ACC 412 Specialised Accounting I

MT KENYA UNIVERSITY
DEPARTMENT OF FINANCE AND

ACCOUNTING
P.O. Box 342
THIKA, KENYA
Email: info@mku.ac.ke
Web: www.mku.ac.ke
Course code: ACC 412:

Course Title: specialized Accounting I
Instructional materials for distance learning students
1
Course Content
ACC 412: SPECIALISED ACCOUNTING I
Contact hours: 42
Pre-requisite ACC 322
Purpose To introduce the learner to advanced accounting for special types of business
Expected Learning Outcomes of the Course

By the end of the course unit the learners should be able to:-
i) Explain the accounting procedure for partnership reorganization ii) Describe procedure for
accounting for consignments
iii) Describe procedure for accounting for branch and agency
iv) Describe procedure for accounting for hire purchase, royalty, and investment
v) Describe procedure for accounting for foreign transactions and translation and price
changes
Course Content
Partnership re-organization, merging of partnerships, conversion to a limited liability company
and dissolution; Accounting for consignments, consignee books, consignor books; Branch accounts;
Hire purchase accounting; Accounting for Royalty; Investment accounting; Accounting for
foreign
transactions and translations; Accounting for price level changes
Teaching / Learning Methodologies: Lectures and tutorials; group discussion;

demonstration; Individual assignment; Case studies
Instructional Materials and Equipment: Projector; test books; design catalogues;

computer laboratory; design software; simulators
Course Assessment
Examination - 70%; Continuous Assessment Test (CATS) - 20%; Assignments - 10%; Total - 100%
Recommended Text Books:

i) John Larsen (2000), Modern Advanced Accounting, Mcgraw-hill Professional
ii) Stice (2008), Financial Accounting : Reporting And Analysis, Cengage Learning ( Thompson )
iii) Reimers (2006), Financial Accounting, Dorling Kindersley (india) Pvt Ltd
Text Books for further Reading:

i) Jenning A.R (1994) Financial Accounting (2nd Edition) DP. Publications Ltd London
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Table of contents
Course Content.............................................................................................................2
................................................................................................................3
Unit 1: PARTNERSHIPS.............................................................................................4
1.1 Objectives................................................................................................................4
1.2 Introduction.............................................................................................................4
1.3 Format for Balance Sheet........................................................................................8
1.4 Admissions and Retirements................................................................................12
1.5 Dissolutions...........................................................................................................15
1.6 Amalgamations......................................................................................................28
1.7 Conversion into a Company..................................................................................33
Revision questions .....................................................................................................34
UNIT 3: ACCOUNTING FOR CONSIGNMENTS.................................................46
3.1 Operating Arrangements......................................................................................46
UNIT 4: BILLS OF EXCHANGE AND PROMISSORY NOTES...........................54
4.1 Introduction...........................................................................................................54
4.2 Classification of bills of exchange.........................................................................54
4.3 Promissory Notes..................................................................................................55
Unit 7: LEASE AND HIRE PURCHASE TRANSACTIONS.................................106
8.1 Accounting entries...............................................................................................120
Revision Question.....................................................................................................128
Unit 9: Accounting for Foreign Transactions and Translations................................130
9.1 FOREIGN SUBSIDIARIES (IAS 21)..................................................................130
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Unit 1: PARTNERSHIPS
1.1 Objectives
At the end of this lesson, you should be able to:
i) Deal with the more complex aspects of partnership accounting dealing with
realignments and dissolutions;
ii) Deal with accounting for the conversion of a partnership into a limited liability company;
iii) Know the provisions of the Partnership Act.
1.2 Introduction
This chapter covers the more complex aspects of dealing with partnerships. At this level
partnerships may be examined from every possible angle, therefore this chapter will be
considering partnerships to the maximum possible depth.
Definition:
A partnership is defined as “the relationship that subsists between two or more persons carrying
on a business in common with a view to making a profit.” (Partnership Act).
Membership:
There may be a minimum of two and a maximum of twenty members in a partnership. In the
U.K however, the Partnership Act 1934 CAP 29 provides that the maximum number of partners
in a firm that offers personal/professional services may be up to 50 if each partner is
professionally qualified, e.g. Accountants, Lawyers, architects doctors, surgeons etc.
Types of Partners:
Partners may be classified into the following categories:
1) Active or dormant;
2) Limited or Unlimited;
3) Adult or Minor;
4) Real or Quasi.
Legal Formalities for the Formation of a Partnership
There are no legal formalities if the partners carry on business in their own names. However, if they
carry on business in another name, then the business must be registered with the registrar of business
names.
The Partnership Deed:

It is the agreement that regulates the partners actions in undertaking the partnership business.
This may or may not have been drawn up. It usually contains, amongst others:
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(i) Name of the firm, names of the partners, their addresses and their occupations;
(ii) The status/type of each partner, e.g. active/dormant, limited/unlimited etc
(iii) The capital to be contributed by each partner
(iv) Their profit sharing ratio
(v) Salaries to partners, if any
(vi) Interest, if any on capital/drawings.
Provisions of the Partnership Act

In the event of absence of a partnership agreement/deed or in the event of ambiguity therein, the
provisions to the partnership Act will apply. The provisions state that, unless the partnership
deed indicates otherwise,
i) Every partner has a right to take part in the conduct of business;

ii) All profits/losses are to be shared equally;
iii) No interest on capital is to be allowed;
iv) No partner is entitled to a salary;
v) No interest on drawings is to be charged;
vi) 6% per annum is to be allowed on amounts contributed by each partner exceeding the agreed
capital amounts;
vii) normal business decisions can be taken by a majority vote;
viii) Major business decisions e.g. major business changes must obtain the full consent of all
partners.
Dissolution of a partnership:
A partnership is dissolved when:
- It is temporary (maybe set up for a given period which has lapsed);

- One partner notifies the others in writing, of his intention to retire;
- A partner dies, becomes insane or bankrupt;
- The partnership becomes unlawful.
Accounting for Partnerships

The owners’ interests in the business are divided into long term and short-term interests. (Long-
term interests refer to original capital commitments and changes thereon. Short-term interests
refer to shares of annual profit and amounts therein withdrawn). The long-term interests are
shown in a capital account whereas short-term interests are shown in a current account.
These accounts are kept in a T-form for examination purposes, a separate column being kept for
each partner.
Example of a current account where there are 3 partners A, B and C:
Current Account
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A B C A B C
Bal b/d (Note 1) X
Bal b/d (Note 1) X X
Interest on drawings X X X
Interest on capital (Note X X X
(Note 2) 3)
Drawings X X X Salaries (Note 4) X X X
Interest on loan X - -
Share of profit (Note 5) X X X
Bal c/d (Note 6) X X - Bal c/d (Note 6) - - X
XX XX XX XX XX XX
- - X Bal b/d X X -
Example of a capital account where there are 3 partners A, B, and C:

A B C A B C
Goodwill written off X X X Bal b/f X X X
Deficit on revaluation X X X Additional capital
brought in as per X X X
agreement
Goodwill X X X
Bal c/d X X X Surplus on revaluation X X X
XX XX XX XX XX XX
Bal b/d X X X
Format for Trading Profit and Loss A/CS:

The trading section remains identical to that of a sole proprietorship, and so does the profit and
loss section. However an additional section is now brought in (called the appropriation account)
in which profits are divided amongst partners.
The appropriation account is a continuation of the P&L account in a similar situation to which
the P&L account is a continuation of the trading account.
Sh Sh Sh
Net profit (as per trading, profit & loss a/c) X
Add: Interest on drawings: A X
B X
C e2
tX X
No X
Less: Interest on capital: A X
te 3
No
Example of a P&L Appropriation A/C where there
are 3 partners A, B and C:
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B X
C X
X
Salaries: A X
B Xe
ot
C NX X (X)
4 sharing ratio
Balance shared according to agreed profit X
Share of profits A X
B te X
C No X X
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Note 1: (See current A/C)

The opening balances for the current accounts can be extracted from the trial balance. These
balances may be debit balances b/d or credit balances b/d. A credit balance b/d is a favorable
balance for the partner, i.e he has not yet withdrawn all his dues from the firm. A debit balance
means the partner has overdrawn his “account”.
Note 2: (See current A/C and appropriations A/C)

Ideally, the partner should wait until the end of the year when the profit is ascertained and
divided up before he can take his share. However, commitments may arise partway through the
year thus forcing the partner to withdraw money earlier. The firm will treat this as a “loan”
extended to the partner until the end of the year. This will attract interest (known as interest on
drawings), which is income to the firm and is added to the net profit.
It is a “loss” to the partner and is therefore debited to his current account.
Note 3: (See current A/C and appropriation A/C)

In a partnership, the partners need not contribute equal capital to go into business. Therefore, in
order to prevent dissatisfaction amongst partners (i.e “why should I bring in more capital than
you?”) Some of the profits of the firm are given to partners in the name of “interest on capital”.
This is a percentage of fixed capital and therefore the larger the capital contribution by the
partner, the larger his share of profit will be.
Note 4: (See Current A/C and appropriation A/C)

Some of the partners may remain in the business on a full time basis to oversee the day to day
running/management of the business, instead of seeking alternative employment elsewhere (thus
earning some more income elsewhere). Part of the available profit will be awarded to them in
the name of “salaries” to compensate them for loss of income elsewhere.
Note 5: (See Current A/C and appropriations A/C)
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If any profit remains after some has been given to partners in the names of “interest on capital”
and “salaries”, then this will be divided amongst partners in profit sharing ratio. NB: If this was
a loss, then it will appear on the debit side of the current A/C.
Note 6: [See current A/C and balance sheet format (below)]

The final balance computed in the current A/C represents the owners’ short term interests at the end
of the year. Once again, if the balance b/d is a debit figure, then it is favorable to the partner. If the
balance b/d is a debit figure, this is unfavorable to the partner (he has drawn more than his profit
share) and this entry will appear as negative in the balance sheet.
1.3 Format for Balance Sheet

The non current assets, current assets and current liabilities sections remain identical to those of a
sole proprietorship. However, the “capital section will change to reflect the capital contribution
by each partner..
Example of a balance sheet where there are 3 partners A, B and C.
(Name)
Balance Sheet as at (date)
Non Current assets Cost (Shs) Depreciation NBV
(Shs) (Shs)
Land & Buildings X X X
Fixtures & Fittings X X X
Plant & Machinery X X X
Motor Vehicles X X X
XX XX XX
Investments, goodwill etc X
Current Assets
Inventory X
Receivables X
Less provision for bad and doubtful (X) X
debts
Prepayments X
Bank X
Cash X
X
Current Liabilities
Payables X
Accruals X (X)
Working capital (C.A – C.L) X
XX
Financed by:
Capitals: A X
B X
C X
X
6
ot
e
8
N
Se
e
Current A/Cs: A X
B X
C (X) X
X
Long term loans X
XX
Note: If a partner extended a loan to the partnership (over and above the capital) then the
interest on such will be an expense in the P&L (before the net profit is computed), and not an
appropriation. The amount will be credited to the partner’s current a/c as due to him. (See
Current A/C format)
Example one
The following list of balances as at 30 September 20X9 has been extracted from the books of
Brick and Stone, trading in partnership, sharing the balance of profits and losses in the
proportions 3:2 respectively.
Kshs.
Printing, stationery and postages 3,500
Sales 322,100
Inventory in hand at 1 October 20x8 23,000
Purchases 208,200
Rent and rates 10,300
Heat and light 8,700
Staff salaries 36,100
Telephone charges 2,900
Motor vehicle running costs 5,620
Discounts allowable 950
Discounts receivable 370
Sales returns 2,100
Purchases returns 6,100
Carriage inwards 1,700
Carriage outwards 2,400
Fixtures and fittings: at cost 26,000
Provision for depreciation 11,200
Motor vehicles: at cost 46,000
Provision for depreciation 25,000
Provision for doubtful debts 300
Drawings: Brick 24,000
Stone 11,000
Current Account balances at 1 October 20x8:
Brick 3,600
Stone 2,400
Capital account balances at 1 October 20x8:
Brick 33,000
Stone 17,000
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Receivables 9,300
Payables 8,400
Balance at bank 7,700
Additional information:
Kshs.10,000 is to be transferred from Brick’s capital account to a newly opened Brick Loan
Account on 1 July 20X9. Interest at 10 per cent per annum on the loan is to be credited to Brick.
Stone is to be credited with a salary at the rate of Kshs.12,000 per annum from 1 April 20X9.
Inventory in hand at 30 September 20X9 has been valued at cost at Kshs.32,000.
Telephone charges accrued due at 30 September 20X9 amounted to Kshs.400 and rent of
Kshs.600 prepaid at that date.
During the year ended 30 September 20X9 Stone has taken goods costing Kshs.1,000 for his
own use.
Depreciation is to be provided at the following annual rates on the straight line basis:
Fixtures and fittings 10%

Motor Vehicles 20%
Required:
Prepare a trading and profit and loss account for the year ended 30 September 20X9.
Prepare a balance sheet as at 30 September 20X9 which should include summaries of the
partner’s capital and current accounts for the year ended on that date.
Note: In both (a) and (b) vertical forms of presentation should be used.
Solution:
Brick and Stone

Trading Profit and Loss Account for the year ended 30 September 20X9
Kshs. Kshs. Kshs.
Sales 322,100.00
Less sales returns (2,100.00)
320,000.00
Less cost of sales
Opening inventory 23,000.00
Purchases 207,200.00
Carriage inwards 1,700.00
208,900.00
Less purchases returns (6,100.00) 202,800.00
225,800.00
Less closing inventory (32,000.00) (193,800.00)
Gross Profit 126,200.00
Discounts receivable 370.00
126,570.00
Less Expenses:
Printing, stationery and 3,500.00
postages
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Rent and rates 9,700.00
Heat and light 8,700.00
Staff salaries 36,100.00
Telephone charges 3,300.00
Motor vehicle running costs 5,620.00
Discounts allowable 950.00
Carriage outwards 2,400.00
Depreciation: Fixtures and 2,600.00
fittings
Motor vehicles 9,200.00
Loan – Brick 250.00 (82,320.00)
Net profit 44,250.00
Less Salary – Stone (6,000.00)
38,250.00
Balance of profits shared in
PSR
Brick 22,950.00
Stone 15,300.00 (38,250.00)
Brick and Stone

Balance Sheet as at 30 September 20X9
Cost Accumulated NBV
Depreciation
Non Current assets Kshs. Kshs. Kshs.
Fixtures and fittings 26,000.00 (13,800.00) 12,200.00
Motor vehicles 46,000.00 (34,200.00) 11,800.00
72,000.00 (48,000.00) 24,000.00
Current Assets
Inventory 32,000.00
Receivables 9,300.00
Less provision for doubtful (300.00) 9,000.00
debts
Prepaid expenses 600.00
Balance at bank 7,700.00
49,300.00
Current liabilities
Payables 8,400.00
Accrued expenses 400.00 (8,800.00)
Net working capital 40,500.00
64,500.00
Capital accounts
Brick 23,000.00
Stone 17,000.00 40,000.00
Current Account
Brick 2,800.00
Stone 11,700.00 14,500.00
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54,500.00
Loan Account 10,000.00
64,500.00
Current Account
Brick Stone Brick Stone
Kshs. Kshs. Kshs. Kshs.
Drawings 24,000.00 12,000.00 Balance b/f 3,600.00 2,400.00
Interest/salary 250.00 6,000.00
Bal c/d 2,800.00 11,700.00 Profit share 22,950.00 15,300.00
26,800.00 23,700.00 26,800.00 23,700.00
1.4 Admissions and Retirements
The major focus on admission or retirement involves making adjustments for goodwill as
discussed above. The next section will just deal with illustrative examples.
Example
Jim and Ken have been trading in partnership for several, sharing profits or losses equally after
allowing for interest on their capitals at 8% p.a. At 1 September 19-7 their manager, Len, was
admitted as a partner and was to have a one-fifth share of the profits after interest on capital. Jim
and Ken shared the balance equally but guaranteed that Len’s share would not fall below
£6,000p.a. Len was not required to introduce any capital at the date of admission but agreed to
retain £1,500 of his profit share at the end of each year to be credited to his capital account until
the balance reached £7,500, until that time no interest was to be allowed on his capital. Goodwill,
calculated as a percentage of the profits of the last five years was agree at £15,000 at September
19-7, and Len paid into the business sufficient cash for his share. No goodwill accounts were to
be left in the books. Land and building were professionally valued at the same date £28,400 and
this figure was to be brought into the books, whilst the book value of the equipment and vehicles
was, by mutual agreement, to be reduced to £15,000 at the date. Len had previously been entitled
to a bonus of 5% of the gross profit payable half-yearly, the bonus together with his manager’s
salary were cease when he became a partner. It was agreed to take out a survivorship policy and
the first premium of £1,000 was paid on 1 September 19-7.
The trial balance at the end of the 19-7 financial year is given below. No adjustments had yet
been made in respect of lens admission, and the amount he introduced for goodwill had been put
into his current account. The drawings of all the partners have been changed to their current
account. It can be assumed that the gross profit and trading expenses accrued evenly throughout
the year. Depreciation on the equipment and vehicles is to be charges at 20% p.a. on the book
value.
£ £
Capital accounts Jim 30,000
Ken 15,000
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Current accounts Jim 7,800
Ken 7,100
Len 1,800
Land and buildings 18,000
Equipment and vehicles 21,000
Inventory 9,200
Gross profit 42,000
Trading expenses 15,000
Managers salary 4,000
Managers bonus 1,050
Accounts receivables & Payables 4,850 3,100
Premium on survivorship policy 1,000
Bank balance 2,900
91,900 91,900
Required:
(a) Prepare the profit and loss account and the partner’s capital and current accounts for the year
ended 31 December 19-7 and a balance sheet as at that date.
Solution
Capital account
JIM KEN LEN JIM KEN LEN
Goodwill written 6,000 6,000 3,000 Bal b/d 30,00 15,00 -
off 0 0
Current a/c –
capital - - 15,00
0
Goodwill 7,500 7,500 -
Current a/c –
goodwill - - 3,000
Bal c/d 35,100 20,10 1,500 Revaluation gain 3,60 3,60 -
0 0 0
41,100 26,10 4,500 41,10 26,10 4,500
0 0 0
Current account
JIM KEN LEN JIM KEN LEN
Balance b/d 7,800 7,100 - Balance b/d 30,00 15,00 -
0 0
Capital a/c – - - 1,500 Accrued bonus - - 1,500
capital
Capital a/c- - - 3,000 Interest on 7,500 7,500 -
goodwill capital
Balance c/d 200 Profit share - - 3,000
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Balance c/d 3,600 3,600 -
8,000 7,100 4,500 8,000 7,100 4,500
Revaluation account
Equipment and vehicles 3,200 Land and building 10,400

Capital account – JIM 3,600
KEN 3,600 7,200
10,400 10,400
Jim, Ken and Len

Partnership, Profit and Loss and Appropriation account
For the year ended 31 December 19-7
1st 8 months 2nd 4 months TOTAL
£ £ £ £ £ £
Gross profit 28,000 14,000 42,000
Expenses
Depreciation on equipment &
vehicles 2,800 1,000 3,800
Trading expenses 10,000 5,000 15,000
Managers’ salary 4,000 - 4,000
Manager bonus 1,400 - 1,400
Premium on survivorship - (18,200 1,000 (7,000 1,000 (25,20
policy ) ) 0)
NET PROFIT 9,800 7,000 16,800
Less: Interest on capital J 1,600 936 2,536
K 800 536 1,336
L - (2,400) - (1,472 - (3,872)
)
Balance of profits share in PSR 7,400 5,528 12,928
J 3,700 1,764 5,464
K 3,700 1,764 5,464
L - (7,400) 2,000 (5,528 2,000 (12,92
) 8)
Jim, Ken and Len Partnership

Balance Sheet as at 31 December 19-7
Cost Depreciation to Net book
revaluation date value
NON-CURRENT ASSETS
Land and buildings 28,400 - 28,400
Equipment and vehicles 15,000 (1,000) 14,000
43,400 (1,000) 42,400
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Life policy asset account 1,000
43,400
CURRENT ASSETS
Inventory 9,200
Account receivables 4,850
Bank 2,900
16,950
CURRENT LIABILITIES
Trade payables (3,100)
Net current assets 13,850
57,250
FINANCED BY:
Capital: J 35,100
K 20,100
L 1,500
56,700
Current account J 200
K (300)
L (350) (450)
Life policy fund account 1,000
57,250
1.5 Dissolutions
A partnership may be dissolved due to various reasons which include:
Poor trading that has led to losses

A partner dying or leaving the firm
The time period for which the partnership was formed has elapsed.
The main objective of accounting for dissolutions is to ensure that the dissolution transactions
are recorded properly. These transactions involve;
Selling the assets of the business and thereafter paying off dissolution expenses and liabilities of
the partnership. The remaining costs are now paid off to the partners.
In the process of selling off the assets, the assets may be sold off at a profit or loss this profit or
loss is supposed to be shared by the partners according to the profit sharing ratio before the final
payments are made to them.
To facilitate the process of dissolution, a new account called realization account in which the
assets being sold are transferred and the cash proceeds received on the sale of the assets.
Generally, the realization account is supposed to record all profits or losses in return to
dissolution and therefore dissolution expenses will also be posted here discounts received from
creditors, and also discounts allowed to debtors.
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The balance on the realization account is the profit or loss on dissolution that is closed off to the
capital accounts.
The following journal entries are relevant for the purpose of recording all dissolutions:
DR. Revaluation account

CR. Asset account
(With the book value of the assets being sold / or being realized)
DR. Cash book

CR. Realisation account
(With the cash received on the assets being realized)
DR. Realisation account
CR. Cash book
(With the dissolution expenses paid)
DR. Creditors account payables

CR. Cash book
(With payment made to the creditors)
DR. Creditors
CR. Realization account
(With the discount received from account payable or creditors)
Dr. Realization account

CR. Capital accounts
(With the profit on realization being the balancing figure and according to PSR)
Incase it is a loss, then the entries are received.
DR. Current account

CR. Capital accounts
(To transfer the accounts due to the partners on their current accounts to the capital account)
DR Capital accounts
CR. Cash book
(To close off the capital accounts with the cash book)
There are two situations that need to be considered under dissolutions. These are:-
Where the assets are sold at once (one single transaction)

Assets are sold on piece meal basis.
Where assets are sold off at once
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Under this situation, the partners are able to get a single buyer who buys al the assets in a single
transaction. The buyer could be an individual, sole trader, another partnership or a company. this
kind of situation is straightforward because the partners can be able to determine profit or loss on
dissolution immediately.
Example:
X, Y and Z have been trading as partners sharing profits and losses in the ratio of 2:2:1 on the 1 st
July 2005, they decided to dissolve the partnership and all the assets were sold in a single
transaction in the market. The balance sheet as at 1s July 2005 was as follows:
X, Y and Z
Balance Sheet as at 1.7.2005
£ £
NON-CURRENT ASSETS
Freehold property 60,000
Equipment 30,000
90,000
CURRENT ASSETS
Inventory 16,000
Account receivables 9,000
Cash at bank 4,200
29,200
CURRENT LIABILITIES
Account payables (6,000)
NET ASSETS 113,200
FIANCNED BY:
Capital accounts X 78,000
Y 26,000
Z 4,000
108,000
Current accounts X 1,400

Y (600)
Z 400 1,200
109,200
NON-CURRENT LIABILITIES
Loan from bank 3,000
Loan from Y 1,000 4,000
113,200
The current assets sold on the market fetched the following assets:
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Freehold property 62,000
Equipment 9,600
Inventory 5,800
The receivables paid their amounts in full while payables gave discounts of £200. The
dissolution amounts to £1600.
Required:
Prepare the relevant accounts to record the dissolution.
Solution
Realization account
£ £
Freehold property 60,000 Cash book equipment 9,600
Equipment 30,000 Property 6,200
Inventory 16,000 Inventory 8,800
Debtors 9,000 Debtors 9,000
Cash book dissolution 1,600 A/c payables discounts 200
expenditure
Loss on dissolution X 12,000
Y 12,000
______ Z 6,000
116,60 116,600
0
Cash book account

£ £
Balance b/d 4,200 Realizable dissolution 1,600
expense
Realisation – equipment 9,600 Accounts payables 5,800
Freehold property 62,000 Loan from bank 3,000
Inventory 5,800 Loan from Y 7,000
Accounts receivables 9,000 Capital X 67,400
Capital account Z 1,600 Y 13,400
92,200 92,200
Capital account
X Y Z X Y Z
£ £ £ £ £ £
Realisation account 12,00 12,00 6,00 Bal b/d 78,00 26,00 4,00
– loss 0 0 0 0 0 0
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Current account - 600 - Current account 1,400 - 400
Cash book (bal. Fig) 67,40 13,40 ____ Cash book (Bal. ____ ____ 1,60
0 0 _ Fig) _ _ 0
79,40 26,00 6,00 79,40 26,00 6,00
0 0 0 0 0 0
In the current example, we have assumed that partner Z is solvent and therefore he is in a
position to bring in the cash required from him so that full distribution is made to the other
partners.
However, in certain situations, a partner/some partners may not be able contribute the additional
cash required and thus they are said to be insolvent.
According to the rule in Gurner V. Murray, if some of the partners are insolvent, then their loss
appearing in the capital balances should be bourne by the solvent partners according to the initial
capital balances (and NOT their Profit Sharing Ratio)
In the given example therefore, if we assume that Z is insolvent, and will therefore not be in a
position to contribute the £1,600 due from him, then it will be shared between X and Y in the ratio
of 78,000:26,000.
Capital account
X Y Z X Y Z
£ £ £ £ £ £
Realisation account 12,00 12,00 6,00 Bal b/d 78,00 26,00 4,00
– loss 0 0 0 0 0 0
Current account - 600 Current account 1,400 - 400
Contra - Z 1,200 400 1,20
X 0
Cash book 66,20 13,00 - ____ ____ 40
0 0 Y _ _ 0
79,40 26,00 6,00 79,40 26,00 6,00
0 0 0 0 0 0
These balances transferred to the cash book shall change i.e. be different from the previous one.
If the rule in Guvner V. Murray in excluded as per requirements of the examiner, then the loss or
balance due from the insolvent partner will be shared by the remaining solvent partners according to
the profit sharing ratio.
In the given example, therefore, if the rule in Guvner V. Murray was excluded, then the loss of
£1,600 due from Z would be shared in the ratio of 2:2 by X and Y i.e. £800 and £800.
19
The partners may sell off the assets of the partnership to a company and instead of being paid by
cash the purchase consideration may be made up of shares or loan stock. The purchase
consideration may have a combination of several items i.e. shares (ordinary and preference), loan
stock and balance inform of cash.
The determination of profit or loss on Realisation ill be done the same way as before an instead of
only the cash being credited in the Realisation account, we may also have the shares and loan stock
issued to the partners.
A separate account may be opened for the ordinary shares and the loan stock issued and the
following entry will be passed.
DR. Loan stock or shares

