IBB- Institute of Bankers Bangladesh

Accounting for Financial Services (AFS) -MAY-2009

Q1.(a) Answer: Accounting is called the language of business.

Accounting as the language of business:

A famous writer of Accounting of the world has regarded Accounting as the language of business. Mail expresses his
feelings through language in written and verbal form, similarly various information of the business organization are
expressed and presented through accounting statements. In language, efforts are made to express a particular feeling
using words one after another. Similarly in accounting financial transactions are recorded in books of accounts and there
from preparing financial statements various financial information is communicated to concerned persons. Accounting
furnishes all information about past events, current activities and future possibilities of a business. Recording and
analyzing past and present financial events, Accounting presents and communicates various information in the form of
statements and reports to the interested parties like owners, employees, managements, investors, buyers, sellers etc. From
these accounts, statements and reports, parties concerned can evaluate their success-failure, financial solvency insolvency
etc. Of course, having sound command over accounting language one call understand these information. These financial
statements are meaningless to those who do not have knowledge of accounting, in the same way as newspaper is a bundle
of papers to an illiterate person. So, Accounting functions like a language. One may think it is not apt to compare
Accounting with language but actually it is not so. Shorthand is a language but the persons who are ignorant of it call not
understand this symbolic language. Similarly it is not illogical to term accounting as a language of business. It is
meaningless to those who are ignorant of this discipline. No language in the world is universal. Similarly accounting
language also is not understandable to all. With the changes of society and human life languages are changing. Similarly
with the advancement and complexity of business accounting language is changing gradually. Therefore, it is apt to say.
Accounting is the language of business.

Accounting management helps the management in the following ways:

(1) Planning: Proper planning is very much needed for successful competition of various management activities. This
plannings cash planning, sales planning, procurement planning, determining quantity of planning, determining quantity
of stock, development planning, fixing up target-profit etc are very much dependent on accounting data and information.

(3) Organizing: Accounting plays a very vital role in proper executing of the important functions of management
organization Accounting helps management-organization by providing in form like: percentage of profit over capital,
investment position, management efficiency in controlling etc.

(3) Motivating: Labor-employees are to be motivated for achieving expected performance financial help is one of the
factors of work. The management is to be aware of financial position of the business for providing financial benefits.
Accounting helps the management by providing necessary information-for taking proper decisions.

(4) Co-ordination: One of' the task of management is to achieve the final target of the business by coordinating various
activities of different departments. Accounting helps in coordinating various activities of different departments of the
business. It also helps the management in the adjustment of purchase with sales, expenditure with income, sales with
debt receivable realization etc. to a great extent.

(5) Controlling: The main functions of the modern management are planning and controlling. Controlling is essential for
completion of activities according to plan. Accounting can help management much in controlling.

(6) Preparation of Final Accounts: The management's responsibility is to communicate operating results for a certain
period and financial position of a business concern to the owners and parties concerned. Accounting provides the
management with information such as profit-loss, financial position through Accounting through statements etc. Besides,
it is the responsibility of the management to keep accounts and get it audited.

(7) Media of Communication: Accounting plays a vital role as a media in communicating various information of different
departments, business and management plan of actions to various departments. For instance, in the modern age
Accounting is regarded as the best media of communication in supplying information to management regarding purchase
and stock, time of purchase, cost of purchase and sales price etc. Besides, the function of Accounting is to collect and
provide information about business to various interested parties.

(8) Budgeting: Preparation of various budgets is essential to run the business successfully. The historical Information
which is needed in preparation of budget is supplied by Accounting.

(9) Professional Advice: An efficient and honest accountant helps the management with valuable professional advice for
the development of its business. III the modem age with the complexities of business management has also become
complex. III this aspect the role of accounting is very important. The efficiency of management depends on the efficient use
of accounting data and information. In the developed countries accountants are regarded as efficient and successful

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managers in the modern age, in big organizations accountants are included in the management committee. It can be said
that, Accounting and Management are interdependent. Accounting is an essential tool of management..

Q1.(b) Accounting is an Information system. It helps managers, creditors, investors, government tax
authority board of directors for making decisions. For investors whether to buy, sell or hold
shares. For Creditors-whether to lend money or not lending money to business houses. Are the
creditors having appropriate credit worthiness? Let us look at the users of accounting information.

Q1. (c)Importance of Studying Accountancy as a banker:

Today, accounting is the nerve centre of almost all business. The modern businessman relies on facts rather than
haunches, and his financial facts are organized for him by accountants. No large scale operations of business can be
operated without the knowledge of accounting. All functions of business-Research & Development, Production, Marketing,
Finance, Human Resources Management are dependent on the data and information provided by accounting. Accounting
helps other managers in their decision-making process through accounting data and information. It is a language of
business and an instrument of administration and commerce. Now-a-days, it is said that the more the information you
possess, the more the wealthier you are. So, one of the main functions of accounting is to provide management with
financial information and guidance with the help of financial statements fairly and intelligently prepared. The financial
statements should act as a report of stewardship; as a basis for fiscal policy; as a criterion of the legality of dividend policy;
as a basis for granting credit; an information to the prospective shareholders or investors; as a guide the value of
investment already made; as an indicator of financial integrity or solvency of the enterprise; as an aid to control; as a basis
for price or rate regulation; as a tool for determining the credit-worthiness; as a true and fair picture and basis for
taxation.

When a person starts a business, whether large or small, his main aim is to earn profit. He receives money from certain
sources like sale of goods, interest on bank deposits etc. He has to spend money on certain items like purchase of goods,
salary, rent, etc. These activities take place during the normal course of his business. He would naturally be anxious at
the year end, to know the progress of his business. Business transactions are numerous, that it is not possible to recall
his memory as to how the money had been earned and spent. At the same time, if he had noted down his incomes and
expenditures, he can readily get the required information. Hence, the details of the business transactions have to be
recorded in a clear and systematic manner to get answers easily and accurately for the following questions at any time he
likes.

i. What has happened to his investment?

ii. What is the result of the business transactions?
iii. What are the earnings and expenses?
iv. How much amount is receivable from customers to whom goods have been sold on credit?
v. How much amount is payable to suppliers on account of credit purchases?
vi. What are the nature and value of assets possessed by the business concern?
vii. What are the nature and value of liabilities of the business concern?
These and several other questions are answered with the help of accounting. The need for recording business transactions
in a clear and systematic manner is the basis which gives rise to Book-keeping.

## Accounting Opportunities:

EXHIBIT 1.3 Accounting Opportunities

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Q2.(a) What do you understand by Accounting Cycle? Discuss the steps of Accounting Cycle.

Answers: Various Steps of Accounting Cycle:

The various steps or phases of an accenting cycle are shown in the following diagram along with explanation. In fact

accounting cycle is the stage-wish expression of accounting activities of an organization. The maximum ten steps of
accounting cycle are shown below in a diagram..

1. Identification of
Transaction

10. Reversing Entries 2. Journalizing

9. Post-closing Trial 3. Posting to Ledger

Balance Account

8. Closing Entries
4. Preparation of
Trial Balance
7. Preparation of 6. Adjusted
5. Adjusting Entries
Financial statement Trial
Balance

Work Sheet (Optional)

The Steps of Accounting Cycle are described below:

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(1) Identification of transaction: The first steps of accounting cycle are the identification of transaction. Many
event occur every day in a business concern or in any other organization, But all events are not transactions. The

events that are transactions are accounted for. So, the events which are measured in terms of money and for which
the financial position of an organization is changed are identified as transactions and in the next stage accounts are

maintained for these. For example, a purchase order of Rs 20000 was placed to a person. This is not a transaction
because it brings no financial change. On the other hand purchase of merchandise Rs 20,000 for cash is a

transaction because it has brought financial changes to the business. Therefore, the events measurable m terms of
money and for which financial changes take place are identified as transactions.

(2) Journalizing: The second stage of accounting cycle is journalizing. In this stage of journal, transactions are
recorded in chronological order of dates debiting one account and crediting the other with brief explanation.

(3) Posting to ledger account: The third step or stage of accounting cycle is to classify business transactions. The
statement which is prepared classifying the transactions in groups like income expense, assets and liabilities is called

account. The book where transactions are recorded permanently in classified and summarized way is called ledger. The
recording process of transaction in the ledger is called posting. As all transactions are finally recorded in this book

penitently it is called permanent book of account. It is possible to know various information regarding business from the
balances of ledger account. That is why ledger is called the king of all books of accounts. '

(4) Preparation of trial balance: It is the fourth step of accounting cycle. After preparing ledger accounts a trial balance is
prepared with the help of ledger account balances. Trial balance is a statement prepared at a particular data of period end

including debit and credit balances of ledger account. Trial balance is prepared to proof the arithmetical accuracy of ledger
account and facilitate preparing financial statement.

