5

ACCOUNTING FOR TRADING

ORGANIZATIONS

Learning Objectives

After studying this chapter you should be able to:

1. Compare the difference between the financial statements of a service

organization and a trading organization
2. Analyze and record the transactions for purchase and sale of goods
3. Compute cost of goods sold and gross profit
4. Prepare a worksheet for a trading organization
5. Prepare trading and profit and loss account
6. Prepare balance sheet of a trading organization
138 Financial Accounting: A Managerial Perspective
Accounting for Trading Organizations 139

Scenario

A
l-Madina Garments is a large retail store of readymade
garments owned by Mr Abdul Qadeer Baig. Mr Baig sells
garments of different well-known brands. His regular sales
are Rs. 1,000,000 (approx.) every month. However, during
the month of Ramazan, i.e. before Eid-ul-fitr, his activities increase
tremendously. In fact, planning for Eid season starts much earlier. The
planning process involves sales forecast of different items keeping in
view the season and latest fashion trends. Based on the sales
forecast, available stocks and resources purchase orders are placed
with different suppliers. Placing large orders can get bulk discounts,
which results in savings in price. Most of the purchases are made on
credit payable within 60 days. However, if payments are made within
15 days a cash discount of 2% is available. Some of the garments are
damaged or not according to the specifications. They are returned to
the manufacturer. The calculation of profit or loss involves determining
the cost of stock at the beginning and as well as at the end of the year.

Point to Think
How does the business of Mr Baig differ from that of a service organization
like Khan Autos?
Al-Madina Garments purchases readymade garments and without making
any alteration resells them. Khan Autos does not purchase items for resale; any
items purchased are for use in repairing the automobiles. Thus, in calculating
the profit or loss there are expenses to be matched with revenues. In case of
trading organizations the major expense is cost of goods sold.
140 Financial Accounting: A Managerial Perspective

I n the preceding chapters, the accounting cycle and preparation of financial

statements for a service organization – Khan Autos – were discussed and
illustrated. The service organizations form a significant part of any economy. The
two other main forms of economic activities in any economy are trading and
manufacturing activities. In the developed economies, manufacturing organizations
are the major contributors towards GNP. In developing countries, however,
agriculture and trading makes the major part of economic activity.
A trading organization sells goods substantially in the same physical form in
which it acquires them. The basic accounting principles explained for service
organization remain applicable to the trading organizations. It, however, requires
certain additional accounts and procedures to record purchase and sale of goods. It
further requires calculating the cost of the unsold stock, which involves certain
conceptual issues. The cost of unsold stock differs under different assumptions,
which are discussed in the subsequent chapters. The issue basically arises due to price
fluctuations. Before getting to the accounting procedures, the following terms used in
the accounting of trading organizations need to be understood:
Goods It means the trading commodity, i.e. the items purchased for resale. For
example, for a cloth merchant, cloth is goods; for a general store, grocery is goods.
Stock The goods held for sale at any particular point of time are called stock as at that
time. The stock at the beginning of the year is called opening stock and the unsold
stock at the year-end is called closing stock.
Purchases When goods are purchased, an accounting head ‘purchases’ is debited. If
some asset other than goods is purchased it is not termed as purchases; rather, a
separate accounting head for that asset is opened. For example, if furniture is
purchased for use, ‘furniture & fixture’ account will be debited.
Carriage-inwards The cost of purchases includes all essential expenses to bring an
item to a saleable position. The transportation cost is the most significant expense and
is the part of the cost of purchases. However, a separate account is opened for
transportation costs called carriage-inwards. While calculating cost of goods sold it is
added to the purchase price.
Accounting for Trading Organizations 141

Sales When goods are sold an accounting head ‘sales’ is credited. If an asset other
than goods is sold, it is not termed as sales.
Fig 5.1 Comparison of steps involved in calculating profit & loss of a service companies and
a trading companies
Service Organisation Trading Organisation

Service Revenue Sales Revenue

minus Trading minus

Account

Expenses Cost of goods sold

P&L equals equals

Account
Profit before tax Gross profit

minus minus

Tax Operating expenses

equals equals

Net profit Profit before tax

P&L
Account minus

Tax

equals

Net profit

THE PURCHASE FUNCTION

The Khan Autos decided to start trading in spare parts and established a separate
trading department on January 1, 1997. The job of this department is to purchase and
sell spare parts. The adjacent premises was hired and furnished for this purpose. Now
spare parts is the trading commodity for Khan Autos and in further discussions
‘goods’ will mean spare parts and when purchased will be known as purchases.
The purchases can be made on cash or credit. According to the accounting principle,
purchases are to be recorded when the title of ownership is transferred from the seller
142 Financial Accounting: A Managerial Perspective

to the purchaser. Like any transaction, the purchases should be supported by a

document. If purchases are on cash, they may be supported by an evidence of paid
cheque, a cash receipt from the supplier or a cash payment voucher. For credit
purchases there should be a purchase document received from supplier. In fact, the
supplier sends a sales invoice which acts as purchase document for purchases. In
large organizations there is a separate purchase department. Each purchase is initiated
on the demand of the sales department or the stores department. When the stock on
the shelf touches a certain minimum level, a requisition is sent by the stores
department to the purchase department. The purchase department places an order
with the supplier who supplies the goods according to the specifications of the
purchase order.
Fig 5.2 The Purchase Function

Requisition
Stores/sales Purchases
department department

Shipment of
goods
Sales Purchase
Receipt slip Invoice order

Supplier

The store receives the goods and issues a certificate of receipt. The entire purchase
process involves time and requires a continuous vigilance on the part of the sales
department and the stores department. Just imagine that how many items would be
there in the stock of Khan Autos’ trading department. A minimum stock of each part
is to be kept and order placed with the supplier in time so that the department is never
out of stock for any item. The stock management will be discussed later in cost
accounting or financial management course. Large departmental stores like the Utility
Stores have to have a very efficient stock management system. A delayed purchase
results in an opportunity cost of lost sales.
In the developed countries, the task of indicating the level of stock on the shelf and
placing the order with the supplier has been taken over by the computers. When a
sale is entered in the computer at the sales counter it automatically updates the stock
Accounting for Trading Organizations 143

record. The suppliers are also connected with the computer network and the moment
the stock touches the specified minimum level the order is placed with the relevant
supplier electronically. The supplier ships the goods in the minimum possible time. It
saves a lot of paper work, manpower, time and opportunity cost. However, this
system requires very reliable suppliers who do not need follow-up as a routine matter.
An efficient purchase function and stock management is the key for better
profitability.
Accounting for Purchases
There are two methods for accounting of purchases and stock – the periodic and
perpetual. When goods are purchased, purchases account is debited and the mode of
payment credited under periodic method which is commonly used. The perpetual
method is explained later. For example, the Khan Autos placed an order with Capital
Motors – a manufacturer of spare parts – for spark plugs, ignition points and
capacitors on Jan. 5, 1997 which were received as per the following invoice:
Fig 5.3

Capital Motors
47 West, Blue Area, Islamabad
Your order No: 123 Invoice No: 101
Date: 7-1-1997
To: Khan Autos
20, Murree Road
RAWALPINDI

S. No. Description Quantity Rate Amount

Rs. Rs.
1 Spark plugs 4´´ 200 20 4,000
2 Spark plugs 3-1/2´´ 200 15 3,000
3 Ignition point Toyota 200 30 6,000
4 Ignition point Suzuki 200 25 5,000
5 Capacitors Toyota 100 50 5,000
6 Capacitors Suzuki 100 50 5,000
Total 28,000
Less trade discount 10% 2,800
Net payable 25,200

Terms: 2/10, n/30 freight-FOB shipping point Shipping clerk: Zahid Imtiaz

The entry for the purchase is:

Jan. 7 Purchases 25,200
Creditors--Capital Motors 25,200
144 Financial Accounting: A Managerial Perspective

To record goods purchased on credit, term 2/10 n/30.

