ACCA F3 - FA Support Material by FBT

ACCA F3 FINANCIAL ACCOUNTING Inte Int ernat nat ional onal St ream TUITION CLAS LASSNOTES

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ACCA F3 Financial Accounting

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Appendix The foll fo llowi owing ng notes not es are suit suitable able for bot h the t he internat int ernational ional and and UK UK strea str eams. ms. There will wil l some t erminolog erminol ogy y diff dif ferences erences between between the two t wo strea str eams ms.. These hese are are summari summaris sed below below::

International

UK

St atement at ement of comprehensive income

Pr ofit of it and los lo ss account account

St ateme at ement nt of f inancial posit posit ion

Balance alance sheet heet

Non-current Non-curr ent ass assets et s

Fixed ass assets et s

Inventory

Stock

Tr ade receivables receivabl es

Debt Debtor ors s

Non-c Non-curr urren entt liab li abililitit ies

Long t erm liab li abililitit ies

Tr ade payables

Cr editor edit ors s

Irrec Irr ecoverable overable debts

Bad debts

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Contents Paper background background Sess ession 1

Introduct Int roductii on t o accounti accounting ng

Session ession 2

Financial st atement at ements s

Session ession 3

Double entry ent ry book keeping

Session ession 4

Non-current Non-curr ent asse assett s

Session ession 5

Inventory Invent ory

Session ession 6

Irrecoverable Ir recoverable Debts ebt s

Sessio ession n7

Contr ont rol Accoun Accountt s

Sessio ession n8

Bank Reconcili econciliat atio ions ns

Sessio ession n9

Accr Accruals and prepayment prepayment s

Sessi ession 10

Limit mit ed Company ompany accoun accountt s

Sess ession 11

St atement at ements s of cas cash flow low

Session ession 12

Incomplet Incomplete e records

Sessio ession n 13

Part nerships nerships

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Paper backgro background und Aim The aim aim of t his paper paper is i s to develop knowledg knowl edge e and and understanding of t he underlying underlyi ng principles principl es and concepts relating to financial accounting and technical proficiency in the use of double-entry accoun accountt ing techn t echniques iques including the pr prepa eparat ration ion of basic basic financ f inancial ial statements. stat ements.

Main capabilit apabilit ies On complet completion ion of t his paper, paper, you should be able able to: t o: Explain the context and purpose of financial reporting Define the qualitative characteristics of financial information and the fundamental bases of accounting Demonst emonst rate rat e the t he use use of double-entry double-entr y and accou account nting ing sys syst ems Record transactions and events Prepare a trial balance (including identifying and correcting errors) Prepare basic financial statements for incorporated and unincorporated entities

The assessment The exa exam m can can be sat sat either eit her writ wr it t en or computer based, based, both bot h methods met hods are 2 hours long. Written 40 x 2 mark quest quest ions

Mult Mul t iple ipl e choice A / B / C / D

10 X 1 mark quest quest ions

Mult Mul t iple ipl e choice choice A / B or A / B / C

Computer based 40 x 2 mark questions questions Quest uest ions can can be mul mul t iple ipl e choice, choice, mult mult iple ipl e respons response, e, mat mat ching or number entry 10 x 1 mark quest quest ions Mult Mul t iple ipl e respons response (correctly (correctl y identif ident ify y t wo from fr om t hree right ri ght ans answers) wers) The pass mark is 50%

SESSION 1 INTRODUCT NTRODUCTIION TO ACC ACCOUNTI OUNTING NG

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Learning earning outc out comes     

Underst Understand and the purpos pur pose e of accounti accounting ng Ident Ident ify if y the t he different diff erent t ypes ypes of busines business ses Indentify the users of accounts Explain the qualitative characteristics of financial statements Understand the underlying assumptions of financial statements

Introduction WHAT IS ACCOUNTING? Accoun Accountt ing is i s made up of two t wo elements: el ements: I. II.

Recording ecordi ng business t ransac ansactt ions - Book keeping keepi ng Presenti resenting ng the informat i nformation ion

WHAT WHAT IS ISA BUS BUSINESS? A busines business s is a commercial commercial organisati organisation on which exist exist s with a view t o making a profit prof it . There are different types of businesses which will fall into 3 categories: Sole ol e Trader This is a business that is owned and operated by one person Partnership This type t ype of business business is owned by seve several ral individuals indi viduals,, some some of which w hich will wi ll act act ively be involved i nvolved in the t he business Companies This type t ype of business business is owned by shareholders shareholders and and is i s operat operated ed on their t heir behalf behalf by a nominated board of director di rectors. s. Companies will wi ll be covered covered in greater det ail in i n later sess essions

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Users Users of account accounts s The users users of of account accounts s will wi ll depend depend on the type t ype of accounts accounts that are produced. produced. There are are two t wo main types of accounts:  

Management accounts Financial account accounts s

Management accounts These hese are produced as oft oft en as a busin busines ess s wants want s t hem (usually mont mont hly). hly). They are produced for f or internal int ernal use and and will wi ll not, not , usually usually be seen seen by ext ext ernal people. Managemen Managementt accou account nts s can can be prepared using using the t he company’s company’s own own int i nternal ernal policies pol icies..

Financ in ancial ial account accounts s These hese acc account ounts s are usuall usually y produced annuall annually. y. They are based based on his hist orical orical infor inf ormat matio ion n and and are rarely rar ely used used internall int ernally. y. Financial account accounts s are used used by external external users for several reasons: reasons: 

Investors



Lenders



Employees



Government



Public

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SESSION 2 FINANCIAL STATEMENTS Learning outcomes After completing this chapter, you should be able to:  



Identify t he layout of a Statement of Financial Posit ion for a sole trader and a company Identify the layout of a Statement of Comprehensive income for a sole trader and a company Understand the principles and layout for a Statement of Changes in Equity

Introduction There are four key financial statements: Statement of Financial Posit ion This financial statement lists the assets and liabilities of a business at a point in time. It is a snapshot of the company’s posit ion “ASAT A POINT IN TIME” Statement of Comprehensive Income This statement is a summary of the income and expenditure of the business for a “PERIOD OF TIME”. Statement of Changes in Equity This statement links the statements of comprehensive income and financial position. Statement of Cash Flow The statement of cash flow reports the cash generation and cash absorption for a “PERIOD OF TIME”.

The starting point in t he preparation of the financial statements is to produce a TRIAL BALANCE. The trial balance is basically a list of ledger balances. A business will use a trial balance as an INDICATION that all accounting entries have been recorded and all entries are correct. A trial balance MUST balance. If t here is an imbalance, this indicates an error in the initial entries. In this case a suspense account is created until the errors can be detected.

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Proforma set of financial statements for a sole trader. Statement of Financial Posit ion as at 31 December 2007 Non – current assets

Buildings Fixtures and fittings Motor vehicles

Cost

Dep’n

NBV

150,000 45,000 26,000

(12,000) (11,250) (13,260)

138,000 33,750 12,740

221,000

(36,510)

184,490

13,777 12,775 2,800 3,400

32,752

Current assets Inventory Trade receivables Prepayments Cash Total assets Opening capital Profit Drawings

217,242 152,465 51,787 (35,900)

168,352

Non – current liabilit ies Loan

20,000

Current liabilit ies Trade payables Accrued Loan int erest Other accruals Total liabilities

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12,445 1,000 15,445

28,890 217,242


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Statement of Comprehensive Income for the year ended 31 December 2007 Revenue

233,000

Less: Cost of sales Opening inventory Purchases Carriage inwards Closing inventory

12,332 119,098 1,009 132,439 (13,777)

GROSSPROFIT

118,662 114,338

Discounts received

5,111

Other income

4,000 123,449

Less: Expenses Discounts allowed Depreciation Gas and electricity Irrecoverable debts Loan int erest Carriage outwards Water rates Advertising Other expenses NET PROFIT

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3,444 10,710 14,122 7,134 4,000 5,666 8,444 15,000 3,142

71,662 51,787


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Proforma set of financial statements for a limited company or Plc Statement of financial position as at 31 December 2007 Non – current assets Intangible assets Tangible assets

Note 6 7

200,000 187,999

Current assets Inventory Trade receivables Cash

8 9

88,432 97,455 13,400

Total assets

199,287 587,286

Equity and liabilit ies Share capit al Retained earnings Revaluation reserve

7

100,000 220,497 38,000

358,497

Non – current liabilit ies Interest bearing borrowings

10

100,000

Current liabilit ies Trade payables Taxation Total liabilities

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5

77,789 51,000

128,789 587,286


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Statement of comprehensive income for the year ended 31 December 2007

Note Revenue (Sales)

385,000

Cost of sales

1

188,000

GROSSPROFIT

197,000

Distribution costs

2

38,500

Administration expenses

3

37,700

PROFIT FROM OPERATIONS

120,800

Finance costs

8,000

PROFIT BEFORE TAX

112,800

Income tax

53,000

PROFIT FORTHE PERIOD

59,800

Statement Of Changes In Equity for the year ended 31 December 2007 (SOCIE) Share Capit al Balance as at 1 Jan 2007

100,000

Profit for the period

Revaluation Reserve

188,697

40,000

59,800

Surplus depreciation (not impt for F 3)

2,000

Dividend paid Closing balance

Retained Earnings

220,497

328,697 59,800

(2,000)

(30,000) 100,000

Total

(30,000) 38,000

358,497

The format for company accounts is laid down in I.A.S. 1 Presentation of Financial Statement s. This structured format aids comparability and makes information more useful. Notes detailing the balances in the financial statements are provided giving a detailed breakdown of the balance.

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SESSION 3 DOUBLE ENTRY BOOK KEEPING Learning outcomes When you have completed this chapter, you should be able to:   

Understand the principles of double entry bookkeeping Apply double entry bookkeeping to a list of transactions Prepare financial statements for a sole trader

Introduction Bookkeeping is “the recording of monetary transactions” of a business.

