Sujit 1-134-380 PDF

11.3.
1 Research and Development Expenditure
Many businesses in the commercial world spend vast amounts of money, on an

annual basis, on the research and development of products and services. These
entities, including pharmaceutical and motor companies, do this with the intention of
developing a product or service that will, in future periods, provide significant
amounts of income for years to come.
11.3.2 Research and Development – Definitions
Research is original and planned investigation undertaken with the prospect of

gaining new scientific or technical knowledge and understanding.
An example of research could be a company in the pharmaceuticals industry

undertaking activities or tests aimed at obtaining new knowledge to develop a new
vaccine. The company is researching the unknown, and therefore, at this early
stage, no future economic benefit can be expected to flow to the entity.
Development is the application of research findings or other knowledge to a plan or

design for the production of new or substantially improved materials, devices,
products, processes, systems, or services, before the start of commercial production
or use.
An example of development is a car manufacturer undertaking the design,

construction, and testing of a pre-production model.
11.3.3 Accounting Treatment of Research and Development
IAS 38, Intangible Assets, separates a research and development project into a
research phase and a development phase.
Research phase
It is impossible to demonstrate whether or not a product or service at the research

stage will generate any probable future economic benefit. As a result, IAS 38 states
that all expenditure incurred at the research stage should be written off to the
statement of profit or loss as an expense when incurred, and will never be
capitalised as an intangible asset.
Development phase
Under IAS 38, an intangible asset must demonstrate all of the following criteria:
 Probable future economic benefits
 Intention to complete and use or sell the asset
 Resources (technical, financial and other resources) are adequate and
available to complete and use the asset
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 Ability to use or sell the asset
 Technical feasibility of completing the intangible asset (so that it will be
available for use or sale)
 Expenditure can be measured reliably
If any of the recognition criteria are not met then the expenditure must be charged to
the statement of profit or loss as incurred.
Note that if all the recognition criteria have been met, capitalisation must take place:
Dr Intangible non-current assets

(SOFP) Cr Bank/Payables
11.4 ACCA SYLLABUS GUIDE OUTCOME 4:

Calculate amounts to be capitalised as development expenditure or to be
expensed from given information.
Lecture Example 1
A company, Clarke Ltd, incurs research costs, during one year, amounting to
$125,000, and development costs of $490,000. The accountant informs you that the
recognition criteria (as prescribed by IAS 38) have been met. How should these
costs be accounted for in the financial statements?
Lecture Example 2
Medica is a company producing medicinal drugs. During the year ended 31

December 20X7, it incurred the following costs:
a) $15,000 on salaries for market research staff

b) $250,000 to purchase a machine to manufacture a new drug. It has an
estimated useful life of 10 years.
c) $40,000 on salaries relating to the design and manufacture of this new drug.
Required:
How should each of the above items be shown in the financial statements of
Medica for the year ended 31 December 20X7?

Explain the purpose of amortisation
Treatment of Capitalised Development Costs
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Once development costs have been capitalised, the asset should be amortised in
accordance with the accruals concept over its finite life.
What is amortization?
A tangible non-current asset, e.g. machinery, is capitalised and then depreciated

over its useful life. Similarly, the cost of the development expenditure should be
amortised over the useful life. Therefore, the cost of the development expenditure is
matched against the revenue it produces.
Amortisation must only begin when the asset is available for use (hence matching
the income and expenditure to the period in which it relates). It is an expense in the
statement of profit or loss: -
Dr Amortisation expense (I/S)

Cr Accumulated amortization (SOFP)
Each development project must be reviewed at the end of each accounting period to
ensure that the recognition criteria are still met. If the criteria are no longer met, then
the previously capitalised costs must be written off to the statement of profit or loss
immediately.
If the intangible asset is considered to have an indefinite useful life, it should not be
amortised but should be subjected to an annual impairment review, i .e. check
wehter there has been a fall in the value of the intangible asset.

Calculate and account for the charge for amortisation
Lecture Example 3
A company manufacturing aircraft engages in a number of research and

development projects.
At 1 January 20X6 the company’s records showed total capitalised development

costs of $18,000,000 made up as follows:
$
Project A17 14,000,000
This project was completed in 20X5 at a total cost of
$16,000,000, and is being amortised over 8 years on
the straight line basis, beginning on 1 January
20X5.
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Project J9 4,000,000
This project began in 20X4 and the $4m balance
represents expenditure qualifying for capitalisation
to 31 December 20X5
Project J9 is due to be completed in 20X9
–––––––
–
18,000,000
––––––––
During the year ended 31 December 20X6 the following further expenditure was
incurred:
Project J9
Further expenditure qualifying for capitalisation $1,500,000
Project A20
Investigation into new materials for aircraft construction $3,000,000
Required:
Calculate the amounts for research and development to be included in the
company’s statement of profit or loss and statement of financial position for
the year ended 31 December 20X6.

Draft the disclosure note for intangible non-current
assets For each class of intangible asset, disclose
 useful life or amortisation rate

 amortisation method
 gross carrying amount
 accumulated amortisation and impairment losses
 line items in the statement of profit or loss in which amortisation is included
 reconciliation of the carrying amount at the beginning and the end of the
period showing:
o additions (business combinations separately)
o assets held for sale
o retirements and other disposals
o revaluations
o impairments
o reversals of impairments
o amortisation
o foreign exchange differences
o other changes
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 basis for determining that an intangible has an indefinite life
 description and carrying amount of individually material intangible assets
 certain special disclosures about intangible assets acquired by way of
government grants
 information about intangible assets whose title is restricted
 contractual commitments to acquire intangible assets
Additional disclosures are required about:
 intangible assets carried at revalued amounts

 the amount of research and development expenditure recognised as an
expense in the current period
Development expenditure
$
Net book value at 1 April 20X0 X
Additions X
Amortisation charge (X
Disposals )
Net book value at 31 March 20X1 (X
)
At 31 March 20X0 X
Cost X
Accumulated amortization (X
Net book value )
X
At 31 March 20X1
Cost X
Accumulated amortisation (X)
Net book value X
Lecture Example 4
Which TWO of the following items must be disclosed in the note to the
financial statements for intangible assets?
(1) The useful lives of intangible assets capitalised in the financial statements
(2) A description of the development projects that have been undertaken during the
period
(3) A list of all intangible assets purchased or developed in the period
(4) Impairment losses written off intangible assets during the period
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A. 1 and 4
B. 2 and 3
C. 3 and 4
D. 1 and 2
155
156
Intangible Non-Current Assets
non-monetary asset without physical

substance
Research Development
Application of
the entity acquires research findings
new scientific or
technical
knowledge
 Must capitalize if all the
recognition criteria
(PIRATE) are met:
an expense in the
statement of o Probable future
profit or loss economic benefits
o Intention to complete and
use/ sell the asset
o Resources are adequate and
available to complete and
use the asset
o Ability to use or sell the asset
o Technical feasibility of
completing the
intangible asset
o Expenditure can be measured
reliably
 Start amortization when

commercial production begins
 Review annually to ensure
criteria are still met – if
not, an expense in the I/S.
157
Q
1. Which of the following statements about research and development

expenditure are correct?
1) Research expenditure, other than capital expenditure on research

facilities, should be recognised as an expense as incurred.
2) In deciding whether development expenditure qualifies to be recognised
as an asset, it is necessary to consider whether there will be adequate
finance available to complete the project.
3) Development expenditure recognised as an asset must be amortised over
a period not exceeding five years.
A. (1), (2) and (3)

B. (1) and (2) only
C. (1) and (3) only
D. (2) and (3) only
2. Which of the following statements about research and development

expenditure are correct according to IAS38 Intangible Assets?
1) If certain conditions are met, an enterprise may decide to capitalise

development expenditure.
facilities, must be written off as incurred.
3) Capitalised development expenditure must be amortised over a period not
exceeding 5 years.
4) Capitalised development expenditure must be disclosed in the statement
of financial position under intangible non-current assets.
A. 1, 2 and 4 only
B. 1 and 3 only
C. 2 and 4 only
D. 3 and 4 only.
3. Which of the following statements concerning the accounting treatment of

research and development expenditure are true, according to IAS 38
Intangible Assets?
1) Development costs recognised as an asset must be amortised over a

period not exceeding five years.
facilities, should be recognised as an expense as incurred.
3) In deciding whether development expenditure qualifies to be recognised
as an asset, it is necessary to consider whether there will be adequate
finance available to complete the project.
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4) Development projects must be reviewed at each statement of financial
position date, and expenditure on any project no longer qualifying for
capitalisation must be amortised through the statement of profit or loss
over a period not exceeding five years.
A. 1 and 4
B. 2 and 4
C. 2 and 3
D. 1 and 3
4. IAS 38 Intangible Assets governs the accounting treatment of expenditure on

research and development.
The following statements about the provisions of IAS 38 may or may not be
correct.
1) Capitalised development expenditure must be amortised over a period not
exceeding five years.
2) If all the conditions specified in IAS 38 are met, development expenditure
may be capitalised if the directors decide to do so.
3) Capitalised development costs are shown in the statement of financial
position under the heading of Non-Current Assets.
4) Amortisation of capitalised development expenditure will appear as an
item in a company’s statement of changes in equity.
Which of these four statements are in fact correct?
A. 3 only
B. 2 and 3
C. 1 and 4
D. 1 and 3
5. A newly set up dot-com entity has engaged you as its financial advisor. The
entity has recently completed one of its highly publicized research and
development projects and seeks your advice on the accuracy of the following
statements made by one of its stakeholders.
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a) Costs incurred during the research phase can be capitalized
b) Costs incurred during the development phase can be capitalized if criteria
such as technical feasibility of the project being established are met
c) Training costs of technicians used in research can be capitalised
d) Designing of jigs and tools qualify as research activities
Which of these four statements are in fact correct?

A. a and b
B. b and c
C. b only
D. b and d
160
Chapter 12
Accruals and Prepayments

Understand how the matching concept applies to accruals and prepayments
We have mentioned that one of the underlying assumptions in the

“Framework for the Preparation and Presentation of Financial Statements” is
the accruals concept. It is also known as the matching concept because of the
way it strives to match costs against the revenues generated by incurring
those costs. Its basic tenet is that revenues should be recognised (i.e.
included in the statement of profit or loss) in the period in which they are
earned, not necessarily when they are received in cash. Thus, for example, a
sale made to a customer on credit just before the year-end would be included
in that year's statement of profit or loss, even though the cash may not be
received until the following year.
In the same way, expenses are recognised according to the period to which
they relate, and not when they are paid. For example, an electricity bill not
paid by the year-end would still be charged in that year's statement of profit or
loss whereas rates paid in advance would be held back and not charged until
the next year.
12.2 ACCA SYLLABUS GUIDE OUTCOMES 2 - 5:

Identify and calculate the adjustments needed for accruals and prepayments
in preparing financial statements
Illustrate the process of adjusting 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.
12.2.1 Accrued expenses (accruals) are expenses which relate to an accounting

period but have not been paid for. They are expenses which are charged
against the profit for a particular period, even though they have not yet been
paid for.
Accruals are included in payables as current liabilities as they represent

liabilities which have been incurred but for which no invoice has yet been
received.
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Accounting Treatment: Accruals
Dr Expense (I/S)
Cr Accruals (SOFP)
Lecture Example 1
Light Stores receives electricity bills quarterly. It paid the following electricity
bills during its accounting year ended 28 Feb 20X7:
Date paid
$
4.6.X6 (covering quarter ended 31.5.20X6) 70.50
10.2. X7 (covering the two months to 28.1.20X7) 108.00
On 3.6.20X7 an electricity bill was received for $105 covering the quarter
ended 30 4.20X7.
On the basis of the above data, you are required to

a. calculate the electricity expense to be charged to the statement
of profit or loss for the year ended 28 February 20X7
b. calculate the amount of any accrual/prepayment at the end of
the year
c. state the journal entry for the accrual/prepayment
Lecture Example 2
A company pays rent quarterly in arrears on 1 January, 1 April, 1 July and 1

October each year. The rent was increased from $90,000 per year to
$120,000 per year as from 1 October 20X2.
What rent expense and accrual should be included in the company’s

financial statements for the year ended 31 January 20X3?
12.2.2 Prepaid expenses (prepayments) are expenses which have already

been paid but relate to a future accounting period. Therefore, these are
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.
162
Prepayments are included in receivables in current assets in the statement of
financial position. They are assets as they represent money that has been
paid out in advance of the expense being incurred.
Accounting Treatment: Prepayments
Dr Prepayments
(SOFP) Cr
Expense (I/S)
Lecture Example 3
A business opens a shop on 1 January 20X7. The rent is $20,000 per annum
and is payable quarterly in advance. Payments were made as follows: -
$
1 January 20X7 5,000
20 March 20X7 5,000
25 June 20X7 5,000
29 September 20X7 5,000
24 December 20X7 5,000
On the basis of the above data, you are required to

a. calculate the rent expense to be charged to the statement of
profit or loss for the year ended 31 December 20X7
b. calculate the amount of any accrual/prepayment at the end of
the year
c. state the journal entry for the accrual/prepayment
Lecture Example 4
Michelle rents premises at an annual rental of $1,000. The rates payable for
the accounting year 1 July 20X6 – 30 June 20X7, his first year of business,
were $360. Cheques for rent and rates were paid as follows: -
20X6 $
July 28 Rates for 9 months to 31 March 20X7 220
Sept 28 Rent for 3 months to 30 September 20X6 250
20X7
Jan 3 Rent for 3 months to 31 December 20X6 250
Mar 28 Rent for 3 months to 31 March 20X7 250
Apr 30 Rates for 6 months to 30 September 20X7 280
What rent and rates expense should be included in the company’s statement
of profit or loss for the year ended 30 June 20X7
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12.2.3 Reversal of Accruals and Prepayments
Accruals and prepayments brought forward at the beginning of the year must be
reversed.
Five steps are involved: -

a. At the beginning of the year, reverse opening accrual or prepayment
b. Double-entry: -
1. Reversal of an accrual
Dr Accruals (SOFP)
Cr Expense (I/S)
2. Reversal of a prepayment
Dr Expense (I/S)
Cr Prepayment (SOFP)
c. Post the cash paid during the year

d. Post any closing accrual or prepayment
e. Balance off the expense and accruals/prepayments accounts
Lecture Example 5
At 1 July 20X4 RCA Malta had prepaid insurance of $8,200. On 1 January 20X5
the company paid $38,000 for insurance for the year to 30 September 20X5.
What figures should appear for insurance in the company’s financial statements
for the year ended 30 June 20X5?
Statement of profit or loss Statement of Financial Position

A. $27,200 Prepayment $19,000
B. $39,300 Prepayment $9,500
C. $36,700 Prepayment $9,500
D. $55,700 Prepayment $9,500
164
Lecture Example 6
Details of a company’s insurance policy are shown below:

Premium for year ended 31 March 20X6 paid April 20X5 $10,800
Premium for year ending 31 March 20X7 paid April 20X6 $12,000
What figures should be included in the company’s financial statements for the
year ended 30 June 20X6?
$ $
A 11,100 9,000 prepayment (Dr)
B 11,700 9,000 prepayment (Dr)
C 11,100 9,000 accrual (Cr)
D 11,700 9,000 accrual (Cr)
12.2.4 Accrued and Deferred Income
An entity will accrue income when it has earned the income during the period but it
has not yet been invoiced or received. This will increase income in the statement of
profit or loss and be shown as a receivable in the statement of financial position at
year end.
Accounting Treatment: Accrued Income
Dr Accrued income (SOFP)

Cr Income Account (I/S)
When an entity has received income in advance of it being earned, it should be

deferred to the following period. This will reduce income in the statement of profit or
loss and be shown as a payable in the statement of financial position at the year
end.
Accounting Treatment: Deferred Income
Dr Income Account (I/S)

Cr Deferred Income (SOFP)
Lecture Example 7
A company sublets part of its office accommodation. In the year ended 30 June
20X5 cash received from tenants was $83,700.
Details of rent in arrears and in advance at the beginning and end of the year were:
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In arrears In advance
$ $
30 June 20X4 3,800 2,400
30 June 20X5 4,700 3,000
All arrears of rent were subsequently received.
What figure for rental income should be included in the company’s statement of profit
or loss for the year ended 30 June 20X5?
A. $84,000
B. $83,400
C. $80,600
D. $85,800
166
K
1. The accruals concept states that revenues should be recognised (i.e.

included in the statement of profit or loss) in the period in which they are
earned, not necessarily when they are received in cash. In the same way,
expenses are recognised according to the period to which they relate, and not
when they are paid.
2. Accrued expenses (accruals) are expenses which relate to an accounting

period but have not been paid for. Accruals are included in payables in current
liabilities as they represent liabilities which have been incurred but for which no
invoice has yet been received.
Accounting Treatment: Accruals
Dr Expense (I/S)
Cr Accruals (SOFP)
3. Prepaid expenses (prepayments) are expenses which have already been paid
but relate to a future accounting period. Prepayments are included in
receivables as current assets in the statement of financial position.
Accounting Treatment: Prepayments
Dr Prepayments
(SOFP) Cr
Expense (I/S)
167
4. Accruals and prepayments brought forward at the beginning of the year must
be reversed.
Four steps are involved: -

a. At the beginning of the year, reverse opening accrual or prepayment
b. Double-entry: -
1. Reversal of an accrual
Dr Accruals (SOFP)
Cr Expense (I/S)
2. Reversal of a prepayment
Dr Expense (I/S)
Cr Prepayment (SOFP)
c. Post the cash paid during the year

d. Post any closing accrual or prepayment
e. Balance off the expense and accruals/prepayments accounts
5. An entity will accrue income when it has earned the income during the period
but it has not yet been invoiced or received. This will increase income in the
statement of profit or loss and be shown as a receivable in the statement of
financial position at year end.
Accounting Treatment: Accrued Income
Dr Accrued income (SOFP)

Cr Income Account (I/S)
When an entity has received income in advance of it being earned, it should be

deferred to the following period. This will reduce income in the statement of
profit or loss and be shown as a payable in the statement of financial position at
the year end.
Accounting Treatment: Deferred Income
Dr Income Account (I/S)

Cr Deferred Income (SOFP)
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6. Effect on profit and assets/liabilities
Effect on Effect on profit Effect on

income/expense assets/liabilitie
s s
Accruals Increases Reduces profit Increases liabilities
expenses
Prepayments Reduces expenses Increases profit Increases assets
Prepayments of Reduces income Reduces profit Increases liabilities
income
Income accrued Increases income Increases profit Increases assetss
1. B, a limited liability company, receives rent for subletting part of its office
premises to a number of tenants.
In the year ended 31 December 20X4 B received cash of $318,600 from its
tenants.
Details of rent in advance and in arrears at the beginning and end of 20X4 are as
follows:
31 December 20X4 31 December 20X3
$ $
Rent received in advance 28,400 24,600
Rent owing by tenants 18,300 16,900
All rent owing was subsequently received
What figure for rental income should be included in the statement of profit or loss
of B for 20X4?
A. $341,000
B. $336,400
C. $300,800
D. $316,200
2. During 20X4, B, a limited liability company, paid a total of $60,000 for rent,
covering the period from 1 October 20X3 to 31 March 20X5.
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What figures should appear in the company’s financial statements for the year
ended 31 December 20X4?

A. $40,000 Prepayment $10,000
B. $40,000 Prepayment $15,000
C. $50,000 Accrual $10,000
D. $50,000 Accrual $15,000
3. Beth’s draft accounts for the year to 31 October 20X5 report a loss of $1,486.
When she prepared the accounts, Beth did not include an accrual of $1,625 and
a prepayment of $834.
What is Beth’s profit or loss for the year to 31 October 20X5 following the
inclusion of the accrual and prepayment?
A. a loss of $695
B. a loss of $2,277
C. a loss of $3,945
D. a profit of $1,807
4. Brighton has received telephone bills as follows:
Date received Amount of bill Date paid

$
Quarter to 30 November 20X0 December 20X0 739.20 Jan 20X1
Quarter to 28 February 20X1 March 20X1 798.00 April 20X1
Quarter to 31 May 20X1 June 20X1 898.80 June 20X1
Quarter to 31 August 20X1 September 20X1 814.80 Oct 20X1
Quarter to 30 November 20X1 December 20X1 840.00 Jan 20X2
Quarter to 28 February 20X2 March 20X2 866.00 March 20X2
What is the charge for telephone in the statement of profit or loss for the year
What is the amount of accrual or prepayment at 31 December 20X1?
5. On 1 April 20X0 a sole trader paid $3,080 in rent for the year ending 31 March
20X1. This was an increase of 10% on the charge for the previous year.
What is the correct charge for rent in her statement of profit or loss for the year
6. A business sublets part of its office accommodation.
The rent is received quarterly in advance on 1 January, 1 April, 1 July and 1

October. The annual rent has been $24,000 for some years, but it was increased
to $30,000 from 1 July 20X5.
170
What amounts for this rent should appear in the company’s financial statements
for the year ended 31 January 20X6?
A $27,500 $5,000 in sundry receivables

B $27,000 $2,500 in sundry receivables
C $27,000 $2,500 in sundry payables
D $27,500 $5,000 in sundry payables
ANS
1. D
Rent receivable A/c

$ $
Rent in arrears - reversal 16,900 Rent in advance - reversal 24,600
I/S 316,200 Cash 318,600
Rent in advance 28,400 Rent in arrears 18,300
361,500 361,500
2. A
60,000
- - - - - - - - - - - - - - - - -
- -
1/10 1/1/X4 31/12/X4 31/3/X5
Expense = 60,000 x 12 months = 40,000

18 months
Prepayment = 60,000 x 3 = 10,000

18
3. B
$
Original loss (1,486)
171
Accrual (1,625)
Prepayment 834
Revised loss (2,277)
4. $3,374.27
(2/3 × 798.00) + 898.80 + 814.80 + 840.00 + (1/3 × 866.00)
5. $3,010
$
$3,080 × 9/12 2,310
$3,080 × 100/110 × 3/12 700
172
3,010
6.
Rent receivable A/c

$ $
1.1 Statement of profit or loss 27,500 1.2 Rent in advance - reversal 4,000
1.4 Cash 6,000
1.7 Cash 7,500
1.10 Cash 7,500
1.1 Cash 7,500
31.1 Rent in advance 5,000
32,500 32,500
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Chapter 13
Irrecoverable Debts and
Allowance for Receivables

Identify the benefits and costs of offering credit facilities to customers
Today, very few businesses expect to be paid immediately in cash. Most

businesses buy and sell to one another on credit terms. A business will allow credit
terms to customers and receive credit terms from its suppliers. This provides the
benefit of allowing businesses to keep trading without having to provide cash 'up
front'.
However, providing credit facilities to customers can lead to problems. Customers

might fail to pay, either out of dishonesty or because they have gone bankrupt.
Therefore, the costs of offering credit facilities to customers can include:
1. Interest costs of an overdraft, if customers do not pay promptly.

2. Costs of trying to obtain payment, e.g. chasing customers by phone
3. Court costs, e.g. the costs of legal letters

Understand the purpose of an aged receivables analysis
A tool to control these problems of providing credit facilities is the aged receivables
analysis. This shows how long invoices have been outstanding, current, 30 days,
60 days, 90 and 90+ days, and may also indicate that a customer is unable to pay.
Most credit controllers will have a system of chasing up payment for long outstanding
invoices.

Understand the purpose of credit limits
Another tool in credit control is the credit limit. A customer will be given a credit limit,
which cannot be exceeded. This is a threshold that a company will allow its
customers to owe at any one time without having to go back and review their credit
file. Credit limit is the maximum amount that a firm is willing to risk in an account.
174
Prepare the book-keeping entries to write off an irrecoverable debt
Irrecoverable debts (bad debts) are specific debts owed to a business which it
decides are never going to be paid. If a debt is definitely irrecoverable, the prudence
concept dictates it should be written off to the statement of profit or loss as a bad
debt. The value of outstanding receivables must be reduced by the amount written
off. This is because the customers are no longer expected to pay, and it would be
misleading to show them in the statement of financial position as current assets of
the business for which cash payment is expected within one year.
Accounting treatment
Dr Bad debts expense (I/S)

Cr Trade Receivables (SOFP)
Lecture Example 1
Dora Co has trade receivables at 31 December 20X7 of $100,000. A customer,

Swiper Inc, who owes Dora Co $5,000, at the end of 20X7, has been declared
bankrupt and the whole amount is considered irrecoverable.
Required: -
a) Calculate the new balance on the trade receivables account
b) Calculate the bad debts expense which is transferred to the statement of profit
or loss

Record a bad (irrecoverable) debt recovered
An irrecoverable debt which has been written off might occasionally be unexpectedly
paid. If it is paid in the same accounting period, the write-off journal can simply be
reversed. The only accounting problem to consider is when a debt written off as
irrecoverable in one accounting period is subsequently paid in a later accounting
period. In this case, the amount paid should be recorded as additional income in the
statement of profit or loss of the period in which the payment is received.
Accounting Treatment
Dr Cash
Cr Trade Receivables
Dr Trade Receivables
Cr Bad debts recovered (I/S)
175
Lecture Example 2
Following from Lecture Example 1, Dora Co subsequently received a cheque from

Swiper Inc of $5,000.
Required: -
Show the treatment of this transaction in the relevant ledger accounts

Prepare the book-keeping entries to create and adjust an allowance for
receivables
13.6.1 Doubtful Debts:
If a debt is possibly irrecoverable, an allowance for the potential irrecoverability of

that debt should be made.
Dr Doubtful debt expense (I/S)

Cr Allowance for receivables (SOFP)
This allowance is offset against trade receivables in the statement of financial

position.
Lecture Example 3
Following from Lecture Example 1, a further review of Dora’s customer files

indicates that there is some uncertainty whether Benny Co will pay its amount due of
$2,500.
Required: -
Show the necessary entries in the relevant ledger accounts
13.6.2 Types of allowances:
There are two types of allowance for receivables.

1. Specific allowance – an allowance against a particular receivable (e.g.
Lecture example 3 – an allowance provided against Benny Co)
2. General allowance – a percentage allowance based on past experience of
irrecoverable debts (e.g. 2% of all outstanding receivables)
176
Therefore, an allowance for receivables provides for future irrecoverable debts, as a
prudent precaution by the business. For both types of allowance for receivables,
the double-entry still remains: -

13.6.3 Specific allowance:
There are two situations in which a specific allowance previously done is no longer
required: -
1. customer pays outstanding amount
2. customer goes bankrupt
13.6.3.1 Customer pays outstanding amount
Dr Cash (SOFP)
Dr Allowance for receivables (SOFP)

Cr Doubtful debts expense
(I/S)
Therefore, this will be credited to income in the statement of profit or loss or it will
reduce the total expense for bad and doubtful debts.
Lecture Example 4
Following from Lecture Examples1 and 3, Benny Co has paid his amount due of
$2,500 in cash.
Required: -
Show the accounting treatment in the books of Dora Co.
13.6.3.2 Customer goes bankrupt

177
Therefore, no entry is posted in the bad and doubtful debts account as this would
have already been debited with the expense in the first year when we have taken the
specific allowance.
Lecture Example 5
Following from Lecture Examples 1 and 3, Benny Co has been declared bankrupt
and his amount due of $2,500 is now considered irrecoverable.
Required: -
Show the accounting treatment in the books of Dora Co.
13.7 ACCA SYLLABUS GUIDE OUTCOME 7

Illustrate how to include movements in the allowance for receivables in the
statement of profit or loss and how the closing balance of the allowance
should appear in the statement of financial position
13.7.1 How do we calculate the general allowance?
There are a number of steps which must be followed.
1. Take the balance on the trade receivables account after posting credit sales
and cash received from credit customers
2. Deduct bad debts from this balance of trade receivables
3. Deduct also any specific allowances from trade receivables
4. Calculate the general allowance by applying the percentage given to the
remaining balance
Example: - General allowance

$
Trade receivables (net of bad debts written off) 10,000
Less: specific allowance ( 2,000)
8,000
General allowance @ 2% (2% x 8,000) 160
13.7.2 General allowance – subsequent years
In subsequent years, adjustments may be needed to the amount of the allowance.

