Fundamentals of

Accounting I
Financial
reporting CHAPTER ONE

Introduction to Accounting
 …Ch1: Introduction to Accounting and Business

Process
Input Output
Accounting
Economic Financial
Cycle
Activities Information
How of acct?
Why of acct?

Objective (Why) of
Acct. : Supply info
useful for making
decisions as to Characteristics: Mainly
Resource Allocation •Financial -Monetary Uses-Evaluate/Assess:
•Quantitative-Numerical • Financial position
• Usefulness –relevant & • Financial performance
faithful • Liquidity (cash position)
Users: Internal & External
 …Ch1: Introduction to Accounting and Business

Process
Input Accounting
Economic Output
Cycle
Activities How of acct?

Economic Entities Set of sequential activities

governed by accounting
principles/concepts-
objective ownership activity framework of acct

Business Sole proprietorship Service Enterprise

[for profit]
Partnerships Merchandising Ent.
Nonbusiness Ch. 02
[Nonprofit] Corporations Manufacturing Ent.
 Who Uses Accounting Data

External
Internal Users
Human Taxing
Users
Resources Authorities
Labor
Unions
Finance
Management Customers

Creditors
Marketing Regulatory
Agencies
Investors
 …Ch1: Introduction to Accounting and Business

International Accounting Standards Board (IASB)

Accounting
Standard
setting International Financial Reporting Standards (IFRS)

bodies
Financial Accounting Standards Board (FASB)

Generally Accepted Accounting Principles (GAAP)

 6
…Ch1: Introduction to Accounting and Business

 IFRS guide the preparation of General Purpose Financial Reports

 General purpose financial reporting
 aims to provide useful financial information about the reporting entity to
primary users who cannot require the reporting entity to provide information
directly to them.

 Special purpose financial reporting

 responds to the requirements of users that have the authority to require the
reporting entity to provide the information that they need for their purposes
directly to them. Examples include:
 prudential regulation reporting requirements
 tax reporting requirements
 …Ch1: Introduction to Accounting and Business

overview of IFRS
What are International Financial Reporting Standards (IFRS) ?
 IFRS Standards are a globally recognized set of standards for the
preparation of financial statements by business entities.
…Ch1:
 IFRS Introduction
Standards prescribe:
tothe
 Accounting and be recognized as assets, liabilities, income and
items that should
Business
expense;
 how to measure those items;
 how to present them in a set of financial statements; and
 related disclosures about those items.
 comprises IAS standards (developed by IASC), IFRS (developed by
IASB), SIC and IFRIC interpretation
 8
…Ch1: Introduction to Accounting and Business

IFRS the Full Version

 sets out recognition, measurement, presentation and disclosure requirements
for general purpose financial statements of profit seeking entities
 Intended to Public Interest Entities and include:
 Conceptual Framework for Financial Reporting: Not a standard.
 IFRS 1-17=16 Standards [Issued by IASB from 2001]
 IAS 1-41=24 Standards [Issued by IASC 1973-2001]
 Both are IFRSs. Effective from January 2016 up to now there are 40
standards.
 IFRIC: IFRS Interpretation Committee’s interpretations. IFRIC 1-21=21
 SIC: IFRC Standing Interpretation Committee interpretations: SIC 7-32=10
SICs
 10

…Ch1: Introduction to Accounting and Business10

 IFRS for SMEs Version

 Intended to SMEs, private entities or entities with no public accountability.
 Based on full IFRS with modifications
 Relevance, Appropriateness or need
 Cost-benefit considerations
 How small is small?
 Nature vs Quantity Threshold
 Only 1 standard with 35 sections
 11
…Ch1: Introduction to Accounting and Business

Ethiopia issued a financial reporting law on December 5, 2014 which requires the
use of IFRS by commercial businesses operating in Ethiopia.

 Proclamation No. 847/2014

 Regulation No. 332/2014
The proclamation requires:
 Commercial organizations to follow
 International Financial Reporting Standards (IFRS), or
 International Financial Reporting Standards for Small and Medium
Enterprises (IFRS for SME)
 Charities and societies to follow International Public Sector Accounting Standards
(IPSAS)
 Auditors to follow International Standards for Auditing.
 …Ch1: Introduction to Accounting and Business

Measurement Principles:

 IFRSgenerally uses one of two measurement

principles, the historical cost principle and Fair Value
principle
 Cost Principle – or historical cost principle, dictates that
companies record assets at their cost.

 Fair Value Principle – states that assets and liabilities should

be reported at fair value (the price received to sell an asset or
settle a liability).
 …Ch1: Introduction to Accounting and Business

Example on Measurement Principle

Assume ABC Co. Purchased a Land.
 Date of Purchase: January 1,2016, at Br 150,000
 Price listed by seller ……………..… Br180,000
 Buyer’s initial offer to buy at……... Br 120,000
 Assessed value for property taxes…Br190,000
 Market Value on December 31, 2016… Br 250,000
1. At what amount should ABC Co. record this Land on its accounting records on January
1,2016?
a) by Cost principle b) by Fairvalue principle
2. At what amount should ABC Co. report this Land on its accounting records on December
31,2016?
a) by Cost principle b) by FairValue principle
 …Ch1: Introduction to Accounting and Business

Accrual method of accounting

It is a method of accounting in which transactions are
recorded in the periods in which the events occur.
Revenue: is recorded in the period it is earned regardless of collection
Expense: is recorded in the period it is incurred regardless of payment
Cash Basis of Accounting
Revenue: is recorded in the period of cash collection
Expense: is recorded in the period of cash payment.
 …Ch1: Introduction to Accounting and Business

Assumptions
Monetary Unit – include in the accounting records only transaction
data that can be expressed in money terms.

