Applied Accounting. Student s Book. NQF Level 4 FET FIRST. S. de Bod L. du Plessis

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2 Applied Accounting Student s Book FET FIRST NQF Level 4 S. de Bod L. du Plessis C

3 FET FIRST Applied Accounting NQF Level 4 Student's Book FET First Softline Pastel Authors: S. de Bod, L. du Plessis, 2008 Illustrations and design Macmillan South Africa (Pty) Ltd, 2008 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, photocopying, recording, or otherwise, without the prior written permission of the copyright holder or in accordance with the provisions of the Copyright Act, 1978 (as amended). Any person who does any unauthorised act in relation to this publication may be liable for criminal prosecution and civil claims for damages. First published Published by Macmillan South Africa (Pty) Ltd Private Bag X Northwold Gauteng South Africa Text design by Resolution Cover design by Deevine Design Typesetting by Resolution The publishers have made every effort to trace the copyright holders. If they have inadvertently overlooked any, they will be pleased to make the necessary arrangements at the first opportunity. ISBN-13: eisbn: It is illegal to photocopy any page of this book without written permission from the publishers.

4 Contents Topic 1: Financial year-end procedures Module 1: The need for adjustments Module 2: Adjustment of the balance sheet accounts Module 3: Adjustments to income accounts Module 4: Adjustments to expense accounts Topic 2: Financial year-end profit or loss calculations Module 1: The concept of profit Module 2: Calculating gross profit in the continuous stock system Module 3: Net profit or loss Module 4: The influence of net profit and loss on capital Module 5: Putting it all together Topic 3: Financial statements Module 1: The purpose of financial year end statements Module 2: Preparing the income statement Module 3: Preparing the balance sheet and notes Topic 4: Accounting software Module 1: The use of accounting software Module 2: The recording of take-on balances Module 3: Value Added Tax (VAT) Module 4: Record credit purchases and returns Module 5: Record cash sales, credit sales and credit returns Module 6: Record cash receipts and cash payments

5 Module 7: The bank reconciliation Module 8: Prepare the petty cash payments cashbook Module 9: Month end adjustments Module 10: Generating and printing reports Pastel Project Portfolio of Evidence Guideline

6 Topic 1 Financial year-end procedures 1

7 Topic 1 Financial year-end procedures Think about it If you had to build one of the soccer stadiums for 2010 and the government transferred all the money to you in Would it be correct presentation to recognise all the income in 2006 and the expenses in 2006 to 2010 as they occur? Introduction In levels two and three of Applied Accounting we discussed the accounting treatment of transactions that take place during a financial year, and how to record all the transactions that the enterprise enters in to on a daily basis. During the financial year transactions are journalised and posted to the relevant ledger accounts. On the last day of each month a trial balance is drawn up. A trial balance is a list of accounts in the general ledger and contains the balances of the accounts in the general ledger on a specific day. The purpose of this trial balance is to ensure that the double-entry principle has been applied correctly in accounting terms. If for each debit entry an equal credit entry (and vice versa) has been made, the trial balance will balance. A trial balance balances when the total of the debit balances is equal to the total of the credit balances. The initial trial balance cannot be used to prepare a proper set of financial statements because it reflects the financial information on a cash basis. GAAP requires financial statements to be prepared on the accrual basis. Under this basis transactions are accounted for as they occur and in the period to which they relate. To be able to produce a proper set of financial statements a series of adjustments needs to take place during the financial year-end procedures. 2 Topic 1

8 Module 1 The need for adjustments Overview After studying this module you will Explain and demonstrate the purpose of adjustments at the financial year-end. Explain and demonstrate the influence of adjustments on balance sheet and nominal section accounts according to Generally Accepted Accounting Practice (GAAP) in the continuous stock system. Unit 1: The purpose of adjustments The pre-adjusted trial balance is used to make certain adjustments to the balances of ledger accounts to ensure that: all income and expenses for a particular period have been realised income and expenses are brought in line with receipts and payments to meet the requirements of the matching and accrual principles assets and liabilities are adjusted with income and expenses that have not been realised that part of fixed assets which has been realised as an expense is brought into account that part of consumables that was consumed is realised as an expense and that part not consumed is transferred as an asset to the next financial year debtors are adjusted to reflect the part that is recoverable, and to write off the part of debtors that is potentially irrecoverable Unit 2: Influence of adjustments on nominal and balance sheet accounts According to the matching and realisation principles, income and expenses must be recognised in the financial period in which they were earned and incurred. When goods are sold on credit for R500 to a person on 31 December 2005, the income from the sale is earned on 31 December However, this money will be received only when the debtor settles his/her debt of R500. The same principle applies to recognising expenses. When weekly wages of R600 are paid, the expenditure on wages for the month is R2 400 (4 weeks R600). Suppose the last week s wages were not paid on 31 December 2005, Module 1 3

