SHEET 1

Basic Concepts of Accounting Md. Mahabbat Hossain

Faculty Member, BIBM Phone: 01716373565 Email: [email protected]  Definition of Accounting In The Accounting Principles book, Weygandt, Kieso and Kimmel say that- ‘Accounting is an information system that identifies, records, and communicates the economic events of an organization to interested users.’ 1. Identifying economic events involves selecting the economic activities relevant to a particular organization. 2. Recording consists of keeping a systematic, chronological diary of events, measured in money. In recording, economic events are also classified and summarized. 3. The identifying and recording activities are of little use unless the information is communicated to interested users. Financial information is communicated through accounting reports, the most common of which are called financial statements. American Accounting Association [AAA] – ‘Accounting is defined as the process of identifying, measuring, and communicating economic information to permit informed judgements, and decisions by users of the information.’ American Institute of Certified Public Accountants [AICPA]- ‘Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events, which are in part at least, of a financial character and interpreting the results thereof.’ Financial Accounting Standard Board (FASB)- ‘Accounting is the service activity of financial recording and reporting.’  Transaction & Event Event: Event refers to a process or part of a process having a particular moment and a place of occurrence. 1. Non Monetary Event: Which is not related to money or not measurable in monetary term. In other word, the event that does not change the financial position of an enterprise, e.g., place an order, win the match etc. 2. Monetary Event: Events that are related to money. In other word, events which change the financial position of an enterprise, e.g., daily exp., salary paid, goods purchase etc. Transaction: Transaction is recordable event that affects the assets, liabilities, owner’s equity, revenues or expenses of an enterprise, e.g. salary paid, paid to creditors, drawings. Transactions are events that (i) cause in an immediate change in the financial resources or obligations of the business and (ii) can be measured objectively in money terms.

Page 1 of 18

 Characteristics of transaction 

Transaction must be expressed in terms of money



Every transaction must be independent



Every transaction must has two parties



Transactions change in the financial resources or obligations



Transactions must have source documents



Transactions may be invisible

 Purposes of Accounting 

Maintain the permanent record of business transactions.



Ascertain the net profit or loss of the enterprise for the accounting period.



Determine the value of business assets and liabilities of the enterprise.



Disclose the financial position of the enterprise in the Balance Sheet date.



Cost control



Give necessary information to management for decision making.



Delivery information to various users in useful format



Help to make a future plan



Determine income tax, sales tax, VAT etc.

 Accounting Cycle The sequence of accounting procedures used to record, classify, and Summarize accounting information is known as the Accounting Cycle. The term cycle indicates that these procedures must be repeated continuously to prepare new up-to-date financial statements at reasonable intervals. The following are the steps in accounting cycle: 1. Identification and Measurement of Transactions and Other Events 2. Recording the transactions in Journal 3. Classifying the transactions through Ledger 4. Summarizing the transactions using Trial Balance 5. Making Adjustment Entries 6. Preparation of Adjusted Trial Balance 

Preparation of worksheet (Optional step)

7. Preparation of Financial Statements 8. Making Closing Entries 9. Preparation of Post Closing Trial Balance 10. Reversing Entries (Optional)

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Identification and Measurement of Transactions and Other Events

Reversing Entries

Journalization Post-closing Trial Balance

Closing Statement Preparation

THE ACCOUNTING CYCLE

Posting / Classifying Ledger

Trial Balance Work Sheet

Adjustments

Adjusted Trial Balance

(When the steps have been completed, the sequence starts over again in the next accounting period)

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 Qualitative Characteristics of Accounting Information 1. Relevance: Helping users to make predictions about the outcome to past, present and future events or to confirm or correct prior expectations 2. Reliability: Information is reliable if it is free from error and bias, and faithfully represents and users can depend upon the information to represent the economic conditions. 3. Timeliness: Having information available to decision maker before it loses its capacity to influence decisions 4. Comparability: The quality of information that enables users to identify similarities in and differences between two sets of economic phenomena. 5. Consistency: Conformity from period to period with unchanging policies and procedures.

Useful Financial Information has: Relevance

1 Predictive value 2 Feedback value 3 Timeliness

Comparability

Reliability

1 Verifiable 2 Faithful representation 3 Neutral

Consistency

 Users of Accounting Information A. Internal Users  Marketing Manager  Production supervisor  Finance Director  Company officers

B. External Users  Investors  Prospective Investors  Creditors  Tax authorities  Regulatory agencies  Customers  Labor Unions  Economic planners  Competitors

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 Double Entry System The first systematic presentation of the double-entry system appears in a mathematics textbook, Summa de Arithmetica, Geometria, Proportione et Proportionalite, written by Luca Pacioli published in 1494. The double-entry system is an accounting system to record the business transactions in the book of account in both side, debit and credit, in equal amount.  Equal debits and credits made accounts for each transaction  Total debits always equal the total credits  Accounting equation always stays in balance, Assets = Liabilities + Owner’s Equity  Debit and Credit  Debit indicates left and Credit indicates right  Recording amount on the left side of an account is debiting the account  Recording amount on the right side is crediting the account  If the total of debit amounts is bigger than credits, the account has a debit balance  If the total of credit amounts is bigger than debits, the account has a credit balance  Determination of Debit and Credit Assets Debit for Credit for Increase (+) Decrease (-) Normal Balance (Dr)

Liabilities Debit for Credit for Decrease (-) Increase (+) Normal Balance (Cr)

Owner’s Equity Debit for Credit for Decrease (-) Increase (+) Normal Balance (Cr)

Revenue Debit for Credit for Decrease (-) Increase (+) Normal Balance (Cr)

Expense Debit for Credit for Increase (+) Decrease (-) Normal Balance (Dr)

Owner’s Drawings Debit for Credit for Increase (+) Decrease (-) Normal Balance (Dr)

 The Recording Process o Analyze each transaction o Enter transaction in a journal o Transfer journal information to ledger (Posting)

Journal: Transactions are initially recorded in chronological order before they are transferred to the ledger accounts. A general journal has Space for dates, Account title and explanations, References and Two amount columns. The Account: An account is an individual accounting record of changes in financial position. There are separate accounts for the items we used in transactions such as cash, salaries expense, accounts payable, etc. The Ledger: A Group of accounts maintained by a company is called the ledger. A general ledger contains all the assets, liabilities, owner’s equity, revenue and expense accounts. The Trial Balance: The trial balance is a list of accounts and their balances at a given time. The primary purpose of a trial balance is to prove the equality between debits and credits after posting. If sum of debits and credits do not agree, the trial balance can be used to discover errors in journalizing or in posting.

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 Some Definitions  Assets: An asset is a resource controlled by the enterprise and from which future economic benefits are expected to inflow to the enterprise. Simply, assets are resources owned by the enterprise. i) Current Assets: Current assets are cash and other resources that are reasonably expected to be realized in cash or sold or consumed in the business within one year of the balance sheet date or the company’s operating cycle, whichever is longer. For example, accounts receivable, inventory etc. ii) Fixed Assets: Fixed assets are resources that are not expected to be realized in cash or sold or consumed in the business within one year of the balance sheet date or the company’s operating cycle. For example, land, building, machinery, furniture etc. 

Liabilities: A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise. Simply, liabilities are claims against assets i. e. liabilities are existing debts and obligations. i) Current Liabilities: Obligations expected to be paid within one year or an operating cycle, whichever is longer, are classified as current. For example, accounts payable, salaries payable, interest payable etc. ii) Long-term Liabilities: Obligations expected to be paid after one year or an operating cycle, whichever is longer, are classified as long-term liabilities. For example, bonds payable, Mortgages payable etc.

 Capital: That amount which is supplied by the owner(s) of the business is known as capital.  Owner’s equity: The ownership claim on total assets is known as owner’s equity. Equity is the residual interest in the assets of the enterprise after deducting all its liabilities. The ownership claim on total assets is known as owner’s equity. The revenue and expenses change owner’s equity.

 Cost: Cost is related to assets. By incurring cost we can get any type of assets. It represents the

exchange price or monetary consideration given for acquiring goods or services. On the other hand, expenses are the using or consuming of goods and services in the process or obtaining revenues.

 Expense: Expenses are a decrease in the economic benefits during the accounting period in the form of outflows or depletion of assets. Expenses are the cost of assets consumed or services used in the process of earning revenue. The amount that is incurred to operate a business or for generate revenue.  Revenue: Revenue is an increase in economic benefits during the accounting period in the form of inflows or enhancements of assets. Revenues are the gross increase in owner’s equity resulting from business activities.

 Net Income: The excess of revenues over expenses.  Net Loss: The excess of expenses over revenues.

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 Accounting Equation or Balance Sheet or Basic Equation (Larson,9th ed.p17, Kieso,6th ed, p12) We know that the sum of the assets shown on the balance sheet must equal liabilities plus the equity of the owner or owners of the business. This equality may be expressed in equation form as follows: Assets = Liabilities + Owner’s equity or A=L+C Where, A = Assets L = Liabilities C = Owner’s equity When balance sheet equality is expressed in equation form, the resulting equation is called the balance sheet equation. It is also known as the accounting equation, since all double-entry accounting is based on it. And like any mathematical equation, its elements may be transposed and the equation expressed: Assets – Liabilities = Owner’s equity The equation in this form illustrates the residual nature of the owner’s equity. An owner’s claims are secondary to the creditors’ claims. Now, we are in a position to say- when the equality between assets and liabilities plus owner’s equity are expressed in the form of equation is called Basic Accounting Equation.

 Expansion of Basic Accounting Equation Already, we have known that the expression of equality between assets and liabilities plus owner’s equity of a business in the form of equation is called basic accounting equation. The basic accounting equation is expressed as; Assets = Liabilities + Owner’s equity There are some other accounts, which affect the owner’s equity, e.g., Revenues, Expenses and Drawings. Revenues increase owner’s equity and Expenses & Drawings decrease owner’s equity. If we show the effect of these additional accounts on the basic accounting equation, the new equation will be treated as Expanded Basic Accounting Equation. The expanded basic accounting equation is expressed as; Assets = Liabilities + Owner’s equity + Revenue – Expenses – Drawing or A=L+C+R-E-D Where, A = Assets R = Revenues L = Liabilities E = Expenses C = Owner’s equity D = Owner’s Drawing

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 Illustration Preparation of Income Statement, Balance Sheet and Owner’s Equity Statement after showing the effects of transactions on accounting equation. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Investment by owner Tk. 15000 Purchase of equipment Tk. 7000 Purchase of supplies on credit Tk. 1600 Services provided for cash Tk. 1200 Purchase of advertising on credit Tk. 250 Services provided for cash Tk. 1500 and credit Tk. 2000 Payment of expenses; rent Tk. 600, salaries Tk. 900utilities Tk. 200 Payment of accounts payable Tk. 250 Receipt of cash on account Tk. 600 Withdrawal of cash by owner Tk. 1300

Transaction

Assets Cash

1

+15000

2

-7000

Balance

8000

+

Accounts Receivable

+

= Liabilities Office Supplies

+

Equipment

=

4

+1200

Balance

9200

+

Capital

=

+15000

+

7000

=

15000

+1600 8000

Owners’ Equity

+

1600

+1600 +

7000

=

1600

+

+

1600

+

7000

=

1600

+

+250 9200

6

+1500

Balance

10700

7

-1700

Balance

9000

8

-250

Balance

8750

9

+600

Balance

9350

10

-1300

Balance

8050

15000 +1200

5 Balance

Investment

+7000

3 Balance

Accounts Payable

+

+

1600

+

7000

=

1850

+2000 +

2000

16200 -250

+

1600

+

7000

=

1850

+

2000

+

1600

+

7000

=

1850

Service Revenue

19450 -600 -900 -200

+

Advertising Expenses

15950 +3500

+

Services Revenue

+

17750

Rent Exp. Salaries Exp. Utilities Exp.

-250 +

2000

+

1600

+

7000

=

1600

+

17750

17750

-600 +

1400

+

1600

+

7000

=

1600

+

+

1400

+

1600

+

7000

=

1600

+

-1300

18050

=

Drawings

16450

18050

Page 8 of 18

SOFTBYTE Income Statement For the Month Ended September 30, 2005 Revenues Service revenue Expenses Salaries expense Rent expense Advertising expense Utilities expense Total expenses

Tk.4,700 Tk. 900 600 250 200

Net income

1,950 Tk.2,750

SOFTBYTE Owner’s Equity Statement For the Month Ended September 30, 2005 Capital, September 1 Add: Investments Net income

Tk.15,000 2,750

Less: Drawings Capital, September 30

Tk. 0 17,750 17,750 1,300 Tk.16,450

SOFTBYTE Balance Sheet September 30, 2005 C. Assets Cash Accounts receivable Supplies Equipment Total assets D. Liabilities and Owner’s Equity Liabilities Accounts payable Owner’s equity Capital Total liabilities and owner’s equity

Tk.8,050 1,400 1,600 7,000 Tk.18,050

Tk.1,600 16,450 Tk.18,050

Page 9 of 18

 Problem 1 The following transactions were engaged during the month of March by Dr. Rafiqul Islam: (1) Opened his practice by investing Tk.1,00,000 in the business (2) Bought office equipment for Tk. 70,000 on account from Medical Products, Inc. (3) Paid Tk.20,000 for various medical supplies for the office (4) Received Tk.16,000 in fees earned during the first month of operations (5) Paid office rent for the month, Tk. 2,000 (6) Paid medical assistant salary for the month, Tk. 4,000 (7) Paid to Medical Products, Inc., Tk. 30,000 on account (8) Withdrew Tk.5, 000 for personal use Requirement a)

Enter each transaction in the following form: Cash + Supplies + Equipment = Liabilities + Capital

b) c) d)

Prepare an Income Statement for the month of March, 200X. Prepare an Owner’s Equity Statement for the month of March, 200X. Prepare a Balance Sheet on March 31, 200X.

 Problem 2 Rahim Mia started the Good Cleaning Service on July 1, 200X, and had the transactions listed below for the month of July. Record them in the blank form, which follows. July

5 7 9 13 15 21 24

Cash

1

Started business; invested Tk.10,000 cash and equipment with book value of Tk.2,500.

Purchased Tk.300 of cleaning supplies on account. Received Tk.2,700 for cleaning services (Fees Income). Paid Tk.200 of the Tk.300 owned for purchase of cleaning supplies from July 5 transaction. Paid Tk.310 rent for month. Paid employee 2 weeks wages of Tk.540 (Salaries Expense). Purchased new cleaning machines for Tk.3,000 on account. Withdrew Tk.1,000 for personal use (use Drawing). 30

+

Took inventory; found he had Tk.125 worth of supplies left (Tk.300 - Tk.175 = Tk.125).

Supplies

+

Equipment

=

Liabilities

+

Capital

Account

Requirement (a) (b) (c) (d)

Prepare a Tabular Analysis of the above transactions according to the given format. Prepare an Income Statement for the month of July, 200X. Prepare an Owner’s Equity Statement for the month of July, 200X. Prepare a Balance Sheet on July 31, 200X.

Page 10 of 18

 Problem 3 Moinul Islam opens his own law office on July 1, 2005. During the first month of operations, the following transactions occurred: 1. Invested Tk. 1,00,000 in cash in the law practice 2. Paid Tk. 8,000 for July rent on office space 3. Purchased office equipment on account, Tk. 30,000 4. Rendered legal services to clients for cash, Tk. 15,000 5. Borrowed Tk.7000 cash from a bank on a note payable 6. Rendered legal services to client on account, Tk. 20,000 7. Paid monthly expenses: salaries, Tk. 5,000; utilities, Tk. 3,000; and telephone, Tk. 1,000 Instructions (a) Prepare a Tabular Summary of the transactions. (b) Prepare the Income Statement, Owner’s Equity Statement, and Balance Sheet on July 31 for Moinul Islam, Bar at Law.

 Problem 4 George Kanaan opened a law office, Gofur Khan, Bar at Law, on July 1, 1999. On July 31, the balance sheet showed cash Tk.40,000, Accounts Receivable Tk.15,000, Supplies Tk.5,000, Office Equipment Tk.50,000, Accounts Payable Tk.42,000, and Gofur Khan, Capital, Tk.68,000. During August the following transactions occurred: 1. Collected Tk.14,000 of accounts receivable. 2. Paid Tk.27,000 cash on accounts payable. 3. Earned revenue of Tk.64,000, of which Tk.30,000 is collected in cash and the balance is due in September. 4. Purchased additional office equipment for Tk.10,000, paying Tk.4,000 in cash and the balance on account. 5. Paid salaries Tk.25,000, rent for August Tk.900, and advertising expenses Tk.3,500. 6. Withdrew Tk.5,500 in cash for personal use. 7. Received Tk.20,000 from Standard Federal Bank- money borrowed on a note payable. 8. Incurred utility expenses for month on account, Tk.2,500. Instructions (a) Prepare a tabular analysis of the August transactions beginning with July 31 balances. The column heading should be as follows: Cash + A / R + Supplies + Office Equipment = Notes Payable + A / P + Capital (b) Prepare an Income Statement for August, an Owner’s Equity Statement for August, and a Balance Sheet at August 31.

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 Problem 5 Account balances for Good Luck Company on June 30 are given below in accounting equation form:

Balance

Cash

+

24,000

+

Assets Accounts + Office Receivable Supplies 2,16,000 + 1,000

+

Equipment

= =

+

35,000

=

Accounts Payable 1,11,000

Liabilities + Owners’ Equity Notes + Capital Payable Stock + 15,000 + 1,50,000

During July Good Luck Company entered into the following transactions. 1. 2. 3. 4.

Collected Tk. 1,25,000 of accounts receivable. Paid Tk. 40,000 on accounts payable. Billed to customers for services performed in the amount of Tk. 1,14,000 Purchased equipment for Tk. 80,000. Paid Tk. 20,000 in cash and signed a note payable for the balance. 5. Paid expenses of Tk. 78,000 in cash (advertising, Tk. 8,000; rent, Tk. 30,000; employees’ wages, Tk. 40,000). 6. Collected Tk. 90,000 of accounts receivable. 7. Used office supplies in the amount of Tk. 890 during the month. 8. Paid Tk. 30,000 on notes payable. 9. Depreciation on the equipment for July is computed to be Tk. 10,000. 10. On July 31, paid interest for July in the amount of Tk. 2,250. Required A) Prepare a schedule with a column for numbering the transactions, a column for each account listed above, and a column for identifying the capital transactions. Enter the June 30 balance for each asset, liability, and owners’ equity account in the schedule. B) Record the effects of each transaction. Show the total of each column after recording each transaction. C) Prepare an income statement and retained earnings statement for the month of July, and a balance sheet as of July 31 for Good Luck Company.

Page 12 of 18

 Problem 6 Rahim Ali owns and operates the Car Repair Shop. A list of the transactions that took place in August 2002 follows: August 1 August 2 August 3 August 4 August 5 August 11 August 13 August 14 August 22 August 24 August 26 August 29 August 31

Rahim began the business by depositing Tk. 50,000 of his personal funds in the business bank account. Rahim rented space for the shop and paid August rent of Tk. 8,000. The shop purchased supplies for cash, Tk. 30,000. The shop paid ‘Daily News’, a local newspaper, Tk.3,000 for an advertisement. Rahim repaired a car for a customer. The customer paid cash of Tk.13,000 for services rendered. Car Repair Shop repaired a car for a customer, Mr. Nazrul Islam, on credit, Tk. 5,000. The shop purchased supplies for Tk. 9,000 by paying cash of Tk. 2,000 and charging the rest on account. The shop repaired a car for Zonab Ali, for Tk.19,000. Rahim collected Tk.10,000 in cash and put the rest on account. Rahim took home supplies from the shop that had cost Tk. 1,000 when purchased on August 3. The shop collected cash of Tk. 4,000 from Mr. Nazrul Islam. The shop paid of Tk. 2000 for clearing expense. Rahim repaired a car for Abul Kashem for Tk. 12,000 on account. Rahim transferred Tk. 5,000 from the business bank account to his Personal bank account.

Instructions (e) (f) (g) (h)

Prepare a tabular analysis of the transactions. Prepare an income statement for the month of August, 2002. Prepare an owner’s equity statement for the month of August, 2002. Prepare a balance sheet on August 31, 2002.

Page 13 of 18

 Transaction Analysis and Making Journal Entries 1. Mr. Ray Neal decides to open a computer programming service which he names Softbyte. On September 01, 2005, he invests Tk. 15,000 cash in the business. 2. September 01, 2005, he places an order to ABC Co. for purchasing a computer for Tk. 7,000. 3. On September. 02, 2005, Softbyte has purchased computer equipment for Tk. 7,000 cash. 4. Softbyte purchases computer paper for Tk. 1,600 on credit on September 07, 2005. 5. Softbyte receives Tk. 1,200 cash from customers for programming services on Sep. 15, 2005 6. Softbyte receives a bill for Tk. 250 on Sep. 20, from The Daily Star for advertising but was not paid. 7. Softbyte provides Tk. 3,500 of programming services for customer on Sep. 23, 2005 (receives Tk. 1,500 in cash and the balance of Tk. 2,000 on credit). 8. Office Expenses paid in cash for Tk. 1,700 on September 28, 2005. 9. Softbyte pays its Tk. 250 advertising bill in cash on September 29, 2005. 10. On Sep. 30, 2005, Tk. 600 in cash is received from customer who has previously been billed. 11. Ray Neal withdraws Tk. 1,300 from the business for his personal use on Sep. 30, 2005.

Page 14 of 18

SOFTBYTE General Journal

J1

Date Account Titles and Explanation 2005 Cash Sep. 01 Mr. Ray Neal’s Capital (Owner’s investment of cash in business) Sep. 01 No Transaction

Ref. 01 06

Debit 15,000

Sep. 02 Computer Equipment Cash (As purchase of computer in cash) Sep. 07 Office Supplies Accounts Payable (As purchase of computer paper on credit) Sep. 15 Cash Service Revenue (As received cash by providing service) Sep. 20 Advertising Expense Advertising Bills Payable (As advertising bill received but not paid) Sep. 23 Cash Accounts Receivable Service Revenue (As service provided in cash and on credit) Sep. 28 Office Expense Cash (As office expense paid in cash) Sep. 29 Advertising Bills Payable Cash (As accrued bill paid) Sep. 30 Cash Accounts Receivable (As cash received from accounts receivable) Sep. 30 Drawings Cash (As withdraw by owner)

04 01

7,000

03 05

1,600

01 08

1,200

10 11

250

01 02 08

1,500 2,000

09 01

1,700

11 01

250

01 02

600

07 01

1,300

Credit 15,000

7,000 1,600 1,200 250

3,500 1,700 250 600 1,300

Page 15 of 18

SOFTBYTE General Ledger Date 2005 Sep. 01 02 15 23 28 29 30 30

Date 2005 Sep. 01 Date 2005 Sep. 01 Date 2005 Sep. XX

Explanation

Cash A/c

Mr. Ray Neal’s Capital Computer Equipment Service Revenue Service Revenue Office Expense Advertising Bills Payable Accounts Receivable Drawings

Ref. J1 J1 J1 J1 J1 J1 J1 J1

Debit

Credit

15,000 1,200 1,500

1,700 250

600

Mr. Ray Neal’s Capital A/c Explanation Ref. Debit Cash

7,000

1,300

Credit

J1

15,000

Computer Equipment A/c Explanation Ref. Debit Cash

J1 XXXX A/c Explanation

XXXXXXXX

Ref. J1

Credit

7,000 Debit

No. 01 Balance 15,000 8,000 9,200 10,700 9,000 8,750 9,350 8,050 No. 06 Balance 15,000 No. 04 Balance 7,000

Credit

……….

………

No. XX Balance …………

SOFTBYTE TRIAL BALANCE SL 01 02 03 04 05 06 07 08 09 10

September 30, 2005 Accounts Title Debit Cash 8,050 Accounts Receivables 1,400 Office Supplies 1,600 Computer Equipment 7,000 Accounts Payable Mr. R. Neal’s Capital Mr. R. Neal’s Drawings 1,300 Service Revenue Office Expenses 1,700 Advertising Expenses 250 Total 21,300

Credit

1,600 15,000 4,700 21,300

Page 16 of 18

 Some Common Transactions 1. Investment by owner in Cash Tk. 50,000 2. Investment of Assets (Building) by owner Tk. 100,000 3. Purchase of inventory in cash Tk. 10,000 4. Purchase of inventory on credit Tk. 8,000 5. Sale of inventory in cash Tk. 12,000 6. Sale of inventory on credit Tk. 9,000 7. Purchase of Assets (Computer) in cash Tk. 30,000 8. Payment of expense (Salary) in Cash Tk. 5,000 9. Incur expense (Rent) on credit Tk. 7,000 10. Revenue (Dividend) received in cash Tk. 2,000 11. Revenue (Interest) earned on credit Tk. 3,000 12. Withdraw by owner in Cash Tk. 1,000 13. Received from Accounts Receivable Tk. 7,000 14. Payment to Accounts Payable Tk. 6,000 General Journal Date Accounts Title 1 Cash Capital (To record investment by owner in cash) 2 Assets (Building) Capital (To record…………………………….) 3 Purchase Cash (As/Since……………………………..) 4 Purchase Accounts Payable (A/P) 5 Cash Sales 6 Accounts Receivable (A/R) Sales 7 Assets (Computer) Cash 8 Expense (Salary) Cash 9 Expense (Rent) Expense Payable (Rent Payable) 10 Cash Revenue (Dividend) 11 Revenue Receivable (Interest Receivable) Revenue (Interest Revenue) 12 Drawing Cash 13 Cash A/R 14 A/P Cash

Ref

Dr 50,000 100.000 10,000 8,000 12,000 9,000 30,000 5,000 7,000 2,000 3,000 1,000 7,000 6,000

Cr. 50,000 100,000 10,000 8,000 12,000 9,000 30,000 5,000 7,000 2,000 3,000 1,000 7,000 6,000

Page 17 of 18

Date 1 3 5 7 8 10 12 13 14

Explanation

Capital Purchase Sales Computer Salary Dividend Drawing A/R A/P

Date 1 2

Cash Building

Date 2

Capital

Date 3 4

Cash A/P

Date 4 14

Purchase Cash

Date 5 6 Date 6 13

Cash A/R Sales Cash

General Ledger Cash Ref

Dr 50,000

6,000

Balance 50,000 40,000 52,000 22,000 17,000 19,000 18,000 25,000 19,000

Dr

Cr 50,000 100,000

Balance 50,000 150,000

Dr 100,000

Cr

Balance 100,000

Dr 10,000 8,000

Cr

Balance 10,000 18,000

Dr

Cr 8,000

Balance 8,000 2,000

Dr

Cr 12,000 9,000

Balance 12,000 21,000

Dr 9,000

Cr

Balance 9,000 2,000

12,000 2,000 7,000

Explanation

Capital Ref

Explanation

Building Ref

Explanation

Purchase Ref

Explanation

A/P Ref

6,000

Explanation

Sales Ref

Explanation

A/R Ref

Cr 10,000 30,000 5,000 1,000

7,000

In this way we are to create an account for each new title ……………………….. Date

Explanation

Ref

Dr

Cr

Balance

Page 18 of 18

SHEET 2

Regulatory Framework of Accounting Md. Mahabbat Hossain Faculty Member, BIBM Phone: 01716373565 Email: [email protected]

 Introduction Different types of organizations are operating their activities in Bangladesh. These organizations are being regulated by several national and international regulatory authorities. A single firm may be regulated, directed and supervised by different regulators and agencies. Therefore, Bangladeshi companies are to follow several rules, regulations, standards and directives issued by the external bodies along with their internal policies. The following parts of this chapter depicts legal framework for the companies regarding their disclosure in Bangladesh.