Economic Entity – requires that activities of the entity be kept

separate and distinct from the activities of its owner and all other
economic entities.
 Proprietorship.
 Partnership. Forms of Business
Ownership
 Corporation.
 …Ch1: Introduction to Accounting and Business
The accounting equation and elements of the
equation
The Accounting Equation: The foundation of accounting system.

The accounting (balance sheet) equation is an equation that expresses the following
relationships:

Assets = Liabilities Owner’s Equity

+
=
Resources Sources of the resources

Equity = Creditors equity + Owners

equity
The Basic Accounting Equation

Assets
Assets = Liabilities
Liabilities + Equity
Equity

Provides the underlying framework for recording and

summarizing economic events.

Applies to all economic entities regardless of size.

 The Basic Accounting Equation

Assets
Assets = Liabilities
Liabilities + Equity
Equity

 Provides the underlying framework for recording and

summarizing economic events.
Assets
 Resources a business controls .
 Provide future services or benefits.
 Cash, Inventory, Equipment, etc.
The Basic Accounting Equation

Assets
Assets = Liabilities
Liabilities + Equity
Equity

Provides the underlying framework for recording and

summarizing economic events.

Liabilities
 Claims against assets (debts and obligations).
 Creditors - party to whom money is owed.
 Accounts payable, Notes payable, etc.
The Basic Accounting Equation

Assets
Assets = Liabilities
Liabilities + Equity
Equity

Provides the underlying framework for recording and

summarizing economic events.

Equity
Ownership claim on total assets.
Referred to as residual equity.
Share capital-ordinary and retained earnings.
The Basic Accounting Equation

Revenues result from business activities entered into for the purpose
of earning income.
Generally results from selling merchandise, performing services,
renting property, and lending money.
The Basic Accounting Equation

Expenses are the cost of assets consumed or services used in the

process of earning revenue.
Common expenses are salaries expense, rent expense, interest
expense, property tax expense, etc.
The Basic Accounting Equation

Dividends are the distribution of cash or other assets to shareholders.

 Reduce retained earnings
 Not an expense
 Fundamentals of r
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Accounting I c le
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FINANCIAL o
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Chapter Two
 DEBIT AND CREDIT
PROCEDURES
Accounts: Record of increases and decreases in a specific
asset, liability, stockholders’ equity, revenue, or expense item.
 Debit = “Left”
 Credit = “Right”

Account Name
An account can Debit / Dr. Credit / Cr.
be illustrated in a
T-account form.
 Debits and Credits

If the sum of Debit entries are greater than the sum of

Credit entries, the account will have a debit balance.

Account Name
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

Transaction #3 8,000

Balance $15,000
 Debits and Credits

If the sum of Credit entries are greater than the sum of

Debit entries, the account will have a credit balance.

Account Name
Debit / Dr. Credit / Cr.

Transaction #1 $10,000 $3,000 Transaction #2

8,000 Transaction #3

Balance $1,000

LO 2
Debits and Credits

Assets  Assets - Debits should exceed

Debit / Dr. Credit / Cr.
credits.
 Liabilities – Credits should
Normal Balance
exceed debits.
 Normal balance is on the
Chapter
3-23

increase side.
Liabilities
Debit / Dr. Credit / Cr.

Normal Balance

Chapter
3-24

LO 2
 Debits and Credits

Equity  Investment by owner and

Debit / Dr. Credit / Cr.
revenues increase equity (credit).
 Drawing and expenses decrease
Normal Balance
equity (debit).
Chapter
3-25

Drawing (Dividend)
Debit / Dr. Credit / Cr.

Normal Balance

Chapter Chapter Chapter

3-25 3-25 3-23

LO 2
Debits and Credits

Revenues  The purpose of earning revenues

Debit / Dr. Credit / Cr.
is to benefit the shareholders.
 The effect of debits and credits on
Normal Balance
revenue accounts is the same as
Chapter
3-26 their effect on equity.
 Expenses have the opposite
Expenses
Debit / Dr. Credit / Cr.
effect: expenses decrease equity.

Normal Balance

Chapter
3-27
 Debits and Credits
Liabilities
Debit / Dr. Credit / Cr.
Normal
Normal Normal
Normal
Balance
Balance Balance
Balance
Debit
Debit Credit
Credit Normal Balance

Assets
Chapter

Debit / Dr. Credit / Cr. 3-24

Equity
Debit / Dr. Credit / Cr.

Normal Balance

Normal Balance
Expenses
Chapter
3-23

Debit / Dr. Credit / Cr.