9 but only on 2 January The expenditure on wages for December 2005 would still be R The payment simply took place on another day, 2 January Similarly, if a debtor owes money and at year end the amount becomes irrecoverable, that debtor should be adjusted to reflect the situation. It is imperative that you understand that adjustments are made to balance sheet and nominal accounts to reflect the true substance of the transaction and not the form it presents itself in. If you apply this principle to the wages example the form would be that there was no wages in the last week because they were never paid. The substance would be that the employees worked and the benefits you derived as an owner of the business were also received before 31 December 2005 thus the expense should be recognised in Important: Before you approach this section, you must be very sure you understand the different GAAP principles and also the difference between income and receipts, expenses and payments. Very simply, receipts refer to all cash which is received during the financial year and recorded in the cashbook and which increases assets or decreases liability. Income refers to the amount that can be related to the current financial year as an income that increases owner s equity. Payments refer to all cash which is paid during the financial year and recorded in the cashbook and petty cash book and which decreases assets or increases liability. Expenses refer to the amount that can be related to the current financial year as an expense that decreases owner s equity. Income and expenses influence owners equity, whereas receipts and payments influence assets. 4 Module 1

10 Module 2 Adjustment of the balance sheet accounts Overview After studying this module you will Calculate the amount of adjustments accurately. Record the adjustments correctly in the general journal. Post to correct accounts in the general ledger according to GAAP in a continuous stock system. The adjustments to be included: o o o o o additional bad debts provision for bad debts (create, increase, decrease) depreciation stock deficit consumable stores on hand. Unit 1: Bad debts Bad debts refer to that part of the outstanding debt of debtors that cannot be collected. Sometimes debtors do not settle their debts because they are insolvent. Sometimes the debt cannot be collected because the debtor cannot be traced. When the enterprise has made sure that a debtor s debt will not be settled, that debtor s account is written off as irrecoverable. This takes place usually after the necessary documentation has been obtained from the executor. Sometimes management decides to write off the debt even if the person can be traced or even if the person is not insolvent. This means that that particular debtor s debt will be removed from the enterprise s books. This transaction is recorded by debiting the account for bad debts (an owner s equity account expenses decrease owner s equity) and crediting the debtors control account (an asset) and the debtor s personal account (assets decrease because of the loss suffered). Bad debts are dealt with as a separate expense in the books of the enterprise and are not deducted from sales. The reason is that bad debts do not affect the sales of the enterprise. Bad debts influence credit control and by indicating bad debts separately, the credit control division can obtain valuable information about the extent of the possibility that a certain portion of the credit sales will not be recovered. Stricter credit conditions and selection processes can therefore be established. Credit sales increase the turnover of an enterprise and the consequent profit. Bad debts increase the loss suffered as a result of extending credit and there is less profit for the enterprise. An enterprise will keep on selling goods on credit as long as the possibility of bad debts can be kept within reasonable limits. Think about it If one of the debtors of the enterprise goes bad, would the cash loss to enterprise be the amount recorded as sales or cost of sales? Module 2 5

11 Bad debt transactions are recorded in the general journal and the source document is a journal voucher. The account for bad debts is debited and the debtor s account as well as the debtors control account is credited. Posting from the general journal to the general ledger and subsidiary ledgers is done like this: The account for bad debts is debited on the day that the transaction is recorded. The debtor s account in the debtor s ledger is credited on the day that the transaction is recorded. At month-end the total of the debtors control column in the GJ is posted to the credit side of the debtors control account in the general ledger. The entry in the details column is journal credits. The transaction decreases both the debtors control account (an asset) and the bad debts (owner s equity). Owner s equity = Assets Liabilities Bad debts Debtors control Debit Credit Debit Credit When a debtor is declared insolvent, part of his/her outstanding debt may be settled. In this case we refer to a dividend received from the insolvent debtor. That portion received will be recorded in the cashbook and the portion not received will be written off as irrecoverable. Example The following transactions are examples of journalising and posting bad debts and receiving a dividend from an insolvent estate: On 1 December 2007 the following balances were taken from the books of Exampler Stores: Debtors control B7 R1 200 B. Botha D1 R800 P. Matabane D2 R400 Transactions for December B. Botha s account must be written off as irrecoverable. 23 Receive a dividend of 40 cents in the rand from the insolvent estate of P. Matabane. The rest must be written off as irrecoverable. Issue receipt Module 2

