Cima

Course Notes
CIMA BA3
Fundamentals of Financial Accounting
From September 2017
Tutor details
SEPTEMBER 2017 RELEASE

ii Introduction CIMA BA3
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CIMA BA3 Introduction iii
Contents
Page
Introduction i
1 Syllabus overview vii

2 Learning outcomes and indicative syllabus content vii
3 The examination vii
4 Studying BA3 viii
5 Study planner viii
1: Introduction to accounting 1
1 Introduction 1
2 User groups 2
3 Types of business entity 2
4 Financial accounts v Management accounts 3
5 The regulatory framework 3
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6 Duties and responsibilities of those charged with governance 5
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2: The conceptual framework 7
1 Conceptual framework 7
3 Accounting concepts ntu ght

2 Qualitative characteristics of financial information 7
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4 Accounting policies and changes in accounting estimates (IAS 8) 9
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5 Financial statements and key definitions 10
6 Integrated reports 12
3: Accounting systems
1 Purpose and role of accounting records

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2 Sources of data 15
3 Books of Prime Entry 16
4 Cash Book 16
5 Petty cash book 17
6 Sales day book 17
7 Purchases day book 17
8 Journal 18
9 Nominal or General Ledger 18
4: Double entry bookkeeping 21
1 Introduction 21
2 The separate entity concept 21
3 The dual effect (“duality”) 21
4 Double entry bookkeeping 22
5 Ledger accounts 23
6 Closing the books 25
7 Chapter summary 29
iv Introduction CIMA BA3
5: The trial balance 31
1 Summary of where we are so far 31

2 The trial balance 32
3 Bookkeeping errors 33
4 Accounting adjustments 33
5 The Statement of Profit or Loss 34
6 The Statement of Financial Position 35
7 The accounting equation 36
6: Sales, purchases and sales taxes 39
1 Recording transactions – recap 39

2 Returns, debit notes and credit notes 40
3 Discounts 41
4 Refunds 43
5 Sales taxes 43
6 Payroll taxes 46
7: Control accounts 49
1 Introduction 49
2 Memorandum ledger accounts 49
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3 Interaction of daybooks, memorandum accounts and nominal ledger 50
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4 Receivables and payables control accounts
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5 Control account reconciliations 52
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6 Supplier statement reconciliations 54
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7 Control account errors 55
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8 Other control accounts 56
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8: Accruals and prepayments 57
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1 Introduction 57
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2 Accruals 57
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3 Prepayments 60
4 Calculating accruals and prepayments 62
5 Accrued and deferred income 63
9: Receivables and irrecoverable debts 67
1 Irrecoverable (bad) debts 67

2 Doubtful debts 67
3 General allowance 68
4 Movement in allowances year on year 70
10: Inventories 73
1 Buying and selling inventories 73

2 Period end inventory adjustments 73
3 Inventory and cost of sales 74
4 Inventory valuation (IAS 2) 75
5 Continuous inventory systems 77
CIMA BA3 Introduction v
11: Non-current assets and depreciation 79
1 Definitions 79
2 Depreciation methods 80
3 Disposals 83
4 Revaluations 84
5 Impairment (a fall in value) 85
6 Non-current asset register 85
7 Intangible assets 86
8 Disclosure requirements for intangible assets 89
12: Bank reconciliations 91
1 Introduction 91
2 Approach to bank reconciliation questions 92
13: Accounting errors 95
1 Types of errors 95
2 Correction of errors 96
14: Incomplete records
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1 Introduction 101
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2 Cost structures 101
3 Using ledger accounts to solve incomplete records 103
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4 Accounting equation 106
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15: Company accounts 109
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1 Introduction 109
2 Capital structure of limited companies 109
3 Reserves 110
4 Share issues 111
5 Dividends 113
6 Preparing limited company accounts (IAS 1) 114
7 Tax in company accounts 117
16: Statements of cash flows 119
1 Introduction 119
2 Definitions 119
3 Pro forma Statement of cash flows – indirect method 120
4 Preparing a statement of cash flows – indirect method 121
5 Proforma Statement of cash flows – direct method 125
17: Interpretation of financial statements 127
1 Introduction 127
2 Profitability ratios 129
3 Liquidity and efficiency ratios 131
4 Risk 133
vi Introduction CIMA BA3
18: Manufacturing accounts 135
1 Introduction 135
2 Layout of manufacturing accounts 136
Solutions to Lecture examples 139
Chapter 4 139
Chapter 5 144
Chapter 6 146
Chapter 7 147
Chapter 8 148
Chapter 9 149
Chapter 10 150
Chapter 11 151
Chapter 12 152
Chapter 13 153
Chapter 14 155
Chapter 15 156
Chapter 16 157
Chapter 18 158
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Appendix – Summary of debits and credits 159
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CIMA BA3 Introduction vii
1 Syllabus overview
The main objective of this subject is to obtain a practical understanding of financial accounting and the
process behind the preparation of financial statements for single entities.
These statements are prepared within a conceptual and regulatory framework requiring an
understanding of the role of legislation and of accounting standards. The need to understand and
apply the necessary controls for accounting systems, and the nature of errors is also covered. There is
an introduction to measuring financial performance with the calculation of basic ratios.
Students will be required to be aware of the format and content of published accounts but are not
required to prepare them. No detailed knowledge of any specific accounting treatment contained in
the International Financial Reporting Standards (IFRSs) - including the International Accounting
Standards (IASs) - is necessary, except in terms of IAS 2 and the treatment of inventory, IAS 16 and
IAS 38 for basic non-current asset transactions.
IAS 1 and IAS 7 formats will form the basis of the financial statements. The terminology used for all
entities will be that seen in the International Financial Reporting Standards. This will enable students
to use a consistent set of accounting terms throughout their studies.
2 Learning outcomes and indicative syllabus content
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On completion of their studies, students should be able to:
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A – Accounting principles, concepts and regulations 10%
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 Explain the principles and concepts of financial accounting
 Explain the impact of the regulatory framework on financial accounting
B – Recording accounting transactions 50% itio

 Prepare accounting records
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 Prepare accounting reconciliations
 Prepare accounting entries for specific transactions
C – Preparation of accounts for single entities 30%

 Prepare accounting adjustments
 Prepare manufacturing accounts
 Prepare financial statements for a single entity
D – Analysis of financial statements 10%

 Identify information provided by accounting ratios
 Calculate basic accounting ratios
3 The examination
The exam is a computer-based assessment of 2 hours duration, comprising 60 compulsory objective
test questions.
Short scenarios may be given to which one or more objective test questions relate.
viii Introduction CIMA BA3
4 Studying BA3
BA3 is one of the trickiest subjects at Certificate level. If you are new to accounting it may take a while
for the concept of double entry to sink in. The key is to persevere through the first six chapters, after
which things will start to make more sense until everything comes together in Chapter 15. If at any
time you are struggling with double entry, go back to the exercises in Chapter 4 until you understand
debits and credits!
5 Study planner
Chapter Subject Time (min) Questions Complete
1 Introduction to accounting 60 Ch 1- all Q’s
The framework we introduce here and in the next
chapter underpins everything that we will cover in
preparing financial statements, and is therefore very
important. You should learn the basic function of
each of the regulatory bodies for a few easy marks
in the exam.
2 The conceptual framework 90 Ch 2 – all Q’s
The accounting concepts are fundamental to
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accounts preparation. Don’t worry too much about
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learning them here as we will constantly be
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referring back to them as we go through later
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chapters. But do make sure you revisit this chapter
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once you have completed the course to make sure
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you understand the balance between these
qualitative characteristics.
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3 Accounting systems 50 Ch 3 – all Q’s
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we will cover in more detail in Session 4. You are
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unlikely to get more than one or two questions on
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this content, but it is very important that you are
familiar with the various source documents and how
they are recorded in an accounting system.
4 Double entry bookkeeping 90 Ch 4 – all Q’s
It is essential that you understand how the double
entry system works and how to distinguish debit
and credit entries for different types of transactions:
DEBITS CREDITS
Expenses Liabilities DEAD
CLIC
Assets Income
Drawings Capital
The accounting equation is a popular area with your

examiner. You will find these types of questions
easier after you have completed the rest of the
chapters.
CIMA BA3 Introduction ix

5 The trial balance 50 Ch 5 – all Q’s
We introduce the trial balance here earlier than the
syllabus guide, mainly to reinforce what you have
learned in the previous sessions in recording
transactions and writing up ledger accounts using
double entry.
6 Sales, purchases, and payroll taxes 100 Ch 6 – all Q’s
You must learn the double entry for sales and
purchase transactions. This will be very helpful
before we go onto control accounts in Chapter 7.
7 Control accounts 100 Ch 7 – all Q’s
It is essential that you are able to draw up control
accounts correctly. There are many opportunities
for the examiner to test your understanding, by
putting entries in the wrong side of the control
account, or including entries that should not be
included at all.
If you are still finding double entry confusing, make
sure you get the opening balance on the right side,
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then think logically about items which increase or
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decrease amounts receivable or payable.
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Receivables are assets, so balances brought forward
are DEBITS in the control account.
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Payables are liabilities, so balances brought forward
are CREDITS in the control account.
8 Accruals and prepayments
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The accruals concept requires us to recognise
income and expenses in the period in which they
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were earned or incurred, rather than when goods or
services are actually paid for. Remember:
Accrual (liability) – an expense not yet invoiced or
paid for
Prepayment (asset) – deferred expense for items
paid for but not yet received
! Read questions very carefully for dates
9 Receivables and irrecoverable debts 60 Ch 9 – all Q’s
Make sure you learn the double entry for writing off
and creating an allowance against receivables.
Questions are most likely to ask you to calculate the
charge to the income statement or the allowance to
be carried forward at the end of an accounting
period. Remember:
 an increase in a general provision is an expense
(debit)
 a decrease in a general provision is credited to
the income statement
x Introduction CIMA BA3

10 Inventories 60 Ch 10 – all Q’s
It is essential that you learn the cost of sales
formula:
Opening Inventory + Purchases – Closing Inventory
Remember inventory is adjusted for at the
beginning and end of an accounting period.
IAS 2 requires inventory to be valued at the lower of
cost and net realisable value (NRV). You may need
to calculate NRV to determine the appropriate value
to use in calculating an inventory valuation.
11 Non-current assets 130 Ch 11 – all Q’s
There is a lot to learn in this core topic. Make sure
you spend plenty of revision time on this area and
practise lots of questions. Read questions carefully
for dates and depreciation methods used.
12 Bank reconciliations 60 Ch 12 – all Q’s
If you have come across bank reconciliations at work
then the principles outlined in this chapter should
be familiar. Differences between the cash book
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balance and the bank statement will either be an
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adjustment to the cash book or a reconciling item,
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or timing difference. Make sure you know which are
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which and you shouldn’t go far wrong. Watch out
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for questions which refer to overdrawn balances –
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an overdraft is a liability and is therefore a CREDIT in
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the financial statements.
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13 Accounting errors 80 Ch 13 – all Q’s
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The examiner sets questions containing a variety of
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bookkeeping errors as it is a great way to test your
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whether transactions should be posted as debits or
credits in various ledgers. In correcting errors you
should always use the 3 step approach:
1 – what have we got?
2 – what do we want?
3 – what correcting journal is required?
If you are asked to calculate the impact on profit
would be having corrected errors, you must be able
to identify which errors affect the income
statement.
14 Incomplete records 60 Ch 14 – all Q’s
There are all sorts of ways the exam can test you on
incomplete records. Many of the control account
questions that we have already seen involve you
finding a missing figure. What we have in this
chapter builds on this, and introduces other
scenarios where you might be required to find a
figure due to having incomplete information. It is a
great way to test your understanding of double
entry and accounting principles.
CIMA BA3 Introduction xi

15 Company accounts 90 Ch 15 – all Q’s
In this chapter you will learn about the format of
company accounts and specific areas of company
accounting such as share issues.
16 Statements of cash flows 70 Ch 16 – all Q’s
Much of this chapter is actually revision of earlier
topics, eg calculating profit or loss on disposal of a
non-current asset. Remember:
in assets = in cash
in liabilities = in cash
Learn the layout of the proforma cash flow

statement so you know which items fall under which
heading/category of cash flow.
17 Interpretation of financial statements 70 Ch 17 – all Q’s
You must learn how to calculate the various ratios.
Additionally you will need to demonstrate an
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understanding of how they are used to interpret
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company performance.
18 Manufacturing accounts 40 Ch 18 – all Q’s
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You need to learn the key terms and the proforma
layout of manufacturing accounts, but essentially is
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it just an application of the cost of sales formula.
TOTAL STUDY TIME (EXCL REVISION) 22 HOURS
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xii Introduction CIMA BA3
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Introduction to accounting
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1 Introduction
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KEY TERM
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Accounting is the process of recording, analysing, summarising and communicating financial
information.
The objective of financial reporting: 017

To provide information about the financial position, performance and changes in financial
position of an entity that is useful to a wide range of users in making economic decisions.
Financial Statements consist of:

 Statement of Financial Position (sometimes called the Balance Sheet)
 Statement of Profit or Loss and Other Comprehensive Income (sometimes called
the Income Statement or Profit and Loss Account)
 Statement of Cash Flows
All of these will be covered in more detail later.
2 1: Introduction to accounting CIMA BA3
2 User groups
Seven main user groups (“POEBALL”):
User group Information needs
Public Any or all of the following
Owners/investors (sometimes How business is doing. What their income is likely to be. How well the
called “equity investors”) managers perform, whether to buy or sell shares
Employees (incl. managers) Stability, profitability, likelihood of pay rise.
Business contacts e.g. customers Stability? Credit-worthiness? Profitability (e.g. scope to negotiate
and suppliers price cuts)
Analysts and advisers Whether current strategies are working. Future plans. Key
performance indicators.
Local and central government Profit for tax purposes, employment information, carbon emissions
(Including HMRC) etc
Lenders Company’s ability to repay debts, assess security.
Other user groups

 Pension funds
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 Pressure Groups
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 Charities
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Different users will have their own reasons for wanting to see the financial statements (accounts) of a
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3 Types of C
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business
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All businesses produce financial information, but the requirements differ according to the type of
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business entity. A business may trade as:
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A sole trader
A partnership
A company
CIMA BA3 1: Introduction to accounting 3
Sole Trader Partnership Company

Minimum One Two (in the UK max 20 if not a One
members recognised profession)
Formalities None None (although partnership Must register (e.g. with
agreement will normally be in Companies House). More
writing) formalities for a
public/listed company.
Advantages Flexible. Flexible. Members have limited
Trader keeps all of the Share risk and management liability
profits. responsibilities. Easier to raise capital.
No disputes with fellow More expertise. Perpetual succession.
owners. Duty of utmost good faith.
Privacy. Privacy.
Disadvantages Unlimited liability for Unlimited liability for Regulatory burden, e.g.
business obligations. business obligations. accounts in a statutory
Harder to raise finance. Harder to raise finance. form, audit, file accounts
Lack of resources. and annual return etc. Lack
of privacy.
Who manages the Owner Owners (i.e. partners) Directors (may or may not
business be shareholders)
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Most businesses carry out a trade in order to make a profit. However, some organisations may have
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other objectives, e.g. clubs, charities and government departments. These are typically known as “not
for profit” organisations.
4 Financial accounts v Management accountsnt g

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All accounts are prepared using an accounting system, from which accounting information is
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produced, typically financial accounts and management accounts.
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Financial accounts Management accounts
Prepared for external users (e.g. shareholders, Prepared for internal purposes, e.g. managers
lenders, tax authorities)
Summary information Detailed information & analysis
Normally deadlines for “publishing” accounts No deadlines for production (other than as set by
management)
Summarise historical data (results and financial Forward looking, e.g. budgets, cash flow forecasts.
position).
5 The regulatory framework

Although a wide range of users may be interested in the financial statements, accounting regulation
views some users as more important than others. These primary users are:
 Investors (owners)
 Lenders and other creditors
Investors and lenders provide finance to a business. If they are external to the business (not involved
in its day-to-day running) they need financial information for two main reasons:
 To make decisions about providing resources to the business (e.g., whether to buy, hold, or sell
shares, whether to make a loan)
 To assess the stewardship of management. Stewardship is management’s responsibility to act

in the best interests of the owners of a business, by safeguarding its assets and using them
efficiently and effectively to generate profits and/or increase their value.
If investors and lenders are external to the business, the published financial statements may be their
only or main source of information. Accounting regulation ensures that the financial statements give a
fair presentation (sometimes called a true and fair view) of the financial performance and financial
position of a business and that they present the information that providers of finance need.
5.1 Sources of regulation

The main sources of regulation are:
 Companies legislation. This varies from country to country. In the UK, the Companies Act 2006
applies to all companies. It sets out prescriptive layouts for the financial statements and
requires the preparers of accounts to present a true and fair view.
 International Financial Reporting Standards (IFRSs) issued by the International Accounting
Standards Board (IASB). In many countries, including the UK, all listed companies are required to
follow these.
 National accounting standards. In the UK, these are issued by the Financial Reporting Council
(FRC). Many countries have now either adopted IFRSs as their national standards, or (as in the
UK) base their national standards very closely on IFRSs. (One important exception is the USA.)
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 Stock Exchange Regulations (listed companies only).
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EXAM SMART
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Note that only companies have to prepare financial statements using IFRSs or other
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accounting standards. In theory, unincorporated businesses such as sole traders and
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partnerships can use whatever accounting regulations they wish.
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5.2 International Financial Reporting Regulatory Framework
F IFRS Foundation
International Financial Reporting
Standards (IFRS) Foundation
(appoint, oversee, raise funds)
IASB
International Accounting IFRS Interpretations
IFRS Advisory Committee
Council Standards Board
(issues standards & exposure (guidance & interpretation)
(advises IASB)
drafts)
Appoints
Reports to
Advises
CIMA BA3 1: Introduction to accounting 5
IFRS Foundation
 Main objective is to develop a single set of high quality IFRSs through its standard-setting body,
the IASB (see below).
 A further objective: to bring about convergence of national and international standards.
 IFRS Foundation Trustees monitor and fund the IASB, IFRS Advisory Council (IFRS AC) and the
IFRS Interpretations Committee (IFRS IC).
 Appoints members of IASB, International Financial Reporting Interpretations Committee and
IFRS Advisory Council
 Establishes and amends operating procedures, consultative arrangements and due processes of
the IASB, IFRS IC and IFRS Advisory Council.
International Accounting Standards Board (IASB)

The IASB is an independent privately-funded body which issues International Financial Reporting
Standards (IFRS). (Before 2003, these were called International Accounting Standards, or IAS.) The
Board has 16 members.
IFRS Interpretations Committee (IFRS IC)

 Provides timely guidance on the application and interpretation of IFRSs

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Provides guidance on new financial reporting issues not specifically addressed by IFRSs.
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 Interpretations are approved by the IASB prior to being issued.
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IFRS Advisory Council (IFRS AC)
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The IFRS Advisory Council is the formal advisory body to the IASB and IFRS Foundation. It takes
recommendations from individuals, corporations and national standard-setters and then provides
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advice to the IASB on priority areas of accounting.
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Corporate Governance is the system by which companies are directed and controlled.
A company needs to be appropriately “governed” as the owners of a business do not necessarily work
for or run the company and therefore need to ensure that the business is being run properly.
The Directors of a company are those “charged with governance”. Their responsibilities are laid down
in law.
6.1 Legal responsibilities of Directors

These vary according to national companies legislation, but directors are normally responsible for:
 The preparation of the financial statements in accordance with the applicable financial
reporting framework (e.g. IFRSs).
 The internal controls needed to prepare financial statements.
 The prevention and detection of fraud.
 Ensuring that the entity complies with all relevant laws and regulations.
Directors should explain their responsibility for preparing accounts within the financial statements.
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The conceptual framework
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1 Conceptual framework
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The International Accounting Standards Board (IASB) has developed a conceptual framework to
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facilitate the preparation and application of accounting standards.
The Conceptual Framework for Financial Reporting contains generally accepted accounting principles,
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which form the basis of all International Financial Reporting Standards.
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The Conceptual Framework explains:
 the objective of financial statements: to provide financial information about the reporting entity
that is useful to existing and potential investors, lenders and other creditors in making
decisions about providing resources to the entity
 the qualitative characteristics of financial information
 the elements of financial statements
2 Qualitative characteristics of financial information

“Qualitative characteristics” are the attributes of financial statements that make the information
useful to users. They are divided into two categories:
 Fundamental qualitative characteristics
 Enhancing qualitative characteristics.
In addition, the conceptual framework requires consideration of the cost versus benefit of requiring
certain financial information.
Fundamental qualitative characteristics

 Relevance - Information in financial statements is relevant when it influences the economic
decisions of users. Relevant information has predictive and confirmatory value i.e. it helps users
to assess past, present or future events (predictive value) and helps users to confirm past
8 2: The conceptual framework CIMA BA3
assessments (confirmatory value). Items need to be material if they are to be of any

importance to users.
 Faithful representation – Information that is faithfully represented is generally complete,
neutral, and free from error. Faithful representation implies that financial information should
reflect the economic substance of an entity’s transactions, even where this is different from
their legal form.
Enhancing qualitative characteristics

There are four characteristics which enhance the usefulness of information:
 Comparability – Users should be able to compare items within the financial statements from
period to period and should be able to compare the financial statements of different entities.
 Verifiability – Different knowledgeable and independent observers should be able to reach a
consensus (not necessarily complete agreement) that particular information is faithfully
represented. Some figures in a set of financial statements can be directly verified e.g. by
counting cash.
 Timeliness – To be useful, information must be provided to users within a reasonable time.
 Understandability – information should be presented in such a way that it is understandable by
users with reasonable business knowledge.
3 Accounting concepts
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3.1 Going concern - the underlying assumption
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Financial statements are normally prepared on the assumption that the company is a going concern: it
will continue in operation for the foreseeable future.
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If the company is not a going concern this fact must be disclosed within the financial statements.
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3.2 Other important concepts
F i Materiality - Information is material if omitting it or misstating it could influence the decisions

that users might make based on a set of financial statements. Items may be material due to
their size or their nature.
 Substance over form - Faithful representation implies that financial information should reflect
the economic substance of an entity’s transactions, even where this is different from their legal
form.
 Business entity / Separate entity concept – The business is a separate entity from its owner.
Double entry bookkeeping is based around this concept (see Chapter 4).
 Accruals – The accruals concept states that income and expenses should be recognised in the
period in which they have been earned or incurred, rather than when cash is received or paid.
 Fair Presentation (True and Fair View) – Financial statements are required to be fairly
presented or show a true and fair view. This does not require 100% accuracy but they must be
materially correct and follow generally accepted accounting practice. Applying IFRSs is
presumed to result in financial statements that are fairly presented.
 Consistency – A business should use the same accounting treatment for similar events and
transactions over a period of time. This leads to comparability.
 Prudence – This concept involves the exercise of caution when making judgements under
conditions of uncertainty. The exercise of prudence means that assets and income are not
CIMA BA3 2: The conceptual framework 9
overstated and liabilities and expenses are not understated. The concept of prudence was
removed from the Conceptual Framework in 2010 in favour of neutrality but its application can
still be seen in a number of areas of accounting.
3.3 Historic cost concept

Transactions are recorded at their historic cost, in other words, the amount paid or invoiced.
 Historic cost enhances verifiability and understandability of financial statements
 Historic cost may not help with relevance or comparability
In periods of rising prices historic cost accounting may overstate profit and understate asset values.
Alternative valuation methods are:

 Fair value – the amount received or paid to sell an asset or transfer a liability in an arm’s length
transaction
 Value in use – the present value of the future cash flows associated with an asset or liability.
 Net realisable value - the net amount of cash that is expected to be received/paid upon
selling/settling that item.
 Current cost – the amount of cash that would be paid today to acquire an equivalent asset. This
method is used in times of high inflation.
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4 Accounting policies and changes in accounting estimates (IAS 8)
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Accounting policies are defined as “the specific bases, conventions, rules and practices applied by an
entity in order to reflect the effects of transactions”.
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The same accounting policies should be adopted from year to year (“consistency”).
Changes should be rare and only made if required:
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 By a change in accounting standards, or
 If the change will result in a more appropriate presentation of information.
A change in accounting policy should be applied retrospectively, i.e. as though the new policy had
always applied.
A change in an accounting estimate is an adjustment to the estimation technique that helps to
calculate the carrying amount of an asset or liability.
Changes in accounting estimates result from new information or new developments.
Changes in accounting estimates are simply adjusted in the financial statements of the period in which
they arise.
5 Financial statements and key definitions

5.1 Statement of profit or loss
The Statement of profit or loss tells the results of the accounting period, i.e. shows financial
performance by way of a profit or loss. A simple statement of profit or loss might look like this.
$
Revenue (sometimes called “sales” or “turnover”) 150,000
Cost of sales Revenue expenditure (40,000)
Gross profit Expenses incurred in 110,000
Other expenses (e.g. rent, wages) everyday trading (75,000)
Net profit 35,000
Cost of sales Gross profit Other expenses Net profit

Direct costs incurred
The excess of All other costs The excess of
in selling goods or
revenue over cost of incurred by the revenue over total
services adjusted for
sales business expenses
movements in
inventory
You must learn these key terms and later on be able to identify which expenses belong in which
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category. It is important that expenses are classified correctly.
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5.2 Statement of financial position
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The Statement of financial position (sometimes called the Balance Sheet) is a “snapshot” of the
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business assets and liabilities at a particular date. A simple statement might look like this.
t
$
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Assets (items you “own”)
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Non-current assets
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- Intangible assets Capital expenditure 10,000
F i- Tangible assets Purchase / improvement of 75,000

Current assets tangible non-current assets 15,000
100,000
Capital and liabilities (items you “owe”)
Capital (includes retained profits of the business) 50,000
Non-current liabilities 20,000
Current liabilities 30,000
100,000
Note the difference between capital expenditure (amounts belong in the statement of financial
position) and revenue expenditure (amounts belong in the statement of profit or loss, and therefore
have a direct effect on profit).
You will also need to learn the following terms.
Asset
A resource controlled by a business as a
result of past events and from which future
economic benefits are expected to arise, i.e.
something the business owns or uses
A Non-current assets
S Assets used over a period of
S more than one year
E Current assets
T Assets that continually flow
S through the business and are
Intangible asset Tangible asset generally used within one
Has no physical existence A physical object that can year.
but still has an ongoing be seen / touched. Examples:
value to the business. Examples: - Inventory (the value of
Examples: - Land & buildings goods not yet sold)
- Licence or Patent - Computers - Receivables (amounts
- Goodwill - Furniture owed by customers)
- Cash at bank
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- Motor vehicles
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A Capital
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P The owners’ stake in the business / what
I the business owes the owner
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T (in companies this is known as “share
A capital”).
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L
Liability 017
A present obligation arising from past
I events, settlement of which is expected to
A result in an economic outflow of resources,
B i.e. something owing to someone else.
I
L
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T Non-current liabilities Current liabilities
I Amounts repayable after Amounts repayable within
E more than one year, e.g. one year, e.g.
S - Bank loan - Bank overdraft
- Trade payables
We will see the financial statements again later on in a bit more detail, so for now it is enough that you
are familiar with the key terms and the key features of the statement of profit or loss and statement of
financial position.
In the Conceptual Framework, capital (what the business owes the owner) is called equity.
Equity = the residual interest in the assets of an entity after deducting all its liabilities, so
EQUITY = ASSETS less LIABILITIES or
EQUITY = NET ASSETS = SHARE CAPITAL + RESERVES
This is the accounting equation: an important principle that underpins double entry bookkeeping. You
will meet it again later on. Notice that the statement of financial position represents this equation:
ASSETS = EQUITY (CAPITAL) + LIABILITIES.
6 Integrated reports
Traditional accounting and financial statements have some important limitations:
 They are normally based on historical information. They do not include forecasts or other
forward-looking information that investors, lenders and other users might need in order to
predict future performance.
 They only report assets and transactions that can be measured reliably in ‘money’ terms. For
example:
 The statement of financial position includes assets such as buildings, plant and
equipment, but does not include internally generated brands, goodwill, or the technical
knowledge, experience and skill of the company’s workforce. All these additional ‘assets’
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may contribute to a company’s success or failure just as much, or even more, than its
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tangible assets.