(5) Adjusting entries: To ascertain operating result of a particular period and exact financial position at a particular data
of a business concern various information regarding accruals and advances is essential to be accounted. These sorts of

information which are not accounted or incorrectly accounted are adjusted through journal entries which are called
adjusting journal entries.

(6) Adjusted trial balance: At the end of each accounting period financial statements of an organization are to be
prepared. But before preparation of financial statements the information relating to particular period which influences the

financial statements are to be Journalized and posted in the ledger accounts again for finding out relevant ledger balances
at the end of the period. The trial balance which is prepared again with these ledger balances is called adjusted trial

balance.

(7) Preparation of financial statements: The seventh stage of accounting cycle is preparation of financial stamens. The

financial statement are prepared form an adjusted trial balance. Financial statements mainly include income statement
and balance sheet. At the end of a particular accounting period to exhibit exact financial position of an organization.

(8) Closing entries: The eighth stage of accounting cycle is preparation of closing entries. Generally after preparation of
financial statements the periodic expenses and incomes including balance of income statement are closed by passing

closing journal entries. The necessity of closing expenses and incomes arises as their utilities ended during the particular
accounting period and these are not carried forward to the next year like assets liabilities.

(9) Post closing trial balance: Post closing trial balance is the ninth stage of accounting cycle. In the trial balance only
assets, liabilities and owner's equity are shown. In this post closing trial balance the total of assets becomes equal to the

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total of liabilities and owner's equity. So it is proved that, A=L+O.E. These assets and liabilities are carried forward to the
next accounting period a opening balances.

(10) Reversal entries: Preparation of reversal entries is the last step of accounting cycle. Passing reversal entries in not
compulsory. (t is an optional step of accounting the beginning of an accounting year which is opposite to outstanding

cycle. Reversal entries are adverse to adjusting entries which are passed at the beginning of next financial year. Infect
reversal entries are passed for outstanding and advances of previous year in and advances.

(11) Work sheet: This is a statement containing multi columns which are prepared at the end of each accounting period.
This is an optional step of accounting cycle, Big business organizations where number of accounts and adjustments are

comparatively huge; work sheet is prepared to facilitate preparation of financial statements conveniently and accurately.
Work sheet is prepared before preparation of financial statements. The steps of work sheet are trial balance, adjustments,

adjusted trial balance, income statement and balance sheet. A worksheet is the complimentary statement to the financial
statements. Financial statements are prepared from the work sheet.

Q2.(b) Generally Accepted Accounting Principles (GAAP)

Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles
(GAAP). To use and interpret financial statements effectively, we need to understand these principles, which can change
over time in response to the demands of users GAAP aims to make information in financial statements relevant, reliable,
and comparable. Relevant information affects the decisions of its users Reliable information is trusted by users
Comparable information is helpful in contrasting organizations.

International Standards

In todays global economy, there is increased demand by external users for comparability in accounting reports. This
demand often arises when companies wish to raise money from lenders and investors in different countries. To that end,
the International Accounting Standards Board (IASB), an independent group (consisting of individuals from many
countries), issues International Financial Reporting Standards (IFRS) that identify preferred accounting practices. If
standards are harmonized, one company can potentially use a single set of financial statements in all financial markets.
Differences between U.S. GAAP and IFRS are slowly fading as the FASB and IASB pursue a convergence process aimed to
achieve a single set of accounting standards for global use. More than 115 countries now require or permit companies to
prepare financial reports following IFRS Further, non-U.S. SEC registrants can use IFRS in financial reports filed with the
SEC (with no reconciliation to U.S. GAAP). This means there are two sets of accepted accounting principles in the United
States: (1) U.S. GAAP for U.S. SEC registrants and (2) either IFRS or U.S. GAAP for non-U.S. SEC registrants. The
convergence process continues and, in late 2008, the SEC set a roadmap for use of IFRS by publicly traded U.S.
companies. This roadmap proposes that large U.S. companies adopt IFRS by 2014, with midsize and small companies
following in 2015 and 2016, respectively. Early adoption is permitted for large multinationals that meet certain criteria.
For updates on this roadmap, we can check with the AICPA (IFRScom), FASB (FASB.org), and IASB (IASB.org.uk).

The FASB and IASB are attempting to converge and enhance the conceptual framework that guides standard setting. The
framework consists broadly of the following:

Objectivesto provide information useful to investors, creditors, and others

Qualitative Characteristicsto require information that is relevant, reliable, and comparable.
Elementsto define items that financial statements can contain.
Recognition and Measurementto set criteria that an item must meet for it to be recognized as an element; and how
to measure that element

Principles and Assumptions of Accounting:

Accounting principles (and assumptions) are of two types. General principles are the basic assumptions, concepts, and
guidelines for preparing financial statements. Specific principles are detailed rules used in reporting business transactions
and events. General principles stem from long-used accounting practices. Specific principles arise more often from the
rulings of authoritative groups. We need to understand both general and specific principles to effectively use accounting
information. Several general principles are described in this section that is relied on in later chapters

Accounting Principles General principles consist of at least four basic principles, four assumptions, and two constraints.
The measurement principle, also called the cost principle, usually means that accounting information is based on
actual cost (with a potential for subsequent adjustments to market). Cost is measured on a cash or equal-to-cash basis.
This means if cash is given for a service, its cost is measured as the amount of cash paid. If something besides cash is
exchanged (such as a car traded for a truck), cost is measured as the cash value of what is given up or received. The cost
principle emphasizes reliability and verifiability, and information based on cost is considered objective. Objectivity means

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that information is supported by independent, unbiased evidence; it demands more than a persons opinion. To illustrate,
suppose a company pays Tk.5,000 for equipment. The cost principle requires that this purchase be recorded at a cost of
Tk.5,000. It makes no difference if the owner thinks this equipment is worth Tk.7,000. Later in the book we introduce fair
value measures. Revenue (sales) is the amount received from selling products and services. The revenue recognition
principle provides guidance on when a company must recognize revenue. Recognize means to record it. If revenue is
recognized too early, a company would look more profitable than it is. If revenue is recognized too late, a company would
look less profitable than it is.Three concepts are important to revenue recognition. (1) Revenue is recognized when earned.
The earnings process is normally complete when services are performed or a seller transfers ownership of products to the
buyer. (2) Proceeds from selling products and services need not be in cash. A common noncash proceed received by a seller
is a customers promise to pay at a future date, called credit sales. (3) Revenue is measured by the cash received plus the
cash value of any other items received. The expense recognition principle, also called the matching principle, prescribes
that a company record the expenses it incurred to generate the revenue reported. The principles of matching and revenue
recognition are key to modern accounting. The full disclosure principle prescribes that a company report the details
behind financial statements that would impact users decisions. Those disclosures are often in footnotes to the statements.

Accounting Assumptions: There are four accounting assumptions: the going concern assumption, the monetary unit
assumption, the time period assumption, and the business entity assumption. The going-concern assumption means
that accounting information reflects a presumption that the business will continue operating instead of being closed or
sold. This implies, for example, that property is reported at cost instead of, say, liquidation values that assume closure.
The monetary unit assumption means that we can express transactions and events in monetary, or money, units. Money
is the common denominator in business. Examples of monetary units are the dollar in the United States, Canada,
Australia, and Singapore; and the peso in Mexico, the Philippines, and Chile. The monetary unit a company uses in its
accounting reports usually depends on the country where it operates, but many companies today are expressing reports in
more than one monetary unit. The time period assumption presumes that the life of a company can be divided into time
periods, such as months and years, and that useful reports can be prepared for those periods. The business entity
assumption means that a business is accounted for separately from other business entities, including its owner. The
reason for this assumption is that separate information about each business is necessary for good decisions. A business
entity can take one of three legal forms: proprietorship, partnership, or corporation.

Q2.(c ) ACCOUNTING EQUATION

Accounting Equation:

Definition and Explanation of Accounting Equation:

Dual aspect may be stated as "for every debit, there is a credit." Every transaction should have twofold effect to the extent
of the same amount. This concept has resulted in accounting equation which states that at any point of time the assets
of any entity must be equal (in monetary terms) to the total of equities. In other words, for every business enterprise, the
sum of the rights to the properties is equal to the sum of the properties owned. The properties of the business are called
"assets". The rights to the properties are called "equities". Equities may be sub-divided into two principle types: The rights
of the creditors and the rights of the owners The equity of the creditors represents debts of the the business and are called
liabilities. The equity of the owner is called capital, or proprietorship or owner's equity.

