2. Chapter 2 Double Entry System in International Accounting System

3. Movement of Accounting Equation At the beginning of the accounting period: Assets=liabilities+Owner ’ s equity Assets=liabilities+Owner ’ s equity During the accounting period Assets ’ =liabilities ’ +Owner ’ s equity+(Income- cost or expenses) Assets ’ =liabilities ’ +Owner ’ s equity+(Income- cost or expenses) Because: Income-cost or expenses=profit And profit ∈ Owner ’ s equity ∴ at the end of the accounting period the accounting equation is show as: the accounting equation is show as: Assets ’ =liabilities ’ + Owner ’ s equity ’ Assets ’ =liabilities ’ + Owner ’ s equity ’

4. Rules of debit and credit entries The rules of debit and credit entries are quite similar with that we have learned in Chinese accounting system. That is: 1. Increases in assets and expense accounts are debit entries, while increases in liability, owners’ equity and revenue accounts are credit entries. 2. Decreases are logically recorded on the side opposite increases. 3. The normal balance of any account appears on the side for recording increases.

5. Steps In Accounting Cycle Analyze transactions from Source documents Analyze transactions from Source documents Record in journals Record in journals Post to general (and subsidiary) ledger accounts Post to general (and subsidiary) ledger accounts Adjust the general ledger accounts Adjust the general ledger accounts Prepare financial statement Prepare financial statement Close temporary accounts Close temporary accounts

6. Journals General General journal and special journals Most Most common special journals

7. Most Common Special Journals Purchase journal or invoice register Purchase journal or invoice register Sales journal Sales journal Cash receipt journal Cash receipt journal Cash disbursement journal Cash disbursement journal

8. Function of the Special Journals Sales journal Sales journal Cash receipt journal Cash receipt journal Purchase journal (invoice register) Purchase journal (invoice register) Sales on credit term Sales on credit term Receipts of cash (including cash sales) Receipts of cash (including cash sales) Purchase of merchandise and other items (supplies, fixed assets, etc) on credit terms Purchase of merchandise and other items (supplies, fixed assets, etc) on credit terms

9. Function of Special Journal Cash disbursement journal Cash disbursement journal Payment of cash (including cash purchases Payment of cash (including cash purchases

10. Ledgers Assets Assets liabilities liabilities Owner ’ s equity Owner ’ s equity Revenue Revenue Costs and expenses Costs and expenses Suspense account Suspense account

11. Conventional Book Structure Two side account that is debit and credit side. The terms debit and credit are used to describe the left-hand and right-hand sides of any “ two- column ” account. Two side account that is debit and credit side. The terms debit and credit are used to describe the left-hand and right-hand sides of any “ two- column ” account. Use a term as “ balance b/d ” that means balance brought down to describe the beginning balance and “ balance c/d ” that means balance carried down for ending balance Use a term as “ balance b/d ” that means balance brought down to describe the beginning balance and “ balance c/d ” that means balance carried down for ending balance “ balance b/d “ and balance c/d ” are usually in opposite side in an account. “ balance b/d “ and balance c/d ” are usually in opposite side in an account.

12. Purchase Let it be absolutely clear about what is mean by the term of “purchase” 1. Bought with the intention of selling them as part of the business trading activities. Good or stock in British English and inventory in American English can be used to describe what we purchased. 2. Bought in order to use them in the manufacture of other goods (eg raw materials).

13. Settlement for purchase Purchase for cash or “ cash purchase ” Purchase for cash or “ cash purchase ” Purchase on credit Purchase on credit In the case of “purchase on credit”, it is always associated with concept of “purchase discount” and “credit period”, both of them are described by a serials of number such as “2/10, 1/20 and n/30.” or “2/10, and n/20”.

14. Sales Transaction of sales can be fallen into following two categories: 1. Sales for cash or cash sales 2. Sales on credit. Conventionally, there is no special distinguish between term of “cash” and “bank” in international accounting community, so, in the case of cash sale, it will include sales for actual cash as well as where payment is received immediately into the business bank account (eg payment by chegue)

15. Two types of “ expense ” If money is spend on buying an asset, such as office equipment, it is debited to the asset account. Money has been spent on owning a resource. It is called as Capital Expenditure. In the case of it, we can use the concept of “cost”, “depreciation”, and “net cost” to describe what we have brought and how we used it. If money is paid for rent, wages, telephone, etc, it is to obtain the use of a resource, but paying for it “as you go” rather than long in advance. It is therefore consistent to debit the expense a/c. It is called Revenue Expenditure.

