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THE UNIVERSITY OF ZAMBIA
INSTITUTE OF DISTANCE EDUCTION
BACHELOR OF SCIENCE
In ACCOUNTING & FINANCE
MODULE II: PREPARATION OF BASIC FINANCIAL STATEMENTS
(SEM 1031)
1
© Copyright
All rights reserved. No part of this publication may be reproduced, stored in a retrieval
system, or transmitted in any form or by any means, electronic or mechanical, including
photocopying, recording or otherwise without the permission of the University of Zambia,
Institute of Distance Education.
Inquiries concerning reproduction or rights and requests for additional training materials
should be addressed to:
The Director,
Institute of Distance Education
The University of Zambia
P.O. Box 32379
Lusaka
Zambia
Tel: +211 290719
Fax: +211 253952
E-mail: [email protected]
Website: www.unza.zm
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ACKNOWLEDGEMENTS
The University of Zambia (UNZA), Institute of Distance Education (IDE) wishes to thank
Mr. Romeo Yohane for writing this module, SEM 1031: PREPARATION OF BASIC
FINANCIAL STATEMENTS
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Contents Contents ........................................................................................................................................................ 3
Introduction .................................................................................................................................................. 7
Knowledge ................................................................................................................................................... 7
Skills ............................................................................................................................................................. 7
Structure of the Module ............................................................................................................................. 7
Assessment ................................................................................................................................................... 7
...................................................................................................................................................................... 8
Prescribed Reading ................................................................................................................................... 8
Recommended Readings ......................................................................................................................... 8
Time Frame ................................................................................................................................................. 8
UNIT 1 ......................................................................................................................................................... 11
Introduction to Final Accounts: Financial Statements of a Sole Trader ..................................................... 11
1.1 Introduction ................................................................................................................................ 11
1.2 Objectives ................................................................................................................................... 11
1.3 Final Accounts............................................................................................................................. 11
1.4 Trading Account ............................................................................................................................... 12
1.5 Profit and Loss (P&L) account .................................................................................................... 14
1.6 Statement of Profit or Loss ........................................................................................................ 14
1.7 Statement of Financial Position (Balance Sheet) ...................................................................... 15
1.7.1 Layout of Statement of Financial Position ................................................................................ 16
1.7.2 Assets .......................................................................................................................................... 16
1.7.3 Liabilities ..................................................................................................................................... 16
UNIT 2 ......................................................................................................................................................... 20
Further considerations: Inventory and IAS 2 .............................................................................................. 20
2.1 Introduction ...................................................................................................................................... 20
2.2 Objectives ................................................................................................................................... 20
2.3 Returns inwards and returns outwards ........................................................................................... 20
2.3.1 Returns Inwards (Sales Returns) ................................................................................................... 20
2.3.2 Returns Outwards (Purchases Returns)..................................................................................... 21
2.4 Inventory .................................................................................................................................... 21
2.4.1 The accounting entries for Inventory ........................................................................................ 22
2.5 The valuation of inventory ......................................................................................................... 24
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2.5.1 The determination of cost .......................................................................................................... 26
2.6 The provisions of IAS 2: Inventories .......................................................................................... 28
2.7 Continuous inventory recording ................................................................................................ 29
UNIT 3 ......................................................................................................................................................... 32
Accruals and Prepayments .......................................................................................................................... 32
3.1 Introduction ................................................................................................................................ 32
3.2 Objectives ................................................................................................................................... 32
3.3 Prepayments ............................................................................................................................... 32
3.4 Accruals ....................................................................................................................................... 34
3.5.1 Subsequent Accounting Periods ................................................................................................ 35
3.5.2 Summary of Entries .................................................................................................................... 38
UNIT 4 ......................................................................................................................................................... 43
Provisions, Contingents and Depreciation .................................................................................................. 43
4.1 Introduction ................................................................................................................................ 43
4.2 Objectives ................................................................................................................................... 43
4.3 International Accounting Standard 37 (IAS 37) ......................................................................... 43
4.4.1 Depreciation ............................................................................................................................... 44
4.4.2 Methods of Calculating Depreciation ........................................................................................ 45
4.4.3 Reducing Balance Method ......................................................................................................... 46
4.4.4 Accounting for Depreciation ...................................................................................................... 47
4.4.5 Sale of non-current assets .......................................................................................................... 49
4.4.6 Provisions of IAS 16: Property, Plant and Equipment ............................................................... 53
UNIT 5 ......................................................................................................................................................... 56
IRRECOVERABLE DEBTS AND ALLOWANCES ............................................................................................... 56
5.1 Introduction ................................................................................................................................ 56
5.2 Objectives ................................................................................................................................... 56
5.3 Definitions .................................................................................................................................. 56
5.4 Treatment in the Financial Statements ..................................................................................... 56
5.5 The Accounting Entries............................................................................................................... 58
UNIT 6 ......................................................................................................................................................... 65
JOURNAL ENTRIES AND SALES TAX ............................................................................................................. 65
6.1 Introduction ................................................................................................................................ 65
6.2 Objectives ................................................................................................................................... 65
6.3.1 Journal Entries ............................................................................................................................ 65
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6.3.2 Layout ......................................................................................................................................... 66
6.4.1 Sales Tax ..................................................................................................................................... 67
6.4.2 The calculation of sales tax ....................................................................................................... 68
6.4.3 The accounting entries ............................................................................................................... 69
UNIT 7 ......................................................................................................................................................... 74
BANK RECONCILIATIONS ............................................................................................................................. 74
7.1 Introduction ................................................................................................................................ 74
7.2 Objectives ................................................................................................................................... 74
7.3 Why prepare a bank reconciliation statement ......................................................................... 74
7.4 Balance on bank statement ...................................................................................................... 74
7.5 Why bank balance may differ from the balance in the cash book ........................................... 75
7.5.1 Preparing a bank reconciliation statement ............................................................................... 75
7.5.2 Fully worked example ................................................................................................................ 76
7.6 Stale and Post-Dated cheques ................................................................................................... 77
7.7 Position when there is a Bank Overdraft .................................................................................. 79
UNIT 8 ......................................................................................................................................................... 81
CONTROL ACCOUNTS .................................................................................................................................. 81
8.1 Introduction ................................................................................................................................ 81
8.2 Objectives ................................................................................................................................... 81
8.3 Control Accounts ........................................................................................................................ 81
8.4 Benefits of maintaining control accounts.................................................................................. 82
8.5 Preparing a control account reconciliation ............................................................................... 83
8.6 The Payables Ledger Control Account ....................................................................................... 86
UNIT 9 ......................................................................................................................................................... 93
ADJUSTMENTS TO PROFITS AND SUSPENSE ACCOUNTS ............................................................................ 93
9.1 Introduction ................................................................................................................................ 93
9.2 Objectives ................................................................................................................................... 93
9.3. Adjustments to Profits ............................................................................................................... 93
9.4 Suspense Account....................................................................................................................... 94
UNIT 10 ..................................................................................................................................................... 101
Partnerships .............................................................................................................................................. 101
10.1 Introduction .............................................................................................................................. 101
10.2 Objectives ................................................................................................................................. 101
10.3 Nature of a Partnership ............................................................................................................ 101
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10.3.1 Definition of a Partnership ...................................................................................................... 102
10.3.2 Types of Partnerships .............................................................................................................. 102
10.3.3 Kinds of Partner ........................................................................................................................ 103
10.4 Partnership Agreement ............................................................................................................ 104
10.5 Distribution of Profits ............................................................................................................... 106
10.5.1 Financial Statements of Partnerships ..................................................................................... 107
10.6 Capital Accounts ....................................................................................................................... 109
10.7 Statement of Financial Position ............................................................................................... 112
10.8 Change in Partnership Form .................................................................................................... 113
10.8 Partnership Dissolution ............................................................................................................ 116
10.8.1 Accounting for Partnership Dissolution ................................................................................... 116
UNIT 11 ..................................................................................................................................................... 126
Incomplete Records .................................................................................................................................. 126
11.1 Introduction .............................................................................................................................. 126
11.2 Objectives ................................................................................................................................. 126
11.3 Causes of incomplete records .................................................................................................. 126
11.4 Using the Accounting Equation ................................................................................................ 127
11.4.1 Increase in Capital .................................................................................................................... 127
11.4.2 Calculating Profit when assets and liabilities are known ....................................................... 127
11.5 Drawing-up a complete set of Financial Statements .............................................................. 131
11.6 Stolen Inventory, lost or destroyed ......................................................................................... 136
Module Summary...................................................................................................................................... 143
REFERENCES .................................................................................................................................. 144
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Introduction
Welcome to SEM 1031 Module II Preparation of Basic Financial Statements
This module introduces you to preparation of basic financial statements for sole traders and
partnerships. The skills learnt in Module I Introduction to Financial Accounting will be applied
and tested in this module at a higher level.
Module Outcomes
The aim of this course is to equip students with knowledge and understanding of the underlying
principles and concepts relating to preparation of basic financial statements.
Knowledge
When you have worked through this module you should be able to:
(i) Define inventory
(ii) Identify the key accounting standards in preparation of financial statements
(iii) Define provisions in line with IAS 37
(iv) Explain incomplete records
Skills
(i) Prepare financial statements for sole traders
(ii) Pass necessary adjustments to financial statements
(iii) Prepare financial statements for partnerships and
(iv) Prepare financial statements from incomplete records
Structure of the Module As you can see from the table of content, the module is divided into eleven (11) units. Each unit
is in turn divided into several sub-units. Each unit has a core text and an exercise at the end. You
are required to read the text and thereafter attempt the exercise before proceeding to the next unit.
Assessment
You will be assessed as follows:
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Continuous Assessment: 40%
Assignment(s ) 20%
Tests 20%
Final examination 60%
100%
All your assignments pertaining to this module, should be submitted to IDE Registry for records
sake.
Prescribed Reading
Wood, F and Sangster, A. (2018) Business Accounting 1, 14th edition, FT Prentice Hall, 2018
Wood, F and Robinson, S. (2009) Bookkeeping and Accounts, 7th edition, FT Prentice Hall
Recommended Readings
Elliott, B J and Elliott, J,(2017) Financial Accounting and Reporting, 18th edition, FT Prentice
Hall
Dunn, J,(2010) Financial Reporting and Analysis, Wiley
Dodge R, (1997) Foundations of Business Accounting, 2nd edition, Cengage Learning
F3 Financial Accounting ACCA study manual
T1 Financial Accounting ZICA study manual
Time Frame
You should devote at least four hours per week in reading, discussing and reflecting upon
contents of this module.
Study skills As a distance education student, you will meet a lot of challenges in your studies, particularly that
you will not always have a lecturer and fellow students to consult. You need, therefore, to make
a strategy for yourself which will make you succeed. Firstly, draw a working time-table and stick
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to it. Secondly, you should know your strengths and weaknesses; capitalize on your strengths.
Thirdly, work judiciously on all the task and assignments. Be truthful since no one is monitoring
what you are doing. Submit all the work that you need to on time.
Studying at a distance There are many advantages to studying by distance education – a full set of learning materials is
provided, and you study close to home in your own community. You can also plan some of your
study time to fit in with other commitments like work or family. However, there are also challenges.
Learning at a distance from your learning institution requires discipline and motivation. Here are
some tips for studying at a distance.
1) Plan – Give priority to study sessions with your tutor and make sure you allow enough
travel time to your meeting place. Make a study schedule and try to stick to it. Set specific
days and times each week for study and keep them free of other activities. Make a note
of the dates that your assessment pieces are due and plan for extra study time around
those dates.
2) Manage your time – Set aside a reasonable amount of time each week for your study
programme – but don’t be too ambitious or you won’t be able to keep up the pace. Work
in productive blocks of time and include regular rests.
3) Be organised – Have your study materials organised in one place and keep your notes
clearly labelled and sorted. Work through the topics in your study guide systematically and
seek help for difficulties straight away. Never leave this until later.
4) Find a good place to study – Most people need order and quiet to study effectively, so
try to find a suitable place to do your work preferably somewhere where you can leave
your study materials ready until next time.
5) Ask for help if you need it – This is the most vital part of studying at a distance. No
matter what the difficulty is, seek help from your tutor or fellow students straight away.
6) Don’t give up – If you miss deadlines for assessment pieces, speak to your tutor –
together you can work out what to do.Talking to other students can also make a difference
to your study progress. Seeking help when you need it is a key way of making sure you
complete your studies – so don’t give up!
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Need help?
In case you have difficulties during the duration of the module, please get in touch with the
Director, Institute of Distance Education, or the resident lecturer in your province.
All enquiries in connection with the payment of fees should be directed to the
Director, Institute of Distance Education:
The Director,
Institute of Distance Education,
University of Zambia,
P. O. Box 32379,
10101 Lusaka
Coordinator, Learner Support Services (Land Cell): +260 978772248
IDE Fax: +260 211 290719
IDE E-mail: [email protected]
http://www.unza.zm
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UNIT 1
Introduction to Final Accounts: Financial Statements of a Sole Trader
1.1 Introduction
This unit introduces you to financial accounting.
In Module 1 we last looked at the trial balance which is the basis for preparing financial statements.
This unit introduces you to the preparation of basic financial statements of a sole trader.
1.2 Objectives
By the end of this unit you should be able to:
(i) Calculate cost of goods sold
(ii) Calculate gross profit
(iii)Prepare a simple Statement of Profit or Loss of a sole trader
(iv) Draw up a simple statement of financial position of a sole trader
1.3 Final Accounts
As you may be aware, every business, sooner or later, wants to know the result of its operations –
i.e. whether a profit has been made or a loss has been sustained, and whether it is still financially
solvent. For this reason, the following accounts must be prepared at the end of the year.
(i) Trading Account
The purpose of this account is to ascertain the gross profit of a trading business.
(ii) Statement of Profit or Loss
A business has many expenses not directly related to its manufacturing processes or its
trading activities, and these are shown in the statement of profit or loss. By subtracting
them from gross profit, a figure for net profit (or loss) is found.
(iii)Statement of Financial Position (Balance Sheet)
As you may recall from Unit 2 of Module I, this is a statement of the assets owned by the
business, and the liabilities outstanding. Strictly speaking, it is not an account, but it is
included in the term "final accounts".
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From these accounts, you will see that we arrive at the results of a firm's trading in two stages.
First, from the trading account we ascertain gross profit. Secondly, from the Statement of Profit
or Loss we determine net profit.
1.4 Trading Account
For the sake of simplicity, we will assume that the business purchases ready-made goods, and re-
sells them at a profit.
What is gross profit?
Once you grasp the significance of this term, the function of the trading account will be abundantly
clear. If you purchase goods worth K100 and sell them for K150, you make a gross profit of K50.
Gross profit may be defined as "the excess of the selling price of goods over their costs price, due
allowance being made for opening and closing stocks, and for the costs incidental in getting the
goods into their present condition and location". Frankwood (2009) defines Gross profit simply as
the excess of sales revenue over the cost of goods sold. Where the cost of goods sold is greater
than the sales revenue, the result is a gross loss.
By deducting cost of goods sold from the sales revenue, it can be seen that the accounting custom
is to calculate a trader’s profits only on goods that have been sold.
Sales – Cost of Goods Sold = Gross Profit
Cost of Goods Sold
This can be defined as the goods purchased less closing stock.
Purchases – Closing Stock = Cost of Goods Sold
Let use B. Sakala to illustrate the above.
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Dr Cr
K K
Sales 38,500
Purchases 29,000
Rent 2,400
Lighting expenses 1,500
General expenses 600
Fixtures and fittings 5,000
Debtors 6,800
Creditors 9,100
Bank 15,100
Cash 200
Drawings 7,000
Capital 20,000
Total 67,600 67,600
Trial Balance As at 31 December 2019Sakala
Closing stock at the end of the year was K3, 000.
Gross Profit for B. Sakala is calculated as follows:
Dr Cr
K K
Sales 38,500
Less: Cost of goods sold
Purchases 29,000
Less Closing Stock (3,000)
Cost of Goods Sold 26,000
Gross Profit 12,500
Trading Account is commonly presented in the vertical format as above, however this can be
presented in two column format.
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2019 K 2019 K
31-Dec Purchases 29,000 31-Dec Sales 38,500
31-Dec Gross Profit to P&L 12,500 31-Dec Closing stock 3,000
41,500 41,500
Trading Account
You should note that the trading account is part of the Statement of Profit or Loss. Statement of
Profit or Loss consists of the trading, profit and loss accounts.
1.5 Profit and Loss (P&L) account
You can now proceed to prepare the profit and loss account. This done as follows:
(i) Credit the P&L account with the gross profit in this case of K12,500
(ii) Transfer the expenses (costs) to the debit side of the P&L account. Remember that the
expenses are listed on the debit side of trial balance.
(iii) Calculate the profit or loss
Your profit and loss account will appear as follows:
2019 K 2019 K
31-Dec Rent 2,400 31-Dec
Gross Profit from
Trading Account 12,500
31-Dec Lighting expenses 1,500
31-Dec General expenses 600
31-Dec Net Profit 8,000
12,500 12,500
Profit and Loss
You can conclude from the above that the business made a net profit of K8, 000.
1.6 Statement of Profit or Loss
The trading and profit and loss account can be combined and presented in simple vertical format.
The result remains the same as you are simply comparing income against costs. The Statement of
Profit or Loss will appear as follows:
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K K
Sales 38,500
Less: Cost of goods sold
Purchases 29,000
Less Closing stock (3,000)
Cost of goods sold (26,000)
Gross Profit 12,500
Less: Expenses
Rent 2,400
Lighting expenses 1500
General expenses 600
Total Expenses (4,500)
Net Profit 8,000
Sakala
Statement of Profit or Loss for the year ended 31 December 2019
The net profit is transferred to the capital account as the profit the business makes belong to the
owner of the business. It is also shown in the balance sheet as part of the capital reserves or retained
earnings as follows:
2019 K 2019
31-Dec Drawings 7,000 01-Jan Cash 20,000
31-Dec Balance c/d 21,000 31-Dec Net Profit 8,000
28,000 28,000
2016
01-Jan Balance b/d 21,000
Capital account
Profits increase the capital of the proprietor while losses and drawings decrease the capital of the
proprietor. In this case you can conclude that Sakala’s capital increased from the initial K20, 000
to K21, 000 after one year of trading.
1.7 Statement of Financial Position (Balance Sheet)
Balance sheet is a list of assets and liabilities. It simply shows what the business owns (assets) and
what it owes (liabilities) hence its financial position.
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As you have observed, the Statement of Profit or Loss was based on the trial balance. Up to this
point, only income and expenses have been transferred to the Statement of Profit or Loss with the
exception of assets and liabilities.
1.7.1 Layout of Statement of Financial Position
If you recall, assets and liabilities were defined in Unit 2 of Module I: Introduction to Financial
Accounting. Therefore we shall proceed to the layout of the statement of financial position.
Your balance sheet will be split into two sections, the first section lists assets and the second section
lists liabilities.
1.7.2 Assets
Assets are listed as either non-current assets (fixed assets) or current assets starting with those
the business will keep the longest, down to those which will not be kept so long in both cases.
For instance:
a) Non-Current Assets
1. Land and Buildings
2. Fixtures and Fittings
3. Machinery
4. Motor Vehicles
b) Current Assets
1. Stock (Inventory)
2. Trade Receivables
3. Cash at Bank
4. Cash in Hand
1.7.3 Liabilities
Likewise, liabilities are listed as either current liabilities or non-current liabilities (long-term
liabilities).
a) Non-Current Liabilities include Debenture Loans and Loans payable after one year
b) Current liabilities include Creditors (Payable)
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As explained in Unit 2 of Module 1, capital is the money invested by the business owner which
the business owes the proprietor hence being classified as a liability.