The act of purchase involves negotiation of price, credit terms and shipping
terms. The above invoice specifies all these items. An explanation of following terms
is essential for understanding accounting for purchases:
Credit Terms: When the goods are purchased or sold on credit the credit terms are to
be specified. The credit terms specify the cash discount rate, discount period and
maximum credit period if discount is not availed. The term 2/10 has two components,
the numerator describes the discount rate and the denominator the discount period. If
payment is made within 10 days the purchaser will be entitled to 2% discount. The
term n/30, means that net amount is to be paid in maximum of 30 days.
Cash Discount: A discount is allowed to customers to encourage them to pay their
accounts earlier than the normal credit period. It is a deduction from the invoice price
of goods if payment is made in the specified discount period. The delayed payments
by the customers may require the business to get loan from the bank on which interest
is to be paid. The finance manager has to make a comparison between the cost of
funds needed and the discount to be allowed or received.

If Khan Autos make payment within the discount period, following is the entry to record the
payment:
Jan 17 Creditors--Capital Motors 25,200
Discount received 504
Bank 24,696
To record payment to Capital Motors within discount period.
If it was decided not to avail the discount, the payment will be made on 30th day, i.e.
February 6, 1997, the entry would be as follows:
Feb 6 Creditors--Capital Motors 25,200
Bank 25,200
To record the payment to Capital Motors after discount period.
Trade Discount: The trade discount is part of price negotiation and is not reflected
anywhere in the accounts. The purchases are recorded at net of trade discount
amount. The trade discount is generally allowed to regular customers in the same
trade. Bulk discount is provided if a customer purchases large quantity at a time. This
discount is also not reflected in the accounts.
Carriage Costs: The purchase or sale agreements specify as to who is going to bear the
transportation costs. The freight or carriage terms are expressed as FOB terms. FOB stands for free
on board and it determines when the legal title of ownership passes from seller to purchaser. For
example, FOB shipping point means that the responsibility of seller is only up to delivering the
goods to the carrier, i.e. airport, seaport, truck stand, etc. Once delivered at shipping point, the title
of ownership passes to the purchaser and he bears the subsequent costs; FOB destination means
that the seller has to deliver the goods at the buyer’s place. In our example, Capital Motors will
Accounting for Trading Organizations 145

deliver the goods at the shipping point and Khan Autos will pay the carriage costs, say Rs. 50. The
entry would be as follows:
Jan. 7 Carriage inward 50
Cash 50
To record the payment of carriage cost on purchases.

Return Outwards: Sometimes a part of the goods supplied are not according to
the specifications of the purchase order. They may be damaged or substandard. Such
goods are returned to the supplier or a reduction in price negotiated. In both cases, the
liability, i.e. amounts payable to the creditor, is decreased.
Return outwards are also known as purchase returns and allowances. Let us
assume that the 100 Suzuki capacitors provided by Capital Motors were not
according to the specifications and therefore returned by Khan Autos. Khan Autos
will issue a debit memorandum to Capital Motors as illustrated in Fig 5.4.
Fig 5.4

Khan Autos
20 Murree Road
RAWALPINDI

To: Date: 10-1-97

Capital Motors Debit Memo No: 1
47 West Blue Area Your Invoice No: 101
ISLAMABAD

S. No. Description Quantity Rate Amount

Units Rs Rs
1 Capacitor Suzuki 100 50 5,000
Less 10% trade discount 500
Net amount debited to your account 4,500

Reasons for return/allowance:

Not according to the specifications

For return outwards, the creditors account is debited and return outwards account
is credited.
The journal entry for return outwards is:
Jan 10 Creditors--Capital Motors 4,500
Return outwards 4,500
To record the return of defective goods.
146 Financial Accounting: A Managerial Perspective

Point to Think
Did you note that purchases account is not credited; rather, a separate account
‘return outward’ is opened? Why?
One of the major objectives of accounting is to provide all material
information under separate classification. It helps in decision making process.
What type of information return outwards account provides and how does
it help in decision making?

When purchases are subject to cash discount and some goods are returned before
the payment, the discount applies only to the amount of remaining goods. In the
above example, the amount for remaining goods is Rs. 20,700.00 (i.e. Rs. 25,200-
4,500). If payment is made within the discount period, the discount will be 2% of Rs.
20,700 which equals Rs. 414. The entry to record the payment on January 18, 1997,
will be:
Jan 17 Capital Motors 20,700
Discount received 414
Bank 20,286
To record the payment to Capital Motors.

If the payment is not made within discount period, the full payment of Rs. 20,700
is to be made. In this case, the discount lost will not be disclosed and reported. Fig
5.5 summarises the entries.

Fig 5.5

General Journal
Jan 7 Purchases 25,200
Creditors--Capital Motors 25,200
Goods purchased on credit, terms 2/10, n/30.
Jan 7 Carriage inward 50
Cash 50
Paid transportation cost on goods purchased.
Accounting for Trading Organizations 147

Jan 10 Creditors--Capital Motors 4,500

Return outwards 4,500
Returned defective goods purchased on Jan 7.
Jan 17 Creditors--Capital Motors 20,700
Discount received. 414
Bank 20,286
Paid for goods purchased on Jan 7.
If the payment is made after the discount period the entry would be as follows.
Feb. 6 Creditors--Capital Motors 20,700
Bank 20,700
Paid for goods purchased on Jan 7.
The ledger account of Capital Motors will appear as follows:
Capital Motors
1997 Rs. 1997 Rs.
Jan 10 Return outwards 4,500 Jan 7 Purchases 25,200
Jan 17 Discount received 414
Jan 17 Bank 20,286
Net Method There is an alternate method to record purchases, which is called net
method. This method assumes that purchases may be recorded at cash price, i.e. net
of discount. The emphasis is that cash discount may be availed in all cases.
Therefore, instead of discount received, discount lost is reported. The entries under net
method are given below:
Jan 7 Purchases 24,696
Capital Motors 24,696
Goods purchased on credit, terms 2/10, n/30 invoice price
Rs. 25,000.
Jan 7 Carriage inward 50
Cash 50
Paid transportation cost on goods purchased.
Jan 10 Capital Motors 4,410
Return outwards 4,410
Returned defective goods to Capital Motors. Invoice price
Rs. 4,500.

Point to Think
Why a firm would like to emphasise discount lost rather than discount
received? What is expected from a finance manager?

If the payment is made within discount period the entry will be as follows:
Jan 17 Capital Motors 20,286
148 Financial Accounting: A Managerial Perspective

Bank 20,286
Paid for goods purchased on Jan 7.
It may be noted that purchases are recorded at net of discount figure. The 2%
discount of Rs. 25,200 becomes Rs. 504. The net price of purchases equals Rs.
24,696, i.e. Rs. 25,200 less Rs. 504. When goods are returned the entry is passed at
net of discount price. The invoice price of goods returned is Rs. 4,500. The discount
at a rate of 2% is Rs. 90. The net price becomes Rs. 4,410, i.e. Rs. 4,500 less Rs. 90.
The proponents of this method argue that payment must be made within discount
period. If it is not done it is a matter of inefficient cash management. This is why
under this method discount received is not recorded; it rather records the discount
lost. For example, if the payment is made on February 6, the entry will be as follows:
Feb 6 Capital Motors 20,286
Discount lost 414
Bank 20,700
Paid to Capital Motors for the goods purchased on Jan 7.
The discount lost is reported as a financial expense along with the interest or as
an administrative expense.

Point to Think
In a cash-tight economy, the prompt collection from debtors is essential if a
company wishes to report profits. Why?

