INVENTORY VALUATION METHODS

Inventory is one of the most important assets in a company’s statement of financial position.
It also affects the statement of profit or loss, having a direct impact on gross profit.

Opening inventory brought forward in the inventory account are transferred to the statement
of profit or loss and so at the end of the accounting year the balance on the inventory account
ceases to be the opening inventory value brought forward and becomes instead the closing
inventory value carried forward.

The quantity of inventory held at the year-end is established by means of a physical inventory
count in an annual stocktake exercise.

STOCKTAKING

In simple cases, when a business holds easily counted and relatively small amounts of
inventory, quantities of inventories on hand at the statement of financial position date can be
determined by physically counting them in a stocktake. The continuous nature of trading
activity may cause a problem in that inventory movements will not necessarily cease during
the time that the physical inventory take is in progress. Two possible solutions are:

a. To close down the business while the count takes place

b. To keep detailed records of inventory movements during the course of the stocktake

Closing down the business for a short period for a stocktake (e.g. over the weekend or at
Christmas) is considerably easier than trying to keep detailed records of inventory
movements during a stocktake so most businesses prefer that method.

VALUING INVENTORIES
The basic rule
There are several methods which, in theory, might be used for the valuation of inventory
items.
a) Inventories might be valued at their expected selling price
b) Inventories might be valued at their expected selling price, less any costs still to be
incurred in getting them ready for sale and then selling them. This amount is referred
to as the net realisable value (NRV) of the inventories.
c) Inventories might be valued at their historical cost (i.e. the cost at which they were
originally bought)
d) Inventories might be valued at the amount it would cost to replace them. This amount
is referred to as the current cost of inventories.

DETERMINING THE PURCHASE COST

Inventory may be raw materials or components bought from suppliers, finished goods which
have been made by the business but not yet sold, or work in the process of production, but
only part-completed (this type of inventory is called work in progress or WIP).

A business may be continually purchasing consignments of a particular component. As each

consignment is received from suppliers they are stored in the appropriate bin, or on the
appropriate shelf or pallet, where they will be mingled with previous consignments. When the
storekeeper issues components to production he will simply pull out from the bin the nearest
components to hand, which may have arrived in the latest consignment or in an earlier
consignment or in several different consignments. Our concern is to devise a pricing
technique, a rule of thumb which we can use to attribute a cost to each of the components
issued from stores.

There are several techniques which are used in practice.

1. FIFO (first in, first out). Using this technique we assume that components are used in
the order in which they are received from suppliers. The components issued are
deemed to have formed part of the oldest consignment still unused and are costed
accordingly.
2. LIFO (last in, first out). This involves the opposite assumption that components issued
to production originally formed part of the most recent delivery, while older
consignments lie in the bin undisturbed.
3. Average cost. As purchase prices change with each new consignment, the average
cost of components in the bin is constantly changed. Each component in the bin at any
moment is assumed to have been purchased at the average price of all components in
the bin at that moment.
4. Standard cost. A pre-determined standard cost is applied to all inventory items. If this
standard price differs from prices actually paid during the period it would be
necessary to write off the difference as a ‘variance’ in the statement of profit or loss.
5. Replacement cost. The arbitrary assumption is made that the cost at which a inventory
unit was purchased is the amount it would cost to replace it. This is often (but not
necessarily) the unit cost of inventories purchased in the next consignment following
the issue of the component to production.

Any or all of these methods might provide a suitable basis for valuing inventories. But it is
worth mentioning here that if you are preparing financial accounts you would normally
expect to use FIFO or average costs for the statement of financial position valuation of
inventory. IAS 2 does not permit the use of LIFO.

EXAMPLE
Assume that a firm has just completed its first financial year is about to value inventory at
cost price. It has dealt in one type of goods. A record of transactions is now shown.

Bought Sold

January 2015 10 at K30 each K300 May 2015 8 for K50 each K400
April 2015 10 at K34 each K340 November 2015 24 for K60 each K1 440
October 2015 20 at K40 each
K800 K32 K1 840
K40 K1 440

FIFO Method

Received Issued Inventory after each transaction

January 2015 10 at K30 each 10 at K30 each = K300
 April 2015 10 at K34 each 10 at K30 each = 300
10 at K34 each = 340 640
May 2015 8 at K30 each 02 at K30 each = 60
10 at K34 each = 340 400
October 2015 20 at K40 each 02 at K30 each = 60
10 at K34 each = 340 400
20 at K40 each = 800 1 200
November 02 at K30 each
2015 10 at K34 each
12 at K40 each

24 8 at K40 each 320

The closing inventory at 31 December 2015 is therefore valued at K320.

