.
  • Goods might become obsolete or out of fashion.

In the causes like that we should remove that cost from cost of goods sold,

Opening stock value --------------------------------XXX
(+)Cost of Purchase or cost of production ---XXX
(-) Damaged stocks -------------------------------(XX)
(-) Stolen stock -------------------------------------(XX)

(-) Closing stock value -----------------------------(XX)
Cost of Goods Sold --------------------------------XXX

Also we should write off that cost in the profit and loss account.


Friday, November 6, 2009

Need of Accounting Information (External parties)

We can identify external parties as below,
  1. Trade contacts.
  2. Providers of finance to the company.
  3. Employees of the business.
  4. The Inland Revenue.
  5. Government and their agencies.
  6. Financial analysts and advisers.
  7. The public.

Trade Contacts

This includes suppliers who supply goods and customers who purchase the goods or services. Suppliers want to know about ability to pay debts; customers want to know that the company is a secure source of supply.

Providers of finance to the business

These include long term loans and short term overdraft the bank or financial institution want to know and ensure that the company is able to keep up with interest payments and repay the amount advanced.

Employees of the business

They want to know about financial situation, because their careers and size of their wages depend on it.

The Inland Revenue

They want to know about profit of the company.

Government and their agencies

They are interested in the allocation of resources and therefore in the activities of enterprises.

Financial analysts and advisers

Financial analysts and advisers, who need information for their clients or audience,

The public

Public wants to know affect members of the public.


Thursday, November 5, 2009

Need of Accounting Information (Internal Parties)

There are two main internal parties need accounting information in business,
  1. Managers Of the company.
  2. Shareholders of the company.

Managers of the company

Managers of a business need the most information, to help them take their planning and control decisions, and they have special access to information about the business, because they can get people to give them the types of statements they want.

These people appointed by the company’s owners to supervise day to day activities of the company. They need information about the company’s financial situation as it is currently and as it is expected to be in the future.

When managers want a large amount of information about the cost and profitability of individual products or different parts of their business they can arrange to obtain it through a system of cost and management accounting.

Shareholders of the company

These will want to access how effectively management is performing its stewardship function. They want to know profitability of the company and how much profit they can afford withdraw from the business for their own use.


Wednesday, November 4, 2009

Accruals and Prepayments

The net profit for a period should be calculated by charging the expenses which are relate to that period, if we preparing financial statements of a business for a period of eight months it would be appropriate to charge eight months expenses and income.


Accruals or accrued expenses are expenses which are charged against the profit for a particular period, even though they have not yet been paid for,
For example assume one of the company paid 240$ telephone bill for the year 2008/2009 but they have to pay 20$ more for that period, in the financial statements
  • We charged to income and expenses account 260$.
  • We show 20$ as accrued expenses in the balance sheet under the topic of current liabilities.


Prepayments are payments which have been made in one accounting period, but should not be charged against profit until a later period because they relate to that later period.
For example assume one of the company paid 240$ but they have to pay 250$ for the year 2008/2009 then we can see they paid 10$ prepayments for the accounting period, in the financial statements

  • We charged to income and expenses account 240$.
  • We show 10$ as prepayments in the balance sheet under the topic of current assets.


Monday, November 2, 2009

Example Trial Balance and Profit and Loss Account

One of the trading company prepared ledger books and find following balances as at 31 March 2009

Cash ------------------------------(Dr) 430
Bank ------------------------------(Dr) 192
Capital ----------------------------(Cr) 500
Rent -------------------------------(Dr) 60
Carriage ---------------------------(Dr) 46
Creditors --------------------------(Cr) 760
Debtors ----------------------------(Dr) 510
Purchases -------------------------(Dr) 918
Sales -------------------------------(Cr) 696
We prepare profit and loss account using income and expenses balances,

Profit and Loss Account
Sales -------------------------------------------------------------696
(-)Cost of sales (Purchases because no stocks) -----918
Gross profit ----------------------------------------------------(222)
(-) Expenses
Rents -------------------------------------------------------------(60)
Carriage --------------------------------------------------------(46)
Loss for the period -----------------------------------------(328)


Sunday, November 1, 2009

An Example for Bookkeeping

A business is established with capital of $ 4000, and this amount is paid into bank account by proprietor. During the first year’s trading, following transactions occurred.

Purchases of goods for resale on credit $ 8600
Payments to trade creditors $ 7200
Sales all on credit $ 11600
Payments from debtors $ 6400
Fixed assets purchased fir cash $ 3000
Other expenses all paid in cash $ 1800
You can see below how to prepare ledger accounts (Double entries).

The first thing is to open ledger accounts. Cash account, Capital account, Creditors account, Purchase account, fixed assets account, Sales account, Debtor account, other expenses account.
Double entries for above transactions

(1). Established with capital of $ 4000
Cash account ---------(Dr) 4000
Capital account -------(Cr) 4000

(2). Purchases of goods for resale on credit $ 8600
Purchases account ---(Dr) 8600
Creditors account ----(Cr) 8600

(3). Payments to trade creditors $ 7200
Creditors account ----(Dr) 7200
Cash account ---------(Cr) 7200

(4). Sales all on credit $ 11600
Debtors account ------(Dr) 11600
Sales account ---------(Cr) 11600

(5). Payments from debtors $ 6400
Cash account ---------(Dr) 6400
Debtors account ------(Cr) 6400

(6). Fixed assets purchased fir cash $ 3000
Fixed assets account --(Dr) 3000
Cash account ----------(Cr) 3000

(7). other expenses all paid in cash $ 1800
Other expenses account -(Dr) 1800
Cash account -------------(Cr) 1800

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