Double entry bookkeeping Double entry bookkeeping is the fundamental concept underlying accountancy. All accounting transactions should be recorded using the double entry system. There are some basic rules that we MUST follow: 1. Every debit must have a credit 2. A debit ent ry is an ASSET in the STATEMENT OF FINANCIAL POSITION or an EXPENSE in the STATEMENT OF COMPREHENSIVE INCOME 3. A credit entry is a LIABILITY in the STATEMENT OF FINANCIAL POSITION or an INCOME in the STATEMENT OF COMPREHENSIVE INCOME

T accounts In order to assist us with the preparation of the financial statements we use T accounts for simplicity. The principles of T accounts are:  



Every debit entry has a credit entry Every T account will belong to the statement of financial position or the statement of comprehensive income The closing balance of a T account at the end of the period is entered into a trial balance

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EXAMPLE1 George commences business on 1 April 2006. The following transactions take place in his first two weeks of trading.        

1 April He invests $50,000 in to a business 1 April He purchases $5,000 worth of goods on credit 2 April He sells half of the inventory for $6,000 cash 5 April He issues a cheque to pay for the goods he received on credit 4 April Pays his rent for April of $450 by cheque 7 April He sells his remaining stock for $6,000 on credit 10 April Purchased goods on credit for $7,000 14 April He purchases a delivery van for $7,000 cash

Required For the first two weeks of trading prepare:    

The T accounts for George (State if the account is Position or Income) The trial balance The Statement of Comprehensive Income The Statement of Financial Position

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EXAMPLE2 Tina starts her business on 1 January 2007. The following transactions take place in her first month of trading:            

1 Jan 2 Jan 2 Jan 3 Jan 14 Jan 15 Jan 16 Jan 18 Jan 20 Jan 21 Jan 25 Jan 31 Jan

She invests $65,000 in to the business She purchases $8,000 worth of goods on credit She sells a quarter of the invent ory for $4,000 cash Issues a cheque to pay for half of the goods she received on credit Pays her insurance for January by issuing a cheque for $75 She sells the remaining inventory for $12,000 on credit Purchases inventory at a cost of $10,000 on credit Purchases some office equipment for $3,000 cash Pays her rent for January by cheque $150 Sells half her inventory for $10,000 cash Withdraws $100 for petty cash Purchases office supplies worth $30 from petty cash

Required For the first month of trading prepare:    

The T accounts for Tina (state if the account is Posit ion or Income) The trial balance The Statement of Comprehensive Income The Statement of Financial Position

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ANSWERTO EXAMPLE1 GEORGE Bank Account Dr 1 April 2 April

Capital Sales

50,000 5 April 6,000 4 April 14 April

Trade Payables Rent Delivery Van Carried Forward

56,000 Bought Forward

Cr 5,000 450 7,000 43,550 56,000

43,550

Capital Account Dr 1 April

Cr 50,000

Bank

Purchases Dr 1 April 10 April

Cr Trade Payables Trade Payables

5,000 7,000

Carried Forward


12,000 12,000

12,000

Trade Payables Dr 5 April

Bank Carried Forward

5,000 1 April 7,000 10 April

Purchases Purchases

12,000


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Cr 5,000 7,000

7,000


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Sales Dr Carried Forward

2 April 12,000 7 April

Cash Trade Receivables

12,000

Cr 6,000 6,000 12,000

Bought Forward

12,000

Rent Dr 4 April

Cr Bank

450

Trade Receivables Dr 7 April

Cr Sales

6,000

Delivery Van Dr 14 April

Cr Bank

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7,000


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George Trial Balance Statement

Dr

Cr

Bank Account

FP

Capital Account

FP

Purchases

CI

Trade Payables

FP

7,000

Sales

CI

12,000

Rent

CI

450

Trade Receivables

FP

6,000

Delivery Van

FP

7,000

Total

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43,550 50,000 12,000

69,000

69,000


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George Statement of Comprehensive Income 2 Week Period Ended 14 April 2007 Sales

12,000

Cost of sales Opening inventory Purchases

0 12,000 12,000

Closing inventory

(7,000) 5,000

GROSSPROFIT

7,000

Less expenses Rent NET PROFIT

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450 6,550


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George Statement of Financial Position as at 14 April 2007 Non Current Assets Delivery Van

7,000

Current Assets Inventory Trade Receivables Bank Account

7,000 6,000 43,550 56,550

TOTALASSETS Capital Profit

63,550 50,000 6,550 56,550

Non Current Liabilities

0

Current Liabilities Trade Payables

7,000 63,550

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ANSWER TO EXAMPLE 2 TINA Bank Account Dr 1 Jan 2 Jan 21 Jan

Capital Sales Sales

65,000 3 Jan 4,000 14 Jan 10,000 18 Jan 20 Jan 25 Jan

Trade Payables Insurance Office Equipment Rent Petty Cash c/ f

79,000 b/ f

Cr 4,000 75 3,000 150 100 71,675 79,000

71,675

Capital Account Dr 1 Jan

Cr 65,000

Bank

Purchases Dr 2 Jan 16 Jan

Cr Trade Payables Trade Payables

8,000 10,000

c/f

18,000

18,000 b/ f

18,000

18,000

Trade Payables Dr 3 Jan

Bank c/f

4,000 2 Jan 14,000 16 Jan

Purchases Purchases

18,000

18,000 b/ f

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Cr 8,000 10,000

14,000 ACCA F3 Financial Accounting

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Sales Dr

c/f

2 Jan 15 Jan 26,000 21 Jan

Bank Trade Receivables Bank

26,000

Cr 4,000 12,000 10,000 26,000

b/ f

26,000

Insurance Dr 14 Jan

Cr Bank

75

Trade Receivables Dr 15 Jan

Cr Sales

12,000

Office Equipment Dr 18 Jan

Cr Bank

3,000

Rent FBT PUBLISHING


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Dr 20 Jan

Cr Bank

150

Petty Cash Dr 25 Jan

Cr Bank

100 31 Jan

Office Supplies c/f

30 70

100 b/f

100

70

Office Supplies Dr 31 Jan

Cr Petty Cash

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30


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Tina Trial Balance Statement

Dr

Cr

Bank Account

FP

Capit al Account

FP

Purchases

CI

Trade Payables

FP

14,000

Sales

CI

26,000

Insurance

CI

75

Trade Receivables

FP

12,000

Office Equipment

FP

3,000

Rent

CI

150

Petty Cash

FP

70

Office Supplies

CI

30

Totals

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71,675 65,000 18,000

105,000

105,000


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Tina Statement of Comprehensive Income For January 2007 Revenue

26,000

Cost of sales Opening inventory Purchases

0 18,000 18,000

Closing inventory

(5,000)

GROSSPROFIT

13,000

Less expenses: Insurance Rent Office supplies

75 150 30 255

NET PROFIT

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12,745


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Tina Statement of Financial Position as at 31 January 2007 Non Current Assets Office Equipment

3,000

Current Assets Inventory Trade Receivables Bank Account Petty Cash

5,000 12,000 71,675 70 88,745

TOTALASSETS Capital Profit

91,745 65,000 12,745 77,745

Non Current Liabilities

0

Current Liabilities Trade Payables

14,000 91,745

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SESSION 4 NON CURRENT ASSETS Learning outcomes When you have completed this chapter, you should be able to:       

Define a non current asset Distinguish between tangible and int angible non-current assets Explain the differences between capital and revenue expenditure Understand the concepts of I.A.S. 16 Accounting for non-current assets Compile a non current asset register Calculate and account for depreciation Record the accounting entries for disposals of non-current assets

Introduction A non-current asset is intended for “ continued use” in a business. This would generally mean for more than one accounting period. Non-currents assets can be either TANGIBLEor INTANGIBLE. ACCA F3 concentrates on tangible non-current assets, however a knowledge of intangible non current assets is needed. Tangible non-current assets These are assets that have physical substance. Examples of tangible non-current assets would be: Land and buildings Plant and equipment Motor vehicles Computers Fixtures and fittings Intangible non-current assets These assets have no physical substance. An example of an intangible non-current asset would be: Goodwill Development

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Non-current assets are normally of substantial value and their accounting can have a material impact on the financial statements. As a result of this there are large numbers of accounting standards that help the preparers of financial statements to account for t hem. The key accounting standard relevant at this level is I.A.S. 16 Non-Current Assets Non-current asset register The majority of companies will own a number of non-current assets, and it is imperative that effective control is kept over them. In order to ensure management are aware exactly where each item is located and that t hey are adequately maintained and serviced, a non current asset register is maintained. A non-current asset register is generally maintained in the finance department. Companies can purchase specifically designed packages or a register can simply be maintained on an Excel spreadsheet. A register would include the following information:         

Item code Date of purchase Item description Cost Estimated useful life Residual value (if any) Depreciation method Location Disposal details

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Capital and revenue expenditure One of t he key areas of accounting for non-current assets is deciding whether expenditure incurred is CAPITALor REVENUE expenditure. If it is capital expenditure it will be capitalised in the statement of financial position and then depreciated over the useful economic life of the asset. If it is revenue expenditure it will be expensed through the statement of comprehensive income. We need to classify expenditure incurred as either capital or revenue in order to ensure appropriate accounting entries are made. Capital expenditure is expenditure likely to increase the future earning capacity of the organisation whereas revenue expenditure is regarded as maintaining the organisation’s present earning capacity. Per I.A.S. 16 the following costs may be capitalised on acquisition of a non-current asset:       

Initial cost Delivery costs Non-refundable import taxes Installation costs Any costs incurred in bringing the asset into intended use Initial training costs Subsequent expenditure that ENHANCESthe performance of the asset

Costs that are regarded as revenue expenditure and may not be capitalised per I.A.S. 16 are:   

Insurance costs Repairs Maintenance

EXAMPLE1 Capit al

Revenue

Purchase of a motor vehicle Purchase of a tax disc Fuel Insurance C D player Alloy wheels New tyre Early sett lement discount

Depreciation FBT PUBLISHING


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Depreciation is the charge to the statement of comprehensive income to reflect the consumption of an asset in a period. By applying depreciation charges, we are consistent with the ACCRUALS/ MATCHING CONCEPT i.e. applying the cost of using the asset to the statement of comprehensive income for the same period. All t angible non-current assets should be depreciated on a systematic basis per I.A.S. 16, with the exception of land. This is because land is seen to appreciate in value. Intangible non-current assets are amortised over their useful economic life (this is just another term for depreciation). Depreciation policies Calculating depreciation in a given period are common questions in this paper. The main methods of calculating depreciation are:  

Straight line Reducing balance

Straight line depreciation Depreciation is charged on a straight line basis over the life of the non-current asset. Thus an equal amount is charged in every accounting period over the life of the asset. To calculate t he depreciation charge the following formula is used:

Depreciation per annum

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=

Original cost – estimated residual value Estimated useful Life


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EXAMPLE2 Company A purchased a non-current asset on 31st July for $150,000. The asset has an expected useful life of 5 years and a residual value of $20,000. Calculate the depreciation charges for the year ended 31st December on the basis: i. ii.

