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Paper F3 (International)
Course Notes
ACF3CN07 (INT)
[
F3 Financial Accounting (INT)
(Paper Based Exam)
Study Programme
Page
Introduction to the paper and the course............................................................................................................... (ii)
(i)
INTRODUCTION
The syllabus
The broad syllabus headings are:
Main capabilities
On successful completion of this paper, candidates should be able to:
• Explain the context and purpose of financial reporting
• Define the qualitative characteristics of financial information and the fundamental bases of accounting
• Demonstrate the use of double entry and accounting systems
• Record transactions and events
• Prepare a trial balance (including identifying and correcting errors)
• Prepare basic financial statements for incorporated and unincorporated entities
Corporate Reporting
(P2)
Financial Reporting
(P7)
This diagram shows where direct (solid line arrows) and indirect (dashed line arrows) links exist between this
paper and other papers that may precede or follow it.
Paper F7 Financial Reporting, assumes knowledge acquired in paper F3 Financial Accounting, and develops and
applies this further and in greater depth. Paper P2 Corporate Reporting, assumes knowledge acquired at the
Fundamentals level including core technical capabilities to prepare and analyse financial reports for single and
combined entities.
(ii)
INTRODUCTION
(iii)
INTRODUCTION
Course Aims
Achieving ACCA's Study Guide Outcomes
(iv)
INTRODUCTION
(v)
INTRODUCTION
Classroom tuition
In class we aim to cover the key areas of the syllabus. To ensure examination success you will to spend private
study time reinforcing your classroom course with question practice and reviewing areas of the Course Notes
and Study Text.
Home study
To support you with your private study BPP provides you with a Course Companion which helps you to work at
home and aims to ensure your private study time is effectively used. The Course Companion includes a Home
Study section which breaks down your home study by days, one to be covered at the end of each day of the
course. You will find clear guidance as to the time to spend on various activities and their importance.
You are also provided with progress tests and two course exams which should be submitted for marking as they
become due.
These may include questions on topics covered in class and home study.
ACCA Forum
We have thriving ACCA bulletin boards at www.bpp.com/accaforum. Register and discuss your studies with
tutors and students.
Helpline
If you have any queries during your private study simply contact your class tutor on the telephone number or
e-mail address that they will supply. Alternatively, call +44 (0)20 8740 2222 (or your local training centre if
outside the London area) and ask for a tutor for this paper to speak to you or to call you back within 24 hours.
Feedback
The success of BPP’s courses has been built on what you, the students tell us. At the end of the course for each
subject, you will be given a feedback form to complete and return.
If you have any issues or ideas before you are given the form to complete, please raise them with the course
tutor or relevant head of centre.
If this is not possible, please email ACCAcoursesfeedback@bpp.com.
(vi)
INTRODUCTION
Key to icons
(vii)
INTRODUCTION
(viii)
Introduction
to accounting
Exam Context
This chapter introduces the subject of accounting. Questions on this area will most likely focus on the different
characteristics of the three types of business entity: sole trader, partnership and limited liability company.
Qualification Context
Sole trader and partnership accounts are only examined in Financial Accounting. The Fundamentals and Professional
level papers of Financial Reporting (F7) and Corporate Reporting (P2) are set in the context of a limited liability
company. These papers will test your understanding of the content of financial statements and the detailed accounting
rules which companies must apply.
1.1
1: INTRODUCTION TO ACCOUNTING
Overview
Introduction
to accounting
1.2
1: INTRODUCTION TO ACCOUNTING
1 Accounting
Definition
1.1 Accounting is a way of recording, analysing and summarising transactions of a business.
1.3
1: INTRODUCTION TO ACCOUNTING
Balance sheet
2.2 Balance sheet as at 31 December 20X7:
$ $
ASSETS
Non-current assets
Land and buildings 100,000
Office equipment 50,000
Motor vehicles 30,000
Furniture and fixtures 20,000
200,000
Current assets
Inventories 50,000
Trade receivables 30,000
Less: allowance for receivables (2,000)
28,000
Prepayments 5,000
Cash in hand and at bank 7,000
90,000
Total assets 290,000
Current liabilities
Bank overdraft 16,000
Trade payables 40,000
Accruals 4,000
60,000
Total capital and liabilities 290,000
1.4
1: INTRODUCTION TO ACCOUNTING
Required
What information would these users of financial information be interested in?
Solution
(a) Investors
(b) Employees
(c) Lenders
(d) Suppliers
(e) Customers
(g) Public
1.5
1: INTRODUCTION TO ACCOUNTING
4 Accounting records
4.1 In order to be able to produce an income statement and a balance sheet a business needs
to keep a record of all its transactions.
4.3 Accounting records should be complete, accurate and valid if the information produced is
to be useful for the users of financial information.
4.4 The mechanics of bookkeeping and the accounting records a business should keep will be
covered in Chapters 4, 5 and 6.
(b) Partnership
6.2 When considering a limited liability company this distinction is laid down in law – the
company has a separate legal identity.
6.3 In preparing accounts, any type of business is treated as being a separate entity from its
owner(s).
1.6
1: INTRODUCTION TO ACCOUNTING
7 Summary of Chapter 1
7.1 Financial statements are used by a wide variety of users, each with different information
needs. Satisfying the investors’ needs will mean that the majority of other users’ needs are
also met.
7.2 There are three main types of businesses. For sole traders and partnerships the owners
have unlimited liability and bear all the risks and reap all the rewards of being in business.
For a limited liability company the shareholders' liability is limited to the extent of their
investment.
7.3 The business entity concept states that a business is a separate entity from its owners
1.7
1: INTRODUCTION TO ACCOUNTING
1.8
Chapter 1: Questions
1.9
1: QUESTIONS
1.1 In a sole trader and a partnership the owners are personally liable if the business cannot meet its debts.
Is this statement true or false?
A True
B False (1 mark)
1.2 If a limited liability company goes into liquidation will the shareholders have to make a financial
contribution to help the company pay its creditors?
A Yes
B No (1 mark)
1.3 Which of the following statements most accurately defines the business entity concept?
A The business must be treated as being separate from its owners.
B A business must be set up as a separate legal entity. (1 mark)
1.10
Chapter 1: Answers
1.11
1: ANSWERS
1.1 A
1.2 B
1.3 A
END OF CHAPTER
1.12
Home study chapter -
The regulatory framework
Exam Context
Questions on this chapter will be knowledge based and so it is important that you are familiar with the role of each body.
The role of IFRIC was tested in the Pilot Paper.
Qualification Context
Financial Accounting introduces the International Accounting Standards Board's role in issuing IFRSs and paper F3
examines some key standards. All of these standards are built upon in the Fundamentals level paper Financial
Reporting (F7) and the Professional level paper Corporate Reporting (P2).
2.1
2: HOME STUDY CHAPTER - THE REGULATORY FRAMEWORK
Overview
Regulatory
framework
IASCF
Issue IFRS
2.2
2: HOME STUDY CHAPTER - THE REGULATORY FRAMEWORK
1 Introduction
1.1 Financial statements are produced by an entity's managers in order to show its owners how
the entity has performed over a period of time.
1.2 Company financial statements particularly need to show a true and fair view.
This means a system of regulation is necessary to ensure that financial statements are
produced to a high standard and are comparable across different companies.
2 Regulatory system
2.1
International Accounting
Standards Committee Foundation
(IASCF)
(22 Trustees)
2.3
2: HOME STUDY CHAPTER - THE REGULATORY FRAMEWORK
3.2 If a company follows the relevant accounting standards its financial statements should show
a true and fair view.
Solution
2.4
2: HOME STUDY CHAPTER - THE REGULATORY FRAMEWORK
Which of the following bodies is involved is trying to achieve convergence of global accounting
standards?
A IASB
B IFRIC
Solution
4 Summary of Chapter 2
4.1 The IASCF appoints members to the IASB, IFRIC and SAC.
2.5
2: HOME STUDY CHAPTER - THE REGULATORY FRAMEWORK
2.6
Chapter 2: Questions
2.7
2: QUESTIONS
2.2 Which of the following best describes the role of The International Financial Reporting Interpretations
Committee?
A Issues International Financial Reporting Standards.
B Provides advice on the development of standards.
C Interprets International Financial Reporting Standards. (1 mark)
2.8
Chapter 2: Answers
2.9
2: ANSWERS
2.1 A
2.2 C
END OF CHAPTER
2.10
Accounting conventions
Exam Context
Questions on this chapter are likely to test your understanding of the qualitative characteristics of information. For
example, the Pilot Paper required you to identify the factors that make information reliable. Questions may also ask you
to define accounting conventions.
Qualification Context
Your understanding of the remaining chapters of IASB Framework will be developed in the Fundamentals level paper
Financial Reporting (F7). You should also expect to see more detailed calculations on IAS 8 tested in Paper F7.
3.1
3: ACCOUNTING CONVENTIONS
Overview
IASB Framework
Accounting conventions
Other issues
3.2
3: ACCOUNTING CONVENTIONS
1 Introduction
1.1 As noted in Chapter 2 financial statements should show a true and fair view of, or present
fairly, the entity's activities. They are produced to provide information to the entity's owners.
1.2 In order for this information to be useful it must possess certain characteristics.
2.3 Whenever a new accounting standard is issued it will be based on the principles of the IASB
Framework. Furthermore its principles should be applied to account for any item where no
accounting standard exists.
5) Recognition of 6) Measurement of
the elements of the elements of
financial statements financial statements
3.3
3: ACCOUNTING CONVENTIONS
Underlying assumptions
2.6 Accruals basis
The effects of transactions and other events are recognised when they occur (and not as
cash or its equivalent is received or paid) and they are recorded in the accounting records
and reported in the financial statements of the period to which they relate.
Going concern
The financial statements are normally prepared on the assumption that an entity is a going
Quick Quiz Q3 concern and will continue in operation for the foreseeable future.
If this is not appropriate, then additional disclosure about the basis of preparation must be
made in the financial statements.
Relevance Reliability
3.4
3: ACCOUNTING CONVENTIONS
Asset
A resource controlled by an entity as a result of past events and from which future
economic benefits are expected to flow to the entity.
Liability
A present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow of economic benefits.
Equity
The residual interest in the assets of an entity after deducting all its liabilities, so
EQUITY = NET ASSETS = SHARE CAPITAL + RESERVES
Income
Increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in increases in equity, other
than those relating to contributions from equity participants.
Expenses
Decreases in economic benefits during the accounting period in the form of outflows or
depletions of assets or increases of liabilities that result in decreases in equity, other
than those relating to distributions to equity participants.
3.5
3: ACCOUNTING CONVENTIONS
What are the advantages and disadvantages of recording the building at its historic cost of
$1 million? (consider the Framework's qualitative characteristics).
Solution
Advantages of historic cost
(1)
(2)
(3)
Disadvantages of historic cost
(1)
(2)
3.2 Note that in times of rising prices using the historical cost convention will lead to asset
values being too low and profits too high in a set of financial statements.
3.3 Due to the limitations of historic cost, alternative valuation bases exist. They are:
• replacement cost
• net realisable value
• economic value
Replacement cost
3.4 Assets are carried at the amount it would cost to acquire an equivalent asset today.
Liabilities are shown at the amount that would be required to settle the obligation today.
Replacement cost is also known as 'current cost'.
3.6
3: ACCOUNTING CONVENTIONS
A Ltd has 100 items in inventory at the year end. The following information is available:
$
Total cost of items to date 1,000
Expected selling price per item 11
Costs which still need to be incurred per item before item can be sold 2
Required
(a) What is the historic cost of the inventory? $
(b) What is the net realisable value of the inventory? $
(c) What value for inventory should be shown in the financial statements? $
Workings
Economic value
3.6 This is the value of an item derived from its ability to generate net cash flows. It can also be
known as 'present value'.
Quick Quiz Q6 For example, the economic value of a machine would be calculated by determining the
value in today's prices, of the future cash inflows from selling items produced by the
machine less the related cash outflows.
3.7
3: ACCOUNTING CONVENTIONS
4 Summary of Chapter 3
4.1 The IASB Framework provides a set of principles on which financial accounting is based.
4.2 Financial statements should provide information on an entity’s financial position, financial
performance and changes in financial position.
4.3 In order for this information to be useful to users the financial statements should contain the
qualitative characteristics of understandability, relevance, reliability and comparability.
3.8
3: ACCOUNTING CONVENTIONS
Additional Notes
3.9
3: ACCOUNTING CONVENTIONS
3.10
3: ACCOUNTING CONVENTIONS
Accounting treatment
6.3 Financial statements contain two years worth of figures. For example a company whose
year end is 31 December 20X7 will show information for 20X7 and 20X6.
The current year figures (20X7) will be produced using the new accounting policy.
In order for the financial statements to be comparable over time the comparative figures
(20X6) will be restated. This means they will be reproduced and drawn up using the 20X7
accounting policies.
6.4 Disclosure
The following disclosure should be made:
(a) The nature of the change in accounting policy
(b) The reasons for the change
(c) The amount of the adjustment in the current period and the comparative period.
Errors
6.5 These are material omissions from, or misstatements in, the financial statements that ought
to have been identified before the financial statements were finalised.
An error is accounted for in exactly the same way as a change in accounting policy.
For example, an entity may discover a material error in the 20X6 figures whilst producing the
20X7 financial statements. When the 20X7 financial statements are produced the 20X6
comparatives should be restated and the error corrected.
3.11
3: ACCOUNTING CONVENTIONS
3.12
Chapter 3: Questions
3.13
3: QUESTIONS
3.1 The Framework for the Preparation and Presentation of Financial Statements identifies two assumptions
which are the bedrock of accounting. What are they?
A Consistency and prudence
B Accruals and going concern
C Materiality and separate entity (1 mark)
3.2 In which of the following circumstances can a change of accounting policy be made?
(i) If the directors want to improve the balance sheet value
(ii) If required by an accounting standard
(iii) If it results in reliable and more relevant information
A (ii) only
B (i) and (ii)
C (ii) and (iii)
D (i), (ii) and (iii) (2 marks)
3.14
Chapter 3: Answers
3.15
3: ANSWERS
3.1 B
3.2 C
END OF CHAPTER
3.16
Sources, records and
books of prime entry
Exam Context
Questions are unlikely to feature solely on this chapter, however, you should have a good understanding of what
constitutes an asset, liability, capital, income and expense. You should also be aware of the principal contents of each
book of prime entry and the purpose of the memorandum ledgers.
Qualification Context
These topics are only examined in Financial Accounting.
4.1
4: SOURCES, RECORDS AND BOOKS OF PRIME ENTRY
Overview
Cash book Sales day book Purchase day book Petty cash book Journal book
4.2
4: SOURCES, RECORDS AND BOOKS OF PRIME ENTRY
Required
List out everything you own and owe.
Solution
(a) Own
(b) Owe
1.2 For a business, this list is formalised as a balance sheet and show the entity's assets and
liabilities.
(a) Asset: is a resource controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity.
(b) Liability: is a present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow of economic benefits.
4.3
4: SOURCES, RECORDS AND BOOKS OF PRIME ENTRY
Current liabilities
Bank overdraft 16,000
Trade payables 40,000
Accruals 4,000
60,000
Total capital and liabilities 290,000
Key features
1.4 (a) Always headed as at, for the date of the balance sheet.
(b) Non-current assets - assets held and used in the business over the long-term (i.e.
more than one year).
(c) Current assets - not non-current assets! Conventionally listed in increasing order of
liquidity (i.e. closeness of assets to cash).
(d) Capital - what the business owes the proprietor/owner. In this case the sole trader
owns all of the business, i.e. its total net worth.
∴ CAPITAL = ASSETS - LIABILITIES
= NET ASSETS
4.4
4: SOURCES, RECORDS AND BOOKS OF PRIME ENTRY
(e) Don't include a caption (item heading) if there isn’t a value for it.
The balance sheet is a snapshot of the business at one point in time.
4.5
4: SOURCES, RECORDS AND BOOKS OF PRIME ENTRY
Key features
2.3 (a) Headed up with the period for which the income and expenses are being included.
(b) The top part Sales X
Cost of sales (X)
Gross profit X
is called the trading account as it records just the trading activities (buying and
selling) of the business.
(c) Sundry income includes items like bank account interest.
(d) Do not include nil value captions.
The income statement is a summary of the business' performance over a period of
time – think of it as a DVD!
3.2 The accounting period is the period for which the income statement was prepared. This is
usually a year.
3.3 Therefore, there will be a balance sheet at the beginning of the year (prior year end) and at
the end of the accounting period.
The income statement is for the intervening period.
Balance Balance
sheet as at sheet as at
31.12.X6 31.12.X7
4.6
4: SOURCES, RECORDS AND BOOKS OF PRIME ENTRY
CASH TRANSACTIONS
CREDIT TRANSACTIONS
Sales Purchases
4.2 This is achieved by having accounting records to record each stage of the process:
Assorted transactions
(eg invoices)
Categorised
(in Books of Prime Entry)
Summarised
(eg nominal ledger, trial balance)
FINANCIAL STATEMENTS
(eg Balance Sheet and Income Statement)
4.7
4: SOURCES, RECORDS AND BOOKS OF PRIME ENTRY
5.2
Books of prime entry
Cash book Sales day Purchase day Petty cash Journal book
book book book
Receipts Payments
Cash book
5.3 (a) Records receipts and payments into and out of the bank.
(b) For exam purposes often assumed to be two books, one for receipts, one for
payments.
4.8
4: SOURCES, RECORDS AND BOOKS OF PRIME ENTRY
5.7 Example:
Date Customer $
3.1.X7 J. Spalding 200
5.1.X7 G. McGregor 400
8.1.X7 J. Spalding 400
14.1.X7 G. McGregor 300
TOTAL 1,300
5.9 Example:
Date Supplier $
1.1.X7 Tewson Co. 400
4.1.X7 Manley & Co. 350
16.1.X7 Manley & Co. 200
TOTAL 950
4.9
4: SOURCES, RECORDS AND BOOKS OF PRIME ENTRY
5.11 Example:
Receipts Payments
Journal book
5.13 Certain transactions do not ‘fit’ in the main books, for example:
(a) period end adjustments
(b) correction of errors
The journal book lists these sundry transactions.
6 Memorandum ledgers
Purpose
6.1 To know how much is owed by a particular customer or to a certain supplier at a point in
time.
For example, the sales day book shows the sales made on credit to all customers and the
cash book receipts shows the cash received from all sources.
J. Spalding owes the business $400 but this cannot be seen from the books of prime entry
without trawling back through the detailed information.
A separate memorandum ledger is kept to show this information.
4.10
4: SOURCES, RECORDS AND BOOKS OF PRIME ENTRY
6.2 There are two types of memorandum ledgers kept by the business:
(a) Receivables ledger – showing how much is owed by each individual customer.
(b) Payables ledger – showing how much is owed to each individual supplier.
6.3 The entries in these ledgers are made by rearranging the information in the day books into
individual customer and supplier accounts.
Receivables ledger
6.4 Example:
J. Spalding (Customer)
G. McGregor (Customer)
Payables ledger
6.5 Example:
Tewson Co. (Supplier)
4.11
4: SOURCES, RECORDS AND BOOKS OF PRIME ENTRY
7 Summary of Chapter 4
7.1 The balance sheet shows the assets and liabilities of a business at a particular point in
time whilst the income statement shows its performance over a period.
7.2 In order to produce a set of financial statements the business’ transactions must first be
categorised into the books of prime entry. The totals on these books are then
summarised in the nominal ledger.
4.12
Chapter 4: Question
4.13
4: QUESTION
4.14
Chapter 4: Answer
4.15
4: ANSWER
4.1 C
END OF CHAPTER
4.16
Ledger accounts
and double entry
Exam Context
Your understanding of double entry will be crucial to passing Financial Accounting. Whilst an individual question may
not ask you to produce a double entry it will be instrumental in answering the question. For example, a question may ask
you to derive the income statement expense for electricity where amounts need to be accrued at the year end. You will
only get this right if you understand the double entry for recording expenses and accruals. A question could also
describe a transaction and ask you to identify the correct double entry to record this.
Qualification Context
Being confident at double entry will help you account for many of the more complex accounting standards you will meet
in the Fundamentals level paper, Financial Reporting (F7) and the Professional level paper, Corporate Reporting (P2).
5.1
5: LEDGER ACCOUNTS AND DOUBLE ENTRY
Overview
Ledger accounts
and double entry
Debit Credit
Balancing off
5.2
5: LEDGER ACCOUNTS AND DOUBLE ENTRY
1 Introduction
1.1 This chapter is designed to enable you to explain the principles of double entry and apply
these principles to the preparation of accounting records within the nominal/general ledger.
1.2 In Chapter 4 we saw how transactions were categorised in books of prime entry, the next
step is to summarise the information in a format nearer to that of the final financial
statements.
We make two entries from each total extracted from the books of prime entry, and call one a
Debit (Dr), and the other one a Credit (Cr).
5.3
5: LEDGER ACCOUNTS AND DOUBLE ENTRY
General rules
2.3 (a) DEBIT entry represents:
(i) an increase in an asset;
(ii) a decrease in a liability;
(iii) an item of expense.
(b) CREDIT entry represents:
(i) an increase in a liability;
(ii) a decrease in an asset;
(iii) an item of income.
This can be remembered as follows
Debits Credits
(increase) (increase)
Quick Quiz
Q1 - 4 Expenses Liabilities
Assets Income
Drawings Capital
5.4
5: LEDGER ACCOUNTS AND DOUBLE ENTRY
Required
What is the double entry for each of the following?
Explain each entry in terms of the general rules above.
Solution
5.5
5: LEDGER ACCOUNTS AND DOUBLE ENTRY
Douglas
Douglas had the following transactions during January:
(1) Introduced $5,000 cash as capital;
(2) Purchased goods on credit from Richard, worth $2,000;
(3) Paid rent for one month, $500;
(4) Paid electricity for one month, $200;
(5) Purchased car for cash, $1,000;
(6) Sold half of the goods on credit to Tish for $1,750;
(7) Drew $300 for his own expenses;
(8) Sold goods for cash, $2,100.
Required
Post transactions (1) to (8) to the relevant ledger accounts.
Solution
5.6
5: LEDGER ACCOUNTS AND DOUBLE ENTRY
5.7
5: LEDGER ACCOUNTS AND DOUBLE ENTRY
3 Flow of information
3.1 In Lecture example 2 the original transactions were posted to the ledger accounts. A
business would firstly categorise this information in the books of prime entry. The totals
from the books of prime entry are then posted to the nominal ledger using double entry.
3.2
The following information has been posted to the cash account below.
Required
Balance off the cash account to determine the amount of cash held at the end of January.
Solution
Dr Cash Cr
$ $
2/1 Sales 500 1/1 Purchases 300
10/1 Sales 500 25/1 Telephone 50
5.8
5: LEDGER ACCOUNTS AND DOUBLE ENTRY
Steps
4.2 (1) Add the debit and credit sides separately.
(2) Fill in the higher of the two totals on both sides.
(3) Literally 'balance' the account (what number do we need and on which side to make
the two sides equal?) – balance c/d
(4) Complete the 'double entry' – balance b/d on opposite side.
Douglas
Refer to Lecture example 2 on page 5.6.
Required
Balance off the ledger accounts for Douglas
Solution
Complete in the solution space for Lecture example 2.
5 Summary of Chapter 5
5.1 The totals on the books of prime entry are posted to the nominal ledger using double entry.
5.2 The principles of double entry work on the basis that for each debit entry there must be a
credit entry.
5.3 A debit entry increases assets, expenses and drawings and a credit entry increases
liabilities, income and capital – this can be remembered as DEAD CLIC.
5.4 At the end of each period the nominal ledger accounts (T accounts) are 'balanced off' to
determine the closing balance on each account.
5.9
5: LEDGER ACCOUNTS AND DOUBLE ENTRY
5.10
Chapter 5: Questions
5.11
5: QUESTIONS
5.1 A credit balance of $3,000 brought down on X Co’s account in Y Co’s books means that
A X Co is owed $3,000 by Y Co
B Y Co is owed $3,000 by X Co
C Y Co has sold $3,000 of goods to X Co (1 mark)
5.2 Which of the statements below best describes the nominal ledger?
A A list of all assets and liabilities at a point in time
B A collection of accounts to record the transactions of the business
C A record of amounts owed to/from individual suppliers and customers
D An initial record of internally generated transactions (2 marks)
5.12
Chapter 5: Answers
5.13
5: ANSWERS
5.1 A The balance represents the outstanding amount i.e. purchases less cash paid.
5.2 B
END OF CHAPTER
5.14
From trial balance to
financial statements
Exam Context
Questions on this chapter may require you to derive missing figures (for example, profit for the period) using the
accounting equation and identify the correct double entry to record transactions such as closing inventory or drawings.
Qualification Context
Financial Accounting is the only paper where you are required to produce financial statements for a sole trader.
Financial statements for limited liability companies are tested in detail in the Fundamentals level paper, Financial
Reporting (F7) and the Professional level paper, Corporate Reporting (P2).
6.1
6: FROM TRIAL BALANCE TO FINANCIAL STATEMENTS
Overview
Accounting equation
6.2
6: FROM TRIAL BALANCE TO FINANCIAL STATEMENTS
1 Introduction
1.1 We saw in Chapters 4 and 5 that:
• transactions are categorised in the books of prime entry;
• the totals are then posted to the ledger accounts in the nominal ledger using double
entry;
• the ledger accounts are then balanced off and the balances brought down.
Example
2.2 Miss Smith – Trial Balance at as 31 December 20X7:
Cash 720
Capital 500
Sales 2,200
Purchases 1,100
Furniture 500
Electricity 120
Telephone 60
Drawings 200
Total 2,700 2,700
If the trial balance doesn't balance then an error must have occurred.
The correction of errors is covered in Chapter 16.
6.3
6: FROM TRIAL BALANCE TO FINANCIAL STATEMENTS
Douglas
Refer to Lecture example 2 in Chapter 5 on page 5.6 where the ledger accounts were balanced
off.
Using the ledger accounts for Douglas, prepare the trial balance as at the end of January.
Solution
6.4
6: FROM TRIAL BALANCE TO FINANCIAL STATEMENTS
Colin opens a business selling cordless telephones. In the first month he buys 50 phones for $20
each, and sells 20 for $30 each. Complete the trading account below.
Solution
$ $
Sales
Cost of sales
Purchases
Less: closing inventories
Gross profit
Accounting treatment
3.2 The closing inventory adjustment is accounted for via a journal entry. The double entry is:
Dr Inventories (B/S)
Cr Closing inventories (COS – I/S)
3.3 This adjustment is usually made after the preliminary trial balance has been prepared.
3.4 Last period's closing inventories will become this period's opening inventories. These items
will be sold in the year and so will form part of cost of sales. As the items are sold they will
no longer be an asset of the business and should be removed from the balance sheet. The
double entry is:
Dr Opening inventories (COS – I/S)
Cr Inventories (B/S
This can be done as soon as the new period begins.