ACCOUNTING FOR STOCK AND COST OF GOODS SOLD

In trading organizations, the revenue is earned through sale of goods. The revenue is
then matched with the cost of goods sold. The difference is gross profit. The unsold
goods at the end of the period are called closing stock and reported as current asset in
the balance sheet. The cost of goods sold can be calculated under two different
methods – periodic and perpetual.
Periodic System
It is the most commonly used and most appropriate system in case of firms selling
large number of items with a low cost per unit like medical, hardware and general
stores. Under this system, the cost of goods sold is determined at the end of the
period. It saves time and clerical costs as compared to perpetual system. However,
the modern technology has made it possible to keep a perpetual record even for
businesses like the ones mentioned above.
Accounting for Trading Organizations 149

In periodic system, the cost of stock on hand at the beginning of the year, called
the opening stock, is reported in the ledger in stock account. No entry is made in this
account during the year. However, in case of any error in recording the opening stock
it is corrected.
The cost of goods purchased during the year are recorded in a separate account
called purchases which is debited at cost price as explained under accounting for
purchases.
A sale of goods is recorded in sales account, which is credited at sales price. No
recurring record is maintained for the stock on hand or cost of goods sold. At the end
of the period, a physical count of stock is undertaken. The process of counting the
stock is called stocktaking. The stocktaking involves the following steps:
i Count the number of units in each category of items.
ii Determine the unit cost to be assigned to each item.
iii Multiply the unit cost with the number of items in each category and
find out the total rupee cost of the stock.
The stock at the end of the period is called closing stock. While taking count of
stock the goods which have been purchased and are in transit must be included in the
stock count.
Cost of Goods Sold Calculated
At this point you know the values of opening and closing stock. Before calculating
the cost of goods sold, you need to work out the net value of purchases made during
the period. The procedure involved is as follows:
Purchases
+ Carriage inwards
= Purchases made during the year
- Return outwards
= Net purchases made during the year
Now cost of goods sold can be worked out with the following formula:
Opening stock
+ Net purchases
= Cost of goods available for sale
- Closing stock
= Cost of goods sold
Let us consider the following example, to understand the calculation of cost of goods
sold:
Ahmad Electronics had 10 television sets costing Rs. 15,000 each at the
beginning of 1997. The firm purchased 92 TVs during the year at the same cost per
150 Financial Accounting: A Managerial Perspective

unit. A transportation cost of Rs. 1,000 was paid and two TVs being defective were
returned to supplier. At the end of the year, 20 TVs remained unsold. These unsold
TVs constitute the closing stock.
The cost of goods sold is calculated as follows:
Rs. Rs.
Opening stock (10x15,000) 150,000
add purchases (92x15,000) 1,380,000
add carriage-inwards 1,000
1,381,000
Less return out (2x15,000) 30,000
Net purchases 1,351,000
Cost of goods available for sale 1,501,000
Less closing stock (20x15,000) 300,000
Cost of goods sold 1,201,000
The carriage inward is added to purchases. The cost of an asset, in this case the
goods purchased, includes the invoice price plus transportation charges and other
costs directly related to acquiring the asset.
Closing Entries
As explained in the previous chapter the revenue and expenditure accounts (nominal
accounts) are closed by transferring their balances to P & L account by passing the
closing entries. The same principle applies in the case of trading organization as well.
However, in the case of trading organization, the balances of additional accounts
related to purchase and sale of goods are transferred to trading account by passing the
following closing entries.
Dec 31 Trading account
Stock
To transfer the opening stock to trading account

Dec 31 Trading account

Purchases
Carriage inwards
Return-inwards*
Other costs directly related to acquiring the assets
To transfer the balances to trading account
*Return-inwards are the goods returned to the company by the customers for the same reasons
the company would return the goods (return-outwards) to its suppliers.
Dec 31 Sales
Stock(closing)
Return-outwards
Accounting for Trading Organizations 151

Trading account
To transfer the balances to trading account
The balance of trading account is transferred to P & L account. In case of gross profit:
Dec 31 Trading account
P & L account
To transfer the gross profit to P & L account
In case of loss:
Dec 31 P & L account
Trading account
To transfer the gross profit to P & L account
The opening and closing stock are included in cost of good sold which is part of
trading account. The trading account is the statement that matches the revenue from sale of
goods with the cost of goods sold. For Ahmad Electronics, the following two entries will be
required to transfer opening and closing stocks to this account:
1997
Dec 31 Trading account 150,000
Stock 150,000
To transfer the opening stock to trading a/c.
Dec 31 Stock 300,000
Trading account 300,000
To record the closing stock.
After the closing entries the balance in the stock account will be equal to the closing
stock. The ledger account for stock is given on the next page:

Stock
1997 Rs. 1997 Rs.
Jan 1 Balance b/d (opening Trading a/c (opening
stock) 150,000 stock) 150,000
Dec 31 Trading a/c (closing Dec 31 Balance c/d (closing
stock) 300,000 stock) 300,000
450,000 450,000
1998
Jan 1 Balance b/d 300,000
Perpetual System
The firms dealing in items of high unit cost and selling a limited number of units may
like to maintain a continuous record of stock sold and on-hand. Under this system,
the goods purchased are recorded in the stock account. The return inwards are
accompanied by a reversing entry for cost of goods sold. The cost of goods sold is
152 Financial Accounting: A Managerial Perspective

recorded at the time of sale. See chapter 8 for detailed discussion of perpetual
method.
The Accounting for Sales
A firm may sell on credit or cash or use both modes. Sales revenue, in accordance
with recognition principle, is earned when the title of ownership of goods is
transferred from the seller to the buyer. Every sales transaction should be supported
by sales invoice like the one shown in Fig 5.1. To illustrate a sales transaction,
assume that Khan Autos sold 100 spark plugs 4 on credit for Rs. 2,500 to Toor
Auto Services on January 15, 1997. The entry to record the transaction is:
Jan 15 Toor Auto Services 2,500
Sales 2,500
Sold 100 spark plugs 4 on credit, terms 2/10 n/30.
Return Inwards A customer may return goods if these are defective or not according to the
specifications ordered by him. Sometimes the goods may not be returned rather a discount in
price known as sales allowance may be asked for. Once the returned goods or allowance is
agreed upon, a credit memorandum like debit memorandum shown in Fig 5.2 is issued to the
customer. To illustrate the entry for return inwards, assume that Toor Auto Services returned
10 defective plugs on January 18, 1997. The entry is shown below:
Jan 18 Return inwards 250
Toor Auto Services 250
Toor Auto Services returned defective goods, for Jan 15
sale.

Discount Allowed As per the sale terms, Toor Auto Services is entitled to a 2%
discount if the payment is made within 10 days, i.e. the discount period. Assuming
that the payment is received within the discount period, the entry would be as
follows:
Jan 25 Bank 2,205
Discount Allowed 45
Toor Auto Services 2,250
Received payment from Toor Auto Services within the
discount period.
As explained in case of discount received the discount allowed is also calculated on
the amount remaining after return inwards. The ledger account of Toor Auto
Services, in the books of Khan Autos, after these three entries have been posted is
shown as below:
Toor Auto Services
1997 Rs. 1997 Rs.
Accounting for Trading Organizations 153

Jan 15 Sales 2,500 Jan 18 Return inward 250

Dec 31 Jan 25 Bank 2,205
Jan 25 Discount allowed 45
Treatment of Discount Received and Discount Allowed
Discount received and discount allowed may be treated as contra to purchases and
sales respectively and this is what most of the American authors do. In such a case,
discount received is subtracted from purchases and discount allowed from sales. The
purchase discount and the sales discount are treated as reduction in purchase cost and
sales respectively. The British authors would treat discount allowed as an expense
and discount received as either an income to be added to gross profit or contra to
discount allowed. In the latter case, net of discounts is taken in profit and loss
account. In this case the discounts are treated as part of financial activity rather than
trading activity.
Worksheet
The worksheet of a merchandising organization differs from that of a service
organization only in items of trading account. The basic steps remain the same. The
year-end adjustments are made in the same way. However, care should be taken in
case adjustments required for opening and closing stock. The stock figures can be
transferred to trading account through adjusting or closing entries. In the following
illustration closing entries have been used for this purpose. Therefore stock entries do
not appear in adjustment columns.