The procedure to be followed then is: -
1. Calculate the new allowance required.
2. Compare it with the existing balance on the allowance account (i.e. the
balance b/f from the previous accounting period).
3. Calculate increase or decrease required.
178
(i) If a higher allowance is required now:
Dr Irrecoverable debts expense
Cr Allowance for receivables
with the amount of the increase.
(ii) If a lower allowance is needed now than before:
Dr Allowance for receivables
Cr Irrecoverable debts expense
with the amount of the decrease.
Lecture Example 6
A. Boots has total receivables outstanding at 31 December 20X2 of $28,000. He

believes that about 1% of these balances will not be collected and wishes to make
an appropriate allowance. Before this date, he has not made any allowance for
receivables at all.
On 31 December 20X3 his trade receivables amount to $40,000. His experience
during the year has convinced him that an allowance of 5% should be made.
What accounting entries should A. Boots make on 31 December 20X2 and 31

December 20X3, and what figures for trade receivables will appear in his statement
of financial position at those dates?
Lecture Example 7
At 31 December 20X4 a company’s trade receivables totalled $864,000 and the

allowance for receivables was $48,000.
It was decided that debts totalling $13,000 were to be written off, and the allowance
for receivables adjusted to five per cent of the receivables.
What figures should appear in the statement of financial position for trade
receivables (after deducting the allowance) and in the statement of comprehensive
income for the total of irrecoverable debts and movement on receivables allowance?
Irrecoverable debts
and receivables allowance Net trade receivables
$ $
A. 8,200 807,800
B. 7,550 808,450
C. 18,450 808,450
D. 55,550 808,450
179
Prepare, reconcile and understand the purpose of supplier statements.
Lecture Example 8
Alpha buys goods from Beta. At 30 June 20X5 Beta's account in Alpha's records
showed $5,700 owing to Beta. Beta submitted a statement to Alpha as at the same
date showing a balance due of $5,200.
Which of the following could account fully for the difference?

A. Alpha has sent a cheque to Beta for $500 which has not yet been
received by Beta.
B. The credit side of Beta's account in Alpha's records has been
undercast by $500.
C. An invoice for $250 from Beta has been treated in Alpha's records as if
it had been a credit note.
D. Beta has issued a credit note for $500 to Alpha which Alpha has not
yet received.
180
K
1. Credit facilities provide the benefit of allowing businesses to keep trading
without having to provide cash 'up front'. However, providing credit facilities to
customers can lead to problems. Customers might fail to pay, either out of
dishonesty or because they have gone bankrupt.
2. An aged receivables analysis shows how long invoices have been

outstanding and may also indicate that a customer is unable to pay.
3. A credit limit is a threshold that a company will allow its customers to owe at
any one time without having to go back and review their credit file.
4. Irrecoverable debts (bad debts) are specific debts owed to a business which
it decides are never going to be paid.
Dr Bad debts expense (I/S)

5. An irrecoverable debt which has been written off might occasionally be

unexpectedly paid.
Dr Cash
Cr Trade Receivables
Dr Trade Receivables
Cr Bad debts recovered (I/S)
6. If a debt is possibly irrecoverable, an allowance for the potential

irrecoverability of that debt should be made.

7. There are two types of allowance for receivables.

a. Specific allowance – an allowance against a particular receivable
b. General allowance – a percentage allowance based on past
experience of irrecoverable debts (e.g. 2% of all outstanding
receivables)
181
8. There are two situations in which a specific allowance previously done is no
longer required: -
a. customer pays outstanding amount
Dr Cash (SOFP)

Cr Doubtful debts expense
(I/S)
b. customer goes bankrupt

9. General allowance – calculation
a. Take the balance on the trade receivables account after posting credit
sales and cash received from credit customers
b. Deduct bad debts from this balance of trade receivables
c. Deduct also any specific allowances from trade receivables
d. Calculate the general allowance by applying the percentage given to
the remaining balance
10. In subsequent years, adjustments may be needed to the amount of the

allowance. The procedure to be followed then is: -
(i) Calculate the new allowance required.
(ii) Compare it with the existing balance on the allowance
(iii) Calculate increase or decrease required.
182
Q
1. A company has been notified that a receivable has been declared bankrupt.
The company had previously made a specific allowance for this debt. Which
of the following is the correct double entry?
DR CR
A. Irrecoverable debts account Account receivable
B. Account receivable Irrecoverable debts account
C. Allowance for receivables Account receivable
D. Account receivable Allow for receivables
2. At 30 June 20X4 a company's allowance for receivables was $39,000. At 30

June 20X5 trade receivables totalled $517,000. It was decided to write off
debts totalling $37,000 and to adjust the allowance for receivables to the
equivalent of 5 per cent of the trade receivables based on past events.
What figure should appear in the statement of comprehensive income for

these items?
A. $61,000
B. $22,000
C. $24,000
D. $23,850
3. At 1 January 20X5, a company had an allowance for receivables of $18,000.

At 31 December 20X5 the company’s trade receivables were $458,000.
It was decided:
a) To write off debts totalling $28,000 as irrecoverable;
b) To adjust the allowance for receivables to the equivalent of 5% of the
remaining receivables based on past experience.
What figure should appear in the company’s statement of comprehensive

income for the total of debts written off as irrecoverable and the movement in
the allowance for receivables for the year ended 31 December 20X5?
A. $49,500
B. $31,500
C. $32,900
D. $50,900
4. At 1 July 20X5 a company’s allowance for receivables was $48,000.

At 30 June 20X6, trade receivables amounted to $838,000. It was decided
to write off $72,000 of these debts and adjust the allowance for receivables to
$60,000.
183
What are the final amounts for inclusion in the company’s statement of
financial position at 30 June 20X6?
Trade Allowance for Net
Receivables Receivables Balance
$ $ $
A. 838,000 60,000 778,000
B. 766,000 60,000 706,000
C. 766,000 108,000 658,000
D. 838,000 108,000 730,000
5. At 1 January 20X6, a company had an allowance for receivables of $49,000.

At 31 December 20X6, the company’s trade receivables were $863,000 and it
was decided to write off balances totalling $23,000 and to adjust the
allowance for receivables to the equivalent of 5% of the remaining receivables
based on past experience.
What total figure should appear in the company’s statement of comprehensive

income for irrecoverable debts and allowance for receivables?
A. $16,000
B. $65,000
C. $30,000
D. $16,150
ANS
1. C
2. B
Allowance for receivables ((517,000 – 37,000) × 5%) 24,000

Previous allowance (39,000)
Reduction (15,000)
Debts written off 37,000
Charge to statement of profit or loss 22,000
3. B
$
Closing receivables 458,000
Irrecoverable debts w/off (28,000)
430,000
Allowance required (5% × 430,000) 21,500
Existing allowance (18,000)
Increase required 3,500
Charge to statement of profit or loss (28,000 + 3,500) 31,500
184
4. B
Trade receivables = 838,000 – 72,000

= 766,000
Allowance for receivables =
60,000 Net balance = 766,000 –
60,000
= 706,000
5. A
Trade receivables 863,000

Irrecoverable debts w/off (23,000)
840,000
Closing allowance for receivables (5% × 840,000) 42,000

Opening allowance 49,000
Reduction (7,000)
Charge = 23,000 – 7,000 = 16,000
185
Chapter 14
Control Accounts

Understand the purpose of control accounts for accounts receivable and
accounts payable
A control account is a total account in the nominal ledger. Its balance represents an
asset or a liability which is the grand total of many individual assets or liabilities. The
control accounts provide a convenient total which can be used immediately in
extracting a trial balance or preparing accounts.
Most businesses operate control accounts for trade receivables and payables, but
such accounts may be useful in other areas too, e.g. sales tax control account.
The accounts of individual trade receivables and payables are found in the
Receivables Ledger (RL) and Payables Ledger (PL) respectively. These are
maintained for memorandum purposes only. Therefore, entering a sales invoice in
the account of an individual customer is not part of the double entry process. These
individual accounts are necessary for administrative convenience. For example, a
customer may wish to query the balance he owes to the business.
Reconciliation between the control account total and the receivables ledger will help
to detect errors, thus providing an important control.

Understand how control accounts relate to the double-entry system
In Chapter 5, we discussed the books of prime entry. We have also looked at the
flow of information where we have seen that the totals from the books of prime entry
are posted in the nominal accounts using double-entry.
186
B = $600 B = $450
Source Cheques
Invoices Received
Documents A= A =
$500 $520
Books of Memorandum
Original Ledger
Entry Receivables
Sales Day Ledger Cash Book
Book (personal accounts)
$ A B $
A 500 500 520 600 450 A 520
B 600 Balance Balance B 450
Total 1100 =$20CR =$150DR 970
Overall Balance
= $130DR
Receivables account
Ledger Sales account (control a/c) Cash account
Accounts CR Total DR Total
(Nominal Sales $1100 DR Total $ Sales $970
/ Sales 1100
CR Total
General
Cash 970
Ledger)
Balance (DR)
130
The trade receivables figure shows the total amount owed by all customers at a
particular point in time. It is also called the receivables ledger control account
(RLCA).
The trade payables figure shows the total amount owed to all suppliers at a particular
point in time. It is also called the payables ledger control account (PLCA).
187
Prepare ledger control accounts from given information
14.3.1 Main entries in control accounts
The two main entries in the RLCA are credit sales and cash received from credit
customers.
The double-entry for credit sales is: -
Dr RLCA
Cr Sales
The double-entry for cash received from customers is: -
Dr Bank/Cash
Cr RLCA
The two main entries in the PLCA are credit purchases and cash paid to credit
suppliers.
The double-entry for credit purchases is: -
Dr Purchases
Cr PLCA
The double-entry for cash paid to suppliers is: -
Dr PLCA
Cr Bank/Cash
There are other entries which will be included in the control accounts. It is important
to note that any transaction recorded in the RLCA or the PLCA is also reflected in
the memorandum ledgers.
14.3.2 Other entries in control accounts
14.3.2.1 Contras
This is where an amount of money is owed to a supplier, who is also a customer who
owes money, i.e., a payable who is also a receivable. Instead of paying the full
amount to the creditor, who then pays the full amount of their debt to you, the two
amounts owed and owing are offset against each other and only the difference is
settled in cash. This must be reflected in the individual accounts in the sales and
purchase ledgers and in the control accounts in the nominal ledger.
188
The double entry for a contra is: -
Dr PLCA
Cr RLCA
The contra value is of the maximum common amount. A contra always has the effect
of reducing both receivables and payables.
14.3.2.2 Returns, Credit Notes and Refunds
When a customer returns goods which have already been paid, he may either be
given a credit note or refunded for the value of these returned goods.
When a credit note is given, the double-entry is: -
Dr Returns In (sales
returns) Cr RLCA
When the customer is refunded: -
Dr RLCA
Cr Bank
The same applies when a customer over-pays an invoice.
14.3.2.3 Interest charged on overdue accounts
An entity may decide to charge interest if a customer does not pay within the
specified credit period.
The double-entry for interest charged on these overdue accounts is: -
Dr RLCA
Cr Interest Receivable (Income (I/S))
14.3.2.4 Discounts
There are two types of discounts: -
1. Trade discount is a reduction in the list price of an article, given by a wholesaler

or manufacturer to a retailer. It is often given in return for bulk purchase orders.
2. Cash/settlement discount is a reduction in the amount payable for the purchase
of goods or services in return for payment in cash, or within an agreed period.
189
Trade discounts received are deducted from the cost of purchases. Trade discounts
allowed are deducted from sales. Therefore, sales are recorded net of trade
discounts but inclusive of settlement discounts. Purchases are also recorded
net of trade discounts but inclusive of settlement discounts. Therefore, trade
discounts never appear in the financial statements.
Lecture Example 1
Joe buys goods worth $3,500 from Eddie. On $2,000 worth, he gets trade discount
of 20%, no trade discount is available on the rest. However Joe always makes sure
that he pays within 10 days in order to obtain Eddie's settlement discount of 5%.
How much will Joe pay Eddie?
A. $2,495
B. $2,945
C. $2,800
D. $3,025
Sales Tax and Discounts
Sales tax is calculated on the amount after all discounts, regardless of whether the
discount is taken or not.
Lecture Example 2
Cloud buys goods with a list price of $50,000 from Moon. Cloud receives a trade
discount of 12% from Moon on all its purchases and a further 4% discount if payment
is made within 10 days. Sales tax is charged at 15%.
What figure should Cloud show in Moon’s personal account to record its purchase?
14.3.3 Proforma Receivables Ledger Control Account
190
Receivables Ledger Control A/c
$ $
Balance b/d 7,120 cash received 52,450
Sales 52,500 Discounts allowed 1,250
Dishonoured cheques 1,000 Returns in 800
Irrecoverable debts 300
Balance c/d 5,820
60,620 60,620
14.3.4 Proforma Payables Ledger Control Account
Payables Ledger Control A/c

$ $
Cash paid 29,840 Balance b/d 8,300
Discounts received 100 Purchases 31,100
Returns out 60
Balance c/d 9,400
39,400 39,400
Lecture Example 3
For the year ended 30 September 20X9 the following particulars are available.
$
Sales 63,728
Purchases 39,974
Cash from trade accounts receivable 55,212
Cash to trade accounts payable 37,307
Discount received 1,475
Discount allowed 2,328
Returns inwards 1,002
Returns outwards 535
Irrecoverable debts written off 326
Cash received in respect of debit balances in payables ledger 105
Amount due from customer as shown by receivables ledger,
offset against amount due to the same firm as shown by
payables ledger (settlement by contra) 434
Allowances to customers on goods damaged in transit 212
On 1st Oct 20X8 Trade Rec were $8024 Dr

$ 57 Cr
Trade Pay were $6235 Cr

$105 Dr
191
On 30 September 20X9 there were no credit balances in the receivables ledger
except those outstanding on 1 October 20X8, and no debit balances in the payables
ledger.
You are required to write up the following accounts recording the above transactions
bringing down the balances as on 30 September 20X9:
a. Receivables control account
b. Payables control account
14.3.5 Control account balances
Very often, PLCA’s have a credit balance since payables are a liability. However,
there may be situations when there will be a debit balance on a PLCA
a) Returning goods which have been paid for and receiving a ‘credit’ (to us, a
debit) on our account
b) Overpayment
c) Payments in advance
There may be situations when there will be a credit balance on a RLCA
a) Returned goods credit to account

b) Overpayment
c) Payments in advance
14.4 ACCA SYLLABUS GUIDE OUTCOME 4-6:

Perform control account reconciliation for accounts receivable and accounts
payable
Identify errors which would be highlighted by performing control account
reconciliation
Identify and correct errors in control accounts and ledger accounts
Both the receivables and payables control accounts should be balanced regularly
and the balance agreed to the sum of the balances on the memorandum ledgers, the
receivables ledger and the payables ledger respectively.
Therefore, if the balances in the receivables/payables ledgers are added up, they
should agree to the RLCA/PLCA balances. If not, an error must have occurred at
the same point in the system.
14.4.1 Types of error
Errors which affect the control accounts:
192
a) Over/undercast SDB, PDB, CB.
b) Transposition error in posting total from SDB/PDB/CB to nominal ledger.
c) Entry omitted from SDB/PDB/CB.
Errors which affect the list of balances (receivables/payables ledger):
a) Omit balance from the list.

b) List a debit balance as a credit/vice versa.
c) Transposition error in filling ledger from books of prime entry.
Errors which affect both the lists of balances and RLCA/PLCA:
a) Details being incorrectly recorded on the original source documentation i.e.

sales/purchase invoice.
b) Loss of original source documentation so it is not recognised anywhere in the
system.
14.4.2 Proforma Receivables Ledger Control Account Reconciliation

$ $
Balance b/d X Transposition error in posting X
Sales day book undercast X
Sales omitted from SDB X Balance c/d X
X X
Reconciliation Statement
$ $ $
+ -
Total per listing of receivables ledger balances X

Adjustments:
Balance omitted X
Credit balance listed as debit (2X)
X X X
Balance as per adjusted control account X
193
14.4.3 Proforma Payables Ledger Control Account Reconciliation
Payables Ledger Control A/c

$ $
Transposition error in posting X Balance n/d X
Purchase day book undercast X
Balance c/d X Purchases omitted from PDB X
X X
Reconciliation Statement
$ $ $
+ -
Total per listing of payables ledger balances X

Adjustments:
Balance omitted X
Debit balance listed as credit (2X)
X X X
Balance as per adjusted control account X
Lecture Example 4
A receivables ledger control account shows a balance of $35,100, while the list of
balances totals $36,500.
The following discrepancies are discovered:
a. A credit balance of $350 has been included in the list of balances as a debit
b. A refund of $125 has not been posted to the receivables ledger control
account
c. One page of the sales day book has been undercast by $575
What is the reconciled balance?
A. $36,500
B. $35,800
C. $35,225
D. $37,200
Lecture Example 5
In reconciling the payables control account to the payables ledger, the following
discrepancies are noticed:
a. a credit note for $105 has been posted to the wrong side of the control
account;
b. the payables ledger has not been adjusted for a receivables ledger offset of
$2,055;
194
c. an account with a credit balance of $348 has been omitted from the list of
payables ledger balances.
The balance on the payables control account is $3,627. The balance on the
payables ledger is $5,124.
What is the reconciled balance?
A. $3,627
B. $3,069
C. $3,417
D. $3,765
1. The Main Purpose of Control Accounts
The main purposes of control accounts include:
(i) to provide a check on the accuracy of entries in the individual accounts;

(ii) to provide a total of debtors and creditors at any time in an accounting
period;
(iii) to identify errors in the completion of the day books and in posting day
book totals;
(iv) to provide an internal check – where the system is being administered by
several persons it is important that internal controls exist and their work is
checked. The control account should be prepared by a person other than
the one completing the day books.
2. Main Entries in Control Accounts
a. Credit Sales
The double-entry for credit sales is: -
Dr RLCA
Cr Sales
b. Cash received from credit customers
195
The double-entry for cash received from customers is: -
Dr Bank/Cash
Cr RLCA
c. Credit purchases
The double-entry for credit purchases is: -
Dr Purchases
Cr PLCA
d. Cash paid to suppliers
The double-entry for cash paid to suppliers is: -
Dr PLCA
Cr Bank/Cash
196
3. Other Entries in Control Accounts
a. Contras
The double entry for a contra is: -
Dr PLCA
Cr SLCA
The contra value is of the maximum common amount. A contra always has the
effect of reducing both receivables and payables.
b. Returns, Credit Notes and Refunds
When a credit note is given, the double-entry is: -
Dr Returns In (sales
returns) Cr RLCA
When the customer is refunded: -
Dr RLCA
Cr Bank
c. Interest charged on overdue accounts
The double-entry for interest charged on these overdue accounts is: -
Dr RLCA
Cr Interest Receivable (Income (I/S))
d. Discounts
Sales are recorded net of trade discounts but inclusive of settlement discounts.
Purchases are also recorded net of trade discounts but inclusive of settlement
discounts.
The double-entry for discounts allowed to customers is: -
Dr Discounts allowed
Cr RLCA
The double-entry for discounts received from suppliers is: -
Dr PLCA
197
Cr Discounts received
Sales tax is calculated on the amount after all discounts, regardless of whether the
discount is taken or not.
4. Control Account Reconciliations
Both the receivables and payables control accounts should be balanced regularly
and the balance agreed to the sum of the balances on the memorandum ledgers, the
receivables ledger and the payables ledger respectively.
Types of error: -
Errors which affect the control accounts:

a) Over/undercast SDB, PDB, CB.
b) Transposition error in posting total from SDB/PDB/CB to nominal ledger.
c) Entry omitted from SDB/PDB/CB.
Errors which affect the list of balances (receivables/payables ledger):

a) Omit balance from the list.
b) List a debit balance as a credit/vice versa.
c) Transposition error in filling ledger from books of prime entry.
Errors which affect both the lists of balances and RLCA/PLCA:

a) Details being incorrectly recorded on the original source documentation i.e.
sales/purchase invoice.
b) Loss of original source documentation so it is not recognised anywhere in the
system.
198
Q
1. The balance on the receivables ledger control account is $52 more than the
list of customer balances.
This could be caused by which one of the following?
A. An invoice for $52 omitted from the sales day book

B. A credit note for $52 omitted from the sales returns day book
C. A customer refund of $52 posted twice to the nominal ledger
D. A credit note for $26 entered twice into the receivables ledger
2. Mabel's supplier has allowed her 5% discount for prompt payment of her
account. How should this be posted?
A. DR Payables ledger control account; CR Discounts allowed

B. DR Discounts allowed; CR Payables ledger control account
C. DR Payables ledger control account; CR Discounts received
D. DR Discounts received; CR Payables ledger control account
3. Andrew buys goods with a list price of $7,200 on which he receives 20% trade
discount. His supplier offers 5% discount for payment within 10 days.
Andrew pays half of the invoiced amount within 10 days and the balance 3
weeks later.
What is the total amount of money that he will pay for this order?
A. $5,616
B. $5,580
C. $5,400
D. $6,300
4. Which of the following is not the purpose of a receivables ledger control

account?
A. A receivables ledger control account provides a check on the

arithmetical accuracy of the personal ledger
B. A receivables ledger control account helps to locate errors in the trial
balance
C. A receivables ledger control account ensures that there are no errors in
the personal ledger
D. Control accounts deter fraud
199
5. In an accounts receivable control account, which of the following lists is
composed only of items which would appear on the credit side of the
account?
A. Cash received from customers, sales returns, irrecoverable debts
written off, contras against amounts due to suppliers in the accounts
payable ledger
B. Sales, cash refunds to customers, irrecoverable debts written off,
discounts allowed
C. Cash received from customers, discounts allowed, interest charged on
overdue accounts, irrecoverable debts written off
D. Sales, cash refunds to customers, interest charged on overdue
accounts, contras against amounts due to suppliers in the accounts
payable ledger.
6. Ordan received a statement from one of its suppliers, Alta, showing a

balance due of $3,980. The amount due according to the payables ledger
account of Alta in Ordan’s records was only $230. Comparison of the
statement and the ledger account revealed the following differences:
(i) A cheque sent by Ordan for $270 has not been allowed for in
Alta’s statement.
(ii) Alta has not allowed for goods returned by Ordan $180.
(iii) Ordan made a contra entry, reducing the amount due to Alta by
$3,200, for a balance due from Alta in Ordan’s receivables
ledger. No such entry has been made in Alta’s records.
What difference remains between the two companies’ records after

adjusting for these items?
A. $460
B. $640
C. $6,500
D. $100
7. A payables ledger control account showed a credit balance of $768,420. The

payables ledger balances totalled $781,200.
Which one of the following possible errors could account in full for the
difference?
A. A contra against a receivables ledger debit balance of $6,390 has been

entered on the credit side of the payables ledger control account.
B. The total of discount allowed $28,400 was entered to the debit of the
payables ledger control account instead of the correct figure for
discount received of $15,620.
200
C. $12,780 cash paid to a supplier was entered on the credit side of the
supplier’s account in the payables ledger.
D. The total of discount received $6,390 has been entered on the credit
side of the payables ledger control account.
8. The following receivables ledger control account has been prepared by a

trainee accountant:

20X5 $ 20X5 $
01-Jan Balance 318,650 31-Jan Cash from credit 181,140
Credit sales 161,770 customers
Cash sales 84,260 Interest charged on 280
Discounts allowed 1,240 overdue accounts
Irrecoverable debts
written off 1,390
Sales returns from
credit customers 3,990
Balance 379,120
565,920 565,920
What should the closing balance at 31 January 20X5 be after correcting the
errors in the account?
A. $292,380
B. $295,420
C. $292,940
D. $377,200
9. The receivables ledger control account below contains several incorrect

entries
Receivables Ledger Control Account

$ $
Balance 138,400 Credit sales 80,660
Cash received from Contras against credit balances 1,000
credit customers 78,420 in payables ledger
Discounts allowed 1,950
Irrecoverable debts 3,000
written off
Dishonoured cheques from 850
credit customers
Balance 129,360
216,820 216,820
201
What should the closing balance be when all the errors are corrected?
A. $133,840
B. $135,540
C. $137,740
D. $139,840
10. The following payables ledger control account contains some errors. All
goods are purchased on credit.
Payables Ledger Control Account

$ $
Purchases 963,200 Opening balance 384,600
Discounts received 12,600 Cash paid to suppliers 988,400
Contras with amounts 4,200 Purchases returns 17,400
receivable in receivables
ledger
Closing balance 410,400
1,390,400 1,390,400
What should the closing balance be when the errors have been corrected?
A. $325,200
B. $350,400
C. $358,800
D. $376,800
A
1. C
2. C
The discount reduces the amount owing to creditors, so it is debited to the

payables ledger control account, and it is credited to 'discounts received' in
the statement of profit or loss. 'Discounts allowed' is used to post
discounts granted to customers.
202
3. A
$
Purchase price (7,200 x 80%) 5,760
Discount ((5,760/2) x 5%)
(144)
5,616
4. C
5. A
6. D
$
Balance per Alta 3,980
Cheque not yet received (270)
Goods returned (180)
Contra Entry (3,200)
Revised Balance per Alta 330
Balance per Ordan (230)
Remaining Difference 100
7. B is correct.
A – The contra should be debited. Hence reduce further the PLCA

by twice the amount, $6,390 x 2 = $12,780.
B – Increase the balance of the PLCA by $12,780 (28,400 –
15,620). C – Reduce the ledger by twice the amount of $12,780.
D – Reduce the PLCA balance by twice the amount of $6,390.
203
8. C

20X5 $ 20X5 $
01-Jan Balance 318,650 31-Jan Cash from credit 181,140
Credit sales 161,770 customers
Interest charged on 280 Discounts allowed 1240
overdue accounts Irrecoverable debts
written off 1,390
Sales returns from
credit customers 3,990
Balance 292,940
480,700 480,700
9. B
$ $
Balance 138,400 Cash received 78,420
Credit sales 80,660 Contras against credit balances 1,000
Dishonoured cheques from 850 in payables ledger
credit customers Discounts allowed 1,950
Irrecoverable debts 3,000
written off
Balance 135,540
219,910 219,910
10. A
Payables Ledger Control Account

$ $
Cash paid to suppliers 988,400 Opening balance 384,600
Discounts received 12,600 Purchases 963,200
Contras with amounts 4,200
receivable in receivables
ledger
Purchases returns 17,400
Closing balance 325,200
1,347,800 1,347,800
204
Chapter 15
Bank Reconciliation

Understand the purpose of bank reconciliations
We have already discussed the cash book as one of the main books of prime entry.
The cash book is used to record the detailed transactions of receipts and payments
affecting the bank account. These are then posted to the nominal ledger periodically.
At the end of each accounting period, the balance on the cash book should equal the
balance in the nominal ledger cash/bank account.
As an extra control over the cash figure, it should be possible to agree this figure to
an independent figure provided by the bank statement. This is not always a
straightforward agreement as there are many reasons why the two figures may not
be exactly the same. Therefore, we need to produce a reconciliation.
The aim of the reconciliation is to prove the

1. completeness
2. accuracy
3. validity
of cash receipts and payments.

