FIN611 Handouts

LESSON # 1 ACCOUNTING FOR INCOMPLETE RECORDS

1.

Introduction

This topic is also known as Single Entry System of Accounting. In this chapter we will learn how an accountant prepares financial statements of those organizations which are not keeping up proper double entry book keeping system of accounting. From accounting system stand point, business organizations can be classified into three broad categories:

1. 1 Small scale business entities These consist of very small sized business entities like; barber shop, mutton shop, washer man, general store, electrician etc. etc.
2. 2 Medium scale business entities These consist of medium sized business entities like; drycleaner, motor car dealers, house building contractors, schools etc. etc.
3. 3 Large scale business entities These consist of large sized business entities like; importers/exporters, motor car manufactures, transporters etc. etc.

Here it must be made clear that large scale business entities have these much resources with them that these can easily afford a systematic accounts department where they will be following the double entry book keeping system. Moreover, most of these concerns are incorporated bodies and these have to maintain systematic accounting records in order to fulfill requirements of the Companies Ordinance 1984 and International Financial Reporting Standards (IFRS).

2.

Accounting for Small scale business entities

Small scale business entities are often single owner organizations (Sole proprietorship). These are very small in size and can not really run an accountants department in their organizations. They have a very little setup in which a sole trader is acting so many rolls; he/she is the sales manager, and also the purchase manager, also responsible for marketing and accounts matters as well. A sole proprietor is also concerned about financial performance (profitability) and financial position of the organization, which can make him/her able to take certain future decisions. Certain government agencies, like taxation department, also require knowing profits of the organization. But as the size of the organizations are very little and these can hardly afford an accountant therefore a very simple accounting system is proposed for such organizations.

2.1

Accounting Records

These organizations do not have to keep any complex accounting records, these are directed by their accounts consultant (Qualified Accountants) to keep certain information relating to cash receipts (introduction of fresh capital) and payments (drawings) and also relating to the period end balances of assets and liabilities. As size of the transactions are very little therefore one can remember very easily what are the year end balances of loan taken or was there any addition or disposal of assets during the year. Finally the consultants prepare a statement of profit or loss for the period and also a balance sheet as on the closing date of such period.

2.2

As you have studied in your earlier courses that profit is an out come of the Income Statement that is prepared in a systematic way with the help of a trial balance extracted from the ledger. But over here in the absence of a trial balance we are not able to prepare an Income Statement. Here we will see that where that profit goes within the financial statements, we finally find that the profit is added up in the Owner’s Equity, which appears like this: Rs. Owner’s Equity (opening balance) Add

Net profit (for the year) Less

Owner’s Equity (closing balance)

For small scale business entities, which are not preparing proper books of accounts and cannot extract a trial balance, the technique to calculate Net Profit will be to come other way round. To calculate Net Profit figure from the above equation one must know the all other information that has to be put into it. Now the above equation will be reversed and Net Profit figure will be its out come and this equation is then named as the

For the year ended December 31, 20x7 Rs. Owner’s Equity (closing balance) Add

Less Owner’s Equity (opening balance)

Net profit (for the year) [balancing figure]

2.3

From examination stand point, Drawings and Fresh capital will be given in the questions but often the students will be required to calculate the opening and closing balances of Owner’s Equity as these will not be given in the question as a single amount. If you have not yet forgotten the basic accounting equation then Statement of Affairs is very simple to understand. What you learned in the basic accounting equation was that: ASSETS OWNER’S EQUITY + LIABILITIES So to calculate the balance of owner’s equity the equation will be reversed like: OWNER’S EQUITY = ASSETS

As on Opening and Closing Date

Opening

Closing

Rs. Rs. ASSETS Furniture and fixture (net of depreciations) *** Stocks Debtors (net of provisions) Prepaid expenses Bank Cash

Loan Creditors Accrued expenses OWNER’S EQUITY (Net Assets)

The balance of Owner’s Equity can also be termed as Net Assets as it is the balance of assets after subtracting all liabilities.

2.4

Difference between Balance Sheet and Statement of Affairs

The only difference is that in Balance Sheet we put RESOURCES (Assets) against the SOURCES (Owner’s equity and Liabilities) by doing this we come to know the financial position of the organization, whereas in Statement of Affairs we simply calculate the balance of owner’s equity at opening/closing dates of the accounting period by subtracting liabilities for the asset. Balance sheet equation provides help in calculating the balance of owner’s equity and that’s all.

Practice Questions

From the following information prepare statement of profit or loss for the year.

Rs.(000)

Opening balance of capital Closing balance of capital Drawings

Bilal Anwar started in business on 1 January 2005 with Rs. 10,000 in a bank account. Unfortunately he did not keep proper books of account. He is forced to submit a calculation of profit for the year ended 31 December 2005