LIFO Method

Received Issued Inventory after each transaction

January 2015 10 at K30 each 10 at K30 each = K300
April 2015 10 at K34 each 10 at K30 each = 300
10 at K34 each = 340 640
May 2015 8 at K34 each 10 at K30 each = 300
02 at K34 each = 68 368
October 2015 20 at K40 each 10 at K30 each = 300
02 at K34 each = 68
20 at K40 each = 800 1 168
November 20 at K40 each
2015 02 at K34 each
02 at K30 each

24 8 at K30 each 240

The closing inventory at 31 December 2015 is therefore valued at K240.

Average cost method (AVCO)

2015 Received Issued Average cost Number of Inventory

per unit of units in after each
inventory held inventory transaction
January 10 at K30 K30 10 K 300
April 10 at K34 K32 20 K 640
May 8 at K32 K32 12 K 384
October 20 at K40 K37 32 K1 184
Novembe 24 at K37 K37 08 K296
r

The closing inventory at 31 December 2015 is therefore valued at K296

  The average inventory in April is calculated as follows: Inventory 10 x K30 =
K300
 10 x K34 = K340
K300 + K340 = K640 K640 / 20 units = K32

 The average inventory in October is calculated as follows: Inventory 12 x K32 =

K384
 20 x K40 = K800
K384 + K800 = K1 184 K1 184 / 32 units = K37

INVENTORY VALUATION AND THE CALCULATION OF PROFITS

Using the figures from inventory valuations shown by the three methods of FIFO, LIFO and
AVCO, the trading accounts would appear:

Trading account for the year ended 31 December 2015

FIFO LIFO AVCO

Sales 1 1 840 1 840

Cost of 840 1 200 1 144
sales 1
120 640 696
Gross Profit

720

Different methods of inventory valuation will mean that different profits are shown.

NET REALISABLE VALUE

As a general rule assets should not be carried at amounts greater than those expected to be
realised from their sale or use. The net realisable value of inventory is calculated as follows:

Saleable value - expenses needed before completion of sale = Net realisable value

The concept of prudence is used when inventory is valued. Inventories should not be over –
valued, otherwise profits shown will be too high. Therefore if the net realisable value of
inventory is less than the cost of inventory, then the figure to be taken to the final accounts is
that of net realisable value.

For example, assume that an art dealer has bought only two paintings during the financial
ended 31 December 2016. He starts off the year without, and then buys a genuine
masterpiece for K6 000, selling this later in the year for K11 500. The other is a fake, but he
does not realize this when he buys it for K5 100, only to discover during the year that in fact
he had made a terrible mistake and that the net realisable value is K100. The fake remains
unsold at the end of the year. The statement of profit or loss would appears as

a. if inventory is valued at cost

b. if inventory is valued at net realisable value

Trading statement of profit or loss

A B

Sales 11 500 11 500

Cost of goods sold 6 000 11 000

Gross profit 5 500 500

Method (A) ignores the fact that a dealer had a bad trading year owing to his skill being
found wanting in 2016. If this method was used, the loss on the fake would reveal itself in the
following year’s trading account. Method (B), however, realizes that the loss really occurred
at the date of purchase rather than at the date of sale. Following the concept of prudence
accounting practice chooses method (B).

ACCOUNTING FOR BAD AND DOUBTFUL DEBTS

Customers who buy goods on credit might fail to pay for them, perhaps out of dishonesty or
perhaps because they have gone bankrupt and cannot pay. For one reason or another, a
business might decide to give up expecting payment and to write the debt off as a ‘lost
cause’.
With many businesses a large proportion, of the sales are on credit basis. The business is
therefore taking the risk that some of the customers may never pay for the goods sold to them
on credit. This is a normal business risk and therefore bad debts as they are called are a
normal business expense, and must be charged as such when calculating the profit or loss for
the period.

