accountancy – Page 3 – Accounting Crash Course

Three Most Common Types of Small Businesses – Sole Proprietorships, Partnerships and Private Limited Companies

Sole Proprietorships

This is the type of business which legally the business entity is not separated from the owner. However, do not get yourself confused with the Separate Entity Concept in accounting. Usually the business is registered with government under a trade name (either with some association with the name of the owner or a different name altogether) and this trade name will represent the business entity in the conduct of its business activities.

Partnerships

This is the type of business with more than one owner. All the owners are called partners. In general all the partners contribute capital to the business and share common objectives of making the business successful and share the profits generated. Generally in law, the partners may have joint liability or joint and several liabilities. However, some countries may allow partnerships in which the liabilities of partners are limited. A partnership agreement could be used to set the terms and conditions among the partners.

Private Limited Companies

Some countries allow single member limited companies to be incorporated and some require minimum two members. The clear distinction of private limited companies from sole proprietorship and partnership is the liability of members is limited to the capital invested. Another distinct feature of limited private companies is that the governing body of the companies are the board of directors. The company incorporated carries its own identity under law and can sue and be sued by others. Of course when a company is found to have guilty legally, financial penalties are imposed because it is meaningless to impose jail terms on companies. In these circumstances, the relevant individuals behind the company (usually the directors) may be penalised financially, with jail terms or both. The relationship between the companies, the members/shareholders and the directors is unique and also can be a complex one whenever there are disputes between the company with third parties or disputes between members/shareholders or among the members of the board of directors. There are relevant sections in the Companies Act or Corporations Act of each country touching on this and of course there are common laws which have set down the legal principles since centuries ago.

You could find a lot of reading materials on the legal aspects of the above three types of business entities. Therefore, I only described them briefly in this post.

Example of Income Statement and Balance Sheet of a Sole Proprietor

Income Statement for the year ended 31 December 2006
	$
Sales	159,270
Cost of Sales	– 90,875
Gross profit	68,395
Other income: –
Interest income	2,356
Operating expenses: –
Accountancy fee	– 800
Depreciation of property, plant and equipment	– 2,500
Donation	– 500
Electricity & water	– 3,340
Insurance premium	– 2,000
Printing & stationery	– 1,697
Rental of premises	– 12,000
Salaries	– 35,579
Upkeep of office	– 3,547
Telephone charges	– 1,285
Travelling, petrol & toll charges	– 2,648
	– 65,896
Net profit for the year	4,855
Retained profits B/F	27,654
Retained profits C/F	32,509

Balance Sheet as at 31 December 2006
	$
Non-current assets
Property, plant and equipment	15,000

Current assets
Inventories	5,200
Trade receivables	6,000
Other receivables, deposits & prepayments	3,458
Cash and bank balances	10,639
	25,297
Current liabilities
Trade payables	– 3,588
Other payables and accruals	– 2,575
	– 6,163
Net current assets	19,134
	34,134
Financed by: –
Capital	15,000
Retained profits	32,509
Net drawings	– 13,375
	34,134

Example of Income Statement and Balance Sheet of a Partnership

Income Statement for the year ended 31 December 2006
		$
Sales		159,270
Cost of Sales		– 90,875
Gross profit		68,395
Other income: –
Interest income		2,356
Operating expenses: –
Accountancy fee		– 800
Depreciation of property, plant and equipment		– 2,500
Donation		– 500
Electricity & water		– 3,340
Insurance premium		– 2,000
Printing & stationery		– 1,697
Rental of premises		– 12,000
Salaries		– 35,579
Upkeep of office		– 3,547
Telephone charges		– 1,285
Travelling, petrol & toll charges		– 2,648
		– 65,896
Profit for the year		4,855
Add: –
Interest on partner’s drawings
Partner A	1,500
Partner B	2,000	3,500

Less: –
Partner’s salary
Partner A	– 15,000
Partner B	– 20,000	– 35,000
Partner’s commision
Partner A	– 3,000
Partner B	– 2,000	– 5,000
Interest charged on partner’s capital
Partner A	– 2,500
Partner B	– 3,500	– 6,000
Net loss for the year		– 37,645
Shared as follows: –
Partner A – 60%		– 22,587
Partner B – 40%		– 15,058
		– 37,645

Analysed as follows: –
	Partner A	Partner B	Total
	$	$	$
Shared net loss for the year	– 22,587	– 15,058	– 37,645
Less: –
Interest on partner’s drawings	– 1,500	– 2,000	– 3,500
Add: –
Partner’s salary	15,000	20,000	35,000
Partner’s commission	3,000	2,000	5,000
Interest charged on partner’s capital	2,500	3,500	6,000
Net profit for the year	– 3,587	8,442	4,855
	Note 1	Note 1

Balance Sheet as at 31 December 2006
			$
Non-current assets
Property, plant and equipment			15,000

Current assets
Inventories			5,200
Trade receivables			6,000
Other receivables, deposits & prepayments			3,458
Cash and bank balances			10,639
			25,297
Current liabilities
Trade payables			– 3,588
Other payables and accruals			– 2,575
			– 6,163
Net current assets			19,134
			34,134
Financed by: –
	Partner A	Partner B	Total
	$	$	$
Capital account	9,000	6,000	15,000
Current account
Balance B/F	45,874	24,280	70,154
Shared net loss for the year	– 22,587	– 15,058	– 37,645
Net drawings during the year	– 12,000	– 5,000	– 13,375
Balance C/F	11,287	4,222	19,134
	20,287	10,222	34,134

Note 1: the net loss for the year for Partner A of $3,587 and net profit of Partner B of $8,422 were derived by calculating from the share of net loss for the year of $37,645, taken into account of the interest on capital, interest on drawings, salary and commission of each partner. You would not be able to know how much is each partner’s share of profit or loss directly from the net profit of $4,855.

