Chapter 16 - Equity in a Sole Proprietor and Company

 All right, final last 2 chapters of this mypoateacher.blogspot blog😁

☝Lets move on to accounting for Equity in this chapter.  This chapter mainly tests us the various components in the Equities Components in a balance sheet. 

We know that: 

Ending Equity = Opening Equity + Additional Capital - Drawings + Net profit - Net loss - Dividends( for Companies only) 

💨Henceforth lets dive in greater details to how the equities components are adjusted:)

1.Additional Capital

When the owner of the Company contribute additional capital to the business for eg, cash of $5,000, the journal entry is 

Dr Cash at bank  $5,000

Cr Capital                        $5,000

Being contribution of Cash $5,000 to the business 

☝However, when the owner contribute $10,000 in trade receivables to the business, how is this accounted? You may ask is trade receivables transferrable? Yes it is in fact alot of companies transfer their trade receivables to bank in return for a mortgage from the bank in what we termed as factoring.

Back to the transfer of trade receivable, the journal will be as such below:-

Dr Trade Receivable   $10,000

Cr Capital                                    $10,000

2.Drawings

☝When the owner takes out $5,000 cash in the business for his own personal usage, how is this accounted?

We will pass the following journal entry:-

Dr Drawings $5,000 and Cr cash $5,000 

Have you wondered how are the Drawings account closed at the end of the period and transfer to capital?

Dr Capital Cr Drawings 

3.Profit & losses from Income Statement

💨All losses and profits from the Profit & loss account are transferred to the capital account of a sole proprietor & retained earnings of a company. 

Since profit increases the capital/retained earnings while losses reduces the capital/retained earnings account

When it is transfer of profit, the capital/retained earnings account has to be Credited while if it is the transfer of losses, the capital/retained earnings account has to be Debited.

Therefore, transfer of Profit:- 

Dr Profit & Loss 

Cr Capital/retained earnings

Therefore, transfer of Loss:- 

Dr Capital/retained earnings

Cr Profit & Loss

4.Dividends(only for companies)

Normally there are 3 steps when a dividend is announced for a company: -

1. Declaring the dividend; 

2.Transfering the dividend to the retained earnings account and 

3. Payment of the dividend

💨For declaring the dividend, a company would usually declare its dividend close to the end of the year around Oct or Nov if the year end is 31 Dec. 

1. Once a company declare dividend, the journal entry will be:-

Dr Dividends 

Cr Dividends Payable 

2. Transferring the dividend to the retained earnings account and 

A company having passed the 1st declare dividend entry above would need to shift the dividend expense from the income statement to the retained earnings account, this is because dividend are not business/trading expenses and should not be reflected in the income statement. The journal entry will be

Dr Retained earnings  

Cr Dividends

3. Payment of the dividend - A company usually pay the dividend after the financial year end unless its for interim dividend or quarterly dividends. Interim dividends are dividends which are paid mid way through the financial year, the payment entry will be as such:

Dr Dividends Payable

Cr Cash at bank 

💥💥💥 Important !Things to note: 

1. Share capital account and retained earnings account add up to form the " Shareholders Equity"component in the balance sheet. 

2. In Issued Share capital account, it only contains the 1.number of shares issued & any 2.additional shares issued normally or through a rights issue. Dividends declared & profits for the year should not be added to issued share capital.

3. In Retained earnings account, only these 2 items are within the account, 1. Profit & Loss transferred & 2. Dividends, any additional issue of shares should not affect the retained earnings account.

A high % of students cannot extinguish the transactions affecting both accounts henceforth often loses mark. Drawings are not applicable to retained earnings as the owner(s) of a company are usually its shareholders and the only way for shareholder returns are the dividends or the share price appreciation. 

☝Lets try one of the question on Dividends since dividend is more complex while the rest of the equity components are more on transfer to the capital account at the end of the year😀

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Chapter 15 - Incomplete records

 Lets move to another major topic of mypoateacher.blogspot.com :- Incomplete records.

💨Basically, there are 3 methods under this method:-

1. Capital comparison method;

2. Account analysis method ;& 

3. Financial ratios analysis method.

💨In incomplete records, the question will give you bits & pieces of information such as cash at bank acc, the opening capital, sales returns, to find figures such as net profit , Total inventory purchase , Total Sales amount and cost of sales. 