6.5
6: FROM TRIAL BALANCE TO FINANCIAL STATEMENTS
4.3 The income and expenditure accounts have now been closed out and a new account will be
created for each income and expenditure item next year.
Douglas
Refer to Lecture example 1 on page 6.4
The cost of goods remaining unsold at year end was $250.
Required
Prepare an income statement in ledger account form.
Solution
6.6
6: FROM TRIAL BALANCE TO FINANCIAL STATEMENTS
5.2 At end of period, clear balances on income statement and drawings to capital account.
Douglas
Refer to Lecture example 3 on page 6.6.
Required
Draw up an income statement for the period and a balance sheet at the end of January.
Solution
DOUGLAS
INCOME STATEMENT FOR THE MONTH OF JANUARY
$ $
Sales
Purchases
Gross profit
Less expenses:
Rent
Electricity
Net profit
6.7
6: FROM TRIAL BALANCE TO FINANCIAL STATEMENTS
DOUGLAS
BALANCE SHEET AS AT 31 JANUARY
NON-CURRENT ASSET $ $
Motor vehicle
CURRENT ASSETS
Inventories
Trade receivables
Cash
PROPRIETOR’S INTEREST $ $
Less: drawings
Balance 31 January
CURRENT LIABILITIES
Trade payables
6.8
6: FROM TRIAL BALANCE TO FINANCIAL STATEMENTS
Douglas
Refer to Lecture example 4 on page 6.7.
Required
Transfer the profit and drawings to the capital account.
Solution
Drawings
5.3 Drawings are amounts being taken out of a business by its owner. Drawings are generally in
the form of cash, but an owner may also take inventory out of the business. Drawings of
inventories are recorded at the cost of the inventories not the sales price.
6.9
6: FROM TRIAL BALANCE TO FINANCIAL STATEMENTS
ASSETS = LIABILITIES
(debits) (credits)
Proprietor’s interest
Douglas
Refer to Lecture example 5.
Required
Prepare the accounting equation for Douglas.
Solution
6.10
6: FROM TRIAL BALANCE TO FINANCIAL STATEMENTS
7 Summary of Chapter 6
7.1 The trial balance consists of a list of the balances brought down on each ledger account.
7.2 At the end of the year an adjustment must be made for closing inventory to match sales
revenue to the cost of making those sales and also to reflect the fact that the inventories are
an asset of the business.
7.3 The opening inventory balance should also be transferred to cost of sales.
7.4 The income statement and balance sheet are then produced from the trial balance
(incorporating any adjustments such as closing inventory).
Dr Inventories (B/S)
Cr Closing inventories (I/S)
Assets = Liabilities
Assets = Capital + Profit + Payables
6.11
6: FROM TRIAL BALANCE TO FINANCIAL STATEMENTS
6.12
Chapter 6: Questions
6.13
6: QUESTIONS
6.1 At the end of the accounting period and after the balance sheet and income statement have been
prepared for a sole trader:
A All journals are reversed
B The balances on asset and liability accounts are transferred to the capital account
C The balances on the income statement and drawings account are transferred to the capital account
D Balances are carried forward on all the accounts in the nominal ledger (2 marks)
6.2 A business has cash of $1,100, trade payables of $2,500, a mortgage liability of $8,000 and land of
$16,000.
What is the proprietor's interest? $ (2 marks)
6.3 Joe, a sole trader, set up business on 1 October 20X6 with $40,000 of his own money. During the year to
30 September 20X7 he won $50,000 on the lottery and paid $30,000 of this into his business. He took
cash drawings of $5,000 during the year and at 30 September 20X7 the net assets of the business
totalled $59,000.
What was the profit or loss of the business for the year ended 30 September 20X7?
A $4,000 profit
B $6,000 profit
C $16,000 loss
D $6,000 loss (2 marks)
6.4 Joan
Joan, a second hand bookseller, has been in business for two months. In this time she:
(1) paid in cash $5,000 as capital;
(2) took the lease of a stall and paid two months’ rent. The annual rental was $1,200;
(3) purchased, on credit from J Fox, books at cost of $825;
(4) spent $420 cash on the purchase of other books from W Smith;
(5) paid an odd-job man $75 to paint the exterior of the stall and repair a broken lock;
(6) put an advertisement in the local paper at a cost of $10;
(7) sold three volumes containing "The Complete Works of Shakespeare" to an American for $60
cash;
(8) sold six similar sets on credit to a local school for $300;
(9) paid J Fox $525 on account for the amount due to him;
(10) received $200 from the school;
(11) purchased cleaning materials at a cost of $10 and paid a char lady $30;
(12) took $100 from the business to pay for her own personal expenses;
(13) made other cash sales during the two months of $1,500;
(14) all books had been sold by the end of two months.
Required
(a) Write up the relevant ledger accounts for these transactions.
(b) Balance off all of the ledger accounts.
(c) Prepare a trial balance, an income statement and a balance sheet.
6.14
6: QUESTIONS
6.5 Brian
Brian set himself up in business on 1 January selling ice creams. During his first two months in business
he:
(1) Introduced $20,000 of cash as capital into the business;
(2) Purchased a second hand ice cream van from John. He paid John $10,500 cash;
(3) Paid Terry $200 to repair the ice cream machine in the van;
(4) Purchased on credit, inventories totalling $750;
(5) Spent $400 on petrol;
(6) Sold goods for $750 in cash;
(7) Paid $600 in tax and insurance;
(8) Made additional cash purchases of $80 for strawberry sauce and chocolate flakes;
(9) Withdrew $300 for his own expenses;
(10) The cost of goods remaining unsold was $500.
Required
(a) Post transactions (1) – (9) to the relevant ledger accounts.
(b) Balance off the ledger accounts.
(c) Prepare a trial balance.
(d) Prepare an income statement in ledger account form (remembering to deal with item 10).
(e) Draw up an income statement for the period and a balance sheet at the end of the period.
(f) Transfer the loss and drawings to the capital account.
6.6 Dealers
On 1 January the proprietor’s interest in a business, Dealers, was $18,500. At 31 January the assets and
liabilities of the business were as follows.
$
Plant and equipment 10,000
Motor vehicles 5,000
Trade payables 3,000
Trade receivables 2,000
Inventories 4,500
Accrued expenses 250
Balance in the bank 3,500
Cash in the till 250
On 7 January the proprietor had paid in additional capital of $2,000. On 14 January he had taken goods
at a cost of $350 for his own consumption and on 30 January had drawn cash of $1,250 from the
business, for his own personal expenditure.
Required
(a) Calculate the net asset value at 1 January.
(b) Calculate the net asset value of the business at 31 January.
(c) Calculate the profit of the business for the month of January.
(d) Show the accounting equation at 31 January.
6.15
6: QUESTIONS
6.16
Chapter 6: Answers
6.17
6: ANSWERS
6.1 C
6.2 $6,600
Dr Cr
$ $
Cash 1,100
Trade payables 2,500
Mortgage liability 8,000
Land 16,000
Proprietor's interest (balancing figure) 6,600
17,100 17,100
6.3 D
$
Net assets at 1.10.X6 40,000
Capital introduced 30,000
Drawings (5,000)
∴ loss for year (balancing figure) (6,000)
Net assets at 30.9.X7 59,000
6.4 Joan
Bank (B/S)
$ $
(1) Capital 5,000 (2) Rent 200
(7) Sales 60 (4) Purchases 420
(10) Trade receivables 200 (5) Repairs 75
(13) Sales 1,500 (6) Advertising 10
(9) Trade payables 525
(11) Cleaning materials 10
(11) Cleaning 30
(12) Drawings 100
Balance c/d 5,390
6,760 6,760
Balance b/d 5,390
Capital (B/S)
$ $
Balance c/d 5,000 (1) Bank 5,000
5,000 5,000
Balance b/d 5,000
Rent (I/S)
$ $
(2) Bank 200 Balance c/d 200
200 200
Balance b/d 200
6.18
6: ANSWERS
Purchases (I/S)
$ $
(3) Trade payables 825 Balance c/d 1,245
(4) Bank 420
1,245 1,245
Balance b/d 1,245
Repairs (I/S)
$ $
(5) Bank 75 Balance c/d 75
75 75
Balance b/d 75
Advertising (I/S)
$ $
(6) Bank 10 Balance c/d 10
10 10
Balance b/d 10
Sales (I/S)
$ $
Balance c/d 1,860 (7) Bank 60
(8) Trade receivables 300
(13) Bank 1,500
1,860 1,860
Balance b/d 1,860
6.19
6: ANSWERS
Cleaning (I/S)
$ $
(11) Bank 30 Balance c/d 30
30 30
Balance b/d 30
Drawings (B/S)
$ $
(12) Bank 100 Balance c/d 100
100 100
Balance b/d 100
Trial Balance
Debit Credit
$ $
Bank 5,390
Capital 5,000
Rent 200
Trade payables 300
Purchases 1,245
Repairs 75
Advertising 10
Sales 1,860
Trade receivables 100
Cleaning materials 10
Cleaning 30
Drawings 100
7,160 7,160
Joan
Income statement for the two months ended……
$ $
Sales 1,860
Purchases (1,245)
Gross profit 615
Rent 200
Repairs 75
Advertising 10
Cleaning (10 + 30) 40
(325)
Profit for the period 290
6.20
6: ANSWERS
Joan
Balance sheet as at….
$
Current Assets
Trade receivables 100
Bank 5,390
5,490
Proprietor's Interest $
Capital 5,000
Profit 290
Less: drawings (100)
5,190
Current Liabilities
Trade payables 300
5,490
6.5 Brian
(a) Bank (B/S)
$ $
(1) Capital 20,000 (2) Van 10,500
(6) Sales 750 (3) Repairs & Maintenance 200
(5) Petrol 400
(7) Tax & Insurance 600
(8) Purchases 80
(9) Drawings 300
Capital (B/S)
$ $
(1) Bank 20,000
Van (B/S)
$ $
(2) Bank 10,500
Purchases (I/S)
$ $
(4) Trade payables 750
(8) Bank 80
6.21
6: ANSWERS
Petrol (I/S)
$ $
(5) Bank 400
Sales (I/S)
$ $
(6) Bank 750
Drawings (B/S)
$ $
(9) Bank 300
Capital (B/S)
$ $
Bal c/d 20,000 (1) Bank 20,000
20,000 20,000
Bal b/d 20,000
Van (B/S)
$ $
(2) Bank 10,500 Bal c/d 10,500
10,500 10,500
6.22
6: ANSWERS
Purchases (I/S)
$ $
(4) Trade payables 750
(8) Bank 80 Bal c/d 830
830 830
Petrol (I/S)
$ $
(5) Bank 400 Bal c/d 400
400 400
Sales (I/S)
$ $
Bal c/d 750 (6) Bank 750
750 750
Bal b/d 750
Drawings (B/S)
$ $
(9) Bank 300
Bal c/d 300
300 300
Bal b/d 300
(c) Trial balance
Debit Credit
$ $
Bank 8,670
Capital 20,000
Van 10,500
Repairs and Maintenance 200
Purchases 830
Trade payables 750
Petrol 400
Sales 750
Tax & Insurance 600
Drawings 300
21,500 21,500
6.23
6: ANSWERS
Purchases (I/S)
$ $
(4) Trade payables 750
(8) Bank 80 Balance c/d 830
830 830
Balance b/d 830 Income statement 830
Petrol (I/S)
$ $
(5) Bank 400 Balance c/d 400
400 400
Sales (I/S)
$ $
Balance c/d 750 (6) Bank 750
750 750
6.24
6: ANSWERS
Inventories (B/S)
$ $
Closing inventories (I/S) 500
(e) Brian
Income statement for the two months ended 28 February
$ $
Sales 750
Less cost of sales:
Purchases 830
Less: closing inventories (500)
330
Gross profit 420
Less expenses:
Petrol 400
Repairs & Maintenance 200
Tax & Insurance 600
((1,200)
Net loss for the period (780)
Brian
Balance sheet as at 28 February
Proprietor’s interest $ $
Capital introduced on 1 January 20,000
Loss for the period (780)
Less: drawings (300)
(1,080)
Balance at 28 February 18,920
Current liabilities
Trade payables 750
Total capital and liabilities 19,670
(f)
Drawings (B/S)
$ $
(9) Bank 300
Bal c/d 300
300 300
6.25
6: ANSWERS
Income statement
$ $
Purchases 830 Sales 750
Gross profit c/d 420 Closing inventories 500
1,250 1,250
Petrol 400 Gross profit b/d 420
Repairs & Maintenance 200
Tax & Insurance 600
Net loss c/d 780
1,200 1,200
Net loss b/d 780 Capital a/c 780
Capital account (B/S)
$ $
Bal c/d 20,000 (1) Bank 20,000
20,000 20,000
6.26
6: ANSWERS
6.27
6: ANSWERS
END OF CHAPTER
6.28
Sales tax
Exam Context
This topic is likely to be tested in two main ways. You may be asked to identify the correct journal entry to post sales and
purchases transactions including sales tax. You may also be required to consider how sales tax affects the calculation of
amounts to be capitalised for non-current assets and the amount for trade receivables where discounts are offered.
Qualification Context
Financial Accounting introduces accounting for sales tax. More detailed rules and calculations relating to this area are
covered in the Fundamentals level paper, Taxation (F6).
7.1
7: SALES TAX
Overview
Accounting treatment
Sales tax
7.2
7: SALES TAX
1 Introduction
1.1 This chapter is designed to enable you to prepare basic accounting entries for sales tax,
known in many countries as Value Added Tax (VAT).
Sales tax
1.2 A business' sales and purchases are often subject to sales tax. This is an indirect tax, as it
is not levied directly on the individual like personal income tax. Sales tax is collected by
traders who charge it on the goods they sell to the customer.
A business charges sales tax on its sales (output tax) and suffers sales tax on its
purchases (input tax). Typically, a business which is registered for sales tax only needs to
make a payment to the tax authorities of the net amount of sales tax (i.e. sales tax owed on
outputs less sales tax suffered on inputs).
Purchases Sales
Goods into factory Goods out of factory
(input tax) (output tax)
Output tax
7.3
7: SALES TAX
2 Accounting treatment
Lecture example 1
A business buys goods for $1,000 plus 15% sales tax. They then sell those goods for $1,500 +
15% sales tax.
The purchases will cost ($1,000 × 1.15) = $1,150
The sales will raise ($1,500 × 1.15) = $1,725
The sales tax payable to tax authorities will be:
$
Payable on outputs (sales) (15% × $1,500) 225.00
Reclaimable on inputs (purchases) (15% × $1,000) (150.00)
Net sales tax to tax authorities 75.00
As the business is purely collecting the sales tax for the tax authorities, and is able to set off its
sales tax suffered it does not include sales tax as either an expense or income in the income
statement. The sales tax is accounted for when the transaction occurs.
Required
(a) Post the double entry to the ledger account below.
$ $
Dr Purchases 1,000
Dr Sales tax control account 150
Cr Trade payables 1,150
Solution
(a)
Purchases (I/S) Trade payables (B/S)
7.4
7: SALES TAX
Points to note
Purchases – NET
Trade payables – GROSS
(b) Post the double entry to the ledger account below.
$ $
Dr Trade receivables 1,725
Cr Sales 1,500
Cr Sales tax control account 225
Solution
Sales (I/S) Trade receivables (B/S)
Points to note
Sales – NET
Trade receivables – GROSS
7.5
7: SALES TAX
4.3 The calculation and accounting treatment of discounts is covered in Chapter 14.
5 Summary of Chapter 7
Quick Quiz
5.1 A business acts as a collecting agent for the tax authorities and charges sales tax (output
tax) on its sales and reclaims sales tax (input tax) on its purchases.
5.3 Sales tax may be charged at various rates, however the rate of sales tax will always be
provided in an exam question.
Dr Purchases net
Dr Sales tax control account tax
Cr Trade payables gross
7.6
Chapter 7: Questions
7.7
7: QUESTIONS
7.1 Elmo is a trader registered for sales tax. All his sales and purchases carry sales tax at a rate of 15%. A
customer has just returned goods sold for $230 plus sales tax, the double entry for this transaction is
A Debit payables $264.50, Credit sales tax $34.50, Credit sales $230
B Debit sales $264.50, Credit trade receivables $264.50
C Debit sales $230, Debit sales tax $34.50, Credit trade receivables $264.50
D Debit sales $230, Debit irrecoverable sales tax $34.50, Credit trade receivables $264.50
(2 marks)
2 During 20X1 Fergus buys two vans and a car each costing $10,000 plus sales tax at 15%. The car will be
used 70% for business use and 30% personal use. He depreciates vehicles on a straight line basis, vans
over five years and cars over six years. What is his depreciation expense to the nearest $ for the year?
In the tax regime in which Fergus operates sales tax is only recoverable on items used wholly for
business purposes.
A $5,917
B $6,517
C $6,100
D $5,666 (2 marks)
7.8
Chapter 7: Answers
7.9
7: ANSWERS
7.1 C
7.2 A Sales tax on the car is not recoverable as it is not wholly used for business purposes. Sales tax is
however recoverable on the vans.
$
Vans (2 × $10,000) ÷ 5 = 4,000
Car ($10,000 × 115%) ÷ 6 = 1,917
5,917
END OF CHAPTER
7.10
Inventory
Exam Context
Accounting for inventories and inventory valuation is a basic principle that affects any business. Examination questions
are likely to test your understanding of the terms cost and net realisable value. You should also expect calculations on
this area and be able to make adjustments for both opening and closing inventory.
Qualification Context
The Fundamentals level paper Management Accounting (F2) explores inventories in more detail. There you will look at
the classification of costs (for example, production versus non production and fixed versus variable) and you will also
cover detailed calculations on overhead absorption.
8.1
8: INVENTORY
Overview
Accounting adjustments
Inventory
FIFO AVCO
8.2
8: INVENTORY
1 Introduction
1.1 For some businesses, for example manufacturing entities, inventory can be a significant
figure.
1.3 Businesses must therefore ensure that their financial statements account for inventory
accurately in terms of:
(a) the accounting adjustment
(b) its valuation
2 Accounting adjustment
2.1 Inventory is generally accounted for as a year end adjustment via a journal entry.
8.3
8: INVENTORY
QUANTITY × VALUATION
FIFO Average
Cost
3 Valuation
3.1 The basic rule per IAS 2: Inventories is:
'Inventories should be measured at the lower of cost and net realisable value.'
8.4
8: INVENTORY
4 Cost
4.1 The cost of an item of inventory includes:
For example:
• purchase price
• import duties
Cost of purchase
But not:
• sales tax
• trade discounts
Relating to productions:
Costs of conversion • direct labour
• direct/variable overheads
Section 5.4
• an allocation of fixed
overheads (based on
normal level of activity)
Other costs incurred in bringing
the inventories to their present For example:
location and condition • carriage inwards
According to IAS 2: Inventories, which of the following should not be included in valuing the
inventories of an entity?
(1) Labour costs
(2) Transport costs to deliver goods to customers
(3) Administrative overheads
(4) Depreciation on factory machine
Solution
8.5
8: INVENTORY
Jessie is trying to value her inventory. She has the following information available:
$
Selling price 35
Costs incurred to date 20
Cost of work to complete item 12
Selling costs per item 1
Required
What is the net realisable value of Jessie's inventory? $
Workings
No netting off
5.3 The IAS 2 rule 'lower of cost and net realisable value' should be applied as far as
possible on an item by item (or line by line) basis.
8.6
8: INVENTORY
Illustration
5.4 Suppose an entity has four items of inventories on hand at the year end. Their costs and
NRVs are as follows:
Inventory item Lower of cost
Cost NRV and NRV
$ $ $
1 27 32 27
2 14 8 8
3 43 55 43
4 29 40 29
113 135 107
It would be incorrect to compare total cost of $113 with total NRV of $135 and state
inventories as $113.
A loss on item 2 of $6 can be foreseen and should therefore be recognised.
The comparison should be made for each item of inventory and thus a value of $107 would
be attributed to inventories.
This would be accounted for by the journal entry:
$ $
Dr Inventories (B/S) 107
Cr Cost of sales (I/S) 107
8.7
8: INVENTORY
On 1 January 20X7 a company held 200 units of finished goods valued at $10 each. During
January the following transactions took place.
Solution
(a) Closing inventories (FIFO)
Purchases
1.1.X7 10.1.X7 20.1.X7 25.1.X7
Sales
8.8
8: INVENTORY
10.1.X7 Purchase
14.1.X7 Sale
20.1.X7 Purchase
21.1.X7 Sale
25.1.X7 Purchase
28.1.X7 Sale
Workings
8.9
8: INVENTORY
7.2 The only figure that varies is the closing inventories, the result being quite different profit
figures.
This re-emphasises the significance of inventory valuation in the preparation of financial
statements.
8 Summary of Chapter 8
8.1 Inventories should be valued at the lower of cost and net realisable value.
8.2 The cost of inventory includes the cost of purchase, costs of conversion and any other
costs necessary to bring the inventory to its present location and condition.
8.3 Methods available to estimate the cost of inventories are first in, first out (FIFO) and
average cost.
8.4 In times of rising prices, using FIFO will mean the financial statements show higher
inventory values and higher profits.
8.5 Net realisable value is the estimated selling price less the costs to completion and any
selling and distribution costs.
8.10
Chapter 8: Questions
8.11
8: QUESTIONS
8.1 An item of inventory could be sold for $100 after it has been modified at a cost of $21. The company
incurs selling and distribution costs of 5% of selling price on each article sold. The cost is $45 per unit
excluding carriage inwards of $2 and production overheads of $17 per unit.
Following the rules in IAS 2 at what valuation should this item be included in the inventories of the
company? $ (2 marks)
8.2 Harrow Co sells one line of inventory. At the year end it has 200 units in inventory which originally cost
$10 per unit and had incurred delivery costs of $120 in total. They expect these goods to sell for $13 per
unit. Harrow Co incurs selling costs amounting to 10% of the selling price on all its sales.
In the balance sheet these items should be valued at:
A $2,000
B $2,080
C $2,120
D $2,600 (2 marks)
8.12
8: QUESTIONS
8.5 T Bag
T Bag commenced business as a tea importer on 1 January 20X5. His purchases and sales during his
first six months of trading are set out below:
Purchases Sales
Tonnes Price per tonne Total price Tonnes Proceeds
$ $ $
1 January 30 700 21,000
15 February 20 750 15,000
27 February 40 36,000
31 March 40 820 32,800
16 April 25 880 22,000
30 April 35 35,000
30 May 35 900 31,500
8 June 10 1,050 10,500
28 June 70 77,000
132,800 148,000
Required
Calculate the value of closing inventories and produce a trading account for the 6 months ended 30 June
20X5 assuming:
(a) Inventories are valued on a FIFO basis
(b) Inventories are valued on a weighted average basis
8.13
8: QUESTIONS
8.14
Chapter 8: Answers
8.15
8: ANSWERS
8.2 C $
200 @ $10 = 2,000
Delivery costs 120
2,120
Cost/ unit = $10.60
Net realisable value per unit = $13 × 90% = $11.70
⇒ valued at cost
8.3 B $
Inventories = 8 @ $10 = 80
72 @ $13.50 = 972
60 @ $13 = 780
40 @ $12.80 = 512
20 @ $12.50 = 250
200 2,594
8.4 Inventories
The inventories total on the balance sheet would be: $12,200 ($1,500 + $8,100 + $2,400 + $200).
Workings
(1) 1 unit of L would be valued at:
$
Selling price 200
Less selling costs (25%) 50
∴ NRV 150
Cost 160
NRV is lower and so 10 units of L are valued at $1,500
(2) 1 unit of M would be valued at:
$ $
Selling price 360
Less: Selling costs (25%) 90
Costs to completion 90 180
∴ NRV 180
Cost 240
NRV is lower and so 45 units of M are valued at $8,100
(3) 1 unit of N would be valued at:
$
Selling price 56
Less selling costs (25%) 14
∴ NRV 42
Cost 40
Cost is lower and 60 units of N are valued at $2,400
Replacement cost is irrelevant.
8.16
8: ANSWERS
Cost of sales
Purchases 132,800 132,800
Closing inventories (W) (15,000) (13,245)
(117,800) (119,555)
Gross profit 30,200 28,445
Workings
(W1) FIFO method
1 Jan 15 Feb 31 Mar 16 Apr 30 May 8 June
Purchases in tonnes 30 20 40 25 35 10
Sales in tonnes:
27 Feb (30) (10)
30 Apr (10) (25)
28 June (15) (25) (30)
Inventories at 30 June 20X5 – – – – 5 10
Cost per tonne $900 $1,050
8.17
8: ANSWERS
END OF CHAPTER
8.18
Tangible non-current
assets
Exam Context
Tangible non-current assets and depreciation are an important part of the F3 syllabus and you should expect several
questions on this area. Questions are likely to focus on areas such as calculating depreciation and asset values (both on
assets held at historic cost and revalued amounts), profits or losses on disposal of assets and the components that can
be included in the cost of a non-current asset.
Qualification Context
The knowledge covered in this chapter is developed in the Fundamentals level paper Financial Reporting (F7) where
you will deal with more complex issues such as impairments of non-current assets and leasing.
9.1
9: TANGIBLE NON-CURRENT ASSETS
Overview
Tangible non-current
assets
9.2
9: TANGIBLE NON-CURRENT ASSETS
1 Introduction
1.1 The purchase of a non-current asset is often a significant cost to a business which will have
a large impact on its financial statements.
2 Non-current assets
Definition
2.1 Non-current assets are assets which are intended to be used by the business on a
continuing basis and include both tangible and intangible assets.
Intangible non-current assets are covered in Chapter 10.
2.2 The accounting treatment of tangible non-current assets is covered by IAS 16: Property,
Plant and equipment.
Tangible non-current assets are defined as those which:
(a) are held for use in the production or supply of goods or services or for administrative
purposes; and
(b) are expected to be used during more than one period.
Required
What examples of tangible non-current assets can you identify?
Solution
(a)
(b)
(c)
(d)
9.3
9: TANGIBLE NON-CURRENT ASSETS
2.4 Capital expenditure results in the appearance of a non-current asset in the balance sheet
of the business.
Revenue expenditure results in an expense in the income statement.
Cost
2.5 Tangible non-current assets should initially be recorded at cost.
Cost includes:
• Purchase price: excluding sales tax and trade discounts but including import
duties
• Directly attributable costs to bring the asset to its intended location and ready to
use. These include:
(a) Initial delivery and handling costs
(b) Installation and assembly costs
(c) Costs of testing whether the asset is working properly
(d) Professional fees
The following costs may not be included:
(a) The cost of maintenance contracts
(b) Administration and general overhead costs
(c) Staff training costs
2.6 The asset can then be kept at cost and depreciated or the entity may choose to revalue its
tangible non-current assets.
9.4
9: TANGIBLE NON-CURRENT ASSETS
Required
At what amount should the machine be capitalised in the entity's records?
A $20,000
B $20,700
C $20,200
D $21,600
Solution
3 Depreciation
3.1 Tangible non-current assets are used in the business to generate the income shown in the
income statement.
