ACCA. Paper F3 (INT) Financial accounting. The Essential Text

Transcription

1 ACCA Paper F3 (INT) Financial accounting The Essential Text

2 British library cataloguing in publication data A catalogue record for this book is available from the British Library. Published by: Kaplan Publishing UK Unit 2 The Business Centre Molly Millars Lane Wokingham Berkshire RG41 2QZ ISBN Kaplan Financial Limited, 2008 Printed and bound in Great Britain Acknowledgements We are grateful to the Association of Chartered Certified Accountants and the Chartered Institute of Management Accountants for permission to reproduce past examination questions. The answers have been prepared by Kaplan Publishing. All rights reserved. No part of this publication may be reproduced,stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of Kaplan Publishing. ii KAPLAN PUBLISHING

3 Contents Page Chapter 1 Introduction to accounting 1 Chapter 2 Statement of financial position and income statement 9 Chapter 3 Double entry bookkeeping 29 Chapter 4 Inventory 55 Chapter 5 Sales tax 75 Chapter 6 Accruals and prepayments 85 Chapter 7 Irrecoverable debts and allowances for receivables 97 Chapter 8 Non current assets 113 Chapter 9 From trial balance to financial statements 143 Chapter 10 Books of prime entry and control accounts 155 Chapter 11 Control account reconciliations 175 Chapter 12 Bank reconciliations 185 Chapter 13 Correction of errors and suspense accounts 197 Chapter 14 Applications of information technology 211 Chapter 15 Incomplete records 219 Chapter 16 Partnerships 239 Chapter 17 Company accounts 259 Chapter 18 Accounting standards 285 Chapter 19 Statement of cash flows 303 Chapter 20 The regulatory and conceptual framework 329 KAPLAN PUBLISHING iii

4 iv KAPLAN PUBLISHING

5 chapter Introduction Paper Introduction v

6 Introduction How to Use the Materials TheseKaplanPublishinglearningmaterialshavebeen carefullydesignedtomakeyourlearningexperienceaseasy aspossibleandtogiveyouthebestchancesofsuccessin yourexaminations. Theproductrangecontainsanumberoffeaturestohelpyou inthestudyprocess.theyinclude: (1) Detailedstudyguideandsyllabusobjectives (2) Descriptionoftheexamination (3) Studyskillsandrevisionguidance (4) Completetextoressentialtext (5) Questionpractice Thesectionsonthestudyguide,thesyllabusobjectives,the examinationandstudyskillsshouldallbereadbeforeyou commenceyourstudies.theyaredesignedtofamiliarise youwiththenatureandcontentoftheexaminationandgive youtipsonhowtobesttoapproachyourlearning. Thecomplete text or essential textcomprisesthemain learningmaterialsandgivesguidanceastotheimportance oftopicsandwhereotherrelatedresourcescanbefound. Eachchapterincludes: vi Thelearning objectivescontainedineachchapter, whichhavebeencarefullymappedtotheexamining body'sownsyllabuslearningobjectivesoroutcomes. Youshouldusethesetocheckyouhaveaclear understandingofallthetopicsonwhichyoumightbe assessedintheexamination. Thechapter diagramprovidesavisualreferencefor thecontentinthechapter,givinganoverviewofthe topicsandhowtheylinktogether. Thecontentforeachtopicareacommenceswitha briefexplanationordefinitiontoputthetopicintocontext beforecoveringthetopicindetail.youshouldfollow yourstudyingofthecontentwithareviewofthe illustration/s.theseareworkedexampleswhichwillhelp youtounderstandbetterhowtoapplythecontentforthe topic. KAPLANPUBLISHING

7 Test your understanding sections provide an opportunity to assess your understanding of the key topics by applying what you have learned to short questions. Answers can be found at the back of each chapter. Summary diagrams complete each chapter to show the important links between topics and the overall content of the paper. These diagrams should be used to check that you have covered and understood the core topics before moving on. Question practice is provided at the back of each text. Icon Explanations Definition Key definitions that you will need to learn from the core content. Key Point Identifies topics that are key to success and are often examined. Expandable Text Expandable text provides you with additional information about a topic area and may help you gain a better understanding of the core content. Essential text users can access this additional content on line (read it where you need further guidance or skip over when you are happy with the topic) Illustration Worked examples help you understand the core content better. Test Your Understanding Exercises for you to complete to ensure that you have understood the topics just learned. Tricky topic When reviewing these areas care should be taken and all illustrations and test your understanding exercises should be completed to ensure that the topic is understood. For more details about the syllabus and the format of your exam please see your Complete Text or go online. On line subscribers Paper introduction Syllabus objectives Paper based examinations tips KAPLAN PUBLISHING vii

8 Introduction Study skills and revision guidance Preparing to study Effective studying Further reading Youcanfindfurtherreadingandtechnicalarticlesunderthe studentsectionofacca'swebsite. viii KAPLANPUBLISHING

9 chapter 1 Introduction to accounting Chapter learning objectives Upon completion of this chapter you will be able to: define accounting explain the different types of business entity: sole trader partnership limited liability company explain who users of the financial statements are and their information needs explain the nature, principles and scope of accounting explain how the accounting system contributes to providing useful information and complies with organisational policies and deadlines. 1

10 Introductiontoaccounting 1Definition of accounting 2Types of business entity Abusinesscanbeorganisedinoneofseveralways: Soletrader abusinessownedandoperatedbyoneperson. Partnership abusinessownedandoperatedbytwoormorepeople. Company abusinessownedbymanypeopleandoperatedbymany (thoughnotnecessarilythesame)people. Expandable text 2 KAPLANPUBLISHING

11 chapter1 3Users of the financial statements Test your understanding 1 Whydoyouthinkthefollowingusergroupsareinterestedina company sfinancialstatements? Management Investorsandpotentialinvestors Employeesandtradeunionrepresentatives Lenders Governmentagencies Suppliers Customers Competitors Thepublic. KAPLANPUBLISHING 3

12 Introductiontoaccounting 4Types of accounting Expandable text 5How an accounting system contributes to providing useful information Themainfeaturesofanaccountingsystemandhowithelpsinproviding informationtothebusinessareasfollows: 4 Inacomputerisedsystemallinformationaboutthebusiness transactionscanbequicklyaccessed.thiswillhelpindecisionmaking. Itprovidesdetailsoftransactionsofthebusinessintherelevant accounts. Whentheaccountsareclosedoffthebalancesforeachoutstanding accountaredetermined.thiswillgivethevalueofassetsandliabilities inthebusiness. Itgivesasummaryofoutstandingbalances. Thissummarycanthenbeusedforthepreparationoffinancial statements. KAPLANPUBLISHING

13 chapter 1 Normally the financial statements are prepared at regular intervals. The accounting system will allow the business to obtain the data and also prepare the financial statements to determine the profitability, liquidity, risks, etc. applicable to the business for a particular period. For internal reporting purposes this could be monthly, whilst for external reporting purposes this is usually yearly. KAPLAN PUBLISHING 5

14 Introductiontoaccounting Chapter summary 6 KAPLANPUBLISHING

15 chapter1 Test your understanding answers Test your understanding 1 Managementneeddetailedinformationinordertocontroltheir businessandplanforthefuture.budgetswillbebaseduponpast performanceandfutureplans.thesebudgetswillthenbecompared withactualresults.informationwillalsobeneededaboutthe profitabilityofindividualdepartmentsandproducts.management informationmustbeveryuptodateandisnormallyproducedona monthlybasis. Investorsandpotentialinvestorsareinterestedintheirpotential profitsandthesecurityoftheirinvestment.futureprofitsmaybe estimatedfromthetargetcompany spastperformanceasshownin theincomestatement.thesecurityoftheirinvestmentwillbe revealedbythefinancialstrengthandsolvencyofthecompanyas showninthestatementoffinancialposition.thelargestandmost sophisticatedgroupsofinvestorsaretheinstitutionalinvestors,such aspensionfundsandunittrusts. Employeesandtradeunionrepresentativesneedtoknowifan employercanoffersecureemploymentandpossiblepayrises.they willalsohaveakeeninterestinthesalariesandbenefitsenjoyedby seniormanagement.informationaboutdivisionalprofitabilitywill alsobeusefulifapartofthebusinessisthreatenedwithclosure. Lendersneedtoknowiftheywillberepaid.Thiswilldependonthe solvencyofthecompany,whichshouldberevealedbythestatement offinancialposition.long termloansmayalsobebackedby security givenbythebusinessoverspecificassets.thevalueof theseassetswillbeindicatedinthestatementoffinancialposition. Governmentagenciesneedtoknowhowtheeconomyis performinginordertoplanfinancialandindustrialpolicies.thetax authoritiesalsousefinancialstatementsasabasisforassessing theamountoftaxpayablebyabusiness. Suppliersneedtoknowiftheywillbepaid.Newsuppliersmayalso requirereassuranceaboutthefinancialhealthofabusinessbefore agreeingtosupplygoods. Customersneedtoknowthatacompanycancontinuetosupply themintothefuture.thisisespeciallytrueifthecustomeris dependentonacompanyforspecialisedsupplies. Competitorswishtocomparetheirownperformanceagainstthat ofothercompaniesandlearnasmuchaspossibleabouttheirrivals inordertohelpdevelopstrategicplans. KAPLANPUBLISHING 7

16 Introductiontoaccounting Thepublicmaywishtoassesstheeffectofthecompanyonthe economy,localenvironmentandlocalcommunity.companiesmay contributetotheirlocaleconomyandcommunitythroughproviding employmentandpatronisinglocalsuppliers.somecompaniesalso runcorporateresponsibilityprogrammesthroughwhichtheysupport theenvironment,economyandcommunityby,forexample supportingrecyclingschemes. 8 KAPLANPUBLISHING

17 chapter 2 Statement of financial position and income statement Chapter learning objectives Upon completion of this chapter you will be able to: explain the main elements of financial statements: statement of financial position income statement explain the purpose of each of the main statements list the main types of business transactions explain how the accounting equation and business entity convention underpin the statement of financial position define assets and liabilities identify examples of receivables and payables explain how and why assets and liabilities are disclosed in the statement of financial position. draft a simple statement of financial position in vertical format explain the matching convention and how it applies to revenue and expenses explain how and why revenue and expenses are disclosed in the income statement illustrate how the statement of financial position and income statement are interrelated draft a simple income statement in vertical format 9

18 Statement of financial position and income statement identify the two sides of each transaction (duality concept) determine the accounting equation after each transaction. 10 KAPLAN PUBLISHING

19 chapter2 1Financial statements Therearetwoelementstothefinancialstatements: Statement of financial position,showingthefinancialpositionofa businessatapointintime,and Income statement,showingthefinancialperformanceofabusiness overaperiodoftime. Thefinancialstatementsshowtheeffectsofbusinesstransactions.The maintypesare: salesofgoods(eitherforcashoroncredit) purchaseofinventoryforresale(eitherforcashoroncredit) purchaseofnon currentassets paymentofexpensessuchasutilities introductionofnewcapitaltothebusiness withdrawaloffundsfromthebusinessbytheowner. The business entity concept Thebusinessentityconceptstatesthatfinancialaccountinginformation relatesonlytotheactivitiesofthebusinessentityandnottothe activitiesofitsowner. Thebusinessentityistreatedasseparatefromitsowners. Expandable text KAPLANPUBLISHING 11

20 Statementoffinancialpositionandincomestatement 2Statement of financial position Theverticalformatofthestatementoffinancialpositionisshownbelow: W ang Statement of financial position as at 31 December 206 Non currentassets: Motorvan Currentassets: Inventory Receivables Cashatbank Cashinhand Capitalaccount: Balanceat1January206 Add:Netprofitforyear Increaseincapital Less:Drawingsforyear Non currentliabilities: Currentliabilities: Payables 2,400 2,390 1,840 1, ,990 8,390 4,200 3,450 1,000 8,650 (2,960) 5,690 1,000 1,700 8,930 Thetophalfofthestatementoffinancialpositionshowstheassetsof thebusiness. Thebottomhalfofthestatementoffinancialpositionshowsthecapital andliabilitiesofthebusiness. The accounting equation ThestatementoffinancialpositionaboveshowsthepositionofWang s businessatonepointintime inthiscaseatcloseofbusinesson31 December206.Astatementoffinancialpositionwillalwayssatisfythe accountingequationasfollows: 12 KAPLANPUBLISHING

21 chapter2 Assets and liabilities Anassetissomethingthebusinessownsorcontrolssuchas: inventory,e.g.goodsmanufacturedorpurchasedforresale receivables,e.g.moneyowedbycreditcustomers,prepaidexpenses cash non currentassets andisavailableforuseinthebusiness. Aliabilityissomethingowedbythebusinesstosomeoneelse,suchas: payables,e.g.amountsowedtocreditsuppliers,accruedexpenses loans. Capitalisatypeofliability.Thisistheamountthatisduetotheowner(s)of thebusiness.itwillincreaseeachyearbyanynewcapitalinjectedintothe businessandbytheprofitmadebythebusiness.itwilldecreasebyany amountswithdrawnfromthebusinessbytheowner(s). Disclosure of assets and liabilities in the statement of financial position KAPLANPUBLISHING 13

22 Statementoffinancialpositionandincomestatement Test your understanding 1 Classifythefollowingitemsintocurrentandnon currentassetsand liabilities: landandbuildings receivables cash loanrepayableintwoyears time payables deliveryvan. Test your understanding 2 Listthefollowingitemsshowingtheleastliquiditemsfirst: 14 cashinhand inventoryoffinishedgoods cashatbank KAPLANPUBLISHING

23 chapter2 receivables inventoryofrawmaterials. 3Income statement Theformatoftheincomestatementisshownbelow: Mr W ang Income statement for the year ended 31 December 206 Salesrevenue Costofsales Openinginventory Purchases Less:Closinginventory Grossprofit Wages Rent Sundryexpenses Netprofit 33,700 3,200 24,490 27,690 (2,390) (25,300) 8,400 3,385 1, (4,950) 3,450 Theincomestatementshowstheperformanceofthebusinessovera periodoftime,inthiscaseforafullyear. Theincomestatementispreparedfollowingtheaccrualsconcept.This meansthatincomeandexpensesarerecordedintheincome statementastheyareearned/incurredregardlessofwhethercashhas beenreceived/paid. Thesalesrevenueshowstheincomefromgoodssoldintheyear, regardlessofwhetherthosegoodshavebeenpaidfor. Thecostofbuyingthegoodssoldmustbedeductedfromtherevenue. Itisimportantthatthecostofanygoodsremainingunsoldisnot includedhere. KAPLANPUBLISHING 15

24 Statementoffinancialpositionandincomestatement Thecurrentyear ssaleswillincludegoodsboughtinthepreviousyear, sothisopening inventorymustbeaddedtothecurrentyear s purchases. Someofthisyear spurchaseswillbeunsoldat31december206 andthisclosing inventorymustbedeductedfrompurchasestobe setoffagainstnextyear ssales. Theincomestatementissplitintotwoparts,thefirstpartgivesgross profitandthesecondpart,netprofit. Grossprofitdividedbysalesrevenuegivesthegross profit margin ratiowhichillustratestheprofitabilityofthebusinessatatradinglevel. Expandable text 4Relationship between the statement of financial position and income statement Thelinkbetweenthestatementoffinancialpositionandincomestatement isshownbelow: 16 Thestatementoffinancialpositionarenotisolatedstatements theyare linkedovertimewiththeincomestatement. Asthebusinessrecordsaprofitintheincomestatement,thatprofitis addedtothecapitalsectionofthestatementoffinancialposition,along withanycapitalintroduced.cashtakenoutofthebusinessbythe proprietor,calleddrawings,isdeducted. KAPLANPUBLISHING

25 chapter2 5The accounting equation Theaccountingequationisasimpleexpressionofthefactthatatany pointintimetheassetsofthebusinesswillbeequaltoitsliabilitiesplus thecapitalofthebusiness. Itfollowsthatassetslessliabilitiesequalthecapitalofthebusiness. Assetslessliabilitiesareknownasnetassets. Eachandeverytransactionthatthebusinessmakesorentersintohas twoaspectstoitandhasadoubleeffectonthebusinessandthe accountingequation.thisisknownasthedualityconcept. Illustration 1 The accounting equation Thisillustrationinvolvesaseriesoftransactionsusingthedualeffectof transactionsandthentheaccountingequationtobuildupasetof financialstatements.thetransactionsareasfollows: Day1Avoncommencesbusinessintroducing1,000cash. Day2Buysamotorcarfor400cash. Day3Buysinventoryfor200cash. Day4SellsallthegoodsboughtonDay3for300cash. Day5Buysinventoryfor400oncredit. Usingtheaccountingequation,wewilldrawupastatementoffinancial positionattheendofeachday stransactions. Expandable text Test your understanding 3 Continuingfromtheillustrationabove,preparethestatementoffinancial positionattheendofeachdayafteraccountingforthetransactions below: Day6SellshalfofthegoodsboughtonDay5oncreditfor250. KAPLANPUBLISHING 17

26 Statementoffinancialpositionandincomestatement Day7Pays200tohissupplier. Day8Receives100fromacustomer. Day9Proprietordraws75incash. Day10Paysrentof40incash. Day11Receivesaloanof600repayableintwoyears. Day12Payscashof30forinsurance. YourstartingpointisthestatementoffinancialpositionattheendofDay 5,fromtheillustrationabove. Onceyouhavedealtwitheachofthetransactions,prepareastatement of financial positionattheendofday12andanincome statement forthefirst12daysoftrading. 18 KAPLANPUBLISHING

27 chapter2 Chapter summary KAPLANPUBLISHING 19

28 Statementoffinancialpositionandincomestatement Test your understanding answers Test your understanding 1 Landandbuildings non current asset. Receivables current asset. Cash current asset. Loanrepayableintwoyearstime non current liability. Payables current liability. Deliveryvan non current asset. Test your understanding 2 Thecorrectorderis: inventoryofrawmaterials inventoryoffinishedgoods receivables cashatbank cashinhand. 20 KAPLANPUBLISHING

29 chapter2 Test your understanding 3 Day 6: Sells half of the goods bought on Day 5 on credit for 250 Thistransactionintroducestwonewconcepts: Sale on credit.essentiallythisisthesameasasaleforcash, exceptthattheassetincreasedisnotcash,butreceivables. Saleofpartoftheinventory.Inpracticethisisthenormalsituation. Theimportantaccountingrequirementistoseparate: inventorystillheldasanasset,from costofinventorysold. Statement of financial position for Day 6 Assets Capital and liabilities Motorcar 400 Capitalintroduced Inventory 200 Add:Profittodate Receivables 250 (100+50) Cash 700 1, ,150 Payables 400 1,550 1,550 Day 7: Pays 200 to his supplier Thedualeffectofthistransactionis: (a) Thebusinesshaspaidout200incash. (b) Thebusinesshasreducedthepayable(liability)by200. Thisissimplythereductionofoneliability(payables)andoneasset (cash)byacorrespondingamount(200). KAPLANPUBLISHING 21

30 Statementoffinancialpositionandincomestatement Statement of financial position for Day 7 Assets Capital and liabilities Motorcar 400 Capital Inventory 200 Add:Profittodate Receivables 250 Cash( ) 500 1, ,150 Payables ( ) 200 1,350 1,350 Day 8: Receives 100 from a customer Thedualeffectofthistransactionis: (a) Thebusinesshasreceived100incash. (b) Thereceivablesofthebusinesshavereducedby100. Statement of financial position for Day 8 Assets Capitaland liabilities Motorcar 400 Capital Inventory 200 Add:Profittodate Receivables 22 1, ( ) 150 1,150 Cash( ) 600 Payables 200 1,350 1,350 KAPLANPUBLISHING

31 chapter2 Day 9: Proprietor draws 75 in cash Thisshowsonthestatementoffinancialpositionasareductionof capital,andasareductionofcash. Cashorotherassetstakenoutofthebusinessbytheownerarecalled amountswithdrawn,or drawings. Thedualeffectofthistransactionis: (a) Thebusinesshasreducedcashby75. (b) Thebusinesshasadrawingsbalanceof75whichreducescapital. Statement of financial position for Day 9 Assets Capital and liabilities Motorcar 400 Capital Inventory 200 Add:Profittodate Receivables 150 Cash(600 75) 525 1,150 Less:Drawings 1,075 Payables 1, (75) 200 1,275 1,275 KAPLANPUBLISHING 23

32 Statementoffinancialpositionandincomestatement Day 10: Pays rent of 40 Thisisanexampleofabusinessexpense. Thedualeffectofthistransactionis: (a) Thebusinesspaysout40incash. (b) Thebusinesshasarentexpenseof40whichreducesprofit. Statement of financial position for Day 10 Assets Capital and liabilities Motorcar 400 Capital Inventory 200 Add:Profittodate Receivables 150 (150 40) Cash(525 40) 485 1,110 Less:Drawings Payables 24 1, (75) 1, ,235 1,235 KAPLANPUBLISHING

33 chapter2 Day 11: Receives a loan of 600 repayable in two years time Thedualeffectofthistransactionis: (a) Thebusinessreceives600incash. (b) Thebusinesshasaliabilityof600. Statement of financial position for Day 11 Assets Capital and liabilities Motorcar 400 Capitalintroduced 1,000 Inventory 200 Add:Profittodate 110 Receivables 150 Cash( ) 1,085 1,110 Less:Drawings 1,035 Loan 600 Payables 200 (75) 1,835 1,835 Day 12: Pays cash of 30 for insurance Thedualeffectofthistransactionis: (a) thebusinesspaysout30incash (b) thebusinesshasaninsuranceexpenseof30whichreducesprofit. KAPLANPUBLISHING 25

34 Statementoffinancialpositionandincomestatement Statement of financial position for Day 12 Assets Capital and liabilities Motorcar 400 Capitalintroduced Inventory 200 Add:Profittodate Receivables 150 (110 30) Cash(1,085 30) 1, ,055 1,805 Less:Drawings (75) 1,005 Loan 600 Payables 200 1,805 1,805 Thismarkstheendofthetransactions.Thefinancialstatementsforthe 12dayperiodcannowbeconsidered. Avon, income statement for the 12 days Salesrevenue: Cash Credit Costofsales: Purchases: Less:Closinginventory Cash Credit (200) Costofgoodssold Grossprofit Rent Insurance Netprofit 26 (400) (70) 80 KAPLANPUBLISHING

35 chapter2 Avon, statement of financial position as at end of Day 12 Non currentasset: Motorcar(atcost) 400 Currentassets: Inventory Receivables 150 Cash 1, ,405 1,805 1,000 Capitalaccount: Capitalintroduced Costofgoodssold Netprofit 80 1,080 Less:Drawings (75) 1,005 Non currentliability: Loan 600 Currentliabilities: Payables 200 1,805 KAPLANPUBLISHING 27

36 Statement of financial position and income statement 28 KAPLAN PUBLISHING

37 chapter 3 Double entry bookkeeping Chapter learning objectives Upon completion of this chapter you will be able to: explain the concept of double entry and the duality concept explain the debit and credit principle explain the meaning of the balance on each type of account record cash transactions in ledger accounts record credit sale and purchase transactions in ledger accounts illustrate how to account for discounts explain sales and purchase returns and demonstrate their recording illustrate how to balance a ledger account extract the ledger balances into a trial balance identify the purpose of a trial balance prepare a simple income statement and statement of financial position from a trial balance explain and illustrate the process of closing the ledger accounts in the accounting records when the financial statements have been completed. 29

38 Doubleentrybookkeeping 1The duality concept and double entry bookkeeping Eachtransactionthatabusinessentersintoaffectsthefinancial statementsintwoways,e.g. Abusinessbuysanon currentassetforcash. Thetwoeffectsonthefinancialstatementsare: (1) Thereisanincreaseinnon currentassets. (2) Thereisadecreaseincash. Tofollowtherulesofdoubleentrybookkeeping,eachtimeatransaction isrecorded,botheffectsmustbetakenintoaccount. Thesetwoeffectsareequalandoppositesuchthattheaccounting equationwillalwaysprovecorrect: 30 Traditionally,oneeffectisreferredtoasthedebitside(abbreviatedto Dr)andtheotherasthecreditsideoftheentry(abbreviatedtoCr). KAPLANPUBLISHING

39 chapter3 2Ledger accounts, debits and credits Transactionsarerecordedintherelevantledgeraccounts.Thereisa ledgeraccountforeachasset,liability,revenueandexpenseitem. Eachaccounthastwosides thedebitandcreditsides: Debit Credit (Dr) (Cr) Nameof accounte.g. cash,sales Date Narrative DateNarrative Thedualityconceptmeansthateachtransactionwillaffecttwoledger accounts. Oneaccountwillbedebitedandtheothercredited. Whetheranentryistothedebitorcreditsideofanaccountdependson thetypeofaccountandthetransaction: Debit Credit Increasein:Expense(Incomestatement) Asset(Statementoffinancialposition) Increasein:Liability (Statementoffinancial position) Income(Incomestatement) Drawings(Statementoffinancialposition) Capital(Statementoffinancial position) Summary of steps to record a transaction (1) Identifythetwoitemsthatareaffected. (2) Considerwhethertheyarebeingincreasedordecreased. (3) Decidewhethereachaccountshouldbedebitedorcredited. (4) Checkthatadebitentryandacreditentryhavebeenmadeandthey arebothforthesameamount. Recording cash transactions Cashtransactionsarethosewherepaymentismadeorreceived immediately. Chequepaymentsorreceiptsareclassedascashtransactions KAPLANPUBLISHING 31

40 Doubleentrybookkeeping Doubleentryinvolvesthebankledger: adebitentryiswherefundsarereceived acreditentryiswherefundsarepaidout. Test your understanding 1 Recording cash transactions Showthefollowingtransactionsinledgeraccounts:(Tip:theledger accountsyouneedarebank,rent,drawings,andsales) (1) Kamranpays80forrentbycheque. (2) Kamransellsgoodsfor230cashwhichhebanks. (3) Hethentakes70outofthebusinessforhispersonalliving expenses. (4) Kamransellsmoregoodsforcash,receiving3,400. Test your understanding 2 Yusufentersintothefollowingtransactionsinhisfirstmonthoftrading: (1) Buysgoodsforcashfor380. (2) Pays20insundryexpenses. (3) Makes1,000insales. (4) Receivesabankloanof5,000. (5) Pays2,600forfixturesandfittings. WhatisthetotalentrytothecreditsideofthecashTaccount? A 6,000 B 6,380 C 3,000 D 2,620 Recording credit sales and purchases Creditsalesandpurchasesaretransactionswheregoodsorservices changehandsimmediately,butpaymentisnotmadeorreceiveduntilsome timeinthefuture. 32 KAPLANPUBLISHING

41 chapter3 Moneythatabusinessisowedisaccountedforinthereceivablesledger. Moneythatabusinessowesisaccountedforinthepayablesledger. Test your understanding 3 NorrisnotesdownthefollowingtransactionsthathappenedinJune. (1) Sellgoodsforcashfor60. (2) Payinsurancepremiumbycheque 400. (3) Sellgoodsfor250 thecustomerwillpayinamonth. (4) Pay50petrolforthedeliveryvan. (5) Buy170goodsforresaleoncredit. (6) Take57outofthebusinessforlivingexpenses. (7) Buyanother40goodsforresale,payingcash. (8) Buyanewcomputerforthebusinessfor800. Recordthesetransactionsusingledgeraccounts Test your understanding 4 Foreachofthefollowingindividualtransactionsstatethetwoledger accountsaffected,andwhethertheledgeraccountshouldbedebitedor credited: (1) Olepurchasesgoodsfor5,000,andpaysbycheque. (2) Olemakesasaletoacustomerfor500.Thecustomerpaysin30 days time. (3) Olepaysatelephonebillamountingto40,andpaysbycheque. (4) Olereceivesbankinterestincomeof150. (5) Olepurchasesstationeryfor12andpayscash. (6) Olemakesasaletoacustomerfor400.Thecustomerpayscash. 3Recording sales and purchases returns Itisnormalforcustomerstoreturnunwantedgoodstoabusiness equallythebusinesswilloccasionallyhavecausetoreturnunwanted goodstotheirsupplier. KAPLANPUBLISHING 33

42 Doubleentrybookkeeping Thedoubleentriesarisingwilldependuponwhetherthereturnedgoods wereinitiallypurchasedoncredit: Originally a Originally a credit transaction cash transaction Sales returns DrSalesreturns DrSalesreturns (returns inwards) CrCash CrReceivables Purchases returns DrCash DrPayables (returns outwards) CrPurchases CrPurchases returns returns Test your understanding 5 Foreachofthefollowing,statethedoubleentryrequiredtorecordthe transactionintheaccounts: (1) Alfieinvests10,000ofhislifesavingsintohisbusinessbank account. (2) HethenbuysgoodsfromIsabel,asupplierfor1,000andpaysby cheque. (3) Asaleismadefor400 thecustomerpaysbycheque. (4) Alfiemakesasalefor600andthecustomerpromisestopayin thefuture. (5) Alfiethenbuysgoodsfromhissupplier,Kamen,for500oncredit. (6) Alifepaysatelephonebillof150bycheque. (7) Thecreditcustomerpaysthebalanceonheraccount. (8) AlfiepaysKamen340. (9) Bankinterestof30isreceived. (10) Acashcustomerreturned20goodstoAlfieforarefund. (11) Alfiesentgoodsof100backtoKamen. 4Accounting for discounts Discountsmaybegiveninthecaseofcredittransactionsforprompt payment: 34 Abusinessmaygiveitscustomeradiscount knownas Discountallowed. Abusinessmayreceiveadiscountfromasupplier knownas Discount received. KAPLANPUBLISHING

43 chapter3 Thecorrectdoubleentriesare: Discount allowed DrDiscountallowed(expense) CrReceivables Theexpenseisshownbeneathgrossprofitintheincomestatement, alongsideotherexpensesofthebusiness. Discount received DrPayables CrDiscountreceived(income) Theincomeisshownbeneathgrossprofitintheincomestatement. Test your understanding 6 Georgeowesasupplier,Herbie,2,000andisowed3,400bya customer,iris.georgeoffersacashdiscounttohiscustomersof2.5%if theypaywithin14daysandherbiehasofferedgeorgeacashdiscount of3%forpaymentwithintendays. GeorgepaysHerbiewithintendaysandIristakesadvantageofthecash discountofferedtoher. Whatledgerentriesarerequiredtorecordthesediscounts? A Dr Cr B Dr Cr C Dr Cr D Dr Cr Payables Discountreceived Discountallowed Receivables Payables Discountreceived Discountallowed Receivables Dr Cr Dr Cr Dr Cr Dr Cr Discountallowed Receivables Payables Discountreceived Discountallowed Receivables Payables Discountreceived Balancing off a statement of financial position ledger account Oncethetransactionsforaperiodhavebeenrecorded,itwillbenecessary tofindthebalanceontheledgeraccount: (1) TotalbothsidesoftheTaccountandfindthelargertotal. (2) Putthelargertotalinthetotalboxonthedebitandcreditside. KAPLANPUBLISHING 35

44 Doubleentrybookkeeping (3) InsertabalancingfiguretothesideoftheTaccountwhichdoesnot currentlyadduptotheamountinthetotalbox.callthisbalancingfigure balancec/f (carriedforward)or balancec/d (carrieddown). (4) Carrythebalancedowndiagonallyandcallit balanceb/f (brought forward)or balanceb/d (broughtdown). Test your understanding 7 Balanceoffthefollowingaccount: Cash Capital Sales 10,000 Purchases 250 Rent Electricity Test your understanding 8 Balanceoffthefollowingaccount: Bank Capital Sales 10,000 Purchases 300 Rent Electricity Newvan 1,000 2, , The trial balance Onceallledgeraccountshavebeenbalancedoffatrialbalanceis prepared. Atrialbalanceisalistofthe balanceb/f ontheledgeraccounts accordingtowhethertheyareonthedebitorcreditside.trialbalance asat31december2005 KAPLANPUBLISHING

45 chapter3 Trial balance as at 31 December 2005 Dr Nameofaccount Sales Purchases Receivables Payables Capital What does the trial balance prove? Cr Thetrialbalancewillbalanceifforeverydebitentrymade,anequalcredit entrywasmadeandthebalanceswerecorrectlyextractedandcast(added up!). Thepurposeofatrialbalanceis: asafirststepinpreparingthefinancialstatements. tocheckthatforeverydebitentrymade,anequalcreditentryhasbeen made. Notethatanumberofadjustmentswillbemadeafterthetrialbalanceis extracted.theseadjustmentsdonotthereforeappearinthetrialbalance. 7Closing off the ledger accounts Attheyearend,theledgeraccountsmustbeclosedoffinpreparationfor therecordingoftransactionsinthenextaccountingperiod. Statement of financial position ledger accounts Assets/liabilitiesattheendofaperiod=Assets/liabilitiesatstartofthe nextperiod,e.g.thecashatbankattheendofonedaywillbethecash atbankatthestartofthefollowingday. Balancingtheaccountwillresultin: abalancec/f(beingtheasset/liabilityattheendoftheaccounting period) KAPLANPUBLISHING abalanceb/f(beingtheasset/liabilityatthestartofthenext accountingperiod). 37