CR. Realisation account
(With the value of the shares and the loan stock issue)
once we determine how much is due to the partners, then the shares and the ban stock account will
be closed off as follows:
DR. Capital accounts

CR. Shares or loan stock accounts
(With the amounts due to each of the partners)
In most cases, the shares and loan stock may be issued to the partners according to some agreed
ratio and any balances remaining in the partners capital accounts will be settled by way of cash.
Example
Amis, Lodge and Pym were in partnership sharing profits and losses in the ratio 5:3:2. The
following trial balance has been extracted from their books of account as at 31st March 19-8:
£ £
Bank interest received 750
Capital accounts (as at 1 April 19-7)
Amis 80,000
Lodge 15,000
Pym 5,000
Carriage inwards 4,000
Cash at Bank 4,900
Current accounts
Amis 1,000
Lodge 500
20
Pym 400
Discounts allowed 10,000
Discounts received 4,530
Drawings:
Amis 25,000
Lodge 22,000
Pym 15,000
Motor vehicles
at cost 80,000
Accumulated depreciation (at 1 April 19-70 20,000
Office expenses 30,400
Plant and machinery
At cost 100,000
Accumulated depreciation (at 1 April 19-7) 36,600
Provision for bad debts
(at 1 April 19-7) 420
Purchases 225,000
Rent, rates, heat and light 8,800
Sales 404,500
Inventory (at1 April 19-7) 30,000
Trade payables 16,500
Trade receivables 14,300 _______
£583,300 £583,300
Inventory as at 31 March 19-8 was valued at £5,000;
Depreciation is to be charged as follows:

Motor vehicles- 25% on the reduced balance
Plant and machinery -20% on the original cost
There were no purchases or sales of property, plant and equipment during the year to 31 March
19-8.
The provision for bad and doubtful debts is to be maintained at a level equivalent to 5% of the
total trade debtors as at 31 March 19-8
An office expense of £405 owed at 31st March 19-8, and some rent amounting to £1,500 had
been paid in advance as at that date. These items had not been included in the list of balances
shown in the trial balance.
Interest on drawings and on the debit balance on each partner’s current account is to be charged a
follows:
21
£
Amis 1,000
Lodge 900
Pym 720
According to the partnership agreement, Pym is allowed a salary of £13,000 per annum. This
amount owed to Pym for the year to 31 March 19-8, and needs to be accounted for.
The partnership agreement also allows each partner interest on his capital account at a rate of
10% per annum. There were no movements on the respective partners accounts during the year
to 31 March 19-8, and the interest had not been credited to them about that date.
Note: The information given above is sufficient to answer part a) i) and ii) of the question, and
notes 8) and 9) below are pertinent to requirements b) i) and ii) of the question.
On 1 April 19-8 Fowles Limited agreed to purchase the business on the following terms:
Amis to purchase one of the partnership’s motor vehicles at an agreed value of £30,000:
The company agreed to purchase the plant and machinery at a value of £ 35,000 and the stock at
a value of £ 38,500;
The partners to settle the trade payables; the total amount agreed with the creditors being
£16,000;
The trade receivables were not to be taken over by the company, the partners receiving cheques
on 1 April 19-8 amounting to £12,985 in total from the trade debtors in settlement of the
outstanding debts;
The partners paid the outstanding office expenses on 1 April 19-8, and the landlord returned the
rent paid in advance by cheque on the same day;
As consideration for the sale of the partnership, the partners were to be paid £63,500 in cash by
Fowles Limited, and to receive 75,000 in £1 ordinary shares in the company, the shares to be
apportioned equally amongst the partners;
Assume that all the matters relating to the dissolution of the partnership and its sale to the
company took place on 1 April 19-8.
Required
Prepare:
22
Amis, Lodges and Pym’s trading, profit and loss appropriations account for the year to 31 March
19-8;
And
Ami’s, Lodge’s and Pym’s current accounts ( In Columna format) for the year to 31 March 19-8
( the final balance on each account is to be then transferred to each partner’s respective capital
account
And
Compile the following accounts:
The partnership realization account for the period up to and including 1 April 19-8;
The partner’s bank account for the period up to and including 1 April 19-8;
and
The partner’s Capital accounts (in column format) for the period up to and including 1 April 19-
8.
Solution
Amis, Lodge and Payne

Trading, Profit and Loss account
£ £ £
Sales 404,500
Cost of sales
Opening stock 30,000
Purchases 225,000
Add carriage in 4,000 229,000
259,000
Closing stock (5,000) (254,000)
Gross profit 150,500
Bank interest received 750
Discount received 4,350 5,280
155,780
Expenses
Increase in provision for bad debts 295
Discount allowed 10,000
Depreciation on plant 20,000
Depreciation on motor vehicles 15,000
Office expenses 30,400
Add accrued 405 30805
Rent, rates, light and heating 8,800
Less prepaid (1,500) 7,300 95,400
NET PROFIT 60,380
23
ADD: Interest on drawings: Amis 1,000
Lodge 900
Payne 720 2,620
63,000
Less Interest on capital: Amis 8,000

Lodge 1,500
Payne 500 (10,000)
53,000
Salaries to Payne (13,000)
Profit shared in PSR 40,000
Amis 20,000
Lodge 12,000
Payne 8,000 (40,000)
-
Amis, Lodger and Payne

Balance Sheet as at 1st April 19-8
COST DEPRECIATION NET BOOK
VALUE
NON-CURENT ASSETS
£ £ £
Property and plant 100,000 (56,600) 43,400
Motor vehicles 80,000 (35,000) 45,000
180,000 91,600) 88,400
CURRENT ASSETS
Inventory 5,000
Receivables 14,300
Less provision for bad debts (715) 13,585
Prepayments 1,500
Cash at bank 4,900
24,985
CURRENT LIABILTIES
Payables 16,500
Accruals 405 (16,905)
24
NET ASSETS 96,480
FINANCED BY
Capital accounts: Amis 80,000
Lodge 15,000
Payne 5,000
100,000
Current accounts: Amis 3,000
Lodge (1,900)
Payne 5,380 (3,520)
96,480
Current account
Amis Lodg Payne Amis Lodg Payn
e e e
£ £ £ £ £ £
Balance b/d 1,000 500 400 Interest on 8,000 1,500 500
capital
Drawings 25,00 22,00 15,000 Salary 13,0
0 0 00
Interest on drawings 1,000 900 720 Profit share 20,00 12,00 8,00
0 0 0
Balance c/d 1,00 ____ 5,380 Balance c/d ____ 9,9 ____
0 _ _ 00 _
28,00 23,40 21,500 28,00 23,40 21,5
0 0 0 0 00
Cash book account

£ £
Balance b/d 4,900 Creditors 16,000
Realisation account dep 12,985 Accrued expenses 405
Realisation account prep 1,500 Capital accounts A 63,500
Realisation from company 63,500 L 2,600
P 380
82,885 82,885
Realization account
£ £
Plant and equipment 43,400 Capital account – A 30,000
Motor vehicle 45,000 Creditors discount 500
Inventory 5,000 Cash book account – received 12,985
Debtors 13,585 Cash book prepayment 1,500
Prepayments 1,500 Cash book 63,500
Capital accounts Ordinary shares 75,000
Profit share A 375,000
25
L 225,000
P 15,000 ______
183,485 183,485
Capital account
Amis Lodg Payne Amis Lodg Payn
e e e
£ £ £ £ £ £
Realization 36,000 - - Balance b/d 80,000 15,00 5,00
0 0
Current accounts - 9,900 - Realisation 37,500 22,50 15,0
a/c 0 00
Ordinary share 25,000 25,00 25,000 Current a/c 1,000 - 5,38
0 0
Cash book 63,50 2,60 380 _____ ____ ____
0 0 _ _ _
118,50 37,50 25,380 118,50 37,50 25,3
0 0 0 0 80
Ordinary share capital account

£ £
Realization 75,000 Capital account A 25,000
L 25,000
_____ M 25,000
75,000 75,000
Piecemeal Realizations and Distributions

Partnership dissolutions may take a substantial number of days 9even months) so it is unlikely that
all cash generated will be simultaneous, unless the business is sold off as a going concern, i.e. a
single unit.
The partners may not be willing to wait for such long durations for the process to be complete
before receiving their repayments of capital.
It is therefore common practice to make interim distributions to partners as soon as a reasonable

amount of cash is available. However, all liabilities must have been paid off by the time any
distribution is made to a partner.
These interim distributions give rise to two problems:

Partners have not always contributed capitals in the same ratio as that in which they share profits;
There will always be uncertainty of future realizations
26
These two problems point in the same direction: how does one pa cash to partners in such
amounts that the partner will never be asked to return any at a later date as excess?
The distribution has to be made in such a way each partner only receives cash after considering
all possible gains and losses attributable to that partner at that stage. Two methods have been
developed to accomplish this;
The maximum possible loss method
The surplus capital method
The maximum possible loss method

Under this method, a table is set up to compute the amounts payable to each partner. The results of
the computation may be then posted into the capital and other relevant accounts. The computation
works on the basis that capital accounts take the following form:
Capitals
Sh Sh Sh Sh
Cashbook X X Bal b/d X X
Realisation loss X X
XX XX XX XX
Therefore: Capital – Cash = Realisation Loss
OR
Capital – Realisation Loss = Cash to be paid.
The table takes the following form: [Assume 3 partners A, B and C].
Schedule of distribution
Total A B C Distributio
n
Capitals X X X X
Available cash (X)
Maximum possible X (X) (X) (X)
loss
XX XX XX XX
In the initial stages, the cash received may be little, and this may result in a large ‘Maximum
possible loss’. When this is divided amongst partners in profit sharing ration and deducted from
capitals, the resultant figure is negative (same as a debit in the capital account – see illustrations 6 &
7). Assuming a maximum possible loss situation, the partner with a negative figure will be deemed
bankrupt, and the negative figure uncollectible. This will be divided amongst the other partners in
profit sharing ratio or the ratio in which capitals are held. It will depend upon whether the ruing in
Garner Vs Murray is to be excluded or applied. Whichever the case, the table will now take the
following form:
27
Schedule of distribution
Total A B C Distributio
n
Capitals X X X X
Available cash (X)
Maximum possible X (X) (X) (X)
loss
X X (X)
XX XX XX XX
It is important to realize that the loss in the table is not real; it will only become real if no further
cash is collected. The loss is only for the cash collected this far.
1.6 Amalgamations
Two sole traders and a partnership, two or more partnerships or a sole trader and other partnerships
may combine or join together to forma a single partnership.
The benefit of amalgamation includes:
An expansion of the capital base

Wider pool of experts
In accounting, for amalgamation, the process involves closing off the books of the individual
partnerships or businesses and preparing the opening balance sheet of the newly combined
business. The process of closing the books of individual businesses follows the same procedure
as that of dissolutions but instead of assets being sold, they are being taken over in the new
business.
Therefore a realization account is opened whereby the book values of the assets are debited and
newly agreed values are credited. The balance of the realization account represents a profit or
loss on amalgamation which is closed off to the capital accounts according to the old profit
sharing ratio.
The capital required by each partner in the new business should be balance carried down (c/d) in
the partners capital accounts. The balancing figures it the capital accounts will be the cash that
will be either paid out or introduced by a partner.
The remaining cash in an individual business will now be transferred to the newly combined
business.
Example
On the 1st January 19-8 the partners of Gee and Co and Bee & Co agreed to amalgamate their
business. The new firm is to be called Beegee & Co. The initial capital of £18,000 is to be
shared as to one half share to the individual partners of Bee & Co.
28
The division of the one half share to the individual partners is to be in the ratio of their capital in
the former partnerships. Any adjustments in the old partnerships are to be made personally
between the partners. The balance sheets on 31st December 19-7 showed the following.
Gee & Co Bee &Co

£ £ £ £
Capital Accounts
Alan 4,000 Desmond 4,000
Brian 3,000 Ernest 2,000
Colin 2,000 ____
9,000 6,000
Current Accounts
Alan 800 Desmond 1,350
Brian 620 Ernest 1,250
Colin 180 ____
1,600 2,600
900 1,100
11,500 9,700
Non Current assets
Goodwill 1,500 1,750
Fixtures & Fittings 1,250 1,000
2,750 2,750
Current Assets
Receivables 7,000 6,000
Work in progress 900 750
Cash 850 200
8,750 6,950
11,5000 9,700
For the purposes of the amalgamation it was agreed as follows:
Goodwill in the new firm is to be £4,000.

Fixtures and fittings are to be taken over from Gee & Co at a value of £600 from Bee & CO at a
value of £500.
Receivables are to be taken over at the amounts shown in the old firms’ balance sheets on 31st
December 19-7 less a discount of 5%. Work in progress is to be valued at 10% of the net debtors
taken over. Responsibility for the creditors of both firms is to be assumed by the new firm.
The balance required for the initial capital is to be provided in cash.
All partners in the new firm are to receive a salary at the rate of £4,000 per annum, interest on
capital at 8% per annum, and share in the balance of profits/losses in proportion to their capital in
the firm. No interest is to be given on current accounts.
The only drawings by each partner against his share of the profits were monthly payments of
£300 and an additional payment equal to 5% of his capital at the end of each quarter.
29
On 1st October 19-8 Desmond was killed in a motor accident. A repayment of capital amounting
to £1,000 was made immediately to his estate but no further payments were made in 10-8.
Interest on the outstanding capital account was agreed at 10% per annum but this should be
based on the initial capital less the amount paid. No adjustments were made to the remaining
partners’ capital accounts and the profit sharing ratios between the individual partners did not
change.
Profits for the year ended 31st December 19-8 amounted to £37,472 before charging interest on
amounts due to Desmond.
You will be required to prepare:
The initial balance sheet of Beegee &Co immediately after the amalgamation, and
Partners’ current accounts in columnar form for the year ended 31st December 19-8.
Solution
(a)
Even though the question does not require the books of the old firms to be closed this can be
done done by preparing the realization account, the capital accounts and the cashbook of the
firms before preparing the opening balance sheet.
Realization a/c
Gee & Co Bee &Co Gee & Co Bee &Co
£. £. £. £.
Goodwill 1500 1750 To new firm
Fix.& fittings 1250 1000 Goodwill 2000 2000
Receivables 7000 6000 Fix & Fitti 600 500
Workin 900 750 Receivables 6650 5700
progress
WIP 665 570
Loss to Cap
Alan - 4 327
Brian - 3 245
Colin - 2 163
Desmond - 487
4
_____ ____ Ernest - _____ 243
2
10650 9500 10650 9500
Capital Accounts (this will be presented in columnar form)
Alan Brian Colin Desmond Ernest

Credits £ £ £ £ £
Balance b/f 4000 3000 2000 4000 2000
30
Current accounts 800 620 180 1350 1250
Cash brought in by paertner (bal fig) 1137
Total for credits 4800 3620 2180 6487 3250
Debits
Loss on Realization 327 245 163 487 243
Cash paid out to the partner (bal fig) 473 375 17 7
Total for debits 800 620 180 487 250
Balance carried down to the new 4000 3000 2000 6000 3000
business
Cashbook
Gee & Co Bee &Co Gee & Co Bee &Co
£. £. £. £.
Balance b/f 850 200 Capital
Capital- 1137 Alan 473
Desmond
Brian 375
Colin 17
Ernest 7
To new firm 15 To new firm 1330
10650 9500 10650 9500
Beegee & Co.

Balance sheet as at 1 January 19-8
Non Current assets £ £
Fixtures and fittings (600+500) 1,100
Goodwill 4,000
5,100
Current assets
Receivables (7000+6000 less provision at 5%) 12350
Work in progress (at 10% of receivables) 1235
Cash (1330-15) 1,315
14,900
Current liabilties
Payables (2000) 12,900
18,000
Capital Accounts: Alan 4000
Brian 3000
Colin 2000
Desmond 6000
Ernest 3000
18,000
31
(b) To prepare the current account we will need to prepare the appropriation account to account
for the distribution of profits before and after Desmonsd Death.
The profits will be split based on months such that for the first nine months it is £28,104
(9/12X28,104) and for the last three months £9,368 (3/12X 37472). But please not that Desmond
is entitled to interst at 10%during the last three months based on the initial capital less the
amount paid. Therefore we will deduct this interest from the profits of the last three months. The
amount deducted is (10% X (6000- 1000))X 3/12) = 125. Therefore the profits for the last three
months will be £ 9,368 – £128 =£ 9,243.
Profit and loss appropriation account 1st nine months

2nd 3moths Total
£ £ £ £ £ £
Net profit 28,104 9243 37347
Less Interest on Capital
Alan 240 80 320
Brian 180 60 240
Colin 120 40 160
Desmond 360 360
Ernest 180 (1080) 60 (240) 240 (1320)
27024 9003 36,027
Salaries
Alan 3000 1000 4000
Brian 3000 1000 4000
Colin 3000 1000 4000
Desmond 3000 3000
Ernest 3000 (15,000) 1000 (4000) 4000 (19000
)
12024 5003 17027
Share of profits
Alan 2672 1667 4339
Brian 2004 1251 3255
Colin 1336 834 2170
Desmond 4008 4008
Ernest 2004 (12024) 1251 (5003) 3255 (17027
)
32
Current accounts (this will be presented in columnar form)
Alan Brian Colin Desmond Ernest

Credits £ £ £ £ £
Interest on Capital 320 240 160 360 240
Salaries 4000 4000 4000 3000 4000
Profits 4339 3255 2170 4008 3255
Total for credits 8659 7495 6330 7368 7495
Debits
Drawings: Normal (30 September) 2700 2700 2700 2700 2700
(9 X 300)
Extra ( 5% X Capital X 600 450 300 900 450
3 quarters)
Drawings : normal (31 December ) 900 900 900 900
(3 X 300)
Extra (5% X Capital X 200 150 100 150
1 Quarter)
To the Executors 3768
Total for debits 4400 4200 4000 4200
Balance carried down to the 4259 3295 2330 3295
balance sheet (CR)
1.7 Conversion into a Company
The partners may convert their business and trade in form of a company. this may be due to
some of the advantages a company has over a partnership. E.g. Limited liability of members and
the number of members of a company can be more than twenty with an exception to professional
firms.
The objective of accounting for conversions is to ensure that nay profit or loss on conversion is
reported and shared between the partners and the opening position of the company is ascertained.
The procedure therefore involves closing off the books of the partnership and preparing the opening
balance sheet of the company. A realization account thus used to facilitate the process and the
balance on the realization account is the profit or loss on conversion which is closed off to the
partners capital accounts.
The book values of the assets being taken over by the company will be posted to the debit side
and the liabilities will be posted to the credit side. The purchase consideration paid by the
company to the partners will be posted on the credit side of the realization account. If the
expenses of formation are to be borne of the partners or the partnership, then this will be posted
to the debit side of the realization account.
33
If the conversion takes place partway during the year, then it is important to update the partners
capital and current accounts before closing off the books of the partnership. This means that the
trading profit and loss account for the year should be split between the two periods i.e. when the
business was run as a partnership and when the business was run as a company.
The trading profit and loss account relating to the partnership period will include the profit and
loss appropriation account showing how profits have been shared between the partners.
The trading profit and loss account for the company will also have the profit and loss
appropriation but this time it will only be for dividends and retained profits that will be taken to
the balance sheet.
The amounts due to the partners according to the balances in their capital accounts after making
adjustments for profit or loss on conversion will be satisfied by payments made from the
company in form of shares (ordinary or preference) and loan stock. The shares and loan stock
will be shared between partners according to the some agreed ratio and the balance may be by
way of paying or being paid cash.
However different approaches may also be use to close off the books of the partnership and
preparing the opening balance sheet of the company.
Revision questions
1 Emojong, Barmoi and Kimani have been partners sharing profits and losses in the ratios 2:2:1.
Accounts have been prepared on an annual basis to 31 December of each year Emojong the only
active partner, died on 31 May 2002 and the remaining partners decided to cease business from
that date. The assets are to be realized, outstanding debts paid and the remainder to be shared by
the partners (including the executors of Emojong’s estate) in an equitable manner, distributions
of cash being made as soon as possible.
A balance sheet prepared as at 31 May 2002 revealed the following position:

Emojong, Barmoi and Kimani
Balance Sheet as at 31 May 2002
Cost Accumulated Net Book
Sh.‘000 Depreciation Value
’ Sh.‘000’ Sh.‘000’
Non Current assets
Goodwill 12,500 - 12,500
Freehold land and buildings 18,750 - 18,750
Plant and machinery 16,625 6,975 9,650
Fixtures and fittings 3,750 1,625 2,125
Motor vehicles 4,000 3,000 1,000
55,625 11,600 44,025
Current assets:
34
Stock 8,000
Debtors 8,125
Less: provision for doubtful debts 750 7,375
Cash 20
15,395
Current liabilities:
Creditors
Bank overdraft 7,125 23,170 (7,775)
16,045 36,250
Financed by:
Capital income:
Emojong 12,500
Barmoi 7,500
Kimani 5,000
25,000
Current accounts:
Emojong 5,000
Barmoi 3,750 8,750
33,750
2,500
Long term liabilities: 36,250
Loan – Emojong
Premiums have been paid on life assurance policies for each partner to provide the firm with
cash on death. The premiums have been charged to insurance expense and the cash payable on
death of any partner is Sh.5,000,000.
The assets were duly sold and the monies received as follows:
Sh.
‘000’
14 June 2002 Life policy on Emojong’s life 5,000
Life policy on the lives of Barmoi and
Kimani surrendered 2,500
16 July 2002 Freehold land and buildings 25,000
Debtors (part) 3,750
Stock (part) 2,500
20 August 2002 Plant and machinery 6,375
Fixtures and fittings 1,500
Motor vehicles 625
15 October 2002 Stock (Remainders) 4,500
Debtors (Remainders) 5,250
Provision was to be made for dissolution expenses of Sh.300,000.
35
As soon as sufficient money was available to pay all outstanding creditors, this was done,
discounts being received amounting to Sh.125,000.
Dissolution expenses amounted to Sh.250,000 and this was paid on 31 October 2002.
Required:
Statement showing how the proceeds of the dissolution would be shared between the partners
(12 marks)
Realisation account (5 marks)
Capital accounts 3 marks)
(Total: 20 marks)
2Three firms of accounts decided to amalgamate into a new firm Cheloti Gusera Kandie & Co.
with effect from 1 April 1999. Until 31 March 1999 Apopo. Cheloti and Chuma were partners in
Apopo Cheloti & Co. sharing capital and profits equally. Guserwa. Kurgat and Ochieng were
partners in Guserwa & Co. sharing capital and profits in the ratio 4:4:1. Kandie was a sole
practitioner.
The balance sheets of the firms as at 31 March 1999 were as follows:
Apopo Cheloti & Guserwa & Co. Kandie

Co.
Sh. ‘000’ Sh. Sh.‘000’ Sh. ‘000’ Sh.
‘000’ 420 ‘000’
Fixed assets: Office 450 1,065 150
equipment 1,500 1,485 240
Intangible assets: Goodwill 1,950 1,050 390
1,800 2,625 240
Current assets: Work-in- 5,250 300 225
progress 750 3,975 165
Debtors 7,800 5,460 630
Cash 9,750 1,020
36
Capital accounts 8,550 4,05 900
Current accounts: Apopo 270 Guserwa 600 0
Cheloti 360 Kurgat 390
Chuma 120 750 Ochieng 60
Creditors 450 1,05 120
9,750 0 1,020
36
0
5,46
0
The terms of amalgamation were as follows:
Apopo retired on 31 March 1999.
The capital of the new firm Cheloti Guserwa Kandie & Co. was to be Sh.15 million and profit
sharing ratios and capital contributions were to be Cheloti 30%, Chuma 30%, Guserwa 15%,
Kurgat 15%, Ochieng 5% and Kandie 5%.
In the opening balance sheet of the new firm, office equipment was to be bought at the old book
values except for that from Apopo Cheloti and Co. where the value was agreed at Sh.300,000.
Work-in-progress was agreed at book value and goodwill for three firms at Sh.3 million.
Debtors were taken in at book values less 20% discount. Creditors were paid by the old practices.
Apopo and Kandie took any cash remaining in their old practices and Guserwa contributed the
necessary cash in his old practice. The total goodwill acquired from old partnerships was in the
ratio in which they share profits in the new.
Partners introduced their balances of capital in cash
A salary of Sh.600,000 per annum per partner was given the new partnership. Drawings of
Sh.45,000 per month per partner were allowed: at the end of each half year, partners were
allowed to draw Sh.30,000 for each 2½ % share of the partnership profit attributable to that
partner.
On 1 October 1999, it was agreed to take Maina into the partnership on similar terms as to salary
and drawings, with a 2½ % share. The capital and profit sharing ratios were altered to Cheloti
22½ %, Chuma 22½ %, Guserwa 20%, Kurgat 20%, Ochieng 5% and Kandie 7 ½%. Kandie and
Maina could only bring in two thirds of what was required. It was agreed that the remaining one
third should remain in a debit in their current accounts to be cleared against future profits.
Cheloti and Chuma withdrew equally the cash capital introduced on 1 October 1999 by Guserwa,
Kurgat, Kandie and Maina.
The profit of the partnership for the year ended 31 March 2000, after deducting partners’ salaries
was Sh.4,800,000: this profit was deemed to have accrued evenly over the year as opposed to
total profit. The partners made all allowable drawings in full.
Required:
The opening journal entries of Cheloti Guserwa Kandie and Co. (7 marks)
The capital and current accounts of each partner (in columnar form)
In the old practices, so as to indicate the resultant indebtedness between the partners: (8
marks)
In the new practice, so as to indicate the balances on 1 April 1999 and 31 March 2000.(10 marks)
37
UNIT TWO: ROYALTIES, CONTAINERS, CONSIGNMENT ACCOUNTS
2.0 Objectives
At the end of this lesson, you should be able to:
Ascertain when a royalty payment is due and payable and how much is payable.
Carry out the necessary accounting for transactions in returnable containers charged out to
customers, reconcile the stock of returnable containers, and ascertain the value of stock of
containers.
Prepare the records of the consignor and consignee in respect of a consignment of goods and to
ascertain the profit made on each consignment. You should understand the relationship between
the consignor and the consignee. You should be able to ascertain the value of goods on
consignment. Write up the Joint venture accounts under the two common methods:
2.1 Royalty Accounts

Royalties:
Royalty is a periodical payment based on output or sales to the owner of an asset or author
of a book or other such person with rights vested in him. The person who makes the payment
to the owner of the asset in exchange for the right to use the asset is known as the lessee, whereas
the owner of the asset – to whom the payment is made, is called the landlord.
Thus, the lessee of the mine pays royalty to the owner of the mine; or by the manufacturer to the
patentee; or by the publisher of a book to the author of such a book.
Important types of royalties are:

Mining royalties: Where a tenant of land has right to mine for minerals, but has to pay a rental
to the landlord – based on output;
Patent royalties: Where the manufacturer of an article has to pay the inventor of such an article
royalties;
Copyright royalties: Where payments are made by the producer and publisher of music and
books to the author and artists respectively.
Accounting for royalties: books of tenant