The formula know as the accounting equation, thus arrived at is as follows:

Assets = Equities

OR

Assets = Liabilities + Proprietorship

Another method of demonstrating the mathematical relationship involves a simple variation in the
form of equation. Again it begins with the position that every business owns or has interest in
certain assets. It also owes certain amounts to its creditors The difference between what it owns and
what it owes represents the owner's capital or proprietorship. Thus the original equation is changed
into:

Assets - Liabilities = Proprietorship

Effects of Transactions on the Accounting Equation:

Each and every business transaction affects the elements of accounting equation. The effect is shown by the use of (+) or
(-) placed against the elements affected. Note particularly that the equation remains in balance after each transaction. The
accounting equation can be understood with the help of the following example:

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Example:

Transaction 1:

Mr. Riaz commences his business with cash Rs50,000. This is an example of investment of asset in the business by the
owner. The effect of this transaction on the accounting equation is that cash asset is increased by Rs50,000 and the
proprietoRship (Riaz's capital) is also increased by the same amount such as:

Assets = Liabilities + Proprietorship

Cash Riaz, Capital
+ 50,000 = ---- + 50,000

Effects of all the transactions explained above are presented in the following table:

Assets = Liabilities + Proprietorship

Cash + Furniture + Merchandise + Debtors Creditors + Riaz, Capital
1 + 50,000 +50,000

50,000 = + 50,000
2 - 10,000 + 10,000

40,000 10,000 = + 50,000

3 - 10,000 + 10,000

30,000 10,000 10,000 = + 50,000

4 + 5,000 + 5,000

30,000 10,000 15,000 = 5,000 + 50,000

5 + 2,000 - 1,500 + 500 (Profit)

32,000 10,000 13,500 = 5,000 + 50,500

6 - 3,000 + 4,000 + 1,000 (Profit)

32,000 10,000 10,500 4,000 = 5,000 + 51,500

7 - 1,000 - 1,000

31,000 10,000 10,500 4,000 = 4,000 + 51,500

8 +1,000 1,000

32,000 + 10,000 + 10,500 + 3,000 4,000 + 51,500

9 1,000 1,000

31,000 10,000 10,500 3,000 = 4,000 + 50,500

The elements of the equation of Mr. Riaz that is,

Cash + Furniture + Merchandise + Debtors = Creditors + Capital

31,000 + 10,000 + 10,500 + 3,000 = 4,000 + 50,500

This may also be stated in vertical form as shown below:

EQUITIES ASSETS

Creditors Rs4,000 Cash Rs31,000

Capital Rs50,500 Debtors 3,000
Merchandise 10,500
Furniture 10,000

Rs54,500 Rs54,500

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The presentation of the effects of transactions in tabular form is only a device which helps beginners to understand the analysis of different types of
transactions. It is not practically feasible to record the effects of transactions in this form. The increases and decreases in the various elements are
recorded in the journal in a special technical form.

Q3.(a) FINANCIAL STATEMENTS OF BANKS

This section introduces us to how financial statements are prepared from the analysis of business transactions. The four
financial statements and their purposes are:

1. Income statement describes a companys revenues and expenses along with the resulting net income or loss over a
period of time due to earnings activities.

2. Statement of owners equity explains changes in equity from net income (or loss) and from any owner investments
and withdrawals over a period of time.

3. Balance sheet describes a companys financial position (types and amounts of assets, liabilities, and equity) at a
point in time.

4. Statement of cash flows identifies cash inflows (receipts) and cash outflows (payments) over a period of time.

ELEMENTS OF FINANCIAL STATEMENTS

The elements which are directly related to the measurement of financial position are assets, liabilities and equity. The
elements which are directly related to the measurement of profit are income and expenses.

Asset: An asset is a resource controlled by the enterprise as a result of past events and from which future economic
benefits are expected to flow to the enterprise.

Liability: A liability is a present obligation of the enterprise arising from past events the settlement of which is expected to
result in an outflow from the enterprise of resources embodying economic benefits. There is a distinction between a
present obligation and future commitment. A decision by the management of an enterprise to acquire assets in future does
not of itself give the rise to a present obligation.

Equity: In a corporate enterprise equity is classified in the Balance Sheet as Share Capital and Reserve and Surplus.
Normally Equity is shown at its paid up value.

Income and Expenses: Income is increase in economic benefits during the accounting period in the form of inflows or
enhancement of assets or decrease of liability that result in increase of equity. Whereas expenses are decreases in
economic benefits during the accounting period in the form of' outflows or depletion of assets or increases in liabilities that
result in decrease in equity other than those relating to distribution to equity participants

Measurement of elements of financial statements

Usually measurement is the process of assigning number or symbols to the characteristics of an object according
to some pre-specified rules.

Measurement is the process of determining the monetary amounts at which the elements of the financial statement are to
be recognized and carried in the Balance Sheet and Income Statement. A number of different measurements are employed
to define degrees in financial statements. They are as follows:

a) Historical cost
b) Current cost
c ) Realistic value
d) Present value.

The commonly adopted basis is historical cost.

Concept of Capital

The financial concept of capital is adopted by most enterprises in preparing their financial statements. Capital is
synonymous with the net assets or equity of the enterprise under a financial concept such as invested money or invested
purchasing power.

Q3. (b) A trial balance does not guarantee freedom from recording errors, however. Numerous errors may exist
even though the trial balance columns agree. For example, the trial balance may balance even when:

1. a transaction is not journalized,

2. a correct journal entry is not posted,

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3. a journal entry is posted twice,
4. incorrect accounts are used in journalizing or posting, or
5. offsetting errors are made in recording the amount of a transaction.

As long as equal debits and credits are posted, even to the wrong account or in the wrong amount, the total debits will
equal the total credits. The trial balance does not prove that the company has recorded all transactions or that the
ledger is correct.

Errors in a trial balance generally result from mathematical mistakes, incorrect postings, or simply transcribing data
incorrectly. What do you do if you are faced with a trial balance that does not balance? First determine the amount of the
difference between the two columns of the trial balance. After this amount is known, the following steps are often helpful:

### How to locate errors in the trial balance?

1. If the error is $1, $10, $100, or $1,000, re-add the trial balance columns and re-compute the account balances.

2. If the error is divisible by 2, scan the trial balance to see whether a balance equal to half the error has been
entered in the wrong column.

3. If the error is divisible by 9, retrace the account balances on the trial balance to see whether they are
incorrectly copied from the ledger. For example, if a balance was $12 and it was listed as $21, a $9 error has been
made. Reversing the order of numbers is called a transposition error.

4. If the error is not divisible by 2 or 9, scan the ledger to see whether an account balance in the amount of the
error has been omitted from the trial balance, and scan the journal to see whether a posting of that amount has
been omitted.

Q4.(a) Definition and Explanation:

From time to time the balance shown by the bank and cash column of the cash book required to be checked. The balance
shown by the cash column of the cash book must agree with amount of cash in hand on that date. Thus reconciliation of
the cash column is simple matter. If it does not agree it means that either some cash transactions have been omitted from
the cash book or an amount of cash has been stolen or lost. The reason for the difference is ascertained and cash book
can be corrected. So for as bank balance is concerned, its reconciliation is not so simple. The balance shown by the bank
column of the cash book should always agree with the balance shown by the bank statement, because the bank statement
is a copy of the customer's account in the banks ledger. But the bank balance as shown by the cash book and bank
balance as shown by the bank statement seldom agrees. Periodically, therefore, a statement is prepared called bank
reconciliation statement to find out the reasons for disagreement between the bank statement balance and the cash
book balance of the bank, and to test whether the apparently conflicting balance do really agree.

Causes of Disagreement Between Bank statement and Cash book:

Usually the reasons for the disagreement are:

1. That our banker might have allowed interest which have not yet been entered in our cash book.
2. That our banker might have debited our account for any such item as interest on overdraft, commission for
collecting cheque, incidental charges etc., which we have not entered in the cash book.

3. That some of the cheque which we drew and for which we credited our bank account prior to the date of closing,
were not presented at the bank and therefore, not debited in the bank statement.

4. That some cheques or drafts which we have paid into bank for collection and for which we debited our bank
account, were not realized within the due date of closing and therefore, not credited by the bank.