12 The effect on the accounting equation Ledgers Owner s equity Assets Liabilities No. Jnl Source document Debit Credit Dr Cr Dr Cr Dr Cr Dec Debtors control: 15 GJ Journal voucher Bad debts B Botha CB Duplicate receipt Bank Debtors control: P Matabane 160* 160 GJ Journal voucher Bad debts Debtors control: P Matabane *Calculation of amount: Dividend amounts to 40 cents in the rand. Total debt is R400. Dividend = 400 ( ) Recording the transactions in the journals CASH RECEIPTS JOURNAL OF EXAMPLER STORES DECEMBER 2007 CRJ10 Doc Day Details Fol Analysis of Receipts Bank Debtors Control P Matabane Discount Allowed Sundry Accounts Amount Fol Details GENERAL JOURNAL OF EXAMPLER STORES DECEMBER 2007 GJ1 Debtors Control Creditors Control Date Details Fol Debit Credit Debit Credit Debit Credit 15 Bad debts 800 B Botha Account of B Botha written off as irrecoverable. Journal voucher Bad debts 240 P Matabane cents in the rand on the account of P Matabane written off as irrecoverable. Journal voucher Module 2 7

13 Posting from the journals to the general ledger Balance sheet accounts section Debtors Control Dec 01 Balance b/d Dec 31 Bad debts GJ Bank and discount allowed CB B Dec 15 B Botha GJ P Matabane GJ Nominal accounts section Bad Debts N22 Posting from the journals to the debtors ledger Debtors Ledger of Exampler Stores B. Botha D1 Date Details Fol Debit Credit Balance 2007 Dec 01 Account rendered Journal voucher 04 GJ1 800 P. Matabane D2 Date Details Fol Debit Credit Balance 2007 Dec 01 Account rendered Receipt 16 CB Journal voucher 05 GJ1 240 Activity 1.1 The following debtors balances were reflected in the books of Bessie Blossoms on 1 January 2011: A. Alers D1 R1 850 B. Botha D2 R1 600 The following transactions took place in Bessie Blossoms during January 2011: 07 Receive a cheque from A. Alers for the partial settlement of his account, R900. Give R50 discount. Issue receipt Module 2

14 23 Receive a letter from A. Alers s trustee informing Bessie Blossoms that A. Alers has been declared insolvent and that no dividend will be paid. 24 B. Botha moved house and cannot be traced. Write his account off as irrecoverable. Required: 1. Show the effect of the transactions on the accounting equation O = A L. 2. Show the necessary entries in the CRJ and GJ for January Draw up the following accounts in the general ledger of Bessie Blossoms for the period 1 January 2011 to 31 January 2011: Debtors control B6 Bad debts N5 4. Draw up the following accounts in the debtors ledger of Bessie Blossoms for the period 1 January 2011 to 31 January 2011: A. Alers D1 B. Botha D2 Unit 2: Provision for bad debts If the debtors control account has a balance of R on the last day of the financial year, it means that the outstanding (total) debt of all debtors is R and that the enterprise should receive R from debtors in the next year. However, when an enterprise sells goods on credit, there is a risk that debtors will not pay their debts. We can assume that the enterprise will not necessarily receive R in the next financial year and that only a portion of the debt will be settled by debtors. If a debtor does not settle his/her debt, for whatever reason, his/her debt will be written off as irrecoverable. The purpose of this is to adjust the outstanding debtors balance to the actual debt that could still be received. Because we suspect that we won t receive the full outstanding debt from debtors owing on the last day of the financial year, we can create a provision for bad debts. A provision can be described as an amount of money set aside for any known expenses that (may) arise and that cannot be determined with any certainty. We cannot say for certain that a specific amount will not be received from debtors. There is a possibility that a certain amount will not be received. A provision for bad debts can be created in the books based on the following principles: There is a possibility of bad debts. The (actual) extent of bad debts can only be determined at a later date (in other words, when it realises). Bad debts must be dealt with as an expense in the financial period when the credit sales took place and not when they realise. Module 2 9

15 2.1 Estimating bad debts Bad debts can be estimated in two ways: As a percentage of total credit sales As a percentage of outstanding debtors In both cases the historical data of the enterprise regarding losses suffered as a result of bad debts is studied. The assumption is that history repeats itself. If 5% of the total credit sales over the past few years has not been realised in receipts, then it can be assumed that 5% of the credit sales in the current financial year will not be realised as receipts either. Similarly, it can be assumed that if 4% of debtors did not settle their debts in the past few years, then 4% of debtors in the current financial year will not settle their debts either. Remember, we cannot say for certain that this will be the actual percentage, so that is why we create the provision. Example The following totals and balances were taken from the books of Exampler Stores on 28 February 2007, the last day of the financial year: Sales N1 R Cash sales R Credit sales R Debtors allowance N9 R Debtors control B7 R Calculate the provision for bad debts if the provision is estimated at: (a) 5% of the total credit sales (b) 5% of outstanding debtors Solution to (a) Total credit sales are calculated as credit sales less debtors allowance. The actual credit sales for the financial year amount to R (R R10 000). Provision for bad debts will be calculated as follows: R ( ) = R Solution to (b) Provision for bad debts will be calculated as follows: R ( ) = R Module 2