Bad debts and the matching concept

Following the matching concept, expenses should be charged in the same accounting period,
as far as possible, as that in which the revenues to which they relate are recognized. Thus it is
necessary to charge bad debts to the accounting period in which the sale which gave rise to
the debt concerned was recognized. This can pose problems where, as will typically be the
case in practice, trade debts are outstanding at the end of an accounting period. It is quite
likely that some of these debts, unpaid at the end of the period in which the sale was made,
will prove to go bad in the subsequent accounting period.
To comply with the matching concept, and to ensure that period end trade debtors are not
overstated, it is necessary to make a judgment about the extent of the bad debt potential of the
trade debtors at the end of the accounting period and to treat that amount as an expense.

Writing off bad debts

When a business decides that a particular debt is unlikely ever to be repaid, the amount of the
debt should be written off as an expense in the statement of profit or loss. When the debt is
found to be bad, the asset as shown by the debtor’s account is worthless, and must
accordingly be eliminated as an asset account.
 Credit the debtors account to cancel the asset
 Debit the bad debts account to increase the expense
Sometimes the debtor would have paid part of the debt leaving the remainder to be written off
as a bad debt. The total of the bad debts account is later transferred to the statement of profit
or loss.

Accounting treatment
P Banda Account

08/01/2014 Sales 50 000 31/12/2014 Bad debts 50 000

N Morgan Account

16/02/2014 Sales 240 000 17/08/2014 Bank 200 000

31/12/2014 Bad debts 40 000

240 000 240 000

Bad debts Account

31/12/2014 P Banda 50 000 31/12/2014 Profit & loss 90 000

31/12/2014 N Morgan 40 000

90 000 90 000
Statement of profit or loss (extract) for the year ended 31 December 2014

Gross profit XXXX

Less: Expenses
Bad debts 90 000

Bad debts written off and subsequently paid/Bad debts recovered

A bad debt which has been written off might occasionally be unexpectedly paid. The only
accounting problem to consider is when a debt written off as bad in one accounting period is
subsequently paid in a later accounting period. The amount received should be recorded as
additional income in the statement of profit or loss in the period in which the amount is
received.

Accounting entries

First reinstate the debt by making the following entries:

Dr Debtor’s account
Cr Bad debts recovered account
The reason for reinstating the debt in the debtor’s account is to have a detailed history of
his/her account as a guide for granting credit in future. When the cash or cheque is later
received from the debtor in settlement of the account or part thereof:
Dr Cash Book
Cr Debtor’s Account
With the amount received.

At the end of the financial year, the credit balance in the bad debts recovered account will be
transferred to either the bad debts account or direct to the credit side of the statement of profit
or loss (other income).
Provision for doubtful debts

When bad debts are written off it means that specific debts owed to the business are identified
as unlikely ever to be collected. When a business expects bad debts amongst its current
debtors, but does not yet know which specific debts will be bad, it can make a provision for
doubtful debts.
A provision is usually defined as an amount set aside out of profit to provide for any known
expense, the amount of which cannot be accurately determined. The business will be more
likely to avoid claiming profits which subsequently fail to materialize because some debts
turn out to be bad.

Why provisions are needed

When we are drawing up our final accounts we want to achieve the following objectives:
a. To charge as expenses in the statement of profit or loss for that year an amount
representing sales of that year for which we will never be paid.
b. To show in the statement of financial position as correct a figure as possible a true
value of debtors at the statement of financial position date.
Out of the credit sales during the year, it may have become obvious by the year end that some
will never be paid for. Taking the year ended 31 December 2013, for example three credit
sales

K500 000 in January 2013

K750 000 in March 2013
K200 000 in June 2013

May be known by the year end definitely to be bad debts. These can then be written off to the
bad debts expense account during the year ended 31 December 2013.

However, how about the sales much later in the year which have not been paid for by the
year end? These have not been owing for so long, and it will be more difficult to determine
which of them will be bad debts.
This means that it is impossible to determine with absolute accuracy at the year-end what the
amount is in respect of debtors who will never pay their accounts. However, you sold the
goods in the year ended 31 December 2013, and that is the year in which you took the risk of
selling goods that might never be paid for. Therefore in the statement of profit or loss for
2013 you want to show the full amount that has become bad debts or will prove to be so.
To overcome the problem of charging against profits for
a. Debts that have proved to be bad, and
b. Debts that are likely to be bad but have not yet proved to be so.

The basic idea has evolved of keeping (a) and (b) in two separate accounts:
1) Bad debts expense account – This is used only when the debt has been proved
to be a bad debt and is written off.
2) Provision for bad debts account – This account is used only for estimates of
the amount of the debtors at the year-end that are likely to finish up as bad
debts.