On a basic level, royalties are payable at a fixed amount per unit of output or sales.
When amount becomes payable to landlord:
Debit Royalties XX
Credit Landlord A/C XX
When amount is actually paid to landlord

Debit Landlord A/C XX
Credit Cash book XX
At the end of the financial year
38
Debit Manufacturing/TradingXX
Credit Royalties XX
Illustration 1
Makaa Ltd took from Misitu Ltd a lease of a coalfield for a period of 10 years commencing 1
April 1998 on a royalty of Sh.2,500 per tonne of coal extracted. The output in the first three
years of the lease was:
Year 1:200 Tonnes

Year 2:360 Tonnes
Year 3:900 Tonnes
Requred:
Show the entries relating to royalties in the books of Makaa Ltd.
Solution:
Royalties payable
1998/99 1998/99
Sh. Sh.
31 March Landlord (1) 31 March Manufacturing (3)
500,000 500,000
1999/2000 1999/2000
Sh. Sh.
900,000 900,000
2000/2001 2000/2001
Sh. Sh.
2,250,000 2,250,000
Landlord A/C
1998/99 1998/99
Sh. Sh.
31 March Cash book (2) 31 March Royalties (1)
500,000 500,000
1999/2000 1999/2000
Sh. Sh.
900,000 900,000
2000/2001 2000/2001
Sh. Sh.
2,250,000 2,250,000
39
(Note the order in which entries are made in the accounts in accordance to the numbering
introductory journals)
Minimum Rent and Short workings

Royalty agreements usually contain a clause that the landlord must receive a minimum amount
irrespective of the production (output) or sales by the tenant in a particular period. Such a
minimum amount is known as minimum rent or dead rent or fixed rent.
If the tenant’s output results in a royalty payable that is lower than the minimum rent, the deficit
is known as short workings.
If in subsequent years, the tenant’s output increases and he surpasses the minimum rent, the
agreement may contain a clause that allows the tenant to recover some of his short workings
from royalties payable in subsequent years. The right of getting back what was paid by the
lessee in excess in previous years is known as the right of recoupment of shortworkings. The
right may be: restricted recoupment floating recoupment (unrestricted)
Restricted recoupment means that upon commencement of the agreement/contract, the right of
recoupment is only for a specified number of years; should shortworkings ever arise in years
after this, they can never be recouped. Under floating rights, the recoupment clause will allow
the tenant to recoup the shortworking in a couple of years after which the shortworkings will
arise. This is irrespective of the year in which shortworkings arose.
Shortworkings recoverable should be carried forward and shown in the balance sheet;
shortworkings not recoupable should be written off to the P&L as an expense.
Accounting entries in the books of the lessee when shortworkings are involved:
When royalties based on output fall below minimum rent:
Debit Royalties A/C – with amounts based on output XX
Debit Shortworkings A/C – with shortfall below minimum rent XX
Credit Landlord A/C – with minimum rent XX
When amounts due are paid to the landlord:

Credit Cash book XX
At the end of the financial year:

(a) Debit Manufacturing A/C/Trading A/C XX
Credit Royalties A/C XX
Carry the balances in the shortworkings A/C as an asset.
In future year, when royalties based on output exceed the minimum rent
Debit Royalties A/C – with amounts based on output XX
Credit Landlord A/C – with same amount XX
When amounts due are paid to the landlord

Credit Shortworkings A/C – with amounts saved XX
40
Credit Cashbook – with amounts paid out XX
At the end of the financial year:
(a) Debit Manufacturing/Trading XX
Credit Royalties A/C XX
Debit P&L with shortworkings written XX

Credit Shortworkings A/C off as irrecoupable XX
Carry down the balance in the shortworkings A/C for amounts still recoupable in future years.
Illustration 2 (Fixed recoupment)

Fingers Ltd leased a coal mine from Hand Ltd at a minimum rent of Sh.150,000 per annum on
which royalty fees was payable at Sh.10,000 per tonne. There was a stipulation that
shortworkings could only be recouped in the first three years of the lease.
The output in the first four years of the lease were 8 tonnes, 13 tonnes, 21 tonnes and 18 tonnes
respectively.
Requred: Show the entries to be made in the books of Finger Ltd in the first four years
assuming the lease commenced on 1 Jan. 1997.
Solution: It is good practice to commence with a table where calculations of amounts paid,
amounts recouped and amounts written off may be made.
Outpu Royalties S/work Surplu S/worki S/worki s/workin Paid to

Year t @ ing s ngs ngs gs Landlord
(tonne Sh10,000/ Recoupe Written C/F
s) T d off
1997 8 80,000 70,000 - - - 70,000 150,000
1998 13 130,000 20,000 - - - 90,000 150,000
1999 21 210,000 - 60,000 60,000 30,000 - 150,000
2000 18 180,000 - 30,000 - - 180,000
Notes: The shortworkings and surplus columns are completed by comparing the royalties with
the minimum rent.
The shortworkings recouped is the lower of:
shortworkings carried forward in the previous year;
Surpluses arising in the current year.
The amounts paid to landlord is decided by the following:

If royalties (column 3) is less than minimum rent, then minimum rent will be paid.
If royalties (column 3) is more than minimum rent, then amount to be paid shall be (royalties –
shortworkings recouped)
41
Royalties A/C
1997 1997
Sh. Sh.
31 Dec Landlord (1) 31 Dec Manufacturing (3)
80,000 80,000
1998 1998
Sh. Sh.
130,000 130,000
1999 1999
Sh. Sh.
210,000 210,000
2000 2000
Sh. Sh.
180,000 180,000
Landlord A/C
1997 1997
Sh. Sh.
31 Dec Royalties A/C (1)
31 Dec Cash book (2) 80,000
150,000 31 Dec Shortworkings (1)
70,000
150,000 150,000
1998 1998
Sh. Sh.
31 Dec Royalties (1)
31 Dec Cash book (2) 130,000
150,000 31 Dec Shortworkings (1)
20,000
150,000 150,000
1999 1999
Sh. Sh.
31 Dec Shortworkings (5) 31 Dec Royalties (4)
60,000 210,000
31 Dec Cash book (5)
150,000 .
210,000 210,000
2000 2000
Sh. Sh.
31 Dec Cash book (5) 31 Dec Royalties (4)
180,000 180,000
42
Shortworkings A/C
1997 1997
Sh. Sh.
31 Dec Landlord A/C (1) 31 Dec Balance c/d (3b)
70,000 70,000
1998 1998
Sh. Sh.
1 Jan Balance b/d (3b)
70,000 31 Dec Balance c/d (3b)
31 Dec Landlord (1) 90,000
20,000
90,000 90,000
1999 1999
Sh. Sh.
31 Dec Landlord (5)
1 Jan Balance b/d (3b) 60,000
90,000 31 Dec Royalties (6b)
30,000
90,000 90,000
Accounting entries to be made in the books of the lessor (landlord)

The landlord keeps 3 accounts in his books on dealings with the tenant:
Royalties receivable (income) A/C
Shortworkings allowable (Also called shortworkings suspense A/C)
Lessee A/C (Tenant A/C)
43
Accounting entries when royalties receivable fall below minimum rent
When amount of royalties receivable based on output
Dr Lessee (Tenant) X
Cr Royalties receivable X
Cr Shortworkings allowable X
When amount due from the tenant is actually collected

Dr Bank/Cash X
Cr Tenant A/C X
At the year end, when final accounts are prepared

Dr Royalties receivable X
Cr Profit and Loss X
Accounting entries when royalties receivable are more than minimum rent and shortworkings are
recouped by tenant
When amount of royalties receivable and shortworkings is
known DR Tenant X
Dr Shortworkings allowable X
Note: The above is a summary of the following entries
Dr Tenant X
Dr Shortworkings X
Cr Tenant X
When tenant pays up his dues (lower amount than the full
royalty due to offset of shortworkings)
Dr Bank X
Cr Tenant X
At the year end, when final accounts are prepared

Dr Royalties A/C X
Cr Profit and Loss X
Sub-lease (or sub-royalty)

Sometimes the terms of the original lease may empower the lessee to sublet the right or part of
the right to another person as a sub-lessee. In such a case the status of the original lessee will
become two-fold:
As a lessee paying royalties to the landlord;
As a sub-lessor receiving royalties from the sub-lessee.
44
As a lessee, he will maintain: (a) Royalties payable A/C
Shortworkings (recoupable) A/C
Landlord A/C
As a sub-lessor he will maintain a) Royalties receivable A/C
Shortworkings allowable A/C
Tenant A/C
The entries to be made in the books are the same as before except in the case of sub-lease,
production or sales by the sub-lessee under sublease will be considered to be production or sales
under the original lease; and royalties payable to the original landlord will be calculated based on
total production/sales by both the original lessee and sub-lessee.
It is important to note that the royalties payable to the overall landlord may or may not be
calculated on the same basis as royalties receivable from sub-tenant. For example, the royalties
payable to the overall landlord may be based on production (of course, both by the original
tenant and the sub-tenant) where as royalties receivable from the sub-tenant may be based on
sales by the sub-tenant.
45
UNIT 3: ACCOUNTING FOR CONSIGNMENTS
It is not always possible or commercially viable for a business to sell goods directly to its
customers. If for example a business wishes to sell goods abroad, establishing a
showroom/office in each country may not be viable unless the volume of sales justifies the
course. Also knowledge by the local agent of conditions where he resides may prove useful for
increasing sales, so the use of local agents is a good option.
3.1 Operating Arrangements
Goods sent to the agent are usually dispatched in bulk, and are termed a consignment. The party
sending the goods is the consignor and the agent receiving them is the consignee. To the
consignor, the consignment is known as outward consignment; whereas to the agent it is known
as inward consignment.
The following are the main points of difference between a consignment and a sale:
In the case of a sale, the legal ownership of the goods sold is transferred to the purchaser of the
goods; whereas in goods sent on consignment, the legal ownership is not transferred to the
consignee but remains vested in the consignor until sold to a third party.
In the case of sale of goods the relationship between the seller and the purchaser is that of a
debtor and creditor whereas for goods sent on consignment, the relationship between the
consignor and consignee is that of a principal and agent.
In consignments, expenses incurred by the consignee in connection with the goods consigned to
him are borne by the consignor, whereas, in a sales situation, expenses incurred after sale are
borne by the purchaser.
In consignments risks attached to goods lie with the consignor till goods consigned are sold by
the consignee; however in a sale, the risk is transferred to the purchaser of the goods.
For consignments unsold consignments stocks will be treated as stock of the consignor whereas
the seller of goods has nothing to do with those goods once they are transferred to the buyer.
3.2 Procedure for consignments:

The consignor sends goods to the consignee and incurs certain expenses in doing so. Goods may
be sent either at cost or at invoice price. The consignee will incur expenses for taking delivery of
the goods and bringing these to the shop. He will then try to sell the goods on a cash or credit
basis, for which he is entitled to a commission. He will remit the takings from the sales after
paying himself his commission and reimbursing himself expenses incurred on behalf of the
consignor.
The consignee may sell goods indiscriminately on credit in order to generate his commission
without checking the credit worthiness of the customer. To prevent this, the consignee may be
given additional commission (Also a percentage of sales) called Del credere Commission. All
bad debts will then be borne by the consignee.
An additional commission may be given to the consignee for working hard to push a new line of
product in the market. Such a commission is known as Over-riding commission.
After a particular fixed time or when the goods have been sold by the consignee, the consignee is
required to send a statement known as account sales to the consignor, which contains:
Quantity of goods sold;
46
Gross proceeds realised on sales;
Expenses incurred on behalf of consignor;
Commission entitlements and advances remitted;
Amounts finally due to the consignor.
An example of Accounts Sales of 100 table fans sold by B. Kariuki of Nairobi, Kenya for the
account and risk of N. Fox of London, UK.
1999 Sh.
Sh.
June 30 Gross Proceeds from sales: 100 fans @ Sh.300
30,000
Less: Freight/Carriage 300
Insurance 150
Warehouse charges 300
Commission at 5%of sales 150
(2,250)
27,750
Less: Advance remittance
(11,000)
Balance sent by bank draft
16,750
47
Accounting entries in the books of the consignor Dr Cr
When goods are sent to the consignee:
Dr Consignment A/C X
Cr Goods sent on consignment X
If there are many consignments, a consignment account is
maintained for each agent; and goods sent to a particular agent are
recorded as:
Dr Consignment to------- (Name of agent) X
Cr goods sent on consignment X
When consignor incurs expenses:

Dr Consignment to ------- X
Cr Bank/Cash X
When agent remits a certain sum in advance (as security against

goods received by him)
Dr Cash/Bank/Bills receivable X
Cr Consignee A/C X
When consignee pays expenses upon receipt of the goods

(As indicated on Account Sales)
Dr Consignment to ------------A/C X
Cr Consignee A/C X
When consignee makes sales (as recorded in account sales)

Dr Consignee X
Cr Consignment to------ X
Entries for consignee’s commission

Dr Consignment to------ X
Cr Consignee X
Entries for interim/final remittance in account settlement

Dr Bank/Cash/Bills receivable X
CR Consignee X
Entries to record profit or loss on consignment:

If profit If Loss
Dr Consignment DR Profit & Loss X
Cr Profit & Loss CR Consignment X
48
At the year end, also:
Dr Goods sent on consignment X
Cr Purchases/Trading X
Accounting entries in the books of the consignee Dr Cr
When goods are sent by consignor to consignee
Dr No entries- the property still belongs to X
CrThe consignor X
Entries for expenses incurred by consignee:

Dr Consignor X
Cr Bank/Cash X
Advance moneys remitted by consignee to consignor

Dr Consignor X
Cr Bank/Cash/Bills payable X
Entries for sales made by consignee

Dr Bank/Cash/Debtors X
Cr Consignor X
Entries for commissions on sales

Dr Consignor X
Cr Commission income A/C X
Entries for bad debts (No Del credere commission is payable)

Dr Consignor X
Cr Debtor X
Entries for bad debts (Del credere commission is payable)

Dr Bad Debts X
Cr Debtor X
Entries for remittance sent to consignor in final settlement of his

Account
Dr Consignor X
Cr Bank/Cash/Bills payable X
Illustration 1
B Kariuki & Co of Nairobi consigned on 15th March 1998, 45 cases of glassware (cost price =
Sh.41,235) to Ochieng and Co for sale at a commission of 5% of gross sales proceeds. The
consignor paid freight and carriage amounting to Sh.539.
The goods arrived at Kisumu on 20th March 1998, and Ochieng and Co. paid railway clearing
charges Sh235, sundry charges sh59, Carriage sh102, and godown charges Sh90.
The goods were sold by Ochieng and Co. as:
15 cases at Sh1,003 per case,
22 cases at Sh1,050 per case, and
49
The remainder at Sh10,000 (total value)
On 21st June 1998, Ochieng and Co sent a draft for Sh10,000 to B. Kariuki & Co. on account.
On 1st July 1998, Ochieng and Co forwarded an account sales together with a bill of exchange for
the balance.
Required: Prepare the necessary accounts to record the above transactions in the books of both
parties.
Solution
Books of B Kariuki (The consignor)
Goods sent on consignment
1998 1998
Sh Sh
1 July Purchases/Trading 15 March Consignment
41,235 41,235
Consignment A/C
1998 1998
Sh Sh
15 March Goods sent on consignment 1July Consignee: Sales
41,235 48,145
15 March Bank: Freight and carriage
539
20 March Consignee: Railway clearing
235
: Sundry charges
59
: Carriage
102 .
: Godown charges
90
1 July Consignee: Commission
2,407
1 July P & L: Profit from consignment
3,478
48,145 48,145
Consignee (Ochieng and Co.)

1998 1998
Sh Sh
1 July Consignment: Sales Mar. 20 Consignee: Railway clearing
48,145 235
: Sundry charges
59
50
: Carriage
102
: Godown charges
90
June 21 Bank: Remittance
10,000
July 1 Consignment: Commission
2,407
July 1 Bills receivable
35,252
48,145 48,145
Books of Ochieng & Co. (The consignee)

Consignor A/C (B. Kariuki)
1998 1998 Sh
Sh
Mar. 20 Bank: Railway clearing 1 July Bank/Cash: Sales 48,145
235
: Sundry charges
59
: Carriage
102
: Godown charges
90
June 21 : Remittance
10,000
July 1 Consignment: income
2,407
July 1 Bills payable
35,252
48,145 48,145
Valuation of Closing Stock

It is quite possible that all goods sent on consignment might not have been sold by the consignee
by the date when final accounts are drawn up by the consignor. It is therefore necessary for the
closing stock-on-consignment to be properly valued and recorded. When correctly recorded in
the consignment account, the correct profit/loss on consignment is established.
While calculating cost of closing stock, a proportionate share of non-recurring expenses is
considered.
Note: Non-recurring expenses are the expenses incurred to bring the goods to the godown of the
consignee (current location) and to bring the goods into current condition. They include import
duty, port charges, freight, insurance-in-transit, packing etc.
Expenses incurred after the goods reach the warehouse of the consignee are not taken into
consideration in valuation of stocks in the warehouse.
Illustration 2
51
The Ondieki consignment in the books of Patel of Nairobi showed a debit balance of Sh1,500
representing the cost of 10 bicycles on 1st January 1998. On March 1st, Patel sent a further
consignment of 40 bicycles to Ondieki in Kisii; each having cost Sh160.
The freight and other charges amounted to Sh210. On 1st June, Ondieki sent an account sales
showing that 8 bicycles form the old stock realised Sh140 each; 25 bicycles from the second
consignment realised Sh200 each; and 15 bicycles remain unsold. Two bicycles from the old
stock, being unsalable in Kisii, were returned to Nairobi for which Ondieki sent a separate debit
note for Sh30, being expenses incurred by him. Ondieki is entitled to a commission of 5% on
sales.
REQ: Show the necessary accounts in the books of Patel (the consignor), assuming he closes his
books on 30th June 1998.
Goods sent on consignment
1998 1998
Sh Sh
30/6 Consignment 1/3 Consignment A/C
300 6,400
30/6 Purchases/Trading
6,100
6,400 6,400
Consignment A/C
1998 1998
Sh Sh
1/1 Balance b/d (opening stock) 1/6 Consignee: Sales
1,500 6,120
1/3 Goods sent on consignment 30/6 Goods sent on consignment: Returns
6,400 300
1/3 Bank: Freight etc.
210
1/6 Consignee: Commission
306 30/6 Closing stock c/d
Expenses on returns 2,479
30
1/7 P & L: Profit
453
8,899 8,899
Consignee (Ondieki)
1998 1998
Sh Sh
1/6 Consignment: Sales 1/6 Consignee: Commission
6,120 306
Expenses on returns
30 30/6 Balance c/d
. 5,784
6,120 6,120
52
Working for closing stock:
Cost of closing stock = original cost + Proportion of non-recurring expenses.
Cost of 1 item in closing stock = 160 + 210/40

= 165.25
Cost of 15 items = 15 X 165.25

= 2,479
Accounting for loss of goods on consignment

The loss of goods on consignment is a loss for the consignor only; therefore, he is the only
person to record the loss. The consignee does not make any entries.
The entries by the consignor depend upon whether the loss is a normal one or an abnormal loss.
Normal losses
These are expected losses which arise due to the nature of goods consigned. Such losses may
arise due to loading/unloading, packing/repacking, evaporation, drying, cutting bulk material into
smaller parts etc. Such a loss is unavoidable because losses are bound to occur even after all
precautions. This is therefore expected, and is deemed to be part of the consignment cost, thus
no entry is made in the books of the consignor. However closing stock computations have to be
made carefully using lower quantities of closing stock.
The total costs on the consignment are divided by the number of good units in order to establish
the cost of closing stock units.
Revision Question
Taveta Outfitters Ltd, have for may years sold specifically made suits through their Kisumu
agents, Fit Ltd.
At the end of February 1990, there was a debit balance of Sh146,960 on Fit Ltd’s account in
Taveta Outfitters Ltd’s ledger and a stock balance carried down of Sh72,000. In March, 120
pairs of suits were consigned at a cost of Sh2,080 per pair. The consignors incurred insurance
Sh1,720 transport Sh3,400 and other expenses Sh480. The consignees incurred warehousing
expenses Sh2,160 and other expenses Sh240 on the March 1990 consignment.
At the end of the March, fit Ltd. Sent an account sales to Taveta Outfitters Ltd. which shows that
all 40 pairs of February 1990 had been sold at the old price of Sh2,920 per pair together with 90
pairs of the March consignment at Sh3,360 per pair. They also enclosed a cheque for Sh216,840.
Sales commission is 10% of the gross sales value.
Stock is valued at the initial purchase cost plus subsequent expenses.

Required:
Prepare the accounts in the ledger of Taveta Outfitters Ltd for the month of March 1990.
53
UNIT 4: BILLS OF EXCHANGE AND PROMISSORY NOTES
4.1 Introduction
A bill of exchange has been defined as:
“An instrument in writing containing an unconditional order, signed by the maker directing a
certain person or to the bearer of the instrument.”
The following are essentials of a bill of exchange:

It should be in writing
It should contain an order by the maker to the addressee to make a payment in future.
The order contained in the bill should be unconditional.
The maker of the bill is known as “drawer” and the bill must be signed by him.
The person to whom the bill is addressed is known as the drawee and he must be a certain
person.
The amount ordered to be paid according to the bill must be certain and fixed.
7. The person to whom the payment of the bill is made is known as the payee, and may
either be a specific person or the bearer of the bill.
The following points are important in a bill and need clarification.

Parties to the bill of exchange: - There can be 3 parties to a bill of exchange:
The drawer – This is the person writing out the bill of exchange. He must sign it.
The drawee/Acceptor – he is the person to whom the bill is addressed and should pay the
money expected from him according to the bill.
The payee – This is the person to whom payment is usually made. Sometimes the name of the
payee is stipulated on the face of the bill; sometimes the payee is simply the any bearer of the
note.
Stamp: - The stamp is affixed on every bill of exchange except those payable on demand.
The amount: - The amount for which the bill is drawn is written twice, once in figures and again
in words to avoid alteration possibilities.
The date of making the bill and the date of payment must be specific from the face of the bill.
However, it is general practice to give the drawee three days of grace over and above the period
of the bill. If a public holiday is caught in the days of grace they will then total to four.
If the drawee (person to pay the bill) signs on the bill accepting to adhere to the terms, the bill
becomes a legal document and is deemed to be accepted.
There are two types of acceptances the drawee can engage in:
General acceptance: - Acceptance by the drawee without adding any further conditions.
Qualified acceptance: - Acceptance given with some further condition attached by the drawee is
known as qualified acceptance. This may be in relation to time, place, amount, or parties to be
paid.
4.2 Classification of bills of exchange

Bills can be divided into 2 categories as follows:
Inland bills: These are bills drawn in Kenya upon persons living in Kenya, or made payable in
Kenya.
54
Foreign bills: These are bills drawn in Kenya but drawn upon persons living outside Kenya, or,
drawn outside Kenya but made payable upon persons resident in Kenya. A foreign bill is drawn
up in sets of 3, each of which is called a via. Upon one copy being accepted, the other 2 become
inoperative.
4.3 Promissory Notes

This is defined as:
“An instrument in writing (other than bank note and currency note) containing an unconditional
undertaking, signed by the maker, to pay a certain sum of money, to, or to the order of a certain
person, or to the bearer of the instrument.”
The following are essentials of a promissory note:
It should be in writing
It must contain a promise by the maker of the promissory note to carry out payment in future.
The promise to pay must be unconditional.
It must be signed by the maker of the instrument.
The amount indicated as payable must be certain and specific.
It should be properly stamped.
Difference between bills of exchange and promissory notes: -

A bill of exchange is an unconditional order to pay, whereas a promissory note is an
unconditional promise to pay.
A bill of exchange is drawn by a creditor demanding that the dues be paid to a third party,
whereas a promissory note is drawn by the debtor himself accepting to pay the Creditor (or a
third party specified by the Creditor)
A bill of exchange usually has 3 parties namely the drawer, the drawee and the payee, whereas
the promissory note only has 2 parties, namely the maker and the payee.
Foreign bills have to be drawn in sets of 3, but foreign promissory notes can be drawn single.
Advantages of bills of exchange and promissory notes: -

These are helpful in increasing the size of the business because they facilitate Credit transactions.
An accepted bill is conclusive and legal proof of the debt and can be enforced in a court for its
payment.
A bill or promissory note fixes the date of payment, thus providing better opportunities on
financial management and financial planning because cash flows have been determined fairly
accurately.
If the Creditor cannot wait for the payment till the date of maturity on the bill or promissory
note, he has the option of having it discounted at a bank and obtaining funds before maturity.
A bill or promissory note is a negotiable instrument and can easily be transferred from one
person to another in settlement of debts.
Accounting Treatment for bills of exchange

Bills receivable: - A bill of exchange or promissory note is treated as a bill receivable if
payment is to be received against it on demand or after a lapse of time. So a bill of exchange is a
bill receivable for the Drawer because he is the one who receives money against it.
A bill receivable is shown as an asset on the balance sheet.
55
Bills payable: - A bill of exchange or promissory note is treated as a bill payable for the party
who has to pay it on the due date. Thus drawees (acceptors) account for a bill of exchange as a
bill payable.
The drawer or promisee receiving the bill has 4 options:

He can keep the bill in his possession till maturity and realise payment against it on the due date.
He can get the bill discounted with the bank any time before maturity if he is in need of the
money. The bank deducts a certain percentage known as discount from the amount on the bill
for the period it has to wait to get the payment due on the bill.
He my transfer the bill in favour of a creditor in payment of his account with the creditor. This is
known as endorsing the bill to the creditor.
He can send the bill to the bank for collection, therefore treating the bank as his agent for this
work.
When a bill is received and retained in own possession till the due date:
When the bill is drawn and duly accepted by the customer (debtor)
Debit Bills receivable
Credit Debtor
When bill is presented on the due date to the drawee for payment
Debit Cash/Bank
Credit Bills receivable.
When bill is received and discounted with the bank