16 2.2 Creating the provision for bad debts When the provision for bad debts is created for the first time, the enterprise must decide which method it will use to calculate this provision. When the provision amount is calculated, it will be journalised on the last day of the financial year by means of a journal entry and posted to the general ledger. Two accounts are opened in the general ledger: Provision for bad debts Provision for bad debts adjustment Important: Provision for bad debts is a negative asset and is classified as a B account. It can be regarded as the expected decrease in debtors debt. Provision for bad debts adjustment is an expense and is classified as an N account. It can be regarded as the expected loss as a result of bad debts. Example The following totals and balances were taken from the books of Exampler Stores on 28 February 2007, the last day of the financial year: Sales N1 R Cash sales R Credit sales R Debtors allowance N9 R Debtors control B7 R Calculate the provision for bad debts if the provision is estimated at 5% of outstanding debtors. Show the effect on the accounting equation. Show the journal entry and posting to the general ledger. The effect on the accounting equation Ledgers Owner s equity Assets Liabilities No. Jnl Source document Debit Credit Dr Cr Dr Cr Dr Cr GJ Journal voucher Provision for bad debts Provision for bad debts 9 000* adjustment *Calculation: = Module 2 11

17 Recording the transaction in the journal GENERAL JOURNAL OF EXAMPLER STORES FEBRUARY 2007 GJ1 Debtors Control Creditors Control Date Details Fol Debit Credit Debit Credit Debit Credit 28 Provision for bad debts adjustment Provision for bad debts Provision for bad debts created at 5% of outstanding debtors. Journal voucher Posting from the journal to the general ledger 2007 Feb 28 Balance b/d Balance sheet accounts section Debtors Control B7 Provision for bad Debts B Feb 28 Provision for bad debts adjustment GJ Nom inal accounts sect Nominal accounts section Provision for bad Debts Adjustment 2007 Feb 28 Provision for bad debts GJ N27 Note: Provision for bad debts and provision for bad debts adjustment are not recorded in the debtors control account. 2.3 Increasing the provision for bad debts If the balance of the debtors control account on the last day of the current financial year is more than the balance of the debtors control account on the last day of the previous financial year, the amount provided for bad debts must be increased. This transaction will be recorded as follows: Example The following totals and balances were taken from the books of Exampler Stores on 29 February 2008, the last day of the financial year. Comparative figures for February 2007 are also given. 12 Module 2

18 29 February February 2007 Debtors control B7 R R Provision for bad debts B18? R9 000 Sales N1 R R Debtors allowance N22 R R Calculate the provision for bad debts if the provision is estimated at 5% of outstanding debtors. Show the effect on the accounting equation. Show the journal entry and posting to the general ledger. The effect on the accounting equation Ledgers Owner s equity Assets Liabilities No. Jnl Source document Debit Credit Dr Cr Dr Cr Dr Cr GJ Journal voucher Provision for bad debts Provision for bad debts adjustment Calculation: R = R Provision for bad debts is already R Provision for bad debts must be adjusted by R1 500 (R R9 000). Recording the transaction in the journal GENERAL JOURNAL OF EXAMPLER STORES FEBRUARY 2008 GJ1 Debtors Control Creditors Control Date Details Fol Debit Credit Debit Credit Debit Credit 29 Provision for bad debts adjustment Provision for bad debts Provision for bad debts adjusted to 5% of outstanding debtors. Journal voucher Module 2 13

19 Posting from the journal to the general ledger Balance sheet accounts section Debtors Control B Feb 29 Balance b/d Provision for bad Debts B8 Provision for bad Debts 2007 Feb 28 Balance B/d Feb 29 Provision for bad debts adjustment GJ Nominal accounts section B Nominal accounts section Provision for bad Debts Adjustment N Feb 29 Provision for bad debts GJ Note: Provision for bad debts and provision for bad debts adjustment are not recorded in the debtors control account. 2.4 Decreasing the provision for bad debts If the balance of the debtors control account on the last day of the current financial year is less than the balance of the debtors control account on the last day of the previous financial year, the amount provided for bad debts must be decreased. This transaction will be recorded as follows: Example The following totals and balances were taken from the books of Exampler Stores on 29 February 2008, the last day of the financial year. Comparative figures for February 2007 are also given. 29 February February 2007 Debtors control B7 R R Provision for bad debts B8? R9 000 Sales N1 R R Debtors allowance N22 R R Calculate the provision for bad debts if the provision is estimated at 5% of outstanding debtors. Show the effect on the accounting equation. Show the journal entry and posting to the general ledger. 14 Module 2