Example of Income Statement and Balance Sheet of a Private Limited Company

Income Statement for the year ended 31 December 2006
	$
Sales	159,270
Cost of Sales	– 90,875
Gross profit	68,395
Other income: –
Interest income	2,356
Operating expenses: –
Accountancy fee	– 800
Depreciation of property, plant and equipment	– 2,500
Donation	– 500
Electricity & water	– 3,340
Insurance premium	– 2,000
Printing & stationery	– 1,697
Rental of premises	– 12,000
Salaries	– 35,579
Upkeep of office	– 3,547
Telephone charges	– 1,285
Travelling, petrol & toll charges	– 2,648
	– 65,896
Net profit for the year	4,855
Retained profits B/F	27,654
Retained profits C/F	32,509

Balance Sheet as at 31 December 2006
	$
Non-current assets
Property, plant and equipment	15,000

Current assets
Inventories	5,200
Trade receivables	6,000
Other receivables, deposits & prepayments	3,458
Amount due by shareholders	13,375	Note 2
Cash and bank balances	10,639
	38,672
Current liabilities
Trade payables	– 3,588
Other payables and accruals	– 2,575
	– 6,163
Net current assets	32,509
	47,509
Financed by: –
Share capital	15,000
Retained profits	32,509
	47,509

Note 2: in this example, the net drawings of the owner in the example of a Sole Proprietor has been shown as amount due by shareholders for comparison purposes

Cash Basis Vs Accrual Basis of Accounting

Many small businesses use cash basis of accounting to record transactions, especially those who prepare the accounts once a year. Please refer to my post: Preparing Accounts of Small Businesses Once A Year – Tips and Pitfalls To Avoid for further illustrations.

Indications that cash basis of accounting is used includes the following:-

No books of original entry such as sales day book and purchases day book used to record sales and purchases.
No debtors ledger or creditors ledger maintained.
All receipts and payments are recorded directly in cash book.

Cash basis of recording transactions and presenting the financial statements produced has long been deemed an inappropriate basis to use. Accrual basis of accounting is the accepted basis and this is stated in International Accounting Standard (IAS) 1: Presentation of Financial Statements.

It is good if a business entity is aware of the difference between cash basis and accrual basis of accounting and records its transactions using accrual basis. However, for those businesses who have recorded the transactions using cash basis do not need to discard those set of accounts produced and record all past transactions using accrual basis of accounting all over again. What need to be done is re-examine all the account items that have been produced using cash basis of accounting to determine as to whether any adjustment is required to adjust those items should accrual basis of accounting is used. Some examples: –

Sale of goods

Under cash basis of accounting, all proceeds collected from sales are recorded in the accounting records upon receiving payments from customers. The balance sheets produced using cash basis of accounting do not show any trade debtor balances! Those sales figures shown in the income statements represent only cash sales. No credit sales are recorded.

The solution is to identify all bills and invoices of those sales in which the transactions have occurred as at the end of the financial year, but still unpaid, i.e. those unpaid sales invoices or bills and put through a journal adjustment to recognise the credit sales and trade debtors as follows: –

Balance Sheet

Income Statement

DR

CR

DR

CR

Trade debtors

XXXX

Sales

XXXX

A point to note on the criteria used to determine the occurrence of transactions (sales recognition in this case) is usually based on delivery and acceptance of goods by customers. You may have come across the solution because I have discussed this in Step 4a, The Worst Case Scenario of my post: Preparing Accounts of Small Businesses Once A Year – Tips and Pitfalls To Avoid.
Purchase of goods

This is the opposite of sales of goods discussed above. Similarly, the balance sheets produced under cash basis of accounting will not show any trade creditor balances. The purchases figures shown in the income statements represent only cash purchases. No credit purchases are recorded.

The solution is the same as discussed in sale of goods above. You need to identify all unpaid bills and invoices in which the transactions have occurred as at the end of the financial year, but still unpaid, i.e. those unpaid purchase invoices or bills and put through a journal adjustment to recognise the credit purchases and trade creditors as follows: –

Balance Sheet

Income Statement

DR

CR

DR

CR

Purchases

XXXX

Trade Creditors

XXXX
Prepayments

Some expenses are paid now but part of them or the entire sums are meant for future period. This is the reason that they are called “Prepayments”. Under cash basis of accounting, prepayments are usually recorded as the respective expense accounts. What is required here is an adjustment to recognise the prepayments as current assets i.e. those portion of the payments that are meant for the next financial year.

The original double entry recording the transactions when payments are made: –

	Balance Sheet		Income Statement
	DR	CR	DR	CR
Expenses			XXXX
Cash at bank		XXXX

Adjustment for prepayments recognition:-

	Balance Sheet		Income Statement
	DR	CR	DR	CR
Prepayments	XXXX
Expenses				XXXX

Example

The financial period of ABC Co. Ltd. is from 1 January 2007 to 31 December 2007. On 1 November 2007, ABC Co. Ltd. paid the insurance premium for its fire policy covering the period from 1 December 2007 to 30 November 2008. The amount paid was $2,400. The prepayment for insurance is therefore $2,200 ($2,400/12 months x 11 months for the period from 1 January 2008 to 30 November 2008).

The original double entry recording the transactions when payments are made: –

	Balance Sheet		Income Statement
	DR	CR	DR	CR
Insurance premium			2,400
Cash at bank		2,400

Adjustment for prepayment recognition:-

	Balance Sheet		Income Statement
	DR	CR	DR	CR
Prepayments	2,200
Insurance premium				2,200

The balance sheet and income statement of ABC Co. Ltd. before and after this adjustment for prepayment recognition are shown below to illustrate the impact of this adjustment: –

Example of Income Statement and Balance Sheet of ABC Co. Ltd.

Income Statement for the year ended 31 December 2007
	BEFORE	Adjustment		AFTER
		DR	CR
	$			$
Sales	159,270			159,270
Cost of Sales	– 90,875			– 90,875
Gross profit	68,395			68,395
Other income: –
Interest income	2,356			2,356
Operating expenses: –
Accountancy fee	-800			– 800
Depreciation of property, plant and equipment	-2,500			– 2,500
Donation	-500			– 500
Electricity & water	-3,340			– 3,340
Insurance premium	-2,400		2,200	– 200
Printing & stationery	– 1,697			– 1,697
Rental of premises	-12,000			– 12,000
Salaries	-35,579			– 35,579
Upkeep of office	-3,547			– 3,547
Telephone charges	-1,285			– 1,285
Travelling, petrol & toll charges	-2,648			– 2,648
	-66,296			– 64,096
Net profit for the year	4,455			6,655
Retained profits B/F	27,654			27,654
Retained profits C/F	32,109			34,309

Balance Sheet as at 31 December 2007
	$			$
Non-current assets
Property, plant and equipment	15,000			15,000

Current assets
Inventories	5,200			5,200
Trade receivables	6,000			6,000
Other receivables, deposits & prepayments:
Sundry receivables	1,058			1,058
Deposits	2,000			2,000
Prepayments	–	2,200		2,200
Amount due by shareholders	13,375			13,375
Cash and bank balances	10,639			10,639
	38,272			40,472
Current liabilities
Trade payables	-3,588			– 3,588
Other payables and accruals	-2,575			– 2,575
	-6,163			– 6,163
Net current assets	32,109			34,309
	47,109			49,309
Financed by: –
Share capital	15,000			15,000
Retained profits	32,109			34,309
	47,109			49,309

Interest income

Business entities may place excess cash as term deposits with financial institutions to earn interest income. Under cash basis of accounting, there was no interest income recognised and recorded in the accounts until the business entities receive the interest upon maturity of the term deposits.