 National Regulatory Body The extent and nature of corporate disclosure of Bangladeshi companies may be regulated by Ministry of Finance (MoF), Ministry of Commerce (MoC), Registrar of Joint Stock Companies and Firms (RJSCF), Bangladesh Securities and Exchange Commission (BSEC), Bangladesh Bank (BB), Insurance Development and Regulatory Authority (IDRA), Microcredit Regulatory Authority (MRA), Dhaka Stock Exchange (DSE), Chittagong Stock Exchange (CSE), Institute of Chartered Accountants of Bangladesh (ICAB), and/or Institute of Cost and Management Accountants of Bangladesh (ICMAB). Table 1: List of national regulatory bodies and concerned companies in Bangladesh Regulator Nature of Companies 1. Ministry of Finance (MoF) 1. Banks 2. Non-Bank Financial Institutions 3. Capital Market 4. Insurance Sector 5. Microcredit Sector, etc. 2. Ministry of Commerce (MoC) Trade and commerce related activities of Bangladesh and deals with Companies Act, Partnership Act, Societies and Trade Organization Ordinance and Law of Insurance. 3. Registrar of Joint Stock Companies and Firms (RJSCF)

1. Private Companies 2. Public Companies Page 1 of 24

3. Foreign Companies 4. Trade Organizations 5. Partnership Firms, etc. 4. Bangladesh Securities and Exchange Commission (BSEC)

5. Bangladesh Bank (BB) 6. Insurance Development Regulatory Authority (IDRA)

&

1. 2. 3. 4. 5. 1. 2. 3. 1. 2. 3. 1.

Listed Companies DSE and its OTC Market CSE and its OTC Market Capital Market Intermediaries Credit Rating Agencies, etc. Scheduled Banks Non-scheduled banks Non-Bank Financial Institutions, etc. Non-life Insurance Companies Life Insurance Companies Insurance Companies in Public Sector, etc. Micro Finance Institutions (MFIs)

7. Microcredit Regulatory Authority (MRA) 8. Dhaka Stock Exchange Limited 1. Companies Listed on DSE (DSE) 9. Chittagong Stock Exchange 1. Companies Listed on CSE Limited (CSE) Source: Researcher’s own analysis based on related documents

 International Regulatory Body Different international bodies issue regulations and guidelines regarding corporate disclosure. The IFRS Foundation is an independent, not-for-profit private sector organisation working in the public interest. The principal objectives of the IFRS Foundation are to develop a single set of high quality, understandable, enforceable and globally accepted International Financial Reporting Standards (IFRSs) through its standard-setting body, the International Accounting Standards Board (IASB); to promote the use and rigorous application of those standards; to take account of the financial reporting needs of emerging economies and small and mediumsized entities (SMEs); and to promote and facilitate adoption of IFRSs (www.ifrs.org). The International Accounting Standards Board (IASB) is the independent standard-setting body of the IFRS Foundation. IASB, based in London, began operations in 2001. After 2001 the Accounting Standards issued by IASB are known as International Financial Reporting Standards (IFRSs). Before establishment of IASB, standards were issued by International Accounting Standard Committee (IASC) and those standards are known as International Accounting Standards (IASs). Up to 2001, a total of 41 IASs have been issued by IASC whereas a total of 15 IFRSs have been issued by IASB from 2001 to June 2014 (www.ifrs.org). Financial Accounting Foundation (FAF) is an independent, private sector organization responsible for the oversight, administration, and finance of the Financial Accounting Standards Board (FASB). FASB has been the designated organization in the private sector since 1973 for establishing standards of financial accounting that govern the preparation of financial reports by non-governmental organizations. These standards have been officially recognized as authoritative ones by the U.S. Securities and Exchange

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Commission (SEC) and the American Institute of Certified Public Accountants (www.fasb.org). The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is an Islamic international autonomous non-for-profit corporate body that prepares accounting, auditing, governance, ethics and Shariah standards for Islamic financial institutions and the industry. AAOIFI was registered on March 27, 1991 in the State of Bahrain. Accounting and Auditing Standards Board (AASB) is the standards-setting body of AAOIFI. A total of 88 standards have been issued by AAOIFI - (a) 48 on Shariah standards, (b) 26 accounting standards, (c) 5 auditing standards, (d) 7 governance, and (e) 2 codes of ethics (www.aaoifi.com). Islami Bank Bangladesh Limited is a member of AAOIFI. The Islamic Financial Services Board (IFSB), based in Kuala Lumpur, started operations on March 10, 2003. It serves as an international standards-setting body of regulatory and supervisory agencies that have vested interest in ensuring the soundness and stability of the Islamic financial services industry. Bangladesh Bank is a member of IFSB. Up to June 2014, IFSB has published 16 standards, 5 guidance notes and 1 technical note (www.ifsb.org). The Bank for International Settlements (BIS) is to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in those areas and to act as a bank for central banks. The BIS is the world's oldest international financial organization established on May 17, 1930. The Basel Committee on Banking Supervision (BCBS) is the primary global standards-setter for the prudential regulations of banks and provides a forum for cooperation on banking supervisory matters. The secretariat of BCBS is provided by the BIS (www.bis.org). There are additional disclosure requirements in guidelines issued by BCBS. South Asian Federation of Accountants (SAFA) was formed in the year 1984 to promote and accelerate development of the accountancy profession in the South Asian Region and uphold its eminence in the world of accountancy (www.esafa.org). SAFA offers award for corporate governance disclosures based on Best Presented Annual Report (BPA) of listed companies. International Federation of Accountants (IFAC) is the global organization for the accountancy profession dedicated to serving the public interest by strengthening the profession and contributing to the development of strong international economies (www.ifac.org). IFAC deals with international regulatory convergence, global adoption of high quality international reporting and professional standards, standard-setting in the public interest, sustainability and integrated reporting, public sector reporting and transparency, etc. Its formal policy positions are issued as Policy Position Papers. IFAC submits comment letters and recommendations to global and regional organizations including the IFRS Foundation.

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 National Regulation List of regulations for the concerned companies of Bangladesh S/N Name of Regulation Important Provision 1 The Securities and Exchange Sec. 2CC: Power to impose conditions . Ordinance 1969 Sec. 2E: Power to call for information Sec. 2F: False information Sec 6: Accounts, Annual Reports, Returns, etc. Sec. 11: Submission of Returns Sec. 12. Submission of Statements of Beneficial Owners Listed Equity Securities. Sec. 18: Prohibition of false statements, etc. BSEC Notification (No. SEC/CMRRCD/2006158/134/Admin/44, dated August 07, 2012) 2 The Securities and Exchange Rule 5: Maintenance of accounts and audit . Rules 1987 Rule 7: Maintenance of books of accounts and other documents by stock exchange Rule 8: Maintenance of books etc. by members Rule 12: Submission of annual report by issuers Rule 13: Submission of periodical reports by issuer Rule 14: Mode of filing or submission of returns/reports 3 The Companies Act 1994 Sec. 181: Books to be kept by company and penalty for not . keeping them Sec. 182: Inspection of books of accounts, etc. of companies Sec. 183: Annual balance sheet Sec. 184: Board’s report Sec. 185: Form and contents of balance sheet and profit and loss accounts Sec. 186: Balance sheet of holding company to include certain particulars as to its subsidiary Sec. 187: Financial year of holding company and subsidiary Sec. 189: Authentication of balance sheet, profit and loss accounts, etc. Sec. 190: Copy of balance sheet etc. to be filed with registrar Sec. 191: Rights of members to copies of accounts and reports Sec. 192: Statement to be published by banking and certain other companies 4 The Bank Companies Act 1991 Sec. 18: Transaction related to directors should be disclosed . Sec. 36: Half yearly returns Sec. 37: Power for publishing information Sec. 38: Accounts and balance sheets Sec. 39: Audit Sec. 40: Report submission Sec. 40: Sending balance sheet etc. to the registrar Sec. 42: Display of audited balance sheet by the banking company operating in Bangladesh Sec. 43: Accounting provisions not retrospective BB Circular (BRPD Circular No. 14/2003; BRPD Circular No. 15/2009) 5 The Financial Institution Act Sec. 11: Balance sheet exhibition . 1993 Sec. 12: Furnishing information Sec. 23: Accounts and audit submission to the bank (BB)

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6 The Insurance Act 2010 .

7 The Partnership Act 1932 .

BB Circular (DFIM Circular No. 11/2009) Sec. 26: Separation of accounts and funds Sec. 27: Accounts and balance sheet Sec. 28: Audit Sec. 29: Special audit Sec. 30: Actuarial report and abstract Sec. 32: Submission of returns Sec. 34: Furnishing reports Sec. 36: Custody and inspection of documents and supply of copies Sec. 37: Powers of Chief Controller of Insurance regarding returns Sec. 39: Evidence of documents Sec. 40: Returns to be published in statutory forms It is expedient to define and amend the law relating to partnership

8 Micro Credit Regulatory Rules Rule 13: Bookkeeping and other activities . 2010 Rule 41: Maintaining register and records Rule 43: General rules for preparation of financial statements Rule 46: Internal audit of accounts Rule 47: External audit Rule 48: Submission of statements, reports, returns, etc. 9 The Listing Regulations of Listing Regulation no. 36 titled Continuing Listing . Dhaka Stock Exchange Limited Requirements 1 The Listing Regulations of the Listing Regulation no. 36 titled Continuing Listing 0 Chittagong Stock Exchange Requirements . Limited

Source: Researcher’s own analysis based on concerned regulations

 International Regulation Along with local regulations, listed companies of Bangladesh are to comply with a number of international regulations. International Financial Reporting Standards (IFRSs) have been issued by IASB whereas International Accounting Standards (IASs) had been issued by IASC. IFRSs and IASs have been adopted in Bangladesh by ICAB as Bangladesh Financial Reporting Standards (BFRSs) and Bangladesh Accounting Standards (BASs) respectively. Status of IASs (BASs) and IFRSs (BFRSs) in Bangladesh as on January 1, 2013 is depicted in Table 2.3. All of the listed companies are to maintain these standards for preparing their general purpose financial statements. Bangladeshi companies are also following some US GAAP (Generally Accepted Accounting Principles) issued by FASB. More than 150 Statement of Financial Accounting Standards (FAS) have been issued by FASB. In July 2009, FASB released Accounting Standards Codification codifying all authoritative US GAAP in one spot with roughly 90 topics (FAF, 2014). There are some other nonauthoritative US GAAPs as well.

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Islamic financial institutions (IFIs) like bank, insurance, non-bank financial institutions have to follow standards issued by AAOIFI. Among others, Financial Accounting Standard No. 1: General Presentation and Disclosure in the FSs of Islamic Banks and Financial Institutions is more relevant for the preparation of financial statements. As per BB guidelines, Islamic banks are to comply with Shariah rules issued by AAOIFI. The IFSB, an international standard-setting organization, issues standard, guidance note and technical note. IFSB-4: Disclosures to Promote Transparency and Market Discipline for Institutions offering Islamic Financial Services, is more relevant with preparation of financial statements of banks under Islamic Shariah. Pillar-3, Market Discipline, of Basel-II issued by the Basel Committee on Banking Supervision (BCBS) requires additional disclosure. In line with Basel II, BB has issued a revised guideline for banks titled “Guidelines on Risk Based Capital Adequacy (RBCA)” in December 2010. RBCA has come fully into force from January 01, 2010 with its subsequent supplements/revisions (BB, 2010b). Status of IASs (BASs) and IFRSs (BFRSs) in Bangladesh BAS/ BAS/BFRS Title BFRS BAS 1 Presentation of Financial Statements BAS 2 Inventories BAS 7 Statement of Cash Flows BAS 8 Accounting Policies, Changes in Accounting Estimates and Errors BAS 10 Events after the Reporting Period BAS 11 Construction Contracts BAS 12 Income Taxes BAS 16 Property, Plant & Equipment BAS 17 Leases BAS 18 Revenue BAS 19 Employee Benefits BAS 20 Accounting of Government Grants and Disclosure of Government Assistance BAS 21 The Effects of Changes in Foreign Exchange Rates BAS 23 Borrowing Costs BAS 24 Related Party Disclosures BAS 26 Accounting and Reporting by Retirement Benefit Plans BAS 27 Separate Financial Statements BAS 28 Investments in Associates and Joint Ventures IAS 29 Financial Reporting in Hyperinflationary Economics BAS 31 Interest in Joint Ventures BAS 32 Financial Instruments: Presentation BAS 33 Earnings per Share BAS 34 Interim Financial Reporting BAS 36 Impairment of Assets

BAS Effective Date on or after 1 January, 2010 on or after 1 January, 2007 on or after 1 January, 1999 on or after 1 January, 2007 on or after 1 January, 1999 on or after 1 January, 1999 on or after 1 January, 1999 on or after 1 January, 2007 on or after 1 January, 2007 on or after 1 January, 2007 on or after 1 January, 2013 on or after 1 January, 1999 on or after 1 January, 2007 on or after 1 January, 2010 on or after 1 January, 2007 on or after 1 January, 2007 on or after 1 January, 2013 on or after 1 January, 2013 on or after 1 January, 2015 on or after 1 January, 2007 on or after 1 January, 2010 on or after 1 January, 2007 on or after 1 January, 1999 on or after 1 January, 2005 Page 6 of 24

BAS 37

BFRS 7 BFRS 8 IFRS 9

Provisions, Contingent Liabilities and Contingent Assets Intangible Assets Financial Instruments: Recognition and Measurement Investment Property Agriculture First-time adoption of International financial Reporting Standards Share-based Payment Business Combinations Insurance Contracts Non-current Assets Held for Sale and Discontinued Operations Exploration for and Evaluation of Mineral Resources Financial Instruments: Disclosures Operating Segments Financial Instruments

BFRS 10 BFRS 11 BFRS 12 BFRS 13 IFRS 14*

Consolidated Financial Statements Joint Arrangements Disclosure of Interests in other Entities Fair Value Measurement Regulatory Deferral Accounts

BAS 38 BAS 39 BAS 40 BAS 41 BFRS 1 BFRS 2 BFRS 3 BFRS 4 BFRS 5 BFRS 6

IFRS 15* Revenue from Contracts with Customers

on or after 1 January, 2007 on or after 1 January, 2005 on or after 1 January, 2010 on or after 1 January, 2007 on or after 1 January, 2007 1 January, 2009 1 January, 2007 1 January, 2010 1 January, 2010 1 January, 2007 1 January, 2007 1 January, 2010 1 January, 2010 NA (Not yet adopted but under review process) 1 January, 2013 1 January, 2013 1 January, 2013 1 January, 2013 1 January, 2016 (Not yet adopted by ICAB) 1 January, 2017 (Not yet adopted by ICAB)

Source: www.icab.org.bd; *www.ifrs.org

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

Recognition of the Elements of Financial Statements

An item that meets the definition of an element should be recognized if- (a) it is probable that any future economic benefit associated with the item will flow to or from the entity; and (b) the item has a cost or value that can be measured with reliability. • Recognition of assets: An asset is recognized in the balance sheet when it is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably. • Recognition of liabilities: A liability is recognized in the balance sheet when it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably. In practice, obligations under contracts that are equally proportionately unperformed (for example, liabilities for inventory ordered but not yet received) are generally not recognized as liabilities in the financial statements. However, such obligations may meet the definition of liabilities and, provided the recognition criteria are met in the particular circumstances, may qualify for recognition. In such circumstances, recognition of liabilities entails recognition of related assets or expenses. • Recognition of income: Income is recognized in the income statement when an increase in future economic benefit related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. This means, in effect, that recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities (for example, the net increase in assets arising on a sale of goods or services or the decrease in liabilities arising from the waiver of a debt payable). • Expense Recognition: Expenses are recognized in the income statement when a decrease in future economic benefit related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. This means, in effect, that recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease in assets (for example, the accrual of employee entitlements or the depreciation of equipment). Expenses are recognized in the income statement on the basis of a direct association between the costs incurred and the earning of specific items of income.



Measurement of the elements of financial statements

A number of different measurement bases are employed to different degrees and in varying combinations in financial statements. However, the measurement basis most commonly adopted by entities in preparing their financial statements is historical cost. • Historical Cost: Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business. • Current Cost: Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently. Page 8 of 24

•

•



Realizable (Settlement) Value. Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business. Present Value: Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business.

FASB (US GAAP)

Since 1973, the Financial Accounting Standards Board (FASB) has been the designated organization in the private sector for establishing standards of financial accounting that govern the preparation of financial reports by nongovernmental entities. Those standards are officially recognized as authoritative by the Securities and Exchange Commission (SEC) and the American Institute of Certified Public Accountants (AICPA). Such standards are important to the efficient functioning of the economy because decisions about the allocation of resources rely heavily on credible, concise, and understandable financial information. The SEC has statutory authority to establish financial accounting and reporting standards for publicly held companies under the Securities Exchange Act of 1934. Throughout its history, however, the Commission’s policy has been to rely on the private sector for this function to the extent that the private sector demonstrates ability to fulfill the responsibility in the public interest. Generally Accepted Accounting Principles, US GAAP or simply GAAP are terms for the "generally accepted accounting principles". Although the SEC (Securities and Exchange Commission) has a stated goal of moving from US GAAP to the International Financial Reporting Standards (IFRS), the provisions of which differ considerably from GAAP progress has been slow and uncertain. Accounting standards have historically been set by the American Institute of Certified Public Accountants (AICPA) subject to Securities and Exchange Commission regulations. The AICPA first created the Committee on Accounting Procedure in 1939, and replaced that with the Accounting Principles Board in 1959. In 1973, the Accounting Principles Board was replaced by the Financial Accounting Standards Board (FASB) under the supervision of the Financial Accounting Foundation with the Financial Accounting Standards Advisory Council serving to advise and provide input on the accounting standards. The FASB issued the FASB Accounting Standards Codification, which reorganized the thousands of US GAAP pronouncements into roughly 90 accounting topics. To achieve basic objectives and implement fundamental qualities GAAP has four basic assumptions, four basic principles, and four basic constraints.

Assumptions 1. Accounting Entity: Accounting entity assumes that the business is separate from its owners or other businesses. Revenue and expense should be kept separate from personal expenses. 2. Going Concern: It is assumed that the business will be in operation indefinitely. This validates the methods of asset capitalization, depreciation, and amortization. Only

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when liquidation is certain this assumption is not applicable. The business will continue to exist in the unforeseeable future. 3. Monetary Unit principle: Monetary unit principle assumes a stable currency is going to be the unit of record. The FASB accepts the nominal value of the US Dollar as the monetary unit of record unadjusted for inflation. 4. Periodicity Concept: The Time-period principle implies that the economic activities of an enterprise can be divided into artificial time periods. Principles 1. Historical Cost Principle: Historical cost principle requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities. This principle provides information that is reliable (removing opportunity to provide subjective and potentially biased market values), but not very relevant. Thus there is a trend to use fair values. Most debts and securities are now reported at market values. 2. Revenue Recognition Principle: Revenue recognition principle holds that companies may not record revenue until (1) it is realized or realizable and (2) when it is earned. The flow of cash does not have any bearing on the recognition of revenue. This is the essence of accrual basis accounting. Conversely, however, losses must be recognized when their occurrence becomes probable, whether or not it has actually occurred. This comports with the constraint of conservatism, yet brings it into conflict with the constraint of consistency, in that reflecting revenues/gains is inconsistent with the way in which losses are reflected. 3. Matching Principle: Expenses have to be matched with revenues as long as it is reasonable to do so. Expenses are recognized not when the work is performed, or when a product is produced, but when the work or the product actually makes its contribution to revenue. Only if no connection with revenue can be established, cost may be charged as expenses to the current period (e.g. office salaries and other administrative expenses). This principle allows greater evaluation of actual profitability and performance (shows how much was spent to earn revenue). Depreciation and Cost of Goods Sold are good examples of application of this principle. 4. Full Disclosure Principle: Amount and kinds of information disclosed should be decided based on trade-off analysis as a larger amount of information costs more to prepare and use. Information disclosed should be enough to make a judgment while keeping costs reasonable. Information is presented in the main body of financial statements, in the notes or as supplementary information

Constraints 1. Objectivity Principle: the company financial statements provided by the accountants should be based on objective evidence. 2. Materiality Principle: The principle indicates that the significance of an item should be considered when it is reported. An item is considered significant when it would affect the decision of a reasonable individual. 3. Consistency principle: It means that the company uses the same accounting principles and methods from period to period.

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4.

Conservatism principle: When choosing between two solutions, the one which has the less favorable outcome is the solution which should be. In other word, accountant should be conservative in determining the amount of profit and asset value.

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

AAOIFI Framework

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is an Islamic international autonomous non-for-profit corporate body that prepares accounting, auditing, governance, ethics and Shari'a standards for Islamic financial institutions and the industry. Accounting & Auditing Standards Board (AASB) of AAOIFI is responsible for setting accounting and auditing standards. AAOIFI was established in accordance with the Agreement of Association which was signed by Islamic financial institutions on 26 February, 1990 in Algiers. Then, it was registered on 27 March, 1991 in the State of Bahrain. As an independent international organization, AAOIFI is supported by institutional members (200 members from 40 countries, so far) including central banks, Islamic financial institutions, and other participants from the international Islamic banking and finance industry, worldwide. AAOIFI carries out its objectives in accordance with the precepts of Islamic Shari’a which represents a comprehensive system for all aspects of life, in conformity with the environment in which Islamic financial institutions have developed. This activity is intended both to enhance the confidence of users of the financial statements of Islamic financial institutions in the information that is produced about these institutions, and to encourage these users to invest or deposit their funds in Islamic financial institutions and to use their services. Total of 88 standards are issued by AAOIFI-(a) 48 on Shari’a, (b) 26 accounting, (c) 5 auditing standards, (d) 7 governance, (e) 2 codes of ethics. In addition, new standards are being developed and existing standards reviewed. AAOIFI standards are followed – as part of regulatory requirement or IFIs’ internal guidelines – in jurisdictions that offer Islamic finance across Middle East, Asia Pacific, South Asia, Central Asia, Africa, Europe, and North America; and Islamic Development Bank Group. Consequently, AAOIFI standards have introduced greater harmonization of Islamic finance practices across the world.



IAS 1: Presentation of Financial Statements  Objective of IAS 1: This Standard prescribes the basis for presentation of general purpose financial statements to ensure comparability both with the entity’s financial statements of previous periods and with the financial statements of other entities. It sets out overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content.

 Scope of IAS 1 o An entity shall apply this Standard in preparing and presenting general purpose financial statements in accordance with International Financial Reporting Standards (IFRSs). o Other IFRSs set out the recognition, measurement and disclosure requirements for specific transactions and other events. o This Standard does not apply to the structure and content of condensed interim financial statements prepared in accordance with IAS 34. This Standard applies equally to all entities, including those that present consolidated financial statements and those that present separate financial statements as defined in IAS 27.

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o This Standard uses terminology that is suitable for profit-oriented entities, including public sector business entities. If entities with not-for-profit activities in the private sector or the public sector apply this Standard, they may need to amend the descriptions used for particular line items in the financial statements and for the financial statements themselves. o Similarly, entities that do not have equity as defined in IAS 32 Financial Instruments: Presentation (e.g. some mutual funds) and entities whose share capital is not equity (e.g. some co-operative entities) may need to adapt the financial statement presentation of members’ or unit-holders’ interests.

 Definitions of Terms used in IAS 1 o General purpose financial statements (referred to as ‘financial statements’) are those intended to meet the needs of users who are not in a position to require an entity to prepare reports tailored to their particular information needs. o Impracticable Applying a requirement is impracticable when the entity cannot apply it after making every reasonable effort to do so. o International Financial Reporting Standards (IFRSs) are Standards and Interpretations adopted by the International Accounting Standards Board (IASB). They comprise: •

International Financial Reporting Standards (IFRSs);

•

International Accounting Standards (IASs); and

• Interpretations developed by the International Financial Reporting Interpretations Committee (IFRIC) or the former Standing Interpretations Committee (SIC). o Material Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions that users make on the basis of the financial statements. Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor. o Notes contain information in addition to that presented in the statement of financial position, statement of comprehensive income, separate statement of comprehensive income (if presented), statement of changes in equity and statement of cash flows. Notes provide narrative descriptions or disaggregations of items presented in those statements and information about items that do not qualify for recognition in those statements. o Other comprehensive income comprises items of income and expense (including reclassification adjustments) that are not recognized in profit or loss as required or permitted by other IFRSs. The components of other comprehensive income include: • changes in revaluation surplus (see IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets);

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• actuarial gains and losses on defined benefit plans recognized in accordance with paragraph 93A of IAS 19 Employee Benefits; • gains and losses arising from translating the financial statements of a foreign operation (see IAS 21 The Effects of Changes in Foreign Exchange Rates); • gains and losses on remeasuring available-for-sale financial assets (see IAS 39 Financial Instruments: Recognition and Measurement); • the effective portion of gains and losses on hedging instruments in a cash flow hedge (see IAS 39). o

Owners are holders of instruments classified as equity.

o Profit or loss is the total of income less expenses, excluding the components of other comprehensive income. o Reclassification adjustments are amounts reclassified to profit or loss in the current period that were recognized in other comprehensive income in the current or previous periods. o Total comprehensive income is the change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners. Total comprehensive income comprises all components of ‘profit or loss’ and of ‘other comprehensive income’. Although this Standard uses the terms ‘other comprehensive income’, ‘profit or loss’ and ‘total comprehensive income’, an entity may use other terms to describe the totals as long as the meaning is clear. For example, an entity may use the term ‘net income’ to describe profit or loss.

 Financial Statements Financial statements are a structured representation of the financial position and financial performance of an entity. The objective of financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. Financial statements also show the results of the management’s stewardship of the resources entrusted to it. To meet this objective, financial statements provide information about an entity’s: (a) assets; (b) liabilities; (c) equity; (d) income and expenses, including gains and losses; (e) contributions by and distributions to owners in their capacity as owners; and (f) cash flows. Information to be presented either in the statement of financial position or in the notes. This information, along with other information in the notes, assists users of financial statements in predicting the entity’s future cash flows and, in particular, their timing and certainty.