1. Capital Comparison method

💥Let us all understand more on Capital comparison method. we all know that Capital is also termed as Owner's Equity which can be calculated by :-

Capital/Owner's Equity = Total Assets - Total Liabilities 

And for Capital/Owner's Equity, we can further break it down by:- 

Ending Capital/owner's Equity = Opening Capital/Owner's equity + Additional Capital contributed by owners + Net profit - net loss - drawings for the period.

Using the capital formula, we can then calculate the net profit/(loss) for the periods:- 

if we have these 3 elements :-

• Opening & Ending Capital
• Drawngs
• Additional contributed by owners into the business

☝Lets try it with a question :-

 

2. Account analysis method , the question will normally ask you to find out total purchases or total sales amount.

💨As we have learned under the previous chapter on trade receivable & payable control accounts, we are able to find the Total credit Sales & purchase figure from the Trade receivable & payable control accounts.

**Note: Remenber to add total cash purchase or Total cash sales to your credit purchase or credit sales in order to derieve the Total Sales/purchase for the period. 

Total Sales Revenue = Total Credit Sales + Total Cash Sales

Total purchases = Total Credit Purchases + Total Cash purchases

☝Let's try a question to find out the Total Credit Sales amount:- 

Total Net Sales Revenue =  $32,000 + $20,000 - $3,000 

        = $49,000

**Note: for Sales returns, the sales revenue is not affected  only the sales returns account and Trade receivable account are adjusted. This is a common mistake which a lot of students make!

Therefore in finding net sales revenue, we need to deduct the sales returns for the period.

☝Similarly, for total purchase, we can find the credit purchase from the total trade payable account 

 

Total Net purchases = $23,500 + $20,000 - $3,000

=$40,500 

*Remember: the few tips when doing the question, Debtor is Debit side and Creditors are Credit side, do not put wrongly the sides of debtors and creditors when doing a trade payable or trade receivable account. 

**For Sales returns & Purchases returns, pls deduct from total purchases & Sales amount to find the net amount:)

Apart from Sales & Purchases figures, the exam may also test on total expenses for the period by giving you a prepaid expenses or accrued expenses acc. 

☝Lets try one on Prepaid acct also on mypoateacher Pte Ltd:-

Note: 

1. The ending balance for the expenses and revenue account has to be nil. 

2. For the balance transfer on the 1 Jan 21, it is a prepaid amount for the previous period but the expenses are paid for the current period which is $2,000, therefore when it transfer down, it is a Debit balance.

3. Financial ratios analysis method.

💨Next we move on to the next method- the financial ratios analysis method which is using financial ratio to find missing amounts: -

For e.g. we all know that Inventory turnover ratio is given by : Cost of Sales / Average inventory 

& Average inventory is calculated by (opening + closing inventory)/2,

☝Qns: If Company A Inventory turnover for Yr 2020 is 5 times and its Average inventory is $30,000 for the same period, can we find the cost of sales?

Since Inventory turn over ratio = Cost of sales/ average inventory, we can substitute the figures into the formula 

Ans:  Inventory turnover = 5 times

Average inventory = $30,000

Therefore, Cost of sales = Inventory Turnover ratio X average inventory 

= 5 times X $30,000

= $150,000 

☝Qns:Using the cost of sales figure calculated, if we have have the Gross profit margin, we are able to find the Net Sales amount too.

Let say Company A has a gross profit margin of 20%,  given cos of sales of $150,000 , can you find the net sales amount?

Yes, Since we know Gross profit margin is 20% therefore the cost of sales margin has to be (100%-20%) 80%, 

therefore if $150,000 represents 80% being cost of sales, can we find 20% which is the nett sales revenue?

Nett Sales Revenue : $150,000/80% X 20% 

= $37,500

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Chapter 14 - Correction of Errors

Let's move onto corrections of errors😀

💨This topic if it comes out would be most probably in the form of a question on itself:- 

Errors not revealed by a trial balance means that the trial balance still ties which is Debit = Credit, but there are errors due to :- posting of wrong amount or wrong account or on the wrong side of the account (Dr/Cr). 