ASSETS K K
Non-Current Assets
Fixture and Fittings 5,000
Current Assets
Stock 3,000
Debtors 6,800
Bank 15,100
Cash 200
25,100
Total Assets 30,100
CAPITAL AND LIABILITIES
Capital 20,000
Add Profit for the period 8,000
Less Drawings (7,000)
21,000
Non-Current Liabilities
Loans -
Current Liabilities
Creditors (Payables) 9,100
9,100
Total Capital & Liabilities 30,100
Sakala
Statement of Financial Position as at 31 December 2015
If your assets and liabilities do not balance, then the balance sheet has not been correctly
prepared. Remember the Accounting Equation which was explained to you in Unit 2:
ASSETS = CAPITAL + LIABILITIES
This means that what the business owns is equal to what it owes (to any creditors, other lenders
and the proprietor).
One other aspect to remember is the trial balance. It is the basis for preparing financial statements.
So if your trial balance consists of errors, the profit may be overstated or understated, consequently
18
the balance sheet will not balance. Therefore the principles of double-entry need not be over
emphasized.
1.8 Exercise
K K
Cash in hand 200
Bank overdraft 2,000
Capital account 28,200
Drawings 500
Land and buildings 20,000
Office furniture 750
Bank loan 1,500
Stock 5,000
Purchases 3,500
Sales 4,800
Returns inwards 650
Returns outwards 700
Wages 200
Salaries 700
Rents received 500
Discounts allowed 250
Discounts received 100
Sundry expenses 150
Rates, taxes and insurance 380
Licence 250
Stationery 150
Electricity 50
Telephone 40
Postage 30
Sundry debtors 8,000
Sundry creditors 3,000
Total 40,800.00 40,800.00
Ndagala Mpofu
Trial Balance for the Year ended 31 December 2019
You are required to prepare a financial statements for Ndagala Mpofu.
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1.9 Summary
This unit introduced you to the preparation of basic financial statements of a sole trader. You
should therefore now be in a position to prepare the trading account, profit and loss account and
the statement of financial position. Further to that you should be in a position to define, calculate
gross profit and net profit. In Module I Introduction to Financial Accounting you were introduced
to the Accounting Equation, now that you are able prepare the Statement of Financial Position you
fully comprehend the equation.
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UNIT 2
Further considerations: Inventory and IAS 2
2.1 Introduction
In the previous unit, you looked at the basic financial statements of the sole trader i.e. the Statement
of Profit or Loss and the statement of financial position. In this unit we shall introduce you to
further considerations.
2.2 Objectives
By the end of this unit, you should be able to:
(i) Record returns inwards and returns outwards in the Statement of Profit or Loss
(ii) Explain why carriage inwards is treated as part of the cost of purchasing goods
(iii)Prepare a stock account showing the entries for opening and closing inventory (stock)
(iv) Prepare a Trading and Profit and Loss Account and a Balance Sheet containing the
appropriate adjustments for returns, carriage, and other items that affect the calculation of
the cost of goods sold
(v) Explain why the costs of putting goods into a saleable condition should be charged to the
trading account
2.3 Returns inwards and returns outwards
In Unit 7 of Introduction to Financial Accounting module, you were introduced to returns inwards
(sales and returns) and returns outwards (purchases returns. In this unit you shall learn how to
record these transactions and their effect on the Statement of Profit or Loss.
2.3.1 Returns Inwards (Sales Returns)
Customers have the right to return goods to your business. This could be due to any of the
following:
(i) We sent goods of the wrong size, the wrong colour or the wrong model;
(ii) The goods may have been damaged in transit;
(iii) The goods are of poor quality.
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Upon receipt of the returned goods, you issue credit note to the customer.
Accounting for returns inwards:
Dr: Returns inwards
Cr: Debtor’s account
On 31 January 2019, Chita returns goods to us worth K100 and you are required to record this
transaction in the books of accounts.
K
31-Jan Chita 100
K
31-Jan Returns inwards 100
Returns Inwards
Chita
Returns inwards effectively reduces the sales made and the amount the debtor owes the business.
2.3.2 Returns Outwards (Purchases Returns)
This is when you return the goods you purchased from your supplier for more or less the same
reason as mentioned in 2.3.1 above. Purchases returns is accounted for as follows:
Dr. Creditor’s account
Cr. Returns outwards
Returns outwards effectively reduce the purchases made and the amount the business owes its
creditor(s).
2.4 Inventory
As you may recall, inventory was defined to you in Unit 2 of Module as goods purchased (bought)
by the business intended for sale.
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Although the actual entries are very simple indeed, they may seem a little strange because with
modern computerised accounting it is now common to have continuous accounting for inventory.
This will be explained within the unit. We will also consider the methods of valuing inventory and
the provisions of IAS 2 Inventories.
2.4.1 The accounting entries for Inventory
You will recall that whenever we buy goods for resale we debit a purchases account, and that
whenever we sell goods we credit a sales account.
No entries have been made to an inventory account as part of the day to day bookkeeping, and this
will remain the case. Any inventory left at the end of the period will be adjusted for by you, the
accountant when preparing the financial statements.
Activity 1
Example 1
In 2019, the business had opening inventory of K4, 000, made purchases of K38, 000 and sold
goods worth K50, 000. There was inventory at the end of the period of K6, 000.
Required:
a) Show the trading account of the business for year 3, in a form suitable for
presentation to the owners, and
b) Write up the accounts for purchases, sales, and inventory, and close them off at the
end of the year.
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Solution
Trading Account
K K
Sales 50,000.0
Less: Cost of sales
Opening Inventory 4,000.0
Add Purchases 38,000.0
Less Closing Inventory (6,000.0)
Cost of goods sold 36,000.0
Gross Profit 14,000.0
K K
31-Dec P&L 50,000 31-Dec Cash 50,000
50,000 50,000
K K
31-Dec Cash 38,000 31-Dec P&L 38,000
38,000 38,000
K K
31-Dec Inventory 4,000 31-Dec Sales 50,000
Purchases 38,000 Inventory 6,000
Profit 14,000
56,000 56,000
K K
31-Dec Balance b/d 4,000 31-Dec P&L 4,000
P&L 6,000 Balance c/d 6,000
10,000 10,000
Balance b/d 6,000
Sales
Purchases
Statement of Profit & Loss
Inventory
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Summary of the accounting entries
At the end of each period, two entries are required:
(i) Remove the opening inventory:
Debit Statement of Profit or Loss account
Credit Inventory account
(ii) Create the closing inventory
Debit Inventory account
Credit Statement of Profit or Loss account
Note that the Inventory account does not keep a day-by-day record of inventory and is therefore
only correct at the end of each period after the adjusting entries have been made.
Now, you should be in a position to prepare the Statement of Profit or Loss with the following
adjustments:
(i) Sales returns
(ii) Purchases returns
(iii)Opening and Closing Inventory
2.5 The valuation of inventory
The figure for the closing inventory in the above examples would have come from physically
counting the inventory. (There are often day by day inventory records kept, but because of the
importance of the accuracy of the figure a physical count would still be made as a check.)
The basic rule for valuation is:
Inventory should be valued at the lower of cost and net realisable value.
(i) Cost is the cost of getting the goods to the state that they are in.
(ii) Net realisable value is the selling price less any extra costs that there will be in order to
get the goods in a state to be sold.
25
Normally the lower of the two will be the cost (otherwise the business would always be making
losses). However, there can be occasions (such as damaged, or obsolete items) when the net
realisable value is the lower.
This rule is an application of the prudence concept, in that we will only take profit when it is
actually realised (the reason for normally valuing at cost), but that you should charge any loss as
soon as it is foreseen (the reason for valuing at net realisable value if this is lower than the cost).
Activity 1
Example 2
A company has closing inventory as follows:
Item Units Cost to date Additional costs
to be incurred
Selling Price
A 100 10 3 15
B 200 12 5 16
C 150 6 4 11
You are required to calculate the total value of inventory at the end of the period.
Solution:
Item Units Lower of Cost or net
realisable value
Inventory value
A 100 10 1,000
B 200 11 2,200
C 150 6 900
TOTAL 4,100
You will notice that product B the cost (K12) is higher than the selling price (K11). This means
that the closing value of product C will be based on K11. Remember inventory should be valued
at the LOWER of cost and net realisable value.
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2.5.1 The determination of cost
The rule is that you value inventory at the lower of cost and net realisable value, always applies.
However, the cost of an item may not be as obvious as might be seemed.
Suppose that we buy and sell lamps. During the year we have bought 10,000 lamps and at the end
of the year we have 1,000 left in inventory. What was the cost of these 1,000 lamps? The cost is
obviously what we paid for them.
Suppose at the beginning of the year we were having to pay K1 a lamp but there have been large
price increases and by the end of the year we were having to pay K5 a lamp (for identical lamps).
Are the ones that we have left in inventory old ones (that therefore cost K1 each) or new ones (that
therefore cost K5 each)? Unless the cost is actually marked on each lamp, the only way in which
we can establish a cost it to have a policy of valuation.
There are four approaches that you should be aware of:
(i) Unit cost
This is where we can establish the cost of each individual item (e.g. the cost is marked on each
item). If you purchase a product at a marked price of K50, the unit cost for that product is K50.
(ii) FIFO: first-in-first-out
With this approach we value inventory on the basis that every time we sold items during the
year we were selling the oldest ones first
(iii) Average cost
Under this approach we value the inventory remaining after each sale at the average cost of the
inventory prior to the sale.
(iv) Selling price less an estimated profit margin
The first and last approaches do not need further illustration as they will be covered under
incomplete records. We will explain the other two approaches by means of an example.
Activity 2
Example 2
On 1 November 2019 a company held 300 units of finished goods valued at K12 each. During
November the following purchases took place:
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Date Units
Purchased
Cost
Per Unit
10 November 400 K12.50
20 November 400 K14.00
25 November 400 K15.00
Goods sold during November were as follows:
Date Units
Purchased
Cost
Per Unit
14 November 500 K20
21 November 400 K20
28 November 100 K20
You are required to calculate the value of the closing inventory applying the FIFO and
average cost bases of valuation.
Solution
Closing stock (units):
300 + 400 + 400 + 400 – 500 – 400 – 100 = 500 units
(i) FIFO
Units Cost Per
Unit
Total
400 K15 K6,000
100 K14 K1,400
500 K7,400
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(ii) Average Cost
Date Activity Units Cost Per
Unit
Total Cost Average
Cost
Total
1 Nov Opening 300 K12 K3,600 K3,600
10 Nov Purchase 400 K12.50 K5,000
700 K8,600 K12.29 K8,600
14 Nov Sale 500
200 K12.29 K2,458
20 Nov Purchase 400 K14 K5,600
600 K8,058 K13.43 K8,058
21 Nov Sale 400 K15 K6,000
200 K13.43 K2,686
25 Nov Purchase 400 K15 K6,000
600 K8,686 K14.47 K8,686
28 Nov Sale 100
500 K14.47 K7,35
You can conclude from the above that, the value of closing inventory depends on the valuation
method that your business adopts.
2.6 The provisions of IAS 2: Inventories
The following are the main provisions of IAS 2:
a) Inventories should always be valued at the lower of cost and net realisable value
b) The cost of inventories should include all costs of purchase, costs of conversion, and other
costs incurred in bringing the inventories to their present location and condition.
Overhead expenses which should be excluded from cost are:
(i) Selling costs
(ii) Storage costs
(iii)Abnormal wastage
(iv) Administrative costs
(i.e. only the costs of production should be included)
c) For measuring cost, unit cost should be used if costs can be specifically identified.
However, if this is not possible, then the benchmark treatments are FIFO and average cost.
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d) Disclosure requirements:
(i) The accounting policy for valuation
(ii) The inventory total, analysed appropriately
(iii)The amount of any inventories valued at net realisable value
2.7 Continuous inventory recording
In the accounting entries illustrated in 2.4.1 above, the only entries for inventory are made at the
end of the period. The inventory account does not keep a day to day record of inventory.
However, in practice it is very common to keep day by day records of inventory, and often (due to
the use of computers) these are integrated into the accounting. When this happens, then a record
is kept of each movement of inventory.
Although this would make the day by day accounting slightly different, the need to physically
count the inventory at the end of the period would remain (as a check on the records). Also, the
valuation rules will remain – for example, any damaged inventory might need to be valued lower.
2.8 Exercise
Question 1
A sole trader took some goods costing K1, 920 from inventory for his own use. The normal selling
price of the goods is K3, 840.
Which of the following journal entries would correctly record this?
Dr Cr
K K
A Drawings account 1,920
Inventory account 1, 920
B Drawings account 1,920
Purchases account 1, 920
C Sales account 3,840
Drawings account 3,840
30
(2 marks)
Question 2
According to IAS 2 Inventories, which of the following costs should be included in valuing the
inventories of a manufacturing company?
1) Carriage inwards
2) Carriage outwards
3) Depreciation of factory plant
4) General administrative overheads
A. All four items
B. 1, 2 and 4 only
C. 2 and 3 only
D. 1 and 3 only
(2 marks)
Question 3
A company values its inventory using the first in, first out (FIFO) method. At 1 May 2018 the
company had 700 engines in inventory, valued at K190 each.
During the year ended 30 April 2008 the following transactions took place:
2007
1 July Purchased 500 engines at K220 each
1 November Sold 400 engines for K160, 000
2008
1 February Purchased 300 engines at K230 each
15 April Sold 250 engines for K125, 000
What is the value of the company’s closing inventory of engines at 30 April 2019?
A. K188, 500
B. K195, 500
C. K166, 000
D. K106, 000
(2 marks)
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Question 4
Which of the following statements about inventory valuation for Statement of Financial Position
purposes are correct?
1) According to IAS Inventories, average cost and FIFO (first in and first out) are both
acceptable methods of arriving at the cost of inventories.
2) Inventories of finished goods may be valued at labour and materials cost only, without
including overheads.
3) Inventories should be valued at the lowest of cost, net realisable value and replacement
cost.
4) It may be acceptable for inventories to be valued at selling price less estimated profit
margin.
A. 1 and 3
B. 2 and 3
C. 1 and 4
D. 2 and 4
(2 marks)
2.9 Summary
This unit introduced you to some of the adjustments that you will be expected to pass when
preparing the financial statements. These bring further complications for you but which you must
be able to handle at this level. The adjustments covered include purchases returns and sales returns,
carriage inwards and carriage outwards. As an Accountant it will be responsibility to understand
the effect of these adjustments and to explain them properly. Further to this you are also expected
to explain why the costs of putting goods into a saleable condition should be charged to the trading
account.
After having adjusted for the above mentioned transactions, you will be expected to prepare the
Statement of Profit or Loss and Statement of Financial Position with less challenges.
32
UNIT 3
Accruals and Prepayments
3.1 Introduction
In the previous unit you were introduced to adjustments that should be taken into account when
preparing financial statements. There are other four types of adjustments that you will normally
have to make when preparing the financial statements to deal with items that will not have been
recorded on a day by day basis by the bookkeeper. These adjustments are:
(i) Accruals and prepayments;
(ii) Depreciation and;
(iii)bad and doubtful debts
We will deal with these adjustments separately. Accruals and prepayments will be dealt with in
this unit, and the others in the subsequent units.
3.2 Objectives
By the end of this unit, you should be able to:
(i) Adjust for accruals
(ii) Adjust for prepayments
(iii)Prepare financial statements accordingly
3.3 Prepayments
A prepayment is a payment in advance. For example, it is normal to pay car insurance for a whole
year at the beginning of the year. If your year-end were to occur half-way through the insurance
period, then you would only have actually used half of the insurance. The other half of the payment
would be paid in advance, and in theory if were we to close down, that would be repayable to the
company. For this reason we do not show the amount of the overpayment as an account receivable,
but show it separately in the Statement of Financial Position as a prepayment.
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The bookkeeper will have recorded the whole amount of the payment. However, if again we had
paid for a year but only used half a year so far, then it would be wrong to show the full payment
as an expense in the Statement of Profit or Loss.
We will illustrate the accounting treatment for prepayments by means of an example.
Activity 1
Example 1
Mwiya started business on 1 January 2017.
During the year to 31 December 2017, he made the following payments for insurance:
5 January 2017 K800 for the 6 months to 30 June 2017
15 June 2018 K2, 000 for the 12 months to 30 June 2018
a) Show extracts from the Statement of Profit or Loss and Statement of Financial
Position
b) Write up the t-account for Insurance for the year to 31 December 2017
c) Close off the t-account
Solution
Dr Cr
K K
05-Jan-17 Cash 800 31-Dec-17 Prepayment 1,000
15-Jun-17 Cash 2,000 31-Dec-17 Profit & Loss1,800
2,800 2,800
Dr Cr
K K
31-Dec-17 Insurance 1,000
Insurance
Prepayments
34
Statement of Profit or Loss
Expenses:
Insurance 1,800
Statement of Financial Position
Current Assets
Prepayment 1,000
3.4 Accruals An accrued expense (or accrual) is the name we give to an amount owing for which we have not
received an invoice. For example, suppose we receive electricity bills every 3 months, at the end
of March, June, September, and December. If our accounting year end occurs at the end of July,
then we will owe for the electricity used in July, even though we will not receive an invoice until
after the end of September. The bookkeeper will only have entered the bills received, and it is
therefore up to you, the accountant to make an adjustment for the amount still owed.
Again, we will illustrate the entries by an example and summarise the rules at the end of the unit.
Activity 2
Example 2
Majorie started business on 1 April 2017, and during the year to 31 March 2018 she made the
following payments in respect of telephone:
18 July 2017 K500 for the 3 months to 30 June 2017
22 October 2017 K600 for the 3 months to 30 September 2017
14 January 2018 K750 for the 3 months to 31 December 2017
As at 31 March 2018, Amit estimated that K950 was owing for the 3 months to 31 March 2018.
She had however not received a bill from the telephone company.
a) Show extracts from the Statement of Profit or Loss and Statement of Financial
Position.
35
b) Write up the t-account for Telephone for the year to 31 March 2018
c) Close off the account
Dr Cr
K K
18-Jul-17 Cash 500 31-Mar-18 Profit & Loss2,800
22-Oct-17 Cash 600
14-Jan-18 Cash 750
31-Mar-18 Accruals 950
2,800 2,800
Dr Cr
K K
31-Mar-18 Telephone 950
Telephone
Accruals
Statement of Profit or Loss
Expenses:
Telephone 2,800
Statement of Financial Position
Current Liabilities
Accruals – Telephone 1,200
3.5.1 Subsequent Accounting Periods
In both of the two previous examples, we were dealing with the first year of trading. At the end of
the year you left balances on the T-accounts for Prepayments (in the case of Mwiya) and on
Accruals (in the case of Majorie).
As a result, you would start the next accounting period with a balance brought forward, and you
should therefore consider what entries are needed in the second period.
We will use the same examples as before, continuing into a second year.