A worksheet of Khan Autos based on the following unadjusted trial balance and the
additional information is illustrated in Fig 5.6.
Unadjusted Trial Balance
Dr. Cr.
Rs. Rs.
Bank 19,000
Debtors 39,000
Prepaid insurance 7,000
Office equipment 40,000
Provision for depreciation 12,000
Store equipment 160,000
Provision for depreciation 32,000
Creditors 40,000
Khan’s capital 200,000
Khan’s drawing 30,000
Sales 960,000
Return inward 24,000
Discount allowed 16,000
Stock 72,000
154 Financial Accounting: A Managerial Perspective

Purchases 650,000
Return outwards 20,000
Discount Received 15,000
Carriage-in 24,000
Carriage-out 14,000
Advertising expense 32,000
Rent expense 38,000
Store salaries expense 80,000
Utilities expense 34,000
Totals 1,279,000 1,279,000
i Rs. 4,000 of prepaid insurance expired during the year.
ii 10% of cost is to be charged as depreciation on equipment.
iii Rs. 10,000 of stores salaries are unpaid at December 31,1997.
iv Stock as at December 31, 1997, was Rs. 80,000.
Accounting for Trading Organizations 155

Fig 5.6 Khan Autos Worksheet

Trial Adjustment Adjusted Trading, Balance
Balance s Trial P&L A/C Sheet
Balance
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Bank 19 19 19
Debtors 39 39 39
Prepaid insurance 7 4 3 3
Office equipment 40 40 40
Prov. for dep. –
office equipment 12 4 16 16
Store equipment 160 160 160
Prov. for dep. – store
equipment 32 16 48 48
Creditors 40 40 40
Khan’s capital 200 200 200
Khan’s drawing 30 30 30
Sales 960 960 960
Return inward 24 24 24
Discount allowed 16 16 16
Stock 72 72 72 80 80
Purchases 650 650 650
Return outwards 20 20 20
Discount received 15 15 15
Carriage-in 24 24 24
Carriage-out 14 14 14
Advertising expense 32 32 32
Rent expense 38 38 38
Store salary expense 80 10 90 90
Utilities expense 34 34 34
Insurance expense 4 4 4
Dep. – storese quip. 16 16 16
Dep.– off. equip. 4 4 4
Salaries payable 10 10 10
Totals 1,279 1,279 34 34 1,309 1,309 1,018 1,075 371 314
Net income 57 57
Totals 1,279 1,279 34 34 1,309 1,309 1,075 1,075 371 371
The treatment of stock may be noted in the worksheet. The opening stock is taken to
the debit of trading a/c while the closing stock is taken in the credit side of the
account. The closing stock is also taken on the debit side of the balance sheet
columns. Further note that the opening stock, carriage-in and purchases are in debit
156 Financial Accounting: A Managerial Perspective

column whereas closing stock and return outwards are in credit columns. It conforms
to the formula of cost of goods sold, i.e.:
[Opening stock + (purchases + carriage in - return out) - closing stock]
The formula can be rearranged as:
(Opening stock + purchases + carriage in) - (return out + closing stock)
This is how the worksheet presents the cost of goods sold.
Preparation of Financial Statements
Fig 5.6
KHAN AUTOS
Trading and Profit and Loss Account
for the period ended December 31, 1997
Rs. Rs. Rs.
Sales 960,000
Less return inwards 24,000
Net sales 936,000
Less cost of goods sold:
Opening stock 72,000
add purchases 650,000
add carriage inwards 24,000
674,000
Less return outwards 20,000
Net purchases 654,000
Cost of goods available for sale 726,000
Less closing stock 80,000 646,000
Gross profit 290,000
add discount received 15,000
305,000
Less operating expenses:
Administrative expenses
Discount allowed 16,000
Rent 38,000
Store salaries 90,000
Utilities 34,000
Insurance 4,000
Depreciation – office equipment 4,000
Depreciation – stores equipment 16,000 202,000
Distribution expenses
Advertising 32,000
Carriage out 14,000 46,000
Total operating expenses 248,000
Net profit 57,000
Accounting for Trading Organizations 157

Fig 5.7

KHAN AUTOS
Balance Sheet
as at December 31, 1997
Fixed assets: Rs. Rs. Rs.
Stores equipment 160,000
Less provision for depreciation 48,000 112,000
Office equipment 40,000
Less provision for depreciation 16,000 24,000 136,000
Current assets:
Stock 80,000
Debtors 39,000
Prepaid insurance 3,000
Bank 19,000
141,000
Less current liabilities
Creditors 40,000
Salaries payable 10,000 50,000
Net current assets 91,000
Total assets less current liabilities 227,000
Financed by:
Capital as at Jan 1, 1997 200,000
add net profit 57,000
257,000
Less drawings 30,000 227,000
Loans (long-term liabilities)
Total capital employed 227,000

As discussed earlier, different formats are used in different countries for preparing the
financial statements. The basic concept, however, remains the same. IAS-8 provides
some guidelines for formats by identifying the items to be disclosed in balance sheet
and income statement (trading and profit and loss account) for companies. The same
guidelines have been used to prepare financial statements of Khan Autos.

DEPARTMENTAL ACCOUNTS
The large trading businesses generally have more than one department. In order to
evaluate the performance of different departments separately, they prepare separate
trading and profit and loss account for each department. The following example will
show the need for departmental accounts:
The profit and loss account of the Sunrise Departmental Store showed that the
store made a profit of Rs. 220,000 for the year ended December 31, 1997. This
158 Financial Accounting: A Managerial Perspective

seemed to be an acceptable result to the management until the accountant prepared

separate results for each department. There were five departments and the respective
net results for the year were as follows:
Department Net Profit Net Loss
Rs. Rs.
Garments 90,000
Grocery 94,000
Footwear 46,000
Fabrics 40,000
Kitchenware 30,000 ______
260,000 40,000
If it were not loss for the fabrics department, the profit could have been Rs.
260,000.
Departmental accounts provide information about the contribution that each
department makes to the overall profit of a business. On the basis of this information
the management makes decisions as to which department needs improvement and if
needed may face closure.
In order to improve the performance a departmental manager may be provided
incentive in the form of commission based upon the profit he earns. If the
commission is calculated as a percentage of the profit after charging the commission,
the calculation is as follows:
Profit before commission  Percentage of commission
100 + percentage of commission
Departmental Trading and Profit and Loss Account
Each department has to keep separate record for its sales, purchases and expenses.
Unless this is done, it is not possible to prepare separate accounts. Separate books
may be kept for each department in the central account section or in each department.
Some of the expenses are direct, i.e. they can be traced and assigned to a particular
department, e.g. the salaries and depreciation. However, most of the expenses are
common and needs to be apportioned between departments on some appropriate
basis. Such expenses include rent, insurance, maintenance, etc.
Examples of bases of apportionment are:
Departmental wages, salaries Actual payroll costs for each department obtained by analysis
of the payroll.
Administrative salaries On the basis of number of employees in each department or on
respective sales volume, i.e. turnover.
Rent, rates, heating, lighting, On relative floor areas of the departments.
property insurance
Accounting for Trading Organizations 159

Depreciation On cost of fixed assets employed by each department.