By charging both (1) and (2) in the statement of profit or loss for the year, we get the full
amount in respect of bad debts that have occurred from sales made during the year shown as
deductions from the gross profit.
By showing (2) as a deduction form the figure of debtors in the statement of financial
position at the year end, we then get a net figure, which represents a more correct figure of
the value of debtors. It may not be absolutely accurate – only time will tell which of the
debtors will turn out to be bad debts – but it is better than not attempting to make an estimate.
To try to get as accurate a figure as possible for debtors, a firm will make a best estimate it
can of the number of debtors who will never pay their accounts. This estimate can be made:
1. by looking at each debt, and estimating which ones will be bad debts;
2. by estimating, on the basis of experience, what percentage of the debts will
prove to be bad debts.

Using an ageing schedule

Some firms draw up an ageing schedule, showing how long debts have been owing. Older
debtors need higher percentage estimates of bad debts than do newer debtors.

Ageing Schedule for Doubtful Debts

Period debt owing Amount Estimated % Provision for

doubtful bad debts
K

Less than 1 month 5 000 1 50

1 month to 2 months 3 000 3 90
2 months to 3 months 800 4 32
3 months to 1 year 200 5 10
Over 1 year 160 20 32

9 160 214

Accounting entries for provisions for bad debts

When a provision is first made, the amount of this initial provision is charged as an expense
in the statement of profit or loss of the business, for the period in which the provision is
created.

Debit Statement of profit or loss with the amount of provision (deduct from
profit and loss as expenses)
Credit Provision for bad debts account

EXAMPLE 1

At 31 December 2013 the debtors figure amounted to K10 000 000. It is estimated that 2 %
of debts (i.e. K200 000) will prove to be bad debts and it is decided to make a provision for
these.

Provision for Bad debts Account

31/12/2013 Profit & loss 200 000

 Statement of profit or loss (extract) for the year ended 31 December 2013

Gross profit XXXX

Less: Expenses
Provision for Bad debts 200 000

Statement of financial position (extract) as on 31 December 2013

Current Assets
Debtors 10 000 000
Less: Provision for Bad debts 200 000
9 800 000
Increasing the provision
When a provision already exists, but is subsequently increased in size, the amount of the
increase in provision is charged as an expense in the statement of profit or loss, for the period
in which the increased provision is made.

EXAMPLE 2
Suppose that for the same firm as in example 1 at the end of the following year, 31 December
2014, the bad debts provision needed to be increased. This was because the provision was
kept at 2%, but the debtors had risen to K12 000 000. A provision of K200 000 had been
brought forward from the previous year, but we now want a total provision of K240 000(i.e.
2% of K12 000 000). All that is needed is a provision for an extra K40 000.

Dr Statement of profit or loss

Cr Provision for bad debts account

Provision for Bad debts Account

31/12/2014 Balance c/d 240 000 01/01/2014 Balance b/d 200 000
31/12/2014 Profit and loss 40 000

240 000 240 000

01/01/2015 Balance b/d 240 000

 Statement of profit or loss (extract) for the year ended 31 December 2014

Gross profit XXXX

Less: Expenses
Provision for Bad debts (increase) 40 000

Statement of financial position (extract) as on 31 December 2014

Current Assets
Debtors 12 000 000
Less: Provision for Bad debts 240 000
11 760 000

Reducing the provision

When a provision already exists, but is subsequently reduced in size, the amount of the
decrease in provision is recorded as an item of income in the statement of profit or loss, for
the period in which the reduction in provision is made.

Let us assume that at 31 December 2015, in the firm already examined, the debtors figure had
fallen to K10 500 000 but the provision remained at 2%, i.e.K210 000 (2& of K10 500 000).
As the provision had previously been K240 000, then it now needs a reduction of K30 000.
Dr Provision for bad debts account
Cr Statement of profit or loss (add to gross profit)

Provision for Bad debts Account

31/12/2015 Profit and loss 30 000 01/01/2015 Balance b/d 240 000
31/12/2015 Balance c/d 210 000

240 000 240 000

01/01/2006 Balance b/d 240 000

Statement of profit or loss (extract) for the year ended 31 December 2015
 Gross profit XXXX

Add: other income

Reduction in Provision for Bad debts 30 000

Statement of financial position (extract) as on 31 December 2015

Current Assets
Debtors 10 500 000
Less: Provision for Bad debts 210 000
10 290 000
CLASS EXERCISE

Chani Fresh Foods owns and runs the town fresh foods shop in Kitwe. He commenced
trading on 1 January 2011, selling fresh foods to customers, most of whom make use of a
credit facility that Chani offers. (Customers are allowed to purchase up to K200 of goods on
credit but must repay a certain proportion of their outstanding debt every month.