20 The effect on the accounting equation Ledgers Owner s equity Assets Liabilities No. Jnl Source document Debit Credit Dr Cr Dr Cr Dr Cr GJ Journal voucher Provision for bad debts Provision for bad debts adjustment Calculation: R = R Provision for bad debts is R Provision for bad debts must be adjusted by R3 000 (R9 000 R6 000). Recording the transaction in the journal GENERAL JOURNAL OF EXAMPLER STORES FEBRUARY 2008 GJ1 Debtors Control Creditors Control Date Details Fol Debit Credit Debit Credit Debit Credit 29 Provision for bad debts Provision for bad debts adjustment Provision for bad debts adjusted to 5% of outstanding debtors. Journal voucher Posting from the journal to the general ledger Balance sheet accounts section Balance sheet accounts section Debtors Control B Feb 29 Balance b/d Provision for bad Debts 2008 Provision for bad debts 2007 Feb 29 adjustment GJ Feb 28 Balance b/d Balance c/d Mar 01 Balance b/d Nominal accounts section B8 Nominal accounts section Provision for bad Debts Adjustment N Feb 29 Provision for bad debts GJ Note: Provision for bad debts and provision for bad debts adjustment are not recorded in the debtors control account. Module 2 15

21 Activity 1.2 The debtors control account below was taken from the financial records of Bessie Blossoms and shows the closing balances of debtors over a period of three years. The provision for bad debts account shows the balance on 28 February 2005 taken from the pre-adjustment trial balance. General Ledger of Bessie Blossoms Date Details Fol Amount Date Details Details Fol Amount Balance sheet accounts section Debtors Control B Feb 28 Balance b/d GJ Feb 28 Balance b/d GJ Feb 28 Balance b/d GJ Provision for bad Debts B Feb 28 Balance b/d GJ Required: 1. Adjust the provision for bad debts to 4% of outstanding debtors at each year-end. 2. Show the effect of the annual adjustment on the accounting equation O = A L. Indicate an increase with +, a decrease with and no effect with 0. Use the following columns: General Ledger Owner s equity Assets Liabilities No. Debit Credit 3. Journalise the necessary journal entries and post them to the provision for bad debts account. Assess yourself a) Mark this exercise together with your lecturer by using the given solution in the Lecturer s Guide. How accurate were you? Percentage correct Result Percentage correct Result 100% Unbeatable! 60% 69% Good 80% 99% Excellent 40% 59% Need a little help 70% 79% Very good 0% 39% Need a lot of help b) Copy and complete the following: I need more help with: I could improve my results if: 16 Module 2

22 Unit 3: Depreciation 3.1 The concept of depreciation Enterprises buy fixed assets and use them to generate income. When an enterprise buys fixed assets such as vehicles or equipment, an asset account (either vehicles or equipment) is debited because assets increase. The bank account or the creditors control account will be credited, depending on how the asset was bought. The amount with which the asset account is debited does not represent an expense for the enterprise because the expenditure is capital in nature. In other words, the fixed asset is not used up in one financial year, but the principle is accepted that the fixed asset will be used for several financial years to generate income (and therefore a profit). According to the matching principle, the expenses incurred and the income generated in a specific financial year must be played off against one another.?? Did you know? Fixed assets are also known as non-current assets. The total cost of purchasing a fixed asset is reflected in the asset account. Suppose a vehicle is bought for R on credit on 1 February A further R6 500 is spent on the car and paid for by cheque a tow bar (R2 500), a CD player (R3 500) and the vehicle licence (R500). The entries in the general ledger will be as follows. We refer to this as the capitalisation of expenses that relate to the acquisition of fixed assets. Balance sheet accounts section Debtors Vehicles Control B4 B Feb 01 Creditors control CJ Bank CB Bank CB Nominal accounts section Nominal accounts section Vehicle Licence N Feb 01 Bank CB1 500 Fixed assets such as vehicles and equipment lose value over a certain period. This decrease in the value of fixed assets is called depreciation. Depreciation represents the monetary value by which the value of the fixed asset decreases and is dealt with as an expense because owner s equity decreases. This depreciation results through wear and tear, assets that become obsolete because of technological advances and the inability of assets to maintain a certain level of production. As fixed assets lose value, the enterprise s books must be adjusted to reflect the actual value of these assets. According to the historical cost principle, assets must be shown at their original purchase price plus Module 2 17

