Chapt - 1 & 6 P. A. I For Exit Material

CHAPTER-ONE
INTRODUCTION TO ACCOUNTING AND BUSINESS

Objective: at the end of this chapter the student will be able to
 The nature of a business
 The role of accounting in business
 Describe the definition of accounting and its business organizations
 Describe the function and accounting performed by accountants.
 Accounting principles and practices (IFRS)
 Describe a business transaction
 Identify the accounting equations and its basic elements
 Instate the effect of business transaction on the three basic elements of the accounting
equation.
1.1 Definition of Business: is a continuous economic activity, which involves production and
provision of goods and services that satisfy the needs and wants of the society for earning profit.
 Business: is an economic activity involving dealing with goods and services.
 The definition also stressed that the goods (physical products) and services (intangible benefits)
to be provided by the business should successfully meet the needs (basic deprivation of human
being) and wants (specific choices of individual) of the consumer.
 A business activity, which does not meet these needs and wants of the users, cannot survive
longer
1.2. Characteristics of Business
Business: is an activity primarily concerned with the objective of profits for the benefit of those on
whose behalf the activity is conducted.
 It is income oriented.
 It is an activity directed towards producing or acquiring wealth through buying or selling
goods.
1.3. Classification of Business
Business, which is directed towards making or selling products or services for a monetary reward,
falls into two broad categories:
 industry and
 Commerce.
 Industry: deals with the making or producing of goods.
 Commerce: deals with distributing of goods and services
Prepared: by Abdisa G. Page 1
1.4. Definition of Accounting:
 Business organizations need good financial information to make good business decision.
 Orderly records of a business financial activities are called accounting records.
 The process of identifying, measuring and communicating financial and economic information
to permit informed judgments and decisions by the users of the information, specifically
 The accounting process (also called accounting cycle) consists of the following group of
functions:
 Accountants observe many events and identify and measure in financial terms those events
considered evidence of economic activity.
 The economic events are recorded, classified into meaningful groups, and summarized for
conciseness.
 Accountants report on a business activity by preparing financial statements and special reports.
Often accountants are asked to interpret these statements and reports for various groups such as
management and creditors.
Accounting: is concerned with the processes of recording, sorting and summarizing data related to
business transaction and events.
Accounting: is also concerned with reporting and interpreting the data. Therefore, accounting has
been defined broadly as: -
1.5. Accounting Information & Its Users
1.5.1 Characteristics of accounting information
Accounting information: is composed principally of financial data about business transactions,
expressed in terms of money.
Generally, the qualitative characteristics of accounting information are as follows:
Relevance: - to be relevant, information must be predictive value and /or feedback value.
The information should be able to related to decisions and able to influence decisions.
Reliability: - it is the extent to which information is verifiable, representational faithful, and
neutral. Verifiable implies consensus among different measures.
Comparability: - accounting information enables users to identify and explain similarities and
difference between two or more assets of economic facts.
In order to be comparability to user, the enterprise should be used uniform accounting procedure in
different fiscal years.

Understandability: - the accounting information should be understandable to users who have
reasonable knowledge of business and economic activities and who are willing to study the
information with reasonable diligence.
1.5.2. Users of Accounting Information
An accounting information system provides data to help the decision making process of individual
outside the business as well as business are affected in some way by the performance of the
business, while the decision making individuals inside the business are responsible for the
performance of the business.
 There are Internal users: who are users that are directly involved in the day-to-day activities
of the organization.
 Management needs information in order:
 To formulate plan
 To prepare budget
 To control activities and
 To evaluate performance.
 There are external users: of accounting information.
a. Owners: Has the company had satisfactory income on its total investment? Should additional
investment be made in this company?
b. Creditors and lenders: Should a loan be granted to the company? Will the company be able to
pay its debts as they become due?
c. Employees and their unions: does the company have the ability to pay increased wages? Is the
company financially able to provide permanent employment?
d. Customers: does the company offer useful products at fair prices? Will the company survive
long enough to honor its product warranties?
e. Government units: is the local public utility charging a fair rate for its services?
f. General Public: is the company providing useful products and gainful employment for citizens
without causing serious environmental problems?
1.6. The profession of Accounting
 As professionals, accountants are typically engaged in either:
Private accounting: - accountants employed by a particular business firm or not for profit
organization.

Public accounting: - accountants who render accounting service on a fee basis, and staff
accountants employed by them.
 Both private and public accountings have long been recognized as excellent training for top
managerial responsibilities.
1.7. Job Opportunities in Accounting
Accounting as an old profession, records of business transactions have been prepared for centuries.
However, only during the last half-century has accounting been accepted as a profession with the
same importance as medical and legal professions.
Today several million are employed in accounting and accounting related fields all over the world.
Typically, accounting jobs can be grouped into four major categories.
Accountants: Persons, who plan, summarize, analyze, and interpret financial information.
They also prepare various accounting reports and assist owners and managers in making financial
decisions. Accountants also supervise the work of other accounting workers, which includes
checking the accuracy of recorded financial information.
Book Keepers: Persons who do general accounting work plus some summarizing and analyzing
words.
In some businesses, bookkeepers may supervise accounting clerks.
 These two office skills are needed for storing accounting records and preparing accounting
reports.
Accounting clerks: Persons, who record, sort and file accounting information.
For example, a clerk working inventory records is sometimes known as inventory clerk.
General office clerks: General office clerks generally do some works related to accounting.
For example, a secretary may be in charge of a small cash fund. A typist may file accounting
reports.
1.8. Difference between Accounting and Bookkeeping
Accounting: - is primarily concerned with the systematic way of recording, analyzing, classifying,
reporting and interpreting accounting information. It is concerned also with designing the system of
gathering information in an organization. It is, therefore, more of conceptual and analytical in
nature.
Bookkeeping: - is the recording of business data in prescribed manner. Bookkeeping may be
responsible for keeping all of the records of a business or of only a small segment, such as

apportion of the customer accounts in a department store. Bookkeeping can be viewed as one of
aspect, i.e., the recording aspect, of accounting
1.9. Business Transactions and the Accounting Equation
1.9.1. Business Transactions
A business transaction: is the occurrence of an event or of a condition that must be recorded.
For example the payment of a monthly electricity bill of Br. 60, the purchase of Br. 2,000 of
merchandise on cash or on credited, and the acquisition of machinery, building and land for Br.
350, 000 are illustrative of the variety of a business transactions.
1.9.2. Accounting Equation
Accounting equation: is the basic equation which you should remember, when you start an
accounting system and throughout the system as well.
Accounting equation shows the relationship between three items:
 Assets
 Liabilities and
 Capital.
Assets: A business owns things, such as cash, equipment, and supplies, which it uses to conduct its
activities. Any things, which have value, and owned by a business or individual is called Asset.
 When a business is started, these three items are there, Assets, Liabilities and Capital.
Liabilities and capital are the two financial rights (equities) on assets of the business.
Owner‟s equity (Capital)
Assets
Creditors equity (Liability)
Assets value includes the value of capital and the value of liability, therefore:
Assets = Equities
The two equities are liabilities and capital:
Assets = Liabilities and Capital
OR
Assets = Liabilities + Capital
 An equation showing the relationship between the assets and equities (equity of a person
outside a business and equity of the owner of a business) is called accounting equation.
The basic accounting equation is written as:
ASSETS = EQUITIES

OR
ASSETS = LIABILITY + CAPITAL
Transection (1)- Owner’s investment
Ato Dawit starts business by depositing Br. 100,000in a bank account opened in the name of
Effective Garage. The transfer of cash from the owner to the business is on owner‟s investment.
Cash ----------------------100,000
Capital --------------------------------100,000
Transaction (2)- Purchase of land for cash
Effective Garage bought land for Birr 20,000 in cash, to be used as a future site for the business.
Land -----------------------20,000
Cash --------------------------------------2
20,000
Transaction (3) -Purchase of Supplies On credit
Ato Dawit bought office supplies for birr 2,500 on credit, to be used by the business. Assets can
be purchased on credit (on account) basis, where the bu yer promises to pay in the future.
Supplies--------------------------------------2,500
Accounts payable -------------------------------------2,500
Transaction ( 4 ) –– Payment of liability
Effective Garage paid Birr. 1,500 to creditors on account. As you might have noticed, the
business bought the supplies in transaction “3” by promising to pay in the future, and as per the
promise made it is now settling its liability.
Accounts payable --------------------1,500
Cash --------------------------------------1,500
Transaction 5 –– Selling of service
During the first month of operation, Effective Garage earned service Fees of Birr 30,000
receiving the amount in cash for the garage services it rendered.
The effect of this transaction is to increase assets (because cash is collected) and to increase
owner‟s equity b y the same amount as revenue is earned.
Cash --------------------30,000
Service Revenue--------------30,000
Transaction (6 )- Recording Expenses
To generate revenue, Effective Garage has to hire emplo yees and pay salary, it has to
consume electric power and water resource and pay the bill, and so forth. The amounts of
such cash payments and using up of supplies are expenses to the business.

During the month of September, Effective Garage paid Birr 15,000 for different t ypes of
expenses (birr 10,000 to salary of emplo yees, birr 3000 Telephone, birr 1,500 for rent, and
birr 500 for advertisement).
Salary expenses --------------------------10,000
Telephone expenses e -------------------3, 000
Rent expenses -----------------------------1,500
Cash------------------------------------------------15,000
Transaction –– 7 Owner’s Withdrawal
Ato Dawit Gemechu, the owner, withdrew Birr 3000 for his personal from the business. Such
assets taken out of the business for the owner‟s personal use, b y the owner are called
Drawing ------------------------------3,000
Cash------------------------------------------3,000
Summary
The transactions of Effective Garage can be summarized in a tabular form as shown below.
Number identifies the transactions here and the balance of each item is shown after each
transaction.
Assets______ = Liabilit y + Owners Equity
Type of
Tra. Accounts Dawit Gem. owner‟s
No Cash + Supplies + Land Payable Capital Transaction
1 +100,000 - - - + 100,000 Owners
Investment
Bal Birr 100,000 - - - Birr 100,000
2 -20,000 - + 20,000 - -
Bal Birr 80,000 - Birr 20,000 - Birr 100,000
3 - +2500 +2500
Bal Birr 80,000 Birr 2,500 Birr 20,000 Birr2500 Birr 100,000
4 -1,500 - -1500
Bal Birr 78,500 Birr 2,500 Birr 20,000 Birr1,000 Birr 100,000
5 + 30,000 - - - + 30,000 Service fee

Bal Birr 108,500 Birr 2,500 Birr 20,000 Birr1,000 Birr 100,000
6 -15,000 - - - -10,000 Salary Exp.
-3000 Teleph. Exp
- - - - -1500 Rent Exp.
-500 Adv. Exp.
Bal Birr 93,500 Birr 2500 Birr 20,000 Birr 1000 Birr 115,000
7 -3,000 - - - -3000 Owner‟s
withdrowal
Bal Birr 90,500 Birr 2500 Birr 20,000 Birr 1,000 Birr 112,000
Total Assets =Birr 113,000 Total Liabilities and capital = Birr 113,000
Financial Statement of Sole Proprietorship

After the effect of the individual transactions has been determined, the essential information is
communicated to users at certain intervals. The accounting reports, which communicate this
information, are called financial statements
The major financial statements used to communicate accounting information about a business
are:
- Income statement
- Balance sheet
- Statement of owner‟s Equity
- Statement of cash flows (will be discussed in senior courses)
1. The Income Statement
The income statement is a financial statement that summarizes the amount of revenues earned
and expenses incurred by a business over a period of time. It reports the profitability of the
business by comparing revenues and expenses for a stated period of time such as a month or a
year. In accounting profitability is measured for a period of time than on a daily basis

The following is an income statement for Effective Garage for the month ended September
30, 200x.
Effective Garage
Income statement
For the Month Ended September 30,200x
Revenues:
Service Fee Birr 30,000.00
Expenses:
Salary Expense Birr 10,000.00
Telephone Expense 3,000.00
Rent Expense 1,500.00
Advertising Expense 500.00
Total Expenses 15,000.00
Net Income Birr 15,000.00
2 Owner’s Equity Statement

This is a statement that summarizes the changes in owner‟s equit y for a specific period of
time. Data for the preparation of owner‟s equity statement are obtained from the owner‟s
equity column of the tabular summary ( Illustration 1- ) and from the income statement.
Effective Garage
Statement of Owner’s Equity
For the Month ended September 30,200x
Dawit G. Capital, September 1………………Birr -0-

Add: Investments………………Birr 100,000.00
Net income……………… 15,000.00 115,000.00
Less: Drawings………………………………………………………………3,000.00
Dawit G. Capital, September 30………………………………… Birr 112,000.00

3 Balance Sheet
The balance sheet, sometimes called the statement of financial Position, lists the company‟s
assets, liabilities and owner‟s equity as of a specific date- usuall y at the end of a month or
year.
Effective
Garage
Balance Sheet
September 30,200x
Assets Liability
Cash…………Birr 90,500.00 Accounts payable…… Birr 1,000.00
Supplies……………2,500.00
Land………………20,000.00 Owner‟s Equit y
Ato Dawit Gem., Capital Br12,000.00.
_________ Total Liabilities and
Total Assets……..113,000.00 Owner‟sequity……...113,000