 Components of a Complete Set of Financial Statements (a) (b) (c) (d)

A statement of financial position as at the end of the period; A statement of comprehensive income for the period; A statement of changes in equity for the period; A statement of cash flows for the period; Page 14 of 24

Notes, comprising a summary of significant accounting policies and other explanatory information; and (f) A statement of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements. (e)

An entity may use titles for the statements other than those used in this Standard. An entity shall present with equal prominence all of the financial statements in a complete set of financial statements.

 General Features of FS •

Fair presentation and compliance with IFRSs: Financial statements shall present fairly the financial position, financial performance and cash flows of an entity. Fair presentation requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework. The application of IFRSs, with additional disclosure when necessary, is presumed to result in financial statements that achieve a fair presentation.

•

Explicit Compliance: An entity whose financial statements comply with IFRSs shall make an explicit and unreserved statement of such compliance in the notes. An entity shall not describe financial statements as complying with IFRSs unless they comply with all the requirements of IFRSs. An entity cannot rectify inappropriate accounting policies either by disclosure of the accounting policies used or by notes or explanatory material. In the extremely rare circumstances in which management concludes that compliance with a requirement in an IFRS would be so misleading that it would conflict with the objective of financial statements set out in the Framework, the entity shall depart from that requirement in the manner set out in this standard if the relevant regulatory framework requires, or otherwise does not prohibit, such a departure. When an entity departs from a requirement of an IFRS it shall disclose that management has concluded that the financial statements present fairly the entity’s financial position, financial performance and cash flows and it has complied with applicable IFRSs, except that it has departed from a particular requirement to achieve a fair presentation. The title of the IFRS from which the entity has departed, the nature of the departure, including the treatment that the IFRS would require, the reason why that treatment would be so misleading in the circumstances that it would conflict with the objective of financial statements set out in the Framework, and the treatment adopted.

•

Going concern: When preparing financial statements, management shall make an assessment of an entity’s ability to continue as a going concern. An entity shall prepare financial statements on a going concern basis unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. When management is aware, in making its assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, the entity shall disclose those uncertainties. When an entity does not prepare financial statements on a going concern basis, it shall disclose

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that fact, together with the basis on which it prepared the financial statements and the reason why the entity is not regarded as a going concern. •

Accrual basis of accounting: An entity shall prepare its financial statements, except for cash flow information, using the accrual basis of accounting.

•

Materiality and aggregation: An entity shall present separately each material class of similar items. An entity shall present separately items of a dissimilar nature or function unless they are immaterial.

•

Offsetting: An entity shall not offset assets and liabilities or income and expenses, unless required or permitted by an IFRS.

•

Frequency of reporting: An entity shall present a complete set of financial statements (including comparative information) at least annually. When an entity changes the end of its reporting period and presents financial statements for a period longer or shorter than one year, an entity shall disclose, in addition to the period covered by the financial statements: I. II.

the reason for using a longer or shorter period, and the fact that amounts presented in the financial statements are not entirely comparable.

•

Comparative information: Except when IFRSs permit or require otherwise, an entity shall disclose comparative information in respect of the previous period for all amounts reported in the current period’s financial statements. An entity shall include comparative information for narrative and descriptive information when it is relevant to an understanding of the current period’s financial statements.

•

Reclassification: When the entity changes the presentation or classification of items in its financial statements, the entity shall reclassify comparative amounts unless reclassification is impracticable. When the entity reclassifies comparative amounts, the entity shall disclose: I. the nature of the reclassification; II. the amount of each item or class of items that is reclassified; and III. the reason for the reclassification. When it is impracticable to reclassify comparative amounts, an entity shall disclose the reason for not reclassifying the amounts, and the nature of the adjustments that would have been made if the amounts had been reclassified.

•

Consistency of presentation: An entity shall retain the presentation and classification of items in the financial statements from one period to the next unless: I.

•

it is apparent, following a significant change in the nature of the entity’s operations or a review of its financial statements, that another presentation or classification would be more appropriate having regard to the criteria for the selection and application of accounting policies in IAS 8; or

II. an IFRS requires a change in presentation. Structure and Content: This Standard requires particular disclosures in the statement of financial position or of comprehensive income, in the separate statement of comprehensive income (if presented), or in the statement of changes in equity and requires disclosure of other line items either in those statements or in the notes. IAS 7 Page 16 of 24

Statement of Cash Flows sets out requirements for the presentation of cash flow information. This Standard sometimes uses the term ‘disclosure’ in a broad sense, encompassing items presented in the financial statements. Disclosures are also required by other IFRSs. Unless specified to the contrary elsewhere in this Standard or in another IFRS, such disclosures may be made in the financial statements. • Identification of the FSs: An entity shall clearly identify the financial statements and distinguish them from other information in the same published document. An entity shall clearly identify each financial statement and the notes. In addition, an entity shall display the following information prominently, and repeat it when necessary for the information presented to be understandable: I. the name of the reporting entity or other means of identification, and any change in that information from the end of the preceding reporting period; II. whether the financial statements are of an individual entity or a group of entities; III. the date of the end of the reporting period or the period covered by the set of financial statements or notes; IV. the presentation currency; and V. the level of rounding used in presenting amounts in the financial statements. •

Statement of Financial Position: As a minimum, the statement of financial position shall include line items that include property, plant and equipment; investment property; intangible assets; financial assets; inventories; trade and other receivables; cash and cash equivalents; trade and other payables; provisions; financial liabilities; liabilities and assets for current tax; deferred tax liabilities and deferred tax assets; non-controlling interest, presented within equity; and issued capital and reserves attributable to owners of the parent. An entity shall present additional line items, headings and subtotals in the statement of financial position when such presentation is relevant to an understanding of the entity’s financial position. When an entity presents current and non-current assets, and current and non-current liabilities, as separate classifications in its statement of financial position, it shall not classify deferred tax assets (liabilities) as current assets (liabilities).

•

Information to be presented either in the statement of financial position or in the notes: An entity shall disclose, either in the statement of financial position or in the notes, further sub-classifications of the line items presented, classified in a manner appropriate to the entity’s operations.

•

Information regarding Share Capital: An entity shall disclose either in the statement of financial position or the statement of changes in equity, or in the notes for each class of share capital. A description of the nature and purpose of each reserve within equity should be disclosed. I. the number of shares authorized; II. the number of shares issued and fully paid, and issued but not fully paid; III. par value per share, or that the shares have no par value; IV. a reconciliation of the number of shares outstanding at the beginning and at the V. end of the period; VI. the rights, preferences and restrictions attaching to that class including restrictions on the distribution of dividends and the repayment of capital; VII. shares in the entity held by the entity or by its subsidiaries or associates; and

Page 17 of 24

VIII. shares reserved for issue under options and contracts for the sale of shares, including terms and amounts; and An entity without share capital, such as a partnership or trust, shall disclose information equivalent showing changes during the period in each category of equity interest, and the rights, preferences and restrictions attaching to each category of equity interest. • Statement of Comprehensive Income: An entity shall present all items of income and expense recognized in a period in a single statement of comprehensive income, or in two statements: a statement displaying components of profit or loss (separate statement of comprehensive income) and a second statement beginning with profit or loss and displaying components of other comprehensive income (statement of comprehensive income). Information to be presented in the statement of comprehensive income or in the notes. When items of income or expense are material, an entity shall disclose their nature and amount separately. •

Profit or loss for the period: An entity shall recognize all items of income and expense in a period in profit or loss unless an IFRS requires or permits otherwise. An entity shall present an analysis of expenses recognized in profit or loss using a classification based on either their nature or their function within the entity, whichever provides information that is reliable and more relevant. An entity classifying expenses by function shall disclose additional information on the nature of expenses, including depreciation and amortization expense and employee benefits expense.

•

Other comprehensive income for the period: An entity shall disclose the amount of income tax relating to each component of other comprehensive income, including reclassification adjustments, either in the statement of comprehensive income or in the notes. An entity may present components of other comprehensive income either net of related tax effects, or before related tax effects with one amount shown for the aggregate amount of income tax relating to those components.

•

Statement of Changes in Equity: An entity shall present a statement of changes in equity. The statement of changes in equity includes the information: I. total comprehensive income for the period, showing separately the total amounts attributable to owners of the parent and to non-controlling interest; II. for each component of equity, the effects of retrospective application or retrospective restatement recognized in accordance with IAS 8; and III. for each component of equity, a reconciliation between the carrying amount at the beginning and the end of the period, separately disclosing changes resulting from:  profit or loss;  other comprehensive income; and  transactions with owners in their capacity as owners, showing separately contributions by and distributions to owners and changes in ownership interests in subsidiaries that do not result in a loss of control. IV. An entity shall present, either in the statement of changes in equity or in the notes, the amounts of dividends recognized as distributions to owners during the period, and the related amount of dividends per share.

Page 18 of 24

•

•

Statement of Cash Flows: Cash flow information provides users of financial statements with a basis to assess the ability of the entity to generate cash and cash equivalents and the needs of the entity to utilize those cash flows. IAS 7 sets out requirements for the presentation and disclosure of cash flow information. Notes to the FS: An entity shall, as far as practicable, present notes in a systematic manner. An entity shall cross reference each item in the statements of financial position and of comprehensive income, in the separate statement of comprehensive income (if presented), and in the statements of changes in equity and of cash flows to any related information in the notes. I. II. III.

information about the basis of preparation of the financial statements and the specific accounting policies used; information required by IFRSs that is not presented elsewhere in the financial statements; and information that is not presented elsewhere in the financial statements, but is relevant to an understanding of any of them.

An entity normally presents notes to assist users to understand the financial statements and to compare them with financial statements of other entities: IV. V. VI.

VII.

statement of compliance with IFRSs; summary of significant accounting policies applied; supporting information for items presented in the statements of financial position and of comprehensive income, in the separate statement of comprehensive income (if presented), and in the statements of changes in equity and of cash flows, in the order in which each statement and each line item is presented; and other disclosures, including contingent liabilities and unrecognized contractual commitments, and non-financial disclosures, eg the entity’s financial risk management objectives and policies.

•

Sources of Estimation Uncertainty: An entity shall disclose information about the assumptions it makes about the future, and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. In respect of those assets and liabilities, the notes shall include details of their nature, and their carrying amount as at the end of the reporting period.

•

Other Disclosures: An entity shall disclose in the notes the amount of dividends proposed or declared before the financial statements were authorized for issue but not recognized as a distribution to owners during the period, and the related amount per share; and the amount of any cumulative preference dividends not recognized. An entity shall disclose the following, if not disclosed elsewhere in information published with the financial statements I.

II. III.

the domicile and legal form of the entity, its country of incorporation and the address of its registered office (or principal place of business, if different from the registered office); a description of the nature of the entity’s operations and its principal activities; the name of the parent and the ultimate parent of the group; and if it is a limited life entity, information regarding the length of its life. Page 19 of 24

Page 20 of 24



IFRS 1: First-time Adoption of IFRSs The objective of this IFRS is to ensure that an entity’s first IFRS financial statements, and its interim financial reports for part of the period covered by those financial statements, contain high quality information that: (a) is transparent for users and comparable over all periods presented; (b) provides a suitable starting point for accounting in accordance with International Financial Reporting Standards (IFRSs); and (c) can be generated at a cost that does not exceed the benefits. An entity shall prepare and present an opening IFRS statement of financial position at the date of transition to IFRSs. This is the starting point for its accounting in accordance with IFRSs. An entity shall use the same accounting policies in its opening IFRS statement of financial position and throughout all periods presented in its first IFRS financial statements. Those accounting policies shall comply with each IFRS effective at the end of its first IFRS reporting period. In particular, the IFRS requires an entity to do the following in the opening IFRS statement of financial position that it prepares as a starting point for its accounting under IFRSs: (a) recognize all assets and liabilities whose recognition is required by IFRSs; (b) not recognize items as assets or liabilities if IFRSs do not permit such recognition; (c) reclassify items that it recognized in accordance with previous GAAP as one type of asset, liability or component of equity, but are a different type of asset, liability or component of equity in accordance with IFRSs; and (d) apply IFRSs in measuring all recognized assets and liabilities. The IFRS grants limited exemptions from these requirements in specified areas where the cost of complying with them would be likely to exceed the benefits to users of financial statements. The IFRS also prohibits retrospective application of IFRSs in some areas, particularly where retrospective application would require judgments by management about past conditions after the outcome of a particular transaction is already known. The IFRS requires disclosures that explain how the transition from previous GAAP to IFRSs affected the entity’s reported financial position, financial performance and cash flows. • Comparative Information: An entity’s first IFRS financial statements shall include at least three statements of financial position, two statements of profit or loss and other comprehensive income, two separate statements of profit or loss (if presented), two statements of cash flows and two statements of changes in equity and related notes, including comparative information for all statements presented. •

Explanation of Transition to IFRSs: An entity shall explain how the transition from previous GAAP to IFRSs affected its reported financial position, financial performance and cash flows.

•

Reconciliations: To comply with this IFRS, an entity’s first IFRS financial statements shall include: (a) reconciliations of its equity reported in accordance with previous GAAP to its equity in accordance with IFRSs for both of the following dates: o

the date of transition to IFRSs; and Page 21 of 24

o

the end of the latest period presented in the entity’s most recent annual financial statements in accordance with previous GAAP.

(b) a reconciliation to its total comprehensive income in accordance with IFRSs for the latest period in the entity’s most recent annual financial statements. The starting point for that reconciliation shall be total comprehensive income in accordance with previous GAAP for the same period or, if an entity did not report such a total, profit or loss under previous GAAP. (c) if the entity recognized or reversed any impairment losses for the first-time in preparing its opening IFRS statement of financial position, the disclosures that IAS 36 Impairment of Assets would have required if the entity had recognized those impairment losses or reversals in the period beginning with the date of transition to IFRSs. •

Definition of Terms used in IFRS

Date of transition to IFRSs: The beginning of the earliest period for which an entity presents full comparative information under IFRSs in its first IFRS financial statements. Deemed Cost: An amount used as a surrogate for cost or depreciated cost at a given date. Subsequent depreciation or amortization assumes that the entity had initially recognized the asset or liability at the given date and that its cost was equal to the deemed cost. Fair Value: Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. (See IFRS 13.) First IFRS Financial Statements: The first annual financial statements in which an entity adopts International Financial Reporting Standards (IFRSs), by an explicit and unreserved statement of compliance with IFRSs. First IFRS Reporting Period: The latest reporting period covered by an entity’s first IFRS financial statements. First-time Adopter: An entity that presents its first IFRS financial statements. International Financial Reporting Standards (IFRSs): Standards and Interpretations issued by the International Accounting Standards Board (IASB). They comprise: (a) International Financial Reporting Standards; (b) International Accounting Standards; (c) IFRIC Interpretations; and (d) SIC Interpretations. Opening IFRS Statement of Financial Position: An entity’s statement of financial position at the date of transition to IFRSs. Previous GAAP: The basis of accounting that a first-time adopter used immediately before adopting IFRSs.

Page 22 of 24



IAS 7: Statement of Cash Flows

The objective of this Standard is to require the provision of information about the historical changes in cash and cash equivalents of an entity by means of a statement of cash flows which classifies cash flows during the period from operating, investing and financing activities. Cash flows are inflows and outflows of cash and cash equivalents. Cash comprises cash on hand and demand deposits. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. Information about the cash flows of an entity is useful in providing users of financial statements with a basis to assess the ability of the entity to generate cash and cash equivalents and the needs of the entity to utilize those cash flows. The economic decisions that are taken by users require an evaluation of the ability of an entity to generate cash and cash equivalents and the timing and certainty of their generation. The statement of cash flows shall report cash flows during the period classified by operating, investing and financing activities. A. Operating activities Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities. Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the entity. Therefore, they generally result from the transactions and other events that enter into the determination of profit or loss. The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the entity have generated sufficient cash flows to repay loans, maintain the operating capability of the entity, pay dividends and make new investments without recourse to external sources of financing. An entity shall report cash flows from operating activities using either: (a) the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or (b) the indirect method, whereby profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows. Examples of cash flows from operating activities are: (a) cash receipts from the sale of goods and the rendering of services; (b) cash receipts from royalties, fees, commissions and other revenue; (c) cash payments to suppliers for goods and services; (d) cash payments to and on behalf of employees; (e) cash receipts and cash payments of an insurance entity for premiums and claims, annuities and other policy benefits; (f) cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities; and (g) cash receipts and payments from contracts held for dealing or trading purposes.

Page 23 of 24

B. Investing activities Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expenditures have been made for resources intended to generate future income and cash flows. The aggregate cash flows arising from obtaining and losing control of subsidiaries or other businesses shall be presented separately and classified as investing activities. Examples of cash flows arising from investing activities are: (a) cash payments to acquire property, plant and equipment, intangibles and other longterm assets. These payments include those relating to capitalised development costs and self-constructed property, plant and equipment; (b) cash receipts from sales of property, plant and equipment, intangibles and other longterm assets; (c) cash payments to acquire equity or debt instruments of other entities and interests in joint ventures (other than payments for those instruments considered to be cash equivalents or those held for dealing or trading purposes); (d) cash receipts from sales of equity or debt instruments of other entities and interests in joint ventures (other than receipts for those instruments considered to be cash equivalents and those held for dealing or trading purposes); (e) cash advances and loans made to other parties (other than advances and loans made by a financial institution); (f) cash receipts from the repayment of advances and loans made to other parties (other than advances and loans of a financial institution); (g) cash payments for futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities; and (h) cash receipts from futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the receipts are classified as financing activities. A. Financing activities Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity. The separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of capital to the entity. An entity shall report separately major classes of gross cash receipts and gross cash payments arising from investing and financing activities. Examples of cash flows arising from financing activities are: (a) cash proceeds from issuing shares or other equity instruments; (b) cash payments to owners to acquire or redeem the entity’s shares; (c) cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short or long-term borrowings; (d) cash repayments of amounts borrowed; and (e) cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease.

Page 24 of 24

Non-cash transactions Investing and financing transactions that do not require the use of cash or cash equivalents shall be excluded from a statement of cash flows. Such transactions shall be disclosed elsewhere in the financial statements in a way that provides all the relevant information about these investing and financing activities. Foreign currency cash flows Cash flows arising from transactions in a foreign currency shall be recorded in an entity’s functional currency by applying to the foreign currency amount the exchange rate between the functional currency and the foreign currency at the date of the cash flow. The cash flows of a foreign subsidiary shall be translated at the exchange rates between the functional currency and the foreign currency at the dates of the cash flows. Unrealized gains and losses arising from changes in foreign currency exchange rates are not cash flows. However, the effect of exchange rate changes on cash and cash equivalents held or due in a foreign currency is reported in the statement of cash flows in order to reconcile cash and cash equivalents at the beginning and the end of the period. Cash and cash equivalents An entity shall disclose the components of cash and cash equivalents and shall present a reconciliation of the amounts in its statement of cash flows with the equivalent items reported in the statement of financial position. An entity shall disclose, together with a commentary by management, the amount of significant cash and cash equivalent balances held by the entity that are not available for use by the group. Interest and dividends Cash flows from interest and dividends received and paid shall each be disclosed separately. Each shall be classified in a consistent manner from period to period as either operating, investing or financing activities. b) The total amount of interest paid during a period is disclosed in the cash flows statement whether it has been recognized as an expense in profit or loss or capitalized as Borrowing Costs. c) Interest paid and interest and dividends received are usually classified as operating cash flows for a financial institution. However, there is no consensus on the classification of these cash flows for other entities. Interest paid and interest and dividends received may be classified as operating cash flows because they enter into the determination of profit or loss. Alternatively, interest paid and interest and dividends received may be classified as financing cash flows and investing cash flows respectively, because they are costs of obtaining financial resources or returns on investments. d) Dividends paid may be classified as a financing cash flow because they are a cost of obtaining financial resources. Alternatively, dividends paid may be classified as a component of cash flows from operating activities in order to assist users to determine the ability of an entity to pay dividends out of operating cash flows. a)

Page 25 of 24

 Reference Bangladesh Bank (BB). (2003), Circular, BRPD Circular No. 14, dated June 25, 2003. Bangladesh Bank (BB). (2009), Circular, BRPD Circular No. 15, dated November 09, 2009 Bangladesh Bank (BB). (2009b), Circular, DFIM Circular No. 11, dated December 23, 2009. Bangladesh Securities and Exchange Commission (BSEC). (2012), Notification, No. SEC/CMRRCD/2006-158/134/Admin/44, dated August 07, 2012. Bangladesh Securities and Exchange Commission (BSEC). (2013), Annual Report 2012-2013, BSEC, Dhaka. Dhaka Stock Exchange (DSE) (1996), Listing Regulations of the Dhaka Stock Exchange Limited, Notification No. SEC/Member-II, dated April 8, 1996. Financial Accounting Foundation (FAF). (2014), “About the Codification”, FASB Accounting Standards Codification, v. 4.9, available at www.fasb.org. www.aaoifi.com, website of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), cited on June 30, 2014. www.bangladesh-bank.org, website of Bangladesh Bank (BB), cited on June 30, 2014. www.bfid.gov.bd, website of the Bank and Financial Institutions Division of Ministry of Finance (MoF), Government of the People's Republic of Bangladesh, cited on June 30, 2014. www.bis.org, website of the Bank for International Settlements (BIS), accessed on June 30, 2014. www.cse.com.bd, website of the Chittagong Stock Exchange (CSE), accessed on June 30, 2014. www.dsebd.org, website of the Dhaka Stock Exchange (DSE), accessed on June 30, 2014. www.esafa.org, website of the South Asian Federation of Accountants (SAFA), accessed on June 30, 2014. www.fasb.org, website of the Financial Accounting Standards Board (FASB), accessed on June 30, 2014. www.icab.org.bd, of the Institute of Chartered Accountants of Bangladesh (ICAB, accessed on June 30, 2014. www.icmab.org.bd, website of the Institute of Cost and Management Accountants of Bangladesh (ICMAB), accessed on June 30, 2014. www.idra.org.bd, website of Insurance Development & Regulatory Authority Bangladesh (IDRA), accessed on June 30, 2014. www.ifac.org, website of the International Federation of Accountants (IFAC), accessed on June 30, 2014. www.ifrs.org, website of the IFRS Foundation, accessed on July 22, 2014. www.ifsb.org, website of the Islamic Financial Services Board (IFSB), accessed on June 30, 2014. www.mincom.gov.bd, website of the Ministry of Commerce (MoC), Government of the People’s Republic of Bangladesh, accessed on June 30, 2014. www.mra.gov.bd, website of the Microcredit Regulatory Authority (MRA), accessed on June 30, 2014. www.roc.gov.bd, website of the Registrar of Joint Stock Companies and Firms (RJSC), accessed on June 30, 2014. www.sec.gov.bd, website of the Bangladesh Securities and Exchange Commission (BSEC), accessed on June 30, 2014. website of IFSB, cited on February 19, 2013 at 4.35 pm

Page 26 of 24

SHEET 3 Preparation of Worksheet  Md. Mahabbat Hossain Faculty Member, BIBM Phone: 01716373565 Email: [email protected]

 Worksheet A worksheet is a multiple column form that may be used in the adjustment process and in preparing  financial statements. As its name suggests, the worksheet is a working tool. A work sheet is not a  permanent accounting record; it is neither a journal nor a part of the general ledger. The worksheet is  merely a device used to make it easier to prepare adjusting entries and the financial statements. The  use of worksheet is optional.

 Steps in Preparing Worksheet  1.

Prepare a Trial Balance on the Work Sheet

2.

Enter the adjustments in the Adjustments columns

3.

Enter adjusted balances in the Adjusted Trial Balance columns

4.

Extend adjusted trial balance amounts to appropriate Financial Statement columns

5.

Total the statement columns, compute the Net Income or Net Loss

Work Sheet Accounts  Titles

Trial Balance Dr.













Cr.

Adjustments Dr.

Cr.

1. Prepare 

2. Enter the 

Trial 

adjustments 

Balance 

in the 

on the Work 

Adjustments 

Sheet

columns

Adjusted 

Income 

Trial Balance

Statement

Dr.

Cr.

3. Enter adjusted  balances in the  Adjusted Trial  Balance columns

Dr.

Balance Sheet

Cr.

Dr.

Cr.

4. Extend adjusted  trial balance amounts  to appropriate  Financial Statement  columns Page 1 of 11

5. Total the statement  columns, compute the  Net Income or Net Loss

Page 2 of 11

 Problem 1  The following is the trial balance of Pioneer Advertising Agency on October 31, 2011 Pioneer Advertising Agency Trial Balance October 31, 2011 Accounts  Accounts Title No. 1 Cash 2 Advertising supplies 3 Prepaid Insurance 4 Office Equipment 5 Notes Payable 6 Accounts Payable 7 Unearned Revenue 8 Capital 9 Drawing 10 Service Revenue 11 Salaries Expense 12 Rent Expense Total

 Debit   Credit   Taka  Taka       15,200        2,500           600        5,000          5,000          2,500          1,200        10,000           500        10,000        4,000           900       28,700        28,700 

An analysis of the accounts shows the following adjustment 1. Advertising supplies on hand at October 31 total Tk.1000 2. Expired Insurance for the month is Tk.50 3. Depreciation for the month is Tk.40 4. Unearned revenue in October total Tk.400 5. Advertising services provided but not billed at October 31, Tk.200 6. Interest accrued at October 31 is Tk.50 7. Accrued Salaries at October 31 are Tk.1200 Requirement 1.

P

repare a 10 column Work Sheet for the month of October, 2011 2.

P

repare an Income Statement for the month of October Page 3 of 11

3.

O

wners Equity Statement for the month of October 4.

P

repare a Balance Sheet as on October 31, 2011 5.

M

ake necessary adjusting entries and closing entries

Page 4 of 11

Req. 1 

   Pioneer Advertising Agency Work Sheet

For the month ended October 31, 2011 Account Titles

Trial Balance Dr.

Adjustments

Cr.

Cash Advertising Supplies

1500 2500

Prepaid Insurance Office Equipment

600 5000

Dr.

Dr.

(b) 50 5000 2500

Unearned Revenue Capital

1200 10000 500

Cr. (a) 1500

Notes Payable Accounts Payable

Drawing Service Revenue

Adjusted  Trial Balance Cr.

(d) 400

Dr.

Cr.

Balance Sheet Dr.

Cr.

15200 1000

15200 1000

550 5000

550 5000

(d) 400

10000

Income Statement

500

5000 2500

5000 2500

800 10000

800 10000

10600

10600

500

(e) 200 Salaries Expenses Rent Expenses

4000 900

(g) 1200

5200 900

5200 900

Advertising Supplies Exp.