5. The banker might have credited our account with amount of a bill of exchange or any other direct payment into
bank and the same may not have been entered in the cash book.

6. That cheques dishonored might have been debited in the bank statement but have not been given effect to in our
books.

How to Prepare a Bank Reconciliation Statement:

To prepare the bank reconciliation statement, the following rules may be useful for the students:

1. Check the cash book receipts and payments against the bank statement.

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 2. Items not ticked on either side of the cash book will represent those which have not yet passed through the bank
statement.

3. Make a list of these items.

4. Items not ticked on either side of the bank statement will represent those which have not yet been passed
through the cash book.

5. Make a list of these items.

6. Adjust the cash book by recording therein those items which do not appear in it but which are found in the bank
statement, thus computing the correct balance of the cash book.

7. Prepare the bank reconciliation statement reconciling the bank statement balance with the correct cash book
balance in either of the following two ways:

(i) First method (Starting with the cash book balance)

(ii) Second method (Starting with the bank statement balance)

First Method (Starting With the Cash Book Balance):

If the cash balance is a debit balance, deduct from it all cheques, drafts etc., paid into the bank but not collected
and credited by the bank and added to it all cheques drawn on the bank but not yet presented for payment. The
(a)
new balance will agree with bank statement.
If the bank balance of the cash book is a credit balance (overdraft), add to it all cheques, drafts, etc., paid into the
bank but not collected by the bank and deduct from it all cheques drawn on the bank but not yet presented for
(b)
payment. The new balance will then agree with the balance of the bank statement.

Second Method (Starting With the Bank Statement Balance):

(a) If the bank statement balance is a debit balance (an overdraft), deduct from it all cheques, drafts, etc., paid into
bank but not collected and credited by the bank and add to it all cheques drawn on the bank but not yet presented
for payment. The new balance will then be agree with the balance of the cash book.
(b) If the bank statement balance is a credit balance (in favor of the depositor), add to it all cheques, drafts, etc., paid
into the bank but not collected and credited by the bank and deduct from it all cheques drawn on the bank but not
yet presented for payment. The new balance will agree with the balance of the cash book.

Alternatively:
Cash book shows debit balanceCash book shows credit
i.e., bank statement shows balance i.e., bank statement
Information
credit balance shows debit balance
CB to BS BS to CB CB to BS BS to CB
Cheques issued but not presented in the
Add Less Less Add
bank
Cheques paid into bank but not collected
Less Add Add Less
and credited by the bank
Credit, if any in the bank statement Add Less Less Add
Debit, if any in the bank statement less Add Add Less

Example 1:

On December 31 2011 the balance of the cash at bank as shown by the cash book of a trader was Tk.1,401 and the
balance as shown by the bank statement was 2,253.

On checking the bank statement with the cash book it was found that a cheque for Tk.116 paid in on the 31st December
was not credited until the 1st January, 1992 and the following cheques drawn prior to 31 December were not presented at
the bank for payment until the 5th January 1992. Rashid & Sons Tk.29, Bashir & Co. Tk.801, MA Jalil Tk.6, Khalid Bros.,
Tk.132.

Prepare a statement recording the two balances:

Solution:

Bank Reconciliation Statement on 31st December 2011

10
First Method:
Balance as per cash book - Dr. 1,401
Less cheques paid in but not collected 116

1,285
Add cheques drawn but not presented:
Rashid & Sons 29
Bashir & Co. 801
MA Jalil 6
Khalid Bros. 132 968

Balance as per bank statement - Cr. 2,253

Second Method:
Balance as per bank statement - Cr. 2,253
Less cheques drawn but not presented 968

1,285
Add cheques paid in but not collected 116

Balance as per cash book - Dr. 1,401

Example 2:

On 31st March, 2011 the bank statement showed the credit balance of Tk.10,500. Cheque amounting to Tk.2,750 were
deposited into the bank but only cheque of Tk.750 had not been cleared up to 31st March. Cheques amounting to
Tk.3,500 were issued, but cheque for Tk.1,200 had not been presented for payment in the bank up to 31st March. Bank
had given the debit of Tk.35 for sundry charges and also bank had received directly from customers Tk.800 and dividend
of Tk.130 up to 31st March. Find out the balance as per cash book.

Solution:

Bank Reconciliation Statement as on 31st March, 2011

Balance as per bank statement - Cr. 10,500

Add cheques deposited but not credited 750

11,250
Less cheques issued but not presented 1,200

10,050
Add bank charges made by the bank 35

10,085
Less omission in cash book (Tk.800 + Tk.130) 930

Balance as per cash book 9,155

Note:

1. Charges made by the bank Tk.35 have not been recorded in the cash book, therefore, the balance in cash book is
more. Add to bank statement balance also.
2. Dividend and amount from customers received by the bank have not been recorded in the cash book. Therefore, in the cash book there is
no entry of Tk.930 (800 + 130). Deduct from the bank statement balance to adjust it according to cash book balance.

11
 1. Charges made by the bank Tk.35 have not been recorded in the cash book, therefore, the balance in cash book is
more. Add to bank statement balance also.

2. Dividend and amount from customers received by the bank have not been recorded in the cash book. Therefore,
in the cash book there is no entry of Tk.930 (800 + 130). Deduct from the bank statement balance to adjust it
according to cash book balances.

###Reasons for disagreement between the balance of Cash Book and the Fuss book:
The detailed reasons for disagreement between the balance of bank as per the books of the depositor and balance The
shown in the Pass book are discussed below:

1. Chouse issued bill not yet presented to the Bank for payment: There may be some cheques issued and recorded
in the books of the depositor, which have not been presented to the hank for payment as yet. Consequently, there is
no record of them in the pass Book.

2. Cheques and Bills deposited but not yet collected by the Bank: There may be sonic cheques and bills deposited
with the bank and record in the books of the depositor, which have not been collected until now. Consequently,
there is no record of them in the Pass Book.

3. Dishonor of Cheques and Bills deposited: There may be some chouse and bills deposited with the bank and
recorded in the books of the depositor, which have subsequently been returned dishonored. Consequently, there is
no record of them in the Pass Book.

4. Direct payment into Bank: Some debtors of the depositor might have deposited money directly into the bank;
which has been recorded in the Pass Book but not in the books of the depositor.

5. Bills Receivable collected by the Bank: Some bills receivable of the depositor might have hccn collected by the
bank, which have been recorded in the Pass Book but not in the bonks of lhe depositor

6. Hills Payablt paid by the Bank: Sonic bills payable of the depositor might have been paid by the hank, which have
been recorded in the Pass book, But not in the books of the depositor.

7. Bank Interest: Bank might have credited or debited interest ol" the depositor's balance or loan respectively, which
has been recorded in the Pass Book but not in the books of the depositor.

8. Bank Charges: Bank might have debited the account of the depositor for commission etc., wind) has been recorded in
the Pass Book but not in 'the books of the depositor. If, for any of the above reasons, the balance of bank as per t
books of the depositor does not agree with the balance shown in it Pass Book (or Bank Statement), these two
balances are reconciled by preparing a statement; is on a particular date. This is called Bank Reconciliation
Statement.
So, a Bank Reconciliation Statement is one that is prepared on a particular date 'with the object I" reconciling the
balance bank as -per the books of the depositor with the balance shown the [W Book (or Rank Statement), on
disagreement between if two balances.

Q4.(b) Answer

Date Details Reference Debit ($) Credit ($)

(i) Cash Account Debit 1,00,000
Capital Account Credit 1,00,000
(ii) Prepaid Insurance Debit 10,000
Drawings Debit 2,000
Cash Account Credit 12,000
(iii) Purchase Account Debit 48,000
Drawings Account Debit 2,000
Cash Account Credit 50,000
(iv) Cash Account Debit 30,000
Bank Account Debit 30,000
Accounts Receivable Debit 60,000
Sales Account Credit 1,20,000
(v) Rent Expense Debit 5,000
Rent Payable Credit 5,000
(vi) Cash Account Debit 500
Commission Revenue Credit 500
(vii) Accounts Receivable Debit 5,000
Sales Account Credit 5,000
(viii) Cash Account Debit 10,00,000
Bank Loan Credit 10,00,000
Total

12
Prepare necessary ledger and trial balance-Try Yourself. (Left for Your own practice)

Q5.(a) Definition of Book-Keeping

Book-keeping, as the very name suggests, is the combination of two terms Book, and "Keeping, Book conveys the
idea of books of accounts of a trader and "keeping" implies maintaining such books of account suitable manner. Thus the
term Book keeping implies the method of keeping books of account of an account of a trader in systematic manner.