A full year’s charge is made in the year of acquisition and none in the year of disposal. The company’s policy is to time-apportion depreciation charges.

EXAMPLE3 Company B purchases a machine for $23,000. They expect t o use it for four years and then sell it for $3,000. What is the annual depreciation charge?

Reducing balance This method of depreciation is generally used for assets which tend to lose more value in t he init ial years and require greater maintenance in t he later years. A good example would be a brand new motor vehicle. Motor vehicles tend to depreciate rapidly in the earlier years and require very little maintenance. A fixed percentage is charged to the net book value on an annual basis. Hence, as the book value of an asset reduces, the depreciation charge reduces accordingly. EXAMPLE4 Company C purchases a motor vehicle for $25,000 and will depreciate it at a rate of 25%. Calculate the depreciation for the first three years.

Once the depreciation charge has been calculated it should be entered int o the accounts via a journal. The journal for depreciation is: Dr

Depreciation expense

(Statement of comprehensive income)

Cr

Accumulated Depreciation

(Statement of financial position)

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Revaluations When a non-current asset is purchased we record them at their initial cost. However, over time these values may materially differ from their market value. For example, if a company purchased a property 20 years ago and therefore subsequently charged depreciation for 20 years, it would be safe to assume that the book value of the asset would be significantly different from today’s market value. In order to overcome this issue I.A.S. 16 permit s companies to reflect t he market value in the statement of financial posit ion. This policy may be adopted, and if so the following rules must be applied per the standard: i. ii. iii. iv.

If a company chooses to revalue an asset they must revalue all assets in that category Revaluations must be regular Subsequent depreciation must be based on the revalued amounts Gains from revaluations are not taken to the statement of comprehensive income, as no gain as been realised. This is covered by the PRUDENCEconcept.

EXAMPLE5 Company X purchased a building for $45,000 15 year ago, and charges depreciation of 2% on a straight line basis. The property has been valued by a qualified person at $150,000 during the current financial year. The directors would like to encompass these figures in the financial statements. Required: Complete the necessary journals to account for the revaluation.

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Disposal of a non-current asset When a business disposes of an asset it is unlikely that the sale proceeds will agree with the net book value. Therefore, a gain or loss will arise from the sale.

EXAMPLE6 Company C has a motor vehicle with a book value of $6,000 (cost $22,000) and disposes of it for $8,000. We can establish that there is a gain of $2,000 (proceeds – book value). The accounting entries will need to follow three steps 1. Clear the cost from the cost account 2. Clear the depreciation from the accumulated depreciation account 3. Enter the proceeds The entries are therefore: Dr

Disposal Account

Cr

Mot or vehicle cost account

Dr

Accumulated depreciation $16,000

Cr

Disposal Account

Dr

Bank

Cr

Disposal Account

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$22,000 $22,000

$16,000

$8,000 $8,000


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ANSWERS TO EXAMPLE1 Capit al Purchase of a motor vehicle Purchase of a tax disc Fuel Insurance C D player Alloy wheels New tyre Early sett lement discount

Revenue

       

ANSWERTO EXAMPLE2 i 150,000

5

20,000

=

26,000

26,000

x

5 12

=

10,833

=

5,000

Ii

ANSWERTO EXAMPLE3 23,000

4

3,000

ANSWERTO EXAMPLE4 Year 1 Year 2 Year 3

25,000 25,000 25,000

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x -

25% 6,250 6,250

x -

25% 4,688

x

25%

= = =

6,250 4,688 3,516


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ANSWERTO EXAMPLE5

Building Cost Account

Pre Revaluation Accumulated Depreciation

Net Book Value

45,000

13,500

31,500

Post Revaluation Building Cost Accumulated Account Depreciation 150,000

4,286

Net Book Value 145,714

Accumulated depreciation pre revaluation 45,000

X

2%

X

15 Years

=

13,500

Accumulated depreciation post revaluation 150,000

/

35 Years

=

4,286 pa

Journals Required Dr Dr

Buildings Cost Accumulated Depreciation

105,000 13,500

Cr

Revaluation Reserve

Dr Cr

Depreciation Accumulated Depreciation

118,500

4,286 4,286

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SESSION 5 INVENTORY Learning Outcomes When you have completed this chapter you should be able to:  



Explain the principles of I.A.S. 2 Inventories Explain and apply the different methods of inventory valuation including F.I.F.O., A.V.C.O. and L.I.F.O. Understand and apply the double entry for inventory

Introduction Inventory is the product we purchase and sell in a business. In a business it is unlikely that all of the inventory will be sold at the end of an accounting period, therefore there will be an adjustment needed in the financial statements for t he value of the closing inventory. Opening and closing inventory needs to be included in the statement of comprehensive income in order to calculate the cost of the goods sold with-in a given period. The statement of financial posit ion will show the value of the inventory at the end of the accounting period (the closing inventory). I.A.S. 2 is the accounting standard that gives us detailed guidance on how to value our closing inventory. RULE: Closing inventory should be valued at t he lower of cost and net realisable value (N.R.V.) By applying the I.A.S. 2 rule we ensure our inventory is never overstated in t he statement of financial posit ion, hence t he PRUDENCE concept. Valuation of closing inventory We will cover three methods of valuing the closing inventory: F.I.F.O. – First In First Out The closing inventory consists of items purchased at the latest dates, as we assume the items that were purchased first were the items sold first. In times of rising prices, closing inventory will have a higher cost and therefore profit will be higher.

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Weight ed average cost (AVCO) Under this method we assume: 

All units are issued at the current weighted average cost per unit



A new average cost is calculated whenever more items are purchased

L.I.F.O. – Last In First Out The closing inventory consists of it ems purchased at the earliest date, as we assume the last item purchased is the first item to be sold. In times of rising prices the closing inventory will have a lower value and therefore profit will be lower. From a practical perspective it is unlikely last items purchased will be sold first, and as a result of this I.A.S. 2 does not permit L.I.F.O. method of stock valuation. W.I.P. – Work in progress In some cases, where a company has modified it’s inventory it is necessary to take the cost of that modification into account when valuing closing inventory. Net realisable value Net realisable value is the amount we can get from selling inventory less any further costs to be incurred. Accounting Entries The double entry to account for closing stock is: Dr

Inventory

Statement of financial posit ion

Cr

Inventory

Statement of comprehensive income

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EXAMPLE1 Navigator Office Supplies made the following purchases and sales in January: Purchases 3rd 12th 16th 22nd 31st

500 500 400 700 900

pens pens pens pens pens

@ @ @ @ @

4.00 4.60 4.75 5.25 5.40

= = = = =

3,000

2,000 2,300 1,900 3,675 4,860 14,735

Sales 7th 13th 17th 29nd

300 400 300 700 1,700

pens pens pens pens

@ @ @ @

10.00 10.00 10.00 10.00

= = = =

3,000 4,000 3,000 7,000 17,000

Required Assuming there is no opening inventories prepare the statement of comprehensive income using the following:   

LIFO FIFO AVCO

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ANSWERTO EXAMPLE1 L.I.FO. IN

OUT

Date

No.

Cost

Total

03/01

500

4.00

2000.00

07/01 12/01

300 500

4.60

400 400

4.75

300 700

5.25

700 900

5.40

No.

1200.00

4.60

1840.00

4.75

1425.00

3675.00

29/01 31/01

4.00

Total

1900.00

17/01 22/01

Cost

2300.00

13/01 16/01

No.

BALANCE

4860.00

5.25

3675.00

Cost

Tot al

500

2000.00

200

800.00

700

3100.00

300

1260.00

700

3160.00

400

1735.00

1100

5410.00

400

1735.00

1300

6595.00

F.I.F.O Total Purchases

3,000 pens

Total Sales

1,700 pens

Closing invent ory

1,300 pens

Valuation 900 @ $5.40 each

$4,860

400 @ $5.25 each

$2,100 = $6,960

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AVCO IN

OUT

Date

No.

Cost

Total

03/01

500

4.00

2000.00

07/01 12/01

300 500

4.60

400

400

4.75

300

700

5.25

700

900

5.40

No.

1200.00

3100 divided by 700

1771.00

3229 divided by 700

1384.00

3675.00

29/01

31/01

4.00

Total

1900.00

17/01

22/01

Cost

2300.00

13/01

16/01

No.

BALANCE

5520 divided by 1100

3513.00

4860.00

Cost

Tot al

500

2000.00

200

800.00

700

3100.00

300

1329.00

700

3229.00

400

1845.00

1100

5520.00

400

2007.00

1300

6867.00

Therefore Income Statement is as follows: All $

L.I.F.O.

Revenue

F.I.F.O. 17,000

AVCO 17,000

17,000

Cost of sales Opening inventory Purchases Closing inventory

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0 14,735 -6,595

0 14,735 -6,960

0 14,735 -6,867

8,140

7,775

7,868

8,860

9,225

9,132


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EXAMPLE2 Radiance Kitchenware has the following items in their financial statements for the year ended 31 st December 2007: Inventory @ 01/01/07

$45,678

Purchases

$98,000

Inventory @ 31/12/07

$42,800

Closing inventory includes the following damaged items: 



A table was purchased for $500. Due to fire damage the maximum it can be sold for is $200 after a wax product costing $50 has been applied. Four chairs costing $100 each were also damaged in the fire. They can be sold for $20.

Required Calculate the cost of sales for 2007.

ANSWERTO EXAMPLE2 Stock Valuation Closing valuation Less Damaged inventory

42,800

Table Chairs

500 400

900

Table (200 – 50) Chairs

150 80

230

Add NRV

42,130

Cost of Sales Opening invent ory Purchases Closing inventory

45,678 98,000 -42,130 101,548

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SESSION 6 IRRECOVERABLE DEBTSAND PROVISION FORDOUBTFUL DEBTS Learning Outcomes When you have completed this chapter, you should be able to:  

Explain the difference between a irrecoverable debt and a doubtful debt Compute the double entries required for irrecoverable debts and the provision for doubtful debts

Introduction The majority of companies sell their product on credit. The length of credit will vary between companies, but the most common length of credit is 30 days. If however, someone fails to pay we need to be able to account for this is our ledgers. It would not be prudent t o hold a receivable in our statement of financial posit ion if we were aware that t hey are unlikely to pay. There are 2 types of debts that we need to consider:  

Irrecoverable debt (bad debt) Doubtful debt

There is a clear distinction between irrecoverable and doubtful debts: Irrecoverable Debt This is a debt t hat you consider to be uncollectable. Circumstances where this would occur are if the company has been fraudulent, gone bankrupt or disappeared. Thus it is unlikely that we will receive the money due to us. If this is the case we should not have this balance in our receivables, and would therefore write the debt off. The double entry would be: Dr

Irrecoverable debts


Cr

Trade receivables

Statement of financial position

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George has a small antiques business and at the end of the financial year ended 30 th April 2007 has a receivables balance of $42,500. Included in the year end balance is $4,000 that is owed by Zippy Traders. George has heard that t hey have been closed down due to financial irregularities and that all t he directors have disappeared. Also included in the amount is $500 owed by Bungle who is George’s brother-in-law. Bungle has left George’s sister and George is not sure if he will pay his debt which is due in 2 weeks time. Required How should George account for these items?

Recovering debts written off If a debt that has been writ ten off is later recovered, we will need to adjust the ledgers to reflect t his. The entry required would be: Dr

Bank

Cr

Irrecoverable debts

Doubtful debt A doubtful debt is a debt that is owed to a business, but they are dubious about its collectability. The distinguishing factor is that t his debt could be collected as it is doubtful not bad. We therefore, make a provision for this amount. The double entry would be: Dr

Irrecoverable debts


Cr

Provision for doubtful debts

Statement of financial posit ion

This type of provision is called a specific allowance as we know exactly which debts the provision is for. As you can see the debt remains in the receivables ledger, as a result the company can still actively chase the debt. If or when the company pays the debt the double entry would be the normal entry for a receipt i.e. Dr

Bank

Cr

Trade receivables

We would then reverse the provision we had for this debt. General allowance

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In order to apply the prudence concept we need to review our receivables at the end of the financial year and take a view of collectables. A large number of companies have a constant provision for receivables. This would be calculated as a percentage of the receivables balance.

EXAMPLE2 For the year ended 31st December 2005 a company’s receivables balance was $150,000. They had a general allowance of 5%. At the year ended 31st December 2006 the company’s receivables are $135,000 – the company would like to maintain a 5% general allowance. Required What is the impact on the statement of comprehensive income and how will the receivables be presented in the statement of financial position?

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ANSWERTO EXAMPLE1 Zippy Traders This debt should be treated as an irrecoverable debt. Therefore the entry needed would be: Dr

Irrecoverable debts

$4,000

Cr

Trade receivables

$4,000

Bungle This debt is neit her an irrecoverable or doubtful debt at t his stage. This is because the debt is not yet due and we know where Bungle lives. We also have no reason to suspect that Bungle cannot afford to repay the debt.

ANSWERTO EXAMPLE2 31ST December 2005 General provision – 5% x $150,000 = $7,500 Double entry Dr

Irrecoverable debts

7,500

Cr

Allowance for receivables

7,500

Extract from statement of financial position: Current assets Receivables General Allowance

150,000 -7,500 142,500

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31st December 2006 General Provision – 5% x $135,000

=

$6,750

Provision bought forward

=

$7,500

Therefore overprovision

=

$750 (7,500 – 6,750)

Double entry Cr

Irrecoverable debts

750

Dr

Allowance for receivables

750

Current assets Receivables General Allowance

135,000 -6,750 128,250

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SESSION 7 CONTROL ACCOUNTS AND CORRECTION OF ERRORS Learning outcomes When you have completed this chapter, you should be able to:     

Understand the principles of control accounts Prepare the control accounts for trade receivables and trade payables Explain the function of a suspense account Prepare nominal ledger accounts Prepare journal entries

Introduction In session 3 we prepared financial statements from T accounts. The number of transactions was limited, and therefore the process was simple to follow. If an error had been made it would have been easy to detect. However, in t he real world of business the number of transactions is large, and to help us detect errors we use control accounts. Therefore, daily entries are normally made in a number of “ Prime Entry” books and then a summary tot al is transferred to the nominal ledger periodically. This could be done daily, weekly or even monthly. The following have a large volume of transactions on a daily basis and are used as prime entries:       

Sales day book Purchase day book Sale returns day book Purchase returns day book Cash book Petty cash book Journal entries

The transactions are recorded in the prime entry books. They are then transferred to the nominal (general) ledger and we then extract a trial balance in order to prepare our financial statements.

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Sales day book This book records all the sales we make on credit . Sales should be recorded net of t rade discount but before cash (settlement) discount. Purchase day book This book of prime entry records all purchases we make on credit . Sale returns day book If a credit customer returns goods, this will be recorded in the sales returns day book. Purchase returns day book This book will record all the credit purchases that we return to suppliers. Cash book This book will record all the money that we will pay into the bank account, and any payments we make from the bank account. This will also record any cash (sett lement) discounts we allow or receive. Petty cash book This records all the small sundry transactions occurring in a business on a day to day basis. Journal entries These are used for ad hoc entries that do not fall into any of the above categories. They are also used to correct errors, both temporary and permanent.

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EXAMPLE1 L & M had the following transactions during the first week in December 2007. 1st December 2007   

Purchased goods on credit from A Ltd for $595 receiving a trade discount of 9.5% Purchased goods on credit for $795 from KP Ltd Sold goods on credit to JK Ltd for $999

3rd December  

Returned KP Ltd goods as they were defective Sold goods on credit to A Jones for $995

5th December  

Sold goods on credit to A Jones for $795 Purchased goods on credit from A Ltd for $995, again with a 9.5% trade discount NB Sales tax is 17.5%

SOLUTION SALESDAY BOOK DATE

INV NO.

01/12 03/12 05/12

100555 100556 100557

CUSTOMER J K Limited A Jones A Jones

NET 999.00 995.00 795.00

SALESTAX @17.5% 174.82 174.12 139.12

2789.00

488.06

TOTAL 1173.82 1169.12 934.12 3277.06

PURCHASE DAY BOOK DATE

INV NO.

01/12 01/12 05/12

999241 867544 999242

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SUPPLIER A Limited K P Limited A Limited

NET 538.47 795.00 900.47

SALESTAX @17.5% 94.23 139.12 157.58

2233.94

390.93

TOTAL 632.70 934.12 1058.05 2624.87


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PURCHASE RETURNS DAY BOOK DATE

INV NO.

03/12

867544

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SUPPLIER K P Limited

VALUE

SALESTAX

TOTAL

795.00

139.12

934.12

795.00

139.12

934.12


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EXAMPLE2 The following are t he balances on Explorers’ ledger accounts in t he month of January Opening receivables balance

22,500

Sales day book

88,650

Cash sales

23,950

Sale ret urns day book

5,555

Refunds to customers

3,325

Discounts allowed

6,786

Irrecoverable debts

4,455

Increase in provision

500

Purchase ledger contra

1,200

Required Calculate total cash received from customers in January Solution RECEIVABLES CONTROL ACCOUNT Dr All Jan

Cr All Jan Opening balance Sales day book Refunds

22,500 88,650 3,325

114,475 Feb

Opening balance

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Returns book Discounts allowed Irrecoverable debts Contra Closing balance Receipts (bal fig)

5,555 6,786 4,455 1,200 18,650 77,829 114,475

18,650


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EXAMPLE3 The following are the balances on a company’s ledger accounts in the month of March: Opening payables balance

12,785

Purchase day book

44,999

Returns outwards daybook

3,950

Returns inwards day book

2,300

Cheques paid to suppliers

37,500

Discounts received

1,400

Sales ledger contras

900

Required Calculate the closing balance for the payables account at t he end of March. Solution PAYABLESCONTROL ACCOUNT Dr All March

Cr All March Returns outwards Payments

3,950 37,500

Opening balance Purchase day book

12,785 44,999

Discounts received Contra Closing bal (bal fig)

1,400 900 14,034

57,784

57,784 April

Opening balance

14,034

Reconciling t he control accounts

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Normally at the end of each month we check to ensure our control accounts reconcile to the individual balances on our ledger accounts. We do this by: Checking our list of individual balances tie into the control account balance. If t here is an imbalance then it must be investigated. The main discrepancies are due to:     

Casting error in the day books Posting error A one sided contra An entry that has been made in the individual account but not in the control accounts An entry being omitted from the control account

EXAMPLE4 At the financial year end 31 December 2007 Explorer Rain Wear had a balance on the payables control account of $22,550. The balance on their purchase ledgers was $20,650. The management accountant found the following discrepancies: 1. 2. 3. 4. 5.

An invoice of $1,200 had been omitted from the control account The purchase day book total was overstated by $1,000 Goods returned of $1,590 had not been recorded in the control account Discounts received of $10 had not been posted Contra entries of $500 need to be recorded in the control account

After these adjustments are made, the control account should balance.

Solution Until a full knowledge of double entry is known, the easiest way to tackle this question is to identify where the error has occurred and amend accordingly. In this case: Error No. 1 2 3 4 5

Location of Error Control Control Control Control Control

Account Account Account Account Account

Amend Control Control Control Control Control

Account Account Account Account Account

PAYABLESCONTROL ACCOUNT Dr FBT PUBLISHING

Cr ACCA F3 Financial Accounting

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All De

All Dec Error 2 Error 3 Error 4 Error 5 Amended balance

1,000 1,590 10 500 20,650

Original balance Error 1

23,750

22,550 1,200

23,750 Jan

Balancer per list

Opening balance

20,650

20,650

EXAMPLE5 Hippo Manufacturing had the following balances on their payables / receivables for the financial year ended 30 June 2006. Credit sales Cash sales Credit purchases Cash purchases Returns inwards Returns outwards Discounts allowed Discounts received Irrecoverable debts Payments made to payables Cash received from receivables Contra’s

450,000 22,000 300,000 4,500 17,000 14,000 11,000 12,000 2,500 263,100 438,580 17,500

Balance at 1 July 2005: Payables Receivables Provision for doubtful debts

53,500 51,500 3,400

Bad debt provision is to be maintained @ 1.5%of credit sales

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SOLUTION This is a common CBA question. It is designed to ensure you know exactly what should go int o control accounts and also your knowledge of double entry. Again until you are comfortable with debits and credits it is easier t o write exactly where things will go before attempting to balance the accounts. In this case:

Credit sales Cash sales Credit purchases Cash purchases Returns inwards Returns outwards Discounts allowed Discounts received Irrecoverable debts Payments made Cash Received Contra

Receivables / Payables

Debit / Credit

Receivables Neither Payables Neither Receivables Payables Receivables Payables Receivables Payables Receivables Receivables / Payables

Debit n/ a Credit n/ a Credit Debit Credit Debit Credit Debit Credit Credit / Debit

PAYABLESCONTROL ACCOUNT Dr

Cr Returns outwards Discounts received Payments Contra

14,000 12,000 263,100 17,500

Closing bal (bal fig)

46,900 353,500

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Opening balance Credit purchases

53,500 300,000

353,500


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RECEIVABLES CONTROL ACCOUNT Dr

Cr Opening balance Credit sales

51,500 450,000

Returns inwards Discounts allowed Irrecoverable debts Cash received Contra Closing bal (bal fig)

501,500

17,000 11,000 2,500 438,580 17,500 14,920 501,500

Correction of errors At the end of an accounting period we extract a trial balance, and use this as a basis for preparing the financial statements. The following are the main purposes of a trial balance:   

Account balances are reviewed t o check for obscurit ies Reconcile all control account balances with the individual ledgers Ensure debits equal the credits.

If there is an imbalance a SUSPENSEACCOUNT will be created. Therefore, a suspense account may have a debit or credit balance. Errors that will cause a difference in the trial balance are:    

Transposit ion error – Entering figures the wrong way round Single entries – Only one side of the transaction has been posted Both entries entered on the same side of the ledger account Casting error – An account has been incorrectly added

Although extracting a trial balance proves the above, there are certain errors that a trial balance will not identify. These are:   



Error of principle – An entry has been entered in the wrong financial statement. Errors of omission – A transaction has been missed out. Errors of commission – Entering an amount in t he wrong account, but in the correct financial statement. Compensating errors – Where two or more errors cancel each other. This is extremely rare.

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Journals are used for several reasons:    

Post unique, one off transactions Transfer items between accounts Adjust balances that are incorrect Correct items that have been incorrectly posted

Journals should have a unique number and should be clearly labelled. Example 6 Correct the following errors using journals: 1. A sales day book has been under cast by $1,000. 2. Inventory purchased for $1,000 has been posted to stationery 3. A non-current asset has been purchased for $7,000 on credit, but has not been recorded.

Solution Account Name

Descript ion

Sales Revenue Trade Receivables

SDB under cast

Stationery Purchases

Incorrectly coded

Non-current asset Other payables

Capital purchased

Debit

Credit 1,000

1,000 1,000 1,000 7,000 7,000

Example 7

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Peter has the following balances on its trial balance at the end of the financial year: Debit

$213,852

Credit

$212,390

A suspense account has been created for the difference. The following errors have been identified by the accountant; after these errors have been corrected the balance on the suspense account should be removed. 1. A payment for stationery for $440 was debited to stationery as $780. 2. Discounts allowed of $1,310 have been recorded as a credit. 3. Other income of $3,742 has only been recorded in the cash book. Required Correct the entries and clear the suspense account. Solution Account Name

Descript ion

Suspense Stationery

Incorrect total posted

Discounts allowed Suspense

Posting to incorrect side

Suspense Other income

One sided entry

Debit

Credit

340 340 2,620 2,620 3,742 3,742

Suspense Account Journal 1 Journal 3

340 3,742 4,082

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Opening Balance Journal 2

1,462 2,620 4,082


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SESSION 8 BANK RECONCILIATIONS

Learning Outcomes When you have completed this chapter, you should be able to:  

Prepare cash and bank accounts Prepare a bank reconciliation

Introduction Within the ledger account is a bank account ledger, and it is important that the balance in the ledger reconciles to the balance on the actual bank statement. We call this exercise a bank reconciliation. Dependant on the size of the company, this can be done on a weekly or monthly basis, and in some larger companies even daily. Preparing a bank reconciliation has many advantages. They include:    

Provides a check on accuracy of recordings in t he cash book Highlights any errors Assists in the day to day cash management Any differences can be identified quickly

Debits and Credits On a bank statement the balances will be from the perspective of the bank not that of the business. Therefore, if a bank statement shows a credit balance, the bank has a creditor. In other words the bank owes the business money and is therefore in a positive position. If the bank statement shows a debit balance this indicates the business is overdrawn. i.e. it is an asset from the bank’s point of view.

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It is extremely unlikely that the balance on the ledger account and the balance on the bank statement will agree. This can be due to the following reasons: 





Cheques issued by the company are immediately entered into the cash book, but they will not appear on the bank statement until they are presented to the bank. These are called unpresented cheques. Receipts by the business are immediately entered in the cash book and then banked. This can take a number of days to clear. There may be items in t he bank statement that have not been processed through the cash book e.g. BACS transfer, standing orders, direct debits, dishonoured cheques and bank charges.

Proforma bank reconciliation Balance per bank statement

65,455

Less : Unpresented cheques

(1,950)

Add: Outstanding lodgements

1,700

Balance per cash book

65,205

Preparing a bank reconciliation 1. Compare the cash book and bank statement and tick matching it ems

2. Post corrections to the cash book i.e. items on the bank statement that have not been processed through the ledger

3. Put in items that are in the cash book that have yet to be presented to the bank as a reconciling item. UNLESS OTHERWISE TOLD, ASSUME FIGURES ON THE BANK STATEMENT ARE CORRECT.

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Example 1 Cash Book 01/04/ 07 03/04/07 05/04/07 12/04/07 29/04/07

b/ d 27 28 29 30

14,500 3,650 1,200 1,100 3,000

01/ 04/ 07 01/04/07 01/04/07 01/04/07 12/04/07 12/04/07 27/04/07 27/04/07 27/04/07 30/ 04/ 07

1437 1438 1439 1440 1441 1442 1443 1444 1445 c/d

450 600 750 150 250 350 395 165 245 20,095

23,450 30/04/ 07

b/ d

23,450

20,095

Bank Statement Date 01/04/ 07 04/04/07 05/04/07 08/04/07 10/04/07 11/04/ 07 12/04/07 14/04/07 17/04/07 17/04/ 07 18/04/07 20/04/07 24/04/ 07

Details Opening balance 1437 1438 27 28 Standing Order – P.S.L. 1439 Direct Debit – Direct Line 1441 BACS(Bank Automated Clearance System) Transfer 1442 29 Bank Charges

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Payment

Receipt

450 600 3,650 1,200 750 750 750 250 3,500 350 1,100 500

Balance 14,500 14,050 13,450 17,100 18,300 17,550 16,800 16,050 15,800 19,300 18,950 20,050 19,550


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Solution Cash Book 30/04/07 17/04/ 07

b/ d BAC

20,095 11/04/07 3,500 14/ 04/ 07 24/04/07 30/ 04/ 07

Standing Order Direct Debit Bank Charges c/d

750 750 500 21,595

23,595 30/04/ 07

b/ d

23,595

21,595

Bank Reconciliation Balance per bank statement Less: unpresented cheques

Add: Outstanding lodgements

19,550 1440 1443 1444 1445 30

150 395 165 245

(955) 3,000 21,595

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Example 2 The assistant accountant of Rainbow is trying to prepare a bank reconciliation as at 30 th November 2007. The cash book has a credit balance of $2,400 and the bank statement at that date has an overdrawn balance of $1,550. As his manager he has asked you for help with the following items: 1. He has discovered cheque number 100678 has been entered into the cash book twice for $459. 2. A direct debit of $225 has been taken from the account and not been entered into the cash book 3. There are unpresented cheques totalling $5,840. 4. There are outstanding lodgements of $8,390. 5. A cheque receipt for $1,450 has been dishonoured by the bank. 6. Bank charges of $1,400 have been charged by the bank. 7. A BACS transfer of $6,196 has been received by the bank and not been accounted for in the cash book. 8. He has entered cheque payment number 100600 into the cash book as $1,680, when the correct amount is $1,860. Required: Correct the cash book with the above and prepare a bank reconciliation.

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Solution: Cash Book 30/11/07 30/11/ 07

Chq 100678 (1) BAC

459 30/11/07 6,196 30/ 11/ 07 30/11/07 30/11/07 30/11/07 30/ 11/ 07 6,655

30/11/ 07

b/ d

b/ d Direct Debit (2) Dishonoured Cheque (5) Bank Charges (6) Chq 100600 (8) c/d

2,400 225 1,450 1,400 180 1,000 6,655

1,000

Bank Reconciliation Balance per bank statement

(1,550)

Less : Unpresented cheques (3)

(5,840)

Add: Outstanding lodgements (4)

8,390 1,000

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SESSION 9 ACCRUALSAND PREPAYMENTS

Learning Outcomes When you have completed this chapter, you should be able to:  

Explain why adjustments are necessary when preparing financial statements Compute the adjustments needed

Introduction The matching concepts states that income and expenses incurred in the period should be accounted for in t hat period, regardless of when invoices are raised or received. The fundamental rule is that income and expenditure are recognised as they are earned or incurred, not as money is received or paid. In order to ensure income and expenditure is recorded in the correct period, it is often necessary to adjust the financial statements. Example 1 - Accruals A sole trader receives his business gas bill quarterly in arrears. In the year ended 31 st December 2007 the following bills were received and paid on the dates indicated.   

30/04/ 07 31/07/ 07 31/10/ 07

$300 $310 $300

When preparing the accounts for the year end the accountant must adjust the Gas ledger account to reflect that not all charges have been recorded. In this case charges for November and December need to be included. Accruals and prepayments will be the estimate of the adjustment needed. The adjustment is calculated using the most up to date information available. In the example above this will be the 31/10/07 bill. Therefore the adjustment needed would be 2/3 x $300. The entry needed would be: Dr

Gas account

$200

Cr

Accruals

$200

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The ledger account would therefore look like this: Gas Account 30/04/ 07 31/07/ 07 31/10/ 07 31/12/07

Cash Cash Cash Accrual

300 310 300 200 31/12/07

Inc Statement

1,110

1,110 1.110

01/ 01/ 08

Accrual b/d

200

It is important to remember to carry forward any accrual or prepayment to the next accounting period.

(Assumption: business began on 1. 2. 07)

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Example 2 - Prepayment s Julie starts her business on 1 st August 2007, and pays her business insurance for the year to 31 st July 2008 totalling $1,800. Her year end is 31 st December each year. What charges for insurance would be stated in the income statement for the period ended 31 st December 2007?

Insurance Account 01/08/07

Cash

1,800 31/12/07 31/12/07

Prepayment (7/ 12) Inc Statement

1,800 01/01/08

Prepayment b/d

1,050 750 1.800

1,050

Assuming the insurance charge remains the same for the year ended 31 st July 2009, the ledger account would look like this: Insurance Account 01/08/07

Cash

1,800 31/12/07 31/12/07

Prepayment (7/ 12) Inc Statement

1,800 01/01/08 01/08/08

Prepayment b/d Cash

1,050 1,800 31/12/08 31/12/08 2,850

01/01/09

Prepayment b/d

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1,050 750 1.800

Prepayment (7/ 12 Inc Statement

1,050 1,800 2,850

1,050


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SESSION 10 LIMITED COMPANY ACCOUNTS

Learning outcomes When you have completed this chapter, you should be able to:   

Prepare a statement of comprehensive income Prepare a statement of changes in equity Prepare a statement of financial position

Introduction Many businesses are constit uted in the form of limit ed companies. The owners of limited companies are referred to as shareholders and are often different from the people that run the company. The shareholders have very little, if any involvement in t he day to day running of the business and employ directors to run it on their behalf. Limited company financial statements have very strict requirements which must be followed by all companies. These are governed by:  

Companies Act 2006 (or local country legislation) The International Accounting Standards Board

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The format to be adhered to per I.A.S. must be the format we adopt in our studies. The proforma financial statements for limited companies were given in session 2, however a copy is given below for reference: Proforma set of financial statements for a limited company or Plc Statement of financial position as at 31 December 2007 Non – current assets Intangible assets Tangible assets

Note 6 7

200,000 187,999

Current assets Inventory Trade receivables Cash

8 9

88,432 97,455 13,400

Total assets

199,287 587,286

Equity and liabilit ies Share capit al Retained earnings Revaluation reserve

7

100,000 220,497 38,000

358,497

Non – current liabilit ies Interest bearing borrowings

10

100,000

Current liabilit ies Trade payables Taxation Total liabilities

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5

77,789 51,000

128,789 587,286


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Statement of comprehensive income for the year ended 31 December 2007 Note Revenue

385,000

Cost of sales

1

188,000

GROSSPROFIT

197,000

Distribution costs

2

38,500


3

37,700

PROFIT FROM OPERATIONS

120,800

Finance costs

8,000

PROFIT BEFORE TAX

112,800

Income tax

53,000


59,800

Statement Of changes in equity for the year ended 31 December 2007 Share Capit al Balance as at 1 Jan 2007

100,000

Retained Earnings

Revaluation Reserve

188,697

40,000

Profit for the period

59,800

Excess depreciation

2,000

Dividend paid Closing balance

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220,497

328,697 59,800

(2,000)

(30,000) 100,000

Total

(30,000) 38,000

358,497


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A limited company must file their statutory accounts with companies’ house. A full set of statutory accounts will include: 1. 2. 3. 4.

Statement of comprehensive income Statement of changes in equity Statement of financial position Cash flow statement

These statements are supported by notes explaining the balances in the financial statements. One of the key differences between a company and a sole trader is that a company is classed as a separate legal entit y. This means that a company is deemed to be a person in it s own right. Therefore, a company can sue individuals and can also be sued. The name limit ed company comes from the fact that the shareholders have limited liabilit y, in other words their liability is restricted to the amount they have paid for their shares. Profit s of a company are distributed by way of dividend payments. These payments are at t he directors’ discretion. Example 1 Freedom Limited has 100,000 ordinary shares in issue. The nominal value (par value) is $1.00 and the directors decide to pay a dividend of 75c per share. If this is the case the company would pay $75,000 (100,000 x 0.75) in dividends Preference shares This type of share is known as a non-equity share, and gets a fixed return on the value of the share. Preference share holders will receive their dividend every year providing the company has distributable profit. Ordinary share holders will receive a dividend if the directors decide to pay one.

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Example 2 The following information relates to Voyager Limited Year ended 31st December 2007 Share capital (25c shares) 6% Preference shares

$ 100,000 50,000

The directors propose an ordinary dividend of 75c per share. Required: Calculate the dividend payable.

Solution Ordinary shares 100,000 / 0.25 = 400,000 shares in issue 400,000 x 0.75

300,000

Preference shares 50,000 x 6% Total dividends paid

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3,000 303,000


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Share premium If a company issues shares after the initial incorporation, it is unlikely they will issue them at a nominal/ par value. As the company has established itself, the net worth of the company would increase. This would be reflected in the share price. Example 3 The following relates to Radiance Limited Capital and reserves Share capit al ($1.00)

200,000

Retained earnings

233,456

Revaluation reserve

125,000

Say the market value price per share is $3.85 and the directors wish to issue a further 50,000 shares for cash injection purposes. The double entry would be: Cr

Share Capital (50,000 x $1.00)

50,000

Cr

Share Premium (50,000 x $2.85)

142,500

Dr

Bank (50,000 x $3.85)

192,500

The Capital and reserves would now be: Share capit al ($1.00)

250,000

Share premium

142,500

Retained earnings

233,456

Revaluation reserve

125,000

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Capital reserve The share premium account is classed as a Capital reserve. This means that t he account cannot be used to pay out dividends. The use of capital reserves is very limited. The key use of the reserve would be to finance a bonus issue of shares. This is when the directors distribute free shares to existing shareholders. The accounting entry for this would be: Cr

Share capital

Dr

Share premium

Dividends As we have seen previously in this chapter, dividend payments are used to distribute profit to shareholders. In order that a dividend can be paid, t he company must have reserves that are distributable i.e. they cannot be paid out of any reserve that is not realised (Revaluation reserve). Final dividends are paid after the year end; once the financial statements have been completed, and the directors have decided the dividend amount. An interim dividend can also be paid mid way through the year. Example 4 Share capit al (50c)

200,000

10% Preference shares

25,000

An interim dividend of 8c per share was paid during the year and the directors would like to propose a final dividend of 9c per share. Required: Calculate the total dividend payable for the year ended 31 st May 2007.

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Solution Ordinary shares $200,000 /$ 0.50 = 400,000 shares in issue Interim dividend (400,000 x 8c)

32,000

Final dividend (400,000 x 9c)

36,000

Preference shares 10% x $25,000

2,500 70,500

Taxation All companies have to pay tax on the taxable profits. The tax charge is normally estimated at the end of the financial year and charged to the statement of comprehensive income, and is paid in the following year. The accounting entry for taxation would be: Dr

Taxation

Comprehensive income

Cr

Taxation liability

Financial position

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Example 5 The trial balance of Jewel Limited as at 31 st March 2007 was as follows: Dr Share capital (50c) 6% Preference shares ($1.00) Retained earnings at 01/04/06 Debenture 10% Inventory at 01/ 04/ 06 Trade receivables Receivables provision Trade payables Cash Building cost account Plant and machinery at net book value Debenture interest Administrative expenses Distribution expenses Profit on disposals Purchases Revenue

Cr 100,000 50,000 234,666 100,000

32,000 45,987 5.987 39,945 73,958 150,000 422,987 5,000 48,000 49,000 1,000 69,666 365,000 896,598

896,598

Notes 1. Depreciation on building is to be charged at 2% 2. Depreciation on plant and machinery is to be charged at 10% reducing balance 3. Closing inventory was valued at $28,990 4. A provision of 5%of receivables is to be maintained 5. Tax charge is estimated at $25,000 6. A final dividend of 15c per share has been proposed before the year end. Required Prepare the statement of comprehensive income, statement of changes in equity and the statement of financial position for Jewel Limited for the year ended 31 st March 2007.

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Solution Journals Dr 1.

Dr Cr

Depreciation charge (150,000 x 2%) Accumulated depreciation - Buildings

Cr

3,000 3,000

2.

3.

4.

5.

6.

7.

Dr Cr

Depreciation charge (422,987 x 10%) Accumulated depreciation – P & M

42,299

Dr Cr

Closing inventory (comp income) Closing inventory (financial position)

28,990

Dr

Receivables provision account

Cr


Dr Cr

Taxation Taxation liabilit y

Dr Cr

Pref Dividends Proposed Div (prefs)

Dr

Dividends in SOCIE (100,000 / 0.5 x 15c)

42,299

28,990 Work 1

3,688 3,688 25,000 25,000 3,000 3,000

30,000

8.

Cr

Proposed dividends

30,000

Dr Cr

Debenture interest (10,000 – 5,000) Debenture int erest accrual

5,000 5,000

Working 1 Receivables Provision Account 01/ 04/ 06 31/03/07

31/03/07

Admin expenses (written back to I/ S)

b/ d

5,987

3,688

c/d (45,987 x 5%) 2,299 5,987

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5,987


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Jewel Limited Statement of Comprehensive Income Year ended 31st March 2007 Revenue

365,000

Cost of sales (32,000 + 69666 – 28990)

(72,676)

GROSSPROFIT

292,324

Distribution costs

(49,000)

Administration expenses (48,000 + 3000 + 42,299 – 3688 + 1000) (88,611) PROFIT FROM OPERATIONS

154,713

Finance costs

(10,000)

PROFIT BEFORE TAX

144,713

Income tax

(25,000)


119,713

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Jewel Limited Statement of financial position As at 31st March 2007 Non – current assets Tangible assets (150,000 + 422,987 – 3,000 – 42,299) 527,688 Current assets Inventory Trade receivables (45,987 – 2,299) Cash

28,990 43,688 73,958 146,636 674,324

Total assets Equity and liabilit ies Ordinary share capit al Preference share capit al Retained earnings (234,666 + 119,713 – 30,000 – 3,000 Pref Div)

100,000 50,000 321,379 471,379

Non – current liabilit ies Debenture

100,000

Current liabilit ies Trade payables Debenture accrual Proposed dividend Taxation

39,945 5,000 33,000 25,000 102,945

Total liabilities

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674,324


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Ordinary Shares Balance @ 01/04/06

100,000

Preference Shares 50,000

Revaluation Reserve

Retained Earnings

Total

234,666

384,666

Profit for the year

119,713

119,713

Dividends: ord pref Shares issued

(30,000) (3,000)

(30,000) (3,000)

321,379

471,379

Revaluation Balance @ 31/03/07

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100,000

50,000


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SESSION 11 STATEMENTS OF CASH FLOW

Learning outcomes When you have completed this chapter, you should be able to: 

Explain the purpose of producing a cash flow statement



Discuss the advantages of a cash flow statement



Explain the principles of I.A.S. 7



Produce a cash flow statement

Introduction The cash flow statement is a primary financial statement and provides fundamental information to the user of accounts. It highlights the key areas where a business has generated and spent physical cash. Good cash management ensures a business has sufficient cash to run its day to day operations. Prior to this session we have focused on profit, but cash is equally vital for the success of a business, especially in the short term. If a business has limit ed cash funds available it will struggle to survive in the short term. Advantages 

Cash flow balances are a matt er of fact and are not distorted by accounting policies



Cash flow balances are objective, unlike profit which is subjective



Users of financial statements can establish exactly t he cash generation of a business



Users can identify exactly how this cash has been utilised



Users can assess the liquidity of a business and assess its ability to repay debts as they fall due



Loans repaid and received are clearly listed in t he cash flow statement



Users can assess management attitude to capital expenditure



Interest payments are highlighted in the cash flow

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I.A.S. 7 I.A.S. 7 lays down the requirements of a cash flow statement. It gives us a detailed proforma and certain definit ions: Cash Cash that is available on demand. An example would be cash in the bank less any overdraft. Cash equivalents Short term, highly liquid investments (will be stated as current assets in Statement of Financial Position) I.A.S. 7 has three main headings. Students should familiarise the layout of a cash flow as questions in the exam will t est this area. The three main headings are: 

Cash flows from operating activities



Cash flows from investing activities



Cash flows from financing activities

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Proforma St atement at ement of Cash ash Flo Flow w for f or year y ear t o ……. $

$

ash ash flows f lows from operating act act ivit ies Profit rof it before t ax

X

Adjust djust ment ment s for: Interes Int erestt payable payable

X

Depreciation

X

(Prof (Profitit)) / loss on t he disposal disposal of a non current ass asset Operating perati ng profit prof it before befor e working wor king capit capital al change changes s

(X) (X) X

Working Worki ng capit capital al chang changes es (Increa (Incr ease se)) / Decreas Decrease e in invent ories ori es

(X) (X)

(Increas (Incr ease) e) / Decrease ecrease in receivables receivabl es

(X) (X)

Increas Incr ease e / (Decr (Decrease) ease) in payables payables

X (X)

Cash ash generated generated f rom operations operat ions

X

Interes Int erestt paid

(X) (X)

Taxat axat ion paid

(X) (X)

NET CASH FROM OPER OPERATING ATI NG ACTIVI ACTIVITIE TIES

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X


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Proforma continued $ NET NET C CA A H FROM OPERATING ATING ACTIVITIE TIVI TIES S

$ X

Cash flow from investing activities Purchas urchase e of a non-current non-cur rent asse assett

(X) (X)

Disposal isposal of a non-current non-current asse assett

X

Interes Int erestt received

X

Dividends ivi dends received

X

CASH FLOW FLOW FROM INVES I NVESTING TING ACTI ACTIVI VITI TIE ES

X

Cash flow from financing activities Procee ro ceeds ds f rom t he issue issue of shares shares

X

Receipt of loans

X

Repayment of loans

(X) (X)

Dividends ivi dends paid

(X) (X)

CASH FLOW FROM FINANCING ACTIVITIE

X

NET CASH FLOW

X

Cash and cash equivalents at the beginning of the period X Cash ash and cash cash equivalent equival ents s at t he end of t he period peri od

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X


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Example 1 Radiance Limited St atement of Financial inancial Position ositi on As at 31 December December 2007 2006

2007

Cost

180

220

Accumulated Accumulated depreciat depreciation ion

(78)

(92)

102

128

Inventory Invent ory

12

17

Trade receivabl eceivables es

2

10

Bonds

10

10

Cash

3

16

129

181

Share capit capit al

45

65

Share premiu premium m

10

12

Accumulated Accumulated profit prof it s

24

68

30

20

Payables ayabl es

19

13

Tax

1

3

129

181

Non-current assets

Current urr ent ass assets et s

Capit al and reserv reserves es

Non-c Non-current urrent liabilit l iabilit ies Loan Current liabilit ies

Notes The tax charge in the statement of comprehensive income is $6,000. Loan was repaid at t he end of t he fina fi nancial ncial year. year. Required Prepare the t he cas cash h flow f low statemen stat ementt for t he year year ended 31st December 2007.

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Solution $

$

ash flows from operating activit ies Profit before tax (68 – 24) + 6

50

Adjustments for: Interest payable Depreciation (92 – 78) (Profit) / loss on the disposal of a non current asset Operating profit before working capit al changes

14 64

Working capital changes (Increase) in inventory (17 – 12)

(5)

(Increase) in receivables (10 – 2)

(8)

(Decrease) in payables (19 – 13)

(6)

Cash generated from operations Interest paid

45 -

Taxation paid (working 1)

(4)

NET CASH FROM OPERATING ACTIVITIES

41

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$ NET CASH FROM OPERATING ACTIVITIES

$ 41

Cash flow from investing activities Purchase of a non-current asset (220 – 180)

(40)

Disposal of a non-current assets

-

Interest re eived

-

Dividends received

-

NET CASH USED IN INVESTING ACTIVITIES

(40)

Cash flow from financing activities Proceeds from the issue of shares (65 – 45) + (12 – 10) Receipt of loans Repayment of loans Dividends paid

22 (10) -

CASH FLOW FROM FINANCING ACTIVITIES

12

NET CASH FLOW

13

Cash and cash equivalents at the beginning of the period (10+3) 13 Cash and cash equivalents at the end of the period (10+3) 26

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Working 1 Taxation Liability

31/ 12/ 07

Cash paid (Bal Fig)

4

c/ d

3

01/ 01/ 07

b/ d

1

31/12/07

Charge for year

6

7

7 01/ 01/ 08

b/ d

7

Direct Method The direct method involves adding together t he cash inflows and deducting the cash outflows. Example 2 The following information relates to Empress Limited: Cash sales

55,000

Cash received from customers

44,000

Cash purchases

33,000

Cash paid to suppliers

12,000

Cash expenses

11,000

Cash wages and salaries

20,000

Required: Calculate the cash generation for Empress Limited

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Solution Cash sales

55,000

Cash received from customers

44,000

Total cash received

99,000

Cash purchases

33,000

Cash paid to suppliers

12,000

Cash expenses

11,000

Cash wages and salaries

20,000

Total cash paid

76,000

Cash generated

23,000

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SESSION 12 INCOMPLETE RECORDS

Introduction As the name suggests, incomplete records are any form of accounting records other than the full double entry system. In reality, accountants come across incomplete records almost daily. This is because their clients are not likely to fully understand the double en try system. We still however, need to prepare a set of financial statements for the client. During the exam, students will often come across incomplete records. The main reason is often due to a flood or fire at the business premises. Calculating profit If a business has very little information about its transactions, it may only be possible to calculate its net profit for the year. This can be done by using the accounting equation (this is very important). The accounting equation can be written as: Net Assets = Capital + Profit - Drawings

Or Change in net assets = Capit al int roduced + Profit – Drawings

You may realise that this is very similar to the statement of financial position. Example 1 A sole trader’s statement of financial position at 31 st December 2006 shows that the business has net assets of $5,000. The statement of financial position at 31 st December 2007 shows that the business has net assets of $8,000. The owner’s drawings for the year amounted to $2,500 and he didn’t introduce any furt her capital in the year Required Calculate the profit for the year ended 31 st December 2007.

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Solution: Change in net assets 3,000

Capital introduced =

Profit for the year

Drawing in period

0

+

?