There are 6 errors not revealed by a trial balance namely: -

1. Error of omission 

2. Error of commission

3. Error of principle 

4. Error of original entry

5. Error of complete reversal

6. Compensating Errors

Lets elaborate more on the 6 errors below:- 

💥1. Error of omission 

Error of omission means that the transaction is not recorded at all. 

💥2. Error of commission 

Error of commission means that the transaction is recorded on the correct side with the right amount but under wrong account of the same class.

For e.g. Trade receivable - Mypoateacher paid $1,000 to settle his outstanding amount. However, when passing the transaction journal entry, the account clerk  Dr Bank Cr Trade Receivable Mr Squid instead. From here you can see that the Dr portion which is Debit bank is corret but Cr portion, he should have Cr Trade Receivable - Mypoatacher instead of Cr Trade Receivable - Mr Squid. 

💥3. Error of principle

Error of principle means that the transaction is recorded on the correct side with the right amount but under wrong account of the different class.

A transaction for the purchase of inventory on cash of $500, the account clerk could Debit Trade Creditor $500 Cr Cash at bank $500, when the correct transaction should be Dr Inventory $500 Cr Cash at bank $500, henceforth the Debit is correct side and the Debit $500 is correct amount, it is jus the wrong account of the different class.  

**What separates an 3. Error of principle from an 2. Error of commission is that error of principle involves posting to a wrong account of the correct/same class while error of principle refers to posting to a wrong account of a different class, the amount and the sides are correct. 

💥4. Error of original entry 

Error of original entry means that when the transaction is first recorded, it is recorded on the correct side, under correct account of the same class but Wrong amount. 

An drawing transaction which the owner takes $500 cash for his own use from his business - instead of passing Dr Drawings $500 Cr Cash at bank $500, the owner pass Dr Drawings $50 Cr Cash at bank $50, the side/class and accounts are correct except the amount is wrong.

💥5. Error of Complete reversal 

Error of complete reversal means the correct accounts and correct amounts are posted except is made on the wrong side of the both accounts.

For e.g. A Sales returns from trade receivable Mr Mypoateacher for $200, the account clerk passes the transaction - Dr Trade receivable - Mr Mypoateacher $200 Cr Sales Returns $200 instead of Dr Sales Returns $200 Cr Trade receivable - Mr Mypoateacher $200. The amount and class are correct just that the account to be debited are credited and account to be credited are debited  - complete opposite of the correct entry. 

💥6. Compensating error 

Compensating error occurs when there are 2 errors made and the 2 errors cancel each other out. 

For e.g.  A trade receivable debit balance was written as $300 whose correct amount should be $500, shortfall of $200 while a trade payable credit balance was written as $1,000 whose correct amount should be $1,200, also a shortfall of $200. The shortfall Debit side of $200 cancel the shortfall of $1,000 henceforth it compensate for each other.

💨How then can the above be translated to helping us answer the questions? That is very easy:- just need to have 3 columns 1. What is the transaction posted? 2. What is the correct entry to be posted & 3. What is the adjusting journal entry?

☝Illustrate the above with the question below :-

The errors for above are :-

• (a) Error of Commission
• (b) Error of Principle
• (c ) Error of Omission 

Hope that the above has allowed you to understand better the 6 types of errors not revealed by the trial balance, in order to do the 3 error columns, you need to know the original entry, correct entry and the adjusting/correcting entry to be able to do that😀

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Chapter 13 - Control Accounts

 Let's start on control accounts:)

Have you ever wondered when you see Trade debtors & Trade creditors in a balance sheet, why is it consolidated as 1 amount/item when the business has 30+ debtors or creditors, finish this chapter and you will know why!

If control accounts comes out in exam,I will be laughing till (maybe) tears comes out😁. It is not difficult.

💨A business has control accounts to totalize or summary the total individual accounts.

☝There are 2 control accounts namely:-

💥Trade Receivables control account &

💥Trade Payables control account.

The purposes of control accounts are:

💥Act as a check of all/total the balances of individual trade receivable and trade payable accounts.

💥Control Accounts helps to facilitate the preparation of trial balance & balance sheet and income statement.