However, under accrual basis of accounting, the amount of interest attributable to the relevant period of the deposits placement must be calculated and recognised accordingly. For examples, the financial period of ABC Co. Ltd. is from 1 January 2007 to 31 December 2007. On 1 July 2007, ABC Co. Ltd. placed $100,000 with its bank as term deposit for 1 year. The interest rate is 3.5% per annum. The interest earned from 1 July 2007 to 30 June 2008 is $350 ($100,000 x 3.5%). In respect for the accounts of ABC Co. Ltd. for the year ended 31 December 2007, the portion of the interest income to be recognised is $175 ($350 x 6months/12months for the period from 1 January 2007 to 31 December 2007).

The journal adjustment to recognise this interest income is as follows: –

Balance Sheet

Income Statement

DR

CR

DR

CR

Interest receivable

175

Interest income

175

The balance sheet and income statement of ABC Co. Ltd. before and after this adjustment for interest income recognition are shown below to illustrate the impact of this adjustment: –

Example of Income Statement and Balance Sheet of ABC Co. Ltd.

Income Statement for the year ended 31 December 2007
	BEFORE	Adjustment		AFTER
		DR	CR
	$			$
Sales	159,270			159,270
Cost of Sales	-90,875			– 90,875
Gross profit	68,395			68,395
Other income: –
Interest income	–		175	175
Operating expenses: –
Accountancy fee	-800			– 800
Depreciation of property, plant and equipment	-2,500			– 2,500
Donation	-500			– 500
Electricity & water	-3,340			– 3,340
Insurance premium	-200			– 200
Printing & stationery	– 1,697			– 1,697
Rental of premises	-12,000			– 12,000
Salaries	-35,579			– 35,579
Upkeep of office	-3,547			– 3,547
Telephone charges	-1,285			– 1,285
Travelling, petrol & toll charges	-2,648			– 2,648
	-64,096			– 64,096
Net profit for the year	4,299			4,474
Retained profits B/F	27,654			27,654
Retained profits C/F	31,953			32,128

Balance Sheet as at 31 December 2007
	$			$
Non-current assets
Property, plant and equipment	15,000			15,000

Current assets
Inventories	5,200			5,200
Trade receivables	6,000			6,000
Other receivables, deposits & prepayments:
Interest receivable	–	175		175
Deposits	14,077			14,077
Prepayments	2,200			2,200
Fixed deposit with licensed bank	100,000			100,000
Cash and bank balances	10,639			10,639
	138,116			138,291
Current liabilities
Trade payables	-3,588			– 3,588
Other payables and accruals	-102,575			– 102,575
	– 106,163			– 106,163
Net current assets	31,953			32,128
	46,953			47,128
Financed by: –
Share capital	15,000			15,000
Retained profits	31,953			32,128
	46,953			47,128

On 30 June 2008, when the deposit matures and interest of $350 is received by ABC Co. Ltd., the double entry to record these transactions is as follows:-

	Balance Sheet		Income Statement
	DR	CR	DR	CR
Cash at bank	100,350
Fixed deposit with licensed bank		100,000
Interest receivable		175
Interest income				175

The balance sheet and income statement of ABC Co. Ltd. for the year ended 31 December 2008 before and after this adjustment are shown below to illustrate the impact of this adjustment: –

Example of Income Statement and Balance Sheet of ABC Co. Ltd.

Income Statement for the year ended 31 December 2008
	BEFORE	Adjustment		AFTER
		DR	CR
	$			$
Sales	109,270			109,270
Cost of Sales	– 40,875			– 40,875
Gross profit	68,395			68,395
Other income: –
Interest income	–		175	175
Operating expenses: –
Accountancy fee	– 800			– 800
Depreciation of property, plant and equipment	– 2,500			– 2,500
Donation	– 500			– 500
Electricity & water	– 3,340			– 3,340
Insurance premium	– 200			– 200
Printing & stationery	– 1,697			– 1,697
Rental of premises	– 12,000			– 12,000
Salaries	– 27,865			– 27,865
Upkeep of office	– 3,547			– 3,547
Telephone charges	– 1,285			– 1,285
Travelling, petrol & toll charges	– 2,648			– 2,648
	– 56,382			– 56,382
Net profit for the year	12,013			12,188
Retained profits B/F	27,654			27,654
Retained profits C/F	39,667			39,842

Balance Sheet as at 31 December 2007
	$			$
Non-current assets
Property, plant and equipment	10,000			10,000

Current assets
Inventories	5,000			5,000
Trade receivables	17,030			17,030
Other receivables, deposits & prepayments:
Interest receivable	175		175	–
Deposits	14,077			14,077
Prepayments	2,200			2,200
Fixed deposit with licensed bank	100,000		100,000	–
Cash and bank balances	12,348	100,350		112,698
	150,830			151,005
Current liabilities
Trade payables	-3,588			– 3,588
Other payables and accruals	-102,575			– 102,575
	-106,163			– 106,163
Net current assets	44,667			44,842
	54,667			54,842
Financed by: –
Share capital	15,000			15,000
Retained profits	39,667			39,842
	54,667			54,842

Out of the $350 interest received, $175 was credited to the interest receivable account and $175 is credited to the interest income account for the year ended 31 December 2008 (for the interest earned for the period from 1 January 2008 to 31 December 2008.

The interest was calculated based on simple interest method. For illustrations on the difference between simple interest and compound interest, please refer to my post: Effective Interest? Simple Interest? Compound Interest? Nominal Interest?