Summary
• A business form that is used to list what the business owns & what the
business owes and what the business worth on a specific date is called Balance
Sheet.
• Assets are economic resources owned by business that are expected to
benefit future operations or is any thing of value owned.
• Liabilities are present obligations of a business to pay cash transfer
assets or provide service to other entities in the future.
• Capital represents the remaining claims by the owners of business on the
assets of the business after deducting liabilities of the business.
• Accounting equation Asset = Liability + Capital
Review Questions
I. Matching
A B
__________ 1. Capital a) Asset
__________ 2. Balance sheet b) what the business is worth
__________ 3. Liability c) what is owed
__________ 4. What is owned d) heading
e) A form that lists asset, liability &
capital of a business
II. Classify each of the following items as Asset, Liability or capital
1. Computer
2. Building
3. Bank loan
4. Table & Chairs
. Photocopy machine
6. Unpaid rent
8. Cash
III. Analyze the following transactions using the accounting equations

1. Mr. T opens a small consultancy business and deposits br 90,000 in bank
2. Paid br 12,000 and bought office equipments
3. Paid br 18,000 and rented office for twelve months

4. Received cash br 6,500 br from consultancy services
5. Paid salary 1,200 br
6. Paid electricity, telephone expense br 100 and 250 respectively.
7. Bought vehicle on credit for br 27,000
Hint: Asset = liability + Capital
Increase 500 = Increase 500
I II . Essay Questions
1. What are the two equities on the assets of the business?
_____________________________________________________________
2. What does balance sheet shows?
_____________________________________________________________
3. Why a balance sheet is needed to be always in balance?
_______________________________________________________________
4. What is the first financial information recorded in the journal? Why we call it that way?
Where do we record the amounts on the left side of the balance sheet?
__________________________________________________________________
5. Where do we record the amounts on the right side of the amounts on the right side of the
balance sheet?
______________________________________________________________________
6. What does the second digit for equipment and awash bank tells about?
___________________________________________________________________
7. What does opening an account mean?
_______________________________________________________________
8. What is posting?
______________________________________________________________
9. What do we call an entry made on the left side of an account?
_____________________________________________________________
10. What do we call an entry made on the right side of an account?
______________________________________________________________
11. What are transactions?
______________________________________________________________

CHAPTER- II
THE ACCOUNTING CYCLE AND ITS COMPLETION
Chapter Objectives:
At the end of this chapter the learner is expected to:
 Describe the common classification of accounts for a small service enterprise
 Describe the nature of chart of accounts for a small service enterprise
 Describe the nature of an account and the general rules of debits and credit and normal
balances of accounts
 Describe and illustrate the use of a two column journal, and a four-column accounts; and
the posting of transactions to the ledger
 Discuss the matching principle as it relates to the cash basis and the accrual basis of
accounting
 Describe and illustrate the basic accounting procedures
 Describe and illustrate the completion of the worksheet and preparation of financial
statements.
2.1Definition of Accounting cycle
Accounting cycle: refers the series of procedures used to record, classify summarize and business
transactions and preparing financial reports.
Basic procedures: -the accounting cycle /process includes the following basic procedures
1. Collection of data about economic events
2. Analyzing data about economic events
3. Recording economic events in a Journal (the genera journal and special journal)
4. Posting to ledger accounts (general and subsidiary ledgers)
5. Preparing unadjusted trial balance
6. Preparing and posting adjusting entries (this is for deferrals, accruals, depreciation expense,
uncollectible accounts expense, inventory adjustment etc)
7. Preparing the adjusted trial balance
8. Completion of the worksheet (optional)
9. Preparation of financial reports

10. Recording and posting closing entries
11. Preparing a post –closing trial balance
12. Recording and posting reversing entries (for prepayments and unearned items).
This all steps /procedures will be illustrated and elaborated by giving a brief example at the end
of this chapter. Before that elaboration, let‟s see the nature and classification of accounts and
some rules of accounts.
2.2 Nature and classification of Accounts
An account: is a business form used to record additions (increases) and deductions
(decreases) for each individual asset, liability, owner‟s equity, revenue and expense items.
A group of related accounts of a specific business enterprise is called a ledger
2.2.1 Nature of an accounts:- the simplest form of an account is called T account ; and it
has three parts
 Title to write the name of the account
 Space for recording increases or decreases in the account (item) interns of money. , i.e. (left
and right sides). It can be presented as follows:
Title (name)
Left side Right side
(Debit) (Credit)
As is shown in the simplest account above the title is used to write the name of the account
(e.g. cash, accounts receivable, salary expense, capital, etc).
The left-hand side of the accounts is called debit, but the right-hand side is called the credit.
The right side (credit) and the left-side (debit) are used to record either the increases or
decreases of the accounts of a transaction. Depending on the type of the account the debit or
credit sides serve to record the effect of the transaction.
2.2.3 Classification of Accounts: generally accounts are categorized as
-Balance sheet accounts and
- Income statement accounts
i) Balance sheet accounts: they are also called real or permanent accounts. They include the
following groups of accounts.
FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 14

a) Assets: are both physical (tangible/ sensible) or rights (intangible or the right to use
something) properties that have monetary values which are owned by the business. They are
further classified as:
Current assets: which are expected to be converted to cash or used up with in a year or less?
Some examples included cash, accounts receivable, prepaid expenses, merchandise inventory,
etc
Plant assets /Fixed assets/ long-term assets (including land, building, equipment‟s,
furniture‟s and fixtures, etc) are those acquired or constructed internally to be used for
relatively long-period of time, usually more than a year.
All plant assets except land lose their usefulness with the passage of time. This decline in
usefulness is called depreciation.
b) Liabilities:- are obligations to pay money or to deliver goods to customer/creditors or
obligations to perform service.
They are, like assets, grouped as current and long- term liabilities.
Current liabilities are liabilities that must be paid or settled with a period of one year or less.
Examples include: accounts payable, salary payable, tax payable, rent payable, unearned rent,
etc.
Liabilities that they will not be paid with in a year or less are called long-term liabilities.
Example, of long- term liabilities include notes payable, bonds, long- term payable, mortage
payable, etc.
c) Owner’s equity: - is the residual claim against the assets of the business after the total
liabilities: are deducted- (for a corporation, owner‟s equity is frequently called stockholders
equity‟s, shareholders equity or stockholders‟ investment). Capital: is the owner‟s equity in a
sole proprietorship and partnership. The owner‟s equity maybe described as net worth. For a
corporation, capital stocks represent the investment of the stockholders, and retained earnings
represent the net income retained in the business.
Drawings: represent the amount of withdrawals made by the owner of a sole proprietorship
and a partnership. For corporations, dividends represent the distribution of earning to
stockholders.
ii) Income statement accounts: - They are also called temporary or nominal accounts, for they
are closed at the end of the accounting year. They include the following:

a) Revenue accounts: - are inflows of assets from sale of merchandise (sales), renting /
leasing properties (rent income), rendering service (fees earned), etc. They are the gross
increase in owner‟s equity as a result of sale of merchandise, the performance of services
for a customer or client, the rental of money, etc.
b) Expenses accounts: -are outflows / consumption of assets in the day-to-day activities of a
business in order to generate profit/ income to the business. Costs expired in the activities
of the business are called expenses.
2.2.4. Rule of Debits and Credits
The rules to debit or credit accounts or transactions occurred may be summarized in short as
follows:
 Increases in asset accounts /expense accounts are recorded in the debit side of the account
but decreases on them are recorded in the credit side.
 Increases in liability, capital and revenue accounts are recorded in the credit side of the
count but decreases on them are recorded in the debit side.
2.2.5 Normal balance of an account:
the difference between the total increases (may be debit or credit depending on the close of the
account) and the total decreases (debit or credit side) recorded in an account is called account
balance. Normal or the usual balance of an account is positive, i.e., the difference between the
sum of the increased side of the account and that of the sum of the decreased side is positive
under normal business operations.
The increase, decrease and the normal balance of the five classes of accounts are summarized
as follows:
Class of the account when increases when decreases its normal balance
Balance sheet accounts
Assets Debit Credit Debit
Liabilities Credit Debit Credit
Owner‟s equity/
Capital stock/Retained turnings/ Credit Debit Credit
Withdrawal and dividends Debit Credit Debit
Income statement account
Revenue Credit Debit Credit
Expenses Debit Credit Debit
Note:

The sum of the increases recorded in an account is usually equal to or greater than the sum of
the decreases recorded in the account. For this reason, the normal balances of all accounts are
positive. For example, in the summary above, the total debits (increases) in an asset account
will ordinarily be greater than the total decreases (credits). Thus, the asset accounts normally
have debit balance. Remember that a normal balance of an account is its increase side
Charts of accounts
The number of accounts maintained by a specific enterprise is affected by the nature of its
operations, its volume of business and the extent to which details are needed for taxing
authorities, managerial decisions, credit purpose, etc.
Accounting systems are intended to show the increase and decrease in financial statement item
in a separate record. This is called an account.
A list of all general ledger account titles and their related identification numbers is called chart
of accounts. The chart of accounts for Aksum Hotel, for example, is shown below.
Balance sheet accounts
1. Assets:
1001 cash
1002 accounts receivable
1003 inventory
1004 supplies
1005 prepaid insurance
1006 prepaid rent
1007 land
1008 office equipment‟s
1009 machinery
2. Liabilities
2001 accounts payable
2002 salary payable
2004 notes payable
2006 unearned rent
2008 bank loan payable
3. Owner’s equity
3001 owner‟s Hotels, capital
3001 owner‟s Drawing
Income statement accounts:
4. Revenue:
4001 sales revenue

4002 rent revenue

4003 interest revenue
5. Expenses:
5001 salary expenses

5002 supplies expenses
5003 utilities expenses
5004 rent expenses
5008 miscellaneous expense
Illustration: - on the debits and credits of the accounts. (Analyzing and summarizing
transaction)
Every business transaction affects a business‟s financial statements (the accounting equation)
and at least two accounts. In chapter one, the effect of each transaction was stated in terms of
the increases (+) and decreases (-). In this chapter, you are introduced what debits and credits
are. Hence, the effects of a business transaction on the accounts will be stated in terms of debits
and credits using examples.
Examples: - 1. Aksum Hotel deposited Br. 150,000 cash in a bank account on September-1
After the deposit, the balance sheet for the business is as follows
Aksum Hotel
Balance sheet
On September 1
Assets Owner‟s
Cash Br. 150,000 Aksum, Capital Br. 150,000
Since the cash account is increased and cash is an asset, this increase is recorded on the left
side (debit side) of the account. And owner‟s equity or capital is increased and this increase is
recorded in the right side (credit) of the account. Hence, using the simplest account the effects
are shown as follows:
Cash Aksume, Capital
Sep. 1 150,000(+) 150,000(+) Sep1
150,000
2. Aksum paid salary Br. 2000 for the month of September on September 30
The effect of the above transaction is decreasing cash (an asset) by Br. 2000 and increasing
salary expense account by Br. 2000. Increase an expenses is recorded on the debit side and
decrease on assets on the credit side. Using the T accounts the effect is shown as follows:

Cash Salary Expense
Sep30 150,000(+) 2000 (-) Sep30 Sep 30 (+) 2000
148,000 2000
At the end of the month the balance on cash account is Br. 148,000, on salary expense Br. 2000
and on the capital account Br. 150,000
Note: - The procedures involved in the accounting cycle will be discussed next using
transactions in an organization.
2.3 The Accounting cycle
It is the sequence of procedures in which that begins with the analysis and journalizing of
transactions and ends with the post-closing trial balance. The procedures are summarized as
follows and will be discussed by considering an example
Unadjusted
Source Analyzing Journalizing Posting trial balance
Adjusting
entries
Adjusted
Post closing Closing Financial trial balance
trial balance entries statements
To illustrate the accounting procedures / steps consider the following example

Roble and Rahel, the two outstanding BST College students and the first batch graduates of the
accounting department had operated a super snak in Rahel‟s parents‟ home on their extra time.
As of January 2002, after graduation, they decided to open a new metal and wood work shop
and moved to rented campus and to devote full time to the business, which is to be known as
“2 R lovers shaping” service.
Assume a fiscal /accounting year of January to December and entered the following transitions
during January

January 1 the following assets were received (transferred) from the super snak to the shop
Cash --------------------------------------------Br. 7500
Accounts receivable ----------------------------900
Supplies ------------------------------------------1,250
Service equipment -----------------------------11,000
There were no liabilities received.
The beginning capital of 2 R lovers shop service is Br. 20,650 (7,500 + 900+ 1,250 + 11,000-0)
which is computed using the accounting equation A = L +C
C = Asset – Liability
The transactions occurred during the month were summarized as follows:
January
1. Paid three-month‟s rent in advance Br. 2, 250, prepaid rent.
2. Paid the premiums on property and casualty insurance policies, Br. 1,740, prepaid
insurance.
4. Purchased additional service equipment on a accounts from Omedad Br. 2,500
6. Received cash from customers on account Br. 500
9. Paid cash for a newspaper advertisement, Br. 110
11. Paid Omedad for the part of liability incurred on January 4, Br. 1, 250
12. Record service revenue on account? Br. 1000
13. Paid laborers for two weeks salary Br. 500
17. Recorded cash from cash customers for service revenue earned during the first half of
January Br. 1, 100
17. Purchased supplies for cash Br. 950
20. Recorded service revenue on account for the period January 13- 20, Br. 700
24. Recorded cash from customers for service revenue earned for the period January 17-
24 Br. 1, 850
27. Received cash from customers on account, Br. 1,200
27. Paid labourers for two weeks salary Br. 500
30. Paid telephone bill for January Br. 75
30. Paid electricity bill for January Br. 140