💥If the 2 persons preparing the trade receivable control and individual receivable accounts are different,the person preparing the control account can check and review the person who post into the individual ledger accounts

💨Okay, having know the rationale behind the preparation of Trade Receivable & Payable control accounts let us identify the items inside the accounts and the source of such items.

💨 Its important to identify the source such as the purchase ledger providing the information of the control account. This question may come out either as a question in control account topic or in Special journal topic. 

** Do note that the source for Discount allowed and Discount received can only be taken from Cash book as the difference between the amount settled and paid and what the debtor/creditor owes will be the Discount allowed from Debtor and Discount received from creditor. 

💨Important* if you still cant gasp the concept of control account ---- just think of the control account as a summary of all the individual debtors account for Trade Receivable Control and individual Creditors for Trade Payable control.... When I adjust one of the individual account let say payment from a debtor, this receipt has to be shown in the Trade Receivable control account too. 

Try to relate the above diagram to your understanding, a control account just combines all individual ledger account, thats it!

☝Test your understanding,try this question below:-

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Chapter 12 - Trade Payables and Long term Borrowings

 Now lets move to Trade payables and long term borrowings😀.

☝What are the difference between a short term borrowing/trade payable and a long term borrowing?

Ans:

💥Classification - A Short term borrowings is presented as a current liability in the balance sheet. While a long term borrowing is presented as a non current liab in the balance sheet. 

💥Duration - A long term borrowing is usually taken up by the business to buy non current assets or to have capital to expand the business. While a short term borrowings helps a company overcome a temporary cash shortage.

💥Interest- Short term borrowings do not have interest to the loan while a long term borrowing has. 

💨Items that impact a trade creditor account

• Trade Discount ( not recorded)
• Cash Discount
• Return Outwards 

☝Lets try a question below to understand the 3 items

Having understood the trade payable and their various items, lets move on to long term borrowings😀

A long term borrowings has 2 components namely the 1. Principal and 2. Interest.

1.Principal

When a Company takes up a bank loan, the journal entry is as such:-

Dr Cash at bank

Cr Long term borrowing

When a Company repays a bank loan, the journal entry is as such:-

Dr Long term borrowing

Cr Cash at bank

In the balance sheet, you need to split the principal sum to 1. Current and 2. Non current portion. 

Current portion would means that the loan amount is paid by the end of the next financial period, while non current would means it will be paid only after the end of the financial period. 

☝Lets try the below question on Long term borrowings - Principal

💨Now lets go onto interest expenses:)

💨On a long term borrowing, the company who is the borrower is expected to pay interest on the principal amount at an interest rate agreed upon the loan agreement.

The formula will be: :- 

Interest for the whole year: Principal X interest rate 

💡When a business pays interest the journal entry are as below:-

Dr Interest expenses

Cr Cash at bank

💡For interest which are not paid but incurred at the year end

Dr Interest expense

Cr Accrued Interest expense

** it is this accrued interest expenses calculations which normally confuses a lot of mypoateacher students.

Lets try on a question on Long-term borrowings - Interest: 

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Chapter 11 - Trade Receivables

Let us now go through another topic - Trade Receivables😀.

💨This topic could most probably come out as part of an adjustment in the 1st question on Profit & loss adjustment or as a question on its own which is pretty rare. 

☝Why do a business have trade receivables?

Ans: Trade receivables arise whenever the company makes a credit sales of goods or services to a customer. The customer is given a period to repay the debt. The journal entry are as such:

💨When a business makes a credit sales:

Dr Trade Receivable        $XX  

Cr Sales Revenue                             $SS

💨When a business receives payment from a trade receivable:

Dr Cash at bank   $XX

Cr Trade Receivable             $XX

When a business gives discount to a customer to encourage customer to pay earlier:-

Dr Discount allowed   $XX

Dr Cash at bank          $XX

Cr Trade Receivable              $XX

💨 Impairment of trade receivables 

Credit Risk is a risk that exist for any business which sells goods/service on credit to customer. It is the risk of not able to collect partially or wholly the amount owed to the business from the credit customer. 