Identify the main reasons for differences between the cash book and the bank
statement
The balance on the cash account (which should be the same as the balance in the
cash book) is compared to the balance on the bank statements at a given date.
However, these two balances may not agree. There are various reasons: -
1. Time lag between writing a cheque and the payment appearing on the bank
statement (unpresented cheques)
2. Time lag between depositing amounts into the bank account and these
appearing on the bank statement (unrecorded lodgements)
3. Direct debits and standing orders are not yet recorded in the cash account (or
cash book)
4. Bank charges not recorded in the cash account (or cash book)
5. Errors, such as transposition errors, or casting errors in the cash account (or
cash book)
6. Errors made by the bank on the bank statement
205
Therefore, differences between the cash book and the bank statement arise for 3
reasons:
1. Errors – usually in the cash book

2. Omissions – such as bank charges, standing orders and direct debits not
posted in the cash book
3. Timing differences – such as unpresented cheques and unrecorded
lodgements
Always remember: -
In our cash book,

A debit bank balance indicates an asset
but
In the bank statement,
A debit balance indicates a bank overdraft (we owe money to the bank – an asset
for the bank)
In our cash book,

A credit bank balance indicates a liability (overdraft)
but
In the bank statement,
A credit balance indicates a positive balance (the bank owes us money)
206
15.3 ACCA SYLLABUS GUIDE OUTCOMES 3 and 4
Correct cash book errors and/or omissions
Prepare bank reconciliation statements
Example – Bank Reconciliation Statement
Bank Account
Balance b/d X Dishonoured cheque X

Direct Credit X Standing order X
Bank charges X
Direct debit X
Balance c/d X
X X
Balance as per bank statement X

less unpresented cheques (X)
add unrecorded lodgements X
add/less bank errors X
Balance as per adjusted cash book X
Lecture Example 1
At 30 September 20X6, the balance in the cash book of Wordsworth Co was

$805.15 debit. A bank statement on 30 September 20X6 showed Wordsworth Co
to be in credit by $1,112.30.
On investigation of the difference between the two sums, it was established that:
1. The cash book had been undercast by $90.00 on the debit side.
2. Cheques paid in not yet credited by the bank amounted to $208.20, called
outstanding lodgements.
3. Cheques drawn not yet presented to the bank amounted to $425.35 called
unpresented cheques.
Required
a. Show the correction to the cash book.
b. Prepare a statement reconciling the balance per bank statement to the
balance per cash book.
207
Lecture Example 2
Gemma is reconciling her cash book to the bank statement. Her cash balance is
$2,357 and the balance on her statement is $25 overdrawn. She finds the following
differences:
a. bank charges of $23 and direct debits totalling $100 have not been
posted to the cash book;
b. there are unpresented cheques of $324; she paid in a batch of
cheques two days ago totalling $2,503 and these have not yet been
credited to her account;
c. a cheque she paid in last week for $80 has been dishonoured.
What will the reconciled balance be?
A. $2,154
B. $2,204
C. $2,357
D. $2,277
15.4 ACCA SYLLABUS GUIDE OUTCOMES 5 and 6

Derive bank statement and cash book balances from given information
Identify the bank balance to be reported in the final accounts.
Lecture Example 3
A bank statement shows a balance of $1,200 in credit. An examination of the

statement shows a $500 cheque paid in per the cash book but not yet on the bank
statement and a $1,250 cheque paid out but not yet on the statement. In addition the
cash book shows deposit interest received of $50 but this is not yet on the
statement.
What is the balance per the cash book?
A. $1,900 overdrawn
B. $500 overdrawn
C. $1,900 in hand
D. $500 in hand
208
Lecture Example 4
The following information relates to a bank reconciliation.

(i) The bank balance in the cashbook before taking the items below into
account was $8,970 overdrawn.
(ii) Bank charges of $550 on the bank statement have not been entered in the
cashbook.
(iii) The bank has credited the account in error with $425 which belongs to
another customer.
(iv) Cheque payments totalling $3,275 have been entered in the cashbook but
have not been presented for payment.
(v) Cheques totalling $5,380 have been correctly entered on the debit side of
the cashbook but have not been paid in at the bank.
What was the balance as shown by the bank statement before taking the items
above into account?
K
1. The cash book is used to record the detailed transactions of receipts and
payments affecting the bank account. These are then posted to the nominal
ledger periodically. At the end of each accounting period, the balance on the
cash book should equal the balance in the nominal ledger cash/bank account.
This figure should also agree with the balance on the bank statement.
2. The balance on the cash account/cash book is compared to the balance on

the bank statements at a given date. However, these two balances may not
agree. Differences between the cash book and the bank statement arise for 3
reasons: -
1. Errors – usually in the cash book
2. Omissions – such as bank charges, standing orders and direct debits
not posted in the cash book
3. Timing differences – such as unpresented cheques and unrecorded
lodgements
3. The bank reconciliation is produced after checking that all the items on the
bank statement have been recorded in the cash book. Any items not in the
cash book will need to be recorded. The balance per bank statement must be
adjusted for any timing differences or errors by the bank.
209
4. Bank reconciliation statement – an example: -
Cash account (cash book)

Balance b/d X Dishonoured cheque X
Bank charges X
Standing orders X
Direct debits X
Balance c/d X
X X
$
Balance per bank statement X RECONCILE
less unpresented cheques (X)
plus unrecorded lodgements X
plus/less bank errors X
Balance per adjusted cash book X
210
Q
1. The following attempt at a bank reconciliation statement has been prepared
by Q Co:
$
Overdraft per bank statement 38,600
Add: deposits not credited 41,200
79,800
Less: outstanding cheques 3,300
Overdraft per cash book 76,500
Assuming the bank statement balance of $38,600 to be correct, what should

the cash book balance be?
A. $76,500 overdrawn, as stated

B. $5,900 overdrawn
C. $700 overdrawn
D. 5,900 cash at bank
2. After checking a business cash book against the bank statement, which of the
following items could require an entry in the cash book?
1. Bank charges
2. Cheque from a customer which was dishonoured
3. Cheque not presented
4. Deposits not credited
5. Credit transfer entered in bank statement
6. Standing order entered in bank statement.
A. 1, 2, 5 and 6
B. 3 and 4
C. 1, 3, 4 and 6
D. 3, 4, 5 and 6
3. At 30 April 20X8 the balance on the bank account in Jim’s general ledger
showed that he had $685 cash at the bank. When he carried out his bank
reconciliation, he found that he had omitted bank charges of $722 for the year
to 30 April 20X8.
What bank balance should be included on Jim’s opening trial balance at

1 May 20X8?
A. $685 debit
B. $685 credit
C. $37 debit
D. $37 credit
211
4. The following bank has been prepared for a
reconciliation statement
company:
$
Add: Deposits credited after date 64,100
103,900
Less: Outstanding cheques presented after 44,200
date
Assuming the amount of the overdraft per the bank statement of $39,800 is
correct, what should be the balance in the cash book?
A. $158,100 overdrawn
B. $19,900 overdrawn
C. $68,500 overdrawn
D. $59,700 overdrawn as stated
5. Sigma's bank statement shows an overdrawn balance of $38,600 at 30 June

20X5. A check against the company's cash book revealed the following
differences:
1. Bank charges of $200 have not been entered in the cash book.
2. Lodgements recorded on 30 June 20X5 but credited by the bank on 2
July $14,700.
3. Cheque repayments entered in cash book but not presented for
payment at 30 June 20X5 $27,800.
4. A cheque payment to a supplier of $4,200 charged to the account in
June 20X5 recorded in the cash book as a receipt.
Based on this information, what was the cash book balance before any
adjustments?
C. $60,300 overdrawn
D. $34,100 overdrawn
6. When doing bank reconciliation, adjustments have to be made for timing

differences.
Which one of these constitutes a timing difference?
A. Unpresented cheques
B. Unposted direct debits
C. Bank charges
D. Dishonoured cheques
212
7. Elaine is preparing her bank reconciliation. She has noted the following:
(i) the bank has levied charges on her account
(ii) a cheque payable to S. Wright has not been presented at the bank
Which of the above errors require an entry in the bank account in her general
ledger?
A. both (i) and (ii)

B. (i) only
C. neither (i) nor (ii)
D. (ii) only
8. The following bank reconciliation statement has been prepared by an

inexperienced bookkeeper at 31 December 20X5.
Bank reconciliation statement

$
Balance per bank statement (overdrawn) 38,640
Add: lodgements not credited 19,270
57,910
Less: unpresented cheques 14,260
Balance per cash book 43,650
What should the final cash book balance be when all the above items have
been properly dealt with?
C. $5,110 overdrawn
D. $72,170 overdrawn
9. Which of the following statements about bank reconciliations are correct?

1. In preparing a bank reconciliation, unpresented cheques must be
deducted from a balance of cash at bank shown in the bank statement.
2. A cheque from a customer paid into the bank but dishonoured must be
corrected by making a debit entry in the cash book.
3. An error by the bank must be corrected by an entry in the cash book.
4. An overdraft is a debit balance in the bank statement.
A. 1 and 3
B. 2 and 3
C. 1 and 4
D. 2 and 4
213
A
1. C
The bank is overdrawn.
$
Overdraft (38,600
)
Deposits 41,200
2,600
Unpresented cheques
(3,300)
Overdraft (700)
2. A - The other two items are part of the bank reconciliation.
3. D
Cash at bank $685

Less bank changes
($722
)
$37 credit (bank o’draft)
4. B
$
Less: deposits credited (64,100)
Add: outstanding cheques 44,200
5. A
$
Balance per bank statement (38,600)
Bank charges 200
Lodgements 14,700
Cheque payments (27,800)
Cheque payment misposted 8,400
Balance per cash book (43,100)
6. A
All of the others will require an entry in the cash book
7. B
214
8. B
Bank reconciliation statement
Balance per bank (overdrawn) (38,640

)
Add: outstanding lodgements 19,270
(19,370
)
Less: unpresented cheques (14,260
)
Balance per cash book (overdrawn) (33,630
)
9. C - Statements 2 and 3 are incorrect. A dishonoured cheque is credited to

the cash book and bank errors do not go through the cash book at all
215
Chapter 16
Correction of Errors

Identify the types of error which may occur in bookkeeping systems
The following are five frequent types of error: -
1. Errors of transposition: - when two digits in an amount are accidentally

recorded the wrong way round.
2. Errors of omission: - failing to record a transaction at all, or making a debit
or credit entry, but not the corresponding double entry.
3. Errors of principle: - making a double entry in the belief that the transaction
is being entered in the correct accounts, but subsequently finding out that the
accounting entry breaks the 'rules' of an accounting principle or concept.
4. Errors of commission: - where the bookkeeper makes a mistake in carrying
out his or her task of recording transactions in the accounts. Two examples
are: - putting a debit/credit entry in the wrong account; errors of casting
(adding up)
5. Compensating errors: - errors which are, coincidentally, equal and
opposite to one another.
Lecture Example 1
Type of error Example

1. Errors of transposition
2. Errors of omission
3. Errors of principle
4. Errors of commission
5. Compensating errors
Some of these errors can be corrected by journal entry; some require the use of a
suspense account.
1. If the correction involves a double entry in the ledger accounts, then it is done
by using a journal entry in the journal.
216
2. When the error breaks the rule of double entry (single entry or error on one
side only), then it is corrected by the use of a suspense account as well as a
journal entry.
Identify errors which would be highlighted by the extraction of a trial balance
Errors that can be detected by a trial balance include: -

 Errors of transposition
 Errors of omission (if the omission is one-sided)
 Errors of commission (for e.g. if one-sided, or two debit entries are made)
Other errors will not be detected by extracting a trial balance, but may be spotted by
other controls (such as bank or control account reconciliations).

Prepare journal entries to correct errors
Suspense Accounts: -
A suspense account is a temporary account. It never appears in the final accounts.
It is used for two main reasons:

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.
Steps to clear a suspense account: -
1. Determine the original accounting entry which was made.

2. Decide what entry should have been made.
3. Make the required adjustment.
Lecture Example 2
The trial balance of Z failed to agree, the totals being: debit $836,200 credit
$819,700.
A suspense account was opened for the amount of the difference and the following
errors were found and corrected:
1. The totals of the cash discount columns in the cash book had not been posted
to the discount accounts. The figures were discount allowed $3,900 and
discount received $5,100.
2. A cheque for $19,000 received from a customer was correctly entered in the
cash book but was posted to the customer's account as $9,100.
217
What will be the remaining balance on the suspense be after the correction of these
errors?
A. $25,300 credit
B. $7,700 credit
C. $27,700 debit
D. $5,400 credit
Lecture Example 3
Which of the following errors could result in a suspense account being required to
'balance' the trial balance?
A. Cash received from credit customers treated as a cash sale

B. A supplier's invoice for $32 recorded as $23 in the purchases account
C. Payments to suppliers of $647 recorded as $674 in the payables ledger
D. One page omitted from the purchase day book

Calculate and understand the impact of errors on the statement of profit or
loss, statement of comprehensive income and statement of financial position
When errors are corrected they may affect the business' profit for the year figure. In
order to find the correct figure for profit, a statement of adjustments to profit has to
be prepared.
Proforma – Statement of Adjustment to Profit
$ $ $
+ -
Original profit X
Adjustment:
Over depreciation expense charged X
Unrecorded expense X
Unrecorded sale X
X (X) X
Adjusted Profit X
218
Lecture Example 4
At the year end of T Down & Co, an imbalance in the trial balance was revealed
which resulted in the creation of a suspense account with a credit balance of $1,040.
Investigations revealed the following errors.
1. A sale of goods on credit for $1,000 had been omitted from the sales account.
2. Delivery and installation costs of $240 on a new item of plant had been
recorded as a revenue expense.
3. Cash discount of $150 on paying a supplier, JW, had been taken, even
though the payment was made outside the time limit.
4. Purchases of stationery at the end of the period of $240 had been ignored.
5. A purchase of raw materials of $350 had been recorded in the purchases
account as $850.
6. The purchase returns day book included a sales credit note for $230 which
had been entered correctly in the account of the customer concerned, but
included with purchase returns in the nominal ledger.
Required:
i. Prepare journal entries to correct each of the above errors. Narratives

are not required.
i. Open a suspense account and show the corrections to be made.
ii. Prior to the discovery of the errors, T Down & Co's gross profit for the
year was calculated at $35,750 and the net profit for the year at
$18,500. Calculate the revised gross and net profit figures after the
correction of the errors.
Lecture Example 5
The bookkeeping system of MVP Limited is not computerised, and at 30 September

20X8 the bookkeeper was unable to balance the accounts. The trial balance totals
were: -
Debit $1,796,100
Credit $1,852,817
Nevertheless, he proceeded to prepare draft financial statements, inserting the

difference as a balancing figure in the balance sheet. The draft profit and loss
account showed a profit of $141,280 for the year ended 30 September 20X8.
219
He then opened a suspense account for the difference and began to check through
the accounting records to find the difference. He found the following errors and
omissions:
1. $8,980 – the total of the sales returns book for September 20X8, had been
credited to the purchases returns account.
2. $9,600 paid for an item of plant purchased on 1 April 20X8 had been debited
to plant repairs account. The company depreciates its plant at 20% per
annum on a straight line basis, with proportional depreciation in the year of
purchase.
3. The cash discount totals for the month of September 20X8 had not been
posted to the nominal ledger accounts. The figures were:
Discount allowed $836
Discount received $919
4. $580 insurance prepaid at 30 September 20X7 had not been brought down as
an opening balance
5. The balance of $38,260 on the telephone expense account had been omitted
from the trial balance
6. A car held as a fixed asset had been sold during the year for $4,800. The
proceeds of sale were entered in the cash book but had been credited to the
sales account in the nominal ledger. The original cost of the car $12,000, and
the accumulated depreciation to date $8,000, were included in the motor
vehicles account and the accumulated depreciation account. The company
depreciates motor vehicles at 25% per annum on a straight line basis with
proportionate depreciation in the year of purchase but none in the year of
sale.
Required:
1. Open a suspense account for the difference between the trial balance
totals. Prepare the journal entries necessary to correct the errors and
eliminate the balance on the suspense account. Narratives are not
required.
2. Draw up a statement showing the revised profit after correcting the above
errors.
220
K
1. Types of errors: -
1. Errors of transposition: - when two digits in an amount are accidentally

recorded the wrong way round.
2. Errors of omission: - failing to record a transaction at all, or making a debit
or credit entry, but not the corresponding double entry.
3. Errors of principle: - making a double entry in the belief that the
transaction is being entered in the correct accounts, but subsequently finding
out that the accounting entry breaks the 'rules' of an accounting principle or
concept.
4. Errors of commission: - where the bookkeeper makes a mistake in carrying
out his or her task of recording transactions in the accounts. Two examples
are: - putting a debit/credit entry in the wrong account; errors of casting
(adding up)
5. Compensating errors: - errors which are, coincidentally, equal and
opposite to one another.
2. Suspense Account
Where the trial balance does not balance a suspense account will be opened and
the errors, once identified, will be corrected via a journal entry. A suspense
account should never appear in the final accounts.
Table 1: Types or error and suspense account
Error type Suspense account involved?

1. Compensating errors – two equal and opposite errors
Yes, to correct
leave the trial balance balancing (this type of error is rare, and each of the errors
can be because a deliberate second error has been made to as discovered
force the balancing of the records or to conceal a fraud)
2. Omission – a transaction is not recorded at all No
3. Error of principle – an item is posted to the correct side
of the wrong type of account, as when cash paid for plant
repairs (expense) is debited to plant account (asset) No
(errors of principle are really a special case of errors of
commission, and once again there is a debit and a credit)
4. Error of commission – an item is entered to the correct
side No
of the wrong account (there is a debit and a credit here, so the
records balance)
221
5. Transposition error – an entry in one record is
incorrectly posted to another Examples: cash £10,000
Yes
entered in the cash book for the purchase of a car is: posted
to Motor cars account
as £1,000
222
Note: when a balance is omitted, or incorrectly extracted, in preparing a trial
balance, the suspense account is involved.
3. Adjustments to Profit
Where the process of correcting errors requires changes to income and expense
accounts the business’ profit will be affected. In this case a statement of
adjustments to profit has to be prepared to determine the revised profit figure for
the year.
QQ
1. Sales returns of $460 have inadvertently been posted to the purchase returns,
although the correct entry has been made to the accounts receivable control.
A suspense account needs to be set up for how much?
A. $460 debit
B. $460 credit
C. $920 debit
D. $920 credit
2. The trial balance of a company did not balance, and a suspense account was
opened for the difference.
hich of the following errors would require an entry to the suspense

account in correcting them?
1. A cash payment to purchase a motor van had been correctly entered in

the cash book but had been debited to motor expenses account.
223
2. The debit side of the wages account had been under cast.
3. The total of the discounts allowed column in the cash book had been
credited to discounts received account.
4. A cash refund to a customer had been recorded by debiting the cash book
and crediting the customer’s account.
A. 1 and 2
B. 2 and 3
C. 3 and 4
D. 2 and 4
3. Which of the following errors would cause a trial balance not to

balance?
1. An error in the addition of the cash book.

2. Failure to record a transaction at all.
3. Cost of a motor vehicle debited to motor expenses account. The cash
entry was correctly made.
4. Goods taken by the proprietor of a business recorded by debiting
purchases and crediting drawings account.
A. 1 only
B. 1 and 2 only
C. 3 and 4 only
D. All four items
4. The draft statement of profit or loss of Lorca, a limited liability company,

showed a profit of $830,000. However, the trial balance did not balance and a
suspense account with a credit balance of $20,000 has been included in the
statement of financial position
The following errors were found on investigation:
1. The proceeds of issue of 100,000 50c shares at 70c per share were
correctly entered in the cash book but had been credited to sales
account.
2. During the year $8,000 interest received on a holding of loan notes had
been correctly entered in the cash book but debited to interest payable
account.
3. In arriving at the net sales and purchases totals for the year, the
$48,000 balance on the returns outwards account had been transferred
to the debit of sales account and the $64,000 balance on the returns
inwards account had been transferred to the credit of purchases
account.
4. A payment of $4,000 for rent had been correctly recorded in the cash
224
book but debited to the rent account as $40,000.
Required:
a. Prepare journal entries to correct the errors. Narratives are NOT

required.
b. Find the revised net profit for the year
5. A company’s trial balance failed to agree, and a suspense account was opened
for the difference.
Subsequent checking revealed that discounts allowed $13,000 had been credited
to discounts received account and an entry on the credit side of the cash book for
the purchase of some machinery $18,000 had not been posted to the plant and
machinery account.
Which two of the following journal entries would correct the errors?
Debit Credit
$ $
1. Discounts allowed 13,000
Discounts received 13,000
2. Discounts allowed 13,000
Suspense account 26,000
3. Suspense account 26,000
225
Discounts allowed 13,000
4. Plant and machinery 18,000
Suspense account 18,000
5. Suspense account 18,000
Plant and machinery 18,000
A. 1 and 4
B. 2 and 5
C. 2 and 4
D. 3 and 5
6. A company’s draft financial statements for 20X5 showed a profit of $630,000.

However, the trial balance did not agree, and a suspense account appeared in
the company’s draft balance sheet.
Subsequent checking revealed the following errors:
1. The cost of an item of plant $48,000 had been entered in the cash book and in
the plant account as $4,800. Depreciation at the rate of 10% per year ($480)
had been charged.
2. Bank charges of $440 appeared in the bank statement in December 20X5 but
had not been entered in the company’s records.
3. One of the directors of the company paid $800 due to a supplier in the
company’s payables ledger by a personal cheque. The bookkeeper recorded
a debit in the supplier’s ledger account but did not complete the double entry for
the transaction. (The company does not maintain a payables ledger control
account).
4. The payments side of the cash book had been understated by $10,000.
Which of the above items would require an entry to the suspense account in
correcting them?
A. All four items

B. 3 and 4 only
C. 2 and 3 only
D. 1, 2 and 4 only
7. With reference to question 6, what would the company’s profit

become after the correction of the above errors?
A. $634,760
B. $624,760
C. $624,440
D. $625,240
226
A
1. C
The sales returns of $460 have been credited to accounts receivable and also $460
has been credited to purchase returns. Therefore the trial balance needs a debit
of 2 × $460 = $920 to balance.
2. B
1. Dr Motor vehicles
Cr Motor expenses
2. Dr Wages
Cr Suspense
3. Dr Discounts received
Dr Discounts allowed
Cr Suspense
4. Dr Receivables
Cr Cash
3. A
The trial balance still agrees if there is an error of omission, commission, principle or
complete reversal of entries.
227
4. (a)
Dr Cr
$ $
1. Sales 70,000
Share capital 50,000
Share premium 20,000
2. Suspense 16,000
Interest payable 8,000
Interest receivable 8,000
3. Sales 16,000
Purchases 16,000
Suspense 32,000
OR
Suspense 48,000
Sales 48,000
Purchases 64,000
Suspense 64,000
Sales 64,000
Suspense 64,000
Suspense 48,000
Purchases 48,000
4. Suspense 36,000
Rent 36,000
(b)
$ $ $
+ -
Original profit 830,000
Adjustment:
Sales 70,000
Interest 16,000
Sales/purchases 32,000
Rent 36,000
52,000 (102,000) (50,000)
Adjusted Profit 780,000
5. C
6. B
228
1. Dr Plant (48,000 – 4,800) 43,200
Cr Cash 43,200
Dr Depreciation expense 4,320

Cr Accounts depreciation 4,320
2. Dr Bank 440
charges Cr 440
Bank
3. Dr Suspense 800
Cr Directors’ account 800
4. Dr Suspense 10,000
Cr Cash 10,000
7. D
+ -
$ $ $
Unadjusted profit 630,000

Depreciation 4,320
Bank charges 440
0 (4,760) (4,760)
Adjusted profit 625,240
229
Chapter 17
Incomplete Records

Understand and apply techniques used in incomplete record situations:
i. Use of accounting equation
i. Use of ledger accounts to calculate missing figures
ii. Use of cash and/or bank summaries
iv. Use of profit percentages to calculate missing figures.
Incomplete records problems occur when a business does not have a full set of
accounting records, for one of the following reasons.
 The proprietor of the business does not keep a full set of accounts.
 Some of the business accounts are accidentally lost or destroyed.
Different techniques can be used to find the missing information: -
17.1.1 Use of accounting equation
It is still possible to calculate a profit or loss figure by using the fact that the profit of a
business must be represented by more assets. We list and value the opening and
closing net assets, then calculate the profit as the difference between the two
Profit = Closing net assets - Opening net

assets
Allowance must be made for proprietor's drawings and extra capital introduced, so
the formula becomes:
Profit = Closing net assets - Opening net assets + Drawings -

Capital introduced
Lecture Example 1
A business has net assets of $70,000 at the beginning of the year and $80,000 at
the end of the year. Drawings were $25,000 and a lottery win of $5,000 was paid into
the business during the year. What was the profit for the year?
A. $10,000 loss
B. $30,000 profit
C. $10,000 profit
D. $30,000 loss
230
17.1.2 Control Accounts
A receivables ledger control account can be prepared to calculate missing credit

sales. However, the figures for the opening and closing receivables of a business
and the cash received from customers must be given.

