Professional Documents
Culture Documents
F3 BPP Notes
F3 BPP Notes
Paper F3 (International)
Course Notes
ACF3CN07 (INT)
Page
Introduction to the paper and the course............................................................................................................... (ii)
1
2
3
4
5
Home Study
Home Study
Home Study
Home Study
Home Study
Revision of syllabus
Testing of knowledge
Question practice
Exam technique practice
(i)
INTRODUCTION
The syllabus
The broad syllabus headings are:
A
B
C
D
E
F
Main capabilities
On successful completion of this paper, candidates should be able to:
Financial Reporting
(P7)
Accountant in
Business (F1)
Financial Accounting
(F3)
This diagram shows where direct (solid line arrows) and indirect (dashed line arrows) links exist between this
paper and other papers that may precede or follow it.
Paper F7 Financial Reporting, assumes knowledge acquired in paper F3 Financial Accounting, and develops and
applies this further and in greater depth. Paper P2 Corporate Reporting, assumes knowledge acquired at the
Fundamentals level including core technical capabilities to prepare and analyse financial reports for single and
combined entities.
(ii)
INTRODUCTION
Marks
80
10
90
(iii)
INTRODUCTION
Course Aims
Achieving ACCA's Study Guide Outcomes
A
Chapter 1
Chapter 1
Chapter 1
Chapter 2
Chapter 3
Chapter 3
Chapters 4 & 5
Chapters 4 & 5
Chapter 24
Chapters 4, 5, 7
& 14
D2 Cash
Chapters 4 & 5
D3 Inventory
Chapter 8
Chapter 9
D5 Depreciation
Chapter 9
Chapter 10
Chapter 11
Chapter 12
Chapter 13
Chapters 20 &
21
(iv)
INTRODUCTION
E1
Trial balance
Chapter 6
E2
Correction of errors
Chapter 16
E3
Chapter 14
E4
Bank reconciliations
Chapter 15
E5
Suspense accounts
Chapter 16
F1
Balance sheets
Chapter 17
F2
Income statements
Chapter 17
F3
Chapter 22
F4
Chapter 19
F5
Chapter 23
F6
Incomplete records
Chapter 18
(v)
INTRODUCTION
Classroom tuition
In class we aim to cover the key areas of the syllabus. To ensure examination success you will to spend private
study time reinforcing your classroom course with question practice and reviewing areas of the Course Notes
and Study Text.
Home study
To support you with your private study BPP provides you with a Course Companion which helps you to work at
home and aims to ensure your private study time is effectively used. The Course Companion includes a Home
Study section which breaks down your home study by days, one to be covered at the end of each day of the
course. You will find clear guidance as to the time to spend on various activities and their importance.
You are also provided with progress tests and two course exams which should be submitted for marking as they
become due.
These may include questions on topics covered in class and home study.
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We have thriving ACCA bulletin boards at www.bpp.com/accaforum. Register and discuss your studies with
tutors and students.
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If you have any queries during your private study simply contact your class tutor on the telephone number or
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outside the London area) and ask for a tutor for this paper to speak to you or to call you back within 24 hours.
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(vi)
INTRODUCTION
Key to icons
(vii)
INTRODUCTION
(viii)
Introduction
to accounting
Identify and define the different business entities of: sole trader, partnership and limited liability company and
recognise the legal differences between them.
Identify the advantages and disadvantages of operating as each of the three types of business entity.
Identify the users of financial statements and state and differentiate between their information needs.
Understand and identify the purpose of each of the main financial statements.
Exam Context
This chapter introduces the subject of accounting. Questions on this area will most likely focus on the different
characteristics of the three types of business entity: sole trader, partnership and limited liability company.
Qualification Context
Sole trader and partnership accounts are only examined in Financial Accounting. The Fundamentals and Professional
level papers of Financial Reporting (F7) and Corporate Reporting (P2) are set in the context of a limited liability
company. These papers will test your understanding of the content of financial statements and the detailed accounting
rules which companies must apply.
1.1
1: INTRODUCTION TO ACCOUNTING
Overview
Balance sheet
Income statement
Financial statements
Users of financial
information
Introduction
to accounting
Sole trader
Partnership
1.2
Limited liability
company
1: INTRODUCTION TO ACCOUNTING
Accounting
Definition
1.1
Income statement
2.1
Cost of sales
Opening inventories
Purchases
Carriage inwards
40,000
110,000
20,000
170,000
(50,000)
Closing inventories
(120,000)
80,000
5,000
3,000
88,000
Gross profit
Sundry income
Discounts receivable
Less:
$
200,000
Expenses
Rent
Carriage outwards
Telephone
Electricity
Wages and salaries
Depreciation
Bad and doubtful debts
Motor expenses
Discounts allowable
11,000
4,000
1,000
2,000
9,000
7,000
3,000
5,000
1,000
(43,000)
45,000
1.3
1: INTRODUCTION TO ACCOUNTING
Balance sheet
2.2
$
100,000
50,000
30,000
20,000
200,000
Current assets
Inventories
Trade receivables
Less: allowance for receivables
50,000
30,000
(2,000)
28,000
5,000
7,000
90,000
290,000
Prepayments
Cash in hand and at bank
Total assets
CAPITAL AND LIABILITIES
Capital
Capital
Profit
Less: drawings
170,000
45,000
(25,000)
190,000
Non-current liabilities
Bank loans
40,000
Current liabilities
Bank overdraft
Trade payables
Accruals
16,000
40,000
4,000
60,000
290,000
1.4
1: INTRODUCTION TO ACCOUNTING
Lecture example 1
Idea generation
Required
What information would these users of financial information be interested in?
Solution
(a)
Investors
(b)
Employees
(c)
Lenders
(d)
Suppliers
(e)
Customers
(f)
(g)
Public
1.5
1: INTRODUCTION TO ACCOUNTING
Quick Quiz Q2
Accounting records
4.1
In order to be able to produce an income statement and a balance sheet a business needs
to keep a record of all its transactions.
4.2
4.3
Accounting records should be complete, accurate and valid if the information produced is
to be useful for the users of financial information.
4.4
The mechanics of bookkeeping and the accounting records a business should keep will be
covered in Chapters 4, 5 and 6.
5.1
Sole trader
(b)
Partnership
(c)
6.1
A business is considered to be a separate entity from its owner and so the personal
transactions of the owner should never be mixed with the business transactions.
6.2
When considering a limited liability company this distinction is laid down in law the
company has a separate legal identity.
6.3
In preparing accounts, any type of business is treated as being a separate entity from its
owner(s).
1.6
1: INTRODUCTION TO ACCOUNTING
Summary of Chapter 1
7.1
Financial statements are used by a wide variety of users, each with different information
needs. Satisfying the investors needs will mean that the majority of other users needs are
also met.
7.2
There are three main types of businesses. For sole traders and partnerships the owners
have unlimited liability and bear all the risks and reap all the rewards of being in business.
For a limited liability company the shareholders' liability is limited to the extent of their
investment.
7.3
The business entity concept states that a business is a separate entity from its owners
1.7
1: INTRODUCTION TO ACCOUNTING
1.8
Chapter 1: Questions
1.9
1: QUESTIONS
1.1
In a sole trader and a partnership the owners are personally liable if the business cannot meet its debts.
Is this statement true or false?
1.2
1.3
True
False
(1 mark)
If a limited liability company goes into liquidation will the shareholders have to make a financial
contribution to help the company pay its creditors?
A
Yes
No
(1 mark)
Which of the following statements most accurately defines the business entity concept?
A
1.10
(1 mark)
Chapter 1: Answers
1.11
1: ANSWERS
1.1
1.2
1.3
END OF CHAPTER
1.12
Understand the role of the regulatory system including the roles of the
Exam Context
Questions on this chapter will be knowledge based and so it is important that you are familiar with the role of each body.
The role of IFRIC was tested in the Pilot Paper.
Qualification Context
Financial Accounting introduces the International Accounting Standards Board's role in issuing IFRSs and paper F3
examines some key standards. All of these standards are built upon in the Fundamentals level paper Financial
Reporting (F7) and the Professional level paper Corporate Reporting (P2).
2.1
Overview
Regulatory
framework
IASCF
SAC
IASB
Issue IFRS
2.2
IFRIC
Introduction
1.1
Financial statements are produced by an entity's managers in order to show its owners how
the entity has performed over a period of time.
1.2
Company financial statements particularly need to show a true and fair view.
This means a system of regulation is necessary to ensure that financial statements are
produced to a high standard and are comparable across different companies.
Regulatory system
2.1
International Accounting
Standards Committee Foundation
(IASCF)
(22 Trustees)
International Accounting
Standards Board
(IASB)
(14 Board members)
Key:
Appoints
Reports to
Advises
The IASCF is a not-for-profit organisation based in the United States which heads up the
regulatory system.
Its Trustees appoint members to the IASB, IFRIC and SAC. They also oversee the
regulatory system and raise the finance necessary to support it.
It has no involvement in the standard setting process.
The IASB's principal aim is to develop a single set of high quality accounting standards:
International Financial Reporting Standards (IFRS).
It also liaises with national accounting standard setters (for example the UK's ASB) to
achieve convergence in accounting standards around the world.
2.3
The IFRIC issues guidance on both how to apply existing IFRSs in company financial
statements and how to account for new financial reporting issues where no IFRS exists. It
reports to the IASB.
The SAC's principal role is to advise the IASB on a range of issues which include:
3.1
IFRSs provide guidance as to how items should be shown in a set of financial statements
both in terms of their monetary amount and any other disclosure.
For example: IAS 2: Inventory states at what amount a company should value its inventory
and also requires that the financial statements breakdown the inventory figure between its
components such as raw materials, work in progress and finished goods.
3.2
If a company follows the relevant accounting standards its financial statements should show
a true and fair view.
Lecture example 1
To advise the IASB on new accounting standards they should consider issuing.
Solution
2.4
Lecture example 2
Which of the following bodies is involved is trying to achieve convergence of global accounting
standards?
A
IASB
IFRIC
Solution
Summary of Chapter 2
4.1
4.2
4.3
4.4
2.5
2.6
Chapter 2: Questions
2.7
2: QUESTIONS
2.1
2.2
the IASB
the IAASB
(1 mark)
Which of the following best describes the role of The International Financial Reporting Interpretations
Committee?
A
2.8
(1 mark)
Chapter 2: Answers
2.9
2: ANSWERS
2.1
2.2
END OF CHAPTER
2.10
Accounting conventions
Identify and explain the main characteristics of alternative valuation bases (for example net realisable value).
Understand the provision of International Financial Reporting Standards governing financial statements regarding
changes in accounting policies.
Identify the appropriate accounting treatment if a company changes a material accounting policy.
Exam Context
Questions on this chapter are likely to test your understanding of the qualitative characteristics of information. For
example, the Pilot Paper required you to identify the factors that make information reliable. Questions may also ask you
to define accounting conventions.
Qualification Context
Your understanding of the remaining chapters of IASB Framework will be developed in the Fundamentals level paper
Financial Reporting (F7). You should also expect to see more detailed calculations on IAS 8 tested in Paper F7.
3.1
3: ACCOUNTING CONVENTIONS
Overview
Underlying assumptions
IASB Framework
Qualitative characteristics of
financial information
Accounting conventions
Other issues
3.2
3: ACCOUNTING CONVENTIONS
Introduction
1.1
As noted in Chapter 2 financial statements should show a true and fair view of, or present
fairly, the entity's activities. They are produced to provide information to the entity's owners.
1.2
Conceptual framework
2.1
2.2
2.3
Whenever a new accounting standard is issued it will be based on the principles of the IASB
Framework. Furthermore its principles should be applied to account for any item where no
accounting standard exists.
2.4
4) The elements
of financial
statements
2) Underlying
assumptions
Framework
3) Qualitative
characteristics
of financial
information
7) Concepts of
capital and
capital
maintenance
6) Measurement of
the elements of
financial statements
5) Recognition of
the elements of
financial statements
To provide information about the financial position, financial performance and changes
in financial position of an entity that is useful to a wide range of users in making economic
decisions.
3.3
3: ACCOUNTING CONVENTIONS
Underlying assumptions
2.6
Accruals basis
The effects of transactions and other events are recognised when they occur (and not as
cash or its equivalent is received or paid) and they are recorded in the accounting records
and reported in the financial statements of the period to which they relate.
Going concern
The financial statements are normally prepared on the assumption that an entity is a going
concern and will continue in operation for the foreseeable future.
Quick Quiz Q3
If this is not appropriate, then additional disclosure about the basis of preparation must be
made in the financial statements.
Comparability
Understandability
Relevance
Reliability
3.4
Faithful representation
Substance over form
Neutrality
Prudence
Completeness
3: ACCOUNTING CONVENTIONS
2.8
Historic cost
3.1
Financial statements are generally produced using the historical cost convention where
items are recorded at their historic cost.
For example, if an entity purchased a building in 20X6 for $1 million then the building would
be recorded as an asset at $1 million. The $1 million asset would then be depreciated to
reflect the wearing out of the building. However, in reality, the value of the building may
appreciate over time depending on market values.
3.5
3: ACCOUNTING CONVENTIONS
Lecture example 1
Idea generation
What are the advantages and disadvantages of recording the building at its historic cost of
$1 million? (consider the Framework's qualitative characteristics).
Solution
Advantages of historic cost
(1)
(2)
(3)
Disadvantages of historic cost
(1)
(2)
3.2
Note that in times of rising prices using the historical cost convention will lead to asset
values being too low and profits too high in a set of financial statements.
3.3
Due to the limitations of historic cost, alternative valuation bases exist. They are:
replacement cost
net realisable value
economic value
Replacement cost
3.4
Assets are carried at the amount it would cost to acquire an equivalent asset today.
Liabilities are shown at the amount that would be required to settle the obligation today.
Replacement cost is also known as 'current cost'.
This values items at their expected selling price less any costs that need to be incurred
before the item can be sold.
Inventory should always be shown in the financial statements at the lower of cost (historic
cost) and net realisable value.
3.6
3: ACCOUNTING CONVENTIONS
Lecture example 2
Preparation question
A Ltd has 100 items in inventory at the year end. The following information is available:
$
1,000
11
2
$
$
$
Workings
Economic value
3.6
Quick Quiz Q6
This is the value of an item derived from its ability to generate net cash flows. It can also be
known as 'present value'.
For example, the economic value of a machine would be calculated by determining the
value in today's prices, of the future cash inflows from selling items produced by the
machine less the related cash outflows.
3.7
3: ACCOUNTING CONVENTIONS
Summary of Chapter 3
4.1
The IASB Framework provides a set of principles on which financial accounting is based.
4.2
4.3
In order for this information to be useful to users the financial statements should contain the
qualitative characteristics of understandability, relevance, reliability and comparability.
3.8
3: ACCOUNTING CONVENTIONS
Additional Notes
3.9
3: ACCOUNTING CONVENTIONS
5.1
In addition to the concepts and conventions set out in the Framework, the following are also
relevant in the preparation of financial statements.
This recognises the distinction between the business and its activities and the owners or
managers themselves. This is particularly important when considering sole trader or
partnership accounts as these businesses are not separately identified by law.
Only items which are capable of being measured in monetary terms should be recognised
in the financial statements. For example, even though a loyal workforce may be of benefit to
a business this value cannot be measured in monetary terms and is therefore not included
on the balance sheet.
Every transaction has two effects. This is the underlying principle of the double entry
accounting system.
Assets and liabilities are recorded at their historical cost. This is the amount recorded when
the transaction took place.
Accounting policies are the significant principles, bases, conventions, rules and practices
applied by an entity in preparing and presenting the financial statements.
It is the way the entity has decided to treat an item in its financial statements, for example
whether non-current assets are carried at historic cost or a revalued amount.
3.10
3: ACCOUNTING CONVENTIONS
Accounting treatment
6.3
Financial statements contain two years worth of figures. For example a company whose
year end is 31 December 20X7 will show information for 20X7 and 20X6.
The current year figures (20X7) will be produced using the new accounting policy.
In order for the financial statements to be comparable over time the comparative figures
(20X6) will be restated. This means they will be reproduced and drawn up using the 20X7
accounting policies.
6.4
Disclosure
The following disclosure should be made:
(a)
(b)
(c)
Errors
6.5
These are material omissions from, or misstatements in, the financial statements that ought
to have been identified before the financial statements were finalised.
An error is accounted for in exactly the same way as a change in accounting policy.
For example, an entity may discover a material error in the 20X6 figures whilst producing the
20X7 financial statements. When the 20X7 financial statements are produced the 20X6
comparatives should be restated and the error corrected.
3.11
3: ACCOUNTING CONVENTIONS
3.12
Chapter 3: Questions
3.13
3: QUESTIONS
3.1
3.2
The Framework for the Preparation and Presentation of Financial Statements identifies two assumptions
which are the bedrock of accounting. What are they?
A
(1 mark)
(ii) only
(2 marks)
3.14
Chapter 3: Answers
3.15
3: ANSWERS
3.1
3.2
END OF CHAPTER
3.16
Identify and explain the function of the main data sources in an accounting system and how the accounting
system provides useful information.
Outline the contents and purpose of different types of business documentation such as an invoice.
Identify the main types of business transactions, for example, sales, purchases, payments and receipts.
Understand and apply the concept of double entry accounting, the duality concept and the accounting equation.
Identify the main types of ledger account and illustrate how to balance and close a ledger account.
Understand and illustrate the uses of journals and the posting of journal entries into ledger accounts.
Record credit sale, credit purchase and cash transactions in ledger accounts and day books.
Understand the need for a record of petty cash transactions and security over the petty cash system.
Exam Context
Questions are unlikely to feature solely on this chapter, however, you should have a good understanding of what
constitutes an asset, liability, capital, income and expense. You should also be aware of the principal contents of each
book of prime entry and the purpose of the memorandum ledgers.
Qualification Context
These topics are only examined in Financial Accounting.
4.1
Overview
Balance sheet
Income statement
Cash book
Memorandum ledgers
4.2
Journal book
1.1
An individual could prepare a list of everything they own and everything by owe.
Lecture example 1
Idea generation
Required
List out everything you own and owe.
Solution
(a)
Own
(b)
Owe
1.2
For a business, this list is formalised as a balance sheet and show the entity's assets and
liabilities.
(a)
Asset: is a resource controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity.
(b)
Liability: is a present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow of economic benefits.
4.3
$
100,000
50,000
30,000
20,000
200,000
Current assets
Inventories
Trade receivables
Less: allowance for receivables
50,000
30,000
(2,000)
28,000
5,000
7,000
90,000
290,000
Prepayments
Cash in hand and at bank
Total assets
CAPITAL AND LIABILITIES
Capital
Capital
Profit
Less: drawings
170,000
45,000
(25,000)
190,000
Non-current liabilities
Bank loans
40,000
Current liabilities
Bank overdraft
Trade payables
Accruals
16,000
40,000
4,000
60,000
290,000
Key features
1.4
(a)
(b)
Non-current assets - assets held and used in the business over the long-term (i.e.
more than one year).
(c)
(d)
Capital - what the business owes the proprietor/owner. In this case the sole trader
owns all of the business, i.e. its total net worth.
CAPITAL =
=
ASSETS - LIABILITIES
NET ASSETS
4.4
Don't include a caption (item heading) if there isnt a value for it.
The balance sheet is a snapshot of the business at one point in time.
Profit example
2.1
Suppose a business buys three books for $10 each. Then it sells them for $15 each:
$
45 Income
(30) Expenditure
15
Sales
Cost of sales
Gross profit
Profit is the excess of total income over total expenditure.
NOTE: The business may have other expenses such as rent, telephone bills, etc. to take off
before the true profit is shown.
Cost of sales
Opening inventories
Purchases
Carriage inwards
40,000
110,000
20,000
170,000
(50,000)
Closing inventories
(120,000)
80,000
5,000
3,000
88,000
Gross profit
Sundry income
Discounts receivable
Less:
$
200,000
Expenses
Rent
Carriage outwards
Telephone
Electricity
Wages and salaries
Depreciation
Bad and doubtful debts
Motor expenses
Discounts allowable
11,000
4,000
1,000
2,000
9,000
7,000
3,000
5,000
1,000
(43,000)
45,000
4.5
Key features
2.3
(a)
Headed up with the period for which the income and expenses are being included.
(b)
Sales
Cost of sales
Gross profit
X
(X)
X
is called the trading account as it records just the trading activities (buying and
selling) of the business.
(c)
(d)
3.1
Balance sheet shows the worth of business at a point in time (financial position).
Income statement shows the trading activities over a period of time (financial
performance).
3.2
The accounting period is the period for which the income statement was prepared. This is
usually a year.
3.3
Therefore, there will be a balance sheet at the beginning of the year (prior year end) and at
the end of the accounting period.
The income statement is for the intervening period.
Income statement for the year ended 31.12.X7
Balance
sheet as at
31.12.X6
Balance
sheet as at
31.12.X7
4.6
4.1
A business will enter into a number and variety of transactions during an accounting period:
CASH TRANSACTIONS
Sales
Purchases
Wages
Stationery
Acquisition
of non-current
assets
CREDIT TRANSACTIONS
Sales
Purchases
This is achieved by having accounting records to record each stage of the process:
Assorted transactions
(eg invoices)
Categorised
(in Books of Prime Entry)
Summarised
(eg nominal ledger, trial balance)
FINANCIAL STATEMENTS
(eg Balance Sheet and Income Statement)
4.7
5.1
The business' transactions are categorised with other similar transactions in the books of
prime entry.
5.2
Books of prime entry
Cash book
Receipts
Sales day
book
Purchase day
book
Petty cash
book
Journal book
Small cash
transactions
Adjustments
and errors
Payments
Cash transactions
Credit sales
Credit purchases
Cash book
5.3
(a)
(b)
For exam purposes often assumed to be two books, one for receipts, one for
payments.
Example:
Date
Narrative
Total
$
Capital
$
2.1.X7
F. Bloggs
4,000
4,000
5.1.X7
J. Spalding
200
6.1.X7
J. Smith
500
4,700
total cash
received
4.8
Sales
$
Receivables
$
200
500
4,000
500
200
Example:
Date
Narrative
6.1.X7
Manley &
Co.
6.1.X7
Petty Cash
8.1.X7
Digby Co
Total
$
Purchases
$
Van
$
Rent
$
Payables
$
350
Petty cash
350
50
1,000
50
1,000
1,400
1,000
total cash
payment
350
50
Lists all sales made on credit, i.e. each individual invoice raised.
5.7
Example:
Date
Customer
3.1.X7
J. Spalding
200
5.1.X7
G. McGregor
400
8.1.X7
J. Spalding
400
14.1.X7
G. McGregor
300
TOTAL
1,300
Lists all purchases made on credit, i.e. each individual invoice received.
5.9
Example:
Date
Supplier
1.1.X7
Tewson Co.
400
4.1.X7
350
16.1.X7
200
TOTAL
4.9
950
Drawings
$
Records the movement of physical cash (kept on the premises) in and out of the
petty cash tin.
Used for small incidental expenses.
5.11 Example:
Receipts
Payments
Date
Narrative
Total
$
6.1.X7
Cheque
cashed
50
Date
Narrative
Total
$
7.1.X7
City
Stationers
10
8.1.X7
F. Bloggs
Stationery
$
Travel
$
10
2
Metro fare
12
10
5.12 (a)
(b)
(c)
(d)
(e)
Journal book
5.13 Certain transactions do not fit in the main books, for example:
(a)
(b)
Memorandum ledgers
Purpose
6.1
6.3
The entries in these ledgers are made by rearranging the information in the day books into
individual customer and supplier accounts.
Receivables ledger
6.4
Example:
J. Spalding (Customer)
Sales
$
Date
Narrative
3.1.X7
Invoice 1032
5.1.X7
Cash received
8.1.X7
Invoice 1101
Cash
$
200
Total
$
200
200
400
400
G. McGregor (Customer)
Date
Narrative
5.1.X7
14.1.X7
Invoice 1033
Invoice 1129
Sales
$
Cash
$
Total
$
400
700
Purchases
$
Total
$
400
400
300
Payables ledger
6.5
Example:
Tewson Co. (Supplier)
Cash
$
Date
1.1.X7
Invoice A112
400
Date
4.1.X7
Invoice 063
6.1.X7
Cash book
16.1.X7
Invoice 097
Purchases
$
350
350
350
200
4.11
Total
$
200
Summary of Chapter 4
7.1
The balance sheet shows the assets and liabilities of a business at a particular point in
time whilst the income statement shows its performance over a period.
7.2
In order to produce a set of financial statements the business transactions must first be
categorised into the books of prime entry. The totals on these books are then
summarised in the nominal ledger.
4.12
Chapter 4: Question
4.13
4: QUESTION
4.1
Cash book
Sales ledger
(1 mark)
4.14
Chapter 4: Answer
4.15
4: ANSWER
4.1
END OF CHAPTER
4.16
Ledger accounts
and double entry
Identify and explain the function of the main data sources in an accounting system and how the accounting
system provides useful information.
Outline the contents and purpose of different types of business documentation such as an invoice.
Identify the main types of business transactions, for example, sales, purchases, payments and receipts.
Understand and apply the concept of double entry accounting, the duality concept and the accounting equation.
Identify the main types of ledger account and illustrate how to balance and close a ledger account.
Understand and illustrate the uses of journals and the posting of journal entries into ledger accounts.
Record credit sale; credit purchase and cash transactions in ledger accounts and day books.
Understand the need for a record of petty cash transactions and security over the petty cash system.
Exam Context
Your understanding of double entry will be crucial to passing Financial Accounting. Whilst an individual question may
not ask you to produce a double entry it will be instrumental in answering the question. For example, a question may ask
you to derive the income statement expense for electricity where amounts need to be accrued at the year end. You will
only get this right if you understand the double entry for recording expenses and accruals. A question could also
describe a transaction and ask you to identify the correct double entry to record this.
Qualification Context
Being confident at double entry will help you account for many of the more complex accounting standards you will meet
in the Fundamentals level paper, Financial Reporting (F7) and the Professional level paper, Corporate Reporting (P2).
5.1
Overview
Ledger accounts
and double entry
Double entry
Ledger accounts
Debit
Balancing off
5.2
Credit
Introduction
1.1
This chapter is designed to enable you to explain the principles of double entry and apply
these principles to the preparation of accounting records within the nominal/general ledger.
1.2
In Chapter 4 we saw how transactions were categorised in books of prime entry, the next
step is to summarise the information in a format nearer to that of the final financial
statements.
(a)
Each item in the balance sheet or income statement will have an "account" (which
might be a page in a book or a record on a computer).
(b)
(c)
The books of prime entry are totalled up and two entries will be made in these
accounts with each of these totals this is called double entry.
The method used stems from the fact that every transaction affects two things, for example:
(a)
(b)
2.1
Debit
CAPITAL
$
Decrease Capital
Credit
$
Increase Capital
We make two entries from each total extracted from the books of prime entry, and call one a
Debit (Dr), and the other one a Credit (Cr).
TOTAL DEBITS = TOTAL CREDITS
5.3
CASH
Cr
$
CASH IN = DEBIT
$
CASH OUT = CREDIT
General rules
2.3
(a)
(b)
an increase in an asset;
a decrease in a liability;
an item of expense.
an increase in a liability;
a decrease in an asset;
an item of income.
Quick Quiz
Q1 - 4
Debits
(increase)
Credits
(increase)
Expenses
Liabilities
Assets
Income
Drawings
Capital
5.4
Lecture example 1
Preparation question
Required
What is the double entry for each of the following?
Explain each entry in terms of the general rules above.
Solution
Transaction
Debit
(a)
(b)
Sales on credit.
(c)
(d)
Purchase on credit.
(e)
(f)
(g)
5.5
Credit
Debit
Lecture example 2
Technique demonstration
Douglas
Douglas had the following transactions during January:
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
Credit
Required
Post transactions (1) to (8) to the relevant ledger accounts.
Solution
5.6
5.7
Flow of information
3.1
In Lecture example 2 the original transactions were posted to the ledger accounts. A
business would firstly categorise this information in the books of prime entry. The totals
from the books of prime entry are then posted to the nominal ledger using double entry.
3.2
4.1
The totals from the books of prime entry may be posted to the nominal ledger each month. A
business will want to know the balance on each account. This is done by 'balancing off' each
account.
Lecture example 3
Technique demonstration
The following information has been posted to the cash account below.
Required
Balance off the cash account to determine the amount of cash held at the end of January.
Solution
Dr
2/1 Sales
10/1 Sales
Cash
$
500
500
5.8
Cr
1/1 Purchases
25/1 Telephone
$
300
50
Steps
4.2
(1)
(2)
(3)
Literally 'balance' the account (what number do we need and on which side to make
the two sides equal?) balance c/d
(4)
Lecture example 4
Technique demonstration
Douglas
Refer to Lecture example 2 on page 5.6.
Required
Balance off the ledger accounts for Douglas
Solution
Complete in the solution space for Lecture example 2.
Summary of Chapter 5
5.1
The totals on the books of prime entry are posted to the nominal ledger using double entry.
5.2
The principles of double entry work on the basis that for each debit entry there must be a
credit entry.
5.3
A debit entry increases assets, expenses and drawings and a credit entry increases
liabilities, income and capital this can be remembered as DEAD CLIC.
