Professional Development Programme on Enriching Knowledge of the Business, Accounting and Financial Studies (BAFS) Curriculum Learning Resources Corner Course 1: Contemporary Perspectives on Accounting Unit 2: Financial Statements Preparation 1 Basic Book-keeping Skills for Learners Case Study 2: Trading Business This Case Study shows how to track entries from the book of original entries (sales daybook, purchases daybook and general journal) right through to the preparation of final accounts for a sole proprietor engaged in a trading business. Moreover, the case study demonstrates the preparation of final accounts for internal use and external use (in accordance with HKAS 1 Presentation of Financial Statements). Background Mr. W. Lo, a sole proprietor has operated in the business of wholesaling electrical goods for a year. You have recently been employed by Mr. W. Lo as a qualified accountant to maintain the daily accounting records and prepare his monthly financial statements. After discussions with Mr. W. Lo and obtaining relevant documents, books and records, you have established an opening trial balance as at 1 January 2007, as follows: W. Lo s Trial Balance as at 1 January 2007 Accounts Name Debit Credit $ $ Non-current assets Office premises 3,000,000 Accumulated depreciation 60,000 Current assets* Inventory 106,800 Accounts receivable (Note 1) 426,000 Bank 337,200 1 of 12 Learning Resources Corner
Non-current liabilities 8% Bank loan, repayable on 31 December 2010 2,100,000 Current liabilities* Accounts payable (Note 2) 370,000 Electricity payable 5,000 Owners equity W. Lo, Capital 1,200,000 Retained profit** 135,000 3,870,000 3,870,000 * A current asset (liability) is an asset (liability) that is expected to be sold (settled) within 12 months after the balance sheet date. ** Retained profit is that portion of owners equity created by earning net profit and retaining the related resources in the business. Note 1: Breakdown of accounts receivable $ John Retailers 170,000 BB Electrical Retailers Ltd 168,000 General Electric Ltd 88,000 426,000 Note 2: Breakdown of accounts payable $ Awa Lights Ltd 180,000 Bob Cables Ltd 120,000 Cad Switches Ltd 70,000 370,000 Previously, all the transactions were recorded in the journal and each transaction is posted into the ledger at a time. 2 of 12 Learning Resources Corner
To facilitate the posting of the ledger, you decide that transactions of the same type are to be entered in the same day book which is posted to the ledger in total at the end of each month. You open two day books to record the credit transactions for W. Lo s business: (a) sales day book; and (b) purchases day book. The journal is now used to record transactions other than sales and purchases on credit, and often it is then referred as general journal. (1) Sales day book This is used to record the sale on credit of goods purchased for resale. The amount entered in the sales day book is after deducting trade discount. At the end of each month, the total of the sales day book is credited to Sales account in the ledger and the amount of each sale is debited to the individual accounts receivable accounts. (2) Purchases day book This is used to record the purchase on credit of goods for resale. The amount entered in the purchases day book is after deducting trade discount. At the end of each month, the total of the purchases day book is credited to Purchases account in the ledger and the amount of each purchase is credited to the individual accounts payable accounts. (3) General journal This is used to record transactions which are not included in any other day books (in this case, sales day book and purchase day book). The most common transactions are the purchase or disposal of non-current assets on credit. These are items purchased for use in the production and distribution of goods sold by the business, rather than for resale. The general journal also records the adjusting entries required at the end of each period, such as accruals, prepayments and correction of errors. (Note: for simplicity of illustration, this Case Study will not deal with other types of day books, e.g. sales return day book, purchases return day book, cash book.) 3 of 12 Learning Resources Corner
Activity 1 The sales and purchases transactions during January 2007, which are all on credit, were as follows: Jan. 2 Purchased goods from Awa Lights Ltd for $30,000 on credit and received 20% trade discount. Jan. 5 Sold goods to John Retailers for $40,000 on credit and allowed them 10% trade discount on this amount. Jan. 11 Sold goods to BB Electrical Retailers Ltd for $50,000 on credit and allowed them 30% trade discount on this amount. Jan. 13 Purchased goods from Bob Cables Ltd for $30,000 on credit and received 30% trade discount. Jan. 16 Purchased goods from Cad Switches Ltd for $18,000 on credit. Jan. 26 Sold goods to General Electric Ltd for $40,000 on credit and allowed them 30% trade discount on this amount. Required: Prepare the necessary entries in the sales day book, purchases day book and ledger for the month of January 2007. Answer Activity 1 Sales day book Date Name of Accounts receivable Our invoice no. Folio Amount 2007 $ 5 Jan. John Retailers 36,000 11 Jan. BB Electrical Retailers Ltd 35,000 26 Jan. General Electric Ltd 28,000 31 Jan. Total sales for January 99,000 4 of 12 Learning Resources Corner
Purchases day book Date Name of Accounts payable Our ref. no. (for supplier s invoice) Folio Amount 2007 $ 2 Jan. Awa Lights Ltd 24,000 13 Jan. Bob Cables Ltd 21,000 16 Jan. Cad Switches Ltd 18,000 31 Jan. Total purchases for January 63,000 The ledger Sales 31 Jan. Total per Sales day book 99,000 Accounts receivable (John Retailers) 1 Jan. Balance 170,000 5 Jan. Sales 36,000 Accounts receivable (BB Electrical Retailers Ltd) 1 Jan. Balance 168,000 11 Jan. Sales 35,000 Accounts receivable (General Electric Ltd) 1 Jan. Balance 88,000 26 Jan. Sales 28,000 Purchases 31 Jan. Total per Purchases day book 63,000 5 of 12 Learning Resources Corner
Accounts payable (Awa Lights Ltd) 1 Jan. Balance 180,000 2 Jan. Purchases 24,000 Accounts payable (Bob Cables Ltd) 1 Jan. Balance 120,000 13 Jan. Purchases 21,000 Accounts payable (Cad Switches Ltd) 1 Jan. Balance 70,000 16 Jan. Purchases 18,000 Activity 2 Following the information in Activity 1, W. Lo s other business transactions during the month of January 2007 are as follows: Jan. 2 Paid building management fee $2,800 for January. Jan. 4 Paid $5,000 electricity payable. Jan. 8 Received $84,000 payment from BB Electrical Retailers Ltd. Jan. 13 Paid $80,000 to Bob Cables Ltd. Jan. 16 Bought stationery and stamps $800 for use. Jan. 19 Paid advertising fee $5,500 for a newspaper advertisement to be published on 29 January. Jan. 26 Paid delivery expenses for $1,300 for goods sold to customers for January. Jan. 28 Received electricity bill $5,200 for January 2007. The bill will be paid in February. Jan. 30 Paid staff salaries $20,000 for January. 6 of 12 Learning Resources Corner
Jan. 31 Withdrew $10,000 for personal use. Jan. 31 Paid bank loan interest for January, $14,000 ($2,100,000 x 8% x 1/12). The adjusting entries required at 31 January 2007 are as follows: Jan. 31 Depreciation provided for January amounted to $5,000. Jan. 31 Inventory at 31 January was found to be $130,800, determined in the taking of a physical inventory. Required: (a) Write up the cash book for the month of January 2007; (b) Show the posting of sales receipts and purchases payments transactions into the ledger; and calculate the balances for each of the accounts receivable and accounts payable accounts; and (c) Prepare the income statement for the month ended 31 January 2007 and balance sheet as at that date. Answer Activity 2 (a) Cash book is an accounting record of the business for all transactions with the bank. Cash Book $ $ 2007 2007 1 Jan. Bal. 337,200 2 Jan. Building management fee 2,800 8 Jan. BB Electrical Retailers 84,000 4 Jan. Electricity payable 5,000 31 Jan. Bal. 281,800 13 Jan. Bob Cables 80,000 16 Jan. Stationery and stamps 800 19 Jan. Advertising fee 5,500 26 Jan. Delivery expenses 1,300 30 Jan. Staff salaries 20,000 31 Jan. W. Lo, Drawing 10,000 31 Jan. Bank loan interest 14,000 7 of 12 Learning Resources Corner
(b) Cash book also serves for the purpose of a ledger account. Accounts receivable (John Retailers) 1 Jan. Balance 170,000 5 Jan. Sales 36,000 31 Jan. Balance 206,000 Accounts receivable (BB Electrical Retailers Ltd) 1 Jan. Balance 168,000 8. Jan. Bank 84,000 11 Jan. Sales 35,000 31 Jan. Balance 119,000 Accounts receivable (General Electric Ltd) 1 Jan. Balance 88,000 26 Jan. Sales 28,000 31 Jan. Balance 116,000 Accounts receivable total = $441,000 (206,000 + $119,000 + $116,000) Accounts payable (Awa Lights Ltd) 1 Jan. Balance 180,000 2 Jan. Purchases 24,000 31 Jan. Balance 204,000 Accounts payable (Bob Cables Ltd) 13 Jan. Bank 80,000 1 Jan. Balance 120,000 13 Jan. Purchases 21,000 31 Jan. Balance 61,000 8 of 12 Learning Resources Corner
Accounts payable (Cad Switches Ltd) 1 Jan. Balance 70,000 16 Jan. Purchases 18,000 31 Jan. Balance 88,000 Accounts payable total = $353,000 ($204,000 + $61,000 + $88,000) (c) W. Lo s business Income Statement for the month ended 31 January 2007 $ $ Sales revenue 99,000 Less: Cost of goods sold Inventory, 1 January 2007 106,800 Add: Purchases 63,000 169,800 Less: Inventory, 31 January 2007 130,800 39,000 Gross profit 60,000 Expenses: Advertising fee 5,500 Bank loan interest 14,000 Building management fee 2,800 Delivery expenses 1,300 Depreciation 5,000 Electricity 5,200 Salaries 20,000 Stationery and stamps 800 54,600 Net profit 5,400 9 of 12 Learning Resources Corner
W. Lo s business Balance Sheet as at 31 January 2007 $ $ $ Assets Cost Accumulated depreciation Book value Non-current assets Office premises 3,000,000 65,000 2,935,000 Current assets Inventory 130,800 Accounts receivable 441,000 Bank 281,800 853,600 Total assets 3,788,600 Owners Equity W. Lo, Capital, 1 January 2007 1,200,000 Add: Retained profit at 31 January 2007 ($135,000 + $5,400) 140,400 Less: Drawings (10,000) W. Lo, Capital, 31 January 2007 1,330,400 Liabilities Non-current liabilities Bank loan 2,100,000 Current liabilities Accounts payable 353,000 Electricity payable 5,200 358,200 Total liabilities 2,458,200 Total equity and liabilities 3,788,600 10 of 12 Learning Resources Corner
HKAS 1 Presentation of Financial Statements HKAS 1 Presentation of Financial Statements sets out the overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content. For presenting an income statement, one major requirement of HKAS 1 is the classification of expenses into cost of sales, distribution costs, administrative expenses and finance costs, based on the function of the expenses. For presenting a balance sheet, HKAS 1 requires current and non-current assets, and current and non-current liabilities, to be presented as separate classifications on the face of the balance sheet. The financial statements shown in Answer to Activity 2 are often described as for internal use. The preparation of financial statements in accordance with HKAS 1 Presentation of Financial Statements is traditionally referred as for external use. Activity 3 Using the Answer in Activity 2, prepare the income statement for the month ended 31 January 2007 in accordance with HKAS 1 Presentation of Financial Statements. Answer Activity 3 W. Lo s business Income Statement for the month ended 31 January 2007 $ Sales revenue 99,000 Cost of sales Working 39,000 Gross profit 60,000 Distribution costs Working 1,300 Administrative expenses Working 39,300 Finance costs Working 14,000 Profit 5,400 11 of 12 Learning Resources Corner
Working - Classification of expenses by function Cost of sales Distribution costs Administrative expenses Finance costs $ $ $ $ Inventory, 1 January 2007 106,800 Add: Purchases 63,000 169,800 Less: Inventories, 1 January 2007 130,800 39,000 Advertising fee 5,500 Bank loan interest 14,000 Building management fee 2,800 Delivery expenses 1,300 Depreciation 5,000 Electricity 5,200 Salaries 20,000 Stationery and stamps 800 39,000 1,300 39,300 14,000 12 of 12 Learning Resources Corner