Cambridge International As and A Level Accounting
Cambridge International As and A Level Accounting
Cambridge International As and A Level Accounting
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1
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n
Introduction "' . . 1 .. !" ,. . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . "' . . . . . ,. ,. . . . . . ,. . . . . . . . . . . . . . . . . . . "' . . . . '"' . . . . . ,.. ,. . . . . . . ,.. . . . . . . . . . . . . , . . . . .. . . . . j,, ,. . . . . . . . . . . . . . . . . . . . ,. , ............ , . . . . . . . . . "' . . . . . . . . . . . . . . . . . . . . . . ,. , . . . . . . . . . . ,. f . . . . . . . . . . . . . "' .. · ~ . . . . . . .. .. " .. ~ . . . . . . . . .. ,. . . . . vi
1
Chapter 1 The dou hie-entry system ... , 11, • • 1• ,11 . . . . . . . 11 . . . . . . . , 1 ,111, 1111, , , 1111 . . . . . . . 1 1 1 , , . . . . I l l • • • • I l l • • • • , 1 1 , • • • • • 111, . I I . . . . . . . ,11 ,1 • • , . 1 . . . . ,1 I l l . . . . . . . I 1
Chapter 1 1 'Suspense accounts .. ,11,, ••• , 11, , . . . . . . . . . . . . . . . . . 111,, ....... .. ....... .. ... ,111 11 1, , ,11111 111 ...................... . ....... .. . .. ... . ,1, ............... 79
Chapter 12 Control systems - bank reconciliations ........ ,u ......................... ,1,,, . .............................. ,1 .. , .. ,1,,,1,,, ............. 83
Chapter 13 Control systems - ledger control accounts .. ,, 11, ......................... 1, 11,111, ..................................... ,1, .. 11 ........... 95
Chapter 14 Statements of financial position .... ... .................... ................................. ....... .. ,1 ••• •• • • •• ••• • ••• •• ••••••••• • •• •• • • • • ••• 11 o
Chapter 15 Profits ...... ....................................... ........................................................ .................................................. 117
Chapter 18 Irrecoverable debts and provision for doubtful debts ....... .. ........................ ........................................... 136
Chapter 19 Depreciation of non-current assets.11 .... . ........................ ,1 . . . . . . . . . . . . . . . . . . . 1., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 . . . . . . . . . . . . . . . . . . . . 145
Chapter 21 Financial statements ...... 1... , ......... 11, .... ,1, .................. 11 ....................... ,1 ,11 ......... .. ... II 11 ...... , 11, .. ,11111, .. ,, II ....... 167
Chapter 22 Incomplete records ............ , .... 111 .. ,111111 .......... . ..... 1111, ............................. . ......................................... II ....... 177
Chapter 23 Partnership accounti ng .. 11 ... ,, .. .. 1, . .. ,1 . .. . ,11,, . .. . .... .... . . . .. . ......... .. .. 1. .... . ...... , •• 11 · 1··· ..... 1. .. .. .. . . . . . .. . ....... . ... . . . ... ... 190
Chapter 24 Partnershi p accounting - structural changes .......... ....... ......... ......................... .. ................... .................. 201
Contents
Chapter 25 The financial statements of I imited companies II •••• 1• 1•• 1• •1 . . . . . 1• • • • •1 • • 1• • 1• •1..... 1 • • • 1•• • • • • • • • • • • • 1 • . . . . . . . 1•1 • • • • • • • •1 •• •1• 235
1 •
Chapter 27 Interpretation and analysis of financial data ....... ........... ................... ......... ......... ..... .............. .... •·1....... .. 267
Chapter 28 Absorption (total) costing ........... .............. ... .. .............. .. .. ............ ... 1 ••••••••• • •• •• ••••••• 1 ••••• • •• ••• ••••••••••• ••• •• • ••••• • 281
336
Chapter 32 Manufacturi ng accounts .......................................................................................................................... 336
Chapt er 3 3 Clubs and societies ... .. ................... ........... ... ................................ ................ .. ................... ........... ............ 3 57
Chapter 34 Published financial statements of limited companies ...................... ............. ..... ....... ....... .... ... .... ....... ... .. 368
Chapt er 38 Busi·ness purchase and merger -....................... ... ............. ................. ...... ..... .. ............................ •1 . . 1 . . . . . . . . . 405
Chapter 44 Budgeting and budgetary control ......... II 1• . . . . . . . . . . . . . . . . I l l . . . . . . . . . . . I l l I I 1 • . . . ,11 • •1 1•1 . . •1 I l l . . . . I l l . . . . . . I l l . . . . I l l 1• II 1•1 1 • •1 1•1 . . 446
Chapter 46 Capital 1
investment appraisal ........... ................... ....................................................... II . . . . . . . . . . . . . . . . . . . . . . . . . . . . 484
iV
Contents
Additional questions
Interactive tests
Revision checkl ists
Examination structure
Glossary of command words
Planning your revision
Answers to Additional questions
Appendix 1: Ratios
Append ix 2: Layouts of financial statements
V
r
The textbook
This book has been written with the needs of students in n1ind~ and I have ttied to rnaxitnise> as far as is possible~ the
achievetnent of positive ]earning. Also> the book has been developed based on tny many years of experience as both an
exanliner and a teacher of the subjrect to Advanced Level srudents both rn the UK and overseas.
The book has been endorsed by Ca mbddge Internation al Exan1inations, listed as an ,e ndorsed t~1:book for students who
study the Can1bridge lnternationaJ Exan1inations syUabus 9706. The te."Xt covers the whole- o f the &i7Uabus~ o rganised and spUt in
accordance ""ith the ,exrunination papers in the syHabus~ and fono~v.s a.s far as is possjble the order in which topics appear in the
published Sy"Uabus. The sections covered by each chapter are Usted. Each area of the sy]fabus is given as a reference point.
yllabu coverage
The first 31 chapters cover the A syllabus in its c;ntirety. At the end of tht:! ,;.\S Lev 1 syllabus chapters 'the ,e :arc examina·tion-.sty]e
questions. S0n1c ,o f the questions are fron, past cxan, papers. '\Vher,e appropriate the original questions have been n1odified to
reflect recent changes in accounting tenninolog.y and practice. Readers are advised that all topics in the AS section ofthe- syllabus
may also 'be e.:Jl·aniined at Adi"Clnced Level.
Chapters 32 to 46 deal with topics that niay be exan1ined at .Advan ced LeveL The exatnination-style questions at the end of the
A Leve[ chapters aJ"e written to ref1ect recent changes in accounting exan1 papers.
vi
Jn trodu ction
Key cone p s
The 9706 syUabu is bu.Ut around five fundam ntal cone pE.s that shou]d b · appli d
s 10 a!l accounting transac[:ions. They ar,e:
Consi tency
The treatment of sinillar transactions and items in the san1e way each year so that the results of business activity ca.n be cotnpared
with previous results.
Business entity
The separation of the owne.r.ship of a business fron1 the 4Kttu:d business itself. Only business assets and transactions are recorded
in the business books of account
Tb se key concepts "'~m dictate the way that you study accounting. They underpin the ·w ork that you will srudy during your
course. You should find that they provide themes that run through all the accounting tocpks that you .study. The above icons
appear in the text 1 indicating v.rhere each Key concept is cover,ed~
\Vhen you are studying a topic, refate one or more of these key concepts 't a that topic.
In accountin I there· are certain layouts that you. must learn .so, it is important that you practise qu.c stioru 'based on each topic area
on a regular basis. Us-c each p iece- of v,_·ork in the book and the CD to build up a bank ,o f knowledge and sk:iUs that you n1ray
be able to app]y to subsequent pieces of work. As a su.~ect, accounting is rather Bke a detective so]ving a crime; the pieces of
infom1ation coUected son1e weeks ago n1ight hdp to solve today's problen1. Most importantly, you n1ust Lea:rn the concepts for each
topic. This is usually easier that you n.1ight first think; the difficult part is app]ying the approp,tiate kno~dedge to the questions.
I hope you e njpy exp]onng in accounting a nd tnay you have good performance in you r AS/A Level exantination s.
Ian Harrison
vn
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The double-entry system
~ ,
By the end of this chapter you should be able to:
• use double-entry book-.keeping to rec,ord f ~na ncia~ transactions
• enter finanda1Itransacti1ons 1into a !ledger using debit and credit entri,es
• un ders1and and e'>,pla~in the purpose o,f us1 ng1a led ger
• understand and ,e ~llajn w hy a iedger ~s generallly d~vided into three pairts.
~ ~
This e h apter looks at the double -entry syste1n, which provides the accountant with
An i ncom state m nt is a statement th~ infonnaEion n,e eded in order to produce the data required to, prepar,e an i11con1e
that ca lcvtates the profit that a business staten1ent d1.3.t wiU show whethet· or not the business has been profttab]e . You wiJJ
has made fo,r a period of time (usually a encoum uer th single-entry systetn in Chapters 22 and 23.
financial yea ~).
.. tb nam bnpJies, double-entry b ok-k t:ping recognises th~u '£her ar,c: two
side or asp cts to every busin s transacti·on. , for ~xan1p], , 't he two side of ach
of d1e foUo'1-ri:ng Eransactiions:
1 fill rny car with !20 of fue].
• l receive the fuel
• The fiUing station attendant p uts the fue] into my vehicle.
11
B The double-entry system
AU financ ial transactions invoh:ing the business are recorded in a format caned a
A ledger account contains the detailed
I dget account or sitnp]y an ccount.
record of financial t ransactions undertaken
1
by a business. Stnce all accounts appear -Y:ou would find ach a,ccount on a .s parate pag in the l dg r. In fa,ct, if a EJ'r at
i,n a1ledger (or book), the term is ofte.n many transactions of a ~itniJar natu, ar undertaken, an acco,unt 111__.ay spr ad ovi r
shortened to the single wo rd account. several pages.
Jlor 't he sake of convenience this one book (the [,e dger) is divided inito severa]
srnaller books, You can imagine that large businesses Uke the Toyota Motor
A ledger i!i the boo k where all accounts Corporation or :tvlcDonaJds could not possibly keep aU their financial records in
aire kept. o ne book.
Initially, to n1ake our task a Unle sinlpier> we shaU .keep aU our records together.
'When the other books a re introduced, you w iU see that it does nrake sense to split
the ledger into sevend clifferent parts.
Do not wony if a]] this see1ns a H'Ede strange. You wiU soon be familiar vtith it but
it does requ ire practice. The key to success in accounting is practice.
An account Jooks ]ike a. 'T~ shape~ like this:
l ne debit s~de of an account is aiways the The credit side of an account is a !ways the
receivin g side ortfie side that shows galns giv1 ng or losing- side - the s~d e that sho\NS
in value. va lue gJven.
Dr An account Cr
Rece,ives Gives
or or
Ga,ins Loses
..s\n account in the .l edger wou]d be headed thus~
Dr ******* account Cr
Note
There should always be a heading~ if the account shown is not a persona] account,
the heading should include the word caccount'.
The go]den n1]e of the gaane of cdou bie entry3 is that every thne you enter
son1ething on the debit side fleft side) of an account you must enter an equivaJent
am,o unt on the credit side (rigbt side) of another account.
This is aU fuirly straightforward, 'but ft doe ~require practice.
2
1.1 Debit and credit entries jn the double-entry system
Bola O\\~s a bu ·in~ s ·Uing meat. Du ring on~ \\o~ek th foUowing financial
transactiorts ta k pJ ce:
Bola purchas mt.J, t $210 from Scragg, a m at who1 a]er. · he VY'iU pay for tb
1
Answer
Pu re h ases are any. items that are purd, ased
with the intention of selling them to Bo]a receives n1eat . . . and S.cragg 'loses' the· n1eat .. .
customers.
Dr Pu re hases account Cr Dr Scragg er
$ $
Sales aire any ltems ·th a,t are sold ,jn the
210 210
normal course of business to c,ustomers.
Bofa ']oses' n1e.at .. . and the Grand Hotel gains the meat ...
1 Bo]a gain the us of her p1 mise ... and sh ']os > (pays) cash .. .
3
B The double-entry system
If you are uncertain a bout th,e telephone aCC{)UOt ask whether Bofa has gained cash
o r 'la.>i:' cash. Yo u know that Bo] a has paid cash to the t lephone company so the
cash ha to b a er dit entry (right sid ); th,e otther ntry has to b a debit ntry Ot:ft
sid ) according to the· rule " of doub! entry.
~················· ·······~···· ........•
> Now try uestion 1.
Greta Teer owns and runs a store seUing newspapers, n1agazines and candies. The
fo]) owing transactions took p lace over the past few days:
1 Cash sa}es of newspapers an10'5mted to $68.
Cash sales of chocolate and ea ndies ~mounte d to $1..l .
- Gt ta purchased cand~ s, potato chips and soft drinks $135. paying cash to h r
who!<;; .. ] r.
h paid $160 cash for JocaJ tax,es.
Greta sol.d four bo..,ces of potato chip to a lo-caJ dub fo r cash $30 1
•
Requit·ed
Enter the transacdons in. Greta 's Jedger.
Answer
Dr Sales account Cr Dr Cash account Cr
s s $
68 68 135
151 1ST
1
160
30 .30
Note
.AU the transac tions involving cash have been e ntere d in o n e cash account. AU the
sales transactions have also been entered in one account.
•••••••••••••••••••••••••••••••••••••••••
>- Now try Question 2. It should be ob\oious that as weU as keeping n1oney in the business>the owners of
businesses will bank tnoney and will pay many bi]ls by n--ieans of c heques. So, as ,veU
.as ha\oi ng a cash account in the Jedger, the business would also keep a. bank account
to record transactio ns using the bu.siness bank account .
4
1.3 The divis~on of the l·~dger
Answer
Dr Freezer account Cr Dr Bank account Cr
s $ $
415 2178 411'5
,. 500
Note
The freezer unit is not p urchases - it is ,c apital expend iture. Ther·e was not already
an account, sow/Jen in doubt ope-n an account. The cheque paid out to the boUday
company is drawings - it is not a busint!Ss e..xpcm5e.
5
B The double-entry system
can you think of ho\"\<~you nlight spfrr the ledg,e t to, make i·1 tnore manag,e able? \Ve·
Credit customers are peop le (or
nlak it mor manageable by gro,u ping together simifar accounts. ~re put:
1
Answer
Debits Credits
Liability accounts rr~co.rd th~ acq ui ~ition
and repaym@nt of loa ns and overdrafts. 1 Purchases account Cash account
2 Cash account Sa les acco unt
··························~·············· When you go to a takeaway food store and you order your tneal, the propdaor does
>- Now try Question 3. not open an account for you; he sin1p]y ta kes your money and gives you your n1eaL
He debits - c ash account (the saJe of your n1eal would be induded in his total
cash sales fo r the day).
He credits - sales account (u~ing the tota l sal es figure for the daf).
Reme:n1ber tha't each account would be in a different ]ed ger according EO the
dassificaUon we ba\.'e discussed.
Each accoum wou]d b shown on a s p arat, page in the: !.e -ger. Ther is not
enou gh pace.; in this book to afford such a lu,.,P1Ury. ·~re "\\"lU Mit~ th acooun on the
.satne pag ,.
6
1.3 The divis~on of the l·~dger
Answer
Dr Non-current assets account (GL) Cr Dr Adil (PL) Cr
$ $
1450 1450
65
Not
• Customers' accounts and suppliers' a,o counts appear in th e sa],e s ]edger (SL)
and in the purchases Ledger (PL) respectively - but ocly if d1.e transactions are
on credit,
• Accounts that are not persona] accou nts are found in the genera] ledger ( GL).
• AU debit enuies have a corresponding cred it e ntry.
• AU ,c redit e ntries have a correspon din g debit entry.
Readers who have bank aocounts will ha.¥e observed that when they recehre a bank
.state1nent frrnn the bank, n1oney paid out of the account is e nte11ed in the Left colun1n
(debit) of tbe bank sta'ten1ent, while n1oneys received into the account are entered in
tbe light column (credit). This causes prob]etns initiaUy.
After what has been said above, this inight seetn to be, the v.-"T.ong way round. · o
who is right? \V.eU ~ both the bank su1. te1nent and tb is 'b oo,k are correct. You need ro
r·emc:rnber ·t hat the bank stare,n~t is written from ·t he point ,o f vi,e w of the bank, not
• • • • • • • • • .. • .. • • • • .. • • • • • • • • • • • • • .. • • • • • .. • • • • from your point of view,
Now try u stion 4. blore d tails on this are iven in Chapter 12.
7
B The double-entry system
8
The books of prime entry
The books of pt·ime e ntry are also known as subsidiary books and books of
original ent ry. There ~ue six books of prime entry and they are:
1 the purchases journal
2 the sales journal
3 the pu rchase.s 1-eturns journal
4 the sales returns journa]
5 the general journal
6 Ehe cash book.
Pul.cha.se-s
joumaJ
sound ,c onfusing: but when you have .seen hmv the books \\i'od.;:, things will booo1n~ clear.
AU transactions 1nust be entered in one o f the books of pritne enuy b fore they
ea n be ,entered in the ledger.
So the cash book is used to get into the ground and it wm also play its part in the
gan1e of dou.b]e entry.
9
II The books of prime entry
• The· books of p,rn1.1e enEry are used as a convenient "1"aY of entering transactions
into th double-entry ~ystem.
• It i J t:ffident ·10 mak entri s into the ] dgers as tbey arise. It :is too, time
constuning and that m~ans it ls enerally more cosdy.
• It is I ~tt r to ,ooUcct th entries and ,catecgorise th m into bundl,es of sin1ilar typ
:and then to post from these books in bulk.
,r
-
Pt4r<:luaes ladgirr
Mary Pickup Ltd s
?vfary Piekup,Ltd 1.25.70
I 125.7~ P. GoHgbUy pk 76.40 Book of
prime entry
Gartcb & foks J .26LOO
P. GoUgbdy .Pfc Geol'ge Ti.mms 99.lO
s ] S62.20
76.40
10
2.1 Recording cr,r~dit purchases and sak~s
Source
docwnents.
91250
$ V 1477.77
11
II The books of prime entry
2.2 Recording the return of goods
2.2. 1 The__pur-
._·c_h a_
-ses_r-turns
e __ _J_~o- urn
_ a-1
The purch_· es renu·ns journal is also k-110,vm a.s the r turns outwards ~ournal ot
purchases retums book.
S0metin1es, goods that have· been purchased turn out to be fau]ty, the wrong
colour, the wrong size or not useful in sotne other way. These goods wiU be returned
to the supplier. The su ppUer in due course wiU send a credit note.
These credit notes are the souti"Ce docun1ents fron1 which the purchases returns
journal is written up.
The purchases returns journaJ is a ]ist of a]] the ,c redit notes received fron1
suppUers. 'When it is convenient~ the Hst is added a nd the total is posted to the credit
of the pu1·chases 1-eturns account (the returns have been sen t back to
the su ppJ 1er).
Not-
• The goods that have been r,e tumed a re not post,e d to the credit side of £be
puriehase.s accounE.
• Each indh,i dual entry in th purchas s rerums journal is then po,sted Eo th debit of
th r sp&-ctive suppli rs account in th purcbas , l ·dger (the suppliers r ct=iv
the goods).
T.he system
Purchases ledger Genera] ledger
E Bfoggs Purchases returns aoo(nrnt
$
28
12
2.3 The general jiournal and its uses
Note
• The goods that have been returned are not debited to the sales account
• Each individual entry in the sa les returns touma] is posted to the credit o f the ,c us-
tomer who returned the goods (they have ~given' the goods back to the suppHer).
The system
Sales .ledger General Jedger
D. Jon~s Sides returns accom1t
$
4,6
General journal
The 1foliio' coJumns aire often omitted in Date Pa rticulars Folio Debit Credit
·exa1mi1nati on questfons. The date of the Tfie a.cco unt to Ledger and page Amount to be
ent11es be debited debtted
The account to Am.o unt to be
be credited crnd ited
A description of why the t ra nsaction was necessary (1rne narrative)
After the two e ntries h ave been entered in the general journal. an exp]anation o f w hy
ihe transacUon was necessary is required . T his is referred to as the n ar:rntive.
The genera] jou rnal has six uses. It is used to record:
1 the purchase of non-current assets o n credit
2 the sale of no n-current assets on credit
3 the entcie-s necessary to op en ledgec aJ·ccounts when a bt11Siness nrst comes int,o
exi.scence
4 tht.; entn r quir d tor, cord th d osing of] dger aocoun:ts wh en a busi:n s Ana]]y
ceas to crad
5 th con ,ec tio n of erro rs
6 int~-]cdger transfers.
The souoce docun1e nts used to vnhe up the general jour nal w ould include~
• p urchase invokes for capjtal expenditure
• sa]es invoices for sa]es of capital iten1s.
On 23 Apd] 2014, Tainara. purchased on credit an xtr/ 397 machine from De,,.'lel and
Co. ~or $12 600.
Requited
Prepare the ,entry in Tam..,ra~s g<:neral joumal to record the t111n.saaion.
Answer
General journal
Date Partic.u I a rs Folio Debit Credit
$ $
.Ma c:hirn~ ty GL23* 12600
account
Dexte~Ltd PL26 12600
Purchase o-f Mach lne xtr/397 0 11 credit from Dextel Ltd
14
2.3 The general jiournal and its uses
On 6 ept, mber 2014 Hu sain. so]d vehide P341 FrX to Greg~s garagt: for $230. Gte
'\"\·i]] s ttl th d bE on 31 Octo er 2014.
Requi, _d
Prepare the enttir in ·Hussain's general journal to r,e cord 'the transaction.
Answer
General journal
Date Partic.u lars Folio Debit Credit
$ $
6 September Greg's garage Sl42 230
2014
Vehicles GUl 230
dFsposaJ account
Sale of vehide ?341 FiX to Gregs garage
tvlarlene sta rted in business on 1 January 2014 by paying 14 OOO into ber business
bank account.
Requh-ed
Prepare the e ntry in i\(adene's general joun1a] to record the transaction .
Answer
General journal
Date Pa rti cu la rs Folio Debit Credit
$ $
11 Janua.ry 20 14 18an k acco unt GL1 114000
Ca pital Gl2 14 000
account
~ you fin di it dHi~ ou1lt to pre pare Capital introduced by Marlene
jo urrnall entr~es; t~ draw~ng up -r
accounts..as you dtd ~in Chapter 1. Then
from1the· accounts draw up the·journa 1.
In rea1li1y, 1he journal should be done fi rst n1.e other three uses are deak \Vitb later:
as it is the book of pr~me entry. • use 4 in Chapter 38 (dosing the Jed ge accou nts when a business ceases to trade)
• use 5 in Chapter 11 (correcting ecror.s in the doub]e-entry systetn)
• use 6 in Chapter 13 (n1aking transfers froin the saJes ledget· to the purchases
ledger}
15
II The books of prime entry
On 2 Augusc 2014, Jared purcha s. on er dit~ an rw tnacbin for his b usine s costing
5400 from Factre Ltd.
Required
Prepare tllte entries in Jared's genera [ joumaJ ~o record tbe tran saction ,
Work·ings
If you are unsure how to tackle th is questtion, draw up the (T accounts.
Ja.red gains a n1achine . Fac.tre Ltd 'loses' the tnacbme.
Answer
General journal
Date Particu lairs Folio Debit Credit
s s
Ma chin ery account Gt1 9 5400
Fact re Ltd PL41 5 400
Purchas-e o.f new mac hine from Factre Ltd
O ther source docun1ents used to write up Ehe cash book wm be encountered in later
chapters.
1'6
2. 5 Trade discount
Extrav pk seU:s a wooden kitchen cupboard to the genera] pulbUc for $300. Clyde is
a kitchen designer and fitter. He purchases a kitchen cupboard from Extrav pk ~ to fit
into one of his customer's kitchens for $240.
Clyde gets t1"3de disoount o f 60. This u-ade discount expressed as a percentage
v.rotdd be 20 per cent.
Trade discount is not recorded in Extrav pk's [edger, nor is it recorded in Clyde's
]edger.
In C]yde's purchases journa] the entry v.rould s how:
$
Extrav ple 240
s
Cilyde 240
TI1.e foUowing at"e the prices o f son1e kitchen cu pboards as charged to the gen.em] public
by Extrav pk·and the rates of trade discount aUowed to other different retail businesses.
Requit-ed
Prepar~ the e ntdes in the sa]es journ al of fu..."lrav p lc.
Answer
Sales journal
$
Hay Bee Ltd 1 117. 50
Sea Dee 2300.00
M . Henn pie 2 034.00
Pea Queue Ltd 567:00
6018.50
17
II The books of prime entry
Shnil arly~ in d1 purchases journal of the customers of Extr-arv pk the an1ounts would
b shown n~t of trad discount.
o in th pur,cha s joutna] of Iiay Be Ltd \\re wouJd And an entry:
$
1Extrav pk 1117.50
Postings to the respective ledgers would foUow the Hnes shown ead ier in this chapter.
Posting is th€l 1:erm used by accouinta.nts
for entering transactions into the ledger
accounts of a bus~ ness.
AH busfru~ss transactions must be ffrst entered in a book of prime ,entry before 1hey
can be entered in the double-entry systeim .
F~ve books of ~:mime entry dea~ w1ith cred~t transactions:
• purchases journal
• sales journal
• purchases re1urns journa1~
• sales returns journal
• genera1lj ourna I.
The f\ive books of pr~me ent1ry air·e 'hsts~ from wh~ch iedlg,er accounts are comp~lled.
The sixth book of p:ri me ·entry is the caish book.
The carsh bo olk dea~s.wrth an cash and ba1nk account 1rair~sa cti.ons. rrt ~s also part of the
doubl·e-entry system1
Trade discount is a reduction in prke charged by a suppHer to a custo1m:er who is in
business.
18
The ledger accounts in detail
useful and it wm give us the infom1ation that \Ve require. However it would be t110t'e
1
usefu [ if the 'T a acounts gave us more deta uls of each transa et ion.
• lt would be t?Seful to know when the transaction took p]ace.
• lt would a]so be useful to be able to foUow 1he whole transaotion through to its
con1pletion, espedaJ]y w h en a prob]etn occurs in the systetn.
7 April GL1 7
The transaction took pJace on 7 Apri]. The 1opposite' entry (the credit entry) is in the
sales account and can be found on page 17 of the genet1al ledga.
Dr Another account Cr
s
I 12 Sept fJ,urc hases GL2 8 4116
Here the transaction took place on 12 Septen1ber. The debit entry is in the purchases
account ~rhioh is on page 28 of the general ledger.
19
II The ledger accounts in detail
3.2 Using ·the books of prime entry
If you are aisked 10 prepare a ledger The information hown in ]edger accounts is derh"ed from ,o:ne o,f Eh books o f
account, then your anmer must have prb'n ntry.
all the deta~ is. However; when you are
w,orkjng 1h in gs out you m,ay use 'T'
aa:ou1nts because 1~h~s i1s iaster and just as
accurate. The foUowing transactions took p lace during .t he first week in October:
Many accountants and tea.chers us-e 'T' 1 October~ _purchased goods for resaJe on credit frruu Arkitned p k 1120
acco unts to sollve tricky prob~erns and for 1 October~ sold goods o n credit to M:o rris & Co. $6,0Q,
general work;ngs.
2 October: p urchased vehicle o n credit fron1 Poo]ey Motors pk $17400
4 October: so]d goods on credit to Ndson pk $315
r. 4 October: purchased goods for resaJe on ,c redit fron1 Bjorn & Co. $450
4 October: p urchased goods for resaJe on ,c redit f1u n"1 Darth & Son 170
Try jotting down your work ~n gs usm g .... 7 October: soJd goods o n credit to O livia Ltd $1340
'T aiccounts. When you gaitn ·Confidence
1
7 October: re·t urned dainaged goods $38 to Arkimed plc
~n thefr us-e you willl f1indl 'that you can us·e .. 7 October: purchased goods for re al~ on ,cn~dit from Charlene $320.
1hem1as a re~ s~o n too I a,ndi for solv1ing
R quit· d
pro ble,mis.
Jdentify th source document that has been used in ach case· to writ up th
book of prin1e entry.
Write up the appropria re books of prhne entry .
Show the entries in each ]edger account.
Answer
Purchase invoices: Transactions l , 3, 5, 6, 9
Copy sales invoices: Transactions 2, 4, 7
Credit n ote: Transaction 8
s s
1 Oct Arkimed pk PL 1 1.20 11Oct Morris & Co. St1 600
40ct ·Bjorn & Co. PL2 450 40ct Nelso n, pie St2 315
40ct Darth & Son PL3 170 7 Oct OUvia Ltd SL~ 1340
7 Oct Charlene PL4 320 2255
1060
$
7 Oct Arkimed PL1 38
General journal
Dr Cr
s s
2 Oct Venicles GL4 17 40-0
PooleiJ Mtrs ple G1.5 17400
Purchase of vehicle from Poofey Motors pie
20
3.2 Using the books of prim@ entry
C Purchases ledger
Dr Arkimed pk Cr
$ $
7 Oct Putchases returns PRJ 1 38 1 Oct Purchases iP J, 1120
I
$
40ct Purchases PJ1 170
Dr Charlene Cr
$
17Oct Purchases PJ 11 320
Sales ledger
-
Dr
1 Oct Sales SJ 1
Morris & Co. Cr
60~ J
Dr Nelson pie Cr
Dr Sales a,cou nt Cr
$
7 Oct su,ndty SJ 1 2255
receivables
Dr Vehicles account Cr
s
2 Oct Pooley Motors GJ1 1'7400
pie.
Tllte cash book is a book of p rbn e entry. It contains the business cash acooun.11 and the
business ba nk accoun t W'e consider the cash book in tn uch more detail in Chapter 4.
21
II The ledger accounts in detail
The follow ing examp]e uses the ca.sh book as a book ,o f prime entry:
Answer
a Cash book
Dr Cash acco un't Cr
s
1 Dec Rent GU 2 50
6 D~c Wages GL4 1782
13 Dec Wages GL4 1780
20 Dec Wag,es GL4 1780
27 Dec Wag-es Gl4 1 781
Dr Ba nk account Cr
$
2 Dec LoeaII taxes GL2 11 a
17 Dec Insurance GL3 240
31 Dec Rent GL1 2 50
b General ledger
Dr Rent account Cr
s
1 o~c Cash CB1 250
31' Dec Bank CB1 250
Dr Insuran ce acc.ount Cr
22
3.2 Using the books of prim@ entry
Etu,e ring transactions in the books of prime en.try· and then the ledgel"s is not a
difficult tasl'"; it ~st talc pati,e no and th abiJity to enter transactions t\V'ic - o:nce
on th dt;bit sidt;· of a n a,,c,c ount and one on th er dit id of anoth r account.
R ,n tnb r, practlce makes pr:rjact.
1 !den'tity the four ~eces of jn'forma1:ion you would expect to i 1ind on the debit
side· ci a ~e.dg,er account.
2 ~dentify the four pjeces of ~nfoirma1:1ion you would expect to i 1ind on t he credlt
side of a fedger account
3 When would you use 'l ' accounts?
4 Which source document would you use to write up the purchases returns
journal?
5 Whkh type of account would you e)q)ect to fin~ in the sales ledger"?
····························~·····~······
> Now t ry Que tion . 6 Name a personal ledger.
!Ledger accounts must show date·, detalls O·t a1'correspondjng' entry; f,01110 detaj~s a1nd
the amount of the transaction.
'T' accounts must ordy be used for revis~on purposes or as part of worki1ngs.
Allll transactions mus-1 be enteradl tin a book of pdme ,entry befo re being posted ta
1
a ledgier.
23
The cash book
By the end of this chapter you should be able to~
• record cash and dheque payments
• record receJpts of caslh and cheques
• i dentjfy the source docum1ents used to write up a1cash book
• balaince the cash and bank co1umins o·f a cash book
• make contra1entn es in a cash book.
The only differences in the layout of the cash book are that the debit entries are
distanced &orn. the credit entries by ·e xtra colu1mns and info rmation; and that the debit
entries~ generaUy, take up the whole of the Jeft page while the credit entrie-s take up
·Ebe whcle of the right page.
24
4.2 Recording cash and cheque payments in a cash book
Cash book
Date Particulars Folio Ca sh Bank
Cash book
Date Pa rti cu la rs Folio Cas h Bank
Dr Cash book Cr
Date Particulars Folio Cash Bank Date Particulars Fo Ii o Cas h Bank
(1) (2) (3) (4) (5) (6) 0) (8) (9) (1O)
The, foHowing transactions took place i.n the first week of S ~ptember~
l Septeoilier. paid R. Serth $34 cash
2 Septenilier. paid T. Horse $167 cash
3 Septenilier: paid V. Dole $78 cash .
R e quiL-e d
Enter the transactions in a cash book.
Answer
Dr Cash book Cr
Da te Pa rticula rs Folio Cash Ba nk Date Pa rticula rs Folio Cash Bank
$
25
II The cash book
Answer
Dr Cash book Cr
Date Particulars Folio Cash Bank Date Particulars Folio Cash Bank
Answer
Dr Cash book Cr
Date Particulars Folio Cash Bank Da·t e Particulars Folio Cash Bank
$
4M'ay Ni.gel SU 2 2 13
1
2i6
4.3 Recording the recejpt of ,cash and chequ@s in a cash book
Answer
Dr Cash book C'r
Date Partkulars Folio Cash Bank Date Parti, ulars Folio Cash Bank
s
2 Jan Steve SLS 249
3 Jain Cash sa les Gt.2~ 851
11 Jan Mustaf Sl 7 29
On ce you have mastered the method of record mg debit entries and a--edit entri,e s it
shouJd be fairly straightforward to con1.bine the two.
Answer
Dr Cash book. Cr
Date Pa rticulars Fo lio Cas h Bank Date Particula rs Folio Cash Bank
$ $
2 Apr Xavier SL4 4S8 4 Apr Motor GL23 530
expenses
6 Apr Milly SL113 77 7 Apr Rent GL8 210
12 Apr Cash sales Gil..2 743 9 Apr i nrs urar,ce GL 11 156
27
II The cash book
Answer
Dr Cash boo k Cr
Date Particulars Folio Cash Bank Dat e Particulars Folio Cash Bank
s s
6 Oct Rt!!nt Gl6 450 3 Oct Price! SL4 350
9 Oct Sales GU 7 21 87 17 Oct Loca,I taxes GL7 219
11 Oct BUff SL1 3 639
It is now shnply a matter of putting cash pay1nentLS and cash :receipts in the satne
·b ook as cheque payn1ents and n1onies paid into the bank.
Answer
Dt cash book er
Date Particulars Folio Cash Bank Date Particulars Fo Iio Cas h Bank
s s $ s
11Nov Norman SL4 288 2 Nov Motor exp en,ses GL12 31 1
10 Nov Sah:s GL9 2390 5 Nov Drawings Gl23 1. 50
2 1 Nov !insurance GL11 273 15 Nov Motor expe nses GU 2 42
30 Nov Sales GL9 5 630 29 Nov Wages GL7 1309
•••••••••••••••••••••••••••••••••••••••••
> Now t ry Question 1.
Copy receipts
De bit s ide
-ReceJpts
Credit side
A further source of infonnation to be used to write up tbe cash book is a copy of the
deta i1s (recorded by the bank) of transactions made using the bus ine.ss bank a ccount
- but n1ore of this source later.
28
4. 5 'Balancing' a cash book
at that date.
Th<; bank bafance in th cash ok can verified by referenoo to th · bank statement.
A balancing figure is an amount that The ha lances are brought down to start the ~new' 'time period.
needs to be includ edl in the de:bi,t side! or
Remernber the cash balance wiU aJv.rays be brought down as a debit. The bank
<:redit sid~ of a,n account to make the d~b it
!dde equal to the credit side. l'he amount ba]ance brought down could be e ither a debit or a e t-edit ba]ance.
used to bafance a cash book column is then
used to 'start' the next time pe riod.
Requit-e di
BaJance the cash and bank eo]uin ns o f the cash book on 16 Noven1ber and carry any
ba]ances down.
Answer
Dr Cas h book Cr
Date Particulars Folio Cash Bank Date Pa rticulars Folio Cash Bank
29
II The cash book
Note
Makt= sure that aU four ·EottaJs .ar: on the same.; lint:. Balano~ th cash c:o]umns. first;
tb n baJ anoe the bank columns. Do not try to do th m both at th sam~ titn .
···········-··················6··········
> Now ry Qu tion 2.
Dr Cash book Cr
Date Particulars Folio Cash Bank. Date Particulars Folio Cash Bank
$ s
4 Jui Cash sales GL32 4 397 5 Jui Purchases GL7 48
Grant ha_s n iore tba n, $4000 ,cash on his preinises - this represents a security risk. I-le
pay.s $4000 into the b usiness b ank account o n 5 J u1y.
Ta lk you rself throu gh this tran saction.
Grant takes $4000 fron1 the tiU ... the ca sh colunm closes' $4000.
Note
th~ date of th transaction
th particular t Hing vth re th 1corrt!sponding' entry is to b Found (in th bank
column)
cc• is for 'oontra showing that Grant's b1J.1JSin s is neither b tter nor worse off
bec~i use of the transaction
$4000 in th e cash colum n shows that cash h as been ~]ost'.
Grant takes the n1oney to tb.e bank and the bank 1·eceives the money.
Note
the date of the transaction
the pa rtkulars telling wher,e tll1~ 1,coJ.'1iesponding' enEry is to be found (in the ,c ash
column)
C' is for 'oo:ntra, showing that G-ra:nt's business is neither a: nor wors ,o ff
1
because of th transaction
$4000 i.n the bank co1umn sho,ws that n1onc,y has been rooeirvcd into the bank -acoount
The effect o n the business is the sarne as the effect on your finances tbat would occur
if you removed a five-doUar bHJ from one pocket and put h into another pocket,
30
4.6 Contra entries in a cash book
Another common contra entry in the cash book is the wHh drav,t,d of cash fton1 the
bank for us~ in the business. This transaction oftc:n oc,curs '\\i"hen cash wages n d to
b ~ id and th, bus in has in.sufn,cient ea b in th sat to mak up th nee ary
wa pack, ts. In fact, for s~curity rE--a ":Ons, many larger busin se.s now pay wag
and salaries directly into staff bank a,coounts so that large an1ounEs of cash do not
n-e,c d to b u-ansponed from the bank and then kept on the bu siness's premises.
Dr Cash book Cr
Date Particulars Folio Cash Ba nk Date Partic uIars Folio Cash Bank.
$ $
12 Aug Robson Sl32 4574 11 Aug Machinery GL6 2 350
16 Aug Nkomo SL79 5490
\Vages ru11ounting 10 4529 ha,, 'Eo be paid in ,cash on lS Aug'U t. Diego w~thdra\vs
this sum from. th b:ink on 17 August.
If w talk ours lves through the proces ·~the ntries b come d ·ar:
Diego g,o es to the bank and withdraws $4529.
•••••••••••••••••••••••••••••••••••••••••
s
>- Now try Qu stion 3. 117 Aug Bank C 4529
:tvlany larger busin ses now k~ pa eh qu~ payin,e nts book and a ea "h i c ipts
and lodgen1ent book. 11,ls is certainJy ·t he case wher,c: th bulk of transactions are
conduct d through th~ bank account
31
II The cash book
The cash book is both a book of prime e·n1ry and his pa1rt of the double-entry
system.
All transactions 1hat ,nvo~ve cash a1nd dhe-ques are enter·ed in the cash book;
AH cash transact~ons are ·en1ered 1i11 the cash co,lumns.
AH transactions 1invo!lvi1ng cheques are entered fn ~he bank columns.
AJll entr~es in a ca5h book need 'corresponding' entides ~n other ledger accounts to
comptete the doubte entry.
Contra items have no effect on the worth of the bus~ness.
Any balance shown 1n the cash co,umn must be a de-b,t bailance.
Ballan~es shown 1n the bank column could be either a debirt or a1cred~t lbalanc-e.
32
Discounts
,
By the end of this chapter you should be able to~
• di stin gu ish between traid e discount and cash discount
• cakula1e both kinds of dcscount
• record caish d~scount allllowed and cash djsco,unt received in ~edger a:ccouints
• use discount columns i1n a cash lboo·k as mem·orandum entries.
~ ~
On 1 August Yung has three deb-tots . H er settlement tern1s aUow a cash d iscount
of five per cent to custoiners \Vho S·ettle their debts b for the ,e nd, of August. (For
i]Justracive purpo es only, Yung does no,t ke pa ea b book.)
- -
Debtor· Amount owed Date of payment by cheque
-
Georgl $2800 23 Aug·ust
An mid $80 17 September
Fatima $360 29 Aug ust
33
II Discounts
Requite d.
Prepar th~ ledger accounts to record the sett]ing of th d bts due.
Answer
Sales ledger
Dr Georgi Cr
$ $
1 Aug1 Bala n,ce bid 2 800.00 23 Aug Bank GL1 2 660.00
23 Aug, Discount al·lo'Wedl Gll 140.00
Dr Ahmed Cr
s $
1 Aug, Ba la nc:e bid 80 .00 17 Sept Bank GIL1 80.00
Dr Fatima er
$ $
l Aug, Ba'lance bid 360.00 29· Au gi Bank Gt 1 342.00
29· Augi Dfscount allowed GL2 18.00
General ledger
Dr Bank account Cr
$
23 Aug Georg,i SL1 2660,.00
29 Aug Fatima SL3 342.00
17 Sept Ahmed SL2 80.00
You can s d1at di count allow is cr~dit · ·co the customer's account, thus r, ducing
the amount to be pajd i,,
settlement. It is d it d to the discount allow d aocou nt in
·the genera] ]cdgar....\hmed did not qua Ufy for a discount - he did not pay bcfor~ the
end of August
Yun g has three creditors o n 1 August (for iUust rative purposes only, Yun g does not
keep a cash book).
7400 5
Carot Ltd 200 3
Answer
Pu re hases ledger
Dr Hameed & Co. Cr
s s
26 Aug 18ank Gl3 392.00 1 Aug1 400.00
26 Aug D'isco unt received GIL4 8.00
Dr BTQ pie Cr
s $
26 Aug Bank Gil 3 7 030 .00 i Aug Bala nce bid 7400.00
26 Aug D.iscount received ,GL4 370.00
Dr Carot Ltd Cr
s $
26 Aug .Bank Gl.3 194 .00 1 Aug Bala nce bid 200.00
26 Aug D,iscount recei,ved GIL4 6.00
General ledger
Dr Bank account Cr
s
26 Aug Ha meed & Co. PL1 392.00
26 A ug BTQ pie PL2 7030,.00
26 A ug Carot Ltd PL3 194.00
YotJ can see duu discount received tS debited to the sup pUer's account, thus reducing
the amount that Yu ng has to pay in setden1er:n. Th discounts are ct~ited to th
discount r c ived acc,o unt in th gen a] ] dg~r.
To sun1,na.ri se:
• Discount aUo wc d iis debite d t·o tht:l discount aUov.red aocaunt in the general ledger
and is crE-dited to th~ c usto nier's account in. the saJes ]edg,~ .
• Discount received is credited to the discount received account in d1e ge neral le dger
and is debited to the suppHer's acaou nt in the purchases ledger.
35
II Discounts
The three-co]un1n cash book headings ]ook Hk,e this :
Dat e Particulars Folio Discount Cash Bank Date Patticu Ia rs Fo Ii o Discount Cash Bank
The discount colunins are memorandiun columns o n.]y, they record the discounts
Memorandum columns record but are no t yet part of the double -e ntry systen1. This is a inuch n ~o re effic ient way o f
inforrmati·on that is not part of the double-
coHecting the infom1atio n necessary to write u p the discou nt a ccounts in the general
entry system .
J.edger rathe r than ex:a n:uning every ac co u nt m the sales ledg.er and every accoun t in
the p urc hases ]edger.
;.Vote that we w .tll now dispense lvith thejolio coh~tnns in most examples and
questions. You will not usual~Jr need to include thmn in your ansuX!rs to qu(!..stion.s.
The entri,e s to record the p revious U"3llsactions in Yung's cash book would look
Ji.ke this:
Dr Cash book Cr
Date Particulars Discount Cash Bank Date Particulars Discount Cash Bank
$ $ s s
23 Aug Geogi 140.00 2660.00 26 Aug fl..lameed & Co. 8.00 392.00
29 Aug ~atima 18.00 342 .00 26 Aug IBTQ pie 370 .00 7030.-00
1,7 s~pt Ahmed 80.00 26 Au g Carot !Ltd 6.00 1,94_,oo
17 Sept Ba~ance d d 4 534.00
158.0.0 7616.00 384.00 76 16.00
1'8 Sept Bctl'ance bid 4 534.-00
The cash and bank ,c 0Ju1n ns in the cash book a re balanced as they Vv"efe in th e cash
book of Grey in ChapteT 4.
Note
• It is i:nlportant to note that the d iscount ,c,o]'umns ar.e totalled. They are not
co1npared and aJanc d since ther is no oonneotion b tw n the entries in th
t\\:o ,cclun1ns. On co]unm r~fers to custoiners~ accounts·i the other coJumn refers to
suppH rs 1 accounts.
• The di oo,unt ,columns are rne»iorrnid, rm ,oo]utn_ns only - tbey .are not part of the
double-entry system.
The totals of the discount co]unu1S are then post ed to the respective discount a Uowed
an d disaou nt received accounts in the genera] ledger.
The purchases ]edger accounts and the sa]e s ledger accounts. are the san1e as
p revious]y shown. HOVvev:er, the d iscount accounts would look like this.
Ge n eral l edger
Dr Di scount allowed a ccount Cr Dr Discount received acc.ou nt Cr
$ $
17 Sept Sundry debtors 158 I , Sept1 Sundty creditors 384 .00
Not _
• The are used; the individual discounts are not shown.
tora]
• Notice also that two separ.ate accounts are used..
3'6
5.4 Entering cash discounts in the ,general l~dger
37
Preparing simple financial
statements
By the end of this chapter you
should be able to~
• prepare a simplle iincome
statement to reveal 1he
profit or !loss eairnedl by a
bus~ness
• prepa1re· a simpl·e· statem.ent of
fInaind al position,
The n1anagers and owners of aU businesses wish that their business wiU survive and
flourish. In order that this ;n1ight happen >the business must generate positive cash
flows as these should ensure its shor1t-te1m survival All cash and bank transactions
are recorded in a cash book. Balancing the ,c ash and bank colun1ns enabte cash and
bank surpluses and defidts to be recognised quickJy. Short-tenn decisions regarding
these sur p]uses and deficits can be then be made to benefit the buisiness.
Profits should ensure surviva] o f the business in the ]ong 'tenn.
We have seen how a]] tral'tsacdons are recorded in detail in tbe l,edge1~ of a
bu in s, but the reootding of cash and er-edit transactions in the ledger do s not
immedblt,c ly reveal wheth r or not a busin is proncabl .
38
6. 1 Ba~andng a !ledger account
Dr An account Cr·
$ $
23 4'5
41 35
16
80· 80
The aooo:t,11nt balances.
This process makes it look as though the debit e ntries were exaccly the same a.tnounts
as the credit entries - not uue1
The debit side totaUed 35 m ore than the cred it .sid e. We need ~o reflect this when we
start the account a.ga in. We carry the bafance down .
We start an ew with an o p ening balance of $35 o n the debit sid e:
Dr An account Cr
s s
23 45
41 35
1'6
80 so
35
The, rules of o ur doub[e~entry gan1e say that every time we in.dude a debit entry in
the syse1:n we m ust aJso inclu de a cred it e ntry. We have don e just that. We insened a
credit e ntry to n1ake the account balance.
Our debit enuy starts us o ff again:
Requit d
Ba]ancc· the accounts a:nd carry down a:ny balanocs.
39
II Preparing simple financial statements
Answer
Dr Zog Cr Dt Melvyn Cr Dr Tan er
s s
- ~
s
- -
$ $ $
23 53 12 34 71 QO
13 41 25 37 27 38
,56 8 73 39 91 61
102 1102 11 0 110 189 189
66 39 61
Answer
Dr Purchases account Cr Dr Buvcu Cr
$ s
1531
153
40
6.2 The trial bal,ance
Trial balance
Debit Credit
$ s
Purchases 153 The account shows a debit balance· -the trial
'
balance sho ~ a debit balance.
Buvciu 153 The account shows a credit balance; 'the trial
balance shoM" a credit balance.
Sal'es 325 Sales have uedit entries totalling $325; the trial
balance sho ~ this balance.
Sa,ngft.a 29 The account sh·ows a debit balance; the trial
balance sho~ a debit balance.
Cash 228 The debit side is greater; the triaJbalance shows
the debit balan d ng figure.
Motor expenses 68 The account shows a debit balance; the trial
balance shoVv'S a debit balance.
478 478
The trla.J balance h~s shown that we have ,entered our un n.s actions accurately.
365 o9
912 12
Requi1-ed
Ba]ance the ]edger a ccounts. Ca.ny down any balances and extract a trial b a]ance to
check the acc uracy o f the e ntcies in the ledger.
Answer
Dr Cash account Cr Dr Bank account er
s $ $ s
42 1·00 365 534
534 458 912 141
12 69
6 533
576 '576 1277 1277
6 533
41
II Preparing simple financial statements
Dr Re nt a c.cou nt Cr Dt Wages account Cr
$ $
100 458
Trial balance
Dr Cr
$ $
Cash 6
Barnk 533
Rent 100
Wages 4'58
sa:i es 13 19
1Purrchases 222
1 3119 1319
Balances ta ke n from the non1i1i1ia] accounts in the ledger of Ong st1ow the fo Howing
infom1ation for a ftna nckd year~
rent and ]ocaJ taxes pa id $870; wages paid $56000; ~ments for other expense.s
18900
.. p urchase of goods for resale 121 SOO; saJles for the year $193000.
Re qun·ed
CarJculate whether or not O ng's h u sines~ has been profitab]e over the yeal·.
Answer
Profitt for th-e year $5730 (= Sales $19300Qi - Expens s 187 270).
· "penses =Purch res 121 -oo + 870 + 56000 + $8 900)
42
6.3 Calcu~ating profit
The foUowin. information has b'" n ."tracted fro1n the notninal accounts in the
]e dg r of Jethro aft r on year of tradin :
sales of goods: $116 OOO
expenses incurred during the year - purchase ~of goods for resale: 59 600
payn1.ents n1ade - rent and loca] taxes: $2760; po,\ver. $8930, wages: ,$.4.2 no;
mo tor expenses: $2950; other expenses: $6840.
Requi1-ed
Ca]culate whether or not Jedno's business has been profitable during the yea.r.
Answe r
Jethro is business has not been profitable. It has n1,ade a ]oss of $785D ( Sa]es
$116000 - Payn~ents $123850).
Sales 5116000, less Payiuents m ade during the y,eru- $123850 1
•
Th1;; calcu] at ion tha·t we have jru ~t don1;;, can sh°"'-n more forma]]y in an incon1e
statem, nt.
Ubenus provides the foUowing inforrna:tion whkh is a ]i.st of the nomina] ledger
ba]ances he extracted frotn his ledger on 31 July 2014 after one years trading.
• Sales: $Z79 988
An income· statement shows how the· Furchases of goods 6oc resaJe: $201 760
business. has performed over a peir~od of Paytnents made - wages: $41215; n1otor expenses: ,$ 8960; ]ocal taxes: $1800•>
time whereas the statement of fin.a nciall advettising: $2430; insurances: $1540; other expense.s: $9610.
pas irt~ on shows the fina ndail po s.rti on of Ubertus incotne stater:nent for the year ended 31 July 2014 wiU include the
the busine5s on a particular date . infom1ation above~
This point i1s ~dent~f1ed fr11the headings -
Ubertus
make· sure that you use them as they a re
important. Inco me statem ent forthe yea r ended 31 July 2014
Dr er
$ $
Reve nu.e 279988
ln income statem,ent, we use 'rev,enu,e' less e~penses
~nstead of •sales'. Purch.;u;es 20 1760
Wag,es 41 215
Mot or expenses 8960
Local taxes 1800
Advert~siri g 2430
Insura nces 1540
Other exp ens.es 9610
Total expenses 2673 15
Profit for the year 12673
43
II Preparing simple financial statements
This is a vecy simple inco1ne· statement.
The differ nc, b rtw, n the sal s r~nu~ g, n~rated and the cost ,o,f th good - ~ o!d
is call d gros profit.
'Wi sha]J develop th~· fayout in furur chapters wh re ·w , ·wiU cons:ider adjustments
EO n1ake the statcn1:ent mor(:! accurate ~nd revea] n1ore infom1ation.
> Now ry Question 1.
6.4 Statements to show financial position
Theti-e are other types of account in a generai ]edger.
Some accounts in the ]edger record the purchase of assets· son1e reco1·d liabilities
incurred by the business. Accounts in the purchases ledger show• credit transactions
with suppHers, ·wlhUe accounts in the sales Ledger show credit transactions with
customers. Balances fron1 these accoW1ts wilJ be used to prepare a statement of
financial position.
A statement of ftna nda] position Usts 'the assets nwned by a business and [iabiJihes
owed by a business. The total value of assets hdd 1nust equal the total value of
JiabiHties.
Exrernal UabUi'Ei~ are an1ounts cmted to peop]e or businesses that a re not the
own~ . The differenc b tween the an1ounts owt:d 10 •t,emaJ ct,t:ditoi and Eh
as heid by a bu ~in
ets i b."nown as capital or :n t a s . It represents the an1ount
of Eh own~r's inve tnct'lt in their business.
Heidi provides the foUowing balances exu-acted fron1 her general ledger:
Pren1ises $65 OOO· n1ortgage on prernises $35 rQOO; vehide $12 OOO; an1ount o~ving to
bank for vehide purchase $4000~ bank balance $1200.
Required
C]assify the inforn1ation given into assets and HabiUties.
Cakulate the value of Heidi s ·C apital.
1
Answer
... Assets: Premises, vehide and bank ba]ance ($65000 + 12rQOO + $1200 =$78200)
Liabilities: rviongage on premises and amount ~ring to, bank $or v hide purchase
=
($55 OOO + $4000 $39 O:QO)
~ Capital =Value of a,ssets less va]ue of HabiHdes
=$78 200 - 539 OOO
=$39200
Katnil provides drie foUowing infom1ation that he has extracted fron1 his Jedgers at
31 Ju]y 2014:
Dr Cr
$ $
.Bank ov·erdra,ft 2200
Long-term bank loan 8000
Machinery 10000
Mortgage on. premises 25000
,Premises 40000
Vehk l~ 8500
Trade pay a,b les 800
Trade receivab les 1 500
44
6.4 Statements to show financial posit~on
Additional buorinarion
Inventories a re goods that have been
purchased for resa,le but havet as yet not Th inventory held at 31 July 2014 was valued at $2000.
been sold. R qui1 d
Pr par a statem,ent of financial position at 31 July 2014.
Answer
Kami I
Statement of fi nandal position at 31 Ju Iy 2014
s s
ASSETS CAPITAL AND LIABILITIES
Inventory 2000 Li a bi Iities
Machine,ry 1'0000 !Bank overdraft 2200
Premises 40 000 1Long-term bank loan 8000
Vehicles 8500 Mo rtg a-ge O·n pre mi,ses 25000
Trade receivabh!S 1 SOO Trade payables 800
36000
Capital (net asseis - dilferen.ce betvveen the 26000
va Iue of assets and exte rn.a I ,Iiab Mities)
Total assets 62000 Tota I capital and Iia bi Iities 62000
Tllie information detailed in business books of accounts can be used to show the
profitability of the b usiness and also to show i.ts financial positions. A tnore fom1~.d
••••••••••••••••••••••••••••••••••••••••• a nd stn1ctured Jayout o f a smten.1ent of financial position wiU be considered in greater
> Now try Question 2. detaU in Chapter 14 (Se ction 14.3).
N onaki p1ovi des the foHo v.-ing Us t of baJances e..-nra cted from his Ledgers at 30
Novro1beJ" 201.4~ after his :first year ,o f trading:
Dr Ct
s $
Bank overdraft 1700
Sa,les 167 880
Pu rchasll:!s 87 500
Wag~s 537 10
Hieat•ng and 'liighti ng 1900
Rent a,n d loca ~ taxes 4890
Vehides 900 0
Moto.r expenses 2 540
Eq.u1pment 6700
Genera I' expenses 1 780
1
Additional infol'mation !
Inventories he]d v...·ere valued at 4370 at 30 Novemb r 2014.
Required
Prepare:
an inoorne statement fo r the year ·e nded 30 Noven1ber 2 0,14
a statement o f financia] p osition at 30 Novetnber 2014.
45
II Preparing simple financial statements
Wo1·kbtg
The purchases show~n in tb~ inc,om .statement is a measure of th,e goods b ought and
t1 ed as sa] . The ngure of S 7 -oo is the value of the oods purcha '" ed for resaJe.
Iio,v.,ever, die additional informati,o n tells u.s Ehat not aU o.f the good!s wer,e in fa,ct
so]d. G,oods to the;; value;; of 1437,0 remain u:nso]d art the end of the financial year~ so
d1c p ur,chais es ~used' to genet-atc profits was $83 130 ( SB7 5,00 less 4370).
1
Answer
Nonaki
Income statement for t he year ended 30 November 2014
Dr Q
s $
Reve nue 167 880
Less purchases 83 130
Gross p roiit 84 750
Less exp enses
Wages 537 10
Hea.ting and Iigniting 1900
Rent and locaI ta,xes 4890
Motor ID::p e·n ses 2540
Genera1 expenses 1780 6482 0
Profit for t he yeair 19930
Nonaki
it is usua:I to put ~n subtotaifs for each Statement of fi na ndal position at 30 November 2014
separate area, e .g. non-current assets, $ $
current assets, non~curren1 l~abil1itiles and ASSETS CAPITAL AND LIABILITIES
current Iii abml 1 ti e-s. Vehicles 9000 Liab ii iti es
Equi,pmer.it 6700 Bari k overdraft 1 700
Trade receJvables 3900 Trade payables 2340
1nventori es 4 370 4040
Total assets 23970 Capital 1gg30
Total capital and liabili1ies 23 9-70
1 The 'left s~d!e of an account adds 10 $349. Th e dght side adds to $421. What
1
46
6.4 Statements to show financial positjon
A tri1al lba,ance is a summary of a,ij the bailances remaining ~n the books of account
(usually extracted a1 the finandal ye,ar ·end).
The ba~ances are arrang,edl jn a de·bit coium1n and a creda column.
The 1otals of the two columns shou~d be the sam,e·.
~f they a1re equa1l1 ~t generally ~ndicates that every deb~t entry has a corresponding:
c:r,ecHt entry (see Chapter 10).
The informa11i,on con1a~ned in a trjaJ balance can be used to fPrepa1r,e two stat ements:
one caku~atJing 1:he profita,billity of the lbus1iness and 1he other showing the ais5ets and
ies of the business.
ljalbdirt 1
47
Accounting principles, concepts
and conventions
By t he end of this chapt er you should~
• unders1air1dl the genera1llly accepted pr1ncip!es,
concepts and conventjons of: business en11ity;
h~stoflic cost; money measurement: g:o:ing1concern;
cons~stency; p1rudence: realisar1ion_ duarlhy;
maten al tty; 1ma1chi ng (accruals); substance
over form .
Over d1e years accounting has evolved rules durt an accountants use when preparing
lhe finanda] staten1ent.s of a business. These rules are referred to as accounting·
con cepts or accounting p d .nciples . Sorne of these principles are enshrined in
Jaw .and in IntemationaJ Accoundng Standards (IAS) kdd down by n1aji0·r .accounting
bodies (see Chapter 36).
The appikation of these ndes by aU accountants tneans that the users of the
financial statetnents can rely o n the infonnadon they contain, safe in the knowledge
that a set of financial staten'lents prepared in Kingston, Kuakii Lun1pur, Karachi or
KaloJ for any type of business have been p:r,e pared using the san1e· ground rtile.s.
The concepts are an important topk: they underpin a]] of the work done by
accountants. Make sute that you are familiar with thea1.
7 .6 Prudence
Prudence requires that revenues and profits are only induded in the accounts when
they are realised or their reaUsaUon is t-easonabJy certain. This prevents pl'oftts fro1n
being overstated. If year end gro~s profit is overstated, then Ehe profit for the year wiU
also be O\ferstated. If pr,o,ftts are overstated. a trader ,nay withdraw tnore resources
(money and goodls) fto1n the bu:dn "S than is wis .
Thi could l ad to a po itio11 wh re as ets couk111ot b replaced wh n necessary
or that trad payabJ s could not be;; paid Vv·hen due. I low ver, th cone pt of
prudence aUo,vs provisio,n to be made for aU kno'w n expenses or losses " "'h en they
bec-on1e known. For e.'1:ample, if damages \Vcte awarded against the business in a
court case, the business cou]d n1ake a provision on th~ estio1ated amount that it might
have to pay out in cotnpensation.
49
II Accounting principles, concepts and conventions
7.7 The realisation concept
Title is the Ieg all term, 'for ownership . Fo,r The realisation cone pt ~tat -s that profits are normaUy l oognis d when the title to
example, tit le deeds to p,remises sh.ows that th goods pass to th cust,omer. no·t nee s arUy wh n tnoney changt!s hand- . Thls
the holder of the deeds is the owner of the ,oonoept is an extension of the lnatching or acauals concept (see -ecdon 7.10).
premises.
Fiona is an engin eer. She is fairly certain tha t~in July, Jack '14,T iU sign a contract to
purchase 1nachi.nery valued at $18000. The $18000 sbou]d not be induded in Fiona's
financial staten1ents until the tide to the n1,a chinery has passed to Jack:.
When goods are sent to a custo1ne1· o n sate or return, a sale does not take place until
the potentia Lcuston1er indicates that they wish lo purchase the goods. Goods sent on
.a sale or retiun basfa ren1ain as inventory in the 'sen der's' books of account.
7.8 Duality
Every financial transaction has a twofo]d cffc-:ct on the posidoo of the bU$in,e~s as
f ,ord din Eh · books of account The asset of bu ine are a[way equal to the
JiabiUd~s. Tb· effect is r ·ogni.sab]e in the aooounting quadon (s, e ection 14.4) and
in th double-entry book..kc.,e,pi:ng system. For example, wh€-n an ass,e t is purchased
either another asse1 is reduced or a liability is incurred.
A business pujcbaises a ruler. The ruler costs $0.45. It estimated that the ruler s ho uld
fast for three years. TechnkaUy) the ruler is a non~cur rent asset and should therefore
be dassified as capital expenditure. To do this ,votdd be rather si.Uy for such a trivial
amount. The i0.45 wou]d b e treated as revenue expenditure an d wou]d be debited to
dther generaJ expenses or office expenses.
This treahnent is not going to have a significant in1pact on profits or the valuation of
net as.sets on a statetnent of finandaJ position - the absolute accuracy of its 't reaunent
is not ,naterfa].
50
7.10 The match~ng ,conc,ept
Juanita has a finanda] year end on 31 Dece1nbe.r 2014. The following amounts have
been paid dudng the year ended 31 Decen1ber 2014 :
s
Wag,e·s 48000
Rent 5 500
locaI tax·es 11800
Insurance 2100
Mo1o r expe,nses 14300
Wag s du 'to, workc---'1s for work completed in tbe w k 24-31 Doo nlb r 2014, but
unpaid 1 amount to $970.
Rent $500, for Deoernboc 2014, was paid on 19 January 2015.
Loca] taxes. have been pa id for the period ending 31 March 2015,, $4 50 relates to
l January· - 31 March 2015.
Insurance includes a prerniu1n $300 fot· the period 1 January- 28 February 2015.
Motor expenses do not indude $236 paid on 27 January 2015 for a vehide servke
con1pleted on 15 December 2014~
Required
Cakulate the mnounts t o be indud·e d in an incon1e sta~en1ent for the year ended 31
Decetnbei· 2014 in respecr of wages, rent, Joe.a] taxes, insurance and motor expenses.
Answer
• Wag.es: $48 970
Jua.nita bas used $48970 skiUs and expettis~ of h r work rs during tht:= year even
Ehou h she ha " only paid them $48000.
• Rent: 16000,
Juanita has had the u.s,e of premises "rotth S6000 to, her; even though sh,e had only
paid SSJOO.
Loca] taxes~ 813 50
Juanita has used local governn1ent facilities va]ued at $1350 fol" d~e year. She has
aAso paid $4Sn for the use of fadJities in 't he fo]]owing. year - we are not, at the
.n1oment > interested in the figures relating to next year.
Insurance $1800
The payn1ent of $2li00 indudes &300, ~or insurance cover next year. This means that
only 1800 refers to this year.
• Motor expenses: $14536
The se1-vice was con1pteted in the year ended 31 Decenlbet 2014 even though it
was not paid fot until th,e foHowing year.
51
II Accounting principles, concepts and conventions
7 .11 Substance over form
This principle ~ nsur s that ananda] tatetn nts obs :-ve tb comm rcia] substance
of transacdon rath r than ju t their J gal form. In most transactions oommer,d aL
St.1bsranc is th sam, as the l gal form but oocasionaHy the accounting treaanent is
1
Accounting concepts and pr'iindples a1re the bas~c ruJes of accounting. They should
be apphed to the recording of aU transact~ons and the preparation of aH account~ng
s1:a1ements.
52
Closing down the double-entry
system
By th e e nd of this chapter you should be abl e t o:
• dose appropdate accounts ~n the g,eneral 1,edger
• 1rainsfer aimou1nts.·horn the nomi1nal accounts in the genera~
ledg:er to· an 1income sta1ement
• tr ainsfer a1Iba ~a nee·from ain income statement 10 the
pro prietorrs cap itai accoun1
• show deta1ills of changes to cap~tall as a caiaula1t~on and in
account iormat
• prepa1re an. 1inventory account in the g·eneral ledger
• va.lue inventory by usj ng cost oir net re·al ~sa bi@· vallue
• id enfrfy and cal aulate the effect that a change rn ~nventory
valuation w ifi have on reported profi1s.
\Ve have s,e en how the doulbie-ent:ry s.ysten1 works. The s.ystetn :re) ies on the basic
principle:
Th FoUowing transactions took plac duling the year ende 31 Augu t 2014 for
Ghola. All transa cttions V.1'.~ · pa id by eh que:
26 epteinber 2013~ purchase of vehicle $17 SOO
30 Septetnber 2013~ payn1ent of rent .$700
11 October 2013: purchase of vebide $16900
1.7 October 2013: payment for advertising S120
l Noverr)ber 2013: paytnent of wages $13200
23 Noven1ber 2013: payment for .adveL'tising 12600
31 Decetnber 2013: paytnent of rent $700
• 1 February 2014: paytnent of wage:s $13 700
31 M·al"d.1 2014: pay ment of rent 700
• 31 !\.'larch 2014 : payment of local taxes $1300
• l May 2014: payn1ent of ,vages ·12 900 1
53
II Closing down the double-entry system
Answer
Dr Vehicles account Cr Dr Rent ace,ou nt Cr
$ $
26 Sept 2013 Baink 17 500 30 Sept 20 13 Bank 700
1 t Oct 20 13 Bank 16900 31 Dec 201~ Bank 700
31 Mar 2014 Bank 700
30 June 2014 Bank 700
finished w ith for Ebe year in question . Not .aU accounts wm be closed down. Soine
accounts that record inccmes ~nd expenses
such as pu tch ases, sales, wa ges rent payable, a,c counts contain information that is re]evant to the bu.siness>s activity in the futu.re.
1
rent recervable, motor expenses, etc. In fact we only dose down th~ nonrl.ttal accounts in the general ledger since
·the information they contain wiU be used to ,c akufa.~ ·t ha,t year's pro.fit. Th 1· al
account will r main t,o carry th it infornu1Jtion through into th foUo\\ring y ar.
Real ac~ounts are general ledger
accounts in which the purcnase and sale How are the nominal accounts closed?
of non~cur:rent assets and cash and bank
transactions an~ recorded. Real accounts The nonlina] aaoounts are dosed by transferring the balances o n each account to the
wou l'd include la·r.d, prem~ses. ph1mt, income statement , which should be found in the general Jedger.
rna chi1nery, off.ice eq uipment. vehicles, cash
IdeaUyt the incon1e statement ought to be in the genera[ ledger. In real ity h is
and bank baLan ces.
rarely kept in the gen eral ledger. The infonnacion contained is of a sensitive nanire
so it wiU generaUy be kept separate]y fron1 the rest o f the genera [ ]edger in a private
l edger.
A private ledger is part of the genera.t
A private ]edger is kept apat1 from the general ledger for obvious reasons. Other
,edger and is k-ept separate. It conta ins
acco un1s of a. sensitive 11a1ur-e tnat the accounts that the owner of a b usiness n1ight wish to keep in .a pdvate ledger may
owner of a business does not wish others ind ude the capital ac,c ount or an ac,c ount that shows Joan transactions 3 etc.
to see.
The accounts shown ia the books of account of Gho]a, above, w·ould b dosed as
foUow :
The nominal accounts ar transferr d to th incom statement. Th tran<Sfer~ "'iU
dose: the accounts for the year in question and ·will ]eave them dear to start! a new
:fi.nandal year.
The accounts and tthe in,oome staten1ent are as foUows:
54
8.1 Closing accounts in the ,general l~dger
No Eice that cre dit entries ar-e made u sin g d oub le -entry p rinciples; e ach credit in :a.
nominal account is nu1tche d by an entry in the lnc,o me stat,"1l'lent.
Th v bjd ac,oount and bank .account stay open sine we will \JS these accounts
n ."'c year.
Th purcha es, sa]es~ purchase r, ums aod sa]es retum .accounts v..iH b ~ dos d
using the same techniqu e but the b a tanocs o n. those a,c counts are· transfen-ed to the
trading accou nt of the income state.tl'le nt.
No t only does the d osin g of the nominal accounts provide us w ith info m,adon
to e nable us to calcu] ate the profits tna de by the b usiness, it also e nables us to h ave
55
II Closing down the double-entry system
a fte-sh sta tt in the gen.eral ledger non1.ina l ac-coun[s next year. Imagine if we did no,t
tidy out th~ accounts on an annual ba is~ ome ac,c oun ts would have hundreds of
thou ands of entri 1fter 20 y ars!
Th nd is that a]l accounts providing us with in~orn1atioo 'thait is r, ]evant to o n
financial year are dosed down at the end of that year - the other accounts :r,c main
in the books o,f accou:nt as baJ an.ces to .start up the syslcn-1 ag,a in next year. AU these
r,e maining bala nces show the financial position o f the business - in the statement of
financial position o n the fina] day of the finan da] year.
The foUowin g Ust of balances has been extracted from the books of Patel~a trader,
.after bis ·first year of trading:
custo mE!lrs.
Land and buildings 60000
Flxtu res and frttfn gs 7000
Vehides 21' OOO
Rent, local taxes and insurance 5430
Lighting and heating expenses 7980
'Motor expenses 9260
Repairs aind renewal5 1 780
Wages 14320
Trade receivab,les 1 740
Trade ,pa,yables 1490
Dra·wings 2 170
Ca pita I 70000
Casn 480
Bank balance 1 840
174600 174 600
Answer
· Th foUowing a,ccounts wiU b do'"ed ~they nre aH nomhia] accounts): purchas s,
sal, s, rent~ ]oca] ta. e.s and insurance~ lighting and h atin , :m ot,o r ,e xp n · =- \ r pairs
and renewal~ and wages.
5'6
8.2 'Closing' the income statement
b Patel
Income statement for the year ended 31 December 2014
$ s
Revenue 103 11 0
Less Cost of sa,1es
Pu.rc:ha s@~ 41600
Less Invento ty 11 010 40590
Giross p rofrt 62520
less Expenses
Rent. bcal taxes and insurance 5430
Li ghtirngi and heating 7980
Motor expenses 9260
Repairs c1 nd rein e-..-va Is 1 780
Wages 14320 38770
Profit for the yea,r 23750
The income statement is ~d osed" w ith the pront for th,e year caJcufatioo of 123 750.
The profit for the year is ent~red ·o n the credit side o f the capital account in the
general Jcdgc1", thus increasing the an,ount of capi.tal invested in the business by the
C
Patel
Statement of finandal position at 31 Dece·m be r 2014
$ $
ASSETS
Non-c.u rrent assets
land and bui ldings
1
60000
F~xtures imd fittings 7000
Veni.cles 21000
88 000
Cur rent assets
Inventory 1010
Trade recei:vables 1740
Ba,nk bal ance
1
1840
Cash 480 5070
Tota I assets 93070
Current liabilities
Trade pa.yab les 1490
Tota I capital and liabi Iities 93070
57
II Closing down the double-entry system
Draft: a,n attempt to prepare a statement
or docu ment which may need to be Th · fon owing draft lis t of baJanc has been ·"" tracted from th books of a,ccount
amended before It ca,n be said to be a
of Mischner on 30 Jun 2014 an r her first year o f trading. The, . are three missing
,perfect copy.
figures. The accounts that wi]l provide 'the missing figure are shown b lo°"'r the ]ist
Dr Premises account Cr
s
1 Ju~y 2.0, 4 l8ala,nce bid 80 OOO
R equired
, Con1pJete the list of balances and ,e nsure that it ba] ances.
Clo se the relevant accounts show n.
· Prepar·e an incon1e s tatement fo r the year ended 3UJune 2014.
Pre pare a staten1e nt o f finanda~position at 30 Ju ne 2014.
Answe r
Tht> balanc totaJs ate S475 23,0.
The r,e pairs account is dosed by a er dh ,e ntry of 2460~ the general ,e p nse
account is closed by a er ~it entry ,o f 813490. The p rem fs,e s account shou]d no t b e
d osed down - the pre mfscs wiU be ·used by the busin~ss in subsequent years.
58
8.2 'Closing' the income statement
C
Mischner
Income statement for the year ended JO June 20 14
s $
Revenue 317830
Less Cost o'f sales
Purchases 1'28360
less Inventory 6480 121 880
Gross .profit 1195950
Less Expenses
Wag es 119000
Rent and loca taxes
1
11 14670
Motor expenses 21630
Repairs 2.460
Lignting, and heating expe nses 9710
Generail expenses 13490 HW960
Profit for the year 14990
cl Mischner
Statement of financial position at JO June 2014
$ $
ASSETS
Non ac.u rrent assets
Premises 80000
Ftxtures a.nd fitt1ings 17000
Veh icles 34000
131 OOO
1
59
II Closing down the double-entry system
Mischn~t' capital account in tht! gf.!nt::ral l dger wou]d l.ook lik thits:
It is useful and usuaJ to show aU the detaUs contained in the capital accou nt in the
staten1ent of financial position, as we .have done above and in previrnns examp]es.
Dr Inventory account Cr
$ s
End of Year 0 Deducted from cost of sa:les 1234
(now) in income statement
At th nd of th fo]Jowin yean
1
60
8.4 Valuation of inventories
Dr Inventory ac.count Cr
s s
End of Year O Deducted from cost of 1234 Start of Added to cost of 1234
(inow) sales i1n jncome statement Year 1 sales in income
1
statement
End of Year i Ded um d from cost of 23 45
sales in .in c:mne statement
$ $
End of Year Deducted from cost of 1234 Start of Added t o cost of sa Ies 1.234
0 (now) sales •n income statement Year 1 in income statement
End of Deducted from cost of 2345 Start of Added to cost of s.a Ies 23~5
Yea.r 1 sales in incomc1! statement YeG!r 2 in i1ncome statement
End of Deducted from cost of 3 4 56
Year 2 sales in 1iflcome statement
The dosing inv<...~tory is deducted fro,m the cua<Jnt year's cost of sales (since it has
n ot as yet been sold) .a nd the ba}anoe in the invent:ory aacou.nt is shown in the
statetnent of fi n ancial position as a CUlTc.-nt asset.
61
II Closing down the double-entry system
The use of net realisable v"aJJue causes probl,e«1s for rnany .students.
.R equired
CaJculate the tota] value of the inventory of components heJ.d at 31 August 20l.4.
Answer
Tota l value o.f inventory of components =$1309.
\Xii rkin2 ·
$
PX/11 7 at cost 336
QR/2183 at cost 53~
T/1798( at realisabJe va l,ue (selHng price) 120
S/5319 at cost 320
Note
• Re-aHsab[e value is seH ing price.
• Net reaUsable value is the reaJisabJe value net of (less) any expenses incurred in
•••••••••••••••••••••••••••••••••••••• •• • getting the goods ready for sale.
Now try Question 2.
1 Nam.e the ~pe ·Of accounts that are dosed down ait the end of the financia l
year.
2 Why do some traders keep a prwate ledger7
3 Wha1 entdes are req ujred 'to dose the fo Hawing accounts 7
Account Debit Credit
Rent p.ayable
Discount received
Purchases
62
8.4 Valuation of inventories
A1 the end of each f~nandall year the nominai accounts ~n the g.ene-ral ledger ar,e
dos·ed by transfernng the balances to an income statement.
Real accounts are not dosed and are shown on the statement of f~nancia1~pos~t,on.
• The prof~t for the year 1is tr ansierre d 10 the cap ltall account
lnventcr~es are valluedl at 1:,he lower of cost or 1net reaHsab~e va1lue.
Ne1 realiisab!e value is the semng1prke of the nems he1d less any costs that m1ight be
~ncurred ln making the items ready for saite.
63
Accruals and prepayments
Wben calculating profit, accountants are intei-ested in accounting for the resources.
A trial balance is a l1ist of t he tota~s of a,11
that the business has used during the financial year to generate the revenu-e rec ipts
l,edger accounts as thiey appear ,in all thie
ledgers.
1
for that am y ar.
~'hen pt p anng financial statetnents. a trader n1u~E include aU items of
,expenditure) paid and payable.
This sounds a Utde strange at ,fin;t bu:t it wiU soon becot11c dear.
Wh.en we pt·epare a set of financial statements we need to i:ndude a U the itemcS
that app[y to the accounting period under consideration.
Sotn e expenses Usted in a trial balance are always paid in advance , for exatnpie:
• insurance has to be pa id in advance
• local taxes are generaUy paid in adva nee.
64
9.2 Deal~ng with accrued expenses
Lori runs a sn1an stor . he has sigood a tenancy agreen1ent with her ]and]ord, stating
that s he can use the store premises for the next Ave years on payment of a. rcnta1. ,of
$6000 per annum payable quartedy in. advance on 1 January, 1 Ap,riJ~ 1 July and
1 October.
At 31 Decen1ber 2014, Lori's fi n anc ia[ year end, lori has only paid her landlord $4 500;
she stiU owes the rent that was due to be paid on 1 October.
TI1e an1ount shown on Lori's incotne statanent as an expense for rent is $6000
since Lori has had the use of a resource (the store) worth 6000 to he]p her generate
her profits.