When a debtor cannot pays up, the business will suffer a loss since the goods & services it provided cannot be obtained back. As such, the loss is term : Impairment loss on trade receivables. The loss is recorded in the income statement as such:-

Dr Impairment loss on trade receivable 

Cr Allowance for impairment of trade receivable 

At the end of each financial period, a business reviews its existing trade receivables and calculate how much it cannot received from customer based on objective evidence.

   

Some examples of objective evidence are: - 

💥1. Despite numerous letters to the debtor, the debtor has not responded or gives excuses for not paying up.

💥2. There are market or same industry news concerning the debtor having financial difficulties.

💥3. The debtor sends a dishonoured cheque which cannot be encash.

Because of the factors above, the business will have to maintain an Allowance for impairment of trade receivable account which is recorded in the balance sheet as below shows:-

💨Recording allowance for impairment for trade receivable

If the business doesn't have an allowance for impairment of trade receivable account, the initial recording will be as such: -

Dr Impairment loss on trade receivable 

Cr Allowance for impairment of trade receivable 

Lets try some example to understand this concept:- 

☝Company ABC has total trade receivables of $10,000 for the financial year ended 31 Dec 2020. The management has reviewed and conclude that out of this $10,000,  $3,000 of debt belonging to Company XYZ was deemed irrecoverable and would like to provide for this amount. Company ABC currently does not has an Allowance for impairment of trade receivables account. Prepare the i) Allowance for impairment of trade receivable account and ii) Impairment loss on trade receivable account:- 

Ans: 

** Note that the journal entry did not touch any Trade receivable account, it was just Allowance account and Impairment loss account !

💨📈Using the previous example of ABC Pte Ltd with Allowance for impairment of trade receivable balance of $3,000 as at 31 Dec 2020, fast forward to 31 Dec 2021,  due to the worsening economic condition, the management has determined the trade debtors who are unable to paid up to be $5,000 as at 31 Dec 2021 with the additional $2,000 coming from the debt of Company DEF.

So currently the balance in the allowance for impairment on trade receivable is $3,000 , we need to increase to ------> $5,000 which is an additional $2,000 ($5,000 - $3,000). The journal entry will be as below: 

Dr Impairment loss on trade receivable account            $2,000

Cr Allowance for impairment of trade receivable acc                  $2,000    

The allowance for impairment of trade receivable account has a balance of $5,000 currently ($3,000 from company XYZ and $2,000 from company DEF) as at 31 Dec 2021. ** Did we adjust trade receivable accounts??? No:)

💨📉using the previous example of ABC Pte Ltd with Allowance for impairment of trade receivable balance of $5,000 as at 31 Dec 2021. Lets fast forward to 2022, lets say this time because of news that DEF company has won a big tender contract and is able to pay off its debt of $2,000, henceforth as at 31 Dec 2022, management reviewed the trade receivable and will want the allowance for impairment to consist of the debt from company XYZ which is $3,000. 

Bearing in mind that the balance in allowance for impairment for trade receivable is $5,000 as per prev year adjustment, now that we need to reduce it to $3,000 , prepare the journal entry:- 

Reduction of allowance for impairment of trade receivables:-

Dr Allowance for impairment of trade receivable         $2,000

Cr Impairment loss on trade receivable account                            $2,000

** We are so used to seeing Dr impairment loss that once it changes to Cr Impairment loss, we wonder whats is it, its an entry to reduce expenses:)

💨Now, referring to the previous example, as at 31 Dec 2022, our allowance for impairment of trade receivable account balance is $3,000.

Lets say on 1st Feb 2023, DEF Company was declared bankrupt, and was able to pay $2,000 and the remaining $1,000 is to be written off, prepare the entry. 

💥 Note that, we have previously provided for DEF allowance in the allowance for impairment of trade receivable account.

Henceforth, we will not be debiting to Impairment loss on Trade Receivable account, instead we will adjust only the Allowance for impairment of Trade Receivable account and Trade Receivable account - DEF Company:- 

1st Step - Adjusting for the $2,000 that DEF Company is able to pay :-

Dr Cash at Bank    $2,000

Cr Trade Receivable DEF Company $2,000

 Dr Cash at bank $2,000 Cr Trade Receivable $2,000 for receipt of $2,000

 

2nd Step-Write off of debt of $1,000 by DEF Company.