Assets will eventually be worn out (used up) and so there is a cost of generating income.
This cost should be shown in the income statement to 'match' against the income.
This is called depreciation.
3.2 Depreciation results in the non-current asset being systematically charged to the income
statement over several accounting periods in recognition of the fact that the asset will
contribute to the income-generating activities of each of these periods.
A formal definition is given by the accounting standard, IAS 16:
"…the systematic allocation of the depreciable amount of an asset over its useful life."
3.3 Land normally has an unlimited useful life and is therefore not depreciated. Buildings have
a limited life and, therefore, are depreciable assets.
9.5
9: TANGIBLE NON-CURRENT ASSETS
4 Methods of depreciation
4.1 There are two main methods for calculating depreciation:
(a) Straight line method
(b) Reducing balance method
Formula
cost − residual value
5.2 Depreciation = or (Cost – Residual value) × %
useful life (years)
where:
Residual value = expected proceeds/scrap value at the end of the asset's useful life.
Useful life = the number of years the business expects to make use of the asset.
5.3 This method is suitable for assets which are used up evenly over their useful life.
A business buys a machine for $2,500. It is expected to have a useful life of three years after
which time it will have a scrap value of $250.
Required
(a) Calculate the annual depreciation charge.
(b) Calculate the cost, accumulated depreciation and net book value (NBV) for each year of the
asset's life. Note: NBV = cost – accumulated depreciation to date.
Solution
(a)
(b)
Year Cost Accumulated NBV
depreciation
$ $ $
1
9.6
9: TANGIBLE NON-CURRENT ASSETS
Formula
6.2 Depreciation = Depreciation rate (%) × Net Book Value (NBV)
where: net book value (NBV) = cost – accumulated depreciation to date
Note: This method does not take account of any residual value, since the NBV under this
method will never reach zero. The depreciation rate percentage will be provided in
the question.
A business buys a machine costing $6,000. The depreciation rate is 40% on a reducing balance
basis.
Required
Calculate depreciation expense, accumulated depreciation and net book value of the asset for the
first three years.
Solution
Year NBV b/d Depreciation Depreciation Accumulated NBV c/d
rate expense depreciation
$ $ $ $
1
9.7
9: TANGIBLE NON-CURRENT ASSETS
7.2 The asset remains at its original cost in the asset account.
Two accounts are set up to record depreciation:
Dr Depreciation expense
Cr Accumulated depreciation
Required
Using the information in Lecture example 3, show:
(a) The journal entry which would have been written at the end of the first year.
(b) The treatment of depreciation for all years in the relevant ledger accounts.
(c) The relevant income statement and balance sheet extracts for each year.
Solution
(a) Journal entry
Debit Credit
$ $
9.8
9: TANGIBLE NON-CURRENT ASSETS
Expenses
9.9
9: TANGIBLE NON-CURRENT ASSETS
(Year 1)
(Year 2)
(Year 3)
Accounting treatment
8.2 Everything to do with the disposal is transferred to a Disposal Account.
Steps:
(1) Remove the cost of the asset:
Dr Disposal account
Cr Non-current asset
(2) Remove the accumulated depreciation charged to date:
Dr Accumulated depreciation
Cr Disposal account
Note: Steps (1) and (2) have effectively transferred the NBV of the asset to the disposal
account.
9.10
9: TANGIBLE NON-CURRENT ASSETS
The machine costing $6,000 in Lecture example 4 is sold in year 3 for $3,000. No depreciation is
charged in the year of disposal.
Required
(a) Calculate the profit or loss on disposal of the machine.
(b) Complete the ledger accounts to show how the disposal would be accounted for.
Solution
(a)
(b)
Machine (B/S)
$ $
Bal b/d 6,000
9.11
9: TANGIBLE NON-CURRENT ASSETS
Disposal account
$ $
Assume in Lecture example 6 that instead of cash proceeds of $3,000, there is a part exchange
allowance of $3,000 on a replacement machine costing $10,000.
Required
(a) Calculate the profit or loss on disposal of the machine.
(b) Calculate the amount of cash paid for the new machine.
(c) Complete the ledger accounts to show both the disposal and the acquisition.
9.12
9: TANGIBLE NON-CURRENT ASSETS
Solution
(a)
(b)
(c)
Old machine (B/S)
$ $
Bal b/d 6,000
Disposal account
$ $
9.13
9: TANGIBLE NON-CURRENT ASSETS
9 Revaluations
9.1 If an entity owns a property it may notice that its value increases over time.
9.2 IAS 16 requires tangible non-current assets to initially be recorded at cost. The entity can
then either keep the asset at cost (and depreciate it) or choose to revalue it (depreciation is
still required).
This is a choice of accounting policy.
9.3 If an entity chooses a policy of revaluation then all items in the same class of assets must be
revalued.
Examples of classes of assets are:
• land and buildings
• plant and machinery
• motor vehicles
9.4 Revaluations must be carried out sufficiently often so that the assets carrying value is not
materially different from its market value.
9.14
9: TANGIBLE NON-CURRENT ASSETS
A building costing $100,000 on which depreciation of $20,000 has been charged is to be revalued
to $150,000.
Required
(a) Show the double entry to record the revaluation and make the postings to the ledger
accounts.
(b) What would be the depreciation charge for the year if the building has a remaining useful life
of 40 years?
Solution
(a)
Building (B/S)
$ $
9.15
9: TANGIBLE NON-CURRENT ASSETS
(b)
10 Summary of Chapter 9
10.1 Capital expenditure results in a non-current asset being shown on the balance sheet.
Revenue expenditure, such as repairs and maintenance, is shown as an expense in the
income statement.
10.2 Tangible non-current assets should initially be recorded at cost. This includes the
purchase price of the item plus any directly attributable costs to bring the item to its
intended location and ready to use.
10.3 Depreciation is an expense charged on the asset each year to reflect the using up of the
asset. Depreciation is usually calculated on a straight line or reducing balance basis.
10.4 On disposal of a non-current asset the sales proceeds are compared to the net book value
of the asset in order to calculate the profit or loss on disposal. Where an asset is given in
part exchange for another asset, the part exchange allowance takes the place of the sales
proceeds.
10.5 An entity may choose to revalue its assets rather than hold them at cost – this is a choice
of accounting policy. Where an entity revalues, it must revalue all assets in the same
class and the depreciation charge will now be based on the revalued amount.
9.16
9: TANGIBLE NON-CURRENT ASSETS
(4) Balance off the disposal account to determine the profit or loss on disposal.
9.17
9: TANGIBLE NON-CURRENT ASSETS
9.18
9: TANGIBLE NON-CURRENT ASSETS
Additional Notes
9.19
9: TANGIBLE NON-CURRENT ASSETS
12 Depreciation revisited
12.1 Depreciation is charged to allocate the wearing out of an asset (depreciable amount) to the
income statement over its useful life.
There are two main depreciation methods available:
• straight line
• reducing balance
12.2 The useful life of an item of property, plant and equipment should be reviewed at least every
financial year-end and, if expectations are significantly different from previous estimates, the
depreciation charge for current and future periods should be revised.
Section 3.12
This is achieved by writing the net book value off over the asset's revised remaining useful
life.
Solution
9.20
9: TANGIBLE NON-CURRENT ASSETS
Solution
9.21
9: TANGIBLE NON-CURRENT ASSETS
9.22
Chapter 9: Questions
9.23
9: QUESTIONS
9.1 What is the effect of the above transaction on the profit for the year in respect of the disposal of the old
vehicle?
A Reduce profit by $1,500
B Increase profit by $1,500
C Reduce profit by $500
D Increase profit by $500 (2 marks)
9.2 Bungo Co charges depreciation at 10% per annum, with a full year’s charge in the year of acquisition.
What will the annual depreciation charge on the new vehicle be? $ (2 marks)
9.3 A company held property, plant and equipment at 31 December 20X5 with a net book value of $22,700.
During 20X6 items with a net book value of $2,100 were sold, realising a profit of $700. The depreciation
charge in the 20X6 income statement was $4,300. Items with a book value of $15,200 were revalued to
$21,250. At 31 December 20X6 the company’s balance sheet showed the net book value of property,
plant and equipment as $44,100.
What was the cost of new property, plant and equipment acquired during 20X6?
A $13,150
B $17,550
C $22,050
D $21,750 (2 marks)
9.4 Nick
Nick started trading on 1 January 20X8 and bought equipment for his business as follows:
1 January 20X8 – Purchased a cutting machine for $4,960. The estimated useful life of the
machine is eight years, after which it will have no resale value.
2 January 20X8 – Purchased a car for $6,800.
1 March 20X8 – Purchased a van for $3,800. This has an estimated useful life of four years,
after which Nick believes he could sell it for $200.
1 May 20X8 – Purchased office furniture costing $5,400. This has an estimated useful life of
10 years with no resale value.
Depreciation for all assets, except the car, is to be calculated on the straight line basis, time apportioned
where the asset is owned for part of a year. The car is to be depreciated at 40% per annum on the
reducing balance basis.
Required
For the years ending 31 December 20X8 and 31 December 20X9, prepare relevant extracts from the
financial statements, together with the appropriate ledger accounts.
9.24
9: QUESTIONS
9.5 Eggo
On 1 January 20X4 Eggo Co, a manufacturer, acquired two identical grinding machines at a cost of
$10,000 each, and a duplicating machine at a cost of $3,000. The grinding machines are depreciated at
the rate of 30% per annum on a reducing balance basis, and the duplicating machine, which has an
estimated life of 10 years and a residual value of $500, is depreciated on a straight line basis. On
1 January 20X5 one of the grinding machines was sold for $5,000 and replaced by a new one costing
$12,000.
Required
Prepare the relevant ledger accounts dealing with the non-current assets, depreciation and the disposal
for the years to 31 December 20X4 and 31 December 20X5, respectively.
9.6 Hopkins
During 20X4 Hopkins gave his old van in part-exchange for a new van. The old van had cost $4,000 and
had accumulated depreciation of $2,400 at the date of exchange. Hopkins received a part-exchange
allowance of $1,800 and made a cash payment of $6,200 for the new van. Depreciation is over four years
on a straight line basis.
Required
(a) Calculate the profit or loss on disposal of the old van.
(b) Calculate the depreciation expense for the year ended 20X4.
9.25
9: QUESTIONS
9.26
Chapter 9: Answers
9.27
9: ANSWERS
9.2 $1,700
10% × $17,000 = $1,700
9.3 D
∴ additions = $21,750
9.4 Nick
Income statement for the year ended 31 December .... (extract)
20X8 20X9
Depreciation Expense $ $
Machine 620 620
Car 2,720 1,632
Van 750 900
Furniture 360 540
4,450 3,692
Balance sheet as at 31 December 20X8 (extract)
Non-current assets Cost Accumulated Net Book
depreciation Value
$ $ $
Machine 4,960 620 4,340
Car 6,800 2,720 4,080
Van 3,800 750 3,050
Furniture 5,400 360 5,040
20,960 4,450 16,510
Balance sheet as at 31 December 20X9 (extract)
Non-current assets Cost Accumulated Net Book
depreciation Value
$ $ $
Machine 4,960 1,240 3,720
Car 6,800 4,352 2,448
Van 3,800 1,650 2,150
Furniture 5,400 900 4,500
20,960 8,142 12,818
Machine (B/S)
$
1.1.X8 Bank 4,960
9.28
9: ANSWERS
$ $
31.12.X8 bal c/d 620 31.12.X8 Dep’n expense:
machine 620
620 620
1.1.X9 bal b/d 620
31.12.X9 bal c/d 1,240 31.12.X9 Dep’n expense
: machine 620
1,240 1,240
1.1.Y0 bal b/d 1,240
Car (B/S)
$
2.1.X8 Bank 6,800
$ $
31.12.X8 bal c/d 2,720 31.12.X8 Dep’n expense: car 2,720
2,720 2,720
1.1.X9 bal b/d 2,720
31.12.X9 bal c/d 4,352 31.12.X9 Dep'n expense: car 1,632
4,352 4,352
1.1.Y0 bal b/d 4,352
Van (B/S)
$
1.3.X8 Bank 3,800
$ $
31.12.X8 bal c/d 750 31.12.X8 Dep’n expense: van 750
750 750
1.1.X9 bal b/d 750
31.12.X9 bal c/d 1,650 31.12.X9 Dep’n expense: van 900
1,650 1,650
1.1.Y0 bal b/d 1,650
Furniture (B/S)
$
1.5.X8 Bank 5,400
9.29
9: ANSWERS
$ $
31.12.X8 bal c/d 360 31.12.X8 Dep’n expense: furniture
furniture 360
360 360
1.1.X9 bal b/d 360
31.12.X9 bal c/d 900 31.12.X9 Dep’n expense:
furniture 540
900 900
1.1.Y0 bal b/d 900
$ $
31.12.X8 Acc’d dep’n: machine 620 31.12.X8 I/S 620
31.12.X9 Acc’d dep’n: machine 620 31.12.X9 I/S 620
$ $
31.12.X8 Acc’d dep’n: car 2,720 31.12.X8 I/S 2,720
31.12.X9 Acc’d dep’n: car 1,632 31.12.X9 I/S 1,632
$ $
31.12.X8 Acc’d dep’n: van 750 31.12.X8 I/S 750
31.12.X9 Acc’d dep’n: van 900 31.12.X9 I/S 900
$ $
31.12.X8 Acc’d dep’n: furniture 360 31.12.X8 I/S 360
31.12.X9 Acc’d dep’n: furniture 540 31.12.X9 I/S 540
9.30
9: ANSWERS
9.5 Eggo
Grinding machines (B/S)
$ $
1.1.X4 Bank 20,000 31.12.X4 Balance c/d 20,000
$ $
31.12.X4 Balance c/d 250 31.12.X4 Depreciation expense 250
250 250
1.1.X5 Balance b/d 250
31.12.X5 Balance c/d 500 31.12.X5 Depreciation expense 250
500 500
1.1.X6 Balance b/d 500
9.31
9: ANSWERS
Working
Depreciation charge
Grinding machines
Machine 1 ($10,000 – $3,000) × 30% 2,100
Machine 2 ($12,000 × 30%) 3,600
Duplicating machine 250
6,250 5,950
9.6 Hopkins
(a) $200 profit
Working
Disposal account (I/S)
$ $
Cost 4,000 Accumulated depreciation 2,400
Profit on disposal 200 Part exchange allowance 1,800
4,200 4,200
Or alternatively:
$
"Proceeds" – part-exchange allowance 1,800
Net book value ($4,000 – $2,400) (1,600)
Profit on disposal 200
(b) $2,000
$
Cost of new van to be depreciated 8,000
($6,200 + $1,800)
END OF CHAPTER
9.32
Intangible non-current
assets
Exam Context
Intangible non-current assets are a smaller part of the syllabus than tangible non-current assets, however you should
still expect this area to be tested. Questions are likely to focus on the difference between tangible and intangible assets,
the accounting treatment for research and the capitalisation criteria for development expenditure. You should also be
confident in calculating amortisation.
Qualification Context
The knowledge covered in this chapter forms a platform which will be built on in the Fundamentals level paper Financial
Reporting (F7). There you will cover internally generated intangible assets and goodwill.
10.1
10: INTANGIBLE NON-CURRENT ASSETS
Overview
Intangible non-current
assets
Amortisation
10.2
10: INTANGIBLE NON-CURRENT ASSETS
1 Definition
1.1 An intangible non-current asset is an identifiable non-monetary asset without physical
substance.
1.2 The following are examples of intangible assets:
– Development expenditure
– Goodwill
– Concessions, patents, licences, trade marks.
The Paper F3 syllabus only requires knowledge of the accounting treatment of research and
development expenditure.
2.2 Companies need to account for these costs and whilst the credit entry will be recorded as a
current liability, the question remains as to where the debit entry should be shown.
The choices are:
(a) to debit the income statement with an expense, or
(b) to debit the balance sheet with an intangible non-current asset.
An intangible non-current asset should only be recorded when the entity is confident that the
expenditure will generate future profit.
10.3
10: INTANGIBLE NON-CURRENT ASSETS
4 Accounting treatment
4.1
Research Development
Z Co incurred the following costs during the year ended 31 August 20X8.
(1) $20,000 on salaries for market research staff sent out to canvass drivers' opinions on a
potential new car.
(2) $100,000 to purchase a machine to manufacture components for the new car. It has an
estimated useful life of 10 years.
(3) $25,000 on materials to manufacture a prototype and $50,000 on salaries relating to its
design and manufacture. The new car is expected to go on sale in 20X9.
Required
How should each of the above items be shown in the financial statements for the year ended
31 August 20X8?
10.4
10: INTANGIBLE NON-CURRENT ASSETS
Solution
5.2 In the same way development expenditure which is incurred now will generate revenue and
profits in the future.
The cost of the development expenditure should be matched against the revenue it
produces. This is called amortisation.
5.3 The 'depreciable amount' (cost less residual value) should be amortised over the useful life
in the same way that revenues are expected to be generated.
5.4 Amortisation should begin when the asset is ready for use.
10.5
10: INTANGIBLE NON-CURRENT ASSETS
5.5 It is an expense in the income statement and is accounted for using the following entry:
Dr Amortisation expense (I/S)
Cr Accumulated amortisation (B/S)
Solution
Income statement extracts
X1 X2 X3 X4 X5
$ $ $ $ $
Expenses
Research expenditure
Amortisation of development expenditure
10.6
10: INTANGIBLE NON-CURRENT ASSETS
6 Summary of Chapter 10
6.1 Research relates to costs incurred to obtain knowledge or understanding. There is no
certainty of future profit from this expenditure and so it should be shown as an expense in
the income statement.
Quick Quiz
10.7
10: INTANGIBLE NON-CURRENT ASSETS
10.8
Chapter 10: Question
10.9
10: QUESTION
10.1 Which of the following statements about research and development are true?
(1) Development expenditure shown on the balance sheet should be amortised over the periods
expected to benefit from the product or service.
(2) Development expenditure must be capitalised if it meets various criteria.
(3) Research expenditure is always written off.
A All of the above
B (1) and (2)
C (2) and (3)
D (1) and (3) (2 marks)
10.10
Chapter 10: Answer
10.11
10: ANSWER
10.1 A
END OF CHAPTER
10.12
Accruals and
prepayments
Exam Context
Accruals and prepayments are key accounting adjustments and you should expect to see them tested in Paper F3. You
may be asked to calculate the balance sheet amount for accruals and prepayments and/or the relevant expense that
would be shown in the income statement. Alternatively, you may be asked to determine the appropriate journal entries to
record accruals and prepayments. The Pilot Paper included questions on the calculation of a year-end prepayment of an
expense and the income to be shown in the income statement where rent is received both in advance and in arrears.
Qualification Context
This area is a basic skill which is not tested in detail in any other paper. The matching concept however is fundamental
to the preparation of financial statements and this is relevant to Paper F7, Financial Reporting.
11.1
11: ACCRUALS AND PREPAYMENTS
Overview
Accounting treatment
Accrued income
and deferred income
Accounting treatment
11.2
11: ACCRUALS AND PREPAYMENTS
1 Introduction
1.1 This chapter is designed to enable you to apply accounting concepts and principles in
relation to the calculation of and adjustments for accruals and prepayments.
1.2 IAS 1 requires financial statements to be prepared on an accruals basis. This is so that
transactions and events are recognised when they occur (and not as cash or its equivalent
is received or paid) and they are recorded in the accounting records and reported in the
financial statements of the period to which they relate.
The accruals basis is also an underlying assumption in the IASB's Framework for the
Preparation and Presentation of Financial Statements.
Accruals
1.3 Accruals are expenses incurred by the business during the accounting period but not yet
paid for, ie. expenses in arrears.
Example
1.4 Fred prepares accounts to 31 December each year. On 1 January 20X8, he pays a
telephone bill of $60 which relates to the period October-December 20X7.
Although the payment does not go through the cash book until 20X8, this expense must be
included in the accounts for the year ended 31 December 20X7, as it was incurred during
this period.
Prepayments
1.5 Prepayments arise when expenses are paid for before they have been used. ie. expenses in
advance.
Example
1.6 On 20 December 20X7 Fred pays for insurance on his business premises for the 12 months
commencing 1 January 20X8.
Although the payment was made in 20X7, the expense should not appear in the accounts
for 20X7. The accounts for 20X7 will show a prepayment for the full amount of the insurance
cost and the expense will be recorded in 20X8.
11.3
11: ACCRUALS AND PREPAYMENTS
2 Accounting treatment
Year-end adjustments
2.1 Adjustments for accruals and prepayments tend to occur at the end of the year and are
made by way of a journal entry. The required entries are:
Accruals
Dr Expense (I/S)
Cr Accruals (B/S)
Prepayments
Dr Prepayments (B/S)
Cr Expense (I/S)
Fiona set up a business on 1 January 20X7. Her cash payments for the year to 31 December 20X7
included:
Rent
1.2.X7 375 3 months to 31 March 20X7
6.4.X7 1,584 12 months to 31 March 20X8
Note: On 6 March 20X8 Fiona received an electricity bill for $168 for the quarter to 28 February
20X8.
11.4
11: ACCRUALS AND PREPAYMENTS
Required
(a) Calculate the expense incurred by Fiona for electricity and rent for the year ended
31 December 20X7.
(b) Calculate the amount of any accruals/prepayments at the end of the year.
(c) State the journal entry required for the year-end adjustments.
Solution
11.5
11: ACCRUALS AND PREPAYMENTS
Required
Using the figures from Lecture example 1:
Complete the necessary entries in Fiona’s ledger accounts as at 31 December 20X7, then balance
off the accounts.
Solution
Electricity expense (I/S)
$ $
10.3.X7 Cash 96
12.6.X7 Cash 120
14.9.X7 Cash 104
10.12.X7 Cash 145
Accruals (B/S)
$ $
Prepayments (B/S)
$ $
Section 1.9
11.6
11: ACCRUALS AND PREPAYMENTS
Double entry
3.3
Rent expense
$ $
10.4.X8 Cash 1,740 31.12.X8 Prepayments
( 3 12 × 1,740 ) 435
Prepayments
$ $
1.1.X8 Balance b/d 396
31.12.X8 Rent 435
This does not produce a sensible answer! The rent expense in the ledger account would
result in a charge to the income statement of $1,305 (not $1,701) and the balance on the
prepayment account would be overstated by $396.
11.7
11: ACCRUALS AND PREPAYMENTS
Solution
3.4 The opening prepayment must therefore be reversed, ie:
Debit Rent expense (I/S) $396
Credit Prepayments (B/S) $396
Post this to the ledger accounts in 3.3 and balance off – the expense should now be correct!
Summary
3.5 Accruals and prepayments brought forward at the start of the year must be reversed.
Reversal of accrual
Dr Accruals (B/S)
Cr Expense (I/S)
Prepayments
Dr Expense (I/S)
Cr Prepayments (B/S)
Approach to questions
3.6 There are four steps to follow:
(1) Reverse opening accrual/prepayment.
(2) Post cash paid during the year.
(3) Post closing accrual/prepayment.
(4) Balance off the accounts.
11.8
11: ACCRUALS AND PREPAYMENTS
Solution
Electricity expense (I/S)
$ $
Accruals (B/S)
$ $
Jimmy Co prepares its financial statements for the year to 30 June each year. The company pays
for its insurance quarterly in advance on 1 March, 1 June, 1 September and 1 December each
year. The annual insurance premium was $24,000 until 31 August 20X6, after that date it
increased to $30,000 per year.
Required
What insurance expense and end of year prepayment should be included in the financial
statements for the year ended 30 June 20X7?
Expense Prepayment
A $29,000 $2,500
B $29,000 $5,000
C $28,500 $2,500
D $28,500 $5,000
11.9
11: ACCRUALS AND PREPAYMENTS
Solution
4 Summary of Chapter 11
Quick Quiz Q2-5
4.1 Accruals and prepayments are an example of the accruals basis which is an underlying
assumption from the IASB Framework.
4.2 Accruals are made when expenses are paid in arrears, whereas prepayments arise when
expenses are paid for in advance.
4.3 Reverse accruals and prepayments at the beginning of the next accounting period so that
the current year expense is correct.
Dr Expense (I/S)
Cr Accruals (B/S)
Dr Prepayments (B/S)
Cr Expense (I/S)
11.10
11: ACCRUALS AND PREPAYMENTS
Accruals:
Dr Accruals (B/S)
Cr Expense (I/S)
Prepayments:
Dr Expense (I/S)
Cr Prepayments (B/S)
11.11
11: ACCRUALS AND PREPAYMENTS
11.12
11: ACCRUALS AND PREPAYMENTS
Additional Notes
11.13
11: ACCRUALS AND PREPAYMENTS
Accrued income
6.2 This relates to when income has been earned during the accounting period but not invoiced
or received.
Illustration
6.3 Jenny owns a property which she rents out for $3,000 per quarter. The property was
occupied all year; however Jenny only received $9,000 in rent because she forgot to send
out the final invoice of the year.
As the property was let for 12 months, Jenny's income statement should show income of
$12,000 (4 × $3,000) as this is what she has earned.
She will therefore need to accrue the 'missing' income of $3,000 as a year end journal and
also show a receivable for "rent in arrears".
The adjustment is:
$ $
Dr Rent in arrears (B/S) 3,000
Cr Rental income (I/S) 3,000
The rent in arrears is shown in the balance sheet within current assets.
Deferred income
6.4 This relates to when income is received in advance of it being earned.
Illustration
6.5 Ben has a year end of December and rents out his property for $1,000 per month. His
tenant pays on time each month and during December 20X7 paid Ben $2,000 as he would
be away when the January 20X8 payment was due.
Ben has received income of $13,000 but only $12,000 of this relates to the current year. He
must therefore remove $1,000 of income from this years accounts because it relates to next
year. A liability will also be shown for "rent in advance".
The adjustment is:
$ $
Dr Rental income (I/S) 1,000
Cr Rent in advance (B/S) 1,000
The rent in advance is shown in the balance sheet within current liabilities.
11.14
11: ACCRUALS AND PREPAYMENTS
Approach to questions
6.6 The approach for accrued income and deferred income is exactly the same as for accruals
and prepayments.
There are four steps to follow:
(1) Reverse opening rent in arrears/advance.
(2) Post cash received during the year.
(3) Post closing rent in arrears/advance.
(4) Balance off the accounts.
11.15
11: ACCRUALS AND PREPAYMENTS
11.16
Chapter 11: Questions
11.17
11: QUESTIONS
Telephone
Quarter ended 31 January 20X5 02.03.20X5 270
Quarter ended 30 April 20X5 05.06.20X5 310
Quarter ended 31 July 20X5 02.09.20X5 320
Quarter ended 31 October 20X5 10.12.20X5 330
A telephone bill for $345 in respect of the quarter ended 31 January 20X6 was received by the company in
February 20X6. The company's year end is December.
11.1 What balance should have been brought forward on the accruals account in relation to rent payable at
1 January 20X5?
A $100 credit
B $200 credit
C $100 debit
D $200 debit (2 marks)
11.2 What will be the income statement charge for telephone expenses for the year ended 31 December
20X5?