The early history of book-keeping is as old as human civilization. It has achieved its present status gradually with the
gradual evolution of human civilization. Man, as a member of the society, requires goods and services from others and
every such transaction brings about some changes in the economic and financial position of the parties concerned. The
concept of book-keeping originated perhaps, to record the effect of economic and financial changes of the parties involved
in a transaction.

Book-keeping is defined by many ravened authors in various outlooks. A few important definitions
of Book-Keeping are given below.
Authors Comments (Definition)

Dickee Book-keeping may be defined as the science of correctly recording in books transactions
involving the transacted of money or moneys worth.

Chambers Book-keeping: The art of keeping accounts in a regular and systematic manner.
Twentieth
Century
Dictionary

Dawsons Book-keeping is the art (based on certain scientific principles) of correctly recording
Accountants transactions (generally mercantile) which involve the transfer of money or moneys worth.
Compendium

Robert T. Book-keeping: The procedure used for classifying and recording business transactions for the
March purpose of reporting the financial condition of the enterprise at a subsequent data.

With the light of above definitions, Book-keeping may be termed as a technique of recording financial transactions
permanently in the books of accounts to control assets, liabilities, incomes and expenses in a scientific manner. So, the
following items are included in Book-keeping:
(a) The analysis of financial transacts lolls.
(b) The recording of financial transactions regularly and correctly in the books of accounts. More Definitions of
Accounting (Different accounting intellectuals across the world)

Accounting refers to the process of identifying, measuring and communicating economic information to permit informed
judgments and decisions by users of the information.

Many definitions are given by the writers of the accounting. A few important definitions of
accounting are given below:
Authors Definition

Weygandt, Accounting is an information system that identifies, records, and communicates the economic events of an
Kieso and organization to interested users
Kimmel

Kochnek and Accounting is the set of rules and methods by which financial and economic data are collected, processed, and
Hillman summarizing into reports that can be used in making decisions.

F.W Fixley Accounting may be described as the science which deals with the recording of monetary transactions of every
description.

Pyle and Accounting is the art of recording, classifying, reporting and interpreting the financial data of an organization
Larson

Tayler and Accounting may be defined as the art and science of recording business in a methodical manner so as to show

13
 Shearing

F.W. Johnson Accounting may be defined as the collection, compilation and systematic recording of business transactions in
term of money, preparations of financial reports, the analysis and interpretation of these reports for the
information and guidance of management.

American Accounting is the art of cording, classifying and summarizing in a significant manner and in terms of money,
Institute of transactions and events which are, in part at least, of a financial character and interpreting the results thereof
Certified Public
Accountants
Committee on
Terminology

Robert N. Accounting is a system for collecting, summarizing analysis and reporting in money terms, information about an
Anthony organization.

Needles, Accounting is defined as an information system that measures, process, and communicates financial information
Anderson, about an identifiable economic entity.
Caldwell

Dupree & The act of collecting, processing, reporting, analyzing, interpreting, and projecting financial information is called
others Accounting.

With the help of above definitions, Accounting may be defined as the art of science of recording of financial transactions
and events in a scientific manner in the books of accounts and determination of financial result and financial position and
preparation of informative reports on the basis of financial results and financial position for the related persons of
concern.

Accountancy:

The discipline that deals with the effects and outcome of financial activities of a person or organizations is called
Accountancy.

Accountancy is all applied discipline. The system in which financial transactions of all organization for a particular period
are recorded to know the operating results and the financial position of that concern to analyze and communicate the
same to interested users is called Accountancy. Determining and analyzing the effects and results of the financial events of
all organization are the main functions of Accountancy.

Renowned accountants and institutes have given various definitions of Accountancy. Some quotable definitions are
mentioned bellow:

Accountants and Institutes Comments (Definition)

According to A.W. Johnson
Accounting may be defined as the collection, compilation and
systematic recording of business transactions in terms of money, the
preparation of financial reports, the analysis and interpretation of these
report and the use of these reports for the information and guidance of
management

American Institute of Certified
Public Accountants (AICPA)
Accounting is the art of recording, classifying and summarizing in a
significant manner and in terms of money, transactions and events,
which are, in part at least, of a financial character and interpreting the
result therefore.

American Accounting Accounting refers to the process of identifying measuring and

Association (AAA) communicating economic information to permit informed judgments and
decisions by users of the information.

Accounting is an information system that identifies records and

communicates the economic events of an organization to interested
users

14
Distinguish between Book-keeping and Accounting.

DISTINCTION BETWEEN BOOK-KEEPING

AND ACCOUNTING

Basis of Book-keeping Accounting

distinction
1. Objective The objective of Book-keeping is to maintain Accounting aims at maintaining business
records of business transactions. records, calculation of business income,
depiction of financial position of business and
communication of business results.
2. Function The function of Book-keeping is to record The function of Accounting is the recording,
business transactions as and when they take classifying, summarizing, interpreting business
place. transactions and communicating the results.
3. Scope It has a limited scope. It is a part of accounting. Its scope is wider. Besides Book-keeping, it
includes classification, summarization,
interpretation and communication.
4. Level of It does not require special knowledge. Only In accounting advance and conceptual
knowledge elementary knowledge of accounting is sufficient. understanding is required.
5. Basic For recording business transactions, vouchers Accounting work is carried on from records
and other supporting documents are prepared. which are available from book-keeping.

Accountancy, Accounting and Book-keeping:

Accountancy refers to a systematic knowledge of accounting. It explains why to do and how to do of various aspects of
accounting. It tells us why and how to prepare the books of accounts and how to summarize the accounting information
and communicate it to the interested parties.

Accounting refers to the actual process of preparing and presenting the accounts. In other words, it is the art of putting
the academic knowledge of accountancy into practice.

Book-keeping is a part of accounting and is concerned with record keeping or maintenance of books of accounts. It is
often routine and clerical in nature.

Q5(b) Capital Transactions

The business transactions, which provide benefits or supply services to the business concern for more than one year or
one operating cycle of the business, are known as capital transactions. The transactions which relate to capital are again
sub-divided into capital expenditure and capital receipt.

Capital Expenditure

Capital expenditure consists of those expenditures, the benefit of which is carried over to several accounting periods. In
other words the benefit of which is not consumed within one accounting period. It is non-recurring in nature.

Characteristics

In other words, it refers to the expenditure, which may be

i. purchase of a fixed asset.
ii. not acquired for sale.
iii. it is non-recurring in nature.
iv. incurred to increase the operational efficiency of the business concern.

Examples

i. Expenses incurred in the acquisition of Land, Building, Machinery, Furniture, Car, Goodwill, Copyright, Trade Mark,
Patent Right, etc.
ii. Expenses incurred for increasing the seating accommodation in a cinema hall.
iii. Expenses incurred for installation of fixed assets like wages paid for installing a plant.
iv. Expenses incurred for remodeling and reconditioning an existing asset like remodeling a building.

Capital Receipt

Capital receipt is one which is invested in the business for a long period. It includes long term loans obtained from others
and any amount realized on sale of fixed assets. It is generally non-recurring in nature.

Characteristics
i. Amount is not received in the normal course of business.
ii. It is non-recurring in nature.

15
Examples
i. Capital introduced by the owner
ii. Borrowed loans
iii. Sale of fixed asset

Revenue Transactions

The business transactions, which provide benefits or supplies services to a business concern for an accounting period
only, are known as revenue transactions. Revenue transactions can be Revenue Expenditure or Revenue Receipt.

Revenue Expenditure

Revenue expenditures consist of those expenditures, which are incurred in the normal course of business. They are
incurred in order to maintain the existing earning capacity of the business. It helps in the upkeep of fixed assets.
Generally it is recurring in nature.

Characteristics

i. It helps in maintaining the earning capacity of the business concern.

ii. It is recurring in nature.

Examples

i. Cost of goods purchased for resale.

ii. Office and administrative expenses.
iii. Selling and distribution expenses.
iv. Depreciation of fixed assets, interest on borrowings etc.
v. Repairs, renewals, etc.

Revenue Receipt

Revenue receipt is the receipt of income which is earned during the normal course of business. It is recurring in nature.

Characteristics

i. It is received in the normal course of business.

ii. It is recurring in nature.

Examples

i. Sale of goods or services.

ii. Commission and Discount received.
iii. Dividend and interest received on investments etc.