5.4
At the end of each period the nominal ledger accounts (T accounts) are 'balanced off' to
determine the closing balance on each account.
5.9
5.10
Chapter 5: Questions
5.11
5: QUESTIONS
5.1
5.2
A credit balance of $3,000 brought down on X Cos account in Y Cos books means that
A
X Co is owed $3,000 by Y Co
Y Co is owed $3,000 by X Co
(1 mark)
5.12
(2 marks)
Chapter 5: Answers
5.13
5: ANSWERS
5.1
5.2
The balance represents the outstanding amount i.e. purchases less cash paid.
END OF CHAPTER
5.14
Exam Context
Questions on this chapter may require you to derive missing figures (for example, profit for the period) using the
accounting equation and identify the correct double entry to record transactions such as closing inventory or drawings.
Qualification Context
Financial Accounting is the only paper where you are required to produce financial statements for a sole trader.
Financial statements for limited liability companies are tested in detail in the Fundamentals level paper, Financial
Reporting (F7) and the Professional level paper, Corporate Reporting (P2).
6.1
Overview
Trial balance
Income statement
Balance sheet
Accounting equation
6.2
Introduction
1.1
the totals are then posted to the ledger accounts in the nominal ledger using double
entry;
the ledger accounts are then balanced off and the balances brought down.
2.1
The trial balance consists of a list of the balances brought down on each ledger account,
separated in to debits and credits as below.
Example
2.2
Debit
$
720
Cash
Capital
500
Sales
2,200
1,100
Purchases
Furniture
500
Electricity
120
Telephone
60
Drawings
Total
2.3
Credit
$
200
2,700
6.3
2,700
Lecture example 1
Technique demonstration
Douglas
Refer to Lecture example 2 in Chapter 5 on page 5.6 where the ledger accounts were balanced
off.
Using the ledger accounts for Douglas, prepare the trial balance as at the end of January.
Solution
6.4
Objective
3.1
Whilst a business will purchase items to sell during the year it is unlikely that all of them will
have been sold by the year end.
The items still held at the year end are known as inventories.
These are an asset of the business and so should be included in inventories in the balance
sheet.
Also when a business determines its profit for the year it should match the sales revenue
earned to the cost of goods it sold, ie, cost of sales.
Lecture example 2
Preparation question
Colin opens a business selling cordless telephones. In the first month he buys 50 phones for $20
each, and sells 20 for $30 each. Complete the trading account below.
Solution
$
Sales
Cost of sales
Purchases
Less: closing inventories
Gross profit
Accounting treatment
3.2
The closing inventory adjustment is accounted for via a journal entry. The double entry is:
Dr Inventories (B/S)
Cr Closing inventories (COS I/S)
3.3
This adjustment is usually made after the preliminary trial balance has been prepared.
3.4
Last period's closing inventories will become this period's opening inventories. These items
will be sold in the year and so will form part of cost of sales. As the items are sold they will
no longer be an asset of the business and should be removed from the balance sheet. The
double entry is:
Dr Opening inventories (COS I/S)
Cr Inventories (B/S
This can be done as soon as the new period begins.
6.5
4.1
The income statement is part of the double entry system and can be shown as a T-account.
The balances on all the income and expenditure T-accounts are transferred to the income
statement and the closing inventory adjustment is made.
4.3
The income and expenditure accounts have now been closed out and a new account will be
created for each income and expenditure item next year.
Lecture example 3
Technique demonstration
Douglas
Refer to Lecture example 1 on page 6.4
The cost of goods remaining unsold at year end was $250.
Required
Prepare an income statement in ledger account form.
Solution
Income Statement a/c
6.6
Balance sheet:
(a)
(b)
(c)
5.2
At end of period, clear balances on income statement and drawings to capital account.
Lecture example 4
Technique demonstration
Douglas
Refer to Lecture example 3 on page 6.6.
Required
Draw up an income statement for the period and a balance sheet at the end of January.
Solution
DOUGLAS
INCOME STATEMENT FOR THE MONTH OF JANUARY
$
Sales
Less cost of sales:
Purchases
Less: closing inventories
Gross profit
Less expenses:
Rent
Electricity
Net profit
6.7
Motor vehicle
CURRENT ASSETS
Inventories
Trade receivables
Cash
PROPRIETORS INTEREST
6.8
Lecture example 5
Technique demonstration
Douglas
Refer to Lecture example 4 on page 6.7.
Required
Transfer the profit and drawings to the capital account.
Solution
Drawings
5.3
Drawings are amounts being taken out of a business by its owner. Drawings are generally in
the form of cash, but an owner may also take inventory out of the business. Drawings of
inventories are recorded at the cost of the inventories not the sales price.
6.9
6.1
6.2
LIABILITIES
(credits)
PROFIT
(less drawings)
CAPITAL
PAYABLES
Proprietors interest
Lecture example 6
Technique demonstration
Douglas
Refer to Lecture example 5.
Required
Prepare the accounting equation for Douglas.
Solution
6.10
Summary of Chapter 6
7.1
The trial balance consists of a list of the balances brought down on each ledger account.
7.2
At the end of the year an adjustment must be made for closing inventory to match sales
revenue to the cost of making those sales and also to reflect the fact that the inventories are
an asset of the business.
7.3
7.4
The income statement and balance sheet are then produced from the trial balance
(incorporating any adjustments such as closing inventory).
7.5
8.1
8.2
8.3
6.11
6.12
Chapter 6: Questions
6.13
6: QUESTIONS
6.1
6.2
At the end of the accounting period and after the balance sheet and income statement have been
prepared for a sole trader:
A
The balances on asset and liability accounts are transferred to the capital account
The balances on the income statement and drawings account are transferred to the capital account
Balances are carried forward on all the accounts in the nominal ledger
A business has cash of $1,100, trade payables of $2,500, a mortgage liability of $8,000 and land of
$16,000.
What is the proprietor's interest?
6.3
(2 marks)
(2 marks)
Joe, a sole trader, set up business on 1 October 20X6 with $40,000 of his own money. During the year to
30 September 20X7 he won $50,000 on the lottery and paid $30,000 of this into his business. He took
cash drawings of $5,000 during the year and at 30 September 20X7 the net assets of the business
totalled $59,000.
What was the profit or loss of the business for the year ended 30 September 20X7?
6.4
$4,000 profit
$6,000 profit
$16,000 loss
$6,000 loss
(2 marks)
Joan
Joan, a second hand bookseller, has been in business for two months. In this time she:
(1)
(2)
took the lease of a stall and paid two months rent. The annual rental was $1,200;
(3)
(4)
(5)
paid an odd-job man $75 to paint the exterior of the stall and repair a broken lock;
(6)
(7)
sold three volumes containing "The Complete Works of Shakespeare" to an American for $60
cash;
(8)
(9)
(10)
(11)
purchased cleaning materials at a cost of $10 and paid a char lady $30;
(12)
took $100 from the business to pay for her own personal expenses;
(13)
(14)
Required
(a)
(b)
(c)
6.14
6: QUESTIONS
6.5
Brian
Brian set himself up in business on 1 January selling ice creams. During his first two months in business
he:
(1)
(2)
Purchased a second hand ice cream van from John. He paid John $10,500 cash;
(3)
Paid Terry $200 to repair the ice cream machine in the van;
(4)
(5)
(6)
(7)
(8)
Made additional cash purchases of $80 for strawberry sauce and chocolate flakes;
(9)
(10)
Required
(a)
(b)
(c)
(d)
(e)
(f)
6.6
Dealers
On 1 January the proprietors interest in a business, Dealers, was $18,500. At 31 January the assets and
liabilities of the business were as follows.
$
Plant and equipment
10,000
Motor vehicles
5,000
Trade payables
3,000
Trade receivables
2,000
Inventories
4,500
Accrued expenses
250
Balance in the bank
3,500
Cash in the till
250
On 7 January the proprietor had paid in additional capital of $2,000. On 14 January he had taken goods
at a cost of $350 for his own consumption and on 30 January had drawn cash of $1,250 from the
business, for his own personal expenditure.
Required
(a)
(b)
(c)
(d)
6.15
6: QUESTIONS
6.16
Chapter 6: Answers
6.17
6: ANSWERS
6.1
6.2
$6,600
Dr
$
1,100
Cash
Trade payables
Mortgage liability
Land
Proprietor's interest (balancing figure)
2,500
8,000
16,000
17,100
6.3
6,600
17,100
$
40,000
30,000
(5,000)
(6,000)
59,000
Cr
$
Joan
Bank (B/S)
(1)
(7)
(10)
(13)
Capital
Sales
Trade receivables
Sales
$
5,000
60
200
1,500
Balance b/d
6,760
5,390
(2)
(4)
(5)
(6)
(9)
(11)
(11)
(12)
Rent
Purchases
Repairs
Advertising
Trade payables
Cleaning materials
Cleaning
Drawings
Balance c/d
$
200
420
75
10
525
10
30
100
5,390
6,760
Capital (B/S)
Balance c/d
$
5,000
5,000
(1)
Bank
Balance b/d
$
5,000
5,000
5,000
Rent (I/S)
(2)
Bank
Balance b/d
$
200
200
200
6.18
Balance c/d
$
200
200
6: ANSWERS
Bank
Balance c/d
$
525
300
825
(3)
Purchases
$
825
Balance b/d
825
300
Purchases (I/S)
(3)
(4)
Trade payables
Bank
Balance b/d
$
825
420
1,245
1,245
Balance c/d
$
1,245
1,245
Repairs (I/S)
(5)
Bank
Balance b/d
$
75
75
75
Balance c/d
$
75
75
Advertising (I/S)
(6)
Bank
Balance b/d
$
10
10
10
Balance c/d
$
10
10
Sales (I/S)
Balance c/d
$
1,860
1,860
(7)
(8)
(13)
Bank
Trade receivables
Bank
Balance b/d
$
60
300
1,500
1,860
1,860
Sales
$
300
Balance b/d
300
100
(10)
Bank
Balance c/d
$
200
100
300
Bank
Balance b/d
$
10
10
10
6.19
Balance c/d
$
10
10
6: ANSWERS
Cleaning (I/S)
(11)
Bank
Balance b/d
$
30
30
30
$
30
30
Balance c/d
Drawings (B/S)
(12)
Bank
Balance b/d
$
100
100
100
Trial Balance
Bank
Capital
Rent
Trade payables
Purchases
Repairs
Advertising
Sales
Trade receivables
Cleaning materials
Cleaning
Drawings
$
100
100
Balance c/d
Debit
$
5,390
Credit
$
5,000
200
300
1,245
75
10
1,860
100
10
30
100
7,160
7,160
Joan
Income statement for the two months ended
$
Sales
Purchases
Gross profit
Rent
Repairs
Advertising
Cleaning (10 + 30)
200
75
10
40
$
1,860
(1,245)
615
(325)
290
6.20
6: ANSWERS
Joan
Balance sheet as at.
$
Current Assets
Trade receivables
Bank
100
5,390
5,490
Proprietor's Interest
Capital
Profit
Less: drawings
$
5,000
290
(100)
5,190
Current Liabilities
Trade payables
6.5
300
5,490
Brian
(a)
(1)
(6)
Capital
Sales
Bank (B/S)
$
20,000
(2)
750
(3)
(5)
(7)
(8)
(9)
Van
Repairs & Maintenance
Petrol
Tax & Insurance
Purchases
Drawings
$
10,500
200
400
600
80
300
Bank
$
20,000
Capital (B/S)
$
(2)
(3)
(4)
(8)
Bank
Bank
Trade payables
Bank
(1)
Van (B/S)
$
10,500
Repairs & Maintenance (I/S)
$
200
Purchases (I/S)
$
750
80
Trade payables (B/S)
$
(4)
Purchases
6.21
$
750
6: ANSWERS
(5)
Bank
Petrol (I/S)
$
400
Sales (I/S)
$
(7)
(9)
Bank
$
750
Bank
Bank
Drawings (B/S)
$
300
(b)
(1)
(6)
(6)
Capital
Sales
Bank (B/S)
$
20,000
(2)
750
(3)
(5)
(7)
(8)
(9)
20,750
Bal b/d
Bal c/d
Van
Repairs & Maintenance
Petrol
Tax & Insurance
Purchases
Drawings
Bal c/d
$
10,500
200
400
600
80
300
8,670
20,750
8,670
Capital (B/S)
$
20,000
(1) Bank
20,000
Bal b/d
$
20,000
20,000
20,000
Van (B/S)
(2)
(3)
Bank
$
10,500
10,500
Bal b/d
10,500
Bank
Bal b/d
Bal c/d
6.22
$
10,500
10,500
$
200
200
6: ANSWERS
(4)
(8)
Trade payables
Bank
Bal b/d
Bal c/d
Purchases (I/S)
$
750
80
Bal c/d
830
$
830
830
830
Trade payables (B/S)
$
750
(4) Purchases
750
$
750
750
Bal b/d
750
Petrol (I/S)
(5)
Bank
$
400
400
Bal b/d
400
Bal c/d
(7)
(9)
Bank
Sales (I/S)
$
750
(6) Bank
750
$
750
750
Bal b/d
750
$
600
600
Bal b/d
600
Bank
Drawings (B/S)
$
300
Bal b/d
300
300
(c)
$
400
400
Bal c/d
Trial balance
Bank
Capital
Van
Repairs and Maintenance
Purchases
Trade payables
Petrol
Sales
Tax & Insurance
Drawings
$
Bal c/d
300
300
Debit
$
8,670
10,500
200
830
Credit
$
20,000
750
400
600
300
21,500
6.23
750
21,500
6: ANSWERS
(d)
Purchases
Gross profit c/d
Petrol
Repairs & Maintenance
Tax & Insurance
Income Statement
$
830
Sales
420
Closing inventories
1,250
400
200
600
1,200
Net loss b/d
(4)
(8)
Trade payables
Bank
Balance b/d
$
750
500
1,250
420
780
1,200
780
Purchases (I/S)
$
750
80
Balance c/d
830
830
830
830
Income statement
830
Petrol (I/S)
(5)
(3)
Bank
$
400
400
Balance c/d
$
400
400
Balance b/d
400
Income statement
400
Bank
Balance b/d
(7)
Bank
Balance b/d
Balance c/d
Income statement
Income statement
Income statement
$
200
200
200
$
600
600
600
Sales (I/S)
$
750
(6) Bank
750
$
750
750
750
750
6.24
Balance b/d
6: ANSWERS
(e)
Inventories (B/S)
$
500
Brian
Income statement for the two months ended 28 February
Sales
Less cost of sales:
Purchases
Less: closing inventories
$
750
830
(500)
330
420
Gross profit
Less expenses:
Petrol
Repairs & Maintenance
Tax & Insurance
400
200
600
((1,200)
(780)
Brian
Balance sheet as at 28 February
Non current assets
Motor vehicles
$
10,500
Current assets
Inventories
Bank
Total assets
500
500
8,670
19,670
Proprietors interest
Capital introduced on 1 January
Loss for the period
Less: drawings
$
(780)
(300)
$
20,000
Balance at 28 February
(1,080)
18,920
Current liabilities
Trade payables
Total capital and liabilities
750
19,670
(f)
(9)
Bank
Drawings (B/S)
$
300
$
Bal c/d
300
300
Capital a/c
300
300
Bal b/d
300
6.25
6: ANSWERS
Income statement
$
830
Sales
420
Closing inventories
1,250
400
Gross profit b/d
200
600
Net loss c/d
1,200
Purchases
Gross profit c/d
Petrol
Repairs & Maintenance
Tax & Insurance
780
Bal c/d
Drawings
Net loss
Bal c/d
6.6
$
750
500
1,250
420
780
1,200
Capital a/c
780
$
20,000
20,000
300
780
18,920
20,000
Bal b/d
20,000
Bal b/d
20,000
18,920
Dealers
(a)
(b)
Profit
Increase in net
assets between
two points in
time
3,000
250
Drawings between
the same two
points in time
6.26
25,250
3,250
22,000
Additional capital
paid in between
the same two points
in time
6: ANSWERS
(d)
$
10,000
5,000
4,500
2,000
3,500
250
25,250
6.27
+ PAYABLES
3,250
Capital at 1 January
Additional capital
Profit
Less: drawings
Trade payables
Accrued expenses
$
18,500
2,000
3,100
23,600
1,600
22,000
3,000
250
25,250
6: ANSWERS
END OF CHAPTER
6.28
Sales tax
Calculate sales tax on transactions and record the consequent accounting entries.
Exam Context
This topic is likely to be tested in two main ways. You may be asked to identify the correct journal entry to post sales and
purchases transactions including sales tax. You may also be required to consider how sales tax affects the calculation of
amounts to be capitalised for non-current assets and the amount for trade receivables where discounts are offered.
Qualification Context
Financial Accounting introduces accounting for sales tax. More detailed rules and calculations relating to this area are
covered in the Fundamentals level paper, Taxation (F6).
7.1
7: SALES TAX
Overview
Output tax
Input tax
Accounting treatment
Sales tax
Discounts
7.2
7: SALES TAX
Introduction
1.1
This chapter is designed to enable you to prepare basic accounting entries for sales tax,
known in many countries as Value Added Tax (VAT).
Sales tax
1.2
A business' sales and purchases are often subject to sales tax. This is an indirect tax, as it
is not levied directly on the individual like personal income tax. Sales tax is collected by
traders who charge it on the goods they sell to the customer.
A business charges sales tax on its sales (output tax) and suffers sales tax on its
purchases (input tax). Typically, a business which is registered for sales tax only needs to
make a payment to the tax authorities of the net amount of sales tax (i.e. sales tax owed on
outputs less sales tax suffered on inputs).
Purchases
Goods into factory
Sales
Goods out of factory
(input tax)
(output tax)
1.3
1.4
$115.00
$287.50
Required
Calculate the amounts due to or from the sales tax authority.
$
Input tax
Output tax
7.3
7: SALES TAX
Accounting treatment
Lecture example 1
A business buys goods for $1,000 plus 15% sales tax. They then sell those goods for $1,500 +
15% sales tax.
The purchases will cost ($1,000 1.15) = $1,150
The sales will raise
($1,500 1.15) = $1,725
The sales tax payable to tax authorities will be:
Payable on outputs (sales)
Reclaimable on inputs (purchases)
Net sales tax to tax authorities
$
225.00
(150.00)
75.00
(15% $1,500)
(15% $1,000)
As the business is purely collecting the sales tax for the tax authorities, and is able to set off its
sales tax suffered it does not include sales tax as either an expense or income in the income
statement. The sales tax is accounted for when the transaction occurs.
Required
(a)
Dr Purchases
Dr Sales tax control account
Cr Trade payables
$
1,150
Solution
(a)
Purchases (I/S)
7.4
7: SALES TAX
Points to note
Purchases
Trade payables
(b)
NET
GROSS
Dr Trade receivables
Cr Sales
Cr Sales tax control account
$
1,500
225
Solution
Sales (I/S)
Points to note
Sales
Trade receivables
NET
GROSS
3.1
In some tax regimes, sales tax on certain inputs is never recoverable. For example, sales
tax on business entertaining or on cars may not be recoverable. In this case the tax is a
genuine expense of the business and is charged to the income statement or included in the
cost of an asset to be depreciated. For example, the double entry for buying a car where
the sales tax is irrecoverable would be:
Dr
Cr
7: SALES TAX
4.1
Many businesses offer discounts to their customers. There are two types:
Quick Quiz
trade discounts
settlement discounts
4.2
4.3
Summary of Chapter 7
5.1
A business acts as a collecting agent for the tax authorities and charges sales tax (output
tax) on its sales and reclaims sales tax (input tax) on its purchases.
5.2
5.3
Sales tax may be charged at various rates, however the rate of sales tax will always be
provided in an exam question.
5.4
6.1
6.2
Purchases
net
Sales tax control account tax
Trade payables
gross
Trade receivables
gross
Sales
net
Sales tax control account
tax
7.6
Chapter 7: Questions
7.7
7: QUESTIONS
7.1
Elmo is a trader registered for sales tax. All his sales and purchases carry sales tax at a rate of 15%. A
customer has just returned goods sold for $230 plus sales tax, the double entry for this transaction is
A
Debit payables $264.50, Credit sales tax $34.50, Credit sales $230
Debit sales $230, Debit sales tax $34.50, Credit trade receivables $264.50
Debit sales $230, Debit irrecoverable sales tax $34.50, Credit trade receivables $264.50
(2 marks)
During 20X1 Fergus buys two vans and a car each costing $10,000 plus sales tax at 15%. The car will be
used 70% for business use and 30% personal use. He depreciates vehicles on a straight line basis, vans
over five years and cars over six years. What is his depreciation expense to the nearest $ for the year?
In the tax regime in which Fergus operates sales tax is only recoverable on items used wholly for
business purposes.
A
$5,917
$6,517
$6,100
$5,666
(2 marks)
7.8
Chapter 7: Answers
7.9
7: ANSWERS
7.1
7.2
Sales tax on the car is not recoverable as it is not wholly used for business purposes. Sales tax is
however recoverable on the vans.
$
Vans (2 $10,000) 5 =
4,000
Car ($10,000 115%) 6 =
1,917
5,917
END OF CHAPTER
7.10
Inventory
Recognise the need for adjustments for inventory in preparing financial statements.
Calculate the value of closing inventory using 'first in, first out' and 'average cost'.
Exam Context
Accounting for inventories and inventory valuation is a basic principle that affects any business. Examination questions
are likely to test your understanding of the terms cost and net realisable value. You should also expect calculations on
this area and be able to make adjustments for both opening and closing inventory.
Qualification Context
The Fundamentals level paper Management Accounting (F2) explores inventories in more detail. There you will look at
the classification of costs (for example, production versus non production and fixed versus variable) and you will also
cover detailed calculations on overhead absorption.
8.1
8: INVENTORY
Overview
Accounting adjustments
Inventory
Valuation
Cost
FIFO
Effects on profit
AVCO
8.2
8:
INVENTORY
Introduction
1.1
For some businesses, for example manufacturing entities, inventory can be a significant
figure.
1.2
1.3
(a)
Balance sheet:
(b)
Income statement:
Businesses must therefore ensure that their financial statements account for inventory
accurately in terms of:
(a)
(b)
Accounting adjustment
2.1
Inventory is generally accounted for as a year end adjustment via a journal entry.
2.2
Opening inventory
The trial balance produced by the entity at the end of the year will show an inventory figure.
This amount generally relates to the opening inventory i.e. the goods held by the business
at the beginning of the year.
Such goods will have been sold during the year. They are no longer an asset of the entity
but will form part of the costs that should be matched against sales revenue when
determining profit.
The accounting entry is:
Dr
Cr
2.3
Closing inventory
The goods held by the business at the end of the year must be included as an asset in the
balance sheet and within cost of sales in the income statement.
The accounting entry is:
Dr
Cr
Inventories (B/S)
Cost of sales (I/S)
8.3
8: INVENTORY
2.4
2.5
Quantity:
Valuation:
Inventory overview
Inventory
Quantity
Continuous
Inventory records
x
Inventory
count
Actual cost
Valuation
Cost
Lower of
and
NRV
Selling price
Less: completion costs
Less: selling costs
Deemed cost
FIFO
Valuation
3.1
Average
Cost
'Inventories should be measured at the lower of cost and net realisable value.'
3.2
(b)
value at cost
do not anticipate profit.
8.4
$
X
(X)
(X)
X
8:
Cost
4.1
INVENTORY
For example:
purchase price
import duties
Cost of purchase
But not:
sales tax
trade discounts
Relating to productions:
direct labour
direct/variable overheads
an allocation of fixed
overheads (based on
normal level of activity)
Costs of conversion
Section 5.4
For example:
carriage inwards
Lecture example 1
According to IAS 2: Inventories, which of the following should not be included in valuing the
inventories of an entity?
(1)
(2)
(3)
(4)
Labour costs
Transport costs to deliver goods to customers
Administrative overheads
Depreciation on factory machine
A
B
C
D
Solution
8.5
8: INVENTORY
5.1
The net realisable value of an item is essentially its net selling proceeds after all costs have
been deducted.
5.2
It is calculated as:
$
X
(X)
(X)
X
Lecture example 2
Preparation question
Jessie is trying to value her inventory. She has the following information available:
$
35
20
12
1
Selling price
Costs incurred to date
Cost of work to complete item
Selling costs per item
Required
What is the net realisable value of Jessie's inventory?
Workings
No netting off
5.3
The IAS 2 rule 'lower of cost and net realisable value' should be applied as far as
possible on an item by item (or line by line) basis.
8.6
8:
INVENTORY
Illustration
5.4
Suppose an entity has four items of inventories on hand at the year end. Their costs and
NRVs are as follows:
Inventory item
Cost
$
27
14
43
29
113
1
2
3
4
NRV
$
32
8
55
40
135
Lower of cost
and NRV
$
27
8
43
29
107
It would be incorrect to compare total cost of $113 with total NRV of $135 and state
inventories as $113.
A loss on item 2 of $6 can be foreseen and should therefore be recognised.
The comparison should be made for each item of inventory and thus a value of $107 would
be attributed to inventories.
This would be accounted for by the journal entry:
Dr
Cr
$
107
Inventories (B/S)
Cost of sales (I/S)
$
107
Issue
6.1
Section 4.3
6.2
If various batches of inventories have been purchased at different times during the year and
at different prices, it may be impossible to determine precisely which items are still held at
the year end and therefore what the actual purchase cost of the goods was. IAS 2 therefore
allows an entity to approximate the cost of its inventories. There are two methods
examinable at Paper F3:
(a)
FIFO
Under FIFO it is assumed that:
(i)
(ii)
(b)
8.7
8: INVENTORY
(ii)
Lecture example 3
Preparation question
On 1 January 20X7 a company held 200 units of finished goods valued at $10 each. During
January the following transactions took place.
Date
Units purchased
10 January
300
$10.85
20 January
350
$11.50
25 January
250
$13.00
Units sold
14 January
280
$18.00
21 January
400
$18.00
28 January
80
$18.00
Required
Determine the valuation of closing inventories and cost of sales using:
(a)
(b)
FIFO
Weighted average cost
Solution
(a)
8.8
Purchases
10.1.X7
20.1.X7
25.1.X7
8:
(b)
b/f
10.1.X7
Purchase
14.1.X7
Sale
20.1.X7
Purchase
21.1.X7
Sale
25.1.X7
Purchase
28.1.X7
Sale
Cost
$
Average
Unit Cost
$
Workings
INVENTORY
FIFO:
8.9
Total
Cost
$
Cost of
Sales
$
8: INVENTORY
7.1
All of the inventory valuation methods affect profits. Using the FIFO, and average cost
examples above, this can be illustrated in an income statement.
FIFO
$
Sales (760 $18)
Cost of sales
Opening inventories
Purchases
Closing inventories
2,000
10,530
(4,285)
2,000
10,530
(4,160)
8,245
5,435
Gross profit
7.2
$
13,680
Weighted average
$
$
13,680
8,370
5,310
The only figure that varies is the closing inventories, the result being quite different profit
figures.
This re-emphasises the significance of inventory valuation in the preparation of financial
statements.
In the above example, the purchase price of inventories was rising during the period. Notice
that when prices are rising:
FIFO will tend to give higher inventory values and higher profits.
Summary of Chapter 8
8.1
Inventories should be valued at the lower of cost and net realisable value.
8.2
The cost of inventory includes the cost of purchase, costs of conversion and any other
costs necessary to bring the inventory to its present location and condition.
8.3
Methods available to estimate the cost of inventories are first in, first out (FIFO) and
average cost.
8.4
In times of rising prices, using FIFO will mean the financial statements show higher
inventory values and higher profits.
8.5
Net realisable value is the estimated selling price less the costs to completion and any
selling and distribution costs.
8.10
Chapter 8: Questions
8.11
8: QUESTIONS
8.1
An item of inventory could be sold for $100 after it has been modified at a cost of $21. The company
incurs selling and distribution costs of 5% of selling price on each article sold. The cost is $45 per unit
excluding carriage inwards of $2 and production overheads of $17 per unit.
Following the rules in IAS 2 at what valuation should this item be included in the inventories of the
company? $
(2 marks)
8.2
Harrow Co sells one line of inventory. At the year end it has 200 units in inventory which originally cost
$10 per unit and had incurred delivery costs of $120 in total. They expect these goods to sell for $13 per
unit. Harrow Co incurs selling costs amounting to 10% of the selling price on all its sales.
In the balance sheet these items should be valued at:
8.3
$2,000
$2,080
$2,120
$2,600
(2 marks)
21.01.X9
30.04.X9
31.07.X9
01.09.X9
11.11.X9
Units
100
300
40
60
80
$/unit
12.00
12.50
12.80
13.00
13.50
Total ($)
1,200
3,750
512
780
1,080
At the year end 200 units are in inventory but eight are damaged and are only worth $10 per unit. These
are identified as having been part of the 11.11.X9 delivery. Lamp operates a FIFO system for valuing
inventories.
The figure for inventories at 31 December 20X9 is:
8.4
$2,524
$2,594
$2,622
$2,700
(2 marks)
Inventories
At the year end, Biggs Co holds the following inventories:
(1)
10 units of L in a completed state; each unit cost $160 to make and has a selling price of $200.