A $1,165
B $1,180
C $1,255
D $1,280 (2 marks)
11.3 At 31 December 20X5 what balance will be included as a prepayment or accrual in respect of rent?
A $300 prepayment
B $200 accrual
C $150 prepayment
D $150 accrual (2 marks)
11.4 At 31 December 20X8 Blue Anchor Co has an insurance prepayment of $250. During the year they pay
$800 in respect of various insurance contracts. The closing accrual for insurance is $90.
What is the income statement charge for insurance for year ended 31 December 20X9? $
(2 marks)
11.18
11: QUESTIONS
11.5 Max has paid his rent for the period 1 April 20X0 to 30 June 20X1 of $4,800. His first set of accounts is
drawn up for the period from 1 April 20X0 to 28 February 20X1. His accounts should reflect
A Rent expense of $4,800 only
B Rent expense of $3,520, a prepayment of $1,280
C Rent expense of $3,600, a prepayment of $1,200
D Rent expense of $3,840, a prepayment of $960 (2 marks)
11.6 Constains Co has an insurance prepayment of $320 at 31 March 20X2. During the year ended 31 March
20X2 Constains paid two insurance bills, one for $1,300 and one for $520. The charge for the year in the
accounts for insurance was $1,760.
What was the prepayment at 31 March 20X1? $ (2 marks)
11.7 An electricity prepayment for $300 was treated as an accrual in a sole trader’s income statement. As a
result the profit was
A Overstated by $600
B Understated by $300
C Understated by $600 (1 mark)
11.8 A. Cruel
A. Cruel prepares his financial statements for the year to 31 December each year. He pays rent on his
premises quarterly in advance on 1 February, 1 May, 1 August and 1 November. The annual rent was
$12,000 until 30 September 20X7 and $15,000 per year thereafter.
(i) What rent expense and prepayment should be included in the financial statements for the year
ended 31 December 20X7?
Expense Prepayment
A $12,750 $1,250
B $12,750 $2,500
C $15,000 $2,250
D $15,000 $1,250
(ii) The following year the reversal of the prepayment will result in which of the following in the rent
expense account?
A Credit balance of $1,250
B Debit balance of $1,250
C Credit balance of $2,500
D Debit balance of $2,250
(iii) A. Cruel has just looked at the accounts you have prepared and is confused as he knows he has
paid more rent than is showing in the income statement.
Which accounting concept means that the income statement may not just show the cash paid?
A Going concern
B Accruals
C Business entity
11.19
11: QUESTIONS
11.9 Fairlop
The accounts of Fairlop are made up to 31 December every year. When preparing the accounts for 20X7
you extract the following information from the payments side of the cash book:
$
20X6
1 October Rent (to 31.3.X7) 500
20X7
10 January Electricity 300
1 April Rent 550
10 April Electricity 300
10 July Electricity 250
1 October Rent 550
10 October Electricity 250
20X8
10 January Electricity 350
You ascertain that rent is paid half-yearly in advance and that electricity bills relate to the quarter ended in
the month before payment.
Required
Calculate the following amounts:
(i) The rent expense for the year ended 31 December 20X7
(ii) The electricity expense for the year ended 31 December 20X7
(iii) The balance on the prepayment account at 31 December 20X7
(iv) The balance on the accruals account at 31 December 20X7
11.20
Chapter 11: Answers
11.21
11: ANSWERS
11.1 B 2
3 × 300 = 200
11.2 D
$
Reverse accrual at 1.1.X5 (180)
Paid (270 + 310 + 320 + 330) 1,230
Accrual at 31.12.X5 ( 2 3 x 345) 230
∴ I/S charge 1,280
11.3 C 1
3 × 450 = 150
11.4 $1,140
$250 + $800 + $90 = $1,140
11.6 $260
Insurance Expense
$ $
∴ Prepayment reversal (β) 260
Cash 1,300 I/S 1,760
Cash 520 Prepayment 320
2,080 2,080
11.7 C The prepayment would have decreased the electricity expense by $300 and increased profits.
Treating the prepayment as an accrual would have increased the electricity expense and
decreased profit. Profit is therefore understated by 2 × $300 = $600.
11.8 A. Cruel
(i) A
Rent expense: $
January – September 20X7 ($12,000 × 9/12) 9,000
October – December 20X7 ($15,000 × 3/12) 3,750
12,750
Prepayment:
1 November payment of $3,750 ($15,000 × ¼) relates to November, December and January.
∴ prepay January 20X8 expense: $3,750 × 1/3 = $1,250.
(ii) B
(iii) B
11.22
11: ANSWERS
11.9 Fairlop
(i) Rent expense: $1,075
(ii) Electricity expense: $1,150
(iii) Prepayments: $275
(iv) Accruals: $350
Workings
Prepayments (B/S)
$ $
1.1.X7 Balance b/d (500 × 3/6) 250 1.1.X7 Rent 250
31.12.X7 Rent (550 × 3/6) 275 31.12.X7 Balance c/d 275
525 525
Accruals (B/S)
$ $
1.1.X7 Electricity 300 1.1.X7 Balance b/d 300
31.12.X7 Balance c/d 350 31.12.X7 Electricity 350
650 650
Rent (I/S)
$ $
1.1.X7 Prepayments 250
1.4.X7 Bank 550
1.10.X7 Bank 550 31.12.X7 Income statement 1,075
31.12.X7 Prepayments 275
1,350 1,350
Electricity (I/S)
$ $
1.1.X7 Accruals 300
10.1.X7 Bank 300
10.4.X7 Bank 300
10.7.X7 Bank 250
10.10.X7 Bank 250
31.12.X7 Accruals 350 31.12.X7 Income statement 1,150
1,450 1,450
11.23
11: ANSWERS
END OF CHAPTER
11.24
Irrecoverable debts
and allowances
Exam Context
Questions on this topic are likely to require you to perform basic calculations dealing with writing off debts, adjusting for
cash subsequently received and adjusting the allowance for receivables. You will also need to be able to determine the
balances to be shown in the income statement and balance sheet.
Qualification Context
This area is a basic skill and detailed calculations are not tested in any other paper.
12.1
12: IRRECOVERABLE DEBTS AND ALLOWANCES
Overview
Amounts recovered
Bad debts
Irrecoverable debts
and allowances
Doubtful debts
Allowances
Specific General
12.2
12: IRRECOVERABLE DEBTS AND ALLOWANCES
1 Introduction
1.1 This chapter is designed to enable you to calculate and make adjustment for bad debts, and
allowances for receivables.
1.2 A trade receivable should only be classed as an asset if it is probable that it is recoverable
(ie that the customer will pay the amounts due).
2 Bad debts
2.1 If a debt is definitely irrecoverable it should be written off to the income statement as a
bad debt. This is an example of prudence.
Accounting treatment
2.2 Dr Bad debt expense (I/S)
Cr Trade receivables (B/S)
You may see the debit entry being made to an 'irrecoverable debts expense' account. This
is effectively the same thing.
Fight & Co has trade receivables at 31 December 20X7 of $65,000. A review of customer files
indicates that two customers, Ali and Tyson, which owe $7,000 and $8,000 respectively, have
gone bankrupt and their debts are considered irrecoverable.
Required
(a) Calculate the balance c/d on the trade receivables account at the end of the year.
(b) Calculate the bad debt expense shown in the income statement.
Solution
12.3
12: IRRECOVERABLE DEBTS AND ALLOWANCES
3 Doubtful debts
3.1 If a debt is possibly irrecoverable an allowance for the potential irrecoverability of that debt
should be made. A new account is created, Allowance for receivables, this account is offset
against the trade receivables’ balance on the balance sheet and the expense taken to the
income statement.
Accounting treatment
3.2 Dr Doubtful debts expense (I/S)
Cr Allowance for receivables (B/S)
A further review of Fight & Co's customer files indicates there is some uncertainty as to whether a
debt of $3,500 owed by Bugner is recoverable.
(a) Calculate the allowance for receivables shown on the balance sheet.
(b) Calculate the doubtful debts expense shown in the income statement.
(c) Show how the information from Lecture examples 1 and 2 would be shown in extracts from
the income statement and balance sheet.
Solution
12.4
12: IRRECOVERABLE DEBTS AND ALLOWANCES
Types of allowance
3.3 (a) Specific: provided against a particular/named individual customer.
(b) General: percentage applied to total trade receivables after:
(i) writing off bad debts;
(ii) deducting full balance of any customers for which specific allowance has been
created.
Order of calculation
3.4 (a) Write up trade receivables account for credit sales and cash received in period.
(b) Write off bad debts
Dr Bad debt expense (I/S)
Cr Trade receivables (B/S)
(c) Make any entries for specific allowances:
Dr Doubtful debts expense (I/S)
Cr Allowance for receivables (B/S)
(d) In workings, calculate the general allowance on trade receivables (after bad debts
written off and excluding full amounts for which specific allowance has been made).
(e)
$
Total trade receivables 100
Less: specific allowances (20)
80
General allowance @ 5% = 4
∴total allowance:
Specific 20
General 4
24
12.5
12: IRRECOVERABLE DEBTS AND ALLOWANCES
A business’s trade receivables account showed a year end balance of $47,440. It was decided that
amounts totalling $340 should be written off as irrecoverable, a specific allowance was to be made
against an amount of $400 due from Dodgy Co, a customer, and a general allowance of 2% was to
be made against remaining debts.
Required
(a) Calculate the allowance for receivables shown in the balance sheet.
(b) Calculate the bad and doubtful debts expense shown in the income statement.
Solution
Trade receivables (B/S)
$ $
Balance b/d 47,440
General allowance
$
Trade receivables (net of bad debts written off)
Less: specific allowance
General allowance @ 2%
12.6
12: IRRECOVERABLE DEBTS AND ALLOWANCES
Dr Cash
Cr Trade receivables
Reverse original
write off
Dr Trade receivables
Cr Bad debt expense
OR
Dr Cash
Cr Bad debt expense
Fight & Co (see Lecture example 1) subsequently receive a cheque of $7,000 from Ali.
Required
Show the treatment of this recovery in the relevant ‘T’ accounts.
Solution
Trade receivables (B/S)
$ $
1.1.X8 Bal b/d 50,000
12.7
12: IRRECOVERABLE DEBTS AND ALLOWANCES
Cash (B/S)
$ $
12.8
12: IRRECOVERABLE DEBTS AND ALLOWANCES
Required
Show the accounting treatment for Fight & Co if, having made a specific allowance (see Lecture
example 2), during the next year Bugner repays his debt of $3,500 to Fight & Co in cash?
Solution
Trade receivables (B/S)
$ $
1.1.X8 Bal b/d 50,000
Doubtful debts – specific allowance last year, goes bad this year
4.3 The debt is no longer doubtful, but definitely bad. It should therefore be removed from the
trade receivables and the allowance for receivables accounts.
12.9
12: IRRECOVERABLE DEBTS AND ALLOWANCES
Required
Following on from the information used in Lecture example 2, suppose that in the next accounting
period, the debt from Bugner is considered to have gone bad.
What double entry would be required to record this?
Solution
Accounting treatment
4.5
(1) Remove opening allowance
Dr Allowance for receivables
Cr Doubtful debts expense
12.10
12: IRRECOVERABLE DEBTS AND ALLOWANCES
OR
Decrease:
Dr Allowance for receivables
Cr Doubtful debts expense
Solution
Long method: 4.5 (1)
12.11
12: IRRECOVERABLE DEBTS AND ALLOWANCES
12.12
12: IRRECOVERABLE DEBTS AND ALLOWANCES
Solution
5 Summary of Chapter 12
Quick Quiz 5.1 A trade receivable is an asset of the business which should only be shown in the financial
statements if it is believed to be recoverable.
5.2 Bad or irrecoverable debts must therefore be written off as an expense in the income
statement.
5.3 An allowance should be made against trade receivables where there is concern as to
whether or not a balance will be recoverable. There are two types of allowance: specific
and general.
5.4 Specific allowances relate to particular customer balances whereas a general allowance is
usually a percentage of remaining debts.
12.13
12: IRRECOVERABLE DEBTS AND ALLOWANCES
6.3 Recording of cash received from a customer whose balance was previously written off:
Dr Cash (B/S)
Cr Bad debt expense (I/S)
6.4 Recording of cash received from a customer against which a specific allowance was
previously made:
6.5 Writing a balance off as irrecoverable where a specific allowance was previously made:
12.14
Chapter 12: Questions
12.15
12: QUESTIONS
12.1 A company receives news that a major customer has been declared bankrupt. The entries now required
are:
A Debit bad debt expense, Credit trade receivables
B Debit sales, Credit trade receivables (1 mark)
12.2 At 1 January 20X9 Farriers has an allowance for receivables of $2,000 consisting of a specific allowance
for $700 in respect of Black Lion Co and a $1,300 general allowance. During the year Black Lion goes
into liquidation and the debt is written off. No other debts go bad and at 31 January 20X9 the balance on
the trade receivables is $50,950. Farriers wishes to provide for a debt of $950 from Verulam and to have
a general allowance of 2½% of good trade receivables. The bad and doubtful debts charged to the
income statement for 20X9 is:
A $900
B $924
C $1,600
D $2,200 (2 marks)
12.3 The preliminary trial balance of Jessie and Co as at 30 September 20X7 included:
Debit Credit
$ $
Trade receivables 90,350
Allowance for receivables (brought forward as at 1 October 20X6) 2,490
Bad and doubtful debt expense 1,985
Further adjustments are to be made as follows:
(i) No entries have been made in respect of cash of $1,320 received from Dome Co whose balance
had been written off last year, and
(ii) At 30 September 20X7 an allowance is required against a balance of $1,950 due from Jed Co as
well as a general allowance of 1.5% of remaining debts.
What is the bad and doubtful debt expense in the income statement? $ (2 marks)
12.4 Gillian
On 31 December 20X4, Gillian’s nominal ledger included a trade receivables balance of $47,900 along
with an allowance for receivables (brought forward as at 1 January 20X4) of $2,551. Of this $537 relates
to a specific customer, the remainder being a general allowance. After a review of trade receivables at the
year end, the following adjustments are to be made:
(1) Debts totalling $1,615 are to be written off as irrecoverable.
(2) No entry has yet been made in the books for $418 cash received on 31 December 20X4 from
David, a customer whose debt was written off during 20X3.
(3) Cash posted to the trade receivables account during the year include $537 from Jim. The amount
due from Jim had been specifically provided against at 31 December 20X3.
(4) Specific allowance is to be made against debts totalling $835 together with a general allowance of
2%.
Required
(a) Write up the relevant ledger accounts for the year ended 31 December 20X4.
(b) Show the relevant extracts from the financial statements.
12.16
12: QUESTIONS
12.17
12: QUESTIONS
12.18
Chapter 12: Answers
12.19
12: ANSWERS
12.1 A
12.2 A
$
Trade receivables balance 50,950
Less specific allowance (950)
50,000
12.3 $1,451
$
Bad and doubtful debts expense per trial balance 1,985
Less: bad debt recovered (1,320)
Add: increase in allowance (W) 786
1,451
$
Allowance c/d – specific 1,950
– general 1.5% × (90,350 – 1,950) 1,326
3,276
Less allowance b/d 2,490
∴ increase 786
12.4 Gillian
(a)
Trade receivables (B/S)
$ $
31.12.X4 Balance b/d 47,900 31.12.X4 Bad debts 1,615
31.12.X4 Balance c/d 46,285
47,900 47,900
2,551 2,551
12.20
12: ANSWERS
Working
Receivables Allowance
$ $
Trade receivables 46,285
Less: specific allowance (835) 835
45,450
General allowance ($45,450 × 2%) 909
1,744
(b) Gillian
Balance sheet as at 31 December 20X4 (extract)
CURRENT ASSETS $ $
Trade receivables 46,285
Less: allowance for receivables (1,744)
44,541
12.21
12: ANSWERS
END OF CHAPTER
12.22
Provisions
and contingencies
Exam Context
Questions on this area are likely to focus on identifying when a provision or contingent liability should be made/disclosed
in the financial statements. You may also be required to calculate a provision. The Pilot Paper included a question on
how a remote contingent liability should be accounted for.
Qualification Context
Your understanding of IAS 37 will be developed at the Fundamentals level paper Financial Reporting (F7) where you are
likely to have to consider whether the provision criteria are satisfied based on more subjective scenarios.
13.1
13: PROVISIONS AND CONTINGENCIES
Overview
Provisions
Provisions and
contingencies
13.2
13: PROVISIONS AND CONTINGENCIES
2 Provisions
2.1 Definition
A provision is a liability of uncertain timing or amount.
2.2 Recognition
A provision should only be recognised (ie. included in the financial statements) when:
(a) An entity has a present obligation (legal or constructive) as a result of a past event;
(b) It is probable that an outflow of economic resources will be required to settle the
obligation; and
(c) A reliable estimate can be made of the amount of the obligation.
Unless all three conditions are met, no provision can be recognised.
13.3
13: PROVISIONS AND CONTINGENCIES
Here no warranty is offered and so Seed Co does not have a legal obligation. Its past
actions however have created a constructive obligation. It should also therefore make a
provision for the probable costs of repairs.
Grass Co is reviewing its warranty obligations. Based on sales during 20X7 it has established that
if all lawnmowers sold required minor repairs this would cost $1m whereas if major repairs were
required this would cost $6m.
Grass Co expects that 75% of lawnmowers will have no faults, 20% will need minor repairs and
5% major repairs.
Required
(a) What provision should be made in 20X7 and what accounting entry is needed to record it?
(b) What entry should be made in 20X8 assuming the provision required then is $0.75m?
(c) What entry should be made in 20X9 assuming the provision required then is $0.3m?
Solution
13.4
13: PROVISIONS AND CONTINGENCIES
3 Contingent liabilities
3.1 A contingent liability is an uncertain liability that does not meet the three criteria for
recognising a provision.
IAS 37 defines a contingent liability as the following:
(a) A possible obligation that arises from past events and whose existence will be
confirmed only the occurrence or non-occurrence of one or more uncertain future
event not wholly within the control of the entity; or
(b) A present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of economic resources will be required to
settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability.
Contingent liabilities should be disclosed in the notes unless probability of an outflow of
resources embodying economic benefits is remote.
Illustrative example
3.2 Company A has entered into an agreement to act as guarantor on a bank loan taken out by
Mr Smith. Mr Smith is a financially secure individual, and the directors are of the opinion that
the chances of him defaulting on the loan are slim.
How should company A account for this guarantee?
Solution
3.3 Company A has a present obligation (it is legally obliged to honour the guarantee).
However, as the likelihood of Company A having to pay out under the guarantee is not
probable then no provision for the liability should be made. Instead, the guarantee should be
disclosed in the notes as a contingent liability (unless considered remote, in which case it
should be ignored altogether).
13.5
13: PROVISIONS AND CONTINGENCIES
4 Contingent assets
4.1 A possible asset that arises from past events and whose existence will be confirmed only by
the occurrence or non-occurrence of one or more uncertain future events not wholly within
the control of the entity.
Contingent assets should be disclosed in the notes where an inflow of economic benefits is
probable, otherwise they should be ignored.
If the probability of an inflow of economic benefits is virtually certain then the asset is not a
contingent asset and should be recognised in the financial statements.
13.6
13: PROVISIONS AND CONTINGENCIES
5 Summary of Chapter 13
5.1 A provision should only be made in the financial statements when an entity has a present
Quick Quiz obligation to incur expenditure. It must also be more likely than not that the expenditure
will be incurred and a reliable estimate of the amount is known.
5.2 A contingent liability should be disclosed where the criteria for making a provision are not
met, but where there is either a possible obligation or a present obligation but it is only
possible that the expenditure will be incurred.
5.3 Contingent assets should only be included in the financial statements if it is certain to be
received and should be disclosed if probable.
Dr Expense (I/S)
Cr Provision (B/S)
Dr Provision (B/S)
Cr Expense (I/S)
13.7
13: PROVISIONS AND CONTINGENCIES
13.8
Chapter 13: Questions
13.9
13: QUESTIONS
13.1 H Co is currently in the middle of a protracted lawsuit which it is vigorously defending. The directors are
reasonably confident that the action will not be successful but are aware that the opposite outcome is a
possibility. It is difficult to quantify any potential damages, but the directors feel they are unlikely to
exceed $50,000.
How should the above item be treated in the financial statements?
A Provision
B Contingent liability
C Contingent asset (1 mark)
13.2 How should a contingent liability and a probable contingent asset be accounted for?
A Probable contingent assets and contingent liabilities should be disclosed in the financial
statements.
B Probable contingent assets must always be accrued and contingent liabilities must always be
disclosed in the financial statements.
C Contingent liabilities must always be either accrued or disclosed and probable contingent assets
must always be disclosed in the financial statements.
D Contingent liabilities must always be provided for and probable contingent assets must be
disclosed in the financial statements.
(2 marks)
13.10
Chapter 13: Answers
13.11
13: ANSWERS
13.1 B
13.2 A
END OF CHAPTER
13.12
Control accounts
Exam Context
Questions on this topic are likely to require you to correct the closing balance on a receivables or payables control
account including items such as contras and discounts. You may also be required to calculate receivables/payables
balances where goods are sold/bought with trade and/or settlement discounts.
Qualification Context
This chapter covers topics which are only examined in Financial Accounting.
14.1
14: CONTROL ACCOUNTS
Overview
Reconciliations
Control accounts
14.2
14: CONTROL ACCOUNTS
1 Recap
1.1 In Chapters 4 and 5 we saw how a business' transactions were categorised in the books of
prime entry. The totals of these were then posted using double entry to the nominal ledger
to give a summary of the information.
1.3 The
nominal ledger contains three ledger accounts which are affected when a business sells on
credit:
(a) Sales
(b) Bank
(c) Trade receivables – this shows the total amount owed by all customers at a
particular point in time.
– it is also called the receivables ledger control account
(RLCA)
1.4 In order to chase overdue debts however a business must know how much each customer
owes at a particular time.
This balance could be determined by going back into the detail of the books of prime entry
and extracting the information for each customer.
This is a very time consuming process and so instead a memorandum ledger is
maintained for each individual customer showing invoices raised, cash received and
therefore the amount owed to the business.
This memorandum ledger is called a receivables ledger.
14.3
14: CONTROL ACCOUNTS
Terminology
1.6 In the nominal ledger:
• Receivables ledger control account (trade receivables/RLCA):
total owed by all credit customers.
• Payables ledger control account (trade payables/PLCA):
total owed to all credit suppliers.
Memorandum ledgers:
• Receivables ledger:
balance owed by each individual credit customer
• Payables ledger:
balance owed to each individual credit supplier
Customer A Supplier X
Bank (B/S)
Trial Balance
Financial Statements
14.4
14: CONTROL ACCOUNTS
2.2 The information in the receivables ledger control account (RLCA) and receivables ledger
(RL) is posted from the same source documents.
Therefore
the balance on the RLCA should equal the sum of all balances from the RL
Similarly
the balance on the PLCA should equal the sum of all balances from the PL
2.3 If the balances do not agree then an error has been made. This will be identified through a
control account reconciliation (Section 5).
Solution
(1) Books of prime entry
Sales day book
Date Customer Amount
14.5
14: CONTROL ACCOUNTS
Memorandum ledgers
Receivables ledger
Customer A Customer B
Payables ledger
Supplier Y Supplier Z
14.6
14: CONTROL ACCOUNTS
Purchases (I/S)
(4) Reconciliation
Balance per list of balances
$
Receivables ledger
Customer A
Customer B
14.7
14: CONTROL ACCOUNTS
3 Other entries
A business must ensure that any transaction recorded in the receivables ledger control
account or the payables ledger control account is also reflected in the memorandum
ledgers.
Contra entries
3.1 Sometimes a business may have a customer which also supplies the business with goods.
Illustration:
P Co is a printing business which sells stationery to F Co, a florist. F Co supplies P Co with
flowers and plants for its offices.
During October, P Co sells stationery worth $200 to F Co and F Co delivers flowers and
plants to P Co worth $70.
P Co has the following amounts in its books:
Receivables: $200
Payables: $70
The two businesses agree to offset the balances receivable and payable via a contra.
The contra will be for the lower of the two amounts: $70. This will decrease both
receivables and payables by $70 and the remaining $130 can then be paid in cash.
3.3 Note that the memorandum ledgers will also need to be updated for the contra entry.
3.5 Steps:
(1) Goods are sold to the customer for $250:
Dr RLCA $250
Cr Sales $250
(2) Customer pays for goods:
Dr Bank $250
Cr RLCA $250
At this point the balance on the receivables ledger control account is nil.
14.8
14: CONTROL ACCOUNTS
(3) Customer returns the goods and is issued with a credit note:
Dr Sales (returns) $250
Cr RLCA $250
This entry reverses the original sale.
The receivables ledger control account will show a credit balance reflecting that the
business owes money to the customer. This could be offset against future purchases
or the customer may request a refund.
(4) The business refunds the customer:
Dr RLCA $250
Cr Bank $250
Once again the balance on the receivables ledger control account is nil.
Over payment
3.7 If a customer pays too much to settle an invoice or pays an invoice twice the business will
owe the excess to the customer.
This may be held and treated like a credit note or the monies refunded to the customer.
4 Discounts
4.1 There are two types of discounts:
(a) Trade discounts
(i) given at the time of the sale/purchase, they reduce the selling price as an
inducement to purchase;
(ii) usually for regular customers or bulk buyers.
(b) Settlement discounts
(a) offered, but not necessarily taken, as an inducement to settle a debt early;
(b) eg. 5% discount if settled within 14 days.
Terminology
4.2 Discounts allowed: offered by a seller to their customer.
Discounts received: received by a business from their supplier.
Discounts allowed
4.3 Accounting treatment
Sales are recorded net of (i.e. after) trade discounts but inclusive of (i.e. before) settlement
discounts.
Therefore trade discounts never appear in the financial statements.
14.9
14: CONTROL ACCOUNTS
Settlement discounts allowed are recorded as discounts allowed and are shown as an
expense in the income statement:
Dr Discounts allowed (I/S)
Cr RLCA
(a) On 1 January 20X7 a business made a sale on credit for $12,000. A trade discount of
$2,000 was available with a further 10% settlement discount if payment were made within
10 days.
Required
Record the initial sale.
Solution
(b) On 4.1.X7, the customer pays for the goods taking advantage of the settlement discount.
The discount will be 10% of sales value.
Required
Record the full settlement of the amount owed.
Solution
14.10
14: CONTROL ACCOUNTS
(c) Required
What would your answer be to part (b) if the settlement discount were not taken?
Solution
Bank (B/S) RLCA (B/S)
Discounts received
4.4 Accounting treatment
Purchases are recorded net of trade discounts but inclusive of settlement discounts.
Again trade discounts never appear in the financial statements.
Settlement discounts received are recorded as discounts received and are shown as
sundry income in the income statement.