36
Activity 3
Example 3
During the year to 31 December 2018, Mwiya made the following payment in respect of insurance:
12 June 2018 K2, 400 for the 12 months to 30 June 2002
a) Write up the t-accounts for Insurance and for Prepayments for the year to 31
December 2018
b) Close off the accounts
c) Show extracts from the Statement of Profit or Loss and Statement of Financial
Position
Solution
Dr Cr
K K
01-Jan-18 Bal b/f 1,000 01-Jan-18 Insurance 1,000
31-Dec-18 Insurance 1,200 31-Dec-18 Bal c/d 1,200
2,200 2,200
Insurance 1200
Dr Cr
K K
01-Jan-18 Prepayment 1,000 31-Dec-18 Prepayment 1,200
Cash 2,400 31-Dec-18 P&L 1,200
3,400 2,400
Prepayments
Insurance
Statement of Profit or Loss
Expenses:
Insurance 2,200
Statement of Financial Position
Current Assets
Prepayment 1,200
37
Activity 4
Example 4
During the year to 31 March 2019 Majorie made the following payments in respect of telephone:
12 April 2018 K950 for the 3 months to 31 March 2018
15 July 2018 K1, 000 for the 3 months to 30 June 2018
24 October 2018 K1, 200 for the 3 months to 30 September 2018
12 January 2019 K1, 350 for the 3 months to 31 December 2018
As at 31 March 2019, Amit estimated that K1, 500 was owing for the 3 months to 31 March. She
had however not received a bill from the telephone company.
You are required to:
a) Write up the t-accounts for Telephone and for Accruals for the year to 31 March 2019
b) Close off the accounts
c) Show extracts from the Statement of Profit or Loss and Statement of Financial
Position
Dr Cr
K K
Cash 950 Accruals 950
Cash 1,000 P&L 5,050
Cash 1,200
Cash 1,350
Accruals 1,500
6,000 6,000
Dr Cr
K K
Telephone (Cash) 950 Bal b/f 950
Balance c/d 1,500 Telephone (Outstanding) 1,500
2,450 2,450
Bal b/d (Telephone) 1,500
Telephone
Accruals
38
3.5.2 Summary of Entries
a) Prepayments
1) Reverse any Prepayments brought forward:
DR Expense Account (e.g. Insurance, Rates)
CR Prepayments Account
2) Enter any payments during the period:
DR Expense Account
CR Cash Account
3) Enter any prepayments at the end of the period:
DR Prepayments Account
CR Expense Account
4) Close-off the accounts:
Transfer the balance on the expense account to the Statement of Profit or Loss.
DR Statement of Profit or Loss t-account
CR Expense Account
b) Accruals
1) Reverse any accruals brought forward:
DR Accruals Account
CR Expense Account (e.g. Telephone, Electricity)
2) Enter any payments during the period:
DR Expense Account
CR Cash Account
3) Enter any accruals at the end of the period:
DR Expense Account
CR Accruals Account
4) Close-off the accounts:
Transfer the balance on the expense account to the Statement of Profit or Loss.
DR Statement of Profit or Loss t-account
CR Expense Account
Leave the balance on the accruals account and show in the Statement of Financial
Position.
39
3.6 Exercise
QUESTION 1
At 31 December 2018 the following require inclusion in a company’s financial statements:
1) On 1 January 2018 the company made a loan of K28, 800 to an employee, repayable on 1
January 2019, charging interest at 2 per cent per year. On the due date she repaid the loan
and paid the whole of the interest due on the loan to that date.
2) The company has paid insurance K21, 600 in 2018, covering the year ending 31August
2019.
3) On 1 January 2019 the company received rent from a tenant K9, 600 covering the six
months to 31 December 2018.
For these items, what total figures should be included in the company’s Statement of
Financial Position at 31 December 2018?
Current assets Current liabilities
K K
A. 24,000 29,376
B. 53,376 nil
C. 24,576 nil
D. 38,976 14,400
(2 marks)
QUESTION 2
Moira prepares its financial statements for the year to 30 April each year. The company pays rent
for its premises quarterly in advance on 1 January, 1 April, 1 July and 1 October each year. The
annual rent was K201, 600 per year until 30 June 2008. It was increased from that date to K230,
400 per year.
What rent expense and end of year prepayment should be included in the financial
statements for the year ended 30 April 2019?
40
Expense Prepayment
A. K223,200 K19,200
B. K223,200 K38,400
C. K225,600 K9,200
D. K225,600 K38,400
(2 marks)
QUESTION 3
A company receives rent from a large number of properties. The total received in the year ended
30 April 2018 was K1, 154,880.
The following were the amounts of rent in advance and in arrears at 30 April 2007 and 2018:
30 April 2017 30 April 2018
K K
Rent received in advance 68,880 74,880
Rent in arrears (all subsequently received) 50,880 44,160
What amount of rental income should appear in the company’s Statement of Profit or Loss
for the year ended 30 April 2018?
A. K1,167,600
B. K1,106,160
C. K1,203,600
D. K1,142,160
(2 marks)
QUESTION 4
A business has received telephone bills as follows:
Date received Amount
of bill (K) Date paid
Quarter to 30 November 2015 December 2015 739.20 January 2016
Quarter to 28 February 2016 March 2016 798.00 April 2016
Quarter to 31 May 2016 June 2016 898.80 June 2016
Quarter to 31 August 2016 September 2016 814.80 October 2016
41
Quarter to 30 November 2016 December 2016 840.00 January 2017
Quarter to 28 February 2017 March 2017 966.00 March 2017
In the Statement of Profit or Loss for the year ended 31 December 2016 the charge for
telephone should be?
A. K3,250.80
B. K3,351.60
C. K3,407.60
D. K3,463.60
(2 marks)
QUESTION 5
Details of a company’s insurance policy are shown below:
Premium for year ended 31 March 2018 paid April 2017 K25, 920
Premium for year ending 31 March 2009 paid April 2018 K28, 800
What figures should be included in the company’s financial statements for the year ended
30 June 2018?
Statement of Profit or Loss Statement of Financial Position
K K
A. 26,640 21,600 prepayment (Dr)
B. 28,080 21,600 prepayment (Dr)
C. 26,640 21,600 accrual (Cr)
D. 28,080 21,600 accrual (Cr)
(2 marks)
QUESTION 6
A company owns a number of properties which are rented to tenants. The following information
is available for the year ended 30 June 2016:
Rent in advance Rent in arrears
K K
30 June 2015 323,040 11,520
30 June 2016 346,560 20,880
42
Cash received from tenants in the year ended 30 June 2016 was K2, 003,040.
All rent in arrears was subsequently received.
What figure should appear in the company’s Statement of Profit or Loss for rent receivable
in the year ended 30 June 2016?
A. K2,017,200
B. K2,640,240
C. K1,365,840
D. K1,988,880
3.7 Summary
This short unit, looked at the concept of the accrual concept. As you may be aware, some business
bills are received after the month end and subsequently paid in the next period. On the other hand
services such as insurance are usually paid for in advance. However the accruals concept requires
you to recognise expenses in the period in which they are incurred. Remember when you calculate
gross profit, you only consider the goods you would have sold. Therefore you should be able to
define both accrual and prepayment. You are further expected account for the accruals,
prepayments and pass the necessary adjustments when preparing financial statements.
43
UNIT 4
Provisions, Contingents and Depreciation
4.1 Introduction
In this unit we will look at provisions, contingent liabilities and asset (IAS 37) as well as
depreciation (IAS 16).
4.2 Objectives
By the end of this unit, you should be able to:
(i) Define contingent liability
(ii) Define contingent asset
(iii) Demonstrate an understanding of the requirements of IAS 37 and IAS 16
(iv) Calculate depreciation and
(v) Adjust for depreciation
4.3 International Accounting Standard 37 (IAS 37)
Contingent liability
We will define contingent liability as a liability that may result, but depends (or is contingent) on
the outcome of uncertain events.
For example, your company may have been taken to court, but the outcome of the case is not yet
known. If you lose the case then you may have to pay a fine. There is therefore a potential liability,
but it is not certain. The question is as to whether or not we show the potential liability in the
accounts.
Contingent asset
This is where there may be an asset resulting for the company, but, again, it is not certain. Let us
explain this to you in another way. It is a possible asset arising from past events whose existence
will be confirmed only by the occurrence of one or more uncertain events not wholly within the
entity’s control.
44
The requirements of IAS 37:
Contingent liabilities Contingent assets
Virtually certain ( > 95% ) Provide Recognise
Probable (50% to 95%) Provide Disclose by note
Possible ( 5% to 50% ) Disclose by note No disclosure
Remote ( < 5% ) No disclosure No disclosure
4.4.1 Depreciation
In this section, we will explain what depreciation is and why it is needed. We will also look at the
different methods of calculating depreciation of which you need to be aware of, and the accounting
entries.
Non-current assets
A non-current asset is an asset intended for use on a continuing basis in the business.
A tangible non-current asset is one that can be touched and refers to such items as plant, buildings
and motor vehicles.
A non-tangible non-current asset is one that cannot be touched and refers to such items as goodwill
and patents (we will cover these in a later unit).
Depreciation
Depreciation is the charging of the cost of a non-current asset over its useful life.
Assume you purchase of a car for K10, 000 is an expense of running the business just as electricity
is an expense. However, if the car is expected to last 5 years, it would be misleading to have one
expense in the Statement of Profit or Loss of K10, 000 every 5 years and nothing in the other years.
It would be more sensible to reflect the fact that the car is being used in the business over 5 years
by charging an expense each year of (say) K2, 000.
The charge of K2, 000 in the Statement of Profit or Loss each year is known as depreciation. At
the same time, the Statement of Financial Position value of the car will be reduced by K2, 000
each year to reflect the fact that it is being used up.
45
The way in which K2, 000 was calculated in the above illustration is known as the straight-line
method of depreciation. There are other methods and we will cover the methods that you need to
know in the following sections of this unit.
The purpose of depreciation is not to place a true value on the asset in the Statement of Financial
Position. It is a method of applying the accruals, or matching, concept by charging the cost of the
asset to the Statement of Profit or Loss as it is being used up.
4.4.2 Methods of Calculating Depreciation
There are several methods of calculating depreciation. The methods that you are expected to be
aware of are the following:
(i) Straight line method
(ii) Reducing balance method
These are the most common methods in practice.
Straight line method
Under this approach we charge an equal amount of depreciation each year.
The depreciation charge each year is calculated as:
𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑐𝑜𝑠𝑡 – 𝑟𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑣𝑎𝑙𝑢𝑒
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑢𝑠𝑒𝑓𝑢𝑙 𝑙𝑖𝑓𝑒
Activity 1
Example 1
Chabala has a year end of 31 December each year.
On 1 April 2012 he purchases a car for K12, 000. The car is expected to last for 5 years and to
have a scrap value at the end of 5 years of K2, 000.
You are required to calculate the depreciation charge for each of the first three accounting
periods, and to show extracts from the Statement of Financial Position and Statement of
Profit or Loss for each of the three accounting periods.
46
Solution
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 12,000 – 2, 000 = 2,000 𝑝. 𝑎
5
2012: 9/12 x 2,000 1,500
2013: 2,000
2014: 2,000
31.12.2012 31.12.2013 31.12.2014
Statement of Profit & Loss
Depreciation 1,500 2,000 2,000
Statement of Financial Position
Cost 12,000 12,000 12,000
Less: Accumulated Depreciation (1,500) (3,500) (5,500)
10,500 8,500 6,500
(Note, in the first accounting period we have charged a fraction of the annual depreciation because
the asset was purchased during the year. A very common alternative in practice is to charge a full
year in the year of purchase, regardless of when in the year it was actually purchased. In the
examination, read the question carefully. If you are told to charge a full year in the year of purchase
then do so. If you are not told, then charge a fraction (or time-apportion) as above.)
4.4.3 Reducing Balance Method
Under this approach we charge more depreciation in the early years of an asset’s life, with a
progressively lower charge in each subsequent year.
The depreciation charge each year is a fixed percentage of the net book value (or written down
value) at the end of the previous year.
Activity 2
Dhlamini has a year end of 31 December each year.
47
On 5 April he purchased a machine for K15, 000.
His depreciation policy is to charge 20% reducing balance, with a full years charge in the year of
purchase.
You are required to calculate the depreciation charge for each of the first three accounting
periods, and to show extracts from the Statement of Financial Position and Statement of
Profit or Loss for each of the three accounting periods.
Solution
Cost 15,000
Yr1 Depreciation (20%) (3,000)
12,000
Yr2 Depreciation (20%) (2,400)
9,600
Yr3 Depreciation (20%) (1,920)
7,680
Yr1 Yr2 Yr3
Statement of Profit & Loss
Depreciation 3,000 2,400 1,920
Statement of Financial Position
Cost 15,000 15,000 15,000
Less: Accumulated Depreciation (3,000) (5,400) (7,320)
12,000 9,600 7,680
4.4.4 Accounting for Depreciation
Whichever method is used, the accounting entries are the same.
We will illustrate the required entries using an example, and will then summarise the entries
afterwards.
Misozi has a year end of 30 June each year.
On 1 January 2012 he purchased a car for K15, 000.
48
The car has an expected life of 5 years, with an estimated scrap value of K1, 000.
Misozi depreciation policy is to use straight line depreciation.
Show the accounting entries for the first three accounting periods.
The accounting entry for charging depreciation each year is:
Debit Depreciation Expense account
Credit Accumulated Depreciation account
The balance on the Depreciation Account will appear in the Statement of Profit or Loss as an
expense.
The balance on the Accumulated Depreciation account will appear in the Statement of Financial
Position as a deduction from the cost of the asset.
Solution
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 15,000 – 1, 000 = 2,800 𝑝. 𝑎
5
Dr Cr
K K
30-Jun Cash 15,000
Dr Cr
K K
2012 Accum Dep 1,400 2012 P&L 1,400
1,400 1,400
2013 Accum Dep 2,800 2013 P&L 2,800
2,800 2,800
2014 Accum Dep 2,800 2014 P&L 2,800
2,800 2,800
Motor Vehicle - Cost
Depreciation Expense a/c
49
Dr Cr
K K
2012 Bal c/d 1,400 2012 Dep. Expense 1,400
1,400 1,400
2013 Bal c/d 4,200 2013 Bal b/d 1,400
Dep. Expense 2,800
4,200 4,200
2014 Bal c/d 7,000 2014 Bal b/d 4,200
Dep. Expense 2,800
7,000 7,000
Accumulated Depreciation a/c
4.4.5 Sale of non-current assets
In practice it is unlikely that an asset will be kept for the precise useful life that was estimated for
depreciation purposes – it might be kept for a longer period or for a shorter period. It is also
extremely unlikely that any sale proceeds will exactly equal the value of the asset as shown in the
financial statements.
On sale, we remove the asset from our books and calculate any difference between the proceeds
and the value in the financial statements. This difference (which is really the effective over or
under charge of depreciation) is called the profit or loss on sale and is shown in the Statement of
Profit or Loss.
Activity 3
Example 3
Using the previous example assume Misozi sells the car on 30 September 2014 for K6, 500.
Write up the ledger accounts for his fourth accounting period and show extracts from his Statement
of Financial Position and Statement of Profit or Loss.
Note that in this example we have charged depreciation in the year of sale for the 3 months the car
was owned. Very often you will be told that the depreciation policy is to charge no depreciation in
the year of sale. The net result in the Statement of Profit or Loss will be exactly the same.
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Dr Cr
K K
Balance 15,000 Disposal 15,000
15,000 15,000
Dr Cr
K K
Accum Dep (3/12x2,800) 700 Inc. Stat. 700
700 700
K K
Disposal 7,700 Balance 7,000
Dep. Expense 700
7,700 7,700
K K
Motor Vehicle 15,000 Accum. Dep 7,700
Cash 6,500
Inc. Stat. (Loss) 800
15,000 15,000
Motor Vehicle - Cost
Depreciation Expense a/c
Accumulated Depreciation a/c
Disposal a/c
Summary of the accounting entries for the sale of a non-current asset:
DR Disposal Account
CR Asset Account
with the cost of the asset sold
DR Accumulated Depreciation Account
CR Disposal Account
with the accumulated depreciation on the asset sold
DR Cash
CR Disposal Account
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with the proceeds of sale
The balance remaining on the Disposal Account is the profit or loss on sale. This should be
transferred to the Statement of Profit or Loss.
Revaluation of non-current assets
During a period of high-inflation, the value of non-current assets may be well in excess of their
net book value.
In this situation a company may choose to show the current worth of such assets on their Statement
of Financial Position.
Any profit resulting from such revaluation is an unrealised profit (in that the asset has not been
sold and therefore no real profit has actually been made). As a result, the profit is shown separately
from the Statement of Profit or Loss in a revaluation reserve. (For a limited company this must be
the case. For a sole trader, where the owner has unlimited liability, this is not a rule even though it
is good practice.)
IAS 16 Property, Plant and Equipment requires that when an item of property, plant or equipment
is revalued, then the entire class of property, plant and equipment to which the asset belongs must
be revalued.
When a non-current asset has been revalued, the future charge for depreciation should be based on
the revalued amount and the remaining economic life of the asset.
The depreciation charge will be higher than it was before the revaluation, and then excess of the
new charge over the old charge should be transferred from the revaluation reserve to accumulated
profits.
E Activity 4
XAMPLE 5
Chifundo has a year end of 31 December each year.
In his Statement of Financial Position as at 31 December 2002 he has buildings at a cost of
K3, 600,000 and accumulated depreciation of K1, 080,000.
His depreciation policy is to charge 2% straight line.
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On 30 June 2013, the building is to be revalued at K3, 072,000. There is no change in the remaining
estimated useful life of the building.
Show the relevant ledger accounts for the year to 31 December 2013.
Solution
Dr Cr
K K
Balance 3,600,000 Revaluation 528,000
Balance c/d 3,072,000
3,600,000 3,600,000
Balance b/d 3,072,000
Dr Cr
K K
Accum Dep 36,000 Inc. Stat. 80,522
Accum Dep 44,522
80,522 80,522
K K
Revaluation 1,116,000 Balance 1,080,000
Dep. Expense 36,000
1,116,000 1,116,000
Dep. Expense 44,522
K K
Building 528,000 Accum. Dep 1,116,000
Profit on Revaluation 588,000
1,116,000 1,116,000
Buildings
Depreciation Expense a/c
Accumulated Depreciation a/c
Revaluation a/c
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(W1) Dep Exp = 6⁄12 × 2% × 3,600,000 = K36, 000
(W2) Dep Exp = 6⁄12 × 3 072 000/34.5 = K44, 522
With depreciation at 2% p.a., expected life of building was 50 years.
At date of revaluation, the accumulated depreciation is K1, 116,000. At the rate of K72, 000 p.a.
this is K1 116 000/72 000 = 15.5 years.
So expected life remaining = 50 – 15.5 = 34.5 years.
4.4.6 Provisions of IAS 16: Property, Plant and Equipment
a) The main points of IAS 16 are as follows:
The conditions for recognition of a tangible non-current asset are that
(i) It is probably that future benefits will flow to the enterprise from the asset
(ii) The cost of the asset can be measured reliably
b) Depreciation should be charged over the useful life of the asset. Land normally has an
unlimited life and therefore does not require depreciation.
c) Any upward revaluation should be credited to a revaluation reserve. Any downward
revaluation should be charged as an expense in the Statement of Profit or Loss.
d) If one asset in a class is revalued, then all assets in that class should be revalued.
Disclosure requirements
The following should be disclosed in the financial statements:
a) The methods of depreciation used
b) The total cost of each asset heading, and the related accumulated depreciation, at the
beginning and end of the period.
c) A reconciliation of the net book value at the beginning and end of the period, showing
additions, disposals, revaluations, and depreciation.
d)
(We will look at examples of the layout in the later unit on limited companies’ financial
statements.)
4.5 Exercise
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QUESTION 1
1. How should a contingent liability be included in a company’s financial statements if the
likelihood of a transfer of economic benefits to settle it is remote?
A. Disclosed by note with no provision being made
B. No disclosure or provision is required
(2 marks)
2. The following items have to be considered in finalising the financial statements of Q, a
limited liability company:
1) The company gives warranties on its products. The company’s statistics show that
about 5% of sales give rise to a warranty claim.