Dr er
$ $
Rent payable 4500
Trade payables a re amounts owed to the Wh n prepar,e the inc,o me staootnent: for eh year ended 31 DecenlJbetr 2014; th,"i~'
'We
SILJ'PP l!iers of goods for 1
resa!e. entries shown above wou ld show;
Extract from income statement for the year ended 31 December 2014
Other payables are amounts owed to the $
supp ~ie rs of goods and services. other than Expenses
those goods purchased for resale.
Rent payable 6000
But this cannot be totally correct. Lori has increased her debit e ntries by $1500 V\dth
no corresponding increase in her credit entries. She needs to include an extra credit
Trade receiva bi es a re amounts owed by
in her finandal sra1en1ents - rent payable o\\1ed at the year end.
credit customets w ho have not y-et settled
th eiir account. ln the statement of financial posttion prepared at the year end, tt·ade payables
represent ~unounts ovled to supp,liets ~vho have suppUed goods but who, have not yet
been paid. Since the· rent payable is ov., d at th date when the stat,e ment ,o f ftnandal
Other receivables are a,mounts owed by position i.s prepar, d. this ·t oo must b a payab] .
peopJe (or businesses) who are not credit Lori has us ed h r premi.s s and 110t y t fuUy paid forth ir u ..e. Rent paryabJ~ mus't
customers. be sho~·n a oth ,. payab! : a cutTent liability·, along with the trad payables.
Not@
• The statement of financiaJ position h as. not been credited.
• The statement of finanda] position is not part of the double-entry systen1; it is
i.n erely a sta.t ernent sboV\-Ting bala nces outstanding at the end of a financial year.
• The outstanding rent is included .in current Habilitie.s with other credit balances (for
exa tnp]e. the trade _p ayables).
65
II Accruals and prepayments
9.3 Dealing with prepaid expenses
o,m etimes a busin ·ss wiU pay for services 'b fore it actuaUy r eives the s rvlces.
lnsu.ranc , for exan1pl , has to b pa ld for b for, cover i pro\lid d. · ome l,ccal taxes
a~ also to be paid b fore tb period for which they ar due;:.
Since we are accounting for resources u scd :i n the pedod covered by the finandaJ
statc:~ents, any atnounts paid in advance n1ust be disregarded.
$
Jrnsurances 23 00
Local taxes 1200
Answer
Lori
Extract from income statement for t he year ended 31 December' 2014
s
Im su rain ce 2 200
Local taxes 900
Lort does not indude the $100 paid :far ne..?:t y.e ars insurance cm~w-r or the 300 for
ne.xt year's locc,l ta."t'l!S. he onJy includes the pay1nents made to acquire the resources
'£hat have been used to run h r busin,- s tbiis year.
But it cannot b tight to reduc lh t\\-·o exp ns s without corr, spending ntri.e s.
'W4 can r due debits by increasing er~ Hts.
Jn ffect Loti has credited insuranc with S100~sh has cr,e dhed Joca] taxes with
300,. · he ne<..."<ls to indude two extra debits - two cxtta rc"Ceivab]es.
Lori's staterncnt of 6nandaJ position at 31 Decenmer 2014 wiU .show~
66
9.4 Recording accrued expenses and prepaid expenses in the ,general l~dger
1
Du ring the year e nded 31 Decenher 2014, Ja ha ngir has pa id w ages of J443 4 08 to his
1
staff. Tbe suni madsed e ntries in the wages account are s.ho,vn:
Dr w ·ages account er
$ s
Banik 1'27 938
Bank 89267
Banik 131442
Banik 94761
At the financiaJ year end, Ja ha.ngir owes his w orkers $2793 for work co1n pJeted d uring
D ecen1.ber 2014.
Requit-ed
a Go1npJete the V;rages account for the year e nded 31 Decen1ber 2014.
Show appropriat,e e ntries in the finanda.[ statetne nts.
Workings
At the year endjahangir owes his workers $2793. Th is accrued expense is ow,ed at
the finandaJ year end - therefore it is a credit (a payab]e). It has to b e sho"'n as a
credit in Eh~ books of aooo,u nEat tht= start of tb next financial year.
Dr Wages account Cr
$
The rules of do ubJe e ntry n1ean we cannot n1ake a credit e ntry w ithout a
corresponding debit entry. Enter a debit e ntry· 'above the Jine' to con11ptete the
double entry.
Dr Wages account er
$ s
8 a 1a nc~ bid
1
Tot a] the accoun t a nd transfer the a djusted an1o unl to the incon1e statement.
67
II Accruals and prepayments
The bafance left on the ac,c,o unt at the financial year ,e nd is shown on rbe stntetnen1
of nnancia l po.sitio:n a a current H~b:iUty - th amount that stiU has to bt: paid 'to
Jahanglr~ smff.
Answer
Dr Wages account Cr
s $
Bank 127938
Bank 89267
Bank 131442
Bank 94 761'
8al;mce d<l 2 793 Income statement 446201
4462011 44620 11
8 ala,nce bid
1
279·3
b EKtract from income statement for the year ended !11 Dece mber 2014
s
Expenses
Wages 446201
Josie has paid l. 798 for insurance at 31 Dece1nber 2014. Th e stnDn1a1ised entries are
shown. $340 ha b n paid in advance for insuranc in 2015.
Required
Prepare the insurance account far the yea r e nded 31 Dece1nber 2014.
Show appropriate entries in the fina ncial staten1ents.
Workings
At the financiaJ year end the jnsuran ce con1pany owes Josie 340; therefore it is a
receivable. It h as to be sh ov.711 as a debit in the books of account at the start of the
nel.'1 Hnan c-bd year.
Dt lnsuran,e account er
$
'Balance bid
1
340
Ren1en1ber every debit entry needs a co1Tesponding credit e ntry.
68
9.5 Dealing wrth ,outstanding revenues and revenues paid in advance
Dr lnsuranc_e account Cr
$ s
340
Bal.ancEl'! bi d 340
Answer
a Dr In su ranee ace,ou nt Cr
s s
Bank 61 0 Income statell'lent 1458
'Bank 720
Bank 468 Ba lance cld 340
1798 1798
8alance bid 340
b E>c:tract; from income statement for the year ended !1 D~ember 2014
s
!:xpenses
tnsurnnce 14S8
Lori sublets the roon-is above her shop to Da n for a. rental of $SO per week. At 31
Decentber Dan owe.s two weeks' .rent.
Lods inconie staten1ent wou]d s how a fun year's rental income o f $2600 even though
she has only actuaUy rece·iv-ed $2500 fron1 Dan.
69
II Accruals and prepayments
1
:H ua. works on con1mission for He nri. Hu a has eam e d $5320 oomnussion for the year
ended 31 January 2015. At 31 January 2015, Hua has received con1imission payments of
$6000.
Re quired
State the an1ount to be entered in Hua's incon1e s1taten1e nt for the year e nded
31 January 2015.
Cakufate the atnount to be shown in the staten11ent of financial position at 31 Janwuy
2015. Na1ne the section of the ~"iate tnent of financial position in 'w~hich it "'wi1J appear.
Answer
c The amount ·r obe sho,vn in the income statem,e nt is 5320. This should be shown
a an additio,n [O th gro s profit.
$680 is hO'wn under cunent UabUide ~ in th~ stat ment of financial position. (Hua
ow H nri $6 0 at th nd of the financial year.)
Gerda s ublets part of her premises to Co] in for f6240 per annui:n. At Gerda '.s financial
year end, 3 1 Ju]y 2014 GoUn bad paid 1,6600 rent.
Required
State the an1ount to be entered in Gerda's incoine statetnent for the year ,e nded 31
July 2014.
Caku late the an1ount to be· shown in the staiernent of flnanci.a] position a·t 31 Ju1y
2014. Nan1e the section of the statement of fina ncial position in which it ·wiU appear.
Answer
n, amoum shown in th · incotne .smtentet1t is &6240. This should b add d to gro s
profit.
L $·360 is . hown as a curr,c nt liabiHty in the statetne nt of financial position.
. 4.rnounts
. ou1ed for expenses by a business at the financial year e nd are usually
totaUed an d entered in the statetnent of financial position as a current Babil:ity. The
toud is shown as 'other payables'.
An10runts paid in advance· for e}.."J)enses by the business a t the financfaJ year e nd
.are usuaUy totaDed and entered in the staten1ent of finanda] position as a current
asset. The total is shoVti"TI as 'other receivables'.
Atnounts owed to a business for couunlssion receivable and rent receivab le a l"e
ll!suaUy added 10 receivables.
8 The amount of an expense on the tri al ba~ance is always entered i1n an income
1
statement True/fa1~se7
9 A receivable ~s a1current a,sset. True/Fallse7
1O A pa1yablie is a current asset. lfiue/Fajse?
11 Money pa~d for the next finandal year's rent is a1cuirre1n t asset. lirue/Faise7
12 Mlo ney receiivedl from a tenant for next year's rent i1s a current aisset. True/False?
70
9.5 Dealing wrth ,outstanding revenues and revenues paid in advance
We a,ccount for resourc-es used during a iiinaindal year, not m·one,y pa~d to .acqu1re
those resources.
The accruals concept recog1ntses the difference betvveen 1he actua~ pa~m1ent of cash
and the leg1al ob Ii g1atio·n to pay cash. Accriu al s a re current I~abJ ~1ities. !Prepayments are
c:uirrent asse1s:.
The concept ail!so recagnjses the dFscti1nct~on b@tiVeen 1he actual receipt of ca,sh and
the f.eg1ail ri1ght to rec,ejv,e cash . Cash rece~,ed before n: ~s due is a current ~~abi~irty. Cash
owed but not yet paid 1is a current asset
71
Control systems the
trial balance
By t he end of this chapt er you should be able
to;
• prepare a tria~ balance
• expla~n the uses and ~ 1m ~at~ons of prepar~ng a tdal
bala1nce as a1co n1ro II system
• identffy ·e1rirors n01 revealed by extract~ng a triai
ba1la1nce.
nei, O\vns and nins a shop seUing dothes. Th,e foUowing transaclio,ns have tak,en
pfact!:
neh 1s cash sa]~s a_mount to $612
he purchases trouser from Caitlin $129 on er dit
neh sells a shirt and shoes to Upsala $76 on credit
.she pays rent for bcr shop $250 cash
she purchases shoes !j45, .For resale, on er.edit fro111 Rohh
Sneh pays wages $166 using cash.
Requir e d
Enter the transactions in Sneh's ].edger. Carey down any balances. Extraot a iria]
balance to check the accuracy of the entries.
72
10.1 The trial bal,ance
Answer
Dt Cash account (GU Cr Dr Sales acou nt (G L) Cr
$ $ $
612 250 612
1:66 76
A trial ba lance is made up of the lbaJan ces extrac1:!ed fran1 the ledger. lt suom1artSes
the balances in an the ledgers.
••••••••••••••••••••••••••••••••••••••••• If you consida- 1he few ttial ba]an ces that have been prepared a pattern has started
> Now t ry Question 1. to e tnerge.
73
11:1 Control systems - the trial balance
A triaJ baiJance wiU show balances tbtts:
Answer
Wages: Expen se/Debit
Preinises: Asset/Debit
Biko·: liability/Credit
Advertisin g: Expen se/Debit
Sa l,e s: Incmne or benefit/Credit
Bank overdraft: LfaJ biUty/Credit
Th foUo,w ing balance· have be n e.~tracted from tht; I dg r.s of Lak umana on
30 AprU 2015:
buM.dings $120000; 6xturcs and fittings $45000; van $1.4500~ tnotor expenses
416o; rent 7000; local taxes $2400; insurance 2100~ cash in hand $120· balance at
bank $3,670; trade receivables $850; trade payables $ 120(}; sales $26o 000; p urchases
1
Answer
Laksumana
Tria l ba la nce a t 30 April 201 5
Dr Cr
5 s
18 uildl,ngs 120000
Fixtures and Fittirng.s 45000
Van 14500
Rent 7000
Local taxes 2 400
Jrnsurance 2 1100
74
10.3 Umitati,ons of using a trial ba,ance as a control system
Note
• The debit and credit column totals are the san1e. So we can say with son1e certainty
that whoever did the double-entry book-keeping probably 1nade a debit entty for
e,,.."er}7 credit entry-. 'Probab]}'"' n1eans that thet",e ' could be some n1issing debit and/or
credits of the siune totaJ va]ue - these are known as con1pensaring er1·ors, whi,c h
wiU b di cussed later.)
• The d it c0Jun1n of the 1ria l bal nee contains only as etts and xp ru s,i th credit
column of th tria.J balance contains only liabilities and incotnc.s or benefits.
1 The deb ~1 side oi a ledger a,cc:ount tota~s. $,242; t he cred~1 s~de tota~s $200. What
is the ba~ance on the account?
2 Genera H~ which s~de ofr a tri1ail balance wil I haive the most entries?
3 Liabilit~es are found on the s~dle of a tr~al balance.
4 lnc:omes are found on the sidle af a triall balance.
5 ~n wh~ch le dger would you expect to -find the account of Girselle, a supp l~er of
goodls on aedi17
6 ~n whkh fedg,er wouId y,ou expect to find the sales re1urns account7
75
11:1 Control systems - the trial balance
3 If you cannot find the er1or~ ]ook at the totals. If the tota l of the debit column is
smaUer than the total of the;: cr,edit column, check that you have: not miss,ed a d it
balanc . if the er di·t column total i th sn1aU r of th two,, check tht1ft you harv not
miss d a credit balanc .
4 If the error has not be n found by g,o ing 't hr,o ugh the three previ,o us points; divide
the difference in the totafa by two. Then ]ook to see if an asset ha been incorrecdy
placed in the ,c redit colun1n or U a liability bas been p]a.ced in the debit colutnn,
itetns in the incon~ect column will double the mistake.
5 If you divide the difference in trial balance totals by nine and your ansvver is a
who]e nutnber>then the error could be what is k nown as a transposition e rrot'1
for exampJe $123 entered as $132 would give a difference in the tria] bafance tota]s
of nine; $96 written as $69 would cause a difference in trial ba1ance totraJs of 27,
which is divisible by nine.
7'6
10.4 Errors that are not revealed by extracting a trial bal,ance
• An error of connnis ion \\oiU not affect pl''Onts .and/0 1 the validil·y of the .statement
of 6nandal position.
• An rror of pi~incipl will aff- et both tb profit of the business and '\\-iU eithe.r
under tat, or o,yer tate, an ntry ,o n the stat n1 nt of financial po~ ition.
You tnay wish to use this rule when trying to decide whether an incorrect posting is
an error of conunission or an error of pnncip]e.
For example, a vehicle costing $23 500 is posted incorrectly to the n1otor expenses
account. Profit will be understated by $23 500. (Profit wiU be .r educed by the 'extra'
expense in the incotne statement) The non-current assets shown on the sraten1ent of
financial position wiU be understated by $23500 also.
Requit""ed
Identify· the types of errors Usted above.
Answer
Reversal of entries
Error of principJe
Error of conunission
Error of original e ntiy (a I.so con1pens at ing error)
77
11:1 Control systems - the trial balance
7 A tr~all ballance balances. This ~s proof tha1t1here are, no mistakes ~n any ledger.
lrue/fa ~se 7
8 Whai1 1is ·the purpose of extracting a triat batance f1ro,m the !ledgers?
9 Can a 1:nal ba~ance be used for any o1her purpos·e than checking fo.r the
arccuracy of the doubJ,e-,entry system 7
., •..........•......•........ ,..•...•.... 10 A tr~all balance is extracted from the genera1I ledger. lirue/Fail-se7
)la- No"v try Question 2. 1, On which side of a t:ria~ balance would you ftind rent receivalbte?
78
Suspense accounts
r ~
Lat-a has extracted a triaJ balance. The totals of the debit and credit colun11ns do not
agree.
79
m Suspense accounts
l.awr no has . tract d a 'trial balance .from h~s ledgers. The total of th d bit and
er ~dit columns do not a r e.
A fourth use of the general joumaJ, as a book of pdn1e e ntry, is to record the
correction of errors.
Casting is a term used by accountants for Ren1ernber that:
adding. Un dercast means that a tot a ri ~s • not aU errors affect the balancing of ithe triaJ ba]anae
l.ower tnan, it ougnt to be. Overcast mearn;
• when the errors are entered in the suspense account, the st1s.pense account balance
that a totall is greater than it ought to be.
should be eHnlinated.
On 31 March 2014 Vijay's tda:l balance failed to agree. The debit colunm tota] W'aS
20 500; the credit ,coh.1mn totaUed 21 ·0 00. The diffe1(;t1lce ,vas entered in a :suspens,e
account.
inoe ·tracting th trial balance the foUowing ,erroi hav· e n found:
1 Th purchas,· aooo:unt wa .· undercast by 1000.
80
111.2 The correction of errors
Goods soJd on credit to J. Latino for 500 wete debited EO J. Latino's account
Thes good had not 'been induded in the sales journaL
quit d
Pr pare:
general journa] entries to correct the errors
('.I
An swer
a General journal
Dr Cr
$ $
1 Puirchas~~ a.ccount 1 OOO
Suspense acco unt 1 orm
Correction oi error: Purchases account underc:ast by $1 OOO
2 Suspense account 500
Sa les account
1
500·
Correction of error: Sale of g:oods to Latino not ,included ,jn sa.iles journal
The totals on Ma ura's trial ba]ance at 30 Noven1ber 2013 fa iled to agree. T he debit
colun1n totaUed $230161; the credit coluinn £otaUed ! 189 521. TI1e difference was
e ntered in a suspense account. On further exan1ination of the books of account, the
foUowing errors \\,ere found:
Motoring expenses $1700 had been entered in the vehicl,e s account
.,. The tota] of the sates journal for Ju]y $16320 had been posted to the debit s ide of
che purchases account.
The to tal of rent received 4000 for the year bad been entered as a debi·t entry in
che rent payltble ac,cou nt.
4 Maura had '\\t~ithdraiwn good for her own U "'e S4700 during th yea:r. Th<: ~ goods
bad been entered on th d bit sid ,o,f th purchases account.
Requir d
Prepare.
a journal e ntries to correct the err ors
b a suspense account.
8,1
m Suspense accounts
Answer
General journal
Dr Cr
$ s
Motor exp 1:m ses a ccou,nt 1700
Ve. '1 ic les a c:cou nt 11700
Eriror of princ1iple: Mot or expenses- included as capital expenditure
Suspense accou nt 32640
Sales account 16320
Pu rd ,ases accou rnt 16320
Postin g error: Sales posted incorrectly t o purchases account
Suspense account 8000
Rent re ce iv abie acco 1.unt 4000
Re n-t payable account 4000
Posting error. Rent receivable entered 1
inco rrectty in t ne rent payable accou,nt
Drawiin gs accounit 4 700
Pu rd,ases acco unt 4700
Posting error: Dra,w ings entered as purcha,ses
b Dr Suspense account Cr
s s
Sates account 16320 Tr,ial baJa nee difference 40 640
Purchases account 16320
Rent receivable account 4000
Rent payabJe account 4000
40640 40640
A suspense account ~s used to mailke·the debi1t coiumn totail agiree with the credit
col u1mn total if the tdal balance does not balance.
When errors are rectifi·ed, the suspense aiccount shoulld 'disappear-.
82
Control systems bank
reconciliations
By the end of this cha pter yo u sho uld be a ble to;
1
• exp!lain the procedure used to check 1he accuracy of 1he entries made in the
cash columns of a cash book
• check the accuracy of entri1es in the bank columns oi a cash book
• jdentrfy and enter any bank transacdons itihat may be mi1ssing fro,m, the bank
columns of a cash book
• identriy and correct any ba,nk transacti,ons incorrecdy entered i1n the baink
columns of a cash book
• prepa,r,e a bank reconcilliatjon startement
• exp,lain the reasons for preparing a ba,:nk recondltat~on sta1e1m-ent .
We have .s,een that the who]e doubJe-entry system can be checked by eJ..··tt"actting a trial
ba]ance~
Remen1ber that even if the trial ba]ance does agree 1 it does not nec,e ssari[y n1ean
that there ar,e no errors in the double-entry system. All you can he sure of is that the
double-entry system Is arlth1nett'cal~v correct.
Can you renletnber the sb;; types of errors that are not revea]ed by e.xtracting a hia]
ba]ance? Remember CROPOO If not, refer back to Chapter 10 (Section 10,6).
Altogether w w four cl1~-cks to verify the accwracy of the system. The tdal
ba]anc is g neraUy prepar d at the ftrumcia] y r nd, ailtbough a tria] balanc could
1
bt: ,e"tr.acted every day Eo s e if th )~stem, is anthm,t:ticaUy correct n,e other 'three
eh cks are dent: at frequ nt inter,~ih throughout they :ar.
Let us first look at the ~ro ,checks that arc used to verify the entries in the cash
book.
83
mControl systems - bank reconciliations
from the tiH to pay a ,d ean.er and no note has been n1:ade of the payment. It is much
, a.si,(:f to remember this imtn d iately .afEdr th eV1 nt than; say, sonlt= four months b!J'ter.
Th cash in the tiU should not only· agr e \Vith the EiU roU totaJ but also should
agro with the 'tOEal of th cash ooh.mrnns in th<.:' ea h book kept by th business.
This is the most frequent check undertaken by bu.sinesse.s. It is fa ir]y
stra lghtforvvard and very easy to o .
'When any bank transaction is tu1deitaken two :re-cords arc kept ,o f the transaction.
One is re-e-orded by the business in a cash book. Tbe other record is kept by tbe
bank. The two records kept are taken fro111. different parts of a source document.
Records of every transaction are kept by the bank and the bank's customer.
cashict~ "1~ho checks the amounts for accuracy and then stamps the paying-in s1ip
and the du.pHcate (tbe counterfoiH or the .stub). From this cou:ntedoil, the debit ,e ntries
.a re n,ade in the cash book - so this is one of the s,oul"Ce docun1cnts to write up the
cash book.
84
12 .2 Che,cking the accuracy of transactions recorded in the bank columns of a cash book
A N.O'ther ~~
~~· A, N. Otner
ANYTOWNBA NK Pl..C
\ .,
ANYTOWN BANK
Cash Book A. ~ . Other
Co.sh 9onk Cash Bank A«oiml a.-mr- A. N. Ofbe:
I/10 S. Dav,i d zoo.oo A«oiml ambtr 007457m
iJraar:/t Kit LtJii
li-.nnuddM1•
:O,ui Dc~J,
I OC:18ce t.l.!l.(PMl'II:
-
Figure 12.1 Records of a transaction when money is pard into t he bank
The bank use·s the actual paying-in slip to show hov.-· nluch tnoney and cheques ha,..re
be,en deposited in the bosiness bank accoi11. nt. Tht.!Se entdes will appear as ,credit
entries oo a copy of the bank's records.
Note
Th ·fifth cohunn o:n the bank statement (or copy of Ehe bank>-, records) show a
running balano figu:r,e .
gs
mControl systems - bank reconciliations
ANYTOWN BANK
Cash Book A. N. Other Curm:rt DOOOllllt l ~ n t
.la:oimr .-,.:, AN. Oths
!/10 D. OtiiJlon 150.60 Ai$'0 iml' .i.llnliw cm:457m
Bn..-n r:lr Kim,di i
Tir.nmoctlQM
Ciltt Dm..il,
J ~~ ,D. :t)Jlnoa
The atnounts Vv'ithdravvn fron1 the bank account by cheque shoul d appear as identical
amounts in the bank colunln on the credit side of the ,c ash book and in the deb.it
column of the bank statetnen1.
Am.ounts paid in houl d aipp ar as id nbcaJ a mounts in che bank colunln on the
d bit id ,of th cash book and in Eh CC\ dit ,ooJu mn of th bank stat~ment. Can
you think. of any :reason why the c . h book entries .should not id nitk al. to tbos
shown in d1e bank's ledger?
The counterfoU might no11 agree with the cheque. The cheque tnight say S110 but
the cheque counterfoil could say $101. So the cash book wm show $101 and the
bank statement wiU show $110. Which amount is correct? The bank wiU have taken
86
12.3 Reasons why a cash book and bank statement mjght not show identical entries
S110 out of thJe account since this is what th instruction (the cheque) .says so 'th is i
Standing orders a,re payments made
the co,rrecc an1ount and the countedoU and cash book should be changed.
auto matiea Ily by a bank on behalf of
customers. They are set amounts and may • Th counterfoi] might not have b n nU ed in trt .all The amount hown in th bank
be pa id weekly, monthly or an nua·l"ly. statern nt hou]d be ncer din th cash book
• The bank rnay have n1ade payments frotn the account on a standing order and
the paytncnt &om the account bas for the motncnt been overlookt.::d by the drawer
Direct debit5 a.re payments ma,di by th e and not yet included in the business cash book. The ainount should be entered as
ba nk on beha :1f of cu.stom ers. The autfl ority a paytnent in the bank column on the credit side of tbe cash book.
to wtthdraw money from the account is • The bank n1ay have niade payn1ent frocn the account by direct debit and the
given to the payee. The amounts withdrawn payn1ent frotn th e -account has been overlooked by the dra"'•er. The an1oun1t should
from the account a re gene ra.llry va,ria b Ie.
be entered. as a payment in the bank ,c olumn on the credit side of the cash book.
• The bank niay have taken n1oney fro1n the account as bank c harge61 and this
a111ount has not yet been included in the business cash book. The amount should
Bank charges are made by banks to be induded as a p.ayn1ent in the bank cohJn1n on 1he credit side of the cash book.
cove r the costs of mai,ntai1ni1:1g the draweir's
• The bank n1ay have n1ade an interest charge for tin1es when the bank st:aten1ent
account.
shows ~ debit ba]ance (Le. Ebe account has been overdrawn). The atnount of
lnk.~,e st charged should be enter,e d as a payment in the bank column on tbe ca:edh
sidt: of the crush book.
Interest on overdrafts: the interest:
• Th bank may have t c iv,ed d posits on b ha]f of 'Eh buslnes dh cdy tbrou h the
charged by banks when an account is
overdrawn. banking S}· ·tem. Any er dit t1·ansf. r should be enter d a reo~·pts by' debiting
the bank colu:rnn in th cash book.
• Wh<.~ a chc.ciquc is received; the cheque wil] be banked. 1:t is entered in the
Credit transfers a re amounts pa,id into hank oo]u nm on the debit side of ilie cash book. Jf; subsequendy, the cheque is
an account directly through the banking dishonoured this fact will be shown on the bank statetnent. (TI1is is referred to
system instead of by issuing a cheque. coUoqufaUy as a cheque that has 'bounced'.) The trader cannot adjust the bank
account in the cash book untU the trader is informed by the bank. If it is not
a]so shown in the cash book, the dishonoured c heque should be entered as a
Dishonoured cheques are cheques payn1ent in the bank colun1n o n the credit side of the cash hook.
that have not g,one throug,h the drawers • The trader can tnake the foUowing errors:
bank account. Often t his may be because • addition erro1·s in either bank co]u1nn of the cash book
the drawer has insufficient funds ,in the~r • entering the incorrect :iunount frotn the cheque and paying- in countetfoUs
account to honour (pay) t he cheque.
• entering the cortect an1ount on the inconect side of the cash book.
• The bank c,o,u ld n1ake the foUowing ,e no,rs:
• entering a v..·ithdrawa l that should hav een debiEed to the account of
someone.: lst:
learn these defi nirtion s. They are very • nt ering a depo,s tt that n er clit d to, the a coount of sotn,e on else.
~mportaint.
Note
It is higWy unJikcly that addition errors wiU take pface in bank sta.ten1ents since they
a re, generaUy, cornpuh~r· generated.
When a trader pays a s upp]ier by cheque, this should be entered in the bank c0Jun1n
on the ,c redit side of the cash book ( using the oounterfoi] as the source docutnent)
on itbe san1e date that the cheque ,vas Mitten. However, tbe bank 1nay not show the
cheque on the bank st::nement until severaJ days later - 'this could be as much as a
Clearing a chequ,e refers to the passage
of a cheque through trie banking system. w k ]at r (days in tbe osul ystem plus days in th clea•:ing sy ten1).
It i nvo Ives the tr-ansfe r of money from one Wh n th trader pays mon y into tht! bt-.sb1 "'S bank account~it viliU b
ac co·unt to another. Thi,s can take a few immediately r,eoordecl in the trader's bank column in the cash book. Howe·,ror1 che
days if the accounts are held at di,fferent bank wiU not credit any c heques that are depositc-d ·t o the· trader>s bank aooount ·u:odl
ba nks.
the cheq ue.s ar,e deared.
87
m Control systems - bank reconciliations
Note
The drawer,s c,count shown on tb bank tatement is prep~red fron1 th actual
eh ques and paying-in slips recei~ d by them. If an error is tnad o n the ooun:terfo,H,
·rwo diff. rent amounts ·wiU be record d by the bank and by th trader.
Which is oorrecr?
The ank wm react to th in truction (the chequ ). which are EO· ren1ove $·315
frotn th account and pay it to BrOV\l·n.
Aft,c t .aU d1e n oessary adiustrnents have b n n1adc, th cash book hould cont in
exactly the san1c infomlation as the bank statement. Or should it? WeU1 it could, but
in real Hfe the like]ihood of this happening is faidy reinote because of the reasons
oudined earHer.
Lodgements are payments made into the Some deposits tnade by the trader on die day the bank statement is produced by the
ba n.k account. bank may not yet be recorded on the state ment. These ·ite1ns a.re caUed 'lodgeinents
not yet credited by the bank'. Some cheques paid out by the trader and entered in the
cash book wHJ stiU be in the postal syste111, in the payee's office or in the bank clearing
Unpresented cheques have not yet been systen1. TI1ese oheques have yet to be presented at the trader's bank - they are called
cleared and debited to the account at 'unpres ent ed cheques'.
the bank.. So we have to reconcile (bring together) the ~ro different ainounts shown in the
cash book and on the bank s'la.tetnent. This is done in a bank recondHation statement.
The statement is set out thus:
Bank reconciH ati on statement at .. . (the elate when the reconciliation is prepared)
'8 a,l!anee at ban k as per cash book
Make sure that you learn the correct Bal:arice at bank as ·per the bank statement ... (date)
layout for a bank n~concmation statement.
B8
12 .4 Procedure used to prepare a bank recondl iation statement
Banik reco ncii iati on at .. . (the elate when the reconciliatfon is prepared)
Balance at bank as per ca,sh book
Note
The aid.j,usted balance shown in the bank colun1ns of the cash book is the baJance to
be shown in both the trial balance and the suten1ent of financial position.
Reme-mber to post aJJ the items entered in the cash book adjustments to the
a.ppr,o priate accounts in the Jedgers.
The bank column of P. Chen~'· c-ash book how th ~ foUo,,;ling d tails for April:
89
mControl systems - bank reconciliations
R quir d
?vlakE.! any nec,e.s ary adjustm nts to P. Ch n 's cash book.
Propar a bank recond] iadon £a'Eetnent at 30 AprH .
Workings
'Tick' an the items that appe ar both in P. Chene's cash book and on her b ank
staten1ent.
The itea1 th at re inains u ntk k.ed in the bank colun1n o n the debit side of the cash
book. is: Cust / 12.55
T he ite ms that rem ain u nticked in the bank coltunn o n the credit side of the cash
book are: Dob / $31U.OO; Edy I $145.37
The item that rem ains u nticked in the credit co]umn of the bank statein e nt is:
Cbotte I J,6 1.00,
Th ~ items that reniain u nticked in the debit colun11n o f the bank state ment are:
Standing order for insurance I $45.66· Bank charges/ $6.4.3 .
lt is in,poitant that Chen e's cash book is updaft,ed. The cash book is a vi"ta] part o f her
doubl,e -entry records so, it shou]d oo corr~ t and ,c ontain aU tht! trans actions 1 Iatin g
10, the bu-Sin .s .
The three transactions r . ,naining un tkked ,o n the bank statenrg,ent ha,1· taken p,laoe.
They remain unticked because she bas not J 'et reco:rded the1n in her cash book.
The first task is to record the transactions in her cash book.
Jn real life tbe cash boo k would s in1p[y lbe extended fo r a fe w lines to e n able the
entdes to be made.
Also1 we .should not forget to con1plele the doub]e entry for these transactio ns
(altho ugh it is pu rely for i1h.1strative p u r.poses, as 1the question did n ot a sk for this):
Dr Chorte (S L) Cr
$
17 Aprtl Bank 6 1.00
90
12 .4 Procedure used to prepare a bank recondl iation statement
Dr Cash book er
s $
1 May Ba~ance b/d 333.20 1'5 April Insurance 45.66
17 Apri l M. Cnorte 6 1.00 30 Apdl Bank cha:rges 6.43
30 Ap rH Balarnc:@ c/d 342. 111
394.20· 394.20
1 May Balance bid 342.1,1
Note
The baJance of $,342.11 is the balance to be entered on Chene's ttia] balance·i it is aJso
the balance to be shovm as a current asset on her. state11--ient of financial position.
Dr Cash book Cr
5 5
1 Oct Ba Ianc:e bid 1.27 .63 2 Oct M. Vaughan 673 272.61
7 Oct D. Paster 367.42 40ct C. Chan 674 81. 13
15 Oct T. Henke'I 84.56 11 Oct M, Vere 675 364.42
1 '5 Oct B. TaJ n 97.42 27 Oct D. Perth 676 182.09
912.38 912.38
1 Nov ea~a rn ce bid 18.51
91
m Control systems - bank reconciliations
Transactions
Date DetD.Hs Debit Credit BaJance
1 October Balance l.27.63
3 October l odg~mt 367.42. 495.05
7 October 674· &l.3 1 413.74
LodgcmCJrt 84.56 498.30
10 October l-0digcmcnt fJ7.42 595.72
15 O ctober 675 364.42 l!il.3'0
16 October 673 272.61 41.:U OD
3 1 October Cn :dit hmlsfcr G. J~ 4 1.99 0.6S
St.dig ordc:r loim ircpmt 150.00 l49.l20D
Dishon oured diequc ll.48 161.800D
Banke~~ 27.S~ 189.3600
Requir ed
Make any adiusto1ents to Dh iUon's cash book .
Pte pare a bank reconcU ia Uo n staten1ent at 31 October.
Answer
a
Dr Cash book Cr
s s
31 Oct Credit transfer G. Jad~s 41 .99 311Oct Balance b/d 18. 5~
40ct Correction, - C. Cha,r, 0.18
31 Oct s/o Loan repayment 150,00
311Oct Dishonoured cheque 12.48
31 Oct Balance c/d
1
Note
The an1ount paid to Chan has been increased - the bank h as paid hin1 $81.31, so
the cash book has to record the payment.
The dishonoured cheque has been credited in the cash book.
Th e opening bafance is a credit ba lan ce o n Eh e bank staten1ent, indicating that
Dhmon has money in the bank; at the end of Octobet· a debit bafa nee is sho~rn on
th,e bank statement indicating that D h iUon is overdrawn.
9'2
12 .4 Procedure used to prepare a bank recondl iation statement
D. Dhillon
Bank recon ci liatio n statement at J 1 0 cto be r
$ s
Balance at bank as per cas'h book 166.74 OD
Add Unprese nte d en eq ues:
D. Perth 182.09
N. Uster 12.13 194.22 This positive
amount added to
27.48
a negative amount
gives this positive
result.
Once rnore we can now say that all the transactions recorded in the bank ooluinns of
the cash book have b~n recorded accurately.
••••••••••••••••••••••••••• •••••••••••••• 1o IExpla~ n why deb n entries j n a1caish book are, shown as ere diit en1ries on a ba,n k
Now try Question 1. state·ment.
93
mControl systems - bank reconciliations
The cash ba1lance shown i1n a1ea sh book shoulld be checked frequently.
Bank recondHa1t~on stateiments are prepared to chedk the accura·cy of transactions
recorded in the bank columns of the cash book.
It is a tvvo-s1tage operation - the cash book js updated first, 1hen the actual
recondl!iat~on s1aitement is p1repared by adjusting the ba~ance shown i1n the cash book
for unpresented cheques and !lodgements not yet credited ijn the bank .stat,ement.
94
Control systems ledger
control accounts
By the e nd of this chapter you should be able to':
• prepare sa~es ledger and purchases led gier contro I a.cc,ou nts
• enter and exp1ain cred~t balances ~n a1sa1 les l edger control account
• en1eir and ,explain debit balances in a purchases ledg,er control account
• enter and exp1a~n the use of ,contra ,entn·es h1 control accounts
• make necessary entries to record bad debts
• explain die advantages and hmitations of usjngi control accounts a,s a1contro·I
medhanism1
• reconcile the· ba~ances shown ~n contro~ accounts wah a sch,edule of balances
extracted f r,omrtl.e perso nai lied gers.
\Ve have .seen that th e arithtnetical accut-acy of the whole double-entry book-keeping
system is checked by e.~tracting a 1tria] balance. Although in theory there is only one
book used to record an double-entry transactions~we have seen that the ledger is
actuaUy divided into three patts. The bu]k o f .aU entries in the double -e ntry system are
in the personal iedg~s: the sales Jedger and the purchases ledger.
Becm.ll5e the,re are so inany entdes in these two ledgers~there its great potential for
er-rors t,o be n1ade. Control accounts are used co check the .accuracy of the eotties
mad~ in ead1 of ih sa1es ~ dgers and in each of the purcha es ]edger .
Each month a contto] acoount l prepared for ach l dg r. In ·this v;ay~errors can
The constructjon of a con1ro, account is
b id ntmed a b in. i:n one particular ledg r in the mon.t h that ch:ey have occurred.
the same whether or not rt is mra~ntai ned
1
95
m Control systems - ledger control accounts
Od'.!Jer businesses use contto] accounts as men1ofandurn accounts, using thetn onJy for
control purposes.
Th saJ l dg r contro] account is a replica. in total, of aU the entd mad .__. in
·tb individua] sale· ]edger accoun'ts. Any ntries that appe r in an indh,.,idu al d btor1s
account wiU appear in rhe contro] aoco,u nt for that ]ociger.
Here is a simple iHustrationt
Sa les ledger
Dr Clogg Cr Dr Saddler Cr
$ $ $ $
1 May Sa les1
50 9 May Cas:h 48 7 iMay Sa,les 60 7 M ay Sal es 29
returns
Answer
If you can rei111en1ber that the control account is an exact replica ofall the- sales ledger
entries~ you s.h ou]d no t get the ilen1s required m prepadng a control account on the
wrong side. (TI1.is of course, assun1e.s that you understand on whkh side each of the
entries appears in an individual a ocount!)
In reality we ·c annot look at every ind ividual account in a sales ledger and copy
them into a sales ledger control account. Nor ca n we add each of the diffetent
categories of entdes to gether - it w ou ld be too cin1e- consun1ing. We can. however~ get
the necessary figures in total by using the books o f prime e ntry.
96
13. 1 Preparation of a sa,es ledger control account
Sale~· joun,al
l1ulit•id 11,11 entries
Art s
Bart 1.0
Carter l5
Dart l2
42 Sales ledger
control a1:co11nl
$ $
Sak!s ledger Ct1sl1 book Sabs 42 Cash J2
Art Disc A 1
Art l 4
s s Bart 8
Rets
lnw
4l
Sales 5 Cash 4
Disc l Bad
debt ]2
Bart
$ s Sales returna
Sa~es [0 Ciitsb 8 jouttud
s 4
4
Gt!naml jo11n1al
Dan
s s Baddehts 12 Sales /1!1'1,rer
control account
Sales 12 Bad 12 Dan ]2
debt $ $
Sales 42 Ca.sb 12
Disc A J
Rets 4
Scheth1le of debtors Inw
s B.ad
dabI
J2
Bart 2
Carter Ll Ba1 % n
42 42
1httd l3
Debtors - Bal % B
I
1
Petra s tarted b usiness in May 2014. She provides the foUowing totals from her books
of prime entry on 31 May 2014:
credit sales ·7300; cash sales $2100; sales returns $4.20·, n1onies received from
Schedule of trade receivables is a list debtors S.S 400.
of de btors' bal1a1nces extracted from each
sates ledger. A schedule of trade receivables extracted fron1 Petra's sa]es ledger on 31 !v]ay 2014
shows they owed $·1 480.
Requil'ed
Prepare .a sales ]edger c·o ntrol account for May 2014.
97
m Control systems - ledger control accounts
Answer
Dr Sales ledger control account Cr
$ $
31 May Sales 7300 31 May Sales returns 420
31 May Cash 5400
31 May Balance c/d 1480"'
7300 7300
1 Jun e Batance bid 1480
E mpl
At the end of her second rnontth of tt-ading 'Pe1tra provides you with the following
infom1ation >which she has eJ..1tracted froin her books of pti111e entry on 30 June 2014:
credit sales $9400; cash sales $2750; n1onies feceived frorn credit custon1et"S $6200;
discount aUm.ved ,610: sales returns $240.
RequiJ;ed
Prepare a ~les Jedger control account for June 2014. (Bring forward the trade
r,e cciv·ables' balanc,e fron1 the May sales ledger control account.)
Answer
Dr Sales ledger (ontrol ac.c ount er
s $
1 June Balance bid 1480 30June Cash 6200
30 June Sah?s 9400 30 June Discount aMowed 610
30 June Sa h?s retu1rns 240
30 June Balance c/d 3830
10880 10880
•••••••••••••••••••••••••••••••••••••••••
Now try Question 1. 1 Joly Balance bid .3 830
98
13.2 Pn~paration of a purchas,es ledger control account
Dr Saleem Cr Dr Toshak Cr
s s s s
l3 July Ca,sh 347 I Jul'y Purchases 350 i g July Cash 20 7 July Purd,ases 125
Djsc·o unt received 3 24 July Purchases returns 18
31 Jul,y Bal dd 87
350 350 125 125
1 Aug 9a,I bid 87
Once a.gain this shnp]e but effective iUusttradon reHes on the fact that you nuust
understand what an individua] account in a purchases ledger looks Uke.
We· cannot look at every inclividua] account in a pu1·chas es ]edger and totaJ thenl.
We us·e totals that can be found in the books of prime entry.
- xan1pl 1
Yip started in business in February· 2015. H,e, provides the fo])owing totals from his
books of p,rbnc entry on 28 February 2015:
credit purchases $9430; cash purchases $1790,, purchases returns $105, montes pa id
Schedule of trade payables (creditors) by Yip to credit suppUees $8100.
is a Ust of creditors' balances extracted from
each of the purchases Iedgers. A schedt1le of trad .e payab] es extracted frotn the purcb ases ]edger on 28 .F ebruary
2015 totals $1225.
Requil-ed
Prepare a purchases ledger control account for Fe bruary 20i15.
Answer
99
m Control systems - ledger control accounts
The 'trade pay.ab]es at the end of February according to the control account should
atnount to $122-. This .agrees Vlith Yip s sch -du],e , so we ,c an ay that hfa purchases
ledger i arithmetkaUy correct for the month of F bn1ary.
c.ash purcha w~r no t mduded b ea liJ-5 ·chey do not app ar in th purcha
Jedger - the ]edger is only used to record. Yip~s transacti,o ns 'With his credit suppHers.
Ylp provides you with the following infom,ation) ~vhkh has been extracted from his
books of pritn e entry for March 2015 ~ his second n.1001:h o f tradin g:
credit purchases $8,600; cash purchases $2930; monies paid by Yip to credit
suppUet-s $,6800; d iscount received fron1 trade payables '460; pu rchases return s 120.
R equired
P repare a purch ases ledger control account for March 2015. ( Brin g forward the trade
payables' balance frotn the February p urchases ledger control account.)
Answer
Dr Pu re hases Iedger control account Cr
$ $
31 March Cash 68'00 1 March BaJari,ce bid l 225
31 March Discount received 460 31' March Purchases 8 60 0
31 Maren Purchases returns 120
3 1 Maren Balance dd 2 445
9 825 9 825
>- Now try Question 2. 1 Apri~ Ba lance bid 2445
On 29 October 2014 Claude :r,c tums $30 of goods which hav~ p:roYcd to be faulty.
Requit~ed
Prepare Claude's account as it wou]d appear in Pihara's sales ]edger at 31 October 2014.
100
13.4 Deb~t balances in a purchases l·~dger
Answer
The qu ,i,o n a ks for the .acoount so it n,ust be produced in detail1 not as a [,Or account.
Dr Cla ude Cr
$ $
3 October Sales 720 23 October Bank 720
29 Octobeir S.a l~s ret u,rns 3·0
You can see that at 31 October there is a credk balan ce in daude's account, a hhough
this account is oonraine d in Phara's saJes ]edger (her debtors1 ledger).
In Phara's Bst of o utstanding ooEances in the sa]es ledger at 31 October 2014 she
wiU have to s how this lba]ance o n Claud e's account as a oi-editor. It wm a lso featu r e in
the sa]e.s [edger contro] account for Ootober as a payable (creditor).
Note
Do not deduct th is amount frotn Plura's total of trade receivab]es (debtors) at the
end of the :month. It m"USt bt: induded in~ tda] balance .a t 31 Octo'b er 2014 and a
state1nent of financial position prepared at 31 Octobe1 2014 with trade payables.
Toddy is a r gu]ar customer of Phara. Ht: has paid 50 ,o n the 24th of each month
to Phara b}" standlng order since 24 Mar)r 2014. On 6 S@ptemb@r Phara sells $230 of
goods to 'Ibddy.
Requl.t"e dl
Prepare the account of Toddy as it would appear in Phara's sa]es ]edger at 30
September 2014.
Answer
Dr Toddy Cr
$ $
6 Septe mber Sales 230 24 May Bank 50
2.4 June Ban,k so
24 July Bank 50
24 August Ban.k 50
30 September Ba ,lairice dd 20 24 September Ban:k so
250 2'50
1 October Ba!ance bid 20
In Phara's Ust of outstanding bal.ances i.n h er sa]es Ledger at 30 Septenilier 2014 the
balance standing o n Toddy's account wiU be shown as a credit $20 - he is a creditor
at that date - an d this should be shown accordin gly on a trial brulanae extracted on 30
Septeniber 2014 or any staternent of finanda] position prepared at 30 Septenilier 2014.
A credit balance could also appear in a debtor's account if the customer had n1ade
a n overpayment or \Vas allowed additionaJ cash or trade discoun t afi:er the account
had been settJJed.
Any ,c.r dit bafanc s in che aJ led r at a m,o nth end wiH be shown a ere dit
ooJ ances in th<;; .sales ledg,er control account for that tnonth.
Any de--bit balanoos in the purchas,e s ledger at a tnonth end wi]) b shov,t n as debit
ba]ances in the p urchases ledger co,n ttoi account for th at month.
Harvey provides the f:oUowing info rn1atio n fro 1n hi.s books o f prune entry at
31 J u]y 2014:
s
Credit sales for Ju1y 693 0
s
Debit bailances appeia ri:ng in th e sa~es ledger at 1 Ju'ly 201'4 2 100
C radit ba famces ap pea ring i1n the sailes Iedger at 1 July 2:0 14 ~O
C redito·r appesiring i1n schedule of trade receivab les ' total at 311 J1uly 2014
1
90
Required
Prepare the sales ledger contro] account for Ju ]y 2014.
Answer
Dr Sales ledge r control aCccount Cr
$ s
1 July Bala.n ce- b/d 2100 1 Juily Balance b/d 30
31 July Sales 6930 31 lul'y Cash 51'00
31 July Discount aIlovved 450
31 July 5a·les return s 180
31' Jul1
y Bala r, ce dd (given) go 31 July Balance c/d (missing figure)
3]60
9 120 9 120
1 Aug:ust Ba,la nce b/d 3360 1 August Balance bid 90
11 Expla~n two reasons why debit balanc,es m1ight appear ~n a purdhases ~edger
co ntro I account.
12 Is it possible ior there 10 be both debit and cr,ed~t balances on a sail,es ledg,er
control account at the end of a month?
13 State a reaison why there could be a credit baiance on a sales ledger control
account at the end of a month.
102
13.5 Contra entries in contr,ol accounts
Niki had suppHed Hoole with goods valued at $4300 on credit. Niki h ad also
purchased $700 of goods for his business o n credit frotu Hoole.
This ·w ould a ppear in Nikfs books o f account thus:
It wouJd not seen1 sensible for Niki to send $700 to HooJe ,vhH,e dernanding that
Hool pay $4300.
Th usuaJ procedure in case Jik this i to transfer th<; sm:aUer :unount from one
l dger to th oth r. Th entri·c.:·s a re:
Sales Iedger Purchases ledger
Dr Hoole Cr Dr· Hoole Cr
s $
Train sf er 700 Transfer 7{)0
f rom to sa~es
·pu rrch ases ledger
!ledger
This wiU ,d ose one account (in the purchases le d ger) and redu ce the balan ce owed
by Hoole (in tbe sa]es ]edget·). The account now l.o oks Hk,e this:
Ge neral journal
Dr Cr
$ s
Hoo le PL.26* 700
103
m Control systems - ledger control accounts
AU entries in the p r8onal ]edgers must also be shown in the control .accounts.
There wiU be an ,e ntry o n the credit side of Nik-i's sal .s Jedger control account
Ther will also b{;!, an entr}1 on th debit .sid of Niki' purchases l dg r control
accou nt r nectin Eh ~ntri, in th two p r onaJ ] d ers.
Example 1
Eiin has a debit balance of $100, in Ricardo's sales Jedger and a credit balance of $30
in Ricar do's p u rchases le dge r.
Re quired
Show the contra entries (set-offs) as they wou]d appear in both Ricardo'.S sa Le.s ledger
contro l account and his purch ases le dger con troJ account
Answer
30
account
s
Transfer to sales Iedger
1
30
control account
mple
Erick has a de it balanc of $710 in Djarak' ales l ger and a credit baJanc~ ,o f
1400 in Djarak' p urchases ledg r.
Requb~ d
. how how the contra (set~offs) wou]d app ar in both Djarak's sales ledger ,c ontrol
accou nt and his purchases ledger conttoi accou nt
Answer
It does not matter whether the debit Dr Dj a rak: Sales ledger control account Cr
balan ce or the credit balance is greater
when showing the contra in die con trol s
accounts: Transfer to purchases ledger 7 10
contro l account
• The sales ledger cuntro~ account 1is
always credited.
• The purchases iedlger control! accouint is
always deb~ted. Dr Djarak: Purchases ledger control account er
In the persona1I,edg,ers irt j s t he smalller s
ballaooe tha1 1s transferred.
Trainsfer from sales ledger contro l 710
account
104
13.6 Bad debts and provision for doubtful debts
Darruen provides Eh :foJJowing infonnati,on tak n from his books at 30, November 2014=
ale J dger balanc,~ 1 Noven1b r S6-340; purcba . ledger balances 1 Noveinber
$3,960.; credit sales fo r Novetnber .S140100; credit purchases for November $64300~
1
inonies received from trad rec<..~vabJes for November $139570) n1onie.s paid to trade
P21Yab]es in Novernbcr 163030; discounts aUowed S350i discoL1nts received $180;
sales returns $9001 purchases returns f 600, transfe,.rs fron1 sales ]edger to p urchases
]edger 440.
Requ it-e dl
Prep are:
a a sa les ]ed ger control accoun t showing dearJy the closing bafa nce of o utstanding
receivables at 30 Novetnber 2014
a purchases Jedger control account show ing clearJy the closing bala nee of
outstanding trade p ayables at 30 Novetnber 2014.
Answer
a
Dr Sales ledger control account Cr
$ s
1 Novembe'r Bal'a,n ce bid 6340 30 November Cash 139570
30 November Sales 140 100 30 November Discount alilowed 350
30 November Sales returns QOO
3-0 November Transfer to pu,rchases
,ledger eontrol account 440
30 November Balance dd 5180
1146440 146440
b
Dr Purchases ledger control account Cr
s s
30 November Cash 63 03,Q 1 NovemberBa·la nce bid 3960
30 November Discount received 180 30 November Purchases 64300
30 November Purc~as es returns 600
30 November Transfer fro m sales
~edger cont rol account 440
30 November 'Ba,la:nce cld 4 010
68.260 68 260
105
m Control systems - ledger control accounts
Ret;ta o Belinda $540. Reeta cannot pay ·t h atnount thaE .s h ow-es. Belinda writ
off th d be.
Re qui1·e d
'Prepar~
Reeta>s account in the sales ledger
If a ques"tion asks. you to prepa1re both the entry in the s a]es le dger control accoun1I.
purchases ledger and sales ledger control
accounts, do, not attempt to pr,epa re
Answer
them at the same time. Extract relevan1 Ree ta Sales ledger control account
informatrion to prepare a purchases
ledger contra~ a,ccount; when you have
s s $
.Balance bid 540 Bad debts 540 Bad debts 540
cormpfeted th~s task, extract in-formation
account
and prepare a sal·eS ledgre,r control
account.
Babita 1naintains a sales ~ed ger controJ account. At th,e end of eptember 2014 she
discovered that th eh dule of trade receivables eJ..'tfacced fro,m her sal,e ]edg r
am,ounted to 6640 while h~r control account showed outstanding balances o,f $913
on diat da~ . An inve Eigation re·v al,e d the fo]]owing error :
Th,c.: sales journal had been under ,cast by 1,000.
The debit balance on a custotner's ac,c ount $430 had been on1ined fron1 rhe
schedule of trade receivables.
106
13. 7 Rec,oncmng contr·ol accounts with ledgers
• Discount recei\."ed '18 fro1n Ni1nola h ad been ·e ntered conecdy in the cash book
but had bean dc=bited to Minola, a c1~ dit cus·tomer.
• Di count a Uo, d $34 0 had not b en enter, d in th ,c ontrol account.
a]es r,e turns $2800 had not b~en entered in di contro1 account
A ,cheque received from S1nytbe for $,6,50 had been ,c-ntered in bis acoount as $560
Required
Re-concile a cmrected sales ]edge:r control account balance with a corrected s,chedule
of trade receivable bafa nces.
Answer
Adjusted sales ledger control account for September
$ $
8al an ce bid 9·138 D·iscount received 18
Sales 11OOO Discount aIii owed 340
Sales returns 2800
8al·ance dd
1
6980
101 38 10 1, 38
Ba·Ian,ce bid 6980
On 30 June 2014 the purchases ledger ,control account for the tnonth showed a
cr .'<lit babtnc of $2480. This anlount did not agret: with a sch~dul of trnd~ payab]c.s
extract d fr.om che· pur,chases [,edger on that dat . D u.ring July 2014 the foUoVv·ing
rrors "rcre rcvea l,cd:
An iovoicc received frotn a supplier $1230 had been correcrly entered in the
purchases jou.mal b ut ha.d been posted lo the s uppH.er's aooount as 12130.
• Goods valued at $190 retum edl to a su pp,Uer had been o tnined fron1 the books of
account.
*
A payn1ent o f 1890 to a s uppJier had been entered twke in the cash book and the
suppUee's account.
A contra item $340 had onJy been entered in the purch ases ledger.
Requil'e d
Prepare the c,orrected p u rchases ledger contro] a,cc,ount.
l Calculate the origjna l tota l of trade payables befo re the co1Tection of enors.
107
m Control systems - ledger control accounts
Answer
Adjusted purchases ledger control account for June
$ $
:Pu re hases retu ·ms 190 Ba:la n,ce b/d 2 480
Contra item 340 Cash entered twice 1890
IBa la nee c/d
1
;J 840
4370 4370
Balance bid 3840
108
13 .8 Advantages and limitations of using contr,ol accounts
Control accounts hetp fiind enoirs jn the two personall liedg:ers qui1ck,y.
A control account wiU be pre·pared for each persona, ledger each mon1h.
Any transarcti1o·n tha1t is ,entered in a sales ledger willl appea,r in the sai~es !edgier control
account.
Any transact~on tha1 js ,enter,ed in a purchases ledg1er w,iU be entered in the purchases
~edgier con1rd account.
Credjt balances ~n a sales ~edger are trade payables and should be treated as current
liabi1In:1
ies.
• Debjt ba~ances ~n a purchases ledger are trade recei~ables and should be treated as
current assets.
Provfsmon for doubtful debts does not appear j111 a saf,e-s ledger control account
Transfers from one ledg1er to a1111other are entered in both control accounts.
These 'set~offs' are cred~te-d to "tthe sales fe-dger c,ontrol account and debned to the
pureha ses lied g,e r controi account.
109
Sta ements of
financial position
By the end of this cha pter you should be
able to:
• prep are a s1aitement of finarncia I pos irti on using
the appropniate cllass~ficatilon for assets a,nd
ii albU i1t1ies
• list assets using the 'r,everse·,order of lliqu~dny'
• cakulate ~he bus~1ness capirtaill for a sol·e trader
• classify bus111ess expenses nto ca1pital
1i
110
14. 2 Caprtal
k,n ow·n as trade receiva bi es. 3 Give a1n exaimple of a1habrnty typ·ically foun d on the staitement oi fjna1nciia,
posirl!~on i or a1restaurant.
,s
4 What meant by the t·erm 1trade credjtorr' 7
Trade creditors are peopl e (or 5 What is meant by the term 'trade rece1vablles'?
organisations) t hat t he b usiness owes
money to; they have si.i ppliced goods for
resa·le that t he b,usriness has received but
as yet has not paid for. C oJlectfvely. a
group of trade credttors is known as trade
14.2 Capital
payables. Staten1ents of finanda] position are presented in two main virays. Hetie ~ve use what iis
known as the h orizontal layout. Later " ;re wiU use a vertiC'al layou t .
3
The horizontal layout lists thie assets of a business on the left of the page. It [iists
Inventory is t he tenrn used to describe the liabiUties ,o pposite the assets on the right of the page.
goods p urcha,sed by a business t hat have
not yet been sold. 1ihe term also desc,ri bes
raw ma,teriaIs, components and partly
finished goods (work in progiress) held by a A statte1n nt of nnanda] position for RoU01s g nend stor might 1
;in lU· this:
ma,n,ufactu r,ing busi:ness.
s $
Premises 45000 Mortgage on prem is$ 25000
Va n 16000 Qan k foan owe d on van 12000
Shop firtti ngs 18000 l rade payables 890
Inventory 1 670
Trade rece ivab l!es 140
Bank bala n.ce 900
All sta.ten1ents of fi nanda l position n1ust 1Ja lance'. This tnean s that the tota l iof assets
held inust equal the tot.a [ of HabUities.
l't ls fa idy ob\.ious that RoUo's stat,eimeot of financial position as shown above does
no't balanoe. To nlake it balance w, need to insert a 1nissing figufr! on 'Ehe· MabiUdes
sid . If w indud $4,3 820 ~1s a liabHity, th E'\\·IO sid s would add to th rutl to,ta[ of
$ 1 710.
\Vha E :is this mi..,;sing figuir,e? What do it repr cnt?
Rollo's business iis wonh $43820. n1e business has assets totaUin g 81710 1 w hile
the b usiness debts unount to $37890. If Rollo, decided to stop trading h e ·w·ou[d seU
his assets, settle h is debts and take $43 820 out of the business.
Anothe r way of expressing the difference between the value of the business assets
a nd its Uab.iBcies is by using the 1enn n et assets; that is. a U assets ]ess aU extet'nal
Ha bUities.
Here~ J43 820 is the a,nount the business 'owes' the owner. I1t is th e an1ount Ro]]o
has tied up (invested) in the b usiness, on the date the state1nent of finandaJ position
V{aS drawn up. This is Rollo's capit al.
Note
Ca pita I is t he ·term used to describe how This assu1nes that the business assets could be so]d for the ·value shown in the
rnuch a business i,s wot:th. It represents how
stat~1nent of financial po,sition. 1n reality the assets 1nay be soJd for tnore o:r ]es.s
mLI eh is rinvested in tne bUS in @SS by the
owner(s). than the values sbmvn in th Utt,em:ent i w-e wm consider th~ attt a later stage in your
studi "',
1111
IIJ Statements of financial position
If w,~ includ~ tbt: Ca?2tal n u~ that we pr viow]y c:aku lated, RoUo's statf.!m,c:nt of
ftnanclal position wiU 'bal anoe' nd look like this:
$ s
ASSETS LIABILITIES
.Premises 45 000 M,ortgag·e on pr~ m.ises 25000
Van 16000 Bank loan owed on van 12 OOO
Shop frttings 18 000 Trade paya:bl'es 890
lrnventory 1 670
Trade receivables 140 CAPITAL 4~820
Barnk balance 900
Tota I assets 81 71 0 Total capital and liabilities 81 710
A statetnent of fi.na nda l position wm always ha.fa.nee because the capital fi gu.re icS
.always the tn1is.s ing figure'.
The fu nds that have fi nanced the acqu isition of the assets used in 1the business have
been provided by:
• the mortgage p rovider
• the bank providin g the finan ce for the ]oan to p urchase the van
• the trade payab]es
• RoUo h iluself.
Notjce that capita] is a HabiHty. InitiaUy this concept is quite difficult to cotne to terms
\\''"ith . Ca pitaJ is ,vhat the business 'owe'!/ the p roprietor.
112
14.4 The account1ing equation
A 25-year loa.n would fall under this head1n.g In reality n1any cu.r:t"ent liabilitie nee~ to be paid much more quickly than one
(except in its final ye.arJ)
1 ye-an for exatl'llpk::, a suppUer of s;·oods is unJikeJy to aUow a 'business 365 days before
the debt is settled.
113
IIJ Statements of financial position
If we 1JJse cbe asset d assificadons ou dined above to RoUo<' st u einent of nnancla]
po ition, it -v.,i ]J Jook 'Iike this:
s $ Comment
ASSETS
Non ..current assets
Pfemises 4'5 OOO Normally used for many years-
Shop fittings ! 8 00 0 Normally used fot; say.: ten years
Vari 16 00 0 Normally in use f or, say, fou.r or five-years
79000
Cur rent assets
Inventory 1 670 Should became c.ash in the next few months
Trade rec{!i,vables 1:40 Should settle th eir debts within 30 .days
The order in whkh assets appear under
Ba nk baiance 900 2 710 Almost as good as cash
th eiir he ad in gs is known as the reverse
order of liquidity. This means that the Totat assets 81 710
most 1iq uid of the assets appears 1.ast w hi,le
the least liquid app ea,rs first. tf w e cfa sify Ro]]o's liabilities. the rjght side o f h is smternent of nnancia] position
would look Jike this:
Comment s
CAPITAL AND LIABILITIES
CapltaJis normaJJy the first jtem to appear. Capital 4~820
Nonacurrent liabilities
Mortgage is generally owed for a Jong time Mortgage on prem1ses 25 OOO
period as is money borrowed to purchase
1
Bank loan to purchase van 112 -000 37 OOO
.a vehide. However; bo"lh of these wouJd be
classified as rurrent liabilities in the f inal y ear
of the debt.
Current I iabU ities
Suppliers will normally expect payment wffhin "trade payables 890
30 days of the debt being incurred.
Tota I ea pital and Iiabi Iities 817 10
114
14.4 The account1ing equation
In recent years there has been a 1nove to present statements of ftnanctal pos iti,o n
using a ~rtical forn1at. The totaJ assets of the busin ss are sho·w n in th top, section
of tb vertkal sta:E 1nent of 6nancia1 position and th capital and total HabUities of the
bu in s ar · shown under th tota] as t ·.
$ '$
AS ETS
N on-cu r rcnt a.~ets
Preinises at cost 45000
Shop fittings at cost 18000
Voo at cost 16000
79000
Current asse
Inventory 1670
Trade receivables 140
Bank balance 900 2710
foh1I ~···et - 81710
PITALAND LI BILITJ ~·
apital 43820
Nun..currcmt Hahilitics
Mortgage 25000
Loan for van 12000 37000
Current 6 ahi Hties
Trade payables 890
Total capit al. a ud Uahilitic 817]0
Figure 14.2 Statement of financia l posrtion in the vertical format
115
IIJ Statements of financial position
A statement of iliinanda! po·s1ti1on is prepared on one day and it shows the assets
belng used by a bus,ness 011 thai day.
Uabi1li1res represen1 the ,ndebtedness of the business to people or org1anisat,ons
outSA de the busi1n,ess on that day.
Carpttal represen1s the indebtedness of the business "to ihe owneir of the business.
A statem,ent of finandal pos1tion must always ba~ance because oi the accounting
equation.
The ais5ets of a business must always equal the hab ii i11ies.
Uab ~li1ies i ndude the owner's cap rrtai.
The term net assets ,s another wa1y of saiy~n g 'alI assets Jess aHexternal l1~ab ~li1ies' .
Cap irta! is wh a1t the business is worth.
Ne1 assets afw ays equal the owner's ea p~tal.
Cap irttal represe n1s the am,ou nt that the bus~n ess 'owes; the owner.
The 'top' part of a verticatfry presented s1atement o,f f1nandal posrt~on must ·equal the
1
1ewer' part.
116
Profits
By the end of this chapter you s hould be able to;
• exp! a~n the 1erms 'profit', 'loss' an dr 'draw,ngs'
• calculate the net assets held by a bus~ness
• determjne 'retai1ned profits; by cormpanng net aissets from
two s-1aite ments of fina nda1! posh~on
• adjust retajned pro~its for capital introduced and dra\Mngs
to detenn~ne tradjng profit
117
IJI Profits
Barker Anin1al Foods had the foUo~iing assets and UabiUties at 1 Januar)' 2014:
nonecu rrent assets $270000; current assets $21000; trade payables tsnoo.
O ne year later on l January 2015 the business h ad the f0Uow 1n.g assets and
UabiHties:
no n-current assets $290000; current assets $27000; trade payab]es $8000.
During d1e year there were no withdra,vals o r in je,o tions of cnoney or assets by the
owner.
R equire d
Calculate the profit earned by Barker Anin1a] Foods fo r the year ende d
31 D ecember 2014.
Answer
$
Barker Animal Foods net assets at Non< urrent assets 270000
1 January 2014
Cur rent assets 21000
291000
Less Current Iiabi Iities 5000
Capital (net assets} 286 000
The net a ets (capitaJ of th business increas(;;d by $23 000 (5309 OOO - $286000
1 1
)
1 Def~n e t he term1'profi1'.
2 Define·t he tenm ~ ~os s
i.
118
15.2 Capital introduced and wjthdrawn fro,m a business
Anjni has been in b usiness for a nu tnber of years. At 1 ~1arch 2014 her business assets
and UabUities were as foUows~
non.-current assets at cost $40000; current assets $10000; current UabHiHes $5000 1
•
One year later, on 28 February 2 015, her business assets and l iabiUties vtere:
non-current assets 45000; current assets $9000; and current liabUities $6000.
During the year she with dre·w cash fron1 the business $14 50Q, for pdvate use.
Requ it"ed
Cakulate Anjni~ business profits for the year ended 28 February· 2015.
Answ er
$
A,njni's net assets at 1 March 2014, ($40 OOO + $10 OOO - $5 OOO) 4'5000
Anjni's n~t assets at 28 February 201 S 48000
Increase in net assets over the year (profits pJougherJ ba:d:: into the business) 3000
$
Inere ase in net assets over the yea r 3000
Draw~ri gs (profits withdrawn duri119 the yean 14 5-00
Busf ness pmfiit ea m ed du ring t he year 17 500
119
IJI Profits
Required
Cak u late the profit that Chang's business m ad e for the year ended 31 July 2014.
Answer
$
C f-iang·s net assets at 1 August 2013 16 000
C liang·s net assets at 31 Ju'ly 201·4 45000
lnc,rease in net assets over the year 29000
on1e of the in crease in net .asse t-a is d ue to Und e Hua 's legacy. This has to be
disr,e garded if ·w e wish to detern1ine the profits ge nerated by -the bt.Jsin ess, so:
$
1rncrea,se in riet assets over the year 29000
Less Capital ,introd uced 20000
8,usrn~ss profit earned during t~e yea,r 9000
Rahila has been in business Ior a ntnnbe r o f years. On 1 February 2014 her capital
stood a t S,30500. At 31 Jantiary 2015 her business sta1ten1ent of finanda] positron
showed the following:
no n-current as sets $45000; current assets $18 000~ no n-cu r:ren t UabUides $20 000;
c u rrent liabiBties $7000.
During the y ear she paid into, the business bank account a cash gift of $100 00
lrotn her grandmo ther. Her drawings for the year amounted to $21 OOO;
Required
Calculat the pr,o,ftt o r [os mad by the busin - s for tb year end d 31 January 2·015.
Answer
$
Rah:ila's net assets (capiud) at 1 February 20114 ;osoo
'Rahilas net assets (capital) at 31 Ja nuary 20 15 36000
,lin u ea se [n net assets over the year 5 500
A dd Draw1'ngs 2 1 OOO
26 500
less Capital ~ntrodu,eed 10 000
8,usin ess profit for the year ended 3 1 January 2015
1
16 500
120
15.2 Capital introduced and wjthdrawn fro,m a business
An swer
$
Helents ne.t assets at 1 May 20 1:4 16500
Helen's net assets at 30 April 2015 9000
Decrease i,n net assets aver the ye ar (7 SOO) Negative numbers ate
Add D.rawings for the year 14 OOO often shown in brackets.
6500
less Capita,I introduced 18000-
Loss made by Hle[ens business dudng the y~ar (1 1 500)
Profmt can be· ca1k ulated qutddy and aa:::uratdy by deduct1ng1total net assets hell d by a
bus~ness at the end of ai fi nancial yeair from1ihe total of net assets held ait the start of
t he yea r.
Adjustments to ·the difference catcu~ated have to be made by ~add~ng baok' drawings
and e~,minaiting any capita1i ~ntroduced dur~ng1the ye.ar.
1211
The trading account
By the end of this chapter you sho uld be able to:
• prepare the trading account of an income staiement
• diist•nguish between capirtal and revenue expenditures
• di1s1~ngurish between caiprtaill and revenue
mncomes
• callcu!.ate cost of sa~es and determi1ne gross profit
• adjuist a trad~ng account for safes retums a1ndl purchases
returns
• make 1he necessary entry i1n a 1rading account to re-cord
carrr~age inwards.
A fun set of financial statements is u suaUy produced at the end of the finandaJ
Financial statements (or final accounts)
year. This enabl,e s the owner of the business to see:
is the term often used to describe the
income statement and statement of • if the business has been n1nrung profitably during the year
financial position produced by t he owner • the assets and Uabillities th at the business owns at the end of the year.
of a business a1 the fi na ncia,I ye.a r end .
(Tecnn icailI~ the statement of finarn ci ail
pos iti o·n is not an account as yo 1J w i11
1 16.1 Income statements
disco,ver later.)
An inconl ate1n nt details the incomes and e..\:penditures mncurred by th business
du ring a set 1 ~iod of time ( usu~JJy a financial year).
Although, as v.re haves n, profits and [ors can b cakulated accurat<;:Jy and
An i ncorne statement is a statement fairly quickly by l_llSLng Eh 'n t ass f tn.e thod, rnanager- or owne1.s of a busin~ s
that calcu.lates the profit that a business gcneraUy need t,o know mor,e than iu t the profit figur,e in isolation.
nas made ·for a period of ·time (usua,lly a An inoome statenlent is divided into t\\l~o sections:
financial ycMr).
• Section 1 shows the resuJts of trading and calculates the gross profit.
• Seotion 2 .sho,v.s the profit (or loss) after aU business expenses have been taken
from the gross profit~ Previously referred to as net profit, this is now referred to as
Capital expenditure is spendJng on profit (before tax) fo.r the year.
non-current assets or tne improvement
Profits a:re generaUy ca kuJated over a. financia l year but they could be cakulated
of ncm-c.u rre nt assets.
for any tirne period. rvtany business owners cakul ate their profits haJfway through
the year as w~U a.sat theb· financfaJ yeat e nd in order to p!ot the progress of their
Revenue expenditure is spending on busin~s. Finandal staten1ents wiU be produced at any tin1e they n1ight b e requited by
everyday expenses. the owner or nlanagets of a business.
Althou.gb the ne t a • e t method of c:a],c uladng the profit of a business does calc ufate
1he profit tJC1-si'{1 and accu.t~ateiy, it do have a major drawback. It do not girve u
Capital receipts are derived from
transactions tfiat are not the usual activit~es any details of h,o w tht.; pr,oft,t (or loss) was arrived in.
of 1jhe busi,r1ess. Th details of how a profit has ~
n arned ,or why a lo "S ha been incurred are
important to both the o'\\rner and any exierna l pr,ovid.crs ,of finance.
• The owner 'Will probably wish to inakc greater pro6ts in the future.
Revenue receipts are Incomes de!rived • Lenders \viU wish to see that their invesunent is safe and that any interest due or
1
from the usuia l' activities of the business.
repayn-lents due wm be ab]e to be met by the business.
122
16. 2 The trading account of an income statement
Tiie detai1s of how pronts are arrived at ar,e shown in an incorne statement.
The term revenue is used in a,n income
statement to desciribe the totail of aiI
revenue re ce1:pts.
••••••••••••••••••••••••••••••••••••••••• 1 llhe O\iVn,er of a busiiness wi,Ugeneral!¥ produce 1\No statements at the end of a
> Now try u stion 1. f ina ndal yea:r. Name the t\w statements.
2 Whkh statement detaUs the incomes aindl expend~tures .of the lbus~ness?
.3 Which s1atBment lists the assets a1nd Habilli ties of the bus1ness7
4 An ~ncom.e statement calruiate.s proi~ts more acc:urateiy than us ingi the 'net
1
Not
>··········~~·····~····················.
Now try Question'"'"· • lncotne tatetn nts arc pr, pare for a period qf lime.
• The statecnents of financial position v.re pr,e;;par d arUer ,vcJje prepared at one
mornent in tin:u.
Bernadette owns a business seUing n1agazines and books. She is able to give you the
foUowing inforn1ation relating to her business for the year ended 31 Decetubel' 2014~
s
Pu rc hases of magazines and books 32 500
Pu re hase of cash reg,iste r 840
Sa les of maga2ines a1nd books 65 BOO
Sa,1es of shop fittings 1,200,
Requil-ed
Prepare a trading ;;tCcourn for Ehe }'" ar ended 31 D-e-cemb r 2014.
123
IIThe trading account
Answer
Bernadette
Trading account for the year ended 31 December 2014
s
Revenue 65 800
Purchas~ 32500
Gross profit 33300
Note
The figu r,e s induded in extract fron1 the incon1e state:muent are figut-es for a yearj the
heading ieHs us this.
The purchase of the cash registei' has not been induded - it is capital ei"Pend iture.
TI1e saJes o f shop fttttngs has not been included - h is a capitaJ receipt.
Purchases are revenue expenditure. They are part o f the everyday costs associat,e d
with running Bernadette~s business.
Sal,e s are revenue receipts. These r,e ceip ts are fro1n Bernadettejs nonnal trading
activiti .
The: gro pront is found by cl~,d.ucting the ,ralue of purch~.s· s fron'l the revenu~
generated by the saJes.
The trading account of the income statetn nt is prepared by using the total value
of purch ases (an example of revenue expenditure) :and sales (an exainp]e of a
revenue t'eceipt).
9 Caphal receipts are 1induded jn the· trading account of the inc:om,e statem1ent.
True/Fa Ilse7
10 Capital expend~ture is i1nduded in a trad•ng account. lru1e/false7
11 A restaurant \1\/ould ~ndude· the purchase of a new cooker in the trading
accou nt ·of an income s1atem1ent. lirue/Fal se?
12 A veh~de repak business would include electddty charges 1
in the trading
a,ccount of an i1ncome statement. liruelfalse?
13 How ~s the cost of goods a1va1labl:e for saie cakulated?
14 Gross profit ~s cak ulatedl by 1a1king the cost of purchases fro,m the revenue
gienerated by mak~ngi sales. True/false?
15 In \!\that way is 'gross profit' d~fferent to 'profit ior 1he year' 7
16 l he tradi1ng account of an rincome statem,e nt is prepared to calcu~ate
17 The semng price of goods is deducted frnm, the _ _ _ _ _ gatned from the
seU~n g of those same goods to ea lcul ate gross profit.
124
16. 3 The treatment of inventories
So the inventory value at tl1e end o.f one nnandaJ year is the inventory va]ue at
the start of th~ foUo~i:ng financial year.
• Inventory at 30 Novem r 2014· is inv nitory at l Dec tnber 2014.
• Th inventoty held by a lbusin at 31 lvlay 20,15 i.s the inventory held on l Jun 2015.
Bai]deep has a n1arket staU selling spkes. She provides the foilo\vin g infom1ation:
invento,y of spices at 1 eptetnlber 2013: 345
purchases of spices for the year ,e nd d 31 August 2014: $J.84-o
saJ s of spk forth year nded 31 August 20,14, S427SO
invt:ntory of ~pices at 31 August 2014: 400.
Required
Prepare the trading account for the y,ear ended 31 August 2014.
Worki·ngs
We first have to fin d the value of the .spke.s that Baldeep .sold during the year.
s
Bak.Jeep started the year with 345 worth of spices
She bought a further 18450 worth of spjces
Sosh e could ha~ sold 18795 worth
1
... but she didn "t ••• she had
... some left. 5he had 400 worth left
So she must ha~ sold 1' 8 395 worth of spices.
Answer
Bal deep
Trading account for the year ended 31 August 2014
$ $
Revenue 42750
Less Cost of sa Ies
Inventory 1 September 2013 345
Purchases 18450
18 795
Less I nventory 31 Augu st 20 14 400 18395
Gross ;profit 24355
125
IIThe trading account
Note
Opening inventon ar addti:d to, purchases.
C]osing inventori ar deducted from goods avaUable for al 10 calcu]ate oost
of sales.
The description for $18 395 is lcost of al~ '.
$18395 is the cost price of the spice:s Ba]deep sold during rbe year fo:r S. 42750.
Notice the use of 'tvt10 colunlns. Aner a few times using this technique you wiU see
that it n1ake.s the caku]ation of gross profit much dearer.
18 Opening jnventory mL..1s1 always be· 1.ess 1han dos;ng1 inventory. lirue/False7
1
19 Inventory he11d at dose of busjness on 31 July cost $13 OOO. It w,~11 lbe so 1d for
1
$20 OOO. What ~s tne value of 1invento ry ait start of business 1 August?
1
20 In the first ye·ar of trading purchases cost $100 OOO. dos~:ng inven1ory valued at
cost amounted to $20000. Wha1 is the cost of sales?
21 Identify two types of g-oods that a1furniture manufa,cturer \Wuld i1ndude as
dos~ng inventory.
22 Is it possible fof some itemis held as opening ~nventory to be hejd ais
dosi1ng inventory7
23 C~os1ng ~nventory at 31 Jully 2014 is the saime as open~ng inventory at 1 August
2 01 4. True o:r false7
24 Whait eff,e ct does dos~ng inventory have on cost of .sales.?
25 Purchases= Cost of sa,es - ,o pening inv,e ntory + C~os1ng11inventory. True/False-?
Make sure that you understa1ndl how to The foll owing information is available regarding the goods ren1aining unsold m
c:a~culate net rea1ljsablle va1Jue. Obika's business at 28 February 2014:
Requit d
r. StatL'; the value of each unit held is inventory.