Preparing Accounts of Small Businesses Once A Year – Tips and Pitfalls To Avoid

Many small business owners started the businesses on their own or with minimal staff strength. Usually, the major focus of the businesses is on revenue generation and leaves the function of transactions record keeping and accounting to inexperience staff. Many business owners leave it aside until the end of the financial year or when the deadline of accounts submission to the authorities coming close. The accounts and financial statements of the business entities are prepared once a year. Please take note that this practice of recording transactions once a year is definitely not encouraged and may even contravene the law imposed on businesses in some countries with the owners unaware of this. Depending on how the accounting documents are filed and kept, the accounting personnel assigned the task of preparing the accounts and the financial statements once a year may face the following three scenarios: –

First Scenario – The worst case scenario

The owners have little or no knowledge of accounting and transactions record keeping. No accounting records or transaction records listing kept. No separate recording of receipts and payments made. All the accounting documents including receipts, invoices & etc are probably not kept in files and in a mess. Personally, I have seen cases whereby all these source documents were just being thrown into a big box throughout the whole financial year! It puzzles me how these business owners monitor the daily cash flow position of the business operations. Many of them have to rely on constantly checking the bank account balances before payments are made or just relying on the fact that the bank account are allowed to be “overdrawn” because of overdraft facility. However, bank balances obtained from banks at any particular point in time do not necessary provide a reliable bank balances of the business available for use because of unpresented cheques and uncleared deposits. In addition, allowing unnecessary utilisation of overdraft facility is actually a waste of money for the business. This is a nightmare for the accounting personnel!

Steps: –

1. Sorting of documents

The first step is to sort all the accounting documents by types and in chronological order.

2. Identify and recover missing documents

Identify any obvious missing documents and take action to get a copy.

3. Key-in transactions in the accounts

Start with the cheque butts and bank statements by entering transactions into the cash book and the relevant accounts in the general ledger. Since there was no recording of transactions throughout the whole financial year, it serves little purpose now if you chose to record the transactions the conventional way to the books of original entry (Sales day book, purchase day book & etc) and then posts the transactions to the general ledger. However, it is good if you decide to do it the conventional way.

Important point: Key in or record the transactions MONTH BY MONTH. After the transactions of the first month have been completely recorded, prepare a bank reconciliation statement BEFORE you move on to the next month! This is important because if you proceed straight to key in all the transactions of the whole financial year in one go into the accounts, you still need to ensure that the bank balance reflected in the accounts as at the end of the financial year does in fact tally with the bank balance reflected on the bank statement (To prepare a bank reconciliation statement). Can you imagine what would happen if the reconciliation does throw out unreconciled differences? You have to go through all the transactions for the whole financial year (Both the entries recorded in the cash account and also the transaction entries reflected on the bank statements) and match each and every of them! By keying in transactions month by month and perform bank reconciliation also month by month, you are actually dividing this gigantic task into small parts and definitely much easier to manage and complete!

4. Further Adjustments

After all the entries have been recorded and reconciled to the bank statements, you still need to perform the following tasks before closing all the accounts and proceed to preparing the balance sheet and income statement: –

a. Credit transactions

Identify all bills, and invoices both for sales and purchases in which the transactions have occurred as at THE END OF THE FINANCIAL YEAR, but still have not been settled or paid. Go through all the invoices or bills settled or paid after the financial year and also all the unpaid or unsettled bills or invoices on hand. The criteria to determine the occurrence of transactions is usually based on the delivery and acceptance of goods and completion of services and NOT on the billing date as reflected on the invoice! Once you have completed this task, a listing of trade debtors, trade creditors, other debtors and other creditors should have also been compiled. Use journal entries to record and post these credit transactions in the respective accounts in the general ledger.

b. Year End Inventories or Stock Balance

The financial year end inventory balance is required to be ascertained. Usually, it is a required practice to conduct a year end stock counting exercise, and depending on the type of the business entities, if the financial statements of the business entities are subject to statutory audit requirement, the auditors should be informed of the stock counting date and be invited to observe the stock counting exercise. However, if the transactions record keeping of the business entities is in such a poor state, usually stock counting exercise at year end is also unlikely to have been conducted. Depending on the nature of the business entities, the task of identifying year end stock balances could be taking a lot of time and effort or just a simple and easy task. If the business is a service provider, no stock balances! If the business is selling only one type of goods, it is still fairly easy to identify the stock balance by way of identify the goods that have been purchased during the financial year (especially towards the end of the financial year) and SOLD in the NEXT FINANCIAL YEAR. Also identify those goods purchased during the financial year and remained unsold at the time of preparing the accounts. Of course if the stocks are beyond the usual stock holding period, the reason why the stocks are still unsold and any write down or write off required is the next issue to consider. However, if the business sells many different types of goods and also the volume of the businesses is large, this is a very time consuming task! Once the year end inventories or stock balance is ascertained, use journal entries to record the balance in the accounts.

c. Prepayment and deposits (balance sheet accounts with debit balances)

If all the prepayment and deposits have been calculated accordingly during the stage of keying in transactions into the accounts in the general ledger, it is of course no longer necessary to consider this. However, if there were no effort spend to calculate them before, you would now required to identify the possible prepayments and deposits which have most likely been recorded as expenses in the income statement items account and do the necessary adjustments by way of journal entries to recognise these items as balance sheet items.

5. Closing accounts and prepare trial balance, balance sheet and income statement

Once the above steps have been completed, it is time now to prepare the trial balance, balance sheet and income statement.

Second Scenario – Moderate cases

Accounting documents are filed by types and in chronological order. No cash book maintained but a listing or book that is used to record and describe each receipt and payment is maintained. In a way, this serves the role or cash receipts journal and cash payment journal.In this scenario, Step 1 and 2 described in the First Scenario are not necessary because the transactions record keeping are organised and in order. However, you need to go through the receipts and payments listing and segregate all the transactions into the respective types or groups and compute the total of each type or group of the transactions in accordance with the general ledger accounts items. You just need to post the total of each type or groups of transactions by way of journal entries the cash account and the respective general ledger accounts. Again, this should be performed month by month and also ensure the bank reconciliation is also performed month by month. After this, perform the tasks described in Step 4 and Step 5 of the First Scenario.

Third Scenario – Organised and Good Transactions Record Keeping

Cash book is used to record all receipts and payments and proper columns in the cash book are used to record each type of group of transactions in accordance with the accounts items in the general ledger. In these cases, the total of each column in the cash book is readily available at the end of each month. Most likely the monthly bank reconciliation statements are also prepared. You just need to record the total of each column in the cash book in the general ledger using journal entries. After this, perform the tasks described in Step 4 and Step 5 of the First Scenario.

Separate Entity Concept

In accounting, a business entity is treated as a separate entity from the owner(s). Therefore, any capital injections made by the owner(s) are recorded as capital contribution from owners in the books of the business entity. The owner(s)’ private expenditure/spending are not recorded in the books of the business entity.