💥Since there are sufficient balance in the Allowance for impairment of trade receivable to adjust, we can avoid touching Impairment loss account. 

The journal entry will be as such for the write off: -

Dr Allowance for impairment of trade receivable   1,000

Cr Trade Receivable - DEF Company                                     1,000

2 Points to note:

💡 DEF Trade receivable account is nil at the end of their settlement and write off.

💡 Had the writeoff belonged to another trade receivable other than DEF Company let say Company TUV, will the writeoff entry still be the same?

Ans: Yes, the writeoff entry Dr Allowance for impairment of trade receivable and Cr Trade Receivable -TUV will still be the same provided the amount being written off is less than the allowance for impairment of trade receivable balance (i.e. lower than $3,000).

Now lets test your understanding by attempting this question:-

                                                                                                                          

💥Note: when trade receivable - Pickachu paid his outstanding debt, no adjustment was made in the Allowance for impairment of trade receivable. Pls note that even though Pickachu was one of the debts which contributed to the allowance for impairment, any payment from Pickachu or other trade debtor should not result in an adjustment in the allowance for impairment unless it is a write-off.

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Chapter 10 - Non Current Asset

 Welcome to chapter 10 of my POA teacher, which is my blog address for you who ended up here by chance haha lets focus on Non Current Asset or Fixed asset in this topic😊

💨What are Non -Current assets?

Non Current assets are assets that a business uses to assist them to generate income. It can be a machine/property/house/ office equipment or vehicles. 

💨2 types of expenditure related to non current assets:

1. Capital Expenditure 

Capital Expenditure refers to costs to purchase the non current assets. The non current asset costs include all expenses incurred to bring the fixed asset to a working condition such as import duties, insurance,freight & installation costs are included in the fixed asset costs. Capital expenditure provides benefits to the business for more than 1 financial period. It is recorded in the Balance sheet under the non current asset category. 

2. Revenue Expenditure

Revenue expenditure refers to expenses that are used to operate/repair/maintain the fixed asset. Example would be petrol expenses for a non current asset of motor vehicle. The benefit of these exenditure are less than 1 financial period as a result these expenses are not recorded in the balance sheet, they are however recorded as an expenses in the income statement.

💨Double entry for purchasing a capital expenditure

Dr Non current asset     $XX

Cr  Bank/Trade creditor                     $XX

**Ps: Include all costs such as import duties, carriage inwards,installation costs that are incurred in bringing the fixed asset to working condition.

☝What is Depreciation?

 Ans: Depreciation is the allocation of an asset original cost over the useful life of an asset. 

When we depreciate assets, we are applying the matching accounting concept . Rmb that all expenses incurred have to be matched with the income generated within the same financial period? The same applies for depreciation as well --->

Income generated from Non- current Asset  MATCH   with Expenses generated from the same Non- current asset.

☝What are the types of depreciation?

1. Straight- line method 

A Straight line method depreciate non current asset equally throughout its useful life. For E.g. a  Machine bought for $10,000 has a useful life of 5 years, how much is its depreciation expenses per year?  Ans: $2,000 per year ($10,000/5 years)

2.  Reducing- balance Method 

A reducing balance method calculates depreciation based on its Net Book Value(NBV) multiply by the depreciation rate. The NBV is calculated by the initial asset original cost less off the accumulated depreciation. 

For e.g. Calculate the depreciation amount for a machine with $10,000 purchase price having an accumulated balance of $2,000 at a depreciation rate of 20%.

Depreciation amount = (Original cost - Accumulated depn)  X depreciation rate

                                     = (10,000 - 2,000) X 20%

                                     = $1,600  

👀Journal entry for depreciation: - 

Dr Depreciation expenses - Machine           $1,600

Cr Accumulated Depreciation - Machine                        $1,600

 Next, I especially want to focus on the disposal of non current asset which is not difficult once you know the steps, you will laugh if it come out in your exams😂

💨4 steps Disposal of Non-current asset -  

Step 1 -  Create a sale of Non-current asset Account and transfer the original asset costs from non-current asset to the sale of Non-current asset Account.