126
16.5 lhe treatment of returned ,goods
Answer
~ Arker - $12; B-o ins $22~ CJods $6; Dynps $40; Edlivs S15
> Now ry Oue ion . $9-
Remeinhet·
• If dosing inventory is Ot)(!1''t1alued then gross profit \Vill be ouerstated.
• lf gross profit is ovet·stated then the profit for the year is overstated.
• If dosing inventory is understated then gross p,rofit wiH be understated.
• lf gross profit is understated then the profit for the year is understated.
26 lnv,en1ories aire goods 1ha1 have been bough1 for resa~e 1hat have not yet been
sold at the finanda~ year end. True/Failse?
27 Goods heldi ait the end of a f i1na ndal yeari co,st $4 SO; they ean cu rr,entiy be,
purchased for $SOO; 1hey harve a11resate value of $700. What i1s the vallue of
dos~n gi iinventory?
28 A da:maged art~de he~d ait the,·end of a finandat year co,st $40; after repairs
costing $114 rit can be soid for $55. What ,s the value of the article ior ~nventory
purposes?
29 Gross profit is $50000. Cllosiing inventory wars va,lued at $3000. It has been
d~scover,ed that dosing inventory should harve been va1lu:ed at $2000. What is
the correct gro.ss profit?
The foUowing infom1ation for the year ended 31 August 2014 relates to the business
of Beebee:
inventory at 1 Septernber 2013 $1200~ inventory at 31 August 2l014 1500;
purchases $480-00; sa]es $72380· sales returns $180, ptu·chases ret1JJrns $360.
Requit-ed
Prepare the ttading account for the year ended 31 August 2014.
127
IIThe trading account
A nswer
Beebee
Trading account for the year ended 31 August 2014
$ $ $
Revenu e 72380
Less Sales returns 180
72200
less Cost of sa 1es
1
One again~ :notk th~ way that th calculation to fi nd th in t~ purchases ftgur has
b· n set back from the second colun1n. Acoo,u ntants often u e textra~ oo,Ju111ns so that
the main column does not get too confus~d.
30 Expla1in the effect t hai1 ~he ind us ioni oi sales returns hais on the gross p ro-fit ,o f a
1
business.
31 l he :indus~on ·o f purchases re1u rns in a trading account has the effect of
increasi ng/decreasing gross profit. (Delete the incorrect word.}
32 Retur ns ~hat ,o ccur ~nthe fast week of a fi nancial year can be ignored, They can
be ;ndudled in the following year5 financial state1ments. Truelfa~s·e7
Carriage outwards is also a.n expense Benji owns a store. The fo Uowin g figures re late to the year ended 30 Septe mber 2014:
which a business incurs wfnen it pays
invento ty at 1 October 201,3 $5300· inventory at 30 Septen1ber 2014 $4900i;
for delivery of goods t o a customer. It :is
som etim-es referred t o as ea rri age on sales. p urchases $124600; saies $3 14 000; returns inw a rd $930; ptn'Chases returns $2100;
carriage inw ards $1750.
128
16.6 The treatment of expens.es incurred in the carr~age of goods
Requit-ed
Prepare the ttading account for th year ended 30 pte.n1ber 2014.
Answer
Benji
Trading acc.o unt for t he year ended iO September 2014
s $
Revenue 3 14000
Less Sa les retu ms 93 0
3 13 070
less C ost of sales
Inventory 1 October 2 013 5300-
Purchases 124 600
Less Pu re hases retums 2100
122500
Carriage- ,inwa rds l 750 124250
129 '550
Less Inventory 30 S~ptember 2014 4900 124650
Gross pro~it 188420
This exan,pJe shows the n1ost cotnpJicated fom1 that a trading account can take . To
n1ake a n1ore diffiouh exatnp]e you could on]y be asl.red to use Larger ntunbers!
Notice once n1ore the use o f three c0Jun1ns. Th is has enabled us to get one figure
for the tot~ cost o f net purchases ($124 250) without Jots of caku]ations in the uiain
columns.
When you attetnpt the questions below you may find it helpful to refer to Benifs
trading account to get a good Jayout. Do not V{orfy about this. )'ou wm soon start to
reJ"ne:rnber \\rhere 't o enter the various itenl8.
33 State how the value of g1oods availabf,e for salle i1s cakufated.
34 State whait ~s meaint by cost of sales.
3 5 Anoither name for returns in\!\fa1rds is purchases retunns. lrue/fa~se7
36 Purchases returns are also kno\.\ln as r,eturns outNa1rds. lirue/False7
37 Carriag,e inwards is deducted irom sa~es revenue. True/Fais,e?
3 8 Carr~age outwards ~ s added to purchases. True/Falls e7
39 sa,e-s $37 980: sales returns $3S6: purchases returns $2'99. What is the value of
net sa~es7
40 Purchases $217 845: sales returns $3 77: purchases returns $652. What is the
value of net purchases?
41 Carr•ag,e inwards will increase/decrease the value of 1purchases/sales. (Cirde 1he
~········································
,.. Now t ry Questions 4 and 5. correct ans\iVer.)
12'9
IIThe trading account
The tradi1ng account is used to cakulate gross profit by deducting sales ait cost price·
1
130
The profit and loss account
By the end of this cha pt-er you sho uld be a ble t o:
• prepar,e the prof1it and ~oss a,ccou nt of arn i ncom·e statement
• explain now account~ng statements are used for stewardsh~p and
marna,g,ement purposes
• combine the trading account and profit and loss a,ccount of an
in come statement
• ,ndude the expens,e oi carrrniag,e oumards in a1profit and !loss
account.
If your weekly income does not cover your weekly expenditure~ what do you do? You
draw son1e n1oney fron1 your savings (if you have any) or you tnay borrow sufficient
money to tide you over unti] your incon1e is enough to cover your spending.
The san1e principle applies to so1neone in business. If the business is unptufitab]e~
the owner niay have to inject sotne of his or bet· savings into the business or borrovv
n1oney to help the business to survive.
We have just seen how to cakulat,e the gross p.rofit. Put simply, the grogs ptoftt :is
the differenc,e between the cos£ of goods so]d by a business and the aimounE that the
goods have been sold for.
Clear]y ther a r '"pens that have to be paid out of 'this gross profit in order that
tht; finn can continue in usine " . Profit forth r ar is ,c akuJat d by d ducting aU
__.. ·pGn incurred by the, busin fron1 th oss p,r,o,fit that it bas ,e-a m ·d throu h
buying and s~Uing its goods during a fina:ncia] ~ar.
During April Didi buys 1000 DVDs for $4000 and she seUs then1 aU for $6990. She
has made a gross profit of $2990 on the :sales. However, she wiU have incurred sotne
expenses in seUing the DVDs.~ and they could have induded~
rent pa id for the use of a n1ru'ket staJl
transport cos'ts to get the DVDs to the staU
wages of any sales a._~istants
money paid to purchase wt-app,ing materials, etc.
'W hen aU other exp-e:nses incurred in 1naking the· s:iJJes have· been Ea ken into
acoount the result is profit for the month.
1311
mThe profit and loss account
1 Explain tlle djfferen ce between t he stewa rdlsh ip f uncbo 11 and the management
function o·f using accounting informat~o11.
2 ~de·ntify two types of person that would use a,c count~ng ~nforma,11ion for
stewardship purposes .
3 ~dentify tvvo types of person tha·t would use accoun1~ng i1nformation for
rmana,gement purposes.
132
17 .2 The profit and loss account
Vi.taly owns and runs a general store. In the year ended 3 1 I\.1arch 2015 he made a
gross profit of 121500. D uring the san1e year he in curred the foUowing expenditure:
s
Rent 750
Wages 8 000
Insurance 400
Pun: ha se of new werghing sc aJes 2 340
Motor expe nses 1 100
Light and heating .expenses SOO
Statioinery and advertisin g 250
Bank charges 135
Purchase of a 1new del'ivery van 15 600'
Genera I expenses
1
18'5
Money sp~nt on fami ly hol,iday 2300
Required
Prepare the profit and ]oss accoun t foi· 't he year ended 31 March 2015.
Answer
Vitaly
Proiit and Ioss account fo r ·t he year ended 31 March 201 5
s $
Gross 'Prof1it 21 500
less 1E~penses
Rent 750
Wages 8000
ln,sura,nce 400
Motor expenses 1 10-0
Light and heatJ ng expenses 500
Statiornery and advertising 250
Bank cha rges 135
GeneraII expenses 185 11 320
Proflt for the year 10180
Note
• The weighing scal,e s and the delivery van have not been included because they
are both ex:unp]es of capita] expenditure. They wiU appear on Vitaly s s1ate1nent of
1
6nandaJ position.
• Tb inon y p nt on th ho!icla)" has not b en indud d inc this ls not a bu in s
xp ns . An income uuement onJy includes business ·pens . Cl
• Th~ mo n y spent on the family holiday i drawings since th transaction had gon, ·
through the records of tb c business.
133
mThe profit and loss account
Requit·ed
Prepare an incon1e staternent for the year ended j l May 2015.
Answer
Danielle
Income statement for the year ended 31 May 2015
s s
Revenue 748381
Less Cost of sales
l,nventory 11June 2014 27268
Purchases 48 1690
508958
less l.nven,tory 31 May 201:5 28420 480 538
Gross ip rofit 267 843
Less ~~penses
Wages 132 471
Rent and loca:I taxes 26 402
Advertising. and insu ra nee 8327
Motor e-xpenses
1
1OS13
Office expenses 12 468
Light and heat 11 235 201416
Profit for the year 6642 7
134
17 .4 The treatm~nt of the expens~ ,o,f carriage outwards
• Providers of finance use finandal state:ments to s,e e it the funds they have prov~ded
are be11ng1 used wise~y. Th~s ~s the stewardslh~p use of account,ng.
IManagseris use the f~nanda1Istatem,ents to see where 1improvements to the business
can be made and to see whPch parts of the bus~ness are lbeiing run effk 1ientJy.
The prof~t and loss account provides 1he detail of how gro·ss profit has ~een utillis·e d
mn the payin 91of the business s expenses.
1
~t l~sts al I revenue exp enditurre incurred by a business ajnd revenue inco·mes ea rn-ed .
The tota 1of aH the revenue expenditure ~s deducted from gross profit 10 g~ve the
1
135
Irrecoverable debts and
provision for doubtful debts
By the end of this chapter you sho uld be able to~
• write off ~ndividual debts thai cannot be settled
• m1ake proviis~on for l~kely doubtful debts
• prepare a1provi1sion fo:r doulbtlrull deb1s aiccount
• caku~ate an annua1lprovis~on based on past -exper~ence of doubtful
debts and on a,n age profHe of ind~v•dual debtors
• record the recovery oi money fro,m a debtor who was regarded as. a
bad debt some years ago.
Thiis is done by debiting a bad debts .account in the general ledger and crediting tbe
An frrecove rab le or a, bad de bt occurs
debtor's acoou nt in the sales ledger.
when a debtor cannot pay the a mount t hat
tS OVl/ed.
Dr Moussa Cr Dr Cindy Cr
$ $
8al ance bid
1
1
143 Bal,1rnce bid 619
Dr Rett er Dr Sandie er
s s
18a11anee bid 51 430
Dr Deck Cr Dr Tina Cr
136,
18.1 lrrecoverable or bad debts
1
It has been revealed that Moussa and Tina are unable to pay their debts and Nobel
has decided to wr1t ith~m off at the yea r end d 31 D ceinb r 2014.
Requi1 d
bow the nee s ary entries to, record tbe transactions.
Answer
Sales ledger
Dr Moussa Cr Dr Tina Cr
$ $ $ $
Bal!ance bid 143 Had debts 143 Balance bid 92 Bad debts 92
Genera I ledger
Dr
$
Moussa 143
Tina 92
Any entd in the do ubl -entry syst m must first b ntered in a book of pdm ,r.:ntry.
·w e sho uld use the general joun1a l ·t o record the ttansfet· of each debtor to the bad
debts account be/or(!/ t-000,rdling the entries in the general ledger.
The ge nera] jr0umaJ e ntries ~ rou) d show:
Dr Cr
$ s
Bad debts account 143
Moussa, 143
Wr,iting off Moussa.·s debt (irrecoverable) to the bad debts account
Bad debts accoUint: 92
Tina. 92
Writi,ng off Tina's debt (i,rrecoverable) to the bad debts acco unt
...\t th
,e nd of the;; fi na ncfal year, tbt= bad deb s account is tomUecl and dosed by
tran i rring th amount to tb incorne statement a a revenue exp n .
Nobel
Extract from profit and loss account ·f orth ar ended 31 December 2014
$
Expenses
Bad de bts 235
137
mIrrecoverable debts and provision for doubtful debts
Digby has est:ir1nated that each year around two per cent ,o f his debtors fail E·o , pay.
Answer
c The provision for doubtful debts is 638 ,C 31900 x 2%).
138
18.3 The Jedg,er accounts recordingi provision for doubtful debts
Deirdre provided the fo]k,vving age profile of her trade rocei va btes at 31 May 2015.
The percentage of debtors proving to be bad has been gained from ,o ver 20 years'
experience m her bus iness.
0-1 1-3 3-6 6 months-- over
Time outstanding month months months 1 year 1 year
-
Amoun1:s owed $120 000 $3000 $400 $.3 00 $1100
Re qui:redl
- calculate tbe an1ount of provision fot doubtful debts at 31 May 2015.
Prepare an extract from the state,nent of financia l position at ·t hat date.
Workino
$
120000 X 1% =1200
3000 X 3% - 90
400 X 5% - 20
300 X 20% - 60
1100 X 50% - 550
1920
Answer
The provision fo r doubtfu] debts is $1920.
Extrac.t from state me nt of fina ncial position a t 3 1 May 201 5
s s
Current assets
Trade receivables 124800
Less Provi.sion fo:r doubtful debts (1 920) 122 880
Note
It v,;as doubtfu] wheth e1' Digby would receive $31900 frotn his debtors. F t"on1 past
experience he feeJs that $31262 wiU be a :n1ore accurate figure. The creation of the
provision has a]lowed hin1 to be prudent.
It was also doubtful whether Deirdre would receive $1.24800 fron1 her debtors.
She feds that ,$122 880 is .a tnore accurate figure. She has been pn1dent in ,creating a
provision for doubtful debts.
139
mIrrecoverable debts and provision for doubtful debts
to, th. balance in d1e pro\-ision for doubtfu] debE account a:nd a corresponding entry
n1aJd in th~ inooine staternent with the adiusttn~nts eith incr asing gross profit or
d et<: "'M it
Lew has dedded. to create· a provision for doubtfu] debts ac,count at wo per cent of
trade receivables o uts ta ndin g at the fioonda] year end o n 30 June each year. Trade
receivables outstanding ait 30 June 2014-was $36700.
.Required
Prepare:
a provision for do ubtful debts account at 30 J une 2014
an extract frorn the incon1e statement for the year ended 30 Jun e 2014 showi ng
relevant details
an extract from the statenu~nt of fin a nc ial position at 30 June 2014.
Answer
a c-=--r Provision for doubtful debts account Cr
Extract from in~ome statement for the year ended iO June 2014
734
s
$
Expenses
Provrs ion for doubtfui debts 734
C
Extract from statement of financial position at 30 June 2014
s $
Current assets
Trade 'recejvables 367 00
less P,rov1sion for doubtfo! debts (7 34) 3 5966
At die fioandaJ year end 3,0 Jrune 2015 Lcw had ou tstanding trade reccivab.lcs an10,undng
io 4 1300 He continues to n1ainrain his provision for doubtfuLdebts aceou:nt at two pet·
1
cent per a nn1.u:n based on trade receivab]es outstan ding at his year e nd.
Required
P repare:
a provision for do ubtfu] debts account at 30 June 2015
an extract fron1 the income statement for the year ended 30 Jun e 2015 showin g
re[,e vant details
an ~~U'act from the statetnent of fina ncial position a't 30 June 2015.
Answer
N ote
•••• • •••• •••••• • •••• • • •••• • ••••• • ••••• ••• • T he amonnt ente re d o n the inco111e sta.ten1ent is only th e increase in the provision .
> Now try Questions 1 and 2 . • It is the a1n o unt needed to 'top up' the a cco unt ·r o the required ]ev·el.
In each e.x ampLe ~nd questio n u sed so fa r there has been an increase in th e provision
fo,r doubtfuJ debts. A decrease in Ehe provision now needs to be considered.
Bernie n1ainta ins a. p rovision fo r doubtful debts account. His p:ro\oisions for the last
three years are listed:
Requ ired
Prepare for each of th , three )'ears
..i a provision for doubtf td d b account
an :Xtract from n inoon1e sta:tetn nt .show ing Eh , djustn1-ent to the provision
accou nt,
Answer
a
Dr Provts ion for d ou btful debts account Cr
$ $
30 April 2013 Ba lance d d 250 30 AprH201,3 lin come statement 250
.340 340
30 April 2015 Income 70 1 May 2014 Bafance bid 340*
statement
30 April 201 5 Balance d d 270
340 340
1 May 201 5 270*
* The balance brought d own is always equal to the ainount of provision needed.
1411
m Irrecoverable debts and provision for doubtful debts
b Be rnie
Extract from income statement for the year ended 30 April 201 3
Less Expenses $
Provision for doubtful debts
250
Bernie
Extract from ine,ome statement for 1he year ended 30 April 2014
s
Less Expenses
90
Provision for doubtfu l debts
Bernie
E)(tract from income statetnent for 1he year ended 30 April 2015
$
Gross profi t
Plus reduction in provision for doubtfu I debts 70 (added t-o gross profit)
Mussa Green n1akes a P1'ovisio n fo t· doubtft.d d e bts based o n o ne per cent o f tmide
recewab les o utstandling at the financial year end .
The foUow in g 'table sh ows th e e ntties in the books of account for each o f the first five
years in business:
(100) 9900
2 12000 120 20 e~pens~ 12000
(1.20) 11880
• Th amount ne~ded EO increa e th',;; provision for doubduJ debts is t:nt red a .. an
expense on the incon1e stat ment.
• The amount needed to decrease the provision for doubtful. debts iis cnt,e r·e d as an
'jn comc' on the in cot11c statement.
142
18.5 Re,covery of bad debts
If a question does not require ]edger accounts~ the result o f the transactions above
can be recorded in the finan da] state111ents as:
• an increase in profit, and
• an increase in cash.
Hassan ow~d BiU $237 6\re years a ~o. At that time Bill w:r,o te Hassan' · debt o ff as bad.
Hassan has set up in business again and is now abJe to pay the I 237 that was
previously written off.
Hassan shou]d be reinstated as a debtor as he is a bout to repay the debt. This fact
should be recorded in BilPs books of account.
This is important to Hassan since he may require criedit facilities fron1 BiU in the
future. The fa.et that he has repaid his debt n1ay be taken into consideration by BilJ.
$ $
Bad debt re covered 237 Hassan 237
143
m Irrecoverable debts and provision for doubtful debts
asan _ _ _ __
4 l n which lledger would you find the baid debts ac-eount7
5 IName the three methods that a trader may use to callou!ate 1he amount needed
••••••••••••••••••••••••••••••••••••••••• for 1he prov1smon for doubtful debts.
Now try Questions 4-6. 6 in wh ich ledger would you fii nd 1he provis~o n for do ubtlul debts account 7
1
The amount owed by h1dividua, debtors Who wiU definhely not pay 1hefr debts 1is
w1nitten off to the ~ncome stateim,ent;
A provi'sion for doubtfld debts is created to take account of credirt customers
who may not pay the~r debts. Any increase tn the pro~s ~on 1is entered as an ·e)Q)ense
in die income statement (thus decreasing1profit for ~he yea1r) and any decrea,se in the
provisi,on is entered as an addl,tr,on to gross prof1it (id,us increaislng profrt for the year),.
Bad debts recovered are added to gross profh in the ~ncome statement (1i11creas1ng
profiit for.1he year) or are used to reduce any lbadl debts written off in the ·Current year
and deb~ted to 1he cash book.
144
Depreciation of non-current
assets
By the end of this chapter you
should be able to:
• descrjbe the factors that affect
the fjfe··Of a non-current asset
• cak ufate the annua, depreda1ion
eh argie us~ ng1:
• the straigh1-Une m1ethod
• 1he redudn g balance m,etho d
• the re,1 a~ ua1ti on m·e~h.o d
• cailculate the prof1it or !loss on
dli1sposail oi no n-cu rren t a,ssets
• record the disposal oi a non-
c:u rrent as5et in 1:he general ~edg·er
• record the allowance made for a
'trade~~n'
• understand the connection
betw·e en depreciation and cash.
14S
m Depreciation of non-current assets
• A machine wiU eventually cease to produce the goods for which it was purchased.
• A delivery vehide wiU eventuaUy cease to be useful for the delivery of goods.
Infinite Iife means an l.m Ii.m ited l,ife spa n.
Of course, land shou]d not be depreciated, because land has an infinite Ufe.
So, the total cost of a non-current asset is never charged ~o the income statement
for the year in which it was purchased. The cost is spread over aU the years that it
is used in order to reflect in the income statement the cost of using the asset in ·t hat
partiCl!l]ru- financia] year.
When a non-current asset i.s purchased and Jater soJ d ~ the a 1no unt that is not
:rec,o vered is ,caUed d ~1· dation .
Donna purchased a non-cu:rr nt asset for $20000.... he sold it thro years later for $2 OOO.
Requit·ed
Ca]culate the cost of using the asset (the amount of dep,redadon) for the three years.
Answer
The crut of usmg the non-cu rrent asset ( Le. the depredation) is
18 OOQr ( $20000 - $2000).
Tbis n1eans. that the actual depredation can only be ac-curate]y caiJculated when th e
non~curre nt asset is n o longer being used.
The annual depr~ciatio n cha rge is theretOf·e an estimate made bast,d on
expeti,c nce.
If w knov.r Eh co >t and can ·make an , ·tin11ate of ho~· long th non-cu nent asset
Vv"iU be u eftd and how much it might be worth at the ~nd of its lifo, w can a]cuJ at ·
the amount of deprc-i:ia'tion that ·wiU tak place aver the lifetime of tl1 · non-cur-root asset.
We need ro apportion this Ufetime cost into each of the years that the o.on-currcnt
asset '"'as used..
• physka l deterioration based o n expected wear and t·e ar: this wm dep end on th e
type of use that the asset _fa e1np]oyed in, how w ,e ll the asset is n1aintained and how
wen any repairs are c: arded o u.t
• econ omic factors such .as the nec,essary output and the po'Een£lal capacity of the
146
19.3 The straight-fine method ,o,f d~preciat~ng non-current assets
• legal o:r other limits p]aced on che as.set; for exampl,e 1 when an asset is acquired
under a l a sing a green1ent the l ssor ma11r pJ ace restdcitions on the us~ of the asse·t.
Ther, ar many method of dividing the Ufedm cl predation charg . 'X" haU
consider the f oncYWin tbrc: tnethod.s:
When a method of cakulating the provision for depredation has been decided upon,
it shou]d be used consistently so that the resu]ts shown in the financial S1Iaten1ents of
different years can be compared.
3 ~n which type o.f account wou1ldl you expect to iiind non-current assets?
4 ~n wtdch ledg·er would you expect to find the ma,chjnery account?
S A second-hand veh,de is purchased. Because the prevjous owner charged
deprec~a1ion on the· veh~cle, the new ,owner does not need to. True/False?
The e,ost of an asset ~s the pu rc'h ase price 19.3 The straight-line method of
fnc'Iud1in9 any taxes pIus ariy other costs
directly attributa,ble to bring tne asset to the
locati.o n and condition, ready for use.
depreciating non-current assets
The straight-line method requkes that the san1e atnount is charged annuaUy to the
incon1e statement over the Hfedtne of a non-current asset.
Attributable costs that are included as
To ca1cubne depreciadon using the straight-line tnethod it is therefol'e necessary to
pa rt of cost woul'd in dude:
consider:
• del,ivery and ha ndl,in,g charges
• profession aI fees charged by solic:irto rs_ • the cost of the non-current asset
architects, site engineers, etc. • rhe estin:lated life o.f the ll'lon~current asset
• making ready the site w here t he asset is • the estirnated 1·"' idli.aJ. value or ijCt-ap va]ue.
to be ,used
• any costs involved in assemb,ling and
testing the ass et.
Co t of non-current a set - Any r duaJ valu
Annual depreciation charge =
Residual (scrap) value is the amount that Estimat o f ntunber of years' use
a non -current asset can be! sold -for at the
end of its useful Irfe.
ff we know the Ufe of an asset ,ve can easily caJcu]ate the annua] rate of deprecfa'tion.
• If an asset has an expected life of ten yea.rs, the annual rate of depredation would
be ten per cent (100 per cent divided by ten years).
• lf an asset has an expected ]ife of SO years, the annual rate of depreciation would
be two per cent (1,00, per cent divided by 50 years).
• lf an asset has an expected JU:e of two years, d1e annua] rate of depreciation would
be 50 per cent (100 per cent divided by two years).
A comput r i purcbas d for $2300,. Its us ful life i exp cted to b two years, after
which it wiU b r p,]ao d. It is exp et d diat it wilJ have .a ttade1.in va lu of I 100.
Requit d
Ca]culat,e the annual depreciation charge using the straight-Bne method.
147
m Depreciation of non-current assets
Answer
Antiual depr,e ciadon charge =$1100.
\~ rkinas
Cost of cotnputer - Residua) value $2200 - $100
E.sthnar@d years of use
- 2
Answ er
Dr De Ii very van ac:cou nt Ct
$
$ $
31 Dec20 11 Balance d d 3000 3 1 Dec 2011 lncome statement 3000
3 000 3000
1 Jan 2012 Bala nce bid 3000
31 Dec 20 12 Balarnce d d 6000 31 D·ec 2012 Inco me statement 3000
60{)0 6000
1 Jan 201.3 Balance bid 6·0 00
31 Dec 2013 Balance c/d 9000 31 Dec 2013 ln come statement 3000
9000 9000
1Jan2014 8a~ance bid 9·0-00
31 Dec 20 14 8afanee c/d 1:2000 31 Dec 20114
1
In co me statement 3000
12000 12000
1 .J an 2015 Ba l".; nce bid 12000
148
19.3 The straight-fine method ,o,f d~preciat~ng non-current assets
c Extract nom income statement for the year ended 31 December 2011
s
l ess Expenses
Provision for d~preciation of deMvery van 3000
Extract from income statement for 't he year ended 31 December 2012
s
Less Expenses
Provision for depreciation of deHvery van 3000
Extract from income statement for the year ended 31 December 2013
s
Less Expenses
Provision for d eprnciati o,n of de'Iive ry van 3000
Extract from income statement for the year ended 31 December 2014
$
l. ess Expenses
Provision for d~preciation of deMvery van 3000
149
mDepreciation of non-current assets
Answer
a
W01kings
Year 201 2 $7200 ($18000x 40%)
Y~ar 2013 $4 320 ($18000 = $7200) X 40%
Y~air 2014 $2592 ($18000 - $7200-$4320) x40%
Dr Cr
$ $
Income state ment 4 32.0
Provision for depreciation of ve hi c les
1
4 320
Depreciation cha rge io:r veh ides fo r t he year ended 3 1 December 2013
1
The provis ion fot depredation account wm ]ook very sitnilar no n1,atter which 1ne thod
is used; only the a nnua.J charge entered in the incon1e staten1ent wm cha nge .
150
19.4 The redudng balance method ,o,f d~preciat~ng non-current assets
Requit-ed
Pre pare:
1 a mach in ry account
l a provision for depreciation of m achine ry aicoount
inoom statetn ent e"-"lracis to record tb~ necessary entries
d cnracts frotn the statements of financia l position for the three years 2012, 2013
and 2014.
Answer
Dr Machinery account Cr
$
1 Jan 2012 Bank 64 000
c Extract ·f rom income statement for the year e nded 31 De ce mbe r 201 2
s
Gro-ss prof it
less Expe nses
Provision for d~preciation of machinery 12 800
Ext ract from income statement for t he year ended J 1 December 201 :B
Gross prof ~t $
less ~ penses
Provision for depre daiti on of ma1c:h ine ry 10240
1511
m Depreciation of non-current assets
\lSe either of the t\Vo methods of providing for depredation pre"ious[y d - crjbe on a
or being stole,n. They are also individ'ualily hamm,e r that c 14.50 or on a pair of wire cun rs costing $4. 75.
of much 1lowe:r va.lu e than the non-current
'You can imagin tht: an1ount of tim that would b 'Eiken up if each ma]J t,ooJ \Vas
assets already encoiuntered in your studies.
1
entered in 't he genera[ [edger and depr,e dat d separately at the end of e~tch year.
IndividuaJly) these iteens are sma]J and tnight .seetn to be insignificant, but 1bey arc
non-cu rre nt assets be.ea use they are to be used for more than one financial year.
In o rde1i to calculate tbe depredation provision in such cases, the foUowing
caku]ation is necessary:
Th· manag,ers of Redjor Engin crin Works vaJu cl loos too] on 1 January 2014 at
$2190. During they: ar n1or tool "' costin S930 wer, purcba ~d.
On. 31 December 2014 th<;; n1anagers valued loo.se tools at 12 400.
Rcqui1·ed
Cakul.ate the dept-eciation of loose tools for the year ended 31 Decen~ber 2014 .
152
19 .6 The sa~e or disposal of non-current assets
1
Answer
$
Value of l:oose tools at 1 Ja,nuary 2014 2 190
Plus Add iti ons du ri ngi the year 930
3 120
less Valu~ of loose tools at 31 December 2014 2 400
Dep redation for the yeair 720
The depr,e d attion would be shown in a n1-a nufacturing account (see Chapter 32) since
the tools wiU be used in the factory.
The value at the end of th e year of ,f 2400 is shown as rhe can1'ing amount for the
non-current asset o n the staten1e nt of finanda] position at 3 1 Decenlber 2014.
A tn achine w hkh cost $32000 fivt~ years ago b as been sold fo1· $14000. T he
accu,nu]ated ( itota]) d epredation to date was 15000.
Requit-ed
Cakulat,e the profit or toss ar1si:ng from the disposal of the machine.
Answer
$
Machine at cost 32 OOO The cost of the machine
Depreciat,ion to date {15,Q00) less depredation to da te
Carr~ing amo unt 17 OOO gives the net value recorded Jn the ledger.
Sa,le p roceeds 14 OOO The cash rece.ived from the sale
Loss on disposal 3 OOO is less than t he value sJi.own in the ledge,; hence the loss
on disposal.
A tnadune whkh cost $1B000 ten years ago has been s,o!d for $1500. Tht:
a,o cunlulated (tota]) deptedadon to da_'f,f;;! wa 17000.
Requit-ed
Cakulat th profit or lo ,o n disposat
153
m Depreciation of non-current assets
Answer
$
Mach ine at cost
1
18 OOO The cost of the machine
If you are asked for a calculation. you may
use the m·ethodl shown above or you may Deprecia:tion to date (17 000) less depreciation to date
choose to show an account to record the Carryi ng amo u.nt 1 OOO gives the net value recorded in tn e ledger.
disposal (a, disposal account). However. Sa le proceeds 1 500 The cash received from the sale
if you are asked for a d~sposal account,
you must show your answer 1in account
:P roflt orn disp osa I
---- 500 is more than the value shown in the ledge,; henc-e the
pro fit on disposal
ioirma1.
Dr Machinery account Cr
$
1 Apri l 2013 Balance bid 66000
In January 2014 .1n1asekgoa sold a machine for $3000 cash. She has entered the cash
received in the cash book but has tnade no other e ntries in the ledger.
The in:achine had cost $18000 son1e years ago. The accumu]ated d epreciation
relating to the n1achine an1ounted to $16500,.
Required
Prepare the n1achinery disposa] account to ~ecord the sa]e of the machine.
Answer
Dr Disposal of machinery account Cr
$ s
Machinery 1SOOO Provi·sion for depredation of machi·nery 16 5·00
:Income statement {profit) 1 500 Cash
1
3000
19500 19 'S OO
154
19.8 The tr,eatme11t of a 'trade-in'
Answer
General journal
Dr Cr
$ $
Di~posal of mad,inery account 18000
Machinery account 18000
Transfer- of ma.ch inery to disposal account
Provf s ion for dep redation of machinery acco 1J nt 16 '500
Disposa·I of mach in e:ry ea cco unt 16500
Depreciat ion relating to the machine being sold transferred to disposal account
Cash account* 3 OOO
Disp osa.l account 3 OOO
Cash received for sale of machi ne
Disposa-1of ma eh inery a(cou nt 1500
lh:o me stateme nt 1 '500
Profit on disposa l of machi,ne transferred to in come staitement
• Cash eru:rl s shoo]d not r,e all~ b sh own in the genera] journal . The cash book is the
• • •, u • • •, , . + " • • • • • • ...., • • • • • • • • " • • • • .. , ., • book o f pr in1 entry that is used fo r an
transactions u ing ea b. How r~you may
Now try · u stion 3. hav co sho w cash entri .s in an answer requiring g . neral joumaJ entti .
Answer
Provision for depreciation
Dr Van B19 JJH account Cr Dr on van B19 JJH account Cr
$ s $ $
Bal'.ance bid 1 1 'SOO Dispos a,I 1T SOO Disposal 9000 Balance bid 9·000
$ $ s
Van 11500 Depreciatio11 9 000 o·1sposaI 275-0
Income 250 Va n 2 750 Bank
1
16250
state me nt DQO; WDA
11 750 11 750
155
mDepreciation of non-current assets
No t e
The proc~dur~ is 'v·ery similar to that us ~d \'\!·hen a :non-currenE ass is purchased for
cash only. The only differenc is that Eh~ nc.~ :non-cu rr~nt ass t 1.s debited '\\ritb any
aUowance b in n1ade by 'Eh suppHcr and the di~posal aooou nt is crcdit,e I with the
aUo\'\rance.
In the case o f a business~ tbere i.s an i.ndh-ect influence that depreciation has o n cash
flows.
Dep redation is ente red in the inco,ne stateinent. Th is non-cash expense reduces
profits for each year of O\Vnership . The red uction in profit n1ay cause the owner
of the business to w ithdraw Jess n1oney frotn the business for personal use· thus
conserving n1ore cash within the business.
Tomaz;s btllSin ss earns an annual pro6t of around ,4- ,QQO. His dra\vings averag
$20 OOO p r year.
Toma.z purchas a new n1achine for the busines ·Oo·sting $80000. Th machin is
expect~d t,o be used .for four y,ea.rs befor it n ~,c:--ds to lb rep] ac d.
When depreciation on the new nlach in,e (using th e stratght-Mne method) is
included in the income state lnent, annual profits are reduced to $25000.
Tomaz may weU reduce his casb drawings in recognition of the business's reduced
profnabiBqr.
156
19.9 The connection betwe,en cash and pro,vid~ng for depredation
8 Define depredat~on.
9 What ,s a pro~sion?
1o FUii ~n the folllowing gaps.
a Non-current assets are shown on 1he side of rea1I accounts in
the g,eneiral ~edger.
b AH assets With a ~iie should be depired ated.
c Only the asset of has an iniin~te l~fe.
11 INa1me two methods of calcula1,ing ainnuaill depreda1 1~on.
12 What aire the book.. keeping entr~es requfred 10 record ~e annuai charge for
depr-ed ati on 7
13 What is meant by t he term 'a1ccurnulated depreda-1tion'7
14 Whia1t is meant by the term icarry~ng amount' 7
•••• ••••••••••••••••••••••••••••••••••••• 15 An a,sset wi1:h a1 c:ar~ng a1m,ourtt of $4000 is sold for $3800. Cakulat·e the
>- Now try Questions 4-6. profit or loss on d~sposat
157
The va Iuation of inventories
• costs of purchase
• conversion costs
• any other costs incurred in bringing the i.nventories to ·t heir present location and
conditjon.
The s1anda1d d ~nne.s net rea]isabJe value as th,e estfrnated se]Ung price m the ordina11·
cours of business ]ess escin1at~d cam of cornpletion and aU esti1nated ,c osts to be
incurr d in tna rketin s Uing and distributing th itt:n1S.
Thea sells one type of vacuum deaner. Th ey 00-st $80 each to purchase. At 31 M'arch
2015 Thea has 14 deaners as inventory. The cleaners nom1ruly sell for ! 120 each .
Thea has one dan laged c leane r remaiini.n g. She intends to b aNe the c [eanef' repaired a t
a cost of $35. It ca n the n be so]d fo r f t OO.
Reqwit-ed
Cakulate the value of Thea's closing inventory at 31 l\.1arch 2015.
Answer
Thea's inventoqr should be va]u ed ait $1 105.
W"orkin gs
s s
13 cleainers at $80 each 1040
1 damaged dea,ner..
SeHi1n g p r,ke 100
l ~ss .Repair costs 35 65
1105
Up to now we h ave valued mo.st inventory at cost a nd net rea lisable value. It Jooks
fafrly stra ighdorward, b ut consider the fo Uowing exatnp]e.
1
Jite.sh seUs only one p roduct, ai sedrh '. He pro,ddes the foUowing infonnation:
Purchases
,.,,; of sedrits Sales of sedrits
Ja,nuany 2 at $1 0 each May 4 at $3 0 each
AprH 3 at $1 5 each December 3 at $3S each
November 4 at $20 each
In total Jitcsh purchased tune scdrits. He, has sold seven.. Therefore he has two
soorits reina.ining as inventory at 31 Deoen1ber. How should he value the two sedrits
ren1aJning?
He should v-a]ue then1 at cost!
Shou]d h e choose to va]ue 1then1 a t $10 each; or 15 each; or $20 each; or one at 810
the other at 15; or ...?
You can see that there a t-e n1any con1binations that we could choose w hen va luing
1
Jitesh s dosing in ventory.
So valuing in\l"entory aE cost is not quite a~ sin1p]e .a s it first seeniS. The tota l purchase.s
figure for the year is S145 and the total salc,;5 revenue for the year is S22S. We cou]d
prepare th ttra ding account of an incom tat, :n:'.Lent if we cou]d d -cide en a method!
by "rhkh \\re oould vaJue the dosing in,rentory.
[n th ~an1pl used abov ~ i.t might e· fairly straightfo,rward to identify the actual
units of sedrits that had bc.~n s·old and hence identify the two ren1aining in the
business. However, if we had m,a ny h undreds of itenlS available for sa]e this wou'ld be
a ln-1ost in1pos s ib le.
1S9
m The valuation of inventories
Most businesses wm be u:nab[ to identify with any precision the '1CtuaJ items that
they ha rt=maining as inventory at th~ end ,of their financial ye~ir and even if they
oould it would 'b a hug · ta k to go back through purchas invoiic to d tem1ine th
price pald for ~ach item.
Tbe valuation of invent,ori.~s is 1herefo1·e a ,natter of ,c..~pediencr n.rther than strict
accuracy.
In the valuation of dosing inventory; we do not trace ·tthrough tb c actual units
that have been sold; rather we identify certain iten1s that are deetned tto be sold and
therefore certain itetns that are deen1ed to renmin.
The methods Hsted in the foUovting section are n1ostt frequendy used to identify
the goods deemed to have been issued either to a final cu.stotner or to another
deparhnent with in the san1e business.
A garage mechanic requires a battery to fit into the car he is working on. The store
keeper .in the parts deparhnent will issue the first battery he can fay his hands on; he
~,m not waste time seeking out the first one bought in to give it o the mechank.
160
20.3 Perpetual and periodk ways of valuing dosing inventory
Thi method is used by business~ that need co cost their \Votk out t,o custoiners
"~1' carefuUy. It is also u d in major super mark. t~. Each tim ai transaction is
•scann d at the eh ck-out th bar cod is read and th :inventory r cord ar up -ated
lectronically to record th al (i s.u. ). E.a eh tin1e a d livery arri es in the Vv·arehotlS
the goods received. wiU be 'scanned and Ehe in~-n:t,o ry records wiU be updated. with
the receipt of the· g·oods.
Other ]ess sophisticated businesses n,ay s imply value their inventory ,o nce at the
financial year end. The owner of your loca] store or restaurant wiU prooobiy va]ue
inventory at dose of business on the last day of the fi na ncial year. They wiU Ust a]]
iteins reniaining unsold o n the last day of the financial year; they wm then assign
a value to each category o f goods he]d~ and the- total value of aU goods gives the
dosin g inventory figure to be used in the year e nd finanda] stateu1ents.
This is known as a periodic method of inventory valuation.
l e t us now- exan1ine the results given when we use a perpetual n1ethod of
inventory va]uation.
During the month of February th~ following receipts and issue~ of the con1ponent
· MH/19 took plac, :
Receipts of SMH/19 Issues of SMH/19
~
2 February 8@ $1 0
7 F~bruairy 6
9 Feb ruary g@ $,1,
16 Febf'tlary 10
24 February 7@ $12
27 February 6
Required
Cakulate the va]ue of d osing inventory o f component SMH/19 lJ.lSing the first-in first-
out tnethod of valuation (FIFO).
Answer
Th valu ,o f closing inventory us ing the FIFO n1 ·t hod ,o f iss,u is S,24.00.
7 February
1
1611
m The valuation of inventories
Answer
Th valu of clo ing inventory of component MH/19 using the '\\o~dghtoo avet-a e
cost (AVCO) n1 thod is $23.70.
Check each of the n1ethods sho\\rn abo,v e. T hey a t·e an important e]ement of your
studies and yo u wUl need to know th m ,velL
FIFO AVCO
if the value of dosing inventory is $ $ $ s
alrtered. reported profits WiHalso· dhang·e : Sa.,les 440 .00 440.00
Unfo1,:unat,ely there h no, shatter version of cakulating closh1g inventory vthen a:n
average price is ta1.""en fo,r issuing goods;
~hould you u e th periodic method or tb~ perp tual methoclP Ahvay.s us~, th
method you find asiest s,e th method you are n1ost comJ.o,rtabl using. inoe
••• ~ .. • • • • • • • • • • .. • + • • u • • • • .. • • • • • • • • • • • the pcdod k ,neth.o d is, I think, ,easier I wou]d use- it every time fo i~FIFO - unless a
;,... Now try ue tions 1 nd . question spccifkaUy requires you to show the perpetual romhod in detail
• LIFO is less re.aBstic than FIFO since it assu tnes that n1ost recently acquired goods
v,liU be issued before older goods.
• The most recent prices are no t used for inventory va]uation purposes.
• LIFO is not accepted by international accountin g standards OAS 2).
for pu:r,cbases.
• AVCO is acceptable to the Co111panie·! Act 1985 and international accounting
standards ([AS 2).
163
m The valuation of inventories
rechno]ogy, the oon1ptrt,e rised valuation that results fr.am this is invariabJy inc,o rrect.
How can this be? Go,mpu~ers nev-et make errors! They are 1nu eh n1ore efficient than
peop]d
It is cru,C;! d1at computers can b tnuch faster than w are. They can b nlot
aocurate than some of us. So why us a physkal tneans of cht;cking dosing inv-entory?
The computer r,eHes on accurate inputs by recehring· departments of a business - no
probJetn. It also rcl ic.s on accurate records for issues and this is where -che problen1
arises.
Consider your local s u.penuarket. 1\.•lost goods sold in the store do get scanned and
ihe inventory records at-e im:mediateJy updated I but what of the goods that are sto]en
and datnaged?
None of the.se ' issues' wiU be recognised by the coinputer. This is why a physka]
check is important to gain an accurate dosing mc\o"'efltory figure to con1plete the
financial staten1ents.
One final problein: somedn1es it is not possible to nuke an inventory check
ilnn:1ediate-fy after the dose of business on the finaJ day of the financiaJ year. Staff may
be absent on the" day. It may be too big a iob to complete in that OOf" day.
AdjtllStments need to bt: 1nade to the ft,gures aniv-~d at if tht: inventory valuation
was mad after the fu.iu1.ndal y ar end in ord r to, d t rmin th actual figure at th
appropriate date.
164
20.8 lnventory rec,ondHations
Gomez 'WI unabl,e 10 conduct hi.s annua] invent,ory check on 31 ~larch 2015, his
ftnanda[ 1 ar ,e nd. Howev r. h \\ras abl to compl :e it on 6 April 2015. Th goods
held had a value of ts 430 on th1t date.
Gomez provid1;.;s tho foUowing information on transactions that took place benvccn
l AprU and 6 .Ap,rU 2015:
goods purchased $450; saJes made $600-i g.o ods returned by Gomez to suppUers
$90; fa u by goods returned by custon1ers $120
A n1ru:k up of 20 per cent is earned by Gotnez on aU his sales.
Requit-ed
Cakulate the va]ue of inventory at 31 ~larch 2015.
Answer
Gomez
Ca. le u Iation of inventory he Id at 31 Ma re h 2015
$
Inventory a,t 6 Apri'l 2014 8430
less Net purchases (360) ($450 - $90)
Add Net sa,les 400 {$600 - $120 = $480 + 1'.2)
lnv@ntory at 3 1 M'arch 2014 8470
Note
• The purchases and saJes figures are nelt of retu ms.
• lnventory is am"ays valued at cost (or net reaHsable value) so the profit nurgin
induded in the net s-a les figure n1usr be removed.
• Purc~ses are deducted frorn the inventory valuation at 6 Ap1i] s.ince they were not
•••• • • •••• • •••• • • • ••• • •••• • • •••• • ••• •• • •• whh Gon1ez at the 31 March. Sales have been added back since Go1ne-z. did have
No N try Que tion 3. these· goods at the end of March.
165
m The valuation of inventories
of valuat~on .
FIIFO. UFO a1nd AVCO are m.ethods 01 va1luing1inventorry; they do not necessanily
detenm~ne the order jn wh~ eh goods are a ctuaHy ~ssued.
FIFO may lbe caktdated using e,ither ai perpetual method or a pooiodiic mie thod. If the
m.ethodl to be used is not st~puJated. then use the periodic method. It is quicker and
eas1ie r, and you a re ~ ess l1ike~ to 1ma ke an error.
1
166
Financial statements
21 .1 Financial statements
A fu]l set' of financial statements enables the owner and fi}aflagers o f a business to see
Financial statements is the term applied
to the income statement and the statement • if the business has been pt-ofita.b] e
of financial position. A 'ful'I sef of financ~a'I • the assets and HabUities that the bus iness has at the end of the financial year.
statements is grenerally produ ced at the end
of each financia'I year (although they can
be prepared at any time thi t man ag:ers or
owners require them).
Eduardo pro-vides the foUov.-ing inf.onnation relating to his sbop. All the :figures in th~
list r,e ]ate to the year ended 2B Felbroa_ry 2015 , except the inventory figure and the
capital figure. These two figures are the value of the inventory at th~ start of the y~ar
and Eduardo's capital at th~ start ,of the yc.:a:r.
$
Premises 80000
Fixtures 14200
Ve. hi d~ 8700
P. uirchases 211 640
Sales 408830
Inventory at 1 March 20 14 26480
Wages 152 610
Lig ht a n.d heatEng expenses 8420
Motor expenses 3 170
Drawings 18500
Advertising· 860
Insurance 1 540
General expenses 3 950
Trade receiva,b'les 1340
Trade payab lies 7 140
Bank bailance 2790
Cap'ita l at 1 March 20 14
1
11823·0
Inventory .at 28 February 2015 wa ~ value-d at S24 -60.
167
m Financial statements
Requited.
Prepar a statene1t of financial position at 28 February 2015 and an inoom
litatement for th year end 2 F bruary 2015.
Answer
Eduardo
Stateme nt of financial posit ion at 28 Fe b ruary 2015
$ s
ASSETS
Non -c.u rre nt asset s
Pr~mises 80 000
Fjxtu1res. 14200
Vehic:le 8700
102900
Cur rent assets
'l,n ventory 24 560
Trad e rece ivables 1340
Sank balance 1
2790 28 690
To ta I a ssets 131590
Current liabilities
Trade paya1bJes 7140
Tota I capital and Iia bi Iitie s 131 590
We have calcuJated the capital figure (n et a sse ts) at th e date of the sta.teinent of
financial p ositi,o n.
When you have studied a top~c. ask The Bst provided by Eduardo ·t ells us that one yea.r earUer his capital (net assets)
you rse I~th~s quest~ on:
l\l"aS $118 23'0.
'Could Ii explain wha1 I ha1ve just iearnedl
to a friend who ~s not an arccountant7' duar o's busin s h.as 1622,0 m·ore n t ass ts iu th. nd of the financial year than
at the tart of the year. These assets have been pro \l'i ded by the profits retained in the
If the answer is 'Yes, i 1h~nk ~ cou~d', then
you do understa nd the topic. bu siness over the year.
If the answer is 1 don't think I couM'. ~hen
11 $
iurther work Is re qu~ r,ed on yo u1r pa rt. IN et assets at 28 Feb rm~
HY20 15 124450
Less Net s sset s 1 March 20 14 118230
Prof.,it ret arned in bus1ness ·6 120
But~Eduardo has been withdrawing profits aJJ thro ugh the year irn order to finance his
]ife o utsid e the b usiness . He has been in aking dra.win gs d urmg the year.
These profits ( drav.-i ngs) take n fron1 ilie business need to be adde d ~o the rettwned
p rofits to te U us the to ta] profit ge nerate d by the b usiness du dng the year.
$
ip roflt reta irir1ed ·in t he b,usiness 6220
Profit wtthdraw,n by Eduard o (drawings} 18S00
Tota,I lbusi,ness prof it f or the year ended 28 February 2014 2472 0
This ca]cuhnio,n does not provide us wid, the dcta ils that may bcJ rcqu iroo for
.l na n agem eot and stewat"ds hip re asons. Therefore, w e must prepar~ a detaUed
incolne state tne nt fo t· the year.
168
21 .2 Preparation of financial statements
Eduardo
Income statement ·f or the yea r ended 21 February 201 5
Aiwaiys g irve a fu~I he,ad~n g. Do, not
abbrevia,te any part of 1he heading. State s $
the date in fuU, for exaimp!-e '3 1 M.arch Revenue 408830
2014' not '3 11/03/14'. Always use the less Cost of saIes
busi1n ess name i1n the he ad ~ng1. Invent ory 1 March 20 14 26480
Purchases 211640
2381.20
Less 'Inventrny 2 8 February 20 15 24 '560 2 13560
Gross profit 195270
l.e5s Expenses
Wages 15261 0
Light and heating expenses 8420
Motor eXJpenses 31170
Advertisifl g 860
Insurance i 540
General: e-~penses 3950 170 550
Profit for the year 24720
You should n ow be aware that u a bus iness is tnaking profits the net assets of a
business wiU increase provided those p rofits are reinv,ested CpJoughed back') and are
not withdraw n front the business.
You sh ou]d a1so be aiware that jf the business was running at a loss the n et assets
·would reduce. Spend a Utt.le 1time running t hrough this in your nlin d It is quite sensible.
If you do not spend aU o f your incon1e~ the surplus tnust show up in your net assets.
169
mFinancial statements
Emc:H owns and runs ve hk]~ repair garage. h supplies the foUowing information
G
Answer
Emeli
Income statement for the year ended 31 May 2015
$ $
Revenue 9243,
less Cost of salles
l1nventory 11 June 2014 945
Pu,rchases 4862'0
49565
L~ss Inventory 31 May 20115
1
48520
Gross: ip rofit 43 9 11
less Expenses
Wages 23789
Local taxes 872
lnsurance 211'50
Advertis inig 450
Stationery 357 27 618
:Pro~it for thre year 16 29.3
170
21 .3 Capaal in the statement of financial posi1tion
Erne Ii
Statement of fina ncial position at J 1 May 2015
$
ASSETS
No n..cu rrent assets
Premises 180000
Break.down truck 14000
Office fu rniture 8.000
212000
Current assets
Inventory 104 5
Trade rece·ivab tes 3450
8 ank ba'la,nc;e 849 5344
Tota I assets 217 344
\Ve can check lo see whether or not we have arrived at the correct figure for Emelri's
profit Jn Chapter 15 vre used the net a S5e1t method of calculating profit. \Ve shall use it to
If you are asked to calculate profit, u s.e· check the profit for d1e )'"ear that we ha,1e caJlculated by preparing an incon1e staten1ent.
the 'net asset' method; rt fS much qu1kkeir
(and you wjll probably have insufl~dent s
infor1matio11 to use any otheir method). C1osing capiYI 31 May 2015 55671
Less Opening capital 1 J.une 2014 '55128
tf you are asked to prepare an incom,e 1
Profits retained 1in Emet~ s business 543
stateme nit, then 1h at ~s pred se~y wha1t you
Plus drawings 15750
must! show!
Tota~profits ge.nerated by the business 116293
These details ar,c an impo,r tant source of in6ocm:ation so they at-e usuaUy incorporated
into the statetnent of finanda l position. Frotn now on we shaH include thein in any
stateinent of financial position that we prepare.
1711
mFinancial statements
Drew ha b :n trading as a flow,er seller for some y,ears. Th fo]]owing infoim, tion
r fates to his ftnanc ial y ar end 31 August 2014~
$
Pu,rchases 58 400
Sales 97260
Inventory 1 'September 20113 230
Genera I expenses
1
42.60
Rent and local taxes 5500
Ught and heating expenses 2300
Stationery and wrappfn9 materials 8700
Fixtures and f1tti ngs .3400
Vehide 7'500
1ra de receivables 85
Trade paya bIes 432
Drawings 13200
Cash 1in hand 87
Ba:lance at bank 990
Caprital 1 Se,ptember 201 3 6960
Answer
Drew
Income statement for the year ended 31 Au gust 2014
s s
Revenue 972·60
Less Cost of sirles
,lrnventory 11 September 201 3 2.30
Purchases 58400
SB 630
'Inventory 31 Augu.st 20 14 211-0 58420
Gross p,rofit 38840
less E~ enses
Genera I expenses 4260
Rent and loca,:I taxes 5500
Ught and' heating expenses 2300
Stationery and ,Mapping matedals 8 700 20 760
Profit fo r the year 1,8080
Drew
Statement of financial position at 31 August 2014
$ $
ASSETS
Non < Urrent assets
Fixtures and fl t~i ngs 3 400
Venic'le 7500
10 900
172
21.4 The effect that the correction of errors has on financial statements
Current assets
Inventory 210
Tirade rece,ivabhes 85
Balance at bank 990
Cash in hand 87 1372
Tota I assets 12272
Current liabilities
Trade payables 432
Tota l ca pita l and lia bilities 12272
• profit
Accou n1:1ing s1:u dents are frequently asked
• as!5ets
to, correct errors and then to work on a
• liabiUties or
draft pro~it to arr1ive at a co nected pro.firt
• a co1nbination o f a ny of the three.
for the peidodl. Make sure you gets lots, o.f
practke jn this. Errors th~n affect the profit o f a busine,ss w ill also affect ·the .stateinent o f financud
position in that pront affects the O\\·ner' capita L
Wages account
SaIes returns accou,nt
Horace's account
173
mFinancial statements
Answer
Account Profit Statement of financial position
Office equipment account No change Cha.nge to assets
Sa,1es account Change Change ·to cap irta I {because of chan9e to profit)
Wages account Change Change to cap i;ta I (beca,use o·f change to profit)
Sailes returns account Cnange Change to capita I {beca,use of change to profit}
Ho irace's acco u nt No change C hang e to t rade receivab Ies
Th tria] balanc of Divya Tal\Var fail d to balance on 31 March 2015. The difference
was ,entered in a s:uspense account A set of draft firu1ncial statements was prepared
befort;: the errors were discovered. The draft profit fo,r the year ~·as 127'864.
The foUowing errors were discovered;
The purchases journaJ had been ovel"Cast by · 100.
A payn1en1: made to 1\.1. DhiUon $121 had been posted to the incorrect side of her
account.
Fixtu res p urchased for 12340 had been entered in the purchases jou rnal.
Good s sold on credit to B. Irfan $97 had been cotnp]etdy on1itted fron1 the books
of accou nt.
- An fr1su r,anoe payn1ent for 430 had been correcdy entered in the cash book but
had not been entered in the insurance ac,c ount.
Required
PrepaT
- g :nt!ra I, journaJ entri s to, cor1ect the ,errors
:, a suspens account showing th oorr ctio,:n ,o f appropriate rrors
a staitcn1 nt sho'\\ring the corrected profiE for th year.
Answer
General journal
Dr Cr
$ $
Suspense account 100
Pu re hases accoont 100
Correction of erro r~ P'U rchases hook overcast by $100
M.Dhill'on 142
Suspense accoun,t 242
Correction of enor: Payment of $1 21 ,posted to t he irncorrect s•de of Dhiillon's account
1
174
21.4 The effect that the correction of errors has on financial statements
B. lrfan 97
Sales account 97
Cor,recti.on of error: Sale of goods to lrfan omitted from !·edgers
Insu,ranee account 43 0
Suspense account 430
Correction of error: lnsuranc~ premium omitted from insurance account
b Dr Suspense ac.cou n t Cr
s s
Purchases account 1cm M.Dhillon 242
Tri·al: balance difference* 572 Insurance acco unt 430
672. 672
• The an1oont o f the difference on the trial baJ ance was not given in the question.
Th $572 must be assu tned co be Eh e it:rnount necessary to make the suspense
aocount ba]ance after aU the errors ha\re been corr cted ,
C
Statement of cor-rected proiit
$
Profit as per clraf t ac:co,uffl:s 27 864
1 Decrease ,in p u rc_hases HlO
3 Decrease ,in pure hases 2 340
4 Increase in sales 97
5 Increase in insura nee (430)
Corrected p refit for the yea.r
Error 2 does not affecE the profit for the year. It would, hov.-~ever, affect the totaJ
of trade payables \J.rhich appears on the statement o f financial position. H wou]d
I~ atransacti an has no eff,ect on the t-educe current liabilities.
answ·er to a problem, say so. If you do Error 3 wiU aJs·o, decreast: pron·t by the ainount of depreciation p,r,ovided for on th·e
not no-one wUI know whether you have
1 6·:.\-tures pu.rchas~d.
omitted th·e transact~on lbecaus,e th~s ~s
the correct treatment o,r because yo u1do
not know what the effect i1s. \Vhen correcting a draft profit for t1'1e ye-ar, rcn1 mbe·t tbat:
• any c~pcnse account that is debited in the iow:nal wiU reduce draft profit for the
year
• any expense account that is ct"eclited in the journal wiU increa.se draft profit for the
yea.r.
Notes
• AJways use headings.
• ~ways gjve a precise narrative to each joumaJ entry.
• You may have ~o cak:uJate the ttiaLbalance diffe rence to enter in the suspense
account.
• Identify any items you have· not used in the stan~n1ent of adjusted profit
175
m Financial statements
1 Why 1s ~t i1
mportant to make the distinction bet\r\teen capital and revenue
ex.pen d~ture 7'
2 Which statemen1 would you prepaire to cakulate gross prof~t7'
3 G~ve an exaimpie ,o f a revenue rec,eipt for a r,estauran1.
4 Which statement would you prepaire to c:allculate net aissets7
5 Explain whait 1is meant by the term •carpritall re ceip1:s •.
6 Whi-ch statement would you prepair,e to cakulate· the cap~ia~of a bus~ness?
1 Gijve two reasons why ~he own,er of a business wou~d prepare finandal
statements.
8 How is cardage inwards treated in an ~ncome statement?
9 In \Nhat way ~s gross profit d~fferent to pr,ofit ior t he year?
10 Why are assets sho\l\lln on a statem,ent oi financial! pos1t~on ait c:os1:?
11 Def1ine 'dlrarw ings'.
12 Sa~es - Cost of safes - l~ enses =:?
....................... ,..........
> Now try Que tion 2
~ ..... , 13
14
15
Cl!osfr1gi cap,tai - Openi1ng1caprtall +Drawings=?
List 1hree item,s 1hat cou id be dassJfied as current ~ ~ab~ ~it1es.
Would an error tn the purchases returns account affect proiiit for the, yea1r?
176
Incomplete records
There are two tnain types of organisation that m:ay not keep a full set of double-enuwy
records: sn1aU cash-based businesses, and clubs and sodeties.
.. ofake sure you kno~ about both types of organisation. They both rely on similar
7
It is inlportant that you are ab]~· to, r cogrui each typ of qu tion.
177
m Incomplete records
Answer
iNo1e 11he wordjng of what ~s required: the s
key word ~s 'cakuiate 1 • C1:osing capital 20·265 (112 400 + 4860 + 590 + SS + 2540 - 18·0)
Less Openi,ng caipital 9985 (2400 + 5400 + 670 + 45 + 1730- 2,60)
Reta1ined profits 10 280
Alwaiys show yo uir wonldogs - they Add Ora.wings 17980 (16750+1230)
can help you find any errors in your Profit forth e year ended 31 December 2014 28260
cal cul a1i orns.
178
22.2 Calcullatjon of the profit or ioss of a cash-based business
During the year e nded 31 I'vlarch 2015 Dreyius n1ade drawings of $23 700. In Fe bruary
2015 be inhedted a legacy of S7 800 fron1 a re lative; h e paid this Stun into the
bu ~mess bank account.
. quh-ed
Cakulate th busin s profit o,r Joss forth ~ year ended 31 March 2015.
Answer
$
C1os i:n g capita I 109110
Less Opening c:ap tta I 111 365
Reta i ned profrits (22.55}
Add Drawings 23700
21445
l.ess Cap ital introduced 7 800
Profit fur the year. ended 31 March 2015 13 645
1
Workings
Closing c:ipital =$60000 + $32400 + $11 340 + 2120 + $120
+ $3 560- $430
= 8109110
Opening capital =$60000 ~ S36rOOO + $12 600 4w $16,SO
+ $135 + $1 450, - $470
= $1 11365
•••••••••••••••••••••••••••••••••••••••••
Now t ry Questions 1 and 2.
179
m Incomplete records
Whenev,c r you are asked to pre-pare an income statement and a statement of financial
position, you wiU need to follow the procedur,es oudined below. owe must ,exarninc:·
our task very carefu]]y.
In order to be ab]e to use thitS second rnethod it iis essential that we have the
foHowing information to hand:
• valuations of assets and liabilities at the start of the finandaJ year
• tota]s of trade receivables and trade payah!e.s at the start of the financial year
• accrued expenses at the start of the year
• prepayn1ents n1a de at the start of the finanda] year
• payn1en1ts tnade by trade receivabJes during the financial year
• pay111ents made to trade payab]es during the finanda] year
• cash paymen·ts tnade during the financial tear
• cash receipts during the: financial year
• valuations of assets m1d liabiliti s at the end of eh financial year
• toml ~ o,f u·ad reetiva b1 .and ttad paya b1 at th ,end of Ehe financial year
• accru d xp nse (payables) at th end of tb HnanciaJ y ar
• prepayn1 nts (receivab]es) made at the .e nd of the nnancial year.
There are five stages involved in the pr,eparation of th.e nnand;:d statetnents from a set
of records that a re incotnpJete.
Leam these five stages. - they are very • Stage 1: Prepare an opening statement of affairs. You may have to caiJcu]ate the
~mip artant. capital (net assets) figure if it is not provided for you.
• Stage 2: Compile a sunimary of bank transactions.
• Stage 3: Con~pile a sununary of cash transactions.
• Stage 4: Constnlct adjusunent accounts (sotue teache1'S can these 'contro] accounts').
• Stage 5: Prepare the financial st:atements by using aU the infonnadon gained frorn
Stages 1, 2, 3 and 4.
It lS es.sentfaJJ to f.oUow these stages n1ethodi,c any e-ach tirne you are asked to produce
.a set ,o f financia] staten1e.nts from incornplete recotds.
The stage that gives most p op]e a problem is ·tage 4.
tag 4 is nee sa ry b · cause most of th~ records kept by trad~s who keep l ss
·t han a full set of books of acoou.nt are l'\ cords of cash sp nt to acquire the neo s ary
resou re to carry on bu ~incss or rooords of cash when it is rc«iv·,ect
As accountants, we must be a\\l~f.e of and app]y the accruals concept - the
paym.n ent to acquire a resource is not the same as rhe use of that resource.
180
22 .3 Preparation of Tinanda Istatements of a cash-based business
Ro han recdv: St20· on 15 Fe ruar)I' 2015 fo r a sale o f oods that took pfa,c, · o n
21 Dc-ocmb-er 2014.
Cash wa.s recorded in Febniary - the profit was earned ii1 Dece1nber (application o f
the realisation con cept ~which is part of the aacrua[s concept) .
The e lectricity meter was read on 28 July fo r e lectricity used in May, June and Ju ly.
The invoice for e lectricity used was received on 13 August a nd the atnoun t was paid
( very latd ) o n 12 October.
Elecltddty (a resource) was used in May~J un e and Ju]y ~so the ~ense is recorded
then - even though the paytnent V¥·as not n1ade u ndl October.
Stage 4 sou nds very con1p]kated, bu t if W·e rely on first prlndp]es th at we le ar-ned
earl ier it s bou] d be sin1plined .
• R Jy on }OW' knowledge of double entry.
• R Jy ,o n using ,., accounts.
Wi wiU concentrate on cag 4 sine this is th · stag that E1ll to caus 1nost
pr,o blc-ms.
Sateetn Zain does not keep fu ll accountin g records. He is able to provide the
foUowing informatio n for the year ended 28 February 2015:
Additional info1~n1ation
Re quired
Prepare the trading account for the year ended 28 Febtual)' 2015.
Workings
~ re need to prep are an adjustment account in order to, de teTmin e the an1ount of
sales for the year. (Re1nembe r that this may lb different to th cash pa id to the trad
rec iva'bJ<=!S during tht! ye ar.)
Wi also ne d to constru et a imilar account to dt:t m1in the aniou.n1 of the
purchases fo rth year.
Note that 'missing ftgu.res' for saJcs and p urchases in tbe fo llowing accounts arc
itaUcise d .
1811
m Incomplete records
Harry Cary does not keep a full set o f accounting records but he is abJe to provide
the foUov.ring information for the year ended 31 JuJy 2015:
$
Amounts paid for staff wages 21387
Amounts patd to landlord for re nt 3400
Amounts pai.d for electrk ity 2 162
Amou.nts pald for insurances 3467
Additional in.formation
Re q u ire d
CaJcubJJte the aino,unts to be indudedl in the inco1ne state1nent for the year ended 31
July 2015.
Answer
Wages $21472
R~rit $3418
Electricity $2043
!insurances $3 31 7
182
22.3 Preparation of Tinanda l statements of a cash-based business
Wot·lting
Use th sa ~nc procedut that was u ed to d~termin sale·s and putchai~ s earUc:r.
Wages a( cou nt
$ $
Notice tha1 the balances have·been
brough1 down. Rem,ember. this ~s Cash 2 1 387 Ba,lance bid 1 August 20 14 211 2
importantt Qa l1ance c/d 3 1 Jiu ly 2015 297 Income stat-ement 21472
21684 21 684
Ba,la,r1e.e bid 1 August 20 15 297
Rent account
$ $
Cash 3 400 Badance bid 1 August 20 14 11!8
Balance dd 31 J1Jly 2015 136 Income statemen t 3418
3 S36 3 536
Ba1,lance bid 1 August 2015 136
Insurances account
$ $
Balance bid 11 August 2014 1·96 Income statement 3317
Cash 3 467 Bala nce dd .31 Ju ly 2015 346
3 663 3663
Balance bid 1 Au gust 201 5 346
Roger Guilfaun1e owns a shop .seUing flowers. H e does no1t maintain prop e r books of
account. He p110vides the foUowing info m1atio n fo r the ye-ar e nded 30 April 2015:
Rent 2800,
Ot her expenses 20075
Drawi1ngs 8409·
Pu ,rcha se of ve hiele 17000
Ba.Janee 3·0 Aprijil 20115 3469
76680 7·6680
183
m Incomplete records
AU takings w re paid into the bank account wi!h 'Ehe exception of tb,e foUowing:
Wages $1 4280
Dirawings $1 2000
Additional infom1ation
R quir d
Prepar,e an incon1e statetnent fer th~ year ended 30 AprH 2015 and a statet:nen't of
.financial. position at that date.
Workings
Note that because we are asked for thepreparation of a set of financial statements,
we n1ust go carefuUy and n1ethodicaUy du-ough each of the five st.1.ges outHned
earliff.
If ~ve are asked for a calculation of the p ro fit or ]oss, we cou]d h ave used the
n1uch quicker net asset (capitaD n1ethod.
Both methods wiU give us the s~une profit figure but the net asset n1ethod wiU not
give us the same amount o f derail that .a fuU set of fi nanciaJ statements '\\..- ilJ.
tag 1
Pr par,t!· an opening statem<:nt of affairs. Do not b concerned ,;vith categ,o ri, s of
Sta.ge 1 ~s part o.f your workjng5 but do, a t=ts and liabilitie . At this point in you1 stumes, you shou]d be abl,e to do this
write the fi g1ures down n,ea,t~y as wel~ ahno t as quickly as you can 'Wtit the itGm down.
as qukkt,.
St ateme nt of affairs at 1 May 2014
s s
Assets lnventorry 2 12
Trade receivables 48
LocaI taxes. paid in adva nee 1080
Cash 142
LoeaI taxes paid in adv a nee l 080
:Fixtures 720
Vehicles 4200
Don't forget ... Banik balance l 79·3
s 1:95
Do no1 just key the assets and Iiab~lit~es Trade ipayables (467)
Liabilities
~nto your cakullator. You wmnot be able
Rent owed (102)
to find the error trf you make one. Wnite
the items down as pa rt of y,our answer {569}
before you key the amou1nts 1in. Net assets 7626 This is also Rogerl capital.
184
22 .3 Preparation of Tinanda Istatements of a cash-based business
Nore that the assets have b en \Vritten down ht the ordet that they have appeared in
the question. No, atttm1pt has been madt: to c~uegodse th rn. The question djd not ask
you to p:r,e pa r an openin stat ·n1ent of financia] position.
Do take car to indudr.: the bank balance if it is not includ din Eh~ l:is,t of assets
and UabiHties given.
Stages 2 and 3
Compile sun1ooa dsed cash and/or bank accou nts. A bank su nm1af}' has been provided
for us, hut we do need to p repare a ca.sh suouuary.
Cash account
s s
Balance 1 Ma y 20 14 (from l ist of 142 Taki,ngs banked (from bank 74887
assets) summary)
Total takings foryear (missing figtne) 101 262 Wages paid 14280
Drawingis 12000
Ba,lance 30 April 201 '5 (from list
1
237
of clos ing balances)
1
Stage 4
Construct adjustment accou nts. You may be uncertain hOVit n1any acliustmt;nt accounts
to use·, o n which accounts to open a nd w hich iterns do not need to be adjusted. Then
open an account for every i tan listed in your state1nent of affairs.
Inventory w ill be adjusted in Stage Sin the trading account of the income
stateo1ent; we have adjusted o ur cash figures in Stage .2; bank has been adjusted for
us in the question.
Open a n adjustment account for each of: trade receivables; ]oca] tax:es fi.J..·ttu,es;
tr~de payables·~ and fin aUy rent.
·oo each adjusbuent in turn, Open a 'T accou.nt fo, each.
Enter th,e opening. balance (debit for an asset credit for a BabUity'.).
Enter the closing ba1 ance under you1· 'T' aiccou nt.
Tall-e the do.sing ba]anc up diagonaHy into the body of th, account.
Fro,n1 the bank or c , h account, debit cash paid.
~ Fro,m the bank or cash account, credit cash receiv d.
nfi , 'Tota I the account.
Cakulate the 111:isS'ingjzgure to be posted to tbe income sratetnent
Let lLlS prepare the adjusunent accounts. N un1bers a.re given in the first two accounts
as a guide 1to the order in wbich the entties ate made.
$ $
[1] Ballance 1 May 2014 48 [4] Cash 10 1262
[7] 5a res (missing figure) 101 .3 44 [3] Ba lance .30 Apri1I2'0 15 1.30
[6]1 101 392
[2] '8al,ance 1 May .2015 130
18S
m Incomplete records
Fixtures account
$ s
Bal1a1nce 1 May 2014 720 Inc stat (missing figure - depreciation) 72
Balance 30 Apriil 20 15 648
720 720
Ba.Ilanee 1 May 201 S 648
Ve hide s a~count
$ $
Ba~ance 1 May 2014 4 200 In c s:tat (missing figure - depreciation) 4700
Casn 17 OOO Balance 30 April 20 15 16 500
211200 21200
16500
Rent account
s s
Cash 2 800 ,Baila·nce 1 May 2014 102
18al1ance 30 AprH 2015 120 Inc stat ( missing figure) 2818
---
2920
.....
2920
Barlaince 1 May 2015 120
Generally at this point you \\riU not have reached your goal unless you ~rere specificaUy
asked to prepare· the opening st:atenient of affairs or one or mu of the ad.just:nlent
aGcotu1ts in detail. Herre we ~rere asked 10 prepare an incorne statetnent and a staten1ent
of financial posjtion an d as yet we have not done that. AU that we have done is the
preparatory work - we have got aU our .infom1ation ready for the fina] part of the answer.
An acco untant ~n praictke would caH alll
the workiings that we have done so far Stage;
'work~ng papers•. lt is now titne for Stage 5~where ~-e bring aU our workings together to prepat-e the
financial statetnents.
A nsw er
Roger Guillaume
Income stat4!ment for ·t he year ended JOApril 201 5
$ $
Revenue 101344
Less Cost of sales
,Inventory .a:t 1 rv1 ay 20 14 21 2
1
Purchases 22358
22570
186
22.4 Cak:uJation of missing cash
Roger Guillaume
Statement of fin an ci a I position at 30 Apri I 2015
$ $
,ASSETS
Non-turrent assets
Fixtures at varuation 648
Vehides at valuation 16500
17148
Current assets
Inventory 1164
Trade rec eivab !es 1,30
Otrher receivables (loca Itaxes} 11340
Bank balance 3469
Cash 23 7 5340
Tota I assets 22488
Current Ii a bi Iities
Tirade payabJes 328
Other ,payables (rent) 120 448
Total capital and liabilities 22488
187
mIncomplete records
Ade]e own a general tor"'. At l January 2014 h r cash in hand was $167. At the
end of tb y ar on 31 Decem r 2014 ea bin hand was $143. 1-'Ier tiU roJJ ~ shO'w her
·t akings to b(; $53 788. During the year she banked S21894 after taking $13600 cash
for private use and paying w~ges 1784iQ,.
Adel.e be] ievcs that son1e cash has be-en stolen in a b urg]af}r in the last week of
Dece,mber.
Required
Calculate the an1ou n1t of cash stolen.
Answer
Cash account
s s
Cash in hand 1 January 2014 167 Cash banked 2 1 S94
Taki(I QS 53788 D·raw,ings 13600
Wages 17840
Cash stolen (missing figure) 478
Cash in hand 31 D·ecember 1'43
20 14
53955 53955
Note 1that the question asked for a cakulattion, not for an account. The answer has
been ghren in account form as th is fits in with the workings used throughout the
chapter~ but the satne resuh cou]d have been gained by other n1eans.
There are a variety of ways of arriving at the correct ans~~er. Each would be
a,cceptabie. However, do show fuU workings jf you choose another tnethod of ani"ing
.at your answer.
Gary owns a ha irdressing salon. Several boxes of 1Hakglo \ an expensive hair product)
have been sto]en. Gary is unsure of the value of the sto]en goods. He provides the
f oUowing infonnadon for the year ended 30 April 2015:
inventory o f Hakglo at 1 fay 2014 $210
inventory of Hair~lo at 30 April 2015 $70
p urchases of Hairglo during the year ended 30 Apri] 2015 $4 690
sales of Hairglo dudng the year f7080.
Hairg]o canies a uniform rnark&up of 50 per cent.
Requii~ d
Cakulat th "'11 lu of th~ n1issing invt!ntory.
188
22.5 Calculation of missing inventory
Answer
Actu aI figures are: They should be:
$ s $ $
Revenue 7080 7080
Less Cost of sa Ies
ltweontory at 1 May 2014 2 10 210
Puirchases 4690 4690
4900 4900
Inventory 30 Apriil 2015 70 180 4720
Sto·len goods (missing figure) ·110 4720
Gross profit 2360 2360
9 Ca,sh received from credit customers during1~he year ~s cred~ted to the trade
1receiva1bl es a djustm,en,t aiccou nt. Tru e/Fal s,e?
1O Sole traders a,re requked by (.a\N to keep a, fuU set of doubl·e-entry books.
···············~·························
Now try Questions 5-8. True/Fals:e7
IP rrofmt for the year can be cakulated by co mpa r1n g net as sets at the start of a1 pe r~o d
{usuallly a year) with ne1 assets at the ,end oi the period.
This is ai very acru1rate way of d1eterm1inhlg prof~t but 1it has the major drawback tha1
~t does not show aU 1he finandal details of exactly how th~s profit was earned. This
deta1i~ iS essent~al for ste\ivardsh~p and management puriposes.
~fa set of finanda,11statem·ents ,s 10 be prepared, then the f~ve-step approach must be
adoJ>ted:
1 Pre par,e an openj ng1statement of affa, rs.
2. (ompite a summary of bank transa.cti1ons.
3 ( omp1ie a summary of ea sh transactions.
4 Construct adjustment accounts.
S Pre pa1r·e fin andai startem ents.
189
Partnership accounting
Ad,vantag'ts Disaclvantages
The so le trader has complete control over how the business is run_ so
1
The sole trader ha,s unlimited iliabiHty for the debts of the business.
success or faUure is dependent on the trader.
Tn~ bus:tness ca1n bc1 @stabllshed with th~ mi1nlmum of legal formalities. Being a sole t1'ader may involve lo,ng incurs of work.
The fi nancfal resuhs of the business do not need 1:o be div ul·ged to other Ulness or other reasons t hat cause absence may affect the iruinnrng of the
members of t he gienera·llp ub~k. business.
There is no-one with who,m to share prob lems or ideas.
~t may be dirffk u,lt to raise extra finance when it is needed.
Expansion of a business usuaUy involves raising extra finance. Raising the necessacy·
finance is very difficult without involv ing other people. This generally n1eans
that a sole trader is faced with the choioe of oonvetting the business into either a
partnership ,o r a ]irnited Jiabil ity c01npany.
We 'Will dea l with ]in1ited co1npanies in Chapter 25.
1'90
23.3 Partnership income statements
parrtne r's ideas for devel·opment of the business ma,y be frustrated by otheli partner(s).
Pa rtne.rs Cq n share "Dh e workload. The number of partners 1s l1imrted to 20 (at least as far as we are concerned). There are exceptions to
this lim1it_e .g. fi rms of so~idtorst, accountants, etc
Partners can pool ideas and share pmblems. Partners have Lml·imijted liab1i,lity for the debts of the busi.11ess.
It is usual for a pa1tnersh ip to have a V.:"Titten partnership agreement (although it is
possib1e that the SJgre,e1nent cou]d be a ve.rbaJ one): 'Ehls wiU :reduce the possibility of
any dispute arising.