There are many instances whereby the owner(s) withdrew money from the business for their personal use. This is actually a lending of money from the business to the owner(s) and should be recorded as such in the books of the business entity. On the other hand, when the owner(s) inject cash into the business to help easing tight cash flow situation faced by the business entity, it is a lending of money from the owner(s) to the business and should also be recorded as such in the books of the business entity.

Many owner(s) of small businesses fail to see this “line” drawn between the business and the owner(s). The direct consequence is the recording of private/personal expenditure in the books of the business entities and therefore the financial position and results of the business entities do not show a “true picture” of the business entities. The business entities may face the following problems: –

• Private/personal expenses not adjusted from the profit/income reported for income tax purposes and therefore understating the income subject to tax. Unnecessary penalty and more seriously, jail terms are possible outcome.

• It may cause the application for banking facility unsuccessful should the assessor of the application notice that the owner(s)’ private expenditure is included in the financial statements of the business entities.

• In general, this does not do good to the application submitted by the business entities whereby financial statements are to be included in the application (e.g. project tender, grant application & etc.)
This problem of keeping the books/accounts of business entities “clean” from owner(s)’ private expenditure can be further compounded if the transactions record keeping of the business entities is poor, making any effort to identify these private expenditure recorded in the books of the business entities for adjustment purposes difficult.

Inventories or Stocks – Part 3, Cost Formula

In Example 1 of my previous post, Inventories or Stocks – Part 2, Methods of Recording in General Ledger, the cost of purchasing inventories had been fixed in order to show the effect of two different methods of recording in General Ledger clearly. In reality, cost of inventory purchases fluctuates from time to time. Let’s explore the common ways of calculating the cost of inventories when purchase price fluctuates from time to time – This is called the Cost Formula of inventories. There are three common Cost Formulas for inventories: –

FIFO (First-in-first-out)
Weighted Average
LIFO (Last-in-last-out)

Please take note of the difference between Cost Formulas (FIFO, Weighted Average or LIFO) and the methods of recording inventories in General Ledger (Periodic Method or Perpetual Method). A business entity could choose a combination of the following in recording its inventories: –

	Methods of recording in General Ledger	Cost Formula
Combination 1	Periodic	FIFO
Combination 2	Periodic	Weighted Average
Combination 3	Periodic	LIFO
Combination 4	Perpetual	FIFO
Combination 5	Perpetual	Weighted Average
Combination 6	Perpetual	LIFO

As you can see from the above table, the choice of cost formula to be used is independent of how an entity chooses the method of recording inventories in the General Ledger.

Referring to the transactions ABC Co. Ltd. in Example 1 of my previous post, assume the following information for ABC Co. Ltd for the financial year ended 31 December 2006 (i.e. the financial period is for 12 months from 1 January 2006 to 31 December 2006):-

Inventories or stocks on hand as at 31 December 2005 comprised the following:-

Quantity

Unit Cost

Total

$

$

Stock Type A

100

5

500

Stock Type B

200

7

1,400

Stock Type C

250

20

5,000

6,900

15 January 2006

Sale of 50 units of Type A stock for $8 each, on credit. Total sales were therefore $400.
20 January 2006

Purchase of 100 units of Type B stock at $7 each, on credit. Total purchases were therefore $700
21 March 2006

Sale of all Type B stocks for $10 each, on credit. Total sales were therefore $4,000.
31 July 2006

Purchase of 50 units of Type A stock at $6 each, on credit. Total purchases were $300.
30 September 2006

Sale of 75 units of Type A stock at $9 each, on credit. Total sales were $675.
30 November 2006

Sale of 150 Type C stock for $25 each, on credit. Total sales were $3,750.

The following table shows the movement of inventories or stocks of ABC Co. Ltd. during the financial year ended 31 December 2006: –

Table 1	Stock Type A	Stock Type B	Stock Type C
	Quantity	Quantity	Quantity
Balance as at 1 January 2006	100	200	250
Stock in:
20 January 2006		100
31 March 2006	50
Stock out:
15 January 2006	(50)
21 March 2006		(300)
30 September 2006	(75)
30 November 2006			(150)
Balance as at 31 December 2006	25	–	100

You would notice that all the above transactions are exactly the same as shown in Example 1 of my previous post except for Transaction e. The purchase cost of Stock A was $6 per unit instead of $5. The difference in this purchase cost requires certain cost formula to determine value of the inventories in hand as at 31 December 2006 and also to determine the cost of goods sold or cost of sales of 75 units of Stock A sold on 30 September 2007. Please take note that the cost of goods sold for the 50 units of Stock A sold on 15 January 2006 makes no difference in terms of the difference cost formula used because the cost per unit of Stock A prior to the sale of this 50 units of Stock A was $5 per unit (assuming the 100 units of Stock A in hand prior to this sale is from the same batch of purchase). The cost of sale and the unit cost of Stock A during the financial year ended 31 December are shown calculated under the three different cost formulas are below: –

FIFO (first-in-first-out)

Under the FIFO cost formula, the earliest batch of inventories would be given the priority over the subsequent batch of purchases whenever there is sale of goods. In the case of Stock A, Table 2 shows the movement of the quantity, cost per unit and the respective cost of sales and inventory value:

Table 2	Stock Type A
	Quantity	Cost	Value	Refer
		$	$
Balance as at 1 January 2006	100	5	500
Stock out:
15 January 2006	(50)	(5)	*(250)
Balance as at 15 January 2006 after the sale of 50 units	50	5	250
Stock in:
31 March 2006	50	6	300
Balance as at 31 March 2006 after the purchase of 75 units	50 50	5 6	250 300	Note 1
Stock out:
30 September 2006	(50) (25)	(5) (6)	(250) (150)	Note 2
Balance as at 31 September 2006 after the sale of 75 units and remained unchanged until year end	25	6	150	Note 3

Note 1: The balance of Stock A as at 31 March 2006 comprises two different batches of stock – 50 units @ $5 per unit (This batch of stock was from the original 100 units brought forward from the previous financial year) and 50 units of new purchase @ $6 each.

Note 2: Under FIFO cost formula, the earliest batch of stock in hand i.e. the 50 units of Stock A @ $5 each is given priority in terms of sale (“Stock out”). The next batch of stocks in hand was therefore 25 units of Stock A @ $6.

Note 3: This is the batch of stock in hand after all sales taken into account during the entire financial year ended 31 December 2006.