When bill is drawn and duly accepted by the customer (debtor)
Credit Debtor
When the bill is taken to the bank for discounting
Debit Bank/Cash (with amount actually received)
Debit Discounting charges (Expense)
Credit Bills receivable
When the bill is received and passed on to a creditor (endorsed) in settlement of liabilities
Credit Debtor
When the bill is handed over to our creditor to settle our liability
Debit Creditor
Credit Bills receivable
When the bills received are sent to the bank for collection
Credit Debtor
When bill is given to bank for collection,
Debit Bills sent for collection
Credit Bills receivable A/C
56
When bank notifies us that bill has been collected.
Debit Bank
Credit Bills sent for collection
Note: In the drawees books (person to pay the bill) the following entries will appear irrespective
of whichever of the 4 options the drawer has applied:
When accepting the bill,
Debit Creditor
Credit Bills payable
When paying the bill at maturity
Debit Bills payable
Credit Bank/Cash
Example:
On 1 January 1999, X sells goods to Y for Shs8,000 and draws 4 bills of exchange on him; the
first for Shs1,500 for 1 month, the second for Shs1,000 for 2 months, the third for Sh2,000 for 3
months and the 4th for Shs3,500 for 4 months. Y accepts the bills and returns them to X.
The second bill was discounted with the bank at 12% per annum, and on the same date the third
bill is endorsed by X to his own Creditor, Z. These took place on 4th Jan 1999.
The fourth bill is sent to the bank for collection on 10 Jan 1999.
Required:
Record the above transactions in the books of X and Y, assuming all bills are met on the due
dates.
Books of X
Sales
1999 1999
Sh Sh
1 Jan Debtor Y
3,000
Debtors (Y)
1999 1999
Sh Sh
1 Jan Sales 1 Jan Bills receivable
8,000 1,500
1 Jan Bills receivable
1,000
. 2,000
3,500
8,000 8,000
57
Bills receivable
1999 1999
Sh Sh
1 Jan Debtor 4 Jan Bank
1,500 1,000
1 Jan Debtor 4 Jan Creditor
1,000 2,000
1 Jan Debtor 10 Jan Bills sent for collection
2,000 3,500
1 Jan Debtor 1 Feb Bank
3,500 1,500
8,000 8,000
Bank (Extract)
1999 1999
Sh Sh
4 Jan Bills receivable 4 Jan Discount charges
1,000 20
1 Feb Bills receivable
1,500
1 May Bills sent for collection
3,500
Creditor
1999 1999
Sh Sh
4 Jan Bills receivable Balance b/d
2,000 XX
Bills sent for collection

1999 1999
Sh Sh
10 Jan Bills receivable 1 May Bank
3,500 3,500
Discounting charges
1999 1999
Sh Sh
4 Jan Bank Profit and Loss
20 20
Dishonour of a bill
This may arise in 2 ways:
58
When the bill drawn by the drawer is not accepted by the drawee (non-acceptance)
When the drawee does not make payment on the maturity date (non-payment after acceptance)
Under this situation (ii), the bill may be with one of the following parties:
With the drawer, if bill is retained by him till maturity date
With the drawer’s bank, if the bill had been discounted with the bank
With the creditor, if the bill had been endorsed in favour of a creditor,
With drawer’s bank, if bill had been sent for collection
If with the drawer, he shall in his books,

Debit Debtor (with original value + noting charges)
Credit Bills receivable (with original value)
Credit Bank (with noting charges paid)
If the bill had been discounted, the drawer shall, in his books
Debit Debtor (with original value + noting charges)
Credit Bank (with original value + noting charges)
If the bill had been endorsed, the drawer shall, in his books
Debit Debtor (with original bill value + noting charges)
Credit Creditor (with original value + noting charges)
If the bill had been sent to the bank for collection,

Debit Debtor (with original bill value + noting charges)
Credit bills sent for collection (with face value)
Credit Bank (with noting charges)
Advantages of bills of exchange

It is legal evidence of the debt; the creditor may sue the debtor in case of default.
It is a negotiable instrument; it is transferable to a third party in settlement of third party debts.
It can be discounted before the maturity date if cash is required.
It can easily be used in transactions involving large amounts, and in various locations e.g. foreign
bills.
Illustration 3
On July 1, 1999, N. Fox purchased goods valued at £7,800 from C. White and on the same date
he accepted a three-month bill for £7,700 in full settlement of the debt. On the same date it was
endorsed by C. White to P. Brown in full settlement of a debt of £8,000 due from him to P.
Brown. P. Brown immediately discounted the bill for £7,600.
On the due date, the bill was dishonoured, and the noting charges incurred by the banker
amounted to £100; but the bill was taken over by C. White on dishonour; i.e. the bank was paid
by C. White.
Required:
Journalise the above transactions in the books of C. White
Prepare C. White’s account in:
59
Books of N. Fox
Books of P. Brown
The Journal (in the books of C. White
THE JOUNAL Dr Cr
Date £ £
1 July N. Fox (Debtor) 7,800
Sales 7,800
1 July Bills receivable 7,700
Discounts allowed 100
N. Fox 7,800
1 July P. Brown (Creditor) 8,000
Discount received 300
Bills receivable 7,700
4 Oct N. Fox 7,900
Bank (Bill + Noting charges value) 7,800
Discount allowed 100
Books of N. Fox:
C. White: Creditor
1999 1999
£ £
1 July Bills payable 1 July Purchases
7,700 7,800
1 July Discount received 4 Oct Bills payable
100 7,700
4 Oct Noting charges expense
Balance c/d 100
7,900 4 Oct Discounts received
100
15,700 15,700
Books of P. Brown
C. White: Debtor
60
1999 1999
£ £
Balance c/d Discounts Allowed
8,000 300
Bills receivable
. 7,700
8,000 8,000
Accommodation bills:
Usually a bill of exchange is drawn to settle a trade debt owing by the drawee to the drawer
because the last words are “for value received” on the face of the bill. Such bills are called trade
bills.
Some times a bill may be drawn when there is no debt from drawee due to drawer, instead just to
oblige a friend who is temporarily in need of money. Such a bill is an accommodation bill
because the object of this bill is to accommodate a certain person with financial assistance for the
duration of the bill. They are also referred to as Kite bills; and are accounted for in almost the
same way as trade bill.
There are 3 possible situations under which these may be drawn:

Where it is drawn on one person (drawee) for accommodation of the drawer only
Where it is drawn on one person (the drawee), but when discounted at the bank, the money is
divided between the drawer/drawee in agreed proportions.When 2 persons draw on each other
for equal amounts for their own accommodation.
REVISION QUESTION
H. Timber Ltd., imports large quantities of timber and re-exports a certain amount of it. Payment
is normally by bills of exchange, Drawn in £ sterling, with discount charges being borne by the
Drawer.
These are some of the company’s transactions –
19_1
Feb 1 Bought timber costing £84,000 from S. Timber Corporation; accepted a bill of exchange
for that amount at 60 days after sight.
Bought timber costing £120,000 from L. Timber Agency; accepted a bill of exchange Drawn on
31st January for 90 days after date.
Sold timber £80,000 to the F. Timber Co., drawing a bill on them for £70,000 for 30 days after
date
Mar 16Accepted bill returned by F. Timber Co., which was discounted with the bank of H.
Timber Ltd. at 2 per cent discount.
Reached an agreement with L. Timber Agency for an allowance of £7,000 in respect of a
previous defective consignment of timber.
Sold Timber to P for £24,000, drawing on him a bill of exchange for £4,000 at 14 days and
another for £20,000 at 90 days.
61
Accepted bills returned by P; the £20,000 bill was discounted with the bank at 2 per cent
discount.
Cheque (in £ sterling) received from the F. Timber Co. for the balance of their account.
Received notice from the bank that the cheque from the F. Timber Co. has not been met and that
the bill discounted on 16th March has been dishonoured.
Drew an accommodation bill on M. Bros. For £100,000 at 90 days; the bill was discounted with
the bank at 2 per cent. In return accepted a bill Drawn by M. Bros for £102,000 at 60 days.
14 Bought timber for £67,000 from the L. Timber Agency; accepted a bill dated 1st April at
60 days for £60,000.
Assuming that all the bills are met on their due dates (excepting where the contrary is stated0,
and ignoring any additional bank charges on the various transactions, you are required to write
up the appropriate personal ledger accounts and nominal ledger accounts of H. Timber Ltd. The
company’s financial year ended on 30th April, 1966, and you should carry down the balances at
that date. Ignore days of grace.
62
Unit 5: ACCOUNTING FOR PRICE LEVEL CHANGES
5.1 Need for Inflation Accounting

• The major reason why inflation accounting or accounting for price level changes has been a
hot topic in the academic literature is because of the deficiencies of the historical cost
accounting (HCA) approach.
• HCA is a well established method of accounting all over the world because it is able to meet
the legal requirements of financial reporting i.e fulfilling the stewardship function assigned to
financial reports. HCA has been able to provide information about the financial position,
performance and changes in financial position of an enterprise to a wide range of users
especially during periods of stable prices.
• However, most economics in the world are characterized with environments of non-stable
prices —inflation. Under such circumstances, it is unlikely that HCA can be able to satisfy
the informational demands of users whose academic needs are dependent on estimates of
future cashflows. HCA is likely to fail because:
(a) The balance sheet figures for assets, based on cost at time of acquisition are unlikely to
reflect present day values since they lack additivity. The balance sheet includes a
conglomerate of costs incurred on different dates which will not enable users to "realistically
predict future cashflows" related to those assets.
(b) If profit (income) is dependent on measure of capital at different dates, then profit
measurement can be considered to be the result of comparing two fairly meaningless totals.
In addition the profit that results is usually considered to be overstated and any ratio,
including return on capital employed, will also be overstated.
(c) Historic cost profit give a misleading impression of the ability of a company to continue to
operate at the same level of operation and/or maintain capital in `real terms' - problem of
capital maintenance.
(d) A series of historic cost accounts can give a misleading impression of the financial trends of
a company.
5.2 Capital Maintenance

There is a relationship between profit and capital. Conventionally, profit is calculated by setting
expenses against revenues in a formal statement known as a profit and loss account. An
alternative view of profit is to see it, in the absence of fresh capital inputs or drawings, as the
increase in the net worth of a business.
Thus the relationship between profit (income) and capital can best be expressed by the following
equation:
I = D + (K2 - K1)
Where I = Income for the period

D = Dividends or distribution
K2 = Capital at the end of the period
63
K1 = Capital at the beginning of the period
If K2 = K1, I = D, i.e. all the income has been distributed
K2 > K1, I > D, i.e. retained profits which form part of the capital at the
beginning of next year
K2 < K1, I < D i.e. dividends have been paid out of capital or reserves
brought forward
As can be seen from the above equations, income is only recognised after the capital at the
beginning of the year is maintained at the end of the year. Thus, capital maintenance is thus a
minimum concept. Capital represents the absolute minimium funding that must be retained to
provide security for creditors, and to keep the business at least at the level of activity that was
originally determined by the owner(s).
In order to keep track of essential capital, accountants have traditionally made a clear distinction
between capital and revenue funds.
The value of income will also depend on the manner in which the capital is measured. A number
of models are available to measure income. These can be broadly categorised into two:
(a) Economic income model
(b) Accounting models
Economic Income Model
It can be measured using the following equation
I= C + (K2 - K1)
Where I = Income for the period

C = Realised cashflow in the period
K2 = Capital at the year-end measured in terms of present value of
future cashflows.
K1 = Capital at the beginning of the year measured in terms of present
value of future cashflows.
This equation is based on Hick's model of ideal income and he defines the income as being "the
amount a man can spend and still be as well off at the end of the period as he was at the
beginning.
This approach to measurement of income sidesteps all the problems associated with year end
adjustment to profit. The estimations of accurals and prepayments, the assumptions about fixed
assets lives etc that are embodied in the traditional profit and loss account are entirely avoided.
However, the main disadvantage is probably that the calculation of well-offness, or capital, is
similarly subject to estimates and professional judgements. Remember the value of capital at the
beginning and the end of the period is defined as the discounted present value of the future
income stream. This income is measured from changes in capital, by contract to the accrual
concept where capital is the residual after measuring income.
64
Future cash flows are discounted at the entity's cost of capital and the maximum one can spend to
maintain the "welloffness" is I and not C. An essential feature of the model is that the definition
of income takes account of consumption and saving and dis-saving. The sums saved should be
reinvested and should earn interest, which will ensure capital maintenance and a constant
income.
5.3 Accounting Models
This includes:
(a) Classical school - Historical cost accounting the capital is maintained by money terms. If
the entity has a historical cost of Shs 1,000 at the beginning of the year and Shs 1,000 at
the end of the year (assuming no distributions and no injections or withdrawal of capital):
Income = Sh 1,500 - Sh 1,000 = Shs 500
This is the traditional approach to profit measurement.
(b) Neo-classical
This includes the Historical cost accounting adjusted for changes in general purchasing
power. This model makes sure that the purchasing power of the capital is maintained.
(c) Modern School - Current Value Accounting

This model tries to maintain the operating capability of the entity. The operating
capability of the business entity is its ability to replace assets as they are consumed or
worn out or its ability to produce the same volume or value of goods i.e. the next year as
in the current year.
5.4 APPROACHES TO INFLATION ACCOUNTING

- HCA does not reflect the impact of changing prices on the net assets and earnings of a
company, but to date no agreement has been reached on a system that will do that and
provide users with the information they require to make decisions in an environment of
moving price levels.
- However, there are two main approaches to inflation accounting. These are:
(a) Current purchasing power accounting system and

(b) Current value systems
5.5 CURRENT PURCHASING POWER (CPP) ACCOUNTING

- It is also referred to as the General Price Level Approach.
- It requires that historical cost based amounts be translated to the current purchasing
power equivalent using the general price level index.
- The CPP accounts attempts to maintain the shareholders' capital in terms of the general or
consumer purchasing power. This is known as the proprietorship concept of capital
maintenance.
- According to the CPP, all items in the profit and loss account are expressed in terms of
current (year-end) purchasing power, while the same will be true in the balance sheet.
65
Thus all items in the balance sheet will have to be converted in terms of year-end
purchasing power except the so called monetary items (assets and liabilities) which are
automatically expressed in such terms.
Example - CPP Accounts

Nyumba Ltd engages in real estate business owning only one property. The company's main
income is rental income.
The balance sheet of the company as at the end of the year 1 and year 2 is as follows:
Year 1 Year 2
KShs KShs
Assets
Building (net) 150,000 105,000
Cash 45,000 90,000
95,000 195,000
The comparative income statements for both year 1 and year 2 are given below:
Year 1 Year 2
Kshs Kshs
Revenue 82,500 90,755
Expense
Depreciation (45,000 (45,000)
Net Income ) 45,755
37,500
Additional Information
 The company was formed on January 1st, Year 1 through a cash investment of KSh
195,000.
 The building was acquired on January 1st Year 1 at a cost of 195,000. Expected useful
life is 4 1/3 years.
 All revenue is received at the end of the year.
 There are no operating expenses except depreciation.
 All net income is paid out as a dividend. The balance of cash is banked at no interest
return.
 The price indexes for Year 1 and Year 2 are as follows:
1st Jan year 1 100

31st Dec Year 1 105
31st Dec Year 2 110
Required:
Prepare the balance sheet and income statements for Nyumba Ltd for the two years using the
current purchasing power approach.
66
Solution:
NYUMBA LTD
Income Statement for Period ending
Year 1 Year 2
KShs KShs
Revenue 82,500 90,755
Depreciation (W1) (47,250) (49,500)
35,250 41,255
Purchasing power
Loss (W2) _____ (2,250)
Net Income 35,250 39,005
Balance Sheet as at end of

Year 1 Year 2
Assets Kshs Kshs
Buildings (net) (W3) 157,500 117,750

Cash (W4) 47,250 96,750
204,750 214,500
Capital (W5) 204,750 214,500
Workings
W1 - Depreciation Expense
Year 1 → 105 x 195,000 = KShs 47,250

100 4 1/3
Year 2 → 110 x 195,000 = KShs 49,500

100 4 1/3
W2 - Purchasing Power Loss
Year 1 - No loss/gain as there was no monetary item at the beginning of the year.
Year 2 - Monetary assets-cash = 47,250 at beginning of Year 2.
Thus the PP loss
= 47,250 x 110 - 47,250

105
= KSh. 2,250
W3 - Buildings
67
Year 1 - Adjusted cost (105 x 195,000) = 204,750
100
Less Acc. Depreciation ( 47,250)
157,500
Year 2 - Adjusted cost (110 x 19,500)= KSh 214,500

100
Acc. Depreciation (47,250 + 49,500) 96,750
117,750
W4 - Cash
Year 1 - Amount of depreciation retained = KShs 47,250

Year 2 - Amount of depreciation retained
to date (47,250 + 49,500) = KShs 96,750
W5 - Capital
Year 1 - 195,000 x 105 = KShs 204,250

100
Year 2 - 195,000 x 110 = KShs 214,500

100
Purchasing Power Gain and Losses

- Purchasing power gains and losses arise as a result of holding non monetary assets or
liabilities during a period when the price level changes.
- Purchasing power gains and losses arise because monetary items, which are fixed in terms
of the number of shillings to be received or paid, gain or lose purchasing power as the price
level changes.
- Monetary assets - assets receivable at fixed amounts either currently or in the future include
cash, accounts receivable, notes receivable.
- Monetary liabilities - liabilities payable in fixed number of shillings either currently or in
the future include both short term liabilities like LTD, notes payable etc.
- He potential for gains and losses is summarised in the table below where "net monetary
assets" refers to total monetary assets exceeding monetary liabilities and the converse is
true for "net monetary liabilities".
PURCHASING POWER GAINS AND LOSSES

State of the Economy
State of the Enterprise Inflation Deflation
Net monetary assets position Purchasing power loss Purchasing power gain
Net monetary liabilities Purchasing power gain Purchasing power loss
position
68
Advantages of CPP
• Current Purchasing Power accounts provide a monetary unit of valuing all items in the
financial statements for proper comparisons.
• Since CPP accounts are based on historical cost accounts the raw data is easily verified
and can be edited
• The restatement of results enhances entities comparability.
• Profit is measured in real terms – as a result more accurate forecasts can be made of
future profits.
• CPP accounts avoid the subjective valuations of CCA.
Problems and criticisms of CPP

Although the CPP restores the additivity of the figures, it has its own problems.
(a) Balance sheet treatment of non-monetary assets.

It is normally regarded as an extension of the historical cost approach. The resultant figures
bear little resemblance to current values of such assets.
(b) The nature of CPP profit
The CPP profit consists of trading profits and losses, and monetary gains and losses. Some
critics were concerned that a highly geared and illiquid company, with substantial liabilities,
could show a trading loss and yet a substantial monetary gain. CPP profit could give a
misleading impression of its ability to pay a dividend.
(c) Difficulty of understanding the purchasing power unit concept.
It has been argued that users of CPP statements may find the current purchasing power
concept difficult to understand and explain. Items in the balance sheet and profit and loss
account may appear rather abstract to non-accountants compared with the basic principles of,
say, current value accounting.
5.6 CURRENT VALUE ACCOUNTING

• There is no such thing as a current value accounting system, but rather several systems
which can be regarded as members of the current value family.
• Three possibilities include:
(a) The economic value method

(b) The net realisable (or exit value) method
(c) The current replacement cost (or entry value) method
The Economic Value Method

Under this method, the current value of an individual asset is based on the present value of the
future cashflows that are expected to arise as a result of owning the asset. This method requires
information concerning the following:
i. the amount of future benefits in cash terms;

ii. The timing of those benefits (for discounting purposes);
69
iii. A suitable discount factor - the cost of capital over the future lifetime of the asset.
The method is soundly based from a theoretical viewpoint but can nevertheless be criticised on
several grounds of a practical nature.
The criticisms include:
• It is difficult to see how cash flow information and estimated discount rates will be
capable of verification by auditors, so that users of accounts may be unwilling to place
reliance on the resulting financial statements.
• The method is highly subjective and the figures required to operate this method could be
extremely difficult to produce e.g estimating cashflows that can be attributed to individual
assets.
• Under this method it would be impossible to provide a detailed analysis of the year's
profit figure. Profit for the year would be based on the difference between opening and
closing net asset valuation figures (aggregated) adjusted for capital introduced and dividends.
The Net Realisable Method (NRV)

- Under the NRV method, asset values in the balance sheet would be based on the net price
that could be obtained in the open market if assets (stock and fixed assets) were sold in an
orderly way at the balance sheet date. This method is sometimes referred to as the "exit
value" approach.
Advantages of NRV include:

- Accounts prepared on this basis show the firm's total position in terms of its net liquidity.
This information will be useful to users of financial statements such as management,
shareholders, creditors, bankers etc. For example, it may assist bankers in making lending
decisions and managers in deciding the best use to which particular assets should be put.
- It also restores the additivity of balance sheet figures.
Disadvantages of NRV include:
• The method places a great emphasis on liquidation. This is inconsistent with the going-
concern assumption.
• The method would be costly and time consuming, involving individual assessment of
individual assets.
• It is also possible that some company assets may lack realisable/market values.
• It may also produce very unrealistic fixed assets values, for example, specialised plant
could have a high value to a particular business, but still have a very low NRV in the market
place. In the absence of liquidation, such a NRV would be meaningless.
• In the case of stocks, for example, profit is taken before goods are sold thus infringing the
realisation concept.
The Replacement Cost Method

• The method is also referred to as the "Entry Value" approach.
70
• The method requires that the value of items be adjusted to reflect the cost at which it
could have been replaced in the normal course of business either at the date of sale goods or
at the balance sheet date.
• The method seems to represent the value of the firm.
Example
The net realisable value method and the replacement cost method are illustrated below:
Assume the example in section 4.2.1 - Nyumba Ltd
Additional Information:
i. Replacement cost for a new building of the same type is KShs 180,000 at the end of Year 1
and KShs 210,000 at the end of Year 2.
ii. Net realisable value for the building is KSh 135,000 and KSh 120,000 a the end of Year 1
and Year 2 respectively.
Required:
Prepare the accounts for Nyumba Ltd using
(a) The Replacement Cost approach

(b) The Net Realisable Value approach
Replacement Cost Approach
Nyumba Ltd - Income Statement for Period ending
Year 1 Year 2
KShs KShs
Revenue 82,500 90,755

Depreciation Expense (W1) (41,538) (48,462
40,962 )
42,293
Balance Sheet as at end of
Year 1 Year 2
Assets Kshs Kshs
Buildings (net) (W2) 138,462 113,076

Cash 41,538 90,000
180,000 203,076
Capital 180,000 203,076
71
Workings:
(W1) - Depreciation ExpenseYear 1 - 180,000 = KSh 41,538
4 1/3
Year 2 - 210,000 = KSh 48,462

4 1/3
(W2) - Buildings (net) Year 1 - (180,000 - 41,538) = KSh 138,462

Year 2 - (210,000 - 2(48,462) = KSh 113,076
Net Realisable Value (NRV) Method
Nyumba Ltd- Income Statement For Year Ending
Year 1 Year 2
KShs KShs
Revenue 82,500 90,755
Depreciation Expense (W1) (60,000) (15,000)
22,500 75,755
Balance Sheet as at End of
Year 1 Year 2
KShs KShs
Buildings (net) (W2) 135,000 120,000
Cash (W3) 60,000 75,000
195,000 195,000
Capital 195,000 195,000
Workings:
W1 - Depreciation Expense Year 1 - (195,000 - 135,000) = KSh 60,000
Year 2 - (135,000 - 120,000) = KSh 15,000
W2 - Buildings (net) Year 1 - 135,000 as given

Year 2 - 120,000
W3 - Cash - Year 1 - Amount of acc. depreciation = KShs 60,000

Year 2 - Amount of acc. depreciation = KSh (60,000 + 15,000)
to date = KSh 75,000
HOLDING GAINS AND LOSSES
72
Just as monetary items are subject to a gain or loss as the price level changes, non-monetary
assets (also called real assets) are subject to a gain or loss as a result of change in their value.
Holding gains or losses on real assets can be divided into two parts:
• Monetary holding gains and losses - arise purely because of the change in the general
price level during the period and
• Real holding gains and losses - these are the differences between general price-level-
adjusted amounts and current values.
Monetary gains and losses are capital adjustments only. They are not a component of income.
Holding gains and losses can also be classified from the standpoint of being realized or
unrealized in the conventional accounting sense.
Example
Assume a piece of land was acquired for KSh 5,000 on Jan 2nd 20X0, when the general price
index was 100. One-tenth of the land was sold on December 31, 20X0 for KSh 575. The entire
parcel of land was valued at KSh 5,750 on Dec. 31 20X0. The total real and monetary holding
gains are computed below:
Current value (31.12.X0) KShs 5,750

General price-level adjusted
Historical cost on 31.12.X0
(5,000 x 110)
100 5,500
Total real holding gain 250
General price-level adjusted

Historical cost on 31.12.X0 KShs5,500
Historical cost 5,000
Total monetary holding gain KShs 500
Holding gains and losses are realized by the process of selling the asset or in the case of a
depreciable asset using it up over time. The division of the holding gains in the above example
is summarized below:
Analysis of Holding Gains

Holding Gain Type
Nature Real Monetary Total
KShs KShs KShs
Realized 25 50 75
Unrealized 225 450 675
Total 250 500 750
A more detailed example follows to illustrate the computation of holding gains and losses.
Example
73
KAMUTI Ltd's financial statements for the year 20X0 are given below:
Kamuti Ltd : Income Statement for the period ended 31.12.20X0
KShs Kshs
Sales 400,000
Cost of goods sold (240,000)
Gross profit 160,000
Less: Operating expenses
Selling and Administration (100,000)

Depreciation expense (40,000) (140,000)
Net profit 20,000
Dividends (10,000)
Retained profits 10,000
Kamuti Ltd - Balance Sheet As at:
31.12.20X0 31.12.1999
KShs KShs
Fixed Assets
Equipment 400,000 400,000
Acc. Depreciation (140,000) (100,000)
260,000 300,000
Current Assets – Inventory 160,000 100,000
-Accounts Receivable 20,000 40,000
-Cash 110,000 20,000
550,000 460,000
Equity
Ordinary Shares 200,000 200,000
Retained Earnings 30,000 20,000
230,000 220,000
Liabilities
Bonds payable 300,000 200,000
Accounts payable 20,000 40,000
550,000 460,000
• The equipment consists of three lots acquired at different times and each has a useful life
of 10 yrs. Cost information is as follows:
At 31.12.1999
Initial cost Age (yrs) Current cost
Lot 1 KShs 240,0003 KShs 260,000
Lot 2 120,000 2 140,000
Lot 3 40,000 1 60,000
74
400,000 460,000
At 31.12.1990
Lot 1 240,000 4 300,000

Lot 2 120,000 3 180,000
Lot 3 40,000 2 80,000
400,000 560,000
• Depreciation is to be charged using the straight-line method. The residual value is zero
for lots of equipment.
• Inventory is accounted for using FIFO basis with an inventory turnover of approximately
four times per annum. In the year 20X0, 12,000 units were sold.
• Current cost of inventory was KSh 104,000 as at Jan 1st 20X0. KSh 166,000 on Dec 31.
20X0. The unit cost of stock was KSh 20 and KSh 25 on 1.1.00 and 31.12.00 respectively.
• Interim dividend amounts to KSh 10,000 was paid on July 1st 20X0.
• The price indexes at relevant dates are as given below:
January 1st 20X0 250