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The performance of a company can be affected by its effect on the natural environment,
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the way it contributes to the community in which it operates, the treatment of its
o p ion employees, and the nature of the risks (uncertainties) that it faces. ‘Traditional’
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numerical financial statements do not include information about any of these matters.
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Because of this, most large companies now include non-financial (narrative) information in their
I n
published financial statements. They may also produce additional, separate reports, such as
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environmental reports. Some companies are now beginning to produce integrated reports.
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An integrated report is a report to stakeholders on the strategy, performance and activities of an
F
organisation to create and sustain value over the short, medium and long term.
A stakeholder is any person or organisation with an interest in any of the activities (not just financial
performance) of a business entity. Stakeholders can include employees, customers, suppliers, business
partners, local communities, legislators, regulators and policy-makers, as well as investors and lenders.
Value includes profit, but is much wider. For example, a business may create value through developing
new products, or looking after the interests of its employees, or through good customer service, even
though it may be impossible to measure the direct effect of these activities on the profits that it
makes.
Integrated reporting has been developed by the International Integrated Reporting Council (IIRC), a
global, not-for-profit organisation. The idea behind the integrated report is that a business creates
value through all its resources and relationships, called capitals. Capitals are stocks of value that are
affected by the activities of an organisation. For example, we have seen that a company’s financial
capital is affected by its profits or losses, but as well as financial capital, a business can have
manufactured, intellectual, human, social and relationship, and natural capital. An integrated report
considers all these capitals.
A key benefit of integrated reporting is that it may help organisations to think holistically about
strategy and plans and to manage key risks, thereby improving their future performance.
6.1 Principles and elements of an integrated report

The IIRC has issued The International <IR> Framework. This explains the principles and concepts which
should be followed in preparing an integrated report and sets out the elements that should be
included.
Guiding principles
 Strategic focus and future orientation: the report should provide insight into the entity’s
strategy, and how this relates to its ability to create value
 Connectivity of information: the report should show a complete picture of the factors (and
their interrelationships) that affect the entity’s ability to create value over time
 Stakeholder relationships: the report should provide insight into the nature and quality of the
entity’s relationships with its key stakeholders
 Materiality: the report should disclose information about matters that substantively affect the
entity’s ability to create value
 Conciseness: the report should be concise
 Reliability and completeness: the report should include all material matters, both positive and
negative, in a balanced way and without material error
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 Consistency and comparability: information should be presented on a basis that is consistent
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over time; and in a way that enables comparison with other entities.
Content elements
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
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Organisational overview and the external environment under which the entity operates
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 Governance structure and how this supports the entity’s ability to create value
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 Business model
 Risks and opportunities and how these affect the entity’s ability to create value


Strategy and resource allocation
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Performance and achievement of strategic objectives for the period and outcomes in terms of
effects on the capitals
 Outlook and challenges facing the entity and their potential implications
 Basis of presentation: how the entity determines what matters should be included in the report
and how these are quantified or evaluated
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15
Accounting systems
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1 Purpose and role of accounting records
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
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Contain day-to-day entries of money received and paid
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 Record business assets and liabilities
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 Record sales and purchases
 Record amounts paid to and by the business


Record the current financial position of the business
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Enable managers to produce financial statements that present fairly (give a true and fair view
of) profit or loss and the assets and liabilities of the entity
A business will deal with a large number of documents. The information contained in these documents
has to be recorded to allow managers to obtain a sense of how the business is performing. The
information is recorded in the accounting system. A computerised accounting system is essentially a
database (system for recording data in a logical manner).
2 Sources of data
 Invoices, sales and purchase (P) All transactions marked (P) have to be
 Cheques, paid and received (P) recorded in the books of prime entry.
 Credit notes, given and received (P)
 Goods received notes and despatch notes
 Sales orders and purchase orders
 Statements
 Remittance advices
16 3: Accounting systems CIMA BA3
3 Books of Prime Entry

Transactions are recorded in one of the five books of prime entry:
 Cash book, all entries involving the payment or receipt of cash, including cash sales and cheques
 Sales day book, all sales on credit
 Purchase day book, all purchases on credit
 Petty cash book, small cash transactions, e.g. purchase of stamps
 Journal, sundry transactions not initially recorded in any of the above
You may also see:
 Sales returns daybook to record return of goods by customers
 Purchase returns daybook to record return of goods to suppliers
4 Cash Book
The cash book may be split into two books, receipts and payments.
The events that trigger cash book entries are the receipt of cheques or cash, the writing of cheques,
withdrawal of cash, and standing orders, direct debits, electronic transfers and bank initiated
transactions.
Typically the cashbook is organised into columns containing the most popular type of transaction, to
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enable managers to analyse different types of receipt and payment. It might look like this:
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Cash Payments book
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Petty Dis- Pur- Rent,
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Date Narrative Total cash counts chases Payables Wages rates
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$ $ $ $ $ $ $
1.6.17 Marcus 1,000 1,000
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1.6.17 Ico Ltd 500 500
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1.6.17 Mike 800 800
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2.6.17 Mr Landlord 2,000 2,000
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2.6.17 Cash 50 50
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3.6.17 Steve 80 80
3.6.17 Nick 300 (100) 400
Cash Receipts book

Sundry
Date Narrative Total Discounts Sales Receivables Capital receipts
$ $ $ $ $ $
1.6.17 Shane 1,000 1,000
1.6.17 Adam 500 500
1.6.17 Stephen 800 800
1.6.17 John 1,900 (100) 2,000
1.6.17 Glen (repayment 50 50
of advance)
Note the discounts column is negative here. This will be explained in Chapter 6.
CIMA BA3 3 : Ac c o u n t i n g s y s t e m s 17
5 Petty cash book

Records the movement of physical cash into and out of the business.
The imprest system

 Managers decide the level of petty cash they need, say $100.
 When cash is removed it is replaced with a petty cash voucher.
 At the end of the period the petty cash book is filled in from vouchers.
 Petty cash is topped up to $100 from bank account
The imprest system is a control system. At any point in time, the total of cash plus vouchers/receipts
should equal the cash float of $100.
Petty cash book
Receipts Payments
Total Post Paper Taxis
Date Narrative $ Date Narrative $ $ $ $
1.6.17 Bank 100 2.6.17 ABC Ltd 20 20
Smiths 10 10
Nobby’s 5 5
100 35 5 10 20
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6 Sales day book
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Lists all sales made on credit. Details of every sales invoice are recorded.
NB Cash sales are not recorded in the Sales day book. Cash sales are recorded directly in the cash
receipts book.
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The sales day book includes information as follows:
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Sales day book
Date Invoice number Name $
1.6.17 1001 Milly 150
1.6.17 1002 Vanilli 80
1.6.17 1003 Queen 220
7 Purchases day book

Lists all purchases made on credit. Every invoice received will be allocated a sequential number for
internal reference purposes.
NB. Cash purchases are not recorded in the Purchases day book. They are recorded directly in the
Cash payments book.
The purchases day book includes information as follows:
Purchases day book
Date Invoice number Name $
1.6.17 1108 Bauer 200
1.6.17 1109 Kim 250
1.6.17 1110 Curtis 180
8 Journal
Used for the following transactions that are not recorded in the other books of prime entry. These are
the main types of adjustments that will be made in preparing year-end accounts.
 Year-end inventory adjustment
 Recording irrecoverable (bad) debt write off adjustments All of these are covered
 Recording period end accruals and pre-payments in later chapters.
 Recording period end depreciation
 Correction of errors
The journal should include brief description to allow the user to determine the nature of the
transaction as shown below:
Journal
Date Narrative Debit $ Credit $
30.6.17 Electricity expense 200
Accruals 200
Being the accrual of estimated electricity costs for the last quarter
9 Nominal or General Ledger
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Once transactions have been recorded in the books of prime entry, the totals are calculated for each
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accounting period and are then transferred to the nominal ledger using double entry (see Chapter 4).
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The nominal ledger contains a separate ledger account for every asset, liability, source of income and
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expense, including sales, purchases, receivables, payables, cash and petty cash. It is effectively a
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summary of the financial affairs of a business and is effectively what is used to produce financial
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statements.
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9.1 Coding systems
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Managers should develop a logical coding system for the nominal ledger. Each account must have a
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unique code.
Advantages
 Customers with same name can be identified
 Code may be shorter than full name
 Easy for staff to identify the type of account
Options include:
Sequence codes – new items are simply allocated the next sequential prefix, meaning that the codes
for similar items might be very different.
01 Notes
02 Texts
03 Question Banks
04 Bitesize Notes
Block codes – different groups of products or geographical regions are allocated to a block.
0001-0999 London customers
1000-1999 Cambridge customers
2000-2999 Bristol customers
3000-3999 Maidstone customers
4000-4999 Reading customers
CIMA BA3 3 : Ac c o u n t i n g s y s t e m s 19
Significant digit codes - which use some of the digits which are part of the description of the item
being coded:
100 Inventories of pens
100R Red
100B Blue
100G Green
Hierarchical codes
2 Statement of profit or loss
2-2 Expense
2-2-3 Indirect expense
2-2-3-7 Rent
2-2-3-7-5 Rent – Bristol
Faceted codes
These codes consist of a number of sections, each one of which represents a different feature of the
item.
For example, a particular customer may have the code “3/7/12” where the “3” represents the country
in which they are based (e.g. “3” = UK), the “7”, represents the town (e.g. “7” = Bristol) and “12”
represents the type of product (e.g. “12” represents televisions).
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Double entry bookkeeping
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1 Introduction
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A version of double entry bookkeeping was invented in the 15th century by a Franciscan friar called
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Luca Pacioli. It was easy to understand, apply and audit.
2 The separate entity concept

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Even if the business is owned and operated by one person, double entry bookkeeping is based on the
premise that the business is a separate entity, distinct from the owner. This means that if the owner
puts capital into the business, the business “owes” that amount to the owner.
3 The dual effect (“duality”)

The beauty of the system lies in the requirement that every transaction affects two accounts.
For every entry there must be an equal and opposite entry. Double entry bookkeeping is the
recording of transactions in the nominal ledger, with two sides to every entry. There can be no single
entries.
ILLUSTRATION 4.1
Sole trader transfers $10,000 from her own account into the business bank account.
Dual effect:
 Business cash increases by $10,000
 Capital (what the business owes the owner) increases by $10,000
22 4: Double entry bookkeeping CIMA BA3
ILLUSTRATION 4.2
Sole trader sells services on credit for $1,500.

Dual effect:
 Receivables increase by $1,500
 Sales increase by $1,500
4 Double entry bookkeeping

All entries are classified as either DEBITS or CREDITS. The next few lines are as important as anything
you will learn in these notes.
DEBITS CREDITS
Expense (e.g. rent, wages) Liability (e.g. payables, accruals)
Asset (e.g. cash, receivables, fixtures and fittings) Income (e.g. sales, interest receivable)
Drawings (which is effectively a decrease in capital) Capital (effectively a liability owed to the owners of
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the business)
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Decrease in liabilities (e.g. making payment to a Decrease in asset (e.g. customer pays us so
supplier)
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DEAD CLIC
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You will find a more detailed version of this table in the Appendix at the end of these notes.
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CIMA BA3 4: Double entry bookkeeping 23
LECTURE EXAMPLE 4.1
Complete the debit and credit entries in the table below for the following transactions (and
understand them!).
Transaction Effect 1 Effect 2 Debit Credit

1 Owner puts Asset (cash) Capital increases
$100 into increases
business
2 Business buys Purchases (an An asset (cash)
goods for $15 expense) decreases
cash increases
3 Business buys Purchases (an A liability
goods for $40 expense) increase (payables)
on credit increases
4 Sell goods for Asset (cash) Income (sales)
$270 cash increases increases
5 Sell goods for Asset Income (sales)
$350 on credit (receivables) increases
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increases
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6 Buy machinery Asset (non- Liability
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on credit for current) increases (payables)
$200 increases
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7 Pay wages $25 Expense increases Cash decreases
cash
8 Pay rent $50 in Expense increases
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Cash decreases
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cash
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9 Pay trade Liability Asset (cash)
payable $40 (payables) decreases
decreases
10 Credit customer Asset (cash) Asset
pays us $300 increases (receivables)
decreases
5 Ledger accounts
Ledger is the term given to the account for each class of transaction. They are written up manually as
T-accounts. Debit entries are entered on the left and credit entries are entered on the right. The cash
ledger account represents the business’ bank account (so may be also be called the bank ledger).
LECTURE EXAMPLE 4.2
Write up the ledger accounts for the transactions listed from Lecture Example 4.1 above.
Cash
No Narrative $ No Narrative $
Capital
Purchases
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F Sales
Receivables
Machinery
Wages expense
Rent expense
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Stop and look: note that all the expense accounts contain DEBIT entries (on the left) and sales is a
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CREDIT (on the right).
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6 Closing the books
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Having recorded transactions, the accountant has to close the books off to be able to proceed with
017
producing financial statements.
If we take the receivables account as an example; we want to know how much we are owed at the
year-end as this is the figure that goes into the Statement of Financial Position. We are owed the
difference between sales on credit and cash received from customers. This is simply the difference
between the debit and credit sides of the receivable account.
Luca Pacioli wanted to ensure he could check every stage of the calculation, so he came up with the
following method of closing the books.
(1) Add up the debit and credit sides separately and put the larger sum in the total box on both
sides.
(2) The difference between the debit and credit sides of the account is the balance.
A debit balance means debits > credits. It is carried forward on the credit side in the above process,
but brought forward on the debit side (i.e. the opposite side).
A credit balance means credits > debits. It is carried forward on the debit side and brought forward on
the credit side (i.e. the opposite side).
If we are in the receivables account, the difference will be year-end receivables.
LECTURE EXAMPLE 4.3: PAUL
In the year ended 31 December 2016, Paul, a not terribly successful trader, made three sales on credit
of $100, $150 and $180 respectively.
He received payments of $100 and $80 from his customers.
Write up the T-accounts and calculate the balance on each account at 31 December 2016.
STEPS
Step 1: Enter each of the transactions into the T-accounts.
Step 2: Add up both sides and put the larger total into both sides.
Step 3: Insert balancing figure to calculate the balance owing at the end of the year and carry it
forward on the opposite side at the start of the new year.
Receivables
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Sales
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F iNo Narrative
Cash
$ No Narrative $
Every ledger account is closed off in the same way to obtain the balance to be included in the financial
statements.
Remember the balancing figure is always brought forward on the opposite side of the T account
because it represents a balance on that side.
LECTURE EXAMPLE 4.4
(1) Write up the debit and credit entries for the following transactions
No Transaction Debit Credit

$ $
1 Sale of goods on credit for $1,500
2 Purchase of office furniture on credit for $5,000
3 Payment of salaries $1,200
4 Cash received from a credit customer $1,000
5 Top up petty cash float $100
6 Cash sale $250
7 Purchase of goods on credit $1,300
8 Payment to supplier $800
9 Return of faulty goods (originally purchased on
credit) to supplier $400
10
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Return of goods by unhappy credit customer $300
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11 Purchase of goods for cash $150
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12 Payment of telephone bill $50
13 Sale of goods on credit $750
14 Payment of rent $6,000
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15 Purchase office stationery on credit $120
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16 Bank interest received $75
17 Cash received from customer $330
18 Purchase replacement goods on credit $400
19 Purchase computer equipment on credit $3,000
20 Refund customer who paid twice $100
(2) Write up the following ledger “T” accounts and show amounts carried forward. (You may want
to write up more T accounts as part of your workings).
 Sales
 Receivables
 Purchases
 Payables
 Cash
Sales
Narrative $ Narrative $
Receivables
Purchases
Narrative
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$ Narrative $
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Payables
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Cash
7 Chapter summary
Don’t worry if at this stage you are finding this difficult. Double entry can be a difficult concept to
grasp at first.
Remember and learn the rules (DEAD CLIC) and forget about logic. There is no rationale behind why
entries are classified as debits and credits… they just are because Luca Pacioli said so!
If you have a transaction involving cash it is always easiest to deal with the cash entry first if you can
remember that cash is an asset and therefore:
An increase in cash = DEBIT
A decrease in cash = CREDIT
You might want to refer to the detailed debits and credits table and the summary ledgers contained in
the Appendix whilst you work through the next few chapters.
7.1 Distinguishing between expenses and assets

Remember an expense is always a debit and represents something that is used up immediately. An
asset is also a debit but generally can be used over a period of more than one year.
Suppose you buy a car. You hope to use the car for many years to come so the cost of the car is an
asset (and is termed “capital expenditure”). But all the things you need to spend to run the car, e.g.
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petrol, servicing and repairs are treated as expenses as these things do not last – they have no long
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term value. These types of expenses might be termed “revenue expenditure”.
7.2 Petty cash

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Remember a business may keep petty cash for sundry receipts and payments. The petty cash account
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in the nominal ledger will be separate from the main cash or bank account in the nominal ledger.
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The petty cash float under the imprest system will need to be “topped up” from time to time, usually
by withdrawing cash from the bank account. The double entry is:
Dr Petty cash
Cr Cash or bank account 017
Carry on through the next three chapters. Once you get to the end of Chapter 7 you should be feeling
more comfortable with double entry and how transactions are recorded in the accounts.
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The trial balance
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1 Summary of where we are so far
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Transactions, e.g. sales and purchases, cash
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received and paid
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Books of prime entry written up from
individual transactions
Nominal ledger written up from books of

prime entry
Nominal ledger accounts closed off at end

of period
Balances on nominal ledger accounts

transferred to Trial Balance
32 5: The trial balance CIMA BA3
2 The trial balance

A trial balance is prepared before the final financial statements are produced.
It is a summary of the balances on all the ledger accounts making up the general ledger.
The trial balance is used to detect errors. Total debits should equal total credits. If they don’t, an
error, or errors have been made. The trial balance is also used to extract the financial statements, via
the “extended trial balance”.
An example of a trial balance is shown below.
Debit $ Credit $
Capital 15,000
Cash 2,500
Sales 150,000
Purchases 40,000
Wages expense 9,000
Rent expense 5,000
Electricity expense 2,000
Telephone expense 1,000
Interest expense 500
Tax expense 1,000
Land and Buildings 40,000
Plant and machinery 20,000
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Fixtures and fittings 4,000
Inventory
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2,000
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Receivables 15,000
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Bank loan repayable in 2019 2,000
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Bank overdraft 500
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Payables 5,500
Drawings 31,000
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173,000 173,000
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Note there is no account for “profit” but that total debits = total credits. To prepare the financial
s
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statements you must be able to classify each balance as an asset, liability, income, capital or expense.
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CIMA BA3 5: The trial balance 33
3 Bookkeeping errors
Typical errors are listed below. Some, but not all, errors will result in the trial balance (TB) being out of
balance. These are explored in more detail in Chapter 13.
Nature of error Example TB balances
Omission 1 – a transaction is not recorded Sales or purchase invoice not recorded in the Yes
at all accounts
Omission 2 – only one side of an entry is Cash received from customer debited to cash No
posted book but not credited to receivables.
Principle – an item is posted to the correct Cash paid for plant repairs (expense) is Yes
side of the wrong type of account debited to plant account (asset)
Commission – an item is entered to the Telephone expense debited to electricity Yes
correct side of the wrong account expense in N/L
Transposition – figures entered wrong way Cash paid to supplier of $540 debited as $450 No
round in one side of an entry in payables account
Compensating – two separate errors of Yes
equal value cancel each other out
Original entry 1 – one side of an entry Purchases of $1,000 posted to payables as No
incorrectly recorded $100
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Original entry 2 – one side of an entry is Sales of $2,000 credited to receivables No
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posted the wrong way round account
Casting error – adding up error either by
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Total debits add up to $120,000, credits add No
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too much (overcast) or too little up to $128,000
4 Accounting adjustments itio

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There are a number of adjustments that have to be made once the trial balance has been drawn up.
These are:
(1) Depreciation
(2) Accruals and prepayments
(3) Irrecoverable (‘bad’) debts
(4) Recording closing inventory
(5) Correcting errors
All have to be recorded in the nominal ledger, via the journal. All of these will be covered in more
detail in later chapters.
5 The Statement of Profit or Loss

The Statement of profit or loss tells the results of the accounting period, i.e. shows financial
performance. The section down to gross profit is sometimes called “the trading account”.
The format is shown below. You will need to learn this.
Statement of profit or loss for the year ended 31 December 2017
$
Revenue 150,000
Cost of sales:
Statement of profit or loss
account
Trading
Opening inventory 2,000

Purchases 40,000
Closing inventory (2,000)
(40,000)
Gross profit 110,000
Distribution costs (5,000)
Administrative expenses (12,000)
Finance costs (500)
Profit before tax 92,500
Income tax expense (1,000)
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Profit for the year 91,500
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At the end of the period when we close the books all income and expense accounts are cleared to the
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statement of profit or loss (sometimes referred to as the “income statement”, ‘profit or loss account’,
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‘income and expenditure account’ or simply “profit or loss”).
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This is a separate ledger account in the nominal ledger and the normal double entry rules apply.
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For example:
t I n Dr Sales (to clear the sales account to zero) $x
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Cr Statement of profit or loss $x
F i The key point to note is that we do not “carry forward” balances on the statement of profit or loss.
This means that all the income and expense accounts start the next period with nil balances.
We need them to because we want to show income and expenses for a period. It would be wrong to
have last year’s sales or wages sitting in the ledger accounts for this year.
The final step is to clear the balance on the statement of profit or loss, which will be the profit or loss
for the year. This is added to the owner’s capital. Drawings are deducted from the owner’s capital.
6 The Statement of Financial Position