*: The total of $650 ($250 + $250 + $150) was the cost of goods sold or cost of sales for Stock A during the financial year ended 31 December 2006.

Weighted Average

Under the Weighted Average cost formula, the weighted average cost of all existing inventories on hand plus the new purchases is calculated and allocated to all inventories on hand (both old and new batch of purchases) with the same weighted average cost calculated. Table 3 shows the movement of the quantity, cost per unit and the respective cost of sales and inventory value:

Table 3	Stock Type A
	Quantity	Cost	Value	Refer
		$	$
Balance as at 1 January 2006	100	5	500
Stock out:
15 January 2006	(50)	(5)	*(250)
Balance as at 15 January 2006 after the sale of 50 units	50	5	250
Stock in:
31 March 2006	50	6	300
Balance as at 31 March 2006 after the purchase of 75 units	100	5.5	550	Note 4
Stock out:
30 September 2006	(75)	(5.5)	*(412.5)	Note 5
Balance as at 31 September 2006 after the sale of 75 units and remained unchanged until year end	25	5.5	137.5	Note 6

Note 4: The weighted average cost of $5.5 was calculated by taking the total of the old batch of Stock A (50 x $5 = $250) plus the total of the new batch of Stock A purchased (50 x $6 = $300), divided by the total quantity of new and old stocks – {$250 + $300}/{50units + 50Units} = $5.5.

Note 5: Once the weighted average cost of $5.5 has been determined, the calculation of the cost of goods sold for this 75 units of Stock A is straight forward – 75 units x $5.5

Note 6: The calculation of closing inventories in hand is also straight forward – 25 units x $5.5

*: The total of $662.5 ($250 + $412.5) was the cost of goods sold or cost of sales for Stock A during the financial year ended 31 December 2006

LIFO (last-in-first-out)

Under the LIFO cost formula, the latest batch of inventories would be given the priority over the earlier batch of purchases whenever there is sale of goods. In the case of Stock A, Table 2 shows the movement of the quantity, cost per unit and the respective cost of sales and inventory value:

Table 4	Stock Type A
	Quantity	Cost	Value	Refer
		$	$
Balance as at 1 January 2006	100	5	500
Stock out:
15 January 2006	(50)	(5)	*(250)
Balance as at 15 January 2006 after the sale of 50 units	50	5	250
Stock in:
31 March 2006	50	6	300
Balance as at 31 March 2006 after the purchase of 75 units	50 50	5 6	250 300	Note 7
Stock out:
30 September 2006	(50) (25)	(6) (5)	(300) (125)	Note 8
Balance as at 31 September 2006 after the sale of 75 units and remained unchanged until year end	25	5	125	Note 9

Note 7: The balance of Stock A as at 31 March 2006 comprises two different batches of stock – 50 units @ $6 per unit (This batch of stock was from the original 100 units brought forward from the previous financial year) and 50 units of new purchase @ $6 each.

Note 8: Under LIFO cost formula, the latest batch of stock in hand i.e. the 50 units of Stock A @ $6 each is given priority in terms of sale (“Stock out”). The next batch of stocks in hand due for stock out was therefore 25 units @ $5 from the earlier batch of Stock A.

Note 9: This is the batch of stock in hand after all sales taken into account during the entire financial year ended 31 December 2006

*: The total of $675 ($250 + $300 + $120) was the cost of goods sold or cost of sales for Stock A during the financial year ended 31 December 2006

The double entries for recording inventories under both the Periodic and Perpetual methods had been shown in my previous post. Of course the figures for Stock A are different from those shown in Example 1 of my previous post, depending on which cost formula is chosen. Figures for Stock B and Stock C remained the same.

Did you notice that the three cost formulas shown above give different cost of goods sold and also different inventory value at the end of the financial year?

Another point to note is that LIFO cost formula is prohibited in some countries.

Inventories or Stocks – Part 2, Methods of Recording in General Ledger

There are two common methods of recording inventories or stocks in the General Ledger of business entities:-

1. The Periodic Method

2. The Perpetual Method

The choice of the method used will directly determine the double entries for the recording of inventories or stocks of the entity concerned.

1. The Periodic Method

Under this method, the inventories or stocks account in the General Ledger would not be updated regularly with the movement of inventories or stocks throughout the whole financial period until the last closing day of the financial period in which the new inventories balance would be determined and adjusted accordingly. The balance of the inventories or stocks account remained at the amount brought forward from the previous financial period i.e. the opening inventories or stocks for the current financial period (this is also the closing balance of inventories or stocks for the previous financial period). At the end of the current financial period, an inventories counting exercise would be conducted to determine the closing balance of inventories and once this is done, the inventories or stocks account in the General Ledger would then be adjusted to reflect the correct inventories or stocks balance on the closing date. On the closing date (i.e. the end of the current financial period), the cost of goods sold would also be determined and deducted against the sales or turnover figure recorded for the current financial period to get the gross profit amount. The steps involved are explained in the following illustration:-

Example 1

Assume the following information for ABC Co. Ltd for the financial year ended 31 December 2006 (i.e. the financial period is for 12 months from 1 January 2006 to 31 December 2006):-

a. Inventories or stocks on hand as at 31 December 2005 comprised the following: –

	Quantity	Unit Cost	Total
		$	$
Stock Type A	100	5	500
Stock Type B	200	7	1,400
Stock Type C	250	20	5,000
			6,900

b. 15 January 2006

Sale of 50 units of Type A stock for $8 each, on credit. Total sales were therefore $400.

c. 20 January 2006

Purchase of 100 units of Type B stock at $7 each, on credit. Total purchases were therefore $700

d. 21 March 2006

Sale of all Type B stocks for $10 each, on credit. Total sales were therefore $4,000.

e. 31 July 2006

Purchase of 50 units of Type A stock at $5 each, on credit. Total purchases were $250.

f. 30 September 2006

Sale of 75 units of Type A stock at $9 each, on credit. Total sales were $675.

g. 30 November 2006

Sale of 150 Type C stock for $25 each, on credit. Total sales were $3,750.