(a) 1500

1500

1500

Insurance Expenses Accum. Dep. ­Equipment

(b) 50

50

50

28700

Depreciation Expenses Accounts Receivable  Interest Expenses Interest Payable

28700

(f) 50

Salaries Payable Totals Net Income Totals

(c) 40

(c) 40 (e) 200 (f) 50

50

(g) 1200 3440

40

40 200

3440

40

40

50

200

50

50

1200 30190

30190

1200 7740

10600

22450

19590

10600

22450

22450

2860 10600

2860

Page 5 of 11

Page 6 of 11

Req. 2

Pioneer Advertising Agency Income Statement For the month ended October 31, 2011 Revenues

Tk. 10600

Service Revenue

Expenses:

Salaries Expenses

Tk. 5200

Advertising Supplies Expenses 

1500

Rent Expenses

900

Insurance Expenses 

50

Interest Expenses

50

Depreciation Expenses 

40 7740

Total Expenses

Tk. 2860

Net Income

Req. 3

Pioneer Advertising Agency Owner’s Equity Statement For the month ended October 31, 2011 Capital, October 1, 2004  Add: Net Income

Tk. 10000 2860 12860

Less: Drawings Capital, October 31, 2004

500 Tk. 12360

Page 7 of 11

Req. 4

Pioneer Advertising Agency  Balance Sheet October 31, 2011 Assets Cash

Tk. 15200

Accounts Receivable

200

Advertising 

1000

Prepaid Insurance 

550

Office Equipment

5000

Less: Accumulated Depreciation

40 4960

Total Assets

Tk.21910 Liabilities and Owner’s Equity

Liabilities Notes Payable Accounts Payable Interest Payable Unearned Revenue  Salaries Payable Owner’s Equity  Capital  Total Liabilities and Owner’s Equity

Tk. 5000 2500 50 800 1200 9550 12360 Tk.21910

Req. 5 Adjusting Entries Closing Entries

Page 8 of 11

Problem 2 Han Solo started his own consulting firm, Solo Company, on June 1, 2002. The Trial balance at June  30 is as follows.

Solo Company Trial Balance June 30, 2002

Accounts 

Accounts Title

No.

Debit

Credit

Taka

Taka

01

Cash

7750

02

Account Receivable

6000

03

Prepaid Insurance

2400

04

Supplies 

2000

05

Office Equipment

06

Accounts Payable

4500

07

Unearned Service Revenue

4000

08

Capital

09

Service Revenue

10

Salaries Expenses

4000

11

Rent Expensed

1000

Total

15000

21750 7900

Tk. 38150

Tk. 38150

Other Data: 1. Supplies on hand on June 30 are Tk. 1300. 2. A Utility bill for Tk. 150 has not been recorded and will not be paid until next month 3. The insurance policy is for a year 4. Tk. 2500 of unearned service revenue has been earned at the end of the  month 5. Salaries of Tk. 1500 are accrued at June 30 6. The office equipment has a 5­year life with no salvage value.  7. Invoice representing Tk. 3000 of service performed during the month have not been recorded  as of June 30

Page 9 of 11

Instructions 1.

P

repare a 10 column Work Sheet for the month of June 2.

P

repare an Income Statement for the month of June 3.

O

wners Equity Statement for the month of June 4.

P

repare a Balance Sheet as on June 30, 2002

Page 10 of 11

 Problem 3 Muddy River Resort opened for business on June 1 with eight air­conditioned units. Its trial balance  before adjustment on August 31 is as follows Muddy River Resort Trial Balance August 31, 2002 Accounts 

Accounts Title

No.

Debit

Credit

Taka

Taka

01

Cash

02

Supplies

3300

03

Prepaid Insurance

6000

04

Land

05

Cottage

125000

06

Furniture

26000

07

Accounts Payable

6500

08

Unearned Revenue

7400

09

Mortgage Payable

80000

10

P.Jovorek, Capital

100000

11

P.Javorek, Drawing

12

Rent Revenue

13

Repair Expense

3600

14

Salaries Expense

51000

15

Utilities Expense

9400

Total

19600

25000

5000 80000

Tk. 273900

Tk. 273900

Other Data 1. Insurance expired at the rate of Tk. 400 per month 2. A count on August 31 shows Tk. 900 of supplies on hand 3. Annual Depreciation is Tk. 4800 on cottages and Tk. 2400 on furniture 4. Unearned rent of Tk. 5100 was earned prior on to August 31 5. Salaries of Tk. 400 were unpaid at August 31 6. Rentals of Tk. 800 were due from tenants at August 31 (Use Accounts Receivable) 7. The mortgage interest rate is 12% per year. The mortgage was taken out on August 1 Page 11 of 11

Requirement 1.

Prepare a ten­column work sheet

2.

P

repare an Income Statement for the quarter  3.

Owners Equity Statement for the quarter

Page 12 of 11

 Problem 4 Julie Brown started her own consulting firm, Astromech Consulting, on May 1 2002. The trial balance at  May 31 is as follows Astromech Consulting Trial Balance May 31, 2002 Accounts 

Accounts Title

No.

Debit

Credit

Taka

Taka

101

Cash

6500

102

Accounts Receivable

4000

103

Supplies

1500

104

Prepaid Insurance

3600

205

Office Furniture

306

Accounts Payable

3500

307

Unearned Service Revenue

3000

408

Service Revenue

6000

309

Capital

510

Salaries Expense

3000

511

Rent Expense

1000

Total

12000

19100

Tk. 31600

Tk. 31600

Other Data 1. Tk. 500 of supplies have been used during the month 2. Travel Expense incurred but not paid on May 31, 2001, Tk. 200 3. The insurance policy is for 2 years 4. Tk. 1000 of the balance in the unearned service revenue account remains unearned at the end of  the month 5. Salaries was paid for two months 6. The office furniture has a 5­year fife with no salvage value 7. Invoice representing Tk. 2000 of services performed during the month have not been recording as  of May 31

Page 13 of 11

Requirement 1.

P

repare a 10 column Work Sheet for the month of May 2.

P

repare an Income Statement for the month of May 3. Prepare a Balance Sheet as on May 31, 2002

Page 14 of 11

 Problem 5 The Roach Motel opened for business on May 1, 2002. Its trial balance before adjustment on May 31 is  as follows Roach Motel Trial Balance May 31, 2002 Accounts 

Accounts Title

No.

Debit

Credit

Taka

Taka

101

Cash

2500

102

Supplies

1900

103

Prepaid Insurance

2400

204

Land

15000

205

Lodge

70000

206

Furniture

16800

307

Accounts Payable

5300

308

Unearned Rent

3600

409

Mortgage Payable

35000

410

Capital

60000

501

Rent Revenue

602

Advertising

603

Salaries Expense

3000

604

Utilities Expense

1000

Total

9200 500

Tk. 113100

Tk. 113100

Other Data 1. Insurance expires at the rate of Tk. 200 per month 2. A count of supplies shows Tk. 900 of unused supplies on May 31 3. Annual depreciation is Tk. 3600 on the lodge and Tk. 3000 on furniture  4. The mortgage interest rate is Tk. 12%. (The mortgage was taken out on May  15) 5. Unearned rent of Tk. 1500 has been earned 6. Salaries of Tk. 300 are accrued and unpaid at May 31

Page 15 of 11

Requirement Prepare a ten­column work sheet

Page 16 of 11

 Problem 6  The following is the trial balance of Ruposh Ad. Co. on October 31, 2004 Ruposh Ad. Co. Trial Balance October 31, 2004 Accounts Title

Debit

Credit

Taka

Taka

Cash in hand

11000

Account Receivable

6020

Office supplies

1050

Prepaid Insurance

2400

Office Equipment

40000

Notes Payable

12000

Accounts Payable

13350

Capital

27000

Drawing

600

Service Revenue

13620

Salaries Expenses

2100

Travel Expenses

1400

Rent Expense

1100

Miscellaneous Expenses Total

300 Tk. 65970

Tk. 65970

An analysis of the accounts shows the following adjustment 1. Supplies on hand at the end of the month Tk. 550 2. Salaries was paid for 1.5 months 3. Interest accrued on notes payable Tk. 500 4. Prepaid insurance was remain Tk. 1500 5. Service provided on credit  Tk. 340, which was not recorded 6. Charge depreciation on equipment @ 15%

Page 17 of 11

Requirement 1.

Prepare a ten­column work sheet

2.

Give necessary adjusting entries

3.

Make Closing entries to close all temporary accounts

Page 18 of 11

 Problem 7 Mr. M Rahman started his own repairing shop, OVERNIGHT AUTO SERVICE, on July 1 2005. The trial  balance at July 31 is as follows: OVERNIGHT AUTO SERVICE Trial Balance July 31, 2005 Accounts Title

Debit

Credit

Taka

Taka

Cash

8900

Accounts Receivable

4100

Shop Supplies

1500

Unexpired Insurance

3600

Furniture

13000

Wages Expenses

3500

Utilities Expenses

1500

Drawing

1000

Accounts Payable

5000

Unearned Revenue

3000

Capital

22100

Service Revenue Total

7000 37100

37100

Additional Information: a)

A count of supplies shows Tk. 900 of unused supplies on July 31.

b)  

Travel Expense on account Tk. 200 is not yet recorded.

c)  

Insurance policy is for 3 years.

d) 

The furniture has a 5­year life with salvage value Tk. 1000

e) 

Invoices representing Tk. 1500 of service performed during the month have not been  recorded as of July 31.

Instructions: 1.

P

repare a 10 column Work Sheet for the month of July 2.

P

repare an Income Statement for the month of July Page 19 of 11

3.

O

wners Equity Statement 4.

P

repare a Balance Sheet

Page 20 of 11

Sheet 4 ACCOUNTING FOR PLANT ASSETS AND DEPRECIATION Md. Mahabbat Hossain Faculty Member, BIBM Phone: 01716 – 37 35 65 Email: [email protected]  Plant assets (Three Characteristics) 1. Have physical substance (a definite size and shape) 2. Used in the operations of a business  3. Not intended for sale to customers   

Plant assets are subdivided into four classes:  

1. Land 2. Land Improvements 3. Buildings 4. Equipment

 Cost of Plant Assets 

Plant assets are recorded at cost in accordance with the cost principle. 



Cost consists of all expenditures necessary to acquire the asset and make it ready for its  intended use



Cost includes purchase price, freight costs, and installation costs.



Expenditures that are not necessary recorded as expenses, losses, or other assets

 The cost of land includes: 

Cash purchase price



Closing costs such as title and attorney’s fees



Real estate brokers’ commissions





Accrued property taxes and other liens on the land assumed by the purchaser. 

All necessary costs incurred to make land ready for its intended use are debited to the Land  account.

Page 1 of 6

Sometimes purchased land has a building on it that must be removed before construction of a new  building.  In this case, all demolition and removal costs, less any proceeds from salvaged materials are  debited to the Land account Land Cash price of property

 100,000

Net removal cost of warehouse

6,000

Attorney’s fee

1,000

Real estate broker’s commission

8,000

Cost of land

 115,000

Page 2 of 6

 Land Improvements The cost of land improvements includes all expenditures needed to make the improvements ready  for their intended use such as: 

Parking lots



Fencing



Lighting

 Cost of Buildings 

The cost includes all necessary expenditures relating to the purchase or construction of a  building



The costs include the purchase price, closing costs, and broker’s commission



Costs to make the building ready for its intended use include o expenditures for remodeling and replacing or o repairing the roof, floors, wiring, and plumbing



If a new building is constructed, costs include contract price plus payments for architects’ fees,  building permits, interest payments during construction, and excavation costs

 Cost of Equipment 

Cost of equipment consists of the cash purchase price and certain related costs.



Costs include sales taxes, freight charges, and insurance paid by the purchaser during transit.



Cost includes all expenditures required in assembling, installing, and testing the unit.



Recurring costs such as licenses and insurance are expensed as incurred. Factory Machinery Cash price

 50,000

Sales taxes

3,000

Insurance during shipping

500

Installation and testing

1,000

Cost of factory machinery

Factory Machinery       Cash 

 54,500

54,500 54,500

Cost of Delivery Truck Page 3 of 6

Motor vehicle licenses and accident insurance on company cars and trucks are expensed as  incurred, since they represent annual recurring events that do not benefit future periods. Delivery Truck Cash price

 2,200,000

Sales taxes

50,000

Painting and lettering

50,000

Cost of delivery truck

 2,300,000

Page 4 of 6

 Depreciation 

Depreciation is the allocation of the cost of a plant asset to expense over its useful (service) life  in a rational and systematic manner.



Cost allocation provides for the proper matching of expenses with revenues in accordance with  the matching principle.



Usefulness may decline because of wear and tear or obsolescence.



Depreciation does not result in an accumulation of cash for the replacement of the asset.



Land is the only plant asset that is not depreciated.

 Factors in Computing Depreciation 

Cost: All expenditures necessary to acquire the asset and make it ready for intended use 



Useful life: Estimate of the expected life based on need for repair, service life, and vulnerability  to obsolescence



Salvage value: Estimate of the asset’s value at the end of its useful life

 Depreciation Methods 

Straight­line 



Units of activity



Declining­balance and



Sum­of­the­Year­Digits Method

Each method is acceptable under GAAP.  Management selects the method that is appropriate in  the  circumstances. Once a method is chosen, it should be applied consistently. Uses of different  methods are  o Straight­line = 82% o Units of activity = 5% o Declining­balance = 4% o Other = 9%  Straight­Line Method 

Depreciation is the same for each year of the asset’s useful life.



It is measured solely by the passage of time.



It is necessary to determine depreciable cost.



Depreciable cost is the total amount subject to depreciation and is computed as follows: Cost of asset ­ salvage value Page 5 of 6

 Units­of­Activity 

Useful life = total units of production or total expected use expressed in hours, miles, units, etc.



Depreciation Cost per Unit = Depreciable Cost ÷ Total Units of Activity. 



Annual Depreciation Expense = Depreciation Cost per Unit x Units of Activity During the Year. 



It is often difficult to make a reasonable estimate of total activity.



When productivity varies from one period to another, this method results in the best matching  of expenses with revenues.

Page 6 of 6

 Declining­Balance 

Decreasing annual depreciation expense over the asset’s useful life.



Periodic depreciation is based on a declining book value (cost ­ accumulated depreciation)



To compute annual depreciation expense multiply the book value at the beginning of the year  by the declining­balance depreciation rate



Depreciation rate remains constant from  year to year but book value declines each year.



Book value for the first year is the cost of the asset. 



Balance in accumulated depreciation at the beginning of the asset’s useful life is zero



In subsequent years, book value is the difference between cost and accumulated depreciation  at the beginning of the year. 



Formula is Book Value at Beginning of Year x Declining Balance Rate = Annual Depreciation Expense



Method compatible with the matching principle because the higher depreciation in early years  is matched with the higher benefits received in these years.



Unlike the other depreciation methods, salvage value is  ignored in determining the amount to  which the declining balance rate is applied.  



A common application of the declining­balance method is the double­declining­balance  method, in which the declining­ balance rate is double the straight­line rate. 

 Office Equipment Data Compare the three depreciation methods, using the following data for office equipment purchased  by Badal on January 1, 2005. Cost

Tk. 13,000

Expected salvage value

Tk. 1,000

Estimated useful life in years

5

Estimated useful life in units

100,000

 Sum­of­the­Year­Digit 

The sum­of­the­year­digit method provides decreasing charges by applying a series of  fractions, each of a smaller value, to depreciable assets. Denominator for the fraction = 

n(n + 1)   2 Page 7 of 6

n = useful life of the assets 

Numerator for the fraction = Weight assigned to the specific year (remaining period the asset  will be used) 

 Revising Periodic Depreciation 

Changes should be made if excessive wear and tear or obsolescence indicates that annual  depreciation estimates are inadequate.



When a change is made no correction of previously recorded depreciation expense. Only the  depreciation expenses for current and future years are revised



To determine the new annual depreciation expense the depreciable cost at the time of the  revision is divided by the remaining useful life.

Page 8 of 6

Badal decides on January 1, 2008, to extend the useful life of the equipment one year because of  its excellent condition.  The company has used the straight­line method to depreciate the asset to  date, and book value is (Tk. 13,000 – Tk. 7,200 =  Tk. 5,800). The new annual depreciation will be; Book Value (1/1/2008)

Tk. 5,800

Less: Salvage Value

Tk. 1,000

Depreciable Cost

Tk. 4,800

Remaining useful life (2008­2010)

3 Years

Revised Annual Depreciation (Tk. 4,800/3) 

Tk. 1,600

Example

At the beginning of 2003, Belal & Co. acquired equipment costing Tk. 60,000. It was estimated that  this equipment would have a useful life of 6 years and a residual value of Tk. 6,000 at that time.  During 2005, the company’s engineers reconsidered their expectations, and estimated that the  equipment’s useful life would probably be 7 years instead of 6 years. The residual value was not  changed at that time. However, during 2008 the estimated residual value was reduced to Tk. 3,000.  How much depreciation expense should be recorded for this equipment each of the year under  straight­line method?  Expenditures During Useful Life   Ordinary repairs:   The expenditures to maintain the operating efficiency and productive life of the unit. Such  repairs are debited to Repairs Expense as incurred and are often referred to as revenue  expenditures. 

Capital expenditures: Additions and improvements increase the operating efficiency, productive capacity, or useful  life of a plant asset o Usually material in amount and occur  infrequently. o Increase the company’s investment in productive facilities.



Capital expenditure is debited the plant asset affected.

Exercise 1 Cost Price Salvage Value Useful Life Useful Life Activity Level (units)

940,000 45,000 5 Years 53,000 Units 2002 2003

2004

2005

2006 Page 9 of 6

13,000

12,500

12,000

9,500

6,000

Solution Depreciation Under Straight-line Method: Year Computation 2002 (Cost - SV) ÷ Useful Life 2003 (Cost - SV) ÷ Useful Life 2004 (Cost - SV) ÷ Useful Life 2005 (Cost - SV) ÷ Useful Life 2006 (Cost - SV) ÷ Useful Life Total Depreciation

Depreciation 179,000 179,000 179,000 179,000 179,000 895,000

Accu. Dep Book Value 179,000 761,000 358,000 582,000 537,000 403,000 716,000 224,000 895,000 45,000

Depreciation under Double-Declining-Balance Method: Depreciation Rate = (100% ÷ Useful Life) x 2 Year Computation Depreciation Accu. Dep Book Value 2002 940,000 40% 376,000 376000 564,000 2003 564,000 40% 225,600 601600 338,400 2004 338,400 40% 135,360 736960 203,040 2005 203,040 40% 81,216 818176 121,824 2006 121,824 76,824 895000 45,000 Total Depreciation 895,000 Depreciation under 150%-Declining-Balance Method: Depreciation Rate = (100% ÷ Useful Life) x 150% Year Computation Depreciation Accu. Dep Book Value 2002 940,000 30% 282,000 282000 658,000 2003 658,000 30% 197,400 479400 460,600 2004 460,600 30% 138,180 617580 322,420 2005 322,420 138,710 756290 183,710 2006 183,710 138,710 895000 45,000 Total Depreciation 895000 Depreciation Under Units-of-activity Method: Depreciation per unit = (Cost - SV) ÷ Total Units = Year Computation Depreciation 2002 13,000 16.88679245 219,528 2003 12,500 16.88679245 211,085 2004 12,000 16.88679245 202,642 2005 9,500 16.88679245 160,425 2006 6,000 16.88679245 101,321 Total Depreciation 895,000

16.89 Accu. Dep Book Value 219,528 720,472 430,613 509,387 633,255 306,745 793,679 146,321 895,000 45,000

Depreciation Under Sum-of-the-Year-Digit Method: Depreciable Value = (Cost Price - Salvage Value ) = 895000 Denominator = (n(n + 1)/2) = 15 Year Computation Depreciation Accu. Dep Book Value 2002 1/3 895000 298,333 298,333 641,667 2003 4/15 895000 238,667 537,000 403,000 2004 1/5 895000 179,000 716,000 224,000 2005 2/15 895000 119,333 835,333 104,667 2006 1/15 895000 59,667 895,000 45,000 Total Depreciation 895,000 Summary of Depreciation under different methods: Page 10 of 6

Straight-line Double-declining 150%-declining Unit-of-activity Sum-of-the-year-degit

2002 179,000 376,000 282,000 219,528 298,333

2003 179,000 225,600 197,400 211,085 238,667

2004 179,000 135,360 138,180 202,642 179,000

2005 179,000 81,216 138,710 160,425 119,333

2006 179,000 76,824 138,710 101,321 59,667

Page 11 of 6

Financial and Management Accounting (MBA 5103)

Chapter 05 ACCOUNTING FOR CURRENT ASSETS: INVENTORY

Md. Mahabbat Hossain Faculty Member BIBM February 26, 2012

1

INVENTORY BASICS • Balance sheet of merchandising and manufacturing companies – inventory is significant current asset

• Income statement – inventory is vital in determining results

• Gross profit – (net sales - cost of goods sold) • watched by management, owners, and others

February 26, 2012

2

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MERCHANDISE INVENTORY

Merchandise inventory 1. Owned by the company 2. In a form ready for sale

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MANUFACTURING INVENTORY • Manufacturing inventories – may not yet be ready for sale • Classified into three categories: 1. Finished goods ready for sale 2. Work in process various stages of production (not completed) 3. Raw materials components on hand waiting to be used February 26, 2012

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DETERMINING INVENTORY QUANTITIES To prepare financial statements determine 1. The number of units in inventory by taking a physical inventory of goods on hand

2. The ownership of goods

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DETERMINING COST OF INVENTORY 1. Apply unit costs to the total units on hand for each item 2. Total the cost of each item of inventory to determine total cost of goods on hand

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OWNERSHIP OF GOODS IN TRANSIT • Goods in transit: included in the inventory of the party that has legal title to the goods • FOB (Free on Board) shipping point: ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller • FOB destination point: legal title to the goods remains with the seller until the goods reach the buyer February 26, 2012

7

TERMS OF SALE

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CONSIGNED GOODS

Consignment: the holder of the goods (consignee) does not own the goods – ownership remains with the consignor of the goods until the goods are sold – consigned goods should be included in the consignor’s inventory, not the consignee’s inventory Owned by a consignor; do not count in consignee inventory February 26, 2012

9

Consignee Company

INVENTORY ACCOUNTING SYSTEMS 1. Perpetual • detailed records • cost of each item maintained • cost of each item sold is determined when sale occurs

2. Periodic • cost of goods sold is determined at the end of accounting period February 26, 2012

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INVENTORY VALUATION METHODS 1. Specific Identification Method 2. Assumed Cost Flow Methods 1. First-in, First-out (FIFO) 2. Last-in, First-out (LIFO) 3. Average Cost

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SPECIFIC IDENTIFICATION METHOD

• If each unit is unique • Best suited to Inventories of • high-priced, low-volume items

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SPECIFIC IDENTIFICATION METHOD

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FIFO • The FIFO method – earliest goods purchased are the first to be sold. – often parallels the actual physical flow of merchandise. – the costs of the earliest goods purchased are the first to be recognized as cost of goods sold.

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FIFO

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LIFO • The LIFO method assumes that the latest goods purchased are the first to be sold. • Under LIFO, the costs of the latest goods purchased are the first goods to be sold.

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LIFO

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AVERAGE COST • The average cost method – assumes goods available for sale are homogeneous. – the cost of goods available for sale is allocated on the basis of the weighted average unit cost incurred. – weighted average unit cost is applied to the units on hand to determine cost of the ending inventory.

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AVERAGE COST

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USE OF COST FLOW METHODS IN MAJOR U.S. COMPANIES Companies adopt different inventory cost flow methods for various reasons. Usually one of the following factors is involved: 1) income statement effects 2) balance sheet effects or 3) tax effects. 5% Other

21% Average Cost

44% FIFO

30% LIFO February 26, 2012

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USING INVENTORY COST FLOW METHODS CONSISTENTLY • Consistency – Companies needs to use its chosen cost flow method from one period to another. – Consistent application makes financial statements comparable over successive time periods. – If a company adopts a different cost flow method: • The change and its effects on net income must be disclosed in the financial statements February 26, 2012

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INVENTORY ERRORS - INCOME STATEMENT EFFECTS • both beginning and ending inventories appear on the income statement • ending inventory of one period automatically becomes the beginning inventory of the next period • inventory errors – affect the determination of cost of goods sold and net income

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EFFECTS OF INVENTORY ERRORS ON CURRENT YEAR’S INCOME STATEMENT

Cost of Goods Sold

Inventory Error

Understate beginning inventory Understated Overstate beginning inventory Overstated Understate ending inventory Overstated Overstate ending inventory Understated

Net Income Overstated Understated Understated Overstated

An error in ending inventory of the current period will have a reverse effect on net income of the next period. February 26, 2012

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ENDING INVENTORY ERROR BALANCE SHEET EFFECTS

Errors in the ending inventory have the following effects on these components: Ending Inventory Error

Overstated Understated

February 26, 2012

Assets

Liabilities

Overstated None Understated None

Owner’s Equity

Overstated Understated

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Page 12

INVENTORY DISCLOSURES • Inventory – classified as a current asset after receivables in the balance sheet

• Cost of goods sold – subtracted from sales in the income statement

• Disclosure either in the balance sheet or in accompanying notes for: 1 major inventory classifications 2 basis of accounting (cost or lower of cost or market) 3 costing method (FIFO, LIFO, or average cost)

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LCM – PERIODIC •

Value of inventory is lower than its cost – The inventory is written down to its market value

• •

Known as the lower of cost or market (LCM) method LCM basis – Market is defined as current replacement cost, not selling price

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COMPUTATION OF LOWER OF COST OR MARKET

Cost Television sets Consoles Portables Total Video equipment Recorders Movies Total Total inventory

Market

Lower of Cost or Market

60000 45000 105000

55000 52000 107000

55000 45000

48000 15000 63000 168000

45000 14000 59000 166000

45000 14000

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159000 27

SHRINKAGE LOSS - PERPETUAL Shrinkage Losses: • Theft • Spoilage • Breakage

Valuation: • LIFO • FIFO or • Average Cost

Recording Shrinkage Losses: • COGS A/c Dr. (if small amount) or • Inventory Shrinkage Losses Dr. (if material amount) February 26, 2012

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Page 14

EXERCISE March 1 March 10 March 15 March 20 March 25 March 30 March 31

Beginning Inventory Purchase Sale Purchase Sale Purchase Ending Inventory

200 Units 500 Units 500 Units 400 Units 400 Units 300 Units ?

@ Tk. 4 @ Tk. 4.50 ? @ Tk. 4.75 ? @ Tk. 5 ?

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EXERCISE 2 Date January 1, 2010

Particulars

Beginning Inventory January 10, 2010 Purchase February 20, 2010 Purchase February 28, 2010 Sales March 15, 2010 Purchase June 20, 2010 Purchase August 20, 2010 Sales September 30, 2010 Purchase December 10, 2010 Purchase December 30, 2010 Sales February 26, 2012

No. of Unit 1000 1500 2000 3000 1000 500 1500 2000 1200 4000

Rate per unit Amount (Tk.) (Tk.) 3.00 3000 4.00 5.00 6.00 4.50 3.00 5.50 3.50 4.50 5.00

6000 10000 18000 4500 1500 8250 7000 5400 20000 30

Page 15

THANKING YOU ALL Md. Mahabbat Hossain Faculty Member BIBM February 26, 2012

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Page 16

Sheet 6 FINANCIAL STATEMENTS: INCOME STATEMENT AND BALANCE SHEET Md. Mahabbat Hossain Faculty Member, BIBM Phone: 01716 – 37 35 65 Email: [email protected]

 Accounting  Accounting is an information system that identifies, records, and communicates the economic events of an  organization to interested users.  Financial Statements Financial Statements (FS) are the output of accounting system. Accounting communicates the financial  information to the interested users through FS. “General purpose financial statements are those intended to  meet the needs of users who are not in a position to demand reports tailored to meet their particular  information needs” (IAS 1, 2006, p. 691). FSs are a structured representation of the financial position and  financial performance of an entity. The objective of general purpose FSs is to provide information about the  financial position, financial performance and cash flows of an entity that is useful to a wide range of users in  making economic decisions. To meet this objective, FSs provide information about an entity’s: (a) Assets,  (b) Liabilities (c) Equity (d) Income and Expenses, including gains and losses (e) Other changes in Equity

(f) Liquidity of assets and liabilities (for banks) and  (g) Cash Flows  Components of Financial Statements (FSs)  After transactions are identified, recorded and summarized, a set of FSs are prepared from the summarized  accounting data. A complete set of FSs comprises: (a) A Balance Sheet Page 1 of 13

(b) An Income Statement (c) A Statement of Changes in Equity showing (d) A Cash Flow Statement (e)

Liquidity Statements (for banks) and

(f) Notes, comprising a summary of significant accounting policies and other explanatory notes. Note: The Income Statement, Statement of Change in Equity, and Cash Flows Statement are all for a   period of time, whereas the Balance Sheet is for a point in time.

Page 2 of 13

 Nature of Companies and Concern Laws Nature of Company

Primary Law

1. Non­financial companies

Companies Act 1994

2. Banking Financial Institutions (BFIs)

Bank Companies Act 1991

3. Non­Banking Financial Institutions (NBFIs)

Financial Institutions Act 1993

4. Insurance Company

Insurance Act 2010

5. Micro­Finance Institution

MRA Rules 2010

Additional laws and regulations for listed companies 1. Securities and Exchange Ordinance 1969 2. Securities and Exchange Rules 1987 3. International Accounting Standards 4. International Financial Reporting Standard 5. Bangladesh Accounting Standard 6. Bangladesh Financial Reporting Standard 7. The Listing Regulations of DSE/CSE  Nature of Companies and Regulators Nature of Company Non­financial companies

Regulatory Authority The   Registrar   of   Joint   Stock   Companies   and   Firms  (RJSC)

Banking Financial Institutions (BFIs)

Bangladesh Bank (BB)

Non­Banking Financial Institutions (NBFIs)

Bangladesh Bank (BB)

Insurance Company

Insurance Development & Regulatory Authority (IDRA)

Listed Companies

Securities and Exchange Commission (SEC)

Micro­Finance Institution

Micro­credit Regulatory Authority (MRA)

Page 3 of 13

 Income Statement  An Income Statement presents the revenues  and  expenses  and resulting  net income  or  net loss  for a  specific period of time. The Income Statement is sometimes referred to as the Statement of Operations,  Earnings Statement or profit and Loss Statement. There are two format of Income Statement; 1. Single Step Income Statement 2. Multiple­Step Income Statement  Single Step Income Statement  ABC Co. Ltd.

Income Statement (Single Step) For the year ended 31st December. 200X Particulars

Taka

Income :

Net sales/service income 

***

Gain on Sales of Equipment

***

Interest Income

***

Dividend Income

***

Commission Income

***

Miscellaneous Income

***

Taka

***

 Total Income Expenses :

Cost of goods sold

***

Selling expenses

***

Operating expenses 

***

Financial expenses

***

Accidental loss

***

 Total Expenses

***

Net Income

***

 Multiple­Step Income Statement  ABC Co. Ltd.

Income Statement (Multiple Steps) For the year ended December 31, 200X

Page 4 of 13

Sales

****

Cost of Goods Sold

****

Gross Profit

****

Operating Expenses  Salaries Expense 

****

Depreciation Expense 

****

Miscellaneous General Expense 

****

Total Expenses 

****

Income from operation

****

Other Income and Expenses: Add: Interest Revenue

****

Less: Interest on notes payable

(***)

Net Income 

****

Calculation of Cost of Goods Sold (For Merchandising Concern) Beginning Merchandise Inventory

****

Purchases 

****

Add: Transportation­In

**** ****

Less: Purchase Returns 

****

Net Purchase

****

Cost of Goods Available for Sale

****

Less: Ending Merchandise Inventory

****

Total cost of Goods Sold

****

Cost of Goods Sold (For Manufacturing Concern) Beginning Raw Material

XXX

Add, Raw Material Purchase

XXX

Raw Material Available for use

XXX

Cost of Direct Material Used

XXX

Ending Raw Material Direct Labor Prime Cost

Factory Overhead

XXX XXX

XXX

XXX

Page 5 of 13

Total Manufacturing Cost

XXX

Total Goods in Process

XXX

Less: Ending Work­in­Process

XXX

Add: Beginning Work­in­Process

XXX

Cost of Goods Manufactured

XXX

Cost of Goods Available for Sale

XXX

Add: Beginning Finished Goods

XXX

Less: Ending Finished Goods

XXX

Cost of Good Sold

XXX

 Owner’s Equity Statement  An Owner’s Equity Statement summarizes the changes in owner’s equity for a specific period of time. ABC Co. Ltd. Owner’s Equity Statement

For the year Ended December 31, 200X Capital, January 1 Add: 

New Investments Net income

Tk. XXX Tk. XXX XXX XXX XXX

Less:  Drawings Capital, December 31

XXX  Tk. XXX

Page 6 of 13

 Balance Sheet Balance Sheet is a formal statement of assets, liabilities and owner’s equity of a specific date. Considering  the presentation, there are two types of Balance Sheet; 1.

Unclassified Balance Sheet  and  2.   Classified Balance Sheet

 Unclassified Balance Sheet ABC Co. Ltd. Balance Sheet (Unclassified) December 31, 200X Taka

Taka

Assets  

Cash

***

 Accounts Receivable

***

 Merchandise Inventory

***

 Prepaid expenses 

***

 Machinery

***

 Buildings

*** Total Assets

***

Liabilities  

Accounts Payable

***

 Notes payable 

***

 Mortgage Loan

***

Capital / Owner’s Equity

***

Total Liabilities

***

 Classified Balance Sheet ABC Co. Ltd. Balance Sheet (Classified) December 31, 200X Assets Current Assets

Taka

Cash

xxx

Accounts Receivable

Liabilities and Owner’s Equity Current Liabilities

Taka

Accounts Payable

xxx

xxx

Notes Payable

xxx

Inventory

xxx

Accrued Expenses 

xxx

Prepaid Expenses

xxx

Long­term Investments

Investment in Share/ Debenture

Long­term Liabilities Long­Term Notes Payable

xxx

Long­Term Bank Loan

Page 7 of 13

Property, plant and Equipment (Net)

Debenture Owner’s Equity

Land  & Building

xxx

Plant and Machinery

xxx

Capital

xxx

Furniture and Fixture

xxx

Retained Earnings

xxx

Reserve

xxx

Intangible Assets (Net) Goodwill

xxx

Trade Mark

xxx

Other Assets Non­current receivable

xxx

Preliminary 

xxx

Total Assets

xxx

Total Liabilities and Owner’s Equity

xxx

 Cash Flows Statement The statement of cash flows reports the cash receipts, cash payments, and net change in cash resulting  from the operating, investing, and financing activities of an enterprise during a particular period. Net Profit for the Current year

Add, Net Cash Provided by Operating Activities

XXX

Add, Net Cash Provided by Investing Activities

XXX

Add, Net Cash Provided by Financing Activities

XXX

XXX

XXX Net Change in Change Balance

XXX

Add, Cash at the beginning of the period

XXX

Cash at the end of the period

XXX

 Illustration Suppose,  you   are   given   an   adjusted   trial   balance   of  SOFTBYTE  of  Mr.  Nehal   Ahmed   at  the  end  of  accounting period. You are to prepare an income statement, owner’s equity statement and a balance sheet. Trial Balance

September 30, 2008

Page 8 of 13

SL

Accounts Title

Debit

Credit

01

Cash

8,050

02

Accounts Receivables

1,400

03

Office Supplies

1,600

04

Computer Equipment

7,000

05

Accounts Payable

06

Mr. R. Neal’s Capital

07

Mr. R. Neal’s Drawings

08

Service Revenue

09

Office Expenses

10

Advertising Expenses

1,600 15,000 1,300 4,700 1,700

Total

250 21,300

21,300

SOFTBYTE Income Statement

For the Month Ended September 30, 2008 Revenues    

Tk.4,700

Service revenue

Expenses

Office expenses Advertising expense

   Net income

Total expenses

Tk. 1,700 250 1,950 Tk.2,750

Page 9 of 13

SOFTBYTE Owner’s Equity Statement

For the Month Ended September 30, 2008 Capital, September 1 Add:

Tk.15,000

Net income

2,750

17,750 Less: Drawings

1,300

Capital, September 30

Tk.16,450 SOFTBYTE Balance Sheet

September 30, 2008 A. Assets Cash

Tk.8,050

Accounts receivable

1,400

Supplies

1,600

Equipment

7,000

Total assets

Tk.18,050

B. Liabilities and Owner’s Equity Liabilities    

Accounts payable

Tk.1,600

 

Owner’s equity

     

Total liabilities and owner’s equity

16,450 Tk.18,050

 Problem

The accounts and their balances in the M. Rahman Company ledger on December 31, 2008, the end of the  fiscal year, are as follows: Debit

Credit

Tk.

Tk.

Cash

 46000

Accounts Receivable & Accounts Payable

69000

Merchandise Inventory  Supplies  Prepaid Rent Equipment

61100

283000 7500 18000 160000

Page 10 of 13

Accumulated Depreciation, Equipment

19000

M Rahman, Capital and Drawing

129000

482000

Purchases and Sales

910000

1280000

Advertising Expense

32000

Salaries Expense Miscellaneous  Total

166000 21600 1842100

1842100

Adjustment Data (a)

Merchandise inventory as of December 31, Tk. 3,34,000 and supplies on hand, Tk. 2,500

(b)

Depreciation for the period, Tk. 6,000 and 

(c)

Accrued salaries, Tk.12,500

Page 11 of 13

  Solution to Problem M. RAHMAN COMPANY Income Statement For the year ended December 31, 2008 Sales

Tk.12,80,000

Cost of Goods Sold Merchandise Inventory, January 1,  2008

Tk.2,83,000

(+) Purchases

9,10,000

Goods Available for Sale

Tk.11,93,000

(­) Merchandise Inventory, December 31, 2008

8,59,00

3,34,000

Gross Profit 

Tk. 4,11,000

Expenses Advertising Expense

Tk.32,000

Salaries Expense

1,78,500

Supplies Expense

5,000

Depreciation Expense

6,000

Miscellaneous Expense 

21,600

Net Income

2,43,100 Tk.1,77,900

Statement of Owner’s Equity  December 31, 2008 M. Rahman, Capital, January 1, 2008 

Tk. 482,000

Add, Net Income for year 2008

177,900

Less, M. Rahman, Drawing for Year 2008

129,000

Page 12 of 13

M. Rahman, Capital, December 31, 2008

Tk. 530,900

Balance Sheet  December 31, 2008 ASSETS Current Assets

Cash

Accounts Receivable Merchandise Inventory  Supplies

Tk.46,000 69,000 3,34,000 2,500

Prepaid Rent

18,000

Property, Plant and Equipment

Equipment

Less: Accumulated Depreciation 

4,69,500

Tk.160,000 25,000

Total Assets

1,35,000 Tk.6,04,500

LIABILITIES AND OWNER’S EQUITY Current Liabilities 

Accounts Payable  Salaries Payable  Owner’s Equity 

Total Liabilities 

Total Liabilities and Capital

Tk.61,100 12,500 Tk.73,600 5,30,900 Tk.6,04,500

Page 13 of 13

Sheet 7 CVP: BREAK EVEN ANALYSIS Md. Mahabbat Hossain Faculty Member, BIBM Phone: 01716 – 37 35 65 Email: [email protected]

 Cost­volume­profit (CVP) Analysis  (Managerial Accounting, Garrison, 10th edition, p. 234) Cost­volume­profit (CVP) analysis is one of most powerful tool that helps management to make their  decision.   It   helps   them   understand   the   interrelationship   between   cost,   volume   and   profit   in   an  organization by focusing on interactions among the following five elements: 1.

Prices of products

2.

Volume or level of activity

3.

Per unit variable cost

4.

Total fixed costs

5.

Mixed of product sold

As CVP analysis helps managers understand the interrelationships among cost, volume, and profit, it is  a   vital   tool   in   many   business   decisions.   These   decisions   include,   for   example,   what   products   to  manufacture or sell, what pricing policy to follow, what marketing strategy to employ, and what type of  productive facilities to acquire.  Contribution Margin Contribution margin is the amount remaining from sales revenue after variable expenses have been  deducted. It is used first to cover the fixed expenses and then whatever remains goes toward profits. If  the contribution margin is not sufficient to cover the fixed expenses, then a loss occurs for the period.  Activity Level 

Activity Level 

Activity Level 

500 Units

600 Units

700 Units

Sales @ Tk. 10 per unit

Tk. 5000

Tk. 6000

Tk. 7000

Less, Variable Expenses @ Tk. 8 per unit

Tk. 4000

Tk. 4800

Tk. 5600

Contribution Margin @ Tk. 2 per unit

Tk. 1000

Tk. 1200

Tk. 1400

Less, Fixed Expenses

Tk. 1200

Tk. 1200

Tk. 1200

Net Operating Income (Loss)

Tk.  (200)

Tk. 0

Tk. 200 Page 1 of 20

In the above example, at activity level 500 units, contribution margin is Tk. 1000, which is less than the  fixed expenses Tk. 1200. So, operating loss at this level Tk. 200 ( Tk. 1200­ 1000). At activity level 600  units, the contribution margin and fixed expenses are equal i. e., Tk. 1200 = Tk. 1200 and it is break­ even level of activity where there is no profit or loss. And at activity level 700 units, the contribution  margin is more than the fixed expenses by Tk. 200, which indicate the operating income for the period. 

Page 2 of 20

 Contribution Margin Ratio CM ratio =

Contribution Margin Total Sales

=

1200 6000

= 20 %

or  CM ratio =

Unit Contribution Margin Unit Selling Price

=

2 10

= 20 %

Here, contribution margin is 20% of total sales. If sales increase then contribution margin will increase  by 20% of the sales increased.  Break­Even Point  Break­even point is that level of activity where there is no profit or loss. At this level, total revenue  equals to total expenses and company’s profit is zero, i.e., Total Sales Revenue = Total Variable Costs  + Total Fixed Costs. If the company exceed break­even level, then the company earns profit and if the  activity   level   is   under   the   break­even   point,   company   suffers   a   loss.   There   are   two   methods   for  calculating break­even point, which are as follows: A. The Equation Method:  Profit = (Sales – Variable Expenses) – Fixed Expenses Sales = Variable Expenses + Fixed Expenses + Profits Example 

Let, Selling price per unit = Tk. 10, Variable Expense per unit = Tk. 8, Total Fixed Expenses =  Tk. 1200, Break­ even Quantity of sales (Q) =? What would be the break­even sales in amount  (Taka)? Sales = Variable Expenses + Fixed Expenses + Profits Tk. 10Q = Tk. 8Q + Tk. 1200 + Tk. 0 Tk. 10Q – Tk. 8Q = Tk. 1200 Tk. 2Q = Tk. 1200 Q = 600 

Therefore, Break­even point in units 

 = 600 Units 

or 

    Break­even point in amount  = Tk. 10 x 600 Units = Tk. 6000 B. The Contribution Margin Method: 

Page 3 of 20

Break­even point in units =

Fixed Expenses Unit Contribution Margin

=

1200 2

= 600 Units

or Break­even point in Taka =

Fixed Expenses Contribution Margin Ratio

=

1200 0.2

= Tk. 6000

Page 4 of 20

 Break­Even Point as a Percentage of Capacity Break­even point as % of capacity output shows at which % of the capacity level the firm reaches its  break­even point. BEP as % of Capacity =

BEP Total Capacity

x 100

Suppose,  Total Capacity = 1000 Units or Tk. 10000 BEP = 600 or Tk. 6000 BEP as % of Capacity = ? BEP as % of Capacity =

600 units 1000 units

x 100 = 60%

or BEP as % of Capacity =

Tk. 6000 Tk. 10000

x 100 = 60%

 Target Profit Analysis  Target profit is that amount of profit that the company wants to earn for this period. CVP formulas can  be used to determine the sales volume needed to achieve a target profit.  A. The Equation Method Sales = Variable Expenses + Fixed Expenses + Profits Example  Let, Selling price per unit = Tk. 10, Variable Expense per unit = Tk. 8, Total Fixed Expenses =  Tk. 1200, Expected Profit = Tk. 200. What will be the expected Quantity of sales (X) =? What  will be the expected sales in amount (Taka)? Sales = Variable Expenses + Fixed Expenses + Profits Tk. 10X = Tk. 8X + Tk. 1200 + Tk. 200

Page 5 of 20

Tk. 10X – Tk. 8X = Tk. 1400 Tk. 2X = Tk. 1400 X = 700 Therefore,  Expected sales in units to achieve the target profit = 700 Units 

 or     

Expected sales in amount to achieve the target profit  = Tk. 10 x 700 Units = Tk. 7000 B. The Contribution Margin Method Expected sales in units =

Fixed Expenses + Profit Unit Contribution Margin

=

1200+200 2

= 700 Units

or Expected sales in Taka =

Fixed Expenses + Profit Contribution Margin Ratio

=

1200+200 0.2

= Tk. 7000

 The Margin of Safety  The margin of safety is the excess of budgeted (or actual) sales over the break­even volume of sales.  The higher the margin of safety, the lower the risk of not breaking even. The formula is: Margin of Safety = Total Budgeted (or actual) sales – Break­even Sales Margin of Safety Percentage =

Margin of Safety in amount Total Budgeted (or actual) Sales

Example (From previous example) Sales 700 units @ Tk. 10

Tk. 7000

Break­even sales 600 units @ 10

Tk. 6000

Margin of Safety in Taka

Tk. 1000

Margin of Safety as a percentage of sales

14.29%

This margin of safety means that at the current level of sales and with the company’s current prices and  cost structure, a reduction in sales of Tk. 1000 or 14.29%, would result in just breaking even  Operating Leverage

Page 6 of 20

Operating leverage is a measure of how sensitive net operating income is to percentage changes in  sales. Operating leverage acts as a multiplier. If operating leverage is high, a small percentage increase  in sales can produce a much larger percentage increase in net operating income.  Degree of Operating Leverage =

Contribution Margin Net Operating Income

The degree of operating leverage is a measure, at a given level of sales, of how a percentage change  in sales volume will affect profits. Example Activity Level 

Activity Level 

Activity Level 

700 Units(100%)

770 Units(110%)

840 Units(120%)

Sales @ Tk. 10 per unit

Tk. 7000

Tk. 7700

Tk. 8400

Less, Variable Expenses @ Tk. 8 per unit

Tk. 5600

Tk. 6160

Tk. 6720

Contribution Margin @ Tk. 2 per unit

Tk. 1400

Tk. 1540

Tk. 1680

Less, Fixed Expenses

Tk. 1200

Tk. 1200

Tk. 1200

Net Operating Income (Loss)

 Tk. 200

  Tk. 340

  Tk. 480

Degree of Operating Leverage =

Contribution Margin Net Operating Income

=

1400 200

= 7

In the above example, degree of operating leverage at activity level 700 units is 7. If sales increase by  10%, then we can expect the net operating income to increase by seven times i.e., 10% x 7 = 70% (Tk.  200 x 170% = Tk. 340). If sales increase by 20%, then we can expect the net operating income to  increase by seven times i.e., 20% x 7 = 140% (Tk. 200 x 240% = Tk. 480).  Preparing the CVP Graph  The relationship among revenue, cost, profit and volume can be expressed graphically by preparing a  CVP graph. 

Suppose, Selling Price Per unit Tk. 10, Variable Cost Per unit Tk. 8, Total Fixed Cost Tk. 1200.  Calculate the Break Even Point using CVP graph.

Page 7 of 20

We are given Total Fixed Cost

= Tk. 1200 (Draw a Fixed Cost Line)

VC (for 0 Unit)     

= Tk. 0

Total Cost (for 0 Units, FC + VC)

= Tk. 1200 (Put a Point (.) for Total Cost at O Unit)

VC (for 800Units)   

= Tk. 6400

Total Cost (for 800 Units, FC + VC)    = Tk. 7600 (Put a Point (.) for Total Cost at 800 Unit and  add with previous Point at 0 unit)

Total Revenue (for 0 Units)

= Tk. 0 (Put a Point (.) for Total Revenue at O Unit)

Total Revenue (for 800 Units)            = Tk. 8000 (Put a Point (.) for Total Revenue at 800 Unit  and add with previous Point at 0 unit) 10000

Total Revenue / Total Cost

9000 8000 7000 6000 5000 4000 3000 2000 1200 1000 0

200

400

600

800

1000

Output (Unit)

Activity Level 

Activity Level 

Activity Level 

500 Units

600 Units

700 Units Page 8 of 20

Sales @ Tk. 10 per unit

Tk. 5000

Tk. 6000

Tk. 7000

Less, Variable Expenses @ Tk. 8 per unit

Tk. 4000

Tk. 4800

Tk. 5600

Contribution Margin @ Tk. 2 per unit

Tk. 1000

Tk. 1200

Tk. 1400

Less, Fixed Expenses

Tk. 1200

Tk. 1200

Tk. 1200

Net Operating Income (Loss)

Tk.  (200)

Tk. 0

Tk. 200

 Importance of CVP Analysis 1. What minimum level of sales is needed to avoid losses? 2. What should be the sales level to earn a target profit? 3. What will be the effect of changes in prices, costs and volume of profits? What will be the new  BEP then? 4. What will be the impact of plant expansion on cost­volume­profit relationship? 5. Which product is the most profitable and which one is the least profitable?

  Assumptions of CVP Analysis  1.

Selling price is constant. The price of a product or service will not change as volume 

changes. 2.

Costs are linear and can be accurately divided into variable and fixed elements.

3.

In multi­product companies, the sales mix is constant

4.

In manufacturing companies, inventories do not change. The number of units produced 

equals the number of units sold.   Limitation of CVP Analysis

1. Selling price may not remain unchanged over a period of time 2. Difficult to segregate costs into fixed and variable component 3. It is not correct to assume that total fixed costs will remain unchanged over the entire range of  activity 4. The assumption of constant unit variable costs in not valid (Discount)

Page 9 of 20

5. It is a short term concept and has a limited use of long­range planning

Page 10 of 20

 The Concept of Sales Mix Sales mix is the relative proportion in which a company’s products are sold. Different products have  different selling prices, cost structures, and contribution margins. Let’s assume ABC Company sells ‘X’ and ‘Y’ and that the sales mix between the two products remains  the same. ABC Co. provides the following information Product X Taka

Product Y %

Taka

Total %

Taka

%

Sales

250,000

100%

300,000

100%

550,000

100.0%

VC

150,000

60%

135,000

45%

285,000

51.8%

CM

100,000

40%

165,000

55%

265,000

48.2%

FC

170,000

NOI

95,000

Sales Mix

250,000

45%

300,000

Contribution Margin

CM ratio =

Total Sales Product X

Taka

=

55%

265,000

550,000

= 48.2 % (Rounded)

550,000

Product Y %

Taka

100%

Total %

Taka

%

Sales

158,714

100%

193,983

100%

352,697

100.0%

VC

95,228

60%

87,293

45%

182,521

51.8%

CM

63,485

40%

106,691

55%

170,176

48.2%

FC

170,000

NOI Sales Mix

Rounded Error 158,714

Break­even point in Amount =

45%

176

193,983

Fixed Expenses Contribution Margin Ratio

55%

=

352,697

170,000 48.2%

100%

= Tk. 352,697

Page 11 of 20

 Problem 1 The average selling price of a cup of coffee is Tk, 20 and the average variable expense per cup is Tk.  12. The average fixed expense per month is Tk. 2500. 1000 cups are sold each month on average.  What is the CM Ratio? a.

40%                               

b.

60%                                

c.

50%                                        

d.

70%

e.

None of the above

 Problem 2 The average selling price of a cup of coffee is Tk, 20 and the average variable expense per cup is Tk.  12. The average fixed expense per month is Tk. 2500. 1000 cups are sold each month on average.  What is the Break­event Point in units (rounded)? a.

78 cups 

b.

313 cups

c.

125 cups  

d.

208 cups

e.

None of the above                 

                     Problem 3

The average selling price of a cup of coffee is Tk, 20 and the average variable expense per cup is Tk.  12. The average fixed expense per month is Tk. 2500. 1000 cups are sold each month on average.  What is the Break­event Point in Amount? a. Tk. 6250                        b. Tk. 4160                            c. Tk. 2500                        d. Tk. 3129 e. None of the above    Problem 4 The average selling price of a cup of coffee is Tk, 20 and the average variable expense per cup is Tk.  12. The average fixed expense per month is Tk. 2500. 1000 cups are sold each month on average.  How many cups of coffee would have to be sold to attain target profits of Tk. 6500 per month? a. 925 cups  b. 1125 cups   c. 1215 cups   

Page 12 of 20

d. 2125 cups e. None of the above            Problem 5 

The average selling price of a cup of coffee is Tk, 20 and the average variable expense per cup is Tk.  12. The average fixed expense per month is Tk. 2500. 1000 cups are sold each month on average.  What is the margin of safety? a. 866 cups  b. 868 cups   c. 686 cups                      d. 688 cups e. None of the above                             

Page 13 of 20

 Problem 1 The average selling price of a cup of coffee is Tk, 1.49 and the average variable expense per cup is Tk.  0.36. The average fixed expense per month is Tk.1,300. 2,100 cups are sold each month on average.  What is the CM Ratio? a. 1.319,                               b. 0.758,                                 c. 0.242,                                         d. 4.139  Problem 2 The average SP = Tk. 1.49 and VC =  Tk. 0.36. FC per month is Tk. 1,300. 2,100 cups are sold each  month on average. BEP in units = ? a. 872 cups                          b. 3,611 cups                   c. 1,200 cups                               d. 1,150 cups  Problem 3 The average SP = Tk. 1.49 and VC =  Tk. 0.36. The average fixed expense per month is Tk. 1,300.  2,100 cups are sold each month on average. BEP in Amount = ? a. Tk. 1,300                        b. Tk. 1,715                            c. Tk. 1,788                       d. Tk. 3,129  Problem 4 The average SP = Tk. 1.49 and VC =  Tk. 0.36. The FC per month is Tk. 1,300. 2,100 cups are sold  each month on average. How many cups of coffee would have to be sold to attain target profits of Tk.  2,500 per month? a. 3,363 cups                     b. 2,212 cups                      c. 1,150 cups                             d. 4,200 cups  Problem 5  The average SP = Tk. 1.49 and VC =  Tk. 0.36. The FC per month is Tk. 1,300. 2,100 cups are sold  each month on average. What is the margin of safety? a. 3,250 cups                       b. 950 cups                             c. 1,150 cups                     d. 2,100 cups  Problem 6 The average SP = Tk. 1.49 and VC =  Tk. 0.36. The FC per month is Tk. 1,300. 2,100 cups are sold  each month on average. What is the operating leverage? Page 14 of 20

a. 2.21                                    b. 0.45                                       c. 0.34                                 d. 2.92  Problem 7 The average SP = Tk. 1.49 and VC =  Tk. 0.36. The FC per month is Tk. 1,300. 2,100 cups are sold  each month on average. If sales increase by 20%, by how much should net operating income increase? a. 30.0%                                       b. 20.0%                                c. 22.1%                              d. 44.2

Page 15 of 20

 Problem  A   Company  manufactures   and   sells  a   telephone   answering   machine.   The   company’s   contribution  format income statement for the most recent year is given below: Taka Sales (2000 units @ Tk. 60 per unit)

  120000

Less, Variable Expenses @ Tk. 45 per unit

 90000

Contribution Margin @ Tk. 15 per unit

 30000

Less, Fixed Expenses

 24000

Net Operating Income 

   6000

Required 1. Compute the company’s Contribution Margin Ratio and Variable Expense Ratio 2. Compute the company’s break­even point in both units and amount using (i) equation method and  (ii) contribution margin method 3. Assume that sales increase by Tk. 40000 next year. If cost behavior patterns remain unchanged by  how much will the company’s net operating income increase? (Use contribution margin ratio) 4. If the company’s target profit is Tk. 9000, how many units will have to be sold and what will be  targeted sales in amount [Use (i) equation method and (ii) contribution margin method] 5. Refer to the original data, compute the company’s margin of safety in both amount and percentage  form 6. (a) Compute the company’s degree of operating leverage at the present level of sales (b) If sales increase by 10% what percentage would you expect net operating income to increase? (c) Prepare a comparative income statement showing 10% increase in sales with the original data.   Solution to Problem  Req. 1 a) Contribution Margin Ratio CM ratio =

Contribution Margin Total Sales

=

TK. 30000 Tk. 120000

= 25 %

   or CM ratio =

Unit Contribution Margin

=

Tk. 15

= 25 %

Page 16 of 20

Unit Selling Price

Tk. 60

b) Variable Expenses Ratio VE ratio =

Variable Expenses Total Sales

=

TK. 90000 Tk. 120000

= 75 %

   or VE ratio =

Variable Expense Per Unit Unit Selling Price

=

Tk. 45 Tk. 60

= 75 %

Page 17 of 20

Req. 2 i)

Break­Even Point (Equation Method)

We Know that

Sales = Variable Expenses + Fixed Expenses + Profits Tk. 60Q = Tk. 45Q + Tk. 24000 + Tk. 0 Tk. 60Q – Tk. 45Q = Tk. 24000 Tk. 15Q = Tk. 24000 Q = 1600   = 1600 Units  or 

Therefore, Break­even point in units 

    Break­even point in amount  = Tk. 60 x 600 Units = Tk. 96000 ii) Break­Even Point (Contribution Margin Method) Break­even point in units =

Fixed Expenses Unit Contribution Margin

=

Tk. 24000 Tk. 15

= 1600 Units

or Break­even point in Taka =

Fixed Expenses Contribution Margin Ratio

=

Tk. 24000 0.25

= Tk. 96000

Req. 3 Sales increase by Tk. 40000 CM Ratio = 25% Net Operating income increase by Tk. 40000 X 25% = Tk. 10000 (As FC will not increase) Req. 4 i) Target Sales to earn profit Tk. 9000 (Equation Method) Let, Target Sales = Q Units Sales = Variable Expenses + Fixed Expenses + Profits Tk. 60Q = Tk. 45Q + Tk. 24000 + Tk. 9000 Tk. 60Q – Tk. 45Q = Tk. 33000 Tk. 15Q = Tk. 33000 Q = 2200 Therefore,  Page 18 of 20

Expected sales in units to achieve the target profit = 2200 Units 

 or     

Expected sales in amount to achieve the target profit  = Tk. 60 x 2200 Units = Tk. 132000 ii) Target Sales to earn profit Tk. 9000 (Contribution Margin Method) Expected sales in units =

Fixed Expenses + Profit Unit Contribution Margin

=

Tk. 24000+9000 15

= 2200 Units

or Expected sales in Taka =

Fixed Expenses + Profit Contribution Margin Ratio

=

Tk. 24000+9000 0.25

= Tk. 132000

Page 19 of 20

Req. 5 i) Margin of Safety Margin of Safety = Total Budgeted (or actual) sales – Break­even Sales Tk. 120000 ­ Tk. 96000 = Tk. 24000 2000 Units – 1600 Units = 400 Units ii) Margin of Safety Percentage =

or Margin of Safety

Tk. 24000

=

Budgeted (Actual) Sales

= 20%

Tk. 120000

Req. 6 a) Degree of Operating Leverage =

Contribution Margin Net Operating Income

=

Tk. 30000 Tk. 6000

= 5

b) If Sales increase by 10%, operating income will increase by 10% X 5 = 50% C) Comparative statement 2000 Units

2200 Units

(100%)

(110%)

Sales @ Tk. 60 per unit

Tk. 120000

Tk. 132000

Less, Variable Expense @ Tk. 45 per unit

 Tk. 90000

 Tk. 99000

Contribution Margin @ Tk. 15 per unit

Tk. 30000

Tk. 33000

Less, Fixed Expenses

Tk. 24000

Tk. 24000

Net Operating Income (Loss)

 Tk. 6000

  Tk. 9000

 Sales increase by 10% = 2000 Units X 110% = 2200 Units  Profit Increase to 150% = Tk. 6000 X 150% = Tk. 9000

Page 20 of 20

Sheet 8 Relevant Costing Md. Mahabbat Hossain Faculty Member, BIBM Phone: 01716373565 Email: [email protected]

 Relevant & Irrelevant Cost (Managerial Accounting, Garrison, 10th edition, p. 586) Relevant costs are considered for making decision.  A relevant cost is a cost that differs between  alternatives.  Only those costs that differ in total between alternatives are relevant in a decision. If a  cost will be the same regardless to the alternative selected, then the decision has no effect on the cost  it can be ignored. For example, if you are trying to decide whether to go to a movie or to rent a video  CD for the evening, the rent on your apartment is irrelevant. On the other hand, the cost of the movie  ticket and the cost of renting the video CD would be relevant in the decision. 

 Sunk Cost (Managerial Accounting, Garrison, 10th  edition, p. 57) A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made  now or in the future. Since sunk costs cannot be changed by any decision, they are not differential  costs. Therefore, they can and should be ignored when making a decision. For example, a company  paid Tk. 50,000 before 5 years for purchase a machine.

 Opportunity Costs (Managerial Accounting, Garrison, 10th edition, p. 57) Opportunity cost is the potential benefit that is given up when one alternative is selected over another.  Opportunity cost is not usually entered in the accounting records of an organization, but it is a cost that  must be considered in making decision by management. For example, Tk. 100,000 can be invested @  10% interest in bond or deposited into bank @ 7% interest, if the amount is invested in bond then the  bank interest (100,000X 7%) Tk. 7000 will be the opportunity cost of bond interest.

 Non­routine Decision (Cost Accounting, Jawahar Lal, 2nd edition, p. 1000) 1. The make or buy decision (p.598) Page 1 of 13

2. Special order (p. 601) 3. Sell or process further (p.607) 4. Add or Drop Products 5. Operate or Temporary Shutdown 6. Replacement or Retain Plant & Equipment 7. Introduce shifting 8. Buy or lease etc.

Page 2 of 13

 Problem 1 (Discontinuance of a Product) The costs and revenue data of three products, A, B & C of a company are given below: Product A Selling Price Per Unit

B

C

Tk. 64

Tk. 60

Tk. 52

Variable Cost Per Unit

40

40

36

Contribution Margin per unit

24

20

16

10,000

5,000

8,000

No. of units produced Total fixed costs the company 

Tk. 122,000

Production arrangements are such that if one product is given up the production of the others can be  raised by 50%. The directors propose that Product C should be given up because the contribution from  that product is the lowest. Present suitable analysis of the data indicating whether the proposal should  be accepted.

 Solution to Problem 1 (Cost Accounting, Jawahar Lal, 2nd edition, p. 1021) 1. Calculation of total profit of the company: Product A

Product B

Product C

Units

10,000

5,000

8,000

Contribution Margin per unit

Tk. 24

Tk. 20

Tk. 16

240,000

100,000

128,000

Contribution (Taka)

Total

468,000

Fixed Costs

122,000

Net Operating income

346,000

2. Calculation of total profit if Product A is given up: Product A

B

Tatal

C

Units

5,000

8,000

Add, increased units

2,500

4,000

Total units

7,500

12,000

150,000

192,000

Contribution (Taka)

342,000

Fixed Costs

122,000

Net Operating income

220,000

Page 3 of 13

3. Calculation of total profit if Product B is given up: Product A Units

Contribution (Taka)

Tatal

C

10,000

8,000

5,000

4,000

15,000

12,000

360,000

192,000

Add, increased units Total units

B

552,000

Fixed Costs

122,000

Net Operating income

430,000

4. Calculation of total profit if Product C is given up: Product A Units Add, increased units Total units Contribution (Taka)

B

C

10,000

5,000

5,000

2,500

15,000

7,500

360,000

150,000

Tatal

510,000

Fixed Costs

122,000

Net Operating income

388,000

Comment

If Product B is given up, the net operating income is the maximum since the total contribution of B is  lowest. And also increase the net operating income by Tk. 84,000 (430,000 ­ 346,000) if Product B is  given up. The proposal to give up product C, therefore, is not advisable.

 Problem 2 (Introduce new product) Millon Company produces Paint and Varnish. The costs and revenue data of these products in 200X  are as follows: Paint Selling Price per kg

Varnish

Tk. 40

Tk. 60

10

14

Direct Labor

8

16

Manufacturing Overhead (50% Fixed)

8

16

Direct Material 

Page 4 of 13

In 200X the company produced and sold Paint 4000 kg and Varnish 6000 kg. Manufacturing overhead  is charged on the basis of normal production, Paint 5000 kg and Varnish 7500 kg. Administrative selling  expenses are Tk. 36,000 and 22,000 respectively.  Company decides to  expand  its product line  by introducing  new  product  Ink. Expected  costs  and  revenue data of the new product are as follows: Selling Price per kg

Tk. 40

Direct Material 

16

Direct Labor

12

Manufacturing Overhead (50% Fixed)

12

Total costs

Tk. 40

If the Ink is produced, fixed manufacturing overhead will increase by Tk. 2000 and addition selling  expenses Tk.  3000. The market demand of ink is 3000 kg. If the present situation remains unchanged,  whether the production of ink is profitable? (Show computation).

Page 5 of 13

 Solution to Problem 2 (Management Accounting, Mondol, 4th edition, p. 170) 1. Calculation of net operating income before introducing new product, Ink: Product Paint Sales

Total Varnish

Taka

Tk. 160,000

Tk. 360,000

Tk. 520,000

Direct Material

40,000

84,000

124,000

Direct Labor 

32,000

96,000

128,000

Fixed*

20,000

60,000

80,000

Variable**

16,000

48,000

64,000

108,000

288,000

396,000

52,000

72,000

124,000

Less, Production Costs:

Manufacturing Overhead:

Total Production Costs Grass Margin Administrative Expenses

36,000

Selling and Distribution Expenses

22,000 58,000

Net Income (Loss)

66,000

* Fixed Overhead: Paint = 5000 units x Tk. 4 = Tk. 20,000, Varnish = 7500 units x Tk. 8 = Tk. 60,000 ** Variable Overhead: Paint =4000 units x Tk. 4 =Tk. 16,000, Varnish = 6000 units x Tk. 8 =Tk. 48,000 2. Differential Statement Without Ink Sales

Ink

With Ink

Tk. 520,000

Tk. 120,000

Tk. 640,000

Direct Material

124,000

48,000

172,000

Direct Labor 

128,000

36,000

164,000

Fixed

80,000

2,000

82,000

Variable

64,000

18,000

82,000

22,000

3,000

25,000

Total Relevant Cost

418,000

107,000

525,,000

Irrelevant Cost and Revenue

102,000

13,000

115,000

Less, Production Costs:

Manufacturing Overhead:

Selling and Distribution Expenses

Income from Ink Net Income (Loss)

13,000 115,000

115,000 Page 6 of 13

* Administrative expense is treated as irrelevant costs. Comment If the new product, Ink, produce and sold then net operating income will increase by Tk. 13,000. That  means, total net operating income will be Tk. (66,000 + 13,000) = Tk. 79,000. So, management is  appreciated to introduce the new product. 

Page 7 of 13

 Problem 3 (Make or Buy Decision) Shima Tools Manufacturers wants to purchase a part for the equipment that it produces. Because the  market price of the part is lower then production by Tk. 8. The annual demand of this part is 5,000 units  and production costs per unit are as follows: Paint Direct Materials

Tk. 21

Direct Labor

12

Manufacturing Overhead (125% of Direct Labour)

15

Total costs

Tk. 48

Company may collect this part from an outside supplier by Tk. 40 per unit. If the company produce this  part,   fixed   manufacturing   overhead   Tk.   4000.   If   purchase   from   outside,   carriage   inward   Tk.   500,  warehousing cost Tk. 1200, labor compensation Tk. 1000. 40% of manufacturing overhead is variable.

 Solution to Problem 3 (Management Accounting, Mondol, 4th edition, p. 171) 1. Determination of costs the two alternatives Cost for Buy Purchase Price (5000x40) Carriage inward

Taka

Cost for Production

200,000 Direct Material (5000 x21) 500 Direct Labor (5000 x12)

Warehouse Cost

1,200 Fixed Manufacturing Overhead

Labor Compensation

1,000 Variable Manufacturing Overhead*

Total Cost Total Cost for purchase from outside Total Cost for production Loss on purchase from outside

202,700 Total Relevant Cost

Taka 105,000 60,000 4,000 30,000 199,000

Tk. 202,700 199,000 Tk. 3,700

* Variable manufacturing overhead cost per unit for production = Tk. 15 x 40% = Tk. 6. Comment The cost of purchase from outside customer is higher than that of cost of production and loss on  purchase from outside by Tk. 3,700. So the company should produce the part rather than purchase  from outside.

Page 8 of 13

 Problem 4 (Sell or Process Further) A manufacturing company produces three products. The related data are given below: Product A

B

C

Production (kg)

3,000

4,000

6,000

Selling Price per kg

Tk. 40

Tk. 45

Tk. 30

Joint Cost

98,000

156,000

160,000

Administrative Expenses

5,000

6,000

7,000

Selling Expenses

2,000

4,000

4,000

If product B is future processed it can be sold @ Tk. 64 per kg. Due to future processing, weight will  reduce by 10% and future processing cost Tk. 40,000. Selling expenses will increase by Tk. 1200.  Administrative expenses will remain unchanged. Whether Product B should process further?

 Solution to Problem 4 (Management Accounting, Mondol, 4th edition, p. 176) Before

After 

Further Process B Further Process B  Sales

Tk. 180,000

Tk. 230,400*

Relevant Cost: Addition processing cost

40,000

Selling cost

4,000

5,200

Total Relevant Cost

4,000

45,200

176,000

185,200

185,200

185,200

Irrelevant cost and revenue  Processing Income

9,200

* Sales Revenue after processing = 4000 units x 90%= 3,600 units x Tk. 64 = Tk. 230,400 Comment

Incremental net operating income of process further Product B is Tk. 9,200. So, Product B process  further is advisable. 

 Problem 5 (Make or Buy a Component) Climate Control, Inc., manufactures a variety of heating and air­conditioning units. The company is  currently   manufacturing   all   of  its   own   component   parts.   An   outside   supplier   has   offered  to   sell   a 

Page 9 of 13

thermostat to Climate­Control for Tk. 20 per unit. To evaluate this offer, Climate­Control Inc., has  gathered the following information relating to its own cost of producing the thermostat internally: Per Unit

15,000 units  per year

Direct Material

Tk. 6

Tk. 90,000

Direct Labor

8

120,000

Variable Manufacturing Overhead

1

15,000

Fixed Manufacturing Overhead, traceable 

5*

75,000

Fixed Manufacturing Overhead, Common but allocated

10

150,000

Tk. 30

Tk. 450,000

Total Cost

* 40% supervisory salaries and 60% depreciation of special equipment (no resale value) Required

1. Assume that the company has no alternative use for the facilities now being used to produce the  thermostat, should the outside supplier’s offer be accepted? Show all computation. 2. Suppose that if the thermostat were purchased, Climate­Control Inc., could use the freed capacity  to launch a new product. The Segment margin of the new product would be Tk. 65,000 per year.  Should Climate­Control Inc., accept the offer to buy the thermostats from the outside supplier for  Tk. 20 each? Show computation. 

 Solution to Problem 5 (Make or Buy a Component) Garrison, p. 614 Calculation of Production Cost for 15,000 units Per Unit Direct Material

Total 

Tk. 6

Tk. 90,000

Direct Labor 

8

120,000

Variable Manufacturing Overhead

1

15,000

Fixed Manufacturing Overhead, traceable (Tk. 5 x 40%)

2

30,000

Tk. 17

Tk. 255,000

Total Cost of Production Req. 1: Determination of Differential gain or loss Total Cost for purchase from outside @Tk. 20 Total Cost for production Difference in favor of continuing to make the parts

Tk. 300,000 255,000 Tk. 45,000

Page 10 of 13

Comment The cost of purchase from outside customer is higher than that of cost of production and gain on  production by Tk. 45,000. So the company should produce the part rather than purchase from outside. Req. 2: Determination of Differential gain or loss Cost of Purchasing  Cost of Making

Make

Buy

Tk. 300,000

Tk. 255,000

Opportunity cost­ Segment Margin forgone  on potential new product line Total Cost Difference in favor of purchasing 

65,000 Tk. 320,000

Tk. 300,000 Tk. 20,000

Comment The cost of purchase from outside customer is lower than that of cost of production and gain on  purchasing by Tk. 20,000. So the company should accept the offer and purchase from outside.

Page 11 of 13

 Problem 6 (Make or Buy a Component) Royal Company manufactures 20,000 units of part R­3 each year for use on its production line. The  cost per unit for part R­3 follows: Direct Material

Tk. 5

Direct Labor

7

Variable Manufacturing Overhead

3

Fixed Manufacturing Overhead Total Cost

10 Tk. 25

An outside supplier has offered to sell 20,000 units of part R­3 each year to Royal Company for Tk.  23.50 per part. If Royal Company accepts this offer, the facilities now being used to manufacture part  R­3 could be rented to another company at an annual rental of Tk. 150,000. However, Royal Company  has determined that Tk. 6 of the fixed manufacturing overhead being applied to part R­3 would continue  even if part R­3 were purchased from the outside supplier. Required Prepare computations to show the net amount advantage or disadvantage of accepting the outside  supplier’s offer.

 Solution to Problem 6 (Make or Buy a Component) Garrison, p. 617 1. Calculation of Production Cost for 20,000 units Per Unit Direct Material

Total 

Tk. 5

Tk. 100,000

Direct Labor 

7

140,000

Variable Manufacturing Overhead

3

60,000

Fixed Manufacturing Overhead, traceable (Tk. 10 ­ 6)

4

80,000

Tk. 19

Tk. 380,000 

Total Cost of Production 2. Determination of Differential gain or loss Cost of Purchasing (20,000 units x Tk. 23.50) Cost of Making Opportunity cost­ Rental Revenue Total Cost

Make

Buy

Tk. 470,000

Tk. 380,000 150,000 Tk. 530,000

Tk. 470,000

Page 12 of 13

Net advantages in favor of buying 

Tk. 60,000

Comment

The cost of purchase from outside customer is lower than that of cost of production and gain on buying  by Tk. 60,000. So the company should accept the offer and buy from outside.

Page 13 of 13

Sheet 9 Financial Statement Analysis under Financial Spread Sheet Md. Mahabbat Hossain Faculty Member, BIBM Phone: 01716 – 37 35 65 Email: [email protected]

 Financial Statements Analysis Financial statement analysis means application of analytical tools and techniques to financial statements  and   other   relevant   data   to   obtain   useful   information.   This   information   reveals   significant   relationships  between data and trends in those data that assess the company’s past performance and current financial  position. The information shows the results or consequences of prior management decisions. In addition,  analysts use the information to make predictions that may have a direct effect on decisions made by users  of financial statements. Analyzing   financial   statements   involves   evaluation   three   characteristics   of   a   company:   its   liquidity,   its  profitability, its solvency and cash flows. Liquidity indicates the ability to meet the short­term obligation from  current assets of the firm. Through profitability we come to know the operating efficiency or operating  success of the firm. Solvency measures the ability to pay external liability from total assets of the firms.  Tools of Financial Statement Analysis Various tools are used to evaluate the significance of financial statement data. The commonly used tools  are follows; 1. Horizontal Analysis   Horizontal analysis is called trend analysis. It is a technique for evaluating a series of financial  statement data over a period of time. It is used primarily in intra­company comparisons. Its  purpose is to determine the increase or decrease that has taken place, expressed as either an  amount or a percentage.

Page 1 of 16

Formula to calculate change

=

Current Year Amount – Base Year Amount Base Year Amount

Two features in published financial statements facilitate this type of comparison: First, each of  the basic financial statements is presented on a comparative basis for a minimum of two years.  Second,  a summary of selected financial data is presented for a series of 5 to 10 years or  more.

Page 2 of 16

2. Vertical Analysis Vertical analysis is a technique for evaluating financial statement data that expresses each  item in a financial statement in terms of a percent of a base amount. Sometimes it is referred to  as common size analysis. The value of total assets is used as the base amount for balance  sheet items and the value of sales for income statement items. Vertical analysis is used in both  intra­company and inter­company comparison. 3. Ratio Analysis Ratio analysis expresses the relationship among selected items of financial statement data. A  ratio expresses the mathematical relationship between one quantity and another. By observing  financials at a glance one cannot immediately understand the actual financial condition of a  firm i.e. whether the financial condition of the firm is improving or not. Ratio analysis is used in  all three types of comparison; intra­company, inter­company and industry average. Ratio can  be expressed as a percentage, rate or simple proportion. 4. Cash Flow Statement Though Cash Flow Statement (CFS) is a separate statement it can help to analyze the cash  inflows and out flows. The statement of cash flows reports the cash receipts, cash payments,  and net change in cash resulting from the operating, investing, and financing activities of an  enterprise during a particular period.  The main aim to prepare the statement is to identify and  analyze the causes of differences between cash amount in the beginning and ending balance  sheet. It provides the answer of three questions, such as: 

Where did the cash come from during the period?



What was the cash used for during the period?



What was the change in the cash balance during the period?

 Basis for comparison Every item reported in a financial statement has significance. It is necessary to compare each item of 

Page 3 of 16

financial statement with other financial statement data. Comparisons can be made on a number of different  bases. Such as: 1)

Intra­company basis:  This basis compares  an   items  or   financial  relationship   within   a  company in the current year with the same item or relationship in one or more prior years.

2)

Industry   averages:  It   compares   an   item   or   financial   relationship   of   a   company   with  industry averages published by financial rating organizations.

3)

Inter­company   basis:  This   basis   compares   an   item   or   financial   relationship   of   one  company with the same item or relationship in one or more competing companies.

(4)

Ideal  Ratio:  The calculated ratios may be compared with ideal ratios. Experts have laid  down some standard ratios after making numerous experiments in various companies and  at various places. 

 Some tips for FSS analysis 

Financial Spread Sheet (FSS) is a technique that helps to analyze financial statements.



It is a customized excel program.



There are two types of sheet; input sheet and output sheet.



Two input sheet: one for balance sheet and other for income statement.



Input sheet should be filled up from traditional financial statements.



Recent year data should be presented in the most right­hand column.



Four output sheets (B/S, I/S, Ratio and CFS) will be generated automatically. 



Prepaid expense should be treated as non­current asset.



Fixed assets should be presented at cost price.



Accumulated depreciation should be deducted from cost price of fixed assets.



The following assets (if any) should be excluded from assets and will be deducted the  same amount from retained earnings:





All intangible assets: Goodwill, patent, trademark, copyright, etc.



Fictitious assets: P/L A/c debit balance or accumulated loss



Deferred revenue expense: Preliminary expense, pre­operative cost, etc.

The current maturity portion of long term debt (CMLTD) should be included in current  liabilities.  

Page 4 of 16



Subordinated loan for directors will be presented under equity.



Total depreciation should be presented separately and should not be included in COGS,  administrative or selling expenses.  



To get a complete output we are to insert three years data. 

Page 5 of 16

 Fundamental classification of Ratio According to Financial Spread Sheet (FSS) there are six types of ratios, which are as follows: 1. Growth Ratio: Growth ratios measure the company’s potentiality, performance. It also measures 

whether the company will survive. Example of growth ratios are sales growth, assets growth etc.  2. Profitability Ratio: Profitability indicates the efficiency of the unit in generating surplus. In order to 

have a ratio, we can compare profit to the factors which regulate the quantum of profit directly, like  sales and the total assets or equity. Profitability ratios measure the income or operating success of  an enterprise for a given period of time e.g., gross profit margin, operating profit margin etc. 3. Coverage Ratio: These ratios measure the ability of a company to generate cash to pay interest 

and principal repayments e.g., interest coverage ratio. 4. Activity Ratio: It has been widely accepted that the profitability of an enterprise to a large extent 

depends on its efficient asset utilization or activity performed. Activity ratios measure how efficiently  the   assets   are   employed   by   the   firm.   These   ratios   are   also   called   efficiency   ratios   or   asset  management ratios. For examples, inventory turnover, total assets turnover etc. 5. Liquidity Ratio: The liquidity or short­term solvency of an organization can be measured with the 

help of current ratio and quick ratio. Liquidity implies to the ability of an organization to pay off its  short­term obligations with the current assets. 6. Leverage Ratio: Ratios, which measures the extent to which a firm has been financed by debt. It is 

also known as debt management ratios. Examples of leverage ratios are debt ratio, etc. 1. Growth Ratios Name of Ratio

Components or Formula

Use

1. Sales Growth, Sales %

[(CY.S ­ PY.S) / PY.S] x 100

Rule of Thumb= Higher is better, comparing with  previous years or industry average

2. Net Sales Growth, Composite % 

[(CY.NS ­ PY.NS) / PY.NS] x 100

Rule of Thumb= Higher is better, comparing with  previous years or industry average

3. Net Income Growth, % 

[(CY.NI ­ PY.NI) / PY.NI] x 100

Rule of Thumb= Higher is better, comparing with  previous years or industry average

4. Total Assets Growth, %

[(CY.A ­ PY.A) / PY.A] x 100

Rule of Thumb= Higher is better, comparing with 

Page 6 of 16

previous years or industry average 5. Total Liabilities Growth, %

[(CY.L ­ PY.L) / PY.L] x 100

Rule of Thumb= Lower is better, comparing with  previous years or industry average

6. Net Worth Growth, %

[(CY.W ­ PY.W) / PY.W] x 100

Rule of Thumb= Higher is better, comparing with  previous years or industry average

Note: CY= Current Year, PY= Previous Year, N= Net, S= Sales, A= Total Assets, L= Total Liabilities, W= Net Worth

Page 7 of 16

2. Profitability Ratios Name of Ratio

Components or Formula

1. Gross Margin, Composite %

(GP / Sales) x 100

Use Indicates the efficiency of management in turning over the  company’s goods at a profit. Rule of Thumb= 25% to 30%, higher is better

2. SG & A, %

(SG & A / Sales) x 100

Rule of Thumb= Lower is better, comparing with previous  years

3. Cushion (GP­SG&A), %

{(GP­SG&A) / Sales} x 100

Rule of Thumb= Higher is better

4. Depreciation. Amortization,%

(Depreciation / Sales) x 100

Rule of Thumb= Lower is better

5. Operating Profit Margin, %

(EBITDA / Sales) x 100

6. Interest Expense, %

(Interest / Sales) x 100

Rule of Thumb= Lower is better

7. Operating Margin, %

(Profit before tax & Extra 

Rule of Thumb= Higher is better

It is used to discuss the general profitability  Rule of Thumb= 20% to 25%, higher is better

Income / Sales) x 100 8. Net Margin, %

(NP / Sales) x 100

This ratio is used to measure the overall profitability.  Rule of Thumb= Higher is better

9. Return on Assets, %

(NP / Assets) x 100

It measures the profitability of investments. Rule of Thumb= Higher is better

10. Return on Equity, %

(NP / Net Worth) x 100

Measures earning power on shareholders’ equity Rule of Thumb= Higher is better

11. Dividend pay out rate, %

(Dividend / NP) x 100

Rule of Thumb= Lower is better to long term creditors.

Note: EBITDA= Earning Before Interest, Tax, Depreciation & Amortization, SG & A= Selling, General & Administrative Exp 

3. Coverage Ratios Name of Ratio

Components or Formula

Use This ratio shows how many times the interest 

1. Interest Coverage (x)

(EBIT / Total Interest)

charges are covered by EBIT.

2. Debt Service Coverage (x)

[EBITDA / (Total Interest + CMLTD)]

Rule of Thumb= higher is better  It reflects the company’s ability to serve long­term debt. Rule of Thumb= Must be Greater than one.

Note: EBIT= = Earning Before Interest & Tax, CMLTD= Current Funded Portion of Term Debts.

4. Activity Ratios Name of Ratio 1. Receivable in Days

Components or Formula (AR / Sales) x 365

Use Shows average number of days receivables are outstanding  before being collected. Rule of Thumb= Lower is better. Should not more than 1/3rd  greater than the company’s term of sales.

2. Payable in days

(AP / COGS) x 365

Indicates the average length of time trade debt is outstanding Rule of Thumb= Higher indicates the creditors are not paid in 

Page 8 of 16

time and lower shows that the business is not taking the full  advantage of credit period allowed by the creditors. 3. Inventory in Days

(Inventory / COGS) x 365

Shows the average no. of days the inventory is held before it is  turned into accounts receivable through  sales. Rule of Thumb= Lower is better, compare with previous years.

4. Sales to Total Assets, (x)

(Sales / Total Assets) 

Shows how efficiently assets are used to generate sales. Rule of Thumb= Higher is better.

Note: Sales= Total Sales Revenue, AR= Account Receivable, AP= Account Payable, COGS= Cost Of Goods Sold

Page 9 of 16

5. Liquidity Ratios Name of Ratio 1. Working Capital

Components or Formula CA – CL

Use It is a measure of company’s liquidity  position. Rule of Thumb= Larger is better

2. Quick Ratio

Cash & Cash Equivalent + Receivables / CL

Measures ability to meet current debts  with most liquid (quick) assets. Rule of Thumb= 1:1, higher is better Measures ability to meet current 

3. Current Ratio

CA / CL

debts with current assets.

4. Sales to Net Working Capital

Sales / Net Working Capital

Rule of Thumb= 2:1, higher is better Rule of Thumb= Higher is better

Note: CA= Current Assets, CL= Current Liabilities

6. Leverage Ratios Name of Ratio

Components or Formula

Use Indicates the extent to which debt financing is 

1. TL / NW (x)

used relative to equity financing.

TL / NW

Rule of Thumb= 1:1, Higher indicates less  protection for lender

2. Affiliate Exposure / NW, %

(Affiliate Exposure / NW) x 100

Rule of Thumb=

3. TL / (NW –Affiliates) (x)

TL / (NW –Affiliates)

Rule of Thumb=

Note:  TL= Total Liabilities, NW= Net Worth

As per CRG score sheet, a bank officer must calculate the following four ratios for understanding the  financial risk of a business. Types Leverage:

Formula

Implications

Total liabilities to 

Highest score (15) if it is less than 0.25. Lowest 

Debt equity ratio (times)

tangible net worth

score (0) if it is more than 2.75. 

Liquidity:

Current assets to 

Highest score (15) if it is greater than 2.74. 

Current Ratio (times)

current liabilities

Lowest score (0) if it is less than 0.70.

Profitability 

Operating profit to net  Highest score (15) if it is greater than 25%. 

Operating Profit margin (%)

sales

Coverage: Interest Coverage (times)

EBIT/ Interest on debt

Lowest score (0) if it is less than 1%. Highest score (5) if it is greater than 2. Lowest  score (0) if it is less than 1.

[Our Lord! We have wronged ourselves. If You forgive us not, and bestow not upon us  Your mercy, we shall certainly be of the losers] 

Page 10 of 16

(Al Quran_Sura Araf 7:23) Reference: Bangladesh Bank (1993), Financial Spread Sheet and Credit Scoring Manual, Financial Sector Reform Project, Bangladesh, Bangladesh Bank, Dhaka. Weygandt, J.J., Kieso, D.E. and Kimmel, P.D. (2005), Accounting Principles, 7th Edition, John Wiley & sons, Inc.

Page 11 of 16

 Exercise on FSS AHMED TOYS (PVT.) LIMITED Balance Sheet

As on 31st December Particulars

2011

2010

2009

Page 12 of 16

ASSETS A. Current Assets

90,000

88,000

88,000

35,000

32,000

5,000

16,000

14,000

10,000

200,000

70,000

25,000

76,000

40,000

nil

54,000

4,000

3,000

93,000

29,000

4,000

      564,000

   277,000

135,000

100,000

nil

nil

50,000

40,000

40,000

2566,000

2928,000

3238,000

 nil

5,000

10,000

    2716,000

  2973,000 

3288000

    3280,000

3250,000

3423,000

nil

10,000

20,000

161,000

142,000

7,000

38,000

21,000

9,000

36,000

26,000

20,000

15,000

245,000

240,000

    417,000

     Long Term Loans

1350,000

1450,000

1550,000

E. Total Liabilities (C+D)

1595,000

1690,000

1967,000

1250,000

1250,000

1250,000

161,000

125,000

274,000

185,000

1685,000

1560,000

      Stock & Stores        Advances & Deposits (including L/C Margin)       Prepaid Expenses       Account Receivables       Marketable securities       Cash in hand       Cash at bank         B.

Total Current Assets (A) Non­Current Assets Investment in Associated Company Investment in Subsidiary Company

      Tangible Fixed Assets (As per Annex 5)       Preliminary Expenses       

Total Non­current Assets (B) Total Assets (A+B)

LIABILITIES C. Current Liabilities       Due to directors        Cash Credit       Expenses Accruals        Accounts Payable       Proposed Dividend       Tax Provision       

Total Current Liabilities (C)

D. Non­Current Liabilities

300,000 40,000 29,000 17,000 11,000

CAPITAL F. Shareholders’ Equity     Share Capital     General Reserve     Retained Earnings     Total shareholders equity (F)

96,000 110,000 1456,000

Page 13 of 16

Note: Contingent liability of the company is Tk.9.00 lac and annual installment on long term loan is Tk.1.0 lac each year.

AHMED TOYS (PVT.) LIMITED Income Statement

For the year ended 31st December Particulars

2011

2010

2009

1. Net sales

1325,000

1245,000

1132,000

2. Cost of Goods Sold (Annex 1)

1072,000

1032,000

965,000

253,000

213,000

167,000

Admn. & General ( Annex 2 )

42,000

39,000

25,000

Selling & Distribution (Annex 3)

16,000

16,000

15,000

58,000

55,000

40,000

5. Operating profit (3 – 4)

195,000

158,000

127,000

7. Profit before tax (5 ­ 6) 

181,000

145,000

114,000

20,000

15,000

11,000

9. Net profit after tax (7 ­ 8) 

161,000

130,000

103,000

11. Surplus Available for Appropriations (9+10)

346,000

240,000

150,000

Transferred to General Reserve

36,000

29,000

23,000

Proposed Dividend

36,000

26,000

17,000

72,000

55,000

40,000

3. Gross Profit (1­ 2)   4. Operating Expenses:

6. Non­operating Expense (Annex 4)

14,000

8. Provision for Taxation 10. Add, Balance of profit b/f from previous year

185,000

13,000

110,000

13,000

47,000

12. Appropriations:

13. Balance of profit /Retained Earnings tr. to B/S (11 – 12) 

274,000

185,000

110,000

2011

2010

2009

Annex 1

Cost of Goods Sold Particulars 1. Opening Stock of Finished Goods

40,000

40,000

51,000

2. Cost of Goods Manufactured (Annex 1.1

1072,000

1032,000

954,000

3. Cost of Goods Available for Sales (1+2)

1112,000

1072,000

1005,000

(40,000)

(40,000)

(40,000)

4. Closing Stock of Finished Goods

Page 14 of 16

5. Cost of Goods Sold (1+2 – 3)

1072,000

1032,000

965,000

2010

2009

Annex 1.1 

Cost of Goods Manufactured Particulars 1. Opening Stock of Work­in­process

2011

11,000

12,000

22,000

2. Raw Materials Used (Annex 1.2)

575,000

612,000

598,000

3. Manufacturing Cost (Annex 1.3)

496,000

419,000

346,000

4. Closing Stock of Work­in­process

(10,000)

(11,000)

(12,000)

1072,000

1032,000

954,000

5. Cost of Production/Manufacturing Cost 

Page 15 of 16

Annex 1.2

Cost of Materials Used Particulars

2011

1. Opening Stock of Raw Materials

2010

2009

37,000

36,000

36,000

2. Add, Net Purchase of Raw Materials 

578,000

613,000

598,000

3. Raw materials Available

615,000

649,000

634,000

40,000

37,000

36,000

575,000

612,000

598,000

2011

2010

2009

4. Less, Closing Stock of raw Materials  5. Cost of Raw Materials Used

Annex 1.3

Manufacturing Cost Particulars Wages, Bonus & Allowances

15,000

13,000

13,000

Power, Fuel & Gas 

15,000

15,000

15,000

Godown Rent

2,000

2,000

2,000

Repairs & Maintenance 

3,000

3,000

3,000

Excise Duty

21,000

20,000

20,000

Depreciation

430,000

356,000

284,000

10,000

10,000

9,000

496,000

419,000

346,000

2010

2009

Others manufacturing cost  Total

Annex 2

Administration and General Expenses Particulars 1. Salaries & Allowances

2011

13,000

12,000

10,000

2. Office Rent

4,000

3,000

3,000

3. Tel., Telex & Fax

2,000

2,000

1,000

4. Stationery 

2,000

2,000

2,000

5. Travelling & Conveyance 

3,000

2,000

1,000

6. Donation

1,000

1,000

1,000

7. Audit & Legal Fees

1,000

2,000

1,000

8. Bad Debts

2,000

2,000

2,000

9. Misc. Expenses

3,000

2,000

1,000

10. Depreciation 

6,000

6,000

3,000

11. Preliminary Expense Write­off

5,000

5,000

nil

Page 16 of 16

Total

42,000

39,000

25,000

Page 17 of 16

Annex 3

Selling and Distribution Expense Particulars

2011

2010

2009

Sales Commission

5,000

5,000

5,000

Sales Promotion Expenses 

3,000

3,000

2,000

Advertisement

3,000

3,000

3,000

Travelling

2,000

2,000

2,000

Carriage Outwards

3,000

3,000

3,000

16,000

16,000

15,000

Total 

Annex 4

Non­operating Expenses: Financial Particulars

2011

Bank Interest Bank Charge & Commission   Total

2010

2009

10,000

10,000

10,000

4,000

3,000

3,000

14,000

13,000

13,000

Annex 5

Schedule of Fixed Assets (Tk.’000) 31st Dec., 2011

Items

W.D.V

Addition

Land

125

0

Factory Building

378

Plant & Machinery Equipment Furniture & Fixture

31st Dec., 2010

31st Dec., 2009

W.D.V

Addition.

0

125

0

0

125

0

0

162

420

0

120

460

80

1838

0

992

2198

23

632

2383

424

161

72

154

117

0

126

225

18

64

2

18

68

29

12

45

6

2566

74

1326

2928

52

890

3238

528

Acc.  Dep.

Acc.  Dep

W.D.V

Acc.  Dep.

Note:  Cost of the Fixed Assets = W.D.V + Accumulated Dep. Written Down Value (W.D.V) = Cost – Accumulated Depreciation.

Page 18 of 16

Input of Balance Sheet Items AHMED TOYS (PVT.) LIMITED Auditor 

AUDITED

AUDITED

AUDITED

Analyst   

M. Hossain

M. Hossain

M. Hossain

FYE

Dec 31,2009

Dec 31,2010

Dec 31,2011

12 Mths

12 Mths

12 Mths

in (000) Taka

in (000) Taka

in (000) Taka

 

 

 

Period Amount CURRENT ASSETS  

 

 

 

Cash/Bank Balances

7

33

147

L/C margin

5

32

35

Fixed Deposits/Marketable Securities

0

40

76

Acc. Receivables­Trade

200

25

70

Accounts Receivable ­ Others

 

 

 

Goods­in­transit

0

0

0

Inventory

88

88

90

 

 

 

  Due from Affiliates ­ Current

 

 

 

 

 

 

 

FIXED ASSETS

 

 

 

Gross Fixed Assets

3,766

3,818

3,892

Less: Depreciation

528

890

1,326

 

 

 

  NON­CURRENT ASSETS Due from Principal, Emp, Affiliate, & Investment Advance Income Tax

 

 

 

40

40

150

 

 

 

10

14

16

 

 

 

 

CURRENT LIABILITIES

 

 

 

Deferred Charges,Pre­pymts & Adv.

 

 

 

 

Short Term Bank Borrowings

300

142

161

Current Funded Portion of Term Debt (CMLTD)

100

100

100

Account Payable ­ Trade

29

9

21

Accrued Items (Exp + Dues to Directors)

60

48

7

Provision for Income Tax/Def. I/T Liabilities

11

15

20

Advance Payment

 

 

 

Dividends Payable

17

26

36

 

 

 

  LONG TERM LIABILITIES

 

 

 

1,450

1,350

1,250

 

 

 

 

NET WORTH

 

 

 

1,250

1,250

1,250

 

 

 

100

180

274

Term Loan

Paid up Capital Directors Loan(subordinated) Retained Earnings

Page 19 of 16

Reserves

96

  BALANCE

125

161

 

 

 

TRUE

TRUE

TRUE

Difference (if any)

0

0

0

Input of Income Statement Items AHMED TOYS (PVT.) LIMITED Auditor Analyst FYE Period Amount

AUDITED M. Hossain Dec 31,2009 12 Mths in (000) Taka

AUDITED M. Hossain Dec 31,2010 12 Mths in (000) Taka

AUDITED M. Hossain Dec 31,2011 12 Mths in (000) Taka

1,132

1,245 0

1,325 0

0

0

0

Less :Cost of Goods Sold

681

676

642

Less: Selling. Gen. & Admin. Expenses

37

44

47

Less: Depreciation Less: Interest Expense

287 13

362 13

436 14

Add: Other Income

0

0

0

Income Taxes

11

15

20

Reserve Cash Withdrawals/Dividend

23 17

29 26

36 36

TRUE

TRUE

INCOME STATEMENT Gross Sales Less:VAT Add: Other Operating Income

BALANCE

Difference (if any)

0

0

Page 20 of 16

Output of Balance Sheet Auditor  Analyst    FYE Period Amount

AUDITED

%

AUDITED

%

AUDITED

%

M. Hossain

TBS

M.Hossain

TBS

M. Hossain

TBS

Dec 31,09

 

Dec 31,10

 

Dec 31,11

 

12 Mths

 

12 Mths

 

12 Mths

 

Tk. (000) 

 

Tk. (000) 

 

Tk. (000)

 

CURRENT ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash/Bank Balances

7

0

33

1

147

4

L/C margin

5

0

32

1

35

1

Fixed Deposits/Marketable Securities

0

0

40

1

76

2

25

1

70

2

200

6

Accounts Receivable ­ Others

0

0

0

0

0

0

Goods­in­transit

0

0

0

0

0

0

Acc. Receivables­Trade

Inventory

88

3

88

3

90

3

Total Inventory

88

3

88

3

90

3

Due from Affiliates ­ Current TOTAL CURRENT ASSETS  

FIXED ASSETS Gross Fixed Assets Less: Depreciation NET FIXED ASSETS  

NON­CURRENT ASSETS Due from Principal, Emp, Affiliate, &  Investment Advance Income Tax Deferred Charges,Pre­pymts & Adv. TOTAL NON­CURRENT ASSETS  

TOTAL ASSETS  

0

0

0

0

0

0

125

4

263

8

548

17

 

 

 

 

 

 

 

0

 

0

 

0

3,766

110

3,818

118

3,892

119

528

15

890

27

1,326

40

3,238

95

2,928

90

2,566

78

 

 

 

 

 

 

 

0

 

0

 

0

40

1

40

1

150

5

0

0

0

0

0

0

10

0

14

0

16

0

3,288

96

2,982

92

2,732

83

 

 

 

3,413

100

3,245

0

100  

 

0

3,280

100

 

 

 

 

 

Short Term Bank Borrowings

300

9

142

4

161

5

Current Funded Portion of Term Debt 

100

3

100

3

100

3

Account Payable ­ Trade

29

1

9

0

21

1

Accrued Items  + Dues to Directors

60

2

48

1

7

0

Provision for Income Tax/Def. I/T 

11

0

15

0

20

1

Advance Payment

0

0

0

0

0

0

Dividends Payable

17

0

26

1

36

1

517

15

340

10

345

11

 

 

 

 

0

 

TOTAL CURRENT LIABILITIES  

LONG TERM LIABILITIES

 

0

 

 

 

0

Term Loan

1,450

42

1,350

42

1,250

38

TOTAL LIABILITIES

1,967

58

1,690

52

1,595

49

NET WORTH Paid up Capital Directors Loan(subordinated) Retained Earnings

 

0

 

0

 

0

1,250

37

1,250

39

1,250

38

0

0

0

0

0

0

100

3

180

6

274

8

Page 21 of 16

Reserves

96

3

125

4

161

5

NET WORTH

1,446

42

1,555

48

1,685

51

LIABILITIES & NET WORTH

3,413

100

3,245

100

3,280

100

Page 22 of 16

Output of Income Statement AHMED TOYS (PVT.) LIMITED

Auditor 

AUDITED

%

AUDITED

%

AUDITED

%

Sales

M.  Hossain

Sales

Analyst   

M. Hossain

Sales

M.  Hossain

FYE

Dec 31,2009

 

Dec  31,2010

 

Dec  31,2011

 

Period

12 Mths

 

12 Mths

 

12 Mths

 

Amount

in (000)  Taka

 

in (000)  Taka

 

in (000)  Taka

 

 

 

 

 

 

 

 

INCOME STATEMENT

 

 

 

 

 

 

  Gross Sales

 

 

 

 

 

 

1,132

100

1,245

100

1,325

100

Less:VAT

0

0

0

0

0

0

Net Sales

1,132

100

1,245

100

1,325

100

0

0

0

0

0

0

Add: Other Operating Income Total Sales Revenue

1,132

100

1,245

100

1,325

100

Less :Cost of Goods Sold

681

60

676

54

642

48

GROSS PROFIT/REVENUE

451

40

569

46

683

52

0

0

0

0

0

0

0

Less: Selling. Gen. & Admin.  Expenses

37

3

44

4

47

4

0

0

0

0

0

0

0

414

37

525

42

636

48

0

0

0

0

0

0

Less: Depreciation

287

25

362

29

436

33

Less: Interest Expense

13

1

13

1

14

1

0

 

0

 

0

 

0

0

 

0

 

0

 

0

114

10

150

12

186

14

0

0

0

0

0

0

0

0

0

0

0

0

0

Income Taxes

11

1

15

1

20

2

TOTAL OPERATING PROFIT  (EBITDA) 0

PROFIT BEFORE TAXES & EXTR  ITEM Add: Other Income

0

0

0

0

0

0

0

NET PROFIT

103

9

135

11

166

13

Reserve

23

2

29

2

36

3

Cash Withdrawals/Dividend

17

2

26

2

36

3

0 TOTAL CHANGES IN RETAINED 

 

0

 

0

 

0

63

6

80

6

94

7

Page 23 of 16

EARNINGS

Page 24 of 16

Output of Ratios AHMED TOYS (PVT.) LIMITED FINANCIAL RATIOS

Dec 31,2009

Dec 31,2010

Dec 31,2011

 

%

%

%

GROWTH RATIOS:

 

 

 

Sales Growth, Sales%

N/A

9.98

6.43

Net Sales Growth, Composite %

N/A

9.98

6.43

Net Income Growth, %

N/A

31.07

22.96

Total Assets Growth, %

N/A

­4.92

1.08

Total Liabilities Growth, %

N/A

­14.08

­5.62

Net Worth Growth, %

N/A

7.54

8.36

 

 

 

 

PROFITABILITY RATIOS:

 

 

 

Gross Margin, Composite %

39.84

45.70

51.55

SG & A, %

3.27

3.53

3.53

Cushion (Gross Margin ­ SG&A), %

36.57

42.17

48.00

Depreciation, Amortization, %

25.35

29.08

32.91

Operating Profit Margin, %

36.57

42.17

48.00

Interest Expense, %

1.15

1.04

1.06

Operating Margin, %

10.07

12.05

14.04

Net Margin, %

9.10

10.84

12.53

Return on Assets, %

3.02

4.16

5.06

Return on Equity, %

7.12

8.68

9.85

Cash Withdrawal/Dividend Payout Rate, %

16.50

19.26

21.69

 

 

 

  COVERAGE RATIOS:

 

 

 

Interest Coverage (EBIT/Total Interest)

9.77

12.54

14.29

Debt Ser.Coverage(EBITDA/Total Interest+CMLTD)

3.66

4.65

5.58

 

 

 

 

ACTIVITY RATIOS:

 

 

 

Receivables in Days

8

21

55

Payables in Days

16

5

12

Inventory in Days

47

48

51

Sales/Total Assets (X)

0.3

0.4

0.4

 

 

 

 

LIQUIDITY RATIOS:

 

 

 

 

 

 

 

Working Capital

­392

­77

203

Quick Ratio (X)

0.07

0.51

1.33

Current Ratio (X)

0.24

0.77

1.59

Sales/ Net Working Capital (X)

­2.89

­16.17

6.53

 

 

 

 

LEVERAGE RATIOS:

 

 

 

1.36

1.09

0.95

Total Liabilities/ Net Worth (X)

Page 25 of 16

Affiliate Exposure/Net Worth (%)

2.8

2.6

8.9

Total Liabilities/(Net Worth­Affiliates) (X)

1.40

1.12

1.04

Page 26 of 16

Output of Cash Flow Statement FYE

 

Period

 

12 Mths

12 Mths

Amount

 

in (000) Taka

in (000) Taka

 

 

 

 

Dec 31,2010

Dec 31,2011

CASH FLOW STATEMENT

 

 

 

Profit Before Tax and Extra Items

 

150

186

 Add: Interest Expense

 

13

14

 Add: Depreciation

 

362

436

Add/Minus: Change in Deferred Taxes

 

4

5

 

 

 

 

529

641

 

EBITDA Cash Flow  

 

 

 

Less: Interest Expense

 

­13

­14

Less:  Taxes

 

­15

­20

Less: Dividends

 

­26

­36

 

 

 

 

475

571

 

CF Before Investing Activities  

 

 

 

Less: Capital Expenditures

 

­52

­74

 

 

 

 

CF Before Working Capital Changes

 

423

497

 

 

 

 

Plus/Minus: Change in Accts Receivable

 

­45

­130

Plus/Minus: Change in Inventory

 

0

­2

Plus/Minus:Change in Prepaid Expense

 

­4

­2

Plus/Minus:Change in Mkt. Securities

 

­40

­36

Plus/Minus: Change in Accounts Payable

 

­20

12

Plus/Minus: Change in Accued Expenses

 

­12

­41

Plus/Minus: Change in Dividends Payable

 

9

10

Total Working Capital Changes

 

­112

­189

 

 

 

 

CF Before Intercompany Transaction

 

311

308

 

 

 

 

Plus/Minus: Inter Trade Rec from/to Affil.

 

0

­110

 

 

 

 

CF Before Other B/S Movements

 

311

198

 

 

 

 

Plus/Minus: Other B/S Movements

 

0

0

 

 

 

 

Financing Needs/Surplus

 

311

198

Share Capital/Directors Loan

 

0

0

Plus/Minus:  ST Bank Debt

 

­158

19

Plus/Minus:  LT Bank Debt

 

­100

­100

Total Financing

 

­258

­81

 

 

 

 

CF after Financing

 

53

117

Plus/Minus: Change In Cash

 

53

117

 

 

 

 

Difference

 

0

0

[Our Lord! We have wronged ourselves. If You forgive us not, and bestow not upon us Your mercy, we shall certainly be of the losers] Page 27 of 16

(Al Quran_Sura Araf 7:23)

Page 28 of 16

Sheet 10 BANK RECONCILIATION Md. Mahabbat Hossain Faculty Member, BIBM Phone: 01716­37 35 65 Reconciling Bank Statement  Because the bank and the depositor maintain independent records of the depositor’s checking account,  we might assume that the respective balances will always agree. In fact, the two balances are seldom  the same at any given time, and it is necessary to make the balance per books agree with the balance  per bank. This process is known as reconciling the bank account and a bank reconciliation statement is  prepared for this purpose. The lack of agreement between the two balances is due to: 1. Time lags that prevent one of the parties from recording the transaction in the same period. 2. Errors by either party in recording transactions. Steps in the Reconciliation Procedure  To   obtain   maximum  benefit   from  bank  reconciliation,  the   reconciliation   should   be   prepared   by an  employee who has no other responsibilities pertaining to cash. In reconciling the bank account, it is  customary to reconcile the balance per books and balance per bank to their adjusted cash balances.  The following steps should reveal all the reconciling items that cause the difference between the two  balances. 1.

Determine deposits in transit and are added to the balance per bank.

2.

Determine outstanding checks and are deducted from the balance per bank.

3.

Trace bank debit memoranda and are deduct from the balance per book.

4.

Trace bank credit memoranda and are added to the balance per book.

5.

Any error identified should be adjusted with balance as per bank or book.  

Exercise 1   The bank statement for the Laird Company shows a balance per bank of $ 15,907.45 on April 30, 2005.  On this date the balance of cash per books is $ 11,589.45. From the forgoing steps, the following  reconciling items are determined. 1.

Deposit in transit: April 30 deposit (received by bank on May 1)

2.

Outstanding checks: No. 453 $ 3,000; No. 457 $ 1,401.30; No. 460 $ 1502.70

$ 2,201.40

Page 1 of 9

3.

Errors: Check No. 443 was correctly written by Laird for $ 1,226.00 and  was correctly paid by the bank. However, it was recorded for $ 1,262.00 by Laird Company.

4.

Bank memoranda: 

Debit –NSF check from J. R. Baron

$ 425.60

Debit –Printing company checks charge 

$ 30.00

Credit –Collection of note receivable for $ 1,000.00  plus interest earned $ 50,less bank collection fee 

$ 1,035 

Instruction (a) Prepare a Bank Reconciliation Statement (b) Make the necessary journal entries

Page 2 of 9

Solution to Exercise 1 W. A. LAIRD COMPANY Bank Reconciliation April 30, 2005 Cash balance per bank statement

$ 15,907.45

Add:  Deposits in transit

2,201.40

18,108.85 Less:  Outstanding checks No. 453

$ 3,000.00

No. 457

1,401.30

No. 460

1,502.70

5,904.00

Adjusted cash balance per bank

$ 12,204.85

Cash balance per books

$ 11,589.45

Add:  Collection of $1,000 note receivable plus interest earned $50, less collection fee $15

$ 1,035.00

Error in recording check 443

36.00

1,071.00 12,660.45

Less:  NSF check

425.60

Bank service charge

30.00

455.60

Adjusted cash balance per book

$ 12,204.85

General Journal Date April 30

Account Titles and Explanation Cash/Bank Bank Service Charge

Debit

Credit

1035 15

Notes Receivable

1000

Interest Revenue

50

(To record collection of N/R) April 30

Cash/Bank

36

Accounts Payable

36

(To correct the error in recording check No. 443) April 30

Accounts Receivable 

425.60

Cash/Bank

425.60

(To record NSF check) April 30

Bank Service Charge

30

Page 3 of 9

Cash/Bank

30

(To record printing charge)

Page 4 of 9

Problem 1 Pavel Company’s Bank statement for May 2007 shows the following data: Credit Balance on May 01, 2007 

Tk. 12,650

Debit Balance on May 31, 2007

Tk. 720

The cash balance per books shows a credit balance at May 31, 2007 is Tk. 1,681. Your review of the  data reveals the following: 1. NSF Check Tk. 175 2. The Note collected by the bank was a Tk. 500, 3 –month, 12% note. The bank charges a Tk. 10 collection fee. No interest has been accrued 3. Outstanding checks at May 31, 2007 total Tk. 2,410 4. Deposits in transit at May 31, 2007 total Tk. 1,752 5. Pavel Company check for Tk. 352 dated May 10 cleared the bank on May 25. This check,  which was a payment on account, was journalized for Tk. 325. Instruction

(b) Prepare a bank reconciliation statement at May 31, 2007 (c) Journalize the entries required by the reconciliation

Problem 2 The cash book of Natasha Ltd. Showed a balance of Tk. 2791 on the 31 st December, 2005. When the  bank statement is received in the first week of January 2006, the following data were available for  reconciling the statement: a) A draft deposited but not credited for Tk. 520 b) A check issued to a supplier was not presented for encashment Tk. 2500 c) Bank charges debited in the bank statement Tk. 35 d) A check issued for Tk. 84 on account of advertising expenses was not yet paid by bank e) Bank directly collected a bill for Tk. 500 and bank charge was Tk. 5 f) Interest credited by the bank was Tk. 185 g) Bank statement balance was Tk. 5500 Problem 3 The cash in bank account for Matin Co. at July 31, of the current year indicated a balance of Tk.  12,192.50 after both the cash receipts journal and check register for July had been posted. The bank  statement indicated a balance of Tk. 19,955.65 on July 31. Comparison with the records revealed the  following reconciling items:

Page 5 of 9

1. A deposit of Tk. 4,015.20, representing receipts of July 31, had been made too late to  appear on the bank statement. 2. Checks outstanding total Tk. 9090.75. 3. The bank had collected for Matin Co. Tk. 3,045.00 on a note left for collection. The face  value of the note was Tk. 3,000.00. 4. A check drawn for Tk. 470.00 had been erroneously charged by the bank as Tk. 740.00 5. A check for Tk. 72.50 had been recorded in the check register as Tk. 7.25. The check was  for   the   payment   of   an   obligation   to   Shams   Equipment   Co.  for   the   purchase   of  office  equipment on account 6. Bank service charges for July amounted to Tk. 22.15 

Prepare a Bank Reconciliation Statement and make necessary journal entries.

Page 6 of 9

Problem 4 The cash in bank account for Iqbal Company on December 31, 2005 indicated a balance of Tk. 3600  after both the cash receipts and the check register for December had been posted. The statement  indicated a balance of Tk. 40,000 on December 31, 2005. Comparison of the bank statement and the  accompanying cancelled checks and memorandum with the records, revealed the following reconciling  items: 1. Total checks outstanding Tk. 25,000 2. A deposit of Tk. 10,000 representing receipts of December 31 had been made to late to  appear on the bank statement. 3. A check for Tk. 20,000 drawn by Imad Company had been erroneously charged the bank  to Iqbal Company’s account. 4. A check for Tk. 21,000 had been recorded in the check register of Iqbal Co. as Tk. 12,000 5. The bank had collected for Iqbal Co. Tk. 50,500 on a note left for collection. The face value  of the note was Tk. 50,000 6. Bank service charge for December amounted to Tk. 100. Instruction

a) Prepare a Bank Reconciliation Statement b) Make the necessary journal entries.

Problem 5  Mario  Tizani Company’s bank  statement  from Last National  Bank at August 31, 2005, shows the  following information: Balance, August 1 August deposits

Tk. 17,400 Bank Credit Memoranda: 73,110

Collection   of   note   receivable   plus Tk. 90 interest

Checks cleared in August

69,660

Interest earned

Balance, August 31

25,932 Bank Debit Memoranda: Safety deposit box rent

Tk. 5,090 32 40

A summary of the Cash account in the ledger for August shows: Balance, August 1, Tk. 16,900;  receipts Tk. 77,000; disbursements Tk. 73,570; and balance August 31, Tk. 20,330. Analysis reveals  that the only reconciling items on the July 31 bank reconciliation were a deposit in transit for Tk. 4,000  and outstanding Tk. 4,500. The deposit in transit was the first deposit recorded by the bank in August.  In addition, you determine that there were two errors involving company checks drawn in August: (1) A 

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check for Tk. 400 to a creditor on account that cleared the bank in August was journalized and posted  for Tk. 420. (2) A salary check to an employee for Tk. 275 was recorded by the bank for Tk. 278.

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Problem 6  Cell Ten Company maintains a checking account at the Commerce Bank. At July 31, selected data  from the ledger balance and the bank statement are as follows: Cash in Bank Per Book Balance, July 1 July Receipts

Tk. 17,600

Per Bank Tk. 18,800

81,400

July Credits

80,470

July Disbursements

77,150

July Debits

74,756

Balance, July 31

Tk. 21,850

Tk. 24,514

Analysis of the bank data reveals that the credits consist of Tk. 79,000 of July deposits and a credit  memorandum of Tk. 1,470 for the collection of a Tk. 1,400 mote plus interest revenue of Tk. 70.  The July debits per bank consist of checks cleared Tk. 74,700 and a debit memorandum of Tk. 56 for  printing additional company checks. You also discover the following errors involving July checks:  (1)

A check for Tk. 230 to a creditor on account that cleared the  bank in July was journalized and posted as Tk. 320.

(2)

A salary check to an employee for Tk. 255 was recorded by the  bank for Tk. 155.

The June 30 bank reconciliation contained two reconcile items:  (a) deposits in transit Tk. 5,000 and  (b) outstanding checks of Tk. 6200. Problem 7 The cash book of Nishu (Pvt.) Ltd. showed a balance of Tk. 3950 on the May 31, 2008. When the  bank statement is received in the first week of June 2008, the following data were available for  reconciling the statement: a) A draft deposited but not credited for Tk. 2800 b) Bank directly collected a bill for Tk. 5000 on behalf of the company

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c) A check issued to a supplier was not presented for encashment Tk. 2750 d) Bank charges debited in the bank statement Tk. 550 e) Total NSF Check was Tk. 3000 f)

Bank statement balance on May 31, 2008 was Tk. 5350 

Instruction:  (a) Prepare a Bank Reconciliation Statement  using corrective balance  method  (b) Make the necessary journal entries

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Solution Problem 1 PAVEL COMPANY Bank Reconciliation May 31, 2007 Cash balance per bank statement

 (720)

Add:  Deposits in transit

1,752

Less:  Outstanding checks

 (2,410)

Adjusted cash balance per bank

(1378)

Cash balance per books

(1681)

Add:  Collection of $ 500 note plus interest $ 15, less charge $ 10 Less:  NSF check

505

175

Error in recording check

27

(202)

Adjusted cash balance per book

(1378)

General Journal Date May 31

Account Titles and Explanation

Debit

Cash/Bank

Credit

505

Bank Service Charge

10

Notes Receivable

500

Interest Revenue

15

(To record collection of N/R) May 31

Accounts Receivable

175

Cash/Bank

175

(To record NSF check) May 31

Accounts Payable

27

Cash/Bank

27

(To correct the error in recording check) Solution Problem 2 NATASHA LTD Bank Reconciliation Statement December 31, 2005 Bank balance as per bank Add. Deposit in transit

5500 Bank Balance as per book 520 Add. Collection by bank 6020

Interest Revenue

2791 495 185

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3471 Less. Outstanding Check  Tk. 2500 Outstanding Check            84  .

Less. Bank Charge (2584)

Adjusted balance as per bank 1. Cash/Bank Bank Services Charge Notes Receivable

(35)

3436 Adjusted balance as per book 495

2. Cash/Bank

    5

3436 185

Interest Revenue 500

3. Bank Charge Cash/Bank

185 35 35

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Solution 3 MATIN COMPANY Bank Reconciliation Statement July 31, 2006 Bank balance as per bank

19955.65 Bank Balance as per book

Add. Deposit in transit

4015.20 Add. Collection by bank

Overcharge by bank (740­470) 

12192.50 3045.00

270.00 24240.85

Less. Outstanding Check Adjusted balance as per bank

15237.50

(9090.75) Less. Error in recording (72.50­7.25)

(65.25)

 Bank Charge

(22.15)

15150.10 Adjusted balance as per book

15150.10

General Journal Date July 31

Account Titles and Explanation Cash/Bank

Debit

Credit

3045.00

Notes Receivable

3000.00

Interest Revenue

45.00

(To record collection of N/R) July 31

Bank Charge

22.15

Cash/Bank

22.15

(To record bank charge) July 31

Accounts Payable

65.25

Cash/Bank

65.25

(To correct the error) Solution 4 Bank balance as per bank

40,000 Bank Balance as per book

Add. Deposit in transit

10,000 Add. Collection by bank

Error by bank 

54,100

(25,000) Less. Error in recording (21000­12000)  Bank Charge

Adjusted balance as per bank

50,500

20,000 70,000

Less. Outstanding Check

3600

45,000 Adjusted balance as per book

(9,000) (100) 45,000

General Journal

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Date December 31

Account Titles and Explanation Cash/Bank

Debit

Credit

50500

Notes Receivable

50000

Interest Revenue

500

(To record collection of N/R) December 31

Accounts Payable

9000

Cash/Bank

9000

(To correct the error) December 31

Bank Charge Cash/Bank

100 100

(To record bank charge)

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Solution 5  MARIO TIZANI COMPANY Bank Reconciliation Statement August 31, 2005 Bank balance as per bank

25,932 Bank Balance as per book

Add. Deposit in transit

20,330

Add. Collection by bank

(77,000­(73,110­4000))

7,890

Error by bank (278­275)

3

Less. Outstanding Check

5,090

Interest

32

Error in recording (420­400)

20

Less.  Bank Charge

(40)

(73,570­20­(69660­3­4500))

(8,393)

Adjusted balance as per bank

25,432 Adjusted balance as per book

25,432

General Journal Date August 31

Account Titles and Explanation Cash/Bank

Debit

Credit

5090

Notes Receivable

5000

Interest Receivable

90

(To record collection of N/R with interest) August 31

Cash/Bank

32

Interest Revenue

32

(To record Interest revenue credited by bank) August 31

Cash/Bank

20

Accounts Payable 

20

(To correct the error) August 31

Bank Charge Cash/Bank

40 40

(To record bank charge)

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Solution 6 CELL TEN COMPANY Bank Reconciliation Statement July 31, 2005 Bank balance as per bank

24,514 Bank Balance as per book

Add. Deposit in transit

21,850

Add. Collection by bank

(81,400­(79,000­5,000))

7,400

1,470

Error in recording (320­230)

90

Less. Outstanding Check ((77,150­90)­(74700+100­6200))

(8,460)

Error by bank (255­155) Adjusted balance as per bank

(100) Less.  Bank Charge

(56)

23,354 Adjusted balance as per book

23,354

General Journal Date August 31

Account Titles and Explanation

Debit

Cash/Bank

Credit

1470

Notes Receivable

1400

Interest Receivable

70

(To record collection of N/R with interest) August 31

Cash/Bank

90

Accounts Payable 

90

(To correct the error) August 31

Bank Charge

56

Cash/Bank

56

(To record the bank charge)

Solution to 7 Bank balance as per bank

5350 Bank Balance as per book

3950

Add. Deposit in transit

2800 Add. Collection by bank

5000

Less. Outstanding Check  

2750 Less. Bank Charge

(550)

NSF Adjusted balance as per bank

5400 Adjusted balance as per book

(3000) 5400

General Journal

Page 16 of 9

Date May 31

Account Titles and Explanation Cash/Bank

Debit

Credit

5000

Notes Receivable

5000

 (To record collection of N/R) May 31

Bank Charge

550

Cash/Bank 

550

(To record bank charge) May 31

A/R

3000 Cash/Bank

3000

(To record NSF)

Page 17 of 9

SHEET 11 PREPARATION OF FINANCIAL STATEMENTS OF BANKS*  Definition of Accounting Accounting is an information system that identifies the business transactions, records and process those transactions and communicates the accounting information of an organization to the interested users through the Financial Statements.  Financial Statements Financial Statements are the output of accounting system. Accounting communicates the financial information to the interested users through FS. The objective of Financial Statements is to provide information about the financial position, financial performance and cash flows of an entity.  Components of Financial Statements As per the Bank Companies Act, 1991 (Amendment, BRPD Circular # 14/2003) and BRPD Circular # 15/2009, a complete set of Financial Statements comprises: (a) (b) (c) (d)

A Balance Sheet An Income Statement A Statement of Changes in Equity A Cash Flow Statement (e) Liquidity Statement (Assets & Liabilities Maturity Statement) and (f) Explanatory Notes to the Financial Statements.  Laws and Regulations For preparing the Financial Statements of banks, the following lows and regulations act as guidelines:         

  

The Companies Act, 1994 The Banking Companies Act, 1991 The Securities and Exchange Ordinance 1969 Securities and Exchange Rules 1987 International Accounting Standards (IAS) Bangladesh Accounting Standards (BAS) International Financial Reporting Standards (IFRS) Bangladesh Financial Reporting Standards (BFRS) The Listing Regulations of DSE and CSE Bangladesh Bank Circular (BCD and BRPD Circular) Accounting Standards for Islamic Financial Institutions developed by AAOIFI Standards issued by Islamic Financial Service Board (IFSB)

*Compiled by Md. Mahabbat Hossain, BIBM, Phone: 01716 37 35 65; Email: [email protected] 1

 Major Regulators of Banking Companies in Bangladesh for disclosure issues 1. 2. 3.

4. 5. 6. 7.

Bangladesh Bank (BB) The Registrar of Joint Stock Companies and Firms (RJSC) Bangladesh Securities Exchange Commission (BSEC) Dhaka Stock Exchange Limited (DSE) Chittagong Stock Exchange Limited (CSE) Accounting and Auditing Organization for Islamic Financial Institution (AAOIFI) Islamic Financial Service Board (IFSB)

 Major Disclosure Provision under Banking Companies Act, 1991 Section 2 of Banking Companies Act, 1991 states that the provisions bearing of this Act shall be in addition to and not , save as hereinafter express by provided, in derogation of, the Companies Act, 1994 and any other laws for the time being in force. Besides, the banking companies should comply with provisions of the Companies Act 1994 as the banking companies are registered with the registered joint stock companies as a company, if otherwise expressed in the Banking Companies Act, 1991. As per section 24 of this Act, every bank shall make a reserve fund and if the amount in that fund together with amount in the share premium account is below the amount than its paid up capital Bank will transfer to the reserve fund not less than 20 percent on profit before tax and it should be disclosed in the profit and loss account made under section 38 of this Act. According to Section 38, the accounts and balance sheet of a banking company will be prepared as per BRPD circular 14/2003 and also the provision of the Companies Act, 1994. Financial audit of the financial statement of the banking companies is mandatory by a person who is qualified according to the Bangladesh Chartered Accountants Order, 1973 and auditor is required to state whether or not adequate provisions have been made, financial reports has been made in accordance with the standard issued by the Bangladesh Bank (As per section 39).  Major Disclosure Provisions under IAS 30 (BAS 30) Paragraph 8 of IAS 30 states that like other business entity, banks may use different methods for recognition and measurement of items in their financial statements. Therefore, for better understanding of the users of accounting information, banks should disclose the accounting policies that are followed for preparing financial statements. Banks should disclose the policy regarding the recognition of the principal types of income; policy regarding the valuation of investment and dealing securities; the distinction between those transactions and other events that result in the recognition of assets and liabilities on the balance sheet and those transactions and other events that only give rise to contingencies and commitments; the basis for the determination of losses on loans and advances and for writing off uncollectable loans and advances; the basis for the determination of charges for general banking risks and the accounting treatment of such charges. 2

As per Paragraph 9, income and expenses should be presented in the income statement as grouped by nature and principal types of income and expenses and should be disclosed separately. It is no longer required to group the assets and liabilities as currents and noncurrents (Paragraph 20). According to Paragraph 23, bank should not offset any asset or liability with other liability or asset unless a legal right of set-off exists and the offsetting represents the expectation as to the realization or settlement of the asset or liability. It is mentioned in the Paragraph 24 that a bank should disclose the fair values of each class of its financial assets and liabilities. Financial assets should be presented by classification as loans and receivables originated by the enterprise, held to maturity investments, held for trading, and available-for-sale (Paragraph 25). According to Paragraph 26, Bank should disclose the amount and nature of contingent liabilities and commitments. It is mentioned in the Paragraph 30 that a bank shall disclose an analysis of assets and liabilities into relevant groupings based on the remaining period at the balance sheet date to the contractual maturity date. Paragraph 33 has provided the maturity grouping of assets and liabilities as: up to 1 month, from 1 month to 3 months, from 3 months to 1 year, from 1 year to 5 years and from 5 years and above. Paragraph 34 states that in the maturity grouping, maturity period of assets and liabilities should be same. As mention in the Paragraph 35, maturity could be expressed in terms of the remaining period to the repayment date, the original period to the repayment date, or the remaining period to the next date at which interest rates may be changed. A bank should disclose an analysis expressed in terms of contractual maturities (Paragraph 36) and if there is no contractual maturity date, bank should assume the expected date on which the assets will be realized (Paragraph 37). Paragraph 39 prescribes that management may provide, in its commentary on the financial statements, information about the effective periods and about the way in manages and controls the risks and exposures associated with different maturity and interest rate profiles.  Major Disclosure Provisions under IFRS 7 (BFES 7) IASB issued IFRS 7 in August 2005 that supersedes IAS 30 (IFRS 7). In Bangladesh, ICAB adopted it as BFRS 7 and made it effective from on or after January 1, 2010. Bangladesh Bank did not issue any circular requiring compliance with BFRS 7. Therefore, it is mandatory for listed banking companies to comply with BFRS 7 but not mandatory for all schedule banks. Now banks are using different techniques for measuring and managing exposure to risks arising from financial instruments. The users of financial statements need information about an entity’s exposure to risks and how those risks are managed (IFRS 7). For ensuring greater transparency regarding risks this standard was issued. BFRS 7 requires disclosure of qualitative and quantitative information about exposure to risks arising from financial instruments, including credit risk, liquidity risk and market risk. Management’s objectives, policies and processes for managing the risks should be disclosed qualitatively. The quantitative disclosures include information about the extent to which the entity is exposed to risks (IFRS 7). 3

 Major Disclosure Provisions under BRPD Circular (BRPD #14/2003, Dated June 25, 2003) BRPD Circular was issued by Bangladesh Bank to replace the BRPD Circular No. 03 dated 18 April 2000. It has been decided to amend the forms of financial statements and directives for preparation thereof with a view to bringing in more disclosure in the financial statements of the bank companies. The forms of the first schedule of the Bank Companies Act, 1991 as amended under sub-section 38(4) of the act have been annexed with this circular. The financial statements to be prepared as per the amended forms and instructions taking effect from the last working day of the year 2003 will help the users of the statements get adequate and transparent idea about the concerned bank company. It will be applicable for all bank companies and other financial institutions working in Bangladesh. Financial statements should include clear and concise disclosure of all significant aspects of accounting principles and procedures, which have been followed. The disclosure of all the significant accounting principles adopted shall be an integral part of the financial statements. The notes to the financial statements shall provide relevant details of the items included in balance sheet, profit and loss account, cash flow statement, liquidity statement and statement of changes in equity, so that adequate disclosures are made for clear understanding of the users. The liquidity statement should be prepared according to the remaining maturity grouping. A bank whose ordinary shares are publicly traded should present Earning Per Share (EPS) on the face of Profit and Loss Account, both in case of profit or loss per share. The bank should make a disclosure by way of note to the financial statements of the calculation of Earning Per Share in accordance with IAS-33. The financial statements should disclose the relationship and transactions between the bank and its related parties till the date on which the statements are prepared. Names of the members of the audit committee formed by the board of directors of the bank and their qualifications should be disclosed. Confirmation as to the number of meetings of the audit committee held with the bank's senior management to consider and review the bank's financial statements, the nature and scope of audit reviews and the effectiveness of the system of internal control and compliance thereof should be made. The income items should be treated as income when there exists no risk or uncertainty regarding its realization. Figures should be rounded off to nearest Taka. Highlights of the bank should be presented in the annual report. Copies of financial statements including the Balance Sheet should be preserved in each of the bank branches, so that the customers of the bank may readily use those on request. Besides, the Highlights and Balance Sheet should be affixed in a visible place of each bank branch. The financial statements should be published in widely circulated one Bangla and one English daily newspapers within one week of submission of the statements to Bangladesh Bank. These should also be disclosed in the bank's website. 4

Balance Sheet as at ………………………. Particulars

Note

PROPERTY AND ASSETS Cash Cash in hand (including foreign currencies) Balances with BB and Sonali Bank (including foreign currencies) Balances with other Banks and Financial Institutions In Bangladesh Outside Bangladesh Money at call and short notice Investments Government Others Loans and advances Loans, Cash Credits, Overdrafts etc. Bills purchased & discounted Fixed assets including land, building, furniture etc. Other assets Non-banking assets TOTAL ASSETS LIABILITIES AND CAPITAL Borrowings from other Banks, Financial Institutions and agents Deposits and other accounts: Current Deposits and other accounts, etc Bills payable Savings Bank Deposits Bearer Certificates of Deposits Term Deposits Other deposits Other liabilities TOTAL LIABILITIES Shareholders Equity/Capital Paid up capital Statutory reserve Other reserves Balance of Profit and Loss Account TOTAL SHAREHOLDERS' EQUITY 5

Current Year (Taka)

Previous Year (Taka)

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY Particulars

Note

Current Year (Taka)

Previous Year (Taka)

Off Balance Sheet Items Contingent Liabilities Acceptances and endorsements Letters of Guarantees Irrevocable letter of credit Bills for collection Other Contingent Liabilities Total Contingent Liabilities Other commitments Documentary Credits and short term trade-related transactions Forward assets purchased and forward deposits placed Undrawn note issuance and revolving facilities Undrawn formal standby facilities, credit lines and other commitments Sport and forward foreign exchange rate contracts Other exchange contracts Total off Balance Sheet items

Income Statement, For the year ended …………………… Particulars

Note

Interest income Less: Interest paid on deposits and borrowings Net Interest income Income from investments Commission, exchange and brokerage Other operating income Total operating income Less: Operating Expenses Salary and allowances Rent, taxes, insurance, electricity etc fees Legal expenses Postage, stamp, telecommunication etc Audit fees Stationery, printing, advertisement, etc. Managing Director's Salary and allowances 6

Current Year (Taka)

Previous Year (Taka)

Directors' fees Loan losses Repairs, maintenance and depreciation Other expenses Total Operating Expense Profit before provisions Provision for loans and advances Specific Provision General Provision Provision for diminution in value of investments Provision against other classified assets Other Provisions Total Provision Profit before tax for the year (PBT) Provision for tax Current Tax Deferred tax Net Profit after tax for the year Appropriations: Statutory reserve General Reserve Proposed cash dividend Total Appropriations Retained Earnings Earnings Per Share Reference: Bangladesh Bank (2003), Amendments to the forms of the First Schedule of the Bank Companies Act 1991, BRPD Circular No. 14/2003 dated June, 25, 2003. Government of the People’s Republic of Bangladesh (1987), Securities and Exchange Rules, 1987, The Bangladesh Gazette No. S.R.O 237-L/87, Dhaka, the 28th September, 1987. Government of the People’s Republic of Bangladesh (1991), The Banking Companies Act, 1991, Act No. 14 of 1991. Government of the People’s Republic of Bangladesh (1994), The Companies Act, 1994, Act No. 18 of 1994. The Chittagong Stock Exchange (CSE) (1997), Listing Regulations of the Chittagong Stock Exchange Limited-CSE, dated May 29, 1997. The Dhaka Stock Exchange (DSE) (1996), Listing Regulations of the Dhaka Stock Exchange Limited, Notification No. SEC/Member-II, dated April 8, 1996. The Institute of Chartered Accountants of Bangladesh (ICAB) (2006), Bangladesh Accounting Standards (BAS) and Bangladesh Financial Reporting Standards (BFRS), Vol. 1 & 2, published in July 2006. Website of Bangladesh bank, http://www.bangladesh-bank.org 7