The Statement of financial position (sometimes called the balance sheet) is a “snapshot” of the
business assets and liabilities at a particular date.
The format is as shown below. It is important to learn this format and the main headings.
Statement of financial position as at 31 December 2017
$ $
ASSETS
Non-current assets
Land and buildings 40,000
Plant and equipment 20,000
Fixtures and fittings 4,000
DEBITS
64,000
Current assets
Inventories 2,000
Receivables 15,000
Cash at bank and in hand 2,500
19,500
Total assets 83,500
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$ $
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CAPITAL AND LIABILITIES
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Capital
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Capital b/f 10,000
Capital introduced 5,000
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Profit (taken from the statement of profit or loss) 91,500
Less: drawings (31,000)
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CREDITS
75,500
Non-current liabilities
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Bank loans 2,000
Current liabilities
Bank overdraft 500
Trade payables 5,500
6,000
Total capital and liabilities 83,500
The statement of financial position simply shows assets and liabilities of the business at the end of the
period. Therefore when we close off ledger accounts there is no double entry as such, we simply
extract the balances and present them in the statement of financial position.
Remember, just because one year ends and another begins, we still have the same assets and
liabilities. The balances in the ledger accounts are therefore carried forward to the next accounting
period as follows:
Receivables
$ $
Sales 120,000 Cash 105,000
31.12.17 Balance c/d 15,000
120,000 120,000
1.1.18 Balance b/f 15,000
From SFP
7 The accounting equation

Because double entry bookkeeping works on the principle that there are always two equal and
opposite entries for every transaction, the accounts should balance, that is the total of debit entries
should be equal to the total of the credit entries. This can be expressed in the form of an equation, and
can be rearranged in many different forms, as follows:
Debits = Credits
Learn these – they
Assets = Liabilities + Capital + Profits – Drawings are likely to come
up in at least one
Assets – Liabilities (Net assets) = Capital + Profit – Drawings
question involving
Net assets = Capital finding missing
Change in Net assets = Change in Capital + Profit – Drawings figures – more in
Chapter 14
Profit = Increase in Net assets – Increase in Capital + Drawings
It may be helpful to think about the statement of financial position to find missing figures.
ILLUSTRATION
Nick, a sole trader, had opening capital of $12,000, and closing capital of $18,000. During the year he
introduced $3,000 of new capital and withdrew $10,000 in drawings.
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What was his profit for the year?
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Opening capital 12,000
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Profit for the year (balancing figure) 13,000
Drawings (10,000)
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Closing capital 18,000
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Another way of looking at this is:
s
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Opening Net Assets 12,000
F
Profit for the year (balancing figure) 13,000
Drawings (10,000)
Closing Net Assets 18,000
HOMEWORK EXERCISE 5.1: JANE
Jane establishes a business with capital of $5,000 paid in cash. During the first month of trading the
following transactions took place:
(a) Non-current assets are purchased for $1,800 cash.
(b) Goods for resale are purchased for $2,000 cash.
(c) Half the goods are sold for $1,500 cash.
(d) Jane draws out $200 in cash.
(e) Jane’s brother lends the business $500.
(f) All the remaining goods are sold on credit for $1,600.
(g) A rent invoice for $1,000 is received but not yet paid.
Required:
Write up the ledger accounts and complete the accounting equation:
Assets = Capital + Liabilities
_________ _________ __________
Approach: Follow the steps below.
STEPS
Step 1: Write up the double entry for each of the transactions
Step 2: Write up the entries in the nominal ledger accounts
Step 3: Close the accounts and calculate the balances
Step 4: Transfer the balances to a trial balance
Step 5: Identify which items are assets and which items are liabilities
Step 6: Complete the accounting equation – capital will be the balancing figure
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Sales, purchases and

sales taxes
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1 Recording transactions – recap
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So far we have seen that transactions are recorded as follows:
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Source documents are received by and generated by the business, e.g. sales and
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INVOICE
purchase invoices, bank statements.
Transaction details are entered in the books of prime entry. Can you list them?
BOOKS OF PRIME
ENTRY 1
2
3
4
5
Totals from the daybooks are recorded in the nominal ledger using double entry.
The accounts are closed off at each period end and a trial balance can be
NOMINAL LEDGER
produced.
40 6 : S a l e s , p u r c h a s e s a n d s a l e s t a xe s CIMA BA3
You should by now be familiar with the double entry for basic sales, purchases and cash transactions.
If not review the table below and complete the double entry.
$ $
1 Sale of goods on credit for $1,500
2 Purchase of goods on credit for $5,000
3 Receipt from customer $1,000
4 Payment to supplier $3,000
5 Sale of goods for cash $200
6 Purchase of goods for cash $50
We will now consider some other transactions which relate to sales and purchases.
2 Returns, debit notes and credit notes

2.1 Sales returns and credit notes
If a customer returns goods to us this is effectively a negative sale. We use a sales returns daybook to
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record the return transaction. The double entry is:
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Dr Returns inwards (or Sales if we issue the customer with a credit note – see below)
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Cr Receivables
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If we have an on-going relationship with a supplier or customer it is normal to issue them with a credit
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note showing them the amount no longer owed.
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2.2 Purchase returns and debit notes
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If we return goods to a supplier, it is effectively a negative purchase. We use a purchase returns
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daybook in a similar way to the sales returns daybook. The double entry is:
F Dr Payables
Cr Returns outwards (or Purchases if a supplier issues a credit note)
When businesses return goods to a supplier they often issue the supplier with a debit note. This is
essentially a formal request for a credit note to be raised.
Example: where a business receives a short delivery or goods are damaged in transit, they can issue a
debit note to the supplier for the amount in 'dispute'.
Returns figures are deducted from sales or purchases figures in the financial statements.
CIMA BA3 6 : Sa l e s , p u r c h a s e s a n d s a l e s t a xe s 41
ILLUSTRATION
A trial balance has the following totals:

Sales 30,000 Cr
Purchases 20,000 Dr
Returns 5,000 Dr 2,000 Cr
Sales will be shown as $25,000 and purchases will be shown as $18,000 in the accounts. A debit
balance on a returns account will always be sales returns and a credit balance will always be purchases
returns.
3 Discounts
3.1 Trade discounts – buying or selling for less than retail price
Double entry is:
Dr Cash or Receivables $x for a sale
Note: no entries are
Cr Sales $x
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made in the discount
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Dr Purchases $x received accounts.
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Cr Cash or Payables $x for a purchase
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Where “x” is the amount AFTER the discount has been deducted.
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3.2 Settlement (or cash) discounts
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A settlement discount is a reduction in the amount due if the debt is paid by a specified date.
This is best illustrated by way of examples.
(a) Discounts allowed
Pete sold goods for $1,000 and offered the customer a 5% discount for payment by 31 October.
The customer paid on 28 October.
The double entry for the sale is as follows:
Dr Receivables $1,000
Cr Sales $1,000
i.e. ignore the settlement discount at the time of the sale.
If the discount is taken up, the entry when the customer pays is as follows:
Dr Cash $950
Cr Receivables $950
The problem is that there is still a balance of $50 on the receivables account yet the customer
has paid in full.
A further entry is required to clear the receivables account:
Dr Discount allowed $50 (an expense account in the statement of profit
or loss)
Cr Receivables $50 (to clear the receivables account to zero)
(b) Discounts received

If Pete buys goods for $100 and takes up a 2% settlement discount the double entry at the date
of purchase would be as follows:
Dr Purchases $100
Cr Payables $100
On payment:
Dr Payables $98
Cr Cash $98
And, to clear the payables account:
Dr Payables $2 (to clear the payables account to zero)
Cr Discount received $2 (income account in the statement of profit
or loss)
Your examiner may try to confuse you by telling you that entries have been posted to the wrong side
of the correct account or the correct or wrong side of the wrong account. Be careful! We will revisit
this area when we look at Suspense Accounts.
If you get a question involving trade and settlement discounts, always deal with the trade discount
first.
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LECTURE EXAMPLE 6.1
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Zoe purchased goods on credit with a list price of $10,000 less a trade discount of 20% and took
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advantage of a settlement discount of 5% on payment. Show the double entry to record the purchase
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and cash payment in the accounts.
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Purchase Payment
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3.3 Discounts and the cashbook
You might sometimes see a discounts column in the cashbook. This is used to record the amount of
the settlement discount at the time cash is paid or received. Learn the following:
 The discounts column in the cash receipts book will relate to discounts allowed
 The discounts column in the cash payments book will relate to discounts received
Have another look at an extract from the example cash receipts book that we saw in Chapter 3:
Date Narrative Total Discount Sales Receivables
$ $ $ $
1.6.17 John 1,900 (100) 2,000
The total cash received is $1,900 relating to an amount owed by John of $2,000. So the full amount is
recorded in the receivables column (to credit receivables and clear the amount owing to nil) and the
difference is recorded in the discounts column and will be debited to discounts allowed in the nominal
ledger.
4 Refunds
Questions will sometimes tell you that a refund has been given to a customer. If you think about it, this
means we have paid some cash to a customer, i.e. there is a credit entry to the cash account.
Therefore we need a debit entry. The correct entry is to debit receivables control account.
Many students get confused with refunds, so learn the following double entry:
Dr Receivables
Cr Cash
It might help to think of the scenario where a customer may have paid you twice by mistake (this
sometimes actually happens!). The transactions will be reflected in the receivables ledger as follows:
(1) Make a sale of $100 to a credit customer:
Dr Trade receivables 100
Cr Sales 100
(2) The customer pays us
Dr Cash 100
Cr Trade Receivables 100
(3) In error, the customer pays us again:
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Dr Cash 100
Cr Trade Receivables 100
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This leaves us with a credit balance on our trade receivables account (i.e. we owe him).
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Therefore, to eliminate this credit balance, we give him this overpayment back
Dr Receivables 100
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Cr Cash 100
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5 Sales taxes
Most countries impose some kind of sales tax on supplies of goods and services. In the UK this is
known as VAT (value added tax).
Registered businesses charge output tax on sales and are charged input tax on purchases. Registered
businesses can recover input tax against the output tax payable to the tax authorities.
Sales, purchases, current and non-current assets are shown net of tax in the financial statements,
unless the tax is irrecoverable, e.g. on the purchase of cars or business entertaining.
Receivables and payables are shown gross of tax.
A sales tax (VAT) control account is maintained to show the amount owed to or from the tax
authorities. This will be a current receivable or payable in the Statement of Financial Position.
5.1 Rates of sales tax

Standard rate applied to most goods and services. In the UK, the standard rate of VAT is 20%.
Zero rate of 0% may apply to some goods and services such as non-luxury food, children’s clothes,
newspapers.
Exempt supplies. Exempt suppliers cannot charge sales tax or recover input tax. In the UK, exempt
supplies include health, burial and financial services transactions.
You may be asked to calculate total sales tax on a variety of supplies and will be given the rate of sales
tax in the exam.
ILLUSTRATION: YASMIN
Yasmin had the following transactions in March:

Sales of books (zero rated) $6,500 net
Sales of DVDs (standard rated) $11,600 net
Sales of stationery (standard rated) $2,820 gross
Assuming a rate of sales tax is 20% what is the total amount of output tax for the month?
SOLUTION
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$
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$11,600 × 20% 2,320
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$2,820 × 20%/120% 470
y r 20 2,790
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5.2 Sales tax control account
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Sales tax (VAT) is accounted for using a control account. Amounts charged on sales are credited to the
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control account (payable to the tax authorities) and amounts recovered on purchases are debited to
ir sthe control account (recoverable from the tax authorities).
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ILLUSTRATION: TIM
Tim had the following transactions in June.

Sales on credit $10,000
Purchases on credit $ 7,000
Tim makes standard rated supplies, at 20%.
The sales tax is calculated as follows:
Net VAT Gross
$ $ $
Sales 10,000 2,000 12,000
Purchases 7,000 1,400 8,400
The relevant ledger accounts will be written up as follows.
Sales
$ $
Receivables (net) 10,000
Receivables
$ $
Sales (gross) 12,000
VAT Control
$ $
Purchases (VAT) 1,400 Sales (VAT) 2,000
Balance c/f 600

2,000 2,000
Purchases
$ $
Payables (net) 7,000
Payables
$ $
Purchases (gross) 8,400
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5.3 Irrecoverable sales tax
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Sometimes businesses are not allowed to recover input tax on supplies, typically company cars or
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business entertaining.
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ILLUSTRATION: BILL
Bill’s sales tax summary for an accounting period is as follows:

Input tax $4,000
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Output tax $3,700
Input tax includes an amount of $400 on an entertaining expense that is not recoverable. The tax
payable for the period will be:
$
Output tax 3,700
Input tax recoverable $4,000 - $400 3,600
Net tax due to the tax authorities 100
6 Payroll taxes
6.1 Gross pay and deductions
Employees usually pay tax on their earnings. These taxes are direct taxes. An employer may make
deductions from employees’ gross pay to arrive at net pay. Deductions include:
 Income tax. In the UK this is administered under the PAYE (pay as you earn) scheme
 Social Security (SS) contributions. In the UK, this is called National insurance (NI) contributions,
known as “employees NICs”
 Pension contributions / charitable donations
Such deductions are calculated by the employer, collected on the employees’ behalf and are then paid
over to the tax authorities or other relevant government body, pensions or savings provider.
You may be required to calculate net pay, gross pay or the cost of employment (see 6.2 below) based
on figures given in the question.
ILLUSTRATION: MIKE
Mike earns a gross salary of $1,000 for July. Income tax amounts to $260 and SS contributions are $70.
Mike contributes $50 per month to a company pension scheme and $10 per month to his favourite
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charity.
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Mike’s net pay will be calculated as follows:
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$
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Gross salary 1,000
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Deductions:
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Income tax (260) Payable to tax authorities
SS contributions (70) Payable to tax authorities
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Pension (50) Payable to pension provider
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Charitable donations (10) Payable to charity
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Net pay 610
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6.2 Employment costs
In addition to employees making SS contributions, in some countries, including the UK, employers
must also pay SS or NI contributions for each of their employees, known as “employers’ SS” or
“employer’s NICs”. The total cost of employment to the business will be employees’ gross salary plus
employers’ SS (plus any other benefits paid for by the employer, such as employer’s pension
contributions).
Suppose the above example also told you that employer’s SS contributions amounted to $115 for July.
The cost of employment is
$
Gross salary 1,000
Employer’s SS contributions 115
1,115
SS contributions are calculated as a percentage of gross salary, depending on the level of income.
LECTURE EXAMPLE 6.2: CLIVE
Clive earns $9 per hour as a cleaner. Earnings of more than $100 per week are taxed at 20%.
Employee’s SS is 8% and Employer’s SS is 11%. During week 42 Clive works 39 hours.
Calculate Clive’s net pay and the cost to his employer.
Net pay Cost to employer
Gross wages
Less: Tax
Less: Employee’s SS
Add: Employer’s SS
6.3 Wages and salary control accounts

At any time, a business may have amounts payable to individuals, the tax authorities or other
organisations. The employer will maintain control accounts to account for the amounts due. We will
see more about control accounts in Chapter 7.
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Control accounts
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1 Introduction
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Credit transactions with customers and suppliers are recorded in the receivables and payables
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accounts in the nominal ledger. These are sometimes called control accounts.
A control account is an account in the statement of financial position which, when all transactions are
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settled, would have a nil balance. In practice, there is always a balance on the receivables and payables
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control accounts as businesses continue to trade from day to day.
2 Memorandum ledger accounts

The problem is that control accounts only deal with total amounts (remember the totals from the
daybooks are posted to the nominal ledger). But a business needs to know how much it is owed from
each individual customer and how much it owes to each supplier.
To do this we use the following memorandum ledgers.
 Receivables ledger (also known as sales ledger or customer ledger)
 Payables ledger (also known as purchase ledger or supplier ledger)
50 7: Control accounts CIMA BA3
Entries in the memorandum ledger are made when transactions are recorded in the sales and
purchase day books and the cash book. Sales invoices or purchase invoices will be recorded on one
side, and payments received from customers or made to suppliers will be recorded on the other side
and matched or offset. They will look like this:
Receivables ledger
Customer: Coppell
Date Narrative $ Date Narrative $
1.8.17 Invoice 011 180 15.8.17 Cash received 180
2.8.17 Invoice 037 200 21.8.17 Cash received 180
5.8.17 Invoice 045 300
7.8.17 Invoice 083 250 Balance c/d 570
930 930
Payables ledger
Supplier: Downes
Date Narrative $ Date Narrative $
12.8.17 Cash paid 300 2.8.17 Invoice 863 300
15.8.17 Cash paid 150 5.8.17 Invoice 1017 400
7.8.17 Invoice 1253 250
Balance c/d 500
950 950
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It is important that you remember that these memorandum accounts do not form part of the
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nominal ledger but double entry principles do apply.
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3 Interaction of daybooks,
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memorandum
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(a) Sales, purchases and cash transactions recorded in books of prime entry
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Credit sales recorded in Cash transactions recorded Credit purchases recorded
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Sales day book (SDB) in Cash book (CB) in Purchases daybook (PDB)
F ir Sales day book

Customer A Sale 100
Customer B Sale 50
Cash book
Receipts
Customer A Receipt 100
__
Payments
Supplier 1 Payment 70
__
Purchases day book
Supplier 1 Purch 70
Supplier 2 Purch 40
150 100 70 110
(b) Individual transactions also recorded in memorandum ledger accounts
Receivables ledger
Not part Payables ledger
Customer A of Supplier 1
Sale 100 Cash 100 double Cash 70 Purchase 70
Customer B entry Supplier 2

Sale 50 system Purchase 40
CIMA BA3 7: Control accounts 51
(c) Day book totals posted to nominal ledger using double entry. Books closed and balances
carried forward in the Statement of Financial Position (SFP) or transferred to the Statement of
Profit or Loss (P/L).
Nominal ledger
Sales Receivables Purchases Payables
SDB 150 SDB 150 PDB 110 PDB 110

CB 100 CB 70
P/L 150 . . C/f 50 . P/L 110 C/f 40 .
150 150 150 150 110 110 110 110
SFP 50 SFP 40
Remember cash sales and cash purchases are written up directly into the cash books and posted to the
nominal ledger. Cash transactions do not appear in the memorandum accounts.
If you are still struggling with this ask your tutor for help now.
4 Receivables and payables control accounts

It should soon become second nature to you that sales are debited to the receivables control account
and purchases are credited to the payables control account.
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Receivables control account
$ $
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Sales X
Cash received X
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Balance c/f X
X X
Balance b/f X
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The balance (carried forward as a DEBIT balance) is the net amount owing from all customers. The
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memorandum account (receivables ledger) shows how much is owed by each customer.
Payables control account
$ $
Purchases X
Cash paid X
Balance c/f X
X X
Balance b/f X
The balance (carried forward as a CREDIT) is the net amount owing to all suppliers. The memorandum
account (payables ledger) shows how much is owed to each supplier.
It is the control account balance that goes into the Statement of Financial Position.
In addition to sales, purchases and cash transactions, there are a number of adjustments or entries
that may affect the control accounts:
 Returns
 Discounts
 Refunds
 Contras
 Irrecoverable debts
We looked at some of these in Chapter 6. Contras and irrecoverable debts adjustments are considered
below.
4.1 Contras
KEY TERM
A contra is the term given for an entry in the ledger which cancels out, or “contras” an
opposite entry in another or the same ledger. A contra may be recorded as: ¢
Typically a contra entry is made when a business owes money to a supplier, and that same supplier
also owes money to the business, i.e. the business has a receivable and a payable with the same
customer. The business may net one amount off against the other and settle the difference.
ILLUSTRATION: ALEX
Alex, an accountant, owes Ben, a stationer, $500. Ben owes Alex $200. They agree to cancel $200 of
debt, leaving Alex owing Ben $300.
The double entry is always:
Dr Payables control To clear the account
Cr Receivables control of the lower amount
As with discounts, the examiner can and does play tricks, either putting a contra on the wrong side of
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an account, or by creating a scenario where the contra has not been recorded in one of the control
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account or the memorandum ledgers.
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4.2 Irrecoverable debts
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Sometimes a customer who owes a business money (a receivable) may not pay the amount due. In
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these cases the debt is said to be “bad” and the amount must be “written off”. The double entry is:
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Dr Irrecoverable debts expense (statement of profit or loss)
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Cr Receivables control
F iWe will cover this in more detail in Chapter 9.
5 Control account reconciliations

All well-run businesses will regularly reconcile the balance on the control account with the sum of the
balances on the memorandum ledgers to ensure the receivables and payables figures in the
Statement of Financial Position are correct.
This requires the correct entry of all relevant transactions to both the control accounts and the
memorandum ledger accounts.
A summary of how the relevant entries appear in the control accounts is shown below. If you are
unsure about any of these entries, go back to previous chapters or ask your tutor for some help now!
Receivables control account ( or “sales ledger control account”)
$ $
Balance b/f X
Sales (from sales day book) X Cash (from cash receipts book) X
Customer refunds (cash book) X Sales returns X
Dishonoured cheques (cash book) X Discounts allowed (expense in P/L) X
Irrecoverable debts (expense in P/L) X
Contra (with payables) X
Balance c/f X
X X
Balance b/f from SFP X
Should agree to sum of balances

in memorandum sales ledger
Payables control account (or “purchase ledger control account”)

$ $
Cash (from cash payments book) X Purchases (from purchase daybook) X
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Purchase returns X Supplier refunds (cash book) X
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Discounts received (income in P/L) X
Contra (with receivables) X
Balance c/f X
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Balance b/f from SFP X
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Should agree to sum of balances in
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memorandum purchase ledger
LECTURE EXAMPLE 7.1: MICHAEL

The following totals have been extracted from the books of Michael’s business.
All balances were taken at 31 October except the control account totals which are from 1 October.
$
st
Receivables control account balance at 1 October 37,455
st
Payables control account balance at 1 October 27,820
Sales daybook total for October 14,800
Purchase daybook total for October 10,300
Contra entry 450
Returns to suppliers 220
Credit note issued to Vaughan, a customer 80
Irrecoverable debt written off 50
Discounts allowed 270
Discounts received 125
Cashbook receipts from receivables in October 16,100
Cashbook payments to payables in October 8,700
Cash received in respect of a debit balance in the purchase ledger 740
Write up the receivables and payables control accounts and show the balances at 31 October.
$ $

$ $
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6 Supplier statement reconciliations
Most businesses produce statements from time to time showing how much each customer owes
them. It is a good control to reconcile the balance from a supplier’s statement to the balance owing in
the payables ledger.
Differences may arise due to timing of payments, invoices, or returns. You may get a question that
requires you to explain the difference between a supplier balance and a business’ own payables ledger
balance.
7 Control account errors

The control account reconciliation will help to detect certain errors that may arise in the control
accounts or memorandum ledgers, as follows:
Error Detected? Reason
Casting error (adding up error) in Yes Individual entry transferred to memorandum ledger,
daybook total posted to control account
Casting error in control account or Yes The total of the memorandum ledger balances will
memorandum ledger not equal the control account balance
Total posted to wrong account in N/L Yes Correct entries made in memorandum accounts
Transaction recorded in wrong No The amount recorded in the ledger matches the total
customer/supplier account in the in the control account, it is simply in the wrong
memorandum ledger customer/supplier account
Omission of transaction from daybook No The entry will not be made in the memorandum
ledger, nor will it be added to the total posted to the
control account
Omission of entry to control account or Yes The entry is only made in one of the ledgers
memorandum account
Transposition error Yes Different amount recorded in memorandum ledger
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and control account (digits reversed)
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Entries posted to wrong side of Yes Double the difference as credit posted as debit or vice
memorandum account or control versa in either control account or memorandum
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account ledger
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Basically the reconciliation will detect anything where a different amount is recorded in the control
account to the memorandum account.
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Questions may tell you that certain errors have been made and ask you to calculate the correct
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balance on a control account. You will need to know the correct double entry for each type of
transaction in order to be able to identify the errors and correct them.
LECTURE EXAMPLE 7.2: TIM
The balance on Tim’s payables control account at 30 September was $27,843. The total of the balances
on the memorandum payables ledger was $23,416.
After an investigation the following items were identified:
(1) A contra entry of $450 had been credited to the account of Mr Bell in the payables ledger.
(2) Discounts allowed of $375 were debited to the payables control account.
(3) Discounts received of $1,237 were not recorded anywhere.
(4) An invoice for $1,935 was posted in the purchase daybook as $1,539.
(5) The purchase daybook total for 14th September was overcast (over-added) by $2,000
(6) Returns outwards of $1,750 have been credited to the payables control account.
(7) When totalling the balances on the payables ledger, the account of Mrs Read was omitted. Mrs
Read was owed $252 at 30th September.
(8) A credit note for $750 issued by Mr Bopara was not recorded in the payables control account.
(9) A debit balance of $400 on the payables ledger was recorded as a credit balance.
Write up the payables ledger control account and reconcile the balance to the balance on the payables
ledger, showing the corrected figure for both.
$ $
Corrected balance c/f
Reconciliation of list of balances to the control account

$
Balance per question 23,416
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Corrected balance (should agree to corrected balance on payables control account!)
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8 Other control accounts
The most common control accounts will be receivables and payables, as covered above. However, the
term control account can be given to any statement of financial position account that typically has
both debit and credit entries and, when all transactions are settled, would come to zero. One example
is the sales tax control account introduced in Chapter 6.
57
Accruals and prepayments
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1 Introduction
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Accruals and prepayments will feature in every exam. Make sure you understand how to calculate the
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related accounting entries.
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It is a fundamental principle of accounts preparation that income and expenditure are recognised in
the period in which they occur (are earned or consumed) rather than the period in which cash is
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received or paid (the accruals or matching concept).
Simply recording transactions in the ledgers when they arise may not necessarily reflect the true use of
resources or assets for a particular period. We use accruals and prepayments adjustments to match
the income or expense for a period to the actual use of resources and assets.
2 Accruals
KEY TERM
Accruals are expenses incurred by the business, using up resources, before the year-end, but
which are paid for after the year-end.
Examples:
 Electricity
 Telephone
 Staff bonuses
 Year-end staff party
The accrual is a liability in the Statement of Financial Position, reflecting the obligation to pay for the
service already used.
58 8: Accruals and prepayments CIMA BA3
ILLUSTRATION: JOHN
John started his business on 1 January, using gas from day 1.