Chapter
3-25
Revenues
Debit / Dr. Credit / Cr.

Normal Balance

Chapter
Dividend
3-27

Debit / Dr. Credit / Cr.

Normal Balance

Chapter
3-26

Normal Balance

Chapter
3-27
 Summary of Debit/Credit Rules

Statement of
Financial Position Income Statement
Asset = Liability + Equity Revenue - Expense

Debit

Credit

LO 2
Debits and Credits

Double-entry system
 Each transaction must affect two or more
accounts to keep the basic accounting
equation in balance.
 Recording done by debiting at least one account and
crediting at least one other account.
 DEBITS must equal CREDITS.

LO 2
Summary of Debit/Credit Rules

Relationship among the assets, liabilities, and equity of a

business:

The equation must be in balance after every transaction.

Total Debits must equal total Credits.
The Accounting Cycle

1.
1. Analyze
Analyze business
business transactions
transactions

9.
9. Prepare
Prepare aa post-closing
post-closing 2.
2. Journalize
Journalize the
the
trial
trial balance
balance transactions
transactions

8.
8. Journalize
Journalize and
and post
post 3.
3. Post
Post to
to ledger
ledger accounts
accounts
closing
closing entries
entries

7.
7. Prepare
Prepare financial
financial 4.
4. Prepare
Prepare aa trial
trial balance
balance
statements
statements

6.
6. Prepare
Prepare an
an adjusted
adjusted trial
trial 5.
5. Journalize
Journalize and
and post
post
balance
balance adjusting
adjusting entries
entries
 The Account

Business documents, such as a sales receipt, a check, or

a bill, provide evidence of the transaction.

Analyze each transaction Enter transaction in a journal Transfer journal information to

ledger accounts
Steps in the Recording Process

The Journal
 Book of original entry.
 Transactions recorded in chronological
order.
 Contributions to the recording process:
1. Discloses the complete effects of a transaction.

2. Provides a chronological record of transactions.

3. Helps to prevent or locate errors because the debit

and credit amounts can be easily compared.
LO 4
The Journal

JOURNALIZING - Entering transaction data in the journal.

Illustration: On September 1, shareholders invested €15,000 cash
in the corporation in exchange for ordinary shares, and Softbyte
purchased computer equipment for €7,000 cash.
Illustration 2-14

GENERAL JOURNAL
Date Account Title Ref. Debit Credit
Sept. 1 Cash 15,000
Share Capital—Ordinary 15,000

Equipment 7,000
Cash 7,000

LO 4
The Journal

SIMPLE AND COMPOUND ENTRIES

Illustration: On July 1, Tsai Company purchases a delivery truck
costing NT$420,000. It pays NT$240,000 cash now and agrees to
pay the remaining NT$180,000 on account. Illustration 2-15
Compound journal entry

GENERAL JOURNAL
Date Account Title Ref. Debit Credit
July 1 Equipment 420,000
Cash 240,000
Accounts Payable 180,000

LO 4
Steps in the Recording Process

The Ledger
 General Ledger contains all the asset, liability, and equity
accounts.
The Ledger

STANDARD FORM OF ACCOUNT

LO 5
 Posting

Transferring
journal entries
to the ledger
accounts.

Illustration 2-18
Posting a journal
entry

LO 6
 The Trial Balance

A trial balance
 is a list of accounts and their balances
at a given time.
 proves the mathematical equality of debits and credits
after posting.

The steps for preparing a trial balance are:

1. List the account titles and their balances.
2. Total the debit and credit columns.
3. Prove the equality of the two columns.

LO 7
Trial Balance
Illustration 2-32
A trial balance

LO 7
Limitations of a Trial Balance

Trial balance may balance even when:

1. A transaction is not journalized.
2. A correct journal entry is not posted.
3. A journal entry is posted twice.
4. Incorrect accounts are used in journalizing or posting.
5. Offsetting errors are made in recording the amount of a
transaction.

LO 7
 Fundamentals of r
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Accounting I c le
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FINANCIAL A
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(Part Three) a
 Timing Issues

Going concern Assumptions: The business will remain in operation for the
foreseeable future. in other words, that it will not liquidate or be forced out
of business, at least for the next twelve months other words, that it
will not liquidate or be .....
Jan. Feb. Mar. Apr. Dec.

Periodicity Assumption: Accountants divide the economic life of a business

into artificial time periods (Time Period Assumption).
Generally a month, a quarter, or a year
 The Basics of Adjusting Entries

Adjusting Entries
 Ensure that the revenue recognition and expense
recognition principles are followed.
 Necessary because the trial balance may not contain
up-to-date and complete data
 Required every time a company prepares financial
statements.
 Will include one income statement account and one
statement of financial position account.
Types of Adjusting Entries

Deferrals Accruals

1. Prepaid Expenses. 1. Accrued Revenues.

Expenses paid in cash Revenues for services
before they are used or performed but not yet
consumed. received in cash or
recorded.
2. Unearned Revenues. 2. Accrued Expenses.
Cash received before Expenses incurred but not
services are performed. yet paid in cash or recorded.
Each account is analyzed to determine whether it is
complete and up-to-date for financial statement purposes.
PREPAID EXPENSES

Illustration: Yazici Advertising Inc. Inc.

purchased supplies costing ₺2,500 on
October 5. Yazici recorded the purchase
by increasing (debiting) the asset
Supplies. This account shows a balance
of ₺2,500 in the October 31 trial balance.
An inventory count at the close of
business on October 31 reveals that
₺1,000 of supplies are still on hand.

Oct. 31 Supplies Expense 1,500

Supplies 1,500
PREPAID EXPENSES

Illustration: On October 4, Yazici Advertising

Inc. paid ₺600 for a one-year fire insurance
policy. Coverage began on October 1. Yazici
recorded the payment by increasing (debiting)
Prepaid Insurance. This account shows a
balance of ₺600 in the October 31 trial
balance. Insurance of ₺50 (₺600 ÷ 12)
expires each month.

Oct. 31 Insurance Expense 50

Prepaid Insurance 50
PREPAID EXPENSES

DEPRECIATION
 Buildings, equipment, and motor vehicles (assets
that provide service for many years) are recorded as
assets, rather than an expense, on the date acquired.
 Depreciation is the process of allocating the cost of
an asset to expense over its useful life.
 Depreciation does not attempt to report the actual
change in the value of the asset.
PREPAID EXPENSES

Illustration: For Yazici Advertising, assume

that depreciation on the equipment is ₺480 a
year, or ₺40 per month.

Oct. 31

Depreciation Expense 40
Accumulated Depreciation 40

Accumulated Depreciation is called

a contra asset account.
• HELPFUL HINT
All contra accounts have increases,
decreases, and normal balances opposite to
the account to which they relate.
PREPAID EXPENSES

Statement Presentation
 Accumulated Depreciation is a contra asset account
(credit).
 Appears just after the account it offsets (Equipment)
on the balance sheet.
 Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.
PREPAID EXPENSES
UNEARNED REVENUES

 Adjusting entry is made to record the revenue for services

performed during the period and to show the liability that remains
at the end of the accounting period.
 Results in a decrease (debit) to a liability account and an
increase (credit) to a revenue account.
UNEARNED REVENUES

Illustration: Yazici Advertising Inc. received ₺1,200 on October 2

from R. Knox for advertising services expected to be completed by
December 31. Unearned Service Revenue shows a balance of
₺1,200 in the October 31 trial balance. Analysis reveals that the
company performed ₺400 of services in October.

Oct. 31 Unearned Service Revenue 400

Service Revenue 400
ACCRUED REVENUES

 Adjusting entry records the receivable that exists and

records the revenues for services performed.
 Adjusting entry:
► Increases (debits) an asset account and
► Increases (credits) a revenue account.
ACCRUED REVENUES

Illustration: In October, Yazici Advertising

Inc. performed services worth ₺200 that were
not billed to clients in October.

Oct. 31
Accounts Receivable 200
Service Revenue 200
ACCRUED REVENUES
ACCRUED EXPENSES

 Adjusting entry records the obligation and recognizes the

expense.
 Adjusting entry:
► Increase (debit) an expense account and
► Increase (credit) a liability account.
ACCRUED INTEREST

Illustration: Yazici Advertising Inc. signed a three-month note

payable in the amount of ₺5,000 on October 1. The note requires
Yazici to pay interest at an annual rate of 12%.

Oct. 31 Interest Expense 50

Interest Payable 50
ACCRUED SALARIES AND WAGES

Illustration: Yazici paid salaries and wages on October 26; the

next payment of salaries will not occur until November 9. The
employees receive total salaries of ₺2,000 for a five-day work
week, or ₺400 per day. Thus, accrued salaries at October 31 are
₺1,200 (₺400 x 3 days).
Adjusting
Entry
ACCRUED EXPENSES
Summary of Basic Relationships
 The Adjusted Trial Balance and
Financial Statements

Preparing the Adjusted Trial Balance

 Prepared after all adjusting entries are
journalized and posted.
 Purpose is to prove the equality of debit balances and
credit balances in the ledger.
 Is the primary basis for the preparation of financial
statements.
 Using a Worksheet

Worksheet
 Multiple-column form used in preparing
financial statements.
 Not a permanent accounting record.
 May be a computerized worksheet using an electronic
spreadsheet program such as Excel.
 Prepared using a five step process.
 Use of worksheet is optional.
Steps in Preparing a Worksheet Illustration 4-1
Form and procedure
for a worksheet
Preparing Financial Statements from a
Worksheet

 Income statement is prepared from the income statement

columns.
 Statement of financial position and retained earnings
statement are prepared from the statement of financial
position columns.
 Companies can prepare financial statements before they
journalize and post adjusting entries.
 Closing the Books
At the end of the accounting period, the
company makes the accounts ready for the
next period.
 Illustration 4-5
Diagram of closing
• HELPFUL HINT process—corporation

The Dividends account is

closed directly to Retained
Earnings and not to Retained earnings is a
Income Summary because permanent account. All
dividends are not an other accounts are
temporary accounts.
expense.
Illustration 4-6
Closing entries journalized
 Posting
Closing
Entries

Illustration 4-7
Posting of closing entries
Preparing a Post-Closing Trial Balance
Learning
Post-closing trial balance Objective 3
Describe the content
and purpose of a
 Lists permanent accounts and their post-closing trial
balance.
balances after the journalizing and
posting of closing entries.
 Purpose is to prove the equality of the permanent account
balances carried forward into the next accounting period.
 Only contains balances for permanent—statement of
financial position—accounts.
 All temporary accounts will have zero balances.
 Illustration 4-8

Illustration 4-8
Post-closing trial balance
Summary of Debit/Credit Rules

Question
Debits:

a. increase both assets and liabilities.

b. decrease both assets and liabilities.

c. increase assets and decrease liabilities.

d. decrease assets and increase liabilities.

LO 2
Summary of Debit/Credit Rules

Question
Accounts that normally have debit balances are:

a. assets, expenses, and revenues.

b. assets, expenses, and equity.

c. assets, liabilities, and dividends.

d. assets, dividends, and expenses.

LO 2
Posting

Question
Posting:
a. normally occurs before journalizing.
b. transfers ledger transaction data to the journal.
c. is an optional step in the recording process.
d. transfers journal entries to ledger accounts.

LO 6
The end!
 Financial Reporting
Chapter Three

Fundamentals of Accounting for

Accounting I merchandising
Business

By: Kibrysfaw G Part one

Accounting for merchendising buss. 90
 Definition and nature
 Merchandising Business are organizations which involves in
business of buying and reselling of goods.

Buy Resell
 Goods ( inventories) bought for reselling purpose are

known as Merchandising Inventory

Accounting for merchendising buss. 91

 Inventory system
Perpetual inventory system Periodic inventory system
Continuously updates the inventory account Inventory balance is updated only once at the end of the
period through adjustment
The inventory account is updated every time when there Transaction which affects the cost of inventory are
is transaction which affects the cost of inventory recorded by using temporary accounts like (Purchase,
Purchases return and discount, Purchase discount &
Transportation in accounts)

The balance of inventory can be known without taking a Taking the physical count is the only way to determine
physical count the balance of ending inventory
When ever there is sales, it captures the decrease of At time of sales, there is no need of adjusting the
inventory and cost of good sold balance of inventory & the related cost of goods sold is
not recognized. At the end of the accounting period
CGS is determined through formula

Taking Physical count of inventory is required to proof Taking Physical count of inventory is required to
the accuracy of the record determine the balance of CEI.
Accounting for merchendising buss. 92
Recording Purchases of Merchandise

Purchase Returns and Allowances

Purchaser may be dissatisfied because goods are damaged or
defective, of inferior quality, or do not meet specifications.

Purchase Return Purchase Allowance

Return goods for credit if the sale May choose to keep the
was made on credit, or for a cash merchandise if the seller will
refund if the purchase was for grant an allowance (deduction)
cash. from the purchase price.
Recording Purchases of Merchandise
Purchase Discounts
Credit terms may permit buyer to claim a cash discount for
prompt payment. Advantages:
 Purchaser saves money & Seller shortens the operating
cycle.

2/10, n/30 1/10 EOM n/10 EOM

2% discount if
1% discount if Net amount due
paid within 10
paid within first 10 within the first 10
days, otherwise
days of next days of the next
net amount due
month. month.
within 30 days.
Recording Purchases of Merchandise

Freight Costs – Terms of Sale

Seller places goods Free On

Board the carrier, and buyer pays
freight costs.

Seller places goods Free On

Board to the buyer’s place of
business, and seller pays freight
costs.

Freight costs incurred by the seller are an operating expense.

LO 2
Recording Sales of Merchandise

Sales Returns and Allowances

 “Flipside” of purchase returns and allowances.
 Contra-revenue account (debit).
 Sales not reduced (debited) because:
► Would obscure importance of sales returns and
allowances as a percentage of sales.

► Could distort comparisons.

Recording Sales of Merchandise

Sales Discount
 Offered to customers to promote prompt payment.
 “Flipside” of purchase discount.
 Contra-revenue account (debit).
Recording Sales of Merchandise

Question
The cost of goods sold is determined and recorded each
time a sale occurs in:
a. periodic inventory system only.
b. a perpetual inventory system only.
c. both a periodic and perpetual inventory system.
d. neither a periodic nor perpetual inventory system.
Recording Purchases of Merchandise

Question
In a perpetual inventory system, a return of defective
merchandise by a purchaser is recorded by crediting:
a. Purchases
b. Purchase Returns
c. Purchase Allowance
d. Inventory
 Financial Reporting

By: Kibrysfaw G Part Two

Fundamentals of
Chapter Three
Accounting I
Accounting for
merchandising
Business
Accounting for merchendising buss. 100
Forms of Financial Statements

Income Statement
 Primary source of information for evaluating a company’s
performance.
 Format is designed to differentiate between the various
sources of income and expense.
Forms of Financial Statements

Income
Statement
Presentation
of Sales
 Forms of Financial Statements

Income
Statement
Key Items:
 Net sales
 Forms of Financial Statements

Income
Statement
Key Items:
 Net sales
 Gross profit
 Forms of Financial Statements

Income
Statement
Key Items:
 Net sales
 Gross profit
 Gross profit rate
 Forms of Financial Statements

Income
Statement
Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Illustration 5-13
Forms of Financial Statements

Income
Statement
Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Other income
and expense
 Forms of Financial Statements

Income
Statement
Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Other income
and expense
 Forms of Financial Statements

Income
Statement
Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Other income and
expense
 Interest expense
 Forms of Financial Statements Illustration 5-14

Income
Statement
Key Items:
 Net sales
 Gross profit
 Operating
expenses
 Other income and
expense
 Interest expense
 Net income
PERIODIC INVENTORY SYSTEM

Determining Cost of Goods Sold

Illustration 5A-2

LO 6
Forms of Financial Statements

Classified Statement of Financial Position

Illustration 5-16
Forms of Financial Statements

Question
The statement for a merchandiser shows each of the
following features except:

a. gross profit.

b. cost of goods sold.

c. a sales revenue section.

d. investing activities section.

Recording Sales of Merchandise

Question
The cost of goods sold is determined and recorded each
time a sale occurs in:
a. periodic inventory system only.
b. a perpetual inventory system only.
c. both a periodic and perpetual inventory system.
d. neither a periodic nor perpetual inventory system.
Recording Purchases of Merchandise

Question
In a perpetual inventory system, a return of defective
merchandise by a purchaser is recorded by crediting:
a. Purchases
b. Purchase Returns
c. Purchase Allowance
d. Inventory
Financial Reporting Chapter Four
Internal control over cash

Fundamentals of
Accounting I
 Internal Control over cash: Use of a Bank

All major payments are made by check;

All cash receipts are deposited in the bank daily;
Use voucher system that calls for approvals at different stages
before disbursements
Use petty cash fund for small disbursements; and
Cash balance per book is reconciled with cash balance per bank
statement monthly by an individual with no cash
handling/recording responsibilities.
Control Features: Use of a Bank

Bank Statements

Debit Memorandum
 Bank service charge.
 NSF (not sufficient
funds).

Credit Memorandum
 Collect notes
receivable.
 Interest earned.
Control Features: Use of a Bank

Reconciling the Bank Account

Reconcile balance per books and balance per bank to
their adjusted (corrected) cash balances.
Reconciling Items:
1. Deposits in transit.
2. Outstanding checks. Time Lags
3. Bank memoranda.
4. Errors.
Control Features: Use of a Bank

Reconciliation Procedures "put it where it isn't."

+ Deposit in Transit + Notes collected by bank

- Outstanding Checks - NSF (bounced) checks
+/- Bank Errors - Check printing or other
service charges
+/- Book Errors

CORRECT BALANCE CORRECT BALANCE

 Control Features: Use of a Bank
on April 30, 2014, the Trading received a bank statement. The cash balance as per
bank statement was $15,907.45 . On the other hand, the firms’ cash ledger has
got balance of $11,589.45. The reconciling items in the Month of may 30,

1. April 30 deposit by the firm were received by bank on May 1. $2,201.40

2. Outstanding checks were identified and listed as follows:
 Check No. 453, $3,000
 Check No. 457, $1,401.30
 Check No. 460, $1,502.70
Total outstanding cheek 5,904.00
3. V. trading write check no. 443 for $1,226.00 and the bank correctly paid that amount. However,
V. trading recorded the check as $1,262.00.
4. The bank send debit memorandum of $425.60 for NSF cheek and $30 of service charge for cheek
printing.
5. The bank send Credit memorandum to notify Collection of note receivable for £1,000
plus interest earned £50, less bank collection fee £15.00= 1,035
 Control Features: Use of a Bank

Illustration: Prepare a bank reconciliation at April 30.

step 1 Cash balance per bank statement $15,907.45

Deposit in transit 2,201.40
Outstanding checks (5,904.00)
Adjusted cash balance per bank ₤12,204.85

step 2 Cash balance per books $11,589.45

Error in check No. 443 36.00
NSF check (425.60)
Bank service charge (30.00)
Collection of notes receivable 1,035.00
Adjusted cash balance per books ₤12,204.85
Control Features: Use of a Bank

Step 4 Entries From Bank Reconciliation

Collection of Note Receivable: Assuming interest of ₤50 has
not been accrued and collection fee is charged to Miscellaneous
Expense, the entry is:

Apr. 30 Cash 1,035.00

Miscellaneous expense 15.00
Notes receivable 1,000.00
Interest revenue 50.00
Control Features: Use of a Bank

Book Error: The cash disbursements journal shows that check

no. 443 was a payment on account to Andrea Company, a
supplier. The correcting entry is:

Apr. 30 Cash 36.00

Accounts payable 36.00

NSF Check: As indicated earlier, an NSF check becomes an

account receivable to the depositor. The entry is:

Apr. 30 Accounts receivable 425.60

Cash 425.60
Control Features: Use of a Bank

Bank Service Charges: Depositors debit check printing

charges (DM) and other bank service charges (SC) to
Miscellaneous Expense. The entry is:

Apr. 30 Miscellaneous expense 30.00

Cash 30.00

Illustration 7-13
 Cash Controls
The small amount of cash kept on hand for payment minor expenditures is called petty cash.
 Establishment
 Disbursement
 Replenishment
 Increase or decrease the amount of petty cash

1. Establishment of Petty cash

Illustration: If Xyz Company decides to establish $3,000 fund

on March 1, the journal entry is:
Petty cash 3,000
Mar. 1 Cash
3,000
Cash Controls

Illustration: Assume that on March 15 XYZ’s petty cash custodian

requests a check for $2,610. The fund contains $390 cash and
petty cash receipts for postage $1,320, freight-out $1,140, and
miscellaneous expenses $150. The general journal entry to record
the check is:

Mar. 15 Postage expense 1,320

Freight-out expense 1,140
Miscellaneous expense 150
Cash
2,610
Cash Controls

Illustration: Occasionally, the company may need to recognize a

cash shortage or overage. Assume that XYZ petty cash custodian
has only $360 in cash in the fund plus the receipts as listed. The
request for reimbursement would, therefore, be for $2,640, and
XYZ would make the following entry:

Mar. 15 Postage expense 1,320

Freight-out expense 1,140
Miscellaneous expense 150
Cash over and short 30
Cash
2,640
Control Features: Use of a Bank

Review Question
The reconciling item in a bank reconciliation that will result in
an adjusting entry by the depositor is:

a. outstanding checks.

b. deposit in transit.

c. a bank error.

d. bank service charges.

 Financial Reporting

Fundamental of Accounting I

Chapter 5
Accounting For Receivables
Part One
 Types of Receivables

Amounts due from individuals and other companies that are

expected to be collected in cash.

Amounts owed by Written promise (as “Nontrade” (interest,

customers that evidenced by a loans to officers,
result from the sale formal instrument) advances to
of goods and for amounts to be employees, and
services. received. income taxes
refundable).

Accounts
Accounts Notes
Notes Other
Other
Receivable
Receivable Receivable
Receivable Receivables
Receivables

LO 1 Identify the different types of receivables.

 Accounting For note receivable
Important terms
Due date: The date a note is to be paid is called the Due Date or Maturity date & can
be expressed in terms of days or months.
Determining due date when the maturity period is given in terms of days
Example: A due date for note issued of 90 days,10% Birr 50,00 note dated on march 10
Term of the Note--------------------------------------------90
Days in March---------------------------31
Minus the date of the note-------------10
Days remaining in March------------------------21
Add days in April---------------------------------30
Add days in May----------------------------------31 82
Number of days remaining to equal 90-days(90 – 82 = 8) Therefore, Due date is June-8.
Computing Interest

Maturity Value: the amount that is due as of maturity date

MV = FV + I
I = 50,00*0.1*(90/360) = 1,250
MV=50,000+1250 = 51,250
Accounting For note receivable
When Promissory not is received for selling of goods and sold on
account the journal entry will be:

Note receivable xxx

sales revenue xxx
When Promissory not is received for as a settlement of past due
Account receivable the journal entry will be:
Note receivable xxx
Account receivable xxx
When the note is honored and collected on the due date
Cash xxx
Note receivable xxx
Interest income xxx
Accounting For note receivable
When a note’s maker is unable or refuses to pay at maturity, the note is
dishonored. If the note is dishonored:
Account receivable xxx
Note receivable xxx
Interest income xxx

Example
1. Nile Co. sales merchandise on account to Tana Co. and receive a Br. 5,000, 90-day,
12% promissory note dated January 10
2. Assume that a 60-day, 10% note dated September 5, 20x1 is accepted by Awash Co.
in settlement of the account of Happy co, which is past due and has a balance of
10,000.
3. XYZ Co. sales merchandise on account to ABC Co. and receive a Br. 12,000, 45-
day, non interest bearing note dated February 12.
 Accounting For note receivable
Note receivable 5,000
January 10
Sales revenue 5,000

Note receivable 10,000

September 5 Account receivable 10,000

Note receivable 12,000

February 12
Sales revenue 12,000

Assume the note dated January 10 is dishonored

Account receivable 5,150
April 11
Note receivable 5,000
Interest income 150
 Accounting For note receivable
Assume the other two notes are honored & collected
Cash 10,167
Note receivable 10,000
November 4 Interest income 167

March 29 Cash 12,000

Note receivable 12,000

Discounting Note Receivable

 Accounting For note receivable
Notes Receivable are discounted with or without recourse. When a note is discounted
without recourse, the bank assumes the risk of a bad debt loss and the original payee
doesn’t have a contingent liability.
To illustrate, assume that a 90-day, 12%, Br. 20,000 N/R from Hiwot Co. dated Jan.1, 20x2 is
discounted at the payee’s bank on February 12, 20x2 at the discount rate of 15%.
To determine the proceed it involves the following steps
Step 1 – Determine the maturity date & maturity value.
MD = days in January (31-1)……30
days in February …………….28
days in march ---------------31
days in April ----------------1 i.e Due date April 1
MV = FV + I = 20,000 + [20,000 X 12% X 90/360]
= 20,600
 Accounting For note receivable
Step 2 – Determine the Bank Discount (Bank discount is an interest that is charged by
the bank and is computed based on the maturity value of the note for the discount period. Discount Period is
the time the bank must hold the note) before it becomes due.
DP = Discount period ( from February12 to April 1)
Days in February (28-12)………..26
days in march ……………………….31
days in April ……………………….1