46 Doubleentrybookkeeping 7.2 Income statement ledger accounts Attheendofaperiodanyamountsthatrelatetothatperiodare transferredoutoftheincomeandexpenditureaccountsintoanother ledgeraccountcalledtheincomestatement. Thisisdonebyclosingtheaccount. Donotshowabalancec/forbalanceb/fbutinsteadputthebalancing figureonthesmallestsideandlabelit incomestatement. Capital account Atthestartofthenextaccountingperiodthecapitalaccountwillhavean openingbalance,i.e.abalanceb/fequaltotheamountthatisowedto theowneratthestartofthatperiod. Thisamountisequaltowhatwasowedtotheowneratthestartofthe previousperiod,plusanycapitalthattheownerintroducedinthe period,plusanyprofitsearnedintheperiodlessanydrawingstaken outintheperiod. Thereforewetransferthebalanceontheincomestatementandthe balanceonthedrawingsaccounttothecapitalaccountattheendofthe periodsothatitwillhavethecorrectopeningbalanceatthestartofthe next. Capital Balanceb/f Lossforyear Profitforyear Drawings Cashinjections Balancec/f Balanceb/f Test your understanding 9 Oddjobhad7,800capitalinvestedinhisbusinessatthestartofthe year.duringthecourseoftheyearhetook3,100cashoutofthe businessandalsopaidhiswife,whodidsomesecretarialworkforhim, 500.Thebusiness profitfortheyearwas8,900.oddjobalsopaid 350foranewsuitusingthebusinesschequebookduringtheyear. 38 KAPLANPUBLISHING

47 chapter3 Whatisthebalanceonthecapitalaccountattheendoftheyear? A 12,750 B 13,250 C 13,600 D 13,100 8Opening balances in the ledger accounts Ifabusinesshasbeeninoperationinthepreviousyear,thenatthe beginningofanyaccountingperioditwillhaveassetsandliabilities suchascashandnon currentassets. Anyopeningamountsareshowninstatementoffinancialposition ledgeraccountsasopeningbalances. Theopeningbalanceonanassetaccountisadebitentry. Theopeningbalanceonaliabilityaccountisacreditentry. Transactionsduringtheyeararethenenteredasnormalintheledger account,andattheyearenditisbalancedofftakingintoaccountthe openingbalance. Note:Incomestatementledgeraccountsdonothaveanopeningbalance. Test your understanding 10 Johnnyhadreceivablesof4,500atthestartof205.Duringtheyearto 31December205hemakescreditsalesof45,000andreceives cashof46,500fromcreditcustomers. Whatisthebalanceonthereceivablesaccountat31December205? A 6,000Dr B 6,000Cr C 3,000Dr D 3,000Cr KAPLANPUBLISHING 39

48 Doubleentrybookkeeping 9Preparation of financial statements Theprocessseenthusfarisasfollows: Examinationquestionsmaydrawonanyparticularstageofthisprocess. Test your understanding 11 Matthewsetupabusinessandinthefirstninedaysoftradingthe followingtransactionsoccurred: (1)January Matthew (2)January Matthew (3)January Matthew (4)January Matthew (5)January Matthew (6)January Matthew (7)January Matthew (8)January Matthew (9)January Matthew 40 introduces10,000capitalbycheque. buyssuppliesworth4,000andpaysbycheque. buysadeliveryvanfor2,000andpaysbycheque. buys1,000ofpurchasesoncredit. sellsgoodsfor1,500andreceivesachequeofthat amount. sellsallhisremaininggoodsfor5,000oncredit. pays800tohissupplierbycheque. paysrentof200bycheque. draws100forlivingexpensesfromthebusiness bankaccount. KAPLANPUBLISHING

49 chapter 3 Required: (a) Complete the relevant ledger accounts. (b) Extract a trial balance. (c) Prepare the income statement for the first nine days. (d) Prepare the Statement of financial position as at 9 January. KAPLAN PUBLISHING 41

50 Doubleentrybookkeeping Chapter summary 42 KAPLANPUBLISHING

51 chapter3 Test your understanding answers Test your understanding 1 Bank Sales(2) 230 Rent(1) Sales(4) 80 3,400 Drawings(3) Sales 70 Bank(2) 230 Bank(4) 3,400 Rent 80 Bank(1) Drawings Bank(3) 70 Test your understanding 2 The correct answer is C Cash Sales 1,000 Purchases 380 Loan 5,000 Sundry expenses 20 Fixturesand fittings 2,600 KAPLANPUBLISHING 43

52 Doubleentrybookkeeping Test your understanding 3 Bank Sales(1) 60 Insurance(2) 400 Motorexpenses (4) 50 Drawings(6) 57 Purchases(7) 40 Non current assets(8) Sales Bank(1) Receivables(3) Insurance (expense) Bank(2) 400 Receivables Sales(3) 250 Motor expenses Bank(4) 50 Purchases Payables(5) 170 Cash(7) 40 Payables 44 Purchases(5) 170 KAPLANPUBLISHING

53 chapter3 Drawings Bank(6) 57 Non current asset (computer) Bank(8) 800 Test your understanding Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr Purchases Bank Receivables Sales Telephoneexpense Bank Bank Interestincome Stationeryexpense Cash Cash Sales 5,000 5, KAPLANPUBLISHING 45

54 Doubleentrybookkeeping Test your understanding Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr Bank Capital Purchases Bank Bank Sales Receivables Sales Purchases Payables Telephoneexpense Bank Bank Receivables Payables Bank Bank Interestincome Salesreturns Bank Payables Purchasesreturns 10,000 10,000 1,000 1, KAPLANPUBLISHING

55 chapter3 Test your understanding 6 ThecorrectanswerisA Payables Cash(97%x 2,000) 1,940 Balanceb/f Discount received 2, ,000 2,000 Receivables Balanceb/f 3,400 Cash(97.5%x 3,400) 3,315 Discountallowed 85 3,400 3,400 Discount received Payables Discount allowed Receivables KAPLANPUBLISHING 47

56 Doubleentrybookkeeping Test your understanding 7 Cash Capital 10,000 Purchases Sales Rent Electricity Balancec/f ,825 10,250 10,250 Balanceb/f 9,825 Test your understanding 8 Bank Capital 10,000 Purchases Sales 300 Rent Balancec/f Electricity 8,950 Newvan 1,000 2, ,000 19,250 19,250 Balanceb/f 8, KAPLANPUBLISHING

57 chapter3 Test your understanding 9 The correct answer is B. Capital Drawings 3,100 Balanceb/f Drawings(suit) 7, Profitfortheyear Balancec/f 8,900 13,250 16,700 16,700 Balanceb/f 13,250 Test your understanding 10 The correct answer is C. Receivables Balanceb/f 4,500 Sales 45,000 Cashreceived Balancec/f 46,500 3,000 49,500 49,500 Balanceb/f 3,000 KAPLANPUBLISHING 49

58 Doubleentrybookkeeping Test your understanding 11 Bank (a)1jan Capital 5Jan Sales 10,000 2Jan Purchases 4,000 1,500 3Jan Deliveryvan 2,000 7Jan Payables 800 8Jan Rent 200 9Jan Drawings Balance c/f Balanceb/f 11,500 4, ,400 Capital Balancec/f 10,000 1Jan Bank 10,000 10,000 10,000 Balanceb/f Purchases 2Jan Bank 4Jan Payables 4,000 1,000 5,000 Balanceb/f 50 2Jan Balancec/f 5,000 5,000 5,000 KAPLANPUBLISHING

59 chapter3 Delivery van 3Jan Bank Balanceb/f 2,000 Balance c/f 5,000 2,000 5,000 2,000 Payables 7Jan 800 Bank 4Jan Purchases 1, Balancec/f 1,000 1,000 Balanceb/f 2,00 Sales Bank 1,500 Balance c/f 6,500 5Jan 6Jan Receivables 6,500 6,500 Balance b/f 6,500 5,000 Receivables 7Jan Sales Balanceb/f 5,000 Balancec/f 5,000 5,000 5,000 5,000 Rent 8Jan Bank Balanceb/f KAPLANPUBLISHING 200 Balancec/f

60 Doubleentrybookkeeping Drawings 9Jan Bank Balanceb/f 100 Balancec/f Trial balance as at 9 January Dr 4,400 Cr Bank Capital 10,000 Purchases 5,000 Deliveryvan 2,000 Payables 200 Sales 6,500 Receivables 5,000 Rent 200 Drawings 100 Income statement for the period ended 9 January Sales 6,500 Openinginventory Purchases 5000 Closinginventory 5,000 Grossprofit 1,500 Expenses Rent 200 1,300 Netprofit 52 KAPLANPUBLISHING

61 chapter3 Statement of financial positionas at 9 January Noncurrentassets Deliveryvan Currentassets Inventory Receivables 5,000 Bank 4,400 Capital Profit Drawings Currentliabilities Payables 2,000 9,400 11,400 10,000 1,300 (100) 11, ,400 KAPLANPUBLISHING 53

62 Double entry bookkeeping 54 KAPLAN PUBLISHING

63 chapter 4 Inventory Chapter learning objectives Upon completion of this chapter you will be able to: explain the need for adjustments for inventory in preparing financial statements illustrate income statements with opening and closing inventory explain and demonstrate how opening and closing inventory are recorded in the inventory account explain the IAS 2 requirements regarding the valuation of closing inventory define the cost and net realisable value of closing inventory discuss alternative methods of valuing inventory explain and demonstrate how to calculate the value of closing inventory from given movements in inventory levels, using FIFO (first in first out) and AVCO (average cost) assess the effect of using either FIFO or AVCO on both profit and asset value explain the IASB requirements for inventories explain the use of continuous and period end inventory records. 55

64 Inventory 1Adjustments for inventory in the financial statements Inordertobeabletoprepareasetoffinancialstatements,inventory mustbeaccountedforattheendoftheperiod. Openinginventorymustbeincludedincostofsalesasthesegoodsare availableforsalealongwithpurchasesduringtheyear. Closinginventorymustbedeductedfromcostofsalesasthesegoods areheldattheperiodendandhavenotbeensold. Expandable text Illustration 1 Adjustments for inventory Peterbuysandsellswashingmachines.Hehasbeentradingformany years.on1january207,hisopeninginventoryis30washing machineswhichcost9,500.hepurchased65machinesintheyear amountingto150,000andon31december207hehas25washing machinesleftininventorywithacostof7,500.peterhassold70 machineswithasalesvalueof215,000intheyear. Calculatethegrossprofitfortheyearended31December Expandable text KAPLANPUBLISHING

65 chapter4 2Recording inventory in the ledger accounts Inventoryisonlyrecordedintheledgeraccountsattheendofthe accountingperiod. Intheinventoryledgeraccounttheopeninginventorywillbethebrought forwardbalancefromthepreviousperiod.thismustbetransferredto theincomestatementledgeraccountwiththefollowingentry: DrIncomestatement(Ledgeraccount) CrInventory(Ledgeraccount). Theclosinginventoryisenteredintotheledgeraccountswiththe followingentry: DrInventory(Ledgeraccount) CrIncomestatement(Ledgeraccount). Oncetheseentrieshavebeencompleted,theincomestatementledger accountcontainsbothopeningandclosinginventoryandtheinventory ledgeraccountshowstheclosinginventoryfortheperiodtobeshownin thestatementoffinancialposition. Illustration 2 Recording inventory in the ledger accounts ContinuingfrompreviousIllustration,wewillnowseehowtheledger accountsforinventoryareprepared. Wewilllookattheledgeraccountsatthefollowingtimes: (a) Immediatelybeforeextractingatrialbalanceat31December207. (b) Immediatelyaftertheyear endadjustmentsandclosingoffofthe ledgeraccounts. (a)ledger accounts before extracting a trial balance Inventory 207 1JanBalanceb/f 9,500 KAPLANPUBLISHING 57

66 Inventory Theinventoryisanassetandthereforeisadebitentryintheinventory account. Purchases 207 Varioussuppliers 150,000 Sales revenue 207 Variouscustomers 215,000 Thebalanceof9,500ininventoryaccountoriginatedfromlast year sstatementoffinancialpositionwhenitappearedasclosing inventory.thisfigureremainsunchangedintheinventoryaccount untiltheveryendoftheyearwhenclosinginventoryat31december 207isconsidered. Theclosinginventoryfigureisnotusuallyprovidedtousuntilafter wehaveextractedthetrialbalanceat31december207. Thepurchasesandsalesfigureshavebeenbuiltupovertheyear andrepresenttheyear saccumulatedtransactions. Thetrialbalancewillincludeopeninginventory,purchasesandsales revenueinrespectoftheinventorytransactions. (b) Ledger accounts reflecting the closing inventory Closinginventoryforaccountingpurposeshasbeenvaluedat 7,500. Step 1 Theincomestatementformspartofthedoubleentry.Attheyearendthe accumulatedtotalsfromthesalesandpurchasesaccountsmustbe transferredtoitusingthefollowingjournalentries: DrSalesrevenue CrIncomestatement DrIncomestatement CrPurchases 215, , , ,000 Thesetransfersareshownintheledgeraccountsbelow. Step 2 Theopeninginventoryfigure(9,500)mustalsobetransferredtothe incomestatementaccountinordertoarriveatcostofsales. DrIncomestatement9,500CrInventory9, KAPLANPUBLISHING

67 chapter4 Step 3 Theincomestatementcannotbecompleted(andhencegrossprofit calculated)untiltheclosinginventoryisincluded. DrInventory7,500CrIncomestatement7,500 Aftersummarisingandbalancingoff,theledgerthenbecomes: Inventory 207 1JanBalanceb/f 9,500 31DecIncomestatement 31DecIncomestatement 7,500 17,000 17,000 7,500 Purchases Dec 150,000 Incomestatement Sales revenue Dec Incomestatement 215,000 Receivables KAPLANPUBLISHING 9,500 1JanBalanceb/f 7,500 31DecBalancec/f Variousdates Payables ,000 Variousdates 215,000 59

68 Inventory Income statement ( T account form) Dec Purchases 150,000 Salesrevenue Inventory 31Dec 9,500 Inventory Grossprofitc/f 215,000 7,500 63, , ,500 Grossprofitb/f 63,000 Expandable text Expandable text Test your understanding 1 Thetradingpositionofasimplecash basedbusinessforitsfirstweekof tradingwasasfollows: Capitalintroducedbytheowner Purchasesforcash Salesforcash 1, Attheendoftheweekthereweregoodswhichhadcost300leftin inventory. Writeuptheledgeraccountsforthefirstweek,includingtheincome statement,andthenprepareaverticalincomestatementtogetherwitha statementoffinancialpositionattheendofthefirstweek. 60 KAPLANPUBLISHING

69 chapter4 Test your understanding 2 ThebusinessdescribedinTestyourunderstanding1nowcontinuesinto itssecondweek.itstransactionsareasfollows: Salesforcash Purchasesforcash 1,000 1,100 Thegoodsleftininventoryattheendofthissecondweekoriginallycost 500. Writeuptheledgeraccountsforthesecondweek,includingtheincome statement,andthenprepareaverticalincomestatementtogetherwitha statementoffinancialpositionattheendofthesecondweek. 3Drawings of inventory Itisnotunusualforasoletradertotakeinventoryfromtheirbusinessfor theirownuse.thistypeoftransactionisaformofdrawings. Thecorrectdoubleentrytoaccountforsuchdrawingsis: DrDrawings CrCostofsales costofinventorytaken costofinventorytaken Thecreditentryensuresthatthecostofinventorytakenisnotincludedas partofthecostofinventorysoldintheincomestatement. 4 Valuation of inventory Inventoryconsistsof: goodspurchasedforresale consumablestores(suchasoil) rawmaterialsandcomponents(usedintheproductionprocess) partly finishedgoods(usuallycalledwork in progress WIP) finishedgoods(whichhavebeenmanufacturedbythebusiness). KAPLANPUBLISHING 61

70 Inventory Inventoryisincludedinthestatementoffinancialpositionat: Expandable text Test your understanding 3 Cole sbusinesssellsthreeproducts,yandz.thefollowing informationwasavailableattheyearend: Cost Netrealisablevalue(NRV) Units Y Z Whatisthevalueoftheclosinginventory? A 8,400 B 6,800 C 7,100 D 7, KAPLANPUBLISHING

71 chapter4 Test your understanding 4 InwhatcircumstancesmighttheNRVofinventoriesbelowerthantheir cost? 5Methods of calculating cost of inventory Method Key points Unit cost Thisistheactualcostof Onlyusedwhenitemsof purchasingidentifiableunits inventoryareindividually ofinventory. distinguishableandofhigh value FIFO first Forcostingpurposes,the Thecostofclosinginventory infirst out firstitemsofinventory isthecostoftheyounger receivedareassumedtobe inventory. thefirstonessold. AVCO Average cost Thecostofanitemof inventoryiscalculatedby takingtheaverageofall inventoryheld. Theaveragecostcanbe calculatedperiodicallyor continously. Expandable text Test your understanding 5 Samstartedherbusinesson1Januaryandprovidesdetailsofthe followingtransactions: Purchases (1) January5unitsat4/unit (2) January5unitsat5/unit (3) January5unitsat5.50/unit Shethensold7unitsfor10/uniton5January. (a) Calculatethevalueoftheclosinginventoryattheendofthefirst weekoftradingusingthefifoandtheavcomethods. (b) Preparetheincomestatementforthefirstweekoftradingunder bothfifoandavco. KAPLANPUBLISHING 63

72 Inventory Test your understanding 6 Abusinesscommencedon1Januaryandpurchasesaremadeas follows: Month Noofunits Jan Feb Mar Apr May Jun Unitprice ,420 Value , ,155 1,290 1,430 6,510 InJune,1,420articlesweresoldfor7,000. Whatisthecostofclosinginventoryandgrossprofitfortheperiodusing thefifomethod: Closinginventory A B C Grossprofit 2,690 2,310 3,077 3,180 2,800 3,567 Expandable text 6IAS 2 Inventories ThekeyrequirementsofIAS2Inventoriesare: 64 Inventoriesarevaluedatthelowerofcostandnetrealisablevalue. Costswhichmustbeexcludedfromthecostofinventoryare: sellingcosts Costincludescostsofpurchase,costsofconversionandothercosts incurredinbringingtheinventorytoitspresentlocationandcondition. storagecosts abnormalwasteofmaterials,labourorothercosts administrativeoverheads. KAPLANPUBLISHING

73 chapter4 Costshouldbeunitcost(ifidentifiable),FIFOorAVCO. Disclosuresmustbemadeabouttheaccountingpolicyforinventory andclassificationofinventoryincludedinthefinancialstatements. Keeping inventory records Abusinessmaychoosetokeepinventoryrecordsonacontinuousbasis throughouttheyearoronlycountinventoryattheperiodend. Expandable text Test your understanding 7 IAS2Inventoriesdefinestheitemsthatmaybeincludedincomputing thevalueofaninventoryoffinishedgoodsmanufacturedbyabusiness. Whichoneofthefollowinglistsconsistsonlyofitemswhichmaybe includedinthestatementoffinancialpositionvalueofsuchinventories accordingtoias2? A Foreman swages,carriageinwards,carriageoutwards,raw materials. B Rawmaterials,carriageinwards,costsofstorageoffinished goods,plantdepreciation. C Plantdepreciation,carriageinwards,rawmaterials,foreman s wages. D Carriageoutwards,rawmaterials,foreman swages,plant depreciation. KAPLANPUBLISHING 65

74 Inventory Chapter summary 66 KAPLANPUBLISHING

75 chapter4 Test your understanding answers Test your understanding 1 First,thetransactionsareenteredintotheledgeraccounts,andthe accountsarebalanced.revenueandpurchasesarethentransferredto theincomestatementledgeraccount. Capital Cash Cash 1,000 Capital 1,000 Purchases Balancec/f 1,100 Salesrevenue Balanceb/f 1,900 1,900 1,100 Sales revenue Incomestatement 900 Cash 900 Purchases Cash 800 Incomestatement 800 Next,theclosinginventorymustbeaccountedforintheinventory accountandtheincomestatementaccount.thereisnoopening inventoryasthisisthefirstweekoftradingforthebusiness. Inventory Incomestatement KAPLANPUBLISHING 300 Cash 1,000 67

76 Inventory Income statement Purchases 800 Salesrevenue 900 Grossprofitc/f 400 Closinginventory 300 1,200 1,200 Grossprofitb/f 400 Sales revenue Incomestatement 900 Cash 900 Purchases Cash 800 Incomestatement 800 Theincomestatementispreparedintheverticalformatbyrearranging theincomestatementledgeraccount. Cash Balanceb/f 1,100 Purchases 1,100 Salesrevenue 1,000 Balancec/f 1,000 Balanceb/f 2,100 2,100 1,000 Thestatementoffinancialpositionispreparedbylistingthebalances broughtdownfromtheledgeraccounts 68 KAPLANPUBLISHING

77 chapter4 Statement of financial position as at Week 1 Inventory Cash Capital Profitfortheweek 300 1,100 1,400 1, ,400 Statement of financial position as at Week 1 Inventory Cash Capital Profitfortheweek 300 1,100 1,400 1, ,400 Test your understanding 2 First,theledgeraccountsmustbewrittenup.Youmustrememberthat thereareopeningbalancesonthestatementoffinancialposition accounts(cashandcapital)buttheincomestatementaccountshaveno openingbalancesastheyweretransferredtotheincomestatementin Week1. KAPLANPUBLISHING 69

78 Inventory Cash Salesrevenue Costofgoodssold: Purchases Less:Closinginventory (300) (500) 400 Grossprofit Sales revenue Incomestatement 1,000 Cash 1,000 Purchase Cash 1,100 Incomestatement 1,100 Income statement Purchases 1,100 Salesrevenue 1,000 Theopeninginventorymustbetransferredtotheincomestatement,and theclosinginventoryenteredintotheledgeraccounts(inventoryand incomestatement)leavingthebalancecarriedforwardwhichwillbe includedinthestatementoffinancialposition. Inventory 70 Balanceb/f 300 Incomestatement Incomestatement KAPLANPUBLISHING

79 chapter4 Income statement Purchases 1,100 Salesrevenue Openinginventory 300 Closinginventory Grossprofitc/f 100 1, ,500 1,500 Grossprofitb/f Income statement for week 2 Salesrevenue Costofgoodssold: Openinginventory Purchases Less:Closinginventory 100 1, ,100 1,400 (500) (900) 100 Grossprofit Statement of financial position as at week 2 Inventory Cash CapitalatstartofWeek2 ProfitforWeek ,000 1,500 1, ,500 KAPLANPUBLISHING 71

80 Inventory Test your understanding 3 ThecorrectanswerisB Y Z (cost)x100 (NRV)x200 (NRV)x300 = = = Total 700 1,600 4,500 6,800 Test your understanding 4 NRVmayberelevantinspecialcases,suchaswheregoodsareslow moving,damagedorobsolete.however,mostitemsofinventorywillbe statedatcost. Test your understanding 5 Unitspurchased(5x3)=15 Unitssold=7 Closinginventory=8 (a) FIFO 3units@5= units@5.50= AVCOAveragecostperunit:((5x4)+(5x5)+(5x5.50))/15= 4.83 Closinginventory=8x4.83= KAPLANPUBLISHING

81 chapter4 (b) FIFO Sales(7x10) Costofsales Purchases(5x4)+(5x5)+(5x5.50) Less:Closinginventory (42.50) (30) 40 Profit Sales(7x10) Costofsales Purchases(5x4)+(5x5)+(5x5.50) Less:Closinginventory Profit (38.64) (33.86) KAPLANPUBLISHING 73

82 Inventory Test your understanding 6 ThecorrectanswerisC Inventoryvaluation(inventoryinhand2,420 1,420=1,000units) FIFO inventoryvaluedatlatestpurchaseprices ,000 1,430 1, ,077 articlesat3.25 articlesat3.00 articlesat2.75 Calculationofgrossprofit: Salesrevenue Purchases Less: Closinginventory Costofgoodssold Grossprofit 7,000 6,510 (3,077) (3,433) 3,567 Test your understanding 7 ThecorrectanswerisC Theotherthreeanswerscontainitemswhichcannotbeincludedin inventoryaccordingtoias2. 74 KAPLANPUBLISHING

83 chapter 5 Sales tax Chapter learning objectives Upon completion of this chapter you will be able to: explain the general principles of the operation of a sales tax calculate sales tax on transactions correctly enter sales tax on sales and purchases into the ledger accounts. 75

84 Salestax 1Principles of sales tax Salestaxisaformofindirecttaxation. Salestaxischargedonpurchases(inputtax)andsales(outputtax). Periodicallythebusinesspaysthesalestaxtothetaxauthorities. Ifinputtaxexceedsoutputtax,thebusinessisrepaidtheexcessbythe taxauthorities. Salestaxissometimescalledvalueaddedtax(VAT)orgoodsand servicestax. Salestaxischargedonmostgoodsandservices. Abusinessthatisregisteredforsalestaxisessentiallyacollection agentforthegovernment. Salestaxisexcludedfromthereportedsalesandpurchasesofthe business. Ifoutputtaxexceedsinputtax,thebusinesspaystheexcesstothetax authorities. 2Calculation of sales tax Itiscommonforarateof17.5%salestaxtobechargedontheselling price. Thefollowingisthereforetrue: Netsellingprice(taxexclusiveprice)100.0% Salestax17.5% Grosssellingprice(taxinclusiveprice)117.5% 76 Thenetsellingpriceistheamountthatthebusinesswishestoachieve. Thegrosssellingpriceisthepricechargedtocustomers. Thedifferenceispaidtothetaxauthorities. KAPLANPUBLISHING

85 chapter5 Illustration 1 Calculation of sales tax Calculationofsalestax Orlandosellsthefollowinggoods: (1) tobrunoatataxinclusivepriceof470. (2) tocosmoatataxexclusivepriceof700. HowmuchsalestaxisOrlandocollectingonbehalfofthegovernment? Expandable Text Test your understanding 1 Lorenzopurchasesgoodsfor170,625(includingsalestax)andsells goodsfor230,500(includingsalestax). Whatamountofsalestaxisultimatelypayabletothetaxauthorities? A 8,918 B 14,926 C 4,471 D 10,479 Thesalestaxrateis17.5%. 3Accounting entries for sales tax Theusualbookkeepingentriesforpurchasesandsalesareonlyslightly amendedbysalestax,themainadditionbeingtheintroductionofasales taxaccount,whichisareceivableorpayableaccountwiththetax authorities. Sales tax paid on purchases (input tax) DrPurchasescostexcludingsalestax(netcost) DrSalestaxSalestax CrPayables/cashCostincludingsalestax(grosscost) KAPLANPUBLISHING 77

86 Salestax Thepurchasesaccountdoesnotincludesalestaxbecauseitisnotan expense itwillberecovered. Thepayablesaccountdoesincludesalestax,asthesuppliermustbe paidthefullamountdue. Sales tax charged on sales (output tax) DrReceivables/cashsalespriceincludingsalestax (grosssellingprice) CrSalessalespriceexcludingsalestax (netsellingprice) CrSalestaxSalestax Thesalesaccountdoesnotincludesalestaxbecauseitisnotincome itwillhavetobepaidtothetaxauthorities. Thereceivablesaccountdoesincludesalestax,asthecustomermust paythefullamountdue. Payment of sales tax DrSalestaxamountpaid CrCashamountpaid Ifoutputtaxexceedsinputtax,apaymentmustbemadetothetax authorities. Receipt of sales tax DrCashamountreceived CrSalestaxamountreceived 78 Ifinputtaxexceedsoutputtax,therewillbeareceiptfromthetax authorities. KAPLANPUBLISHING

87 chapter5 Test your understanding 2 Purchases Sales (alloncredit) (alloncredit) Net Salestax 180,000 31, ,000 45,500 Total 211, ,500 Recordthesetransactionsintheledgeraccounts. Test your understanding 3 Valerie sbusinessisregisteredforsalestaxpurposes.duringthe quarterending31march206,shemadethefollowingsales,allof whichweresubjecttosalestaxat17.5%: 10,000excludingsalestax 7,402includingsalestax 6,745excludingsalestax 11,632includingsalestax. Shealsomadethefollowingpurchasesallofwhichweresubjecttosales taxat17.5%: 15,000excludingsalestax 12,455includingsalestax 11,338includingsalestax 9,870includingsalestax. Whatisthebalanceonthesalestaxaccounton31March206? A 7,639Dr B 1,875Dr C 7,639Cr D 1,875Cr KAPLANPUBLISHING 79

88 Salestax Chapter summary 80 KAPLANPUBLISHING

89 chapter5 Test your understanding answers Test your understanding 1 ThecorrectanswerisA Outputtax: Sales(includingsalestax) Salestax(17.5/117.5) Inputtax: Purchases(includingsalestax) Salestax(17.5/117.5) Payabletotaxauthorities: Outputtax Inputtax(34,330 25,412) 230,500 34, ,625 25,412 8,918 KAPLANPUBLISHING 81

90 Salestax Test your understanding 2 Sales Receivables 260, ,000 Notethatsalesarerecordedexcludingsalestax,asthisisnotincome forthebusiness. Purchases Payables 180, ,000 Notethatpurchasesarerecordednetofsalestax,asthisisnotacostto thebusiness. Receivables Sales/Salestax 305, ,500 Receivablesarerecordedincludingsalestax(thegrossamount)asthe customermustpaytothebusinessthecostofthegoodsplusthesales tax. Payables 82 Purchases/Sales tax 211, ,500 KAPLANPUBLISHING

91 chapter5 Aswithreceivables,thepayablesmustberecordedinclusiveofsales tax,asthebusinessneedstopayitssuppliersthegrossamount. Sales tax account(a personal account with tax authorities) Payables 31,500 Receivables Balancec/f 14,000 45,500 45,500 Balanceb/f 45,500 14,000 Note:Asthebalanceonthesalestaxaccountrepresentsanormaltrade liabilityitisincludedinaccountspayableonthestatementoffinancial position. Test your understanding 3 The correct answer is B Sales tax Purchases: Sales: 15,000x17.5% 2,625 10,000x17.5% 1,750 12,455x17.5/ ,855 7,402x 17.5/ ,102 11,338x17.5/ ,689 6,745x17.5% 1,180 9,870x17.5/ ,470 11,632x 17.5/ ,732 Balanceb/f 1,875 7,639 7,639 Balanceb/f 1,875 KAPLANPUBLISHING 83

92 Sales tax 84 KAPLAN PUBLISHING

93 chapter 6 Accruals and prepayments Chapter learning objectives Upon completion of this chapter you will be able to: explain the need for adjustments for accruals and prepayments in preparing financial statements illustrate the process of adjusting for accruals and prepayments in preparing financial statements. 85

94 Accrualsandprepayments 1Accruals basis of accounting Theaccrualsbasisofaccountingmeansthattocalculatetheprofitforthe period,wemustincludealltheincomeandexpenditurerelatingtothe period,whetherornotthecashhasbeenreceivedorpaidoraninvoice received. Profitistherefore: Incomeearned Expenditureincurred Profit () Expandable text 2Accrued expenditure Anaccrualariseswhereexpensesofthebusiness,relatingtotheyear,have notbeenpaidbytheyearend. Inthiscase,itisnecessarytorecordtheextraexpenserelevanttotheyear andcreateacorrespondingstatementoffinancialpositionliability(calledan accrual): DrExpenseaccount CrAccrual Anaccrualwillthereforereduceprofitintheincomestatement. 86 KAPLANPUBLISHING

95 chapter6 Illustration 1 Accrued expenditure Accrued expenditure Abusiness electricitychargesamountto12,000pa.intheyearto31 December205,9,000hasbeenpaid.Theelectricityforthefinal quarterispaidinjanuary206. Whatyear endaccrualisrequiredandwhatistheelectricityexpensefor theyear? Showtherelevantentriesintheledgeraccounts. Expandable text Test your understanding 1 JohnSimnel sbusinesshasanaccountingyearendof31december 201.Herentsfactoryspaceatarentalcostof5,000perquarter, payableinarrears. Duringtheyearto31December201hiscashpaymentsofrenthave beenasfollows: 31March(forthequarterto31March201)5,000 29June(forthequarterto30June201)5,000 2October(forthequarterto30September201)5,000 Thefinalpaymentdueon31December201forthequartertothatdate wasnotpaiduntil4january202. Showtheledgeraccountsrequiredtorecordtheabovetransactions. 3Prepaid expenditure Aprepaymentariseswheresomeofthefollowingyear sexpenseshave beenpaidinthecurrentyear. KAPLANPUBLISHING 87

96 Accrualsandprepayments Inthiscase,itisnecessarytoremovethatpartoftheexpensewhichisnot relevanttothisyearandcreateacorrespondingstatementoffinancial positionasset(calledaprepayment): DrPrepayment CrExpenseaccount Aprepaymentwillthereforeincreaseprofitintheincomestatement. Illustration 2 Prepaid expenditure Theannualinsurancechargeforabusinessis24,000pa.30,000was paidon1january205inrespectoffutureinsurancecharges. Whatistheyear endprepaymentandwhatistheinsuranceexpensefor theyear? Showtherelevantentriesintheledgeraccounts. Expandable text Test your understanding 2 TubbyWadlowpaystherentalexpenseonhismarketstallinadvance. Hestartsbusinesson1January205andonthatdatepays1,200in respectofthefirstquarter srent.duringhisfirstyearoftradehealso paysthefollowingamounts: 3March(inrespectofthequarterended30June)1,200 14June(inrespectofthequarterended30September)1,200 25September(inrespectofthequarter1,400 ended31december) 13December(inrespectofthefirstquarterof206)1,400 Showthesetransactionsintherentalexpenseaccount. 88 KAPLANPUBLISHING

97 chapter6 4Proforma expense T account Expense Balanceb/f(opening prepaidexpense) Bank(totalpaid duringtheyear) Balancec/f(closing accruedexpense) Balanceb/f(opening prepaidexpense) Balanceb/f(opening accruedexpense) Incomestatement(total expensefortheyear) Balancec/f(closing prepaidexpense) Balanceb/f(opening accruedexpense) Test your understanding 3 On1January205,WillyMossopowed2,000inrespectofthe previousyear selectricity.willymadethefollowingpaymentsduringthe yearended31december205: 6February2,800 8May3,000 5August2,750 10November3,100 At31December205,Willycalculatedthatheowed1,800inrespect ofelectricityforthelastpartoftheyear. Whatistheelectricitychargetotheincomestatement? A 1,800 B 11,450 C 11,650 D 13,450 5Accrued income Accruedincomeariseswhereincomehasbeenearnedintheaccounting periodbuthasnotyetbeenreceived. KAPLANPUBLISHING 89