$ $
Opening balance 38,600 Cash received 218,650
Sales (balancing 221,250 Closing balance 41,200
figure)
259,850 259,850
The same technique can be used to calculate credit purchases. A payables ledger
control account can be prepared using given figures for opening and closing
payables and cash paid.
Note: -
Total sales = Cash sales + Credit sales

Total purchases = Cash purchases + Credit
purchases
Lecture Example 2
Senji does not keep proper accounting records, and it is necessary to calculate her
total purchases for the year ended 31 January 20X4 from the following information:
$
Trade payables
31 January 20X3 130,400
31 January 20X4 171,250
Payments to suppliers 888,400
Cost of goods taken by Senji for her personal use 1,000
Refund received from suppliers 2,400
Compute the figure for purchases for inclusion in Senji's financial statements.
Lecture Example 3
The following information is available for the year ended 31 December 20X1 for Ski,
a well-run company:
231
$
Opening cash 1,000
Closing cash 2,000
Opening balance on the trade payables control account 8,000
Closing balance on the trade payables control account 10,000
Opening balance on the trade receivables control account 12,000
Closing balance on the trade receivables control account 14,000
Cash paid to trade accounts payable in the period 9,000
Opening inventory 6,000
Closing inventory 7,000
Mark-up on cost - 10%
Assuming the information above is complete, what was the sales figure for the
period?
17.1.3 Cash/Bank
A cash account may need to be set up to find the figure missing for proprietor’s
drawings or cash stolen. Details of cash receipts and payments plus details of
opening and closing balances must be given.
Lecture Example 4
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:
$
General expenses 4,500
Drawings 6,250
Total banking 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?
232
17.1.4 Cost Structure
Margin: gross profit is expressed as a percentage of sales
For example a margin of 25% gives:
Sales 100%
Cost of sales 75%
Gross profit 25%
Mark-up: gross profit is expressed as a percentage of cost of sales,
For example a mark-up of 35% gives:
Sales 135%
Cost of sales 100%
Gross profit 35%
Cost of sales = opening inventories + purchases – closing inventories
Lecture Example 5
Aluki fixes prices to make a standard gross profit percentage on sales of 33 1/3%.
The following information is available for the year ended 31 January 20X4 to
compute her sales total for the year:
$
Inventory
1 February 20X3 243,000
31 January 20X4 261,700
Purchases 595,400
Purchases returns 41,200
Calculate the sales figure for the year ended 31 January 20X4.
Lecture Example 6
A business usually has a mark-up of 20% on cost of sales. During a year, its sales
were $90,000. What was the cost of sales?
233
Lecture Example 7
Brown has budgeted sales for the coming year of $175,000. He achieves a constant
gross mark-up of 40% on cost. He plans to reduce his inventory level by $13,000
over the year. What will Brown's purchases be for the year?
17.1.5 Goods Drawn By Proprietor
The owners of the business may at times take goods or cash from the business for
their own use. This is known as drawings.
Cash drawings
Dr Drawings
Cr Cash
Goods taken for own use
Dr Drawings
Cr Purchases
These are recorded at the cost to the business not at selling price. They are taken
out of purchases and not recorded against inventories.
Lecture Example 8
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?
17.1.6 Goods destroyed, stolen or lost
When inventory is stolen, destroyed or otherwise lost, the loss must be accounted for
depending on whether or not these goods were insured against the loss.
234
If the lost goods were not insured,
Debit expense (e.g. admin expenses in the

I/S) Credit cost of sales
If the lost goods were insured,
Debit insurance claim account (current asset in

SFP) Credit cost of sales
Lecture Example 9
On 1 September 20X6, a business had inventory of $380,000. During the month,

sales totalled $650,000 and purchases $480,000. On 30 September 20X6 a fire
destroyed some of the inventory. The undamaged goods in inventory were valued at
$220,000. The business operates with a standard gross profit margin of 30%.
Based on this information, what is the cost of the inventory destroyed in the
fire?
A. $185,000
B. $140,000
C. $405,000
D. $360,000
K
1. Incomplete records problems occur when a business does not have a full set of
accounting records, for one of the following reasons.
 The proprietor of the business does not keep a full set of accounts.
 Some of the business accounts are accidentally lost or destroyed.
235
2. Different techniques can be used to find the missing information: -
2.1 Use of accounting equation
Profit = Closing net assets - Opening net

assets
Allowance must be made for proprietor's drawings and extra capital introduced.
Profit = Closing net assets - Opening net assets + Drawings -

Capital introduced
2.2 Control Accounts
A receivables ledger control account can be prepared to calculate missing credit

sales. However, the figures for the opening and closing receivables of a business
and the cash received from customers must be given.
The same technique can be used to calculate credit purchases. A payables ledger
control account can be prepared using given figures for opening and closing
payables and cash paid.
2.3 Cash/Bank
A cash account may need to be set up to find the figure missing for proprietor’s
drawings or cash stolen .Details of cash receipts and payments plus details of
opening and closing balances must be given.
2.4 Cost Structure
Margin: gross profit is expressed as a percentage of sales
For example a margin of 25% gives:
Sales 100%
Cost of sales 75%
Gross profit 25%
236
Mark-up: gross profit is expressed as a percentage of cost of sales,
For example a mark-up of 35% gives:
Sales 135%
Cost of sales 100%
Gross profit 35%
Cost of sales = opening inventories + purchases – closing inventories
3. Goods Drawn By Proprietor
Cash drawings
Dr Drawings
Cr Cash
Goods taken for own use
Dr Drawings
Cr Purchases
These are recorded at the cost to the business. They are taken out of
purchases and not recorded against inventories.
237
238
Q
1. The net assets of Altese, a trader, at 1 January 20X3 amounted to $128,000.
During the year to 31 December 20X3, Altese introduced a further $50,000 of
capital and made drawings of $48,000. At 31 December 20X3, Altese's net
assets totalled $184,000. Using this information compute Altese's total profit for
the year ended 31 December 20X3.
2. The profit earned by a business in 20X7 was $72,500. The proprietor injected
new capital of $8,000 during the year and withdrew goods for his private use
which had cost $2,200.
If net assets at the beginning of 20X7 were $101,700, what were the closing net
assets?
A. $35,000
B. $39,400
C. $168,400
D. $180,000
3. A business has compiled the following information for the year ended 31 October
20X2:
$
Purchases 989,000
Closing inventory 422,700
The gross profit as a percentage of sales is always 40%
Based on these figures, what is the sales revenue for the year?
A. $1,333,500
B. $1,587,500
C. $2,381,250
D. The sales revenue figure cannot be calculated from this information
4. A sole trader took some goods costing $800 from inventory for his own use. The
normal selling price of the goods is $1,600.
Which of the following journal entries would correctly record this?
A. Dr Inventories $800
Cr Purchases $800
B. Dr Drawings $800
Cr Purchases $800
C. Dr Sales $1,600
Cr Drawings $1,600
239
D. Dr Drawings $800
Cr Sales $800
5. A sole trader fixes her prices by adding 50 per cent to the cost of all goods
purchased. On 31 October 20X3, a fire destroyed a considerable part of the
inventory and all inventory records.
Her trading account for the year ended 31 October 20X3 included the following
figures:
$ $
Sales 281,250
Cost of Sales
Opening Inventories 183,600
Purchases 249,200
432,800
Closing Inventories 204,600
Cost of Sales 228,200
Gross Profit 53,050
Using this information, what inventory loss has occurred?
A. $61,050
B. $87,575
C. $40,700
D. $110,850
6. Adam, a sole trader has net assets at 31 December 20X1 of $65,250. During
the year he made a loss of $3,000, he took inventory for his own use of $850 and
removed cash of $2,250.
If he introduced capital of $5,000 during the year, what was the capital as at 1
January 20X1?
7. On 30 April 20X1 part of the inventory of Neutron, a limited liability company, was
destroyed by fire.
The following information is available.

• Inventory at 1 April 20X1 $99,600
• Purchases for April 20X1 $177,200
• Sales for April 20X1 $260,000
• Inventory at 30 April 20X1 – undamaged items $64,000
• Standard gross profit percentage on sales 30%
Based on this information, what was the cost of the inventory destroyed?
240
1.
ANSWER 1 $
Opening capital 128,000
Capital introduced 50,000
178,000
less: Drawings 48,000
130,000
Closing capital 184,000
Profit is therefore 54,000
2. D
I = P + Ci – D
= $(72,500 + 8,000 – 2,200)
= $78,300
Therefore, closing net assets = $(101,700 + 78,300) = $180,000.
3. B
Purchases 989,000
Closing inventory (422,700)
Cost of sales 952,500
952,500 × 100/60 = 1,587,500
4. B - The selling price is not relevant to this adjustment.
5. C - Cost of sales = $281,250 × 2/3 = $187,500

Loss of inventory = $228,200 – 187,500 =
$40,700 6. $66,350
Net assets = capital

$'000
Capital at 1.1.X1 (balancing figure) 66,350
Additional capital 5,000
71,350
Drawing (cash) (2,250)
(inventory) (850)
Loss (3,000)
Net assets @ 31.12.X1 65,250
7. $30,800
$
Theoretical gross profit 30% × $260,000 78,000
Actual gross profit:
$260,000 – $99,600 – $177,200 + $64,000 47,200
Shortfall – missing inventory
30,800
241
Chapter 18
Provisions and Contingencies
IAS 37 – Provisions, Contingent Liabilities and Contingent Assets
18.1 ACCA SYLLABUS GUIDE OUTCOMES: 1- 6

Understand the definition of “provision”, “contingent liability” and
“contingent asset”
Distinguish between and classify items as provisions, contingent liabilities or
contingent assets
Identify and illustrate the different methods of accounting for provisions,
contingent liabilities and contingent assets
.Calculate provisions and changes in provisions
Account for the movement in provisions
Report provisions in the final accounts
18.1.1 Provisions
A provision is a liability of uncertain timing or amount.
IAS 37 requires a provision be recognised when all of the following apply:
1. an entity has a present obligation (legal or constructive) as a result of a past

event
2. it is probable that an outflow of resources embodying economic benefits will
be required to settle the obligation
3. a reliable estimate can be made of the amount of the obligation
Therefore, a provision is made for something which will probably happen. It should
be recognised when it is probable that a transfer of economic events will take place
and when its amount can be estimated reliably.
Provisions can be distinguished from other liabilities (e.g. trade payables and
accruals) due to the uncertainty concerning the timing or amount of the future
expenditure required in settlement. In contrast, trade payables are liabilities to pay
for goods that have been received and invoiced, hence the timing and amount of the
expenditure is agreed with the supplier.
A provision is accounted for as follows: -
Dr Expense (I/S) 242

Cr Provision (SOFP)
The required provision will be reviewed at each year end and increased or
decreased as necessary.
To increase a provision:
Dr Expense (I/S)
Cr Provision (SOFP)
To decrease a provision:
Dr Provision (SOFP)
Cr Expense (I/S)
Measurement of Provision
The amount recognised as a provision should be the best estimate of the

expenditure required to settle the present obligation at the end of the reporting
period.
Provisions for one-off events (restructuring, environmental clean-up, settlement of

a lawsuit) are measured at the most likely amount.
Provisions for large populations of events (warranties, customer refunds) are

measured at a probability-weighted expected value.
Worked out example
A company sells goods with a warranty for the cost of repairs required in the first 2
months after purchase.
Past experience suggests:

1. 88% of the goods sold will have no defects
2. 7% will have minor defects
3. 5% will have major defects
If minor defects were detected in all products sold, the cost of repairs will be
$24,000; if major defects were detected in all products sold, the cost would be
$200,000.
What amount of provision should be made?
(88% x 0) + (7% x 24,000) + (5% x 200,000) = $11,680.
Lecture Example 1
243
A business has been told by its lawyers that it is likely to have to pay $10,000
damages for a product that failed. The business duly set up a provision at 31
December 20X7. However, the following year, the lawyers found that damages were
more likely to be $50,000. How is the provision treated in the accounts at:
(a) 31 December 20X7?
(b) 31 December 20X8?
Disclosure note
For each class of provision, an entity should disclose: -

1. the net book value at the beginning and the end of the period
2. additional provisions made in the period, including increases to existing
provisions
3. amounts utilised during the period
4. unused amounts reversed during the period
An entity should also disclose, for each class of provision: -

1. a brief description of the nature of the obligation and the expected timing of
any resulting outflows of economic benefits
2. an indication about the uncertainties about the amount and timing of those
outflows
3. the amount of any expected reimbursement, stating the amount of any asset
that has been recognised for that expected reimbursement
18.1.2 Contingent Liabilities
Contingent liabilities are:

(a) possible obligations that arise from past events and whose existence will be
confirmed only by the occurrence or nonoccurrence of one or more uncertain
future events not wholly within the control of the entity
(b) present obligations that arise from past events but are not recognised
because:
i. they are not probable that an outflow of resources embodying
economic benefits will be required to settle the obligation; or
i. the amount of the obligation cannot be measured with sufficient
reliability
Contingent liabilities should not be recognized in financial statements but they should
be disclosed, unless the possibility of any outflow is remote. The required
disclosures are:
 A brief description of the nature of the contingent liability;
 An estimate of its financial effect;
 An indication of the uncertainties that exist relating to the amount or timing
of any outflow; and
 The possibility of any reimbursement.
244
Disclosure Note
Unless the possibility of any outflow is remote, for each class of contingent liability,
an entity should disclose at the end of the reporting period, a brief description of the
nature of the contingent liability and where practicable: -
1. an estimate of its financial effect
2. an indication of the uncertainties relating to the amount or timing of any
outflow; and
3. the possibility of any reimbursement
Lecture Example 2
Amazon Inc. has been sued for the following two alleged infringement of law:
1. unauthorized use of a trademark; the claim is for $100 million
2. non-payment of end-of-service severance pay and gratuity to 5,000
employees who were terminated without Amazon Inc. giving any reason; the
class action lawsuit is claiming $3 million.
Legal counsel has communicated to Amazon Inc. this assessment of the two
lawsuits:
Lawsuit 1: the chances of this lawsuit are remote

Lawsuit 2: it is probable that Amazon Inc. would have to pay the displaced
employees, but the best estimate of the amount that would be payable if the plaintiff
succeeds against the entity is $2 million.
What accounting treatment is required for these 2 lawsuits?
18.1.3 Contingent assets
Contingent assets are possible assets that arise from past events and whose
existence will be confirmed only by the occurrence or nonoccurrence of one or more
uncertain future events not wholly within the control of the entity.
A contingent asset must not be recognized. Only when the realization of the related
economic benefits is virtually certain should recognition take place. At that point,
the asset is no longer a contingent asset!
Contingent assets must only be disclosed in the notes if they are probable. A brief
description of the contingent asset must be provided together with an estimate of its
financial effect and details of any uncertainties.
245
Disclosure Note
Where an inflow of economic benefits is probable (contingent asset), an entity

should disclose a brief description of the nature of the contingent assets at the end of
the reporting period and, where practicable, an estimate of their financial effect.
Lecture Example 3
How does a company account for a contingent asset that is not probable?
A. By way of note
B. As an asset in the statement of financial position
C. It does nothing
Lecture Example 4
An employee dismissed in August 20X3 began an action for damages for wrongful
dismissal in October 20X3.
She is claiming $100,000 in damages. Aluki is resisting the claim and the company’s
lawyers have advised that the employee has a 30% chance of success in her claim.
The financial statements currently include a provision for the $100,000 claim.
Required:
Explain to the directors how this matter should be treated in the financial statements
for the year ended 30 September 20X3, stating the relevant accounting standards.
246
K
1 Provisions
A provision is a liability of uncertain timing or amount.
IAS 37 requires a provision be recognised when all of the following apply:
1. an entity has a present obligation (legal or constructive) as a result of a past

event
2. it is probable that an outflow of resources embodying economic benefits will
be required to settle the obligation
3. a reliable estimate can be made of the amount of the obligation
A provision is accounted for as follows: -
Debit Expense Account (I/S)

Credit Provision Account (SOFP)
2 Contingent Liabilities
Contingent liabilities are:

(a) possible obligations that arise from past events and whose existence will be
confirmed only by the occurrence or nonoccurrence of one or more uncertain
future events not wholly within the control of the entity
(b) present obligations that arise from past events but are not recognised
because:
ii. they are not probable that an outflow of resources embodying
economic benefits will be required to settle the obligation; or
iv. the amount of the obligation cannot be measured with sufficient
reliability
be disclosed, unless the possibility of any outflow is remote.
3 Contingent assets
Contingent assets are possible assets that arise from past events and whose
existence will be confirmed only by the occurrence or nonoccurrence of one or more
uncertain future events not wholly within the control of the entity.
Contingent assets must only be disclosed in the notes if an inflow of economic

benefits is probable, otherwise they should be ignored. If the probability of an
inflow
247
of economic benefits is virtually certain then the asset is not a contingent asset and
should be recognised in the financial statements.
248
Q
1. Which of the following statements about the requirements of IAS 37
Provisions, contingent liabilities and contingent assets are correct?
1. A contingent asset should be disclosed by note if an inflow of
economic benefits is probable.
2. No disclosure of a contingent liability is required if the possibility of
a transfer of economic benefits arising is remote.
3. Contingent assets must not be recognised in financial statements
unless an inflow of economic benefits is virtually certain to arise.
A. All three statements are correct

B. 1 and 2 only
C. 1 and 3 only
D. 3 only
2. The following items have to be considered in finalising the financial

statements of Q, a limited liability company:
1. The company gives warranties on its products. The company’s
statistics show that about 5% of sales give rise to a warranty claim.
2. The company has guaranteed the overdraft of another company. The
likelihood of a liability arising under the guarantee is assessed as
possible.
What is the correct action to be taken in the financial statements for these
items?
ANSWER A
249
3. Which of the following statements about contingent assets and contingent
liabilities are correct?
1. A contingent asset should be disclosed by note if an inflow of economic
benefits is probable.
2. A contingent liability should be disclosed by note if it is probable that a
transfer of economic benefits to settle it will be required, with no
provision being made.
3. No disclosure is required for a contingent liability if it is not probable
that a transfer of economic benefits to settle it will be required.
4. No disclosure is required for either a contingent liability or a contingent
asset if the likelihood of a payment or receipt is remote.
A. 1 and 4 only
B. 3 only
C. 2, 3 and 4
D. 1, 2 and 4
4. A company is being sued for $10,000 by a customer. The company’s lawyers

reckon that it is likely that the claim will be upheld. Legal fees are currently
$5,000.
How should the company account for this?
A. Provision
B. Contingent liability
C. Contingent asset
250
251
252
Chapter 19
Preparing the Financial Statements of Limited
Liability Companies
There are some fundamental differences between the accounts of sole traders and
partnerships and limited liability companies. The following are perhaps the most
significant.
a) Legislation governing the activities of limited liability companies tends to be

very extensive. It may specify that the annual accounts of a company must be
filed with a government bureau and so available for public inspection; and
they often contain detailed requirements on the minimum information which
must be disclosed in a company's accounts. Also, the financial statements of
companies must be audited annually.
b) The owners of a company (its shareholders) may be very numerous. Their

capital is shown differently from that of a sole trader; and similarly the
'appropriation account' of a company is different.
c) The liability for the debts of the business in a sole trader or partnership is
unlimited, which means that if the business runs up debts that it is unable to
pay, the proprietors will become personally liable for the unpaid debts, and
would be required, if necessary, to sell their private possessions in order to
repay them. On the other hand, limited liability companies offer limited liability
to their owners. Limited liability means that the maximum amount that an
owner stands to lose in the event that the company becomes insolvent and
cannot pay off its debts, is his share of the capital in the business.

Understand the capital structure of a limited liability company including:
a. Ordinary shares
b. Preference shares
c. Loan notes
The owners' capital in a limited liability company consists of share capital. When a
company is originally set up, it issues shares. These are paid for by investors, who
then become shareholders of the company. Shares are issued in units of 10 cents,
25 cents, 50 cents, $1 or even $2. The 'face value' of the shares is called their par
value or nominal value, e.g. 100,000 shares of $1 each par value were issued at $1
each.
253
However, shares may be issued at a price higher than their par value, e.g. the
company may issue 20,000 shares of $1 each at $1.25 per share. This excess over
the par value is called share premium.
1. Authorised capital is the maximum amount of share capital that a company
is empowered to issue. The amount of authorised share capital can change
by agreement.
For example, a company's authorised share capital might be 10,000,000
ordinary shares of $1 each.
2. Issued capital is the amount at nominal value of share capital that has been
issued to shareholders. This amount of issued share capital cannot exceed
the amount of authorised capital. Therefore, the company with authorised
share capital of 10,000,000 ordinary shares of $1 might have issued
6,000,000 shares. It may issue 4,000,000 more shares at some time in the
future.
3. Called-up capital. When shares are issued, a company may not always be
paid the full amount for the shares at once. It might call up only a part of the
issue price, and wait until a later time before it calls up the remainder.
For example, if a company issues 6,000,000 ordinary shares of $1, it might
call up only, say, 80 cents per share. Although the issued share capital would
be $6,000,000, the called-up share capital would only be $4,800,000.
4. Paid-up capital. When capital is called up, some shareholders might delay
their payment (or even default on payment). Paid-up capital is the amount of
called-up capital that has been paid.
For example, if a company issues 6,000,000 ordinary shares of $1 each, calls
up 80 cents per share, but only receives payments of $3,600,000, the capital
not yet paid up would be $1,200,000 (4,800,000 – 3,600,000)
19.1.1 Preference shares
Preference shares carry the right to a final dividend which is expressed as a

percentage of their par value: e.g. a 5% $1 preference share carries a right to an
annual dividend of 5c.
Preference dividends have priority over ordinary dividends. The managers of a

company are obliged to pay preference dividend first. If the preference shares are
cumulative, it means that before a company can pay any ordinary dividend it must
not only pay the current year's preference dividend, but must also make good any
arrears of preference dividends which were not paid in previous years.
Also, preference shareholders have priority over ordinary shareholders to a return of

their capital if the company goes into liquidation. However, preference shares do
not carry a right to vote.
254
Preference shares may be either redeemable or irredeemable
255
Redeemable preference shares mean that the company will repay the nominal
value of those shares at a later date.
For example, 'redeemable 6% $1 preference shares 20X8' means that the company
will pay these shareholders $1 for every share they hold on a certain date in 20X8.
Redeemable preference shares are treated like loans and are included as non-
current liabilities in the statement of financial position. However, if the redemption is
due within 12 months, the preference shares will be classified as current liabilities.
Dividends paid (6c per share in our example) on redeemable preference shares are
included as a finance costs (added to interest paid) in the statement of profit or
loss.
Irredeemable preference shares form part of equity and their dividends are treated
as appropriations of profit.
19.1.2 Ordinary shares
Ordinary shares carry no right to a fixed dividend but ordinary shareholders are
entitled to all profits. In fact, the amount of ordinary dividends fluctuates from year to
year.
Ordinary shares normally carry voting rights. Therefore, ordinary shareholders are
the effective owners of a company. They own the 'equity' of the business including
any reserves of the business. Ordinary shareholders are sometimes referred to as
equity shareholders.
19.1.3 Loan Notes
Limited liability companies may issue loan stock or bonds to raise finance. These
are non-current liabilities but are different from share capital: -
a) Shareholders are the owners of a company, while providers of loan capital are
creditors of the company.
b) Shareholders receive dividends whereas loan holders are entitled to a fixed
rate of interest every year. This interest is an expense in the statement of
profit or loss and is calculated on the par value, regardless of its market value.
c) Loan holders have to be paid interest when due. Otherwise, they can take
legal action against the company if their interest is not paid. Therefore, loan
stock is generally less risky than shares.

Record movements in the share capital and share premium accounts
Lecture Example 1
256
A company made an issue for cash of 1,000,000 50c shares at par. What is the
double-entry of this transaction?
257
Lecture Example 2
A company made an issue for cash of 1,000,000 50c shares at a premium of 30c per
share.
Which of the following journal entries correctly records the issue?
Debit Credit
$ $
A. Share capital 500,000
Bank 800,000
B. Bank 800,000
C. Bank 1,300,000
Share capital 1,000,000
D. Share capital 1,000,000
Bank 1,300,000

Identify and record the other reserves which may appear in the company
When describing ordinary shareholders, we have said that these own the ‘equity’
of the business including any reserves. Shareholders' equity consists of: -
a) Share capital (at nominal value)

b) Share premium – the difference between the issue price of the share
and its par value
c) Revaluation surplus – a non-distributable reserve representing
unrealised profits on the revalued assets (refer to Chapter 10)
d) Other reserves – very often, these are revenue reserves which may
either have a specific purpose (e.g. asset replacement reserve) or
not (e.g. general reserve)
e) Retained earnings – these are profits earned by the company and
which have been retained by the business, i.e. they have not been paid
out as dividends, taxes or transferred to another reserve. This reserve
usually increases from year to year as companies do not normally
distribute all their profits.
258
Define a bonus (capitalisation) issue and its advantages and disadvantages
A company may wish to increase its share capital without needing to raise additional
finance. A bonus issue raises no funds.
A company can make a bonus issue to re-classify some of its reserves as share
capital. Any reserve may be re-classified in this way, including a share premium
account or other reserve. Therefore, these reserves will be debited and share capital
credited. Such a re-classification increases the capital base of the company and
gives greater protection to the company’s creditors.
Advantages: -
a) Increases share capital without reducing present shareholders' holdings
b) Capitalises reserves, therefore less is available for distribution as dividends
Disadvantages: -
a) Does not increases cash
b) If profits fall, the payment of dividends could be jeopardised

Record and show the effects of a bonus (capitalisation) issue in the
Dr Share Premium
Cr Share Capital
A bonus issue is always done at nominal value.
259
Lecture Example 3
At 31 December 20X1 the capital structure of a company was as follows:

$
Ordinary share capital
100,000 shares of 50c each 50,000
Share premium account 180,000
During 20X2 the company made a bonus issue of 1 share for every 2 held, using the
share premium account for the purpose, and later issued for cash another 60,000
shares at 80c per share.
What is the company’s capital structure at 31 December 20X2?
Ordinary share capital Share premium account

$ $
A. 130,000 173,000
B. 105,000 173,000
C. 130,000 137,000
D. 105,000 137,000

Define a rights issue and its advantages and disadvantages
A rights issue is an issue of shares for cash. These shares are usually issued at a
discount to the current market price. The 'rights' are offered to existing
shareholders, who can sell them if they wish.
Advantages: -
a) Raises cash
b) Reserves are available for future dividend distribution
Disadvantages: -
a) If a shareholder sells his rights, he will be losing (diluting) his control in the
company
260
Record and show the effects of a right issue in the statement of financial
position
Dr Cash
Cr Share Capital
Cr Share Premium
Lecture Example 4
At 30 June 20X2 a company’s capital structure was as follows:

$
Ordinary share capital
500,000 shares of 25c each 125,000
In the year ended 30 June 20X3 the company made a rights issue of 1 share for
every 2 held at $1 per share and this was taken up in full. Later in the year the
company made a bonus issue of 1 share for every 5 held, using the share premium
account for the purpose.
What was the company’s capital structure at 30 June 20X3?
Ordinary share capital Share premium account

$ $
A. 450,000 25,000
B. 225,000 250,000
C. 225,000 325,000
D. 212,500 262,500

Record dividends in ledger accounts and the financial statements
Dividends are an appropriation of retained earnings to shareholders. They are not

an expense in the statement of profit or loss.
Dr Retained Earnings (SOFP)

Cr Dividends Payable (SOFP)
261
Dividends can be paid during the year (interim dividends) or at the end of the year
(final dividends). The final dividend will only be accounted for if it has been declared
before year end. Otherwise, it will be disclosed as a note to the financial
statements.
Lecture Example 5
A company's issued share capital consists of $100,000 in 5% $1 preference shares

and $50,000 in 50c ordinary shares. Its net profit for the year was $176,000 and the
directors paid an ordinary dividend for the year of 10c per share.
What is the company's retained profit for the year?
Lecture Example 6
The issued share capital of Alpha, a limited liability company, is as follows:

$
Ordinary shares of 10c each 1,000,000
8% Preference shares of 50c each 500,000
In the year ended 31 October 20X2, the company has paid the preference dividend
for the year and an interim dividend of 2c per share on the ordinary shares. A final
ordinary dividend of 3c per share is proposed.
What is the total amount of dividends relating to the year ended 31 October 20X2?
A. $580,000
B. $90,000
C. $130,000
D. $540,000

Calculate and record finance costs in ledger accounts and the financial
statements
The interest expense incurred on loan stock and bonds will be shown as an expense
called ‘finance costs' in the statement of profit or loss. We have also seen that
dividends paid on redeemable preference shares are also included as finance costs.
Dr Finance Costs (I/S)

Cr Bank
262
Lecture Example 7
At 30 June 20X2 a company had $1m 8% loan notes in issue, interest being paid
half-yearly on 30 June and 31 December.
On 30 September 20X2 the company redeemed $250,000 of these loan notes at par,
paying interest due to that date.
On 1 April 20X3 the company issued $500,000 7% loan notes, interest payable
half- yearly on 31 March and 30 September.
What figure should appear in the company’s statement of profit or loss for interest
payable in the year ended 30 June 20X3?
A. $88,750
B. $82,500
C. $65,000
D. $73,750
Lecture Example 8
A company's share capital consists of 20,000 25c ordinary shares all, of which were
issued at a premium of 20%. The market value of the shares is currently 70c each.
What would the balance on ordinary share capital be?
A. $14,000
B. $6,000
C. $5,000

Record income tax in the statement of profit or loss of a company including
the under and overprovision of tax in the prior year
Lecture Example 9
A company has a tax liability brought forward of $16,000. The liability is finally
agreed at $17,500 and this is paid during the year. The company estimates that the
tax liability based on the current year’s profits will be $25,000. Calculate the tax
expense and the tax payable for the year
263
Further Question: 1
The issued share capital of RCA Ltd is as follows:
$
Ordinary shares of 20 cents each 1,000,000
8% preference shares of 50 cents each 500,000
In the year ended 30 September 2010, the company paid the preference dividend for
the year and an interim dividend of 3 cents per share on the ordinary shares. A final
ordinary dividend of 5 cents per share was declared on 29 September 2010.
Calculate the total amount of dividends accounted for in the year ended 30
September 2010.
$
Further Question: 2
Pulis plc has the following capital structure:
$
400,000 shares of $0.25 each 100,000
It makes 1 for 5 rights issue at $1.45, which is fully subscribed.
Calculate the balances on the share capital and share premium accounts after the
rights issue.
Further Question: 3
At 31 December 20X8 the capital structure of Pilot Ltd was as follows:
$
200,000 ordinary shares of $0.50 each 100,000
During 20X9, the company made a 1 for 2 bonus issue, using the share premium
account for the purpose, and later issued for cash another 120,000 shares at $1.60
per share.
Calculate the balances on the company’s share capital and premium accounts as at
31 December 20X9.
264
Further Question: 4
The following figures relating to tax of Plot plc are provided:
Tax payable at 1 April 2010 28,600