This credit system gives rise to a large number of bad debts, and Chani’s results for the first
three years of operation are as follows:

Year to 31 December 2011

Gross profit 27 000
Bad debts written off 8 000
Debts owed by customers as at 31 December 2011 40 000
Provision for doubtful debts 2% of outstanding debtors
Other expenses 20 000

Year to 31 December 2012

Gross profit 45 000
Bad debts written off 10 000
Debts owed by customers as at 31 December 2012 50 000
Provision for doubtful debts 2% of outstanding debtors
Other expenses 28 750

Year to 31 December 2013

Gross profit 60 000
Bad debts written off 11 000
Debts owed by customers as at 31 December 2013 30 000
Provision for doubtful debts 3% of outstanding debtors
Other expenses 32 850

Required:

For each of these three years, prepare the statement of profit or loss of the business and state
the value of debtors appearing in the statement of financial position as at 31 December.

ACCRUALS AND PREPAYMENTS

It has already been stated that the gross profit for the period should be calculated by matching
sale s and the cost of goods sold. In the same way, the net profit for the period should be
calculated by charging the expenses which relate to that period. For example, in preparing the
statement of profit or loss of a business for a period, of say, 6 months, it would be appropriate
to charge 6 months’ expenses for rent and rates, insurance costs and telephone costs etc.

Expenses might not be paid for during the period to which they relate. For example, if a
business rents a shop for K1200 000 per annum, it might pay the full annual rent on, say, 1
April each year. Now if we were to calculate the profit of the business for the first 6 months
of the year 2017, the correct charge for rent in the statement of profit or loss would be K600
000 even though the rent payment would beK1 200 000 in that period. Similarly, the rent
charge in the statement of profit or loss for the business in the second 6 months of the year
would be K600 000, even though no rent payment would be made in that 6-month period.

Accruals/Accrued expenses

Accrued expenses are expenses which are charged against the profit for a particular period,
even though they have not yet been paid for.

Assume that rent of K1, 000 000 per year is payable at the end of every three months. The
rent was not always paid on time. Details were:

Amount Rent due Rent paid

K250 000 31 March 2015 31 March 2015
K250 000 30 June 2015 2 July 2015
K250 000 30 September 2015 4 October 2015
K250 000 31 December 2015 5 January 2016

Rent Account
 2015 K
March 31 Cash 250 000
July 2 ” 250 000
October 4 ” 250 000

The rent paid 5 January 2016 will appear in the books of the year 2016 as part of the
double entry.

The expense for 2015 is obviously K1, 000 000 as that is the year’s rent, and this is the
amount that we need to transfer to the statement of profit or loss. But if K1 000 000 was put
on the credit side of the rent account (the debit being in the statement of profit or loss) the
account would not balance. We would have K1, 000 000 on the credit side of the account
and only K750 000 on the debit side.

To make the account balance the K250 000 rent owing for 2015, but paid in 2016, must be
carried down to 2016 as a credit balance because it is a liability on 31 December 2015.
Instead of rent owing it could be called rent accrued or just simply an accrual. The completed
account can now be shown:

Rent Account

2015 K 2015 K
March 31 Cash 250 000 Dec 31 Profit and loss 1,000 000
July 2 ” 250 000
Oct 4 ” 250 000
Dec 31 Accrued c/d 250 000

1000 000 1,000 000

2016
Jan 1 Accrued b/d 250 000

The balance c/d has been described as accrued c/d, rather than a balance. This is to explain
what the balance is for; it is for an accrued expense.

Class exercise

Hachi trading as HMS (Hachi Motor Spares) ends his financial year on 28 February each
year. His telephone was installed on 1 April 2016 and he receives his telephone account
quarterly at the end of each quarter. He pays it promptly as soon as it is received. On the basis
of the following data, you are required to calculate the telephone expense to be charged to the
statement of profit or loss for the year ended 28 February 2017.

HMS Telephone expenses for the three months ended

K
30 June 2016 23.50
30 September 2016 27.20
31 December 2016 33.40
31 March 2017 36.00

Prepayments

Prepayments are the payments which have been made in one accounting period, but should
not be charged against profit until a later period, because they relate to that later period.