December 31st 20X0 270
Average for 20X0 260
Last Quarter - 20X0 245
Last Quarter - 20X0 265
Equipment
Lot 1 200
Lot 2 225
Lot 3 240
Required
(a) Income statement for period ending 31.12.90 for KAMUTI Ltd adjusted for price level
changes.
(b) Balance Sheet as at 31.12.00 for Kamuti Ltd adjusted for price level changes.
SOLUTION
(A) KAMUTI Ltd: Income Statement
For the year ended 31.12.20X0
KShs KShs
Sales 400,000
Cost of sale (W1) (249,140
Gross profit )
Operating Expenses 150,860
Selling and (100,000)
Administration (49,000)
Depreciation Expense 149,400
75
(W2) 1,460
Net income from normal 14,240
operations
Add: Purchasing power Gain 15,700
(W3) (10,000)
5,700
Net income for the year
Dividends
Retained profits
Workings:
W1 - Cost of sales
Amount HCA Adjustment factor Adjusted amount
KShs KShs KShs
Opening inventory (1.1.00) 100,000 260/245 106,120
Add purchases 300,000 260/260 300,000
Cost of goods available for sales 400,000 406,120
less:closing inventory (31.12.00) (160,000 ) 260/245
(156,980)
Cost of sales 240,000 249,140
W2. Depreciation Expense

KShs
Lot 1 240,000 x 260 x 10% =31,200
200
Lot 2 120,000 x 260 x 10% =13,866

220
Lot 3 40,000 x 260 x 10% = 4,334

240
Total 49,400
W3. Purchasing Power Gain/Lossses
31/12/99 31/12/00
KShs KShs
Monetary Assets 60,000 130,000
Monetary Liabilities (240,000) 320,000
Net Monetary Liabilities 180,000 190,000
1.1.00- Purchasing power equivalent (180,000 x 260/250) 187,200
Add net charge during 10 years 10,000 x 260/200 10,000
Less
31.12.00- Purchasing power equivalent (190,000 x 260/270) 182,960
76
Purchasing power gain 14,240
(B) KAMUTI Ltd - Balance Sheet As at 31.12.20X0
Fixed Assets Kshs Kshs

Equipment (W1) 513,000
Acc. Depreciation (W2) (145,390)
367,610
Current Assets
Inventory (W3) 163,020
Accounts Receivable (W4) 20,000
Cash (W4) 110,000 293,020
980,630
Equity
Ordinary Shares (W5) 216,000
Retained Earning (W6) 31,160
Holding Gain (W7) 93,470 340,630
660,630
Liabilities
Bonds Payable (W4) 300,000
Accounts Payable (W4) 20,000
980,630
Workings
W1 - Equipment
Initial cost Adjust Factor Adjusted Amount
Lot 1 240,000 (270/260) 324,000
Lot 2 120,000 (270/225) 144,000
Lot 3 40,000 (270/240) 45,000
400,000 513,000
W2 - Accumulated Depreciation - Equipment
(140,000 x 270) = KShs 145,390

260
W3 - Inventory - 31.12.90
(160,000 x 270) = KShs 163,020

265
W4 - Monetary Assets and liability remain the same
W5 - Ordinary Shares
(200,000 x 270) = KSh 216,000

250
77
W6 - Retained Earnings
(30,000 x 270) = KShs 31,160

260
W7 - Holding Gain/Loss
Non monetary items General Price

Level Adjusted Historical Difference
Amount Cost
KShs KShs KShs
Equipment 513,000 400,000 113,000

Accumulation Depreciation 145,390 (140,000) (5,390)
Inventory 163,020 160,000 3,020
Ordinary Shares 216,000 200,000 (16,000)
Retained Earnings 31,160 30,000 1,160
Holding Gain 93,470
5.7 ADJUSTMENTS TO CURRENT COST ACCOUNTING

Current cost accounts are usually produced by making adjustments to Historical cost accounts.
The following adjustments are be incorporated in current cost accounts:
• Depreciation adjustment (DA)

• Cost of sales adjustment (COSA)
• Monetary working capital adjustment (MWCA)
• Gearing adjustment (GA)
Depreciation adjustment is the additional depreciation arising due to increase in prices of

goods. It is calculated as follows:
Apply the depreciation rate to the current value of the asset. From the resultant figure, deduct
depreciation already charged in the profit and loss account (HCA). The DA should be treated as
follows:
Dr. Current cost P/L Account xx

Cr. Provision for Depreciation xx
Cost of sales adjustment (COSA) is the additional cost of sales arising due to inflation. There
are two ways of computing the COSA.
i. If one or many items are involved, then the cost of the items sold is deducted from the
current value of those items to get the COSA.
Example:
78
Assume 100 items were purchased at KShs 250 each and were sold at 400 each during the
period. Extra stock was purchased at 310/= each. Then the COSA will be
= Change in cost of item x No. of units sold

= (310 - 250) x 100 = KShs 6,000
ii. Averaging Method

- Under this method, opening stock and closing stock are reinstated at the average price.
The procedure is as follows:
• Restate both the opening and closing stock to average price.

• Compute the difference between the value of opening stock and closing stock on
historical basis. This difference is made up of two elements - volume change and price
change.
• Compute the difference between opening and closing stock - both stated to average price
- the difference is due to volume change.
• The difference between (b) and (c) above is the COSA.
(see example below).
Monetary working capital adjustment (MWCA)

- MWCA = Debtors - Creditors
- Does not include cash unless it is directly linked to movement in working capital
- MWCA represents the amount of additional (or reduced) finance needed for the monetary
working capital as a result of changes in the input prices of goods and services used and
financed by the business.
- Monetary working capital includes the following elements:-
Monetary Assets
• Trade debtors
• Trade bills receivable
• Prepayments
• VAT recoverable
• Any part of the bank balance (or overdraft) arising from fluctuations in the level of stock,
debtors, creditors, etc.
• Any part of the cash floats required to support day to day operations of the business.
• Certain stocks not subject to COSA e.g
-Seasonal purchases
-Dealing stocks
-Unique contracts
Monetary Liabilities
i. Trade creditors
79
ii. Trade bills payable
iii. Accruals and expense creditors
iv. VAT payable
Gearing Adjustment
This is the gain due to the shareholders as a result of financing the assets through loans. The
acquired assets increase in value during periods of inflation while the amount of loan remains the
same. Borrowings are usually fixed in monetary amount, irrespective of changes in the prices in
the various parts of operating capability. If prices rise, the value to the business of assets exceed
the borrowing that has financed them. The excess (less interest on the borrowings) accrues to the
shareholders and is realised as the assets are used or sold in the ordinary course of business.
Gearing Adjustment (GA)
= (DA + COSA + MWCA)* Borrowing (Average)

Borrowing + Shareholders Funds
(Average) (Average)
Borrowing comprises of all monetary liabilities less all monetary assets. In particular,
convertible loan stock, debentures and deferred taxation should be included in borrowing.
Example
The following are extracts from the historical cost accounts of Inflac PLC for the year ending
31.Dec. 20X9
Profit and Loss Account

Kshs.
‘000’
Operating profit (after depreciation of Kshs. 500
150,000) (100)
Interest 400
Profit before tax (70)
Tax 330
Profit after tax (30)
Dividends 300
Retained profit
Balance Sheet
31/12/20X9 31/12/20X8
Kshs ‘000’ Kshs ‘000’
Fixed Assets-cost 2,000 2,000
- acc. Depreciation (1,150) (1,000)
850 1,000
Current Assets – stock 800 600

- debtors 1,050 900
80
- cash 300 200
Total Assets 3,000 2,700
Capital and Reserves

Ordinary shares 600 600
Retained profit 700 400
1,300 1,000
Debentures 600 600
Deferred tax 100 100

Current liabilities
Creditors 600 500
Overdraft 300 400
Taxation 70 75
Proposed dividends 30 25
Total Equity and Liabilities 3,000 2,700
• Transactions occur evenly throughout the year.

• The price index for stock (and used for monetary working capital) was as follows:
At date closing stock - 20X8 were purchased173.3

31 December 20X8 177.4
Average for 20X9 190.7
At date closing stock - 20X9 were purchased197.9
31 December 20X9 202.4
• Cost of sales for 20X9 was Kshs. 2,200,000

• Fixed assets were purchased four years ago when the relevant index was 130. This index
had moved to 195 by 31. December 20X8 and 227.5 by 31. December 20X9. Straight line
depreciation of 7.5 per cent per annum.
Required
(a) Calculate the following adjustments for current cost accounts
i. Depreciation Adjustment
ii. Cost of sales adjustment
iii. Monetary working capital adjustment
iv. Gearing Adjustment
(b) Prepare the current cost accounts for Inflac Ltd for the year ending 31.12. 20X9.
Solution
i. Depreciation Adjustment
Kshs`000'
81
Historic cost depreciation - 1999 150.0
Current cost depreciation (150 x 227.5) 262.5
130 ____
Depreciation adjustment 112.5
ii. Cost of sales adjustment (COSA)
Historic cost Index Adj. Current cost

Kshs`000' Kshs`000'
Closing stock 800 190.7/197.9 770.9

Opening stock (600) 190.7/173.3 (660.3)
200 110.6
Of the total increase of Kshs.200,000 in stock value Kshs.110,600 can be attributed to

volume increases. The balance of Kshs.89,400 is considered to result from changing
price levels and it is this amount which constitutes the COSA.
iii. Monetary working capital adjustment (MWCA)
Historic cost Index Adj. Current cost

Kshs`000' Kshs`000'
Closing MWC 450 190.7/202.4 424
Opening MWC (400) 190.7/177.4 (430)
50 (6)
There has been a volume decrease of Kshs6,000. The increase of Kshs.50,000 results
from a price increase of Kshs.56,000. This is the value of the MWCA.
iv. Gearing Adjustments (GA)

20X9 20X8
Kshs. ‘000’ Kshs. ‘000’
Net borrowings:
Debentures 600 600
Deferred Tax 100 100
Overdraft 300 400
Tax 70 75
Cash (300) (200)
700 975
Simple average = 770 + 975 = Kshs.872,500

2
82
Shareholders' funds: it is not convenient to calculate the capital and reserves at this point. The
figures are calculated by reference to the current cost net assets.
20X9 20X8
Ksh ‘000’ Ksh ‘000’
Fixed Assets 1,487.5 1,500
Stocks 818.2 614.2
Debtors 1,050 900
Creditors 600 500
Cash less overdraft 200
Tax (70) (75)
Deferred Tax (100) (100)
Debentures (600) (600)
985.7 1,539.2
Simple Average = 1,985.7 + 1,539.2 = Kshs.1,762,450

2
Gearing Adjustment =
Kshs. (Kshs.112,500 + Kshs. 89,400 + Kshs. 56,000) * 872,500___________
Kshs.872,500 + Kshs.1,762,450
872,500 + 1,762,450
GA = Kshs. 85,400
(b) In order to prepare the current cost accounts, the following workings are necessary
W1 - Fixed Assets
Accumulated .Depreciation.(1.1.X9) = Kshs 1,000,000 x 195 = Kshs.1,500,000

130
Accumulation .Depreciation.(31.12.X9) =Kshs.1,000,000 x227.5 = Kshs.1,750,000
130
Backlog depreciation charge 250,000
Accumulated current cost depreciation

= Acc. Dep (1.1.99) + Depreciation charge
= Kshs. 1,750,000 + 262,500 = Kshs. 2,012,500
Gross current cost of fixed assets

= Kshs. 2,000,000 x 227.5 = Kshs.3,500,000
130
Net current cost of fixed assets = Kshs. 1,487,500
83
W2 - Stock
Closing stock should be based on the index on 31.12.X9
Thus Kshs.800,000 x 202.4 = Kshs. 818,200

197.9
Opening stock should be based on the index on 31.12.X8
Thus Kshs.600,000 x 177.4 = Kshs.614,200

173.3
Thus an adjustment (Kshs.818,200 - Kshs.614,200) = Ksh.6,000
Should be reflected in the reserves
W3 - Current Cost Reserve
Kshs.`000' Kshs.`000'
Backlog depreciation 250 Balance b/f 514.2
Gearing adjustment 85.4 Asset revaluation 500.0
COSA 89.4
Balance cf 828.2 MWCA 56.0
. Stock increase 4.0
1,163.6 1,163.6
Current cost profit and loss account for the year ended 31 December 1999
Ksh. ‘000’ Kshs.
‘000’
Operating profit 500
Current cost adjustment
Depreciation (112.5)
COSA (89.4)
MCWA (56.0) (257.9)
Current cost operating profit 242.1
Gearing adjustment 85.4
Less: interest payable (100.0) (14.6)
Current cost profit before tax 227.5
Taxation (70.0)
Current cost profit after tax 157.5
Dividends 30.0
Retained profit-current cost 127.5
Current Cost Balance Sheet As at 31.12.20X9
84
KSHS.`000
'
Fixed Assets (NBV) 1,487.5
Net Current assets
Stock 818.2
Trade debtors less trade creditors 450.0
Other current liabilities (100)
Total assets less current liabilities 2,655.7
Deferred tax (100.0)
Debentures (600.0)
1,955.7
Ordinary Shares 600
Current cost Reserves 828.2
Retained profit 527.5
1,955.7
CURRENT COST ACCOUNTING (CCA)
Merits of CCA (also called Current Cost Deprival Value Model)
1. It is relevant to the needs of users of financial statements in;
• Assessing the stability and sustainability of the business entity.

• Assessing the vulnerability of a business against take over predators.
• Evaluating the performance of management in maintaining and increasing the
operating capacity of the business.
• Evaluating future performance.
2. CCA can be implemented easily by making adjustments to cost.

3. By excluding holding gains from profits CCA can be use to indicate whether or not a
dividend should be paid.
4. Assets are valued not only at their current costs but after management has evaluated the
opportunity cost of holding them and the benefit of their future use to the business.
WEAKNESS OF CCA
IAS 15 has been criticize on a number of grounds;
(a) The inclusion of a monetary working capital adjustment and a gearing adjustment:
• Causes problems of definition particularly in relation to cash and overdrafts.
• Treats preference share capital like equity, although it is in reality nearer to
borrowings in terms of sources of finance. This is due to the need to show profit
attributable to all shareholders, ordinary and preference as required by the Companies
Acts.
85
The guidance notes suggest that where a company has material amount of preference
shares with fixed repayment rights, it may wish to show in a note the effect of
including preference share capital in net borrowings.
• Includes in borrowings such disparate items as taxation and debentures. While
the latter might be expected to be maintainable in a constant ratio to equity (excluding
preference shares) the former will IAS 12 vary in relation to taxable profit.
(b) It can be regarded that monetary working capital and gearing adjustments reflect some of
the benefit of borrowing in a period of inflation, by allowing for the netting off or adding
back of that portion of the realized holding gain’s financed by monetary liabilities.
However, there is still no indication given of the real effect, in general purchasing power
terms, of inflation on the investor’s stake.
(c) Profits are not comparable in real terms from year to year, nor from company to company
within one year.
(d) Treatment of backlog depreciation: It is debited to current cost reserve (reducing the
unrealized holding gain on fixed assets). Would it be better to treat it as under-provision
for depreciation in earlier years and it set against cumulative retained current cost profits?
Otherwise cumulative retained current cost profits? Otherwise cumulative retained
current cost profit will not represent the amount which can be distribute without depleting
the operating capability.
Practical problems in operating current cost accounting

Amongst the practical problems encountered in operating current cost accounting are the
following:
Selection of a suitable index

It is not always easy to obtain an index which is perfectly suitable for measuring the movement
in the current cost of a particular type of asset. This need not be an insuperable problem because
the company may be able to construct its own index or to apply one which gives results which do
not materially distort result.
Overseas assets
It is often difficult to obtain a suitable index for use with overseas assets. Once again a proxy is
often possible.
Valuation of specialist plant and buildings

It is often difficult to obtain a suitable market value for specialist items, but indices may be
constructed as an alternative.
d) There may be no intention to replace an asset, possibly due to a change in the nature
of the business
In such a case the current cost of the existing asset was not given a relevant adjustments.
Where a company is trying to maintain its operating capacity in a different area it should
use a suitable index base on a possible replacement in the new field of activitiy.
e) There may be no modern equivalent asset due to the advance of technology
86
In such a case it is necessary to calculate what proportion of the cost of a new asset is
required in order to maintain the volume of output and determine the current cost of the
old equivalent therefrom. That part of the charge which gives added output or cost
advantages should be disregarded.
f) It may be difficult to audit some of the adjustments
In practice it is generally no more difficult to verify these areas than other subjective
aspects of accounting.
In addition to the above penalties, any person guilty of insider trading is liable to pay
Compensation to any person who in the transaction for the purchase or sale of securities, entered
into with the insider, or with a person acting on his behalf, suffers loss, by reason of the
difference between the price at which securities were transacted and the price at which they
would have likely have transacted if the offence had not been committed. In the event the harm
is done on the market as a whole, or those harmed cannot be reasonably and practicably
determined, the payment shall be made to the Compensation Fund of the CMA. The amount of
compensation to be paid is the amount of loss sustained by the person claiming compensation.
Revision Questions
QUESTION ONE
“Inflation accounting is an element but a useless creature with a prodigious appetite for extra
data. It is the sterile offspring of a scandalous marriage between high financial economics and
mismanaged economics”.
Required:
a) In light of the above statement, summarise some of the arguments that can be advanced to
defend Historical cost accounting. (8 marks)
b) What flaws exist under Historical cost accounting that can encourage setting of an
accounting standard for firms operating under inflationary conditions (8 marks)
c) Provide the criteria that should be used in the selection of appropriate accounting
measurements in business reports. (4 marks)
87
UNIT 6.ACCOUNTING FOR BRANCHES AND AGENCY
6.1 Objectives
At the end of the lesson you should be able to:
i. Deal with the accounting system whereby branch transactions are recorded in the Head
office books;
ii. Deal with the maintenance of current accounts between the head office and branches
where each branch maintains its own records, and the preparation of the overall Trading
and Profit and Loss Account and Balance Sheet for the enterprise as a whole;
iii. Account for transactions between a head office and a branch situated in a foreign country,
and translate the foreign currency financial statements of a branch into the reporting
currency of the Head Office in order to prepare the overall Trading and Profit and Loss
Account and Balance Sheet of the enterprise as a whole.
6.2 Introduction
Accounting has two main objectives:
i. To assist control over the assets and liabilities, and the income and expenditure of the
enterprise; and
ii. To ascertain the profit or loss of the enterprise, the main sources of income and
expenditure contributing to this profit or loss and the assets and liabilities that represent
the profit or loss.
iii. If the owners of an enterprise want it to earn more profit, they must increase the volume
of turnover. As turnover increases, the enterprise must expand physically; as it expands,
it will create departments, which deal with different lines of sales or services; there is a
limit to the physical expansion at a single site – and the market there is also limited.
Hence, enterprises set up branches, so that expansion can be continued. The need then
arises to control the assets, liabilities, income and expenditure of the different
departments and/or branches.
6.3 System One - The Head Office Maintains All The Accounts
This system is suitable for an enterprise that has small branches (possibly in another area of the
town or city where the Head Office –HO – is situated), which sell goods supplied by the HO. On
the sale of goods, cash is received which should be banked intact into the local branch of a bank;
the bank can be instructed to credit the Head Office account, which is maintained at a different
branch of the same bank. Cash expenditure by a branch is normally funded by an imp rest
provided by the HO, replenished at regular intervals by a cheque for the actual amount of
expenditure incurred. Where credit sales are permitted at a branch, each invoice raised at the
branch will be made out in the triplicate; one copy is given to the customer as the invoice; the
second copy is sent (as part of a batch of invoices) to the HO; the third is retained by the branch
for reference. All goods should be purchased through a central buying department at the HO.
Goods are issued to branches on the basis of requisitions received from branch managers. Of
course it should be realized, that with the advent of computers the amount of paperwork may be
substantially reduced and procedures not exactly as described.
88
The branch manager should be required to forward to HO at weekly, fortnightly or monthly
intervals, returns giving particulars of goods received from and returned to HO, cash and credit
sales, cash received from debtors, expenses, cash banked and stock and cash in hand at the end of
the period. From these, the HO will maintain accounts for the branch in the HO books.
In order to provide a check that branch managers and staff deal properly with goods and cash
passing through their hands, goods are normally charged to branches at the actual prices at which
branches sell them. Consider the following set of figures relating to a branch:
20X2 Shs’000
January Goods in hand at the branch, valued at selling price 3,000
1:
January Goods sent from the Ho to the branch, valued at selling 3,460
31: price
January Goods sold to customers for cash in the month of January 3,280
31:
What would be the value of closing stock at the branch at 31st January 20X2, valued at selling
price?
It would be:
Shs’000
Opening stock (at selling price) 3,000
Add goods received (at selling price) 3,460
Total goods available 9at selling price) 6,460
Deduct goods sold (at selling price) 3,280
Closing stock (at selling price) 3,180
In the above example, it was assumed that there was no wastage of goods, no breakages, and no
pilfering by customers, and that all sales were made at the predetermined selling price. A check
can be made by staff from the HO, e.g from the internal audit department, to ensure that the
stock of Shs 3,180,000 is really present at 31st 20X2. Usually an allowance will be made for
wastage and breakages, e.g. if an allowance of 1% of goods sent to a Brach is given as a “normal
loss”, a closing stock figure of Shs 3.18m – Shs 34,600 = Shs 3,145,400 would be accepted; if
the stock level is less than this, an investigation as to why this is the case would be made.
In the HO books, the following accounts are kept in respect of each branch:
Branch Stock Account

It sis maintained at estimated selling price (invoice price).
It controls branch stocks.
The balance should represent the selling price of branch stock in hand.
Any difference between physical stock and the balance on the account must be investigated
(unless this difference is a normal loss)
Branch Mark-up Account
89
The opening balance represents the provision for unrealized profit on stock brought forward.
This account records anticipated profits on goods sent to branch.
The balance carried forward, representing unrealized profit on closing stock, is deducted from
the branch stock account balance in the balance sheet thus reducing stock to cost.
The gross profit of the branch will be the balancing figure in the account.
Goods Sent To Branch Account

The amount on this account at the year-end represents the cost of goods sent to branch.
This figure is credited to the HO Trading account to reduce goods available for sale by head
office (or if the head office is not a selling organization, the stocks held on behalf of the branches
at the year end).
This account has neither an opening nor a closing balance.
Branch Total Debtors Account – This is used to control branch debtors.

Profit and loss account – The expenses incurred by each branch (posted to separate branch
expense accounts) are charged against the branch gross profit to give the net profit or loss of the
ranch. These profit and loss accounts are normally prepared in a columnar format, so that the
profit and loss account for the enterprise as a whole can be arrived at. As s the gross profit is
shown in the mark up account, it is not necessary to prepare the trading account unless the
examiner specifically requires this. In practice, however, the trading account is required so that
the total turnover of the enterprise can be obtained.
Balance Sheet – This is not normally required by the examiner under this system. However, if it
is required, stock is shown at cost, which is arrived at by deducting the balance carried down on
the mark up account from that on branch stock account.
Sundry Matters
The accounting system is also appropriate for departmental accounts.
The branch stock account is a practical means of controlling stock at the branch. Supervisors can
quickly ascertain the selling price of stock at a branch and compare this with the balance shown
in the head office books. Such spot checks will bring to light:
Normal differences e.g. wastage, evaporation, minor miscalculation of selling price, or errors in
stock taking;
Abnormal differences e.g. goods or cash stolen.
This method prevents branch staff from knowing the cost of goods being sold and preserves
secrecy with regard to profits.
Ascertaining the percentage or fraction to deduct from invoice price may cause some students
difficulty. No doubt it is appreciated that the percentage to be deducted from the selling price is
not the same as that which is added to cost, e.g. If 33 1/3% is added to cost to arrive at invoice
price then 25% must be deducted from selling price to get back to cost.
Mark up is defined as the rate of gross profit to cost of sales:
Mark up = Gross Profit
90
Cost of sales
Margin is defined as the rate of gross profit to sales:
Margin = Gross profit

Sales
Calculations of markup and margin are necessary to compute the profit loading on:
Closing stock at the branch

Returns from branch to head office
Examination questions may provide information on either the markup or the margin. If one is
provided, it may be necessary to compute the other.
Let us assume: X = Gross Profit

Y = Sales
Therefore: Margin= Gross Profit = X

Sales Y
However:
Sales – Costs = Gross Profit
Or:
Costs = Sales – Gross Profit
Which is stated as:

Costs = Y–X
And since:
Mark up = Gross Profit
Costs
This is stated as:
Mark up = X
Y–X
In summary, if: Margin = P/Q
Then the related Markup shall be P/(Q – P)
Using similar arguments, it can be established tat if the Markup is give by P/Q,
Then the related margin shall be P/(Q+P)
91
For example, B Ltd marks up its goods by 2/11 of the cost. It the sales are Sh 202,800, what is
the gross profit?
In conclusion, let us assume C Ltd earns a gross profit of 2/17 of its selling price. It the cost of
sales in a particular month was Sh 4,819,500, what were the sales and gross profit?
Gross Profit = 2/15 X 4,819,500 = 642,600
Sales = (4,819,500 + 642,600)= 5,462,100
Sales = (17/2 X 642,600) = 5,462,100
Sales = 17/15 X (4,819,500) = 5,462,100
Double entry
Transactions Debit Credit
Cost of goods sent to Branch stock account Goods sent to branch account
branch
Mark-up on goods sent to Branch stock account Branch mark up account
branch
Cost of goods returned by Goods sent to branch Branch stock account
branch to head office account
Mark-up on goods returned Branch mark-up Branch stock account
to head office account
Cash sales Cash account Branch stock account
Credit sales Branch debtors Branch stock account

account
Returns from credit Branch stock account Branch debtors account

customers
Discounts allowed to credit Branch profit and loss Branch debtors account
customers account
Bad debts written off Branch profit and loss Branch debtors account
account
Amount of cash lost from Branch profit and loss Branch stock account (or branch
branch account cash account)
Cost of stock lost from Branch profit and loss Branch stock account
branch account
Mark-up on stock lost from Branch mark-up Branch stock account
branch account
Amount of normal stock Branch mark-up Branch stock account
loss of branch account
Balance on branch mark-up Branch mark-up Branch profit and loss account
account being gross profit account
of branch
Balance on goods sent to Goods sent to branch HO trading account
branch account being cost account
of goods sent for period
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Illustration 1
A limited set up a branch in Buruburu, Nairobi, on 1st January 2002 to expand its volume of
business. The accounts for the branch are maintained in the HO Ledger. Goods sent to the
branch are invoiced to the branch at selling price, which is HO cost plus 33 1/3% of O cost.
By 31st December 2002, goods with a selling price of Shs 4m had been sent to the branch; goods
with a selling price of Shs 200,000 were unsuitable for sale in this branch and were returned to
the head office. In the year cash sales amounted to Shs. 2,800,000 and credit sales amounted to
Shs 600,000 and closing stock on 31 December 2002 was (at selling price) Shs 400,000.
The Head Office and branch expenses ere Shs 2,200,000 and Shs 810,000 for the year to 31
December 2002 respectively. For simplicity, these expenses have not been analyzed into their
constituent components; they are posted in their total amounts in a columnar Expense Account.
BRANCH STOCK ACCOUNT