98 Accrualsandprepayments Inthiscase,itisnecessarytorecordtheextraincomeintheincome statementandcreateacorrespondingassetinthestatementoffinancial position(calledaccruedincome): DrAccruedincome(SFP) CrIncome(IS) Illustration 3 Accrued income Accruedincome Abusinessearnsbankinterestincomeof300permonth.3,000bank interestincomehasbeenreceivedintheyearto31december205. Whatistheyear endassetandwhatisthebankinterestincomeforthe year? Showtherelevantentriesintheledgeraccounts. Expandable text 6Prepaid income Prepaidincomeariseswhereincomehasbeenreceivedintheaccounting periodbutwhichrelatestothenextaccountingperiod. Inthiscase,itisnecessarytoremovetheincomenotrelatingtotheyear fromtheincomestatementandcreateacorrespondingliabilityinthe statementoffinancialposition(calledprepaidincome): DrIncome(IS) CrPrepaidIncome(SFP) Illustration 4 Prepaid income Prepaid income Abusinessrentsoutapropertyatanincomeof4,000permonth. 64,000hasbeenreceivedintheyearended31December205. Whatistheyear endliabilityandwhatistherentalincomefortheyear? Showtherelevantentriesintheledgeraccounts. 90 KAPLANPUBLISHING

99 chapter6 Expandable text 7Proforma income T account Income Balanceb/f(opening accruedincome) Incomestatement (totalrevenuefortheyear) Balancec/f(closing prepaidincome) Balanceb/f(opening prepaidincome) Cash(totalreceived duringtheyear) Balancec/f(closing accruedincome) Balanceb/f(opening prepaidincome) Balanceb/f(opening accruedincome) Test your understanding 4 Accruedandprepaidincome LibbyFarquarreceivesincomefromtworentalunitsasfollows: Period Unit1 2,100 2,150 2,150 2,200 2,200 2,200 Unit2 Received ,300 1,300 1,300 1,400 1,400 1,400 Received WhatisLibby srentalincomeintheincomestatementfortheyear ended31december205? A 5,400 B 8,700 C 14,000 D 14,100 KAPLANPUBLISHING 91

100 Accrualsandprepayments Chapter summary 92 KAPLANPUBLISHING

101 chapter6 Test your understanding answers Test your understanding 1 Rental expense 31Marchcash 5,000 29Junecash 5,000 2Octobercash 5,000 Accrualc/f 5,000 Incomestatement 20,000 20,000 20,000 Accrualb/f 5,000 Test your understanding 2 Rental expense 1Januarycash 1,200 3Marchcash 1,200 14Junecash 1,200 25Septembercash 1,400 Incomestatement 5,000 13Decembercash 1,400 Prepaymentc/f 1,400 Prepaymentb/f 6,400 6,400 1,400 KAPLANPUBLISHING 93

102 Accrualsandprepayments Test your understanding 3 The correct answer is B Electricity expense 6Februarycash 2,800 Accrualb/f 8Maycash 3,000 5Augustcash 2,750 10Novembercash 3,100 Incomestatement Accrualc/f 1,800 2,000 11,450 13,450 13,450 Accrualb/f 1, KAPLANPUBLISHING

103 chapter6 Test your understanding 4 The correct answer is D Incomestatement Prepaidincomec/f Rental income (Unit 1) Prepaidincomeb/f cash cash 8, cash 2, cash 10,900 Prepaidincomeb/f Rental income (Unit 2) Accruedincomeb/f 1, cash 1, cash 1, cash 1,300 Incomestatement 5, cash Accruedincomeb/f 2,150 2,150 2,200 2,200 2,200 10,900 2,200 Accruedincomec/f 1,400 1,400 6,700 6,700 1,400 Totalincome:8,700+5,400=14,100 KAPLANPUBLISHING 95

104 Accruals and prepayments 96 KAPLAN PUBLISHING

105 chapter 7 Irrecoverable debts and allowances for receivables Chapter learning objectives Upon completion of this chapter you will be able to: identify the benefits and costs of offering credit facilities to customers explain the purpose of an aged receivables analysis explain the purpose of credit limits prepare the bookkeeping entries to write off an irrecoverable debt record an irrecoverable debt recovered identify the impact of irrecoverable debts on the income statement and statement of financial position prepare the bookkeeping entries to create and adjust an allowance for receivables illustrate how to include movements in the allowance for receivables in the income statement and how the closing balance of the allowance should appear in the statement of financial position. 97

106 Irrecoverabledebtsandallowancesforreceivables 1The provision of credit facilities Themajorityofbusinesseswillselltotheircustomersoncreditandstatea definedtimewithinwhichtheymustpay(acreditperiod).themainbenefits andcostsofdoingsoareasfollows: Benefits Thebusinessmaybeabletoenternewmarkets. Thereisapossibilityofincreasedsales. Customerloyaltymaybeencouraged. Costs Canbecostlyintermsoflostinterestsincethebusinessisaccepting paymentlater. Cashflowofthebusinessmaydeteriorate. Thereisapotentialriskofirrecoverabledebts. Aged receivables analysis Wherecreditfacilitiesareoffered,itisnormalforabusinesstomaintainan agedreceivablesanalysis. 98 Analysisisusuallyalist,orderedbyname,showinghowmucheach customerowesandhowoldtheirdebtsare. Thecreditcontrolfunctionofabusinessusestheanalysistokeeptrack ofoutstandingdebtsandfollowupanythatareoverdue. KAPLANPUBLISHING

107 chapter7 Timelycollectionofdebtsimprovescashflowandreducestheriskof thembecomingirrecoverable. Credit limits Itisalsonormalforabusinesstosetacreditlimitforeachcustomer.Thisis themaximumamountofcreditthatthebusinessiswillingtoprovide. Theuseofcreditlimitsmay: reducerisktobusinessofirrecoverabledebtsbylimitingtheamount soldoncredit helpbuildupthetrustofanewcustomer bepartofthecreditcontrolstrategyofabusiness. 2Irrecoverable debts Theaccrualsconceptdictatesthatwhenasaleismade,itis recognisedintheaccounts,regardlessofwhetherornotthecashhas beenreceived. Ifsalesaremadeoncredit,theremaybeproblemscollectingthe amountsowingfromcustomers. Somecustomersmayrefusetopaytheirdebtorbedeclaredbankrupt andunabletopaytheamountsowing. Somecustomersmaybeinfinancialdifficultiesormaydisputethe amountowedandtheremaybesomedoubtastowhethertheirdebt willbepaid. Ifitishighlyunlikelythattheamountowedbyacustomerwillbe received,thenthisdebtisknownasanirrecoverabledebt.asitwill probablyneverbereceived,itiswrittenoffbywritingitoutoftheledger accountscompletely. Ifthereissomedoubtwhetheracustomercanorwillpayhisdebt,an allowanceforreceivablesiscreated.thesedebtsarenotyet irrecoverable.howeverthecreationofanallowance for receivables meansthatthepossiblelossisaccountedforimmediately,inlinewith theconceptofprudence.theamountoftheoriginaldebtwillstillremain intheledgeraccountjustincasethecustomerdoeseventuallypay. Expandable text 3Accounting for irrecoverable debts Anirrecoverable debtisadebtwhichis,orisconsideredtobe, uncollectable. KAPLANPUBLISHING 99

108 Irrecoverabledebtsandallowancesforreceivables Withsuchdebtsitisprudenttoremovethemfromtheaccountsandto chargetheamountasanexpenseforirrecoverabledebtstotheincome statement.theoriginalsaleremainsintheaccountsasthisdidactuallytake place. Thedoubleentryrequiredtoachievethisis: DrIrrecoverabledebtsexpense CrReceivables Test your understanding 1 Araf&Cohavetotalaccountsreceivableattheendoftheiraccounting periodof45,000.oftheseitisdiscoveredthatone,mriunwhoowes 790,hasbeendeclaredbankrupt,andanotherwhogavehisnameas MrJoneshastotallydisappearedowingAraf&Co1,240. Calculatetheeffectinthefinancialstatementsofwritingoffthesedebts asirrecoverable. 4Accounting for irrecoverable debts recovered Thereisapossiblesituationwhereadebtiswrittenoffasirrecoverablein oneaccountingperiod,perhapsbecausethecustomerhasbeendeclared bankrupt,andthemoney,orpartofthemoney,dueisthenunexpectedly receivedinasubsequentaccountingperiod. Whenadebtiswrittenoffthedoubleentryis: DrIrrecoverabledebtsexpense CrReceivables(removingthedebtfromtheaccounts) Whencashisreceivedfromacustomerthenormaldoubleentryis: DrCash CrReceivables Whenanirrecoverabledebtisrecovered,thecreditentry(above)cannotbe takentoreceivablesasthedebthasalreadybeentakenoutofthe receivablesbalance. Insteadtheaccountingentryis: DrCash CrIrrecoverabledebtsexpense 100 KAPLANPUBLISHING

109 chapter7 Somebusinessesmaywishtokeepaseparate irrecoverabledebts recovered accounttoseparatetheactualcostofirrecoverabledebtsinthe period. Expandable text Test your understanding 2 CeliaJoneshadreceivablesof3,655at31December207.Atthat dateshewroteoffadebtfromlennysmithof699.duringtheyearto 31December208Celiamadecreditsalesof17,832andreceived cashfromhercustomerstotalling16,936.shealsoreceivedthe699 fromlennysmiththathadalreadybeenwrittenoffin207. Whatisthefinalbalanceonthereceivablesaccountat31December 207and208? 207 2,956 2,956 3,655 3,655 A B C D 208 3,852 3,153 4,551 3,852 5Allowance for receivables Theremaybesomedebtsintheaccountswherethereissomecausefor concernbuttheyarenotyetdefinitelyirrecoverable. Itisprudenttorecognisethepossibleexpenseofnotcollectingthedebtin theincomestatement,butthereceivablemustremainintheaccountsin casethecustomerdoesinfactpayup. Anallowanceissetupwhichisacreditbalance.Thisisnettedoffagainst tradereceivablesinthestatementoffinancialpositiontogiveanetfigure forreceivablesthatareprobablyrecoverable. Therearetwotypesofallowancethatmayappearintheorganisation s accounts: Therewillbesomespecificdebtswherethecustomerisknowntobein financialdifficulties,isdisputingtheirinvoice,orisrefusingtopayfor someotherreason(badserviceforexample),andthereforetheamount owingmaynotberecoverable.theallowanceforsuchadebtisknown asaspecific allowance. KAPLANPUBLISHING 101

110 Irrecoverabledebtsandallowancesforreceivables Thepastexperienceandhistoryofabusinesswillindicatethatnotallof itstradereceivableswillberecoverableinfull.itmaynotbepossibleto identifytheamountthatwillnotbepaidbutanestimatemaybemade thatacertainpercentageofcustomersarelikelynottopay.an additionalallowancewillbemadefortheseitems,oftenknownasa general allowance. 6Accounting for the allowance for receivables Anallowanceforreceivablesissetupwiththefollowingjournal: DrIrrecoverabledebtsexpense CrAllowanceforreceivables Ifthereisalreadyanallowanceforreceivablesintheaccounts(opening allowance),onlythemovementintheallowanceischargedtotheincome statement(closingallowancelessopeningallowance). Astheallowancecanincreaseordecrease,theremaybeadebitoracredit intheirrecoverabledebtsaccountsotheabovejournalmaybereversed. Whencalculatingandaccountingforamovementintheallowancefor receivables,thefollowingstepsshouldbetaken: (1) Writeoffirrecoverabledebts. (2) Calculatethereceivablesbalanceasadjustedforthewrite offs. (3) Ascertainthespecificallowanceforreceivablesrequired. (4) Deductthedebtspecificallyprovidedforfromthereceivablesbalance (besuretodeductthefullamountofdebtratherthantheamountof specificallowance). (5) Multiplytheremainingreceivablesbalancebythegeneralallowance percentagetogivethegeneralallowancerequired. %(closingreceivables irrecoverabledebts debtsspecifically allowedfor). (6) Addthespecificandgeneralallowancesrequiredtogether. (7) Comparetothebroughtforwardallowance. (8) Accountforthechangeinallowance. 102 KAPLANPUBLISHING

111 chapter7 Test your understanding 3 On31December201JakeWilliamshadreceivablesof10,000. FrompastexperienceJakeestimatedthattheequivalentof3%ofthese customerswerelikelynevertopaytheirdebtsandhethereforewished tomakeanallowanceforthisamount. During202Jakemadesalesoncredittotalling100,000andreceived cashfromhiscustomersof94,000.hestillconsideredthatthe equivalentof3%oftheclosingreceivablesmayneverpayandshouldbe allowedfor. During203Jakemadesalesof95,000andcollected96,000from hisreceivables.at31december203jakestillconsideredthatthe equivalentof3%ofhisreceivablesshouldbeallowedfor. Calculatetheallowanceforreceivablesandtheirrecoverabledebt expenseaswellastheclosingbalanceofreceivablesforeachofthe years201,202,203. Test your understanding 4 JohnStamphasopeningbalancesat1January206onhistrade receivablesaccountandallowanceforreceivablesaccountof68,000 and3,400respectively.duringtheyearto31december206john Stampmakescreditsalesof354,000andreceivescashfromhis receivablesof340,000. At31December206JohnStampreviewshisreceivableslistingand acknowledgesthatheisunlikelyevertoreceivedebtstotalling2,000. Thesearetobewrittenoffasirrecoverable.Pastexperienceindicates thatjohnshouldalsomakeanallowanceequivalentto5%ofhis remainingreceivablesafterwritingofftheirrecoverabledebts. WhatistheamountchargedtoJohn sincomestatementfor irrecoverabledebtexpenseintheyearended31december206? A 2,700 B 6,100 C 2,600 D 6,000 KAPLANPUBLISHING 103

112 Irrecoverabledebtsandallowancesforreceivables Test your understanding 5 Gordon sreceivablesoweatotalof80,000attheyearend.these include900oflongoverduedebtsthatmightstillberecoverable,butfor whichgordonhascreatedanallowanceforreceivables.gordonhas alsoprovidedanallowanceof1,582,whichistheequivalentof2%of theotherreceivables balances.whatbestdescribesgordon s allowanceforreceivablesasathisyearend? A Aspecificallowanceof900andanadditionalallowanceof1,582 basedonpasthistory. B Aspecificallowanceof1,582andanadditionalallowanceof900 basedonpasthistory. C Aspecificallowanceof2,482. D Ageneralallowanceof2, KAPLANPUBLISHING

113 chapter7 Chapter summary KAPLANPUBLISHING 105

114 Irrecoverabledebtsandallowancesforreceivables Test your understanding answers Test your understanding 1 Asthetwodebtsareconsideredtobeirrecoverable,theymustbe removedfromreceivables: Receivables Balanceatperiod end 45,000 Irrecoverabledebts Mriun 790 Irrecoverabledebts MrJones 1,240 Balancec/f 42,970 45,000 Balanceb/f 42,970 Irrecoverable debts expense Receivables Mriun Receivables 790 MrJones 45,000 1,240 Incomestatement 2,030 2,030 2,030 Notethatthesalesrevenueaccounthasnotbeenalteredandthe originalsalestomriunandmrjonesremain.thisisbecausethese salesactuallytookplaceanditisonlyafterthesalethattheexpenseof notbeingabletocollectthesedebtshasoccurred. 106 KAPLANPUBLISHING

115 chapter7 Test your understanding 2 The correct answer is A 207 Receivables 31Dec 3,655 Irrecoverable debts LennySmith Balancec/f 699 2,956 3,655 Balanceb/f 3,655 2,956 Irrecoverable debts expense Receivables LennySmith 699 Income statement 699 Receivables Balanceb/f ,956 Sales 17,832 Cashreceived 16,936 Balancec/f Balanceb/f 3,852 20,788 3,852 20,788 Irrecoverable debts expense Income statement 699 Cash KAPLANPUBLISHING 107

116 Irrecoverabledebtsandallowancesforreceivables Test your understanding Receivables At31December 10,000 Balancec/f 10,000 10,000 Balanceb/f 10,000 10,000 Allowancerequired:10,000x3% =300 Allowance for receivables Balancec/f Irrecoverable debts Allowancefor receivables 300 Balanceb/f Irrecoverable debts expense 31Dec Dec 31Dec 300 Income statement Statement of financial position presentation Currentassets Receivables 10,000 Less:Allowance forreceivables (300) , KAPLANPUBLISHING

117 chapter7 202 Receivables Balanceb/f 10,000 Sales 100,000 Cash 94,000 16,000 Balancec/f 110,000 Balanceb/f 110,000 16,000 Allowancerequired:16,000x3% =480 Allowance for receivables Balanceb/f Balanceb/f Dec increasein allowance Balanceb/f Irrecoverable debts expense 31Dec Allowanceforreceivables 31Dec 180 Income statement Statement of financial position presentation Currentassets Receivables 16,000 Less:Allowancefor receivables (480) 15,520 KAPLANPUBLISHING 109

118 Irrecoverabledebtsandallowancesforreceivables 203 Receivables Balanceb/f 16,000 Sales 95,000 Cash 96,000 Balancec/f 15, , ,000 Balanceb/f 15,000 Allowancerequired:15,000x3%= 450 Allowance for receivables 31Dec Balanceb/f 480 decreasein 30 allowance Balancec/f Balanceb/f 450 Irrecoverable debts expense 31Dec 31Dec Incomestatement 30 Allowancefor 30 receivables Statement of financial position presentation Currentassets Receivables 15,000 Less:Allowancefor (450) receivables 14, KAPLANPUBLISHING

119 chapter7 Test your understanding 4 The correct answer is C Receivables 206 1JanBalance b/f 31Dec ,000 31Deccash Salesrevenue 354,000 31Dec Irrecoverable debts 31Dec Balancec/f 1JanBalance b/f 422,000 Irrecoverable debts expense 206 2,000 forreceivables 31Dec 600 Income statement KAPLANPUBLISHING 80,000 80,000 31Dec Receivables 2, , Dec Allowance 340, ,600 2,600 2,

120 Irrecoverabledebtsandallowancesforreceivables Allowance for receivables DecBalance c/f 206 1JanBalance b/f 3,400 4,000 31Dec Irrecoverable debts 4, JanBalance b/f 600 4,000 4,000 Notethatonlytheoneirrecoverabledebtsexpenseaccountisusedboth towriteoffirrecoverabledebtsandtoincreaseordecreasethe allowanceforreceivables.thereisnoneedtouseseparateaccounts foreachtypeofexpense. Working Allowanceforreceivables 5%x80,000=4,000 Test your understanding 5 ThecorrectanswerisA Thereisaspecificallowanceforthedebtof900whichhasstillnot beenwrittenoffasirrecoverable,andanadditionalallowanceequivalent to2%oftheremainingbalancebasedonpasthistory. 112 KAPLANPUBLISHING

121 chapter 8 Non current assets Chapter learning objectives Upon completion of this chapter you will be able to: define non current assets distinguish between capital and revenue expenditure explain the function and purpose of an asset register explain and illustrate the ledger entries to record the acquisition of non current assets define and explain the purpose of depreciation explain the straight line and reducing balance methods of depreciation and make necessary calculations explain and illustrate how depreciation expense and accumulated depreciation are recorded in ledger accounts explain and illustrate how depreciation is presented in the income statement and statement of financial position explain the relevance of consistency and subjectivity in accounting for depreciation make the necessary adjustments if changes are made in the estimated useful life/residual value of a non current asset explain and illustrate the ledger entries to record the disposal of non current assets for cash explain and illustrate the ledger entries to record the disposal of non current assets through part exchange explain and illustrate the inclusion of profits or losses on disposal in the income statement 113

122 Non current assets explain and record the revaluation of a non current asset in ledger accounts and in the statement of financial position explain the impact of a revaluation on accounting for depreciation and disposal of a non current asset explain and illustrate how non current asset balances and movements are disclosed in company financial statements. 114 KAPLAN PUBLISHING

123 chapter8 1Non current assets Non currentassetsaredistinguishedfromcurrentassetsbythe followingcharacteristics:they: arelong terminnature arenotnormallyacquiredforresale arecouldbetangibleorintangible areusedtogenerateincomedirectlyorindirectlyforabusiness arenotnormallyliquidassets(i.e.noteasilyandquicklyconvertedinto cashwithoutasignificantlossinvalue). 2Capital and revenue expenditure Itfollowsthatabusiness expendituremaybeclassifiedasoneoftwotypes: 3Non current asset registers Non currentassetregistersare,asthenamesuggests,arecordofthenon currentassetsheldbyabusiness.theseformpartoftheinternalcontrol systemofanorganisation. Expandable text KAPLANPUBLISHING 115

124 Non currentassets Expandable text 4Acquisition of a non current asset Anon currentassetregisterismaintainedinordertocontrolnon current assetsandkeeptrackofwhatisownedandwhereitiskept. Itisperiodicallyreconciledtothenon currentassetaccountsmaintainedin thegeneralledger. Thecostofanon currentassetisanyamountincurredtoacquirethe assetandbringitintoworkingcondition Includes Excludes Capitalexpendituresuchas: Revenueexpendituresuch as: purchasepricerepairs repairs deliverycostsrenewals renewals legalfeesrepainting repainting subsequentexpenditurewhichenhances theasset Thecorrectdoubleentrytorecordthepurchaseis: DrNon currentasset CrBank/Cash/Payables Aseparatecostaccountshouldbekeptforeachcategoryofnon currentasset,e.g.motorvehicles,fixturesandfittings. Expandable text 116 KAPLANPUBLISHING

125 chapter8 Test your understanding 1 Acquisition of a non current asset BilboBagginsstartedabusinessprovidinglimousinetaxiserviceson1 January205.Intheyearto31Decemberheincurredthefollowing costs: Officepremises 250,000 Legalfeesassociatedwithpurchaseofoffice 10,000 CostofmaterialsandlabourtopaintofficeinBilbo sfavourite 300 colour,purple MercedesEseriesestatecars 116,000 Numberplatesforcars 210 Deliverychargeforcars 180 Roadlicencefeeforcars 480 Drivers wagesforfirstyearofoperation 60,000 BlanktaxireceiptsprintedwithBilboBaggins businessname 450 andnumber Whatamountsshouldbecapitalisedas Landandbuildings and Motor vehicles? A B C D Landandbuildings 260, , , ,300 Motorvehicles 116, , , ,870 KAPLANPUBLISHING 117

126 Non currentassets 5Depreciation IAS16definesdepreciationas themeasureofthecostorrevalued amountoftheeconomicbenefitsofthetangiblenon currentassetthat hasbeenconsumedduringtheperiod. Insimpleterms,depreciationisamechanismtoreflectthecostofusing anon currentasset. Depreciationmatchesthecostofusinganon currentassettothe revenuesgeneratedbythatassetoveritsusefullife. Thisisachievedbyrecordingadepreciationchargeeachyear,the effectofwhichistwofold( thedualeffect ): Reducethestatementoffinancialpositionvalueofthenon current assetbycumulativedepreciationtoreflectthewearingout. Recordthedepreciationchargeasanexpenseintheincome statementtomatchtotherevenuegeneratedbythenon current asset. Expandable text 6Methods of calculating depreciation Straight line method Depreciationcharge=(Cost Residualvalue)/Usefullife Or%xcost 118 KAPLANPUBLISHING

127 chapter8 Residualvalue:theestimateddisposalvalueoftheassetattheendofits usefullife. Usefullife:theestimatednumberofyearsduringwhichthebusinesswilluse theasset. Expandable text Reducing balance method Depreciationcharge=%xNetbookvalue(NBV) NBV:originalcostofthenon currentassetlessaccumulateddepreciation ontheassettodate. Assetsbought/soldintheperiod Ifanon currentassetisboughtorsoldintheperiod,therearetwowaysin whichthedepreciationcouldbeaccountedfor: provideafullyear sdepreciationintheyearofacquisitionandnonein theyearofdisposal monthlyorpro ratadepreciation,basedontheexactnumberofmonths thattheassethasbeenowned. Illustration 1 Reducing balance method Dev,atrader,purchasedanitemofplantfor1,000on1August201 whichhedepreciatesonthereducingbalanceat20%pa.whatisthe depreciationchargeforeachofthefirstfiveyearsiftheaccountingyear endis31july? Expandable text Test your understanding 2 Karenhasbeenrunningasuccessfulnurseryschool LittleMonkeys since201.sheboughtthefollowingassetsasthenurserygrew: anewovenforthenurserykitchenatacostof2,000(purchased1 December204). aminibustotakethechildrenontripsfor18,000(purchased1 June204). KAPLANPUBLISHING 119

128 Non currentassets Shedepreciatestheovenat10%straightlineandtheminibusat25% reducingbalance.afullyear sdepreciationischargedintheyearof purchaseandnoneintheyearofdisposal. Whatisthetotaldepreciationchargefortheyearended31October 206? A 2,531 B 2,700 C 4,231 D 2,731 Test your understanding 3 ThefollowinginformationrelatestoBangers&Smash,acarrepair business: Cost Purchasedate Depreciation method Machine1 12,000 1August205 20%straightlinepro rata Machine2 8,000 1October206 10%reducingbalancepro rata Whatisthetotaldepreciationchargefortheyearsended31December 205and206? 205 A B C D 206 2,400 1,000 2,400 1,000 2,600 2,600 3,200 3,200 7Accounting for depreciation Whichevermethodisusedtocalculatedepreciation,theaccounting remainsthesame: DrDepreciationexpense(IS) CrAccumulateddepreciationSFP 120 Thedepreciationexpenseaccountisanincomestatementaccountand thereforeisnotcumulative. KAPLANPUBLISHING

129 chapter8 Theaccumulateddepreciationaccountisastatementoffinancial positionaccountandasthenamesuggestsiscumulative,i.e.reflects alldepreciationtodate. Onthestatementoffinancialpositionitisshownasareductionagainst thecostofnon currentassets: Cost Accumulateddepreciation () NBV Illustration 2 Accounting for depreciation SantarunsalargetoyshopinWindsor.Intheyearended31August 205,sheboughtthefollowingfixedassets: Anewcashregisterfor5,000.Thiswaspurchasedon1 December204,intimefortheChristmasrush,andwastobe depreciatedat10%straightline. Anewdeliveryvan,purchasedon31March205,atacostof 22,000.Thevanistobedepreciatedat15%reducingbalance. Santachargesdepreciationonamonthlybasis. Whatisthedepreciationchargefortheyearended31stAugust 205? Showtherelevantledgeraccountsandstatementoffinancial positionpresentationatthatdate. Expandable text Test your understanding 4 Cocoacquiredtwofixedassetsforcashon1August205foruseinher partyorganisingbusiness: a25 yearleaseonashopfor200,000 achocolatefountainfor4,000. Thefountainistobedepreciatedat25%pausingthereducingbalance method. KAPLANPUBLISHING 121

130 Non currentassets Afullyearofdepreciationischargedintheyearofacquisitionandnone intheyearofdisposal. Showtheledgeraccountentriesfortheseassetsfortheyearsending31 October205,206and207. 8Consistency and subjectivity when accounting for depreciation Thefollowingareallbasedonestimatesmadebythemanagementofa business: depreciationmethod residualvalue usefullife. Differentestimateswouldresultinvaryinglevelsofdepreciationand, consequently,profits. Itcanbearguedthatthesesubjectiveareascouldthereforeresultin manipulationoftheaccountsbymanagement. Inordertoreducethescopeforsuchmanipulationandincreaseconsistency oftreatment,ias 16 Property, Plant andequipmentrequiresthe following: Depreciationmethodshouldbereviewedateachyearendand changedifthemethodusednolongerreflectsthepatternofuseofthe asset. Residualvalueandusefullifeshouldbereviewedateachyearendand changedifexpectationsdifferfrompreviousestimates. Illustration 3 Changes to estimates Alfiepurchasedanon currentassetfor100,000on1january202 andstarteddepreciatingitoverfiveyears.residualvaluewastakenas 10,000. At1January203areviewofassetliveswasundertakenandthe remainingusefullifewasestimatedateightyears.residualvaluewas estimatedasnil. Calculatethedepreciationchargefortheyearended31December 203andsubsequentyears. 122 KAPLANPUBLISHING

131 chapter8 Expandable text Test your understanding 5 Albertoboughtawood burningovenforhispizzarestaurantfor30,000 on1january200.atthattimehebelievedthattheoven susefullife wouldbe20yearsafterwhichitwouldhavenovalue. On1January203,Albertoreviseshisestimations:henowbelieves thathewillusetheoveninthebusinessforanother12yearsafterwhich hewillbeabletosellitsecond handfor1,500. Whatisthedepreciationchargefortheyearended31December 203? A 2,000 B 2,125 C 1,875 D 2,375 9Disposal of non current assets Profit/Loss on disposal Proceeds(cashorpartdisposalallowance)>NBVat disposaldate Proceeds(cashorpart<disposalallowance)NBVat disposaldate Proceeds(cashorpart=disposalallowance)NBVat disposaldate Profit Loss Neitherprofitnor loss AdisposalsTaccountisrequiredwhenrecordingthedisposalofanon currentasset.thisisanincomestatementaccountwhichreflectsanyprofit orlossondisposal. Disposal for cash consideration Thisisathree stepprocess: (1) Removetheoriginalcostofthenon currentassetfromthe non current asset account. DrDisposalsoriginalcost CrNCassetsoriginalcost KAPLANPUBLISHING 123

132 Non currentassets (2) Removeaccumulateddepreciationonthenon currentassetfromthe accumulateddepreciation account. DrAcc ddep nacc ddep n CrDisposalsacc ddep n (3) Recordthecashproceeds. DrCashproceeds CrDisposalsproceeds ThebalanceonthedisposalsTaccountistheprofitorlossondisposal: Disposal Originalcost Profitondisposal ß Accumulateddepreciation ß Proceeds Lossondisposal TheprofitorlossondisposalcanalsobecalculatedasproceedslessNBV ofassetatdisposal. Test your understanding 6 PercyThrowerprunsalandscapegardeningbusiness.On1February 202,hepurchasedasit onlawnmowercosting3,000.he depreciatesitat10%straightlineonamonthlybasis.afewyearslater hedecidestoreplaceitwithonewhichhasanenclosedcabinforwhen itrains.hesellsthelawnmowertoanoldfriend,alantitchmuck,for 2,000on31July205. HowmuchischargedtoPercy sincomestatementinrespectofthe assetfortheyearended31december205? Disposal through a part exchange agreement Apartexchangeagreementariseswhereanoldassetisprovidedinpart paymentforanewone,thebalanceofthenewassetbeingpaidincash. 124 KAPLANPUBLISHING

133 chapter8 Theproceduretorecordthetransactionisverysimilartothethree step processseenforacashdisposal.thereishoweverafourthstep: (1) Removetheoriginalcostofthenon currentassetfromthe non current asset account. DrDisposalsoriginalcost CrNCassetsoriginalcost (2) Removeaccumulateddepreciationonthenon currentassetfromthe accumulateddepreciation account. DrAcc ddep nacc ddep n CrDisposalsacc ddep n (3) Recordthepartexchangeallowance(PEA)asproceeds. DrNCassets(=partofcostofnewasset)PEA CrDisposals(=saleproceedsofoldasset)PEA (4) Recordthecashpaidforthenewasset. DrNCassetscash CrCashcash Again,thebalanceonthedisposalsTaccountistheprofitorlosson disposal: Disposal Originalcost Profitondisposal ß Accumulateddepreciation Proceeds Lossondisposal ß Expandable text KAPLANPUBLISHING 125

134 Non currentassets Test your understanding 7 BindiBobbinrunsabusinessalteringandrepairingclothes.Whenshe startedbusinesson1january202,sheboughtasoopastitchiisewing machinefor2,500.shedepreciatessewingmachinesusingthe straight linemethodatarateof20%pa,andshechargesafullyearof depreciationintheyearofacquisitionandnoneintheyearofdisposal. Thebusinesshasnowgrownsuchthatsheneedsafastermachine,and shewillupgradetothesoopastitchvduringdecember205.the Soopastitchsalesmanhasofferedherapartexchangedealasfollows: PartexchangeallowanceforSoopastitchII750 BalancetobepaidincashforSoopastitchV4,850 Showtheledgerentriesfortheyearended31December205toreflect thistransaction. 10Revaluation of non current assets Somenon currentassets,suchaslandandbuildingsmayriseinvalue overtime.businessesmaychoosetoreflectthecurrentvalueofthe assetintheirstatementoffinancialposition.thisisknownasrevaluing theasset. ThedifferencebetweentheNBVoftheassetandtherevaluedamount (normallyagain)isrecordedinarevaluationreserveinthecapital sectionofthestatementoffinancialposition. Thisgainisnotrecordedintheincomestatementbecauseitis unrealised,i.e.itisnotrealisedintheformofcash. IAS1requiresthatarevaluationgainisdisclosedin"other comprehensiveincome"onthestatementoffinancialposition. Expandable text Illustration 4 Revaluation of non current assets Vittorioownslandwhichoriginallycost250,000.Nodepreciationhas beenchargedonthelandinaccordancewithias16.vittoriowishesto revaluethelandtoreflectitscurrentmarketvalue,whichhehasbeen advisedis600,000. Whatisthedoubleentrytorecordthisrevaluation? 126 KAPLANPUBLISHING

135 chapter8 Expandable text Illustration 5 Revaluation of non current assets Hamishrunsakilt makingbusinessinscotland.hehasrunthebusiness formanyyearsfromabuildingwhichoriginallycost300,000andon which100,000totaldepreciationhasbeenchargedtodate.hamish wishestorevaluethebuildingto750,000. Whatisthedoubleentryrequiredtorecordtherevaluation? Expandable text Insummary: Revaluation surplus = Revalued amount NBV Foranon depreciatedasset: DrNon currentasset costrevaluationsurplus CrRevaluationreserverevaluationsurplus Foradepreciatedasset: DrAccumulateddepreciationdepreciationtodate DrNon currentasset costß CrRevaluationreserverevaluationsurplus Therevaluationgainisdisclosedonthefaceofthestatementof comprehensiveincomeunder"othercomprehensiveincome"andinthe statementofchangesinequity(socie). Test your understanding 8 Maxownsafish fingerfactory.thepremiseswerepurchasedon1 January201for450,000anddepreciationchargedat2%pastraight line. Maxnowwishestorevaluethefactorypremisesto800,000on1 January207toreflectthemarketvalue. KAPLANPUBLISHING 127