Prepaid Expenses
Insurance for a firm is at the rate of K840 a year, starting from 1 January 2015. The firm has
agreed to pay this at the rate of K210 every three months. However, payments were not
made at the correct times. Details were:

Amount Insurance due Insurance paid

K210 000 31 March 2015 K210 000 28 February
2015
K210 000 30 June 2015 K420 000 31 August 2015
K210 000 30 September 2015
K210 000 31 December 2015 K420 000 18 November
2015

Insurance

2015 K
February 28 Bank 210 000
August 31 ” 420 000
November 18 ” 420 000

Now the last payment of K420 000 is not just for 2015; it can be split as K210 000 for the
three months to 31 December 2015 and K210 000 for the three months ended 31 March 2016.
For a period of 12 months, the cost of insurance is K840 000 and this is, therefore, the figure
needing to be transferred to the statement of profit or loss.

If this is entered then the amount needed to balance the account will therefore be K210 000
and at 31 December 2015 this is a benefit paid for but not used up; it is an asset and needs
carrying forward as such to 2016, i.e. as a debit balance. It is a prepaid expense.
The account can now be completed:

Insurance Account

2015 K 2015 K
 Feb 28 Bank 210 000 Dec 31 Profit and loss 840 000
Aug 31 ” 420 000
Nov 18 ” 420 000 ” 31 Prepaid c/d 210 000
1, 050 000 1, 050 000
2016
Jan 1 Prepaid b/d 210 000

Prepayment will also happen when items other than purchases are bought for use in the
business, and they are not fully used up in the period.

For instance, packing materials are normally not entirely used up over the period in which
they are bought, there being inventory of packing materials in hand at the end of the period.
This inventory is therefore a form of prepayment and needs carrying down to the following
period in which it will be used.

This can be seen in the following example:

Year ended 31 December 2015. Packing materials bought in the year K2, 200. Inventory of
packing materials in hand as at 31 December 2015 K400.

Looking at the example, it can be seen that in 2015 the packing materials used up will have
been K2, 200 - K400 = K1, 800. We will still have inventory of K400 packing materials at
31 December 2015 to be carried forward to 2016. The K400 inventory of packing materials
will be carried forward as an asset balance (debit balance) to 2016.

Packing Materials

2015 K 2015 K
Dec 31 Bank 2, 200 Dec 31 Profit and loss 1, 800
Dec 31 Inventory c/d 400
2, 200 2, 200
2016
Jan 1 Inventory b/d 400

The inventory of packing materials is not added to the inventory of unsold goods in hand in
the statement of financial position, but is added to the other prepayments of expenses.

Class exercise

The Copperbelt University pays fire insurance annually in advance on 1 June each year. The
institution’s financial year end is 28 February. From the following record of insurance
payments you are required to calculate the charge to the profit and loss for the financial year
to 28 February 2018.

Insurance paid

01/06/16 600 000

01/06/17 700 000

Revenue owing at the end of period

The revenue owing for sales is already shown in the books. These are the debit balances on
our customer’s accounts, i.e. debtors. There may be other kinds of revenue, all of which has
not been received by the end of the period, e.g. rent receivable. An example now follows:

Our warehouse is larger than we need. We rent part of it to other firm for K800 000 per
annum. Details for the year ended 31 December were as follows:

Amount Rent due Rent received

K200 000 31 March 2015 4 April 2015
K200 000 30 June 2015 6 July 2015
K200 000 30 September 2015 9 October 2015
K200 000 31 December 2015 7 January 2016

The account for 2015 will appear as:

Rent receivable Account

2015 K
April 4 Bank 200 000
July 6 Bank 200 000
October 9 Bank 200 000

The rent received of K200 000 on 7 January 2016 will be entered in the books in 2016.

Any rent paid by the firm would be charged as debit to the statement of profit or loss.

Any rent received, being the opposite, is transferred to the credit side of the statement of
profit or loss, as it is revenue.

The amount to be transferred for 2015 is that earned for the 12 months, i.e. K800 000 the rent
received account is completed by carrying down the balance owing as a debit balance to
2016. The K200 000 owing is an asset on 31 December 2015.