(2)
45 units of M in a partly completed state. Costs to date have amounted to $240 per unit and
completion costs will amount to $90 per unit. Selling price per unit is $360.
(3)
60 units of N purchased for $40 each. These sell at $56 each and would now cost $48 each if
additional units were bought.
(4)
50 units of O costing $10 each. These cannot be sold unless they are modified at a cost of $2 per
unit. After that, the selling price will be $8.
8.12
8: QUESTIONS
8.5
T Bag
T Bag commenced business as a tea importer on 1 January 20X5. His purchases and sales during his
first six months of trading are set out below:
Tonnes
1 January
15 February
27 February
31 March
16 April
30 April
30 May
8 June
28 June
30
20
Purchases
Price per tonne
$
700
750
Total price
$
21,000
15,000
40
25
820
880
32,800
22,000
35
10
900
1,050
31,500
10,500
132,800
Tonnes
Sales
Proceeds
$
40
36,000
35
35,000
70
77,000
148,000
Required
Calculate the value of closing inventories and produce a trading account for the 6 months ended 30 June
20X5 assuming:
(a)
(b)
8.13
8: QUESTIONS
8.14
Chapter 8: Answers
8.15
8: ANSWERS
8.1
$64
8.2
200 @ $10 =
Delivery costs
Cost/ unit = $10.60
Net realisable value per unit = $13 90% = $11.70
valued at cost
8.3
B
Inventories =
8.4
8
72
60
40
20
200
@ $10
@ $13.50
@ $13
@ $12.80
@ $12.50
$
80
972
780
512
250
2,594
=
=
=
=
=
Inventories
The inventories total on the balance sheet would be: $12,200 ($1,500 + $8,100 + $2,400 + $200).
Workings
(1)
$
200
50
150
Cost
160
Selling price
Less: Selling costs (25%)
Costs to completion
NRV
90
90
Cost
$
360
180
180
240
$
56
14
42
Cost
40
8.16
8: ANSWERS
(4)
$
8
2
2
NRV
Cost
4
10
T Bag
Trading account for the 6 months ended 30 June 20X5
FIFO
Weighted
average
$
148,000
$
148,000
Sales
Cost of sales
Purchases
Closing inventories (W)
132,800
(15,000)
132,800
(13,245)
(117,800)
30,200
Gross profit
(119,555)
28,445
Workings
(W1) FIFO method
Purchases in tonnes
Sales in tonnes:
27 Feb
30 Apr
28 June
Inventories at 30 June 20X5
Cost per tonne
1 Jan
30
15 Feb
20
(30)
(10)
(10)
31 Mar
40
16 Apr
25
30 May
35
8 June
10
(25)
(15)
(25)
(30)
5
$900
10
$1,050
$4,500
$10,500
Valuation
Total valuation $4,500 + $10,500 = $15,000
(W2) Weighted average method
Tonnes
1 Jan
15 Feb
27 Feb
31 March
16 April
30 April
30 May
8 June
28 June
30
20
50
(40)
10
40
25
75
(35)
40
35
10
85
(70)
15
Cost
$
700
750
820
880
900
1,050
8.17
Average
Unit Cost
$
720
827
883
Total
Cost
$
21,000
15,000
36,000
(28,800)
7,200
32,800
22,000
62,000
(28,945)
33,055
31,500
10,500
75,055
(61,810)
13,245
Cost of Sales
$
28,800
28,945
61,810
119,555
8: ANSWERS
END OF CHAPTER
8.18
Tangible non-current
assets
Define non-current assets and recognise the difference between current and non-current assets.
Explain the difference between capital and revenue items and classify expenditure accordingly.
Prepare ledger entries to record the acquisition, disposal, depreciation and accumulated depreciation of noncurrent assets.
Calculate and record profits or losses on disposal of non-current assets in the income statement.
Record the revaluation of a non-current asset and calculate its subsequent depreciation and profit or loss on
disposal.
Illustrate how non-current asset balances and movements are disclosed in company financial statements.
Calculate the charge for depreciation using the straight line and reducing methods, identifying when each is
appropriate.
Calculate the adjustments to depreciation necessary if changes are made in the estimated useful life and/or
residual value of a non-current asset.
Exam Context
Tangible non-current assets and depreciation are an important part of the F3 syllabus and you should expect several
questions on this area. Questions are likely to focus on areas such as calculating depreciation and asset values (both on
assets held at historic cost and revalued amounts), profits or losses on disposal of assets and the components that can
be included in the cost of a non-current asset.
Qualification Context
The knowledge covered in this chapter is developed in the Fundamentals level paper Financial Reporting (F7) where
you will deal with more complex issues such as impairments of non-current assets and leasing.
9.1
Overview
Cost
Tangible non-current
assets
Revaluations
Depreciation
Disposals
Reducing balance
depreciation
9.2
Introduction
1.1
The purchase of a non-current asset is often a significant cost to a business which will have
a large impact on its financial statements.
1.2
Non-current assets
Definition
2.1
Non-current assets are assets which are intended to be used by the business on a
continuing basis and include both tangible and intangible assets.
Intangible non-current assets are covered in Chapter 10.
2.2
The accounting treatment of tangible non-current assets is covered by IAS 16: Property,
Plant and equipment.
Tangible non-current assets are defined as those which:
(a)
are held for use in the production or supply of goods or services or for administrative
purposes; and
(b)
Lecture example 1
Idea generation
Required
What examples of tangible non-current assets can you identify?
Solution
(a)
(b)
(c)
(d)
9.3
2.4
(a)
Capital expenditure:
(b)
Revenue expenditure:
Capital expenditure results in the appearance of a non-current asset in the balance sheet
of the business.
Revenue expenditure results in an expense in the income statement.
Cost
2.5
Purchase price:
Directly attributable costs to bring the asset to its intended location and ready to
use. These include:
(a)
(b)
(c)
(d)
The asset can then be kept at cost and depreciated or the entity may choose to revalue its
tangible non-current assets.
Lecture example 2
Cost of machine
Delivery costs
One-year maintenance contract
Further installation costs of $500 were also incurred.
9.4
$20,000
$20,700
$20,200
$21,600
Solution
Depreciation
3.1
Tangible non-current assets are used in the business to generate the income shown in the
income statement.
Assets will eventually be worn out (used up) and so there is a cost of generating income.
This cost should be shown in the income statement to 'match' against the income.
This is called depreciation.
3.2
Depreciation results in the non-current asset being systematically charged to the income
statement over several accounting periods in recognition of the fact that the asset will
contribute to the income-generating activities of each of these periods.
A formal definition is given by the accounting standard, IAS 16:
"the systematic allocation of the depreciable amount of an asset over its useful life."
'Depreciable amount'
'Residual value'
3.3
=
=
Land normally has an unlimited useful life and is therefore not depreciated. Buildings have
a limited life and, therefore, are depreciable assets.
9.5
Methods of depreciation
4.1
5.1
Formula
5.2
Depreciation =
where:
Residual value = expected proceeds/scrap value at the end of the asset's useful life.
Useful life
5.3
= the number of years the business expects to make use of the asset.
This method is suitable for assets which are used up evenly over their useful life.
Lecture example 3
Preparation question
A business buys a machine for $2,500. It is expected to have a useful life of three years after
which time it will have a scrap value of $250.
Required
(a)
(b)
Calculate the cost, accumulated depreciation and net book value (NBV) for each year of the
asset's life. Note: NBV = cost accumulated depreciation to date.
Solution
(a)
(b)
Year
Cost
$
1
2
3
9.6
Accumulated
depreciation
$
NBV
$
6.1
This method is suitable for those assets which generate more revenue in earlier years than
in later years; for example a machine which may become progressively less efficient as it
gets older.
Under this method the depreciation charge will be higher in the earlier years and reduce
over time.
Formula
6.2
Depreciation
where:
Note:
This method does not take account of any residual value, since the NBV under this
method will never reach zero. The depreciation rate percentage will be provided in
the question.
Lecture example 4
Preparation question
A business buys a machine costing $6,000. The depreciation rate is 40% on a reducing balance
basis.
Required
Calculate depreciation expense, accumulated depreciation and net book value of the asset for the
first three years.
Solution
Year
NBV b/d
Depreciation
rate
$
1
2
3
9.7
Depreciation
expense
$
Accumulated
depreciation
$
NBV c/d
$
Dual effect
7.1
7.2
It reduces the value of the asset on the face of the balance sheet.
It is an expense in the income statement.
Depreciation expense
Accumulated depreciation
(a)
(b)
Reduces original cost of the asset on the balance sheet. (The balance on the account
is offset against the cost account for the corresponding asset.)
(c)
Separate account kept for each class of asset (eg motor vehicles, buildings, plant and
machinery).
Lecture example 5
Preparation question
Required
Using the information in Lecture example 3, show:
(a)
(b)
(c)
The journal entry which would have been written at the end of the first year.
The treatment of depreciation for all years in the relevant ledger accounts.
The relevant income statement and balance sheet extracts for each year.
Solution
(a)
Journal entry
Debit
$
9.8
Credit
$
Machine (B/S)
(c)
9.9
Year 2
$
Year 3
$
Accumulated
depreciation
$
Net book
value
$
(Year 1)
(Year 2)
(Year 3)
When a non-current asset is disposed, of its net book value needs to be removed from the
balance sheet.
The sales proceeds received are unlikely to be exactly the same as the asset's net book
value and so a profit or loss on disposal will arise.
If:
Sales proceeds > NBV profit on disposal
Sales proceeds < NBV loss on disposal
This is not a 'true' profit or loss, but rather a book adjustment to reflect the fact that the
depreciation charged over the asset's life wasn't completely accurate.
Accounting treatment
8.2
(2)
Disposal account
Non-current asset
Accumulated depreciation
Disposal account
Note: Steps (1) and (2) have effectively transferred the NBV of the asset to the disposal
account.
9.10
(4)
Cash
Disposal account
Lecture example 6
Preparation question
The machine costing $6,000 in Lecture example 4 is sold in year 3 for $3,000. No depreciation is
charged in the year of disposal.
Required
(a)
(b)
Solution
(a)
(b)
Machine (B/S)
Bal b/d
$
6,000
9.11
$
3,840
Disposal account
$
Instead of receiving sales proceeds as cash, a part exchange allowance could be offered
against the cost of a replacement asset:
Dr
Cr
The part exchange allowance takes the place of proceeds in the disposals account.
Lecture example 7
Preparation question
Assume in Lecture example 6 that instead of cash proceeds of $3,000, there is a part exchange
allowance of $3,000 on a replacement machine costing $10,000.
Required
(a)
(b)
(c)
9.12
Solution
(a)
(b)
(c)
Old machine (B/S)
Bal b/d
$
6,000
$
3,840
Disposal account
$
9.13
Revaluations
9.1
If an entity owns a property it may notice that its value increases over time.
9.2
IAS 16 requires tangible non-current assets to initially be recorded at cost. The entity can
then either keep the asset at cost (and depreciate it) or choose to revalue it (depreciation is
still required).
This is a choice of accounting policy.
9.3
If an entity chooses a policy of revaluation then all items in the same class of assets must be
revalued.
Examples of classes of assets are:
9.4
Revaluations must be carried out sufficiently often so that the assets carrying value is not
materially different from its market value.
(1)
(2)
(3)
Note: The balance posted to the revaluation reserve will equal the new revalued amount
less the previous net book value.
9.6
9.7
9.14
Lecture example 8
Preparation question
A building costing $100,000 on which depreciation of $20,000 has been charged is to be revalued
to $150,000.
Required
(a)
Show the double entry to record the revaluation and make the postings to the ledger
accounts.
(b)
What would be the depreciation charge for the year if the building has a remaining useful life
of 40 years?
Solution
(a)
Building (B/S)
$
9.15
(b)
10 Summary of Chapter 9
10.1 Capital expenditure results in a non-current asset being shown on the balance sheet.
Revenue expenditure, such as repairs and maintenance, is shown as an expense in the
income statement.
10.2 Tangible non-current assets should initially be recorded at cost. This includes the
purchase price of the item plus any directly attributable costs to bring the item to its
intended location and ready to use.
10.3 Depreciation is an expense charged on the asset each year to reflect the using up of the
asset. Depreciation is usually calculated on a straight line or reducing balance basis.
10.4 On disposal of a non-current asset the sales proceeds are compared to the net book value
of the asset in order to calculate the profit or loss on disposal. Where an asset is given in
part exchange for another asset, the part exchange allowance takes the place of the sales
proceeds.
10.5 An entity may choose to revalue its assets rather than hold them at cost this is a choice
of accounting policy. Where an entity revalues, it must revalue all assets in the same
class and the depreciation charge will now be based on the revalued amount.
9.16
(2)
(3)
(4)
Cash (B/S)
Disposal account (I/S)
Balance off the disposal account to determine the profit or loss on disposal.
9.17
9.18
Additional Notes
9.19
12 Depreciation revisited
12.1 Depreciation is charged to allocate the wearing out of an asset (depreciable amount) to the
income statement over its useful life.
There are two main depreciation methods available:
straight line
reducing balance
Section 3.12
12.2 The useful life of an item of property, plant and equipment should be reviewed at least every
financial year-end and, if expectations are significantly different from previous estimates, the
depreciation charge for current and future periods should be revised.
This is achieved by writing the net book value off over the asset's revised remaining useful
life.
Lecture example 9
Preparation question
1.1.X1
1.1.X3
Required
Calculate the depreciation charge, accumulated depreciation and NBV for each year of the asset's
life (year end 31 December).
Solution
Depreciation Accumulated
charge
depreciation
$
$
20X1
20X2
20X3
20X4
9.20
NBV
$
12.3 The depreciation method should be reviewed at least every financial year-end and, if there
has been a significant change in the expected pattern of the asset's use, the method should
be changed.
This is achieved by writing the net book amount off over the remaining useful life, using the
revised method.
Lecture example 10
Preparation question
1.1.X1
1.1.X3
Required
Calculate the depreciation charge, accumulated depreciation and NBV for each year of the assets
life (year ended 31 December).
Solution
Depreciation Accumulated
charge
depreciation
$
$
20X1
20X2
20X3
20X4
20X5
9.21
NBV
$
9.22
Chapter 9: Questions
9.23
9: QUESTIONS
9.2
What is the effect of the above transaction on the profit for the year in respect of the disposal of the old
vehicle?
A
(2 marks)
Bungo Co charges depreciation at 10% per annum, with a full years charge in the year of acquisition.
What will the annual depreciation charge on the new vehicle be? $
9.3
(2 marks)
A company held property, plant and equipment at 31 December 20X5 with a net book value of $22,700.
During 20X6 items with a net book value of $2,100 were sold, realising a profit of $700. The depreciation
charge in the 20X6 income statement was $4,300. Items with a book value of $15,200 were revalued to
$21,250. At 31 December 20X6 the companys balance sheet showed the net book value of property,
plant and equipment as $44,100.
What was the cost of new property, plant and equipment acquired during 20X6?
9.4
$13,150
$17,550
$22,050
$21,750
(2 marks)
Nick
Nick started trading on 1 January 20X8 and bought equipment for his business as follows:
1 January 20X8
Purchased a cutting machine for $4,960. The estimated useful life of the
machine is eight years, after which it will have no resale value.
2 January 20X8
1 March 20X8
Purchased a van for $3,800. This has an estimated useful life of four years,
after which Nick believes he could sell it for $200.
1 May 20X8
Purchased office furniture costing $5,400. This has an estimated useful life of
10 years with no resale value.
Depreciation for all assets, except the car, is to be calculated on the straight line basis, time apportioned
where the asset is owned for part of a year. The car is to be depreciated at 40% per annum on the
reducing balance basis.
Required
For the years ending 31 December 20X8 and 31 December 20X9, prepare relevant extracts from the
financial statements, together with the appropriate ledger accounts.
9.24
9: QUESTIONS
9.5
Eggo
On 1 January 20X4 Eggo Co, a manufacturer, acquired two identical grinding machines at a cost of
$10,000 each, and a duplicating machine at a cost of $3,000. The grinding machines are depreciated at
the rate of 30% per annum on a reducing balance basis, and the duplicating machine, which has an
estimated life of 10 years and a residual value of $500, is depreciated on a straight line basis. On
1 January 20X5 one of the grinding machines was sold for $5,000 and replaced by a new one costing
$12,000.
Required
Prepare the relevant ledger accounts dealing with the non-current assets, depreciation and the disposal
for the years to 31 December 20X4 and 31 December 20X5, respectively.
9.6
Hopkins
During 20X4 Hopkins gave his old van in part-exchange for a new van. The old van had cost $4,000 and
had accumulated depreciation of $2,400 at the date of exchange. Hopkins received a part-exchange
allowance of $1,800 and made a cash payment of $6,200 for the new van. Depreciation is over four years
on a straight line basis.
Required
(a)
(b)
9.25
9: QUESTIONS
9.26
Chapter 9: Answers
9.27
9: ANSWERS
9.1
9.2
$1,700
B/d
Revaluation
(21,250-15,200)
Additions
$
2,100
4,300
C/d
?
50,500
44,100
50,500
additions = $21,750
9.4
Nick
Income statement for the year ended 31 December .... (extract)
Depreciation Expense
Machine
Car
Van
Furniture
20X8
$
620
2,720
750
360
4,450
20X9
$
620
1,632
900
540
3,692
Accumulated
depreciation
$
620
2,720
750
360
4,450
Net Book
Value
$
4,340
4,080
3,050
5,040
16,510
Accumulated
depreciation
$
1,240
4,352
1,650
900
8,142
Net Book
Value
$
3,720
2,448
2,150
4,500
12,818
Cost
Machine
Car
Van
Furniture
$
4,960
6,800
3,800
5,400
20,960
Cost
Machine
Car
Van
Furniture
$
4,960
6,800
3,800
5,400
20,960
Machine (B/S)
1.1.X8
Bank
$
4,960
9.28
9: ANSWERS
$
620
31.12.X8
620
31.12.X9 bal c/d
1,240
1,240
Depn expense:
machine
1.1.X9
31.12.X9
bal b/d
Depn expense
: machine
1.1.Y0
bal b/d
$
620
620
620
620
1,240
1,240
Car (B/S)
2.1.X8
Bank
$
6,800
Car Accumulated Depreciation (B/S)
$
2,720
2,720
4,352
4,352
31.12.X8
1.1.X9
31.12.X9
bal b/d
Dep'n expense: car
1.1.Y0
bal b/d
$
2,720
2,720
2,720
1,632
4,352
4,352
Van (B/S)
1.3.X8
Bank
$
3,800
Van Accumulated Depreciation (B/S)
$
750
750
1,650
1,650
31.12.X8
1.1.X9
31.12.X9
bal b/d
Depn expense: van
1.1.Y0
bal b/d
Furniture (B/S)
1.5.X8
Bank
$
5,400
9.29
$
750
750
750
900
1,650
1,650
9: ANSWERS
31.12.X8
360
31.12.X9 bal c/d
900
900
1.1.X9
31.12.X9
bal b/d
Depn expense:
furniture
1.1.Y0
bal b/d
$
360
360
360
540
900
900
$
620
620
31.12.X8
31.12.X9
I/S
I/S
$
620
620
$
2,720
1,632
31.12.X8
31.12.X9
I/S
I/S
$
2,720
1,632
$
750
900
31.12.X8
31.12.X9
I/S
I/S
$
750
900
$
360
540
31.12.X8
31.12.X9
I/S
I/S
$
360
540
Machine
4,960 8
Car
6,800 40%
Van
1,632
10
= 750
12
(10 months)
Furniture
2,720
20X9
$
620
(5,400)
8
(8 months)
12
750
(full year)
900
360
(full year)
540
9.30
9: ANSWERS
9.5
Eggo
Grinding machines (B/S)
$
20,000
1.1.X4
Bank
1.1.X5
1.1.X5
Balance b/d
Bank
20,000
12,000
32,000
1.1.X6
Balance c/d
22,000
$
20,000
10,000
22,000
32,000
3,000
8,700
11,700
1.1.X5
Balance b/d
31.12.X5 Dep'n expense (W)
1.1.X6
Balance b/d
$
6,000
6,000
5,700
11,700
8,700
Bank
$
3,000
1.1.X5
1.1.X5
Balance b/d
Balance b/d
3,000
3,000
$
3,000
3,000
Balance c/d
31.12.X5
Balance c/d
$
250
250
500
500
$
250
250
31.12.X4
Depreciation expense
1.1.X5
31.12.X5
Balance b/d
Depreciation expense
250
250
500
1.1.X6
Balance b/d
500
$
6,000
250
6,250
5,700
250
5,950
9.31
$
31.12.X4 I/S
6,250
6,250
31.12.X5 I/S
5,950
5,950
9: ANSWERS
Grinding machines
$
10,000
1.1.X5 Bank
1.1.X5 Acc Dep'n grinding machine
31.12.X5 I/S loss on disposal
10,000
$
5,000
3,000
2,000
10,000
Working
Depreciation charge
Year ended 31 December
20X4
$
6,000
250
6,250
9.6
20X5
$
2,100
3,600
250
5,950
Hopkins
(a)
$200 profit
Working
Disposal account (I/S)
$
4,000
200
Cost
Profit on disposal
4,200
Accumulated depreciation
Part exchange allowance
$
2,400
1,800
4,200
Or alternatively:
"Proceeds" part-exchange allowance
Net book value ($4,000 $2,400)
Profit on disposal
(b)
$
1,800
(1,600)
200
$2,000
$
8,000
2,000
END OF CHAPTER
9.32
Intangible non-current
assets
Identify the definition and treatment of research and development costs in accordance with IFRS.
Calculate and account for the charge for amortisation and explain its purpose.
Exam Context
Intangible non-current assets are a smaller part of the syllabus than tangible non-current assets, however you should
still expect this area to be tested. Questions are likely to focus on the difference between tangible and intangible assets,
the accounting treatment for research and the capitalisation criteria for development expenditure. You should also be
confident in calculating amortisation.
Qualification Context
The knowledge covered in this chapter forms a platform which will be built on in the Fundamentals level paper Financial
Reporting (F7). There you will cover internally generated intangible assets and goodwill.
10.1
Overview
Intangible non-current
assets
Research
Development expenditure
Accounting treatment
Accounting treatment
Amortisation
10.2
Definition
1.1
1.2
Development expenditure
Goodwill
Concessions, patents, licences, trade marks.
The Paper F3 syllabus only requires knowledge of the accounting treatment of research and
development expenditure.
2.1
2.2
Companies need to account for these costs and whilst the credit entry will be recorded as a
current liability, the question remains as to where the debit entry should be shown.
The choices are:
(a)
(b)
An intangible non-current asset should only be recorded when the entity is confident that the
expenditure will generate future profit.
Definitions
3.1
(a)
(b)
10.3
Accounting treatment
4.1
Research
Development
Lecture example 1
Preparation question
Z Co incurred the following costs during the year ended 31 August 20X8.
(1)
$20,000 on salaries for market research staff sent out to canvass drivers' opinions on a
potential new car.
(2)
$100,000 to purchase a machine to manufacture components for the new car. It has an
estimated useful life of 10 years.
(3)
Required
How should each of the above items be shown in the financial statements for the year ended
31 August 20X8?
10.4
Solution
5.1
A tangible non-current asset, such as a machine, is capitalised and then depreciated over its
useful life. This is to allocate its costs over the accounting periods which benefit from its use.
5.2
In the same way development expenditure which is incurred now will generate revenue and
profits in the future.
The cost of the development expenditure should be matched against the revenue it
produces. This is called amortisation.
5.3
The 'depreciable amount' (cost less residual value) should be amortised over the useful life
in the same way that revenues are expected to be generated.
5.4
10.5
It is an expense in the income statement and is accounted for using the following entry:
Dr
Cr
Lecture example 2
Technique demonstration
38,000
20X1
20X2
20X3
20X4
20X5
Development
$
55,000
65,000
The development expenditure meets the IAS 38 criteria that require capitalisation ('PIRATE'). The
item developed in 20X1 and 20X2 goes on sale on 1.1.X3 and it will be three years from then until
any competitor is expected to have a similar product on the market.
Required
Show income statement and balance sheet extracts for the years 20X1 20X5 inclusive.
Solution
X1
$
X5
$
X1
$
X5
$
Expenses
Research expenditure
Amortisation of development expenditure
Non-current assets
Development expenditure
Amortisation
Net book value
10.6
Summary of Chapter 10
6.1
6.2
Quick Quiz
10.7
10.8
10.9
10: QUESTION
10.1
Which of the following statements about research and development are true?
(1)
Development expenditure shown on the balance sheet should be amortised over the periods
expected to benefit from the product or service.
(2)
(3)
(2 marks)
10.10
10.11
10: ANSWER
10.1
END OF CHAPTER
10.12
Accruals and
prepayments
Identify and calculate the adjustments needed for accruals and prepayments in preparing financial statements.
Prepare the journal entries and ledger entries for the creation of an accrual or prepayment.
Understand and identify the impact on profit and net assets of accruals and prepayments.
Exam Context
Accruals and prepayments are key accounting adjustments and you should expect to see them tested in Paper F3. You
may be asked to calculate the balance sheet amount for accruals and prepayments and/or the relevant expense that
would be shown in the income statement. Alternatively, you may be asked to determine the appropriate journal entries to
record accruals and prepayments. The Pilot Paper included questions on the calculation of a year-end prepayment of an
expense and the income to be shown in the income statement where rent is received both in advance and in arrears.
Qualification Context
This area is a basic skill which is not tested in detail in any other paper. The matching concept however is fundamental
to the preparation of financial statements and this is relevant to Paper F7, Financial Reporting.
11.1
Overview
Accounting treatment
Year-end adjustments
Accrued income
and deferred income
Accounting treatment
11.2
Introduction
1.1
This chapter is designed to enable you to apply accounting concepts and principles in
relation to the calculation of and adjustments for accruals and prepayments.
1.2
Accruals
1.3
Accruals are expenses incurred by the business during the accounting period but not yet
paid for, ie. expenses in arrears.
Example
1.4
Prepayments
1.5
Prepayments arise when expenses are paid for before they have been used. ie. expenses in
advance.
Example
1.6
On 20 December 20X7 Fred pays for insurance on his business premises for the 12 months
commencing 1 January 20X8.
Although the payment was made in 20X7, the expense should not appear in the accounts
for 20X7. The accounts for 20X7 will show a prepayment for the full amount of the insurance
cost and the expense will be recorded in 20X8.
11.3
Accounting treatment
Year-end adjustments
2.1
Adjustments for accruals and prepayments tend to occur at the end of the year and are
made by way of a journal entry. The required entries are:
Accruals
Dr Expense (I/S)
Cr Accruals (B/S)
Prepayments
Dr Prepayments (B/S)
Cr Expense (I/S)
Accruals:
Sub-heading under 'current liabilities'
Prepayments:
Sub-heading under 'current asset'.
Lecture example 1
Preparation question
Fiona set up a business on 1 January 20X7. Her cash payments for the year to 31 December 20X7
included:
Date paid
Amount
$
Period
Electricity
10.3.X7
96
12.6.X7
120
14.9.X7
104
10.12.X7
145
1.2.X7
375
6.4.X7
1,584
Rent
12 months to 31 March 20X8
Note: On 6 March 20X8 Fiona received an electricity bill for $168 for the quarter to 28 February
20X8.
11.4
Calculate the expense incurred by Fiona for electricity and rent for the year ended
31 December 20X7.
(b)
(c)
Solution
11.5
Lecture example 2
Preparation question
Required
Using the figures from Lecture example 1:
Complete the necessary entries in Fionas ledger accounts as at 31 December 20X7, then balance
off the accounts.
Solution
10.3.X7
12.6.X7
14.9.X7
10.12.X7
1.2.X7
6.4.X7
Cash
Cash
Cash
Cash
Cash
Cash
Accruals (B/S)
$
Prepayments (B/S)
$
Section 1.9
11.6
Problem
3.1
Using the figures from Lecture example 1, what is Fionas rent expense for the year to 31
December 20X8 assuming that on 10 April 20X8 she paid rent of $1,740 for the 12 months
commencing 1 April 20X8?
3.2
1.1.X8
1.4.X8
31.12.X8
Double entry
3.3
10.4.X8
Rent expense
$
1,740
31.12.X8
Cash
Prepayments
$
396
435
1.1.X8
Balance b/d
31.12.X8 Rent
$
Prepayments
( 3 12 1,740 )
435
This does not produce a sensible answer! The rent expense in the ledger account would
result in a charge to the income statement of $1,305 (not $1,701) and the balance on the
prepayment account would be overstated by $396.
11.7
Solution
3.4
$396
$396
Post this to the ledger accounts in 3.3 and balance off the expense should now be correct!
Summary
3.5
Accruals and prepayments brought forward at the start of the year must be reversed.
Reversal of accrual
Dr Accruals (B/S)
Cr Expense (I/S)
Prepayments
Dr Expense (I/S)
Cr Prepayments (B/S)
Approach to questions
3.6
Lecture example 3
Preparation question
Amount
$
Period
12.3.X8
168
9.6.X8
134
12.9.X8
118
12.12.X8
158
During March 20X9 Fiona received an electricity bill for $189 for the quarter to 28 February 20X9.
Required
Calculate the electricity expense and accrual for the year ended 31 December 20X8 and complete
the ledger accounts.