Tax paid during the year ended 31 March 2011 25,400
The estimated tax liability for the year ended 31 March 2011 is $31,200
Calculate:
a) The tax expense in the statement of profit or loss.
b) The tax due at 31 March 2011 which will be included in the SFP.
265
K
1. Types of share capital
Authorised share capital: the maximum amount of share capital that a company
is empowered to issue.
Issued share capital: the amount of share capital that has been issued to
shareholders.
Called-up share capital: the amount the company has asked shareholders to
pay, for the time being, on shares issued to them.
Paid-up share capital: the amounts actually paid by shareholders on shares

issued to them.
2. Capital Structure
Preference shares carry the right to a final dividend which is expressed as a

percentage of their par value. Preference dividends have priority over ordinary
dividends. Also, preference shareholders have priority over ordinary shareholders to
a return of their capital if the company goes into liquidation. However, preference
shares do not carry a right to vote.
Preference shares may be either redeemable or irredeemable. Redeemable

preference shares mean that the company will repay the nominal value of those
shares at a later date. Irredeemable preference shares form part of equity and their
dividends are treated as appropriations of profit.
Ordinary shares carry no right to a fixed dividend but ordinary shareholders are
entitled to all profits. Ordinary shares normally carry voting rights.
Limited liability companies may issue loan stock or bonds to raise finance. These
are non-current liabilities and the interest is an expense in the statement of profit or
loss
3. Shareholders’ Equity
Shareholders' equity consists of: -
a) Share capital (at nominal value)

b) Share premium – the difference between the issue price of the share and its
par value
c) Revaluation surplus – a non-distributable reserve representing unrealised
profits on the revalued assets
266
d) Other reserves – very often, these are revenue reserves which may either
have a specific purpose (e.g. asset replacement reserve) or not (e.g.
general reserve)
e) Retained earnings – these are profits earned by the company and which have
been retained by the business
4. Bonus Issue
A company may wish to increase its share capital without needing to raise additional
finance. A bonus issue raises no funds. A bonus issue increases the capital base of
the company and gives greater protection to the company’s creditors
Dr Share Premium
Cr Share Capital
A bonus issue is always done at nominal value.
5. Rights Issue
A rights issue is an issue of shares for cash. These shares are usually issued at a
discount to the current market price. The 'rights' are offered to existing
shareholders, who can sell them if they wish.
Dr Cash
Cr Share Capital
Cr Share Premium
6. Dividends
Dividends are an appropriation of retained earnings to shareholders. They are not an

expense in the statement of profit or loss.
Dr Retained Earnings (SOFP)

Cr Dividends Payable (SOFP)
7. Finance Costs
The interest expense incurred on loan stock and bonds will be shown as an expense
called ‘finance costs' in the statement of profit or loss.
267
Dr Finance Costs (I/S)
Cr Bank
268
269
Q
1. The equity capital of a limited liability company comprises
A. Ordinary share capital, preference share capital and retained earnings

B. Ordinary share capital
C. Ordinary share capital and retained earnings
D. Preference share capital
2. When a company makes a rights issue of equity shares which of the following
effects will the issue have?
1. Working capital is increased

2. Share premium account is reduced
3. Investments are increased
A. 1 only
B. 1 and 2
C. 3 only
3. A limited liability company issued 50,000 ordinary shares of 25c each at a

premium of 50c per share. The cash received was correctly recorded but the full
amount was credited to the ordinary share capital account.
Which of the following journal entries is needed to correct this error?
Debit Credit
$ $
A. Share premium account 25,000
Share capital account 25,000
B. Share capital account 25,000
C. Share capital account 37,500
D. Share capital account 25,000
Cash 25,000
270
4. Which of the following journal entries could correctly record a bonus
(capitalisation) issue of shares?
Debit Credit
$ $
A. Cash 100,000
Ordinary share capital 100,000
B. Ordinary share capital 100,000
C. Share premium 100,000
Ordinary share capital 100,000
D. 100,000
Investments 100,000
Cash
5. Which of the following statements are correct?
1. A company might make a rights issue if it wished to raise more equity

capital.
2. A rights issue might increase the share premium account whereas a bonus
issue is likely to reduce it.
3. A rights issue will always increase the number of shareholders in a
company whereas a bonus issue will not.
A. 1 and 2
B. 1 and 3
C. 2 and 3
D. 2 and 4
271
272
Chapter 20
Financial Statements for Companies
IAS 1 (revised) “Presentation of Financial Statements” prescribes the basis for

presentation of general purpose financial statements to ensure comparability both
with the entity’s financial statements of previous periods and with the financial
statements of other entities. It sets out overall requirements for the presentation of
financial statements, guidelines for their structure and minimum requirements for
their content.
A complete set of financial statements comprises:

(i) a statement of financial position as at the end of the period;
(ii) a statement of comprehensive income for the period;
(iii) a statement of changes in equity for the period;
(iv) a statement of cash flows for the period;
(v) notes, comprising a summary of significant accounting policies and
other explanatory information; and
(vi) a statement of financial position as at the beginning of the earliest
comparative period when an entity applies an accounting policy
retrospectively or makes a retrospective restatement of items in its
financial statements, or when it reclassifies items in its financial
statements.
An entity shall present a complete set of financial statements (including comparative

information) at least annually.
20.1 ACCA SYLLABUS GUIDE OUTCOMES 1 and 2:

Prepare extracts of a statement of profit or loss and statement of profit or loss
and other comprehensive income from given information
Prepare extracts of a statement of financial position from given information
One of the statements introduced by IAS 1 (revised) is the statement of

comprehensive income. This statement presents all items of income and expense
recognized in profit or loss together with all other items recognized in income and
expense. Entities may present all items together in a single statement or present two
linked statements – one displaying the items of income and expense recognised in
the statement of profit or loss and the other statement beginning with profit or loss
and displaying all the items included in ‘other comprehensive income’.
Therefore, whereas the statement of profit or loss includes all realised gains and
losses (e.g. net profit for the year), the statement of comprehensive income would
include both the realised and unrealised gains and losses (e.g. revaluation
273
surplus).
274
20.1.1 Proforma 1: One single statement
Statement of comprehensive income for the year ended 31 March 20X8

20X8 20X7
$’000 $’000
Revenue X X
Cost of sales (X) (X)
Gross profit X X
Other income
X X
Distribution costs (X (X
) )
Administrative expenses (X) (X)
Finance costs (X) (X)
Investment income X X
Profit before tax X X
Income tax expense (X) (X)
Profit for the year X X
Other comprehensive income:
Gains on property revaluation X X
Total comprehensive income for the year X X
20.1.2 Proforma 2: Two separate

statements
Statement of profit or loss for the year ended 31 March 20X8

20X8 20X7
$’000 $’000
Revenue X X
Cost of sales (X) (X)
Gross profit X X
Other income X X
Distribution costs (X) (X)
Administrative expenses (X) (X)
Finance costs (X) (X)
Investment income X X
Profit before tax X X
Income tax expense (X) (X)
Profit for the year X X
Statement of comprehensive income for the year ended 31 March 20X8

20X8 20X7
$’000 $’00
Profit for the year X 0
275
X
276
Other comprehensive income:
Gains on property revaluation X X
Total comprehensive income for the year X X
20.1.3 Statement of financial position as at 31 March 20X8
$'000
ASSETS
Non-current assets
Property, plant and equipment X
Other intangible assets X
X
Current assets
Inventories X
Trade receivables X
Other current assets X
Cash and cash equivalents X
X
Total assets X
EQUITY AND LIABILITIES
Equity
Share capital X
Share premium account X
Revaluation surplus X
Retained earnings X
X
Non-current liabilities
Long term borrowings X
Long term provisions X
Current liabilities
Trade payables X
Short term borrowings X
Current tax payable X
Short term provisions X
Total equity and liabilities X

Identify the components of the statement of changes in equity
The revised statement of changes in equity separates owner and non-owner

changes in equity. It includes only details of transactions with owners, with all non-
owner changes in equity presented as a single line – total comprehensive
income.
277
Statement of changes in equity – Proforma
Share Share Revaluation Retained Total

Capital Premium Reserve Earnings
‘000 ‘000 ‘000 ‘000 ‘000
Balance at 31 March 20X7 X X X X X
Changes in accounting X X
policy
Restated balance X X X X X
Issue of share capital X X X
Dividends (X) (X)
Total comprehensive X X X
income
Balance at 31 March 20X8 X X X X X
Lecture Example 1
At 1 July 20X3 the statement of financial position of Sugar, a limited liability

company, contained the following items:
$m
Issued share capital – ordinary shares of 50c 100
Share premium account 140
Revaluation surplus 1 60
Retained earnings 120
–––
–
420
––––
During the year ended 30 June 20X4 the following events took place:
(i) On 1 July 20X3 the company issued 200m ordinary shares, ranking equally
with those already in issue, at $1.40 per share.
(ii) Some land held by the company as a non-current asset was sold for $100m.
The land had originally cost $25m and was revalued to $85m in 20X2, giving
rise to the revaluation surplus of $60m shown above.
(iii) The company’s draft pre-tax profit for the year ended 30 June 20X4 was
$40m.
(iv) Dividends totalling 2c per share were paid in the year on the enlarged capital.
Required:
Prepare the company’s statement of changes in equity for the year ended
30 June 20X4.
278
Lecture Example 2
Which of the following statements about company financial statements is/are

correct, according to International Financial Reporting standards?
1. A material profit or loss on the sale of part of the entity must appear in the
statement of comprehensive income as an extraordinary item.
2. Dividends paid and proposed should be included in the statement of
comprehensive income.
3. The statement of comprehensive income must show separately any
material profit or loss from operations discontinuing during the year.
4. The statement of changes in equity must not include unrealised gains or
losses.
A. 1, 2 and 3
B. 2 and 4
C. 3 only

Explain the purpose of disclosure notes
Notes to the accounts are prepared for the following three purposes:
(i) present information about the basis of preparation of the financial
statements and the specific accounting policies used;
(ii) disclose the information required by IFRSs that is not presented elsewhere
in the financial statements; and
(iii) provide information that is not presented elsewhere in the financial
statements, but is relevant to an understanding of any of them.

Draft the following disclosure notes
We have already prepared the disclosure notes when dealing with the relevant
standard. However, these are the disclosure notes you would need to know for your
exams.
20.4.1 Property, Plant and Equipment
For each class of property, plant and equipment, disclose:
 basis for measuring carrying amount

 depreciation method(s) used
 useful lives or depreciation rates
279
 gross carrying amount and accumulated depreciation and impairment losses
period, showing:
o additions
o disposals
o acquisitions through business combinations
o revaluation increases or decreases
o impairment losses
o reversals of impairment losses
o depreciation
o net foreign exchange differences on translation
o other movements
If property, plant, and equipment is stated at revalued amounts, certain additional

disclosures are required:
 the effective date of the revaluation

 whether an independent valuer was involved
 the methods and significant assumptions used in estimating fair values
 for each revalued class of property, the carrying amount that would have been
recognised had the assets been carried under the cost model
 the revaluation surplus, including changes during the period and any
restrictions on the distribution of the balance to shareholders
Land Machinery Office Total

and Equipment
Buildings
$ $ $ $
Cost or valuation
At 1 January 2010 50,000 10,000 8,000 68,000
Revaluation surplus 12,000 2,000 2,000 16,000
Additions in year 4,000 4,000 - 8,000
Disposals in year (1,000) (1,000) - (2,000)
At 31 December 2010 65,000 15,000 10,000 90,000
Depreciation
At 1 January 2010 16,000 6,000 4,000 26,000
Charge for year 4,000 3,000 2,000 9,000
Eliminated on disposals (500) (500) - (1,000)
At 31 December 2010 19,500 8,500 6,000 34,000
Carrying Amount
At 31 December 2010 45,500 6,500 4,000 56,000
At 1 January 2010 34,000 4,000 4,000 42,000
280
20.4.2 Intangible non-current assets (IAS 38)
For each class of intangible asset, disclose
 useful life or amortisation rate

 amortisation method
 gross carrying amount
 accumulated amortisation and impairment losses
 line items in the statement of profit or loss in which amortisation is included
period showing:
o additions (business combinations separately)
o assets held for sale
o retirements and other disposals
o revaluations
o impairments
o reversals of impairments
o amortisation
o foreign exchange differences
o other changes
 basis for determining that an intangible has an indefinite life
 description and carrying amount of individually material intangible assets
 certain special disclosures about intangible assets acquired by way of
government grants
 information about intangible assets whose title is restricted
 contractual commitments to acquire intangible assets
Additional disclosures are required about:
 intangible assets carried at revalued amounts

 the amount of research and development expenditure recognised as an
expense in the current period
Development expenditure
$
Net book value at 1 April 20X0 X
Additions X
Amortisation charge (X)
Disposals (X)
Net book value at 31 March 20X1 X
At 31 March 20X0
Cost X
Net book value X
281
At 31 March 20X1
Cost X
Net book value X
20.4.3 Provisions, Contingent Liabilities and Contingent Assets (IAS 37)
Provisions: -
At 1 April 20x0 X
Increase in period X
Released in period (X)
At 31 March 20x1 X
be disclosed, unless the possibility of any outflow is remote. The required
disclosures are:
 A brief description of the nature of the contingent liability;
 An estimate of its financial effect;
 An indication of the uncertainties that exist relating to the amount or timing
of any outflow; and
Where an inflow of economic benefits is probable, an entity should disclose: -

1. a brief description of its nature; and where practicable
2. an estimate of the financial effect
20.4.4 Events after the reporting period (IAS 10)
IAS 10 requires these three disclosures: -
1. the date when the financial statements were authorised for issue and who
gave that authorisation.
2. if information is received after the end of the reporting period about conditions
that existed at the end of the reporting period, disclosures that relate to those
conditions should be updated in the light of the new information.
3. where non-adjusting events after the reporting period are of such significance
that non-disclosure would affect the ability of the users of financial statements
to make proper evaluations and decisions, disclosure should be made for
each such significant category of non-adjusting event regarding the nature of
the event and an estimate of its financial effect or a statement that such an
estimate cannot be made.
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20.4.5 Inventories (IAS 2)
The financial statements should disclose the following: -
 accounting policy for inventories

 carrying amount, generally classified as merchandise, supplies, materials,
work in progress, and finished goods. The classifications depend on what is
appropriate for the entity
 carrying amount of any inventories carried at fair value less costs to sell
 amount of any write-down of inventories recognised as an expense in the
period
20.5 IAS 18 - Revenue
IAS 18, Revenue, prescribes the requirements for the recognition of revenue arising
from an entity’s ordinary activities.
20.5.1 Measurement of Revenue
Revenue is to be measured at the fair value of the consideration received or

receivable. By fair value, we mean “the amount for which an asset can be
exchanged, or a liability settled, between knowledgeable parties in an arm’s length
transaction.”
Generally, revenue is recognized when the entity has transferred to the buyer the
significant risks and rewards of ownership and when the revenue can be measured
reliably.
20.5.2 Scope
IAS 18 covers the revenue from: -

1 Sale of goods
2 Rendering of services
3 Interest, royalties and dividends
20.5.2.1 Revenue from the sale of goods
Revenue from the sale of goods should be recognized when all of the following
criteria are satisfied: -
1 The significant risks and rewards of ownership of the goods have been
transferred to the buyer
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2 The seller retains neither continuing managerial involvement to the degree
usually associated with ownership nor effective control over the goods sold
3 The amount of the revenue can be reliably measured
4 It is probable that economic benefits associated with the transaction will flow
to the seller
5 The costs incurred or to be incurred in respect of the transaction can be
measured reliably
20.5.2.2 Revenue from the rendering of services
For revenue arising from the rendering of services, revenue should be recognised by
reference to the stage of completion of the transaction at the end of the reporting
period. The following criteria must be met:
1 the amount of revenue can be measured reliably;

2 it is probable that the economic benefits will flow to the seller;
3 the stage of completion at the balance sheet date can be measured reliably; and
4 the costs incurred, or to be incurred, in respect of the transaction can be
measured reliably.
20.5.2.3 Interest, royalties and dividends
Interest, royalties and dividends are included as income because they arise from the
use of an entity’s assets by other parties. They are recognised as revenue when the
economic benefits are expected to flow to the enterprise and the amount of revenue
can be measured reliably.
Revenue does not include sales taxes, value added taxes or any other tax which is
collected for third parties.
Lecture Example 3
Xtra Ltd, a new company manufacturing and selling consumable products, has come
out with an offer to refund the cost of purchase within one month of sale if the
customer is not satisfied with the product.
When should Xtra Ltd recognize the revenue?
A. When goods are sold to the customers

B. After one month of sale
C. Only if goods are not returned by the customers after the period of one
month
D. At the time of sale along with an offset to revenue of the liability of the
same amount for the possibility of the return
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Lecture Example 4
Revenue from an artistic performance is recognized once: -
A. The audience register for the event online

B. The tickets for the concert are sold
C. Cash has been received from the ticket sales
D. The event takes place
K
1. A complete set of financial statements comprises:
(i) a statement of financial position as at the end of the period;
(ii) a statement of comprehensive income for the period;
(iii) a statement of changes in equity for the period;
(iv) a statement of cash flows for the period;
(v) notes, comprising a summary of significant accounting policies and
other explanatory information; and
(vi) a statement of financial position as at the beginning of the earliest
comparative period when an entity applies an accounting policy
retrospectively or makes a retrospective restatement of items in its
financial statements, or when it reclassifies items in its financial
statements.
2. The statement of comprehensive income includes both the realised gains and
losses from the statement of profit or loss and the unrealised gains and losses
from the statement of financial position.
3. The statement of changes in equity shows the movements in share capital

and reserves (equity) which are included in the statement of financial
position.
4. Notes to the accounts are prepared to:
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a. present information about the basis of preparation of the financial
statements and the specific accounting policies used;
b. disclose the information required by IFRSs that is not presented
elsewhere in the financial statements; and
c. provide information that is not presented elsewhere in the financial
statements, but is relevant to an understanding of any of them.
5. IAS 18 covers the revenue from: -

a. Sale of goods
b. Rendering of services
c. Interest, royalties and dividends
Generally, revenue is recognized when the entity has transferred to the buyer
the significant risks and rewards of ownership and when the
286
Q
1. Which of the following items are required to be disclosed in a limited liability
company’s financial statements according to IAS 1 Presentation of Financial
Statements?
1. Authorised share capital

2. Finance costs
3. Depreciation and amortization
4. Issued share capital
A. 1, 2 and 3 only
B. 2, 3 and 4 only
C. All four items
2. Which of the following could appear as separate items in the statement of

changes in equity required by IAS I Presentation of Financial Statements as
part of a company’s financial statements?
1. Gain on revaluation of land.

2. Loss on sale of investments.
3. Prior year adjustments.
4. Proceeds of an issue of ordinary shares.
5. Dividends proposed after the year end.
A. 1, 3 and 4 only
B. 1, 2 and 4 only
C. 1 and 3 only
D. All five items
3. Which of these statements about limited liability companies is/are correct?
1. A company might make a bonus (capitalisation) issue to raise funds

for expansion.
2. The profit or loss on the disposal of part of a company’s operations
must be disclosed in the statement of comprehensive income as an
extraordinary item if material.
3. Both realised and unrealised gains and losses may be included in the
statement of changes in equity required by IAS 1 Presentation of
Financial Statements.
A. 1 and 3
B. 2 and 3
C. 1 and 2
D. 3 only
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4. Which of the following statements regarding a limited liability company
statement of comprehensive income is correct?
A. Accounting standards define the expenses which are reported

under 'cost of sales'
B. 'Depreciation' appears as a separate heading
C. Interest payable is deducted from profit after taxation
D. Irrecoverable debts will be included under one of the statutory
expense headings (usually administrative expenses)
5. According to the illustrative financial structure in IAS 1 (revised) Presentation

of financial statements, dividends paid during the year should be disclosed in:
A. Statement of comprehensive income (statement of profit or loss)

B. Statement of changes in equity
C. Statement of financial position
D. None of these
6. Which of the following statements is incorrect?
1. All non-current assets must be depreciated.

2. If property is revalued, the revaluation surplus appears only in the
statement of comprehensive income.
3. If a tangible non-current asset is revalued, all tangible assets of the
same class should be revalued.
4. In a company’s published statement of financial position, tangible
assets and intangible assets must be shown separately.
A. 1 and 2
B. 1 and 3
C. 2 and 3
D. 3 and 4
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A
1. C - All of these items are disclosed, either in the financial statements or in
the notes.
2. A - The loss on sale of investments will be recognised in the statement of

comprehensive income
3. D - A bonus issue does not raise any funds (no cash involved) and items
are no longer classified as extraordinary.
4. D - The contents of cost of sales are not defined by any IAS; net profit is
calculated after interest; depreciation will be included under the relevant
statutory heading
5. B – Dividends are not an expense. Dividends declared but still due at year
end go into SFP and SOCIE.
6. A – Land is usually not depreciated; gain on revaluation is also included in

the statement of changes in equity.
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Chapter 21
IAS 10: EVENTS AFTER THE REPORTING
PERIOD
Define an event after the reporting period in accordance with International
Financial Reporting Standards
According to IAS 10, “Events after the reporting period” are those events, both
favourable and unfavourable, that occur between the end of the reporting period and
the date when the financial statements are authorised for issue”.
These events can have important effects on the financial statements.

Classify events as adjusting or non-
adjusting Two types of events can be identified:
a. those that provide evidence of conditions that existed at the end of the
reporting period (adjusting events); and
b. those that are indicative of conditions that arose after the end of the reporting
period (non-adjusting events).
21.2.1 Examples of adjusting events given in IAS 10 are:
a. the resolution of a court case, as the result of which a provision has to be

recognised instead of the disclosure by note of a contingent liability;
b. evidence of impairment of assets;
c. bankruptcy of a major customer;
d. sale of inventories at prices suggesting the need to reduce the figure in the
Statement of Financial Position to the net value actually realized;
e. discovery of fraud or errors that show the financial statements were incorrect.
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21.2.2 Examples of non-adjusting events given in IAS 10 are:
a. decline in market value of investments;

b. announcement of a plan to discontinue part of the enterprise;
c. major purchases and sales of assets;
d. destruction of a major asset by fire etc;
e. sale of a major subsidiary;
f. major dealings in the company's ordinary shares;
Further provisions covered by IAS 10: -
a. Authorisation for issue of financial statements
An enterprise should disclose the date when the financial statements were
authorised for issue and who gave that authorisation. If the owners or others have
the power to amend the financial statements after issue, that fact should be
disclosed.
b. Going concern
If the management decides after the end of the reporting period that it is necessary
to liquidate the enterprise, the financial statements should not be prepared on a
going concern basis.
c. Dividends
If an entity declares dividends after the reporting period, the entity shall not
recognise those dividends as a liability at the end of the reporting period. That is a
non-adjusting event.

Distinguish between how adjusting and non-adjusting events are reported
in the financial statements.
Financial statements should be adjusted for adjusting events. This means that the
amounts in the financial statements should be changed.
Non-adjusting events do not, by definition, require an adjustment to the financial

statements, but if they are of such importance that non-disclosure would affect the
ability of users of the financial statements to make proper evaluations and decisions,
the enterprise should disclose by note:
a. the nature of the event; and

b. an estimate of its financial effect, or a statement that such an estimate cannot
be made.
291
Lecture Example 1
Which of the following statements are correct, according to IAS 10 Events after
the reporting period?
1. Details of all adjusting events must be disclosed by note to the financial

statements.
2. A material loss arising from the sale, after the reporting period, of inventory
valued at cost in the statement of financial position must be reflected in the
financial statements.
3. If the market value of investments falls materially after the end of the reporting
period, the details must be disclosed by note.
4. Events after the reporting period are those that occur between the end of the
reporting period and the date when the financial statements are authorised for
issue.
A 1 and 2 only
B 1, 3 and 4
C 2 and 3 only
D 2, 3 and 4
Lecture Example 2
Which of the following events after the statement of financial position date would
normally qualify as adjusting events according to IAS 10 Events after the reporting
period?
1. The bankruptcy of a credit customer with a balance outstanding at the end of

the reporting period.
2. A decline in the market value of investments.
3. The declaration of an ordinary dividend.
4. The determination of the cost of assets purchased before the end of the
reporting period.
A 1, 3, and 4
B 1 and 2 only
C 2 and 3 only
D 1 and 4 only
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Lecture Example 3
Which of the following events between the end of the reporting period and the date
the financial statements are authorised for issue must be adjusted in the financial
statements?
1. Declaration of equity dividends.

2. Decline in market value of investments.
3. The announcement of changes in tax rates.
4. The announcement of a major restructuring.
A 1 only
B 2 and 4
C 3 only
D None of them
K
Key Definitions
 Events after the reporting period:
Those events, both favourable and unfavourable, that occur between the end of the
reporting period and the date when the financial statements are authorised for issue.
 Adjusting events:
Those events that provide evidence of conditions that existed at the end of the
reporting period.
 Non-adjusting events:
Those events that are indicative of conditions that arose after the end of the
reporting period.
Typical examples of adjusting events given in IAS 10 are:
a. the resolution of a court case;

b. evidence of impairment of assets;
c. bankruptcy of a major customer;
d. sale of inventories at prices lower that their cost;
e. discovery of fraud or errors.
293
Typical examples of non-adjusting events given in IAS 10 are:
a. decline in market value of investments;

b. announcement of a plan to discontinue part of the enterprise;
c. major purchases and sales of assets;
d. destruction of a major asset by fire etc;
e. sale of a major subsidiary;
f. major dealings in the company's ordinary shares
Further provisions covered by IAS 10: -
a. Authorisation for issue of financial statements
An enterprise should disclose the date when the financial statements were
authorised for issue and who gave that authorisation.
b. Going concern
If the management decides after the end of the reporting period that it is necessary
to liquidate the enterprise, the financial statements should not be prepared on a
going concern basis.
c. Dividends
If an entity declares dividends after the reporting period, the entity shall not
recognise those dividends as a liability at the end of the reporting period. That is a
non-adjusting event.
Accounting for adjusting and non-adjusting events: -
Financial statements should be adjusted for adjusting events.
For material non-adjusting events, the enterprise should disclose by note:
a. the nature of the event; and

b. an estimate of its financial effect, or a statement that such an estimate cannot
be made.
294
Q
1. Which of the following events occurring after the reporting period are
classified as adjusting, if material?
1. The sale of inventories valued at cost at the end of the reporting period for
a figure in excess of cost.
2. A valuation of land and buildings providing evidence of an impairment in
value at the year end.
3. The issue of shares and loan notes.
4. The insolvency of a customer with a balance outstanding at the year end.
A 1 and 3
B 2 and 4
C 2 and 3
D 1 and 4
2. Clogs Co has proposed dividends of $10,000 after the end of the

reporting period. What is the correct treatment according to IAS 10?
A Adjust for the dividends

B Disclose in a note to the financial statements
C Do nothing
3. Which of the following would be a non-adjusting event after the

reporting period when preparing financial statements at 30 September
20X0 according to IAS 10, Events after the reporting period?
A An insurance claim is agreed on 10 October 20X0 for compensation for

a fire in September which destroyed part of the warehouse inventory
B A decision is made on 9 October 20X0 to sell the group's major trading
activities in Eastern Europe
C Inventory valued at $30,000 is judged no longer saleable
D Notification received on 11 October 20X0 that a customer owing
$50,000 as at 30 September 20X0 has gone into liquidation
4. When does an event after the reporting period require changes in the
financial statements?
A Never
B If it provides further evidence of conditions existing at the end of the
reporting period
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5. A receivable has been written off as irrecoverable. However, the
customer suddenly pays the written off amount after the end of the
reporting period. Is this event:
A Adjusting
B Non-adjusting
1. B – Inventories should always be valued at lower of cost and NRV.
2. B – Non–adjusting
3. B
A, C and D are adjusting events. B is a post year-end decision not

clarifying the position at the end of the reporting period and is therefore
non-adjusting.
4. B
5. A
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Chapter 22
Accounting Policies, Changes in Accounting
Estimates and Errors
22.1 ACCA SYLLABUS OUTCOME 1:

Understand the provision of International Financial Reporting Standards
governing financial statements regarding changes in accounting policies.
.
IAS 8 prescribes criteria for selecting and changing accounting policies and also sets
out the requirements for changes in accounting estimates and corrections of errors.
Accounting policies are specific principles, bases, conventions, rules and practices
applied by an entity in preparing and presenting financial statements. Once selected,
accounting policies must be applied consistently for similar transactions, other
events and conditions. They may be changed only if the change
b) is required by a standard or an interpretation;
c) results in financial statements providing reliable and or relevant information.