British Gas sent him two gas bills, as follows:
Period of supply Invoice date $
th
January 1 – February 28 March 15 250
st
March 1 – May 31 May 31 330
(a) Calculate John’s gas expense for the 3 months to 31 March
Easy! $250 + 1/3× $330 = $360
BUT: Note that, at 31 March, John has only received a bill for 2 months’ worth of gas, January
and February. If he is preparing accounts for the 3 months to 31 March, he will therefore need
to account for the gas used in March, but for which he has not received a bill.
This March gas expense needs to be “accrued”.
(b) Calculate John’s accrual for gas at 31 March
i.e. 1/3 × $330 = $110
As we are required to present expenses fairly, rather than producing accounts that are accurate
to the penny, we do not need to take a gas reading on 31 March. It is perfectly acceptable to
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estimate consumption (e.g. take half of the 2 month bill for Jan and Feb) or to take a third of the
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next bill – which is what we have done here.
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(c) Show the entries in the nominal ledger as at 31 March
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When John receives a gas bill, he will post the expense as:
C uitDr Gas expense $250
t
Cr Trade payables or cash $250
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However, we know the “true” expense to be $360. We therefore need to accrue the March gas
s
used:
F ir Dr Gas expense $110 (calc above)

Cr Accruals $110
In summary:
Gas expense
$ $
15.3 Invoice received 250
31.3 Accrued gas expense 110
31.3 To statement of profit or 360
loss (bal)
360 360
Accrual (payables)
$ $
31.3 Accrued gas expense 110
31.3 Balance c/f 110
360 110
CIMA BA3 8 : Ac c r u a l s a n d p r e p a y m e n t s 59
ILLUSTRATION: JOHN 2
Let’s suppose that John’s next accounts are made up to the 2 months ending 31 May. The correct gas
expense for those 2 months should therefore be 2/3 × $330 = $220. Also, there will be no need for an
accrual at the end of May as we have received an invoice for the period in question.
If we use the same procedure as before, we will post the invoice to the gas expense when it is
received:
Gas expense
$ $
31.5 Invoice 330
Accrual (payables)
$ $
1.4 Balance b/f 110
If we leave the gas expense as it is, we will ultimately record an expense for the period of $330, which
we know to be wrong. To “correct” this anomaly, we must reverse any accruals brought forward at
the start of the next period. This is called “reversing out the accruals.”
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The double entry to reverse the accrual is the opposite of what we posted earlier:
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Dr Accrual (payables account) $110
Cr Gas Expense $110
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The ledger accounts will then look like this:
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Gas expense
$ $
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31.5 Invoice 330 1.4 Reversal of opening accrual 110
31.5 To statement of profit or loss 220
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(bal.fig)
330 330
Which we know to be the “correct figure”

Accrual (payables)
$ $
1.4 Reversal of opening accrual 110 1.4 Balance b/f 110
110 110
3 Prepayments
KEY TERM
Prepayments occur when a business pays an invoice for an expense that relates wholly or
partly to the following period.
Examples:
 Business Rates
 Rent
 Insurance
 Advertising (cost of next year’s campaign)
The prepayment is an asset in the Statement of Financial Position, reflecting the amount already paid
for the service not yet used.
ILLUSTRATION: PAUL
Paul has to pay the rent on his premises in advance.

His rent invoice for the five months to 31 May was $1,000, due 1 January.
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Paul’s rent expense could be split is as follows:
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3 months to 31 March 3/5 × $1,000
2
$600
y
2 months to 31 May 2/5 × $1,000 $400
o p ion $1,000
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When Paul receives his rent invoice, he has to record the invoice at the full amount with the journal:
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Dr Rent expense $1,000
I
t
Cr Payables $1,000
ir s Rent expense
F
$ $
1.1 Payables 1,000
At the moment, the rent expense is overstated and there is no record of the asset, rent pre-paid.
Paul has prepaid for 2 months’ rent at 31 March.
To correct the ledger accounts we set up a prepayment
Dr Prepayments (current asset) 2/5 × $1,000 $400
Cr Rent expense 2/5 × $1,000 $400
The corrected ledger accounts will look like this:
Rent expense
$ $
1.1 Invoice 1,000
31.3 Prepaid rent 400
31.3 Statement of profit or loss 600
(bal.fig.)
1,000 1,000
Expense in statement of profit or

loss for 3 months to 31 March
Prepayments (current asset)

$ $
31.3 Prepaid rent 400
31.3 Balance c/f 400
400 400
Current asset in Statement of

Financial Position at 31 March
ILLUSTRATION: PAUL 2
Paul’s ledger accounts for the two months to 31 May will look as follows.
Rent expense
$ $
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i.e empty as no invoices have been received during this 2-month period.
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Prepayments
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$ $
1.4 Balance b/f (prepaid rent) 400
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We know that Paul’s rent for the two months is $400, and at 31 May he has not paid any rent in
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advance.
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To correct the ledger accounts we have to reverse the pre-payment set up at 31 March (just like we
reversed out the accrual earlier)
We always do this on the first day of the next period.
The double entry is:
Dr Rent expense 2/5 × $1,000 $400
Cr Prepaid rent (current asset) $400
The corrected ledger accounts for the 2 months to 31 May will therefore now look like this:
Rent expense
$ $
1.4 Reversal of prepaid rent 400
31.5 To statement of profit or loss 400
(bal.fig.)
400 400
Prepayments
$ $
1.4 Balance b/f (prepaid rent) 400 1.4 Reversal of prepaid rent 400
400 400
4 Calculating accruals and prepayments

Normally we use T accounts to calculate amounts to be charged to the statement of profit or loss.
Note. This is the only way to tackle questions where you are given amounts brought forward for
accruals or prepayments.
LECTURE EXAMPLE 8.1: HELENA
Helena has the following amounts in her Statement of Financial Position as at 30 June 2015:
Prepayments (insurance) $900
Accruals (gas) $75
The following invoices were received and paid during the year to 30 June 2016:
Date paid $
4 Sep 2015 Gas (quarter to 31 August 2015) 320
7 Dec 2015 Gas (quarter to 30 November 2015) 380
3 Jan 2016 Insurance (year to 31 December 2016) 2,000
8 Mar 2016 Gas (quarter to 28 February 2016) 410
6 Jun 2016 Gas (quarter to 31 May 2016) 330
Calculate the gas and insurance expenses for the year ended 30 June 2016.
SOLUTION
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To answer this style of question, use the following approach:
2
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o
STEPS
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Step 1: Post the reverse of the b/f prepayment or accrual to the expense account.
I n t
Step 2: Post the invoices received into the expense account.
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Step 3: Calculate the correct y/e prepayment or accrual and post the double entry.
r
F iStep 4: The correct expense for the period should then be the balancing figure in the expense
T account.
Insurance expense
$ $
1.7.15 B/f prepayment reversed
Gas expense
$ $
1.7.15 B/f accrual reversed
If you are not given amounts brought or carried forward you may be able to calculate amounts using a
time line, or simply by looking at the dates and amounts given.
ILLUSTRATION: ANNIE
Annie pays rent of $6,000 per annum. On 1 October 2017 the rent increases to $8,000 per annum.
What is her rental expense for the year ended 31 December 2017?
If you use a timeline, put in the year start and end dates, then put in the date that the amount
changes. Then time apportion the relevant amounts over the accounting year:
9 months at $6,000 p/a 3 months at $8,000 p/a
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9/12 x $6,000 = $4,500 3/12 x $8,000 = $2,000
1 January 17 1 October 17 31 December 17
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So total expense = $4,500 + $2,000 = $6,500
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5 Accrued and deferred income
ion
201
We have talked about accrued and prepaid expenses, but you may also get questions concerning
income. For example, a business may receive rental income, or receive interest on its cash deposits.
7
The thing to remember is that exactly the same principles apply.
ILLUSTRATION: JIM
On 1 February 2016, Jim sublets part of his office building for $120,000 per year. Rent is invoiced and
received quarterly in advance on 1 February, 1 May, 1 August and 1 November. Jim’s year end is
30 June.
Jim’s ledgers would be written up as follows:
Rental income (Statement of Profit or Loss)
$ $
1 Feb Rent received – cash 30,000
1 May Rent received – cash 30,000
30 Jun Deferred rental income 10,000
Statement of profit or 50,000
loss
60,000 60,000
Deferred income (Statement of Financial Position)

$ $
30 Jun Deferred rental income 10,000
The rent that Jim has received in advance is treated as a liability in the Statement of Financial
Position.
It is often easiest to think of these types of question in terms of the cash entry. If we have received
cash (for any type of transaction) the entry is to DEBIT CASH. So the opposite side of the entry must be
a CREDIT, in this case, deferred income.
If we receive income in arrears, i.e. after the goods or services have been provided, we are owed cash
for those services, so we recognise an ASSET in the Statement of Financial Position, called accrued
income.
You may get a question involving more than one source of income.
LECTURE EXAMPLE 8.2: BOB
Bob owns two rental properties. The following balances are extracted from his accounting records in
respect of rental income from each property:
Property A Property B
At 30 June 2016 $8,000 Dr $24,000 Cr
At 30 June 2017 $2,000 Cr $30,000 Cr
During the year ended 30 June 2017 Bob received cash of $42,000 from Property A and $128,000 from
Property B. What is Bob’s total rental income to be included in the statement of profit or loss for the
t
year ended 30 June 2017?
SOLUTION
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y r 20 Rental income
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$ $
o
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Property A
$ $
Property B
$ $
6 Chapter summary
Learn and understand the following for several marks in the exam.
To accrue expenses at period end To set up a prepayment at period end

Dr Expense Dr Prepayment (asset)
Cr Accruals (liability) Cr Expense
To record income received in advance at period To record income due but not yet received at
end period end
Dr Income Dr Accrued income (asset)
Cr Deferred income (liability) Cr Income
Remember all these entries must be reversed at the start of the next accounting period.
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67
Receivables and irrecoverable

debts
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1 Irrecoverable (bad) debts
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Receivables are current assets. An asset is a right to future economic benefits arising from past
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transactions or events. Sometimes amounts invoiced to customers may turn out to be irrecoverable,
e.g. if a customer has gone into liquidation (or if an individual has been declared bankrupt). Such
receivables may be referred to as irrecoverable or “bad debts”.
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Management should carry out a review for irrecoverable and doubtful debts after the initial trial
balance has been drawn up. If a receivable is considered to be irrecoverable it should be “written off”
to the statement of profit or loss so that assets are not overstated. Double entry:
Dr Bad and doubtful debt expense (Statement of profit or loss)

Cr Receivables control account
i.e. We do not reverse the original sale. The amount written off should also be removed from the
individual memorandum ledger.
Occasionally, we may receive cash from a customer that has previously been written off (obviously
never happens in real life, but it may happen in your exam!) Double entry:
Dr Cash
Cr Bad and doubtful debt expense
2 Doubtful debts
Sometimes management may have concerns over the recoverability of its receivables, e.g. where a
customer disputes an invoice, or is in some financial difficulty. Such receivables are called “doubtful
debts”.
68 9: Receivables and irrecoverable debts CIMA BA3
In these cases we do not want to write the debt off, but we still want to take a reasonably cautious
approach. The alternative to a write off is to set up an allowance for receivables / doubtful debts. NB
Allowances are Statement of Financial Position accounts. They reduce the value of assets.
If we want to create an allowance for doubtful debts the entries are as follows:
Dr Bad and doubtful debt expense (Statement of profit or loss)

Cr Allowance for receivables (Statement of financial position)
NB The amount remains in the trade receivables ledger and in the individual memorandum ledger.
This ensures that credit control staff still attempt to collect the amount due.
Once an allowance has been made, one of two things can subsequently happen:
(1) The customer still refuses to pay and the debt is considered irrecoverable
(2) The customer pays
2.1 Doubtful receivable subsequently written off
EXAM SMART
Be careful with this one. Remember we have already taken the expense of setting up the
allowance, so we do not take another expense.
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Instead we remove the receivable and remove the allowance from the ledgers.
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Dr Allowance for receivables
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C uit
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2.2 Cash received from a previously allowed receivable
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This is an occasion when the receipt of a cheque gives rise to double double entry!
ir s
F
STEPS
Step 1: Record the receipt of cash from the customer
Dr Cash
Step 2: Remove the allowance from the ledgers and recognise the “bonus income” we have
received (as we have already recognised a doubtful debt expense).
Dr Allowance for receivables

Cr Bad and doubtful debt expense
3 General allowance
What we have covered so far is known as a “specific allowance” where certain customers were
identified as being bad or doubtful.
However, an allowance is often set against debts generally, i.e. a “general allowance”. This recognises
that a small percentage of all receivables will go bad.
CIMA BA3 9: Receivables and irrecoverable debts 69
The general allowance is provided on the debts remaining after:

 writing off irrecoverable debts, and
 specific allowances have been made
When tackling questions it is essential that you calculate the adjusted receivables figure after
deducting write offs and after deducting the specific allowance. Calculate the general allowance as a
percentage of the adjusted receivables figure.
The double entry is the same as for the creation of a specific allowance.
Dr Bad and doubtful debt expense

Cr Allowance for receivables
LECTURE EXAMPLE 9.1: DODGY
The balance on Dodgy’s receivables control account at 1 July 2015 was $285,326. During the following
year, sales on credit totalled $385,250 and cash received from credit customers amounted to
$343,228. There were no allowances for doubtful debts at 30 June 2015.
In addition to the above amounts Dodgy received a cheque for $10,000 in respect of a debt written off
in 2014.
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Following a detailed review of the receivables ledger at 30 June 2016 Dodgy decided to write off debts
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totalling $10,880 and to make an allowance against specific debts of $15,440.
Dodgy has also been advised to set up a general allowance of 2% of the remaining debts.
Calculate:
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(a) The receivables control account balance at 30 June 2016
(b) The bad and doubtful debt expense for the year ended 30 June 2016
(c)
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The balance on the allowance for receivables account at 30 June 2016
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(d) The amount to be shown in the Statement of Financial Position for receivables
SOLUTION
$ $
Bad and doubtful debt expense

$ $
Allowance for receivables

$ $
Working - General allowance

$
Year end receivable balance after debt write off
Less: receivables specifically provided against
Balance against which general allowance is needed
General allowance is 2%
4 Movement in allowances year on year

The allowance is a Statement of Financial Position account. It is netted off against the trade
receivables balance in the Statement of Financial Position.
Remember, the double entry for creating an allowance is:
Dr Bad and doubtful debt expense
Cr Allowance for receivables
If the allowance increases, there will be an expense in the year of increase.
If the allowance decreases, there will be a reduction in the expense for the year.
ILLUSTRATION: PETE
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Pete has always had an allowance of 2% against his receivables balance.
o
C uit
Receivables at 31 December 2014
Receivables at 31 December 2015
$25,000
$30,000
n t
Show the allowance for doubtful receivables account and calculate the doubtful receivables expense
I
t
for 2015.
s
STEP 1
F ir STEP 2
Allowance for receivables
$
1.1.15 Balance b/f (2% × $25,000)
$
500
31.12.15 Doubtful debt expense 100
(bal.fig.)
31.12.15 Balance c/f (2% × $30,000) 600
600 STEP 3 600
The expense for the year is 2% of the difference between the opening and closing allowance.
CIMA BA3 9: Receivables and irrecoverable debts 71
LECTURE EXAMPLE 9.2: KATHY
Kathy’s trade receivables at 31 December 2015 were $94,000. You are told that:
(a) An irrecoverable debt of $3,000 is to be written off.
(b) Specific allowances of $800 and $700 are to be made against two doubtful debts.
(c) A general allowance of 5% is to be maintained. The opening balance on the account for general
allowance is $4,000.
Calculate the charge to the statement of profit or loss for bad and doubtful debts and the allowance
for receivables for the year ended 31 December 2015.
SOLUTION
Stmt of Statement
financial of profit
position or loss
STEP 1 Calculate adjusted receivables after write off.
STEP 2 Calculate specific allowance
STEP 3 Calculate general allowance as % of adjusted receivables
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STEP 4 Deduct opening allowance figure to find increase or
decrease in general allowance = charge to statement of
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profit or loss.
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73
10
Inventories
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1 Buying and selling inventories
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Inventories are goods produced or purchased and held for resale by a business.
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When businesses buy and sell inventories the double entry is as follows:
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Purchase of inventories:
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Dr Purchases
Cr Cash or Payables
Sale of inventories:
Dr Cash or Receivables
Cr Sales
No entries are made in the inventories account at the time of the transaction.
2 Period end inventory adjustments

A business may not have sold all of its inventory at the year end. The value of inventory held is an
asset and must be recorded in the Statement of Financial Position. We therefore need to make a
period end inventory adjustment.
Closing inventory value is found by performing a period end count. The double entry is:
Dr Inventory (a current asset account in the Statement of Financial Position)
Cr Statement of profit or loss
74 10: Inventories CIMA BA3
This entry will be made via a post trial balance journal entry.
And we must remove opening inventory from the inventory account, also via a post TB journal.
The double entry is:
Dr Statement of profit or loss
Cr Inventory (Statement of financial position)
3 Inventory and cost of sales

The double entry above refers to entries in the statement of profit or loss. The entries affect the cost
of sales figure.
You will need to learn the following formula:
Cost of Sales (COS) = Opening inventory + Purchases – Closing inventory
Remember the purchases account is used to reflect all purchases of inventory. The opening and closing
inventory adjustments arise at the period end for the value of inventory not sold at the end of the
period.
ILLUSTRATION: EDMUND
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On 31.12.14 Edmund had inventory of 50 units valued at $8 each ($400).
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During 2015 he purchased 300 units for $10 and sold 320 units (including all the brought forward
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inventory) for $14.
o
C uit
Required:
t
Calculate Edmund’s profit and closing inventory value to be included in the Statement of Financial
I n
Position and Statement of profit or loss for the year ended 31.12.15.
s t
Closing inventory will be 30 units (50 from opening inventory plus the 300 units purchased, less 320
ir
units sold). These are valued at their cost of $10 each.
F Statement of Financial Position (extract)

Current assets
$
Inventory (30 × $10) 300
Statement of Profit or Loss (extract)
$ $
Sales (320 × $14) 4,480
Cost of sales:
Opening inventory (50 × $8) 400
Purchases (300 × $10) 3,000
Less: Closing inventory (from above) (300)
(3,100)
Gross profit 1,380
CIMA BA3 10: Inventories 75
4 Inventory valuation (IAS 2)

“Inventories should be valued at the lower of cost and net realisable value.”
Cost - All costs of purchase, costs of conversion and other costs incurred, including irrecoverable taxes
and duties, in bringing the inventories to their present location and condition. Cost includes fixed and
variable overheads allocated on a normal level of production.
For a retail business cost is normally simply the purchase price plus carriage inwards. For a
manufacturing business cost may include costs such as factory plant depreciation and costs
(“attributable production overheads”), and factory staff wages (“direct labour” costs). Note that the
cost of storing finished goods cannot be included in the cost of inventory.
KEY TERM
Net realisable value (NRV) – Estimated selling price less the estimated costs of completion
and the estimated costs necessary to make the sale.
Selling costs include carriage outwards and sales commission.
EXAM SMART
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Questions will often require you to calculate both cost and NRV of a particular inventory
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item to determine the correct value to use in the financial statements (i.e. the lower
amount), so you must learn these definitions.
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For most businesses, the valuation rule above would mean that their inventories would be valued at
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cost (or “historical cost”), since they would hope to sell their goods for more than cost. However, in
some circumstances, inventories would be valued at net realisable value.
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For example, a new business hoping to gain customer may sell goods for less than cost to encourage
customers to try their new product. Therefore, their inventories would be valued at NRV, so that they
are not overstated.
4.1 Cost flow assumptions

There are different assumptions in valuing closing inventories:
 First in first out (FIFO)
 Weighted average cost (WAC) – using either the periodic or continuous method
 Last in first out (LIFO) (Not allowed under IAS 2)
These are best explained by use of examples.
LECTURE EXAMPLE 10.1: CONWAY
Conway had opening inventory of 100 units at $10 each = $1,000. He had the following transactions in
2016:
Transaction $
Sale 1 80 × $15 1,200
Purchase 140 × $12 1,680
Sale 2 150 × $15 2,250
Calculate closing inventory values using each of the above assumptions.

(a) FIFO (the first goods to be purchased are the first ones to be sold – this means that newer /
most recently purchased items are always held as closing inventory, best for perishable goods)
Units Cost $ Total $
Opening inventory 100
Sale 1 (80)
20
Purchase 140
160 Profit high, closing

inventory high
Sale 2 (150)
Closing inventory 10
(b) LIFO (the last items to be purchased are the first ones to be sold – this means that older items
are always held as closing inventory, hard to see how this could be useful in practice)
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Sale 1 (80)
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Purchase 140
C uit 160
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Profit low, closing
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inventory low
I
Sale 2 (150)
r s t Closing inventory 10
F i (c) WAC (inventory is valued on a weighted average basis, taking into account changes in purchase
price of goods over time, best for commodities where prices fluctuate regularly)
The continuous weighted average is calculated by taking the weighted average cost before each
sale transaction to give the cost of sales. This leaves a residual inventory figure at the end of the
period.
Sale 1 (80)
20
Purchase 140 Profit middling,
closing inventory
160 middling
Sale 2 (150)
CIMA BA3 10: Inventories 77
Alternatively, the periodic weighted average is calculated by taking the weighted average cost
of opening inventories and all purchases to give cost of sales and inventory, ignoring the timings
of sales during the period.
Inventory available for sale:
Units Unit Cost Value
$ $
Opening inventory 100 10 1,000
Purchases 140 12 1,680
Total 240 2,680
So closing inventory is calculated as 10 units × $2,680/240 = $111.67
Cost of sales would be (80 + 150) × $2,680/240 = $2,568.33
5 Continuous inventory systems

Some companies use computer systems to track inventory quantities and values in real time. With
these systems it is unnecessary to perform a period end inventory count to determine the value to be
included in the Statement of Financial Position. However, inventory counts should still be carried out
at regular intervals as a control to ensure that the value in the system is correct. If the count is not
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carried out at the exact period end date, you can determine the period end value by adjusting for
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transactions posted between the period end and the count dates.
For example, if the period end is 31 December and the count takes place on 3 January, the totals are
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adjusted by adding back the cost/NRV of all items sold between 31 December and 3 January and
deducting the cost of items purchased during that period.
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11
Non-current assets
and depreciation
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1 Definitions
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1.1 Non-current assets
KEY TERM
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A non-current asset is an asset acquired for use on a continuing basis, normally over more
than one year.
Examples include:
 Land and buildings
 Plant and machinery
 Fixtures and fittings
Non-current assets are recorded in the Statement of Financial Position. The items above are tangible
non-current assets (with a physical existence). Intangible assets are considered later in this chapter.
The cost of an asset should include all the costs incurred in bringing the asset into use, e.g. delivery,
installation and set up costs.
However, the costs of training staff on how to use an asset are not included in the cost of the asset.
The reason is that it is uncertain whether staff will stay in the business and hence the benefit of the
training may not last for the full life of the asset.
80 11: Non-current assets and depreciation CIMA BA3
1.2 Depreciation
KEY TERM
Depreciation is the allocation of the depreciable amount of an asset over its estimated
useful life. Depreciation spreads the cost of a non-current asset on a systematic basis over
its useful life.
It is a means of matching the cost of the asset with the profits that the asset generates, directly or
indirectly, for the business.
Note that deprecation is NOT an attempt to arrive at the market value of the asset  this is a
common error in the exam.
All assets with a finite useful life have to be depreciated. This includes buildings, but not land (unless
the benefit of the land is being used up, e.g. quarrying).
Depreciation is charged to the statement of profit or loss as an expense.
Unless told otherwise, depreciate from the month of acquisition to the month of disposal.
2 Depreciation methods
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There are two common methods, both of which may be examined.
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Straight line (most common)
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Reducing balance
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Whichever method is chosen, the method must be applied consistently and must be disclosed in the
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notes to the financial statements.
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2.1 Straight line method
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Charges the same amount of depreciation in each period and is calculated as follows:
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Cost – residual value
Expected useful life
Residual value is the value an asset is expected still to have at the end of its useful life. In practice this
is normally zero. Residual value and expected useful life will be estimates.
ILLUSTRATION: SARAH
Sarah bought a Volvo estate car for $26,000 cash. She planned to use it for four years and estimated
that it would be worth $10,000 at the end of the four-year period.
The double entry for the purchase will be:
Dr Non-current assets (SFP) $26,000
Cr Cash $26,000
The annual depreciation expense will be calculated as follows:
($26,000−$10,000)
= $4,000 per annum
4
CIMA BA3 1 1 : No n - c u r r e n t a s s e t s a n d d e p r e c i a t i o n 81
The double entry for the annual depreciation charge will be:
Dr Depreciation expense (statement of profit or loss) $4,000
Cr Accumulated depreciation (SFP) $4,000
The amounts for the four year life would be as follows:
Depreciation Accumulated Carrying amount
Cost expense per depreciation at (cost less accumulated
Year (never changes) annum year-end depreciation)
$ $ $ $
1 26,000 4,000 4,000 22,000
2 26,000 4,000 8,000 18,000
3 26,000 4,000 12,000 14,000
4 26,000 4,000 16,000 10,000
The carrying amount (sometimes called carrying value, net book value, or NBV) at the end of the
asset’s useful life will be equal to its residual value. It is the carrying amount that is shown in the
Statement of Financial Position.
CARRYING AMOUNT = COST – ACCUMULATED DEPRECIATION
The accumulated depreciation (sometimes called “allowance for depreciation”) is always a credit
balance that is deducted from cost in the SFP.
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Note: Sometimes exam questions might be worded slightly differently. For example, instead of saying
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“Sarah plans to use the asset for 4 years”, the question might state: “Sarah’s depreciation policy is to
depreciate the asset on a straight-line basis at 25% per annum”. Note that you still proceed in exactly
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the same way as above, but the depreciation charge would be calculated:
25% × (26,000 – 10,000) = $4,000 per annum
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Calculates depreciation as a fixed percentage of the carrying amount at the start of the year.
ILLUSTRATION: RUTH
Ruth bought a threshing machine on 1 January 2012 for $10,000. She expected to use the asset for five
years, at the end of which time she expected to sell it for $3,300. Ruth depreciated the asset at 20%
per annum on the reducing balance basis.
The amounts charged to the statement of profit or loss for depreciation and the carrying amount at
the end of each year are as follows:
Carrying Depreciation expense Accumulated
amount (20% of the CA at the depreciation
Year end b/f start of the year) at year-end Carrying amount
$ $ $ $
31.12.12 10,000 2,000 2,000 8,000
31.12.13 8,000 1,600 3,600 6,400
31.12.14 6,400 1,280 4,880 5,120
31.12.15 5,120 1,024 5,904 4,096
31.12.16 4,096 819 6,723 3,277
Note. The expected residual value is ignored when calculating the annual expense. Remember this
rule: you will be tested on it.
The reducing balance method is most appropriate for assets that depreciate quickly in the early years
of ownership, e.g. cars.
Note: There is a quicker way to calculate the carrying amount of an asset at any date:
CARRYING AMOUNT = COST × (1 – RATE OF DEPRECIATION)n
where n is the number of years the asset has been depreciated for.
Therefore, in the above example, the carrying amount at the end of 3 years is $10,000 × 0.83 =$5,120.
LECTURE EXAMPLE 11.1: HUSSAIN
Hussain had the following balances in his nominal ledger at 30 June 2014:
Plant at cost $50,000
Plant accumulated depreciation $24,000
On 31 January 2015 Hussain sold plant with a carrying amount of $8,000 for $9,000 cash. The plant
had originally cost $16,000. Hussain’s policy is to charge a full year’s depreciation in the year of
purchase and none in the year of disposal.
Calculate Hussain’s depreciation charge for the year ended 30 June 2015 under both the straight line
and reducing balance methods, assuming a depreciation rate of 25%.
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Straight line method
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2.3 Change in estimated useful life

A business may sometimes change the useful life of an asset, e.g. in order to give a fairer presentation.
The rule is to depreciate the carrying amount of the asset over the revised remaining useful life.
ILLUSTRATION: DITHER
Dither purchased a non-current asset on 1 July 2015 for $60,000 when it was estimated to have a
useful life of 5 years and a residual value of $10,000. On 1 July 2016 a modification costing $12,000
was made to the asset, extending its useful life by a further year, and maintenance work was carried
out on the asset costing $4,000.
What is the charge for depreciation expense for the year ended 30 June 2017, assuming the company
uses the straight line method?
Year Dep’n Carrying amount
30 June 2016 $60,000 – $10,000 = $10,000 $50,000
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30 June 2017 $50,000 + $12,000 – $10,000 = $10,400
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Note: Maintenance expenses are ignored as they are charged directly to the statement of profit or loss
as an expense.
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3 Disposals st I pyri
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A business may decide to dispose of a non-current asset at any time during or after the end of its
useful life. When it does so, it may make a profit or loss on disposal which is recorded in the
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statement of profit or loss. This is calculated as follows:
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PROFIT/(LOSS) = SALE PROCEEDS – CARRYING AMOUNT OF ASSET AT DATE OF DISPOSAL
Proceeds are debited to the cash or bank account and credited to an asset disposal account in the
statement of profit or loss. Balances on the non-current asset cost and accumulated depreciation
account are cleared to nil and also transferred to the disposal account. The balance on that account is
the profit or loss on disposal.
ILLUSTRATION: RUTH 2
Ruth, from the previous illustration, sells her threshing machine for $5,500 on 1 May 2013. Ruth’s
policy is to depreciate assets in full in the year of acquisition and not in the year of disposal.
The profit or loss on disposal will be calculated as follows:
$
Proceeds 5,500
Less: carrying amount at date of disposal (see earlier illustration) (6,400)
(Loss) on disposal (900)
Remember:
CARRYING AMOUNT = COST – ACCUMULATED DEPRECIATION
3.1 Part Exchange

Rather than selling an asset, a company may part exchange an old asset for a new one. In this case the
old asset is treated as a disposal, with profit or loss being calculated as above but with the part
exchange allowance being substituted for proceeds. The new asset is then capitalised at its cost.
ILLUSTRATION: RUTH 3
Ruth, from above, exchanges her threshing machine on 1 May 2013 for a new machine which retails at
$12,000. She receives a part exchange allowance of $7,000 for the old machine and pays $5,000 in
cash.
The profit or loss on disposal will be calculated as follows:
$
Part exchange allowance 7,000
Less: carrying amount at date of disposal (6,400)
Profit on disposal 600
The new asset cost ledger will be debited with the part exchange allowance of $7,000 and $5,000 cash.
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4 Revaluations
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Non-current assets are normally recorded at historic cost and are depreciated, with the carrying
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An alternative accounting policy is to revalue non-current assets and include them in the Statement of
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Financial Position at their fair value. If a company chooses this policy it must apply it consistently to all
assets in that class.
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The difference between the carrying amount of the asset and its fair value is credited to a revaluation
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reserve/surplus in the Statement of Financial Position.
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REVALUATION SURPLUS = FAIR VALUE – CARRYING AMOUNT OF ASSET AT DATE OF
VALUATION
Depreciation is charged on the revalued amount over the remaining useful life of the asset.
ILLUSTRATION: AMANDA
Amanda bought a property on 1 July 2011 for $200,000 (including land for $50,000). Amanda
depreciated the building at 2% straight line per annum from the date of acquisition. On 31 December
2017 Amanda revalued the property to $280,000 (including land of $70,000).
Calculate the revaluation surplus at 31 December 2017 and the depreciation expense for the year
ended 31 December 2018.
STEPS
Step 1: Calculate the carrying amount of the asset at date of revaluation.
At the date of revaluation, Amanda will have owned the building for 6.5 years.
Carrying amount = Cost $200,000 – Depreciation (6.5 years × 2% × $150,000 = $19,500)
= $180,500
Step 2: Calculate the revaluation surplus using the formula.

Fair value $280,000 – carrying amount $180,500 = $99,500
Double entry:
Dr Cost of asset ($280,000 – $200,000) $80,000
Dr Accumulated depreciation (all of the depreciation to date) $19,500
Cr Revaluation surplus $99,500
Step 3: Calculate depreciation following the revaluation.
Fair value of building $210,000 / 43.5 years remaining life = $4,828 per annum.
If a revalued asset is subsequently disposed of, profit or loss on disposal is calculated in the normal
way, i.e. proceeds less carrying amount.
5 Impairment (a fall in value)

An asset can become impaired because it has been damaged, or has become obsolete, or for other
reasons.
Non-current assets should be included in the financial statements at no more than their “recoverable
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amount”, where “recoverable amount” = the higher of net realisable value and value in use.
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Any impairment is generally charged to the statement of profit or loss. The amount of the impairment
is the difference between the asset’s carrying amount and its recoverable amount.
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Depreciation after the impairment adjustment is charged on the revalued (impaired) amount.
6 Non-current asset register itio

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Companies keep this register as part of their internal control system. It is not part of the nominal
ledger (like a memorandum account) but should be reconciled to the nominal ledger on a regular
basis.
It contains details of all non-current assets, including:
 Name, description and internal reference number
 Purchase date
 Cost
 Location
 Estimated life/depreciation method and rate
 Carrying amount
Questions will normally require you to compare the carrying amount of assets in the nominal ledger to
the carrying amount of assets in the non-current asset register and explain why there might be a
difference.
LECTURE EXAMPLE 11.2: JULIA
Julia’s trial balance shows the carrying amount of plant and equipment as $175,000 but her non-
current asset register shows a total of $180,000. The difference could be explained by:
(a) Purchase of a new server for $5,000 not being recorded in the non-current asset register.
(b) Disposal of a server with a carrying amount of $5,000 not being recorded in the nominal ledger.
(c) Disposal of a server not being recorded in the non-current asset register. Disposal proceeds
amounted to $10,000 and resulted in a loss on disposal of $5,000.
(d) Disposal of a server not being recorded in the non-current asset register. Disposal proceeds
amounted to $10,000 and resulted in a profit on disposal of $5,000.
Hint:
The trial balance (or nominal ledger) has a value $5,000 less than the non-current asset register.
Values are always the carrying amount of assets (unless otherwise stated). We are therefore looking
for a transaction with a carrying amount of $5,000 that would result in the nominal ledger balance
being more than the register.
7 Intangible assets
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Tangible assets are physical items, e.g. computer equipment, furniture, that are used in a business
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over a period of more than one year.
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Intangible assets are identifiable assets:
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with no physical substance,
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 which are controlled by the entity and
 from which future economic benefits are expected to flow.
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The most common examples of intangibles are goodwill and research and development. Other
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examples are licences (e.g. licence to operate a rail service) and patents.
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7.1 Goodwill (IFRS 3)
KEY TERM
The difference between the cost of a business as a whole and the fair value of its separable
net assets.
Purchased goodwill (‘positive goodwill’) is created when a business is acquired for more than the fair
value of its separable net assets.
Where a business is acquired for less than the fair value of its separable net assets, ‘negative’ goodwill
(sometimes called ‘gain on a bargain purchase’) arises.
Accounting treatment:
Positive Goodwill – capitalise and review annually for impairment.
 Cannot increase in value, can only maintain or reduce by way of impairment adjustment.
 Show asset separately in statement of financial position within non-current assets.
Negative Goodwill – recognise immediately as a gain in the statement of profit or loss.
Internally generated goodwill is inherent in a business and should not be recognised in the financial
statements.
7.2 Research and development (IAS 38)

7.2.1 Research
KEY TERM
The original and planned investigation undertaken with the prospect of gaining new
scientific or technical knowledge and understanding.
Examples:
 Activities aimed at gaining new knowledge.
 Search for applications of research findings.
 Search for alternative uses for materials, products or services.
 Design, evaluation and final selection of possible alternatives for new or improved materials,
products, or services.
Accounting treatment: Research costs must be written off (i.e. recorded as an expense in the
statement of profit or loss) in the period in which they are incurred.
7.2.2 Development
KEY TERM
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The application of research findings or other knowledge to a plan or design for the
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production of new or substantially improved materials, devices, products, processes,
systems or services before the start of commercial production or use.
Examples:
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 Design and production of prototypes and models.
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 Design of tools, moulds, dies etc involving new technology.
 Design, construction and operation of a pilot plant that is not of a scale economically feasible
for commercial production.
 Design, construction and testing of a chosen alternative for new or improved materials,
products, or services.
Accounting treatment: Development costs should be written off in the period in which they are
incurred, unless they satisfy all of the following conditions:
 P robable future economic benefits will be generated by the asset
 I ntention to complete and use/sell asset
 R esources adequate and available to complete and use/sell asset
 A bility to use/sell the asset
 T echnical feasibility of completing asset for use/sale
 E xpenditure can be measured reliably.
Where costs meet all of these criteria they must be capitalised as an intangible non-current asset and
amortised over their expected useful life.
Note. Total development costs recognised as an asset should not exceed the probable future net
economic benefits expected to be derived from the asset.
The following costs should be included in the amount capitalised as an intangible asset:
 Materials
 Services
 Wages and salaries
 Depreciation on plant etc used in development
Selling and administrative expenditure cannot be included.
7.2.3 Amortisation
Once capitalised, development costs must be amortised on a systematic basis to match the cost with
the related revenue or cost savings. In practice, the straight line method is normally used.
Amortisation must commence when the asset is available for use.
If the asset is considered to have an infinite useful life, it is not amortised but is subjected to an annual
impairment review.
7.3 Other internally generated intangible assets (IAS 38)

Assets such as internally generated brand names, publishing titles and customer lists are not
recognised in the financial statements.
ILLUSTRATION: SONNY
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Sonny, an electronics company, incurred the following expenditure in the year ended 31 December
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2015.
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Project 1 $50,000 on market research to assess possible demand for an electronic book-reader the
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company is considering developing.
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Project 2 $100,000 designing and making a prototype DVD player that will play DVDs in both HD and
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Blu-ray formats. Each production unit is expected to cost $220 to make ($140 direct cost and
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Project 3
$80 of attributable overhead) and Sonny has budgeted for sales of 100,000 units at $400 each
commencing in 2016.
$3,000,000 on a brand new “convergence” product, the XYY box, that will allow consumers all
the computing and gaming power of a PC with the convenience of a fully functioning HD
television. Given the projected cost of the product, and the increased opportunity to watch
TV programmes through conventional PCs, senior managers at Sonny are unsure what
demand there will be for the XYY box. Despite these uncertainties, Sonny is going to develop
the XYY box as a commercial product.
Required:
Explain how the three projects will be dealt with in Sonny’s financial statements for the year ended 31
December 2015.
Determine the nature of each type of expenditure, as research or development
Project 1 - This is a research project per the examples given in IAS 38 and as such the costs should be
expensed in the year ended 31 December 2015.
Project 2 – Meets all the criteria to be recognised as a development asset so expenditure must be
capitalised to create an intangible non-current asset at 31 December 2015. Amortisation of the asset
should commence in 2016. Amortisation should be matched against future revenue on a systematic
basis.
Project 3 – As this project does not meet all the criteria set out above, the costs of this project should
be classified as development expenditure and expensed in 2015.
8 Disclosure requirements for intangible assets

For each class of intangible asset and distinguishing between internally generated and other intangible
assets, must disclose:
 G ross carrying amount & accumulated amortisation/impairment losses at beginning and end of
period
 R econciliation of carrying amount at beginning and end of period showing:
– Additions in year
– Amortisation in year
– Impairment losses in year
– Other Changes in year
 E stimated useful lives or amortisation rates
 A mortisation method
 T he line item of the statement of profit or loss in which any amortisation is included
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12
Bank reconciliations
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1 Introduction
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A reconciliation of the balance in the cashbook to the balance on the bank statement is a standard
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control that all well-run businesses should carry out on a regular, at least monthly, basis.
The balance in the cash account in the general ledger goes into the Statement of Financial Position.
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This is not necessarily the same as the figure on the bank statement.
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1.1 Differences between the cashbook balance and the bank statement
balance (adjusting items)
 Timing differences (cheques written/received not yet presented/lodged at the bank)
 Bank errors
 Cashbook errors These items should
 Standing orders/ direct debits not recorded in cashbook be written up or
 Bank charges/ interest not recorded in cashbook adjusted in the cash
 Dishonoured (bouncing) cheques not written off in cashbook book
1.2 Reconciling items between cashbook and bank statement
KEY TERMS
 Unpresented cheque A cheque written by the business, not yet paid into the bank by
the supplier.
 Uncleared lodgement A cheque received by the business not yet credited by the bank.
 Bank errors A bank error would remain as a difference until the bank corrects the error.
92 12: Bank reconciliations CIMA BA3
These should always be reconciling items which explain the difference between the cashbook balance
and the bank statement balance at the year end. Other differences should be made as corrections to
the cashbook balance before performing the bank reconciliation.
1.3 Debits and credits

If the business has cash, this will be shown as a debit balance in the business’ books because it is an
asset. A bank overdraft will be a credit balance (liability owing to bank).
Watch out for questions involving overdraft balances and remember these are credits, entered on
the right hand side of the cash ledger.
If anyone has cash in the bank, they are said to be “in credit” and the cash shows as a credit balance
on the bank statement. This is because the bank statement is issued by the bank and it shows the cash
position from the bank’s perspective, i.e. the bank owes that cash to its customer and is therefore a
liability of the bank.
2 Approach to bank reconciliation questions

STEPS
Step 1: Write up the corrected cashbook from the information supplied. Remember the
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corrected cash account balance will go into the Statement of Financial Position.
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Step 2: Perform a bank reconciliation by reconciling the balance per the bank statement to the
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cashbook balance.
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You must identify which items are adjustments required in the cashbook and which items are timing
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differences which will be reconciling items between the cashbook balance and the bank statement.
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LECTURE EXAMPLE 12.1: MARTIN
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Martin is attempting to reconcile his cashbook balance with the bank statement balance at 30 June.
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The cashbook balance is $2,020 overdrawn and Martin discovers the following:
(a) Bank charges of $25 appear on the bank statement on 28 June but have not been entered into
the cashbook.
(b) A cheque for $1,800 has not yet been presented.
(c) A cheque payment has been entered in the cashbook as $75 but appears in the bank statement
as $57. The bank statement is correct.
(d) A direct debit payment of $123 has not been entered into the cashbook.
(e) Cash paid into the bank of $210 has not yet been credited.
(f) A customer cheque for $250 which was paid into the bank on 21 June was dishonoured on 29
June.
(g) Cash receipts of $475 have been entered into the cashbook as a credit instead of a debit.
What is the adjusted cash book balance and the bank statement balance at 30 June?
CIMA BA3 12: Bank reconciliations 93
STEPS
Step 1: Calculate the adjusted cash book balance as at 30 June
Cashbook
Step 2: Perform the bank reconciliation to calculate the bank statement balance
$
Balance per bank statement
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Balance per adjusted cashbook
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3 Chapter summary
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To tackle questions you need to look carefully at the requirement and the information you are given.
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Normally the requirement is for the adjusted cashbook figure (as this goes into the Statement of
Financial Position), but you do need to take care with your approach.
If given the cash book figure If given the bank statement figure
Look for adjusting items and adjust the cash book Look for timing differences and use the proforma
figure accordingly. Typical items are: bank reconciliation statement:
 Direct debit and standing order payments on Balance per bank statement $750
the bank statement not yet recorded LESS: Unpresented cheques –$550
 Bank charges ADD: Uncleared deposits $800
 Dishonoured cheques Balance per adjusted cashbook $1,000
 Cashbook errors
 Electronic Funds Transfers
Watch out for questions that ask for the uncorrected cashbook balance, after giving you the bank
statement figure. Here you need to perform the reconciliation first, as above, to get to the adjusted
cashbook figure, and then also adjust back the adjusting items to find out what the cashbook balance
was before the corrections.
94 12: Bank reconciliations CIMA BA3
LECTURE EXAMPLE 12.2: MARGARET
Margaret’s bank statement shows an overdraft of $1,000 at 30 September.

In preparing the bank reconciliation she discovers:
 Uncleared lodgements of $500
 Unpresented cheques of $1,300
 Electronic Funds transfer out of $100 not recorded in the cashbook
 Bank charges of $50 not recorded in the cashbook
 Customer cheque for $80 dishonoured by the bank on 29 September.
What is the uncorrected cashbook figure in Margaret’s accounts at 30 September?
Balance per bank statement
Adjusted/correct cash book figure
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Uncorrected cash book
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13
Accounting errors
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1 Types of errors
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We have already seen that a trial balance can be used to detect certain errors, namely those that
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result in debits not being equal to credits. Let’s revisit the table that we saw in Chapter 5.
TB Suspense account
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Nature of error Example balances? involved?
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Omission 1 – a transaction is not Sales or purchase invoice not Yes No
recorded at all recorded in the accounts
Omission 2 – only one side of an Cash received from customer No Yes
entry is posted debited to cash book but not
credited to receivables.
Principle – an item is posted to the Cash paid for plant repairs (expense) Yes No
correct side of the wrong type of is debited to plant account (asset)
account
Commission – an item is entered to Telephone expense debited to Yes No
the correct side of the wrong electricity expense in N/L
account
Transposition – figures entered Cash paid to supplier of $540 No Yes
wrong way round in one side of an debited as $450 in payables account
entry
Original entry 1 – one side of an Purchases of $1,000 posted to No Yes
entry incorrectly recorded payables as $100
Original entry 2 – one side of an Sales of $2,000 credited to No Yes
entry is posted the wrong way receivables account
round
96 13: Accounting errors CIMA BA3
LECTURE EXAMPLE 13.1
Which of the following errors would be detected by preparing a trial balance?
(a) Total discounts received column in the cashbook was not posted to the discounts YES / NO
received ledger account
(b) The last day’s credit sales had been excluded from the sales daybook YES / NO
(c) Discounts allowed were credited to the payables ledger control account YES / NO
We use a suspense account to correct errors where debits do not equal credits, i.e. when the trial
balance does not balance.
A suspense account may also be used where the other side of an entry is unknown, i.e. we want to
post a transaction to the account but do not yet know where to post all of the entry, e.g. cheque
received with no remittance so we do not know which customer it is from.
The suspense account is a temporary account. It must be cleared before the financial statements are
prepared.
2 Correction of errors
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Some errors will be corrected by journal entry.
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Others will involve the suspense account. In these cases, we use a 3 step approach:
S
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TEPS
t
Step 1: What double entry have we got?
I n
Step 2: What double entry do we want?
s t
Step 3: What double entry is required to correct the error?
F ir
We cover below the main errors that involve suspense accounts.
2.1 Error of omission: one side of a double entry is not posted

A temporary bookkeeper received a cheque in the post. The only entry he made was to “debit cash”.
The trial balance will not balance. The difference must be credited to the suspense account.
Step 1: What have we got?
Dr Cash
Cr Suspense
Step 2: What do we want?
Assuming the cheque is from a credit customer then the correct double entry should have been:
Dr Cash
Cr Receivables
Step 3: Correct the error:
Dr Suspense (to clear the account)
Cr Receivables (to record the cash received)
CIMA BA3 1 3 : Ac c o u n t i n g e r r o r s 97
2.2 Transposition errors

If a question informs you that the bookkeeper made the following entries for an estimated $450
electricity expense:
Dr Electricity expense 450
Cr Accruals 540
Cr Accruals 540
Dr Suspense 90
Cr Accruals 450
Dr Accruals (to reduce the accrual to 450) 90
Cr Suspense (to clear the account) 90
2.3 Error of original entry 1

The accountant receives a telephone bill for $150, but records the telephone expense as $15.
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Dr Telephone expense 15
Dr Suspense 135
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Cr Payables 150
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Cr Payables 150
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Cr Suspense (to clear) 135
2.4 Error of original entry 2