30. Recorded cash from cash customers for services revenues earned for the period
January 25- 30, Br. 950
30. Recorded sales on account for the remainder of January, Br. 800
30. Rahel and Robel withdrew Br. 1,500 for their personal use
Instructions:
1. Complete the worksheet, using the following adjustment data:
a. Insurance expired during January ---------------Br. 145
b. Inventory of supplies on January31-------------1520
c. Depreciation of service equipment for January 100
d. Accrued salary on January 31 ------------------ 100
e. Rent expired during September ------------------- 750
2. Prepares an income statement, a statement of owners‟ equity, balance sheet to the
organization
3. Journalize and post the adjusting entries
4. Journalize and post the closing entries
5. Prepare a post-closing trial balance
Solution:
Dear learner! The answers for the problem are presented step-by-step by explaining the
accounting procedures involved in the accounting cycle. Therefore, the steps, the answers
depending on the steps are illustrated as follows
Procedure /steps: 1. Collecting data about economic events
Business transactions are economic events that they need recording. Bills, invoices etc could be
used as source documents to record the transaction. The transactions involved from
January1 - January 31 in the example, above, are the data for the economic events.
Procedure / step 2 single analyzing the data about economic events
The ability to analyze the effects of transactions on financial statements is an essential skill for
a successful career in a business.
Double accounting system is very powerful tool in this regard.
Analyzing transactions involve the following steps.
a. Determine whether an assets, a liability, owner‟s equity, revenue of an expense account is
affected by the transaction

b. For each account affected by the transaction, determine whether the accounts increases or
decreases
c. Determine whether each increase or decrease should be recorded as a debit or a credit
To illustrate this analysis let’s consider two transactions from the example given.
Transaction (January 2 and January 9) is taken randomly.
January 2 paid the premiums on property and casualty insurance policies, Br. 1, 740
Analysis: advance payments of expenses such as
a. Insurance are prepaid expenses, which are assets. Hence the accounts involved are assets
(prepaid insurance) and cash (an asset).
b. The asset cash decreases and another asset prepaid insurance increases
c. Cash is credited and prepaid insurance debited.
January 9: paid cash for a newspaper advertisement.Br.110
Analysis:
a. The accounts involved are cash (asset) and advertisement expense (could simply be
charged to miscellaneous expense)
b. Cash decreases and miscellaneous expense increases
c. Cash is credited and miscellaneous expense debited
Step 3 Journalizing: is the process of recording transactions in a business book called
journal. This recording transaction in a chronological order is done, after collecting the source
documents and annualizing the transaction
The following is called a two – column Journal used to record transactions
Procedure / step4 posting: is the process of transferring debits and credits from the journal to
the accounts in the ledger. There are different types of accounts. T- Account, two columns,
three- column and four- column accounts.
There are two types of ledgers-general and subsidiary.
A general ledger is the principal ledger when used in conjunction with the subsidiary ledgers
that contains all accounts. It is containing account.
Subsidiary ledger is a ledger containing individual accounts with common characteristic

Journal page 1
Post
Date Description Ref Debit Credit
2002
Jan 1 Prepaid rent 15 Br.2250 00
Cash 11 2250 00
2 Prepaid insurance 16 1740 00
Cash 11 1740 00
4 Service equipment 18 2500 00
Accounts payable 21 2500 00
6 Cash 11 500 00
Accounts receivable 12 500 00
9 Miscellaneous expe. 59 110 00
Cash 11 110 00
11 Accounts payable 21 1250 00
Cash 11 1250 00
12 Accounts receivable 12 1000 00
Service revenue 41 1000 00
13 Salary expense 51 500 00
Cash 11 500 00
17 Cash 11 1100 00
17 Supplies 14 950 00
Cash 11 950 00
20 Accounts receivable 12 700 00
24 Cash 11 1850 00
Three lines are requiring in recording a transaction in a journal:
1. For recording debit part
2. For recording credit part
3. Reason for recording the transaction

Journal page 2
Post
2002
Jan 27 Cash 11 1200 00
Accounts receivable 12 1200 00
27 Salary expense 51 500 00
Cash 11 500 00
30 Miscellaneous expense 59 75 00
Cash 11 75 00
30 Miscellaneous expense 59 140 00
Cash 11 140 00
30 Cash 11 950 00
30 Account receivable 12 800 00
30 2R- Drawing 32 1500 00
Cash 11 1500 00
31 Adjusting entries
Insurance expense 55 145 00
Prepaid insurance 16 145 00
Supplies expense 53 680 00
Supplies 14 680 00
Depreciation ex. Stor.eq. 54 100 00
Accumulated dep.exp. 19 100 00
Salary expense 51 100 00
Salary payable 22 100 00
Rent expense 750 00
Prepaid rent 15 750 00
Three lines are require in recording a transaction in a journal:

4. For recording debit part
5. For recording credit part
6. Reason for recording the transaction

Journal page 3
Post
2002 Closing entries:
Jan 31 Income summary 33 3100 00
Insurance expense 55 145 00
Supplies expense 53 680 00
Rent expense 52 750 00
Dep. Exp. Store eq 54 100 00
Salary expense 51 1100 00
Miscene. Expense 59 325 00
To close expenses
Service Revenue 41 6400 00
Income summary 33 6400 00
To close revenue
2R capital 31 1500
2R drawing 32 1500 00
To close drawing
Income summary 33 3200 00
2R – capital 31 3200 00
To close income sum.
(Net income of the period)
(The above Journal shows an answer to question # 2 which is journalizing transaction in a

Journal)
This is a general journal of 2R- shopping service consisting all the transaction occurred and
recorded during the month of January
The debit and credit section shows the amount debited and credited and the post reference
represents where the amount is posted to (the account number)
These accounts which are described in the following few pages are answers to question # 1 and
3 opening an account and posting. All are completed accounts at the end of the month after the
adjusting and the closing entries are posted.

Cash account no 11
Post ref Balance
Date Item Debit Credit Debit Credit
2002 Balance 7500 00
Jan 1 1 2250 00 5270 00
2 1 1740 00 3510 00
6 1 500 00 4010 00
9 1 110 00 3900 00
11 1 1250 00 2650 00
13 1 500 00 2150 00
17 1 1100 00 3250 00
17 1 950 00 2300 00
24 1 1850 00 4150 00
27 1 1200 00 5350 00
27 2 500 00 4850 00
27 2 75 00 4775 00
30 2 140 00 4635 00
30 2 950 00 5585 00
30 1500 00 4085 00
Ending balance 4085 00
Account receivable 12
Balance
Date Item Post ref Debit Credit Dr. Cr.

2002 Balance 900
Jan 1 500 400
6 1 1000 1400
12 1 700 2100
20 2 1200 9000
27 2 800 1700
30
Ending balance 1700

Supplies 14
Balance

Before
2002 Balance 1250 adjustm
Jan 17 1 950 2200 ent
31 Adjusting entry 2 680 1520 balance
1520
After adjustment
Prepaid Rent 15
Balance
Date Item Post ref Debit Credit Dr. Cr. Before

2002 2250 adjustm
Jan 1 1 2250 750 1500 ent
31 Adjusting entry 2 balance
1500
After adjustment
Prepaid insurance 16
Balance
Before
Date Item Post ref Debit Credit Dr. Cr. adjustm
ent
2002
balance
Jan 2 1 1740 1740
31 Adjusting entry 145 1595
1595
After adjustment
Service equipment 18
Balance

2002 Balance 11,000
Jan 4 Purchase of equip. 1 2500 13,500
145
Ending balance 13500

Accumulated depreciation service equipment 19
Balance

2002
Jan Adjusting entry 2 100 100
Accounts payable 21
Balance

2002
Jan 4 1 2500 2500
11 1250 1250
1250
Salary Payable 22
Balance

2002
Jan 31 Adjusting entry 2 100 100
100
2R - Capital 31
Balance
Date Item Post Debit Credit Dr. Cr.

ref
2002 Balance 20650
Jan 31 Closing Drawings 3 1500 1700
31 Closing net income 3 3200
22350
2R drawing 32

Balance

2002
Jan 33 2 1500 1500
31 Closing entry 3 1500 -
Income summary 33
Balance

2002
Jan 31 Closing expense 3 3200 3200
31 Closing revenue 3 6400 3200
31 Closing net income 3 3200
(Income summary)
Service revenue 41
Balance

2002 12 1 1000 1000
Jan 17 1 1100 2100
20 1 700 2800
24 1 1850 4650
30 2 950 5600
30 2 800 6400
31 Closing entry 3 6400
Salary Expense 51
Balance

2002 13 Payment 1 500 500
Jan 27 payment 2 500 1000
31 Adjusting entry 2 100 1100
31 Closing entry 3 1100 -
Rent expense 52

Balance

2002
31 Closing entry 3 750 _
Supplies expense 53
Balance

2002
Depreciation expense- service equipment 54

Balance

2002
31 Closing entry 3 100
Insurance expense 55
Balance

2002

Miscellaneous expense 59
Balance

2002
Jan 6 1 110 110
30 2 75 185
30 2 140 325
Procedure/ step 5: preparation of a trial balance

The equality of debits and credits in a ledger must be proved at the end of each accounting
period. This is made by preparing a trial balance. Trial balance is a list of tittles and related
balances of the accounts in the ledger.
After posting all the entries, including adjusting and closing, the end balances and tittles of 2R-
shopping service using the trial balance is shown as below.
2R –shopping service
Trial balance
On January 31, 2002
Title Debit Credit
Cash 4085 00
Accounts receivable 1700 00
Supplies 2200 00
Prepaid rent 2250 00
Prepaid insurance 1740 00
Service equipment 13500 00
Accounts payable 1250 00
2R- lovers capital 20650 00
2R- drawing 1500 00
Service revenue 6400 00
Salary expense 1000 00
Miscellaneous expense 325 00
Total 28,300 00 28,300 00
(The above trial balance which is computed and completed is is an answer to question # 4)

The trial balance does not provide the complete proof of accuracy of the ledger. It indicates
only that debits and credits are equal.
If the two totals of the trial balance are not equal it is probably due to the following errors.
 Errors in preparing the trial balance was incorrectly added: it may be due to one of
the following activates
Correction of errors: For incorrect journal entry but not yet posted or for incorrect amounts
posted draw a single line through the error and write the correct title or amount
-For incorrect Journal entry which is posted or for posting to the wrong account journalizing
and posting a correcting entry.
Procedure / step 6: adjusting process
Before directly involving in to the adjusting procedure and the adjusting entries it is important
to introduce some basic concepts such as the following:
i. Accounting period concept: according to this concept reports should be prepared at
periodic intervals such as monthly, quarterly or yearly called accounting periods.
The annual accounting period adopted by a business enterprise is called fiscal/ accounting
year. Financial statements prepared for less than one-year period are called interim financial
statements
ii. Accrual concept: there are two revenue and expense recording methods
Cash basis: under this method revenues are recorded and reported in which cash is collected;
and expenses are recorded and reported in the period in which cash is paid
Accrual basis: under this method of accounting revenues are recorded and reported in the
period in which they are earned (goods are sold or services are performed regardless of
collection of cash). Expenses are recorded and reported in the period in which they are incurred
(assets are consumed or expired; services are received regardless of payment of cash).
iii. Matching principle: this principle states that in determining net income / net loss for a
given period, all expenses incurred in that period should be deducted from the revenues earned
in that period, i.e. the income statement should match the revenues earned and the expenses
incurred in a certain period to determine net income/ net loss of that period.
Prepaid expenses (deferred expenses):- initially recorded as assets but are expected to become
expenses over time in the business. Examples include prepaid rent, prepaid insurance, supplies
etc

Accruals: are created by failure to record an expense that has been incurred or revenue that has
been earned. Examples include unrecorded wage (accrued expense/ accrued liabilities) and
unrecorded fees earned (accrued revenue often called accrued assets)
Unearned revenues: are liabilities created by receiving cash in advance for provision of goods
or services
Note: deferrals are cash received or paid in the current period but revenues or expanse recorded
in the future period
Procedure/ step 7: worksheet completion: it is a working paper used by an accountant.
2R shopping service
Worksheet
For the month ended January 31, 2002
Account title Trial balance Adjustments
Adjusted trial In come Balance sheet
balance statement
Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr
Cash 4085 4085 4085
Acco/Receivable 1700 1700 1700
Supplies 2200 b) 680 1520 1520
Prepaid Rent 2250 e) 750 1500 1500
Prepaid insurance 1740 a) 145 1595 1595
Service. Equip. 13500 13,500 13500
Acc. Payable 1250 1250 1250
2R-capital 20,650 20,650 20650
2R,drawing 1500 1500 1500
Service Revenue 6400 6400 6400
Salary expense 1000 d) 100 1100 1100
Misce. Expense 325 325 325
Total 28,300 28,300
Insurance Expe.
Supplies. Exp.
Deprecation Exp. a) 145 145 145
Accumulated dep. b) 680 680 680
Salary payable c) 100 100 100
Rent expense c) 100 100 100
e) 750 d) 100 751 100 750 6,400 25,400 100
1875 1875 28,500 28,500 3,200 6,400 25,400 22,200
3,200 3,200
6,400 25,400
Adjustment
b) Supplies used Br. 650 (2200-1520)

a) Insurance expired Br. 145
e) Rent expired Br. 750
d) Salary accrued but not paid Br. 100
c) Depreciation of service equipment Br. 100
Procedures /step 8: financial statements preparation. The financial statements are directly
derived from the work sheet. The statements are, therefore, prepared as follows
2R- shopping service
Income statement
For the month ended January 31, 2002
Service revenue ------------------------------------------------Br. 6400
Less: Expenses
Salary expenses Br. 1100
Insurance expense 145
Supplies expense 680
Rent expense 750
Depreciation expense 100
Miscellanies expense 325 3200
Net income Br. 3200
2R shopping service
Statement of owner’s equity
For month ended January 31, 2002
2R- capital, January 2002 ------------------Br. 20650
Add. Net income for the month 3200
Less with drawl 1500
Increase in capital 1700
2R –capital, January 31,2002 22,350

Balance sheet
On January 31, 2002
Assets:
Current assets:
Cash -----------------Br.4085
A/R 1700
Supplies 1520
Prepaid rent 1500
Total current assets Br. 10400
Plane assets:
Less accumulate. Depreciation ( 200) 13300
Total assets 23,700
Liabilities and capital:
Account payable 1250
Salary payable 100
Total liability 1350
2R- capital 22,350
Total liab& capital 23,700
Procedure /step 9: closing entries
Revenues, expenses and drawing /dividend account are temporary accounts used to
accumulated effects of some transaction on owner‟s equity account for a specific period. At the
end of the accounting period the balances of revenue and expense accounts are summarized in
one another temporary account called the income summary. The balance in the income
summary is transferred/closed to the capital (owner‟s equity) account. The balance on the
drawing /divided account is directly closed to the capital (retained earnings account).

