Adjustments For Financial Statements: Chapter One Capital Expenditure and Revenue Expenditure Capital Expenditure

ADJUSTMENTS FOR FINANCIAL STATEMENTS
This part is concerned with all the adjustments that have to be made before financial
statements can be prepared.
CHAPTER ONE
CAPITAL EXPENDITURE AND REVENUE EXPENDITURE
Capital expenditure
‘Capital expenditure’ has nothing to do with the owner’s “Capital Account”. The two
terms happen to start with the same first word, and they are both things that are likely to
be around the business for quite a long time.
While both are, in a sense, long-term investments, one made by the business, the other
made by the owner, they are, by definition, two very different things.
Capital expenditure is incurred when a business spends money either to:

1) Buy fixed assets, or
2) Add to the value of an existing fixed asset.
Included in such amounts should be spending on:
 Acquiring fixed assets
 Bringing them into the business
 Legal costs of buying buildings
 Carriage inwards on machinery bought
 Any other cost needed to get a fixed asset ready for use.
Revenue expenditure
This is an expenditure which is not spent on increasing the value of fixed assets, but on
running the business on a day-to-day basis.
The difference between revenue expenditure and capital expenditure can be seen clearly
with the total cost of using a van for a business.
 Buying a van is capital expenditure. This is because van will be in use for several
years and is therefore, a fixed asset.
ANTIDIUS B. RWEZAHURA 1
 Paying for petrol to use in the van is revenue expenditure. This is because the
expenditure is used up in a short time and does not add to the value of fixed
assets.
Examples
S/n Expenditure Type of Expenditure
1 Buying van Capital
2 Petrol costs for van Revenue
3 Repairs to van Revenue
4 Putting extra headlights on van Capital
5 Buying machinery Capital
6 Electricity costs of using machinery Revenue
7 We spent £1,500 on machinery: £1,000 was for an Capital £1,000
item (improvement) added to the machine; £500 for Revenue £500
repairs
8 Painting outside of new building Capital
9 Three years later – repainting outside of building in (8) Revenue
If one of the following occurs:

 Capital expenditure is incorrectly treated as revenue expenditure, or
 Revenue expenditure is incorrectly treated as capital expenditure, then
both the figures in the statement of financial position and in the income statement will be
incorrect. This means that the net profit figure will also be incorrect and,
If the expenditure affects items in the trading account part of that statement, the gross
profit figure will also be incorrect.
Treatment of loan interest

If money is borrowed to finance the purchase of a fixed asset, interest will have to be paid
on the loan. The loan interest is not a cost of acquiring the asset, but is simply a cost of
financing its acquisition. This means that loan interest is revenue expenditure and not
capital expenditure
However, IFRS 15 allows interest directly attributable to the construction of a tangible
fixed asset to be capitalised as part of the cost of that asset.
Note.
FRS 15 does not permit capitalisation of interest incurred on the funds used to purchase a
fixed asset, only interest incurred on the construction of a fixed asset. IAS 23 (Borrowing
costs) has similar rules concerning capitalisation of interest.
REVIEW QUESTIONS
Question One
a) What is meant by ‘capital expenditure’, and ‘revenue expenditure’?
b) Some of the following items should be treated as capital and some as revenue. For
each of them state which classification applies:
i. Purchase of a new van.
ii. Purchase of replacement engine for existing van.
iii. Cost of altering interior of new van to increase carrying capacity.
iv. Cost of motor tax for new van.
v. Cost of motor tax for existing van.
vi. Cost of painting business’s name on new van.
vii. Repair and maintenance of existing van.
Question Two
You are required to allocate each or part of the items above to either ‘capital’ or
‘revenue’ expenditure.
S/n Expenditure Capital Revenue
a) Purchase of extra milling machine (includes
Tsh.300,000 for repair of an old machine) 2,900,000
b) Rent 750,000
c) Electrical expenses (includes new wiring Tsh.600,000
part of premises improvement) 3,280,000
d) Carriage inwards (includes Tsh.150,000 carriage on
new cement mixer) 1,260,000
e) Purchase of extra drilling machine 4,100,000
Question Three
For the business of J Charles, wholesale chemist, classify the following between ‘capital’
and ‘revenue’ expenditure:
a) Purchase of an extra van.
b) Cost of rebuilding warehouse wall which had fallen down.
c) Building extension to the warehouse.
d) Painting extension to warehouse when it is first built.
e) Repainting extension to warehouse three years later than that done in (d).
f) Carriage costs on bricks for new warehouse extension.
g) Carriage costs on purchases.
h) Carriage costs on sales.
i) Legal costs of collecting debts.
j) Legal charges on acquiring new premises for office.
k) Fire insurance premium.
l) Costs of erecting new machine.
Question Four
The following costs were also incurred by Napa Ltd during the financial year ended 30
June 2021:
a) Interest on loan to purchase microcomputer.
b) Cost of software for use with the microcomputer.
c) Cost of customising the software for use in Napa Ltd’s business.
d) Cost of paper used by the computer printer.
e) Wages of computer operators.
f) Cost of ribbons used by the computer printer.
g) Cost of adding extra memory to the microcomputer.
h) Cost of floppy disks used during the year.
i) Costs of adding a manufacturer’s upgrade to the microcomputer equipment.
j) Cost of adding air conditioning to the computer room.
Required:
Classify each of the above as capital expenditure or revenue expenditure.
Question Five
Classify the following items as either revenue or capital expenditure
a) An extension to an office building costing £24,000.
b) The cost of replacement valves on all the labelling machines in a canning factory.
c) Repairs to the warehouse roof.
d) Annual service costs for a courier firm’s fleet of vans.
e) Replacement of rubber tread on a printing press with a plastic one that has resulted in
the useful economic life of the printing press being extended by three years.
f) A new bicycle purchased by a newsagent for use by the newspaper delivery boy.
g) Repairs to a refrigeration system of a meat wholesaler.
h) Repainting of the interior of a bar/restaurant which has greatly improved the potential
for finding a buyer for the bar/restaurant as a going concern.
i) Wages paid to employees who worked on the construction of their company’s new
office building.
CHAPTER TWO
BAD DEBTS, PROVISIONS FOR DOUBTFUL DEBTS, AND PROVISIONS FOR
DISCOUNTS ON DEBTORS
I. Bad Debts
With many businesses if not all, a large proportion of the sales are on credit. The business
is therefore taking the risk that some of the customers may never pay for the goods sold
to them on credit.
This is a normal business risk and such bad debts are a normal business expense. They
must be charged to profit and loss as an expense when calculating the profit or loss for the
period.
The other thing that needs to be done is to remove the bad debt from the asset account.
Usually, this will mean closing the debtor’s account, but not always.
When a debt is found to be ‘bad’, the asset as shown by the debt in the debtor’s account is
worthless. It must be eliminated from the account. This is done by
 Crediting the debtor’s account - to cancel the asset, and
 Debiting bad debt account – to increase the expense account of bad debts
Reasons for bad debts

a) The debtor may be refusing to pay one of a number of invoices;
b) The debtor may be refusing to pay part of an invoice;
c) The debtor may owe payment on a number of invoices and has indicated that only
a proportion of the total amount due will ever be paid because the debtor’s
business has failed;
d) The debtor’s business has failed and nothing is ever likely to be received.
Treatments
Whatever the reason, once a debt has been declared ‘bad’, the journal entry is the same.
DR. The bad debt account (with the amount of the bad debt)
CR. The debtor’s account in the Sales Ledger (to complete the double entry).
At the end of the period, the total of the bad debts account is transferred to the profit/loss
account.
Illustration
DR C Blandina CR
8 Jan Sales 520,000 31 Dec Bad debts 520,000
DR R Shayo CR
16 Feb Sales 375,000 17 Aug Cash 125,000
………. 31 Dec Bad debts 250,000
375,000 375,000
DR Bad Debts CR
31 Dec C Blandina 520,000 31 Dec Profit/Loss 770,000
31 Dec R Shayo 250,000 ……….
770,000 770,000
Profit/Loss Account (extract) for the year ended 31 December, 2021

Gross profit xxx
Less Expenses:
Bad debts (770,000)
II. Provisions for doubtful debts

Why provisions are needed?
Provision for doubtful debts are needed in order to achieve the following objectives:
 To charge as an expense in the profit/loss account for that year an amount
representing debts that will never be paid;
 To show in the balance sheet a debtors figure as close as possible to the true value
of debtors at the balance sheet date.
How to determine the amount as a provision?
It is impossible to determine with absolute accuracy at the year-end what the true amount
is in respect of debtors who will never pay their accounts (after removing those which
have been written off as bad)
In order to arrive at a figure for doubtful debts, a business must first consider that some
debtors will never pay any of the amount they owe, while others will pay a part of the
amount owing only, leaving the remainder permanently unpaid. The estimated figure can
be made:
 by looking at each debt, and deciding to what extent it will be bad;
 by estimating, on the basis of experience, what percentage of the total amount due
from the remaining debtors will ultimately prove to be bad debts
It is well known that the longer a debt is owing, the more likely it is that it will become a
bad debt. Older debtors need higher percentage estimates of bad debts than do newer
debtors.
Accounting entries for provisions for doubtful debts
The accounting entries needed for the provision for doubtful debts are:
 Debit the profit/loss account with the amount of the provision (i.e. deduct it from
gross profit as an expense).
 Credit the Provision for Doubtful Debts Account.
Example One
At 31 December 2018, the debtors figure after deducting bad debts was Tsh.10,000,000.
It is estimated that 2% of debts (i.e. Tsh.200,000) will eventually prove to be bad debts,
and it is decided to make a provision for these.
Provision for Doubtful Debts
31.12.2018 Profit/loss 200,000
Profit/Loss Account (extract) for the year ended 31 December 2018

Gross profit xxx
Less: Expenses:
Provision for doubtful debts (200,000)
Balance Sheet (extract) as at 31 December 2018
Current assets
Debtors 10,000,000
Less: Provision for doubtful debts (200,000)
9,800,000
Note:
We use two different accounts to make the two different debtor adjustments. This is done
in order to make it clear
 how much is being written off as bad, and
 how much is being treated as a provision for doubtful debts
1) Bad debts account: This expense account is used when a debt is believed to be
irrecoverable and is written off.
2) Provision for doubtful debts account: This expense account is used only for
estimates of the amount of the debtors remaining at the year-end after the bad debts
have been written off that are likely to finish up as bad debts. (This account is also
known as the ‘provision for bad debts account’.)
INCREASING THE PROVISION

Example Two
At 31 December 2019, the doubtful debts provision needed to be increased. This was
because the provision was kept at 2%, but the debtors had risen to Tsh.12,000,000. A
provision of Tsh.200,000 had been brought forward from the previous year, but we now
want a total provision of Tsh.240,000 (i.e. 2% of Tsh.12,000,000). All that is now needed
is a provision for an extra Tsh.40,000. The double entry will be:
1. Debit Profit/Loss Account with the increase in the provision (i.e. deduct it from
gross profit as an expense).
2. Credit the Provision for Doubtful Debts Account.
2019 2019
Dec 31 Balance c/d 240,000 Jan 1 Balance b/d 200,000
…….... Dec 31 Profit/loss 40,000
240,000 240,000
Gross profit xxx
Less: Expenses:
Increase in provision for doubtful debts (40,000)
Current assets
Debtors 12,000,000
11,760,000
REDUCING THE PROVISION
Example Three
Let’s assume that at 31 December 2020, the debtors figure had fallen to Tsh.10,500,000
but the provision remained at 2%, i.e. Tsh.210,000.
As the provision had previously been Tsh.240,000, it now needs to be reduced by
Tsh.30,000. The double entry is:
1. Debit Provision for Doubtful Debts Account.
2. Credit Profit/Loss Account (i.e. add it as a gain to gross profit).
2020 2020
Dec 31 Profit/loss 30,000 Jan 1 Balance b/d 240,000
Dec 31 Balance c/d 210,000 ………..
240,000 240,000

Gross profit xxx
Add: Decrease in provision for doubtful debts 30,000

Current assets
Debtors 10,500,000
10,290,000
Note
 An increase in the provision for doubtful debts increases the total for expenses.
 A decrease in the provision for doubtful debts is added to the gross profit.
BAD DEBTS RECOVERED

Sometimes, a debt written off in previous years is recovered. When this happens,
1. Reinstate the debt by making the following entries:
Dr Debtor’s account
Cr Bad debts recovered account
2. When payment is received from the debtor in settlement of all or part of the debt:
Dr Cash/bank
Cr Debtor’s account (with the amount received).
At the end of the financial year,
The credit balance in the bad debts recovered account is transferred to
 Either the bad debts account
 Or direct to the credit side of the profit/loss account.
The effect is the same, since the bad debts account will, in itself, be transferred to the
profit/loss account at the end of the financial year.
III. Provisions for Cash Discounts on Debtors

Some businesses create provisions for cash discounts to be allowed on the debtors
outstanding at the balance sheet date.
The procedure for dealing with this is similar to the doubtful debts provision.
Note
The estimate of discounts to be allowed should be based on the net figure of debtors less
doubtful debts provision, as it is obvious that cash discounts are not allowed on bad
debts!
Example 4
Year ended 31 Dec Debtors Provision for d/debts Provision for cash disc/allw
2018 4,000,000 200,000 2%
2019 5,000,000 350,000 2%
2020 4,750,000 250,000 2%
Provision for Cash Discounts on Debtors
2018 2018
Dec 31 Balance c/d 76,000 Dec 31 Profit/loss 76,000
2019 2019
Dec 31 Balance c/d 93,000 Jan 1 Balance b/d 76,000
……… Dec 31 Profit and loss 17,000
93,000 93,000
2020 2020
Dec 31 Profit and loss 3,000 Jan 1 Balance b/d 93,000
Dec 31 Balance c/d 90,000 ……..
93,000 93,000
2021
Jan 1 Balance b/d 90,000
Profit/Loss Account (extracts) for the year ended 31 December

Gross profits (2018, 2019 and 2020) xxx
Less: Expenses
(2018) Provision for cash discounts on debtors (76,000)
(2019) Increase in provision for cash discounts on debtors (17,000)
Add: Other income
(2020) Reduction in provision for cash discounts on debtors 3,000
Balance Sheets (extracts) as at 31 December

2018 Debtors 4,000,000
Less Provision for doubtful debts 200,000
Less Provision for cash discounts on debtors 76,000 (276,000) 3,724,000
2019 Debtors 5,000,000
2020 Debtors 4,750,000
REVIEW QUESTIONS
Question One
The following trial balance was extracted from the books of M Mapunda on 30 April
2017. From it, and the note below it, prepare his trading and profit/loss account for the
year ending 30 April 2017, and a balance sheet as at that date.
DR (Tshs) CR (Tshs)
Sales 18,614,000
Purchases 11,570,000
Stock 1 May 2016 3,776,000
Carriage outwards 326,000
Carriage inwards 234,000
Returns inwards 440,000
Returns outwards 355,000
Salaries and wages 2,447,000
Motor expenses 664,000
Rent 576,000
Sundry expenses 1,202,000
Motor vehicles 3,400,000
Fixtures and fittings 600,000
Debtors 4,577,000
Creditors 3,045,000
Cash at bank 3,876,000
Cash in hand 120,000
Drawings 2,050,000
Capital 13,844,000
35,858,000 35,858,000
Note:
a) Closing stock amounted to Tshs. 4,000,000.
b) Depreciation is to be charged at rates of 10% on cost for Fixtures and Fittings and
25% on cost for Motor Vehicles.
c) Bad debts of Tshs. 800,000 are to be written-off.
Question Two
The following trial balance was extracted from the books of R Malima at the close of
business on 28 February 2021.
DR (Tshs) CR (Tshs)
Purchases and sales 92,800,000 157,165,000
Capital account 1 March 2020 11,400,000
Drawings 17,100,000
Office furniture 2,900,000
Rent 3,400,000
Wages and salaries 31,400,000
Discounts 820,000 160,000
Debtors and creditors 12,316,000 5,245,000
Stock 1 March 2020 4,120,000
Provision for doubtful debts 1 March 2020 405,000
Delivery van 3,750,000
Van running costs 615,000
Bad debts written off 730,000
174,375,000 174,375,000
Notes:
a) Stock 28 February 2021 Tshs. 2,400,000.
b) Wages and salaries accrued at 28 February 2021 Tshs. 340,000.
c) Rent prepaid at 28 February 2021 Tshs. 230,000.
d) Van running costs owing at 28 February 2021 Tshs. 72,000.
e) Increase the provision for doubtful debts by Tshs. 91,000.
f) Provide for depreciation as follows: Office furniture Tshs. 380,000; Delivery van
Tshs. 1,250,000.
Required:
Draw up the trading and profit/loss account for the year ending 28 February 2021
together with a balance sheet as on 28 February 2021.
Question Three
Koku Rutta, a sole trader, extracted the following trial balance from her books at the
close of business on 31 March 2019:
DR (Tshs) CR (Tshs)
Purchases and sales 61,420,000 127,245,000
Stock 1 April 2018 7,940,000
Capital 1 April 20X8 25,200,000
Bank overdraft 2,490,000
Cash 140,000
Discounts 2,480,000 62,000
Returns inwards 3,486,000
Returns outwards 1,356,000
Carriage outwards 3,210,000
Rent and insurance 8,870,000
Provision for doubtful debts 630,000
Fixtures and fittings 1,900,000
Van 5,600,000
Drawings 21,400,000
General office expenses 319,000
168,383,000 168,383,000
Notes:
a) Stock 31 March 2019 Tshs. 6,805,000.
b) Wages and salaries accrued at 31 March 2019 Tshs. 3,500,000; Office expenses
owing Tshs. 16,000.
c) Rent prepaid 31 March 2019 Tshs. 600,000.
d) Increase the provision for doubtful debts by Tshs. 110,000 to Tshs. 740,000.
e) Provide for depreciation as follows: Fixtures and fittings Tshs. 190,000; Van Tshs.
1,400,000.
Required:
Prepare the trading and profit/loss accounts for the year ended 31 March 2019 together
with a balance sheet as at that date.
Question Four
From the following trial balance of Mary Manase, store owner, prepare a trading account
and profit/loss account for the year ended 31 December 2017, and a balance sheet as at
that date, taking into consideration the adjustments shown below:
Trial Balance as at 31 December 2017
DR (Tshs) CR (Tshs)
Sales 400,000,000
Sales returns 5,000,000
Purchases returns 6,200,000
Opening stock at 1 January 2017 100,000,000
Rates 6,000,000
Telephone 1,000,000
Shop fittings at cost 40,000,000
Van at cost 30,000,000
Bad debts 200,000
Capital 179,000,000
Bank balance 3,000,000
Drawings 18,000,000
593,000,000 593,000,000
Note:
a) Closing stock at 31 December 2017 Tshs. 120,000,000.
b) Accrued wages Tshs. 5,000,000.
c) Rates prepaid Tshs. 500,000.
d) The provision for doubtful debts to be increased to 10 per cent of debtors.
e) Telephone account outstanding Tshs. 220,000.
f) Depreciate shop fittings at 10 per cent per annum, and van at 20 per cent per annum,
on cost.
Question Five
The following trial balance has been extracted from the ledger of Fatuma Urio, a sole
trader.
Trial Balance as at 31 December 2016
DR (Tshs) CR (Tshs)
Sales 138,078,000
Carriage 5,144,000
Drawings 7,800,000
Rent, rates and insurance 6,622,000
Postage and stationery 3,001,000
Advertising 1,330,000
Bad debts 877,000
Debtors 12,120,000
Creditors 6,471,000
Stock as at 1 June 2015 11,927,000
Equipment - at cost 58,000,000
- accumulated depreciation 19,000,000
Capital 53,091,000
216,770,000 216,770,000
The following additional information as at 31 May 2016 is available:

a) Rent is accrued by Tshs. 210,000.
b) Rates have been prepaid by Tshs. 880,000.
c) Tshs. 2,211,000 of carriage represents carriage inwards on purchases.
d) Equipment is to be depreciated at 15% per annum using the straight line method.
e) The provision for doubtful debts to be increased by Tshs. 40,000.
f) Stock at the close of business has been valued at Tshs. 13,551,000
Required:
Prepare a trading and profit/loss account for the year ended 31 May 2016 and a balance
sheet as at that date.
Question Five
Mr. Chai has been trading for some years as a wine merchant. The following list of
balances has been extracted from his ledger as at 30 April 2017, the end of his most
recent financial year.
Capital 83,887,000
Sales 259,870,000
Trade creditors 19,840,000
Returns out 13,407,000
Discounts allowed 2,306,000
Discounts received 1,750,000
Returns inwards 5,624,000
Carriage outwards 4,562,000
Drawings 18,440,000
Carriage inwards 11,830,000
Rent, rates and insurance 25,973,000
Heating and lighting 11,010,000
Postage, stationery and telephone 2,410,000
Advertising 5,980,000
Bad debts 2,008,000
Stock as at 1 May 2016 15,654,000
Trade debtors 24,500,000
Fixtures and fittings – at cost 120,740,000
Provision for depreciation on fixtures and fittings as at 30.April 63,020,000
2017
Depreciation 12,074,000
The following additional information as at 30 April 2017 is available:

a) Stock at the close of business was valued at Tshs. 17,750,000.
b) Insurances have been prepaid by Tshs. 1,120,000.
c) Heating and lighting is accrued by Tshs. 1,360,000.
d) Rates have been prepaid by Tshs. 5,435,000.
e) The provision for doubtful debts is to be adjusted so that it is 3% of trade debtors.
Question Five
The trial balance for a small business at 31 August 2018 is as follows
DR (Tshs) CR (Tshs)
Stock 1 September 2017 8,200,000
Purchases and Sales 26,000,000 40,900,000
Rent 4,400,000
Business rates 1,600,000
Sundry expenses 340,000
Motor vehicle at cost 9,000,000
Bank 1,500,000
Provision for depreciation on motor vehicle 1,200,000
Capital at 1 September 2017 19,700,000
Drawings 11,700,000
63,900,000 63,900,000
At 31 August 2018 there was:

a) Stock valued at cost prices Tshs. 9,100,000
b) Accrued rent of Tshs. 400,000
c) Prepaid business rates of Tshs. 300,000
d) The motor vehicle is to be depreciated at 20% of cost
Required:
Prepare a trading profit/loss account for the year ending 31 August 2018, together with a
balance sheet as at that date.
CHAPTER THREE
RATIO ANALYSIS
Introduction
Ratio Analysis is the most common financial statements analysis that is widely employed
by business and academicians. It is one of the strongest analysis that is well used along
with other measures.
Ratios
A ratio is a comparison between numerator and denominator. It is the relationship
between two figures and is obtained by dividing the former by the later.
Accounting ratios
Accounting ratios are relationships expressed in mathematical terms between figures
which are connected with each other in some manner.
Types of ratios
Ratios are categorized into the following groups
a) Liquidity ratios
b) Efficiency/Turnover ratios
c) Profitability ratios
d) Gearing/Leverage/Debt ratios
e) Market ratios
I. LIQUIDITY RATIOS
These ratios attempt to measure the company’s ability to meet short term obligations.
They are generally based on the relationship between current assets and current liabilities.
i. Current Ratio = Current Assets A ratio of 2:1 is a standard and
desirable.
Current Liabilities
ii. Quick (Acidic –Test ) Ratio = Quick Assets
Quick Liabilities
= Current Assets – Inventory
Current Liabilities – BOD
A ratio of 1:1 is a standard and desirable although higher values are preferable
II. EFFICIENCY RATIOS

Efficiency ratios are sometimes known as Turnover ratios and are also referred to as
Activity ratios or assets management ratios. They attempt to measure how efficiently the
assets are employed by the firm. It measures how efficiently the firm uses its resources
(assets) at its command.
i. Stock Turnover = Cost of sale/COGS
Average stock
This ratio measures how fast (how often) throughout the year is the inventory
moving/replaced through the firm and generating sales.
Example
If the cost of promoting materials sold is 40,000,000
Opening stock is 4,000,000 and closing stock is 6,000,000
What is the stock turnover for the firm?
Solution
Average stock = ½ (4,000,000 + 6,000,000) = 5,000,000
 Stock turnover = 40,000,000
5,000,000
= 8 times
Interpretation: The stock is replaced 8 times on average a year to generate sales
 Number of days = Average stock x 365 OR 365/Stock turnover
Cost of sale
= 365/8
= 61 days or 2 months
Interpretation: The stock is being replaced after 61 days, i.e. two months
ii. Debtors turnover = Credit sales/Net sales
Average debtors
In absence of opening balance, the closing balance is used as the average and the Net
sales is used where there is no credit sales.
This ratio shows how many times the debtors turn over during the year.
Debtors’ period = Debtors x 365 OR Debtors’ period = 365/Debtors turnover
Credit Sales
Debtors’ period measures the number of days it takes for debtors to settle their bills.
Desirable is shorter period implying management thriftiness in debts collection. A long
collection period indicates that the entity’s selling and collection policy is not effective.
Examples
If Debtors at year end = 4,000,000 and Sales = 40,000,000
Calculate a) Debtors’ turnover b) Debtors collection period
Solution
a) Debtors turnover = 40,000,000/4,000,000 = 10 times
b) Debtors’ collection period = 365/10 = 37 days
Interpretation: On average, it takes 37 days to collect the debts
Reasons for poor Debtors’ collection period
 The debt being too high
 Laxity in debt collection
 Poor credit policy
Measures to reduce debtors’ collection period
 Offering cash discounts to debtors thereby tempting them to pay up sooner
 Reviewing credit policy and credit facility
 Using debt collection agencies if their associated costs are lower than the benefits
 Employ thrift management for debt collection
iii. Creditors turnover = Credit purchases/Net purchases

Average creditors
This ratio shows how many times the creditors get paid during the year. A longer period
indicates that the entity is not paying its bills on time and may lose suppliers although
delaying payments indicates that the entity takes advantage of the borrowed short term
credit to generate more revenue.
Creditors’ payment period = Average creditors x 365 OR 365/Creditors turnover
Credit purchases
Note. If no credit and cash purchases, cost of sales figure is used
III. PROFITABILITY RATIOS

Profits have always been considered a main indicator of successful business. Success of
the business is tested by evaluating its profit earning capacity in relation to Capital
employed
Profitability ratios measure how management is effective in generating Earnings/Profit
(PBIT) using its sales or services. The higher the Profitability ratio the better
i. ROCE = EBIT/CE CE = FA + CA – CL or Share capital + Reserves + Loan
Example
Non-current assets of 15,000,000 invested generate income of 2,000,000. Other assets
include Current assets equal to 8,000,000 and Current liabilities equal to 3,000,000.
Determine the Return on Capital Employed
Solution
ROCE = 2,000,000 x 100% = 10%
20,000,000
Interpretation: On average, the capital employed generates 10% of the net income (i.e.
one shilling of the employed capital generates 0.1 shilling of the net profit)
ii. ROE = EBIT/Equity
iii. ROA = EBIT/TA
iv. Total Assets Turnover = Sales x 100%
TA
v. GP ratio = GP x 100%
Sales
vi. NP ratio = NP x 100%
Sales
An entity may generate low profit due to the following reasons
 Poor pricing = Increase Selling price
 High cost of goods/services provided by the entity = Reduce cost of goods sold
 Improper goods/services provided by the entity=Improve goods/service
provided
 High operating expenses = Reduce operating expenses
 Poor production and selling techniques = Increase volume of sales
IV. DEBT RATIOS

Debt ratios (also called Leverage ratios or Capital structure or Gearing ratios or long term
solvency ratios) are ratios used to measure the contributions of financing by owners
compared with the financing provided by the outsiders such as Preference shareholders,
Debenture holders and long term creditors
These ratios measure the ability of the firm to pay all its long term debts.
i. Debt Equity ratio = Total Debt/ Total Equity
ii. Total Debt Ratio = TA - Equity = Total Debt
Total Assets Total Assets
iii. Long term Debt ratio = Long term Debt = Long term Debt
Total Assets Total Debt + Equity
iv. Interest Earned ratio = EBIT/Interest
V. STOCK MARKET RATIOS

These are also called shareholders or investors ratios. These ratios help the investors to
make a better choice and compare the alternative investments. They are used to measure
the return on investments and determine the future prospects. These include:
i. Dividend Yield = DPS/MPS
ii. Dividend Payout Ratio = DPS/EPS
iii. Price Earnings Ratio = MPS/EPS
iv. Dividend Cover = EPS/DPS
v. EPS = PAT/Shares
vi. DPS = Dividends/Shares
vii. Earnings Yield = EPS/MPS

Adjustments For Financial Statements: Chapter One Capital Expenditure and Revenue Expenditure Capital Expenditure

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Adjustments For Financial Statements: Chapter One Capital Expenditure and Revenue Expenditure Capital Expenditure

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ADJUSTMENTS FOR FINANCIAL STATEMENTS

Capital expenditure is incurred when a business spends money either to:

If one of the following occurs:

Treatment of loan interest

Reasons for bad debts

Profit/Loss Account (extract) for the year ended 31 December, 2021

II. Provisions for doubtful debts

Proﬁt/Loss Account (extract) for the year ended 31 December 2018

Balance Sheet (extract) as at 31 December 2018

INCREASING THE PROVISION

Proﬁt/Loss Account (extract) for the year ended 31 December 2020

Balance Sheet (extract) as at 31 December 2020

BAD DEBTS RECOVERED

III. Provisions for Cash Discounts on Debtors

Proﬁt/Loss Account (extracts) for the year ended 31 December

Balance Sheets (extracts) as at 31 December

The following additional information as at 31 May 2016 is available:

The following additional information as at 30 April 2017 is available:

At 31 August 2018 there was:

II. EFFICIENCY RATIOS

iii. Creditors turnover = Credit purchases/Net purchases

III. PROFITABILITY RATIOS

IV. DEBT RATIOS

V. STOCK MARKET RATIOS

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