136 Non currentassets Whatisthebalanceontherevaluationreserveafterthistransaction? A 350,000 B 395,000 C 404,000 D 413,000 11Depreciation and disposal of a revalued asset Depreciation of a revalued asset Whenanon currentassethasbeenrevalued,thechargefor depreciationshouldbebasedontherevaluedamountandthe remainingusefullifeoftheasset. thischargewillbehigherthandepreciationpriortotherevaluation. theexcessofthenewdepreciationchargeovertheolddepreciation chargeshouldbetransferredfromtherevaluationreserveto accumulatedprofits(withinthecapitalsectionofthestatementof financialposition): DrRevaluationreserve CrAccumulatedprofits Illustration 6 Depreciation of a revalued asset EddieownsaretailunitincentralSpringfield.Heboughtit25yearsago for100,000,depreciatingitover50years.atthestartof206he decidestorevaluetheunitto800,000.theunithasaremaininguseful lifeof25years. Whataccountingentriesshouldbemadein206? Expandable text Disposal of a revalued asset 128 Thedisposalofarevaluedassetisrecordedasalreadyseen. KAPLANPUBLISHING

137 chapter8 Test your understanding 9 SpartacusUnitedfootballclub sstatementoffinancialpositionat31 December207includesthefollowinginformation: Stadiumcost Depreciation 1,500, ,000 1,050,000 Depreciationhasbeenprovidedat2%onthestraight linebasis. Thestadiumisrevaluedon30June208to1,380,000.Thereisno changeinitsremainingestimatedfutureusefullife. Whatisthedepreciationchargefortheyearended31December 208? Test your understanding 10 TigerTreesownsandrunsagolfclub.SomeyearsagoTigerpurchased landnexttotheexistingcoursewiththeintentionofcreatingasmaller nine holecourse.thecostofthelandwas260,000.tigerhasn tyet builttheadditionalcoursebuthasrevaluedthislandto600,000.he hasnowdecidedthatbuildingthenewcourseisuneconomicalandhas foundabuyerwhoiswillingtopay695,000fortheland. Whataretheledgerentriesondisposal? 12Disclosure of non current asset balances in company financial statements Expandable text KAPLANPUBLISHING 129

138 Non currentassets Chapter summary 130 KAPLANPUBLISHING

139 chapter8 Test your understanding answers Test your understanding 1 ThecorrectanswerisA Landandbuildings Officepremises:250,000 Legalfees:10,000 Total:260,000 Thecostofthepurplepaintdoesnotformpartofthecostofthe officeandsoshouldnotbecapitalised.insteaditshouldbetakento theincomestatementasarevenueexpense. Motorvehicles 3MercedesEseries116,000 Numberplates210 Deliverycharges180 Total116,390 Thenumberplatesareone offchargeswhichformpartofthe purchasepriceofanycar. Theroadlicencefee,drivers wagesandreceiptsareongoing expenses,incurredeveryyear.theycannotbecapitalised,but shouldbetakentotheincomestatementasexpenses. KAPLANPUBLISHING 131

140 Non currentassets Test your understanding 2 The correct answer is D Oven 2,000x10% Minibus 204:25%x18,000=4, :25%x(18,000 4,500)=3, :25%x(18,000 7,875)=2,531 Totaldepreciationcharge ,531 2,731 Test your understanding 3 ThecorrectanswerisB Machine1 205:20%x12,000x5/12=1, :20%x12,000=2,400 Machine2 206:10%x8,000x3/12=200 Totaldepreciationcharge 205:1, :2, , KAPLANPUBLISHING

141 chapter8 Test your understanding 4 Leases (cost) 1.8.5Cash Balanceb/f 200,000 Balancec/f 200, , , ,000 Fixtures and fittings (cost) 1.8.5Cash Balanceb/f 5accumulated depreciation 6accumulated depreciation 7accumulated depreciation KAPLANPUBLISHING 4,000 Balancec/f 4,000 4,000 4,000 4,000 Depreciation charge 9,000 Incomestatement 8,750 Incomestatement 8,563 Incomestatement 9,000 8,750 8,

142 Non currentassets Depreciation charge 5depreciation charge Balancec/f 8,000 8,000 8,000 8,000 Balanceb/f 6depreciation charge Balancec/f 16,000 8,000 8,000 16,000 16,000 Balanceb/f 7depreciation charge Balancec/f 24,000 16,000 8,000 24,000 24, Balanceb/f 24,000 KAPLANPUBLISHING

143 chapter8 Accumulated depreciation (fixtures and fittings) 5depreciation charge Balancec/f 1,000 1,000 1,000 1,000 Balanceb/f 6depreciation charge Balancec/f 1,750 1, ,750 1,750 Balanceb/f 7depreciation charge Balancec/f 1,750 2, ,313 2,313 Balanceb/f 2,313 Accumulateddepreciation(fixturesandfittings) 1DrDisposals 3,000 CrFixturesandfittingscost 3,000 2DrAccumulateddepreciation 1,050 CrDisposals 1,050 Depreciationworking: 210%x3,000x11/12 = %x3,000 = %x3,000 = %x3,000x7/12 = DrCash 2,000 CrDisposals 2,000 KAPLANPUBLISHING 135

144 Non currentassets Annualdepreciationworkings: Note,detailsofthedepreciationmethodandratefortheleasearenot giveninthequestion.wearehowevertoldthattheleasetermis25 years.thissuggeststhatitwouldbeappropriatetousethestraight line methodwithausefullifeof25years. 205 Lease:200,000/25years=8,000 Fountain:4,000x25%=1,000 Total:9, Lease:200,000/25years=8,000 Fountain:3,000x25%=750 Total:8, Lease:200,000/25years=8,000 Fountain:2,250x25%=563 Total:8,563 Test your understanding 5 ThecorrectanswerisA Initialdepreciationcharge=30,000/20years=1,500 NBVatdateofchange=30,000 (1,500x3yrs) =25,500 Newdepreciationcharge=25,500 1,50/12years0 =2,000pa 136 KAPLANPUBLISHING

145 chapter8 Test your understanding 6 (1) DrDisposals3,000 CrFixturesandfittingscost3,000 (2) DrAccumulateddepreciation1,050 CrDisposals1,050 Depreciationworking: 210%x3,000x11/12= %x3,000= %x3,000= %x3,000x7/12=175 Total:1050 (3) DrCash2,000 CrDisposals2,000 Disposals: fixturesand fittingscost Profitondisposal(ß) 3,000 Accumulated depreciation 1, Cashproceeds 2,000 3,050 3,050 Thechargetotheincomestatementfortheyearended31December 205is: Depreciationchargefortheyear175 profit/lossondisposa(50) Note:Asdepreciationischargedmonthly,itisnecessarytochargean amounttotheincomestatementfortheperiod1january205tothe disposaldate31july205. KAPLANPUBLISHING 137

146 Non currentassets Test your understanding 7 Sewing machine Balanceb/f 2,500 Disposal Newasset 2,500 PEA 750 Cash 4,850 Balancec/f Balanceb/f 5,600 8,100 8,100 5,600 Accumulated depreciation (Sewing machine) Disposal 1,500 Balanceb/f Balancec/f 1,500 Depreciation 1,120 charge5 1,120 2,620 2,620 Balanceb/f 1,120 Depreciationb/fworking: 2,500x20%x3years=1,500 Disposals Sewingmachine cost 138 2,500 Sewingmachine accumulated depreciation 1,500 PEA 750 Lossondisposal (ß) 250 2,500 2,500 KAPLANPUBLISHING

147 chapter8 Depreciation charge Sewingmachine accumulated depreciation 1,120 Incomestatement 1,120 Depreciationchargeworking: 5,600x20%=1,120 KAPLANPUBLISHING 139

148 Non currentassets Test your understanding 8 The correct answer is C Factory cost Balanceb/f 450,000 Revaluation 350,000 Balancec/f 800, , , ,000 Accumulated depreciation (factory) Revaluation (2%x450,000 54,000 Balanceb/f 54,000 Balancec/f 800,000 x6years) 350,000 54,000 54,000 Revaluation reserve Factorycost Accumulated 404,000 depreciation Balancec/f 350,000 54, , ,000 Balanceb/f 404, KAPLANPUBLISHING

149 chapter8 Test your understanding 9 Depreciationmustcontinuetobechargedontheoriginalcostuntilthe dateofrevaluation.thereafteritischargedontherevaluedamount: 1Januaryto30June208 2%x1,500,000x6/12 15,000 Notethatthisispartofthedepreciationclearedoutonrevaluationand soisnotpartoftheaccumulateddepreciationbalanceattheyearend. 1Julyto31December208 (1,380,000/34.5years)x(6/12) 20,000 Thisamountwillformtheaccumulateddepreciationattheyearend. Totaldepreciationcharge Test your understanding 10 Land (valuation) Balanceb/f 600,000 Disposal Disposal Landvaluation 600,000 Proceeds Profitondisposal 95, , ,000 KAPLANPUBLISHING 141

150 Non current assets 142 KAPLAN PUBLISHING

151 chapter 9 From trial balance to financial statements Chapter learning objectives Upon completion of this chapter you will be able to: illustrate the process of adjusting the financial statements for accruals and prepayments, depreciation, irrecoverable debts and the allowance for receivables. 143

152 Fromtrialbalancetofinancialstatements 1Trial balance Inthischapterwewillbringtogetherthematerialfromthepreviouschapters andproduceasetoffinancialstatementsfromatrialbalance. Thiswillinvolveadjustingforthefollowingitems: closinginventory depreciation accrualsandprepayments irrecoverabledebtsandtheallowanceforreceivables. Oncetheseadjustmentshavebeenmade,theincomestatementand statementoffinancialpositioncanbeprepared. Whenmakingtheadjustmentsitisimportanttoensurethateachtransaction containsthecorrectdoubleentry. Purpose of the trial balance Thepurposeofthetrialbalanceis tocheckthatforeverydebitentrymade,anequalcreditentryhasbeen made asafirststepinpreparingthefinancialstatements. Limitations of the trial balance Althoughthetrialbalanceisusefulinensuringthatdoubleentryhasbeen maintained,itwillnot: 144 identifyerrorssuchasmispostingstothewrongaccountoradouble entryforthewrongamount KAPLANPUBLISHING

153 chapter9 identifywhereerrorshavebeenmade,orwhatthoseerrorsare. 2Adjustments Hereisareminderoftheaccountingentriesfortheadjustmentsrequired whenpreparingthefinancialstatements: Closinginventory DrInventory(SFP) CrCostofsales(IS) Withtheclosinginventoryattheendoftheperiod. Depreciation DrDepreciationexpense(IS) CrAccumulateddepreciation(SFP) Withdepreciationchargefortheyearforeachclassofasset. Accruals DrExpenses(IS) CrAccrual(Liability)(SFP) Witheachaccruedexpense. Prepayments DrPrepayment(Receivables)(SFP) CrExpenses(IS) Witheachprepaidexpense. Irrecoverabledebts DrIrrecoverabledebtexpense(IS) CrReceivables(SFP) Withthetotalofreceivableswrittenoff. KAPLANPUBLISHING 145

154 Fromtrialbalancetofinancialstatements Allowanceforreceivables DrIrrecoverabledebtexpense(IS) CrAllowanceforreceivables(SFP) Withtheincreaseordecreaseintheallowancefortheperiod. Illustration 1 Preparation of financial statements Inthisexample,wewillaccountfortheperiod endadjustmentsand prepareasetoffinancialstatementsfromatb. ThetrialbalanceofTyndallat31May206isasfollows: Trial balance of Tyndall at 31 May 206 Capitalaccount Drawingsbyproprietor Purchases Returnsinwards Returnsoutwards Discounts Creditsales Cashsales Customsduty Carriageinwards Carriageoutwards Salesman scommission Salesman ssalary Officesalaries Bankcharges Loaninterest Lightandheat Sundryexpenses ,258 5,970 73,010 1,076 1,870 3, ,520 30,296 11,760 2,930 1, ,970 7, ,653 2,100 KAPLANPUBLISHING

155 chapter 9 Rent 3,315 Insurance 4,000 Printing and postage 2,103 Advertising 1,044 Irrecoverable debts 1,791 Allowance for receivables 437 Receivables 10,760 Payables 7,411 Cash at bank 2,634 Cash in hand 75 New delivery van (less trade in) 2,200 Motor expenses 986 Furniture and equipment: Cost 8,000 Depreciation at 1 June 205 2,400 Old delivery van: Cost 2,000 Depreciation at 1 June 205 1,000 Loan account at 9% (repayable in five years) 5, , ,007 The following information is relevant: (1) Closing inventory has been valued for accounts purposes at 8,490. (2) The motor van was sold on 31 August 205 and traded in against the cost of a new van. The trade in price was 1,400 and the cost of the new van was 3,600. No entries have yet been made for this transaction apart from debiting the 2,200 cash paid to the New delivery van account. (3) Straight line depreciation is to be provided on a monthly basis at the following annual rates: Motor vans 25% Furniture and equipment 10% (4) Past experience indicates that an allowance for receivables should be made equivalent to 5% of the closing receivables. (5) An accrual of 372 is required in respect of light and heat. KAPLAN PUBLISHING 147

156 Fromtrialbalancetofinancialstatements (6) Aquarter srentto30june206amountingto900waspaidon2 April206.Insurancefortheyearto31March207amountingto 1,680waspaidon16April. Prepareanincomestatementandastatementoffinancialpositionfor theyearended31may206. Expandable text Test your understanding 1 KevinSuricarriesonbusinessasaretailtrader.Thetrialbalanceofhis businessasat31december205wasasfollows: Dr Capital Salesandpurchases Inventoryat1January205 Returns Wages Rent Motorexpenses Insurance Irrecoverabledebts Allowanceforreceivables 1January205 Discounts Lightandheat Bankoverdraftinterest Motorvehiclesatcost aggregatedepreciation 1Jan205 Fixturesandfittingsatcost aggregatedepreciation 1Jan205 Land Receivablesandpayables ,800 23,340 1,200 46,160 13,000 3, , ,000 Cr 225, ,200 1, ,622 12,240 28,000 16, ,000 17,330 23,004 KAPLANPUBLISHING

157 chapter 9 Dr Cr Bank 3,412 Buildings at cost 100,000 aggregate depreciation 1 Jan 205 6,000 Drawings 20, , ,654 You are given the following additional information: (1) Inventory at 31 December 205 was 25,680. (2) Rent was prepaid by 1,000 and light and heat owed was 460 at 31 December 205. (3) Land is to be revalued to 250,000 at 31 December 205. (4) Following a final review of the receivables at 31 December 205, Kevin decides to write off another debt of 130. He also wishes to maintain the allowance for receivables at 3% of the year end balance. (5) Depreciation is to be provided as follows: (a) building 2% annually, straight line (b) fixtures & fittings straight line method, assuming a useful economic life of five years with no residual value (c) motor vehicles 30% annually on a reducing balance basis. A full year s depreciation is charged in the year of acquisition and none in the year of disposal. Prepare an income statement for the year ended 31 December 205 and a statement of financial position as at that date for Kevin Suri. KAPLAN PUBLISHING 149

158 Fromtrialbalancetofinancialstatements Chapter summary 150 KAPLANPUBLISHING

159 chapter9 Test your understanding answers Test your understanding 1 Kevin Suri Income statement for the year ended 31 December ,200 (1,200) 364,000 Sales Returnsin Costofsales OpeningInventory Purchases Returnsout Closinginventory 23, ,800 (1,600) 288,540 (25,680) (262,860) 101,140 1, ,834 Grossprofit Sundryincome Discountreceived Expenses Wages Rent(13,000 1,000) Motorexpenses Insurance Irrecoverabledebts( ) Discountsallowed Lightandheat(3, ) Bankinterest KAPLANPUBLISHING 46,160 12,000 3, ,

160 Fromtrialbalancetofinancialstatements Depreciation Buildings(W1) Fixturesandfittings(W1) Motorvehicles(W2) 2,000 5,600 3,528 (78,490) 24,344 Netprofit OtherComprehensiveIncome RevaluationGain TotalComprehensiveIncome 150, ,344 Statement of financial position as at 31 December 205 Non currentassets Land Buildings Fixturesandfittings Motorvehicles Currentassets Inventory Receivables(17, ) Allowanceforreceivables (17,2003%) 152 Cost Accdep n 250, ,000 8,000 28,000 22,400 24,000 15, , ,000 NBV 250,000 92,000 5,600 8,232 46,168 25,680 17,200 (516) 16,684 KAPLANPUBLISHING

161 chapter9 Prepaidexpenses(rent) Bank Capital Profit Revaluationreserve/surplus (250, ,000) Drawings Currentliabilities Payables Accruedexpenses (lightandheat) Cost Accdep n 1,000 3,412 46, ,608 NBV 225,600 24, ,000 (20,800) 379,144 23, , ,608 Working Cost Accumulateddepreciation NBV Depreciationrate Annualdepreciationcharge Motorvehicles 24,000 (12,240) 11,760 x30% 3,528 KAPLANPUBLISHING 153

162 From trial balance to financial statements 154 KAPLAN PUBLISHING

163 chapter 10 Books of prime entry and control accounts Chapter learning objectives Upon completion of this chapter you will be able to: identify the main data sources and records in an accounting system describe the contents and purpose of different types of business documentation outline the form of accounting records in a typical manual system record credit sale and purchase transactions (with and without sales tax) using day books post day book totals to the ledger accounts explain the division of the ledger into sections explain the nature and purpose of control accounts for the accounts receivable and accounts payable ledgers account for contras between trade receivables and payables record cash transactions using the cash book explain the need for a record of petty cash transactions illustrate the typical format of the petty cash book explain the importance of using the imprest system to control petty cash list the necessary controls and security over petty cash that would normally be found in a business explain the uses of the journal illustrate the use of the journal and the posting of journal entries into ledger accounts. 155

164 Booksofprimeentryandcontrolaccounts 1Business documentation Thetablebelowsummarisesthemaintypesofbusinessdocumentationand sourcesofdataforanaccountingsystem,togetherwiththeircontentand purpose. Contents Purpose Quotation Quantity/description/detailsof Toestablishpricefrom goodsrequired. varioussuppliersandcross refertopurchase requisition. Purchase order Detailsofsupplier,e.g.name, Senttosupplierasrequest address.quantity/ forsupply.tochecktothe description/detailsofgoods quotationanddeliverynote. requiredandprice.termsand conditionsofdelivery, payment,etc. Sales order Quantity/description/detailsof Crosscheckedwiththe goodsrequiredandprice. orderplacedbycustomer. Senttothe stores/warehouse departmentforprocessing oftheorder. Delivery Detailsofsupplier,e.g.name Providedbysupplier. note (goods andaddress.quantityand Checkedwithgoods delivery note descriptionofgoods receivedandpurchase GDN) order. Goods received note (GRN) 156 Quantityanddescriptionof goods. Producedbycompany receivingthegoodsas proofofreceipt.matched withdeliverynoteand purchaseorder. KAPLANPUBLISHING

165 chapter10 Purchase invoice Detailsofsupplier,e.g.nameand address.containsdetailsof goods,e.g.quantity,price,value, salestax,termsofcredit,etc. Issuedbysupplieras requestforpayment. Crosscheckedwith deliverynote,and purchaseorder. Statement Statement Detailsofsupplier,e.g.name andaddress.hasdetailsofdate, invoicenumbersandvalues, paymentsmade,refunds,amount owing. Issuedbythesupplier. Checkedwithother documentstoensure thattheamountowingis correct. Credit note Detailsofsupplier,e.g.nameand address.containsdetailsof goodsreturned,e.g.quantity, price,value,salestax,termsof credit,etc. Issuedbythesupplier. Checkedwith documentsregarding goodsreturned. Debit note Detailsofthesupplier.Contains detailsofgoodsreturned,e.g. quantity,price,value,salestax, termsofcredit,etc. Issuedbythecompany receivingthegoods. Crossreferredtothe creditnoteissuedbythe supplier. Remittance advice Methodofpayment,invoice number,accountnumber,date, etc. Senttosupplierwith,or asnotificationof, payment. Receipt Detailsofpaymentreceived. Issuedbytheselling companyindicatingthe paymentreceived. 2Accounting records KAPLANPUBLISHING 157

166 Booksofprimeentryandcontrolaccounts Booksofprimeentry Ifledgerswereupdatedeachtimeatransactionoccurred,theledger accountswouldquicklybecomeclutteredanderrorsmightbemade. Toavoidthis,alltransactionsareinitiallyrecordedinabookofprime entry. Severalbooksofprimeentryexist,eachrecordingadifferenttypeof transaction: Book of prime entry Transaction type Salesdaybook Creditsales Purchasesdaybook Creditpurchases Salesreturnsdaybook Returnsofgoodssoldoncredit Purchasesreturnsdaybook Returnsofgoodsboughtoncredit Cashbook Allbanktransactions Pettycashbook Allsmallcashtransactions Thejournal Alltransactionsnotrecordedelsewhere Entryofatransactiontoabookofprimeentrydoesnotrecordthe doubleentryrequiredforthattransaction. Thebookofprimeentryis,however,thesourcefordoubleentriestothe ledgeraccounts. Thedoubleentryarisingfromthebookofprimeentrywillberecorded periodically(daily,weekly,monthly)dependingonthevolumeof transactions. 3Ledger accounts and the division of the ledger Inamanualsystem,ledgerscanbethoughtofasbookscontainingthe individualaccounts: Thegeneral ledgercontainsallaccountsorasummaryofallaccounts necessarytoproducethetrialbalanceandfinancialstatements. Theaccounts receivable ledgercontainsanaccountforeachcredit customertoshowhowmucheachoneowes. Anaccounttosummarisethisinformation,thereceivables control account,isnormallycontainedwithinthegeneralledger. 158 KAPLANPUBLISHING

167 chapter10 Theaccounts payable ledgercontainsanaccountforeachcredit suppliertoshowhowmuchtheyareowed. Anaccounttosummarisethisinformation,thepayables control account,isnormallycontainedwithinthegeneralledger. Wherethereareindividualaccountsinareceivablesorpayablesledger ANDacontrolaccountinthegeneralledger,onlyonecanformpartofthe doubleentrysystem.theotherexistsformemorandumpurposes.itis normallythecasethatthecontrolaccountsformpartofthedoubleentry. Expandable text 4Sales and purchases day books Sales day book Date Invoice Customer Jake Bella Fizz Milo Max LedgerRef RL3 RL18 RL6 RL1 RL12 4,500 3,000 2,200 10, ,200 Totalfor4.1.6 Theformatofthedoubleentryresultingfromthesalesdaybookwilldepend uponwhethertheindividualaccountsintheaccountsreceivableledgeror thereceivablescontrolaccountinthegeneralledgerispartofthedouble entrysystem: KAPLANPUBLISHING 159

168 Booksofprimeentryandcontrolaccounts Purchases day book, sales returns day book and purchases returns day book Theformatoftheremainingdaybooksissimilartothatofthesalesday book.thedoubleentriesarisingare: Individual accounts part of double entry Control accounts part of double entry Purchases day book DrPurchases.Cr DrPurchases.CrPayablesledger Individualaccountsin controlaccount.eachentryalso accountspayable postedtoindividualmemorandum ledger. accountsinaccountspayable ledger. Sales returns DrSalesreturns.Cr DrSalesReturns.CrReceivables day book Individualaccountsin ledgercontrolaccount.eachentry accountsreceivable alsopostedtoindividual ledger. memorandumaccountsinaccounts Receivablesledger. Purchases returns day book DrIndividual accountsinaccounts payableledger.cr Purchasesreturns. DrPayablesledgercontrolaccount. CrPurchases.Eachentryalso postedtoindividualmemorandum accountsinaccountspayable ledger. Expandable text Expandable text Expandable text 5Sales tax in day books Ifabusinessisregisteredforsalestax,thesalesandpurchasesdaybooks mustincludeentriestorecordthetax. 160 KAPLANPUBLISHING

169 chapter10 Illustration 1 Sales tax in day books Sales day book Date Invoice Customer Ledger Ref Spencer Archie J1 S5 Gross Salestax Net , , Purchases day book Date Customer Peggy Zena Ledger Ref Y1 Z8 Gross 1, , Salestax Net 1, ,800 Expandable text Test your understanding 1 ThefollowingsalesinvoiceshavebeenissuedbyQuincy.inJuly: Date Customer InvNo Ledgerref. Salestax 8July Simpson 1100 A (includingsalestax) 10July Burns 1101 B5 1,300(excludingsalestax) Quincyisregisteredforsalestax,appliedatarateof17.5% KAPLANPUBLISHING 161

170 Booksofprimeentryandcontrolaccounts Whatdoubleentryarisesfromthedaybook? A Receivablesledgercontrolaccount Salestax B Receivablesledgercontrolaccount C Receivablesledgercontrolaccount Salestax D Receivablesledgercontrolaccount Dr 1, Sales , Sales Salestax 1, Sales , Sales Salestax Cr 2, , , , Control accounts Controlaccountsareledgeraccountsthatsummarisealargenumberof transactions. Thereceivablesledgercontrolaccountmayincludeanyofthefollowing entries: Receivables ledger control account Balanceb/f Creditsales(SDB) Bank(CB)dishonouredcheques Bank(CB)refundsofcredit balances Balanceb/f Salesreturns(SRDB) Bank(CB) Irrecoverabledebts (journal) Discountsallowed Balancec/f Balanceb/f 162 Contra Balancec/f Balanceb/f KAPLANPUBLISHING

171 chapter10 Thepayablesledgercontrolaccountmayincludeanyofthefollowing entries: Payables ledger control account Balanceb/f Bank(CB) Purchasesreturns(PRDB) Discountsreceived Balancec/f Balanceb/f Balanceb/f Creditpurchases(PDB) Bank(CB)refundsofdebit balances Balancec/f Balanceb/f SDBSalesdaybook PDBPurchasesdaybook SRDBSalesreturnsdaybook PRDBPurchasesreturnsdaybook CBCashbook Note that any entries to the control accounts must also be reflected in the individual accounts within the accounts receivable and payable ledgers. Contra entries Thesituationmayarisewhereacustomerisalsoasupplier.Insteadofboth owingeachothermoney,itmaybeagreedthatthebalancesarecontra d, i.e.cancelled. Thedoubleentryforthistypeofcontrais: DrPayablesledgercontrolaccount CrReceivablesledgercontrolaccount Theindividualreceivableandpayableaccountsmustalsobeupdatedto reflectthis. KAPLANPUBLISHING 163

172 Booksofprimeentryandcontrolaccounts Credit balances on the receivables ledger control account Sometimesthereceivablesledgercontrolaccountmayshowacredit balance,i.e.weowethecustomermoney.theseamountsareusuallysmall andarisewhen: Thecustomerhasoverpaid. Creditnoteshavebeenissuedforfully paid forgoods. Paymentisreceivedinadvanceofraisinginvoices. Thepayablesledgercontrolaccountmayshowadebitbalanceforsimilar reasons. Test your understanding 2 JonespreparesmonthlyReceivablesandPayablesledgercontrol accounts.at1november2005thefollowingbalancesexistedinthe company srecords. Receivablesledgercontrolaccount Payablesledgercontrolaccount Dr 54, Cr 1,000 43,000 ThefollowinginformationisextractedinNovember2005fromthe company srecords: Creditsales Cashsales Creditpurchases Cashpurchases Creditsalesreturns Creditpurchasesreturns Amountsreceivedfromcreditcustomers Dishonouredcheques Amountspaidtocreditsuppliers Cashdiscountsallowed Cashdiscountsreceived Irrecoverabledebtswrittenoff Increaseinallowancesforreceivables Interestchargedtocustomers Contrasettlements ,000 34,000 77,000 29,000 11,000 3, , ,000 3,000 2,000 1,000 1,200 1, KAPLANPUBLISHING

173 chapter10 At30November2005thebalancesintheReceivablesandPayables ledgers,asextracted,totalled: Receivablesledgerbalances Payablesledgerbalances Dr Tobecalculated 200 Cr 2,000 Tobecalculated Preparethereceivablesledgercontrolaccountandthepayablesledger controlaccountforthemonthofnovember2005todeterminethe closingdebitandclosingcreditbalancesonthereceivablesledger controlaccountandpayablesledgercontrolaccountrespectively. 6The cash book Alltransactionsinvolvingcashatbankarerecordedinthecashbook. Anoteofcashdiscountsgivenandreceivedisalsorecordedinthe cashbook.thisistofacilitatetherecordingofdiscountsinboththe generalandaccountspayable/receivableledgers. Itiscommonforbusinessestouseacolumnarformatcashbookin ordertoanalysetypesofcashpaymentandreceipt. Manybusinesseshavetwodistinctcashbooks acash payments bookandacash receipts book. Illustration 2 The cash book Thecashpaymentsbook Thefollowingisthecashpaymentsbookofasmallprintbusiness. Date Detail MrA Office MrB MrC Shop Bank Discount Payables ledger 1, ,400 3, , , , ,210 Rent 3, ,400 Whataretheaccountingentriesarisingfromthetotalsinthecashbook attheendoftheday,assumingcontrolaccountsarekept? KAPLANPUBLISHING 165

174 Booksofprimeentryandcontrolaccounts Expandable text Test your understanding 3 ThefollowingisthecashreceiptsbookoftheSMArtGallery. Date Detail CMonet InterestAcc# VVGogh InterestAcc# PPicasso Bank received 10, Discount Receivables Rent ledger , , ,700 48,820 25, ,700 48, Whataretheaccountingentriesarisingfromthetotalsinthecashbook attheendoftheday,assumingcontrolaccountsarekept? 7The petty cash book Alltransactionsinvolvingsmallamountsofpettycasharerecordedin thepettycashbook. Thepettycashsystemisusuallydesignedtodealwithsundrysmall paymentsincashmadebyabusiness,e.g.payingthemilkman, purchasingbiscuits,buyingstationeryorreimbursingtravelexpenses. Thecashreceiptswillberecordedtogetherwiththepaymentswhich willbeanalysedinthesamewayasacashbook. The imprest system Thebestwayofdealingwithpettycashisbymeansofanimprestsystem, whichworksasfollows. Step 1 Thebusinessdecidesontheamountofcashtobeheldasafloat. DrPettycash CrBank 166 KAPLANPUBLISHING

175 chapter10 Thisroundsumamountwillbereferredtoasthe pettycashfloat. Step 2 Asthepettycashiermakespaymentsherecordstheseinthepettycash book,whichisnotpartofthedoubleentrysystem.allexpendituremustbe evidencedbyanexpensereceiptandthepettycashierwillattachan expensevouchertoeachexpense. Step 3 Whenthepettycashrunslow,achequeisdrawntoreturnthepettycashto theexactamountoftheoriginalfloat.atthisstagetheexpensevouchers shouldbeproducedbythepettycashiertothechequesignatorywhichwill exactlyequalthechequerequired. Thisaspectofcontrolistheessentialfeatureofthepettycashsystem.At anystage: Float = Cash in petty cash box + sum total of expense vouchers since last reimbursement Controls over petty cash Thefollowingcontrolsandsecurityoverpettycashshouldbefoundina business: Pettycashmustbekeptinapettycashbox. Allpettycashmustbesupportedbyinvoices. Regularspotchecksmustbecarriedouttoensurethatthepettycashis accurate. Pettycashboxmustbesecuredinasafe. Personresponsibleforpettycashmustbereliableandknowwhat he/sheisdoing. Pettycashvouchersmustbesignedbytheclaimantandtheperson responsibleforrunningthepettycash. KAPLANPUBLISHING 167

176 Booksofprimeentryandcontrolaccounts Illustration 3 The petty cash book On1March209apettycashfloatof100isintroducedbyDialex. DuringMarchthefollowingpaymentsaremadeoutofpettycash: 2March 8March 11March 16March 25March Biscuits Stationery Busfare Trainfare Stationery On31Marchthecashisreimbursed.Writeupthepettycashbookfor themonthandshowtheresultingentriestothegeneralledger. Expandable text 8The journal Thejournalisabookofprimeentrywhichrecordstransactionswhichare notroutine(andnotrecordedinanyotherbookofprimeentry),forexample: year endadjustments depreciationchargefortheyear irrecoverabledebtwrite off recordmovementinallowanceforreceivables accrualsandprepayments closinginventory acquisitionsanddisposalsofnon currentassets openingbalancesforbalancesheetitems correctionoferrors. Thejournalisaclearandcomprehensiblewayofsettingoutabookkeeping doubleentrythatistobemade. Presentation of a journal Ajournalshouldbelaidoutinthefollowingway: DrNon currentasset CrCash 168 KAPLANPUBLISHING

177 chapter10 torecordthepurchaseofanewnon currentasset. Abriefnarrativeshouldbegiventoexplaintheentry. Test your understanding 4 IgorRomanovrunsaRussianrestaurant.Heisaverygoodchefbutnot quitesogoodataccountingandneedshelptorecordthefollowing transactions: (1) Closinginventoryof250bottlesofvodkaatacostof2,750hasnot beenrecorded. (2) Igorneedstochargedepreciationonhisrestaurant.Heholdsa25 yearleasewhichcosthim150,000tenyearsago. (3) Aregularcustomer,VShady,keepsatabbehindthebar.He currentlyowes350butwaslastseenbuyingaone wayticketto Moscow.Igorhasgivenuphopeofpaymentandintendstowritethe debtoff. (4) OnthelastdayoftheyearIgorboughttwonewsofasforcashforthe barareaoftherestaurant.theycost600eachbutthepurchase hasnotbeenreflectedintheaccounts. WhatjournalsshouldIgorpost? KAPLANPUBLISHING 169