Identify the appropriate accounting treatment if a company changes a material
accounting policy.
A change in accounting policies must be applied retrospectively. That is to say, the

new policy is applied to transactions, other events and conditions as if the policy had
always been applied. The practical impact of this is that corresponding amounts (or
“comparatives”) presented in financial statements must be restated as if the new
policy had always been applied. The impact of the new policy on the retained
earnings prior to the earliest period presented should be adjusted against the
opening balance of retained earnings.
Lecture Example 1
Accurate Ltd changed its accounting policy in 20X8 with respect to the valuation of
inventories. Up to 20X7, inventories were valued using a weighted-average cost
method. In 20X8, the method changed to first-in, first-out, as it was considered to
more accurately reflect the usage and flow of inventories. The impact on inventory
valuation was determined to be:
At December 31, 20X6: - an increase of $10,000
297
At December 31, 20X7: - an increase of
$15,000 At December 31, 20X8: - an
increase of $20,000
The statements of profit or loss prior to adjustment are: -
20X8 20X7
$ $
Revenue 250,000 200,000
Cost of sales 100,000 80,000
Gross profit 150,000 120,000
Administration costs 60,000 50,000
Selling and distribution costs 25,000 15,000
Net profit 65,000 55,000
Required: -
Present the change in accounting policy in the statement of profit or loss and the
adjusted retained earnings in accordance with the requirements of IAS 8.
Changes in accounting estimates are not examinable in the F3/FFA Paper

Understand the provision of IFRS governing financial statements regarding
material errors which result in prior period adjustments
Prior-period errors are omissions from, and misstatements in, financial statements
for one or more prior periods arising from a failure to use, or misuse of, reliable
information that was available at the time and could reasonably be expected to have
been obtained and taken into account in the preparation and presentation of financial
statements. Misstatements or omissions are “material” if they could, either
individually or cumulatively, influence the decisions of users of financial statements.
Discovery of material errors relating to prior periods shall be corrected by restating

comparative figures in the financial statements for the year in which the error is
discovered.
Lecture Example 2
The auditor of Roman Co noticed in 20X8 that, in 20X7, the entity had omitted to
record in its books of accounts an amortisation of development expenditure of
$30,000.
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The following are extracts from the statement of profit or loss for the years ended 31
December 20X7 and 20X8, before correction of the error: -
20X8 20X7
$ $
Gross Profit 300,000 345,000
General and administrative expenses (90,000) (90,000)
Selling and distribution costs (30,000) (30,000)
Amortisation expense (30,000) XXXXX
Net income before income taxes 150,000 225,000
Income taxes (30,000) (45,000)
Net Profit 120,000 180,000
The retained earnings of Roman Co for 20X7 and 20X8 before correction of the error
are: -
Retained earnings, beginning of 20X7 $45,000

Retained earnings, end of 20X7 $225,000
Retained earnings, end of 20X8 $345,000
The income tax rate was 20% for both years
Required: -
Prepare the accounting treatment prescribed by IAS 8 for the correction of the errors.
299
K
1. Accounting policies: -
Accounting policies are specific principles, bases, conventions, rules and

practices applied by an entity in preparing and presenting financial
statements.
They may be changed only if the change

a) is required by a standard or an interpretation;
b) results in financial statements providing reliable and or relevant
information.
A change in accounting policies must be applied retrospectively.

Comparatives presented in financial statements must be restated as if the
new policy had always been applied. The impact of the new policy on the
retained earnings prior to the earliest period presented should be adjusted
against the opening balance of retained earnings.
2. Prior-period errors: -
Prior-period errors are omissions from, and misstatements in, financial

statements for one or more prior periods.
Discovery of material errors relating to prior periods shall be corrected by

restating comparative figures in the financial statements for the year in which
the error is discovered. Therefore, the adjustment is also done
retrospectively.
300
Q
1. XYZ Co changes its method of valuation of inventories from weighted-average
method to first-in, first-out method. XYZ Co should account for this change as
A. A change in account policy and account for it prospectively

B. A change in account policy and account for it retrospectively
C. Account for it as a correction of an error and account for it
prospectively
D. Account for it as a correction of an error and account for it
retrospectively
2. Change in accounting policy does not include: -
A. Change in useful life from 10 years to 7 years

B. Change of method of valuation of inventory from FIFO to weighted-
average
C. Change of method of valuation of inventory from weighted-average to
FIFO
1. B - Changes in accounting policies and prior–period errors are always

accounted for retrospectively.
2. A - Change in useful life is a change in an accounting estimate. Take the

NBV before the change and calculate on remaining useful years.
301
Chapter 23
STATEMENTS OF CASH FLOW
23.1 ACCA SYLLABUS GUIDE OUTCOMES 1 AND 2:

Differentiate between profit and cash flow
Understand the need for management to control cash flow
A business may appear profitable on its statement of profit or loss, however if its
cash outflow exceeds its cash inflow over a prolonged period then it will not survive.
Readers of a company's financial statements might also be misled by a reported

profit figure.
1. Shareholders might believe that if a company makes a profit after tax, then
this is the amount which it could afford to pay as a dividend.
2. Employees might believe that if a company makes profits, it can afford to pay
higher wages next year.
3. Survival of a business entity depends not so much on profits as on its ability to
pay its debts when they fall due.
Indeed, a business must generate sufficient cash from its operations to reward the
various stakeholders e.g., shareholders and lenders. An expanding company might
have negative operating cash flow as it builds up the level of its inventories and
receivables in line with the increased turnover. However, an increase in working
capital without an increase in turnover might indicate operational inefficiencies and
will lead to liquidity problems.

Recognise the benefits and drawbacks to users of the financial statements of
a statement of cash flows
One of the most useful financial statements produced by a business is the statement
of cash flow because it provides a clear and understandable picture of cash
movements over the financial year. A statement of cash flow provides useful
additional information that is not provided by the statement of profit or loss. For
example, it identifies whether cash has increased or decreased from one year to the
next and also where the cash has come from.
Statements of cash flow are a useful addition to the financial statements of a

company because accounting profit is not the only indicator of performance. They
concentrate on the sources and uses of cash and are a useful indicator of a
company's liquidity and solvency. Also, users of accounts can readily understand
302
cash flows, as opposed to statements of profit or loss and statements of financial
position which are subject to manipulation by the use of different accounting policies.
However, the main weakness of a statement of cash flow is that it is a historic
statement. Therefore, it does not indicate whether the business will be able to meet
its debts in the future. A more helpful statement would be a forecast statement of
cash flow.

Classify the effect of transactions on cash flows
IAS 7, Statements of Cash Flows, splits cash flows into the following headings:
1. Cash flows from operating activities
2. Cash flows from investing activities
3. Cash flows from financing activities
Cash flows
outflows inflows
Cash Cash
equivalents
Cash on hand Short term highly liquid

Demand deposits investments e.g.
current investments
23.3.1 Cash flows from operating activities

These represent cash flows derived from operating or trading activities.
There are two methods which can be used to find the net cash from operating
activities: - direct and indirect method. These will be discussed in the next
sections.
23.3.2 Cash flows from investing activities

These are 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.
303
23.3.3 Cash flows from financing activities
Financing cash flows comprise receipts from or repayments to external
providers of finance in respect of principal amounts of finance. For e.g.:
(i) Cash proceeds from issuing shares
(ii) Cash proceeds from issuing debentures, loans, notes, bonds,
mortgages and other short or long term borrowings
(iii) Cash repayments of amounts borrowed
(iv) Dividends paid to shareholders
In order to calculate such figures the closing statement of financial position figure for
debt or share capital and share premium is compared with the opening position for
the same items.
23.3.4 Statement of cash flows for the year ended 31 December 20X7
(INDIRECT METHOD)
$000 $000
Cash flows from operating activities
Profit before taxation 3,390
Adjustment for:
Depreciation 450
Investment income (500)
Interest expense 400
3,740
Increase in trade and other receivables (500)
Decrease in inventories 1,050
Decrease in trade payables (1,740)
Cash generated from operations 2,550
Interest paid (270)
Income taxes paid (900)
Net cash from operating activities 1,380
Cash flows from investing activities

Purchase of property, plant and equipment
(900
) Proceeds from sale of equipment 20
Interest received 200
Dividends received 200
Net cash used in investing activities (480)
Cash flows from financing activities

Proceeds from issue of share capital 250
Proceeds from long-term borrowings 250
Dividends paid* (1,290)
Net cash used in financing activities (790
)
Net increase in cash and cash equivalents 110
Cash and cash equivalents at beginning of period 120
Cash and cash equivalents at end of period 230
304
* This could also be shown as an operating cash
flow.
305
Calculate the figures needed for the statement of cash flows including:
i) Cash flows from operating activities
ii) Cash flows from investing activities
iii) Cash flows from financing activities
Prepare extracts from statements of cash flows from given information
Lecture Example 1
Extracts from ACD Co’s statements of financial position show the following items of
property, plant and equipment at net book value:
30 June
20X7 20X6
$ $
Property, plant and equipment
Freehold property 1,230,000 750,000
Plant and equipment 465,000 380,000
Furniture and fixtures 90,000 105,000
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.
a. What is the total figure for depreciation in ‘cash flows from operating
activities’ in respect of property, plant and equipment?
b. What is the figure for the profit or loss on disposal to be included in

‘cash flows from operating activities’?
c. What is the total expenditure on property, plant and equipment included

under ‘cash flows from investing activities’?
d. What is the figure for proceeds from disposal of plant and equipment to
be included under ‘cash flows from investing activities’?
306
Lecture Example 2
These extracts have been taken from the accounts of Clarkes Co.
Statement of financial position (extracts)

31 October 31 October
20X8 20X7
Current liabilities
Income tax payable 9,850 8,750
The income tax charge during the year was $14,500.
What will appear as “income tax paid” in the statement of cash flows for
the year ended 31 October 20X8?
Lecture Example 3
These extracts have been taken from the accounts of Johns Co.
Statement of financial position (extracts)

31 October 31 October
20X8 20X7
Current liabilities
Dividends payable 9,750 5,750
Dividends charged to retained earnings during the year were $15,500.
What will appear as “dividends paid” in the statement of cash flows for the
year ended 31 October 20X8?
A. $5,750
B. $11,500
C. $15,500
D. $21,250

Calculate the cash flow from operating activities using the indirect and direct
method
23.5.1 The direct method
In the direct method, the cash records of the business are analysed for the period,
picking out all payments and receipts relating to operating activities. These are
summarised to give the net figure for the cash flow statement. Not many
businesses
307
adopt this approach as it can be quite time consuming. However, this is the preferred
method under IAS 7.
$000 $000
Cash flows from operating activities
Cash receipts from customers 30,150
Cash payments to suppliers and employees (27,600)
Interest paid (270)
Income taxes paid (900)
Lecture Example 4
The following information is available about the transactions of Mermot, a limited

liability company, for the year ended 31 December 20X1.
$000
Depreciation 880
Cash paid for expenses 2,270
Increase in inventories 370
Cash paid to employees 2,820
Decrease in receivables 280
Cash paid to suppliers 4,940
Decrease in payables 390
Cash received from customers 12,800
Net profit before taxation 2,370
Mermot has no interest payable or investment income.
Required: -
Compute Mermot’s net cash flow from operating activities for the company’s
cash flow statement for the year ended 31 December 2001 using: -
a. Direct method
b. Indirect method
308
Lecture Example 5
The statements of financial position of RCA Malta, a limited liability company, at 30

June 20X5 and 20X6 are as follows
Notes:
1. The depreciation charge for the year was $13,000,000
2. $6,200,000 was paid during the year to settle the income tax liability at 30
June 20X5.
3. The additional loan notes were issued on 1 January 2006. All interest due was
paid on 31 December 20X5 and 30 June 20X6.
4. Dividends paid during the year totalled $4,000,000.
Required:
Prepare the statement of cash flow for the company for the year ended 30 June
20X6, using the format in IAS 7 Statements of Cash Flow.
309
Further Questions
1. At the start of the accounting period the company has a tax liability of $50 and
at the reporting date a tax liability of $90. During the year the tax charged in
the statement of profit or loss was $100.
Required: Calculate the tax paid
2. At the start of the accounting period the company has PPE with a carrying
amount of $100. At the reporting date the carrying amount of the PPE is $300.
During the year depreciation charged was $20, a revaluation surplus of $60
was recorded and PPE with a carrying amount of $15 was sold.
Required: Calculate the cash paid to buy new PPE.
3. At the start of the accounting period the company has retained earnings of
$500 and at the reporting date retained earnings are $700. During the
reporting period a profit for the year of $450 was reported.
Required: Calculate the dividend paid.
4. Extracts from the financial statements are as follows:
Operating profit 80,000
Investment income 12,000
Finance costs (10,000

)
Profit before tax 82,000
Tax (32,000
)
Profit for the year 50,000
Other comprehensive income
Revaluation gain 40,000
Total comprehensive income 90,000
310
Closing balance Opening balance
Inventory 30,000 25,000
Receivables 20,000 26,000
Current liabilities
Trade payables 14,000 11,000
Additional information
During the year depreciation of $50,000 and amortisation of $40,000 was charged to
profit.
Receipts from customers, combined with cash sales, were $800,000, payments to
suppliers of raw materials $400,000, other operating cash payments were $100,000
and cash paid on behalf and to employees was $126,000.
Interest paid is $12,000 and taxation paid is $13,000.
Required :
(a) Using the direct method, prepare the operating activities section of the statement
of cash flows.
(b) Using the indirect method, determine the operating activities section of the
statement of cash flows.
Statement of Cash Flows – Further Illustrations2
2 Clendon T., Cash Flow Statements, February 2016, http://www.accaglobal.com/gb/en/student/exam-support-

resources/fundamentals- exams-study-resources/f3/technical-articles/cashflow-statements.html
311
1. At the start of the accounting period the company has a tax liability of $50 and
at the reporting date a tax liability of $90. During the year the tax charged in
the statement of profit or loss was $100.
Required: Calculate the tax paid.
Income Tax Payable

A/c
Tax paid (missing

figure) 60 Bal b/d 50
Bal c/d 90 P/L (tax expense) 100

150 150
2. At the start of the accounting period the company has PPE with a carrying
amount of $100. At the reporting date the carrying amount of the PPE is
$300. During the year depreciation charged was $20, a revaluation surplus of
$60 was recorded and PPE with a carrying amount of $15 was sold.
Required: Calculate the cash paid to buy new PPE.
PPE
A/c
Bal b/d 100 Depnexp 20

Revaluation reserve 60 Disposal 15
Bank ( missing 175 Bal c/d 300
figure)
335 335
3. At the start of the accounting period the company has retained earnings of
$500 and at the reporting date retained earnings are $700. During the
reporting period a profit for the year of $450 was reported.
Required: Calculate the dividend paid
Retained earnings
A/c
312
Dividends paid (missing
figure) 250 Bal b/d 500
313
Bal c/d 700 Profit for the year 450
950 950
4. Below find the extracts from the financial statements: -
Additional information
During the year depreciation of $50,000 and amortisation of $40,000 was charged to
profit.
314
Receipts from customers, combined with cash sales, were $800,000, payments to
suppliers of raw materials $400,000, other operating cash payments were $100,000
and cash paid on behalf and to employees was $126,000.
Interest paid is $12,000 and taxation paid is $13,000.
Required:-
(a) Using the direct method prepare the operating activities section of the statement
of cash flows.
(b) Using the indirect method determine the operating activities section of the
statement of cash flows.
Operating Activities - Direct Method

Cash received from customers 800,000
Cash paid to suppliers -400,000
Cash paid to employees -100,000
Other operating payments -126,000
Interest paid -12,000
Income taxes paid -13,000
Operating Activities - Indirect Method

Adjustments:
Depreciation 50,000
Amortisation 40,000
Investment income -12,000
Finance cost 10,000
170,000
Increase in inventory (30 - 25) -5,000
Decrease in receivables (20 - 26) 6,000
Increase in payables (14 - 11) 3,000
Interest paid -12,000
Income taxes paid -13,000
315
K
1. What is the difference between profit and cash?
A business may appear profitable on its statement of profit or loss, however if its
cash outflow exceeds its cash inflow over a prolonged period then it will not survive.
An expanding company might have negative operating cash flow as it builds up the
level of its inventories and receivables in line with the increased turnover. However,
an increase in working capital without an increase in turnover might indicate
operational inefficiencies and will lead to liquidity problems.
316
2. The advantages and disadvantages of a statement of cash flows
Advantages: -
i. It provides a clear and understandable picture of cash movements over the

financial year.
i. A statement of cash flow provides useful additional information that is not
provided by the statement of profit or loss. For example, it identifies whether
cash has increased or decreased from one year to the next and also where
the cash has come from.
ii. It is a useful addition to the financial statements of a company because
accounting profit is not the only indicator of performance. Statements of cash
flow concentrate on the sources and uses of cash and are a useful indicator of
a company's liquidity and solvency.
iv. Users of accounts can readily understand cash flows, as opposed to
statements of profit or loss and statements of financial position which are
subject to manipulation by the use of different accounting policies.
Disadvantages: -
i. It is a historic statement. Therefore, it does not indicate whether the

business will be able to meet its debts in the future.
3. Difference between cash and cash equivalents
Cash comprises cash on hand and on demand deposits, less bank overdrafts.
Cash equivalents are short term, highly liquid investments such as current asset
investments (shares) which can be converted into known amounts of cash
relatively quickly without having a major impact on the entity’s activities.
317
4. The Statement of Cash Flows
Cash flows
Operating Investing Financing

Activities Activities Activities
Cash and cash Acquisition and Cash raised from

equivalents disposal of non- the issue of shares
generated and current assets and and loans; cash
used by trading return on used in repayment
activities investments of loans and
payments of
dividends
Direct Method Indirect

Method
318
Q
1. IAS 7 requires the statement of cash flows to open with the calculation of net
cash from operating activities arrived at by adjusting net profit before taxation.
Which of the following lists consists only of items which could appear in such a
calculation?
A. Depreciation, increase in receivables, decrease in payables, proceeds from sale

of equipment, increase in inventories
B. Increase in payables, decrease in inventories, profit on sale of plant,
depreciation, decrease in receivables
C. Increase in payables, proceeds from sale of equipment, depreciation, decrease
in receivables, increase in inventories
D. Depreciation, interest paid, proceeds from sale of equipment, decrease in
inventories.
2. A draft statement of cash flows contains the following calculation of cash flows
from operating activities:
$m
Profit before tax 13
Depreciation 2
Decrease in inventories (3
)
Decrease in trade and other receivables 5
Decrease in trade payables 4
Net cash inflow from operating activities 21
Which corrections need to be made to the calculation?
3. A limited liability company sold a building at a profit.
How will this transaction be treated in the company's statement of cash flows?
Proceeds of sale Profit on sale

A. Cash inflow under financing activities Add to profit in calculating cash flow
from operating activities
B. Cash inflow under investing activities Deducted from profit in calculating
cash flow from operating activities
C. Cash inflow under investing activitiesAdded to profit in calculating cash
flow from operating activities
D. Cash inflow under financing activities Deducted from profit in
calculating
cash flow from operating activities
319
4. Which of the following items could appear as items in a company’s
statement of cash flows?
1. A bonus issue of shares

2. A rights issue of shares
3. Revaluation of non-current assets
4. Dividends paid
A. All four items

B. 1, 3 and 4 only
C. 2 and 4 only
D. 2 and 3 only
5. Which of the following assertions about cash flow statements is/are

correct?
1. A cash flow statement prepared using the direct method produces a different
figure for operating cash flow from that produced if the indirect method is used.
2. Rights issues of shares do not feature in cash flow statements.
3. A surplus on revaluation of a non-current asset will not appear as an item in a
cash flow statement.
4. A profit on the sale of a non-current asset will appear as an item under Cash
Flows from Investing Activities in a cash flow statement.
A. 1 and 4
B. 2 and 3
C. 3 only
D. 2 and
A
1. B
2. Decrease in inventories should be added, decrease in payables should be

deducted.
3. B - The proceeds will appear under investing activities and any profit will be
deducted under operating activities.
4. C Only cash items appear in the statement of cash flows. Therefore items 1
320
and 3 are incorrect as they do not involve cash movements.
5. C - A rights issue is for cash. A bonus issue is “for free”; hence it is not
included in the statement of cash flows.
Chapter 24
GROUP ACCOUNTING:
CONSOLIDATED
321
STATEMENT OF FINANCIAL POSITION -
SUBSIDIARY

Define and describe the following terms in the context of group accounting:-
i. Parent
ii. Subsidiary
iii. Control
iv. Consolidated or group financial statements
v. Non-controlling interest
vi. Trade/simple investment
i. Parent : - an entity that has one or more subsidiaries.
ii. Subsidiary: - an entity, including an unincorporated entity such as a

partnership, that is controlled by another entity (known as the parent).
iii. Control: - the power to govern the financial and operating policies of an
entity so as to obtain benefits from its activities
iv. Consolidated or group financial statements: - the financial statements of

a group presented as those of a single economic entity.
v. Non-controlling interest: – Non-controlling interest (NCI) arises when the

parent entity controls a subsidiary but does not own 100% of it; e.g. if P owns
only 70% of the ordinary shares of S, there is a NCI of 30%
vi. Trade/simple investment: - an investment in the shares of another entity,

that is held for the accretion of wealth, and is not an associate or a subsidiary.
Trade investments are shown as investments under non-current assets in the
consolidated SFP of the group.

Identify subsidiary within a group structure
359
Owns more than 50% of equity shares
i.e.
P controls S
P is an individual legal entity, known as the parent. The parent is an entity that has
one or more subsidiaries.
S is an individual legal entity, known as the subsidiary.
P owns more than 50% of the ordinary shares of S. It has enough voting power to
appoint all the directors of S. P has the power to govern the financial and operating
policies of an entity so as to obtain benefits from its activities.
Although P and S remain distinct, in economic substance, they can be regarded as a

single unit, the group.
Although control is usually based on ownership of more than 50% of voting power,
IAS 273 lists the following situations where control exists, even when the parent
owns only 50% or less of the voting power of an enterprise.
(a) The parent has power over more than 50% of the voting rights by virtue of
agreement with other investors
(b) The parent has power to govern the financial and operating policies of
the enterprise by statute or under an agreement
(c) The parent has the power to appoint or remove a majority of members of
the board of directors (or equivalent governing body)
(d) The parent has power to cast a majority of votes at meetings of the
board of directors
Consolidated financial statements present the results of the group; they do not
replace the financial statements of the individual group companies.
24.3 ACCA SYLLABUS GUIDE OUTCOMES 3 AND 4:

Describe the components of and prepare a consolidated statement of financial
position or extracts thereof including:-
3 IAS 27 – Consolidated and separate financial statements
360
(i) Fair value adjustments at acquisition on land and buildings (excluding
depreciation adjustments)
(ii) Fair value of consideration transferred from cash and shares (excluding
deferred and contingent consideration)
(iii) Elimination of inter-group trading balances (excluding cash and goods

in transit)
(iv) Removal of unrealised profit arising on inter-group trading
(v) Acquisition of subsidiaries part-way through the financial year
Calculate goodwill (excluding impairment of goodwill) using the full goodwill

method only
24.3.1 Preparing a consolidated SFP:
1. Take the individual accounts of the parent and subsidiary and cancel out
items which appear as an asset in one company and a liability in another, e.g.
receivables in one company and payables in another.
2. Add together all the uncancelled assets and liabilities throughout the group on
a line by line basis.
3. The investment in the subsidiary (S) shown in the parent’s (P) statement of
financial position is replaced by the net assets of S.
The consolidated statement of financial position shows:
 The net assets of the whole group (P + S)
 The share capital of the group which always equals the share capital of P only
and
 The retained profits, comprising profits made by the group (i.e. all of P’s
historical profits + profits made by S post-acquisition).
24.3.2 Goodwill
The value of a company will normally exceed the value of its net assets. The
difference is goodwill. This goodwill represents assets not shown in the statement of
financial position of the acquired company such as the reputation of the business
and the loyalty of staff.
Where less than 100% of the subsidiary is acquired, the value of the subsidiary
comprises two elements:
361
 The value of the part acquired by the parent;
362
 The value of the part not acquired by the parent, known as the non-controlling
interest.
Positive goodwill is:-
1. An intangible non-current asset in the SFP

2. Tested annually for impairment (amortisation of goodwill is not permitted).
Impairment of goodwill is not examinable for F3 purposes
Negative goodwill:-
1. Arises where the cost of the investment is less that the value of net assets
purchased.
2. Negative goodwill is credited directly to the statement of profit or loss.
Although there are two methods in which goodwill may be calculated following the
update to IFRS 3, only the full goodwill method is examined in F3: -
Fair value of non-controlling interest method (Full Goodwill)
This results in 100% of the goodwill being shown in the group statement of financial
position – that belonging to the shareholders of the parent and that belonging to the
non-controlling interest.
24.3.3 Pre- and Post-Acquisition Profits
Pre-acquisition profits are the reserves which exist in a subsidiary company at the
date when it is acquired.
These are included in the goodwill calculation.
Post-acquisition profits are profits made and included in the retained earnings of
the subsidiary company since acquisition.
They are included in group reserves.
Only the group share of the post-acquisition reserves of S is included in the group
statement of financial position, i.e. the reserves of S which arose after acquisition by
P.
N.B. Where the acquisition occurs during the financial year, it is important to
calculate the value of profits at the date of acquisition using time-apportionment,
24.3.4 Non-controlling Interest (NCI)
363
As mentioned in Section 1 above, a parent may not own all of the shares in the
subsidiary, e.g. if P owns only 70% of the ordinary shares of S, there is a non-
controlling interest of 30%.
Accounting treatment of a non-controlling interest
 In the consolidated statement of financial position, include all of the net assets of
S
 Transfer back the net assets of S which belong to the non-controlling interest
within the capital and reserves section of the consolidated statement of financial
position. A proportion of goodwill on acquisition is also transferred back to the
NCI.
Lecture Example 1:
The following balances relate to P and S on 31 December 2009.
Parent Subsidiary
Co. Co.
$ $
Investment in S 200
Other Net Assets 100 400
Share Capital 100 100

Retained Earnings 200 300
P acquired 80% of S on 1 January 2009 when S’s retained earnings were $80.
On the date of acquisition, the fair value of the non-controlling shareholding in S was
$36.
Prepare the consolidated SFP of the group
364
Lecture Example 2
The following balances relate to P and S on 31 December 2009.
Parent Subsidiary
Co. Co.
$ $
Investment in S 200

P acquired 70% of S on 1 January 2009 when S’s retained earnings were $140. On
the date of acquisition, the fair value of the non-controlling shareholding in S was
$72.
Prepare the consolidated SFP of the group
24.3.5 Fair Value of Assets and Liabilities
The fair value of assets and liabilities is defined in IFRS 3 as ‘the amount for which
an asset could be exchanged or a liability settled between knowledgeable, willing
parties in an arm’s length transaction’.
IFRS 3 requires that the subsidiary’s assets and liabilities are recorded at their fair
value for the purposes of the calculation of goodwill and production of consolidated
accounts.
Adjustments will therefore be required where the subsidiary’s accounts themselves

do not reflect fair value.
(1) Adjust both columns of the net assets calculation to bring the net assets to fair
value at acquisition and reporting date.
(2) At the reporting date, make the adjustment on the face of the SFP when adding
across assets and liabilities.
365
Lecture Example 3:
Draft SFPs of P and S on 31 March 2009 are as follows:
Parent Co. Subsidiary Co.
$ $
Cost of investment S 200

Two years ago P acquired 90% of S when S’s retained earnings were $100. At
acquisition, the fair value of S’s net assets exceeded their book value by $10. Any
difference in fair value is due to land.
On the date of acquisition, the fair value of the non-controlling share of P in S was
$26.
Prepare the consolidated SFP of the group.
Lecture Example 4:
Below are the SFP of P and S as at 31 December 2004.
Parent Subsidiary
Co. Co.
$ $
Investment in S 100