2002 Shs 000 2002 Shs 000
Dec 31 GSTB 3,000 Dec 31 Goods sent to branch 150
Dec 31 Branch Mark up 1,000 Dec 31 Branch mark-up 50
Dec 31 Cash book 2,800
Dec 31 Branch debtors 600
____ Dec 31 Balance c/d 400
4,000 4,000
2003
Jan 1 Balance b/d 400
BRANCH ADJUSTMENT (Mark up) ACCOUNT

2002 Shs 000 2002 Shs 000
Dec 31 Branch stock a/c 50 Dec 31 Branch stock a/c 1,000
Dec 31 Branch P & L 850
Dec 31 Balance c/d 100 ____
1,000 1,000
2003
Jan 1 Balance b/d 1,000
GOODS SENT TO BRANCH ACCOUNT

2002 Shs 000 2002 Shs 000
Dec 31 Branch stock a/c 150 Dec 31 Branch stock 3,000
Dec 31 HO trading a/c 2,850 ____
3,000 3,000
EXPENSE ACCOUNTS
2002 Shs Shs 2002 Shs 000
000 000
HO Branch Dec HO Branch
31
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Dec Cash 2,200 810 Dec P&L a/cs 2,20 810
31 book/creditors 31 0
Let us see how the figures relating to this branch would now be combined with a set of figures
for the HO to give an overall trading and Profit and Loss Account. The overall or combined
sales figure would be shown in the statutory accounts of A Limited. We will assume that the
following information relates to the head office:
Shs 000
Opening stock at HO 1,000
Closing stock at HO 550
Purchases made by HO 10,500
Sales made by HO 10,800
TRADING & PROFIT & LOSS ACCOUNT FOR THE YEAR ENDED 31ST DECEMBER
2002
Head office Branch Combined
Shs 000 Shs 000 Shs 000
Sales 10,800 3,400 14,200
Opening stock 1,000 NIL 1,000
Purchases/goods from HO 10,500 2,850 10,500
11,500 2,850 11,500
(2,850)
Closing stock 8,650
Cost of sales (550) (300) (850)
Gross profit (8,100) (2,550) (10,650)
Expenses 2,700 850 3,550
Net profit 2,200 810 3,010
Branch 500 40 540
Combined 40
540
Even though the stocks and purchases in the branch are not accurate, let us assume that this is so
until autonomous branches have been studied.
The branch sales, opening stock, goods from HO and closing stock figures are all memorandum
figures i.e. these figures are extracted from the accounts in the ledger but they do not arise as a
result of the double entry process.
In 2003, the following transactions occurred: we shall now call the Buru Buru branch of A
Limited branch 1 (one) to distinguish it from branch 2, branch 3, etc.
Shs 000
Goods sent to branch 1, at invoice price 6,000
Goods returned to HO from branch 1 at invoice price 180
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Cash sales 4,800
Credit sales 1,020
Returns to branch 1 debtors 60
Returns to the HO by branch debtors 80
Goods sent to branch 2 from branch 1 (at selling price) 96
Goods sent to branch 1 from branch 3 (at selling price) 76
Branch 1 expenses for the year 1,100
We shall consider four different scenarios at 31st December 2003. In situation (a) when stock
was counted on 31st December 2003, the value of the physical stock on hand valued at selling
price agreed wit the balance in the stock account.
In situation (b) when stock was counted on 31 December 2003, the value of physical stock on
hand valued at selling price was Shs 360,000. After investigation, it was found that stock at
selling value of Sh 80,000 had been stolen in the year.
In situation (c) again the closing stock was discovered to be short by Sh 80,000 (at selling price).
In this case, it was established that cash was stolen on its way to the bank.
In situation (d), the closing stock was short by Shs 80,000 (at selling price). This figure is an
acceptable normal loss amount due to evaporation, spilling, etc).
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BRANCH 1 STOCK ACCOUNT
a b, c, &
d
2003 Shs Shs 000 2003 Shs Shs Shs Shs
000 000 000 000 000
Jan 1 Bal b/d 400 400 Dec Sundry a/c 180 180 180 180
31
Dec Sundry 6,00 6,000 CB 4,80 4,80 4,80 4,800
31 a/c 0 0 0 0
Branch 1
Dec Debtors Dec Branch 1 a/c
31 a/c 60 60 31 1,02 1,02 1,02 1,020
0 0 0
Dec Branch 3 Branch 2
31 Stock a/c 76 76 Dec Stock a/c 96 96 96 96
31
Branch 1
Dec mark up a/c
31 - 20 - 80
Branch 1
Dec P & L a/c - 60 80 -
31
Dec Bal c/d 440 360 360 360
31
6,53 6,536 6,53 6,53 6,53 6,536
6 6 6 6
2004
Jan 1 Bal b/d 440 360
BRANCH I MARK UP ACCOUNT

a b c d a b,c,d
2003 Shs Shs Shs Shs Shs Shs
000 000 000 000 000 000
Dec
31
Branch 1 45 45 45 45 Jan 1 Bal b/f 100 100
stock a/c
Branch 1 20 20 20 20 Dec Branch 1 stock 1,50 1,50
debtors a/c 31 a/c 0 0
Branch 2 24 24 24 24 Branch 3 markup 19 19
markup a/c ac
Branch 1 - 20 - 80
stock a/c
Branch 1 1,4 1,420 1,44 1,36
P&L 20 0 0
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Bal c/d 110 90 90 90 ____ ____
1,6 1,619 1,61 1,61 1,61 1,61
19 9 9 9 9
2004
Jan 1 Bal b/d 440
GOODS SENT TO BRANCH ACCOUNT

2003 Shs 2003 Shs
000 000
Dec 31 Branch 1 stock a/c 135 Dec Branch 1 stock a/c 4,500
31
Branch 1 debtors a/c 60 Dec Goods sent to branch 3 57
31 a/c
Goods sent to branch 2 72
a/c
HO trading a/c 4,290 ____
4,557 4,557
COMPUTATION OF SALES
In situations (a), (b) and (d), Branch 1 sales for the year are arrived at as follows;
Shs’000 Shs’000 Shs’000

Cash sales 4,800
Credit sales 1,020
Deduct returns to: branch 60
HO 80 140 880
Net sales 5,680
In situations (c ), Branch 1 sales for the year are arrived at as follows;
Shs’000
Cash sales as above 4,800
Add: cash collected but stolen before being banked 80
Total cash sales 4,880
Net credit sales, as above 880
Net sales 5,760
In d below it can be said that a normal loss is not reported separately in the Trading and Profit
and Loss Account; since it is “normal’, it is included as part of cost of sales and reduces the gross
accordingly
Branch 1 Trading & Profit And Loss Account For The Year Ended 31 December 2003
(a) (b) (c ) (d)
No loss Stock loss Cash loss Normal
loss
Shs ‘000’ Shs ‘000’ Sh ‘000’ Sh ‘000’
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Sales MEMO FIG 5,680 5,680 5,760 5,680
Opening stock MEMO FIG 300 300 300 300
Goods received from MEMO FIG 4,290 4,290 4,290 4,290
HO
4,590 4,590 4,590 4,590
Goods Stolen MEMO FIG (60)
4,530
Closing stock MEMO FIG (330) (270) (270) (270)
Cost of sales 4,260 4,260 4,320 4,320
Gross profit DOUBLE
ENTRY 1,420 1,420 1,440 1,360
FIG
Expenses (1,100) (1,100) (1,100) (1,100)
Goods or cash stolen ___- (60) (80) __-
Net profit 320 260 260 260
GOODS AT BRANCH MARKED DOWN, OR MARKED UP BY AN ADDITIONAL

AMOUNT
If goods at the branch are not selling well, branch could be authorized by the Head office to
mark-down the goods. Conversely, if the goods are selling much better than expected, or if
replacement goods will cost more, the selling price could be marked up. These mark-downs and
mark-ups are credited or debited into the branch stock account and debited or credited into the
branch mark-up account respectively.
Special care needs to be exercised in valuing closing stock.
3.4 System Two – “Autonomous Branches”
Legal Aspects
There is no law relating to branch accounts but examination problems under this heading are
frequently linked to either partnership or company account problems. Answering such problems
will therefore requires knowledge of branch accounting as well as the legal matters appropriate
to partnership or company accounting.
Accounts required and their purpose
Branch Current Account (Head Office Books)

Records all transactions branch and head office;
The balance represents the investment made by head office in the branch.
Head office Current Account (Branch Books)

Records all transactions between branch and head office;
The balance represents the branch’s capital;
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Profit and loss account balance must be transfeeed to this account at the end of the period.
Final accounts
Examination questions – two types of problems arise in examinations:
Either (a) transfers between head office and branch are made at cost;
Or
(b) Transfers between head office and branch are made at “wholesale” price which will
include a small element of profit. In such cases the examiner frequently requires the final
columnar accounts to show in the branch column, goods from head office and stocks at invoiced
price, but not reduce these the head office cost in the combined column.
Trading Account – head office column records transactions from the point of view of the head
office. It show all purchase made by the head office, sales to customers and transfers to the
branch at “wholesale” price.
Trading Account – branch column records transactions from the point of view of the branch. It
shows goods received from head office at “wholesale” price and local purchases at cost, and
stocks of goods from head office valued at “wholesale” price (i.e. includes an element of
unrealized profit from the point of view of the business as a whole) and stocks of local purchases
valued at cost.
Trading Account – combined column records transaction from the point of view of the business
as a whole, profits between head office and branch being eliminated – gross profit figures will
not cross-cast to the combined gross profit.
Profit and loss account – provisions for unrealized profits on closing stock held by the branch an
on goods in transit are entered in the head office column. Net profit figures will cross cast to the
combined net profit.
Balance Sheet – current accounts will appear in the head office and the branch columns but not
in the combined column;
The provision for unrealized profit on branch stock and goods in transit will appear under current
liabilities in the head office column but will be deducted from the stock figures in the combined
column.
The ‘combined’ column in the trading and profit and loss account and in the balance sheet are
derived from the head office figures and the branch figures; normally the head office figures and
the branch figures should be prepared first and the combined columns are then prepared from the
individual columns.
Sundry Matters
Current accounts balances must always be equal and opposite.

The head office current account in the branch books should always have a credit balance.
The branch current account in the head office books should always have a debit balance.
Goods in transit and cash in transit must always be adjusted in the head office books (regardless
of the direction in which they are in transit)
The final entry to close the current account will be the transfer of branch profit to head office.
99
Double Entry
IN HEAD OFFICE
BOOKS
Invoice value of goods sent Branch current account Goods sent to branch
to branch (may be cost or account
“wholesale” price)
Cash received from branch Cash account Branch current account
Expenses of branch paid by Branch current account Cash account or expense
head office (if any) creditors account
Profit of branch transferred Branch current account Profit and loss account
into head office books
Provision for unrealized Profit and loss account Provision for unrealized
profit where goods are profit account
invoiced to branch at cost
plus a mark up
Adjustment for goods and cash in transit are always made on the credit side of the branch current
account. The accounts will have equal and opposite balances once adjustments are made.
The balance on the current account is in fact represented by the branch fixed and current assets
less liabilities (i.e. the head office has provided the branch with its capital).
IN BRANCH BOOKS
Invoice value of goods Goods received from head Head office current account
received by branch (will not office account
be the same as goods sent
by head office if there are
goods in transit)
Cash sent to head office Head office current account Cash account
(will not be the same as
cash received by head office
if there is cash in transit)
Expenses paid by head Relevant expense account Head office current account
office on behalf of branch
Profit of branch transferred Profit and loss account Head office current
into head office books
Pro-forma balance sheet for a head office and autonomous branch:

Head Branch Combined
office
ASSETS Sh Sh Sh Sh Sh Sh
Non – Current assets
Property plant and equipment X X X
Financial assets: investment in branch X
Less unearned profit (X)
100
X _-_ _-_
X X X
Current assets
Stocks in warehouses X X X
Stocks in transit X
Less unearned profit (UP) (X)
X - X
Debtors X X X
Cash at bank X X X
Cash in hand X X X
Cash in transit X - X
X X X
XX XX XX
EQUITY AND LIABILITIES
Head office current account X
Ordinary share capital X X
P & L Reserve X X
X X
Non-current liabilities
Bank loan X X
Current liabilities
Creditors X X X
Accruals X X X
X X X
XX XX XX
Pro-forma income statement for a head office and autonomous branch

Head Branch Combined
office
Sh Sh Sh Sh Sh Sh
Sales X X X
Goods sent to branch X _-_ _-_
X X X
Cost of sales:
Opening stock X X X
Purchases X - X
Goods from head office _-_ X _-_
X X X
Less closing stock (X) (X) (X)
(X) (X) (X)
Gross profit X X X
Sundry expenses X X X
Increase in UP X _-_ _-_
(X) (X) (X)
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Net profit XX XX XX
TACKLING THE QUESTION

It is recommended that you reconcile the balances on the current accounts before working on the
final accounts, which are most probably what the exam question will require. The positioning of
current account balances in trial balances will be seen as follows:
TRIAL BALANCE (EXTRACTS)

Head office Branch
X X
Head office current account X
Branch current account X
X X
X X
X __ X __
XX XX XX XX
It is highly unlikely that the balances will be equal and opposite. The difference arises due to
items in transit. What was sent out by the head office and recorded by them has not been fully
received by the branch and reported. The difference may also arise when a branch sends items to
the head office but the head office has not received everything dispatched by the branch.
Therefore, each party has reported different values for transactions with each other, the
difference being items in transit.
Reconciliation of these accounts merely requires reporting items in transit in the branch current
account in the books of the head office.
6.4 Foreign Branches:
The head office may set up a branch in a foreign country. IAS 21 requires that the results of that
foreign branch to be translated into the local currency for the purpose of preparing the financial
statements for the whole business.
There are two main ways of translating the results of the branch ;
The functional currency method. (formerly temporal method)

Under this method, the branch is considered to be an extension of the head office and this is
reflected by the trading arrangement between the head office and branch.
In most cases the head office will send goods to the branch and the branch will remit the
proceeds on sale of these goods to the head office. Any exchange gain or loss arising from
translating the results of the branch is treated as profit and loss item reported as an income or an
expense.
Presentation method (formerly closing rate or net investment method)
102
Under this method, the branch operates with a lot of degree of autonomy from the head office.
This position is reflected by the fact that there are fewer transactions taking place between the
head office and the branch.
Any exchange gain or loss arising from translating the results of branch should be transferred to
the foreign exchange reserve.
The following should be the exchange rates to be used in translating the balances of the branch
under each of the respective methods.
REF: Historical rate : Rate when transaction took place (e.g. rate when asset was
acquired)
Closing rate : Rate on balance sheet date (end of financial period)
Average rate : Average rate of or the financial period.
Actual rate : Actual rate on date of conversion of cash from the branch.
Specific rate : Rate agreed by head office and branch for goods transferred from head
Balance Functional Presentation

currency
Method Method
Profit and loss items
Sales Average Average
Opening inventory Historical Average
Purchases Average Average
Goods transferred from head office Average/specific Average/speci
fic
Closing inventory – local purchases Historical Average
Goods from head office Average/specific Average/speci
fic
Depreciation Historical Average
Office expenses Average average
Balance sheet items

Property, plant and equipment Historical Closing
Inventory – from local purchases Historical Closing
From head office Specific Specific
Receivables Closing Closing
Cash – at bank Closing Closing
- in transit Actual Actual
Payables Closing Closing
Head office current account – no translation but we take branch current account and
deduct GIT and CIT
103
The following steps should be followed in preparing the final accounts where we have a foreign
branch.
Update the trial balance of the branch that is given in the foreign currency with the following
items:
closing inventory DR Balance sheet
CR profit and loss.
b) Accrued or prepaid expenses. Accrual : DR. profit and loss (expense)

CR balance sheet (liability)
Prepayment : DR. Balance sheet (Asset)

CR Profit and loss (expense, income)
c) Depreciation: DR. Profit and loss (expense)

CR Balance sheet (provision)
Translate the updated trial balance of the branch using the exchange rates given and depending
on the method of translation.
Once the trial balance has been translated into the local currency, the debit side may not be the
same as a credit side and balancing figure is the exchange gain or loss.
If the debit side is more than the credit side, then difference is an exchange gain and if the credit
side is more than the debit side then the difference is an exchange loss.
Prepare the final accounts of the branch in the normal way using the trial balance of the head
And the translated trial balance of the branch.
Care should be taken on the treatment of the exchange gain or loss. The following points should
be applicable.
If the functional currency method is being used, then any exchange gain or loss will appear in
the column of the branch and the combined business in the profit and loss accounts. An
exchange gain will appear as other incomes under gross profit and exchange loss and expense in
the profit and loss account.
b) If the presentation method is being used, then the exchange gain or loss will be taken to a
foreign exchange reserve which will appear as part of capital and reserves in the balance
sheet
of the branch and the combined business or added to the head office current account.
Revision Questions
QUESTION ONE
104
B LTD, whose head office is in Mombasa, operates a branch at Malindi. All goods are
purchased by head office and invoiced to and sold by the branch at cost plus 331/3%. Other than
a sales ledger kept in Malindi, all transactions are recorded in the books in Mombasa. The
following particulars are given of the transactions at the branch during the year ended 30th June
20X7.
Shs
Stock on hand, 1st July 20X6 at invoice price 308,000
Debtors on 1st July 20X6 276,220
Stock on hand, 30th June 20X7 at invoice price 276,360
Goods sent from Mombasa during the year at invoice price 1,736,000
Credit sales 1,470,000
Cash sales 168,000
Returns to head office at invoice price 70,000
Invoice value of goods stolen 42,000
Bad debts written off 10,360
Cash from debtors 1,568,000
Normal loss at invoice price due to wastage 7,000
Cash discount allowed to debtors 29,960
Any further loss should be treated as a loss of cash.

You are required to write up the Branch Stock Account, the Branch Mark-up Account and
Branch Total Debtors Account for the year ended 30th June 20X7 as they would appear in the
head office books.
105
Unit 7: LEASE AND HIRE PURCHASE TRANSACTIONS
7.1 Objectives
At the end of this lesson you should be able to:
• Record lease and hire purchase transactions in the books of the vendor and the purchaser.
• Distinguish the two classes of leases, their accounting treatment and disclosure in the
financial statements of
• both the lessee and the lessor in accordance with the provisions of the International
Accounting Standard No.17
• Calculate the finance charge or hire purchase interest and its apportionment over the lease
term; adjustment
• Required on the repossession of goods sold on hire purchase terms.
• Distinguish, where appropriate, between the normal gross profit made on hire purchase
sales, and interest
• Earned on outstanding instalments.
7.2 Accounting for Leases (Ias 17)

A company may acquire the right to use a fixed asset over its useful life in a number of ways.
These include:
1. Outright purchase for cash;

2. Outright purchase on credit (or using proceeds of a secured/unsecured loan)
3. Hire purchase
4. Lease Acquisition.
In (1) and (2) the legal title to the fixed asset is obtained on the date of purchase.
In (3) title is obtained when the final instalment is paid. In a finance lease, legal title can never
pass to the
lessee (person utilising the asset)
Leases are best understood as rental agreements. If a person gives out an asset that he owns - to
be used by another person in exchange for periodic rental payments, the person may be said to be
leasing out his asset.
Leases are broadly classified into 2:
1. Operating leases
2. Finance leases
106
Operating leases in the simplest terms are short-term agreements for rentals of assets.
They are accounted as follows:
Transaction/Event Books of Lessee Books of Lessor

(user of asset) (owner of asset)
Rental Income/Expense - DR Rent Expense - DR Cash book
is due CR Cash book CR Rent Income
and remitted
To record ownership of - Does not show asset in - Is the rightful owner of asset
the accounting records. and
asset carries it in his accounting
books.
To depreciate assets - Does not depreciate the - He will depreciate the asset.
asset
since he does not own it.
Entries to appear in P&L - Show rent expense in - Show rent income in P&L
P&L
Notes:
1) The emphasis of IAS 17 is on finance leases, and not operating leases.
2) Operating leases are just regular rental agreements covered by paragraphs 25 - 27 and 41 - 48
in IAS 17.
3) The examiner rarely expects you to carry out computations on operating leases.
Finance leases are also rental agreements; however, the rental duration is so long that the lessee
(user of the asset) ends up using the asset for most of its life. He will therefore be the sole user
of the asset even though he has rented it from someone else who is the rightful owner of such an
asset. He will thus be using the asset as if it is his own.
Under the “substance-over-form” concept, a transaction should be accounted for according to

economic substance rather than its legal form. In finance leases, the economic substance is that a
person uses an asset as if it is his own. The legal form of finance leases is that the asset is owned
by a different person (lessor).
107
Event/Transaction Books of Lessee Books of Lessor
(user of asset) (owner of asset)
Rental Income/Expense is - Record payments as - Record receipts as a receipt
due payments from debtor to whom asset is
and remitted to supplier of asset. sold.
To record ownership of - Record asset as if it is his - Does not record the asset as
asset own if
even if this is not the case. it is his; Instead shows a
- At the same time, shows a debtor
creditor whose value is to whom asset has been sold.
equal
to the value of the asset.
Note: If the above explanations are not too clear, don’t worry; the first example (further in this
chapter) will clear it up. The important thing is to realise that the lessee (user of the asset) does
not show rental payments, but instead records the transactions as “a purchase on credit”. All
rental payments are thus deemed to be payments to a supplier of an asset.
Further Aspects of Leases

Proper Definition of a Lease
This is a contract between a lessor and a lessee, whereby the lessor conveys to the lessee, in
return for the payment of specified rentals, the right to use an asset over an agreed period of time.
The lessor retains ownership of the asset.
Types of Leases:
i) Finance leases
ii) Operating leases
Finance Leases
This is a lease that transfers substantially all the risk and reward of ownership of the asset to the
lessee. Finance leases are usually non-cancellable and the lessee enjoys substantially all the risks
and rewards associated with asset ownership. At the end of the initial lease period (primary lease
period), title may or may not be passed to the lessee.
Risks and rewards associated with asset ownership include:
Risks: i) Losses from idle capacity;
ii) Losses from technological obsolescence;
iii) The variations in return due to changing economic conditions.
Rewards: i) Expectations of profitable operations over the asset’s economic life;
ii) Gain from appreciation in value of an asset, or realisation of a residual value.
A finance lease is usually non-cancellable, but may be cancelled under the 3 following
conditions:
a) Upon occurrence of some remote contingency;
b) With permission of the lessor;
c) If the lease is extended or renewed.
108
Operating Leases
This is any lease other than a finance lease. The lease assets are “rented out” to many different
lessees (users) over their useful economic lives. The lessee pays for the hire or use of the asset.
Ownership of the asset remains with the lessor, who assumes all the risks and rewards of the
asset and takes responsibility for repairs, maintenance and insurance expenses.
Criteria Categorising Finance Leases

i) The lease often transfers ownership of the leased asset to the lessee by the end of the lease
term, but till then
the lessor retains the title to the asset.
ii) The lease agreement contains a bargain purchase option.
iii) The lease term is equal to 75% or more of the economic or useful life of the asset.
iv) The present value of the minimum lease payments must be 90% of the fair value of the
asset.
v) The lessee cannot cancel the lease without paying adequate compensation to the lessor.
vi) The lessee is responsible for repairs, maintenance and insurance of the asset.
Explanation of terms:
i) Present value: This is obtained by discounting the minimum lease payments using the
interest rate implicit the lease as a discount factor.
ii) Minimum lease payments: The sum of all instalments payable by the lessee to the
lessor. (This excludes cost of services and taxes to be paid by or to be reimbursed by
lessee to lessor). However minimum lease payments should include residual amounts
guaranteed by the lessee - if lessee had done so when entering into lease agreement.
iii) Fair Value: This is the price for which the asset could change hands in an ‘arm’ length
transaction, i.e. its cash purchase price – normally at the lease contract commencement.
Accounting for Leases

Although the lessee never obtains legal title, in the case of finance leases, the lessee’s rights and
obligations are such that the risks and rewards from the use of the asset are substantially similar
to those of an outright purchaser.
The lessee will therefore, in the balance sheet:
i) Include finance lease assets together with owned assets under the heading of tangible
fixed assets. However, leased assets should be distinguished from owned assets and
amount disclosed.
ii) Show a liability in respect of lease payments not yet made. The liability in respect of
minimum lease
payments not yet paid is split into long-term and current liabilities.
Example: Assume that an organisation leases an asset whose fair value is Sh 100,000 under
terms of
“Sh 10,000 per year for 10 years”. The balance sheet immediately thereafter will be as follows:
109
Balance Sheet (Extract)
Fixed Assets Current Liabilities
Sh Sh
Leasehold property Amounts due on finance lease
100,000 10,000
Long term liabilities
Amounts due on finance lease
90,000
Notes: (1) The fixed asset will be subject to depreciation like any other owned asset.
(2) In the above example, the fair value of the asset is equal to the minimum lease
payments; i.e. there is no finance charge.
The lessee will, in the profit and loss A/C:

(i) Show the depreciation on the asset during the year.
(ii) Show the portion of finance charge allocated to the year.
Note (1)
Theoretically the amount to be capitalised and recorded in the balance sheet as an asset (as well
as obligation) should be the present value of the minimum lease rentals - discounted at the rate of
interest implicit in the lease. However, in many cases, the fair value of the asset will provide a
reasonable approximation to the above.
Note (2)
The asset should be depreciated over the shorter of
i) The lease term, and
ii) The asset’s useful life.
Here, the lease term includes:

a) The period for which the lessee has contracted to lease the asset (i.e. the non-cancellable
primary
period) plus
b) Any further secondary periods under which the lessee has an option to continue leasing the
asset
(possibly
renewing on an annual basis)
Note (3)
The payments made by the lessee (henceforth known as rentals) should be apportioned between
finance charge and repayment obligation. The finance charge refers to the difference between
the total of rentals (Minimum lease payments) and the fair value of the asset.
Example: Assume an organisation leases an asset whose fair value is Sh 100,000 under the
terms “Sh 12,000 per year for 10 years”:
Sh
Minimum lease payments = (12,000 x10) 120,000
110
Fair value of the asset = (100,000)
Therefore, Finance Charge = 20,000
Each payment by the lessee (in the above example Sh 12,000) is apportioned towards the asset’s
fair value repayment and the finance charge:
12000 12000 12000 12000
Fair Finance Fair Finance Fair Finance Fair

Finance
value charge value charge value charge value Charge
By the end of the lease period, the total payments would have covered:
i) The full value of the asset
ii) The full finance charge
A critical question that arises is, in each payment (instalment) how much constitutes the fair
value amount, and how much constitutes the finance charge amount?
Allocation of Finance Charges