2) The company has guaranteed the overdraft of another company. The likelihood of a
liability arising under the guarantee is assessed as possible.
What is the correct action to be taken in the financial statements for these items?
Create a provision
Disclose by note only
No action
3. The plant and machinery account (at cost) of a business for the year ended 31 December
2018 was as follows:
Dr Cr
2018 K 2018 K
1-Jan Bal b/f 240,000 1-Jan Disposal a/c 60,000
30-Jun Cash 160,000 31-Dec Bal c/d 340,000
400,000 400,000
Plant & Machinery - Cost
The company’s policy is to charge depreciation at 20% per year on the straight line basis,
with proportionate depreciation in the years of purchase and disposal.
What should be the depreciation charge for the year ended 31 December 2018?
A. K68,000
B. K64,000
C. K61,000
D. K55,000
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(2 marks)
4. What is the correct double entry to record the depreciation charge for a period?
A. DR Depreciation expense
CR Accumulated depreciation
B. DR Accumulated depreciation
CR Depreciation expense
(2 marks)
5. On 1 January 2017 Krin Co. bought a machine for K70, 000. It was estimated that the
machine’s useful life would be 7 years and its residual value K7, 000. Two years later the
useful life was revised to three remaining years and at 31 December 2019 the machine was
sold for K30, 000.
What is the profit on disposal?
A. K2,000
B. K8,000
C. K12,000
D. K20,000
(2 marks)
4.6 Summary
Some liabilities can be reliably measured while others their value depend on the occurrence of
certain events and may only be provided for. In this unit we looked at contingent liabilities and
assets. We further explained the provisions of IAS 37 which helps you classify an item as either
a contingent liability or asset and the disclosure requirements.
In this unit you also learnt that non-current assets depreciate (lose value) with time due to use and
such this should be recognised by every business as guided by IAS 16 Property, Plant and
Equipment. You will be expected to account for depreciation and pass the necessary adjustments
in your financial statements. Ensure that you fully understand it.
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UNIT 5
IRRECOVERABLE DEBTS AND ALLOWANCES
5.1 Introduction
In this unit we will consider what a company should do in the situation where an accounts
receivable does not pay his debt, or where there is some doubt about the eventual payment of all
or part of the debt.
We will examine both the accounting entries and the presentation in the financial statements.
5.2 Objectives
By the end of this unit, you should be able to:
(i) Define irrecoverable debt
(ii) Define doubtful debt and
(iii) Account for doubtful debt, irrecoverable debt and specific allowance
5.3 Definitions
An irrecoverable debt is where we are reasonably certain that the receivable is not going to pay.
For example, the customer may have died leaving no assets, or may have disappeared without
trace.
A doubtful debt is where we are worried that the receivable might not pay. For example, the debt
may have been outstanding for some time and the customer may not be replying to letters.
(Note that obviously if a customer refuses to pay we are at liberty to take them to court. However,
it may be that the costs of going to court will be more than the amount of the debt and that therefore
we decide not to do so.)
5.4 Treatment in the Financial Statements
It is important that you do not overstate assets in the Statement of Financial Position (that you
apply the prudence concept) and that therefore you should only show the receivables that we feel
confident will pay.
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Equally, if we realise that we might not receive payment (and therefore lose money) we should
show this as an expense in the Statement of Profit or Loss as soon as any doubt arises.
As a result the treatment is as follows:
Irrecoverable debts:
These are removed completely, and will no longer appear as part of accounts receivable.
Doubtful debts:
You will leave the debt outstanding as part of accounts receivable (because we are still trying to
collect the money), but you will deduct from receivables an “allowance for receivables” equal to
the amount of any doubtful ones, so that the net figure left in the Statement of Financial Position
is the total receivables for which we foresee no problem.
Specific allowance for receivables:
This is an allowance for particular (or specific) debts, where you know that there is a problem (for
example, the debt has been owing for a long time).
General allowance for receivables:
It may be that in our company it is the nature of the business that on average (say) 5% of our
debtors end up not paying. However, it may be that at the year-end all of the individual debts are
reasonably recent and we have no way of identifying which particular customers will end up not
paying. We do feel, however, that probably 5% of them will not pay. Again, to be prudent, we will
deduct 5% from receivables to leave only the amount we are reasonably certain of. As this 5%
does not relate to any specific customer, we call it a general allowance for receivables.
In all cases, the cost of removing irrecoverable debts and of allowing for doubtful debts is charged
as an expense in the Statement of Profit or Loss.
Activity 1
Example 1
At the end of the first year of trading there is a balance on the receivables account of Street of
K62, 500. On investigation, this amount is found to include two debts from A plc and B plc which
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are to be regarded as irrecoverable. The amounts owing are K2, 500 and K1, 600 respectively. In
addition there is K2, 800 owing from Z plc which is regarded as doubtful. Street has a policy of
maintaining a general allowance for receivables of 4%.
Show extracts from the Statement of Financial Position and Statement of Profit or Loss of
Street.
Statement of Financial Position
K
Current assets
Receivables (W1) 58,400
Less: Allowance for receivables (W2) (5,024)
53,376
Statement of Profit or Loss
Expenses
Irrecoverable debts (2,500 + 1,600) 4,100
Increase in allowance for receivables 5,024
9,124
(W1) Receivables: 62,500 – 2,500 – 1,600 = K58, 400
(W2) Allowance for receivables:
Specific: 2,800
General: (4% × (58,400 – 2,800) 2,224
5,024
5.5 The Accounting Entries
The required entries are very easy however, the problem in examinations results from the fact that
there can be many accounting entries required in a question and it is easy to get lost. We will
illustrate the necessary entries using two worked examples below:
Activity 2
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EXAMPLE 2
Cilla started business on 1 January 2018. As at 31 December 2018, the balance on her Receivables
Account was K82, 000.
On investigation this was found to include the following debts:
a) John owed K5,000 which is irrecoverable
b) George owed K8,000 and is a doubtful debt
c) Paul owed K3,000 which is irrecoverable
d) Ann owed K2,000 and is a doubtful debt
In addition is had been decided to have a general provision of 4% of remaining debts.
a) Write up the Accounts Receivable, Irrecoverable debts Expense, and Allowance for
Receivables accounts
b) Show extracts from Cilla’s Statement of Financial Position and Statement of Profit
or Loss
Solution:
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Dr Cr
K K
Balance b/d 82,000 Irrecoverable 5,000
Irrecoverable 3,000
Balance c/d 74,000
82,000 82,000
Balance b/d 3,072,000
Dr Cr
K K
Receivables 5,000 Inc. Stat. 20,560
Receivables 3,000
Allwance 12,560
20,560 20,560
K K
Irrecoverable 12,560
Receivables
Irrecoverable Debts Expense
Allowance for Receivables
Calculation for allowance for receivables
Specific: (8,000 + 2,000) 10,000
General: (4% × (74,000 – 10,000) 2,560
12,560
To be able to illustrate all of the possible entries, we now need to look at the position in the
following year.
Activity 2
Example 2
During the year ended 31 December 2017, Cilla had made sales on credit of K261, 000 and had
received cash from customers of K238, 000.
These amounts had been entered into the Receivables Account, and a balance extracted.
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On investigation, the following was discovered:
a) Paul had paid K2,200 of his previously irrecoverable debt (we do not expect to receive any
more)
b) George had still not paid the K8,000 owing, and must now be regarded as irrecoverable
c) Ann had paid her debt of K2,000 in full
d) Ringo was owing K4,000 which is irrecoverable
e) Mick was owing K6,000 and is a doubtful debt
It was decided to maintain the general allowance for receivables at 4% of the remaining debts
(Note: the amounts received from Paul and Ann are included in the total cash receipts for the year
of K238, 000)
a) Write up the Accounts Receivable, Irrecoverable Debts Expense, and Allowance for
Receivables accounts
b) Show extracts from Cilla’s Statement of Financial Position and Statement of Profit
or Loss
Solution:
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Dr Cr
K K
Balance b/d 74,000 Cash 238,000
Sales 261,000 Balance c/d 97,000
335,000 335,000
Balance b/d 97,000
Dr Cr
K K
Receivables 8,000 Receivables 2,200
Receivables 4,000 Allowance 3,312
Inc. Stat. 6,488
12,000 12,000
K K
Irrecoverable debts 3,312 Balance 12,560
Balance 9248
12,560 12,560
Receivables
Irrecoverable Debts Expense
Allowance for Receivables
5.6 Exercise
QUESTION 1
At 30 June 2017 a company’s allowance for receivables was K93, 600. At 30 June 2018 trade
receivables totalled K1, 240,800. It was decided to write off debts totalling K88, 800 and to adjust
the allowance for receivables to the equivalent of 5 per cent of the trade receivables based on past
events.
What figure should appear in the Statement of Profit or Loss for the year ended 30 June
2018 for these items?
A. K146,400
B. K52,800
C. K57,600
D. K57,240
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(2 marks)
QUESTION 2
At 31 December 2015 the ledger of X Co. included a K5, 376 allowance for receivables. During
the year ended 31 December 2016 irrecoverable debts of K2, 040 were written off. Receivables
balances at 31 December 2016 totalled K173, 760 and the company wished to carry forward a
general allowance of 2%.
The total charge for irrecoverable debts and change in allowance for receivables in the 2016
Statement of Profit or Loss is
A. K98.40
B. K139.20
C. K3,904.80
D. K5,515.20
(2 marks)
QUESTION 3
Yv Co’s trial balance shows a receivables’ account balance of K50, 000, this includes the
following:
1. K2,500 from Mike who has gone into liquidation
2. Debts of K500 + K1,500 which are to be specially allowed for
3. Cash received from Ken of K1,800 which had previously been written off
4. Cash received from John of K2,900 which had previously been allowed for
What is the revised receivables figure?
A. K52,200
B. K50,200
C. K49,300
D. K45,500
(2 marks)
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QUESTION 4
At 1 July 2017 a company’s allowance for receivables was K48, 000.
At 30 June 2018, trade receivables amounted to K838, 000. It was decided to write off K72, 000
of these debts and adjust the allowance for receivables to K60,000.
What are the final amounts for inclusion in the company’s Statement of Financial Position
at 30 June 2018?
Trade receivables Allowance for receivables Net balance
K K K
A. 838,000 60,000 778,000
B. 766,000 60,000 706,000
C. 766,000 108,000 658,000
D. 838,000 108,000 730,000
5.7 Summary
This Unit also focused on further adjustments. You should appreciate that these are additional
items to your Statement of Profit or Loss and Statement of Financial Position. In other words you
are expected to continue working on the financial statements after passing these necessary
adjustments.
You learnt in this unit that there are debts that are irrecoverable due to various reasons including
the death of a customer, a client being declared bankrupt etc. As such you will not be expected to
maintain such debtors under receivables but write-off the amount to profit and loss account.
However some debtors are doubtful but not necessarily irrecoverable and you will be expected to
pass the necessary adjustments in your accounts t record them accordingly.
Remember to apply the double-entry principles when adjusting for these items.
65
UNIT 6
JOURNAL ENTRIES AND SALES TAX
6.1 Introduction
We mentioned in Unit 7 of Module 1that one of the books of prime entry is known as the journal,
and is used to list unusual transactions. In this unit we shall briefly explain how the journal is used
as a book of prime entry.
We shall also take time to focus on sales tax and the respective accounting effect.
A journal entry is an entry in this book. However, it is also used in the examination to refer to any
entry that is written down in words (as opposed to actually entered in t-accounts).
In this unit we will explain how journal entries are written in the examination.
6.2 Objectives
By the end of this unit, you should be able to;
(i) Define a journal entry
(ii) Write an entry in a journal
(iii) Define sales tax and;
(iv) Demonstrate an understanding of the principles of sales tax
6.3.1 Journal Entries
A journal entry is the name given to an entry that is written in words
In the early history of double-entry book-keeping, the journal was the only book of prime entry
that was kept. All transactions were recorded in the journal –or "day book" as it was called.
Gradually, however, as certain types of transaction became more numerous (such as sales and
purchases), the journal was divided into sections, and then into separate books.
Nowadays, the specialised entry books are the cash book (and petty cash book), purchases and
sales books, and the purchases-returns and sales-returns books. All transactions that cannot be
passed through one of these books are passed through the journal.
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The journal is, therefore, a day book for miscellaneous transactions. In addition, it serves another
useful function: where a transaction arises from abnormal circumstances, or is exceptionally
complicated, a full explanation can be written in the journal, so that the exact nature of the
transaction can be seen if it is queried later–for instance, by an auditor. Furthermore, where one
debit item corresponds to a number of small credit items, the journal shows that the credit items
have been correctly entered in the ledger to complete the double entry.
6.3.2 Layout
The format is always as follows:
a) Write the debit entry first, followed by the credit entry on the next line.
b) Write below the entry a brief description of why the entry is to be made. This is known as
the narrative.
Activity 1
Example 1
The business purchases goods for resale from Mike for K2, 500 on credit.
You are required to write down the journal entry for this transaction
Solution
Description Dr Cr
Purchases K2,500
Payables K2,500
Being the Purchase of goods on credit
Activity 2
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Example 2
On 12 March, a filing cabinet was purchased for K104.30 and a desk for K152.00, both on credit,
from Office Services Ltd. On 15 March, a delivery van was sold on credit to Timothy Garages
Ltd, for K2, 500.
The journal entries would be as follows:
Date Description Dr Cr
K K
12-Mar Office Equipment a/c 104.30
Office Equipment a/c 152.00
Office Services Ltd 256.30
15-Mar Timothy Garages 2,500.00
Motor Vehicle a/c 2,500.00
Being credit purchase of filing cabinet and
office desk
Being credit sale of delivery van
Journal
You should note the layout of the journal is as shown above. The narration, i.e. explanation, is
always given, and then the entry is ruled off. Amounts entered in the debit column must be equal
to amounts entered in the credit column before each entry is ruled off –but these columns are not
totalled. The appropriate ledger folio is given, and the journal folio entered in the ledger is prefixed
"J".
6.4.1 Sales Tax
If your business is registered with the state for sales tax, then they are required to add the tax to
the price of all your sales. You are acting as tax collectors for the state, and the tax that you have
charged on your sales is payable to the state periodically (in some countries it is accounted for
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monthly and in some countries three-monthly). The tax charged on their sales is known as output
tax.
However, your business will have suffered (i.e. will have been charged) sales tax on your
purchases.
The tax you have suffered is known as input tax.
At the end of each period, the excess of the output tax collected by your business over the input
tax suffered by the business is payable to the state.
If in any period the input tax exceeds the output tax then the difference will be repaid by the state.
6.4.2 The calculation of sales tax
The rate of sales tax is determined by the state and differs from country to country. Also, many
countries have different rates of sales tax depending on the nature of the item being sold.
Some businesses quote their selling price without sales tax, and then add the relevant percentage.
Other businesses (particularly shops selling to the general public) quote a selling price including
sales tax.
It is important in the examination to be able to identify the net sales price, the gross sales price,
and the amount of sales tax.
Activity 3
Example 3
Alpha sells goods at a net (or tax exclusive) price of K150.
The rate of sales tax is 16%.
What is the gross (or tax inclusive) selling price?
Solution
Gross selling price = 150 + (16% × 150)
= 150 + 24 = K174
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Activity 4
Example 4
Beta sells goods at a gross (or tax inclusive) price of K120.
The rate of sales tax is 16%.
What is the net (or tax exclusive) selling price, and what is the amount of the sales tax?
Solution
If net selling price = x,
then 120 = x + (0.16 × x)
x = 120/1.16 = K103.45
6.4.3 The accounting entries
Input tax
When a company makes purchases, the amount charged will include sales tax, but the tax suffered
will be recovered from the state.
The entry is therefore:
Dr Purchases (with the net cost)
Dr Sales tax (with the amount of the tax)
Cr Payables / Cash (with the gross cost)
Output tax
When a company makes sales, the amount charged includes sales tax, but the tax collected will be
paid to the state.
The entry is therefore:
Dr Receivables / Cash (with the gross amount)
Cr Sales (with the net amount)
Cr Sales tax (with the amount of the tax)
The balance on the Sales Tax account will represent the amount of sales tax owing to or from the
state.
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If, at the end of the period, there is a credit balance, then the balance will be paid to the state:
Dr Sales tax
Cr Cash
If alternatively there is a debit balance, then the state will repay the business:
Dr Cash
Cr Sales tax
(Note that more commonly a debit balance is not repaid, but is left on the account to reduce the
payment to the state in the following period)
Activity 5
Example 5
Delta’s purchases and sales for December are as follows:
Net Sales tax Gross
Purchases on credit 432,000 75,600 507,600
Sales on credit 624,000 109,200 733,200
Record these transactions in the ledger accounts.
Solution
71
Dr Cr
K K
Payables 432,000
Dr Cr
K K
Purchases 507,600
Dr Cr
K K
Receivables 624,000
Dr Cr
K K
Sales 733,200 624,000
Dr Cr
K K
Purchases 75,600 Sales 109,200
Balance c/d 33,600.0
109,200 109,200
Balance b/d (Payable) 33,600
Purchases
Payables
Sales
Receivables
Sales Tax
6.5 Exercise
1. Jim sells goods on credit to John. John receives a 10% trade discount from Jim and a further
5% settlement discount if goods are paid for within 14 days. John bought goods with a list
price of K480, 000 from Jim. Sales tax is at 17.5%.
What amount should be included in Jim’s receivables ledger for this transaction?
A. K564,000
72
B. K507,600
C. K482,220
D. K503,820
(2 marks)
2. Gareth, a sales tax registered trader purchased a computer for use in his business. The invoice
for the computer showed the following costs related to the purchase:
K
Computer 2,136
Additional memory 228
Delivery 24
Installation 48
Maintenance (1 year) 60
2,496
Sales tax (17.5%) 436.80
Total 2,932.80
How much should Gareth capitalise as a non-current asset in relation to the
purchase?
A. K2,932.8
B. K2,496
C. K2,136
D. K2,436
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6.6 Summary
In this unit we looked at the journal and how to pass a journal entry. As an Accountant, you will
be expected to follow the layout as shown in this unit. During the examination ensure that you also
use this format and describe the transactions properly.
Sales tax is an important component of your studies, however you will learn more about tax in
Principles of Taxation. In this unit we focused on the calculation of sales which you are expected
to master. You are also expected to differentiate input tax and output tax. Further to this you should
be in a position to explain and account for the same.
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UNIT 7
BANK RECONCILIATIONS
7.1 Introduction
There are many errors that can be made in the bookkeeping – for example, it is very easy to enter
a number incorrectly – and it is therefore important to carry out as many checks as possible on the
accuracy. This unit therefore focuses on bank reconciliations.
7.2 Objectives
By the end of this unit, you should be able to;
(i) Explain why bank reconciliations are prepared
(ii) Reconcile Cash Book balances with bank statement balances
(iii) Make the necessary entries in the accounts for dishonoured cheques
7.3 Why prepare a bank reconciliation statement
One of the most obvious checks is to compare the cash book with the bank statement. The balance
on both should be the same. If there are any errors then this check should discover that they exist.
In principle this check is very simple, but it can be a little more involved due, mainly, to the use
of cheques in many countries.
7.4 Balance on bank statement
One important aspect to be aware of is that if you put money into the bank, the bank statement will
show a credit balance. This is despite the fact that in the books of the business we will debit the
cash account and say that we have a debit balance. The reason for this is that the bank statements
is a reflection of the balance on your account in the books of the bank. As far as the bank is
concerned, they owe you money – hence the credit balance.