Dr PLCA (B/S)
Cr Discounts received (I/S)
Ryan Co purchases goods worth $5,000 from Austin Co. Ryan Co will receive a 5% settlement
discount if the goods are paid for within seven days. Ryan Co has every intention of taking
advantage of the settlement discount.
Required
(a) Show the initial recording of the purchase.
(b) Record the payment for the goods assuming Ryan pays within seven days.
(c) Record the payment for the goods if payment is made after seven days.
14.11
14: CONTROL ACCOUNTS
Solution
Brick buys goods with a list price of $50,000 from Cement. Brick receives a trade discount of 12%
from Cement and a further discount of 4% if payment is made within 10 days. Sales tax is at 15%.
Required
What amount should Brick show in Cement's payables ledger to record this purchase?
A $48,576
B $50,336
C $50,600
D $57,500
14.12
14: CONTROL ACCOUNTS
Solution
X X
Balance b/d X
Reconciliation Statement
$ $ $
+ –
Total per listing of receivables ledger X
balances
Adjustments
Balance omitted X
Credit balance listed as debit (2X)
X X X
14.13
14: CONTROL ACCOUNTS
(a) Required
Post the following transactions to and balance off the receivables ledger control account.
(1) Opening balance $614,000
(2) Credit sales made during the month $302,600
(3) Receipts from customers $311,000
(4) Bad debts were written off $32,000
(5) Discounts allowed for prompt payment $3,400
(6) Contras against amounts due to suppliers in payables ledger $8,650
(b) The receivables ledger list of balances totals to $563,900.
You have found the following errors:
(i) The total of the sales day book was undercast by $3,600.
(ii) A credit balance of $450 was included in the list of balances as a debit.
(iii) A customer balance of $2,150 was left out when the receivables ledger list of
balances was totalled.
Required
Reconcile the receivables ledger control account to the receivables ledger list of balances.
Solution
14.14
14: CONTROL ACCOUNTS
6 Summary of Chapter 14
6.1 At any point in time the balance on the receivables ledger control account should equal the
total of all the balances in the receivables ledger. Also the balance on the payables ledger
control account should equal the total of all the balances in the payables ledger. Where the
two balances are not the same an error must have arisen and a reconciliation should be
performed to identify the errors.
6.2 If a customer is also a supplier the two parties may choose to settle their accounts by
making a contra entry. The contra is always for the lower of the two balances.
6.3 Sometimes a business may offer discounts to attract custom. There are two types of
discounts: trade discounts and settlement discounts.
6.4 Sales and purchases are recorded after trade discounts but before settlement
discounts.
6.5 Sales tax is calculated on the amount after all discounts, regardless of whether the
discount is taken or not.
14.15
14: CONTROL ACCOUNTS
14.16
Chapter 14: Questions
14.17
14: QUESTIONS
14.1 The adjusted balance on the receivables ledger control account is:
A $125,560
B $126,400
C $127,240
D $129,400 (2 marks)
14.3 A page of the sales day book is undercast by $250. The journal necessary to correct the error is:
A Debit trade receivables $500, Credit sales $500
B Debit sales $500, Credit trade receivables $500
C Debit trade receivables $250, Credit sales $250
D Debit sales $250, Credit trade receivables $250 (2 marks)
14.4 Winn Co has opening trade payables of $24,183 and closing trade payables of $34,665. Purchases for
the period totalled $254,192 ($31,590 relating to cash purchases).
What were total payments recorded in the payables ledger for the period? $ (2 marks)
14.18
14: QUESTIONS
14.6 The following receivables ledger reconciliation has been prepared by the bookkeeper of Julian Co as at
31 October 20X7:
$
Total per listing of receivables ledger balances 26,170
Debit balance omitted 1,740
Credit listed as debit (1,220)
Unexplained difference 300
Balance per control account 26,990
Which of the following errors could have produced the ‘unexplained difference’?
A A refund of $300 was omitted from the receivables ledger.
B The sales day book for October was undercast by $300.
C The trade receivables column of the cash receipts book was overcast by $300.
D A payables ledger contra of $300 was not entered in the memorandum records. (2 marks)
14.7 Justin has attempted to write up his own nominal ledger but is very confused about debits and credits. He
realises he has made some mistakes and has asked you to correct the following receivables ledger
control account:
Receivables ledger control account
$ $
Balance b/d 12,460 Cash sales 4,430
Sales on credit 15,520 Cheques from credit customers 11,650
Purchase ledger contra 1,600 Discounts allowed 890
Balance c/d 12,610
29,580 29,580
The opening balance is correct. What should the closing balance be?
A $9,410
B $13,840
C $15,620
D $17,040 (2 marks)
14.8 Which of the following is not a valid reason for a credit balance on a customer's account in the
receivables ledger?
A Over payment
B Cheque dishonoured by bank
C Returned goods credited to account (1 mark)
14.19
14: QUESTIONS
14.9 During April a company receives an invoice for $12,000 relating to goods bought on credit. These
purchases qualify for a 5% trade discount which has not yet been taken into account. The company also
sells goods with a list price of $20,000. A 6% trade discount is to be offered on these goods. Sales tax is
applicable to all items and is at 15%. Sales tax is not included in the above amounts. If there is no
opening balance on the sales tax account at the beginning of April, what is the closing balance at the end
of April?
A $1,110 Cr
B $1,110 Dr
C $1,200 Cr
D $1,200 Dr (2 marks)
14.10 The following transactions were recorded in a company’s books during one week of its trading year:
$
Trade purchases (at list price) 4,500
Sales on credit (at list price) 6,000
Purchase of a van 10,460
A trade discount of $300 was given on the sales. All figures are given exclusive of sales tax at 15%.
If the balance on the sales tax account was $2,165 credit at the beginning of the week, what is the
balance at the end of the week? $ (2 marks)
14.11 Thomas
Thomas is a sole trader. He has been reading a book on basic bookkeeping but his grasp of the subject is
weak.
He has produced the following receivables ledger control account but is not sure whether his closing
balance is correct.
Receivables ledger control account
$ $
Balance b/d 1.1.X6 12,240 Cheques received from customers 74,730
Discounts allowed 2,165 Cheques dishonoured by customers 425
Cash paid to customers with Irrecoverable debts 470
credit balances 180 Allowance for receivables 1,470
Sales 71,250 Cash received from customers 870
Returns inwards 2,250
Purchase ledger contras 230 Balance c/d 31.12.X6 10,350
88,315 88,315
14.20
14: QUESTIONS
14.12 Duff
On 31 December 20X7 the balance on Duff’s receivables ledger control account was $1,070, but the
receivables ledger balances totalled only $890.
You ascertain the following:
(1) The sales day book was overcast by $100 on 1 December 20X7.
(2) Receivables ledger balances totalling $70 had been omitted from the list.
(3) A contra entry of $20 had been made between the payables ledger and receivables ledger
accounts of Jones & Co, but no other entry had been made.
(4) The only posting made in respect of sales on 15 December 20X7, $50 in total, had been to
individual ledger accounts.
(5) $60 worth of goods had been returned by Smith Co in November; this had been recorded only in
the control account.
(6) The ledger account balance of Davis & Co had been listed as $90, but was in fact $190.
Required
Prepare a reconciliation between the receivables ledger control account and the receivables ledger.
14.21
14: QUESTIONS
14.22
Chapter 14: Answers
14.23
14: ANSWERS
$ $
Balance b/d 130,000 SDB overcast 600
Contra 3,000
∴balance c/d 126,400
130,000 130,000
14.3 C
$ $
Bal b/d 24,183
∴ Payments 212,120
Bal c/d 34,665 Purchases
($254,192 – $31,590) 222,602
246,785 246,785
14.5 B
14.6 A B – Day book total has no effect on the receivables ledger, where individual invoice
amounts will be entered.
C – Cash book total has no effect on receivables ledger.
D – If a contra had been omitted, the receivables ledger total would have to be reduced by
$300.
$ $
Balance b/d 12,460 Purchase ledger contra 1,600
Sales on credit 15,520 Cheques from credit customers 11,650
Discounts allowed 890
Balance c/d 13,840
27,980 27,980
14.8 B This would leave a debit balance as the original debt would be reinstated.
14.24
14: ANSWERS
14.9 A $
Input sales tax
$12,000 × 95% × 15% 1,710
14.10 $776 Cr
$ $
Balance b/d 12,240
Cash – cheque dishonoured 425 Cheques 74,730
Cash – credit balances 180 Irrecoverable debts 470
Sales 71,250 Cash received 870
Discounts allowed 2,165
Returns inwards 2,250
Purchase ledger contras 230
Balance c/d 3,380
84,095 84,095
14.12 Duff
Receivables ledger control account
$ $
Balance b/d 1,070 SDB Overcast (1) 100
Sales 15.12.X7 (4) 50 Purchase ledger contra (3) 20
Amended balance c/d 1,000
1,120 1,120
14.25
14: ANSWERS
END OF CHAPTER
14.26
Bank reconciliations
Exam Context
Exam questions are likely to ask you to perform calculations to correct a bank reconciliation. Alternatively they may ask
you to state whether differences between the cash book and the bank statement should be adjusted in the cash book or
in the reconciliation statement.
Qualification Context
This chapter covers a topic which is only examined in Paper F3.
15.1
15: BANK RECONCILIATIONS
Overview
Bank reconciliations
Differences
15.2
15: BANK RECONCILIATIONS
1 Introduction
1.1 This chapter is designed to enable you to explain and apply the approach to identifying and
correcting errors through the use of bank reconciliations.
1.2 The cash book is used to record the detailed transactions of receipts and payments into and
out of the bank account. These are then posted to the nominal ledger periodically using
double entry. At the end of each accounting period, the balance on the cash book should
equal the balance in the nominal ledger cash account.
1.3 Bank statements provide an independent record of the balance on the bank account but this
balance is unlikely to agree exactly to the cash book balance – therefore a reconciliation is
required.
Differences between the cash book balance and the bank statement
1.4 Differences essentially occur for three reasons:
(a) Timing differences:
(i) unrecorded lodgements (money paid into the bank by the business but not
yet appearing as a receipt on bank statement)
(ii) outstanding/unpresented cheques (cheques paid out by business which
have not yet appeared on bank statement).
(b) Errors by the business (i.e. in the cash book):
(i) omissions, such as:
standing orders
direct debits
bank charges
interest
(ii) transposition errors
(iii) casting errors
(c) Errors by the bank.
A word of warning
1.5
In the books of the business:
POSITIVE BANK BALANCE = ASSET = DEBIT
NEGATIVE BANK BALANCE (OVERDRAFT) = LIABILITY = CREDIT
But from the bank’s point of view:
POSITIVE BALANCE = LIABILITY = CREDIT (the bank owes you your money)
NEGATIVE BALANCE (OVERDRAFT) = ASSET = DEBIT
(you owe the bank ∴ this is an asset for the bank)
15.3
15: BANK RECONCILIATIONS
$
Balance per bank statement X
plus unrecorded lodgements X
less outstanding cheques (X)
plus/less bank errors X/(X)
Practical tips
2.3 (a) On reconciliation, put overdrafts and payments in brackets.
(b) It is the corrected cash account balance which is shown on the balance sheet. This
figure will be the recalculated 'Balance c/d' on the cash account (or the total at the
end of the reconciliation statement – which should be identical!).
15.4
15: BANK RECONCILIATIONS
The cash account of Graham showed a debit balance of $204 on 31 March 20X8. A comparison
with the bank statements revealed the following.
$
(1) Cheques drawn but not presented 3,168
(2) Amounts paid into the bank but not credited 723
(3) Entries in the bank statements not recorded in the cash account
(i) Standing order payments 35
(ii) Interest on bank deposit account 18
(iii) Bank charges 14
(4) Balance on the bank statement at 31 March 20X8 2,618
Required
Make any necessary adjustments to the cash book balance and complete the bank reconciliation
statement as at 31 March 20X8.
Solution
Adjustment of cash book balance
Cash account
$ $
$
Balance per bank statement 31 March 20X8
Unrecorded lodgements
Outstanding cheques
15.5
15: BANK RECONCILIATIONS
Whilst preparing a bank reconciliation statement at 31 December. The following items caused a
difference between the bank statement balance and the cash book balance.
(1) Bank interest charged to the account in error
(2) Direct debit for $500 for insurance
(3) Bank charges of $70
(4) Cheque paid to a supplier on 29 December
(5) Receipt from a trade receivable by electronic transfer
Required
Which of these items will be shown in the bank reconciliation?
A 2, 3, and 5
B 1 and 4
C 1, 4, and 5
D 1, 3 and 5
Solution
3 Summary of Chapter 15
Quick Quiz
3.1 A business maintains a cash book to tell it how much cash it has at a particular point in time.
It should reconcile this balance to the bank statement in order to ensure the cash book
information is accurate.
3.2 Differences between the cash book balance and the bank statement balance will arise for
three reasons: timing differences, errors by the business and errors by the bank.
15.6
Chapter 15: Questions
15.7
15: QUESTIONS
15.1 What figure will be shown in the balance sheet as at 31 December 20X8 for ‘bank overdraft’?
A $5,480
B $5,680
C $6,130
D $7,380 (2 marks)
15.2 Assuming that the above items are all that is required to reconcile the cash book balance to the balance
per the bank statement, what balance did the bank statement show as at 31 December 20X8?
A $5,280 overdrawn
B $6,080 overdrawn
C $7,780 overdrawn
D $8,580 overdrawn (2 marks)
15.3 Rectify
A summary of the cash book of Rectify Co for the year to 31 May 20X5 is as follows:
Cash Book
$ $
Opening balance b/d 805 Payments 146,203
Receipts 145,720 Closing balance c/d 322
146,525 146,525
After some investigation of the cash book and vouchers you discover that:
(1) bank charges of $143 shown on the bank statement have not yet been entered in the cash book;
(2) a cheque drawn for $98 has been entered in the cash book as $89, and another drawn at $230
has been entered as a receipt;
(3) a cheque received from a customer for $180 has been returned by the bank marked ‘refer to
drawer’, but it has not yet been written back in the cash book;
(4) an error of transposition has occurred in that the opening balance of the cash book should have
been brought down at $850;
(5) cheques paid to suppliers totalling $630 have not yet been presented at the bank, whilst payments
in to the bank of $580 on 31 May 20X5 have not yet been credited to the company’s account;
(6) a cheque for $82 has been debited to the company’s account in error by the bank;
(7) the company owes $430 to the electricity board;
(8) standing orders appearing on the bank statement have not yet been entered in the cash book:
(i) interest for the half year to 31 March on a loan of $20,000 at 11% pa;
(ii) hire purchase repayments on the managing director’s car – 12 months at $55 per month;
(iii) dividend received on a trade investment – $1,147;
15.8
15: QUESTIONS
(9) a page of the receipts side of the cash book has been undercast by $200;
(10) the bank statement shows a balance overdrawn of $870.
Required
Prepare a bank reconciliation as at 31 May 20X5.
15.9
15: QUESTIONS
15.10
Chapter 15: Answers
15.11
15: ANSWERS
15.1 B $
Unadjusted cash book balance (6,530)
15.2 A $
Adjusted cash book balance (5,680)
Less: unrecorded lodgements (1,900)
Add: outstanding cheques 2,300
Balance per bank statement (5,280)
15.3 Rectify
Bank
$ $
Balance b/d 322 Bank charges (1) 143
Error in opening balance (4) (850 – 805) 45 Cheque drawn entered as $89 (2) 9
(98 – 89)
Dividend received (8iii) 1,147
Cheque drawn entered as receipt (2) 460
Undercast (9) 200
(2 × $230)
Balance c/d 838
Cheque returned written back (3) 180
Loan interest (8i) 1,100
HP repayments (8ii) 660
2,552 2,552
END OF CHAPTER
15.12
Correction of errors
Exam Context
Questions on this area are likely to focus on three main areas. You may be asked to identify which explanations could
have led to a particular difference or be asked to identify the journal entry to correct an error. You may also need to
determine the effect errors may have on the profit figure.
Qualification Context
This topic is only tested in Financial Accounting.
16.1
16: CORRECTION OF ERRORS
Overview
Types of error
Correction of errors
16.2
16: CORRECTION OF ERRORS
1 Introduction
1.1 Chapter 6 showed us how the trial balance was extracted from the ledger accounts and that
it should balance, i.e. total debits should equal total credits.
1.2 If the trial balance doesn't balance then an error has definitely been made and must be
corrected.
2 Types of error
2.1 The following errors will still allow the trial balance to balance.
Error of commission
Error of principle
Compensating error
2.2 The trial balance will not balance if total debits do not equal total credits.
This could be due to the following:
(1) Transposition error
(b) a debit entry has been posted and no corresponding credit made (or vice
versa)
16.3
16: CORRECTION OF ERRORS
(c) two debit entries or two credit entries have been posted.
These errors will be corrected by creating a suspense account and making a journal entry
to correct the error.
3 Suspense accounts
3.1 A suspense account is a temporary account. They never appear in the final accounts.
3.4 Illustration
W Co sold goods with a value of $2,500 to James, a credit customer. When recording the
sale W Co posted the transaction to the correct accounts but made two debit entries.
Steps
(1) Entry made was:
Dr Trade receivables $2,500
Dr Sales $2,500
(2) Entry should have been:
Dr Trade receivables $2,500
Cr Sales $2,500
(3) Correction:
The trade receivables entry is correct but sales have been debited by $2,500 when
they should have been credited by that amount.
The correction is therefore twice the original error:
Dr Suspense account $5,000
Cr Sales (2 × $2,500) $5,000
Being: correction of sales posting.
16.4
16: CORRECTION OF ERRORS
Dan, the bookkeeper of Tiffany's, has made his usual mess of things and produced the following
attempt at a trial balance for the year ended 30 April 20X7.
$ $
Property, plant and equipment
At cost 60,000
Provision for depreciation 31,000
Capital at 1 May 20X6 53,000
Profit for the year 12,300
Inventory, at cost 14,000
Receivables ledger control account 9,600
Payables ledger control account 6,500
Balance at bank 1,640
85,240 102,800
As chief accountant you discover the following:
(1) A rent payment of $350 in March 20X7 had been debited in the receivables ledger control
account.
(2) Discounts allowed of $500 during the year ended 30 April 20X7 had not been recorded in
the books.
(3) No entry had been made for the refund of $2,620 made by cheque to V Woolf in March
20X7, in respect of defective goods returned to Tiffany. V Woolf, who had already paid for
the goods, returned them on 28 February 20X7.
(4) The total column of the cash receipts book had been overcast by $1,900 in March 20X7.
(5) The purchase of stationery for $1,460 cash in June 20X6 has not been posted to the
appropriate expense account.
(6) Capital of $35,000 was recorded incorrectly as $53,000.
Required
Prepare
(a) Journal entries to correct the above errors;
(b) A suspense account showing how it is cleared.
16.5
16: CORRECTION OF ERRORS
Solution
16.6
16: CORRECTION OF ERRORS
4 Adjustments to profit
4.1 When errors are corrected they may affect the business' profit for the year figure.
4.2 For example in Lecture example 1, item 5 tells us that a stationery expense of $1,460 has
not been recorded in the expense account.
The profit for the year figure in the trial balance of $12,300 is therefore too high and needs
to be corrected.
Proforma
4.4
$ $ $
+ –
Original profit X
Adjustment:
(a) over depreciation X
(b) unrecorded expense X
(c) unrecorded sale X
X (X) X
Adjusted profit X
Required
Prepare a statement of adjustments to profit for Lecture example 1.
Solution
Statement of adjustments to profit for the year ended 30 April 20X7.
Increases Decreases
$ $ $
Draft profit
Adjustments
Revised profit
16.7
16: CORRECTION OF ERRORS
Z Co's income statement showed a profit of $112,400 for the year ended 30 September 20X7. The
following errors were later discovered:
(1) Sales returns of $2,700 had been recorded as a new sale.
(2) A machine which had been held for two years and had originally cost $15,000 was
depreciated this year using a 33 31 % reducing balance basis. Z Co's policy is to depreciate
machines over four years.
Required
What would be the net profit after adjusting for these errors?
A $103,250
B $105,750
C $105,950
D $108,450
Solution
5 Summary of Chapter 16
Quick Quiz
5.1 Some errors, such as errors of omission and errors of principle, will still allow the trial
balance to balance.
5.2 Where the trial balance does not balance a suspense account will be inserted and the
errors, once identified, will be corrected via a journal entry.
5.3 Some of these corrections may impact the business’ profit; in this case a statement of
adjustments to profit can be prepared to determine the revised profit figure.
16.8
Chapter 16: Questions
16.9
16: QUESTIONS
16.1 Which of the following errors could result in a suspense account being required to balance the trial
balance?
A Cash received from receivables treated as a cash sale
B Payments to suppliers of $513 recorded as $531 in the payables ledger
C A supplier’s invoice for $19 recorded as $91 in the purchases account (1 mark)
16.2 Duncan corrected the following errors before producing his final balance sheet. What was the balance on
the suspense account before he did this?
(i) Sales day book for March overcast by $63.
(ii) Cash receipts from receivables of $713 posted to the receivables ledger control account as $731.
(iii) Cash received from the issue of $1,000 debentures at par had been posted to a suspense
account.
A $982 Dr
B $982 Cr
C $1,018 Dr
D $1,018 Cr (2 marks)
16.3 Russell’s bookkeeper transposed some figures when the week’s cash payments were being posted to the
nominal ledger. Payments for staff wages of $125 were posted to the wages account as $152 and
payments of $31 for stationery were posted to the stationery expense account as $13. The entry required
to correct this is
A Dr stationery $18 Dr suspense $9 Cr wages $27
B Dr wages $27 Dr stationery $18 Cr suspense $45
C Dr wages $27 Cr stationery $18 Cr suspense $9
D Dr suspense $45 Cr wages $27 Cr stationery $18 (2 marks)
16.4 Which of the following errors would cause a trial balance imbalance?
(i) The discounts received column of the cash payments book was overcast.
(ii) Cash paid for the purchase of office furniture was debited to the general expenses account.
(iii) Returns inwards were included on the credit side of the trial balance.
A (i) only
B (i) and (ii)
C (iii) only
D all of the errors (2 marks)
16.5 If sales of $150 has been wrongly entered on the debit side of the purchases account, but correctly
entered in the trade receivables account, the totals on the trial balance would show:
A The debit side to be $150 more than the credit side
B The debit side to be $300 more than the credit side
C The debit side to be $150 less than the credit side
D The debit and credit sides to be equal in value (2 marks)
16.10
16: QUESTIONS
16.6 Platinum Co
Platinum Co, a manufacturer of electrical goods, has just produced its draft accounts for the year ended
30 September 20X7. These show a draft profit of $28,960.
Unfortunately, the accountant has since discovered the following matters which require consideration
before the final accounts can be prepared:
(1) Returns outwards to Metals Co in June 20X7 of $490 have been treated as returns inwards in
error in the nominal ledger.
(2) R. Silverman, a customer owing $1,850 has gone bankrupt. Full allowance had been made
against this amount in Platinum's accounts for the year ended 30 September 20X6.
(3) An item of equipment with a net book value of $6,000 (cost $10,000) was sold for $5,000 in
September 20X7. The proceeds were included in cash and credited to the motor expenses
account. No other entries were made.
(4) An amount owing from Aluminium Co of $780 was written off in January 20X7. The amount was
removed from trade receivables and debited to the sales account.
Required
Calculate the corrected profit for the year ended 30 September 20X7.
16.11
16: QUESTIONS
16.12
Chapter 16: Answers
16.13
16: ANSWERS
16.1 C
16.2 B
Suspense account
Transposition error (731 – 713) 18 Cash from debentures 1,000
Bal c/d 982
1,000 1,000
Bal b/d 982
16.3 A
16.4 C
16.5 B
16.6 Platinum Co
(a) Statement of corrected profit for the year ended 30 September 20X7.
$ $ $
Draft profit + – 28,960
END OF CHAPTER
16.14
Preparation of
financial statements for
sole traders
Exam Context
This chapter recaps some of the key skills you have learnt in the chapters covered to date. Whilst you will not be asked
to produce a balance sheet or an income statement in the real exam any of the adjustments in this chapter could be
tested as an individual question. This chapter will also help you to see how financial accounting fits together.
Qualification Context
The skills to produce a balance sheet and an income statement are tested in detail in the Fundamentals level paper,
Financial Reporting (F7).
17.1
17: PREPARATION OF FINANCIAL STATEMENTS FOR SOLE TRADERS
Overview
Preparation of financial
statements for sole traders
Trial balance
17.2
17: PREPARATION OF FINANCIAL STATEMENTS FOR SOLE TRADERS
1 Introduction
1.1 The purpose of this chapter is to recap some of the skills covered in Chapters 1–16.
1.2 You will not be required to answer a question in the format of Lecture example 1 in the
exam. However completing this exercise will revise your understanding of topics covered so
far and enable you to see the end product – a business' transactions ordered into a set of
financial statements.
You have been given the information below and asked to prepare the accounts of Mugg for the
year ended 31 December 20X7.
Trial balance as at 31 December 20X7.
Dr Cr
$ $
Capital account at 1 January 20X7 2,377
Rent 500
Inventories 1 January 20X7 510
Electricity 240
Insurance 120
Wages 1,634
Trade receivables 672
Sales 15,542
Repairs 635
Purchases 9,876
Discounts received 129
Drawings 1,200
Petty cash 5
Bank 762
Motor vehicles at cost 1,740
Furniture and fixtures at cost 830
Accumulated depreciation at 1 January 20X7
– Motor vehicles 435
– Furniture and fixtures 166
Travel and entertaining 192
Trade payables 700
Suspense account 433
19,349 19,349
The following information is also available:
(1) Closing inventories, valued at cost, amounts to $647;
(2) Mugg has drawn $10 a month and these drawings have been charged to wages;
(3) Depreciation is to be provided at 25% on cost on motor vehicles, and 20% on cost on
furniture and fixtures;
(4) Bad debts totalling $37 are to be written off;
17.3
17: PREPARATION OF FINANCIAL STATEMENTS FOR SOLE TRADERS
(5) $180 received from a credit customer was correctly entered in the trade receivables account
and credited to the bank account;
(6) Mugg has taken goods from inventories for his own use. When purchased by his business
these goods cost $63 and they would have been sold for $91;
(7) The annual rental of the business premises is $600, and $180 paid for electricity in August
20X7 covers the 12 months to 30 June 20X8;
(8) Discounts allowed of $73 have only been recorded in the trade payables account.
Required
(a) Prepare journal entries to record items (1) – (8).
(b) Clear the suspense account.
(c) Produce an income statement for the year ended 31 December 20X7 and a balance sheet
as at that date.
Solution
(a) Journals
(1)
(2)
(3)
(4)
17.4
17: PREPARATION OF FINANCIAL STATEMENTS FOR SOLE TRADERS
(5)
(6)
(7)
(8)
(b)
Suspense account
$ $
17.5
17: PREPARATION OF FINANCIAL STATEMENTS FOR SOLE TRADERS
(c) Mugg
Income statement for the year ended 31 December 20X7
$ $
Sales
Less: cost of sales
Opening inventories
Purchases
Less: closing inventories
Gross profit
Discounts received
Less: expenses:
Rent
Electricity
Insurance
Wages
Repairs
Depreciation
Travel and entertaining
Bad debts
Discounts allowed
Current assets
Inventories
Trade receivables
Prepayments
Cash and bank balances
Capital
Capital as at 1 January 20X7
Profit for the period
Less: drawings
Current liabilities
Trade payables
Accruals
17.6
17: PREPARATION OF FINANCIAL STATEMENTS FOR SOLE TRADERS
2 Summary of Chapter 17
2.1 The balance sheet and income statement are the end product produced by a business. All
Quick Quiz the business’ transactions need to be categorised into the books of prime entry and posted
to the nominal ledger. The trial balance is then extracted and some adjustments may need
to be made before the financial statements are drawn up.
2.2 You will not have to produce a balance sheet or income statement however this chapter
should reinforce your understanding of Chapters 1 – 16.
17.7
17: PREPARATION OF FINANCIAL STATEMENTS FOR SOLE TRADERS
17.8
Chapter 17: Question
17.9
17: QUESTION
17.1 Drawings are an expense of the business. Is this statement true or false?
A True
B False (1 mark)
17.10
Chapter 17: Answer
17.11
17: ANSWER
17.1 B
END OF CHAPTER
17.12
Incomplete records
Exam Context
Questions on this chapter will require you to identify missing figures, for example sales, closing inventories and
drawings. The Pilot Paper included two questions asking you to derive the value of closing inventories using information
about the gross profit margin earned by the business.
Qualification Context
This topic is only tested in Financial Accounting.
Business Context
Some sole traders do not keep very detailed accounting records. They still however need to produce accounts so they
know how their business is performing and also how much tax to pay to the tax authorities. The preparation of accounts
from incomplete records can generate a lot of income for smaller accountancy practices.
18.1
18: INCOMPLETE RECORDS
Overview
Incomplete records
18.2
18: INCOMPLETE RECORDS
1 Issue
1.1 Individuals running small businesses such as a newsagent or greengrocer may not keep all
of the accounting records we have studied or have a detailed understanding of double entry
bookkeeping.
1.2 They still need to know how the business is performing and so will produce financial
statements. If some necessary information isn't maintained by the business, it will need to
be derived from other available information.
2 Cost structures
2.1 Cost structure information is usually expressed in one of two ways, either as a margin or a
mark-up.
(a) Margin: here gross profit is expressed as a percentage of sales, for example a
margin of 25% gives:
Sales 100%
Cost of sales 75%
Gross profit 25%
(b) Mark-up: here gross profit is expressed as a percentage of cost of sales, for
example a mark-up of 35% gives:
Sales 135%
Cost of sales 100%
Gross profit 35%
18.3
18: INCOMPLETE RECORDS
Y Co operates with a standard mark-up of 30% and has the following information available for
20X7.
$
Sales 221,000
Opening inventories 43,000
Closing inventories 47,500
Required
What is the value for purchases in 20X7? $
Workings
On 1 January 20X7 J Co had inventory of $620,000. Sales for the month amounted to $985,000
and purchases were $700,000. At the end of January a fire in the warehouse destroyed some
inventory items. The owners salvaged inventory valued at $180,000. J Co operates with a mark up
of 25%.
What is the cost of inventory destroyed in the fire?
A $335,000
B $352,000
C $401,250
D $532,000
Solution
18.4
18: INCOMPLETE RECORDS
$
Workings
Trade payables
$ $
18.5
18: INCOMPLETE RECORDS
B Co maintains a cash float of $50. In 20X7, all receipts from credit customers were banked, after
the following payments from the till had been made:
$
General expenses 4,500
Drawings 6,250
Total bankings in the year amounted to $28,454, and opening and closing trade receivables were
$1,447 and $1,928 respectively.
Required
Based on the information above what was the value of sales made during the year? $
Workings
Cash
Trade receivables
18.6
18: INCOMPLETE RECORDS
Bob owns and manages B Co although he does not keep detailed accounting records.
All of Bob's sales are for cash. He pays certain expenses from his till and then banks the remaining
funds.
Bob maintains a $1,000 float and operates with a margin of 20%. He has provided you with the
following information.
$
Purchases of goods 20,000
Wages for clerical assistant (per week) 100
Stationery 500
Electricity 1,200
Bankings 12,800
Opening inventories 2,000
Closing inventories 3,000
Bob is unsure of the level of drawings taken during the year but estimates they were between $60
and $90 per week.
Required
What were Bob's drawings during the year? $
Workings
18.7
18: INCOMPLETE RECORDS
These are recorded at the cost to the business not at sale price.
They are taken out of purchases and not recorded against inventories.
Note: If you are using a trade payables T account to calculate purchases remember to
adjust purchases for any goods taken by proprietor.
Example
4.2 During the year ended 31 December 20X7, Peter Albert, a sole trader, carried out the
following transactions:
$
Sales (40 units @ $100) 4,000
Purchases (45 units @ $60) 2,700
His inventories (at cost) were:
$
1 January 20X7 (5 units @ $60) 300
31 December 20X7 (8 units @ $60) 480
During the year he had withdrawn two units for his own use. Firstly, ignoring the drawings,
an outline trading account would appear as follows:
$ $
Sales 4,000
Cost of sales
Opening inventories 300
Purchases 2,700
3,000
Less: closing inventories (480)
2,520
Gross profit 1,480
How should the drawings of goods be treated?
18.8
18: INCOMPLETE RECORDS
It should be fairly obvious that the debit entry will be to drawings on the balance sheet, but
what about the credit entry? It will not, as you might initially think, go to inventories (because
these goods were not in hand at the year end so they are not included in the value of $480)
but rather to purchases (as this is where they will have been previously recorded).
In the trading account, this credit entry is often shown as a separate deduction from cost of
sales, i.e.:
$ $
Sales 4,000
Cost of sales
Opening inventories 300
Purchases 2,700
Less: goods drawn by proprietor
2 units @ $60 (120)
2,880
Less: closing inventories (480)
2,400
Gross profit 1,600
Points to note
4.3 (a) Drawings of goods are recorded at cost.
(b) Gross profit figure now makes sense, i.e. profit of $40 per unit × 40 units sold.
5 Summary of Chapter 18
Quick Quiz
5.1 Not all businesses keep proper accounting records, however all businesses need to know
how much profit they have made in a particular year so that they can pay the relevant
amount of tax over to the tax authorities.
5.2 Where a business does not have sufficient records to produce financial statements they
need to piece together the missing information.
5.5 A business is a separate entity from its owner which means that any monies or goods taken
out of the business for personal use must be classified as drawings. Drawings of goods
are recorded at cost.
18.9
18: INCOMPLETE RECORDS
Dr Drawings (B/S)
Cr Cash (B/S)
Dr Drawings (B/S)
Cr Purchases (I/S)
18.10
Chapter 18: Questions
18.11
18: QUESTIONS
18.1 If a business has sales of $6,000 and a margin of 20%, what is the gross profit? $
(1 mark)
18.2 A trader has budgeted sales for the coming year of $300,000. He achieves a constant mark-up of 25% on
cost. He plans to reduce his inventory level by $14,000 over the year. How much will his purchases for
the year be?
A $211,000
B $239,000
C $226,000
D $254,000 (2 marks)
18.3 A business has opening inventories of $273 and makes purchases during the year of $2,781. The
proprietor removes goods costing $87 for his own use. The business achieves a constant mark-up of 20%
on cost and records sales for the year of $3,360.
What is the cost of closing inventories? $ (2 marks)
18.4 Jethro sold goods for $157,470 during the year ended 31 October 20X7. Inventories at that date were
valued at $8,920 more than at the previous year end. Jethro prices his goods to give a mark-up of 45%.
What was the total value of purchases in the year ended 31 October 20X7?
A $77,689
B $95,529
C $99,680
D $117,520 (2 marks)
18.12
Chapter 18: Answers
18.13
18: ANSWERS
18.1 $1,200
$6,000 × 0.2 = $1,200
18.2 C $
100
Cost of sales = $300,000 × 240,000
125
18.3 $167
Cost of sales $
100
$3,360 × 2,800
120
END OF CHAPTER
18.14
Partnerships
Exam Context
Questions on this topic are likely to require you to calculate a partner's profit share. This may include dealing with
partners' salaries, interest on capital and drawings and loan interest. You may also need to allocate goodwill to partners
when a new partner is admitted.
Qualification Context
Partnerships are only examined in this paper.
Business Context
Many individuals set up business as a sole trader – as they expand they need new finance. One way of obtaining this is
to go into partnership with someone else. That other person could provide some of the finance needed. They may also
bring new ideas to the table. Becoming a partnership will mean that the sole trader will share some of their risk but they
will also need to share their profits too!
It is always recommended that a partnership agreement is drawn up to retain a legal record of how the partnership will
operate.
19.1
19: PARTNERSHIPS
Overview
Partnerships
19.2
19: PARTNERSHIPS
1 Definition
1.1 Partnership: The relationship which exists between two or more persons carrying on
a business with a view to profit.
1.2 Partnerships are similar to sole traders. With a sole trader the owner will run the business
and any profits belong to him. The sole trader also bears the risk that the business may not
be successful.
In a partnership, the owners (partners) run the business together and share profits and risk.
1.3 Most partnerships have unlimited liability which means the partners are personally liable
for the debts of the business.
Liability is also joint and several so if one partner cannot meet the partnership's obligations
the other partners must make up any shortfall.
1.4 Limited liability partnerships (LLPs) exist nowadays to limit partner liability. These are
outside the scope of the F3 syllabus.
2 Partnership agreements
The partners will need to agree the terms under which the partnership will operate, and
decide, for example how much capital each partner will contribute and what share of profits
they will be entitled to.
This is done by way of a partnership agreement which usually covers the following areas:
2.1
Area Consideration
Capital • how much each partner pays in
• whether a "Fixed Capital" level is specified
Profit sharing ratio • allocation of profit
(PSR) • more to senior partners?
• equal shares?
• guaranteed minimum profit share?
Salaries • whether or not partners are entitled to salaries
• it is an appropriation of profit
• it is not an income statement expense
Interest on capital • whether or not allowed
• paid on capital injected
• interest rate
Drawings • may set a limit
• may set an interest charge
19.3
19: PARTNERSHIPS
X X
* PSR is always the last entry, splitting the residual profit after all other allocations
19.4
19: PARTNERSHIPS
19.5
19: PARTNERSHIPS
(a) On 1 January 20X4 Tick, Cast and Balance entered into partnership together as chartered
certified accountants. They agreed that Balance would receive a salary of $15,000 p.a., they
would all be allowed interest on capital of 12% p.a. and they would share profits in the ratio:
Tick five tenths, Cast three tenths, Balance two tenths. They paid in the following capital
amounts:
Tick $50,000
Cast $30,000
Balance $20,000
In the year to 31 December 20X4 their profit for the period was $50,000.
During the year they had made drawings in cash as follows:
30.6.20X4 Tick $6,000
30.9.20X4 Cast $4,000
31.12.20X4 Balance $8,800
Required
(i) Write up their capital accounts in columnar form.
(ii) Write up the appropriation account.
(iii) Write up their current accounts in columnar form.
(iv) Show the partners' balances on the balance sheet.
Solution
(i)
Capital Accounts
Tick Cast Balance Tick Cast Balance
$ $ $ $ $ $
19.6
19: PARTNERSHIPS
(ii)
Appropriation account for the year ended 31 December 20X4
$ $
(iii)
Current accounts
Tick Cast Balance Tick Cast Balance
$ $ $ $ $ $
19.7
19: PARTNERSHIPS
Capital accounts
Tick
Cast
Balance
Current accounts
Tick
Cast
Balance
(b) What would your answer be to (ii) and (iii) if the agreement had also provided for interest to
be charged on drawings at the rate of 10% p.a.?
(ii)
Appropriation account for the year ended 31 December 20X4
$ $
19.8
19: PARTNERSHIPS
(iii)
Current accounts
Tick Cast Balance Tick Cast Balance
$ $ $ $ $ $
19.9
19: PARTNERSHIPS
4.2 If when the appropriation of profits is made this level is exceeded, there is nothing further to
do.
4.3 If, however, there is a shortfall then this will be made up by the remaining partners in their
profit sharing ratio.
4.4 Illustration
A, B and C are in partnership and share profits in the ratio 2:2:1.
The partnership made a profit for the year of $50,000. A and B each receive a salary of
$12,000. Interest due on the partners' capital is $2,000, $1,700 and $1,500 respectively.
No interest is charged on drawings.
C has a guaranteed minimum profit share of $7,000.
A B C Total
$ $ $ $
Salaries 12,000 12,000 – 24,000
Interest on capital 2,000 1,700 1,500 5,200
Profit share (2:2:1) 8,320 8,320 4,160 20,800
Subtotal 22,320 22,020 5,660 50,000
Guaranteed minimum profit
share shortfall (2:2) (670) (670) 1,340 –
5 Loans
5.1 Unlike sole traders, a partner can make a loan to the partnership.
Accounting treatment
5.3 The loan is shown as a non-current liability on the balance sheet and not in the partner's
capital account.
5.4 The interest incurred on the loan is shown as an expense in the income statement (just
like bank interest). It will need to be deducted from the profit figure before any appropriation
is made if it has not already been accounted for.
19.10
19: PARTNERSHIPS
5.5 If the loan interest has not been paid by the end of the year, the liability will be shown in the
relevant partner’s current account.
The double entry would be:
Dr Loan interest expense (I/S)
Cr Current account (B/S)
Workings
19.11
19: PARTNERSHIPS
6.2 Always use the old partnership agreement to appropriate the profits for the first part of the
year and the new partnership agreement for the latter part of the year.
6.3 Assume profits accrue evenly unless the question specifies otherwise.
Melanie, Sarah and Angela are in partnership, compiling their accounts for the year to
31 December each year. The partnership agreement states the following:
Until 30 June 20X3
19.12
19: PARTNERSHIPS
7.2 It is likely that over time the value of items such as property, plant and equipment will
increase over their net book value.
However, hopefully the business will also have built up a good reputation and a loyal
customer base and the business itself will be worth more than its individual assets.
7.3 The worth of a business over and above its individual assets is called goodwill.
Section 2.8-2.10 7.4 When a partner retires it is important that he is paid a sum that represents not just the
money he invested but also his share of the extra value created in the business, i.e. his
share of goodwill.
Goodwill is therefore added to the partners' accounts according to the existing or old profit
sharing ratio.
7.5 Similarly, when a new partner joins, he will pay in a sum of money (capital). It is important
that the original partners value the partnership so they know its worth and can determine
how much the partner should contribute.
7.6 Goodwill is an extremely subjective figure and so it is not left in the partnership's balance
sheet, but is removed.
This is done using the new profit sharing ratio.
Katie, Chantel and Heather are in partnership sharing profits in the ratio 4:3:2.
On 1 September Heather decides to retire and leaves the partnership. At that point the partnership
has goodwill valued at $180,000. Katie and Chantel continue to share profits 4:3.
On 1 December Stacy joins the partnership contributing $200,000. At that time goodwill is valued
at $210,000. The new profit sharing ratio for Katie, Chantel and Stacy is 3:2:2.
Required
Show how the goodwill would be accounted for at each change of the partnership.
19.13
19: PARTNERSHIPS
Solution
Goodwill
$ $
Capital account
$ $
8 Summary of Chapter 19
Quick Quiz
8.1 The purpose of a partnership agreement is to specify how the partnership operates in
terms of the how much capital the partners pay in and whether they are paid interest on
capital; whether they are entitled to a salary; whether interest is charged on drawings
and the profit sharing ratio.
8.2 Partners’ salaries are not an expense of the business but an appropriation of profit.
8.3 Capital accounts represent the capital paid in by each partner and are generally static.
8.4 Current accounts record the partners’ day to day transactions with the business.
8.5 Whenever a new partner is admitted or an existing partner retires the partnership will be
valued. The worth of the partnership over and above the balance sheet valued is called
goodwill. This is allocated to the partners according to their profit sharing ratio.
19.14
Chapter 19: Questions
19.15
19: QUESTIONS
19.16
19: QUESTIONS
19.4 A, B and C
A, B and C are in partnership, agreeing to share profits in the ratio of 4:2:1. They have also agreed to
allow interest on capital at 8% per annum, a salary to C of $5,000 per annum, and to charge interest on
drawings made in advance of the year end at a rate of 10% per annum.
The balance sheet as at 30 June 20X8 disclosed the following:
$ $
Capital accounts A 50,000
B 30,000
C 10,000
90,000
Current accounts A 2,630
B 521
C (418)
2,733
Loan account (5% interest) A 15,000
107,733
Drawings were: A $6,400, B $3,100, C $2,000, with all sums being withdrawn on 1 July 20X8.
Profit for the year to 30 June 20X9 was $24,750, before charging interest on A's loan. The partnership
made a payment to A for loan interest on 29 June 20X9 but has not recorded this in its books.
Required
Prepare the current accounts and the appropriation account for the partners as at 30 June 20X9.
19.17
19: QUESTIONS
19.18
Chapter 19: Answers
19.19
19: ANSWERS
19.1 $10,300
$
Profit per accounts 40,000
Less loan interest
6
4% × $100,000 × 12
(2,000)
38,000
19.2 $12,775
19.3 C Interest on drawings increases available profits to share and is therefore not an appropriation of
profit.
Current accounts
A B C A B C
$ $ $ $ $ $
19.20
19: ANSWERS
Appropriation account
$ $
Salary C 5,000 Profit (W1) 24,000
Interest A 4,000 Interest A 640
on capital B 2,400 on drawings B 310
C 800 C 200
7,200 1,150
19.21
19: ANSWERS
END OF CHAPTER
19.22
Introduction to
company accounting
Exam Context
Questions on this chapter are likely to focus on the calculation of share capital movements (new issues, bonus issues
and rights issues), dividends and finance costs and their associated journal entries. You may also see a question
comparing a sole trader and a limited company as was included in the Pilot Paper.
Qualification Context
The knowledge covered in this chapter is developed further in the Fundamentals level paper Financial Reporting (F7).
This paper looks in more detail at whether shares and borrowings should be classified as debt or equity and also at how
they should be valued. The area of income taxes is also extended to include adjustments for deferred tax as well as
current tax.
Business Context
When a company is seeking to raise finance it will evaluate its current financing structure and gearing levels before
deciding how to secure additional funds. It will also consider the degree of risk attached to each method of financing and
will weigh up the cost in terms of interest payments versus future dividends. A company will also receive tax relief on its
interest payments (but not on dividends) and so the tax implications will form part of the final decision.
20.1
20: INTRODUCTION TO COMPANY ACCOUNTING
Overview
Finance costs
Introduction to
company accounting
Shares
Accounting treatment
Dividends
20.2
20: INTRODUCTION TO COMPANY ACCOUNTING
1 Introduction
1.1 We have seen how financial statements are produced for sole traders and partnerships.
These accounts are not subject to any specific regulation and so there is some flexibility as
to how they are presented.
1.2 Companies use exactly the same bookkeeping process as sole traders and partnerships;
however, the financial statements they produce are subject to regulation and must follow a
prescribed format.
Many of the differences are due to the terminology used by company financial statements.
20.3
20: INTRODUCTION TO COMPANY ACCOUNTING
Current liabilities
Trade payables X
Short term borrowings X
Current tax payable X
Short term provisions X
Total equity and liabilities X
3 Share capital
Share capital
3.1 It is necessary to be able to distinguish between the following types of share capital:
(a) Authorised share capital – maximum number of shares the company may issue.
Section 2.3
(b) Issued share capital – number of shares actually issued to shareholders.
(c) Called up share capital – the amount of issued share capital the company has
asked shareholders to pay for to date.
(d) Paid up share capital – amount of called up share capital which has been paid
for.
20.4
20: INTRODUCTION TO COMPANY ACCOUNTING
Types of shares
3.2
Ordinary share Preference share
• Equity share • Fixed rate of dividends (eg 7%
preference share)
• Ordinary shareholders – own business • Receive dividend in priority to ordinary
shareholders
• Usually have voting rights • On winding up, receive capital in priority
• No right to a dividend, receive what
directors decide to pay
On 1 June 20X6 Rab Co issued a further 200,000 ordinary shares of 50c each for 80c per share.
Required
Show how this issue of shares would be accounted for and what the balance sheet would look like
immediately after the issue.
20.5
20: INTRODUCTION TO COMPANY ACCOUNTING
Solution
Dr Cr
$ $
Dr Cash
Cr Share capital
Cr Share premium account
Rab Co balance sheet (extract) as at 1 June 20X6
Equity
$
Share capital – 50c ordinary shares
Share premium account
4.4
Advantages Disadvantage
• Bonus issue can be made from the share • The rationale for a bonus issue is not
premium account which has few other always understood by shareholders
uses
• Will allow the share price to fall (without
disadvantaging shareholder wealth) to
make the company's shares more
affordable to new investors
• Shareholders will now own more shares
and could sell part of their holding
20.6
20: INTRODUCTION TO COMPANY ACCOUNTING
Rab Co
Balance sheet (extract)
$
Share capital – 50c ordinary shares 150,000
Share premium account 60,000
Retained earnings 200,000
410,000
Several years later Rab Co is to make a bonus issue on a 1 for 4 basis.
Required
Show how this issue of shares would be accounted for and prepare the balance sheet of Rab Co
immediately after the issue.
Solution
Dr Cr
$ $
Dr Share premium account
Cr Share capital
Rab Co
Balance Sheet (extract)
$
Share capital – 50c ordinary shares
Share premium account
Retained earnings
Rights issue
4.6 (a) A rights issue is an issue of shares for cash (unlike a bonus issue) to existing
shareholders.
(b) ‘Rights’ are offered to the existing shareholders who can sell them if they wish.
20.7
20: INTRODUCTION TO COMPANY ACCOUNTING
4.7
Advantages Disadvantages
• More cost effective way for the • Lack of shareholder interest may reflect
company to raise finance than a badly on the company
fresh issue to the public
• A more time efficient way to issue • Unwelcome predators may try to acquire
shares shares where not all rights are taken up
• If all rights are taken up • Effect on future dividend policy as company
shareholders will maintain their will have issued more shares under the
existing percentage shareholding rights issue than it would have under a fresh
issue to the public
One year later, Rab Co is to make a rights issue on a 1 for 5 basis. The rights price is $1.50. All
shareholders take up their rights.
The following balance sheet extract shows the position before the issue
Rab Co
Balance sheet (extract)
$
Share capital – 50c ordinary shares 187,500
Share premium account 22,500
Retained earnings 230,000
440,000
Required
Show how this issue of shares would be accounted for and prepare the balance sheet of Rab Co
immediately following the issue.
Solution
Dr Cr
$ $
Dr Cash
Cr Share capital
Cr Share premium account
Rab Co
Balance sheet (extract)
$
Share capital – 50c ordinary shares
Share premium account
Retained earnings
20.8
20: INTRODUCTION TO COMPANY ACCOUNTING
5 Reserves
5.1 The following reserves are commonly found in limited liability company accounts.
(a) The share premium account:
(i) Typical permitted uses:
(1) to issue bonus shares;
(2) to write off share issue expenses.
(b) The revaluation reserve (see Chapter 9):
(c) Other reserves:
as designated by the individual company, for example a 'general reserve'.
(d) Retained earnings:
cumulative undistributed profits less any losses.
6 Dividends
Definition
6.1 Dividends – a sharing out/appropriation of retained earnings to owners/shareholders.
Illustration
6.2 Suppose a company with 1,000 ordinary $1 shares in issue made a profit of $500 in its first
year. The company has two choices as to what can be done with this profit:
(a) distribute it as a dividend to the shareholders;
(b) retain it in the business.
If this company decides to pay a dividend of 10c per share and retain the remaining profits,
the financial statements would appear as follows:
Income statement for the year ended 31 December 20X7
$
Profit for the period 500
Balance Sheet as at 31 December 20X7 (extract)
$
Share capital – $1 shares 1,000
Retained earnings (500 – 100) 400
1,400
6.3 Dividends are charged directly to retained earnings as they are an appropriation of profits
earned to date. They are not an expense of the income statement.
20.9
20: INTRODUCTION TO COMPANY ACCOUNTING
Solution
$ $
Retained earnings at beginning of year
Profit for the period
Dividends – Preference
– Ordinary
20.10
20: INTRODUCTION TO COMPANY ACCOUNTING
7.2 One way of raising long term finance is for a company to issue loan notes (also called loan
stock or debentures).
These loans usually carry a fixed rate of interest and have a pre-determined redemption
date, for example, $50,000 10% debentures 2012. This means the company will pay interest
at 10% on the $50,000 borrowed each year. The capital amount of $50,000 will be repaid in
2012.
8 Finance costs
8.1 The interest expense incurred on long term borrowings will be shown as an expense called
'finance costs' in the income statement.
9 Income taxes
9.1 Companies must pay income tax on their profits. This tax is payable after the end of the
financial year and so the financial statements will include an accrual for the directors' best
estimate of the tax due on the profit for the period.
9.2 The tax is shown as an expense in the income statement and a current liability in the
balance sheet and will be accounted for as follows:
Dr Income tax expense (I/S)
Cr Current tax payable (B/S)
9.3 Often the actual amount of tax paid will be different from the amount that was recorded in
the financial statements.
This over or under provision is simply adjusted in the next financial statements.
20.11
20: INTRODUCTION TO COMPANY ACCOUNTING
Solution
(1) Income tax expense (I/S)
$ $
$ $
20.12
20: INTRODUCTION TO COMPANY ACCOUNTING
10 Comparison
The following table shows a comparison between a sole trader and a limited liability
company.
20.13
20: INTRODUCTION TO COMPANY ACCOUNTING
11 Summary of Chapter 20
11.1 In a limited liability company the shareholders own the business. A company may raise
Quick Quiz finance by issuing new share capital. Where shares are issued at a premium to their
nominal value, the premium is recorded in the share premium account.
11.2 A bonus issue is where the company issues shares for no cash consideration. With a
rights issue, shares are issued for cash but the price charged is slightly lower than the
current market price.
11.3 Shareholders may receive a dividend as a return on their investment; these are accounted
for as a deduction to retained earnings.
11.4 A company may also raise finance by issuing debt such as loan notes or debentures. It will
have to pay interest on these and this will be shown as 'finance costs' in the income
statement.
20.14
Chapter 20: Questions
20.15
20: QUESTIONS
20.1 A company has an authorised share capital of 1,000,000 50c ordinary shares and an issued share capital
of 800,000 50c ordinary shares.
If an ordinary dividend of 5% is declared what is the amount payable to shareholders? $
(1 mark)
20.2 If a shareholder in a limited liability company sells his shares to another private investor, for less than he
paid for them, the share capital of the company will
A Remain unchanged
B Increase by the nominal value of the shares
C Increase by the amount received for the shares
D Decrease by the nominal value of the shares (2 marks)
20.3 A company’s issued share capital consists of $100,000 in 6% $1 preference shares and $50,000 in 50c
ordinary shares. The directors wish to pay an ordinary dividend for the year of 5 cents per share. What is
the company’s total dividend for the year?
A $8,500
B $11,000
C $5,000
D $17,000 (2 marks)
20.16
Chapter 20: Answers
20.17
20: ANSWERS
20.1 $20,000
5% × (800,000 × 0.50)
20.2 A
END OF CHAPTER
20.18
Preparation of
financial statements for
companies
Exam Context
Whilst you will not be required to produce an entire income statement, balance sheet or statement of changes in equity
you may be asked to calculate individual elements of each statement. A question on the Pilot Paper required you to
demonstrate understanding of what was included in the statement of changes in equity.
Qualification Context
The topics covered in this chapter are developed further in the Fundamentals level paper Financial Reporting (F7). Here
you will need to produce financial statements using the format specified by IAS 1. You will also learn how accounting
standards such as IFRS 5 affect the presentation of the financial statements if, for example, a company discontinues
part of its operations.
Business Context
Financial statements are used by a wide range of user groups to make decisions, for example whether or not to buy
shares in a company. Financial statements need to be prepared in a consistent way in order for users to be able to
compare different companies. The notes to the accounts will also provide a lot more detail on the headline figures shown
in the income statement and balance sheet.
21.1
21: PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES
Overview
21.2
21: PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES
1 Introduction
1.1 As stated in Chapter 20 the financial statements of a limited liability company are subject to
regulation and must follow a prescribed format.
1.2 Much of the prescribed format is determined by IAS 1. This accounting standard states what
should be included in a set of financial statements and how they should be presented.
A complete set of financial statements in accordance with IAS 1 comprises:
(a) a balance sheet
(b) an income statement
(c) a statement showing either:
(i) all changes in equity; or
(ii) changes in equity other than those arising from transactions with equity holders
acting in their capacity as equity holders;
(d) a cash flow statement; and
(e) notes, comprising a summary of significant accounting policies and other explanatory
notes.
21.3
21: PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES
Current liabilities
Trade payables X
Short term borrowings X
Current tax payable X
Short term provisions X
Total equity and liabilities X
21.4
21: PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES
The following balances have been extracted from the trial balance of Arrow, a limited liability
company, at 30 September 20X6.
$'000
Sales 12,740
Share capital – 50c ordinary shares 1,500
Share premium account 200
Trade receivables 1,000
Bad debts written off 45
Bank balance 835
Purchases 7,200
Revaluation reserve 800
Office expenses 1,800
Property, plant and equipment 4,400
6% loan notes 20X9 1,200
Short term warranty provisions 50
Vehicle distribution costs 2,060
Inventories at 1 October 20X5 450
Trade payables 550
Administrative staff salaries 500
Retained earnings 1,250
The following information still needs to be accounted for:
(1) During the year the company made a rights issue on a 1 for 6 basis. The issue was fully
subscribed and the rights price was $1.27.
(2) No account has been taken of the interest on the loan notes.
(3) The estimate for tax payable on this year's profit is $270,000.
(4) Inventories held at the year end amounted to $610,000.
(5) The warranty provision needs to be increased to $80,000.
(6) The property, plant and equipment was valued at $5m and this amount needs to be
incorporated in the financial statements.
(7) A dividend of $300,000 was paid in the year but this has not been accounted for.
Required
Prepare the income statement of Arrow for the year ended 30 September 20X6 and a balance
sheet as at that date.
21.5
21: PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES
Solution
Arrow
Income statement for the year ended 30 September 20X6
$'000
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Finance costs
Profit before tax
Income tax expense
Profit for the period
Arrow
Balance sheet as at 30 September 20X6
$'000
ASSETS
Non-current assets
Property, plant and equipment
Current assets
Inventories
Trade receivables
Cash and cash equivalents
Total assets
Non-current liabilities
Long term borrowings
Current liabilities
Trade payables
Other payables
Current tax payable
Short term provisions
21.6
21: PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES
21.7
21: PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES
2.3 Statement of changes in equity for the year ended 31 March 20X7
Share Share Reval- Retained Total
capital premium uation earnings equity
account reserve
$'000 $'000 $'000 $'000 $'000
2.4 As an alternative the statement of changes in equity may be presented as a note to the
financial statements. In this case it is replaced by the statement of recognised gains and
losses as a primary statement.
Statement of recognised gains and losses for the year ended 31 March 20X7
$'000
Gain on revaluation of properties X
Tax on items taken directly to equity (X)
Net income recognised directly in equity X
Profit for the period X
Total recognised income and expense for the period X
21.8
21: PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES
From the trial balance in Lecture example 1, Arrow had the following equity balances at 1 October
20X5:
$'000
Share capital – 50c ordinary shares 1,500
Share premium account 200
Revaluation reserve 800
Retained earnings 1,250
3,750
Required
Using the information from Lecture example 1, produce a statement of changes in equity for Arrow
for the year ended 30 September 20X6.
Solution
Share Share Reval- Retained Total
capital premium uation earnings equity
account reserve
$'000 $'000 $'000 $'000 $'000
21.9
21: PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES
At 31 March 20X7
Cost or valuation X X X X
Accumulated depreciation (X) (X) (X) (X)
Net book value X X X X
At 31 March 20X6
Cost or valuation X X X X
Accumulated depreciation (X) (X) (X) (X)
Net book value X X X X
At 31 March 20X7
Cost X
Accumulated amortisation (X)
Net book value X
At 31 March 20X6
Cost X
Accumulated amortisation (X)
Net book value X
21.10
21: PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES
4 Summary of Chapter 21
4.1 The financial statements produced by a company need to follow the format prescribed by
IAS 1.
4.2 The statement of changes in equity shows the movements on each of the accounts in the
equity section of the balance sheet in a separate statement.
21.11
21: PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES
21.12
Chapter 21: Questions
21.13
21: QUESTIONS
21.1 Which of the following items impact on the Statement of Changes in Equity?
(i) Issue of ordinary shares
(ii) Revaluation of a building
(iii) Profit for the period
(iv) Revaluation of a non-current asset investment
A (i)
B (i), (iii)
C (ii), (iii)
D All of the above (2 marks)
21.2 Spend Co
The following balances remain in the books of Spend Co at 30 June 20X8 after the preparation of the
trading account.
$
Share capital
80,000 $1 ordinary shares 80,000
40,000 8% $1 preference shares 40,000
Share premium account 10,000
Revaluation reserve 30,000
Inventories at 30 June 20X8 83,852
Trade receivables and prepayments 27,200
Trade payables and accruals 13,722
Bank balance 7,796
10% debentures 16,000
General reserve 28,000
Irrecoverable debts 340
Gross profit for the period 81,508
Wages and salaries 28,200
Insurance 1,410
Postage and telephone 620
Light and heat 1,216
Debenture interest (½ year to 31 December 20X7) 800
Directors fees 2,500
General expenses 3,108
Vehicles (cost $19,400) 6,800
Office furniture and equipment (cost $44,640) 27,440
Land and buildings at valuation 132,200
Retained earnings at 1 July 20X7 24,252
The following information is also available:
(1) The land and buildings are to be revalued at $150,000;
(2) Office furniture and equipment is to be depreciated at 15% on cost, and vehicles at 20% on cost;
(3) A bill for $348 in respect of electricity consumed up to 30 June 20X8 has not been entered in the
ledger;
(4) The amount for insurance includes a premium of $300 paid in December 20X7 to cover the
company against fire loss for the year 1 January 20X8 to 31 December 20X8;
21.14
21: QUESTIONS
21.15
21: QUESTIONS
21.16
Chapter 21: Answers
21.17
21: ANSWERS
21.1 D
21.2 Spend Co
Spend Co
Income statement for the period ended 30 June 20X8
$ $
Gross profit for the period 81,508
Less expenses:
Irrecoverable debts 340
Wages and salaries 28,200
Insurance (1,410 – (300 x 6/12)) 1,260
Postage and telephone 620
Light and heat (1,216 + 384) 1,564
Debenture interest (800 + 800) 1,600
Directors’ fees (2,500 + 5,000) 7,500
Audit fee 1,200
General expenses 3,108
Depreciation: Office furniture and equipment 6,696
Vehicles 3,880
55,968
Profit for the period 25,540
Spend Co
Balance sheet as at 30 June 20X8
Cost or Acc. NBV
Valuation Dep'n
$ $ $
NON-CURRENT ASSETS
Land and buildings 150,000 – 150,000
Furniture and equipment 44,640 23,896 20,744
Motor vehicles 19,400 16,480 2,920
214,040 40,376 173,664
CURRENT ASSETS
Inventories 83,852
Trade receivables and prepayments (27,200 + (300 × 6/12)) 27,350
Cash and cash equivalents 7,796
118,998
292,662
EQUITY
Share capital
80,000 $1 ordinary shares 80,000
40,000 8% $1 preference shares 40,000
Share premium account 10,000
Revaluation reserve (30,000 + 17,800) 47,800
General reserve (28,000 + 12,000) 40,000
Retained earnings (Working) 34,592
252,392
NON-CURRENT LIABILITIES
10% debentures 16,000
CURRENT LIABILITIES
Trade payables and accruals (13,722 + 5,000 + 1,200 + 800 + 348) 21,070
Dividends payable 3,200
24,270
292,662
21.18
21: ANSWERS
Working
Retained earnings $
Retained earnings at 1 July 20X7 24,252
Profit for the period 25,540
Dividends declared
8% preference dividend (3,200)
Transfer to general reserve (12,000)
Retained earnings at 30 June 20X8 34,592
21.19
21: ANSWERS
END OF CHAPTER
21.20
Events after the
balance sheet date
Exam Context
Questions on this topic are likely to require you to identify adjusting and non-adjusting events from a list of options and
the appropriate accounting treatment of each event. Both these types of questions were tested in the Pilot Paper.
Qualification Context
The knowledge in this chapter is tested again at the Professional level paper, Corporate Reporting (P2) where you will
be expected to consider how events after the balance sheet date may impact the way in which transactions are reported.
22.1
22: EVENTS AFTER THE BALANCE SHEET DATE
Overview
Definition
22.2
22: EVENTS AFTER THE BALANCE SHEET DATE
1 Definition
1.1 Events after the balance sheet date: events, both favourable and unfavourable, that occur
between the balance sheet date and the date when the financial statements are authorised
for issue.
1.2 There are two types of event after the balance sheet date.
• Examples: • Examples:
(1) resolution of a court case (1) destruction of major asset, eg by
(2) bankruptcy of a major customer flood or fire
(3) evidence of NRV of inventories (2) major share transactions
(4) discovery of fraud or errors that show (3) announcement of a plan to close part
the financial statements were incorrect of a business
2.2 (a) Dividends proposed or declared after the balance sheet date but before the financial
statements are approved should be disclosed in a note to the financial statements.
(b) A non-adjusting event that affects going concern becomes an adjusting event.
22.3
22: EVENTS AFTER THE BALANCE SHEET DATE
Which of the following events after the balance sheet date would normally qualify as a non-
adjusting event?
1 A fall in the market price of shares held by the entity as investments.
2 Insolvency of a trade receivable with a balance of $200,000 outstanding at the balance
sheet date.
3 Declaration of the year-end dividend by the directors.
4 Confirmation of the amount of damages awarded to an employee who sued for unfair
dismissal after being sacked two months before the year end.
A 2 only
B 1 and 3
C 1, 3 and 4
D 2 and 4
Solution
3 Summary of Chapter 22
Quick Quiz
3.1 Events after the balance sheet date are events which occur between the balance sheet date
and the date the financial statements are approved for issue.
3.3 Adjusting events provide evidence of conditions that existed at the balance sheet date.
The financial statements should be changed to include this information.
3.4 Non-adjusting events relate to conditions which arose after the balance sheet date.
These should be disclosed as a note to the financial statements.
22.4
Chapter 22: Questions
22.5
22: QUESTIONS
22.1 The following are examples of events which might occur between the balance sheet date and the date on
which the financial statements are authorised for issue:
(1) Losses on inventories as a result of a catastrophe such as a fire or flood after the year end
(2) The discovery of fraud which shows that the financial statements were incorrect
(3) Revaluations of property which provide evidence of an impairment in value
Which of the examples given should normally be classified as an adjusting event?
A (1), (2) and (3)
B (1) and (2)
C (1) and (3)
D (2) and (3) (2 marks)
22.2 Robin Co has a year end of 31 December 20X8, the directors were informed on 27 February 20X9 that a
serious fire at one of the company's factories would stop production there for at least six months to come.
On 3 March 20X9 the directors of Robin Co were informed that a major customer had gone into
liquidation. The liquidator was pessimistic about the prospect of recovering anything for unsecured
creditors. The financial statements for the year ended 31 December 20X8 were approved on 20 March
20X9.
In accordance with IAS 10, Events after the balance sheet date, how should the two events be treated in
the financial statements?
Fire Liquidation
A Accounts adjusted Disclosed in notes
B Disclosed in notes Disclosed in notes
C Accounts adjusted Accounts adjusted
D Disclosed in notes Accounts adjusted (2 marks)
22.3 A Co has a year end of 31 December 20X7. During the preparation of the financial statements in March
20X8 the following issues arose:
(1) Sales of a particular inventory line were poor during the second half of 20X7. The directors had
hoped that sales would pick up in 20X8 but it is now apparent that the inventory will need to be
marked down below their original cost in order to sell them.
(2) On 12 February 20X8 one of the company's production plants was struck by lightening. The
company will suffer a net loss of $55,000 as a result of this.
(3) Sporran Co is a valued customer which owed A Co $34,000 at the balance sheet date, although
they were behind with their payments. Since the year end sales to Sporran Co were $12,000. The
directors have just received notification that Sporran Co has gone into liquidation.
How should the above events be classified according to IAS 10 Events after the balance sheet date?
Adjusting Non-adjusting
event event
A 2,3 1
B 1, 2 3
C 1,3 2
D 1, 2, 3 (2 marks)
22.6
Chapter 22: Answers
22.7
22: ANSWERS
22.1 D (1) After the balance sheet date and therefore non-adjusting.
(2) The financial statements are incorrect, therefore clearly we must adjust.
(3) The impairment is assumed to have taken place by the balance sheet date. We simply did
not find out until later.
22.2 D The fire is a non-adjusting event as it does not affect the value of the building at 31 December
20X8. It is therefore only disclosed in a note to the financial statements unless it threatens the
company's going concern in which case it would become an adjusting event.
The customer is assumed to be insolvent at 31 December 20X8. We simply did not know this and
therefore it is an adjusting event and it should be adjusted for.
22.3 C
END OF CHAPTER
22.8
Cash flow statements
Exam Context
Questions on this chapter are likely to focus on whether you can identify which items should and should not go into the
cash flow statement and also on performing basic calculations. For example, you may be asked to calculate figures such
as the cash generated from operations from given information or the cash paid to acquire property, plant and equipment.
Qualification Context
The knowledge covered in this chapter is developed in the Fundamentals level paper Financial Reporting (F7) where
you will have to produce a cash flow statement in full. This is likely to involve more complex areas such as cash flows
related to non-current assets held on finance leases. You will also need to be able to interpret a cash flow. Group cash
flows are examined in the Professional level paper Corporate Reporting (P2).
Business Context
The ability to generate cash is key to the survival of an entity. Whilst directors may use cash budgets to estimate future
cash flows, the cash flow statement shows an historic record of how cash has been generated and where it was spent.
Cash is not subject to manipulation through an entity's choice of accounting policies. It is therefore a reliable measure of
performance that is relevant to users of the financial statements.
23.1
23: CASH FLOW STATEMENTS
Overview
Cash flows
Cash flow
statements
IAS 7
23.2
23: CASH FLOW STATEMENTS
1 Purpose
1.1 To show the effect of a company’s commercial transactions on its cash balance.
It is thought that users of accounts can readily understand cash flows, as opposed to
income statements and balance sheets which are subject to manipulation by the use of
different accounting policies.
Cash flows are used as an investment appraisal method such as net present value and
hence a cash flow statement gives potential investors a method with which to evaluate a
business.
Definitions
2.2 (a) Cash (b) Cash equivalents
eg current asset
investments (shares)
(c)
Cash flows
23.3
23: CASH FLOW STATEMENTS
2.3 XYZ CO
Cash flow statement for the year ended 31 December 20X7 (indirect method)
$000 $000
Cash flows from operating activities
Profit before taxation 3,390
Adjustment for:
Depreciation 450
Investment income (500)
Interest expense 400
3,740
Increase in trade and other receivables (500)
Decrease in inventories 1,050
Decrease in trade payables (1,740)
Cash generated from operations 2,550
Interest paid (270)
Income taxes paid (900)
23.4
23: CASH FLOW STATEMENTS
In the balance sheets of Tacks Co as at 31 December 20X9 and 31 December 20X8 were the
following amounts for income tax payable.
31 December
20X9 20X8
$ $
Income tax payable 156,000 168,000
The income statement tax charge for 20X9 amounted to $104,000.
Required
What is the amount of income taxes paid during the year? $
Workings
Income tax payable
$'000 $'000
23.5
23: CASH FLOW STATEMENTS
On 31 December 20X8 the value of plant and equipment in the books of Erosion Co was as
follows:
$
Plant and equipment at cost 200,000
Accumulated depreciation 80,000
Plant and equipment at net book value 120,000
On 1 January 20X9 an item of plant was sold for $8,000 which had originally cost $20,000 when
new, but had a net book value of $11,000 at the time of sale. (The balance sheet values shown
above do not show that this sale has taken place.)
On 31 December 20X9 the value of plant and equipment in the balance sheet was:
$
Plant and equipment at cost 280,000
Accumulated depreciation 111,000
Plant and equipment at net book value 169,000
Required
Show the relevant entries for property, plant and equipment which would appear in a cash flow
statement for Erosion Co in 20X9.
Solution
Workings
Plant & equipment – cost
$'000 $'000
Accumulated depreciation
$'000 $'000
23.6
23: CASH FLOW STATEMENTS
Dividends paid
5.2 The cash outflows included in dividends paid are dividends paid on the reporting company's
equity shares.
Distribution Co balance sheet extract for the year ended 31 December 20X9
20X9 20X8
$'000 $'000
Dividends payable 45 35
Dividends charged to retained earnings were $60,000.
Required
What are the dividends paid during the year ended 31 December 20X9? $
Workings
Dividends payable
$'000 $'000
23.7
23: CASH FLOW STATEMENTS
The summarised accounts of the Emma Co for the year ended 31 December 20X8 are as follows:
Balance sheets as at 31 December
20X8 20X7
$'000 $'000
Non-current assets
Property, plant and equipment 628 514
Current assets:
Inventories 214 210
Trade receivables 168 147
Cash 7 –
389 357
1,017 871
Equity
Share capital ($1 ordinary shares) 250 200
Share premium account 70 60
Revaluation reserve 110 100
Retained earnings 314 282
744 642
Non-current liabilities
10% debentures 80 50
Current liabilities
Trade payables 136 121
Income tax payable 39 28
Dividends payable 18 16
Overdraft – 14
193 179
1,017 871
23.8
23: CASH FLOW STATEMENTS
You are additionally informed that there have been no disposals of property, plant and equipment
during the year. The new debentures were issued on 1 January 20X8.
Required
Produce a cash flow statement for Emma Co for the year ended 31 December 20X8.
Solution
EMMA CO
Cash flow statement for the year ended 31 December 20X8
$’000 $’000
Cash flows from operating activities
Profit before taxation
Adjustments for:
Depreciation
Interest expense
23.9
23: CASH FLOW STATEMENTS
Workings
23.10
23: CASH FLOW STATEMENTS
6.2 The only difference is the direct method derives the 'cash generated from operations' figure
in a different way. The operating element of the cash flow statement should be shown as
follows:
$000 $000
Cash flows from operating activities
Cash receipts from customers 30,150
Cash payments to suppliers and employees (27,600)
Cash generated from operations 2,550
Interest paid (270)
Income taxes paid (900)
23.11
23: CASH FLOW STATEMENTS
Required
Using the information in Lecture example 4 produce the 'cash flows from operating activities'
section of the cash flow statement using the direct method.
Solution
EMMA CO
Cash flow statement for year ended 31 December 20X8 (extract)
$ $
Cash flows from operating activities
Cash receipts from customers
Cash payments to suppliers and employees
Cash generated from operations
Interest paid
Income taxes paid
Net cash used in operating activities
23.12
23: CASH FLOW STATEMENTS
7 Summary of Chapter 23
7.1 The cash flow statement shows the movement between a company’s cash and cash
equivalents at the beginning and the end of the year.
Quick Quiz
7.2 Cash comprises cash on hand and on demand deposits. Cash equivalents are short term,
highly liquid investments such as shares held as a current asset investment.
7.3 The cash flow categorises cash flows under one of three headings: cash flows from
operating activities; cash flows from investing activities and cash flows from financing
activities.
23.13
23: CASH FLOW STATEMENTS
23.14
Chapter 23: Questions
23.15
23: QUESTIONS
23.1 In a cash flow statement which of the items below would not appear as an outflow of cash?
A The nominal value of debenture redeemed at par during the year
B The dividends paid to preference shareholders during the year
C The income statement charge for tax for the year (1 mark)
23.2 What is the total figure to be adjusted for in ‘cash flows from operating activities’ in respect of property,
plant and equipment? $ (2 marks)
23.3 What is the total expenditure on property, plant and equipment included under ‘cash flows from investing
activities’? $ (2 marks)
23.4 In a cash flow statement, a decrease in loan stock would be shown as a cash inflow under 'cash flows
from financing activities'.
A True
B False (1 mark)
23.5 These extracts have been taken from the accounts of Jeanne Co.
Balance sheet (extracts) 31 October 31 October
20X7 20X6
Current liabilities
Dividends payable 9,750 5,750
Dividends charged to retained earnings during the year were $15,500.
What will appear as “dividends paid” in the cash flow statement for the year ended 31 October 20X7?
A $5,750
B $11,500
C $15,500
D $21,250 (2 marks)
23.16
23: QUESTIONS
23.6 Jane Co
Income statement for the year ended 31 December 20X2
$’000
Revenue 2,553
Cost of sales 1,814
Gross profit 739
Distribution costs 125
Administrative expenses 264
Investment income 25
Finance costs 75
Profit before tax 300
Income tax expense 140
Profit for the period 160
Equity
Share capital ($1 ordinary shares) 200 150
Share premium account 160 150
Revaluation reserve 100 91
Retained earnings 160 100
620 491
Non-current liabilities
Long term loan 100 –
Current liabilities
Trade payables 127 119
Bank overdraft 85 98
Income tax payable 190 160
Dividends payable 100 80
502 457
Total equity and liabilities 1,222 948
23.17
23: QUESTIONS
23.18
Chapter 23: Answers
23.19
23: ANSWERS
23.1 C Income tax paid is a cash flow not the income statement tax charge.
23.2 $104,000
Property, plant and equipment
$’000 $’000
Bal b/d Freehold property 750
Plant & Equipment 380 Disposal – Plant & Equipment
Furniture & Fixtures 105 (49 – 35) 14
Depreciation
Freehold property 6
Plant & Equipment 37
Furniture & Fixtures 55
Revaluation Freehold property 95 98
∴ Acquisitions 567 Bal c/d Freehold property 1,230
Plant & Equipment 465
Furniture & Fixtures 90
1,897 1,897
23.3 $567,000
See previous calculation
23.4 B
$ $
Balance b/d 5,750
∴ Paid 11,500
Retained earnings 15,500
Balance c/d 9,750
21,250 21,250
23.20
23: ANSWERS
23.6 Jane Co
Cash flow statement for the year ended 31 December 20X7
$’000 $’000
Cash flows from operating activities
Profit before taxation 300
Adjustments for:
Depreciation (W2) 90
Loss on sale of property, plant and equipment (45 – 32) 13
Profit on sale of non-current asset investments (30 – 25) (5)
Investment income (25)
Finance costs 75
448
Increase in trade receivables (390 – 315) (75)
Increase in inventories (150 – 102) (48)
Increase in trade payables (127 – 119) 8
Cash generated from operations 333
Interest received 25
Interest paid (75)
Income taxes paid (W4) (110)
Net cash from operating activities 173
$’000 $’000
Balance b/d 595 Disposals 85
Revaluation (100 – 91) 9
Additions (bal fig) 201 Balance c/d 720
805 805
(W2)
Property, plant and equipment - Accumulated depreciation
$’000 $’000
Disposals (85 – 45) 40 Balance b/d 290
Balance c/d 340 ∴Depreciation charge 90
380 380
23.21
23: ANSWERS
(W3)
Development expenditure
$’000 $’000
Balance b/d 200
∴ additions 50 Balance c/d 250
250 250
(W4)
Income tax payable
$’000 $’000
∴ Income tax paid 110 Balance b/d 160
Balance c/d 190 Income statement 140
300 300
(W5)
Dividends payable
$’000 $’000
∴ Dividends paid 80 Balance b/d 80
Balance c/d 100 Retained earnings 100
180 180
END OF CHAPTER
23.22
Home study chapter –
Information technology
Exam Context
Questions on this topic are likely to focus on the advantages and disadvantages of using a computerised system and the
differences between a manual and a computerised system.
Qualification Context
The importance of accounting systems and internal controls is tested in the Fundamentals level paper, Accountant in
Business (F1).
24.1
24: HOME STUDY CHAPTER – INFORMATION TECHNOLOGY
Overview
Integrated software
Computerised accounting
Accounting modules
packages
Information
technology
Databases Spreadsheets
24.2
24: HOME STUDY CHAPTER – INFORMATION TECHNOLOGY
1 Introduction
1.1 In today's world most businesses use accounting systems which are computerised, although
some smaller businesses may keep manual records.
1.2 The same principles of double entry are used regardless of whether an accounting system is
manual or computerised.
2 Accounting packages
2.1 There are two main types of computerised accounting packages:
(a) Dedicated accounting packages, for example SAGE.
(b) General software, for example spreadsheets which can be used to keep accounting
records.
Advantages Disadvantages
(1) Large amounts of data can be (1) Time and cost in setting up the system
processed very quickly and staff training
(2) Computerised systems are more (2) Need for internal controls and security
accurate checks to ensure the accuracy of data
(3) Large volumes of data can be (3) Lack of 'audit trail'
processed
(4) Little training is required (4) Staff may resist the introduction of a
computerised system
(5) Computer can analyse data into
tailored reports
3 Accounting modules
Definition
3.1 Accounting module – a program which deals with one part of a business' accounting
system
24.3
24: HOME STUDY CHAPTER – INFORMATION TECHNOLOGY
Integrated software
3.3 Each module may be integrated with other modules so that when information is recorded in
one module it is automatically updated in another module.
Section 1.5 Examples:
(a) The payroll module may be integrated with the nominal ledger module so that once
the payroll information is determined the associated wages expense is updated in the
nominal ledger.
(b) The invoicing module may be integrated with the inventory, receivables ledger and
nominal ledger modules so that once an invoice is sent the inventory levels are
updated as is the customer's account in the receivables ledger.
Advantages Disadvantages
(1) An entry in one module (1) These systems require more memory than
automatically updates all the a stand-alone system so there is less space
others to store actual data
(2) Reports generated by the (2) Each module may be limited to fewer
system can draw information functions than a specialised module
from all relevant modules (because one program is doing everything)
(3) Reduction in clerical time used (3) An error in one part of the system will flow
to input information and errors through to all areas
4 Databases
Definition
4.1 A database is a 'pool of data' which can be used by any number of applications.
4.2 Examples:
(a) Non-current asset register
(b) List of customers/suppliers
(c) Price lists
24.4
24: HOME STUDY CHAPTER – INFORMATION TECHNOLOGY
What sort of information might be contained in a database file for a non-current asset register?
Solution
5 Spreadsheets
5.1 Spreadsheets are essentially an electronic piece of paper. They are used in all parts of a
business, predominantly to perform numerical calculations.
24.5
24: HOME STUDY CHAPTER – INFORMATION TECHNOLOGY
6 Summary of Chapter 24
6.1 There are two main types of accounting packages: dedicated packages and general
Quick Quiz software.
6.2 An accounting module is a program which deals with one part of a business’ accounting
system. These modules may or may not be integrated with other modules.
6.3 Databases and spreadsheets are electronic ways of holding and manipulating information.
24.6
Chapter 24: Questions
24.7
24: QUESTIONS
24.1 All businesses will apply the same principles of double entry bookkeeping regardless of whether they
operate a manual or a computerised system.
Is this statement true or false?
A True
B False (1 mark)
24.2 If a database is to contain accurate and valid information it should only be amended by authorised
personnel.
Is this statement true or false?
A True
B False (1 mark)
24.8
Chapter 24: Answers
24.9
24: ANSWERS
24.1 A
24.2 A
END OF CHAPTER
24.10
Answers to
Lecture Examples
25.1
25: ANSWERS TO LECTURE EXAMPLES
Chapter 1
Answer to Lecture Example 1
Users of financial information
(a) Investors
– Profitability
– Future prospects
– Likely risk and return
– Chance of capital growth
– Ability to pay dividends
(b) Employees
– Profitability
– Long-term growth
– Security of their job
– Likelihood of bonus
– Number of employees
– Ability to pay retirement benefits
(c) Lenders
– Whether return on finance will continue to be met
– Other providers and security of their debt
– Likelihood of repayment of capital amount
(d) Suppliers
– Likelihood of payment on time
– Likelihood of payment at all
– Whether they should continue to supply
(e) Customers
– Ability of entity to continue supplying
– Profitability as a measure of value for money of goods bought
(f) Government and their agencies
– Statistics
– Size of company
– Growth rates
– Average payment periods
– Foreign trade
– Profits made
– Corporate income tax liability
– Sales tax liability
(g) Public
– Contribution to local economy
– Information about trends in the prosperity of the entity
– Range of activities provided
25.2
25: ANSWERS TO LECTURE EXAMPLES
Chapter 2
Answer to Lecture Example 1
A The IASCF appoints members to the IASB, IFRIC and SAC. The SAC advises the IASB on its
agenda.
Chapter 3
Answer to Lecture Example 1
Advantages of historic cost
(1) The transaction cost of $1 million is a very reliable figure which was quantified at the date of
acquisition.
(2) Using current market values for the building may lead to volatility in asset values due to changing
market prices.
(3) Any change in the asset's value will affect the amount of depreciation charged and therefore the
entity's profits. This makes comparability more difficult.
Disadvantages of historic cost
(1) Asset values generally appreciate over time and so using historic cost will mean that the financial
statements contain information which is out of date and therefore less useful for decision making.
(2) Sales revenue and costs will be shown at current prices but depreciation will be based on historic
cost and therefore too low a figure. Profits will therefore look artificially high.
25.3
25: ANSWERS TO LECTURE EXAMPLES
Chapter 4
Answer to Lecture Example 1
Own
Examples:
(i) House
(ii) Car
(iii) Cash
Owe
Examples:
(i) Mortgage
(ii) Car loan
(iii) Credit card
Chapter 5
Answer to Lecture Example 1
Transaction Debit Credit
25.4
25: ANSWERS TO LECTURE EXAMPLES
25.5
25: ANSWERS TO LECTURE EXAMPLES
25.6
25: ANSWERS TO LECTURE EXAMPLES
Sales
$ $
Bal c/d 3,850 Trade receivables 1,750
Cash 2,100
3,850 3,850
Bal b/d 3,850
Chapter 6
Answer to Lecture Example 1
Trial Balance
Debit Credit
$ $
Cash 5,100
Capital 5,000
Trade payables 2,000
Purchases 2,000
Rent 500
Electricity 200
Car 1,000
Drawings 300
Trade receivables 1,750
Sales 3,850
10,850 10,850
Purchases
$ $
Creditors 2,000 Bal c/d 2,000
25.7
25: ANSWERS TO LECTURE EXAMPLES
25.8
25: ANSWERS TO LECTURE EXAMPLES
DOUGLAS
BALANCE SHEET AS AT 31 JANUARY
NON-CURRENT ASSET $ $
Motor vehicle 1,000
CURRENT ASSETS
Inventories 250
Trade receivables 1,750
Cash 5,100
7,100
8,100
PROPRIETOR’S INTEREST $ $
Capital introduced on 1 January 5,000
Profit for the year 1,400
Less: drawings 300
Balance 31 January 6,100
CURRENT LIABILITIES
Trade payables 2,000
8,100
25.9
25: ANSWERS TO LECTURE EXAMPLES
Chapter 7
Answer to Exercise
Net Sales tax Gross
$ $ $
(1) Factory buys raw material 100 15.00 115.00
Sales
$ $
Trade rec. 1,500
Chapter 8
Answer to Lecture Example 1
C Transport costs to deliver goods to customers are an example of carriage outwards and should
not be included. Administrative overheads do not relate to production and cannot therefore be
included.
The depreciation of the factory machine is a production overhead and should be included.
25.10
25: ANSWERS TO LECTURE EXAMPLES
@ $11.50 @ $13.00
= $1,035 = $3,250
$4,285
25.11
25: ANSWERS TO LECTURE EXAMPLES
Chapter 9
Answer to Lecture Example 1
Examples include:
(a) Land and buildings
(b) Plant and equipment
(c) Motor vehicles
(d) Furniture and fittings, computers
25.12
25: ANSWERS TO LECTURE EXAMPLES
25.13
25: ANSWERS TO LECTURE EXAMPLES
Disposal account
$ $
(a) Machine 6,000 (c) Cash 3,000
25.14
25: ANSWERS TO LECTURE EXAMPLES
Disposal account
$ $
(a) Machine 6,000 (c) New machine (part exchange) 3,000
Profit on disposal (I/S) 840 (b) Accumulated depreciation 3,840
6,840 6,840
Building (B/S)
$ $
Bal b/d 100,000
Revaluation reserve 50,000 Bal c/d 150,000
150,000 150,000
Bal b/d 150,000
$150,000
(b) Depreciation charge is = $3,750
40 years
25.15
25: ANSWERS TO LECTURE EXAMPLES
Chapter 10
Answer to Lecture Example 1
(1) Market research would take place at an early stage in any development process. Its purpose is to
gather information about whether there may be interest in a potential product. At this point in time
an entity cannot be certain that the expenditure will lead to profits and so the costs are research
costs. $20,000 should be shown as an expense in the income statement.
(2) A machine is a tangible non-current asset and is accounted for under IAS 16 regardless of its use.
The $100,000 should be capitalised as a tangible non-current asset and depreciated over its
useful life of 10 years.
(3) Material costs and design and manufacture salaries are part of the development process. They
should be capitalised as an intangible non-current asset provided that all of the 'PIRATE' criteria
are met.
The costs should be amortised in 20X9 once the car is available to be sold on the market.
25.16
25: ANSWERS TO LECTURE EXAMPLES
Chapter 11
Answer to Lecture Example 1
(a)
$
Electricity expense
Cash paid: 10.3.X7 96
12.6.X7 120
14.9.X7 104
10.12.X7 145
465
December expense missing ( 1 × $168) 56
3
521
$
Rent expense
Cash paid: 1.2.X7 375
6.4.X7 1,584
1,959
Less: expense relating to Jan – March × ( 3 × $1,584) (396)
12
1,563
(b) & (c)
Electricity accrual is $56
$ $
Dr Electricity expense (I/S) 56
Cr Accruals (B/S) 56
Being: electricity expense accrued at 31 December 20X7.
Rent prepayment is $396
$ $
Dr Prepayments (B/S) 396
Cr Rent expense (I/S) 396
Being: rent expense prepaid at 31 December 20X7.
25.17
25: ANSWERS TO LECTURE EXAMPLES
1,959 1,959
Accruals (B/S)
$ $
31.12.X7 Bal c/d 56 31.12.X7 Electricity 56
56 56
1.1.X8 Bal b/d 56
Prepayments (B/S)
$ $
31.12.X7 Rent 396
31.12.X7 Bal c/d 396
396 396
1.1.X8 Bal b/d 396
Accruals (B/S)
$ $
1.1.X8 Accrual reversed 56 1.1.X8 Bal b/d 56
31.12.X8 Bal c/d 63 31.12.X8 Electricity accrual (W) 63
119 119
1.1.X9 Bal b/d 63
25.18
25: ANSWERS TO LECTURE EXAMPLES
Chapter 12
Answer to Lecture Example 1
(a) The balance c/d on the trade receivables account at the end of the year is $50,000.
(b) The bad debt expense shown in the I/S is $15,000
Workings
Trade receivables (B/S)
$ $
31.12.X7 Bal b/d 65,000 31.12.X7 Bad debt expense
(Ali $7,000) 15,000
(Tyson $8,000)
31.12.X7 Bal c/d 50,000
65,000 65,000
25.19
25: ANSWERS TO LECTURE EXAMPLES
Working
(W) General allowance:
$
Trade receivables (net of bad debts written off) 47,100
Less: specific allowance (400)
46,700 × 2%
= $934
25.20
25: ANSWERS TO LECTURE EXAMPLES
Cash (B/S)
$
25.21
25: ANSWERS TO LECTURE EXAMPLES
Short method
Allowance for receivables (B/S)
$ $
31.3.X7 Bal b/d
($20,000 × 5%) 1,000
31.3.X8 Bal c/d
($30,000 × 5%) 1,500 Doubtful debts expense 500
(increase in allowance)
1,500 1,500
Chapter 13
Answer to Lecture Example 1
(a) A provision should be made using expected values:
($1m × 20%) + ($6m × 5%) = $0.5m
Dr Warranty cost expense (I/S) $0.5m
Cr Provisions (B/S) $0.5m
(b) In 20X8 the provision needs to increase by $0.25m ($0.75m – $0.5m). Entry is:
Dr Warranty cost expense (I/S) $0.25m
Cr Provisions (B/S) $0.25m
25.22
25: ANSWERS TO LECTURE EXAMPLES
(c) In 20X9 the provision needs to decrease by $0.45m ($0.75m – $0.3m). Entry is
Dr Provisions (B/S) $0.45m
Cr Warranty cost expense (I/S) $0.45m
Chapter 14
Answer to Lecture Example 1
(1) Books of prime entry
Sales day book
Date Customer Amount
10 Jan X6 Customer A 150
10 Jan X6 Customer B 200
350
Purchase day book
Date Supplier Amount
15 Jan X6 Supplier Y 100
15 Jan X6 Supplier Z 1,300
1,400
200 200
Cash payments book
Date Narrative Total Purchases Payables
21 Jan X6 Supplier Y 100 100
100 100
Memorandum ledgers
Receivables ledger
Customer A
$ $
10.1.X6 Sales 150
Bal c/d 150
150 150
Bal b/d 150
Customer B
$ $
10.1.X6 Sales 200 21.1.X6 Payment received 200
200 200
25.23
25: ANSWERS TO LECTURE EXAMPLES
Payables ledger
Supplier Y
$ $
21.1.X6 Payment made 100 15.1.X6 Purchases 100
100 100
Supplier Z
$ $
Bal c/d 1,300 15.1.X6 Purchases 1,300
1,300 1,300
(2)&(3) Nominal ledger
RLCA (B/S)
$ $
10.1.X6 Sales 350 21.1.X6 Bank 200
Bal c/d 150
350 350
Bal b/d 150
PLCA (B/S)
$ $
21.1.X6 Bank 100 15.1.X6 Purchases 1,400
Bal c/d 1,300
1,400 1,400
Bal b/d 1,300
Bank (B/S)
$ $
21.1.X6 RLCA 200 21.1.X6 PLCA 100
Bal c/d 100
200 200
Bal b/d 100
Sales (I/S) Purchases (I/S)
$ $ $ $
10.1.X6 350 15.1.X6 1,400
RLCA PLCA
I/S 350 I/S 1,400
350 350 1,400 1,400
(4) Reconciliation
Balance per list of balances
$
Receivables ledger
Customer A 150
Customer B –
150
25.24
25: ANSWERS TO LECTURE EXAMPLES
(b)
Bank (B/S) RLCA (B/S)
$ $ $ $
4.1.X7 RLCA 9,000 1.1.X7 Sales 10,000 4.1.X7 Bank 9,000
Discounts 1,000
allowed
10,000 10,000
(c)
Bank RLCA (B/S)
$ $ $ $
4.1.X7 RLCA 10,000 1.1.X7 Sales 10,000 4.1.X7 Bank 10,000
10,000 10,000
(b)
5,000 5,000
25.25
25: ANSWERS TO LECTURE EXAMPLES
(c)
$
Balance per list of balances 563,900
(ii) Credit balance included as a debit (2 × $450) (900)
Customer balance omitted 2,150
1,250
565,150
25.26
25: ANSWERS TO LECTURE EXAMPLES
Chapter 15
Answer to Lecture Example 1
Adjustment of cash book balance
Cash account
$ $
Balance b/d 204 Standing order (3i) 35
Bank interest (3ii) 18 Bank charges (3iii) 14
Balance c/d 173
222 222
Bank reconciliation statement
$
Balance per bank statement at 31 March 20X8 2,618
Unrecorded lodgements 723
Outstanding cheques (3,168)
Balance per cash book at 31 March 20X8 173
Chapter 16
Answer to Lecture Example 1
(a) Journal entries
Dr Cr
$ $
(1) Rent and rates 350
Trade receivables 350
25.27
25: ANSWERS TO LECTURE EXAMPLES
Increases Decreases
$ $ $
Draft profit
Adjustments 12,300
Rent (1) 350
Discounts allowed (2) 500
Stationery (5) 1,460
Total adjustments (2,310)
Revised profit 9,990
Chapter 17
Answer to Lecture Example 1
(a) (1)
Dr Cr
$ $
Dr Inventories (B/S) 647
Cr Closing inventories (I/S) 647
Being: adjustment to record year end closing inventories.
(2)
$ $
Dr Drawings (12 × $10) 120
Cr Wages 120
Being: correction of cash drawings posted as wages.
25.28
25: ANSWERS TO LECTURE EXAMPLES
(3)
$ $
Dr Depreciation expense (I/S) 601
Cr Accumulated depreciation:
Motor vehicles ($1,740 × 25%) 435
Furniture and fittings ($829 × 20%) 166
Being: adjustment to record depreciation for the year
(4)
$ $
Dr Bad debt expense 37
Cr Trade receivables 37
Being: write off of irrecoverable customer balance.
(5)
$ $
Dr Bank (2 × $180) 360
Cr Suspense account 360
Being: adjustment to correct cash receipt from trade receivables.
(6)
$ $
Dr Drawings 63
Cr Purchases 63
Being: adjustment for goods drawn from business (removed at cost value)
(7)
$ $
Dr Rent expense (600 – 500) 100
Cr Accruals 100
Being: accrual of rent expense.
$ $
Dr Prepayments ($180 × 6/12) 90
Cr Electricity expense 90
Being: prepayment of electricity expense.
(8)
$ $
Dr Discounts allowed (I/S) 73
Cr Suspense account 73
Being: adjustment for discounts allowed omitted.
(b)
Suspense account
$ $
Bal b/d 433
(5) Bank 360
(8) Discounts allowed 73
433 433
25.29
25: ANSWERS TO LECTURE EXAMPLES
(c) Mugg
Income statement for the year ended 31 December 20X7
$ $
Sales 15,542
Less: cost of sales
Opening inventories 510
Purchases (9,876 – 63) 9,813
10,323
Less: closing inventories 647
9,676
Gross profit 5,866
Discounts received 129
5,995
Less expenses:
Rent (500 + 100) 600
Electricity (240 – ( 612 × 180)) 150
Insurance 120
Wages (1,634 – 120) 1,514
Repairs 635
Depreciation 601
Travel and entertaining 192
Bad debts 37
Discounts allowed 73
3,922
Profit for the period 2,073
Mugg
Balance sheet as at 31 December 20X7
Accumulated NBV
Cost depreciation
$ $ $
Non-current assets
Motor vehicles 1,740 870 870
Furniture and fixtures 830 332 498
2,569 1,202 1,368
Current assets
Inventories 647
Trade receivables (672 – 37) 635
Prepayments 90
Cash and bank balances (5 + 762 + 360) 1,127
2,499
3,867
Capital $
Capital as at 1 January 20X7 2,377
Profit for the period 2,073
Less: drawings (1,200 + 63 + 120) (1,383)
3,067
Current liabilities
Trade payables 700
Accruals 100
800
3,867
25.30
25: ANSWERS TO LECTURE EXAMPLES
Chapter 18
Answer to Lecture Example 1
% $
Sales 100 476,000 x 60%
COS 60 285,600
GP 40 190,400
GP 30 51,000
Purchases: $
Cost of sales
Opening inventory 43,000
+ Purchases 174,500
25.31
25: ANSWERS TO LECTURE EXAMPLES
Trade receivables
$ $
Bal b/d 1,447 Cash (deduced from
Sales* (2) 39,685 cash a/c) 39,204
Bal c/d 1,928
41,132 41,132
Cash
$ $
Balance b/d 1,000 Wages 5,200
Stationery 500
Sales 23,750 Electricity 1,200
Bankings 12,800
∴ drawings 4,050
Bal c/d 1,000
24,750 24,750
25.32
25: ANSWERS TO LECTURE EXAMPLES
Chapter 19
Answer to Lecture Example 1
(a)
(i)
Capital accounts
Tick Cast Balance Tick Cast Balance
$ $ $ $ $ $
Bal c/d 50,000 30,000 20,000 Bank 50,000 30,000 20,000
(ii)
Appropriation account for the year ended 31 December 20X4
$ $ $
Salary – Balance 15,000 Profit b/d from the
income statement 50,000
Interest on capital (12%
Tick 6,000
Cast 3,600
Balance 2,400
12,000
Profit share
Tick (5/10) 11,500
Cast (3/10) 6,900
Balance (2/10) 4,600
23,000
50,000 50,000
(iii)
Current accounts
Tick Cast Balance Tick Cast Balance
$ $ $ $ $ $
Drawings 6,000 4,000 8,800 Salary 15,000
Bal c/d 11,500 6,500 13,200 Interest on
capital 6,000 3,600 2,400
Profit share 11,500 6,900 4,600
17,500 10,500 22,000 17,500 10,500 22,000
25.33
25: ANSWERS TO LECTURE EXAMPLES
(iv)
TICK, CAST AND BALANCE
Balance Sheet as at 31 December 20X4 (extract)
$ $
Capital accounts
Tick 50,000
Cast 30,000
Balance 20,000
100,000
Current accounts
Tick 11,500
Cast 6,500
Balance 13,200
31,200
131,200
(b) Alternative answer to parts (ii) and (iii) (including interest on drawings)
(ii)
Appropriation account for the year ended 31 December 20X4
$ $ $
Salary – Balance 15,000 Profit b/d 50,000
Interest on drawings
Interest on capital (12%) Tick (6,000 x 10% x 6/12) 300
Tick 6,000 Cast (4,000 x 10% x 3/12) 100
Cast 3,600
Balance 2,400
12,000
Profit share
Tick (5/10) 11,700
Cast (3/10) 7,020
Balance (2/10) 4,680
23,400
50,400 50,400
(iii)
Current accounts
Tick Cast Balance Tick Cast Balance
$ $ $ $ $ $
Drawings 6,000 4,000 8,800 Salary 15,000
Interest on Interest on
drawings 300 100 – capital 6,000 3,600 2,400
Balance c/d 11,400 6,520 13,280 Profit share 11,700 7,020 4,680
17,700 10,620 22,080 17,700 10,620 22,080
25.34
25: ANSWERS TO LECTURE EXAMPLES
$
Profit for year 400,000
Add bank expense relating to first half of year 40,000
440,000
1st Half
$ $
Profit ($440,000 x 6/12) 220,000
Expense relevant to first half of year (40,000)
180,000
Salary S (40,000 x 6/12) (20,000)
A (20,000 x 6/12) (10,000)
150,000
PSR M 60% (90,000)
S 20% (30,000)
A 20% (30,000)
(150,000)
–
2nd Half
$ $
Profit ($440,000 x 6/12) 220,000
Salary –
220,000
PSR M 50% (110,000)
S 30% (66,000)
A 20% (44,000)
(220,000)
–
25.35
25: ANSWERS TO LECTURE EXAMPLES
Capital account
K C H S K C H S
$ $ $ $ $ $ $ $
1 Sept 102,857 77,143 – – 1 Sept 80,000 60,000 40,000 –
Goodwill Goodwill
1 Dec 90,000 60,000 – 60,000 1 Dec 120,000 90,000 – –
Goodwill Goodwill
Chapter 20
Answer to Lecture Example 1
Rab Co
$ $
Dr Cash (200,000 × 80c) 160,000
Cr Share capital (200,000 × 50c) 100,000
Cr Share premium account (200,000 × 30c) 60,000
Balance sheet
$
Share capital – 50c ordinary shares (150,000 + 37,500) 187,500
Share premium account (60,000 – 37,500) 22,500
Retained earnings 200,000
410,000
25.36
25: ANSWERS TO LECTURE EXAMPLES
375,000
New share capital: × 50c 37,500
5
375,000
Share premium: × $1 75,000
5
$ $
Dr Cash 112,500
Cr Share capital 37,500
Cr Share premium account 75,000
Rab Co
Balance Sheet (extract)
$
Share capital – 50c ordinary shares 225,000
Share premium account 97,500
Retained earnings 230,000
525,500
25.37
25: ANSWERS TO LECTURE EXAMPLES
Chapter 21
Answer to Lecture Example 1
Arrow
Income statement for the year ended 30 September 20X6
$'000
Revenue 12,740
Cost of sales (W3) 7,040
Gross profit 5,700
Distribution costs 2,060
Administrative expenses (W1) 2,375
Finance costs (W6) 72
Profit before tax 1,193
Income tax expense 270
Profit for the period 923
Arrow
Balance sheet as at 30 September 20X6
$'000
ASSETS
Non-current assets
Property, plant and equipment 5,000
5,000
Current assets
Inventories 610
Trade receivables 1,000
Cash and cash equivalents (W2) 1,170
2,780
Total assets 7,780
25.38
25: ANSWERS TO LECTURE EXAMPLES
Current liabilities
Trade payables 550
Other payables (W6) 72
Current tax payable 270
Short term provisions 80
972
Total equity and liabilities 7,780
Workings
(W1) Administrative expenses
$'000
Bad debts written off 45
Office expenses 1,800
Administrative staff salaries 500
Increase in warranty provision (80 – 50) 30
2,375
(W2) Cash and cash equivalents
$'000
Per trial balance 835
Issue of shares (W5) 635
Dividend paid (300)
1,170
(W3) Cost of sales
$'000
Purchases 7,200
Opening inventories 450
Closing inventories (610)
7,040
(W4) Retained earnings
$'000
Per trial balance 1,250
Less: dividend paid (300)
Profit for period (per I/S) 923
1,873
25.39
25: ANSWERS TO LECTURE EXAMPLES
(W7) Revaluation
$'000
Revalued amount 5,000
PPE per trial balance (4,400)
Increase 600
Total recognised income and expense 1,500 200 1,400 2,713 5,273
for the period
Chapter 22
Answer to Lecture Example 1
B 1 and 3 are non-adjusting events as the condition did not exist at the balance sheet date.
25.40
25: ANSWERS TO LECTURE EXAMPLES
Chapter 23
Answer to Lecture Example 1
Income taxes paid
Income tax payable
$'000 $'000
Income tax paid 116 Bal b/d 168
Bal c/d 156 I/S 104
272 272
Accumulated depreciation
$'000 $'000
Disposal 9 Bal b/d 80
Bal c/d 111 ... Charge 40
120 120
Profit/loss on disposal:
$
Net book value of asset sold 11,000
Sales proceeds (8,000)
Loss on sale (3,000)
The entries in the cash flow statement for 20X9 would be:
$
(i) Cash flows from operating activities (extract)
Adjustments for
Depreciation 40,000
Loss on sale of plant 3,000
43,000
(ii) Cash flows from investing activities (extract)
Purchase of property, plant and equipment (100,000)
Proceeds from sale of plant 8,000
(92,000)
25.41
25: ANSWERS TO LECTURE EXAMPLES
25.42
25: ANSWERS TO LECTURE EXAMPLES
747 747
(W2) Trade payables
$'000 $'000
Bal b/d 121
∴ cash paid 452 Expenses (W3) 467
25.43
25: ANSWERS TO LECTURE EXAMPLES
Chapter 24
Answer to Lecture Example 1
Information that may be included in a database file for a non-current asset register:
(1) Code/item number to identify asset
(2) Details of category of asset (motor vehicles, machine etc)
(3) Serial number of the asset
(4) Details of physical location of the asset
(5) Person responsible for the asset
(6) Cost of the asset
(7) Date of purchase
(8) Depreciation policy for the asset
(9) Accumulated depreciation charged to date
(10) Net book value of the asset
(11) Insurance details
25.44
Pilot Paper
Questions only
26.1
26.2
26: PILOT PAPER (QUESTIONS ONLY)
26.3
26: PILOT PAPER (QUESTIONS ONLY)
26.4
26: PILOT PAPER (QUESTIONS ONLY)
26.5
26: PILOT PAPER (QUESTIONS ONLY)
26.6
26: PILOT PAPER (QUESTIONS ONLY)
26.7
26: PILOT PAPER (QUESTIONS ONLY)
26.8
26: PILOT PAPER (QUESTIONS ONLY)
26.9
26: PILOT PAPER (QUESTIONS ONLY)
26.10
26: PILOT PAPER (QUESTIONS ONLY)
26.11
26: PILOT PAPER (QUESTIONS ONLY)
26.12
26: PILOT PAPER (QUESTIONS ONLY)
26.13
26: PILOT PAPER (QUESTIONS ONLY)
26.14
26: PILOT PAPER (QUESTIONS ONLY)
26.15
26: PILOT PAPER (QUESTIONS ONLY)
26.16
26: PILOT PAPER (QUESTIONS ONLY)
26.17
26: PILOT PAPER (QUESTIONS ONLY)
26.18