The double entries for the above transactions are: –

a. No double entry required. The transactions had been recorded in the General Ledger in the previous financial year.

b. 15 January 2006

	Balance Sheet		Income Statement
	DR	CR	DR	CR
31 January 2006
Trade debtors	400
Sales				400
(Sales for January 2006)

c. 20 January 2006

	Balance Sheet		Income Statement
	DR	CR	DR	CR
31 January 2006
Purchases			700
Trade creditors		700
(Purchases for January 2006)

d. 21 March 2006

	Balance Sheet		Income Statement
	DR	CR	DR	CR
31 March 2006
Trade debtors	3,000
Sales				3,000
(Sales for March 2006)

e. 31 July 2006

	Balance Sheet		Income Statement
	DR	CR	DR	CR
31 July 2006
Purchases			250
Trade creditors		250
(Purchases for July 2006)

f. 30 September 2006

	Balance Sheet		Income Statement
	DR	CR	DR	CR
30 September 2006
Trade debtors	675
Sales				675
(Sales for September 2006)

g. 30 November 2006

	Balance Sheet		Income Statement
	DR	CR	DR	CR
30 November 2006
Trade debtors	3,750
Sales				3,750
(Sales for November 2006)

The following table shows the movement of inventories or stocks of ABC Co. Ltd. during the financial year ended 31 December 2006: –

Table 1	Stock Type A	Stock Type B	Stock Type C
	Quantity	Quantity	Quantity
Balance as at 1 January 2006	100	200	250
Stock in:
20 January 2006		100
31 March 2006	50
Stock out:
15 January 2006	(50)
21 March 2006		(300)
30 September 2006	(75)
30 November 2006			(150)
Balance as at 31 December 2006	25	–	100

The amount of inventories as at year end i.e. 31 December 2006 was $2,125, comprising 25 units of Type A stock valued at $5 each (Total of Type A stock = $125) plus 100 units of Type C stock valued at $20 each (Total of Type C stock = $2,000).

Note: In this example, the cost of purchases of inventories during the year was intentionally fixed to remain the same as those as at 1 January 2006 for the purpose of simplifying the illustration of this topic. For Type A stock, the purchase of inventories made on 31 March 2006 was at $5 each, the same cost as at 1 January 2006. Similarly, for Type B stock, the purchase cost was $7. In reality, this may not necessary be the case as the price of goods do fluctuate from time to time. In Part 3, the methods commonly used by business entities to determine the unit costs of inventories will be discussed.

Once the closing inventories balance as at 31 December 2006 is determined, the following journal entries would be made to reflect the correct inventories balance: –

	Balance Sheet		Income Statement
	DR	CR	DR	CR
31 December 2006
Cost of goods sold			6,900
Inventories		6,900
(Being transfer of opening inventories to cost of goods sold account)

31 December 2006
Inventories	2,125
Cost of goods sold				2,125
(Being recognition of closing inventories)

The relevant accounts in the General Ledger of ABC Co. Ltd are as follows: –

			ABC Co. Ltd				Page 10
			General Ledger
			Inventories
DEBIT				CREDIT
Date	Descriptions	Folio	$	Date	Descriptions	Folio	$
2006				2006
01-Jan	Balance B/F		6,900.00	31-Dec	Cost of goods sold	GL45	6,900.00
31-Dec	Cost of goods sold	GL45	2,125.00	31-Dec	Balance C/F		2,125.00
			9,025.00				9,025.00

			ABC Co. Ltd
			General Ledger
			Trade Debtors				Page 15
DEBIT				CREDIT
Date	Descriptions	Folio	$	Date	Descriptions	Folio	$
2006				2006
31-Jan	Sales	GL30	400.00	31-Dec	Balance C/F		7,825.00
31-Mar	Sales	GL30	3,000.00
30-Sep	Sales	GL30	675.00
30-Nov	Sales	GL30	3,750.00
			7,825.00				7,825.00

			ABC Co. Ltd
			General Ledger
			Trade Creditors				Page 20
DEBIT				CREDIT
Date	Descriptions	Folio	$	Date	Descriptions	Folio	$
2006				2006
31-Dec	Balance C/F		950.00	31-Jan	Purchases	GL40	700.00
				31-Jul	Purchases	GL40	250.00
			950.00				950.00

			ABC Co. Ltd
			General Ledger
			Sales				Page 30
DEBIT				CREDIT
Date	Descriptions	Folio	$	Date	Descriptions	Folio	$
2006				2006
31-Dec	Transfer to Income statement		7,825.00	31-Jan	Trade debtors	GL15	400.00
	Transfer to Income statement			31-Mar	Trade debtors	GL15	3,000.00
				30-Sep	Trade debtors	GL15	675.00
				30-Nov	Trade debtors	GL15	3,750.00
			7,825.00				7,825.00

			ABC Co. Ltd
			General Ledger
			Purchases				Page 40
DEBIT				CREDIT
Date	Descriptions	Folio	$	Date	Descriptions	Folio	$
2006				2006
31-Jan	Purchases	GL20	700.00	31-Dec	Cost of goods sold	GL45	950.00
31-Jul	Purchases	GL20	250.00
			950.00				950.00

			ABC Co. Ltd
			General Ledger
			Cost of Goods Sold				Page 45
DEBIT				CREDIT
Date	Descriptions	Folio	$	Date	Descriptions	Folio	$
2006				2006
31-Dec	Inventories	GL10	6,900.00	31-Dec	Inventories	GL10	2,125.00
31-Dec	Purchases	GL40	950.00	31-Dec	Transfer to Income Statement		5,725.00
					Transfer to Income Statement
			7,850.00				7,850.00

The extract of the Income Statement of ABC Co. Ltd for the year ended 31 December 2006 is as follow: –

ABC Co. Ltd
Extract of Income Statement for the Year Ended 31 December 2006
	Ref	$

Sales	GL30	7,825.00	A
Cost of Goods Sold or Cost of Sales:
Opening Inventories	GL45	– 6,900.00	B
Purchases	GL45	– 950.00	C
Closing Inventories	GL45	2,125.00	D
		– 5,725.00	E = B+C-D
Gross Profit		2,100.00	F = A+E

An important point to note is for the Periodic Method of recording inventories or stocks, the Cost of Goods Sold or Cost of Sales has three components i.e. the opening inventories, the purchases during the year and also the closing inventories. This is also the formula of Cost of Goods Sold or Cost of Sales: –

Cost of Goods Sold/Cost of Sales = Opening Inventories + Purchases – Closing Inventories

Refer to Table 1, you could actually calculate the Cost of Goods Sold or Cost of Sales by multiplying the Quantity of Stock Out with the respective unit cost of the inventories as follows:-