178 Booksofprimeentryandcontrolaccounts Chapter summary 170 KAPLANPUBLISHING

179 chapter10 Test your understanding answers Test your understanding 1 ThecorrectanswerisD Salesdaybook Date 8July 10July Customer Invoice Simpson 1100 Burns 1101 Ledger ref. A8 B5 Gross Salestax Net , , , , Thedoubleentryfortheabovetransactionwillbe: Dr Receivablesledgercontrolaccount Cr Salestax Cr Sales 1, , KAPLANPUBLISHING 171

180 Booksofprimeentryandcontrolaccounts Test your understanding 2 Recievables ledger control account Balanceb/f 54,000 Balanceb/f 1,000 Creditsales 251,000 Salesreturns 11,000 Dishonoured cheques 500 Cashreceived Interestcharged 242,000 1,400 Discounts allowed Irrecoverable debts Contra Balancec/f 3,000 1, ,000 Balancec/f Balanceb/f 50, , ,900 50,100 Balanceb/f 2,000 Payables ledger control account Balanceb/f 200 Balanceb/f Purchasesreturns 3,000 Creditpurchases Cashpaid 74,000 Discounts received 2,000 Contra 43,000 77, Balancec/f 40,200 Balancec/f Balanceb/f , , Balanceb/f 40, KAPLANPUBLISHING

181 chapter10 Test your understanding 3 The cash transactions are recorded in total as follows: DrBank48,820 CrReceivablesledgercontrolaccount48,700 CrInterestincome120 Thediscountisrecordedasfollows: DrDiscountsallowed800 CrReceivablesledgercontrolaccount800 EntriesmustalsobemadetoMonet,GoghandPicasso sindividual accountsintheaccountsreceivableledgerinordertoreflectthe paymentsreceivedanddiscountsallowed. KAPLANPUBLISHING 173

182 Booksofprimeentryandcontrolaccounts Test your understanding 4 (1) DrClosinginventory(statementoffinancialposition)2,750 CrClosinginventory(costofsales)2,750 Torecordtheclosinginventoryofvodka. (2) DrDepreciationexpense6,000(150,000/25yrs) CrAccumulateddepreciation6,000 Torecorddepreciationontherestaurantlease. (3) DrIrrecoverabledebtexpense350 CrReceivablesledgercontrolaccount350 Torecordthewrite offofadebtoutstandingfromvshady. NBIgormustalsoremembertoupdateVShady sindividualaccountin theaccountsreceivableledger. (4) DrFixturesandFittingscost1,200 CrCash1,200 Torecordthepurchaseoftwosofasforthebar. 174 KAPLANPUBLISHING

183 chapter 11 Control account reconciliations Chapter learning objectives Upon completion of this chapter you will be able to: prepare, reconcile and understand the purpose of supplier statements identify errors which would be highlighted by performing a control account reconciliation perform basic control account reconciliations for receivables and payables, identifying and correcting errors in control accounts and ledgers. 175

184 Controlaccountreconciliations 1Control accounts 176 Controlaccountsareameansofprovingtheaccuracyoftheledger accounts,suchasreceivablesandpayables. Thediagramaboveshowstheinformationthatisincludedinthe accounts receivables ledger. Ifwewantedtochecktheaccuracyoftheaccountsreceivablesledger, onewaywecandothisisbygettingtheinformationfromdifferent sources: Thesalescanbetakenfromthesalesdaybook. Thecashreceivedanddiscountsallowedarerecordedinthecash book. Theopeningbalancescanbetakenfromthepriormonth sclosing balances. Analternativewaytochecktheaccuracyoftheaccountsreceivables ledgeristocomparethesumtotaloftheindividualreceivables accountswiththebalanceonthereceivablesledgercontrolaccount. Remember,thecontrolaccountisnormallypartofthedoubleentry system,whereastheledgercontainsmemorandumaccountswhichare notpartofthedoubleentrysystem.nevertheless,bothareupdated usingthesamesourcesandthereforeshouldagree. KAPLANPUBLISHING

185 chapter11 2Supplier statements Thesestatementsareissuedtoabusinessbysupplierstosummarisethe transactionsthathavetakenplaceduringagivenperiod,andalsotoshow thebalanceoutstandingattheendoftheperiod. Theirpurposeistoensurethattheamountoutstandingisaccurateand agreeswithunderlyingdocumentation. Thepayablesledgercontrolaccountandindividuallistofpayables balancesshouldagreewiththetotalofthesupplierstatements. Assuch,theseareafurtherwaytoprovetheaccuracyofaccounting records. 3Control account reconciliations Thereconciliationisaworkingtoensurethattheentriesintheledger accountsagreewiththeentriesinthecontrolaccount.thetwoshouldhave thesameclosingbalanceasideallytheyhavehadexactlythesameentries inbothaccounts. Areceivables ledger reconciliationcomparesthetotalofthe accountsinthereceivablesledgerwiththebalanceonthereceivables ledgercontrolaccount. Apayables ledger reconciliationcomparesthetotaloftheaccounts inthepayablesledgerwiththebalanceonthepayablesledgercontrol account. Iftherearedifferencesbetweenthecontrolaccountandtheledger accounts,theymustbeidentifiedandreconciled.differencesmayarisedue to: errorsinthereceivablesorpayablesledger errorsinthereceivablesorpayablesledgercontrolaccounts errorsinboththecontrolaccountandledgeraccount. Test your understanding 1 Suggestreasonswhytheremightbeadifferencebetweenthebalance onthereceivablesledgercontrolaccountandthetotalofthelistof accountsreceivableledgerbalances. KAPLANPUBLISHING 177

186 Controlaccountreconciliations 4Preparing a control account reconciliation Theformatofacontrolaccountreconciliation,inthiscaseforsalesisas follows: Receivables ledger control account Balancegivenbytheexaminer Adjustmentsforerrors Adjustmentsforerrors Revisedbalancec/f Reconciliation of individual receivables balances with control account balance Balanceasextractedfromlistofreceivables Adjustmentsforerrors Revisedtotalagreeingwithbalancec/foncontrolaccount Theexaminerwillprovidedetailsoftheerror(s). /() Youmustdecideforeachwhethercorrectionisrequiredinthecontrol account,thelistofindividualbalancesorboth. Whenallerrorshavebeencorrected,therevisedbalanceonthecontrol accountshouldagreetotherevisedtotalofthelistofindividual balances. DuetothenatureoftheF3exam,youwillnotbeaskedtoproduceafull controlaccountreconciliation,howeveryoumaybeaskedforthe revisedbalanceonthecontrolaccount/listofindividualbalancesafter oneortwoerrorshavebeencorrected. Illustration 1 Preparing a control account reconciliation Alston spayablesledgercontrolaccountisanintegralpartofthedouble entrysystem.individualledgeraccountbalancesarelistedandtotalled onamonthlybasis,andreconciledtothecontrolaccountbalance. InformationforthemonthofMarchisasfollows: (1) Individualledgeraccountbalancesat31Marchhavebeenlistedout andtotalled19,766. (2) Thepayablesledgercontrolaccountbalanceat31Marchis 21, KAPLANPUBLISHING

187 chapter11 (3) Onfurtherexaminationthefollowingerrorsarediscovered: Thetotalofdiscountreceivedforthemonth,amountingto 1,715,hasnotbeenenteredinthecontrolaccountbuthas beenenteredintheindividualledgeraccounts. Onlisting out,anindividualcreditbalanceof205hasbeen incorrectlytreatedasadebit. Apettycashpaymenttoasupplieramountingto63hasbeen correctlytreatedinthecontrolaccount,butnoentryhasbeen madeinthesupplier sindividualledgeraccount. ThepurchasesdaybooktotalforMarchhasbeenundercast (understated)by2,000. Contras(set offs)withthereceivablesledger,amountingintotal to2,004,havebeencorrectlytreatedintheindividualledger accountsbutnoentryhasbeenmadeinthecontrolaccount. (i) Preparethepartofthepayablesledgercontrolaccountreflecting theaboveinformation. (ii) repareastatementreconcilingtheoriginaltotaloftheindividual balanceswiththecorrectedbalanceonthecontrolaccount. Expandable text Test your understanding 2 Rayneydazeisabusinesssellingumbrellasbrandedwithcorporate logos.theumbrellasaresoldinbulklotsoncredit.theaccountantis carryingoutareconciliationofthereceivablesledgercontrolaccount balance,whichis172,120tothetotalofthebalancesontheindividual accountsinthereceivablesledger,whichis176,134. Thefollowinghasbeenfound: (1) Acontraitemof1,500hasnotbeenenteredinthereceivables ledgercontrolaccount. (2) Achequefor555fromacustomerhasbeendishonoured.The correctdoubleentryhasbeenpostedbuttheindividualaccounts havenotbeenupdated. (3) Apaymentof322fromacustomerhasincorrectlybeenenteredin theaccountsreceivableledgeras233. (4) Discountsallowedtotalling120havenotbeenenteredinthe controlaccount. KAPLANPUBLISHING 179

188 Controlaccountreconciliations (5) Cashreceivedof800hasbeendebitedtotheindividual customer saccountintheaccountsreceivableledger. (6) Totalcreditsalesof4,500toalargeaccountancyfirm,Close& Counterhavebeenpostedcorrectlytotheledgeraccountbutnot recordedinthecontrolaccount. Correctthereceivablesledgercontrolaccountandreconcilethistothe sumtotaloftheindividualaccountsintheaccountsreceivableledger. Test your understanding 3 Tongareceivedastatementfromasupplier,Cook,showingabalance of14,810.tonga spayablesledgershowsabalanceduetocookof 10,000.Investigationrevealsthefollowing: (1) CashpaidtoCookof4,080hasnotbeenallowedforbyCook. (2) Tonga srecordedthefactthata40cashdiscountwasnotallowed bycook,butforgottorecordthisinthepayablesledger. WhatdiscrepancyremainsbetweenTongaandCook srecordsafter allowingfortheseitems? A 9,930 B 9,850 C 770 D KAPLANPUBLISHING

189 chapter11 Chapter summary KAPLANPUBLISHING 181

190 Controlaccountreconciliations Test your understanding answers Test your understanding 1 Thefollowingarereasonswhytheaccountsreceivablecontrolaccount maynotagreewiththeledgeraccount: Thesalesdaybook,salesreturnsdaybookorcashreceiptsbook havebeenincorrectlytotalled. Atotalfromabookofprimeentryhasbeentransferredtothecontrol accountasadifferentfigure. Anindividualentryfromabookofprimeentryhasbeentransferred totheindividualcustomer saccountasadifferentfigure. Anentryinthecontrolaccountortheindividualcustomer saccount hasbeenomittedorpostedtothewrongsideoftheaccount. Thedoubleentryforadaybooktotalhasbeenincorrectlymade. Anentryhasbeenmadeineitherthecontrolaccountorthe individualcustomer saccountbutnotinboth. Anindividualcustomer sbalancehasbeenomittedfromthelistof balances. Anindividualcustomer saccounthasbeenincorrectlybalanced. Thelistofaccountsreceivableledgerbalanceshasbeenincorrectly totalled. 182 KAPLANPUBLISHING

191 chapter11 Test your understanding 2 Receivables ledger control account Balanceb/f Creditsales(6) 172,120 4,500 Contra(1) 1,500 Discounts(4) Balancec/f , , ,620 Balanceb/f 175,000 Sales Ledger Reconciliation Balanceper accounts receivableledger 176,134 Dishonoured cheque(2) 555 Misposting(3) (89) Cashreceived(5) (1,600) Revisedbalance 175,000 Test your understanding 3 The correct answer is D. Cook Difference Balanceperquestion Adjustment Revisedbalance Tonga 14,810 (4,080) 10,730 10, , KAPLANPUBLISHING 183

192 Control account reconciliations 184 KAPLAN PUBLISHING

193 chapter 12 Bank reconciliations Chapter learning objectives Upon completion of this chapter you will be able to: describe the purpose of bank reconciliations identify the main differences between the cash book and the bank statement identify the bank balance to be reported in the final accounts correct cash book errors or omissions prepare bank reconciliation statements derive bank statement and cash book balances from given information. 185

194 Bankreconciliations 1The bank reconciliation Theobjectiveofabankreconciliationistoreconcilethedifferencebetween: thecashbookbalance,i.e.thebusiness recordoftheirbankaccount, and thebankstatementbalance,i.e.thebank srecordsofthebank account. Notethatdebitsandcreditsarereversedinbankstatementsbecausethe bankwillberecordingthetransactionfromitspointofview,inaccordance withthebusinessentityconcept. Expandable text 2Differences between the bank statement and the cash book Whenattemptingtoreconcilethecashbookwiththebankstatement,two typesofdifferencemaybefound: 186 unrecordeditems timingdifferences. KAPLANPUBLISHING

195 chapter12 Unrecorded items Theseareitemswhichariseinthebankstatementsbeforetheyare recordedinthecashbook.such unrecordeditems mayinclude: interest bankcharges dishonouredcheques. Theyarenotrecordedinthecashbooksimplybecausethebusinessdoes notknowthattheseitemshavearisenuntiltheyseethebankstatement. Thecashbookmustbeadjustedtoreflecttheseitems. Test your understanding 1 Onwhichsideofthecashbookshouldthefollowingunrecordeditems beposted? bankcharges directdebits/standingorders directcredits dishonouredcheques bankinterest. Timing differences Theseitemshavebeenrecordedinthecashbook,butduetothebank clearingprocesshavenotyetbeenrecordedinthebankstatement: Outstanding/unpresentedcheques(chequessenttosuppliersbutnot yetclearedbythebank). Outstanding/unclearedlodgements(chequesreceivedbythebusiness butnotyetclearedbythebank). Thebankstatementbalanceneedstobeadjustedfortheseitems: Balanceperbankstatement Less:Outstanding/unpresentedcheques Add:Outstanding/unclearedlodgements Balancepercashbook(revised) KAPLANPUBLISHING () 187

196 Bankreconciliations 2.3 Errors in the cash book Thebusinessmaymakeamistakeintheircashbook.Thecashbook balancewillneedtobeadjustedfortheseitems. Errors in the bank statement Thebankmaymakeamistake,e.g.recordatransactionrelatingtoa differentpersonwithinourbusiness bankstatement.thebankstatement balancewillneedtobeadjustedfortheseitems. Expandable text 3Proforma bank reconciliation Cash book Balb/f Adjustments Revisedbalc/f Revisedbalb/f Balb/f Adjustments Revisedbalc/f Revisedbalb/ Bank reconciliation statement as at.. Balanceperbankstatement Outstandingcheques Outstandinglodgements Otheradjustmentstothebankstatement Balancepercashbook(revised) () /() 188 Bewareofoverdrawnbalancesonthebankstatement. Bewareofdebits/creditstobankstatements. Bewareofaggregationofdepositsinabankstatement. Note that the bank balance on the balance sheet is always the balance per the revised cash book. KAPLANPUBLISHING

197 chapter12 Test your understanding 2 Inpreparingacompany sbankreconciliationstatement,theaccountant findsthatthefollowingitemsarecausingadifferencebetweenthecash bookbalanceandbankstatementbalance: (1) Directdebit530. (2) Lodgementsnotcredited1,200. (3) Chequepaidinbythecompanyanddishonoured234. (4) Outstandingcheques677. (5) Bankcharges100. (6) Errorbybank2,399(chequeincorrectlycreditedtotheaccount. Whichoftheseitemswillrequireanentryinthecashbook? A 3,4and6 B 1,3and5 C 1,2and4 D 2,5and6 KAPLANPUBLISHING 189

198 Bankreconciliations Test your understanding 3 ThefollowinginformationhasbeenextractedfromtherecordsofN Patel: Bank account 1Dec 2Dec Balance b/f Able Baker 10Dec Charlie 14Dec Delta 21Dec Echo 23Dec Cash sales Fred 30Dec ,491 1 Dec Dec 1, Dec 2, Dec Dec Dec 529 Chq no Alexander Burgess Barry Cook Hay Rent Balance Dec c/f 22,262 19,973 22,262 KAPLANPUBLISHING

199 chapter12 High Street Bank Bank Statement N. Patel Date Details WithdrawalsDepositsBalance 1December Balanceb/f 17,478 2December December ,315 2December Deposit ,491 5December ,587 5December Bankcharges 47 6December Deposit 2,065 17,652 17,515 10December Standingorder(rates) ,303 11December December Deposit 2,312 19,615 19,104 17December December Deposit ,523 23December Deposit ,850 24December Deposit ,378 28December ,035 30December ,738 31December Balancec/f 19,738 (a) Prepareabankreconciliationstatementat1December. (b) UpdatethecashbookforDecember. (c) Prepareabankreconciliationstatementat31December. Test your understanding 4 ThefollowingisasummaryofAmi scashbookaspresentedtoyoufor themonthofdecember206: Receipts Balancec/f 1,469 Balanceb/f 554 Payments 2, ,262 2,023 Allreceiptsarebankedandpaymentsmadebycheque. KAPLANPUBLISHING 191

200 Bank reconciliations On investigation you discover: (1) Bank charges of 136 entered on the bank statement had not been entered in the cash book. (2) Cheques drawn amounting to 267 had not been presented to the bank for payment. (3) A cheque for 22 had been entered as a receipt in the cash book instead of as a payment; (4) A cheque drawn for 6 had been incorrectly entered in the cash book as 66. What balance is shown on the bank statement at 31 December 206? A 913 B 941 overdraft C 941 D 407 overdraft 192 KAPLAN PUBLISHING

201 chapter12 Chapter summary KAPLANPUBLISHING 193

202 Bankreconciliations Test your understanding answers Test your understanding 1 Cash book Bankinterest Directcredits Bankcharges Directdebits/ standingorders Dishonoured cheques Test your understanding 2 ThecorrectanswerisB 194 KAPLANPUBLISHING

203 chapter12 Test your understanding 3 Bankreconciliationstatementasat1December Balanceperbankstatement Less:Outstandingcheques( ) Add:Outstandinglodgements Balancepercashbook 17,478 (1,163) ,491 Bank Balanceb/f Error cheque 783 ( ) 19,973 Deposit difference ( ) Bankcharges Rates s/order Revisedbalance c/f 19,982 19,797 Revisedbalance b/f Bankreconciliationstatementasat31December Balanceperbankstatement Less:Outstandingcheques(97+260) Add:Outstandinglodgements(Fred) Bankerror(Cheque310923) Balancepercashbook ,797 19,982 19,738 (357) ,797 KAPLANPUBLISHING 195

204 Bankreconciliations Test your understanding 4 The correct answer is D Cash book Adjustmentre cheque(4) 60 Balanceb/f Balancec/f 674 Bankcharges(1) Adjustmentre paidcheque enteredas receipt(3) Balanceb/f 674 Bank reconciliation statement as at 31 December 206 Balanceperbankstatementat31December206 (407)O/D (derived) Less:Chequesissuedbutnotyetpresented(2) (267) Balancepercashbookat31Dec206 (674)O/D 196 KAPLANPUBLISHING

205 chapter 13 Correction of errors and suspense accounts Chapter learning objectives Upon completion of this chapter you will be able to: identify the types of error which may occur in bookkeeping systems identify errors which would not be highlighted by the extraction of a trial balance identify errors leading to the creation of a suspense account. describe the purpose of a suspense account prepare journal entries to correct errors and clear out a suspense account prepare statements correcting profit for errors discovered. 197

206 Correctionoferrorsandsuspenseaccounts 1Type of error 198 KAPLANPUBLISHING

207 chapter13 Errors where the trial balance still balances Error of omission:atransactionhasbeencompletelyomittedfrom theaccountingrecords,e.g.acashsaleof100wasnotrecorded. Error of commission:atransactionhasbeenrecordedinthewrong account,e.g.ratesexpenseof500hasbeendebitedtotherent accountinerror. Error of principle:atransactionhasconceptuallybeenrecorded incorrectly,e.g.anon currentassetpurchaseof1,000hasbeen debitedtotherepairexpenseaccountratherthananassetaccount. Compensating error:twodifferenterrorshavebeenmadewhich canceleachotherout,e.g.arentbillof1,200hasbeendebitedtothe rentaccountas1,400andacastingerroronthesalesaccounthas resultedinsalesbeingoverstatedby200. Error of original entry:thecorrectdoubleentryhasbeenmadebut withthewrongamount,e.g.acashsaleof76hasbeenrecordedas 67. Reversal of entries:thecorrectamounthasbeenpostedtothe correctaccountsbutonthewrongside,e.g.acashsaleof200has beendebitedtosalesandcreditedtobank. Whencorrectingtheseerrors,agoodapproachistoconsider: (1) Whatwasthedoubleentry?( diddo ). (2) Whatshouldthedoubleentryhavebeen?( shoulddo ). (3) Thereforewhatcorrectionisrequired?( tocorrect ). Alwaysassumethatifonesideofthedoubleentryisnotmentioned,ithas beenrecordedcorrectly. Test your understanding 1 Providethejournaltocorrecteachofthefollowingerrors: (1) Acashsaleof100wasnotrecorded. (2) Ratesexpenseof500,paidincashhasbeendebitedtotherent accountinerror. (3) anon currentassetpurchaseof1,000oncredithasbeendebited totherepairsexpenseaccountratherthananassetaccount. (4) Arentbillof1,200paidincashhasbeendebitedtotherent accountas1,400andacastingerroronthesalesaccounthas resultedinsalesbeingoverstatedby200. (5) Acashsaleof76hasbeenrecordedas67. KAPLANPUBLISHING 199

208 Correctionoferrorsandsuspenseaccounts (6) Acashsaleof200hasbeendebitedtosalesandcreditedto cash. Errors where the trial balance does not balance Singlesidedentry adebitentryhasbeenmadebutnocorresponding creditentryorviceversa. Debitandcreditentrieshavebeenmadebutatdifferentvalues. Twoentrieshavebeenmadeonthesameside. Anincorrectadditioninanyindividualaccount,i.e.miscasting. Openingbalancehasnotbeenbroughtdown. Extractionerror thebalanceinthetrialbalanceisdifferentfromthe balanceintherelevantaccount. Ifthereisadifferenceonthetrialbalance,thenasuspenseaccountisused tomakethetotaldebitsequalthetotalcredits: Non currentassets Receivables Inventory Cash Payables Loan Capital Suspenseaccount 5, , , ,000 4, ,750 Thebalanceonthesuspenseaccountmustbeclearedbeforefinalaccounts canbeprepared. Correctionstoanyofthesixerrorsmentionedabovewillaffectthe suspenseaccount. Approachtoquestions: Taketheapproachasbefore. Usethesuspenseaccounttomakethe diddo Dr=the diddo Crand thenpartofthecorrectionjournalwillbetoreversethissuspense accountentry. E.g.Thepurchaseofanon currentassetcosting100hasbeenrecorded bydebiting10tothenon currentassetsaccountandcrediting100to cash. 200 KAPLANPUBLISHING

209 chapter13 What was the double entry? ('Did do') DrNon current assets (Drsuspense CrCash What should the Correcting journal double entry have been? ('Should do') 10DrNon current 100DrNon current 90 assets assets 90)CrCash 100CrSuspense Whereanopeningbalancehasnotbeenbroughtdown,journalitinand sendtheoppositeentrytosuspense. Thecorrectionjournalmustalwaysincludeanequaldebitandcredit. Expandable text Test your understanding 2 Thedebitsideofacompany stbtotals1,200morethanthecredit side.whichofthefollowingerrorswouldfullyaccountforthedifference? A Thepettycashbalanceof1,200hasbeenomittedfromtheTB. B Areceiptof1,200forcommissionreceivablehasbeenomitted fromtherecords. C 600paidforplantmaintenancehasbeencorrectlyenteredintothe cashbookandcreditedtotheplantcostaccount. D Discountreceivedof600hasbeendebitedtothediscountallowed account. Test your understanding 3 Bond stbfailedtoagreeandasuspenseaccountwasopenedforthe difference.bonddoesnotmaintaincontrolaccountsforsalesand purchases.thefollowingerrorswerefoundinbond saccounting records: (1) Inrecordingthesaleofanon currentasset,cashreceivedof 33,000wascreditedtothedisposalsaccountas30,000. (2) Anopeningaccrualof340hadbeenomittedfromtheTB. (3) Cashof8,900paidforplantrepairswascorrectlyaccountedforin thecashbookbutwascreditedtotheplantcostaccount. (4) Achequefor12,000paidforthepurchaseofamachinewas debitedtothemachineryaccountas21,000. KAPLANPUBLISHING 201

210 Correctionoferrorsandsuspenseaccounts Whichoftheerrorswillrequireanentrytothesuspenseaccountto correctthem? A 1,3and4only. B All. C 1and4only. D 2and3only. Test your understanding 4 Onextractingatrialbalance,theaccountantofETTdiscovereda suspenseaccountwithadebitbalanceof1,075includedtherein she alsofoundthatthedebitsexceededthecreditsby957.shepostedthis differencetothesuspenseaccountandtheninvestigatedthesituation. Shediscovered: (1) Adebitbalanceof75onthepostageaccounthadbeenincorrectly extractedonthelistofbalancesas750debit. (2) Apaymentof500toacreditsupplier,,hadbeencorrectly enteredinthecashbook,butnoentryhadbeenmadeinthe supplier saccount. (3) Whenamotorvehiclehadbeenpurchasedduringtheyearthe bookkeeperdidnotknowwhattodowiththedebitentrysohemade theentrydrsuspense,crbank1,575. (4) Acreditbalanceof81inthesundryincomeaccounthadbeen incorrectlyextractedonthelistofbalancesasadebitbalance. (5) Areceiptof5fromacreditcustomer,Y,hadbeencorrectlyposted tohisaccountbuthadbeenenteredinthecashbookas625. (6) Thebookkeeperwasnotabletodealwiththereceiptof500from theowner sownbankaccount,andhemadetheentrydrbankand CrSuspense. (7) Noentryhasbeenmadeforachequeof120receivedfroma creditcustomerm. (8) Areceiptof50fromacreditcustomer,N,hadbeenenteredinto hisaccountas5andintothecashbookas5. Whatjournalsarerequiredtocorrecttheerrorsandeliminatethe suspenseaccount? 202 KAPLANPUBLISHING

211 chapter13 2Adjustments to profit Thecorrectionjournalmayresultinachangeinprofit,dependingonwhether thejournaldebitsorcreditstheincomestatement: DrStatementoffinancialpositionaccount CrStatementoffinancialpositionaccount Noimpactonprofit DrIncomestatementaccount CrIncomestatementaccount Noimpactonprofit DrIncomestatementaccount CrStatementoffinancialpositionaccount Profitdecreases DrStatementoffinancialpositionaccount CrIncomestatementaccount Profitincreases Forthispurposethesuspenseaccountisdefinedasastatementof financialpositionaccount. Test your understanding 5 ThefollowingcorrectionjournalshavebeenpostedbyBorisBrokovitch, aself employedplumber: (1) DrSuspense4,000 CrRent4,000 (2) DrPayables2,500 CrSuspense2,500 (3) DrLoaninterest1,000 CrLoan1,000 (4) DrSuspense650 CrSundryincome650 (5) DrSuspense6,000 CrCash6,000 Boris draftprofitfigurepriortothepostingofthesejournalsis355,000. KAPLANPUBLISHING 203

212 Correction of errors and suspense accounts What is the revised profit figure? A 354,000 B 358,650 C 356,150 D 358, KAPLAN PUBLISHING

213 chapter13 Chapter summary KAPLANPUBLISHING 205

214 Correctionoferrorsandsuspenseaccounts Test your understanding answers Test your understanding 1 Whatwasthe doubleentry? Whatshouldthedouble entryhavebeen? Correcting journal 1) Drsuspense675 Crpostages675 2) Crcash500 (Drsuspense500) Drpayables() Crcash500 Drpayables() 500 Crsuspense 500 3) Motorvehiclecost 1,575 Crbank1,575 Drsuspense1,575 DrMotorvehicle1,575 DRvehiclecost 1,575 Crsuspense 1,575 4) Crincome162 Drsuspense 162 sundry 5) Drcash625 Drcash5 Crreceivables5 Crreceivables5 (Crsuspense 620) Drsuspense 620 Crcash620 6) Drbank500 Crsuspense500 Drsuspense 500 Crcapital500 Drbank500 Crcapital500 7) Drbank120 Crreceivables120 Crreceivables(M) 120 Drbank KAPLANPUBLISHING

215 chapter13 Test your understanding 2 The correct answer is D AandCwouldresultinthecreditsideoftheTBbeing1,200higher thanthedebitside. BwouldhavenoeffectontheTBsinceneitherthedebitnorthecredit sideofthetransactionhasbeenaccountedfor. Test your understanding 3 ThecorrectanswerisB Anentrytothesuspenseaccountisrequiredwhereveranaccountis missingfromthetrialbalanceortheinitialincorrectentrydidnotinclude anequaldebitandcredit. KAPLANPUBLISHING 207

216 Correctionoferrorsandsuspenseaccounts Test your understanding 4 Whatwasthe doubleentry? Whatshouldthedouble entryhavebeen? Correctingjournal 1) Drsuspense675 Crpostages675 2) (DrSuspense 500) Crcash500 Drpayables()500 Crcash500 Drpayables() 500 Crsuspense500 3) Drsuspense 1,575 Crbank1,575 DrMotorvehiclecost 1,575 CrBank1,575 DRMotorvehicle cost1,575 Crsuspense 1,575 4) Drsuspense162 Crsundryincome 162 5) Drcash625 Drcash5 Crreceivables5 Crreceivables5 (Crsuspense 620) Drsuspense620 Crcash620 6) Drbank500 (Crsuspense 500) Drbank500 Crcapital500 Drsuspense500 Crcapital500 7) Drbank120 Drbank120 Crreceivables(M)120 Crreceivables(M) 120 8) Drcash5 Crreceivables5 Drcash50 Crreceivables50 Drcash45 Crreceivables KAPLANPUBLISHING

217 chapter13 Suspense account Balanceb/f 1,075 Trialbalancedifference Postage(1) 675 Payable(2) Sundryincome(4) 162 Motorvehiclecost(3) Cash(5) 620 Capital(6) ,575 3,032 3,032 Test your understanding 5 The correct answer is B. Increase Draftprofit 1Rent 2Noimpact 3Loaninterest 4Sundryincome 5Noimpact Revisedprofit Decrease 355,000 4, ,000 3, ,650 KAPLANPUBLISHING 209

218 Correction of errors and suspense accounts 210 KAPLAN PUBLISHING

219 chapter 14 Applications of information technology Chapter learning objectives Upon completion of this chapter you will be able to: outline the form of accounting records in a typical computerised system compare manual and computerised accounting systems identify the advantages and disadvantages of computerised systems explain the use of integrated accounting packages explain the nature and use of microcomputers describe the main elements of a computerised accounting system describe typical data processing work explain other business uses of computers explain the nature and purpose of spreadsheets explain the nature and purpose of database systems. 211

220 Applicationsofinformationtechnology 1Manual accounting systems Atypicalmanual systemconsistsofthefollowing: separatebooks of original entry,whicharetheoriginalaccounting recordsofabusinessandarenotpartofthedoubleentry general ledger,abookwithinwhichthereisapageforeachledger accountinthedoubleentrysystem furtherledgers,themainonesbeingtheaccounts receivable ledger, theaccounts payable ledgerandthecash book. Expandable text 2Computerised accounting systems Computerisedaccountingsystemscanvaryintheformtheytake.Theymay be: completelycomputerised partiallycomputerised. Expandable text 3Manual versus computerised accounting systems Advantagesofcomputersinamodernbusinessenvironmentinclude: 212 speed storedprogram decisionmaking KAPLANPUBLISHING

221 chapter14 filestorageandprocessing accuracyandreliability. Expandable text Disadvantagesofcomputersinamodernbusinessenvironmentinclude: lackofintelligence quantifiabledecisions initialcosts inflexibility vulnerability. Expandable text 4Integrated accounting packages Theusualpatternforfinancialaccountinghasbeenforcomputerisationona piecemealbasis,tacklingtheaspectsinvolvingmostworkfirst,e.g.: accountsreceivableledger accountspayableledger payroll. Anumberofintegratedaccountingpackagesexistwhichhandleallpartsof theprocessandultimatelyproducethefinancialstatements.eachpackage varies,butthebroadgroupsare: cashbooksystems basicbookkeepingsystems,and bookkeepingandaccountingsystems. Expandable text 5Microcomputer packages Mostmicrocomputeraccountingpackagesareusedbypeoplewhoarenot computerprogrammersorsystemsanalysts. KAPLANPUBLISHING 213

222 Applicationsofinformationtechnology Theusersofsuchsystemsarenormallyaccountantsandtheiraccounting staff. Torunanaccountingpackage,theuserwillnormallyhavetheprogramona harddisk.datamaybeonseparatedisksordiscs.theprogramwill probablyoperateona menusystem,i.e.theuserwillselecttherequired optionsfromalistofchoices(themenu). Atypicalinitialmenuwouldincludethefollowingoptions: (1) createnewaccounts (2) editaccountdata (3) posttransactions (4) createreportlayouts (5) printreports (6) quit. Expandable text 6Word processing Wordprocessingisthenamegiventotheproductionoftypescriptusing computerfacilities.thefacilitiesaretheabilitytostoretextandto manipulateitonavdu(visualdisplayunit)screen. Theminimumhardware requirementsare: VDUandkeyboard processor diskdrive printer. Wordprocessingdevelopedtoovercomesomeoftheproblemsofusinga typewriterfortheproductionoftypescript: repetition corrections checking. Expandable text 214 KAPLANPUBLISHING