A bookkeeper pays a supplier $500 but credits payables instead of debiting payables with the $500. He
correctly credits cash with the $500.
Dr Suspense 1,000
Cr Cash 500
Cr Payables 500
Dr Payables 500
Cr Cash 500
Dr Payables (to give a net debit of 500) 1,000
Cr Suspense (to clear) 1,000
Whenever an entry has been made on the wrong side of an account, the error can be corrected by
doubling the amount and recording it on the correct side of the account.
LECTURE EXAMPLE 13.2: MISS TAKE
In extracting her trial balance for the year ended 31 March 2008 Miss Take found that debits exceeded
credits by $2,800. Upon investigation she found the following:
 A sales invoice $1,500 had been omitted from the sales account.
 A cheque received from a customer of $1,820 had been credited to receivables as $1,280.
 Discounts received of $630 had been debited to discounts allowed.
 An electricity bill of $550 had been debited to the electricity expense as $50.
 Plant repairs of $4,000 had been debited to the plant & machinery account. Plant is depreciated
over 4 years with a full year’s charge in the year of purchase.
Required:
Write up the suspense account ledger showing the corrections and calculate the adjustment to profit.
STEPS
Step 1: Make sure you put the opening balance on the suspense account on the correct side. If
debits exceed credits, then the balance on the suspense account will be a credit balance (to
make both sides add up to the same in the trial balance).
Step 2: Work through each of the errors and determine if there is an entry to the suspense
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account. Remember the steps: 1 – What have we got? 2 – What do we want? 3 – What do we
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do to correct the error? You may find it helpful to write the double entries down as you go.
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Suspense account
o
$ $
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r s t
F i
CIMA BA3 1 3 : Ac c o u n t i n g e r r o r s 99
Step 3: Work out which adjustments affect the statement of profit or loss and whether a debit
or credit entry is required. Remember a debit entry to a statement of profit or loss account will
reduce profit.
Profit adjustment:
$
3 Chapter summary
It is important that you are competent with double entry in order to correct errors, and that you
Co
understand the use of the suspense account. This is a popular area with examiners and there are many
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different types of question that can be set.
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For example, questions may say: “The suspense account shows a debit balance of $100.” It is
important that you understand that this means either:
 We have too many credits, or
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 We don’t have enough debits
The question may ask what caused the situation or what is needed to correct the error.
Another approach that examiners like is as follows:
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“A contra entry of $x has been debited to the receivables control account but has been correctly
recorded in the payables account.” The total of the trial balance would show:
A Debit side to be $x more than the credit side
B Debit side to be $2x more than the credit side
C Debit side to be $x less than the credit side
D Debit side to be $2x less than the credit side
HOMEWORK EXERCISE 13.3
Complete the double entry required to correct the following errors. The first one has been completed
as an example. You may find it helpful to write out the three steps in your workings.
No Error Correcting Debit Correcting Credit

Account $ Account $
1 Telephone expense of $65 posted to rent Telephone 65 Rent 65
expense account. expense expense
2 Sales invoice of $1,500 posted to
customer account as $150.
3 Cash received from a previously written
off debt of $45, debited to cash but
other side of entry unknown.
4 Doubtful debt of $80 credited to
payables.
5 Factory machine purchased for $2,000
debited to plant repairs.
6 Purchase invoice $750 recorded in
t
payables ledger as $570.
7
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Depreciation expense $1,500 credited to
i
r 0
depreciation expense.
8
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p ion 2
Cash received from customer $500
o
credited to payables ledger.
9
C uitMotor vehicle service invoice $400
t
posted to motor vehicle asset account.
10
t I n
Discount allowed of $75 credited to
s
discounts received account.
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Now, for each of the errors above, identify the type of error and state the impact on the financial
statements (net assets and profit). Again the first one has been completed as an example.
No Type of error Impact on financial statements $

1 Error of commission None – misclassified expense 0
2
3
4
5
6
7
8
9
10
101
14
Incomplete records
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1 Introduction
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This is another popular area with the examiner. You are likely to get more than one question requiring
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you to calculate a missing figure.
Records may be incomplete because of:
 Incompetence
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 Fraud
 Event outside the bookkeeper’s control, e.g. fire, computer failure.
This is sometimes known in accountancy practice as a “brown paper bag job”.
Information that should be available: bank statements, supplier statements.
Information that may be available: cheque stubs, cost structures or profit margins.
You may get questions that need you to use
 Cost structures
 Control accounts and ledger accounts
 Accounting equation
2 Cost structures
KEY TERMS
Profit margin – a percentage of sales.
Profit mark up – is an addition to cost, i.e. a percentage of cost of sales.
We can use information about profit margins or mark-up to calculate sales or cost of sales.
It is essential that you know the difference between margin and mark-up.
102 14: Incomplete records CIMA BA3
Technique: make the figure that profit is a function of equal to 100%, as follows:
PROFIT MARGIN 40% PROFIT MARK-UP 40%
% %
STEP 1 Sales 100 STEP 3 Sales 140
STEP 3 Cost of sales (bal.fig.) 60 STEP 1 Cost of sales 100
STEP 2 Gross profit 40 STEP 2 Gross profit 40
This means that if we know either of cost of sales or sales we can work out the other (sales or cost of
sales).
EXAM SMART
You will need to remember the formula for cost of sales, as a question may give you
inventory and purchases figures, rather than the cost of sales figure.
LECTURE EXAMPLE 14.1: MARK
Mark is hopeless. He has a pile of supplier’s statements, last year’s Statement of Financial Position and
he is surrounded by inventory. Mark makes a profit of 30% on every sale he makes.
t
Mark knows that opening inventory (from last year’s Statement of Financial Position) was $800.
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Closing inventory (from count) is $600, and purchases (from supplier statements) were $3,500.
Required:
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Calculate sales and gross profit.
STEPS o
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Step 1: Calculate cost of sales
r s t $
i
Opening inventory
F Purchases
Closing inventory
COS
Quick Calculation: COS is purchases less increase/(plus decrease) in inventory.

Step 2: Calculate sales and gross profit
% $
Work out the percentages then fill
Sales
in COS figure from above to
COS (from above)
calculate sales and profit.
Gross profit
CIMA BA3 14: Incomplete records 103
3 Using ledger accounts to solve incomplete records

Find sales, missing cash or purchases by using ledger accounts and inserting balancing figures. This is
simply revision of Chapters 6 and 7.
ILLUSTRATION: MARK
Mark has now found his payables account, balances are as follows:
$
Balance at 1.1.2015 400
Balance at 31.12.2015 450
Payments from bank 3,250
Payments in cash 200
We can deduce purchases as follows slotting in the information given:
STEP 1
Trade payables
$ $
1.1.15 Balance b/f 400
Bank payments 3,250
STEP 3
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Cash payments 200
Purchases (bal.fig.) 3,500
st I
31.12.15 Balance c/f 450
STEP 2
3,900
yri 3,900
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Quick calculation: purchases = payments plus increase/(less decrease) in creditors
Mark has now found his receivables account!

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$
Balance at 1.1.2015 1,095
Balance at 31.12.2015 850
Receipts in bank 5,130
Receipts in cash 400
See if you can now deduce sales:
Trade receivables
$ $
Quick calculation: sales = receipts plus increase/(less decrease) in receivables
Be careful with questions involving missing cash. You may need a separate T account for cash and for
bank. (It may be helpful to think of a small corner shop whose transactions are mostly for cash. They
may pay some wages and expenses out of the “till” and “bank” any remaining cash at the end of the
day).
ILLUSTRATION: GERRY
Gerry makes all of his sales in cash. The following data is relevant for December:
$
Opening cash 400
Sales 46,000
Cash banked 38,000
Sundry expenses paid in cash 2,300
Wages paid in cash 4,600
What is Gerry’s closing cash position at the end of the month?
Opening cash 400
Cash sales not banked (46,000 – 38,000) 8,000
Sundry expenses (2,300)
Wages paid (4,600)
Therefore, cash balance at end of month 1,500
LECTURE EXAMPLE 14.2: SUE, GRABBIT AND RUN

The bookkeeper of Sue, Grabbit and Run is missing, as is the cash from the till. He may have been
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stealing all year as he has been seen driving around town in a new Ferrari.
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The following information may be useful:
2
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The opening cash balance on 1.1.2015 was $150
o
 Payments to trade suppliers in the period were $25,000
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 Cash from customers banked was $17,500
t
All receipts were banked after paying the following:
t I n $
r s
Staff wages 4,000
F i
General expenses 2,500
Balances on the ledgers were as follows:
1.1.15 31.12.15
$ $
Trade receivables 1,200 1,300
Trade payables 1,000 800
Inventory 2,000 2,400
The firm achieves a mark up of 25% on cost.
(1) Find purchases
(2) Find cost of sales
(3) Find sales
(4) Find cash received from customers
(5) Find the cash stolen by the bookkeeper
(1) Purchases
Trade payables
$ $
b/f 1,000
c/f 800
(2) Cost of sales

$
Opening Inventory
+ Purchases
– Closing Inventory
= COS
(3) Sales
The mark up is 25%, therefore we make COS equal to 100%.
% $
Sales 125
COS 100
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Gross profit 25
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(4) Cash received from customers
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Trade receivables
$ $
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b/f 1,200
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(5) Cash stolen 017
Cash
$ $
4 Accounting equation
We introduced the accounting equation in Chapter 5. We can use the equation to find missing figures.
It will be helpful if you learn the format of the bottom part of the Statement of Financial Position.
ILLUSTRATION: ANDY
Andy’s net profit for the year may be deduced using which of the following formulae?
(a) Opening capital – drawings + capital introduced – closing capital
(b) Opening capital + drawings – capital introduced – closing capital
(c) Closing capital + drawings – capital introduced – opening capital
EXAM SMART
Assign simple numbers for the various items that are in the formula and lay them out in the
format of the bottom part of the Statement of Financial Position. Then slot the figures into
each of the given options to find which mathematical equation works. For example:
Opening capital 5
Capital introduced 3
Drawings (2)
t
Profit 8
Closing capital
i g h 1 7
14
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You should find that answer C is the only equation that works once you have slotted in these
p ion
figures (14 + 2 – 3 – 5 = 8).
o
C uit
I n
ILLUSTRATION: PANDY
t
r s t
i
Pandy’s profit for 2015 was $16,500. Pandy had injected new capital of $8,000 during the year and
F
drew a monthly salary of $500. He also took goods for his private use which had cost $1,250. If net
assets at the end of 2015 amounted to $41,375 what were opening net assets?
Again if you are familiar with the layout of the bottom part of the Statement of Financial Position you
should be able to slot the figures in.
Opening net assets 24,125
Drawings (7,250)
Profit 16,500
Closing net assets 41,375
Watch out for questions giving you extracts from the financial statements as in the example below.
You should tackle this in the same way, but need to calculate the net assets figures.
LECTURE EXAMPLE 14.3: ADAM
Adam started trading on 1 October 2015 and traded for a year. At the start and end of the year his
accounts contained the following balances:
1 Oct 2015 30 Sep 2016
Plant and equipment $12,000 $18,000
Cash at bank $2,000 ($4,200)
Inventory $5,000 $9,800
Receivables Nil $3,900
Payables Nil ($700)
Adam took cash drawings amounting to $12,000 during the year. What was Adam’s profit for the year?
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109
15
Company accounts
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1 Introduction
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There are different types of trading entity:
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 Sole trader
 Partnership
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 Company
017
Companies are owned by shareholders (members) who pay for share capital, either by subscribing for
original shares from the company or by buying existing shares from other members. Shareholders’
liability is limited to the value of shares they own. Companies can be private or public. Directors, who
may also be members, run the company.
2 Capital structure of limited companies

Companies can be financed by equity (shares), or loans or a mixture of both. Companies pay dividends
to shareholders and interest to holders of loan notes.
2.1 Share capital

There are two types:
(1) Ordinary shares – carry voting rights but no automatic right to dividend.
(2) Preference shares – attract a fixed dividend, paid in priority to ordinary dividend but no
automatic right to a dividend. No voting rights.
The “cost” of share capital is the amount of dividend paid on the shares (see below). Shareholders are
members of the company.
110 15: Company accounts CIMA BA3
KEY TERMS
 Issued share capital. The share capital actually issued by the company. Note that share
capital is recorded at its nominal (or face) value. Sometimes called issuing shares “at
par”.
 Share premium. If shares are issued for more than their nominal value, the premium
on issue is credited to the share premium account.
 Market value. Shares may be sold or purchased at more than their nominal value, but
may not be issued by the company for less than nominal value. Reflects value of
company as a whole but does not affect underlying financial records.
 Redeemable preference shares. The company will buy back the shares from the
shareholder at a future date. Should be classified as long term liabilities in Statement of
Financial Position.
 Irredeemable preference shares. Treated as shares.
2.2 Loan capital

Loan notes or bonds are long term liabilities which accrue interest. Holders of loan notes are creditors
of the company.

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Receive interest at fixed rate
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 Can enforce payment
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
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No voting rights
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 Less risky than shares
o
 Normally redeemable at a future date
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The “cost” of loan capital is the amount of interest paid on the loan notes, e.g. $25,000 7% loan notes
t
will accrue interest of $1,750 per annum.
t I n
Interest is paid out of pre-tax profits. Interest is charged to the statement of profit or loss as an
r s
expense when it falls due, rather than when it is actually paid, i.e. companies may have to accrue
F iinterest costs at the year-end.

If loan stock is purchased or sold mid-way through an accounting period, the interest charge will be
calculated according to the number of months the loan notes were in issue.
3 Reserves
These are shown on the Statement of Financial Position after share capital.
3.1 Retained earnings (also known as revenue reserves)

Contains the accumulated retained profits, after appropriation of dividends, of the company. Retained
earnings are fully distributable. Even if a company makes a loss in one year, it may still pay a dividend
out of retained earnings from previous years.
Dr Statement of profit or loss
Cr Retained earnings
To clear the retained profit for the year to the Statement of Financial Position.
CIMA BA3 15: Company accounts 111
3.2 Revaluation surplus (see Chapter 11 non-current assets)

Created when a company revalues its non-current assets upwards.
Revaluation surpluses or reserves are non-distributable, i.e. a company cannot distribute the assets
represented by these reserves to its members (because the gain represented by the revaluation has
not been realised).
3.3 General reserve

A general reserve is fully distributable. The general reserve is created when a company makes a
transfer from retained earnings. There is no requirement to do this and, except in exams, companies
rarely do anything they are not required to do!
Dr Retained earnings
Cr General reserve
3.4 Share premium

Arises when shares are issued for more than their nominal value (see 4.1 below).
4 Share issues
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The purchase and sale of existing shares does not give rise to any accounting entries. Companies will
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maintain a register of shareholders (like a memorandum account) and will update the register for the
new names and addresses of the current shareholders.
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When a company issues new shares, the accounts need to reflect the increase in capital, so this gives
rise to entries in the nominal ledger.
4.1 Issue of shares at a premium itio

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If a company issues shares for more than their nominal value then the excess is credited to a share
premium account.
SILLUSTRATION: FIRST
017
First issues 1,000 $1 shares at $2.50 each.
Double entry:
Dr Cash $2,500
Cr Share capital (nominal value) $1,000
Cr Share premium $1,500
Note that the share premium account has limited uses:

 Bonus issue (below)
 Cost of issuing shares can be debited to the share premium account
4.2 Bonus issue

An issue of “free” shares to existing shareholders. A bonus issue is made to reduce the value of shares
to increase their marketability (e.g. Investors may be more inclined to buy 2,000 shares at $10 than
1,000 shares at $20).
Bonus issues are always made at nominal (face) value. A bonus issue is not a means of raising
additional finance, as no cash is involved. The bonus issue is debited to the share premium account (or
may be debited to other available reserves, including retained earnings, if there is no share premium
account).
ILLUSTRATION: FIRST 2
First subsequently makes a 1 for 2 bonus issue. From above we know that there are already $1,000
shares in issue, so there will be a further 500 $1 shares issued.
Double entry:
Dr Share premium $500
Cr Share capital $500
4.3 Rights issue
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Existing shareholders are offered the right to acquire more shares, normally for less than the full
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market price. It is a means of raising additional finance from existing investors.
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ILLUSTRATION: FIRST 3
o
C uit
First’s Statement of Financial Position currently looks as follows:
I n t $
t
Assets (cash) 2,500
ir s
Share capital ($1,000 + $500) 1,500
F
Share premium ($1,500 – $500) 1,000
2,500
First then made a rights issue of 1 new share for every 2 in issue for $4 each, i.e. there are already
1,500 shares in issue, so 750 new shares are issued for a total of $3,000.
Double entry:
Dr Cash (1/2 × 1,500 shares previously in issue × $4) $3,000
Cr Share capital (1/2 × 1,500 shares previously in issue) $750
Cr Share premium (bal.fig.) $2,250
The revised Statement of Financial Position will look as follows:
$
Assets (cash) ($2,500 + $3,000) 5,500
Share capital ($1,000 + $500 + 750) 2,250

Share premium ($1,500 – $500 + 2,250) 3,250
5,500
5 Dividends
Dividends are an appropriation of profit, not an expense in the statement of profit or loss. They are
paid out of post-tax profits.
Companies may pay an interim dividend during the accounting period and they may also propose a
final dividend which is payable after the year end. The total dividend for the year is the sum of the
interim and final dividends.
A question may tell you that the company proposes a dividend of 8%. This means the dividend is 8% of
the nominal value of the shares in issue. You may also be given a rate of dividend as a number of cents
per share.
5.1 Calculating dividends
ILLUSTRATION
Calculate the return due to shareholders of the following shares:

(a) A holds 1,000 8% preference shares of $2 each
Preference dividend: 1,000 × $2 = $2,000 × 8% = $160
Co
(b) B holds 1,000 6% preference shares of 50c each
Fir
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Preference dividend: 1,000 × $0.50 = $500 × 6% = $30
(c) C holds 2,000 ordinary shares of $1 each, for which he paid $3. C receives a dividend of 3c per
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share.
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Ordinary dividend: 2,000 × 3c = $60
(d) D declares a dividend of 5c per 50c ordinary share. Issued share capital amounts to $50,000.
Ordinary dividend:
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$50,000 / 0.50 = 100,000 shares × 5c = $5,000
5.2 Accounting treatment

017
 Dividends paid are shown the Statement of Changes in Equity (see below) and debited to
retained earnings. Not shown in statement of profit or loss.
 Dividends declared or proposed after the year end (but before the accounts are issued) are not
recorded in the accounts at all but are disclosed by note.
Look at dates carefully when you get questions involving dividends as this could be relevant.
ILLUSTRATION
Last has 1,000,000 10c ordinary shares in issue. For the year ended 31 December 2015 it paid an
interim dividend of 6c per share and, on 2 January 2016, proposed a final dividend of 9c per share to
be paid four months after the year-end.
Double entry:
(a) Interim dividend
Dr Retained earnings (Statement of Changes in Equity) $60,000
Cr Cash $60,000
(b) Final dividend proposed: not recognised as this was not proposed during the year. The amount
will be disclosed in the notes to the financial statements.
6 Preparing limited company accounts (IAS 1)

IAS 1 sets out suggested formats for company financial statements. It also gives guidance on how
items should be presented in the financial statements.

t
Some items must appear on the face of the Statement of Profit or Loss and Other
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Comprehensive Income or Statement of Financial Position.

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Statements must have the company name, year end and should show comparative figures for the
o
previous year.
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t
6.1 Proforma Statement of Profit or Loss and Other Comprehensive Income
t I n
ABC Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 2015
ir s $
F
Revenue 139,200
Cost of sales (122,400)
Statement of profit or loss and other
Gross profit 16,800

Other income 1,000
comprehensive income
Distribution costs (5,000)

Other expenses (2,500)
Finance costs (1,500)
Profit before tax 2,800
Income tax expense (580)
Profit for the year 2,220
Other comprehensive income:
Gains on property revaluation 500
Total comprehensive income 2,720
The line items shown above are the headings that must be used. All items of income and expense must
be classified into one of these headings. You must be able to identify the most appropriate heading
for different types of expense, for example:
 Carriage inwards is included in cost of sales
 Carriage outwards is included in distribution costs (this is a cost of selling)
 Irrecoverable and doubtful debts expense is included in administrative expenses.
6.2 Proforma Statement of Financial Position

ABC Statement of Financial Position as at 31 December 2015
31.12.15 31.12.14
Assets $ $ $ $
Non-current assets
Property, plant and equipment 6,500 4,800
Goodwill 350 350
6,850 5,150
Current assets
Inventories 600 250
Trade and other receivables 400 300
Other current assets 100 100
Cash and cash equivalents 200 100
1,300 750
Total assets 8,150 5,900
Equity and liabilities
Capital and reserves
Share capital 1,000 500
Share premium 800 400
Revaluation surplus 1,300 800
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Retained earnings 2,400 900
5,500 2,600
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Loans 500 1,500
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Current liabilities
Trade and other payables 1,200 1,080
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Current tax payable 950 720
2,150 1,800
Total Equity and Liabilities
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8,150 5,900
Generally:
Current – amounts due within one year
017
Assets and liabilities must be distinguished between current and non-current.
Non-current – amounts due after more than one year
6.3 Proforma Statement of Changes in Equity

ABC Statement of Changes in Equity as at 31 December 2015
Share Share Revaluation Retained
capital premium surplus earnings Total
$ $ $ $ $
At 31 December 2014 500 400 800 900 2,600
Total comprehensive 500 2,220 2,720
income for the year
Dividends (720) (720)
Issue of share capital 500 400 900
At 31 December 2015 1,000 800 1,300 2,400 5,500
The SOCIE essentially explains the movements in the equity balances in the statement of financial
position over the year. For the exam, note which items are included in the statement above and
understand the interaction with the other financial statements.
Notice that the net profit for the year and the gain on property revaluation are presented in different
columns but on the same line; these make up total comprehensive income for the year.
LECTURE EXAMPLE 15.1: SOX
Sox made a profit before tax of $80,000 and had an estimated tax charge of $9,000 for the year ended
31 March 2016. The company transferred $10,000 to a general reserve and paid a final dividend of
$12,000 on 31 January 2016 relating to the prior year, that dividend having been proposed on 1 April
2015. On 1 April 2016 the directors declared a final dividend of $15,000 for the current year.
By how much has Sox’s retained earnings reserve increased for the year ended 31 March 2016?
6.4 Disclosure notes

As well the statement of profit or loss and other comprehensive income, statement of financial
position, statement of changes in equity and statement of cash flow, a full set of financial statements
should also include disclosure notes.
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These disclosure notes give supplementary information on key parts of the financial statements, so
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make the information more useful and easier to understand. At this stage you should be aware of the
2
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disclosure notes for the following:
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6.4.1 Non-current assets
t
Land and Plant &
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buildings equipment Total
t
Cost/valuation at 1 January 2015 X X X
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Additions X X X
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Revaluation in the year X – X
Disposals (X) (X) (X)
Cost/valuation at 31 December 2015 X X X
Accumulated depreciation at 1 January 2015 X X X

Charge for the year X X X
Released on revaluation (X) (X)
Released on disposal (X) (X) (X)
Accumulated depreciation at 31 December 2015 X X X
Net carrying amount @ 31 December 2015 X X X
Net carrying amount @ 31 December 2014 X X X
If there are also intangible assets, these are disclosed in a separate note. Refer to Chapter 11 for
details.
6.4.2 Inventories
The financial statements should disclose:
 Accounting policies adopted in measuring inventories
 Total carrying amount of inventories in classifications appropriate to the entity
 Carrying amount of inventories carried at NRV
7 Tax in company accounts
Every year end, a company will estimate its tax bill for the year (of, say, $1,000) and will post the
following journal:
Dr SPL: tax expense $1,000

Cr SFP: tax liability $1,000
Often, this estimate will be revised by the tax inspector, with the actual bill being paid a few months
after the year end. For example, the actual bill might be $1,200 not $1,000 in the above example. In
this case, the following journal would be needed:
Dr SFP: tax liability $1,200

Cr Cash $1,200
Therefore, there will now be a debit balance of $200 for the tax liability in the SFP even though the tax
liability has been settled. This $200 represents the under-provision made in last year’s financial
statements. Before we post this year’s tax charge estimate, we need to eliminate this balance with the
following journal:
Dr SPL: tax expense
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Cr SFP: tax liability $200
This has the effect of eliminating the statement of financial position figure and increasing the expense
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in the following year. We do not go back and adjust the initial expense of $1,000. We can now post
this year’s estimate of the tax bill.
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119
16
Statements of cash flows
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1 Introduction
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Businesses should measure cash flows in addition to profits. Profits may differ from cash flows because
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certain items are charged against profit even if there is no cash effect, e.g. depreciation, sales on
credit.
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One way to value a business is by considering its ability to generate cash.
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The statement of cash flows:
 Links the statement of profit or loss with the opening and closing statements of financial
position, i.e. explains changes in financial position during a period
 Is easier to understand than the statement of profit or loss
 Is less easy to manipulate than the statement of profit or loss
 Enhances the comparability of financial statements
2 Definitions
KEY TERMS
Cash – Cash on hand and demand deposits
Cash equivalents – Short term, highly liquid investments, readily convertible to cash
Operating activities – Principal revenue-producing activities
Investing activities – Acquisition and disposal of non-current assets and other investments
not included in cash equivalents
Financing activities – Result in changes in the size and composition of the equity capital and
borrowings of the entity
120 16: Statements of cash flows CIMA BA3
2.1 Indirect v Direct method

Indirect method most commonly used as is easier to prepare. Net profit or loss is adjusted for changes
in working capital and non-cash items.
Direct method shows total gross cash receipts and payments and is therefore more useful to the user,
but is more time consuming to prepare and is rarely used. IAS 7 permits either method.
3 Pro forma Statement of cash flows – indirect method

McClaren Statement of cash flows for the year ended 31 December 2015
$ $
Cash flows from operating activities
Net profit before taxation 4,250
Adjustment for:
Depreciation 500
Loss on disposal of property, plant and equipment 100
Investment income (500)
Interest expense 350
Operating profit before working capital changes 4,700
Increase in trade and other receivables (400)
Increase in inventories (500)
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Increase in trade payables 180
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Cash generated from operations 3,980
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Interest paid (450)
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Income taxes paid (600)
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Net cash from operating activities 2,930
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Cash flows from investing activities
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Purchase of property, plant and equipment (1,100)
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Proceeds from sale of equipment 220
t
Interest received 140
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Dividends received 200
F iNet cash used in investing activities

Cash flows from financing activities
(540)
Proceeds from issue of share capital 400

Proceeds from long-term borrowings 200
Dividends paid (1,000)
Net cash used in financing activities (400)
Net increase in cash and cash equivalents 1,990
Cash and cash equivalents at beginning of period (Note) 210
Cash and cash equivalents at end of period (Note) 2,200

CIMA BA3 16: Statements of cash flows 121
McClaren Notes to the Statement of cash flows for the year ended 31 December 2015
Cash and cash equivalents consist of cash on hand and balances with banks, and investments in money
market instruments. Cash and cash equivalents included in the statement of cash flows comprise the
following statement of financial position amounts:
31.12.15 31.12.14
$ $
Cash on hand and balances with banks 2,070 80
Short-term investments 130 130
Cash and cash equivalents 2,200 210
4 Preparing a statement of cash flows – indirect method

4.1 Cash flows from operating activities
A $ of profit is not a $ of cash. We have to adjust the profit figure for:
 Non-cash items, e.g. depreciation, profit/loss on disposal of non-current asset
 Items appearing elsewhere in the statement of cash flows, e.g. interest
4.1.1 Working capital changes
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If we make a sale on credit and a customer has not yet paid, we have less cash than sales would
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indicate. Similarly, if we don’t pay a supplier, we have more cash than purchases would indicate.
The same applies to inventory. If inventory increases, profit is unaffected, as closing inventory is
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deducted from COS. Cash decreases however as we have used it to buy the extra inventory.
ILLUSTRATION: STEVE
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In his first year of trading, Steve had the following transactions:
Sales
Purchases
017 $
100
70
$ $
Sales 100
Purchases 70
Closing inventory (10)
COS (60)
Operating profit 40
At the period end, Steve has $30 in cash (sales less purchases)
Statement of cash flows
$
Operating profit before working capital adjustments 40
Increase in inventory (10)
Net cash from operating activities 30
If there are receivables of $20 at the year-end, Steve will only have $10 in cash and his statement of
cash flows will look as follows:
$
Operating profit before working capital adjustments 40
Increase in receivables (20)
Increase in inventory (10)
Net cash from operating activities 10
Remember and learn the following treatment in the statement of cash flows:
INCREASE DECREASE
ASSETS (Inventories and receivables) - +
LIABILITIES (Payables) + -
4.1.2 Income taxes paid

You may be given a statement of profit or loss and this and last year’s statement of financial position.
Income tax paid will be the figure in the statement of profit or loss adjusted for opening and closing
income tax payables.
t
ILLUSTRATION: INCOME TAX
i g h 1 7
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2015 2014
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$ $
o
Income tax expense 100 –
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Income tax payable 70 60
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Income tax payable (liability)
I
$ $
r s t 1.1.15 B/f 60
i
Income tax expense 100
F
Cash paid (bal.fig.) 90
31.12.15 C/f 70
160 160
4.2 Cash flows from investing activities

Here we have cash flows for acquisition and disposal of non-current assets and investments and the
returns received from investments.
EXAM SMART
You may have four pieces of information about non-current assets in a statement of cash
flows.
 Depreciation These are adjusting items in arriving at “operating
 Profit/loss on sale profit before working capital changes”
 Cost of new assets These are included in “cash flows from

 Proceeds from sale of asset investing activities”
Note. If the examiner gives information about cost and accumulated depreciation, you may need
separate “non-current” asset and “accumulated depreciation” accounts. If you are given information
about carrying amounts, you will only need a “non-current asset at carrying amount” account.
LECTURE EXAMPLE 16.1: FIXED
The following balances were extracted from the books of Fixed:

2015 2014
$ $
Plant and equipment at cost 10,000 8,000
Accumulated depreciation (2,500) (1,500)
7,500 6,500
During the year an item of plant was sold for $1,000. This had originally cost $2,500 and had a carrying
amount of $1,400 at the date of sale.
Required:
Show the relevant extracts from the statement of cash flows.
STEPS
Co
Step 1: Consider the checklist. Have we been given:
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 Depreciation expense? X
 Profit or loss on sale? X
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 Additions? X
 Sale proceeds? √
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Step 2: Set up ledger accounts for asset at cost and accumulated depreciation to find the
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missing figures.
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Plant at cost
$ $
Accumulated depreciation
$ $
We can calculate the profit or loss on disposal as:

PROCEEDS – CARRYING AMOUNT =
Step 3: Show the relevant entries in the statement of cash flows.

$
Cash flow from operating activities
Net profit before taxation XXXX
Depreciation
Loss on sale
Operating profit before working capital changes YYYY
Cash flow from investing activities
Purchase of plant
Proceeds from sale of plant
4.3 Cash flows from financing activities

 Proceeds from share and loan issues
 Repayment of borrowings/shares
 Dividends paid
ILLUSTRATION: CARTER
The following balances were extracted from the books of Carter
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2015 2014
i g 1
$ $
y r 20
Share capital ($1 nominal value) 1,450 1,000
p ion
Share premium 900 300
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C uit
During the year there was a 1:5 bonus issue followed by an issue at full price. The bonus issue was
funded out of retained earnings.
I n t
Required: Calculate the cash raised from share issues during the year.
s t
This is best approached using a table rather than T accounts:
F ir
Brought forward
Share
capital
1,000
Share
premium
300
Bonus issue 200 – Debit entry is to retained earnings
Cash issue 250 600
Carried forward 1,450 900
The balancing entries for share capital and share premium are both credit entries, the debit entry is to
cash, i.e. the amount of cash raised is £850.
5 Proforma Statement of cash flows – direct method

Some businesses may use an alternative method of presentation.
McClaren Statement of cash flows for the year ended 31 December 2015 (extract)
$ $
Cash flows from operating activities
Cash receipts from customers 20,680
Cash paid to suppliers and employees (16,700)
Cash generated from operations 3,980
Interest paid (450)
Income taxes paid (600)
Net cash from operating activities 2,930
The figure for net cash from operating activities is the same as that calculated under the indirect
method. The format below net cash from operating activities is the same as that for the indirect
method.
Direct method is rarely used in practice as it requires disclosure of the additional information shown
above, but you need to be familiar with how you would arrive at a statement of cash flows using the
direct method.
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127
17
Interpretation of
financial statements
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1 Introduction
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Management and analysts use ratios to assess company performance. Ratios can highlight areas that
require further investigation. Useful if compared to:

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Prior periods (trends over several years more useful than just the previous year)
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 Budget
 Competitors
 Industry averages
Ratios are of little or no use if they are not used with comparatives.
Three major categories:
Profitability
 Gross profit margin How profitable is a company?
 Operating profit margin How well is a company run?
 Net profit margin What return can shareholders expect?
 Return on capital employed
 Asset turnover
Liquidity
How easily can a company meet its debts and
 Current ratio obligations?
 Quick ratio (acid test) How effectively does a company manage its
 Receivables collection period working capital?
 Payables payment period
 Inventory turnover
Risk
How much borrowing does a company have?
 Gearing Can it meet its interest payments?
 Interest cover
128 17: Interpretation of financial statements CIMA BA3
Ratios are calculated using figures in the company’s statement of profit or loss and statement of
financial position. You will need to learn the formulas on the following pages and be able to make an
appropriate comment based on the results. You may be asked to identify reasons for changes in
accounting ratios.
The term working capital means a company’s net current assets, i.e. inventories, receivables less
payables. Generally a business is said to “manage” its working capital if it maximises cash generation
from these items, i.e. with shorter payment periods for receivables, and quick turnaround of
inventory.
We use “efficiency ratios” such as inventory turnover and trade receivables collection period to
measure how well a business manages its working capital.
We will illustrate each of these ratios using the example financial statements below. You may be
required to calculate basic ratios or explain the importance of ratios. Later in your studies you will use
ratios to interpret financial statements and analyse company performance.
ABC Statement of profit or loss for the year ended 31 December 2015
2015 2014
$ $
Revenue 10,000 7,700
Cost of sales (4,500) (4,000)
Gross profit 5,500 3,700
Other income 300 250
t
Distribution costs (1,000) (900)
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Administrative expenses (400) (390)
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Other expenses (150) (160)
y 2
Finance cost (80) (20)
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Profit before tax 4,170 2,480
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C uit
Income tax expense
Net profit for the period
(1,500)
2,670
(1,000)
1,480
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F i
CIMA BA3 17: Interpretation of financial statements 129
ABC Statement of financial position at 31 December 2015

2015 2014
$ $
ASSETS
Non-current assets
Property, plant and equipment 6,850 4,500
Current assets
Inventories 600 500
Trade and other receivables 400 320
Other current assets 100 80
Cash and cash equivalents 200 240
1,300 1,140
Total assets 8,150 5,640
EQUITY and LIABILITIES

Capital and reserves $ $
Share capital 1,000 700
Share Premium 200 0
General reserve 300 300
Retained profits 3,900 2,430
5,400 3,430
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Loans 500 125
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Current liabilities
Trade and other payables 700 715
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Accruals 50 70
Income tax payables 1,500 1,300
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2,250 2,085
Total equity and liabilities 8,150 5,640
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2 Profitability ratios
Gross profit
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Gross profit margin =
Revenue
2015 2014
5,500 3,700
= 55% = 48%
10,000 7,700
 Used to make pricing decisions – increased selling price relative to direct costs will result in
increased gross profit margin
 Falling margin may be due to increased costs or reduced prices to buy market share.
 Check that accounting policies are consistent
Operating profit (before interest and tax)

Operating profit margin =
Revenue
 Note: you need to be careful when calculating profit before interest and tax (PBIT). Most
statements of profit or loss only give profit before tax so you will need to add back the interest
charge.
2015 2014
4,250 2,500
= 42.5% = 32.5%
10,000 7,700
Net profit (before tax)

Net profit margin =
Revenue
2015 2014
4,170 2,480
= 42% = 32%
10,000 7,700
 Both these ratios can reflect how efficiently a business is being run, i.e. through controlled
overheads or economies of scale
Revenue
Asset turnover =
Total assets less current liabilities
Note: Total assets less current liabilities (TALCL) is the same as shareholders’ funds (share capital +
reserves) plus non-current liabilities.
t
2015 2014
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10,000 7,700
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= 1.69 = 2.17
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(8,150 – 2,250) (5,640 – 2,085)

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Measures how much sales revenue is generated for every $ of net assets employed
o
 When were new assets acquired?
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 What are new assets used for?
t
 Are they working efficiently and or have they improved performance?
I n
This ratio can also be calculated using non-current assets only (rather than net assets).
t
ir s Revenue
F
Non-current asset turnover =
Non-current assets
2015 2014
10,000 7,700
= 1.45 = 1.71
6,850 4,500
 Measures how much sales revenue is generated for every $ of non-current assets employed
Profit before interest and tax

Return on capital employed (ROCE) =
Total assets less current liabilities
2015 2014
4,250 2,500
= 72% = 70%
(8,150−2,250) (5,640−2,085)
 Measures how much profit is generated for every $ of assets employed

 Indicates how efficiently the company uses its assets
 Different industries will have different benchmark rates as some businesses such as
manufacturers will be more capital intensive than others such as service businesses.
Note: ROCE is sometimes calculated using average capital employed for the period. Read the question
carefully.
ROCE is the only ratio which compared profits to the overall size of the business and is sometimes
called the primary ratio in ratio analysis.
ROCE = Operating Profit margin × Net Asset turnover
3 Liquidity and efficiency ratios

The term liquid means “readily convertible into cash”. Certain assets are more readily convertible into
cash, e.g.
Cash and bank deposits – is already cash!
Reducing
liquidity
Receivables – require a customer to pay to turn into cash

Inventory – must sell goods and then receive cash from the customer
Working capital is defined as current assets – current liabilities
Current assets
Co
Current ratio =
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Current liabilities
2015
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1,300 1,140
= 0.58 = 0.55
2,250 2,085

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Measures how easily a company can meet its current obligations

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Less than 1 means CL > CA and could be a cause for concern, e.g. how will company pay tax and
017
dividend?
 “Correct” level depends on the industry:
– Too high indicates too much cash tied up in working capital
– Too low and we cannot meet obligations as they fall due
Current assets – Inventory

Quick ratio =
Current liabilities
2015 2014
700 640
= 0.31 = 0.31
2,250 2,085
 In times of crisis, businesses struggle to sell inventory quickly

 Quick ratio (or acid test) sometimes seen as better test of liquidity
Trade receivables
Receivables collection period = × 365
Credit sales
2015 2014
400 320
× 365 = 14.6 days × 365 = 15.2 days
10,000 7,700
 Shows how quickly customers settle their debts

 Depends on credit policy
 Competitors/ Industry average?
Note: Calculation should use average receivables, but if current and previous year end figures are
similar then year end figures can be used as an approximation.
Trade payables
Payables payment period = × 365
Credit purchases (or COS)
2015 2014
700 715
× 365 = 56.8 days × 365 = 65.2 days
4,500 4,000
 Shows how quickly a business pays its suppliers

 What terms are available?
 Is the business struggling to pay suppliers?
 Preferable to use “credit purchases” as the denominator but OK to use “COS” if this isn’t
available. Read the question carefully.
Inventories
Inventory days = × 365
COS
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2015 2014
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600 500
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× 365 = 48.7 days × 365 = 45.6 days
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4,500 4,000
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Shows how long a business takes to sell its inventory
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 Ideal inventory holding depends on nature of inventory (e.g.perishable foods v stationery).
 No business wants too much inventory

I n t
Risk of obsolete inventory.
t
You may be asked for the rate of inventory turnover, which is:
ir s COS
F
Inventories
In the above example this would be 4,500/600 = 7.5 times, i.e. the company would ‘turn over’ its
inventory 7.5 times in 2015.
3.1 The operating, or cash, cycle

This is the total time taken from purchase of raw materials to collection of cash. It can be measured as:
Inventory days x
Plus Receivables days x
Less Payables days (x)
Operating cycle days x
EXAM SMART
Use a timeline!
Buy goods Pay for goods Sell goods Customer pays
Payment days Receivables days

Inventory days
INVENTORY CASH OUT RECEIVABLES CASH IN
4 Risk
Companies may be financed by equity or borrowings, or a mixture of both. Analysts need to know
how a company is financed and whether it can meet its interest repayments.
High gearing means there is a high proportion of borrowing (loans)
Low gearing means there is a high proportion of equity (shares)
Generally, the higher the level of gearing (i.e. debt) the more risky a company is (because loans attract
a fixed rate of return and may have specified repayment dates).
Interest bearing debt (excl. overdraft, incl Pref shares)

Gearing ratio =
TALCL (SF + NC liabilities)
2015 2014
500 125
= 8.5% = 3.5%
5,400+500 3,430+125
 Low levels signifies low risk

 No ideal, depends on industry standards and economic situation in particular countries
Advantages of gearing Disadvantages of gearing
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Debt cheaper than equity Harder to raise extra finance
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 interest is fixed whilst profits grow in  lenders unlikely to advance more funds if
times of inflation or economic growth) loans already exist
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 interest is tax deductible  shareholders may not wish to buy shares
as more risky (dividends paid after
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interest)
Interest cover =
Profit before interest and tax
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Interest/finance costs
2015 2014
4,250 2,500
= 53 times = 125 times
80 20
This ratio shows how many times the interest expense can be covered by profits. In simple terms, the
higher this figure is, the easier the company will find it to pay its interest expense.
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18
Manufacturing accounts
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1 Introduction
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Remember the formula for calculating cost of sales is:
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COST OF SALES = OPENING INVENTORY + PURCHASES – CLOSING INVENTORY
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This is fine for a business that simply buys and resells goods.
However, when a company manufactures goods, there may be different raw materials that are
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purchased and processed to produce finished goods. In these cases, the figure that replaces
“purchases” in the above equation is “cost of finished goods produced”.
We use manufacturing accounts to calculate the cost of producing finished goods. They are prepared
for management purposes only and are not for publication.
1.1 Definitions
KEY TERMS
 Direct factory cost – increases with each unit of production, e.g. piecework wages.
 Prime cost (direct costs) – total cost of direct material, direct labour and direct
expenses (i.e. raw materials plus direct factory cost)
 Production overheads (indirect costs) – do not vary with production, e.g. supervisor’s
salary, business rates, light, heat and power.
 Factory cost of production – prime cost plus production overheads (i.e. total direct and
indirect costs)
 Factory cost of finished goods – factory cost of production adjusted for changes in
work in progress.
136 19: Manufacturing accounts CIMA BA3
1.2 Work in progress

At the end of the accounting period there may be some goods in the production process that are not
yet finished. This is known as “work in progress” (or WIP). The change in value of WIP is adjusted in
arriving at cost of finished goods.
2 Layout of manufacturing accounts

If you can learn the proforma layout of manufacturing accounts you should be able to tackle most
exam questions on this topic.
Proforma manufacturing account for the month ended 31 December 2015
$ $
Raw materials
Purchases 480
530
Less: closing inventory (60)
Raw materials used in production 470
Direct factory costs: factory wages 3,000
Prime cost 3,470
t
Indirect factory expenses
g h 7
Salaries 1,100
Depreciation
y r i
Light, heat and power
201 80
45
p ion
Business rates 200
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Sundry expenses 125
1,550
t
Factory cost of production 5,020
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Work-in-progress
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Opening balance 125
F i
Closing balance (80)
45
Factory cost of finished goods produced 5,065
Statement of profit or loss (extract)

$ $
Sales 7,000
Opening inventory of finished goods 280
Factory cost of finished goods transferred 5,065
5,345
Closing inventory of finished goods (345)
(5,000)
Gross profit 2,000
CIMA BA3 19: Manufacturing accounts 137
LECTURE EXAMPLE 18.1 – GERRARDS WELLS
Gerrards Wells had the following transactions in 2010:

$
Inventory 1 January 2010:
Raw materials 500
Work-in-progress 240
Finished goods 800
Purchases 4,000
Direct wages 10,000
Salaries 3,500
Light, heat and power 1,000
Selling costs 400
Depreciation:
Factory 1,000
Warehouse 450
Sales 22,000
Following a year-end count, inventory at 31 December 2010 was:
$
Raw materials 850
Work-in-progress 300
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Finished goods 350
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The salaries figure includes $500 for the factory manager, $2,000 for administrative staff and $1,000
for the sales team.
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Calculate the following:
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 Prime cost
 Factory cost of production
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 Factory cost of finished goods produced
EXAM SMART
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Use the proforma layout and bear in mind that some figures may not be relevant.
SOLUTION
138 19: Manufacturing accounts CIMA BA3
The business profits will then be calculated producing a basic statement of profit or loss using the
factory cost of finished goods produced in the cost of sales calculation.
Gerrards Wells – Statement of profit or loss for the year-ended 31 December 2010
$ $
Sales 22,000
Factory cost of finished goods produced
Closing inventory of finished goods (350)
Gross profit
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Distribution costs (1000 + 400 + 450) (1,850)
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Net profit for the year
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Solutions to
Lecture examples
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Chapter 4
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Lecture example 4.1
017
Complete the debit and credit entries in the table below for the following transactions (and
understand them!).

1 Owner puts Asset (cash) Capital Cash $100 Capital $100
$100 into increases increases
business
2 Business buys Purchases (an An asset (cash) Purchases $15 Cash $15
goods for $15 expense) decreases
cash increases
3 Business buys Purchases (an A liability Purchases Payables
goods for $40 expense) (payables) $40 $40
on credit increase increases
4 Sell goods for Asset (cash) Income (sales) Cash $270 Sales $270
$270 cash increases increases
5 Sell goods for Asset Income (sales) Receivables $350 Sales $350
$350 on credit (receivables) increases
increases
6 Buy machinery Asset (non- Liability Non-current Payables $200
on credit for current) (payables) assets $200
$200 increases increases
7 Pay wages $25 Expense Cash decreases Wages $25 Cash $25
increases
140 S o l u t i o n s t o L e c t u r e e xa m p l e s CIMA BA3

8 Pay rent $50 Expense Cash decreases Rent $50 Cash $50
increases
9 Pay trade Liability Asset (cash) Payables $40 Cash $40
payable $40 (payables) decreases
decreases
10 Credit Asset (cash) Asset Cash $300 Receivables
customer pays increases (receivables) $300
us $300 decreases
Lecture example 4.2

Write up the ledger accounts for the transactions listed from Lecture Example 4.1 above.
Cash
1 Capital 100 2 Purchases 15
4 Sales 270 7 Wages 25
10 Receivables 300 8 Rent 50
9 Payables 40
Capital
ht
1 Cash 100
r i g 01 7
y 2
Purchases
No
o p ion Narrative $ No Narrative $
C uit
2 Cash 15
3 Payables 40
I n t
s t
Payables
ir
F
9 Cash 40 3 Purchases 40
6 Machinery 200
Sales
4 Cash 270
5 Receivables 350
Receivables
5 Sales 350 10 Cash 300
Machinery
6 Payables 200
CIMA BA3 So l u t i o n s t o L e c t u r e e xa m p l e s 141
Wages
7 Cash 25
Rent
8 Cash 50
Lecture example 4.3

Write up the T-accounts and calculate the balance on each account at 31 December 2016.
Receivables
1 Sales 100 5 Cash received 100
2 Sales 150 6 Cash received 80
3 Sales 180
Balance c/f 250
430 430
Balance b/f 250
Fir Cop
Sales
st I yri
1 Receivables 100
2 Receivables 150
ntu ght
3 Receivables 180
Balance c/f 430
itio
430 430
n2
Balance b/f 430
017
Cash
5 Receivables 100
6 Receivables 80
Balance c/f 180
180 180
Balance b/f 180
Lecture example 4.4

(1) Write up the debit and credit entries for the following transactions

$ $
1 Sale of goods on credit for $1,500 Receivables $1,500 Sales $1,500
2 Purchase of office furniture on credit for $5,000 Furniture asset Payables

$5,000 $5,000
3 Payment of salaries $1,200 Salaries expense Cash $1,200
$1,200
4 Receipt from customer $1,000 Cash $1,000 Receivables
$1,000
5 Top up petty cash float $100 Petty cash $100 Cash $100
6 Cash sale $250 Cash $250 Sales $250
7 Purchase of goods on credit $1,300 Purchases $1,300 Payables

$1,300
8 Payment to supplier $800 Payables $800 Cash $800
ht 7
Return of faulty goods to supplier $400 Payables $400 Purchases
r i g 201
$400
y
p ion
10 Return of goods by unhappy customer $300 Sales $300 Receivables
o
$300
C uit
11 Purchase of goods for cash $150 Purchases $150 Cash $150
12
I n t Payment of telephone bill $50 Telephone expense Cash $50
t
$50
ir s
13 Sale of goods on credit $750 Receivables $750 Sales $750
F 14
15
Payment of rent $6,000
Purchase office stationery on credit $120