It is very easy to get confused in an exam question, and so be very careful. A credit balance on the
bank statement means that you have money, whereas a debit balance on the bank statement means
that you are overdrawn.
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7.5 Why bank balance may differ from the balance in the cash book
If there is a difference between the balance on the bank statement and the balance in the cash
account, then clearly we need to find out why.
There are three types of situations that can result in a difference:
(i) Cash book errors and omissions
If there are any cash book errors or omissions, then these must be corrected. This may
happen when you forget to record some transactions in your cash book, for instance you
issue a cheque to your supplier who deposits in his bank the same day. As a way of
correcting that you will record that in your cash book as the bank would have debited your
account.
(ii) Bank mistakes
If there are any errors by the bank, then the bank must be informed and these errors
corrected by the bank. For instance you deposit cash in your account and the deposit is not
appearing on your account, you will inform bank so that they correct the mistake.
(iii)Timing differences
Even if all the entries in the bank statement and the cash book are correct, the two balances
are unlikely to agree. This is because of unpresented cheques and lodgements not credited.
Lodgements are deposits made on your account but not yet appearing on your statement.
The receipts and payments have been correctly entered in the cash book, but because of the
time delay they have not yet appeared in the bank statement. This is not a mistake on the
bank’s part – the transactions will appear at some time in the future – and so no correction
is necessary. However, if we list the unpresented cheques and lodgements not yet credited,
we should be able to explain (or reconcile) the difference between the balances. If we
cannot reconcile the two then there must be errors remaining which we must find.
The statement reconciling the balances is called a bank reconciliation statement.
7.5.1 Preparing a bank reconciliation statement
1. Compare the cash account to the bank statement and tick off all items that agree
2. Any remaining items must be either errors or timing differences
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3. Correct any errors in the cash account by putting through the necessary debits or credits (in
the examination write up a t-account, starting with the balance given in the question and
ending with the correct balance)
4. Prepare a bank reconciliation statement. This is always a statement (not a t-account),
starting with the balance on the bank statement, listing any bank errors and timing
differences, and ending with what should be the corrected balance in the cash account.
Pro-forma bank reconciliation statement:
Balance per bank statement x
Add/Less bank errors x
X
Add: Lodgements not credited x
Less: Unpresented cheques (x)
Balance as per (corrected) cash account x
7.5.2 Fully worked example
At 31 December 2017, the balance on the cash account was K11, 820 (DR), but the balance
appearing on the bank statement was K15, 000 (CR).
The reasons for the difference were as follows:
1. Bank charges of K20
2. A payment of K1,200 had been entered in the cash account as K2,100
3. A cheque for K200 had been dishonoured
4. There were unpresented cheques totalling K6,500
5. Lodgements of K4,000 had not yet appeared on the bank statement
Calculate the correct balance on the cash account, and prepare a bank reconciliation
statement.
Solution
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Dr Cr
K K
Balance b/d 11,820 Bank charges 20
Error in payment 900 Dishonoured cheque 200
Balance c/d 12,500
12,720 12,720
Balance b/d 12,500.00
K
Balance at bank 15,000
Add: Lodgements not credited 4,000
Less: Unpresented cheques (6,500)
Balance as per cash book 12,500
Bank Reconciliation Statement
Cash a/c
The practice is for credit to be passed by the bank immediately the deposit is received, irrespective
of the soundness of the cheques included in the amount paid in. All banks, of course, reserve the
right to refuse to pay against such deposits until the cheques have been cleared. This right is
usually exercised only in cases of small, unsound accounts.
If you are given an item of bank charges in the bank statement and this does not appear in the cash
book, first adjust the cash book, before preparing the reconciliation statement. In other words,
show the cash book itself with the bank charges entered and the adjusted balance carried down.
Then reconcile the bank statement with the adjusted cash book balance.
Position when there is a Bank Overdraft
Instead of adding amounts paid in but not yet credited, you now deduct; and, instead of deducting
cheques drawn but not yet presented, you now add such amounts. In other words, where you
previously added you now deduct, and vice versa.
7.6 Stale and Post-Dated cheques
You may have noticed that the use of cheques is becoming far less important as more and more
businesses use different forms of card payment and Internet banking to effect direct transfers
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between the supplier and customer banks. However, you should still be aware of these two
characteristics of payment by cheque.
Stale Cheques
If a cheque is not presented by the holder within six months of the date written upon it, it becomes
"stale" or outdated and the bank will refuse payment. When more than six months have elapsed
from the date of issue, the procedure to be adopted is described below.
1) Write to the bank, asking them to stop payment of the cheques in question.
2) Debit the cash book (in the bank column) and credit the personal account of the person to
whom the cheque was give –, i.e. the ledger account which was originally debited.
The person is a now creditor (at least to the extent of the payment made, but not presented) and
the account will show credit (or a reversed debit) in the books, and the stale cheque will
disappear from future bank reconciliation statements prepared.
1) Write to the person concerned, enquiring the reason for non-presentation of the cheque.
On obtaining satisfactory explanation (and, if possible, the uncashed cheque), you can issue
a new cheque–although often this step is usually omitted, leaving it up to the creditor to
chase up non-payment.
You should note that frequent cause of cheques becoming stale is their being incorrectly dated for
example, a cheque drawn early in January could, absentmindedly, be dated for the previous year.
Therefore it is important for you to ensure that the date is correct when issuing the cheque.
Post-dated Cheques
A post-dated cheque is one, which is so dated as to preclude presentation for payment until
sometime after the actual date of its receipt. For example, on 30 September Mr. AB may wish to
pay a debt of K5, 000 to Ms. CD, but may have insufficient money in the bank to meet payment
of the cheque. He may hope to have sufficient money by 31 October, so he "post-dates" his cheque
by writing 31 October on the date space. He may now give the cheque to his creditor and be
assured that it cannot be debited to his bank account until 31 October.
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From the creditor's point of view, even a post-dated cheque affords some actionable evidence of a
debt –but Ms. CD will not accept the cheque from Mr. AB unless she is certain that AB has
justifiable grounds for post-dating it. Having accepted it, she will keep it in the cash-book until
31 October, and then pay it into the bank.
7.7 Position when there is a Bank Overdraft
Instead of adding amounts paid in but not yet credited, you now deduct; and, instead of deducting
cheques drawn but not yet presented, you now add such amounts. In other words, where you
previously added you now deduct, and vice versa.
7.8 Exercise
1. The following bank reconciliation statement has been prepared by a trainee accountant:
K
Overdraft per bank statement 9,264
less: Outstanding cheques 21,984
12,720
add: Deposits credited after date 40,056
Cash at bank as calculated above 52,776
What should be the correct balance per the cash book?
A. K52,776 balance at bank as stated
B. K8,808 balance at bank
C. K27,336 balance at bank
D. K8, 808 overdrawn.
(2 marks)
2. In preparing a company’s bank reconciliation statement at March 2016, the following items
are causing the difference between the cash book balance and the bank statement balance:
1) Bank charges K912
2) Error by bank K2,400 (cheque incorrectly debited to the account)
3) Lodgements not credited K10,992
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4) Outstanding cheques K3,540
5) Direct debit K840
6) Cheque paid in by the company and dishonoured K960.
Which of these items will require an entry in the cash book?
A. 2, 4 and 6
B. 1, 5 and 6
C. 3, 4 and 5
D. 1, 2 and 3
(2 marks)
3. Which of the following statements about bank reconciliations are correct?
1) In preparing a bank reconciliation, unpresented cheques must be deducted from a
balance of cash at bank shown in the bank statement.
2) A cheque from a customer paid into the bank but dishonoured must be corrected by
making a debit entry in the cash book.
3) An error by the bank must be corrected by an entry in the cash book.
4) An overdraft is a debit balance in the bank statement.
A. 1 and 3
B. 2 and 3
C. 1 and 4
D. 2 and 4
(2 marks)
7.7 Summary
You invest in a business in order to make money and this money should be properly accounted
for. Bank reconciliations help us in checking if we are accounting for all the cash properly. You
should appreciate the fact the fact that the bank can also make mistakes on your account and they
simply keep the money on your behalf. It is your responsilbility to ensure that you bring to the
bank’s attention any errors and ommissions on their part. In other words you need to take regular
stock of your cash with the bank by way of bank reconciliations. It is for this reason that you should
explain the importance of bank reconciliations, prepare bank reconciliations and pass necessary
adjustments in your books of accounts.
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UNIT 8
CONTROL ACCOUNTS
8.1 Introduction
In the previous you covered bank reconciliations as a method of checking the accuracy of the entry
of transactions concerning cash in and out of the bank.
However, a great many of the transactions of a company involve purchases and sales on credit.
It is important to have a way of checking these also. This unit covers a way of checking them.
It is important that you revise, and are happy with, the unit on Books of Prime Entry in Module I.
You will not be asked to write up these books, but, as you will see, it is very likely that you will
be presented with errors that have been made in these books.
8.2 Objectives
By the end of this unit, you should be able to;
(i) Explain the purpose of control accounts
(ii) Reconcile respective sub-ledgers with their control accounts
(iii) Correct the errors
8.3 Control Accounts
A control account is a total account to which is debited and credited, in total, all the transactions
that have been debited and credited in detail to the individual ledger accounts. Control accounts
are used with regard to receivables and payables balances
You will remember that in practice, the following occurs if we make a sale on credit:
a) The invoice is listed in the Receivables Journal (no double entry)
b) The amount of the invoice is taken from the Receivables Journal and entered in the account
of the relevant customer in the Receivables Ledger (not double entry)
c) At the month end, the total of the Receivables Journal is posted in the Nominal Ledger:
Debit: Receivables account,
Credit: Sales account
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In a similar way, if cash is received from a customer:
a) The amount is listed in the Cash Receipts book (no double entry)
b) The amount of the receipt is taken from the Cash Receipts book and entered in the account
of the relevant customer in the Receivables Ledger (no double entry)
c) At the month end, the total of the Cash Receipts book is posted in the Nominal Ledger:
Debit: Cash account;
Credit: Receivables account.
As a result, we end up with several ‘receivables’ accounts. We have an account for each individual
customer in the Receivables Ledger, and also a (total) Receivables account in the Nominal Ledger.
To avoid any confusion, we call the account in the Nominal Ledger the Total Receivables Account,
or (more commonly) the Receivables Ledger Control Account.
An obvious check that we can perform every month is to ask the bookkeeper in charge of the
Receivables Ledger to list all the individual balances and to total them up. This total should agree
with the balance on the Receivables Ledger Control Account. If the two figures do not agree, then
there must be an error (or errors) that need to be corrected.
If the Receivables Ledger Control Account contains errors, then our Financial Statements will be
incorrect. If the Receivables Ledger contains errors, then we risk chasing individual customers for
the wrong amounts, or alternatively not chasing debtors when we should be doing so.
This check will not discover all types of errors, but is a simple exercise to perform and certainly
detect many types of errors.
8.4 Benefits of maintaining control accounts
If the control accounts are kept purely as memorandum records then they are not necessary for the
double entry system to function fully. However the control accounts will still have some uses for
the firm and these are as follows:
(i) If the control accounts do not balance then it is obvious that a mistake has taken place in
the respective ledger. This will save time in the locating of the error. If we relied on the
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trial balance alone then we would have to check all the three main ledgers as well as the
cashbook.
(ii) Control accounts can be kept by a person who is not he same person who maintains the
personal accounts of debtors and creditors. In this case, fraud is less likely to occur
(unless both the ledger clerks and the person maintaining the control accounts are in
collaboration together).
(iii)The debtors and creditor figures can be ascertained more speedily for construction of the
trial balance, than having to balance off each individual personal account in the sales
and purchases ledgers.
(iv) Errors not affecting the trial balance
Given the many entries that are made in the ledger accounts, it is not surprising to know
that errors will be frequently made when making these entries. Most firms, even if using
computerised system will make mistakes in the double entry accounts. Fortunately, there
are various ways in which an account can be checked or verified, such s the use of control
accounts, bank reconciliation statements and the trial balance.
8.5 Preparing a control account reconciliation
The format of a control account reconciliation, in this case for receivables, is as follows:
Receivables control account
This is often known as sales control account or total debtors account. It is a summary account of
the individual debtors ‘ledger balances.
Format and Double Entry
The general format of the debtors control account is shown below.
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Dr Cr
K K
Balance b/d x Balance b/d x
Sales x Cash x
Dishonored bills of exchange x Discount allowed x
Returned cheques x Sales returns x
Sundry journal debits x Bad debts x
Balance c/d x Bills receivable x
Sundry journal credits x
Balance c/d x
x x
Balance b/d x Balance b/d x
Receivables ledger control a/c
We shall now consider each of the above entries in turn, together with the double entry.
Remember that we are regarding the control account as part of the double entry system (and not
the individual debtors ‘ledger accounts).
On the debit side
a) Balance b/d
This represents the total amount owing by debtors at the beginning of the period.
b) Sales
This information has been obtained from the sales day book and the double entry is:
Debit: Debtors control account
Credit: Sales account
Memo entries are also made on the individual debtors' ledger records or accounts (although the
format of these is not important as they are outside the double entry system).
c) Dishonoured bills of exchange
Both the above items occur because a bill of exchange proves non-collectable or a cheque is
dishonoured –it 'bounces'. The original bill or cheque will have removed the debt from the
control account and this can be considered as a reinstatement of the entry for the sum owing.
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Information is obtained from the journal, in the case of a bill of exchange, and from the cash
book in the case of a cheque. The double entry is:
Debit: Debtors control account
Credit: Bills of exchange account or Cash at bank account.
d) Sundry journal debits
These were considered earlier unit under ‘Journals & Sales tax’, together with sundry journal
credits, once the total creditors account has also been discussed, as they often arise because of
transfers between control accounts.
e) Balance c/d
This arises where (say) a debtor has overpaid his account; for example, he has been sold goods
worth K75 and paid K80.
It would be incorrect to deduct the K5 overpaid from the total owing by the other debtors, as
this would result in an understatement of debtors (trade receivables) on the statement of
financial position (balance sheet). Instead, it is shown separately in the debtors control account
and classified as a current liability (overpayment by debtor) on any statement of financial
position.
On the credit side
a) Balance b/d
This represents the total amount owed back to debtors at the beginning of the period.
b) Cash
This represents sums received from debtors during the period and the information has been
obtained from the cash book. Often the trader will add an extra column on the debit side of
the cash book (in a similar manner to 'discounts allowed' discussed in an earlier chapter) into
which all cash received from debtors is inserted:
c) Discount allowed
As shown above, this information can be also obtained from the cash book:
K K
Debit: Discount allowed account 70
Credit: Debtors control account 70
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d) Sales returns
This information is obtained from the sales returns day book and the double entry is:
Debit: Sales returns account
Credit: Debtors control account
e) Bad debts
This information is obtained from the journal. The double entry is:
Debt: Bad debts account
Credit: Debtors control account
f) Bills receivable
These are a method of 'paying' for debtors and are really a 'swap' of an unofficial undertaking
to pay for goods for an official one. The definition of a bill of exchange is:
An unconditional order in writing, addressed by one person to another ..., requiring the person
to whom it is given to pay on demand or at a fixed or determinable future time, a certain sum
in money to, or to the order of, a specified person.
The double entry is:
Debit: Bills receivable account
Credit: Debtors control account
g) Balance c/d
This represents sums owed by debtors at the end of the period concerned, capable of proof
against individual debtors ‘records.
Hence, the control account is built up not from an analysis of debtors' accounts, but from
information provided from subsidiary books such as day books, the journal and the cash book.
8.6 The Payables Ledger Control Account
Throughout this unit so far, we have been using sales on credit to illustrate the use of Control
Accounts.
However, exactly the same situation occurs with purchases on credit, and the balance on the Total
Payables Account – or Payables Ledger Control Account – should equal the total of the list of
individual balances in the Payables Ledger.
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Returns, discounts and contra entries stand to be applicable in exactly the same sort of way as with
the Receivables Ledger Control Account.
Activity 1
EXAMPLE 1
Ganizani Co, proves the accuracy of its receivables and payables ledgers by preparing monthly
control accounts. At 1 September 2017 the following balances existed in the company’s accounting
records, and the control accounts agreed:
Debit Credit
K K
Receivables ledger control account 186,220
Payables ledger control account 89,290
The following are the totals of transactions which took place during September 2017, as extracted
from the company’s records.
K
Credit sales 101,260
Credit purchases 68,420
Sales returns 9,160
Purchases returns 4,280
Cash received from customers 91,270
Cash paid to suppliers 71,840
Cash discounts allowed 1,430
Cash discounts received 880
Irrecoverable debts written off 460
Refunds to customers 300
Contra settlements 480
Prepare the receivables ledger control and payables ledger control (total) accounts for the
month of September 2017
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Solution
(i) Receivables ledger control account
Dr Cr
K K
Balance b/d 186,220 Returns 9,160
Sales 101,260 Cash 91,270
Refunds 300 Discounts 1,430
Irrecoverable debts 460
Contras 480
Balance c/d 184,980
287,780 287,780
Balance b/d 184,980
Receivables ledger control a/c
(ii) Payables ledger control account
Dr Cr
K K
Returns 4,280 Balance b/d 89,290
Cash 71,840 Purchases 68,420
Discounts 880
Contras 480
Balance b/d 80,230
157,710 157,710
Payables ledger control a/c
8.7 Exercise
1. The following control account has been prepared by a trainee accountant:
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Dr Cr
K K
Opening balance 740,640 Cash from credit customers 353,280
Credit sales 370,080 Discount allowed 3,360
Cash sales 211,440 Interest on overdue accounts 5,760
Contras - offset 11,040 Irrecoverable debts 11,760
Allowances for receivables 6,720
Closing balance 952,320
1,333,200 1,333,200
Receivables ledger control a/c
What should the closing balance be when all the errors made in preparing the
receivables ledger control account have been corrected?
A. K948,480
B. K730,320
C. K742,800
D. K737,040
(2 marks)
2. Peter received a statement of account from a supplier Paul, showing a balance to be paid
of K8, 950. Peter’s payables ledger account for Paul shows a balance due to Paul of K4,140.
Investigation reveals the following:
1) Cash paid to Paul K4,080 has not been allowed for by Paul
2) Peter’s ledger account has not been adjusted for K40 of cash discount disallowed
by Paul.
What discrepancy remains between Peter’s and Paul’s records after allowing for
these items?
A. K690
B. K770
C. K9,850
D. K9,930
(2 marks)
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3. Junitor is a sole trader who does not keep full accounting records. The following details
relate to his transactions with credit customers and suppliers for the year ended 30 June
2018:
K
Trade receivables, 1 July 2017 130,000
Trade payables, 1 July 2017 60,000
Cash received from customers 686,400
Cash paid to suppliers 302,800
Discounts allowed 1,400
Discounts received 2,960
Contra between payables and receivables ledgers 2,000
Trade receivables, 30 June 2018 181,000
Trade payables, 30 June 2018 84,000
What figure should appear in Janitor’s Statement of Profit or Loss for the year
ended 30 June 2018 for purchases?
A. K331,760
B. K740,800
C. K283,760
D. K330,200
4. The total of the list of balances in Adele’s payables ledger was K438, 900 at 30 June 2018.
This balance did not agree with Adele’s payables ledger control account balance. The
following errors were discovered:
1) A contra entry of K980 was recorded in the payables ledger control account, but
not in the payables ledger
2) The total of the purchase returns journal was under cast by K1, 000.
3) An invoice for K4, 344 was posted to the supplier’s account as K4, 434.
What amount should Adele report in its Statement of Financial Position as accounts
payable at 30 June 2018?