23 any capital expenses incurred relating to the installation and/or acquisition of the assets. The value of the asset therefore cannot be adjusted in the relevant ledger account for the fixed asset. In the general ledger of the enterprise, two new accounts will be created, the depreciation account (owner s equity) and accumulated depreciation on vehicles or accumulated depreciation on equipment (a negative asset). The accumulated depreciation on vehicles account is considered to be a negative asset because it reduces the value of the asset (vehicles). 3.2 Methods of calculating depreciation Depreciation can be calculated in two ways to bring the expense of owning and using an asset into account. The first method is called the straight-line method or cost price method. The second is called the diminishing balance method or book value method. The method used will be determined by the nature of the asset and the management of the enterprise. However, it is vital to be consistent. When a method is chosen for a specific fixed asset, it is assumed that the same method and rate will be used in consecutive financial years. Depreciation is brought into account on the last day of the financial year and is calculated for the number of months (out of 12) that the asset has been in the enterprise s possession. In the straight-line, fixed instalment or cost price method, the depreciation is spread in equal portions over the lifespan of the fixed asset at a fixed rate (percentage). In this case the rate/percentage at which depreciation is written off as well as the value at which the depreciation is calculated will remain the same. Example The following totals and balances were taken from the books of Exampler Stores on 29 February 2008, the last day of the financial year. Comparative figures for February 2007 are also given. 29 February February 2007 Vehicles B3 R R Equipment B4 R R Note: A vehicle was bought for R on 31 August Calculate the depreciation on vehicles on 28 February 2007 if depreciation on vehicles is calculated at 20% per annum on cost price. Calculate the depreciation on vehicles on 29 February 2008 if depreciation on vehicles is calculated at 20% per annum on cost price. 18 Module 2

24 Solution: Depreciation on 28 February 2007 R = R Depreciation on 29 February 2008 R = R R = R R In the diminishing balance or book value method, the depreciation is calculated at a fixed rate (percentage) on the book value of that asset. The book value of a fixed asset refers to the cost price of that asset less the accumulated depreciation on the asset. In this case the rate/percentage at which depreciation is written off remains the same, but the value on which the depreciation is calculated drops. Example The following totals and balances were taken from the books of Exampler Stores on 29 February 2008, the last day of the financial year. Comparative figures for February 2007 are also given. Note: A vehicle was bought for R on 31 August 2007 and the equipment was bought on 1 March Calculate the depreciation on equipment on 28 February 2007 if depreciation on equipment is calculated at 20% per annum on book value. Calculate the depreciation on equipment on 29 February 2008 if depreciation on equipment is calculated at 20% per annum on book value. Solution: Depreciation on 28 February February February 2007 Vehicles B3 R R Equipment B4 R R R = R Depreciation (owner s equity) on 28 February 2007 amounts to R Accumulated depreciation (asset) on 28 February 2007 amounts to R The book value of the asset on 28 February 2007 amounts to R (R R15 000). Module 2 19

25 Depreciation on 29 February 2008 R = R Depreciation (owner s equity) on 29 February 2008 amounts to R Accumulated depreciation (asset) on 29 February 2008 amounts to R (R R12 000). The book value of the asset on 29 February 2008 amounts to R (R R R12 000). The effect of the different methods is illustrated in the example below. Example The following totals and balances were taken from the books of Exampler Stores on 29 February 2008, the last day of the financial year. Comparative figures for February 2007 are also given. 29 February February 2007 Vehicles B3 R R Calculate the depreciation and accumulated depreciation on vehicles if depreciation on vehicles is calculated at 20% per annum on: a) cost price b) book value (Vehicles were bought on 1 March 2006) Solution: a) Depreciation on vehicles at 20% per annum on cost price. Year-end Cost price Depreciation Accumulated depreciation on vehicles 29 Feb Feb Feb Feb Feb R = R R = R R = R R = R R = R Carrying value (book value) R = R R = R R = R R = R R = R1 Note: On 29 February 2012 the full amount of depreciation is not written off. If the full amount were to be written off, the carrying value of vehicles would be R0, which would mean that the 20 Module 2

26 vehicle would no longer be recorded in the books. It must remain in the books for as long as the vehicle is in the enterprise s possession. That is why the carrying value of the vehicle is kept at R1. b) Depreciation on vehicles at 20% per annum on book value. Year-end Cost price Depreciation Accumulated depreciation on vehicles 29 Feb Feb Feb Feb Feb R = R R = R R = R R = R R = R25 395,20 Carrying value (book value) R = R = R = R = R ,20 = R , = R = R = R ,20 = R ,80 It is clear from this example that writing off depreciation on the carrying value takes place over a much longer period than on cost price. 3.3 Journalising and posting depreciation When the enterprise purchases assets, it must decide which method it will use to calculate depreciation. When the depreciation has been calculated, it will be journalised on the last day of the financial year by means of a journal entry and posted to the general ledger. Two accounts are created in the general ledger: Depreciation Accumulated depreciation on vehicles adjustment Important: The accumulated depreciation on vehicles account is a negative asset and is classified as a B account. This account decreases the book value of the asset concerned. The depreciation account is an expense and is classified as an N account. It can be regarded as the cost of using the asset concerned in the financial period. Module 2 21