Rent expense
$6,000
Stationery expense
Cash $6,000
Payables $120
$120
16 Bank interest received $75 Cash $75 Interest
income $75
17 Remittance received from customer $330 Cash $330 Receivables
$330
18 Purchase replacement goods on credit $400 Purchases $400 Payables $400
19 Purchase computer equipment on credit $3,000 Computer Payables

equipment asset $3,000
$3,000
20 Refund customer $100 Receivables $100 Cash $100
(2) Write up the ledger “T” accounts for the following and show amounts carried forward.
 Sales
 Receivables
 Purchases
 Payables
 Cash
Sales
10. Receivables (returns) 300 1. Receivables 1,500
6. Cash 250
13. Receivables 750
Balance carried forward 2,200
2,500 2,500
Balance brought forward 2,200
Receivables
1. Sales 1,500 4. Cash 1,000
13. Sales 750 10. Sales (returns) 300
20. Cash (refund) 100 17. Cash 330
Balance carried forward 720
2,350 2,350
Balance brought forward
Fir
720
Co
st I pyri
Purchases
ntu ght
7. Payables 1,300 9. Payables (returns) 400
itio
11. Cash 150
18. Payables 400
n2
Balance carried forward 1,450
1,850 1,850
017
Payables
8. Cash 800 2. Office furniture 5,000
9. Purchases (returns) 400 7. Purchases 1,300
15. Office stationery 120
18. Purchases 400
Balance carried forward 8,620 19. Computer equipment 3,000
9,820 9,820
Cash
4. Receivables 1,000 3. Salaries 1,200
6. Sales 250 5. Petty cash 100
16. Bank interest 75 8. Payables 800
17. Receivables 330 11. Purchases 150
12. Telephone expense 50
14. Rent 6,000
Balance carried forward 6,745 20. Customer refund 100
8,400 8,400
(OVERDRAFT)
Chapter 5
Homework exercise 5.1
Step 1: Write up the double entry for each of the transactions
DEBIT $ CREDIT $
Cash 5,000 Capital 5,000
(a) Non-current assets 1,800 Cash 1,800
(b) Purchases 2,000 Cash 2,000
(c) Cash 1,500 Sales 1,500
(d) Drawings 200 Cash 200
(e) Cash 500 Loan (liability) 500
(f) Receivables 1,600 Sales 1,600
(g) Rent 1,000 Payables 1,000
Step 2: Write up the entries in the nominal ledger accounts
Step 3: Close the accounts and calculate the balances
Capital
Cash – Jane 5,000
t
Balance c/f 5,000
h 7
5,000 5,000
r i g 201
y
Cash
p ion
o
Capital - Jane 5,000 a) Non-current assets 1,800
C uit
c) Sales 1,500 b) Purchases 2,000
t
e) Loan 500 d) Drawings 200
I n
Balance c/f 3,000
t
7,000 7,000
ir s
F
Non-current assets
a) Cash 1,800
Balance c/f 1,800
1,800 1,800
Purchases
b) Cash 2,000
Balance c/f 2,000
2,000 2,000
Sales
c) Cash 1,500
f) Receivables 1,600
Balance c/f 3,100
3,100 3,100
Drawings
d) Cash 200
Balance c/f 200
200 200
Loan
e) Cash 500
Balance c/f 500
500 500
Receivables
f) Sales 1,600
Balance c/f 1,600
1,600 1,600
Rent
g) Payables 1,000
Balance c/f 1,000
Fir Co
1,000 1,000
st I pyri
Payables
ntu ght
g) Rent 1,000
Balance c/f 1,000
1,000
itio 1,000
n2
Step 4: Transfer the balances to a trial balance
017
Debit Credit
$ $
Capital 5,000
Non-current assets 1,800 A
Cash 3,000 A
Purchases 2,000
Sales 3,100
Drawings 200
Loan 500 L
Receivables 1,600 A
Rent 1,000
Payables 1,000 L
9,600 9,600
Step 5: Identify which items are assets and which items are liabilities
See A and L above
Step 6: Complete the accounting equation – capital will be the balancing figure
Assets = Capital + Liabilities
1,800 + 3,000 + 1,600 ? 500 + 1,000
Therefore capital = 4,900
Note: This can be proved as follows:
Capital 5,000
Less: drawings (200)
Plus: profit * 100
4,900
* Profit is calculated as sales less all expenses: 3,100 – 2,000 – 1,000 = 100
Chapter 6
Lecture example 6.1
Purchase Payment
Dr Purchases $8,000 Dr Payables $8,000
Cr Payables $8,000 Cash $7,600
ht
Discount rec’d $400
i g 01 7
Purchase amount $10,000 less 20% trade discount – settlement discount ignored
r
y 2
Settlement discount calculated as 5% × $8,000
o p ion
Lecture example 6.2
C uit
t
Clive earns $9 per hour as a cleaner. Earnings of more than $100 per week are taxed at 20%.
I n
Employee’s SS is 8% and Employer’s SS is 11%. During week 42 Clive works 39 hours.
r s t
Calculate Clive’s net pay and the cost to his employer.
i
Cost to
F
Net pay employer
Gross wages (39 × $9) 351.00 351.00
Tax (($351 – £100) × 20%) (50.20)
Employee’s SS ($351 × 8%) (28.08)
Employer’s SS ($351 × 11%) 38.61
272.72 389.61
Chapter 7
Lecture example 7.1
$ $
1 Oct Balance b/f 27,820
Contra 450 Purchases daybook 10,300
Returns 220 Cash from debit balance 740
Discounts received 125
Cash paid 8,700
31 Oct Balance c/f 29,365
38,860 38,860

$ $
1 Oct Balance b/f 37,455
Sales daybook 14,800 Contra 450
Credit note 80
Irrecoverable debt 50
Discounts allowed 270
Co
Cash received 16,100
Fir
31 Oct Balance c/f 35,305
st I pyri
52,255 52,255
Lecture example 7.2

ntu ght
itio
$ $
n2
30 Sep Balance b/f 27,843
Discounts received (3) 1,237 Discount allowed (2) 375
Purchases overcast (5)
Returns outwards (6)
Credit note (8)
2,000
3,500
750
017
Transposition error (4) 396
Corrected balance c/f 21,127

28,614 28,614
Reconciliation of list of balances to the control account

$
Balance per question 23,416
Contra on wrong side of account (1) (900)
Discount received omitted (3) (1,237)
Misposting in purchases daybook (4) 396
Balance omission (7) 252
Debit balance on wrong side (9) (800)
Corrected balance c/f 21,127
Chapter 8
Lecture example 8.1
Insurance expense
$ $
1.7.15 Reversal of b/f prepayment 900
Insurance to 31.12.16 2,000 30.6.16 Statement of profit or loss 1,900
(bal)
30.6.16 Prepayment calc (6/12 ×
$2,000 premium paid) 1,000
2,900 2,900
Gas expense
$ $
1.7.16 Reversal of b/f accrual 75
4.9.15 Invoice : Gas to 31.8.15 320
Invoice : Gas to 30.11.15 380
Accrual calc (1/3 × $330) 110
30.6.16 Statement of profit or loss 1,475
ht
(bal)
r i g 01 7 1,550 1,550
y
p ion
Lecture example 8.2
2
o
C uit
Rental income
$ $
30/6/16
I n t Property A b/f 8,000 30/6/16 Property B b/f 24,000
t
Statement of profit or 154,000 Cash – Property A 42,000
s
loss (bal fig)
ir
Cash – Property B 128,000
F
30/6/17 Property A c/f 2,000
30/6/17 Property B c/f 30,000
194,000 194,000
Property A
$ $
30/6/16 b/f debit 8,000 30/6/16 REVERSAL of b/f debit 8,000
30/6/17 Property A c/f credit 2,000 Calc’n (bal) 2,000

10,000 10,000
Property B
$ $
30/6/16 REVERSAL of b/f 24,000 30/6/16 b/f credit balance 24,000
30/6/17 c/f credit (given) 30,000 Calc’n (bal) 30,000

194,000 194,000
Chapter 9
Lecture example 9.1
$ $
1.7.15 Balance b/f 285,326 Cash received 343,228
Sales on credit 385,250 Bad debt written off 10,880
Balance c/f 316,468
670,576 670,576
Bad and doubtful receivable expense

$ $
Cash from debt previously
Bad debt written off 10,880 written off 10,000
Specific allowance 15,440 Statement of profit or loss
General allowance (W) 6,021 (bal.fig.) 22,341
32,341 32,341
Allowance for doubtful receivables

$ $
Fir Co
1.7.15 Balance b/f 0
st I pyri
Specific allowance 15,440
Balance c/f (SFP) 21,461 General allowance (W) 6,021
21,461 21,461
Working - General allowance

ntu ght
itio
$
Year end receivable balance after debt write off 316,468
n2
Less: receivables specifically provided against (15,440)
017
Balance against which general allowance is needed 301,028
General allowance is 2% × $301,028 6,021

Statement of financial position: current assets
$
Adjusted receivables 316,468
Less: allowance for receivables (21,461)
Balance shown in the statement of financial position 295,007
Lecture example 9.2

Stmt of Statement
Financial of Profit
Position or Loss
STEP 1 Calculate adjusted receivables after write off. $91,000 $3,000
($94,000 – $3,000)
STEP 2 Calculate specific allowance ($1,500) $1,500
($800 + $700)
STEP 3 Calculate general allowance as % of adjusted receivables
(5% × ($91,000 – $1,500)) ($4,475)
STEP 4 Deduct opening allowance figure to find increase or

decrease in general allowance = charge to statement of
profit or loss. $475
($4,475 – $4,000)
$85,025 $4,975
Net trade Expense in

receivables P/L
Chapter 10
ht 7
i g
Lecture example 10.1
r 201
(a)
y
p ion
FIFO
o
C uit Opening inventory
Units
100
Cost $
10
Total $
1,000
t
Sale 1 (80) 10 (800)
I n
20 10 200
s t
Purchase 140 12 1,680
ir
160 1,880
F
Sale 2 (150) 20@10 (200)
130@12 (1,560)
Closing inventory 10 12 120
Profit high, closing inventory high

(b) LIFO
Sale 1 (80) 10 (800)
20 10 200
Purchase 140 12 1,680
160 1,880
Sale 2 (150) 140@12 (1,680)
10@10 (100)
Closing inventory 10 100
Profit low, closing inventory low

(c) WAC
Sale 1 (80) 10 (800)
20 10 200
Purchase 140 12 1,680
160 1,880
Sale 2 (150) 150/160 ×
1,880 (1,762)
Closing inventory 10 118
Profit middling, closing inventory middling
Chapter 11
Straight line method
Cost 30 June 2014 $50,000
Co
Less: disposal (Cost) $16,000
Fir
Cost 30 June 2015 $34,000
st I pyri
Depreciation 25% × $34,000 = $8,500
ntu ght
Reducing balance method
itio
Carrying amount b/f ($50,000 – $24,000) $26,000
Less: disposal (carrying amount) $8,000
n2
Carrying amount c/f $18,000
017
Depreciation 25% × $18,000 = $4,500

The answer cannot be (a) as this would result in $5,000 being added to the non-current asset register total.
The answer cannot be (b) because this would reduce the nominal ledger total by $5,000.
Answer (c) would mean the carrying amount of the server was $15,000 (remember the formula:
proceeds – carrying amount = profit/(loss) on disposal). So this is not the correct answer.
The correct answer is (d) as this item has a carrying amount of $5,000 and would mean that the non-
current asset register balance is higher than the nominal ledger.
Chapter 12
Step 1: Calculate the adjusted cash book balance as at 30 June
Cashbook
(c) Transposition error 18 Balance b/f 2,020

(g) Posting error 950 (a) Bank charges 25
(d) Direct debit 123
(f) Dishonoured cheque 250
Adjusted balance c/f 1,450
2,418 2,418
Note : this is a credit balance = overdraft

Step 2: Perform the bank reconciliation to calculate the bank statement balance
$
Bank statement balance (= balance) 140
less : unpresented cheque (1,800)
t
plus : uncleared lodgement 210
i g h 1 7
0
Balance per adjusted cash book
r
(1,450)
y
p ion 2
o
C uit
Balance per bank statement (1,000)
t
Add: Uncleared lodgements 500
I n
Less: Unpresented cheques (1,300)
t
Adjusted / correct cash book figure (1,800)
ir sEFT 100
F
Bank charges 50
Dishonoured cheque 80
Uncorrected cash book figure (1,570)
Alternative working:
Cashbook
Balance b/f BAL 1,570

EFT 100
Bank charges 50
Dishonoured cheque 80
Adjusted balance c/f 1,800
1,800 1,800
Start here: Correct cashbook figure (note that this is a credit balance/overdraft)
Therefore, uncorrected cashbook figure (i.e. original b/f) = 1,570
Chapter 13
Which of the following errors would be detected by preparing a trial balance?
(a) Total discounts received column in the YES Discounts received will have been debited
cashbook was not posted to the to payables but not posted to the discounts
discounts received ledger account. received account, so debits do not equal
credits.
(b) The last day’s credit sales had been NO If items not recorded in the sales daybook
excluded from the sales daybook. then no double entry will be made, i.e.
missing debit and credits.
(c) Discounts allowed were credited to the NO There is a matching debit and credit, but the
payables ledger control account. credit is to the wrong account.

Suspense account
$ $
Co
STEP 1 Opening balance 2,800
Fir
(a) Sales invoice 1,500
st I pyri
(b) Cheque received 540
(c) Discounts received (2 × $630) 1,260
ntu ght
(d) Electricity expense 500
3,300 3,300
Profit adjustment:
itio
n2 $
017
(a) Sales invoice (credit to sales in the statement of profit or loss) 1,500
(c) Discounts received (credit to discounts received in statement of profit or loss and
credit discounts allowed in statement of profit or loss) 1,260
(d) Electricity expense (debit electricity expense in statement of profit or loss) (500)
(e) Plant repairs (debit repair expense in statement of profit or loss) (4,000)
(f) Plant repairs (credit depreciation expense in statement of profit or loss to reverse 1,000
out the depreciation charge made)
Total reduction in profit (740)
Homework exercise 13.3

Complete the double entry required to correct the following errors.
No Error Correcting Debit Correcting Credit

Account $ Account $
1 Telephone expense of $65 posted to Telephone 65 Rent expense 65
rent expense account. expense
2 Sales invoice of $1,500 posted to Receivables 1,350 Suspense 1,350
customer account as $150. control
3 Cash received from a previously written Suspense 45 Irrecoverable 45
off debt of $45, debited to cash but debts expense
other side of entry unknown.
4 Doubtful debt of $80 credited to Payables 80 Allowance for 80
payables. receivables
5 Factory machine purchased for $2,000 Plant & 2,000 Plant repairs 2,000
debited to plant repairs. machinery (SFP)
6 Purchase invoice $750 recorded in Suspense 180 Payables 180
payables ledger as $570.
7 Depreciation expense $1,500 credited Depreciation 3,000 Suspense 3,000
t
to depreciation expense. expense
8
g h 1 7
Cash received from customer $500
i
Payables 500 Receivables 500
r 0
credited to payables ledger.
9
y
p ion 2
Motor vehicle service invoice $400 Motor vehicle 400 Motor 400
o
posted to motor vehicle asset account. repairs vehicle asset
10
C uit
Discount allowed of $75 credited to Discount 75 Suspense 150
t
discounts received account. allowed
I n
Discount 75
t
received
ir s
F
Now, for each of the errors above, identify the type of error and state the impact on the financial
statements (net assets and profit). Again the first one has been completed as an example.
No Type of error Impact on financial statements $

1 Error of commission None – misclassified expense 0
2 Error of original entry 1 Assets (receivables in SFP) understated 1,350
3 One sided entry Profit (statement of profit or loss) 45

understated
4 Error of commission None – misclassification in the SFP 0
5 Error of principle Profit understated (expense overstated) 2,000
6 Transposition error Liabilities (payables) understated 180
7 Error of original entry 2 Profit overstated (depreciation expense 3,000

understated)
8 Error of commission None – misclassification in the SFP 0
9 Error of principle Profit overstated (repair expense 400

understated)
10 Error of original entry and commission Profit overstated (expense understated) 150
Chapter 14
Step 1: Calculate cost of sales
$
Purchases 3,500
Closing inventory (600)
COS 3,700
Quick Calculation: COS is purchases less increase/(plus decrease) in inventory

Steps 2: Calculate sales and gross profit
% $
Sales 100 5,285 Work out the percentages then fill
COS (from above) 70 3,700 in COS figure from above to
Gross profit 30 1,585 calculate sales and profit.
Illustration: Mark
Fir Co
Trade receivables
st I pyri
$ $
1.1.15 Balance b/f 1,095
Cash receipts 400
Sales (bal.fig.) 5,285

ntu ght Bank receipts 5,130
itio Balance c/f 850
n2
6,380 6,380

(1) Purchases 017
Trade payables
$ $
1.1.15 B/f 1,000
Payments 25,000
Purchases (Bal.fig.) 24,800
31.12.15 C/f 800
25,800 25,800
(2) Cost of sales

$
Opening inventory 2,000
Purchases 24,800
Less : closing inventory (2,400)
Therefore COS : 24,400
(3) Sales
The mark up is 25%, therefore we make COS equal to 100%
% $
Sales 125 30,500
COS 100 24,400
Gross profit 25 6,100
(4) Cash received from customers

Trade receivables
$ $
1.1.15 B/f 1,200
Sales 30,500
Cash received (bal.fig.) 30,400
31.12.15 C/f 1,300
31,700 31,700
(5) Cash stolen

Cash
$ $
1.1.15 B/f 150
Cash received from 30,400 Expenses 2,500
t
customers (from
h 7
receivables account)
i g 1
Wages 4,000
y r 20
Cash banked 17,500
p ion
Cash stolen (bal.fig) 6,550
o
30,550 30,550
C uit
t
t I n
Net assets at 1 Oct 2015 ($12,000 + $2,000 + $5,000) $19,000
r s
Drawings ($12,000)
F i Profit (balancing figure)

Net assets at 30 Sep 2016 ($18,000 – $4,200 + $9,800 + $3,900 – $700)
$19,800
$26,800
Chapter 15
By how much has Sox’s retained earnings reserve increased for the year ended 31 March 2010?
$
Profit after tax ($80,000 - $9,000) 71,000
Transfer to general reserve (10,000)
Dividend paid in year (12,000)
49,000
Chapter 16
Show the relevant extracts from the statement of cash flows.
Plant at cost
$ $
1.1.15 B/f 8,000
Disposal at cost 2,500
Additions (bal.fig) 4,500
31.12.15 C/f 10,000
12,500 12,500
Accumulated depreciation
$ $
1.1.15 B/f 1,500
Disposal accum. dep’n 1,100
Dep’n expense (bal.fig) 2,100
C/f 2,500
3,600 3,600
Fir Co
We can calculate the profit or loss on disposal as:
st I pyri
PROCEEDS $1,000 – CARRYING AMOUNT $1,400 = LOSS – $400.
Extract from Statement of Cash Flows
ntu ght
$
Cash flow from operating activities
itio
Net profit before taxation XXXX
n2
Depreciation 2,100
Loss on sale 400
017
Operating profit before working capital changes YYYY
Cash flow from investing activities

Purchase of plant (4,500)
Proceeds from sale of plant 1,000
Chapter 18
Gerrards Wells - Manufacturing account for the year-ended 31 December 2010
$ $
Raw materials
Purchases 4,000
Less: closing inventory (850)
Raw materials used in production 3,650
Factory wages 10,000
Prime cost 13,650
Indirect factory expenses
Salaries 500
Depreciation 1,000
Light, heat and power 1,000
2,500
Factory cost of production 16,150
Work-in-progress
Opening balance 240
t
Closing balance (300)
g h 1 7
(60)
r i 0
y
p ion 2
o
C uit
Gerrards Wells – Statement of profit or less for the year-ended 31 December 2010
$ $
Sales
I n t 22,000
t
s
F ir Closing inventory of finished goods

16,890
(350)
(16,540)
Gross profit 5,460
Distribution costs (1000 + 400 + 450) (1,850)
Net profit for the year 1,610
CIMA BA3 Ap p e n d i x: S u m m a r y o f d e b i t s a n d c r e d i t s 159
Appendix
DEBITS CREDITS
EXPENSES INCOME Statement of profit or loss
Purchases Sales Revenue X
Returns inwards Discounts received Cost of sales* (X)
Carriage inwards Interest received Gross profit X
Carriage outwards Profit on disposal of non- Distribution costs (X)
Administrative expenses X
STATEMENT OF PROFIT OR LOSS
Discounts allowed current assets

Wages and salaries Other income (X)
Staff entertaining / travel Net profit X
Rent / Rates
Other credit entries in
Electricity * Cost of sales = opening
statement of profit or loss
Telephone inventory + purchases –
(tend to be netted off income
Repairs and maintenance closing inventory
or purchases) include:
Depreciation
Loss on disposal of non- All expenses will fall under
current assets  Returns outwards
one of the above headings.
Bad and doubtful debts Retained profit is transferred
Advertising and marketing
Co
to retained earnings in the
Fir
Client entertaining SFP at year end.
st I pyri
Legal / professional fees
Insurance
ntu ght
Interest paid
ASSETS LIABILITIES Statement of Financial
itio
Non-current assets: Payables Position
 Goodwill Accruals
n2
 Land & buildings Taxes payable Non-current assets X
 Motor vehicles
017
Dividend payable
 Plant & equipment Bank overdraft Current assets:
 Computer equipment Loans Inventories X
 Fixtures & fittings Provisions Receivables X
STATEMENT OF FINANCIAL POSITION
Receivables Bank and cash X

Prepayments X
Other credit entries in
Accrued income Statement of Financial
Inventories Total assets Z
Position, tend to be netted off
Bank and cash the relevant asset include:
Petty cash Capital and reserves:
 Allowance for depreciation Capital X
 Allowance for doubtful debts Retained earnings X
X
Non-current liabilities:
Bank loan X
DRAWINGS CAPITAL and RESERVES Current liabilities:

Note: Drawings only appear Note: Company accounts may Trade payables X
in the accounts of sole include: Other payables X
traders and partnerships. X
 Share capital
 Share premium
Total capital and liabilities Z
Dividends are a debit in the  Retained earnings
SFP of companies.  Revaluation reserve
Total assets = capital +
 Other reserves
liabilities
160 A p p e n d i x: S u m m a r y o f d e b i t s a n d c r e d i t s CIMA BA3
The T-accounts below illustrate how entries are made in the ledger accounts as debits or credits, e.g.,
an increase in an asset is recorded in the debit side of the account, a reduction in an asset is recorded
in the credit side of the account.
Asset
Debit Credit
+ -
Increase in asset Decrease in asset
Liability
Debit Credit
- +
Decrease in liability Increase in liability
ht 7
r i g 201
y
p ion
o
Allowance
C u i t
Debit Credit
I n t - +
r s t
F i
Decrease in allowance Increase in allowance
Capital
Debit Credit
- +
Decrease in capital Increase in capital
(drawings)
CIMA BA3 Ap p e n d i x: S u m m a r y o f d e b i t s a n d c r e d i t s 161
Expense
Debit Credit
+ -
Increase in expense Decrease in expense
Income
Debit Credit
- +
Decrease in income Increase in income
Fir Co
st I pyri
ntu ght
itio
n2
017
162 A p p e n d i x: S u m m a r y o f d e b i t s a n d c r e d i t s CIMA BA3
ht 7
r i g 201
y
p ion
o
C uit
I n t
r s t
F i

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Course Notes

SEPTEMBER 2017 RELEASE

Any unauthorised reproduction or distribution in any form is strictly

© First Intuition Ltd, 2017

1 Syllabus overview vii

3 Accounting concepts ntu ght

1 Purpose and role of accounting records

4: Double entry bookkeeping 21

5: The trial balance 31

1 Summary of where we are so far 31

6: Sales, purchases and sales taxes 39

1 Recording transactions – recap 39

9: Receivables and irrecoverable debts 67

1 Irrecoverable (bad) debts 67

1 Buying and selling inventories 73

11: Non-current assets and depreciation 79

12: Bank reconciliations 91

13: Accounting errors 95

14: Incomplete records

16: Statements of cash flows 119

17: Interpretation of financial statements 127

18: Manufacturing accounts 135

Solutions to Lecture examples 139

2 Learning outcomes and indicative syllabus content

B – Recording accounting transactions 50% itio

C – Preparation of accounts for single entities 30%

D – Analysis of financial statements 10%

s t I This is an important introduction to accounting that

The accounting equation is a popular area with your

Chapter Subject Time (min) Questions Complete

Chapter Subject Time (min) Questions Complete

ir s understanding of double entry, in particular

Chapter Subject Time (min) Questions Complete

Learn the layout of the proforma cash flow

The objective of financial reporting: 017

Financial Statements consist of:

Other user groups

Sole Trader Partnership Company

4 Financial accounts v Management accountsnt g

5 The regulatory framework

 To assess the stewardship of management. Stewardship is management’s responsibility to act

5.1 Sources of regulation

International Accounting Standards Board (IASB)

IFRS Interpretations Committee (IFRS IC)

6 Duties and responsibilities of those charged with governance 017

6.1 Legal responsibilities of Directors

The conceptual framework

2 Qualitative characteristics of financial information

Fundamental qualitative characteristics

assessments (confirmatory value). Items need to be material if they are to be of any

Enhancing qualitative characteristics

F i Materiality - Information is material if omitting it or misstating it could influence the decisions

3.3 Historic cost concept

Alternative valuation methods are:

5 Financial statements and key definitions

Cost of sales Gross profit Other expenses Net profit

F i- Tangible assets Purchase / improvement of 75,000

You will also need to learn the following terms.

6.1 Principles and elements of an integrated report