Insurance of fixed assets other than On replacement values of assets in each department.
property

Example
Al-Shifa Chemists have separate departments for drugs, cosmetics and photographic
equipment. The following balances were extracted from their books for the year
ended December 31, 1997:
Rs. Rs.
Purchases: Drugs 57,600
Cosmetics 50,600
Photographic 26,500 134,700
Sales: Drugs 90,000
Cosmetics 120,000
Photographic 50,000 260,000
Stock at January 1, 1997 Drugs 13,400
Cosmetics 11,700
Photographic 16,000 41,100
Salaries and wages 46,500
Sales commission 11,500
Rent and rates 14,000
Heating and lighting 3,750
Advertising 2,400
Delivery expense 2,100
Depreciation of fixed assets 5,250
Administration and general expense 12,000
Additional Information
Stocks at December 31, 1997 were as follows:

Rs.
Drugs 12,500
Cosmetics 13,300
Photographic 13,500

ii Salaries and wages are to be allocated as follows:

Rs.
Drugs 14,600
Cosmetics 19,400
Photographic 12,500

iii Sales commission is to be apportioned in the ratio of the turnover of each

department.
iv Rent and rates, light and heat, are to be apportioned in the ratio of
departmental floor areas as follows:
160 Financial Accounting: A Managerial Perspective

Drugs 30% Cosmetics 40% Photographic 30%

v All other expenses are to be apportioned equally between the departments.

AL-SHIFA CHEMISTS
Departmental Trading and Profit and Loss Account
for the year ended 31 December 1997
Drugs Cosmetics Photographic Total
Rs. Rs. Rs. Rs. Rs. Rs. Rs. Rs.
Sales 90,000 120,000 50,000 260,000
Less cost of sales
Stock Jan 1, 1997 13,400 11,700 16,000 41,100
Purchases 57,600 50,600 26,500 134,700
71,000 62,300 42,500 175,800
Stock Dec 31, 1997 12,500 58,500 13,300 49,000 13,500 29,000 39,300 136,500
Gross profit 31,500 71,000 21,000 123,500
Salaries and wages 14,600 19,400 12,500 46,500
Sales commission 3,981 5,308 2,211 11,500
Rent and rates 4,200 5,600 4,200 14,000
Heating and lighting 1,125 1,500 1,125 3,750
Advertising 800 800 800 2,400
Delivery expenses 700 700 700 2,100
Depreciation 1,750 1,750 1,750 5,250
Administration and
general expenses 4,000 31,156 4,000 39,058 4,000 27,286 12,000 97,500
Net profit/(loss) 344 31,942 (6,286) 26,000
The balance sheet is not prepared on departmental basis; rather, a consolidated
balance sheet is prepared for the entire organization.
Accounting for Trading Organizations 161

Demonstration Problem
Ghazi Departmental Stores purchased Rs. 80,000 worth of goods, terms 2/10, n/30, from Elahi Bukhsh
Corporation on September 14.
Required
1 Give the entries in Ghazi’s books to record the purchase and payment under each of the following
situations:
a Purchases are recorded at gross amount, and payment is made on September 24.
b Purchases are recorded at gross amount, and payment is made on October 14.
c Purchases are recorded at net amount, and payment is made on September 24.
d Purchases are recorded at net amount, and payment is made on October 14.
2 Give the entries in Bukhsh’s books to record the sale and its collection under each of the four
situations above. Assume all sales are recorded at gross amounts.
Solution
Situation Date 1 Ghazi’s Books 2 Bukhsh’s Books
a Sept 14 Purchases 80,000 Debtors 80,000
Creditors 80,000 Sales 80,000
To record purchases-gross To record sales
method
Sept 24 Creditors 80,000 Cash 78,400
Purchases Discount 1,600 Sales Discounts 1,600
Cash 78,400 Debtors 80,000
To record purchase-gross To record collection
method
b Sept 14 Purchases 80,000 Debtors 80,000
Creditors 80,000 Sales 80,000
To record payment- To record sales
gross method
Oct 14 Creditors 80,000 Cash 80,000
Cash 80,000 Debtors 80,000
To record payment-gross To record collection
method
c Sept 14 Purchases 78,400 Debtors 80,000
Creditors 78,000 Sales 80,000
To record payment-net To record sales
method
Sept 24 Creditors 78,400 Cash 78,400
Cash 78,400 Sales Discounts 1,600
Debtors 80,000
To record purchase-net To record collection
method
d Sept 14 Purchases 78,400 Debtors 80,000
Creditors 78,400 Sales 80,000
To record purchase-net To record sales
method
Oct 14 Creditors 78,400 Cash 80,000
Purchases discounts lost 1,600 Debtors 80,000
Cash 80,000
To record payment- To record collection
net method
162 Financial Accounting: A Managerial Perspective

Questions for Class Discussion

1 Which account titles are likely to appear in the ledger of a trading company which do not appear in
the ledger of a service enterprise?

2 What entry is made to record a sale of goods on account?

3 Describe trade discount and cash discount.

4 Sale discount and sale returns and allowances are deducted from sales on the income statement to
arrive at net sales. Why not deduct these directly form the sales account by debiting sales each time
a sales discount, return, or allowance occurs?

5 What are the two basic procedures for accounting for stock? How do these two procedures differ?

6 What useful purpose does the purchases account serve?

7 Explain how the use of net method of accounting for purchases can improve internal control.

8 How would purchase discounts lost be shown in the profit and loss account?

9 What do the letters FOB stand for? When terms are FOB destination, who incurs the cost of
freight?

10 What type of an expense is delivery expense? Where is this expense reported in the profit and loss
account?

11 Periodic stock procedure is said to afford little control over stock. Explain why?
12 How does the accountant arrive at the total rupee amount of the stock after taking a physical count
of the stock?

13 How is cost of goods sold determined under periodic stock procedure?

14 If the cost of goods available for sale and the cost of the ending stock are known, what other
amount appearing on the profit and loss can be calculated?

15 What is gross profit? Why might management be interested in the percentage of gross profit to net
sales?

16 After closing entries are posted to the ledger, which types of accounts have balances? Why?

True and False

1 Both trade and bulk discounts are price adjustments for which there is no explicit accounting
recognition.

2 Sales returns occur on the books of the retailer when he, for whatever reasons, returns an item for a
cash refund or a credit to his account.
Accounting for Trading Organizations 163

3 For trading and manufacturing companies, stock is often the single largest long-term asset.

4 A perpetual stock system keeps a running balance of both stocks on hand and the cost of goods
sold.

5 In the absence of any clerical errors, the stock account will always equal the actual cost of the items
on hand.

6 Under periodic method, a stock shortage is automatically included in cost of goods sold.

7 The normal balance in purchase discounts lost account is credit.

8 If the terms of a shipping agreement are FOB destination, the seller will debit a selling expense
called carriage out.

9 After the adjusted trial balance has been prepared, the figures can be spread to the appropriate profit
and loss and balance sheet columns.

10 The profit and loss can be prepared directly form the worksheet. However, before the balance sheet
is prepared, closing entries should be made.

Fill-ins
1 A --------------- firm is one that purchases finished products for resale.

2 --------------- are discounts offered to a certain class of buyer. --------------- discounts are deduction
from the list price due to quantity purchases.

3 A --------------- is a cash reduction offered to customers in an attempt to ensure that they make
prompt payment on their trade account.

4 There are two methods used to record purchases: the ------------ method and the ------------ method.

5 Discount lost is a type of --------------- account.

6 --------------- are items held for resale to customers in the normal trading.

7 --------------- systems do not keep continuous track of closing stock and cost of goods sold.

8 Under the net method of recording purchase discounts, if the firm does not pay within the discount
period, the difference between amount payable debited to creditors account and cash credited is a
debit to an account is entitled -------------.

9 The cost of freight on goods purchased for resale is referred to as ------- or -------.

10 If the terms of the sale are ---------------, legal title of the goods does not pass to the buyer until the
goods have reached the buyer’s receiving point.