Step 2 -Transfer the Non current asset's accumulated depreciation expenses thus far from the accumulate depreciation account to the sale of Non-current asset Account

*Depending on the question, if the question specify "no depreciation is charged in the year of disposal", we can safely extract the depreciation amount in the accumulated depn account, otherwise, we will need to pro-rate the depreciation expenses, for e.g. an asset is sold in March and the business finance year is from 1st Jan to 31 Dec, we will need to 

---> Dr Depreciation Expenses $XX

       Cr Accumulated Depn Exp         $XX

(3/12 X yearly depn exp)

Step 3- Charge the proceed of the sales to the Sale of non current asset account, for e.g. cash proceed 

---> Dr Cash at Bank  $XX

       Cr Sale of Non Current Asset  $XX

** May not always be cash, payment could be in the form of an non current asset too. 

Step 4 - Calculate the Gain/loss of the disposal of the non Current asset.

Not very difficult right haha, ok come lets attempt this question for a clearer understanding

☝Test your understanding 

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Chapter 9 - Inventory

 Inventory - every companies need inventory be it a manufacturing or trading one😊. A Service company may need inventory but inventory costs will not be a high porportion of its total costs, a hair saloon may have shampoo or clips but its main costs will still be the hairdressers wages.👩

When a business purchase inventory, the double entry are as such: -

Dr Inventory                                                           XX

Cr Cash at bank/ Trade payable                                                         XX

When a business returns inventory 

Dr Cash at bank/trade payable                       XX 

Cr Inventory                                                                          XX

☝Question: - 

☝ Question - When a customer returns goods why isn't the Cost of sales and inventory account affected? 

Ans: Its because the business like the prev example above has purchases of 200 squids and also sale pf 200 squids which has already take place and cannot be reversed/adjusted.

 Instead we Debit Sales returns when a customer returns goods as, it will reflect a reduction to the business sales as such in the income statement: -

 

☝Question - When do we adjust the inventory account?

Ans: when we return goods back to Suppliers, the double entry is as follow:- 

Dr Trade Creditor/Supplier     $XX

Cr Inventory                                           $XX 

💨Which brings us to the next point, what are the items inside inventory account other than the cost of the product?

1. Freight/transport costs of bringing the good to the company 

2. Import duties or custom duties 

3. Insurance 

4. Packing materials 

5. Salaries paid to workers to process the goods to finished product

💨FIFO - First In First Out    

What is FIFO, it means First In First Out - it is a method to calculate the cost/product as part of the cost of sales. A business say for example that buys & sell Squid -- I like squid lah haha, the purchase price cannot always be the same right? Henceforth how do we determine the cost of the squid everytime we sell? The FIFO method assumes that the cost of the squid that is sold will be based on the earliest purchase  batch of the squid, until the earliest batch of  purchase is finish, then it will move to the 2nd batch of earliest purchase as its cost price.

☝Question - 

The total inventory at month end is $300.

Impairment/loss/Fire

💨Whenver we are asked to value stock, people always say "Lower of cost or Net book value lor, so easy"

But exactly whats that huh?

Let me explain - Cost refers to the initial/historical purchase price that is the price that was sold by supplier to you ;

Net book value would refers to Selling price less additional costs to bring the stock to its current condition. The selling price could be a market price, i.e.  the price that the stock can fetch at current market condition less selling cost.

See if either the costs is lower or the Net Book Value is lower then we will apply the lower of the 2 values.

For e.g. our stock costs is $500 current however its net book value( Selling price - selling costs) is $450, we will have to choose $450.

Henceforth impairment has occured because our stock in our balance sheet current asset is still $500 while the net book value is $450 , a reduction of $50.

we will need to pass our impairment journals : -

Dr  Impairment loss( Income Statement)                  $50 

Cr  Inventory/Stock( Balance sheet)                                        $50

☝Why is impairment needed?

Ans: it is because we need to fulfil the prudence accounting principle in that we should not overstate assets and undervalue our liabilities as this will present a wrong balance sheet information to user of our financial statements. 

☝Ok, what happens when we don't pass impairment losses above? 

Ans: Our profit and inventory values will be overstated by $50.

Test your understanding - try doing this question

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