The rent receivable account can now be completed:

Rent receivable Account

2015 K 2015 K
Dec 31 Profit and loss 800 000 April 4 Bank 200 000
July 6 Bank 200 000
October 9 Bank 200 000
 December 31 Accrued
c/d 200 000
800 000 800 000
2016
Jan 1 Accrued b/d 200 000

Expenses and revenue account balances and the statement of financial position

In all the cases listed dealing with adjustments in the final accounts, there will still be a
balance on each account after the preparation of the statement of profit or loss. All such
balances remaining should appear in the statement of financial position. The only question
left is where and how they shall be shown.

The amounts owing for expenses are usually added together and shown as one figure. These
could be called expense creditors, expenses owing or accrued expenses. The item would
appear under the current liabilities, as they are expenses which have to be discharged in the
near future.

The items prepaid are also added together and called prepayments, prepaid expenses or
payments in advance. They are shown next under the debtors. Amounts owing for rents
receivable or other revenue owing are usually added to debtors.

Expenses and revenue accounts covering more than one period

Students are often asked to draw up an expense or revenue account for a full year, and there
are amounts owing or prepaid at both the beginning and end of the year. We can now see
how this is done.

Example A

The following details are available

(a) On 31 December 1994, three months rent of K3, 000 was owing.

(b) The rent chargeable per year was K12, 000.

(c) The following payments were made in the year 1995:

6 January K3, 000; 4 April K3, 000; 7 July K3, 000; 18 October K3, 000

(d) The final three months rent for 1995 is still owing.

Now we can look at the completed rent account. The letters (a) to (d) give reference to the
details above.
 Rent Account

2015 K 2015 K
Jan 6 Bank (C) 3, 000 Jan 1 Owing b/f (a) 3, 000
Apr 4 Bank (C) 3, 000 Dec 31 Profit and (b) 12, 000
loss
Jul 7 Bank (C) 3, 000
Oct 18 Bank (C) 3, 000
Dec 31 Accrued c/d (D) 3, 000
15,000 15, 000

Jan 1 Accrued b/d 3, 000

QUESTION 2

The following trial balance was extracted from the books of T. Jones on 31 December 1995.
K K
Sales 100 000
Purchases 50 000
Cash in hand 1 000
Capital account (1 January 17 000
Drawings 9 500
Rent 5 000
Wages and salaries 12 000
Electricity 1 500
Debtors and Creditors 9 000 8 000
Inventory (1 January) 10 000
Accumulated depreciation – 1 January 13 000
Delivery van at cost 34 000
Other expenses 6 000

138 000 138 000

The following additional information is provided:

1. Goods which cost K1 000, were received during 2015 and were included in closing
inventory. No invoice was included in purchases for them in 2015.
2. Rent of K500 is prepaid.
3. Electricity of K350 is accrued.
4. The depreciation charge for the year is K6 000.
5. Jones took inventory for his own use which cost K450. No entry was made in the
books in respect of this.
6. The closing inventory is K12 000.
7. Bad debts of K150 are to be written off.
8. A provision for doubtful debts of K100 is to be created.

Required:

Prepare a statement of profit or loss of T Jones for the year to 31 December 2015 and the
statement of financial position as at that date.
QUESTION 3

STEPHEN MOONGA
TRIAL BALANCE AS AT 31 MAY 2011
K K
Property at cost 120 000
Equipment at cost 80 000
Provision for depreciation (as at 1 June 2010)
On property 20 000
On equipment 38 000
Purchases 250 000
Sales 402 200
Discounts allowed 18 000
Discounts received 4 800
Returns out 15 000
Bad debts 4 600
Loan interest 5 100
Trade creditors 36 000
Trade debtors 38 000
Cash in hand 300
Bank 1 300
Capital account (1 June 2010) 121 300
Drawings 24 000
Provision for bad debts 5 00
Wages and salaries 58 800
17% Long term loan 30 000
Inventory (1 June 2010) 50 000
Other operating expenses 17 700

667 800 667 800

The following additional information as at 31 May 2011 is available.

a. Inventory as at the close of business has been valued at cost at K42 000
b. Wages and salaries need to be accrued by K800.
c. Other operating expenses are prepaid by K300
d. The provision for bad debts is to be adjusted so that it is 2% of trade debtors.
e. Depreciation for the year ended 31 May 2011 has still to be provided for as follows:
 Property: 1.5% per annum using the straight line method; and
 Equipment: 25% per annum using the diminishing balance method.

Required:
Prepare Stephen Moonga’s trading statement of profit or loss for the year ended 31 May
2011and his statement of financial position as at that date.