11.8
Solution
Electricity expense (I/S)
$
Accruals (B/S)
$
Lecture example 4
Jimmy Co prepares its financial statements for the year to 30 June each year. The company pays
for its insurance quarterly in advance on 1 March, 1 June, 1 September and 1 December each
year. The annual insurance premium was $24,000 until 31 August 20X6, after that date it
increased to $30,000 per year.
Required
What insurance expense and end of year prepayment should be included in the financial
statements for the year ended 30 June 20X7?
A
B
C
D
Expense
$29,000
$29,000
$28,500
$28,500
Prepayment
$2,500
$5,000
$2,500
$5,000
11.9
Solution
Summary of Chapter 11
4.1
Accruals and prepayments are an example of the accruals basis which is an underlying
assumption from the IASB Framework.
4.2
Accruals are made when expenses are paid in arrears, whereas prepayments arise when
expenses are paid for in advance.
4.3
Reverse accruals and prepayments at the beginning of the next accounting period so that
the current year expense is correct.
5.1
Accruals adjustment:
Dr
Cr
5.2
Expense (I/S)
Accruals (B/S)
Prepayments adjustment:
Dr
Cr
Prepayments (B/S)
Expense (I/S)
11.10
(2)
(3)
(4)
11.11
11.12
Additional Notes
11.13
6.1
Accruals and prepayments relate to when expenses are paid in arrears or advance. Income
may also be received in arrears or advance.
Accrued income
6.2
This relates to when income has been earned during the accounting period but not invoiced
or received.
Illustration
6.3
Jenny owns a property which she rents out for $3,000 per quarter. The property was
occupied all year; however Jenny only received $9,000 in rent because she forgot to send
out the final invoice of the year.
As the property was let for 12 months, Jenny's income statement should show income of
$12,000 (4 $3,000) as this is what she has earned.
She will therefore need to accrue the 'missing' income of $3,000 as a year end journal and
also show a receivable for "rent in arrears".
The adjustment is:
Dr
Cr
$
3,000
$
3,000
The rent in arrears is shown in the balance sheet within current assets.
Deferred income
6.4
Illustration
6.5
Ben has a year end of December and rents out his property for $1,000 per month. His
tenant pays on time each month and during December 20X7 paid Ben $2,000 as he would
be away when the January 20X8 payment was due.
Ben has received income of $13,000 but only $12,000 of this relates to the current year. He
must therefore remove $1,000 of income from this years accounts because it relates to next
year. A liability will also be shown for "rent in advance".
The adjustment is:
Dr
Cr
$
1,000
$
1,000
The rent in advance is shown in the balance sheet within current liabilities.
11.14
Approach to questions
6.6
The approach for accrued income and deferred income is exactly the same as for accruals
and prepayments.
There are four steps to follow:
(1)
(2)
(3)
(4)
11.15
11.16
11.17
11: QUESTIONS
Date paid
02.01.20X5
02.01.20X5
31.04.20X5
30.07.20X5
01.11.20X5
Amount
$
300
300
450
450
450
Telephone
Quarter ended 31 January 20X5
Quarter ended 30 April 20X5
Quarter ended 31 July 20X5
Quarter ended 31 October 20X5
02.03.20X5
05.06.20X5
02.09.20X5
10.12.20X5
270
310
320
330
A telephone bill for $345 in respect of the quarter ended 31 January 20X6 was received by the company in
February 20X6. The company's year end is December.
11.1
11.2
11.3
11.4
What balance should have been brought forward on the accruals account in relation to rent payable at
1 January 20X5?
A
$100 credit
$200 credit
$100 debit
$200 debit
(2 marks)
What will be the income statement charge for telephone expenses for the year ended 31 December
20X5?
A
$1,165
$1,180
$1,255
$1,280
(2 marks)
At 31 December 20X5 what balance will be included as a prepayment or accrual in respect of rent?
A
$300 prepayment
$200 accrual
$150 prepayment
$150 accrual
(2 marks)
At 31 December 20X8 Blue Anchor Co has an insurance prepayment of $250. During the year they pay
$800 in respect of various insurance contracts. The closing accrual for insurance is $90.
What is the income statement charge for insurance for year ended 31 December 20X9? $
(2 marks)
11.18
11: QUESTIONS
11.5
11.6
Max has paid his rent for the period 1 April 20X0 to 30 June 20X1 of $4,800. His first set of accounts is
drawn up for the period from 1 April 20X0 to 28 February 20X1. His accounts should reflect
A
Constains Co has an insurance prepayment of $320 at 31 March 20X2. During the year ended 31 March
20X2 Constains paid two insurance bills, one for $1,300 and one for $520. The charge for the year in the
accounts for insurance was $1,760.
What was the prepayment at 31 March 20X1? $
11.7
11.8
(2 marks)
(2 marks)
An electricity prepayment for $300 was treated as an accrual in a sole traders income statement. As a
result the profit was
A
Overstated by $600
Understated by $300
Understated by $600
(1 mark)
A. Cruel
A. Cruel prepares his financial statements for the year to 31 December each year. He pays rent on his
premises quarterly in advance on 1 February, 1 May, 1 August and 1 November. The annual rent was
$12,000 until 30 September 20X7 and $15,000 per year thereafter.
(i)
What rent expense and prepayment should be included in the financial statements for the year
ended 31 December 20X7?
A
B
C
D
(ii)
Prepayment
$12,750
$12,750
$15,000
$15,000
$1,250
$2,500
$2,250
$1,250
The following year the reversal of the prepayment will result in which of the following in the rent
expense account?
A
B
C
D
(iii)
Expense
A. Cruel has just looked at the accounts you have prepared and is confused as he knows he has
paid more rent than is showing in the income statement.
Which accounting concept means that the income statement may not just show the cash paid?
A
B
C
Going concern
Accruals
Business entity
11.19
11: QUESTIONS
11.9
Fairlop
The accounts of Fairlop are made up to 31 December every year. When preparing the accounts for 20X7
you extract the following information from the payments side of the cash book:
$
20X6
1 October
Rent (to 31.3.X7)
500
20X7
10 January
1 April
10 April
10 July
1 October
10 October
Electricity
Rent
Electricity
Electricity
Rent
Electricity
300
550
300
250
550
250
20X8
10 January
Electricity
350
You ascertain that rent is paid half-yearly in advance and that electricity bills relate to the quarter ended in
the month before payment.
Required
Calculate the following amounts:
(i)
(ii)
(iii)
(iv)
11.20
11.21
11: ANSWERS
11.1
11.2
300 = 200
$
(180)
1,230
230
1,280
11.4
$1,140
450 = 150
11.6
$260
$4,800
$1,280
Insurance Expense
Prepayment reversal ()
Cash
Cash
$
260
1,300
520
$
I/S
Prepayment
2,080
11.7
11.8
A. Cruel
(i)
1,760
320
2,080
The prepayment would have decreased the electricity expense by $300 and increased profits.
Treating the prepayment as an accrual would have increased the electricity expense and
decreased profit. Profit is therefore understated by 2 $300 = $600.
A
Rent expense:
January September 20X7 ($12,000 9/12)
October December 20X7 ($15,000 3/12)
$
9,000
3,750
12,750
Prepayment:
1 November payment of $3,750 ($15,000 ) relates to November, December and January.
prepay January 20X8 expense: $3,750 1/3 = $1,250.
(ii)
(iii)
11.22
11: ANSWERS
11.9
Fairlop
(i)
(ii)
(iii)
(iv)
Rent expense:
Electricity expense:
Prepayments:
Accruals:
$1,075
$1,150
$275
$350
Workings
Prepayments (B/S)
1.1.X7
31.12.X7
$
250
275
525
1.1.X8
Balance b/d
275
Rent
Balance c/d
$
250
275
525
1.1.X7
31.12.X7
Balance b/d
Electricity
$
300
350
650
1.1.X8
Balance b/d
350
1.1.X7
31.12.X7
Accruals (B/S)
1.1.X7
31.12.X7
Electricity
Balance c/d
$
300
350
650
Rent (I/S)
1.1.X7
1.4.X7
1.10.X7
Prepayments
Bank
Bank
$
250
550
550
$
31.12.X7
31.12.X7
Income statement
Prepayments
1,350
1,075
275
1,350
Electricity (I/S)
$
10.1.X7
10.4.X7
10.7.X7
10.10.X7
31.12.X7
Bank
Bank
Bank
Bank
Accruals
300
300
250
250
350
1,450
11.23
1.1.X7
Accruals
31.12.X7
Income statement
$
300
1,150
1,450
11: ANSWERS
END OF CHAPTER
11.24
Irrecoverable debts
and allowances
Prepare the bookkeeping entries to write off a bad debt, record a bad debt recovered and create and adjust an
allowance for receivables.
Identify the impact of bad debts on the income statement and on the balance sheet.
Illustrate how to include movements in the allowance for receivables in the income statement and how the
closing balance of the allowance should appear in the balance sheet.
Exam Context
Questions on this topic are likely to require you to perform basic calculations dealing with writing off debts, adjusting for
cash subsequently received and adjusting the allowance for receivables. You will also need to be able to determine the
balances to be shown in the income statement and balance sheet.
Qualification Context
This area is a basic skill and detailed calculations are not tested in any other paper.
12.1
Overview
Amounts recovered
Bad debts
Irrecoverable debts
and allowances
Doubtful debts
Allowances
Specific
General
12.2
Introduction
1.1
This chapter is designed to enable you to calculate and make adjustment for bad debts, and
allowances for receivables.
1.2
Bad debts
2.1
Accounting treatment
2.2
Dr
Cr
You may see the debit entry being made to an 'irrecoverable debts expense' account. This
is effectively the same thing.
Lecture example 1
Preparation question
Fight & Co has trade receivables at 31 December 20X7 of $65,000. A review of customer files
indicates that two customers, Ali and Tyson, which owe $7,000 and $8,000 respectively, have
gone bankrupt and their debts are considered irrecoverable.
Required
(a)
(b)
Calculate the balance c/d on the trade receivables account at the end of the year.
Calculate the bad debt expense shown in the income statement.
Solution
12.3
Doubtful debts
3.1
If a debt is possibly irrecoverable an allowance for the potential irrecoverability of that debt
should be made. A new account is created, Allowance for receivables, this account is offset
against the trade receivables balance on the balance sheet and the expense taken to the
income statement.
Accounting treatment
3.2
Dr
Cr
Lecture example 2
Preparation question
A further review of Fight & Co's customer files indicates there is some uncertainty as to whether a
debt of $3,500 owed by Bugner is recoverable.
(a)
(b)
(c)
Show how the information from Lecture examples 1 and 2 would be shown in extracts from
the income statement and balance sheet.
Solution
Allowance for receivables (B/S)
12.4
Types of allowance
3.3
(a)
(b)
Specific:
General:
(i)
(ii)
deducting full balance of any customers for which specific allowance has been
created.
Order of calculation
3.4
(a)
Write up trade receivables account for credit sales and cash received in period.
(b)
(c)
(d)
In workings, calculate the general allowance on trade receivables (after bad debts
written off and excluding full amounts for which specific allowance has been made).
(e)
$
100
(20)
80
4
20
4
24
12.5
Lecture example 3
Preparation question
A businesss trade receivables account showed a year end balance of $47,440. It was decided that
amounts totalling $340 should be written off as irrecoverable, a specific allowance was to be made
against an amount of $400 due from Dodgy Co, a customer, and a general allowance of 2% was to
be made against remaining debts.
Required
(a)
(b)
Solution
Balance b/d
General allowance
$
Trade receivables (net of bad debts written off)
Less: specific allowance
General allowance @ 2%
12.6
Bad debts written off last year, customer pays this year
4.1
If a bad debt is recovered having previously been written off, it is credited to the bad debt
expense account, i.e. the accounting treatment from the original write-off is reversed.
Accounting treatment
(1)
Cash received
Dr
Cr
Cash
Trade receivables
Reverse original
write off
Dr
Cr
Trade receivables
Bad debt expense
OR
(2)
Short method
Dr
Cr
Cash
Bad debt expense
Lecture example 4
Preparation question
Fight & Co (see Lecture example 1) subsequently receive a cheque of $7,000 from Ali.
Required
Show the treatment of this recovery in the relevant T accounts.
Solution
Trade receivables (B/S)
1.1.X8 Bal b/d
$
50,000
12.7
Cash (B/S)
$
A credit entry for the cash is made to the trade receivables account because the debt is still
included in the total trade receivables figure.
The allowance is then reversed as it is no longer needed.
Accounting treatment
(a)
Cash (B/S)
Trade receivables (B/S)
then:
(b)
Remove allowance
Dr
Cr
12.8
Lecture example 5
Preparation question
Required
Show the accounting treatment for Fight & Co if, having made a specific allowance (see Lecture
example 2), during the next year Bugner repays his debt of $3,500 to Fight & Co in cash?
Solution
Trade receivables (B/S)
1.1.X8 Bal b/d
$
50,000
$
3,500
Doubtful debts specific allowance last year, goes bad this year
4.3
The debt is no longer doubtful, but definitely bad. It should therefore be removed from the
trade receivables and the allowance for receivables accounts.
Dr
Cr
Lecture example 6
Preparation question
Required
Following on from the information used in Lecture example 2, suppose that in the next accounting
period, the debt from Bugner is considered to have gone bad.
What double entry would be required to record this?
Solution
Allowance is usually changed at the end of each period to reflect the change in value of total
trade receivables.
Accounting treatment
4.5
(1)
Dr
Cr
Dr
Cr
12.10
Decrease:
Dr
Cr
Lecture example 7
Preparation question
Solution
Long method: 4.5 (1)
Allowance for receivables
$
12.11
Lecture example 8
$13,000
$15,000
$17,000
$23,000
12.12
Solution
Quick Quiz
Summary of Chapter 12
5.1
A trade receivable is an asset of the business which should only be shown in the financial
statements if it is believed to be recoverable.
5.2
Bad or irrecoverable debts must therefore be written off as an expense in the income
statement.
5.3
5.4
12.13
6.1
6.2
6.3
Recording of cash received from a customer whose balance was previously written off:
Dr
Cr
6.4
Cash (B/S)
Bad debt expense (I/S)
Recording of cash received from a customer against which a specific allowance was
previously made:
Record cash received:
Dr
Cash (B/S)
Cr
Trade receivables (B/S)
Remove the allowance:
Dr
Allowance for receivables (B/S)
Cr
Doubtful debts expense (I/S)
6.5
Writing a balance off as irrecoverable where a specific allowance was previously made:
Dr
Cr
12.14
12.15
12: QUESTIONS
12.1
12.2
12.3
A company receives news that a major customer has been declared bankrupt. The entries now required
are:
A
(1 mark)
At 1 January 20X9 Farriers has an allowance for receivables of $2,000 consisting of a specific allowance
for $700 in respect of Black Lion Co and a $1,300 general allowance. During the year Black Lion goes
into liquidation and the debt is written off. No other debts go bad and at 31 January 20X9 the balance on
the trade receivables is $50,950. Farriers wishes to provide for a debt of $950 from Verulam and to have
a general allowance of 2% of good trade receivables. The bad and doubtful debts charged to the
income statement for 20X9 is:
A
$900
$924
$1,600
$2,200
(2 marks)
Trade receivables
Allowance for receivables (brought forward as at 1 October 20X6)
Bad and doubtful debt expense
1,985
Credit
$
2,490
No entries have been made in respect of cash of $1,320 received from Dome Co whose balance
had been written off last year, and
(ii)
At 30 September 20X7 an allowance is required against a balance of $1,950 due from Jed Co as
well as a general allowance of 1.5% of remaining debts.
What is the bad and doubtful debt expense in the income statement?
12.4
(2 marks)
Gillian
On 31 December 20X4, Gillians nominal ledger included a trade receivables balance of $47,900 along
with an allowance for receivables (brought forward as at 1 January 20X4) of $2,551. Of this $537 relates
to a specific customer, the remainder being a general allowance. After a review of trade receivables at the
year end, the following adjustments are to be made:
(1)
(2)
No entry has yet been made in the books for $418 cash received on 31 December 20X4 from
David, a customer whose debt was written off during 20X3.
(3)
Cash posted to the trade receivables account during the year include $537 from Jim. The amount
due from Jim had been specifically provided against at 31 December 20X3.
(4)
Specific allowance is to be made against debts totalling $835 together with a general allowance of
2%.
Required
(a)
(b)
Write up the relevant ledger accounts for the year ended 31 December 20X4.
Show the relevant extracts from the financial statements.
12.16
12: QUESTIONS
12.5
Johnson & Co
(1)
Johnson & Co had total receivables owing to them at 31 December 20X7 of $9,650. They
included $700 owed by T Black, who had fled the country six months earlier, and various debts
due from K White, totalling $335 and dating back to the years 20X1-20X5. It was decided that the
above debts should be written off.
(2)
During 20X8 Johnson & Co made sales on credit of $40,385 and received cash from trade
receivables of $32,050. There were no irrecoverable debts. However, there was some doubt as to
whether a debt of $450 owed by J Green would be met and it was decided to make an allowance
against this specific debt and against 2% of the remaining debts.
(3)
During 20X9 credit sales totalled $50,235 and cash of $37,140 was received from trade
receivables. A review of trade receivables at the year end revealed the following:
(i)
The amount owed by J Green was now considered irrecoverable and should be written off;
(ii)
(iii)
(iv)
Required
Produce ledger accounts to record the above transactions for the years ended 31 December 20X7, 20X8
and 20X9.
12.17
12: QUESTIONS
12.18
12.19
12: ANSWERS
12.1
12.2
A
Trade receivables balance
Less specific allowance
$
50,950
(950)
50,000
$1,250
$
950
(50)
900
$1,451
Bad and doubtful debts expense per trial balance
Less: bad debt recovered
Add: increase in allowance (W)
Allowance c/d
specific
general 1.5% (90,350 1,950)
$
1,985
(1,320)
786
1,451
$
1,950
1,326
3,276
2,490
786
Gillian
(a)
31.12.X4
Balance b/d
Trade receivables
12.20
$
1,615
46,285
47,900
$
2,551
2,551
$
418
807
390
1,615
12: ANSWERS
Working
Receivables
$
46,285
(835)
45,450
Trade receivables
Less: specific allowance
General allowance ($45,450 2%)
(b)
Allowance
$
835
909
1,744
Gillian
Balance sheet as at 31 December 20X4 (extract)
CURRENT ASSETS
Trade receivables
Less: allowance for receivables
$
46,285
(1,744)
$
44,541
390
Johnson & Co
$
1,035
8,615
9,650
1.1.X8
Balance b/d
Sales
8,615
40,385
49,000
Bank
31.12.X8 Balance c/d
32,050
16,950
49,000
1.1.X9
Balance b/d
Sales
16,950
50,235
Bank
31.12.X9 Irrecoverable
debts expense
(450 + 545)
31.12.X9 Balance c/d
37,140
995
67,185
1.1.YO
Balance b/d
29,050
67,185
29,050
780
995
46
1,041
12.21
$
1,035
780
1,041
1,041
12: ANSWERS
$
780
780
46
826
Workings
(W1) Allowance for receivables as at 31 December 20X8.
Trade receivables
Less: specific allowance (J Green)
General allowance ($16,500 2%)
Receivables
$
16,950
(450)
16,500
Allowance
$
Receivables
$
29,050
(250)
28,800
Allowance
$
450
330
780
Trade receivables
Less: specific allowance (P Brown)
General allowance required ($28,800 2%)
END OF CHAPTER
12.22
250
576
826
Provisions
and contingencies
Understand the definition of 'provision', 'contingent liability' and 'contingent asset', distinguish between them and
classify items accordingly.
Identify and illustrate the different methods of accounting for provisions, contingent liabilities and contingent
assets.
Calculate provisions and changes in provisions and account for the movement in provisions.
Exam Context
Questions on this area are likely to focus on identifying when a provision or contingent liability should be made/disclosed
in the financial statements. You may also be required to calculate a provision. The Pilot Paper included a question on
how a remote contingent liability should be accounted for.
Qualification Context
Your understanding of IAS 37 will be developed at the Fundamentals level paper Financial Reporting (F7) where you are
likely to have to consider whether the provision criteria are satisfied based on more subjective scenarios.
13.1
Overview
Accounting treatment
Recognition criteria
Provisions
Provisions and
contingencies
Contingent liabilities
Contingent assets
13.2
1.1
Introduction
Before the introduction of IAS 37, there was little guidance on when a provision must and
must not be made.
This caused problems as entities tended to choose to make and then release provisions in
order to smooth out profits, rather than making a provision where they had an obligation to
incur expenditure.
IAS 37 aims to prevent this happening in the future.
Provisions
2.1
Definition
A provision is a liability of uncertain timing or amount.
2.2
Recognition
A provision should only be recognised (ie. included in the financial statements) when:
(a)
(b)
(c)
Legal obligation
A legal obligation usually arises out of a contract.
Illustration
Grass Co sells lawnmowers and offers a one-year warranty on all models.
Once Grass Co sells a lawnmower (the past event) it has a legal obligation to repair any
defects according to the warranty agreement.
It should therefore make an estimate of the probable costs of repair and make a provision
for this amount in its financial statements.
2.4
Constructive obligation
A constructive obligation arises through past behaviour and actions where the entity has
raised a valid expectation that it will carry out a particular action.
Illustration
Seed Co also sells lawnmowers. It does not offer a warranty on its products, however it has
a reputation for making free reasonable repairs to lawnmowers bought from the business.
Customers buying from Seed Co all expect to receive this benefit.
13.3
Accounting treatment
The provision represents both a cost to the business and a potential liability:
Dr
Cr
Expense (I/S)
Provision (B/S)
The required provision will be reviewed at each year end and increased or decreased as
necessary.
To increase a provision:
Dr
Cr
Expense (I/S)
Provision (B/S)
To decrease a provision:
Dr
Cr
Provision (B/S)
Expense (I/S)
Lecture example 1
Preparation question
Grass Co is reviewing its warranty obligations. Based on sales during 20X7 it has established that
if all lawnmowers sold required minor repairs this would cost $1m whereas if major repairs were
required this would cost $6m.
Grass Co expects that 75% of lawnmowers will have no faults, 20% will need minor repairs and
5% major repairs.
Required
(a)
(b)
(c)
What provision should be made in 20X7 and what accounting entry is needed to record it?
What entry should be made in 20X8 assuming the provision required then is $0.75m?
What entry should be made in 20X9 assuming the provision required then is $0.3m?
Solution
13.4
Contingent liabilities
3.1
A contingent liability is an uncertain liability that does not meet the three criteria for
recognising a provision.
IAS 37 defines a contingent liability as the following:
(a)
A possible obligation that arises from past events and whose existence will be
confirmed only the occurrence or non-occurrence of one or more uncertain future
event not wholly within the control of the entity; or
(b)
A present obligation that arises from past events but is not recognised because:
(i)
(ii)
Illustrative example
3.2
Company A has entered into an agreement to act as guarantor on a bank loan taken out by
Mr Smith. Mr Smith is a financially secure individual, and the directors are of the opinion that
the chances of him defaulting on the loan are slim.
How should company A account for this guarantee?
Solution
3.3
Company A has a present obligation (it is legally obliged to honour the guarantee).
However, as the likelihood of Company A having to pay out under the guarantee is not
probable then no provision for the liability should be made. Instead, the guarantee should be
disclosed in the notes as a contingent liability (unless considered remote, in which case it
should be ignored altogether).
13.5
Decision Tree
Contingent assets
4.1
A possible asset that arises from past events and whose existence will be confirmed only by
the occurrence or non-occurrence of one or more uncertain future events not wholly within
the control of the entity.
Contingent assets should be disclosed in the notes where an inflow of economic benefits is
probable, otherwise they should be ignored.
If the probability of an inflow of economic benefits is virtually certain then the asset is not a
contingent asset and should be recognised in the financial statements.
13.6
Quick Quiz
Summary of Chapter 13
5.1
A provision should only be made in the financial statements when an entity has a present
obligation to incur expenditure. It must also be more likely than not that the expenditure
will be incurred and a reliable estimate of the amount is known.
5.2
A contingent liability should be disclosed where the criteria for making a provision are not
met, but where there is either a possible obligation or a present obligation but it is only
possible that the expenditure will be incurred.
5.3
6.1
6.2
Expense (I/S)
Provision (B/S)
Provision (B/S)
Expense (I/S)
13.7
13.8
13.9
13: QUESTIONS
13.1
H Co is currently in the middle of a protracted lawsuit which it is vigorously defending. The directors are
reasonably confident that the action will not be successful but are aware that the opposite outcome is a
possibility. It is difficult to quantify any potential damages, but the directors feel they are unlikely to
exceed $50,000.
How should the above item be treated in the financial statements?
13.2
Provision
Contingent liability
Contingent asset
(1 mark)
How should a contingent liability and a probable contingent asset be accounted for?
A
Probable contingent assets and contingent liabilities should be disclosed in the financial
statements.
Probable contingent assets must always be accrued and contingent liabilities must always be
disclosed in the financial statements.
Contingent liabilities must always be either accrued or disclosed and probable contingent assets
must always be disclosed in the financial statements.
Contingent liabilities must always be provided for and probable contingent assets must be
disclosed in the financial statements.
(2 marks)
13.10
13.11
13: ANSWERS
13.1
13.2
END OF CHAPTER
13.12
Control accounts
Understand the purpose of control accounts for accounts receivable and accounts payable.
Perform basic control account reconciliations for accounts receivable and accounts payable and identify errors
which would be highlighted by performing them.
Exam Context
Questions on this topic are likely to require you to correct the closing balance on a receivables or payables control
account including items such as contras and discounts. You may also be required to calculate receivables/payables
balances where goods are sold/bought with trade and/or settlement discounts.
Qualification Context
This chapter covers topics which are only examined in Financial Accounting.
14.1
Overview
Reconciliations
Receivables ledger
Payables ledger
Control accounts
Contra entries
Trade discounts
Discounts
allowed and received
Settlement discounts
14.2
Recap
1.1
In Chapters 4 and 5 we saw how a business' transactions were categorised in the books of
prime entry. The totals of these were then posted using double entry to the nominal ledger
to give a summary of the information.
1.2
1.3
The
nominal ledger contains three ledger accounts which are affected when a business sells on
credit:
(a)
Sales
(b)
Bank
(c)
Trade receivables this shows the total amount owed by all customers at a
particular point in time.
it is also called the receivables ledger control account
(RLCA)
1.4
In order to chase overdue debts however a business must know how much each customer
owes at a particular time.
This balance could be determined by going back into the detail of the books of prime entry
and extracting the information for each customer.
This is a very time consuming process and so instead a memorandum ledger is
maintained for each individual customer showing invoices raised, cash received and
therefore the amount owed to the business.
This memorandum ledger is called a receivables ledger.
1.5
14.3
Terminology
1.6
Memorandum ledgers:
Receivables ledger:
balance owed by each individual credit customer
Payables ledger:
balance owed to each individual credit supplier
2.1
Sales
Invoice
Memo
Receivables
Ledger
SDB
Payment
to
suppliers
Receipt
from
customers
Cash book
Purchase
Invoice
PDB
Memo
Payables
Ledger
Supplier X
Customer A
Customer B
Nominal Ledger
PLCA
Trade payables
Customer C
Supplier Y
Supplier Z
Bank (B/S)
Purchases (I/S)
Sales (I/S)
Trial Balance
Financial Statements
14.4
The information in the receivables ledger control account (RLCA) and receivables ledger
(RL) is posted from the same source documents.
Therefore
the balance on the RLCA should equal the sum of all balances from the RL
Similarly
the balance on the PLCA should equal the sum of all balances from the PL
2.3
If the balances do not agree then an error has been made. This will be identified through a
control account reconciliation (Section 5).
Lecture example 1
Preparation question
Record the above transactions in the books of prime entry and the memorandum ledgers.
Post the totals from the BOPE to the nominal ledger.
Balance off nominal ledger accounts.
Reconcile the memorandum ledgers to the control accounts.
Solution
(1)
Customer
14.5
Amount
Supplier
Amount
Narrative
Total
Sales
Receivables
Total
Purchases
Payables
Narrative
Memorandum ledgers
Receivables ledger
Customer A
Customer B
Payables ledger
Supplier Y
Supplier Z
14.6
PLCA (B/S)
Bank (B/S)
Sales (I/S)
Purchases (I/S)
(4)
Reconciliation
Balance per list of balances
$
Receivables ledger
Customer A
Customer B
Balance per RLCA
Balance per list of balances
$
Payables ledger
Supplier Y
Supplier Z
Balance per PLCA
14.7
Other entries
A business must ensure that any transaction recorded in the receivables ledger control
account or the payables ledger control account is also reflected in the memorandum
ledgers.
Contra entries
3.1
Sometimes a business may have a customer which also supplies the business with goods.
Illustration:
P Co is a printing business which sells stationery to F Co, a florist. F Co supplies P Co with
flowers and plants for its offices.
During October, P Co sells stationery worth $200 to F Co and F Co delivers flowers and
plants to P Co worth $70.
P Co has the following amounts in its books:
Receivables:
Payables:
$200
$70
The two businesses agree to offset the balances receivable and payable via a contra.
The contra will be for the lower of the two amounts: $70. This will decrease both
receivables and payables by $70 and the remaining $130 can then be paid in cash.