Table 2	Stock Type A			Stock Type B			Stock Type C			Grand Total
	A	B	C = A x B	D	E	F = D x E	G	H	I = G x H	J = C + F + I
	Qty	Unit Cost	Total	Qty	Unit Cost	Total	Qty	Unit Cost	Total
		$	$		$	$		$	$	$
Stock out:
15.1.06	-50	5.00	-250.00	–	–	–	–	–	–	-250.00
21.3.06	–	–	–	-300	7.00	-2,100.00	–	–	–	-2,100.00
30.9.06	-75	5.00	-375.00	–	–	–	–	–	–	-375.00
30.11.06	–	–	–	–	–	–	-150	20.00	-3,000.00	-3,000.00
TOTAL			-625.00			-2,100.00			-3,000.00	-5,725.00

2. The Perpetual Method

Under the Perpetual Method of recording inventories, the movement of inventories during the financial period is updated regularly to the inventories account in the General Ledger. As a result of this kind of regular updates, more time and effort is required if compared with the Period Method of recording inventories. Refer to the same transactions shown in Example 1, the journal entries required using the Perpetual method of recording inventories are as follows: –

a. No double entry required. The transactions had been recorded in the General Ledger in the previous financial year.

b. 15 January 2006

	Balance Sheet		Income Statement
	DR	CR	DR	CR
31 January 2006
Trade debtors	400
Sales				400
(Sales for January 2006)

Cost of goods sold			250
Inventories		250
(Being cost of goods sold for January 2006)

c. 20 January 2006

	Balance Sheet		Income Statement
	DR	CR	DR	CR
31 January 2006
Inventories	700
Trade creditors		700
(Purchases for January 2006)

d. 21 March 2006

	Balance Sheet		Income Statement
	DR	CR	DR	CR
31 March 2006
Trade debtors	3,000
Sales				3,000
(Sales for March 2006)

Cost of goods sold			2,100
Inventories		2,100
(Being cost of goods sold for March 2006)

e. 31 July 2006

	Balance Sheet		Income Statement
	DR	CR	DR	CR
31 July 2006
Inventories	250
Trade creditors		250
(Purchases for July 2006)

f. 30 September 2006

	Balance Sheet		Income Statement
	DR	CR	DR	CR
30 September 2006
Trade debtors	675
Sales				675
(Sales for September 2006)

Cost of goods sold			375
Inventories		375
(Being cost of goods sold for September 2006)

g. 30 November 2006

	Balance Sheet		Income Statement
	DR	CR	DR	CR
30 November 2006
Trade debtors	3,750
Sales				3,750
(Sales for November 2006)

Cost of goods sold			3,000
Inventories		3,000
(Being cost of goods sold for November 2006)

If you compare the above journal entries with those under the Periodic Method, the difference is for each sale transaction, the cost of goods sold or cost of sales must also be determined and recorded accordingly. This means, a systematic tracking method of the cost of inventories such as shown in Table 2 must be in place to facilitate monitoring the movement of inventories cost. In addition, the journal entries for transferring opening and closing inventories balances to the Cost of Goods Sold account as in the Periodic Method are not required. You would also notice that when ABC Co. Ltd made purchases of inventories, it was the Inventories account that was debited instead of the Purchases account under the Periodic Method. Should there be no incidence of inventories loss due to pilferage etc., the inventories account balance in the General Ledger would reflect the correct balance of closing inventories. The explanation on how stock losses are recorded and reflected will be done in other posts later. The obvious advantage of having a Perpetual Method of recording inventories over the Periodic Method is that those business entities using Perpetual Method are able to know the inventories balance at any point in time.

The relevant accounts in the General Ledger using Perpetual method of recording inventories are as follows: –

			ABC Co. Ltd				Page 10
			General Ledger
			Inventories
DEBIT				CREDIT
Date	Descriptions	Folio	$	Date	Descriptions	Folio	$
2006				2006
01-Jan	Balance B/F		6,900.00	31-Jan	Cost of goods sold	GL45	250.00
31-Jan	Trade creditors	GL20	700.00	31-Mar	Cost of goods sold	GL45	2,100.00
31-Jul	Trade creditors	GL20	250.00	30-Sep	Cost of goods sold	GL45	375.00
				30-Nov	Cost of goods sold	GL45	3,000.00
				31-Dec	Balance C/F		2,125.00
			7,850.00				7,850.00

			ABC Co. Ltd
			General Ledger
			Trade Debtors				Page 15
DEBIT				CREDIT
Date	Descriptions	Folio	$	Date	Descriptions	Folio	$
2006				2006
31-Jan	Sales	GL30	400.00	31-Dec	Balance C/F		7,825.00
31-Mar	Sales	GL30	3,000.00
30-Sep	Sales	GL30	675.00
30-Nov	Sales	GL30	3,750.00
			7,825.00				7,825.00

			ABC Co. Ltd
			General Ledger
			Trade Creditors				Page 20
DEBIT				CREDIT
Date	Descriptions	Folio	$	Date	Descriptions	Folio	$
2006				2006
31-Dec	Balance C/F		950.00	31-Jan	Inventories	GL10	700.00
				31-Jul	Inventories	GL10	250.00
			950.00				950.00

			ABC Co. Ltd
			General Ledger
			Sales				Page 30
DEBIT				CREDIT
Date	Descriptions	Folio	$	Date	Descriptions	Folio	$
2006				2006
31-Dec	Transfer to Income Statement		7,825.00	31-Jan	Trade debtors	GL15	400.00
	Transfer to Income Statement			31-Mar	Trade debtors	GL15	3,000.00
				30-Sep	Trade debtors	GL15	675.00
				30-Nov	Trade debtors	GL15	3,750.00
			7,825.00				7,825.00

			ABC Co. Ltd
			General Ledger
			Cost of Goods Sold				Page 45
DEBIT				CREDIT
Date	Descriptions	Folio	$	Date	Descriptions	Folio	$
2006				2006
31-Jan	Inventories	GL10	250.00	31-Dec	Transfer to Income Statement		5,725.00
31-Mar	Inventories	GL10	2,100.00		Transfer to Income Statement
30-Sep	Inventories	GL10	375.00
30-Nov	Inventories	GL10	3,000.00
			5,725.00				5,725.00

The extract of the Income Statement of ABC Co. Ltd for the year ended 31 December 2006 is as follow: –

ABC Co. Ltd
Extract of Income Statement for the Year Ended 31 December 2006
	Ref	$

Sales	GL30	7,825.00	A
Cost of Goods Sold or Cost of Sales:	GL45	– 5,725.00	B
Gross Profit		2,100.00	C = A + B

As you can see, there is no purchases account created under the Perpetual Method.