Procedure / step 10: post-closing trial balance: It is a trial balance prepared after all
adjusting and closing entries is posted. It is prepared to check the equality of the total debit and
the total credit of the balance of the real accounts.
Post-closing trial balance
On January 31, 2002
Account title Debit Credit

Cash Br.4085
Accounts receivable 1700
Supplies 1520
Prepaid rent 1500
Accumulated dep. Service 200
Accounts payable 1250
Salary payable 100
2R- capital 22,350
Total 23,800 23,800

CHAPTER- THREE
ACCOUNTING FOR A MERCHANDISING ENTERPRISE
Business organization could be classified in to groups based on their activities.

Manufacturing, service giving, merchandising etc, are some classifications, which could
be mentioned.
Merchandising business acquires merchandise for resale to customers. This selling of
merchandise, not service, or finished products, differs these business organizations from the
activities of service enterprises or manufacturing companies. Because they are different
organization types in their acquisitions, therefore, they need their own accounting principles
and concepts.
This is to mean looking the accounting for transactions between the buyers and the sellers of
merchandise.
Chapter Objectives:
After studying this chapter the learner will be able to:
 Illustrate the accounting for merchandise transactions including
 Describe the sequence of year- end procedures for a merchandising enterprise
 State the two merchandise inventory systems.
 Describe and illustrate the cost of merchandise sold section of an income statement
 Describe and illustrate the journal entries for merchandise inventory adjustments at year
end
3.1 Purchasing and selling procedures
3.1.1 Accounting for purchases
In merchandising businesses like Guan Trading share company East African trading Plc, etc
the purchases of merchandise are usually identified in the ledger as purchases. This is the most
commonly used account. “Purchase of merchandise” which is a more exact account could be
used. But the briefer and most commonly used is the “purchase” account.
A merchandising enterprise, thus, can accumulate in the purchase account the cost of all
merchandise purchased for resale during the accounting period.
Purchases could be made for cash though most are made on account.

If purchases are made on cash or on accounts the transaction could be recorded as follows.
Purchases xxx
Cash (or Accounts payable) xxx
This is the entry to record purchase from a supplier firm
3.1.2 Purchase discounts
The buyer and the seller may reach in agreement for some arrangements as to when payments
for merchandise are to be effected.
If the purchases or the merchandise are on accounts such arrangements are called credit terms.
If payment is required immediately upon delivery, the terms are said to be “cash” or “net
cash”. Otherwise, the buyer is allowed a certain amount of time, known as the credit period, in
which to pay the amount.
It is usual for the credit period to begin with the date of the sale as shown by the date of the
invoice.
If payments are due within a stated number of days after the date of the invoice, for example 45
days, the terms are said to be “net 45 days,” which may be written as “n/45.”
To encourage early payments before the credit period the seller may offer a discount called
purchase discount by the buyer. They are recorded by crediting purchase discount account and
considered as a control account to purchases.
For example in the expression 2/10, n/45 if the amount is paid within 10 days there will be a
2% discount otherwise the full amount will be settled within 45 days of the invoice date.
Consider the following transaction to record purchases & purchase discounts.
ABC trading purchased merchandise, from XYZ on 1 January 2004 organization amount Br.
1800 terms 2/10, n/30. On 9 January 2004 the total amount was settled.
Required record the transaction.
January 1: purchases --------------1800
Accounts payable -------------------------1800
January 9: accounts payable -----1800

Cash (1800-36) ----------------1764
Purchase discount (2%x1800) ------------36
This is the entry to record the initial purchase and the payment with in the due date.

3.1.3. Purchases returns and allowances
Some times after merchandises are sold some items may be found defective or of the wrong
specification. In such cases the merchandise may be returned (purchase return) or a price
adjustment (purchase allowance) may be requested.
The buyer usually communicates with the seller in writing. The details may be stated in a
letter, or the buyer (debtor) may use a debit memorandum form which consists of the reasons
why the creditors (seller) accounts is debited.
Accredit memorandum is prepared for confirmation by the creditor to the debtor to record the
account- purchase returns and allowance.
Illustration
To illustrate, assume ABC trading purchased merchandises from BCD manufacturing company
amounted Br. 2,000 terms, 2/10, n/30 on March 1, 2004.
On March 5 when the merchandise were delivered some items costing Br.200 were found
defective and returned to the seller by writing debit memorandum # 21.
Required record the transactions.
March 5, 2004 purchases ----- 2000
Accounts payable 2000
March 5, 2004 Accounts payable 200
Purchase returns and allowance 200
Debit memo # 21
Assume further that the amount was paid within the discount period (March 10, 2004). Record
the transaction.
Accounts payable (2000-200) ---------------------1800
Cash (1800- 36) -----------------------------1764
Purchase discount (2%x1800) ---------------36
3.2 Accounting for sales
In merchandising businesses merchandise sales are usually identified in the ledger as sales.
A business enterprise may sell merchandises on cash in which case a cash register may be used
and the total will be summed up at the end of the day.
If merchandise is sold on cash on a certain time on a day the entry to record the transaction
will be

Cash --------------xxx
Sales ---------------------------------xxx
To record cash sales
A business may also sell merchandise on account. In such sells the entry is
Accounts receivable --------------xxx
Sales ---------------------------------------xx
3.2.1 Sales retunes and allowances
In merchandising businesses if some items of the merchandise sold are found defective or
wrong specification the buyer may return (sales return) or may be allowed a reduction from the
original price at which the goods were sold (sales allowance).
If the return or allowance is for a sale on account, the seller usually gives the buyer a credit
memorandum which shows the amount for which the buyer is to be credited and there reason
therefore. The effect of this account is reduction in sales revenue and a reduction in cash or
accounts receivable.
3.2.2 Sale discounts
In merchandising businesses the seller refers the discounts taken by the buyer for early
payments of an invoice as sales discounts.
Like sales returns and allowances account sales discounts are considered and viewed as a
contra (or offsetting) accounts to seals.
To illustrate the sales returns and allowance and sales discounts accounts assume the following
example
ABC merchandising business sold merchandises to XYZ organization costing Br. 50,000 on
January 5, 2004, terms 2/10, n/30. On January 10 when the goods were delivered some items
costing Br. 5000 were found defective and returned to the seller with acceptable reasons stated.
The seller collects half of the credit sales on January 14, 2004
Required: Record the necessary Journal entry for the transactions involved.
January 5 accounts receivable -------------50,000
Sales--------------------------------------50,000
10. Sales returns and allowance --------------------5.000
Account receivable--------------------------------5,000
14 cash (22,500-450) --------------------22,050

Sales discount (2%x 22,500)------------450
Account receivable -----------------------------------22,500
3.2.3. Transportation costs
A clear agreement should be reached as to who (the buyer or the seller) should cover the
transportation cost and when and where should be the title of ownership should be transferred
from the seller to the buyer.
If the ownership passes to the buyer when the seller delivers the merchandise to the shipper,
the buyer is to absorb the transportation costs and the terms are said to be FOB shipping pint.
This means the seller places the merchandise “free on board” at the shipping point and the
buyer will assume any related costs beyond that point.
If the title of ownership passes at the destination of the buyer the seller will assume the
transportation cost and the terms of agreement is called FOB destination.
When merchandise is purchased on terms of FOB shipping point, the transportation costs
covered by the buyer should be debited to Transportation in or freight - in account and its
balance should be added to net purchases in determining the total cost of merchandise
purchased.
Illustration:
- Assume that on June 10, 2004, ABC Company purchased merchandises from XYZ
Corporation on account, Br. 900, terms FOB shipping point, 2/10, n/30, with prepaid
transportation costs of Br. 50 added to the invoice. Assume, further that ABC paid the amount
within 10 days.
Required: record the entries by both companies
On the book of On the book of
ABC Company (buyer) XYZ company (seller)
June 10. Purchases------------------- 900 June 10. Accents receivable ---------950
Transportation in ----------50 Cash------------------------50
Accounts payable --------------------950 sales----------------------------900
June 20. Account payable -------------------950 June 20. Cash -----------------932

Cash------------------------------ 932 Sales discount-------------------18
Purchase discounts---------------18 Account receivable----------------950

Note: in merchandising businesses if the sales are cash sales the seller will collect the sales tax
but when sales is made on account, the buyer is charged for the tax. The seller credits the sales
account for only the amount of sale, and credits the tax to sales tax payable which will be paid
periodically to the taxing unit, and the sales tax payable is debited.
3.3 Periodic Reporting for merchandising Enterprises
Like any business organizations for any merchandising enterprises at yearly intervals
throughout their life operating data for the fiscal year must be summarized and reported to
users. Financial statements such as an income statement, a balance sheet and others must be
prepared. Legers and accounts must be updated or adjusted, and closed when necessary so that
they will be ready to receive transactions that will occur in the following year.
The sequence of year-end procedures may be changed slightly, but in general the following
outline is typical.
1. Prepare a trial balance of the ledger on a worksheet form
2. Review the accounts and gather the data required for the adjustments.
3. Insert the adjustments and complete the worksheet.
4. Prepare financial statements from the data in the worksheet.
5. Journalize the adjusting entries and post to the ledgers
6. Journalize the closing entries and post to the ledgers
7. Prepare a post-closing trial balance of the ledger.
The difference is on the merchandizing inventory side, you will be presented the worksheet
using illustrative problem and be clear yourself with the concepts.
3.3.1 Merchandise Inventory Systems:
There are two main systems for accounting for merchandise held for sale:
a) Periodic: this system is used by many merchandising enterprises. In this system, the
revenues from sales are recorded when sales are made, but no attempt is made on the sales
date to record the cost of the merchandise sold.
b) Perpetual system: here in this system, both the sales amount and the cost of merchandise
sold amount are recorded when each item of merchandise is sold. In this manner, the
accounting records continuously (perpetually) disclose the inventory on hand.

3.3.2 Cost of merchandise sold
In merchandising enterprise‟s that use periodic inventory system income statement the cost of
merchandise sold is reported in a separate section. To illustrate this fact let‟s consider the
following examples.
ABC Trading, assumes, began its business operation on January 1, 1992 and purchased Br.
500,000 of merchandise during the year. Assume, the ending inventory on hand using physical
count was found costing Br. 100,000 on Dec 31, 1992 (year-end). The cost of merchandise sold
during the year (1992) would be reported in the income statement of the organization as
follows:
Cost of merchandise sold:
Purchases----------------------------------------------------------Br. 500,000
Less: merchandise Inventory, December 31, 1992 --------------100,000
Cost of merchandise sold----------------------------------Br. 400,000
To continue the illustration assumes that during 1993 the company purchased additional
merchandise of Br. 600,000 received credit memo for purchase returns & Allowances of Br.
10,000 took purchase discounts of Br. 5000 and paid transportation costs of Br. 5000.
Assume ending inventory of 90,000 for the report 1993 would be reported, in the income
statement would be prepared as follows (only the cost of goods sold section).
Merchandise Inventory (beginning), January 1,1993 ---------------------------Br. 100,000
Purchases (in 1993) Br. 600,000
Less: Purchase returns & Allowances 10,000
Purchase discounts 5,000 15,000
Net purchases 585,000
Add: Transportation in 5,000
Cost of merchandise purchased 590,000
Merchandise available for sale 690,000
Less: merchandise Inventory (ending) December 1993 90,000
Cost of merchandise sold 600,000

Note that in the cost of merchandise sold section the beginning inventory is added to the cost of
merchandise purchased, which is the sum of net purchases (purchases – purchase returns &
allowances – purchase discounts) and transportation in, if any.
The sum of the beginning inventory and the cost of merchandise purchased give the total
merchandise available for sale during a period. When the ending inventory determined by
physical count at the end of a period is deducted from the merchandises available for sale the
cost of merchandise sold is computed.
Illustration
To illustrate these adjusting entries consider the balances on the merchandise inventory of
ABC trading stated above. The adjusting entries for the enterprise for the year ended on
December 31, 1993 would be:
Dec 31 Income summary------------------------------100,000
Merchandise Inventor--------------------------------------100,000
It is entry to transfer the amount to income summary as a part of the cost of merchandise
available for sale it is replaced by a debit of Br. 90,000 the merchandise inventory at the end of
the year as follow.
Dec 31 Merchandise Inventory-----------------------------------90,000
Income summary -----------------------------------------------------90,000
3.4 Deferrals & Accruals
It is recalled in the previous chapter that adjusting entries at the end of the accounting period
are used to match properly the revenues and expenses for the period.
Deferrals & accruals need adjusting entries at the end of a period. A deferral is a delay of the
recognition of an expense already paid or of revenue already received. An accrual is an
expense that has not been paid or revenue that has not been received.
Deferred expenses expected to benefit a short period of time are reported in the balance sheet
among the current assets, where they are called prepaid expenses. They are costs of goods and
services that have been purchased but not used. An adjustment is necessary at the end of the
period so that the portion of the asset that has been used during the period becomes an expense;
the remainder is an asset. Long-term prepayments that can be charged to the operations of
several years are presented on the balance sheet in a section called deferred charges.