P acquired 80% of S two years ago when S’s retained earnings were $50. At that
date, S’s PPE had a fair value of $10 in excess of the carrying value.
$20.
366
Lecture Example 5:
Below are the SFP of P and S as at 31 December 2004.
Parent Subsidiary
Co. Co.
$ $
Investment in S 200

P acquired 60% of S when S’s retained earnings were $110. At that date, S’s land
had a fair value of $10 in excess of book value.
$88.
24.3.6 Share for share exchanges
Share for share exchanges form part, or all, of the cost of investment which is used
in the goodwill calculation.
If this exchange has yet to be accounted for, the double entry is always: -
Dr Cost of Investment
Cr Share capital (with the nominal value of P shares given
out) Cr Share premium (with the premium)
Lecture Example 6:
P acquired 80% of S shares via a 2 for 1 share exchange. At the date of

acquisition, the following balances were in the books of H and S:
Parent Co. Subsidiary

Co.
Share Capital ($1) $400 (0.50 $400
c)
Share Premium $100 $50
367
The share price of P was $2 at the date of acquisition. This has not been accounted
for.
Show the accounting treatment required to account for the share

exchange. Lecture Example 7:
368
Parent Co. Subsidiary Co.
Share Capital ($1) $100 ($1) $100
Share Premium $100 $100
P acquired 80% of S shares via a 3 for 2 share exchange. The share price of P at
acquisition was $3. This has not been accounted for.
Show the accounting treatment required to account for the share exchange.
Lecture Example 8:
Able Co. bought 51,000 shares in Baker on 1.1.2011. Baker had 60,000 shares
in issue on this date.
Able Co. paid $1.25 for every share in Baker and gave Baker’s shareholders 3
shares for every 2 shares acquired. The nominal value of Able’s shares is $1 per
share and their fair value at the date of acquisition has $2.30.
What was the consideration Able has paid to control Baker?
24.3.7 Intra Group Balances
If the companies within the same group trade with each other, then this will probably
lead to:
 A receivables account in one company’s SFP

 A payables account in the other company’s SFP.
These are amounts owing within the group rather than outside the group and
therefore they must not appear in the consolidated statement of financial position.
They are therefore cancelled against each other on consolidation.
369
Lecture Example 9:
Berino, a limited liability company, owns 70% of the shares in Muggie. Berino has
payables of $244,000. Muggie has payables of $40,000 of which $6,000 is owed to
Berino. Berino has receivables of $360,000 and Muggie has receivables of
$150,000.
What amounts should be recorded for consolidated receivables and payables

in the group accounts of Berino?
Payables Receivables
$ $
A. 278,000 504,000
B. 194,600 352,800
C. 284,000 510,000
D. 290,000 516,000
24.3.8 Unrealised Profit
Unrealised profit may arise within a group scenario on:

a. Inventory where companies trade with each other
b. Non-current assets where one company has transferred an asset to the other
company within the same group.
a. Adjustment for unrealised profit in inventory
(1) Determine the value of closing inventory which has been purchased from the
other company in the group.
(2) Use mark-up or margin to calculate how much of that value represents profit
earned by the selling company.
(3) Make the adjustments according to who the seller is.
If the seller is the parent company:
Dr Group retained earnings

Cr Group inventory (deduct the profit when adding P’s inventory + S’s
inventory on the face of the consolidated SFP).
If the seller is the subsidiary:
Dr Subsidiary retained earnings

Cr Group inventory (deduct the profit when adding P’s inventory + S’s
inventory on the face of the consolidated SFP).
370
Lecture Example 10:
371
H sells to S some goods at a selling price of $100. H makes 20% profit margin. S
sold ⅓ of these goods at cost.
What is the unrealised profit?
Lecture Example 11:
H sells to S goods worth $600. H makes 20% profit margin. S sells $200 of these
goods at cost.
Lecture Example 12:
H sells to S goods worth $1000. H makes 40% profit margin. S sold $400 worth
of goods (at cost).
Lecture Example 13:
S sells goods to H for $600. S makes a 20% mark up. H has goods at cost left in
stock worth $200.
372
b. Adjustment for unrealised profit in the transfer of non-current assets
Occasionally, a non-current asset is transferred within the group (say from a parent
to a subsidiary). The parent may have manufactured the asset as part of its normal
production (and therefore included the sale in revenue), or it may have transferred
an asset previously used as part of its own non-current assets. If the transfer is
done at cost, then, in the first case, the cost of the asset must be removed from both
revenue and cost of sales. In the second case, no elimination would be required.
If one company sells non-current assets to another company in the same group at a
profit, adjustments must be made for:
1. Profit on sale
2. Depreciation
The whole scenario has to be recreated as if the sales have never occurred.
Carrying value at reporting date X

Carrying value at reporting date if intra-group transfer
had not occurred X
Adjustment X
The double-entry of this adjustment is: -
Dr Retained Earnings of the seller

Cr Non-Current Assets (P’s NCA + S’s NCA – Adjustment for UP)
Lecture Example 14:
H sells PPE to S costing $1000 for a selling price of $1500, depreciation at 10% per
annum.
Lecture Example 15:
S sold a machine with a NBV of $100 000 to H at a transfer price of $120 000 at the
year start. Group policy dictates that the machine is depreciated over its remaining
life of 5 years.
Calculate the unrealised profit on the sale of the machine.
373
Further Questions4
Question 1
Green Co owns the following investments in other companies:
Non-equity shares
Equity shares held
held
Violet Co 80% Nil
Amber Co 25% 80%
Black Co 45% 25%
Green Co also has appointed five of the seven directors of Black Co.
Which of the following investments are accounted for as subsidiaries in the

consolidated accounts of Green Co Group?
A. Violet only
B. Amber only
C. Violet and Black
D. All of them
374
Question 2
Pink Co acquired 80% of Scarlett’s Co ordinary share capital on 1 January 2012.
As at 31 December 2012, extracts from their individual statements of financial

position showed:
Pink Co Scarlett Co
$ $
Current assets:
Current
liabilities: 70,000 42,000
Payables
As a result of trading during the year, Pink Co’s receivables balance included an
amount due from Scarlett of $4,600.
What should be shown as the consolidated figure for receivables and payables?
Receivables Payables
$ $
A. 80,000 112,000
B. 75,400 112,000
C. 74,000 103,600
D. 75,400 107,400
Question 3
Red Co acquired 80% of Blue Co’s 40,000 $1 ordinary share capital on 1 January
2012 for a consideration of $3.50 cash per share.
The fair value of the non-controlling interest was $50,000 and the fair value of the
net assets acquired was $145,000.
What should be recorded as goodwill on acquisition of Blue Co in the consolidated

financial statements?
A. $17,000
B. $45,000
C. $46,000
375
D. $112,000
376
377
K
1. Parent: - an entity that has one or more subsidiaries.
2. Subsidiary: - an entity, including an unincorporated entity such as a

partnership, that is controlled by another entity (known as the parent).
3. Control: - the power to govern the financial and operating policies of an entity
so as to obtain benefits from its activities.
4. Consolidated or group financial statements: - the financial statements of a

group presented as those of a single economic entity.
5. Non-controlling interest: – Non-controlling interest (NCI) arises when the

parent entity controls a subsidiary but does not own 100% of it.
6. Trade/simple investment: - an investment in the shares of another entity,

that is held for the accretion of wealth, and is not an associate or a subsidiary.
7. Although control is usually based on ownership of more than 50% of voting

power, IAS 27 lists other situations where control exists, even when the
parent owns only 50% or less of the voting power of an enterprise.
P has enough voting power to appoint all the directors of S. P has the power
to govern the financial and operating policies of an entity so as to obtain
benefits from its activities.
8. Goodwill represents assets not shown in the statement of financial position of

the acquired company such as the reputation of the business and the loyalty
of staff.
9. Positive goodwill is:-
 An intangible non-current asset in the SFP

 Tested annually for impairment
10. Negative goodwill:-
 Arises where the cost of the investment is less that the value of net assets
purchased.
 Negative goodwill is credited directly to the statement of profit or loss.
11. Pre-acquisition profits are the reserves which exist in a subsidiary company at
the date when it is acquired.
378
12. Post-acquisition profits are profits made and included in the retained earnings
of the subsidiary company since acquisition. Only the group share of the post-
acquisition reserves of S is included in the group statement of financial
position, i.e. the reserves of S which arose after acquisition by P.
13. The value of the part not acquired by the parent is known as the non-
controlling interest.
In the consolidated statement of financial position, include all of the net assets
of S. Transfer back the net assets of S which belong to the non-controlling
interest within the capital and reserves section of the consolidated statement
of financial position. A proportion of goodwill on acquisition is also transferred
back to the NCI.
14. The fair value of assets and liabilities is defined as ‘the amount for which an
asset could be exchanged or a liability settled between knowledgeable, willing
parties in an arm’s length transaction’.
15. Share for share exchanges
Dr Cost of Investment
Cr Share capital (with the nominal value of P shares given out)
Cr Share premium (with the premium)
16. Amounts owing within the group rather than outside the group must not
appear in the consolidated statement of financial position. They are cancelled
against each other on consolidation.
17. Unrealised profit may arise within a group scenario on:

 Inventory where companies trade with each other
 Non-current assets where one company has transferred an asset to the
other company within the same group.
18. Adjustment for unrealised profit in inventory
If the seller is the parent company:
Dr Group retained earnings

Cr Group inventory
If the seller is the subsidiary:
Dr Subsidiary retained earnings

Cr Group inventory
379
19. Adjustment for unrealised profit in the transfer of non-current assets
380
Carrying value at reporting date X
Carrying value at reporting date if intra-group transfer
had not occurred X
Adjustment X
The double-entry of this adjustment is: -
Dr Retained Earnings of the seller

Cr Non-Current Assets
381
Q
1. At 1 May 2009 Tibor purchased six million of Kinnot’s ten million $1 ordinary
shares for $6,000,000. At that date Kinnot had net assets with a fair value of
$8,450,000 and its share price was $1.10. It is group policy to value the non-
controlling interest at the fair value of the subsidiary’s identifiable net assets
using the market value of the shares at acquisition.
What is the total goodwill on acquisition of Kinnot?
A. $930,000
B. $2,450,000
C. $1,550,000
D. $1,950,000
2. Scarfell has 10 million $1 issued ordinary shares. At 1 May 2009 Snowdon

purchased 70% of Scarfell’s $1 ordinary shares for $8,000,000. At that date
Scarfell had net assets with a fair value of $8,750,000 and its share price was
$1·20. It is group policy to value the non-controlling interest at the fair value of
the subsidiary’s identifiable net assets using the market value of the shares at
acquisition.
What was the total goodwill arising on acquisition at 1 May 2009?
A. $4,400,000
B. $350,000
C. $750,000
D. $2,850,000
3. Grape Company has a 49% shareholding in each of the following three

companies:
Pear Company: Grape Company has the right to appoint or remove a

majority of the directors of Pear Company.
Peach Company: Grape Company has more than half the voting rights in
Peach Company as a result of an agreement with other investors.
Plum Company: Grape Company has the power to govern the financial and
operating policies of Plum Company.
Which of these companies are subsidiaries of Grape Company for financial
382
reporting purposes?
A. Pear Company and Peach Company only

B. Plum Company and Peach Company only
C. Plum Company and Pear Company only
D. Plum Company, Pear Company and Peach Company
4. Kinder Co has 5 million $1 issued ordinary shares. At 1 May 2010 Peak Co

purchased 60% of Kinder Co’s $1 ordinary shares for $4,000,000. At that date
Kinder Co had net assets with a fair value of $4,750,000 and a share price of
$1·10. Peak Co valued the non-controlling interest in Kinder Co at acquisition as
$2,200,000.
What is the total goodwill on acquisition at 1 May 2010?
A. $1,150,000
B. $1,750,000
C. $750,000
D. $1,450,00
383
5. Tomsett Co, a limited liability company, owns 65% of the shares in Frew Co. Frew
Co owes Tomsett Co $5,000. Tomsett Co has receivables of $300,000 and Frew
Co has receivables of $130,000.
What are the consolidated receivables for Tomsett Co?
A. $425,000
B. $381,250
C. $379,500
D. $435,00
6. Which of the following statements apply when producing a consolidated

statement of financial position?
(i) All inter-group balances should be eliminated.

(ii) Inter-group profit in year-end inventory should be eliminated.
(iii) Closing inventory held by subsidiaries needs to be included at fair value.
A. (i) only
B. (i), (ii) and (iii)
C. (i) and (ii) only
D. (iii) only
7. On 30 June 20X2, H acquired 80% of the share capital of S. The non-controlling

interest had a fair value of $1,300,000.
Extracts from the statement of financial position of S at 30 June 20X2 and 30 June
20X6 are shown below:
Statement of Financial Position

30 June 20X2 30 June 20X6
$ $
Ordinary share capital 1,000,000 1,000,000
Share premium account 400,000 400,000
Retained earnings 4,700,000 5,600,000
What figure for non controlling interest should appear in the consolidated
statement of financial position as at 30 June 20X6?
A. $1,220,000
B. $1,300,000
C. $1,480,000
D. $1,400,000
384
8. Wheddon Co purchased 60,000 ordinary shares in Raleigh Co for $85,000 five years
ago, when Raleigh Co’s retained earnings were $20,000.
Raligh Co’s equity and reserves at 31 July 20X9 were as

follows: Ordinary shares $1 80,000
Retained earnings 70,000
The fair value of the non-controlling interest at acquisition was $22,000.
What was the goodwill arising on acquisition of Raleigh Co?
A. $7,000
B. $10,000
C. $25,000
D. $43,000
A
1. D
$
Consideration transferred 6,000,000
Fair value of non-controlling interest (4,000,000 x $1.10) 4,400,000
10,400,000
Less fair value of net assets at acquistion
(8,450,000
) Goodwill =
1,950,000
2. D
$
Consideration 8,000,000
Fair value of non-controlling interest (3 million x $1·20) 3,600,000
11,600,000
Less fair value of net assets at acquisition (8,750,000)
Goodwill 2,850,000
3. D
385
4. D
$
Consideration 4,000,000
Fair value of non-controlling interest (2 million x $1·10) 2,200,000
––––––––
–
6,200,000
Less fair value of net assets at acquisition (4,750,000)
–––––––––
Goodwill 1,450,000
–––––––––
5. A
Tomsett Co’s receivables 300,000 + Frew Co receivables 130,000 less 5,000 due
from Tomsett Co = 425,000
6. C
7. C
$000
At acquisition 1,300
% Post acquisition (5,600 – 4,700) x 20% 180
–––––
–
1,480
––––––
8. A
$
Cost 85,000
NCI 22,000
Shares (80,000)
Retained Earnings (20,000)
–––––
–
7,000
––––––
386
Chapter 25
GROUP ACCOUNTING:
CONSOLIDATED
STATEMENT OF COMPREHENSIVE INCOME -
SUBSIDIARY

Describe the components of and prepare a consolidated statement of profit or
loss or extracts thereof including:-
1. Elimination of inter-group trading balances (excluding cash and goods
in transit)
2. Removal of unrealised profit arising on inter-group trading
3. Acquisition of subsidiaries part-way through the financial year
Basic principles
1. From sales revenue to profit after tax, include all of P’s income and expenses
plus all of S’s income and expenses (where a mid-year acquisition has occurred,
these must be time-apportioned).
2. Once the profit after tax is calculated, deduct share profits due to the non-
controlling interest.
Non-controlling interest
This is calculated as: NCI% x subsidiary’s profit after tax (taken from S’s column
of consolidation schedule).
Dividends
A payment of a dividend by S to P must be cancelled. Any dividend income shown

in the consolidated statement of profit or loss must arise from investments other than
those in subsidiaries or associates.
Unrealised Profits
The adjustment to unrealised profit should be shown as an increase to cost of sales

(add to cost of sales). It affects the books of the SELLER.
387
Sales and Purchases
Intra-group trading must be eliminated from the consolidated statement of profit or

loss.
Consolidated sales revenue = P’s revenue + S’s revenue – intra-group

sales Consolidated cost of sales = P’s COS + S’s COS – intra-group
sales
Interest on loan
If loans are outstanding between group companies, intra-group loan interest will be
paid and received. Both the loan and loan interest must be excluded from the
consolidated results.
Transfers of non-current assets
If one group company sells a non-current asset to another group company, the
following adjustments are needed in the statement of profit or loss:-
1. Any profit or loss arising on the transfer must be deducted
2. The depreciation charge must be adjusted so that it is based on the cost of
the asset to the group
Mid-year acquisitions
If a subsidiary is acquired part way through the year, then it is important to time
apportion the results of S in the year of acquisition. Unless indicated otherwise,
assume that revenue and expenses accrue evenly.
Lecture Example 1:
Several years ago H acquired 80% of the ordinary share capital of S. Their results
for the year ended 31 December 2005 were as follows:
Statement of profit or loss
H S
(80%)
Revenue 100 100
COS (40) (40)
Expenses (40) (40)
Profit after Tax 20 20
388
Prepare the consolidated statement of profit or loss for the year ended 31
December 2005.
Lecture Example 2:
Several years ago H acquired 80% of the ordinary share capital of S. Their
results for the year ended 31 December 2005 were as follows:
Statement of profit or loss
H S
(80%)
Revenue 1000 800
COS (600) (200)
Expenses (100) (100)
Tax (100) (100)
Profit after Tax 200 400
H acquired 80% of S. At that date, 3 years ago, S’s PPE had a fair value of $100 in
excess of the carrying value and a 5 year useful economic life. Depreciation is
charged to COS.
Prepare the consolidated statement of profit or loss for the year ended 31
December 2005.
Lecture Example 3:
Exe Co acquired 70% of the ordinary share capital of Barle Co six years ago. The
following information relates to Barle Co for the year ended 30 September 20X3.
$
Sales revenue 480,000
Cost of sales 270,000
Administration expenses 90,000
Taxation 30,000
What is the profit attributable to the non-controlling interest in the

consolidated statement of profit or loss?
A. $27,000
B. $63,000
C. $36,000
D. $84,000
389
Other Comprehensive Income
The consolidated statement of comprehensive income is produced using the

consolidated statement of profit or loss as a basis. Remember that in F3/FFA, the
only item of other comprehensive income you may have is the revaluation of PPE.
This is shared between the owners of the parent and NCI according to the
percentage of their investment.
Example
S Co made a $30,000 revaluation gain on its property during the year. P Co has
acquired 70% of the equity of S Co five years ago.
Other comprehensive income attributable to: -
Owners of the parent (70% x 30,000) 21,000

Non-controlling interest (30% x 30,000) 9,000
Lecture Example 45:
Purple Co acquired 70% of the voting share capital of Silver Co on 1 October 2011.
The following extracts are from the individual statements of profit or loss of the two
companies for the year ended 30 September 2012:
Purple Co Silver Co
$ $
Revenue 79,300 29,900
Cost of sales (54,990) (17,940)
Gross Profit 24,310 11,960
Purple Co had made sales to Silver Co during the year of $5,000. Purple Co had
originally purchased the goods at a cost of $4,000. Half of these items remained in
inventory at the year end.
What should be the consolidated revenue for the year ended 30 September 2012?
What should be the consolidated cost of sales for the year ended 30 September
2012?
390
K
1. Non-controlling interest
This is calculated as: NCI% x subsidiary’s profit after tax (taken from S’s
column of consolidation schedule).
2. Dividends
A payment of a dividend by S to P must be cancelled. Any dividend income
shown in the consolidated statement of profit or loss must arise from
investments other than those in subsidiaries or associates.
3. Unrealised Profits
The adjustment to unrealised profit should be shown as an increase to cost of
sales. It affects the books of the SELLER.
4. Sales and Purchases

Intra-group trading must be eliminated from the consolidated statement of
profit or loss.
Consolidated sales revenue = P’s revenue + S’s revenue – intra-group

sales Consolidated cost of sales = P’s COS + S’s COS – intra-group
sales
5. Interest on loan
If loans are outstanding between group companies, intra-group loan interest
will be paid and received. Both the loan and loan interest must be excluded
from the consolidated results.
6. Transfers of non-current assets

If one group company sells a non-current asset to another group company,
the following adjustments are needed in the statement of profit or loss:-
 Any profit or loss arising on the transfer must be deducted
 The depreciation charge must be adjusted so that it is based on the cost of
the asset to the group
7. Mid-year acquisitions
If a subsidiary is acquired part way through the year, then it is important to
time apportion the results of S in the year of acquisition. Unless indicated
otherwise, assume that revenue and expenses accrue evenly.
391
392
Q
1. The summarised statements of profit or loss of Big Co and Small Co, for the year
ended 31 October 2010, are provided below. Big Co acquired 3,600,000 ordinary
shares in Small Co for $5,250,000 on 1 November 2009 when the retained earnings
of Small Co were $300,000. On the same date, Big Co also acquired 40% of Small
Co’s loan notes of $400,000.
Statement of profit or loss for the year ended 31 October 2010
Big Co Small Co
$000 $000
Revenue 9,600 3,900
Cost of sales (5,550) (2,175)
––––––– ––––––
Gross profit 4,050 1,725
Distribution costs (1,050) (480)
Administrative expenses (1,650) (735)
Finance costs – (25)
Income from Small Co: Loan note interest 10 –
Dividends 150 –
––––––– ––––––
Profit before tax 1,510 485
Income tax expense (600) (120)
––––––– ––––––
Profit for the year 910 365
––––––– ––––––
The following information is also available:
(i) Small Co’s total share capital consists of 6,000,000 ordinary shares of $1
each.
(ii) It is group policy to value the non-controlling interest at full fair value. The fair
value of the non-controlling interest at the acquisition date was $3,200,000.
(iii) During the year ended 31 October 2010, Big Co sold goods costing $200,000
to Small Co for $300,000. At 31 October 2010, 50% of these goods remained
in Small Co’s inventory.
Required:
a) Calculate the goodwill arising on the acquisition of Small Co.
$000 $000
393
Consideration transferred
NCI
Assets at acquisition:
Share capital
Retained earnings
Goodwill on acquisition
b) Complete the consolidated statement of profit or loss for Big Co for the
year ended 31 October 2010.
Big Co
Consolidated statement of profit or loss for the year ended 31 October 2010
$000
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Finance cost
Profit before tax
Income tax expense
Profit for the year
Profit attributable to:

Owners of the parent
Non-controlling
interest
394
2. You are presented with the following information for Bradshaw, a limited liability
company, and its subsidiary, Martin:
Statement of profit or loss for the year ended 31 October 2009
Bradshaw Martin
$000 $000
Revenue 125,000 77,900
Cost of sales (65,000) (38,500)
––––––– –––––––
Gross profit – –
60,000 39,400
Distribution costs (6,750) (8,050)
Administrative expenses (17,500) (9,780)
Finance costs – (20)
Income from Martin: Loan note interest 15 –
Dividends 5,200 –
––––––– –––––––
Profit before tax – –
40,965 21,550
Income tax expense (19,250) (10,850)
––––––– –––––––
Profit for the year – –
21,715 10,700
–––––––– ––––––––
Statements of financial position as at 31 October 2009
Bradshaw Martin
ASSETS $000 $000 $000 $000

Non-current assets
Property, plant and equipment 75,000 31,901
Investments:
$1 ordinary shares in Martin at cost 34,000 –
Martin loan notes 150 –
––––––– –––––
–
109,150 31,901
Current assets
Inventory, at cost 9,750 4,162
Cash and cash equivalents 3,150 30,025 1,255 16,742
–––––– ––––– –––––– ––––
Total assets – – ––
139,175 48,643
–––––– ––––––
EQUITY AND LIABILITES
395
Capital and Reserves
$1 Ordinary shares 77,000 23,150
Retained earnings 35,362 9,538
396
––––––– ––––––
Total equity 112,362 32,688
10% Loan note – 200
Current liabilities
Payables 16,613 9,500
Tax 10,200 6,255
Total liabilities 26,813 15,755
–––––– –––––– ––––– –––––
Total equity and liabilities – –
139,175 48,643
––––––– –––––
–
The following information is also available:
(i) Bradshaw purchased 18,520,000 $1 ordinary shares in Martin on 1 November

2008. At that date Martin’s retained earnings were $5,338,000.
(ii) It is group policy to value the non-controlling interest at full fair value. The fair
value of the non-controlling interest at the acquisition date was $7,408.
(iii) Bradshaw owns $150,000 of Martin’s loan notes. The annual interest of
$15,000 due to Bradshaw has not been paid and is included in Martin’s
payables and Bradshaw’s receivables.
(iv) During the year ended 31 October 2009 Bradshaw sold goods to Martin
for
$15,000,000. Bradshaw made a profit on these goods of $2,500,000.
Martin still has all of these goods in inventory at 31 October 2009.
(v) At 31 October 2009 Martin owed Bradshaw $3,000,000 for some of the goods
that Bradshaw supplied during the year.
(vi) All Martin’s dividends of $6,500,000 were paid in the financial year ended 31
October 2009.
Required:
(a) Calculate the goodwill arising on the acquisition of Martin as at 1

November 2008.
397
$000 $000
Consideration transferred
NCI
Assets at acquisition
Share capital
Retained earnings
(b) Prepare the following financial statements for Bradshaw:

(i) the consolidated statement of profit or loss for the year ended 31
October 2009;
Bradshaw
$000
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Finance costs
Profit before tax

Income tax expense
PROFIT FOR THE YEAR

Owners of the parent
Non-controlling
interest
398
(ii) the consolidated statement of financial position as at 31 October
2009.
Bradshaw
Consolidated statement of financial position as at 31 October 2009
ASSETS $000 $000

Non-current assets
Property, plant and equipment
Intangible – goodwill
Current assets
Inventory, at cost
Receivables
Cash and cash equivalents
Total assets
EQUITY AND LIABILITY

$1 Ordinary shares
Retained earnings
Non-controlling interest
Total equity
10% Loan note
Current liabilities
Payables
__________
397
Tax
Total current liabilities
Total equity and liabilities
Prepare your answers to the nearest $000. (CAT Paper T6 Section B Question 1)
1. (a) Goodwill on acquisition of Small Co
$000 $000
Consideration transferred 5,250
NCI 3,200
Assets at acquisition:
Share capital 6,000
Retained earnings 300 (6,300)
Goodwill on acquisition 2,150
398
(b) Big Co
$000
Revenue (9,600 + 3,900 – 300) 13,200
Cost of sales {5,550 + 2,175 – 300 + (50% x 100)} (7,475)
Gross profit 5,725
Distribution costs (1,530)
Administrative expenses (2,385)
Finance cost (25 – 10) (15)
Income tax expense (720)
Profit for the year 1,075

Owners of the parent 929
Non-controlling interest (365 x 40%) 146
1,075
2. (a) Goodwill on acquisition of Martin
$000 $000
Consideration transferred 34,000
NCI (23,150 – 18,520) x $1·6 7,408
Assets at acquisition
Retained earnings 5,338 (28,488)
––––––
12,920
–––––
–
(b) Bradshaw
(i)
$000
Revenue (125,000 + 77,900 – 15,000) 187,900
Cost of sales (65,000 + 38,500 - 15,000 + 2,500*) (91,000)
–––––
Gross profit –
96,900
Distribution costs (14,800)
Administrative expenses (27,280)
Finance costs (20 – 15) (5)
–––––
Profit before tax –
54,815
399
Income tax expense (30,100)
––––––
PROFIT FOR THE YEAR 24,715

Owners of the parent 22,575
Non-controlling interest (20% x 10,700) 2,140
––––––
24,715
(ii) Bradshaw
Consolidated statement of financial position as at 31 October 2009
ASSETS $000 $000

Non-current assets
Property, plant and equipment 106,901
Intangible – goodwill 12,920
–––––––
–
119,821
Current assets
Inventory, at cost (9,750 + 4,162 – 2,500*) 11,412
Receivables (17,125 + 11,325 - 3,000** - 15***) 25,435
Cash and cash equivalents 4,405 41,252
–––––––– ––––––––
Total assets 161,073
EQUITY AND LIABILITY

$1 Ordinary shares 77,000
Retained earnings (W1) 36,222
–––––––
–
113,222
Non-controlling interest (W2) 8,248
––––––––
Total equity 121,470
10% Loan note (200 – 150) 50
Current liabilities
Payables (16,613 + 9,500 – 3,000** – 15***) 23,098
Tax 16,455
––––––––
Total current liabilities 39,553
––––––––
Total equity and liabilities 161,073
400
Notes:
* Remove the unrealised profit on goods still held at year-end ($2,500,000),

** Remove intra-group balances ($3,000,000),
*** Remove intra-group balances ($15,000)
Workings
W1 - Retained earnings as at 31 October 2009
$000 $000
Bradshaw as per statement of
financial position 35,362
Less unrealised profit (2,500)
Martin :
Retained earnings 9,538
Pre-acquisition reserves (5,338)
––––
–
4,200
Group share (80% x $4,200,000) 3,360
––––––
36,222
W2 - Non-controlling interest
NCI at acquisition date 7,408

Share of post-acquisition profit {(9,538 – 5,338) x 20%} 840
––––––
8,248
401
Chapter 26
GROUP ACCOUNTING:
ASSOCIATE

Define and identify an associate and significant influence and identify the
situations where significant influence or participating interest exists
Describe the key features of a parent-associate relationship and be able to
identify an associate within a group structure
IAS 28 defines an associate as:
An entity over which the investor has significant influence but not control or joint
control and that is neither a subsidiary nor an interest in joint venture.
Significant influence is the power to participate in the financial and operating policy
decisions of the investee but is not in control or joint control over those policies.
There are several indicators of significant influence, but the most important are
usually considered to be a holding of between 20% and 50% of the voting shares
and board representation.
The existence of significant influence by an investor is usually evidenced in one or

more of the following ways:
 representation on the board of directors or equivalent governing body of the

investee
 participation in the policy-making process
 material transactions between the investor and the investee
 interchange of managerial personnel
 provision of essential technical information

Describe the principle of equity accounting
Equity accounting brings an associate investment into the parent company’s

financial statements initially at cost.
The basic principle of equity accounting is that P Co should take account of its share
of the earnings of A Co whether or not A Co distributes the earnings as dividends.
A’s sales revenue, cost of sales, expenses and revenue are not added with those of
the group. Instead the group share only of A’s profit after tax is included in the
consolidated statement of profit or loss as a single amount.
402
P Co should also include its share of A Co’s other comprehensive income in its
consolidated statement of comprehensive income.
In the consolidated statement of financial position, the associate is included as a

non-current asset investment, calculated as:
$’000
Cost of investment X
P’s share of post acquisition profits of A X
Less: impairment losses of A (X)
X
Lecture Example 1:
X has a 40% shareholding in each of the following three companies:

P: X has the right to appoint or remove a majority of the directors of
P. Q: X has significant influence over the affairs of Q.
R: X has the power to govern the financial and operating policies of R.
Which of these companies are subsidiaries of X for financial reporting purposes?
A. Q and R only
B. P and R only
C. P and Q only
D. P, Q and R
Lecture Example 2:
IAS 28 Investments in Associates governs the identification of associates.