The key principle is that the total finance charge should be allocated to accounting periods
during the lease terms so as to produce a constant periodic rate of charge on the obligation
outstanding.
Possible approaches are:
1) The actuarial method - This involves the use of the implicit interest rate, and accords
exactly with
the above
requirements, i.e. the interest charge is a fixed percentage of the liability in any given
year. For example, if the finance charge apportioned to a given year proves to be x% of
the liability in that year, then the finance
charge to be apportioned to the next year should be such that it is once again x% of the
outstanding liability
in that next year.
2) Sum of digits (Rule of 78) method - This is a close approximation to the actuarial method –
provided the lease
terms are not very long, and the interest rates are not very high.
3) Straight line method (Level Spread method) - This does not produce a constant periodic
rate of
charge, and is
thus not usually acceptable. However, it may be used in practice where the total finance
charge is not
material.
Illustration 1
111
B Ltd. entered into an agreement to lease a vehicle from M Ltd.:
Cash price of the vehicle £10,000
Lease payments: 5 instalments of £2,571 paid in arrears
Required: How much of this finance charge will appear in each year’s profit and loss as an
expense?
Solution £
Total lease payments = 2571 x 5 = 12,855
Fair Value = (10,000)
Therefore, Finance Charge = 2,855
i) Actuarial Method
Here the implicit rate of interest needs to be established. The cumulative factor is established
by:
Fair Value
Annual Rental
= 10,000 = 3.89
2,571
Using discount tables (Annuity tablets), the rate of interest may be established:
Years Interest rates (r)

(n)
1 2 3 4 5 6 7 8 9 10
1 0.9901 0.9304 0.9708 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174
0.9091
2 1.8704 1.9446 1.9135 1.8861 1.8594 1.8334 1.8080 1.7833 1.7591
1.7355
3 2.9410 2.8838 2.8286 2.7751 2.7232 2.8730 2.6243 2.6771 2.5313
2.4869
4 3.8020 3.8077 3.7171 1.6299 3.5460 3.4851 3.3872 3.3121 3.2397
3.1699 è5 4.8534 4.7135 4.5787 4.4518 4.3295 4.2124 4.1002 3.9927
3.889 3.7908
6 5.7955 5.8014 5.4122 5.2421 5.0757 4.8173 4.7665 4.6229 4.4859
4.3553
7 6.7282 6.4720 6.2302 6.0021 5.7864 5.5824 5.3883 5.2064 5.0330
4.8684 8 7.6517 7.3255 7.0187 7.7327 6.4832 6.2098 5.9713 5.7466
5.5348 5.3349
9 8.5880 8.1622 7.7861 7.4353 7.1078 6.8017 6.5152 6.2469 5.8952
5.7590
10 9.4713 8.9828 8.5302 8.1108 7.7217 7.3601 7.0236 6.7101 6.4177
6.1446
112
11 10.3676 9.7868 9.2528 8.7605 8.3084 7.8869 7.4987 7.1390 6.8052
6.4951
12 11.2551 10.5753 9.9540 9.3851 8.8633 8.3838 7.9427 7.5361 7.1607
6.8137
13 12.1337 11.3484 10.6350 9.9856 8.3836 8.8527 8.3577 7.9036 7.4869
7.1034
14 13.0037 12.1062 11.2961 10.5631 9.8986 9.2950 8.7455 8.2442 7.7862
7.3667
15 13.8651 12.8483 11.9379 11.1184 10.3797 9.7122 9.1079 8.5595 8.0607
7.6061
16 14.7179 13.5777 12.5611 11.6523 10.8378 10.1059 9.4466 8.8514 8.3126
7.8237
17 15.5623 14.2919 13.1661 12.1657 11.2741 10.4773 9.7632 9.1216 8.5436
8.0216
18 16.3983 14.9920 13.7535 12.6593 11.6896 10.8276 10.0591 9.3719 8.7556
8.2014
19 17.2260 15.6785 14.3238 13.1339 12.0853 11.1581 10.3356 9.6036 8.9501
8.3649
20 18.0456 16.3514 14.8775 13.5803 12.4622 11.4699 10.5940 9.8181 9.1285
8.5136
The rate of interest is established at 9%

It can now be applied to the outstanding liability to establish the finance charge for each year.
Amount Interest Amount Instalme Closing
Yr outstanding charged outstanding nt liability
at beginning of during year at year end(pre-
year inst)
1 10,000 900 10,900 2,571 8,329
2 8,329 750 9,079 2,571 6,508
3 6,508 586 7,094 2,571 4,523
4 4,523 407 4,930 2,571 2,359
5 2,359 212 2,571 2,571 0
Note 1: The interest charged during the year is 9% of amount outstanding at the beginning of the
year
2: The amount outstanding at the year end is arrived at by adding amounts outstanding at
the beginning of year to interest charged during the year.
3. Since the amount of finance charge for each of the years has been computed using a
percentage – like interest – it has been generally referred to as “interest charged”
The accounts of the lessee and lessor can be drawn up. The lessor’s books will be considered
later. The lessee will maintain the following accounts:
i) Lessor
ii) Finance Charge
iii) Asset A/C
iv) Provision for depreciation A/C
113
Entries are made using the following journals:
When asset is first acquired:

Dr Asset A/C with fair value or cash price
Cr Lessor A/C of asset
At the end of any year within the lease period

Dr Finance Charges with finance charges
Cr Lessor apportioned
Dr Profit and Loss with finance charges
Cr Finance Charges apportioned
When rentals are paid to lessor:

Dr Lessor
Cr Cashbook
Books of Lessee
Lessor A/C
Year 1 Year 1
£ £
Bank Vehicle
2,571 10,000
Balance c/d Finance Charge
8,329 900
10,900 10,900
Year 2 Year 2
Bank Balance b/d
2,571 8,329
6,508 750
9,079 9,079
Year 3 Year 3
Bank Balance b/d
2,571 6,508
4,523 586
7,094 7,094
Year 4 Year 4
Bank Balance b/d
2,571 4,523
2,359 407
4,930 4,930
Year 5 Year 5
Bank Balance b/d
2,571 2,359
Finance Charge
114
. 212
2,571 2,571
Finance Charge A/C

Year 1 Year 1
£ £
Lessor Profit and Loss
900 900
Year 2 Year 2
750 750
Year 3 Year 3
586 586
Year 4 Year 4
407 407
Year 5 Year 5
212 212
Leasehold Vehicle
Year 1 Year 1
£ £
Lessor A/C Balance c/d
10,000 10,000
Year 2 Year 2
Balance b/d Balance c/d
10,000 10,000
Year 3 Year 3
10,000 10,000
Year 4 Year 4
10,000 10,000
Year 5 Year 5
115
10,000 10,000
Provision for depreciation A/C

Year 1 Year 1
£ £
Balance c/d Profit and Loss
2,000 2,000
Year 2 Year 2
Balance b/d
Balance c/d 2,000
4,000 Profit and Loss
2,000
4,000 4,000
Year 3 Year 3
Balance b/d
Balance c/d 4,000
2,000
6,000
6,000
Year 4 Year 4
Balance b/d
Balance c/d 6,000
2,000
8,000 8,000
Year 5 Year 5
Balance b/d
Balance c/d 8,000
2,000
10,000 10,000
For balance sheet purposes, the total outstanding liability at the end of any given year should be
split into:
(i) Current liabilities (amount of liability payable within 1 year from balance sheet date
(ii) Long term liabilities (amount of liability payable after expiry of one year from the
balance sheet date)
Example: The total liability at the end of year 1 (£8,329) can be split into:
(i) Current Liability (£1,821)
(ii) Long term Liability (£6,508) as follows:
116
Calculations of liabilities at the end of year 1
Yr 1 Yr 2 Yr 3 Yr 4 Yr 5
Instalment Instalment Instalment Instalmen Instalment

= 2571 = 2,571 = 2,571 = 2,571 = 2,571
Interest Liability Interest Liability Interest Liability Interest Liability

= 750 = 1,821 = 586 = 1,985 = 407 =2,164 = 212 = 2,359
Current Liability Long term Liability

= 1,821 = 6,508
Note:
(1) The total liability at the end of year 1 (£8,239) in balance c/d in the lessor A/C at the
end of year 1.
(2) The amount of liability payable in year 2 is current liability in the balance sheet for end
of year 1.
(3) The long-term liability in balance sheet for year (1) is arrived at by:
(a) Splitting all instalment payments after expiry of one year from balance sheet
date
into interest (finance
charges) and liability repayment.
(b) Adding all liability repayments together.
In the above diagram, payments 1 year from balance sheet date will be payments in years 3, 4,
and 5.
B Ltd
Balance sheet (extract) at the end of year 1
Fixed Assets Cost Depreciation NBV
Vehicle 10,000 2,000 8,000
Current Liabilities
Obligations under
finance lease 1,821
Long term Liabilities
Obligations under
finance lease 6,508
The total liability at the end of year 2 (£6,508) can be split into:
(i) Current liability (£1,985)
(ii) Long term liability (£4,523) as follows:
REVISION QUESTION
117
(a) Define a finance lease and state the criteria, which distinguish it from an operating lease.
(4 marks)
(b) Two companies entered into an agreement whereby the lessor (ABC Ltd.) leased on finance
lease to the
lessee (XYZ Ltd.) an item of capital, which cost the lessor Sh.100,000 on 1 September 1993.
The lease was to run for five years from 1 September 1993. The plant to be depreciated on a
straight line basis, is
considered to have nil residual value at the end of the agreement. The agreement specifies
that a rental of
Sh.7,400 per quarter is payable in advance.
It is proposed that, in the lessor’s account, profit should only be taken pro rata to the interest
received and
that the total interest elements included in the rentals should be allocated over the period of
the lease using the actuarial method. It is further proposed that in the lessee’s accounts, the
lease should be capitalised. The interest rate implicit in the lease is 5% per quarter.
Required:
(i) The necessary ledger accounts in the books of both ABC Ltd. and XYZ Ltd. to record the
above transactions for the year ended 31 August 1994.
(ii) Show how the above transactions would appear in the financial statements of both ABC
Ltd. and XYZ Ltd for the year ended 31 August 1994. (assume interest is paid after it is
incurred and round all workings where applicable to the nearest whole number.)
118
Unit 8: ACCOUNTING FOR INVESTMENTS
It is a fairly common practice for a business to invest in stocks, shares, etc. of other companies.
There are two basic categories of investments:
Those which carry a fixed rate of return on nominal value (e.g. preference shares and debentures)
Those which carry a fluctuating rate of return on nominal value (e.g. ordinary shares)
On acquisition the capital cost includes brokerage and other charges associated with the
purchase.
On disposal, the capital proceeds are net of all the expenses associated with the selling.
In each case a further adjustment may be necessary for dividends and interest.
The adjustment for dividends or interest depends upon whether the transaction is cum-div (cum-
int) or ex-div (ex-int).
THE INSTITUTION
(whose shares/debentures are

held by investors)
The institution pays dividends and

interest to the security holders
Security holder (1) Security holder (2)

[now the seller because he [Now the purchaser because
is to sell he is to buy security from
security to holder (2)] holder (1)]
Transfer of securities (shares,

debentures etc.)
The institution pays dividends and interest to the latest known holder of the shares and
debentures. If the transfer of securities is not notified to the institution, the institution will keep
on paying the dividends and interest to the previous owner. If the transfer notice is given, all
interest and dividends will be paid to the new holder. Quotations of prices are always cum-
div/cum-interest unless specifically stated as ex-div/ex-interest.
The implication of “cum-div” (cum-int) is that “The investment is transferred together with the
next dividend or interest that the institution will pay “i.e. the next time the institution pays out
dividends or interest, it will go to the purchaser.
The implication of “ex-div” is that “the investment is sold without the next dividend or interest
payment”. The dividend will go to the first owner (seller) rather than the new holder (purchaser).
119
The institutions paying interest do so to the registered owners of the securities. Each time the
securities change hands, the institution has to amend the appropriate statutory records e.g. the
register of shareholders. On payment date, the institution pays the dividend/interest to the latest
registered holder.
If the buyer (new owner) is the latest registered owner in the institution’s books,
dividends/interest paid by the institution will go to him; and the sale is said to be cum-div (or
cum-interest)
If the seller (old owner) is still the registered owner in the institution’s books, it means that the
ownership transfer has not yet been effected in the institution’s books (or the notice was too
late) by the time dividends had been paid out. Such dividends end up going to the old owner,
and the sale is said to be ex-div (or ex-interest)
8.1 Accounting entries

In the books, a separate account is opened for each security. Each account has 3 debit columns
and 3 credit columns, which are;
Column 1: A memorandum column in which is recorded the nominal value of each transaction
in either value or quantitative terms.
Column 2: A (double entry) income column to record the investment income transactions.
Column 3: A (double entry) capital column to record the investment capital transactions.
Investment A/C
N (£) I (£) C (£) N (£) I (£) C (£)
Recording a Cum-Int. purchase
When we purchase an investment cum-int, the interest will be received by us even if part of it
related to the previous owner
| J | A | S | O | N | D |
Interest is Interest is
paid by the paid by the
institution institution.
Transfer of
securities owner-
ship (cum-int)
Interest legally Interest legally belongs Interest

is
belongs to previous to new owner (4 months) collected by
owner. (2 months) new owner
for full 6
months
120
The seller will have inflated the price to cover the fact that he will not collect his interest (2
months). The purchaser will therefore have to deflate the purchase price (to get the correct
capital cost.) and at the same time make an adjustment to the six months’ of interest received to
reflect that some of it is not his income. This is done as follows:
Split purchase price into Inflation by seller due to
his element of interest.
Remaining amount – making up the

true capital value of the security.
Debit Income column (with seller’s interest element) X

Debit Capital column (with capital value of security) X
Credit Cash/Bank (with full payment) X
Illustration 1
A company bought £100,000 12% Marlshire County Council Loan Stock on 1 September 1998
at 94 Cum-interest. Interest is payable ½ yearly on 30th June and 31st December.
Required: Show the entries in the investing company’s ledger for the year ended 30 June 1999.
12% Marlshire County Council Loan stock

1998 N (£) I (£) C (£) 1998 N (£) I (£) C (£)
1 Sept. Bank 100,00 2,000 92,00 31 Dec. Bank 6,000
0 0
1999 1999
30 June Bank 6,000
30 June P & L 10,00 30 June Balance 100,00 - . 92,000
. 0 . c/d 0
100,00 12,00 92,00 100,00 12,00 92,000
0 0 0 0 0
1 July Balance 100,00 92,00
b/d 0 0
£
Quoted price = 94% X 100,000 94,000
Interest lost by previous owner
= 2/12 X 12% X 100,000 (2,000)
Correct purchase price (if there is no interest loss) 92,000
Recording an ex-int purchase
121
| J | A | S | O | N | D |
Interest is paid Interest is

by the institution paid by the
institution.
Transfer of
securities’ owner-
Interest legally ship (ex-int)
belongs to previous
owner. Interest legally belongs
to us, the current owners
All interest is
collected by
the previous
holder even if
some is ours.
The previous owner will deflate his selling price to cover the fact that he will collect all the
interest on 31st December even though part of it is ours (new owners). Therefore, we (the new
owners) have to:
increase the purchase price to reflect the correct capital cost;
reflect our legal position of income in the income columns. This is achieved by:
Debit Capital column (with low price paid)
Debit Capital column (with inflation needed for our interest share)
Credit Bank (with low price paid)
Credit Income column (with required inflation)
Illustration
On 1 July 1998, a company had £100,000 12% Marlshire County Council loan stock whose cost
was £90,000. On 1 Dec 1998, the company sold some of the loan stock (Nominal value =
£25,000) at 91 ex-int. Interest is paid on 30th June and 31st December.
Required: Show the entries in the investing company’s books for the year ended 30 June 1999.
Solution:
Cost of investments sold = 25,000 X 90,000 = 22,500
100,000
Cost of investments unsold = 75,000 X 90,000 = 67,500

100,000
12% Marlshire County Council Loan stock
1998 N (£) I (£) C (£) 1998 N (£) I (£) C (£)
1 July Balance 100,00 90,00 1 Sep. Bank 25,000 22,750
b/d 0 250 0 (Disp.) 250
1 Dec. Adj. 1 Dec. Adj 6,000
122
31 Dec. Bank
1999 1999
30 June P & L: 10,25
Inc. 0 30 Jun Bank 4,500
30 June P & L: . 500 30 June Balance 75,000 67,500
Profit on disposal c/d .
.
100,00 10,50 90,50 100,00 10,50 90,000
0 0 0 0 0
1 July Balance b/d 75,000 67,50
0
Calculation for correct disposal selling price: Quoted price = 91% X 25,000 =
22,750
Inflation (Adj ) = 12/100 X 1/12 X 25,000 = 250
Correct price = 23,000
Cost of items sold (see above) (22,500)
Profit on disposal 500
Partial disposal where there was gradual build-up of holding:

Where the investment held has been built up gradually by successive acquisitions at different
times, there may be difficulty in computing:
The cost of investments sold;
The cost of investments unsold (Balance c/d to next year)
There are ways of computing these (for examination purposes)

FIFO approach
Weighted Average approach (commonly used)
Illustration 6
An investing company originally acquired £40,000 9%debentures in Zed PLC at a capital cost of
£36,000, and subsequently increased its holding by another £80,000 (Nominal) at a capital cost
of £76,000. Eventually the company sold £60,000 (Nominal) of its holding.
If the investing company held both the investments on 1 July 1998, the disposal took place on 1
Dec. 1998 at 91 ex-div, and the company Zed PLC pays debentures interest on 30th June and 31st
December,
Required: Show the entries to be made in the books of the investing company for the year
ended 30th June 1999.
Solution: Under FIFO system: N (£) C (£)

Cost of debentures sold 40,000 36,000
20,000 19,000 20,000 X 76,000
60,000 55,000 80,000
Cost of debentures unsold 60,000 57,000 60,000 X 76,000
123
80,000
Under the Weighted Average System:
Total stock analysis 40,000 36,000
80,000 76,000
120,000 112,000
Cost of stock = 60,000 X 112,000) = 56,000

120,000
The cost of unsold stock is also (60,000 X 112,000) = 56,000

120,000
9% Debentures in Zed PLC (FIFO)

1998 N (£) I (£) C (£) 1998 N (£) I (£) C (£)
1 July Balance 120,00 112,00 1 Dec. Bank 60,000 54,600
b/d 0 450 0 (Disp.) 450
31 Dec. Bank 0
1999 1999
30 June P & L: 7,65 30 June Bank 2,70
Inc. 0 30 June Balance 60,000 0 57,000
30 June P & L: . 50 c/d . .
Profit on
disposal . .
120,00 8,10 112,05 120,00 8,10 112,05
0 0 0 0 0 0
1 July Balance 60,000 57,000
b/d
Calculation for correct disposal selling price : Quoted price = 91% x 60,000 = 54,600
: Inflation (Adj) = 9/100 X 1/12 X 60,000 = 450
: Corrected selling price 55,050
: Cost of items sold: (see above) (55,000)
Profit on disposal 50
9% Debentures in Zed PLC (FIFO)

1998 N (£) I (£) C (£) 1998 N (£) I (£) C (£)
1 July Balance 120,00 112,00 1 Dec. Bank 60,000 54,600
b/d 0 450 0 (Disp.) 450
31 Dec. Bank
1999 1999
30 June Bank 2,700
30 June: P&L
30 June P & L: 7,650 loss 950
Inc. . . . on 60,000 56,000
124
disposal .
30 June Balance
c/d
120,00 8,100 112,00 120,00 8,100 112,00
0 0 0 0
1 July Balance 60,000 56,000
b/d
Calculation for correct disposal selling price: Quoted price = 91% X 60,000 =
54,600
Inflation (Adj) = 9% X1/12 X 60,000 = 450
Corrected selling price = 55,050
Cost of items sold (see above) (56,000)
Loss on disposals 950
Accounting for Investment with Fluctuating Rate of Return on Nominal Values

These are usually ordinary shares. When accounting for these, it is not necessary to make
adjustments to the quoted price for dividends lost by either purchaser or seller, due to the fact
that dividends do not accrue uniformly over time. The purchase price (or selling price) is
straight away recorded into the capital column of the investment account.
There are two additional issues that may arise when accounting for investments in ordinary
shares:
Right issue
Bonus issue
Rights issues:
A relatively easy and inexpensive way for any well known company whose shares are listed on
the stock exchange to raise additional capital is to make a rights issue of ordinary shares. The
company allots rights certificates (to the amount of the required additional capital) on a pro-rata
basis to its existing shareholders. These certificates entitle the holder to subscribe for extra
shares in the company at advantageous rates.
The recipients have 3 courses of action open to them:
To take up the rights and subscribe for the shares; and /or
To sell the rights to third parties (who then subscribe for the shares); and/or
To renounce the rights (in which case the directors can dispose of the shares to third parties and
remit surplus proceeds over and above rights price to the shareholder concerned)
The entries to be made in the investment account of the investing company will depend upon the
course of action taken up.
a) If the rights are taken up; i) Nominal value of shares acquired are added onto nominal
column:
ii) Their cost is debited to capital column
b) If the rights are sold to a third party: i) No entry is made in the nominal column
ii) The proceeds are credited to the capital column.
If upon renounciation of rights, proceeds are received after shares were disposed of by directors
in an open
market, i) No entry is made in the nominal column;
125
ii) The proceeds are credited to the capital column.
Bonus Issues
These are free shares distributed to shareholders in proportion to current shareholding. This is in
order for the company to capitalise reserves (the company may have large amounts of reserves
that it cannot pay out as cash dividend to shareholders either because it is prohibited by law, or
because of financial prudence.) Shareholders are not required to pay any amounts for such
shares, and the only entry to be made is in the nominal column of the investment account.
Illustration
Dim Ltd carried out the following transactions in the shares of Bright Ltd:
On 1 April 1998 he purchased 20,000 £1.00 ordinary shares (fully paid up) for £30,000.
On 15th May he sold 4,000 shares for £7,600.
At a meeting held on 15th June 1998, the company decided:
To make a bonus issue of 1 fully paid share for every 4 shares held on 1st June 1998;
To give its members the right to apply for 1share for every 5 shares held on 1st June 1998 at a
price of £1.50 per share; 75p payable on or before 15th July 1998, and the balance (75p per share)
on or before 15th September 1998.
The shares issued under (i) and (ii) were not to rank for dividend for the year ended 31 December
1998
Dim received his bonus shares and took up 2,000 shares under the rights issue, paying the sums
thereon when due, and selling the rights to the remaining shares at 40p per share. The proceeds
were received on 30th September 1998.
On 15th March 1999, he received a dividend from Bright Ltd of 15% for the year ended 31
December 1998.
On 30th march 1999 he received £14,000 form the sale of 10,000 shares.
Required:
Record the above transactions in the investment account as appearing in the books of Dim Ltd
for the year ended 31 March 1999. Apply the weighted average basis for valuation of shares,
and ignore all taxes and expenses.
Investment in Ordinary Shares of Bright Ltd.

1998 N° I(£) C(£) N° I(£) C(£)
1 Apr. Bank 20,00 30,00 15 May Bank 4,000 7,600
15 June Bonus issue 0 0 (Disposal) 480
15 July Bank: Rights 4,000 30 Sep. Bank rights
issue 2,000 1,500 sale
15 Sep. Bank: rights 1,500
1999 1999
31 March P&L: 2,40 15 Mar. Bank 2,40
Income 0 15 Mar. Bank 10,00 0 14,00
31 March P&L: 3,545 (disposal) 0 0
Profit on . 31 Mar. Balance c/d 12,00 14,46
disp . 0 . 5
osal
26,00 2,40 36,54 26,00 2,40 36,54
126
0 0 5 0 0 5
1 Apr. Balance b/d 12,00 14,46
0 5
Workings:
N° of bonus shares = (20,000 – 4,000) X ¼ = 4,000 shares.
No of rights shares entitlement = (20,000 – 4,0000 X 1/5 = 3,200 shares.