11 --------------- are goods that have been purchased but have not yet been received by the purchaser.
12 Under the --------------- stock method, shortages are automatically included in cost of goods sold.
164 Financial Accounting: A Managerial Perspective

13 A --------------- perpetual system keeps a running balance of both stocks on hand and the firm’s cost
of goods sold.

14 The accounting treatment for the return of previously purchased stock items is similar to accounting
for sales returns and allowances, except that the account used for the earlier one is ---------------.

15 A ---------- is a document prepared by the purchaser that indicates to the seller the quantity, type
and estimated price of the items that the buyer wishes to purchase.

Self-Study Questions
1 Which of the following accounts is least likely to be adjusted on the worksheet?
a Supplies on hand b Cash
c Prepaid rent d Unearned delivery fees
2 Aslam & Co. purchased a product form Baig Brothers for Rs. 12,000, terms 3/10, n/60. What is the
effective interest rate associated with these terms?
a 36.7% b 22.2%
c 16.8% d 14.9%
e 10.6%
3 Hasan Associates use the gross method to record its purchases. If they purchase Rs. 1,000 of goods
from Zamans (Pvt) Ltd, terms 2/10, n/30, and if they pay their bill in full within the discount period,
the entry Hasan makes to record the payment will include:
a Debit to creditors for Rs. 980. b Credit to creditors for Rs. 980.
c Credit to discount received for Rs. 20. d Debit to creditors for Rs. 1,000.
e Credit to sales for Rs. 980.
4 The gross method of recording sales discount is very common in practice. However, several
problems do exist with this method. Which of the following is NOT a shortcoming of the gross
method?
a It is based on the assumption that the customer will not take the discount.
b It often results in an overstatement of receivables and sales at the time the sale is recorded.
c It highlights only discounts taken rather than discounts NOT taken.
d Most electronic data processing systems are not designed to record invoices at the gross
prices.
e All of the above are shortcomings of the gross method.
5 Newcity Enterprises uses the net method of recording discount allowed. It sold goods for Rs. 1,000,
terms 2/10, n/30. The bill was received in full within the discount period. As a result of this
collection, Newcity will:
a Debit debtors for Rs. 980. b Credit debtors for Rs. 980.
c Credit sales discount for Rs. 20. d Credit debtors for Rs. 1,000.
e Credit sales for Rs. 980.
6 If a customer does not make a payment within the discount period associated with a sales discount
and the net method is being used, the difference between the full invoice price and the net amount
at which the receivable was recorded is credited to:
a Sales b Discounts allowed.
Accounting for Trading Organizations 165

c Cash d Sales discounts not taken.

e Debtors

7 Trade discounts has a normal balance that is:

a Credit b The same as discount received.
c The same as purchase returns and allowances. d All of the above are true.
e None of the above is true.
8 Purchase returns and allowances has a balance that is:
a Credit b The same as discount allowed.
c The same as sales returns and allowances. d All of the above are true.
e None of the above is true.
9 Sales discounts not taken is:
a A revenue account b An expense account
c A contra-revenue account d A liability
e None of the above
10 Discount allowed is:
a A revenue account b An expense account
c A contra-revenue account d A liability
e None of the above
11 Zaib purchased goods from Mujahid Brothers on account. One week after the sale, Zaib determined
that the goods were defective and returned them. The entry on Mujahid’s books would include:
a A debit to debtors b A credit to debtors
c A debit to cash d A credit to cash
e A credit to sales returns and allowances
12 The entry to close discounts received at the end of the year includes:
a A credit to discounts received. b A debit to cost of goods sold.
c A credit to trading account. d All of the above selections are true.
e None of the above selections is true.

Exercises
E5.1 Prepare journal entries to record the following transactions of Faisal General Store:
July 5 Purchased goods form Mashriq Traders for Rs. 6,000 subject to the following terms:
2/15, n/60, FOB factory.
7 Paid Qasim Goods Forwarding Agencies Rs. 650 for shipping charges on the
purchase of July 5.
9 Returned to Mashriq Traders unacceptable goods, listed price Rs. 2,000.
19 Sent a cheque to Mashriq Traders for the July 5 purchase, net of discount and
returns.
20 Purchased goods from Pak Tajirs subject to the following terms: Rs. 9,000 list price,
2/10, n/30, FOB factory. The invoice showed that Pak Tajirs had paid the trucking
company Rs. 700 as carriage.
24 After advising Pak Tajirs that some goods was damaged, received a credit
memorandum for Rs. 3,000 on the July 20 purchase.
166 Financial Accounting: A Managerial Perspective

30 Paid Pak Tajirs for the July 20 purchase, net of the allowance, and the shipping
charges prepaid by them.
E5.2 On July 6, 1997, Nuareen’s Collection, a boutique, received Rs. 70,000 of garments and an
invoice dated July 5, terms 2/10, n/30, FOB factory from Gohar Fashions, a garment
manufacturer. On the day the goods were received, NC paid freight Rs. 2,700 to shipping
company on the purchases. The next day, NC returned to GF Rs. 6,000 of defective goods and,
on July 15, mailed GF a cheque for the amount owed. Prepare general journal entries to record
these transactions: a) on the books of NC; and b) on the books of GF. Assume that GF
recorded the return and the check the next day after each was sent.
E5.3 The Cottage is a single proprietorship business that ends its annual accounting period on
December 31. The profit and loss columns of The Cottage’s December 31, 1997, worksheet
are given below. Use the information in these columns to prepare a 1997 profit and loss
account for The Cottage.
Debit Credit
Stock 645,000 720,000
Sales 3,600,000
Return inward 22,500
Discount allowed 27,000
Purchases 2,160,000
Return outward 15,000
Discount received 45,000
Transportation-in 10,500
Selling expenses 540,000
General and administrative expenses 375,000
3,780,000 4,380,000
Net income 600,000
4,380,000 4,380,000
E5.4 The following trial balance was taken from the ledger of Baloch Marbles, at the end of its
annual accounting period:
BALOCH MARBLES
Unadjusted Trial Balance as at December 31, 1997
(Rs. in thousands)
Cash 30
Debtors 130
Stock 90
Store supplies 60
Store equipment 150
Accumulated depreciation, store equipment 40
Creditors 60
Salaries payable - -
Capital 180
Loan 150
Sales 630
Sales returns and allowances 30
Purchases 280
Purchases discounts 50
Transportation-in 30
Depreciation expense, store equipment - -
Salaries 170
Rent 100
Accounting for Trading Organizations 167

Store supplies expense - -

Advertising 40
Totals 1,110 1,110
Required
Prepare a worksheet for Baloch Marbles. Copy the unadjusted trial balance onto the worksheet
and complete it by using the following information:
i Store supplies on hand, Rs. 20,000.
ii Estimated depreciation of the store equipment, Rs. 60,000.
iii Accrued salaries payable, Rs. 30,000.
iv Ending stock, Rs. 100,000.
E5.5 Jamal Farms is a large merchandising firm engaged in the retail sales of eggs. Its sole
supplier at the present time is Noor Poultries. Noor’s list price to retailers is Rs. 200 per
crate. However, discounts may be offered on the following bulk purchases:
Quantity Purchased % of Discount

Below 10 crates 0%
10 to 20 crates 8%
21 to 30 crates 10%
Over 30 crates 15%
During July, Jamal purchased 30 crates from Noor with terms of 3/10, n/30.
Required
i Record the sale and the receipt of payment by Noor within the discount period using
the gross method.
ii Record the purchase and the payment by Jamal with in the discount period using the
gross method.
E5.6 The trial balance that follows was taken from the ledger of Qaisrani Steels at the end of its
annual accounting period. Anwar Qaisrani, the owner of Qaisrani Steels, did not make
additional investments in the business during 1997.
QAISRANI STEELS
Unadjusted Trial Balance
December 31, 1997
(Rs. in thousands)
Cash 120
Debtors 160
Stock 240
Store supplies 140
Creditors 280
Accrued salaries - -
Qaisrani’s capital 390
Qaisrani’s drawings 90
Sales 930
Sales returns and allowances 80
Purchases 370
Purchases discounts 60
Transportation-in 70
Salaries 280
Rent 110
168 Financial Accounting: A Managerial Perspective

Store supplies expense - -

Totals Rs.1,660 Rs.1,660
E5.7 Al-Mubeen Stores purchased Rs. 100,000 of goods on account. The terms of the sale were 4/10,
n/60. Al-Mubeen is currently faced with two alternatives:
a Pay Rs. 96,000 within the discount period.
b Invest the Rs. 96,000 in a special money market account yielding 26% interest for 50
days, and pay the full Rs. 100,000 60 days from the date of the sale.
As Al-Mubeen’s financial adviser, show by computation, which alternative Al-Mubeen should
take.
E5.8 Durrani Stationers had total cash and credit sales of Rs. 22,500,000 in 1997. Total sales discounts
amounting to Rs. 250,000 were recorded during the year using the gross method. In 1997,
trade and quantity discounts amounted to Rs. 1,670,00. Of Durrani’s total sales, 6% involved
defective goods for which customers received full credit and refunds.
Required
Prepare abstracts from Durrani’s profit and loss account.
E5.9 Khawar Paints uses a periodic inventory system. In May of the current year, goods totalling Rs.
3,200,000 were purchased on account. Sales in May amounted to Rs. 4,020,000 which
represented the sale of exactly half of the units purchased in May.
Required
i Record the purchases for the month of May.
ii Record May sales.

Problems
P5.1 Prepare general journal entries to record the following transactions of Qutub Distributors:
Sept 2 Purchased goods priced at Rs. 47,000 on credit, terms 1/15, n/30, FOB the seller’s
factory.
3 Purchased a new computer for office use on credit for Rs. 100,000.
3 Sold goods on credit, terms 2/10, 1/30, n/60, Rs. 29,000.
4 Paid Rs. 2,250 cash for freight charges on the shipment of goods purchased on
September 2.
8 Sold goods for cash, Rs. 4,700.
10 Purchased goods on credit, terms 2/15, n/30, Rs. 26,000.
12 Received a Rs. 4,000 credit memorandum for goods purchased on September 10.
19 Sold goods on credit, terms 2/10, n/30, Rs. 24,600.
22 Issued a Rs. 3,350 credit memorandum to customer who had returned a portion of
the goods purchased on September 19.
23 Purchased office supplies on credit, Rs. 2,950.
24 Received a credit memorandum of Rs. 700 for unsatisfactory office supplies
purchased on September 23 and returned.
25 Paid for the goods purchased on September 10, less the return and the discount.
29 The customer who purchased goods on September 3 paid for the purchase of that
date less the applicable discount.
29 Received payment for the goods sold on September 19, less the return and applicable
discount.
Oct 1 Paid for the goods purchased on September 2.
Accounting for Trading Organizations 169

P5.2 A December 31, 1997, year-end, unadjusted trial balance from the ledger of Shaheen Traders, a
single proprietorship, is as follows:
SHAHEEN TRADERS
Unadjusted Trial Balance
December 31, 1997
Rs. Rs.
Bank 24,000
Loan 100,000
Stock 61,520
Stationery 4,380
Store supplies 14,100
Prepaid insurance 32,760
Office equipment 106,440
Accumulated depreciation, office equipment 31,932
Store equipment 381,780
Accumulated depreciation store equipment 114,534
Creditors 8,776
Debtors 200,000
Capital 503,158
Drawings 32,400
Sales 742,774
Sales returns and allowances 2,094
Sales discounts 3,816
Purchases 555,650
Purchases returns and allowances 1,332
Purchases discounts 5,292
Carriage-in 1,558
Depreciation, store equipment -0-
Sales salaries 38,304
Rent, selling space 23,220
Store supplies expence -0-
Advertising 684
Depreciation, office equipment -0-
Office salaries 22,356
Insurance -0-
Rent, office space 2,736
Stationary expense -0-
Totals 1,507,798 1,507,798
Required
i Copy the unadjusted trial balance on a worksheet and complete the worksheet using the
following information:
a Ending store supplies inventory, Rs. 240.
b Ending office supplies inventory, Rs. 150.
c Expired insurance, Rs. 26,820.
d Estimated depreciation of store equipment, Rs. 38,178.
e Estimated depreciation of office equipment, Rs. 10,644.
f Closing stock, Rs. 92,784.
ii Prepare closing entries for the store.
170 Financial Accounting: A Managerial Perspective

iii Prepare Trading ,ProfitandLoss Account, and Balance Sheet

P5.3 Following is the unadjusted trial balance of Mehmood & Sons, a sanitary ware stores, on
December 31, 1997, the end of the annual accounting period:
MEHMOOD & SONS
Unadjusted Trial Balance
December 31, 1997
Rs. Rs.
Cash 570
Bank 6,000
Stock 62,778
Office supplies 570
Store supplies 1,104
Prepaid insurance 3,798
Office equipment 15,192
Accumulated depreciation, office equipment 1,662
Store equipment 66,954
Accumulated depreciation, store equipment 6,372
Creditors 1,434
Accrued salaries payable -0-
Income taxes payable -0-
Capital 72,000
Loan 26,190
Sales 494,676
Return inward 3,348
Purchases 320,058
Return outward 1,344
Discount received 5,262
Transportation-in 3,930
Depreciation, store equipment -0-
Sales salaries 44,370
Rent, selling space 18,900
Store supplies expense -0-
Advertising expense 6,180
Depreciation, office equipment -0-
Office salaries 45,228
Insurance -0-
Rent, office space 2,760
Office supplies expense -0-
Income taxes expense 7,200
Totals 608,940 608,940
Required
i Copy the unadjusted trial balance on a worksheet and complete the worksheet using the
information that follows:
a Ending store supplies stock, Rs. 294.
b Ending office supplies stock, Rs. 222.
c Expired insurance, Rs. 2,950.
d Depreciation on the store equipment, Rs. 6,450.
Accounting for Trading Organizations 171

e Depreciation on the office equipment, Rs. 1,782.

f Accrued sales salaries payable, Rs. 4,000; accrued office salaries payable, Rs. 5,280.
g Additional income tax expense, Rs. 7,620.
h Closing stock, Rs. 59,680.
ii Prepare adjusting and closing entries.
iii Prepare a Trading and profit and loss account.
iv Prepare a balance sheet.

P5.4 Following is the unadjusted trial balance of Haris Cloth Merchants on December 31, 1997, the
end of the annual accounting period:
HARIS CLOTH MERCHANTS
Unadjusted Trial Balance
December 31, 1997
Rs. Rs.
Cash 52,544
Bank 12,000
Debtors 27,198
Stock 62,214
Stationery 930
Store supplies 2,898
Prepaid insurance 3,906
Office equipment 15,012
Accumulated depreciation, office equipment 3,390
Store equipment 74,376
Accumulated depreciation, store equipment 12,996
Creditors 9,972
Salaries payable -0-
Capital 127,568
Drawings 18,000
Sales 674,568
Sales returns and allowances 6,084
Purchases 462,102
Purchases returns and allowances 2,184
Discount received 5,652
Transportation-in 6,150
Depreciation, store equipment -0-
Rent, selling space 24,300
Store supplies expense -0-
Depreciation, office equipment -0-
Office salaries 57,996
Insurance expense -0-
Rent, office space 10,620
Office supplies expense -0-
Totals 836,330 836,330

Required
172 Financial Accounting: A Managerial Perspective

i Copy the unadjusted trial balance on a worksheet from and complete the worksheet using
the information that follows:
a Ending store supplies stock, Rs. 534.
b Ending stationery stock, Rs. 270
c Expired insurance, Rs. 3,360.
d Depreciation on the store equipment, Rs. 6,490.
e Depreciation on the office equipment, Rs. 1,780.
f Accrued sales salaries payable, Rs. 5,330; accrued office salaries payable, Rs. 6,250.
g Ending stock, Rs. 65,230.
ii Prepare a year-end classified balance sheet.
iii Prepare adjusting and closing entries.
P5.5 The following trial balance was extracted from the books of Awan Stores, a grocery wholesaler,
on December 31, 1997:
Rs. (000) Rs. (000)
Capital, January 1, 1997 2,000
Loan from Umer Toor 500
Bank loan at 10% 500
Premises (at cost) 2,550
Delivery van (at cost) 350
Furniture and fittings (at cost) 100
Provision for depreciation
Delivery van 70
Furniture and fittings 20
Stock, January 1, 1997 400
Cash at bank 30
Debtors and creditors 400 90
Provision for doubtful debts 10
Rates (local taxes) 150
Purchases and sales 5,000 7,000
Returns inwards and outwards 40 30
Warehouse wages 700
Office salaries 140
Drawings 200
Office expenses 70
Van expenses 90
_____ _____
10,220 10,220
Taking into consideration:
i Stock at December 31, 1997 valued at Rs. 370,000.
ii Depreciation: Delivery vans 20% of cost.
iii Furniture and fittings 10% of cost.
iv Rates paid in advance, Rs. 30,000.
v Wages unpaid, Rs. 10,000
vi Bank loan interest at 10% has been debited to the business bank account, but no entries
have been made in the firm’s books.
vii The loan from Umer Toor does not carry a fixed rate of interest, but he receives 4% of
the gross profit.
viii The provision for doubtful debts is to be increased to Rs. 2,000.
Accounting for Trading Organizations 173

Prepare trading and profit and loss account for the year ended December 31, 1997, and a
balance sheet on that date.
Note: Ignore the adjustment for bad debts for the time being. Do it later after studying the
chapter on stock and debtors.

P5.6 A retail business called Zubairi Foods is divided into two departments: fresh foods and frozen
foods.
The following trial balance was extracted from the books on March 31, 1998:
Rs. (000) Rs. (000)
Capital, April 1, 1997 1,120
Premises 780
Fixtures and fittings 300
Sales: fresh foods 300
Frozen foods 150
Purchases:
Fresh vegetables 160
Frozen foods 140
Proprietor’s cash drawings 40
Stocks, April 1, 1997:
Fresh foods 30
Frozen foods 10
Rates 20
Wages of shop assistants 80
Heating and lighting 40
Creditors 40
Cash in hand and bank 10

1610 1610
Prepare trading and profit and loss account in columnar form to show the profit or loss on each
department for the year ended March 31, 1998 and a balance sheet on that date.
The following are to be taken into consideration:
(000)
i Stock taken for proprietor’s own use at cost:
Fresh vegetables 10
Frozen foods 20
ii Fixtures and fittings are to be depreciated by 10% of book value
iii Stock given to assistants as perks (additional wages) at cost:
Fresh vegetables 20
Frozen foods 20
iv Rates, heating and lighting costs are to be divided equally
between the two departments.
v Depreciation, shop assistants’ wages and perks are to be divided
between departments in proportion to sales.
vi Stock in hand, March 31, 1998:
Fresh vegetables 20
Frozen foods 20
174 Financial Accounting: A Managerial Perspective

P5.7 Tahir Khattak is a sole trader who retails carpets. On April 30, 1998, the following balances were
extracted from his books:
Trial Balance
at April 30, 1998
Rs. Rs.
Capital 72,255
Drawings 8,600
Purchases and sales 49,400 83,000
Returns inwards and outwards 300 500
Discount allowed and received 800 1,200
Premises 75,000
Fixtures and fittings at cost 14,000
Stock, May 1, 1997 23,450
Motor vehicles at cost 5,700
Provision for depreciation:
Motor vehicles 2,280
Fixtures and fittings 5,600
Debtors and creditors 8,955 1,030
Cash 3,480
Bank o/d 1,200
Loan 25,000
Bad debts written off 500
Insurance 700
Heat and light 830
Wages to assistant 300
Motor vehicle expenses 50
______ ______
192,065 192,065
Additional Information:

a Stock at April 30, 1998, is valued at Rs. 30,350.

b
c Tahir depreciates motor vehicles and fixtures and fittings at 20% p.a. on cost.
d At April 30, 1998:
Loan interest unpaid was Rs. 2,500.
Wages unpaid were Rs. 5,250.
e Stock valued at Rs. 7,500 had been damaged during the year. It was not included in the
closing stock figure of Rs. 30,350 and Tahir decided to write off the damaged stock.
f On April 30, 1998, after preparation of the trial balance, it was discovered that discount
allowed of Rs. 50 had been posted as Rs. 500 both to the debtors and to the discount
allowed account. This error was corrected.
Required
From the above information, prepare for Tahir a trading and profit and loss account for the
year ending April 30, 1998, and a balance sheet at that date.
Note: Bad debts is an expense.
Accounting for Trading Organizations 175

P5.8 Rana Velvet is a retail business which sells curtain fabrics and accessories. On December 31,
1997, the balances of the accounts in their books were extracted and the following trial balance
was drawn up:
Trial Balance
at December 31, 1997
Rs. Rs.
Capital, January 1, 1997 167,700
Stock of materials and accessories, Jan 1, 1997 123,000
Purchases and sales 1,250,000 1,583,000
Discount received 24,500
Rent 70,000
Fixtures and fittings at cost 35,000
Motor van at cost 105,000
Advertising 19,600
Motor van expenses 11,200
Heat and light 7,900
Wages for assistant 68,000
Accountant’s fees 12,000
Insurance expense 7,000
Debtors and creditors 31,000 27,000
Cash 2,500
Bank 38,400
Bank charges and interest 2,700
Drawings 92,000
General expenses 17,700
Provision for depreciation of fixtures and fittings 14,000
________ ________
1,854,600 1,854,600
Additional Information:
At December 31, 1997:
a Stocks of materials and accessories were valued at Rs. 105,000.
b Rent paid in advance for January and February 1998 was Rs. 10,000.
c Wages owing to assistant were Rs. 3,000.
d Depreciate the fixtures and fittings at 10% p.a. on cost.
e The motor vehicle was purchased on January 1, 1997. Rana Velvet decides to create a
provision for depreciation on the motor vehicle of 20% p.a. on cost.
f Rana has taken materials that cost Rs. 5,000 for his own use during the year. This amount
had not been recorded in the accounts.
g During the year, Rs. 9,500 of materials had been stolen. The insurance company had
agreed to compensate Rana in full for this loss but the claim had not been settled by
December 31, 1997. No entries concerning this loss had been made in the accounts.
Required
Prepare for Rana Velvet:
a A trading and profit and loss account for the year ending December 31, 1997.
b A balance sheet as at December 31, 1997.
176 Financial Accounting: A Managerial Perspective

P5.9 Rashid, a retailer, whose accounting year-end is October 31, suffered a burglary on October 23,
1998, when a large quantity of stock was stolen along with most of the stock records.
However, the following information has been obtained from the accounting records:
As at October 31, 1997: Rs.
Trading stock, at cost 321,000
Debtors 235,900
Creditors 328,000
Year ended October 31, 1998:
Purchases 3,840,000
Purchases returns 260,000
Sales 3,120,000
Sales returns 146,000
Discounts allowed 10,900
Cash paid to suppliers 3,432,000
Discounts received 29,100
Cash received from customers 2,870,900
General administrative expenses 451,000
As at October 31, 1998:
Trading stock, at cost 382,000
Additional Information:
i Normally, all sales produce a gross profit of 25% .
ii All purchases and sales are on a credit basis.

Required
The trading and profit and loss account.