16. Profit or loss To determine profit or loss would be a simple matter if we can determine sale as revenue and expense and cost. To determine the revenue and expense, it should be not only depend on the accrual accounting system, but also on the whether it is revenue expenditure or whether it is capital expenditure.

17. Adjustment Procedures 1) Apportioning recorded costs to period benefited. 1) Apportioning recorded costs to period benefited. 2) Apportioning recorded revenue to period in which it is earned. 2) Apportioning recorded revenue to period in which it is earned. 3) Accruing unrecorded expenses. 3) Accruing unrecorded expenses. 4) Accruing unrecorded revenue. 4) Accruing unrecorded revenue.

18. Cost There are serial concepts concerned with cost, which are cost of purchase or net purchase, production cost, cost of products or cost of completed products, cost of sold goods, but only the cost of sold can be taken into our consideration to obtain our profit during an accounting period although all kinds of cost is related and influential one by one.

19. Illustration of influence of costs Cost of raw materials Production Cost Cost of completed products Cost of purchased Cost of sold goods

20. Merchandise Inventory Adjustment In accounting for the inventories system, there would be tow kinds of inventories system that are: In accounting for the inventories system, there would be tow kinds of inventories system that are: Periodic inventory system and perpetual inventory system Periodic inventory system and perpetual inventory system

21. Periodic Inventory System Under a periodic inventory system, a firm determines it merchandise only at the end of each accounting period and adjust its records through the Income summary account. Under a periodic inventory system, a firm determines it merchandise only at the end of each accounting period and adjust its records through the Income summary account.

22. Treatment of end inventory adjustment Transfer beginning inventory to Income summary Transfer beginning inventory to Income summary Dr Cr Dr Cr Income summary XXXX Income summary XXXX Inventory XXXX Inventory XXXX To record ending inventory To record ending inventory Dr Cr Dr Cr Inventory yyyyy Inventory yyyyy Income summary yyyyy Income summary yyyyy To close purchase and related a/c To close purchase and related a/c Dr Cr Dr Cr Income summary ZZZZ Income summary ZZZZ Purchase returns and allowance ZZZZ Purchase returns and allowance ZZZZ Purchase discounts ZZZZ Purchase discounts ZZZZ Purchase ZZZZ Purchase ZZZZ

23. Perpetual Inventory System Under perpetual inventory system, accounting treatment is quite similar with that in Chinese accounting system. Under perpetual inventory system, accounting treatment is quite similar with that in Chinese accounting system. Set up an account that called “ Cost of goods sold ” to determine cost of goods sold in the accounting period. Set up an account that called “ Cost of goods sold ” to determine cost of goods sold in the accounting period. “ Cost of goods sold ” is one of temporary account. “ Cost of goods sold ” is one of temporary account.

24. Cost of sold There are several methods to calculate the cost of sold if the cost of completed products is known in the case of periodical inventory system. Which are: 1. First in first out (FIFO) 2. Last in first out (LIFO) 3. Average weight running 4. Average methods 5. Particular methods

25. Trial Balance To determine all debit entry equal to all credit entry in all journal entries. To determine all debit entry equal to all credit entry in all journal entries. To determine all debit balances equal to all credit balance in the double entry system To determine all debit balances equal to all credit balance in the double entry system If trial balance is out of balance, it necessary to search for the error. If trial balance is out of balance, it necessary to search for the error. Even the trial balance is balanced, we can not sure there is no error in the accounting procedure. Even the trial balance is balanced, we can not sure there is no error in the accounting procedure.

26. Errors Trial Balance con not Detected Failing to record or enter a particular transaction. Failing to record or enter a particular transaction. Entering a transaction more than once. Entering a transaction more than once. Entering one or more amounts in the wrong a/c. Entering one or more amounts in the wrong a/c. Making a compensating error that exactly offsets the effect of another error. Making a compensating error that exactly offsets the effect of another error.