Deferred revenues may be listed on the balance sheet as current liabilities, where they are
called unearned revenues or revenues received in advance (deferred credits if a long period
of time is involved).
Any unrecorded accruals must be recorded before financial statements are prepared.
Accrued expenses may be described on the balance sheet as accrued liabilities, or reference to
the accrual may be omitted from the title, as in “Wages payable”.
Accrued revenues may be described on the balance sheet as accrued assets, or reference to the
accrual may be omitted from the title, as in “Interest receivable” and “Fees receivable”.
Illustrating adjusting entries for Accrual and deferrals prepaid expenses (Deferrals):
Assume that the office supplies account of ABC trading has a balance of Br. 500 on December
31, 1993, the end of the year. It includes the cost of supplies on hand at the beginning of the
year and the cost of supplies purchased during the year. Assume the cost of supplies on hand
using physical inventory at the end of the year total Br. 500. Hence, the cost of supplies used
during the year is Br. 1000 (1500-500). The adjusting entry to record the Br. 1000 decrease of
the asset and the corresponding increase in expense is as follows.
Dec 31 Supplies expense-------------------------------1000
Supplies-------------------------------------------------- 1000
The supplies expense will be reported on the income statement with other expenses and the
remaining balance on the supplies account (1500-1000 = 500) will be reported in the balance
sheet as an asset in the current assets section.
Illustrating adjusting entries for unearned revenues (Deferrals): By accepting advance
payment of a good or a service, a business commits itself to furnish the good or the service at
some future time. At the end of the accounting period, if some portion of the good or the
service has been furnished, part of the revenue has been earned.
To illustrate assume the following transactions: On March1, 1993, ABC trading rents a portion
of its building for a period of one year receiving Br. 24,000 in payment for the entire year‟s
rental. Assume also at the end of the year (Dec 31, 1993) adjusting entries are recorded. Hence,
the entry to record the initial entry & the revenue and reduce the liability appears as follows.
March 1 Cash …....................................... 24,000
Unearned Revenue …...................... 24,000
Entry to record the advance receipt of cash for rent.

Dec 31 Unearned Rent (24,000 = 2000, 2000 x 9 months) ….. 18,000
12
Rent Income ….................................................... 18,000
Adjusting entry to record the revenue earned
After this entry has been posted, the unearned rent account will have a balance of Br. 6000
(24,000-18,000), which will be reported as a liability on the balance sheet and the rent income
will have a balance of Br.18,000, which will be reported on the income statement.
Illustrating adjusting entries for Accrued liabilities (Accrued expenses):
Some expenses accrue from day to day but are usually recorded only when they are paid. The
amounts of such accrued but unpaid items at the end of the fiscal period are both an expense
and a liability. It is for this reason that such accruals are called accrued liabilities or accrued
expenses.
To illustrate consider the following transactions for ABC trading. Assume that on December
31, 1993, the end of the fiscal year, the sales salaries expense account and the office salaries
expense account have a debit balance of Br.65,000 and Br.30,000 respectively. During the year
salaries have been paid every two weeks. For this particular fiscal year, the records of the
business show that the accruals for sales salaries and office salaries are Br. 750 and Br. 450,
respectively, at the end of the year. The entry to record the additional expenses and liability is
as follows.
Dec 31 Sales Salary expense …............ 750
Office Salary expense …............ 450
Salary payable …................... 1200
After the adjusting entry has been posted to the accounts, the sales salaries expense totals
Br.65,750 (Br.65,000+Br.750), and the office salaries expense totals Br.30,450
(Br.30,000+Br.450). These amounts will appear as expense on the income statement. The
balance on the salary payable account totals Br. 1200 and that amount will be reported as
liability on the balance sheet.
Illustration
Illustrating adjusting entries for Accrued Assets (Accrued Revenues):
In merchandising enterprises and other business organizations all assets and all revenues
belonging to the business should be recorded. Sometimes it is common to record some types of

revenues only as the cash is received; consequently, at the end of the period there may be items
of revenue that have not been recorded. In such cases, debiting an asset account and crediting a
revenue account must record the amount of the accrued revenue. Because of the dual nature of
such accruals, they are called accrued assets or accrued revenues.
Consider the following example for illustration: On December 31, 1993, the end of the fiscal
year, ABC trading has an interest bearing note receivable. All interest income will be collected
in the next year (1994), when payment is due on the note.
Assume further that the interest earned but not collected on December 31,1993 amounted Br.
3000. The entry to record this increase in the amount of interest due/ receivable on the note and
the revenue earned is as follows:
Dec 31. Interest Receivable …................ 3000
Interest income ….................. 3000
3.5. Financial Statements for Merchandising Enterprises.
The basic financial statements for a merchandising enterprise are the income statement,
statement of owner’s equity or retained earnings, statement, and balance sheet.
There are two widely used forms for the income statement: multiple step and single step.
The multiple-step income statement is so called because of its many sections, subsections, and
intermediate balances. The single step income statement derives its name from the fact that the
total of its expenses is deducted from the total of all revenues.
3.5.1Adjusting, closing & Reversing entries
The adjusting entries are prepared for a merchandising enterprise from the work sheet
adjustments column. After the adjusting entries have been posted, the balance of all assets,
liability & revenue and expense accounts correspond exactly to the amounts reported in the
financial statements.
The closing entries are recorded in the Journal immediately following the adjusting entries. All
the temporary accounts (Revenues & Expenses should close to income-summary, a temporary
account that is opened & closed at the end of the accounting period, and the income summary
to the owner‟s equity/capital account. The withdrawal or dividend account should also closed
to capital account) and cleared off their balances, reducing them to zero.

The following selected accounts and their normal balances appear in the income statement and
balance sheet columns of the worksheet of ABC-company for the fiscal year ended
December31,1991.
Cash………………………………………………….. Br.87,750.00
Notes Receivable…………………………………….. 50,000.00
Accounts Receivable………………………………… 97,000.00
Merchandise Inventory, Jan1, 1991………………….. 75,000.00
Merchandise Inventory, Dec 31,1991………………... 85,000.00
Office Supplies……………………………………….. 2,600.00
Prepaid insurance…………………………………….. 9,800.00
Office equipment…………………………………….. 27,750.00
Accumulated depreciation-office equipment………… 10,800.00
Store equipment………………………………………. 50,000.00
Accumulated depreciation-store equipment………….. 18,900.00
Accounts payable……………………………………... 35,000.00
Salaries payable………………………………………. 2,500.00
Note payable (final payment, 2001)………………….. 25,000.00
Capital stock………………………………………….. 150,000.00
Retained Earnings…………………………………….. 140,210.00
Dividends……………………………………………... 25,000.00
Sales…………………………………………………... 975,000.00
Sales Returns & Allowance…………………………… 9,000.00
Sales Discounts……………………………………….. 8,500.00
Purchases……………………………………………… 775,000.00
Purchase Returns & Allowances……………………… 16,200.00
Purchase Discounts…………………………………… 3,800.00
Transportation – in……………………………………. 10,300.00
Sales salaries expense…………………………………. 83,000.00
Advertising Expense…………………………………. 16,300.00
Depreciation Expense-store equipment……………… 4,800.00
Miscellaneous selling expense………………………. 1,000.00

Office salaries expense……………………………..... 25,900.00
Rent expense…………………………………………. 12,150.00
Depreciation expense-office equipment……………… 3,500.00
Insurance expense……………………………………. 2,750.00
Office supplies expense………………………………. 900.00
Miscellaneous Administrative expense……………….. 1,150.00
Interest income………………………………………… 5,000.00
Interest expense……………………………………….. 3,260.00
Instructions:-
1. Prepare a multiple-step income statement
3. Prepare a retained earnings statement
5. Prepare a report form of a balance sheet, assuming that the current portion of the
note payable is Br. 2,500.
2. Prepare a single-step income statement
4. Prepare a combined income & retained earnings statement, using the single-step
form for the income statement portion.
Solution 1. Multiple-step income statement
ABC-Company
Income statement
For the Year ended Dec 31,1991
Revenue from sales:
Sales…………………………………………… Br.975,000.00
Less: sales Returns & Allowance……………… Br.9000.00
Sales Discounts………………………… 8500.00 17,500.00
Net sales…………………………...................... Br.957,500.00
Merchandise Inventory, Jan, 1991…………….. 75,000.00
Purchases………………………………………. 775,000.00
Less: Purchase Returns & Allowance…………. Br.16,200.00
Purchase Discount……………………….. 3,800.00 20.000.00
Net Purchases………………………………….. Br.755.000.00

Add: transportation in…………………………… 10,300.00
Cost of merchandise purchased…………… 765,300.00
Merchandise available for sale……………. Br.840,300.00
Less: merchandise Inventory, December 31,1991. 85,000.00
Cost of merchandise sold…………………. 755,300.00
Gross profit………………………………………. 202,200
Operating expenses:
Selling expenses:
Sales salaries expense…………………… Br.83,000.00
Advertising expense…………………….. 16,300.00
Depreciation expense-store equipment…. 4,800.00
Miscellaneous, selling expense………….. 1,000.00
Total selling expense……………… Br.105,100.00
Administrative expenses:
Office salaries Expense……………………. Br.25,900.00
Rent expense………………………………. 12,150.00
Insurance expense…………………………. 2,750.00
Depreciation expense-office equipment…… 3,500.00
Office supplies expense……………………. 900,00
Miscellaneous Administrative expenses……. 1,150.00
Total Administrative Expenses………….. Br.46,350.00
Total operating expenses………………… Br.151,450.00
Operating income………………………………… Br.50,750.00
Other Income:
Interest income…………………………5,000.00
Other Income:
Interest expense……………………….. 3,260.00 1740.00 1,740.00
Net income…………………………………….. Br.52,490.00
Solution 2. Single- step income statement

ABC- Company
Income statement (Single step)
For the year ended December 31, 1991
Revenues:
Net sales………………………….. Br.957,500.00
Interest income……………………5,000.00
Total Revenue………………….. Br.962,500.00
Expenses:
Cost of merchandise sold………. Br.755,300.00
Selling expense…………………105,100.00
Administrative expense…………. 46,350.00
Interest expense………………..... 3,260.00
Total expenses……………….. 910,010.00
Net income………………………Br. 52,490.00
Solution 3. Retained Earnings statement:
ABC Company
Retained Earnings Statement
For the year ended December 31,199
Retained Earnings Jan 1, 1991………...Br.140,210.00
Net income for the year……………......Br.52,490.00
Less: Dividends ……………………......25,000.00
Increase in retained earnings………… 27,490.00
Retained Earnings December 31,1991.. Br.167,700.00
Solution 4: Income & Retained Earnings statement
ABC-Company
Income & Retained earnings statement
For the year ended December 31,1991
Revenues:
Net sales……………………………… Br.957,500.00
Interest income……………………….. 5,000.00
Total Revenue……………………… 962,500.00

Expenses:
Cost of merchandise sold……………... Br.755,300.00
Selling expense……………………….. 105,100.00
Administrative expense………………. 46,350.00
Interest expense………………………. 3,260.00
Total expenses…………………….. 910,010.00
Net income…………………………… Br. 52,490.00
Retained earnings, January 1, 1991…… 140,210.00
Less:Dividends……………………….. Br.192,700.00
Retained Earnings, December 31,1991.. 25,000.00
Br.167,700.00
Solution 5. Report form of the balance sheet For ABC- Company
ABC- Company
Balance Sheet
On December 31, 1991
Assets:
Current Assets:
Cash ………………………………………….. Br.87,750.00
Accounts Receivable…………………………. 97,000.00
Notes Receivable…………………………….. 50,000.00
Office Supplies………………………………. 2,600.00
Merchandise Inventory………………………. 85,000.00
Prepaid Insurance……………………………. 9,800.00
Total Current Assets…………………………. Br.332,150.00
Plant Assets:
Office equipment ………………………….. Br.27,750.00
Less: Acc. dep-office equip…………………. 10,800.00 16,950.00
Store equipment…………………………….. Br. 50,000.00
Acc. dep-Store equip………………………… 18,900.00 31,100.00
Total plant assets………………………… 48,050.00
Total assets…………………………… Br.380,200.00

Liabilities
Current Liabilities:
Accounts payable………………………… 35,000.00
Salaries payable ………………………….. 2,500.00
Notes payable……………………………. 2,500.00
Total current liabilities………………… Br.40,000.00
Long-term liabilities:
Notes payable (final payment,200)………. 22,500.00
Total liabilities…………………………… Br. 62,500.00
Stockholders equity
Capital stock……………………………… 150,000.00
Retained Earnings………………………… 167,700.00
Total stockholder‟s equity……………… 317,700.00
Total liabilities & stockholders‟ equity… 380,200.00

CHAPTER-FOUR
CASH
Chapter Objectives:
At the end of the course the student is expected to understand:
Controlling mechanism of cash
 Internal control of cash receipts
 Internal control of cash payments
 Bank reconciliation statements
 Voucher systems and petty cash
4.1. The Bank account as mechanism for controlling of cash
One of the major devices for maintaining control over cash is the bank account. To get the best
benefit from a bank account all cash received must be deposited in the bank and all payment
must be made by checks drawn on the bank or from special cash funds.
When such a system is followed, there is a double record of cash, one maintaining by the
business and the other by the Bank
Compensating balance: - in some cases, a bank may require a business to maintain in a bank
account a minimum cash balance. This requirement is generally imposed by the bank as part of
a loan agreement or line of credit which is an amount the bank is willing to lend. This
minimum balance that has to be maintained in a bank is called compensating balance
The forms used by a business in connection with a bank account are: signature card, deposit
ticket, checks and record of checks drawn.
1. Signature card: - at the time an account is opened, an identifying number is assigned to
the account, and signature is must be signed by each person authorized to sign checks
drawn on account.
2. Deposit ticket: The details of a deposit are listed by the depositor on a printed form
supplied by a bank. Deposit ticket may be prepared in duplicating, in which case the copy
is stamped or initialed by the bank‟s teller and given to the depositor as a receipt. This
method gives the depositor written proof of the date and the total amount of the deposit.

3. Check: - A check is a written instrument signed by the depositor, ordering the bank to pay
a certain sum of money to the order of the designated person. There are three parties to a
check
a) The drawer:- the drawer is the one who signs the check ordering the bank to pay cash
from that person‟s account or the account of a business.
b) The drawee:- the drawee is the bank on which the check is drawn
c) The payee:- the payee is the one to whose order the check is drawn. It is a person or a
business to whom the bank is ordered to pay the cash.
When checks are issued to pay bills, they are recorded as credits to cash on the day issued even
though they are not presented to the drawers‟ bank until some later time. More over , when
checks are received from customers, they are recorded as debits to cash, on the assumption that
the customer has enough money on deposit.
4. Records of checks drawn:- a memorandum record of the basic details of a check should
be prepared at the time the check is written. The record may be a stub from which the
check is detached or it may be a small booklet designed to be kept with the check forms.
Each type of record also provides spaces for recording deposits and the current bank
balance. Checks issued to a creditor on account are usually accompanied by a notification
of the specific invoice that is being paid. The purpose of such notification sometimes called
a remittance advice.
It helps to make sure that proper credit is recorded in the accounts of the creditor. Mistakes are
less likely to happen and the possible need for exchange of correspondence is reduced.
4.2 Internal control of cash receipts
Department stores and other retail business as ordinarily receive cash from two main sources.
1. Over the counter from cash customers
2. By mail from charge customer making payment on account
At the end of the business day, each sales check counts the cash in the assigned cash drawer
and records the amount on a memorandum from.
An employee from the cashiers department remove the cash register taper on which total
receipts were recorded from each cash drawer, counts the cash, compares the total with the
memorandum and the tape noting any difference. The cash is then taken to the casher „s office

and the tapes and memorandum forms are forwarded to the accounting department, where they
become the basis for entries in the cash receipts journal
People who open incoming mail compare the amount of cash received with the amount shown
on the accompanying remittance advice (remittance notice) to be certain that the two amounts
agree. If there is no separate remittance advice, an employee prepares one on a form designed
for such use. All cash received, usually in the form of checks and money orders, is sent to the
cashiers department where it is combined with the receipts from cash sales a deposit ticket is
prepared.
The remittance advices are delivered to the accounting department, where they become the
basis for entries in the cash receipts journal and for posting to the customer‟s account in the
subsidiary ledger
4.2.1 Petty Cash
As previously emphasized, adequate internal control over cash requires that all cash received
be deposited in the bank and all disbursements be made by check. However, every business
finds it convenient to have a small amount of cash on hand with which to make small minor
expenditures.
In most business there is a frequent need for the payment of relatively small amounts, such as
for postage due , for transportation charges or for the purchase of urgently needed supplies at a
nearby retail store.
Payment by check in such cases would result in delay, annoyance, and excessive expense of
maintaining the records. Because these small payments may occur frequently and therefore,
amounts to a considerable total sum, it is desirable to retain close control over such payments.
This may be done by maintaining a special cash fund called petty cash.
In establishing the petty cash fund, the first step is to estimate the amount of cash needed for
disbursement of relatively small amounts during a certain period, such as a week or a month
If a voucher system is used, a voucher is then prepared for this amount and it is recorded in the
voucher register as a debit to petty cash and a credit to account payable i.e.
Petty cash ---------------------xx
Account payable -----------------------xx

However, the check drawn to pay the voucher is recorded in the check register as a debit to
account payable and credit to cash in bank i.e.
Account payable ------------------xx
Cash in bank--------------------------------xx
The money obtained from cashing the check is placed in the custody of a specific employee
(cashier) who is authorized to disburse the fund according to restrictions as to maximum
amount and purpose.
When the amount of money in the petty cash fund is reduced to the predetermined minimum
amount, the fund is replenished.
Replenished the petty cash fund restores it to its original amount. If the voucher system is used
in replenishing the petty cash fund, the accounts debited on the replenishing voucher are those
indicated by a summary of expenditures.
The voucher is then recorded in the voucher register as debit to various expenses and asset
accounts and accredits to account payable.
If the petty cash fund is used for the purchase of office supplies, utility expenses, store supplies
etc, the entry will be:
Office supplies ----------------------------------xxx
Store supplies--------------------------------- xxx
Utility expenses-----------------------------xxx
Account payable -----------------------------------------------------xxx
Because disbursements are not recorded in the accounts until the fund is replenished, petty cash
funds and other special funds that operate in like a manner should always be replenished at the
end of the accounting period.
The following example helps you to understand the recording system while the petty cash fund
is established and replenished.
Assume that a petty cash fund of Br. 200 was established on June 1 and that payment total
Br.174.95 was made from the fund during the next two weeks. Since the Br. 200 originally
placed in the fund is nearly exhausted, the fund therefore should be replenished. To replenish
petty cash fund means to replace the amount of money that has been spent, thus, restoring the
fund to its original amount. A check is drawn payable to petty cash for the exact amount of the
expenditure, Br. 174, 95. This check is cashed and the money placed in the petty cash box.

The several entries to record establishment of the petty cash fund is shown as follows.
June1 Petty cash 200
Cash at bank 200
The journal entry to record replenishment of petty cash fund is also shown as follows (assume
the petty cash is spent to purchase office supplies, for transportation, portage and other
miscellaneous expenses), therefore
Office supplies expense 80.60

June 15 Transportation - 16.00
Postage expense 45.25
Miscellaneous expense 33.10
Cash 174.95
Note that expense accounts are debited each time fund is replenished and the petty cash
account is debited only when the fund is first established. The petty cash fund is usually
replenished at the end of accounting period, even though the fund is not running low.
4.2.2. Cash short and over
It is a usual practice that the amount of cash actually received during a day does not agree with
the record of cash receipts. Whenever there is a difference between the record and the actual
cash and no error can be found in the record, it must be assumed that the mistake occurred in
making change. The cash shortage and overage is recorded in an account entitled cash short
and over. A common method for handling such mistakes is to include in the cash receipts
journal,
- As a debit to cash short and over account if cash is found to be short
- As a credit to cash short and over account if cash is found to be over
* If the amount of cash actually received is greater than the amount of cash shown in the
record, the difference is said to be cash overage. If the amount of cash actually recorded is less
than the amount of cash shown - In the record, the deference is said to be cash shortage
For example, if the actual cash received from daily sales is less the amount indicated by the
cash registered totally, the entry in the cash journal would be:
Cash in bank xx

Cash short and over xx
Sales xx
If, however, the actual cash received from daily sales is grater than the amount indicated by the
Cash registered totally, the entry in the cash journal would be:
Cash in bank xx
Sales xx
Cash short & over xxx
If cash overage is found at the end of the fiscal period, it is revenue and may be listed in the
other income section of the income statement. However, if cash shortage is found at the end of
the period, it is an expense and may be included in the miscellaneous administrative expense
on the income statement.
The following example helps you to understand how to maintain a record when ever cash short
and over is occurred.
Example 1 .
If the actual cash received from cash sales is Br. 4,577.60 for the day. However the amount
indicated by the cash register is Br. 4,550.76. Therefore, the actual cash received is less than
the amount indicated by the cash register by the amount of Br. 3.16
Cash ---------------------------------4,577.60
Cash short and over ----------------3.16
Sales ------------------------------------- 4,580.76
Example 2
If the actual cash received from cash sales for the day is Br. 5000 and the amount indicated by
the cash registered is Br. 4,850 there for ,the actual cash received is greater than the amount in
the cash registered by Br. 150.
The entry to show the above fact is :
Cash ------------------------------5,000
Sales -------------------4,850
Cash short and over-----------------------------150

4.2.3 Bank statement
Banks usually maintain an original and a copy of all checking account transactions. When this
is done the original becomes the statement of account that is mailed to the depositor, usually
once each month.
The bank statement shows the beginning balance, checks and the debits (deduction by the
bank), deposits and other credits (added by the bank) and the ending balance.
The depositor‟s checks received by the bank during the period may accompany the bank
statement, arranged in the order of payment.
4.2.4 Bank reconciliation
Bank reconciliation is a schedule explaining any difference between the balance shown in the
bank statement and the balance shown in the depositor‟s account records..
Bank reconciliation
The balance shown in a monthly bank statement seldom equals the balance appearing in the
depositor‟s accounting records. Certain transactions recorded by the depositor may not have
been recorded by the bank. The most common examples are:
1. Outstanding checks: are checks issued and recorded by the company but not yet presented
to the bank for payment.
2. Deposit in transit: cash receipts recorded by the depositor, but which reached the bank too
late to be included in the bank statement for the current month.
In addition, certain transactions appearing in the bank statement may not have been recorded
by the depositor. For example:
1. Service charges: banks often charge a fee for handling small accounts, the amount of this
charge usually depends up on both the average balance of the account and the number of
checks paid during the month.
2. Charges for depositing sufficient fund: when checks are deposited, the bank increases
(credits) the depositor‟s account. On occasion, one of these checks may prove to be un
collectible, because the maker of the check does not have sufficient funds in his or her
account. In such case, the bank will reduce the depositor‟s account by the amount of this un
collectible item and return the check of the depositor marked “NSF”

The depositor should view an NSF check as an account receivable from the maker of
the check, not as cash. The accounting entry required consists of a debit to the account
receivable from the customer and a credit to cash.
3. Credit for interest earned: most banks offer some checking accounts which earn interest.
At month end, this interest is credited to the depositor‟s account and reported on the bank
statement.
4. Miscellaneous bank charges and credits: banks charge for services such as printing
checks, handling collections of notes receivable, and processing Non sufficient fund checks
the bank deducts these changes from the depositors account and notifies the depositor by
including a debit memorandum in the monthly bank statement
Example 1
The July bank statement sent by the bank to ABC Company shows a balance of cash on deposit
at July 31 of Br.5000.17. Assume that on July 31
Assume the on July 31, ABC‟s ledger shows a bank balance of Br. 4, 262. 83.
1. A deposit of Br 410. 90 made after banking hours and doesn‟t appear in the bank statement
2. For checks issued in July have not yet been paid by the bank (outstanding checks). Theses
checks are:
Check No date amount
801 June 15 Br. 1,000. 00
888 July 24 Br. 10.25
890 July 27 Br. 402.50
891 July 30 Br. 205.00
3. Proceeds from collection of anon – interest bearing note receivable from David. ABC
Company had left this note with the banks collection department.
4. Br. 24.75 interest earned on average account balance during July
5. Br. 5,00 fee charged by bank for handling collection of note receivable
6. Br. 50.25 check from customer John deposited by ABC company charged bank as Non-
sufficient fund (NSF)
7. Br. 12.00 service charged by bank for the month of July.
8. Check number 875 was issued July 20 in the amount of Br 85 but was erroneously recorded
in the cash payment Journal as Br 58 for payment of telephone expense

ABC Company
Bank reconciliation
July 31, 200
Balance per bank statement July 31, 2001 -----------------Br. 5000. 17
Add. Deposit in transit-------------------------------------------- 410.90
Br 5, 411.07
Deduct: outstanding checks
Check No 801 Br 1,000
No 888 10.25
No 890 402,50
No 891 205,00 ( 717.75)
Adjusted cash balance -------------------------------------------------------Br 4, 693.32
Balance per depositor‟s record July 31, 2001 -----------------------------------4,263.83
Add. Notes receivable collected for us by bank Br 500,00
Interest earned during July ---------------------- 24.74 524.74
Deduct: collection fee------------------------------- -Br. 5,00
NSF Br. 50.25
Bank service change 12.00
Error on check stub No 875 27.00
Br.(94.25)
Adjusted cash balance Br. 4, 693.32
Up dating the accounting records
The last step in reconciling a bank statement is to up date the depositor‟s accounting record for
any unrecorded cash transaction brought to light. In the bank reconciliation, every adjustment
to the balance per depositor‟s record is a cash receipt or a cash payment that has not been
recorded in the depositor‟s accounts.
* To record collection of note receivable from Devid collected by bank and interest earned by
bank:
Cash ------------------------------524.74
Notes receivable ------------------- 500,00
Interest Revenue ------------------- 24.75