Deferred Revenue Expenditure

A heavy revenue expenditure, the benefit of which may be extended over a number of years, and not for the current year
alone is called deferred revenue expenditure. For example, a new firm may advertise very heavily in the beginning to
capture a position in the market. The benefit of this advertisement campaign will last for quite a few year Tk. It will be
better to write off the expenditure in three or four years and not only in the first year.

Characteristics

i. Benefit is enjoyed for more than one year

ii. It is non-recurring in nature

Examples

i. Expenses incurred on research and development

ii. Abnormal loss arising out of fire or lightning (in case the asset
has not been insured).
iii. Huge amount spent on advertisement.

Revenue expenditure, Capital Expenditure and

Deferred revenue expenditure Distinction

Distinction Capital Expenditure and Revenue Expenditure

16
1. Period of benefit -Benefit is enjoyed Benefit is consumed Benefit enjoyed for beyond the during the current more than
one year accounting year,- But in case of capital expenditure the benefit extends more than one year.

2. Purpose Relates to the Incurred for Relates to the acquisition of fixed the purpose of capturing or assets generating
revenue.

3. Nature of Non-recurring Recurring in Non-recurring occurrence in nature.

Capital profit and Revenue profit

In order to find out the correct profit and the true financial position, there must be a clear distinction between capital
profit and revenue profit.

Capital profits

Capital profit is the profit which arises not from the normal course of the business. Profit on sale of fixed asset is an
example for capital profit.

Revenue profits

Revenue profit is the profit which arises from the normal course of the business. i.e, Net Profit the excess of revenue
receipts over revenue expenditures.

Capital loss and Revenue loss

In order to ascertain the loss incurred by a firm it is important to distinguish between capital losses and revenue losses.

Capital Losses

Capital losses are the losses which arise not from the normal course of business. Loss on sale of fixed asset is an example
for capital loss.

Revenue Losses
Revenue losses are the losses that arise from the normal course of the business. In other words, net loss i.e., excess of
revenue expenditures over revenue receipts.

Illustration 1:

Sumon & Co., incurred the following expenses during the year 2012.Classify the following items under capital or revenue:

i. Purchase of furniture Tk.1,000.

ii. Purchase of second hand machinery Tk.4,000.
iii. Tk.50 paid for carriage on goods purchased.
iv. Tk.175 paid for repairs on second hand machinery as soon as it was purchased.
v. Tk.600 wages paid for installation of plant.

Solution

i. Capital expenditure as it results in the acquisition of fixed asset.

ii. Capital expenditure as it results in the acquisition of fixed asset.
iii. Revenue expenditure expenses incurred on purchases of goods for sale.
iv. Capital expenditure as it is spent for bringing the asset into working condition.
v. Capital expenditure as it is spent for bringing the asset into working condition.

Statement of cash flows A basic financial statement that provides information about the cash receipts, cash payments,
and net change in cash during a period, resulting from operating, investing, and financing activities.

Example:

A. Cash flows from operating activities:

Cash receipts from customers $978,000

Less: Cash payments:

To suppliers $ 678,000
For operating expenses 179,000

17
 For income taxes 24,000 881,000

Net cash provided by operating activities 97,000/=

B. Cash flows from investing activities

Purchase of equipment (180,000)
Sale of equipment 17,000

Net cash used by investing activities (163,000)

C. Cash flows from financing activities:

Issuance of bonds payable 130,000
Payment of cash dividends (32,000)

Net cash provided by financing activities 98,000

(A+B+C) Net increase in cash 32,000
Cash at beginning of period 159,000
Cash at end of period $191,000

Note: Non-cash investing and financing activities

Issuance of common stock to purchase land $ 60,000

Juarez Company
Stat
KOSINSKI MANUFACTURING COMPANY

Statement of Cash FlowsDirect Method

For the Year Ended December 31, 2012

A. Cash flows from operating activities:

Cash collections from customers $6,418,000*

Cash payments:

For operating expenses $4,843,000**

For income taxes 353,000 5,196,000

Net cash provided by operating activities 1,222,000

B. Cash flows from investing activities

Sale of machinery 270,000

Purchase of machinery (750,000)

Net cash used by investing activities (480,000)

C. Cash flows from financing activities

Payment of cash dividends (200,000)

Net cash used by financing activities (200,000)

(A+B+C) Net increase in cash 542,000
Cash at beginning of period 130,000
Cash at end of period $ 672,000

Direct-Method Computations:

*Computation of cash collection from customers:

Sales revenue per the income statement $6,583,000
Deduct: Increase in accounts receivable (165,000)
Cash collections from customers $6,418,000
** Computation of cash payments for operating expenses:
Operating expenses per the income statement $4,920,000
Deduct: Loss from sale of machinery (24,000)
Deduct: Decrease in inventories (33,000)
Deduct: Increase in accounts payable (20,000)
Cash payments for operating expenses $4,843,000

Q5 (c) Cash Forecast vs. Cash Flow Statement

18
L Cash flow forecasts
An accurate cash flow forecast is an asset as essential as an online presence or a key staff member. In fact, its a vital cog
in the financial machine that can quite literally inspire confidence in you and your business. At its core, a cash flow
forecast simply predicts for a given period:
The amount of cash going into your business
The amount going out
And the amount you have left.
It sounds quite underwhelming, but cash budgeting is a powerful tool. It allows you to prepare for any shortfalls in the
future and it shows investors you know what youre talking about inspiring confidence all round. Cash flow records are
usually provided as spreadsheet documents that accompany the Final Accounts (containing a Trading, Profit and Loss
Account, and a Balance Sheet). Together, they form the core financial documents of a company. A cash flow forecast takes
exactly the same structure as a cash flow record.

Benefits of Cash Budgeting

Forces small business owners to think ahead
Helps them see when commitments are due and whether money is available to meet them
Reveals weaknesses in debt collection policy
Shows periods where shortages of cash may occur and when there might be excess cash
Gives small business owners the ability to undertake a comparison with actual results
r Ended December 31, 2012
CASHFLOW FORECASTS

CASHFLOW:

Cash flow is simply the movement of money into and out of a business over a certain length of time. The Net Cash flow is
the difference between money coming in and money going out; it may be positive (ending with a surplus) or negative
(ending with a deficit). Annual Net Cash flow is the difference between money coming in and going out over a period of
one year; it may also be negative or positive.
Capital Needs
A business owner must have capital for business activity. The owner needs to know how much capital will be required
and when it will be needed. He may need to agree the amount and the timing in advance with a bank.
The cash flow budget is a forecast, normally for one year, of the flow of money. It shows the amounts of money expected to
be spent and received and also the expected timing of transactions. Knowing this, funds can be made available to pay the
necessary outgoings of the business. While it is preferable that income is always greater than expenditure throughout the
year, this is seldom the case and borrowing is needed. Lenders need reassurance that the business will be able to repay
its debts.
Cash and the Cash flow Budget
Cash refers to amounts paid directly into or debited from a bank account.
Receipts and payments are the total of the funds and can be categorised as Trading, Capital or Personal:
Trading items refer to the normal payments and expenditure of business activity and are contained in the Profit
or Loss account.
Capital refers to the fixed assets of the owner and the assets needed to run the business e.g. machinery, breeding
livestock and fixed equipment along with the funds needed to finance it. The value of these items is recorded in the
balance sheet at the beginning and end of the financial year.
Personal items refer to the owners domestic expenditure or receipts.

Receipts
Trading receipts are the cash received from the sale of livestock or produce, or services such as contract work. Receipts
also come from the funds generated when debtors make payment for the goods they have bought previously. Capital
receipts come from sale of Fixed Assets. New cash (funds) can be borrowed from other sources including relatives, banks,
venture capitalists or can be introduced by the owner from personal wealth; DEFRa and other grants are included in this
category.

Payments

Trading payments are the cash paid for Goods and Services bought. Funds are also needed when creditors are reduced
(debts repaid).
Capital payments are made for purchasing Fixed Assets. Funds are needed to repay borrowing from outside the business.
The owner can also take funds out of the business to live on.

19
CASHFLOW BUDGETS

Cash flow budgets have two important features. They show when a money transaction is expected to occur and they put
that transaction into a category that defines what the payment or receipt is for. Conventionally, timing is arranged in
columns, typically for each month or quarter. Categories are in rows running across a page. Since all businesses are
different, the exact make up of the categories will vary from farm to farm. However, it is often helpful to use the broad
groupings listed above (Trading, Capital & Personal).
The budget will highlight when cash shortages are likely to arise. Either plans can be adjusted to prevent this (production,
marketing) or funds can be sought from lenders to bridge the cash gap until income arises.
It is important that realistic estimates are made, both of money amounts and of timings. This also requires realistic
estimates of physical performance. If budgets are found later to be over-optimistic, lenders will be much more wary
another time and may be unprepared to fund the business further. Over-pessimism should also be avoided, since it may
prevent opportunities being recognized, encourage over-borrowing and de-motivate management and staff.

20
21
INFLATION AND CASHFLOW BUDGETS
Currently in the UK inflation is low enough to be ignored.

Judgmental approach:
Definition: The Judgmental Approach is a method for developing the Pro Forma Balance Sheet where values
of certain balance sheet accounts are estimated, and others are calculated, based on a ratio analysis.

Note: Projected changes in assets from the latest fiscal year to the forecast year determines the Total
Financing Required (TFR).

Summary
Pro Forma statements are vital for
Management to evaluate the future expected financial position
Investors and Creditors to evaluate the firms ability to provide a return on funds invested
Three key outputs of forecasting:
Pro forma income statement
Pro forma balance sheet
Statement of external financing requirements
Inputs:
Financial statements from the previous year
Sales forecast for the forecast year
Forecasts for all other financial statement accounts
Approach (pro forma income statement):
Percentage-of-sales & its weaknesses
Judgmental approach (pro forma balance sheet)

Q5 (d) What are tangible Assets?

Plant assets are tangible resources used in the operations of a business and not intended for sale to
customers Plant assets are subdivided into four classes: Land; Land improvements; Buildings;
Equipment. Plant assets are recorded at cost in accordance with the cost principle. Cost consists of all
expenditures necessary to acquire the asset and make it ready for its intended use includes purchase
price, freight costs, and installation costs, Expenditures that are not necessary recorded as expenses,
losses, or other assets.

Q5. (d) What are intangible assets?

INTANGIBLE ASSETS

PATENTS

A patent
exclusive right issued by the Patent Office
manufacture, sell, or otherwise control an invention for a period of 20 years from the date
of grant
Cost of a patent
initial cost is the cash or cash equivalent price paid to acquire the patent
legal costs amount an owner incurs in successfully defending a patent are added to the
Patent account and amortized over the remaining useful life of the patent
should be amortized over its 20-year legal life or its useful life, whichever is shorter.
National Labs purchases a patent at a cost of Tk.60,000. If the useful life of the patent is 8 years,
the annual amortization expense is Tk.7,500 (Tk.60,000 8).
Amortization Expense is classified as an operating expense in the income statement. The entry to
record the annual patent amortization is:

COPYRIGHTS

Copyrights
grants from the federal government
gives the owner the exclusive right to reproduce and sell an artistic or published work
Copyrights extend for the life of the creator plus 70 years

22
 The cost of a copyright is the cost of acquiring and defending it.

A trademark or trade name

word, phrase, jingle or symbol identifying a particular enterprise or product
Trademark or trade name purchased
the cost is purchase price
Trademark developed by a company
the cost includes attorneys fees, registration fees, design costs and successful legal
defense fees

Franchise
contractual arrangement under which the franchisor grants the franchisee the right to sell
certain products, render specific services, or use certain trademarks or trade names,
usually restricted to a designated geographical area
Another type of franchise, commonly referred to as a license or permit
entered into between a governmental body and a business enterprise and permits the
enterprise to use public property in performing its services.

Goodwill
value of all favorable attributes that relate to a business enterprise
attributes may include exceptional management, desirable location, good customer
relations and skilled employees
cannot be sold individually in the marketplace; it can be identified only with the business
as a whole

Goodwill
recorded only when a transaction involves the purchase of an entire business
excess of cost over the fair market value of the net assets (assets less liabilities) acquired
not amortized
reported under Intangible Assets

Q5.(e) Off Balance Sheet Items :

(i) Bankers Acceptance

(ii) Letter of Credit
(iii) Guarantee of Payment

Q6. (a) Fiscal and Calendar Years

Both small and large companies prepare financial statements periodically in order to assess their financial
condition and results of operations. Accounting time periods are generally a month, a quarter, or a year.
Monthly and quarterly time periods are called interim periods. Most large companies must prepare both
quarterly and annual financial statements. An accounting time period that is one year in length is a fiscal
year. A fiscal year usually begins with the fi rst day of a month and ends twelve months later on
the last day of a month. Most businesses use the calendar year (January 1 to December 31) as their
accounting period. Some do not. Companies whose fiscal year differs from the calendar year include Delta Air
Lines, June 30, and Walt Disney Productions, September 30. Sometimes a companys year-end will vary from
year to year. For example, PepsiCos fi scal year ends on the Friday closest to December 31, which was
December 30 in 2008 and December 29 in 2009.

Q6.(b) Accrual- vs. Cash-Basis Accounting

What you will learn in this chapter is accrual-basis accounting. Under the accrual basis, companies record
transactions that change a companys financial statements in the periods in which the events occur. For
example, using the accrual basis to determine net income means companies recognize revenues when earned

23
(rather than when they receive cash). It also means recognizing expenses when incurred (rather than when
paid). An alternative to the accrual basis is the cash basis. Under cash-basis accounting, companies record
revenue when they receive cash. They record an expense when they pay out cash. The cash basis seems
appealing due to its simplicity, but it often produces misleading financial statements. It fails to record revenue
that a company has earned but for which it has not received the cash. Also, it does not match expenses with
earned revenues. Cash-basis accounting is not in accordance with generally accepted accounting
principles (GAAP). Individuals and some small companies do use cash-basis accounting. The cash basis is
justified for small businesses because they often have few receivables an payables. Medium and large
companies use accrual-basis accounting.

Q6.(c)

Cost-volume-profit (CVP) analysis is a powerful tool that helps managers understand the relationships
among cost, volume, and profit. CVP analysis focuses on how profits are affected by the following five factors:
]
1. Selling prices.
2. Sales volume.
3. Unit variable costs.
4. Total fixed costs.
5. Mix of products sold.
Because CVP analysis helps managers understand how profits are affected by these key factors, it is a vital
tool in many business decisions. These decisions include what products and services to offer, what prices to
charge, what marketing strategy to use, and what cost structure to implement. To help understand the role of
CVP analysis in business decisions, consider the case of Acoustic Concepts, Inc., a company founded by Prem
Narayan.

Q6.(c ) Break Even Analysis:

Break even is the level of sales at which the profit is zero. Cost volume profit analysis is some time referred to
simply as break even analysis. This is unfortunate because break even analysis is only one element of cost
volume profit analysis. Break even analysis is designed to answer questions such as "How far sales could drop
before the company begins to lose money." For

Contribution margin is the amount remaining from sales revenue after variable expenses have been
deducted. Thus it is the amount available to cover fixed expenses and then to provide profits for the period.
Contribution margin is first used to cover the fixed expenses and then whatever remains go towards profits. If
the contribution margin is not sufficient to cover the fixed expenses, then a loss occurs for the period. This
concept is explained in the following equations:

Sales revenue Variable cost* = Contribution Margin

*Both Manufacturing and Non Manufacturing

Contribution margin Fixed cost* = Net operating Income or Loss

*Both Manufacturing and Non Manufacturing

For further clarification of the basic concept of cost volume and profit Analysis (CVP analysis) we now
take an example.

Example:

Assume that Masers A. Q Asem Private Ltd. has been able to sell only one unit of product
during the period. If company does not sell any more units during the period, the
company's contribution margin income statement will appear as follows:

Masers A. Q. Asem Private Ltd

Contribution margin Income Statement
For the month of-------------
Total Per Unit

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Sales (1 Unit only) $250 $250
Less Variable expenses 150 150
--------- ---------
Contribution margin 100 100
Less fixed expenses 35,000 ======
---------
Net operating loss $(34,900)
======

For each additional unit that the company is able to sell during the period, $100 more in contribution margin
will become available to help cover the fixed expenses. If a second unit is sold, for example, then the total
contribution margin will increase by $100 (to a total of $200) and the company's loss will decrease by $100, to
$34800. If enough units can be sold to generate $35,000 in contribution margin, then all of the fixed costs
will be covered and the company will have managed to at least break even for the month-that is to show
neither profit nor loss but just cover all of its costs. To reach the break even point, the company will have to
sell 350 units in a period, since each unit sold contribute $100 in the contribution margin. This is shown as
follows by the contribution margin format income statement .

Masers A. Q. Asem Private Ltd

Contribution Margin Income Statement
For the month of-------------
Total Per Unit
Sales (350 Units) $87,500 $250
Less variable expenses 52,500 150
--------- ---------
Contribution margin 35,000 $100
Less fixed expenses 35,000 ======
----------
Net operating profit $0
======

Note that the break even is the level of sales at which profit is ZERO.

Once the break even point has been reached, net income will increase by unit contribution margin by each
additional unit sold. For example, if 351 units are sold during the period then we can expect that the net
income for the month will be $100, since the company will have sold 1 unit more than the number needed to
break even. This is explained by the following contribution margin income statement.

Masers A. Q. Asem Private Ltd

Contribution Margin Income Statement
For the month of-------------
Total Per Unit
Sales (351 Units) $87,750 $250
Less Variable expenses 52,500 150
---------- ----------
Contribution margin 35,100 100
Less fixed expenses 35,000 ======
----------
Net operating loss $100
======

If 352 units are sold then we can expect that net operating income for the period will be $200 and so forth. To
know what the profit will be at various levels of activity, therefore, manager do not need to prepare a whole
series of income statements. To estimate the profit at any point above the break even point, the manager can
simply take the number of units to be sold above the breakeven and multiply that number by the unit
contribution margin. The result represents the anticipated profit for the period. Or to estimate the effect of a
planned increase in sale on profits, the manager can simply multiply the increase in units sold by the unit
contribution margin. The result will be expressed as increase in profits. To illustrate it suppose company is

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currently selling 400 units and plans to sell 425 units in near future, the anticipated impact on profits can be
calculated as follows:

Increased number of units to be sold 25

Contribution margin per unit 100

Increase in the net operating income 2,500

======

To summarize these examples, if there were no sales, the company's loss would equal to its fixed expenses.
Each unit that is sold reduces the loss by the amount of the unit contribution margin. Once the break even
point has been reached, each additional unit sold increases the company's profit by the amount of the unit
contribution margin.

Difference between Gross Margin and Contribution Margin:

Gross Margin is the Gross Profit as a percentage of Net Sales. The calculation of the Gross Profit is: Sales
minus Cost of Goods Sold. The Cost of Goods Sold consists of the fixed and variable product costs, but it
excludes all of the selling and administrative expenses.

Contribution Margin is Net Sales minus the variable product costs and the variable period expenses. The
Contribution Margin Ratio is the Contribution Margin as a percentage of Net Sales.

Example:

Lets illustrate the difference between gross margin and contribution margin with the following
information: company had Net Sales of $600,000 during the past year. Its inventory of goods was the
same quantity at the beginning and at the end of year. Its Cost of Goods Sold consisted of $120,000 of
variable costs and $200,000 of fixed costs. Its selling and administrative expenses were $40,000 of variable
and $150,000 of fixed expenses.

The companys Gross Margin is: Net Sales of $600,000 minus its Cost of Goods Sold of $320,000 ($120,000 +
$200,000) for a Gross Profit of $280,000 ($600,000 - $320,000). The Gross Margin or Gross Profit Percentage
is the Gross Profit of $280,000 divided by $600,000, or 46.7%.

The companys Contribution Margin is: Net Sales of $600,000 minus the variable product costs of
$120,000 and the variable expenses of $40,000 for a Contribution Margin of $440,000. The Contribution
Margin Ratio is 73.3% ($440,000 divided by $600,000).

Cost Volume Profit (CVP) Relationship in Graphic Form:

The relationships among revenue, cost, profit and volume can be expressed graphically by preparing a cost-
volume-profit (CVP) graph or break even chart. A CVP graph highlights CVP relationships over wide ranges
of activity and can give managers a perspective that can be obtained in no other way.

Preparing a CVP Graph or Break-Even Chart:

In a CVP graph some times called a break even chart unit volume is commonly represented on the horizontal
(X) axis and dollars on the vertical (Y) axis. Preparing a CVP graph involves three steps.

1. Draw a line parallel to the volume axis to present total fixed expenses. For example we assume total
fixed expenses $35,000.

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2. Choose some volume of sales and plot the point representing total expenses (fixed and variable) at the
activity level you have selected. For example we select a level of 600 units. Total expenses at that activity level
is as follows

Fixed Expenses $35,000

Variable Expenses (150600) $90,000
---------
Total Expenses $125,000
======

After the point has been plotted, draw a line through it back to the point where the fixed expenses line
intersects the dollars axis.

Q6.d) Periodic inventory system An inventory system under which the company does not keep detailed
inventory records throughout the accounting period but determines the cost of goods sold only at the end of
an accounting period. Perpetual inventory system An inventory system under which the company keeps
detailed records of the cost of each inventory purchase and sale, and the records continuously show the
inventory that should be on hand.

Flow of Costs

The flow of costs for a merchandising company is as follows: Beginning inventory plus the cost of goods
purchased is the cost of goods available for sale. As goods are sold, they are assigned to cost of goods sold.
Those goods that are not sold by the end of the accounting period represent ending inventory describes these
relationships. Companies use one of two systems to account for inventory: a perpetual inventory system or
a periodic inventory system.

PERPETUAL SYSTEM

In a perpetual inventory system, companies keep detailed records of the cost of each inventory purchase
and sale. These records continuouslyperpetuallyshow the inventory that should be on hand for every
item. For example, a Ford dealership has separate inventory records for each automobile, truck, and van on
its lot and showroom floor. Similarly, a Kroger grocery store uses bar codes and optical scanners to keep a
daily running record of every box of cereal and every jar of jelly that it buys and sells. Under a perpetual
inventory system, a company determines the cost of goods sold each time a sale occurs.

PERIODIC SYSTEM

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In a periodic inventory system, companies do not keep detailed inventory records of the goods on hand
throughout the period. Instead, they determine the cost of goods sold only at the end of the accounting
periodthat is, periodically. At that point, the company takes a physical inventory count to determine the
cost of goods on hand.

To determine the cost of goods sold under a periodic inventory system, the following steps are necessary:

1. Determine the cost of goods on hand at the beginning of the accounting period.
2. Add to it the cost of goods purchased.
3. Subtract the cost of goods on hand at the end of the accounting period.

Q6.(e) Depreciation Methods:

Depreciation is generally computed using one of the following methods:

1. Straight-line
2. Units-of-activity
3. Declining-balance
4. Annuity Method
5. Sum of the years digit method

Q7.

Requirement
(i) Cost of Goods Available for Sale: (Beginning Inventory + Net Purchase) = $ 17,200

January 1: 400 units @ $8 = $ 3,200

February 20: 200 units @ 9 = $1,800
May 5: 500 units @ $ 10 = $ 5,000
August 12: 300 units @ 11 = $ 3300
December 8: 100 units @ 12 = 1200
December 18: 200 units @ 14 = $ 2800

Requirement (ii) For the methods, Cost of Goods Available for Sale = $17,200

Cost of Inventory (Under FIFO): Nill

Cost of Goods Sold: $17,200

Cost of Inventory (Under LIFO): Nill

Cost of Goods Sold: $17,200

Income Statement: under LIFO & FIFO

Sales Revenue = 27,200

(-) Cost of Goods Sold = 17,200

Gross Profit = $10,000

Q8. Ratio Analysis

(i) Current Ratio = Current Assets / Current Liabilities

=140,000/50,000
= 2.8:1
Standard = 2:1

Comment: Since the current ratio of Delta Company is higher than standard, the ability to pay short-
term debts is highly satisfactory.

(ii) Acid-Test Ratio = Current Assets Inventory / Current Liability

= 1,40,000-60,000/50,000
= 1.6:1
Standard = 1:1

Comment: Since the current ratio of Delta Company is higher than standard, the ability to pay short-
term debts is highly satisfactory.

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 (iii) Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
= 420000-20000/(62500)
= 6.4 Times

(iv) Cash Return on Sales = Net Cash Provided by operating Activities / Net Sales X 100
= 33,000/ 4,00,000
= 8.25%
Standard: Not Given
Comment: Since Standard is not given, comment is not possible.

(v) Cash Debt Coverage Ratio = Net Cash Provided by Operating Activities / Average Debt * 100

= 33,000/ 1,55,000 * 100

= 21.29%

(vi) Gross Profit Ratio = Gross Profit / Net Sales * 100

= 2,02,000/4,00,000*100
=50.50%
Comment: Delta Company has a very high rate of gross profit compared to other company.

(vii) Net Profit Ratio = Net Profit after tax / Net Sales * 100
= 25,000/ 4,00,000 * 100
= 6.25%

Comment: Net profit ratio is not highly satisfactory.

The End.

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