= 48
Bank Discount = MV X DR X DP where MV = Maturity value ( 20,600)
DR = Discount Rate (15%)

Discount = 20,600 X 15% X 48/360 = 412

Step 3- Determine proceed (proceed is the amount of cash paid to the endorser after deducting discount)
i.e. proceed = MV – D
= 20,600 – 412 = 20,188
 Accounting For note receivable
Step 4: Record the necessary journal entry at the date of discount. (Here,
record interest revenue which is the excess of proceeds from the face
value or record interest expense when the proceed is less than the face
value of the note)
Feb 12. Cash---------------------------------20,188
N/R -----------------------------------------20,000
I. Rev. --------------------------------------188.00
If the note is dishonored and if the discounting of the note is with recourse
A/R----------------------------------20,188
CASH………………………………………….20,188
 Accounting For Account Recivable
Recognizing Accounts Receivable
Service organization - records a receivable when it provides
service on account.
Merchandiser - records accounts receivable at the point of sale
of merchandise on account.

Uncollectible Accounts Receivable

Sales on account raise the possibility of accounts not being collected.
Seller records losses that result from extending credit as Bad Debt Expense
 Accounts Receivable

Methods of Accounting for Uncollectible Accounts

Direct Write-Off Allowance Method

Theoretically undesirable: Losses are estimated:
 No matching.  Better matching.
 Receivable not stated at  Receivable stated at cash
cash realizable value. realizable value.
 Not acceptable for financial  Required by IFRS.
reporting.
 Accounts Receivable
Allowance Method
Estimates bad debt expense at the end of each accounting period and
records it through an adjusting entry.
To illustrate this method, assume the A/R account has a balance of Br.
50,000 and based on careful study of the experience of other companies,
Nile Co. estimates that a total of Br. 2000 will be uncollectable.
Dec. 31 Uncollectible Accounts Expense 2000
Allowance for Doubtful Accounts 2000
Write-off to the Allowance Account
When specific accounts are identified as uncollectible, they are
written-off against the Allowance for Doubtful Accounts
 Accounts Receivable
Assume after spending some time trying to collect from Shala Co., Nile Co. decides that
Shala's Br. 200 accounts receivable is uncollectible and makes the following entry to writ-it
off.
Jan. 25 Allowance for Doubtful Accounts 200
A/R-Shalla Co. 200
Recovery of Uncollectible Accounts
For example, assume the amount written-of in the preceding entry is later collected on
February 15.
Feb. 15- A/R Shalla Co. 200
Allowance for Doubtful Accounts 200
To reinstate accounts previously written-off
Feb. 15- Cash 200
A/R-Shalla Co. 200
To record full payment of account
 Accounts Receivable

ESTIMATING UNCOLLECTIBLE
1. ESTIMATING BASED ON SALES
To illustrate, assume Wonji Co. has credit sales of Br. 500,000 in 20X2.
Based on past experience and the experience of other Cos, Wonji Co.
estimated 0.007% of credit sales are uncollectible. Using this prediction, the
adjusting entry for uncollectible accounts at the end of the period, 20X2 is as
follows.

Dec. 31 Uncollectible Accounts Exp. (500,000 X 0.007%) 3500

Allowance for Doubtful Accounts 3500
 Accounts Receivable

Aging the accounts receivable - customer balances are

classified by the length of time they have been unpaid.
Illustration 8-8

LO 3
 Accounts Receivable
To illustrate, assume there is as credit Balance of Br. 1300 in the allowance account
before adjustment. The amount to be added to this balance is therefore Br. 928 (B.r
2228 – Br. 1300) and the adjustment entry is as follows:
Dec. 31 Uncollectible Accounts Expense 928
Allowance for Doubtful Accounts 928
To record Uncollectible expense.
Alternatively, if the Allowance for Doubtful Accounts had an unadjusted debit
balance of Br. 700, then the required adjustment is Br. 2928. (Br. 2228 + 700) and
the adjustment entry is as follows:
Dec. 31 . Uncollectible Accounts Expense 2928
Allowance for Doubtful Accounts 2928
To record Uncollectible expense .
 Accounts Receivable
THE DIRECT- WRITE-OFF METHOD
The Direct Write-off method of accounting for bad debts records the loss from an
uncollectible A/R at the time it is determined to be uncollectible

If Wonji Co. uses a direct write-off method and determines on Feb. 20, it can’t
collect from a customer- Home Co.- Br. 500. The entry to write-off the
customer’s account is as follows

Feb. 20 Uncollectible Accounts Expense 500

A/R- Home Co. 500
To write-off Uncollectible accounts