LOUW t STEYN The agreen1ent usuaUy cov~r :
PROKUREURS • th duties of tht: individua] partners
• rh~ amount of capita] to be subscribed by each ,o f the partners
• the ways that profits are to be shared
• the fi nancial arrangernents if there are any changes to the structure of the partnership.
If there is no agreernent~ the Partnet~ship Act of 1890 ]ays down the foUowing ru}e-S
You can tell this is a partnership business by which n1ust apply~
the use of tv.Jo partners' names. • Partners sh ould contribute equa] amounts o f capital
• No partner should be entided to interes1t on capita l.
• No partner is entided to a salary.
• No partner is to be ch arged interest o n dlrawtngs .
• Residual p rofits or Josses are to be shared equaUy.
• Any [oa n n1a.de to the partnership by a partner wm carry interest at the rate of five
pe'.f cent per annu 1n.
~ no details of the way IP rofits are to be 1 A sole tra,der ha1s Umtted Uarbihty. True/Fals·e7
shared are g~ven. yo'U must ass uime that
2 Partners hav,e uniim~tedl l~abi1lity. Tru e/Fals,e?
no parmers hjp ag reem,ent e>dsts and so 3 Expla,1in t\No adva nta,ges of be 1n g ~ n pairtnership.
the Partnership Act 011890 app!i1es.
4 Give ·t he da1te of 1he Partnershi1p Act that governs the basic rules that apply if a
pa1rtnersh~p does not have a pairtneirsh~p a,gree1ment.
5 Ust four ndes 1ha1t a1pply ~fa partnershMp does not have a partnersh~p aigreeme---nt
1911
m Partnership accounting
An to ine and Bu rcu am in ~.rtnersh ip, sharing res1duaiJ praofits in tbe ratio of 2:1.
respectivdy.
The profit {before tax) for the year ended 3 1 July 2014 was $36450.
Required
Prepare an app ropriation account for the year ended 31 Ju]y 2014.
Answer
Antoine and Burcu
Appropriation account for the year e nded 31 July 2014
$ $
ProTit f or "the year 36 4'50
Share of profit-Anto,ine (24300)
Burcu (12 150) (36 450)
If a partner is e ntitled to a partne rship safaty , this is taken frotn the p!t5ofit for th e y,ea.r
befo re the resid ua l p 110:fit shares are c ak u]ated .
Conserva and Divya are in pa rtne t'5hip, sharing residua] p11ofh s in th e ratio 3:2
tespectiveJy after creditin g Divya with a partne rs hip sa]ary o ,f $4 200.
The profit for the y--ea r ,ended 31 December 2014 was $29460.
Requit d
Pr par, an appropriation account for th y,ear ·e nd d 31 D camber 2014.
23.3 Partnership income statements
Answer
Consetva and Divya
Appropriation account for the year ended !1 December 2014
$ $
Proflt for tlh~ ye arr 29460
Less Salary - Divya (4 200)
25260
Share of profit - Conserva (15156)
No t e
Divya's salruy is deducted 'before 'the sharing of residual profits.
Divya's share of profits. fa $14 304. (She does not earn a sal ary in the same way ·Eha1
,e mployees earn a salary1 she i a part owner of the bu iness and as such she ,ea:rns
proftts no n1atter how they are de cribed.)
Enriques and Faraz are in partnership. They tnaJntain fixed capita] accounts> the
balance.s of which are $30000 and $20000 respectivdy. Their partnership agreen1entt
provides that profits and losses are shared 2:1 after jroetsestt on capital is p rovided at
eight pet cent per annutn. The profit for lhe year ended 31 March 2015 was 32 269.
Requ it-ed
Prepare an appropriation account for the year e n ded 31 Ma1ch 2015.
An sw er
Enriques and Fataz
Appropriation account for the year ended J 1 March 201 5
$ $
Profit for the year 32 269·
Less Int erest on capit.a. I - ;eniriq ues (2400)
IFa raz (1 600) {4 000)
28269
Share of prcrli.t - En r]ques (1 8846)
1
Note tthe use of the 'inset' to show deady the individual appropriations and the total
a ppropriadons.
Enriques' share of the profit fa $21246 (interest 2 400 p]us $18 84 6 share of residua l
profit).
Faraz' shar of the profit is $11023.
193
m Partnership accounting
Gen11:is and H~upre t are in partnership,. They maintain fixed capit~l accounts at $-o ooo,
and $32000 respecEively. Th profit forth year end d 31 Augu t 2014 v..-a $47632.
Tbe pattnership agreeinenE provid~s that Harpreet be credited with a partnership
salary of 3 750 per annun1; that interest at the rate of seven per cent P'(.,"'f ~nnum be
credited on partners' capita] aocount ba]ances~ a nd that resjdual profits be shared in
the ratio 4~ 1 respectively.
Required
Prepare an appro priation account for the year ,ended 31 August 2014.
Answer
Gervais and Har preet
Appropriation account for the year ended 31 August 2014
$ s
.Profit for the year 47 6.32
Less Salary - Harpreet (3 7'50)
43882
Less Interest on capftal - Gervais (3 500)
Harpreet (2240) (574,0)
38142
Share of prof·i t - GE?rvais (305 14)
Harpreet (7 628) (38142)
·-·······································
> Now try Qu stions 1- 3. N o1:e that the residua] profit shares have been rounded.
The partnership agre n1ent o:f Arbuthnot and Be pro,v id s that int rest b
charg d ,on drawin sat ftv·e per c,ent per annu1n. The busin year nd is 31
Dectn1ber.
1'94
23.3 Partnership income statements
Answer
Arbuthnot wiU be charged .£.29'1.25 intet"·e st on drawings.
Beebee wiU be charged 307. 50 interest on drawings.
w rkin
Mtbutbnot
3000 x 5% x ~ ye-ar =$112.50
5 000 x 5% X lh year =$125.00
f 4300 X 5% X 3m year= $53.75
Beebee
2000 x 5% X ~ yeat· =$75.00
6 500 x 5% X 1A year ~ $162.50
5600 X 5% X 1A year = ·1 70.00
Note that no interest has been charged for drawtngs n1ade on ilie fast: day of the ye.ar.
The a1mount oi interest on drawings Goctay and Hanif are it1. partnership. T hey supply the fono~ling in fonnation for the
wm be giiven, so you win not be required year ended 31 August 2014:
to rakula1e the amounts to be charg,ed The partnership a.gr,e ement provides 1hat Goctay be credited with a partnership
to ·ea.eh partner. safaty of $5600; that partnet"S be credited with interest on capital of e ight per cent
per a.nnun-1; that partners be charged inte,rest o n thek drawings at five per cent per
a.nnutn· and that residual profits be shared equaUy.
Goctays fixed capita] account St'.ands at $42 OOO, whiJe Hanifs fixed capita] account
stands at 50 OOO.
The profit for the y,ea r before a pproprladons was $5'6 934.
During th y ar Coot:3.ry made dr~r\ving'"' o f t 32900 and Ha:nil's drawings were 217S0.
• lnter~st on drawings was calculated aE $·348 for Goctay and 8180 for fcJanif.
Requit-ed
Prepare an appropriation account for the ye-ar nded 31 August 2014.
195
m Partnership accounting
Answer
Goctay and Han if
Ap prop riatio n account for the year ended 31 August 2014
$ $
Proiit for the year 56 934
Add ·Int~ rest on drawings - Goctay 348
Han if 180 528
57462
less Salary- Goctay (5 600)
51862
Less Interest on capita!- Goctay {3 360)
Hanif (4000) (7360)
44502
Share of profit- Goctay (22251}
••••••••••••••••••••••••••••••••••••••••• !Hanif (22251) (44502}
>- Now try Que lion 4.
s s
Profit for the year 34 745
less Sa lary - Tayyiba
1
(6 OOO}
28 74'5
Interest on ea p i1a.l - Tayyiba (2 400)
Adna·n (.3 OOO} (5 400)
13 34'5
Share of profit- Tayyiba (9338)
Ad nan (14 007) (23345)
Th cap,ital acc,o unt balance at 1 Juiy 2014 w er $40000 and -o OOO r sp ctiv ]y.
Drawing for tht- yeat· w re Tayyiba $22350 and Adnan S268SO.
Requh~ d
Prepare th.c capita] aocounts of Tayyiba and Ad:oan at 30 June 2015.
1'96
23.4 Partnersh1p capitai and current accounts
Answer
Ca pit.al accounts
Tayyiba Ad nan Tayyiba Adnan
s s s s
Drawings 22350 26850 Ba~ance bid 40000 S-0000
Ba lane e c/d .35~88 40157 Salary 6000
Interest on cap.itail 2400 3 OOO
Sha re of p rofi,t 9338 14007
57738 67007 57738 67 0-07
BaJan ces bid 3'5388 40157
Notice that a colun1nar fayou t has been u sed. This saYes Hme and space. Do try it h
n1ay be difficuJt the Hrst tin11e or t\vo that you use it but it d oes ,nean that you do not
lrf you are asked to prepare caprtail have 1:0 repeat th e descriptions used in each acoo,unt.
accounts; you must produce the The capim l accounts would genera]]y be sho\Vn on die sratetneflt of financial
inf.ormaitton in account form as shown position of Eh pannership as foUows:
above. Hyou are asked for a ,calcula1Uon,
Tayyiba and Adnan
or are not asked spedficallly for
•accounts'. then a 'cakul.anon' approach Extrart from statement of financial position at 30 Ju ne 2015
is acceptable. Tayyiba Adnan
The use of the accounts wHI save $ s $
space ln .an answer so ~n many ways it is Capital accounts
preferable to draw up 1he l!edg,er accounts
Op ening balance 40000 50000
and mere·ly insert ihe totals of the ledger
Add Salary 600()
acc·o unts irn the ·statemie nt of fin andaill
posi1iorn. 1lnterest on capital 2400 3000
Tawanda and Jacob ar,e in partnership. They provide the following infonnatio n for the
year ended 31 August 20 14:
Tawanda Jacob
s s
Capirtal account ba~ances , September 2013 30000 45000
Current account balances l September 20 13 1 54.2 Cr 238 er
Drawln gs for the year we re 20653 1623 4
Interest to be charged on drawings 541 452
197
m Partnership accounting
$
Sa lary - Tawanda 4800
.lrnterest on capita l - Tawanda 2 1100
Jacob 3 150
Shan~ of residual ~refits - Tawanda 18 000
Jacob 9 000
Re qu ire d
P repare detailed capita l aocou nt5 and cu rrent accoun ts for the partnership at
31 Au gust 2014.
Answer
Ca pita I accounts
Tawanda Jacob Tawa nda Ja~ob
$ $ s
Ba Ia,nces bid 30000 45000
Current a«ounts
Tawanda Jacob Tawanda Jacob
$ $ $ $
Draw ings 20 653 16234 Bailan ces bid 1 542 238
lriterest on drawl ngs 541 452 Salary 4800
Init ere5t on captt:aI 2100 3 1'50
Share of p rofi·ts 18 000
1
9000
Ha.Ia nee c/d 5248 8a!lance dd 4 298
26442 16686 1.6442 16686
Ba la nee bid
1
4 298 13 a:la nee .bid 5248
Th capital accounts have remained 1nx d' and the profits ~arn d and profits
'W'hhdra"rn from the busin- (drawlngs) and m~ r ton dra,vin~ a_re re ordcd in th
current acoou nts.
It is) ,o f cours~~possible that a partner n1ay withdraw inorc profits from the
bu siness than they have eamed. In sucb a case the partner's current account wiJl
show a debit balance.
Vikram a nd Walter pflovide the foHowtng infom--iatioo for their partnership for the year
ended 30 April 2015:
Vikram Wa lte r
s $
Current account ba1la,nces 164 Cr 298 Cr
1
1 nterest on ea pi,ta I for the year SOO 7-00
Share of residual profits 25300 112650
Dra,wJ ngs for the year 20000 115000
1,nte.rest on dra,w ings 270 4,60
1'~}8
23.4 Partnersh1p capitai and current accounts
Requit-ed
Prepare:
1 an appropriation account for th~ year end,e d 30 April 2015
An swer
199
mPartnership accounting
200
Partnership accounting
structural changes
By the end o·f this chapter you should be able to:
• account for 1h e ad miss~on of a ne·w partner
• account io.r 1he re1:iremen1 of ai partner
• un derstan di the term 'goo dw~I I·; how ~t js valued and the factors that ma1y
contr1b urte to its establishment
• make en1iries 1in the books ·Of account to record adjustments to pa1rtners capital 1
accounts when:
• a goodwrn account i1s majntaiined
• g,oodlwrn is written out of the books
• make the necessary ad!ius-tm-e:nrts in the books oi account to record a change 1
in
the profit sharing ratio
• sugg1est reasons why a partnership m1 ight be dissolved
• use a reahsation account to ajd the di ssolut~on process
1
• record the effects 1hat the purchase of as.sets by a l1mi1ted company have on the
books of account oi a partnership
• dose the partnership books of account.
When thet·e is any kind of cha nge to the structure of a pa11:nership the treatment is
the san1e; one bu:s iness ceases to exist at the date of the change and kn.mediately after
the date of the change a new business ·co1ne.s into being.
When Aituro and Batista adn1itted Cados as a partner on 1 Aptil 2014 there wer,e
two businesses involved:
O\!'vners are Artu·ro and Batista. Owners are Arturo, Batista and Carlos.
EJI Partnership accounting - structural changes
.... Wben lain retired from the partnership of lain, Jing and Kris on 30 eptenlbet 2014
ther wer t\Vo, businesses invclved:
Deirdre and Engleben were in partnersh ip sharing profits and losses equ any. When
they chan ged their profit sharing ratio to 3: 2 on 30 June 2014 there were tvvo
businesses involved:
Owners a,re Deirdre and Eng~ebert. Ow ners are De irdrre and Englebert
Wlhe11 ~here j5 a structural! change to
a partnership. trreai 1he ~nforrna1~on (profit shaire equal) (profrt sha re 3:2)
relating to 1he business befo-re the change drifferent proftt shau·e = di,fferent business
separateJy from the 1nfot mat1i·on relat~ng1
to the busj ness a1fter the chan g:e.
Ade]e an d Gaynor are in partnership. sh aring profits and losses equaUy. T heir
:fina nd .a [ year end is 31 Decen1ber. They ad1n it Chin as a p artner on 1 July 2014. They
aU agree that Adele, Gaynor and Chin wm share p ro fits 3: 2: 1 respectively.
The profit for the year end ed 31 December 2014 was $40000. TI1e p ro fit accrued
evenly thro ughout th e year.
Required
Prepa re the ap p ropriation accounts frn: the year ended 31 Decen1be1: 2014.
Answer
Remembet· that ":e are dea Ung v.,ith two busin es.
Owners \vere Adele arn d Gaynor. Owners are Adele, Gaynor and Clhin.
So:
s s
Profit for the six months 20000
Profit share - Adefe (10 OOO)
Gaynor (10 000) (20000)
202
24.1 Changes in partnerships
rounded. Do not wo:rk us~ng cents unless Cniri (3333} (20 OOO)
you are spedficaHy instructed to do,.
$
Premises at cost 118 500 Remember that ~ value assets
at cost, not at what they co,uld
Eq uJp me nt at cost 5 500
be sold for - the 'going concern'
Other assets at cost 2000 concept.
26000
Cap i,ta I- Gra ndfat he r 1i1 OOO
Grand mother 15000
26 OOO
Nov.-- in1agin e that your grandpare nts adnlit \1\1UHarn Fox a.s a partner into their
busint!SS. They ask h im ro provide $20000 caplta]. He agrees and e nters the b usiness.
What would the statement ,o f nnancia] posi'tion look ]ik,e, now?
s
Premises at cost 18 5·00 SimpleJ
Eq,uip ment at cos-t 55 00 Your grandparents would not agree to what
Othe r assets at cost 22000 has takm pJac~I Remember that 'they have
been in business for 40 years. Now much
46000
must the premises be worth now?' Surely they
Capital - Gr.a ndfat neir l 1 OOO are worlh more than the carrying amount
Grandm othe r 15000 shown?
WiHiam Fox 20000
46000
Can you see your likd y future inheritan ce disa ppearing into Will i:a1n Fox's pocket?
ln fact w hat need s 10 h appen when an y kind o f snucturaJ chan ge takes p lace is
1
that the b us iness assets have to b e revalued; The increa.s·e in vaJue o r dec:r,e ase in
va]ue) belongs Eo, the o,~inal partners.
203
EJI Partnership accounting - structural changes
Ov·er the years property p-rkes have, nsen. The premises l\-·ere \l'a]ued $70000 at the
end of A:ptiJ 2015.
R qub·ed
.Prepare a statf:tn<.:nt of financial position at l ~1ay 2015 after the admission of Kiri a
a partner.
Answer
Mi kae I, Jeanette and Kiri
Statement of financial position at 1 May 2015
$ $
ASSETS
Non -c.u rrent assets
Pra.mism, at v-alu,rtion 70 000
Equri.pment at cost 16 000
86000
Curreht assets
Inventory 3500
Trade rece ivables 4300
Bank balance 26560 34360
Tota I assets 1'20~60
204
24.1 Changes in partnerships
CAPITALAND LIABILITIES
Capital accounts - Mikael 46000
Jeanette 46000
Kiri
1
25000
1117000
Current Iia bi Iities
Trade pao/sbles 3360
Total capital and Jiabilities 1,20 360
TI1e rise in the v:a]ue of 1the p renlises has taken pface while :rvlikae l and J eanene have
been die only proprietors, .so any profits (because of property mflaition) belong to 1the111.
The increase in th e value of tbe pren1ises d id n ot occur when Kiti was a pa rtner
......................................... ................... so s h e shou ]d not b enefit. As they are e qua] partners~ the increase has been divided
> Now try Que ti o n 1. e quaUy bet\veen Mikael and Jeanette.
It is n1ore us1JJal [o nnd a uue,nent of finandaJ position showing d rails of aU assets and
liabilities. When a .structuraJ change takes p]aoe ln such instances we use an account to
record any chang · '£ 0 d1 valu of t.s and liabiliti bown on th stateinent ,of financw
position and benc to calculate the profit or Jo ~ resulting fr.0111 th{;; chang "' jn value.
A temporary account is op~ncd and it is onJy u.sed to record aditlStrn~ nts to the
a<..~ou.nt balances fro m the [,e dgers shown on the statement of fi nanctal po.sjtion.
Thiis is how the 'len1pora.ry account works~
Xandra a nd Aziz are in p artnership, s haring profits and losses in the ratio 4:3
respective]y. They ~dn1h Lian a as a partner on 1 August 2014. She pays $35UOO to ttbe
partnership as he r capital
The partne rsh ip staten1e nt of finandaJ position at 3 1 Ju]y 2014 was:
205
EJI Partnership accounting - structural changes
lt was agreed that the assets on 31 July 2014 be valued as follows:
$
Premises lOO OOO
Equipment 4 500
Vehrcle 6000
tnventory 2000
1ra.de receivables 1650
Re quired
Prepare a statetnent of financial p ositio n at 1 Au gust 2014 after the adn1ission o f Liana
a s a partner.
·w orkings
An account is o pene d fo r each asset that is to b e reva lued:
A revaluation account is used to ad.ju st the asset accounts and to calculate any profit
o r Joss on revalu~n ion . The p rofit o r loss is trans fe rred to the e-xistting p artners' ca1)1tai
.accounts h?fore the n ew p a ,1ne,· is adin in ed.
206
24.2 GoodwiU
Capita I - A!:i 2
$ $
Ba,I bid 30000
Bal c:ld 45000 Reval'n ale 15000
45000 45000
Bal bid 45000
Answer
Xand ra, Aziz and Lian a
Statement of financial position at 1 Augu.st 2014
$ $
ASSETS
Non-c urre nt assets
Pf'emises a·t va,luation 100000
Eq u:ip ment at va Iuati on 4 500
Vehide at va l,uati on 6 000
1' 10500
Current assets
Inventory 2000
Trade receivabh~1s 1650
Ba nlk ha.la nce 37200 40850
Tota I assets 11 51350
Note that the changes l o the capital structure o f the business a re e ntered in trhe
partners' capital accounts. The cu1ren t accounts have no t been used. The current
accounlS wiU o nly change when tracUng profits o r losses are shared benveen partners
or as pa rtnei'S ina ke d rawings .
Notice aJso that tbe non-current assets are now labe]]ed iat valuation' since they d o
~····················
>- No rv try Question····················
2. not now appear 'at cost'.
\Vhen you get used 10 n1aking adjusttnents to the partnership state1nen t of nnandaJ
position b ecause of a striuct1ural change you n1ay find that you do not have to open an
acoount for each asset and Habillity. Howev,e r it will be ater fo,r you to ah,-,..-ays o,p ~n a
ttNalu ation aoooun:c to 'c::oUt,et' th.e changes that harVe ~n in1pl,enl nted.
24.2 Goodwill
Good"iU is an intangib]e asset. h cannot be seen; it bas no physicai presence, unlike
Goodwill is the cost of acqu i;niing a business tangible as.sets Uke prenuse.s or machinery or vehides.
Iess th ~ tot.a :1va1lue of the assets a r1d I•ah iHt:ies When a successful business is sold the vendor wiU genera Uy price the b us iness at .a
that nave been :purchased.
price greater than the totaJ of the ne t assets being so]d
207
EJI Partnership accounting - structural changes
Th°" stat~ent of ftnandal po idon of a local rt:!!ltaU1ant O'\Vn~d by Terri i:s h°"·n:
$ s
ASSETS
Non-c.u rrent assets
Eq,uipment 34000
Fixtures and fittii ngs 8 400
42400
Cur rent assets
Inventory 840
Banik balance 2345
Cash in hand 455 3640
Tota I assets 46040
CAPITALAND LIABILITIES
Capital - Teriri 44620
Current liabilit ies
Trade payables 1420
Tota I capital and Iia bi Iit ies 46040
Terri decided to selJ her bustness. She advertised it at $90 OOO. Hu-a bou gbt the
business for 90000.
GoodwiU ~s not sold ; it ~son~ purchased.
Two points emerge:
The seller maik es a prof~t; t he purchaser
buys all the net assets ~nduding g1
oodwilll. Terri sold her business at a profit of $48180. (She wouJd not seU the bank balance
or c ash in hand.) She sold no n-current assets $424oO, inventory $840 less current
BabiUties $1420 for $90000.
Hua purchased me business net as-sets fo r $90000. He has purchased net tangible
assets fo r $41 B20 and an intangib]e asset (goodwill) for 48 180.
We have already s-aid that when there is a structural chang,e to a pa rtnt:~hlp tbe
cha_nge invoJvi s two busines · s:
• the busin s that exist d befor th chang
• the busin s duu oomes into~ istenc,c becau-su of th change.
When a new partne r is admitted ro a partners.hip we have ake.ady seen that the assets
need to be revalued. We also need to place a value on the intangible asset goodwiU.
208
24.2 GoodwiU
It has been agreed that goodwm be va]ued at two years' purchase of the average
profits ta ken over the past fi. ve yea t'S. Profits for the past five years were:
Year s
1 12450
l 12560
3 114890
4 8450
5 11650
R qui d
Cakul.at,e the \i"a]ue to be placed on goodlvviU.
Answer
GoodwiU is valued at $24 000.
Workings
Tota] profits for five years = $12 450 + $12 56D + $14 890 + $8450 + $11650
= $60000
Total profits ior five years
Good"'-m va]ued == x 2
5
=$60000
.. x2
=$24000 1
2 A multiple of average weekly sa les generated over the past financial year
It has been agreed that geodwiU be valued at fo ur v,reeks' purchase of average weekly
sales over the past financial year. Last year's annua] sales were $322 40Qi.
Requit-ed
Ca]culate the va]ue to be pJaced on goodwiU,
Answer
Goodw·m is valued at $24800.
Workin
$322400
--- X 4 =$6200 X .q. =$24800
52
209
EJI Partnership accounting - structural changes
•••••••••••••••••••••••••••••••••••••••••••••
3 A multiple of an average of the gross fees earned over a number of years
Thi · m thod is u ed by many pr,ofessional busin · es, such as a,ccountants, doctors,
]avi,y rs, veterinary suri eons. tc .. wben a partner retire or a new partner enters [b
'b u iness.
It has been agreed that goodwill be valued at two years.' purchase of average gross
fees over the past four years. Fees for the past four years were:
Vear s
1 98000
2 77000
3 72000
4 69000
R quir d
Calculate th valu to b plac'"'d on oodwiJJ.
Answer
GoodwiU is vah.11ed at $158000.
Workings
98000 + $77000 + $72000 + $69000 ~ J316000
-316000,
--- X 2 = $79000, X l = $158000
4
Dkgen; a property develop r. has $.-oooo capital inve~t d in his busine . lf hewer
wod~jn fo r another property d vcioper h, could eam $23000 salary per annum. His
bu sin sis currondy earning profits nf ,38000.
Requit·ed
Calculate the atnount of super profits earned by Oirg,e n's business.
Answer
Super profits earned were $·12 500.
Workings
$
If Dirgen ~vorked for another pro,p erty de,..eJoper be could earn: 2300n
If Dirgen invest d his ,c apit~ ouisid~ his busines he c,o uld earn (say) 2500
ft ve per cent
25500
By carrying on as a self- mployed pro,p rty developer, he eam 112 500 mort1 than he
would earn using his capital and talents in the ooxt best ahctnative.
210
24.3 Adjustments to partners' capita, accounts to record goodwill
Homer ovvns aind runs a small ar re-pair busin . Profim for tht: past few years hav
avera d 18 OOO. Hom r has 14 OOO capital in\li ·tE'Ci in his bu iness. H could t!atn
$12000, as a car m€cll,ank ,,v orking locaUy. He currently cams nve per cent per annum on
a savings account at a Jocal ba.nk GoodwiH is to be vah.:ted at three yeara super profits.
Requit'.'e d
Cakulate the value to be pJaced on goodwiU.
Answer
Goodw·m is valued at $15 900.
Workings
Earnings a.s 1nechank 12000
Interest: on capital ( 14 OOO) inve~1ed in bank S70o
12 700
($18 0-00 - f 12 700) X J =s- 300 X 3 =$159 00
No doobt you can think of one or t\vo other factors ithat njight contribute to the
estabH.shtnent of goodwill.
S01 why might you pay 30 000 more tban the net asset valu~ pJaced o n a bu.sinc:ss in
11
n,e reason why you might pay the 'extra' $-30 OOO is because you can see the prospect
of earning high pro fits in the funu-e - you can envisage yourse]f earning lots of profits.
l.ssn1aU and Gudn1n are in pa rtnership, seUing deaning n1atcrials. They trai\rel fr,o m
holLISe to h o use .sc[Ung the ir products to peopJe in their hon1es. They share profits, and
losses in the 1-atio 3: 1 respectively, Their staten1ent of finanda] position at 31 August
2014 showed:
2111
EJI Partnership accounting - structural changes
lss mail and Gudrun
Gudrun
Tota I capital 370
Iss1nai1 and Gudru n admit Lucrezia t,o the partnership wid'l effect fron1 l Septen1ber 2014.
l uct-evLia ,c ontributes S2000 as ber capital The--y agree that goodwill be valued at $8000.
Requ:ir d
Prupar~ a s'tatement of financial position at 1 pt mb · r 2014 immecUat Jy an r
Lucrt zia w.as ad,nitted t,o , the partnership.
Answer
lssm a ii, Gud run and Lu crezia
Ext ract from statement of financial position at 1 September 2014
s
ASSETS
Non -c.u rre nt assets
8 000
Cur rent a ssets
Bank balance 2370
Tota I assets 10370
CAPITAL
Ca pita I accounts - lss mait 6200
Gudrun 21170
Lucirt?,ia 2000
Tota I capital 10370
Workings
Notice that a n ew asset bas appeared on the statenie nt of financial positioni a non-
c urrent asset (intangib]e) that has built up over the years w hiJe Issn1ail and Gudrun
have been in business as partn ers. The two original partners h ave been responsible
for creating. the goodwiH through rheir pcrson aUty, products, a fi:er saJes seni ce, et:c. ,
so it is only their capital accounts that have been credited in the p rofit sharing t-atios.
The book~keeping entries ito tecotd the introduction of goodwiU into the
partnership books vvouJd Look Hke this:
Goodwi 11 acc.ou nt
s
....... ····················-·~··········
Now try Question 3.
Capital - l,ssmairl
Capi,tal - Gudrun
6 OOO
2 OOO
Adhaf and Sbavay are in partnership sharing p rofits and losses equally. They provide
the follov.,ing infonnation:
CAPITAL
Capital a ccounts -Adhaf 3500
Shavay .3 OOO
Tota I ea pita I 6500
Th y admit Paris as a partner with ffect from l Augus1 2014·. Pads pays 15000 into
the partn rship bank account a her capitaL They agr that goodwiU · valu cl at
Sl OOO and tl1at th account wiU not app ar in th uu-1n nt of financi:d posi.t·ioo.
They further a gre to share futur profits and loss s :, i2!l resp cti.vely.
Requif _d
Prepat·e a statement of fioancia] position at 1 August 2014 after the adlt'nission of Paris
as a partner.
213
EJI Partnership accounting - structural changes
Answer
Adhaf, Shavay and Paris
Extract from statement of financial position at 1 August 2014
s
ASSETS
Cur rent assets
Bank balance 11 SOO
Tota I assets 11 500
CAPITAL
Capita l ace,ounts -Adhaf 3 500
Shavay 6000
Pa:ri.s 2000
Tota I capital 11 500
Workin
The 'book-ke - ping entries showing the abo·" transactions are~
Goodwi 11 ac.cou nt
s s
Ca pita ls - Adhaf {1) 9000 Capital,s - Adhaf (4) 9 000
Shavay (2) 9000 Shaivay (5) 6000
Paris (6) 3000
18000 18 000
Nuinbers in brackets h ave been p laced next to ,e ach entry so that you can nace each
,entr y· individually· ito ead1 account.
•• •••••••••••••••• ............. •••••• ...... Notice that th e goodwiU account has disappeared and is not shown in [he final
> Now t r Question 4. statement of ftnancia[ position..
Cleady h · vei1' unusual for a bu in t,o have a bank: balano a its only as ~ t. Tb
above ,e xatnpJes W6'1'e used to hi hUght th "''1Y goodwil] is treated when it does n ot
reniain in the books of account.
Let us put together a tnorc detailed scenario - a situation where the asse ts arc
reva]ued and a w lue is p laced o n goodwj]l.
214
24.3 Adjustments to partners' capita, accounts to record goodwill
Lopata, DiilaU and Beauregard ar in partnershi'P, shadng profits and loss tn the
ratio 3~2:l r p tiv ly. They provid the foHowing infom1ation:
They agr,ee that Cbantite be adn1itted as a partner with effect frotn 1 June 2015. Profits
a nd losses in future will be shared equaUy. They further .agree that non-current asse-ts
be va]ued at $28000 and that goodwi]] be valued at $10000. Goodwin should not
remain in the business books of account.
Cbantile is to pay 5000 into the business bank account as capital
Reqw in: d
Prepat-e:
~ a revaJuation account
b an in1a ngibl,e assets account
capital accounts for each partner
d a tat,en1ent of financia] position au 1 Jun 2015 after th~ adn1dssion of ChantU a" a
partner.
Answer
a Reval1.1ation account b Goodwill account
$ $ s s
Cap - Lopa:ta 6 OOO Non-current assets 2000 Reva;luation ale 10 OOO Cap ita'I - Lopata 2500
DJi.la~i 4000 Goodwill 10000 Dj,ilali 2500
Beauregard 2000 Beauregard 2 500
112000 12000 Charntile 2500
10000 1.0000
215
EJI Partnership accounting- structural changes
Lopata, Dj i lal i, Beall regard and Chanti le
Statement of financial position at 1 June 2015 (after the admission
of Chanti le)
$
ASSETS
Non-current as;sets at valuation 28000
Cur rent assets 1,4 000
Tota I assets 42 000
Note the us of oolumnar capitaJ accounts~ th:is t chnique sa\1t:s a little 't ime. Four
partners have been involved in the partnership to, show that the t d\ruqu~s do not
W'1ite figures o ur1t 1i n ful I. M1a1ny students change w bcn a qu<:stion bas more than throe partners. Questions 11.isuaUy have two or
make errors wheni t hey f orget t h at they three partne rs .
are using thousands and put a fig uire as, No te the h eading t,o o. AU :accounting stateinents need a heading~ including the
sa~ $13 .5 w hen it shoull d say $1 3 500. n am e o f the business.
Careless mistakes co st~ Check your work
careiuHy.
If w e conside r a n10re detailed statein ent o f fina ncial position. we wm see tha t the
p rincip les for d ealing with the intro duction of ano the r partner are just the siune as
those already used .
Now try Qu stion 5.
Re111e111ber that w e coUect a U the detailed cha nges to assets and liabilities in the
reva luatio n account.
Gwok and Di1n it1i ar in partnership, haring profits and lo s in tbi · ratio .3 :2
resp tiveJy. Tht! foUowing inforr.nation is providt!d:
Current liabilities
Trade payables 2000
Total capital and liabilities 1102 OOO
Antoinette ""'as admitted 'to the partnership on 1 July 2014. It was agreed that sh paid
83rQ OOO into the busin ess bank account as he t· capital and share o f the g,ood,;vm.
It was agreed that the· assets of the business be va]ued at:
$
Premises 80000
Equipment 15 OOO
Venides 8000
Inventory 10800
Tirade receiva bles
1
4400
Goodwil'I 40000
It " ..-as ftnthe t agreed that in future profi ts and losses be shared equaUy and that
gooikviUsh,o,lJJ ld not rema in in cbe books of account.
R quit d
Pfi pare:
a revaluation aoco'U nt
a goo-dwiU account
partners' ea.pita l accoi:1nts
d a staten1ent o f financia] positio n at 1 July 2014 a fter the admissio n of Antoinette as
a p artner.
Answer
a
RevaI uati on acco unt
s s
Equipment 8000 Premises 35000
Ve hides 9000 Goodwi11 40000
Inventory 200
Trade recelvables 100
Caprtal - Gwok 34 620
Dimit ri1 23 080
75 000 75000
b
Goodwi 11 a cco U'n t
$ $
Revaluation accou nt 40 OOO Cap.ita~ - Gwok 13 334
Dtmrtd 13 3.3.3
Antoinette 13 333
40000 4 0 000
C
Capital accounts
Gwok Dimitri Antoinette Gwok Dimitri Antoinette
$ s $ $ s s
GoodwiU 13 334 13333
1
1,3 333 Ba la nc es bid
1
60 000 40000
Reva luation ale 34620 23080
Batances 81 286 49747 16667 Bank 30000
rid
94620 63080 30 000 94 620 ·6 3080 30000
Ba lanees bid 81 286 49747 1-6 667
217
EJI Partnership accounting - structural changes
d Gwok, D.i mitri and Antoinette
Statement of financial position at 1 July 2014
$ s
ASSETS
No n-current assets
103 OOO
Current assets
lnvento.ry 10800
Trade ,receivables 4400
8anrk bala nee
1
31 500 46700
Tota I assets 149 700
In1agine that you h ave been a partne r in a bus iness for tnany~n1any years a nd the
foUowing is th e Sllll11H]arised sra1ten1e nt o f finan da] position:
$
ASSETS
Non-current assets at c:ost 12 000 These non-current assets include your premises
that were purchased .ma.ny years ago. Ptoperty
prices in general have risen over your years of
Cur rent assets 8 000
ownership and these premises could now be
Tota I assets 20 000 sold foi; say, $80 0001
218
24.4 The retirement of a partner
Ymi would have the business assets valued so that you ,c ould r,eti:re (or perhaps sta1t a
n Vl bu iness) and r cdve the tru~ v.alue of your worth repr sen t~d by th net ass ts
of tb busine s.
Gerard, SyJv:estre and Jean are in partnership, sharing profits a nd Losses in the ratio
3:2~1 respectively. They suppJy the following infom1ation~
Gerard, Sylvestre and Jean
Statement of financial position at 30 September 2014
s $
ASSETS
Non-current assets at cost 45000
Current assets
Inventory 4 300
Trade rece:ivables 3700
Bank bala nee 4000 12 OOO
Tota I assets 57000
Jean has decided to retire with effect from dose of business on 30 Septembe.r 2014.
The partn rs hav agreed that:
• non-current a ts b valu at 9100 000
inventory b~ valued at 4OOO
trade rec iva bl s b~ valu d at 83OOO
C
goodwm be va.lued ~u $12000 and that goodwm should not appear in the business
books of account.
Any an-iount due to Jean wow d be paid from the business bank account (:assun1.e
that overdraft fad lities have been agreed with the business bank).
• Jn the future Gerard and Sylve.s1'.re wiU share profits and losses e quaUy.
Requit-ed
Prepare:
a a revaJuation account
a goodwiU a ccount
partne rs~ capital accounts
d a stata nent of fi nanda] position at 30 eptember 2014 aft,e r the r,e dternent of Jean.
219
EJI Partnership accounting - structural changes
Answer
Revaluation
- -
account
$ s
Inventory 300- Non-curre,r,t assets 55 OOO
Receivabiles 700- Goodw,iU 12 OOO
Capita1I- G 33000
Capital- S 22000
C apitall - ·J 11 OOO
67000 67000
b Goodwi II account
s $
Revaluation 12000 Capital - G 6000
account
Capital - S 6000
12000 1'2 000
C
Capital accounts
Gerard Sylvestre Jean Gerard Sylvestre Jean
$ s 5 s s s
Bank 25000 Ba :lam: es bid 20000 ,,sooo 14 000
GoodwiH 6000 6 000 Revalua1ion 33 000 22 000 11 OOO
Ba la.n c~s c:!d 4-7000 31 OOO
53000 37000 25000 53000 37000 2SOOO
Ba :lane es bid 47 000 31000
cJ Gerard and Sylvestre
Statement of financial position at 30 September 2014
$ $
ASSETS
Non-current assets at valuation 1·00000
Current assets
Invent-c ry 4000
Trade irece ivables1
3000 7000
Total assets 107000
Workin
Note th question i dealt w ith in nvo p,a:rts. be cause it inv·o lves two busln sses:
220
24.6 Achange t,o the profit sharing ratio
p,residedl over the increase in the \o"'il lue ,o f the assets as ,veU as contributing to the
vaJur: of the goodwiU of the business.
w~ debi't d the ffl'O capital accounts (there ar~ only nvo partn rs, Gerard and
y]vesw 1 i:n this 'new-' business) Wi't h th~ waiting off o.f the asset of goo lwHL Notic
that when Wt: ~"rote off the goodwil] there w r only rv,.,,o partners to the 'ne·w '
business - Jean is now no longer involved in the running of the 'business.
Juan and Jose a re in partnership, sb-aclng profits and losses in the ra.tio 3:1
respectively. Fron1 1 January 2015 they agree to s hare profits and losses equaUy.
The ir sun1nuuised staten1ent of finaocia] position at 31 Decenilier 2014 showed :
2211
EJI Partnership accounting - structural changes
The partners agreed rhar non-current asset"' be va]ued at $70 000 and that goo-dwiU
1
Answer
Juan and Jose
Statement of fi nan ci a I position at 31 December 2014
$
ASSETS
Non-current assets 70000
Cur rent assets 12 000
Tota I assets 82000
CAPITALAND LIABILITIES
Capital a,counts - Juan 53 SOO ($30000 + $37 SOO- $14 OOO)
Jose 20 '500 ($22000 + $12 500 -· $14000)
74000
Realisation account
Th e ca rrying amoLmt of the assets The proceeds from the sales of the assets shovvn op posite
The most common error m1ade by 1
stu den1s 1s to enter itihe amount ra1~sed by Costs of the dissolution Other incomes or benefits
the sale of the assets 1in the deb~t side of D·iscounts aIlowed
1
Discounts rece.ived
the realisation account Make sure·that it Profit on dissoliuti on Loss on disso l·ut ion
is the· canrying am,o unt of the arssets t hat
Unless you are told differently, assume 'th at the pa rtnership v.riU coUect any
you en1er on the d@blir side.
o utstan ding n1on ies from receivables (debtors) and pay off outstanding pa~bles
(creditors). Try to think what you wou]d be doing in the drcun1stances when a
partnership is dissolved .
• A]] the assets to be disposed o f a t-e entered o n the debit side of the realisation
account.
• AU the p roceeds a re entered o n the credit sjde.
An.y profit resu lting frocn the d isposal of the assets wUl appear on the debit sidE:- of
the realisation account. It is posted from her·e to the cred1t side of th.e partners' capital
accounts in their profit shadng ratios.
Any fos.s wUJ be shown on the credit side ·o f the reaHsacion account and it "-' m be
posted to the debit stde of the pattners' capitaJ aooounts in their profit sharing ratios.
If any partner tak ,over any of the partnership ass ~s, tt·:.at thi as al aJ t ·t o that
partner. Cr dit th~ r~a]isation aocount w ith the agr, d "-aJue of th<; a et(s) to be
taken over by the partner and d bit the respective ea pita[ account.
Debit Jl osie 's capital account with Credit Rea,l fsation account
the ag reed value of tne inventory
223
EJI Partnership accounting - structural changes
Wu and Xlan are in partnership,, harin profits and losse in th rati·O· 2:1 r,e.sp ctiveJy.
Th y agr, to d issoJv.e the partnership o n 30 No,v.en1b r 2014. They provide th
foHowin information~
CAPITALAND LIABILITIES
Capital accounts - Wu 50 000
Xian 36000
86000
Required
Prepare
""i a ban k account
, a rea Us adon account
" partners' capital accounts.
Answer
Bank account
$ $
Balance 3 OOO Current liabil'i.ties 14000
Realisation - Non current assets
9
100 OOO Wu - Cap;ital account 62000
Cu.rrent assets 15 00-0 Xian - Cap ~ta I a cco u nt
1
42000
118 OOO 1118 OOO
b Realisation account
$ $
Non-current assets 80 OOO bank (non~urrent assets} 100 OOO
C: u rrent assets 17 OOO bank (c urrent assets) 15 OOO
Cap·iti~I accounts~ Wu 12000
Xian 6000
11 5000 1 15 OOO
1
224
24.8 Rea,isation accounts
Wot·lting
In order to show Ehe sequence of the entries show-n a bov, , the entries have be n
You may find the prepara,tion of journal jo,uma]ised:
entri·es to be a very use·ful revi s~on a~d.
lrf you jouma Use any comp!-ex answer or Dr Cr
an exerciise that your teadher has gone $ s
through iin da ss, you should f~ nd it ea,s~er
Cur.re nt Ii,abi Iith~s 14000
to rev~se the order in whii eh the processes
Bank account 14.0QO
involved took: p!ace when you return to
the exampfe some weeks or months later. Paying current Ua bil'ities
Note
Do not attempt to share any baJance Jeft in the bank a,c count in any pre-detern1ined
ratio. The bank account is used to dear any outstanding balances .!e ft on the
panner.s' caphaJ atocou nts.
A 'E the end of this type of exercise there should be no outstanwng balances
anyw·h ere in your ~n&'W·eT.
225
EJI Partnership accounting - structural changes
Rollo and Johann are in pru:tnership, sharlo profits and los ~ 3·:2 respectively. They agr
to, dis 01\11 tb ir partnership on 2 Febntary 2015. They pro, id th following information:
1
CAPITALAND LIABILITIES
Capital accounts - Rollo 25 000
Jioha1nn 19000
1
44000
Answer
a Realisation account
s $
Nonpcurrent assets 40 OOO Capital - Rolllo 36000
CLI rre nt a.ssets 8000 Bank 7000
Capital - Ro.llo ~OOO
Johann 2000
48000 48 000
b Bank account
s s
Balance bid 2 OOO Current 'liabHitie.s 6000
Rea l'i sati on account 7 OOO Ca,pital account -J ohann 17000
Capita~ account - Rollo 14000
2.3 OOO 23 OOO
C Capital
--
accounts
-
Wot·lting
Again, to show tb e .sequence of events, here a re che journal, entries:
Dt Cr
s s
Currant liabilities 6000
Ba nk acc:ou n.t 6 000
Paying off current liabil,i;ties
Clearlyi there a re tin1es when receivab]es do n ot aU p ay d1e an101.11nts that they owe
to the business wh en a partnet"Sh ip is Vfound u p. This n1ay be because there n1ay be
sane b ad deb ts or because the partners hip offers cash discounts in order to get the
cash in qi.1sickly.
Simila rly there in ay be times w hen a partnership is able to benefit fro1n cash
discounts avaHab)e &om rrade payables.
Any discounts a Uowed to receivables is debited to the realisation account (as
would any debto l~s w ho pruited to be bad). Any discounts received fron1 payab]e.s
is er.edited to the reallsadon account. Tl1e .a ctuaJ cash recdved fron1 recdvables is
debited to the pannership bank account and the cash paid to payables is credited ,to
the bank account
•.i\.s]an1, Brannen and Chesn y decide.:: to dis o]v tbeir partnc~ship on 30 April 2015. At
that date trade receivables ainounted to $7 450 and trade payables totaUed S3950.
·o ebtor.s (rooeiv:ables) pa id $7250 in settleluent and ,c reditors (payables) accepted
$3800 in setdanent.
227
EJI Partnership accounting - structural changes
Requite d.
Prepar th~ fo]]owing accounts to, record the transactions:
l a t a Bs ation a,ooou nt
IJ a bank account
tot al trade rocei vvJbles account
total trade p ayables accou nt.
Answer
a Realisation account
s s
Tota:I trade rece iva bIes 200 Total trade payab.les 150
account acco unt
b Bank account
$ $
Tota Itra.de rreceivables
1
7250 Total't rade ,payables 3800
account account
C Total trade receiva bi es account
$ $
Ba'lan.ce bid 74.50 Ba,nk accour1t 7250
Real'isation account 200
74.50 7 450
Winding up a partnership wiU ine vi·t ably incur costs. These costs may be to adv,ertise
vari:ous assets to be so]d; ch ere may be costs paid to ai JaV\fYer w h o will tie up and
formalise 't he 1 gal ide o f tbe dissolution. Any costs involved should b :
Yoko and Cesc were in partn ership, sharing p r ofitts an d losses equaUy. They agreed to
dissolve their p artnership on 31 July 2015. They provide the fo Uowing information:
228
24.8 Rea,isation accounts
Answer
Realisation account
$ $
Discounts ;;l'Uowed l 00 Disco un:ts irece ived 500
Non ..current assets 40000 Bank (non .. current assets) 58000
tnventory ~}000 Capital account - ·voko (inventory) 7700
Bank (costs) 3400
Profirt: on rea,lisatio n - Yoko 6800
Cesc 6800
66200 66 2.00
b Bank account
$ $
Ba:lan ce bid 2 OOO Loari - Cesc 2000
Tra de rec:~ivables 3 800 Trade payables 7500
Realisation account {1ncm-cu1rrenrt 58 OOO Realisation account (costs) 3400
assets} Capital .accounts - Yoko 241 00
Cesc .26800
63800 63800
22'9
EJI Partnership accounting - structural changes
Karl. .and Bun:u were mpartnership, sharing profits and losses in the ratio 2:1
re.spective]y. They agreed lo seU thefr business to Tontong Ltd. The purchase
consideration was $100000~being m,a de up of 20000 cash and 50000 ordinary shares
of $1 each. The partners agreed that the shares be distributed in the profit sharing
ratios. The foUowing infom1ation in11uediateJy prior to the takeover is provided:
$
Net assets 82000
Capital accounts - Karl 50000
Burc:u 32000
82000
R quit· d
Prepare ledger acoout,ts ·to do,se drte book of account.
230
24.9 Assets taken over by a limited company
Answer
Rea Iisati on account
$ $
Net assets 82 OOO Tontong Ltd 1,00000-
Capital accounts (proitt on rea'lisation) - Karl 12 OOO
'Burcu 6000
100000 100000
Tontong Ltd
s $
Realisat1on account lOO OOO Bank 20000
Ca pita 1 (Shares) - Ka r,I
1
53 .3.33
Burcu 26667
1·00000 100000
Bank account
s s
Tontong ltd 20 OOO Capital accounts - Ka,rl 8667
BU'rcu 111333
20000 20000
Capital accounts
Karl Burcu Karl Burcu
s $ $ $
Ord~nary shares in Tm,tong 53333 26 667 Bal·ances bid 50000 32000
Ltd
Bank 8667 11 33 3 IReai is:ation 12000 6000
account
62000 38000 62000 38000
Wotkin .·
1-'I, tt! ar,e journa] entri s so chat you c n fo]Jow ·che chronology of th ~ntnes:
Dr Cr
$ $
R@il Iisa ~ion ac:coun t 82000
Net assets 82000
Th is doses down the asset accounts.
To ntong ILtd 100000
IRe alisation account 100000
Purchase consideration agreed bet\N'een the partners and Tontong Ltd
Realisation accm.J nt li 8 OOO
Ca.pi.ta I - Kar1 1'2 ·000
Buircu 6000
Pn:rfit on reaHsa·tion cred ited to partners 1n ·their profit shariT11g ratros
Banik account 20 OOO
To.ntong Ud 20000
Cash paid by Ton tong: Ltd
Capkta l accounts - Karl 53333
Buircu, 26667
Toritong ltd 80-000
Sha,res given1to partners i,n the agreed re1tios - note that the o rdinary sha,re; are distributed in
vat ue tenns not in nom.ina I vatues.
23 11
EJI Partnership accounting - structural changes
The shares must be ,vorth $1.60 each ($80 000 + SrQOOO)
1
to ihe partners.
Capita I accounts - Ka rl
1
8667
Burcu 11333
Bank 20000
Cash is withdrrawn from the ba,nk account to bafa1nee t he ca,pita,I accounts.
1
Ta lk yourself through this exarnp]e a couple o f tin1es. H is 01uch easier than you
think. The point at w h ich tnost students go wrong is when the ordinat'y shares have
to be shared between the partners - shnply d ivide the ba]ance (of share value to be
disuibute d) ren1aining in the purchasing con1pany's account by the ratios given in the
q uestion .
Un1ber£0 and Claudius are in partnership~ sharing profits and [osse in the ratio
3 :2 respecdvely. They sen their business to Darken Ltd for an agreed purchase
oonsideradon of J.200,000. Th purchas coruid ration is Lnad u:p a foUo"'·s=
Casn $40000
6% deb entuires $50000
30 OOO ordinary shares or $1 each
Recne n1ber that those $1 shares tnay be worth more (or Jess) tha n tbe $1 non1inal
va]ue. So how much they are worth per share? #3.67 each.
It was agreed that the partners Vil ould distribute th e debentures in the fast agreed
capitaJ account l"3tios a n d that the ordinary- .sh ares wou1d be d ivided accot~ding to the
profit and ]oss sharing ratio.
The partnership statetnent of finan da] position in1mediately prior to the takeover
showed:
$
Net assets 120000
Ca pital accolJ nts - Umberto 800 00
Cllaudius 40000
120000
Requ u:ed
Preprure ledger accounts ·t o dose the books of account .
Answer
Re a I isati on account
s s
Net assets 120 00 0 Dork en Ltd 200000
Capital accounts - Umberto 48000
Claud ius 32000
200000 2-00000
Dorken Ltd
5 $
ReaHsat,io n account 200 OOO Bank 40000
Ca,p ita I accounts - Debentures 50000
Cap~tal accounts - Ord,inary shares 11 0000
200000 200000
232
24.9 Assets taken over by a limited company
Bank account
$ $
Dorke·n Ltd 40000 Ca,pital accounts - Umberto 28667
Claud~us 11333
40000 40000
Ca pita I accounts
Umberto Claudius Umberto Claudius
s s s s
Oorken Ltd (debentures) 33333 16 667 Ba1ances bid 80000 40000
Dorrken Ltd (ordinary 66000 44000 Real'isati.on acc ount 48000 32000
sharres)
Bank account (ta balance) 28 667 11 33.3
128000 72000 128000 72000
Workings
Jourrud ,e oEries (as a revision aid)~
Dr Cr
$ $
Reo Iisation account 120000
Net assets a·ccount 120000
Mi a point .of inter,e st, the e ntrie s in the ledger of Do rrken Ltd wo uld show·:
bank accounEte duced by -40 OOO
• d(!benrures incrc:ased by 1-0000
• ordinary shar, capital incre as d by $30 OOO
• shar premiutn account increased by $ 0 OOO
•••• • •••• • ••••• • •••• • ••••• • •••• • ••••• • ••• net tang ible asse ts increase d by $120 000
Now try Que stio ns 9 a nd 10. goodwiU $80 0()0, (Do rke n paid $200 000 for $120 000 o f tangible assets.)
233
EJI Partnership accounting - structural changes
• if goodwHI ha1s to be written off th~s ~s done in ~he profit sha1ring rados ·Of the
1
nev,1' pairtners.
A partnersh~p is d,ssolved
• on the death of a partner
• on the reti remen1 01 a1partner
• when a pairtner is declared bankrupt
• by 1mutua~ agreem,en1 oi the partners.
• The debts of a partnership should be settled in 1he folllow~ng order:
• payables
• partners' loan ac:cou nts
• partners' capi1tal accounts.
When a partnershi1p is W·ound up, assets are transferred to the· debir1t of a realisa11ion
a,ccount. The rea1Usatton account is cired~ted w~th ~he 'sellling' pnice oi each asset. The
profit or loss on ireai ~sat~on is calc ulaite d. The profit (or lies s) s then app orci one d to
1i
234
The financial s atements of
limited companies
By the e nd of this chapter you should be able to:
• expla~n 1:hecharacter1st ks of a limirted ,c ompany
• make a comparison between pairtnersh ip s,. private I, mite d co mpan1ies and
publk limited co:m1pani1es
• prepare the ~ncome statement of a l~mi•ted co1m1pany suitab~e for jnternall use
• prep are a statement o,f chan 9es tn equ ny
• prepare a s~mple cash flow statement
• identify and expla~n 1he dljfferent components of a statement of fin andal
position of a Umrted com1pany
• ,expla1in 1he term 'reserves'
• dj stingui1sh b et\wen revenue and ca1prta1 I reserves
• show the effect o,f an issue oi shares at a premium on the statement of
fiinandail pos:itj on of a II~m rted corn parny
• show how the reva1!uation of non-current assets wm affect a statement of
f1na1fldal posnj on
• show 1:he ,effect on a statement of fi nanda~ position of a rights issue of
shares and a bonus is s.ue of shares.
~ - . L'1m·1t_e d_ co
251 -- mp_a-n1·es
--
A limit d company ea n b a very small business er a gianr multinational busine ~
A limited company is a,n orga,nisa:tion with branch<.:Js and/or sub idiary companies trading throughout the world.
t hat has a legail id:e ntity tha,t ,is separate The n,a iority of bt-J1Sinesses are sole trndet-s or partnerships. The major
from that of its OV11ners. Th~ ovvners of a drawback of thes,e two types of business is that thcir owner(s) have unHn1ited UabtUty.
limited company are ca lled shareholders
{or members); ~he1r liabi'lity ts limited t o the As we have seen , a sole trader is responsible for aU debts incurred by hto1 or h er
am.aunt that ·t hey have agreed to pay the in the course o f running the business . For exan1ple, if Moona >a sole 11:radert runs up
company f or their shares. business debts of $25 OOO, she n1ay have to setcle these debts fron1 her private sav.mgs
or she n1ay have to seU ber house or ear to clea 1· the debts. Moona has unlhruted
HabUity.
SitniJady, if the b us iness partnership o f Clint and Dyke has debts of 83'0000~both
partners are 'joinciy and severally responsib],e ' for the debts of the business and
b etween thetn they n1ay have to raise 11:he tnoney privatcly to pay off 1the an1ount that
is owed. CUnt and Dyke have unlin1ited Ji.ability.
Hmvever~ Blinva pk (public Hnlit,e d oo,m pany) has debts of $34- OOO. Jemma, a
sharehoJ der in the ,c ompany (sh owti.s SOO ot·dinary shar of $1 ac.h) cou]d not b(;
a ked to contribut further funds in order to he]p pay off th deb!!. of th ,oo,mpany.
~ be could Jose her inv ttncn,t lbur that is aU he Vv',ould ]ose. H r personal poss·cssio11S
are . afo. Jemrna ha ltmited liability.
So; unlimited ]iahUity means that the ,o wners o f a buisiness have r,e spons ibility for
aU the debts incun·ed by their business.
235
ED The financial statements of limited compan ies
Jn the vast 1najority· of cases, unJin1ited ]iabUity is of Uttle significance. However,
if a busmn ss is making loss .s on. a r gufar basis then th continuo us exis~nc of
th bu.sin · ~ lmy weU be in doubt. So a major drawbad!c of bein a sol trader or a
partner in a busin~s is unlirnite I liability forth own~rs.
As a consequence of u nJ imited ]iabi] ity there i.s another tnajor drawback for
unlinuted businesses. Tbcre arc fewer opportunities to ftnd extra 1capital that may be
necessary for an expansion progran1me. Pr,ospe-ctive investors may not wish to take
the risk of Josing their private assets as weU as their investment.
* Partnerships are not taxed oa their business profits. Individual partnet'S pay tax on
·r heir earnings as partners.
236,
25.4 Financial statements
On the ,o ther hand; if the directors of a publk lhnit,ed oonlpany wish to, 1'jjise
additional finance, the directors may weU advertise th~ face in tbe nnandaJ s ctio:ns of
claj]y new pa.p rs in order that the public at ]arge may sub. crib to tl1 offer.
Th adv-'1ntag of Hrnited UabiUty ·tatus and eh abiHty to ra is. ]arg - amounts of
finance are offset by certain .legal ,o bligations:
• Annual financia l statetnents 1nus·~ho audited by pl"ofessionaiJJy qualified personnel.
(This is not the case with partnet·ships or ,vith sole traders.)
• Annual returns must be cotnp,leted and fi]ed with the Registrar of C.Otnpa rues.
These returns n1ay be inspected by the general pu'bBc. The nnandaJ staten1ents
induded as part of the annual return lack much of the detail that couJd be used by
a cotnpetitor.
• Con1panies a1e usuaUy regulated by gov,errunent legislation and/or agencies.
• Coptes of the con1pany's annual audited finanda] staten1ents n1ust be sent to each
shareholder and debentut-e holder.
Under the stewardship umbrella we also find the need to provide accounts that
con1ply with:
• governmental t~quiren'lents
• accounting standards
• stock exchange regufations
• Eax 1egislation.
\~e have seen that the nnancia] sr,uenents prepared fot al] business organisations are
broadly ·imilar. Aprut from the heading, a set of financial sta'tement pr pared for a limited
company "1"0uJd look imilar to a s t of financial staten1ents pr pared for :a so1e tmder.
Figure 25.1 shows th potential u er" of th finandal tatetn nts prepar d for a
licnited company.
- - - - - - ShB:rebolders - - - -
Customers
/ Fmranci.al Statement 0
1.ltl~ ,:r.icc~ l links
~
Suppliers
/ ---- C -- "'
Ojre etors
I ___
------
- .-
Competitors
I
Banks
--- Resear,cbers
"' Students
-
"' Tax authori1ie
- - - - Financial press
Flgure 25.1 The usi=rs of the financial statements of a limited company
237
ED The financial statements of limited companies
5 ldentrfy the diifference bet\i\teen a1private llimirted company and a pubUc Umi1ed
company.
6 Privaite ~imt1ed compani,es can have their sharres quoted on a recoginised stock
marke1. True/Failse?
7 A private liim1ited co,mpany could have 35 shareho!lders. True/fa lse?
8 Privai't e !limited companies cannot seU their goods in ano~her countty. True/
False?
9 Private ~imrt.ed companies can on~y ~ssue shares to r-elatives. True/False?
10 Which type of busi1ne~ses 'file thei r annual finandal statermenr1s \i\/ii:h the
Registrar ofr Companaes7
11 Only prof1itable companies must ~i le t he~r annua~ finandai statements wrth the
Reg~strar of Co'm panies. Tnue/failse7
238
25.5 The income statement of a limited company
An r th dedu,c tion of Lntercst payabl frotn the profit from op rations v,l c have pro.fit
before uocadon.
One other point is that it m.s usual to group certain types of ,e xpenses togethe,r. The
reason for this is that it nmkes the production of pubHishe:dl accounts easier. We "riU
consider pubHishedl account s in Chapter 34 in the A-level section of the book.
54970
ad mini:rtrative 67830
D~p.reciat ion - d~Uwry vehhd@S 54 000
prem ise$ 20000
Other exp e:n ses - sel'Irn g and distrib ut ion 31 140
ad mrn1strat ive 34 800
Audit fees 23000
Debe nt:u re interest 40000
Corporation taxation 21 OOO
Requil"ed
Prepare an incon1e statem,e nt for the year ended 31 October 2014.
239
ED The financial statements of limited compan ies
Answer
Treadle pie
Income stat ement for t he year ended 11 October 2014
$ s
·Revenue 9·56230
Less Cost of sah~s
1,n verrtory 1 November 2013 43310
Purchases 438 920
482230
1lnventory 31 October 2014 (4 1 760 ) 440 470
Gross profit 51 5 760
Overheads~
Se'lli.ng and distribution costs
Sa iaries ('54 970)
Directors' fees (1106 900)
Otner eXJpenses (31 140)
Audirt: fees (23 000)
De prec ia,t i on - de Iive ry vehicles (54000) (270 01 O}
Adm,i,n istrativ~ expenses
Sa lari~s (67 8.30)
Otner expenses (34800)
Depreciation, - p remises (20000) (122 630)
Profit from operations 123~20
Finance costs (40000)
Profit before t ax 83 120
C o:~ oratton tax (21 OOO)
Profit for the year attriburtabl.e to equ·ity holders sz ,20
240
25.6 Statements of changes in equity
1
The foUowin infotmation is available l 'E 31 March 2015 f.or Evahline pk.
sooo
Profit before ta,x 74·6
Tax 218
Ordinary dividernds paid 146
1
Required
Prepare:
a an extract fron1 the inco1ne staternent for the year ended 31 March 2015
b an extract fron1 a sta.tenent showing changes in equity.
Answer
Be ea refu~ when us~ng m~ Hi1ons and a Evahline pie
thousands - 1ma1ny e1nrors are caused when Extract from income statement for the year ended 31 March 2015
in the wrong place.
dedm,all points aire put 1 $000
For example:
Profit before tax 746
Correct./ Wrong I Tax 218
$000 $000 Profit for the yea,r attri:butab I~ to equity hold~rs
1
528
30 ~0000
1.6 1600 b Evah Ii ne pic
Extract from statement of changes in equity
Errors Iik e this can be e)q) ens~ve 11
If you are not confident, th1en write the Retained ea rnings: $000
figures jn full , -for exarmple: Ba,lance at 1 Aprill 2014 814
s Pro flt for the year 528
30000 1342
1 600
Dividends paid (146)
Bala,nce at 31 March 201 S 1
1196
Prefi renct: dividends wiU have been indud d a pan of the finance costs.
A stateinent of changes in equity s hows details of changes that have! taken pJac-e
to any of the com,p on,ents of a .limited company's equity. Changes to permanent share
capita] and any changes to the reserves he]d by a company are shown.
An extract fron1 the statetnent of financial position of Tantang pk shrnvs the following
Issued share capi1al ls the amount of
detai1s:
snare capita I that has actuaIly been rissued
by a company. The jssued share c.1p~ral can $000
never exceed t he authorised sha:re cap,ital1
•
During the year ended 31 December 2014 the fo]Jowing changes to equity took place!
1 OOO OOO ordb"la.ry shares of $1 each were issued at a price o f $2. 50 each.
Non-current assets currendy valued at $850000 ~vere reva]ued at $1000000.
2411
ED The financial statements of limited companies
A transfer of $ --o OOO "°-as n1ade fr,0-1n rec:ained ,earnings to the genera] reser\te.
The pr,ofiit fo,r itb y ar ended 3l. D c 111bt:r 2014 was S63B 160.
Ordinar)' dividends paid we I 125 ,ooo.
Requit~ d
.Prepare a statcm nt of changes in ~quity for tl1c year nded 31 Dee<2mbcr 2014.
Answ@r
Statement of changes in equity for the year e nded 31 December 2014
Share capital Share premium Reva Iu ati on rese rve Ge ne ral reserve Reta ined e arnings Total
sooo $000 $000 $000 sooo sooo
8 ail aince at start of the year 2500 500 1 OOO 7'50 1876 6 626
Share issue 1 OOO 1, 500 2 500
Revaluation 1150 150
Transfer to ge nera 1res@r\l"·e
1
so (SO) 0
Profit for the year 638.16 6.38. 16
0 i¥idends 1Pa td (1,25) (1' 25}
Ba.lance at end of the year 3 500 2000 , 1150 800 2339.16 9789.16
You can s that m statE1nent ha beer} adjust d to rc:fl t th n~w valu of each
oo,mponcnt making up equity capital
The foUov{ing infom1ation is p i~ovided for the year e nded 31 Decen1ber 2014 for
Doho111a pie:
$000
Revenu e 3160
Purchases 211
Inventory at 1 Jan·uary 2014 87
at 3 1 December 2014 91
Sa Iaries and genera eXif)e nses
11 53 1·
Di·rectors fees
1
312
Re,nt and local taxes BO
Dep reeiiati,ori of de Iivery vehicles 7'5
Salar:ies of sales assista,n:ts 612
Advertisi1ng 147
Ordin ary share dividend paid 200
Preference share dividend pa id 180
Tax 312
Depreciat km - office eqllJ ipm ent 28
Debentu re interest 50
Ret ai ned ea rnings at~ January 2014
1
4106
Re quir ed
Prepare:
an inco1ne statetnent for the year ended 31 Decen1ber 2014
a :nate1nent shov.-ing changes in equ ity for the year ended 31 Decen1ber 2014.
242
25.6 Statements of changes in ,equity
Answer
a
Dohoma pie
Income statement for the year ended 31 De,ember 2014·
$000 sooo
!Revenue 3160
less Cost of sa Ies
1lrnventory at 1 January 201,4 87
Purchases 211
298
,lniVentory at 31 Decembe r 2014 {91) 2rJ7
Gross profit 2953
Sethng and distribution costs
Salaries (61,2)
Advettising. (147)
Dep.reciation - del'ivery van (75) (B34)
Ad m,in istrative e;xipenses
Salaries and genera~ expenses (531)
Directors' fees (312)
Rent and locail taxes {80)
Depreciation - off.i ce equipment (28) (951')
Profit from op~ rations 11 68
Fin a nee costs (230)
IP rofit before tax 938
Tax (3 12)
Profit for the year attributable to equ.ity hofders 626
EKtract from statement of c.hanges in equity for the year ended 31 Dec:ember 2014
$000
Retained earnings
Balance at 1 January 2014 4 106
'Profit for the yea r 626
4732
iD ividends pa i,d (200)
8ah:inc~ at 31 Decembet 2014 4532
Note the way that the expenses are c.ategorised. You should be able to te U quite
eas i1y which expense goes under whid1 heading.
Make sure that you use the corr,e ct ]abeis as they are crucial in the finandaJ
sta ten1ents:
• cost of saJes
• gross profit
• profit fro in operations
• profit before tax
• profit for the year attributab]e to equity ho]der"S.
243
ED The financial statements of limited compan ies
12 Whar1 is ihe term used to descr~be a dividend that is partd part v,;ay through a,
finanda~ year?
13 A bm~1ed company 1m1ust alwa,rs pary arn interim div~dend. Truelfa~se?
14 Ordi1nary dividends must be greater than pref-erence divjdends. lirue/Fals,e-7
15 A pubhc hmited company could have·3 SOO shareholders. Truen=afse7
16 Explain to arpotentEai ~nvestor 1:he difference between the return on debentures
and die return on101rd~nary shares.
17 Ord~nary sharehollders must O'Ml a m~ntmum of 100 shares mn order to have a
vote· at a company's AGM. True/Failse?
18 Pro-fit from operations ms onily earned by p r~vately owned hospi11:als and clinks.
True/false7
19 What expens·e-s might be found under the headiingi of finarndal costs?
20 Name two sets of peopie who shou~d rec,eive the annual finarnda~ stateiments
of a I~m ited company.
21 What 1is shown ~n a statement ·Of chan g:es in e qu irty?
22 Expt a1in why d~v~dends paid are shown 1in a statement of changes in equiity.
23 IF~nance costs and tax pa1~d are shown as deduct~on s ~n a s1:a1e,ment of chain g1es
in equ1 ity. True/False?
••••••••••• ••••••••••••••••••••••••••••••
Now try Question 1.
• issue shar, s
never exceed the au th od,sed share ea pita 1:.
• issue d b nturt:s
• borrow fron1 nnanda] institutions.
Called-up share capi1al is the a.mount of
The statcn1cnt ,o f :financial posilmon of a Hrnired ,co1npany is very sin1ilar 'EO the
issued sha.re capital!that ·the sna,reholders
nave been asked to pay to date. It may statements of nnancia] position that you have already prepared inany times before.
be less tnain the va,lue of the issued snare
1
But there are son1e in1!portant differences in layout and in the accounting tenns used.
caprital. The 'top' section of a statetnent of finanda] position for sole traders and
partnerships nught look Uke this:
244
25.7 The statement of finandal position of a lrmited company (induding typ,es of share capitaU
The ]ower p art o f the sta1ten1e nt of finandaJ position of a Untited con1pany n1igh t Look
Equity is made up of the oroinlHY share
Hke tlds:
cap ita,I, permanent p'i'eterence share ea p,ital
and reserves of a Irm ited company. $
EQ UITV AND LIABI Lrrl ES
Equity
OrcHnaty shares of $1 each 35
6 o/o preference sha res of $0.50 each 25
Reserves 10
70
Non-current Iiab iliti es 50
Current Ii a bi Iities 10
Total equity and liabmties 130
Srn
Equity
Ordinary shares of $1 each 50.00
7 o/o preference shares of $1, each 1'.00
The extract from the statement of financial position shows that the nominal va]ue of
each d ass of sha re is · 1. It s hows that 50 miHion o t-dina.ry shares have actually been
issued and 1 n1ilUon preference shares have acrua]}y been issued.
Any ordinary d ividend to be paid wiU be expressed as a percentage of the notnina l
va]ue or as an atuount per share. So a dividend n1ay be de dared as five per cent (Le.
five per cent of $1 nominal value) or as a.n atnount of say) 6.3 cents O.e. the h older of
1 OD shares would receive $6.30 as a dividend).
The preference shareholder wi]] receive a dividend of seven per cent (i.e. 7 cents
for every $1 share he] d).
foUow. n ,u:y may receive a variable dividend in year' when the con1pany is profitable
(and has suf6dcnt cash resources). They rnay receive mterin1 di,v idends during the
year and a fioa] dividend s hortly after the fin3lflciaJ year en d.
24S
ED The financial statements of limited compan ies
Liquidation is a legal procedure applied 25. 7.3 Pr,eference shares
to a llmited company when tt is unab le to Prefet'\ nee, shar, h0Jde1 are enddt=d to a fix,ed dividend (if pro:fi:Es and cash a~
discharge its liabilities.
availab]~). The perc ntag\! is calculated on 'the nominaJ value of the share . In tht!
event of liquidation, the prefer nc . . . shareholders ~re entitled t,o be repaid the
nominaJ value of their shares befotc the ordinary shares ~uc rcpa id.
Pr,e fcrence s hares 111ay be cwnulative or non-cu1J1u1ative.
• Th e dividends due on cumulative preference shares wm accun1u]ate if the conlpany
is unab ]e to pay a dividend in any partku lar year - for exan1ple if six per cent
cutuulative p ,r eference shares h ave no t received a divirdend for three years 1 the
holders wou]d receive 24 per cent dividend in year 4 if sufficient profits were made
and the cash was avaUab]e. Most preference shares are cW11uladve.
• If the preference shares are non-cun1u lative, any divide nds not paid are fodeit.
25.7.4 1
Debentures 1
Debentures are not .shares; they a re lbonds recording a long-te m11 Loan to a. company.
The docuiue nt is evidence of the l.oan and the ho]der is entided to a fixed rate of
Do not show debentures as. part of interest each year. Debentures n1ay be repayable at soine future date or they may be
equtfy. They should always be shown irredeeinab]e - that is> the ho]der wm only be repaid if the con1p0ny goes into liquidation.
on a statement of fi nandal position as Soine debentl1rt.-es have the loan secut'.'ed against: specific noo-cutTent as.sets or
a non- current Ii1aib:i lity. against an "the company's assets. These are known at mot-tgage debentures.
If the conlpany is wound up or falls to pay the interest due the holders of mortgage
deoentur,e s can seU the assets of the company and recoup any outstanding amounts.
Pa~d o ut last in case of liquidation Paid out before ordtnary shareholde:rs in case of Paid out before preference sh areh o Ide rs in case
liquidatron of liquidation
Dividends [) i:vidends lnterest
1
Part of equity capital Part of equity capital (urdes5, they are redeemabfe) Not pa1rt of eq urty cap iita I
25.8 Reserves
The profits of any b11.tiSin s bt.dong to th , ov,l ners. The profit ,earned by a o[ trader
or by partners belongs to them (th<;: owners). The profit eamcd by il Hn1ited company
also b ~ longs to 'th owner.s - that is. the ordinary sllar holder ·.
In the case of a sole trader or partnership, son1c profits may be taken out of a
business by the owners as dra"rings. In the case of a Un1itcd company, some of the
profits nlay be paid to the shareholders as dividends. The profit that retnains in the
bu siness increases the capital structu re of the business.
246
25.8 Reserves
29 Authorised sha,re cap~tall ~s one of ~he terms applied to the shares ~ssued by a
l~mirted compa,ny. TrueiFa,~se?
frnancia l position. They a·re 'normal' trading ticserves a_re found to, be cessiv· ,o r are unnec ssary th,e y can b added back to
5
profits that have been reta,ined ep Ioughed current profits and used for divide nd purp
back') in1the company. They are added to Th revenut: f(;!:S rv can :ith r be et a"id for a sp cine purpo Jik th
the retained earni ngs from previous years in
1
Answer
Ordinary share capital account Bank account
$ $
Bank 50000 Ordinary 1 SOOOO
1
share capital1
and share
premium
More often than not the ]edger accounts wiU no t be required~ although you n1ay be
asked to shov;r the effect o n the cotnpany sta1Len1ent of financial position.
Changes to a s1Latement o f fina ncial po.sition:
$
Cur rent assets
Bank +150000
Equity
0 rdin ary shares of 50 cents ea eh +50000
S~are prem~um account +1 00000
248
25.9 The issue of shares and the share premium account
On 1 Novei:nber 2014 a further 200000 o rdinary shares -were issued at a price of SO.SO
each .
Required
Pt·epare a sununarised statecnent of finand a] position at 1 Nove mber 2014 a fter the
share issue.
Answer
Capdo Ltd
Summarised statement of financial position at 1 November 2014
$ s
ASSETS
No"'"' u rren t assets 17000
Other current assets 10000
Bank bala nce ($2000 +· $100000) 10.2000 112000
Tota I assets 129000
249
ED The financial statements of limited compan ies
A re'Valuation reserve is created when 25.10 Revaluation reserves
non-current assets are revatu ed in ord er to
1
refIect an in crease in th.e vaiue. It ensures Once.= agam th book-k ping entri are fairly strai btforn·a:rd.
that tne statement of f inancial position
shows the permanent 1increase in value.
Kato pie
Sum mar ised statement of fi na nc ial position at 31 De cember 2014
$000
ASSETS
Non-c:u rrent asset s at cost 40 OOO
Current assets 12 000
Tota I assets 52 000
The directors o f the con1pany reva]ue the non-current assets on 31 Decen11ber 2U14 a t
is1 000000.
Required
Pre pare ai. sum n1arised sta te ment of financfal position a.t 31 Decen"1ber 2014 afte r
revah.1 ation of the non-current assets.
Answer
Kato pie
Summarise d stateme nt of fin a ncial pos ition at 31 De ce mbe r 2014
sooo
ASSETS
Non< urrent assets at val'uati,on 51' 00 0 (Increase of $11 OOO 000)
Cur rent assets 12000
Tota I assets 63000
250
25.11 Increases and reductions of share cap~tal
If the non-current asset to he revalued has been depreciated, men any depredation
n ds to b~ written ,o ff.
An swer
a
Provision for depreciation of premises
Premises account account
$ $ $
Bal bid 200 000 Reval,uation 120000 19 sl bid 120000
reserve
Reva luation
1
150 000
rese,ve
Revaluation reserve
$
Premises l 50 OOO
Depredation l 20 OOO
General journal
$ $
Pre!mises account 150000
P,rovision for dep rred,ation of p rem,ises aecou nt 120 000
Revatua1tioni reserve 270000
Rev ah.rat io n of premises to a vailue of $350 OOO
A revah.1ation reserve may be used to pay up u nissued shares to issu e as bonus shares.
·amp] l 00 OOO o,r dinary sha_r, s o f 1.00 made into 400 OOO ordinaty shar~ of
generally interchangeable. Stock is made
up of bundles of shares that may be traded $0.25 , ach
i,n fracti,ona,I amounts. Shares may on:ly • cane l bar tnat hav not y t b n taken up
be t raded in bundles of $1 . So stock cou ld • convert paid up shar into stock
be traded 'for $78 .90 or $23 .45: Whereas • reconvert stock into sbar,es.
shar€s can onlly be traded in mu'ltiples or$ L
The control of the company does not change; The control of the company does not change; 1
,it remains with the exrsting sharehol:ders tt rema,tns with ·t he exis ting shareholders
Spedfied price is ,usua lly cheaper th an present No charge to share holders
1
The cotnpany n1ade a righ ts issue of o ne new sha1~ for every four .shares aJready hcld at
a pdc,e o f $·l. 2 5. AU .shareho ld ers took up ·t heir righ'lS an d monies due were paid.
Requh ·ed
Redraft the statement ,o f financial posidon after the rights issue has b en
compl ted .
Gahir own"' -o,o ,ordin ary shares in Ard le pk. After tb lights issu has be n
c0111pleted, cakulat,e
i the tota] nun1ber of ordi.nary shares owned by Ga bir
ii the price paid by Ga.hir for her new sh at"es.
252
25.12 Rij ghts, issues and bonus issues ,of shares
Answer
Atdele pie
Statement of fin an cia I position after the rights issue
s
Tota I assets 4487 SOO
EQUITY
Ordinary shares of $0 .50 each 3 12 5000
Share premium 937 500
Heta in ed eam ~ng s 425 000
Tota I equity 4487 500
Gahit nov,r owns 625 ordinary shares. She paid $156.25 for the new shan~s.
Shar,e holders w·bo do :not wish to e.'X,ercise their rights may .sell their righis. The effect
of a rights issue on ai S1ate:rnent of financia] poshion is xacdy th ame a 'th effec1s
of a 'normaP issue to, th eneraJ pubHc.
You cans that over th year th ordinary shat· capital ha ~ rcn'llained unchang d,
"rhcrcas the asset base of the company has incrcas d with r utin d rev nue reserv
and ,capital reserves.
The d.iir,ectors maiy redress this imbalance, if the shareholders agree1 by transfe·r ring
so1.ne o f the ba lances o n reserve accounts t·o the ordinary share capital account.
Again >the process is faidy straightforward:
De bit the rese rve(s) account Credit t he .sh a.re cap.it a I account
The foUowing su1n 1nartsed statement of fina ncial position is given for Blazet pk:
$
Tot a I assets 13000
EQUITY
Ordinary sha1re capitail 4,000
Share premiu,m account 2000
Retarned earnings 7000
Tota l equity 1,3 OOO
2S3
ED The financial statements of limited compan ies
A bonus issue is .r.1.1ade on the basis of one ne\V share for every share already held.
It is th clirt=ctors' policy to nu.inta in r ·erves in their most He: ibl fornl,
R quii· d
Prepare· a su,nrnari.sed statement of financial position after the bonus irsu· has n
oon1pl etc-d.
Answer
Blazet pie
The jnformation mlatirngi to 'ma~ntaiirn~ng1 Summarised sta't ement of financial position after completion of the bonus issue
the reserves in thek most fl e,,a ble farm ' $
me-ans 1hat capital reserves should be Tota I assets 13000
used be-fore using revenue r,eserves for EQUITY
an issue of bonus shares. s~nce ca1pital Ord:inary share capha I
1
8,000
reserves have a m ud1 more, restf1icted use
Reta~ned earn·ings 5000
than r,evenue r~serves.
Tota I equity 13000
Notk th.at th bar p:r~m1un1 account has been fu]]y us, cl and th renutinder of tb
· su has com from 'tht! r ta ined earninjS.
254
25. 14 Statements of cash flo,ws
• 1"angible nonacu1·t·ent assets: these ate assets that can be een and touched -
examp]es would include land and building , plant and nu.chin ~y, n>.."tu~ and
6 ning 1 vehides; etc.
• Inv tn1 nt , Hke O'Eb -r a ES, should valued at cost. (Rem,e mber th1t thes
invcstm,ents are ]ong term, Le. invested. .for :mor,e than one y,ear. If the investment
was for .~css than one year then it \vou]d be dassi6ed as a currcn:t asset.)
25.13.3 Liabilities
Liabilities are classified according to, when paymient is due.
• Non-c.u1·1· nt liabilitie faU due for repayment in mor that1 one financial year.
Tb e c,o uld indud debenrur s, n1ortgag long-tem1 bank loans.
i
• Ctirrent liabilid--- w,ould indud ~ trade payabJ s a·nd other payables (e.g. current
taxaiion due, accni..,d expenses, etc).
Hquidarton.
These tbree statcnrents taken togcthe1\ s how sun1n1aries o f 11:1.ost of the ftn.andal
infonnation requh-ed by the users o f accounting information.
2SS
ED The financial statements of limited compan ies
The statement of cash flows takes information from a valiety of sources to show an
overall picture of th monie fio,ving into, and out of th~ busin s during the nna:ndaJ
year. The tatement cone ntnl't on liquidity and may e..irp,lain w·hy, for !'ampl , a
b usin s may need a bank overdraft in a year when profirts w,e re buoyant.
E'ven though srna]] con-:tpanies, sol,e traders and partnerships do not have to
pr,o duoc a tatem.ent of cash flows. they may nnd that it is in their bt!st interests
to prepare o ne.
Changes in cash held b~r a business over the period of a yea 1· are not the sanle as
Cash equivalents are short-te rm highly
the pro fits generated by the business over the year. A business could have a p ositive
l!rq u id 1in vestments t hat are c:onve rti bile
iinto cas h without notice. They ha,ve less bank ba1ance at the sta1't of a year, n1ake a profit over the year> yet end the year with
t han t nree months to run w he n acqu ired. a ba nk overdraft A business could in1prove its bank baJance over the course of a
Ove,drafts repay.able in l ess than three year, yet have inturred a ]oss. How can 1his be so?
months are ded ucted from cash eq:u ivailemts.
[i,e re are four examples ,o f tran sactions u ndettaken by a business and th e resu ldng
ff~cts on profits a nd ,e a sh.
I Profit I Cash
11 Purchase of goods for iresa,le for cash $200 No effect Reduce $200
2 Purchase of goods for resa le on credit $300 No effect No effect
3 Sa le of goods (which cost$ 150) for casn for $400
1
l'ncreas~ $2 50- lncrea,se $400
4 Sale of goods (which cost $250) on credit $600 Inc rnase $3 5Q, No effect
Sonie exan1ples of tra.nsaotions that will reduce cash balances in a business but that
would not affect profits:
Some exatnp]e-S of transactions that wouJd increase the cash balances but that wo u]d
not affect profits:
Sole trader Limited company
Cap it.a I introduced
lssu e of shares a nd/ar debentures
Sale of r,o n-cu rrent assets Saile of non-current assets
Tax retunds
S0n1e examples o f transaotions ihat vrou[d reduce profits (or increase losses) in a
business but that would not affect cash:
Sole trader Limited company
lncrease in provision for depreciation
1
256
25. 15 The calcu fat ions
Some ,e xamples of transactions chat would increase profits (or decrease Josses) in
busine s but that would no'£ affect ea h~
Sole trader Limited company
Decrease in provision for depreciatJon Decrease in provision for depredation
Decrease in provision fo,r doubtfu~ debts Decrease in provision fo r doubtfu debts
11
Profit on sale of ri on-cu rrE:! n,t assets ProfLt on sale! of ri on-curr@nt assets
It is important that you undetm:and the dear distinction bemreen cash flows a nd profits.
Nohinar pie
Statements of financial position
at 31 March 2015 at 31 March 2014
$000 $000 $000 5000
ASSETS
Non-current assets
Premises 11377 7 065
less Dep reci~ t~on (3 967) 7 410 (3 112.) 3953
Mach inery at cost 441 3 3789
Less De prec iation, (1 736) 2677 {1 351) 2438
Vehioles at cost 1657 1657
Less Depredat ion, (11 76) 48 1 (763) 894
10 568 7285
Current assets
Inventory 918 734
Trade receiva btes 323 330
Cash and -cash equiv.a'lents 145 1112
1386 11'76
Tota I assets 11' 954 8 461
EQUITY AND LIABILITIES
Equity
Orchn ~HY shares 3850 2 570
Sha,re 'Premium 2375 11735
Retained ea,rnings 4 739 3235
10 964 7 540
Cutrent Ii a bi Iities
Trade p_a,yables 338 312,
Tax liabil'ities 652 609
ggo 92 1
Total equity and liabilities , ,, g54- 8 46 1
257
ED The financial statements of limited compan ies
Note
No interim dwid 1ids have be\;n p~id during the year.
There hav b en no disposals of non-current a s ts during they ·ar.
R qui1· d
'Pre pare a statetn n t identify·ing cash inflows and outflows during the year ended 31
.March 201.5.
Workings
Each ca]culation is done in turn , identif\rmg the cash inflow or cash outflow. We
are going to systen1aticaUy consider each item and crnnpare the figut'eS fron1 t he
state1nent of financial p osition at the start of the year and the figures fron1 the
statement at the end o f the year. Any diffet-ence between the two figu res w iU be
because of a 1novetnent of cash (with on e notable exception). Thus we 'WiU identify
any cash inflows m outflovvs. The sun1lnal'Y appears art the end when aU the
ca1ou]ations hav,e been con1p[eted.
Pre:01ises on the first da}'~ of the financial year cost $706- ,ooo; ,o n the last day of the
:financial year che ngure had risen to $11377000. Nohinar pk .m ust ha¥e purchased
additional premis during tht: year at a cost off $4 312 000'. Th purchase of tht:se
additional premi ~es must ha, entail d cash beblg sp nt by Nohinar.
Ragesh is a tl"ader who deals on1y in cash tl"ansaction s. Du ring one particular week,
Ragesh drives his van lo a local m anufacturer and purchases sp orts shoes costting $400;
he sells then1 during the week fo r $600.
He prepares an incon1e sra1en1e nt for the week:
s
Sa les 600
Less Purchases (400)
Fuel costs f o·r va·n (35)
Profit for the week 165
s
,lin !ome from saJes 600
Less Paym em for sports shoes (40 0)
Paym em for f ue~ (35)
Cash in'fl'owfor t he week 165
Rag,e sh's cash inflow and his profit for the w eek are the san1e~Ho~rever, as a
student of a ccounting you ar,e able 10 explain to Ragesb that the 'tnatt:hing~,o oncept
requires hi,n to, indude the "Vafue pfaced on the use of assets used to generate p t-oftt.
H, shou]d indude in bis incom tatement an a1nount for the us of his van (i.e.
d predation on his van). You sugg t $20.
258
25. 15 The calcu fat ions
$
Sal'es 600
less Purchases (400)
Fuel costs for van (35)
Depreef atlon of vao (20}
Profit for the w eek 145
Ragesh's profit for the week no longer n1atche.s his cash flow. How can we reconcile
the tvvo figures?
We can do that by adding the depeecfatio n charge to the profit figure calculated in the
incon1e st:aternent:
So, in ordc,r ro calculate any cash flows for the year~ dcprceiation charg<,;;S should lbe
added to the profit for the year (,or deducted fro,n any loss for the year).
Depreciation of p1·e mises at the stan of the yea.1· was j .3 112 OOO; at the end of
the yeaF it is $3 967 OOO. The charge f()(' the year was 855 000.
Although this is not really a cash inflow, it is treated as though it were, ;ust as we
did with Ragesh.
Cash ~nf~ow~$855 OOO
The depredation ch~uge to the inco:rne staten1ent for th e other two non-cun ent assets
shouJd be treated in the san1e way. Add to cash inflow:
Depreciation of vehicles: $41.3 OOO
De,pfeda ti on of machinery: $385000
)lachi:n ry purchas cl durin they ar amount, d ,o 624000. WouJd this cause cash
to How into th bu ~in~s ,o r to, tl,ow 011.it of the busincs ? It is a ,cash oudlo,v.
Ca,sh outflow. $624000
Ther,e has been no change in the valu of v hicles held by the business ,o ver the
fina ncial year. So, as far as we can tell fron1 the two staten1ents of finandaJ position,
no purchases or sales of veh icles have ta ken place.
D uring the finanda] year inve ntories have increased by 184000. Jn O t".der to
increase inventories a cash outflow needed to take pJace.
Cash out fl ow: $184 OOO
Trade receivables a t the start of the financial year were t3.3 0000. At the end of the
fina ncial yeaI the amount owed Vto-as 323 OOO I so trade re,ccivabl,e s have faUen by
$7rQOO. Th is is because of a net cash inflov.-:
Cash .inflow~$7 000
The next ite1n1 cash and cash equivale nts, is overJ ooked at the rnoment, becau s~
·i to "plain why· d1e1 is a chang,e in the baJanc,
w~ are 'trying to atnass infonnaciom
over the financial year.
Tt·ad · payabl · at th start of th financial year ~rer 0'1.'ed $312000. One year lat r, they
were ,owed $338000. They have inct'fCa'.Sed by S26000. This increase in trade payables can
be used to finance the co1npanys acdvittes and is therefore treated as an i.nf]ow of cash.
Cash inflow~ $26 OOO
2S9
ED The financial statements of limited compan ies
We can see th~1c at the ,e nd of the nnandal year Nohinar pk o~red Ebe tax authodties
6-2 OOO. This a.n1ount has e n enter d in the co1npany .s incotnt: stat ,nent for
th y, ar - it has reduc, d this year' r mined ,e arnmg but it will not be paid to th
·tax authoriti for son1 tiin~ y c (this is why it app ars as a curr nt )fabiJity). It has
reduced the profit for the year but it bas not as yet become ~. cash outflow. This
.amount noc..~s to be ~ddcd back to the profit as a cash inflow.
Cash ,i nflow: $652 OOO
In last year's ca]cufadon of cash tlows the satne adjustn1ent for taxation was 01.ade.
But last year's ta..-..:: owed "WiU have been pa id iin the year under review> so:
Cash outflow: $609000
The ordinary sl1are capital has increased by $1280000. The company has n1r-ade a
further issu e of ordina.ry shares during the yeat, bringing cash into the busin ess.
Cash 1nfl ow: $1 280 OOO
The sluu.·e pre1niuu1 has lncreased by $640000. The ne"*r fasoe of sh:ares has dea.dy
been issued at a p renliutn o f 50 c,e nts o n their nomjnal v:iLue. M,o r,e cash fio"ting into
the business:
(ash Jn flow: $640 OOO
Fin ,Uy, r -tain d ea-1·nings incr,eased by .$1504 0 0, the ainount of unapproprfa,tE;d
profit plough d back into the company.
Cash inflow: $1 504000
A sutnrnary of aU the differences would look like this~
Answer
Cash inflows Cash outflows
$000 $000
DepreciatJ.on- premises 85 S Purchase of p remrses 4312
machinery 385 machinery 624
vehicles 413 lrn:rease in inventory 184
Decrease in trade receivables 7 Tax paid 609
lnctease i,n trade payables 26
Tax owed 652
Share issu,e 1 280
1Prem ium or, share issue 640
·Profit 1 504
5762 5729
So you can see that according to our cakufations Nohinar pk received $33000
($5762 000 - $5 729000) n1ore cash tba n it spent durin g the year.
This sh ould be reflected in the cash and cash equivalent ooJance"5 held by the
,con1pany at the end of the finanda] year con1pared tto those it held at the start o f the
financial year.
$000
Net increase/(decrease) in cash and cash equivalents 33
Cash and cash eq uiva1ents at begin n,tng of the
1 1
year l 12
Cash and cash eq u·iva1ents at the end of the year
1
1145
260
25. 15 The calcu fat ions
51 Ca1sh flows show detaOs of how profits have been earned. True/Fals,e?
52 Leg1aUy, soie traders must prepare a, statem,ent of cash flows. True/False?
53 ln year 1 a1lbusjrness has a p:rovi,s~on for deprecriation of $200. In year 2 the
provis~on hS ~ncre:a,sed 10 $240. Wha1 is 1he cash flo·w resulting from the change
1
1in provi,sjon 7
54 INon-currenrt assets cost$ 5,0 OOO; ~hey naive an est~matedl lirfe of ten years.
IDepredat~on is proviided at $5000 per annum. Ha\N much cash is set aside a,s
depireda1ion 1in o rder ta rep~ace "the asse1s in t he -future? Exptain how the cash
fl rnN of ai business ~s affecte di.
5 5 A so~e trader makes drawings du1dng a year of $8900. How would these
dra\Mings be shown on a cash f~ow statement7
56 Which o·f the foUow~ng trainsactions woulld result ,n a flow of cash into a
lbusiness7
a Purchase of a machine
b Sal·e· oi a veh ide
c lncreaise i1n inventoriies
•+•• •••••••••••••••••••••••••••••••• , ••• d !Increase i1n payables
Novv try Qu tions 6 and 7. e Capital introduced in1o· a bus~ness.
Companies must send a copy of the finanda~ statements to aiU shareholders and
debenture holders. The pub!l~shed finaindal s-tatem1ents are produced ~n an abr~dg,ed
f o,rmait i11 order to protect the co.mp any.
A Hm11ted co:mpany has a legal 1identrty separate from that of its m,embers.
Shareholders have l~1m~ted l1iab~li1y. They may reoe•ve div~dends if the company i1s
p:rofEtabte and it has sufficient cash "to pay the dividend.
Directors of a c·o:mpany are no1 irts owners. The,y run the·,corn pany on beh all f of the
shaireho Id ers.
Compan1 ies raise caipi~ai by issuing shares and debentures. Debentures are not part of
the share capj ta II.
A share premium account js cr,e,aited when a company i1 ssues shares for a1 pr~ce that ~s
greater tha1n the no m1inallvaiue.
When non-current assets are 1 reva1,uedl at a p~ice that is hig:her than the canyi1ng
amount, a reva~uation reserve 1is created.
A share premium a,ccount and a revaluar1ion l '·eserve are both cap~tal reserves.
IProfits are reta ~n ed wi1thin the comipa11ny i1n the f onm of reserves.
!Revenue reserves arre tradjngi proTits that nave been 'ploughed! back' jnto the
company and may be used to pay diiV11dends . CapJtallir@se:rves arise through capital!
pro-fiits and ma1y not be used to issue dividends.
Assets sh ould be d.assified as tangible, iintangib~e and investments.
Liabilities are dassified ,nto those thait fall! due ~n less than one yeair and tho se t hat
are due to be paid in more than a year.
A bonus issue of shares m1ay be 1made from ·ei~he;r ·capirtal or revenue· reserves .
If a ,compa1ny wishes to maintain rts reserves ~n the 1most flexibJe form, it shoufd i1ssue
bonus shares from capirt:a1i reserves before using rrevenue reserves.
Statemrents of cash flows are prepared to show differences in cash and cash
equwal~nts that have taken place over a year that are not evjdent ~n the prepairation
of otl1e r parts of fin andaJstatem·ents.
AU movements of cash are shown in the statement.
Non-catSh fllows are not shown ~n the stai1ement
2611
Company financing
Hire purchase
Trade and other payables
Long-1:erm fi nanc: in g Retah, ed ea n, in gs Sha re ea pit ail
Loan ea p ital - de berrtures
Convert ib te loan stock
Long4erm ba nk loans
Leasing
Saile and Ieaseba ck
26,2
26.2 Short-t,erm interna~ financrng
of inve ntory. EOQ is a method o f finding 11:h e optimal order [eve] to n1inin1ise costs of
holding mventoty. JIT 1neans that raw n1at,a ials inventory is deUvered just before it is
needed. This again means that ho]ding Jarge an1ounts of inventoi:y is unnecessary and
that inventoly holding costs are kept to a mjninnim.
263
m Company financing
Bank Joans. rend t,o havi a r pay1nent p liod of a longer term than that ,oJ a bank
overdraft. Ov drafit faciUti s ar dep ndent on the 1nanag,ernent of a busin s~
convincing the bank that cash shortag<;S are of a temporary nature. Lo2!lns tc--nd to
require sotne more tangible fonn of security. They are often secured o n some specific
asset. The loan is taken out for an agreed length of tinle. Tihe repaynrents are usuaUy
for an agreed an1ount on specified intetva]s during the period of the Joan.
Even though a hank n1ay bold the tide to non-current assets as collateral, the loan
does not give the bank any say or rights in the everyday running o f the business.
264
26.6 Lang-term externa~ financing
}J1 these share issues ptuvide finance that can be used in whatever way tbe di.r,e ctors
fed is appropriate to the needs. of the con1pany.
We discussed the different types of shares n1ore fu]]y .in Chapter 25 'The financial
statements of Jimited cotnpanies'.
26S
mCompany financing
26.7.1 Leasing
A business 1nay ]ease non-current assets rather tha n purchase men1. Once .again, this
action \ViU con ente cash in the short tenn. However, the business doc.s not O\\oTI the
as et. The rental charge " are shown in d1e income statenlent as an expense.
266
Interpretation and analysis
of financial data
By the end of this chapter you s hould be
able to:
• identirfy 1he users of tinaindal rinformation
and be aware of the Jnformrati10n they
woulld find useful
• exp!ajn why ra1ri-os are used as a
perfom,iance tnd1cator
• cat,ru,llate aind i,rrterpret prof~taibi~ ify ra11io s
• cakula1te and interpret liquidity rat~os
• assess 1he advarntages of using ratios as a
perionT11ance ~ nd icator
• rident~fy the Iim;tati10 ns of us~ng account~ng
infor1m,ati on as a perfonmance ~ndkator.
1
267
mInterpretation and analysis of financial data
- - - - - - - - Sbarehol®rs - - - - - -
Customers
/ ~
Suppliers
- --
Directors
I
------
- -- "' I Competitors
Banlcs
-- -
---
Researcbera
"' Sti!.?den1s
~
Tax authotitmes
--
- - - - - - Finm:ial press
What are these different gro ups of people inte rested in? With the odd exception, aU
are probably interested in the survival of the business. The exceptions 1night indude
·Con1petitors and environn1entaLgroups.
Survival of the business \\7 Hl depend on the business's ability to gene t'ate:
• profits - profitabiHty
• cash - Hquidity.
Profits are necessary for the Jong-term survival of the business and cash is needed for
its day-to-day running, in other words its short-ten11 survival
Supp~iers a.nd custome.rs May wish long-term s·urvival to ensure a sound and lasting trading
,pa,rtne rshi,p
Genera I pub Iic To gain information reg.arding the business's attitude towards
environmenta I issues1 etc.
Gov~rnment agencies f'o r tax purposes and to ensure that th~ busJness conforms to· Acts of
Pa,rliam~nt that may be re levan\ e.g. lo ng-te rm pla nning
1
Fiina,ncial press To corn me n,t a, nd report on va rio IJ$ business issues and activtties
268
27.3 Methods ,o,f anranging data for analysis purposes
%
8.8* 18.6 3.3
269
m Interpretation and analysis of financial data
2 T1· nd ai1alysis uses a base ],eve] of 100 fot the BtsE year of an~1ysis. Each
subs quent ~ar is then rt:la'Eed to, th ba e ]evel o,f 100. 1
Anders scores 28 in an accounting test. Has he done weU? \Ve cannot teU· \Ve need to
put the result in context.
If tbe tna..ximucn mark available was 30, then he has done ·-we]] .
If the tnaxi1nun1 mark was 100, he has not done too w ,eU.
If the rest of the class scored :m ore than 60 n1arks, then Anders has a poor .score.
However~ if ·t he r,est ,o f the cfa"'s scored be:]ow 20 madcs, he has don~ well.
The users of ai,ccounting information foUow sirnilar procedures to the ones that you
migh:t use,.
Managers wH] ask: irs tb~ busine s perfotn1ing better (or wors~ than 1he figures
produced in buds rts or fo r casts?'
Th :y and otbe;;r u rs ask:
• ~Is the busin ss performlng better (or worse) than ]ast year?r They compare previous
results with. the c1.u-ren.1t year's resu lts.
270
27. 5Why use ratios?
• tls the business p rfottn ing bettet (or ·w orse) than sunilar businesses?' They
compar the results ,of businesses in tthe same industrial s cEor.
• 'Is the bu iness p rforming better (or worse) than tb 6 lr av.ailabl for nationaJ
1
.Although we w iU group ratios u nder these four n1tajor headings )'OU wm not usuaUy
be asked to categorise your answers in this w.ay.
In order to calculate a nd eJ...'PJain the ratios we wiU use the foUowing financial
1
statements of Oyan Magenta, a public Un1ited company fot· the year-s 2015 and 2014.
Even though the figures rdate to a Hn:uted con1p any, the ptincip]es would apply
equaUy as weU to tbe finandaJ results of a so]e trader or a pattnel'ship.
Oya n Magenta p le
lnc.o me statement for the year ended 31 M arch
201 5 2014
$ 000 $000 $000 $000
Revenu.e 2600 2000
less Cost of sa Ies
lnvento ries no go
Pu rchases 1460 11240
1 570 11330
Invent o ri es (120) 1450 ( 11U) 1220
Gmss profit 1 150 780
less SeJ11n g and d istri b utro n costs (3 10) (140)
Admln istratio n expenses (340) (650) (180) (.320)
Prof,it from o p erat ,io ns 500 460
(debentll re interest
Fi nance costs (46) (22)
and preference dividend)
Profit before tax 454 438
Tax (145) (1 51)
Prof1it for the year attributable to 309 287
eQ u·ity holders
2711
mInterpretation and analysis of financial data
Oyan Magenta pi c
Statements of ·fi na nci a I position
at 31 March 201 S at 31 Match 2014
$000 $000 $000 sooo
ASSETS
Non-<.urrent assets at carrying am ou nt ~063 1800
Cur rent assets
Inventories 120 1110
Trade rec€ivahles 240 220
Cash and cash equiva~ents 140 500 570 900
Tota I assets 3563 2 7-00
Oyan Magenta pi c
Extract from state me nt of chang es in e quity for the ye ar ended 31 March 2015
$000
Retained earnings
Balance 1 April 20 14 595
·Profit for the ye.ar 309
904
Divi den ds pa-id (5 5)
Ballance 31 March 2015 849
272
27.6 Profitability rati,os
2015 .2014
Always s-tate the formu~ a thait you use SOO x 100 460 X 100
when ca1~cuiat1ing any ratio. - - - ~ 15.39% - - - ~ 19.21%
3249 23'95
This teUs us that for every $100 invested in the business in 2013 the business
1
earned 19.21; a y,e ar later the business earned 15.39 for every $100 invested - a
wurse result.
CouJd th,e capita] be used elsewhere to earn a greater return? Con1pare· this ratio
v.-·ith the re·Eurn in shnifar businesses.
Certainly, there has be-en a d terioration since 2014.
Gross profit
Gross margin = - - - - - - - - x 100
Re"venue
2015 2014
This shows that for e-very $100 of sa[,es, the nmrgin "ras $39.00 in 201.4·; that is~every $100
of sales earned th business $39.00 of gross profit. It then iinproved 10 $44.23· in 2015.
The rnargin will vary fro:n1 busint: to busln :ss. Busin ses with a rapid turnove
of inventory wm eneraUy havt. a knver mar in than a busin ,vith a sl
inventor}' turnover.
The change iclenti6,e d might be due 1to a decrease in the cost of goods sold \\rhile
1naint~ining selling price or it n1ay be due to a slight increase in the sclUng price
while tbe cost of goods so] d has t educed.
273
m Interpretation and analysis of financial data
27.6.3 Mark up
Mark up :is caJculated as foUows:
Gross pro6t
Mark up = - x 100
Cost of sales
2015 2014
2015 2014
This shows that, in 20141 out o f ·every $100 saJes, the business eamed S2l.90 after aJJ
op rating costs and cost of sal had lb en covered. This amount feH to $17.46 the
f oHo"'dng yc:ar. '\ Vt: ,c an look at this fro1n another angf .
This ratio teUs us that in 2014 ihe business expenses were $17.10 out of every .$100
of goods '" oid. In 2015 this an1ount sp tit on e>.,"P tue t,o,sc to $26. 77. This begs
th question: is the busin J,osing c,ontro1 as far ,as ~"P n · ar cone me d?
274
27 .7 Uquidity ratios
In ~bsolute tenns, e}.,-penses have more chain doubled yet sales have only increased
by 600/2000, i. . 30 per cent. We -c an p rhaps s why this has happ n d by
examining th detruJ of the cp nse ho wn in th incom tatenl nt.
[n 2014 s Uing and di'5tribuEion expense accounted for $7 of each $100 of ·al
revc,nue generated~ :in 2015 it rose to Sl 1.92.
[n 2014 administration costs atnounted to 9 in every $100 of sales revenue
generated; in 2014 it rose to 113.08.
Current assets
Current ratio =- - - - - - -
Gurrent liabilities
2015, 2014
500 900
- = 1.59:1 =2,95:l
314 305
275
mInterpretation and analysis of financial data
The current ratio ha faUen by around 46 per cent (1.36/2.95). It appear that in 2014
t,o o tnany r~ourc s ,,,,ter ti d up in unproducth-e asse·ts and it app a1s that in 20 l -
this -wa mor und control .
Obvious]y~ Eh greater ·tb nutnb r of years' results that ac availablf;;;~the e~rier it is
EO· identify ancl conn m1 a trend.
201 201 .·
380 790
- = 1.21:1 - = 2.59:l
314 305
The ratio fior 2014 seems rather h igh, so rather too nmny .resources are tiied up in .a
Uquid fom1 not earning profits.
The rado improved in 2015. The busin ess is stiH able to cover every $1 owed with
f 1. 21 of Uquid assets.
Once again, it iis in1rpossibie to say ~rhat is .an acceptable JeveLof ratio - sotne
bu sinesses, for examp]e sonu.e supennarkets, perform satisfactorily with a liquid ratio
of Jess than 0.5: l.
276
27.8 Effic~e ncy rati,os
Net re-Yi nu
Non-current asset turnov -
Total c rrying amo unt of non-curr tit assets
2015 2014
2 ,6 00 2000
- - ;; 0.85 titnes. : 1.11 tin1es
3063 1800
There has been less efficient use o f non-current assets in 2015. In 2014 each $1
invested earned S1.11. Investment :in n o n-current assets inct·eased by tnore than
70 per cent. However, tthe sa les revenue onJy increased by 30 per cent. There is no
indication. when the extra assets were purchased. The increase rnay be greate r in the
future \\'~he n a fun year's revenue wm be earne d .
Trade reeieiva.bles
Trade receivables turnover = X 365 days
Credit sales
2015 2014
240 220
- - x 36- =34 days -- X 365 =41 daiys
2600 2000
Not~ rb rounding of the answer. Jn 2014 the act1.m] figure c~kulat~d was 40.15 days
(diat is, 40 days 3 hours 36 minutesO. We ,ifw.ays round ·t o the next fuU day.
Re n1en1ber that the calculation wiU give us an average coUection time, It us,e s aH
trade receivables - this n1ay tuask the fact that one significant debtor is a very poor
payer while tthe other debtors pay protnpdy.
Thirty days' c t·edit is a reasonab]e yardstick 10 1Jse. So using this ineasure , in
2014 debts were o utsttanding for 41 days - perhaps a Httle too long . There was an
improveiu e nt in 2015 when debts were coUeotedl in 34 days - a week faster.
277
mInterpretation and analysis of financial data
This is aJso known as cl· ditors turnover Ol' av ,·ag paym nt period.
It m,e;;asures th avera time a lbusin~ • takes to pay it-s trad~ payabl t: s.
Trade payables
Trade payables tumover = X .365 d~ys
Credit purchases
2015 2014
169' 154
-- X 365 = 43 days -- X 365 = 46 days
I 4<50 1240
In 2014 the bustness was paying its lrade payables on avert1ge in 46 days~ a year
fa.h!l" it 'Was paying in 43 days.
The 3-day reduction. do s need investigation.
A 001nparison of th i - iv·ab] coHc tion dary and the payab[ " pa}'ment days
shows that, in both years, the trade payable ar ,o n average b ing paid more s lowly
than cash fs being received from the trade r~oeivabJcs . This is a good policy. However
care n1ust be ta ken lo ensure· that suppUers are not antagonised by belng paid too
slowly.
201:5, 2014
This shows that in 2015 Oyan Magenta soJd the in¥entory held one day faster than
in 2014.
Cost of sales
Rate of inventQtY rur nov·er = - - - - - - - -- - - - - -
Average in ventory h ]d du ring th year
20 S 2014
1450 1220
- - = 12..61 cifl'lC.S - --= 12.2 tinies
115 100
278
27 .9 Limitat~ons of using accounting information to, .assess perform.anc,e
1
Th.is shows thac in 2014 the cotnpany sold the goods held as inventory approxinuneJy
12 ti1nes during th~ year; its inventory turnover v;as faster in 2015.
279
m Interpretation and analysis of financial data
Rati as are us,ed ais a metli od of IP edonnance e;a~ ua1~on. 'Ratros' ~s the genedc term
used for true ratios, percentag,es aindl other measures.
Ratjos are only useiull jf companisons are m1ade either wjth o1her organ1isartions in the
same line of business orr w1ith prrevi:ous years' results - i.e. tre,nd analys.ts.
Rat~os can be d~Vlided i1ntc prof~tabiii~ty rat,os, t~quidny rait~os and effidency rattos.
It i1s necessary to learn 1:he formulae for rat~os and produ ce thes,e before calculatmng
the figures.
280
Absorp ion (total) cos ing
2811
m Absorption (tota I) costing
0 Activity leve]
(units o f output)
Figu re 28. 1 Total fixed costs
0 Activity Jevel
(units of output)
Figure 28.2 Unit fixed costs
You wiH recognise this classification as those itetns that n1ake up p1ime cost in the
preparation of a manufacturing account (see Chapter 32).
Short-tem1i decisjon n~aking is mainly concerned v.rith accounting for variable
,c osts.
Cost centres are usuaUy detern1ined by the type of business being considered .
A cost centre may be a depa.rtrnent, a 1nacbine or ~ person to whom costs can be
associat,ed. In your ,ooH s~ 0 1· a farg. retailer~ the primary cost centre might be each
d partmen't. In a garag . the cost c rures might 'bt: the r pair departm nt, Ehe sal s
department ,or th parts deparunent.
282
28.1 Types of cost
Cost unit is a unit of a product o:r service) co ,vhkh costs can be :Utribuc,e d - a
unit which absorbs tb~ cost oenb'les overhead ,c osts. Cost units in a coU ge n1igbt
b tu.d nts, while in th garag · repair departm,ent th, co t unit tnight b each car
b ing work,e;:d on. It could b a vehicle in a factory produdn motor vehides. I:n a
passenger transport business, a oost unit might be a passenger n1ile.
Direct costs are denned by 'th(;' Chartered Institut,c of Management Acc·ountan,ts
(Clrvl.A) as 'e"-"Penditure which can be eoonon1k:aUy- identined with .a specinc s.aleab]e
Direct mat rials co ts and direct labour
costs ca1n be. specificaHy iden,tifled w ith the cost unit'. Direct costs can be d.irecdy attributed to a unit of production, so direct
fini,shed product (or service}. costs aee always variable costs. The cost of the paper that this book is printed on is an
example of a direct materials cost. The wages of a hairdressa· .styUng your hair is
a n example o f a direct Jabaut· cost.
Prime cost is the tota,I of aU the dkect
cost:3:
Direct e:xpe11ses a.re any other costs that can be sped.ficaUy identified with the
finished product (or service). Royalties payable to the inventor of a process or design
Prime cost!!:!! Direct material cost5 + Direct
la bou r costs + Direct e>-;pe nses
1 of a product :is an exatnple ,o f a direct expense: another ex;;unple nlight be the costs
of hiring equipn1ent needed for a specific job.
1 - - - - - - - - - - - - - - - - - -Vatiable costs
0 Activity level
(units of output)
Figure 28.3 Unit variable costs
Variable costs
0 Activity leve]
(units of output)
Figure 28.4 Total variable costs
1
283
m Absorption (tota I) costing
Semi~vatiable costs
$
mi-variable costs
0 Activity leve]
(units of output)
Figure 28. 5 Semi•var.iable costs
d fixed costs
------ Stepp
(semi-flxed)
,,.
0 Activity 1eve1
(tmits of output)
Figure 28.6 Stepped fixed costs
28'4
28.2 Wage systems
Unit costs are those that can easily be identified and so allocated to a ~:pedfic unit>
for exan1pte nlaterial costs 1 labour costs and other direct oosts, \Vhen it is not possib]e
to identify material costs to .a specific unit, the costs w iU be aUocated by using fiist-in
first-out (F[FO) or weighted average cost (AVCO) n1ethods of issue (se,e Chapter 20
for a detaUed expJanation of these n1ethods).
Labour costs are gener~a]]y tnuch sitnp]er to aUocate to specific units.
The oost of ea.eh individual unit of production can be cakulated by dividing
the total costs attributed to it by the nurnber of units a.ctuaUy produced. Any partly
coinp]eted units (\vork in pt'Ogress) are converted into the ir ·e quiva]ent nuniber o.f
co1npJeted uni·ts.
285
mAbsorption (tota I) costing
.Production workers ar,e paid $6.00 per hour for a. 40-hour working week.
Each etnp]oyee is paid $240.00 per week (40 x 6.00).
Any hours wol'ked over the agreed contraotuai] requirements are general1y paid at
overtune ra.tes. TI1is is an extra paytnent above the agreed hourly rate. It cou]d be at
'dn1e and a half', that is one-and-a-half times the hourly rate ~or 'doub]e tin1e\ that
is twice the hourly rate. Overtin1e is an overhead oost unJess it is at the 1:·equest of a
customer in ordeT to speed up the completion o f a job. In such cases the 0'1"'e1'tin1e
·b econ1es part of direct wages. The ca]cu]ation is relatively straightforw~uu and
employees can caJculate fur thetnsd'\'""eS how much their w.age wUl be e~ch week.
A criticism of this forn1 of remuneration is that U can lead to staff oruy doing a
rnini1num ]evel of work during their nonna [ ,c ontractual hours so that they hav, to
oomp] te · xtra work at overtime rat .s.
Tbne rate e tnp]oyees are paid 5.0Qi per hour for a 40-hour worldng Vtreek. NonnaL
output is 20 units per hour.
High day rate employees are paid f6.00 per hour for a 40-hour working week.
They produce 2 5 units per hoi-:11r.
Required
Cakulate the u:njt costs for ea eh type of ,en1pt.oyee.
Answer
Time rate workers: 40 hours X 20 units =weekly output 800 units
So eacb unit costs $0.25 ($200-: 800 units).
1-ligh day rate ·w urkers: 40 hours x 25 units =weekly output lOOQi units
So ea eh unit costs $0 24 ($,240 7" 1. OOO units).
286
28.2 Wage systems
A worker is paid $10.00 for <..""Very batch of eight units produced. A worker produces
1S4 unhs in on panku lar w; k.
Requi, _d
Cakulat,e the v.--ages ,earned by the ,vorker for ber week's work.
Answer
She w Ul be p aid 230.00 for her week's work.
Some v..,~orkers resent the use o f straight piece wotk to caJculate their weekly incotne
since they canno t guarantee their 1take hotne pay'. To overcon1e this pr,oblen1 many
btlsinesses guarantee workers a n1inimum weekly wage.
40 hours are aUowed per week to cocnp]ete a )ob. A ~·orker takes only 35 hours. His
rate of pay is 7. 50 per hour.
·Required
Cakulate me work.~r's pay f.o,r the week.
Answer
Th v.rorker'~ pay for the week is $318.75 (= Tin1 rate $300,.0Q, 40 hou · x $7.-0 +
S!B.75 (~ ,of 5 hours >< $7.50)).
36 hours are a Uo"',.ed to con11.p]ete a job. A worker takes only 32 hours. Her L-a.t,e of
pay is $6.00 pel' hour.
Required
Cakulat the w~ork, r's pay fo,r the w k.
A nsw er
The worker's pay for the week is $,223,20.
Time rat~ j216.00 G6 hours x 6.00) + $7.20 (30.o/o of 4 ho urs x ,s.6.00)
287
mAbsorption (tota I) costing
14 hours are aUow,e d to con1plete a job. A worker oon1pletes the task in onJy
11 hours. The rate of pay i.s $8.00 pet hour.
Required
Calculate the workel.)s pay for the job.
Answer
The workeiJs pay =$130.86
Time rat 9112.00 (14 x B.00) + 818.86 (rounded) (11/l4ths of 3 x $8.00)
The foUoV¥'1ng inforn1atl,011 is availabl. for the month of January 2015 for Chaudhry
and on. a manufacturing bu in • Th business p,r od uc s one product, a 'big]e'.
Production for January 2015 was 1000 higlcs and the costs inv,oivcd were:
$
Direct :labour costs 78000
Direct m,ateria I costs 56000
Indirect .labour costs 34000
Indirect material costs 17000
Other indirect costs 26000
Sel'ling, and di,stribution costs 46000
Admin,istrat~on expenses 62000
Manufacturing royalties 2000-
Deprec iati on of factory ma.d, inery 1·4 OOO-
Requi1· d
Prepare an absorption costing stat,e-n1 ·nt for the· m,onth of January- 2015.
Cakulate the cost of pr,o ducing one higle, us ing an absorpt ion costing basis.
288
28.SOverheads
An swer
a Absorption costing sta tern e nt ·fo r January 2015
$
Dkect materiaIs 56000
D'irect labour 78000
Royalrties 2000
Prime cost 136000
lindk ect materia,ls 17 OOO
lndi:rect ~abour 34000
Other indfrect costs 26000
Dep rec iaho n 14000
Tota I, p rodut t jon cost 227 OOO
SeUing and distl!'1ibutto-n costs 46000
Ad mi nistra,t ion costs 62000
Total cost 335 OOO
1 On an absorption costln ba is, each hi.gJ ha oost $335.00 (= 533- o,oo,+ 1 OOO).
289
m Absorption (tota I) costing
appUes to, the business .as a wh0Je·1 each cost centre s hould bear sorne part of the
Apportionment of overheads is the
total cost of providing the s~t\.ic~.
process by which so me overhead costs aire
charged to cost centres on some ratio na I Cost centres that are a,ctivi ly involv, d in the production proc ·will 'b au
oca.t d ~
basis becaiuse they cannot be d irectly mainly, with dir · t costs - th~r is no need for apportionm nt in uch cas but they
a,ttriibuted to a partic,ular cost cen,tre. shou]d a]so be charged '1t.rith other appropriate indirect costs.
These are usuaUy costs ,vhkh apply to the busin ss as a whole. They need to, be
apportioned on son1e equitable basis. Apportionn1ent wiU be based on managet·s'
When a Iii overhead costs have been p-ercepcion of tbe benefits that each individual cost centre receives from the provision
app o rti one d to a cost centre, the tot a I of the service.
has to be charged to specific u111iits of
Considet the foUo~dng scenario.
p:rod uction. Th is process is kn own as
a bsor pti on.
Ivor can very easily pr·e pare an absorption costing statement s ince an
the costs go
'loward.s manufacturing the toothbrushes. He can use the statement to caku late his
profits and be ,can ,even us , it to, v.ro,r k out his pcidng strategy.
..~ rer a c:,o upJ of succ sfuJ y a r:s~I·fa.rry·, y now a skill d brush mak r, suggests that
·tb ry shouJ d div sify into al o pro .)udng liairl,ru "b s. Jvor agre ~ chat this 'W·O uld b
an e:xooU nt idea. ln thu smaller of the nvo ren:ccd units, Ivor continu s ·to, produce
1oothbrushcsj while in the large r unit Hany produces haitibrushes.
How would Ivor determine the costs involved in produd ng the two different types o f
brushes?
He can easily aHocate the direct costs to each product, since ]abour costs >and
material costs, are unique to each product.
The problen1 arises when rent~ ]ocaJ taxe.s, uti]ity charges and othe1 overheads have
to be charged to Ebe two products. These are costs that app]y to the business as a
,\,~hole. They need to be appor1tioned in so1ne equitable in.armer.
~eating1and lighting Volume of cost amtr~ (if this is not availab le th~n floor airea may be used)
IDep red ation Cost or book va lue of the asset jn, cost centre
Canteen Numbers of personne I in each cost centre
Personnel Numbers of personne I in ea.ch cost centre
Additional buorinarion
Reqwit"Cd
Prepare an overhead analysis sheet for Febnliary.
Answer
Total cost Basis of DeptA Dept 8
Overhead
s apportionment s· s
Rent 375000 Floor area, 9·3750 281250
Local taxes 90000 Floor area, 22500 67500
Power 300000 kWh 180000 120000
Su,perviso,ry wages 96000 Number of workers 72000 24000
Dep red at ion of machi,ne ry 150000 Cost of machinery 50,000 100000
~········································
Now try Question 4. 1 O11 OOO 418250 592 750
Thlerity· Ltd has thr,e e production deparhn nts. The company operat, s s caff cant,een
fo,r all staff. The foUo"ring budg~ cost information is given ajier aU co ts have · n
aUo ated or apportion d to the· appropri:at,~ department
2911
m Absorption (tota I) costing
$
Department ,D 412000
Department IE 346000
Department F' 110000
Carrteen 63000
Requ:i:r ed
Prepare a table showing the appot1iontnent o f canteen overheads to the production
deparunents.
Answer
Not
C:an you gu hov,l the cant n oo! · have been apportioned? What information wa
nlissing in the question?
The inforniadon that was 111.issing was tbe nun1bet·s of peop]e working in each
departtnent. There ~vere ten workers in Deparunent D; eight in Deparnnent E; tht-ee
in Depan1nent F.
•••••••••••••••••••••••••••••••••••••••••
Now try Question 5. Do not worry - the ·inforn1ation will be given in any question you nee<l. to answrer.
The cost accountant o f ()xjan L1td provides. the f o]lowing infonna1tion on budgeted
'total departmental costs after aU costs have been aUocated or appotdo n ed:
292
28.8 The absorption of overheads1
Requit-ed
Prepare a stat m nt to show how the c,o ts of th service d<.;partments at,
reappordonc d b~tween th production departments.
Answer
Production departments Service d~partments
M N p Q R
$ $ $ $ $
Total costs 45000 60000 20000 10000 12 OOO
Apportionment of Dept R costs 2400 1200 3600 4800 (12 OOO)
47400 61200 23600 14800
Note
Depanment R has now been e lhninat,e d .
Always start with the service deparhnent with the greater ,c osts.
From above: 47400 61200 23600 14800
Ap porti onrne:n t of Dept Q costs 5920 4440 2960 (1 4800) 1480
53320 65640 26560 1480
Direct labour hou rs per unit is the 28.8.1 !Direct labour hour rate
number of hours (or pa,rt of an hour) that a \l:'hen a p:anrtkubr deparunent is labour intensive and there is ]inle n-1ad1inery 1,11sed or
worker would take to produce one unit of 1nachine costs are low, the overhead absorption rate n1ay be cakulated using the n1an
output
hours requwed to complete each unit of production.
Cul a
1
10000 2
Ginar 8000 ,,.5
293
m Absorption (tota I) costing
Answer
Total direct Jabour ho urs "= 20000 + 12 OOO = 32 OOO
. $75840
Labour hou 1· overhead absorption rate :;::: = 2.37 per hou r
32000
Overhead a bsorption rate for each unit: c ula = 4.74 (2 hours X $2.37)
gin ar = $3.56 (1~ houts X $2.37)
If the budgets are tnet, then the tota] overheads wUJ be absorbed as foUows:
s
10 OOO un,its of cu!a wi Iii absorb 47400 (10 OOO X $4. 74)
8 OOO ,units of gi.na,r wUI abso~b 28 440 (8 OOOx $3. 55'5)
Total overheads absor1bed 75840
You n1ay find that the t\vo subtota]s calculated above are referred to as the 01te rhead
••••••••••••••••••••••••••••••••••••••••• reco, rery 1'.'ates. So, in the tnonth of October the to ta l overheads $75840 will be
> Now tty Question 7. recovere d by culas 47 400 and by ginars $28 440.
Tryndra Ltd tnanufa.ctur s ·derEins> and 'ghUos'. The budg t d production for each
product for F<;;!bruary ; .. shown:
Answer
Total machine hour : 2000 + 5000 =7000
. . $66780
Machine ho,t u ,overhead absorpuon rat~= = S9.S4 t;;lf hour
7000 1
294
28.8 The absorption of overheads1
$
4 OOO ,units of derti.n wiill absorb 19 080 (4 OOO X $4. 77)
20 OOO units of ghiil o will absorb 47 700 (20 OOO x $2.385)
66780
..... •••••• •...... •. ••••, ...... ••••• ••••+• •... The total overheads in February wUl lbe recovered partly by sates of denin. ($19080)
Now t ry Q uest ion 8. and partly by sale.s of gbi]os ( 47700).
There are four other possible ways of ca]cubting the overhead recovery rate.
TotaJ over'h.eads for April arc estimated to be $283 992. Tota] dit-cct labour c,o sts are
escimated to be $151060i.
Requb.""ed
Cakulate the overhead recovery rate for April using the direct labour cost n1ettbod.
Answer
_ . = .,0 1.88 per ~t: 1 o f d'
Overh ead recovery rate = $283992 . 1.rect 1.i a b our co51:.
151o60
Total overheads for Decefflber are estilnated to be $1954170. Tot-al [nateda] costs are
estimat,e d to be $502 350.
RequiL-ed
Ca]rulate the overhead recovery rate for Deceu1ber using the direct materia] cost
n1ethod.
Answer
0'1".f:th ad riecov ry rat~ =$1954170, =$3. 9 per $1 of dbit!
.1
t
.
matertal u d
$5023~0
295
mAbsorption (tota I) costing
TDt3 l ov.e-rheads for JuJy are est:itnate d to be $1355 500. Prime cost is estitnated to be
f412000.
Required
Cakulate the overhead recovery rate for Ju]y using the pdn1e cost n1ethod.
Answer
1355500
. -~.., rate = f.412000 - $3 . 29 per 1 of pdme cost
0¥e:rhead recoVPnT
Total overheads for May are estin1a1:ed to be $15 500. Th e 'total number o f units
produced is es1:in1ated to be 14 500.
Requir ed
Cakulate the overhead recovery rate for Mary using the cost un it cnetbod .
Answer
1-500
OVerheadl r covery rate = 14500 =$1.07 p r unit
Job--:•• Prhue costs _ ____,.,. ,._ Propor tion of overheads ---i.-.... Propot1ion of overheads--•··- etc.
nunl Department l fron1 Department 2
- ~-- Total ~1 of product + Mark up = lUng pnc
Figure 28.J Products passing through departments
296
28. l OOver absorption and under absorption of overheads 1
Yves Pichot manufactures tdesirs.'. Ea,ch desir pass through two, departn1e nts ,o n its
path to comp} tion.
'fnfom1ation for each departtnent is giv~n:
A des i1' spends four hours passing through DepMtn1ent 1 and three hours passing
through Depa.runent .2 before compledon.
Requil-ed
a Cakulate the overhead absorption rat,e for a destr for each departn1ent using:
i labour hours
i i machine hours.
tat~ which m ·t hod of overl'lt:-ad ~ cove1y hou[d b~ us, din the tvto de partme nts.
Givt:! rea ons for your a rui.~, r.
c Calcu]at the tota] ov rheads ·t o b abso, cl by one unit of d ~ir if budgets arc met.
Answer
a
Department 1: OAR using labour hours - $8.40 ($40 320 -i- 4800)
OAR using machine hours = $1.34,40 ($40 320.;. 300)
297
mAbsorption (tota I) costing
Jf activity ]eveJs are tbe same as those budgeEed, but actual spending is Jess than
that budgeted, th this too, wiU tn an less spending on overlteads. There wm b an
over r covery of ov rh ads.
Any under recov ·ry of overb ads is debited ·t o th , costing incotne tat~1nent.
Any over recovery of overheads is credited to th costing income statem.ent
Bartasil Ltd n1a nufacn1res <kityos'. The directors budget for overhead expenditure of
i2s OOO, each tnonth. Th is figure is based on an output of 5000 k.ityos. The overhead
absorption rate is $5.00 per unit~
The foUowing infonnation is given:
R @q u ir.ed
Cakulate the over or u nder recovery rate for each of ·t he six months.
Answer
Actual expenditure Overheads recovel"ed Over/ under recovery
on overheads
s s s
January 24000 25 ·0 00 1·000 over recovery
February 25000 24500 500 under recovery
Ma1rch 25000 25 500· SOO over recovery
April 25 100 25 ·000 100 under recovery
1May 28050 25 500 2550 under recove·ry
June 26000 25 500 500 under recovery
These costs are reco,..-:ered through the n1ark&up added to the goods before they are
so]d to the fin~] custo,m er.
Tbes CO·S ts are treat d a p siiod co ts and as such ar entered in the incotn
stat~mr.:ot a. we have done on previou occa ions in this book.
298
28.13 Absorption costing and IAS 2
personnel depan,nent if ,e ither bas a direcl input into tb~ running o,f the production
departmuent
.M anagers can use whatever ba.s is tbey Uke when produdng financial sta.temuents for
intema1 tnanagernent use) since IAS 2 does not apply.
299
mAbsorption (tota I) costing
Alloca1ion of expendfture i1s used when 1he cost is 1incurred for a specrfic cos1 centre.
Expend~tur,e tha1t cannot be a1Uoca1ted is apportioned to the cost centres, uslng1 some
equ~tabfie ba1s1is.
Service costs are apport~ on ed to p rodu cti1on cost centres.
In the case oi redprocal servkes., c,osts shoutd be apportioned by the el~m1ination method.
The ov,e rheads of cost centres are charged 1o cost units by usmng calcuiated overhead
a1bsorptron ra1tes.
Overhead absorption rates are g-eneraHy based on direct labour hours if the opera1rion
is ~abour inte1nsrrve or on1diirect maahine hours 1f "the operation is capital 1intens~ve.
1
Higher than budget,ed activity and/or lower than budgeted overhead expendrture win
resuit ~nan ov,er recovery of overheads.
Lower than budgeted actirvrty and~or higher than budgeted overhead e:>qJendjture w~II
result in an under recovery of overheads.
300
Marginal costing
3011
m Marginal costing
W'e saw 111 Chaptet 28 't hat the Cota] cost of a pr,o duct w,as 1nad up of variable
oo,sts ph.lS fix d costs.
W also, know that n ·ed. ,c osts or p nod co , ar not affect ad by chan sin the
nun1ber of units produc d. Therefore, if th nt11nber o,f units product::d is increased,
then only the variable cost part ,o f total cost wou ld increase.
Mru~gina l cost s usuaUy oomprise ex.1ra. materhd oostsi ema direct w age costs~
Margin a I costs aire th e costs th ait a re extra dii·ect e,.."Pencliture~ other extra variable oosts in seUing a nd distributing the
tncurred w hen one extra un,1i t is produced
product and any extra ad.rnin i.stration costs that adse when there is an incre-ase in the
above the pranned level·.
]evei of production.
By defin ition, an increase in p roduction (that is an increase in business activity)
Margin a I reven u s are the revenues will not increase ftxed costs - th ey w iU rem a in unchanged.
earned by the sale of one extra 'Unit.
Output in units Fixed costs Vt1ria bi e costs Total costs Marg in al costs
per uni1
$ t 5 $
100
1
5000 1 OOO 6000
101 5000 11 010 6010 10
102
1
5000 11 020 6020 10
Contribution is 't he difference between 103
1
5000 1030 603·0 10
sell irig prke and tota I variabl~ costs.
1
Contrib uti o n should more properly be Note the variable costs ,c hange in Hne with the ]evcl of production.
te.rm ed 'c.o nt rJ b1Jtion towards ffxed costs The fixed costs have not changed with the increase in the Jevel of production.
and profif, si.n ce once fixed costs ilre aU The vatiab]e costs are the nlargina] costs (in tb is sin1ple example).
cove red. co ntri b uti on becomes p rofrt
s
Th e sell,ing price of a uniit of VX/32 is 100
Vaniable costs per iJnirt- d1irect m~ter.als 27
direct l·abour 32
royalties 8
Fixed costs per u,nit 17
Requit· d
Cakul.at the contribution ,nadc by the saJc of one unit of VX/ 29.
Answer
Contribution per unit ; ; ; SeUing price per unit - Variable coSl[s per unit
= $100 - $67 ( 27 + $32 + f8)
= $33
True/False,?
4 IFiixed costs ~ Profrt = ?
302
29. 2 Marginal cost statemients
Rauk Ltd is a tnanu facnui ng business. The foUowing infonnacion refates to the year
ended 31 May 2015:
$
Direct materiars 120000
D1irect wag~s 360000
Va1ri ab1le factory overhead expenses 60000
Fixed 'factory overhead e>:lP-= nses 1110000
Vatiab'le sel11ing and distributio·n expenses 56000
Fixed se IIi ng and di·stri buti on expenses 45000
Va·riablle admin,istrative expenses 16000
~ixed adm inistrative expenses
1
38 000
Tota l sales rewm..Je 950000
1
Requl.t"e dl
Prepare a n1arginal cost staten1ent for the year e nded 31 !vlay 2015.
Answer
Rault Ltd
Marginal cost statement for··t he year ended 31 May 2015
$ s
Reven ue 950000
Less Va ria b1e costs
Di'rect materials (120000)
D·irect wages (360000)
Fa,cto ry expenses (60000)
Selting and d~s-tribution exp~ms~s (56000)
Ad'm inistrative ~xp~nises (16000) (612 OOO)
Total contribution 338000
Less Fixed costs
Factory overheads {11 0 OOO)
S·eliling and dJstribution overhead (45000)
Adm in istraitive overhead '38 OOO) (193 OOO)
Profit fur the year 145000
303
mMarginal costing
Ematn prod uces a "'ingle product Th fo Uowing informati,on relat s t,o the productio·n
and aJ of the product in Octob 1~
Answer
Emam
Marginal , ost statement for the month of October
$ $
Revenue 70000
Less Direct matel'iials1
{1 5 OOO)
Direct labou r (12000}
Royalties ('S OOO) (32 OOO)
Co.ntrfhuti on 3-8000
Less Fixed costs (20 OOO)
Profit for the month 18000
The data are th~ same as in tbe above worked example but l 001 units are produced
an.d sold .
R quit· d
Prepare an income star,e ment for Ocrob r. showing the tom] contribution and pro6t.
Answer
Emam
Income statement for·the month oi October
$ $
Revenue 70070
Less Direct materla;ls {15 015)
Di re et Jabour (12012)
Roya.lties (5005) (32 032)
Co,ntribution 38038
less Fixed costs (20000}
Profit for the month 1S038
304
29.3 The uses of marginal costing
Note
The toca] contribution has ri en by the oonttibution of the extra unit produced
and sold.
The fixed oosts have not risen \1-en though the activity ratt.: has risen.
The profit has risen by the.; ainount of the contribution gained from tbe sale of the
one ,e.'1l'a unit.
Marginal costing spUts tota] costs into its two nla ill elen:ients - fixed costs and variab]e
costs.
The identification of cont1'ibution is essentia] in this type of problau.
Fi xed costs 8
305
mMarginal costing
There is spare capacity in tl\e faeiOtjt. A retai]er :li n the USA has indicated that
sh~ would be '\\:i]Hng to purcha.s e 200 troncdls b U'Conly if the pric to h r was
35 't: ,eh.
R qui1· d
Advise the man agement of Ttu nceU whether th,ey should a,o cept tb~ order.
Answer
The order should be accepted. The o rder w tU make a positi¥e contdbution of $600
($ 3 per unit).
Workings
Contribution = SeUing price per unit - 1argin a] costs p er unit
= $35 - $32
= 83 per troncen
.N ot
The specia] order has no need to oover the fixed costs since they have already b en
absori ed into the 'no nnaP eUing prkt!.
Th American contract has none d Eo cover the fixed costs again.
The conttact is providLng th manufacturer w ith an ·tta (marginal) contribution.
\Ve ca n check to see if the acc,e ptance of the American ,c ontract does make the
business roore profitable by preparing n1argina] cost statemenis:
Not
TI1.c fix,ed co,sts have nor changoo with th incr as ~d l N" l of pr,o ducbon.
The pront bas incrG11secl by the- atn,o unt of the rotaJ contribution ,e arned by
:accepting the order frotn America.
306
1
29.4 ·Make or buy decisions
• care nlust be taken to ensure that com:np dto:rs do not match the price for their
regufar cu~1on1f::rs, thus starting a pd,o , \Vaf in which aJJ produc rs VviU suffer &001
lowet prk .
acoept,e d.
Ac hin1 ·o robHn n1anufacn1res sweatshirts in fauritius for sa] e to sports r,etaiLe:rs. The
estim ated costs and revenues for the next fina ncial year are given:
Costs and revenues per unit, based on production and sales of 140 OOO sweatshirts
s
Selhn g p r.ice 12
D1irect materials 2
D1i1rect l:abour 3
Fixed costs 4
Total productlon cost 9
Profit per SW'eat shirt 3 Tota I profit $42 0 OOO
A ,nanufacrurer i:n India has :i ndkated that du, sweatshilts could b supplied t,o Achm'l1
at a tot'al ,c ost of only $7 ,e ach. Ac.him bas caJcula.tcd th at if existing selling price is
n1aintained then profits wnl rise to $5 per sweatshirt and total profits wiU rise to
$7UOOOO next year - an increase in profits of $280000.
307
mMarginal costing
Requited.
wbt=thet, on financial grounds, he should accept th offer from the
AdVi ·e Acbin11
Indian manufacturer.
Answer
Achitn should not accept tbe ,offer. If he did, he would be worse off nCA"t year than if he
continued to n1anufaature the .sweatshirts himLSe]f. Profits would faU to only $140000.
Workings
Contribution per unit if he continues to n1anufacture hhuseU ;:: $7.UO
(SeHing price $12 .00 - Marginal (vadabJe costs) 5.00· ($2.00 + $3.00))
Contribution pef unit if he purchases &om India. = 5.00
(SeU1ng prke $12.00 - Marginal (vatiab]e cost) 7.00~.
Marginal costjng staten1ents show uhe positions c )ear]y:
Mak e Buy
s $ s
Revenue 1,680000 Revenue 1680000
.Di:rect mater,ia,!s (280000)
Di·rect labour (420000} (700000) Purchase prke (980000)
Contribut ion 980000 Contribution 700000
less Fixed costs 560000 l ess Fixed costs 560000
Profit 420000 Profit 140000
Not e
It has been assumed that any resouroes re]eased by accepting the offer from India
could not be used ,e ]sewhere by Achirn.
If the tna nufactudng space could be sublet to another tnanufacturer the incotne
received would be a source of 1narginal. re·\'"enY.e and should be added to the sales
te¥enue as atra .,ncon1e.
If extra c~"'tS had to be incu.rred in transporting the goods to the USA~ tb is would
have represent, -I a f1.lrth r nlafgina] cost.
If extra cosES w ,e rc incurred ke ping the .manufacturhig area saf~ at1d/or s 3CU:t ·;
Ehes oosts wo,u ld also repr c nt n1arginal costs and wo,uld hav to b · included in
Achhn's caJculadons.
Achim is faced ~rith the san1e detaUs given above. However, he can sublet his
manufacturing a rea at a rental of $200000.
Required
Advise Achin1 whether, on finandaJ grounds, he should accept the offer frotn India.
Answer
H, should not accept tbie off.er.
With th renta] inoom , the total contribution wouJd ris to 900000 (origina]
oontribution 87000 O· + rental incon1 $200 000), which is still less than th S9 0000
,c onuibutlon be would earn by continuing to manufacture the sweatshirts himself.
Profit Vi.<'Ou]d faU to S54JO, ,OOO colnpar d to 1420 000.
1
308
29.5 Making a choice between compatlng1 courses of action
Answer
Achin1 should not accept the Indian offer.
The conttibudon would onJy be $480 OOO con1pared to the oliginal contribution
••••••••••••••••••••••••••••••••••••••••• of $980000.
:> No rv try Question 4.
Although in each case the conttibution is positive, the new contribution \\'uuld be l,e ss
than the conrribu'tlon ,e arned if Achi,n continued to 111anufaoture the sv.,~eatshirus.
Marsha Krw: starts a s1nall furniture manufacturing business. She is only abJe to produce
one type of product She needs to choose whether to produce rabies, chab's or oupboa:rds.
She provides the foHowing ptedicted inforti1.1ation:
~
Predicted ptodudio n and sales s $ s
SeHi ng price rper wri it 400 120 380
Dkect ma1terial costs per unit sn 13 70
Direct labour costs per unit 70 '67 ,,0
Total fixed costs 50000 50000 50000
Requit""ed
Advise Marsha which pt oduct she should tnanufacture.
4
Answer
:rvi·arsha should p11oduce tab]es.
Each tabJ,e produced wiU give a positive contribution of 2S0, compared to a
contribution of $40 per chair and ,$200 p-er cupboard.
···········~···························~·
No ,v try u stion S. Check your. ans~r.er by preparing marginaJ cost sta'tements for each type of fum:iture.
309
m Marginal costing
Product
p Q R 5
Selling price per u ni,t ($} 200 300 1'00 400
M,aximum demand for product (.unns) 11OOO 800 1200 900
M·aterial usage per unit (kg) 7 12 4 15
Labour hours per un,i t 3 4 2 6
Materials cost $10.,00 per kilogran1; labour costs $15.00 per hour.
Required
Prepare a. stateinent showing the level of production for each product that would
n1axin1ise the profits for the Lavme Company jf:
on]y 25 OOO, kllognuns ,of materia]s :are availibJe
on]y 10000 labour hours are available.
Answer
p
-
Q R s
Contribution earned by each product $ $ $ $
Setling price per unit 200 300 100 400
Marginal costs per unit 111 S 1,80 70 240
Contr.i butlon per un+t 85 120
1
30 160
You can see that the LavUle Con1pany shou]d produce as niany o f pro duct Pas
possible. If there are s tlU materiaiJs ~vaiJab]e, lt sbou]d produc,e ais many of product
Sas possible; then product Q and finaJly product R.
If LaviHe could produce au produces:
t:h ey wo uId produce 1 OOO 800 1200 900
1::h is vvou Id use 7000 kg, 9600 kg 4800 kg 13 500 kg
310
29 7 Penetration or destroyer pridng
1
You can see that the LavU]e Con1pany should produce as many units of product Q
as possibie; then produce as a1any units of product P as possible, then product S
and finally product R.
lf LaviHe cou]d produce aU products:
A Japanese business nu,nufa.c tures electrical generators. The generators retail in Ja pan
at $273 per unit. The cost of producing one generator is:
s
Compo,nerrts 56
Labour costs 112
Fixed costs 32
Total costs 200
Profit 73
SeUing price in Japan
1
273
The n1anage rs wish to penetrate the Scandinavian tnarket.
31 11
m Marginal costing
The business could seU its generator .a t $1,68. Thie would ,c over the marginal costs
incurr d. The cotnpany could use this to establish the pro-duct in the candinavian
market ait th\" p1ic and b no woe off. Jf consun1 -1 Joyalty can b~, establish d in
· candinavia, eh busin ss ,nay be able to incr,e ase prio , so makln a contribution
Eov..-ards fi~ed costs and profits. n tnight also mean tbiat other products ·w ith the same
brand naolc might hav,e a coinp(;thive advantage.
The foUowing infom1atlon is given for ihe production and sales of 50000 'phnkies':
Answ er
Tota] fixed costs
; Break-even point = = $250 OOO = 19 231
. .
p1 mkles
Contribution per unit S13
Break-even sa]es revenue =19 231 X $30 == $576 930
?vlargin of safety =30 769 pimkles (50 OOO - 19 231)
Son1t.:tim s information is not given, in th~ precise \Vary tl\at W,c;; would like. ,~ema!}'~
n d to get it into, a form ·that wt:: vi.,·ould pr~fer.
312
29.8 Cost-volume-profit a1nallysis
The foUowin i:nfotmation i.s given forth production and ai.J of 2450 'hupets~.
s
Total di:rect materfal costs 56350
Tota I direct ,labour costs 4,16'50
Total fixed costs 54000
Tota l salt?s revenue 183750
Required
Cakulate.:
a the b reak-even point for h upers
the n1a l"gl n of safety.
Workings
The inforn1ation given uses tota] costs and tota] rev·enue. The break-even calculation
using this fonnula uses total fb.."ed ,c ost and contribution per unit. So it is necessary
that w ,~ work out th~ contrlbudon per unit to use in OtJr cakuh1don.
s
Direct maite,rial costs per unit 23 ($56 3 50 + 2 4,50)
D,jrect Ia:bo ur costs per unrt 17 ($41650+2450)
Totatl va 1:iai bh~ costs 40
Sa les revenue per unit 75 ($183 750 -r 2 4 50)
Answer
Total fixed costs 54 OOO
a Break-even point = - = 1543 hupers
· Contribution per unit $35
Margin of safety = Achievab]e sates - Break~even sales level
~ 2 4-5,0 - 1543
=907 bupers
act answ~ for br ak ~ n is 1542. 57 hup r ~ but w ahvay round up sine h
is usuaUy imp sibl, · to s ..upart of the unit that w,r;; are cono e1ned with.
1
The foUowing infonnatio:n is given for the production and saJes of l 500 dares'~
s
Direct material, costs per uritt 8.00
Direct labour costs per unit 13.00
Fixed costs per unit 7 .50
Se~Hng prj,ce per unit 40.00
Requit-ed
Ca]culat,e:
a th~ break-even point for dorc.s
Eht, margin of safety.
313
m Marginal costing
Workitigs
Total nxed oo~ts tnust b used but oontribu.tion pr:;r uni't is r~quired ·when using this
formula .
Tota l fixed costs =$11250 ($7.50 x 1500)
Contribution per unit= ScUing price per unit - Variab],e costs per unit
=S4o - S13 an.d $8
=$19
Answer
Tota] fixed costs f 11250
Bre:ak-even = = ~ = 593 dorcs (actuaUy 592.105)
Gonuibudon per unit -tt19 ·
Tanzeel ft!QUires a profit ,o,f SBO OOO. He suppli - the foJlowing infonnation:
$
Setli ng price ,pt!r unit 56.00
Va rJable cost5 pe r unit .j2.00
Tot al fixed costs 60000
R equired
Calculate the nun1bet· of units th at need to be so]d in order to acrueve a profit
of $80000.
Answ er
Units to be sold =Total fixed costs + tai-get profit
Contribution per unit
=$60 OOO + $80000,
$56 - S32
$140000
=-S24
--
= 5834 u nits (r,ounde-d. frorn 5833.33)
314
29.8 Cost-volume-profit a1nallysis
Tiie 1na}Ol· drawback with using the above method of determining break ,even is thai
it wHJ only work for a single product. Ob\.io·u:BJy, diff ·enc pr,oducts wm nave differ. nt
cost pa.nerns and therefore different oontriburioru to differ nt Axed costs. In order to
o r,c o1ne this probJe1n , th foUowing ,netbod can b~· u d. Howe\r r~ the method about
to be described "~U not cakulate the nu1nbcr ,o f units to be so1d in ,o rder to break c-ven.
Total conuibution
Contribution to sales (c/s) ratio :.: - - - - - - -
Tota) sales revenue
Total fixed costs
Break ven =-----------
Contdbution/s l s (c/s) ratio
Provided that the selling pric~ pc1' unit and the ,narginal co:,;s per unit do not change,
th~ contribution/sales r31tio wiU retnain ~ ed.
A s inl!p le illustration dernonstrates this:
\l:" can u " this infonnation to caJcuhn,ti break even and th total sal s l · enu
needed to achieve a partkular level of profits.
Cl ra
!l<li,o
y
=Conttibution - $ _
232400 L
=\J4.8% or 0.64
3 8 700
Total fixed co "t $150 0 Qr
Break-C\ren po,int = Contribution/sales ratio
= 0.64-8
=1231 82 sales revenue
315
m Marginal costing
Required
Calculate the sa]es revenue n ecessary to g:irve Godri Ltd a profit of $90 OOO.
Answer
. to s aJ, , .s rallo
Contn'butlon . S210 OOO x
=8400 l OO· = .:-, 2·.::n.
J 'YO
1. (O .• .)
·' 2
000
Fi.'t'.cd oosts + S90,ooo
Sa]es volunle required to give $90000 profit= Contribution/sa]e.s ratio
:Required
Graphs aire a· v1i suai aid. They must be Pl! pare a break-ev n graph for tab! ~ sho wing the b:r,e ak- v n point and th margin
accurate and ,easy to· read. ,o f afety.
316
29.8 Cost-volume-profit a1nallysis
Workings
tao · 1
The horizontal a,c ' of yo,ur ra.p h ]s used to show th sales output ln units.
The vcrticaJ a.,i.s ,o f y,o ur raph i use;; · tto how costs and r,ev<2nu .
Where the mro axes n1eet is ,caUedl the origin and denotes zc"'.fo for both a."'ICes. It
shou]d be tnarked O.
2500 (a)
2.()00
Costs
and ]500
revenues JOOO
($000)
500
Units pe:r
0 25000 50000 75000 JOOOOO year
It is important to remember that the data must be scaled e,.tenJy, othenvise the graph
that you draw wiU be diston d and v,.rm give inaccurate :r suits.
t g 2
Always give your _aph a hf..:.ading,
Break-even graph for 'fa'bJes
2500 (b)
2.000
Costs
aru:11 l500
revenues JOOO
($000)
500
Units per
0 25000 50000 75000 JOOOOO year
Stage 3
Draw in the fixed costs.
2500 (C)
2000
Co~ts
and ]500
re\·enues JOOO
($000),
500
Units per
0 2-5000 50000 75000 100000 year
Stage 4
In order to p]ot the ·v ariable costs, you need to do a few cakubcions.
The varlabl,e costs are $15 pert-able (\Vood costs + direct wages + vanab1e
manufacturing overheads + variable sales ove111ead).
0 10000 60000
.
Sales output
s s S·
Vairi,ablle costs ($15 per unit) 0 ,.soooo 900000 -
i: ixed costs 600·000 600000 600000
Tota Is costs 600000 750000 1 500000
We now mark with an x the point that indicates O on the horizontal. axis and 600000
on 1the vettical axis.
317
m Marginal costing
W'e then put an x on th point that indicates 10000 on the hodzontal axis and
7 -:o OOO on th~ verUca] axis.
W th n put an x on th point that indicat s; 6-0000 on the horizontal axi~ and
1SOO OOO on th vertical axis.
Bceak-eve111. gra·ph for tables
2500 {d>
2000
Cos.15 . Vnda.ble
and J SOO CO.'slS
.revenues 1000
{$000) Fjxed costs
500
Units per
0 25000 50000 75000 J0) OOO year
, ta :1e 5
Draw in the sal,~s revenu~ curve.
The compleE graph should ]ook like this:
Break-even graph for tables Total revenu.e
Total costs
2.500 (e
2000
Casts. . Variable
and ] 500 costs
:reve.nues 1000
($000) Fbed costs
500
Units per
0 25000 50000 75000 J(OOOO year
Stage 6
Mark on your graph che break-e,..~en point and indicate d1e lnargin o f safety.
Answer
Total r1vem1e
Break-even Total costs
2 SOO (f) B.reak-e,ven grnp·h
fot t1.!t.'b ]1?S pont~
2000
Variabte
] .500 costs
:revenues 000
( 1
($000 I
Fixed costs
500 Margm of safety
Units per
0 25000 50000 75000 100000 year
You wiH notice that fixed costs have been drawn in as a line that is paraUd to the
••••••••••••••••••••••••••••••••••••••••• horizontal (sal,e s vohnne) axis o f the graph .
Now try Question 8. An ahernative· way ta construct a graph draws Ehe ft."'(ed costs line paraHel to Ehe
variabJe cost Hne - this L kno\\<n as a co11t.1·ib\!ttion g t·aph.
318
29.9 The vaJue of ,cost-profit-volume (CPV) anaJysls as an aid to decision making
• The break-even chart assu1nes that the only faaor affecting costs and sale revenueB
is sales voium~. Costs and revenu, may be affected by:
• increa s in ,o utput
• chang{;! in eco:namk dimat
• change- in technology, etc.
• T·t is assumed that ·the cost mix ren1:ains constant but businesses ,change th~ir
c-apitalelabour rnix over an1e or as circun1stances n1ay dictate.
• There is an assu11:11ption that aU pr,o ducdon iis sold..
• The charts generaUy apply to o nly o ne produ et.
P1ofit-vo]ume graph
Profits
$
Profits,/losses
.Break-even
:point
i
o-.--,,.-~-c:po-~---~-,,.-~~--~~~~~~--~~~~~
Units of production
and sales
Losses
$
Figure 29.1 Profitfvolurne graph
Graphs:
• depkt CPV in a form that hdps n1ost pe-0plc understand the infnrmation shown
qukkiy and n1ore effectively (but do retner:nber that for dedsion-nlaking purpose.s
the use of calculations is mnuch n1ore accurate)
319
mMarginal costing
$ $
Sailes (500 0 x $20) 100000
Variable costs (5000 x $'5) (25 OOO}
Fixed costs (52 OOO)· (77000)
Profit 23000
320
29.11 Margiina l costing and IAS 2
16 State the formula used to cakulate the break-even poiint using the unit
cont1ri butJo n method.
17 IExpla~n When the con1rilbutlonlsa1les method would be used to find the
break-even pomnt.
18 Ano~her name for brea1k-ev,en ~s marg~n of safefy. true/False?
19 IBrea,k-even output= 7 500 unirts; totai productjon = 10000 un~ts. Wha1 js the
1m1argfr11of safety in un~ts7
20 A graph shou~d be us,ed where poss~ble to find t he break•eveni point since l1 is
the mos1 accurate of the me1hods. True/False?
21 Give another name, for break-even analysis.
a•••••••••••••••••••••••••••••••••••••••• 22 !Explain 1jhe 1erm 'sensitivity anaJys~:s'.
Now t ry Qu stions 9- 14. 23 l nventoiri1es cannot be vallued using marg1ina~ cost techniques. TrueliFa,lse?
Find~ng the break-even po~nt by grapnka~ me,ans is usefut but it is time consum~ng1
and so ma1y not be required rin a question. However, you should be able to extract
data f rom a graph.
Forecast profit js dependent on the accurracy of predkted data. Sensit~vity anallysis
c:onsiders the degree of change necessary in the data that wiU result in a loss adsing1.
32 11
Unit, job and batch costing
A n-1ethod of costing is designed to meet the needs of the business using it.
There are two n1a in types of coUecting financial infonnado n to be used when
Ai this point in your .studies, you needl to costing products or servke.s. These a.re~
c:oncen1ria1te on~ on job. un~t and batch • job costing
cosiing. • process costing.
Managers adapt these two n1ain types to suit the individ ual requiretnents of their
business. The system they e tnp]oy ~vm depend o n the type of p110duct1on process in
their factory an d the type of good a t~ service being prrn,~ided. Th e a dapta.tions ~vm
have a number of nan1es, including batch costing and ,c ontract costing.
Absorption ,c osting can be u.sed in any bus iness. The prindp]es of cost aUocation
and apportionm n t are stiJJ appH d. The type of c,o sting s,rstem used wi]) dep nd on
eh typ of busin s being cons idered.
Busb1 s activity generally faUs into one o.f tvilo, cat goti
• busin s s vthose pr,oduction proo ss is a concinuo,us ,o p ration
• those that dea] with sp cine orders.
322
30 .2 Job costing
In organisations that produce a wide range of products or jobs and where each
order is uniqu. , tht= cost of ach ord 1 n1ust I e s, paratdy ,calculated. Each job VliU
r uir differing amounts of labour, tnat rials and ,overh ads spent on it. Becau of
thi ~ s parat oo·sting records ar kept for ea,ch j;ob, detailing a]] th costs incurred in
co,npl eting the j;ob and identifying the proftt or l.oss for th job.
The job is a cost centre to which aU the costs are charged.
The costing detaUs U'HlY also be used to cost simHar future jobs and lo fonn the
basis of p reparing future quotations for jobs being considered.
It is therefore an appropriate costing S}'S1:e111 for bus inesses w hose work consists
of separate jobs, for example installers of air con ditioning units, spedaUst building
contractors> spedaHst hon1e decorators, architects a nd tailors.
Tiu1e booked in the n1achine shop f:or the job 1s 120 null chine hours .
Adtnin istration and seUing overh eads are caku]ated at 20 per cent of factory cost.
Re qu i.t--e d
Cakulate the ,c o,st of job A/341 and Ebe profit made on the jrob.
Answ er
Ovcth ad ab- orption rates (OAR):
. $18000 .
.Machine shop: .
4_.,0 00
=$4. 50 per n1achtne hour
$5000
Paint shop: -- - 2.00 per labour hour
1
2500
323
m Unit, job and batch costing
324
30.4 Calcu~ation of the vaJue of inventory
additional ,costs. The product cost wm ,c onsist of the average cost of the common
operation to , eh ieve the 'basic' dress plus the .,;pacific costs of the additionaJ changes.
The final product co t consi ts of a com' ination of proc s co ting t chniques and
iob costing technique . This ;y.stem :is r ferr,edl co as op 1·arion co ting or batch
co ting.
Answer
$29440
Cost per unit =- ... 2. 30
12,000 + 800
Closing in ven~ory = $3450.00 ( 1500 crn11p]ete units at $,2.30 each)
$1 840.00 (80 per cent of 1000 units at $2.30 each)
1
••••. •••••. •••• •• ••••. •••• •• ••••. •••••. •• Tota] \o"a]ue of clrning inventoty $5290.00
Now try Que tion 5.
325
mUnit, job and batch costing
Spedik order costing i1s used when production is desi,gned 1:0 meet a, spedfic
custome-r1s requjrements.
it is also used in the preparation of quotations for an ,ndividuai j,ob.
Batch costling 1 is used ~n production processes where many ident1 ica~ irtems. are
produced a1nd ~t would be difficult or not cost effecbve to catru,ate the, cost of each
j ndw~d ua~ nem.
The cost of partly finished goods i1s converted 1into the equivalent number ,of
completed un iits.
326
Business planning
Because of the intetdependen.cy and the cootdinadon of the budgets, 1na na ger ~
nlU!,~ comn1unicate with each oth~r when prep,adng budg~ts - ihe;r must also
oon1mu nkate th plans to staff I Jow and management abo~ .
Th nature of forecasting in an.s that d cisions hav,e to b · mad . If pro5 ts ar to
increase then decisions 11i.ust be made regarding sa les and production. levels, et,c.
Budg·e ts wiU be ,c ompared with actual resuhs . Remedial action can then be taken
when actual results are worse than budgeted resuJts. In cases where actual results
are better than those budgeted~ exan1pJes of good practice may be identified and
repeat,e d e]sewhere in the organisation.
• While budgets are beblg prepared, any Unuting. factors need to be identified .and
ta ken into account.
328
31.5 Advantages and disadvantages of using a system of budgetary control
329
Examination-style questions lhe foHowing 1ransa1ct1
ions took p1lace duning the yea1r
ended 30 April 201 S:
1 lhe foUow~ng ~nformation 1
rela1
1e:s 10,1he business of
$
Moussa:
Purch.ases 400000
at 31 July at 31 July at 31 July
Sal·es 600000
2015 2014 2013
Purchases returns 8000
s $ $
Sares returns 12000
IBan k bail.i3 n c:e 800 1 100 ~ OOO
Wages 60000
Bank loarr ,repayable 30000
in 2023 Other expenses 7S000
·1nvento ri es 7000 6500 6000 Addrtional informatjon at 3 oApril 201s~
Machinery 6SOOO 65000 48000 • ~nvento1ry was vallued at $ 91 OOO.
Premises 70000 50000 5·0000 • Trade receivabtes were $61 OOO,
Tra.de payab les 1
2700 2600 2 5001 • Trade payab~es w,e:re $43 OOO.
• Ba,nk balanc,e was $251 700.
Tra:de ,receivables 3800 420-0 4000
• Ac:orued wages amounted to $2700.
v~hid~s 1,2000 110000 10000 • Prepa,i1d expenses wer,e $3300.
Required • It was dedded that debts of $3 OOO should be· wr~tten off
a Cakullate the profit or loss -for the· years ended 311July as bad.
2014 and 31 July 20,15. 1(7]1 • loan and debenture ~nte,res1 for the year were pai1d in
b Prepare a statement of fin ancia~ posit ion at 31 Ju ly full on 30 Apr~I 2015.
20,15. [1 O]I • The provision for doubtlull debts was to be 2.5% of
c Explain why 1it might be in Moussa;s bes1 jnterests to trade rece•vab~es.
prepare a detailed ~nc:ome statement showing his profit • Depredati:on on premises was two per cent stra1igiht ~~ne.
or toss for the year. [7]1 • Depreciat ~on on equipment was 40°/o reduciing1
d idenbfy three pjece s of add irtr~on a1 ~nf ormait,ion -that (dimin~h~11g1) balance.
Moussa1would need jn order 10 prep are a, deta,1ted • A further 40 00 o ordinary shares were issued at a
fin anda1istatem-ents. [6]1 pre,mium of $0.SO in Aprjl 2015.
l[lo1ai: 3 O]I • A dirvi1dend of 7% was paid on aB ord~nary shaires iin
~ssue ait the end of February 2015.
2 The foHowing sellected ~nfor1mati1011 relates to M-endoza pk • The preference d~~dend was paiid Jn ful l.
at 30 AprU 2014: • $20000 was transferred to the Genera1l Res,erve.
$ • A provi1s1ion of $6000 for taxat1ion due ~s to be made.
lssued o rdi n,a ry shares of $1 ea eh 200000 Required
a Prepzu-,e ain ~n,c:ome stateim ent for the year ended
Issued 6% preferenc-e shares of $1 each 75000
30 Apllil 20115. [1 O]
4o/o debentures 50000
b Prepare a statem·e nt of changes in equity for the
8% bank loan repayable 2023 100000 year ended 30 Apri I .2 0·15. [1 O]
Premises at cost 350000 c Prepare· the statement of fina ndal posrti on at
Equfpment at cost 110 OOO 30 Aprill 20 15. [1 O]
Provision for depreciatio·n - premises 49000 [Tota l: 30]
- equ~pment 70400 3 Hang, Ivan aind Atlya are irn partnership, shariing profits 2:1:1
Genera I' rese,rve 62000 respectjve(y. lhe:ir partnersh~p agreement provided that:
Share premium 30000 • ~nterest at 4% per ainnum be aUowed on caplta,I account
Retained earnings 88600
balances at the start of each fina,1ndal y.eair
• Hang be aiil-owed an annual sal.ary o.f $21 OOO.
Inventory 85000
330
Examination-style questions
The partners ma~ntain only capital! a,ccoun1s. The balances c Expla11in how a prov~sion for depredat~on aiffects a
on 11August 2014 were: s1ate·ment of f~na ndal posn~ on [2]
d Explain the connect~on bet\tveen cash and 1 mak~ng a
$
prov~sion for depredat~on. (6]
~iang 80000
[Total: 15]
1
lvarn 50000
5 The f olllowing ~nformati on ~s g~ven for IBajpa n pk:
Atiya 40000
at 28 February 201 5 at 28 Febr'Uary 2014
4 The lik het manufacturing company has loose tools vatued at Required
$12 980 on 1 February 2 0 12. During the year tools costing b Cakulate Kateriina's contr~but~on as a percentage· o,f
$1780 were purchased!. At 31 January 2013 loose 1oolls sales (ds ratro). (4)
were· valued at $1 0 7 40. c Caku late Kateri1n a's break-even point. [3]
!Required d Cakula1e 1he sales in doHars necessary 10 make a
a Cakui ate the depr,eda1tion of loose tools for 1he year profit of $1 00 OOO. 14]
ended 3 1 Janua1ry 2013. [3] e Cakulate the profit or loss if sailes for the month
Additiona I information are· $375000. [4]
The company solid some out-oi-date equjpment that had f If the orjginal sai~es prices aire reduced by 5% but
cost $30 OOO. tt had been depred ated at SO% per annum costs do not cha ng·e, callculate 1he va~ ue of sales
using the 1redu dn g1ba lla nee method. needed 10 ad1i1eve a profirt of $80 OOO. [11]
11 was sold after three ye-airs of use for $3700. [Total: 30)
Require d (Cambridge lntfErnational AS and A level Accounting 9706.
b Prepare a d,sposa,~account 'for the equ1ipm1ent. [4] Paper 22 03 May/June 2010)
1
33 11
AS Leve, examination-sty1e questions
Cash and cash eq'lJivalents 4000 95000 ind kator of II~qu1 dj ty than 1he current ra'ci o. [2]
Tot aI assets 1265 OOO
[Total: 30]
(Adapted from Cambridge International AS and A level
Accounting 9706, Paper 23 Q1, MayOune 2011)
CAPITA L AND LIABILITIES
8 An extra,ct irom t he stait ement of finandal pos~ition oi Bach
Capital
ltd at 1 January 2012 is shown below:
Openin g balance 1 000000
Cost Ac.cumulated Net book
Add Profit for the year 80000
depreciation valu e
1 080 000
1
332
Examination-style questions
Depredation on machinery ris charged on a1strajght !line e (akulla,1e the revised b:reakeven point as a perceintag:e
ba1sis based on a five yeair Irie and an ,est,ma,ted residual of capa,dt~ (3]
value of 10o/o of the o-rig in al cost. f P1re·pare a marg~na~ cos1 statement to show A~rHe
It is 1he compainy pollicy to chargre a full year's depreciat~on Umiited's reyjsedl 1otall profiit ·f'or 1he year ending
in the year ,a.f purchase but none in the year of di sposa t 3O June 2O14 if 1he machri nery s purchase di.
1i I[4]
Req uire d g Advi1se the directors whe·th1er ihey should go ahead
w1ith thehr pllans. Give reasons io r your ain swer. 1(7]
a Prepare the folllow~ng ledger a,cc:ounts for the year
[Total: 30]
ended 3 1 December 20'1.2 .
(Adapted frorn Cambridge lnrernational AS and A l..evel Accou.n ting
i Mla ~nery account [5]
9706, Paper 21 03, May/June 2014)
ii Pro~si:on for depreciation of 1mach1nery account [6]
iii Madh~nery disposals ac,count. (6] 10 Asif operates a delmv,ery serv;ce and does not keep proper
b ideniirfy two al·terruitjve methods of prov•ding for accountjng records. He provjded the following iinformaition
depreda1~on. (2) for the year ended 30 June 2014.
c State th ree caus-es of depreaiat~on. [3]
Total: [22] $
(Adapted from Cambridge International AS and A Leve{ Cash in hand at 1July 20T 3 3270
Accounting 9706, Paper 21 Q2 a-c, May/June 2013)
Ca1sh in hand at 30, June 201 41
2349
9 AkHe Uimited manufactures one product. The foUowing
Ca,sh receipts and 1paym ents:
information ~s avaHab!e for the production of one uni1t of
product fo:r the year ·ending 30 June 2014. Veh ide nil!;pa ,rs 2400
Fuel paymen,ts for vehides 14301
$
Driver's wag,es 4748
Sel~ing price 32.00
Rent of a garage 1·600
Di,rect materia Is 6.50
Sundry expenses 2972
Direct labo ur 8.50
Drawings 11450
F~xed factory overheads 5.00
Receipts from sale of old vehicle 1300
Variiable factory overheads 3.00
Cash stolen by Asiif's driver 430
Fixed sei:.ling and administration ove rheads 3.50
Cash raceiwd from customers 7
Variable seUi11g and administration overheads 2.50
Required
The budgeted output ,s ·18 OOO units per year, wh1 eh
represents 75o/o of total productJon capacity. a Prepaire Asrfs cash accouint for the year ended
30 June 2014. 1(7]
Required
a (akuiate the breakeven pojnt ~n units. IS) Additional Information
b (akullate the breakeven po1nt as a percentage s
of caip adty. (3)
Trade receivables at 1 hl·ly 2013 3766
c Prepare a1marginal cost statement to show Airlire
Trade receivables at 30J une 2014 2863
Lim·ited's budgeted total profit for the year endingi
.3 0 June 2014 based on the budgeted output of 13eld debts wriitten off during the year 11 648
333
AS Leve, examination-sty1e questions
334
Examination-style questions
335
Man tac ring accounts
So far we have prepa~ the finandaJJ staten1ents of traders - businessinen .and wornen
who have bought finish,ed goods and sold thetn on to the fina] cust:on1eir. Most of the
bUJSmesses that you con1e into contact with in everyday life fail into th_
e ca1teg01y of trading
orgarusations. The c01111mon factor is that retail out1 ets buy their products frotn a
inanufacturer and seU thern on.
We have a]ready produced n1any income staten1ents. Now, w e need Eo prepare
the finandaJ stateuents of businesses that make goods that are so]d to retaUers., who
·cben seU thetn to members of ·che general public - in other wo,r ds, manufactudng
business~.
Tbest: bU,SiRt!'SS ,o rganisations pr..:pare Jnantd'actu1·ing account as part ,of ·their
int rnaJ financial statem nts. A manufacturing account shows the costs of running and
mainta irung the factory· in which a final product i mad(,;.
A manufucl!uring bus iness v.."iU aho trade by seHing its finished product to
wholesal,ers or retailers, so it wm prepare a trading atcou.n.t in its inco,n-le statement
as wen as a manu factunng account.
The overheads secrion jndudes aH O'ther revenue expend1ture for a factory that is
with a sp edfic sa,lea ble cost'.
not parE of prhne cost
The prime cos·t section of a :manufacturing account wou] d contain .aU the resourc·e~
used in the manufacturing proc~
• purcha · s of raw tnatenals
• diri; t w-ages
• royahies
• any other direct ,c osts.
The .raw tnateriaJs used in the n-}anufacturing process are not necessarily the .raw
nraterials purchased> so we have to 1nake an adjustment to the raw n1aterial purchase
figure in order to find how n1any of the raw n1ateriaJ purcb ases were acruaiUy used
during the year.
RaJph Shoernaker tnakes footwear. The f oUowing information relates to the year
ended 31 March 2015:
inventory of leather at l Aptil 2014 · 4 790
purchases of leather during the year $507')0
inventory of l ather at 31 March 201S $3 640.
Required
Cakulat~ the value of leather used to make shoes during the year nded 31 !v!arch
2015.
337
m Manufacturing accounts
Answer
s
l1nventory 1 ApMI 2014 4790
Pu rd, a.ses of Ieather S0790
S5580
less Inventory :31 Maren 2015 (3640)
Le·athe r used in pm du ct,ion 51940
havay 1nakes cakes for sa]e, to hotels and restta u rants. She provides the foHowing
infom1ation eat the year ended 30 April 2015:
inventory of :mat,e rials· it 1 May 2014 #37,6
inventory of n1aterial at 30 April 201- $297
purchas s of materials du:ring th yi ar 58748
direct 'wag $27 360; oth r wages S16 492.
Required
Prepare a staten1ent .sho"ring the prime costs for the ye-ar ended 30 April 2015.
A.nswer
Shavay
Statement showing prime costs for the year ended 30 Apri l 2015
s
Inventory of 1raw materials 1 May 2014 1
376
Purch ases of raw mate-ri a-ls
1
58748
59 124
less inventory of raw mater,ials 30 Apr-ii 20 115 (297)
Cost of raw materi aIs used 58827
Direct wages 27380
Pri·me cost 86207
.N ote
On]y the direct wages have been included. Prune cost ,o nly lists the resources direcdy
used in the production of the c.akes, i.e, the Oour, butter, sugar, etc, p]us the ·wages of
the people who actuaUy work dir,e ctly o n p:rodudng the cakes - the people who n1ix
the ingt'e dients, bake the cakes and decorate then1.
Office workers' ~vages or saJes assistants' wage.s are no t included - these people
do not work in the factoly.
338
32.3 The manufacturtng acc,ount
The foUowing list has been prepared by Bhooni .B eech; a n1anu racturer of gardel1
furniture:
Requu-ed
Identify" ,vhkh are pdme costs 1nd which are overheads.
Answer
Purch~s s of tin11b r1 scr w and nails, wood glue and \vages of asse1nbly work :rs
ca n a]] be identified as prime costs. Rent of \\rorkshop, depr:-c~fation of power saws,
p]anes, ,e tc and factor;r power a,e an
ovet11eads.
Note
OffiGe managers wages would appear in the profit a nd ]oss account of the income
stat ement, as would delivery van expenses. Bhooni's drawings would be deducted
fron1 her capitaJ on the staten1ent of finanda] position .
$
Inventory of raw materials 1 Decemb@r 2013 90000
Inventory of raw materi a Is 30 Nove mber 2 0 14 80000
Purchases of raw mate.rial~ 390000
Man ufactu ring wages 212000
Manufacturing royalties 15000
Supervisor's wages 27000
Factory rent 120000
Factory insura,nce 30000
De'Preciation of rnad,in,ery 17 500
Requ ir- d
Prepare a manufacturing account for the year nded 30 November 201 .
339
m Manufacturing accounts
Answer
Faw,ett Products
Manufacturing a,cou nt for the year ended 30 November 2014
$
Cost of material consumed
Inventory of raw materials 1 1December 2.01,3 90000
Purchases of raw rnatedals 390000
480000
less Inventory of raw materials 30 November 2014 (80000)
400000
Man ufa ctu r~ngi wages 212000
Royalties 1:sooo
Prime cost 627000
Add Factory overheads
Supervisor's wages 27000
Factory rent 120·000
Factory insuranee 30000
Depreciation - mac.hi1nery 17 500 194500
Production cost of goods completed 821 5·00
Note
• The most con1mon n1istake you can n1ake when preparing a manufacturing accoun1t
is to deduct the total overheads frotn the pniue cost Remeniber~ we are calculating
the total cost'. of manufacturing a product.
• Always label the prune cost and the cost of 1na nu facru re - these labe]s he]p to
show the high standard of your work.
The foUowing 'balances have b een extracted at 31 Decenlber 201.4 fron1 the books of
And Patel, a n1anufac nu~er of kitchen furniture:
$000
Purchases of raw materials 2 4-70
Manurfacturfng v,ages 1 380
Man ufac1:u ring roya lties 37
5up e rviso·ry wages 87
Cairriage inwards
1
.3
Factory 'Fent 60
Factory p ovver 30
01:!her factory overhea,ds 27
Deprreciation of ma ehinery 42
Dep,rec iati on of office eq u,ipm ent 13
Inventory of raw materia ls t Janua ry 2014 89
lrwentory of raw materials 3 1 Dec:ember 2014 111
340
32.4 The treatment of inventorres in a manufacturrng business
Requit-ed
Pre p are a manufactur ing acc,o unt for the· y,e ar end d 31 D, cetnber 2014, ho·w ing
prim ·c ost and cost of manufacture .
Answer
Atul Patel
Manufacturing account for ·t h e year ended 31 December 2014
$000 $000
Cost of mater ia I c.o nsu med
Inventory of ravv ma,terials 1 January 20 14 89
Purchases of raw mater,ia!s 247 0
Carriage inwards 3 2473
2 '562
Less rrwentory of raw rnate'fial s 31 December 2014 (11 1)
2451
Man ufacturi ngi wages 1380
Royailties 37
Prime cost 3 868
Add Factory overheads
Supervisory w ages 87
Factory rent 60
Factory power 30
Other factory overheads 27
Dep reci a:tion - mach ine·ry 42 246
Production cost of good s completed 4 l 1:4
Note
Office equipment is not used in the factof}t - it is an office expens·e and so should be
entered in the p rofit and loss accoo:nt o f an incom t! statem n t. Micbin~y is always
u ed in the factory. hence its mndusion in th · man ufacturing account.
341
m Manufacturing accounts
shoes; DVD players short of a few con1ponents· kitchen fumirure without doors and
handles, ,etc.
• fini. h d goods: Th are good that liav oonlpl ·ted th journey throu. h th ,
manufacturing proo ss and ar ·w aiting to br.:· old o r d spa!'tche ·t o a custon1~r.
Each type of inv:cntory appears in a different pan of the .financia] statctn,e nts. They
appear in chronological order in the fioo:ndaJ statements1 i.e. the inanufacrunng
account and the trading aocou nt of the income staten--ient.
Inventories are current assets a nd are s hown in the staten1ent o f financial position.
In the case of .a manufacturing business, the three types of inventory held have to be
identified.
We have just seen how to treat inventories of raw materials.
¥ou hare a lt-e-ady vvorked with inventoqr of finished goods - in the trading account
of an incotne s tatetnent (a business usually trades with finished goo ds).
Work in p rogress stiU has to go through the t·e1'nainder of the mianufacturing
process before it becomes a finished product~so it should appear in the
nu1Jnufacturing account. \Votk in p rogress appears after the c.ost of 111anufacture has
been cakulated.
The treatment is the satne a for aU types of inventories. ~ re add the , ..alu of w,o rk
in prog "'S at th tart of ·th p riod and deduct th valu ,o f work in progr s at th
end of tbe period.
There arc two \Va.}'"S of doing this; both are acceptable and are equa U;, 1,c;garded.
H,e rc is an exampl.e that iUustrates both methods.
Bet1ti Logg is a rna nufacturer. He provides the foUov.dng infonnadon for the year
ended 31 Ju]y 2014:
Answe r
Method 1 Method 2
$ $ $
Cost of ma nu factu re 217432 Cost of manufacture 2.1:7 432
Add Work in progress 4 698 Add Work in progress 4 698
1 August 201 3 1 August 2013
(S ubtota l) 222130 Less Work i·n progress (3 48 1) 1 217
31 July 2014
less Work in, progress (3 481 )
3 1 July 2014
Production cost of 21:8649 Production cost o·f 21' 8649
goods comp leted goods complet ed
You can Sf.; th at both m tbods i\re e:"actly the same total production ,o o ts.
Choose one n1ethod and always use it In the foUOVili.ng a"Can1ples, ,ve- us
M·c tbo d l (h is usua]}y considered to be easier),
342
32.4 The treatment of inventorres in a manufacturrng business
Laurel Choo is a mat1ufacrurer. he provid t_he :foUowing infom1ation for the year
nded 28 February 20 15:
s
lnventor,ies at 1 Mall"Cn 2014:
1
Machinery 90000
Off.ice eq1uipment 2 ~000
Royalties 7500
Other indrreclr expenses:
Factory .32600
Offi.ce 28400
Sa,les 1000000
Inventories 28 February 2015:
Raw materia~s
Work in progress 19400
1
Requh"Cd
Prepat·e:
d a m anufacturing account for the year ended 28 February 2015
l a trading account for the year ended 28 February 2015
an ,e xtract from a statetnent of financiaJ position at 28 Febniary 2015 sho\vin.g how
inventories v,.rou]d appear.
343
m Manufacturing accounts
Answer
Laureil Choo
Manufacturing account for the year ended 28 February 2016
$ $
C: ost of materia I cons,umed
Inventory of raw matena Is 1 March 201,4 116 500
255.300
less lnv~ntory of ra.w materials 28 Februa.ry 201·5 1 6000
1
239 .300
Manufacturing wages 458900
Royalties 7500
Prime cost 705700
Add Factory overheads
1
Supervisor s wages 17800
1
'879 200
less Work in progress 28 February 201 5 (1 9400)
b Laurel Choo
Trading account for the year ended 28 February 2015
$ $
R.even,ue ,, 000000
less costs of sa,lE?S
Opening inventory of fi,nisned goods 20600
880400
Less clos·in,g invento.ry of fi nished goods
1
(21350) 859050
Grt.Jss profit 140950
C Laurel Choo
Extract from statement of financial position at 28 February 2015
s
Current assets
Inventories - Raw materiars 16000
Work in progress 11 9400
Finished goods 2 1 ~50
344
32.4 The treatment of inventorres in a manufacturrng business
$
Sales 2913 502
49780
Work in p rogre~ 23640
Fin is hed 9oods 4021!0
offi.ce 21300
Insurance - factory 19170
office ~0830
Heat and lig-ht- factory 4260
office 1 830
Factory power 17 282
Req_ui1-ed
Prepare:
d a 1nanufacturing account for the year ended 31 :t\.:lay 2015
b a trading account for the year ended 3,1 May 2015.
345
m Manufacturing accounts
Answer
Mike Tong
Man u factu ring account f or the year ended 31 May 201 5
s
Cost of marmri aI corisu m~ d
lnvento.ry of raw materi a,ls 1 J,une 2014 49780
Pu rrc:h ases ofi raw m ateria Is 846289
Carriage· inwards 4 612
900681
Less .Inventory of raw materials 31 May 20 15 48340 852341
Direct wages 7501 gg
Royalties 19000
Prime cos1 1621 540
Add Facto ty ove:rhea ds~
Jn direct wages 187 442
Superv~sors' wages 68720
Rent and Ioca I taxes 48700
'Insurance 19 170
~~ati,ngi and lightin g exp~inses 4. 260
Power 17282
Othe r ind kect expenses 5 671
De predaiti on 48000 3gg 245
2020785
Add Work in progress 1 June 2014 23640
2044 42 5
Less Work in progress 31 May 20 15 (Z.O 119)
Produ ct1 on, cost o-f goods compIeted 20.24306
Mike Tong
Tradi ng a~count for the year encled 31 May 201 S
$ $
Revenue 2913 502
l.iss cost of sa.les
Jnverrto,ry of f inished goods 1 June 2014 40210
Piroduction cost of goods completed 1
2024 306
2064'516
less 'Inventory of fi n,ished g.oocfu 3 1 May 20 15 38461 2026055
G ross profit" 887447
•••••••••••••••••••••••••••••••••••••••••
Now try Que tion 2.
346
32.5 Manufacturing profit
When d1,e tnanage1s of a bush1ess transfer the Eota[ production cost to the 'tGJJding
account, gross profit is fou nd by d d ucting the ,oost of saJes (cost ,o f goods sold or
COG ) f:rom sal s rev nue. niis method d,o have a flav.r - ther is no indicati,on of
how profi tabl the factory is .
Gross p rofit in a n1anufa.c turing b usiness is cle,rivecl in tvv·o vvays:
• by manufacb.uing ef6dent1y
• by scUing the goods at a pr ice that is higher than the productio n cost.
We can dete rmine the factory rnanufactu d ng profit by finding the d ifferenoe b etween
the cost of produc tio n a nd the cost of purchasing the goods ene m a Uy.
Let us ]o ok at the manu factud ng a ccounts of LaureJ Choo a nd Mike Tong produced
in Sectio n 32.4 above.
The same nunilier of goods mad,e in Laurel's factory could be purchased by L-iu rel's
buying deparhnent for $900,000.
Requh-ed
Prepare:
a a ·tunmarised manufacturing account for the ~..ear endc;d 28 F ruary 2015 shOW"lng
the ma nufacturing profit
b the trading account for the year ended 28 f'c-hn1ary 2015.
Answer
a Laure[
Summarised manufac1u ring account for the year ended 2 8 February 2015
s
Prim-e cost 705 700
Add Overheads 155300
Add Work in progress 1 March 2014 182()0
879200
Less Work tri progress 28 Febrt1ary 201 5 (1' 9400)
Product,ion,cost of goods completed 859 800
Manuf acturi,ng profit 40200
Transfer p,riCE! to income statemElnt goo oao,
h Laurel
Trading account for the year ended 28 February 2015
$ $
Revenue 1000000
Less cost of saies
Inventory of fi,ni:sned goods 1 March 2014 2.0600
920600
Less Inventory of fini shed goods on 28 Febrt.1ary 201 5 21350 S9925 0
347
m Manufacturing accounts
Mike Ton =t.s buying departtnc..:.tt1t cou]d purchas· th am,e nuin1 er ,of oods made in
his factot1' for 2. 5 miUion.
Re q u i1·e d
Prepar~
a sun1n1arised tnanufacturing acco u nt for the year ended 31 May 2015
the trading ac co unt for the year ended 31 May 2015.
Answer
Mike Tong
Summarised manufacturing account for the year ended 31 May 2015
$
Prime cost 1621 540
Add Overhea ds 399245
2020785
Add Work 1n progress 1 June 2014 23640
2044425
less Work in progress 31 Ma,y 20 15 (20 11 9}
Producti,on cost of goods compl'eted
1
2024306
Fact ory pirofit 4 7569-4
Transfe r price to in come statement 2500000
b Mike Tong
Trading account ·for the year ended 31 May 2015
$ s
!Revenue 2913 502
348
32.5 Manufacturing profit
O]ga ·travinska is a tnanufacrur, r. The foUo"'·ing infonnation relate to her business .at
31 Octob r 2014:
Production ,oost of goods comp]etod $348 700; inventory of 6nished goods at l
1
Novenlbcr 2013 37 498; inventory of finishG-d goods at 31 October 2014 &39613; sales
for the year 8598 136
OJga transfers goods frou1 ber factor}' to the tradin g account at cost p]us 20 per
cent.
Required
Prep.are:
a a n e1..1:ra.c t fro n1 'the tnanufacturing acoount
the trading account for the year ended 3,1 October 2014, shnwing n1anufactul'ing
p rofit and the transfer price of the goods inanufactured.
Answer
a
Olga Stravinska
Extra rt from manufacturing account for the year ended
31 October 2014
$
Produ ct,io n coS"t of 348 700
goods co mpi eted
Tiransfer p rrce
l Olga Stravinska
3961 3 41 6 32 5
Gross profi,t on·trading 181 811
349
m Manufacturing accounts
MougH Godin rnanufacn1lres printed drcuits. He p asses the goods fron1 his factory
at cost p lus 2 5 per cent. At bis financial year end his inventory of finished goods is
valued at $2SQrOOO.
Required
Cakulate the cost pdce o f ifougU's c losing inventory to be e ntered in the business
staten1ent of financ ial pos ition.
Answer
The cost price o f the do.sing inventory o f finished goods is 200000.
2So/o 25%
25% J25o/°' ofoost • $250000
2.5% 25%
2-5% 25%
2.5% 25%
+
G - $250000
So
lOO of$250 OOO 25 of $250 OOO
+ = $250000
.125 125
S200000 + 50000 -
350
32.6 Provision for unreaJis~d profit 1
Answer
The dosing inventory of finished ge nerators should be va]ued at $350000.
351
m Manufacturing accounts
The n???!! f could be depreciation doubtfu] debts oi· unr-eal ised p L'o,ftts.
The balanc ,o n a provision for unreai:is d pront account is shown in tb stat tnent
of ftnandaJ position a a d duction fron1 the dosing inv ntory of 6nishe ,o od , thus
i;;nsuring that th inventory appears in th statement of AnanciaJ position at co "'t price.
The aincunt shown in the provision account described as lincoine statefn,ent' ( 1;0) is
deducted from the gros.s profit on manufacturing i.n the income staten1ent.
Paqu ho plc trans fe rs manufactured goods lto its incotne statetnent at cost ph.JS 30 per
ce n t The ba.fance brought down m the provision fot unrealised profit account at 1
April 2014 is $1 300. Inventory of finishe d goods is valued .at $6500 on 3 1 March 2015.
Required
Prepare a provis ion fo r unrealised profit account s howing dearly the an10unt to be
transferred to the incorne state:rnent
Answer
1SOO 1500
1 Apr 2015 8 ail a nee bid 1 SOO ($6500 x 30 ~ 130)
Q u1esHons o ften ask you to prepare, the whoie of ihe provis1o n account (including the
caku]acion o f the opening balance). If you can ,c alculate the dosing balanc,e in the
question above, the opening ba]an.oe shouJd pose no prob]ern.
Celine lnarks up the goods manufacrur-ed in her factory by 35 por ,c ent to, tr-ansfer
·t betn to an incon1e statement. Her inventory .o f fin ish ed goods on 1 March 2014
was $9450. Her inventory of finfahed goods one year fater on 28 February 2015
W'aS j ,9 720.
Required
P repare a provis ion for unrealised profit account for the year ended 28 Pebn..11.a1"Y 2015.
Answer
$ $
1 Mar 20114 Ba'lanee bid 2450 ($9450 x 35 % ~ 135%)
28 Feb 20 ~5 Ba'lance dd 2520 28 Feb 2015 tncome statement 70 Missing income statement
figure
2520 2520
1 M,ar 20-15 Balance bid 2520 ($9720 x 35 o/o -i- 135o/o}
3S2
32.6 Provision for unreaJis~d profit 1
BertoU ma1,ufacn1r s washin machines. Tbey ar 'Eransf rred to "n incom ~Uement 1
at CO&"t plus ,60 per cent. Th inventory of fini h d washlng nlachin s at 1 June 2013
w-a 57600; in 3l May 2014 it ,vas $,60160.
Requit-ed
Prepare a provision for unreaH.sed profit showing the atnount to be transferred to an
incorne st:a.ten1ent for the year e nded 31 May 2014.
Answer
Dr Provision for u n rea Iised p roiit a«ou n t Cr
s $
1 Jun 2013 Bafance bid 21 600 ($57 600 X 60% + 160% )
31 May 2014 Ba1lance dd 22 560 31 May 20114 ncome statement g 60 Missjng figure
2256-0
1
-22560
--
1 Jun 201,4 Barlcince bid 22 560 ($60160 X 60% ~ 160o/o)
Like aU pro¥ision accounts, it is possible that th · p rovision at tl-ie end of eh~ financial
year could be le ·s than rbe provision brought dov.rn at the st:a rt of tbt.: finanda] year.
In such cases the atnount trrans.ferred to an inco1ne s tate1nent would be added to the
gross .P rofit on rnanufa.cn1re shown in the incon1e statetnent.
Chin manufactures woks. The finished ,vo'ks a re trans ferred to her incon1e statetnent
at cost ptice plus 50 per cent. The inventory of fi nished vvoks at 1 November 2013
was 4500. The inventory of finished woks a t 31 Ootober 2014 was 3900.
Requ ll'.'e d
PL'epare a p rovisi:on for unreaJised profit s howing dear1y 'the an1ount to be transfer-r,e d
to an inco,:mue s1atetnent for the year ended 31 October 2014.
An sw er
Dr Provision for unrealised profit account Cr
s
Missing figure 3 1 0 et 20 114 l'ncome statement 200 1 Nov 20 13 9aJance bid 1 500 ($4500 x 50% + 1 50%)
added to GP
31 Oct 2,0 14 Bala nce d d 1300
1 500 1 500
1 Nov 2014 19allari ce :bid 1 300 ($3 900 X SO o/a ,,;,, 150o/o}
~~·····································~·
Now try Question 6.
353
m Manufacturing accounts
Matisse n1anufacrures lawnrnowers. He transfers fin ished goo ds frotn the factoqr to his
i.nco n1e state n1e nt at cost p]us 30 p e t· ce nt. He provides the foUovring infonnation for
the finandaJ year e nde d 30 Septen1ber 2014:
$
Total production at cost prtce 76 500
Inventory of f inished goods 1 October 2013 6045
Inventory of f inished goods 3,0 Septembe r 20 14 6 864
Sa~es for t he year ended 30 September 2014 2 10000
R quil· d
Caku late the tra n fer price o,f goods manufactured for inclusion in :an inco tn
statern nt fo,r th year ended 30 epte,nb r 2014.
Propat1C an income statement for the year ended 30 cptci-nber 2014 shrnving the
transfer.
c. P1-ep are a provision fo r unreaUsed p rofit accou nt for the yeru-.
Pt e pare an exu-act fron1 an incmn e state tnent fo r the year ended 30 Septetnbe r
2014 sho~\ting to ta] gross p rofit and the treatme nt of the p rovision fo t unreal ised
4
profit.
Prepare an extract fron1 a statement of financial position a t 30 Septen1ber 2014
showing how the inventory o f fln ished goods is treated.
Answer
~ Tr.ansfer price is $99450: production cost $76 500 plus $22 950 ( 76 ""00 x 30%).
b Mat isse
Extract from income statement for the year ended JO September 201 4
s s
Reve nue 21 OO00
l ess cost of saI~s
Inventory at 1 October 201 ~ 604.S
Product1oin cost of good s completed 9945 0 ($76 500 X 130 %)
10549 5
l.ess inventory at 30 September 20 14 6 864 9863 11
Gross p rofrt on 1:rad in g
C
Dr Provision for unrealised profit account Cr
$ $
1 Oct 2013 Bala nce bid 1 395 {$6045 x 30% ~ 130o/o)
30 Sept 201 4 Balance dd 1 584 30 Sept 2014, Income
1
statement
1 584 1584
1 Oct 2014 ,Balance bid 1 584 ($6864, )( 30% + 130o/o)
354
32. 7 The indusion of unreaJised proftt in financial! statements
d Matisse
Extract from income statement for the year ended 30 September 2014
$ s
Gross profit on trading 111 369
Gross profit on manufacturing (from pa rt a) 22950
less Provis ion for unrealised pmfiit (189) 22761
Tota I gross profit 1341,30
Matisse
Extract from statement of iinancial position at 30 September 2014
Current assets $ $
Irnv-ento ry of finished goods 6864
Less Provision for unrealised profit 1 584 5280
Raw uic manufacrur, b droom fiurniru r . 1-'Je tran fer finish d g,ood.s frotn his
factory to his income statement at oo,s tt p]us 70 per ccntt. He provides the foUowing
infom1,ation for the year ended 31 Dec@tnbe r 2014!
$
Sa'les for the year ended 31 December 2014 974000
Total production at cost pdce 476 4-00
Inventory of fln rished goods 1 January 2014 10S40
Inventory of flnished goods 31 December 2014 15980
Required
Calculate the transfer prke of goods 1nanufactured for inclusion in an incon1e
statement.
,J Prep,a r :an extract &001 the incom,e statement for the year ,e ndt:d 31 Deoeniber 2014.
Prepar a provi ion for unr alised profit account for they ar.
d Pr par an , xttact &om the income· statem ru for th ye-ar end d 31 D ~ tnb-er
2014 sho"'·ing total gro,s s pro,fit and the treatnumt o f th~ provision for unrcaB.sed
profit.
Prepare an ,e xtract from a statement of financial position at 31 Decem ber 2014 to
sho'V\iThow the inventory of finished goods is n eated.
Answer
a Transfer price 8809880: productio n cost 476400 plus 333480 ($476400 x 70%).
b Rawstric
Extract from income stat-ement for the year ended 31 December 2014
$ $
Revenue 974000
Cost of sa'les
Inventory at 1 January 2014 10540
'Production cost of goods comp Ieted 809880
802420
Inventory at 31 December 2014 (15 980) 804440
Gross p rofi,t 169'560
355
m Manufacturing accounts
C
Dr Provision f-or 1.1nrealised profit account Cr
$ $
1 Jan 2014 Balance bid 4340 ($10 540 >< 70o/o + 170o/o)
31 Dec Balance 6 580 31 Dec 20, 4 Income statement 2240
20,:4 cld
6580 6580
d Rawstric
Extract from income statement for the year e nded 31 December 2014
$ $
Gross profit on trading 169560
Gross profit on manufactur,ing 333480
Less Provision f or unraa,l~ sed profii t (2240} .3.311240
Tota'I g,ross profit 500800
Rawstric
Extract from statement of financial position at 31 December 2014
Current assets $ $
lnvento ry of ·fi,nis hed goods 15 Q80
Less Provisfon for u nr-ea li:s~d ,prof~ t (6580) 9400
There are mro tnain types of organisation that niay not keep a fuU .set of double-entry
records. They are:
• c lubs and sodeties
• s1naU cash-based businesses.
It is essential that you know about both types of organisation; both feature
ft-equenUy in questions .
Both types r,e ]y on similar skills and techniqu,e s i:n order to prepare a fuU set of
financial statements.
Jn this chapter w cotuid r the financial sta·tements of dubs and sodedes; the
financial smteluents of cash-bas d busmes tthat do not ke~, 'fun et' of ftnandal
records have b en d aJ E v,ritb in Chapter 22.
The principles involv din calculating the surplus or denci't for a d ub or society are
the same as tl10.s,e used in Chapters 15 and 22.
Not~
For ease of reference, both dubs a nd .societies are referred to in this chapter as 'dubs'.
357
m Clubs and societies
The inain function of a dub or soctery is nor to trade. It exist,e oce is ro provide
facUhie for n1e1ribers or to pro\1ide an oppottunity for p ople to n1eet and fu11her
'th ir common int re -c.
Often the n1etnbers ,o f a dub har\r • litcle· or n,o know!edg - of accountin or I ook-
keeping and because of this many dub treasurers pres·ent a 'receipts and pa.ymen:tts
account' to the club's annual genenll] meeting as a set of finandaJ statelncnts.
A receipts and paynients account does n.ot shov;..T the lnen1bers~
• the true finan cial position of the dub
• any accrued expense.s or any prepayn1ents nlade
• the asset base of the dub or by how n1uch the assets have depreciated dudn g the
year
• an y ]iabil hies that are outstanding at the y,e a t end.
To present a tnore complete picture o f the c lub's financia] activities and position 1
.an incon1e and expenditure account and a st:aternent o f financial position should be
prepared.
Any profit made by a dub is ca]]ed an excess of incon1e over expenditure. lt is often
shortened to 1surp,Jus'. Any loss tnade by a dub is called an exces.s of expenditure
over incon1e. so1netiu1es shonened to 'deficit'.
358
33.3 Preparation of finandal statements for clubs and societies
• Stage 4: deduct any textra1 funds introduced. ometi:rnes the dub n:lJay rec,eive a
donation or a J~gacy that ha.s to be crt:ared as a capita] receipt This , xtra injection
of funds wi]] increas th a sets owned by th dub at the· nd of th year. In turn
this ·wiU increas~ th Agu~ we bav calculat cl as a st1rplu Ot couJd reduc Eh
figure caku lated as a. deficit). Obviously the an1ount of the donation or le acy
is not an inc rease in net as.sets \ ?amed· by the activiti~s of the dub so it ID\.1St be
disregarded in our calcufa:tion - benoe Stage 4: deduct any 1e,..""tra' funds 1introducedl'.
Hightown Tennis Club had the foUov.ring assets and UabiHties at 1 January 2014:
n ts Sl U; inventor}r of t,e nrus balls $26; an1ount ow, d to supplier of ·termi balls
S72; invent·OfY o ff tiH.ser $54; Hn paint Bi balance at bank $13,6
At 31 Dec niber 2014 th clu b as ts ancl liabilities V¥'er :
nets $80; inventory of tennis baUs $20~ inventory of feniliser $4B; balance at bank $207
Requb-ed
Cakulate the surpJus or deficit fo t· the yeai~ ended 31 Decen1ber 2014.
ln th~s type of question, you w ~lI ai~ways be
aske ~ to calculate the surp! us or d@fiidt. Answer
$
Closing net assets {accumLl'lated fund) 355 (80 + 20 + 48 + 207)
Op en,i ng net assets (ace um uIated fund) 264 (1 12 + 2 6 + 54 + 8 + 1.3 6 - 72)
Surplus for the ye ar 91
Stage 3 is the stage that ·w iU cake up much of our thne since th1s is the area thcil't
The su1m1mar~sed receipts and payments
seen1s t,o cause tno-st ptobleJil'lS.
acc,ount and 1h e sum1ma1rise-d bank (Stage
2) are gene,rai ly given in the question.
359
m Clubs and societies
For each andllary activity the cfu b treasu rer should caJcufate whether the activity
is profitab]e or n ot and in clude the p ro fit o r ]ass in the incon1e and expend iture
.accou nt.
The treasurer of the Apes Rugby Club provides the foUowing infom1atio n for the year
ended 31 May 2015 for a s nack b ar o perated by the dub~
l. June 2014: an1ount owed to sur~p Her o f fru it juices and .snacks $213
31 !vlay 2015: a n1ount owed to s upplier o f fruit juke.s and snacks $186
s n ack b ar sales for the ye-ar 127759
amounts paid 10 th.e sup p Uer o f fnijt juices and snacks during the year $14 621
inventoiy of fn1it jukes and snacks 1 Ju ne 2014: 165
invent01-y of frui·t juices and snacks 31 May 2015: l.'91.
Requir d
Prepare a snack bar trading account for the· year ,ended 51 !vlay 2015.
The key to recognjsiing ~h,s type ,o f
qu:estion1, on fina ndal statemients. is Answer
found 1in the words us,ed. You must read
Apes Rugby Club
t he 'req uii red' i ns1ructio n very ea reiuHy.
The key word he re i.s prepare. Snack bar trading account for 1he year ended 31 May 2015
$ s
Revenue 27 759
Less Cost of sailes
Inventory 1i ll un e. 2014 l 65
Pu rchases 14594
14759
l1nv-ento ry .3 1: 1M ay 20115 (19·1) 145·68
Snack bar· profit (to income and expenditure account) 131'911
360
33 .4 Addit1onal activiti,es
Workings
Trade payables account
s $
31 May 2015 Cas.n 1462 1 1 June 20 14 Balance bid 213
31 May20t5 Bal'ance cld 1186 31 May 20 15 Ca fe trading 14594-
account (missing
fJgure)
14807 14807
1 June 2.0, S Balance bid 186
The foUowing receipts and payn1ents account for the year ended 31 October 2014 has
been prepared by the treasurer o f the Dantong Gardening Ch1b:
$ $
Ban k bal'ance 1 November 201 .3 1,46 Payments to seed sup p1Iie r
1
407
Seed sales 612 Purchase of gardening eq·uipment 2842
An honorariun1 is. a. payment made to a
Subscr,iptions received 5040 Meeting room rent 750
dub cffi cia I to cover expenses and time
spent on club activities. Show entry fees 326 Secretary-s honoradum 1'00
Ann ua I d, nner dance t icket sa1les 2250 S,peakers expenses1
240
Equipment hire 420 Ba,nk cha,rg:es 28
Advertising 126
Insu,rances 348
Post.ages a.nd tehiph one 142
Dinner da nee expe ns~s 1874
Printing for dinne1r dance 128
Show prizes 247
Shaw expenses 1.48
BaJance at bank 31 October 2014 14114
8794- 8794
361
m Clubs and societies
Require d.
Prepar an inoo,n1e, ancl e.-qx~dirurt= account fo,r th y, ar ,e nded 31 Octob(;.!f 2014 and
a tat m nt of anancia] position at that dat .
Answer
Stage l: prepare an opening statement o.f affaics
$ s
Assets
Equmpment 840
Prepayment - ins ura nee 112 ~bsaiptions owing - members ~ o owe
Su bsc ri pt ions owing 180 the dub ma,ey are receivables (debto1S).
Bank ba,tance 1'46 1:278
Li ab illibes
Payables - seed merchants (128}
Pnintng (62) Subscr:iptjons in advance - payables
Subsciriptions pai.d in adva·nce {360) (550} (creditors).
Accumulated fund 728
tagi 2 ~ compile a reo ipts and paym,e nm aooount and/ or bank account - tt has be n
provid ed for us,
Stage 3: construct adjustment accounts. Th is is the iicnportan t stage·. Use o ne account
for eacb ttem in Stage 1.
Insurance account
s $
1 November 2013 ·Bafance bid 1112 31 October 20 14 Income and expenditure 254
account (missing figure)
31' October 20·14 'Bank 348 31 October 20 114 8al'ance cld
1 206
460 460
1 November 2014 Balance bid 206
Seeds account
5 s
31 October 2014 9aink 407 1 November 201 3 Bal.since bid 128
31: October 2014 Balance 84 3 1 October 20 14 Income and expenditure 363
account missing figure)
491 491
1 November 2014 1
8al'ance 84
Printing account
s s
311October 2014 Bank 128 1 November 201 3 Balance 62
31 October 20 14 1Balance d d 7 5 1 November 2014 Income and expenditure 141
account (missing figure)
203 203
Balance 75
362
33 .4 Addit1onal activiti,es
The nexl adjustn1ent account i the one that seents to cause the most probJ,ems. It is
th subscri,pti,o:ns account.
Put yourself in 1h e pos~1ion of a dub Amounts ow, by p pl (including member-~) or organisations art: 1 ceivabl
treaisurer. (debit b alanc s ).
ubsaiptions owing (or in arrears) at the end of tbe- year are r ceivable (d ~bit
balances).
At the en d of any year tbere n1ay be soiue 1neinbers o f a club who have pa id 1heir
s ubscdpdons for the foUowing year. He o t· she wiU be a creditor of the dub.
Amoun ts owed to peop]e (induding members.) or organisadons are pay ables
(credit balances) .
Subscriptions pajd in advance at the en d of the year are p ayables (cr edit ba lances).
Monies received du ring the year fro1n n1en1bers are debited m the cash book. We
need to complete the double entry in the subscriptions (adiust:rnent) accoun t.
It wiU be shown as a debit in th.e receipts and payments account (the cash book
sumn1ary). We cornpJete the doubh.:• entry b}r crediting the subscriptions account.
Suibscrrii p11ions accounts aire· a~so often You wil] make fewer ,e rrors if you use the technique outlined earlier in d1apte1" 9.
asked for as a short questiori. Put your dosing balanc :S below the account and then bring them back i:nEo
the account.
Subscriptions account
$ $
Ba,I 1 !Nov 20 13 (subs 180 Bal 1 Nov 2013 (s ubs in adv) 360
owing)
I & E St (missing figure) 5310 Cash 5040
Ba Iranee 3 1 October 135 225
20 14
5625
Bal 1 Nov 20 14 (subs 135
owtng)
As you can see, there is quite a bit of work involved j1..1st for the figure of $ 5 31.0 for
subscdpcions.
tag 4: prepare an income and ~p ndltur,e account.
363
m Clubs and societies
Advenising l26
Insurance 254
Postag es and t elephone 142
Depreciation of equtp mem 682 239 1
Excess of income over expendtture 3823
Notice a]so the change in the ien.n s used: incotne an d exp e nditu re account, excess
of incotne over expen dirure a nd accun1u]ated fund.
In practice tnany dubs ~vrite ·o ff any su bscrip tions n ot pa id by the end of the club's
fina ncial year1 since if a l'nember has not paid their subscription by the ,e nd o f the
year the n~ is a stron g Ukelihood that the n1e nlbership has Japsed.
If you a1-e expected to take this line of action this VviU be mad e clear in the question.
During the year endt:d 30 Jun,e 2014 cash rec~ived for u cdpdons to th~ Dropkkk
Rugby Club atnount,e d to $1 860.
At 1 July 2013 subscriptions paid in advance ain,ountecl to 8140: at 30 June 2014
subsctiptions paid in acki'anoe weJ·,e· 880.
At 30 June 2i014 su bscriptions totaUing; $60 ren"]ain ecl unpaid.
It is d ub poHcy to w rite off any subscriptio ns that ren1ain u npakl. at the financial
year end.
364
33.5 lrncome from other sources
Requit-ed
Prepare a subscriptions account for the year nded 30 Jun 20·14.
Answer
Subscriptions a«ou nt
$ s
I& f 5t 1980 Bal·anee bid 140 $1980 is sh O\N!l as in come on J & E
Ba l'ance cld 80 Cash 1860 Statement
f& E St (s ubs w/o) 60 $60 fs shown as an expense on
I & E Statement
2060 2060
Bal,ance bid 80
The O]d Jacks Bowling Club opeta·ces a life ineinbership schen1e. Tite Jife
menlbetship su cription is $350. The ba)anct: standing on the Bf. membership fund
at 30 ~ptember 2013· was $2940.
urin rh '-'·year ended 30 · poomber 2014 nve members took out Ufe membetsbip,,
paying S17SO. The dub transf~'fS ten per c,oot of th balanoo standing in the Jic
melnbership fund at the end of each ftnandaJ year ro the income and expenditure account.
Requit~d
Prepal-e a Ufe men1bership fund for the year ended 30 Sep1te1nber 2014.
Answer
Life membership fund
$ s
30 September Income and 469 1 October 2013 Bida,nce b/d 2940
20·14 expenditure account
A tife m,embershjp payment is a 1one 30 September Balance dd 4221i Yea.r- 2013/14 Bank 1750
2014
off~ payment and is rece,ived by the
dub when the payment 1is made. The
1 4690 4690
annual transfers to the· dub i ncom,e and 1 October 20 14 Ba'la nee bid 4221
e>qJendliture account are m,ere~y transfers Note
in the dub fs books oi ac·cou n1. The
1
$469 is shown as an income on th,e income and e:xpenditu.r,t,; a cc,ount.
amount transfened does not ~ ncrease ~ne
$4221 is shown as a non-current UabiHty in the statement of financial position.
cash ~ nf1 ow that year.
365
m Clubs and societies
33.5.3 Donations
Another source of incon1e is in the form of donations. Sn1aH donal:fons should be
treated as revenue inconie. However> if ai large donation is received it shou]d be
treated as a ea phaJ receipt.
If a dub receives a large donation (or ]egacy) that has been given for a particular
purpose h shouJd be credited to a speda] t1'-1St fund and a special bank account
shou]d be o p ened . This avoids the money being used for genera l ,d ub expenditure.
The trust fund should be debited each year with the amount o f the annua]
expenditure o n the special purpose; the debit ,e ntry is in the income and expenditure
account. The entries ar,e s in1ilar to those used in a Jife membership fund account.
On l January 2014 the Stun1ps Cricket Oub received a donation of 50000 to bui1d a new
paviUon. In .-ilugust 2014 ~Chang, a builde1· was pafd S3874 afrtcr laying the foundadons.
1
In epteo1:ber 2014 .ano ther building 6nn, Chou, vi..•as paid f.4751 for work done.
Required
Prepare the necessary accounts lo record the transactions.
Answer
Bank- building accoun1
Label your work~ngs so that people $ $
can see wh~ eh f1igure you have been [1] Builld~ng fund 50 OOO {4J Chang 3 874
ea, cul ati ng. {5] Chou 4751
Ba,1anee c/d 41375
50000 50000
41375
Pavi Ii on account
$
[21 Chang 3874
[31 Chou 4751
Chang Chou
$ $ s s
,(4) Ba.n'k 3 874 [2)1 PavHtoni 3874 [5] Bank 4 751 [3] Pavillion 47511
The numbers refer to the sequence of events. Ther,e- wiU be an 1extra' inco1ne in the
income and expenditure account for the year.
366
33.5 lrncome from other sources
························~·········~·~····
Now t ry Questions 4 .
There ~s a change 1n some· oi the headings use-di when prepadng1 the firnancia1I
statements of dubs and so det~es.
Income state,m@nt becomes 'inco.me and expenditure account' .
IP'rof~t becomes 'excess oi 1income over eXJpend~ture' or 'surplus\
l oss bec:om,es 'excess of expendtture over income' or 'deficrit'.
Cap!tal becom·es 'accumufraited fund '.
Any add;1~011al adlivities should be netted to appear as one f igure on t he income and
expendi1ure accountL
lli~e membership, entrance fees and donations are generaHy treated itis cap~tal
rece~pts.
367
Publish d financial sta ements
of limited companies
By the end of this chapter yo u should be able to:
• identify and co,mment on the ma1~n disdosure requ~rements assodated
1.1 Preparation of financial w~th the pubUsihed annual reports of !limited compa1nies, induding:
statements • income state,mient
• statement of finandal pos1ti1on
• state:ment oi cash flows
• state,ment oi dha nges i1n ,equ~fy
• directors 1 report
• aud~1oris' rre·port
The annual return is filed v.-ith the Registrar of Con1panies and may be examined by
any me:n1her of the generaJ pub] ic.
Legtslation requires every ,c,01npany to send a copy of the corpot·ate repo1·t to:
• every shareholdt!t
• ev·e ry debenture holder
• aH other pers,o ns entitled 10 r,eceiv:e copi s.
The ftnancia] statements must be S(..~t not less than 21 clays befo,r c the Annual
Genera] Meeting (AGM).
368
34. 2 The published financial statemrents of Jrmited companies
In ~dditio,n to the statutol'y accounts the ,c orporate report wiU oo,ntain notes to the
Tr u means that a,11,the tra nsa.cti on,s
accounts and a statem~nt of tbt!' accounting poHci,es that have b en appUed in the
reported in the income statement have
taken place and assets recorded in the pr,eparation ,o f tb aoocunts.
statement of fi,nancial position actuaHy exist Th Coinpa ru Act 19s- r . ,quit that the financial tat tnents g:ive .a t1~e and
a·nd are va lued approp,riateiy. Fair i.mplies fair v:ievi,• ,o f the financtal state of ~h.e company during the time peri,o d ,cov,cred by the
that all, transactions conform to gen·eraHy statements.
ac ce:Pted acco unti ng ru,les. .Directors are responsible for ensuring that the provisions of the Con1ipanies Act 1985
are adhered to. The directors n1ust also ensu.re that the financi~ statetnents are prepared
in accordance with Intemationa] Accounting Standards (IAS) (see Chapter 36).
The directors must ensure that the company's accounting records contain:
• detaUs of a]] transactions invo]ving n1oney
• a record of aU die company's assets and liabiUdes, including detaUs of inventories
he[d at the financial year end.
369
m Published financial statements of limited companies
370
34. 2 The published financial statemrents of Jrmited companies
1 What is the d~fference betw,een statutory accounts and the, annua1I report a:nd
accounts?
2 Pnvate li1
m,ited companies do not have·1o file theiir statutory accounts \Mith the
Reg~strar of Companies. True/False?
3 Dkecto1rs own a compa,,ny. Truelfa,lse7
4 Shareholders own a 1 company. True/Fa11se7
5 Directors run a comipany for the shareho~ders. lrue/Fallse?
6 Auditors r un a company for the tax author~ties. True/false?
7 A sharehokfer could be a d~rector oi a ~smitedl co·mpany. TrtJe/Fahe-7
8 Name t\lvo publlic: lljmited companies.
9 Name the ,components of a compiete set of finandal statements.
10 E,qplain why the publrished 1income stat-ement of a li1
m~t1:d company does not
have to ,give a1Ht he detaiils of every ,expense irnciurflred during the accounting
per~od.
11 ldent~fy three rrtems 'that must be drisdosed in an income statement for a1 Uimirted
compa,ny.
371
IAS 7 Sta m nts of cash
flows
By the end of this cha pte r you sho uld be a ble to:
• prepare a s1atement of cash flows using tlie IAS 7 format
1.1 Preparation of financial • use the headings requrred by IAS 7
statements • e·xplain the purpose·s of prepa1nng a statement of caish fiows
• calculate ail the cash flows assodated wilth depredatJon and disposal of nona
current assets
• e,qptaiin 1he effect 1hat an issue of bonus shaires has o:n ca sh ~ows
1
• e·xplain 1he effect that a r,evaluatr,on of non-current assets has on caLSh flows
• reco ndle nei cash flows w~th movements in net debt
372
35.4 The IAS 7 headrngs
• n reveals info nnation that is no t d:isdosed in the income .statement. This hclps in
nnan da] pfan ning.
• l't p rovid information that heJp to ass s the· liquidity~viability 1nd ftnancia]
adaptability of th busin s .
• It aHows comparisons to be tnade year 0 n year or :i nter-fi:nn. Thhi is faci]itated by
1
the prescribed fon'ml!t. (But do rerocmh r~when making comparisons that the 1
state n1ent is a histor ic-a] d.ocu tnent. The state m ent is prepared using figures fron1 the
previous financial year.)
• lt he ]ps p rovide infom1atio n that will assis t in the projectio n of futu re cash flows.
•••••••••••••••••••••••••••••••••••••••••
> Naw t ry Question 1.
35.3 Transactions that result in cash
inflows and cash outflows
IAS 7 re quires that companie.s pre p are a s'tat,e tn ent o f cash flo,\ts in th e founat
described in the standa rd. A state1nent of cash flo ws should be ind uded w ith rbe
other published financial Sta'Eetnents.
The standard requir; ~ an adj~1ment to profit fron1 operations in order to, calculate
th · cash How generat~d fron1 op rating activiti .
0 1 the starEen1ent of cash flow~ bou]d includ - aU inflows and outflov.rs from th
busin s involving cash. Any ·tran actions that do not involve cash s ho uld not appear
in the statement.
Table 35.1 Examples of transactto ns t hat result in cash inflovvs a nd cash outflavvs
The standard p rovides a t,e n1plate using the thr,e e headin gs.
373
ID IAS 7 Statements of cash flows
The caJculatio:n is don using the profit frotn operation (that is profit for the
Amor i tion is the writing off of part (or
year bc:fo,r e d duction of tax and int<.=r~t). o, the operating cash flavvs -. ction of tht=
a,11) o'f the cost of an 1intang1ble asset such
as goodwilit It is similar to 't he depredat1ion tatement contains th foUmving adju stments:
chcrrged on, a tang,ible nonl'"current asset • add d pr elation forth, y,eru- (and ny airno1·ti ation of gooch'lliU)
• add lo ses on sales of non-cu n-ent ass<:
• deduct profits on sales of non-current assets
add decrease in inven~ory (or deduct decrease in inven.tot},)
• add dect-ease in trade reccivables (or deduct increase in trade t·eceivables)
add increase in trade payables (or deduct decrease in trade payables),
TI1ese adjust111ents to d1e profit frotn ·O perations gives the cash (used in)/fron1 operations.
Two further adjusunents are necessary~
• deduct interest paid d uring the year
• deduct taxation pa id during the year.
The r,e sult is the net cash ( used in)/fron~ operating activities.
The foUmving information is given for the year end,e d 31 JuJy 2014 for Schmidt p]c:
$000
Profit before tax (interest pa id $60) 212
Tax liabil'tty 70
Required
Prepare an e..--Uract fron1 the incotne statement showing dearly the profit from
operations, p1ofit before tax and the profit for tbe year.
A nswer
Sc hrnidt p le
Extract from income statement for the year ended 11 Ju ly 2014
$000
Profit from operations 272
1l1nte:rest paid (60)
,P roilt before tax 21,2
Tax (70)
Profit for t h~ year 142
374
35.5 Calculation of profit ~rom operations
It is ioft:en the ,case chat no incotne statt!tn e ni extract is given in ·eh q uestion; it has to
b r~ onstructed fro1n the ai\1 a1lablt!' information.
The foUowln__g extracts are rnken from rhe statetnt1lts of financial position of Ocset pk
at 31 Decctnber.
2014 2013
$000 $000
Current Iia bi Iities
Tax Hability (120) (168)
Equity
Oa hnary snares 2 500 2 500
GeneraII reserve 400 .350
Retar ned eairn ings 1662 1346
During the, year ended 31 Decembe r 2014, debenture interest p aid amo unted to
$"7 OOO. DNidends amoun ting to ·150 000 wer,e paid.
Requir d
Cakulat, the profit from operations forth year ended 31 DE'Ccmb r 2014.
Answer
$000 sooo
In crease in retai:ned earnings over the year 31'6
Add Provision f.or taxation 120
Debenture interest paid 78
Transfer to g·enera:I rese rve 50
Divfdends patd 150 398
Profit from op erat.ions 7 14
The foU owin g e xtracts h ave been taken fron1 the state111ents o f financial position of
Beta and Bigga plc:
.Requit·ed
CaJculate :
the pro visio n for depreciation for the year ende d 31 JuJy 2014 for each non-curr,e.nt
asset
" th~ amount to be included in th~ staEt!m n c of cash flov,s for the year nded
31 July 2014·.
A nsw er
$
Provision for d~preciation - pram.ises 50 000
machinery 183 000
offii(e eq ulp ment 61 OOO
venides 225000
The ain ou nt to b e added to the profit fron1 operations under 't he heading o f
toperaUng aicdvities' ls $519000.
······~········~·························
Now try Question 3.
37'6
35.7 Ca~cu !atio11 of cash Hows resu !ting from the disposa I of non-current ass,ets {derecogn ition)
13.35 1 31 1
During th year nded 30 April 2015. non-cun· nc ass~ts ,vhkh had cost $720000
,ver,e old for $274 0 0,. Tbe as ets soJd had b en depreciated by $4330 O.
1
R quit _d
Idcnt:if:y any cash :flows rosubing from. the saJe of n,on-current assets.
Workings
Using <T accounts , we can gain a con1pLete picture of d1e uansactions involved in the
probJen1.
Joumal entries are given to h.elp you with the Eilning of each entry:
s $
D1isposal 433 11M a,y 20 15 Bal,aince bid 1 0-21
30 April 201 S Balia,nce c:/d 1 238 Mis5ing figure
167 1 1 671
1 May 2015 Bal,ance bid 1238
Disposal of non-curren·t assets account
$ s
Ncn-c urre nt assets 72 0 Dep rec:i ~,t ion of non -current 433
assets
274
i nco me statement 13
720 720·
377
ID IAS 7 Statements of cash flows
Journal entries sh o'9ling the ttin1ing~of each entry:
Dr Cr
$ $
Disposa1
I of non..cuirrent asserts account 120000,
Non-current assets acc:ourrt 720000
Nori-current assets are removed from the non-current assets account a,nd are entered in
a disposa I account.
1
DepreciatJon 'belonging' to t he asset is ta ken fro m tihe provision for depredation account and
e ntered in the disposaJ account
Bank acco unt (not shown) 274000
Disposal of noni-c urrent assets ace ount 274000
The cash inflow is entered i1n the di~posa I account.
1
$ $
The ':Joss' incurred on disposal is entered in the income statement. It is not cash but it
has been entered in the incotne statetnent a.s an eJ..'lra expense - it reduces profit but
13,000 is not ca.sh - there has been no moven1ent of cash.
Enter the closing balances given in the question. Enter them underneath the
account and take then1 back diagonaUy into the account.
Add the non-current asset account a nd Ehe depreci,.l'Uon account. TI'ley wiU not
add unJess you put in the, two mis ing figures. The rnissing ngure in ·the non-current
a,c count must clther be " r, wa[uation or tht= purchas of further :non-curr~nt ass,~ . A
'f,e valuation ha · not b n mentioned~so the mis ing ngurt: must b non-current a
p urchas~d durin the year: a cash outflow of $961000.
lb make th·e provision for depreciation account balance~this year·s charge to
the in.,corne stat,c.ment n1ust be inserted: 8650000 is the atno unt to be entered in the
account and in the incoore statement.
The profit is reduaed by S,650 OOO but ·n o cash has tnoved in o r out of 1tbe business.
Both the Joss on disposal f 13 OOO and the dept·edation fot' the year of $650,0:00
have reduced p rofit but thet~e has lbeen no n1oven1ent of cash.
Both have to lbe adde d b ack to the profit fro in operations to arrive at the actua]
cash floVv~ generated by the coinpany> just Uke tbe depredation charge on Ragesh's
van in the exan1p]e in Chapter 25.15.
Answer
••••••••••••••••••••••••••••••••••••••••• Cash ' inflows' : Joss 13 OOO and depreciation 650000; cash outflow: $961 OOO.
> Now try Questions 4 and 5.
378
35.10 Reasons why a business might prepare a statemient of cash flows
379
ID IAS 7 Statements of cash flows
31 May 2015 31 May 2014
sooo sooo
EQUITY AND UABI LITl ES
Equity
Ordinary shares 1,2600 12100
Sha r2 premium 6150 4 650
RevaJu.;]ti on reserve 3200
Retained earnings (not e 2) 11298 10 906
33248 27 656
Non -current Ii a bi Iities
8 o/~ de ber:iture stock (reyaf abl'e 2045) ~ 200 1200
Current liabilitie s
Trade paya·bles (1, 1i 75) 0 007)
Tax !iabil'iti es (420) (.380)
(1 595) (1 .387)
Tota I Ii a bi Iities (2795) (2 587)
During the year e nded 31 M:ay 2015 tnach inecy w hich had originally cost $1200000
v.-~s so}d for $750 000. TI'le deprec iation charge on this tnacbinery up to 31 ivJay 2014
1
was $480000. No additions t:o 1nach.inery w,e re tnade d uring the year ended 31 May
2015.
There w,e re no disposals of hmd, buildings or vehictes du ring the year ended 31
May 2015.
Not e 2
Th sum,naris d incom stat. fllent forth y1 ar ended 31 May 2015 was as foDows (a
,changes in quity tatcment bas not b~::.n used):
380
35.10 Reasons why a business might prepare a statemient of cash flows
$000
Profiit for the year bef.ore tax 1 112
Provision for corporation tax (420)
692
DivJdends paid (.300)
lm:reasi2 ini l'@taii:ned ~arnings for t ~E:! year 392
Requ it-ed
Prepare a stateme nt of cash Hows for the year en ded 31 1\.'lay 201 S using the JAS 7 fom 1at.
Workings
(nu = n1ilssin g figure)
Revaluation reserve
I $000
3 200
381
ID IAS 7 Statements of cash flows
Cash flows
$000 $000
.l1ncirea se i,n inventories (270)
Jn crease i,n trade rece iva bies (300)
hicrease in trade payables 168
Taxatron (last yea1r's tax Hab•lity pa.id in th~s year) (380)
D ivi den ds paid (300)
Debenture interest (You might have t o deduct debenture (g6)
interest. The tnterest figure might be g ·iven in the question, o r
you may have to caktt'late lt, as .in t his examP'le.)
8 % of $1200000; $96000
lnuease in share ea pita I 500
,l nuease in share premium 1 500
Reva Iuati on reserve No movement of c:ash
Profit ·f rom ope rations
(Prof it before ta~ -+- il nterest $111 2 OOO + $96 000) 1208
The d tfference i:n the total of these cash ·floW'S should equa I ·the
chang,e in cash and cash equ1ivalent s over the yeair.
Totals S636 56!1
Change in ca,sh and cash equ iva,lents over t he yea.r $5 OOO
C nan g~ in ca,$h fl o'W'S $5636 OOO - $S63 1 OOO - ($15 OOO)
11ncrea,se in cash and cash equ·ivalents during the y~ar 5
Answer
Yukita pie
State me nt of cash flows for ·t he year e nded 31 May 2015
sooo sooo
Cash ilows (used' in)/from operating activities
Profit from opera,t ions 1'208
Adj ustmerrts for
iDepredation d,arges - larid a:nd buiildings
1
1
650
ma,chinery 660
vehk1es 200 1S10
382
35.11 Reconciliation of net cash to movement in net debt
Required
Prepare a recond1iaUon of net cash How to n 1oven1e nt in net debt.
Answer
Reconciliation of net cash flow to movement in net
debt for the year ended 31 May 2015
sooo
Increase in cash in t he pe,riod 63
Cash used to repu·rchase debentures 150
Cha:ng.~ in net debt 213
Net debt at 1 Jlune 20 14 (2 1·9)
Note
Net incre ase in cash and cash equ ivalents during the yeat" e nd ed 31 May 2015:
$63000 1
•
383
ID IAS 7 Statements of cash flows
384
lnterna ional a coun ing
standards
By the end of thi s chapter you should be able to;
• demonstrate knowlledge of the f oUowing rinternatronail
1.1 Preparation of financial statements a1ccounting1 standards:
• ~AS 1 Priesentatiion of finanda, sta1
1ements
• IAS 2 Inventories
• ~AS 7 Statement ,of cash ff ows
• IAS 8 Account,ng polides
• ~AS 10 Events after 1he reporting pen·od
• ~AS 16 Property, plaint and ,equipm1ent
• IAS 3 6 Imp ai rm,ent o.f a:ss ets
• ~AS 37 Prov~s~ons, contingent liabill~t~es and! c:ont~ngent ar5sets
• ~AS 38 Intangible assets.
• understand 1he non-finandal aspect of decis1on making
• rident~iy a number of sodall costs and ethicalrconsiderati:ons
• discuss the conflict of p rofitabjtmty versus sodal r,esponsibmlrty
an di ~ dentify areas of such confl ~et.
lnteination:d Accounting tanda rds (IA .) are graduaUy being teplaood with
lncemational Financ lal Reporting tandards (JFRS).
AJthough it is not. as yet, mandatory fo:r the nnanda] ";tat,ements of p:riva te Jimited
companies to b prepar d in aooordanc with the _ s) its ms in~vltabl that ~in
dnie the tandards wiU apply to all Utrutcd companies. Conscqill.endy1 in this book
appropriate standards hav:c been appUed to the preparation of the fi:nancia] statc1nents
of all Utuitedl con1panies.
385
m
International accounting standards
The Companies Act 1'9S9 introduced a requirenent that the nnancia l m:atemenits of
oon1pani s muSlt b pr~par din accordance v.dtb th standards in fore and that any
material d viations from th standards should b id ntin d and reasons iven for
any ~u.,cb d :v:iadon.
Although the adherence to int(:rnationa] accounting standards is not e,nbod.iied in
law, the Companies Act 1989 requires that directors of :a company using the standards
to prepare the company's financia l staten1ents n1ust state that they are doing so.
In 1.989 ~Framework for the pt~paration of fina.ndaJ staten1ents' was issued by
the lnternationa] Standards Go1nmittee. It sets out the under]ying princ ip]es for the
preparation and presentation of financial statetnents.
The Fran1ework Sl[ates that:
' .. . finandal staten1ents ... provide infomiation about the financial position 1
peifonnance and changes in financial position of an entity ... '
It can be assun1e<l that aU nnanda] stateinents have been prepaFedl using t,vo
,c,onoepts dut you c.arne across in Chapter 7:
• The accruals ,c oncept (or n1atching concept). This records the value of the resources
used y the business and the benefits d(:iiv' d fron1 dt~ us~ of 't ho resources in
the finand.a1 yea:r of us, a-11d not wh n c~ h is paid or rec iv d.
Th going co net: n cone pt. Thi concept n1(;:atis tb at un] ~ we ha Vt: know]ed ,c: to
the contrary~ we assuine that rh corn:pany wiU continue to trade :in iu; present form
for the f-oreseea bie futu r .
FinandaJ statetnents should be usefu] to an the people who use the stat,en1ents. The
Fran1e~rod:( identifies four characteristics of financial staten1ents that are meant to
ensure their usefulness to the users:
U nderstand!abilhy. Infom1«tion shou] d be capable of being understood by people
with a reasonable knowledge of business and accounting. This may require 'study
with reasonab]e diligence on behaff of the user',
• Rdevance. The staten1ents tnust contain informa.d on that is ab]e to influence the
decisions of use:rs and, if it is provided in tfu11e, influence tho.5e decisions.
• ReHabiHty. The statements n1ust contain infornration that can be reUed on as a
faithful representation of the Sl1bstance of "'~hat has taken place. The infonnation
should lbe unbiased~ prudent co1np]etcly free ftonl n1aterial errors and record the
effe,ct of a transaction (accurat, representation; substance over Jo:rm).
• Comparability. Tht: user of financial stat ments must b ,confident that they can
co1nparc data &onl on tim period 't o anoth-.;r. Thb is acbi v d b)' th nnancia]
statements being prepared on a consistent basis and ensuring that accounting
policies used in the preparition of the 6nandaJ st.aten1ents are disdoscd. Tbis wiU
ena b]e users to identify and mralu~ne differences and s hni]arities.
The Fran1ework states that if the f:our characteristks are present in the preparation
of finanda] stateinents then~ under nonnal ckcurnstances, the statements wiU show .a
true and fair view of the financial position.
There a.re a nun1ber of concepts (see Chapter 7) which fonn the n1ajor influences
in prepating the financial straten1ents:
• Business entity. Only the expenses and revenues refating to the business are
recorded in the business books of account. Transactions involving the private
affairs of the owner(s) or directors shouJd not be mduded in the business books of
account.
• IvlateriaJity. If the indusion or ·e xdusion of inforniation wouJd tnislea d the users of
nnandaJ tat n1ents then that information is n1ateriaL Thls cone pE reoogn:is that 1
sotne typ [:', of t:xpenditur at"e less itnportant in a busin s cont~xt than othe1. - o
absoluk: precision i$ no[ alway • ~ entfal.
Prudenc,e. This rcqii.1ires that :re,renucs and profit arc only included in the acc,ounts
when they a:r,e re.a.Used or \vh,ere their reaUsadon is r,easonably certain. The concc.;,t
1
36.2 JAS 1 Presentation of flnandall statements
does .aUo\'V for ptovisjoos to b nu.de for known expenses ot l,osses ~rhen ther
b cotne known {chru"acte.risdc of reliability).
• Consist ncy. Thi requir, that once a n1 thod of l'reating i:nfom1ado:n ha
b n estab]ished th tnedil,o d hou[d b t ed in subsc.:qu ni )l a:r ' accounts. lf
infonnJldon is treated differently each year then inter-y·e ar r suks cannot be easily
compared and trends detern1incd ( characteristic of co,mparabiJ ity).
• Historical oost. n1is is an objectiv.e valuation. Va]ues based on what any asset(s)
nught be .sold for if tbe business were to Hquidate are irrelevant to the business's
abiHty tto generate profits or cash.
• Duality.The assets of a business are ah~.rays equal to the liabilities of the business.
Directors ensure that standards a re applied So, every financial transaction has a double unpaot on the fina ndal records of the
to their preparation of a company's financial
business.
statements.
You wiU need 'an understanding of the disdosure standards adopted by quoted
companies'. You wiU also need 'a bask knowledge of .. . standards and how these
standards re]ate' to other topics in your accounting studies.
·H owever, remember that you do not need a deraUed knowledge of any of the lASs
v.rith the &ception of IAS 7 Statement of cash tlows. In each instanc you should
know the numb~ and the h ad ing, for i;;!',Xa mpJe l 2 Inv ntori,es.
Th standard r, quires ·chat the ftnanclal statements should contain an cxplkit and
unr s rved statem,ent that they ~omply with int national standards. Th· hould mean
that d1e stat meilts achiev .a fair presentation.
The standard requires that the statements comply with aooounting concepts.
In order to faciUtate compariso11., there is a requirement that the figures from
previous periods must be pubUsbed.
The natne of the co1npany should be given; a]ong with the titne period covered by
the financial statetnents.
387
m International accounting standards
Tbe following l.nformacion is available for ·onuk plc foir the year end d 31 August 2014:
$000
Ad ministrative e~penses 173
D~btmture interest paid 28
Distribution costs 158
Ordinary d•vtdends paid 48
Jinventories - 1 September 2013 32
31 August 20, 4 28
Purchases 243
Reta1ined earn~ngs at 1 September 2013 623
Revaluation reserve at 1 September 2013 470
Sales 900
Sa les returns 12
The cUr cto r ·wish to lnake a provision for cor,poratio:n tax of 69 OOO.
R quir d
Prepar,e an inoon1e statetnent fer th~ ye ar ended 31 August 2014.
Answer
Sonuk pie
Income statement for the year ended
31 August 2014
$000
Revenue 88 8 Sales less sales returns
C ost of sales (247) Opening inventory plus purchases Jess closing in ventoty
Gross profit 641
Distri butio n costs (1S8) Warehouse costs plus cost of getting goods to
customers
Adm inlstrative exipenses (17 3) Costt o.f maintaining and running the offices
Profit from operations 310
Finance costs
Proiit before tax
---- (28) Interest paid
282
Tax (69)
:Profit for the year 213
388
36.2 JAS 1 Presentation of flnandall statements
Requit-ed
Prepare a stateinent showing the chang in equity for the year ended 31 August 2014.
Answer
Extract from statement of changes in equity
$000
Retained earnings
8aL~nce at 1 September 2 013 623
Profit for the year 2113
83 6
01"'1id ends pa td (48)
Bal ance at 31, Au gust 20 14
1
788
Revaluation rese rve
Balance at 1 September 2013 47 0
Reva lua,t ion of non-current assets 110
Batance at 31 Au gust 20 14 ·580
Using the san1e infonnation provided previously for Sonuk pk, the statement would
a ppear as foUows:
Sonuk pie
Stateme nt of recog nised gains a nd losses fo r the year e nde d 3 1 August 2014
$000
Gains/~losses) on revaluation of no.n-current assets 11 0
Net in co me recogn isecd directly in equity 11 0
Profitl(Ioss} f.o rr t he year 165
Total recognised gain for-the year 2 75
389
m International accounting standards
• tax ]iabUides
• i su cl capital
• r rves.
Current assets and non~current assets
Current assets cotnp1'i.se~
• cash and cash equivalents
• assets that wiU be disposed of within the next nonnal operating cycle (usually the
next financial year} exan1ples are inventories, trade r·e ccivables and cash and cash
equtvalents.
Equity
The foUowin . details must be sh~11 ehher as part of the stat m nt of financial
position or in the notes to, d1e financi~ statements:
• the number of shai-cs issued and fuUy paid
• the nunmer of shares issued and not fuUy patd
• the par value of the s hares.
AU shares o f a pennanent nature are dassifiedl as equity. So equity comprises ordinaty
share a nd preference shares. However, redeecnab]e preference shares are not patit of
equity capita].
36.2.5 Res,erves
A Hst of aU the reserves created is shown either on the face of the statement of
financial position or as a note to the finandaiJ statecnents. If the detaUed list of
reserves is shown as a not,e~ then the total of an reserves is shown on tbe face of the
state11lent of ftnan.ciaL position,
The directors of Nivlan p]c pr,o vidc the foHowing inform1tion at 31 Ju]y 2014:
$000
C: ash and cash eq uivailents 142
Goodwil1I 150
Inventories a,t 31 Ju!ly 2014 896
Issued share capita l 3000
Prape rty. p Iant and eq u:ip ment 8760
'Reta~ ned earnings 2298
Reva.l uati on, reserve
1
1 500
S'h are ,pre mj;u m ac::cou nt 1000
Trade and oth er payables 'SS7
Trade and other receivab Ies 779
9o/c debentures (repayable 2028) 2000
Th directors have made a provisi,on for corporation tax of $342000.
R quir d
Prepare a. statement of financial position at 31 Jul.y 2014,
390
36.2 JAS 1 Presentation of flnandall statements
Answer
Nivlan pie
Statement of financial position at ! 1 July 2014
$000 sooo
ASSETS
No n~cu rrent assets
GoodwiU 150
Property, plant and equipment 87 60 8910
Current assets
Inrvento des 896
Trade and other receivables 77g
Cash and cash equiv.a lents 142 1 81 7
Tota I assets 10727
Th · fon owing infonnation is avaUabl~ for En ary pk f.or the financial year ended 31
D cen1b · 2014:
January 20 1,4 Drirectors propose a Un,a l: dividend of $34 000 on ordinary sha res based on
1
Requ ired
Prepare a stat,ein,e nt detailing the total enuy jn ·the nrrnndal scat,e ments for the year
ended 31 Deoenlber 2014 for di~.ridends.
Answer
Dividend entry in finan cial statements for the year ended 31 December 2014
s
Rnal1djvidend fo r year e nded 311December 201 3 34 000
Interim dfvrden:d for ha If year ended 30 June 201·4 19 000
Total, entry for div~dends 53 000
The details o f dividends pa id during the financial year are shown in a note to the
pubHshed accounts. The above infonnatioo for Engary plc would be shown as
follows :
Dividends
392
36.3 IAS 2 lnventori,es
con1pany's affairs and of i\ts profit/Joss for the period covered by the audit.
The audi\tors' report should also give an opinion as to whether or not the financial
stateo1ents have been properly prepared in accordance with the Con1panies Act 1985.
393
m International accounting standards
' .. . the specific pdncipJes, bases conventions, r u]es and practices applied . . . in
preparing and presenting financial stateinents'.
The pdndp],e s are the concepts that you have .aJready Jeamed. They apply to .aU
ihe finandaJ statements that you have prepared in your studie.s so far. They are the
going ,oo,:ncern concept, the accrua]s concept~ prudence. consistency and n1ateriaBty.
The bases a the individual 1n thods of treatment used when applying accounting
principl ·to partku]a r ituadons for ·~l..."an1ple th appHc~nion of cost value or n
1
394
36. 7 JAS 16 Property, pJant and equipment
Propo·s ed dhrid nds at the financial year end are non-aidjusting events and soar~
not recorded as a current liability on dle tatem nE of nnancia] po ition. They are
:recorded as a note to tbe accounts. e th"" e..'"(ample of Engary pk in ocdon 36.2,5.
395
m International accounting standards
Depreciation pol icy is not affected by tepaks and/ot n1aintena.nce. How·ever the
Residual valu is ·the amount that the·
r sidual valu and th usefu] life of th~ ass t ne d to be reviewed on an annual
company expects to obtain for an asset less 1
any disposal costs at the end of tt.s usefut Ufe. ba is to detennine if any chang · should mad ln th d pr ciation policy.
G neraUy, fond and bui]din bou]d be tr a'E d s parately sine land is not
depreciated; it has an infinite- economic ]ife, unlike other non-current assets, wb,i ch
hav:c a ft nit<.; economic ]ife. Not<.: tha·t leasehold. Ja nd does have a finite Hfe (the
duration of the ]ease), and therefore should be depreciated.
A variety of methods can be used to c-akulate the annual depreciation charge. The
three that you will find n1ost: usefu] are:
• the straight-]ine n1ethod, which charges a constant annual an1ount over the Ufe of
the asset
• the reducing balance 1nethod whjch charges a decreasing annual aanount over the
Bf.e of the asset
• the revaluation n1ethod, which charges tbe difference between the value of an asset
at the end o:f a year and the value at the sta.1:t of the year p]us any additions to the
asset duting the year.
financial statetnents):
• the basis foJ· d etem1ining the carrying an1ount
• the depredation n1eth od used
• the duration ,o f the useful econon1ic Ufe or the rates of charging depredation
• the carry:ing amount
• accumubned depredation and in1prurmenE losses at the sran and end of the
accounting peri,o d
• a r conciliation of th carrying an1ount aE the start and end o,f th , . accounting
perlod that .shows:
• additions
• disposals
• re,va]u a dons
• in.1.painnent losses
• depredation.
396
36.10 IAS 38 ~ntangible assets
• a signincant faU in the va]ue ,o f an asset due to it being damaged. resulting in the
as.s ts fail- va]u falling o,r its furu re ea sh-genera ting abiliity faUing
• a sfgnUkant faU in the vaJu of an ass rt due to a restructuring ,o f th 'business.
An impai.tmetu lo, sis rooogni.sod when ·the recoverable amo,unE is l~ss than the
ea rcying a1nount The ruuount of the loss is to be shown in th.e inco,n1c statement.
397
m International accounting standards
Deve]optnent i-s the application .of knowledge gained fronl research EO pr,o duce ot
improv~ a product or process b fore it i.s marketed cotnm~rdany.
lA.S 3 requir· that a db"'tinction is mad I ~·n veen r venue .. cp nclftur and capitaJ
p ndhu r1 on r -~arch.
Revenue e.."Cpcndirure is e ntered in the lncotne statein,e nt, while capjral expenditure
on non-current assets is rec,orded as non-current assets and they at·e depreciated over
·t heir usefllJl Ufe.
Development costs are treated as an expense in the incotne state:l!:nent when they
are incurred, or they tnay be capitaHsed as an intangible asset if the directo1·s can
detnonstrate that they can establish the resuh as an asset that can be used or sold.
398
36.1 1 Soda] responsibillity
A business may be profna ble but v,lhat of its 'hidden costs i? In pursuing prafita bUity
what ar~ the.! co Es to, people outside tb~ organisation as weM as tbos..: t'!mployed
"ithin the bu.sin s?
The business activity may also have an in1pact nationaUy in the form of poUution and
dan1age to rivers and ail' quality and even gloooUy~ fol' exatnple throt1gh poUucion
which contributes to global Vv"'arming.
399
m International accounting standards
4GO
The rol of the audi or and
directors
By the end of this cha pter you should be able to:
• discuss the roi,e .of the au dirtor
1.1 Preparation of financial statement • discuss ~he audrtor's basi1s of opiniion
• ident,fy the records tha1 require 10 be aud~ted
• e)~p~a~n the con nectPon betw·een snare holders, d~ recto-rs and
audi~ors
• understand What is mean1 by 1he term 'ttiue and fafr vievv'
• d~scuss die role oi directo:rs.
2 Ba.sis of opinion - the frarneVv"Otk of audi1lng standards wiEhUl which the audit v...as
conducted, other as essmcnts and th wa}' in which ·t he audit wa.s pfan:ned and
performed. If the auwto,r fails to, obtain infomunion and planations nee sary
to support hi.s audit then this 1nu.st b r ported. Any devtatio11 from th n c ' Sary
disclosure requirements tnust b identified.
3 Opinion - the auditor's vie~r of the co,mpany's finan,clal smten".l!cnts.
Shareholders
appoint
recommend
Auditors . . . . - - - - - - - - - - - - - - - - - - - D i J·ectors
Figure 37.1 The regulatory framework
Because of the interdependence of the tluee parties there is a need for rules and
regulations that aocountants fo]]ow in the preparation and presentation of financial
statements. The sourc,es of me regul a.Uons are £he Coinpanies ...i\.cts and the appJ ication
of accounting standards.
Acc,ounting standards are not law . However, in the UK, tbe Compani s .A.e t
198 5 requires that dir, ctor,5 mU.')1 sou in th not to ilie nnanciaJ u1tem nts dlat
international ac,cou nting standards hav ~ be n appl i,e d in the preparation of the
statements.
402
37.2 The rore of directors
U the directors 3J'e re.sponsible for keeping financial records and ihe preparation of
the annual financial staten1ents, how can shareholders be guaranteed that the records
are prepared in an objective way? Shareho]ders appoint a tearn of professionaUy
qualified accountants. (auditors) to check and vedfy the financfa] statetuents and the
transactions that ]ed to their preparation.
403
m The role of the auditor and directors
Audi1ors are appo~ntedl by shareho~ders to ver~fy that the fiinanda~ statemrents show a
true and fai1r vJew of the state of affairrs of the company.
Auditors giv·e an opin~on as to Whether or not the financial s1aitements do show a
tJrue and i atr vJ,ew.
Dfr,ectors are responsibfe ior managring a ,company oin a1day-to-day bas~s on behalf of
the owners (the shareholders).
404
B siness purchase and merger
By the e nd of this chapter y ou sho uld be able t o:
• evatuate a business w~h a v~ew to ~ts acquisiJt~on
1.2 Business purchase and merger • prepare a statement of financia1I posrbon of:
• un ~n corporaited lbusiinesses merg,ing to fo,nm a
pairtnership by combining or purchasi1ng aissets aind
ll~abUi11es
• a lim~tedl company 1hat has purchased an
u1n ~ncorp oraited busriness by issui1n g shares,
debentures and by cash
• one· business puirch asi ng the assets a1n d I~abi Ut~e:s ·Of
an other business
• a new co1m,p any purchasing one or more exi1sti ng
bu si1n esses
• a Ii1m~ted company ac:qu iring shares iin another
limited comipany.
405
m Business purchase and merger
• financial econ.0111.ies - [arget businesses are genera.Hy able to ra.ise H:nance 1nore
easily and they tend to ha a great r variety ,o f potentia] sourc...:s frotn which to
,choos
• purch asing con orni · - larger busin es are mor Bkely to purcbas mat-e:rials
in larger quantities and therefore take adV11ntage of bulk disoountlng.
• Research and development cao be u:odBrtaken rnorc cffccdvc-Jy by a larger business.
• Diver.siacarion. iis easier in a Larger business1 a n 1ore diverse portfolio of pr,o clucts
wiU open up further n1arkets and reduce the risks associated with a Btn ited !l·.ange of
products.
You V{il] need to be ab]e to show the effects of tbe business purchase on the
statement of fina ncial position for the 'ne~v' business.
Aiisha a ndl Bo,:rak a.re· sol · trade . They agree ~o merg their ·t wo bu.sin into a
partnership as &om 1 January 2015,
The foUowing infonnation relating to the nvo businesses is given:
406
38.2 The amallgamat,on of two soie traders busjnesses 1
Aiisha Borak
$ $ $ s
CAPITAL AND UABI LITI ES
Capital 32700 94200
Current Iia bi Iities
Trade pa¥ables 2500 5000
Total capital and liabilities _j5200 99200
TI1e partners agree the foUowing values for the assets to be taken over by the partners.hip:
Aiisha Barak
$ $
Non·current assets 30000 70000
Invento ries 3000 15 OOO
Trade receivables 5000 6700
The partnership wouJd assume responsibility for the current liabilities at 31 December
2014 of both ole trader .
They fU'rther agt1 th=tt each partner wiU mrt in the partnership busines with.
capita] of S50000,.
·The partner.ship ba nkers have agr,e ed to, pt"Ovicle any ncc,cssa:ry overdraft raciU1ties.
Requil'ed
Prepare a statelnent of finandaJ position for the partnership as it would appear at the
start of trading on l January 2015.
Answer
Aiisha and Borak
Statement of financial position at 1 January 2015
s $
ASSETS
No n-c u rren·t ass:ets 100000
Current assets
Inventories 18000
Trade rece,ivables 11' 700 29700
Tota I assets 129700
CAPITALAND LIABILITIES
Capital accounts -Ai1sha SQ OOO
Barak SO OOO 100000
Current Ii a bi Iities
Trade payables 7 'SOO
Cash and casn equiva lents (overdraft} 22200 29700
Tota I ea pita I and Ii a bi Iities 129700
Workings
Capital account - Ai ish a Capital account- Borak
$ s $ s
Cash Bal bid
700 1 32700 Cash 1200 18al1bid 94200
Bal·c/d 35500 Valuationi
1
\'\'hy, you might ask, would a purchaser pay ino re than the \r~1ue o f the net as-sets
Goodwill is the cost of acqui,ring a (assets less the UabiUties) acquired?
business iless the tota[ value of the a.nd The purc haser is paying forth ad\."a:ntage of acquiring an alri ady established.
Ha b~ Iiti es that have been p utcha·sed. It is busin s. This advan·ta ~ usually takt:S 'the tonn of profits ·2 reat r than tho t; tbat
an intan.gible asset d,a,t is, it is without
p h;iska I su1bsta nee. could reasonably· be e~ cted on the tangible a · ets taken over.
On occasions d1 runount pa id for a busin i.s J ·s than th fair va]u of its
separable (individual) net assets; this resuhs in the purchase of negative goodwill.
Negative good"dJ] is shown as a negative atnount under the h eading of intangible
non~current assets.
When a successful buisiness is so]d, the vendor wm generaUy set the seUmg price
at a level greater than the value of the n et assets being sold.
The cash paid by the p1.u·d1aser of a b usiness to acquire the goodwiU is paid in
order to gain access to future profits generated by the business taken over.
Hovig ovms a successfuJ, busy genera] store. The late.st sununadsed statement of
financial position s h o,w·.s:
$
ASSETS
Non < urrent assets 120000
Current assets (induding, $1 OOO cash) 61: OOO
Tota I assets 181' OOO
CAPITAL AND LIABILITIES
Capital - Hovig 147 OOO
Cur rent liabilities 34000
Tota I capital and Iia bi Iities 181 OOO
Th o,p rung statem nt of financfaJ posi·ttio n for Faw:dg would app ar as foUow·s:
s
ASSETS
Non"(.urrent tangible assets 120 000
Non <u rrent inta ng i bi e asset
Goodwill 54000
408
38.3 The purchase of the business of a sole trader by a lim~ted company
Fo r 1no1-e o n goodwill. its u·eatn1e nt and valuation , se e Section 24.2 o n the structuraJ
changes in p artnerships.
Although the exan1ples u sed re fer to unincorporated businesses, the prindp]es
a pply to any bus iness pu ochrudng n et as se,ts at a p rice grea £er tha n a value of those
assets to the vend or.
s
ASSETS
No n-current assets 48000
Current assets 12000
Tota l assets 60000
CAPITAL 60 000
$000
ASSETS
No n..clJ rrent assets 1· 750
Current assets 290
Tota l assets 2040
Require d
Prop.are a sununarised statement of 6nanda] position for ea.bee Hay pk at
1 January 2015, bn mediately a ner tbe acquisition of the busin.e ss o f .Akrim.
409
m Business purchase and merger
Answer
Note
.ilii.m has made a cap·ital gain (pront) on the sa)e of h is bu sines,9 of $40000.
Ak:rhn's 30000 ordinary shares have a value to Akdn1. o f $65 (lOO ($100000 purchase
eonsiderado n Jess cash $35 QOQ,) or 82.17 per share ($65 000/30000).
•••••••••••••••••••••••••••••••••••••••••
> Now try Question 2.
o]e traders, A.~e] and Brian , de-cide to fom1 a Bn, ited cotnpany, Briaxe] Ltd, that wm
incorporate both b usin esses. TI1e company w iU comtnen ce trading on 1 February
2015 and wmh ave an issued sh are capita[ of 400 OOO ordinary shares o f 81 each to be
issued at p ar; the s hares wiU be d ivided equ aUy between the two tnen.. Staten1ents of
fina nc ia l p osition fo r the t\vo b usinesses at 31 January 2015 are .shov.'"n :
Statements of financ.ial position at 31 January 2015
Axel Brian
s s
ASSETS
Non-< u rrent assets
Premi'5es 60000 80 000
Machinery 40000 50000
Vehicl'es 12 000 lOOOO
11 2 OOO 140 000
1
410
38.4 The purchase of more than one business to form a new lim~ted company
All assets he ld by the hvo soJe traders wiU be taken over by Brfaxel Ltd at th e
fo Uowing vaJue.s. The new~ cotnpa ny w ill assutne re:Spons ibiUty for the payn1ent o f
current UabiUdes.
Axel Brian
s s
Premlses 100000 90000
Machinery 20000 20000
Veihides 10000 10000
Inve ntory 7000 8000
Trad~ rec~,ivabl es 5000 7000
Requll'.'ed
Prepare a statement showin g the fi nandaJ positio n of BriaxeJ Ltd at the Sl[art of trading
o n 1 February 2015.
Answer
Briaxe l Ltd
State me nt of financial position at 1 Fe bruary 2015
$
ASS ETS
Non-cur-rent assets
Goodwlll 128500
Premises 190000
Machfne,ry 40000
Vehicles 20 000
378500
Current assets
Inventory 15 OOO
Trade rec elvab Ies 12000
Cash and casn equiva lents 3500
30500
Tota I assets 409000
411
m Business purchase and merger
Workings
Good~..mcakulations
You could also lbe asked to dose 1he tPur-chai 'consideration Jess value of A:. el's net ass taken ov r by th~ company:
books of account for each sole trader. Jn
such cases dlo· not attempt to ainsweir both 200 OOO ordinary shares of 1 each =9.2,00000
parts of the question at the sam,e tiime; ($100000· + 20000 + $10000 + $7000 + $5000 + $2000- 4000) =$140000
treat ,e ad, pairt ais a1separaite task.
Value o f goodwnl (Axel) = $6000Qi
'Purchase' consideration less value of Brian's net assets taken o,ver by the company:
Answer
Rea Iisatio n account
$ $
Prem~ses 80000 Trade payabies 5000
Machinery 50000 Briaxel Ltd 200000
Vehk.les 10 OOO
'I nventory 9000
Trade receiva b.les 7500
Casn 1 SOO
Profit on realisation 47000
205 OOO 205 OOO
6 Explain why TuVo soi,e traders m1~ght combine their bus~nesses and form a ,imit,ed
co:mp.any.
7 When tvvo sole traders form, a1!~mit,ed company they would reta,~n the p1ninc1ip!e
of unUmirted l~abi1Uty. True/Fa~se7
412
38.51he purchase of a partnership by a lim~ted company
Yukio and Mussa. are in part neeship, sharing p rofits and losses in the rat10 of 2:1
respective]y. A state tnent of fina ncial position a t 31 January 2015 shovted:
The partnership was taken over by Sparta plc before the start of business on
1 February 2015. The p u rch ase cons ideration was $400 000 consisting of:
1
$30000 cash
$6oOOO seven per cent debentures to be shared between the pannet'.s in their profit
shadng ratios
B00 000 ordin ary shaH:s of S0.25 each shared equaUy between the partners.
1
For the purposes of the talreover, the partnership assets .have been valued as follows:
s
Premises 200000
Office equipment 20000
Vehicles 50000
lrw entory 16000
1rade receiva bles 5000
413
m Business purchase and merger
Sparta pie
Statement of financial position at 31 January 2015
sooo
ASSETS
Non -c.u rrent assets
Land and buildin9s 6700
Machjnery 560
Vehic1es 300
7560
Current assets
Inventory 56
Trade receivables 34
Cash and cash equivaiemts 17
1107
Tota I assets 7667
Requii:ed
~ Prepare, a sunement ,o f financial po,:sition for parta plc .a t 1 F,e bruary 2015
imn1-ediateiy after the 'Eakeo,vet of 'Eh partner hip.
Based on the purchas consideration pric'=, ,c akuJa'te the value of ,o n€ share h ld
by a pa rtner on 1 February 20,15,
Answer
Sparta pie
Statement of fi na ndal position at 1 February 2015
$000
ASSETS
Non-current assets
GoodwJII 11,7
land and b utl d1ri gs 6900
Machinery 560
Offi c:e equj pment 20
Vehides 350
7·947
Current assets
Inventory 72
Trade rectrivables 39
n,
Total assets 8058
414
38.51he purchase of a partnership by a lim~ted company
Using the info nnacio n g iven in the ab ove exan1pl,e , show the entries required in the
partnership books of account to d.isso]ve the p aetne t·ship of Yu kio a nd f\.lllSSa.
Re men'lber do not uy to dose the books o f account at the satne titne as you
prepare the oompany s state ment of finandal position. Treat each patt o f such a
1
Answer
Realisation ac,c ou nt Sparta pie
s s s s
Premises 150000 Spart.a pk. 400000 ReaUsation 400000 Cash 30000
Cap- Y 40 000 (deb)
Office eq u rp m·e nt 40000 Trade payables 8000
Cap-M 20 000 (deb)
Vebicles 60000
Cap - Y 155 000 (shares)
~nventory 18000
Cap-M 155 000 (shares)
Trade rnce,ivables 6000
400000 400 000
Cap·ital - Yukio 89333
Capital - Mussa. 44667 Loan account - Mussa
408000 408 000 $ s
Bank 50000 I Bal bid 50000
415
m Business purchase and merger
Ca pita I accounts
Yukio Mussa Yukio Mussa
s $ $ $.
Bank account
$ $
Bar bid 4 OOO Loan - Mussa 50 000
Sparta pie 30 OOO Ca,pital - Yukio 14333
Capita~ - Mussa· 3·0 333
64333 64333
The "'itaten1ents of financia] position at 30 April 2015 of .,~ av'a ne Ltd and Borg Ltd
'\'\l"et-e as foUo'ft\,"S!
$ $
ASSETS
Non-current assets 565000 120000
Cur rent assets 84000 28500
Tota I assets 649000 148500
41'6
38. 61he acquisition of one !limited company by .another Iimited company (am algamation) 1
On 1 Ma.y 2015 Amvane Ltd acquired aUthe assets of Borg Ltd ~,.cept the bank
ba]~nce ($2500) and ass1JJm .· responsibility for paying the c1JJn-ent li.abilitid. Th
purchas oonsideradon oonlsisted ,o f 75000 shar in Ara\rane Ltd at par, with any
balance being paid in ,c ash.
Require d
Prepare a statement of 6 nandaJ position for Aravane Ltd at l May 2015 itnrnediately
a fter the acquisition of the net assets of Borg Ltd.
Answer
Aravane Ltd
State ment of ii nanda I position at 1 May 201 5
$
ASSETS
Non-current assets 685 OOO ($565 000 + $120000)
Workings
Ne t assets of Borg Ltd = $128000 (Aravane -would not purchase the bank bafa.nce:" o f
Borg). The purchase consideration was $75 OOO in shares and the ba]ance $53 OOO in
cash.
The retained earning ar merely a book entry in Borg books of account, so this
do ·s not f earu r in the;; 'new·~statement ,o f financial position,
The assets of the ,c ompany being taken over are unlikely to be taken over at the book
value shown in the companys st:aten'l!ent of financial position >as in the previous
worked e.."Xarnple.
'\When the purchase price is greater tha n the value of the n et assets being taken
over then the excess represents a payn1ent for goodwUL
The foHowing stat,e tnents of financial posi.t ion at 31 Ju]y 2014 are given:
417
m Business purchase and merger
Ade;Jiaide pk took over the assets of Bradford (~."cept the cash and cash equivalents)
o n 1 August 2014 at tb following values?
$000
Premises 350
Pliant and ma eh in ery 75
Ve hides 40
Office equipment 50
lnventory
1
18
Trade rece.ivables 6
shar s of $1 in Ad falde pk .at a prk,e o f $1.25 each .and the ba]anc in cash.
R quit· d
Prepar~· a statcm nt of nnancial position for Adelaide pk , t 1 A.ugust 2014
in1,nedfate ly after th\;' acquisition of Bradford Ltd.
Answer
Adelaide pi c
Sta·t ement of fi na nci a I position at
1 August 2014
$000
ASSETS
Non-current assets
Goodwill H7
Premi.ses 3050 ($2 700 + $3 50)
Plaint and mac hi ne1ry 127'5 ($1 200 + $75)
Venides 840 ($800 + $40)
Office equipment 450 ($400 + $50)
5732
418
38.7 The acquisttion o,f a shareholding·in one limited company by another lim~ted company
Cu rtent assets
Inventory 83 ($65 + $18)
Tirade receivables 23 ($1 7 + $6)
106
Total assets 5 8~8
EQ UrrY AND LIABILITIES
Equity
Ordinary shares of $1 each 4500 ($4-000 + $500)
Share premium 12S
Reta i n ed
1
earnings 1194
5819
Current Ii a bi Iities
Trade payables 12
Cash and cash equivalents 7 ($24 - $25 - $6)
19
Total equity and liabilities 5 83 8
Note
The vahu~ to Adela ide p]!c of the assets taken ove-r ·was 539000 less payables of
$6000, givi..n g a ne t asset valu e of $533 ,OOO.
GoodwiU is therefore valued at $117000 (purd1ase considerat ion · 65000Qi less
$533 OOO value of net assets tak en over).
The foUowing sununarised info lmation is g iven for m"D Urnited con1panies .at 30
Novernber 2014:
419
m Business purchase and merger
EQUITY
Ordina,ry sha,res of $1 each 25 000 500
Retai n.ed eairn in gs 30 340 325
Tota I equity 55340 825
Answer
In each case the state1nent of financial position for Beach would remain the s~une
as sho\\-,1 ln th question. The only change that has taken plact! is the change in the.;
ownership of th ordinary shar ; this ohangi;.: W'Ou[d b r oord d in Beach,s regi ter
of mcmb cs h Jd at the company's r gis t,ered ofno .
1
The ,equity section of tl1e statt:tnent of financ ia l. position would remain the sarne in aJJ
cases:
$000
Equity
Ordinary shar~s of $1, ~ach 25000
,Retained ea,rnings 30 340
Total equity 55340
The answer shown above involved a p urchase p rice of $1 per sh are in Beach pk.
Consider the statements of financial position if the purchase, price per ordinary share·
had been:
... $1.10 per shair,e
t, $1.60 per hare or
t 12.10 per hare.
420
38.7 The acquisttion o,f a shareholding·in one limited company by another lim~ted company
Once again the equity section in each scenario would not change~
EQUITY sooo
O rd~n ary sh aires of $1 eac: h 25000
Reta i ned eatning s 30.340
Tota l equity 55340
Gon1pany A may gain control of Company B by purch,sing m nore than 50 per cent of
ordinary shar·es in Company B.
:In such a case, cotnpany A is known as the holding company, while Company
Bis known as the subsidiary company, If Company A owned aU of the ordinary
shares in G:unpany B, then Con1pany B would be a wholly owned subsidiat-y.
Take the exrunple of Beach an<l Sands above.
• Jn example (a), the investtnent should be recorded as a non-current asset ( unti] the
fina] year of ho]ding the investn1ent Vif•ben it would be classified as a current asset).
• l n exan1ple (b), Beach pk should be regarded as a subsidiary con1pany.
• In exan1pJe (c), Beach pk-,vould be a whoUy owned subsidfary of Sands pk.
Owneirs genera Uy w~sh to corn bi ne bus1inesses to g1a1,n greateir f ~na ndal benefits. (i.e. a1
pos~tlive return on i nvestm·en1).
Soi,e traders may comb~ ne the~ r busi nes ses to achieve this.
When a1i~m1i1ted com1pany a,cqu~res anofuer busjness the purchase cons~derat~on 1ma1y
be made up of cash, debentures or shares. or any com~nat1on O·f the tliree.
So~e tradlers o:r pa1rtnersh1ps may com1bine to ach~·eve a1greater return, on investment,
Un~ncorporated businesses may be purchased by a limmtedl company for the same
reason.
llim1~ted compan ies acqusre the share cap~tall or a1proport1ion of the· share capjtaill ~n
other !~mrted c:ompan~es f or the return that the investment w~II yi-e1d.
42 1
Consignment accoun s
~ir, an cport based in outh Africa s · ds goods to in1, her ag nt, in Kuala Lu111pur.
i
Ankir purcha ed the goods for S1000 on 1 ApriL b paid freight charges of $120.
Shn incurred Malaysian huport d uties arnounting to 1235 and further e..~panses of $65.
Shn sold tl1e goods for 12150. H~ deducted bis expenses and his cotnn1ission of 10
per cent of sa]es. Sim remitted the an1ount due to Ankir at the end ,o f ~ay.
Required
Prepare appropriate accounts in ...,i\nkir's books o f account.
Answer
422
39.2 Commission
Dank account
s $
Sim 1 6~5 Consiginment account - Sfm 120
39.2 Commission
If a question gives the sa]es o n the consigntnent after the deduction of the
conunissio n earn ed by the consignee, the amount of s~les befor,e deduction of
comn~iS.5ion tnust be detenruned for inclusion in the consign1nent account.
Worki·ngs
7.5 pei- cent of the sales value gives the cotnu1iission earned.
TI1e sales value divided b}1 0.925 ( 100%- 7.5%) will give the sales net of conunission.
Sales before deduction of con1n1tssion $4500 7 0.925 (92.5%) = $4865.
Now· try these ca]cu1ations to deteonin e sales frotn ~ rhkh the con1n1ission has b een
deducted:
423
m Consignment accounts
Answer
~Jes of $2100, $·17 360 and $20667.
800, 'll.'lniES of a product ,costing 82.50 acb hav be ·n desp.atch d to, VJn ~g nt Duti s
and landing charges amounting to $600 have n paid. At the financ ial year end
100 units re,nain unso,ld with th ag nt. The inventory is valued at 1325 (cost 1250 +
100 X $0.75) ,
Chang, a trader in Hong Kong, sent a. consignment of 450 units of his product to
Umesh~ an agent in NepaL The goods had cost Chang $68 each~ he also paid freight
a nd 1nsurance costs a tnounting to $360.
At Chang's financia] year end Un1esh had so)d 380 units for 90 each. Un1esb
A d el c redere agent js an ag~nt w ho
had pa1d landing charges 1800 import duUes of · 675 and other direct expen.s,e s
guarantees payment by a cust om er. For t hirs
guara ntee t he agent is pa id an ~ddtt ional o f &45. Umesh is paid 5 per cent commission on sa]es plus 25 per cent deJ credere
co mmission. con1,russion. At the nnancfatJ year end Un1esh sent Chang $25000.
Required
Prepare:
Th consignment account in Chang>- books of aooount.
Um sh' account.
Answer
Consignment account - U mesh
$ $
Goods on consignme nt 30 600 Umes h. - sa les 34200
Bank - freight and insurance 3 60 Ba l'anee cld 5208*
Umesh- landjng charges 1800
'Umesh - import duties 675
'Limes h - other expe nses 45
Umesh - basic: c:o mrnisston 1 710
Umesh - del credere commission 855
Consig:nm ent profit 3363
39 408 39408
Balance bid 5208
• This balance is rnadu up of 70 units of the product unsold (cost $68 + freight and
insurance $0,8 + fanding charges J4. + bnport dudes $1 .50 + other direct O."J)en.ses
~0.10 so 70 units at $74.40 per unit).
424
39. 3 Va!uat~on of inventories rema tning with an agent
Umesh
s $
Consiginment account - sa,tes 34200 Consiginment account - ·landing chairges 1800
Consi gnme nt accou:n t - import duties 675
Co111signment account - other e~ense:s 45
Consignment account- comm,issiori 2565
Bank 2socm
B.aLance dd 41 15
34 200 34200
Balance bid 4 11' 5
A cons,gnment is groods sent by the ,owner (the· cons,gnor) to an a.gent who then
seHs them on be·ha1Hof the consignor.
The d·ebtt side of the consignment account r,ecords aH expenditures incurred by both
the consJgnor and hjs agent re~ating 10 the consignm,en1 .
If the d,eb~ts are greater than the credrrt entries 1hen a, loss has been incurred; jf fue
credit s~de is the la1rger then the cons~gnment has been prof~table.
~nventor,es held by an agent a1 a year ,end are valued: care must be taken in the
determinahon of the cost of these, goods. Onty costs relati1ng1 to die unsold goods a1re
~ndu ded ;n this va ~u ati orn.
425
Joint v nture accounts
Se]ena. and Micha enter into a joint venture. They both supp]y n1aterl~ ls and seU the
finished products. Profits are to be .shared Sel,e na two-thirds and rvlicha one-thtrd.
$
Materials supp~ ied Serena 3400
Micha 2900
Wages paid Sel,ena 800
Micha , , so
Micha· paid warehouse costs 315
Micha pa id de Iivery costs 199
Other selling expenses pa1d Sel:ena 238
Micha 307
C: asn received from sales Set~na 6780
Micha 5220
426
40.2 M,emorandum joint venture accounts
Requit-ed
Prepare the c;;ntnes relating to the joint ventur in ·t he books of account of:
1 :.olena
{kha.
Answer
Selenals books of accoun t
Deal with ea.eh party 1o the j,oint venture The entries shmvn a bO¥e are e ntered using basic doub]e-eotry princip]es.
se·paratei1y. In the example shown, we In Selena's books of a ccount the re wiU b e a credit entry in th e purch ases a ccount
first make the ·entries j n Sefena 's books of in he r genera l ledger for $3 400; there wil] be two credit entries in her cash book for
account. When these entries have been $800 and $238 an d a d ebit entry aino unting to $6 780.
c:om,pf.eted we 'then m1a1ke the e·n1riies in Micha's double entry would be ,o on1p leted with the fo]Jowing cash book e ntties:
IMic:ha's books. a debit entry of $5220 and credit entries of J 150, $315, 199 and $307. There wouJd
- - - - - - - - also be a credit entry jn hi purchases account of $2900.
427
m Joint venture accounts
Now that the patties k-now th e pront ,eatned it can be e ntered in their own joint
v,e nture accounts. Th is \V'ill determine how much cash needs to be transfe rre d
between th,e parties to draw the venture to a close.
l:n -elena' books ,o f account:
Being p ~nt of a joint venture does not guarantee that the ventw:e wUJ be profitable,
although parties to the ,:enrure ,o bviously '1--ish it to be so. hou]d a ]o s aris af£e1
Ehe ventur is v.round up Ehis woul d b born b},· the pardes in th agr~«t ~profit'
sharing ratios.
A h a red loss ina.y not ahogetbe r b what the parti s would ha¥ \\l"isbed but the
venture may lead ro, a 1norc pro nta bJe venture i:n the future ot· even increase uadc in
their d ay-to-day oou rse o,f business.
428
40.2 M,emorandum joint venture accounts
1 Jojnt ventures can on1¥ be entered into by joint stock co1mpanies. Tru~a1l!se?
2 How many parties can be 1involrve-d 1in a joint venture?
3 E~pla11n the difference lbetv,;een a joJnit venture and a partnershjp_
4 A jojn1 venture can only be entered into by peopl,e Uving1In drfferen1 countries.
··························~··············
> Now try uestion 1 . lirue/fals·e?
429
•
Corn put r1s d accoun ing
systems
By th e e nd of this cha pter you should be able to:
• e:xpia1in the need to computeriise an account~ng system
1.4 Computerised accounting systems • discuss the adrvan1ages and disadvantages that occur
when a computer~sed system is introduced ~nto a
bus~ness
• e~plain the process of computetis,ngi a,n accounttng
system,
• descrrbe ways tha:1 ensure the ij ntegrrty of a,
computerised system.
430
41.3 Benefits to staff of using a computerised accounting system
A good IT system of co1nputerised accounting ~iU aUow aJU le\<"e1s of maoogenl-ent to~
• creat<; plans
• put tho plans into practice
• C·o ntrol activitic '
• evaluate outcomes so, that adjusunents to the business can be· n1ade and any errors
,can be rectified quickly,
A cotnputecised accounting systen1 provides managers with insl!ant and up-to-date
reUable infbrtnadon in real titne that can be u s,ed to plan and cont.roi the business.1
a Uowin g pron1pt decis io n n1aking. lnforrnation obtained fron1 the con1puterised
accounting systen1 can be used to help guide and contro] bllsiness po]ky.
41.2 Spreadsheets
A spreadsheet is a 'table o f c,eUs (boxes) arranged in rov.t.s and coJutnns in which text
and figures ate e ntered. The computer works out any caku lations that nero lo be
made. Managers .and staff at aU l,eve]s c:in use spreadsbeeui for a ·variety of tasks.
The tnajor advantage of using a spreadsheet is that if any figures are adjusted aU
other figur affected a,~ ,changed aut,o,matically. For exacnp]e. 'What wou]d happen
t,o an other parts of the busin s if sales w,~ to lnc:r ase by ~ ven per ,cent?'
Changing this on variabl v.110uld ~timulate automatk r ·c l,cuJation of chang m
a U re] ated areas.
431
m Computerised accounting systems
41 5 Disadvantages of introducing a
computerised accounting system
• Hardwar _ costs: The initial CQ.'!i."'tS of instaUing a ,computerised aocounting · yst~m
can be expensive. Onoe the dred.sion has b~en rnade to instaU a system) the
hardware "..-m ki.evi·ta bly need to be updated and replaced on a regufar basis,
leading to further costs.
• Soft"\\rare costs: Accounting software needs to be kept up to date. Investment in
software therefore requires a ]ong-tenu financial comtnitnrent~
• Sita.ff training: Staff wm need training to use the software and training updates
eaoh tirne the system is tnodified.
• Opposition &orn staff: S0n1e staff n1ay fee] demotivated at the piuspect af using
a co1nputerised syste1n. Other n1;en1bers of staff n-aay fea:r that the introduction of a
new S}1Stem wm ]e3d to staff redundancies, whkh could inch.1 de then1. Changing
to a cotnputerised systen1 can cause disn1pcion in the wurkplace and changes to
existing working practices may 1na ke staff fee] uneasy.
• Inputting t·rors: ·caff can becon1e con1p]acent bt,caus~ inputting into the ystem
beco1ne$ more repetiliv:e and tl1e1'1efor,e they ,nay Jos - concentration v..~hich can l ad
to input not .
• Da1nage to h alth; Tb rf,;: a11 1nany cases of reported health hazard to .staff
working ]ong hours at a compu tcr tetminat The health issues range frotn repetitive
strain injrurie.:s through to backache and headaches.
432
41.6 Computerising the records
They are also integt"aled, which tneans that the input of o ne transaction is recorded
snnuhaneous ly in anthe appropriate accounting records. For example, when the
receipt of an invoke fcorn a supplier is keyed into 1the syste1n1 a]] ]edger e nt1ies are
made instantly:
• the supplier's account in the purchases ]edger is Cfled ited
• d1e- p urchases account in the general ledger is debited
• inventory records show an increase in goods heJdl.
Wh~n th~ supplier is paid:
• th.e bank sc,oou ru: is er~ dited
• Eh suppli,~r>.s account l debit d.
433
m Computerised accounting systems
434
Investment and o her ratios
Information frotn the financial statements of Oyan Magenta ft'Dlll Chapter 27 is given.
Data in the foU owing sections wiU be based on this infom1ation:
435
m Investment and other ratios
Extract from statement of changes in equity for the year ended 31 March 2 01 5
$000
Retained earnings
.Balance 1 April 20 14 595
Profit for the year 309
904
Divtdends paid (55)
Ballance 31 March 201 5 849
Additional information
2015 2014
s $
Profit for the year after tax and .preference dividends 309000 287000
Debenture interest paid durrng the year 40000 'f 6 OOO
1Ma rket price per share 1.70 1.50
Dividends paid during the year
Preference shares 6000 6000
Orcfinary sh~res 55000 48000
Working capital cycle =Trade receivables turnover + Inventory tun1o"·er - Trade payables turnover
2015 20 14
34 + 29 - 43 = 20 days 41 + 30 - 46 = 25 days
In both years the rados seem accep table. There has been a sligbt hnprovetnent of
the situation. Although receivables a nd in,re,nto ry tu rnovers a re inoving in the right
direction, for sot:ne reason the ccnnpany is paying its payables son1e 3 days fas·ter! The
shorter the cyde ~ ·t he lower the value of working capital needed ·t o, be financed &o·m
otber sources.
Th cyd can b · hon n d by~
• reducing levels of inventod heJ cl
• spe-cding up ,coUecdon ,o f monies from receh,"ahles
• delaying payo1ent to payables.
2015 2014
Interes t charges
Income gearing = x 100
Profit fro.n1 operations
201s 201
437
m Investment and other ratios
'B oth rado,s a re low - interest is easily covered by pt"O~:i'ts. However, in the second year
the income gearing has incr~as cl by n1ore than half dut: to the incr as d debe.nrure
intel'1 ·t. Debentur have· ri en from $200000 to, $800000 so a fuU
1
year intere ·En ~t y~ar wiU be $·64000~ which could incr ase.: th income gearing
,even n1ore.
Fixed cost ea pital Non-current JiabiJ ide s + Tssue d prefe.tence share capital
Gearing ratio l!l!I ~ -
TotaJ capital Non-current liabilities + Issued preference shares + Issued ordinary shares + A.U re.serves
2015 .2 014
800 + 100,
~~~~~~~~~ - 900 X 1.00 200 + 100 _ 300 X 100
800 + lOO + 1500 + 84'9 3249 200 + 100 + 1500 + 595 2395
=27.7% =12.5%
The gearing of a con-11pany is said tto be:
• high when the ratio is n1ore than SO per cent
• neutral when the ratio is SO per cent
• low when the ratio is Jess than 50 per cent.
438
42.5 lnvestment ratios
Earnings are p1rofit for the yeair a,'ft-er 42.5.1 Earnings per share
taxation a1nd preferenc:e dJvidends; tha1t is,
In year 2014: :E amings are i3n9 OOO profit for the year after taxation and pr~ferenc,e
ea,mtngs the1t belong to1:all¥ to the ordinary
sharehollders. dividends, dutt is, profits avaUabJe for ordinaty shareholders
ln yeaJ" 2015 ~ Earnings are $319' OOO profit for the year after taxation and
preference dividends, that is~ profits available for ordinat11 shareholders
The earnings per share (EPS) increased in the second year. It huprovcd by 1.5 cents
per share.
201S 2014
Investol's are more confident at 31 !vJarch 2015 than they were a year eadiec·. They are
paying 8. 25 times the earnings to acquire shares in Oyan l\llagenta plc.
Since the ratio cotnpares current market price with earnings per share~ an inoease
in n1a rket price will increase the ratio. Den1and for shares is dependent on investors'
perception of the cornpany'.s future pedom1ance. An increase in deinand for the
shares VtriU generaUy cause an increase in the share pdce-. A h1gh P/E ratio \ViH
indicate e}..."'Pected future growth (or an overvalued share). A Jow P/E ratio indkat,es
e..xpected poor perfonnance in the future (or an undervalut:d shat"e).
439
m Investment and other ratios
2015 2014
The dividend y.it:ld is stlU lo·W but has inct~a, d .slightly in the second year.
Anoth r ve.r ·ion of the f onnufa ist
2015 2014
309 OOO . 287r000 = 5.98 times
--- = 5.62 omes
55000 48000
Both are quite high but the .second year shows a slight deterioration. Although
profits have tncreased (J.7 per cent), the dividend pa id has increased by a greater
percentage (14.6 per cent) . Is ·t his a sign of a ,c hange in divide nd policy?
440
42.5 lnvestment ratios
I cyde ,cakulated7
1 How is the working capita1
2 Geanngi shows ho\tV much long-term finance a limited company needs. Truer
Fabe7
3 Sales "7 Number of shares =Ea1r1n~ngs per share. 1irue/fa~se7
4 A l ~m1,ted co1
mpany has ~ssu1ed ordiinary share ca~tall $100 OOO; preference
shares $50000; reseives $120000; debentures $70000. This company is high~y
geared.
lirue/fals,e7
S A hmtted company has an i1ssued ordinary cap~tail of $200000. Each share w.as.
~ssued a number ,of years ago for $0.25. The totall dividend pa;d for 'dire year is
$56000. l he current rmarket pruce irS $0.70 per share. Calculate the dtvidend
yield .
••••••••••••••••••••••••••••••••••••••••• 6 What is meant by an 1nvestrnent ratio?
>- Now try Qu stions 1- 5~
from opeH,atio ns
• gearing rai11io wh~ch indicates how reHant a business is on outside fina1nce.
1
The investment rat~os are mainly used by potential ~nv,estors to dete:rm~ne whether an
~nvesiliment shoulld be ma de ~n the co1mpany. They are:
1
• earrnings per share - the aimount of profit attjdbuitabh~ to ,each ordtnary share
• price earnjngs ratio - 1he number of years' earnings that an 1investor i1s prepared to
pay to purchase one share
• d~vJdend yield-what the div1idends rece•ved by the share·ho~der are, expressed as a1
id for the share
percentage of the pr~ce pa1
• di1vjdend cover - how mainy t,mes 1he curr,en1 di:vktend ·Could have been pa1id out oi
profit
• di1vjdend paid per share - the actua1Idwidend pa1;d on one ord~nary share held.
441
Activity based costing
r
By t he e nd of th e chapt er you s ho uld be a ble to:
2.1 Activity based costing (ABC) • define the,ter1ms used 1in an actwi1ty based costi1ng
syste·m1
• allocate ap propr1ia1te overheads to cost dnlvers
• ca~oulaite arctirvi1ty cost dr~ver rates
• absorb direct and ~nd ir-ect ·costs into a1product
• caku!ate a semng price after the absorpt~on of aU costs
• identify the advantages and d1isa dvanta91es of us~ ng
an actirvity barsed costing system.
442
43.2 Stages in using an activity based costing system
$
Machinery set-up 7452
Ordertn g costs 6000
Quality control 1 972
Selti ng ex:penses 7225
Product seUing pri,oo is based ,o n ,cost plus 30 per cent
Additional infot~n1,ation
Requir d
Cakulat,t:.
Th activity-co~, driver rate
J Overheads per product
r Tota] cost per product
d SelBng price for each p,roduct.
Answer
a
Activity Machine set-ups Ordering Qua Iity control Sel Ii ng expenses
Cost ($) 7452 6 000 , g7.z 7225
Cost driver 54 6000 68 8500
Cest driver irat e $1 3 8.00 $1.0 0 $29.00 $0.85
443
EEi Activity based costing
Total ove1heads:
A $ 11 120 ($4140 + $3 OOO + "580 + 534 00)
1
C
Product A Product B Product C
s $ $
Atloc:ated di rec:t costs -
mat er~als 10 OOO 3000 9 000
l'abou r 12 OOO 1'5000 4 000
Apporti o n.ed overh ead.s
Tota l cost
------
11· 120
33 120
670'5
24705
4824
17824
T he seU ing p rke can be detenn ined by using the tota] costs fron1 (C;) or by using
the on it cosui.
Using total costs 533120 x l.3 (lnarkaup) =$43-056 for 5000 units o:f A
elling price per unit of product A= $ .61 (143 0'""6 .;. 5000)
Tota] costs 824705 x 1.3 = 32117 for 3000 urut of B
elBng price p r unit of product B =$10. 71 ($32117 + 3000)
Tota] costs S17 824 x 1.3 = 23171 fo,r 900 units of pro duct C
Selling price per unit o f p roduct C =$25. 75 ($23171 .;. 900)
Using u_nit costs for each p ro duct:
444
43.4 Limitations of applying an activity based system of apportioning overheads
ABC allocates costs according1to how those costs are actuallly consumed.
• It is argued that ABC allIce.ates costs in a more accu1rate way by 1identifyin g the
a c:tiv~t1ies that dri1ve each overhead.
Cost driiVers measure the use oi each ove;nhead in shared actjvrt1ies.
ABC links cost 1recovery to ,cost be:haV1iour.
When the activirty cost drw·er rate ~s caku~ated the rate can then be alllocated more
accu rat,eily.
445
Budgeting and budgetary
control
By th e e nd of this chapter you should be abl e to :
2.2 Budgeting and budgetary control • understand the need for bu dg·eti ng
• expla•n the benefits of budgets arndr budgetary
control
imjtadons of b udgetjng and bud g;etary
• ·e ~lain the l1
control
• prepare: sailes budgets: production budg:ets;
purdhases budgets; taibour budgets; trade
recewabies budgets; trade· payablfes budg,ets;
cash budgets; master budgets (budg,e1ed hicome
statements and budgeted staiements of finanoia~
position}
• expllain the need to flex a budget
• prepare a f ~exed budget statement
• calcu~a;te variances t hat adse when actual
performance da-ta ~s ava~lable.
446
44.2 Production budgets
Requ it-e di
Prepare a sales budget for the three months ending 31 J\;1arch.
Answer
Sales budget for the three months ending 31 March
January February March
Bud g e1ed sales 10 12 113
Budgeted sa1es tt!ve riue $2 1 OOO $25200 $27 950
months.
Answer
The total production for tbe tht"eC n1onths is found by u sing the: fo]Jowing calculation~
Note
The cakuhnion ha.s been used 'to detennine the budgeted production for a period
of three months. The san1e ca]culation could be used to determine the budgeted
production for a nionth. six n1onths, a year, etc.
An ven production flow· m an that Za id ·wjU h.av to, produc 12 ma.chin p r
month. The pr,o ducdon budg wi]] look lU· this:
447
mBudgeting and budgetary control
Dansc Ltd. has the foUowmn budget for sales ,of 'Hn1ts':
Answer
Units
'Budgeted sa'les (1' 20 + 140 + 160) 420
Plus Budgeted closingi inve,ntory 41
Total1p1urchases needed to meet budgeted sa~es and closingi inventory 461 1
Danst wiU need 110 purdi.ase 435 units in tota] during February, 1\llat·ch and April. If an
even arnount of purchases ·\ vere required each month throughout the ye ar~ then 145
u nits (435 divided by 3) wou]d b e pu1·d1.ased each tnonth. T herefo1ei using the figures
that we nov.r know, the budget wou]d look Bke this:
448
44.3 Purchases budgets
We can now fin in the pps (we hop~) by· working back through the ,n,otu:hs:
It is n ot usuaUy necessa i•y to h ave an eq ual flo w of purchases each m onth. However~
it n1ight be necessary to have a specified number of u nh:s held as inventory at the
start o f e ac h rnonth.
The 1n ethod of ca1culation fo r this typ e of b udge t is the san1e as th at used in the
p revious exa1np]e.
Borga & Co. supply the following bud eted saJ s Agui s:
Answe r
We can calculate the op ening invento ry eac h m onth frorn w hat we know:
449
mBudgeting and budgetary control
If eadt unit of pur,c hases ,c osts $2.00, the budget in terms of $s spent would show.
Cedse has produced tthe f:oUo,'lling p roductio n budget for tbe du·oe numths e nding 31
August:
Each unit o f p roduction requires four ho urs o f labour. Each w orker works 40 h ours
per we,ek . Cerise has 100 w o rkers.
Requit·ed
Prepare a fa bo ur budget for the three nIDnths e nding 31 August (assun1e fo ur weeks
in each mo nth).
Answ er
The budget show~ th~t in July Ceris ha a shortag of vrorkers requit d to meet
:i
450
44. 5 Trade receivables budgets
The n1anagers o f Ch in Ltd provide the following budgeted infonn ation for the three
n1onths e nd ing 31 Afarch:
$
1 January amounts owed by credit customers 31) 000
Budgeted credi.t saJes for January 40 000
February 50000
Maren 60 000
Cash sales for Ja nuary 12 000
Feb,rua,ry 10 OOO
March 14000
All c-redit cu~o,n1e rs ar,c expc"Cted to sen[e their debts in the month foUowing the ale
of goods. They a re aUowed, and wiJl take, five per cent cash d iscount.
Requit-ed
Pt-epare a tradle recehra bles budget fo r the duee n1o nths ending 31 !\.'larch.
Answer
Trade receivables budget for ·t he three months ending 31 March
Note
Cash sales h ave n ot b een mduded . Cash customers do n ot have an acco un t in the
sales ]edger. Cash custorne rs are n ever tra d e i·eceivabies. The cash received fron1 cash
sales ~-...m
be recot'ded irn a cash budget (see below).
451
m Budgeting and budgetary control
Th · manag,er.s of Novotny Ltd provide d,~ following infom1ation :for the tht'i e months 1
ending BO No:vember:
s
July
1
33000
August 27000
31 August amouflt OV11ed by credit customers 3 8 OOO (receivables from July $ 11 OOO;
r eceivables from August $2 7 OOO)
Budgeted cre dit sales September 30000
October 39000
November 36000
T wo-thirds o f credit custo iners a re expecte d to settle the ir debts in the tnonth
foUowing reccipt o f th~ goods; tbe re 111ainder w iU settJe two, n1ond1S after receipt.
Requil'ed
Pr par, a trad rec ·vabl,t:s b udg rt: ~or th three rnonths nding 30 Novembet.
Answer
Tr-ade receivables budget for the three months ending 30 November
September October November
$ $ $
Bala.nce brought forward
1
38000 39000 49000
C redit sa l~s 30000 39000 36000
68000 78000 85000
C ash rece~ved (18 OOO) (Aug) (2,o OOO) (Sept) (26 OOO) (Oct)
C ash rece1ived {11 OOO) (Ju~y) (9000) (Aug) (10000) {Sept)
••••••••••••••••••••••••••••••••••••••••• Ba,l!anee ea rrted forward
1
39000 49 000 49000
Now try Question 2.
The n ianagers of Pavfa Ltd provide the foUowing. jnfor m:Hion for the three months
ending 30 June:
$
1 ApriJpredicted arnou nt owed to trade ,payables 1'4 000
,Sudg,eted purchases on credit terms for AprU 15000
May 16000
JU,ne 17000
:9udgeted casri purch,a,ses AprH 2000
May 5000
June 3 000
452
44.6 Trade payables budgets
...i\.11 trade pay·ables wmbe paid h1 the n1o nth foUo,vjng p urchase. Pavla Ltd wm receive
a cash discount of five per ,oent on aH credit pu rchast:S.
Requ i1 d
Prepare a trade payabl bud et fo,r ·cbe thrc~ months endi 30 June.
An swer
The n1anage rs o f Bergbaus Ltd pro,vide the foUow ing budge te d info rmation fo r the
perio d en ding 30 Septenilier:
$
Budg·e1:ed credit purchases May 30 000
Juine 2.4000
J1Jly 2.7000
August 32 000
Septemb@tr 29000
1 July predicted amount owed t o suppljers 39000 (payables from May $11sOOO;
payables from h.me $24000)
Bergbaus L'td ,vm "'c.:ttl SO ;:r cenE of outstanding payabJ,e " in th n10:nth following
purcha e of thtl goods; th ren1ainder wiU bes ttl<.1d two months aft r p,urchas .
ltequh _d
Prepai-e a trade payables budget for the three rnonths ending 30 September.
Answer
Tra de payables budget for the three months e nding 30 Septembe r
July Aug ust Septembe r
$ s s
Balance bro ught forward 39000 39 000 451500
Pvrchases on credit te rms 27000 32000 29000
66 000 7 1000 74 S00
Cash paid to suppliers (1'5 000) (May) (1 2000) (June} (1 3 SOO) Ouly)
Cash paid to supp l,iers (1 2 000) (June) (13 500) (July) (1 6 OOO) {Aug)
Ba·Ianee earri ed fo l'Vl/a ,rd 39 000 4 5 '500 45000
>- Now try Question .
453
m Budgeting and budgetary control
A cash budget may be prepared weeldy or monthly. TI1e budget fooocas'ts the cash
(and cheques) cotning into a business and the cash (and cheque) payments that the
n1anagers think vviU lbe made.
The net cash fiow n:my be a positive an1ount if the forecast receipts exceed the
forecast expenditure. It tnay be negative if it is forecast that expenditure is expected
to be greater than r,e aeipts.
There are a number of dlifferent Iayo uts Arvane opens a sn1aU sto.r e using $8000 savjngs. She estknates that he!" purchases and
for cash bud gets. Choose the v,eirsi on sales for her first three tnonths of trading wiH be:
that you fe~ most camfortalb l!e us ~n g and
st~ck with it. Purchases Sales
$ s
March 8000 12000
April 7000 14000
May 11, OOO 28000
Arvan wiU purchase faxrures and fittings for her s tore co.sting $11000. he mn pay
for 't hes in April
H r suppJiet. r uir payment for purchas in the month of purchas ,
Her sa]~s are 50 per c~nt cash sales.
Her credit customers are expected to pay in the n1onth foUov.ring sa]e.
Wages wiU amount to $1000 per month payab]e when due.
4 54
44.7 Cash budgets
Rent for the .store i $2000 for a three amonth pedod. The first payment fo1· rent is
du~ ,o n 1 Mar,ch.
Other "pens ar
~'Peet d to b S1700 per month payabl in the month
foUowing that in which they occur.
Required
Prepare a cash budgett for the three tnonths ending 31 May.
Co1n n1ent on the results sh o\\' n by the bud get.
Answer
a Cash budget for t he t hree mont hs ending 31 May
March Ap ril May
$ s s
Receipts
Sales - cash 6000 7000 14 000
credit 6000 7000
6000 13000 21000
E~pen diture
Purchases 8 000 7000 1,1OOO
Wages 1 OOO 1 OOO 1OOO
Rent 2 000
0th er expenses 1 700
1
1700
Fi,xtu res a nd fittings 11, OOO
11 OOO 20700 13700
Arvane w·mhav,e to arran ge an ove1draft ·with her bank to cover her expenditu re
during April and probably part of May. Hopc:fu]Jy she wi]l in future haiv·c: positiv;
cash flows ach month - understandably, th capha l "pendin.1rt! was th(-,;! ] rg t
expense in h r first thri mo nth of trading. Provid d th at th G?.."Pendiiur
patte rns are s hniJar in future rnon ths it w ould appear that Arvane>s cash flows
should b~ posjdve.
Note
The heading should conta in the word 'budge1t' or 'forecast' and the tinie period
cove1~e d . Notice a]so that it is a forecast a nd so the heading teUs us that the three
n1onths wiU end a t 31 May.
1 E)q)~ain t\No reaso n1s why a m ana g1er might prepare a cash bud ge1.
2 Exip~a1in how tllere cain be a negiat~ve cash b,danc·e shown in a cash budget at
the end of a mon1h.
3 A ca,sh budg·et ~s another name for an income sta1ement True/False?
4 'There is no· need to prepare a: cash budget rt 1m1y business is prof~tab,e,
1
1
a businessman was heard to say. Do you agiree7 E:xpla~n your rep~ to h~s
statement
.••..••.. ,...•...•.•...••,....••.•...•.•. 5 Depredation j5 oniy ~1nd uded ~n a (ash budget ~n 1he ftnal m,onitlh. True/fatse7
Now try Question 4.
45S
m Budgeting and budgetary control
Th · following 'budg ted figure; r,e]at to Cropp Ltd for the chr, · month ending ,:,0
Answer
Cash budget for eac.h of the three months ending 30 September
Jui y August September
S 5 S
Rec.eipts
Casn sa les 10000 1000 0 12 000
C asn recei\l·ed from customers 26000 28000 27000
36000 38000 39 000
Payments
To s,upp,liers 9000 11 OOO 12000
Cash purchases 6 000 6000 7000
Rent 2 1OOO
Loca,I taxes 1,200
Wages 8 000 8000 8000
Other expenses 2750 3750 2 800
25750 49750 31 OOO
Balance brought forward 820 11070 (680}
Receipts 36000 38000 39000
36820 4907 0 38320
Payments 25750 49 750 31' OOO
9 al,a nee earri ed forward 1' 1 070 (680) 7 320
The cash b udgeit shov,ts that overdraft fadlicies tnust be arrang.e d to cover tbe cash
defk:it in Augu st.
456
44.7 Cash budgets
Bra dfo rd Itd sells o ne typ e of machin e at a seUing p rice of 86600 each. Fffty _p et· cent
is payable in the n1onth of .sale and 50 per cent the fo Uowing month.
The tnachines a re purchased from a supplier at a cost o f $1500, paid in the tnonth
foHowing purchase.
The fo llowin g fo re,cast infom1ation is .availab le :
Answer
C'a s h budget for 'th e t hree months e nding 31 March
January Fe bruary March
s $ $
Receipts
Cash received from trade recei,vab les 13200 (Dec) 19800 Oan) 9900 (Feb}
Cash received from trade receivab les 19800 Ua n) 9900 (Feb} 16500 (Mar)
3~000 29700 26 400
Payments
Payments t o trade payables 9000 ~Dec} 4 500 (Jan) 7 500 (Feb}
Rent 1 500 1 500 1 500
W ages 19000 19000 19000
Other e xpens es 5200 5100 4 800
34 700 30100 32800
8al'ance brought fol'\i\tard 1800 100 '300)
Rec.ei.pts 33000 29700 26400
34800 29800 26100
Pa,yments 34700 30100 32 800
Balance carried fof'VIJafd 100
1
(300) (6 7·00)
Note
••••• ••••••• ••••• ••••••••• •••••••••••• ••• Depreciadon has not been included - it is a non-cash expense.
Now t ry Question 5.
457
m Budgeting and budgetary control
Sales budget
Master budget
Payables budget /
Pnrc-hases budgel
Figure 44.1 Individual budgets used to prepare the m~ster budget
Q uestioru asking for s un1n1calised staten1ents a re d esigned to test your ability to:
• ap p ly the concepts of aca-1!.lals a nd realisation
It is poss1ble that you cou!d be asked to • differentiate benvee.n capital and revenue expenditure.s and capital and revenue
prepare a summartsed i1ncom,e statemen1 inco:1n es
and/or a sum11madsed statement of • disting uish between cash and non-cash expenses.
f ~na ncial posirti on from a cash budget .
458
44.8 The master budget
Requit-ed
Prepare:
1 a cash budget for , ach of the three n1onth endln 30 Noven1ber
l a budgeted incon1c :unem. n t for th thr(~ mo nths ncHng 30 Noven1ber.
An swe r
a
Cash budget for t he three months ending 30 Nove mber
Septem ber October Novem ber·
Always show the months separat e~y when
preparAng a cash budg1et. $ $ $
Receipts
Cash received from credit oustomers 30000 40 000 35000
Payments:
Cash paid t o credit suppl,iers 15000 20000 15 000
Wages 7500 7 500 7'500
Other expenses 8400 8 100 9000
Pu rcha,se of machine 110000
40 900 35600 3 1 500
-
The sales figure is the to ta] of the budgeted figure.s for the d1ree months under reviev.,
- epte mber $40 000, October $35000 an d N<:rvember $45000 - not the amoun'ts
1
Do not show separaite montJh~ f1ig-ures 1 in shown in the cash budget. Do yo,'IJJ re t:ne mber the rea]isation concept in Chaprer 7?
the budgeted i1ncom·e statement. This is The purchases figure is the total of the· budget,e d figure~ for the thr,e e months
pro ba,bly the bi1ggest s1nglle error made ~n
1
under r,e vit.~ - pternber $20 000 Octo · r 815000 and No,vemb r $25000 - not th
1
answ·er~ng questjons on th~s topk. amounts used mthe cash b udget. Once again, the reali adon concept is being applied.
Depredation is i:nducl din the b udgeted income -Eaitcment b cause ,o f th~ accruals
concept - the machine is a resou rce th:at w iU be u.sed to g,e ncratc profits~ so a charge
has to be made.
459
m Budgeting and budgetary control
·c omponent used i:n th manufacturing proo . Factorr spac mJght be limhed. There
could b a shortage of labour possessing a pa,tia.ifar s kjU.
Variances arise when tnere is a- difference
between actu.;rl and budgeted figurns. \"\'hen the productive capadty of a business is r·estricted so that det}1.and for
·t he product cannot be met the ]imicing factor n1ust be idendfied. Wil.1,Ue individual
Favourable variances fncrease profi ts.
budgets a t-re being prepared it is essential that coordination. takes place end changes
Adverse variances red uce profits.
are 01ade to the budgets affected. For exarnple ~ it V¥·ouJd not be sensibie to .set a
sales budget of 500000 units if the factory i.-; on]y capable of producing 450000 units.
Sitnuarly, a production budget requiring ,6 0000 hours of labour input would not be
n1et if o nly 50 OOO hours -was avaUab[e ]ocaUy.
Budgets a:re plans and n'lay be used as contro] n1echa nisnlS when acnia]
petfonnance is compared to the budgeted petfonnanc,e . Variations from the budgeted
data need to be investigated and acUon taken.
Adverse variances need corrective action to be taken.
The causes of favourable var:iiances need to be identified and 1 where possible 7
appH,~ 'Eo o ther area o,f the busine s.
Actual r; uks can b oon1pared to a fixed budg :t based on as t leve] of sale.: or
output. Ho"rever, this type of comparison can gwe misleading resu]ts, which can ],ead
to n1anagers tnaking inappr,o,p:riate b usin .s ~ decisions.
To overcotne this problem budgets should be 1flc..."'=ed' to reflect changes in o utput
and ru mover.
C[eady~usage has been ~e.ss than the budge ted an1ou nt - or has jtf
In fact ocly· 400 units of dngeis ·w ere manufactured , so actual use has been 0.45 kg
per \ilnit.
According to Cl~lA; a fl xibl budget reco ruses . . . different cost · haviou r patt · ns
. . . as volume ,o f output changes'.
Jn order to prepare accurate budgets capab le of being used fm budgetary control
purposes) managers need to :adjust budgeted k.,vels of activity. If the actual lcve]
of activity is different to rhe budgeted ]evel rhen managers wm h ave to aUow fo r
460
44.11 Budgetary control
dif'feri_ng Jevels of expenditure o n the factors of production they use. Va dable· ,c,o sts
and r venu,e s n1ust be chang d to r fleet the actuaJ level of activity achieved.
The budgets tthat are pr, par d should b bas cl on th .adjust d levels o f acti,..ity. Th,
fl~ed budg w.iU refl et ·tb different bt:havjour pattram.s of 6~ d and variabt costs.
The proc ss requires that variances are analysed and in the case of adv~rse
variances any necessary r,en1cdfa] action is taken. ResponsibHit~,r for varianoes rests
with depa.rtn1ental heads.
The benefits an d U.mitations of budgeting out.Hned in Chapter 31. page 3281 a lso
a pp]y to budgetary contto].
The foHowing data are available for Grizzel, a public Umited cotnpany) for the year
ending 30 Septen1ber:
Budget Adu.al
s $
Level of production (u nits) 8000 8500
Va,riabfe costs - direct materials 1'5200 16000·
direct labour 19200 21000
var:iabl,e overheads 4800 5000·
Tota I va riab1@costs 39200 42000
l=bced costs 15000 16000
Total cost 54200 580(,0.
Requ i1:-e d
Prepare a flexed budgeted operating state111ent for GdzeU for the year ending JO
Sept,e mber.
Answer
Flexed b udget Ac1ual Variances
D1irect materials 16 1SD 16000 150 (favourabJe)
D1irect labour 20400 21OOO (600) (adverse)
Variable overheads 5 100 5000 100 (favourable)
41 6'50 42000 (350) (adverse)
l=ixed costs 15000 16000 (1 OOO) {a dVE! rse}
566'50 58000 (1 350} (a.dwrs~),
46 1
m Budgeting and budgetary control
462
Standard costing
If rhe desired tin1e for con1p[etion of the 400 nietres was not achi:ev,ed., this cou] d be
due to:
• an unr aUstic target
• poor training regjm~
• poor atbl tic die·t~ tc.
463
IIJl standard costing
m
If a business does not achiev·e the s-candards set, the n1anagers "1 also ~ish to nnd
out why th~ ~1andards wer~ not achieved.
timated co ts for Jabour, matetiaJ and Ov"eth ads Vv·iU 'b cakulated and add-d
10g ther to i. tb · tandard cost for the product. Th estimait d or targ c ts ar
based on the costs that should be incutred under efficient pr,o duction conditions.
The standard costs can be based on:
• past data used to fore-cast ]i.ke)y usage of n1aterials and Labour
• detailed study o f the production processes invoJved in n1a.nufacturing .
Matetia Lstandards are based o n the quantity o f m aterials that wi]J be neoessary to
con1p]ete each unit of output.
labour standards are based on production methods and the hours required by an
average worker to comp]ete each u nit of output,
Ethel Bigome budg ·ted to use dir et materia] "' costing $36000 in January·. In February
Ethel wa abl<..+ to d termi:n that actual dir~-ct ·materials cost $34 ·00.
R quit.· _d
Calculate the rota] direct ,nateriaJs variance.
464
45.3 Materials varrances
Answer
Tota] dk et mat,erials vadance =$1200 :fa\--outaible ($36 OOO - 34800)
Not
Tht: favourable total tnaooriaJ variance cost the busit'lt:SS les~~ than anticipated and
therefore woul cl incr,casc pro,nts (thus having a favourabl.e effect on profits).
It is fine that we can detel"rnine whether tl1e prke acru aUy paid has cost us more or
]ess than was anticipated but frotn a rnanagen1ent point of vievv it would be n1uch.
n1ore useful if we could d iscover w hy the varia nce from budgeted figures had arisen .
The difference in the cost of direct tnateda]s used could be due to:
• ,nore matetials being used than was expected (adve·rse varianc,e)
• fewer materials bein g used Eh an v.,~s expected (favou ra b]e variance)
• an increase in the prices of n1aterials since the budget ,vas prepared (adverse
vadance)
• a decrease in the prices of nlaterials since the budget ,vas prepared (favout-a b)e
vananc)
• a co1nbinaUon of a ,ch1nge in rt.be us of mat :ial ~ and a ch:ang in pric .
We can id ndfy differ,ence in budgeted and actual expenditure r uhing from th~
a hove factors by ca]culadng sub-varianc - .
Answer
fvlateria]s usage sub-variance $800 adverse caused by using n1ore n1ateriaJs than we1·e
budgeted for
T. Cup provid the foUowing information for raw material t,o b u din p:roducdon
during eptemb r:
Budgeted Actual
M ate r~a Is used 830 m2 810 m2
M,ater~al cost p~r m2 $4 $4
465
IIJl standard costing
Requited.
Calculate the raw n1at nals usage sub-variance-.s for eptember.
Answer
80 favourable sub,.varianc ; caused by fewer matc-riaJs being used Utan budgeted for
A direct tuatetia]s price variance ca]cu]:ates any d ifferences bet\Veen budgeted and
actuaJ costs due to su'b-v.aria nces that arise because of a change in the priGes of the
Always indicate which va ir~ance you raw tnateiiaJs being used.
haive c:al culla"ted and state whether jt • A direct n1aterials prke su b-vadance wiU adse w hen the price of the n1aterials
~s a favo urab~ e vadance or an adverse changes .
.
vanance. • An adverse price sub-~-...-arhllnce ·w iU arise when the cost of ac:q.u iring th e direct
matenafa has ·r isen.
• A fav:ou ra b]e pdc sub-variance arises when che cost of acquiring the d irect
mat~rfa] ;. ha · f aUe.n.
Gwock provides the f:oUowing information for raw n1at.erials to be used in he,
production process for December~
Budgeted data
Mate rials to be used 1200 Mtres
Cost per 1itre $.9.60
Answer
Mat,erials price sub-variance 2-40 advet·s,e , caused by an increase in the oost of
acquiring ,e ach ]iu-e of the material used
q X p
Aq X p
Aq x Ap
466
45.3 Materials varrances
So: =
Sq the standard quantity
=
p the Standard price
Aq = the acruaJ quantity used
=
Ap tb~ actual prio~ of th tnareriaJ us d
q>c p=
Any difference ( variance) bctvilcen. these two totals n1ust
be due to diffet·enoes in the budgeted usage and the actual
usage since the standard price ren1i:dns the same on both
lines.
Aq X Sp =
Any difference (variance) betwee n these two totals n1ust
be due to differences in th e budgeted price as the aott1Jall
quantities ren1ain the same.
Aq x Ap =
Th foUowing infotmadon is given forth use of mat :rial u:s d to ,produo 'befures,=
- Budgeted
--
Actual
Direct materials 720 metres 730 metres
Dfrect material costs per metre $3.00 $3 .50
Requit"ed
Cakulate.
~ the n1atenals usage sub~varfance
b the n1aterials price sub-variance
the tot~ n1ateli.als variance.
Answer
Sq X Sp
720 X $3 = $2160
Aq x p $,30 Retne,nb r you .also n d to identify wh tber
730, x S3 =12190, th - e variances are adver5e or favourable.
Aq x .Ap
730 >< $3.50 = $2555
Tlfle first Une teUs us tha.t b udgeted ttota] n1aterfa[s a.re expected to cost 2160.
The second ]ine te.Us us tha.t total m.atetia]s actuaUy cost £2190.
Ma.terials in the second Hne cost S30 n101i-e than the budgeted costs on line 1. An
increase in costs v,rouid have an ad,r,erse effect on profits, so $30 is an adverse usage
sub-variance.
The second .Hne teUs us that materials actuaUy used should cost S2190.
The third Hne ieUs us that n1a·ue,,ials actually used cost 2555.
Material on the third line cost $.3<5- rnore than cbe cost on the second Jine. An
increa e in co ,vould hav~ an a dver "'e cffect 01'\ p:ronts, so 9365 is an aclv·ers prlct!
sub-variano .
The tn_aterials usage uh-variance and the materials prk~ su~varlanc·~ together will
give the total matedals vari.anoo. S01
467
IIJl standard costing
Sq x Sp
720 X $5 =$2160
Aq x P' $30 Adverse material usag sub-"i.111irianoe
730 X j.3 =$2190
Aq xAp $365 Adverse n1aterials piice sub-vadance
730 >< J3.50 ~ 12555
We have successfully identified the three vadances asked for in the question.
The foHOVt.-'ing infotn1atioo is given for Eh , use ,o f n"laterials used in the· 1nanufa.ctunng
o f ~trusmedas':
Budgeted Actual
ID irect materia,ls
1
24'00 litres 2250 litres
ID1 rect materi a,ls cost per Ii.tre $8 $~0
R@quit·ed
C:akulate:
. the tna.teria]s usage sub-variance
the tna.teria]s prke sub-variance
the ttota l direct n1aterfa ls variance.
Answer
Sq x Sp
2400 x 8 =$19·200
Aq x p 11200 Pavourabl m.a·teriaJs usage sub-varia nce
225JO x $8 =11 OOO
468
45.4 Direct Jabour varrances
Tony bas budget cl that direct ]~bour costs for March v,ould b $172000. Th actual.
a ,nount ~pent vi..-.as $178 000.
1
Requi, _d
Cakulat,e the total direct labo,ur variance for March.
Answer
Tota] direct labour variance::::; $6000 adverse (~178000 - $172000)
Magdalen budgeted to use $83000 of diJ:i-ed: labour in May. In early June, she
discovered that she bad actuaUy spent $82 500.
Requit-ed
Cakulate the total direct labour variance.
Answer
The t,oud direct ]abour vadance =$500 favourable ( 83 000
1 1
- !82 500)
In the first example above, Jabour cost tnore than ~ras budgeted - this had an ad,rerse
effect on profits.
ln the second e.~atnple~ $500 was saved on 'the budget,e d an1ount - this would
have a favourable- effect on profit.
It would be useful for managers of a business to deter:1:nine whether the total
variance was caused by:
• wofkers being n1ore efficient (favourable vadance)
• workers being less ,e fficient (adJ\.~erse variance)
• workers being paid more (adverse ·v ariance)
• wod.."":ers being paid less (fa.vourabL,e var1ance) 01·
• .somt: oon1binadon of a chang,e in ef:n,ciency and a ,c h~nge in ,','ag·e r.ates.
\Vi.: can us~ th amr.:· t chruque used to d~ternlin direct materiaiJ sub-varian'Ce to,
ea ku]$ E sub-variances in the budget d and actual an1ou nts sp nt on dir: et la bou:r.
1
Aq >< Sp
Aq >< Ap
q X p
A.q x p
Aq xAp
469
IIJl standard costing
o;
Katap Ltd provides the foUowing infonnarion ior the direct Jabour for November.
Budgeted Actual
Dfrect Iabou r 37 OOO hours 39000 hours
Dfrect labour wage ir ate per nour $7.00 $7.20
Requi:1:ed
Cakulate:
the direct labour effkiency sub-variance
the direct labour wage nue sub-variance
the tornl direct Jabour variance.
Answer
Sq x Sp
37000 x S7.00 =$259 OOO
Retnetnber that you need to
Aq xSp 14000 identify whether these
39000 X $7.00 = $273 000 sub-variances are adverse or
favourable.
Aq XAp 6200
Wht:n th second Une is con1p ·r,~ to what actuaUy ha.pp ned1 w ea n sc that
another O\~spend occurr d. Th profi \vou1d ackrers· ]y aff. cred by· $6200.
470
45.4 Direct Jabour varrances
Bash Ltd provides the foDowtng information for direct labour for April:
Budgeted Actual
Djrect la bou r 6200 hours 6250 hours
D.irect labour rate per hour $9. 50 $9.30
Requit-ed
Ca]culate
a the direct fa bour effid~ncy sub-varianc~
the direct Ja our wage rate;: ub-,i-ananoe
r the co,rn1 Jabour varianc .
Answer
Sq X Sp
N ot ·
•••• • ••••• • •••• • • •••• • •• •• • • •••• • ••••• • •• The tcnn 'standard' is used in place of 'budgeted~ in the fo])owin_g quesdons, nov.r that
Now try Question 3, you have got used to the detaUed cakuladons required.
You "'..iU often be faced with situations - in questions and in real Ufe - in which
you are given inf'om1at,i on for both direct matedaJs a nd direct labour and are l'lequired
to caJcufau:e aU seven variances.
Th.e n1anagers of Hasbec Ltd provide the foUowing infom1ation for Deceniber:
Sta nclard costs:
47 1
IIJl standard costing
Requited.
Calculate:
the direct material usage ub-varianc
J the direct materfals pd.ice sub-\.11/riance
the total direct materials variance
the direct Jabour afid.ency sub-variance
tbe direct Jabour rate s ub-variance
the total dkect Jabour variance
the total direct expenses variance.
A nswer
The manag,e r of Cottou pk has budget€d to produc 100000 pair of carton trou rs
in August. he b ud.gets for the use of 14,QOOO m2 of cotton in th production proooss.
The actual figures avaifab]e in Septen1ber show that only 120000ro2 of cotton was
used and totaJ production was 90000 trousers.
472
45.5 The ffexed budget
Clearly. the production has used Jess cotton rhan had been anticipated but fewet
trousers w ,e rt: manufactur d , so on~ woul,d "pecc that less mareriaJ had b n used
(140000 tn:z ,c ompared with 120000 m2).
How ver, we ar not 001nparing Hke with Ukc.
140000 m2 should have n1ade 100000 pairs of trousers .
• 1.20000 m:Z actuaUy 1nade 90,0 00 pairs of ttol!Jscrs.
In order to make a val id cotnparison to see if the n1cfderla ls have been used efficiendy
or not we need to adjust our budget - the a djusbnent is caUed fle:xit1g.
If we had known earlier~ when the standard was set~ that ocly 90000 pairs of trousers
would be inade >the budgeted figures for n1ate:rials to be used would have been:
126000 m 2 (i.e. '90000/100000 or nine-tenths of 140000 m 2)
and the figures to be used would be:
Standard costs:
90000 pairs ,o f trousers requiring 126 OOO n1.2 of cotton
So a comparison can nov.:' be nu1ide quite easily:
• Standard matet·ial u ag :
90000 pair of trous r requiring 126 000 m3 of cotton 1
The n1anagers of Getang Ltd provide the fuJJowing inforn1a1tion for the production of
'sdvings' during March:
Answer
Flexed budget Budgeted use of direct mate riill s
7 0 OOO selviian gs 210 OOO litres (718 x 240 OOO)
Actual output Actu a I use of direct materi a Is
7 0 noo selvfr1 gs 22 0 OOO I~tres
So J,Q OOO Httes of direct materials were used that had not been budgeted for. The
reasons for this 'wastage' sh ou]d be jnvestigated and if possible a retnedy sought.
lt wiU also be necessary to flex the standards :set for the use of dire,ct labour.
473
IIJl standard costing
Th · foUowing info:nnation :is given for direct ]about hours for Ju]y for the pro duction
of 'Hngts':
Standard Actual
Production 250 OOO un~ts 225 OOO wiits
D~n~ct labour nou rs 70000 hours 65 OOO hours
Req1.1.ired
CaJculate the direct ]abour- hoW's to be used in a flexed budget for July.
Answer
Production of 225,QOO ]ingts shouJd use 63000 hours of direct Jabour (225,000(250000
X 7000Qi hours).
On~y flex the standard quant~ty of d~rect The f o.U ovving infom1adon is given for th.e production of 'trapeds':
materjals and/or the standard hours of
Standard costs for 1OOO trapeds
direct ~abour to be used ~n your gr~d.
Dfrect mat erra Is 220 kg at $5 per kg
Dfrect Iabou r 60 hours at $9. SO per hour
Actual costs for the production of 950 trapeds
Djrect materials 204 kg a.t $5.75 per kg
IDj rect labour 58 hours at $9.30 per hour
·R equired
Cakulate:
the direct mat,e rials usagt! sub-variance
the dkc..~t m~ut..:.rials pdce ~rub-vad.ance
the total direct n1a teria ls variance
the diti et ]abour efficit:ncy sub-variance
th'-,: direct ]abour rate Sllbmv~uiance
f the rota I direct nlaterfa ls variance.
Answer
The budget rnuslt fust be Hexed. Only 9 5 per cent of the budgeted trapeds have been.
produced, so the standard usage of direct tnatecia]s and direct labour :should be
cakufa.ted to constn1ct an amended budget - a flexed budget.
(Ren1en-iber, onJy the standard (budgeted) quantities wiU be changed.)
Stan dard costs for 950 trapeds (950{1000 =0.95) should use:
95 per cent of budgeted n1ate'fials, so, 0. 95 x 2 20 = 209 kg
Standard costs for 950 n-apeds (950/1000 =0.9-) sho,u ld use~
95 per ceru ,o f bud eted ]abour hours. so, 0.'95 x 60 =57 hours.
Re'\\-'Of k.ing the mndard costs:
tandard ~o for 990 trap ds~
Direct mateda!s: 209 kg at S5.00 per kg
Direct labour~57 hours at $9.SO peT hour
These figures are used in the 'grid'.
474
45.6 fixed overhead varrances
Direct matei:ial : Sq x Sp
209' X $5 =$1045 $25 FavourabJ~ direct mat naJ
Aq ~ :p usage sub-varianct!
204 X $5 =$1020 $15 3 Adverse direct n1atcrials
Aq xAp price sub-w riance
Answer
Standard fixed overhead per unit $10
Tota l fixed overhead variance= standard fixed overhead absorbed by actua]
production less actual fixed overhead incurred (900 units at $10.00) $9000 - $10 OOO~
$(1000) adverse.
ln this exatnpJe there- has bet>-n an under recove11r of fixed overheads. There is
therefore a n adverse variance. This cou]d be due to
• 1nore e>.."Penditure on Hxed overheads than w-as anticipated in the b udget~ or
budgeted production not being achieved
The total tlx"ed overhead -variance does not give n1anagets enough relevant inlo1mation
fro1n whlch :improveinents to th,e production process can b made. This probJe1n can be
reotint:d by e..'Camlinmg each indh,idttal :itt:m t1h at m~k Sup the, t,otal :fixed Q\l, rhea.cl ln this
v.,~y r ons for variano may iclenti6 cl and, wh pos ibi , ,oontroll,ed.
Th total ftxecl ,o verhead can b eparated into two parts to shOVv thes tw~o
u
possible explanations.
475
IIJl standard costing
Required
Cak ulate the fixed overhead expenditure variance.
Answer
Expenditure variance = Budgeted fixed overhead $9080 -Actual fixed ovethead
i 10 OOO = $(92 O) adverse
If fue acruaJ fixed overhead had been Jess than the budg.eted figure the variance
Vv-ould have been favourab]e.
This may be caused by increases in the overheads incuned in the production of the
product
Required
Cakulate the fixed oved1,e ad volun1e variance
Answer
VoJume varianc,e- ~ Budgeted th..-ed overhead $9080 - Standard cost absorbed by
.a ctua] production 9000::: $(80) adverse.
I:f actua:[ output had been greater than planned output the volume variance '9,tou]d
hav, b "'n favourable,
Variance- may b du to changes in tbe volume o,f oods produced caus d by
shortag , in th faaor of production, niachine breakdrnvns, industrial disputes~ poor
production schG~l ing ~ etc.
.A favourable variance occurs when acrua] production exceeds bt1dgeted production.
An adverse va dance occurs when actuaJ production is less th.an budgeted production.
Note that if the volume variance is con1bined with the e.~pend.iture variance the resuk
is the tota] fixed overhead vadance.
Vo)u me variance $(80) + expenditu.t e variance (920) = tota] variance $(1 OOO)
bu.dge ted output is 4000 u.ni'ts so ·the budget is based on the assu lnption tb at direct
476
45.6 fixed overhead varrances
Jabour hours of input ViliU be 16 OOO hours. If in fact the actuaJ hours of input were
l - ,QOO hours tb, busin~s has fail d to us,e the p]annt!d capacity. If production had
"rork cl at the l . eJ of efndency that liad b n planned a further 1000 hours would
hav n worked and 6000 tnor; nx d overht1ad would hav b~en a or'b d.
The foUowing infonnation regarding ftxro overheads is ~ivailable for Maketio for the
month of Febnmry:
Budgeted fixed overhead (10 ho urs at 4.50 per du-,ect labour hour) $45.00.
The budg t,ed produ,ction l vel
1
".-a 1,000 ui\its.
Tota[ budg, te · - B)l; d ov rht!ad iw·as S45 OOO.
Actu fiyed overh ad cost S58 250.
1
]
Answer
il ex.-penditure variance = actuaJ ~penditut-e - budgeted expenditure
= $3 250 - $45 OOO
= $,6 7·,0 favourab],e
1
The fixed O\"erh,ead absorp1ion rate wa-s $6 750 gr,cat r than needed, so, a
favourable variance
capac ity variance= budget ed overhead - (actua] hours worked x overl,ead
=
absorption rate) $45 OOO - $38 250 $6 750 adverse .ii\..ctua] ho urs worked are ]ess
than the budgeted hours so not e nough overhead has been absorbed into
production.
efficiency variance = total actual ho u rs worked - total S1tanda rd hours for
actua] production x standard fixed overh ead rate per dkect labour hour
8 500 hours - 9 OOO hours = 500 hours X $4.50 per hour = $2 250 favourable
The vtork is vlorth 9000 sta n dard hours but it o nly took 8500 hours to
con1ptete production.
d volun1e variance::::. b u.dgered overh ead - actua] hou rs worked X ,ov·erniead
absorption rate.
=
45 OOO - 40 SOO (9 OOO x S4.SO)
=
4500 adiver ""t!
Actual fixed ove:rh ad = $3 250 Toud standard oos'Efor actual production
=S40 500
Total varia nee =$22;0 favourabl.e
477
IIJl standard costing
Budgeted sa]es of Redro wet-e 11 OOO urtlts at $6.30 per unit, The actua] sa]es were
10 800 at $6.40 per unit.
Required
Cakulate:
~ the saJ v:o!u1ne variance sub-va1·iance
the sal prk sub-\i-aoanct:
the total sales variance.
Answer
Sq x Sp
11000 x $6.20 =$68200.00
$1240.00 Adverse vo]u1ne variance (an adverse
Aq x Sp impaot on profit)
478
45.8 Working wjth variance anal1ys~s
Varia nee anaJysis highlights aJteas of concern and areas of good practice and y,o u
may be isk, cl to ~,:plain possib]e reasons for the variances.
You may a]so b asked to id ntify som interr lacionship b twe n different
ub-varfanc .
Many of the comn1e nts you n1aiy make could be speculative b cause you wiU have
,o nly a limited picture or scenario and thus may lack the detail necessary ro arrive at a
definitive conclusion. Your a.n swer vtilJ r,e quire a Jot of thought a nd the a pp]i,cation of
aonlmon sense.
The vadan ces that we have ca lculated up to this point have been cakulated in
isoJadon fr-om data prepared for setting standards an d budgets. Th ey have detailed
individual costs output and in crnn es.
A busin ess that operates a standlard costing sys1ten1 and a system o f budgetary control
should be able to "ll.1!8e the systen1s to use the data to cak ulate its future profitability.
Changes in operatio ns due to variances are going to affect profit earned;
faivourab]e va tiances in sales. a nd costs exp]ain how profits have in~proved frrn.n those
budgeted; adverse variances explain the factors that have reduc,edl budgeted profit.
Future performa nce can be compared with ihe standards set by managetnent.
As part of a 1nanage1nent C·ontroi systein, a standard costlng income stat,ement may
'b prepared reconciling bud.g d profit with actual p rofit ,e arned.
479
IIJl standard costing
Requir d
Prepru- a tatentent :reconciling standard cost with actual cost.
Answer
$ s s
Sta1ndard costs (10 OOO units) 76000
Only 9500 uniit.s produced so ~a.ndard cost is actuat~y 72200
Favourable Adverse
DJrect material' varia:nces - usage variance 5 850
price v aria nee 1 525
Direct l,abour vanainces - effidency 45 0
rate 2 800
Fixed overhead variances - expenditure 500
volu,me 350
2.475 9000 6525
7S725
Not
Th direct e..,:pens(;: variances have b en cakula.ted using 1th grid 1•
The :fixed overhead e,._-penditure variance is tb1e difference between the budgeted
figure a nd the acnial figure. The voh.une vari.ance arise because SOO fewer sa]es wer,e
inade thus giving a shortfa]] in the absorption of overheads of SOO x $0. 70 :: 350.
The total ,of the varfances cakulated is $,6 525 adverse which nieans. that fui1her
costs fron1 stand ard have been incurred and this tota] needs to be added to the
tota] standard crusts.
480
45.8 Working wjth variance anal1ys~s
3S0
3425 9000 5 575
Actua 1profit
1
12475
Workings for budg,e t,ocl p rofit (after f1~in g based on actual sales of 9500 units)
s $
Budgeted sales revenue (9500 x $9.5} 9-0 250
Direct materials (14000 x o.gs ;;;; 13 300 x $3 .00) 3ggoo
Direct 'labou,r (3750 X 0.95;; 3562.S x $7 .20} 25650
Fixed ove~heads (9500 x $0. 70) 6650 72200
8 ud geted profit 18 050
1
Wh,e.n answo-ring an exatnination question show tba £ you arc aware of possible causes
o f devfatio,n s from sta ndard figures> b ut d o no,t Labour the point; rather, :l!u ake it as a
general coiu me nt that wiU app]y t o aU sub-varian ces.
481
IIJl standard costing
Noce d1at the Atst three factors in both co]urt"uts tefer 10 v.rastage of rnateria]s.
Tabl 45 .. 2 Direct materials price sub-variance
482
45.8 Working wjth variance anal1ys~s
3 Us ag·e ~s aipplii ed to d~rect mate1rial s. Wha1t is the, word tha1 rep1 aces ·usage' in
'D~rect ~a1bour sub-vanaince'7
4 We say 'miaterials pnce'. What word do we uise for the price of la1bour7
5 S1a1ndard quanth:y direct materials iinformaition: -4 0 unns; .standard prke $10.00.
Actua1iquaintirty 50 units; actual pr~ce $ 110.00. Calculate the d~rect ma1eri1a1~s
usa ge sulb-va r~a1nce.
1
Standa1rd costs are p:rede1ermi1ned and reflect possib~e !,eve~s of costs and revenues
1ha1 ought to be aichieved under cond~tions of a,cceptable levels of eff~dency.
Standard cosits are used to prepare budg;ets and may be used i11n priding pol1ides.
• Vadances i1dentny d~fferences be1w,ee,n standards set and actual! performance. They
a re co mpo-s ed of sub~va rmarnces.
• lf actual performance ~s different from standard performance. the budget m,ay have
to be fiexed.
Ana~ysis of sub~var~ances is necessary in order to eradicate problem areas in
production or to copy ,good pract~ce.
A suib-var~anc,e in one area may cause a sub-varia1nce •11 another connected area.
483
Capital investment appraisal
• land
• buUdings
• ~nachinery
• plant
• vehicles
• office equipn1ent, etc.
They are used in the business £or more than one finanda] time period.
The n1anagec:s of a business are a lways Looking for good va]ue when they
pu1~chase non~u'fent assets, just as you do when buying dothes a n10bHe phone etc .
Like you the managers of a business do not ha.ve unlhnited resources; as whh you ,
avai.lab],e cash is a scarce resource~ and, like you, the n1anagers n1ust plan their capita]
apendi'Eure 'V ety carefuUy so chat they gee the best value for their money. They want
t·o ensure· that they eam n1axin.1u1n benefits fro111 th~t purchase, just like ymt
inc the tn,011, y availabl,e to a bu in s for a ,capita I pro,jeci is Ukely to b , Umi·t d
o r in short suppJy, om form ,of rati·o ning th avaUabl money is often required.
Capital inv:esttnent appraisal t·echnlques are us d by managers to a si t them in 'their
choice of appropriate inv:esunent opportunities.
Capi.taJ projects are appraised (evaluated) according to potential eaming power.
484
46.1 The ne,ed for appraisal of capital investment projects
It is equ~ Uy in1portant that n1.anagers of a business take care when t11aking a capital
1nvestn1ent appraisal. As n1uch detailed information as possible should be obtained
frotn aH sources that may be affected by the decision, or that n'lay affect the decision.
Production
/
Projec1
A major investment in capital equipme1,t needs
careful appraisal.
Sales
/ ~ Purchasing
Finance
Figure 46.1 Some .sources of information that may affect or be affected by an investment decision
Capital projects are evaJuated (.appraised) in terms of their potential earning power.
If the nlanagers of a business need ·t o repface an obsolete piece o,f machinery or
purcl,ase fultber piec:e of nu11ch1nery EO comp] tea ne'\\l" proj, et, the-y must decide
which new n1achine to purcbas . Th rt:: "'·ould b no ,c hoice to b n1ad if ther
\\r-as only one type of machine on tb inarket that Vt.rouk1l do, the job~, th~y would not
have to 1nake a choice (other than to buy or not to buyO. Jn the real wiedd th.er€· arc
usuaUy a ltcm~tive options from. ·which to, choose.
. lac hines might:
• have different price-S
• have different quaUtie-S
• produce different quantitie.s of goods
• produce different quaUty of goods
• have different Ufe spans
• have different rates of obso]escence.
These differences apply 10 most capital purchases in both the business ~vodd and in
the wodd o utside of business, for example TV sets, DVD tnaichines, co1nputers.
There are five main tncthods of evaluating a ,c apital proj:ect. The·y are:
• the payback n1etbod
• the accounting rat of r tum metho I (ARR)
• tht: n t pr nt valu m thod (NPV)
A
485
1111 Capital investment appraisal
If the ptedictions are inaccurate, the:re couJd be seriotlS problems for the business
because ,of:
• the ]a sums of c sh ~ eing invoh: d
• th\; ]on -tenn commitm nt of cash and oth r :re· ou.rc
• the effect on profits.
Note~ Fro1n this point, reference wm lbe n1ade only to projects' but be aware that the
Opportu nity cost i,s th~ b~nefi.t from the
alternative use of resources that ls foregone text does also apply to the purchase of non-current assets.
when a new project is un de-rt.a ken. So, rnan:agers wH] often use niore than one method of appraising a project that
could -affect the business for niany years.
OUv.e Branch itS considering the purchase of a new tnach ine. Two different n1achines
wiJ] suit her purpose.
The cash flows are given:
486
46.2 The payback method
Answer
• l\itachin Argo
~h initial ouday VY'ill b paid back pan,vay through Year 3.
($70000· Year l + S80000· Year 2 + $60000 pam:ay through Year 3)
More prcciseiy 60000f9000-0ths through the third yC1tr
1
N ote
In the fonowing questions and exa1np]es:
.................. , u •• ....... , •••• •, ••••, •••••, •• • the date of initial p,urchase is labeUed Y4 ilt 0.
> Now try Question 1. • aH cash outf]ow.s and inflows ar de ,n d to accrue evenly throughout each y, r.
ome questio,ns requir that you calculate the project6--d cash flow to , include· in your
cak:u]adon s.
Thci-e are tw,o , types of question: when profits are given. in the question, and when
a n.nu al cash inflows a nd annu a] cash o utflows ar,e given separately.
Additional infol"mation
The profit 6or each pro,jrect has been cakulated after p roviding for annuaJ depreciation
as tb Uows:
Requit-ed
Calculate the payback p~riod for both proj~cts.
tate Vy·hich proj et should be;: undertaki n .
487
1111 Capital investment appraisal
Answer
Proj 2178 Project 2179
Cash flows $000 $000
Year 0 (14000) (12000)
Year 1 5000 4700
Year 2 6. SOO 5200
Year 3 9 500 6 700
Payback 2.26 years 2.31 years
. . . . . . . . . . . .... . . ..... ""'...... .......... . . . . . . . . ......... .. J Project 2178 should be undet1:aken - it h as the shorter payback period.
.> Now try Question 2.
Yea r l Cash receipts $100000~ cash e.xpencliture $20 OOO; na: cash flow $80000
• Year 2 Cash receipts $1200007 cash e.xpenclirnre $25 OOO; n et cash flow S95 OOO
~.. ..................... ....... . .................. . Ye ar 3 Cash receip ts $ 13U OOO; cash expenditure $25 OOO; n et cash flow S105000
> Now try Qu stion 3 .
:ln the examples used an dJ in the question ~we have n1erely considered the fi nan cia]
.aspects o f decidin g on a project. CJeady, the n1am.gers o f a b usiness would consider
a U the "'+afs th at a. decision 1n ight impinge on the business. They would a]so consider,
for exru11ple, how a decision n1igbt affect:
• the v.,-orkfo.rce - does the decision require n1ore v.,·orken~?
- does the decision t11ean that so1ne workers wil] lose thdr jobs?
• th envirorunent - poUudon
• th~ ]ocaUty - is mor.__. space n~ de'CI for expan~ion?
- 'is the ]ocal infrastru.ctu re capable of supporting the 'nc."'W' pro ject?
The tim value of mon y. Money received 46.2.2 Disadvantages ·Of using the payback method
or ipaid in t he furture does not have the • It ignor s the titne-value of n1one;r (but s e b lO'\\i·).
saime value as money lieceived or paid today. • Jt ignor s th~ life .. "p tancy of the pr,ojr e t; it do not cons id r cash flow that
This concept recogn1lses that $1 received
tak place after the payback p~iod.
today is worth mofr'E! than $1 received in one
year's t tme or in iiv~ years' time. • Projects may have different patterns of cash infloVvrs.
488
46.3 The accounting rate of return method (ARR)
Project 1 Project 2
$ $
YearO (10 000) (10000)
,
Vear 1
Vear2
10000
1 ,
Year 3 1 socmo
Year 4 1 5000{)
A machine is purchased for lliOOOOO. It wi]) be u.sad for two years and "tin then be
trad~d in for $20000.
Requh-ed
Cakulate the average invesunent o n the n1acbine over the two years.
Answer
TI1e n1acrune will incur depredation using the stra.ight-Une n1ethod, of UOOOO per annun1.
($100,000 - $20 000 = $80000 + 2 years = $40000 per annutn)
O:
• in l1i ar 1. averag invesunent = $80 OOO
• in Y~ar 2, average inve. unent = $40 OOO
1120 ,0 00
489
1111 Capital investment appraisal
A n1achine is purchased for $350000. It w il] b used :for nve yea1 , after which it wiU
have a scrap valu~ of ,-,0 000.
Re qu i1·ed
Ca.Jculate the average investn1ent in the machin(;,:· over the fiv·e years.
Answer
Average investment ::;:; $200000
AnnuaJ depredation= $300 000 -;- 5 = $60000
1
There is a n addunetic .short cut which gives 1the correct answer withou t the ]ong
con1pUcated c-alcuJation .sho\\rn in the two worked exan1ples given above:
It does seen1 hnprobable that ·r he scrap value :is added~ but it does world
Check ·che two worked ,examples above:
Exam le 1
Purchase price 100000...,. crap, value 20000 =$120000
$120000 . . OOO
- -2 - = t,
Avefage Jnvesunent f 60 .
Example 2
Purchase price 350000 + Scrap vaJue S0,0 00 = $400,000
400000
= Average inve.shnent $200000
2
cash flows .
Aoife is considering the purchase of a machin.e. There are two models that wi]] sui.t
her n eeds. AU profits are assuo1ed to accru,e on the- Last day of the year.
490
46.3 The accounting rate of return method (ARR)
Required
a Calculate the accounting rate of return for both cnachines.
Advise AoUe which ma,c h ine she shou]d purchase.
Answer
Machine Ara Machine Sib i
Answer
i
Av:erage lnvestn1ent =84"'0 OOO + 8SO OOO, =$275 000 1
I think that n1ost people wou]d say that $ liQO spent today wou]d give then1 the
better value.
Why.7
The futinre is uncettain - there is an e len1ent of risk involved. Also, as tin1e goes
on, there is a tendency for n1oney to beco1ue less valuable.
When your grandpa rents bought their a partnient n1any years ago, Ehey n1ay have
spent 12000. Would tbat buy ·t he san'le apartmrot today? I don't think sot
If $1 ,vere /<eceived and inv ted at nve per cent per annum, it would be· worth
!1.rOS in one year' 'tin1 ; if it wer J
to accumuJat,~ irn · SE it would c.: worth ;ust
fE
ov r 1.10 $1.102) in two· years~ ti,ne and just under Sl.16 ($1.1-a) in th~ e y ari time.
Cost of ca pita l is based on the weighted Looked at fron1 anotb~r perspective:
av,erage cost of cap ita I ava i,lab le to a • If 86.4 cents were inve-Sted today at five per cent for three years, this v..~ou]d yield S1.
busine;s. • If 90. 7 cents were invested today at five per cent for two years, this wolllld yield $1.
• If 95.2 cents were invested at five per cent for one ye.ar, this wou]d yield 1.
A discount factor aIfows the value of The net present value method of investtnent a ppraisa] of a project is calcu lated by
future cash flows to be calcu.lated in terms taking the present day (discounted) value of aU future net cash Hows based on the
of t:heir value ff t hey were received today.
business's cost of capita] and s ubtraoting the initial cost of the inveshnent.
Managers of a business invest in capital p m.~ojects to provide security for the future
through profits and cash flows.
As individuals, we invest to provide for the future , and we hope that the n1onetary
rev.rards in the future v.<i]J be worth waiting for.
In giving up 'the n1oney today, w,e expect a reward. The re~""ard is the interest th.at
"""e wiU ·e arn on our investment.
In the am vray that we n1ay in\o~st in~say, a bank "'aving account to get a :retum
on our inv·estment~ mana rs of a btlSine s wiU inve tin projects that will pay a r, tum
on ·th ·r investment.
Managers evaluate .a project by cotnparing the capital investment w ith the rerum
that the investn1cnt wiU bring in the future.
In order to make a meaningful comparison between the arnount otiginaUy
invested and the incotne generated in the future by t1hat investn1-ent, there is a need to
492
46.4 The net present value method (NPV)
discount the cash fio'9ls so that they are the equivalent of ca.sh flows now. Thus we
can co1npare Jik:~ with Uke.
W'1 can cotnpar th initial inv tment at today' prke "rith future cash inflow ,
discounh,d. to give th it va lue in to-daiy 1 wodd.
The discount factor used in net present value NPV) cala.1Jati,ons is generaUy based
on a wcightod av,c rage cost o f ,caphal availab]e to the business.
Note
Th xampl, is corr et in pnndpl . How~er, th int st ,o n d b ntu · stock and
the bank ]o-'1!_n ar revenue )i."P nditure (they 11educ profits) - tht:y would :r, ~u,ce the
I~ you are gtven a number of discount ~unount of tax payab]<:? by chiffe Ltd. o, in r aBty1 the ~ ro :figur should shov.rn
factors to choose from, se~ect the one· in the 011 l,c ulation net ,o f taxation.
ident~fied as the cost of capjtaL More in1portant note.: You wUJ be given the discount factor (i.e. th,e cast of
caphaO in a question - 'thank goodness~, I hear you say!
There is .a 1nisconceplion by s tudents that a discount factor iis used to take into
acoount the effects of intlation o n future cash flows - this is not so. The effects that
inflation have o n results are self-correcting.
The cliscount factor is based on the b usiness's cost of capita] (see above) .
Generally, what we consider is what would happen if we were fortunate enough
to be a ble to invest say, $1000 in a bank acco11.Jnt or a business project for. say,
four years. We c~culate how much our investment " rou]d lbe wo11h ,e ach year if the
investn1ent v.,~ere ,e arning, say, five per ce·n t per annum.
At th,e end of:
Vear 1 $1050
Vear2 $1102
Vear3 $11 58
Year 4 $1 21:6
493
1111 Capital investment appraisal
Jf I require 11000 in four years' titne and the interest rate~01 rate of retur-n, was five
p · c nt~ how n1uch do t have to inv,est today? I wou ld have to lnveit $823.
Net present vallue tab!l·es. wm lb e giiven The pr: .· nt v"atu gh~ th \ra[u of a futur~ sum of tnoney at todayt.s v.a]u ~.
~n any question requ~r~ng the use of ne1 If you wish to have $1OQi in four y: ar I tim,e· and th in·tter,e E ra·t · wer v-e:n per
prese n1 value. oent , you should invest $76.30 today.
Working this in reverse, ,,.le can say that 100 i"eccived in four years ' thne ls
1 1
Vear 1 1.030
Year 2 1J)61
Vear 3 1.09~
Year 4 1.126
Answer
$1 investted today wou ld yield 11.09 ($1.093) in three yea rs1 lime, so $120 invested
would yield $131.16 ($120 x 1.093).
$214.23
r $45.91
Year 1 0.917
Year2 0 .842.
Year 3 0.772
Year 4 0.708
Year 5 0.650
Answer
$1 received in fiv y a:rs, tim \'VOtlld hav a valu of 65 c nts if received today, so
$926 roc~iv~d in five y ar · thn has a valu of $60190 today.
$4n.30
t $897.00
494
46.4 The net present value method (NPV)
The net present wJue inethod of capital investment appraisal ,co1npares th,e
investment (at t,o day's pric s) with futur nf.;E ca.rm flows ( discou_nt d to give d1~
~.:1Ju at today's pcic ·).
I Jere i-s a table bowing th~ pr nt v-a[u of S1 at a nutn' r of different d ' count rates:
4% I S% 6% 7%
-
8%
-
9%
-
10%
-
Jan1es Squi.rrd is Qon:ddering whether to purchase a new· n--iachine f.or his workshop.
The n1achine wm cost $12 OOO and be used for five years, after which time it be ,vm
scrapped. The foUo,\\ting ,cash Hows relate, to the machine.
The current cost of capital for Jan1es is ten per cent. AU costs are patd and incomes
received on the last day of each financial year.
The foHov.-ing extract is taken from the present value table.s for $1:
10%
Year 1 0.909
Year2 0.826
Vear 3 0.7Sl
Year 4 0.683
Vear 5 0.621
Required
re Calculate the net present value of purchasing the new machine.
Advis,e Jan1es whether he should invest in the new n1achine.
Answer
Year Cash flows Discount fador Net present value
-
s s
0 (now) {12 OOO) 1.000 (112 OOO)
1 4000 0.909 3636
2 3500 0.826 2891
3 3000 0.75 1 2253
4 2000 0.683 1366
5 2000 0.62 1 1242
Net present va,lue i61.2)
JaJJnes should not invest in the new machine as h: wiU yield a neg-ative net present va]ue.
495
1111 Capital investment appraisal
Note
The cash inflo\\'S ar,e cakul ated from the r ¥enu~ r ceipts less revenue ~pendirur- .
Any proj et that yields a positive net pr s nt vaJut: should b con idered.
Pr,oje-cts diat yield n~sa·t iv net p:r,es nt valu hould b re; et d on financial
grounclls but n1ay be consider,ecl on other grounds, for ,e xample to keep a good
customer happy; to keep a good, skiUed wo,rkforce virithin the business· perhaps to
get further profitable orders in the near future.
The n}anagers of Dvorak Ltd wish to purchase a new n1achine. They w:iU use the
machine fo,r four years. There are three machines that are capable of producing the
quaUty of goods that are desked. The current cost of ea.pita] for Dvorak Ltd is nine
per cent. The foHowing is an extract from the present va]ue tables for 1.
9%
Year 1 0.917
Year 2 0.842
Year3 0.772
Year4 0.708
AU cash flows arise at the end of th~ rd,c vant y-E--ar.
The foUowing information is available for the three tnacb ines:
Requi;: d
; Cakulatt! the;: NPV o,f each mac_
hine.
b Advise the managers of D"'IO,r ak Ltd whkh of th three machin ~ tb y shou]d
purcha e·.
Answer
a Machine 78/B~ 92/DC 36/FE
Present values s s $
Year 0 (88000) (99000) (115 OOO)
Year ·1 40348 43099 45850
Year 2 37048 39574 41' 258
Year 3 30880 36284 .37056
Year4 28320 31' 860 .31; t 52
Net present values 48596 51 817 40316
496
46.4 The net present value method (NPV)
If a]] the machifles yielded a negative net present value, then none of the machines
should b purcha ed.
In this exa,np]t::; aU machines wiU yield a pos itiv--e NPV and; under differt!nt
drcum tanc s, the}' wouJd aU be worth purchasing.
$
Year 1 40000
Year 2 40 000
Year 3 40 000
Year 4 40 000
An swer
Cash ilows Disc.aunt factor NPV
s s
Year 1 40000 0.961, 38440
Year 2 40000 0.92 5 37000
Year 3 400{)0 0.889 35560
Year 4 40000 0.855 34200
Net present va Iu es Net present va lue- 145200
The same resuhs would be given if ,3.63 (0.961 + 0.925 + 0.889 + 0.855) is mubipUed
by the (constant) $40000.
497
1111 Capital investment appraisal
Note
This technique can only b u d if the net cash fl,ows are Eh san1e ainount.
W satd earl i r that a major draw ack in u ing the payback n1ethod was that it did
:not tak,r,;; into account th 'titn valut: of money. Wt: can takt: 'the curr nt ,c ost of capital
into a ccount by 'IJJtsfng disoou nting techniques (se below).
5% 6% 7%
Year 1 0.952 0.943 0.935
Year- 2 0.907 0.890 0.873
Year 3 0.864 0.840 0.816
Year- 4 0.813 0.792 0.76.3
Year- 5 0.784 0.747 0. 71'3
Requh· d
Caikulaite the discounted payback period for Ehe machine.
498
46.5 The discounted payback method
Answer
The: tbr,ee u1bies are given because questions in c.;"aminations on1 ·time provid
mor, than on . If this is th ea e~ choos th tab] that corresponds to th curr, nt
cost of capita]. In thjs ea e, the six pet cent table hould be chosl;n.
Cash flow Discount factor Net present value -
s $
Year 1 30000 0.943 28290
Year 2 45000 0.890 40050
Year 3 50000 0.840 42.000
Year 4 55000 0.792 43560
Year 5 4:5 OOO 0,747 33615
$OOO
Year 1 240
Year 2 320
Year 3 650
At the end of Year 3 the machine wiU be s·old. It is estin1ated that it wm seU for
$60000.
Requh-ed
Prepare a schedule of cash inflows generated by the n1achine.
Answer
Schedule
,.
of cash inflows
$000
Year 1 240
Vear2 320
Year 3 710
($650 OOO + $60 000)
499
1111 Capital investment appraisal
46.6 The internal rate of return
method (I RR)
A business inust b pro,fitabJe in order to SUMVi . A business 1nust en.sure that
projects undertaken are profitable.
Net p:resent value eotnpares present day values of furur,e estin1ated cash inflo'\vs
with present day cash outflows. However, such a co1n.parlson does not ghre managers
the rate of return expected on the invesunent.
The return on a pro ject inust cover the cOSI[ of capital>so if a b1:i:siness has a cost of
capital o f 12 per cent> any projects undertaken n1ust yie]d a return that is greater than
12 per cent
Managet·s need to be able to ca]cufate the rate of return that any project being
considered is Uk:e]y to yield; this expected yie]d can then be cocnpai"ed with the cost
o f the capital needed to fund the project. The prooe~ inv:o]ved is to cakulate the
pres,e nt value, of futur,e cash flows whkb, when discounted, wiU equaJ Ziero.
The l:>rocess used is to S-elect tvvo discounting rates: one that wiU glve a positive
net pre ent value and a .second that '\\oiU gtv ,1 negati~ net pre·s ent value. Tbe results
ar then u ·.edJ in the foUo,w ing fonnuJa :
'n' is a negative valu e. so it should be added to the, va]ue of c_p in. the denominator
1
The managers of Kai Ltd are consiclcnn . "'hethcr or :not to in,,,cst in a new ma-chin -
costing $9000. Tiheir cun-ent oost of capital is 12 per ocnt. They have estimated that
ibe furure cash flows using a net present va}ue of ten per cent wi]J be $871.80 and at
15 per cent the va]ue wm be (378.9-0) .
.Requii·ed
Advise the managers of Kai 'Ltd whether or not, on nnanda] groundis, they should
.invest in the n e\v n1achine.
Answer
The machine shouJd be purchased. It v.riU yield ain 1ntenud rate of return of 13,.485 per
c,ent I wbkh is greater than the cost of capitaJ.
Workings
lRR=P+[(N -P X
p p+ H J
=10 + [ (]5 -
.
10) X
7
S ] .SQ
871.80 + 378.90
J
500
46. 7 Sensitivity analrys~s
=10 + (S x n.697)
=10 + 3.48-
=13.4 5%
The manag,o t"' ,o f Kai Ltd should invest in th n rw macbin ~iflce th IRR is gr ater
than th~ oo·m pany's current cost of capital.
Hugo is con sidering the purchase of a mach ine w hich would require an initial ouday
of $160000. His current cost of capita] is 12.5 per cent. TI'le net present value o f future
cash flows for the tnad1me are as JoUows:
NPV at 10% = $5408~ NPV at 40% = $(52242)
Re qwi1-e d
Advise Hugo whether o r not, on financia l grounds, he should invest in d1e new
machine.
An sw er
Hugo hould invest in th new machin ince it ,vm yi ld 12.81 per cent, which is
1
Wor kings
A project will require an initial out]ay of $45 OOO. It is estitnated that the project ·wiU
generate net receipts of ,S15 OOO over the lleA'l four years. The business's ,c urrent cost
of capitaJ is ten per ,c ent.
The present va lu~ of th~ project~s net receipts is $47 535.
The int maJ r~ue of r cum is 12. 73 p r cent.
Workin gs
NPV a·t 10% =$15 OOO x 3.169 (Le. 0.909 + 0.826 + o. 751 4- o.683)
=,$47535 -
$45000 =$2353
mR requit"es a negative NPV:, so let's try 16 per aent net present value~
NPV a lt 16% = $15000 x 2.798 (0.862 + 0.743· + 0.641 + 0.552)
== $41970 - $45000 ~ - $3030
501
1111 Capital investment appraisal
IRR= 10 + [ 6 X
2 3
- -
2535 + 30.30
J 12.733%
=
the NPV of the receipts had been $2535 or 5.33 per cent less
the current cost of capital faced by the business rises above 12.733 per cent, an
increase of 27. 33 per cent.
As you can j1nagine1 in the (rea] "'·odd) sensitlv:ity ,1naJ}'"'Si-s can b much more
compHc ted than th , xampJes u d her and in Chapter 29.10. In a dynamk
bu in nvitonn1ent, it i.s highly ]ik ly that NernJ varia ] could ohang·t: aft. r tb
projected dat1 m,1 produced.
502
Examination-style questio ns 1
Genera l
De p rec iati on (186) 709 (199) 846
27463
expenses Machinery 995 770
De p recjatio n (447 ) 548 (348) 422
134291 134291
1431 1466
frt 1is dub pollicy to transfer 110% of th1e ba1lance standing11in Cu rren1 assets
the Hie membership found at the finandal year end to the l:nve n,toriies g:32 634
i1ncom,e and ,expenditure account. Trade receivables 805 6S6
Required Cash aind ca,sh 462 2199 77 1367
Prepare: eq uivalen,ts
a a c.a11e 1:raid 1ng account for the year ended Total assets- 3630 2833
30 September 201 4 [3]
503
A Leve~ examination-style questions
Tihey expect rash rece~pts arndl payments to be as follows: The net present value 'for each superma1rket us,ng ai cost
Without Ieasing Wi,th W.n:h
of capita IIof 14o/o ~s esti ma1ed to be:
eitber new supermafket supermarket Supermarket A $1057900 negati~e
supermarket A B Supermarket B $2. 127 '600 negative.
Year s s $ Required
Tota I rec e.ipts
d Callculate the i1nternal rate· of return ORR) for
11 61m 63 .6m 63.9m
supermarrke·t B. [4]
2 64rn 67 .7m 69.4m e Advise 'the managers of lesda pk the· supermarket
.3 67m 71 .2.m 73.3m thait t hey sho·uld l,ease. [4]
4 71m 75.Sm 77.9m [Total: 25]
5 7Sm 80.1m 83.4m (Adapted from Cambridge Jntemational AS and A level Accounting
9706/04, Paper 4 03 May/June 2007)
,
Total! payments
20m 21.8m 21.8m
2 23,m 25.0m 25.7m
504
Examination-style questions
4 Prescott, 1Rohini1and Singh have been in partnership for Ashburton Ltd·s statemen1 of finandai pos~tion ait
many years with a profit sharing rati·o- of 2: 2 : 1. The~r 30 June 20 11 was as foHows:
statemient of fiinandall posirt~on at 30 June 201 11 was as
Ashburton Ltd
foUows:
Statement of financial position at 30 June 2011
Prescott_. Roh i ni a nd Singh $ s
Statement of financial position at 30 June 2011
ASSETS
s s s Non-current assets
ASSETS Property 125 000
No n-c.u rrent assets Fixtures and fltti ngs 67750
P:roperty 100 000
Motor vehicles 24975 2 17725
1
505
A Leve~ examination-style questions
6 The m,anagers of Tawanda pile have pre,pared a1draft set 7 Orooj Chaudhry i1s a manufacturer. The foH,ow~ng
of finaincia~ state:ments for the year ended 31 July 2015. 1nforma11ion i1s avaUa1b~e for the yeair endled 30 Apri1II 2015:
Accord~ng to the draft ~ncom,e stat,e,ment; the profit for the Revenue $525 342
year was $7119 OOO. Production cost ,of goods comp !,eted $258 600
The statement of finandal pos~tion at 311July 2014 shows
retafr1ed profits $1 890 OOO. Inve nto ries 30 April 201 S 1 May 2014
The foHowjng i1nforma1t1ion is no,w ava1ilable: s $
1 Som,e ~tems of damaged inventory have not been Raw m,aterials 3980 3 720
~nduded ~n the income statement at 31 July 2015. These Wor1< in progress 7020 6140
Ftems cost $630: when perfect they have a seHing pric:,e Finished goods 9412 10 S30
of $720. They could now be sdd for $650 after repar~rs
costing $110 have been undertaken. Orooj transfers goods to h-er trading account ait cost
2 Trade rece•vabies have increased ~y $4800 during the ~us 30%.
finandal year ended 31 July 2015. A prov~si1on for Required
doubtlu! debts 1i s ma de ann uaHy. No prov1s ~on has been
a Prepa1r,e the tradiing ac,count for the year ,ended
made iin the current finrandal ye,ar.
30 April 20115. 1(5,]
3 A non-current asse1 is shown ~n the statement of tiina1ncial
b Exp lai1n reasons why Orooj might transfer goods
posrt~on at a canying1amount of $1 S OOO. ,ts value 1in use
to her tradjng account at ,a pr~ce gr,eaiter than the
i1s expecte-d to be $10000 a1nd its fair va1fue is $8000.
4 La1nd a1ndl buildings that cost $1 SO OOO had been cos1 of productjon. [6]
c Prepare a provj s~on for un reaUsed prof i1t account
depreciated uintill the year ended 31 Ju,y 2014 at 2'Vo on
for the year ended 3O Apr~I 2O1S. 1(3]
cost ~n the past yea1r property ptkes have faUen so no
d Prepare a statement showing the iota~ giross
depredat~on has been chairged i1n the finandal sta1ements
for the year ended 31 Ju~y 201 5. profi1 earned by Oroofs bus~ness for the year
ended 30 Apri~ 2015. [4]
5 The foUow~ngi d!ata refers to divi1dlends, pajdl and proposed:
e D~scuss why the manag1ers of a manufactur~ng
August 20~4 Directors propose a final dividend of business might need to prepare a provis~on for
$50 00 0 based on reported profits for the 1.m realised prof; t account. [7]
year ended 31 Ju'ly 2014. [TotaJ: 25]
Octoher 2014 Shareholders approve tne ,final dividend for
8 Mpofu Manuiactudng Umited produces one product.
the year ended 31 July 2014
The budg1e1edl costs and revenues for Ju~ are shown below:
December 2014 Final dividend of $SO OOO for the year ended
• Unrts produced and sold 1OOO
31 July 20114 is paid to shareho,lders.
• Standard s,~i1ing pti'ce $125
May 20115 lnterrm d,ividend of $2,QOOO pa,id to • Standard djrect m1a1teria1ls 6 kilos at $8 per k1l!o
s'harel,o,lders based on profi,ts for the half • Standard direct labour S hours at $10 per hour.
year ended 31 January 201'5. • AilI overheads are fixe di.
Aug1Jst 2015 Directors prro,pose a fina'I dividend of • ~n Jufy 1200 unhs were, produced and so,ld. SellUng prke
$52 OOO based on profi,ts for the year ended rema1~ned at $125 per unijt
31 July 201 'S.
• Actu all costs were:
506
Examination-style questions
Direct materia,fs 7100 ki1los ait a, total cost of $57 51 O • Revenue for ~he yea,r ended 31 August 2015 was
Direct labour 6150 hours at a 10,tal cost of $,60 270. $900 OOO.
Required • Inventory at 31 Au g:ust 20 15 co.st $70 OOO.
a !Prepare the ong~na11budget and the file,xed budget ior • A fina,I ordinary dNkfend of $0.04 per share ior the, yea1r
Juty to show budgeted contribution,. [BJ ended 31 Augu~ 201 '1 was paid jn Dec,ember 201 a.
b Callcu late 1he actuai contributEOn for Ju~y. [1] The dfr,ectors propose a final ordinary d~vidend of $0.05
c IExp~ain tl'ie term 'contribution'. [2] per share ior the yea,r ended ,31 August 2015. An
d Prepare a statement reconci lmng the co ntJri but~on ~nterim ordinary div~dend of $0.02 per share was paid ~n
from the flexed budget wdh the actual Februairy 2015.
contri bruti10n. [11OJ • The tax liab il1i'ty for ihe year en de di 3 11 Au g1ust 2 0 1S is
e Suggest two rea,sons for the inter dependency cak1u~ated at $40 OOO.
of 1:he ma1eri1ail us.age variance and the labour • A 9°/o bank loan of $ 50 OOO is due f'or repayment
effidency va,darnce. [4] ~n 2031.
[To1al: 25] Require d
9 Sa1mira aind Ariun ,enter joto a joint venture se~fjng a Pre,paire a sum,manised ,income statem,ent for 1he y,ear
reconditioned ai,r-con un~s. They agree to share profjts ended 31 August 2015. [9]
and ~osses 1in the rait~o 3: 1 respe-oavely. They provide the b Prepar,e the retained earnjng.s extract from t he
foUow~ng information of the transa,cti10,ns undertaken: state,men1 of eh anges in eq ujty ior the year ended
31 August 2015. [S]
s c Exp! a~n the ro,~e of
Samira suppHe:r air-con units 2.980 i sha1re holders [2]
materials 1140 i i di rectors [2]
iii auditors. [2)
Aru n sup p1ies materla Is 860
d Discuss the rnte of the annual report ars mea,ns
Sam,ira paid warehouse costs 520
oi communication to shareholder. [5]
Wages paid: Samira 6950 [Tota~: 2 5]
Anm 1800
11 The sru mmarised statement of fin andall pos irbon of
Freight and carriage paid: Samifa 1370
Chaunte pie at 31 October 2015 was as follows:
Airun 400
$000
Re,q uired
ASSETS
a Prepare a, joint venture wrth Alrun account in the
Non-current assets (carrying amou:nt) 2840
~edger of Sam,ra. [7]
b Prep are a,j 01int venture whh Sam1ira account in Cur rent assets 638
'the ledg,er of Arun. [5] Tota I assets 3478
c Prepare a memorandum j,01nt venture account. [2]
d Exp~aini what is 1meant by the te,rm 'memorandum, EQUITY AND UABI Lill&: S
account'. [2] Eq uity
e Callcutate,1he am1o unt of cash pa~d or rec~ved by
Ordinary sh.;;ires of $0.25 each 800
each party to the joint venture. [4]
f ID is.cuss the rea-sons that Sam~ra and Arun mi1ght have Shaire premh.llm account 200
considered before entening mnto the joint venture . [5] Retained earnings 1328
[Total; 25] 2328
10 The fo!llo,w ingr inforrnat~on relates to Sandeal ltd at 311 Non-cur rent Ii a bi Iities
Aug1ust 2015 6o/o pirefernnce 5hares of $1 ,ead1 350
Gross mairgin 33j-% 8o/o debentu,res (2015 - 2027) 600
Profjt ma rgj n 10% 950
Rate of ~nventory turnover 12 times Cur rent Iia bi Iities
Additional information Trade payables 93
• lssued share capita,I was ,800 OOO ordinary shares of
1
Other paya,bres 107
$0.50 eadh; 250 OOO 6'% preference shares of $'1 each. 200
• Retained eairnings at 31 Augiust 2015 was $416 OOO.
Total equity and liabilities 3478
507
A Leve~ examination-style questions
Additional information During the year ·ended 3 0 June 201 5 the f oU owhi1g
1
• Chaun1e's profi1 from ·Operations for the year ended 31 transacti1ons relatjn,g to non-current aissets took place:
October 20115 was $'682 OOO. 1 Premi1ses were reva,ued on 30 June 2015 at
• lhe tax UabU1ity for 1he year was $80 OOO. $3 OOO OOO.
• A div~dend of $0.03 wais paid on ordinary shares far the 2 Purdha ses of non-current a,ssets:
year. pi ant and rma dh~neiy cas-t $ 55 0 0 O
• The ordinary shares had a marke1 value of $1.20 each motor vehid,es cos1 $112 OOO
ait 31 October 201 S. office equ~pmen1: co.st $25 OOO
Required 3 Dudng the year plant and machinery t hat cost $35 OOO
a Catoul ate the profit or loss for ·t he year ended 31 w as sold. Accumulated depr,eci.ation relating1 to d1e
October 2015 attributabfre to equ~ty holders . [3] machinery was $28 OOO. The profit on disposa1I was
b Calcutate the follllowiing ratios to two dedma~ pJaces: $ 1000.
'
geanng 4 Durfri g 1he year vehk!e.s 1hat cost $47 OOO were sold.
ii eannrin gs per share Accumulated dep redat~on reiatingrto the vehides was
iii prke earn~ngs rati-o $22 OOO. The loss on d~sposal was $5000.
iv divjdendl ~eld 5 Depredatton is proviid ed ann uaUy at the f oi fow1ing rates
v diV1dend cover. 1(1O] using the str.a~ ght ,ine method:
~ n July 20116 1h,e d1rectors of Chau nte pie ptan to bu Ud Prem~ses 2%
an adlditi1011a1Ifa.ctory. Thrs wiH requ~re add~t~onai capitall Plant and mach~nery 10%
expenditure of $1 OOO OOO. llhe new factory ~s e,qpectedl Motor vehides 20%
10 be profitable i1n 2020. Offiice· equ ~pment 10 %
The d~rectors are consider~ng ra~sing the addi1i,ona~ funds
Required
needed to f~nance 1he bui~d~ng work by one of the
a Prepare a sch@du~e of non-current asse1s at 3 0
foHowrin,g me~hods:
June 2015. [lO]
• an ~ss ue of 1,0 % debentures {2 040} at par
b Ca k:u1 ate the total arnou nit oi sail e proceeds from
• a r~ghts i1ssue of ordinary shares of $0.25 a1 $ 1.05
sales of non~current assets during the year ended
per share
30 June 2015 . [6]
• an ~ssue of 6°/o pireferenc.e shares at $1 each .
c ident~fy three causes of depreciatEon. [3]
Required d D~scu ss 1he statement 'The· provj sion for depredat~on
c Driscuss each of the methods of ra~s~ng1the add~1,onal of no n-cu nent assets p:rov~des ca~h to pay for 1hefr
finairKe needed to fund the build~ng work. Adv1ise the replacement. ' [6]
d~rectors the method they should choose. I[12] (Total: 2S]
[TotaII: 2 5]
12 The foUow~ng 1nforrna1tion ~s avaUab!e for Wakoso L1d at 1
July 20114:
Non..cur rent Aa:u mul ated
assets at cost depreciation
$ $
Premises 1 200 OOO
1
272000
P'la nt and machinery 180000 126000
Motor veh ides 85000 68000
Office equtpment 35000 14000
508
accounting rate of :fettl!:n:l ni.ethod articles of as.sodation 251
absorption (total) costing 281-300 (A.RR), cap:ita] irnvestn1ent
absorption costing statements 288-9 appmi.sa] 485, 489-92 carumgent 397
assodated pr:a hlems 299 addiirional working cap:itta] 4-91 cu.nent 112, 390
calcwation of ()1'o.fit ,~vhen sellfo.g price advantages of use 491 defi.rution 110
fixed 289 disadvantages of use 492 depredation see depredation
calcwation of selJing price witen accounts impaumeot 396-i
predete.rnuned 1eve] of p1ofit annuaJ 368 intangible 112, 254. 3'97-398
l"equi.led 28'9 appropriatiom:1., of p.:utntm,Wps 192 net 44, ill , 117, 162
6xed costs 281, 282 bank see bank aCC'O\ints lW1i: 437
worlcing ru:;sets to .sales
J 2 requ:i1-e,nent.s 299 busine~ 85 no.n-c:u rrent see noo-curcent russets
overhenclls 289-91,297-8 capitnl, of p rtnersh.i.p 19.3-4, 196-9· oi·igin3l co , reco1ding m 114
products p , mg through ""Ver rt] do.sing .4--6 revnlu ati.on foUowin .strucrurnJ change
d.ep itrtients 296-7 conhol see control accounr.s (putn1r.:rsh.ips) 203
reciprocal .s~rv kes 292-., cun-enc, of partt1cEShips 196-9 statements of 6,1and:;1l po.sit.ton
sen'li.-va.riab]e costs 283-4 joint ve11ture 426-29 110. ll11, 112
servke department costs, ledger see ledger a:ccou t1.ts taken rn"e.r by a linuted con1pany
ttarufer 291-2 liability 6 230-,-3
n'lemornndum 95
step_ped costs .284 tangible 112, 255
nomtn.:J 6, 42, 54, 55, 146
sunk casts 284 atttibutable costs 14 7
person ail 6
total casts 285 auditing
rea] 6, 54, 146
types of cost 281- 5 audit requirements 402:
realisation (pait:nerships) 222- 30
unirt costs 28:5 1
audito.rs report 370~ 393~ 401
s luue p rem.ium 248-9
wes 289. 322 external auditors 401
starutory 370
v'ariable costs 282-3 interna] auditors 401
trading see trading accounts
wc1ge .systents 285-8 opinion of audho1 401-2
accruaJs c:,oncept 50, 51. 64, 1.64, 180 1 386
accounting equation lll}-15 qua]ilied re po1t 401
accrued expenses 65. 67-9
accounting e.sEim3te..o,;, changes ill 3% accru~d il.'E::,....c;::nues 70
reguhno.ry frnntevtcuk 402
accou111tit1g infonnaiti.on 132, 4.32 .rol~ of m.1d1Eot 401-3
nccutnulaE d fund . dubs and .societies .357
see also Anandal tem~nts~ add ·cest r3l-io 276
uu~ an fttir vi~w 02-3
.stat~n1.enits
ctiv1ty bnse?d co.sdng 2-5 authorised hare cap.itaJ 2.56 ~ 244, 245
accounting packages 433 AVCO (weighte d av rage cost method of
advantages of use 444
acc:ountin_g policies 370, 394 coin drivers _.42 inrventto.ry valu atfon) 160. 1'62, 28 ..
a~counting principles a,i.d concepts 4,8-52 cost pools 42 advantages of use 163
acc.ru.als 50,51, 64,164,180 definition 442 dlsadvantage..s of use l 64
bu.smess entity 48, 386 ]uniitations af applying 445 a.v e('age coUection ped od 277
consistency 49, 164 overheads apportionn.ient 442 1 445 average pay.rDent pet·iod 278
cost 164 stages musing of systems 443-4
chulirty 1 ~ 50 administrative Sl!:aff 432
going concern 49, 386 adve .rse vadances 460 'b ad debts 105 1 136
hli.storic cost 48-9, 279 aUocacion of costs 269 :recovery 143
inventory va:Juation 164 acn..'1.lgaa:mtion see aJso provision for doubtfuj debts
matching 50, 5 l of two linuted co1npuliires 41()-19 balancing
matecdaUty 50, 386 of tw"O sole tmdeI$ ' busjne.sses 406-7 of ca.sh book 29-3'0
money measurem~nt 24~ 49 amoltisation 374 of ]~clger ac:count 38-40
ptud'en.c ~ 9, 16 , 386 annual accounts, lim~ted c.on1paru,a; 368 bala11ci.ng figure 29, 36
reaJJisat~on SO annuaJ pron l 31 bank accounts 8 • B5
substance ov·\?r form 52 nnuaJ rcuirn, lmiti.:d co111p ni~ 368 b nk charg-~s 87
title to goods 50 applif!d research 397 b~·ut._k foan.s 26
uue at"ld. fak ""icw 371, 02-3 appropriadon ~ecou:nts, of partnerships 192 'b ank overdrafts 87, 264
509
Index
bank reoonciliacioru 83-94 purchase of multiple busin sse.s to form a money trnnsac:tions, recoKl.i:ng 24
checking accuracy of cruih balan~ shown ne\v limited co1np.. ny 10-12. rt:cording of cash atid cheque payment.
:iJn cash book 83-4 2 -6
d1e:dtlng. ccuracy of trnnsacdo11.s recording ,-eceipt of cas.h and r.:hequ es
1corded tn bMk c:olum_ns of cash call d-up share capu,l 2 4 .26-8
book 84-5 capitUtl sho~ti~g different ePtries to bank
procedure used to pt-epare a sr~tement case of 492 statements 86-8
8~ defirudon. 44, 111-l:2. sntaU, cash-based businesses 177
!l.'easoru vrh.y cash book .tnd. bank expendiru:re 112, 122, 146 .sourre docu.men.ts 28--9
statement .might not shoVi..,. identicaJ :introduced or withdrn~rri from a ~three-collu.mn" 35
entries 86-8 bu.smess 11~21 used as book of prune entty 16, 21
recoll.'d:ing morue.s paid into a bank Joan 265-6 cash budgets 4 55-9
account 84 and nlliate:riality concept :50 pEeparation 456-7
recording 1notrie..s withdrawn from a bank rece1pts 122 cash discounts
account 8-S rese:rves 247, 248, 2:54 aUowed, recording 33--4
statements ITT, 89---94 in the state me .111t of financial position defuutiot1 33
bank statemenra 85, 86--s 111-]2, 171-3 entel'.~ng in general ledger 35-7
b3se cost 39 se~ also capita] accounts of panneJShips; received 34-5
batch costing 322, 324-5 sbare.s/share c: .. p.ilta] recording 33-5
bonus ~sues, hares 253-41 379 capttn] ccount of pannersh.ips 196-9 see also discounts; tmd discounts
boob of prim2 entty see pthne ~ntry p book.tS of intGrest on balances 193-4 c . h flow srn1wn~nts, limited comp tn-i
b i.;ak-ev n int ., 12 c: pirtal investtnent appraisal 8+-50,2 25;-7
_mphical method of d?te1'1.llirung 3l6-l8 ac::countEog rate of return m.etho I bonus lSS\tes 379
break-even ~m~ly.sis srn c:ost-volunic-pront 485~489-92 eakulation of cash flows created by
(break-even) analv.si.s
•
discounted payback method 485, 98-9 dep:rec ~ation 376
budgetnrr contro] 329, 4,61- 2 inc:reme.ntaJ value and expendiru.re 486 cakt.·d ation of cash flows resulting f rot.ll
budgeting 446--62 iote-rna1 :rate of return n1ethod. 485) di.sposaJ of non~cuF.rent aissets
benefits and linutartlons 328 500-1 (deirecogni.tion) 377-8
pF.iindpal bud.get factor 460 need fOF 484-6 cak,uilation of profit from operations
budgets net piesent value .n11rethod 4 85, 492--8 374-5
business pfaa.ning 327-8 oppom.llluty cost 486 .finandng activ,tie.s 374
cash 454-7 payb adc method 485, 4 86-9 headings 373--4
definition of budget 463 sem.1Sitivity analysis 501-2. lAS 372-84.394
n~cd 460-11472-5 c;:,.p.i.1:.1] structw-e, limited companies 244-5 ~ndirect method of prep a ring 257
labour 450 car--riagein~ 128t342 ~nvesting activities 374
l1m.iting fuctoFS 460 carriage of goods, expenses incun.-ed 128-9 .net debt 383
ma~'ter 58-9 carriage on .sal~s 128, 135 opel'atmg actiivities 373-4
proch1crtfon 7-8 earring"~ ou~-ards 128, 135 re~ ~oru; f--or pre paring 379-83
purcha 49-9 carrying aniiounc 148, 397 .rec:onciliati.on of n01: cash to inovem nt in
.sales 4 6-7 cash net d ~bi ,s
trade p ayablcs 452-3 definitions 2 55 requirement to prepare 372
tirade receivables 451-3 equ i:va.lcnts 256, l59 ircvaluatior:11 of .n o,n <WTent aissel,
S~f! also budgetar.y control~ b1J.1:dgeting ex:penditu:.re 4 55 rtreaunent 3 79
bus;ne.ss accounts, wi.d.1drawab. fro.m 85 n1,mage n1ent of 263 transactions !'eSl!J]ting :io cash inflows and
business entity con cept 48? 386 n1~ing, cakuJation 187-8 outflows 373
business planning 327-9 p ayn1ents; reco1rd.1ng 24-6 uses of 372-3
benefits aind Uo:utatiorn of budgeting 328 receipt 1 recording 26--8 see also cash flows
budgetary contco] 329 stolen 187 cash Hows
'b udgets 327- 8 whlidrnwal f1onri bank 31. cakulating 376; 377---8
long-term and short-tenn 32.7 see also cash books; cash budgets5 cash finandng activities 374
bus.ioe..ss purchase and me1ger 405-21 discounts; cash .flo~r .statemenli:S, investing activities 374
!Jlllalgam...'Uton or two ]i.mi.ted companies ]u.n'tr~d companies; cash Hows nee 454
417-19 cash lxiok 24-32 open111ing activiti.es 373--4
ainu..lgnnutkm of t~vo sofa• tcadem:s' b:alanciir:tg 29-30 posidve and nega·Mre 454
busin._:ss~ ,o 6-7 ch~cking accurncy of c-ash baku1ce ho\\"n and proftts 256-7
b nefits of combining busiin'-? ~s 05-7 it\ 8.3-4 rn~nienu: see c •6h Row st temcm •
multiple businesses purchn d to form a dieckms ac:cun.cy of tr ,,"lSactio:ns linuced compnnles
n~· Limited conipany 10-12 roco1ded in bank c:olufflJ'l.S of 84-5 v..~hen ~nnua[ cash inflows and outflov,;rs
purchase oJ a partnership b}• a limited contra cncries 1n 30-2 are given separa-r:ely 488
co1npany 41~-t6 a1ld double--entry system 24 cash in h and 29
purdiase of a sole traders business by a ]ayoum 24, 25 cash recetip~. forecast 454
Um,.ited. con1pany 408-10 memo.randum coLunms 36 cashier 24
510
Index
512
Index
513
Index
514
Index
materials usage and price sub-vatiattce.s see also assets ; current ~sets; .Profit sharms rdtio ~d.u.nge '° 221-2
,66-8 depredation of norn-cu rtent sse1. reaJJi~acion 222-3-0
nl)iah: rials usagtl sub-v, n:.u1c~ 65-6 non-currant linbmtie.,; 1 3, 2 S. .390 ~tructuml eh. ,n "'r.::S 201-3 , 222,
total d · , et tnateriaJs varianci.;; 464 no,1-nnanci l aspe of acc:ounit.ing, ocbd 230, 234
memorandum accounts 95 ponsibiUty 398 ,-a,."3.1Ju atlo:n of a ·ets foUowing 203
nilemof'ancl'li.lffl ,colun-u"JJE;. cash book 36 rrcatn1.e.ni of in.Ionnal'ion. refoting ·t o
m.en1o randum jomt vcnrture accoun1ts 427-8 busi.ne.ss ptior- to/ f oHo~ing the
nr1erge!I.', defin.irdon 406 on:u.ss io n, en:ors of 76 d 1ange 202
:rni.dlcDe m.anagers 431. o penjng 1nvenro1·y 12; types of changes 201-7
mnem.oni.cs 76 o perntmg aotivities, cash fio-..vs 373--4 valuation o f goodwill 20&-l.1
money ope!t"ation costing batch costing
Se& see also valuation of p artne!fship accounts
.f orm 24 o per-ation.s ~ profit &orn 238 partnerships 19-0--2001 235
time vafue 488 oppOEtunity CO.St :no, 488 admission o f new pa:rtnens) 202- 7
money m.easlu-e1nent: 241 49 o:rdinary dividends 238 definitions 191
mortgage debentures 246 o rdinary shares 245 1 260 dissolution 222
mutuaJ exdus ivity 491 origin ai] cost, reoo.rdm.g o f assets at 114 features 236
originaJ e ntry 1 books of see :prune emry, mn.ethods of paying a p.'IJnnets when
N boob o f le avmg a pa1me1slup 2 21
na11.mtive, general journal 14 outstandtng revemJe.s, recordms; 69 purchase by a ]imited. company 413-15
n~gative contribuci.on.s. mrugi1tal overcast 80 ~ttrrtmf,!nt of par~rs 218-21
costing 307 o""erdrafts, inte ~ t on 87. 2.64 saJari4.:s of palltners 192-3
negativ goodwill ,,08 Oll 1.>fh acl and "'ole trod rs 190,
net ass ~ 4, 11.J!., 117 absorption of 289-91, 29~6 types of changes 201-7
reporEed, effect: of mv€l'ntot·y overa ::u\d undc.r--absorption of payables
vaJu arion O f\ 162 297~ dubs and societies 363
n et book value (NBV) 148 apportioornent 1 i.n activ.ity based costing oche,. 65; 70, 265
net cash fllow 454 442.445 trade 6,65, 111.,259,265
net debt 383 definition 238 also trade payab]es nunovec
S(](!
net pre.sent value (NPV) method, capital fixed ovemead variances 475-7 payback method, capita] investn1eot appraiisa]
i:nvestment appraisal 4851 general 298 484,486-9
492-8 1nanufaotudng accounts 336, 339 advantages of use 488
advantages of llSe 497 over recove!l.y o f 297 di.sad.vantages o f use 488-9
disadvantages of use 497-9 pn:p,ducti.on 393 whe n ainm.1ru C't11Sh i:rrllows and Ollftflo~
net rea]isable value 61, 126! ll 58-60, 39'3 undeC" recovery of 297 a:re given .separately 488
nel w orlcing assets to sales 43 7 when profits Siven 487-8
nominal accoonirs 6, 42. 54, 55. l ·6 payb adt: p~riod 486
nominal ledgtl!r 6 paid-up capiEa 244 payees of cheques 85
nominal v~ilu..:, ~hares 245 pm: va1u~, shan:-s 24 paying-jo slips 8
non-c::a.sl1 exp ns l ""6 p smdpating prefer nee .shnre.s 246 p .n(?ttation or destroyer pridng 311-l 2
.non-cua "11t a ~~t tumover 276 p iutner~hip accounts p ri'-oim~nce. e,talu~tion 270-1
n-on-curront assets ac:c:ou n.t f omi, for capital acco unts 197 1
period costs 281-
account~ng pfindples and concepts 49 adj1u stme.nts TO capital accou nts m:o record perpetual at1d periodk methods of invc_ntory
cost 147 goodwill 211- 18 valuation
defi.rution 14 5-6 appropriation accounM 192 choice of n1.ettbod 162--3
disposall (derecognition) s@e disposal o:f as.sets taken over by a lin-1.ited con1p any do.sing mvento!ly. 16&-2
non-cw -re m assets (derecogom.rio n) 230--3 peFsonal accounts 6
factors affecting usefuJ 1ife 146-7 c-apilal and cturent accm.mts 1'96-9 1 p iece work 286--7
.finite Ufe 146 211-18 postings l.8
lAS l (Presentation ofR1ianctal goodwill 207- l 1 preference dividen~ 2..18
Statetnents) 390 adiustn1ents niade ~.,.hen no goodwill preference sh ace.s 246, 435
jntangible see imangib]e assets account is introdu1ced 213--18 premises, Jiinited company 258, 259
]edge.r accounts used m record disposal adjusrments made v.tith a goodwiU premiu m bonus schemes 287
of 154-5 acc:ount 211-13 prepaid expenses 64, 66
funm.tecl comparu.e.s 2 54=5 factors comtibu tim.1 g w esuablishntenr m
rec:01:dlmg general ledge r 67-9
and real nccount.s 6 of 211 prase.ntation of Anandal sttu~mi;.-nts ([AS 1)
r~siclu l ~ ctap) value 1 7 valtJa·1ion of see- "'aJuation of good\Vill. aud1m:ors' repoff 395
revaluation 3 79 partnerships directot ' 1 pon 392-3,
sale o,· d1sposnl 1.53-4 income smten1en·ts 19.ll-6 div.id~nch 391-2
statenl.l?nts of financial, position 112 incomplete records 180 cqwry. statcm.ent of changes in 389-90
tangjb[e see. tangible as.sets interost on partners• capit~ account going COnc€VJl 49
trade-in' 155--6 balances 193"""4 .ii11.1Co me .stateilnenrs 387-8
l!lnused., lbSin:g to raise fit1.aince 264 interest on partners' cuaw1ngs 194-6 Notes to financial staten1.ents 393
515
Index
irecognised gains and. ]osse.s, st.1.tenient .sun.ival of business depending upon 36 c-eal accounts 61 54, 146
of 389 before tax 122 realisable valu~ 126
tal"emt?1.1t of financial positio,n 369-90 un1~au~d 3,52-8 realilsaE;ion accounts, partoorships 2.22-30
pric~ earnings ratio (P'/E.) 439 see also !~s ; ratam~d earnings profit) i alls tion cott~pt 50
pl'idng, penetration or dlcstrt)'yr..r 311-12 profit/volume g,-aph.s 315, 319 ccce1pr.s 122, 45 '
primary ratio 272 property, plant ,nd, equipnlent (PPE) 9, receip~ and p ~yn~ent accout'H. dubs and
prime rost r""am:e 296 3,95--,6 societies 357-9
prime costs 282. 337--9 provision fof' bad debts 138 rece.iivables
prime entry, books of 9-18. 18 p.rovi.swn for d.oulbtful deb~ 1061 138-9 dubs and societies 363
as books of original enny 9 c akubtlon based on an age p:ro@e of other 65
cash book wed as book of pdme eut1y 16 indivickmal debtors 13,9 tuade 6 65,
1 C)i, 111
general journai] 13-16 caloubl!tion based on past s~ also crade receivable.s turnover
naa-ative 14, experience 138 1t:edptocal services 292-3
outline 9 dec-reasi.ng 141- 2 reconciliatioru
postings 18 :increasing 142 ban.k see bank recondUations
purchases jouilna1 10 ledger accounts recording l.39-41 jOvento.my 1.64-5,
purdrnses .reruul.s im.umd 12. proVISlOIClS recordirn.g
11."Eqlliiremem to list 1:1:ansactions .in 9 bad. debts see provision for bad debts cash discount allowed 33-4, 34-5
.:;ales j:o,u rna] 11 defumion l 4B of credit purcfot.ses aod .sales l 0-1 . 11.
.sal~s ceturru; journn] 13 for cl!otibtful d~bts see provision for of nron~s paid mto
bm.1k account 8-4, 85
s subsidtmy books 9 do\1btfu.J debts of ncionJe "'ithcllrawn &om a bank
urade discount 17-18 JAS 37 397 account 85
uslng 20-3 ]im~tcd con,panies 255 01.1c.standing rev~ues 69
principal bi1dget factor 60 unt-ca~sed profim:s 350-3 prep:1id rcvenu(l:s 70
principle~ errors of 7o-7 prudence con-cepl! 49, 164 1 386 of returned. goods 12-,.,-13, 127-8
private ledgeJr 54 public Hm~ted con1parues, and private limited of transaotions wh.en payment rtnade 'b y
private 1in."1ited companies co.mpanies 236-7 cheque S5.
features .236 purchase co!l.1.Sideradon 408 t-ecords1 computer- 433
and public llinited companies 236- 7 purchase of businesses see business pu.uchase recoverable amount 396
procruction budgets 447--9 and merger redeemable prefet-ence share.s 246
production overheads 393 purchase.s redudng balance de pred.atm.on method
profit and loss account 132i 13,3 credit, recocding of 10-11 147, 150- 2
cakuladng profit o.r loss f o.r a s.maU, ct11Sh- defirution 3. 123 mpo!Lting pe.riod, events following 395
based business 17&-9 pu,-chases budgets 488--9 1t:ese arch, applied and pure 397
profit margin 2 74 pun:hase.s jpumal 10 reserves
profi.rnbil~ty r..tt:iol5 purchases JledgeE 6~ 101-2 cnpiirnJ 247, 248, 254
expense to revenue 27 4-5 pu rcbases fadger c onuol accounts, IAS l requis:e,ments 390-2
gross ,nacg1n 273 pt~parntion 99-100 Umi.ted con1paru~ 246-8, 255
mnrkup 274, purchases return , trading accounts 127 ma:ittttdning 25 ,
profit mDJrgin 27 purchaisc,$ rcrurns ~ccounc 12 retained mings ] 18. 2 7
rotu rn on captttd ~nllployed. 27 2-3, 89 purchases r~wvns journal 12 rcva]uQdon 250-l
ptufks l 17-2J!. p1uc::hasi..ng cconon~i.es 406 lrCVl?t\Ue 240. 2.47, 2:54
annual 131 pu.re reseatr(:h ,597 residual (scmp varue 147, 3911
cakulating 42-4, 118; 289, 374-6 !l.'esidual profits, partnerships 192
and cash flows 256--7 ( r.-esout"Ces, sca.rce 308
defirutioru 117 quick ratio 276 retained earrung.s (profit) .ll 18, 247 1 260, 265
draft, con:ecting 175 fe,t w-n of goods, recording 12-13,1 127-8
fixed selling price. when 289 retun1 on capira.l employed {ROCE) Eatio
gross pro.fit 44, 61, ]23, 131, 347 rate of inventory turnover 278--9 272-3~489
Utrnm.ted companies 238 1 256--7 ratios 271-9~ 435-41 11.-etu.rn on investn1ent 405
manufacturing 34&-9 defirution 270 n=:,tuE.n s in/rn.n 127
f ron\ o peratioru 236 effiden.cy 276-9 revaluation depreciation method 147, 152-3
operations, cakufation of profit jnve.stment 439-41 rev~uation of n01.tacu.r.rent asset, treatlneot
from 374-5 liquidity 275--6 381,399
pront~ b1lity vs. social costs 399 primary 27 2 revaluation re.5erves 2S0-l
rucondlin.g ~tandard proSt co acrual prolitabmty 212.-s ,1-,,venu~
ptont 80-1 ratio an- lysts 270 definirtion 123
ropottecl, effect of Ln,;1.:n.tory valuation reasons fo,· using 271-2 (!xp(:ncl~rure JJl2~ 122, 124, J 5
on162 see t:1lso inte rpt-em.,tion/ analysis of Umtted c-onlpanies 2.38
re~du.al>of p :utnersl1ips 192 finat1dal data mffrginaJ 301
sodal costs and profuabiliity 399 raw materials 341, 34 2 311,,d inaterialliy couc~pt 50
516
Index
517
Index
time rates 286 totnJs in dLSagreement 75 Ja.st-in~nrst-out method ( UfO) lc°M.), 163
ti1ne value of monev 88
~
us~ of iS perpetual i,nd periodic medto 100-3
titlf:: to goods 50 tru~ and fair vi~w 3i1. 04-S .recondJJia.cioru 164-
total co.stlnS 288 weig-hted ave:rnge cos£ a1eihod (AVCO)
total costs 2S 5 160,163.16 ',285
motal fixc,d ovcrltead vairi~ncc 477 unden::ast 80 see also inventories
m:radc credocor.s 6, 11.1 u.nincorpo:rated businesses 406 varialble casts 282-3 , 30 l
trade debtors 6, 111 Sf!f! also parme r.ships 1 sole traders -vadance analysis 4 7&-83
trade discounts 17-18, 33 unit contcibution .m ethod 312-15 reconciling standa:rd. cost to a ctual cost
Sflfl also casb di!scounts; discounts unk costing 322 479-80
trade payables 6, 6;, l.11. , 259, 26; unit ,c osts 285 .recond]ing standa.rd pt"ofi.t to actua1
trade p aya bies budget 454--5 unit p.Foduced rate 296 .profit 480-1
trade JP aya btes sd1edule ~ unlim.ned. ]tabi1ity 236 variances
trade p ayabies turnover 278 unpre.sented cheques 88 adve:rse o.r favourable 4 6o, 464
trade .receivables 6, 65. :ll 11 unrealised profits direct labour 468- 72
trade receivables bt1dget 452--4 indusi.0 11 i.n financiaJ statements 354-{i .fixed overhead 475- 7
trade receivables schedule 97 pf"ovision fo1 350-3 materials 464, 464-8
trade: receivables turnover- 277 sales 478
'trade-in' 155-6 T
variance ainali~r.sis see variance
Ernillng account5 122-30 va.luuiion of goodwill, partcuas.hjp.s 208-11 analvsRJ
•
carrias~ of goods, expense8 incurred in mwtlpl ol an avem.11 of thr.:: gro.s.s see also ~tandard co.sting; sub-,;-ada.nces
128-9 fectii amed o·v~r number of Vl nical layout. stntem.erus of financial posidon
do ins ,ia:v~:mory 125 y ars .210 111, !]5
cosr: of sales 125 nluhiple of average p(Ofits geneirarcd over
mventorie.s, treatme nt 124"""6 past fol;\." years 209
n1anuiacmri:ng busm.esse.s 338 n1u1tiple of average v.reeldy sales genemted w~ge systems 2:8~
opening .inventory 125 ove.r the past financial year 209 direct labou f' cost rate 295
pu:,-chases .retta:rn.s 127 mu]tiple of super profits earned by the clir-ect b.lbour ho ur 1ate 293-4
realisable value/ net realisable value 126 bwi.ness 210 Halsey sd.1.en1e/Ha1sey-Weir
11:eturned goods 127-8 see also goodwiU; partnership accounts sd1eme 2.87
sales returns 127 valuation o:lf inventories 61- 3, 126-7 i high. day rates 286
transposition e mus 76 158-66 machine .hour rate 294- 5
trend ana]ysis 270 and accounting concepts 16-4 piece wo.r.k 286-7
tria] bn]ance agent 1 iavento.ry remrurung with -424-5 pre11.niwn bonus sd1emes 287
accruals and prepayme nts 64 cakulartmg 325 Rowan scheme 288
dosing inve11tory 60 d osing invento1y, pe.rpetuaJ and periodic t~m.e mites 286
contcoJ sy.stcm'l.5 72-8 ~ 75, 78 ways of valuing uso-2 weightad a.vetage cost metb.ocl (AVCO)
c~dit 'b alanc:e-9 7~ con5ignme,it accounts ,24- see AVCO (we:igb1~d average cob't
debk b lances 7; co.sL or net real· able value, us · of method of mventoty 'Vahmtion)
deA.rutLon 38 158-60 whoHy owned ~ub id iary 421
l?n'O!$ n.01 rev~al4?d by Clttractit\g 76-8 cffeet on. !f.'C potted p~-o!5t and net work in pro .n?.ss 341
iincom e staEeJ1~ents 72 assets 162 ~to!f.'km.g capital cycle 37
lin~tations of using as couuo l s,,"'Stem 75-6 fir.st~in 1 .first'"°ut m.cthod (FJFO) 160, 163 working ea pita] nuu.rngen1.ent 262
preparatiot1 of financial state n1.e 1)ts 40-2 279, 285 working p aipe r.s 180
518