However rights taken up = 2,000 shares
∴ Rights sold 1,200 shares
Selling price per right = £ 0.40
∴ Total proceeds on rights sold = 1,200 X £0.40 = £480
Valuation of shares on weighted average method:

N° Value (£)
Shares initially purchased 20,000 30,000
Shares sold (cost: 4,000@1.50 = 6,000) (4,000) (6,000)
Bonus shares obtained 4,000 -
Rights shares purchased 2,000 3,000
rd
Rights sold to 3 parties - (480)
22,000 26,520
2nd Lot of shares sold (Cost = 26,520 X 10,000) (10,000) (12,055)
22,000
Unsold shares at year end (cost = 26,520 X 12,000)12,000 14,465
22,000
Calculation of profit on disposal as an independent entry:

Nominal Value Cost Sales proceeds Profit on Disposal
1st Disposal 4,000 6,000 7,600 1,600
nd
2 Disposal 10,000 12,055 14,000 1,945
14,000 18,055 21,600 3,545
Illustration
A Ltd. Buys Shs.10,000 N.C.C 3% par value Shs.100 stock on 1st March 1991, when the
quotation was 92-94. Interest is paid bi-annually on 30 April and 31 October. On 31st July 1991,
the company sold cum-int half of its investment, the price quoted being 88-90. Give the ledger
account recording the investment.
127
Investment in N.C.C 3% Stock Account
N I C N I C
1991 Shs Shs Shs 1991 Shs Shs Shs
March 1 C.B 10,00 100 9,300 April 30 C.B 150
0 July 31 C.B 5,000 37.5 4,362.
Oct. 31 C.B 75 5
Dec. 31 P & L
Dec. 31 P&L 162.5 Dec. 31 Balance 5,000 . 287.5
A/C . . c/d 4,650.
0
10,00 262.5 9,300 10,000 262.5 9,300
0
Workings
Shs
a. Purchase consideration: 10,000 X 94 = 9,400
100
less accrued interest: 1/3 X 3% X 10,000 = (100)
9,300
b. Interest payable as at 30 April = ½ X 3% X 10,000 = 150

c. Sales proceeds 5,000 X 88 = 4,400
100
less accrued interest: ¼ X 3% X 5,000= 37.5
4,362.5
d. Interest payable as at 31 October = 1 X 3% X 5,000 = 75
Value of stock holding at 31 December = 5,000 X 9,300 = 4,650

10,000
The difference of the capital columns i.e. Shs.287.5 represents the loss on the sale of
Shs.5,000 of stock.
i.e. Shs.4, 650 – Shs.4, 362.5 = 287.5
Revision Question
The following transactions took place in the books of Chui Ltd.;
Jan 1 Purchased 200 6% debentures of £100 each of Punda Milia Company (interest payable
December 31 and June 30) at £98 ex-interest.
Purchased 500 £1 ordinary shares of Swala Company for £2.50 each.
Feb 1 Purchased 300 £1 ordinary shares of Swala Company for £2.40 each
Mar 31Swala Company:
128
paid a six month interim dividend of 10%
made a bonus issue of 1 for 4.
Apr 30 Sold 50 of the debentures at 101 cum-interest.
Jun 30 Received the debenture interest.
Jul 1 Sold 100 of the ordinary shares at £2.50 each
Sep 30 Swala company:
paid a 5% final dividend.
Gave the right to shareholders to apply for one new share for every three so held at the price of
£2.00 per share payable in full on application.
Nov 15Sold one half of the rights at £60 each.
Nov 20Exercise the remaining rights.
Dec 31 Received the debenture interest.
Required:
The investment accounts in the books of Chui Ltd. It is not the company policy to apportion
dividends. Ignore withholding tax, brokerage fees, stamp duty and other expenses. Workings
should be shown.
129
Unit 9: Accounting for F or ei gn Transactions and Translations
9.1 FOREIGN SUBSIDIARIES (IAS 21)
The objective of IAS 21 is to prescribe how to include foreign currency transactions and foreign
operations in the financial statements of an entity and how to translate financial statements into a
presentation currency. The principal issues are which exchange rate(s) to use and how to report
the effects of changes in exchange rates in the financial statements.
Important definitions in IAS 21
Functional currency: The currency of the primary economic environment in which the entity
operates. The term 'functional currency' is used in the 2003 revision of IAS 21 in place of
'measurement currency' but with essentially the same meaning. Presentation currency: The
currency in which financial statements are presented.
Exchange difference: The difference resulting from translating a given number of units of one
currency into another currency at different exchange rates.
Foreign operation: A subsidiary, associate, joint venture, or branch whose activities are based
in a country other than that of the reporting enterprise.
Foreign Currency Transactions
A foreign currency transaction should be recorded initially at the rate of exchange at the date of
the transaction (use of averages is permitted if they are a reasonable approximation of actual). At
each subsequent balance sheet dates:
Foreign currency monetary (Receivable and Payables) amounts should be reported using the
closing rate.
Non-monetary(like property, plant and equipment) items carried at historical cost should be
reported using the exchange rate at the date of the transaction.
Non-monetary items carried at fair value should be reported at the rate that existed when the fair
values were determined.
Exchange differences arising when monetary items are settled or when monetary items are
translated at rates different from those at which they were translated when initially recognized or
in previous financial statements are reported in profit or loss in the period, with one exception.
The exception is that exchange differences arising on monetary items that form part of the
reporting entity's net investment in a foreign operation are recognised, in the consolidated
financial statements that include the foreign operation, in a separate component of equity; they
will be recognised in profit or loss on disposal of the net investment. If a gain or loss on a non-
monetary item is recognised directly in equity (for example, a property revaluation under IAS
130
16), any foreign exchange component of that gain or loss is also recognised directly in equity.
Prior to the 2003 revision of IAS 21, an exchange loss on foreign currency debt used to finance
the acquisition of an asset could be added to the carrying amount of the asset if the loss resulted
from a severe devaluation of a currency against which there was no practical means of hedging.
That option was eliminated in the 2003 revision.
EXAMPLES
A number of examples are worked below to illustrate the accounting requirements for foreign
currency transactions.
(a) Purchase of property, plant and equipment:

Joki Ltd agreed to purchase a piece of plant and machinery from a Dutch company for Guilders
2450 on 31 March 2001 to be paid for on 31 August 2001 at a contract rate of KSh 30.5. The
Exchange rates on 31 March 2001 was G1 = KSh 30.
The plant and machinery will be recorded in the accounts at historic cost. This cost can be
ascertained by reference to the effective fixed shilling price of KShs 74,725. Thus, the
transaction would have been recorded as:
KShs KShs
DR Plant and Machinery (30.5 x 2,450) 74,725
CR Notes payable A/c 74,725
This is the true liability for such a purchase and should therefore be used to value the creditor for
the period that the debt is outstanding. No adjustment to this cost should be made in future
period. Similar arguments would apply Joki Ltd had entered into a forward contract to purchase
G2450 at KSh 30.5 for every G1 on 31 August 2001.
If no contract rate had been agreed the asset would have to be recorded as costing KSh 73,500
(G2450 @ KSh 30) and as before no subsequent translations would be necessary. It is likely that
an exchange difference would have risen on settlement.
(b) Payables
A Kenyan company purchases goods from a UK company in July 2001 for Kshs.550. The
company paid off Kshs.200 in August 2001 and the balance was outstanding at the end of the
year: i.e. 30 Sept. 2002.
Exchange rates were:
July 2001 Kshs.1 = KSh 70

August 2001 Kshs.1 = KSh
30 Sept. 2001 Kshs.1 = 80.1
KSh
82.7
The creditors account would appear as follows:
131
Payables Account
KShs KShs
Aug. 2001 Cash July 2001 Purchase
A/c 16,020 A/c 38,500
(200 x (550 x 70)
80.1)
28,945 P & L (Bal figure) 6,465
Sept. 2001 Bal. c/d 44,965 44,965
(350 x
82.7)
(c) Receivables
A Kenyan company sells goods to a German company for DM 3000. Payment is received in
August 2001. Exchange rates were:
May 2001 1 DM = KShs 27.3

August 2001 1 DM = KShs 26.7
The Kenyan company would make the following entries in the ledger account:
Debtors Account
Kshs Kshs
May 2001 Sales A/c Aug. 2001 Cash A/c 80,100
(27.3 x 3,000) 81,900 (3,000 x 26.7)
P & L (Year End)
_____ Exchange loss 1,800
81,900 81,900
(d) Long term Loans

Amabera Ltd, a Kenyan company acquired a loan from a Canadian bank on 1 January 2001 of
Kshs.10, 000. The proceeds were converted into shillings and remitted to Kenya. The year-end
for the Amabera Ltd is on 31 December 2001
The Exchange rates were as follows:
1 Jan 2001 1Kshs. = KSh 35.3

31 December 2001 1Kshs. = KSh 33.4
31 December 2001 1Kshs. = KSh 34.9
The loan account in the books of Amabera Ltd would appear as follows:
132
Loan Account
Kshs Kshs
31 Dec. 2001 1 Jan 2001
Bal c/d (33.4 x 10,000) 334,000 Cash A/c (35.3 x 353,000
P & L A/c 19,000 10,000)
(Exchange gain) ______ ______
353,000 353,000
31.12.02 Bal c/d 1.1.02 Bal b/d 334,000
(34.9 x 10,000) 349,000 P & L A/c 15,000
______ (Exchange loss) ______
349,000 349,000
Notes:
i. The amounts outstanding at each year end (Kshs.10, 000) should be translated into Kenyan
shillings at the exchange rate each year end.
ii. Exchange differences (2001 gain of 19,000/-, 2002 loss of 15,000/-) should according to
the requirements of IAS 21 be reported in the profit and loss account as part of the profit
from ordinary operations, but must be disclosed in the notes as an unrealised holding
gain/loss.
The consolidated Financial Statements
This section deals with the second problem which a company may have in foreign currency
translation namely the translation of complete financial statements of foreign entities (subsidiary,
branches, associate companies).
The major problem is to determine which Currency to be used (determining the functional
currency)
A holding company with a foreign operation must translate the financial statements of those
operations into its own reporting currency before they can be consolidated into group accounts.
There are two methods normally used and each method depends on whether the foreign
operation has the same functional currency as the parent. IAS 21 requires the firm to consider the
following factors in determining its functional currency:
(i) The currency that influences the sales price for goods,
(ii) The currency of the country whose competitive forces and regulations mainly determine the
sales price of its goods and services,
 The currency that influences labor, material and other costs.
Translation Methods
According to IAS 21, the method to be used is determined by the relationship between the
holding company and the foreign entity concerned.
Two methods commonly used are:
(a) The Presentation Currency Method (Formerly called Net investment or Closing rate
method)
133
This approach is normally used if the operations of the operations of the subsidiary company are
different from those of the parent company and therefore the subsidiary is considered to be semi
autonomous from the holding company.
The results and financial position of an entity whose functional currency is not the currency of a
hyperinflationary economy shall be translated into a different presentation currency using the
following procedures:
(i) Assets and liabilities for each balance sheet presented (i.e. including comparatives) shall
be translated at the closing rate at the date of that balance sheet;
(ii) Income and expenses for each income statement (i.e.including comparatives) shall be
translated at exchange rates at the dates of the transactions;and
(iii) All resulting exchange differences shall be recognized as a separate component of equity.
For practical reasons, a rate that approximates the exchange rates at the dates of the transactions,
for example an average rate for the period, is often used to translate income and expense items.
However, if exchange rates fluctuate significantly, the use of the average rate for a period is
inappropriate.
Under such circumstances, it is assumed that changes in the exchange rate has little or no direct
effect on the activities or present and future cash flows from operations of either the parents or
the foreign entity and because the foreign operation is not an integral part of the operations of the
parent.
Translation Procedure
Balance sheet of a foreign entity
All balance sheet items should be translated into the reporting currency of the investing company
using the rate of exchange ruling at the balance sheet date.
Profit and loss account of the foreign entity

Items should be translated at either an average rate for the period, or at the closing rate.
Exchange differences:
These may arise for three reasons:
1. The rate of exchange ruling at the balance sheet date is different from that ruling at the
previous balance sheet date. For example, land and buildings translated last year at one rate
will be included in the consolidated balance sheet this year at a different rate.
2. The average rate used to translate the profit and loss account differs from the closing rate.
The exchange differences may also arise out of measurements of cash flow differences
(occurring immediately or in the future).
(b)The functional method (formerly referred to as temporal method)
134
IAS 21 states that where the operations of the foreign entity is an integral part of the operations
of the parent company i.e. the affairs of a foreign subsidiary company are so closely interlinked
with those of the holding company that the business of the foreign entity is regarded as a direct
extension of the business of the investing company rather than as a separate and quasi
independent business - the functional currency method should be used instead of the closing rate
method.
IAS 21 gives the following as examples of situations where the temporal method should be used,
where:
i. The foreign entity acts as a selling agency receiving stocks of goods from the investing
company and remitting the proceeds back to the company.
ii. The foreign entity produces a raw material or manufactures parts or sub-assemblies which
are then shipped to the investing company for inclusion in its own products.
iii. The foreign entity is located overseas for tax, exchange control or similar reasons to act as
a means of raising finance for other companies in the group.
Note
Each subsidiary company must be considered separately. The relationship between each
subsidiary and the holding company must be established so that the appropriate translation
method can be determined. The method should then be used consistently from period to period
unless the financial and other operational relationships which exist between the investing
company and the subsidiary changes.
Translation Procedure
(a) Exchange differences out of translation should be reported either as part of the profit and
loss for the year from ordinary operations or as an extraordinary item as the case may be.
(b) Profit and loss items
Item Rate
Sales, cost of sales Average
Depreciation charge Historical
Expenses Average
Tax charge Average
Dividend paid Actual (at date of payment)
Dividend proposed Year end (closing)
(c) Balance sheet items
Item Rate
Fixed assets (1) if acquired before subsidiary became

part of the group, use exchange rate of
date of acquisition of subsidiary
135
(2) if acquired post acquisition, use
historical cost.
Stock Rate on date of acquisition of stock (Year end is usually –

reasonable, practical approximation)
Debtor/cash/creditors/loans Year end (closing rate)
Example
Kenya Curios (KC) Limited purchased 80% of the ordinary share capital of Tanzan Artefacts
(TA) Limited, a company incorporated in Tanzania; on 1 October 1995 when there was a credit
balance on the profit and Loss Account of Tanzania (T) shillings 630 million. Both companies
sell a range of products to tourists and to the tourist industry.
136
Draft income statements for the Draft Balance Sheets
year ended 30 September 1998 as at 30 September
1998
KC TA KC TA
Ksh. Tsh. Ksh. Tsh.
Million Million PPE (Net book value) Million Million
Revenue 930 2,211 Land and buildings 90 1,764
Opening inventory 52 537 Equipment 60 84
purchases 780 1,353 Motor vehicles 12 60
832 1,890 162 1,908
Closing inventory (57) (702)
Cost of sales 775 1,188 Investment in 312
subsidiary
Gross profit 155 1,023 Current Assets:
Operating expenses (29) (99) Inventory 57 702
Depreciation (18) (76) Receivables 160 660
(47) (175) Bank 31 264
Operating profit 108 848 248 1,626
Dividend from 8 Current liabilities:
subsidiary
Profit before tax 116 Payables 91 396
Taxation (33) (242) Taxation 7 132
Profit after tax 83 606 Proposed dividend 40 420
Dividends: Interim paid (20) (112) 138 948
Final (40) (420) 110 678
proposed
(60) (532) 584 2,586
23 74
Retained profit: Financed by:
For the year 23 74 Ordinary shares Sh. 400 1,400
10
Brought 161 1,112 Retained Profits 184 1,186
forward
Carried 184 1,186 584 2,586
forward
1. In the year ended 30 September 1998, KC Limited sold goods worth Ksh. 98 million to TA
Limited. These goods had cost KC Limited Ksh. 82 million. In the group accounts, the
unrealised profit at the commencement of the year was Ksh. 6 million and Ksh. 8 million at
the end of the year. Group policy is to recover the whole of the unrealised profit from
group stock and from the company which made the profit, the minority interest bearing its
share if appropriate. Dividends payable to minority interests are shown as current
liabilities.
2. Both companies were established on 1 October 1993. The land, buildings and equipment of
both companies were purchased on this date. All the motor vehicles in both companies
137
were replaced on 29 September 1997 – No depreciation had been charged on these motor
vehicles in the year ended 30 September 1997.
Both companies charge depreciation on the straight line basis at the following rates:
Land and buildings : 2% per annum on cost (the land is leasehold and had 50
years
remaining at 1 October 1993
Equipment : 10% per annum
Motor vehicles : 25% per annum
3. The fair values of TA’s assets and liabilities on 1 October 1995 were the same as book
values.
4. Sales, purchases and expenses occur evenly over the year. In TA, debtors represent 4
months’ sales; creditors represent 3 months’ purchases; stock represents 6 months’
purchases. At 30 September 1998, TA owed KC Tsh.288 million, whilst KC’s books
showed that TA owed Ksh.24 million.
5. KC has not yet accounted for the dividend receivable from TA. The interim dividend was
paid when the exchange rate was Ksh. 1 = Tsh. 11.2.
6. Relevant rates of exchange are:
1 October 1993 Ksh.1 = Tsh.6 30 September 1997 Ksh.2 = Tsh.10
1 October 1995 Ksh.1 = Tsh.7 31 March 1998 Ksh.1 = Tsh.11
31 March 1997 Ksh.1 = Tsh.9.3 30 June 1998 Ksh.1 =
Tsh.11.7
30 June 1997 Ksh.1 = Tsh.9.6 30 September 1998 Ksh.1 = Tsh.12
Average for the year to 30 September 1998 Ksh.1 = Tsh.11.
Required:
The directors of KC Limited have directed you to prepare the consolidated income statement for
the year ended 30 September 1998 and the consolidated balance sheet as at 30 September 1998.
Using the following methods:
1. Presentation method (assuming goodwill was not impaired and it is an asset of the
subsidiary)
2. Functional currency method (goodwill is impaired at the rate of 20% per annum and it
is an asset of the holding company).
(a) Presentation Method
Consolidated income statement Ksh
Revenue 1,033.00
Cost of sales (783.00)
Gross profit 250.00
138
Operating expenses (63.00)
Profit before tax 187.00
Income tax expense (55.00)
Profit for the period 132.00
Attributable to Holding company 121.00
Attributable to Minority interest 11.00
132.00
Statement of changes in equity extract

Ksh
Retained profit b/f KC(less UPOI) 155.00
Share in TA (31.04)
123.96
Profit for the period 121.00
244.96
Less dividends Interim paid (20.00)
Final proposed (40.00)
Retained profit c/f 184.96
Share of retained profits b/f in TA Ksh
Opening net assets in TA(Ksh) 251.20

Net assets on acqusition (ksh) 290.00
Reduction in net assets ( Loss) (38.80)
Share of the holding Co@80% (31.04)
Consolidated balance
sheet Ksh
Non Current assets
Property plant and 321.0
equipment 0
137.0
Goodwill 0
458.0
0
Current assets
Inventory 107.50
A/C receivable 191.00
351.5
Cash at bank 53.00 0
809.5
Total assets 0
400.0
Ordinary share capital 0
Foreign exchange reserve 20.4
139
4
184.9
Retained profit 6
605.4
0
Minority 43.1
interest 0
648.5
0
Current
liabilties
Accounts
payable 100.00
Current tax 18.00
165.0
Proposed dividends 47.00 0
813.5
0
Balance sheet TA Exchange TA
Tsh rate Ksh
1,908. 159.0
PPE 00 1/12 0
Current assets
702. 58.5
Inventory 00 1/12 0
660. 55.0
A/C receivable 00 1/12 0
264. 22.0
Bank 00 1/12 0
1,626. 135.5
00 0
Current
liabilities
396. 33.0
A/C payables 00 1/12 0
132. 11.0
Current tax 00 1/12 0
420. 35.0
Proposed divs 00 1/12 0
948. 79.0
00 0
Net current 678. 56.5
assets 00 0
Net assets 2,586. 215.5
140
00 0
1,400. 200.0
Ordinary shares 00 1/7 0
630. 90.0
Retained profits Pre acquisition 00 1/7 0
Post 556. (74.5
acquisition 00 bal fig 0)
2,586. 215.5
00 0
Income
statement
2,211. 201.0
Sales 00 1/11 0
537.
Opening stock 00
1,353.
Purchases 00
1,890.
00
(702.
Closing stock 00)
1,188. 108.0
Cost of sales 00 1/11 0
1,023. 93.0
Gross profit 00 0
(99.0 (9.0
Expenses 0) 1/11 0)
(76.0 (7.0
Depreciation 0) 1/11 0)
(175. (16.0
00) 0)
848. 77.0
Operating profit 00 0
Income tax (242. (22.0
expense 00) 1/11 0)
606. 55.0
Profit after tax 00 0
Interim (112. (10.0
Dividends: dividends 00) 1/11.2 0)
(420. (35.0
Final proposed 00) 1/12 0)
Retained profit 74.0 10.0
141
0 0
CoC
Ksh Ksh
312. 160.0
Inv in S 00 OSC (80%x200) 0
72.0
P&L(80%x90) 0
80.0
Goodwill 0
312. 312.0
00 0
Goodwill restated 137.0

(80X12/7) 0
(80.0
Goodwill based on historical rate 0)
Gain on exchange to Foreign exchange 57.0
reserve 0
Gain/Loss on foreign currency exchange

translation
Ksh
215.5
Net closing assets of TA in KSh 0
Net opening assets of TA in KSh(2586- 251.2
74)/10 0
(35.7
0)
Less increase in retained profits ( P&L in 10.0
KSh) 0
(45.7
Foreign exchange loss 0)
Group P & L
Ksh Ksh
72. 184.0
Coc 00 KC 0
12. 15.5
MI 24 TA 0
Dividends 28.0
receivable 0
UPCI 8. Forex Loss 45.7
00 0
142
180.
Balance c/d 96
273. 273.2
20 0
Foreign Exchange reserve

Ksh Ksh
45. 9.1
Group P & L 70 MI (20%x45.7) 4
57.0
Goodwill 0
20.
Balance c/d 44
66. 66.1
14 4
MI balance
sheet
Ksh
Ordinary share capital in 40.0
TA 0
12.2
Share of profit 4
52.2
4
(9.1
Less share of forex loss 4)
43.1
0
(b) Functional Method
KC Ltc & Its Subsidiary

Consolidated Income Statement for Year Ended 30.9.95
KC TA Adjustments Group Ksh.

Ksh. Ksh.
Sales 930 201 930 + 201 - 98 1033

Cost of Sales (775) (117) 775 + 117 – 98 – 6+ 8 796
Gross Profit 155 84 237
Expenses (Introducing
Depreciation) 29 + 18 (47) (19) 47 + 19 (66)
Goodwill Amortized - - See Cost of Control (16)
See Step 3 on
Exchange Loss - - computation (3)
Operating Profit 108 65 152
Investment Income - Ignore Investment
143
Dividends 8 - Income -
Profit before tax 116 65 152
Taxation (33) 22 33 + 22 (55)
Profit after tax 83 43 2 97
Minority Interest - - 20% x 43 - 3 (8)
Profit attributable to KC
83 43 89
Dividends; Interim (20) (10) Only for KC (HC) (20)
paid
Final proposel (40) (35) (40)
Retained Profits for the 23 (2) 29
year
Statement of Retained Profits

B/fwd Year C/fwd
KC 123 33 56
TA 37.6 (4) 33.6
Group 160.6 29 189.6
KC and its subsidiary

Consolidated balance sheet as at 30.9.98
Non-Current Assets Ksh.M Ksh.M
PPE 432
Intangible Goodwill 32
Current Assets 464
Inventory 113
Receivables 191
Bank 53 357
Total Assets 821
Ordinary Share Capital 400

Retained Profits 189.6
Shareholders funds 589.6
Minority interest 66.4
workings
Current Liabilities
Payables 100
Taxation 18
Proposed Dividends 47 165
821
Workings
Step 1 Translate income statement of subsidiary co. TA

TA Exchange Rate TA
144
Ksh.M Ksh.M
1 201
Average
Sales 2211 11 ____
1 58
(Date stock
9.3
Opening Inventory 537 was acquired
31/3/98)
1
Average
Purchases 1353 11 123
1890 181
1
(Date stock
11
Closing Inventory (702) was acquired (64)
31/3/98)
Cost of Sales 1188 117
Gross Profit 1023 84
1 9
Average
Expenses 99 11
1 5.6
Rate on 1st
Depreciation: Land & 39.2 7
buildings October 95
1 2.4
Rate on 1st
Equipment 16.8 7
October 95
1
Rate on 30
Motor 20 10 2
Vehicles September 97
Total Expenses 175 19
Operating Profit 848 65
1
Average
Taxation (242) 11 22
Profits after tax 606 43
Dividends; interim (112) 1 (10)
(Rate on date
paid 11 .2
of payment)
Final (420) 1
Closing rate
proposed 12
____ (Rate at b/s date) (35)
Retained profit for the 74 2
year
Step 2 Translation of subsidiary’s Balance Sheet

TA Exchange Rate TA
Ksh. Ksh.
Non-current Assets
145
Land and Buildings 1764 1
Rate on 1.10.95
7 252
Equipment 84 1
Rate on 1.10.95
7 12
1
Rate on 1.10.95
Motor Vehicles 60 7 6
1908 270
Current Assets
Inventory 702 1
Rate stock was
11 64
acquired
Receivables 660 1
Rate on b/sheet
12 55
1
Rate on b/sheet
Bank 264 12 22
1626 141
Current Liabilities
1
Rate on b/sheet
Payables 396 12 33
1
Rate on b/sheet
Taxation 132 12 11
1
Rate on b/sheet
Proposed Dividends 420 12 35
948 79
Net Current Assets 678 62

Net Assets 2586 332
Ordinary Shares 1400 1

Rate of acquisition of
7 200
sub
P & L - Pre-acquisition 630 1
Rate of acquisition of
7 90
sub
Post acquisition
1186 - 630 556 Balancing Figure _42
2586 332
Cost of Control
Ksh. Ksh.
Investment of TA 312 OSC 80% x 200 160
P & L at acq 80% x 90 72
146
Goodwill Amortized b/f 32
Amortized for year 16
Bal c/d Amortized – 32
B/Sheet
___ ___
312 312
Step 3 Computation of Exchange Difference
Ksh.
Closing Net assets of subsidiary (translator) as at 332
30.9.98
Opening net assets of subsidiary as at 30.9.97 337.1
Decrease in Net Assets (5.1)
Less loss as per translated income statement of

subsidiary co. (2)
3.1
Workings for opening Net assets

TA
Non-Monetary TA M Exchange Rate Kshs. M
Assets
Land & 1
Buildings 1803.2 7 257.6
1
Equipment 100.8 7 14.4
Motor Vehicles 1
80 10 8
Stock 1
537 9.3 58
Net Monetary Balancing figure
Items (9) (0.9)
2512 337.1
Workings for retained profits
KC B/fwd Year C/fwd

As per the accounts 161 23 184
Less Goodwill (32) (16) (48)
amortised
UPCS (6) 6 -
147
UPCS - (8) (8)
Dividends receivable
80% x 35 - 28 28
123 33 156
A – Share of post acquired profits
As per the accounts 47 (2 45

)
Less exchange loss - (3 (3)
)
Adjusted past acq. profits 47 (5 42
)
HC – HC’s share of 80% 37. (4 33.
6 ) 6
Workings for B/Sheet KC TA

Continued
PRE; Land and Buildings 90
Equipment 60
Motor Vehicle 12
162 270
Minority Interest a/c

Sh.M Sh.M
OSC 20% X 200 40
Bal c/d 66.4 P & L 20%(90 26.4
+42)
66.4 66.4
148

ACC 412 Specialised Accounting I

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ACC 412 Specialised Accounting I

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MT KENYA UNIVERSITY

DEPARTMENT OF FINANCE AND

Course code: ACC 412:

Expected Learning Outcomes of the Course

Teaching / Learning Methodologies: Lectures and tutorials; group discussion;

Instructional Materials and Equipment: Projector; test books; design catalogues;

Recommended Text Books:

Text Books for further Reading:

The Partnership Deed:

Provisions of the Partnership Act

i) Every partner has a right to take part in the conduct of business;

- It is temporary (maybe set up for a given period which has lapsed);

Accounting for Partnerships

Example of a current account where there are 3 partners A, B and C:

Example of a capital account where there are 3 partners A, B, and C:

Format for Trading Profit and Loss A/CS:

Less: Interest on capital: A X

Note 1: (See current A/C)

Note 2: (See current A/C and appropriations A/C)

It is a “loss” to the partner and is therefore debited to his current account.

Note 3: (See current A/C and appropriation A/C)

Note 4: (See Current A/C and appropriation A/C)

Note 6: [See current A/C and balance sheet format (below)]

1.3 Format for Balance Sheet

Example of a balance sheet where there are 3 partners A, B and C.

Fixtures and fittings 10%

Brick and Stone

Brick and Stone

1.4 Admissions and Retirements

Equipment and vehicles 3,200 Land and building 10,400

Jim, Ken and Len

Jim, Ken and Len Partnership

Poor trading that has led to losses

DR. Revaluation account

DR. Cash book

DR. Creditors account payables

Dr. Realization account

DR. Current account

Where the assets are sold at once (one single transaction)

Where assets are sold off at once

Current accounts X 1,400

Cash book account

DR. Loan stock or shares

DR. Capital accounts

Inventory as at 31 March 19-8 was valued at £5,000;

Depreciation is to be charged as follows:

Compile the following accounts:

Amis, Lodge and Payne

Less Interest on capital: Amis 8,000

Amis, Lodger and Payne

Cash book account

Ordinary share capital account

Piecemeal Realizations and Distributions

It is therefore common practice to make interim distributions to partners as soon as a reasonable

These interim distributions give rise to two problems:

The maximum possible loss method

Therefore: Capital – Cash = Realisation Loss

The benefit of amalgamation includes:

An expansion of the capital base

Gee & Co Bee &Co

For the purposes of the amalgamation it was agreed as follows:

Goodwill in the new firm is to be £4,000.

You will be required to prepare: