1 Calculating sales tax Sales Tax calculations have to be considered in the context of adding the Sales Tax to a value exclusive of Sales Tax i.e. the net value, and also in the context of finding the Sales Tax content given a value which is inclusive of Sales Tax i.e. the gross value. The formula for calculating Sales Tax to be added to the net total of goods sold, assuming a Sales Tax rate of 20%, is: Sales Tax = total of goods net value (100%) x Sales Tax percentage rate (20%) The formula for working out Sales Tax of a Tax inclusive, assuming the rate of Sales Tax to be 20% is: Sales Tax = Sales Tax % rate 20% x total amount paid Net value (100% + Sales Tax % rate)120% (100% + 20%) Example Making sales tax calculations (assuming a Sales Tax rate of 20%) (i) Adding Sales Tax to a Net Goods Value If a product has a net price of, say $600 and Sales Tax is to be added at standard rate then a simple calculation is required as follows: Sales Tax = $600 x 20% = $120 The gross price of the product is therefore $600 + $120 = $720 (net price + Sales Tax = gross price). (ii) Finding the Sales Tax Content of a Gross Price Figure If the gross price was given as $720 you can work out the Sales Tax content of the gross value as follows: $ = $6 x 20 = $120 Sales tax and settlement discounts Where a settlement discount is offered for prompt settlement of an invoice the Sales Tax on the net goods value is calculated on the discounted value of the net amount, i.e. the lowest amount payable, even if the settlement discount is not taken.
2 Example Petty cash voucher The following is an example of a petty cash voucher together with the till receipt from which the voucher was prepared: The voucher should show the purpose for which the cash was paid. Details Petty Cash Voucher The date is entered by hand and is normally the date the cash is taken from the petty cash box. Date: No: May 201Y Amount $ Vouchers should be consecutively numbered. Ideally, the vouchers are pre-printed, otherwise the numbers are entered by hand. Authorisation will normally come from the petty cashier, unless the amount paid exceeds his/her authorisation limit.. Stationery- pens, pencils and correcting fluid Sales 20% Signature: Oliver Faroux Authorised by: Diane Kelly (Petty Cashier) Oliver Faroux is the person to whom the cash was paid. Till Receipt Super Stationery Ltd $ Qty Total Includes Sales 20% Cash Change /05/1Y
3 Net realisable value (NRV) Net realisable value is defined as the actual or estimated selling price less all further costs to completion and all costs to be incurred in marketing, selling and distribution. Comparison between cost and net realisable value should be made for each item of inventory held, with the valuation used being the lower of the two figures in each case. If it is not possible to value each inventory item separately then groups of similar inventory items within an inventory line may be valued collectively. Examples of situations where net realisable value may be less than cost include: üü üü üü üü üü Instances where a business is not to continue trading as a going concern and inventory hasto be disposed of in a liquidation sale. Where there has been a general fall in selling price. Where there has been a physical deterioration of the inventory. Obsolescence of an inventory line. An error in production or purchasing inventory (buying or making too many). Example - Valuing inventory at cost and net realisable value (1) A business trades in the following six categories of product - the Arundel, Boston, Chelsea, Derby, Exeter and Fulham. As at their financial year ended 31 March 201Y each inventory line was valued at both cost and net realisable value as follows: Inventory Line Valuation at Cost $ Valuation at NRV $ Arundel 27,985 56,180 Boston 12,655 4,625 Chelsea 56, ,500 Derby 29,150 59,120 Exeter 15,565 7,250 Fulham 34,165 69,100 Total 175, ,775 The closing inventory value would be recorded in the books by taking the lower of cost or net realisable value for each inventory line, viz: current assets are purchased partway through a financial year. Two options are available, these being:
4 The Full Year Basis here, in the year of acquisition (the first year of life), the date on which the non-current asset was purchased is ignored and full year s depreciation is charged irrespective of when, within the financial year, the asset was purchased. In applying the full year basis we charge no depreciation to the Income Statement in the year of disposal of a non-current asset. The Month for Month Basis here depreciation is calculated and charged to the Income Statement according to the period of time for which the non-current asset is owned each financial year. Depreciation using this basis is charged in the year of acquisition of the asset and in the year of disposal (provided in the year of disposal the asset has not already been written down to a nil residual value). The following are examples of depreciation calculations using the straight line method and reducing balance method applied on a month for month and full year basis. Examples of Depreciation Calculations Example 1 - Straight Line Method Using the Month for Month Basis The financial year of Gearboxes UK ends on 31 December. On 1 July 201V they purchase an item of workshop equipment at the cost of $4,000. The equipment is estimated to have a useful life of 4 years to the business with a nil residual value. The policy of Gearboxes UK is to depreciate equipment by using the straight line method applied on a month for month basis. The following calculations were made in respect of depreciation of the equipment over the period of its economic life. cost $4,000 less $nil residual value = depreciation $1,000 per year 4years estimated useful life Note as the equipment is being depreciated from cost to a nil residual value a percentage depreciation calculation could be applied, in this case 25% per year. However. the percentage must be applied each year to the initial cost of the item. $ Equipment Cost (1 July 201V) 4,000 Depreciation Year 1 (31 December 201V) 500 (25% of cost 6 months) Carrying value 3,500 Depreciation Year 2 (31 December 201W) 1,000 (25% of cost 12 months) Carrying value 2,500 Depreciation Year 3 (31 December 201X) 1,000 (25% of cost 12 months) Carrying value 1,500
5 Depreciation Year 4 (31 December 201Y) 1,000 (25% of cost 12 months) Carrying value 500 Depreciation Year 5 (31 December 201Z) 500 (25% of cost 6 months) Carrying value NIL Introduction A sole trader invests funds into his/her business which is known as capital. The balance on the capital account fluctuates each year as the profits made by the business increase the capital balance, while the drawings made by the proprietor reduce the capital balance. A limited company has a different capital structure to a sole trader that consists of share capital and reserves and this lesson covers the various forms of the capital structure that could be encountered in the Financial Statements assessment. Share capital It is a requirement of law that a limited company maintains a level of permanent funding that cannot be distributed to the owners of the company. These permanent funds are known as the share capital of the company. The owners or members of the company, also known as shareholders, contribute capital by purchasing shares in the company. In this way the company is able to raise a large amount of funds from different investors rather than depending on the financial capacity of just one or a few individuals. Example Raising capital Suppose that a company wishes to raise capital of $1,000,000. This is a large amount of money and it may therefore be difficult to obtain the funds from a small number of investors. To assist in raising this capital the company might divide this amount into 1,000,000 units of $1 each. By doing this investors could then choose how much they wanted to invest and could then buy as many units as they wished. These units are known as shares. Each shareholder is a part owner of the company. The value of each unit is the par or nominal value of the share. Once the par value has been set by the directors of the company it does not change. It will remain at that value for the duration of the company s existence. It is important to understand that this is not necessarily the amount that is paid for the share. The par value should not be confused with the market value of the share which is the amount that the share could be bought or sold for on a recognised stock exchange. The market value of the share will change over time and is irrelevant for the company s accounts.
6 Example Statement of Comprehensive Income for Internal Use Dauphin Ltd Statement of Comprehensive Income for the year ended 31 December 20X1 $ $ $ Revenue 4,736,000 Cost of sales Opening inventories 316,000 Purchases 2,744,500 3,060,500 Less: Closing inventories 289,000 2,771,500 Gross profit 1,964,500 Less: Overheads Distribution costs Distribution overheads 96,500 Salesmen salaries 42, ,000 Administrative expenses Rent, rates and insurance 320,500 Advertising 61,500 Wages and salaries 531,000 Directors remuneration 482,500 Auditors remuneration 31,000 Sundry expenses 38,500 Depreciation: Plant and machinery 34,500 Motor vehicles 15,000 1,514,500 1,653,500 Profit from operations 311,000 Finance costs 47,500 Profit before tax 263,500 Tax 63,000 Profit for the year 200,500
7 Transfer to general reserve 10, ,500 6% Preference dividend 27,000 Interim ordinary dividend 60,000 87,000 Retained earnings for the year 103,500 Retained earnings at 1 January 20X1 160,000 Retained earnings c/f 263,500 Disposal of a revalued asset Where an asset that has been revalued is subsequently sold, the profit on disposal calculation will need to take into account the balance on the revaluation reserve relating to the asset being sold. The disposal account will be debited with the non-current asset valuation and credited with the accumulated depreciation, sales proceeds and balance on the revaluation reserve account relating to the asset. The difference will be the profit or the loss on disposal. Appropriation account Example Revaluation downwards A company has sold a property that has previously been revalued. The balance on the revaluation reserve account related solely to the asset being disposed of. The following information is relevant: Original cost when the property was purchased $80,000 Original depreciation $1,600 per annum Carrying value at date of revaluation $70,400 Revaluation value $118,800 Revised depreciation $2,700 per annum Sales proceeds $130,000 The company has not made any transfers in respect of excess depreciation. The ledger accounts would have the following entries for transactions from the date of purchase to the disposal of the property.
8 Property Cost/valuation $ $ Purchase 80,000 Balance c/d 118,800 Revaluation reserve 33, ,800 Balance b/d 118,800 Disposals account 118, , ,800 Property Accumulated Depreciation $ $ Transfer to revaluation reserve 9,600 Depreciation charge 9,600 Disposals account 24,300 Depreciation charge 24,300 The next three lessons concentrate on producing consolidated financial statements for a group of companies consisting of a parent company and one or more subsidiary companies. Control The key to a creating a group of companies is control. A subsidiary is a company that is controlled by another company known as the parent (or holding company). The first indicator of control is the percentage number of shares (carrying voting rights) held by the investing company. A company can own shares either directly or indirectly. Direct ownership If one company owns more than 50% of the shares (carrying voting rights) in another company then there is a direct parent/ subsidiary relationship. This can be illustrated thus: Parent > 50% Subsidiary Once a company owns more than 50% of the equity shares with voting rights in another company then it can exercise control because it will have more than 50% of the voting power of that company. The above example shows a single entity group and is the only type examinable in this Unit. In reality though, group structures are more complex and when determining control through share ownership, any investments held by the subsidiary companies will also need to be considered.
9 Parent Subsidiary Subsidiary Ultimate holding company > 50% Holding company > 50% Intra-group trading It is common within a group situation that companies within the group will trade with each other. This is known as intra-group trading. Each of the companies will include the sale or purchase in its own company financial statements which is the correct procedure from the perspective of each company being a single entity. When the consolidated financial statements are prepared the intra-group transactions need to be removed because, when considered from a group perspective, they represent sales to itself. Example Intra group trading During the year ended 31 December 20X1 Quill Ltd sold goods to Ink Ltd for $30,000. These goods had originally cost Quill Ltd $21,000. Ink Ltd used all of the goods purchased from Quill Ltd to make sales outside the group before the end of December 20X1 so none of these goods remained in inventory. An extract from the Company Statement of Comprehensive Incomes of Quill Ltd and Ink Ltd for the year ended 31 December 20X1 is shown below. Income Statement (extract) for the year ended 31 December 20X1 Quill Ltd Ink Ltd $000 $000 Revenue 570, ,000 Cost of sales 234, ,000 Gross profit 336, ,000 The figures in the total column are the ones that will be included in the Consolidated Income Statement of Comprehensive Income for 31 December 20X1.
10 SELF-TEST QUESTIONS Now attempt these questions on lesson 24 and check your answers with the model answers on the VLC. QUESTION 24.1 Which one of the following is the most appropriate definition of an associate? A B C D An entity over which the investor has significant influence but which is neither a subsidiary nor a joint venture An entity, including an unincorporated entity, such as a partnership, that is controlled by another entity Shares are purchased in another entity but the relationship is not one of subsidiary or associate An entity that has one or more subsidiaries QUESTION 24.2 Which one of the following is the most appropriate definition of trade investment? A B C D An entity over which the investor has significant influence but which is neither a subsidiary nor a joint venture An entity, including an unincorporated entity, such as a partnership, that is controlled by another entity Shares are purchased in another entity but the relationship is not one of subsidiary or associate An entity that has one or more subsidiaries QUESTION 24.3 Describe the equity method of accounting for associates.