223 chapter14 Features of word processing Therearemanyfeaturesofwordprocessingpackageswhichinclude: enteringthetext storingthetext retrievingthetext editingthetext printingthetext. Expandable text 7Spreadsheets Aspreadsheetisacomputerpackagethatcanbeusedfornumerous modelling typebusinessapplicationssuchasbudgetingandforecasting. AspreadsheetdisplaysontheVDUaseriesofrowsandcolumns.The intersectionofrowsandcolumnsform cells intowhichtheusercantype informationusingthecomputerkeyboard.threetypesofinformationare entered: text,e.g.january,february,march,april. numbers,e.g.200,300,400,500. formulae,e.g.sales Costs=Profit. Whenthecontentofanycellisalteredtheeffectsofthealterationare reflected,usingtheformula,onallothercells,thisisknownas whatif analysis. Expandable text Features of a spreadsheet Spreadsheetshavebeendesignedwithmanyfeatureswhichmakethema valuableaccountingtool,theseinclude: whatif analysis conditionalstatements lookuptables selectiveprinting graphics KAPLANPUBLISHING 215

224 Applicationsofinformationtechnology goal seekingfacility statisticalfunction flexibility. Expandable text 8Database systems Adatabaseisacollectionofinformationthatcanbeusedformanydifferent purposes,andbyanumberofbusinessapplications. Forexamplesupplierdatabasecontainsthedatarelatingtosuppliers,and mayuseheadings(fields)suchas: suppliername suppliercode supplieraddress. Theadvantagesofadatabaseoveramanualcardindexsystemwould include: Theamountofinformationheldineachrecord/fieldcanbemuchlarger thanacardindex. Calculationscanbeperformedautomatically,e.g.returnoncapital employed. Recordsmaybesorted,orthosematchingacertaincriterionselected, automatically,andinavarietyoforders. Reportsbasedontheinformationmaybepreparedandprinted. Expandable text 216 KAPLANPUBLISHING

225 chapter14 Chapter summary KAPLANPUBLISHING 217

226 Applications of information technology 218 KAPLAN PUBLISHING

227 chapter 15 Incomplete records Chapter learning objectives Upon completion of this chapter you will be able to: explain and illustrate the calculation of profit or loss as the difference between opening and closing net assets explain techniques used in incomplete record situations: calculation of opening capital use of ledger total accounts to calculate missing figures. use of cash and/or bank summaries use of given gross profit percentage to calculate missing figures. 219

228 Incompleterecords 1Identification of profit figure using the accounting equation Ifabusinesshasrecordedverylittleinformationofitstransactionsitmay onlybepossibletocalculatenetprofitfortheyear.thiscanbedoneusing theaccountingequationasfollows: Netassets=Capital+Profit Drawings Therefore: Changeinnetassets=Capitalintroduced+inperiodProfitfortheperiod Drawingsfortheperiod. NB:Netassets=Assets Liabilities Test your understanding 1 AndyCarp sstatementoffinancialpositionat31december2004 showsthathisfishingbusinesshasnetassetsof5,000.thestatement offinancialpositionasat31december205showsthatthebusiness hasnetassetsof8,000.andy sdrawingsfortheyearamountedto 2,500andhedidn tintroduceanyfurthercapitalinthatyear. WhatprofitismadebyAndyCarpintheyearended31December 2005? (a) 5,500 (b) 500 (c) 10,500 (d) 7,500 NB:Netassets=Assets Liabilities 220 KAPLANPUBLISHING

229 chapter15 2Identification of individual account balances within financial statements Inmostcasesabusinesswillkeeplimitedaccountingrecordsfrom whichitispossibletoprepareafullsetoffinancialstatements.youmay beaskedtocalculateanyofthebalanceswithinthesefinancial statements. Inthesetypesofquestionstheopeningassetandliabilitybalanceswill begiventogetherwithdetailsoftransactionsduringtheyear. Openingcapitalcanbecalculatedas: Opening assets Opening liabilities Twofurthermethodsmaybeusedtoidentifyothermissingfigures: (1) Useofledgeraccountstofindabalancingfigure (2) Useofratios. 3The balancing figure approach Thebalancingfigureapproach,usingledgeraccounts,iscommonlyusedin thefollowingway: Ledger account Receivables Payables Cashatbank Cashinhand Missing figure CreditsalesMoneyreceivedfromreceivables CreditpurchasesMoneypaidtopayables DrawingsMoneystolen CashsalesCashstolen Cash at bank Cashreceivedfrom customers Bankingsfromcashinhand Sundryincome Balanceb/f KAPLANPUBLISHING Cashpaidtosuppliers Expenses Drawings Moneystolen Balancec/f 221

230 Incompleterecords Cash in hand Cashsales Sundryincome Balanceb/f Cashpurchases SundryExpenses Bankings Moneystolen Balancec/f Inthecaseofreceivablesandpayables,youmayneedtousetotal receivablesandtotalpayablesaccountswhereinformationgivencannotbe splitbetweencashandcreditsalesandpurchases: Total receivables Balanceb/f Totalsales (cashandcredit) Balanceb/f Total payables Totalcashpaidin respectofpurchases (cashpurchasesandpaymentsto creditsuppliers) Balancec/f 222 Totalcashreceived inrespectofsales (fromcashandcredit customers) Balancec/f Balanceb/f Totalpurchases (cashandcredit) Balanceb/f KAPLANPUBLISHING

231 chapter15 Test your understanding 2 SupposethatopeningreceivablesforBRubble sbusinessare30,000. Therehavebeentotalreceiptsfromcustomersof55,000ofwhich 15,000relatestocashsalesand40,000relatestoreceiptsfrom receivables.discountsallowedintheyeartotalled3,000andclosing receivableswere37,000. Whataretotalsalesfortheyear? (a) 65,000 (b) 50,000 (c) 47,000 (d) 62,000 Test your understanding 3 TheopeningpayablesofDickDastard Lee sbusinessare15,000. Totalpaymentsmadetosuppliersduringtheyearwere14,000. Discountsreceivedwere500andclosingpayableswere13,000. Whataretotalpurchasesfortheyear? (a) 16,500 (b) 16,000 (c) 12,000 (d) 12,500 Questionsmayrequireyoutocalculate missing incomestatementfigures, forexamplerentandratesvalues,fromalistofinformationincluding paymentsandopening/closingaccrualsandprepayments. Tocalculatethemissingvalueforeachexpenseuseeither: T accounts,or Equations KAPLANPUBLISHING 223

232 Incompleterecords Test your understanding 4 ThefollowinginformationrelatestoIvorBig Head sbusiness: On1January Cashpaidintheyear On31December Electricityaccrued Rentprepaid Electricity Rent Electricityaccrued Rentprepaid ,000 2, Whataretheincomestatementchargesforelectricityandrentforthe year? ElectricityRent (a) 1,0502,100 (b) 1,0501,900 (c) 9501,900 (d) 9502,100 Test your understanding 5 On1JanuaryElmaFudd sbankaccountisoverdrawnby1,367. Paymentsintheyeartotalled8,536andon31Decembertheclosing balanceis2,227(positive). Whataretotalreceiptsfortheyear? (a) 4,942 (b) 7,676 (c) 9,396 (d) 12, KAPLANPUBLISHING

233 chapter15 Test your understanding 6 On1January,DaiseeChain sbusinesshadacashfloatof900.during theyearcashof10,000wasbanked,1,000waspaidoutasdrawings andwagesof2,000werepaid.on31decemberthefloatwas1,000. Howmuchcashwasreceivedfromcustomersfortheyear? (a) 12,900 (b) 14,900 (c) 13,100 (d) 6,900 4Ratios mark up and margin Grossprofitcanbeexpressedasapercentageofeithersalesorcostof sales: E.g. Sales5,000 Costofsales(4,000) Grossprofit1,000 Grossprofitmargin=(1,000/5,000)x100=20% Markup=(1,000/4,000)x100=25% KAPLANPUBLISHING 225

234 Incompleterecords Test your understanding 7 PadraigO Flahertyhassalesof1,000.Hemakesamarginof25%. Whatisthecostofsalesfigure? (a) 200 (b) 800 (c) 750 (d) 250 Test your understanding 8 Ratios LornaMcDuffhascostofsalesof600anda25%markup. Whatishersalesfigure? (a) 750 (b) 800 (c) 250 (d) 200 Using margin and mark up Anexamquestionwilloftenprovideyouwithmarginandcostofsalesor markupandsales.youwillthenberequiredtocalculatetheremaining figuresintheincomestatement.thiscanbedoneusingthefollowing relationship columns: Margin25% Sales Costofsales Grossprofit 2100% 3Logic! 1Ratio Markup25% Sales3 Costofsales Grossprofit 3Logic! 2100% 1Ratio Therefore,ifweknowthemarkupormarginpercentageandoneofthe figuresintheincomestatement,wecancalculatetheremainingfiguresin theincomestatement. 226 KAPLANPUBLISHING

235 chapter15 Test your understanding 9 JethroLonghorncantellyouthefollowingwithregardtohisbusiness: Margin5% Openinginventory800 Closinginventory600 Purchases2,840 CompleteJethro sincomestatementwiththeabovefigures. 5Cost of lost inventory Inincompleterecordquestions,inventorymayhavebeenlost probablyduetoafireorflood. Closinginventorythathasnotbeenlostissubtractedfromcostofsales becausebydefinition,theinventoryhasnotbeensoldintheyear. Lostinventoryhasnotbeensoldintheyearandthereforealsoneeds subtractingwithincostofsales. Therefore,toworkoutthecostoflostinventory,completethetrading accountfromtheinformationgivenandthenlostinventorycanbe calculatedasabalancingfigure. Test your understanding 10 JackSprattprovidesthefollowinginformationabouthisbusiness: Margin Sales Openinginventory Purchases Closinginventoryafterfire 20% 100,000 10,000 82,000 3,000 Whatisthecostofinventorylostinthefire? (a) 12,000 (b) 9,000 (c) 69,000 (d) 5,667 KAPLANPUBLISHING 227

236 Incompleterecords Double entries for inventory and lost inventory Actualclosinginventoryispostedby: DrInventory(SFP) CrIncomestatement Lostinventorywillstillbecreditedtotheincomestatementsothatitis removedfromcostofsales.however,thedebitsideoftheentrywilldepend onwhetherornotthelostinventoryhasbeeninsured: Ifinsured:DrInsurancecompany(Currentasset) CrIncomestatement(Costofsales) Ifnotinsured:DrIncomestatement(Expense) CrIncomestatement(Costofsales) Test your understanding 11 Fredlosthisentireinventoryinafire.Hisunsignedinsurancepolicyis stillinthepocketofhisgoodsuit.fredhassuppliedyouwiththe followinginformation: Markup25% Sales10,000 Openinginventory2,000 Purchases7,500 PrepareFred sincomestatementandshowthejournaltorecordclosing inventory. 228 KAPLANPUBLISHING

237 chapter15 6Reconstruction of full financial statements Althoughyouwillnotfaceanexamquestionofthislength,thefollowing illustrationwillhelpyoutoseehowafullsetoffinancialstatementscanbe reconstructedusingthemethodswithinthischapter. Illustration 1 Reconstruction of full financial statements Malcolmisaretailer,sellingstationery.Hedoesnotkeepafullsetof records.thefollowingrecordshavebeenextractedfromhisbooks. Fixturesandfittings: Cost Accumulated depreciation Motorvehicles:Cost Accumulated depreciation Inventory Receivables Allowancesfor receivables Prepayments Rates Bank Cash Payables Accruals Lightand heat KAPLANPUBLISHING 30September ,000 30September 2005 Tobedetermined 8,000 Tobedetermined 22,000 4,180 Tobedetermined Tobedetermined 18,000 10, ,900 12,000 Tobedetermined 400 2, , (15,500) 600 4,

238 Incomplete records He also has the following cash and bank transactions for the year ended 30 September Cash Bank Balance b/f 600 2,000 Receipts: Cash sales 15,000 From receivables 140,000 Loan received (longterm) 30,000 Sale proceeds of a motor vehicle sold during the year 8,200 Cash banked 15,000 Payments: 15, ,200 Payables 110,000 Rates 9,000 Light and heat 2,000 Telephone 1,500 Loan interest 1,500 Insurance 1,000 Rent 20,000 Wages and salaries 25,000 Withdrawals 15,000 Purchase of fixtures 5,000 Purchase of new motor 20,000 vehicle Sundry expenses 700 Cash paid into bank 15,000 Balance c/f 600 (15,500) 230 KAPLAN PUBLISHING

239 chapter15 Thefollowingfurtherinformationisavailable: (1) Theloanwasreceivedatthebeginningoftheyearandisentitledto 5%interestpa. (2) Themotorvehicledisposedofduringtheyearhadcost10,000 andtheaccumulateddepreciationonitasat30september2004 was1,900. (3) Discountreceivedduringtheyearamountedto500. (4) Goodsamountingto1,000atcostwerewithdrawnbyMalcolm duringtheyear. (5) Thedepreciationpolicyisasfollows: (a) Fixturesandfittings,20%paonastraight linebasis. (b) Motorvehicles,10%paonareducing balancebasis. (6) Theallowanceforreceivablesistobeprovidedat5%paonthe closingreceivables. (a) PrepareMalcolm sincomestatementfortheyearended30 September2005. (b) PrepareMalcolm sstatementoffinancialpositionasat30 September2005. Expandable text KAPLANPUBLISHING 231

240 Incompleterecords Chapter summary 232 KAPLANPUBLISHING

241 chapter15 Test your understanding answers Test your understanding 1 ThecorrectanswerisA Changeinnetassets=Capitalintroduced+Profitfortheyear Drawingsfortheyear 8,000 5,000 = 0 + Profit for the year 2,500 Profit=3,000+2,500 =5,500 KAPLANPUBLISHING 233

242 Incompleterecords Test your understanding 2 The correct answer is A Receivables Balanceb/f 30,000 Bank Creditsales(ß) 50,000 Discountallowed 40,000 3,000 Balancec/f 37,000 80,000 Balanceb/f 80,000 37,000 Receivables Totalsales=50,000+15,000=65,000 OR Total receivables Balanceb/f 30,000 Bank 55,000 (totalcashrec d) Totalsales(ß) 65,000 Discountallowed Balancec/f 3,000 37,000 95,000 95, KAPLANPUBLISHING

243 chapter15 Test your understanding 3 The correct answer is D Total payables Bank Discount received Balancec/f 14,000 Balanceb/f Purchases(ß) ,000 12,500 13,000 27,500 Balanceb/f 27,500 13,000 Test your understanding 4 The correct answer is B Incomestatement(extracts): Expenses Electricity( 250+1, )=1,050 Rent(300+2, )=1,900 Test your understanding 5 The correct answer is D Bank Receipts(ß) Balanceb/f 12,130 Balanceb/f Payments Balancec/f 12,130 2,227 1,367 8,536 2,227 12,130 KAPLANPUBLISHING 235

244 Incompleterecords Test your understanding 6 The correct answer is C Cash in till Balanceb/f Receipts Balancec/f 900 Bank 13,100 Drawings Wages Balancec/f 14,000 1,000 10,000 1,000 2,000 1,000 14,000 Test your understanding 7 The correct answer is C Grossprofit:1,000x25%=250 Costofsales: Sales Costofsales(ß) Grossprofit 1,000 (750) 250 Test your understanding 8 The correct answer is A Grossprofit:600x25%=150 Sales: Sales(ß) Costofsales Grossprofit 750 (600) KAPLANPUBLISHING

245 chapter15 Test your understanding 9 Sales: Costofsales: Openinginventory Purchases % 3, (3,040) 160 (95) ,840 (600) Grossprofit: Test your understanding 10 The correct answer is B Sales: Costofsales: Openinginventory Purchases Closinginventory Inventorylost(ß) Grossprofit: 100,000 % ,000 82,000 (3,000) (9,000) (80,000) 20,000 (80) 20 KAPLANPUBLISHING 237

246 Incompleterecords Test your understanding 11 Sales: Costofsales: Openinginventory Purchases Inventorylost(ß) Grossprofit: DrIncomestatement (expense): CrIncomestatement(cost ofsales): 10,000 % 125 2,000 7,500 (1,500) (8,000) 2,000 1,500 (100) 25 1,500 Beingtherecordingofuninsuredinventorydestroyedbythefire. 238 KAPLANPUBLISHING

247 chapter 16 Partnerships Chapter learning objectives Upon completion of this chapter you will be able to: define the circumstances creating a partnership explain the advantages and disadvantages of operating as a partnership compared with operating as a sole trader or limited liability company explain the typical contents of a partnership agreement, including profit sharing terms explain the accounting differences between partnerships and sole traders: capital accounts current accounts division of profits explain and illustrate how to record partners shares of profits/losses and their drawings in the accounting records and financial statements explain and illustrate how to account for guaranteed minimum profit share explain how to account for loans from partners define goodwill in relation to partnership accounts identify the factors leading to the creation of goodwill in relation to partnership accounts calculate the value of goodwill from information given account for the effect of the admission of a new partner. 239

248 Partnerships 1Definition of a partnership Apartnershipis therelationshipwhichsubsistsamongstpersons carryingonabusinessincommonwithaviewofmakingprofit. Thereforeapartnershipisabusinesswhichhastwoormorejoint owners. Asinthecaseofasoletrader,theprofitsofthebusinessareowedto theowners. Itisthereforenecessarytosharetheprofitsofthebusinessamongst thepartners. Expandable text 2Advantages and disadvantages of partnerships 240 Advantages of a partnership over a sole trader Apartnershipsharesbusinessrisksbetweenmorethanoneperson. Greaterresourceswillbeavailablesincemoreindividualswillbe contributingtothebusiness. Eachpartnercandevelopspecialskillsuponwhichtheotherpartners canrely,whereasasoletraderhasresponsibilityforeverything. KAPLANPUBLISHING

249 chapter16 Disadvantages of a partnership Partnersarejointlyandseverallyliablefortheirpartners.Thusifone partnerisbeingsuedinrelationtothebusiness,allpartnerssharethe responsibilityandpotentialliability. Advantages of a partnership over a limited liability company Thearrangementislessformalthansettingupacompany,which requirestheissueofsharesandtheappointmentofdirectors. Ifthepartnerswishtodissolvethebusiness,thisiseasiertoachieveby apartnershipthanbyacompany. Disadvantage of a partnership Theremaybedisputesintherunningofthebusiness. Thepartnersarenotprotectedfromthecreditorsofthebusiness. Unlessthepartnershipissetupasalimitedliabilitypartnership, partnershaveunlimitedliability. 3The partnership agreement Apartnershipwillusuallyhaveapartnershipagreementwhichwillstatehow theprofitsaretobeshared( appropriated )amongstthepartners. Thedivisionofprofitstatedintheagreementmaybequitecomplexinorder toreflecttheexpecteddifferingeffortsandcontributionsofthepartners. Salaries Maybeawardedtopartnerswhotakeonextraresponsibility withinthebusiness. Interest on Maybeprovidedatasetpercentagetoreflectthediffering capital amountsofcapitalinvested. Interest on Topenalisethosepartnerswhotakeoutmoredrawingsfrom drawings thebusiness,thepartnershipmaychargeintereston drawings.interestmaybechargedonalldrawingsoronly thoseaboveacertainlevelthisresultsinareductioninthe amountofprofitthatthepartnerisallocated Profit share Thisistheratioinwhichanyremainingprofitsshouldbe ratio (PSR) sharedamongstthepartnersaftertheyhavebeenallocated salaries,interestoncapitalandinterestondrawings. Itisimportanttoappreciatethattheabovesuggestionsaremeansof dividingtheprofitsofthepartnershipandarenotexpensesofthebusiness. A partnership salary is merely a device for calculating the division of profit it is not a salary in the normal meaning of the term. Expandable text KAPLANPUBLISHING 241

250 Partnerships 4Financial statements for a partnership Theincome statementforapartnershipisexactlythesameasthatfor asoletrader. Anextrastatementisrequiredinwhichtheprofitfromtheincome statementissharedbetweenthepartners.thisisreferredtoasa statement of division of profitorappropriation account: Partner Partner Total A B Salaries Interestoncapital Interestondrawings Profitshareratio3:2 () () ß Totalprofitshare Netprofitfromincomestatement Theprofitsallocatedtoeachpartnerarecreditedtothepartners current account.drawingsarealsorecordedinthisaccount. Current account Ptnr Ptnr Ptnr Ptnr A B A B Balanceb/f Drawings Profitshare(from profitappropriation account) Balancec/f 242 KAPLANPUBLISHING

251 chapter16 Thepartners capital accountrecordstheinitialcapitalinvestedinthe businessbyeachpartner.transactionsinthisaccountarerare,beingthe injectionoffurthercapitalorwithdrawalofcapitalbyapartner: Capital account Ptnr Ptnr A B Balanceb/f Injectionof long termcapital Ptnr Ptnr A B Withdrawalsof long termcapital Balancec/f Balanceb/f Theclosingbalancesonthepartners currentandcapital accounts formthecapitalsectionofthestatementoffinancialposition: Capital accounts PartnerA PartnerB Current accounts PartnerA PartnerB Theremainderofthestatementoffinancialposition(assetsand liabilities)isasforasoletrader. Expandable text Test your understanding 1 ParvatiandLavenderrunabusinesssellinghome madepotionsand lotions.theyhavebeenverysuccessfulintheirfirstyearoftradingand havemadeaprofitof48,000. Theirpartnershipagreementmakesthefollowingprovisions: Parvatiistobeallocatedasalaryof11,000toreflectherextensive potionknowledge. Interestoncapitalistobeprovidedat7%perannum. KAPLANPUBLISHING 243

252 Partnerships Thebalanceofprofitsistobesplitequally. Whentheysetthebusinessup,Parvatiinjectedcapitalof8,000and Lavender12,000. HowmuchprofitisallocatedtoLavender? A 18,360 B 24,140 C 18,640 D 29,360 Test your understanding 2 Britney,JustinandCameronareinpartnershipsellingCDsandDVDs viatheirwebsitebigstars.com.theyhaven tbeenverysuccessfulinthe pastyearandintheyearended30june206,recordedalossof 120,000Theirpartnershipagreementstatesthefollowing: interestoncapitaltobeprovidedat4%perannum Camerontobeallocatedasalaryof25,000,andJustin14,000 nointeresttobechargedondrawings balanceofprofitstobesharedintheratio4:3:1. Capitalbalancesatthestartoftheyearstoodasfollows: Britney35,000 Justin26,000 Cameron40,000 HowmuchprofitorlossisallocatedtoCameron? A 6,220 B 36,220 C (34,540) D 54,920) 244 KAPLANPUBLISHING

253 chapter16 Test your understanding 3 HamishandCampbellstartedabusinessmakinganddistributing haggison1january206.thiswaslargelypromptedbyhamish winning40,000atbingojustbeforechristmas.hamishinvestedhalf hiswinningsinthebusinessandcampbellborrowed14,000fromhis UncleHoolietoinvest. Inthefirstyearoftrade,thebusinessmade25,000profit,withwhich bothpartnerswereratherpleased. Theyhavesetupapartnershipagreement,butevensoarenotsurehow muchprofittheyareeachallocated.theagreementsaysthefollowing: Neitherpartnerreceivesasalary. Interestoncapitalistobeprovidedat4%. Interestondrawingsistobechargedat2%. Thebalanceofprofitistobesplitintheratio3:2. BothHamishandCampbelldrew5,000fromthebusinesson1July 206topayfortheirannualfishingholidayinSpain. Showhowthisinformationappearsinthepartners capitalandcurrent accountsandinthestatementoffinancialposition. 5Guaranteed minimum profit share Apartnermaybeguaranteedaminimumshareoftheprofits. Ifthepartnerhasnotreceivedthisguaranteedamountafterallocatingprofits intheusualway,theshortfallshouldbegiventothepartner. Thisamountisfundedbytheotherpartnersinaccordancewiththeprofit shareratio. Test your understanding 4 Apartnership,organisingEuropeanholidays,hasfourpartners Pierre, Wolfgang,EdwinandCarmen.Intheyearto30June205the partnershipmadeprofitsof106,250. Pierreinvested100,000inthepartnership.Hewithdrew30,000from thebusinesson1july204. Wolfganginvested20,000inthepartnership.Hewithdrew30,000on 30June205. KAPLANPUBLISHING 245

254 Partnerships Edwininvested50,000intothebusiness.Hewithdrew25,000on1 July2004andafurther25,000on1January2005. Carmenalsoinvested50,000andwithdrew30,000on1July204. Allocatetheprofitsofthebusinessinaccordancewiththefollowing partnershipagreement: interestoncapitalat5%pa Wolfgangtoreceive5,000salary interestondrawingsat10%pa profitshareratio2:1:3:4 guaranteedminimumprofitshareof42,500forcarmen. 6Loans from partners Apartnermayloanthebusinesssomemoneyandmaythenreceive interestonthisloan. Thedoubleentrywhentheloanismadeis: DrCash CrLoan(liability) Theinterestarisingistreatedasabusinessexpensewhichischarged toprofitsbeforetheprofitsareshared. Thedoubleentryfortheloaninterestis: DrLoaninterestexpense CrBank(ifpaid)or Currentaccount(ifoutstanding) 246 KAPLANPUBLISHING

255 chapter16 Illustration 1 Full partnership accounts KenandBarbieareinpartnershipmakingandsellinggourmetpies.The TBoftheirbusinessat30June206was: Irrecoverabledebts Rentandrates Motorexpenses(includingdepreciation) Allowanceforreceivables Motorvehicles cost Motorvehicles accumulateddepreciation Cashatbank Drawings Ken Drawings Barbie Inventory Fixturesandfittings cost Fixturesandfittings accumulateddepreciation Sundryexpenses Sales Payables Receivables Purchases Currentaccount Ken Currentaccount Barbie Capitalaccount Ken Capitalaccount Barbie Dr 2,350 35,000 17,400 Cr 5,450 32,750 15, ,500 15,000 3,000 27,000 13,500 14, ,000 9,800 16,000 96, ,247 7,655 9,264 35,000 20, ,247 Theyprovidethefollowingfurtherinformationwhichisnotreflectedinthe TB: Inventoryheldattheyearendcost4,500. Prepaymentsattheyearendwere2,500inrespectofrates. Fixturesandfittingshavenotyetbeendepreciated theapplicable rateis10%straightline. Onthelastdayoftheyear,Kenpaid13,000tothebusinessbank accountasaloan. KAPLANPUBLISHING 247

256 Partnerships Barbieisawardedasalaryof7,500. Interestoncapitalisprovidedat8%perannum. Thebalanceofprofitsissplitequally. Youarerequiredtoprepareanincomestatement,statementofdivision ofprofits,partners currentaccountsandastatementoffinancialposition at30june206 Expandable text 7Partnership accounts and goodwill Goodwillisthedifferencebetweenthevalueofthepartnershipbusinessas awholeandtheaggregateofthefairvaluesofthenetassets: Valueofthebusiness Fairvalueofnetassets Goodwill () Anumberoffactorswillleadtothecreationofgoodwillinapartnership business: goodreputation location technicalknow how excellentprofitsoverthepastyears goodprospectsinthefuture. Goodwill belongs tothepartnersinthesameratioastheirprofitshare agreement,althoughattributinggoodwillisonlynecessarywhen: (1) Thepartnerselecttochangetheirprofitshareratio. (2) Apartnerretiresordies. (3) Anewpartnerjoinsthepartnership. Expandable text Expandable text 248 KAPLANPUBLISHING

257 chapter16 8Adjustments to partnership accounts Ifanyofthefollowingsituationsoccur: theprofitshareratioischanged apartnerretiresordies anewparterjoinsthebusiness thentheprofit sharingratiowillchangeandsoownershipofthegoodwill alsochanges.adjustmentstothecapitalaccountsofthepartnersare requiredbeforesuchachangetakesplaceinorderthatpartnersretaintheir shareofgoodwillgeneratedtodate.thiscanbedonewithorwithouta goodwillaccount. Use of a goodwill account Calculatethegoodwillinthebusinessandthen: DrGoodwillaccount CrCapitalaccountsinoldratio Adjustment without a goodwill account Calculatethegoodwillinthebusinessandthen: DrCapitalaccountsofpartnersinnewratio CrCapitalaccountsofpartnersinoldratio Inorderthatpartnersnowtakingasmallershareoftheprofitsare compensated forthegoodwill lost,this compensation isfundedbythe partnersnowtakingalargershareoftheprofits. Notethatthedeathofapartnerisnotexaminable. Illustration 2 Revaluation of assets John,LewisandFraserhavebeenpartnersinadelicatessenfor10 years.theysharetheirprofitsintheratio3:4:2.aslewiswishestostep backfromtheoperationalsideofthebusinessinordertospendmore timewithhisfamily,ithasbeenagreedthattheprofitshareratiowillbe changedto3:1:2.thevalueofthegoodwillinthebusinessis54,000. KAPLANPUBLISHING 249

258 Partnerships Whatjournalsarerequiredtoaccountforthis (a) Ifagoodwillaccountisused (b) withoutagoodwillaccount? Expandable text Test your understanding 5 Harvey,NicholandSelfridgehavebeeninpartnershipforanumberof yearswithaprofitshareratioof1:1:4.theyhaveagreedtochangethis ratioto1:1:2.thevalueofgoodwillinthebusinessis24,000. Howshouldthisbeaccountedfor? 9Revaluation of assets on a change in partnership structure Whenthereisachangeinthestructureofthepartnershipduetoan admission,retirementordeathofapartner,thentheassetswill generallyberevalued. Anyrevaluationprofitsorlossesareawardedtothepartnersintheold profitshareratio. Thisreflectsthefactthattheoldpartnershavebuiltupthebusinessand theyarethereforeentitledtothegainormustbeartheloss. Illustration 3 Revaluation of assets ProperandQuibblearepartnerssharingprofitsandlossesintheratioof 4:1.On1January206,whenProperandQuibble scapitalbalances standat27,000and12,000respectively,anewpartnerrightjoinsthe business,andthefollowingtakeplace: Rightintroducescapitalof10,000. Landandbuildingsarerevaluedupwardsby80,000. Goodwillisvaluedat40,000. Theprofitshareisrevisedto2:2:1(P:Q:R). Writeupthecapitalaccountsofthepartnerstorecordtheabove, assumingthatagoodwillaccountisused. 250 KAPLANPUBLISHING

259 chapter16 Expandable text Test your understanding 6 MirandaandCharlottearepartnerssharingprofitsandlossesequally. Capitalaccountbalancesat1January206are50,000and50,000 respectively.onthisdate,anewpartner,carrie,joinsthebusiness, introducingcapitalof30,000.landandbuildingsarerevaluedby 100,000andgoodwillisvaluedat20,000.Aftertheadmissionof Carrie,theprofitshareisrevisedto2:2:1andgoodwillistobe eliminatedfromthebooks. WhatisthebalanceonCharlotte scapitalaccountafterthistransaction hasbeenaccountedfor? A 60,000 B 102,000 C 110,000 D 52,000 KAPLANPUBLISHING 251

260 Partnerships Chapter summary 252 KAPLANPUBLISHING

261 chapter16 Test your understanding answers Test your understanding 1 ThecorrectanswerisC Parvati Lavender Salaries Interestoncapital Profitshareratio1:1 Totalprofitshare Netprofitfromincomestatement 11, ,800 29,360 Total 11, ,400 17,800 35,600(ß) 18,640 48,000 Test your understanding 2 ThecorrectanswerisA Britney Salaries Interestoncapital Profitshareratio Totalprofitshare Netprofitfrom incomestatement 1,400 (81,520) (80,120) Justin Cameron Total 14,000 25,000 39,000 1,040 1,600 4,040 (61,140) (20,380) (163,040)(ß) (46,100) 6,220 (120,000) KAPLANPUBLISHING 253

262 Partnerships Test your understanding 3 Statement of division of profit Hamish Campbell Total ,360 (50) (50) (100) 14,244 9,496 23,740(ß) 14,994 10,006 25,000 Interestoncapital Interestondrawings(w) Profitshareratio3:2 Totalprofitshare Netprofitfromincome statement Working interest on drawings 5,000x2%x6/12=50 Balance c/f Hamish 20,000 20,000 Hamish Drawings 5,000 Balance 9,994 c/f 14,994 Capital account Campbell 14, injection 14,000 Balanceb/f Current account Campbell 5,000 Profitshare 5,006 10,006 Hamish Campbell 20,000 14,000 20,000 20,000 14,000 14,000 Hamish Campbell 14,994 10,006 14,994 Balanceb/f 9,994 Statement of financial position presentation Capitalaccounts Hamish 20,000 Campbell 14,000 Currentaccounts Hamish 9,994 Campbell 5,006 10,006 5,006 34,000 15,000 49, KAPLANPUBLISHING

263 chapter16 Test your understanding 4 P Salaries Interestoncapital Interestondrawings Profitshare ratio2:1:3:4 W E C Total 5,000 5,000 5,000 1,000 2,500 2,500 11,000 (3,000) (3,750) (3,000) (9,750) 20,000 10,000 30,000 40, ,000 (ß) 22,000 16,000 28,750 Adjustment Pierre2/6x3,000 Wolfgang1/6x3,000 Edwin3/6x3,000 39,500 3,000 (500) (1,500) 21,000 15,500 27,250 42, ,250 (1,000) Working interest on drawings Pierre Wolfgang Edwin 30,000x10% Nointerestasdrawingsatyearend 25,000x10% 25,000x10%x6/12 Carmen 30,000x10% 3,000 2,500 1,250 3,750 3,000 KAPLANPUBLISHING 255

264 Partnerships Test your understanding 5 With goodwill account: DrGoodwil CrCapital(Harvey)1/6x24,000 CrCapital(Nichol)1/6x24,000 CrCapital(Selfridge)4/6x24,000 24,000 4,000 4,000 16,000 Without goodwill account: Capital HarveyNicholSelfridge HarveyNicholSelfridge Balance b/f Goodwill adjustment 4,000 4,000 16,000 Goodwill adjustment 6,000 6,000 12,000 Balance c/f Balance b/f Thereforetheoveralleffectisto: DrCapital(Harvey)2,000 DrCapital(Nichol)2,000 CrCapital(Selfridge)4,000 ThusHarveyandNichol,whohaveagreatershareofgoodwillunderthenew profit shareratio,arecompensatingselfridge,whoisentitledtoalesser shareunderthenewprofit shareratio. 256 KAPLANPUBLISHING