27 Example The following totals and balances were taken from the books of Exampler Stores on 28 February 2007, the last day of the financial year. 28 February 2007 Vehicles B3 R Equipment B4 R Depreciation is calculated like this: At 20% per annum on cost price of vehicles At 25% per annum on carrying value of equipment Show the effect on the accounting equation. Journalise the adjustment amount for depreciation on 28 February 2007 for vehicles and equipment. Post the general journal to the general ledger. The effect on the accounting equation Ledgers Owner s equity Assets Liabilities No. Jnl Source document Debit Credit Dr Cr Dr Cr Dr Cr 1 GJ Journal voucher Depreciation Accumulated depreciation on vehicles GJ Journal voucher Depreciation Accumulated depreciation on equipment (1) R = R (2) R = R Recording the transactions in the journal GENERAL JOURNAL OF EXAMPLER STORES FEBRUARY 2007 GJ1 Date Details Fol Debit Credit 28 Depreciation Accumulated depreciation on vehicles Depreciation on vehicles at 20% p.a. on cost price brought into account. Journal voucher Depreciation Accumulated depreciation on equipment Depreciation on equipment at 25% p.a. on book value brought into account. Journal voucher Module 2

28 Posting from the journal to the general ledger Balance sheet accounts section Debtors Vehicles Control B3 B Feb 28 Balance b/d B Feb 28 Balance b/d Equipment B4 Accumulated Depreciation on Vehicles B Feb 28 Depreciation GJ Accumulated Depreciation on Equipment B Feb 28 Depreciation GJ Nominal accounts section Depreciation N Feb 28 Accumulated depreciation on vehicles GJ Accumulated depreciation on equipment GJ Depreciation is regarded as an expense and therefore reduces the profit of the enterprise. The annual depreciation that is written off on a fixed asset is accumulated in the accumulated depreciation account. This account accumulates the annual depreciation written off on an asset and therefore decreases the carrying value of the asset. Remember, the carrying value of an asset is the cost price of the asset less the accumulated depreciation on that asset. On the last day of the next financial year (29 February 2008) the adjustment and posting of depreciation will be done like this: Example The following totals and balances were taken from the books of Exampler Stores on 29 February 2008, the last day of the financial year: 29 February 2008 Vehicles B3 R Equipment B4 R Accumulated depreciation on vehicles B9 R Accumulated depreciation on equipment B10 R Module 2 23

29 Depreciation is calculated like this: At 20% per annum on cost price of vehicles At 25% per annum on carrying value of equipment Show the effect on the accounting equation. Journalise the adjustment amount for depreciation on 28 February 2008 for vehicles and equipment. Post the general journal to the general ledger. The effect on the accounting equation Ledgers Owner s equity Assets Liabilities No. Jnl Source document Debit Credit Dr Cr Dr Cr Dr Cr 1 GJ Journal voucher Depreciation Accumulated depreciation on vehicles , ,00 2 GJ Journal voucher Depreciation Accumulated depreciation on equipment , ,50 (1) R = R32 000,00 12 (2) (R R18 750) = R14 062,50 12 Recording the transactions in the journal GENERAL JOURNAL OF EXAMPLER STORES FEBRUARY 2008 GJ2 Date Details Fol Debit Credit 29 Depreciation ,00 Accumulated depreciation on vehicles ,00 Depreciation on vehicles at 20% p.a. on cost price 29 Depreciation ,50 Accumulated depreciation on equipment ,50 Depreciation on equipment at 25% p.a. on book value. Journal voucher , ,50 24 Module 2

30 Posting from the journal to the general ledger Balance sheet accounts section Debtors Vehicles Control B3 B Feb 28 Balance b/d ,00 Equipment B Feb 28 Balance b/d ,00 Accumulated Depreciation on Vehicles 2007 Feb 28 Depreciation GJ , Feb 29 Depreciation GJ ,00 Accumulated Depreciation on Equipment , Feb 28 Depreciation GJ , Feb 29 Depreciation GJ ,50 Nominal accounts section B9 B ,50 Depreciation N Accumulated depreciation on Feb 28 vehicles GJ ,00 Accumulated depreciation on equipment GJ ,50 Activity 1.3 On 1 January 2005 Miracle Paints bought a vehicle for R on credit. Depreciation is calculated at 20% per annum on cost price. 1. Show the journal entries in the general journal of Miracle Paints on 31 December 2005 and Draw up the following accounts in the general ledger of Miracle Paints: a) Vehicles B3 b) Accumulated depreciation on vehicles B4 (1 January 2005 to 31 December 2009) c) Depreciation N17 (31 December 2005) Module 2 25