Which of the following would suggest that an entity is an associate of another entity?
A. The investing entity has owned its share since the incorporation of the
investee entity.
B. The investor holds greater than 20% but less than 50% of the voting power of
the investee.
C. The investing entity has some influence over other entities in the same
industry.
D. The investor often trades with the investee.
403
Lecture Example 36:
Which of the following investments owned by Indigo Co should be equity accounted

in the consolidated financial statements?
• 30% of the non-voting preference share capital in Yellow Co
• 18% of the ordinary share capital in Blue Co with directors of Indigo Co having two
of the five places on the board of Blue Co
• 45% of the ordinary share capital of Red Co, with directors of Indigo Co having four
of the six places on the board of Red Co
A. 1 and 2
B. 2 only
C. 1 and 3 only
D. 2 and 3 only
404
K
1. An associate is an entity over which the investor has significant influence but not
control or joint control and that is neither a subsidiary nor an interest in joint
venture.
2. Significant influence is the power to participate in the financial and operating

policy decisions of the investee but is not in control or joint control over those
policies.
3. There are several indicators of significant influence, but the most important are
usually considered to be a holding of between 20% and 50% of the voting shares
and board representation.
4. Equity accounting brings an associate investment into the parent company’s

financial statements initially at cost.
5. P Co should take account of its share of the earnings of A Co whether or not A

Co distributes the earnings as dividends.
6. A’s sales revenue, cost of sales, expenses and revenue are not added with
those of the group.
7. In the consolidated statement of financial position, the associate is included as a

non-current asset investment, calculated as:
$’000
Cost of investment X
P’s share of post acquisition profits of A X
Less: impairment losses of A (X)
X
405
Q
1. Define an ‘associate’ relationship and give some examples that might
demonstrate such a relationship exists.
2. Which of the following statements regarding the method of consolidation is true?

(1) Subsidiaries are consolidated in full
(2) Associates are equity accounted
A. Neither statement
B. Statement 1 only
C. Both statements
D. Statement 2 only
3. Bingo is an associate of Tingo.
How should profits generated by Bingo be shown in the consolidated accounts of

Tingo?
A. All the profits after tax generated by Bingo are included in the consolidated
statement of profit or loss of Tingo as a single amount
B. All the profits after tax generated by Bingo are included by consolidating the
revenue and expenses of Bingo on a line by line basis from revenue down to
profit for the year
C. Tingo’s share of Bingo’s profit after tax is included by the payment of a
dividend from Bingo to Tingo, which is shown in the consolidated statement of
profit or loss of Tingo
D. Tingo’s share of Bingo’s profit after tax is included in the consolidated
statement of profit or loss of Tingo as a single amount
406
A
1. An associate is defined as an entity in which an investor has significant influence
and which is neither a subsidiary nor a joint venture of the investor. Significant
influence can be determined by the holding of voting rights (usually shares) in
the entity. If an investor holds 20% to 50% of the voting power of the investee,
then the investor will usually have significant influence over the investee, unless
it can be clearly demonstrated this is not the case.
The following are examples that might demonstrate the existence of significant
influence:
(a) A representative of the investor on the board of directors of the
investee.
(b) The participation by the investor in the policy making process of the
investee.
(c) Material transactions between investee and investor.
(d) The interchange of management personnel between the two
companies.
(e) The provision of essential technical information by the investor to the
investee.
2. C
3. D
407
408
Chapter 27
INTERPRETATION OF FINANCIAL
STATEMENTS

Describe how the interpretation and analysis of financial statements is used in
a business environment.
Explain the purpose of interpretation of ratios
The financial statements of a business provide important financial information for

people outside the business (external users) who do not have access to the internal
accounts. For example, current and potential shareholders can see how much profit
a business made, the value of its assets and the level of cash reserves. Although
these figures are useful, they do not mean a great deal by themselves. To
summarise and present financial information in a more understandable form, they
need to be properly analysed using accounting ratios and then compared with either
the previous year’s ratios or against averages for the industry.
The lack of detailed information available to the external user is a considerable

disadvantage in undertaking ratio analysis. There may simply be insufficient data to
calculate all of the required ratios. Comparisons with previous year’s ratios can be
difficult especially if there have been changes in accounting policies or in the nature
of the business. Comparability between companies may be impaired due to different
accounting policies and different environments in which the two companies are
operating.
Lecture Example 1:
Which of the following statements is true?
A. The interpretation of an entity’s financial statements using ratios is only useful

for potential investors.
B. Ratios based on historical data can predict the future performance of an

entity.
C. The analysis of financial statements using ratios provides useful information

when compared with previous performance or industry averages.
D. An entity’s management will not assess an entity’s performance using

financial ratios.
409
Calculate key accounting ratios: -
1. Profitability
2. Liquidity
3. Efficiency
4. Position
Explain the interrelationships between ratios.
Calculate and interpret the relationship between the elements of the financial
statements with regard to profitability, liquidity, efficient use of resources and
financial position.
Draw valid conclusions from the information contained within the financial
statements and present these to the appropriate user of the financial
statements.
Explain the interrelationships between ratios
Calculate and interpret the relationship between the elements of the financial
statements with regard to profitability, liquidity, efficient use of resources and
financial position
Draw valid conclusions from the information contained within the financial
statements and present these to the appropriate user of the financial
statements
27.2.1 Profitability Ratios
27.2.1.1 Return on Capital Employed (ROCE)
A business buys assets such as trucks, computers, etc to help makes its operations
more efficient, cut down on costs and make bigger profits.
ROCE shows how well a business has generated profit from its long-term financing.
It is expressed in the form of a percentage, and the higher the percentage, the
better.
410
ROCE is calculated either:
Profit Before Interest and Tax

Total Assets – Current Liabilities (Capital Employed)
OR
Profit before Interest and Tax

Shareholder’s Equity + long-term
liabilities
How can firms increase the ROCE ratio?
Movements in return on capital employed are best interpreted by examining profit

margins and asset turnover (in more detail below) as ROCE is made up of these
component parts.
Firms can increase their ROCE ratio by:

(a) Cutting costs so as to increase the profit margin ratio
(b) Increasing the revenue made from their assets, i.e. more efficient use of
assets
Limitations of using ROCE ratio
Be careful when using the ROCE ratio because it does not always yield the correct
percentage.
For instance, a company may simply run down its old assets. This means the
denominator “Total Assets – Current Liabilities” (value of assets is lower) will be
lower and so give a higher ROCE percentage.
In this case, there has been no improvement in operations of the company, in fact
the firm is cutting down on potentially profitable capital investments.
Note
Always compare a company’s ROCE to the interest rate it is charged. The ROCE
needs to be higher.
Similarly if a company pays off a 5% loan, while its current ROCE is 10%, then this is
illogical. It should use the money to get 10% not pay off a loan which only costs 5%.
411
27.2.1.2 Asset Turnover
Asset turnover shows how efficiently management have utilised assets to generate
revenue.
It is calculated as:
- Revenue
Total assets – current
liabilities
When looking at the components of the ratio, a change will be linked to either a
movement in revenue, a movement in net assets, or both.
An increase in asset turnover can result from: -

(a) a significant increase in sales revenue
(b) the business entering into a sale and operating lease agreement, then the
asset base would become smaller, thus improving the result.
27.2.1.3 Return on Equity (ROE)
The ROE ratio reveals how much profit has been made in comparison to shareholder
equity.
A business that has a high return on equity is more likely to be one that is capable of
generating cash internally.
Profit after tax – preference dividends

Equity shareholders funds
27.2.1.4 Gross Profit Margin
The gross profit margin looks at the performance of the business at the direct trading
level.
Gross profit
Revenue
Variations in the Gross Profit Margin are as a result of:

(i) changes in the selling price/sales volume
(ii) changes in cost of sales.
412
For example, cost of sales may include inventory write downs that may have
occurred during the period due to damage or obsolescence, exchange rate
fluctuations or import duties.
27.2.1.5 Net Profit Margin
The net profit margin is generally calculated by comparing the profit before interest
and tax of a business to revenue.
Profit before interest and tax

Revenue
However, the examiner may specifically request the calculation to include profit
before tax.
Analysing the net profit margin enables you to determine how well the business has
managed to control its indirect costs during the period. In the exam, when
interpreting operating profit margin, it is advisable to link the result back to the gross
profit margin.
For example, if gross profit margin deteriorated in the year then it would be expected
that the net profit margin would also fall. However, if this is not the case, or the fall is
not so severe, it may be due to good indirect cost control or perhaps there could be a
one-off profit on disposal distorting the operating profit figure.
It is important to note that the profit margin and asset turnover together explain the
ROCE.
Profit Margin x Asset Turnover = ROCE
PBIT x Sales = PBIT

Sales Capital Employed Capital Employed
Lecture Example 2
Comparator assembles computer equipment from bought-in components and

distributes them to various wholesalers and retailers. It has recently subscribed to an
inter-firm comparison service. Members submit accounting ratios as specified by the
operator of the service, and in return, members receive the average figures for each
of the specified ratios taken from all of the companies in the same sector that
subscribe to the service.
413
The specified ratios and the average figures for Comparator’s sector are shown
below.
Ratios of companies reporting a full year’s results for periods ending

between 1 July 2003 and 30 September 2003:
Return on capital employed 22.1%

Net assets turnover 1.8 times
Gross profit margin 30%
Net profit (before tax) margin 12.5%
Current ratio 1.6:1
Quick ratio 0.9:1
Inventory holding period 46 days
Accounts receivable collection period 45 days
Accounts payable payment period 55 days
Debt to equity 40%
Interest cover 7 times
Dividend yield 6%
Dividend cover 3 times
Comparator’s financial statements for the year to 30 September 2003 are set out
below:
Statement of profit or loss $000

Sales revenue 2,305
Cost of sales (1,870)
Gross profit 435

Other operating expenses (215)
Operating profit 220

Interest payable (34)
Profit before taxation 186

Income tax (90)
Profit after taxation 96
414
Extracts of changes in
equity: Retained earnings – 1 October 2002 179
Net profit for the period 96
Dividends paid (interim $60,000; final (90)
$30,000)
Retained earnings – 30 September 2003 185
Statement of Financial Position $000 $000

Non-current assets (note (i)) 540
Current Assets
Inventory 275
Accounts receivable 320
Bank nil 595
1,135
Share Capital and Reserves

Ordinary shares (25 cents each) 150
Retained Earnings 185
335
Non-current
liabilities 8% loan 300
notes
Current liabilities
Bank overdraft 65
Trade accounts payable 350
Taxation 85 500
1,135
Notes
1) The details of the non-current assets are:
Cost Accum depn Net book value

$000 $000 $000
At 30 September 2003 3,600 3,060 540
415
2) The market price of Comparator’s shares throughout the year averaged $6.00
each.
Required:-
a. Calculate the profitability ratios for Comparator equivalent to those

provided by the inter-firm comparison service.
b. Assess the performance of Comparator based on the ratios calculated in
(1) above.
(December 2003 ACCA Paper 2.5 adjusted)
27.2.2 Liquidity Ratios
27.2.2.1 Current Ratio
Current Assets
Current Liabilities
The current ratio considers how well a business can cover the current liabilities with
its current assets. It is a common belief that the ideal for this ratio is between 1.5
and 2 : 1 so that a business may comfortably cover its current liabilities should they
fall due.
However this ideal should be considered in the context of the company: the nature of
the assets in question, the company’s ability to borrow further to meet liabilities and
the stability of its cash flows.
For example, a business in the service industry would have little or no inventory and
therefore could have a current ratio of less than 1. This does not necessarily mean
that it has liquidity problems so it is better to compare the result to previous years or
industry averages.
416
27.2.2.2 Quick Ratio
Current Assets –
Inventories Current
Liabilities
One of the problems with the current assets ratio is that the assets counted include
inventories which may or may not be quickly sellable (or which may only be sellable
quickly at a lower price).
The ideal ratio is thought to be 1:1, but as with the current ratio, this will vary
depending on the industry in which the business operates.
The quick ratio is also known as the acid test ratio. This name is used because it is
the most demanding of the commonly used tests of short term financial stability.
When assessing both the current and the quick ratios, remember that both of these
ratios can be too high. This would mean too much cash is being tied up in current
assets as opposed to new more profitable investments.
It is important to look at the information provided within the question to consider

whether or not the company has an overdraft at year-end. The overdraft is an
additional factor indicating potential liquidity problems and this form of finance is both
expensive (higher rates of interest) and risky (repayable on demand)
Lecture Example 3
Following from Lecture Example 1:-
a. Calculate the liquidity ratios for Comparator equivalent to those

b. Assess the liquidity position of Comparator based on the ratios

calculated in (1) above.
27.2.3 Efficiency Ratios: control of receivables and inventory
27.2.3.1 Inventory Turnover Period
Closing (or average) Inventory x 365

COS
417
This ratio calculates how long goods to be sold stay in stock.
Generally, the lower the number of days that inventory is held the better as holding
inventory for long periods of time constrains cash flow and increases the risk
associated with holding the inventory. The longer inventory is held the greater the
risk that it could be subject to theft, damage or obsolescence. However, a business
should always ensure that there is sufficient inventory to meet the demand of its
customers.
27.2.3.2 Receivables Collection Period (in days)
Trade Receivables x 365

Credit Sales
This ratio calculates how long credit customers take to pay.
A short credit period for receivables will aid a business’ cash flow. However, some
businesses base their strategy on long credit periods to achieve higher sales in
highly competitive markets.
If the receivables days are shorter compared to the prior period, it could indicate
better credit control or potential settlement discounts being offered to collect cash
more quickly whereas an increase in credit periods could indicate a deterioration in
credit control or potential bad debts.
27.2.3.3 Payables Payment Period (in days)
Trade Payables x 365

Credit Purchases7
This ratio calculates how long the company takes to pay its suppliers.
An increase in payables days could indicate that a business is having cash flow
difficulties and is therefore delaying payments. It is important that a business pays
within the agreed credit period to avoid conflict with suppliers.
If the payables days are reducing, this indicates suppliers are being paid more
quickly. This could be due to credit terms being tightened or taking advantage of
early settlement discounts being offered.
7 Take cost of sales if credit purchases are not given
418
27.2.3.4 Working Capital Cycle (cash cycle)
A company only gets cash once an item has been in stock and then the debtor pays
(Inventory days + receivables days).
This total should then be reduced by the payable days (the company doesn’t need
the cash until the end of this).
So, the working capital cycle (in days) is:

Inventory (in days) + Receivables (in days) – Payables (in days)
This needs to be kept as small as possible for liquidity purposes.
Lecture Example 4
a. Calculate the efficiency ratios for Comparator equivalent to those


(1) above.
27.2.4 Long-term Solvency: Debt and Gearing Ratios
27.2.4.1 Debt Ratio
Debt ratio = Total debts

Total assets
Assets = non-current assets + current assets

Debts include all payables, whether they are due within one year or after more than
one year.
419
27.2.4.2 Gearing
A company can raise money by loans (Debt) or issuing shares (Equity).
Gearing can be calculated

either:
Debt8
Debt +
Equity9
OR
Debt
Equity
The gearing ratio is of particular importance to a business as it indicates how risky a

business is perceived to be based on its level of borrowing.
High gearing means high debt (in relation to equity). As borrowing increases so
does the risk as the business is now liable to not only repay the debt but meet any
interest commitments under it. If interest rates increase, then the company could
be in trouble unless they have high enough profits to cover this. In addition, to raise
further debt finance could potentially be more difficult and more expensive.
27.2.4.3 Leverage (equity to sales ratio)
Leverage is the converse of gearing, i.e. the proportion of total assets financed by
equity.
Shareholder’s equity x 100

Shareholders’ equity + total long term debt
OR

Total assets less current liabilities
420
8 Debt = Loans + Preference Shares
9 Equity = Ordinary share capital + Reserves + Non-controlling interest
421
27.2.4.4 Interest Cover
If a company has a high level of gearing it does not necessarily mean that it will face
difficulties as a result of this.
For example, if the business has a high level of security in the form of tangible non-
current assets and can comfortably cover its interest payments, a high level of
gearing should not give an investor cause for concern.
The interest cover is calculated:

(PBIT) Interest payable
A ratio of at least 3 is deemed to be satisfactory.

The interest coverage ratio is a measurement of the number of times a company
could make its interest payments with its earnings.
It is the equivalent of a person taking the combined interest expense from their
mortgage, credit cards etc, and calculating the number of times they can pay it with
their annual income.
PBIT has its short fallings; companies do pay taxes, therefore it is misleading to act
as if they didn’t. A wise and conservative investor would simply take the company’s
earnings before interest and divide it by the interest expense. This would provide a
more accurate picture of safety.
Lecture Example 5
a. Calculate the gearing ratios for Comparator equivalent to those provided

by the inter-firm comparison service.

(1) above.
422
Lecture Example 6
Which two of the following are valid reasons why the inventory turnover of a
company increases from one year to the next?
1. A slow down in trading

2. A marketing decision to reduce selling prices
3. Seasonal fluctuations in orders
4. Obsolete goods
A. 1 and 2
B. 2 and 3
C. 1 and 4
D. 3 and 4
Lecture Example 7
A company has increased the length of time allowed for customers to pay their
invoices. This has resulted in an increase in which ratio?
A. Receivables collection period

B. Gearing ratio
C. Interest cover
D. Payables payment period
423
K
1. To summarise and present financial information in a more understandable
form, users need to be properly analysed using accounting ratios and then
compared with either the previous year’s ratios or against averages for the
industry.
2. Ratio analysis has a number of limitations.
3. ROCE is calculated either:
Profit Before Interest and Tax

Total Assets – Current Liabilities (Capital Employed)
OR

Shareholder’s Equity + long-term
liabilities
4. Asset turnover =
Revenue
Total assets – current
liabilities
5. Return on equity =
Profit after tax – preference dividends

Equity shareholders funds
6. Gross Profit Margin =
Gross profit
Revenue
7. Net Profit Margin =
424
Profit before interest and tax
Revenue
425
8. ROCE (alternative method) =
Profit Margin x Asset Turnover = ROCE
PBIT x Sales = PBIT

Sales Capital Employed Capital Employed
9. Current Ratio =
Current Assets
Current Liabilities
10. Quick Ratio =
Current Assets –
Inventories Current
Liabilities
11. Inventory Turnover Period =
Closing (or average) Inventory_ x 365

COS
12. Receivables Collection Period (in days) =
Trade Receivables x 365

Credit Sales
13. Payables Payment Period (in days) =
Trade Payables x 365

Credit Purchases10
426
10 Take cost of sales if credit purchases are not given
427
14. Working capital cycle (in days) is:
Inventory (in days) + Receivables (in days) – Payables (in days)
15. Debt Ratio =
Total debts
Total assets
16. Gearing =
Debt11
Debt + Equity12
OR
Debt
Equity
17. Leverage (equity to sales ratio) =
.
Shareholders’ equity + total long term debt
OR

Total assets less current liabilities
18. Interest Cover =

(PBIT) Interest payable
11 Debt = Loans + Preference Shares

12 Equity = Ordinary share capital + Reserves + Non-controlling interest
428
Q
1. Xena has the following working capital ratios:
20X9 20X8
Current ratio 1·2:1 1·5:1

Receivables days 75 days 50 days
Payables days 30 days 45 days
Inventory turnover 42 days 35 days
Which of the following statements is correct?
A. Xena’s liquidity and working capital has improved in 20X9

B. Xena is receiving cash from customers more quickly in 20X9 than in 20X8
C. Xena is suffering from a worsening liquidity position in 20X9
D. Xena is taking longer to pay suppliers in 20X9 than in 20X8
2. The following extracts are from Hassan’s financial statements:
$
Profit before interest and tax 10,200
Interest (1,600)
Tax (3,300)
–––––––
Profit after tax 5,300
–––––––
Reserves 15,600
––––––
–
35,600
Loan liability 6,900
––––––
–
42,500
–––––––
What is Hassan’s return on capital employed?
A. 15%
B. 29%
C. 24%
D. 12%
429
3. A company’s gross profit as a percentage of sales increased from 24% in the
year ended 31 December 20X1 to 27% in the year ended 31 December 20X2.
Which of the following events is most likely to have caused the increase?
A. An increase in sales volume

B. A purchase in December 20X1 mistakenly being recorded as happening in
January 20X2
C. Overstatement of the closing inventory at 31 December 20X1
D. Understatement of the closing inventory at 31 December 20X1
4. Which one of the following would cause a company’s gross profit

percentage on sales to fall?
A. A reduction in the total value of goods returned to suppliers.

B. An increase in the costs of delivery of goods to customers.
C. A decline in average inventory levels.
D. An increase in theft of inventory by customers and staff
5. A company’s gross profit as a percentage of sales increased from 28% in the

year ended 31 December 2005 to 33% in the year ended 31 December 2006.
Which one of the following could have caused the increases?
A. An increase in sales volume.

B. Understatement of closing inventory at 31 December 2005.
C. Overstatement of closing inventory at 31 December 2005.
D. Goods received in December 2005 and included in inventory at 31 December
2005 were not recorded in purchases until January 2006.
6. Which of the following events would reduce a company’s gearing?
(i) An issue of loan notes

(ii) A rights issue of equity shares
(iii) A bonus issue of equity shares
A. (i) and (ii)

B. (i) and (iii)
C. (iii) only
D. (ii) only
430
ANS
1. C – Liquidity has worsened – current ratio
Working capital has improved – from 40 (50 + 35 – 45) to 87 (75 + 42 -

30)
2. C – (10,200 / 42,500)
3. D – Which one would cause either Gross Profit to increase or Sales to fall?
Lower Closing Inventories in 20X1 would show as lower Opening
Inventories in X2, lower Cost of Sales, higher Gross Profit.
4. C – Lower Inventories would increase Cost of Sales and decrease Gross

Profit.
5. B – (Similar to Question 3).
6. D – An issue of loan notes increase debt (gearing); a bonus issue has

no effect on equity (higher SC, lower SP).
431

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11.3.

1 Research and Development Expenditure

Many businesses in the commercial world spend vast amounts of money, on an

11.3.2 Research and Development – Definitions

Research is original and planned investigation undertaken with the prospect of

An example of research could be a company in the pharmaceuticals industry

Development is the application of research findings or other knowledge to a plan or

An example of development is a car manufacturer undertaking the design,

11.3.3 Accounting Treatment of Research and Development

It is impossible to demonstrate whether or not a product or service at the research

Dr Intangible non-current assets

11.4 ACCA SYLLABUS GUIDE OUTCOME 4:

Medica is a company producing medicinal drugs. During the year ended 31

a) $15,000 on salaries for market research staff

11.5 ACCA SYLLABUS GUIDE OUTCOME 5:

Treatment of Capitalised Development Costs

A tangible non-current asset, e.g. machinery, is capitalised and then depreciated

Dr Amortisation expense (I/S)

11.6 ACCA SYLLABUS GUIDE OUTCOME 6:

A company manufacturing aircraft engages in a number of research and

At 1 January 20X6 the company’s records showed total capitalised development

11.7 ACCA SYLLABUS GUIDE OUTCOME 7:

assets For each class of intangible asset, disclose

 useful life or amortisation rate

Additional disclosures are required about:

 intangible assets carried at revalued amounts

non-monetary asset without physical

 Start amortization when

1. Which of the following statements about research and development

1) Research expenditure, other than capital expenditure on research

A. (1), (2) and (3)

2. Which of the following statements about research and development

1) If certain conditions are met, an enterprise may decide to capitalise

3. Which of the following statements concerning the accounting treatment of

1) Development costs recognised as an asset must be amortised over a

4. IAS 38 Intangible Assets governs the accounting treatment of expenditure on

Which of these four statements are in fact correct?

Which of these four statements are in fact correct?

12.1 ACCA SYLLABUS GUIDE OUTCOME 1:

We have mentioned that one of the underlying assumptions in the

12.2 ACCA SYLLABUS GUIDE OUTCOMES 2 - 5:

12.2.1 Accrued expenses (accruals) are expenses which relate to an accounting

Accruals are included in payables as current liabilities as they represent

On the basis of the above data, you are required to

A company pays rent quarterly in arrears on 1 January, 1 April, 1 July and 1

What rent expense and accrual should be included in the company’s

12.2.2 Prepaid expenses (prepayments) are expenses which have already

Accounting Treatment: Prepayments

On the basis of the above data, you are required to

Five steps are involved: -

c. Post the cash paid during the year

Statement of profit or loss Statement of Financial Position

Details of a company’s insurance policy are shown below:

12.2.4 Accrued and Deferred Income

Accounting Treatment: Accrued Income

Dr Accrued income (SOFP)

When an entity has received income in advance of it being earned, it should be

Accounting Treatment: Deferred Income

Dr Income Account (I/S)

All arrears of rent were subsequently received.

1. The accruals concept states that revenues should be recognised (i.e.

2. Accrued expenses (accruals) are expenses which relate to an accounting

Accounting Treatment: Accruals