265 chapter16 Test your understanding 6 The correct answer is B Without goodwill account Miranda Charlotte Carrie Miranda Charlotte Carrie Balanceb/f 50,000 50,000 50,000 50,000 Oldratio (1:1) Goodwill Goodwill 10,000 10,000 adjustment adjustment 2:2:1 8,000 8,000 4,000 Bank 30,000 Balance 102, ,000 26, , ,000 30,000 c/f 110, ,000 30,000 Balancec/f 102, ,000 26,000 KAPLANPUBLISHING 257

266 Partnerships 258 KAPLAN PUBLISHING

267 chapter 17 Company accounts Chapter learning objectives Upon completion of this chapter you will be able to: explain the difference between a sole trader and a limited liability company illustrate the IAS1 required presentation of financial statements identify items requiring separate disclosure on the face of the income statement explain the capital structure of a limited liability company explain and illustrate the share premium account define a rights issue and its advantages and disadvantages record a rights issue in ledger accounts and show the effect in the statement of financial position define a bonus (capitalisation) issue and its advantages and disadvantages record a bonus issue in ledger accounts and show the effect in the statement of financial position explain and illustrate other reserves which may appear in a company statement of financial position explain why the heading, retained earnings, appears in a company statement of financial position explain how finance is raised by borrowing rather than by the issue of shares calculate and record finance costs in the ledger accounts and the financial accounts 259

268 Company accounts explain the requirements of IAS as regards current assets and liabilities explain the impact of income tax on company profits and illustrate the ledger account required to record it record income tax in the income statement and statement of financial position of a company explain and illustrate the recording of dividends. 260 KAPLAN PUBLISHING

269 chapter17 1Characteristics of limited companies Limited liability company Sole trader Separate legal Alimitedcompanyisaseparate entity legalentity,i.e.intheeyesofthelaw itisapersoninitsownrightandis distinctfromitsowners. Asoletraderis legallynotseparate fromhisbusiness eventhoughheis treatedassuchfor accountingpurpose Liability Ifasoletradergoes intoliquidationthen heispersonally liableforany outstandingdebts ofhisbusiness. Acompanyisfullyliableforitsown debts.thismeansthatifthe companygoesintoliquidation,the owners(shareholders)ofthe companyareliableonlyforamounts thattheyhavenotyetpaidfortheir shares.thustheshareholdersare saidtohavelimitedliability. Ownership Acompanyisownedby Asoletraderis and shareholders.themanagersofthe generallyboththe management companyarecalleddirectorsand ownerandmanager areappointedbytheshareholders. ofhisorher Thedirectorsmayormaynotbe business. shareholdersinthecompany.thus mostshareholdersdonotplayapart intheday to dayrunningofthe company. Formalities Formalitiesinvolvedvaryfrom Nosuchformalities countrytocountry,butfrequently existforsole requirepublicavailabilityoffinancial traders. statementsandanannualauditby qualifiedauditors. Expandable text 2IAS 1 presentation of financial statements IAS1incorporatestherecommendedformatsforcompanypublished accounts.thefollowingfinancialsummariesarerequired: statementoffinancialposition astatementofcashflowsandsupportingnotes statementofcomprehensiveincome statementofchangesinequity notestotheaccounts(thef3syllabusdoesnotrequireknowledgeof these). KAPLANPUBLISHING 261

270 Companyaccounts notestotheaccounts(thef3syllabusdoesnotrequireknowledgeof these). 3Statement of financial position Therearemanysimilaritiestothestatementoffinancialpositionofasole trader,althoughsomeitems(markedinbold)willrequirefurtherexplanation. NotethatIAS1requiresanassetorliabilitytobeclassifiedascurrentif: itwillbesettledwithin12monthsofthestatementoffinancialposition date,or itispartoftheenterprise snormaloperatingcycle. Statement of financial position for YZ at 31 December m m Assets Intangible Non currentassets Property,plantandequipment Investments Currentassets Inventories Tradeandotherreceivables Prepayments Cash Totalassets Equityandliabilities Capitalandreserves Ordinarysharecapital Preferencesharecapital Sharepremiumaccount Reserves Accumulatedprofits 262 KAPLANPUBLISHING

271 chapter17 Non currentliabilities Loannotes Currentliabilities Tradeandotherpayables Overdrafts Taxpayable Totalequityandliabilities Expandable text 4Statement of comprehensive income Thesuggestedformatisasfollows. Notethatallexpensesareclassifiedunderoneofthreeheadings: Cost of sales Thisiscalculatedasforasoletrader.Howeverthecalculationshould beshowninanotetotheaccountsratherthanonthefaceoftheincome statement. Distribution costs Theseareallexpensesrelatingtosellingordeliveringproductsor services. Administrative expenses Thisincludesallexpensesnotclassifiedwithincostofsalesor distributioncosts. Someexpensessuchasdepreciationwillbesplitacrossallthreeexpense categories. KAPLANPUBLISHING 263

272 Companyaccounts Statement of comprehensive income for YZ for the year ended 31 December m () Revenue Costofsales Grossprofit Otheroperatingincome Distributioncosts Administrativeexpenses () () () Profitfromoperations Netinterestcost(interestpaidlessinterestreceived) Profitbeforetax Incometaxexpense Netprofitfortheperiod Othercomprehensiveincome: Gainonpropertyrevaluation Totalcomprehensiveincomefortheyear Relationship between the income statement and statement of financial position Thelinkbetweenthestatementoffinancialpositionandincomestatement isshownbelow: Expandable text 264 KAPLANPUBLISHING

273 chapter17 5Statement of changes in equity Thisstatementisincludedwithintheaccountstoprovidefurtherinformation oncertainstatementoffinancialpositionaccounts,namelysharecapital andreserves. Statement of changes in equity for YZ Ltd Balanceat1January Equitysharesissued Revaluationsurplus Netprofit Dividends Share Share Revaluation Accumulated Total capital premium reserve profits m m m m m () () 6Share capital Acompanyisownedviashares. KAPLANPUBLISHING 265

274 Companyaccounts Redeemablepreferencesharesarepreferenceshareswhichare repayablebythecompanyataspecifiedfuturedate.onthisdatethe sharesarecancelledandtheshareholdersrepaid. Theseshareshavethecharacteristicsofdebt.Theyaretherefore classifiedasaliabilityonthestatementoffinancialposition. Irredeemablepreferencesharesarepreferenceshareswhicharenot redeemable.theyremaininexistenceindefinitely. Thesesharesareclassifiedasequityonthestatementoffinancial position. Expandable text Share capital values Eachsharehasanominalorparvalue,often1,50cor25c.Thisvalue isoftenusedasameansofcalculatingdividendstoshareholders(paid asapercentageofthenominalvalue). Sharesareissuedbythecompanyatanissueprice.Thisisatleast equaltothenominalvalueoftheshare,butoftenexceedsit. Expandable text Share capital terminology Authorisedsharecapitalisthenominalvalueofthemaximumnumber ofsharesthatacompanycanhaveinissueatanyparticularpointin time. Issuedsharecapitalisthesharecapitalthathasactuallybeenissued toshareholders.thenumberofissuedsharesisusedinthecalculation ofdividends. Called upsharecapitalistheamountofthenominalvaluepaidbythe shareholderplusanyfurtheramountsthattheyhaveagreedtopayinthe future. Paid upsharecapitalistheamountofthenominalvaluewhichhas beenpaidatthecurrentdate. Accounting for the issue of shares Acompanywillgenerallyissuesharesatabovepar(nominal)value. 266 KAPLANPUBLISHING

275 chapter17 Thedoubleentrytorecordanordinaryorirredeemablepreferenceshare issueis: DrCashIssuepricexno.shares CrSharecapital(SFP)Nominalvaluexno.shares CrSharepremiumß Boththesharecapitalandsharepremiumaccountsareshownonthe statementoffinancialpositionwithinthe ShareCapitalandReserves section. Thedoubleentrytorecordaredeemablepreferenceshareissueis: DrCashIssuepricexno.shares CrLiabilityIssuepricexno.ofshares Test your understanding 1 Bourbonissues200,00025csharesatapriceof1.75each. Showthistransactionusingledgeraccounts. 7Rights issues Arights issueis: theofferofnewsharestoexistingshareholdersinproportiontotheir existingshareholdingatastatedprice(normallybelowmarketvalues). Theadvantagesare: Arightsissueisthecheapestwayforacompanytoraisefinance throughtheissuingoffurthershares. Arightsissuetoexistingshareholdershasagreaterchanceofsuccess comparedwithashareissuetothepublic. Thedisadvantagesare: Arightsissueismoreexpensivethanissuingdebt. Itmaynotbesuccessfulinraisingthefinancerequired. Arightsissueisaccountedforinthesamewayasanormalshareissue. KAPLANPUBLISHING 267

276 Companyaccounts Test your understanding 2 Uponincorporationin204,TheJammyDodger,alimitedliability company,issues1,00050csharesatnominalvalue.needingfurther funds,in205itmakesarightsissueof1for5at0.75.thisofferis fullytakenup. Whataccountingentriesarerequiredin204and205?Illustratethe relevantsectionofthestatementoffinancialpositionatyearend205. 8Bonus issues Abonus(or capitalisation or scrip)issueis: theissueofnewsharestoexistingshareholdersinproportiontotheir existingshareholding.nocashisreceivedfromabonusissue. Theadvantagesare: Issuedsharecapitalisdividedintoalargernumberofshares,thus makingthemarketvalueofeachoneless,andsomoremarketable. Issuedsharecapitalisbroughtmoreintolinewithassetsemployedin thecompany. Thedisadvantagesare: theadmincostsofmakingthebonusissue. Asnocashisreceivedfromabonusissue,theissuemustbefundedfrom reserves.anyreservecanbeused,thoughanon distributablereservesuch asthesharepremiumaccountwouldbeusedinpreferencetoreserves whichcanbedistributed: DrSharepremiumNominalvalue (orotherreserve) CrSharecapitalNominalvalue 268 KAPLANPUBLISHING

277 chapter17 Test your understanding 3 GingerKnut,alimitedliabilitycompany,has20,00050csharesinissue (eachissuedfor1.25)andmakesa1for4bonusissue,capitalising thesharepremiumaccount. Whatarethebalancesonthesharecapitalandsharepremiumaccounts afterthistransaction? A B C D SC 15,000 12,500 25,000 22,500 SP 10,000 12,500 Nil 2,500 Test your understanding 4 RichTisalimitedliabilitycompanywith200,00025csharesinissue.At 1Januarythebalanceonthesharepremiumaccountis75,000.The followingtransactionsoccurintheyearended31december206: 31JanuaryThereisafullytaken up2for5rightsissue.theissueprice is AugustThereisa1for10bonusissuemadeusingtheshare premiumaccount. Whatarethebalancesonthesharecapitalandsharepremiumaccounts on31december206? A B C D SC SP KAPLANPUBLISHING 269

278 Companyaccounts 9Other reserves Anybalancesrepresentingprofitsorsurplusesowedtotheshareholders arecalledreserves. Expandable text 10Loan notes (loan stock) Alimitedcompanycanraisefundsbyissuingloannotes. Thenominalvalueoftheloannotewillberepayableafteracertain numberofyears. Inthemeantime,theloannote holderwillreceiveanannualfixed amountofinterestbasedonthenominalvalue. Theinterestincurredisincludedin financecost intheincome statement. Aloannoteisadocumentthatisevidenceofadebt. Apersonwillbuyaloannoteforasetnominalvalue,e.g.100.Heor sheiseffectivelyloaning100tothecompany. Test your understanding 5 CustardCreameriesisanincorporatedbusinesswhichneedstoraise fundstopurchaseplantandmachinery.on1march205itissues 150,00010%loannotes,redeemablein10years time.interestis payablehalfyearlyattheendofaugustandfebruary. Whataccountingentriesarerequiredintheyearended31December 205?Showrelevantextractsfromthestatementoffinancialposition. 270 KAPLANPUBLISHING

279 chapter17 11Income tax Companiesarechargedincometaxontheirprofits. Thismeansthatacompanywillnormallyunder oroverprovidefortax inanygivenyear Taxwillthereforeappearintheyear endfinancialstatementsas: Achargetoprofitsintheincomestatementbeing Currentyearestimatedtax+previousyear sunderprovision or Accountingforincometaxisinitiallybasedonestimates,sincea company staxbillisnotfinalisedandpaiduntilninemonthsafterits yearend. Currentyearestimatedtax previousyear soverprovision. Ayearendliabilityinthestatementoffinancialpositionbeingthe currentyear sestimatedtax. Test your understanding 6 GarryBaldycommencedtradeon1January204andestimatesthat theincometaxpayablefortheyearended31december204is 150,000. InSeptember205,theaccountantofGarryBaldyreceivesandpaysa taxdemandfor163,000fortheyearended31december204.at31 December205heestimatesthatthecompanyowes165,000for incometaxinrelationtotheyearended31december205. Drawupthetaxchargeandincometaxpayableaccountsfortheyears ended31december204and205anddetailtheamountsshownin thestatementoffinancialpositionandincomestatementinbothyears. Test your understanding 7 Choccychipestimatedlastyear staxchargetobe230,000.asit happened,theirtaxadvisorsettledwiththetaxauthoritiesat222,000. Thisyear,Choccychipestimatetheirtaxbilltobe265,000,buttheyare alittleconfusedastohowthisshouldbereflectedinthefinancial statements.whichofthefollowingiscorrect? KAPLANPUBLISHING 271

280 Companyaccounts A B C D Statementoffinancialpositionliability Incomestatementtaxcharge () () 257, , , , , , , ,000 12Dividends Dividendsaretheshareofprofitspaidouttoshareholders. Dividendsonpreferencesharesareafixedamount. Dividendsonordinarysharesareexpressedasanamountpershare e.g10cpershareor10%ofnominalvalue Preference dividends Inlinewiththestatementoffinancialpositionpresentationofpreference shares: redeemablepreferencesharedividendsareclassifiedasfinance costs irredeemablepreferencesharedividendsareclassifiedasdividends. Expandable text Ordinary dividends Acompanymaypayamid yearorinterimdividend.thedoubleentryis: DrDividends (statementofchangesinequity) CrBank Attheendoftheyearcompaniesmayproposeadividendtotheordinary shareholders(i.e.telltheshareholderstheamountofadividendtobepaid aftertheyearend).thisisafinal dividend.itisnotrecordedunlessithas beendeclared(orconfirmed)priortotheyearend.ifthisisthecase,the doubleentryis: DrDividends (statementofchangesinequity) CrDividendspayable(SFP) Thebalanceonthedividendspayableaccountisshownasacurrentliability onthestatementoffinancialposition 272 KAPLANPUBLISHING

281 chapter17 Test your understanding 8 Cracker,acompany,hassharecapitalasfollows: Ordinarysharecapital(50cshares)200,000 8%IrredeemablePreferencesharecapital50,000 Thecompanypaysaninterimdividendof12.5cpersharetoitsordinary shareholdersandpaysthepreferenceshareholderstheirfixeddividend. Beforetheyearendthecompanydeclaresafinaldividendof36.5cper sharetoitsordinaryshareholders. Calculatetheamountsshowninthestatementofchangesinequity (SOCIE)andstatementoffinancialposition(SFP)inrelationto dividendsfortheyear. SOCIE A B C D SFP nil Preparation of company accounts YouwillnotbeaskedtoproduceafullsetofaccountsintheF3examination, althoughyoumayberequiredtoprovidecertainbalances. Thefollowingexamplewill,however,helpyoutofullyunderstandthe preparationofcompanyaccounts. KAPLANPUBLISHING 273

282 Companyaccounts Test your understanding 9 Preparation of company accounts ThetrialbalanceofPenguin,acompanyasat31December205was asfollows: Salesandpurchases Inventory Distributioncosts Administrationexpenses Receivablesandpayables Fundamentalreorganisationcosts Cashatbank Ordinaryshares50c 10%irredeemablepreferenceshares1 10%loannotes Non currentassetsatnetbookvalue Sharepremium Accumulatedprofitsat1January205 LoannoteInterest Preferencedividend Interimordinarydividend Incometax Suspense 274 Dr 20,000 8,000 8,000 15,550 10,000 2,400 8,100 35,000 Cr 50,000 20,000 8,000 9,000 8,000 3,000 3, , , , ,500 KAPLANPUBLISHING

283 chapter 17 The following is to be taken into account. (1) A building whose net book value is currently 5,000 is to be revalued to 11,000. (2) A final ordinary dividend of 10c per share is to be proposed. (3) The balance on the income tax account represents an overprovision of tax for the previous year. Income tax for the current year is estimated at 3,000. (4) Closing inventory is 12,000. (5) The balance on the suspense account represents the proceeds from the issue of 4,000 ordinary shares. Prepare the following statements for the year ended 31 December 205: (1) statement of comprehensive income (2) statement of financial position (3) Statement of changes in equity KAPLAN PUBLISHING 275

284 Companyaccounts Chapter summary 276 KAPLANPUBLISHING

285 chapter17 Test your understanding answers Test your understanding 1 Cash Sharecapital/ 350,000 sharepremium Share capital Cash Share premium 50,000 Cash 300,000 Working: Nominalvalue:200,000x25=50,000 Fundsraised:200,000x1.75=350,000 KAPLANPUBLISHING 277

286 Companyaccounts Test your understanding 2 204DrCash500 CrSharecapital Foreveryfivesharesashareholderowns,heorsheisareentitled tobuyanotherone.theofferisfullytakenup,meaningthat200new sharesareissued. DrCash(200x75c)150 CrSharecapital(200x50c)100 CrSharepremium50 Statement of financial position Capitalandreserves: Sharecapital 50cordinary 600 shares Sharepremium 50 Accumulatedprofit Test your understanding 3 The correct answer is B Foreveryfoursharesheld,anewshareisissued. Therefore5,000newsharesareissued DrSharepremium(5,000x50c)2,500 CrSharecapital2,500 Statement of financial position Capitalandreserves: Sharecapital 50cordinaryshares(20,000x50c)+ 2,500 Sharepremium(20,000x50c)+2,500 Accumulatedprofit 12,500 12, KAPLANPUBLISHING

287 chapter17 Test your understanding 4 The correct answer is D Balancec/f Share capital Balanceb/f Rightsissue(cash) 77,000 Bonusissue 77,000 Balanceb/f Share premium Balanceb/f Bonusissue(SC) 50,000 20,000 7,000 77,000 77,000 75,000 7,000 Rightsissue(cash) Balancec/f 124, , , ,000 Balanceb/f 192,000 Statement of financial position Capitalandreserves:p Sharecapital 25cordinaryshares Sharepremium Accumulatedprofit 77, ,000 Workings: Rightsissue:(200,000/5)x2=80,000newshares Proceeds:80,000x1.80=144,000 Nominalvalue:80,000x25c=20,000 Bonusissue:(280,000/10)x1=28,000newshares Nominalvalue:28,000x25c=7,000 KAPLANPUBLISHING 279

288 Companyaccounts Test your understanding 5 1March205DrCash150,000 Cr10%Loannotes150,000 31August205DrFinancecost7,500 CrCash7, ,000x10%x6/12=7,500 31December205DrFinancecost5,000 CrInterestaccrua5, ,000x10%x4/12=5,000 Statement of financial position Non currentliabilities 10%Loannotes Currentliabilities Tradepayables Loannoteinterestpayable 150,000 5, KAPLANPUBLISHING

289 chapter17 Test your understanding 6 Income tax payable (statement of financial position) 204 incomestatement September5Bank 150, ,000 Balancec/f 13, , ,000 Balanceb/f (underprovision) 13, income Balancec/f 165,000 statement(ß) 178, , ,000 Balanceb/f 165,000 Tax charge (income statement) 204taxpayable 205taxpayable 150,000 Incomestatement 150, , ,000 Theincomestatementtaxchargein205isincreasedtoreflectthe underprovisionmadein204. Statement of financial position Incometaxliability 150 Income statement Incometaxexpense KAPLANPUBLISHING 281

290 Companyaccounts Test your understanding 7 ThecorrectanswerisC Theliabilityinthestatementoffinancialposition=theestimated amountpayableforthecurrentyear. Thetaxchargeintheincomestatement=theestimatedamount payableforthecurrentyear lastyear soverprovision. Test your understanding 8 The correct answer is C No.ofordinaryshares=200,000/50c=400,000 Ordinarydividend Interim Final 400,000x12.5c 400,000x36.5c 50, , ,000 Preferencedividend 50,000x8%=4,000 Statement of changes in equity atstartofyear dividends(196,000+4,000) Atendofyear Retainedearnings (200,000) statement of financial position Currentliabilities Proposeddividend146, KAPLANPUBLISHING

291 chapter17 Test your understanding 9 Penguin Statement of comprehensive incomefor the year ended 31 December 205 Salesrevenue 50,000 Costofsales(8,000+20,000 12,000) (16,000) Grossprofit 34,000 Distributioncosts (8,000) Administrativeexpenses (15,550) Operatingprofit 10,450 Fundamentalreorganisationcosts (2,400) 8,050 Interestpayable(10%x8,000) (800) Profitbeforetaxation 7,250 Taxation(*3, ) (2,500) Profitaftertaxation 4,750 OtherComprehansiveincome RevaluationGain 6,000 TotalComprehansiveIncome 10,750 Statement of financial position at 31 December 205 Tangibleassets 41,000 (35,000+6,000) Currentassets Inventory 12,000 Tradereceivables 10,000 Cashatbankandin 8,100 hand 30,100 Totalassets 71,100 KAPLANPUBLISHING 283

292 Company accounts Capital and reserves Ordinary share capital 10,000 (8, ,000) 10% preference share 9,000 capital Share premium account 9,000 (3, ,000) Revaluation reserve 6,000 Accumulated profits 5,250 39,250 Non current liabilities 10% loan notes 8,000 Current liabilities Trade payables 20,000 Proposed preference dividends ( ) 450 Taxation 3,000 Loan note interest ,850 71, KAPLAN PUBLISHING

293 chapter 18 Accounting standards Chapter learning objectives Upon completion of this chapter you will be able to: recognise the difference between tangible non current assets and intangible non current assets identify types of intangible non current assets. define research and development explain the accounting treatment of research and development costs in accordance with IAS 38 calculate the amounts to be capitalised as development expenditure or expensed from given information. explain the purpose of amortisation calculate the amortisation charge and account for it correctly define an event after the reporting revised. account for both adjusting and non adjusting events correctly in the financial statements classify events as adjusting or non adjusting. define provision, contingent liability and contingent asset. classify items as provision, contingent asset or contingent liability from information given account for provisions, contingent liabilities and contingent assets correctly calculate provisions and changes in provisions and account for these changes correctly report provisions in the final accounts 285

294 Accountingstandards explainwhatismeantbyanaccountingpolicyandtheprovisionsofias 8regardingchangesinaccountingpolicy identifytheappropriateaccountingtreatmentforachangeinamaterial accountingpolicyaccordingtoias8 describetheprovisionsofias8whichgovernfinancialstatements regardingmaterialerrorswhichresultinpriorperiodadjustments explaintherequirementsofias18governingrevenuerecognition. 1Intangible non current assets Non currentassetsareassetsusedwithinthebusinessonanongoing basisinordertogeneraterevenue. 286 KAPLANPUBLISHING

295 chapter18 Theycanbesplitintotwodistincttypes: 2Research and development (IAS 38) Researchcanbedefinedasoriginalandplannedinvestigationundertaken withtheprospectofgainingnewscientificortechnicalknowledgeand understanding. Developmentcanbedefinedastheapplicationofresearchfindingsor otherknowledgetoaplanordesignfortheproductionofnewor substantiallyimprovedmaterials,devices,products,processes,systemsor servicesbeforethestartofcommercialproductionoruse. Test your understanding 1 Whichofthefollowingshouldbeclassifiedasdevelopment? (1) BrayneeLtdhasspent300,000investigatingwhetheraparticular substance,flubber,foundintheamazonrainforestisresistantto heat. (2) CleverclogsLtdhasincurred120,000expensesinthecourseof makinganewwaterproofandwindproofmaterialwiththeideathatit maybeusedforski wear. KAPLANPUBLISHING 287

296 Accountingstandards (3) AyplusLtdhasfoundthatachemicalcompound,knownasY,is notharmfultothehumanbody. (4) BrayneeLtdhasincurredafurther450,000usingflubberin creatingprototypesofanewheat resistantsuitforstuntmen. A Allofthem B 1and3 C 2and4 D 2only Accounting treatment of research and development Whereacompanyundertakesresearchanddevelopment,expenditureis beingincurredwiththeintentionofproducingfuturebenefits. Theaccountingissueisthereforewhetherthesecostsshouldbeexpensed totheincomestatementorcapitalisedasanintangibleassetonthe statementoffinancialpositiontomatchtofuturebenefitsarising. Research Allresearchexpenditureshouldbewrittenofftotheincomestatement asitisincurred.thisisincompliancewiththeprudenceconcept. Researchexpendituredoesnotdirectlyleadtofuturebenefitsand thereforeitisnotpossibletofollowthematchingconcept. Anycapitalexpenditureonresearchequipmentshouldbecapitalised anddepreciatedasnormal Development 288 Developmentexpendituremustbecapitalisedasanintangibleasset providedthatcertaincriteriaaremet: Separateproject Expenditureidentifiableandreliablymeasured Commerciallyviable Technicallyfeasible Overallprofitable Resourcesavailabletocomplete Iftheabovecriteriaarenotmet,developmentexpendituremustbe writtenofftotheincomestatementasitisincurred. Onceexpenditurehasbeentreatedasanexpense,itcannotbe reinstatedasanasset. KAPLANPUBLISHING

297 chapter18 Subsequent treatment of capitalised development expenditure Theassetshouldbeamortisedovertheperiodthatisexpectedto benefit.thisensuresthatcostsarematchedtotherevenueinthe incomestatement. Amortisationshouldcommencewithcommercialproduction. Eachprojectshouldbereviewedattheyearendtoensurethatthe SECTOR criteriaarestillmet.iftheyarenolongermet,thepreviously capitalisedexpendituremustbewrittenofftotheincomestatement immediately. Ifapolicyofcapitalisationisadopted,itshouldbeappliedtoallprojectsthat meetthecriteria. Expandable text Illustration Accounting for development costs BrightsparkLtdisdevelopinganewproduct,thewidget.Thisis expectedtobesoldoverathree yearperiodstartingin206.the forecastdataisasfollows: Netrevenuefromotheractivities Netrevenuefromwidgets Developmentcosts (900) Showhowthedevelopmentcostsshouldbetreatedif: (a) thecostsdonotqualifyforcapitalisation (b) thecostsdoqualifyforcapitalisation. Expandable text Test your understanding 2 Thisyear,DeepBlueSeaLtdhasdevelopedanewmaterialfromwhich thenextgenerationofwetsuitswillbemade.thisspecialmaterialwill ensurethatswimmersarekeptwarmerthatever.thecostsincurred meetthecapitalisationcriteriaandbythe31december205yearend 250,000hasbeencapitalised. KAPLANPUBLISHING 289

298 Accountingstandards Thewetsuitsareexpectedtogeneraterevenueforfiveyearsfromthe datethatcommercialproductioncommenceson1january206.what amountischargedtotheincomestatementintheyearended31 December206? A nil B 250,000 C 100,000 D 50,000 Expandable text 3Events after the reporting period revised (IAS 10) Events after the reporting period revisedcanbedefinedasthose materialeventswhichoccurbetweenthestatementoffinancialpositiondate andthedateonwhichthefinancialstatementsareapproved. Adjusting and non adjusting events 290 KAPLANPUBLISHING

299 chapter18 Examples of adjusting and non adjusting events ThefollowingexamplesaretakenfromIAS10: Adjusting events Thesettlementafterthereportingdateofacourtcasewhichconfirmsa yearendobligation. Thereceiptofinformationafterthereportingdatethatindicatesthatan assetwasimpairedatthereportingdate. Thebankruptcyofacustomerafterthereportingdatethatconfirmsthat ayear enddebtisirrecoverable. Thesaleofinventoriesafterthereportingperiodatapricelowerthan cost. Thedeterminationafterthereportingdateofthecostofassets purchasedorproceedsfromassetssoldbeforethestatementof financialpositiondate. Thediscoveryoffraudorerrorsshowingthatthefinancialstatements areincorrect. Non adjusting events Announcingaplantodiscontinueanoperation. Enteringintosignificantcommitmentsorcontingentliabilities(see section4). Commencingacourtcasearisingoutofeventsafterthestatementof financialpositiondate. Majorpurchasesofassets. Thedestructionofassetsafterthestatementoffinancialpositiondate byfireorflood. Expandable text Proposed dividends Itisnotacceptabletoincludedividendsdeclaredafterthestatementof financialpositiondateasliabilitiesattheyearend. Ifdividendsaredeclaredbeforetheyearend,theymustbeshowninthe statementofchangesinequityandaccruedforinthereportingperiod update. KAPLANPUBLISHING 291

300 Accountingstandards Test your understanding 3 WhichofthefollowingareadjustingeventsforBigCoLtd?Theyearend is30june206andtheaccountsareapprovedon18august206. (1) Salesofyearendinventoryon2July206atlessthancost. (2) Theissueofnewordinaryshareson4July206. (3) Afireinthemainwarehouseoccurredon8July206.Allstockwas destroyed. (4) Amajorcreditcustomerwasdeclaredbankrupton10July206 (5) Allofthesharecapitalofacompetitor,TeenyCoLtdwasacquired on21july206. (6) On1August206,500,000wasreceivedinrespectofan insuranceclaimdated13february206. A 1,4and6 B 1,2,4and6 C 1,2,5and6 D 1,4,5and6 Disclosure Wheretherearematerialnon adjustingevents,anotetothefinancial statementsshouldexplain: thenatureoftheevent anestimateofthefinancialeffect. Expandable text 4Provisions, contingent liabilities and assets (IAS 37) A provisioncanbedefinedasaliabilityofuncertaintimingoramount. A Contingent Liabilitycanbedefinedaspossibleobligationthatarises frompastevents. A ContingentAssetcanbedefinedaspossibleassetsarisingfrompast events. Expandable text 292 KAPLANPUBLISHING

301 chapter18 Accounting for contingent liabilities and assets TherequirementsofIAS37asregardscontingentliabilitiesandassetsare summarisedinthefollowingtable: Probability of Occurance Contingent liabilities Contingent assets Virtuallycertain Provide Recognise Probable Possible Remote Provide Discloseinnote Ignore Discloseinnote Ignore Ignore Notethatthestandardgivesnoguidanceasthemeaningoftheterms intheleft handcolumn.onepossibleinterpretationisasfollows: Virtuallycertain>95% Probable51% 95% Possible5% 50% Remote<5% Foracontingentliabilitytoberecordedasaprovision,thefollowing conditionsmustbemet: Apresentobligationexistsastheresultofapastevent. Thereisaprobabletransferofeconomicbenefits. Areliableestimateoftheamountcanbemade. Expandable text Test your understanding 4 ThedraftfinancialstatementsofMadras,alimitedliabilitycompany,for theyearended31december206iscurrentlyunderreview.the followingpointshavebeenraised: KAPLANPUBLISHING 293

302 Accountingstandards (i) Anex employeehasstartedanactionagainstthecompanyfor wrongfuldismissal.thecompany slegalteamhavestatedthatthe ex employeeisnotlikelytosucceed.thefollowingestimateshave beengivenbythelawyersrelatingtothecase: (a) Legalcosts(tobeincurredwhethertheclaimissuccessfulor not)5,000 (b) Settlementofclaimifsuccessful15,000 Tota20,000 Currentlynoprovisionhasbeenmadebythecompanyinthe financialstatements. (ii) Thecompanyhasapolicyofrefundingthecostofanygoods returnedbydissatisfiedcustomers,eventhoughitisundernolegal obligationtodoso.thispolicyofmakingrefundsisgenerally known.attheyearendreturnstotalling4,800havebeenmade. (iii) Aclaimhasbeenmadeagainstacompanyforinjurysufferedbya pedestrianinconnectionwithbuildingworkbythecompany.legal advisershaveconfirmedthatthecompanywillprobablyhavetopay damagesof100,000butthatacounterclaimmadeagainstthe buildingsubcontractorsfor50,000wouldprobablybesuccessful. Statewithreasonswhatadjustments,ifany,shouldbemadebythe companyinthefinancialstatements. Accounting entries for provisions Aprovisionshouldinitiallybeaccountedforatthebestestimateofthe probableoutflow: Drrelevantexpenseaccount Crprovision Movement in provisions Provisionsshouldbereviewedateachbalancesheetdateandadjustedto reflectthecurrentbestestimate. Increaseinprovision: Decreaseinprovision: DrRelevantexpenseaccount CrProvision DrProvision CrRelevantexpenseaccount 294 KAPLANPUBLISHING

303 chapter18 Expandable text 5Accounting policies, changes in accounting estimates and errors (IAS 8) Themainissuescoveredbythisstandardare: changesinaccountingestimates changesinaccountingpolicy correctionofpriorperioderrors. Changes in accounting estimates Theseresultintheadjustmentofthecarryingamountofanassetor liability,e.grevisingtheusefullifeofanon currentassetfromfiveyears tosevenyears. Anynecessarychangeshouldbeincludedinthecurrentincome statementunderthesameheadingasthepreviousestimate,witha notegivingdetailsofthechangeifithasamaterialeffect. Changes in accounting policies Accountingpoliciesarethespecificprinciples,bases,conventions, rulesandpracticesappliedbyanentityinpreparingandpresenting financialstatements. Theconsistencytheorymeansthatacompany saccountingpolicieswill generallyremainthesamefromyeartoyear.theremay,however,be circumstanceswherethepoliciesdohavetochange: Ifrequiredbyastandardorinterpretation. Ifthechangewillresultinamorereliableandrelevantpresentation ofeventsinfinancialstatements. Thechangeisappliedretrospectivelybyadjustingtheopeningbalance ofaccumulatedprofit thisisreflectedinthestatementofchangesin equity.comparativeinformationforpreviousyearsisalsorestated. Fundamental errors E.g.discoveryofamajorfraudwhichoccurredlastyear Thecorrectioninvolvesadjustingtheopeningbalanceofaccumulated profits thisisreflectedinthestatementofchangesinequity. Comparativeinformationforprioryearsshouldalsoberestatedif practical. Ifafundamentalerrorfromapriorperiodisreflectedintheaccounts, thismustbecorrected. KAPLANPUBLISHING 295