31 Assess yourself a) Mark this exercise together with your lecturer by using the given solution in the Lecturer s Guide. How accurate were you? Percentage correct Result Percentage correct Result 100% Unbeatable! 60% 69% Good 80% 99% Excellent 40% 59% Need a little help 70% 79% Very good 0% 39% Need a lot of help b) Copy and complete the following: I need more help with: I could improve my result if: Activity 1.4 On 1 January 2005 Miracle Paints bought equipment worth R on credit. Depreciation is calculated at 20% per annum on book value. 1. Show the journal entries in the general journal of Miracle Paints on 31 December 2005 and Draw up the following accounts in the general ledger of Miracle Paints: a) Equipment B5 b) Accumulated depreciation on equipment B6 (1 January 2005 to 31 December 2009) c) Depreciation N17 (31 December 2005) Peer assessment a) Your friend must mark your answers to this exercise together with your lecturer by using the given solution in the Lecturer s Guide. How accurate were you? Percentage correct Result Percentage correct Result 100% Unbeatable! 60% 69% Good 80% 99% Excellent 40% 59% Need a little help 70% 79% Very good 0% 39% Need a lot of help b) Copy and complete the following: I particularly struggle with: Activity 1.5 The general ledger accounts which follow were taken from the financial records of Bessie Blossoms and reflect the closing balances of land and buildings, vehicles and equipment over a period of three years. The vehicles and equipment were purchased on 01 March Module 2

32 Required: 1. Journalise the necessary journal entries and post them to the ledger accounts in the general ledger. Depreciation must be calculated as follows: At 25% p.a. on cost price on vehicles At 40% p.a. on the diminishing balance on equipment 2. Show the effect of the annual adjustment on the accounting equation O = A L. Indicate an increase with +, a decrease with and no effect with 0. Use the following columns: 3. Briefly explain the difference between the adjustment of depreciation on cost price and on book value. 4. Briefly explain what you would do when adjusting depreciation when an asset was purchased during the financial year. 5. Briefly explain why depreciation is not written off on land and buildings. General Ledger of Bessie Blossoms Date Details Fol Amount Date Details Details Fol Amount 2005 Feb 28 Balance b/d Balance sheet accounts section Land and buildings B Feb 28 Balance b/d Mar 01 Creditors control CJ Feb 28 Balance b/d Aug 31 Creditors control CJ Vehicles Equipment Accumulated Depreciation on Vehicles 2004 Mar 01 Balance b/d B/d 2005 Feb 28 B4 B5 B Feb 28 Accumulated Depreciation on Equipment B Mar 01 Balance b/d B/d 2005 Feb Feb 28 Module 2 27

33 2005 Feb 28 Nominal accounts section Depreciation N Feb 28 Nominal accounts section Depreciation N28 Unit 4: Stock deficit 4.1 Adjustment of trading stock and trading stock deficit as a year-end adjustment When the continuous inventory system is used, the trading stock account could be regarded as an ongoing record of the movement of stock. Trading stock is a current asset and increases are recorded on the debit side and decreases on the credit side. When trading stock is purchased, the trading stock account is debited (A+) with the total purchase price of the trading stock and the amount spent on getting the trading stock to the store, e.g. carriage on purchases/freight/packaging/customs duty. Depending on the nature of the transaction, the stock account will be debited either with bank (cash purchases of merchandise) OR creditors control (credit purchases of merchandise) OR petty cash (petty cash purchases of merchandise) 28 Module 2

34 When trading stock is sold, the cost of sales for that particular transaction is calculated and recorded in the general ledger. The cost of sales account is debited (O ) and the trading stock account is credited (A ). Sales returns by debtors will cause the trading stock account to be debited (A+) and purchases returns to creditors will cause the trading stock account to be credited (A ). At any given time the trading stock account should therefore reflect the actual value of trading stock present in the enterprise (on hand). TRADING STOCK B Jan 01 Balance b/d Dec 31 Cost of sales CB Dec 31 Bank CB Cost of sales DJ Creditors control CJ Creditors control PRJ Cost of sales SRJ Donations GJ Jan 01 Balance b/d Drawings GJ Balance c/d On the last day of the financial year a physical stocktaking is done to determine the actual value of trading stock on hand in the enterprise. If there is a difference between the closing balance of the trading stock and the value of the physical stocktaking, the difference needs to be adjusted. If the stocktaking reveals a smaller amount than the closing balance of the trading stock account, there is a deficit. A trading stock deficit could be a result of theft, obsolescence of stock, damage to stock or, destruction of stock through fire/flood, etc. The value at which trading stock is indicated in the general ledger must correspond with the actual trading stock on hand. If the physical stocktaking reveals that trading stock on hand is R31 400, the trading stock account cannot have a balance of R This balance will have to be adjusted to R by making an entry in the general journal. The enterprise suffers a loss of R600 as a result of the trading stock deficit. When the amount of the trading stock deficit has been determined, a new account is created in the general ledger that represents the loss that the enterprise suffered. The trading stock deficit account is debited (O ) and the trading stock account is credited (A ). The closing balance of the trading stock account is therefore adjusted to the amount revealed by the physical stocktaking. Module 2 29