* To record bank service charges, to reclassify NSF checks from customer as account
receivable and to correct understatement of cash payment for telephone expenses.
Bank service changes 17.00
Account receivable 50.25
Telephone expense 27.00
Cash ----------- --------- 94.25
Importance of bank reconciliation
The bank reconciliation is an important part of the system of internal control, because
1. It is a means of comparing recorded cash, as shown by the accounting records, with the
amount of cash reported by the bank.
2. It provide a means for finding and correcting errors and irregularities
In order to have a greater internal control, the bank reconciliation has to be prepared by
employees who do not take part in recording cash transactions with the bank. Proper separation
of duties is important to prevent cash from embezzlement.
Instruction
1. What is meant by cash? Why is cash said to be the most liquid assets?
2. Distinguish between the drawers and the payee of a check?
3. What is the purpose of preparing bank reconciliation?
4. Identify each of the following reconciling items as:
i) An addition to the balance per bank statement
ii) A deduction from the balance per bank statement
iii) An addition to the balance per depositor‟s record
iv) A deduction from the balance per depositor‟s record
a) Deposit in transit
b) Note collected by bank
c) Outstanding checks
d) Check for Br. 100 charged by bank as Br. 1000
e) Check drawn by depositor for Br. 25 but recorded as Br. 250
f) Bank service charges
g) Check of a customer returned by bank to depositor‟s because of insufficient fund

5. The combined cash counts of all cash registers at the close of a business is Br. 3.50 more
than the cash sales indicated by the cash registered tapes
a) In what account is the cash overage recorded?
b) Are cash overages debited or credited to this account?
6. What is meant by the term voucher as applied to the voucher system?
7. What is meant by the term petty cash? Distinguish between establishment and
replenishments of petty cash?
8. The cash in the bank account of XYZ Company at June 30, of the current year indicated
a balance of Br. 19, 650.30 after both the cash receipts Journal and the check
registered for June had been posted. The bank statement indicated a balance of Br.
30,606.30 on June 30. Other related events occurred during the month were:
1. Checks outstanding totaled Br. 14,941.50
2. A deposit of Br. 6,467.75 representing receipts of June 30, had been made too late to
appear on the bank statement
3. The bank had collected Br. 3090 on a note left for collection. the face of the note was Br.
3000
4. A check for Br. 91 returned with the statement had been recorded erroneously in the check
register as Br. 19. The check was for the payment of an obligation to ABC Company for
the purchase of office equipment on account.
5. A check drawn for Br. 55 had been erroneously charged by the bank as Br. 550
6. Bank service charges for June amounts to Br. 40.75

CHAPTER – FIVE
RECEIVABLES
Chapter Introduction:
Dear learners! Business organizations sell their items or services on cash or on account. It is
common for these organizations to sell their items or services on account to increase sales
volume. In this case receivables are created. The term receivables include all money claims
against people, organizations, or other debtors. Receivables are required by a business
enterprise in a various kinds of transactions, the most common being the sale of merchandise
or services on a credit sale.
Chapter Objectives:
At the end of this chapter you will be able to:
 Describe the common classifications of receivables.
 Describe the common characteristics of notes receivables; and describe the basic
principles of internal control over them.
 Illustrate the accounting for note, receivables, including the discounting of notes
receivables & dishonored notes receivable.
 State the basic concepts in accounting for uncollectible.
 Illustrate the two methods (Allowance & Direct write-off) of accounting for uncollectible
receivables.
 Identify the estimation of uncollectible based on sales and on analysis of receivables.
5.1 Classification of Receivables
Receivables can be classified broadly as trade receivables and other receivables.
Trade Receivables: are resulted from revenue producing activities such as sale of goods or
services.
Under this classification examples included are accounts receivable & notes receivable.
A promissory note frequently referred to, as a notes receivable, is a written promise to pay a
sum of money on demand or at a definite time.
Notes are more secured than accounts receivables.
It is also more liquid (easily changed into cash) than accounts receivable.
Other receivables: are resulted from transactions not directly related to sales.
Here included are interest receivables, loans to employees or loans to companies.

Note
Note that all receivable that are to be collected within a year are presented in the current asset
section of the balance sheet.
Others such as long-term loans are to be listed under investment account below the current
asset section of the balance sheet.
5.2 Controls over Receivables
The control procedures over the receivables include two broad mechanisms:
a) Separation of the business operations adjustments, such as credit approval, credit
collection, credit handling of receivables etc. and the accounting for receivables such as
handling of the accounts receivable subsidiary ledger and general ledger; and
b) Separation of duties for related functions.
5.3 Notes Receivable. (A note)
Definition: A note is a written promise to pay a sum of money on demand or at a definite time.
Characteristics: a note has different characteristics that have accounting implications, which
are explained in the following ways:
Parties: In notes receivable there are two parties involved. The one to whose order the note is
payable (the holder or the receiver of the note) is called the payee (the seller); and the
one making the promise/ issuer of the note or the buyer is called the maker.
Due Date: is the date at which the note is retired or paid. It is also called the maturity date.
Issuance date: is the date at which the note is written or issued.
Maturity value: is the amount that is due at the maturity or due date.
Maturity value = Principal + interest
Types: There are two types of notes. Interest bearing (Interest = Principal * Rate of interest
* Time) the time period can be expressed in terms of days, months or weeks; and non-interest
bearing which has no interest on it but other indirect charges may be there.
To illustrate the above characteristics consider the following examples:
a) Br.10,000, 10% interest, 120 days note dated March 16.
b) Br.12,000, 10% interest, 4 months note dated June 5.

Required: calculate the interest, the maturity value and determine the due date of each note.
Solution: a) Interest = Principal * Rate * Time
= Br.10,000 *10% * 120 days = Br.333.30
360 days
Maturity value = Principal + Interest
= Br.10,000 + 333.33 = Br.10,333.33
Due date: Term of the note ............................................... 120 days
Days in March .......................31
Less: Term date (issuance date)------------16 15
105 days
Days in April .......................... 30
Days in May ........................... 31
Days in June ........................... 30
Total 91 days
The due date is July 14
Remark:
January is a month of 31 days
February is a month of 28 days
March is a month of 31 days
April is a month of 30 days
May is a month of 31 days
June is a month of 30 days
July is a month of 31 days
August is a month of 31 days
September is a month of 30 days
October is a month of 31 days
November is a month of 30 days
December is a month of 31 days
b) I = P * R * T
= 12,000 * 12 * 4 months = Br. 480

100 12 months
Maturity value = P + I
= Br.12,000 + Br. 480 = Br.12,480
Due date: June6 – July5 = 1 month

July 6 – Augusts = 1 month
August 6 – September 5 = 1 month
September 6 – October 5 = 1 month
4 months
Therefore, the due date is October 5.
5.5 Accounting for Receivables
In a business organization notes may be received or created when:
 Items/ services are sold on long-term credit, usually greater than 90-days.
 Cash is lent to an entity (individuals, business organizations etc.).
 The account of a customer becomes delinquent (a delinquent accounts receivable is an
account receivable which is not paid on its last payment date and changed to notes
receivable).
When a note is received from a customer to apply on account, the facts are recorded by
debiting the notes receivable account and crediting the accounts receivable controlling account
(delinquent account) and the account of the customer from whom the note is received.
Example:
Assume that the account of Glenn Enterprise, which has a balance of Br.9,200, is past due
(delinquent). A 90 -day non-interest bearing note for that amount dated May 16,1990, is
accepted in settlement of the account. The notes receivable is recorded at its face value and the
entry to record the transaction is as follows.
May 16. Notes Receivable ................................ 9200
Accounts Receivable ....................... 9200
When the amount is collected on the due date (August 14)
Cash ........................................ 9200
Notes Receivable .............. 9200
Interest bearing note: If a note received from a customer on account is interest bearing,
interest must be recorded as appropriate.

To illustrate this transaction, assume that the account of X-company that has a debit balance of
Br.6,000 is past due. A 30 -day, 12% note for that amount dated December 31, 2001 is
accepted in settlement of the account. Assume the end of the year is December 31, 2001.
Assume a 360- days year.
Required: a) Determine the due date
b) Prepare journal entries to record
I) Receipt of the note
ii) Accrual of interest (adjusting entries) on December 31, 2001
iii) Reversing entry on January 1, 2001
iv) Collection of cash at maturity.
Solutions:
a) Term date ........................................ 30
Days December (31-21) ................. 10
The due date is ............................... 20
b) I) entry to record receipt of the note on December 21, 2001.
Notes Receivable ............................. Br. 6000
Accounts Receivable (of X-company) ......... Br. 6000
ii) According to the accrual basis of Accounting revenues should be recognized of
reported on the date they earned. If not recorded on that date using adjusting entries they
should be updated or adjusted at the end of the year.
For this example, there, for interest income revenue for the period December 21 to December
31 is 20 days revenue (31-21 = 20 days). The total interest is computed as follows:
I = Br.6,000 * 12% * 30 days = Br. 60
360
From the total amount Br.60 interest Br.20 (Int. = Br.6,000 * 12% * 10 days = Br.20) is
360
the 2001 interest. But Br.40 (Int. =Br.6000 * 12% * 20 days = Br.40) is the coming
360 days
Year‟s, 2002 interest.
Interest receivable ............................... Br.20

Interest income ..................................... Br.20

The interest income is reported on the income statement on the other income section, and the
interest receivable is reported on the balance sheet of the organization in the current
assets section.
iii) Reversing entry, which is optional, and the exact reverse of the adjusting entry. It is
employed to avoid inconveniencies at the beginning date of the upcoming accounting year. For
our example, the upcoming fiscal year begins on January 1, 2002. So the entry on that date is:
Interest income .............................. Br. 20
Interest Receivable ........................... Br. 20
iv) The due date is January 20, 2002. The maturity value is Br.6060 (Br.6000 + Br.60 =
Br.6060). Assuming that the whole amount is collected on the due date. The entry is recorded
as follows.
Cash ............................................. Br. 6060
Notes Receivable ............................ Br. 6000
Interest income ................................ 60
5.6 Discounting Notes Receivable
If the holder of the note is in need of more funds/ cash for current operation, it may be
endorsed or transferred to a bank or any financial agency. This process if called discounting
notes receivable.
When a note is discounted at bank, the bank charges an interest on the maturity value of the
note. This interest is called discount and it is computed using the following formula.
Discount = Maturity value * Discounting rate * Discounting period/time
The amount of money paid to the endorser/ holder of the note who transfers it to the bank
because of high need of cash, is called proceeds/ balance. It is the excess of the maturity value
over the discount, i.e., Proceeds = Maturity value – Discount.
Illustration
To illustrate a discounting notes receivable, assume that a 90-day, 12% notes receivable for
Br.1800, dated November 8, 2001, is discounted at the bank on December 31, 2001 at the
discounting rate of 14%. Assume a 360-days year.
Required:
1) Determine the due date, discounting period, Interest, the discount, maturity value, and
proceeds.

2) Prepare entries to record discounting of the note.
Solution:
1) Interest = Principal * Rate * Time
= Br. 1800 * 12% * 90 days = Br. 54
360
Maturity value = Principal + interest
= Br.1800 + Br.54 = Br. 1854
Due date = Terms ........................................ 90 days
Days in November (30-8) 22
Days in December 31
Days in January 31 84
Due date is February 6
Discount period:
December (31-3) 28
January 31
February 6
65 days
November 8 December 3 February 6

(Issuance date) (Discounting date) (Due date)
Discount = Maturity value * Discounting rate * Discounting period
= Br. 1854 * 14% * 65/360 = Br. 46.87 this is the amount to the bank
as an interest.
Proceeds = Maturity value – Discount
= Br. 1854 - Br. 46.87 = Br. 1807.13 this is the amount the holder of the
note will receive from the bank in exchange of the note.
2) Entries on December 3, when the note is endorsed to the bank is (to record the proceeds)
Cash ..................................... Br. 1807.13
Notes Receivable ............................. 1800
Interest income (Br.54 - Br. 46.87) ... 7.13

Note that if the proceeds are greater than the face value of the note, there will be an interest
income to the organization. Otherwise, there will be interest expense. Or if the interest is
greater than the discount the difference is interest income to the discounting notes but if the
interest is less than the discount the difference is charged to interest expense account to the
organization, which discounts the note at bank.
5.7 Dishonored notes
In business organizations, the maker of the note may fail to pay the debt on the due date. Here,
in this case, the note is said dishonored, which is not longer negotiable or transferable. For this
reason the holder usually transfers the claim, including any interest due, to the accounts
receivable. To illustrate this fact, assume a Br. 12,000, 30-days, 12% notes receivable on
December 31, 2001, had been dishonored at the due date (January 20, 2002 determine it your
self).
Required:
1) Calculate the maturity value.
2) Record entries occurred on the issuance date and maturity date?
Solutions:
1) Interest = Br.12,000 * 12% * 30/360 = Br.120
Maturity value = Br.12,000 + Br.120 = Br.12,120
2) Entries on the issuance date (December 21, 2001)
Notes Receivable ......................... Br. 12,000
Accounts Receivable ................................... Br. 12,000
Entries on the maturity Date (January 20, 2002)
Accounts Receivable ............................. Br. 12,120
Notes Receivable ...................................... 12,000
Interest income .......................................... 120
5.8 Dishonored Discounted notes
When a discounted note receivable is dishonored, the holder usually notifies the endorser of
such fact and asks for payment. If the request for payment and notification of dishonor are
timely, the endorser is legally obligated to pay the amount due on the note. The entire amount
paid to the holder by the endorser, including interest, should be debited to the account
receivable of the maker.