304 Accountingstandards 6Revenue (IAS 18) IAS18Revenuedefineswhenrevenuefromvarioussourcesmaybe recognised.itdealswithrevenuearisingfromthreetypesoftransactionor event: saleofgoods renderingofservices interest,royaltiesanddividendsfromtheassetsoftheenterprise. Sale of goods Revenuefromthesaleofgoodsshouldberecognisedwhenallthefollowing conditionshavebeensatisfied: (a) Allthesignificantrisksandrewardsofownershiphavebeentransferred tothebuyer. (b) Thesellerretainsnoeffectivecontroloverthegoodssold. (c) Theamountofrevenuecanbereliablymeasured. (d) Thebenefitstobederivedfromthetransactionarelikelytoflowtothe enterprise. (e) Thecostsincurredortobeincurredforthetransactioncanbereliably measured. Conditions(a)and(b)areusuallymetatthetimewhenlegalownership passestothebuyer,buttherearefourexamplesinias18wheretheseller retainssignificantrisks: whenthesellerhasanobligationforunsatisfactoryperformancebeyond normalwarrantyprovisions whenthereceiptofthecashforthesaleiscontingentuponthebuyer sellingthegoodsonandreceivingcash whenthegoodsaretobeinstalledatthebuyer ssiteandthishasnot yetbeencompleted whenthebuyerhastherighttocancelthecontract. Revenueandassociatedcostsarerecognisedsimultaneouslyin accordancewiththematchingconcept. 296 KAPLANPUBLISHING

305 chapter18 Rendering of services Theprovisionofaserviceislikelytobespreadoveraperiodoftime. IAS18statesthatrevenuefromservicesmayberecognisedaccordingto thestageofcompletionofthetransactionatthestatementoffinancial positiondate. Aswiththesaleofgoods,conditionsmustbesatisfied: (a) Theamountoftherevenuecanbemeasuredreliably. (b) Thebenefitsfromthetransactionarelikelytoflowtotheenterprise. (c) Thestageofcompletionoftheworkcanbemeasuredreliably. (d) Thecostsincurredortobeincurredforthetransactioncanbereliably measured. Whenapartlycompletedserviceisinitsearlystages,ortheoutcomeofthe transactioncannotbereliablyestimated,revenueshouldberecognisedonly uptotheamountofthecostsincurredtodate,andthenonlyifitisprobable thattheenterprisewillrecoverinrevenueatleastasmuchasthecosts. Ifitisprobablethatthecostsofthetransactionwillnotberecovered,no revenueistoberecognised. Expandable text KAPLANPUBLISHING 297

306 Accountingstandards Chapter summary 298 KAPLANPUBLISHING

307 chapter18 Test your understanding answers Test your understanding 1 The correct answer is C Both1and3involveresearchingmaterials,withoutanyformof commercialproductioninmind. Test your understanding 2 The correct answer is D Amortisationwillbechargedforeachofthefiveyearsthatrevenueis generated. Asthereisnoreliablepatternofthisrevenue,amortisationwillbe chargedonthestraight linebasis. Thereforetheamortisationchargeforeachoftheyearsended31 December206 20Y0willbe: 250,000/5years=50,000 KAPLANPUBLISHING 299

308 Accountingstandards Test your understanding 3 The correct answer is A (1) Salesofyearend inventoryatless thancost Adjusting Closinginventorymustbe valuedatthelowerofcost andnetrealisablevalue. Thepost year endsale providesevidenceofthenet realisablevalue.therefore closinginventorymustbe adjustedtoreflectthe reductioninvalue. (2) Shareissue Non adjusting (3) Fireinwarehouse Non adjusting IfthisisBigCo'sonlyor mainwarehouseandthe fireaffectsgoingconcern, theeventwillbereclassified asadjusting. (4) Bankruptcyof majorcustomer Adjusting (5) Acquisitionof TeenyCoLtd Non adjusting (6) Receiptof insurancemonies Adjusting Thebankruptcyofthe customerprovidesevidence oftheirinabilitytopaytheir debtattheyear end.the amountoutstandinpgfrom thecustomerat30june 206shouldthereforebe writtenoffintheyearend accounts. Thereceiptofinsurance moniesprovidesevidence ofayear endasset.the amountsubsequently receivedshouldbereflected assuchintheyear end accounts. 300 KAPLANPUBLISHING

309 chapter18 Test your understanding 4 (i) IAS37definesacontingencyasanobligationoranassetthat arisesfrompasteventswhoseexistencewillbeconfirmedonlyby theoccurrenceornon occurrenceofoneormoreuncertainfuture eventsnotwhollywithinthecontroloftheenterprise.aprovision shouldbemadeif: (a) Thereisanobligation. (b) Atransferisprobable. (c) Thereisareliableestimate. Thelegalcostsof5,000shouldthereforebeprovidedforsince theywillhavetobepaidwhatevertheoutcomeofthecase. However,theclaimisnotlikelytosucceedandsonoprovision shouldbemade.adisclosurenoteshouldbemadeforthepotential lossof15,000. (ii) IAS37statesthatanobligationcanbelegalorconstructive.Inthis casethepolicyofrefundshascreatedaconstructiveobligation.a provisionfor4,800shouldthereforebemade. (iii) Asthesuccessoftheclaimfordamagesof100,000isprobable,it constitutesapresentobligationasaresultofapastobligating event,andwouldthereforebeaccountedforasaprovision.the successofthecounterclaimfor50,000isalsoconsidered probableandwouldthereforeneedtobedisclosedasacontingent asset(reimbursement).onlyifitwereconsideredvirtuallycertain wouldthecounterclaimberecognisedasanassetinthestatement offinancialposition. KAPLANPUBLISHING 301

310 Accounting standards 302 KAPLAN PUBLISHING

311 chapter 19 Statement of cash flows Chapter learning objectives Upon completion of this chapter you will be able to: explain the differences between profit and cash flows explain the need for management to control cash flows explain the value of a statement of cash flows to users of financial statements explain the inward and outward flows of cash in a typical company calculate cash flows from operating activities using the indirect method calculate cash flows from operating activities using the direct method calculate the cash flows from investing activities calculate the cash flows from financing activities prepare extracts from statement of cash flows from given information. 303

312 Statementofcashflows 1The need for a statement of cash flows Profit and liquidity Theaccountingconceptsofaccrualsandmatchingareusedtocomputea profitfigurewhichshowstheadditionalwealthcreatedfortheownersofa businessduringanaccountingperiod.however,itisimportantfora businesstogeneratecashaswellastomakeprofits.thetwodonot necessarilygohandinhand. Expandable text Expandable text 2Format of a statement of cash flows IAS 7 Statement of cash flowsrequirescompaniestopreparea statementofcashflowswithintheirfinancialstatements.thecashflowmust bepresentedusingstandardheadings. 304 KAPLANPUBLISHING

313 chapter19 Statement of cash flows for the period ended Cash flows from operating activities Cashgeneratedfromoperations Interestpaid Dividendspaid Incometaxespaid Netcashfromoperatingactivities Cash flows from investing activities Purchaseofproperty,plantandequipment Proceedsofsaleofequipment Interestreceived Dividendsreceived Netcashusedininvestingactivities Cash flows from financing activities Proceedsofissueofshares Repaymentofloans Netcashusedinfinancingactivities Netincreaseincashandcashequivalents Cashandcashequivalentsatthe beginningoftheperiod Cashandcashequivalents attheendoftheperiod 000 2,550 (270) (300) (420) 1,560 (900) (480) 1,210 (2,000) (790) Expandable text Expandable text 3Cash generated from operations Therearetwomethodsofcalculatingcashfromoperations thedirector indirectmethod.themethodusedwilldependupontheinformation providedwithinthequestion. KAPLANPUBLISHING 305

314 Statementofcashflows Direct method Thismethodusesinformationcontainedintheledgeraccountsofthe companytocalculatethecashfromoperationsfigureasfollows: Cashsales Cashreceivedfromdebtors Less: Cashpurchases Cashpaidtocreditsuppliers Cashexpenses Cashgeneratedfromoperations () Expandable text Indirect method Thismethodreconcilesbetweenprofitbeforetax(asreportedintheincome statement)andcashgeneratedfromoperationsasfollows: Profitbeforetax Financecost Investmentincome Depreciationcharge Loss/(profit)ondisposalofnon currentassets (Increase)/decreaseininventories (Increase)/decreaseintradereceivables Increase/(decrease)intradepayables Cashgeneratedfromoperations () /() ()/ ()/ /() Expandable text 306 Inordertoprepareastatementofcashflows,informationfromthecurrent andprioryearstatementoffinancialpositionandthecurrentyearincome statementisused.thefollowingfinancialstatementsprovidethesource datafortherequirementsoftestyourunderstanding1throughoutthis chapter: KAPLANPUBLISHING

315 chapter19 Test your understanding 1 Requirement 1 Statement of cash flows source data Statement of financial position of Geronimo at 31 December Non currentassets Accumulateddepreciation Currentassets Inventory Tradereceivables Dividendreceivable Cash Totalassets Capitalandreserves Sharecapital Sharepremium Revaluationreserve Accumulatedprofits KAPLANPUBLISHING , (190) (120) ,

316 Statementofcashflows Non currentliabilities Loan Currentliabilities Tradepayables Dividendpayable Interestaccrual Tax Totalliabilities 1,157 Income statement of Geronimo at 31 December 206 Salesrevenue Costofsales Grossprofit Operatingexpenses Operatingprofit Investmentincome interest dividends Financecharge Incometax Netprofitforyear ,100 (678) 422 (309) (22) (71) 92 Operatingexpensesincludealossondisposalofnon currentassetsof 5,000. Duringtheyearplantwhichoriginallycost80,000andwith depreciationof15,000wasdisposedof. Calculatethecashgeneratedfromoperationsusingtheindirectmethod. 4Cash from operating activities Cashflowsmayinclude: 308 interestpaid dividendspaid KAPLANPUBLISHING

317 chapter19 incometaxespaid. Calculation of interest/income taxes paid Thecashflowshouldbecalculatedbyreferenceto: thechargetoprofitsfortheitem(shownintheincomestatement) and anyopeningorclosingpayablebalanceshownonthestatementof financialposition. ATaccountworkingmaybeuseful: e.g Interest payable Cashpaid(ß) Interestaccrualc/f Interestaccrualb/f Incomestatement Interestcharge Ifthereisnoopeningorclosingshouldbestatementoffinancialposition payableamount,itfollowsthatthechargetoprofitsisthecashoutflow. Calculation of dividends paid Thecashflowshouldagainbecalculatedbyreferencetothechargeto profitsandtheopeningorclosingdividendpayableshowninthestatement offinancialposition. Notethatthechargetoprofitsfordividendsisnotshownintheincome statement.itcan,however,bederivedusinganaccumulatedprofitst accountworking. Test your understanding 2 Requirement 2 Identifyandcalculatetheremainingamountstobeshownunderthe heading Cashflowsfromoperatingactivities withingeronimo s statementofcashflows. KAPLANPUBLISHING 309

318 Statementofcashflows 5Cash from investing activities Cashinflowsmayinclude: interestreceived dividendsreceived proceedsofsaleofequipment. Cashoutflowsmayinclude: purchaseofproperty,plantandequipment. Calculation of interest and dividends received Again,thecalculationshouldtakeaccountofboththeincomereceivable shownintheincomestatementandanyrelevantreceivablesbalancefrom theopeningandclosingstatementoffinancialpositions. ATaccountworkingmaybeuseful: e.g Interest receivable Interestreceivableb/f Incomestatementinterestreceivable Cashreceived(ß) Interestreceivablec/f Test your understanding 3 Requirement 3 Identifyandcalculatethedividendsandinterestreceivedtobeshown undertheheading cashflowfrominvestingactivities within Geronimo sstatementstatementofcashflows. Calculation of purchase of property, plant and equipment and proceeds of sale of equipment Theseamountsareoftenthetrickiesttocalculatewithinastatementofcash flows.itisthereforerecommendedthattaccountworkingsareused. 310 KAPLANPUBLISHING

319 chapter19 ThefollowingTaccountswillberequiredforeachclassofassets: costaccount accumulateddepreciationaccount disposalsaccount(whererelevant). Dataprovidedinthesourcefinancialstatementsshouldthenbeenteredinto thesetaccountsandtherequiredcashflowsfound oftenasbalancing figures. NB If there is evidence of a revaluation, remember to include the uplift in value on the debit side of the cost T account. Insomecases,insufficientdetailisprovidedtoproduceseparatecostand accumulateddepreciationaccounts.instead,anetbookvalueaccount shouldbeused: Net book value(nbv) NBVb/f Additions at NBV (= cash to purchase PPE) Revaluation DisposalsatNBV Depreciationchargefor year Netbookvaluec/f Test your understanding 4 Requirement 4 Identifyandcalculatethecashoutflowtopurchaseproperty,plantand equipmentandtheproceedsfromthesaleofequipmenttobeshown undertheheading Cashflowsfrominvestingactivities within Geronimo sstatementofcashflows. 6Cash from financing activities Cashinflowsmayinclude: proceedsofissueofshares KAPLANPUBLISHING 311

320 Statementofcashflows proceedsofissueofloans/debentures. Cashoutflowsmayinclude: repaymentofloans/debentures. Calculation of proceeds of issue of shares Thiscashinflowisderivedbycomparisonofthesumbroughtforwardand sumcarriedforwardbalancesontwoaccounts: sharecapital sharepremium. Calculation of proceeds of issue of loans/repayment of loans Thiscashflowisderivedbysimplysubtractingthebroughtforwardbalance fromthecarriedforward. Test your understanding 5 Requirement 5 Identifyandcalculateeachoftheamountstobeshownunderthe heading Cashflowsfromfinancingactivities withingeronimo s statementofcashflows. Test your understanding 6 Requirement 6 CompletethefollowingproformastatementofcashflowsforGeronimo usingyouranswerstotestyourunderstanding1requirements1 5. Statement of cash flows for Geronimo for year ended 31 December Cash flows from operating activities Cashgeneratedfromoperations Interestpaid Dividendspaid Taxpaid 312 KAPLANPUBLISHING

321 chapter19 Net cash from operating activities Cashflowsfrominvestingactivities Proceedsofsaleofequipment Purchaseofproperty,plantandequipment Interestreceived Dividendsreceived Net cash used in investing activities Cashflowsfromfinancingactivities Proceedsofissueofshares Repaymentofloans Net cash used in financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end period Test your understanding 7 Youaregivenbelow,insummarisedform,theaccountsofAlgernon,a limitedcompany,for206and207. Plant Buildings Investmentsatcost Land Inventory Receivables Bank KAPLANPUBLISHING 206 Cost Dep n 10,000 4,000 50,000 10, SFP Net Cost Dep n Net 6,000 11,000 5,000 6,000 40,000 90,000 11,000 79,000 46,000 85,000 50,000 80,000 43,000 63,000 55,000 65,000 40,000 50,000 3, , ,

322 Statementofcashflows Ordinarysharesof1each Sharepremium Revaluationreserve(land) Accumulatedprofit 10%Loannotes Payables Bank 40,000 12,000 45, ,000 40, ,000 50,000 14,000 20,000 45, ,000 60,000 4, ,000 Costofsales Expenses Interest Netprofitforyear 206 (100,000) 100,000 (50,000) 50,000 (10,000) 40, (120,000) 80,000 (47,000) 33,000 (13,000) 20,000 Notes: A20,000dividendhasbeenpaidintheyear. (a) PrepareastatementofcashflowsforAlgernonfor207,toexplain asfaraspossiblethemovementinthebankbalance.thestatement ofcashflowsshouldbepreparedusingthedirectmethod. (b) Usingthesummarisedaccountsgiven,andthestatementyouhave justprepared,commentontheposition,progressanddirectionof Algernon. 314 KAPLANPUBLISHING

323 chapter19 Test your understanding 8 Partofacompany sstatementofcashflowsisshownbelow: Operatingprofit Lossondisposal Increaseinreceivables Increaseinpayables 000 1,255 (455) (198) 340 Thefollowingcriticismsoftheextracthavebeenmade: (1) Thelossondisposalshouldhavebeenadded,notdeducted. (2) Increaseinreceivablesshouldhavebeenadded,notdeducted. (3) Increaseinpayablesshouldhavebeendeducted,notadded. Whichofthecriticismsisvalid? A 1,2and3 B 1only C 2and3only D noneofthem Test your understanding 9 Whichofthefollowingcouldappearinacompany sstatementofcash flows? (1) Proposeddividend (2) Dividendsreceived (3) Bonusissueofshares (4) Surplusonrevaluationofnon currentassets A 1and2 B 1,2and3 C 2only D 2and3 KAPLANPUBLISHING 315

324 Statementofcashflows Test your understanding 10 ThefollowingdetailsareprovidedtotheaccountantofCaddyshackLtd, whichhasanoperatingprofitof469,850intheyearended31 December206: (1) Depreciationof37,400hasbeenchargedtotheincome statement thisincludedanamountof7,600whichwasthelosson disposalofanon currentasset. (2) Thefollowingextractofthestatementoffinancialpositionat31 December205and206havebeenprovided: Inventory Tradereceivables Prepayments Tradepayables Interestaccrual 31December December Whatisthecashgeneratedfromoperations? A 511,250 B 510,850 C 501,250 D 503, KAPLANPUBLISHING

325 chapter19 Chapter summary KAPLANPUBLISHING 317

326 Statementofcashflows Test your understanding answers Test your understanding 1 Requirement (72) (16) (5) 189 Netprofitbeforetaxation Financecharge Investmentincome Depreciation(W1) Lossondisposalofplant Decreaseininventory Increaseintradereceivables Decreaseintradepayables Cashgeneratedfromoperations (W1) Accumulated depreciation Disposals Balancec/f balanceb/f 190 Depreciationcharge (ß) KAPLANPUBLISHING

327 chapter19 Test your understanding 2 Requirement 2 Interest paid Interest payable 000 Cashpaid(ß) Interestaccrualc/f 000 Interestaccrualb/f 5 24 Incomestatement 3 financecharge Dividends paid Accumulated profits 000 Dividend(ß) Balanceb/f 35 Retainedprofit showninincome statement Balancec/f 318 Dividend payable 000 Dividendpayableb/f Cashpaid(ß) 32 Dividend (accumulated profits) Dividendpayablec/f 30 KAPLANPUBLISHING

328 Statementofcashflows Income tax payable Taxpayableb/f 67 Cashpaid(ß) 62 Incomestatement taxcharge 71 Taxpayablec/f Test your understanding 3 Requirement 3 Thereisnobalanceforinterestreceivableatthestartorendoftheyear thereforeinterestreceivedmustequalinterestreceivableintheincome statement Interestreceived15,000 Dividends received Dividends receivable Dividendsreceivable b/f Incomestatement dividendsreceivable 50 Cashreceived(ß) Dividendsreceivablec/f KAPLANPUBLISHING

329 chapter19 Test your understanding 4 Requirement 4 (seesolutiontorequirement1foraccumulateddepreciationaccount.) PPE Cost 000 balanceb/f 750 Additions(=Cashto purchaseppe) 178 Disposals Revaluation 200 Balancec/f 80 1,048 1,128 1,128 Disposals 000 Cost Accumulated depreciation Lossondisposal Proceeds(ß) KAPLANPUBLISHING 321

330 Statementofcashflows Test your understanding 5 Requirement 5 Sharecapital Sharepremium Proceedsofshareissue 106 Repayment of loan Balanceonloanaccountwas300,000in205 in206itis 200,000. Therefore100,000hasbeenrepaid. 322 KAPLANPUBLISHING

331 chapter19 Test your understanding 6 Requirement 6 Statement of cash flows for Geronimo for year ended 31 December Cash flows from operating activities Cashgeneratedfromoperations Interestpaid Dividendspaid Taxpaid (24) (32) (62) 71 Net cash from operating activities Cashflowsfrominvestingactivities Proceedsofsaleofequipment Purchaseofproperty,plantandequipment Interestreceived Dividendsreceived 60 (178) (53) Netcashusedininvestingactivities Cashflowsfromfinancingactivities Proceedsofissueofshares Repaymentofloans Netcashusedinfinancingactivities Netincreaseincashandcashequivalents Cashandcashequivalentsatbeginningofperiod Cashandcashequivalentsatendofperiod 106 (100) KAPLANPUBLISHING 323

332 Statementofcashflows Test your understanding 7 Statement of Cashflows for Algernon for year ended 31 December 2007 Cash flows from operating activities Cashreceiptsfromcustomers(W1) Cashpaidtosuppliersand employees(w2) 190,000 (155,000) Cashgeneratedfromoperations Interestpaid Dividendspaid Netcashfromoperatingactivities Cash flows from investing activities Purchaseoftangiblenon currentassets(1, ,000) Purchaseofinvestments Netcashusedforinvestingactivities Cash flows from financing activities Issueofshares(10,000+2,000) Loannotes Netcashfromfinancingactivities Netdecreaseincashandcashequivalents Cashandcashequivalentsat1January207 Cash and cash equivalents at 31 December ,000 (13,000) (20,000) 2,000 (41,000) (30,000) (71,000) 12,000 50,000 62,000 (7,000) 3,000 (4,000) Balanceatbank December ,000 (4,000) KAPLANPUBLISHING

333 chapter19 Workings (W1) Receipts from sales Receivables control Balanceb/f 40,000 Cashreceipts(ß) Salesrevenue 200,000 Balancec/f 190,000 50, , ,000 (W2) Payables and wages control Payable and wages control Cashpaid(ß) 155,000 Balanceb/f Depreciation 2,000 Purchasesrecostof sales(w3) Balancec/f 40, ,000 60,000 Expenses 47, , ,000 (W3) Cost of sales Cost of sales Openinginventory Purchasesand wages(ß) KAPLANPUBLISHING 55,000 Costofsales 130,000 Closinginventory 120,000 65, , ,

334 Statementofcashflows Tutorial note Little information has been given as to the nature of the costs of the company for example, no information is supplied on wages and salaries. The payments figure thus includes all cash outflows relating to trading activities. Depreciation would have been charged in either cost of sales or expenses and this needs to be adjusted for. It does not matter whether the adjustment is shown in the payables control or the cost of sales accounts. (b) Algernonhasinvestedsubstantiallyinbuildings,investments, inventoryandreceivablesintheyear.thefinancehascomefrom newsharecapitalinpartbutmainlyfromloans.theequitytoassets ratioofthecompanyhasthusdecreased.theworkingcapitalhas beenfinancedbyanequalincreaseintradepayables. Theprofitshavebeenfullydistributedasdividendsdespitethe halvingofprofitsfromlastyear.itmighthavebeenwisertocutback ondividendsintheperiodofexpansionuntilthebenefitsofthe expansionareseenintheformofhigherprofits. Test your understanding 8 The correct answer is B Alossondisposalshouldbeaddedbacktoprofitasitisanon cash expense. Test your understanding 9 The correct answer is C Dividendsreceivedinvolveacashreceipt.Theothertransactionsdonot involveamovementofcash. 326 KAPLANPUBLISHING

335 chapter19 Test your understanding 10 The correct answer is D Operatingprofit Depreciationandlossondisposal Decreaseininventory Decreaseintradereceivables Increaseinprepayments Decreaseintradepayables 469,850 37,400 22,000 1,000 (11,000) (16,000) 503,250 Notethatthemovementintheinterestaccrualisnotpartofthe reconciliationasthisisdealtwithwithintheinterestpaidlineofthe statementofcashflows. KAPLANPUBLISHING 327

336 Statement of cash flows 328 KAPLAN PUBLISHING

337 chapter 20 The regulatory and conceptual framework Chapter learning objectives Upon completion of this chapter you will be able to: explain the regulatory system: International Accounting Standards Committee (IASC) Foundation International Accounting Standards Board (IASB), the Standards Advisory Council (SAC) and the International Financial Reporting Interpretations Committee (IFRIC) explain how International Financial Reporting Standards (IFRSs) affect the financial reporting process explain the meaning of the qualitative characteristics of financial reporting and define and apply each of the following: relevance (including materiality) reliability (including faithful representation, substance over form, neutrality, prudence and completeness) comparability understandability illustrate the problems of achieving a balance between the qualitative characteristics 329

338 The regulatory and conceptual framework explain the meaning of accounting concepts and define and apply each of the following: going concern accruals consistency materiality substance over form prudence explain the advantages and disadvantages of historical cost accounting (HCA) in times of changing prices explain in principle the main alternatives to HCA: replacement cost net realisable value economic value. 330 KAPLAN PUBLISHING

339 chapter20 1The regulatory framework The need for regulation Regulationensuresthataccountsaresufficientlyreliableanduseful, andpreparedwithoutunnecessarydelay. Financialaccountsareusedasthestartingpointforcalculatingtaxable profits. Theannualreportandaccountsisthemaindocumentusedfor reportingtoshareholdersontheconditionandperformanceofa company. Thestockmarketsrelyonthefinancialstatementspublishedby companies. Internationalinvestorspreferinformationtobepresentedinasimilar andcomparableway,nomatterwherethecompanyisbased. The role of international accounting standards Internationalaccountingstandardsaretherulesthatgovernaccounting fortransactions. Theydon thavetheforceoflaw.theyareeffectiveonlyifadoptedby thenationalregulatorybodies. KAPLANPUBLISHING 331

340 Theregulatoryandconceptualframework 2The role and structure of the IASB TheIASC Foundationisthesupervisorybody.Itsobjectiveisto: develop,inthepublicinterest,asinglesetofhigh quality accountingstandards promotetheuseandrigorousapplicationofthosestandards bringabouttheconvergenceofnationalaccountingstandardsand internationalaccountingstandards. TheIASBisresponsibleforissuingnewInternationalFinancial ReportingStandards(IFRSs). TheIFRICissuerapidguidancewheretherearediffering interpretationsofiass/ifrss. TheSACadvisestheIASBindevelopingnewaccountingstandards. Expandable text 3The conceptual framework Theframeworkforthepreparationandpresentationoffinancialstatements setsouttheconceptsthatunderliefinancialstatementsforexternalusers.it isdesignedto: 332 assisttheboardoftheiasbindevelopingnewstandardsand reviewingexistingones assistinharmonisingaccountingstandardsandprocedures assistpreparersoffinancialstatementsinapplyingiass/ifrssandin dealingwithtopicsnotyetcoveredbyiass/ifrss assistauditorsinforminganopinionastowhetherfinancialstatements conformwithiass/ifrss assistnationalstandard settingbodiesindevelopingnational standards KAPLANPUBLISHING

341 chapter20 assistusersoffinancialstatementsininterpretingfinancialstatements providethoseinterestedintheworkoftheiasbwithinformationabout itsapproachtotheformulationofifrss. The scope of the framework Theframeworkdealswith: theobjectiveoffinancialstatements thedefinition,recognitionandmeasurementoftheelementsfromwhich financialstatementsareconstructed(notexaminableatthislevel). conceptsofcapitalandcapitalmaintenance(notexaminableatthis level). thequalitativecharacteristicsthatdeterminetheusefulnessof informationinfinancialstatements Underlying assumptions of the framework Theframeworkidentifiestwounderlyingassumptions: (1) theaccrualsbasisofaccounting (2) thegoingconcernbasis. ThesealsoappearinIAS1. 4Objectives of financial statements Theobjectiveoffinancialstatementsistoprovideinformationabout: thefinancialpositionofanentity(providedmainlyinthestatementof financialposition) thefinancialperformance(providedmainlyinthestatementof comprehensiveincome)and changesinthefinancialpositionofanentity(providedinthestatement ofchangesinequityandstatementofcashflows) thatisusefultoawiderangeofusersinmakingeconomicdecisions. Expandable text KAPLANPUBLISHING 333

342 Theregulatoryandconceptualframework 5Qualitative characteristics of financial statements Thequalitativecharacteristicsoffinancialstatementsareasetofattributes whichtogethermaketheinformationinthefinancialstatementsusefulto users. Problems of achieving a balance between the qualitative characteristics Atanygivenpointintimeitisunlikelythatallofthequalitative characteristicscanbesatisfied,andthereforetherewillbeconflicts betweenthem.examplesareasfollows: Relevance and timeliness Iffinancialstatementsaretobetailoredtotheneedsofeachindividual user,thentheywilltakelongertoprepare. Understandability and completeness Ifallaspectsofthebusinessaretobeshown,thismaymakethe financialstatementslesscomprehensible. Relevance and reliability sometimestheinformationthatismost relevantisnotthemostreliableorviceversa.insuchconflicts,the informationthatismostrelevantoftheinformationthatisreliableshould beused. Thisconflictmightalsoariseoverthetimelinessofinformation,e.g.a delayinprovidinginformationcanmakeitoutofdateandsoaffectits relevance,butreportingontransactionsbeforeuncertaintiesare resolvedmayaffectthereliabilityoftheinformation.informationshould notbeprovideduntilitisreliable. 334 KAPLANPUBLISHING

343 chapter20 Neutrality and prudence neutralityrequiresinformationtobefreeof deliberateorsystematicbiaswhileprudenceisapotentiallybiased concepttowardsnotoverstatinggainsorassetsorunderstatinglosses orliabilities.neutralityandprudencearereconciledbyfindinga balancethatensuresthatthedeliberateandsystematicoverstatement ofassetsandgainsandunderstatementoflossesandliabilitiesdonot occur. Expandable text 6Other accounting principles Thesegenerallyrecognisedprinciplesunderlieaccountingandfinancial statements. Going concern Theassumptionthatthebusinesswillcontinuein operationfortheforeseeable futurewithoutsignificantlycurtailingitsactivity. Accruals/Matching Tocalculatetheprofitfortheperiod,onemust includealltherevenueandexpenditure relatingtotheperiod,whetherornotthecashhas beenreceivedorpaid. Thisconceptalsostatesthatincomeandexpenses shouldbematchedagainsteach otherwithinanaccountingperiodasfaraspossible. Consistency Itemsshouldbetreatedinthesamewayyearon year.thiswillenablevalidcomparisonsto bemade.however,ifcircumstanceschangethena businessisallowedtochangepoliciestogive afairerrepresentationofthefinancialstatements. Materiality KAPLANPUBLISHING Materialityisathresholdqualitythatisdemandedof allinformationgiveninthe financialstatements,i.e.informationthatismaterial shouldbegiveninthefinancial statementsbutinformationthatisnotmaterialneed notbegiven.informationismaterialifitsomissionor misstatementmightreasonablybeexpectedto influencetheeconomicdecisionsofusers. Whetherornotinformationismaterialwilldependon thesizeandnatureoftheitemand thesizeofthebusiness. 335

344 Theregulatoryandconceptualframework Substance overform Theeconomicsubstanceofatransactionshouldbe recordedratherthansimplyitslegal form.e.g.anon currentassetacquiredunderahire purchaseagreementshouldbeaccounted forasanownedasset.thisisthecommercial substanceofsuchasituation,eventhoughit isnotthecaselegally. Prudence Prudenceistheinclusionofadegreeofcaution whenmakingestimatesunderconditionsof uncertainty. Itensuresthatassetsandincomearenotoverstated andliabilitiesorexpensesarenotunderstated. Test your understanding 1 Whichofthefollowingstatementsarecorrect? (1) Materialitymeansthatonlytangibleitemsmayberecognisedas assets. (2) Substanceoverformmeansthatthecommercialeffectofa transactionmustalwaysbeshowninthefinancialstatementsevenif thisdiffersfromlegalform. (3) Abusinessmayonlychangeanaccountingpolicytoachieveafairer representation. A 2and3only. B Allofthem. C 1and2only. D 1and3only. 7Historical cost The limitations of historical cost accounting Underhistoricalcostaccounting,assetsarerecordedattheamountofcash orcashequivalentspaid,orthefairvalueoftheconsiderationgivenfor them. Liabilitiesarerecordedattheamountofproceedsreceivedinexchangefor theobligation.thismethodofaccountinghasadvantages,butitalsohas seriousdisadvantages. 336 KAPLANPUBLISHING

345 chapter20 Advantages of historical cost accounting (1) Recordsarebasedonobjectivelyverifiableamounts. (2) Itissimpleandcheap. (3) Theprofitconceptiswellunderstood. (4) Withinlimits,historicalcostfiguresprovideabasisforcomparisonwith theresultsofothercompanies,withtheresultsofthesamecompanyfor previousperiodsandwithbudgets. (5) Lackofacceptablealternatives. Disadvantages of historical cost accounting (1) Itoverstatesprofitswhenpricesarerisingthroughinflation. (2) Itmaintainsfinancialcapitalbutdoesnotmaintainphysicalcapital. (3) Thestatementoffinancialpositiondoesnotshowthevalueofthe enterprise. (4) Itprovidesapoorbasisforassessingperformance. (5) Itdoesnotrecognisethelosssufferedthroughholdingmonetaryassets whilepricesarerising. Expandable text Expandable text Test your understanding 2 Inatimeofrisingprices,whateffectdoestheuseofthehistoricalcost concepthaveonanentity sprofitandassetvalues? A Bothprofitandassetvaluesareunderstated. B Profitisunderstatedandassetvaluesoverstated. C Profitisoverstatedandassetvaluesunderstated. D Bothprofitandassetvaluesareoverstated. KAPLANPUBLISHING 337

346 Theregulatoryandconceptualframework Chapter summary 338 KAPLANPUBLISHING