27. How to use trial balance The following is the trial balance of Wedburn after his first years trading. You are required to draw up a trading and profit and loss account for the year ended 31 December year 6 following

28. Financial Statement Balance sheet Income statement or profit and loss account or P/L a/c Cash flow statement

29. Case study 1 Mr. Lee, who won in a lottery, earned 1 million dollars from a lottery after payment of individual income tax for this event. With the amount of money, he purchased a grocery at a price $600,000 on January 1,2002, the grocery, which including inventories amount to $200,000 and business equipments $50,000, will be dismantled in 7 year because of occupation of new express way. With the grocery, Mr. Lee began his business. As usually, credit transactions always occurred in both his purchase and sale, and recorded by himself. All cash transactions, without any record, has been controlled by Mr. Lee, At the end of 2002, the tax authority urged him to pay business income tax. But he can not provide any date of his annually profit. He had to ask you to help. When you agree to do so. How to start your accounting job for Mr. Lee ’ s grocery?

30. Case study 1 (continued) After your physical check and interview with Mr. Lee, you obtained following information After your physical check and interview with Mr. Lee, you obtained following information Cash in hand $160,000 Cash in hand $160,000 Inventories $380,000 Inventories $380,000 Business Debtors $120,000 Business Debtors $120,000 Business Creditors $30,000 Business Creditors $30,000 Loan to his relatives $150,000 Loan to his relatives $150,000 Water and electric bills $15,000 Water and electric bills $15,000 Mr. Lee ’ s Consumption in this year $100,000 Mr. Lee ’ s Consumption in this year $100,000

31. Case Study 2 Next year, Mr. Lee continue his business, and do not want to employ any accountant, because he believe that accountant ’ job would be redundant to his business and bank records could help him as accountant. Therefore, he put all his remained cash into a bank and open a checking account in the bank. On July 1, he purchased a van, which is expected to use in 10 years (no residual value after 10 years), at a price of $80,000 for his business transportation, On the same day, he paid $20,000 for it comprehensive insurance for one year. On September 1, he employed a shop assistant with agreed monthly salaries of $1,000, but will pay him each month salaries in next month. At the end of this year, his grocery had $180,000 of inventories, $530,000 of cash in bank, (but among it, bank claimed that $30,000 are put into, in mistake, his checking account). Trade debtors were stand at $400,000 and trade creditors $250,000, and both debtors and creditors were occurred in current year. And Mr. Lee acknowledged that he had consumed $40,000 of his inventories in this year. Next year, Mr. Lee continue his business, and do not want to employ any accountant, because he believe that accountant ’ job would be redundant to his business and bank records could help him as accountant. Therefore, he put all his remained cash into a bank and open a checking account in the bank. On July 1, he purchased a van, which is expected to use in 10 years (no residual value after 10 years), at a price of $80,000 for his business transportation, On the same day, he paid $20,000 for it comprehensive insurance for one year. On September 1, he employed a shop assistant with agreed monthly salaries of $1,000, but will pay him each month salaries in next month. At the end of this year, his grocery had $180,000 of inventories, $530,000 of cash in bank, (but among it, bank claimed that $30,000 are put into, in mistake, his checking account). Trade debtors were stand at $400,000 and trade creditors $250,000, and both debtors and creditors were occurred in current year. And Mr. Lee acknowledged that he had consumed $40,000 of his inventories in this year.

32. Case study 2 (continued) After check Mr. Lee ’ s checking a/c in the bank, you obtain: All expenses for the van during this year were $3,000 All expenses for the van during this year were $3,000 All business expenses in this year were $12,000, excluded any amount of salaries. All business expenses in this year were $12,000, excluded any amount of salaries. Cash receiving from proceeds in this year were $800,000 Cash receiving from proceeds in this year were $800,000 Cash disbursement for purchasing inventories in this year were $390,000 Cash disbursement for purchasing inventories in this year were $390,000 Cash receiving from collection of the loan of last year were $80,000 Cash receiving from collection of the loan of last year were $80,000 Suppose that income tax rate is 33% You are required to calculate: 1. Profit before tax during this year 2. To justify the bank ’ s claiming