A. K436,830
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B. K438,010
C. K439,790
D. K437,830
(2 marks)
5. A debit entry to the sales account could represent
A. Cash sales
B. Credit sales or the correction of an error
C. Irrecoverable debts written off
D. The correction of an error or goods returned
(2 marks)
6. The payables ledger control account below contains a number of errors:
Dr Cr
K K
Opening balance (owed to
suppliers) 318,600 Purchases 1,268,600
Cash paid to suppliers 1,364,300
contras agaisnt debit
balances in receivables
ledger 48,000
Purchases returns 41,200 Discounts received 8,200
Refunds received from suppliers 2,700 Closing balance 402,000
1,726,800 1,726,800
Payables ledger control a/c
All items relate to credit purchases.
What should the closing balance be when all the errors are corrected?
A. K128,200
B. K509,000
C. K224,200
D. K144,600
(2 marks)
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8.8 Summary
Not every manager can fully understand and appreciate book-keeping principles, however control
accounts are meant to bridge that gap at some point. Control accounts can be used as a tool by non-
finance professional to quickly check the balances on either receivables or payables balances. In
short this means that control accounts are easy to prepare as anyone can easily draw up a control
account and have any over view of how much is owed to us and by us. Ensure that you are in a
position to prepare control accounts and correct any identifiable errors.
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UNIT 9
ADJUSTMENTS TO PROFITS AND SUSPENSE ACCOUNTS
9.1 Introduction
In Unit 8 of Module 1, you learnt about errors that do not affect the trial balance. However, there
are many errors that have an effect on the trial balance. In this unit you will be taught how to deal
with such errors temporarily in order for you to prepare the financial statements and use the
suspense account accordingly.
9.2 Objectives
By the end of this unit, you should be able to;
(i) Prepare a statement of adjustments to profits
(ii) Explain why a suspense account may be used
(iii)Correct errors using a suspense account
(iv) Explain why using a suspense account is generally inappropriate
9.3. Adjustments to Profits
These are two areas, often related, asking you to show the effect of correcting errors. They are a
good way of testing your knowledge and understanding of bookkeeping, without requiring you to
produce lots of t-accounts.
In these questions, a set of draft (or rough) financial statements have been prepared. However,
subsequently various errors and omissions have been discovered.
Our task is to calculate the correct profit. However, you are not required to produce a new
Statement of Profit or Loss. Therefore we produce a statement which starts with the profit from
the financial statements, adds or subtracts to adjust for the various errors listed, and ends with the
correct profit.
Activity 1
Example
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Alison’s draft financial statements show a net profit for the year of K52, 380. Subsequently, the
following errors come to light:
a) No entry has been made for K563 cash received from Adele, a customer whose debt was
written off last year as irrecoverable.
b) Closing inventory valued in the draft accounts at its cost of K8,920, was believed to have
a potential sales value of K7,930
c) Goods which had cost K2,000 had been sent to a customer just before the year end on a
sale or return basis. These had been accounted for as a firm sale, with a profit of 20% of
cost. No confirmation of the sale had been received from the customer.
d) A payment for rent charged in full to the current year included K490 which relates to the
next accounting period. No adjustment had been made for this when preparing the draft
accounts.
Prepare a statement of adjustments to profit in order to calculate the correct net profit for
the year.
Solution:
K
Draft Profit 52,380
Debt recovered 563
Closing inventories (8,920 - 7,930) (990)
Sales or return (400)
Prepayment 490
Adjusted Profit 52,043
Statement of Adjustments to Profits
9.4 Suspense Account
In Unit 9 of Module 1, we looked at the Trial Balance. The trial balance should balance, and if it
does not then there must be errors somewhere that need to be found.
However, it is likely that the difference on the trial balance is the net result of several errors. In
practice, we would have to start checking the bookkeeping entries until we found an error. It would
then be useful to have a note of how much errors still remained in order that we would know when
we had finally found all the errors.
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A common way of doing this (and a common exercise in the examination) is to open a t-account
called the Suspense Account (or Difference Account) with a balance equal to the trial balance
difference. This is in some ways an artificial account, in that had the double entries all been correct
then there would be no trial balance difference.
However, it does provide a useful check when finding errors. Every time we find an error in the
bookkeeping, we will correct it and at the same time make an entry in the Suspense Account to
show that part of the difference had been found. When all the errors have been found, the balance
on the Suspense Account will fall to zero.
Activity 2
Bukuta prepared the following trial balance:
Dr Cr
Motor Van, at cost 5,500
Inventory 6,230
Receivables Ledger Control 19,167
Cash at bank 218
Petty Cash 50
Payables Ledger Control Account 13,166
Prepayments 490
Accruals 70
Motor Van – accumulated depreciation 2,000
Sales 93,870
Purchases 76,182
Rent expense 1,200
Wages expense 12,500
Electricity expense 516
Telephone expense 230
Accountancy expense 500
Van expenses 280
Depreciation expense 1,000
Capital 10,000
Total 124,063 119,106
The trial balance does not balance, and Bukuta realises that this means that there must be errors in
the bookkeeping.
On investigation, the following errors are discovered:
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a) A transposition error was made when posting a sales day book total of K8, 132. The correct
figure was entered in the receivables ledger control account, but it was posted to the sales
account as K1,832
b) The balance on the electricity account was incorrectly recorded and should read K615
c) One cash payment for electricity of K200 had been recorded throughout as K20
d) When accounting for the telephone accrual of K70 at the year end, a single entry had been
made. It was the expense account entry that had been missed out.
e) A mistake had been made when casting the purchases account. The total should have been
K77,356
You are required to open a suspense account. For each error make any relevant entries in
the suspense account.
Solution:
Dr Cr
K K
Sales 6,300 Balance 4,967
Electricity 99
Telephone 70
Purchases 1,174
6,300 6,310
Suspense a/c
9.5 Exercise
1. The debit side of a company’s trial balance totals K1,920 more than the credit side.
Which one of the following errors would fully account for the difference?
A. K960 paid for plant maintenance has been correctly entered in the cash book and
credited to the plant asset account.
B. Discount received K960 has been debited to discount allowed account
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C. A receipt of K1920 for commission receivable has been omitted from the records
D. The petty cash balance of K1920 has been omitted from the trial balance.
(2 marks)
2. A company’s Statement of Profit or Loss for the year ended 31 December 2015 showed a
net profit of K200, 640. It was later found that K43, 200 paid for the purchase of a motor
van had been debited to the motor expenses account. It is the company’s policy to
depreciate motor vans at 25% per year on the straight line basis, with a full year’s charge
in the year of acquisition.
What would the net profit be after adjusting for this error?
A. K254,640
B. K168,240
C. K233,040
D. K243,840
(2 marks)
3. Tom’s trial balance failed to agree and a suspense account was opened for the difference.
The following errors were found in Tom’s accounting records:
1) In recording an issue of shares at par, cash received of K333,000 was credited to
the ordinary share capital account as K330,000
2) Cash K2,800 paid for plant repairs was correctly accounted for in the cash book but
was credited to the plant asset account
3) The petty cash book balance K500 had been omitted from the trial balance
4) A cheque for K78, 400 paid for the purchase of a motor car was debited to the motor
vehicles account as K87, 400.
Which of the errors will require an entry to the suspense account to correct them?
A. 1, 2 and 4 only
B. 1, 2, 3 and 4
C. 1 and 4 only
D. 2 and 3 only
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(2 marks)
4. In October 2006 James sold some goods on sale or return terms for K2, 500. Their cost to
James was K1, 500. The transaction has been treated as a credit sale in James’s financial
statements for the year ended 31 October 2016. In November 2016 the customer accepted
half of the goods and returned the other half in good condition.
What adjustments, if any, should be made to the financial statements?
A. Sales and receivables should be reduced by K2, 500, and closing inventory
increased by K1, 500.
B. Sales and receivables should be reduced by K1,250, and closing inventory
increased by K750
C. Sales and receivables should be reduced by K2,500, with no adjustment to closing
inventory
D. No adjustment is necessary
5. A business received a delivery of goods on 29 June 2016, which was included in inventory
at 30 June 2016. The invoice for the goods was recorded in July 2016.
What effect will this have on the business?
1) Profit for the year ended 30 June 2016 will be overstated.
2) Inventory at 30 June 2016 will be understated.
3) Profit for the year ending 30 June 2017 will be overstated.
4) Inventory at 30 June 2016 will be overstated.
A. 1 and 2
B. 2 and 3
C. 1 only
D. 1 and 4
(2 marks)
6. Which of the following errors would cause a trial balance not to balance?
1) An error in the addition in the cash book.
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2) Failure to record a transaction at all.
3) Cost of a motor vehicle debited to motor expenses account. The cash entry was
correctly made.
4) Goods taken by the proprietor of a business recorded by debiting purchases and
crediting drawings account.
A. 1 only
B. 1 and 2 only
C. 3 and 4 only
D. All four items
(2 marks)
7. The bookkeeper of Barbara made the following mistakes:
Discounts allowed K3, 840 was credited to the discounts received account
Discounts received K2, 960 was debited to the discounts allowed account
Which journal entry will correct the errors?
DR CR
A Discounts allowed K7, 680
Discounts received K5, 920
Suspense account K1, 760
B Discounts allowed K880
Discounts received K880
Suspense account K1, 760
C Discounts allowed K6, 800
Discounts received K6, 800
D Discounts allowed K3, 840
Discounts received K2, 960
Suspense account K880
(2 marks)
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9.6 Summary
When preparing financial statements, you will discover a number of errors that require adjustments
before finalising the final accounts. This unit introduced you to the Suspense account and the
Statement of Adjustment to Profits. You need to bear in mind that the suspense account is used to
clear unknown balances pending reconciliations. However at the end of each accounting period,
you should ensure that the suspense account is cleared to a nil balance. As we have looked at
adjustments to profits and suspense accounts, you should now be able to:
(i) Prepare a statement of adjustments to profits
(ii) Explain why a suspense account may be used
(iii)Correct errors using a suspense account
(iv) Explain why using a suspense account is generally inappropriate
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UNIT 10
Partnerships
10.1 Introduction
So far you have learnt about preparing financial statements for a sole trader. The same principles
are applicable when you prepare the financial statements of a partnership. This unit will therefore
focus on other aspects that affect partnerships other than the preparation o financial statements.
10.2 Objectives
By the end of this unit you should be able to:
(v) Define partnership
(vi) Identify the different types of partnership
(vii) Describe the main features of partnership agreement
(viii) draw up the ledger accounts and financial statements for a partnership
(ix) calculate the adjustments needed when there is some form of change in a partnership
10.3 Nature of a Partnership
You have learnt that being a sole trader means being in control of the business; being responsible
for all the decision-making and being entitled to all the profits of the business or having to suffer
all its losses. However, practising as a sole trader can be restrictive in two main areas:
(i) Limited time available (i.e. hours put in by sole trader himself).
(ii) Limited resources available (i.e. capital contributed by the sole trader, although loans, etc.
may be available).
Forming a partnership may lift these restrictions in that more person-hours and more capital
become available. It may also become easier to obtain a loan. However you have to be aware of
the fact that, in a partnership no one person has total control nor a right to all the profits.
You will discover that partnerships are commonly found:
(i) In family businesses.
(ii) Where two or more sole traders have come together to form a partnership.
(iii)In professional firms such as solicitors, accountants and doctors.
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10.3.1 Definition of a Partnership
It is important that before you proceed to learn more about partnerships, you should have a clear
understanding of what a partnership is.
According to Section 1 of the Partnership Act 1890, a partnership is defined as follows:
"The relation which subsists between persons carrying on a business in common with a view to
profit".
In keeping with this definition, the essential elements of a partnership are as follows.
a) There must be a business. Under the term 'business’, we include trades of all kinds and
professions, although the rules of a particular profession may disallow partnerships
between its own members (for example, in the case of barristers).
b) The business must be carried on in common.
c) The parties must carry on the business with the object of gain. There are many associations
of persons where operations in common are carried on, but as they are not carried on with
the view to profit, they are not considered as partnerships For example, a sports club).
10.3.2 Types of Partnerships
There are two main kinds of partnership that you should be aware of and these are:
(a) Ordinary or General partnership
There are a number of ordinary partners, each of whom contributes an agreed amount of
capital, is entitled to take part in the business (but is not entitled to a salary for so doing,
unless specially agreed) and to receive a specified share of the profits or losses. Each
partner is jointly liable to the extent of his/her full estate for all the debts of the partnership.
(b) Limited liability partnerships
In the United Kingdom, Limited liability partnerships (LLPs) were introduced by the
Limited Liability Partnership Act 2017. These are something of a hybrid between an
incorporated company and an ordinary partnership. The partnership has a separate legal
identity, separate from its owners, in the same way as accompany. The owners (the
partners) of Partnerships 219 the LLP have the same rights as in an ordinary partnership,
but have limited liability for the debts of the partnership (limited to the extent of their
investment in the capital of the business), although the business itself is liable for all debts
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to the extent of its assets. You should be aware that the partnership is required to be
registered and must file annual accounts (as with a company). This form of partnership has
proved very popular with professional businesses, such as solicitors and accountants.
10.3.3 Kinds of Partner
When you are enter into a partnership, you can be one the following partners described below
depending on your roles in the agreement:
(a) Active partner
One who takes an active part in the business; such partners may have unlimited or limited
liability, depending on the type of partnership.
(b) Dormant or sleeping partner
This type of a partner retires from active participation in the business, but leaves capital in
the business and receives a reduced share of the profits. (Such partners may also have
unlimited or limited liability, depending on the type of partnership.)
(c) Quasi partner
This partner, retires and leaves capital in the business as a loan. Interest, based on a
proportion of the profits, is credited to the retired partner's account each year and debited
as an expense to Statement of Profit or Loss. This type of partner would be more accurately
described as a deferred creditor i.e. one who receives payment after all other creditors.
Now let us compare the features of a partnership to those of a limited company. The table below
illustrates the differences between these two types of entities:
Ordinary Partnership Limited Liability
Partnership
Public Limited Company
Maximum number of
partners is 20, with certain
exceptions.
No maximum number of
partners.
No maximum number of
shareholders.
A partner cannot transfer an interest to another so as to
constitute a partner. A new partner can be introduced only
if all existing partners agree.
A shareholder may freely
transfer or assign his/her
shares to another.
Partners are managers of the business and agents for the
firm.
A shareholder (unless a
director) does not act as a
manager nor as an agent of
the company.
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The liability of partners is
unlimited.
Liability of partners is
limited to the amounts they
have contributed in capital.
Liability of shareholders is
limited to the amounts they
have signed to pay for their
shares.
Ordinary Partnership Limited Liability
Parternship
Public Limited Company
A partnership has no
separate legal existence
(except in Scotland).
A LLP is a separate legal
entity quite distinct from
the partners.
A company is a separate
legal entity quite distinct
from the shareholders.
A partnership can be made
bankrupt.
An insolvent LLP is wound
up.
An insolvent company is
wound up.
A partnership terminates on
the death of a partner. If
the survivors remain in
business, this is a fresh
partnership.
The partnership does not
cease to exist if a partner
dies.
A company does not cease
to exist if a shareholder
dies.
10.4 Partnership Agreement
Before you enter into a partnership, you need to agree on how the partnership business will be
conducted. You will also have to agree on the roles and responsibilities of each partner, profit
sharing ratios etc. The usual accounting contents are:
1. Capital Contributions
Partners need not contribute equal amounts of capital. What matters is how much capital
each partner agrees to contribute. It is not unusual for partners to increase the amount of
capital they have invested in the partnership.
2. Profit (or Loss) sharing ratios
Partners can agree to share profits/losses in any ratio or any way that they may wish.
3. Interest on Capital
If the work to be done by each partner is of equal value but the capital contributed is
unequal, it is reasonable to pay interest on the partners’ capitals out of partnership profits.
This interest is treated as a deduction prior to the calculation of profits and their distribution
among the partners according to the profit sharing ratio. The rate of interest is a matter of
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agreement between the partners, but it should equal the return which they would have
received if they had invested the capital elsewhere.
4. Interest on Drawings
It is obviously in the best interests of the firm if cash is withdrawn from the firm by the
partners in accordance with the two basic principles of: (a) as little as possible, and (b) as
late as possible. The more cash that is left in the firm the more expansion can be financed,
the greater the economies of having ample cash to take advantage of bargains and of not
missing cash discounts because cash is not available and so on.
To deter the partners from taking out cash unnecessarily the concept can be used of
charging the partners interest on each withdrawal, calculated from the date of withdrawal
to the end of the financial year. The amount charged to them helps to swell the profits
divisible between the partners. The rate of interest should be sufficient to achieve this
without being too harsh.
5. Partnership salaries
One partner may have more responsibility or tasks than the others. As a reward for this,
rather than change the profit and loss sharing ratio, the partner may have a partnership
salary which is deducted before sharing the balance of profits.
6. Performance-related payments to partners
Partners may agree that commission or performance-related bonuses be payable to some
or all the partners linked to their individual performance. As with salaries, these would be
deducted before sharing the balance of profits.
The other contents of the partnership that we will not discuss into detail may include:
1. Arrangements for admission of new partners
2. Procedures to be carried out when a partner retires or dies.
You will discover that in real life, a clear partnership agreement may not exist. The question is,
how do you share profits, whom do you pay salaries and at what rate etc. Where no express
provision has been made in partnership agreement, or in the absence of any such agreement, default
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provisions are specified in the relevant legislation. You will discover that section 24 of the
Partnership Act 1890 states the following:
(a) Profits and losses are to be shared equally.
(b) There is to be no interest allowed on capital.
(c) No interest is to be charged on drawings.
(d) Salaries are not allowed.
(e) Partners who put a sum of money into a partnership in excess of the capital they have agreed
to subscribe are entitled to interest at the rate of 5 per cent per annum on such an advance.
Section 24 applies where there is no agreement. There may be an agreement not by a partnership
deed but in a letter, or it may be implied by conduct, for instance when a partner signs a balance
sheet which shows profits shared in some other ratio than equally. Where a dispute arises as to
whether an agreement exists or not, and this cannot be resolved by the partners, only the courts are
competent to decide.
10.5 Distribution of Profits
At this stage, it will be helpful if we place these various items together in a worked example as
this will help understand it better. Will start by illustrating to you about the distribution of profits.
Taylor and Clarke have been in partnership for one year sharing profits and losses in the ratio of
Taylor 3/5, Clarke 2/5. They are entitled to 5 per cent per annum interest on capitals, Taylor having
£20,000 capital and Clarke £60,000. Clarke is to have a salary of £15,000. They charge interest on
drawings, Taylor being charged £500 and Clarke £1,000. The net profit, before any distributions
to the partners, amounted to £50,000 for the year ended 31 December 2017. The following shows
how these events were accounted for:
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Net profit 50,000
Add Charged for interest on drawings:
Taylor 500
Clarke 1,000
1,500
51,500
Less Salary: Clarke 15,000 15,000
Interest on capital:
Taylor 1,000
Clarke 3,000
4,000
(19,000)
Balance of profits 32,500
Shared:
Taylor 3/5 19,500
Clarke 2/5 13,000
32,500
Arising from the above, we can conclude that the profits of K50, 000 were distributed as follows:
Taylor Clarke
Balance of Profits 19,500 13,000
Interest on Capital 1,000 3,000
Salary - 15,000
20,500 31,000
Less Interest on drawings (500) (1,000)
20,000 30,000
As you may have noticed, we started the illustration after the net profit had already been arrived.
This is explained under section 10.5.1 below.