To illustrate this fact assume that a 60-day, 12% Br. 42,00 note dated November 8, 2001,
discounted on December 3, 2001 at 14% discounting rate is dishonored at maturity by the
maker. Assume, the bank charged Br.50 as penalty for the failure (called protest fee). Assume
further a 360-days accounting year ending on December.
Required: Record all the necessary transactions & compute all the amounts required.
Due date:
Solutions: Term period .......................................................... 60 days
Days in November (30-8) .................................... 22
38
Days in December ................................................ 31
January 7 is the due date ....................................... 7
Discounting period:
Days in December (31-3) ..................................... 28
January ................................................................. 7
35 day
Interest = Br. 42,000 *12% * 60/360 = Br. 840
Maturity value = Br. 42,000 + Br. 840 = Br. 42,840
Discount = Br. 42, 840 * 14% * 35/360 = Br. 583.10
Proceeds = Br. 42,840 - Br. 583.10 = Br. 42,256.90
Entries: On November 8 (issuance date:
Notes Receivable .............................. Br. 42,000
Accounts Receivable .......................... Br. 42,000
On December 3, 2001 to record the proceeds.
Cash ...................................... Br. 42,256.90
Notes Receivable ..................... Br. 42,000
Interest income ......................... 256.90
On January 7,2002, to record the dishonored discounted note.
Accounts Receivable (42,840 + 50) ................. 42,890
Notes Receivable ............................................. 42,890

5.9 Uncollectible Receivables
Regardless of the care used in granting credit and the effectiveness of collection procedures
used, a part of the claims against customers usually proved to be uncollectible. This could be
because of bankruptcy, closing of the debtors business of failure of repeated attempts to
collect. In any way, the operating expense incurred because of the failure to collect receivables
is called an expense /a loss from uncollectible accounts/ doubtful accounts or bad debt
Expense.
There are two methods of accounting for receivables that are believed to be uncollectible.
a) The allowance method (reserve method)
b) The direct write-off (direct charge-off method)
A) The allowance method: This method provides in advance for uncollectible receivables.
The advance provision or estimation for future uncollectibility is made by an adjusting
entry at the end of the fiscal year. It reduces the value of receivables to the amount of cash
expected to be realizable from customers in future. It matches current expense with current
revenue.
Example:
ABC-company started its operation on January 1, 2001 and chooses to use the calendar year as
its fiscal year. The accounts receivable, has a balance of Br. 200,000 at the end of the period in
total.
At this period no specific accounts are believed to be wholly uncollectible. But it seems likely
that some will be collected only in part and that others are likely to become worthless.
Assume based on a careful study, it is estimated that a total of Br. 8000 will eventually proved
to be uncollectible. Then,
i) What is the expected realizable accounts Receivable.
ii) Journalize the entry to record the estimated bad debt expense
iii) what do you think will be the effect of not recording such corrections?
Solution:
i) Net realizable value = Br. 200,000 - Br. 8000 = Br. 192,000
ii) Bad debt expense ........................ Br. 8000
Allowance for uncollectible.................... Br. 8000

The bad debt expense is reported on the income statement but the allowance for
uncollectible is reported on the balance sheet as contra of accounts receivable.
iii) The effect is understating expenses and overstatement of net income, capital and
asset amounts.
Note that the Br. 8000 reduction in accounts receivable cannot yet be identified with a specific
customer accounts in the subsidiary ledger and should, therefore, not be credited to accounts
receivable but to allowance for doubtful account, which is a contra asset account.
2.9.1 Write-offs to the allowance account.
When an account is believed to be uncollectible, the amount is transferred from the allowance
for doubtful account to the accounts receivable.
To illustrate, assume Br. 2000 of the accounts receivable of customer – x of ABC company has
been determined to be uncollectible during 2002. The adjusting entry to write-off the
allowance would be:
Allowance for doubtful account .................. 2000
Accounts receivable customer-x ..................... 2000
If an accounts receivable that has been written-off against the allowance account is later
collected, the account should be re-instated by an entry that is exact reverse of the write-offs
entry:
Example:
Assume that ABC company‟s customer-x has paid the Br.2000. Record the entry.
Accounts receivable – (customer-x) ......................... 2000
Allowance for uncollectible account .......................... 2000
This is entry to re-instate the write-offs.
Cash ................................. Br.2000
Accounts receivable (customer-x) ................ 2000
This is entry to record collection of cash
2.9.2 Estimating uncollectible
The estimate of uncollectible at the end of the fiscal period is based on past experiences and
forecasts of future business activities. It is based on either:
a) The amount of sales for the entire period (called an income statement approach) or

b) The amount and age of receivables account at the end of the fiscal period. (called balance
sheet approach).
a) Income statement approach:
Formula:
Estimated = Net credit sales * Percentage of estimated
Bad debt expense to be uncollectible
The amount of this estimate is added to whatever balance exists in the allowance for doubtful
account.
Examples:
Assume net credit sales on December 31, 2001 for ABC organization is Br.200, 000, estimated
uncollectible ..................................... 1.5%
Required: Record the entry
Bad debt expenses (200,000 * 1.5%) ............... 3000
Allowance for uncollectible............................. 3000
c) Balance sheet approach: The process of analyzing the receivable accounts in terms of the
length of time past due is sometimes called aging of the receivable.
The due date of the account is the base point for determining age.
Example:
At the end of 2001 accounts receivable ledger of ABC company has the balance of Br.200,000
which can be categorized as follows:
Age group amount Estimated percentage Estimated amount of
(a) of uncollectible uncollectible
(b) C=a*b
Not yet due Br. 80,000 0.5% Br. 400
1-30 days past due 25,000 1% 250
31-60 days past due 20,000 2% 400
61-120 days past due 60,000 5% 3000
More than 120 days
past due 15,000 20% 3000
Br.200,000 Br.7050

The Br.7050 amount is the desired balance of allowance account after adjustment; and to be
deducted from accounts receivable to determine the net realizable value. Assuming that the
allowance for uncollectible account had no balance, the entry to record this new amount is:
Bad debt expense .............................. Br.7050
Allowance for uncollectible ...................... Br.7050
Note that if the allowance account has a debit or credit balance before adjustment, it must be
considered accordingly when the base of the estimation is the balance sheet approach.
B) Direct write off, method
Under this method of accounting for receivables no valuation of allowance for accounts
receivable is used. The business recognizes no uncollectible account expense until specific
receivables are determined to be worthless. Thus, receivables are not stated at net realizable
value. This method lacks to follow the matching principle.
The entry to record the write-off the uncollectible account is:
Bad debt expense .............................. xxx
Accounts receivable ............................ xxx
To record the recovery of accounts previously written-off is:
Accounting receivable ............................ xxx
Bad debt expense ................................... xxx and
Cash ......................................... xxx
Accounts receivable ....................... xxx
Summary
It is common for these organizations to sell their items or services on account to increase
sales volume. In this case receivables are created. The term receivables include all money
claims against people, organizations, or other debtors. Receivables are required by a
business enterprise in a various kinds of transactions, the most common being the sale of
merchandise or services on a credit sale.
Instructions: Dear student well done! Here, after completion of this chapter you are
expected to give a summary work by your own in recording the transactions in
general Journal form.

Review Questions
Part I. Multiple Choices
1. What is the maturity value of a 90-day, 12% note for $10,0007
a. $8,8000 c. $10,300
b. $10,000 d. $11,200
2. On June 16, an entries discounts a 60-day, 10% note receivable for $15,000 dated June,
at the rate of 12% The proceeds are:
a. $15,000.00 c. $15,250.00
b. $15,021.25 d. $15,478.75
3. At the end of fiscal year, before the accounts are adjusted, Accounts Receivable has a
balance of $200,000 and Allowance for Doubtful Accounts has a credit balance of
$2,5000. If the estimate of uncollectible accounts determined by aging the receivables
is $8,500, the current provision to be made for uncollectible accounts expense would
be:
a. $2,500 c. $8,500
b. $6,000 d. $200,000
4. At the end of the fiscal year, Accounts Receivable has a balance of $100,000 and
Allowance for Doubtful Accounts has a balance of $7,000. The expected realizable
value of the accounts receivable is:
a. $7,000 c, $100,000
b. $93,000 d, $107,000
5. Under what caption a temporary investment in stock would be reported in the balance
sheet?
a. Current assets c. Investment
b. Plant assets d. None of the above
Part II:
Selected transactions completed by Rodrigus Company are as follows, Rodrigues Company
uses the allowance method of accounting for uncollectible accounts receivable.
Jan. 28. Sold merchandise on account to Lakeland Inc, $10,000.
Mar. 1. Accepted a 60-day, 12% note for $10,000 from Lakeland Inc, on account,
Apr. 11, Wrote off a $4,500 account from Exdel Inc. as uncollectible

16, Loaned $7,500 cash to Thomas Glass receiving a 90day, 14% note.
30, Received the interest due from Lakeland Inc. and a new 90-day, 14% note as a
renewal of the loan, (Record both the debit and credit to the notes receivable accout.)
May. 1, Discounted the note from Thomas Glasser at the First National Bank at 10%.
June. 13. Reinstated the account of Excel Inc. written off on April 11, and receved $4,500 in
full payment.
July. 15. Received notice from First National Bank that Thomas Glass dishonored his note,
paid the bank the maturity value of the note plus a $20 protest fee.
29. Received from Lakeland Inc. the amount due on its note of April 30.
Aug 14. Recived from Thomas Glasser the amount owed on the dishonored note, plus interest
for 30 days at 15%, computed on the maturity value of the note and the protest fee.
Dec, 31. It is estimated that 2% of the credit sales of $958,600 for the year ended December 31
will be uncollectible.
Part III:
1. March 1 Sold merchandise on account to G-company Br.15, 000
30 Accepted a 60-day, 12% note for Br.15, 000 from G-company on account
May 29 Received from G-company the amount due on the note of March 30.
June 1 sold merchandise on account to R-company for Br. 5000.
5 Loaned Br. 6000 cash to F-company, receiving a 30-day, 14% note.
11 Received from R-company the amount due on the invoice of June1 less 1%
discount.
July 5 received the interest due from F-company and a new 60-day, 14% note as a
renewal of the loan of June 5 (record both the debit and credit to the note
receivable account).
September 3 Received from F-company the amount due on his note of July 5.
16. Sold merchandise on account to Z-company Br.4000.
October 16 accepted a 60-day, 12% note for the # 4000 from z-company on account.
November 15 discounted the note from z-company at a bank at 10% discounting rate.
December 15 Received note from the bank that z-company had dishonored its note and paid
the bank the maturity value of the note.

30 Received from z-company the amount owed on the dishonored note plus interest
for 15 days at 10% computed on the maturity value of the note.
Required: Record the transactions in general journal form
2. Using the following data prepare the necessary adjusting entries on the following cases:
a) The company recognizes 2% of credit sales as doubtful account expense.
b) Through an aging of the accounts receivables Br.6000 of the accounts receivable is
expected to be uncollectible.
Data given: - Net credit sales ............................................. Br.250,000
- Outstanding accounts receivable Br.20,000
- Balance of allowance for doubtful account 300 credit.
3. At the end of the current year, the accounts receivable account has a debit balance of
Br.112, 500 and net credit sales for the year total Br.1, 200,000.
Determine the amount of adjusting entry to record the provision for doubtful accounts under
each of the following assumptions.
a) The allowance account before adjustment has a credit balance of Br. 750.
1. Uncollectible accounts expense is estimated at 1% of net credit sales.
2. Analysis of the accounts in the customers ledger indicates doubtful accounts of
Br.12,450
b) The allowance account before adjustment has a debit balance of Br. 500.
1. Uncollectible account expense is estimated at ¾ of 1% net credit sales.
2. Analysis of the accounts in the customer ledger indicates a doubtful accounts of
Br.8,850.

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CHAPTER-ONE

INTRODUCTION TO ACCOUNTING AND BUSINESS

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Financial Statement of Sole Proprietorship

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2 Owner’s Equity Statement

Dawit G. Capital, September 1………………Birr -0-

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III. Analyze the following transactions using the accounting equations

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THE ACCOUNTING CYCLE AND ITS COMPLETION

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FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 14

FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 15

FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 16

4001 sales revenue

FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 17

5001 salary expenses

Cash Br. 150,000 Aksum, Capital Br. 150,000

FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 18

To illustrate the accounting procedures / steps consider the following example

FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 19

FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 20

FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 21

FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 22

FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 23

Three lines are require in recording a transaction in a journal:

FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 24

(The above Journal shows an answer to question # 2 which is journalizing transaction in a

FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 25

Date Item Post ref Debit Credit Dr. Cr.

FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 26

Date Item Post ref Debit Credit Dr. Cr.

Date Item Post ref Debit Credit Dr. Cr. Before

Date Item Post ref Debit Credit Dr. Cr.

Ending balance 13500

FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 27

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FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 28

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FUNDAMENTAL PRINCIPLE OF ACCOUNTING I Page 29

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Depreciation expense- service equipment 54

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