-

2,500

+

2,500

=

Prof it

This can be writ ten as: 3,000

-

0

Profit

=

5,500

As you can see it is impossible to know the make-up of the net profit figure due to lack of information. Preparing financial statements from incomplete records In the majorit y of cases a small business will keep limited amount of records. In these types of questions you will be given information regarding the opening and closing balances of assets and liabilit ies of t he business. You will also be given information about certain transactions during the period; this is usually a summary of the cash book. There are two main t echniques used in incomplete records: 1. Balancing figures in ledger accounts 2. Ratios for mark-up (based on cost) or margin (based on selling price) Balancing figures The balancing figure approach is commonly used the following way: Ledger Account Accounts receivable

Missing Figure 



Money received from accounts receivable Purchases



Money paid to accounts payable



Drawings



Money stolen



Cash sales



Cash stolen



Accounts payable Cash at bank Cash in hand

Sales

Example 2

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Suppose that the opening balance on the accounts receivables ledger was $50,000, there had been receipts from account receivables in the year of $45,000, irrecoverable debts have been writ ten off worth $5,000 and the closing balance was $55,000. Required: What were the credit sales for the year? Account Receivables Opening b/ d

50,000

Receipts

45,000

Sales (Bal Fig)

55,000

Bad debts

5,000

Closing c/d

55,000

105,000

105,000

Example 3 Suppose that the opening accounts receivables balance was $30,000, there have been total receipts from customers of $55,000 of which $15,000 relates to cash sales and $40,000 relates to receipts from accounts receivables. Discounts allowed in t he year totalled $3,000 and the closing balance was $37,000. Required: What are the total sales for the year? Due to the information given in the question we can approach this in 2 different ways. We can calculate credit sales as above and then add on cash sales, or we can use the ledger account to calculate tot al sales. Both methods are shown below: Solut ion 1 - Total sales Account Receivables (Total Sales a/ c) 01/ 01/ 07

b/ d

31/12/07

Total sales (Bal fig)

30,000

31/ 12/ 07

Total receipts

31/12/07

Discounts allowed

31/ 12/ 07

c/d

55,000 3,000

65,000

95,000

37,000 95,000

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01/ 01/ 07

b/ d

30,000

31/ 12/ 07

Credit receipts

31/12/07

Credit sales

50,000

31/12/07

Discounts allowed

31/ 12/ 07

c/d

50,000

Cash sales

15,000

Total sales

65,000

3,000 37,000

80,000 Credit sales

40,000

80,000

Example 4 The opening balance on the accounts payable ledger was $30,000. Payments made to account payables during the year were $33.000, discounts received are $4,000 and the closing balance was $26,000. Required: What was the total purchases figure for the year? Solution: Payables Control a/ c 31/12/07

Payments

31/12/07

Discounts received

31/12/07

c/d

33,000

b/ d

30,000

31/12/07

Purchases

33,000

4,000 26,000 63,000

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01/12/07

63,000


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Example 5 Suppose the opening accounts payable balance is $15,000, the total payments made to suppliers was $14,000 of which $10,000 related to credit purchases. Discounts received were $500 and the closing balance was 11,000. Required: What was the total purchases figure for the year? Solution: Total Purchases a/ c (Account Payables) 31/12/07

Total payments

14,000

31/12/07

Discounts received

31/12/07

c/d

01/12/07

b/ d

15,000

31/12/07

Purchases

10,500

500 11,000 25,500

25,500

Example 6 The following information relates to the rent and rates for Susan for the year ended 31 st December 2007. Opening balance

Rent prepaid

300

Rates accrued

500

Cash paid during the year

Rent and rates

4,100

Closing balance

Rent prepaid

350

Rates accrued

450

Solution: Rent and Rates 01/01/07

Rent b/d (Prepaid)

31/12/07

Cash paid

31/12/07

Rates accrued

01/ 01/ 07 300 4,100

31/12/07

Rates b/ d (Accrued) Charge (Bal Fig)

450

31/12/07

Rent prepaid

4,850

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500 4,000 350 4,850


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Example 7 On 1st January the bank is overdrawn by $1,367, payments in t he year totalled $8,536 and on 31 st December the closing balance was a positive balance of $2,227. Required: What is the tot al receipts figure for t he year? Solution: Cash Book 31/12/07

Receipts

12,130

01/01/07

b/ d

1,367

31/12/07

Payments

8,536

31/ 12/ 07

c/d

2,227

12,130

12,130

Example 8 Scott has a cash float at the beginning of the year of $900. During the year cash of $10,000 was banked, $1,000 was paid out for drawings and wages of $2,000 was paid. Scott decided to increase the float to $1,000 at the end of the year. Required: How much cash was received from customers during the year? Solution: Cash Account 01/01/07 31/12/07

b/ d Receipts

900 13,100

14,000

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31/12/07

Banked

10,000

31/12/07

Drawings

1,000

31/12/07

Wages

2,000

31/ 12/ 07

c/d

1,000 14,000


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Ratios – Mark-up and Margin The gross prof it of a company can be expressed as a percentage. This percentage can be calculated based on the sales figure or the cost of sales figure. 

Gross Profit Mark-up

Based on Cost of Sales



Gross Profit Margin

Based on Sales

If we look at the following trading account: Sales REvenue

5,000

Cost of sales

4,000

Gross profit

1,000

Gross prof it mark-up

1,000 / 4,000 x 100 = 25%

Gross prof it margin

1,000 / 5,000 x 100 = 20%

Example 9 Margin

25%

Sales

$1,000

Required: What is the gross profit and cost of sales? $

%

1,000

100%

Cost of sales (1,000 / 100 x 75) (Bal fig)

750

75%

Gross profit

250

25%

Sales

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Example 10 Mark-up

25%

Cost of sales

$600

Required: What is gross profit and sales? Sales (600 / 100 x 125)

750

125%

Cost of sales

600

100%

Gross profit

150

25%

6,600

110%

6,000

100%

600

10%

Example 11 Mark-up

10%

Sales

$6,600

Opening inventory

$300

Closing invent ory

$500

Required: Complete a trading account from the above information. Sales Cost of sales Opening inventory

300

Purchases (Balancing Figure)

6,200

Closing inventory

(500)

Gross profit (6,600 / 110 x 10)

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Example 12 Margin

5%

Purchases

$2,840

Opening inventory

$800

Closing invent ory

$600

Required: Complete a trading account from the above information. Sales (3,040 / 95 x 100)

3,200

100%

3,040

95%

160

5%

Cost of sales Opening inventory

800

Purchases

2,840

Closing inventory

(600)

Gross profit

Cost of lost inventory In incomplete record questions, it is likely that inventory has been lost due to the infamous fire or flood. Closing inventory that has not been lost is subtracted in cost of sales because by definition, the inventory has not been sold in the year. Lost inventory has also not been sold in the year and therefore also needs subtracting within cost of sales. Therefore, to work out the cost of lost inventory, complete the trading account from the information given and then lost inventory can be calculated as a balancing figure.

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Example 13 Margin

20%

Sales

$100,000

Opening inventory

$10,000

Closing inventory (after fire)

$3,000

Purchases

$82,000

Required: Complete a trading account from the above information. Sales

100,000

100%

80,000

80%

20,000

20%

Cost of sales Opening inventory

10,000

Purchases

82,000

Closing inventory

(3,000)

Inventory lost in fire (balancing figure)

(9,000)

Gross profit (100,000 / 100 x 20)

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SESSION 13 PARTNERSHIPS Definition “The relationship which subsists between persons carrying on a business in common wit h a view t o profit” A partnership therefore has two or more part ners or owners. In the same way as for a sole trader, the profits of the business are owned by the partners. This makes it necessary to share the profit s of the business amongst the partners. A partnership will usually have a “Partnership Agreement” which will state how the profits are to be shared amongst other things. THE SHARING STORY A partnership has four part ners – Jason, Howard, Gary and Mark. In the year to 30th June 2007 the partnership has made profits totalling $106,250. Jason is rich but stupid. He was made a part ner because he could invest $100,000 into the partnership. He withdrew $30,000 from the business on 1st July 2006. Howard is poor but clever and could only invest $20,000 into t he part nership. Due to him being clever and completing work quicker than the other partners he took responsibility for hiring and firing staff in the business. He withdrew $30,000 on 30th June 2007. Gary invested $50,000 int o the partnership. He has a liking for designer clothes and fast cars. Consequently he withdrew $25,000 on 1 st July 2006 and a further $25,000 on 1 st January 2007. Mark also invested $50,000 and withdrew $30,000 on 1 st July 2006. Mark’s wife has just had a baby and he would therefore like to have a guaranteed share of the profits. The partners have decided that profits should be distributed at a ratio of 2 : 1 : 3 : 4 (Jason : Howard : Gary : Mark)

How do you think the profits should be shared amongst the partners?

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Interest on capital To reward part ners who have invested more into the business, the partnership may allocate some of the profits based on the level of capital invested. This is called interest on capit al. Salaries To reward those part ners who take on extra responsibilities with-in the business, they may receive a salary. A partners’ salary is not a business expense like the salary of an employee, but a way in which profits are allocated. Interest on drawings To penalise those part ners who take out more drawings from the business, the partnership may charge interest on drawings. Interest on drawings results in a reduction in the amount of profit the partner is allocated. Profit sharing ratio This is the ratio in which any remaining profits should be shared amongst the partners after they have been allocated interest on capital, salaries and interest on drawings. Guaranteed minimum profit share A partner may be guaranteed a minimum share of the profit s. If the partner has not received this share after allocating profits in accordance to the above, the shortfall should be given to the partner. The short fall is then taken from t he other partners in accordance with the profit sharing ratio. Example 1 Using the amounts detailed in the sharing story, allocate the profits of the business in accordance with the following partnership agreement: a) Interest on capital is 5% per annum b) Howard is to receive a salary of $5,000 c) Interest on drawings is 10% per annum d) Profit sharing ratio is as stated 2 : 1 : 3 : 4 e) Mark has a guaranteed minimum profit share of $42,500

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Appropriation of Profit Account Jason

Howard

Gary

Mark

Total

Profit

106,250

Interest on capital

5,000

1,000

2,500

2,500

(11,000)

-

5,000

-

-

(5,000)

(3,000)

-

(3,750)

(3,000)

9,750

Salaries Interest on drawings

100,000 P.S.R. 2 : 1 : 3 : 4 Guaranteed share

20,000

10,000

30,000

40,000

(100,000)

22,000

16,000

28,750

39,500

-

(1,000)

(500)

(1,500)

3,000

21,000

15,500

27,250

42,500

Financial statements for a partnership The format of the financial statements for a partnership will be the same as for a sole trader except for t he capital section of the statement of financial position. Each partner will have a capital account and a current account. Capit al account This will record the assets that have been introduced into the partnership. The account will remain fixed unless more assets are introduced. The capital account will have a credit balance. Capital Accounts A

Balance c/d

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B

C

X

X

X

X

X

X

A

B

C

Balance b/ d

X

X

Bank

X

X

X

X


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ACCA F3 - FA Support Material by FBT

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