10.5.1 Financial Statements of Partnerships
You would notice that the sales, stock and expenses of a partnership are usually the same as that
of a sole trader, therefore the Statement of Profit or Loss would be identical with that as prepared
for the sole trader. However, a partnership would have an extra section shown under the profit and
loss account. This section is called the profit and loss appropriation account, and it is in this account
were you will show the distribution of profits. The heading to the trading and profit and loss
account for a partnership does not normally include the words ‘appropriation account’. It is purely
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an accounting custom not to include it in the heading. (Sometimes you may be asked to include it
in the heading)
Now let us look at the example in 10.5 above again taking into consideration the above
explanations pertaining to the ‘Profit and Loss Appropriation account. The profit and loss
appropriation account of Taylor and Clarke from the details given would be:
Net profit (from Profit and Loss Account) 50,000
Interest on drawings:
Taylor 500
Clarke 1,000
1,500
51,500
Less Salary: Clarke 15,000
Interest on capital:
Taylor 1,000
Clarke 3,000
4,000
(19,000)
Balance of profits shared: 32,500
Taylor 3/5 19,500
Clarke 2/5 13,000
32,500
Taylor and Clarke
Statement of Comprehensive Income for the year ended 31 December 2017
(Trading Account - same as Sole trader)
(Profit and Loss Account - same as Sole trader)
Profit and Loss and Appropriation Account
You will notice that the Profit and Loss Appropriation in the above illustration is similar to the
example on distribution of profits in 10.5 above. It is important that you note the difference as this
will be applicable in your final examinations. The assumption taken in this example is that, the
Statement of Profit or Loss for the partnership are the same as for sole trader. It is for this reason
that this example explicitly states that the ‘Trading Account, Profit and Loss Account same as Sole
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Trader’. However in your exam you may be expected to show all the calculations commencing
with the trading and profit and loss account. So it is important that you appreciate that the trading
and profit and loss account for the partnership is no different from that of a sole trader.
10.6 Capital Accounts
You may recall from your earlier studies of this module that a capital account is used to account
for any contributions and drawings of profits by the owner. The cash and assets contributed by
each partner constitute his/her capital and you will account for their capital accounts.
If the partnership agreement provides that capitals are to remain fixed (i.e. unaltered), you should
open a separate current account for each partner to record share of profits, salary, interest on
capital and loans, drawings (transferred from drawings account) and interest on drawings.
Unless it is specified that profits, etc. are to be adjusted in the capital account, you should always
open a current account.
Where fixed capitals apply, any moneys later advanced by the partners must be treated as loans
(unless they agree to incorporate such advances in capitals). These loans bear interest at 5% per
year, or such other rate as may be agreed upon.
In other words there are two choices open to partnerships: fixed capital accounts plus current
accounts, and fluctuating capital accounts.
1. Fixed capital accounts plus current accounts
The capital account for each partner remains year by year at the figure of capital put into the
firm by the partners. The profits, interest on capital and the salaries to which the partner may
be entitled you will credit the current account for the partner, and the drawings and the interest
on drawings you will debit. The balance of the current account at the end of each financial year
will then represent the amount of undrawn (or withdrawn) profits. A credit balance will be
undrawn profits, while a debit balance will be drawings in excess of the profits to which the
partner was entitled.
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If we continue with the example of Taylor and Clarke, their capital and current accounts,
assuming drawings of K15,000 for Taylor and K26,000 for Clarke will be as follows:
2007 £
1-Jan Bank 20,000
2007 £
1-Jan Bank 60,000
Taylor - Capital
Clarke - Capital
2017 K 2017 K
31-Dec Cash: Drawings 15,000 31-Dec P&L Appropriation:
P&L Appropriation: Interest on Capital 1,000
Interest on Drawings 500 Share of profits 19,500
Balance c/d 5,000
20,500 20,500
2018
01-Jan Balance b/d 5,000
2017 K 2017 K
31-Dec Cash: Drawings 26,000 31-Dec P&L Appropriation:
P&L Appropriation: Salary 15,000
Interest on Drawings 1,000 Interest on Capital 3,000
Balance c/d 4,000 Share of profits 13,000
31,000 31,000
2018
01-Jan Balance b/d 4,000
Taylor - Current account
Clarke - Current account
Notice that the salary of Clarke was not paid to him, it was merely credited to his current account.
If instead it was paid in addition to his drawings, the K15,000 cash paid would have been debited
to the current account, changing the K4,000 credit balance into a K11,000 debit balance.
Note also that the drawings have been posted to the current accounts at the end of the year.
The amounts withdrawn which add up to these amounts were initially recorded in the Cash
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Book. Only the totals for the year are posted to the current account, rather than each individual
withdrawal.
In the examination you will often be asked to show the capital accounts and current accounts
in columnar form. For Taylor and Clarke, these would appear as follows:
Taylor Clarke Taylor Clarke
2017 K K 2017 K K
01-Jan Bank 20,000 60,000
Taylor Clarke Taylor Clarke
2017 K 2017 K
31-Dec Cash: Drawings 15,000 26,000 31-Dec Salary 19,500 15,000
Interest on Drawings 500 1,000 Interest on Capital 1,000 3,000
Balance c/d 5,000 4,000 Share of profits 13,000
20,500 31,000 20,500 31,000
2018
01-Jan Balance b/d 5,000 4,000
Capital accounts
Capital accounts
2. Fluctuating capital accounts
When you maintain fluctuating capital accounts, you would credit the capital account with the
share of profits, debit it with drawings and interest on drawings. Therefore the balance on the
capital account will change each year, i.e. it will fluctuate.
Using the same example of Taylor and Clarke, their Capital accounts would look like this:
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2017 K 2017 K
31-Dec Cash: Drawings 15,000 01-Jan Bank 20,000
P&L Appropriation: 31-Dec P&L Appropriation:
Interest on Drawings 500 Interest on Capital 1,000
Balance c/d 25,000 Share of profits 19,500
40,500 40,500
2018
01-Jan Balance b/d 25,000
2017 K 2017 K
31-Dec Cash: Drawings 26,000 01-Jan Bank 60,000
P&L Appropriation: 31-Dec P&L Appropriation:
Interest on Drawings 1,000 Salary 15,000
Balance c/d 64,000 Interest on Capital 3,000
Share of profits 13,000
91,000 91,000
2018
01-Jan Balance b/d 64,000
Taylor - Current account
Clarke - Current account
You will discover that the keeping of fixed capital accounts plus current accounts is considered
preferable to fluctuating capital accounts. When you as a partner; are in the habit of taking out
greater amounts than the share of the profits that you are entitled to, this is shown up by a debit
balance in your current account and so acts as a warning.
10.7 Statement of Financial Position
The statement of financial position will not be very different from that of a sole trader. In this case
you will be expected to prepare the statement of financial position the same way you prepare that
of a sole trader. Please take note that this is just an extract of the statement of financial position:
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Capital accounts Taylor 20,000
Clarke 60,000
80,000
Current accounts Taylor Clarke
Salary 15,000
Interest on capital 1,000 3,000
Share of profits 19,500 13,000
20,500 31,000
Less drawings (15,000) (26,000)
Interest on drawings (500) (1,000)
5,000 4,000 9,000
Extract of Statement of Financial Position as at 31 December 2017
Now suppose if one of the current accounts had finished in debit, for instance if the current account
of Clarke had finished up as K400 debit. You would show the figure of K400 in brackets and the
balances would appear net in the totals column as illustrated below:
Taylor Clarke
K K K
Closing balance 5,000 (400) 4,600
If the net figure turns out to be a debit figure then you will deduct from the total of the capital
accounts.
10.8 Change in Partnership Form
At any point in time, you may wish to change the form of your partnership due to a number of
reasons. You may change the profits or loss sharing ratios as a result of any of the following
reasons:
(i) A partner may now not work as much as in the past, possibly because of old age or ill-
health.
(ii) A partner’s skills and ability may have changed, perhaps after attending a course or
following an illness.
(iii)A partner may now be doing much more for the business than in the past or
(iv) You are admitting a new partner
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Why would you admit a new partner? Mostly you would admit a new partner because of some of
the following reasons:
(i) As an extra partner, either because the firm has grown or because someone is needed with
different skills.
(ii) To replace partners who are leaving the firm. This might be because of retirement or death
of a partner.
When this happens you will be expected to pass certain adjustments so as to reflect the change
or the new form.
During your examination, you will not be assessed on the adjustments relating to goodwill,
however you are encouraged to do further research as this will help you in the future.
Worked Example
Wilson, Player and Sharp are in partnership. They shared profits in the ratio 2:4:3. It is decided to
admit Titmus. It is agreed that goodwill is worth K72, 000 and that it is to be brought into the
business records. Titmus will bring K30, 000 cash into the business for capital. The new profit-
sharing ratio is to be Wilson 5: Player 8: Sharp 4: Titmus 3.
The statement of financial position before Titmus was introduced was as follows:
K
Assets (Other than Cash) 200,000
Cash 2,000
Total Assets 202,000
Capital: Wilson 57,000
Player 76,000
Sharp 38,000
171,000
Liabilities 31,000
Capital and Liabilities 202,000
Show:
a) The entries in the capital accounts of Wilson, Player, Sharp and Titmus, the accounts to be in
columnar form.
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b) The statement of financial position after Titmus has been introduced.
Solution
The solution for the above example is as follows:
(a) Capital Accounts
Wilson Player Sharp Titmus Wilson Player Sharp Titmus
Bal c/d 73,000 108,000 62,000 30,000 Bal b/d 57,000 76,000 38,000
Cash 30,000
Share of Goodwill 16,000 32,000 24,000
73,000 108,000 62,000 30,000 73,000 108,000 62,000 30,000
Bal b/d 73,000 108,000 62,000 30,000
Capital Accounts
As you may have noticed, the goodwill has been credited to the capital accounts of Wilson, Player
and Sharp only. This is because in this case, goodwill represents the value of the reputation of the
business which was built by the old partners hence the benefit accruing to them. As earlier
indicated, goodwill adjustments will not be examined in the examination.
(b) Statement of Financial Position
K
Goodwill 72,000
Assets (Other than Cash) 200,000
Cash 32,000
Total Assets 304,000
Capital: Wilson 73,000
Player 108,000
Sharp 62,000
Titmus 30,000
273,000
Liabilities 31,000
Capital and Liabilities 304,000
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Goodwill is an intangible asset so you will be expected to classify it under assets as shown in this
solution.
10.8 Partnership Dissolution
It is a fact that, at some point a partnership has to be terminated and the following are some of the
reasons you would terminate a partnership:
a) The partnership is no longer profitable, and there is no longer any reason to carry on
trading.
b) The partners cannot agree between themselves how to operate the partnership. They
therefore decide to finish the partnership.
c) Factors such as ill-health or old age may bring about the close of the partnership.
What does the Partnership 1890 Act say about Dissolution?
When you dissolved your partnership, the firm stops trading or operating. Then, in accordance
with the Partnership Act 1890:
a) The assets are disposed of;
b) The liabilities of the firm are paid to everyone other than partners;
c) The partners are repaid their advances and current balances – advances are the amounts
they have put in above and beyond the capital;
d) The partners are paid the final amounts due to them on their capital accounts.
You would share any profit or loss on dissolution as per your profit and loss sharing ratios. Profits
would increase capitals repayable to you while losses would reduce the capitals repayable.
If your final balance on the capital and current accounts is in deficit, you will have to pay that
amount into the partnership bank account.
If you decide to buy the assets of the partnership, the value of such assets will be charged
(debited) to your capital account.
10.8.1 Accounting for Partnership Dissolution
You will record the dissolution entries in an account known as the realisation account. It is this
account in which you will calculate the profit or loss arising from the disposal (realisation) of
assets. This better explained to you by way of an example.
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The last balance sheet of X and Y, who share profits X two-thirds: Y one-third is shown below.
On this date they are to dissolve the partnership.
K K
Non-Current Assets
Buildings 100,000
Motor Vehicles 12,000
112,000
Current Assets
Inventory 6,000
Receivables 8,000
Bank 2,000
16,000
Total Assets 128,000
Capital
X 82,000
Y 41,000
123,000
Current Liabilities
Payables 5,000
128,000
Statement of Financial Position as at 31 December 2016
The buildings were sold for K105, 000 and the stock for K4, 600. K6, 800 was collected from
debtors. The motor vehicle was taken over by X at an agreed value of K9, 400, but he did not pay
any cash for it. K5, 000 was paid to creditors. The K400 cost of the dissolution was paid.
You will be expected to complete the double entry as follows:
(A) Transfer book values of all assets to the realisation account:
Debit realisation account
Credit asset accounts
(B) Amounts received from disposal of assets:
Debit bank
Credit realisation account
(C) Values of assets taken over by partner without payment:
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Debit partner’s capital account
Credit realisation account
(D) Creditors paid:
Debit creditors’ accounts
Credit bank
(E) Costs of dissolution:
Debit realisation account
Credit bank
(F) Profit or loss on realisation to be shared between partners in profit and loss sharing ratios:
If a profit: Debit realisation account
Credit partners’ capital accounts
If a loss: Debit partners’ capital accounts
Credit realisation account
(G) Pay to the partners their final balances on their capital accounts:
Debit capital accounts
Credit bank
The entries are now shown. The letters (A) to (G) as above are shown against each entry:
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K K
Balance b/d 100,000 Realisation 100,000
100,000 100,000
K K
Balance b/d 12,000 Realisation 12,000
12,000 12,000
K K
Balance b/d 6,000 Realisation 6,000
6,000 6,000
K K
Balance b/d 8,000 Realisation 8,000
8,000 8,000
Buildings
Motor Vehicle
Inventory
Receivables
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K K
Assets at Book Value: Realised Values
Buildings 100,000 Buildings 105,000
Motor Vehicle 12,000 Motor Vehicle (Partner X) 9,400
Inventory 6,000 Inventory 4,600
Receivables 8,000 Receivables 6,800
Dissolution costs 400 Loss on realisation:
X (2/3) 400
Y (1/3) 200
126,400 126,400
K K
Bank 5,000 Balance b/d 5,000
5,000 5,000
K K
Motor Vehicle 9,400 Balance b/d 82,000
Share of losses 400
Bank 72,200
82,000 82,000
K K
Share of losses 200 Balance b/d 41,000
Bank 40,800
41,000 41,000
K K
Balance b/d 2,000 Receivables 5,000
Buildings 105,000 Realisation costs 400
Inventory 4,600 Capital - X 72,200
Receivables 6,800 Capital - Y 40,800
118,400 118,400
Bank
Realisation account
Payables
Capital account - X
Capital account - Y
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The final balances on the partners’ capital accounts should always equal the amount in the bank
account from which they are to be paid. For instance, in the above exhibit there was K113,000 in
the bank from which to pay X K72,200 and Y K40,800. You should always complete the capital
account entries before you can complete the bank account entries. If the final bank balance does
not pay out the partners’ capital accounts exactly, you will have made a mistake somewhere.
10.9 Exercise
1. Sage and Onion are trading in partnership, sharing profits and losses and equally. Interest at
5% per annum is allowed or charged on both the capital account and the current account
balances at the beginning of the year. Interest is charged on drawings at 5% per annum. The
partners are entitled to annual salaries of: Sage K12, 000; Onion K8, 000.
Required:
From the information given below, prepare the partnership profit and loss account for the year
ended 31 December 2016, and the balance sheet as at that date.
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K K
Capital Accounts:
Sage 100,000
Onion 50,000
Currentl Accounts:
Sage 2,000
Onion 600
Cash drawings
Sage 15,000
Onion 10,000
Freehold Premises at cost 50,000
Inventory at 1 Jan 2016 75,000
Fixtures & Fittings at cost 15,000
Purchases & Purchases Returns 380,000 12,000
Bank 31,600
Sales Returns & Sales 6,000 508,000
Trade Receivables & Trade Payables 52,400 33,300
Carriage inwards 21,500
Carriage outwards 3,000
Staff Salaries 42,000
VAT 8,700
Office expenses 7,500
Provision for doubtful debts 2,000
Advertising 5,000
Discounts Received 1,000
Discounts allowed 1,200
Bad debts 1,400
Rent and Business rates 2,800
Accumulated provision for depreciation for fixtures & fittings 3,000
720,000 720,000
Sage and Onion
Trail Balance as at 31 December 2016
At 31 December 2016:
a) Stock on hand was valued at K68, 000.
b) Purchase invoices amounting to K3, 000 for goods included in the stock valuation at
(a) above had not been recorded.
c) Staff salaries owing K900.
d) Business rates paid in advance K200.
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e) Provision for doubtful debts to be increased to K2, 400.
f) Goods withdrawn by partners for private use had not been recorded and were valued
at: Sage K500, Onion K630. No interest is to be charged on these amounts.
g) Provision is to be made for depreciation of fixtures and fittings at 10% on cost.
h) Interest on drawings for the year is to be charged: Sage K360, Onion K280.
2. X, Y and Z have been in partnership for several years, sharing profits and losses in the ratio
3 : 2 : 1. Their statement of financial position which was prepared on 31 October 2019 is as
follows:
K K
Non-Current Assets
Cost 20,000
Depreciation (6,000)
14,000
Current Assets
Inventory 5,000
Receivables 21,000
26,000
Total Assets 40,000
Capital
X 4,000
Y 4,000
Z 2,000
10,000
Current Liabilities
Payables 17,000
Bank Overdraft 13,000
40,000
Statement of Financial Position as at 31 December 2019
Despite making good profits during recent years they had become increasingly dependent on
one credit customer, Smithson, and in order to retain his custom they had gradually increased
his credit limit until he owed the partnership K18, 000. It has now been discovered that
Smithson is insolvent and that he is unlikely to repay any of the money owed by him to the
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partnership. Reluctantly X, Y and Z have agreed to dissolve the partnership on the following
terms:
(i) The stock is to be sold to Nelson Ltd for K4, 000.
(ii) The fixed assets will be sold for K8, 000 except for certain items with a book value of
K5, 000 which will be taken over by X at an agreed valuation of K7, 000.
(iii) The debtors, except for Smithson, are expected to pay their accounts in full.
(iv) The costs of dissolution will be K800 and discounts received from creditors will be
K500. Z is unable to meet his liability to the partnership out of his personal funds.
Required:
(a) The realisation account;
(b) The capital accounts to the partners recording the dissolution of the partnership.
Question 3
(a) Explain the difference between general and limited liability partnerships.
(b) What is a "sleeping” partner?
Question 4
(a) What is the purpose behind charging interest on a partner's drawings?
(b) Describe the circumstances in which a partner will be paid a salary.
Question 5
(a) What is the purpose of the appropriation account?
(b) Under what circumstances would a partner lend the business money?
Question 6
Banda, Lungu, Kasonde are partner’s sharing profits in the ratios 3:2:1.The partnership agreement
provided for interest on capital at the rate of 9% per annum and for a salary for Kasonde of
K9,000m per annum. Net profit for 2012 was K95, 000m and the balances on partner’s capital
accounts during the year were: Banda K12, 000m; Lungu K18, 000m; Kasonde K15, 000m.
What was Kasonde’s closing balance on her current account assuming the opening balance was
nil?
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A. K23, 358m credits
B. K24, 008m credit
C. K8, 333m debit
D. K8, 333m credit
10.10 Summary
In this unit we defined partnerships and discussed the contents of a partnership agreement. We
also discussed what leads to change of partnership form which includes admission of a new partner.
We further discussed the dissolution of a partnership and the accounting entries that you will be
expected to make. It is crucial that you apply the double-entry principles when closing the assets
account and transferring the values to the realisation account. Always remember that partnerships
profits or losses are shared as per profits or losses sharing ratios. The distribution of profits should
always be shown in the appropriation account. Depending on the preference of the partners, you
will be expected to maintain either a fixed capital account plus current account or a fluctuating
capital account. You should learn to present the capital accounts in columnar form as this will be
commonly used in most examinations.
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UNIT 11
Incomplete Records
11.1 Introduction
From unit 1 to 10 we have considered the perfect environment, where all the records are kept
properly and double entry principles are being applied accordingly. However, Zambia and most
African countries do not operate in a perfect world. It is common that small business enterprises
do not keep complete records i.e. incomplete records. This unit will therefore focus on incomplete
records.
11.2 Objectives
By the end of this unit you should be able to:
(i) Deduce the figure of profits where only the increase in capital and details of drawings are
known
(ii) Draw up a Statement of Profit or Loss and statement of financial position from records not
kept on a double entry system
(iii)Deduce the figure for cash drawings when all other cash receipts and cash payments are
known
(iv) Deduce the figures of sales and purchases from incomplete records
11.3 Causes of incomplete records
You may have noticed that small businesses like general dealers, internet café may only maintain
single entry rather than double entry. Some of the reasons that are attributed to this include:
(iv) The processes including in double entry
(v) The volumes of the petty transactions involved
(vi) The inability to employ qualified people and
(vii) The lack of capacity of investing in modern accounting systems.
The challenge you will face as an Accountant, is how to prepare the financial statements in the
absence of proper records.
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11.4 Using the Accounting Equation
Reflection
Let us see if you still remember the Accounting equation, write it down somewhere?
Well if you have forgotten it, here it is: ASSETS = CAPITAL + LIABILITIES
If need be, you will have to revisit this equation and ensure that you really understand it as ti will
be more applicable in this unit.
11.4.1 Increase in Capital
If you know the capital at the start of a period and the capital at the end of the period, you can
calculate the profit or loss for the period by subtracting capital at the start of the period from that
at the end of the period (Closing Capital – Opening Capital).
Imagine you are in business, at the end of 2014 capital was K20, 000. During 2015 there were no
drawings, and no extra capital was brought in by yourself. At the end of 2015 the capital was K30,
000. From this incomplete information you can still calculate the profit that you made in 2015.
Net profit = Closing Capital – Opening Capital
= K30, 000 – K20, 000 = K10, 000
Now assume you had drawings amount to K7, 000, how much profit did you make?
Last year’s Capital + Profits − Drawings = This year’s Capital
K20, 000 + Net Profit − K7, 000 = K30, 000
Net Profit = K30, 000 – K20, 000 + K7, 000
= K17, 000
Therefore, the profit that you made during the year was K17, 000
11.4.2 Calculating Profit when assets and liabilities are known
Sometimes you will be asked to calculate profit when you only have information pertaining to
assets and liabilities only. To help you understand this easily, will use the following example:
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Dorcas Sajeni has not kept proper bookkeeping records, but she has kept notes in diary form of the
transactions of her business. She is able to give you details of her assets and liabilities as at 31
December 2015 and 31 December 2016:
At 31 December 2015
Assets: Van K6, 000; Fixtures K1, 800; Stock K3, 000; Debtors K4, 100; Bank K4, 800; Cash
K200.
Liabilities: Creditors K1, 200; Loan from J Ogden K3, 500.
At 31 December 2016
Assets: Van (after depreciation) K5, 000; Fixtures (after depreciation) K1, 600; Stock K3, 800;
Debtors K6, 200; Bank K7, 500; Cash K300.
Liabilities: Creditors K1, 800; Loan from J Ogden K2, 000.
Drawings during 2016 were K5, 200.
You are required to ascertain the profit that Dorcas Sajeni made during 2016.
You need to put all these figures into a format that will enable you to identify the profit and you
can do this by using the Accounting equation: ASSETS = CAPITAL + LIABILITIES
The accounting equation simply summarises the statement of financial position (balance sheet).
Since you are dealing with incomplete records, your statement of financial position will be known
as the Statement of Affairs. Firstly you have to draw up the Statement of Affairs as at 31
December 2015 which help us find the Opening Capital for 2016.
From the accounting equation, you know that capital is the difference between the assets and
liabilities. So the Statement of Affairs will help you find this figure:
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K K
Non-Current Assets
Motor Vehicles 6,000
Fixtures 1,800
7,800
Current Assets
Inventory 3,000
Receivables 4,100
Bank 4,800
Cash 200
12,100
Total Assets 19,900
Capital (Note 1) 15,200
Non-Current liabilities
Loan 3,500
Current Liabilities
Payables 1,200
Capital & Liabilities 19,900
Dorcas Sajeni
Statement of Affairs as at 31 December 2015
Note 1
This figure can be found by using the accounting equation:
Assets = Capital + Liabilities
K19, 900 = Capital + K4, 700
K19, 900 - K4, 700 = Capital
Capital = K15, 200
Secondly, draw up the statement of affairs as at 31 December 2016. Do this by inserting the figures
you know first and leave a blank for net profit as this is the only unknown figure.
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K K
Non-Current Assets
Motor Vehicles 5,000
Fixtures 1,600
6,600
Current Assets
Inventory 3,800
Receivables 6,200
Bank 7,500
Cash 300
17,800
Total Assets 24,400
Capital as at 1 January 2016 15,200
Net Profit???????
Drawings (5,200)
Non-Current liabilities
Loan 2,000
Current Liabilities
Payables 1,800
Capital & Liabilities 24,400
Dorcas Sajeni
Statement of Affairs as at 31 December 2016
Net profit for the year is the only missing figure. You can find this applying the accounting
equation. Remember profit made during the year is added to the Capital as this the money that the
business owner would have made, therefore it belongs to him. Therefore you can rephrase the
accounting equation as follows:
Assets = Capital (Capital + Profit - Liabilities) + Liabilities
K24, 400 = K15, 200 + Net Profit – K5, 200 + K3, 800
K24, 400 – K15, 200 – K3, 800 + K5, 200 = Net Profit
Net Profit = K10, 600
Now you can proceed to insert the missing net profit figure of K10, 600.
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11.5 Drawing-up a complete set of Financial Statements
From the above examples, we only considered circumstances where the information given relates
to the preparation of a statement of financial position. However in some cases you will expected
to prepare both the Statement of Profit and Loss as well as the statement of financial position. In
this section, we will look at the situation were you have been asked to prepare both Statement of
Profit or Loss and statement of financial position from incomplete records.
Activity 1
Example 1
The accountant has found the following details of transactions for Hayley’s shop for the year ended
31 December 2015.
(a) The sales are mostly on credit. No record of sales has been kept, but K61, 500 has been
received from persons to whom goods have been sold − K48, 000 by cheque and K13, 500
in cash.
(b) Amount paid by cheque to suppliers during the year = K31, 600.
(c) Expenses paid during the year: by cheque: Rent K3, 800; General Expenses K310; by cash:
Rent K400.
(d) Hayley took K250 cash per week (for 52 weeks) as drawings.
(e) Other information is available:
At 31.12.2014 At 31.12.2015
K K
Debtors 5,500 6,600
Creditors for goods 1,600 2,600
Rent owing – 350
Bank balance 5,650 17,940
Cash balance 320 420
Stock 6,360 6,800
(f) The only fixed asset consists of fixtures which were valued at 31 December 2014 at K3,
300. These are to be depreciated at 10 per cent per annum.
You will prepare the financial statements in five stages.
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Stage 1
Firstly draw up the statement of affairs for the year that ended 31 December 2014
K K
Non-Current Assets
Fixtures 3,300
3,300
Current Assets
Inventory 6,360
Receivables 5,500
Bank 5,650
Cash 320
17,830
Total Assets 21,130
Capital (Note) 19,530
Non-Current liabilities
-
Current Liabilities
Payables 1,600
Capital & Liabilities 21,130
Hayley
Statement of Affairs as at 31 December 2014
Note 2
Remember Capital is derived at by using the accounting equation:
ASSETS = CAPITAL + LIABILITIES
Verify the accuracy of the inserted figure by using the accounting equation.
Stage 2
Secondly, prepare the cash book to confirm the bank and cash balances.
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K K K K
Opening Balance 320 5,650 Suppliers 31,600
Receipts from Debtors 13,500 48,000 Rent 400 3,800
General Expenses 310
Drawings 13,000
Balance c/d 420 17,940
13,820 53,650 13,820 53,650
Cash Book
Stage 3
Purchases
Calculate the purchases figures from the given information as this will be used in the Statement of
Profit or Loss.
K
Cash Paid during the year 31,600
Less Payables (Opening balance) 1,600
30,000
Add Credit Purchases 2,600
Purchases for the year 32,600
Sales
Calculate the sales figures from the given information as this will be used in the Statement of Profit
or Loss.
K
Cash Paid during the year 61,500
Less Payables (Opening balance) 5,500
56,000
Credit Sales 6,600
Sales for the year 62,600
Stage 4: Expenses
Where you do not have accruals or prepayments either at the beginning or end of the accounting
period, then expenses paid will equal expenses used up during the period.
On the other hand, where you have prepayments or accruals exist, an expense account should be
drawn up for that particular item. In this case you need to draw up the rent account.
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K K
Bank 3,800 Profit & Loss (Missing figure) 4,550
Cash 400
Accrued c/d 350
4,550 4,550
Rent
Stage 5
Now you can proceed to prepare your financial statements as follows:
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K K
Sales 62,600
Less Cost of Sales
Opening Inventory 6,360
Add Purchases 32,600
38,960
Less Closing Inventory (6,800)
Cost of Sales 32,160
Gross Profit 30,440
Less Expenses:
Rent 4,550
General expenses 310
Depreciation on Fixtures 330
(5,190)
Net Profit 25,250
K K
Non-Current Assets
Fixtures 3,300
Depreciation (330)
2,970
Current Assets
Inventory 6,800
Receivables 6,600
Bank 17,940
Cash 420
31,760
Total Assets 34,730
Capital 19,530
Add net profit 25,250
Drawings (13,000)
31,780
Current Liabilities
Payables 2,600
Accrual - Rent 350
Capital & Liabilities 34,730
HayleyStatement of Comprehensive Income for the year
ended 31 December 2015
Statement of Financial Position as at 31 December
2015
Hayley
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11.6 Stolen Inventory, lost or destroyed
As you may be aware of, it is common that unfortunate events such as theft of inventory occurs at
higher scale, inventory is lost or destroyed. You may be required to calculate the value of the
stolen, lost or destroyed inventory for purposes of justifying insurance claims, taxation purposes,
knowing the value of the missing inventory etc.
If you had valued your inventory immediately before the fire, burglary, etc., then the value of the
inventory lost would obviously be known. Also, if you had a full and detailed system of inventory
records, then the value would also be known. However, as the occurrence of fires or burglaries
cannot be foreseen, and many small businesses do not keep full and proper inventory records, the
value of the inventory has to be calculated in some other way. We will use two examples to
illustrate this to you.
Activity 2
Example 2
Mumba lost the whole of his stock in a fire on 17 March 2019. The last time that a stock-taking
had been done was on 31 December 2018, the last balance sheet date, when stock was valued at
cost at K19, 500. Purchases from then until 17 March 2019 amounted to K68, 700 and sales in that
period were K96, 000. All sales were made at a uniform gross profit margin of 20 per cent.
Solution
The first thing you should do, is to draw up the trading with the known figures included and insert
the missing figures later.
K K
Sales 96,000
Less Cost of Sales
Opening Inventory 19,500
Add Purchases 68,700
88,200
Less Closing Inventory C ?
Cost of Sales B ?
Gross Profit A ?
Trading Account for the Period 1 Jan 2019 to 31 Mar 2019
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This how you can calculate the missing figures:
It is known that the gross profit margin is 20 per cent, therefore gross profit (A) is 20% of
K96, 000 = K19, 200.
Now (B) + (A) K19, 200 = K96, 000, so that (B) is the difference between sales and gross profit,
i.e. K76, 800.
Now that (B) is known, (C) can be deduced: K88, 200 − (C) = K76, 800, therefore (C) is the
difference, i.e. K11, 400.
You can therefore conclude that the figure for goods destroyed by fire, at cost, is K11, 400.
Activity 3
Example 3
The first example was a straight forward one, now let us consider a more complicated example.
Mulenga had the whole of his stock stolen from his warehouse on the night of 20 August 2016.
Also destroyed were his sales and purchases journals, but the sales and purchases ledgers were
salvaged. The following facts are known:
(a) Stock was known at the last balance sheet date, 31 March 2016, to be K12, 480 at cost.
(b) Receipts from debtors during the period 1 April to 20 August 2016 amounted to K31, 745.
Debtors were: at 31 March 2016 K14, 278, at 20 August 2016 K12, 333.
(c) Payments to creditors during the period 1 April to 20 August 2016 amounted to K17, 270.
Creditors were: at 31 March 2016 K7, 633, at 20 August 2016 K6, 289.
(d) The gross profit margin on all sales has been constant at 25 per cent.
The first thing you should do, is to calculate the missing figures for sales and purchases. After
calculating these figures you then apply the procedures of drawing up the trading account as shown
in example 1 above. The sales figure can be found by way of a sales ledger control account,
whereas the purchases figures can be determined through a purchases ledger control account.
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K K
Cash and Bank 17,270 Balance b/d 7,633
Balance c/d 6,289 Purchases (Balancing figure) 15,926
23,559 23,559
K K
Balance b/d 14,278 Cash and Bank 31,745
Sales (Balancing figure) 29,800 Balance c/d 12,333
44,078 44,078
Purchases Ledger Control Account
Sales Ledger Control Account
You can proceed to draw up the trading account as illustrated in example 1 above. Remember to
insert the known figures first, then the missing figures after deducing them:
K K
Sales 29,800
Less Cost of Sales
Opening Inventory 12,480
Add Purchases 15,926
28,406
Less Closing Inventory C ?
Cost of Sales B ?
Gross Profit A ?
Trading Account for the Period 1 Jan to 20 August 2016
Mulenga
Gross profit can be found, as the margin on sales is known to be 25%, therefore (A) = 25% of
K29, 800 = K7, 450.
Cost of goods sold (B) + Gross profit K7, 450 = K29, 800, therefore (B) is K22, 350.
K28, 406 − (C) = (B) K22, 350, therefore (C) is K6, 056.
The figure for cost of goods stolen is therefore K6, 056.
11.7 Exercise
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1. Frank Lungu started in business on 1 January 2012 with K35, 000 in a bank account.
Unfortunately he did not keep proper books of account.
He is forced to submit a calculation of profit for the year ended 31 December 2015 to
Zambia Revenue Authority. He ascertains that at 31 December 2012 he had stock valued
at cost K6, 200, a van which had cost K6, 400 during the year and which had depreciated
during the year by K1, 600, debtors of K15, 200, expenses prepaid of K310, a bank balance
of K33, 490, a cash balance K270, trade creditors K7, 100, and expenses owing K640.
His drawings were: cash K400 per week for 50 weeks, cheque payments K870.
Draw up statements to show the profit or loss for the year.
2. B Barnes is a dealer who has not kept proper books of account. At 31 October 2013 his
state of affairs was as follows:
K
Cash 210
Bank balance 4,700
Fixtures 2,800
Stock 18,200
Debtors 26,600
Creditors 12,700
Van (at valuation) 6,800
During the year to 31 October 2014 his drawings amounted to K32, 200. Winnings from
the Lottery of K7, 600 were put into the business. Extra fixtures were bought for K900.
At 31 August 2014 his assets and liabilities were: Cash K190; Bank overdraft K1, 810;
Stock K23, 900; Creditors for goods K9, 100; Creditors for expenses K320; Fixtures to be
depreciated K370;
Van to be valued at K5, 440; Debtors K29, 400; Prepaid expenses K460.
Draw up a statement showing the profit and loss made by Barnes for the year ended
31 October 2014.
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3. The following is a summary of Jane’s bank account for the year ended 31 December
2012:
K K
Balance b/d 4,100 Payments to creditors for goods 67,360
Receipts from debtors 91,190 Rent 3,950
Balance c/d 6,300 Insurance 1,470
Sundry expenses 610
Drawings 28,200
101,590 101,590
Bank account
All of the business takings have been paid into the bank with the exception of K17, 400.
Out of this, Jane has paid wages of K11, 260, drawings of K1, 200 and purchase of goods
K4, 940.
The following additional information is available:
31-Dec-11 31-Dec-12
K K
Stock 10,800 12,200
Creditors 12,700 14,100
Debtors 21,200 19,800
Insurance Prepayment 420 440
Rent 390 -
Fixtures at Valuation 1,800 1,600
You are to draw up a set of financial statements for the year ended 31 December 2012.
Show all of your workings.
4. A business prepares its financial statements annually to 30 April and stock-taking is carried
out on the next following weekend. In 2015, 30 April was a Wednesday. Stock was taken
on 3 May and the stock actually on the premises on that date had a value at cost of K124,
620.
The following additional information is ascertained:
(i) The cash and credit sales totalled K2, 300 during the period 1–3 May.
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(ii) Purchases recorded during the period 1–3 May amounted to K1, 510 but, of this
amount, goods to the value of K530 were not received until after 3 May.
(iii)Sales returns during 1–3 May amounted to K220.
(iv) The average ratio of gross profit to sales is 20%.
(v) Goods in stock at 30 April and included in stock-taking on 3 May at K300 were
obsolete and valueless.
Required:
Ascertain the value of the stock on 30 April 2015 for inclusion in the financial statements.
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11.8 Summary
One of the most challenging tasks that an Accountant will be expected to do, is to produce
financial statements from incomplete records. In this unit you were introduced to incomplete
records and the causes of incomplete records. We also illustrated to you the procedures that
you should follow when preparing financial statements depending on the disclosed
information. If the information relates to the statement of financial position, you will be
expected to apply the accounting equation and use the statement of affairs to calculate the
missing figures. We also looked at the situation where you will be expected to draw up the
Statement of Profit or Loss and statement of financial position. You will be expected to master
the five stages that will make it easier for you to deduce the missing figures.
Inventory can be stolen, lost or destroyed by fire etc. if you do not keep proper inventory
records you will be expected as the Accountant to calculate the value of the missing figures.
As such ensure that you are in a position to calculate the value of the missing figures as this
will be assessed in the examination.
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Module Summary Congratulations, you have come to the end of this module. In this module, we introduced you to
Financial Accounting. We hope you can now:
(i) Prepare financial statements for sole traders
(ii) Pass necessary adjustments to financial statements
(iii) Prepare financial statements for partnerships and
(iv) Prepare financial statements from incomplete records
However, if you are unable to demonstrate competencies in the above objectives, kindly go back
and read through specific potions where you have difficulties. Remember to attempt all the
activities even as you revise and get ready to write your examination in this module.
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REFERENCES
Wood, F and Sangster, A. (2018) Business Accounting 1, 14th edition, Pearson Education
Limited
Wood, F and Sangster, A. (2011) Business Accounting 1, 12th edition, FT Prentice Hall, 2011
Wood, F and Robinson, S. (2009) Bookkeeping and Accounts, 7th edition, FT Prentice Hall
Elliott, B J and Elliott, J,(2017) Financial Accounting and Reporting, 18th edition, FT Prentice
Hall
Dunn, J,(2010) Financial Reporting and Analysis, Wiley
Dodge R, (1997) Foundations of Business Accounting, 2nd edition, Cengage Learning
Harrison, W, T, Horngren, C, T, Thomas, C, W (2013) Financial Accounting, Pearson, United
States
Wild, J, J (2011) Financial Accounting Fundamentals, McGraw Hill Irwin
ABE (2011) Introduction to Accounting, Association of Business Executives, www.abeuk.com
www.zica.co.zm
www.accaglobal.com