3.2
PLCA
RLCA
Note that the memorandum ledgers will also need to be updated for the contra entry.
Sometimes when a business has made a sale, the customer will return the goods.
3.5
Steps:
(1)
(2)
RLCA
Sales
$250
$250
Bank
RLCA
$250
$250
At this point the balance on the receivables ledger control account is nil.
14.8
Sales (returns)
RLCA
$250
$250
RLCA
Bank
$250
$250
Once again the balance on the receivables ledger control account is nil.
3.6
Over payment
3.7
If a customer pays too much to settle an invoice or pays an invoice twice the business will
owe the excess to the customer.
This may be held and treated like a credit note or the monies refunded to the customer.
Discounts
4.1
(b)
Trade discounts
(i)
given at the time of the sale/purchase, they reduce the selling price as an
inducement to purchase;
(ii)
Settlement discounts
(a)
(b)
Terminology
4.2
Discounts allowed
4.3
Accounting treatment
Sales are recorded net of (i.e. after) trade discounts but inclusive of (i.e. before) settlement
discounts.
Therefore trade discounts never appear in the financial statements.
14.9
Lecture example 2
(a)
Preparation question
On 1 January 20X7 a business made a sale on credit for $12,000. A trade discount of
$2,000 was available with a further 10% settlement discount if payment were made within
10 days.
Required
Record the initial sale.
Solution
The initial sale would be recorded as:
Sales (I/S)
(b)
RLCA (B/S)
On 4.1.X7, the customer pays for the goods taking advantage of the settlement discount.
The discount will be 10% of sales value.
Required
Record the full settlement of the amount owed.
Solution
Bank (B/S)
14.10
Required
What would your answer be to part (b) if the settlement discount were not taken?
Solution
Bank (B/S)
RLCA (B/S)
Discounts received
4.4
Accounting treatment
Purchases are recorded net of trade discounts but inclusive of settlement discounts.
Again trade discounts never appear in the financial statements.
Settlement discounts received are recorded as discounts received and are shown as
sundry income in the income statement.
Dr
Cr
PLCA (B/S)
Discounts received (I/S)
Lecture example 3
Preparation question
Ryan Co purchases goods worth $5,000 from Austin Co. Ryan Co will receive a 5% settlement
discount if the goods are paid for within seven days. Ryan Co has every intention of taking
advantage of the settlement discount.
Required
(a)
(b)
(c)
14.11
Solution
Sales tax is calculated on the amount after all discounts, regardless of whether the
discount is taken or not.
Lecture example 4
Brick buys goods with a list price of $50,000 from Cement. Brick receives a trade discount of 12%
from Cement and a further discount of 4% if payment is made within 10 days. Sales tax is at 15%.
Required
What amount should Brick show in Cement's payables ledger to record this purchase?
A
B
C
D
$48,576
$50,336
$50,600
$57,500
14.12
Solution
5.1
5.2
Balance b/d
Sales day book undercast
Sales omitted from SDB
X
Balance b/d
$
X
X
X
Reconciliation Statement
$
+
Total per listing of receivables ledger
balances
Adjustments
Balance omitted
Credit balance listed as debit
14.13
$
X
X
X
(2X)
X
X
X
Lecture example 5
(a)
Technique demosntration
Required
Post the following transactions to and balance off the receivables ledger control account.
(1)
(2)
(3)
(4)
(5)
(6)
(b)
(ii)
(iii)
A customer balance of $2,150 was left out when the receivables ledger list of
balances was totalled.
Required
Reconcile the receivables ledger control account to the receivables ledger list of balances.
Solution
14.14
Summary of Chapter 14
6.1
At any point in time the balance on the receivables ledger control account should equal the
total of all the balances in the receivables ledger. Also the balance on the payables ledger
control account should equal the total of all the balances in the payables ledger. Where the
two balances are not the same an error must have arisen and a reconciliation should be
performed to identify the errors.
6.2
If a customer is also a supplier the two parties may choose to settle their accounts by
making a contra entry. The contra is always for the lower of the two balances.
6.3
Sometimes a business may offer discounts to attract custom. There are two types of
discounts: trade discounts and settlement discounts.
6.4
Sales and purchases are recorded after trade discounts but before settlement
discounts.
6.5
Sales tax is calculated on the amount after all discounts, regardless of whether the
discount is taken or not.
7.1
7.2
7.3
14.15
14.16
14.17
14: QUESTIONS
The sales day book total for week 22 had been overcast by $600.
(ii)
A credit balance of $420 on Orinocos account had been incorrectly treated as a debit entry when listing
the receivables ledger.
(iii)
A contra of $3,000 has been entered in Bungos account in the receivables ledger but no other entry had
been made.
14.1
14.2
14.3
14.4
$125,560
$126,400
$127,240
$129,400
(2 marks)
$125,560
$126,400
$127,240
$129,400
(2 marks)
A page of the sales day book is undercast by $250. The journal necessary to correct the error is:
A
Winn Co has opening trade payables of $24,183 and closing trade payables of $34,665. Purchases for
the period totalled $254,192 ($31,590 relating to cash purchases).
What were total payments recorded in the payables ledger for the period? $
14.5
(2 marks)
(2 marks)
14.18
(2 marks)
14: QUESTIONS
14.6
The following receivables ledger reconciliation has been prepared by the bookkeeper of Julian Co as at
31 October 20X7:
$
26,170
1,740
(1,220)
300
26,990
14.7
The trade receivables column of the cash receipts book was overcast by $300.
A payables ledger contra of $300 was not entered in the memorandum records.
(2 marks)
Justin has attempted to write up his own nominal ledger but is very confused about debits and credits. He
realises he has made some mistakes and has asked you to correct the following receivables ledger
control account:
Receivables ledger control account
Balance b/d
Sales on credit
Purchase ledger contra
$
12,460
15,520
1,600
29,580
Cash sales
Cheques from credit customers
Discounts allowed
Balance c/d
$
4,430
11,650
890
12,610
29,580
The opening balance is correct. What should the closing balance be?
14.8
$9,410
$13,840
$15,620
$17,040
(2 marks)
Which of the following is not a valid reason for a credit balance on a customer's account in the
receivables ledger?
A
Over payment
(1 mark)
14.19
14: QUESTIONS
14.9
During April a company receives an invoice for $12,000 relating to goods bought on credit. These
purchases qualify for a 5% trade discount which has not yet been taken into account. The company also
sells goods with a list price of $20,000. A 6% trade discount is to be offered on these goods. Sales tax is
applicable to all items and is at 15%. Sales tax is not included in the above amounts. If there is no
opening balance on the sales tax account at the beginning of April, what is the closing balance at the end
of April?
A
$1,110 Cr
$1,110 Dr
$1,200 Cr
$1,200 Dr
(2 marks)
14.10 The following transactions were recorded in a companys books during one week of its trading year:
$
Trade purchases (at list price)
4,500
Sales on credit (at list price)
6,000
Purchase of a van
10,460
A trade discount of $300 was given on the sales. All figures are given exclusive of sales tax at 15%.
If the balance on the sales tax account was $2,165 credit at the beginning of the week, what is the
balance at the end of the week? $
(2 marks)
14.11 Thomas
Thomas is a sole trader. He has been reading a book on basic bookkeeping but his grasp of the subject is
weak.
He has produced the following receivables ledger control account but is not sure whether his closing
balance is correct.
Required
Produce a corrected receivables ledger control account.
14.20
$
74,730
425
470
1,470
870
10,350
88,315
14: QUESTIONS
14.12 Duff
On 31 December 20X7 the balance on Duffs receivables ledger control account was $1,070, but the
receivables ledger balances totalled only $890.
You ascertain the following:
(1)
(2)
Receivables ledger balances totalling $70 had been omitted from the list.
(3)
A contra entry of $20 had been made between the payables ledger and receivables ledger
accounts of Jones & Co, but no other entry had been made.
(4)
The only posting made in respect of sales on 15 December 20X7, $50 in total, had been to
individual ledger accounts.
(5)
$60 worth of goods had been returned by Smith Co in November; this had been recorded only in
the control account.
(6)
The ledger account balance of Davis & Co had been listed as $90, but was in fact $190.
Required
Prepare a reconciliation between the receivables ledger control account and the receivables ledger.
14.21
14: QUESTIONS
14.22
14.23
14: ANSWERS
14.1 B
$
130,000
SDB overcast
Contra
balance c/d
130,000
14.2 B
Receivables Ledger
$
600
3,000
126,400
130,000
$
127,240
(840)
126,400
14.3 C
14.4
$212,120
Trade payables
$
Bal b/d
Payments
Bal c/d
212,120
34,665
Purchases
($254,192 $31,590)
246,785
$
24,183
222,602
246,785
Bal b/d
34,665
14.5 B
14.6 A
Day book total has no effect on the receivables ledger, where individual invoice
amounts will be entered.
If a contra had been omitted, the receivables ledger total would have to be reduced by
$300.
14.7 B
$
12,460
15,520
27,980
Note: Cash sales are not recorded in the control account
14.8
This would leave a debit balance as the original debt would be reinstated.
14.24
$
1,600
11,650
890
13,840
27,980
14: ANSWERS
14.9
$
Input sales tax
$12,000 95% 15%
1,710
(2,820)
(1,110) Cr
14.10 $776 Cr
$2,165 + [15% ($6,000 $3,000)] [15% $4,500] [15% $10,460] = $776
14.11 Thomas
Receivables ledger control account
Balance b/d
Cash cheque dishonoured
Cash credit balances
Sales
$
12,240
425
180
71,250
$
Cheques
Irrecoverable debts
Cash received
Discounts allowed
Returns inwards
Purchase ledger contras
Balance c/d
74,730
470
870
2,165
2,250
230
3,380
84,095
84,095
14.12 Duff
Receivables ledger control account
Balance b/d
Sales 15.12.X7 (4)
$
1,070
50
$
100
20
1,000
1,120
1,120
Balance b/d
1,000
Adjustments:
Balances omitted (2)
Goods returned (5)
Balance understated (6)
100
170
Amended total
14.25
60
60
110
1,000
14: ANSWERS
END OF CHAPTER
14.26
Bank reconciliations
Identify the main reasons for differences between the cash book and the bank statement.
Prepare bank reconciliation statements and identify the bank balance to be reported in the final accounts.
Derive bank statement and cash book balances from given information.
Exam Context
Exam questions are likely to ask you to perform calculations to correct a bank reconciliation. Alternatively they may ask
you to state whether differences between the cash book and the bank statement should be adjusted in the cash book or
in the reconciliation statement.
Qualification Context
This chapter covers a topic which is only examined in Paper F3.
15.1
Overview
Bank reconciliations
Differences
Timing differences
15.2
Introduction
1.1
This chapter is designed to enable you to explain and apply the approach to identifying and
correcting errors through the use of bank reconciliations.
1.2
The cash book is used to record the detailed transactions of receipts and payments into and
out of the bank account. These are then posted to the nominal ledger periodically using
double entry. At the end of each accounting period, the balance on the cash book should
equal the balance in the nominal ledger cash account.
1.3
Bank statements provide an independent record of the balance on the bank account but this
balance is unlikely to agree exactly to the cash book balance therefore a reconciliation is
required.
Differences between the cash book balance and the bank statement
1.4
(b)
Timing differences:
(i)
unrecorded lodgements (money paid into the bank by the business but not
yet appearing as a receipt on bank statement)
(ii)
(c)
(ii)
transposition errors
(iii)
casting errors
A word of warning
1.5
In the books of the business:
POSITIVE BANK BALANCE = ASSET = DEBIT
NEGATIVE BANK BALANCE (OVERDRAFT) = LIABILITY = CREDIT
But from the banks point of view:
POSITIVE BALANCE = LIABILITY = CREDIT (the bank owes you your money)
NEGATIVE BALANCE (OVERDRAFT) = ASSET = DEBIT
(you owe the bank this is an asset for the bank)
15.3
Procedures
2.1
(a)
(b)
Compare the bank statement to the cash account and tick off all items which agree.
Remaining items must represent timing differences or errors decide which!
Balance b/d
Under cast error in balance b/d
$
X
X
X
X
X
X
$
X
X
(X)
X/(X)
Practical tips
2.3
(a)
(b)
It is the corrected cash account balance which is shown on the balance sheet. This
figure will be the recalculated 'Balance c/d' on the cash account (or the total at the
end of the reconciliation statement which should be identical!).
15.4
Lecture example 1
Preparation question
The cash account of Graham showed a debit balance of $204 on 31 March 20X8. A comparison
with the bank statements revealed the following.
$
(1) Cheques drawn but not presented
3,168
(2)
(3)
(4)
723
35
18
14
2,618
Required
Make any necessary adjustments to the cash book balance and complete the bank reconciliation
statement as at 31 March 20X8.
Solution
Adjustment of cash book balance
Cash account
$
15.5
Lecture example 2
Whilst preparing a bank reconciliation statement at 31 December. The following items caused a
difference between the bank statement balance and the cash book balance.
(1)
(2)
(3)
(4)
(5)
Required
Which of these items will be shown in the bank reconciliation?
A
B
C
D
2, 3, and 5
1 and 4
1, 4, and 5
1, 3 and 5
Solution
Quick Quiz
Summary of Chapter 15
3.1
A business maintains a cash book to tell it how much cash it has at a particular point in time.
It should reconcile this balance to the bank statement in order to ensure the cash book
information is accurate.
3.2
Differences between the cash book balance and the bank statement balance will arise for
three reasons: timing differences, errors by the business and errors by the bank.
15.6
15.7
15: QUESTIONS
Bank charges of $100 and overdraft interest of $50 have been omitted.
Cheques received from customers totalling $1,900 have not yet been cleared by the bank.
Cheques drawn in favour of suppliers amounting to $2,300 are outstanding at the year end.
A credit transfer from a customer of $2,000 was not recorded.
A direct debit to a supplier of $1,000 was omitted.
15.1
What figure will be shown in the balance sheet as at 31 December 20X8 for bank overdraft?
15.2
15.3
$5,480
$5,680
$6,130
$7,380
(2 marks)
Assuming that the above items are all that is required to reconcile the cash book balance to the balance
per the bank statement, what balance did the bank statement show as at 31 December 20X8?
A
$5,280 overdrawn
$6,080 overdrawn
$7,780 overdrawn
$8,580 overdrawn
(2 marks)
Rectify
A summary of the cash book of Rectify Co for the year to 31 May 20X5 is as follows:
$
805
145,720
146,525
Cash Book
Payments
Closing balance c/d
$
146,203
322
146,525
After some investigation of the cash book and vouchers you discover that:
(1)
bank charges of $143 shown on the bank statement have not yet been entered in the cash book;
(2)
a cheque drawn for $98 has been entered in the cash book as $89, and another drawn at $230
has been entered as a receipt;
(3)
a cheque received from a customer for $180 has been returned by the bank marked refer to
drawer, but it has not yet been written back in the cash book;
(4)
an error of transposition has occurred in that the opening balance of the cash book should have
been brought down at $850;
(5)
cheques paid to suppliers totalling $630 have not yet been presented at the bank, whilst payments
in to the bank of $580 on 31 May 20X5 have not yet been credited to the companys account;
(6)
a cheque for $82 has been debited to the companys account in error by the bank;
(7)
(8)
standing orders appearing on the bank statement have not yet been entered in the cash book:
(i)
(ii)
(iii)
interest for the half year to 31 March on a loan of $20,000 at 11% pa;
hire purchase repayments on the managing directors car 12 months at $55 per month;
dividend received on a trade investment $1,147;
15.8
15: QUESTIONS
(9)
a page of the receipts side of the cash book has been undercast by $200;
(10)
Required
Prepare a bank reconciliation as at 31 May 20X5.
15.9
15: QUESTIONS
15.10
15.11
15: ANSWERS
15.1 B
15.2
15.3
$
(6,530)
(150)
2,000
(1,000)
(5,680)
$
(5,680)
(1,900)
2,300
(5,280)
Rectify
Bank
$
$
Balance b/d
322
45
1,147
Undercast (9)
200
Balance c/d
838
143
460
180
1,100
HP repayments (8ii)
660
2,552
2,552
Bank reconciliation statement as at 31 May 20X5
Balance per bank statement
$
(870)
580
(630)
O/D
82
(838)
END OF CHAPTER
15.12
O/D
Correction of errors
Calculate and understand the impact of errors on the income statement and balance sheet.
Record entries in a suspense account and make journal entries to clear it.
Exam Context
Questions on this area are likely to focus on three main areas. You may be asked to identify which explanations could
have led to a particular difference or be asked to identify the journal entry to correct an error. You may also need to
determine the effect errors may have on the profit figure.
Qualification Context
This topic is only tested in Financial Accounting.
16.1
Overview
Types of error
Correction of errors
Suspense account
Adjustments to profit
16.2
Introduction
1.1
Chapter 6 showed us how the trial balance was extracted from the ledger accounts and that
it should balance, i.e. total debits should equal total credits.
1.2
If the trial balance doesn't balance then an error has definitely been made and must be
corrected.
Types of error
2.1
The following errors will still allow the trial balance to balance.
Type of error
Section 1
Example
Error of omission
Error of commission
Error of principle
Compensating error
2.2
The trial balance will not balance if total debits do not equal total credits.
This could be due to the following:
(1)
Transposition error
(2)
debits credits
(b)
a debit entry has been posted and no corresponding credit made (or vice
versa)
16.3
These errors will be corrected by creating a suspense account and making a journal entry
to correct the error.
Suspense accounts
3.1
A suspense account is a temporary account. They never appear in the final accounts.
3.2
3.3
(1)
To account for a debit or credit entry when the accountant is unsure as to where it
should go
(2)
To make a preliminary trial balance balance when an error has been detected.
3.4
Illustration
W Co sold goods with a value of $2,500 to James, a credit customer. When recording the
sale W Co posted the transaction to the correct accounts but made two debit entries.
Steps
(1)
(2)
$2,500
$2,500
(3)
Trade receivables
Sales
Trade receivables
Sales
$2,500
$2,500
Correction:
The trade receivables entry is correct but sales have been debited by $2,500 when
they should have been credited by that amount.
The correction is therefore twice the original error:
Dr
Cr
Suspense account
Sales (2 $2,500)
$5,000
$5,000
16.4
Lecture example 1
Technique demonstration
Dan, the bookkeeper of Tiffany's, has made his usual mess of things and produced the following
attempt at a trial balance for the year ended 30 April 20X7.
$
Property, plant and equipment
At cost
Provision for depreciation
Capital at 1 May 20X6
Profit for the year
Inventory, at cost
Receivables ledger control account
Payables ledger control account
Balance at bank
60,000
31,000
53,000
12,300
14,000
9,600
6,500
1,640
85,240
102,800
A rent payment of $350 in March 20X7 had been debited in the receivables ledger control
account.
(2)
Discounts allowed of $500 during the year ended 30 April 20X7 had not been recorded in
the books.
(3)
No entry had been made for the refund of $2,620 made by cheque to V Woolf in March
20X7, in respect of defective goods returned to Tiffany. V Woolf, who had already paid for
the goods, returned them on 28 February 20X7.
(4)
The total column of the cash receipts book had been overcast by $1,900 in March 20X7.
(5)
The purchase of stationery for $1,460 cash in June 20X6 has not been posted to the
appropriate expense account.
(6)
Required
Prepare
(a)
(b)
16.5
Solution
16.6
Adjustments to profit
4.1
When errors are corrected they may affect the business' profit for the year figure.
4.2
For example in Lecture example 1, item 5 tells us that a stationery expense of $1,460 has
not been recorded in the expense account.
The profit for the year figure in the trial balance of $12,300 is therefore too high and needs
to be corrected.
4.3
Proforma
4.4
$
+
Original profit
Adjustment:
(a) over depreciation
(b) unrecorded expense
(c) unrecorded sale
$
X
X
X
X
X
(X)
Adjusted profit
Lecture example 2
X
X
Technique demonstration
Required
Prepare a statement of adjustments to profit for Lecture example 1.
Solution
Statement of adjustments to profit for the year ended 30 April 20X7.
Increases
$
Draft profit
Adjustments
Revised profit
16.7
Decreases
$
Lecture example 3
Z Co's income statement showed a profit of $112,400 for the year ended 30 September 20X7. The
following errors were later discovered:
(1)
(2)
A machine which had been held for two years and had originally cost $15,000 was
depreciated this year using a 33 31 % reducing balance basis. Z Co's policy is to depreciate
machines over four years.
Required
What would be the net profit after adjusting for these errors?
A
$103,250
$105,750
$105,950
$108,450
Solution
Quick Quiz
Summary of Chapter 16
5.1
Some errors, such as errors of omission and errors of principle, will still allow the trial
balance to balance.
5.2
Where the trial balance does not balance a suspense account will be inserted and the
errors, once identified, will be corrected via a journal entry.
5.3
Some of these corrections may impact the business profit; in this case a statement of
adjustments to profit can be prepared to determine the revised profit figure.
16.8
16.9
16: QUESTIONS
16.1
16.2
16.3
16.4
16.5
Which of the following errors could result in a suspense account being required to balance the trial
balance?
A
(1 mark)
Duncan corrected the following errors before producing his final balance sheet. What was the balance on
the suspense account before he did this?
(i)
(ii)
Cash receipts from receivables of $713 posted to the receivables ledger control account as $731.
(iii)
Cash received from the issue of $1,000 debentures at par had been posted to a suspense
account.
$982
Dr
$982
Cr
$1,018 Dr
$1,018 Cr
(2 marks)
Russells bookkeeper transposed some figures when the weeks cash payments were being posted to the
nominal ledger. Payments for staff wages of $125 were posted to the wages account as $152 and
payments of $31 for stationery were posted to the stationery expense account as $13. The entry required
to correct this is
A
Dr stationery $18
Dr suspense $9
Cr wages $27
Dr wages $27
Dr stationery $18
Cr suspense $45
Dr wages $27
Cr stationery $18
Cr suspense $9
Dr suspense $45
Cr wages $27
Cr stationery $18
(2 marks)
The discounts received column of the cash payments book was overcast.
Cash paid for the purchase of office furniture was debited to the general expenses account.
Returns inwards were included on the credit side of the trial balance.
(i) only
(iii) only
(2 marks)
If sales of $150 has been wrongly entered on the debit side of the purchases account, but correctly
entered in the trade receivables account, the totals on the trial balance would show:
A
16.10
(2 marks)
16: QUESTIONS
16.6
Platinum Co
Platinum Co, a manufacturer of electrical goods, has just produced its draft accounts for the year ended
30 September 20X7. These show a draft profit of $28,960.
Unfortunately, the accountant has since discovered the following matters which require consideration
before the final accounts can be prepared:
(1)
Returns outwards to Metals Co in June 20X7 of $490 have been treated as returns inwards in
error in the nominal ledger.
(2)
R. Silverman, a customer owing $1,850 has gone bankrupt. Full allowance had been made
against this amount in Platinum's accounts for the year ended 30 September 20X6.
(3)
An item of equipment with a net book value of $6,000 (cost $10,000) was sold for $5,000 in
September 20X7. The proceeds were included in cash and credited to the motor expenses
account. No other entries were made.
(4)
An amount owing from Aluminium Co of $780 was written off in January 20X7. The amount was
removed from trade receivables and debited to the sales account.
Required
Calculate the corrected profit for the year ended 30 September 20X7.
16.11
16: QUESTIONS
16.12
16.13
16: ANSWERS
16.1
16.2 B
Suspense account
Transposition error (731 713)
Bal c/d
16.3
16.4
16.5
16.6
Platinum Co
(a)
1,000
1,000
982
Draft profit
(1)
(2)
(3)
980
(4)
$
28,960
6,000
980
Revised profit
END OF CHAPTER
16.14
(6,000)
(5,020)
23,940
Preparation of
financial statements for
sole traders
Prepare extracts of a balance sheet and income statement from given information.
Exam Context
This chapter recaps some of the key skills you have learnt in the chapters covered to date. Whilst you will not be asked
to produce a balance sheet or an income statement in the real exam any of the adjustments in this chapter could be
tested as an individual question. This chapter will also help you to see how financial accounting fits together.
Qualification Context
The skills to produce a balance sheet and an income statement are tested in detail in the Fundamentals level paper,
Financial Reporting (F7).
17.1
Overview
Preparation of financial
statements for sole traders
Trial balance
Adjustments
Suspense account
17.2
Introduction
1.1
The purpose of this chapter is to recap some of the skills covered in Chapters 116.
1.2
You will not be required to answer a question in the format of Lecture example 1 in the
exam. However completing this exercise will revise your understanding of topics covered so
far and enable you to see the end product a business' transactions ordered into a set of
financial statements.
Lecture example 1
Technique demonstation
You have been given the information below and asked to prepare the accounts of Mugg for the
year ended 31 December 20X7.
Trial balance as at 31 December 20X7.
Dr
$
Capital account at 1 January 20X7
Rent
Inventories 1 January 20X7
Electricity
Insurance
Wages
Trade receivables
Sales
Repairs
Purchases
Discounts received
Drawings
Petty cash
Bank
Motor vehicles at cost
Furniture and fixtures at cost
Accumulated depreciation at 1 January 20X7
Motor vehicles
Furniture and fixtures
Travel and entertaining
Trade payables
Suspense account
Cr
$
2,377
500
510
240
120
1,634
672
15,542
635
9,876
129
1,200
5
762
1,740
830
435
166
192
700
433
19,349
19,349
(2)
Mugg has drawn $10 a month and these drawings have been charged to wages;
(3)
(4)
$180 received from a credit customer was correctly entered in the trade receivables account
and credited to the bank account;
(6)
Mugg has taken goods from inventories for his own use. When purchased by his business
these goods cost $63 and they would have been sold for $91;
(7)
The annual rental of the business premises is $600, and $180 paid for electricity in August
20X7 covers the 12 months to 30 June 20X8;
(8)
Discounts allowed of $73 have only been recorded in the trade payables account.
Required
(a)
(b)
(c)
Produce an income statement for the year ended 31 December 20X7 and a balance sheet
as at that date.
Solution
(a)
Journals
(1)
(2)
(3)
(4)
17.4
(6)
(7)
(8)
(b)
Suspense account
$
17.5
Mugg
Income statement for the year ended 31 December 20X7
$
Accumulated
depreciation
$
NBV
$
Sales
Less: cost of sales
Opening inventories
Purchases
Less: closing inventories
Gross profit
Discounts received
Less: expenses:
Rent
Electricity
Insurance
Wages
Repairs
Depreciation
Travel and entertaining
Bad debts
Discounts allowed
Profit for the period
Mugg
Balance sheet as at 31 December 20X7
Cost
$
Non-current assets
Motor vehicles
Furniture and fixtures
Current assets
Inventories
Trade receivables
Prepayments
Cash and bank balances
Capital
Capital as at 1 January 20X7
Profit for the period
Less: drawings
Current liabilities
Trade payables
Accruals
17.6
Quick Quiz
Summary of Chapter 17
2.1
The balance sheet and income statement are the end product produced by a business. All
the business transactions need to be categorised into the books of prime entry and posted
to the nominal ledger. The trial balance is then extracted and some adjustments may need
to be made before the financial statements are drawn up.
2.2
You will not have to produce a balance sheet or income statement however this chapter
should reinforce your understanding of Chapters 1 16.
17.7
17.8
17.9
17: QUESTION
17.1
True
False
(1 mark)
17.10
17.11
17: ANSWER
17.1
END OF CHAPTER
17.12
Incomplete records
Exam Context
Questions on this chapter will require you to identify missing figures, for example sales, closing inventories and
drawings. The Pilot Paper included two questions asking you to derive the value of closing inventories using information
about the gross profit margin earned by the business.
Qualification Context
This topic is only tested in Financial Accounting.
Business Context
Some sole traders do not keep very detailed accounting records. They still however need to produce accounts so they
know how their business is performing and also how much tax to pay to the tax authorities. The preparation of accounts
from incomplete records can generate a lot of income for smaller accountancy practices.
18.1
Overview
Margin
Cost structures
Mark-up
Incomplete records
Sales
Purchases
Drawings
18.2
Inventory
Issue
1.1
Individuals running small businesses such as a newsagent or greengrocer may not keep all
of the accounting records we have studied or have a detailed understanding of double entry
bookkeeping.
1.2
They still need to know how the business is performing and so will produce financial
statements. If some necessary information isn't maintained by the business, it will need to
be derived from other available information.
Cost structures
2.1
Cost structure information is usually expressed in one of two ways, either as a margin or a
mark-up.
(a)
Margin:
(b)
Mark-up:
100%
75%
25%
2.2
135%
100%
35%
Remember that:
Cost of sales = opening inventories + purchases closing inventories
Lecture example 1
Preparation question
Workings
18.3
Lecture example 2
Preparation question
Y Co operates with a standard mark-up of 30% and has the following information available for
20X7.
$
Sales
221,000
Opening inventories
43,000
Closing inventories
47,500
Required
What is the value for purchases in 20X7?
Workings
Lecture example 3
On 1 January 20X7 J Co had inventory of $620,000. Sales for the month amounted to $985,000
and purchases were $700,000. At the end of January a fire in the warehouse destroyed some
inventory items. The owners salvaged inventory valued at $180,000. J Co operates with a mark up
of 25%.
What is the cost of inventory destroyed in the fire?
A
B
C
D
$335,000
$352,000
$401,250
$532,000
Solution
18.4
Lecture example 4
Preparation question
1.1.X7
31.12.X7
$
38,450
43,825
430
167,224
Required
Based on the information above what was the value of purchases made during the year?
$
Workings
Trade payables
$
18.5
Lecture example 5
Preparation question
B Co maintains a cash float of $50. In 20X7, all receipts from credit customers were banked, after
the following payments from the till had been made:
$
4,500
6,250
General expenses
Drawings
Total bankings in the year amounted to $28,454, and opening and closing trade receivables were
$1,447 and $1,928 respectively.
Required
Based on the information above what was the value of sales made during the year? $
Workings
Cash
Trade receivables
18.6
Lecture example 6
Bob owns and manages B Co although he does not keep detailed accounting records.
All of Bob's sales are for cash. He pays certain expenses from his till and then banks the remaining
funds.
Bob maintains a $1,000 float and operates with a margin of 20%. He has provided you with the
following information.
$
20,000
100
500
1,200
12,800
2,000
3,000
Purchases of goods
Wages for clerical assistant (per week)
Stationery
Electricity
Bankings
Opening inventories
Closing inventories
Bob is unsure of the level of drawings taken during the year but estimates they were between $60
and $90 per week.
Required
What were Bob's drawings during the year?
Workings
18.7
4.1
The owners of the business may at times take goods or cash from the business for their own
use. We have seen these before as drawings.
In incomplete records questions these drawings need to be included.
Cash drawings
Dr
Cr
Drawings
Cash
Drawings
Purchases
These are recorded at the cost to the business not at sale price.
They are taken out of purchases and not recorded against inventories.
Note: If you are using a trade payables T account to calculate purchases remember to
adjust purchases for any goods taken by proprietor.
Example
4.2
During the year ended 31 December 20X7, Peter Albert, a sole trader, carried out the
following transactions:
$
4,000
2,700
(5 units @ $60)
(8 units @ $60)
$
300
480
During the year he had withdrawn two units for his own use. Firstly, ignoring the drawings,
an outline trading account would appear as follows:
$
$
Sales
4,000
Cost of sales
Opening inventories
300
Purchases
2,700
3,000
Less: closing inventories
(480)
2,520
Gross profit
1,480
How should the drawings of goods be treated?
18.8
Points to note
Quick Quiz
4.3
(a)
(b)
Summary of Chapter 18
5.1
Not all businesses keep proper accounting records, however all businesses need to know
how much profit they have made in a particular year so that they can pay the relevant
amount of tax over to the tax authorities.
5.2
Where a business does not have sufficient records to produce financial statements they
need to piece together the missing information.
5.3
5.4
5.5
A business is a separate entity from its owner which means that any monies or goods taken
out of the business for personal use must be classified as drawings. Drawings of goods
are recorded at cost.
18.9
6.1
6.2
Drawings (B/S)
Cash (B/S)
Drawings (B/S)
Purchases (I/S)
18.10
18.11
18: QUESTIONS
18.1
If a business has sales of $6,000 and a margin of 20%, what is the gross profit? $
(1 mark)
18.2
18.3
A trader has budgeted sales for the coming year of $300,000. He achieves a constant mark-up of 25% on
cost. He plans to reduce his inventory level by $14,000 over the year. How much will his purchases for
the year be?
A
$211,000
$239,000
$226,000
$254,000
(2 marks)
A business has opening inventories of $273 and makes purchases during the year of $2,781. The
proprietor removes goods costing $87 for his own use. The business achieves a constant mark-up of 20%
on cost and records sales for the year of $3,360.
What is the cost of closing inventories? $
18.4
(2 marks)
Jethro sold goods for $157,470 during the year ended 31 October 20X7. Inventories at that date were
valued at $8,920 more than at the previous year end. Jethro prices his goods to give a mark-up of 45%.
What was the total value of purchases in the year ended 31 October 20X7?
A
$77,689
$95,529
$99,680
$117,520
(2 marks)
18.12
18.13
18: ANSWERS
18.1 $1,200
$6,000 0.2 = $1,200
18.2 C
$
100
Cost of sales = $300,000
125
240,000
(14,000)
226,000
18.3 $167
Cost of sales
100
$3,360
120
$
2,800
Cost of sales
purchases
(273)
(2,694)
167
END OF CHAPTER
18.14
Partnerships
Understand and identify the typical content of a partnership agreement, including profit sharing terms.
Understand the nature of capital accounts, current accounts and division of profits.
partners' drawings
interest on drawings
interest on capital
partner salaries
Prepare extracts of the income statement, including division of profit, and balance sheet of a partnership.
Define goodwill in relation to partnership accounts and identify the factors leading to the creation of goodwill.
Exam Context
Questions on this topic are likely to require you to calculate a partner's profit share. This may include dealing with
partners' salaries, interest on capital and drawings and loan interest. You may also need to allocate goodwill to partners
when a new partner is admitted.
Qualification Context
Partnerships are only examined in this paper.
Business Context
Many individuals set up business as a sole trader as they expand they need new finance. One way of obtaining this is
to go into partnership with someone else. That other person could provide some of the finance needed. They may also
bring new ideas to the table. Becoming a partnership will mean that the sole trader will share some of their risk but they
will also need to share their profits too!
It is always recommended that a partnership agreement is drawn up to retain a legal record of how the partnership will
operate.
19.1
19: PARTNERSHIPS
Overview
Partnership agreements
Appropriation account
Partnerships
Capital accounts
Current accounts
Guaranteed minimum
profit share
19.2
Other issues
Loans
Goodwill
19: PARTNERSHIPS
Definition
1.1
Partnership:
1.2
Partnerships are similar to sole traders. With a sole trader the owner will run the business
and any profits belong to him. The sole trader also bears the risk that the business may not
be successful.
In a partnership, the owners (partners) run the business together and share profits and risk.
1.3
Most partnerships have unlimited liability which means the partners are personally liable
for the debts of the business.
Liability is also joint and several so if one partner cannot meet the partnership's obligations
the other partners must make up any shortfall.
1.4
Limited liability partnerships (LLPs) exist nowadays to limit partner liability. These are
outside the scope of the F3 syllabus.
Partnership agreements
The partners will need to agree the terms under which the partnership will operate, and
decide, for example how much capital each partner will contribute and what share of profits
they will be entitled to.
This is done by way of a partnership agreement which usually covers the following areas:
2.1
Area
Consideration
Capital
allocation of profit
equal shares?
it is an appropriation of profit
interest rate
Salaries
Interest on capital
Drawings
19.3
19: PARTNERSHIPS
3.1
There are two key differences between accounting for a sole trader and a partnership.
These are illustrated below.
3.2
Income statement
Sole trader
Sales
Cost of sales
Gross profit
Less: expenses
Profit for period
Partnership
$
X
(X)
X
(X)
X
$
X
(X)
X
(X)
X
Sales
Cost of sales
Gross profit
Less: expenses
Profit for period
All belongs to
sole trader
The profit for the period is appropriated (shared out) between the partners according to
their partnership agreement.
Steps
(1)
(2)
(3)
(4)
Appropriation account
Profit before appropriation
Interest on drawings
X
Partner A
X
Partner B
X
X
X
X
X
X
X
X
* PSR is always the last entry, splitting the residual profit after all other allocations
19.4
19: PARTNERSHIPS
3.4
Balance sheet
Sole trader
Partnership
$
Capital
Capital
Profit
Less: drawings
$
Capital accounts
Partner A
Partner B
X
X
(X)
X
Current accounts
Partner A
Partner B
X
X
X
X
X
X
Capital accounts
These represent the capital invested in the business by each individual partner. The
balances in these accounts will remain relatively static.
The capital account can be shown as one T account subdivided into columns.
For example, if Partner A contributed $5,000 and Partner B $8,000, the capital account
would show.
Capital account
Ptnr
A
$
Ptnr
B
$
Bal b/d
3.6
Ptnr
A
$
5,000
Ptnr
B
$
8,000
Current accounts
These record each partner's day to day transactions with the business.
The main entries in the current account will be the partners appropriation of profits (salary,
interest on capital and profit share) less drawings they have taken from the business and
any interest charged on those drawings.
Current account
Drawings
Interest on drawings
Bal c/d
Ptnr
A
$
2,900
100
Ptnr
B
$
970
30
4,000
7,000
5,000
6,000
19.5
Bal b/d
Salaries
Interest on capital
Profit share
Ptnr
A
$
1,000
1,500
500
4,000
7,000
Ptnr
B
$
1,500
800
3,700
6,000
19: PARTNERSHIPS
Lecture example 1
(a)
Preparation question
On 1 January 20X4 Tick, Cast and Balance entered into partnership together as chartered
certified accountants. They agreed that Balance would receive a salary of $15,000 p.a., they
would all be allowed interest on capital of 12% p.a. and they would share profits in the ratio:
Tick five tenths, Cast three tenths, Balance two tenths. They paid in the following capital
amounts:
Tick
Cast
Balance
$50,000
$30,000
$20,000
In the year to 31 December 20X4 their profit for the period was $50,000.
During the year they had made drawings in cash as follows:
30.6.20X4 Tick
30.9.20X4 Cast
31.12.20X4 Balance
$6,000
$4,000
$8,800
Required
(i)
(ii)
(iii)
(iv)
Solution
(i)
Tick
$
Cast
$
Capital Accounts
Balance
$
19.6
Tick
$
Cast
$
Balance
$
19: PARTNERSHIPS
(ii)
Appropriation account for the year ended 31 December 20X4
$
(iii)
Current accounts
Tick Cast Balance
$
$
$
19.7
Tick
$
Cast
$
Balance
$
19: PARTNERSHIPS
(iv)
Capital accounts
Tick
Cast
Balance
Current accounts
Tick
Cast
Balance
(b)
What would your answer be to (ii) and (iii) if the agreement had also provided for interest to
be charged on drawings at the rate of 10% p.a.?
(ii)
Appropriation account for the year ended 31 December 20X4
$
19.8
19: PARTNERSHIPS
(iii)
Tick
$
Current accounts
Cast
Balance
$
$
19.9
Tick
$
Cast
$
Balance
$
19: PARTNERSHIPS
4.1
It may be that the partnership agreement specifies that one or more partners must receive a
minimum share of profits.
4.2
If when the appropriation of profits is made this level is exceeded, there is nothing further to
do.
4.3
If, however, there is a shortfall then this will be made up by the remaining partners in their
profit sharing ratio.
4.4
Illustration
A, B and C are in partnership and share profits in the ratio 2:2:1.
The partnership made a profit for the year of $50,000. A and B each receive a salary of
$12,000. Interest due on the partners' capital is $2,000, $1,700 and $1,500 respectively.
No interest is charged on drawings.
C has a guaranteed minimum profit share of $7,000.
Salaries
Interest on capital
Profit share (2:2:1)
Subtotal
Guaranteed minimum profit
share shortfall (2:2)
A
$
12,000
2,000
8,320
22,320
B
$
12,000
1,700
8,320
22,020
C
$
1,500
4,160
5,660
(670)
(670)
1,340
21,650
21,350
7,000
Loans
5.1
Total
$
24,000
5,200
20,800
50,000
50,000
(a)
(b)
(c)
(d)
Accounting treatment
5.3
The loan is shown as a non-current liability on the balance sheet and not in the partner's
capital account.
5.4
The interest incurred on the loan is shown as an expense in the income statement (just
like bank interest). It will need to be deducted from the profit figure before any appropriation
is made if it has not already been accounted for.
19.10
19: PARTNERSHIPS
5.5
If the loan interest has not been paid by the end of the year, the liability will be shown in the
relevant partners current account.
The double entry would be:
Dr
Cr
Lecture example 2
19.11
19: PARTNERSHIPS
6.1
Profits are always appropriated according to the partnership agreement. Therefore if the
terms of the agreement change during the period this will affect the profit appropriation.
6.2
Always use the old partnership agreement to appropriate the profits for the first part of the
year and the new partnership agreement for the latter part of the year.
6.3
Lecture example 3
Melanie, Sarah and Angela are in partnership, compiling their accounts for the year to
31 December each year. The partnership agreement states the following:
Until 30 June 20X3
Annual salaries
Sarah
Angela
$40,000
$20,000
Sarah
Angela
182,000
130,000
88,000
200,000
116,000
84,000
198,000
118,000
88,000
180,000
132,000
88,000
19.12
19: PARTNERSHIPS
7.1
When a partner retires from the partnership or a new partner is admitted to the partnership it
is usual for the partners to value the business.
7.2
It is likely that over time the value of items such as property, plant and equipment will
increase over their net book value.
However, hopefully the business will also have built up a good reputation and a loyal
customer base and the business itself will be worth more than its individual assets.
Section 2.8-2.10
7.3
The worth of a business over and above its individual assets is called goodwill.
7.4
When a partner retires it is important that he is paid a sum that represents not just the
money he invested but also his share of the extra value created in the business, i.e. his
share of goodwill.
Goodwill is therefore added to the partners' accounts according to the existing or old profit
sharing ratio.
7.5
Similarly, when a new partner joins, he will pay in a sum of money (capital). It is important
that the original partners value the partnership so they know its worth and can determine
how much the partner should contribute.
7.6
Goodwill is an extremely subjective figure and so it is not left in the partnership's balance
sheet, but is removed.
This is done using the new profit sharing ratio.
Lecture example 4
Preparation question
Katie, Chantel and Heather are in partnership sharing profits in the ratio 4:3:2.
On 1 September Heather decides to retire and leaves the partnership. At that point the partnership
has goodwill valued at $180,000. Katie and Chantel continue to share profits 4:3.
On 1 December Stacy joins the partnership contributing $200,000. At that time goodwill is valued
at $210,000. The new profit sharing ratio for Katie, Chantel and Stacy is 3:2:2.
Required
Show how the goodwill would be accounted for at each change of the partnership.
19.13
19: PARTNERSHIPS
Solution
Quick Quiz
Goodwill
$
Capital account
$
Summary of Chapter 19
8.1
8.2
Partners salaries are not an expense of the business but an appropriation of profit.
8.3
Capital accounts represent the capital paid in by each partner and are generally static.
8.4
Current accounts record the partners day to day transactions with the business.
8.5
Whenever a new partner is admitted or an existing partner retires the partnership will be
valued. The worth of the partnership over and above the balance sheet valued is called
goodwill. This is allocated to the partners according to their profit sharing ratio.
19.14
19.15
19: QUESTIONS
19.1
(2 marks)
19.2
(2 marks)
19.3
19.16
(1 mark)
19: QUESTIONS
19.4
A, B and C
A, B and C are in partnership, agreeing to share profits in the ratio of 4:2:1. They have also agreed to
allow interest on capital at 8% per annum, a salary to C of $5,000 per annum, and to charge interest on
drawings made in advance of the year end at a rate of 10% per annum.
The balance sheet as at 30 June 20X8 disclosed the following:
Capital accounts
A
B
C
$
50,000
30,000
10,000
Current accounts
A
B
C
2,630
521
(418)
90,000
2,733
15,000
107,733
Drawings were: A $6,400, B $3,100, C $2,000, with all sums being withdrawn on 1 July 20X8.
Profit for the year to 30 June 20X9 was $24,750, before charging interest on A's loan. The partnership
made a payment to A for loan interest on 29 June 20X9 but has not recorded this in its books.
Required
Prepare the current accounts and the appropriation account for the partners as at 30 June 20X9.
19.17
19: QUESTIONS
19.18
19.19
19: ANSWERS
19.1 $10,300
$
40,000
6
12
(2,000)
38,000
John
$
5,000
3,000
(225)
10,300
18,075
Salary
Interest on capital
Interest on drawings
PSR (2:2:1)
Total profit
Paul
$
2,500
(25)
10,300
12,775
David
$
2,000
5,150
7,150
Total
$
5,000
7,500
(250)
25,750 ()
38,000
19.2 $12,775
Current account Paul
Drawings
Interest on drawings
c/d
19.3
2,000
25
12,775
14,800
Interest on capital
Loan interest
PSR
2,500
2,000
10,300
14,800
12,775
b/d
Interest on drawings increases available profits to share and is therefore not an appropriation of
profit.
Partner salaries are an appropriation of profit, not an expense.
19.4
A, B and C
A
$
B
$
Balance b/d
Drawings
6,400
Interest on drawings 640
Balance c/d
6,990
14,030
3,100
310
3,211
6,621
Current accounts
C
$
418
2,000
200
5,032
7,650
19.20
Balance b/d
Salary
Interest on capital
Share of profit
Balance b/d
A
$
B
$
2,630
521
4,000
7,400
14,030
6,990
2,400
3,700
6,621
3,211
C
$
5,000
800
1,850
7,650
5,032
19: ANSWERS
Appropriation account
Salary
Interest
on capital
C
A
B
C
(W1)
4,000
2,400
800
7,400
3,700
1,850
Profit
Interest on loan
$
5,000
7,200
12,950
25,150
24,750
(750)
24,000
19.21
Profit (W1)
Interest
on drawings
A
B
C
640
310
200
$
24,000
1,150
25,150
19: ANSWERS
END OF CHAPTER
19.22
Introduction to
company accounting
Understand the capital structure of a limited liability company including ordinary shares, preference shares and
loan notes.
Define a bonus issue and a rights issue, their advantages and disadvantages and show how they are recorded in
the balance sheet.
Identify and record the other reserves which may appear in the company balance sheet.
Calculate and record finance costs in ledger accounts and the financial statements.
Exam Context
Questions on this chapter are likely to focus on the calculation of share capital movements (new issues, bonus issues
and rights issues), dividends and finance costs and their associated journal entries. You may also see a question
comparing a sole trader and a limited company as was included in the Pilot Paper.
Qualification Context
The knowledge covered in this chapter is developed further in the Fundamentals level paper Financial Reporting (F7).
This paper looks in more detail at whether shares and borrowings should be classified as debt or equity and also at how
they should be valued. The area of income taxes is also extended to include adjustments for deferred tax as well as
current tax.
Business Context
When a company is seeking to raise finance it will evaluate its current financing structure and gearing levels before
deciding how to secure additional funds. It will also consider the degree of risk attached to each method of financing and
will weigh up the cost in terms of interest payments versus future dividends. A company will also receive tax relief on its
interest payments (but not on dividends) and so the tax implications will form part of the final decision.
20.1
Overview
Finance costs
Reserves
Income taxes
Introduction to
company accounting
Shares
Accounting treatment
Issue at a premium
Bonus issue
Dividends
20.2
Rights issue
Introduction
1.1
We have seen how financial statements are produced for sole traders and partnerships.
These accounts are not subject to any specific regulation and so there is some flexibility as
to how they are presented.
1.2
Companies use exactly the same bookkeeping process as sole traders and partnerships;
however, the financial statements they produce are subject to regulation and must follow a
prescribed format.
Many of the differences are due to the terminology used by company financial statements.
2.1
Revenue
Cost of sales
Gross profit
Other income
Distribution costs
Administrative expenses
Other expenses
Finance costs
Investment income
Profit before tax
Income tax expense
Profit for the period
20.3
$'000
ASSETS
Non-current assets
Property, plant and equipment
Other intangible assets
X
X
X
Current assets
Inventories
Trade receivables
Other current assets
Cash and cash equivalents
X
X
X
X
X
X
Total assets
EQUITY AND LIABILITIES
Equity
Share capital
Share premium account
Revaluation reserve
Retained earnings
X
X
X
X
X
Non-current liabilities
Long term borrowings
Long term provisions
X
X
X
Current liabilities
Trade payables
Short term borrowings
Current tax payable
Short term provisions
Total equity and liabilities
X
X
X
X
X
2.3
Share capital
Share capital
3.1
Section 2.3
(b)
(c)
(d)
20.4
Types of shares
3.2
Ordinary share
Preference share
Equity share
Rab Co started business on 1 January 20X6 issuing 100,000 ordinary shares of 50c each
for 50c per share. The initial balance sheet would be:
Cash
$
50,000
50,000
Where shares are issued for more than their nominal value, the excess must be credited to
a share premium account.
Lecture example 1
Preparation question
On 1 June 20X6 Rab Co issued a further 200,000 ordinary shares of 50c each for 80c per share.
Required
Show how this issue of shares would be accounted for and what the balance sheet would look like
immediately after the issue.
20.5
Solution
Dr
$
Cr
$
Dr Cash
Cr Share capital
Cr Share premium account
Rab Co balance sheet (extract) as at 1 June 20X6
Equity
$
Share capital 50c ordinary shares
Share premium account
This is used when a company wishes to increase its share capital without needing to raise
additional finance by issuing new shares. Any reserve may be used including the share
premium account.
4.4
Advantages
4.5
Disadvantage
20.6
Lecture example 2
Preparation question
Rab Co
Balance sheet (extract)
$
150,000
60,000
200,000
410,000
Show how this issue of shares would be accounted for and prepare the balance sheet of Rab Co
immediately after the issue.
Solution
Dr
$
Cr
$
Rights issue
4.6
(a)
A rights issue is an issue of shares for cash (unlike a bonus issue) to existing
shareholders.
(b)
Rights are offered to the existing shareholders who can sell them if they wish.
20.7
Disadvantages
Lecture example 3
Preparation question
One year later, Rab Co is to make a rights issue on a 1 for 5 basis. The rights price is $1.50. All
shareholders take up their rights.
The following balance sheet extract shows the position before the issue
Rab Co
Balance sheet (extract)
$
187,500
22,500
230,000
440,000
Show how this issue of shares would be accounted for and prepare the balance sheet of Rab Co
immediately following the issue.
Solution
Dr
$
Cr
$
Dr Cash
Cr Share capital
Cr Share premium account
Rab Co
Balance sheet (extract)
20.8
Reserves
5.1
The following reserves are commonly found in limited liability company accounts.
(a)
(b)
(c)
Other reserves:
as designated by the individual company, for example a 'general reserve'.
(d)
Retained earnings:
cumulative undistributed profits less any losses.
Dividends
Definition
6.1
Illustration
6.2
Suppose a company with 1,000 ordinary $1 shares in issue made a profit of $500 in its first
year. The company has two choices as to what can be done with this profit:
(a)
(b)
If this company decides to pay a dividend of 10c per share and retain the remaining profits,
the financial statements would appear as follows:
Income statement for the year ended 31 December 20X7
Profit for the period
$
500
Dividends are charged directly to retained earnings as they are an appropriation of profits
earned to date. They are not an expense of the income statement.
6.4
Retained earnings
Dividends payable (B/S)
20.9
Interim
Final
(mid year)
(end year)
In reality the directors will wait until they know the company's full year profit before declaring
the final dividend.
The final dividend will only be accounted for in the current year if it is declared before the
year end. Otherwise it will be disclosed in a note to the financial statements (see Chapter
22).
Lecture example 4
Preparation question
6% $1 preference shares
50c ordinary shares
Show the movement in retained earnings for ABC Co for the year ended 31 December 20X7.
Solution
$
Retained earnings at beginning of year
Profit for the period
Dividends
Preference
Ordinary
20.10
7.1
7.2
One way of raising long term finance is for a company to issue loan notes (also called loan
stock or debentures).
These loans usually carry a fixed rate of interest and have a pre-determined redemption
date, for example, $50,000 10% debentures 2012. This means the company will pay interest
at 10% on the $50,000 borrowed each year. The capital amount of $50,000 will be repaid in
2012.
Finance costs
8.1
The interest expense incurred on long term borrowings will be shown as an expense called
'finance costs' in the income statement.
8.2
Income taxes
9.1
Companies must pay income tax on their profits. This tax is payable after the end of the
financial year and so the financial statements will include an accrual for the directors' best
estimate of the tax due on the profit for the period.
9.2
The tax is shown as an expense in the income statement and a current liability in the
balance sheet and will be accounted for as follows:
Dr
Cr
9.3
Often the actual amount of tax paid will be different from the amount that was recorded in
the financial statements.
This over or under provision is simply adjusted in the next financial statements.
20.11
Lecture example 5
Preparation question
Record the tax entries for the years ended 31 December 20X5 and 20X6 in the ledger
accounts.
(2)
Prepare the tax note which relates to the income statement for the year ended 31 December
20X6.
Solution
(1)
(2)
20.12
10 Comparison
The following table shows a comparison between a sole trader and a limited liability
company.
Sole trader
Company
Ownership
Liability
Members/shareholders have
limited liability. This means that
they are only liable to the extent of
their investment in the business.
Legal status
Management
Members/shareholders do not
usually manage the business, but
appoint a Board of Directors to run
the company on their behalf.
Profits
Members/shareholders receive
profits in the form of dividends.
The remainder of the profits are
retained in the company. The
directors receive a salary from the
company and this is an expense in
the income statement.
Taxation
Balance sheet
Legal
requirements
Other
20.13
11 Summary of Chapter 20
Quick Quiz
11.1 In a limited liability company the shareholders own the business. A company may raise
finance by issuing new share capital. Where shares are issued at a premium to their
nominal value, the premium is recorded in the share premium account.
11.2 A bonus issue is where the company issues shares for no cash consideration. With a
rights issue, shares are issued for cash but the price charged is slightly lower than the
current market price.
11.3 Shareholders may receive a dividend as a return on their investment; these are accounted
for as a deduction to retained earnings.
11.4 A company may also raise finance by issuing debt such as loan notes or debentures. It will
have to pay interest on these and this will be shown as 'finance costs' in the income
statement.
11.5 Companies pay income tax on their profits.
20.14
20.15
20: QUESTIONS
20.1
A company has an authorised share capital of 1,000,000 50c ordinary shares and an issued share capital
of 800,000 50c ordinary shares.
If an ordinary dividend of 5% is declared what is the amount payable to shareholders? $
(1 mark)
20.2
20.3
If a shareholder in a limited liability company sells his shares to another private investor, for less than he
paid for them, the share capital of the company will
A
Remain unchanged
(2 marks)
A companys issued share capital consists of $100,000 in 6% $1 preference shares and $50,000 in 50c
ordinary shares. The directors wish to pay an ordinary dividend for the year of 5 cents per share. What is
the companys total dividend for the year?
A
$8,500
$11,000
$5,000
$17,000
(2 marks)
20.16
20.17
20: ANSWERS
20.1
$20,000
5% (800,000 0.50)
20.2
20.3
END OF CHAPTER
20.18
Preparation of
financial statements for
companies
Recognise how the balance sheet equation and business entity convention underlie the balance sheet.
Understand the nature of reserves and report them in a company balance sheet.
Understand why the heading 'retained earnings' appears in a company balance sheet.
Calculate revenue, cost of sales, gross profit and net profit from given information and disclose items of income
and expenditure in the income statement.
Understand the inter-relationship between the balance sheet and income statement.
Identify items requiring separate disclosure on the face of the income statement.
Exam Context
Whilst you will not be required to produce an entire income statement, balance sheet or statement of changes in equity
you may be asked to calculate individual elements of each statement. A question on the Pilot Paper required you to
demonstrate understanding of what was included in the statement of changes in equity.
Qualification Context
The topics covered in this chapter are developed further in the Fundamentals level paper Financial Reporting (F7). Here
you will need to produce financial statements using the format specified by IAS 1. You will also learn how accounting
standards such as IFRS 5 affect the presentation of the financial statements if, for example, a company discontinues
part of its operations.
Business Context
Financial statements are used by a wide range of user groups to make decisions, for example whether or not to buy
shares in a company. Financial statements need to be prepared in a consistent way in order for users to be able to
compare different companies. The notes to the accounts will also provide a lot more detail on the headline figures shown
in the income statement and balance sheet.
21.1
Overview
Income statement
Balance sheet
Statement of
changes in equity
21.2
Introduction
1.1
As stated in Chapter 20 the financial statements of a limited liability company are subject to
regulation and must follow a prescribed format.
1.2
Much of the prescribed format is determined by IAS 1. This accounting standard states what
should be included in a set of financial statements and how they should be presented.
A complete set of financial statements in accordance with IAS 1 comprises:
(a)
a balance sheet
(b)
an income statement
(c)
(ii)
changes in equity other than those arising from transactions with equity holders
acting in their capacity as equity holders;
(d)
(e)
2.1
Revenue
Cost of sales
Gross profit
Other income
Distribution costs
Administrative expenses
Other expenses
Finance costs
Investment income
Profit before tax
Income tax expense
Profit for the period
21.3
X
X
X
Current assets
Inventories
Trade receivables
Other current assets
Cash and cash equivalents
X
X
X
X
X
X
Total assets
EQUITY AND LIABILITIES
Equity
Share capital
Share premium account
Revaluation reserve
Retained earnings
X
X
X
X
X
Non-current liabilities
Long term borrowings
Long term provisions
X
X
Current liabilities
Trade payables
Short term borrowings
Current tax payable
Short term provisions
Total equity and liabilities
X
X
X
X
X
21.4
Lecture example 1
Technique demonstration
The following balances have been extracted from the trial balance of Arrow, a limited liability
company, at 30 September 20X6.
$'000
12,740
1,500
200
1,000
45
835
7,200
800
1,800
4,400
1,200
50
2,060
450
550
500
1,250
Sales
Share capital 50c ordinary shares
Share premium account
Trade receivables
Bad debts written off
Bank balance
Purchases
Revaluation reserve
Office expenses
Property, plant and equipment
6% loan notes 20X9
Short term warranty provisions
Vehicle distribution costs
Inventories at 1 October 20X5
Trade payables
Administrative staff salaries
Retained earnings
The following information still needs to be accounted for:
(1)
During the year the company made a rights issue on a 1 for 6 basis. The issue was fully
subscribed and the rights price was $1.27.
(2)
(3)
(4)
(5)
(6)
The property, plant and equipment was valued at $5m and this amount needs to be
incorporated in the financial statements.
(7)
A dividend of $300,000 was paid in the year but this has not been accounted for.
Required
Prepare the income statement of Arrow for the year ended 30 September 20X6 and a balance
sheet as at that date.
21.5
Solution
Arrow
Income statement for the year ended 30 September 20X6
$'000
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Finance costs
Profit before tax
Income tax expense
Profit for the period
Arrow
Balance sheet as at 30 September 20X6
$'000
ASSETS
Non-current assets
Property, plant and equipment
Current assets
Inventories
Trade receivables
Cash and cash equivalents
Total assets
EQUITY AND LIABILITIES
EQUITY
Share capital
Share premium account
Revaluation reserve
Retained earnings
Non-current liabilities
Long term borrowings
Current liabilities
Trade payables
Other payables
Current tax payable
Short term provisions
Total equity and liabilities
21.6
21.7
2.4
Dividends
Issue of share capital
Balance at 31 March 20X7
X
X
X
X
Retained Total
earnings equity
$'000
$'000
X
(X)
X
X
(X)
X
X
(X)
X
X
(X)
X
X
(X)
(X)
X
X
21.8
$'000
X
(X)
X
X
X
Lecture example 2
Technique demonstration
From the trial balance in Lecture example 1, Arrow had the following equity balances at 1 October
20X5:
$'000
1,500
200
800
1,250
3,750
Using the information from Lecture example 1, produce a statement of changes in equity for Arrow
for the year ended 30 September 20X6.
Solution
Share
capital
$'000
Balance at 30 September 20X5
Gain on revaluation of property, plant and
equipment
Net income recognised directly in equity
Profit for the period
Total recognised income and expense
for the period
Dividends
Issue of share capital
Balance at 30 September 20X6
21.9
Share
premium
account
$'000
Revaluation
reserve
$'000
Retained
earnings
Total
equity
$'000
$'000
3.1
Machinery
At 31 March 20X7
Cost or valuation
Accumulated depreciation
Net book value
At 31 March 20X6
Cost or valuation
Accumulated depreciation
Net book value
3.2
Total
$
X
X
(X)
(X)
X
Office
equipment
$
X
X
(X)
(X)
X
X
(X)
X
X
(X)
X
X
(X)
X
X
(X)
X
X
(X)
X
X
(X)
X
X
(X)
X
X
(X)
X
$
X
X
X
(X)
(X)
X
X
(X)
X
At 31 March 20X6
Cost
Accumulated amortisation
Net book value
X
(X)
X
21.10
At 1 April 20X6
Increase in period
Released in period
At 31 March 20X7
3.4
3.5
3.6
Summary of Chapter 21
4.1
The financial statements produced by a company need to follow the format prescribed by
IAS 1.
4.2
The statement of changes in equity shows the movements on each of the accounts in the
equity section of the balance sheet in a separate statement.
21.11
21.12
21.13
21: QUESTIONS
21.1
21.2
(i)
(i), (iii)
(ii), (iii)
(2 marks)
Spend Co
The following balances remain in the books of Spend Co at 30 June 20X8 after the preparation of the
trading account.
$
Share capital
80,000 $1 ordinary shares
80,000
40,000 8% $1 preference shares
40,000
Share premium account
10,000
Revaluation reserve
30,000
Inventories at 30 June 20X8
83,852
Trade receivables and prepayments
27,200
Trade payables and accruals
13,722
Bank balance
7,796
10% debentures
16,000
General reserve
28,000
Irrecoverable debts
340
Gross profit for the period
81,508
Wages and salaries
28,200
Insurance
1,410
Postage and telephone
620
Light and heat
1,216
Debenture interest ( year to 31 December 20X7)
800
Directors fees
2,500
General expenses
3,108
Vehicles (cost $19,400)
6,800
Office furniture and equipment (cost $44,640)
27,440
Land and buildings at valuation
132,200
Retained earnings at 1 July 20X7
24,252
The following information is also available:
(1)
(2)
Office furniture and equipment is to be depreciated at 15% on cost, and vehicles at 20% on cost;
(3)
A bill for $348 in respect of electricity consumed up to 30 June 20X8 has not been entered in the
ledger;
(4)
The amount for insurance includes a premium of $300 paid in December 20X7 to cover the
company against fire loss for the year 1 January 20X8 to 31 December 20X8;
21.14
21: QUESTIONS
(5)
Directors fees
Audit fee
The outstanding debenture interest.
(6)
The directors made the following recommendations prior to the year end which have not yet been
adjusted for:
(i)
(ii)
Required
Prepare the income statement from the gross profit line downwards for the period ended 30 June 20X8
and a balance sheet as at that date (ignore income tax).
21.15
21: QUESTIONS
21.16
21.17
21: ANSWERS
21.1
21.2
Spend Co
Spend Co
Income statement for the period ended 30 June 20X8
$
Gross profit for the period
Less expenses:
Irrecoverable debts
Wages and salaries
Insurance (1,410 (300 x 6/12))
Postage and telephone
Light and heat (1,216 + 384)
Debenture interest (800 + 800)
Directors fees (2,500 + 5,000)
Audit fee
General expenses
Depreciation:
Office furniture and equipment
Vehicles
$
81,508
340
28,200
1,260
620
1,564
1,600
7,500
1,200
3,108
6,696
3,880
55,968
25,540
NON-CURRENT ASSETS
Land and buildings
Furniture and equipment
Motor vehicles
Cost or
Valuation
$
Acc.
Dep'n
$
NBV
150,000
44,640
19,400
214,040
23,896
16,480
40,376
150,000
20,744
2,920
173,664
CURRENT ASSETS
Inventories
Trade receivables and prepayments (27,200 + (300 6/12))
Cash and cash equivalents
EQUITY
Share capital
80,000 $1 ordinary shares
40,000 8% $1 preference shares
Share premium account
Revaluation reserve (30,000 + 17,800)
General reserve (28,000 + 12,000)
Retained earnings (Working)
83,852
27,350
7,796
118,998
292,662
80,000
40,000
10,000
47,800
40,000
34,592
252,392
NON-CURRENT LIABILITIES
10% debentures
16,000
CURRENT LIABILITIES
Trade payables and accruals (13,722 + 5,000 + 1,200 + 800 + 348)
Dividends payable
21.18
21,070
3,200
24,270
292,662
21: ANSWERS
Working
Retained earnings
Retained earnings at 1 July 20X7
Profit for the period
Dividends declared
8% preference dividend
Transfer to general reserve
Retained earnings at 30 June 20X8
$
24,252
25,540
(3,200)
(12,000)
34,592
21.19
21: ANSWERS
END OF CHAPTER
21.20
Define an event after the balance sheet date in accordance with International Financial Reporting Standards.
Distinguish between how adjusting and non-adjusting events are reported in the financial statements.
Exam Context
Questions on this topic are likely to require you to identify adjusting and non-adjusting events from a list of options and
the appropriate accounting treatment of each event. Both these types of questions were tested in the Pilot Paper.
Qualification Context
The knowledge in this chapter is tested again at the Professional level paper, Corporate Reporting (P2) where you will
be expected to consider how events after the balance sheet date may impact the way in which transactions are reported.
22.1
Overview
Definition
Adjusting events
Non-adjusting events
22.2
Definition
1.1
Events after the balance sheet date: events, both favourable and unfavourable, that occur
between the balance sheet date and the date when the financial statements are authorised
for issue.
1.2
There are two types of event after the balance sheet date.
2.1
Adjusting events
Non-adjusting events
(1)
(2)
(3)
(4)
Examples:
resolution of a court case
bankruptcy of a major customer
evidence of NRV of inventories
discovery of fraud or errors that show
the financial statements were incorrect
Examples:
(1) destruction of major asset, eg by
flood or fire
(2) major share transactions
(3) announcement of a plan to close part
of a business
Accounting treatment:
Accounting treatment:
(a)
Dividends proposed or declared after the balance sheet date but before the financial
statements are approved should be disclosed in a note to the financial statements.
(b)
22.3
Lecture example 1
Which of the following events after the balance sheet date would normally qualify as a nonadjusting event?
1
Confirmation of the amount of damages awarded to an employee who sued for unfair
dismissal after being sacked two months before the year end.
A
B
C
D
2 only
1 and 3
1, 3 and 4
2 and 4
Solution
Quick Quiz
Summary of Chapter 22
3.1
Events after the balance sheet date are events which occur between the balance sheet date
and the date the financial statements are approved for issue.
3.2
3.3
Adjusting events provide evidence of conditions that existed at the balance sheet date.
The financial statements should be changed to include this information.
3.4
Non-adjusting events relate to conditions which arose after the balance sheet date.
These should be disclosed as a note to the financial statements.
22.4
22.5
22: QUESTIONS
22.1
The following are examples of events which might occur between the balance sheet date and the date on
which the financial statements are authorised for issue:
(1)
(2)
(3)
Losses on inventories as a result of a catastrophe such as a fire or flood after the year end
The discovery of fraud which shows that the financial statements were incorrect
Revaluations of property which provide evidence of an impairment in value
22.2
(2 marks)
Robin Co has a year end of 31 December 20X8, the directors were informed on 27 February 20X9 that a
serious fire at one of the company's factories would stop production there for at least six months to come.
On 3 March 20X9 the directors of Robin Co were informed that a major customer had gone into
liquidation. The liquidator was pessimistic about the prospect of recovering anything for unsecured
creditors. The financial statements for the year ended 31 December 20X8 were approved on 20 March
20X9.
In accordance with IAS 10, Events after the balance sheet date, how should the two events be treated in
the financial statements?
Fire
22.3
Liquidation
Accounts adjusted
Disclosed in notes
Disclosed in notes
Disclosed in notes
Accounts adjusted
Accounts adjusted
Disclosed in notes
Accounts adjusted
(2 marks)
A Co has a year end of 31 December 20X7. During the preparation of the financial statements in March
20X8 the following issues arose:
(1)
Sales of a particular inventory line were poor during the second half of 20X7. The directors had
hoped that sales would pick up in 20X8 but it is now apparent that the inventory will need to be
marked down below their original cost in order to sell them.
(2)
On 12 February 20X8 one of the company's production plants was struck by lightening. The
company will suffer a net loss of $55,000 as a result of this.
(3)
Sporran Co is a valued customer which owed A Co $34,000 at the balance sheet date, although
they were behind with their payments. Since the year end sales to Sporran Co were $12,000. The
directors have just received notification that Sporran Co has gone into liquidation.
How should the above events be classified according to IAS 10 Events after the balance sheet date?
Adjusting
event
Non-adjusting
event
2,3
1, 2
1,3
1, 2, 3
(2 marks)
22.6
22.7
22: ANSWERS
22.1 D
22.2
(1)
(2)
(3)
The impairment is assumed to have taken place by the balance sheet date. We simply did
not find out until later.
The fire is a non-adjusting event as it does not affect the value of the building at 31 December
20X8. It is therefore only disclosed in a note to the financial statements unless it threatens the
company's going concern in which case it would become an adjusting event.
The customer is assumed to be insolvent at 31 December 20X8. We simply did not know this and
therefore it is an adjusting event and it should be adjusted for.
22.3
END OF CHAPTER
22.8
Differentiate between profit and cash flows and understand the need for management to control cash flow.
Recognise the benefits and drawbacks to users of the financial statements of a cash flow statement.
Classify the effect of transactions on cash flows and how they should be treated in a company's cash flow
statement.
Calculate the figures needed for the cash flow statement including cash flows from operating, investing and
financing activities.
Calculate the cash flow from operating activities using the direct and indirect method.
Exam Context
Questions on this chapter are likely to focus on whether you can identify which items should and should not go into the
cash flow statement and also on performing basic calculations. For example, you may be asked to calculate figures such
as the cash generated from operations from given information or the cash paid to acquire property, plant and equipment.
Qualification Context
The knowledge covered in this chapter is developed in the Fundamentals level paper Financial Reporting (F7) where
you will have to produce a cash flow statement in full. This is likely to involve more complex areas such as cash flows
related to non-current assets held on finance leases. You will also need to be able to interpret a cash flow. Group cash
flows are examined in the Professional level paper Corporate Reporting (P2).
Business Context
The ability to generate cash is key to the survival of an entity. Whilst directors may use cash budgets to estimate future
cash flows, the cash flow statement shows an historic record of how cash has been generated and where it was spent.
Cash is not subject to manipulation through an entity's choice of accounting policies. It is therefore a reliable measure of
performance that is relevant to users of the financial statements.
23.1
Overview
Cash
Cash equivalents
Cash flows
Cash flow
statements
IAS 7
Indirect method
Direct method
23.2
Purpose
1.1
2.1
Definitions
2.2
(a)
Cash
(b)
Cash equivalents
cash on hand
demand deposits
eg current asset
investments (shares)
(c)
Cash flows
23.3
XYZ CO
Cash flow statement for the year ended 31 December 20X7 (indirect method)
$000
Cash flows from operating activities
Profit before taxation
Adjustment for:
Depreciation
Investment income
Interest expense
Increase in trade and other receivables
Decrease in inventories
Decrease in trade payables
Cash generated from operations
Interest paid
Income taxes paid
3,390
450
(500)
400
3,740
(500)
1,050
(1,740)
2,550
(270)
(900)
1,380
(900)
20
200
200
$000
(480)
250
250
(1,290)
(790)
110
120
230
23.4
3.1
Section 1.7.1
(a)
The direct method, whereby major classes of gross cash receipts and payments are
disclosed (preferred method per IAS 7 see Section 6.1), or
(b)
The indirect method (as above), whereby reported profit or loss is adjusted for the
effects of transactions of a non cash nature, any accruals or prepayments of
operating expenses, and items relating to investing or financing cash flows.
Income taxes paid may need to be calculated from other data given to you. This is best
achieved by putting the relevant figures into a 'T' account working.
Lecture example 1
Preparation question
In the balance sheets of Tacks Co as at 31 December 20X9 and 31 December 20X8 were the
following amounts for income tax payable.
31 December
20X9
20X8
$
$
156,000
168,000
Workings
Income tax payable
$'000
23.5
$'000
Section 1.7.2
4.1
The cash flows included in this section are those related to the acquisition or disposal of any
non-current assets or investments together with returns received in cash from investments,
i.e. dividends and interest. This section shows the extent to which expenditures have been
made for resources intended to generate future income and cash flows.
Lecture example 2
Preparation question
On 31 December 20X8 the value of plant and equipment in the books of Erosion Co was as
follows:
$
200,000
80,000
120,000
On 1 January 20X9 an item of plant was sold for $8,000 which had originally cost $20,000 when
new, but had a net book value of $11,000 at the time of sale. (The balance sheet values shown
above do not show that this sale has taken place.)
On 31 December 20X9 the value of plant and equipment in the balance sheet was:
Plant and equipment at cost
Accumulated depreciation
Plant and equipment at net book value
$
280,000
111,000
169,000
Required
Show the relevant entries for property, plant and equipment which would appear in a cash flow
statement for Erosion Co in 20X9.
Solution
Workings
Plant & equipment cost
$'000
$'000
Accumulated depreciation
$'000
$'000
23.6
5.1
Financing cash flows comprise receipts from or repayments to external providers of finance
in respect of principal amounts of finance. Examples of financing cash flows are:
Section 1.7.3
Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other
short or long term borrowings
In order to calculate such figures the closing balance sheet figure for debt or share capital
and share premium is compared with the opening position for the same items.
Dividends paid
5.2
The cash outflows included in dividends paid are dividends paid on the reporting company's
equity shares.
Lecture example 3
Preparation question
Distribution Co balance sheet extract for the year ended 31 December 20X9
20X9
$'000
45
Dividends payable
20X8
$'000
35
Workings
Dividends payable
$'000
23.7
$'000
Lecture example 4
Technique question
The summarised accounts of the Emma Co for the year ended 31 December 20X8 are as follows:
Balance sheets as at 31 December
Non-current assets
Property, plant and equipment
Current assets:
Inventories
Trade receivables
Cash
Equity
Share capital ($1 ordinary shares)
Share premium account
Revaluation reserve
Retained earnings
Non-current liabilities
10% debentures
Current liabilities
Trade payables
Income tax payable
Dividends payable
Overdraft
20X8
$'000
20X7
$'000
628
514
214
168
7
389
1,017
210
147
357
871
250
70
110
314
744
200
60
100
282
642
80
50
136
39
18
193
1,017
121
28
16
14
179
871
23.8
$'000
600
319
281
186
8
87
31
56
You are additionally informed that there have been no disposals of property, plant and equipment
during the year. The new debentures were issued on 1 January 20X8.
Required
Produce a cash flow statement for Emma Co for the year ended 31 December 20X8.
Solution
EMMA CO
Cash flow statement for the year ended 31 December 20X8
$000
Cash flows from operating activities
Profit before taxation
Adjustments for:
Depreciation
Interest expense
Increase in trade receivables
Increase in inventories
Increase in trade payables
Cash generated from operations
Interest paid
Income taxes paid
Net cash from operating activities
Cash flows from investing activities
Purchase of property, plant and equipment
Net cash used in investing activities
Cash flows from financing activities
Proceeds from issue of shares
Proceeds from issue of debentures
Dividends paid
Net cash from financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
23.9
$000
23.10
6.1
As noted in Section 3.1, IAS 7 has two methods available under which the cash flow
statement can be prepared:
6.2
The only difference is the direct method derives the 'cash generated from operations' figure
in a different way. The operating element of the cash flow statement should be shown as
follows:
$000
Cash flows from operating activities
Cash receipts from customers
Cash payments to suppliers and employees
Cash generated from operations
Interest paid
Income taxes paid
Net cash from operating activities
$000
30,150
(27,600)
2,550
(270)
(900)
1,380
This represents cash flows received during the accounting period in respect of sales.
This represents cash flows made during the accounting period in respect of goods and
services and amounts paid to employees.
23.11
Lecture example 5
Technique question
Required
Using the information in Lecture example 4 produce the 'cash flows from operating activities'
section of the cash flow statement using the direct method.
Solution
EMMA CO
Cash flow statement for year ended 31 December 20X8 (extract)
$
Cash flows from operating activities
Cash receipts from customers
Cash payments to suppliers and employees
Cash generated from operations
Interest paid
Income taxes paid
Net cash used in operating activities
23.12
Quick Quiz
Summary of Chapter 23
7.1
The cash flow statement shows the movement between a companys cash and cash
equivalents at the beginning and the end of the year.
7.2
Cash comprises cash on hand and on demand deposits. Cash equivalents are short term,
highly liquid investments such as shares held as a current asset investment.
7.3
The cash flow categorises cash flows under one of three headings: cash flows from
operating activities; cash flows from investing activities and cash flows from financing
activities.
23.13
23.14
23.15
23: QUESTIONS
23.1
In a cash flow statement which of the items below would not appear as an outflow of cash?
A
(1 mark)
20X6
$
1,230,000
465,000
90,000
750,000
380,000
105,000
The building element of the freehold property was depreciated by $6,000 and then revalued on 30 June 20X7 by
$95,000. Plant and equipment, which had cost $49,000 when purchased in January 20X2 on which $35,000 of
depreciation had been charged, was disposed of in November 20X6 for $8,000. Depreciation on the plant and
equipment for the year amounted to $37,000. Depreciation of $55,000 has been charged on furniture and
fixtures.
23.2
What is the total figure to be adjusted for in cash flows from operating activities in respect of property,
plant and equipment? $
(2 marks)
23.3
What is the total expenditure on property, plant and equipment included under cash flows from investing
activities? $
(2 marks)
23.4
In a cash flow statement, a decrease in loan stock would be shown as a cash inflow under 'cash flows
from financing activities'.
23.5
True
False
(1 mark)
These extracts have been taken from the accounts of Jeanne Co.
Balance sheet (extracts)
Current liabilities
Dividends payable
31 October
20X7
31 October
20X6
9,750
5,750
$5,750
$11,500
$15,500
$21,250
(2 marks)
23.16
23: QUESTIONS
23.6
Jane Co
Income statement for the year ended 31 December 20X2
$000
2,553
1,814
739
125
264
25
75
300
140
160
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Investment income
Finance costs
Profit before tax
Income tax expense
Profit for the period
Balance sheet as at 31 December
Non-current assets
Property, plant and equipment
Development expenditure
Investments
Current assets
Inventories
Trade receivables
Short-term investments
Cash in hand
Total assets
Equity
Share capital ($1 ordinary shares)
Share premium account
Revaluation reserve
Retained earnings
Non-current liabilities
Long term loan
Current liabilities
Trade payables
Bank overdraft
Income tax payable
Dividends payable
20X7
$000
20X6
$000
380
250
630
305
200
25
530
150
390
50
2
592
1,222
102
315
1
418
948
200
160
100
160
620
150
150
91
100
491
100
127
85
190
100
502
1,222
23.17
119
98
160
80
457
948
23: QUESTIONS
(b)
Furniture and fixtures, with an original cost of $85,000 and a net book value of $45,000, were sold
for $32,000 during the year;
(c)
The current asset investments fall within the definition of cash equivalents under IAS 7;
(d)
Cost
Accumulated depreciation
Net book value
(e)
50,000 $1 ordinary shares were issued during the year at a premium of 20c per share;
(f)
(g)
Required
Prepare a cash flow statement for the year to 31 December 20X7.
23.18
20X6
$000
595
290
305
23.19
23: ANSWERS
23.1
Income tax paid is a cash flow not the income statement tax charge.
23.2 $104,000
Property, plant and equipment
Bal b/d
Freehold property
Plant & Equipment
Furniture & Fixtures
$000
750
380
105
95
567
1,897
$000
Disposal Plant & Equipment
(49 35)
Depreciation
Freehold property
6
Plant & Equipment
37
Furniture & Fixtures
55
Bal c/d Freehold property
Plant & Equipment
Furniture & Fixtures
14
98
1,230
465
90
1,897
$000
98
6
104
$567,000
See previous calculation
23.4
23.5 B
Dividends payable
$
Balance b/d
Paid
11,500
Balance c/d
9,750
21,250
Retained earnings
$
5,750
15,500
21,250
23.20
23: ANSWERS
23.6
Jane Co
Cash flow statement for the year ended 31 December 20X7
$000
$000
300
90
13
(5)
(25)
75
448
(75)
(48)
8
333
25
(75)
(110)
173
(201)
32
30
(50)
(189)
60
100
(80)
80
64
(97)
(33)
Workings
(W1)
Property, plant and equipment cost
Balance b/d
Revaluation (100 91)
Additions (bal fig)
$000
595
9
201
805
Disposals
Balance c/d
$000
85
720
805
(W2)
Property, plant and equipment - Accumulated depreciation
Disposals (85 45)
Balance c/d
$000
40
340
380
23.21
Balance b/d
Depreciation charge
$000
290
90
380
23: ANSWERS
(W3)
Development expenditure
Balance b/d
additions
$000
200
50
250
$000
Balance c/d
250
250
(W4)
Income tax payable
Income tax paid
Balance c/d
$000
110
190
300
Balance b/d
Income statement
$000
160
140
300
(W5)
Dividends payable
Dividends paid
Balance c/d
$000
80
100
180
Balance b/d
Retained earnings
END OF CHAPTER
23.22
$000
80
100
180
Understanding the basic function and form of accounting records in manual and computerised systems.
Compare manual and computerised systems and identify advantages and disadvantages of computerised
accounting systems.
Understand business use of computers and the nature and purpose of spreadsheets and database systems.
Exam Context
Questions on this topic are likely to focus on the advantages and disadvantages of using a computerised system and the
differences between a manual and a computerised system.
Qualification Context
The importance of accounting systems and internal controls is tested in the Fundamentals level paper, Accountant in
Business (F1).
24.1
Overview
Integrated software
Computerised accounting
packages
Accounting modules
Information
technology
Databases
Spreadsheets
24.2
Introduction
1.1
In today's world most businesses use accounting systems which are computerised, although
some smaller businesses may keep manual records.
1.2
The same principles of double entry are used regardless of whether an accounting system is
manual or computerised.
Accounting packages
2.1
2.2
(a)
(b)
General software, for example spreadsheets which can be used to keep accounting
records.
Disadvantages
Accounting modules
Definition
3.1
Accounting module a program which deals with one part of a business' accounting
system
3.2
Invoicing
Receivables ledger
Nominal ledger
Payroll
Cash book
Non-current asset register
24.3
Integrated software
3.3
Each module may be integrated with other modules so that when information is recorded in
one module it is automatically updated in another module.
Examples:
Section 1.5
3.4
(a)
The payroll module may be integrated with the nominal ledger module so that once
the payroll information is determined the associated wages expense is updated in the
nominal ledger.
(b)
The invoicing module may be integrated with the inventory, receivables ledger and
nominal ledger modules so that once an invoice is sent the inventory levels are
updated as is the customer's account in the receivables ledger.
Disadvantages
(1)
(1)
(2)
(2)
(3)
(3)
Databases
Definition
4.1
4.2
Examples:
(a)
(b)
(c)
24.4
Lecture example 1
Idea generation
What sort of information might be contained in a database file for a non-current asset register?
Solution
4.3
It should be shared
(d)
The database must be able to grow and develop according to the needs of the business
Spreadsheets
5.1
Spreadsheets are essentially an electronic piece of paper. They are used in all parts of a
business, predominantly to perform numerical calculations.
5.2
24.5
Quick Quiz
Summary of Chapter 24
6.1
There are two main types of accounting packages: dedicated packages and general
software.
6.2
An accounting module is a program which deals with one part of a business accounting
system. These modules may or may not be integrated with other modules.
6.3
Databases and spreadsheets are electronic ways of holding and manipulating information.
24.6
24.7
24: QUESTIONS
24.1
All businesses will apply the same principles of double entry bookkeeping regardless of whether they
operate a manual or a computerised system.
Is this statement true or false?
24.2
True
False
(1 mark)
If a database is to contain accurate and valid information it should only be amended by authorised
personnel.
Is this statement true or false?
A
True
False
(1 mark)
24.8
24.9
24: ANSWERS
24.1
24.2
END OF CHAPTER
24.10
Answers to
Lecture Examples
25.1
Chapter 1
Answer to Lecture Example 1
Users of financial information
(a)
Investors
(b)
Employees
(c)
(g)
Customers
(f)
Suppliers
(e)
Profitability
Long-term growth
Security of their job
Likelihood of bonus
Number of employees
Ability to pay retirement benefits
Lenders
(d)
Profitability
Future prospects
Likely risk and return
Chance of capital growth
Ability to pay dividends
Statistics
Size of company
Growth rates
Average payment periods
Foreign trade
Profits made
Corporate income tax liability
Sales tax liability
Public
25.2
Chapter 2
Answer to Lecture Example 1
A
The IASCF appoints members to the IASB, IFRIC and SAC. The SAC advises the IASB on its
agenda.
Chapter 3
Answer to Lecture Example 1
Advantages of historic cost
(1)
The transaction cost of $1 million is a very reliable figure which was quantified at the date of
acquisition.
(2)
Using current market values for the building may lead to volatility in asset values due to changing
market prices.
(3)
Any change in the asset's value will affect the amount of depreciation charged and therefore the
entity's profits. This makes comparability more difficult.
Asset values generally appreciate over time and so using historic cost will mean that the financial
statements contain information which is out of date and therefore less useful for decision making.
(2)
Sales revenue and costs will be shown at current prices but depreciation will be based on historic
cost and therefore too low a figure. Profits will therefore look artificially high.
(b)
Show inventory at the lower of cost and net realisable value = $900.
25.3
Chapter 4
Answer to Lecture Example 1
Own
Examples:
(i)
(ii)
(iii)
House
Car
Cash
Owe
Examples:
(i)
(ii)
(iii)
Mortgage
Car loan
Credit card
Chapter 5
Answer to Lecture Example 1
Transaction
Debit
Credit
(a)
Cash
increase asset
Sales
income
(b)
Sales on credit
Receivables
increase asset
Sales
income
(c)
Purchases
expense
Cash
decrease asset
(d)
Purchases on credit
Purchases
expense
Payables
increase liability
(e)
Electricity
expense
Cash
decrease asset
(f)
Cash
increase assets
Receivables
decrease assets
(g)
Payables
decrease liability
Cash
decrease asset
(h)
Cash
increase asset
Loan
increase liability
25.4
Capital
Sales
Rent
Electricity
Car
Drawings
$
500
200
1,000
300
Capital
$
Cash
Trade payables
$
Purchases
Trade payables
Purchases
$
2,000
$
5,000
$
2,000
$
Rent
Cash
$
500
Cash
Electricity
$
200
Car
$
1,000
Cash
Drawings
$
300
Cash
Trade receivables
$
1,750
Sales
Sales
$
Trade receivables
Cash
$
1,750
2,100
Sales
Sales
$
500
500
1,000
Bal b/d
650
25.5
Cash
1/1 Purchases
25/1 Telephone
Bal c/d
$
300
50
650
1,000
Cr
$
5,000
2,100
Rent
Electricity
Car
Drawings
Bal c/d
7,100
Bal b/d
$
500
200
1,000
300
5,100
7,100
5,100
Capital
Bal c/d
$
5,000
5,000
Cash
Bal b/d
Bal c/d
Trade payables
$
2,000
Purchases
2,000
$
5,000
5,000
5,000
$
2,000
2,000
Bal b/d
2,000
Trade Payables
Purchases
$
2,000
Bal c/d
$
2,000
Bal b/d
2,000
Rent
Cash
$
500
Bal b/d
500
Bal c/d
$
500
Electricity
Cash
$
200
Bal b/d
200
Bal c/d
$
200
Car
Cash
$
1,000
Bal c/d
$
1,000
Bal b/d
1,000
Cash
Drawings
$
300
Bal c/d
$
300
Bal b/d
300
Sales
Trade receivables
$
1,750
Bal c/d
Bal b/d
1,750
25.6
$
1,750
Sales
Bal c/d
$
3,850
Trade receivables
Cash
$
1,750
2,100
3,850
Bal b/d
3,850
3,850
Chapter 6
Answer to Lecture Example 1
Trial Balance
Debit
$
5,100
Cash
Capital
Trade payables
Purchases
Rent
Electricity
Car
Drawings
Trade receivables
Sales
2,000
500
200
1,000
300
1,750
10,850
Credit
$
5,000
2,000
3,850
10,850
Creditors
Purchases
$
2,000
Bal c/d
$
2,000
Bal b/d
2,000
2,000
Income statement
Rent
Cash
$
500
Bal c/d
$
500
Bal b/d
500
Income statement
500
Electricity
Cash
$
200
Bal c/d
$
200
Bal b/d
200
Income statement
200
Bal c/d
$
3,850
Sales
3,850
Income statement
3,850
25.7
Trade receivables
Cash
$
1,750
2,100
3,850
Bal b/d
3,850
$
600
1,000
(600)
400
200
Gross profit
Income Statement
$
2,000
Sales
2,100
Closing inventory
4,100
500
Gross profit b/d
200
1,400
2,100
$
3,850
250
4,100
2,100
2,100
1,400
DOUGLAS
INCOME STATEMENT FOR THE MONTH OF JANUARY
$
Sales
Less cost of sales:
Purchases
Less: closing inventories
$
3,850
2,000
( 250)
1,750
Gross profit
2,100
Less expenses:
Rent
Electricity
500
200
(700)
1,400
Net profit
25.8
DOUGLAS
BALANCE SHEET AS AT 31 JANUARY
NON-CURRENT ASSET
Motor vehicle
CURRENT ASSETS
Inventories
Trade receivables
Cash
250
1,750
5,100
PROPRIETORS INTEREST
Capital introduced on 1 January
Profit for the year
Less: drawings
Balance 31 January
$
5,000
1,400
300
$
1,000
7,100
8,100
$
6,100
CURRENT LIABILITIES
Trade payables
2,000
8,100
Drawings
$
300
Bal c/d
300
Capital
Capital
Income statement
$
2,000
Sales
2,100
Closing inventory
4,100
500
Gross profit b/d
200
1,400
2,100
1,400
Net profit b/d
Balance c/d
$
5,000
Purchases
Gross profit c/d
Rent
Electricity
Net profit c/d
$
300
300
$
3,850
250
4,100
2,100
2,100
1,400
Capital
Drawings
Balance c/d
300
6,100
6,400
25.9
Cash
$
5,000
Balance b/d
Net profit
5,000
1,400
6,400
Balance b/d
6,100
Chapter 7
Answer to Exercise
(1)
Net
$
100
(2)
250
Sales tax
$
15.00
Gross
$
115.00
287.50
37.50
22.50 Due to sales tax authority
Trade payables
$
Trade payables 1,000
Purchases
Trade receivables
$
1,725
Sales
$
1,150
Trade payables
$
150
Trade rec.
$
225
Sales
$
Trade rec.
$
1,500
Chapter 8
Answer to Lecture Example 1
C
Transport costs to deliver goods to customers are an example of carriage outwards and should
not be included. Administrative overheads do not relate to production and cannot therefore be
included.
The depreciation of the factory machine is a production overhead and should be included.
25.10
(200)
10 Jan
20 Jan
25 Jan
300
350
250
(180)
(80)
Nil
250
@ $11.50
= $1,035
@ $13.00
= $3,250
(80)
(220)
Nil
Nil
$4,285
Cost of sales (FIFO)
$
2,000
10,530
12,530
(4,285)
8,245
b/f
200
10.1.X2
Purchase
300
500
14.1.X2
Sale
(280)
220
20.1.X2
Purchase
350
570
21.1.X2
Sale
(400)
170
25.1.X2
Purchase
250
420
28.1.X2
Sale
(80)
340
(W1)
$5,255
500
= $10.51
(W2)
Average
Unit Cost
$
Cost
$
10.00
10.85
(W1) 10.51
10.51
11.50
(W2) 11.12
11.12
13.00
(W3) 12.24
12.24
$6,337
570
25.11
= $11.12
(W3)
Total
Cost
$
2,000
Cost of
Sales
$
3,255
5,255
(2,943)
2,312
2,943
4,025
6,337
(4,448)
1,889
4,448
3,250
5,139
(979)
4,160
$5,139
420
= $12.24
979
8,370
Chapter 9
Answer to Lecture Example 1
Examples include:
(a)
(b)
(c)
(d)
The cost capitalised should include the purchase price ($20,000) plus all directly attributable costs
(delivery and installation).
The cost of the maintenance contract should be shown as an expense in the income statement.
(b)
Depreciation charge
$2,500 - $250
3 years
Year
Cost
1
2
3
$
2,500
2,500
2,500
Accumulated
depreciation
$
750
1,500
2,250
NBV
$
1,750
1,000
250
Year 1
Year 2
Year 3
NBV b/d
Depn
rate
(6,000 0)
(6,000 2,400)
(6,000 3,840)
40%
40%
40%
Depn
expense
$
2,400
1,440
864
Accumulated
depreciation
$
2,400
3,840
4,704
NBV c/d
$
3,600
2,160
1,296
Journal entry
Debit
$
750
Depreciation expense
Accumulated depreciation
Credit
$
750
25.12
(b)
2,500
2,500
2,500
Bal b/d
Bal c/d
2,500
2,500
Year 1
Accumulated depn
750
Year 1
I/S
750
Year 2
Accumulated depn
750
Year 2
I/S
750
Year 3
Accumulated depn
750
Year 3
I/S
750
Bal c/d
750
Year 1
Depreciation expense
750
Bal c/d
1,500
Year 2
Bal b/d
Depreciation expense
750
750
1,500
Year 3
Bal b/d
Depreciation expense
1,500
750
2,250
1,500
Bal c/d
2,250
2,250
(c)
Year 1
$
Year 2
$
Year 3
$
750
750
750
$
2,500
2,500
2,500
Machine
Machine
Machine
25.13
Accumulated
Depreciation
$
(750)
(1,500)
(2,250)
Net Book
Value
$
1,750
1,000
250
$
3,000
(2,160)
840
Sales proceeds
NBV at end of year 2
(b)
Machine (B/S)
$
6,000
Bal b/d
(a)
Disposal account
$
6,000
Disposal account
3,840
$
Bal b/d
3,840
Disposal account
(a)
Machine
Balance = profit
on disposal (I/S)
$
6,000
(c)
Cash
(b)
Accumulated depn
$
3,000
840
6,840
3,840
6,840
The profit on disposal is still $840, the only difference is that the proceeds were not received in
cash, but in the form of a part exchange allowance.
(b)
$
6,000
(a)
Disposal account
$
6,000
Disposal account
$
3,840
Bal b/d
$
3,840
$
3,000
7,000
10,000
10,000
25.14
Bal c/d
$
10,000
10,000
Disposal account
(a) Machine
Profit on disposal (I/S)
$
6,000
840
6,840
(c)
(b)
$
3,000
3,840
6,840
$
50,000
20,000
$
70,000
Building (B/S)
$
Bal b/d
$
100,000
50,000
150,000
150,000
Revaluation reserve
Bal b/d
Revaluation reserve
Bal c/d
150,000
150,000
$
20,000
(b)
Building
Accumulated depreciation
70,000
70,000
Depreciation charge is
Bal b/d
$
50,000
20,000
70,000
70,000
$150,000
= $3,750
40 years
Depreciation
charge
$
8,000
Accumulated
depreciation
$
8,000
NBV
$
32,000
20X1
40,000
5
20X2
40,000
5
8,000
16,000
24,000
20X3
24,000
2
12,000
28,000
12,000
20X4
24,000
2
12,000
40,000
40,000
25.15
40,000 25%
30,000 25%
22,500 - 1,500
3
20X1
20X2
20X3
20X4
20X5
Accumulated
depreciation
$
10,000
17,500
24,500
7,000
7,000
38,500
31,500
38,500
NBV
$
30,000
22,500
15,500
8,500
1,500
Chapter 10
Answer to Lecture Example 1
(1)
Market research would take place at an early stage in any development process. Its purpose is to
gather information about whether there may be interest in a potential product. At this point in time
an entity cannot be certain that the expenditure will lead to profits and so the costs are research
costs. $20,000 should be shown as an expense in the income statement.
(2)
A machine is a tangible non-current asset and is accounted for under IAS 16 regardless of its use.
The $100,000 should be capitalised as a tangible non-current asset and depreciated over its
useful life of 10 years.
(3)
Material costs and design and manufacture salaries are part of the development process. They
should be capitalised as an intangible non-current asset provided that all of the 'PIRATE' criteria
are met.
The costs should be amortised in 20X9 once the car is available to be sold on the market.
X1
$
35,000
X2
$
X3
$
X4
$
X5
$
38,000
40,000
40,000
40,000
X3
$
120,000
(40,000)
80,000
X4
$
120,000
(80,000)
40,000
X5
$
120,000
(120,000)
X1
$
55,000
55,000
X2
$
120,000
120,000
25.16
Chapter 11
Answer to Lecture Example 1
(a)
$
Electricity expense
Cash paid:
10.3.X7
12.6.X7
14.9.X7
10.12.X7
96
120
104
145
465
56
521
$
Rent expense
Cash paid:
1.2.X7
6.4.X7
375
1,584
1,959
(396)
1,563
$
56
$
396
56
396
Cash
Cash
Cash
Cash
Accruals
$
96
120
104
145
56
521
25.17
31.12.X7
Transfer to income
statement
521
521
$
375
1,584
Cash
Cash
$
31.12.X7
31.12.X7
Transfer to income
statement
Prepayments
1,563
396
1,959
1,959
Accruals (B/S)
31.12.X7
$
56
56
Bal c/d
31.12.X7
Electricity
1.1.X8
Bal b/d
$
56
56
56
Prepayments (B/S)
31.12.X7
Rent
$
396
Bal b/d
396
396
$
31.12.X7
1.1.X8
Bal c/d
396
396
$
168
134
118
158
63
Cash
Cash
Cash
Cash
Accrual ( 13 $189)
1.1.X8
31.12.X8
$
56
585
Accrual reversed
To Income statement
641
641
Accruals (B/S)
1.1.X8
31.12.X8
$
56
63
119
Accrual reversed
Bal c/d
1.1.X8
31.12.X8
1.1.X9
$
56
63
119
63
Bal b/d
Electricity accrual (W)
Bal b/d
Insurance expense
July X6 August X6 ( 212 $24,000)
4,000
25,000
29,000
Prepayment
1 June X7 paid (
Less: June X7 (
7,500
1 $30,000)
4
1 $7,500)
3
(2,500)
5,000
25.18
Chapter 12
Answer to Lecture Example 1
(a)
(b)
The balance c/d on the trade receivables account at the end of the year is $50,000.
The bad debt expense shown in the I/S is $15,000
Workings
Trade receivables (B/S)
31.12.X7
$
65,000
Bal b/d
65,000
$
31.12.X7
31.12.X7
15,000
50,000
65,000
$
31.12.X7
Trade receivables
15,000
31.12.X7
To I/S
15,000
Working
Allowance for receivables (B/S)
$
Bal c/d
3,500
$
Doubtful debts expense
3,500
$
Allowance for receivables
3,500
3,500
Expenses
Bad debts (see Lecture Example 1)
Doubtful debts expense
(15,000)
(3,500)
I/S
$
50,000
(3,500)
46,500
25.19
Bal b/d
47,440
Bal b/d
$
340
47,100
47,100
47,100
Allowance for receivables (B/S)
Bal c/d
Specific
General (W)
$
400
934
1,334
1,334
$
1,334
1,334
Bal b/d
1,334
$
340
1,334
1,674
$
I/S
1,674
1,674
Working
(W)
General allowance:
$
47,100
(400)
46,700 2%
= $934
50,000
$
I/S
7,000
25.20
Cash
7,000
Cash (B/S)
$
Bad debt expense
7,000
$
50,000
(a)
$
3,500
46,500
50,000
Cash
Bal c/d
50,000
Allowance for receivables (B/S)
$
(b)
3,500
$
Bal b/d
3,500
$
I/S
3,500
(b)
3,500
3,500
$
3,500
$
1,000
1,500
2,500
25.21
$
1,000
$
1,500
(a)
$
1,000
500
1,500
1,500
Short method
Allowance for receivables (B/S)
$
31.3.X8
Bal c/d
($30,000 5%)
31.3.X7
1,500
Bal b/d
($20,000 5%)
1,000
1,500
500
1,500
500
$
I/S
500
$13,000
Allowance for
receivables
$
(1)
(2)
(3)
24,000
21,000
3,000
Income
statement
$
(2,000)
18,000
(3,000)
13,000
Chapter 13
Answer to Lecture Example 1
(a)
(b)
$0.5m
$0.5m
In 20X8 the provision needs to increase by $0.25m ($0.75m $0.5m). Entry is:
Dr
Cr
$0.25m
$0.25m
25.22
(c)
Provisions (B/S)
Warranty cost expense (I/S)
$0.45m
$0.45m
Chapter 14
Answer to Lecture Example 1
(1)
Customer
Customer A
Customer B
Amount
150
200
350
Supplier
Supplier Y
Supplier Z
Amount
100
1,300
1,400
Narrative
Customer B
Total
200
Sales
200
Receivables
200
200
Narrative
Supplier Y
Total
100
Purchases
100
Payables
100
100
Memorandum ledgers
Receivables ledger
Bal b/d
Customer A
$
150
Bal c/d
150
150
10.1.X6
Customer B
$
200
21.1.X6 Payment received
$
200
200
200
10.1.X6
Sales
Sales
25.23
$
150
150
Payables ledger
21.1.X6
Payment made
Bal c/d
Supplier Y
$
100
15.1.X6 Purchases
$
100
100
100
Supplier Z
$
1,300
15.1.X6 Purchases
$
1,300
1,300
1,300
10.1.X6 Sales
Bal b/d
PLCA (B/S)
$
100
15.1.X6 Purchases
1,300
1,400
Bal b/d
21.1.X6 Bank
Bal c/d
Bal b/d
$
Sales (I/S)
10.1.X6
RLCA
(4)
$
1,400
1,400
1,300
Bank (B/S)
$
200
21.1.X6 PLCA
Bal c/d
200
100
21.1.X6 RLCA
I/S
$
200
150
350
350
350
$
350
350
15.1.X6
PLCA
$
100
100
200
Purchases (I/S)
$
1,400
1,400
I/S
$
1,400
1,400
Reconciliation
Balance per list of balances
Receivables ledger
Customer A
Customer B
150
150
150
Payables ledger
Supplier Y
Supplier Z
1,300
1,300
1,300
25.24
RLCA (B/S)
$
10,000
$
1.1.X7 Sales 10,000
(b)
Bank (B/S)
4.1.X7 RLCA
$
9,000
RLCA (B/S)
$
$
1.1.X7 Sales 10,000
$
4.1.X7 Bank 9,000
Discounts 1,000
allowed
10,000
10,000
$
1,000
(c)
Bank
$
4.1.X7 RLCA 10,000
RLCA (B/S)
$
$
1.1.X7 Sales 10,000
$
4.1.X7 Bank 10,000
10,000
10,000
$
5,000
PLCA (B/S)
$
$
Purchases
$
5,000
(b)
Bank
$
Bank
PLCA (B/S)
$
4,750
Bank
Discounts
received
$
4,750
$
5,000
250
5,000
25.25
Purchases
5,000
$
250
(c)
Bank
$
PLCA (B/S)
$
PLCA
5,000
$
Bank
5,000
5,000
Purchases
$
50,000
(6,000)
44,000
(1,760)
42,240
List price
Less: trade discount (12%)
Record purchase at this value
Less: settlement discount (4%)
Calculate sales tax on this value
Sales tax at 15%
$50,336
6,336
(b)
RLCA
$
614,000
Bank
302,600
Discounts allowed
Contras (PLCA)
Bad debts
Bal c/d
916,600
$
311,000
3,400
8,650
32,000
561,550
916,600
Reconciliation
RLCA
$
561,550
3,600
565,150
25.26
Bal c/d
565,150
565,150
$
563,900
(900)
2,150
1,250
565,150
Chapter 15
Answer to Lecture Example 1
Adjustment of cash book balance
Cash account
$
204
Standing order (3i)
18
Bank charges (3iii)
Balance c/d
222
Balance b/d
Bank interest (3ii)
$
35
14
173
222
(1) is a bank error, (4) is an outstanding cheque (2), (3) and (5) have all been processed correctly
by the bank but need recording in the cash book.
Chapter 16
Answer to Lecture Example 1
(a)
Journal entries
(1)
Dr
$
350
350
(2)
Discounts allowed
Trade receivables
500
(3)
Trade receivables
Cash at bank
2,620
(4)
Suspense account
Cash at bank
1,900
1,460
(5)
(6)
Brought forward
(102,800 85,240)
Cash at bank (4)
500
2,620
1,900
1,460
Capital
Suspense account
(b)
Cr
$
18,000
18,000
Suspense account
$
17,560
1,900
19,460
25.27
$
1,460
18,000
19,460
Draft profit
Adjustments
Rent (1)
Discounts allowed (2)
Stationery (5)
Total adjustments
Revised profit
Decreases
$
$
12,300
350
500
1,460
(2,310)
9,990
Increases
$
Draft profit
Adjustments:
(1) sales returns (2 $2,700)
(2) depreciation (W)
Decreases
$
5,400
1,250
6,650
Adjusted profit
(W )
$
112,400
(6,650)
105,750
Chapter 17
Answer to Lecture Example 1
(a)
(1)
Dr
Cr
Inventories (B/S)
Closing inventories (I/S)
Dr
$
647
Cr
$
$
120
647
120
25.28
(3)
Dr
Cr
$
601
$
435
166
$
37
$
37
$
360
Bank (2 $180)
Suspense account
$
360
$
63
Drawings
Purchases
$
63
Being: adjustment for goods drawn from business (removed at cost value)
(7)
Dr
Cr
$
100
$
100
$
90
$
90
$
73
$
73
$
433
433
25.29
$
(5) Bank
(8) Discounts allowed
360
73
433
(c)
Mugg
Income statement for the year ended 31 December 20X7
$
Sales
Less: cost of sales
Opening inventories
Purchases (9,876 63)
$
15,542
510
9,813
10,323
647
9,676
5,866
129
5,995
Gross profit
Discounts received
Less expenses:
Rent (500 + 100)
Electricity (240 ( 612 180))
600
150
Insurance
Wages (1,634 120)
Repairs
Depreciation
Travel and entertaining
Bad debts
Discounts allowed
120
1,514
635
601
192
37
73
3,922
2,073
Capital
Capital as at 1 January 20X7
Profit for the period
Less: drawings (1,200 + 63 + 120)
1,740
830
2,569
Accumulated
depreciation
$
870
332
1,202
NBV
$
870
498
1,368
647
635
90
1,127
2,499
3,867
$
2,377
2,073
(1,383)
3,067
Current liabilities
Trade payables
Accruals
700
100
800
3,867
25.30
Chapter 18
Answer to Lecture Example 1
Sales
%
100
$
476,000
COS
60
285,600
GP
40
190,400
x 60%
%
130
$
221,000
COS
100
170,000
GP
30
51,000
Purchases:
x 100/130
Cost of sales
Opening inventory
43,000
+ Purchases
174,500
Closing inventory
47,500
170,000
=
=
125%
100%
25%
=
=
$
985,000
788,000
197,000
Cost of sales
$
620,000
700,000
1,320,000
(788,000)
532,000
(180,000)
352,000
Opening inventories
Purchases
Less: cost of sales
Closing inventories should be
Closing inventories is
inventory lost in fire
25.31
$
38,450
Bal b/d
430
167,224
43,825
211,479
Purchases*
Dr Purchases (I/S)
Cr Trade payables
173,029
211,479
$173,029
$173,029
Bal b/d
Receipts from
Trade receivables (1)
50
General expenses
Drawings
Bankings
Bal c/d
39,204
39,254
Trade receivables
$
1,447
Cash (deduced from
39,685
cash a/c)
Bal c/d
41,132
Bal b/d
Sales* (2)
4,500
6,250
28,454
50
39,254
$
39,204
1,928
41,132
Balance b/d
Sales
=
=
100%
80%
20%
=
=
$
23,750
19,000
4,750
Cash
$
1,000
Wages
Stationery
23,750
Electricity
Bankings
drawings
Bal c/d
24,750
25.32
$
5,200
500
1,200
12,800
4,050
1,000
24,750
Chapter 19
Answer to Lecture Example 1
(a)
(i)
Bal c/d
Tick
$
50,000
Capital accounts
Cast Balance
$
$
30,000 20,000
Bank
50,000
30,000
20,000
Bal b/d
Tick
$
50,000
Cast
$
30,000
Balance
$
20,000
50,000
50,000
30,000
30,000
20,000
20,000
(ii)
Salary Balance
Interest on capital (12%
Tick
Cast
Balance
Profit share
Tick (5/10)
Cast (3/10)
Balance (2/10)
11,500
6,900
4,600
$
50,000
12,000
23,000
50,000
50,000
(iii)
Drawings
Bal c/d
Tick
$
6,000
11,500
17,500
Current accounts
Cast Balance
$
$
4,000
8,800
Salary
6,500 13,200
Interest on
capital
Profit share
10,500 22,000
25.33
Tick
$
6,000
11,500
17,500
Cast
$
3,600
6,900
10,500
Balance
$
15,000
2,400
4,600
22,000
(iv)
TICK, CAST AND BALANCE
Balance Sheet as at 31 December 20X4 (extract)
$
(b)
Capital accounts
Tick
Cast
Balance
50,000
30,000
20,000
Current accounts
Tick
Cast
Balance
11,500
6,500
13,200
100,000
31,200
131,200
$
50,000
300
100
50,400
(iii)
Drawings
Interest on
drawings
Balance c/d
Tick
$
6,000
300
11,400
17,700
Current accounts
Cast Balance
$
$
4,000
8,800
Salary
Interest on
100
capital
6,520 13,280
Profit share
10,620 22,080
Bal b/d
25.34
Tick
$
Cast
$
Balance
$
15,000
6,000
11,700
17,700
3,600
7,020
10,620
2,400
4,680
22,080
11,400
6,520
13,280
X
$
15,000
400
25,320
Y
$
400
12,660
Z
$
8,000
400
4,220
Total
$
23,000
1,200
42,200
66,400
(W)
()
$
67,000
(600)
66,400
M
$
Salary
PSR (1st half)
PSR (2nd half)
90,000
110,000
200,000
S
$
20,000
30,000
66,000
116,000
$
10,000
30,000
44,000
84,000
$
400,000
40,000
440,000
(90,000)
(30,000)
(30,000)
$
220,000
(40,000)
180,000
(20,000)
(10,000)
150,000
(150,000)
2nd Half
$
Profit ($440,000 x 6/12)
Salary
PSR M 50%
S 30%
A 20%
(110,000)
(66,000)
(44,000)
25.35
$
220,000
220,000
(220,000)
$
180,000
210,000
Capital a/c
Capital a/c
1 Sept
1 Dec
$
180,000
210,000
Capital a/c
Capital a/c
Capital account
1 Sept
Goodwill
1 Dec
Goodwill
K
$
102,857
C
$
77,143
H
$
S
$
90,000
60,000
60,000
1 Sept
Goodwill
1 Dec
Goodwill
K
$
80,000
C
$
60,000
120,000
90,000
H
$
40,000
Chapter 20
Answer to Lecture Example 1
Rab Co
Dr Cash (200,000 80c)
Cr Share capital (200,000 50c)
Cr Share premium account (200,000 30c)
$
160,000
$
100,000
60,000
$
150,000
60,000
210,000
300,000
50c = $37,500
4
Double entry:
$
37,500
$
37,500
Balance sheet
Share capital 50c ordinary shares (150,000 + 37,500)
Share premium account (60,000 37,500)
Retained earnings
25.36
$
187,500
22,500
200,000
410,000
S
$
375,000
50c
5
37,500
Share premium:
375,000
$1
5
75,000
$
112,500
Dr Cash
Cr Share capital
Cr Share premium account
$
37,500
75,000
Rab Co
Balance Sheet (extract)
$
225,000
97,500
230,000
525,500
125,000
$
50,000
preference
ordinary
6,000
10,000
(16,000)
159,000
$
62,000
3,000
43,000
25.37
$
62,000
$
62,000
62,000
30.9.X6
65,000
Bank
43,000
108,000
(2)
Balance b/d
$
62,000
62,000
62,000
3,000
43,000
108,000
43,000
Chapter 21
Answer to Lecture Example 1
Arrow
Income statement for the year ended 30 September 20X6
$'000
12,740
7,040
5,700
2,060
2,375
72
1,193
270
923
Revenue
Cost of sales (W3)
Gross profit
Distribution costs
Administrative expenses (W1)
Finance costs (W6)
Profit before tax
Income tax expense
Profit for the period
Arrow
Balance sheet as at 30 September 20X6
$'000
ASSETS
Non-current assets
Property, plant and equipment
5,000
5,000
Current assets
Inventories
Trade receivables
Cash and cash equivalents (W2)
610
1,000
1,170
2,780
7,780
Total assets
25.38
$'000
1,750
585
1,400
1,873
5,608
Non-current liabilities
Long term borrowings
1,200
1,200
Current liabilities
Trade payables
Other payables (W6)
Current tax payable
Short term provisions
550
72
270
80
972
7,780
$'000
45
1,800
500
30
2,375
$'000
7,200
450
(610)
7,040
Purchases
Opening inventories
Closing inventories
(W4) Retained earnings
$'000
1,250
(300)
923
1,873
25.39
3,000,000
500,000
Record as:
Dr
Cr
Cr
$635,000
$250,000
$385,000
Revalued amount
PPE per trial balance
Increase
$'000
1,500
Share
premium
account
$'000
200
Dividends
Issue of share capital
Balance at 30 September 20X6
$'000
800
Retained
earnings
$'000
1,250
600
Revaluation
reserve
200
250
385
1,750
585
1,400
1,400
923
600
923
2,713
5,273
(300)
(300)
635
1,873
5,608
Chapter 22
Answer to Lecture Example 1
B
1 and 3 are non-adjusting events as the condition did not exist at the balance sheet date.
25.40
$'000
3,750
600
600
1,500
Total
equity
Chapter 23
Answer to Lecture Example 1
Income taxes paid
Income tax payable
$'000
116
156
272
Bal b/d
I/S
$'000
168
104
272
$'000
200
100
300
Disposal
Bal c/d
$'000
20
280
300
Accumulated depreciation
Disposal
Bal c/d
$'000
9
111
120
Bal b/d
... Charge
Profit/loss on disposal:
$'000
80
40
120
$
11,000
(8,000)
(3,000)
(ii)
40,000
3,000
43,000
25.41
(100,000)
8,000
(92,000)
$'000
50
45
95
$'000
35
60
95
Bal b/d
Retained earnings
$000
87
42
8
137
(21)
(4)
15
127
(8)
(20)
99
(146)
(146)
60
30
(22)
68
21
(14)
7
Workings
(W1)
25.42
$000
42
628
670
(W2)
Income tax paid
Bal c/d
(W3)
Dividends paid
Bal c/d
$000
28
31
59
Dividends payable
$000
22
Bal b/d
18
Dividend for year
40
$000
16
24
40
$'000
579
(452)
127
(8)
(20)
99
Workings
(W1)
Bal b/d
Revenue (I/S)
Trade receivables
$'000
147
cash received
600
Bal c/d
$'000
579
168
747
(W2)
cash paid
Bal c/d
747
Trade payables
$'000
Bal b/d
452
Expenses (W3)
$'000
121
467
136
588
(W3)
588
$'000
319
214
(210)
Cost of sales
Add: closing inventories
Less: opening inventories
Purchases
Other expenses
Less: depreciation
186
(42)
25.43
$'000
323
144
467
Chapter 24
Answer to Lecture Example 1
Information that may be included in a database file for a non-current asset register:
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
25.44
Pilot Paper
Questions only
26.1
26.2
26.3
26.4
26.5
26.6
26.7
26.8
26.9
26.10
26.11
26.12
26.13
26.14
26.15
26.16
26.17
26.18