Financial Accounting 1 by Harold.doc

CONTENTS

ACKNOWLEDGMENT....................................................................................iiINSTRUCTIONS FOR STUDENTS.................................................................iiiFINANCIAL ACCOUNTING I COURSE DESCRIPTION..................................viLESSON ONE.................................................................................................1

INTRODUTION TO ACCOUNTING.........................................................................1LESSON TWO...............................................................................................32

FINAL ACCOUNTS...............................................................................................32LESSON THREE...........................................................................................68

ACCOUNTING THEORY.......................................................................................68LESSON FOUR.............................................................................................81

ADJUSTMENTS TO FINAL ACCOUNTS...............................................................81LESSON FIVE.............................................................................................136

FURTHER ADJUSTMNETS TO ACCOUNTS.......................................................136LESSON SIX...............................................................................................176

OTHER ASPECTS OF FINAL ACCOUNTS..........................................................176LESSON SEVEN.........................................................................................231

PARTNERSHIPS..................................................................................................231LESSON EIGHT..........................................................................................287

COMPANY ACCOUNTS......................................................................................287LESSON NINE............................................................................................334

REVISION AID....................................................................................................334

Lesson One 1

LESSON ONEINTRODUTION TO ACCOUNTING

a) NATURE OF ACCOUNTING Accounting is defined as the process of identifying, measuring and reporting economic information to the users of this information to permit informed judgment

Many businesses carry out transactions. Some of these transactions have a financial implication i.e. either cash is received or paid out. Examples of these transactions include selling goods, buying goods, paying employees and so many others.Accounting is involved with identifying these transactions measuring (attaching a value) and reporting on these transactions. If a firm employs a new staff member then this may not be an accounting transaction. However when the firm pays the employee salary, then this is related to accounting as cash involved. This has an economic impact on the organization and will be recorded for accounting purposes. A process is put in place to collect and record this information; it is then classified and summarized so that it can be reported to the interested parties.

b) USERS OF ACCOUNTING INFORMATIONAccounting information is produced in form of financial statement. These financial statements provide information about an entity financial position, performance and changes in financial position.Financial position of a firm is what the resources the business has and how much belongs to the owners and others.The financial performance reflects how the business has performed, whether it has made profits or losses. Changes in financial positions determine whether the resources have increased or reduced.The users of accounting information have an interest in the existence of the firm. Therefore the information contained in the financial statements will affect the decision making process.

The following are the users of accounting information:i. Owners:

They have invested in the business and examples of such owners include sole traders, partners (partnerships) and shareholders (company). They would like to have information on the financial performance, financial position and changes in financial position. This information will enable them to assess how the managers of the business are performing whether the business is profitable or not and whether to make drawings or put in additional capital.

ii. Customers

FINANCIAL ACCOUNTING 1

Course Description 2

Customers rely on the business for goods and services. They would like to know how the business is performing and its financial position.This information would enable them to assess whether they can rely on the firm for future supplies.

Acknowledgement 3

SuppliersThey supply goods or services to the firm. The supplies are either for cash or credit. The suppliers would like to have information on the financial performance and position so as to assess whether the business would be able to pay up for the goods and services provided as and when the payments falls due.

iii. ManagersThe managers are involved in the day-to-day activities of the business. They would like to have information on the financial position, performance and changes in financial position so as to determine whether the business is operating as per the plans.In case the plan is not achieved then the managers come up with appropriate measures (controls) to ensure that the set plans are met.

iv. The LendersThey have provided loans and others sources of capital to the business. Such lenders include banks and other financial institutions. They would like to have information on the financial performance and position of the business to assess whether the business is profitable enough to pay the interest on loans and whether it has enough resources to pay back the principal amount when it is due.

v. The Government and its agenciesThe Government is interested in the financial performance of the business to be able to assess the tax to be collected in the case there are any profits made by the business.The other government agencies are interested with the financial position and performance of the business to be able to come with National Statistics. This statistics measure the average performance of the economy.

vi. The Financial Analyst and AdvisorsFinancial analyst and advisors interpret the financial information. Examples include stockbrokers who advise investors on shares to buy in the stock market and other professional consultants like accountants. They are interested with the financial position and performance of the firm so that they can advise their clients on how much is the value their investment i.e. whether it is profitable or not and what is the value.Others advisors would include the press who will then pass the information to other relevant users.

vii. The EmployeesThey work for the business/entity. They would like to have information on the financial position and performance so as to make decisions on their terms of employment. This information would be important as they can use it to negotiate for better terms including salaries, training and other benefits.

They can also use it to assess whether the firm is financially sound and therefore their jobs are secure.


4 Introduction to Accounting

viii. The PublicInstitutions and other welfare associations and groups represent the public. They are interested with the financial performance of the firm. This information will be important for them to assess how socially responsible is the firm.This responsibility is in form the employment opportunities the firm offers, charitable activities and the effect of firm’s activities on the environment.

c) THE ACCOUNTING EQUATIONA business owns properties. These properties are called assets. The assets are the business resources that enable it to trade and carry out trading. They are financed or funded by the owners of the business who put in funds.These funds, including assets that the owner may put is called capital. Other persons who are not owners of the firm may also finance assets. Funds from these sources are called liabilities.The total assets must be equal to the total funding i.e. both from owners and non-owners. This is expressed inform of accounting equation which is stated as follows:

ASSETS = LIABILITIES + CAPITAL

Each item in this equation is briefly explained below.Assets:

An asset is a resource controlled by a business entity/firm as a result of past events for which economic benefits are expected to flow to the firm.An example is if a business sells goods on credit then it has an asset called a debtor. The past event is the sale on credit and the resource is a debtor. This debtor is expected to pay so that economic benefits will flow towards the firm i.e. in form of cash once the customers pays.

Assets are classified into two main types:i) Non current assets (formerly called fixed assets).ii) Current assets.

Non current assets are acquired by the business to assist in earning revenues and not for resale. They are normally expected to be in business for a period of more than one year.Major examples include:

Land and buildings Plant and machinery Fixtures, furniture, fittings and equipment Motor vehicles

Current assets are not expected to last for more than one year. They are in most cases directly related to the trading activities of the firm. Examples include:

Lesson One 5

Stock of goods – for purpose of selling. Trade debtors/accounts receivables – owe the business amounts as a

resort of trading. Other debtors – owe the firm amounts other than for trading. Cash at bank. Cash in hand.

Liabilities:These are obligations of a business as a result of past events settlement of which is expected to result to an economic outflow of amounts from the firm. An example is when a business buys goods on credit, then the firm has a liability called creditor. The past event is the credit purchase and the liability being the creditor the firm will pay cash to the creditor and therefore there is an out flow of cash from the business.

Liabilities are also classified into two main classes.

i) Non-current liabilities (or long term liabilities)ii) Current liabilities.

Non-current liabilities are expected to last or be paid after one year. This includes long-term loans from banks or other financial institutions. Current liabilities last for a period of less than one year and therefore will be paid within one year. Major examples:

Trade creditors/or accounts payable – owed amounts as a result of

business buying goods on credit. Other creditors - owed amounts for services supplied to the firm

other than goods. Bank overdraft - amounts advanced by the bank for a short-term

period.

Capital: This is the residual amount on the owner’s interest in the firm after deducting liabilities from the assets. The Accounting equation can be expressed in a simple report called the Balance Sheet. The basic format is as follows:

Name Balance sheet as at 31.12.

Sh Sh Sh ShCapital xx Non Current Assets

Land & Buildings xxNon Current Liabilities Plant & Machinery xxLoan xx Fixtures, furniture & fittings

xx Motor vehicles xx

Current liabilities xx


Overdraft xx Current AssetsCreditors xx xx Stocks xx Debtor’s xxCapital and Liabilities Cash at bank xx Cash in hand xx

xx xx Total assets xx

Lesson One 7

The above format of the balance sheet is the horizontal format however currently the practice is to present the Balance Sheet using the vertical format which is shown below.

NameBalance sheet as at 31.12.

Non Current Assets Sh Sh ShLand & Buildings xxPlant & Machinery xxFixtures, furniture & fittings xxMotors vehicles xx

xxCurrent AssetsStocks/inventories xxDebtors/ trade receivables xxCash at bank xxCash in hand xx

Current LiabilitiesBank Overdraft xxCreditors/trade payables xx (xx)Net Current Assets xxNet assets xx

Capital xx Non Current LiabilitiesLoan (from bank or other sources) xx

xx

Please pay attention to the format. The Non Current assets are listed in order of permanence as shown i.e. from Land and Buildings to motor vehicles. The Current Assets are listed in order of liquidity i.e. which asset is far from being converted into cash. Example ,stock is not yet sold, (i.e. not yet realised yet) then when it is sold we either get cash or a debtor (if sold on credit). When the debtor pays then the debtor may pay by cheque (cash has to be banked) or cash.The Current Liabilities are listed in order of payment i.e. which is due for payment first. Bank overdraft is payable on demand by the bank, then followed by creditors.Note that in the vertical format, current liabilities are deducted from current assets to give net current assets. This is added to Non Current assets, which give us net assets.Net assets should be the same as the total of Capital and Non Current Liabilities.


Example 1.1B Kelly has a business that has been trading for some time. You are given the following information as at 31.12.2002

£Buildings 11,000Furniture & Fittings 5,500Motor Vehicles 5,800Stocks 8,500Debtor 5,600Cash a bank 1,500Cash in hand 400Creditors 2,500Capital 30,800Loan 5,000

You are required to prepare a Balance Sheet as at 31 December 2001

B KellyBalance Sheet as at 31 December 2001

Non Current Assets £ £ £Buildings 11,000Furniture & Fittings 5,500Motor Vehicles 5,800

22,300

Current LiabilitiesStock 8,500 Debtors 5,600 Cash at bank 1,500 Cash in hand 400

16,000Creditors (2,500)Net Current Assets 13,500Net Assets 35,800

Capital 30,800Non-Current LiabilitiesLoan 5,000

35,800

Example 1.2L Stokes sets up a new business. Before he actually sells anything he has bought motor vehicles of 3,000, premises of 7,000, stock of goods 2,000. He ₤ ₤ ₤still owes 800 in respect of them. He had borrowed 4,000 from D Evans. After₤ ₤ the events just described and before trading starts, he had 300 cash in hand ₤and 600 cash at bank.₤

Lesson One 9

You are required to calculate the amount of his capital.

Solution : Assets: ₤ ₤Motor Vehicle 3,000Premises 7,000Stock 2,000Cash at bank 600Cash in hand 300

12,900

Liabilities:Creditors 800Loan - D Evans 4,000 (4,800)

8,100

Capital 8,100

Remember the Accounting equation: Assets = Liabilities + Capital.

To get capital we rearrange the equation as follows: Capital = Assets - Liabilities

Total Assets = 12,900₤Total Liabilities = 4,800₤Capital = 12,900 - 4,800₤ = 8,100₤

Example 1.3C Kings has the following items in his balance sheet as on 30 June 2002.Capital £41,800, Creditors £3,200, Fixtures £7,000, Motor Vehicles £8,400, Stock of goods £9,900, Debtors £6,500, Cash at bank £12,900 and Cash in hand £240.

During the first week of July 2002:a. He bought extra stock of goods £1,540 on credit.b. One of the debtors paid him £560 in cash.c. He bought extra fixture by cheque £2,000.

You are to draw up a balance sheet as on 7 July 2002 after the above transactions have been completed.


First we need to look at the effect of the above transactions on the assets and liabilities of C Kings.For

(a) Buying extra stock increases the level of stock by £1,540 and because this is bought on credit the creditors increase by £1,540 also.

(b) Amount received from the debtor means that the level of debtors reduces and cash increases by £560.

(c) Extra fixtures bought by cheque, will increase the fixtures and reduce the cash at bank by £2,000.

This can be summarized as follows:

Opening Increase/(Decrease) Closing Balances Balances £ £Capital 41,800 - 41,800Creditors 3,200 1,540 4,740Fixtures 7,000 2,000 9,000Motor Vehicles 8,400 - 8,400Stock 9,900 1,540 11,440Debtors 6,560 (560) 6,000Cash at bank 12,900 (2000) 10,900Cash in hand 240 560 800

Given these closing balances then the balance sheet can be drawn as follows:

C KingsBalance sheet as at 7 July 2002 .

Non Current Assets £ £Fixtures 9,000Motor Vehicles 8,400

17,400

Current AssetsStock 11,440Debtors 6,000Cash at bank 10,900Cash at hand 800

29,140Current LiabilitiesCreditors (4,740)Net Current Assets 24,400Net Assets 41,800

Capital 41,800

Lesson One 11

From the illustration remember that any change in the items of the balance sheet will have a double effect on the accounting equation has a double effect and therefore the equation will always balance.


Example 1.4D Moody has the following assets and liabilities as on 31 April 2002:

£Creditors 15,800Equipment 46,000Motor Vehicle 25,160Stock 24,600Debtors 23,080Cash at bank 29,120Cash in hand 160

During the first week of May 2002 Moody:a. Bought extra equipment on credit for £5,520.b. Bought extra stock by cheque £2,280.c. Paid creditors by cheque £3,160.d. Debtors paid £3,360 by cheque and £240 by cash.e. Moody put in extra £1,000 cash as capital.

Required:a. Determine the capital as at 1st May 2002.b. Draw up a balance sheet after the above transactions have been

completed.

Solution:(i) Using the accounting equation of Assets = Liabilities + Capital, then assets and liabilities can be listed as follows.Assets £ Liabilities £Equipment 46,000 Creditors 15,800Motor Vehicle 25,160Stock 24,600Debtors 23,080Cash at bank 29,120Cash in hand 160

148,120

Capital = Assets – Liabilities = £148,120 - £15,800 = £132,320

(ii) To draw up the balance sheet, we consider the effect of the above transactions on the relevant balances:

a. Buying extra equipment means that the equipment balance will increase by £5,520 and the creditors will also increase by the same amount.

b. Buying extra stock by cheque means that the level of stock goes up by £2,280 and the balance at bank reduces by the same.

c. Paying creditors by cheque reduces the balance on the creditors account and also reduce the amount at the bank.

d. Debtor paying the firm reduces the debtors balance by £3,600 and increases the cash at bank and cash in hand by £3,360 and £240 respectively.

Lesson One 13

e. Additional cash of £1,000 increases the cash in hand balance by £1,000 and the capital balances.


This is also summarized as follows: Opening Adjustment Closing Balance Increase/Decrease Balance

Assets/Liabilities £ £ £Equipment 46,000 +5,520 51,520Motor Vehicle 25,160 25,160Stock 24,600 +2,280 26,880Debtors 23,080 -3,600 19,480Cash at bank 29,120 (-2,280 – 3,160 + 3,360)

27,040Cash in hand 160 (+240 + 1000) 1,400Creditors 15,800 (+5,520 – 3,160) 18,160Capital 132,320 +1,000 133,320

The balance sheet will therefore be prepared as follows:D MoodyBalance sheet as at 7 May 2002

Non Current Assets £ £Equipment 51,520Motor vehicle 25,160

76,680Current AssetsStock 26,880Debtors 19,480Cash at bank 27,040Cash in hand 1,400


Capital 133,320

Double Entry AspectsThe Accounting equation forms the basis of double entry and therefore it should always be maintained. Any change in assets, liabilities or capital will have a double effect such that assets will always be equal to liabilities plus capital. If the owners put in additional capital then this will increase the cash at bank and the capital amount therefore the equation is still maintained.

Name Debit Credit Date Detail Folio Amount Date Detail Folio Amount

Lesson One 15

In this account the date will show the opening period of the asset ,liability or capital i.e. the balance brought forward. It will also show the date when a transaction took place (i.e. either an asset was bought or liability incurred).The detail column (also called the particulars column) shows the nature of the transaction and reference to the corresponding account. The Folio Column for purposes of detailed recording shows the reference number of the corresponding account. The amount column shows the amount of the asset, liability or capital.The left side of the account is called the debit side and the right side is called the credit side. All assets are shown or recorded on the debit side while all the liabilities and capital are recorded on the credit side. Each type of asset or liability must have its own account whereby all transactions affecting them are recorded in this account. Therefore there should be an account for Premises, Plant and Machinery, Stock, Debtors, Creditors etc.Under the accounting equation if all assets are represented by liabilities and capital therefore all debits should be the same as credits.For the double entry to be reflected in the accounts, every debit entry must have a corresponding credit entry. The transactions affecting these accounts are posted in the account as debit entry and credit entry to complete the double entry.

When we make a debit entry we are either:

i. Increasing the value of an asset.ii. Reducing the value of a liability.

iii. Reducing the value of capital.

When we make a credit entry we are either:

i. Reducing the value of an asset.ii. Increasing the value of a liability.

iii. Increasing the value of capital.

Example 1.5H Jumps has the following assets and liabilities as on 30 November 2002:Creditors £39,500; Equipment £115,000; Motor vehicle £62,900; Stock £61,500; Debtors £57,700;Cash at bank £72,800 and Cash in hand £400.

Compute the balance on the capital account as at 30 November 2002.

During the first week of December 2002, Jump:

a. Bought extra equipment on credit for £13,800.b. Bought extra stock by cheque £5,700.c. Paid creditors by cheque £7,900.


d. Received from debtors £8,400 by cheque and £600 by cash.e. Put in an extra £2,500 cash as capital.

You are to draw up a balance sheet as on 7 December 2002 after the above transactions have been completed.

Lesson One 17

Answer:Capital = Assets – Liabilities

Assets £ Liabilities

£

Equipment 115,000 Creditors

39,500

Motor vehicle 62,900Stock 61,500Debtors 57,700Cash at bank 72,800Cash in hand 400

371,300

Capital = £371,300 - £39,500 = £330,800

Creditors A/C Motor Vehicles a/c 2002 £ B 2002 £ 2002 £ 2002

£ Bank 7900 1.12 Bal b/d 39,500 1.12 Bal b/d 62,900 1.12 Bal c/d 62,900 1.12 Bal c/d 31,600 62,900 62,900 39,500 39,500

Equipment a/c2002 £

2002 £

1.12 Bal b\d 115,000Creditors 13,800 7.12 Bal c\d

128,800128,800 128,800

Stock a/c2002 £

2002 £

1.12 Bal b\d 61,500Bank 5700 7.12 Bal c\d 67,200

67,200 67,200


Debtors a/c2002 £

2002 £

1.12 Bal b\d 57,700 Bank 8,400

Bank 570Cash 6007.12 Bal c\d 48,700

57,700 57,700

Cash at Bank a/c2002 £

2002 £

1.12 Bal b\d 72,800 Stock 5,700Creditors 7,900

Debtors 8,400 7.12 Bal c\d 67,60081,200 81,200

Cash in hand a/c2002 £

2002 £

1.12 Bal b\d 400Debtors 600Capital 2500 7.12 Bal c\d 3500

3500 3500

Capital2002 £

2002 £

1.12 Bal b\d 3308007.12 Bal b\d 333300 Cash 2500

128,800 128,800

Creditors Of Equipment2002 £

2002 £

7.12 Bal b\d 13800 Equipment 1380013,800 13,800

H JumpBalance sheet as at 7 December 2002

Non Current Assets £ £ £

Lesson One 19

Equipment 128,800Motor vehicles 62,900

191,700

Current AssetsStock 61,200Debtors 48,700Cash at Bank 67,600Cash in Hand 3,500

187,000

Current LiabilitiesCreditors of equipment 13,800Creditors 31,000 (45,400)Net Current Assets 141,000Net Assets 333,300

Capital 333,300


Example 1.6Write up the asset, capital and liability accounts in the books of M Crash to record the following transactions:2002June 1 Started business with £50,000 in the bank.“ 2 Bought motor van paying by cheque £12,000.“ 5 Bought Fixtures £4,000 on credit from Office Masters Ltd.“ 8 Bought a van on credit from Motor Cars Ltd £8,000.“ 12 Took £1,000 out of the bank and put it into the cash till.“ 15 Bought Fixtures paying by cash £600.“ 19 Paid Motor Cars Ltd by cheque £8000.“ 21 A loan of £10,000 cash is received from J Marcus.“ 25 Paid £8,000 of the cash in hand into the bank account.“ 30 Bought more Fixtures paying by cheque £3,000.

Capital a/c Cash at bank a/c

2002 £ 2002 £ 2002 £ 2002 £30/6 Bal c/f 50,000 1/6 Bank 50,000 1/6 Capital 50,000 2/6 Van 12,000 12/6 Cash 8,000 12/6Cash 1,000

19/6Motor ltd 8,000

50,000 50,000 30/6 Fixtures 3,000

30/6 Bal c/f 34,000 58,000 58,000

Motor Van

2002 £ £2/6 Bank 12,0008/6 Super M 8,000

30/6 Bal c/f 20,000

20000 20000

Fixtures2002 £ 2002 £5/6 young 4,000 15/6 Cash 60030/6 Bank 3000

Bal c/f 7,600

Lesson One 21

7,600 7,600

Motor Car Ltd – Creditors2002 £ 2002 £19/6 Bank 8000

8/6 Van 8000

8000 8000

Office Masters Ltd - Creditor2002 £ 2002 £30/6 B\f

40008/6 Fixtures 4000

4000 4000

Cash in hand2002 £ 2002 £12/6 Cash 1,000

15/6 Cash 60025/6 Bank 800

21/6 J. Marcus 10000 30/6 Bal c/f 240011000 11000

J. Marcus - Loaner2002 £ 2002 £30/6 c\f

1000021/6 Cash 10000

Note that the difference between the debit side and the credit side is the balancing figure. Most assets will have a balance on the credit side and most liabilities and capital accounts will have a balance on the debit side.A simple balance sheet from these balances will be as follows:

M CrashBalance Sheet as at 30th June 2002

£ £Non Current AssetsFixtures 7,600Motor vehicles 20,000

27,600

Current AssetsCash at bank 34,000Cash in hand 2,400

36,400

Current LiabilitiesCreditors – others (4,000) Net Current Assets 32,400


Net Assets 60,000

Capital 50,000 Non Current LiabilitiesLoan – J Jarvis 10,000

60,000

Let us now consider other transactions that take place in a business and the accounting entries to be made.

Accounting for sales, purchases, incomes and expenses.

Sales:This is the sell of goods that were bought by a firm (the goods must have been bought with the purpose of resale). Sales are divided into cash sales and credit sales. When a cash sale is made, the following entries are to be made.

i. Debit cash either at bank or in hand.ii. Credit sales account.

For a credit sale:i. Debit debtors/ Accounts receivable account.

ii. Credit sales account.A new account for sales is opened and credited with cash or credit sales.

Purchases:Buying of goods meant for resale. Purchases can also be for cash or on credit. For cash purchases:

i. Debit purchases.ii. Credit cash at bank/cash in hand

For credit purchases, we:i. Debit purchases.

ii. Credit creditors for goods.

A new account is also opened for purchases where both cash and credit purchases are posted. NOTE: NO ENTRY IS MADE INTO THE STOCKS ACCOUNT.

Incomes:A firm may have other incomes apart from that generated from trading (sales). Such incomes include:

Rent Bank interest Discounts received.

When the firm receives cash, from these incomes, the following entries are made:

Debit cash in hand/at bank. Credit income account.

Each type of income should have its own account e.g. rent income, interest income.

Lesson One 23

Incomes increase the value of capital and that is the reason why they are posted on the credit side of their respective accounts.

Expenses:These are amounts paid out for services rendered other than those paid for purchases. Examples include:

Postage and stationery Salaries and wages Telephone bills Motor vehicle running expenses. Bank charges.

When a firm pays for an expense, we:i. Debit the expense account.

ii. Credit cash at bank/in hand.Each expense should also have its own account where the corresponding entry will be posted. Expenses decrease the value of capital and thus the posting is made on the debit side of their accounts.

The following diagram is a simple summary of the entries made for incomes and expenses.


Debit cash book/bank/in hand

INCOMES/EXPENSES Debit Expense A/C

Credit cash book /bank/in hand

Returns Inwards and Returns Outwards.

Returns Inwards: These are goods that have been returned by customers due to various reasons e.g.

i. They may be defective/damaged,ii. Being of the wrong type .

iii. Excess goods being delivered.

Goods returned may relate to cash sales or credit sales. For the goods returned in relation to cash sales and cash is refunded to the customer the following entries are made:

i. Debit returns – inwardsii. Credit cashbook.

For goods returned that relate to credit sales; no cash has been given to customer, the following entry is to be made.

i. Debit returns inwards.ii. Credit debtors.

Returns Outwards: These are goods returned to suppliers/creditors. They may be for cash purchases or for credit purchases. For cash purchases a cash refund given to the firm by the supplier,

i. Debit the cashbook (cash at bank/hand).ii. Credit returns outwards.

For credit purchases and no refund has been made:i. Debit creditors.

ii. Credit returns outwards.

INCOME

EXPENC

Credit

Lesson One 25

Diagrammatically shown as follows: Debit returns inwards.

Cash Credit cashbook. Inwards Debit returns inwards

Credit Credit debtors Debit cashReturns Cash

Outwards Credit returns outwards Debit creditors

Credit

Credit returns outwardsNow lets us take one example that includes most of the above transactions.

Example 1.8You are to enter the following transactions, completing the double entry in the books for the month of May 2002.2002May 1 Started business with £2,000 in the bank.“ 2 Purchased goods £175 on credit from M Rooks.“ 3 Bought furniture and fittings £150 paying by cheque.“ 5 Sold goods for cash £275.“ 6 Bought goods on credit £114 from P Scot.“ 10 Paid rent by cash £15.“ 12 Bought stationery £27, paying in cash.“ 18 Goods returned to M Rooks £23.“ 21 Let off part of the premises receiving rent by cheque £5.“ 23 Sold goods on credit to U Foot for £77.“ 24 Bought a motor van paying by cheque £300.“ 30 Paid the month’s wages by cash £117.“ 31 The proprietor took cash for himself £44.

Example Bank a/c

2002 £

2002 £

1/5 Capital 2,000

3/5Furn& fitting 150 24/5 Motor vehicle 300


21/5 Rent 5

31/5 Bal c/f 1,555

2,005 2,005

Capital a/c31/5 Bal c/f 2,000

1/5 Bank 2,000

Purchases a/c2002 £

2002 £

2/5M Rooks 1756/5 P Scot 114

31/5 Bal c/f 289

289 289

Creditor – M Rooks a/c2002 £

2002 £

18/5 Returns in 23

2/5 Purchases 175

31/5 Bal c/f 152

175 175

Furniture & Fittings a/c2002 £ 2002 £ Sales a/c3/5 Bank 150 31/5 Bal c/f 150 2002 £ 2002 £ 31/5 Bal c/f 352 5/5 Cash 275

150 150 23/5 U. Foot 77

352 352

Cash in hand a/c2002 £ 2002 £ P Scot a/c

Lesson One 27

5/5 Sales 275 10/5 Rent 15 2002 £ 2002 £ 12/5 Stationery 27 31/5 Bal c/f 114 6/5Purchases 114 30/5 Wages 117 31/5 Bal c/f 116

275 275 114 114

Expenses – Rent a/c Expenses – Stationery a/c 2002 £ 2002 £ 2002 £ 2002 £11/5 Bal c/f 15 10/5 Cash 15 12/5 Cash 27 31/5Bal c/f 27 27 27


Returns – Out a/c Income – Rent a/c2002 £ 2002 £ 2002 £ 2002 £31/5 Bal c/f 23 18/5 M Rooks 23 21/5 Bal c/f 5 31/5 Bank 5

Debtors – U Foot a/c Motor vehicle a/c2002 £ 2002 £ 2002 £ 2002 £23/5 Sales 77 31/5 Bal c/f 77 24/5 Bank 300 31/5 Bal c/f 300

Expenses – Wages a/c Drawings a/c2002 £ 2002 £ 2002 £ 200 £30/5 Cash 117 31/5 Bal c/f 117 31/5 Cash 44 31/5 Bal c/f 44

Accounting for drawings, discounts allowed and discounts received.

DrawingsThe owner makes drawings from the firm in various ways:

i) Cash or bank withdrawalsWhen the owner withdraws money from the business we debit drawings and credit cashbook (cash in hand or cash at bank).

ii) Taking goods for own use and When the owner takes out some of the goods for his own use, we debit drawings and credit purchases.

iii) Personal expenses, paid by the businessHere we debit the drawings and credit expense account

Taking some of the other assets from the business e.g. motor vehicles or using part of the premises.Sometimes the owner may take over some of the assets of the business e.g. vehicle or converting business premises into living quarters or not paying into the

Lesson One 29

business cash collected personally from the customers. When this happens we debit drawings and credit the relevant asset e.g. motor vehicles, premises or some building or even debtors.


DiscountsDiscounts received.A discount received is an allowance by the creditors to the firm to encourage the firm to pay the amount dues within the agreed time. It is an amount deducted from the invoice price.When a discount is given by the supplier then we debit creditor’s account and credit discounts received e.g. A. Ltd sells some goods on credit to B Ltd. 1,000₤ under the terms of sale, B Ltd, will receive a discount of 5% if they pay the amount due within one month. B decides to take up the offer and pays the amount within the given time. B will record the transaction as follows.

Debit: Creditor – A LtdCredit: Discounts Received

Creditor A. Ltd a/c Purchases a/c 2002 £ 2002 £ 2002 £ 2002 £Bank 950 Purchases 1,000 A Ltd 1,000 Discount received 50 1000 1000

Discounts Received a/c Bank a/c200 £ 2002 £ 2002 £ 2002 £Bal c/f 50 A Ltd 50 A Ltd 950

Discounts AllowedThese are the allowances made by a firm on the amounts receivable from the customers to encourage prompt payment. The amounts deducted from the sales invoice. In the previous example when A Ltd issued the discount and was taken up by B the entries will be:

i. Debit - discount allowedii. Credit - debtors - B Ltd.

Debtors B Ltd a/c Sales a/c2002 £ 2002 £ 2002 £ 2002 £Sales 1,000 Bank 950 Discount 50 Debtor 1,000 1,000 1,000

Lesson One 31

Discount allowed a/c Bank a/c2002 £ 2002 £ 2002 £ Debtor 50 Bal c/f 50 Debtor 950

TRIAL BALANCEThe trial balance is a simple report that shows the list of account balances classified as per the debits and credits. The purpose of the trial balance is to show the accuracy of the double entries made and to facilitate the preparation of final accounts i.e. the trading, profit & loss account and a balance sheet.The debits of the trial balance should be the same as the credits, if not then there is an error in one or more of the accounts.

The trial balance in example 1.8 would be extracted as follows:

NameTrial balance as at 31 May 2002

Debit Credit

£ £Rent – income 5Debtor – U Foot 7Motor vehicle 300Bank 1555Purchases 289Wages 117Capital 2000Creditor – M Rooks

152

Furniture & Fittings

150

Sales 352Cash in hand 72Creditor – P Scot 114Expenses – Rent 15Expenses – Stationery

27

Returns Outwards

23

Drawings 44 . 2464 2464

From the trial balance please note that assets and expenses are on the debit side. Capital, liabilities and incomes are normally listed on the credit side.The next example is a detailed one that shows extracting of trial balance once all the postings have been made in the relevant accounts.


Example 1.9Write up the following transactions in the books of S Pink:2003March 1 Started business with cash £1,000.“ 2 Bought goods on credit from A Cliks £296.“ 3 Paid rent by cash £28.“ 4 Paid £1,000 of the cash of the firm into a bank account.“ 5 Sold goods on credit to J Simpson £54.“ 7 Bought stationery £15 paying by cheque.“ 11 Cash sales £49.“ 14 Goods returned by us to A Cliks £17.“ 17 Sold goods on credit to P Lutz £29.“ 20 Paid for repairs to the building by cash £18.“ 22 J Simpson returned goods to us £14.“ 27 Paid A Cliks by cheque £279.“ 28 Cash purchases £125.“ 29 Bought a motor vehicle paying by cheque £395.“ 30 Paid motor expenses in cash £15.“ 31 Bought fixtures £120 on credit from R west.

Solutions Capital a/c Cash in hand a/c 2003 £ 2003 £ 2003 £ 2003 £31/3 Bal c/d 1,500 1/3 Cash 1,500 1/3 Capital 1,500 3/3 Rent 28 11/3 Sales 49 4/3 Bank 1,000 20/3 Repairs 18 28/3 Purchases 125 30/3 Motor exp. 15 31/3 Bal c/d 363 1,549 1,549 Purchases a/c

2003 £ 2003 £2/3 A Hanson 296 31/3 Bal c/d 421 Creditors – A Cliks ac28/3 Cash 125 2003 £ 2003 £

Lesson One 33

421 421 14/3 Returns out 17 2/3 Purchases 296

27/3 Bank 279 296

296

Rent –Expenses a/c Bank a/c 2003 £ 2003 £ 2003 £ 2003 £3/3 Cash 28 31/3 Bal c/d 28 4/3 Cash 1,000 5/3 Stationery 15 27/3 A. Hanson 279 29/3 Motor van 395 31/3 Bal c/d 311 1,000

1,000

Debtor – J Simpson a/c Sales a/c 2003 £ 2003 £ 2003 ` £ 2002 £3/3 Sales 54 22/3 Returns in 14 31/3 Bal c/d 132 5/3 JSimpson 54 31/3 Bal c/d 40 11/3 Sales 49 17/3 P Lutz 29 54 54 132 132


Stationery a/c 2003 £ 2003 £ Returns outwards a/c7/3 Bank 15 31/3 Bal c/d 15 2003 £ 2003

£ 31/3 Bal c/d 17 14/3 A Cliks 17

P Lutz – Debtor a Building repairs - expenses 2003 £ 2003 £ 2003 £ 2003 £17/3 Sales 29 21/3 Bal c/d 29 20/3 Cash 18 31/3 Bal c/d 18

Returns - Inwards Motor vehicle

2003 £ 2003 £ 2003 £ 2003 £22/3 J Simpson 14 31/3 Bal c/d 14 29/3 Bank 395 31/3 Bal c/d 395

R West – Creditor (others) Motor expenses 2003 £ 2003 £ 2003 £ 2003 £31/3 Bal c/d 120 31/3 Fixtures 120 30/3 Cash 15 31/3 Bal c/d 15

Fixtures2003 £ 2003 £31/3 A. Webster 120 31/3 Bal c/d 120

Lesson One 35

S PINKSTRIAL BALANCE AS AT 31 MARCH 2003

Debit (£)

Credit (£)

Capital 1500Purchases 421Cash in hand 363Bank 311Rent expense 28Sales 132Fixtures 120Debtor – J Simpson 40Debtor – P Lutz 29Motor vehicle 395Creditors - -Motor expenses 15Returns inwards 14Creditors others – R West

120

Stationery 15Returns outwards 17Building repairs 18 -

1769 1769

Example 1.10The following transactions took place during the month of May:

2003 May 1 Started firm with capital in cash of £250.“ 2 Bought goods on credit from the following persons: R Kelly £54;

Pcombs £87; J Role £25; D Mobile £76; I. Sims £64.

“ 4 Sold goods on credit to: C Blanes £43; B Long £62; F Skin £176.“ 6 Paid rent by cash £12.“ 9 C Blanes paid us his account by cheque £43.“ 10 F Skin paid us £150 by cheque.“ 12 We paid the following by cheque: J Role £25; R Kelley £54.“ 15 Paid carriage by cash £23.“ 18 Bought goods on credit from P Combs £43; Mobile £110.“ 21 Sold goods on credit to B Long £67.“ 31 Paid rent by cheque £18.


AnswerCapital Cash in Hand

2003

£ 2003

£ 2003

£ 2003

£

31/5

Bal c/d

250 1/5 Cash 250 1/5 Capital

250 6/5 Rent 12

15/5

Carriage

23

. 31/5

Bal c/d 215

250 250

Creditor R Kelly Creditor P Combs2003

£ 2003

£ 2003

£ 2003

£

12/5

Bank

54 2/5 Purchases

54 31/5

Bal c/d 130 2/5 Purchases

87

. 18/5 Purchases

4 3

130 130

Creditor – J Role Creditor – D Mobile2003

£ £ 2003

£ 2003

£

12/5

Bank

25 2/5 Purchases

25 31/5

Bal c/d

186 2/5 Purchases

76

. 18/5

Purchases

110

186 186

Creditor I Sims Debtor C. Blares2003

£ 2003

£ 2003

£ 2003

£

31/5 Bal c/d

64 2/5 Purchases

64 4/5 Sales 43 4/5 Bank 43

Debtor B Long Debtor F Smith 2003

£ 2003

£ 2003

£ 2003

£

4/5 Sales

62 31/5

Bal c/d 129 4/5 Sales 176 10/5

Bank 150

21/5

Sales

67 .

. 31/5

Bal c/d 2 6

129 129 176 176

Lesson One 37

Purchases Sales2003

£ 2003

£ 2003

£ 2003

£

2/5 R Kelly 54 31/5

Bal c/d

459

31/5

Bal c/f

348 4/5 C Blanes

43

2/5 P Combs 87 4/5 F Long 622/5 J Role 25 4/5 F Skin 17

62/5 D Mobile 76 4/5 B Long 672/5 L Sims 64

.18/5 P Combs 43 34

818/5 D.

Mobile 10

0 .

459

459

Bank Carriage Expenses2003

£ 2003

£ 2003 £ 2003

£

9/5 C Blanes

43 12/5 J Role 25 15/5 Cash 23 31/5

Bal c/d 23

10/5 H F Skin

150

12/5 R Kelly

54

31/5 Rent 18

.31/5 Bal

c/d 9

619

319

3

Rent19x6

£ 19x6

£

6/5 Cash 12 31/5

Bal c/d

30

31/5

Bank 1 8

.

3 0

30

Trial Balance as at 31/5/2003

Debit CreditCapital - 250


Cash 215 -Creditor – R Kelly - -Creditor – P Combs - 130Creditor – J Role - -Creditor – D Mobile - 186Creditor – L. Simms - 64Debtor – C. Blanes - -Purchases 459 -Sales - 348Debtor- B. Long 129 -Debtor- F Skin 26 -Bank 96 -Carriage -Rent 30 - 978 978

Lesson One 39

REINFORCEMENT QUESTIONSQuestion OneSpark has been trading for a number of years as an electrical appliance retailer and repairer in premises which he rents at an annual rate of $1,500 payable in arrears. Balances appearing in his books at 1 January 19X1 were as follows:

$ $Capital account 1,808Motor van 1,200Fixtures and fittings 806Provision for depreciation on motor van (credit) 720Provisions for depreciation on fixtures& fittings (credit)

250

Inventory at cost 366Receivables for credit sales:Brown 160Blue 40Stripe 20

220Cash at bank 672Cash in hand 5Payables for supplies:Live 143Negative 80Earth 73

296Amount owing for electricity 45Local taxes paid in advance 100

Although Sparks has three credit customers the majority of his sales and services are for cash, out of which he pays various expenses before banking the balance.

The following transactions took place during the first four months of 19X1January

February

March

April

$ $ $ $Suppliers’ invoices:Live 468 570 390 602Negative - 87 103 64Earth 692 - 187 -Capital introduced 500Bankings of cash (from cash sales) 908 940 766 1,031Expenditure out of cash sales before banking:Withdrawals on account 130 120 160 150Stationery 12 14 26 21Travelling 6 10 11 13Petrol and van repairs 19 22 37 26


Sundry expenses 5 4 7 3Postage 12 10 15 19Cleaner’s wages 60 60 65 75Goods invoiced to credit customers:Brown 66 22 10 12

Blue120 140 130 180

Stripe 44 38 20 48Cheque payments (other than those to suppliers):Telephone 40 49 59 66Electricity 62 47 20 106Local taxes - - 220 -Motor van (1 February 19X1) - 800 - -Unbanked at the end of April - - - 12

Spark pays for goods by cheque one month after receipt of invoice, and receives a settlement discount of 15% from each supplier.

Credit customers also pay by cheque one month after receipt of invoice, and are given a settlement discount of 10% of the invoice price.

Required:

Write up the ledger accounts of Spark for the four months to 30 April 19X1, and extract a list of account balances after balancing off the accounts.

Question TwoMaryBalance Sheet as at 31 December 2000

Non Current Assets £ £Premises 25,000.0

0Plant 12,000.0

037,000.0

0Current Assets:Stock 11,000.00Debtors 10,000.00Cash at bank 5,000.00Cash in hand 3,000.00

29,000.00Current liabilities:Creditors (12,000.0

0)17,000.0

054,000.0

0

Lesson One 41

Capital 34,000.00

Non Current Liabilities:Loan from bank 20,000.0

0 54,000.00

During the year to 31 December 2001 the following total transactions occurred:

a) Mary withdrew a total of £10,000.00 in cashb) Stock in trade was bought, all on credit, for £34,000.00c) Sales were made totaling 60,000.00 of stock in trade which had cost

£37,000.00. Of these sales £51,000.00 were on credit and £9,000.00 for cash.d) A total of £16,000.00 was drawn from the bank in cash to the cash till.e) Electricity for the year paid by cheque totaled £2,000.00f) Rates for the year paid by cheque totaled £1,000.00g) Wages for the year all paid cash totaled £10,000.00h) Sundry expenses all paid in cash totaled £2,000.00i) Creditors were paid a total of £36,000.00 all by chequej) Debtors paid a total of £54,000.00 all in cheques.k) The bank charged interest on the loan deducting £3,000.00.

Required:

Prepare a revised balance sheet. (20 marks)

Question Threea) Explain the nature of accounting and the accounting equation

(8 marks)b) Calculate the profit for the year ended 31 December 2001 from the following information

(12 marks)

Non Current Assets

01.01.2001

31.12.2001

£ £Property 20,000.00 20,000.00Machinery 6,000.00 9,000.00

26,000.00 29,000.00Current Assets:Debtors 8,000.00


4,000.00Cash 1,000.00 1,500.00

5,000.00 9,500.00Current Liabilities:Creditors 5,000.00 3,000.00Overdraft 6,000.00 9,000.00

11,000.00 12,000.00Net Current Liabilities

(6,000.00) (2,500.00)

Net Assets 20,000.00 26,500.00

Drawings during the year amounted to £4,500.00Additional capital introduced by the owner £5,000.00

Question FourBrian Barmouth is a sole trader. At 30 June 2000 the following balances have beenextracted from his books:

£Sales 47,600.

00Purchases 22,850.

00Office expenses 1,900.0

0Insurance 700.00Wages 7,900.0

0Rates 2,800.0

0Heating and Lighting

1,200.00

Telephone 650.00Discounts allowed 1,150.0

0Opening stock 500.00Returns inwards 200.00Returns outwards 150.00Premises 40,000.

00Plant and 5,000.0

Lesson One 43

Machinery 0Motor Vehicles 12,000.

00Debtors 12,500.

00Bank balance 7,800.0

0Creditors 3,400.0

0Loan-long term loan

10,000.00

Capital 60,000.00

Drawings for the year

4,000.00

Closing stock 550.00

Required:Construct a trial balance, from the above list of balances.

CHECK YOUR ANSWERS WITH THOSE GIVEN IN LESSON 9 OF THE STUDY PACK

Acknowledgement 44

LESSON TWO

FINAL ACCOUNTS

FINAL ACCOUNTS FOR SOLE TRADERS(a) TRADING ACCOUNTThe trading account summarises the trading activities (sale and purchase of goods/stocks) of the business and tries to determine the gross profit for the relevant financial period. The gross profit is then taken up in the profit and loss account as part of the income.

Format for the trading account:

NameTrading Account for the year ended 31 Dec.

₤ ₤ ₤

Sales xLess: Returns Inwards (x)

x

Less: Cost of SalesOpening stock x Purchases xAdd: Carriage Inwards x

xLess: Returns Outwards x xCost of stock available for sale xLess: Closing stock x (x)Gross Profit x

Example: 2.1From the following details draw up the trading account of Springs for the year ended 31 December 2002, which was his first year in business.

₤Carriage inwards 6,700Returns outwards 4,950Returns inwards 8,900Sales 387,420


Lesson Two 45

Purchases 333,330Stock of goods: 31 December 19x7 74,890

46 Final Accounts

SpringsTrading Account for the year ended 31 Dec 2002

£ £

Sales 387,420Less: Returns Inwards 8,900

378,520

Less cost of salesPurchases 333,330Add: Carriage Inwards 6,700

340,030Less: Returns outwards 4,950 335,080Less: Closing stock 74,890 260,190Gross Profit 118,330 Example 2.2The following details for the year ended 31 March 2003 are available. Draw up the trading account of R Sings for that year.

£Stocks: 1 April 2002 16,523Returns inwards 1,372Returns outwards 2,896Purchases 53,397Carriage inwards 1,122Sales 94,600Stocks: 31 March 2003 14323

AnswerR SingsTrading Account for the year ended 31 Mar 19x8

₤ ₤ ₤Sales 94,600 Less: Returns Inwards (1,372)

93,228Less: Cost of salesOpening Stock 16,523Purchases 53,397Add: Carriage Inwards 1,122

54,519Less: Returns Outwards 2,896 51,623Cost of goods available for sale 68,146

Lesson Two 47

Less: Closing stock 18,504 (49,642)Gross Profit 43,586

(b) PROFIT AND LOSS ACCOUNT It shows the net profit or net loss that the business has made from all the activities during a financial period.The net profit (or loss) is determined by deducting all the expenses from all the incomes of the same financial period.In practice, the trading account is combined together with the net profit and loss account into one report so that the format is as shown below:

NameTrading, Profit and Loss Account for the year ended 31/12/19xx

£ £ £Sales x Less: Returns Inwards x

x

Less: Cost of salesOpening stock xPurchases xAdd: Carriage Inwards x

xLess: Returns Outwards x xCost of goods available for sale xLess: Closing stock x (x)Gross Profit xDiscount received xRent received xInterest received xOther incomes x

x

Less: ExpensesCarriage Outwards xDiscounts allowed xPostage & stationary xSalaries & wages xRent paid xInsurance & rates xBank charges xOther expenses x (x)Net profit/ (loss) x/(x)

48 Final Accounts

Example 2.3From the following trial balance of P Boones draw up a trading and profit and loss account for the year ended 30 September 2002, and a balance sheet as at that date.

Dr Cr £ £

Stock 1 October 19x8 23,680Carriage outwards 2,000Carriage inwards 3,100Returns inwards 2,050Returns outwards 3,220Purchases 118,740Sales 186,000Salaries and wages 38,620Rent 3,040Insurance 780Motor expenses 6,640Office expenses 2,160Lighting and heating expenses 1,660General expenses 3,140Premises 50,000Motor vehicles 18,000Fixtures and fittings 3,500Debtors 38,960Creditors 17,310Cash at bank 4,820 Drawings 12,000Capital 126,360

332,890 332,890

Lesson Two 49

AnswerP BoonesTrading, Profit and Loss Account as at 30 September 2003

£ £ £Sales 186,000Less: Returns Inwards (2,050)

183,950

Less: Cost of salesOpening stock 23,680Purchases 118,740Add: Carriage inwards 3,100

12,1840Less: Returns Outwards 3,220 118,620Cost of goods available for sale 142,300Less: Closing stock 29,460 (11,2840)Gross Profit 71,110

Less ExpensesSalaries & wages 38,620Carriage outwards 2,000Rent 3,040Insurance 780Motor expenses 6,640Office expenses 2,160Lighting & heating 1,660General expenses 3,140 (58,040)Net Profit 13,070

50 Final Accounts

(c) BALANCE SHEETThis is a simple report that shows the assets and liabilities of the business and the capital of the owner as at a certain point in time. The format is at shown below:

NameBalance sheet as at 31/Dec/19xx

£ £ £Non Current AssetsLand & Buildings xPlant & Machinery xFixtures, Furniture & Fittings xMotor vehicles x

xCurrent AssetsStock/inventories xDebtors – trade xDebtors – others xCash at bank xCash at hand x

xCurrent LiabilitiesBank overdraft xCreditors – trade xCreditors – others x (x)Net current assets xNet Assets x

Capital xAdd: Net profit x

xLess: Drawings (x)

x

Non Current LiabilitiesLoan (s) x

x

The balance Sheet of P Boones in example 2.3 will be produced as follows:

Lesson Two 51

P BoonesBalance Sheet as at 30 Sept 2002

£ £Non Current AssetsPremises 50,000Fixtures & fittings 3,500Motor vehicles 18,000

71,500Current AssetsStock 29,460Debtors 38,960Cash at bank 4,820


Capital 126,360Add: Net Profit 13,070

139,430Less: Drawings (12,000)

127,430`

D) BOOKS OF PRIME ENTRY The diagram below shows the components of an accounting system for a firm that carries out trading activities from the source documents that record the evidence of transactions, where the documents are recorded and the postings to made.

52 Final Accounts

Source Books of The List of the FinalDocuments Prime entry Ledger Balances Accounts

Recorded Sales

The Ledger

Trading

AccountRecorded

Recorded

Purchases The

Ledger Profit

& Loss Loss

Recorded Account

Recorded General Ledger

Recorded

Balance

Balance Sheet

A brief description of each component is explained below.SOURCE DOCUMENTS

SalesInvoice

SalesJournal

PurchaseInvoice

PurchasesJournal

Creditnote

ReturnInwardsJournal

DebitNote

ReturnOutwardsjournal

Receipts

ChequesPetty

The cashbook&

Petty cashbook

OtherCorrespondence

GeneralJournal

THE

TRIAL

BAL-ANCE

Lesson Two 53

This shows the evidence transactions. They are collected, filed and posted in the books of prime entry. Example, if a firm sells goods on credit, then an invoice is raised. The source documents as shown in the above include:

54 Final Accounts

Sales invoice Purchases invoice Credit note Debit note Receipts, cheques and petty cash vouchers Other correspondences.

(i) Sales Invoice The sales invoice is raised by the firm and sent to the debtor/customer when the

firm makes a credit sale. The sales invoice contains the following:

i. Name and address of the firmii. Name and address of the buying firm

iii. Date of making the sale – invoice date.iv. Invoice numberv. Amount due (net of trade discount)

vi. Description of goods soldvii. Terms of sale

(ii) Purchases Invoice A purchase invoice is raised by the creditor and sent to the firm when the firm

makes a credit purchase. It shows the following:i. Name and the address of the creditor/seller

ii. Name and address of the firmiii. Date of the purchase (invoice date)iv. Invoice numberv. Amount due

vi. Description of goods soldvii. Terms of sale

(iii) Credit note A credit note is raised by the firm and issued to the debtor when the debtor returns some goods back to the firm. It’s contents include:

i. Name and address of the firmii. Name and address of the debtor

iii. Amount of creditiv. Credit note numberv. Reason for credit e.g. if goods sent but of the wrong type.

The purpose of the credit note is to inform the debtor or customer that the debtor’s account with the firm has been credited i.e. the amount due to the firm has been reduced or cancelled.The credit note may also be issued when the firm gives an allowance of the amounts due from the debtors. From the context we can assume that all credit notes are issued when goods are returned.(iv) Debit note This is raised by the creditor and issued to the firm when the firm returns some goods to the creditor. It includes the following items:

i. Name and address of the firmii. Name and address of the creditor

Lesson Two 55

iii. Amount of debitiv. Debit Note numberv. Reason for the debit

The purpose of the debit note is to inform the firm that the amount due to the creditor has been reduced or cancelled.

Credit sales (sales invoice)

Returns inwards (credit note)

Credit purchase (purchase invoice)

Returns outwards (debit note)

(vi) Receipts A receipt is raised by the firm and issued to customers or debtors when they make payments in the form of cash or cheques. It shows:

i. The name and address of the firmii. The date of the receipt

iii. Amount received (cash or cheque or other means of payment)iv. Receipt number.

ChequesWhen a firm opens a current account with the bank, a chequebook containing cheques issued. The cheques allow the firm to make payments against the account with the bank. When a firm issues a cheque to its creditors for payments, it authorizes the bank to honour payments against the firm’s account with the bank. The cheque contains the following information:

i. Name and account number of the firm (account holder)ii. The date of the cheque

iii. Name of the payee (creditor)iv. Name of the firm’s bankv. Amount payable in words and figures

vi. The cheque numbervii. The authorized signature(s)

Petty cash vouchers A petty cash voucher is raised by a cashier to seek authority for payments (payments of small value in the firm which require cash payments e.g. fuel, bus-fare, office snacks), which is approved by a senior manager and filed for record purpose. It shows:

TheFirm

TheDebtor

TheFirm The

Creditor

56 Final Accounts

i. Date of paymentii. Amount paid

iii. Reason for paymentiv. Authorized signature(s):v. Person approving

vi. Person receiving The person receiving the money must then return a document supporting how the money was utilized e.g. fuel receipt, bus ticket e.t.c.

(vii) Other correspondence These include information received within or outside the firm that has a financial implication in the accounts. Examples are:

i. Letters from the firm’s lawyers about a debtors balance.ii. Hire-purchase/credit sale or credit purchase agreements that relate to

non-current assets.iii. Memorandum from a senior manager requiring changes to be made in

the accounts.iv. Bank statement from the bank, e.g. bank charges.

BOOKS OF PRIME ENTRY

They record the source documents.Sales JournalIt is also called a Sales Day Book. It records all the sales invoices issued by the firm during a particular financial period. The format is as follows (with simple records of invoice).

SALES JOURNAL Page 5

Date 19x8 Detail Folio Amount £

1st March S. Spikes SL.10 200.00 3rd March T. Binns SL.19 350.00 5th March L.Thompson SL,8 150.00

Total 700.00

The individual entries in the sales journal are posted to the debit side of the debtor’s accounts in the sales ledger and the total is posted on the credit side of the sales account in the general ledger.

Lesson Two 57

This is shown below:

Sales Ledger General Ledger

S Spikes General Account 19x8

£ 19x8

£ 19x8

£ 19x8

£

1/3 Sales

200 5/3 Credit sales for period

700


T Binus 19x8

£ 19x8

3/3 Sales

350

L Thompson19x8

£ 19x8

£

3/3 Sales

150

Example 2.4You are to enter up the sales journal from the following details. Post the items to the relevant accounts in the sales ledger and then show the transfer to the sales account in the general ledger.

2003Mar 1 Credit sales to J Gordon £1,870“ 3 Credit sales to G Abrahams £1,660“ 6 Credit sales to V White £120“ 10 Credit sales to J Gordon £550“ 17 Credit sales to F Williams £2,890“ 19 Credit sales to U Richards £660“ 27 Credit sales to V Wood £280“ 31 Credit sales to L Simes £780

58 Final Accounts

Answer

SALES JOURNAL Page 10

Date (2003) Detail Folio Amount

1/3 J. Gordon 1,870.00 3/3 G. Abrahams 1,660.00 6/3 V. White 120.00 10/3 J. Gordon 550.00 17/3 F. Williams 2,890.00 19/3 U. Richards 660.00 27/3 V. Wood 280.00 31/3 L. Simes 780.00

8,810.00

Sales Ledger

J Gordon U Richards2003

£ 2003

£ 2003

£ 2003

£

1/3 1570

19/3

Sales

660

10/3

550

G Abrahams V Wood 2003

£ 2003

£ 2003

£ 2003

£

3/3 Sales

1,660

27/3

Sales

280

U White L Simes2003

£ 2003

£ 2003

£ 2003

£

6/3 Sales

120 31/3

Sales

750

F Williams Sales a/c

Lesson Two 59

2003

£ 2003

£ 2003

£ 2003

£

17/3

Sales

2890

Credit Sales

Purchases JournalPurchases journal is also called a purchases day-book. It records all the purchase invoices received by the firm during a particular financial period. It has the following format (including records of invoices).

PURCHASES JOURNAL Page 15 Date 19x6 Description/Detail Folio Amount

1/5 C. Kelly PL. 10 400 2/5 L. Smailes PL. 20 350

TOTAL 750

The individual entries in the purchases journal are posted to the credit side of the creditor’s accounts in the purchases ledger and the total is posted to the debit side of purchases account of the general ledger. This is shown below:

C Kelly Purchases a/c19x6

£ 19x6

£ 19x6

£ 19x6

£

1/5 Purchases

400

31/5

Sundry Creditors

750

L Smailes 19x6

£ 19x6

£

2/5 Pur-chases

250

Returns Inwards JournalIt is also called the returns inwards day-book. It records all the credit notes raised by the firm and sent to customers during a particular financial period, it has the following format.

60 Final Accounts

RETURNS INWARDS JOURNAL Pg 10

Date Detail Folio Amount

1 March S. Spikes SL. 22 £20 2 March C. Kelly SL. 18 £18 5 March T. Bills SL. 9 £15

TOTAL £53

Individual entries in a return inwards journal are posted to the credit of the debtors accounts in the sales ledger and the total is posted to the debit side of the return-inwards account of the general ledger.


S. Spikes a/c Returns Inwards a/c£ £ £ £

1/3

Returns In

20 31/3

Sundry Debtors

53

C Kelly a/c T. Bills a/c£ £ £ £

2/3

Returns In

18 5/3

Returns In

15

Lesson Two 61

Returns Outwards JournalIt is also called the returns outwards daybook. It records all the debit notes received by the firm from the creditors during a particular financial period. It has the following format.

RETURNS OUTWARDS JOURNAL

DATE DETAILS FOLIO AMOUNT (£)

2 May L. Thompson PL. 15 14 3 May M. Hyatt PL. 10 12 4 May T. Bills PL. 7 19

TOTAL 35

Individual entries are posted on the debit side of the creditors account in the purchases ledger and on the total to credit side of the returns outwards account in the general ledger.

Purchases Ledger General Ledger

L. Thompson a/c Returns Outwards a/c

` £ £ £ £ 2/5 Returns out 14 31/5 sundry creditors 35

M. Hyatt a/c £ £

3/5 Returns out 12

T. Bills a/c

£ £4/5 Returns Out 19

62 Final Accounts

The following example 2.5 shows how the four journals are used.

Lesson Two 63

Example 2. (Frankwood adapted)You are to enter the following items in the books, post to personal accounts, and show transfers to the general ledger.

19x5July 1 Credit purchases from: K Hill £3800; M Norman £500; N Senior £106.“ 3 Credit sales to: E Rigby £510; E Phillips £246; F Thompson £356.

5 Credit purchases from: R Morton £200; J Cook £180; D Edwards £410; C Davies £66.

“ 8 Credit sales to: A Green £307; H George £250; J Ferguson £185.“ 12 Returns outwards to: M Norman £30; N Senior £16.“ 14 Returns inwards from: E Phillips £18; F Thompson £22.“ 20 Credit sales to: E Phillips £188; F Powell £310; E Lee £420.“ 24 Credit purchases from: Ferguson £550; K Ennevor £900.“ 31 Returns inwards from: E Phillips £27; E. Rigby £30.“ 31 Returns outwards to: J Cook £13; C Davies £11.

Study the solution provided:

SALES JOURNAL

DATE DETAIL AMOUNT (£)

3 July E. Rigby 510 3 July E. Phillips 246 3 July F. Thompson 356 8 July A. Green 307 8 July H. George 250 8 July J. Ferguson 185 20 July E. Phillips 188 20 July F. Powell 310 20 July E. Lee 420

TOTAL 2,772

Sales Ledger

E Rigby E Phillips19x5

£ 19x5

£ 19x5

£ 19x5 £

3/7 Sales

510

3/7 Returns Inwards

30 3/7 Sales

246 14/7 Returns 18

20/7

Sales

188 31/7 Retuns in

27

64 Final Accounts

F. ThompsonJ. Ferguson

19x5

£ 19x5

£ 19x5

£ 19x5 £

3/7 Sales

356

14/7

Returns in

22 8/7 Sales

185

Green F. Powell19x5

£ 19x5

£ 19x5

£ 19x5 £

8/7 Sales

307

20/7

Sales

310

H George E Lee 19x5

19x5

£ 19x5

£ 19x5 £

8/7 Sales

250

20/7

Sales

420

PURCHASES JOURNAL

DATE DETAIL AMOUNT (£)

1 July K. Hill 380 1 July M. Norman 500 1 July N. Senior 106 5 July R. Mortan 200 5 July J. Cook 180 5 July D. Edwards 410 5 July C. Davies 66 24 July C. Ferguson 550 24 July K. Ennevor 900

Total 3,292

Purchases Ledger

N. Senior

Lesson Two 65

1995 £

1995 £

12/7 Returns out 16

1/7 Purchases 22

M. Norman1995

£ 1995

£ 30/7 Returns out

301/7 Purchases 500

J. Cook1995

£ 1995

£ 31/7 Returns out

135/7 Purchases

180

C. Davies1995

£ 1995

£ 31/7 Returns out

115/7 Purchases

60

K. Hill1995

£ 1995

£ 1/7 Purchases

380

R. Morton1995

£ 1995

£ 5/7 Purchases

200

D. Edwards1995

£ 1995

£ 5/7 Purchases

410

C. Ferguson1995

£ 1995

£ 27/7 Purchases

550

K. Ennevor1995 1995

66 Final Accounts

£ £ 24/7 Purchases

900

General LedgerSales a/c

1995 £

1995 £

31/7 Sundry debtors 2772

Purchases a/c1995

£ 1995

£ 31/7 Sundry creditors 3292

Returns Inwards a/c1995

£ 1995

£ 31/7 Sundry debtors 97

Returns Outwards a/c1995

£ 1995

£ 31/7 Sundry creditors

RETURNS INWARDS JOURNAL

DATE DETAILS AMOUNT14 July E. Phillips 1814 July F. Thompson 2231 July E. Phillips 2731 July E. Rigby 30

97

RETURNS OUTWARDS JOURNAL

12 July M. Norman 3012 July N. Senior 1631 July J. Cook 1331 July C. Davies 11

70

Lesson Two 67

70

CASH BOOKSA cashbook records all the receipts (cash and cheques from customers and debtors or other sources of income) and all the payments (to creditors or suppliers and other expenses) for a particular financial period. The cashbook will also show us the cash at bank and cash in hand position of the firm.

There are two types of cashbooks:

i. Cash in hand cashbook, which records the cash transactions in the firm or business.

ii. Cash at bank cashbook, which records the transactions at/with, the bank.

The cashbook is the most important book of prime entry because it forms part of the general ledger and records the source documents (receipts and cheques). The cash at bank cashbook and cash in hand cashbook are combined together to get a two-column cashbook. The format is as follows:

Two-column cashbook.

CASH BOOK

Date Details Cash Bank Date Details Cash Bank

(£) (£) (£) (£)

Additional columns for discounts allowed and discounts received can be included with the cash at bank columns to get a 3 – column cashbook. The format is as follows:

Date Details Discount Cash Bank Date Details Discounts Bank Cash

Allowed (£) (£) Received £) (£)

68 Final Accounts

The balance carried down (Bal c/d) for cash in hand and cash at bank will form part of the ledger balances and the discounts allowed and discounts received columns will be added and the totals posted to the respective discount accounts. The discount allowed total will be posted to the debit side of the discount allowed account in the general ledger and the total of the discount received will be posted to the credit side of the discount-received account of the general ledger.Cash at bank can have either a credit or debit balance. A debit balance means the firm has some cash at the bank and a credit balance means that the account at the bank is overdrawn. (the firm owes the bank some money).

Example 2.7Write up a two-column cashbook from the following details, and balance off as at the end of the month:

2003

May 1 Started business with capital in cash £1,000.“ 2 Paid rent by cash £100.“ 3 F Lake lent us £5,000, paid by cheque.“ 4 We paid B McKenzie by cheque £650.“ 5 Cash sales £980.“ 7 N Miller paid us by cheque £620.“ 9 We paid B Burton in cash £220.“ 11 Cash sales paid direct into the bank £530.“ 15 G Moores paid us in cash £650.“ 16 We took £500 out of the cash till and paid it into the bank account.“ 19 We repaid F Lake £1,000 by cheque.“ 22 Cash sales paid direct into the bank £660.“ 26 Paid motor expenses by cheque £120.“ 30 Withdrew £1,000 cash from the bank for business use.“ 31 Paid wages in cash £970.

Cash BookCash Bank Cash Bank

Capital 1000F Lake (loan)

5000

Sales 980N Miller 620Sales 530G Moores 650Cash CSales Bank C

Lesson Two 69

Cash BookCash Bank Cash Bank

Capital 1000 Rent 100F. Lake (Loan)

5000 B McKenzie 650

Sales 980 B Burton 220N Miller 620 Bank C 500Sales 530 F Lake

(loan)1000

G Moores 650 Motor Expenses

120 100

Cash C 500 Cash CSales 660 Wages 970Bank C 1000 Balances c/d 1840 4540

363 0

7310 3630 7310

Example 2.7(Frankwood adapted)A three-column cashbook is to be written up from the following details, balanced off, and the relevant discount accounts in the general ledger shown.

19x8Mar 1 Balances brought forward: Cash £230; Bank £4,756.“ 2 The following paid their accounts by cheque, in each case deducting 5

percent discounts: R Burton £140; E Taylor £220; R Harris £800.“ 4 Paid rent by cheque £120.“ 6 J Cotton lent us £1,000 paying by cheque.“ 8 We paid the following accounts by cheque in each case deducting a 2

½ per cent cash discount: N Black £360; P Towers £480; C Rowse £300.

“ 10 Paid motor expenses in cash £44.“ 12 H Hankins pays his account of £77, by cheque £74, deducting £3 cash

discount.“ 15 Paid wages in cash £160.“ 18 The following paid their accounts by cheque, in each case deducting 5

per cent cash discount: C Winston £260; R Wilson & Son £340; H Winter £460.

“ 21 Cash withdrawn from the bank £350 for business use.“ 24 Cash Drawings £120.“ 25 Paid T Briers his account of £140, by cash £133, having deducted £7

cash discount.

70 Final Accounts

“ 29 Bought fixtures paying by cheque £650.“ 31 Received commission by cheque £88.

Lesson Two 71

Answer

Cash BookDisct Cash Bank Disct Cash Bank

BankBal b/d 230 4756 Rent 120R Burton 7 133 N Black 9 351E Taylor 11 209 P Towers 12 468R Harris 15 285 C Rowse 20 780J Cotton: loan

1000 Motor expenses

44

H Hankins 3 74 Wages 160C Winston 13 247 Cash 350R Wison & Son

17 323 Drawings 120

H Winter 23 437 T Briers 7 133Bank 350 Fixtures 650Commission 88 Balances c/d 123 4833

89 580 7552 48 580 7552

Discounts Received3/1 Sundry

Creditors 48

Discounts Allowed 3/1 Sundry

Debtors 89

Petty Cash Book and the imprest system of Accounting.Petty Cash Book is a record of all the petty cash vouchers raised and kept by the cashier. The petty cash vouchers will show summary expenses paid by the cashier and this information is listed and classified in the petty cash book under the headings of the relevant expenses such as:

Postage and stationery Traveling Cleaning expenses.

The format is as shown: Petty Cash Book

Receipts Date Detail Payments Expenses The

72 Final Accounts

Amount Postage Stationery Traveling Ledger

The balance c/d of the petty cash book will signify the balance of cash in hand or form part of cash in hand. The totals of the expenses are posted to the debit side of the expense accounts. If a firm operates another cashbook in addition to the petty cash book, then the totals of the expenses will also be posted on the credit side of the cash in hand cashbook.

The Imprest systemThis system of accounting operates on a simple principle that the cashier is refunded the exact amount spent on the expenses during a particular financial period. At the beginning of each period, a cash float is agreed upon and the cashier is given this amount to start with. Once the cashier makes payments for the period he will get a total of all the payments made against which he will claim a reimbursement of the same amount that will bring back the amount to the cash float at the beginning of the period.This is demonstrated as follows:

£Start with (float) 1,000Expenses paid (720)Balance 280Reimbursement 720Cash float 1,000

Example 2.8A cashier in a firm starts with £2,000 in the month of March (that is the cash float). I n the following week, the following payments are made:

£1st March – bought stamps for 802nd March – paid bus fare for 1202nd March – cleaning materials 2403rd March – bought fuel 1503rd March – cleaning wages 3004th March – bought stamps 2004th March – paid L. Thompson (creditor) 4005th March – fuel costs 150 On the 5th of March the cashier requested for a refund of the cash spent and this amount was reimbursed back.

Lesson Two 73

Required: Prepare a detailed petty cash book showing the balance to be carried forward to the next period and the relevant expense accounts, as they would appear on the General Ledger.

74 Final Accounts

Answer

Receipts

Date Detail Payments

Expenses THE LEDGE

R

(£)Amount

(£)Postage (£)

Cleaning (£)

Travel(£) (£)

2000 1/3 Bal b/d1/3 Stamps 80 802/3 Bus Fare 120 1202/3 Cleaning

Materials240 240

3/3 Fuel 150 1503/3 Cleaning

wages300 300

4/3 Stamps 200 2004/3 L Thompson 400 4005/3 Fuel 150 . . 150 .

1640 280 540 420 400 1640 5/3

5/3 Bal c/d 20003640 36402000 6/3 Bal b/d

The General JournalIt records information from other correspondence (information that is not recorded in the above books of prime entry). It explains the type of entries that will be made in the ledger accounts giving a reason for these entries.The type of transactions recorded here are:

i. Writing off of assets from the accounts e.g. bad-debts.ii. Drawings for goods or other assets from the business by the owner, not

cash drawings.iii. Purchase or sale of non-current assets on credit.

The format is as shown:

The General Journal

GENERAL JOURNAL

Date Detail Debit Credit

1/3 Account to be debited x Account to be credited x (Narrative)

Lesson Two 75

Example 2.9You are to show the journal entries necessary to record the following items:

2003 May 1 Bought a motor vehicle on credit from Motors Ltd for £6,790. 2003 May 3 A debt of £34 owing from N Smart was written off as a bad debt. 2003 May 8 Furniture bought by us for £490 was returned to the supplier

Wood Offices, as it was unsuitable. Full allowance will be given us. 2003 May 12 we are owed £150 by W Hayes. He is declared bankrupt and

we received £39 in full settlement of the debt. 2003 May 14 we take £45 goods out of the business stock without paying for

them. 2003 May 28 Some time ago we paid an insurance bill thinking that it was

all in respect of the business. We now discover that £76 of the amount paid was in fact

insurance of our private house. 2003 May 28 Bought Machinery £980 on credit from Xerox Machines Ltd.

76 Final Accounts

a. Answer

GENERAL JOURNAL Date (19x5) Detail Debit (£) Credit (£)1/5 Motor Vehicle 6,790

Motors Ltd 6,790Motor vehicle bought on creditfrom Motors Ltd

_________________________________________________________________________ 3/5 Bad debts 34

N Smart - Debtors 34Amount due from N Smart written off as bad

_________________________________________________________________________

8/5 Wood offices 490Furniture 490Office Furniture returned toWood offices

_________________________________________________________________________12/5 Bad debts 111

W. Hayes 111Amount owed now written offas bad debt.

________________________________________________________________________ 14/5 Drawing for goods 45

Purchases 45Goods taken from thebusiness for personal use.

_________________________________________________________________________ 8/5 Drawings 76

Insurance Expenses 76Insurance relating to private housenow transferred to drawings

_________________________________________________________________________ 28/5 Machinery 980

Xerox Machines 980Machinery bought fromXerox Machines

Lesson Two 77

THE LEDGER The ledger is simply the accounts. The Ledger is classified into 3 main classes.

1. Sales Ledger, which has the accounts of all the debtors.2. Purchases Ledger, which has the accounts of all the creditors.3. The General Ledger. Has all the other accounts i.e. other assets, liability,

incomes and expenses and capital.The ledger accounts can also be classified as follows:

OtherNon-current Liabili-

tiesassets

Other Inventories/AssetsStocks

Income

Ex-penses

Capital

LEDGERACCOUNTS

PERSONALACCOUNS

DEBTORS(for goods)

CREDITORS(For goods)

IMPERSONALACCOUNTS

NORMALa/cs

REALACCOUNTS

78 Final Accounts

REINFORCING QUESTIONSQUESTION ONEMr J Ockey commenced trading as a wholesaler stationer on 1 May 2000 with a capital of £5,000.00 with which he opened a bank account for his business.

During May the following transactions took place.

May 1Bought shop fittings and fixtures from store fitments Ltd for £2,000.00May 2Purchased goods on credit from Abel £650.00May 4Sold goods on credit to Bruce £700.00May 9Purchased goods on credit from Green £300.00May 11 Sold goods on credit to Hill £580.00May 13 Cash sales paid into bank account £200.00May 16 Received cheque from Bruce in settlement of his accountMay 17 Purchased goods on credit from Kay £800.00May 18 Sold goods on credit to Nailor £360.00May 19 Sent Cheque to Abel in settlement of his account May 20 Paid rent by cheque £200.00May 21 Paid delivery expenses by cheque £50.00May 24 Received from Hill £200.00 on accountMay 30 Drew cheque for personal expenses £200.00 and assistant wages £320.00May 31 Settled the account of Green.

Requireda) Record the transactions in the books of prime entry.b) Post the entries in the ledger accountsc) Balance the ledger accounts where necessaryd) Extract a trial balance as at 31 May 2000.

Lesson Two 79

QUESTION TWOThe following trial balance has been drawn up from the accounts of Endpages bookshop.

Endpages Bookshop

Trial balance as at 31 December 2002

RequiredPrepare a Trading and profit and loss account for the year ended 31 December 2002 and a balance sheet as at that date.

(20 marks)

Dr Cr

SalesPurchasesSalaries and wagesOffice expensesInsuranceElectricityStationeryAdvertising

TelephoneRatesDiscount allowed Discount receivedRent received Returns inwardsReturns outwardsStock at 01 Jan 2001Premises Stock as at 31 Dec 2001Fixtures and fittingsDebtors and CreditorsCash in HandCash in bankCapitalDrawingsStock as at 31 Dec 2001

£

103,500.0018,700.00

2,500.001,100.00

600.002,400.003,500.00

800.003,000.00

100.00

1,500.00

46,000.0080,000.0041,000.00

5,000.004,800.00

200.00

14,000.00

________328,700.00

£

151,500.00

200.002,000.00

3,500.00

7,500.00

12,000.0011,000.00

41,000.00328,700.00

80 Final Accounts

QUESTION THREEThe following is the trial balance of KSmooth as at 31 March 2002. Draw up a set of final accounts for the year ended 31 March 2002.

Dr Cr

Stock 1 April 2001SalesPurchasesCarriage inwards Carriage outwardsReturns outwardsWages and salariesRent and ratesCommunication expensesCommissions payableInsuranceSundry expensesBuildingsDebtorsCreditorsFixturesCash at bankCash in handDrawingsCapital

£1,816,000

6,918,50042,000

157,000

1,024,000301,500

62,40021,60040,50031,800

2,000,0001,432,000

285,000297,000

11,500762,000

152,028

£

9,234,000

64,000

816,000

5,088,800

152,028

Lesson Two 81

QUESTION FOURSkates drew up the following trial balance as at 30 September 2002. You are to draft the trading and profit and loss account for the year to end 30 September 2002 and a balance sheet as at that date.

Dr Cr

CapitalDrawingsCash at bankCash in handDebtors CreditorsStock 30 September 2001Motor vanOffice equipmentSalesPurchasesReturns inwardsCarriage inwardsReturns outwardsCarriage outwardsMotor expensesRentTelephone chargesWages and salariesInsuranceOffice expensesSundry expenses

£

842,000311,500

29,5001,230,000

2,391,000410,000625,000

9,210,00055,00021,500

30,900163,000297,000

40,5001,281,000

49,200137,700

28,400

17,153,200

£3,095,500

937,000

1,309,000

30,700

17,153,200


82 Final Accounts

COMPREHENSIVE ASSIGNMENT No.1

TO BE SUBMITTED AFTER LESSON 2

To be carried out under examination conditions and sent to the Distance Learning Administrator for marking by the University.

EXAMINATION PAPER. TIME ALLOWED: THREE HOURS. ANSWER ALL QUESTIONS

QUESTION ONE

The books of Mr T, a trader in tea showed the following balances as at 31 March 1998:

Shs.Opening stock of tea 100,000Purchases – Tea 400,000Salaries paid 80,000Buildings 95,000Cash in hand 2,000Cash at bank 135,000Rent, rates and council taxes 15,000Insurance premium paid 3,000Miscellaneous receipts 10,000Sales 720,000Discounts allowed 4,750Bad debts 3,250Building repairs 2,900Miscellaneous expenses 8,700Advertisement 20,000Commission to sales manager 32,400Furniture and fittings 35,000Air conditioners 30,000Sundry debtors 100,000Sundry creditors 80,000Loan on mortgage 70,000Interest paid on the above 3,000Prepaid expenses 4,000Drawings 18,000Bills payable (Current liability) 30,000Bank charges 2,000Legal charges 6,000Motor vehicles 80,000Travelling and conveyance 10,000Capital 280,000

The following further information was obtained :

Lesson Two 83

1. Closing stock was Shs.55,000.2. Legal charges include Shs.5,000 for the cost of stamps and registration of a

new building acquired during the year.3. Purchases include 4000 kg tea valued at Shs.20,000, which was found

totally spoilt. An insurance claim of Shs.15,000 has been accepted by the insurance company.

4. Travelling and conveyancing include proprietor’s personal travelling for which he is charged Shs.4, 800.

5. The sales manager is entitled to commission of 7.5% of the total sales. However any bad debts incurred during the year are deductible from such commission entitlements.

6. Debtors include:7. Shs.10, 000 due from M & C0 (Creditors include Shs.18, 000 due to the

same party).8. Shs.5, 000 due from the sale of furniture.9. Further bad debts of Shs.2, 00010.Provision for bad debts is to be created at 2% of net amount outstanding

from trade debtors.11.Depreciation is chargeable as follows:

Buildings 2.5%Furniture and Fittings 10%Air conditioners 15%Motor vehicles 20%

12.Miscellaneous receipts represent sales proceeds of furniture, whose written down value was Shs.12, 000.

13.Prepaid expenses include insurance premiums for the next year.

Required:Prepare a trading, profit and loss account for the year ended 31st March 1998 and a Balance Sheet as at that date.

QUESTION TWOHall Ltd., which makes up its accounts to 30th June each year, has a fleet of motor lorries. Annual depreciation on motor lorries is calculated at a rate of 25% on the reducing balances, with a full year’s depreciation being made in the year of purchase, but no charge in the year of sale. An extract from the company’s balance sheet as on 30th June 1997 showed the following:

ShsMotor Lorries at cost: 164,900Less provision for depreciation: 93,382Net book Value: 71,518

During the year ended 30th June 1998 purchases and sales of lorries were as follows:

Purchases: Reg.No Cost (Shs)1997

July 30th H11 8,500

84 Final Accounts

Oct 1st H12 7,0001998

Feb 25th H13 9,000June 24th H14 5,900

Sales: Reg.No Purchased on: Cost (Shs)Proceeds (Shs)

1997July 30th H1 14th May 1993 1,592 300Oct 1st H4 10th July 1994 2,560 8501998Mar 1st H6 9th March 1996 8,000 4,600June 25th H7 21st Sept 1996 3,648 2,700

Required:Write up the following accounts in the books of the company for the year ended 30th June 1998:

a) The Motor lories accountb) Motor lorries provision for depreciation accountc) Motor lorries disposal account.

QUESTION THREEThe following trial balance was extracted form the books of Rodney, a sole trader, at 31st December 1997:

Shs Shs.Drawings/Capital 2,148 20,27

1Debtors/Creditors 7,689 5,462Purchases/Sales 62,10

181,74

2Rent and Rates 880Light and heat 246Salaries and wages 8,268Bad debts 247Provision for bad debts 326Stock in trade 31st Dec 1996 9,274Insurance 172General Expenses 933Bank balances 1,582Motor van at cost/Provision for depreciation

8,000 3,6000

Proceeds on sale of van 250Motor expenses 861Freehold premises at cost 15,00

Lesson Two 85

0Rent received 750Provision for depreciation on buildings

5,000

117,401

117,401

The following matters are to be taken in to account:

1. Stock in trade at 31st December 1997 was Shs.9,8842. Rates paid in advance at 31st December 1997, Shs.403. Rent receivable due at 31st December 1997, Shs.2504. Lighting and heating due at 31st December 1997, sh.855. Provision for doubtful debts to be increased to Shs.3886. Included in the amount for insurance Shs.172, is an item for Shs82 for motor

insurance and this amount should be transferred to motor expenses.7. Depreciation has been and is to be charged on vans at an annual rate of 20%

on cost.8. Depreciate buildings Shs.5009. On 1st January 1997 a van which had been purchased for Shs.1,000 on 1st

January 1994 was sold for Shs250. The only record of matter is the credit of Shs.250 to “Proceeds of sale on van” account.

Required:A Trading Profit and Loss account for the year ended 31st December 1997 and a Balance Sheet as at date using vertical format.

QUESTION FOURThe Batley Print Shop rents a photocopying machine from a suppler for which it makes quarterly payments as follows:

Three moths rental in advance;A further charge of 2 pence per copy made during the quarter just ended.

The rental agreement began on 1st August 19X4, and the first six quarterly bills were as follows

Bills and dates received Rental (Shs) Cost of copies (shs) Total cost (Shs)1 August 19X4 2,100 0 2,1001 November 19X4 2,100 1,500 3,6001 February 19X5 2,100 1,400 3,5001 May 19X5 2,100 1,800 3,9001 August 19X5 2,700 1,650 4,3501 November 19X5 2,700 1,950 4,650

Required:

86 Final Accounts

Given that Batley Printing shop ends its accounting year on 31 August,Calculate the charge for photocopying expenses for the year to 31 August, 19X5 and the amount of prepayments and / or accrued charges as at that date.

Show the entries in the ledger of the Batley Printing Shop.

QUESTION FIVE “The historical cost convention looks backwards but the going concern convention looks forwards.”

Required:a) Explain clearly what is meant by:

The historical cost convention The going concern convention.

b) Does traditional financial accounting, using the historical cost convention, make the going concern convention unnecessary? Explain your answer fully.

c) Which do you think a shareholder is likely to find more useful – a report on the past or an estimate of the future? Why?

END OF COMPREHENSIVE ASSIGNMENT No.1

NOW SEND TO THE DISTANCE LEARNING CENTRE FOR MARKING

Acknowledgement 87

LESSON THREE

ACCOUNTING THEORY

(a) International Accounting Standards and International Financial Reporting Standards.

The foreword to accounting standards defines Accounting Standards as Authoritative statements of how particular types of transaction and other events should be reflected in financial statements. Accounting Standards are developed to achieve comparability of financial information between and among different organizations. International Accounting Standards (IAS’s) and International Financial Reporting Standards (IFRS) are meant to apply to most organizations in the world. IAS’s and IFRS’s are produced by the International Accounting Standards Board (IASB) whose objectives are:

(a) To formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and to promote their worldwide acceptance; and

(b) To work generally for the improvement and harmonization of regulations, accounting standards and procedures relating to the presentation of financial statements.

The IASB is an affiliate of the International Federation of Accountants (IFAC) established in 1977 which co-ordinates the Accounting profession worldwide. Most accounting bodies of countries are members of IFAC. The IASC develops IAS’s through an international process that involves the worldwide accountancy profession, the preparers, users of financial statements and national standard setting bodies and other interested parties.The IASB sets up a steering committee to develop a statement of principles, an Exposure Draft and ultimately an Accounting Standards once a new topic is suggested. The process includes:

Identifying and reviewing of all the issues associated with the topic, Studying national and regional accounting requirements and practice,

consultation with the member bodies’ standard setting bodies and other interested groups,

Public Exposure of the draft Accounting Standard, Evaluation by the steering committee and the board of the comments

received on exposure drafts.

Currently the IASB has developed about 40 IASs. Examples include:


88 Accounting Theory

IAS 1 Presentation of Financial Statements

IAS 2 Inventories

IAS 16 Property plant and equipment.

Previously new standards were called International Accounting Standards but from 2003 any new standards will be called International financial Reporting Standards. However in the current practice is to refer to all standards as International Financial Reporting Standard.In Kenya, Accountants used to prepare the financial statements in accordance with Kenya Accounting Standards (IASs), which were developed and published by ICPAK (Institute of Certified Public Accountants of Kenya). This were later dropped and International Accounting Standards adopted.Reasons why Accountants should observe International Accounting Standards:

a) Use of IASs adds credibility to the financial statements as they can be compared with others globally.

b) Facilitates communication within an enterprise that has foreign branches or subsidiaries due to harmonized reporting by the separate entities in the group.

c) Adds value to the financial statements incase an entity is sourcing for foreign capital.

d) Incase an entity wishes to be quoted on the Stock Exchange Market more so for companies.

(c)Accounting Concepts Bases and Policies

I) Concepts/conventions/principlesAccounting Concepts are broad basic assumptions that underlie the periodic financial accounts of business enterprises. Examples of concepts include:

i) The going concern concept: implies that the business will continue in operational existence for the foreseeable future, and that there is no intention to put the company into liquidation or to make drastic cutbacks to the scale of operations.Financial statements should be prepared under the going concern basis unless the entity is being (or is going to be) liquidated or if it has ceased (or is about to cease) trading. The directors of a company must also disclose any significant doubts about the company’s future if and when they arise.The main significance of the going concern concept is that the assets of the business should not be valued at their ‘break-up’ value, which is the amount that they would sell for it they were sold off piecemeal and the business were thus broken up.

ii) The accruals concept (or matching concept): states that revenue and costs must be recognized as they are earned or incurred, not as money is

Lesson Three 89

received or paid. They must be matched with one another so far as their relationship can be established or justifiably assumed, and dealt with in the profit and loss account of the period to which they relate.Assume that a firm makes a profit of £100 by matching the revenue (£200) earned from the sale of 20 units against the cost (£100) of acquiring them.If, however, the firm had only sold eighteen units, it would have been incorrect to charge profit and loss account with the cost of twenty units; there is still two units in stock. If the firm intends to sell them later, it is likely to make a profit on the sale. Therefore, only the purchase cost of eighteen units (£90) should be matched with the sales revenue, leaving a profit of £90.


The balance sheet would therefore look like this:

£

Assets

Stock (at cost, i.e. 2 x £5) 10

Debtors (18 x £10) 180

190

Liabilities

Creditors 100

90

Capital (profit for the period) 90

If, however the firm had decided to give up selling units, then the going concern concept would no longer apply and the value of the two units in the balance sheet would be a break-up valuation rather than cost. Similarly, if the two unsold units were now unlikely to be sold at more than their cost of £5 each (say, because of damage or a fall in demand) then they should be recorded on the balance sheet at their net realizable value (i.e. the likely eventual sales price less any expenses incurred to make them saleable, e.g. paint) rather than cost. This shows the application of the prudence concept. (See below).

In this example, the concepts of going concern and matching are linked. Because the business is assumed to be a going concern it is possible to carry forward the cost of the unsold units as a charge against profits of the next period.

Essentially, the accruals concept states that, in computing profit, revenue earned must be matched against the expenditure incurred in earning it.

iii) The Prudence Concept: The prudence concept states that where alternative procedures, or alternative valuations, are possible, the one selected should be the one that gives the most cautious presentation of the business’s financial position or results.Therefore, revenue and profits are not anticipated but are recognized by inclusion in the profit and loss account only when realized in the form of either cash or of other assets the ultimate cash realization of which can be assessed with reasonable certainty: provision is made for all liabilities

Lesson Three 91

(expenses and losses) whether the amount of these is known with certainty or is best estimate in the light of the information available.Assets and profits should not be overstated, but a balance must be achieved to prevent the material overstatement of liabilities or losses.

The other aspect of the prudence concept is that where a loss is foreseen, it should be anticipated and taken into account immediately. If a business purchases stock for £1,200 but because of a sudden slump in the market only £900 is likely to be realized when the stock is sold the prudence concept dictates that the stock should be valued at £900. It is not enough to wait until the stock is sold, and then recognize the £300 loss; it must be recognized as soon as it is foreseen.A profit can be considered to be a realized profit when it is in the form of:

Cash Another asset that has a reasonably certain cash value. This includes

amounts owing from debtors, provided that there is a reasonable certainty that the debtors will eventually pay up what they owe.

A company begins trading on 1 January 20X2 and sells goods worth £100,000 during the year to 31 December. At 31 December there are debts outstanding of £15,000. Of these, the company is now doubtful whether £6,000 will ever be paid.The company should make a provision for doubtful debts of £6,000. Sales for 20x5 will be shown in the profit and loss account at their full value of £100,000, but the provision for doubtful debts would be a charge of £6,000. Because there is some uncertainty that the sales will be realized in the form of cash, the prudence concept dictates that the £6,000 should not be included in the profit for the year.

iv) The consistency concept: The consistency concept states that in preparing accounts consistency should be observed in two respects.

a) Similar items within a single set of accounts should be given similar accounting treatment.

b) The same treatment should be applied from one period to another in accounting for similar items. This enables valid comparisons to be made from one period to the next.

v) The entity concept: The concept is that accountants regard a business as a separate entity, distinct from its owners or managers. The concept applies whether the business is a limited company (and so recognized in law as a separate entity) or a sole proprietorship or partnership (in which case the business is not separately recognized by the law.

vi) The money measurement concept: The money measurement concept states that accounts will only deal with those items to which a monetary value can be attributed.

For example, in the balance sheet of a business, monetary values can be attributed to such assets as machinery (e.g. the original cost of the machinery;


or the amount it would cost to replace the machinery) and stocks of goods (e.g. the original cost of goods, or, theoretically, the price at which the goods are likely to be sold).The monetary measurement concept introduces limitations to the subject matter of accounts. A business may have intangible assets such as the flair of a good manager or the loyalty of its workforce. These may be important enough to give it a clear superiority over an otherwise identical business, but because they cannot be evaluated in monetary terms they do not appear anywhere in the accounts.

Lesson Three 93

vii) The separate valuation principle: The separate valuation principle states that, in determining the amount to be attributed to an asset or liability in the balance sheet, each component item of the asset or liability must be determined separately.These separate valuations must then be aggregated to arrive at the balance sheet figure. For example, if a company’s stock comprises 50 separate items, a valuation must (in theory) be arrived at for each item separately; the 50 figures must then be aggregated and the total is the stock figure which should appear in the balance sheet.

viii) The materiality concept: An item is considered material if it’s omission or misstatement will affect the decision making process of the users. Materiality depends on the nature and size of the item. Only items material in amount or in their nature will affect the true and fair view given by a set of accounts.An error that is too trivial to affect anyone’s understanding of the accounts is referred to as immaterial. In preparing accounts it is important to assess what is material and what is not, so that time and money are not wasted in the pursuit of excessive detail.Determining whether or not an item is material is a very subjective exercise. There is no absolute measure of materiality. It is common to apply a convenient rule of thumb (for example to define material items as those with a value greater than 5% of the net profit disclosed by the accounts). But some items disclosed in accounts are regarded as particularly sensitive and even a very small misstatement of such an item would be regarded as a material error. An example in the accounts of a limited company might be the amount of remuneration paid to directors of the company.The assessment of an item as material or immaterial may affect its treatment in the accounts. For example, the profit and loss account of a business will show the expenses incurred by he business grouped under suitable captions (heating and lighting expenses, rent and rates expenses etc); but in the case of very small expenses it may be appropriate to lump them together under a caption such as ‘sundry expenses’, because a more detailed breakdown would be inappropriate for such immaterial amounts.

Example:

a) If a balance sheet shows fixed assets of £2 million and stocks of £30,000 an error of £20,000 in the depreciation calculations might not be regarded as material, whereas an error of £20,000 in the stock valuation probably would be. In other words, the total of which the erroneous item forms part must be considered.

b) If a business has a bank loan of £50,000 balance and a £55,000 balance on bank deposit account, it might well be regarded as a material misstatement if these two amounts were displayed on the balance sheet as ‘cash at bank £5,000’. In other words, incorrect presentation may amount to material misstatement even if there is no monetary error.

ix) The historical cost convention: A basic principle of accounting (some writers include it in the list of fundamental accounting concepts) is that resources are normally stated in accounts at historical cost, i.e. at the amount


that the business paid to acquire them. An important advantage of this procedure is that the objectivity of accounts is maximized: there is usually objective, documentary evidence to prove the amount paid to purchase an asset or pay an expense. Historical cost means transactions are recorded at the cost when they occurred.

In general, accountants prefer to deal with costs, rather than with ‘values’. This is because valuations tend to be subjective and to vary according to what the valuation is for. For example, suppose that a company acquires a machine to manufacture its products. The machine has an expected useful life of four years. At the end of two years the company is preparing a balance sheet and has decided what monetary amount to attribute to the asset.

x) Objectivity (neutrality):An accountant must show objectivity in his work. This means he should try to strip his answers of any personal opinion or prejudice and should be as precise and as detailed as the situation warrants. The result of this should be that any number of accountants will give the same answer independently of each other. Objectivity means that accountants must be free from bias. They must adopt a neutral stance when analysing accounting data. In practice objectivity is difficult. Two accountants faced with the same accounting data may come to different conclusions as to the correct treatment. It was to combat subjectivity that accounting standards were developed.

xi) The realization concept: Realization: Revenue and profits are recognized when realized. The concept states that revenue and profits are not anticipated but are recognized by inclusion in the income statement only when realized in the form of either cash or of other assets the ultimate cash realization of which can be assessed with reasonable certainty.

xii) Duality: Every transaction has two-fold effect in the accounts and is the basis of double entry bookkeeping.

xiii) Substance over form: The principle that transactions and other events are accounted for and presented in accordance with their substance and economic reality and not merely their legal form e.g. a non current asset on Hire purchase although is not legally owned by the enterprise until it is fully paid for, it is reflected in the accounts as an asset and depreciation provided for in the normal accounting way.

Example 3.1It is generally agreed that sales revenue should only be ‘realized’ and so ‘recognized’ in the trading, profit and loss account when:

a) The sale transaction is for a specific quantity of goods at a known price, so that the sales value of the transaction is known for certain.

b) The sale transaction has been completed, or else it is certain that it will be completed (e.g. in the case of long-term contract work, when the job is

Lesson Three 95

well under way but not yet completed by the end of an accounting period).

c) The critical event in the sale transaction has occurred. The critical event is the event after which:

i) It becomes virtually certain that cash will eventually be received from the customer.

ii) Cash is actually received.


Usually, revenue is ‘recognized’

(a) When a cash sale is made.(b) The customer promises to pay on or before a specified future date, and the

debt is legally enforceable.

The prudence concept is applied here in the sense that revenue should not be anticipated, and included in the trading, profit and loss account, before it is reasonably certain to ‘happen’.RequiredGiven that prudence is the main consideration, discuss under what circumstances, if any, revenue might be recognized at the following stages of a sale.

(a) Goods have been acquired by the business, which it confidently expects to resell very quickly.(b) A customer places a firm order for goods.(c) Goods are delivered to the customer.(d) The customer is invoiced for goods.(e) The customer pays for the goods.(f) The customer’s cheque in payment for the goods has been cleared by the bank.

Answer(a) A sale must never be recognized before a customer has even ordered the

goods. There is no certainty about the value of the sale, nor when it will take place, even if it is virtually certain that goods will be sold.

(b) A sale must never be recognized when the customer places an order. Even though the order will be for a specific quantity of goods at a specific price, it is not yet certain that the sale transaction will go through. The customer may cancel an order, the supplier might be unable to deliver the goods as ordered or it may be decided that the customer is not a good credit risk.

(c) A sale will be recognized when delivery of the goods is made only when:

i) The sale is for cash, and so the cash is received at the same time.ii) The sale is on credit and the customer accepts delivery (e.g. by signing a

delivery note).

(d) The critical event for a credit sale is usually the dispatch of an invoice to the customer. There is then a legally enforceable debt payable on specified terms, for a completed sale transaction.

(e) The critical event for a cash sale is when delivery takes place and when cash is received, both take place at the same time. It would be too cautious or ‘prudent’ to await cash payment for a credit sale transaction before recognizing the sale, unless the customer is a high credit risk and there is a serious doubt about his ability or intention to pay.

(f) It would again be over-cautious to wait for clearance of the customer’s cheques before recognizing sales revenue. Such a precaution would only be justified in cases where there is a very high risk of the bank refusing to honour the cheque.

Lesson Three 97

II) BasesBases are the methods that have been developed for expressing or applying fundamental accounting concepts to financial transactions and items. Examples include:

Depreciation of Non current Assets (e.g. by straight line or reducing balance method)

Treatment and amortization of intangible assets (patents and trade marks) Stocks and work in progress (FIFO, LIFO and AVCO)

III) PoliciesAccounting policies are the specific accounting bases judged by business enterprises to be the most appropriate to their circumstances and adopted by them for the purpose of preparing their financial accounts.

Qualities of Useful Financial InformationThe four principal qualities of useful financial information are understandability, relevance, reliability and comparability.

Understandability: an essential quality of the information provided in the financial statements is that it is readily understandable by users. For these reason users are assumed to have a reasonable knowledge of business and economic activities and accounting.Relevance: information has the quality of being relevant when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming or correcting their past evaluations. The relevance of information is affected by its nature and materiality.Reliability: information is useful when it is free from material error and bias and can be depended upon by users to represent faithfully that which it purports to represent or could reasonably be expected to represent. To be reliable then the information should:

a) Be represented faithfully,b) Be accounted for and presented in accordance with their substance and

economic reality and not merely their legal form,c) Be neutral i.e. free from bias,d) Include some degree of caution especially where uncertainties surround some

events and transactions (prudence),e) Be complete i.e. must be within the bounds of materiality and cost. An

omission can cause information to be false.Comparability: users must be able to compare the financial statements of an enterprise through time in order to identify trends in its financial position and performance. Users must also be able to compare the financial statements of different accounting policies, changes in the various policies and the effect of these changes in the accounts. Compliance with accounting standards also helps achieve this comparability.

The Accounting Profession in Kenya


The Accountants Act Cap 531 (1977) establishes the Institute of Certified Public Accountants of Kenya (ICPAK) and two boards, to be known as the Registration of Kenya Accountants Board (RAB) and Kenya Accountants and Secretaries National Examinations Board (IASNEB)

Lesson Three 99

The following are the functions of ICPAK as outlined by the Act;

a) To promote standards of professional competence and practice amongst members of the institute.

b) To promote research into the subjects of accountancy and finance, and related matters, and the publication of books, periodicals, journals and articles in connexion therewith;

c) To promote the international recognition of the institute;

d) To advise the Examinations board on matters relating to examination standards and policies;

e) To carry out any other functions prescribed for it under any of the provisions of the Act or under any other written law; and

f) To do anything incidental or conducive to the performance of any of the preceding functions.

A council known as the Council of the institute governs the Institute, which consists of the Chairman, nine members from the institute and one member appointed by the Minister of finance.The Registration of Accountants Board (RAB) functions include issuing out practicing certificates and registration of qualified persons as members of the institute.The Act also outlines the following as the functions of IASNEB:

a) To prepare syllabuses for accountants’ and secretaries’ examinations, to make rules with respect to examinations, to arrange and conduct examinations and issue certificates to candidates who have satisfied examination requirements;

b) To promote recognition of its examinations in foreign countries; andc) To do anything incidental or conducive to the performance of any preceding

functions.

Example 3.2 PILOT PAPER OCTOBER 1991

Briefly explain the meaning and the significance of the following:(i) Accounting concepts.(ii) Accounting bases.(iii) Accounting policies.(iv) Accounting standards.

(Total: 20 Marks)

(Covered adequately in the text).


Example 3.3 PILOT PAPER JULY 2000

(a) Define the following accounting concepts and for each explain their implication in the preparation of financial statements.

(i) The Going concern concept 4 marks (ii) Business entity concept 4 marks(iii) Materiality 4 marks(iv) Realization 4 marks

(b) Two accounting concepts or conventions could clash or there could be inconsistency between them.Give two examples of such situations and explain how the inconsistency should be resolved.

4 marks

Solution:

(i) The Going Concern ConceptThe concept of going concern is that an entity will continue trading into the foreseeable future at a similar level as it does when the accounts are prepared. Going concern has implications for the value of the entities assets and the way the user may read the financial statements. If a business is to cease trading after the period of account the financial statements should be prepared on a break up basis as all liabilities will be due and assets will be valued at net realizable value.(ii) The Entity ConceptThe organization preparing accounts is a distinct and separate entity. Financial statements are prepared to reflect the activities of the entity. This concept prevents any confusion between the owner’s private finances and those of the entity, hence the option of drawings when a proprietor effectively reduces the capital of the entity.(iii) MaterialityMateriality relates to significant amounts and items in the financial statements. A rough guide to what material amount is 5% of pre tax profits. However, this is only a guide. If say, cash in hand is offset against the overdraft balance this is a material misstatement.

Materiality prevents time being wasted on items which do not impact on the results of the entity; it provides a focus on the significant items.

(iv) RealizationThe realization concept involves recognizing amounts in the financial statements at the point at which they crystallize. Profit should not be reflected in the profit and loss account until it has been earned.The realization concept means that the profit in the financial statements should be reasonably stated.

Lesson Three 101

(c) Clashes between accounting concepts

Accruals and prudenceThe accruals concept requires future income (e.g. in relation to credit sales) to be accrued. The prudence concept dictates that caution should be exercised, so that if there is doubt about the subsequent receipt, no accrual should be made.

Consistency and prudenceIf circumstances change, prudence may conflict with the consistency concept, which requires the same treatment year after year.

In both situations, prudence must prevail.

Example 3.5 DECEMBER 1994 QUESTION FIVE

(a) Explain the nature of the Accounting Equation. (5 marks)(b) What are accounting standards and why are they important?

(5 marks)(c) Describe the role of the Institute of Certified Public Accountants of Kenya.

(5 marks)(d) In addition to the Kenya Accounting Standards, why is it important for an

Accountant to make use of International Accounting Standards? (4 marks)

(Total: 19 marks)(Covered adequately in the text)


REINFORCEMENT QUESTIONS

Question OneExplain, with examples, each of the following terms:

Fundamental accounting concepts Accounting bases Accounting policies

Question Two Accounting practice depends upon the guidance provided by a number of accounting concepts, some of which are to be found in IAS 1 and/or in the conceptional framework of the International Accounting Standards Committee.

Required:(a) Define and explain the relevance of the following accounting concepts.

Neutrality Money measurement Accruals Substance over form Consistency

(15 marks)

(b) Give two examples of situations in which there is a clash or inconsistency between two accounting concepts or conventions, and explain how the inconsistency should be resolved. (In answering this part of the question, you need not confine yourself to considering the concepts listed in part (a))

(5 marks)

(20 marks)

Question ThreeIf the information in financial statements is to be useful, regard must be had to the following:

Materiality Comparability Prudence Objectivity Relevance

RequiredExplain the meaning of each of these factors as they apply to financial accounting including in your explanations one example of the application of each of them. (Four marks for each of (a) to (e).)

Lesson Three 103

(20 marks)


Question Foura) Explain what is meant by materiality in relation to financial statements and

state two factors affecting the assessment of materiality. (4 marks)

b) Explain what makes information in financial statements relevant to users. (5 marks)

c)1. Two characteristics contributing to reliability are ‘neutrality’ and ‘prudence’.

Explain the meaning of these two terms.2. Explain how a possible conflict between them could arise and how that

conflict should be resolved. (5 marks)

d) One of the requirements of financial statements is that they should be free from material error. Suggest three safeguards, which may exist, inside or outside a company to ensure that the financial statements are free from material error. (6 marks)


Acknowledgement 105

LESSON FOUR

ADJUSTMENTS TO FINAL ACCOUNTS

a) ACCRUALS AND PREPAYMENTSRevenue and costs must be recognized as they are earned or incurred, not as money is received or paid. They must be matched with one another so far as their relationship can be established or justifiably assumed, and dealt with in the profit and loss account of the period to which they relate. Therefore all incomes and expenses that relate to a particular financial period will be matched together to determine the profit for the year.

ACCRUALSIncome: Accrued IncomeThis is income that relates to the current year but cash has not yet been received. An accrued income should be reported in the profit & loss account and the same income will be shown in the balance sheet as a current asset.Example 4.1A firm lets out part of its properties and receives rent of £2,000 per month, assuming that this is the first year of renting and rent is received in arrears (rent 4 January is received early Feb).The ledger accounts of the firm will be as follows:

CashbookYear 1 £

Feb (rent 4 Jan) 2,000Mar (rent 4 Feb) 2,000April (rent 4 Mar) 2,000May (rent 4 Apr) 2,000June (rent 4 May) 2,000July (rent 4 Jun) 2,000Aug (rent 4 July) 2,000Sept (rent 4 Aug) 2,000Oct (rent 4 Sept) 2,000Nov (rent 4 Oct) 2,000Dec (rent 4 Nov) 2,000


106 Adjustment to Final Accounts

22,000

Lesson Four 107

Rent – IncomeYear 1 £ Year 1 £ Jan C/B 2,000

Feb C/B 2,000Mar C/B 2,000April C/B 2,000May C/B 2,000Jun C/B 2,000July C/B 2,000Aug C/B 2,000Sept C/B 2,000Oct C/B 2,000

31/12 P&L 24,000 Nov C/B 2,000 Dec Accrued c/f 2,000

24,000 24,000

Although the cashbook is showing that rent received amounts £22,000, the full rental income of £24,000 will be reported in the Profit & Loss a/c as rent income and the accrued rent for Dec of £2,000 will be reported in the balance sheet as a current asset.

Expenses: Accrued Expenses An accrued expense is an expense that is payable or due for payment but has not

yet been paid during that period. An accrued expense should be charged in the P&L account and shown in the

balance sheet as a current liability. Assume in the above example that the firm is meant to pay the rent, thus it

becomes an expense with the facts still the same i.e. £2,000 payable in arrears. The ledger account will be as follows.

CashbookYear 1 £ Year 1 £

Feb (rent 4 Jan) 2,000 Mar (rent 4 Feb) 2,000 Apr (rent 4 Mar) 2,000 May (rent 4 Apr) 2,000 June (rent 4 May) 2,000 July (rent 4 June) 2,000 Aug (rent 4 July) 2,000 Sept (rent 4 Aug) 2,000 Oct (rent 4 Sept) 2,000 Nov (rent 4 Oct) 2,000 Dec (rent 4 Nov) 2,000


Rent – Expenses Year 1 £ Year 1 £C/B Rent for Jan 2,000

Rent for Feb 2,000Rent for Mar 2,000Rent for Apr 2,000Rent for May 2,000Rent for June 2,000Rent for July 2,000Rent for Aug 2,000Rent for Sept 2,000Rent for Oct. 2,000Rent for Nov 2,000

31/12 Bal c/d 2,000 31/12 P&L 24,000 24,000 24,000

The cashbook shows that the rent for the 11 months was paid for. However in the P&L a/c we should report rent for the full year of £24,000 and the £2,000, rent for Dec being the accrued expense will be shown in the balance sheet as a current liability.

PREPAYMENTSPrepaid Income

This is income that is not yet due but cash has been received for it. This happens where an income is payable in advance e.g. Rent payable 3 months in advance.

A prepaid income should not be reported in the current financial period but should be carried forward and reported in the period it relates to.

The accounting treatment will be to show it as a current liability.

Example 4.2A firm receives rent income of £5,000 per month payable quarterly in advance. Assuming that the firm’s rental income began in 1st March and the financial year, end is on 31st Dec. The ledger accounts will be:

15,000 15,000 15,000 15,000 15,000

1.3 1.6 1.9 1.12 1.3

Cashbook

Lesson Four 109

Year 1 £ Year 1 £1/3 Rent 15,0001/6 Rent 15,0001/9 Rent 15,0001/12 Rent 15,000

Rent – Income

Year 1 £ Year 1 £ 1/3 Cashbook 15,000 1/6 Cashbook 15,000

P&L (10 x 5,000) 50,000 1/9 Cashbook 15,00031/12 Bal c/d 10,000 1/12 Cashbook 15,000

60,000 60,000

Rent for the 4 quarters of 12 months has been received as per the cashbook but because the end of the financial year is at 31 Dec, rent for 2 months is pre-paid. This £10,000 is not charged in the P&L but is carried forward as current liability in the balance sheet.

Prepaid ExpensesA prepaid expense is an expense that is not payable but cash has already been paid. A prepaid expense should not be charged in the P&L a/c but should be carried forward to the next financial period and should be shown in the balance sheet as a current asset.

ExampleAssume as in the previous illustration, that all the facts are as stated except that rent is an expense. The ledger accounts is as follows:

CashbookYear 1 £ Year 1 £

1/3 Rent 15,000 1/6 Rent 15,000 1/9 Rent 15,000 1/12 Rent 15,000

Rent – Expenses

Year 1 £ Year 1 £1/3 C/B (Mar, April, May) 15,0001/6 C/B (June, July, Aug) 15,0001/9 C/B (Sept, Oct, Nov) 15,000 P&L (10 x 5,000) 50,0001/12 C/B (Dec, Jan, Feb) 15,000 31/12 Bal c/d (2 x 5,000) 10,000

60,000 60,000


Rent of £10,000 for 2 months is carried forward to the next financial period and shown in the balance sheet as a current asset.

Lesson Four 111

The following is the summary of treatment for Accruals and Prepayments: P&L

B/Sheet Accrued - Report as

Current Income Assets

Income

Prepaid -Not reported Current

Liability

Accruals/Prepayments

Accrued - Charge asCurrent

an expenseLiability

Expense

Prepaid - Not charged

CurrentIn P& L Assets

Accrued Incomes and Expenses and Prepaid Incomes and Expenses are shown in the Balance Sheet as follows:

Balance Sheet Extracts£ £

Current AssetsStock xDebtors xAccrued Incomes/Prepaid Expenses xCash at bank xCash in hand x

x

Current LiabilitiesBank overdraft xCreditors xPrepaid Incomes/Accrued Expenses x

X


The accruals and expenses items may also be adjusted in the relevant income and expense accounts so that the correct amount of expense or income is reported in the profit and loss account for the year.

Example 4.4The financial year of H Seamers ended on 31 December 2002. Show the ledger accounts for the following items including the balance transferred to the necessary part of the final accounts, also the balances carried down to 2003:

a) Motor expenses: Paid in 2002 £7,440; Owing at 31 December 2002 £2,800.

b) Insurance: Paid in 2002 £42,000; Prepaid as at 31 December 2002 £3,500.

c) Stationery: Paid during 2002 £18,000; Owing as at 31 December 2001 £25,000; Owing as at 31 December 2002 £49,000.

d) Rates: Paid during 2002 £95,000; Prepaid as at 31 December 2001 £2,200; Prepaid as at 31December 2002 £2,900.

e) Seamers sub-lets part of the premises. Receives £5,500 during the year ended 31 December 2002. Tenant owed Seamers £1,800 on 31 December 2001 and £2,100 on 31 December 2002

a) Motor Expenses19X6 £ 19X6 £

Cashbook 7,440 31/12 Bal c/d 280 P/L a\c 7220

7200 7200 19x7 1/1 Bal b/d 280

b) Insurance

19x6 £ 19x6£

Cashbook 4,200 31/12 P&L a/c 3850 31/12 Bal c/d 350

4,200 420019x7

1/1 Bal b/d 350 ===

c) Stationery

19x6 £ 19x6 £Cashbook 18,000 1/1 Bal b/d 2,500

Lesson Four 113

31/12 Bal c/d 4,900 P&L a/c 20,400

22,900 22,900 ==== ====

19x71/1Bal b/d 4,900


d) Rates

19x6 £ 19x6 £1/1 Bal b/d 2200 P&L 8800

Cashbook 9500 31/12 Bal c/d 2900 11,700

11,700

19x71/1 Bal b/d 2900

e) Rent – Income

19x6 £ 19x6 £1/1 Bal b/d 1800 Cashbook 5500

P&L 5800 31/12 Bal c/d 21007600 7600

19x71/1 Bal b/d 2100

b) BAD AND DOUBTFUL DEBTSSome debtors may not pay up their accounts for various reasons e.g. a debtor may go out of business. When a debtor is not able to pay up his/her account this becomes a bad debt. Therefore the business/firm should write it off from the accounts and thus it becomes an expense that should be charged in the profit & loss account.In practice a firm may also be unable to collect all the amounts due from debtors. This is because a section of the debtors will not honor their obligations. The problem posed by this situation is that it is difficult to identify the debtors who are unlikely to pay their accounts. Furthermore the amount that will not be collected may also be difficult to ascertain. These debts that the firm may not collect are called doubtful debts. A firm should therefore provide for such debts by charging the provision in the profit and loss account. Provision for doubtful debts maybe specific or general. Specific relate to a debtor whom we can identify and we are doubtful that he may pay the debt (if one of our debtor goes out of business).

Accounting For Bad & Doubtful Debts.Bad debtsWhen a debt becomes bad the following entries will be made:

i. Debit bad debts account Credit debtors account with the amount owing.

ii. Debit Profit and Loss Account.

Lesson Four 115

Credit bad – debts account to transfer the balance on the bad – debts account to the Profit and Loss Account.


Doubtful DebtsA provision for doubtful debts can either be for a specific or a general provision. A specific provision is where a debtor is known and chances of recovering the debt are low.The general provision is where a provision is made on the balance of the total debtors i.e. Debtors less Bad debts and specific provision.The accounting treatment of provision for doubtful debts depends on the year of trading and the entries will be as follows. If it is the 1st year of trading (1st year of making provision):

i. Debit P&L a/c.ii. Credit provision for doubtful debts (with total amount of the provision).

In the subsequent periods, it will depend on whether if it is an increase or decrease required on the provision.If it is an increase:

i. Debit P&L a/c.ii. Credit provision for doubtful debts (with increase only).

If it is a decrease:i. Debit provision for doubtful debts.

ii. Credit P&L a/c (with the decrease in provision only).

Example

Debtors xBad debts (x)

xSpecific Provision (x)

xGeneral Provision (x)

x

A firm started trading in the year 1999, the balance on the debtor’s account was £400,000. Bad debts amounting to £40,000 were written off from this balance, there was a specific provision of £5,000 to be made to one of the debtors and a general provision of £5% was to be made on the balance of the debtors. The ledger accounts of 1999 were as follows:

Debtors Provision for doubtful debts 1999 £ 1999 £ 1999 £ 1999 £Bal B/d 400,000 Bad debts 40,000 31/12 Bal c/d 22,750 31/12

P&L 22,750 Bal c/d 360,000

Lesson Four 117

400,000 400,000


Bad debts1999 £ 1999 £Debtors 40,000 31/12 P&L 40,000

£Debtors 400,000Bad debts (40,000)

360,000Specific Provision (5,000)

355,000General Provision (5%) (17,750)

337,250

Profit & Loss A/C (Extract) for the year ended 31/12/99

£ £Expenses: Bad debts 40,000Increase in provision for D/debts 22,750

Balance Sheet (Extract) as at 31/12/99£ £

Current AssetsStocks xDebtors 360,000Provision for D/debts (22,750) 337,250 337,250 337,250

In the year 2,000, the debtors balance goes up to £500,000 from which bad debts of £50,000 needs to be written off there is no specific provision but the general provision is to be maintained at 5%. The ledger accounts will be as follows:

Debtors 500,000 Bad debts (50,000)

450,000 General Provision (5%) 22,500

427,500

Lesson Four 119

Debtors2000 £ 2000 £ Bal b\d 500,000 Bad Debts 50,000

______ Bal c\d 450,000500,000 500,000

Provision for Doubtful Debts2000 £ 2000 £ P\L 250 1\1 Bal b\d 22,750Bal c\d 22,500

22,750 22,750

Bad Debts2000 £ 2000 £ Debtors 50,000 31\12 P& L 50,000

Profit And Loss Account (Extract) for year ended 31/12/2002.£ £

IncomesDecrease in provision for D/debts 250

ExpensesBad debts 50,000

Balance Sheet (Extract) as at 31/12/2002

£ £Current AssetsDebtors 450,000Provision for bad debts (22,500)

427,500

In the year 2001 the debtors balance goes up to £600,000 from which bad debts of £50,000 need to be written off, there is no specific provision but the general provision is to be maintained at 5% the ledger accounts is as shown:

£ Debtors 600,000 Bad debts (50,000)

550,000 General provision % (27,500)

522,500


Debtors2001 £ 2001 £ Bal b\ 600,000

Bad Debts 50,000

______ Bal c\d 550,000600,000 600,000

Provision for Doubtful Debts2001 £ 2001 £

1\1 Bal b\d 22,500Bal c\d 27,500 P& L 5,000

22,500 27,500

Bad Debts2001 £ 2001 £ Debtors 50,000 31\12 P& L 50,000

Profit And Loss Account (Extract) for the year ended 31/12/2001£ £

ExpensesBad debts 50,000Increase in provision 5,000

Balance Sheet (Extract) as at 31/12/2001£ £

Current AssetsDebtors 550,000Less: Provision for Doubtful Debts (27,500) 522,500

Example 4.6In a new business during the year ended 31 December 2002 the following debts are found to be bad, and are written off on the dates shown:

30 April H Gordon £1,10031 August D Bellamy Ltd £64031 October J Alderton £120

On 31 December 2002 the schedule of remaining debtors, amounting in total to £68,500, is examined, and it is decided to make a provision for doubtful debts of £2,200.

Lesson Four 121

You are required to show:a. The Bad Debts Account, and the Provision for Doubtful Debts Account.b. The charge to the Profit and Loss Account.c. The relevant extracts from the Balance Sheet as at 31 December 2002.


£ Bad DebtsDebtors 70,036 2002 £ 2002

£ Bad debts (1,860) Bad debts 1860 31/12 P\L 1860

68,500 Provision for D/Debt (2,200)

66,300

Provision for doubtful debts2002 £ 2002 £31/12 Bal c/d 2,200 31/12 P&L 2,200

Profit & Loss Account (Extract) £ £

ExpensesBad debts 1,860Increase in provision for Doubtful debts 2,200

Balance Sheet (Extract) £ £

Current AssetsDebtor 8,500Less: Provision for D/Debts (2,200)

6,300Example 4.2A business started trading on 1 January 2001. During the two years ended 31 December 2001 and 2002 the following debts were written off to the Bad Debts Account on the dates stated:

31 August 2001 W Best £85030 September 2001 S Avon £1,40028 February 2002 L J Friend £1,80031 August 2002 N Kelly £60030 November 2002 A Oliver £2,500

On 31 December 2001 there had been a total of debtors remaining of £405,000. It was decided to make a provision for doubtful debts of £5,500.On 31 December 2002 there had been a total of debtors remaining of £473,000. It was decided to make a provision for doubtful debts of £6,000.

You are required to show:

Lesson Four 123

i. The Bad Debts Account and the Provision for Doubtful Debts Account for each of the two years.

ii. The relevant extracts from the Balance Sheet as at 31 December 2001 and 2002.

SolutionsBad debts = 2,250

405,000Provision (5,500)

399,500 Bad Debts

2001 £ 2001 £ 31\8 W.Best 85030\9 S.Aron 1400 31\12 P&L 2250

2250 2250

Provision for D/Debts2001 £ 2001 £ 31\12 Bal c\d 550 31\12 P&L 550

2001 £ 2001 £ 1\1 Bal b\d 550

1\1 Bal c\d 600 31\12 P&L 50600

600

Bad Debts2001 £ 2001 £28/2 J. Friend 1,80031/8 N. Kelly 60030/11 A. Oliver 2,500 31/13 P&L 4,900 4,900 4,900


Profit & Loss Account (Extract)

19x6 £ £

ExpensesBad debts 2,250Provision for Doubtful Debts 5,000

19x7Bad debts 4,900Increase in provision for D/Debts 500

Balance Sheet as at 19x6£ £

Current AssetsDebtors 405,000Less provision (5,500) 399,500

19x7Debtors 473,000Less: provision (6,000) 467,000

Provision for discounts allowable.In some cases a firm may create a provision for discounts allowable in addition to provision for doubtful debts. This happens where a firm anticipates that some of the debtors may take up cash discounts offered by the firm. The accounting treatment is similar to accounting for provision for doubtful debts. The provision should be made after creating a provision for doubtful debts (debtors figure less either general/specific provision for doubtful debts).

Debtors xBad debts (x)

xSpecific provision (x)

x(x)

xProvision for discount allowed (on balance) (x)

x

Lesson Four 125

Profit & Loss Account (Extract)£ £

IncomesDecrease in provision for D/Debts xDecrease in provision for discounts allowed x

ExpensesBad debts xIncrease in provision for D/Debts xIncrease in provision for discounts allowed x

Balance Sheet (Extract)

Current Assets £ £Debtors xLess: provision for Doubtful Debts (x)Less: provision for discounts allowed (x) x

Bad Debts RecoveredA firm may be able to recover a debt that was previously written off. The following entries will be made if this happens:

i. Debit – DebtorsCredit – credit bad debts recovered account – to restore the bad debt recoverable.N/B: This should be the amount to be recovered.

ii. Debit – CashbookCredit – Debtors with the cash received.

iii. Debit – bad debts recovered account.Credit – P & L account with the same balance as bad debts account.

Example:A firm recovers debts amounting to £10,000 that had been written off in the previous periods. In the same financial period the firm writes off bad debts amounting £30,000. The ledger accounts will be as follows:

Bad debts£ £

Debtors 30,000 Bad Debt Recovered 10,000P\L 20,000

30,000 30,000

Bad debts recovered£ £

Bad Debt 10,000 Debtors 10,000


c) BANK RECONCILIATION STATMENTSThe cashbook for cash at bank records all the transactions taking place at the bank i.e. the movements of the account held with the bank. The bank will send information relating to this account using a bank statement for the firm to compare.Ideally, the records as per the bank and the cashbook should be the same and therefore the balance carried down in the cashbook should be the same as the balance carried down by the bank in the bank statement.In practice however, this is not the case and the two (balance as per the bank and firm) are different. A bank reconciliation statement explains the difference between the balance at the bank as per the cashbook and balance at bank as per the bank statement.Causes of the differences:

Items Appearing In The Cashbook And Not Reflected In The Bank Statement.

Unpresented Cheques: Cheques issued by the firm for payment to the creditors or to other supplies but have not been presented to the firm’s bank for payment.Uncredited deposits/cheques: These are cheques received from customers and other sources for which the firm has banked but the bank has not yet availed the funds by crediting the firm’s account.Errors made in the cashbookThese include:

Payments over/understated Deposits over/understated Deposits and payments misposted Overcastting and undercasting the Bal c/d in the cashbook.

ii) Items appearing in the bank statement and not reflected in the cashbook:

Bank charges: These charges include service, commission or cheques.Interest charges on overdrafts.Direct Debits (standing orders) e.g. to pay Alico insurance.Dishonored chequesA cheque would be dishonored because: Stale cheques Post – dated cheques Insufficient funds Differences in amounts in words and figures.Direct creditsInterest Income/Dividend incomes

Lesson Four 127

Errors of The Bank Statement (Made By The Bank).Such errors include:

Overstating/understating. Deposits Withdrawals

The Purposes of a bank reconciliation statement.1. To update the cashbook with some of the items appearing in the bank

statement e.g. bank charges, interest charges and dishonoured cheques and make adjustments for any errors reflected in the cashbook.

2. To detect and prevent errors or frauds relating to the cashbook.3. To detect and prevent errors or frauds relating to the bank.

Steps in preparing a bank reconciliation statement.1. To update the cashbook with the items appearing in the bank statement and

not appearing in the cashbook except for errors in the bank statement. Adjustments should also be made for errors in the cashbook.

2. Compare the debit side of the cashbook with the credit side of the bank statement to determine the uncredited deposits by the bank.

3. Compare the credit side of the cashbook with the debit side of the bank statement to determine the unpresented cheques.

4. Prepare the bank reconciliation statement which will show: a) Unpresented cheques

b) Uncredited depositsc) Errors on the bank statementd) The updated cashbook balance.

The format is as follows:(Format 1)

Name:Bank Reconciliation Statement as at 31/12

£ £Balance at bank as per cashbook (updated) xAdd: Un presented cheques x Errors on Bank Statement (see note 1) x x

xLess: Uncredited deposits x Errors on Bank Statement (see note 2) x (x)Balance at bank as per Balance Sheet x

Note 1: These types of errors will have an effect of increasing the balance at bank e.g. an overstated deposit or an understated payment by the bank.Note 2: These types of errors will have an effect of decreasing the balance at bank e.g. an understated deposit or an overstated payment by the bank, or making an unknown payment.


Format 2Name:Bank Reconciliation Statement as at 31/12

£ £Balance at bank as per bank statement xAdd: Uncredited deposits x Add errors on bank statement (note 2) x x

xLess: Unpresented cheques x Errors on bank statement (note 1) x (x)Balance at bank as per cashbook (updated) x

===

Example 4.8Draw up a bank reconciliation statement, after writing the cashbook up to date, ascertaining the balance on the bank statement, from the following as on 31 March 2003:

£Cash at bank as per bank column of the cashbook (Dr) 38,960Bankings made but not yet entered on bank statement 6,060Bank charges on bank statement but not yet in cashbook 280Un presented cheques C Clarke 1170 Standing order to ABC Ltd entered on bank statement, but not in cash book 550Credit transfer from A Wood entered on bank statement, but not yet in cashbook 1,890

SolutionCashbook – Bank

19X9 £ 19X9 £ 31/3 Bal b/d 38960

Bank charges 280 ABC (standing order)

550A Wood (credit transfer) 1890 31/3 Bal C/D 40,020

40,850 40,850 Bank Reconciliation as at 31/03/2003

Lesson Four 129

£ £Balance at bank as per cashbook 40,020Add: Unpresented cheques 1,170

41,190Less: Uncredited deposits (6,060)Balance at bank as per Balance Sheet 35,130

=====Example 4.9The following are extracts from the cashbook and the bank statement of J Richards. You are required to:

a) Write the cashbook up to date, and state the new balance as on 31 December 2002, and

b) Draw up a bank reconciliation statement as on 31 December 2002.

Cashbook2002 Dr £ 2002 Cr £Dec 1 Balance b/d 1,740 Dec 8 A Dailey 349Dec 7 J Map 88 Dec 15 R Mason 33Dec 22 J Cream 73 Dec 28 G Small

115Dec 31 K Wood 249 Dec 31 Balance c/d 1,831Dec 31 M Barrett 178 2,328 2,328

Bank Statement2002 Dr Cr Balance

£ £ £Dec 1 Balance b/d 1,740Dec 7 Cheque 88 1,828Dec 11 A Dailey 349 1,479Dec 20 R Mason 33 1,446Dec 22 Cheque 73 1,519Dec 31 Credit transfer: J Walters 54 1,573Dec 31 Bank charges 22 1,551

Cashbook –Bank

2002 £ 2002 £31/12 Bal b/d 1,831 31/1 Bank charges 2231/12 J. Walters (C/T) 54 31/12 Bal C/D 1,863 1,885 1,885


Lesson Four 131

J. RichardsBank Reconciliation Statement as at 31/12/2002

£ £Balance at bank as per cashbook – bank 1,863Add: Unpresented cheques – (G Small) 115

1,978Less: Uncredited deposits

K Wood 249M. Barret 178 (427)

Balance at bank as per balance sheet 1,551OR:Balance at bank as per balance sheet 1,551Add: Uncredited deposits:

K. Wood 249 M. Barret 178

1,978Less: Unpresented cheques (115)Balance at bank as per cashbook – bank 1,863

Exam Type Question: Nov 2001 Q4QUESTION FOUR(a) Explain the term “bank reconciliation” and state the reasons for its preparation.(b) Ssemakula, a sole trader received his bank statement for the month of June 2001. At that date the bank balance was Sh. 706,500 whereas his cash book balance was Sh.2,366,500. His accountant investigated the matter and discovered the following discrepancies:

1. Bank charges of Sh.3, 000 had not been entered in the cashbook.2. Cheques drawn by Ssemakula totaling Sh.22, 500 had not yet been

presented to the bank.3. He had not entered receipts of Sh.26, 500 in his cashbook.4. The bank had not credited Mr Ssemakula with receipts of Sh.98, 500

paid into the bank on 30 June 2001.5. Standing order payments amounting to Sh.62, 000 had not been entered

into the cashbook.6. In the cashbook Ssemakula had entered a payment of Sh.74, 900 as

Sh.79, 400.7. A cheque for Sh.15, 000 from a debtor had been returned by the bank

marked “refer to drawer” but had not been written back into the cashbook.

8. Ssemakula had brought forward the opening cash balance of Sh.329, 250 as a debit balance instead of a credit balance.

9. An old cheque payment amounting to Sh.44, 000 had been written back in the cashbook but the bank had already honored it.


10.Some of Ssemakula’s customers had agreed to settle their debts by paying directly into his bank account. Unfortunately, the bank had credited some deposits amounting to Sh.832, 500 to another customer’s account. However acting on information from his customers Ssemakula had actually entered the expected receipts from the debtors in is cashbook.

Required:i. A statement showing Ssemakula’s adjusted cashbook balance as at 30 June

2001. (9 marks)ii. A bank reconciliation statement as at 30 June 2001.

(5marks)(Total: 20 marks)

Solutiona) Bank reconciliation is an attempt to explain the difference between the cash at bank balance as per the cashbook and the cash at bank balance as per the bank statement.

Reasons for preparing a bank reconciliation statement are:1. To update the cashbook with some of the relevant entries in the bank

statement.2. To detect and prevent errors or frauds that relate to the cashbook.3. To detect and prevent any errors or frauds that relate to the bank.

b) ADJUSTED CASHBOOK

2001 Sh. 2001 Sh.

Bal b/d 2,366,500 Bank charges 3,000

Receipts omitted 26,500 Standing orders 62,000

Payment overstated 4,500 Debtors (dishonored cheques) 15,000

Error on opening balance 329,250 Balance C/F 329,250 Cheque payment 44,000 Balance C/D 1,615,000

2,397,500

2,397,500 SSEMAKULABank Reconciliation Statement as at 30 June 2001.

Lesson Four 133

Sh. Sh.Cash at bank as per the updated cashbook 1,615,000Add: Unpresented cheques 22,500

1,637,500Less: Uncredited cheques 98,500Error on bank statement 832,500 (931,000)Balance as per the bank statement 706,500


Exam type Question: Nov 96 Q4QUESTION FOUR(a) What is the purpose of preparing a bank reconciliation statement?

(4marks)(b) The following is the bank statement of Kakamega Retail Traders for the month of October 1996:

Date Particulars Debit Credit Balance1996 Sh. Sh. Sh.

October 1 Balance b/d 365,875 2 Cheque no. 63 31,000 334,875

2 Cheque no. 67 3,548331,327 2 Cheque no. 65 13,000318,327 2 Deposit 82,000 400,327 4 Cheque no. 69 6,000 394,327 4 Cheque no. 68 3,115 391,212 4 Cheque no. 64 51,000340,212 4 Deposit 7,280347,492 7 Cheque no. 70 7,000 340,492 7 Cheque no. 71 51,500288,992 7 Deposit 36,100 325,092 8 Cheque no. 66 9,000 316,092 8 Deposit 28,000344,092

October 9 Cheque no. 72 1,330 342,762 9 Cheque no. 73 6,250 336,512 9 Deposit 51,000387,512 15 Cheque no. 74 2,800 384,712 15 Deposit 20,560405,272 16 Cheque no. 75 65,000340,272 16 Deposit 18,014358,286 17 Deposit 34,500392,786 19 Cheque no. 76 8,500384,286

Lesson Four 135

19 Deposit 42,750427,036 21 Cheque no. 79 2,410 424,626 21 Cheque no. 77 12,506412,120 21 Cheque no. 78 4,000 408,120 21 Cheque no. 81 6,500401,620 21 Deposit 9,000410,620 23 Cheque no. 82 16,240394,380 23 Deposit 63,000457,380 26 Cheque no. 84 1,500455,880 26 Dividends 8,750 464,630 26 Deposit 62,500527,130 28 Cheque no. 88 35,500491,630 28 Standing order 10,400481,230

(Insurance) 28 Cheque no. 85 27,000454,230 28 Cheque no. 87 22,500431,730 28 Deposit 13,025444,755 31 Service charge 750 444,005 31 Deposit 28,050472,055

The following is the bank column of the cashbook:Date Particulars Debit Date Particulars Credit 1996 Sh. 1996 Sh.

October 1 Balance b/d 365,875 October 1 Cheque no. 65 13,000 1 Deposited at bank 7,280 1 Cheque no. 66 9,000 3 Deposited at bank 36,100 1 Cheque no. 67 3,548 5 Deposited at bank 28,000 2 Cheque no. 68 3,115 8 Deposited at bank 51,000 4 Cheque no. 69 6,000 10 Deposited at bank 20,560 5 Cheque no. 70 7,000 15 Deposited at bank 18,014 5 Cheque no. 71 51,500 15 Deposited at bank 34,500 7 Cheque no. 72 1,330 17 Deposited at bank 42,750 8 Cheque no. 73 6,250 19 Deposited at bank 15,700 10 Cheque no. 74 2,800 19 Deposited at bank 9,000 11 Cheque no. 75 65,000 22 Deposited at bank 36,000 15 Cheque no. 76 5,800


24 Deposited at bank 26,500 18 Cheque no. 77 12,506 27 Deposited at bank 13,025 19 Cheque no. 78 4,000 28 Deposited at bank 28,050 19 Cheque no. 79 2,410 29 Deposited at bank 171,010 19 Cheque no. 80 3,860 31 Deposited at bank 31,525 19 Cheque no. 81 6,500

22 Cheque no. 82 16,24023 Cheque no. 815,000 26 Cheque no. 84 1,50028 Cheque no. 85 27,00028 Cheque no. 86 10,52028 Cheque no. 87 22,50028 Cheque no. 88 53,50030 Cheque no. 89 2,50031 Cheque no. 90 64,52931 Cheque no. 91 15,50031 Balance c/d 502,481

934,889 934,889

Notes:1. The bank reconciliation on 30 September 1996 showed that one deposit was

in transit and two cheques had not yet been presented to the bank.2. Deposits of Sh.62, 500 and Sh.36, 000 had been entered in the cashbook as

Sh.26, 500 and Sh.36, 000 and in the bank statement as Sh.62, 500 and Sh.63, 000, respectively.

3. A cheque from Mkulima for Sh.15, 700 was deposited on 18 October 1996 but was dishonored and the advice was received on 4 November 1996.

4. Counterfoils for cheques no. 76 and no. 88 showed they had been drawn for Sh.5, 800 and Sh.33, 500 respectively.

Required:a) A correct cashbook balance. (8 marks)b) A bank reconciliation statement on 31 October 1996. (8

marks)(Total: 20 marks)

Lesson Four 137

No 96 Q4

CASHBOOK (ADJUSTED)

1996 Sh. 1996 Sh.31.10 Bal b/d 502,481 Standing order (insurance)

10,400Dividends 8,750 Service charge

750Error on deposit 36,000 Dishonored cheques (debtor)

15,700Error on cheque 88 18,000 Bal c/d

538,381 565,231 565,231

Bank Reconciliation Statement as at 1 October 1996. (Previous period)

Sh. Sh.Balance as per the cashbook 365,875Add: Unpresented cheques 63 31,000 64 51,000 82,000

447,875Less: Uncredited cheques Deposits (82,000)Balance as per the bank statement 365,875

Bank Reconciliation Statement as at 31 October 1996Sh. Sh.

Balance as per the correct cashbook 538,381Add: Unpresented cheques

Cheque no. 80 3,860Cheque no. 83 15,000Cheque no. 86 10,520Cheque no. 89 2,500Cheque no. 90 64,529Cheque no. 91 15,500

Error on bank statement 27,000 138,909677,290

Less: Uncredited Cheques Deposits 171,010

“ 31,525Error in bank statement 2,700 (205,235)Balance as per the bank statement 472,055


d) CAPITAL AND REVENUE EXPENDITURECapital Expenditure: This is the amount spent on the acquisition of a non-current asset or adding value to a non-current asset.

Examples of expenses incurred in acquisition:i. Purchase price/cost of the asset.

ii. Delivery/carriage inwards costs (e.g. shipping charges or import taxes).iii. Costs incurred to get the asset in use (e.g. assembly, testing)iv. Installationv. Demolition costs in order to construct a new building.

vi. Architect fees for construction and supervisionvii. Legal fees incurred in acquisition of a new asset (e.g. lease agreement)

Examples of expenses incurred in adding value to an asset:i. Modify plant to increase its useful life.

ii. Upgrading plant to improve quality of output.iii. Adopting or upgrading the production process to improve or reduce costs.

Revenue Expenditure: There’s an amount spent by the firm in the normal trading process or to assist in earning revenues or income. Examples:

i. Postage and stationery.ii. Carriage outwards (sales).

iii. Repairs and maintenance.

Example 4.10For the business of K Spinns,a wholesaler, classify the following between ‘capital’ and ‘revenue’ expenditure:

a) Purchase of an extra motor van.b) Cost of rebuilding warehouse wall, which had fallen down.c) Building extension to the warehouse.d) Painting extension to warehouse when it is first built.e) Repainting extension to warehouse three years later than that done in (d).f) Carriage costs on bricks for new warehouse extension.g) Carriage costs on purchases.h) Carriage costs on sales.i) Legal costs of collecting debts.j) Legal charges on acquiring new premises for office.k) Fire insurance premium.l) Costs of erecting new machine.

Solution.a) Capital expenditureb) Revenue expenditurec) Capital expenditured) Capital expendituree) Revenue expendituref) Capital expenditureg) Revenue expenditureh) Revenue expenditurei) Revenue expenditurej) Capital expenditure

Lesson Four 139

k) Revenue expenditurel) Capital expenditure.

e) DEPRECIATION It is the loss of value of a non-current asset throughout its period of use by the firm. IAS 16 on property, plant and equipment defines depreciation as the allocation of a depreciable amount of a non-current asset over its estimated useful life. Under the matching concept, all incomes or revenues and expenses for a particular period should be reported in the financial statements and because depreciation is an expense of the business therefore, it will be charged in the P&L A/C.

Causes of Depreciation1. Physical Factors

a) Wear and tear: Some non-current assets depreciate or lose value due to use overtime e.g. machinery and motor vehicles.

b) Rot/decay/rust:: This happens on assets that are not well maintained by the firm e.g. Some machines.2. Economic Factors

a) Inadequacy: Some assets lose value due to them becoming inadequate e.g. when a

business grows or expands then some buildings may become inadequate due to space. Also some machines that are unable to manufacture a large number of goods.

b) Obsolescence: Some assets become obsolete due to change in technology or different

methods of production e.g. computers.

3. Time Factors Some assets have a legal fixed time e.g. properties on lease.4. Depletion

This occurs when some assets have a wasting character due to extraction of raw materials, minerals or oil. Such assets include mines, oil wells, and quarries.

Methods of Calculating DepreciationThese are the methods developed to assist in estimating the amount of depreciation to be charged in the P&L a/c as an expense.The methods chosen by a firm should be in accordance with the agreed accounting practice, accounting standards and suit the firm’s non-current assets. There are 2 main methods of estimating depreciation and 5 others that will apply in a firm’s situation.The main methods are: Straight-line method and Reducing Balance method. The other 5 methods include:

i. Sum of the digits methods – uses a formular.ii. Revaluation method – applies to a non-current asset of low value.


iii. Machine-Hour method – depreciation is based on number of hours a machine is expected to operate (manufacturing process).

iv. Unit of output method – depreciation is based on the number of units a machine is expected to produce.

v. Depletion of units – depreciation is based on number of units extracted from the asset.

Lesson Four 141

Straight-Line MethodThis method ensures that a uniform amount of depreciation is charged in the P&L a/c for a particular asset and is based on the following formular:

Depreciation for year = Cost of asset – Residual Value = £100,000 - £20,000 Estimated useful life 8

= £10,000 per year.

Cost of Asset – Residual ValueEstimated useful life of asset.

Residual ValueThe amount the firm expects to sell the asset after the period of use in the firm, also called Sales Value / Scrap Value.

Estimated Useful LifeThe period the asset is expected to be used in the firm.

Example 4.1A firm buys a machine for £100,000 which it expects to use in the firm for eight years. After the eight years the machine will be sold for £20,000. Under the straight-line method, the depreciation amount will be computed as follows:

This means for this asset £10,000 will be charged in the P&L account as depreciation expense on the machine.The straight line method assumes that benefits accruing on use of a non-current asset are spread out evenly over the life of the asset e.g. buildings use straight-line method.Percentage rate based on cost as opposed to number of years can also be used to calculate the depreciation.Reducing Balance MethodThe firm determines a fixed percentage rate that is applied on the cost of the asset during the first period of use. The same rate is applied in the subsequent financial periods but the rate is applied on the reduced value of the asset. (Cost of asset – total depreciation provided to date).This method ensures that higher amount of depreciation are charged in the P&L account in the earlier periods of use and lower amounts in the latter periods of use as shown in the following example:

Example 4.12


Assume a firm buys machinery for £100,000 and provides depreciation on machines at 20% p.a. on reducing balance method. The depreciation charged to the P&L will be as follows for the next 3 years.

Lesson Four 143

Year 1

£Cost 100,000Depreciation 20% of 100,000 (20,000) P&L YR 1

Balance to YR 2 80,000

Year 2Depreciation 20% of 80,000 80,000

(16,000) P&L YR 2


Year 3Depreciation 20 % of 64,000 64,000

(12,800) P&L YR 3


Reducing balance method (diminishing balance method) assumes that benefits accruing from the use of an asset are higher in the first periods of use and lower in the latter periods e.g. Fixtures, furniture and fitting. Plant and machinery. Motor vehicles.

ACCOUNTING TREATMENT ON DEPRECIATIONWhen non-current assets are depreciated, a new account for each type of asset is opened; this account is called a provision for depreciation whereby the following entries will be made:Debit – P&L a/cCredit – Provision for depreciation a/cWith the amount of depreciation charged for the period.

Example on straight-line methodThe entries will be as follows:Debit – P&L a/c with £10,000Credit – Provision for depreciation. Machines a/c with £10,000 being depreciation provided for the machine.

The ledger accounts will be as follows: Machinery Provision for Depreciation Machinery

£ £ £ £Cashbook 100,000 31/12 Bal c/d 100,000 31/12 Bal c/d 10,000 P&L 10,000


The final accounts extracts will be shown as follows:(a) Profit And Loss Account (Extract) for the year ended

Expenses £ £Depreciation:

Buildings xPlant and machinery 10,000Furniture, Fixtures and Fittings xMotor vehicles x

(b) Balance sheet (Extract) as at________

Non Current Assets Cost Total NBV (Net Book Value)

£ Depreciation (£) £

Land x - xBuildings x (x) xPlant and Machinery x (x) xFurniture, Fixtures & fittings x (x) xMotor vehicles x (x) x

x x x

Example 4.13A company starts in business on 1 January 2002. You are to write up the motor cars account and the provision for depreciation account for the year ended 31 December 2002 from the information given below. Depreciation is at the rate of 20 per cent per annum. Using the basis of one month’s ownership needs one month’s depreciation.

2002 Bought two motor vans for £12,000 each on 1 JanuaryBought one motor van for £14,000 on 1 July.

Motorcars a/c

2002 £ 2002 £1/1 Cashbook 24,000 1/7 Cashbook 14,000 31/12 Bal c/d

38,00038,000 38,000

Calculation for depreciation1/1 24,000 x 20 x 12 = £4,800 + 1/7( 14,000 x 20 x 6 = 1,400 ) 100 12 100 12

Lesson Four 145

= £4,800 + 1,400 = £6,200


Provision- Depreciation for Motor cars A/c2002 £ 2002 £

31/12 Bal c/d 6,200 31/12 P&L 6,200

Profit And Loss Account (Extract) for the period.

Expenses £ £Depreciation:

Motor vans 6200

Balance Sheet (Extract) as at 31/12/2002

Non-current Assets Cost Total NBVDepreciation

Motor vans 38,000 (6200) 31,800

Example 4.14A company starts in business on 1 January 1999, the financial year end being 31 December.You are to show:

a. The plant account.b. The provision for depreciation account.c. The balance sheet extracts for each of the years 1999, 2000, 2001, 2002.

The machinery bought was:

1999 1 January 1 plant costing £8,0002000 1 July 2 plant costing £5,000 each

1 October 1 plant costing £6,0002002 1 April 1 plant costing £2,000

Depreciation is at the rate of 10 per cent per annum, using the straight-line method, plant being depreciated for each proportion of a year.

Lesson Four 147

Plant a/c1999 £ 199 £1/1 Cashbook 8000 31/12 Bal c/d 8000

2000 20001/1 Bal b/d 80001/7 Cashbook 10,0001/10 Cashbook 6,000 31/12 Bal c/d 24,000

24,000 24,000

2001 20011/1 Bal b/d 24,000 31/12 Bal c/d 24,000

2002 20021/1 Bal b/d 24,0001/4 Cashbook 2,000 31/12 Bal c/d 26,000

26,000 26,000

Calculation for Depreciation

1999 £ Accumulated Depreciation£8,000 x 10/100 x 12/12 = 800 800

2000£10,000 x 10/100 x 6/12 = 500

£6,000 x 10/100 x 3/12 = 150

£8,000 x 10/100 x 12/12 = 800 1,450 2,250

2001£24,000 x 10/100 x 12/12 = 2400 4,650

2002£24,000 x 10/100 x 12/12 = 2400

£2,000 x 10/100 x 9/12 = 150 2,250 7,200


Provision – Depreciation Machines1999 £ 1999 £31/12 Bal c/d 800 31/12 P&L 800

2000 £ 2000 £1/1 Bal b/d 800

31/12 Bal c/d 2,250 P&L 1,4502,250 2,250

2001 £ 2001 £1/1 Bal b/d 2,250

31/12 Bal c/d 4,650 P&L 2,4004650 4650

2002 £ 2002 £1/1 Bal b/d 4,650

31/12 Bal c/d 7,200 P&L 2,5507,200 7,200

Balance Sheet (Extract) as at 31/12/99 – 31/12/02

Non Current Assets Cost Total NBVDepreciation

1999Motor vans 8,000 (800) 7,200

1999Motor vans 24,000 (2,250) 21,750

1999Motor vans 24,000 (4,650) 19,350

1999Motor vans 26,000 (7,200) 18,800

DISPOSALS OF ASSETS A firm may dispose off its non-current assets in the following 3 ways:

i. Selling the asset.ii. Asset being written-off from damage/accident/theft.

iii. Asset is scrapped/not used anymore.

Lesson Four 149

When an asset is disposed and is no longer used by the firm, the appropriate entries should be made in the asset account and the total depreciation provided to date on the asset and the entries required will depend on the type of disposal. When the asset is sold, the following entries will be made:

(a) Debit – asset disposal a/c Credit – asset a/cWith the cost of the asset being disposed.

(b) Debit – provision for depreciation of asset a/c. Credit – asset disposal a/cWith the total depreciation provided to date on the asset.

(c) Debit – cashbook. Credit – asset disposal a/cWith the cash received on disposal.

When an asset is written off as a result of damage/accident/theft. If it was insured and the insurance company accept liability but by the end of the period the insurance company has not yet paid.(a) Debit – asset disposal a/c Credit – asset a/cWith the cost of the asset damaged.

(b) Debit – provision for depreciation of asset a/c Credit – asset disposal a/c

(c) Debit – insurance receivable a/c Credit – asset disposal a/cWith the amount expected from the insurance.

If the insurance pays before the end of the financial period, it will not be necessary to create an insurance debtor so the following entries will be made:

Debit – cashbook.Credit – asset disposal a/c

If the asset is not used anymore or scrapped by the firm, the appropriate entries will be made in the asset account and provision for depreciation a/c only.

Debit – asset disposal a/c Credit – asset a/cWith the cost of the asset no longer in use.

Debit – provision for depreciation for asset Credit – asset disposal a/cWith the total depreciation provided to date.

The balance in the disposal a/c after the above entries will either be a debit balance or a credit balance. A credit balance represents a profit on disposal,


which is reported in the profit and loss a/c together with other incomes. The entry will be:

Debit – asset disposal a/cCredit – P&L a/c

With the balance in the account.

A debit balance in the asset disposal a/c is loss on disposal which is reported in the P&L a/c as an expense and therefore the entry will be.

Example 4.15A firm has a motor vehicle costing £1,000 total depreciation provided to date is £800. The firm decides to trade in the motor vehicle with a new one the value of the new one being £500. The supplier of the new vehicle agree with the firm that the old motor vehicle is worth £300, therefore the difference will be paid by cash.

Motor vehicle a/c £ £

Bal b/d 1,000 Motor vehicle disposal 1,000Disposals 300Cashbook 200 Bal c/d 500

1,500 1,500===== ====

Motor Vehicle Disposal a/c

£ £Motor vehicle a/c 1,000 Provision for depreciation 800P&L 100 Motor vehicle 300

1,100 1,100

JOURNAL ENTRIES £ £Debit – motor vehicles disposal 1,000Credit – motor vehicles a/c 1,000(Motor vehicle being traded in now transferred to disposal a/c)

Debit – Provision for depreciation – motor vehicles 800Credit – Motor vehicle disposal a/c 800(Total depreciation provided for motor vehicle)

Debit – Motor vehicle a/c 500Credit – Asset disposal a/c 300 - Cashbook 200(New motor vehicle acquired by trade-in value of £300 and cheque payment of £200)

Debit – Asset disposal a/c 100Credit – P&L 100

Lesson Four 151

(Profit made on disposal)

In case of a loss,

Debit – P&L a/cCredit – asset disposal a/c

If the firm trades in an old asset for a new one, the following entries will be made in addition to the movements in the asset and depreciation a/c.Debit – asset a/c (value of the new asset)Credit – cashbook (cash paid as difference of new value i.e. trade in value of old asset)Asset disposal a/c (with trade-in value of old asset)

Example 4.16A company depreciates its plant at the rate of 20 per cent per annum, straight line method, for each month of ownership. From the following details draw up the plant account and the provision for depreciation account for each of the years 1999, 2000, 2001 and 2002.

1999 Bought plant costing £900 on 1 January.Bought plant costing £600 on 1 October.

2001 Bought plant costing £550 on 1 July.2002 Sold plant which had been bought for £900 on 1 January 1999 for the

sum of £275 on 30 September 2002.

You are also required to draw up the plant disposal account and the extracts from the balance sheet as at the end of each year.

Example Plant a/c1999 £ 1999 £1/1 Cashbook 900 1/10 Cashbook 600 31/12 Bal c/d 1,500

1,500 1,500

2000 £ 2000 £1/1 Bal b/d 1,500 31/12 Bal c/d 1,500

2001 £ 2001 £1/1 Bal b/d 1,5001/7 Cashbook 550 31/12 Bal c/d 2,050

2,050 2,050

2002 20021/1 Bal b/d 2,050 30/9 Disposal 900


31/12 Bal c/d 1,150 2,050 2,050

Plant Provision for Depreciation a/c

1999 £ 1999 £31/12 Bal c/d 210 31/12 P&L 210

2000 2000 1/1 Bal b/d 210

31/12 Bal c/d 510 P&L 300 510 510

2001 2001 1/1 Bal b/d 510

31/12 Bal c/d 865 P&L 355 865 865

2002 200231/12 Disposals 675 1/1 Bal b/d 865

Bal c/d 555 P&L 365 1,230 1,230

Calculation for DepreciationDate Cost Months Depreciation charge

£19991/1 900 12 20/100 x 900 x 12/12 = 1801/10 600 3 20/100 x 600 x 3/12 = 30

210

20001/1 1,500 12 20/100 x 1,500 x 12/12 = 300

20011/1 1,500 12 20/100 x 1,500 x 12/12 = 300

Lesson Four 153

1/2 550 6 20/100 x 550 x 6/12 = 55355

200230/9 900 9 20/100 x 900 x 9/12 = 13531/12 550 12 20/100 x 550 x 12/12 = 11031/12 600 12 20/100 x 600 x 12/12 = 120

365

Plant Disposal a/c2002 £ 2002 £Plant a/c 900 30/9 Provision for depreciation 675P&L 50 30/9 Cashbook 275

950 950

Balance Sheet (Extract)Total

Non Current Assets Cost Depreciation NBV1999 Plant 1,500 (210) 1,290

2000 Plant 1,500 (510) 990

2001 Plant 2,050 (865) 1,695

2002 Plant 1,150 (555) 595

CHANGE OF DEPRECIATION POLICY A firm may change its depreciation policy in several ways e.g. from straight line to reducing balance or vice versa, or it may increase/decrease the number of estimated useful years of an asset. A firm should always follow the depreciation policy adopted consistently and incase there is need to change the policy may be due to a new accounting standard or change in circumstances. This change should be disclosed in the financial statements.When there is change in the depreciation policy this may result in an increase or a decrease in the depreciation to be charged in the Profit and loss account .IAS 16 requires that depreciation should be based on the remaining net book value at the start of the period.Example 4.17 A firm buys a machine for £100,000 for which it expects to use for the next 10 years. The firm depreciates the machines on a straight-line basis on the years of the number of estimated useful years. In the 4th year, the estimated useful life of the machine is now reduced to 8 years. year.Required: Show the charge in the provision for depreciation a/c and the balance carried down for year 4. Change for 10yr – 8 yr is same as change from 10% to 12.5%


Provision for Depreciation

Year 1 £ Year 1 £31/12 Bal c/d 10,000 31/12 P&L

10,000

Year 2 Year 2 1/1 Bal b/d 10,000

31/12 Bal c/d 20,000 P&L10,000

20,000 20,000Year 3 Year 3

1/1 Bal b/d 20,00031/12 Bal c/d 30,000 31/12 P&L

10,000 30,000 30,000

Year 4 Year 4 1/1 Bal b/d 30,000 31/12 P&L 14,000

31/12 Bal c/d 44,000 44,000 44,000

Workings:The net book value at the beginning of Year 4 is £ 70,000 (100,000- 30,000). And the remaining useful life is 5 (8 years- 3 years). The charge for year 4 for depreciation will be

£ 70,000 = 14,000. 5

Assuming that in this example the life of the machine does not decrease but increases from 10 years to 13 years.

Required: Show the provision of depreciation account in year 4

Lesson Four 155

Provision for Depreciation

Year 1 £ Year 1 £31/12 Bal c/d 10,000 31/12 P&L

10,000

Year 2 Year 2 1/1 Bal b/d 10,000

31/12 Bal c/d 20,000 P&L10,000

20,000 20,000

Year 3 Year 331/12 Bal c/d 30,000 1/1 Bal b/d

20,000

_____ P&L 10,000 30,000

30,000

Year 4 Year 4 1/1 Bal b/d 30,00031/12 Bal c/d 37,000 31/12 P&L 7,000

37,000 37,000

REVALUATION OF NON CURRENT ASSETSSome of the non-current assets in a firm tend to appreciate in value rather than depreciate e.g. land and buildings. IAS 16 on property, plant and equipment requires that such assets may be carried in the accounts at the revalued amounts (may be based on the their market price).Land is not depreciated, and therefore the adjustments required are minimal, but for buildings, changes should be made at the cost and depreciation reserve account is usually opened for the purpose of these adjustments.Example 4.18A firm has the following assets as part of the non-current assets:

Asset Cost Depreciation

(a) Land £1,000,000 - (b) Buildings £800,000 40,000


Illustration 1The firm decides to revalue these two assets to reflect their current market prices and these are revalued at:

Land -£ 1,200,00Buildings -£ 900,000

The following entries would be made(a) Debit – Land A/c – with revaluation gain - £ 200,000

Credit – Revaluation Reserve a/c with the same - £ 200,000 (Revaluation gain on the land 1,200,000 – 1,000,000)

(b) Debit – Building a/c with revaluation gain - £100,000 Credit – Revaluation Reserve a/c with the same - £100,000

(Revaluation gain on buildings 900,000 – 800,000) (c) Debit – Provision for depreciation for buildings a/c with £ 40,000

Credit – Revaluation Reserve a/c with the same £ 40,000Total credit depreciation charged to date on buildings now transferred to

revaluation reserve a/cThe ledger a/c will be as follows:

Land a/c£ £

Bal B/D 1,000,000Revaluation

reserve__200,000 Bal C/D 1,200,000

1,2000,000 1,200,000

Buildings a/c£ £

Bal B/D 800,000Revaluation

reserve100,000 Bal C/D 900,000

900,000 900,000Revaluation Reserve a/c

£ £

Lesson Four 157

Land 200,000Buildings 100,000

Bal C/D 340,000 Provision for depr. 40,000340,000 340,000

Provision for depreciation (Buildings)£ £

Revaluation 40,000 Bal B/D 40,000

Bal c/d 45,000 P & L 45,00085,000 85,000

The balances in the Land and Building a/c will be shown as cost in the Balance Sheet and the revaluation reserve a/c appears together with the capital as a revaluation reserve (especially used in company accounts.

Land 1,200,000 – 1,000,000 = 200,000Buildings 900,000 – 760,000 = 140,000 340,000

Any depreciation to be charged for the buildings should be based on the revalued amount (900,000)If we assume depreciation of 5% for buildings, we shall have £45,000 charged in the P & L and will also be the Bal c/d in the provision for depreciation a/c.Assume again that the firm decides to revalue its non-current assets or land and buildings downwards in year 3 to the following values:Land : £900,000Buildings: £700,000These amounts are to be reflected in the accounts for year 3.

The Ledger accounts will be as follows: Land

Year 3 £ Year 3 £


1/1 Bal B/D 1,200,000 31/12 Revaluation 200,000

P & L 100,000

________ Bal C/D __900,000

1,200,000 1,200,000

BuildingsYear 3 £ Year 3 £

1/1 Bal B/D 900,000 31/12 Revaluation

100,000

P & L 100,000_______ Bal C/D 700,000

900,000 900,000

Revaluation ReserveYear 3 £ Year 3 £

31/12 Land 200,000 1/1/ Bal B/D 340,00031/12 Building 100,000

31/12 Prov. For depr. _40,000 _______340,000 340,000

Exam Type Question 4.19 (December 1995 ) Question 4James Mbuvi started a taxi business in Nairobi March 1990 under the firm name Mbuvi Taxis. The firm had two vehicles KA and KB, which had been purchased forSh.560, 000, and Sh.720, 000 respectively earlier in the year.In February 1992 vehicle KB was involved in an accident and was written off. The insurance company paid the firm Sh.160, 000 for the vehicle. In the same year the firm purchased two vehicles, KC and KD for Sh.800, 000 each.In November 1993 vehicle KC was sold for Sh.716, 000. In January 1994 vehicle KE was purchased for Shs.840,000. In March 1994 another vehicle KF was

Lesson Four 159

purchased for Sh.960, 000.The firm’s policy is to depreciate vehicles at the rate of 25 per cent on cost on vehicles on hand at the end of the year irrespective of the date of purchase. Depreciation is not provided for vehicle disposed of during the year. The firm’s year ends on 31 December.

Required:a) Calculate the amount of depreciation charged in the profit and loss

account for each of the five years. (7 marks)

b) Prepare the motor vehicle account (at cost).(8 marks)

c) Calculate the profit and loss on disposal of each of the vehicles disposed of by the company.

(5 marks) (Total: 20 marks)

aVehicle 1990 1991 1992 1993 1994

KA 560,000 560,000 560,000 560,000KB 720000 720,000 - - -KC - - 800,000 - -KD - - 800,000 800,000 800,000KE - - - - 840,000KF - - - - 960,000

Total cost 1,280,000

1,280,000

2,160,000

1,360,000

2,600,000

Depreciation at 25%

320,000

320,000

540,000

340,000

650,000

Motor Vehicle 1990 Sh 1990 Sh1/3 Cashbook 1,280,00

031/12 Bal c/d 1,280,000


1991 19911/1 Bal b/d 1,280,00

031/12 Bal c/d 1,280,000

1992 19921/1 bal b/d 1,280,00

01/2 Disposal 720,000

Cashbook 1,600,000

31/12 Bal c/d 2,160,000

2,880,000

2,880,000

1993 19931/1 Bal b/d 2,160,00

01/11 Disposal 800,000

________ 31/12 Bal c/d 1,360,0002,160,00

02,160,000

1994 19941/1 Bal b/d 1,360,00

01/1 Cashbook 840,0001/3 Cashbook 960,000 31/12 Bal c/d 3,160,000

3,160,00 3,160,000

Lesson Four 161

Provision For Depreciation – M/V1990 Sh 1990 Sh31/12 Balc/d 320,000 31/12 P & L 320,0001991 1991

1/1 Bal b/d 320,000199231/12 Bal c/d 640,000 31/12 P& L 320,000

640,000 640,0001992 19921/2 Disposal 360,000 1/1 Bal b/d 640,000

31/12 Bal c/d 820,000 3/12 P & L 540,0001,180,00

01,180,000

1993 19931/11 Disposal 200,000 1/1 Bal b/d 820,000

31/12 Bal c/ 960,000 31/12 P & L 340,0001,160,00

01,1

60,0001994 1994

31/1 Bal b/d 960,00031/12 Bal c/d 1,610,00

0P & L 650,000

1,610,000

1,610,000

Note:KA is fully depreciated by 1994,so no depreciation is charged for that asset. Cost still remains until the asset is disposed. So depreciation ;

= 25% x 2,600,000= 650,000

Exam type QuestionPentland Limited complies its financial statements for the year to 30 June each year.


At 1 July 1999 the company’s balance sheet included the following figures:l

Accumulated

Net book

Cost Depreciation

Value

£000 £000 £000Land 4,000 Nil 4,000Buildings 2,200 800 1,400Plant and machinery

1,600 600 1,000

Motor vehicles 600 200 400

Depreciation is charged at the following annual rates (all straight line):Land NilBuildings 2%Plant and machinery 15%Motor vehicles 20%

Appropriate depreciation charge is made in the year of purchase, sale or revaluation of an assetDuring the year ended 30 June 2000 the following transactions took place:

1. I January 2000 The company decided to adopt a policy of revaluing its buildings; and they were revalued to £3.4m.

2. 1 January 2000 Plant which has cost £300,000 was sold for £50,000. Accumulated depreciation on this plant at 30 June 1999 amounted to £230,000.New plant was purchased at a cost of £400,000.

3. 1 April 2000 A new motor vehicle was purchased for £30,000. part of the purchase price was settled by part exchanging another motor vehicle, which had cost £20,000, at an agreed value of £12,000. the balance of £18,000 was paid in cash.

4. The motor vehicle given in part-exchange had a net book value (cost less depreciation) at 30 June 1999 of £10,000

Required:Prepare ledger accounts to record these transactions in the records of Pentland

Limited.(16 marks)

Lesson Four 163

Land1999 £ 1999 £1/7 Bal b/d 4,000

2000 20001/1 Revaluation 1,200 30/6 Bal c/d 5,200

5,200 5,200

Buildings1999 £ 1999 £1/7 Bal b/d 2,200

2000 20001/1 Revaluation 1,200 30/6 Bal c/d 3,400

3,400 3,400

Revaluation Reserve2000 £ 2000 £

1/1 Buildings 1,20030/6 Bal C/D 2,022 1/1 Provision for

depr.822

2,022 2,022

Provision for Depreciation - Building

1999 £ 1999 £1/7 Bal b/d 800

2000 20001/1 Revaluation 82

230/6 P & L

2,200 x ½ x 15

30/6 Bal c/d 34_

3,400 x ½ x 15

56_


856

856

Plant1999 £ 1999 £1/7 Bal B/D 1,600

2000 20001/1 Cashbook 400 1/1 Disposal 300

_____ 30/6 Bal c/d 1,7002,000 2,000

Provision for Depreciation - Plant1999 £ 1999 £

1/7 Bal b/d 600

2000 20001/1 Disposal 252.50 30/6 P & L 247.50

Bal c/d 595.00847.50 847.50

Motor Vehicles1999 £ 1999 £

1/7 Bal b/d 600

2000 20001/4 Disposal 12 1/4 Disposal 20

1/4 Cash book 18 30/6 Bal C/D 610630 630

Motor Vehicle Disposal2000 £ 2000 £1/4 Motor Vehicle

20 1/4 Provision for depr.

13

P & L 5 1/4 Motor Vehicle 1225 25

Lesson Four 165

Provision for depreciation - Vehicle

1999 £ 1999 £1/7 Bal b/d 200

2000 20001/4 Disposal 13 1/4 P & L 120.530/6 Bal c/d 307.5 30/6 Bal C/D ______

320.50 320.502000 £ 2000 £1/1 Plant 300 1/1 Provision for

depr.252.50

P & L 2.50 Cash book 50___25 302.50


Property, Plant and Equipment Schedule:Cost/

ValuationFreehold property

Leasehold Property Plant and

Fixture, Furniture

Total

(£) Long leases

(£)

Short lease(£)

Machinery (£)

And fittings (£)

(£)

Bal as at 1/1/01

x x x x x x

Additions xx xx xx xx xx xxRevaluations

(gains)xx - - - - xx

Reclassifications

- (xx) xx - - -

Disposals (xx) (xx) (xx) (xx) (xx) (xx)Bal as at 31/12/01 xx xx xx xx xx xx

Depreciation/

AmortizationBal as at 1/1/10

xx - xx xx xx xx

Change for year

xx - xx xx xx xx

Revaluation (xx) - (xx) (xx) (xx) (xx)Eliminated

on Disposal (xx) - (xx) (xx) (xx) (xx)Bal as at 31/12/01 (xx)

-(xx) (xx) (xx) (xx)

N.B. V as at 31/12/01

xx xx xx xx xx xx

NBV as at 31/12/01

xx xx xx xx xx xx

Additional information is in this schedule called reclassifications where some of the non-current assets are transferred into a different class. (e.g.) some of the properties hold under long leases (over 50 years) will be transferred to the short leases classes when their term becomes less than 50 years. This is a reclassification from long lease to short lease and so is shown in the schedule at the value of transfer as a deduction in the long lease class and on addition in the short lease class

Exam Type Questions

May 2000 Question Threea) Briefly explain the nature and purpose of accounting for depreciation.

Lesson Four 167

b) The chief accountant of Jitegemea Ltd has encountered difficulties while accounting for fixed assets and the related depreciation in the company’s draft accounts for the year ended 30 April 2000. He has decided to seek your professional advice and presented the following balances of fixed assets as at 1 May 1999:


Acquisition Accumulated Depreciation

Cost Depreciation RatesSh. Sh. %

Furniture 900,000 300,000 12.5Trucks 3,525,000 1,470,000 25Plant and machinery 7,387,500 4,462,500 10Land 2,775,000 - NilBuildings 2,925,000 292,500 2.5

The following additional information was also available:

1. It is the company’s policy to write off cost of the assets using above percentages on cost.2. Depreciation is fully charged in the year of acquisition and none in the year of disposal.3. A three year old machine acquired for sh.187,500 was sold for sh.15,750.4. It has been decided to adjust and charge depreciation on buildings at 4%.5. A used delivery truck purchased three years ago for sh.248,250 was traded in

during the year at a value of sh.157,500 in part exchange of the new delivery truck costing sh.450,000.

6. Land, buildings and machinery were acquired for sh.1,350,000 from a company that went out of business. At the time of acquisition sh.90,000 was paid to have the assets revalued by a professionally qualified valuer. The revaluation indicated the following market values.

Sh.Land 900,000Buildings 600,000Machinery 300,000

Required:A schedule of movement of fixed assets as requested by the Chief Accountant for inclusion in the company’s accounts for the year ended 30 April 2000.

(10 marks) (Total: 15 marks)

SOLUTIONDepreciation is the loss of value of an asset (non-current) throughout the period of use by the firm. IAS 16 on property plant and equipment defines depreciation as allocation of a depreciable amount of a non-current asset throughout its useful life.Under the matching concept, all revenues should be matched with all the expenses that relate to a particular financial period and therefore because the firm to earn revenue or income uses the assets, then the loss of value should be marched with these revenues.A charge is made in the Profit and Loss account as a depreciation expense for the non-current asset.

Lesson Four 169

Property, Plant & Equipment Schedule:Cost/Valuation Land,

BuildingsAnd

Machinery

Furniture Motor Total

Sh. Sh. Sh. Sh.Bal as at 1/5/99 13,087,5

00900,000 3,225,000 17,512,500

Additions 1,350,000 - 450,000 1,800,000Revaluation 450,000 - - 450,000Disposals (187500) _____- (248,250) (435,750) Bal as at 30/4/2000 14,700,000 900,000 3,726,750 19,326,750

DepreciationBal as at 1/5/99 4,755,000 300,000 1,470,000 6,525,000Charge for the year

1,066,500 112,500 931,687.5 2,110,687.5

Eliminated on disposal

(37,500) -______ (124,125) (161,625)

Bal as at 30/4/2000 5,784,000 412,500 2,277,562.5

8,474,062.5

NBV 1/5/99 8,332,500 600,000 2,055,000 10,987,500NBV 30/4/2000 8,916,000 487,500 1,449,187.

510852,687.

8

Workings:

Depreciation on Furniture = 900,000 x 12.5% = 112,500

Motor vehicle = cost 3,525,000 Add 450,000

3,726,750 x 25% = 931,687.5

Buildings = (292,500 + 600,000) x 4%

= 141,000At 2.5% = 2,925,000 x 2.5% x 4 = 292,5004% = 292,500 x 4% x 4 = 468,000

175,500

Machinery: cost c/f + Additions – Disposals = Bal x 10%

73,787,500 + 300,000 – (187,500) = 7,500,000 x 10% = 750,000


Lesson Four 171

REINFORCING QUESTIONS

QUESTION ONEOtter Limited operates a computerized accounting system for its sales and purchases ledgers. The control accounts for the month of September 1999 are in balance and incorporate the following totals:

£Sales ledger:Balances at 1 September 1999: Debit

386,430

Credit

190

Sales 163,194Cash received 158,288Discounts allowed 2,160Sales returns inwards 590Credit balances at 30 September 1999

370

Purchases ledger:Balances at 1 September 1999: Credit

184,740

Debit

520

Purchases 98,192Cash payments 103,040Discounts received 990Purchases returns outwards 1,370Debit balances at 30 September 1999

520

Although the control accounts agree with the underlying ledgers, a number of errors have been found, and there are also several adjustments to be made. These errors and adjustments are detailed below:

1. Four sales invoices totaling £1,386 have been omitted from the records.2. A cash refund of £350 paid to a customer, A Smith, was mistakenly treated

as a payment to a supplier, A Smith Limited.3. A contra settlement offsetting a balance of £870 due to a supplier against

the sales ledger account for the same company is to be made.4. Bad debts totaling £1,360 are to be written off.5. During the month, settlement was reached with a supplier over a disputed

account. As a result, the supplier issued a credit note for £2,000 on 26 September. No entry has yet been made for this.

6. A purchases invoice for £1,395 was keyed in as £1,359.7. A payment of £2,130 to a supplier, B Jones, was mistakenly entered to the

account of R Jones.


8. A debit balance of £420 existed in the purchases ledger at the end of August 1999. The supplier concerned cannot now be traced and it has been decided to write off this balance.

Required:Prepare the sales ledger and purchases ledger control accounts as they should appear after allowing, where necessary, for the errors and adjustments listed.

QUESTION TWOApril showers sells goods on credit to most of its customers. In order to control its debtor collection system, the company maintains a sales ledger control account. In preparing the accounts for the year to 31 October 20X3 the accountant discovers that the total of all the personal accounts in the sales ledger amounts to £12,802, whereas the balance on the sales ledger control account is £12,550.

Upon investigating the matter, the following errors were discovered:

1. Sales for the week ending 27 March 20X3 amounting to £850 had been omitted from the control account.

2. A debtor’s account balance of £300 had not been included in the list of balances.

3. Cash received of £750 had been entered in a personal account as £570.4. Discounts allowed totaling £100 had not been entered in the control

account.5. A personal account balance had been undercast by £200.6. A contra item of £400 with the purchase ledger had not been entered in the

control account.7. A bad debt of £500 had not been entered in the control account.8. Cash received of £250 had been debited to a personal account.9. Discounts received of £50 had been debited to Bell’s sales ledger account.10.Returns inwards valued at £200 had not been included in the control

account.11.Cash received of £80 had been credited to a personal account as £8.12.A cheque for £300 received from a customer had been dishonored by the

bank, but no adjustment had been made in the control account.

Required:Prepare a corrected sales ledger control account, bringing down the amended balance as at 1 November 20X3.Prepare a statement showing the adjustments that are necessary to the list of personal account balances so that it reconciles with the amended sales ledger control account balance.

QUESTION THREEGeorge had completed his financial statements for the year ended 31 March 1999, which showed a profit of £81,208, when he realized that no bank reconciliation statement had been prepared at that date.

Lesson Four 173

When checking the cashbook against the bank statement and carrying out other checks, he found the following:

1. A cheque for £1,000 had been entered in the cashbook but had not yet been presented.

2. Cheques from customers totaling £2,890 entered in the cashbook on 31 March 1999 were credited by the bank on 1 April 1999.

3. Bank charges of £320 appear in the bank statement on 30 March 1999 but have not been recoded by George.

4. A cheque for £12,900 drawn by George to pay for a new item of plant had been mistakenly entered in the cash book and the plant account as £2,900. Depreciation of £290 had been charged in the profit and loss account for this plant.

5. A cheque for £980 from a credit customer paid in on 26 March was dishonoured after 31 March and George decided that the debt would have to be written off as the customer was now untraceable.

6. A cheque for £2,400 in payment for some motor repairs had mistakenly been entered in the cash book as a debit and posted to the credit of motor vehicles account. Depreciation at 25% per annum (straight line) is charged on motor vehicles, with a full year’s charge calculated on the balance at the end of each year.

7. The total of the payments side of the cash book had been understated by £1,000. On further investigation it was found that the debit side of the purchases account had also been understated by £1,000.

George had instructed his bank to credit the interest of £160 on the deposit account maintained for surplus business funds to the current account. This the bank had done on 28 March. George had made an entry on the payments side of the cashbook for this £160 and had posted it to the debit of interest payable account.George had mistakenly paid an account for £870 for repairs to his house with a cheque drawn on the business account. The entry in the cashbook had been debited to repairs to premises account.George had also mistakenly paid £540 to Paul, a trade supplier, to clear his account in the purchases ledger, using a cheque drawn on George’s personal bank account. No entries have yet been made for this transaction.

The cashbook showed a debit balance of £4,890 before any correcting entries had been made. The balance in the bank statement is to be derived in your answer.

Required:1. Prepare an adjusted cash book showing the revised balance which should

appear in George’s balance sheet at 31 March 1999.

(6 marks)2. Prepare a bank reconciliation statement as at 31 March 1999. (2

marks)3. Draw up a statement for George showing the effect on his profit of the

adjustments necessary to correct the errors found.


(8 marks)

4. Prepare journal entries to correct items (9) and (10). Narratives are required.

(4 marks)

QUESTION FOUR1. Name and explain four types of errors which are not disclosed by the trial

balance.(8 marks)

The trial balance of S Juma, a sole trader, did not balance on 30 April 1995. The difference was put in the suspense account. The final accounts which were then prepared showed a net profit of Sh. 64,000. During audit, the following errors were noted:

A loan from ABD Bank of Sh 10,000 was entered correctly in cash book but was not posted to the ledger.

A cheque of Sh. 4,000 for rent was not entered in the books. Closing stock was overvalued by Sh 1,500. Discount allowed of Sh 500 was entered in the discount-received

account. The opening stock was understated by Sh 3,200. Prepaid insurance of Sh 220 had been included in the profit and loss

account. Goods destroyed by fire amounting to Sh 12,000 were written off in

the profit and loss account. However, the insurance company has agreed to compensate the full amount.

Required:1. Journal entries to correct the errors. (8 marks)2. Statement of corrected profit. (2 marks)3. Suspense account. (2 marks)

(Total: 20 marks)

QUESTION FIVEThe following Trial Balance was taken from the ledger of P Spike, a sole trader, on 31st December 2002:

£ £Capital 40,000Purchases 26,154Sales 36,246Salaries 4,814Opening stock 4,307

Lesson Four 175

Insurance 820Rent 965Buildings 25,000Furniture 14,500Debtors 6,140Other expenses 1,060Creditors 4,638Commission _____ __946

82,795 82,795

Adjustments:

1. Salaries due, £3502. Insurance was paid for one year up to 31st March 19-2.3. Rent received for January 19-2, £165.4. Commission accrued but not yet received, £120.5. Furniture to be depreciated by 10%.6. 5% of debtors are doubtful.7. Stock on 31st December 19-1 was valued at £5,008.

Required: Prepare a 10 column worksheet.

QUESTION SIX1. Explain the purposes for which control accounts are prepared in a business

organization.(3 marks)

XML Ltd maintains control accounts in its business records. The balances and transactions relating to the company’s control accounts for the month of December 1994 are listed below:

Balance at 1 December 1994: Sales ledger 6,185,0

00(debit)

52,500 (credit)Purchases ledger 16,500 (debit)

4,285,000

(credit)

Transactions during December 1994:Sales on credit 8,452,0

00Purchases on credit 5,687,5

00Returns inwards 203,50


0Returns outwards 284,00

0Bills of exchange payable 930,00

0Bills of exchange receivable 615,00

0Cheques received from customers

7,985,000

Cheques paid to suppliers 4,732,000

Cash paid to suppliers 88,500Bill payable dishonoured 400,00

0Charges on bill payable dishounered

10,000

Cash received from credit customers

153,000

Bad debts written off 64,500Cash discounts allowed 302,00

0Bill receivable dishonoured 88,500

Balances at 31 December 1994:Sales ledger 44,000 (credit)Purchases ledger 23,500 (debit)

Required:Post the sales ledger and the purchases ledger control accounts for the month of December 1994 and derive the respective debit and credit closing balances on 31 December 1994.

(17 marks)


Acknowledgement 177

LESSON FIVE

FURTHER ADJUSTMNETS TO ACCOUNTS

(a) CONTROL ACCOUNTSControl accounts are so called because they control a section of the ledgers. By control we mean that the total on the control accounts should be the same as the totals on the ledger accounts. There are two main types of control accounts:

(i) Sales ledger control Account – also called total debtors. The balance on the sales ledger control account should be the same as the total of the balances in the sale ledger.

(ii) Purchases Ledger Control Account – also called total creditors .The balance carried down (Bal c/d) on the purchases Ledger Control Account should be the same as the total of the balances in the purchases ledger.

Example (Sales Ledger Control a/c)

Sales Ledger Control A/c

Sales 1400 CashBook 700Bal C/D 700

1400 1400

SALES LEDGER Debtor A a/c

Sales 200 C/B 50Bal c/d 150

200 200

Debtor B a/c


400 400


Sales = 200 + 300 + 400 + 500Cashbook = 50 + 100 + 250 + 300Balance c/d = 150 + 150 + 200

178 Further Adjustments to Accounts

Debtor C a/c


300 300

Lesson Five 179

Debtor D a/c


500 500

Example: Purchases Ledger Control a/c

Purchases Ledger Control a/c

C/B 1900 Purchases

2600

Bal c/d 7002600 2600

PURCHASES LEDGER

Creditor A

C/B 400 Purchases

600

Bal c/d 200600 600

Creditor B

C/B 450 Purchases

700

Bal c/d 250700 700

Creditor C

C/B 350 Purchases

500

Bal c/d 150500 500

Creditor D

C/B 700 Purchases

800

Bal c/d 100800 800


Purpose of Control Accounts1. Provide for arithmetical check on the postings made in the individual

accounts (either in the sales ledger or purchases ledger.)2. To provide for a quick total of the balances to be shown in the trial balance

as debtors and creditors.3. To detect and prevent errors and frauds in the customers and suppliers

account.4. To facilitate delegation of duties among the debtors and creditors clerks.

FORMAT OF A SALES LEDGER CONTROLSales Ledger Control a/c

1. Balance b/d of the total debit balances from previous period

1. Total credit balances of the sales ledger brought forward

2. Total credit sales for the period (from the sales journal)

2. Total cash received from credit customers/debtors (from cash book)

3. Refunds to customers (from cashbook)

3. Total cheques received from credit customers/debtors (from cash book)

4. Dishonored cheques (from cashbook)

4. Total returns-inwards (returns-inwards journal)

5. Bad debts recovered (from general journal)

5. Total cash discount allowed to customers (from cash book)

6. Bad debtors written-off (from general journal)

7. Cash received from bad debtors recovered (cash book)

8. Purchases Ledger contra

9. Allowances to customers (price reduction in excess to discounts allowed)

6. Total credit balances of the sales Ledger carried forward

10.Total debit balance carried down to the next period – to be derived after posting all those transactions

Refunds to CustomersSometimes a firm can refund some cash on the customers account. This takes place when there is a credit balance on the debtor’s a/c and the customer is not a creditor too.The entry will be:

Dr. Debtor’s a/c

Lesson Five 181

Cr. Cashbook

Example:Debtor A

£ £Sales 1000 Cashbook 950(Refunds) C/B 100 Discounts 50

Returns 1001100 1100

If the firm has not paid this amount owed to the customer, then it’s carried forward to the next period then is a credit balance in the customer’s a/c. Therefore, if a firm has several customer, this information will be shown in the control a/cs as total balance c/f (debit side).

Contra against the purchases ledger balances:Some debtors may also be creditors in the same firm and therefore, if the amount due to them as creditors is less than what they owe as debtors, then the credit balance is transferred from their creditors a/c to their debtors a/c as a contra entry.

Example: Debtor (A)

Sales 2000 Contra- purchases

1000

Bal c/d 10002000 1100

Creditor (A)

Contra - Debtor

1000 Purchases 1000

FORMAT OF A PURCHASES LEDGER CONTROL ACCOUNTPurchases Ledger Control A/C

1. Total debit balances from purchases ledger brought forward from previous period

1. Total credit balance brought forward (of purchases ledger from the previous period)

2. Total cash paid to creditors (from cash book)

2. Total credit purchases for the period (from purchases journal)

3. Total cheques paid to creditors 3. Refunds from suppliers


(from cash book) (from cash book)4. Total cash discounts received (from cash book)5. Allowances by suppliers

6. Sales ledger contra

7. Total returns outwards (from returns-outwards journal)8. Total credit balance (to be derived after posting entries)

4. Total debit balances (of the purchases ledger carried forward)

NOTES:The following notes should be taken into consideration:

1) Cash received from CASH SALES should NOT be included in sales ledger control a/c.

2) Only cash discounts (allowable & receivables) should be included. Trade discounts should NOT be included.

3) Provision for doubtful debts is NOT included in the sales ledger control a/c. i.e. increase or decrease in provisions for doubtful debts will not affect this account.

4) Cash purchases are NOT posted to the Purchases Ledger Control A/C. However in some cases it can be included especially where there are incomplete records (Topic to be covered later).

5) Interest due that is charged on over due customers’ account may also be shown on the debit side of the sales ledger control. However when trying to determine the turnover under incomplete records then it is wise to omit it.

Example 5.1You are required to prepare a purchases ledger control account from the following for the month of June. The balance of the account is to be taken as the amount of creditors as on 30 June.

2003 £June 1 Purchases ledger balances 36,760

Totals for June: Purchases journal 422,570 Returns outwards journal 10,980 Cheques paid to suppliers 387,650 Discounts received from suppliers

8,870

June 30 Purchases ledger balances ?

Solution Purchases Ledger Control A/C

Lesson Five 183

2003 £ 2003 £Returns out 10,980 Bal b/d (1/6) 36,760Bank 387,95

0Discounts received 8,870Bal c/d (30/6) 51,830 Purchases 422,570

459,330

459,330

Example 5.2Prepare a sales ledger control account from the following:

2003£

May 1 Debit balances 64,200Totals for May:Sales journal 128,000Cash and cheques received from debtors 103,700Discounts allowed 3,950Debit balances in the sales ledger set off against credit balances in the purchases ledger

1,450

May 31 Debit balances ?Credit balances 500

Solution

Sales Ledger Control A/C2003 £ 2003 £1/5 Bal b/d 64,20

0Cash book 103,70

0Sales 128,0

00Discounts allowed

3,950

Purchases contra

1,450

31/5 Bal c/d 500 31/5 Bal c/d 83,600192,7

00192,70

0


Example 5.3 (Exam type question – November 1997 Question 2)

(a) Explain the purposes for which control accounts are prepared. (3 marks)(b) The balances and transactions affecting the control accounts of Kopesha Ltd.

for the month of November 1997 are listed below:-

Sh.Balances on 1 November 1997:Sales ledger 9,123,00

0(debit)

211,000 (credit)Purchases ledger 4,490,00

0(credit)

88,000 (debit)Transactions during November 1997: Purchases on credit 18,135,0

00 Allowances from suppliers 629,000 Receipts from customers by cheques

27,370,000

Sale on credit 36,755,000

Discount received 1,105,000

Payments to creditors by cheques 15,413,000

Contra settlements 3,046,000

Bills of exchange receivable 6,506,000

Allowances to customers 1,720,000

Customers cheques dishonored 489,000 Cash received from credit customers

4,201,000

Refunds to customers for overpayments

53,000

Discounts allowed 732,000Balances on 30 November 1997 Sales ledger 136,000 (credit) Purchases ledger 67,000 (debit)

Required:

The sales ledger and purchases ledger control accounts for the month of November 1997 and show the respective debit and credit closing balances on 30 November 1997.

(17 marks)(Total: 20 marks)

Lesson Five 185

(a)i) Provide for arithmetical check on the postings made in the

individual accounts (either in the sales ledger or purchases ledger.)

ii) To provide for a quick total of the balances to be shown in the trial balance as debtors and creditors.

iii) To detect and prevent errors and frauds in the customers and suppliers account.

iv) To facilitate delegation of duties among the debtors and creditors clerks.


Kopesha Ltd

Sales Ledger Control A/C1997

Sh 1997

Sh

1/11 Bal b/d 9,123,000

1/11 Bal b/d 211,000

Sales 36,755,000

Bank 27,370,000

Dishonored cheques 489,000 Contra 3,046,000Refunds to customers 53,000

Bills of exchange receivable 6,506,000Allowances 720,000Cash 4,201,000Discounts allowed 732,000

30/11

Bal c/d 136,000 30/11

Bal c/d 2,770,000

46,556,000

46,556,000

Purchases Ledger Control A/C1997

Sh 1997

Sh

1/11 Bal b/d 88,000 1/11 Bal b/d 4,490,000Allowances from suppliers 629,000

Purchases 18,135,000

Discounts received

1,105,000

Bank 15,413,000

Contra settlement 3,046,000

30/11

Bal c/d 2,411,000

30/11

Bal c/d 67,000

22,692,000

22,692,000

Example 5.4 (Exam Question – May 2000 Question 4)Poesha Limited keeps sales and purchases control accounts in the General Ledger. The transactions for the month ended 30 April 2000 were as follows:

ShCredit balances on 1 April 2000 -Sales ledger 154,000 -Purchases

ledger569,000

Debit balances on 1 April 2000 -Sales ledger 956,000 -Purchases

ledger196,000

Lesson Five 187

Credit balances on 30 April 2000 -Sales ledger 178,000Debit balances on 30 April 2000 Purchases

ledger189,000

Credit purchases 2,450,000Credit sales 4,563,000Cheques received from debtors 3,140,000Cash received from debtors 1,367,000Cheque payments to creditors 1,994,000Cash payments to creditors 352,000Bad debts written off 68,000Discounts received 104,000Discounts allowed 169,000Contra entry to sales ledger from purchases ledger

234,000

Refunds to debtors 62,000Returns outwards 138,000Returns inwards 231,000

Required: Sales ledger and purchases ledger control accounts for the month ended 30 April 2000.

(20 marks)ERRORS ON ACCOUNTSThere are two types of errors in accounts:

Errors that don’t affect the trial balance Errors that affect the trial balance

Errors that don’t affect the trial balanceThe trial balance produced from the accounts appears to be okay/correct, i.e the debits are the same as the credits. However, on taking a close check on the balances and transactions posted, errors may have been made and therefore the balances shown on the trial balance may be incorrect i.e. under/over stated.There are 6 main types of errors that don’t affect the trial balance and these are explained as follows:

a) Error of omissionHere, a transaction is completely omitted from the accounts and therefore the double entry is not made e.g. a sales invoice of £400 is not posted in the sales journal therefore no entry is made in the debtor’s account and the sales account i.e. both debit of £400 in debtor’s account and credit of £ 400 in the sales account.

The effect of the error is understates both the debtors and the sales.To correct this error, the transaction is posted in the books by:

Debiting debtors £400Crediting sales £400

b) Error of CommissionThis error occurs when a transaction is posted to a wrong account but the account is of the same class. Example: a credit sale to T Thompson is posted to L


Thompson’s account for an amount of £ 200. Instead of a debit to T Thompson’s account it is made to L Thompson’s account and the corresponding credit in the sales account is correct.

Although the debit entry is made into the wrong account, the two accounts are of the same class i.e. debtors.To correct this error a transfer is made from L Thompson’s account to T Thompson by:

£

(i) Debit T Thompson a/c 200(ii) Credit L Thompson a/c 200

c) Error of principleIn this type of error a transaction is posted not only to the wrong account but also of a different class e.g. Motor vehicle purchased for £ 400 is posted to the motor vehicle expenses a/c. (Instead of debiting motor vehicles, we debited motor vehicle expenses a/c and the credit entry in the cashbook is correct)

The motor vehicles account is a non-current asset, and motor vehicles expenses a/c is an expense account. Therefore a capital expenditure has been posted as revenue expenditure.

To correct this error a transfer is made from the motor expenses account to the motor vehicles a/c by:

£(i) Debit Motor vehicles a/c 400

(ii) Credit Motor expenses a/c 400

d) Complete reversal of entriesA transaction is posted to the correct accounts but to the wrong sides of the accounts i.e. a debit is posted as a credit and a credit is posted as a debit. Example: cash drawn from the bank of £150 for business use is posted as a debit in the bank account and credit in cash in hand.

To correct this error, two entries are made in the relevant accounts:(i) Correct the error

(ii) Post the transaction correctly

The entries will therefore be as follows:

(i) Debit Cash in hand by £150Credit bank by £150

To correct the error of £ 150 posted in the wrong sides of these account

(ii) Debit cash by £150Credit bank by £150

Lesson Five 189

To post the entries correctly

e) Error of Original entryHere a transaction is posted to the correct accounts but the amount posted is not correct i.e. it is either under/over stated. In some cases, this is known as a transposition error e.g. cash received from a debtor of £980 is credited/posted to the customer’s account as £890.

To correct this error, the amount understated or overstated is posted to these accounts to reflect the correct balance. In this case, we will:

£Debit cash book 90Credit debtors 90

f) Compensating ErrorsThese are errors that tend to cancel out each other i.e. if the effect of one error is to understate the debits or credits then another error may take place to overstate the debits or credits by the same amount, hence canceling out each other. E.g. if the balance c/d of the purchases a/c is £3,980 but shown in the trial balance as £3,890 and another error carried to the trial balance of fixture amounting to £4,540 instead of £4,450:


£Purchases 3,980

3,890 (90)

£Fixtures 4,450

(4,540) 90

This type of error is corrected by use of a suspense account.

Example 5.5Give the journal entries needed to record the corrections of the following. Narratives are required.

a) Extra capital of £ 10,000 paid into the bank had been credited to Sales account.b) Goods taken for own use £ 700 had been debited to General Expenses.c) Private insurance £ 89 had been debited to Insurance account.d) A purchase of goods from C Kelly £ 857 had been entered in the books as £ 587.e) Cash banked £ 390 had been credited to the bank column and debited to the

cash column in the cashbook.f) Cash drawings of £ 400 had been credited to the bank column of the cashbook.g) Returns inwards £ 168 from M McCarthy had been entered in error in J

Charlton’s account.h) A sale of a motor van £ 1,000 had been credited to Motor Expenses.

Lesson Five 191

Solution THE JOURNAL

Debit Credit Sales 10,000 CapitalAdditional capital passed into sales a/c now transferred to capital a/c

10,000

Drawings 700 General expensesDrawings debited in general expense now transferred to drawing a/c

700

Drawings 89 Insurance 89Private insurance transferred from insurance a/c to drawings a/c Purchases 270 C Kelly 270Purchases and creditors amount to 857 initially entered as £587 Bank 390 Cash 390Correct error in posting Bank 390 CashTo post the cash banked correctly

390

Bank 400 Cash 400Cash drawings correctly started from bank to cash J Charlton 168 M McCarthyReturns in from McCarthy entered in error in J Carlton now transferred to his a/c Motor expenses Motor disposal a/cTo correct error in recording sales proceeds In expense account

1000168

1000

Example 5.6 (Exam type question – May 200 Question 2)

The balance sheet of N Patel, a sole trader, as at 31 March 2000 was as follows:


Sh’000 Sh’000 Sh’000 Sh’000

Capital 1 April 1999 1,890 Land and buildings (at valuation)

1,650

Profit for the year ended 31 March 2000

450Machinery (at cost)

1,200

Deduct: drawings 150 300 Deduct: depreciation

750 450

Creditors 630 Stock at cost 570Bank overdraft 270 Debtors 420 990

3,090 3,090

Further investigation reveals the following information:

1. The closing stock includes damaged goods which, although they had cost Sh. 10,000 have an estimated sale value of Sh.7, 500.

2. Debtors include Sh. 20,000 in respect of a customer who has gone bankrupt. A provision for doubtful debts of 2 ½% is also required on the balance of the debtors.

3. The machinery was acquired five years ago and is being depreciated to its scrap value on a straight-line basis over eight years. A more realistic estimate indicates that the life span will be 10 years.

4. Wages owing at 31 March 2000 amounted to Sh. 9,500 but this has not been reflected in the accounts.

5. Charges for the bank overdraft, amounting Sh 8,000 have not been reflected in the accounts.

6. In arriving at the profit for the period, a drawing of Sh 100,000 paid to Mr. Patel had been deducted as an expense.

7. Sh 20,000 rent owing to Mr. Patel for the letting of part of his business premises to external party had not been received and no entry had been made in the books in respect of this item.

Required:a) Journal entries to correct errors and omissions. (10

marks)b) A statement of revised profit for the year ended 31 March 2000. (8

marks)c) A revised balance sheet as at 31 March 2000. (7


Lesson Five 193

Solution

a) THE JOURNALDebit Credit

Trading account 2,500 Stock Being a reduction in stock for damaged goods

2,500

Profit and loss(Bad debts) 20,000 DebtorsDebtors gone bankrupt written off

20,000

Profit and loss) 10,000 Provision for doubtful debtsBeing a provision for doubtful debts created at 20%.

10,000

Provision for depreciation 150,000 Profit and lossA change in estimated lifespan for machinery

150,000

Profit and loss( wages ) 9,500 Accrued expensesWages owing omitted in the accounts

9,500

Profit and loss (Bank overdraft charges)

8,000

Bank overdraftChanges for overdraft not reflected in the accounts.

8,000

Drawings 100,000 Profit and lossDrawing to Mr. Patel deducted as an expense.

100,000


Accrued income 20,000 Profit and loss (rent income)Rent receivable owing not reflected in the accounts.

20,000

b) STATEMENT OF ADJUSTED NET PROFIT Sh Sh

Net profit as per the account 450,000Add: Provision for depreciation 50,000 Drawings 100,000 Accrued income (rent) 20,000 170,000

620,000Less: Stock reduction 2,500 Bad debts 20,000 Provision for doubtful debts

10,000

Accrued expenses 9,500 Bank charges 8,000 (50,000)Net profit (revised) 570,000

REVISED BALANCE SHEET AS AT 31 MARCH 2000Sh Sh Sh

Land and buildings 1,650,000 - 1,650,000Machinery 1,200,000 (700,000) 500,000

2,850,000 700,000 2,150,000Add: Current Assets Stock 567,500 Debtors 400,00Less: Provision for doubtful debts

(10,000) 390,000

Accrued rent income 20,000977,500

Less Current liabilities Creditors 630,000 Accrued wage expense 9,500 Bank overdraft 278,000 (917,500) 60,000

2,210,000Capital 1,890,000Add Net Profit 570,000

Lesson Five 195

2,460,000Less drawings (250,000)

2,210,000

Errors That Affect The Trial Balance And The Suspense AccountThese types of errors are reflected on the trial balance because the debits will not be same as the credits. The debits may be more than the credits and vice versa.Examples include:

1. Transaction is posted on one side of the accounts i.e. only a debit entry or a credit entry. Example cash received from a debtor is debited to the cashbook and no other entry is made in the account, i.e. no credit entry on the debtor’s a/c.

2. A transaction is posted on one side of both the accounts i.e. two debits or two credits. Example a payment to a creditor of £ 300 is credited in the cashbook and also credited in the creditor’s accounts.

3. A transaction is posted correctly but different amounts i.e. debit is not the same as the credit. Example – cash received from a debtor of £ 450 is debited in the cashbook as £ 450 and credited as £ 540 in the debtor’s a/c.

4. Error on balances of accounts – i.e. understatement or overstatement of an account balance due to mathematical errors.

5. Balance on an account is shown on the wrong side of the account when opening the ledger accounts or when taken up to the trial balance. Example Bal c/d in the cash book for cash at bank of £ 2000 is shown as a credit i.e. an overdraft, instead of a debit in the trial balance. The balance may also be brought down as an overdraft instead of a debit balance in the trial balance.

6. A balance is omitted from the trial balance on the accounts in total.

To correct the above errors, the appropriate or the adjusting entries are made through an account called a suspense account.The difference in the accounts is posted to this account and the entries to correct the accounts are posted here. The balance to be shown on the suspense accounts depends on which side the error is shown on the trial balance.

If the debits credits, then an amount is included on the credit side of the trial balance so that the debits = credits. This is a credit balance and will be taken to the suspense account on the credit side.

Example:DR CR

Total 240 200Suspense - 40

240 240

Suspense a/c

£ £Difference as per T/B 40


If the credits are more than the debits this is a debit balance and therefore we require an amount to be added to the total of the debits for the two side to be same. This debit balance is posted to the debit side of the suspense a/c.

DR CRTotal 260 300Suspense 40 -

300 300

Suspense a/c£ £

Difference as per T/B

40

Posting the correct entries should eliminate the balance on the suspense account.

In some cases, after checking for all errors that can affect the trial balance, the suspense a/c has a balance. This balance depends on whether it is a credit or debit and whether it is material or not for purposes of proper accounting treatment. The following is the recommended approach:

Balance Material Not MaterialDebit Show as an asset (eg)

other debtorsCharge in P& L as an expense

Credit Show as a liability (eg) other creditors

Report as income in P&L

Example 5.7A bookkeeper extracted a trial balance on 31 December 2002 that failed to agree by £3,300, a shortage on the credit side of the trial balance. A suspense account was opened for the difference.In January 2003 the following errors made in 2003 were found:

(i) Sales daybook had been undercast by £1,000.(ii) Sales of £2,500 to J Church had been debited in error to J Chane account.

(iii) Rent account had been undercast by £700.(iv) Discounts received account had been under cast by £3,000.(v) The sale of a motor vehicle at book value had been credited in error to Sales

account £3,600.You are required to:

a) Show the journal entries necessary to correct the errors.b) Draw up the suspense account after the errors described have been

corrected.c) If the net profit had previously been calculated at£79,000 for the year ended

31 December 2002, show the calculations of the corrected net profit

Solution THE JOURNAL

Lesson Five 197

£ £Suspense 1,000SalesSales under cast of £100 now corrected

,1000

J Church 2,500 J ChaneSale to J Church posted to J Chane corrected

2,500

Rent 700 SuspenseUnder cast in rent balance now corrected

700

Suspense 3,000 Discount receivedUnder cast in discount received balance now corrected

3,000

Sales a/c 3,600 Disposal ,3600Sale of motor vehicle entered in sales a/c now corrected

Suspense a/c£ £

Sales 1,000 Bal b/d 3,300Discount received 3,000 Rent 700

4,000 4,000

STATEMENT OF CORRECTED NET PROFIT£ £

Net profit as per account

79,000

Add: Sales 1,000 Discount received 3,000 4,000Less: Rent 700 Sales 3,600 (4,300)Corrected net profit 78,700

Example 5.8Chi Knitwear Ltd is an old fashioned firm with a handwritten set of books. A trial balance is extracted at the end of each month, and a profit and loss account and balance sheet are computed. This month, however, the trial balance did not balance, the credits exceeding debits by £1,536.


Your are asked to help and after inspection of the ledgers discover the following errors:

(i) A balance of £87 on a debtor’s account has been omitted from the schedule of debtors, the total of which was entered as debtors in the trial balance.

(ii) A small piece of machinery purchased for £1,200 had been written off to repairs.

(iii) The recipiets’ side of the cashbook had been under cast by £720.(iv) The total of one page of the sales daybook had been carried forward as

£8,154, whereas the correct amount was £8,514.(v) A credit note for £179 received from a supplier had been posted to the

wrong side of his account.(vi) An electricity bill in the sum of £152, not yet accrued for, is discovered in a

filing tray.(vii) Mr. Smith, whose past debts to the company had been the subject of a

provision, at last paid £731 to clear his account. His personal account has been credited but the cheque has not yet passed through the cashbook.

Solution Suspense a/c

£ £Opening balance 1,536.0

0Debtors 87.00

Sales - under record

360.00 Cashbook under cast 720.00

Creditors error 179.00Creditors (correct) 179.00Cashbook: smiths debt paid

731.00

1,896.00

1,896.00

i. Increase total for debtors by 87.ii. Add 1,200 to fixed assets and reduce repair costs by 1,200 therefore an in-crease in profits.iii. Increase sales by 360.iv. Reduce the creditors by 358.v. accruals by 152 and reduce profits by the same.vi. Increase the cash balance by 731.

Lesson Five 199

Example 5.9 (Exam type question – May 2002 question 1).On 31 December 2001, an inexperienced bookkeeper working for Wanji, a sole trader extracted a trial balance. Due to errors committed by the bookkeeper, the trial balance failed to balance by Sh 369,400. He placed the difference in a suspense account as shown below:

Wanji trial balance as at 31 December 2001Sh Sh

Fixed assets – cost 832,000Stocks: 1 January 2001 148,000 31 December 2001

98,800

Trade debtors 76,000Prepayments 10,000Trade creditors 34,600Bank overdraft 15,200Accruals 16,000Drawings 359,600Capital 1,054,000Sales 1,043,200Provision for depreciation

166,400

Purchases 733,000Operating expenses 126,000Provision for doubtful debts

3,800

Discounts received 5,000Discounts allowed 5,800Suspense account ________ 369,400

2,548,400 2,548,400

Investigations carried out after preparing the above trial balance detected the following errors:

1. The total of the sales daybook for December 2001 was overcast by Sh 25,700.2. On July 2001, the business purchased office equipment for Sh 40,000. These

were debited to purchases account. Depreciation on the equipment is at the rate of 10% per annum on cost and based on the period (months) of usage in the year.

3. A payment to a creditor by cheque of Sh. 8,500 was erroneously credited to the creditor’s account.

4. A payment of Sh. 4,500 for telephone expenses was debited to telephone account as Sh 5,400.

5. An amount of Sh 15,000 received from a debtor was not posted to the debtor’s account from the cashbook.

6. Purchases daybook for October 2001 was under cast by Sh 28,000.


Assume the business had reported a net profit of Sh 85,800 before adjusting for the above errors.Required:(a) The adjusted trial balance and the correct balance of the suspense account.

(6 marks)(b) Journal entries to correct the errors (Narrations not required)

(6 marks)(c) Suspense account starting with the balance determined in the adjusted trial

balance in (a) above. (4 marks)

(d) The adjusted net profit for the year. (4 marks)

Solution:Adjusted Trial Balance

Sh ShFixed assets – cost 832,000Stock - 1 January 2001 148,000Trade debtors 76,000Prepayments 10,000Trade creditors 34,600Bank overdraft 15,200Accruals 16,000Drawings 359,600Capital 1,054,000Sales 1,043,200Provision for depreciation

166,400

Purchases 733,000Operating expenses 126,000Provision for doubtful debts

3,800

Discounts received 5,000Discounts allowed 5,800Suspense account 47,800 _______

2,338,200 2,338,200

THE JOURNALDr Cr

Sales 25,700Suspense 25,700

Office equipment 40,000Purchases 40,000

Provision for depreciation 2,000Profit and loss 2,000

Lesson Five 201

Creditors 8,500Suspense 8,500Creditors 8,500Suspense 8,500

Suspense 900Telephone 900

Suspense 15,000Debtor 15,000

Suspense 2,500Discounts allowed 2,500

Suspense 2,500Discounts received 2,500

Purchases 28,000Suspense 28,000

SUSPENSE ACCOUNT2001 Sh 2001 Sh1 Jan Bal b/d 47,800 1 Jan Sales 25,700

Telephone 900 Creditors 8,500Debtors 15,000 Creditors 8,500Discount allowed

2,500 Purchases 28,000

Discount received

2,500

Bal c/d 2,000 ______70,700 70,700

STATEMENT OF ADJUSTED NET PROFIT

Sh ShNet profit as per the accounts 85,800AddPurchases 40,000Telephone expenses 900Discount allowed + received 5,000 45,900

131,700LessSales 25,700Depreciation 2,000Purchases 28,000 (55,700)Corrected Net Profit 76,000

c) STOCK VALUATION (IAS 2 INVENTORIES)


inventories in a firm includes:

(a) Finished goods (assets held for sale)(b) Work in progress (assets still in production for purposes of sale)(c) Raw materials (to be used in production process).

The cost of inventories should include all costs of purchase. (Purchase price and other taxes like import duties), costs of conversion (e.g. direct labour) and other costs incurred in bringing the inventories into their present location and condition (carriage inwards).Inventories or stock is a sensitive area, as it does not form part of the double entry. In most cases either carrying out stocktaking or checking the stock records that the firm is kept determines the value of stock at the end of the financial period. Stocktaking involves counting the number of units of finished goods, work in progress or raw materials available or in the stores/warehouse/saleroom.The value of stock to the final accounts is then derived by multiplying the cost per unit to the total number of units available.

Example.A firm has three products A, B and C whose costs are shs.200, shs.300 and shs.400 each respectively. At the end of year 2002, stocktaking was carried out and the following units were available:

Product A 200,000 units Product B 20,000 units Product C 30,000 units

Lesson Five 203

Required:Compute the cost of stock to be included in the final accounts.

Solution: (200,000 x 200) + (20,000 x300) + (30,000 x 400) = shs.58, 000,000

Cost Formular:The cost of the different units of stock that a firm has should be assigned to each unit as far as the business can be able to identify each item.For those units that the business cannot identify the specific cost due to the number of transactions and changes in the cost price, IAS 2 on inventories recommends the use of the following estimates:

(i) First In First Out (FIFO)The business assumes that items of stocks that were purchased first are sold first and therefore, items left as part of closing stock were purchased recently.(ii) Weighted Average Cost (AVCO)Under this method, the cost of each item is determined from the weighted average of the cost of similar items at the beginning of the period and the cost of similar items purchased during the period.

(iii) Last In First Out (LIFO)This method assumes that items of stock which were purchased last are sold first and therefore, the closing stock shows items that were bought first.

Net Realizable Value (SP- Expenses)This is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.In some cases, the value of stock may decline where below the cost price (either actual or estimated under the different methods) and if the firm was to sell the stock, then it will fetch an amount below this cost.IAS 2 requires that closing stock should be stated at the lower of cost or net realizable value.

Example: A firm has a closing stock of Sh 300,000 (cost) out of which stock valued Sh 20,000 is damaged. This stock can fetch the firm Sh 22,000 after repairs and packaging that will cost Sh 4,000.

Required: What value will be attached on this damaged units and the total closing stock for the final accounts purposes.

ShCost 20,000Selling price 22,000Repairs 4,000NRV (22-4) 18,000


The NRV (22,000 – 4,000) is lower than the cost of Sh. 20,000 and therefore, this damaged unit will be shown as Sh 18,000. The balance of the stock of Sh 280,000 + 18,000 of the damaged stock will be included in the final accounts and shown together as Sh 298,000.

Lesson Five 205

d) WORKSHEETSA work sheet is a simple report that shows the final accounts inclusive of the trial balance in column form. A work sheet has 8-10 columns and the simple headings are as follows:

TRIAL BALANCE

ADJUSTMENT

TRADING ACCOUNT

PROFIT & LOSS ACCOUNT

BALANCE SHEET

Dr Cr

Dr Cr

Dr Cr

Dr Cr

Assets Liabilities + Capital

£ £

£ £

£ £

£ £

£ £

Example 5.10Mr Chai has been trading for some years as a wine merchant. The following list of balances has been extracted from his ledger as at 30 April 19X7, the end of his most recent financial year.

£Capital 83,887Sales 259,870Trade creditors 19,840Returns out 13,407Provision for bad debts 512Discounts allowed 2,306Discounts received 1,750Purchases 135,680Returns inwards 5,624Carriage outwards 4,562Drawings 18,440Carriage inwards 11,830Rent, rates and insurance 25,973Heating and lighting 11,010Postage, stationery and telephone 2,410Advertising 5,980Salaries and wages 38,521Bad debts 2,008Cash in hand 534Cash at bank 4,440Stock as at 1 May 19x6 15,654Trade debtors 24,500Fixtures and fittings – at cost 120,740Provision for depreciation on fixtures and fittings – as at 30 April 19X7 63,020Depreciation 12,074

The following additional information as at 30 April 19X7 is available:


(a) Stock at the close of business was valued at £17,750.(b) Insurances have been prepaid by £1,120.(c) Heating and lighting is accrued by £1,360.(d) Rates have been prepaid by £5,435.(e) The provision for bad debts is to be adjusted so that it is 3% of trade

debtors.

Required:MR CHAI Trial Balance Adjustments Trading

accountProfit & loss a/c

Balance sheet

WORKSHEET

£ £ £ £ £ £ £ £ £ £

Dr Cr Dr Cr Dr Cr Dr Cr Dr CrCapital 83,887 83,8

87Sales 259,87

0259,8

70Trade creditors

19,840 19,840

Returns outwards

13,407 13,407

Provision for B debts

512 223 735

Discounts allowed

2,306

2,306

Discounts received

1,750 1,750

Purchases 135,680

135,680

Returns Inwards

5,624 5,624

Carriage outwards

4,562 4,562

Drawings 18,440 18,440

Carriage inwards

11,830 11,830

Rent, rates & insurance

25,973 6,555

19,418

Heating & lighting

11,010 1,360 12,370

Postage, stationery and telephone

2,410 2,410

Advertising 5,980 5,980Salaries and wages

38,521 38,521

Bad debts 2,008 2,008Cash in hand 534 534

Lesson Five 207

Cash at bank 4,440 4,440Stock at 1 May 19X6

15,654 15,654

Trade debtors

24,500 24,500

Fixtures & fittings at cost

120,740

120,740

Provision for depreciation

63,020 63,020

Depreciation 12,074 12,074

442,286

442,286

Stocks 30.04.19X7 – asset

17,750

17,750

Stocks 30.04.19X7 – Cost of Sales

17,750

17,750

Insurance prepaid

1,120 1,120

Heating and lighting accrued

1,360

1,360

Rates prepaid

5,435 5,435

Provision for bad debts

223 223

25,888

25,888

Gross profit (Balancing figure)

122,239

122,239

291,027

291,027

Net profit (Balancing figure)

24,117

24,117

123,989

123,989

192,959

192,959

Prepare a worksheet for the year to 30 April 19X7SolutionThis marks the end of the session on preparing final accounts with adjustments. In the next session we shall prepare the final accounts incorporating these adjustments. Some adjustments will affect the format of final accounts and therefore they will look as follows:


FORMAT OF FINAL ACCOUNTS WITH ADJUSTMENTS

NAMETRADING, PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DEC …

£ £ £Sales XXLess Returns inwards

(XX)

XXLess cost of salesOpening stock

XX

Purchases XXAdd carriage in

XX

XXLess Returns out

(XX)

XX

XXLess closing stock

(XX) (XX)

Gross profit

XX

Discount received

XX

Other incomes (rent, interests, dividends)

XX

Profit on disposal of non-current assets

XX

Reduction in provision for doubtful debts

XX

Reduction XX

Lesson Five 209

in provision for discount allowableInterest on overdue debtors balances

XX

XXLess ExpensesBad debts XXDepreciation: (eg) Plant

XX

Motor vehicle

XX

Increase in provision for doubtful debts

XX

Increase in provision for discount allowable

XX

Loss on disposal of non current assets

XX

Loss of other assets (eg) stock

XX

Interest charged by creditors

XX

Other expenses: Rent

XX

Insurance XXPostage XX


Interest on loan etc

XX (XX)

NET PROFIT

XX

BALANCE SHEET AS AT 31 DEC…….

Non current assets

£ £ £

Land XX - XXBuildings XX (XX) XXPlant and machinery

XX (XX) XX

Fixtures, furniture and fittings

XX (XX) XX

Motor vehicle XX (XX) XX

XX XX XXCurrent assets

Stock XXDebtors XXLess provision for doubtful debts

(XX) XX

Accrued income XX

Prepaid expenses XX

Cash at bank XX

Cash in hand XX

Lesson Five 211

Current liabilitiesBank overdraft XX

Trade creditors XX

Prepaid income XX (XX)

Net current assets

XX

Net assets XX

Capital XXAdd net profit X

XXX

Less drawings (XX)

XXNon current liabilities

Loan XX


Loan XX


Loan XX


Loan XX

XX


Non current liabilities XX

Loan

Example 5.11Given the question 5.10, the final accounts for the year ended 30 April 19X2 will be as follows:Mr ChaiTrading and Profit and Loss Account for year ended 30 April 19X7

£ £

£

Sales 259,870

Less Returns inwards

(5,624)

254,246

Less cost of salesOpening stock

15,654

Purchases

135,680

Add carriage in

147,510Less Returns out

(13,407) 134,103

Cost of goods available for sale

149,757

Less closing stock

(17,750) (132,007)

Gross profit

122,239

Add: Discount received

1,750

123,9

Lesson Five 213

89Less ExpensesDiscount allowed

2,306

Carriage outwards

4,562

Rent, rates and insurance

19,418

Heating and lighting

12,370

Postage, stationery and telephone

2,410

Advertising

5,980

Salaries and Wages

38,521

Bad debts

2,008

Provision for bad debts

223

Provision for depreciation – fixtures and fitting

12,074 99,872

Net profit

24,117

Mr ChaiBalance Sheet as at 30 April 19X7


Non current asset

£ £ £

Fixtures and fittings

120,740

(63,020) 57,720

Current assetsStock 17,750Debtors 24,50

0Less provision for doubtful debts

(735) 23,765

Prepayments

6,555

Cash at bank

4,440

Cash in hand

534

53,044Current liabilitiesCreditors 19,84

0Accruals 1,360 (21,200) 31,844

89,564Capital 83,887Add net profit

24,117

108,004Less drawings

(18,440)

89,564

Example 5.12The following trial balance has been extracted from the ledger of Mr. Yousef, a sole trader.Mr. YousefTrading and Profit and Loss Account for the year ended 31 May 19X6.

£ £Sales 138,078Purchases 82,350Carriage 5,144Drawings 7,800

Lesson Five 215

Rent, rates and insurance 6,622Postage and stationery 3,001Advertising 1,330Salaries and wages 26,420Bad debts 877Provision for bad debts 130Debtors 12,120Creditors 6,471Cash in hand 177Cash at bank 1,002Stock at at 1 June 19X5 11,927EquipmentAt cost 58,000Accumulated depreciation 19,000Capital ______ 53,091

216,770 216,770

The following additional information as at 31 May 19X6 is available:(a) Rent is accrued by £210.(b) Rates have been prepaid by £880.(c) £2,211 of carriage represents carriage inwards on purchases.(d) Equipment is to be depreciated at 15% per annum using the straight line

method.(e) The provision for bad debts to be increased by£40.(f) Stock at the close of business has been valued at £13,551.

Required:Prepare a trading and profit and loss account for the year ended 31 May 19X6 and a balance sheet as at that date.Solution:


Mr. YousefTrading and Profit and Loss Account for the year ended 31 May 19X6.

£ £ £Sales 138,078Less cost of salesOpening stock 11,927Purchases 82,350Carriage inwards 2,211 84,561

96,488Less closing stock (13,551

)(82,937

Gross profit 55,141Less expensesCarriage outwards 2,933Rent, rates and insurance 5,952Postage and stationery 3,001Advertising 1,330Salaries and wages 26,420Bad debts 877Increase in provision for bad debts

40

Depreciation – equipment 8,700 (49,253Net profit 5,888

Mr. YousefBalance Sheet as at 31 May 19X6.

£ £ £Non Current assetsEquipment 58,000 (27,700) 30,300Current AssetsStocks 13,551Debtors 12,120Less provision for doubtful debts

(170) 11,950

Prepayments 880Cash in hand 177Cash at bank 1,002Current Liabilities 27,560Creditors 6,471Accruals 210 6,681 20,879

51,179

Capital 53,091Add: Net Profit 5,888

58,979Less Drawings (7,800)

Lesson Five 217

51,179


Example 5.13The following trial balance has been extracted from the ledger of Herbert Howell, a sole trader, as at 31 May 20X9, the end of his most recent financial year.

Herbert HowellTrial Balance As At 31 May 20x9

Dr Cr£ £

Property at cost 90,000Equipment at cost 57,500Provision for depreciation (as at 1 June 20X8)Property 12,500Equipment 32,500Stock as at 1 June 20X8 27,400Purchases 259,600Sales 405,000Discounts allowed 3,370Discounts received 4,420Wages and salaries 52,360Bad debts 1,720Loan interest 1,560Carriage out 5,310Other operating expenses 38,800Trade debtors 46,200Trade creditors 33,600Provision for bad debts 280Cash on hand 151Bank overdraft 14,500Drawings 28,93013% loan 12,000Capital, as at 1 June 20X8 ______ 98,101

612,901 612,901

The following additional information as at 31 May 20X9 is available:(a) Stock as at the close of business was valued at £25,900.(b) Depreciation for the year ended 31 May 20X9 has yet to be provided as follows:

Property - 1% using the straight-line methodEquipment -15% using the straight-line method

(c) Wages and salaries are accrued by £140.(d) Other operating expenses include certain expenses prepaid by £500. Other

expenses included under this heading are accrued by £200.(e) The provision for bad debts is to be adjusted so that it is 0.5% of trade debtors

as at 31 May 20X9.(f) Purchases include goods valued at £1,040, which were withdrawn by Mr

Howell for his own personal use.

Required:

Lesson Five 219

Prepare Mr. Howell’s trading and profit and loss account for the year ended 31 May 20X9 and his balance sheet as at 31 May 20X9.

(20 marks)

Solution:£ £

Sales 405,000Less cost of salesOpening stock 27,400Purchases 258,560

285,960Less closing stock (25,900) (260,060)Gross profit 144,940Discounts received 4,420Decrease in provision for bad debts

____49

149,409Less expensesDepreciation: Property 900 Equipment 8,625 Discounts allowed

3,370

Wages and salaries

52,500

Bad debts 1,720 Loan interest 1,560 Carriage out 5,310 Other operating expenses

38,500 (112,485)

NET PROFIT 86,924

Herbert HowellBalance Sheet as at 31 May 2000

£ £ £Non current AssetsProperty 90,000 (13,400) 76,600Equipment 57,500 (41,125) 16,375

147,500

54,525 92,975

Current AssetsStock 25,900Debtor 46,200Less provision (231) 45,969Prepayments 500Cash in hand 151

72,520Current liabilitiesBank overdraft 14,500


Creditors 33,600Accruals __340 (48,440)

24,080117,055

Capital 98,101Add net profit 36,924

135,025Less drawings (29,975)

105,055Non current liabilitiesLoan (13%) 12,000

117,055

Workings:1) Depreciation for:

Property 1% X 90,000 = 900Equipment 15% X 57,500 = 8,625

2) Provision for bad debts0.5% X (46,200) =231

Decrease in provision for bad debts280 – 231= 49

3) Wages and salariesPaid 52,360Accruals 140

52,5004) Other operating expenses

Paid 8,800Pre-paid (500)

8,300 Accruals 200

8,500

5) Purchases: 259,600 – 1,040 = 258,560Drawings: 28,930 + 1,040 = 29,990

Lesson Five 221


QUESTION ONEDavid Dolgellau, a sole trader has prepared the following balance as at 31 March 2001

£

SalesDiscount ReceivedRent Received Returns outwardsCreditorsBank OverdraftCapitalPurchasesSalaries and WagesOffice expensesInsurance premiumsElectricityStationeryAdvertisingTelephoneBusiness RatesDiscounts allowedReturns InwardsStocks as at 1 April 2000Warehouse, shop and officeFixtures and fittingsDebtorsCash in tillDrawings

378,500.002,400.007,500.007,700.0018,700.0030,000.00287,500.00261,700.0045,700.008,400.003,100.001,600.006,200.008,400.002,100.007,500.00600.004,100.00120,600.00210,000.0012,800.0013,000.00500.0026,000.00

The following further information was obtained:

Closing stock was £ 102,500.00 Electricity charges accrued £ 700.00 Advertising expenses accrued £ 500.00 Insurance premiums paid in advance £ 900.00 Business rates prepaid £ 1,500.00

Required:Prepare a trial balance, trading, profit and loss account for the year ended 31 March 2001 and balance sheet as at that date.


QUESTION TWODonald Brown, a sole trader, extracted the following trial balance on 31 December 20X0.

TRIAL BALANCE AS AT 31 DECEMBER 20X0Debit Credit

Capital at 1 January 20X0DebtorsCash In HandCreditorsFixtures and fittings at costDiscounts allowedDiscounts receivedStock at 1 January 20X0SalesPurchasesMotor Vehicles at costLightning and heatingMotor expensesRentGeneral expensesBalance at bankProvision for depreciation

Fixtures and fitting

Motor vehiclesDrawings

£

42,7371,411

42,2001,304

18,460

387,93645,730

6,1842,8628,8417,413

_26,568591,646

£26,094

35,404

1,175

491,620

19,861

2,20015,292_______

591,646

The following information as at 31 December is also available:

a) £218 is owing for motor expenses.b) £680 has been prepaid for rent.c) Depreciation is to be provided of the year as follows:

Motor vehicles: 20% on costFixtures and fittings: 10% reducing balance method

d) Stock at the close of business was valued at £19,926.

Required

Prepare Donald Brown’s trading and profit and loss account for the year ended 31 December 20X0 and his balance sheet at that date.

Lesson Five 223

QUESTION THREEThe following trial balance has been extracted from the accounts of Brenda Bailey, a sole trader.

Brenda BaileyTrial Balance As At 30 June 20x9

Dr Cr

SalesPurchasesCarriage inwardsCarriage outwardsWages and salariesRent and ratesHeat and lightStock at 1 July 20X8DrawingsEquipment at costMotor vehicles at costProvision for depreciation:

EquipmentMotor vehicles

DebtorsCreditorsBankSundry expensesCashCapital

£

302,41947682964,21012,4664,75715,31021,600102,00043,270

50,633

8,426477______626,873

£427,726

22,2508,920

41,7923,295

122,890626,873

The following information as at 30 June 20X9 is also available.

a) £350 is owing for heat and light.b) £620 has been prepaid for rent and rates.c) Depreciation is to be provided for the year as follows:

Equipment - 10% on costMotor vehicles - 20% on cost

d) Stock at the close of business was valued at £16,480

Required Prepare Brenda Bailey’s trading and profit and loss account for the year ended 30June 20X9 and her balance sheet at that date.


QUESTION FOUROn 10 January 19X9, Frank Mercer received his monthly bank statement for December 19X9. The statement showed the following.

MIDWEST BANK

F Mercer: Statement of AccountDate19X8Dec 1Dec 5Dec 5Dec 5Dec 8Dec 10Dec 11Dec 14Dec 20Dec 20Dec 21Dec 21Dec 24Dec 27Dec 28Dec 29Dec 29Dec 31

Particulars

Balance417864DividendBank Giro Credit417866417867Sundry CreditStanding Order 417865Bank Giro Credit417868416870Bank chargesBank Giro CreditDirect Debit417873Bank Giro Credit417871

Debits$

243

17417

32307

9516118

8812

25

Credits$

26212

185

118

47

279

Balance$1,8621,6191,6451,8571,6831,6661,8511,8191,5121,6301,5351,3741,3561,4031,3151,3031,5821,557

Lesson Five 225

His cashbook for the corresponding period was as follows.

CASH BOOK19x8

Dec 1 Balance b/d

$

1,862

19x8

Dec 1 Electricity

Cheque No

864

$

243

Dec 4 J Shannon

212 Dec 2 P Simpson

865 307

Dec 9 M Lipton 185 Dec 5 D Underhill

866 174

Dec 19 G Hurst 118 Dec 6 A Young 867 17Dec 26 M Evans 47 Dec 10 T Unwin 868 95Dec 27 J Smith 279 Dec 14 B Oliver 869 71Dec 29 V Owen 98 Dec 16 Rent 870 161Dec 30 K

Walters 134 Dec 20 M Peters 871 25

Dec 21 L Philips 872 37Dec 22 W

Hamilton873 12

_____

2,935

Dec 31 Balance c/d

1,7932,935

Requireda) Bring the cash book balance of $1,793 up to date as at 31 December 19X8.

(10 marks)b) Draw up a bank reconciliation statement as at 31 December 19X8 (5 marks)


Acknowledgement 226

LESSON SIX

OTHER ASPECTS OF FINAL ACCOUNTS

(a)INCOMPLETE RECORDSAn incomplete record situation is whereby, the accounting system falls short of the double entry. This may be due to:

Lack of records at all; or Insufficient records that will facilitate the preparation of final accounts.

Reasons for incomplete records:a) Managers or owners may not have the skills or expertise in preparing and

maintaining an accounting system (records and procedures).b) It may not be economical for the business to maintain accounting records

due to the volume or/and nature of transactions (small scale businesses)c) Records are destroyed (e.g. through fire), stolen or misplaced.

There are 4 main approaches in preparing final accounts where there are insufficient records.

a) Estimating income from the net assets.b) Estimating income from the use of ratios.c) Use of a simple cashbook and bank statement.d) Use of control accounts.

N/B: approach number c and d are normally used together.

(a) Estimating Income from the Net AssetsWhere the available records are so deficient (i.e. it is impossible to compile a reasonable complete cash summary, the only method of estimating the profits or loss for the period, is to prepare statement of affairs showing the net worth of the business at the beginning and at the end of the period.

The profit/loss is estimated by use of the following formulas:

Profit or loss = Closing – Opening + Drawings – Additional Capital Capital Capital

Or where there are no non current liabilities then this optional formula can be used


Lesson Six 227

Profit or loss = Closing - Opening + Drawings - Additional Net Asset Net Asset Capital

228 Other Aspects of Final Accounts

Example: 6.1A sole trader’s capital position is as follows:

31 December

19X2 19X3£ £

Motor vehicle: Cost 7,500 7,500 Depreciation 3,000 4,500

4,500 3,000Stock 2,960 3,450Debtors 1,150 2,060Bank 925 2,125Cash __263 ___54

9,798 10,689Creditors 2,860 3,340Net assets 6,938 7,349

He has estimated his drawings for 19X3 at £12,500. Estimate his net profit for the year.

Solution:Net profit = Closing - Opening + Drawings - Additional

Net Asset Net Asset Net assets

= 7,349 – 6,938 + 12,500

= £12,911

(b) Use of RatiosThere are 3 important ratios to be looked at:

1) Gross profit margin2) Mark up3) Stock turnover

If a firm has a uniform Gross Profit for all the items sold then any information available on sales or purchases can be used to derive the total Gross Profit for the period and incase there is sufficient information on expenses, then the Net Profit can also be derived.

The above ratios are computed as follows:

1) Gross Profit Margin = Gross Profit x 100 Sales (selling price)

E.g. If the selling price of a unit is £100 and Gross Profit made per unit is £25, the Gross Profit Margin will be:

= 25 x 100 100

Lesson Six 229

= 25%


If a firm sells 1,000 units in a financial period, then the Gross Profit will be:

= 25% (£100,000)

= £25,000

2) Mark up

= Gross Profit x 100 Cost of Sales (cost price per unit)

In the above example, the mark up will be:

= 25 x 100 75

= 33.33%

N/B: 75 = 100 – 25Cost = selling price – gross profit

3) Stock Turnover

Measures the rate at which a firm uses its stocks to make sales or turnover.

The formula is: = Cost of Sales Average Stocks expressed as number of times

Average stock = Opening Stock + Closing Stock 2

Example: A firm has the following data for the period:

Opening stock £ 20,000Purchases £300,000Closing stock £ 30,000

Required: The Stock Turnover Ratio.

Average Stock = 30,000 + 20,0002

= 25,000

Cost of sales= (20,000 + 300,000) – 30,000= 290,000

Stock Turnover = 300,000 25,000

Lesson Six 231

= 11.6 times

Example 6.2M Jones gives you the following information as at 30 June 2002

£Stock 1 July 2001 6,000Purchases 54,000

Jones’s mark-up is 50% on cost of goods sold. His average stock during the year was £12,000. Draw up a trading and profit and loss account for the year ended 30 June 2002.

a) Calculate the closing stock as at 30 June 19X7.b) State the total amount of profit and loss expenditure Jones must not exceed

if he is to maintain a net profit on sales of 10%.

Solution

a) Average Stock = Opening Stock + closing stock 2

12,000 = 6,000 + C 2

C = 24,000 – 6,000

= 18,000

Gross profit = 50%

Cost of Sales = 42,000

Gross Profit = 50% 42,000

Gross Profit = 21,000.

MEMORANDUM TRADING ACCOUNT£

Sales 63,000Less cost of sales (42,000)Gross profit 21,000Expenses (14,700)Net profit 6,300

Example 6.3W White’s business has a rate of turnover of 7 times. Average stock is £12,600. Trade discount (i.e. margin allowed) is 33¼% off all selling prices. Expenses are 66 ¾% of gross profit.

You are to calculate:(a) Cost of goods sold.


(b) Gross profit margin.(c) Turnover.(d) Total expenses.(e) Net profit.

Lesson Six 233

Solution:Profit schedule

£Turnover 132,300Cost of goods sold 88,200Gross profit 44,100Expenses (29,400)Net profit 14,700

Turnover = Cost of Sales Average stock

Margin = Gross Profit Sales

7 = Cost of Sales 12,600

Cost of Sales = 88,200

(c) Use of Cashbook and Bank Statement (in addition) Control Accounts.If there is sufficient information relating to cash payments and receipts, then a simple cashbook for both cash in hand and cash at bank can be prepared in confirmation of deposits and payments made from the bank statement.The information can then be posted to the relevant accounts e.g. any income received to the relevant income accounts, expenses to relevant expense accounts and assets and liabilities to relevant accounts.Information relating to amounts owed to suppliers/creditors and amounts due from debtors can be posted in summary to the control accounts. The preparation of the cashbook and control accounts will enable one to estimate any cash sales or credit sales and cash purchases or credit purchases.

Steps in Preparing the Final Accounts

1) Prepare a statement of affairs at the beginning of the period (a list of all assets and liabilities) to determine the beginning capital.

2) Open and post the balances and transactions to these 3 relevant accounts (i.e. the cashbook (for both cash in hand and bank), sales ledger control account and purchases ledger control account.Any other account can be opened where necessary.

3) Make adjustments for any accruals or prepayments.4) Extract a list of the balances. (Trial balance).5) Prepare the final accounts.

Example 6.4Hobbs does not keep proper books of account. You ascertain that his bank payments and receipts during the year to 31 December 19X8 were as follows:


Reciepts Payments£ £

Balance 1 Jan 19X8

572 Purchases 10,007

Cheques for sales 13,179

Expenses 2,950

Cash banked 14,005

Drawings 11,250

Balance 31 Dec 19X8

3,751 Delivery van 7,300

31,507

31,507

From a cash notebook you ascertain:£

Cash in hand 1 January 19X8

62

Cash takings 16,300Purchases paid in cash 1,850Expenses paid in cash 375Cash in hand 31 December 19X8

65

Drawings by proprietor in cash

Unknown

You discover that assets and liabilities were as follows:

1 Jan 19X8 31 Dec 19X8

£ £Debtors 1,850 2,070Trade creditors 1,250 1,420Stock on hand 2,650 2,990

Depreciation on the van is to be provided at the rate of 20% per annum.

Statement of Affairs as at 1 January 19x8£

CURRENT ASSETS

Cash at bank 572Cash in hand 62Debtors 1,850Stock 2,650

5,134CURRENT LIABILITIES

Creditors (1,250)Net Assets 3,884

Lesson Six 235

Capital 3,884

Sales Ledger Control Account£ £

Balance b/d 1,850 Cash Takings

16,300

Sales 29,699

Bank 13,179

______ Bal c/d 2,07031,54

931,549


Purchases Ledger Control Account£ £

Cash purchases 1,850 Bal b/d 1,250Bank 10,00

7Purchases 12,027

13,277

13,277

Cash in Hand Account£ £

Balance b/d 62 Creditors 1,850Debtors/sales 16,30

0Expenses 375

Bank 14,005Bal c/d 65

_____ Drawings ___6716,36

216,362

The capital invested at any point of time in a business by the owner is represented by the difference between the assets and liabilities at that time.

The difference between the capital at the end and the capital at the beginning of the trading period represents the trading profit made during that period, unless there were withdrawals or investments of additional capital.

HobbsTrading and Profit and Loss Account for the year ending 31 December 19X8

£ £Sales 29,699Less cost of goods sold:Opening stock 2,650Add purchases 12,027

14,677Less closing stock (2,990) 11,687GROSS PROFIT 18,012Less Expenses:Expenses (375 + 2,950) 3,325Depreciation 1,460 (4,785)NET PROFIT 13,227

Lesson Six 237

HobbsBalance Sheet as at 31 December 19X8

£ £ £Fixed Assets Cost Depreciation NBVDelivery van 7,300 1,460 5,840

Current AssetsStock 2,990Debtors 2,070Cash ___65

5,125Less current liabilitiesCreditors 1,420Bank overdraft 3,751 5,171

5,794Financed by:Capital 3,884Add net profit 13,2

2717,111

Less drawings (11,250 + 67) 11,3175,794

Example 6.5 (Exam Type Questions May 2001 Question 3)Kimeu commenced his business of making furniture on 1 April 2000. Due to his limited accounting knowledge he has not maintained proper books of account. You have been engaged to examine his records and prepare appropriate accounts there from. You perform an examination of the records and from interviews with Kimeu you ascertain the following information.

1. At the commencement of business on 1 April 2000, he deposited Sh 1,200,000 into business bank account. On the same day he brought into the firm his pickup and estimated that it was worth Sh 660,000 and then that from 1 April 2000 it will have useful life of three years.

2. To increase his working capital he borrowed Sh 400,000 at 15% interest per annum on 1 July 2000 from his sister but no interest has yet been paid.

3. On 1 April 2000, Sally was employed as a clerk at a salary of Sh. 720,000 per annum.

4. He had drawn Sh 18,000 per week from the business account for private use during the year.

5. He purchased timber worth Sh 1,960,000 out of which Sh 158,000 worth of stock was retained in the workshop on 31 March 2001. He also spent Sh 960,000 on the purchase of some equipment at the commencement of the business which he estimates will last him five years.

6. Electricity bills received up to 31 January 2001 were Sh 240,000. Bills for the remaining two months were estimated to be Sh 48,000. Motor vehicle expenses were Sh 182,000 while general expenses amounted to Sh 270,000 for


the year. Insurance premium for the year to 30 June 2001 was Sh 160,000. All these expenses have been paid by cheque.

7. Rates for the year to June 2001 were Sh 36,000 but these had not been paid.8. Sally sent out invoices to customers for Sh 6,178,000 but only Sh 5,080,000

had been received by 31 March 2001. Debt totaling to Sh 17,000 were abandoned during the year as bad. Other customers for jobs too small to invoice have paid Sh 726,000 in cash for work done of which Sh 560,000 was banked. Kimeu used Sh 75,000 of the difference to pay for his family’s foodstuff, bought Kenya Charity Sweepstake tickets worth 24,000 and Sally used the rest on general expenses except for Sh 30,100 which was left in the office on 31 March 2001.

9. You agree with Kimeu that he will pay you Sh 55,000 for accountancy fee.

Required:(a) Profit and loss account for the year ended 31 March 2001. (10 marks)(b) Balance sheet as at 31 March 2001. (10 marks)

(Total: 20 marks)

Solution:Cash book – BankSh Sh

Capital 1,200,000

Salary 120,000

Loan 400,000 Drawings 936,000Debtors 5,080,00

0Timber 1,960,000

Cash 560,000 Equipment 960,000Electricity 240,000Motor vehicle expenses

182,000

General expenses 270,000Insurance 160,000

________ Bal c/d 1,812,0007,240,00

07,240,000

CapitalSh Sh

Bank 1,200,000Bal c/d 1,860,00

0Pick up 660,000

1,860,000

1,860,000

Debtors

Lesson Six 239

Sh ShSales 6,178,00

0Bank 5,080,000

Bad debts 17,000________ Bal c/d 1,081,000

6,178,000

6,178,000

Cash book - cash in handSh Sh

Sales 726,000 Bank 5,080,000Drawings 17,000Drawings 1,081,000General Expenses 36,900

______ Bal c/d 30,100726,000 726,000


Loan interest = 400,000 x 15% x 9/12

Rates = 36,000 x 9/12 = 27,000

Accruals = Electricity bills = 48,000Rates = 27,000Agency fees = 55,000Loan interest = 45,000

175,000

KimeuProfit and Loss Account For the year ended 31 March 2001

Sh ShSales (cash + credit) 6,904,000Less expensesTimber used (1,960,000 – 158,000)

1,802,000

Depreciation – motor vehicle 220,000 - Equipment 192,000Loan interest 45,000Salary 720,000Electricity bills 288,000Motor vehicle expenses 182,000General expenses 306,900Insurance premium 120,000Rates 27,000Bad debts 17,000Accountancy fees 55,000 (3,974,900)Net profit 2,929,100

Lesson Six 241

KimeuBalance Sheet as at 31 March 2001

Non current Asset Sh Sh ShEquipment 960,000 192,000 768,000Motor vehicle 660,000 220,000 440,000

1,620,000 412,000 1,208,000

Current AssetsStock 158,000Debtors 108,000Insurance – prepayments 40,000Cash at bank 181,200Cash in hand 30,000

3,121,100Less current liabilitiesAccruals 175,000 2,946,100

4,154,100

Capital 1,860,000Add net profit 2,929,100

4,789,100Less drawings 1,035,000

3,754,100Non current liabilityLoan 15% 400,000

4,154,100

Example 6.6 (Exam Type) June 1995 Question 2Abi, a proprietor of a grocery and general store has not previously engaged an accountant. He informs you that this year his bankers have insisted on a proper set of accounts. Abi supplies you with his trading results for the year ended 30 June 1994 which are as follows:

Sh ShPayments for goods 4,747,50

0Takings 5,465,000

Payments for expenses 565,000Profits 152,500 ________

5,465,000

5,465,000

Abi instructs you to examine his records and prepare accounts. From your examination of the records and interview with your client, you ascertain the following information:

1. The takings are kept in a drawer under the counter; at the end of each day the cash is counted and recorded on a scrap of paper; at irregular intervals Mrs. Abi transcribes the figures into a notebook; a batch of slips of paper was inadvertently destroyed before the figures had been written into the notebook,


but Mr. And Mrs. Abi carefully estimated their takings for that period, and the estimated figure is included in the total of Sh. 5,465,000.

2. Mr. Abi involved himself in betting for 30 weeks of the year, spending Sh. 500 per week with cash taken from the drawer. His winnings totaled Sh. 29,500.

3. The following balances are ascertained as correct:30 June

1994 1993Sh Sh

Cash in hand 43,500 22,500Balance at bank 109,500 78,000Sales debtors 245,500 229,000Creditors for purchases of stock

121,500 139,500

Stock at cost 950,000 975,000

4. Debts totaling Sh. 178,000 were abandoned during the year as bad; the takings included Sh 12,500 recovered in respect of an old debt abandoned in the previous year.

5. Mr. Abi rents the shop for living accommodation at Sh. 1,500 per week for 52 weeks in a year; the rent is included in expenses of Sh 565,000. The living accommodation comprises one-third of the building.

6. The total expenses also include:

Sh. 17,500 running expenses of Abi’s private car; Sh. 30,000 for exterior decoration of the whole premises; Sh. 80,000 for alterations to the premises to enlarge the storage

accommodation.

7. Mr. Abi takes Sh. 5,000 per week from the business for his wife’s personal expenses. This excludes the amount indicated in note 8.

8. Mr. Abi draws Sh. 750 per week for cigarettes and beer.9. During the year, Mr. Abi bought a secondhand car (not for use in the business)

from a friend; the price agreed was Sh. 175,000, but as the friend owed Mr. Abi Sh. 33,500 for goods supplied from the business, the difference was settled by cheque.

10. An insurance policy for Mr. Abi’s life matured and realized Sh. 320,500.11. Mr. Abi cashed a cheque for Sh. 50,000 for a friend; the cheque was

dishonored and the friend is repaying the Sh. 50,000 by installments. He had paid Sh. 20,000 by 30 June 1994.

12. Other private payments by cheque totaled Sh. 48,000 plus a further sum of Sh. 55,000 for income tax.

13. You are to provide Sh. 21,000 for accountancy fees.

N.B. All receipts and payments of Mr. Abi are made through his business account.Required:

Lesson Six 243

(a) Mr. Abi’s balance sheet for the business at 30 June 1993.(4 marks)

(b) Mr. Abi’s profit and loss account for the year ended 30 June 1994.(12 marks)

(c) Mr. Abi’s balance sheet for the business at 30 June 1994. (6 marks)

(Total: 20 marks)


Solution:Abi

Balance Sheet as at 30 June 1993

Current Assets Sh ShStock 97,500Debtors 229,00

0Cash at bank 78,000Cash in hand 22,500

1,304,500

Current liabilitiesCreditors (139,50

0)1,165,0

001,165,0

00

Capital 1,165,000

Cash at BankSh Sh

Balance b/d 78,000 Drawings – personal expense for wife

260,000

Sales ledger control a/c

12,500 Drawings – cigarettes and beer

39,000

Insurance (drawings) 320,500 Expenses 565,000Drawings 50,000 Drawings – second hand car 141,500Drawings 20,000 Cash in hand 6,500Debtors 5,591,00

0Drawings – friend 50,000

Creditors 4,747,500Dishonored cheque – drawings

50,000

Drawings 48,000Income tax 55,000

________ Balance c/d 109,5006,072,00

06,072,000

Cash in HandSh Sh

Balance b/d 22,500 Drawings 15,000Drawings – betting 12,500Bank 6,500 Balance c/d 43,500

Lesson Six 245

58,500 58,500

Sales Ledger Control A/cSh Sh

Balance b/d 229,000 Bad debts 178,000Bad debts recovered 12,500 Bank 12,500Credit sales 5,819,00

0Drawings 33,500

Bank 5,591,000________ Balance c/d 245,5006,060,500

6,060,500

Purchases Ledger Control A/cSh Sh

Bank 4,747,500

Balance c/d 139,500

Balance c/d 121,500 Credit purchases

4,729,500

4,869,000

4,869,000

ExpensesTotal Business Private

Rent 78,000 52,000 26,000Motor running expenses

17,500 - 17,500

Decoration 30,000 20,000 10,000Alterations 80,000 80,000Other expenses 359,500 359,500 _____

565,000 532,500 53,500

AbiTrading Profit and Loss Account for the year ended 30 June 1994

£ £Sales 5,819,000Less cost of salesOpening stock 975,000Purchases 4,729,500

57,040,500Less closing stock 950,000 4,754,500Gross profit 1,064,500Less expensesRent 52,000Decoration 20,000Alterations 80,000Other expenses 359,500Bad debts 165,500


Accountancy fees 21,000 (698,000)Net profit 366,500

AbiBalance Sheet as at 30 June 1994

Cost Depreciation

Book Value

Current Assets: £ £ £Stock 950,000Debtors 245,500Cash at bank 109,500Cash in hand 43,500

1,348,500Current LiabilitiesCreditors 121,500Accruals 21,000 (142,500) 1,206,000Capital 1,165,000Add net profit 366,500

1,531,500Less drawings (325,500)

1,206,000

NON PROFIT MAKING ORGANIZATIONS (Club, Associations and Others)These are some form of organizations that are set up to promote or to cater for the welfare of the members involved and not to make a profit. These include clubs, (e.g. football clubs, sports clubs), welfare associations and any other societies (charitable institutions).Because these organizations are not trading, the types of accounts to prepare are different from the ones of trading organizations.

Example:

1. Instead of a cashbook, the clubs will maintain a receipts and payments which has similar entries to those of a cashbook.

2. Instead of profit and loss account, we have an income and expenditure account.3. Because the club is not formed by any one owner (has no owner), it is funded

by members’ contributions, donations, income from investments to get an accumulated fund instead of capital.

From the income and expenditure account, if the incomes are more than the expenditures for the period, then the club has a surplus and not a net profit.If the expenditure is more than incomes, then the club has a deficit and not a loss.The club may carry out some trading activities on a small scale to finance some of the clubs activities and incase a firm has a trading activity, then in addition to the income and expenditure account and the balance sheet, prepare a Bar Trading Account.

Lesson Six 247

Format of the Final AccountsName

Income and Expenditure Account for the year ended 31 December ……

Incomes £ £

Profit from trading activities XX

Subscriptions XX

Income from investments XX

Donations XX

Income from other activities

[dinner dance, raffles, festivals]

XX

XX

Expenditure

Depreciation XX

Salaries and wages XX

Expenses on other activities [prizes]

XX

Loss from trading activities XX

All other expenses XX (XX)

SURPLUS/( DEFICIT ) XX/(XX)


NAMEBALANCE SHEET AS AT 31 DECEMBER ……

Non current Assets £ £ £Buildings XX (XX) XXFixtures, fittings and equipment

XX (XX) XX

Motor vehicle XX (XX) XXXX (XX) XX

Investments XXCurrent AssetsStocks XXDebtors XXPrepayments and accrued income

XX

Cash at bank/hand (receipts + payments)

XX

XXCurrent liabilitiesCreditors XXAccrued expenses and prepaid income

XX

Bank overdraft XX (XX) XXXX

Accumulated fund balance b/f XXAdd/less surplus / deficit XX/(XX)

Other fundsLife membership fund XXBuilding fund XXEducation fund XX XX

XX

Notes To The Above Format:

1. Subscriptions:These are the amounts received by the club from the members to renew their membership. It is often paid on an annual basis.

It is income for the club and therefore reported in the income and expenditure account.

Depending on the policy of a club, any subscriptions due but not received are shown as accrued income (debtors for subscriptions) in the balance sheet.

Any amounts prepaid are shown as prepaid (creditors for subscriptions). Some clubs will not report subscriptions as income until it is received in form of

cash.

2. Income from Investments:Some clubs invest excess cash in the bank (fixed deposit account), shares of limited companies, treasury bills and any other investment that may be available.

Lesson Six 249

If the club is investing with no specific intention (i.e a general investment) then income from this investment should be reported in the income and expenditure account.

If the investment is for a specific purpose and relates to a specific fund (e.g building fund) it will not be reported in the income and expenditure account but credited directly to the fund.

3. Other funds These are funds set up for a specific purpose and not general. They will be

shown together with the accumulated fund. Any incomes relating to these funds, will be credited directly to the funds and

any expenses will be taken off from these funds e.g. building fund, education fund.

Life Membership FundSome members may pay some amount to become life members of the club and if this happens, there may be a need to spread out this income over the expected life of the members in the club.Depending on the policy of a club, the following accounting treatment may be allowed:

i. The full amount is reported in the Income and Expenditure account in the year it is received and therefore no balance is retained in the life membership account.

ii. The amount is shown separately in the life membership fund with no transfer in the Income and Expenditure account and hence no balance in the life membership account.

iii. To transfer some amounts from the life membership funds to the income and expenditure account over the expected life of membership to the club.

Example 6.7The following is the receipts and payments account of the Friendship Club for the year ended 31 December 19X1:

£ £

Balance at bank31 December 19X0

102 Bar purchases 4,434

Entrance fees 42 Wages 416Subscriptions: 19X0

25 Rent 186

19X1

305 Heating and lighting

128

19X2

35 Postage and stationery

33

Bar Sales 5,227 Insurance 18Sale of investments

750 General expenses 46

Payments on


account of new furniture

450

_____Balance at bank, 31 December 19X1

775

6,486 6,486

The following information is also supplied:

(1) 31 December 19X0

31 December 19X1

Bar stock, at cost 272 315Creditors for bar purchases 306 358Rent due 18 36Heating and lighting

expenses due16 19

Subscriptions due 25 40Insurance paid in advance 5 7

2) On 31 December 19X0, the club held investments which cost £500. During the year ended 31 December 19X1, these were sold for £750.

3) Furniture was valued at £300 on 31 December 19X0. On June 19X1, the club purchased additional furniture at a cost of £520. Depreciation of all furniture is to be provided for at the rate of 10% per annum.

Required:(a) Prepare an income and expenditure account for the year ended 31 December

19X1.(b) Prepare a balance sheet at that date.

Solution:Friendship Club

Accumulated Fund As at 1.1.19X1

Assets £ £

Stock 272Subscriptions due 25Insurance prepaid 5Investments 500Furniture 300Balance at bank 102

1,204LiabilitiesCreditors 306

Lesson Six 251

Rent due 18Heating and lighting expenses 16 (340)Accumulated fund 864

Creditors£ £

Receipts and payments

4,434 Balance b/f 306

Balance c/d 358 Purchases 4,4864,792 4,792

Subscriptions£ £

Balance b/d 25 Receipts & payments

365

Income & expenditure

345

Balance c/d 35 Balance c/d 40405 405


Friendship ClubBar, Trading Account for the year ended 31 December 19X1

£ £

Sales 5,227

Less: Cost of Sales

Opening stock 272

Purchases 4,486

4,758

Less closing stock (315) (4,443)

Gross profit to income & expenditure a/c

784

Friendship ClubIncome and Expenditure Account for the year ended 31 December 19X1

£ £Profit from bar trading 784Entrance fees 42Subscriptions 345Profit from sale of investments 250

1,421ExpenditureWages 416Rent 204Heating and lighting 131Postage and stationery 33Insurance 16General expenses 46Depreciation – furniture 56 (902)Surplus 519

Lesson Six 253

Friendship ClubBalance Sheet as at 31 December 19X1

Non current Assets £ £ £Furniture 820 (56) 764

Current AssetsStock 315Subscriptions due 40Prepaid expense 7Cash at bank 775

1,137Current liabilitiesCreditors 398Prepaid subscriptions 35Accrued expenses 55Creditors fixtures 70 (518) 619

1,383Accumulated fund b/f 864Add surplus 519

1,383

Example 6.8 (Exam Type) November 2001(a) State and briefly explain any three distinguishing features between (i) a

receipts and payments account and (ii) an income and expenditure account.(6 marks)

(b) The accountant of Mamba Sports Club has extracted the following information from the books of account for the year ended 31 March 2001.


Receipts Payments

Sh Sh

Balance brought forward

288,000 Salaries and wages 254,000

Subscriptions New equipment 565,000

Year: 1999/2000 249,000 Repairs and maintenance

124,000

2000/2001 2,050,000 Office expenses 415,000

2001/2002 194,000 Printing and stationery

168,000

Dinner dance 723,000 Purchase of beverages

497,000

Beverage sales 657,000 Dinner dance expenses

315,000

Investments income 400,000 Refund of subscriptions

45,000

Sports prizes 25,000

Transport 248,000

Investments 1,500,000

_______ Balance carried forward

_405,000

4,561,000 4,561,000

Balances as at 31 March 2000

31 March 2001

Furniture and fittings (net)

240,000 -

Equipment (net) 690,000 -

Lesson Six 255

Investment at cost 3,500,000 -

Subscriptions in arrears

300,000 375,000

Salaries accrued 68,000 72,000

Stock of beverages 162,000 184,000

Subscriptions in advance

85,000 -

Additional information:

1. Subscriptions in arrears are written-off after twelve months.2. Depreciation is provided for on reducing balance method at 10% and 20% per

annum on furniture and fittings and equipment respectively.3. Investments, which had cost Sh. 500,000, were sold on 30 March 2001 for Sh.

625,000. No entries have been made in the books in this respect.

Required:(a) Income and expenditure account for the year ended 31 March 2001.

(8 marks)(b) Balance sheet as at 31 March 2001. (6


Solution:

Mamba Sports ClubStatement of Affairs

Assets Sh Sh

Furniture and fittings 240,000

Equipment 690,000

Receipts and payments 288,000

Investment at cost 3,500,000

Subscriptions in arrears 300,000

Stock of beverages 162,000

5,180,000

Liabilities


Subscriptions accrued 85,000

Accrued salaries 68,000 (153,000)

5,027,000

Lesson Six 257

Mamba Sports ClubTrading Account for the year ended 31.3.2001

Sh ShSales 657,000Less cost of salesOpening stock 162,000Purchases 497,000

659,000Less closing stock (184,000) (475,000)Profit to income and expenditure

182,000

Subscriptions2001 Sh 2001 £Balance b/d 300,000 Balance b/f 85,000Receipts and payments

45,000 Receipt and payment

2,493,000

Income & expenditure

2,465,000 Income & expenditure

51,000

Balance c/f 194,000 Balance c/f 375,0003,004,000 3,004,00

0

Mamba Sports ClubIncome and Expenditure Account for the year ended 31 March 2001

Incomes ShProfit from trading account 182,000Subscriptions 2,465,000Dinner dance 723,000Investment income 400,000Profit on sale of investments 125,000

3,895,000


Example 6.9 (Exam Type) DECEMBER 2000 QUESTION 3The following trial balance was extracted from the books of Literary and Philosophical Society as at 30 September 2000:

Sh ShBalance at bank: current account 724,800Accumulated fund 1 October 1999 5,771,200Land and buildings, at cost 3,700,000Debtors for subscription 62,000Furniture and fittings 1,874,000Provision for depreciation of furniture & fittings

284,000

Subscriptions 1,450,800Lecturer’s fees 920,000Lecturer’s travel and accommodation expenses

358,000

Donations 108,000Camera and projector repairs 17,000Projectors, cameras and audio equipment

190,400

Depreciation of equipment 54,400Rates and water 277,000Lighting and heating 367,200Rental of rooms 495,000Wages – Caretaker 880,000 - Restaurant 1,600,000 - Bar staff 800,000Purchase of food 1,565,800Stock – bar 1 October 1999 473,600Bar receipts 4,032,000Bar purchases 2,842,000Restaurant receipts 3,642,000Loan 1,600,000Deposit account – bank 1,000,000Interest payable and receivable 36,000Creditors for bar and food ________ 178,400

17,651,800 17,651,800

Additional information:1. The bar stock was valued at Sh. 642,800 as at 30 September 2000.2. It is expected that, of the debtors for subscriptions, Sh. 43,600 will not be

collectable.3. The interest account is net. The loan is at a concessional rate of 4% while 10%

has been earned on the deposit account. No changes have taken place all year in the principal sums involved.

4. An invoice for Sh. 43,000 of wine had been omitted from the records at the close of the year although the wine had been included in the bar stock valuation.

5. Depreciation for the year is to be provided as follows:Furniture and fittings Sh. 194,000Projectors, cameras, etc. Sh. 19,000.

Lesson Six 259

Required:(a) Bar and restaurant trading account for the year ended 30 September 2000

(6 marks)(b) An income and expenditure account for the year ended 30 September 2000

(8 marks)(c) A balance sheet as at 30 September 2000 (6



Solution:Literary and Philosophical SocietyBar and Restaurant Trading Account for the year ended 30 September 2000

Sh ShSales 7,674,000Less cost of salesOpening stock 473,600Add purchases 4,450,800

4,924,400Less closing stockProfit to the income and expenditure

(642,800) (4,281,600)

3,392,400

Literary and Philosophical SocietyIncome and Expenditure Account for the year ended 30 September 2000

Income Sh ShProfit on trading account 992,400Interest on bank deposit account

100,000

Subscriptions 1,450,000Donations 108,000Rental of rooms 495,000

3,146,200ExpenditureLecturer’s fees 920,000Depreciation on furniture and fitting

194,000

Equipment 19,000Lecturer’s travel and accommodation exp.

358,000

Camera repairs 17,000Rates and water 277,000Lighting and heating 867,200Caretakers wages 880,000Interest on loan 64,000Provision for subscription 43,600 (3,139,800)Surplus 6,400

Lesson Six 261

Literary and Philosophical SocietyBalance Sheet as at 30 September 2000

Non current Assets Sh Sh ShLand and buildings 3,700,000 - 3,700,000Fixtures and fittings 1,874,000 (478,000) 1,396,000Equipment 190,400 (73,400) 117,000

5,764,400 551,400 5,213,000Current assetsStock 642,800Debtors of subscription 18,400Balance at bank – deposit a/c 1,000,000 - Current a/c 724,800

2,386,000Current liabilitiesCreditors (221,400) 2,164,600

7,377,600Accumulated fund b/f 5,771,200Add surplus ___6,400

5,777,600Non current liabilities4% loan 1,600,000

7,377,600

(c ) Manufacturing AccountsSome firms may manufacture or produce goods rather than buy due to savings in operational costs. (i.e. it is cheaper to produce the goods rather than buy).Due to additional costs involved in the production process, additional information is reported in the final accounts.Therefore, in addition to a trading, profit and loss account, a new account called manufacturing account is shown before these others.The purpose of the manufacturing account is to report all the costs incurred in producing the goods. These costs are divided into 2 classes:

1) Direct costs (prime costs)2) Indirect costs (overheads)

Direct Costs/Prime CostsThis is a cost that can be traced directly to a unit that has been produced. This include

1) Direct material2) Direct labour (wages)3) Direct expense

Indirect costs/Production overheadsThese are all other costs incurred in the production of manufacturing of goods but cannot be traced directly to any particular unit. Example:

1) Rent for the factory2) Salaries to supervisors and factory managers3) Depreciation of plant and machinery used in production


The manufacturing account will show the factory cost of goods produced that will be shown in the trading account in place of purchases.

Lesson Six 263

FORMATNameManufacturing Trading Profit and Loss Account for the year ended 31 December

Raw Materials£ £

Opening stock of raw materials XXPurchases of raw materials XXAdd carriage inwards XX

XXLess returns outwards (XX) XXCost of raw materials available for use XXLess closing stock of raw materials (XX)Raw materials consumed XXDirect labour (factory wages) XXDirect expenses XXPrime cost XXFactory overheadsSalary to factory manager XXDepreciation on – Plant and machinery XX - Factory buildings XXOther expenses – Factory power XX Lighting and heating XX Water XX Cleaners wages XX XXTotal cost of production XXAdd: opening Work In Progress XXLess: closing Work In Progress (XX) XXFactory cost of production (cost of finished goods)

XX Note 1

FACTORY PROFIT XX Finished goods at a transfer price XX Note 2

Sales XXLess returns inwards (XX)

XXLess cost of salesOpening stock – finished goods XXFactory cost of production/transfer price XX

XXLess closing stock of finished goods (XX) (XX)Gross profit XXAdd factory profit XXOther incomes – discount received XX - Profit on disposal XX

XXLess expensesSalaries and wages – administration & non production

XX


Rent for administration building XXDepreciation - Delivery vans XX - Fixtures and distribution XXOther selling and distribution costs XX (XX)Net profit/(net loss) XX/(XX)

For the balance sheet, the format is the same for all the assets and liabilities except for the current assets section whereby the stock at the end of the period should be shown for each type of stock as per this format:

Current Assets £ £Stock: raw materials XXWork in progress XXFinished goods XX XX

Note 1: This represents the total costs of all the units produced during the period and therefore will be taken to the trading account as the goods are transferred to the selling department.Note 2: If the firm transfers the goods to the selling department at a price higher than the cost of production, then this generates a factory profit. The goods will be shown in the trading account at the transfer price and the factory profit is added to the Gross Profit of the period.Expenses can also be classified into:1) Administration ExpensesThese are expenses incurred in running or managing the affairs of the firm and includes managers salaries (not factory managers), legal and accounting fees, depreciation of furniture and fixtures and equipment not used in production, finance cost e.g. loan interest.2) Selling and DistributionThese are expenses incurred to generate sales income e.g.

Salaries and commission to the sales manager and staff Carriage outwards (i.e. to deliver goods to the customers Depreciation on motor vehicles (used for the delivery purpose) Advertising Bad debts

Lesson Six 265

Example 6.10B spikesTrial Balance as on 31 December 2002

Dr CrStock of raw materials 1.1.2002 21,000Stock of finished goods 1.1.2002 38,900Work in progress 1.1.2002 13,500Wages(direct £180,000: factory indirect£145,000)

325,000

Royalties 7,000Carriage inwards (on raw materials) 3,500Purchases of raw materials 370,000Productive machinery (cost £280,000)

230,000

Accounting machinery (cost £20,000) 12,000General factory expenses 31,000Lighting 7,500Factory power 13,700Administrative salaries 44,000Sales representatives’ salaries 30,000Commission on sales 11,500Rent 12,000Insurance 4,200General administration expenses 13,400Bank charges 2,300Discounts allowed 4,800Carriage outwards 5,900Sales 1000,000Debtors and creditors 142,300 125,000Bank 56,800Cash 1,500Drawings 20,000Capital as at 1.1.2002 ______ 29,680

1,421,800 1,421,800

Notes at 31.12.2002

1. Stock of raw materials £24,000, stock of finished goods £40,000, work in progress £15,000.

2. Lighting, and rent and insurance are to be apportioned: factory 5/6ths, administration 1/6th.

3. Depreciation on productive and accounting machinery at 10 per cent per annum on cost.

Required:Prepare a manufacturing, Trading Profit and Loss Account for the year ended 31 December 2002.


Solution:

B SpikesManufacturing, Trading Profit and Loss Account for the year ended 31 December 2002Raw Materials £ £Opening Stock of raw materials 21,000Purchases 370,000Carriage inwards on raw materials 3,500 373,500

394,500Less: closing stock of raw materials (24,000)Raw materials consumed 370,500Direct wages 180,000PRIME COST 550,500Factory OverheadsWages 145,000Royalties 7,000Depreciation: productive machinery 28,000General factory expenses 31,000Lighting( 5/6 x 7,500) 6,250Factory power 13,700Rent(5/6 x 12,000) 10,000Insurance( 5/6 x 4,200 ) 3,500 24,4,450Total cost of production 794,950Add: opening work in progress 13,500

808,450Less: closing work in progress (15,000)Factory cost production per finished goods

793,450

Sales 1,000,000Less cost of salesOpening stock of finished goods 38,900Factory cost of production 793,450

832,350Less closing stock of finished goods (40,000) 792,350Gross profit 207,650ExpensesAccounting machinery – depreciation 2,000Lighting (1/6 x 7,500) 1,250Administrative salaries 44,000Sales representatives salaries 30,000Commission on sales 11,500Rent ( 1/6 x 12,000) 2,000Insurance (1/6 x 4200) 700General administrative expenses 13,400Bank charges 2,300Discounts allowed 4,800Carriage outwards 5,900 (117,850)Net profit 89,800

Lesson Six 267

B SpikesBalance Sheet as at 31 December 2002

COST DEPRECIATION

NET BOOK VALUE

Non current Assets £ £ £Productive machinery 280,000 (78,000) 202,000Accounting machinery 20,000 (10,000) 10,000

300,000 88,000 212,000Current AssetsStock: raw materials 24,000Finished goods 40,000Work in progress 15,000 79,000Debtors 142,300Cash at bank 56,800Cash in hand 1,500

279,600Current liabilitiesCreditors (125,000) 154,600

366,600Capital 296,800Add net profit 89,800


366,600


Example 6.11 (Exam Type – June 1986 Question Two)Bibi Maridadi owns and manages a small manufacturing business. The following balances have been extracted from her books of account at 31 January 1986:

Dr CrSh Sh

Capital at 1 February 1985 171,120Accounts payable 86,000Bank and cash balance 5,400Accounts receivable 92,000Drawings 60,000Administration expenses 150,360Advertising expenses 12,000Factory direct wages 60,000Factory indirect wages 24,000Factory power 36,000Furniture and fittings (all offices) 18,400Heat and light 16,000Plant and equipment 276,800Motor vehicle (used by salesmen) 144,000Plant hire 4,000Provision for bad debts 3,200Provision for depreciation 1 February 1985: Furniture and fittings 9,200 Plant and equipment 138,400 Motor vehicle 24,000Raw material purchases 228,000Rent rates 20,000Sales 829,440Selling and distribution expenses 66,400Inventories at cost, 1 February 1985: Raw materials 8,000 Work in progress 16,000 Finished goods 24,000 _______

1,261,360 1,261,360

The following additional information is provided:(i) Accruals at 31 January 1986 were:

Factory power - Sh.1,600Rent and rates - Sh. 4,000

There was also prepayment of Sh. 800 for salesmen’s motor vehicle insurance.(ii) Inventories at 31 January 1986, were valued at cost as follows:

Raw materials - Sh. 15,200Work in progress - Sh. 30,400Finished goods - Sh. 45,600

Lesson Six 269

(iii) Depreciation is to be charged on plant and equipment, motor vehicle, furniture and fittings at the rates of 20%, 25% and 10% per annum respectively on cost.

(iv) Expenditure on heat and light, and rent and rates is to be apportioned between the factory and office in the ratio of 9 to 1 and 3 to 2 respectively.

(v) The provision for bad debts is to be made equal to 5% of accounts receivable at 31 January 1986.

Required:Using the vertical method, prepare Bibi Maridadi’s manufacturing, trading and profit and loss account for the year ended 31 January 1986 and a balance sheet as at that date. (22 marks)

Solution:Bibi MaridadiManufacturing, Trading and Profit and Loss Account for the year ended 31 January 1986Direct materials Sh ShOpening stock of raw materials 8,000Add: purchases of raw materials 228,000

236,000Less: closing stock of raw materials (15,200)Raw materials consumed 220,800Factory direct wages 60,000PRIME COST 280,800Factory overheadsFactory indirect wages 24,000Factory power 37,600Plant hire 4,000Heat and light 14,400Rent and rates 14,400Depreciation on plant 55,360 149,760

430,560Add opening work in progress 16,000

446,560Less closing work in progress (30,400)Factory cost of production 416,160Sales 829,440Less cost of salesOpening stock of finished goods 24,000Add factory cost of production 416,160

440,160Less closing stock of finished goods (45,600) 394,560Gross profit 434,880Less expensesIncrease in provision for doubtful debts

1,400

Rent and rates 9,600Heat and light 1,600Depreciation: motor vehicle 36,000Furniture and fittings 1,840


Selling and distribution expenses 65,600Administration expenses 150,360Advertising expenses 12,000 278,400Net profit 156,480

Bibi MaridadiBalance Sheet as at 31 January 1986

COST DEPRECIATION

NET BOOK VALUE

Non current Assets £ £ £Plant and equipment 276,800 (193,760) 83,040Furniture and fittings 18,400 (11,040) 7,360Motor vehicle 144,000 (60,000) 84,000

439,200 (264,800) 174,400Current AssetsStock: Raw materials 15,200 Work in progress 30,400 Finished goods 45,600 91,200Debtors 92,000Less: provision for doubtful debts

(4,600) 87,400

Prepayments 800Cash in hand and bank 5,400

184,800Current liabilitiesCreditors 86,000Accruals 5,600 (91,600) 93,200

267,600Capital 171,120Add net profit 156,480


267,600

UNREALISED PROFITS ON CLOSING STOCKIn most cases where business transfers finished goods at a profit to the selling department and the goods are reflected in the balance sheet at the transfer price, then the closing stock includes a profit that has not been earned or realised. If the mark up profit (the profit based on cost of production is always uniform, then any changes in the value of closing stock will result in a reduction or an increase in the unrealised profits.If there is an increase on unrealised profit on the closing stock, then this increase will be reduced from the gross profit from our profit and loss account and if there is a reduction in unrealised profits, then this reduction will be added to the gross profit in our profit and loss account.Any unrealised profit of closing stock should be deducted from the closing stock in the balance sheet.The slight change in the format of the Profit and Loss Account and Balance Sheet will be as follows

Lesson Six 271

Increase in unrealised profit in closing stock (UPCS)Profit and loss (extract) Account for year ended………..

£ £Gross profit XAdd: factory profit XAdd: other expenses X

XLess expensesOther expenses XIncrease in unrealised profit on closing stock

X (X)

Net profit X

Decrease in UPCSProfit and Loss Account (extract) for year ended …………

£ £Gross profit XAdd: factory profit XAdd: other incomes XAdd: decrease in UPCS X

XLess expensesOther expenses (X)Net profit X

Example:A firm always values its stock (finished goods) at a mark-up of 20% on cost of production. The opening stock of finished goods for the period was valued at Sh. 100,000. (The marked up cost) The closing stock at the end of the financial period was Sh.160,000.

Opening Stock: 100,000 (marked up) = 120% (16,667) = (20%) 83,333 = 100%

Closing Stock 160,000 (marked up) = 120% (26,667) = (20%)133,333 = 100%

UPCSBalance b/f 16,667

Balance c/d

26,667 Profit and loss a/c

10,000

26,667 26,667


Profit and Loss (Extract)Less: Expenses: Sh ShIncrease in unrealized profits on closing stock 10,000

Balance Sheet (Extract)

Current Assets Sh ShStock:Raw materials XWork in progress XFinished goods 160,000Less: UPCS (26,667) 133,333

(d) DEPARTMENTAL ACCOUNTS

Some organizations have various departments carrying out trade and therefore the profitability of each department needs to be established. For each department, trading, profit and loss account should be prepared. The final accounts will be very important for the management to assess the performance of each department.The expenses in relation to a specific department should be charged in the Profit and Loss account for that department. The accounts will be represented in columnar form and the format will be as follows: (Assume a firm has departments A and B).

NameTrading Profit and Loss account for the year ended 31 December

Department A Department B Department C£ £ £ £ £ £

Sales XX XX XXLess cost of salesOpening stock XX XX XXPurchases XX XX XX

XX XX XXLess closing stock (XX) (XX) (XX) (XX) (XX) (XX)Gross profit XX XX XX XXOther incomes XX XX XX

XX XX XXLess expensesSalaries and wages XX XX XXDepreciation XX XX XXOther expenses XX XX XXManagers commission

XX (XX) XX (XX) XX (XX)

NET PROFIT XX XX XX

The balance sheet will reflect the position of the whole organization and therefore a departmental balance sheet is not required.

Lesson Six 273

When departments in a firm are sharing resources, then the various expenses need to be apportioned between or among the different departments e.g. if the departments are sharing a building, then rent expense should be apportioned among the departments.The following guidelines can be followed in apportioning the expenses among the departments.

Type of Expense Basis of apportionment1) Rent, rates, heat, light, repairs

to buildings,depreciation of buildings and insurance.

Floor area occupied by each department.

2) Depreciation, insurance and maintenance of equipment

Cost or net book value of the equipment in each department.

3) Salaries, canteen expenses, welfare and other expenses relating to employees.

Number of employees in each department

4) Carriage inwards. Purchases in each department.

5) Advertising, depreciation and maintenance of delivery van.

Value of sales in each department.

6) Increase in provision for doubtful debts, bad debts and discounts allowed.

Sales or debtors in each department.

Example 6.12J Spratt is the proprietor of a shop selling books, periodicals, newspapers and children’s games and toys. For the purposes of his accounts, he wishes the business to be divided into two departments:

Department A Books, periodicals and newspapersDepartment B Games, toys and fancy goods.

The following balances have been extracted from his nominal ledger at 31 March 19X9:

Dr CrSales Department A 15,000Sales Department B 10,000Stocks Department A, 1 April 19X8

250

Stocks Department B, 1 April 200


19x8Purchases Department A 11,800Purchases Department B 8,200Wages of sales assistants Department A

1,000

Wages of sales assistants Department B

750

Newspaper delivery wages 150General office salaries 750Rates 130Fire insurance – buildings 50Lighting and air conditioning 120Repairs to premises 25Internal telephone 25

Cleaning 30Accountancy and audit charges 120General office expenses 60

25,000 25,000

Stocks at 31 March 19X9 were valued at:

Department A £300Department B £150

The proportion of the total floor area occupied by each department was:

Department A one fifthDepartment B four-fifths

Prepare J Spratt’s trading and profit and loss account for the year ended 31 March 19X9, apportioning the overhead expenses, where necessary, to show the Department profit or loss.

The apportionment should be made by using the methods as shown:

Area - Rates, Fire insurance, Lighting and air conditioning, Repairs, Telephone, Cleaning:

Turnover -General office salaries, Accountancy, General office expenses.

Lesson Six 275


Solution:J Sprat

Trading, Profit and Loss Account for the year ended 31 March 19X9

Department A Department B Department C£ £ £ £ £ £

Sales 15,000 10,000 25,000Less cost of salesOpening stock 250 200 450Purchases 11,800 8,200 20,000

12,500 8,400 20,450Less closing stock (300) (11,750

)(150) (8,250) (450) (20,000

)Gross profit 3,250 1,750 5,000

Less expensesWages 1,000 750 1,750Newspaper delivery wages

150 - 150

General office salaries 450 300 750Rates 26 104 130Fire insurance – buildings

10 40 50

Lighting and air-conditioning

24 96 120

Repairs to premises 5 20 25Internal telephone 5 20 25Cleaning 6 24 30Accountancy or audit charges

72 48 120

General office expenses

36 (1,784) 24 (1,426) 60 (3,210)

NET PROFIT 1,466 324 1,790

Workings:

1) General Office Salaries: A = 15,000 X 750 = 450 25,000

B = 10,000 X 750 = 300 25,000

2) Rates: A = 1/5 X 130 = 26 B = 4/5 X 130 = 104

3) Fire Insurance: A = 1/5 X 50 = 10 B = 4/5 X 50 = 40

4) Lighting: A = 1/5 X 120 = 24 B = 4/5 x 120 = 96

Lesson Six 277

5) Repairs: A = 1/5 X 25 = 5 B = 4/5 X 25 = 20 etc.


Interdepartmental TradingA department may buy goods from another department in the same firm and therefore the departments trade with one another. Example, in 4.16 above, department A sells goods to Department B. (Department B is buying from department A). Interdepartmental sales and purchases should be excluded from the total sales and total purchases of the whole firm. If we assume that A sold goods to B amounting to £1,000 and this figure is included in sales of A and purchases of B, the trading account for the whole firm will be as follows (other items will remain the same):

£ £Sales 24,000Less cost of salesOpening stock 450Purchases 19,000

19,450Less closing stock (450) (19,000)Gross profit 5,000

Managers CommissionA commission based on the net profit made in each department may reward managers of each department.The commission is normally a percentage of the net profit but it may be a percentage on the net profit before or after charging the commission.

1) Percentage Before Charging Commission

If we assume in example 4.16 that the managers in each department is paid a commission of 5%, before charging such commission, the commission will be as follows:

Department A Department B TotalNet profit before commission

1,466 324 1,790

Managers commission @ 5%

(73.3) (16.2) (89.5)

Net profit after commission

1,392.7 307.8 1,700.5

2) Percentage After Charging Commission

Assume the commission is 5% of the net profit after charging such commission:

Department A Department B TotalNet profit before commission

1,466 324 1,790

Managers commission @ 5%

(69.8) (15.4) (85.2)

Net profit after commission

1,392.2 308.6 1,704.5

Lesson Six 279

Note:If we use percentage for each commission assuming a 5% rate, the commission will be computed as follows:

Before charging

commission

After charging commission

Net profit before commission

100 105

Commission of 5% __5 __5Net profit after commission

95 100


QUESTION ONEDare is a grocer who had not kept a full set of books.The following was a summary of his bank statement for the year ended 31 December 19X6:

£ £Amounts credited by bank

32,050 Balance at 1 January 19X6

892

Payments to trade creditors

27,380

Rent and rates 475Fixtures 100Lighting and heating 210General expenses 800Loan interest 120Drawings 900Customers’ cheques dishonoured

180

_____ Balance at 31 December 19X6

993

32,050 32,050

You are given the following information:

1. Trading receipts consisted partly of cash and partly of cheques. During the year, Dare had paid, out of his takings, wages for part-time staff amounting to £2,914 and sundry expenditure of £140. He retained between £2 and £5 per week pocket money and maintained a balance of £20 in the till for change. The balance of his takings, together with cheques amounting to £250, which he had cashed out of his takings for the convenience of certain friends, was paid into the bank.


2. Cheques drawn payable to trade creditors, but not presented at 1 January 19X6, amounted to £280 and at 31December 19X6 to £320.

3. All dishonoured cheques were re-presented and honoured during the year.4. The loan interest was paid to a close friend, Bryant, who had lent Dare £4,000

some years ago at a nominal rate of interest of 3% per annum. The interest was duly paid half-yearly on 31st March and 30 September, and the loan was still outstanding at the end of the year.

5. Discounts allowed by trade creditors amounted to £480 and those allowed to debtors were £520.

6. Other balances at 1 January and 31 December 19X6 are given below:

1 January 31 December

£ £Stocks 4,500 5,800Trade debtors 2,800 3,200 (including a bad debt of

£200 to be written off)Accrued general expenses

240 190

Rates paid in advance 40 50Fixtures valued at 2,800 2,550 (including those

purchased during the year)

Trade creditors 1,800 2,200Creditors for heating and lighting 80 70

7. There is a standard gross profit margin of 25% on sales.

You are required to prepare:(a) a statement of Dare’s capital on 1 January 19X6;(b) a profit and loss account for the year ended 31 December 19X6;(c) a balance sheet as on that date.

QUESTION TWOYou have agreed to take over the role of bookkeeper for the AB Sports and Social Club.The summarized balance sheet on 31.12.94 as prepared by the previous bookkeeper contained the following items. All figures are in £s.

AssetsHeating oil for clubhouse 1,000Bar and café stocks 7,000New sports ware, for sale, at cost 3,000Used sports ware, for hire, at valuation

750

Equipment for grounds person – cost

5,000

Lesson Six 281

- depreciation

3,500 1,500

Subscriptions due 200Bank – current account 1,000 - deposit account 10,000ClaimsAccumulated fund 23,150Creditors – bar and café stocks 1,000 - Sports ware 300


The bank account summary for the year to 31.12.95 contained the following items:

Receipts:Subscriptions 11,000Bankings – bar and sale 20,000Sale of sports ware 5,000Hire of sports ware 3,000Interest on deposit account 800PaymentsRent and repairs of clubhouse 6,000Heating oil 4,000Sports ware 4,500Grounds person 10,000Bar and café purchases 9,000Transfer to deposit account 6,000

You discover that the subscriptions due figure as at 31.12.94 was arrived at as follows:

Subscriptions unpaid for 1993 10Subscriptions unpaid for 1994 230Subscriptions paid for 1995 40

Corresponding figures at 31.12.95 are:

Subscriptions unpaid for 1993 10Subscriptions unpaid for 1994 20Subscriptions unpaid for 1995 90Subscriptions paid for 1996 200

Subscriptions due for more than 12 months should be written off with effect from 1.1.95

Asset balances at 31.12.95 include:Heating oil for club house 700Bar and café stocks 5,000New sports ware, for sale, at cost 4,000Used sports ware, for hire, at valuation

1,000

Closing creditors at 31.12.95 are:

For bar and café stocks 800For sports ware 450For heating oil for clubhouse 200

Lesson Six 283

2/3 rds of the sportswear purchases made in 1995 had been added to stock of new sportswear in the figures given in the list of assets above, and 1/3 had been added directly to the stock of used sportswear for hire.

Half of the resulting ‘new sportswear for sale at cost’ at 31.12.95, to transfer these older items into the stock of used sportswear, at a valuation of 25% of their original cost.

No cash balances are held at 31.12.95. The equipment for the grounds person is to be depreciated at 10% per annum, on cost.

Required:Prepare income and expenditure account and balance sheet for the AB Sports club for 1995, in a form suitable for circulation to members. The information given should be as complete and informative as possible within the limits of the information given to you. All workings must be submitted.

(23 marks)

QUESTION THREEMr Cherono trades as a retailer of electric lamps and related products under the name of Chero Hardware. Most goods in which he trades are purchased from various suppliers in a finished form. In addition, a separate department of the firm manufactures various types of lampshades from purchased raw materials. When finished, the lampshades are transferred to the shop at an agreed transfer price for sale. No lampshades are sold other than through the shop.

The firm’s Accounts Assistant presents you with the following trial balance at 30 June 1988:

Sh ShCapital account – Cherono 740,000Drawings – Cherono 95,000Long term loan (interest at 15% p.a)

240,000

Fixtures and fittings at cost 900,000Accumulated depreciation at 1 July 1987

350,000

Motor vehicle at cost 208,000Accumulated depreciation at 1 July 1987

60,000

Stock at 1 July 1987 (at cost): Raw materials for lampshades 40,000 Completed lampshades 20,000 Other goods 328,000Trade debtors and creditors 122,000Bank balance 98,000Sales 4,100,000Purchases – raw materials for lampshades

855,000

- other goods 2,400,000


Wages 254,000Rent and rates 96,000Water and electricity 47,000Motor expenses 60,800Repairs 12,000Interest on loan 18,000Bank charges 4,000Insurance 18,000Sundry expenses 21,200 _______

5,597,000 5,597,000

Lesson Six 285

Additional Information:

(i) Rent and rates include a prepayment of rates of Sh. 6,000.(ii) The insurance includes a premium for the period ending 31 October 1988.(iii) A trade debt of Sh. 14,000 is not expected to be realized.(iv) During the year a pick-up van, which was bought for Sh. 86,000, was

sold for Sh. 30,000, and replaced with another pick-up van costing Sh. 152,000. Both transactions have been posted to the motor vehicle account. No disposal account has been opened. The straight-line rates of depreciation based on cost are 25% p.a. for motor vehicle and 10% p.a. for fixtures and fittings. A full year’s depreciation is charged in the year of acquisition and none in the year of disposal.

(v) Accruals at 30 June 1988 were:Water and electricity Sh. 5,000Sundry expenses Sh. 4,000

(vi) Stocks at 30 June 1988 were:Sh.

Lampshades raw materials 80,000Lampshades (at transfer price) 30,000Other goods at cost 252,000

(vii)

(a) The agreed transfer price for lampshades produced was Sh. 1,000,000. The workshop produced 50,000 lampshades during the year.

(b) Wages include those of the lampshades making employee who has been paid Sh. 50,000 for the year. In addition, she is entitled to a commission on the annual profit of her department of 10% p.a. after charging such commission. Shop assistants’ wages were Sh. 108,000.

(c) The apportionment of rent and rates; and water and electricity to the lampshades is 25% of the total.

Required:(a) Prepare a manufacturing, trading and profit and loss accounts for the year

ended 30 June 1988, disclosing clearly (i) the profit earned by the lampshades-making department and (ii) the gross profit earned by the shop.

(b) Prepare a balance sheet as at 30 June 1988.

QUESTION FOUROn 2 November 1983, the Treasurer of the Olympiad Athletics Club died. The financial year of the club, which had been formed to provide training facilities for both field and track event athletes, had ended two days previously on 31 October 1983. An extraordinary general meeting was convened for the purpose of appointing a new treasurer whose task it would be to prepare the annual accounts for that financial year.An enthusiastic club member, Guy Rowppe, was duly appointed but, having only an elementary knowledge of bookkeeping, soon found himself in difficulty.He sought your assistance, which you agreed to give. During your conversation he said, ‘The previous treasurer maintained a Cash and Bank account. I have


summarized the detailed entries into what I think you call a Receipts and Payments Account, and have rounded the figures to the nearest £1’.

At this point he supplied you with a copy of the following document:

Lesson Six 287

Olympiad Athletics ClubReceipts and Payments Account for 12 months ended 31 October 1983

Note

Receipts Note

Payments

No. No.Cash Bank Cash Bank

£ £ £ £Balance c/d 73 - Balance b/d - 105Membership fees: (4) Insurance

premiums paid to brokers

580

(1) Entrance 80 170 (7) Payments to suppliers of sporting requisites

5,270

(1) Annual subscriptions

215 4,465 (5) Wages of grounds man

3,600

(2) Life membership 530 (8) Postages and telephones

692

(3) Training ground fees

454 7,206 (9) Stationery 629

Insurance: World-wide Athletics Club affiliation fee

50

(4) Premiums 638 (10) Rates of training ground

846

(4) Commissions 53 Upkeep of training ground 1,200

(11)

Interest received from investments 626

Transfers to bank 700

(12)

Sale of office furniture

370 (11) Purchase of investments

5,600

(6) Sale of sporting requisites

8,774 (11) Short term deposits

3,000

Advertising revenue 603Transfers from cash ____ __700 Balances c/d 122 2,563

£822 £24,135

£822 £24,135

Balances b/d 122 2,563

After you had perused the above account, Guy Rowppe explained the numbered items, as follows:

(1) On admittance to membership of the club, new members pay an initial entrance fee together with their annual subscription. At 31 October 1982, annual subscriptions of £70 had been paid in advance and £180 was owing but unpaid; of this latter amount, £40 related to members who left during the current year and is now no longer recoverable. The figures at 31 October 1983 are £100 subscriptions in advance and £230 subscriptions in arrear. The policy of the club is to take credit for subscriptions when due and to write off irrecoverable amounts as they arise.


(2) As an alternative to paying annual subscriptions, members can at any time opt to pay a lump sum, which gives them membership for life without further payment.Amounts so received are held in suspense in a Life Membership Fund account and then credited to Income and Expenditure Account in equal instalments over 10 years; the first such transfer takes place in the year in which the lump sum is received. On 31 October 1982 the credit balance on the Life Membership Fund Account was £4,720, of which £850 credited was as income for year ended 31 October 1983.

(3) The club has a permanent training ground. Non-members can use the facilities on payment of a fee. In order to guarantee a particular facility, advance booking is allowed. Advance booking fees received before 31 October 1983 in respect of 1984 total £470. The corresponding amount paid up to 31 October 1982 in advance of 1983 was £325. Members can use the facilities free of charge.

(4) Club members can take out insurances through the club at advantageous rates. Initially, premiums are paid by members to the club. Subsequently, the club pays the premiums to an insurance broker and receives commission. At 31 October 1982, premiums received but not yet paid over to the broker amounted to £102 and commissions due but not yet received were £11. The corresponding amounts at 31 October 1983 are £160 and £13 respectively.

(5) The grounds man is employed for the six months April to September only. He is then paid a retaining fee to secure his services for the following year. At 31 October 1982 the grounds man had been paid a retainer (£250) for 1983. Included in the Wages figure (£3,600) is the retainer (£300) for 1984.

(6) Sporting requisites are sold only on cash terms. There are therefore no debtors for these items.

(7) On 31 October 1982 sums owed to suppliers of sporting requisites totaled £163; the corresponding figure on 31 October 1983 was £202.

(8) Stock of unsold sporting requisites on 31 October 1982 was £811 and on 31 October 1983, was £927. In arriving at this latter figure, the sum of £137, representing damaged and unsaleable stock at cost price, had been excluded.

(9) Postage stamps unused at 31 October 1983 totalled £4.(10) Stock of stationery on 31 October 1982 and 1983 was £55 and £36

respectively.(11) Rates are payable to the District Council in two installments (in advance)

each year. £360 had been paid on 1 October 1982, £390 on 1 April 1983 and £456 on 1 October 1983.

(12) The club receives interest on investments bought a number of years ago at a cost of £7,400 (current valuation £7,550). At the end of October 1983, the club had acquired further investments which cost £5,600 (current valuation £5,600) and at the same time placed £3,000 in a short-term deposit account.

(13) The written down value of the furniture which had been sold during the year was £350; it had originally cost £800.

Other Matters:Initially, the training ground had been acquired freehold* from a farmer at an inclusive cost of £4,000. Subsequently, the club had some timber buildings

Lesson Six 289

erected to provide various facilities for members. The total cost of these buildings was £35,000; depreciation is calculated at the rate of 10% per annum on a straight-line basis. At 31 October 1982, the provision for depreciation account had a balance of £9,400.At 31 October 1982, the furniture and equipment etc. was recorded in the club’s books as £7,900 (cost) against which there was a provision for depreciation of £4,150 (calculated on the same basis as for buildings). Apart from the disposal referred to in note (12) above there had been no other disposals or acquisitions during the year.

Required:Prepare the club’s Income and Expenditure Account for year ended 31 October 1983 and the Balance sheet at that date.

All workings must be shown.

*Freehold land is land held in perpetuity.







QUESTION ONEThe bank account of Fuller Ltd, prepared by the company’s book-keeper, was as shown below for the month of October 19-6:

Bank Account19-6

19-6

Oct Oct1 Balance c/d 91.40 2 Petty Cash 0623

1336.15

3 McIntosh and Co 260.11

3 Freda’s Fashions 062314

141.17

3 Malcolm Brothers 112.83

6 Basford Ltd 062315

38.04

3 Cash sales 407.54

8 Hansler Agencies 062316

59.32

14 Rodney Photographic

361.02

9 Duncan’s storage 062317

106.75

17 Puccini’s Cold Store Ltd

72.54 9 Aubrey plc 062318

18.10

20 Eastern Divisional Gas Board – rebate (August direct credit)

63.40

10 Secretarial services Ltd

062319

28.42

22 Grainger’s Garage 93.62 14 Trevor’s Auto repairs

062320

11.75

29 Cash sales 235.39

15 Wages cash 062321

115.52

31 Balance c/d 221.52

16 Towers Hotel 062322

44.09

17 Bank charges (September)

- 12.36

20 Broxcliffe borough Council SO 504.2

221 Eastern Area

Electricity Board DD 108.64

Lesson Six 291

24 Eastern Divisional Gas Board DD 41.20

28 Petty Cash 062323

119.07

30 Wages cash 062324

337.74

______ 31 Salaries transfer - ______1,919.

371,919.

37Nov

1 Balance c/d 221.52

In early November, the company’s bank sent a statement of account which is reproduced below:


Statement of Account with Lowland Bank plcAccount: Fuller Ltd Current Account No 10501191

Date of issue: 1 November 19-619-6 Oct

Description Debit Credit Balance

£ £ £

1 BCE 90.45

2 CR 175.02 265.47

2 062310 111.34 154.13

3 062312 9.18 144.95

3 062309 15.41 129.54

3 CR 780.48 910.02

7 062313 36.15 873.87

10 ADJ 12.90 886.77

15 062315 38.04 848.73

16 062314 141.17 707.56

17 CR 443.56 1,151.12

20 SO 504.22 646.90

21 062317 106.75 540.15

21 DD 196.83 343.32

21 062320 11.75 331.57

22 141981 212.81 118.76

22 ADJ 10.00 108.76

22 062319 28.42 80.34

22 062320 11.75 68.59

Lesson Six 293

22 CR 93.62 162.21

24 ADJ 212.81 375.02

27 INT (loan a/c) 26.35 348.67

27 062321 115.52 233.15

28 062322 44.09 189.06

28 DD 108.64 80.42

30 CGS 9.14 71.28

31 ADJ 11.75 83.03

Abbreviations:BCE = Balance SO = Standing Order CR = Credit ADJ = AdjustmentINT = Interest DD = Direct Debit CGS = Charges

Required:Prepare the company’s bank reconciliation statement as at 31 October 19-6.

(Chartered Association of Certified Accountants)

QUESTION TWOPAUL RUDYERDThe following balances have been extracted from the accounting records of Paul Rudyerd, a wholesale fruiter, at the end of his financial year ended on 31 May 19X1.

£ £Purchases and sales 104,310 146,200Stocks 3,010Motor vehicles at cost 26,360Provision for depreciation on motor vehicles as at 1 June 19X0

12,960

Warehouse equipment at cost 20,000Debtors and creditors 25,250 21,200Bank 3,200Motor vehicle expenses 11,960Rent and rates 11,220Advertising 2,500Sundry expenses (including insurance and electricity)

3,470

Drawings 6,600Capital as at 1 June 19X0 ______ 31,120

214,680 214,680


Lesson Six 295

Additional information and opinions are given as follows:

(a) Stocks at 31 May 19X1 were valued at £2,600. This amount includes a consignment of rare fruit from abroad which cost £300, which would normally sell for approximately £660, but which is badly bruised and could be sold as juice pulp for £100.

(b) Depreciation on motor vehicles is normally charged at an annual rate of 20%, using the reducing balance method. The motor vehicles at cost figure includes a new car purchased during the year for £9,600 for Rudyerd’s personal use which it is estimated will last four years with an estimated residual value of £4,000.

(c) Expenses prepaid and accrued at 31 May 19X1 were estimated as follows:Prepayments Accruals

£ £Rates 230Rent 160Insurance 180Electricity 200

(d) A bad debt of £250 is to be written off. A provision for doubtful debts of 1% of outstanding debtors should be created.

(e) A recording error has resulted in a second-hand delivery van, purchased on 2 June 19X0 for £9,000, being treated as a motor vehicle expense.

(f) No record has been made of fruit, estimated to have cost £520, withdrawn from the business by Rudyerd for his personal use.

(g) No adjustment should be made, in preparing the answer to part (a) for the new warehouse equipment purchased during the year.

Required:(a) Prepare a draft trading, profit and loss account for Paul Rudyerd’s wholesale

fruit business for the year ended 31 May 19X1 and a draft balance sheet as at 31 May 19X1. (15 marks)

(b) Briefly explain what accounting concepts and conventions would be important in considering the treatment of the new warehouse equipment. (4 marks)

(c) Itemize the additional information that you would wish to know before you could make the appropriate adjustments to the above financial statements in respect of the new warehouse equipment.

(3 marks)

QUESTION THREEABC LTDYou have just been appointed as an accounting assistant to ABC Ltd. A week after your arrival the finance director is rushed into hospital; the auditors are about to arrive to prepare the accounts for the recently-ended financial year; you cannot find any working papers for the previous year’s accounts; and the other accounts staff are too busy to assist you in preparing for the auditor’s visit.The eight situations described below are detailed on a notepad left by the finance director and their treatment in the accounts needs to be considered by you.


(a) A supply of office stationery was purchased five months before the year-end at a cost of £1,000. At the year-end it is estimated there is about £250 worth left in stock.

(b) An electronic typewriter was purchased during the year at a cost of £270. It is estimated to have a useful life of five years.

(c) A batch of goods was produced to a customer’s special order. The goods cost £5,800 but have not been delivered as it transpires the customer is now bankrupt. A buyer for the goods has been found, who will pay £4,500 but modifications costing £1,200 will have to be made to the goods.

(d) Three technical staff have spent the last six months exclusively on a new product design project; their salaries for this period amount to £22,000. At the year-end it is known that the design stage will take another month, to be followed by market research; after this the directors will decide whether the project should proceed to production and marketing. The company’s chief engineer is confident that sales of the new product will start in the next financial year and will last for at least four years.

(e) A freehold property was purchased on the first day of the financial year at a cost of £650,000. The building is estimated to have a useful life of ten years when it is expected it will have to be demolished for redevelopment. It is estimated that the freehold land, at the time of purchase, was worth £500,000.

(f) A specialist machine was purchased seven years ago for £200,000. It has been depreciated, using the straight-line method, at 10% per annum since then. To the beginning of the year under review £120,000 depreciation has been provided. The chief engineer has advised that the machine is worn out and would need to be rebuilt to last more than another two years. The directors have already decided the machine should not be rebuilt but scrapped one year after the end of the year under review.

(g) The debtors’ ledger shows balances totalling £52,000 at the year-end. Two debts, totalling £2,000, are known to be bad. Another customer has gone into liquidation owing £3,000; it is expected he will be able to pay 60p of every £ owed to his creditors. The sales director recommends a general bad debt provision of 2% in respect of the remaining debtor balances.

(h) The company has undertaken a heavy advertising campaign throughout the year under review to promote its corporate image and product range. The sales and managing directors feel that this campaign will benefit the company for at least a further six months after the year end. You determine that the campaign cost £150,000 and has been fully paid for before the year-end.

Required: For each of the eight situations described above:(a) Describe what action should be taken in respect of:

(i) The amount to be charged or credited to the year’s profit and loss account (if any);

(ii) The value to be placed on the asset in the balance sheet at the year end (if any);

(8 marks)(b) State what accounting assumptions, conventions or concepts could be involved

and give reasons, where there is a conflict between two or more of them, why

Lesson Six 297

you have chosen the action you propose.(9 marks)


QUESTION FOURThe following final balance was extracted from the books of J Yeats, a trader, at 31 December 19X9:

Ksh KshCarriage inwards 6,310Capital account at 1 January 19X9

500,000

Motor vans 200,000Stock at 1 January 19X9 164,000Balance at bank 116,860Purchases 1,593,690Sales 2,224,000Trade debtors 290,000Trade creditors 157,600Rent and rates 56,080Salaries 350,400General expenses 44,720Motor expenses 25,600Discounts allowed 40,400Discounts received 37,600Insurance 17,600Bad debts 30,400Provision for doubtful debts 1 Jan 19X9

8,000

Provision for depreciation on vans

60,000

Drawings 50,000Disposal 6,000Returns inwards 7,140 _______

2,993,200 2,993,200

The following matters should be taken into account:

(a) After examination of the debtors account, it was decided to:Write off a bad debt of Ksh 12,000Make a specific provision in the accounts for the following doubtful debts,

Ksh 5,000 from WordsworthKsh 3,000 from ColeridgeMake a general provision of 5% on the debtors.

(b) Goods unsold at 31 December 19X9 had cost Ksh 201,600 but Yeats expected to sell them at Ksh 232,470.

(c) Salaries accrued at 31 December 19X9 amounted to Ksh 32,000.(d) The rent of the premises is Ksh 40,000 a year, payable quarterly in arrears, but

the instalment due on 31 December 19X9 was not paid until 15 January in the next year.

(e) Insurance paid in advance at 31 December 19X9 amounted to Ksh 2,000.

Lesson Six 299

(f) Depreciation is to be provided for on the motor truck at the rate of 20% per annum straight line on cost.

(g) General expenses include Ksh 3,060 relating to the telephone account which is made up of:

- Rent – three months in advance from 30 November 19X9 at Ksh. 420.- Calls – three months ended 30 November 19X9 at Ksh 2,640.

(h) It has been agreed with Inland Revenue (Taxation Office) that 12.5% of the rent sand rates relate to private use.

Prepare a trading and profit account for the year to 31st December 19X9, and a balance sheet as at 31 December 19X9.

QUESTION FIVEThe balance sheet of Johnson’s shop at 1 October 19X7 was as follows:

Non current assets

Ksh Ksh Ksh Ksh

Shop premises 45,000 Capital as at 1 Oct

51,000

Shop fittings 12,000Delivery van 4,000 61,000

Current assets Current liabilities

Stock in trade 14,000 Trade creditors 12,000Cash in hand 2,000 16,000 Bank overdraft 14,000 26,000

77,000 77,000

The following is a summary of the transactions which took place during the year to 30 September 19X8:

1. Sales were made, all for cash, of Ksh 145,000. The stock in trade sold cost Ksh 83,000.

2. Stock in trade bought, all on credit for Ksh 78,000.3. Cash of Ksh 113,000 was taken from the till (cash register) and paid into the

bank.4. The trade creditors were paid Ksh 73,000 by cheque.5. Johnson borrowed Ksh 30,000 from Black, which was paid into the bank. The

loan is for 5 years.6. Wages of Kshs 17,000 were paid in cash.7. Rates of Ksh 2,900 were paid by cheque.8. Sundry expenses of Ksh 6,000 were paid in cash.9. Electricity bills of Ksh. 1,600 were paid by cheque.10. The owners of the business withdrew Ksh 9,000 in cash.

At 30 September 19X8 you discover the following:

1. Interest Ksh 2,500 due to Black for the year was unpaid.2. Shop fittings are to be depreciated at 10% per annum on the total at the year-

end; the delivery van is to be depreciated at 20% per annum of the total at the


year-end.3. The rates payment during the year included Ksh 1,000 in respect of the period

1/10/19X8 to 31/3/19X9.4. The electricity bill for the quarter to 30/09/19X8 for Ksh 500 was unpaid.

Prepare a balance sheet as at 30 September 19X8 and a profit and loss account for the year to that date.


NOW SEND TO THE DISTANCE LEARNING CENTRE FOR MARKING

Acknowledgement 301

LESSON SEVEN

PARTNERSHIPS

A partnership is a relationship that subsists between two or more persons carrying on a business common with a view to making profit.Reasons for partnership

1) Additional capital incase a sole trader or one person is not able to raise sufficient capital.

2) Incase there is need for skills or expertise in certain areas of the business.3) To involve more persons in the business especially for a family.

MembershipA partnership has minimum membership of two (2) maximum of fifty (50) except for professional firms (e.g.) lawyers, doctors, accountants etc. whose maximum membership is twenty (20) persons.

Partnership deedWhere two or more persons wish to form a partnership, then it is recommended that they agree on the terms upon which the partnership will be run and the relationship between each other. This is done in writing and signed off as agreed by all the partners and therefore it becomes a partnership deed or agreement.Contents of partnership agreement

1) Name(s) and address(s) of both the firm and the partners2) Capital to be contributed by each partner3) The profit sharing ratios that may be expressed as a fraction or as a percentage.4) Salaries to be paid to any partners who will be involved in the active

management of the business5) Any interest to be charged on drawings made by the partners.6) Interests to be given to the partners on their capital balances.7) Procedures to be taken on the retirement or admission of a partner.

Accounting for partnerships.The interest of the partners in the business is either long term or short-term. The long-term interest is the capital contributed by each partner and the balance is expected to remain fixed. It will only change when the partners agree or incase of any changes in the partnership like admission of or retirement of a partner.The short-term interest is reflected in form of a current account which is affected by the trading activities of the partnership (i.e.) the profits or losses and any drawings made by the partners.


Lesson Seven 302

In most partnerships, both a capital and a current account are maintained and therefore the capital account becomes a fixed capital account. When there is no distinction between a capital account and a current account then any short- term changes are passed through the capital account therefore the capital account becomes a fluctuating capital account.Some of the transactions to be passed through the capital account and the current account are shown in the following formats.

(Assume a firm of 3 partners A, B and C)

CAPITAL ACCOUNTA B C A B C£ £ £ £ £ £

Loss or revaluation

xx xx xx Bal b/d xx xx xx

Goodwill written off

xx xx xx Additional capital(c/book or asset)

xx xx xx

Gains on revaluation xx xx xxBal c/d xx xx xx Goodwill xx xx xx

xx xx xx xx xx xxBal b/d xx xx xx

CURRENT ACCOUNT A B C A B C

£ £ £ £ £ £Bal b/d xx Bal b/d xx xxInterest on drawings

xx xx xx Interest on capitalxx xx xx

Drawings xx xx xx Salaries xx xx xxShare of profits xx xx xx

Bal c/d xx xx - Loan interest - xx -Bal c/d xx

xx xx xx xx xx xxxx Bal b/d xx xx xx

Format For Final Accounts:Profit and Loss AccountThe profit and loss account is exactly as the one for the sole trader and in addition to the profit and loss account, a new section called the Appropriation account is included and this account shows how the partners share the Net Profit for the period. (In addition to other expenses in the profit and loss, an expense for interest on loan given by one of the partners is included and the credit entry is made on the partner’s current account.)The format for the Appropriation account is as follows:

303 Partnerships

£ £Net Profit for the year xx

Add: Interest on drawings.A xxB xxC xx xx

xxLess: Interest on capital.

A xxB xxC xx (xx)

£ £xx

Less: SalariesA xxB xxC xx (xx)

xxBalance of profit to be shared in percentage ratio

A (ratio) xxB (ratio) xxC (ratio) xx (xx)

Balance sheetThe balance sheet also the same as that for a sole trader but the interest of each partner in the business should be shown separately and any loan given by a partner to the firm is also shown separately in the non-correct liability section therefore, the format will be as follows.

£ £ £Net assets. xxCapital: A xx B xx

C xxxx

Current account A xx B xx

C (debit balance). (xx) xxxx

Non-current liabilities10% loan – B xx10% loan – bank xx xx

xx

Lesson Seven 304

Example 7.1Read the following and answer the questions below.

A and B own a grocery shop. Their first financial year ended on 31 December 2002.The following balances were taken from the books on that date:

Capital: A- £60,000; B - £48,000.Partnership salaries: A - £9,000; B - £6,000.Drawings: A - £12,000; B - £13,400.

The firm’s net profit for the year was £32,840.Interest on capital is to be allowed at 10% per year.Profits and losses are to be shared equally.

(a) From the information above prepared the firm’s appropriation account and the partners’ current accounts.

SOLUTIONA and BProfit and Loss Appropriation account for the year ended 31 Dec 2002

£ £Net Profit for the year 32,840

Less: Interest on capitalA 6000B 4800 (10,800)

22,040Less: Salaries

A 9000B 6000 (15,000)

Balance of profit to be shared in Profit Share Ratio 7,040A ½ 3520B ½ 3520 (7,040)

CURRENT ACCOUNTA B A B£ £ £ £

Drawings 12,860

13,400 Interest on capital

6,000 4,800

Salaries 9,000 6,000Bal c/d

5,660 920 Profit shared. 3,520 3,520

18,520

14,320 18,520 14,320

Bal b/d 5,660 920

305 Partnerships

EXAMPLE 7.2Draw up a profit and loss appropriation account for the year ended 31 December 19X7 and balance sheet extracts at the date, from the following:

i. Net profits £30,350ii. Interest to be charged on capitals: W £2,000; P £1,500; H £900

iii. Interest to be charged on drawings; W £240; P £180; H £130iv. Salaries to be credited: P £2,000; H £3,500.v. Profits to be shared: W 50%; P 30%; H20%.

vi. Current accounts: balances b/f W £1,860; P £946; H £717vii. Capital accounts: balances b/f W £40,000; P £30,000; H £18,000

viii. Drawings: W £9,200; P £7,100; H £6,900.

SOLUTIONSW,P and HProfit and Loss Appropriation Account for the year ended 31 December 2002

£ £Net profit for the year 30,350

Add: Interest on drawingsW 240P 180H 130 550

30,900Less: Interest on capital

W 2,000P 1,500H 900 (4,400)


P 2,000H 3,500 (5,500)

Balance of profit to be shared 21,000W 50% 10,500Pl 30% 6,300H 20% 4,200 (21,000)

Current AccountW P H W P H

£ £ £ £ £ £Interest on draw

240 180

130 Bal b/d 1,860 946

717

Drawings 9,200 7,100

6,900 Interest on capital

2,000 1,500

900

Bal c/d Salaries 2,000

3,500

Lesson Seven 306

Share of profits

10,000 6,300

4,200

Bal c/d 4,920 3,466

2,287

14,360 10,746

9,317 14,360 10,746

9,317

Balance sheet (extract) as at 31 Dec 2002£ £ £

Net Assets xxCapital W 40,000

P 30,000 H 18,000

88,000Current Accounts

W 4,920 Pl 3,466 H 2,287 10,673

98,673

Example 7.3The following list of balances as at 30 September 19X9 has been extracted from the books of Brick and Stone, trading partnership, sharing the balance of profits and losses in the proportions 3:2 respectively.

£Printing, stationery and postage 3,500Sales 322,100Stock in hand at 1 October 19X8 23,000Purchases 208,200Rent and rates 10,300Staff salaries 36,100Telephone charges 2,900Motor vehicle running costs 5,620Discounts allowable 950Discount receivable 370Sales returns 2,100Purchases returns 6,100Carriage inwards 1,700Carriage outwards 2,400Fixtures and fittings: at cost 26,000Provision for depreciation 11,200Motor vehicles: at cost 46,000Provision for depreciation 25,000Provision for doubtful debts 300Drawings: Brick 24,000

Stone 11,000Current account balances

307 Partnerships

At 1 October 19X8:Brick 3,600 creditStone 2,400 credit

Capital account balancesAt 1 October 19X8:

Brick 33,000Stone 17,000

Debtors 9,300Creditors 8,400Balance at bank 7,700

Additional information1. £10,000 is to be transferred from Brick’s capital account to a newly opened

Brick Loan Account on 1 July 19X9.2. Interest at 10 per cent per annum on the loan is to be credited to Brick.3. Stone is to be credited with a salary at the rate of £12,000 per annum from 1

April 19X9.4. Stock in hand at 30 September 19X9 has been valued at cost at £32,000.5. Telephone charges accrued due at 30 September 19X9 amounted to £400 and

rent of £600 prepaid at that date.6. During the year ended 30 September 19X9 Stone has taken goods costing

£1,000 for his own use.7. Depreciation is to be provided at the following annual rates on the straight line

basis:Fixtures and fittings 10%Motor vehicles 20%

Required:(a) Prepare a trading and profit loss account for the year ended 30 September 19X9.(b) Prepare a balance sheet as at 30 September 19X9 which should include

summaries of the partners’ capital and current accounts for the year ended on that date.

Note: In both (a) and (b) vertical forms of presentation should be used.

SOLUTIONBrick And Stone.Trial Balance As At 30 September 19x9

Debit Credit £ £

Printing and stationery and postage 3,500Sales 322,100Stock (1 October 19X8) 23,000Purchases 208,200Rent and rates 10,300Heat and light 8,700Staff salaries 36,100Telephone charges 2,900Motor vehicle running expenses 5,620

Lesson Seven 308

Discounts allowable 950Discounts receivable 370Sales returns 2,100Purchases returns 6,100Carriage inwards 1,700Carriage outwards 2,400Fixtures and fittings at cost 26,000Provision for depreciation 11,200Motor vehicles at cost 46,000Provision for depreciation 25,000Provision for doubtful debts 300Drawings: Brick 24,000

Stone 11,000

309 Partnerships

Current accounts:Brick 3,600Stone 2,400

Capital accounts:Brick 33,000Stone 17,000

Debtors 9,300Creditors 8,400Balance at bank 7,700

429,470 429,470

TRADING AND PROFIT LOSS ACCOUNT FOR THE YEAR ENDED 30 SEPTEMBER 19X9

£ £ £Sales 322,100

Less: Sales returns 2,100320,000

less cost of salesOpening Stock 23,000Purchases (adjustment) 207,200

Add: Carriage inwards 1,700208,900

Less: Purchases returns (6,100) 202,800225,800

Less: Closing Stock (32,000) (193,800)Gross profit 126,200Discount receivable 370

Less ExpensesTelephone charges (adjustment)) 3,300Printing and stationery and postage 3,500Rent and rages (adjustment) 9,700Heat and light 8,700Staff salaries 36,100Motor vehicle running expense 5,620Discount allowable 950Carriage outwards 2,400Depreciation on fixtures and fittings 2,600Depreciation on motor vehicles 9,200Interest on loan (adjustment) 250 (82,320)Net profit 44,250

Less: Salaries Stone (adjustment) (6,000)Balance of profit to be shared 38,250

Brick 22,950Stone 15,300 (38,250

Lesson Seven 310

Balance sheet as at 30 September 19X9Non current Asset £ £ £Fixtures and fittings 26,000 (13,800)

12,200Motor vehicles 46,000 (34,200) 11,800

72,000 48,000 24,000Current AssetStock 32,000Debtors 9,300Less: Provision (300) 9,000Payments 600Cash at bank 7,700

49,300Current LiabilitiesCreditors 8,400Accruals 400 (8,800) 40,500

64,500Capital

Brick (adjustment) 23,000Stone 17,000

Current:Brick adjustment 2,800Stone 11,700 14,500

54,500Non-Current Liabilities10% loan – Brick 10,000

64,500

Current AccountBrick Stone Brick Stone£ £ £ £

Drawings 24,000

12,000(adj)

Bal b/d 3,600 2,400

Interest on loan 250Bal c/d

2,80011,700 Salaries.

6,000Share profits 22,950 15,30

026,800

26,800 26,800 23,700

311 Partnerships

EXAMPLE 7.4Mack and Spencer are in partnership sharing profits and losses equally. The following is the trial balance as at 30 June 2003.

Dr. Cr. £ £

Buildings (cost £750,000) 500,000Fixtures at cost 110,000Provision for depreciation: Fixtures 33,000Debtors 162,430Creditors 111,500Cash at bank 6,770Stock at 30 June 19X8 419,790Sales 1,236,500Purchases 854,160Carriage outwards 12,880Discount allowed 1,150Loan interest: King 40,000Office expenses 24,160Salaries and wages 189,170Bad debts 5,030Provision for bad debts 4,000Loan from J King 400,000Capitals: Mack 350,000

Spencer 290,000Current accounts: Mack 13,060

Spencer 2,890Drawings: Mack 64,000

Spencer 56,500 2,446,040 2,446,040

Required:Prepare a trading and profit and loss appropriation account for the year ended 30 June 19X9 and a balance sheet as at that date.

a) Stock, 30 June 2003, £563,400b) Expenses to be accrued: Office Expenses £960; Wages £2,000c) Depreciate fixtures 10 per cent on reducing balance basis, buildings £10,000d) Reduce provision for bad debts to £3,200.e) Partnership salary: £8,000 to Mack. Not yet enteredf) Interest on drawings: Mack£1,800; Spencer £1,200.g) Interest on capital account balances at 10 per cent.

Lesson Seven 312

Mack and SpencerQ 5.2 Trading and Profit Loss Account for the year ended 30 June 2003

£ £ £Sales 1,236,500Less cost of salesOpening Stock 419,790Add: Purchases 854,160

1273,950Less: Closing Stock (563,400) 710,550Gross Profit 525,950Reduction in provision for bad debts (400-300) 800

526,750Less ExpensesDepreciation: Fixtures & Fittings (110,000-33,000 x )7,700

Buildings 10,000Carriage outwards 12,880Discount allowed 1,150Office expenses (24160 + 960) 25,120Loan interest 40,000Salaries and wages (18,9170 + 2000) 191,170Bad debts 5,030 (293050)Net Profit for the period 233,700Add: Interest on drawings:

Mack 1,800Spencer 1,200 3,000

236,700Less: Salaries – Mack (8,000)

228,700Less: interest on capital

Mack 35,000Spencer 29,500 (64,500)

164,200Balance of profits

Mack ½ 82,100Spencer ½ 82,100 164,200

Mack – Current Account£ £

Drawings 64,000 balance b/d 13,060Interest on drawings 1,800 salary 8,000

Interest on capital 35,000Profit 82,100

bal c/d 72,360 138,160 138,160

313 Partnerships

Spencer – Current Account

£ £Drawings 56,500 bal b/d 2980Interest on drawings 1200 Interest on capital 29,500

Profit 82,100Bal c/d 56,880

114,580 114,580

Balance Sheet as at 30 June 19X9

£ £ £Non Current Assets Cost Depreciation NBVBuildings 750,000 (260,000) 490,000Fixtures 110,000 (40,700) 69,300

860,000 (300,700) 559,300

Current AssetsStock 56,3400Debtors (16,243 – 320) 15,9230Cash at bank 6770

72,9400Current LiabilitiesCreditors 111,500Accruals (200 + 96) 2,960 (114,460) 61,4940

1,174,240

Capital Accounts: Mack 35,000 Spencer 29,500 64,500Current Accounts: Mack 72,360 Spencer 56,880 129,240

Loan from J. King 400,000 1,174,240

Lesson Seven 314

Example 7.5JUNE 1998 QUESTION 4

The balance sheet of the partnership of Kombo and Nzuki as at 31 March 1997 was as follows:

Capital accounts: Shs. Sh. Fixed asset sh. shKombo 1,400,000 (at cost less depreciationNzuki 1,400,000 2,800,000 Premises 1,200,000

Equipment 520,000Vehicles 418,000

2,138,000Current Accounts:Kombo 136,000Nzuki (81,200) 54,800

Current Liabilities: Current Assets:Creditors 501,600 Stock 894,200Accruals 25,600 527,200 debtors 475,900

Provision (46,400) 429,500Prepayments 28,600

Suspense account 326,300 Bank and cash 281,000 1,570,300 3,708,300 3,708,300

After a lengthy check of all the entries, the following errors were identified1. Discounts received, sh.26,400 had been debited to discounts allowed.2. The sales account had been under cast by sh.200,000.3. A credit sale of Sh.29,400 had been debited to a customer’s account as

Sh.42,900.4. A vehicle bought originally for sh.140,000 four years ago and depreciated

at 20% by straight line method on an assumed residual value of Sh.20,000 had been sold at Sh.60,000 but no entries, other than in the bank account had been passed through the books.

5. An accrual of Sh.11,200 for electricity charges had completely been omitted.

6. A bad debt of Sh.31,200 had not been written off an provision for bad debts should have been maintained at 10% of debtors.

7. Kombo’s current account had been credited with a partnership salary of Sh.60,000 which should have been credited to Nzuki’s current account.

8. Kombo had withdrawn, for personal use, goods to the value of Sh.39,200. No entries had been made in the books.

9. The partners share of profits and losses as follows: Kombo 60% and Nzuki 40%

Required:a) A statement of adjustments to show the correct net profit for the y

(12 marks)

315 Partnerships

b) A suspense account showing how the balance is eliminated from the books. (2 marks)

c) A corrected balance sheet as at 31 March 1997. (8 marks)

Lesson Seven 316

SOLUTIONThe following journal can be included although not required in the question.

DR CRi) DR: Suspense Account 26,400

CR: Discount Allowed Account 26,400

DR: Suspense Account 26,400CR: Discount receive 26,400Making the correct in the accounts

ii) DR: Suspense Account 200,000CR: Sales Account 200,000Sales undercast now corrected

iii) DR: Suspense Account 13,500 CR: Debtors Account 13,500Being an overstatement of debtors account now corrected

iv) DR: Asset Disposals Account 140,000CR: Asset Account 140,000DR: Provision for depreciation AccountCR: Asset Disposal AccountDR: Suspense Account 60,000CR: Asset Disposal Account 60,000DR: Asset Disposal Account 16,000CR: Profit and Loss Account 16,000

v) DR: Profit and Loss Account 11,200CR: Accrue expenses Account 11,200

vi) DR: Profit and Loss Account 31,200

CR: Debtors Account 31,200DR: Provision for doubtful debts Account 3,280CR: Profit and Loss Account 3,280

DR: Kombo’s Current Account 60,000CR: Nzuki’s Current Account 60,000DR: Kombo’s Current Account 39,200CR: Profit and Loss Account (Purchases)

39,200

317 Partnerships

(a) Kombo and Nzuki PartnershipStatement of Corrected Net Profit for the year

Sh. Sh.AdjustmentsDiscount allowed 26,400Discount received 26,400Sales undercasted 200,000Profit on disposal of asset 16,000Accrued electricity charges (11,200)Bad debts (31,200)Decrease in provision for bad debts 3,280Drawings (goods) 39,200

Net adjustments to Net Profit 268,880

Partners Current AccountKombo Nzuki Kombo NzukiShs Shs. Shs. Shs.

Bal b/d - 81,200

Bal b/d 136,000

-

Nzuki 60,000

- Kombo - 60,000

Drawings 39,200

- Net profit adjustments

161,328

107,552

Bal c/d 198,128

86,352

297,328

167,552

297,328

167,552

(b) Suspense Account Shs. Shs.

Discount allowed 26,400 bal b/d 326,300Discount received 26,400Sales 200,000Debtors 13,500Motor vehicle disposal 60,000

326,300 326,300

Lesson Seven 318

(c) Kombo and NzukiBalance Sheet as at 31 March 1997Fixed Assets Shs. Shs. Shs.Premises 1,200,000Equipment 520,000Vehicles 374,000

2,094,000Current AssetsStocks 894,200Debtors (431,200 – 43,120) 388,080Prepayments 28,600Bank and Cash 218,000

1,528,880Current LiabilitiesCreditors 501,600Accruals (25,600 + 11,200) 36,800 (538,400) 990,480

3,084,480

Capital AccountsKombo 1,400,000Nzuki 1,400,000 2,800,000

Current AccountsKombo 198,128Nzuki 86,352 284,480

3,084,480

NBThis is a very good question on partnership as it combines both errors on the accounts and Partnerships. Please study it carefully and follow up the entries and adjustments.

The next example is still on past paper and combines both incomplete records and partnerships.

EXAMPLE 7.6 JUNE 1997Question 1Kefa and Mark are partners sharing profits and losses equally. They do not maintain proper books of accounts. The following information has been obtained from the available records on 31 March:

1996 1997Sh. Sh.

Balance at bank 94,800 169,680Stock in trade 541,200 488,640Trade debtors 612,000 ?Trade creditors ? 305,760Furniture 360,000Motor vehicles (book value) 1,920,000

319 Partnerships

Total sales during the year ended 31 March 1997 amounted to Sh.3,849,120 while purchases, all on credit for the same period were Sh.2,952,480. On 31 March 1996 Kefa’s capital was Sh.200,000 less than that of Mark. The analysis of the cash book for the year ended 31 March 1997 shows the following:

Receipts:Cash from credit sales 3,491,520Additional capital by Kefa 240,000Cash sales 586,800

Payments:For purchases 3,070,080Salaries paid 420,000Rent paid (for 6 months to 30.9.96) 144,000Rates paid (for 6 months to 30.6.97) 120,000Electricity charges 60,000Advertising 41,760Motor vehicle expenses 119,520Sundry expenses 33,600Drawings - Kefa 132,480

Mark 102,000

On 31 March 1997 liabilities were as follows:Sh.

Electricity charges 12,480Advertisement 6,240Sundry expenses 3,600

On 20 March 1997 the firm decided to dispose of two of its motor vehicles. One vehicle was sold on credit for Sh.640, 000 while the other was taken over by Kefa at a valuation of sh.250, 000. the combined book value of the two vehicles was Sh.660,000. the transaction has not been recorded in the books.Depreciation at the rate of 10 percent is to be provided on furniture and motor vehicles on hand at 31 March 1997. No depreciation is to be provided for the vehicles, which were disposed of.Required:

a) Trading, profit and loss account for the year ended 31 March 1997. (10 marks)

b) Balance sheet as at 31 March 1997. (8 marks)c) Partner’s capital accounts (4 marks)

(Total: 20 marks)SOLUTIONJune 1997 Question 1

KEFA and MARKSTATEMENT OF AFFAIRS AS AT 31 March 1997

Assets Sh. Sh.Bank 94,800Stock 541,200Debtors 612,000

Lesson Seven 320

Furniture 360,000Motor vehicle 1,920,000

3,528,000LiabilitiesCreditors (423,360)Net Assets 3,104,640 Capital Kefa 1,452,320

Mark 1,652,320 3,104,640

Trading, Profit and loss account for the year ended 31 March 1997Sh Sh.

Sales 3,849,120Less cost of salesOpening stock 541,200Purchases 2,952,480

Less: Closing stock 488,640) (3,005,040)Gross profit 844,080Profit on disposal adjustment 230,000

1,074,080 Less Expenses

Salaries 420,000Rent adjustment 288,000Rates 60,000Electricity 72,480Advertising 48,000Motor vehicle 119,520Sundry expense 37,200Depreciation – Furniture 36,000

- Motor vehicle 126,000 (1,207,200) (133,120)

Net Loss should in PSRKefa (66,560)Mark (66,560) 133,120

Balance sheet as at 31 March 1997Non-current Assets Sh. Sh. Sh.Furniture 360,000 (36,000) 324,000Motor vehicle 1,260,000 (126,000) 1,134,000

1,620,000 (162,000) 1,458,000

Current AssetsStock 488,640Debtors – Trade Adjustment 382,800

- others vehicle 640,000Prepayments 60,000Bank 169,680

1,741,120

321 Partnerships

Current LiabilitiesCreditors 305,760Accruals 166,320 (472,080) 1,269,040

2,727,040Capital - Kefa 1,243,280 Mark 1,483,760

2,727,040

Lesson Seven 322

Capital AccountKefa Mark Kefa markShs. Shs. Shs. Shs.

Drawings 132,480

102,000

Bal b/d 1,452,320

1,652,320

Disposal 250,000

Cash 240,000

Loss shared 66,560

66,560

Bal c/d 1,243,280

1,483,760

1,692,320

1,652,320

1,692,320

1,652,320

(c) GOODWILL AND REVALUATION OF ASSETSThis is defined as the advantage, whatever it may be, a person gets by continuing to be entitled to represent to the outside would that he is carrying on a business which has been carried on for sometime previously. “Judge Warey in Hull V Frases”Goodwill is the element that arises from a business due to its reputation and therefore, enjoys benefits that a new business may not get.(e.g.) A new business may not make profits easily during the first year of

trading.

Factors that contribute to goodwill

1. Quality of products/Services2. Good personnel3. Marketing4. Location5.

In accounting, goodwill is very important for ascertaining the element or the share of a partner’s effort to improve the business. The problem is normally to ascertain the value or cost of goodwill.There are two types of goodwill:

1. Non-Purchase goodwillNon- purchased goodwill is determined by using subjective estimates. There are various approaches to these. Goodwill maybe arrived at by taking the average profits for lets say three previous years of trading.Due to this subjective estimate, this type of goodwill is not maintained or shown in the accounts.

2. Purchased goodwillThis is less subjective because it is the excess amount paid for a business above its net assets.This is less subjective because it is the excess amounts paid for a business above its net assets.

323 Partnerships

(e.g) If a business pays Sh.3.5 m to acquire the net assets (i.e. in these case the net assets will be total assets less total liabilities) of another business that is still trading on and the value of the net asset is 3 M, therefore the purchased goodwill may be shown in the accounts as an intangible asset. Purchased goodwill can be treated in the following three main ways:

1) Goodwill is written off from the accounts2) Is carried at its value an amortized over a period of time3) Carried at its value without being amortized.

The practice is normally to carry it in the accounts together with the other assets (as an intangible asset) and amortize it over estimated period of time.

Lesson Seven 324

In a partnership, there are normally three situations where goodwill is accounted for in the accounts:

a) If there is a change in the profit sharing ratio.b) On admission of a new partner.c) On retirement of an old partner.d)

Example (when there is a change in profit sharing ratio)When there is a change in the profit sharing ratio, then goodwill is introduced in the accounts by

Dr. Goodwill account Cr. Partner’s capital account ( the credit is based on the old profit sharing ratio.)

The goodwill may remain in the accounts and therefore no partner entries will be made.

If the goodwill is to be written off from the accounts, this will be done by Debiting partner’s capital account (in the New profit sharing ratio)Crediting goodwill account

Example:A and B have been trading as partners sharing profits and losses equally. They decided to change profit sharing ration to 3:2. The capital balances are:

A: - Sh.1,000,000B: - Sh.1,500,000

Goodwill has been agreed at Sh.500,00.

Required: The partner’s capital balances assuming that:1) Goodwill is to be retained in the accounts2) Goodwill is to be written off form the accounts.

Solution:

1) CAPITAL ACCOUNTA B A B

Bal b/d 1,000,000

1,500,000

Goodwill(OPSR) 250,000

250,000

Bal c/d 12,500,000

1,750,000

12,500,000

1,750,000

2) CAPITAL ACCOUNTA B A B

Goodwill 300,000 Bal b/d 1,000,000 1,500,00

325 Partnerships

(NPRS) 200,000 0Bal c/d (NPSR) 950,000 1,550,00

0Goodwill(OPSR)

250,000 250,000

12,500,000

1,750,000

12,500,000

1,750,000

REVALUATION OF ASSETS.The business may revalue some of the assets to reflect their fair values (e.g.) based on market price.The revaluation is normally done when a new partner is to be admitted or an old partner is retiring.

Any revaluation gains or losses are passed through a new account (i.e) a Revaluation account and the balance on this account profit or low on revaluation is transferred to the partner’s capital accounts in the existing profit sharing ratio.

Example:(A, B, and C are trading as partners sharing profits and losses in the ratio of 2:2:1. They have the following assets and liabilities at the book values and they wish to restate these values at market values and agreed values.

Assets/Liabilities Book value Market price/Agreed value Gain)£ £ Loss

Buildings 2,000,000 2,500,000 100,000Fixtures, Fittings & furniture 900,000 800,000 (100,000)

Motor vehicle 1,200,000 1,150,000 (50,000)Stock 700,000 650,000 (50,000)Debtors 450,000 400,000 (50,000)Creditors 800,000 700,000 100,000

Required:Prepare Revaluation account and the partner’s capital account given the partner’s balances as

A £3,000,000 B £2,500,000 C £1,500,000

REVALUATION ACCOUNT£ £

Fixtures 100,000 buildings 500,000Motor vehicles 50,000 Creditors 100,000Stock 50,000Debtors 50,000Capital A/C A 140,000 B 140,000

Lesson Seven 326

C 70,000600,000

600,000

CAPITAL ACCOUNTA B C A B C

Goodwill £ 000 £ 000 £ 000 £ 000 £ 000 £ 000Bal b/d 3,000 2,500 1,500

Bal c/d 3,140 2,640 1,510 Revaluation

140 140 70

3,140 2,640 1,570 3,140 2,640 1,570

If there is a profit on revaluation, then the profit will be transferred to the partner’s capital account by:

Dr. RevaluationCr. Partner’s capital account in the profit share ratio

If there is loss thenDr. Partner’s capital accountCr. Revaluation in the profit share ratio

EXAMPLE 7.7Alan, Bob and Charles are in partnership sharing profits and losses in the ratio 3:2:1 respectively.

The balance sheet for the partnership as at 30 June 19X6 is as follows;

Fixed Assets £ £Premises 90,000Plant 37,000Vehicles 15,000Fixtures 2,000

144,000Current AssetsStock 62,379Debtors 34,980Cash ___760 98,119

£242,119

CapitalAlan 85,000Bob 65,000Charles 35,000

185,000Current account

327 Partnerships

Alan 3,714Bob (2,509)Charles 4,678 5,883

Loan – Charles 28,000

Current liabilitiesCreditors 19,036Bank overdraft 4,200

£242,119

Charles decides to retire from the business on 30 June 19X6, and Don is admitted as a partner on that date. The following matters are agreed:

Lesson Seven 328

a) Certain assets were revalued;Premises £120,000Plant £35,000Stock £54,179

b) Provision is to be made for doubtful debts in the sum of £3,000.c) Goodwill is to be recorded in the books on the day Charles retires in the sum of

£42,000. The partners in the new firm do not wish to maintain a goodwill account so that amount is to be written back against the new partners’ capital accounts.

d) Alan and Bob are to share profits in the same ratio as before, and Don is to have the same share of profits as Bob.

e) Charles is to take his car at its book value of £3,900 in part payment, and the balance of all he is owed by the firm in cash except £20,000 which he is willing to leave as a loan account.

f) The partners in the new firm are to start on an equal footing so far as capital and current accounts are concerned. Don is to contribute cash to bring his capital and current accounts to the same amount as the original partner from the old firm who has the lower investment in the business.

The original partner in the old firm who has the higher investment will draw out cash so that his capital and current account balances equal those of his new partners.

Required;a) Account for the above transactions, including goodwill and retiring partners’

accounts.b) Draft a balance sheet for the partnership of Alan, Bob and Don as at 30 June

19X6.

Solution: Capital Accounts

Don Alan Bob Charles

Don Alan Bob Charles

£ £ £ £ £ £ £ £Goodwill written off

12,000

18,000

12,000

- Bal b/d - 85,000

65,000

35,000

Motor vehicle

- - - 3,900 Goodwill

- 21,000

14,000

7,000

Cashbook - 21,000

38,100

Cash book

79,000

- - -

Bal c/d 67,000

67,000

67,000

-

79,000

106,000

79,000

42,000

79,000

106,000

79,000

42,000

Current AccountsDon Alan Bob Charl Don Alan Bob Charl

329 Partnerships

es es£ £ £ £ £ £ £ £

Bal b/d - - 2,509

- Bal b/d - 3,714 - 4,678

Cash book

9,023

7,478 Revaluation a/c

- 8,400 5,600

2,800

Cash book 3,091

- - -

Bal c/d 3,091

3,091 3,091

-

3,091

12,114

5,600

7,478 3,091

12,114

5,600

7,478

Lesson Seven 330

Revaluation Account£ £

Plant 2,000 Premises 30,000Stock 8,200Debtors 3,000Profits shared: Alan 8,400 Bob 5,600 Charles 2,800 _____

30,000 30,000

Cash book£ £

Bal b/d 760 Charles – capital account

38,100

Don - capital account

79,000 Loan 8,000

Current account 3,091 Current account

7,478

Alan – capital account

21,000

Current account 9,023Bal c/d ******

Cash book£ £

Bal b/d 4,200Don - capital account

79,000 Charles – capital account

38,100

Current account 3,091 Loan account 8,000 Current account 7,478Alan – capital account

21,000

Current account 9,023

331 Partnerships

Alan, Bob and Don PartnershipBalance Sheet as at 30 June 19X6

Fixed Assets Cost Depreciation

NBV

Premises 120,000Plant 35,000Vehicles 1,100Fixtures 2,000

168,100Current AssetsStock 54,179Debtors 31,980Cash __760

86,919Less Current LiabilitiesCreditors 19,036Bank overdraft 5,710 (24,746) 62,173

230,273Capital accountsAlan 67,000Bob 67,000Don 67,000 201,000

Current AccountsAlan 3,091Bob 3,091Don 3,091 9,273

210,273Non current liabilitiesLoan – Charles 20,000

230,273

NOTE:

i. Goodwill introduced shared among the partners in the old partnership in current profit sharing ratios.

ii. Same case applies for any gain or loss in the revaluation of assets.iii. Goodwill written off in the new profit sharing ratios against the capital

accounts only for the new partners.iv. When there is no enough cash to be paid to the retiring partners, his balance

remains in the business as a loan.

(d) Admission of a new partner.When a new partner is admitted into the firm, this marks the end of the old partnership and the beginning of a new one.

Lesson Seven 332

The new partner will have to bring in the capital that is due from him as per the agreement and also pay for a share of the goodwill.Goodwill is credited to the partner’s account(only the old) and is again written off by debiting the partner’s account(inclusive of the new one in the new Profit Sharing Ratio).

If the admission is taking place part way through the financial period, then the new partner will be entitled to the profits or losses for the remaining part of the financial period. (i.e from the point of joining the partnership).Care should be taken when apportioning interest on capital, salaries and profits because of the changes

Example:The following was the partnership trial balance as at 30 April 2001:

Sh. Sh.Fixed capital accounts

Rotich 750,000Sinei 500,000

Current accountsRotich 400,000Sinei 300,000

Leasehold premises (purchased 1 May 2000) 2,250,000Purchases 4,100,000Motor vehicle (cost) 1,600,000Balance at bank 820,000Salaries (including partners’ drawings) 1,300,000Stocks: 30 April 2000 1,200,000Furniture and fittings (cost) 300,000Debtors 225,000Accountancy and audit fees 105,000Wages 550,000Rent, rates and electricity 310,000General expenses (Sh.352,400 for the six monthsto 31 October 2000) 660,000Cash introduced – Tonui 1,250,000

Sh. Sh.Sales (Sh.3,500,000 to 31 October 2000) 8,750,000Accumulated depreciation: 1 May 2000

Motor vehicle 300,000Furniture and fittings 100,000Creditors 1,070,000

13,420,000 13,420,000Additional information:1. On I November 2000 Tonui was admitted as a partner and from that date

profits and losses were to be shared on the ratio 2:2:1. For the purposes of this admission, the value of goodwill was agreed at Sh.3, 000,000. No account for goodwill was to be maintained in the books, adjusting entries for transactions between the partners being made in their current accounts. On that date, Tonui introduced Sh.1,250,000 more into the firm of which

333 Partnerships

Sh.375,000 comprised his fixed capital and the balance was credited to his current account.

2. Interest on fixed capitals was still to be allowed at the rate of 10% per annum after Tonui’s admission. In addition, after Tonui’s admission, no interest was to be charged or allowed on current accounts.

3. Any apportionment of gross profit was to be made on the basis of sales. Expenses, unless otherwise indicated were to be apportioned on a time basis.

4. A charge was to be made fro depreciation on motor vehicle and furniture and fittings at 20% and 10% per annum respectively, calculated on cost.

5. On 30 April, the stock was valued at Sh.1,275,000.

6. Salaries included the following partners’ drawings: Rotich Sh.150,000, Sinei Sh.120,000 and Tonui Sh. 62,5007. A difference in the books of Sh.48,000 had been written off at 30 April 2001 to

general expenses, which was later found to be due to the following clerical errors: Sales returns of Sh. 32,000 had been debited to sales returns but had not

been posted to the account of the customer concerned; The purchases journal had been undercast by Sh.80,000

8. Doubtful debts (for which full provision was required) amounted to Sh.30,000 and Sh.40,000 as at 31 October 2000 and 30 April 2001 respectively.

9. On 30 April 2001, rates and rent paid in advance amounted to Sh.50,000 and a provision of Sh.15,000 for electricity consumed was required.

Required:a) Trading and profit and loss account for the year ended 30 April 2001. (9

marks)b) Partners’ current accounts for the year ended 30 April 2001

(4 marks)c) Balance sheet as at 30 April 2001 (7 marks)

(Total: 20 marks)

Solutiona) ROTICH, SINEI AND TONUI

TRADING, P ROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 30 APRIL 2001

Sh. Sh.Sales 8,750,000Less: cost of sales

Opening stock 1,200,000Purchases 4,180,000

5,380,000Less: Closing stock (1,275,000) 4,105,000 Gross Profit 4,645,000

Lesson Seven 334

1.3.2000-3.10.2000

1.11.2000-30.4.2001

Sh Sh Sh Sh Sh ShGross profit 1,858,00

02,787,000

4,645,000

ExpensesDep. Motor Vehicle

160,000

160,000

320,000

Furniture 15,000

15,000

30,000

Salaries 483,750

483,750

967,500

Accountancy fees

52,500

52500 105,000

Wages 275,000

275,000

550,000

Rent, rates, electricity

137,500

137,500

275,000

General expenses

362,400

359,600

612,000

Prov. For depreciation

30,000

(1,506,150)

10,000

(1,393,350)

40,000

2,899,500

Net Profit 351,850

1,393,650

1,745,500

Less: Interest on capital Rotich

37,500

37,500

75,000

Sinei 25,000

25,000

50,000

Tonui - (62,500)

18,750

(81,250)

18,750

(143,750)

Balance of profit shared

289,350

1,312,400

1,601,750

Rotich 192,900

524,960

717,860

Sinei

335 Partnerships

96,450

524,960

621,410

Tonui - - (289,350)

262,480

(1,312,400)

262,480

(1,601,750

b)

Current AccountR S T R S CSh. Sh. Sh. Bal b/d Sh. Sh. Sh.

Goodwill w/o

1,200,000

1,200,000

600,000

400,000

300,000

-

Capital A/C

- - 375,000

Cash book

1,250,000

Drawings 150,000

120,000

62,500

Goodwill (2:1)

2,000,000

1,000,000

Interest on capital

75,000

50,000

18,750

Profit share

717,860

621,410

262,480

Bal c/d 1,842,860

651,410

493,730

3,192,860

1,971,410

1,531,230

3,192,860

1,971,410

1,531,230

c) Rotich, Sinei and TonuiBalance Sheet as at 30 April 2001

Non-Current Assets Sh Sh. Sh.Leasehold premises 2,250,000 - 2,250,000Furniture and Fittings 300,000 (130,000) 170,000

Lesson Seven 336

Motor vehicle 1,600,000 (620,000 980,000 4,150,000 (750,000) 3,400,000

Current AssetsStock 1,275,000Debtors 193,000Less Provision (40,000) 153,000Prepayments 50,000Balance at bank 820,000

2,298,000Current LiabilityCreditors 1,070,000Accruals 15,000 (1,085,000) 1,213,000

4,613,000

Capital: Rotich 750,000 Sinei 500,000 Tonui 375,000

1,625,000Current Account: Rotich 1,842,860

Sinei 651,410 Tonui 493,730 2,988,000

4,613,000

(d) The adjusting entries on admission of a new partner should be made to the capital account (i.e) for any introduction of goodwill and revaluation of assets

Some of the adjustments may also be made in the current accounts if adjustments are made in the capital account and the admission is partway through the financial period, then any interest to be charged on capital will be based on the adjusted capital balance.

If the adjustments are made in the current account then there will be no change on the capital balance and therefore no change on the interest charged on the capital balances.

(e) Retirement of a partnerWhen a partner retires (i.e.) leaves the firm and the others partners are left to continue with the business then the retirement marks the end of one partnership and the start of a new one.The partner who is leaving should be paid all the amounts due to him. This

include:1) Capital balanceThis will be all the amounts the partner has invested in the firm. Some firms may not be able to refund the amount in full and therefore it may be transferred t o a loan account whereby interest will be paid on the balance.2) GoodwillBecause this partner contributed to the improvement (existence) of the partnership therefore it will be fair to pay him his share of the goodwill. Goodwill is introduced to the accounts in the old profit sharing ratio ((i.e.)

337 Partnerships

credited to all the partner’s capital accounts in the old profit sharing ratio), then written off from the accounts by debiting the capital accounts of the remaining partners in the new profit share ratio.

2) Credit balance on the current account This amount due to the partner is paid directly from the cashbook or

transferred to the capital account whereby the total cash payable is to be determined.The transfer is made by:

Dr. Current accountCr. Capital account

4) Share of profitsIf the retirement takes place during the financial period, then the retiring partner is entitled to take profits made up to the point of retirement. Any interest of capital, salaries and balance of profit shared in profit share ratio will be credited to the partner’s current account.Therefore the profit and loss account will be split between the two periods and appointment of profits done and this will be based on the terms of the partnership in each period.

EXAMPLE 7.9May 2002 Question 3Kyamba, Onyango and Wakil were partners in a manufacturing and retail business and shared profits and losses in the ratio 2:2:1 respectively

Given below is the balance sheet of the partnership as at 31 March 2001.Balance sheet as at 31 March 2001Assets Sh. Sh.Non-current assets:Fixed assets 465,000Current assets:Stock 294,000Debtors 209,000 503,000

968,000Capital and liabilities:Capital accounts:

Kyamba 160,000Onyango 140,000Wakil 200,000

500,000Current accounts:

Kyamba 65,300Onyango 49,000Wakil 53,000

167,300667,300

Current Liabilities:Bank overdraft 48,000Trade creditors 252,000

300,700

Lesson Seven 338

968,000


1. On 1 April 2001, Wakil retired from the partnership and was to start a business as a sole trader while Kyamba and Onyango continued in partnership.

2. On retirement of Wakil, the manufacturing business was transferred to him while Kyamba and Onyango continued with the retail business

The assets and liabilities transferred to Wakil were as follows:Net book value Transfer valueSh Sh.

Fixed assets 260,000 306,000Stocks 166,000 157,000Debtors 172,000 165,000Creditors 156,000 156,000

Wakil obtained a loan from a commercial bank and paid into the partnership the net amount due for him.

3. On retirement of Wakil form the partnership, goodwill was valued at Sh.200, 000 but was not to be maintained in the books of the partnership of Kyamba and Onyango.

4. After retirement of Wakil on 1 April 2001, Kyamba and Onyango agreed on the following terms and details of the new partnership.

Kyamba and Onyango to introduce additional capital of Sh.48, 000 and Sh.68, 000 respectively.

Each partner was entitled to interest on capital at 10% per annum with effect from 1 April 2001 and the balance of the profits be shared equally after allowing for annual salaries of Sh.72, 000 to Kyamba and Sh.60, 000 to Onyango.

5. The profit of the new partnership before interest on capitals and partners’ salaries was Sh.240,000 for the year ended 31 March 2002.

6. The profits made by the new partnership increased stocks by Sh.100,000, debtors by Sh.90,000 and bank balance by Sh.50,000.

7. Drawings by the partners in the year were Kyamba Sh.85,000 and Onyango Sh.70,000.

Required:a) Profit and loss and appropriation account for the year ended 31 March 2002.

(4 marks)b) Capital accounts for the year ended 31 March 2002

(4 marks)c) Current accounts for the year ended 31 March 2002.

(4 marks)d) Balance sheet of the new partnership as at 31 March 2002.


339 Partnerships

SOLUTIONa) Kyamba and Onyango

Profit and loss appropriation account for the year ended 31.3.2002

Sh Sh.Net profit for the year 240,000Less: Interest on capital

Kyamba 20,000Onyango 20,000 (40,000)


Kyamba 72,000Onyango 60,000 (132,000)

Balance of profits shared in PSR 68,000Kyamba ½ 34,000Onyango ½ 34,000 (68,000)

b) CAPITAL ACCOUNTK O W K O W

(2) Goodwill in New PSR

100,000

100,000

- Bal b/d 160,000

140,000

200,000

(4) Fixed Assets

306,000

(1)Goodwill in old PSR

80,000

80,000

40,000

Stocks 157,000

Cashbook 48,000

68,000

-

Debtors 165,000

Profit on transfer in old PSR

12,000

12,000

6,000

Creditors 156,000

Bal c/d 200,000

200,000

Current account (3)

53,000

Cash book (**)

173,000

300,000

3000,000

628,000

300,000

300,000

628,000

c) CURRENT ACCOUNTK O W K O WSh Sh Sh Sh Sh sh

Capital - - 53,000 Bal b/d 65,300 53,00

Lesson Seven 340

49,000

0

Drawings

85,000

70,000

- Interest on capital

20,000 20,000

-

Salaries 72,000 60,000

-

Bal c/d 106,300

93,000

- Share of profits

34,000 34,000

-

191,300

163,000

53,000 191,300 163,000

53,000

KYAMBA AND ONYANGOBalance Sheet as at 31 March 2002.Non-Current Assets Sh. Sh.Current Assets 205,000Stock 228,000Debtors 127,000Bank 135,300

490,300LiabilitiesCreditors (96,000) 394,300

599,300Capital:

Kyamba 200,000Onyango 200,000

400,000Current:

Kyamba 106,300Onyango 93,000 199,300

599,300b) Bank

Working capital 173,000 Bal b/d 48,700Kyamba- capital 48,000 DrawingsOnyango – capital 68,000 Kyamba 85,000Increase 50,000 Onyango 10,000 _______ Bal c/d 135,300

339,000 339,000

Workings:

Non Current Assets:

341 Partnerships

Bal b/f 465,000Transfer 260,000Balance 205,000

Stock:Bal b/f 294,000Transfer (166,000)Increase 100,000

228,000

Debtors:Bal b/f 209,000Transfer (172,000)Increase 90,000

127,000Creditors:

Bal b/f 252,000Transfer 156,000

96,000

EXAMPLE 7.10Upp and Downe are in partnership. The following trial balance has been extracted from their books of account as at 31 March 19 –2 after their trading and profit and loss account has been prepared, but before any consequent adjustments have been made to the partners’ respective capital accounts.

Dr. Cr.Capital accounts (as at 1 April 19 – 1): £ £

Upp 60,000Downe 40,000

Cash 6,600Creditors 29,250Debtors 201,000Downe: goods withdrawn 400Drawings:

Upp (all at 31 December 19 – 1) 20,000Downe (all at 30 September 19 – 1) 15,000

Fixed assets: at cost 200,000Accumulated depreciation 90,000

Accrued interest on Upp’s Loan account 10,000Loan account: Upp 50,000Net profit for the year to 31 March 19 – 2)

179,750Salary: Downe 12,000Stocks 3,500Upp: private expenses paid (on 31 March 19 – 2) 500

£459,000 459,000

Additional information1. The partnership agreement contains the following provisions:

Lesson Seven 342

a) Profits and losses are to be shared equally;b) Current accounts are not to be kept;c) The partners will be entitled to interest on their capital account balances as

at 1 April in each year at a rate of 15% per annum;d) The partners will be charged interest on any cash drawings made during the

year at a rate of interest of 10% per annum;e) Downe is to be allowed a salary of £16,000 per annum;f) A specific loan made by any partner is to bear interest at a rate of 20% per

annum;g) Upon the retirement of a partner the partnership assets and liabilities ar to

be revalued at their market value as at the date of retirement of the partner.

2. Upp decided to retire at 31 March 19 – 2. In accordance with the partnership agreement, the assets and liabilities were revalued as follows:

£Car (to be retained by UPP) 10,000Remaining fixed assets taken over by the new partnership 50,000Stocks 5,000Debtors 180,000Creditors 35,000Goodwill 40,000Legal and other expenses connected with the partnership change

4,7503. Following Upp’s decision to retire, Downe invited Side to join him in

partnership as fro 1 April 19 – 2. Side agreed to pay £75,000 into the new partnership as at that date as his capital contribution. Profits and losses are to be shared in the proportion Downe 75% and side 25%. Goodwill is not to be retained in the books of the partnership.

4. Upp agreed to leave half of the total amount owing to him on his retirement as a long run term loan in the new partnership, the other half being paid to him in cash.

5. It may be assumed that all of the transactions relating to the changes in the respective partnerships take place on 1 April 19 – 2. The legal and other expenses connected with the partnership changes were due for payment on 30 April 19 – 2.

Required:Prepare:

a. Upp and Downe’s profit and loss appropriation account for the year to 31 March 19 – 2.

b. Upp, Downe and Side’s respective capital accounts sufficient to reflect all of the above transactions. and

c. Downe and Side’s balance sheet as at 1 April 19 – 2 immediately after all of the above transactions havebeen settled.

(Detailed working should be submitted with your answer).

SOLUTION(a)Upp and Downe

343 Partnerships

Profit and loss appropriation account for the year ended 31 March 19-2

£ £ £Net profit b/d 179,750 Add interest on drawings Upp [3/12 x (10% x 20,000)]

500

Downe [16/12 x (10% x 15,000)]

750 1,250

181,000Less: Interest on capital 9,000 Upp [15% x 60,000] 6,000 (15,000) Downe [15% x 40,000 166,000Less: Salary – Downe (16,000)Balance of profits shared in PSR

150,000

Capital – Upp (1/2) 75,000 - Downe (1/2) 75,000 150,000

_____-

Lesson Seven 344

(b)

Capital AccountsUpp Downe Upp Downe£ £ £ £

Appropriation Balances b/d 60,000

40,000

- interest on drawings

500 750 Loan interest 10,000

Salary 12,000 AppropriationDrawings 20,00

015,000 -salary 16,000

Private expenses/goods

500 400 -interest on capital

9,000 6,000

Car 10,000

-residual profit 75,000

75,000

Revaluation (deficit) (W1)[see workings after (c)]

20,000

20,000

Loan (balancing figure)

103,000

Balance c/d _____- 88,850 ______ ______154,000

137,000

154,000

137,000

Side Downe Side Downe£ £ £ £

Goodwill written back (W2)

10,000

30,000 Balance b/d - 88,850

Balances c/d 65,000

58,850 Cash 75,000

____-

75,000

88,850 75,000

88,850

(c)Balance Sheet as at 1 April 19-2

£ £Non current assets 50,000Current assets Stocks 5,000 Debtors 180,000 Cash (W3) __5,100

190,100

345 Partnerships

Current liabilities Creditors [35,000 + 4,750] 39,750Working capital 150,350Net assets employed 200,350Financed byCapital Downe 58,850 Side 65,000

123,850Loan Upp (W4) _76,500

200,350

Workings

W1 Revaluation

£ £Debtors 201,00

0Creditors 29,250

Fixed assets (cost) 200,000


90,000

Stocks 3,500 Capital – Upp (car) 10,000Legal etc expenses 4,750 Fixed assets 50,000Creditors 35,000 Stocks 5,000

Debtors 180,000

Goodwill 40,000______ Balance c/d (deficit) 40,000444,250

444,250

Balance b/d 40,000 Capital-Downe (1/2) 20,000

_____ -Upp (1/2) 20,00040,000 40,000

W2 Goodwill

£ £Revaluation 40,000 Capital

-Downe (75%) 30,000_____ -Side (25%) 10,00040,000 40,000

Lesson Seven 346

W3 Cash

£ £Balance b/d 6,600 LoanCapital -Upp [1/2 x

153,000]76,500

-Side 75,000 Balance c/d 5,10081,600 81,600

Bal b/d 5,100

W4 Loan - Upp

£ £Cash 76,500 Balance b/d 50,000Balance c/d 76,500 Capital

-Upp 103,000

153,000

153,000

Balance b/d 76,500

347 Partnerships


QUESTION ONE1. K. Kimeu and M. Maingi are in partnership as manufactures of Tick Toys,

Kimeu being responsible for the factory and Maingi for the sales. All completed toys are transferred from the factory to sales department at agreed price. Profits are shared on the following basis:

Factory Sales DepartmentKimeu 80% 40%Maingi 20% 60%

The following trial balance has been extracted from the books at 31 March 1992:

Sh. Sh.Freehold factory at cost 1,053,750Factory plant, at cost 843,750Provision for depreciation 1 April 1991 151,250Delivery van, at cost 401,250Provision for depreciation 1 April 1991 86,250Stocks at 1 April 1991

Raw materials 100,700Work-in-progress 85,000Toys completed (30,000 at Sh.40) 1,200,000

Sales (45,500 toys) 2,775,500Purchases of raw materials 716,250Factory wages 375,500Sales department wages 150,750Expenses:

Factory 301,750Sales Department 250,500

Provision for doubtful debts 1 April 1991 40,000Trade debtors and creditors 450,000 150,000Bank overdraft 176,200Capital accounts:

Kimeu 1,400,000Maingi 1,425,000

Drawings:Kimeu 150,000Maingi 125,000

6,204,200 6,204,200

Lesson Seven 348

Additional information:i 38,000 toys at Sh.45 each were manufactured and transferred to Sales

Department during the year. Tys in stock at the end of the year were to be valued at Sh. 45 each. Stock of raw materials was Sh.79.50 and work-in-progress was valued at prime cost of Sh.126, 250 at 31 March 1992.

ii Accrued expenses outstanding at 31 March 1992:Factory Sales DepartmentSh. Sh.

Expenses 52,250 27,000 Factory wages7,000 -

iii Provision for depreciation is to be made as follows:- Factory plant 10% p.a. on cost- Delivery van 20% p.a. on cost

iv The general provision for bad debts is to be maintained at 10% of the trade

debtors.

Required:Manufacturing, trading and profit and loss accounts for the year ended 31 March 1992 and a balance sheet as at that date.

(20 marks)

QUESTION TWO

Amis, Lodge and Pym were in partnership sharing profits and losses in the ratio 5:3:2. The following trial balance has been extracted from their books of accounts as at 31 March 19-8:

£ £Bank interest received Capital accounts (as at 1 April 19-7):

Amis 80,000Lodge 15,000Pym 5,000

Carriage inwards 4,000Carriage outwards 12,000Cash at bank 4,900Current accounts:

Amis 1,000Lodge 500Pym 400

Discount allowed 10,000Discount received 4,530Drawings:

Amis 25,000Lodge 22,000Pym 15,000

Motor vehicles: 80,000Accumulated depreciation (at 1 April 19-7) 20,000

Office expenses 30,400

349 Partnerships

Plant and machinery:At cost 100,000Accumulated depreciation (at 1 April 19-7) 36,000

Provision for bad and doubtful debts(at 1 April 19-7) 420

Purchases 225,000Rent, rates, heat and light 8,800Sales 404,500Stock (at 1 April 19-7) 30,000Trade creditors 16,500Trade debtors 14,300

£583,300 £583,300Additional information:

1. Stock at 31 arch 19-8 was valued at £35,000.2. Depreciation on the fixed assets is to be charged as follows:

a. Motor vehicles – 25% on the reduced balanceb. Plant and machinery – 25% on the original cost.

There were no purchases or sales of fixed assets during the year to 31 March 19-8.3. The provision for bad and doubtful debts is to be maintained at a level

equivalent to 5% of the total trade debtors as at 31 March 19-8.4. An office expense of £405 was owing at 31 March 19-8, and some rent

amounting to £1,5000 had been paid in advance as at that date. These items had not been included in the list of balances shown in the trial balance.

5. Interest on drawings and on the debit balance on each partner’s current account is to be charged as follows:

£Amis 1,000Lodge 900Pym 720

6. According to the partnership agreement, Pym is allowed a salary of £13,000 per annum. This amount was owing to Pym for the year to 31 March 19-8, and needs to be accounted for.

7. The partnership agreement also allows each partner interest on his capital account at a rate of 10% per annum. There were no movements on the respective partners’ capital accounts during the year to 31 March 19-8, and the interest had not been credited to them as at that date.

Required:a) Prepare the Partners trading, profit and loss account for the year ended

31 March 19-8b) The partners current accounts and a balance sheet as at 31 March 19-8

QUESTION THREEAmber and Beryl are in partnership sharing profits in the ratio 60:40 after charging annual salaries of £20,000 each. The regularly make up their accounts to 31 December each year.

Lesson Seven 350

On July 1996 they admitted Coral as a partner and agreed profits shares from that date of 40% Amber, 40% Beryl and 20% Coral. The salaries credited to Amber and Beryl ceased from 1 July 1996.

351 Partnerships

The partnership trial balance at 31 December 1996 was as follows:

£ £Capital accounts as at 1.1.96: Amber 280,000 Beryl 210,000Capital account Coral (see note (d) below) 140,000Current accounts as at 1.1.96 Amber 7,000 Beryl 6,000Drawing accounts Amber 28,000 Beryl 24,000 Coral 15,000Loan account Amber 50,000Sales 2,000,000Purchases 1,400,000Stock 1.1.96 180,000Wages and salaries of staff 228,000Sundry expenses 120,000Provision for doubtful debts at 1.1.96 20,000Freehold land at cost (see not (e) below) 200,000Buildings: cost 250,000 Aggregate depreciation 1.1.96 30,000Plant, equipment and vehicles: cost 240,000 Aggregate depreciation 1.1.96 50,000Trade debtors and creditors 420,000 350,000Cash at bank 38,000

3,143,000 3,143,000

In preparing the partnership accounts the following further information is to be taken into account:

a) Closing stock at 31 December 1996 was £200,000b) Debts totaling £16,000 are to be written off and the provision for

doubtful debts increased by £10,000.c) Provision is to be made for staff bonuses totaling £12,000.d) The balance of £140,000 on coral’s capital account consists of £100,000

introduced as capital and a further sum of £40,000 paid for a 20% share of the goodwill of the partnership. The appropriate adjustments to deal with the goodwill payment are to be made in the capital accounts of the partners concerned, and no goodwill account is to remain in the records.

e) It was agreed that the freehold land should be revalued upwards on 30 June prior to the admission of Coral from £200,000 to £280,000. The revised value is to appear in the balance sheet at 31 December 1996.

f) Amber’s loan carries interest at 10% per annum and was advanced dot the partnership some years ago.

g) Provide depreciation on the straight-line basis on cost as follows:Buildings 2%

Lesson Seven 352

Plant, equipment and vehicles 10%h) Profits accrued evenly during the year.

Require:a) Prepare a trading account, profit and loss account and appropriation

account for the year ended 31 December 1996 and a balance sheet as at that date. (17 marks)

b) Prepare the partners’ capital accounts and current accounts for the year in columnar form.

(7 marks) (Total: 24

marks)QUESTION FOURDuke and Earl are in partnership operating a garage business named Aristocratic Autos.In addition to selling petrol and oil, the garage has a workshop where car repairs and maintenance are carried out and also a small showroom form which new and second hand cars are sold.

For accounting purposes, each of these three activities is treated as a separate department.At 30th September 1986 balances extracted from the ledgers of Aristocratic Autos comprised:

£Cash sales: Workshop (repair charges) 32,125 Petrol and oil 32,964 Showroom (car sales) 8,500Credit sales: Workshop (repair charges) 65,892 Petrol and oil 41,252 Showroom (car sales) 81,914Stocks (at 1 October 1985): Workshop (repair materials) 1,932 Petrol and oil 3,018 Showroom (cars) 20,720Credit purchases: Workshop (repair materials) 23,860 Petrol and oil 41,805 Showroom (cars) 52,100Fixed assets (at 1 October 1985): *Freehold buildings: Workshop 12,600 Petrol and oil 14,200 Showroom 38,000Plant, equipment and vehicles: Workshop 65,180 Petrol and oil 22,900

353 Partnerships

Showroom 17,450Provisions for depreciation (at 1 October 1985): Freehold buildings: Workshop 5,060 Petrol and oil 7,100 Showroom 19,390*Note ‘Freehold’ – held in perpetuityPlant, equipment and vehicles: Workshop 48,254 Petrol and oil 17,077 Showroom 9,451Fixed asset acquisitions during year (at cost): Plant and equipment: Workshop 26,210 Petrol and oil 4,250 Showroom 1,060Fixed asset disposal proceeds during the year (see note (3)): Plant and equipment: Workshop 5,200Salaries: Showroom 10,200Rates 26,738Electricity 9,453General expenses 10,692Wages: Direct: Workshop 34,050 Petrol and oil 5,602Indirect: Workshop 6,810 Showroom 4,160Creditors: Workshop 4,225 Petrol and oil 5,602 Showroom 15,250Bank/Cash: Workshop 316 Petrol and oil 1,605 Showroom 30,470Debtors: Workshop 1,365 Petrol and oil 537Drawings: Duke 12,190 Earl 9,740Current accounts (at 1 October 1985) (credit balances):

Lesson Seven 354

Duke 9,750 Earl 10,477Capital accounts: Duke 50,000 Earl 40,000

355 Partnerships

Notes at 30 September 1986

1) Stocks at 30 September 1986:Workshop 2,752Petrol and oil 2,976Showroom 25,310

2) Depreciation is calculated using the straight-line method (assuming no residual value) and is applied to the original cost of the asset at eh end of the financial year, using the following rates:

%Freehold buildings 20Plant, equipment and vehicles 20

The depreciation charges for the current year have not yet been posted to the accounts.

The freehold buildings are temporary structures with a five year life.3) No entries have yet been made to transfer the cost (£19,500) and

accumulated depreciation (£15,633) of the workshop plant sold during the year.

4) Accruals at 30 September 19861 £ Wages:

Direct: Workshop 113

Petrol and oil 83 Indirect:

Workshop 214Showroom 231

Electricity 517General expenses 1,304

5) Prepayments at 30 September 1986 £

Rates 13,300

6) Rates and electricity are apportioned over departments on the basis of the original cost of freehold buildings at the end of the current financial year.

7) General expenses are apportioned over departments on the basis of turn over for the current year.

8) Duke and Earl are credited with interest on their respective capital account balances at the rate of 5% per annum.

Required:Prepare, using separate columns for each department and the business as a whole;

a) A departmental trading and profit and loss account for Aristocratic Autos for the year ended 30 September 1986. (20 marks)

b) A departmental balance sheet for Aristocratic Autos as at 30 September 1986.


Lesson Seven 356

357 Partnerships

QUESTION FIVEReg, Sam and Ted are in partnership, sharing profits and losses equally. Interest on capital and partnership salaries is not provided. The position of the business at th end of its financial year is:

Balance Sheet 30 June 19-6£ £ £ £

Capital accounts:

Buildings 17,000

Reg 9,000 Equipment 3,300 Sam 8,000 Stock 900 Ted 8,000 Debtors 2,020

25,000

Bank 2,840

Current Accounts: Reg 140 Sam 200

340 Ted (debit)

100

240Creditors ___82

0_____

26,060

26,060

Reg died suddenly on 31 October 19-6.The partnership agreement provides that in the event of the death of a partner the sum to be paid to his estate will be the amount of his capital and current account balances at the last financial year-end adjusted by his share of profit or loss since that date together with his share of goodwill. A formula for calculation of goodwill is given, and its application produced a figure of £7,500. no goodwill account is to remain in the books after any change of the partnership constitution.The stock value at 31 October has been calculated and all other accounts balanced off, including provisions for depreciation, accrued expenses and prepaid expenses.

This results in the following position at 31 October.£

buildings 17,000Equipment (including additions of £400) 3,480Stock 1,100Debtors 2,230Bank balance 3,370Creditors 980

There were no additions to, or reductions of, the capital accounts during the four months, but the following drawings have been made:

Lesson Seven 358

Reg £2,000Sam £1,600Ted £1,800

359 Partnerships

It has also been agreed that the share of a deceased partner should be repaid in three equal installments, the first payment being made as on the day after the day of death.

The surviving partners agree that Abe (son of Reg) should be admitted as a new partner with effect from 1 November, and it is agreed that he will bring into the business £4,000 as his capital together with a premium for his share of the goodwill (using the existing valuation). The new profit-sharing agreement is: Sam, two-fifths; Ted, tow-fifths; and Abe one-fifth.

Show the partnership Balance Sheet as at 1 November 19-6, on the assumption that the above transactions have been completed by that date.


Lesson Seven 360



To be carried out under examination conditions and sent to the Distance Learning Administrator for marking by the College.


QUESTION ONEThe Dohray Amateur Musical Society has a treasurer who is responsible for receipts and payments, which he records in cash and bankbooks. Periodically, these books are handed over to the firm of certified accountants that employs you.One of your tasks is to prepare the final accounts of the Society. As a preliminary step, you have prepared the receipts and payments account (rounded to the nearest £1) for the year ended 31 May 1985. This is shown below, together with the explanatory notes which the treasurer has supplied to enable you to understand the nature o f some of the items.

Dohray amateur Musical SocietyReceipts and Payments AccountFor the year ended 31 May 1985

Receipts PaymentsCash Ban

kCash Bank

£ £ £ £

£

£

£

£Opening balances b/d

31 309 Creditors: trade

Debtors: members

Fixed assets (note 4)

Joining fees (note 1)

190 160 Musical instruments

522

361 Partnerships

Annual subscriptions

Trophies 83

(Note 2) 285 70 Creditors: tradeAnnual concert (note 3)

Purchase for resale

Takings 1,791 (Note 4)Sales of goods (note 4)

Sheet music 118

Musical instruments

287 Annual concert (note 3)

Prize moneys (note 7)

190 Hall booking fees 490

Sponsorship grant Printing of publicity

(Note 5) 300 Posters 112Refreshment sales 113 Hire professionalRaffle profits 64 Soloists 236PAC grants (note 6)

Musicians 174

Revenue 100 Adjudication fees Capital 400 Musical Festivals

(note 7)Transfers from cash a/c

2,910

Entrance fees 250

Hire of buses 281Honoraria (note 8) Secretary 150 Treasurer 100R.M.F.C affiliation fee (Note 9) 72Rent of society’s premises (Note 10) 510Refreshment purchases

72

Bank charges 42Sundry expenses 60Transfers to bank a/c

2,910

Closing balances c/d 49 723

3,091 4,249

3,091 4,249

Explanatory notes supplied by the treasurer

Lesson Seven 362

1) On joining the Society, members pay a non-returnable fee of £10 (before 1 June 1982, the fee had been £). It has been found from experience that, on average, members remain in the Society for five years. On this basis, one fifth of each joining fee is credited to Income and Expenditure account each year.

New members’ statistics are

During the yearEnded 31 May

Number ofnew members

Joining fees inSuspense at 31 May 1984

No. £1981 20 201982 24 481983 32 1921984 27 2161985 35 Nil

£476

2) Annual subscriptions are due on 1 June each year. It is Society’s policy to credit these to income and expenditure account on an actual receipts basis, not an accruals basis. However, if subscriptions are received in advance, the amounts are credited to income and expenditure account for the year, which they are paid.

3) The Society’s major money raising event is its annual public concert. This is given in a large hall, which the Society hires. The society also hires professional musicians and soloists and has to pay the fees of the adjudicators (judges).

4) The society buys trophies (silver bowls and shield) to present to the winners of individual musical items at the annual concert. It also buys musical instruments some of which are for use by the members and others for resale to the members. Musical scores and sheets are also bought for resale to the members.

5) A local building company has given a grant to the Society for a period of three years in return for publicity. This sponsorship grant was received in full on 1 June 1984 and is being credited to income and expenditure account in equal installments in each o the three years to 31 May 1987.

6) The performing Arts Council (PAC) has awarded the Society an annual grant towards the running costs. In addition the PAC makes capital grants. The society’s policy is to hold capital grants in suspense and to release each year’s grant to income and expenditure account over a period of five years, from the year of grants onwards. At 31 May 1984 capital grants held in suspense were analyzed as follows:

In respect of yearEnded 31 May

Capital grantsSuspense

363 Partnerships

£1981 301982 701983 1201984 120

£340

7) Throughout the year, the Society competes at various musical festivals. Cash prizes won by individual members are retained by the Society and credited to income and expenditure account in order to reduce the cost of attending the festivals.

8) The offices of secretary and treasurer are unpaid but the society gives each of them an ex-gratia (honorary) cash award, termed an honorarium.

9) In order to participate in the musical festivals, the Society has to be affiliated to the Regional Musical Festival Community (RMFC). The annual fee, which has remained the same for a number of years, is paid on 1 March in each year.

10) The Society pays rent for its premises. The rental, which is inclusive of rates, heating, lighting, cleaning etc. is reviewed annually on 31 March. The payment shown in the receipts and payments account represents quarterly payments in advance, as follows:

1984 Payment£

30 June 12030 September

120

31 December

120

1201985

31 March 150 £510

The treasurer supplied further information as follows:

1) Creditors at 31 May 1984 1985 £ £

Fixed assets Musical instruments 79 119 Trophies 23 13Purchases for resale Sheet music 14 20 Musical instruments 45 39

2) Subscriptions Payments in advance included in the actual receipts for the year 30 40

Lesson Seven 364

3) Stocks at 31 May Goods for resale Sheet music 31 52 Musical instruments 70 94Refreshments not brought into account on the grounds thatIt is not material in amount

4) Fixed assets (at cost) at 31 May musical instrument 1,378 Trophies 247

There were no fixed asset disposals during the year

5) Provision for depreciation at 31 May Musical instruments 704 Trophies 96

Depreciation is calculated on the cost of these assets at the end of the financial year. The straight-line method is employed using the following assumed asset lives.

Musical instruments 5 years Trophies 10 years

Required:Prepare for the Dohray Amateur Musical Society

a) The Income and Expenditure account for year ended 31 May 1985, showing the surplus or deficit on each of the activities:and

b) The Balance Sheet at that date.Note: WORKINGS are an integral part of the answer and must be shown.

(34 marks)

QUESTION TWOA client of the firm of accountants by which you are employed is interested in buying a road transport business from the widow of its deceased owner.The senior partner of the practice is investigating various aspects of the business and has delegated to you the task of discovering the amount of investment in vehicles at the end of each of the financial years ended 30 September 1980 to 1983 inclusive. The business had commenced operations on 1 October 1979.The only information available to you is the fact that the owner calculated depreciation at a rate of 20% per annum, using the Reduction Balance method, based on the balance at 30 September each year, and copies of certain ledger accounts which are reproduced below:

Provision for depreciation of vehicles£ 1980 £

365 Partnerships

1 Oct.

Balance b/ 32,000

1981 198130 Sept.

Balance c/d 57,600 30 Sept.

Profit and loss

25,600

57,600 £57,600

£ £1982 1

Oct.Balance b/d 57,600

30 Sept.

Disposals 10,800 1982

Balance c/d 73,440 30 Sept.

Profit and loss

26,640

includes £10,000(depreciation on 1982

_____

acquisitions) ___ __

£84,240

£84,240

£ £198330 Sept.

Disposals 29,280 1 Oct.

Balance b/d 73,440

Balance 79,328 198330 Sept.

Profit and loss

35,168

(includes £20,000Depreciation on

_______

1983 acquisitions)

______

£108,608

£108608

1 Oct.

Balance b/d 79,328

Disposals£ £

1982 198230 Sept.

Vehicles (vehicles

30 Sept.

Provision for

Originally Depreciation 10,800

Lesson Seven 366

acquiredOn 1 October 1979)

30,000 Bank 16,000

Profit and loss

3,200

______

______

£30,000

£30,000

£ £1983 198330 Sept.

Vehicles (vehicles

300 Sept.

Provision for

Originally acquired

Depreciation 29,280

On 1 October 1979)

60,000 Bank 42,000

Profit and loss

11,280

______

______

£71,280

£71,280

Required:a) Calculate the cost of asset, vehicles, held by the business at 30

September in each of the years 1980 to 1983 inclusive(4 marks)

b) Show the detailed composition of the charge for depreciation of the vehicles to profit and loss account at 30 September 1981, 1982 and 1983.

(9 marks)All workings must be shown. (13 marks)

QUESTION THREEThe trial balance of Happy Bookkeeper Ltd, as produced by its bookkeeper includes the following items:

Sales ledger control account £110,172Purchase ledger control account £78,266Suspense account (debit balance) £2,315

You have been given the following information:

367 Partnerships

i. The sales ledger debit balances total £111,111 and the credit balances total £1,234.

ii. The purchase ledger credit balances total £77,777 and the debit balances total £1,111.

iii. The sales ledger includes a debit balance of £700 for business X, and the purchase ledger includes a credit balance of £800 relating to the same business X. Only the net amount will eventually be paid.

iv. Included in the credit balance on the sales ledger is a balance of £600 in the name of H. Smith. This arose because a sales invoice for £600 had earlier been posted in error from the sales daybook to the debit of the account of M. Smith in the purchase ledger.

v. An allowance of £300 against some damaged goods had been omitted from the appropriate account in the sales ledger. This allowance had been included in the control account.

vi. An invoice for £456 had been entered in the purchase daybook as £654.vii. A cash receipt from a credit customer for £345 had been entered in the

cashbook as £245.viii. The purchase daybook had been overcast by £1,000.

ix. The bank balance of £1,200 had been included in the trial balance, in error, as an overdraft.

x. The bookkeeper had been instructed to write off £500 from customer Y’s account as a bad debt, and to reduce the provision for doubtful debts by £700. By mistake, however, he had written off £700 from customer Y’s account and increased the provision for doubtful debts by £500.

xi. The debit balance on the insurance account in the nominal ledger of £3,456 had been included in the trial balance as £3,546.

Required:Record corrections in the control and suspense accounts. Attempt to reconcile the sales ledger control account with the sales ledger balances, and the purchase ledger control account with the purchase ledger balances. What further action do you recommend?

(25 marks)

Lesson Seven 368

QUESTISON FOURRay Dyo, Harry UII and Val Vez are in partnership, trading under the name of Radtel Services, as radio and television suppliers and repairers, sharing profits and losses in the ratio one half, one third and one sixth, respectively. Val Vez works full-time in the business with responsibility for general administration for which she receives a partnership salary of £4,000 per annum.

All partners receive interest on capital at 5% per annum and interest on any loans made to the firm, also at 5% per annum.

It also had been agreed that Val Vez should receive not less than £4,000 per annum in addition to her salary. Any deficiency between this guaranteed figurer and her actual aggregate of interest on capital, plus residual profit (or less residual loss) less interest on drawings, is to be borne by Dyo and UII in the ratio in which they share profits and losses; such deficiency can be recouped by Dyo and UII at the earliest opportunity during the next two consecutive years provided that Val Vez does not receive less than the guaranteed minimum described above. During the year ended 30 September 1983, Dyo and UII had jointly contributed a deficiency of £1,500.

Radtel Services rents two sets of premises - one, a workshop where repairs are carried out, the other, a shop from which radio and television sets are sold. The offices are situated above the shop and are accounted for as part of the shop.The workshop and shop are regarded as separate departments and managed, respectively, by Phughes and Sokkitt who are each remunerated by a basic salary plus a commission of one ninth of their departments’ profits after charging their commission.

On 30 September 1984, the trial balance of the firm was:

£ £Stocks at 1 October 1993: Shop (radio and television sets) 19,750 Workshop (spares, components etc.) 8,470Purchases: Radio and television sets 155,43

0 Spares, components etc. 72,100Turnover: Sales of radio and television sets 232,60

0 Repair charges 127,00

0Wages and salaries (employees): Shop and offices 54,640 Workshop 18,210Prepaid expenses (at 30 September 1984)

640

Accrued expenses (at 30 September 3,160

369 Partnerships

1984)Provision for doubtful debts at 1 October 1983

920

Rent and rates: Shop and offices 7,710 Workshop 8,450Stationery, telephones, insurance: Shop and offices 2,980 Workshop 1,020Heating and lighting: Shop and offices 4,640 Workshop 3,950Debtors 4,460Creditors 15,260Bank 48,540Cash 960Other general expenses: Shop and offices 3,030 Workshop 2,830Depreciation: Shop and offices (including vehicles) 2,400 Workshop 2,580Shop fittings (cost) 17,060Workshop tools and equipment (cost) 55,340Vehicles (cost) 27,210Discount received: Shop 420 Workshop 390Bank loan (repayable in 1988) 15,000Loan from Harry UII 10,000Capital Accounts: R. Dyo 40,000 H. UII 40,000 V. Vez 20,000Current Accounts (after drawings have been debited): R. Dyo 290 H. UII 1,040 V. Vez 920Loan interest: Bank loan 2,400 Loan from H. UII 500Provision for depreciation:Shop fittings 3,190Workshop tools and equipment 10,020Vehicles 5,670

£525,590

£525,590

Lesson Seven 370

The following matters are to be taken into account:

1) Manager’s commissions.2) Partnership salary (Vez).3) Interest on partners’ capital accounts (these have not altered during the

year).4) Interest on partners’ drawings; Dyo £70; UII £30; Vez £20.5) Closing stocks: shop £31,080; workshop £10,220.6) Provision for doubtful debts at 30 September 1984, £540.7) Residual profits/Losses.

N.B. Loan interest and the movement in the provision for bad debts are regarded as ‘shop’ items.

371 Partnerships

Required:a) Prepared columnar departmental trading and profit and loss accounts

and a partnership appropriation account for he year ended 30 September 1984 and the partnership balance sheet at that date.

(21 marks)b) Complete the posting of the partners’ current accounts for the year.

(4 marks)(25 marks)

QUESTSION FIVEErnie is a building contractor, doing repair work for local householders. His wife keeps some accounting records but not on a double-entry basis.The assets and liabilities of the business at 30 June 1997 were as follows:

£Assets Plant and equipment: cost 12,600 Depreciation to date 5,800 Motor Van: cost 9,000 Depreciation to date 6,500 Stock of materials 14,160 Debtors 9,490 Rent of premises paid in advance to 30 September 1997

750

Insurance paid in advance to 31 December 1997

700

Bank balance 1,860 Cash in hand 230

Liabilities Creditors for supplies 3,460 Telephone bill owing 210 Electricity owing 180

His cash and bank transactions for the year from 1 July 1997 to 30 June 1998

are as follows:

Cash and Bank summaryReceipts Cash Bank Payments Cash Bank

£ £ £ £Opening balances 230 1,860 Suppliers 83,99

0Receipts from customers

52,640

150,880

Rent of premises 3,600

Loan received 10,000

Insurance (to 31.12.98) 1,600

Proceeds of sale of vehicles

Purchase of plant and equipment

8,400

Held at the beginning of year

3,000 Purchase of new vehicle 12,800

Cash paid into the 24,04 Telephone 860

Lesson Seven 372

bank 0Cash withdrawn from bank

48,260

Electricity 890

Closing balance 2,100 Wages of repair staff 68,200

Miscellaneous expenses 1,280Drawings by Ernie 8,000

Refund to customer 400Cash paid into bank 24,04

0Cash withdrawn from bank

48,260

Closing balance 890 29,800

101,130

191,880

101,130

191,880

The following further information is available

1) Plant and equipment is to be depreciated at 25% per annum on the reducing balance with a full year’s charge in the year of purchase.

2) The new motor vehicle was purchased on 1 January 1998. Ernie’s depreciation policy is to charge depreciation at 25% per annum on the straight-line basis with a proportionate charge in the year of purchase but not in the year of sale.

3) The rent of the premises was increased by 20 % from 1 October 1997.4) The loan of £10,000 was obtained from Ernie’s brother on 1 April 1998. It

carries interest at 10% per annum, payable on 30 September and 31 March.5) At 30 June 1998, Ernie owed the following amounts:

£Suppliers 4,090Telephone 240Electricity 220Miscellaneous expenses 490

6) At 30 June 1998, amounts due from customers totaled £10,860. Of this amount, Ernie considered that debts totaling £1,280 were bad and should be written off.

7) Stock of materials at 30 June was £12,1708) Ernie agreed to pay his wife £5000 for her assistance with his office work

during the year. This amount was actually paid in August 1998.

Required:Prepare Ernie’s trading profit and loss account for the year ended 30 June 1998 and a balance sheet as at that date.


373 Partnerships

NOW SEND YOUR ANSWERS TO THE DISTANCE LEARNING CENTRE FOR MARKING

Acknowledgement 374

LESSON EIGHT

COMPANY ACCOUNTS

Introduction:COMPANY ACCOUNTS:Limited companies come into existence because of the growth in size of business and the need to have many investors in the business.Partnerships were not suitable for such businesses because the membership is limited to 20 persons.Types of companiesThere are 2 principle types of companies:Private companiesThese have the words limited at the end of the name. Being private, they cannot invite the members of the public to invest in their ownership.Public companiesThere much larger in size as compared to private companies. They have the words public limited company at the end of their name.They can invite the members of the public to invest in their ownership and the companies may be quoted on the stock exchange.Share capital of a company.The owner’s interest in a limited company consists of share capital. The share capital is divided into shares. The investor will then pay for and be issued with the shares and therefore, they become owners.Each share has a flat value called Par value/face value/nominal value. (e.g.) If a company decides to set up a share capital of Sh. 200,000, it may decide to issue:200,000 shares of Sh. 1 each per value.100,000 shares of Sh. 2 each per value.400,000 shares of Sh. 50 each per value.

There are 2 main types of share capitalPreference share capitalThis is made up of preference shares and a preference share carries the right to a final dividend, which is expressed as a percentage of their par value. E.g. 10% preference shares.Preference shares do not carry a right to vote and therefore no control in the company.Ordinary Share capital These are the most common shares. They carry no right to a fixed dividend but are entitled to residual value of the business during winding up, and all profits after the claim on all of the preference dividend have been paid. The more the no. of ordinary share held, the higher the control.


375 Company Accounts

Lesson Eight 376

Share capital may also have the following meaning:Authorized share capitalAlso called, registered or nominal capital. Is the total of the share capital which the company is allowed to issue to shareholders. A company cannot issue more shares than the amount that is authorized.Issued share capitalThis is the total of the share capital actually issued to the shareholders.Called up share capitalThis is the amount the shareholders have been asked to pay where the amount of capital required is less than the issued share capital.(e.g.) If a firm issues ordinary shares of £1 each and request the shareholders to pay 60p. Assuming that the issued 100,000 shares, then the called up share capital will be:60p 100,000 = £60,000Uncalled share capitalThis is part of the issued share capital for which the company has not requested for payment and therefore these amounts will be received in the future.In the above (e.g.) because the firm had not requested for 40p, therefore the uncalled capital is 40p 100,000 = £40,000.Paid-up share capitalThis is the total of the share capital, which has been paid for by the shareholders.

IllustrationA limited has an authorized share capital of 200,000 shares of £1 each out of which only 150,000 share have been issued, Although the firm requested the shareholders to pay 80p per share, the shareholders were able to pay 50p per share.

Required:Determine the:

Authorized share capital Issued share capital Called up share capital Uncalled up share capital Paid up share capital

Authorized share capital200,000 £ = £200,000

Issued share capital150,000 £1 = £150,000

Called up share capital150,000 80p = 120,000

Uncalled up share capital150,000 20 p = £30,000

Paid up share capital150,000 50p = £75,000


The principal distinctions between unlimited partnerships and limited companies are:

Unlimited Partnerships Limited Companies

No separate Legal Entity apart from its members

Separate legal entity, which is not affect by changes in its membership. A company may contract, sue or be sued in it’s own name.

Liability of each member for debts of the firm is unlimited.

If the company is limited by share, each shareholder is limited to the amount he has agreed to pay the company for share allotted.

Number of partners limited to 20 except for professional firms.

A limited company must have at least 2 members. The maximum number of shares is restricted to the company’s authorized share capital.

Every partner can normally take part in the management of the business. He can legally bind the firm by his action.

Rights to management are delegated to directors who alone can act on behalf of and bind the company.

Copy of accounts need not be filed with the Registrar of Companies

Copies of accounts must be registered with the Registrar of Companies

Although a written Partnership deed is desirable it is not mandatory.

A company is required to have a memorandum and articles of association which defines powers and duties of directors.

A partnership is subject to the partnership Act which can be varied by mutual agreement.

A company is subject to the Companies Act the provisions of which cannot be varied.

The partners contribute the capital by agreement. The amount need not be fixed.

The authorized share capital is fixed by the memorandum of association. It can be altered by passing ordinary resolution or by the court.

Lesson Eight 378

A share in a partnership cannot be transferable except by the consent of all partners.

In public companies shares are freely transferable. In private companies share transfer are subject to any restrictions imposed by the articles of association.

A partnership is not obliged to keep statutory books of account and an audit is not compulsory.

A company is required to keep specialized accounting records and is subject to compulsory audit.

Format Of Final AccountThe P & L of a company, is the same as that of a sole trader, but there are additional expenses that are unique to the company and therefore, they should be included in the P & L A/C.

(e.g.) Director’s fees salaries and other expenses Audit fees Amortization e.g. goodwill Debenture interest

In addition to the P & L A/C, just like a partnership has an appropriation A/C which shows the allocation of the net profit for the period. Therefore, the format will be as shown:Format for Company AccountsB LimitedTrading, profit and loss and Appropriation Account for the year ended 31.12

SalesLess Returns inwards

Less Cost of SalesOpening Stock

PurchasesAdd Carriage in

Less purchase returns

Less Closing stockGross ProfitAdd incomes

Discount receivedProfit on disposal (sale of Assets)Income from investment (can also be

shown below)Other incomes e.g. interest received from

bank

£

xxx

(x)

£

x

xx

(x)

xx

£x

(x)x

(x)xxxxxxx


Less ExpensesOther expensesDirectors salaries/fees/----Audit feesDebenture InterestAmortization of good will

Operating profit for the periodAdd investment incomeProfit before taxTaxation: Corporation taxTransfer to deferred taxUnder or over provisionProfit after taxLess: transfer to the general reserve

Less: DividendsPreference dividend: Interim paid

Final proposed

Ordinary dividend: Interim paid Final proposed

Retained profit for the yearRetained profit b/fRetained profit c/d

xxx

xxx

xxxxx

(x)xxx

(x)x

(x)x

(x)xxx

B Limited Balance sheet as at 31.12………

Non current AssetsLand & Building

Plant and MachineryFixtures, Furniture & FittingsMotor vehicle

Intangible AssetsGoodwillCopyrights, patents

(Longterm) Investments (mkt value sh x)

Current AssetsStockDebtorsLess provision for bad debtsPrepayments(Short term) InvestmentsCash at bank

£

xxxxx

xxx

x(x)

£

(x)(x)(x)(x)

x

(x)(x)

x

x

xxxxx

£

xxxxx

xx

xx

Lesson Eight 380

Cash in hand

Current liabilitiesBank overdraftCreditorsAccrualsInterest payable(debenture interest)Tax payableDividends payable

Financed by Authorized share capital100,000 ordinary shares of £1 each100,000 preference shares of £1 each

Issued and Fully paid80,000 ordinary shares of £1 each50,000 10% preference shares of £1 each

Capital ReservesShare premiumRevaluation ReserveCapital Redemption ReserveRevenue ReservesGeneral ReserveProfit and loss A/C

Deffered tax A/C

Non Current Liabilities10% debentureOther Long term Loans

xxxxxx

x

(x)

xxx

xx

xx

xx

xxx

(x)x

xx

x

xxx

xx

Director’s salaries:Salaries, fees and other expenses in relation to the directors are expenses as far as company accounts are concerned.This is different from that of Partnerships & Sole traders which are shown as appropriations – expenses.Audit feesAll companies are required to prepare the accounts which should be audited and therefore any fees paid in relation to audit and accountancy is an expense.Debenture interestLoans taken up by companies are called debentures. The interest paid on these loans are charged as an expenses and unpaid amount are shown as current liabilities in the business.The debenture is classified under non-current liability.


Corporation taxCompanies pay corporation tax on the profits they earn. This is shown in the accounts because a company is a separate legal entity unlike for sole traders and partnerships whose tax is shown as drawings.The tax is listed under those 3 items as shown in the appropriation (under/over provision for previous period, transfer to deferred tax corporation tax for the year).The under provision and corporation tax relate to direct liability to the government and therefore is a deduction from the net profit for the period .Transfer to deferred tax is to cater for future possible tax liability.

Assume that a firm had estimated that the corporation tax for the year ended 31.12.99 is £150,000. In 2000, the liability is now agreed at £160,000, which the company pays and at the end of the year 2000, the company estimates that the tax liability is £140,000.Prepare a tax A/C and show the amount to be deducted as tax for the year (ignore deferred tax).

(e.g.) Taxation Account

Cashbook 160,000 Bal b/d 150,000Bal c/d 140,000 Appropriation 150,000

300,000 300,000

Under provision 10,000 (160 -150)Corporation tax 140,000

DIVIDENDSShareholders are also entitled to a share of profits made by the company and this is because the shareholders do not make drawings from the company.A company may pay dividends in 2 stages during the cause of the financial period:Interim dividendsIs paid part way --- the financial period. (e.g.) after the 6 -----

Final proposedIs paid after the year-end or after the completion to final accounts.If a company pays in these 2 stages then the dividend section of the P & L appropriation should disclose interim paid and final proposed.

Lesson Eight 382

CAPITAL RESERVESAmounts reflected in Capital reserves cannot be paid out or distributed to shareholders. The three types of capital reserves are:

Share Premium: A share premium arises when accompany issues shares at a price that is more than the par value. The share Premium may be applied in:

Paying un issued shares. Writing off preliminary expenses. Write off discounts on shares.

Example:A Ltd wishes to raise capital by issuing 100,000 ordinary shares at £1 each (per value) and the issue price (selling price) is £1.5 each.The following are the entries to be made in the A/C.Dr Cashbook (100,000 £1.5) 150,000Cr Ordinary shares capital (100,000 £1) 100,000Cr Sahre Premium A/C (100,000 £0.5) 50,000Issue of shares at a premium of £0.5

Revaluation Reserve: Any gain made on revaluation of non current Assets especially for Land and buildings. When company sills it’s property to realize the gain, the amount is transferred to the Profit and Loss Account.

Capital Redemption Reserve: A reserve created after redemption or purchase of Preference shares without issuing new shares. The transfer is made from either the share premium or the profit and loss account.

REVENUE RESERVESThis can be distributed and includes the retained profits (P & L Accounts) and the General Reserves. Transfers are made from the Profits to the General reserves to provide for expansion or purchase of non current assets. The General Reserves can also be used to issue bonus Shares.DEBENTURE LOANSThe term debenture is used when a limited company receives money on loan, and certificates called debenture certificates are issued to the lender.They are also called loan stock or loan capital. Debenture interest has to be paid whether profits are made or not. A debenture may either be redeemable of irredeemable. Redeemable is repayable at or by a particular date and irredeemable is payable when the company is officially terminated.BONUS SHARESShares issued to existing shareholders free of charge. They are paid out from either the share premium, balance of retained profits of the General Reserves.A scrip issue is similar to bonus issue only that a scrip issue gives the shareholder the choice of receiving cash or stock dividends. In a bonus issue the shareholder has no choice but to take up the shares.ExampleA Ltd has 100,000 shares at £1 each to form an ordinary share capital of £100,000 and a balance on the share premium A/C of £50,000. It issues some bonus shares to


existing shareholders at a rate of 1 share for every 5shares held. This amount is to be financed by the share premium. The entries will be as follows:

Shares to be issued:100,000 1 =20,0005

Dr share premium A/C [20,000 £1 ] 20,000Cr ordinary share capital 20,000 A bonus issue of 20,000 shares

Balance sheet (extract)

Ordinary shares of £1 120,000Capital ReservesShare premium 30,000

Rights IssueA right issue is an option on the part of the shareholder given by the company to existing shareholders at a price lower than the market price.It involves selling ordinary shares to existing shareholders of the company on a prorata basis. When the rights are issued the shareholders have 2 options available.Buy the new shares and exercise their rightsSell the rights in the market,Ignore the rights.A rights issue therefore gives the shareholder the right (but not an obligation) to buy the new shares issued by the company.

Example:A Ltd has a share capital of £200,000 trade up of 100,000shares of £2 each. The balance on the share premium is £60,000. Additional capital is raised by way of a right issue. The term are:For every 5 shares held in the company, a shareholder can buy 2 shares at a price of £2.5 per share.Required:The journal entries to reflect the above transaction assuming that all the shareholders exercise their rights and the relevant balance sheet extract.

Shares to be issued 100,000 2 =40,000 shares

5Dr cash book [40,000 £2.5 ] £100,000Cr Ordinary share capital[40,000 £2 ] £80,000Cr Share Premium [40,000 £0.5 ] £20,000

Balance sheet (extract)

Lesson Eight 384

140,000 Ordinary shares @ £2 280,000Capital ReservesShare premium 80,000

The following examples will illustrate the preparation of final Account for companies.

Example 8.1Just before you launch yourself into the question that follows remember that everything you have learnt about double entry bookkeeping and the presentation of year end accounts is valid in the context of companies, subject only to the points we have added in this session.

The following is the trial balance of Transit Ltd at 31 March 19X8.

Issued share capital (ordinary shares of £1 each)Leasehold properties, at costMotor vans, at cost (used for distribution)Provision for depreciation on motor vans to 31 March 19X7Administration expensesDistribution expensesStock, 31 March 19X7PurchasesSalesDirectors’ remuneration (administrative)Rents receivableInvestments at costInvestment income7% DebenturesDebenture interestBank interestBank overdraftDebtors and creditorsInterim dividend paidProfit and loss account, 31 March 19X7

£

75,000

2,500

7,65010,00

012,00

0138,7

50

25,000

6,750

1,050162

31,000

1,260 311,1

22

£42,00

0

1,000

206,500

3,600

34015,00

0

73024,10

0

17,852

311,122

You ascertain the following:All the motor vans were purchased on 1 April 19X5. Depreciation has been, and is to be, provided at the rate of 20% per annum on cost from the date of purchase to the date of sale. On 31 March 19X8 one van, which had cost £900, was sold for £550, as part settlement of the price of £800 of a new van, but no entries with regard to these transactions were made in the books.


The estimated corporation tax liability for the year to 31 March 19X8 is £12,700.It is proposed to pay a final dividend of 10% for the year to 31 March 19X8.Stock at the lower of cost or net realizable value on 31 March 19X8 is £16,700.

Required:

Prepare, without taking into account the relevant statutory provisions:

A profit and loss account for the year ended 31 March 19X8: A balance sheet at that date. (22 marks)

Lesson Eight 386

Solution:Transit Ltd

Profit and Loss A/C for the year ended 31.3.19X8

Gross profitProfit on disposal of vanRent Receivable

Less: ExpensesDepreciation on motor vansAdministration expensesDistribution expensesDebenture interestBank interestTrading profit for the yearAdd investment incomeProfit before taxTaxationProfit after taxLess: DividendsInterim paidFinal proposedRetained profit for the yearRetained profit b/fRetained profit c/d

£

50032,65

010,00

01,050

162

1,2604,200

£72,45

0190

3,60076,24

0

(44,362)

31,878

34032,21

8(12,7

00)19,51

8

(5,460)

14,058

17,852

31,910


Transit LtdBalance sheet as at 31.3.19X8

Non-Current AssetsLeasehold propertiesMotor vans

Investments

Current AssetsStockDebtors

Current liabilitiesBank overdraftCreditorsTax payableProposed dividends

Financed by:Authorized issued and fully paid42000 ordinary share of £1Revenue ReservesProfit and Loss A/C c/f

Non-Current liabilities7% Debentures

£

75,0002,400

77,400

98024,10012,700

4,200

£

-(960)

960

16,70031,00047,700

(41,980)

£

75,0001,440

76,4406,750

83,190

5,72088,910

42,000

31,91073,910

15,00088,910

WorkingsSales 206,500Less: Cost of salesOpening stock 12,000Purchases 138,750

150,750Less Closing stock (16,700) (134,050)Gross profit 72,450

Motor Vehicle – DepreciationDisposal 540 Bal b/d 1,000Bal c/d 960 P & L 500

1,500 1,500

Motor vehicleBal b/f 2,500 Disposal 900Disposal 550

Lesson Eight 388

Cashbook 250 Bal c/d 2,4003,300 3,300

Motor vehicle Disposal Disposal 900 Motor Vehicle 550P & L 190 Depreciation 540

1090 1090

Example 8.2The Following Trial Balance Was Extracted From The Books Of Collins Ltd At 31 December 19X5

Share capital authorized and issued:

80,000 ordinary shares of £1 eachFreehold premises at costMotor vansBalance 1 January 19X5 at costAdditions less sale proceedsProvisions for depreciation of motor vans to 31 December 19X4Stock in trade 31 December 19X4Balance at bankProvision for doubtful debts 31 December 19X4Trade debtors and creditorsDirectors’ remunerationWages and salariesMotor and delivery expensesRatesPurchasesSalesLegal expensesGeneral expensesProfit and loss account: balance at 31 December 19X4

£

59,000

15,000

650

13,930

6,615

12,395

4,00013,12

73,258

700108,4

40

6445,846

243,6

05

£

80,000

6,750

27511,38

0

142,770

2,430243,6

05

You are given the following information.:

i. Stock in trade, 31 December 19X5, £14,600.ii. Rates paid in advance, 31 December 19X5, £140.iii. Debts of £1,075 to be written off and the provision to be increased to

£350.iv. On 1 January 19X5, a motor van which had cost £680, was sold for £125.


v. Depreciation provided for this van up to 31 December 19X4 was £475.vi. Provide for depreciation of motor vans (including additions) at 20% of

cost.vii.The balance on legal expenses account included £380 in connection with

the purchase of one of the freehold properties.viii. The directors have decided to recommend a dividend of 5%.

Required:With particular emphasis on presentation, prepare a trading and profit and loss account for the year 19X5, and a balance sheet at 31 December 19X5, ignoring taxation. (24 marks)

Lesson Eight 390

Solution:Trading and profit and loss accountfor the year ended 31 December 19X5

SalesOpening stockPurchases

Less: Closing stockCost of goods sold

Directors’ remunerationWages and salariesMotor and delivery expensesRates (700 - 140)Legal expenses (644 - 380)General expensesBad debtsLoss on disposalDepreciationNet profit

Proposed dividend

Retained profit brought forwardRetained profit carried forward

£

13,930

108,440

122,370

14,600

4,00013,12

73,258

560264

5,8461,150

803,019

£142,7

70

107,770

35,000

31,304

3,6964,000(304)2,4302,126

Balance sheet at 31 December 19X5

Non-Current AssetsFreehold propertiesMotor vans

Current AssetsStockDebtors and prepayments, less provision for doubtful debtsCash at bank

Current liabilitiesCreditorsProposed dividends

£

59,38015,09574,475

11,3804,000

£

----(9,294)(9,294)

14,600

11,1106,615

32,325

15,380

£

59,3805,801

65,181

16,94582,126


Share capitalOrdinary shares of £1 eachProfit and loss account

80,0002,126

82,126

WorkingsBad debts

£Debtors 1,075Balance c/f 350

1,425

£Balance b/f 275Profit and loss account 1,150 1,425

Motor vans£

Balance b/f 15,000Additions 775

15,775

£Disposals 680Balance c/f 15,095

15,775


£Disposals 475Balance c/f 9,294

9,769

£Balance b/f 6,750Profit and loss account 3,019

9,769

Disposals£

Motor vans 680

680

£Provision for depreciation 475Proceeds 125Loss on capital 80

680

Example 8.3Owik-Freez p.l.c. is a company which provides refrigerated storage facilities to local farmers.Services offered include the collection of produce, the use of rapid freezing equipment, storage of the frozen produce and transport from frozen storage in

Lesson Eight 392

refrigerated vehicles to any point within the country. Orders for these services are secured by the company’s sales staff.

The company’s revenue consists of charges for transport and freezing, and of storage rentals. Customers may hire storage space either on a long-term contract basis at advantageous charges (payable in advance) or on a casual basis (invoiced monthly).

A considerable amount of electricity from the public supply is used by the company in the freezing and storage operations. In the event of a sudden failure in this supply, the company is able to generate its own emergency supplies from standby generators kept for this purpose. An insurance policy has been taken out to protect the company against the claims which would arise should any of the frozen produce deteriorate as the result of power or equipment failure.

At the end of the company’s financial year ended 30 September 1982, the assistant accountant extracted the following balances from the ledgers.


Assets AccountLand and buildings (at cost)Plant (at cost)Vehicle (at cost)Provision for depreciation (at 1 October 1981):Land and buildingsPlantVehiclesStock of consumable stores (at 30 September 1982)Debtor – for rentalsfor chargesBankCash

Liability AccountsTrade Creditors7% Debentures 2004/2012Ordinary Share Capital (see note 7)General reserveUnappropriated profit (at 1 October 1981)Share Premium

Revenue AccountsStorage rentals – long term contracts CasualFreezing chargesTransport charges

Expense AccountsWages, salaries and related expensesRatesElectricityTransport costsRepairsConsumable storesPostages, stationery, telephonesInsurance premiumDebenture interestSundries

Other AccountsSuspense (credit balance)

£390,000271,900

82,600

39,600144,800

27,05023,44918,204

2,33230,710

1,103

7,39080,000

200,00025,000

108,28415,000

302,09085,063

112,81090,107

128,00479,11276,86043,27130,31929,80015,604

7,8005,6009,176

8,650

Notes at 30 September 1982:At the beginning of the 1981-82 financial year, the company had sold refrigeration plant (which had originally cost £26,000 and on which £20,800 had been provided as depreciation to date of disposal) for £4,000. The only accounting entries relative

Lesson Eight 394

to this disposal which have been made so far, are a debit to Bank and a credit to Suspense of the amount of the sale proceeds.In April 1982, the compressor unit in No.7 storage unit failed and as a consequence the contents deteriorated to such an extent that they had to be disposed of by incineration. Compensation of £1,350 was paid to the farmer by Owik – Freez by cheque and debited to Suspense.

The insurance company has admitted liability under the policy but no further ledger entries have as yet been made.During the 1981-82 financial year, the company replaced one of its refrigerated vehicles, which has originally cost £16,400 and on which £13,120 had been provided as depreciation to date of disposal. A trade-in (part exchange) allowance of £6,000 was granted in respect to this vehicle. A replacement vehicle was acquired at a list price of £27,000. The entries relating to the disposal of the old vehicle have not yet been made, except that the trade-in allowance has been debited to Vehicles and credited to Suspense. The balance of the price of the new vehicle has been paid by cheque and debited to Vehicles account.It is the company’s policy to provide for depreciation on a straight line basis calculated on the cost of fixed assets held at the end of each financial year and assuming no residual value. Annual depreciation rates are:

%Building 2Plant 10Vehicles 25

The ‘Buildings’ content of the item Land and Buildings included in asset account balances is £120,000.Adjustments, not yet posted to the accounts, should be made for the following items:

£Storage rentals received in advance 25,631Insurance premium prepaid 600Wages and Salaried accrued 1,920Rates prepaid 28,820Electricity accrued 5,757

Consumable stores include £4131 and Repairs include £9972 relating to vehicles.The authorized and issued capital of the company consists of 400000 Ordinary Shares of £0.50 per share. The directors have recommended a dividend for the year of £0.12 per share.

Required:Prepare, for internal circulation purposes, a Profit and Loss account for Qwik-Freez p.l.c.for the year ended 30 September 1982 and a Balance Sheet at that date. All workings must be shown.

(31 marks)Open the Suspense account and post the entries needed to eliminate the opening credit balance.

(2 marks)


(33 marks)Solution:Qwik-Freez (East Anglia) p.l.c.Profit and Loss Account for the year ended 30 September 1982Workings:

RevenueStorage rentals – long term

(302,090 – 25631) casual

Freezing chargesTransport charges

Less:ExpensesWages, Salaries etc. (128,004 + 1,920)Rates (79,112 – 28,820)Electricity (76,860 – 5,757)Transport costs (43,271 + 4,131 + 9,972)Repairs (30,319 – 9,972)Consumable stores (29,800 – 4,131)Postages, stationery, telephonesInsurance premiums (7,800 - 600)1,2 *Depreciation Debenture InterestSundries

5 Profit (less loss) on disposal of fixed assetsNet Profit For The YearRetained profit brought forwardDistributed profitLess:Ordinary dividends proposedRetained profit carried forward

£

129,924

50,29282,61757,37420,34725,66915,604

7,20043,540

5,6009,176

£

276,45985,063

112,81090,107

564,439

447,343117,096

1,520118,616108,284226,900

48,000178,900

Workings:

Fixed Assets:Balance 1 October 1981(veh 82,600 – (6,000 + 21,000))Acquisitions (21,000 – 6,000)DisposalsBalance 30 September 1982

Land£

270,000

Buildings£

120,000

Plant£

271,900

(26,000)

Vehicle£

55,600

27000(16,40

0)

Total£

717,500

27,000(42,40

0)270,0

00120,00

0245,90

066,200 702,10

0

Lesson Eight 396

Depreciation -rate

-current year charge

-£-

2%£2,400

10£24,590

25£16,550

£43,540

Alternatively the depreciation charge for vehicles (£16,550) can be classified as a transport cost, thereby increasing that figure to £73,924.


Provision for Depreciation:Balance 1 October 1981DisposalsCurrent year charge

Balance 30 September 1982

-

-

39,600

2,400

144,800(20,800)24,590

27,050(13,120)16,550

211,450(33,920)43,540

- 42,000 148,590

30,480

221,070

Written down values at 30 September 1982

£

270,000

£

78,000

£

97,310

£

35,720

£

481,030

Proceeds from disposalsLess:Written down values of disposals(26,000 – 20,800)(16,400 – 13,120)Profit/(Loss) on disposals

4,000

5,200

6,000

3,280

10,000

8,480

£(1,200)

2,720 1,520

Qwik-Freez (East Anglisa) p.l.cBalance Sheet as at 30 September 1982Workings:

Lesson Eight 398

Fixed AssetsLand and BuildingsPlantVehicles1,3,4Current AssetsStocksDebtors - for rentalsfor charges- for insured lossesPrepaid expenses (600 + 28,820)BankCashLess:Current LiabilitiesCreditorsAccrued expenses (1920 + 5757)Advance receiptsProposed dividendsWorking CapitalNet Assets employedFinanced by:Share Capital, authorized, issued and fully paid,400000 Ordinary shares of £0.50 per share16Reserves Share PremiumGeneral ReserveProfit and Loss accountShareholders’ fundsLong-term loan7% Debentures 2004/2012Cost£390,000245,90066,200Depreciation£42,000148,59030,480Net£348,00097,31035,720702,100


221,070481,030

17,870498,900

200,000

218,900418,900

80,000498,900

18,2042,3321,350

Lesson Eight 400

7,3907,67725,63148,000

23,449

21,88629,42030,7101,103106,568

88,698


15,00025,000178,900

Suspense £ £

Fixed Asset Disposals:` Plant 4000 Balance b/d 8650 Vehicle 6000 Debtors (insured loss) 1350

10000 10000Example 8.4Mwanga and Sons Ltd is a small manufacturing firm owned by members of the family. The following trial balance was extracted from the books of the company as at 31 March 1993:

Freehold property, at cost (land Sh. 75,000)Plant, at costDepreciationMotor vehicle, at costDepreciation – motor vehicleFittings and fixtures, at costDepreciation – fittings and fixtures20,000 Ordinary shares of Sh. 10 each authorized, issued and fully paidShare premiumGeneral reserveInterim dividend paidCash at bank and in handAccounts receivable and payable15% DebenturesDiscount receivedProfit and loss account 1 April 1992Purchases of raw materialsSales of finished goodsInventories 1 April 1992:Raw materials Work in progressFinished goodsProvision for doubtful debtsBad debtsRates and insuranceWagesFactory powerLight and water

Sh.125,00

0130,00

0

53,000

38,600

16,00033,570130,54

0

942,380

33,06057,660107,86

0

Sh.

62,000

30,500

11,790

200,000

50,000120,00

0

57,430100,00

03,640

103,870

1,254,760

6,400

Lesson Eight 402

Plant maintenanceSalariesReturns of raw materialSales returnsAdvertisingTransport expenses (Sales department)Bank chargesGeneral expenses

4,8909,430

108,370

22,56016,28010,97090,000

1,3608,580

24,3203,040

36,1 60

2,003,630

3,240

2,003,

630



Depreciation is to be provided for the year using the reducing balance method and applying rates of 15% on plant, 25% on motor vehicle and 10% on fittings and fixtures.

Building is to be depreciated at the rate of 4% using the straight-line method. (Assume the whole building is used for manufacturing purposes).

Provision for doubtful debts is to be adjusted to a figure equal to 10% of accounts receivable.

Light and water, insurance and general expenses are to be apportioned in the ratio 4:1 between factory and administrative overheads.

Electricity and wateer accrued wasInsurance prepaid wasRates prepaid were

Inventories were valued at:

Raw materialsWork in progressFinished goods

Sh.860270780

139,63082,450124,320

Debenture interest has not yet been paid. The directors require provision for a final dividend which will bring the

dividend for the year up to Sh. 2 per share.

Required:Prepare in vertical form a Manufacturing, Trading and Profit and Loss Account for the year ended 31 March 1983 and a Balance Sheet as at that date. (25 marks)

Lesson Eight 404

MWANGA AND SONS LTDManufacturing Account for the year ended 31 March 1993Raw materials:Opening stocksPurchases Less Returns In.

Less Closing stocksPrime CostsFactory Overheads:Plant depreciationRates and insuranceFactory powerLight and waterPlant maintenanceGeneral expenses

Opening W.I.P.Less: Closing W.I.P.Goods manufactured

942,380(3,240)

10,2002,0006,704

22,56013,71210,97028,928

57,660(82,450)

33,060

939,140972,140

(139,630)832,570

95,074927,644

(24,790)902,854

Trading, Profit And Loss Account For The Year Ended 31 March 1993

SalesLess: Closing stocks

Opening stockGoods manufactured

Less: Closing stocks

Discount received

Debenture interestProvision for bad debtsDepreciation

- Motor vehicle- Fittings and fixtures

Dividend - Interim- Fianl

Retained Profit for the yearRetained Profit brought forwardRetained Profit carried forward

Shs

107,860902,854

1,010,714(124,320)

15,0006,654

5,6252,681

16,00024,000

Shs1,254,760

(1,360)1,253,400

886,394367,006

3,640370,646

40,00049,150

103,870153,870


Balance Sheet As At 31 March 1993

Fixed AssetsFreehold propertyPlantMotor vehicleFittings and fixtures

Current AssetsStocks- Raw materialswork in progressfinished goodsDebtors, less provisionsCash at bank and in handPrepaid expenses

Current LiabilitiesCreditorsAccrualsDividend proposed

Net current assets

Financed by:Authorized, and issued share capital:20,000 Ordinary shares each Sh. 10Reserves:

Share PremiumGeneral ReserveProfit and Loss account

15% debentures

Cost£

125,000130,000

53,00038,600

346,600

139,63082,450

124,320

Depreciation

£2,000

72,20036,12514,471

124,796

346,400117,486

33,5701,050

498,506

57,43015,86024,00097,290

50,000120,000153,000

Net£

123,00057,80016,87524,129

221,804

401,216623,020

200,000

323,020523,020

100,000623,020

Workings:

Rate And Insurance B/d 9,430 Prepaid 270

Prepaid 780 Profit and Loss Account 1,676 Factory 6,704

9,430 9,430

Lesson Eight 406

Issuance Of SharesIssue and Forfeiture of shares:The sale of shares by 2 PLC to members of the public can be categorized as follows:

When shares are sold in exchange for lump sum cash payment and this is at per value, the entries to be made are:DEBIT: CashbookCREDIT: Share Capital

When shares are sold in exchange for lump sum cash payment and this is at a premium, the entries to be made are:DEBIT: CashbookCREDIT: Share CapitalCREDIT: Share Premium

Sale of shares which are to be paid for in installments are normally dealt with as follows:The number of installments may vary from 2 – 4. Each installment is collected through a comprehensive set of processed(called a stage). The 4 possible stages are:Application stageAllotment stage1st Call stage2nd Call stage

Application StageIn this stage, the company invites members of the public to send in applications for share they (the public) are interested in purchasing.The application firms must be accompanied by the 1st installment money when the public respond to the company’s offer.

Sale of

Sale at per Sale at a

Lump sumSale1.

Lump sumSale2.

Lump sumSale3.

Lump sumSale4.

For each stage, an account is opened. This account must close at the end of the stage. (The application stage & allotment stage may be dealt with in a single account called the application/


When the company requests members of the public to send in application forms & application money it will make the following entries in its books:DEBIT: Application A/C

CREDIT: Share CapitalWhen the public responds by sending funds, the company will thenDEBIT: CashbookCREDIT: Application A/C

There may be an over or under subscription. If there is an under subscription,DEBIT: CashbookCREDIT: Application

If there is an over-subscription, then the excess applications may either be rejected outright and the applicants’ money refunded, or applications awarded on a pro-rata basis. (i.e. a lower number of shares allotted compared to the number applied for)If outright rejection, the company will:DEBIT: ApplicationCREDIT: CashbookIf pro-rata issue, the company will:DEBIT: ApplicationCREDIT: AllotmentThis marks the end of the application stage.

Allotment StageIn this stage, the company selects the applicants and informs them of their allotment. It also requests them to bring in a second installment. As it requests for the second installment the entries to be made are:DEBIT: Allotment A/C.

CREDIT: Share Capital.When the public respond by sending in the second installment money, the company, will in its books: - DEBIT: Cashbook.

CREDIT: Allotment.Generally only the correct amount of money is collected at this stage. Since the account has closed by this stage, the stage is deemed to be over.

1 st Call Stage Here the company requests for the third installment from the public. As the company does this, it will:DEBIT: 1st Call A/C .

CREDIT: Share Capital.When the public respond by bringing in the installment money, the company, will in its books:DEBIT: CashbookCREDIT: 1st Call A/C.It is possible that some of the allotees do not pay their 1st installment money on time. When this is so,DEBIT: Cashbook – with money receivedDEBIT: Calls in Arrears – with money not receivedCREDIT: 1st Call A/C – with total.

With

With refunded money

With amount required to close the application A/C.

Lesson Eight 408

This marks the end of the Call stage.

2 nd Call Stage this is very similar to the 1st Call whereby the company requests for the second (and last) call money; as it does so, it will:DEBIT: 2nd Call A/C

CREDIT: Share CapitalWhen the public respond by sending in the second call money, then the company will:DEBIT: CashbookCREDIT: 2nd Call A/C

It is possible that some of the allotees do not pay up their 2nd Call money. When this is so:DEBIT: Cashbook – with money collected.DEBIT: Calls in arrears with money not receivedCREDIT: 2nd Call A/C.

THIS MARKS THE END OF THE NORMAL ISSUE OF SHARES PROCEDURES.

When a debtor for share money (calls – in –arrears) does not pay up his dues, his shares will be cancelled and any money he previously gave the company forfeited (i.e. not refunded to him). This is known as Share Forfeiture. The entries to be made when shares are forfeited are:DEBIT: Share CapitalCREDIT: Calls in ArrearsCREDIT: Share forfeiture.

Forfeited shares may be resold as follows:At per valueAt a premiumAt a discount

If resold at per:DEBIT: Cashbook.

CREDIT: Share Capital.If resold at a premium:DEBIT: CashbookCREDIT: Share Capital.CREDIT: Share premiumWhen shares are sold at a discount, a condition will have to apply. The share sale will be expressly illegal unless:Amounts collected from previous allotee plus an amount collected from current allotee equals or is greater than the par value.If the condition is fulfilled and shares are sold at a discount, thenDEBIT: Cashbook – with money received.DEBIT: Share forfeited – with deficit.

CREDIT: Share Capital with par value.


Last entry in this exercise is to transfer any balance on the share forfeiture A/C to Share Premium A/C as follows:DEBIT: Share forfeiture .

CREDIT: Share Premium.

Example 8.5 MAY 1999QUESTION FOURGive a brief definition of memorandum of association and certificate of incorporation.

(5 marks)Radhi Tea Company Limited has an authorized share capital of Sh. 10,000,000 ordinary shares of Sh.10 each. The shares were issued at par as follows:

Payable on application Sh.1.00Payable on allotment Sh.3.00Payable on first call Sh.4.00Payable on second call Sh.2.00

Applications were received for 1,630,000 shares.It was decide to refund applicants monies on 130,000 shares and to allot all the shares on the basis of two for every three applied for.

The excess application monies received from the successful applicants is not to be refunded but is to be applied to reduce the amount payable on allotment.

The calls were made and paid in full with the exception of one member of one member holding 5,000 shares who paid neither the first nor the second call and another member who did not pay the second call on 1,000 shares. After requisite action by the directors the shares were forfeited. They were later reissued at a price of Sh.8 per share.

Required:The necessary ledger accounts to record these transactions (15 marks)

(Total: 20 marks)

Solution:Memorandum of association explains the relationship between the company and the outside world. It shows the object of the company, the name, address, the authorized share capital, its location (its registered office) and the date of incorporation.Articles of association state the rules under which the company will operate e.g. the number of directors, the structure, and meetings. It explains the relationship between the different directors and shareholders.Certificate of incorporation is a document issued to the company when it is registered by the registrar of companies.

Radhi Tea Co.

Application A/C

Sh. Sh.

Lesson Eight 410

Cashbook 130,000 Cashbook 1,630,000OSC 1,000,000Allotment 500,000

1,630,000 1,630,000

Allotment A/C

Sh. Sh. OSC 3,000,000 Application 500,000 Allotment Cashbook 2,500,000

3,000,000 3,000,000

1st CallSh. Sh.

OSC 4,000,000 Calls in arrears 20,000 Cashbook 3,980,0004,000,000 4,000,000


2nd Call Sh. Sh.

OSC 1,990,00 Calls in arrears 2,000 Cashbook 1,988,000

1,990,000 1,990,000

Share Premium Sh. Sh.

Bal c/d 1,630,000 Share forfeiture 1,630,000

Ordinary Share CapitalSh. Sh.

Share forfeiture A/C 50,000 Application 1,000,000Allotment 3,000,000

1st Call 4,000,0002nd Call 1,990,000

Bal c/d 10,000,000 Share forfeiture 60,000 10,050,000 10,050,000

Share Forfeiture A/C

Sh. Sh.Calls in arrears 22,000 OSC 50,000OSC 60,000 Cashbook 48,000Share Premium 16,000

98,000 98,000

Calls in Arrears Sh. ` Sh.

1st Call 20,0002nd Call 2,000 Share forfeiture 22,000

22,000 22,000

FINANCIAL STATEMENT ANALYSIS(RATIO ANALYSIS)Financial statements include a profit and loss A/C (income statement) that tells us the performance of a company throughout the financial period. It also includes a balance sheet that shows the financial position or status of a company and lastly a cash flow statement which shows changes in cash position of the entity,We analyse financial statements by the use of accounting ratios. There are 5 classes of ratios:

Liquidity Leverage/Gearing ratios Activity Ratios Profitability

Lesson Eight 412

Equity / Investor ratios.


LIQUIDITY RATIOS.These measure the firm’s ability to meet its short term maturing obligations.Leverage/Gearing Ratios – These measure the extent to which a firm has been financed by non-owner supplied funds.Activity Ratios – These measure the efficiency with which the firm is using various assets to generate sales revenue or how active has the firm been.Profitability Ratios – These measure the efficiency with which the firm uses various funds to generate profits or returns. They also measure the management’s ability to control the various expenses in the firm.Equity Ratios/Investor Ratios – They measure the relative value of the firm and returns expected by the owners of the firm. They also try to look at the overall performance of the firm and going concern of the firm.

The following question will be used to illustrate the above classes of ratiosABC ltdProfit and Loss A/C for the year ended 31.12.1992

SalesLess: Cost of SalesOpening stockPurchases

Less: Closing stocksGross profitLess expensesSelling and distributionDepreciationAdministration expensesEarnings before interest & taxesInterestEarnings before taxTax @ 50%Less ordinary dividend(0.75 per share)Retained profit for the year

Sh

99,500559,500659,000

(149,000)

30,00010,000

135,000

Sh850,000

(510,000)340,000

(175,000)165,000(15,000)150,000

75,00075,000

(15,000)60,000

ABCBalance Sheet as at 31 December 1992

Non Current AssetsLand and BuildingsPlant & Machinery

Current AssetsInventoryDebtors

75,000(4,000)

Sh.250,00

080,000330,00

0

149,000

Issued share capital(20000 share of Sh, 10)ReserveRetained profitLong termCurrent liabilities.

Sh.200000

9000060000

100000130000

580,000

Lesson Eight 414

Less provisionCash

71,00030,000580,00

0

Additional NoteCash purchases amount to 14,250.

Required:Compute the relevant ratios.LIQUDITY RATIOSCurrent Ratio = Current Assets

Current Liabilities

Current Ratio = 250,000 = 1.92 : 1 130,000

The higher the ratio then the more liquid the firm is.

Quick Ratio/Acid Test Ratio= Current Assets - Inventories Current Liabilities

= 250,000 – 149,000 = 101,000130,000 130,000

= 0.78 : 1

this is a more refined ration that tries to recognize the fact that stakes may not be easily converted into cash. The higher the ratio, the better for the firm as it means an improved liquidity position.

Cash Ratio= Cash + Marketable Securities

Current Liabilities

= 30,000 = 0.23 : 1 130,000

= 0.23 : 1

This ratio assumes that stakes may not be converted into cash easily and the debtors may not pay up their accounts on time. The higher the ratio, the better for the firm as the Liquidity position is improved.

Net Working Capital Ratio.= Net Working Capital

Net Assets


Net Working Capital =CA –CL = 250,000-130,000=120,000

Net Working Capital = 120,000 = 0.27 : 1 450,000

= 0.27 : 1

The higher the ratio the better for the firm and therefore the improved Liquidity position.

GEARING RATIOSThese measure the financial risk of a firm (the probability that a firm will not be able to pay up its debts). The more debts a business has (non owner supplied funds) the higher the financial risk.Debt Ratio

= Total Liabilities Total Assets

This ratio measures the proportion of total assets financed by non owner supplied funds. The higher the ratio, the higher the financial risk .

= 230,000 = 0.4 580,00040% is supplied by non owners

Debt Equity Ratio

= Total Liabilities Networth (share holders funds)

= 230,000 = 0.66 350,00040% is supplied by non-owners

This ratio measures how much has been financed by the non-owner supplied funds in relation to the amount financed by the owners i.e. for every shilling invested in the business by the owners how much has been financed by the non-owner supplied funds.For ABC Ltd, for every 1 shilling contributed in the business by the owner, the creditor have put in 67 cents.The higher the financial risk.

Long Term Debt Ratio = Non Current Liabilities Net Assets

= 100,000 = 0.2 450,000

This measures the proportion of the total net assets financed by the non-owner supplied funds.

Lesson Eight 416

The higher the ratio, then the higher the financial risk.

ACTIVITY RATIOStock Turnover

= Cost of Sales Average Stocks

whereAverage Stocks = Opening Stock + Closing Stock

2 = 510,000 = 4.1 124,250

= 4.1 times

This is the number of times stock has been converted to sales in a financial year. The higher the ratio the more active the firm is.An alternative formula is

= SalesClosing Stock

Debtors Turnover

= Credit Sales Average Debtors

WhereAverage Debtors = Opening debtors + Closing debtors

2Assume the opening debtors was 89,000 and all sales are on credit

Debtor Turnover = 850,000 = 10.62580,000

The higher the ratio, the more active the firm has been (we had debtors over 10 times to generate the sales)

NoteAverage Collection Period = 360

Debtors Turnover

= 360 = 34 days10.625

This measure the number of days it takes for debtors to pay up. The lesser the period, the better for the firm as it improves the liquidity position.

Creditors Turnover= Credit PurchasesAverage Creditors= 545,250


130,000

= 42 timesThe ratio tries to measure how many times we have creditors during a financial period. The lesser the ratio the better.

Non Current Assets Turnover (Fixed Assets Turnover)= Sales Average Fixed Assets

A.F.A = 340,000 + 330,000 = 670,000 = 335,0002 2 = 850,000 = 2.54 times 335,000

The ratio measures the efficiency with which the firm is using its fixed/ Non Current Assets to generate sales.The higher the ratio the more active the firm.

Total Assets Turnover

= Sales Total Assets

= 850,000 580,000

= 1,046 times

Measures the efficiency with which the firm is using its total assets to generate sales.

PROFITABILITY RATIOSProfitability in Relation to SalesGross Profit Margin

= Gross Profit = 165,000 = 19% Sales 850,000

The higher the margin, the more profitable the firm is.

Net Profit Margin= Net Profit after tax = 75,000 = 9% Sales 850,000

The higher the margin, the more profitable the firm is.Margin affected by:Operating expenses for the period.

Profitability in Relation to investment

Lesson Eight 418

Return On Investment= Net Profit after tax Total Assets

= 75,000 = 13% 580,000

Shows how efficient the firm has been in using the total assets to generate returns in the business.

Return On Capital Employed= Net Profit after tax Net Assets

= 750,000 = 17% 450,000

How efficient the firm has been in using the net assets to generate returns in the business.

Return On Equity= Earnings after tax Networth

= 75,000 850,000

= 21%

Efficiency of the firm in using the owner’s capital to generate returns.

NOTEThe higher the ratio the more efficient is the firm.

EQUITY RATIOSEarnings Per Share (Eps)

EPS = Earnings attributable to ordinary shareholders No. of ordinary shares outstanding.

= 75,000 20,000

= 3.75

This is the return expected by an investor for every share held in the firm.

Earnings Yield= Earnings Per Share Market price per share

Assume that the market price for the ABC’S shares is Sh20/Share.


= 3.75 100% 20= 19%

This is the return amount expected by a shareholder for every shilling invested in the business.

Dividend Per Share= Total Dividend (ordinary shareholders) Ordinary shares outstanding.

= 15,000 20,000

= 0.75 cts per share

This is the amount expected by an investor for every share held in the firm.

NOTEThe higher the amounts, the better for the firm.

LIMITATIONS ON USE OF RATIOS It is difficult to categorise firms in the various industries due to

diversification. This makes inter-company comparison difficult. It is difficult to compare one company with others in case of monopolist

firms. Different, firms use different accounting policies and methods e.g. on

depreciation, provisions and other estimates so this makes comparison of companies difficult.

Ratios are compiled at a point in time and may be affected by short term changes. Therefore ratios are used for short term planning.

Ratios are computed from historical data and therefore are not good indicators of the future.

DEFINITIONSTREND ANALYSIS – Comparing or assessing a company’s performance over time.CROSS SECTIONAL ANALYSIS – Comparing two or more companies in the same industry.

Example 8.6 (ACCA DEC 98)Beta Ltd is reviewing the financial statements of two companies, Zeta Ltd and Omega Ltd. The companies trade as wholesalers, selling electrical goods to retailers on credit. Their most recent financial statements appear below.

PROFIT AND LOSS ACCOUNTS FOR THE YEAR ENDED 31 MARCH 20X8

Zeta Limited Omega Limited

Lesson Eight 420

SalesCost of salesOpening stockPurchases

Less: closing stock

Gross profit

ExpensesDistribution costsAdministrative expensesInterest paid

Profit before taxTaxationNet profit for the period

£’000

2003,2003,400

400

200290

10

£’0004,000

3,0001,000

500500120380

£’000

8004,8005,600

800

150250400

£’0006,000

4,8001,200

800400

90310


Balance Sheets As At 31 March 20x8

Fixed assetsTangible assetsWarehouse and office buildingsEquipment and vehicles

Current assetsStockDebtor – trade- sundryCash at bank

Current liabilitiesCreditors – trade- sundryOverdraftTaxation

Long-term loan (interest 10% pa)

Share capitalRevaluation reserveProfit and loss account

Zeta Limited Omega Limited£’000

1,200600

400800150

-1,350

(800)(80)

(200)(120)

£’000

1,800

1501,950

-1,9501,000

-950

1,950

£’000

5,0001,000

800900

80100

1,180

(800)(100)

-(90)

£’000

6,000

8906,890

(4,000)2,8901,600

500790

2,890

Required:a) Calculate for each company a total of eight ratios which will assist in

measuring the three aspects of profitability, liquidity and management of the elements of working capital. Show all workings.

(8 marks)b) Based on the ratios you have calculated in (a), compare the two companies

as regards their profitability, liquidity and working capital management.

(8 marks)c) Omega Ltd is much more highly geared than Zera Ltd. What are the

implications of this for the two companies?

(4 marks)(20 marks)

Solution:

Lesson Eight 422

PROFITABILITY

Gross profit marginGross profit 100% Sales

Net profit marginNet profit 100%Sales

Return on capital employedProfit before interest and taxCapital employed

Return on shareholders’ capitalProfit before taxShare capital and reserves

Asset turnoverSalesCapital employed

LIQUIDITYCurrent ratioCurrent assetsCurrent liabilities

Quick ratioCurrent assets – stockCurrent liabilities

GearingLong – term loansCapital

Interest coverProfit before interest and taxInterest charges

WORKING CAPITAL MANAGEMENTDebtors daysTrade debtors 365 days Sales

Creditor daysTrade creditors 365 days Purchases

1000 100% = 25%4000

500 100% = 12.5%4000

510 = 26.2%1950

500 = 25.6%1950

4000 = 2.1 times1950

1350 = 1.1:11200

950 = 0.8:11200

nil = nil1950

510 = 51 times10

800 365 = 73 days4000

1200 100% = 20%6000

400 100% = 6.7%6000

800 = 11.6%6890

400 = 13.8%2890

6000 = 0.9 times6890

1880 = 1.9:1990

1080 = 1.1:1990

4000 = 58%6890

800 = 2 times400

900 365 = 55 days6000


Stock daysAverage stock 365 days Cost of sales

800 365 = 91 days3200

300 365 = 37 days3000

800 365 = 61 days4800

800 365 = 61 days4800

Note. We have used average stock here. When you have the information use it.

ProfitabilityZeta has a higher gross margin than Omega. This may indicate a differing pricing policy. Omega’s net margin is lower than Zeta’s. Omega’s expenses are therefore proportionally higher. It should be noted that Omega’s bottom line profit is reduced significantly by the interest charge.Return on Omega’s capital is around half of Zeta’s. Omega has a higher fixed asset base due in part to a revaluation. It may be that a revaluation of Zeta’s assets will partially close the gap.LiquidityOmega has nearly twice as many current assets as current liabilities. Although both companies’ quick ratios are much closer, Zeta’s liquidity does appear to be an issue especially as there is no cash at hand. It would be wise to examine projected cashflows to see how readily Zeta’s profits will improve this situation. As Zeta has no long-term loans they may be able to borrow in order to improve liquidity.Working capital managementZeta is turning stock over more quickly than Omega. This is beneficial in a market which can be subject to obsolescence.

Zeta’s creditor and debtor days are a cause for concern. Debtors should be collected within 60 days if not sooner. 60 day collection would improve cash flow by over £140,000 reducing the debtors balance to £658,000(60/73 £800,000).

Creditors should be paid at least as quickly as Omega pays theirs. Zeta risks damaging the goodwill it has with its suppliers. Paying creditors within 60 days would have an adverse effect on cash flow of over £270,000. The creditors balance would be £527,000 (60/91 £800,000).

Omega is highly geared whereas Zeta has no long-term loans. Omega’s gearing means that should profits fall they may not be in a position to pay the loan interest. Zeta’s capital is entirely share capital and so a fixed return is not required.

Omega’s loan appears to be fixed rate. This means that in times of falling interest rates Omega will have higher interest costs than say, Zeta, if Zeta borrowed the same amount. The converse is true in times of rising interest rates.

Lesson Eight 424


REINFORCEMENT QUESTIONSQUESTION ONEThe chief accountant of AZ Limited has extracted the following trial balance as at 31 October 1999.

Authorized and issued capitalShare premium8% debenture stockProfit and loss stockMotor vehicles at costProvision for depreciation on motor vehiclePlant and machinery at costProvision for depreciation on plant and machineryLand buildings at costStock in hand 1 November 1998 – Finished goods

– Raw materials – Work-in-progress

Trade debtorsOffice furniture and equipment at costProvision for depreciation on office furniture and equipmentTrade creditorsPurchase of raw materialsSales of finished goodsDirect wagesDirect expensesFactory expensesIndirect materialsFactory insuranceSales room expensesAdministration expensesOffice salaries and wagesVehicles running expensesBad debts written-offBalance at bank – overdrawn

Sh.

16500000

25800000

30000000

420000

380000

560000

Sh.736000

0 89000

0

9500000

1350000

395000 290000 350000 150000 485000 620000 840000 656000 640000

96610000

Sh. 400000

00 5000

00 100000

00 55000

00

3400000

6300000

Sh.

185000

1000000

28550000

1175000

96610000

Lesson Eight 426

Notes:Closing stock includes

– Finished goods– Raw materials– Work-in-progress

Accrued salariesThe directors recommended a dividend of 10% on the issued share capital and a transfer of Sh. 2000000 to a general reserve.Debenture interest has not been paidDepreciation is provided on straight-line method at 10% and 25% per annum on furniture and equipment, plant and machinery and motor vehicles respectively.The overdraft interest of Sh. 725000 was communicated to the company by the bank on 5 November 1999 and therefore it has not been posted in the cash book.

Required:

Manufacturing, trading, profit and loss account for the year ended 31 October 1999.

(12 marks)Balance sheet as at 31 October 1999. (8 marks)

(Total: 20 marks)

QUESTION TWOThe Chief Accountant of KK Ltd has extracted the following trial balance as at 31 October 1998.

Authorized and issued capital (shares of Sh. 20 each fully paid)Share premium10% premiumGeneral reserveProfit and loss account 1 November 1997Motor vehicles at costProvision for depreciationFreehold propertyTrade debtorsTrade creditorPurchases and salesStock in hand 1 November 1997Furniture and fittings at costProvision for depreciationGoodwillRent receivableSalaries and wagesGeneral expensesVehicles running expensesBad debtsTelephone and postage

Sh,’000’

3,500

44,500

1,375

95,650 3,478 1,540

500

2,285 358

2,470 124

Sh,’000’

30,000 350

3,500 2,000 2,850

265

460127,45

0

138

385


Water and electricityRates and insuranceCash at bank

568 269 289

10,492167,39

8 167,39

8

Notes:1. Credit sales amounting to Sh.165,000 were made on 31 October 1998 but no

entries were made in the books. 2. Returns outwards amounting to Sh.128,000 were dispatched on 31 October

1998 but no entries were made in the books.3. Closing stock was valued at Sh.4,398,000.4. Accrued salaries and telephone bills amounted to Sh.134,000 and Sh.55,000

respectively.5. Rent for the month of October 1998 amounting to Sh.35,000 had not been

received from the tenant.6. Provision for depreciation on furniture and fittings and the motor vehicles

are 10% and 20% on cost respectively.7. Provision for bad and doubtful debts of 5% on trade debtors should be made.8. Corporation tax should be provided at 35% of the net profit before tax.9. The directors propose a dividend of 15% on issued share capital and a

transfer of Sh.2,500,000 to the general reserve.10.The debenture interest has not yet been paid.

Required:1. Trading, profit and loss account for the year ended 31 October 1998. (13

marks)2. Balance sheet as at 31 October 1998. (7 marks)

(Total: 20 marks)

QUESTION THREE ACCA PILOT PAPERThe balance sheet of Grand Limited, a wholesaler, at 31 December 1995 and 1996 were as follows:

31 December

1995 1996

Lesson Eight 428

Tangible fixed assetsCost of valuationAggregate depreciation

Current assetsStockDebtorsCash

Current liabilitiesTrade creditorsCorporation taxProposed dividend

Net current assets

Loans (due for repayment 1999)

Called up share capital Share premiumRevaluation reserveProfit and loss account

£000

126,300(50,000)

12,00010,500

1,40023,900

6,8003,4004,000

14,200

£000

76,300

9,70086,000

(60,000)

26,000

6,0001,000

-19,00026,000

£000

162,400

(64,000)

15,000

14,000

2,00031,00

0

9,4005,0006,00020,40

0

£000

98,400

10,600

109,000

(60,000)

49,000

10,000

3,0008,00028,00

049,00

0

The stock at 31 December 1994 was £10,000,000.


The summarized profit and loss accounts for the company for the years ended 31 December 1995 and 1996 were:

SalesCost of salesGross profitExpensesNet profit before tax

Year ended 31 December1995£00064,00040,00024,00010,00014,000

1996£000108,00075,60032,40012,40020,000

Required:a) Calculate the following accounting ratios for both years:

The gross profit percentage The current ratio and the quick ratio (or acid test) Debtors’ collection period in days Trade creditors’ payment period in days (based on purchases figures

which are to be calculated) Gearing ratio.

b) Show you full workings. (10 marks)c) Explain what you can deduce from the ratios as at 31 December 1996 and

from comparing them with those for 1995. (5 marks)d) State two points which could cause the movement in the gross profit

percentages between the two years and explain how they could bring the change about. (2 marks)

e) State the extent to which you agree or disagree with the following and give brief reasons for your answers.

f) The current ratio and the quick ratio help to assess whether a company is able to meet its debts as they fall due. Therefore the higher these ratios are the better placed the company is.

g) A high gearing ratio is advantageous to shareholders, because they benefit from the income produced by investing the money borrowed.

(3 marks)(20 marks)

QUESTION FOUROn 1 February 19X1 the directors of Alpha Ltd issued 50,000 ordinary shares of £1 each at 120p per share, payable as to 50p on application (including the premium), 40p on allotment and the balance on 1 May 19X1.The lists were closed on 10 February 19X1, by which date applications for 70,000 shares had been received. Of the cash received, £4,000 was returned and £6,000 was applied to the amount due on allotment, the balance of which was paid on 16 February 19X1. All shareholders paid the call due on 1 May 19X1, with the exception of one allotee of 500 shares. These shares were forfeited on 29 September 19X1 and reissued as fully paid at 80p per share on November 19X1.

Lesson Eight 430

You are required to write up the necessary accounts, excluding those relating to cash, to record these transactions.







QUESTION ONEPesa Nyingi had a retail business and employed an assistant at a weekly wage of Shs.5,000.00. On 2 January 2002, this assistant did not report for work and it was found that he had left, taking with him the balance in the till. It had been Pesa Nyingi’s practise to bank each Monday morning the balance in the till resulting from the previous week’s transactions. No float was maintained. The only records kept, apart from the bank statement, were details of sales on credit and unpaid invoices for goods.

You ascertain the following balances on 1 January 2001.

Stock 688,000.00Creditors 988,000.00Bank 276,000.00Debtors 344,000.00Cash 228,000.00Accrued expenses 100,000.00Fixtures and Fittings 1,000,000.00

You also ascertain the following:An analysis of the bank statement for the year ended 31 December 2001 showed the following

Receipts 180,000.00Banking from debtors cheques 4,116,000.00Cash 4,296,000.00

Payments 3,748,000.00Creditors for goods 232,000.00Rent and expenses 3,980,000.00

Before banking the amounts, Pesa Nyingi paid the assistant and took Shs. 4,000.00 for himself every week.Expenses Paid out of the till could be assumed to average Shs. 8,000.00 per week excluding wages.Stock at the end of the period was valued at Shs.360,000.00.The debtors summary showed that credit sales for the period amounted to Shs. 13,960,000. An amount of Shs. 336,000.00 was still outstanding.

Lesson Eight 432

Creditors for goods have always been paid by cheque. Unpaid invoices on 31 December 2001 amounted to Shs. 1,120,000.00. Creditors for expenses were Shs. 800,000.00.Although creditors were agreed at Shs. 1,120,000.00, goods had been returned against a cash receipt of Shs. 48,000.00. The receipt has not been recorded There was a fixed margin of gross profit of 20% on selling price.The insurance company has agreed to admit a claim for the amount of the theft.A depreciation charge of 20% is to be charged on the value outstanding on the fixtures and fittings at the end of the year.A cheque from one of the debtors of Shs. 10,000.00 was dishonored but this fact has not yet been reflected in the bank statement.Assume a 50 week year

Required:a) Prepare workings showing your calculation of the amount of the theft.

(8 marks)b) Prepare a trading, profit and loss account for the year ended 31 December

2001 and a balance sheet as at that date. 17 marks)

QUESTION TWOJambo Dealers Ltd maintains a Sales Ledger and a Purchases Ledger.The monthly accounts of the company for May 2002 are being prepared and the following information is available.

Sales Ledger balances as at 1 May 2002Purchases Ledger balances as at 1 May 2002Sales Ledger balances as at 31 May 2002Purchases Ledger balances as at 31 May 2002

Credit Sales Credit PurchasesCash and cheques received Sales LedgerPurchases LedgerCash and cheques received Sales LedgerPurchases LedgerCredit notes issued (for returns inwards)Debit notes received (returns outwards)Dishonoured chequesDiscounts allowedDiscounts receivedBad debts written off in December 2001 but now recovered

Debit1,672,000.0028,000.00?36,500.00

Credit114,600.00747,000.0067,000.00?

18,938,000.00670,000.001,549,700.0013,000.0047,000.00632,000.00119,800.0024,000.0032,000.0043,000.0033,800.0014,200.00

It has been decided to set off a debt due from a customer, A Mutiso, of Shs. 30,000.00 against a debt due to him of Shs. 120,000 in the creditors ledger.The company has decided to create a provision for doubtful debts of 2.5% of the total debtors on 31 May.


Required:a) Prepare the sales ledger control account and the purchases ledger control

account for May 2002 in the books of Jambo Dealers Ltd.(14

marks)b) Produce an extract of the balance sheet as at 31 May 2002 of Jambo Dealers

Ltd relating to the company’s trade debtors and trade creditors.

(3 marks)c) Briefly explain the purpose of control accounts. (3

marks)

QUESTION THREEThe following are the summarized trading, profit and loss accounts for the year ended 30 April 2000, 2001, 2002 and balance sheet as at 30 April 1999, 2000, 2001 2002 for James Mwendapole, a sole trader.Trading, Profit and Loss Accounts for the year ended 31 May

SalesCost of salesGross ProfitExpenses (including loan interest)Net Profit

2000Sh’000’

1,000.00(600.00)

2001Sh’000’

1,200.00(720.00)

2002Sh’000

’1,400.0

0(980.0

0)400.00

(200.00)480.00

(300.00)420.00(280.0

0)200.00 180.00 140.00

Balance Sheets as at 31 May

Non Current Assets

Current AssetsStocksDebtorsBalance at bankTotal Current Assets

Current LiabilitiesCreditorsLoan (received on 31 May 2001)Total Current Liabilities

1999Sh’000’380.00

140.00100.00900.00

2000Sh’000’480.00

160.00180.00130.00

2001Sh’000’680.00

200.00400.00390.00

2002Sh’000’900.00

290.00520.00160.00

330.00

(40.00)-

470.00

(80.00)-

990.00

(120.00)(500.00)

970.00

(180.00)(500.00)

(40.00)

290.00

(80.00)

390.00

(620.00)

370.00

(680.00)

290.00

Lesson Eight 434

Net Current AssetsNet Assets

CapitalOpening CapitalAdd Net Profit

670.00 870.00 1,050.00 1,190.00

510.00160.00

670.00200.00

870.00180.00

1,050.00140.00

670.00 870.00 1,050.00 1,190.00

Additional information:James MwendaPole, a man of modest tastes, is the beneficiary of a small income from his grandfather and therefore has taken no drawings from his retail business.Interest of 10% per annum has been paid on the loan from 1 June 2001.It is estimated that Shs. 120,000.00 would have been paid per year for the services rendered to the business by James MwendaPole.All sales are on 30 days credit basis.James MwendaPole is able to invest in a bank deposit account giving interest at the rate of 8% per year.

Required:1. Calculate for each of the years ended 31 May 2000, 2001, 2001, the

following financial ratios. Return on capital employed Quick ratio Stock turnover Net Profit Margin (8 marks)

2. Use two financial ratios (not referred in (a) above) to draw attention to two aspects to the business which would appear to give cause for concern.

(6 marks)3. Advise James MwendaPole whether, on financial grounds, he should

continue trading and whether it was a sound decision to borrow the loan.

(6 marks)

QUESTION FOURBingwa and Shabiki are in partnership as manufacturers of high quality wheelbarrows, Bingwa being responsible for the factory and Shabiki being responsible for sales. Completed wheelbarrows are transferred from the factory to the warehouse at agreed prises. Bingwa and Shabiki are credited with one third of the manufacturing profit and 10% of the trading gross profit respectively and the balance of the firm’s profit being shared equally. All wheelbarrows are sold at Sh. 680.00 each. No interest is credited or charged on capital accounts or drawings.

The following trial balance was extracted on 31 March 2002.


Capital AccountsBingwaShabikiDrawingsBingwa ShabikiFreehold factory (including land Sh. 300,000.00)Factory Plant at costDelivery Van at costProvision for depreciationFreehold FactoryFactory PlantDelivery VanStocks on 1 February 2001Raw materialsWork in progressWheelbarrows (1220 at Shs. 440)SalesReturn inwardsPurchases of raw materialsPAYEFactory wagesOffice wagesExpenses FactoryOfficeProvision for unrealized stock (in warehouse)Provision for doubtful debtsDebtors and creditorsBank

Sh.

96,000.00

87,400.00

708,800.00

326,400.00

82,000.00

42,000.00

40,200.00

536,800.00

13,600.00

291,600.00

165,400.00

48,000.00

126,800.00

143,400.00

217,600.00

Sh.

482,000.00

507,000.00

307,040.00

110,160.00

38,400.00

1,237,600.00

8,800.00

48,800.00

19,200.00

109,200.00

57,200.00

2,926,000.00

2,926,000.00


Lesson Eight 436

a) 1540 wheelbarrows at Sh. 480 each were transferred to the warehouse during the year.

b) Wheelbarrows in stock being balance of the current year’s production, were valued at agreed price of Sh. 480 each.

c) The stock of raw materials was Sh. 34,000.00 and work in progress is valued at Sh. 53,600.00

d) Accrued expenses on 31 March 2002 amounted to 62,400 (including office(Sh. 32,800.00) and prepaid rates Sh,3,200.00 (including office Shs. 1,200.00 )).

e) Provision for depreciation is to be made as follows:

Factory buildings 2% p.a.Factory Plant 10% p.a.Motor vehicles 25% p.a.

The general provision for doubtful debts is to maintain at 10% of the trade debtors.

Required:Manufacturing, trading and profit and Loss Accounts for the year ended 31 March 2002 and a balance sheet as at that date.

(20 marks)

QUESTION FIVEState and explain the qualities of useful financial information. (10 marks)To what extent do International Accounting Standards help achieve these qualities. (5 marks)

(25 marks)

Acknowledgement 437


NOW SEND YOUR ANSWERS TO THE DISTANCE LEARNING CENTRE FOR MARKING

PUBLIC SECTOR ACCOUNTING

OBJECTIVES

At the end of this lesson you should be able to meet these objectives:

State the accounting concepts, bases and policies of relevance to government accounting.

Prepare analyse and interpret financial statements of government units.

Public sector accounting; the development of accounting standards and their applicability to the public sector.

Fund accounting and its relationship to entity theory


438 Revision Aid Income measurement and valuation in the public sector.

Prepare the accounts of state corporations and similar organisations.

CONTENTS

Public Sector Accounting

Fund Accounting

Lesson Nine 439

PUBLIC SECTOR ACCOUNTING

Public sector accounting is necessary because of the central rule it plays both politically and in economic terms. The public sector is composed of the following:

Central Government Local government Parastatals Charitable organisations

All public sector organisations have one characteristic, namely they derive their specific power from Parliament, and as a result they are represented in Parliament. The accountability of public sector to Parliament takes a variety of forms. For example, under central government, the department heads are directly accountable to Parliament for the activities of their organisation, such as the PS of a given ministry is accountable to Parliament through what is known as Parliamentary Accounts Committee for the proper management of his ministry. The Parastatals are accountable through their ministries, while local authorities are partially accountable to Parliament, and to some extent, to the local electorate. Typically a local authority can set out policies necessary for the improvement of services to the local population, and will look for funds either directly or from Parliament.

The accountability to Parliament will then set the basis for objectives for different organisations. For the central government, the objectives are directly set by Parliament, while the parastatals (e.g. KPLC) will have general objectives set by Parliament, but specific operational objectives are to be set by the Board of Directors appointed by the minister to oversee the operations of the Parastatal.

The following are objectives of Public Sector Accounting:

To provide financial information useful for the determination and predicting of the cash inflows, the balances and financial requirements to meet the short term needs of the organisation, i.e. the accounting information should be able to provide adequate information regarding the tax base as the main source of income to the organisation.

To provide financial information useful for determination and predicting the economic condition of the organisation.

To provide information useful for determining and evaluating the performance of the organisation in terms of legal, contractual and statutory requirements, i.e. the financial statements should be able to indicate whether the transactions of the organisation have been carried out legally and in accordance with statutory requirements and contractual terms.

To provide financial information necessary for the preparation of the budget-planning and to predict the impact of the acquisition and allocation of resources to the organisation.

To provide information necessary for evaluating the managerial performance of the organisation.

The users of public sector accounts can be summarised as follows: Parliament – for control purposes

440 Revision Aid Government departments – to evaluate

performance. Tax payers – to confirm how tax has been used Voters – to decide whether to elect a parliament

back and evaluate government performance. Investors and persons giving grants – such as

donors.

FUND ACCOUNTINGA fund is defined as a distinct accounting entity with a self balancing set of accounts which has objectives set out to be met. In commercial accounting, a fund may be equated to a specific division of the company; that division being charged with specific responsibilities or given specific objectives, such as would be the case for a production department.In government accounting the emphasis is based on the fund as a part of an entity contributing to the overall objectives of the organisation. For this reason, a fund account will be set to receive cash inflows, record expenditures, show assets, as well as liabilities. An example would be a library fund A/C.An organisation may be composed of various fund entities, each fund will have its own books of account as if it was completely independent from the whole organisation.

ACCOUNTING THEORY

Accounting theory refers to the financial reporting that may be adopted by the organisation. It is necessary to note that fund accounting is the representation of the entity accounting theory as used in commercial accounting. This means a fund will be considered a distinctive unit separate from the people related to it. The financial statements prepared for each fund will be for use of those who are interested in the fund. The parallel in commercial accounting is that a company is a separate entity from shareholders, directors, debtors and creditors. The financial statements of the company are prepared to be used by such people.In public sector accounting, the main accounting concepts used are that of stewardship and accountability. Under the stewardship accounting concept, the steward is charged with the responsibility of making sure that the assets of an organisation are not misappropriated. Under accountability, the head of department is accountable for his actions regarding the management of the organisation as whole.

FINANCIAL ACCOUNTING TECHNIQUES

Public sector organisations may adopt different accounting techniques; the most important listed are below:1) Budgetary accounting2) Cash Accounting3) Accruals Accounting 4) Commitment Accounting (encumbrances)5) Fund Accounting

1) Budgetary AccountingRefers to the preparation of operating accounts in form of budgets. A budget is a management plan that has been transformed into figures necessary to evaluate the achievement of the organisations’ objectives.

Under budgetary accounting, the concept is based on the forecasted cash flows, and operations must be limited to the budget estimates. The organisation cannot overspend above budget restrictions without Parliamentary approval.

Lesson Nine 441

Budgetary accounting therefore, aims at achieving the following:

(a) Ensure efficiency of managers.(b) Communicate the objectives of the organisation to the employees(c) Provide controls(d) Provide a yardstick for measuring performance of employees.

2) Cash AccountingUnder this system only cash inflows and outflows are recognised and recorded. The system does not recognise any revenue or expenditure that has not been received or paid. (i.e. accrued)

3) Accrual AccountingThe accruals concept states that revenues and costs are recognised as they are earned and incurred. Most of the organisations in the private sector prefer this method. However, under public sector accounting, both cash and accrual accounting can be used by different entities or kinds of organisations; e.g. if a part of an organisation is charged with the responsibility of running activities on the same basis as commercial organisations, such an entity may adopt accrual accounting irrespective of the accounting techniques adopted by the main organisation.

4) Commitment AccountingThis accounting system recognises transactions when the organisation is committed to them. It means the transaction is not recognised when cash is paid or received, nor when an invoice is received or issued, but at an early stage where orders are received and placed. This accounting method is meant to ensure that government units do not overspend because transactions will only be entered into after checking committed balances.

5) Special fundsSome specific departments of a governmental organisation may adopt special fund accounting according to the set objectives they have to meet. The following are some common special funds to governmental organisations:

(a) Trust funds: These are those funds where the government receives money in the capacity of a trustee. They are also referred to as Agency funds, or Fiduciary funds. Examples of such funds include NSSF and NHIF. The governmental organisation does not have absolute title to the assets held; there are statutory restrictions upon their use.

442 Revision Aid(b) Sinking funds: These are funds created to account for the accumulation of resources for

retiring term bonds at their maturity. Thus their main purpose is the repayment of public debts. Such funds are set up through the approval by the Parliament, and some appropriation may be made from these funds. The amounts appropriated are invested to earn interest; when public debt matures, the sinking fund is used to redeem this debt.

(c) Working capital funds/Revolving funds: They are also known as internal service funds and enterprise funds. They are used to account for services provided to other departments (internal departments – internal service funds, external services = Enterprise funds) for a fee – usually cost-reimbursement basis. They are set up through the approval of Parliament to have the necessary resources for achieving their specific objectives.

(d) Capital Project Funds: This provides resources for the completion of some specific capital projects. The main sources of financing such funds include proceeds from treasury bonds, grants, and transfers from other ministries and funds. This category excludes any capital projects under trust funds or revolving funds.

(e) Specific Revenue funds or special funds: Funds of this class are created and operated to account for revenue designated by law for specific purpose. An example of this would be library services.

(f) General funds: These are funds established to account for resources devoted to financing the general services which the governmental units perform for its citizens. These include general administration, protection of life and property etc.

Note: In government accounting, sources of income can be divided into 2, namely 1) Recurrent expenditure income;2) Development expenditure income.

Recurrent expenditure income can be equated to operating income in financial accounting. Development expenditure income can be equated to capital income in commercial accounting.

CONSOLIDATED FUNDAll Revenues for the government are recorded into a fund known as a consolidated fund. The consolidated fund account is kept by the treasury under the ministry of finance, and all revenues and grants received by the Government are paid into this account. No money can be withdrawn from this account without approval of Parliament, i.e. Parliament is the sole signatory to this account. This is necessary to ensure that all government incomes are used to carry out activities of public interest; and interests are represented in such decision making through the MPs. It is also important to note that each governmental unit may be in a position to raise funds from its local activities (e.g. Ministry of Education – Fees from students, Ministry of Health – Hospital fees).Money realised in this manner is called Appropriations-In-Aid (A-I-A). Each governmental unit is expected to make a budget of its estimated Appropriation-In-Aid and submit the budget to Parliament through the relevant ministry. Appropriations-In-Aid is supposed to be retained by the government unit that generated it. It will be added to the appropriation (allocation by Parliament) to cover the expenditure of the governmental unit.The following books of accounts are kept by each department (governmental unit) to record the transactions of the organisation:

1. Cash BookThe cash book is that book in which all receipts and payments are recorded. Each accounting unit will maintain a cash book. There are different types of receipts and payments in different ministries, and the general point is that all receipts whether in cash or cheque will be recorded in the cash book.

Lesson Nine 443

Illustration

The following cash transactions (cash) took place for a government unit for the month of January 19X8

Sh.

02/01/119X8 Opening balance: Cash 4,000

Bank 25,000

02/01/19X8 Received cheque in respect of trading license 62,500

03/01/19X8 Paid Peter and Sons (cheque for goods supplied) 20,000

05/01/19X8 Cash received in respect of fees 2,500

05/01/19X8 Paid telephone charges (cheque) 8,700

06/01/19X8 Paid AB Ltd by cheque 52,000

06/01/19X8 Paid cash to James Burton 2,800

08/01/19X8 Received cheque for Licenses 210,000

09/01/19X8 Paid wages in cash 5,000

10/01/19X8 Kept a cash balance 10,000 and banked rest together

with all cheques in hand.

Required: Prepare a cash book for the governmental unit.

Solution

CASHBOOK

Jan 19X8

CASHShs.

BANKShs.

Jan 19X8

CASHShs.

BANKShs.

2 Jan2 Jan8 Jan10 Jan

10 Jan

Balance b/dTrade LicensesLicensesCash

Balance c/d

4,00062,500210,00

0

25,000

261,200

4,500

3 Jan5 Jan6 Jan6 Jan9 Jan10 Jan10 Jan

Peter & SonsTelephone chg.AB LtdJames BurtonWagesBankBalance c/d

2,8005,000

261,200

10,000

20,0008,700

52,000

-__

279,000

290,700

279,000

290,700

11 Jan

Balance b/d 10,000 - 11Jan Balance b/d - 4,500

444 Revision AidNote: In the illustration, the government unit has a debit balance in the bank – meaning

they have an overdrawn account with the bank. For control purposes and using the cash accounting technique, such a situation is not allowed. The accounting officer should only release government cheques when there is at least an equivalent amount in the bank, otherwise such cheques may be dishonoured.

2. Vote bookIn commercial accounting, ledgers are a set of accounts; entries being recorded in such accounts. Under public sector accounting, ledgers are substituted with an equivalent called the vote book. In this book, various accounts are opened. These accounts relate to various expenditure heads and sources of revenue. In the vote book, the vote number of any particular department or ministry is used. This is an equivalent to a folio number under commercial accounting. The common head numbers include:110 – Travelling and accommodation120 – Postal and telegram expenses121 – Telephone expenses130 – Official entertainment174 – Stationery etc.These vote heads are necessary to speed up the processing and posting of various expenditures.

Note: The vote book accounts are not to be balanced off as would be in the case of commercial accounting (personal or real accounts) but is a statement to indicate the total amount committed together with the payments that have been made against a given vote. It is presented generally in the form of a T- Account with commitments indicated on the left hand side, and actual payments and balances on the right thereof, i.e.

Commitments Payment Balance

ILLUSTRATION

Vote head – Ministry of Public WorksA I E (Authority to incur expenditure) No. 225 – 35.A I E (Authority to incur expenditure) K£5,000 (or Ksh100,000)

Transactions (Dec 19X6)1 Dec Ordered for iron sheets and cement from Ton & Co. for Sh.25,000;

L.P.O. No. 52136 Dec Paid Sh.3,000 for lorry hire to transport cement; PV No. 357Transactions (Jan 19X7)10 JanPaid Ton & Co. Sh.15, 000 being part payment for goods ordered through LPO No. 5213;

PV No. 358.15 JanPurchased goods from AB & Co. for Sh.5,000 (timber); PV No. 35920 JanIssued LPO No. 5214 to Patel & Sons for windows and doors for Sh.20,000.25 JanPart payment to Patel & Sons Sh.7,000; PV No. 360.

Lesson Nine 445Solution

Commitment PaymentDate19X6

Ref EstimatedCost

Date19X6

PV No.

Amount

Balance

1 Dec

Tom & Co. LPO 5213Shs.25,000

6th Dec 357

Shs.

3,000

Shs.100,00097,000

19X7

19X7

20th Patel & Co. LPO 5214 20,000 10th Jan 15th Jan25th Jan

358359360

15,0005,0007,000

82,00077,00070,000

On 25th January the balance on the vote book will indicate Sh.70,000 with a commitment of Sh.23,000. (Tom = 10,000; Patel = 13,000) Any other commitment must take into account the only expendable amount in the vote is Sh.70,000 – 23,000 = Sh47,000.

Annual AccountsEvery governmental unit will prepare financial statements to account for the money allocated to them. The financial statements differ according to the nature of the activities undertaken by the governmental unit. However, the following types of accounts are common among government units:

1) Income and expenditure accounts;2) Statement of assets and liabilities,3) General Accounts of Vote (GAV)4) The exchequer account5) Paymaster General Account (PMG)6) Appropriation account7) Revenue Account

The techniques involved in preparation of the account shall be given by means of the following worked examples:

1) Income & Expenditure A/CThis is similar to income and expenditure accounts for non-profit making organisations. It is however prepared by governmental units, which provide commercial services e.g. a staff canteen or students welfare canteen (at governmental colleges).

Illustration The following account balances were extracted form the books of a pension fund for the year ended 30th June 19X7:

Dr (Shs) Cr(Shs)Payments to membersMembers’ contributionsPayment for management expensesInterest on investment by fund

500,000

150,000800,000

400,0001,800,000

446 Revision AidFund AccountCash balance (PMG)Investment A/C

350,0002,000,000 ________

3,000,000 3,000,000

Requitred: Prepare an income and expenditure account for the year ended 30th June 19X7 and a balance sheet as at that date.

Note: The fund is the amount set aside to meet the specific objectives of the governmental unit. It is equal to the capital in a business in commercial accounting.

SolutionIncome and Expenditure account for the year ended 30th June 19X7

INCOME

Members’ contributionInterest income from investments

Sh.‘000 Sh.‘000800400

Payments to members Expenses of management

500150

1,200

(650)Surplus 550

Balance Sheet as at 30 June 19X7ASSETS

Investment A/CCash balance

Sh.‘000 Sh.‘0002,000 _350

2,350Fund Account B/FAdd Surplus

1,800550 2,350

2,350

2) General Account of Vote (GAV)During a budget speech, the Minister for Finance will give detailed appropriations (allocations) of funds to different governmental units. Through an appropriation bill, The Parliament will approve different estimates to individual governmental units. The amount approved to each governmental unit by Parliament is then recorded into a particular account known as “General Account of Vote” (GAV). This account therefore records funds allocated to various governmental units.

All incomes of the government are received and recorded into an account called the “Exchequer account”. The total amount available in the exchequer represents the consolidated fund, i.e. the consolidated fund operates an account called exchequer.

IllustrationThe approved estimates and actual details of the Ministry of Culture and Social Services for the year 19X6/19X7 were as follows:

Gross estimated expenditure K£640,000Estimated Appropriation-In-Aid K£ 40,000

Lesson Nine 447Drawings from exchequer K£530,000Gross Expenditure K£480,000Actual appropriations in aid K£30,000

Required: Prepare a) i) The General Account of Voteii) The exchequer accountiii) Paymaster General Account

b) A statement of assets and liabilities as at 30-6-19X7

SOLUTION

Note: (i) The exchequer account records the amount accrued by the consolidated fund to a particular government unit

(ii) The GAV account will record amounts approved by Parliament to a particular governmental unit. However, the consolidated fund will issue different amounts for a given period of time to a particular government unit subject to the maximum, which was approved by Parliament. E.g. Parliament may approve K£600,000 for a particular governmental unit, but due to various reasons, the consolidated fund may issue a different amount to the unit, but not exceeding K£600,000.

(iii) The Paymaster General Account (PMG) is the cash account operated by the individual governmental units. It records amounts so far withdrawn from the exchequer.

All money approved for a governmental unit is intended to meet a specific purpose. This means each governmental unit will maintain an expenditure account, in which shall be recorded debits for various expenses incurred. The corresponding credit is in the PMG account (cash account). The expenditure account will then be closed to GAV. The difference between the amount approved by Parliament and total expenditure will then represent a fund balance, that should be surrendered back to the treasury at year end if not used.

GENERAL ACCOUNT OF VOTEK£ K£

30 June 19X7 Expenditure 480,00030 June 19X7 Balance c/d 190,000

1 July 19X6 Exchequer 640,00030 June 19X7 Appropriation in Aid 30,000

670,000 670,000

EXCHEQUER ACCOUNTK£ K£

1 July 19X7 General Account for vote 640,000 _______

30 June 19X7 PMG A/C 530,00030 June 19X7 Balance c/f 110,000

640,000 640,000

PAYMASTER GENERAL ACCOUNTK£ K£

30 June 19X7 Exchequer 30 June 19X7 Expenditure

448 Revision Aid

530,00030 June 19X7 Appropriation In Aid 30,000

480,00030 June 19X7 Balance c/d 80,000

560,000 560,000

EXPENDITURE ACCOUNT30 June 19X7 PMG A/C 480,000

30 June 19X7 General Account of Vote 480,000

Notes:1) Appropriation-In-Aid (AIA) is the amount to be generated by the governmental unit from its

internal activities. It is subtracted from the gross estimate (gross vote) to arrive at net estimate of (net vote) which is approved by Parliament to be released from the consolidated fund. An A-I-A account may be maintained, Where: When A-I-A is received from own operations:

Dr PMG Account Cr A-I-A Account

At the year end:Dr A-I-A Account Cr GAV Account

2) At the beginning of each year, each governmental unit has an estimated Appropriation-In-Aid which will guide them on the total amount expected to be generated internally. Thus the sum of net estimates approved and actual appropriation in aid will constitute the total funds allocated to each governmental unit. This sum constitutes the credit side of the GAV account.

STATEMENT OF ASSETS AND LIABILITIES AS AT 30-6-19X7ASSETS

Exchequer (Amount not yet drawn)Paymaster General (PMG)

K£110,00080,000

K£______

190,000

FUNDED BY

General Account of Vote190,000

Thus funds allocated have been adequately accounted for and the balance of K£190,000 will be surrendered back to the Treasury.

In this case, the government unit will surrender the Sh80,000 from the PMG, while the exchequer will surrender Sh 110,000 on behalf of the ministry.

Illustration:The following information relates to a governmental unit for the fiscal year 19X6/19X7.Gross estimates: K£720,000Appropriation-In-Aid estimated: K£90,000Drawings from the exchequer K£450,000Actual gross expenditure K£520000Actual appropriation-in-aid K£120,000

Lesson Nine 449Required:a) Prepare the following accounts: i) General Account of vote (GAV)

ii) Exchequer A/Ciii) PMG A/C

b) Statement of assets and liabilities as at 30 June 19X7.

Solution:For clear accounting procedure it is necessary to distinguish between the proportion of gross estimate that will be generated internally and that proportion that is expected from the treasury after Parliamentary approval.

GENERAL ACCOUNT OF VOTEK£ K£

30 June 19X7 Excess in A-I-A 30,00030 June 19X7 Expenditure 52,00030 June 19X7 Balance c/d 20,000

1 July 19X6 Exchequer A/C 630,00030 June 19X7 A-I-A 120,000 ______

750,000 750,000

NOTE: TO SIMPLIFY ACCOUNTING ENTRIES, THE A-I-A IS RECORDED IN THE GAV AT THE END OF THE FISCAL YEAR. THIS WILL ENABLE US TO DETERMINE WHETHER THERE WAS A SHORTFALL

(DEFICIENCY) IN A-I-A FROM THE EXPECTED AMOUNT, OR THERE WAS A SURPLUS.

EXCESS APPROPRIATION-IN-AIDK£ K£

30 June 19X7 Balance c/d 30,000

30 June 19X7 GAV A/C 30,000

EXCHEQUER ACCOUNTK£ K£

1 July 19X6 General Account of vote630,000 ______

30 June 19X7 PMG 450,00030 June 19X7 Balance c/d 180,000

630,000 630,000

PMG ACCOUNTK£ K£

30 June 19X7 Exchequer A/C 450,00030 June 19X7 A-I-A 120,000

30 June 19X7 Exchequer A/C 520,00030 June 19X7 Balance 50,000

570,000 570,000

APPROPRIATION IN AID ACCOUNTK£ K£

30 June 19X7 GAV 30 June 19X7 PMG

450 Revision Aid

120,000120,000

Note: amounts to be surrendered back to the exchequer will be £230,000. The governmental unit is also expected to remit any A-I-A to the consolidated fund – This is more apparent in a statement of appropriation. (also known as appropriation A/C).

STATEMENT OF ASSETS AND LIABILITIES AS AT 30th June 19X7AssetsExchequer A/CPaymaster General (PMG)

K£180,00050,000

K£______

230,000Funded byExcess in AIAGeneral Account of Vote

30,000200,000

______230,000

APPROPRIATION ACCOUNTS

These may be drawn in two different ways (one being a slight variation from the other).

An example of an appropriation account would be as follows:

APPROPRITATION ACCOUNT FOR THE YEAR ENDED 30TH JUNE 19X4 (K£)Details Approved estimate Actual

Expenditure

Amount under-spent

Amount overspent

Personal emoluments: - original estimate - supplementary estimateHouse allowancePassage and LeaveTravelling expenses: - original estimate - supplementary estimateElectricity & WaterPurchase of plant & mach.

80,0008,000

22,000(2,000)

88,00015,0005,000

20,0006,000

50,000

90,00013,0004,500

23,0006,500

40,000

2,000500

10,000

2,000

3,000500

_____

Gross AppropriationAppropriation-In-Aid

184,000(15,000)

177,000(12,000)

12,500 5,500

Net Appropriation 169,000 165,000

Note:

1) Net estimate exceeds actual expenditure by K£4,000. This indicates that there was no over expenditure for the governmental unit as a whole. However, there are some over-expenditures on individual items; but since these are not significant, no explanations are required by the accounting officer.

2) The gross estimates and gross actual expenditures are recorded before taking into account the effect of A-I-A. In this case gross expenditure estimate exceeds the gross actual expenditure by K£7,000. But in order to determine the surplus to be returned to the treasury or over-expenditure, we must take into account the effects of either surplus AIA or deficiency of AIA. In this case, there is a shortage in AIA of K£3,000. The deficiency must be netted off from the surplus of “approved estimates and actual expenditure”:

Lesson Nine 451Surplus of estimates over actual expenditure

K£7,000Less deficiency in A-I-A (3,000) Expendable balance K£4,000

Therefore there is no net over-expenditure by the ministry.

IllustrationThe approved estimates and actual expenditure details of the Ministry of Agriculture for the year 19X7/19X8 were as follows:

CODE Details Approved estimates K£

Actual Expenditure K£

000050080100110120190196230620

Personal emolumentsHouse AllowancePassage and LeaveTravelling and accommodationTransport and maintenancePostal and Telecom expensesMiscellaneous chargesTraining expensesPurchase of equipmentAIA (Realised income)

12328019,55041,0401,334

16,1004,600

17,4805,980

21,0001,000

97,52014,260

6671,656

13,5933,312

16,8824,738

39,8005,560

The ministry made fair equal withdrawals from the exchequer in July 19X7, October 19X7, January 19X8 and May 19X8. In total, the ministry had drawn K£200,000 by the year-end.Required:a) The general account of voteb) The exchequer accountc) The PMG accountd) Statement of assets and liabilities as at 30th June 19X8.

SOLUTION

It would help if an appropriation account is drawn up. In this illustration it is drawn in a slightly varied version:CODE Details Approved

Estimates K£Actual Expenditure K£

Over/UnderExpenditure K£

000050080100110120190196230

Personal emolumentsHouse AllowancePassage and LeaveTravelling and accommodationTransport and maintenancePostal and Telecom expensesMiscellaneous chargesTraining expensesPurchase of equipment

12328019,55041,040

1,33416,100

4,60017,480

5,98021,000

97,52014,260

6671,656

13,5933,312

16,8824,738

39,800

25,7605,290

40,373(322)2,5071,258

5981,242

(18,800)

620Gross AppropriationA-I-A

250,364(1,000)

192,428(5,560)

57,9364,560

Net Appropriation 249,364 186,868 62,496

GAV ACCOUNTK£ K£

452 Revision Aid

30 June 19X8 Excess A – I – A A/C 4,50030 June 19X8 Expenditure A/c 192,42830 June 19X8 Balance c/d 57,936

1 July 19X7 Exchequer A/c 249,36430 June 19X8 A – I – A A/C 5,560 _______

254,924 254,924

Excess Appropriation in Aid AccountK£ K£

30 June 19X8 Balance c/d 4,560

30 June 19X8 GAV A/C 4,560

Exchequer AccountK£ K£

1 July 19X7 GAV A/C 249,364

30 June 19X8 Expenditure 200,00030 June 19X8 Balance c/d 49,364

249,364 249,364

PMG AccountK£ K£

30 June 19X8 Exchequer (Total) 200,00030 June 19X8 A – I – A A/C 5,560

30 June 19X8 PMG (Total) 192,42830 June 19X8 Balance c/d 13,132

205,560 205,560

ExpenditureK£ K£

30 June 19X8 PMG 192,428

30 June 19X8 GAV A/C 192,428

Appropriation-In-aid AccountK£ K£

30 June 19X8 GAV 5,560

30 June 19X8 PMG 5,560

STATEMENT OF ASSETS AND LIABILITIES AS AT 30 JUNE 19X8ASSETS

Exchequer A/CPaymaster General A/C

K£49,36413,132

K£_____

62,496

FUNDED BY

Lesson Nine 453General Account of VoteExcess appropriation-in-aid

57,9364,560

______62,496

REVENUE ACCOUNTS

A revenue account records only the estimated revenue and actual revenue from each particular revenue source for the governmental unit. The difference between the two, if significant must be explained by the accounting officer. Alternatively the significant difference between the two can be used to correct future estimations by the governmental unit. It could also represent new factors emerging during the year which were not taken into account during the previous budget.

ILLUSTRATION

From the following data, prepare a statement of revenue for the year ended 30th June 19X7.

Estimated Revenue Actual ReceiptsRenting building and equipment K£850,000 K£870,000Fee for trading licenses K£430,000 K£400,000Fees for import/export licenses K£470,000 K£480,000Other receipts K£235,000 K£210,000

The following additional details are available: -(i) Balance on hand on 30th June 19X6 K£247,000(ii) Balance on hand on 30th June 19X7 K£160,000

REVENUE A/C FOR THE YEAR ENDED 30TH JUNE 19X7Details Estimat

e £Actual

£Details £

Balance b/d (30-June-19X6)Rent for building/machineryFees for trading licensesFees for import/exportOthers

850430470235

1,985

247870400480210

1,960

Payment to Treasury

Balance c/f (30.6.19X7)

2,047

160

2,207 2,207

Note: There are no serious differences between estimate and actual receipts, hence no explanation is required by the accounting officer.

Illustration:The following are extracts from the trial balance for revenue head No. 180 – 240, Airport revenue collection for the year ended 30th June 19X8:Code Details Dr(£) Cr (£)630 Renting building and equipment 807,456631 Rent from land 3,796,205651 Aviation landing fee 3,542,221652 Airport passenger tax 3,991,029670 Other airport receipts 798,144

Payment of revenue to exchequer 13,288,687

The following additional details are made available:

454 Revision Aid

i) Balance in hand at 30th June 19X7 £2,568,242.ii) Estimated receipts for the year:

CODE AMOUNT630 £1,000,000631 £2,500,000651 £3,000,000652 £3,600,000670 £1,100,000

Required:a) A statement of revenue for the year ended 30th June 19X6b) Give appropriate footnotes for material differences between estimates and the actual

receipts.Solution

REVENUE ACCOUNT FOR THE YEAR ENDED 30TH JUNE 19X8Details Estimate

£Actual £ Details K£

Balance b/d (30-June-19X7)Renting building/machineryRent for landAviation landing feesAirport passenger taxOther airport receipts

1,000,0002,500,0003,000,0003,600,0001,100,000

11,200,000

2,568,242807,456

3,796,2053,542,2213,991,029798,144

12,935,055

Payment to Treasury

Balance c/f 30.6.19X8

13,288,687

2,214,610160

_________

15,503,297

15,503,297

Note: There may have been a significant increase in the volume of business at the airport. It is possible that a new airline (previously not operational to Kenya) has decided to make Kenya one of its destinations/stopovers. It is also possible that some land and buildings have been sold, thus leading to a fall in rental income.

GENERAL AND SPECIAL FUNDS ACCOUNTSIn carrying out its functions to meet both economic and political needs of the country, the government sets out various funds that are charged with specific governmental units, ministries or departments that will oversee the operations of the fund.Note: A fund is an entity with self-balancing books to meet specified objectives. For proper accounting, different funds are named in accordance with the activities they are supposed to undertake. For example, the general fund of a governmental unit is the entity that accounts for all resources and assets used for financing the general administration of the unit. The general administration of the unit is for traditional services provided to the people, such as security, health, education and eradication of poverty.

In some cases, the government may set aside funds to meet special duties or activities which are different from ordinary traditional services being offered to the people. This means whenever a tax or other revenue source is authorised by Parliament to be used for a specified purpose, then a governmental unit avails itself of that source, and may create what is known as a Special Revenue Fund.

Lesson Nine 455

The purpose of a special revenue fund is to show that the revenue from such sources was used for a specific purpose only; and the governmental unit will then operate what is known as a special fund account to record the resources and liabilities for such an entity.

The general fund and special funds are commonly known as revenue funds of a governmental unit. Thus, where there is no specification, the revenue fund of a governmental unit may refer either to the general fund or the special fund.

It is important to note that the general fund as well as special revenue fund only record current assets and current liabilities of the governmental unit. Long term assets as well as long term liabilities for governmental units are covered under different funds e.g. property funds. The difference between current assets and current liabilities of a general or special fund constitute what is known as “fund equity”. Fund equity would thus be an equivalent of net working capital in commercial accounting. However from the governmental accounting point of view, fund equity represents the fund balance that has not been directly used or committed. The fund equity can further be divided into two parts:i) Fund balanceii) Reserves

The reserves part of a fund equity represents funds that have been committed but the liability not yet incurred. For example, where a contract has been entered into, and the contractor has been issued with an LPO, but he has not yet supplied or provided the service; the amount committed to the LPO will be represented in form of a reserve to indicate that it is fund balance which cannot be distributed/utilised. The other distributable amounts are listed under fund balance.

BUDGETARY ACCOUNTING

All funds set up by the government to meet different objectives will have a budget as a source of control with regard to estimated revenue as well as estimated expenditure (appropriations). In order to record transactions of a governmental unit, the following general ledger control accounts are recommended:

i) Estimated revenue A/Cii) Appropriation A/Ciii) Encumbrances A/C

These three accounts are general ledger control accounts which must be supported by the relevant subsidiary accounts as illustrated below:

IllustrationThe expected revenue source of a particular governmental unit were as shown below:

REVENUE LEDGER

Taxes £882,500Licenses and permits £125,500Intergovernmental revenues £200,000Charges for services rendered £90,000Fines and forfeitures £32,500Miscellaneous revenues £19,500

456 Revision Aid

Total Expected Revenue £1,350,000

The Expected revenue would be recorded in the general ledger control accounts as £1,350,000; being the sum of individual expected revenue. The journal entry to record this transaction is:

Dr £ Cr £Estimated Revenue Fund balanceTo record approved revenue to a governmental unit

1,350,0001,350,000

Subsidiary ledgers will however record details of individual sources of revenue.Note: Estimated revenues are potential assets for the non-governmental organisation and are comparable to debtors in commercial accounting; hence the debit entry in the estimated revenue control account. On the other hand, appropriations are potential liabilities and are recorded through credit entries in the appropriations control A/C.

Estimated revenues represent what the government unit expects from various sources. At the end of year, the actual revenue realised may be different from the estimated revenue. The revenue realised is recorded through the following entries:

Debit Cash Credit Revenue A/c (This also acts as a control A/C)The revenue account is then closed to estimated revenue account to indicate whether estimated revenue exceeds actual revenue or vice versa.

EXPENDITURE ACCOUNT

This account records actual liability incurred as opposed to the appropriation account which records estimated or potential liability. The corresponding credit is in the individual liability accounts, e.g.

Expenditure Account£

Wages payable 60,000Postage payable 14,000

£Appropriations A/C 74,000

74,000 74,000

The total expenditures incurred will then be compared with appropriations (or estimated expenditure). For this reason, the expenditure account is closed to appropriations A/C.

Wages Payable£

Cash 60,000

£Expenditure A/C 60,000

Postage payable£

Cash £

Expenditure A/C

Lesson Nine 45714,000 14,000

EncumbrancesEncumbrances record the commitments that have been entered into but services are yet to be received. The purpose of recording the commitments is to ensure that the budgeted appropriations are not exceeded. In this way, accounting officers may guard against over expenditure.E.g. assume that approved estimates for a governmental unit was Sh1,000,000, and so far during the year Sh800,000 had already been incurred. Also assume that LPOs amounting to Sh120,000 have been committed to vote books. This therefore means that out of the Sh1,000,000, only Sh80,000 is available either to be retained to the treasury or to be expended by the governmental unit. The commitments are recorded in:i) Encumbrances accounts;ii) Fund balance reserved for encumbrances A/C

In the above example, the encumbrances of Sh120,000 will be recorded as follows:

EncumbranceSh

Fund balance reserved... 120,000

Sh

Fund balance reserved for encumbranceSh

Encumbrance 120,000

After the expenditure has been incurred (commitments have been fulfilled). The above entries are reserved. At the same time, the expenditure is fully recorded. Assume the encumbrance of Sh120,000 was in respect of pool chlorine for training governmental unit forces; and the supplier has already fulfilled the commitment and has been paid: Encumbrance A/C

ShFund balance reserved... 120,000

ShFund balance reserved… 120,000


Encumbrance 120,000

ShEncumbrance 120,000

Expenditure A/C£

Pool Chlorine 120,000

£Appropriations 120,000

Pool Chlorine A/CSh

Cash 120,000

ShExpenditure 120,000

458 Revision Aid

Sometimes there is an overlap between the end of the accounting period and when the commitments are fulfilled. Assume that the governmental unit accounting period ends on 30th

June every year, and a commitment entered into during the month of April for Sh250,000 have been partially services to the tune of Sh210,000 at the end of the accounting period to 30 th June 19X7. From the point when commitment was entered into, the following entries shall be made:

Lesson Nine 459Encumbrance A/C

ShFund balance reserved... 250,000 _____

ShFund balance reserved… 210,000Fund balance 40,000

250,000 250,000

This account is not to be balanced but closed to fund A/C


Encumbrance 210,000Balance c/d 40,000

ShEncumbrance 250,000 ______

250,000 250,000Balance b/d 40,000

The fund balance reserve for encumbrances will then appear in the statement of assets and liabilities at the end of the period.

COMPREHENSIVE ILLUSTRATION

The city of Westcycle fiscal period ends on 30th June. The trial balance of the general fund as on 1 July 19X7 was as follows:

Dr £ Cr £Cash Balance 12,600Savings A/C 66,800Property tax receivable 480,000 Accounts payable 7,300Wages payable 4,450Fund balance 548,250

560,000 560,000

The operations for the year ended 30th June 19X8 are summarised as follows:i) Estimated revenues: £2,400,000; Appropriations: £2,350,000ii) Revenues from property taxes levy: £1,925,500iii) Cash received from property taxes: £2,005,600; and other revenues: £485,700iv) Expenditures encumbered and evidenced by purchase orders: £1,760,000v) Liquidation of encumbrances and vouchers prepared for purchase order billings:

£1,755,000.vi) Expenditure for payroll £602,000vii) Cash disbursed for vouchers: £1,740,000

Cash for payment of wages: £598,000Cash transferred to savings A/C: £150,000.

Required:a) Open the ordinary ‘T’ accounts for the accounts appearing in the trial balance and enter the

balances as at 1 July 19X7.b) Open ‘T’ accounts for: Fund balance reserves for encumbrances

: Estimated revenues

460 Revision Aid: Revenues: Appropriations: Expenditure: Encumbrances

c) Prepare journal entries to post the foregoing summarised operations.d) Post the entries recorded in (c) above into the accounts.e) Record appropriate entries to dwell the accounts as at 30th June 19X8.f) Prepare a balance sheet as at 30th June 19X8.

Cash £ £

Balance b/d 12,600

Property tax 2,005,600

Other revenue 485,700

________

Accounts payable 174,000

Wages 598,000Savings 150,000

Balance c/d 15,900

2,503,900 2,503,900

SavingsSh Sh

Balance b/d 66,800

Cash 150,000

Balance c/d 216,800

216,800 216,800

Fund BalancesSh Sh

Appropriations 2,350,000

Encumbrance 5,000

Appropriation 7,000

Balance c/d 597,450

Balance b/d 548,250

Estimated revenue 2,400,000

Estimated revenue 11,200

________

2,959,450 2,959,450Balance b/d 597,450

Fund Balance reserved for encumbrancesSh Sh

Encumbrances 1,755,000

Balance c/d 5,000


________

1,760,000 1,760,000

Lesson Nine 461Balance b/d 5,000

Estimated revenueSh Sh

Fund balance 2,400,000

Fund balance 11,200

Revenue 2,411,200

________

2,411,200 2,411,200

Property taxesSh Sh

Balance b/d 480,600

Revenue A/C 1,925,500

Cash 2,005,600

Balance c/d 400,500

2,406,100 2,406,100Balance b/d 405,500

Wages payableSh Sh

Cash 598,000Balance c/d 8,450

Balance b/d 4,450Expenditure 602.000

606,450 606,450Balance b/d 8,450

Accounts payableSh Sh

Cash 1,740,000

Balance c/d 22,300

Balance b/d 7,300Expenditure 1,755,000

1,762,300 1,762,300Balance b/d 22,300

Encumbrances

462 Revision AidSh

Fund reserved … 1,760,000

________

Fund reserved … 1,755,000Fund balance 5,000

1,760,000 1,760,000

AppropriationsSh Sh

Expenditure A/C 2,357,000

________

Fund balance 2,350,000Fund balance 7,000

2,357,000 2,357,000

Revenue A/CSh Sh


Property tax 1,925,500Other revenue 485,700

2,411,200 2,411,200

Expenditure A/CSh Sh

Wages payable 602,000Accounts payable 1,755,000


2,357,000 2,357,000

Other revenueSh Sh

Revenue account 485,700

Cash 485,700

Lesson Nine 463

The Journal Dr (Sh) Cr (Sh)

Estimated Revenue A/C Fund Balance A/CFund Balance A/c Appropriations A/C

2,400,000

2,350,0002,400,000

2,350,000

Property Taxes receivable A/C Revenue A/CCash Property taxes receivable A/C

1,925,500

2,005,6001,925,500

2,005,600

Cash Other Revenue A/COther revenue A/c Revenue A/C

485,700

485,700485,700

485,700

Encumbrances Fund balance reserved for encumbrancesFund balance reserved for encumbrances EncumbrancesFund balance Encumbrances

1,760,000

1,755,000

5,000

1,760,000

1,755,000

5,000

Expenditure A/C Wages Payable

602,000602,000

Wages payableAccounts payable Savings bank A/C Cash

598,0001,740,000

150,0002,488,000

Expenditure A/C Accounts payable

1,755,0001,755,000

Revenue A/C Estimated Revenue A/CEstimated Revenue Fund Balance

2,411,200

11,2002,411,200

11,200

Appropriations A/C ExpenditureFund Balance Appropriations

2,357,000

7,0002,357,000

7,000

Balance Sheet as at 30th June 10X8Assets Sh

Liabilities Sh

Cash 15,900

Savings A/C 216,800 Property taxes receivable

400,500_______

Wages payable 8,450

Accounts payable 22,300

Fund Balance 597,450

Reserve for encumbrances 5,000

633,200 633,200

IllustrationThe following data relates to the city of Kababwe:

464 Revision Aid

Trial Balance As At 1 – 7 – 19x7 Dr (Shs) Cr (Shs)

CashSavings A/CProperty taxes receivableInvestment in government Treasury BillsAccounts payableWages payable Fund Balances

242,500250,000185,000350,000

________

162,60030,000

834,9001,027,500 1,027,500

The transactions completed during the year for the general fund are summarised and recorded as follows for the year ended 30 – June – 19X8.JOURNAL Sh Sha) Estimated Revenue A/c Appropriations Fund Balance b) Property Taxes receivable Revenue c) Cash Property taxes receivable A/C Other revenued) Expenditure Wages payableEncumbrances Fund balance reserved for encumbrancesFund balance reserved for encumbrances EncumbrancesExpenditure Accounts payableAccounts payableWages payable Cash Estimated Revenue Fund balancesAppropriations Expenditure Fund BalanceFund balance Encumbrances

9,100,000

9,105,000

3,280,000

5,800,000

5,785,000

5,785,000

5,800,0003,270,000

9,070,000

15,000

9,070,00030,000

6,470,0002,635,000

3,280,000

5,800,000

5,785,000

5,785,000

9,100,00038,000

9,065,0005,000

15,000

Required:a) Open appropriate accounts, post entries therein, and balance them at the year endb) Draw a trial balance as at 30.6.19X8c) Prepare a statement of assets and liabilities.

SOLUTION

Cash A/CSh Sh

Balance b/d 242,500

Property taxes 6,470,000

Other revenue 2,635,000

Accounts payable 5,800,000

Wages payable 3,270,000

Balance c/d 277,500

9,347,500 9,347,500

Lesson Nine 465

Property tax receivableSh. Sh.

Balance b/d 185,000Revenue

6,500,000

Cash 6,470,000

Balance c/d 215,000

6,685,000 6,685,000

Wages payableSh. Sh.

Cash 3,270,000Balance c/d 40,000

Balance b/d 4,450Expenditure 602.000

3,310,000 3,310,000

Revenue A/CSh. Sh.


________


Cash other revenue 2,635,000

9,135,000 9,135,000

EncumbrancesSh. Sh.


________


Fund balance 15,000

5,800,000 5,800,000

Fund reserved for encumbrancesSh. Sh.


Balance c/d 15,000


________

5,800,000 5,800,000

Savings A/CSh. Sh.

Balance b/d 250,000

Balance c/d 250,000

Treasury Bills A/CSh. Sh.

Balance b/d 350,000

Balance c/d 350,000

Accounts payableSh. Sh.

466 Revision Aid

Cash 5,800,000

Balance c/d 147,600

Balance b/d 162,600

Expenditure 5,785,000

5,947,600 5,947,600

Fund BalancesSh. Sh.


Encumbrance 5,000

Appropriation 7,000

Balance c/d 889,450

Balance b/d 834,900



Appropriations 5,000

9,974,900 9,974,900

Expenditure A/CSh. Sh.




9,065,000 9,065,000

AppropriationsSh. Sh.


Fund balance 5,000


________

9,070,000 9,070,000

Estimated revenue A/CSh. Sh.


Fund balance 35,000

Revenue 9,135,000

________

9,135,000 9,135,000Trial Balance As At 30 – 6 – 19x8 Dr Cr Cash Savings A/CTreasury BillsProperty taxes receivableAccounts payableWages payableFund balance reserved for encumbrancesFund balance

277,500250,000350,000215,000

________

147,60040,00015,000

889,9001,092,500 1,092,500

Lesson Nine 467

Balance Sheet as at 30 – 6 – 19X8ASSETSCash Savings A/CTreasury BillsProperty taxes receivable

LIABILITIESWages payableAccounts payable

FUND EQUITYUnreserved fund balance Fund balance reserved for encumbrances

Shs. Shs.

40,000147,600

Shs.277,500250,000350,000215,000

1,092,500

(187,600)904,900

889,90015,000

904,900

Illustration:The city’s general fund trial balance as at 1 June 19X7 is as follows:

Dr £ Cr £CashSavings A/C Property taxes receivableInvestment in treasury billsAccounts payable Wages payable Fund balance

225,00080,000

122,500100,000

527,500

52,70019,200

455,600527,500

The following data summarises operations for the current fiscal year that ends operations on 30 – 6 – 19X8:

£a) Estimated: Revenues 2,180,000

: Appropriations 2,115,000b) Revenue from property tax levy 1,450,000 Cash received from property taxes 1,460,000 Other revenues received 760,000c) Expenditure on payroll 1,150,000 Expenditure encumbered and evidenced by LPOs 1,210,000 Liquidation of encumbrance vouchers for order billings 1,050,000d) Cash disbursed: for vouchers 1,065,000

: for payment of wages 1,155,800 : for savings A/C 40,000

Cash A/C£ £

Balance b/d 225,000

Property taxes 1,460,000

Other revenue 760,000________



Savings A/C 40,000

Balance c/d 184,200

2,445,000 2,445,000

468 Revision Aid

Savings A/C£ £

Balance b/d 80,000

Cash 40,000

Balance c/d 120,000

120,000 120,000

Property tax receivable£ £

Balance b/d 122,500Revenue

1,450,000

Cash 1,460,000

Balance c/d 112,500

1,572,500 1,572,500

Accounts payable£ £

Cash 1,065,000

Balance c/d 37,700

Balance b/d 52,700


1,102,700 1,102,700

Wages payable£ £

Cash 1,155,800

Balance c/d 13,400

Balance b/d 19,200


1,169,200 1,169,200

Estimated revenue A/C£ £


Fund balance 30,000

Revenue A/C 2,210,000

________

2,210,000 2,210,000

Revenue A/C£ £



Cash (other revenue) 760,000

2,210,000 2,210,000

Appropriations£ £


________


Fund balance 85,000

Lesson Nine 4692,200,000 2,200,000

Encumbrances£ £


________


Fund balance 160,000

1,210,000 1,210,000

Fund Balances£ £


Appropriations 85,000

Encumbrance 160,000

Balance c/d 305,600

Balance b/d 455,600



________

2,665,600 2,665,600

Expenditure A/C£ £




2,200,000 2,200,000

Fund reserved for encumbrances£ £


Balance c/d 160,000


________

1,210,000 1,210,000

BALANCE SHEET AS AT 30 – 6 – 19X8Assets £ £Cash 184,200Savings A/C 120,000Treasury bills 100,000Property Taxes receivable 112,500

516,700LIABILITIES

Accounts payable 37,700Wages payable 13,400 (51,100)

470 Revision Aid

465,600Financed byUnreserved fund B/F 305,600Fund balance reserved for encumbrances 160,000

465,600SPECIAL FUNDS

Special fund accounts are created by governmental units to account for the revenues and expenditures of specialised governmental unit operations, which are outside the traditional services offered by the government. Once a particular activity is identified, a special fund account is created to ensure that revenues allocated to this account are properly received and accounted for; and that expenditure from this fund must be incurred in respect of activities associated with the special fund.Once identified, the special operation necessitating creation of special fund will be treated exactly in the same way as general fund accounting, i.e. estimated revenue, revenue, appropriations and expenditure will be recorded in the same way as was done with the general fund. This also applies to encumbrances.

Common examples of activities that require creation of special funds are:1) Construction and maintenance of streets, roads and bridges2) Libraries3) Grants received either from foreign countries or specific government bodies that are geared

towards specified operations.

Note: Grant accounting requires a slightly different approach in the sense that the grantor would require the grantee to use the grants for a specified purpose; and in order to attain this objective, grant accounting is on the basis of reimbursement. This means that grant revenue will only be recognised as having been received after actual expenditure has been incurred.It is only then the grantor will release the grant revenue. However, for any given period it is possible for the grantee to account for any grant receivable by creating an account known as deferred revenue.

The deferred revenue account is a liability account showing that there is a potential revenue which will only be recognised upon meeting certain conditions. Relevant entries are as follows:

Assume that Town X was given a grant of Sh.50,000,000 for construction of streets in a particular region of the town. Upon receiving this information, the governmental unit will record the transaction as follows:Dr Grant receivable 50,000,000 Cr Deferred Revenue A/C 50,000,000The basis of this entry is that the recognised accounting principles under special funds/general funds in the “modified accrual basis of accounting”. Under this principle, both revenues and expenditures are only recognised when the possibility of their realisation is certain.

Grants will normally be released under specified conditions are being met; and under modified accrual basis of accounting such revenues cannot be recognised until the conditions required have bee fulfilled.

In the above example, assume that 3 months later, Town X has identified the contractor and given out contracts to construct streets in the required region to the tune of Sh.30,000,000. When this is done, then the specified conditions have been met and the grant receivable revenue is recognised. The following entries are then made:

Lesson Nine 4711. Dr Deferred Revenue 30,000,000

Cr Revenue Account 30,000,000

2. Dr Expenditure 30,000,000 Cr Accounts payable 30,000,000

The second entry is required to enter the liability incurred when the contract is entered into while the first entry is now to recognise part of the grant revenue as receivable revenues under the modified accrual basis. However, where the contract has been entered into but the work is not yet performed, the encumbrance entries will be recorded instead of (2) above.

The concept of modified acrrual basis of accounting is used in many other governmental units funds that will require the revenue to be recognised when there is uncertainty regarding their realisation.

One such fund is the capital projects fund. The capital projects fund is a fund created to cater/account for revenues and resources that are associated with capital projects of a governmental unit. The capital projects fund is an equivalent to capital budgeting/ financing under commercial accounting.

General funds and special funds are not normally used to finance capital projects. Major sources of financing capital projects of a governmental unit are as follows:(1) Long-term debt(2) Governmental treasury bonds(3) Grants from other governmental units or foreign governments.(4) Transfer from other funds within the government.(5) Gifts (from individuals or organisations) that are specified to be used in particular projects.

Once the sources of funds have been identified and set aside, a special account called the capital project fund account will be created to ensure proper utilisation of resources. The capital project fund will then operate on the basis of modified accrual principles of accounting, whereby related revenues and expenditures are recognised when there is a certainty of their occurrence.

Assume that a governmental unit gets authority to issue long-term bonds to finance a particular capital project. Once authority is granted, the concerned governmental unit will only record the request’s acceptance, but the revenue arising thereon will only be recognised when bonds are issued and sold to the public.

Under capital project funds, contracts will be entered into, and there may be a time lapse from when the contract is granted and when services are received. Such activities will be recorded as encumbrances in respect of the particular capital project. Actual expenditure incurred will be recorded against account payable. At the conclusion of the capital project comparison will have to be carried to between:

1) Sources of funds identified to finance the project;2) Total expenditure – including the encumbrance incurred.

The difference between (1) and (2) represents the excess/deficit of funds arising from a particular project; and is transferred to the governmental unit’s fund balance in the year in which the project was completed, e.g. suppose a particular capital project was to last 5 years, the financial statements for the interim period (1 – 4) will not include the balance in the capital

472 Revision Aid

project fund account. The surplus/deficit will be transferred to fund account at the end of year 5. Such transfers are known as equity transfers.

FUND ACCOUNTINGThe accounts of a government unit are partitioned into segments called funds, and separate financial statements are prepared for each fund. A fund accounting system is a collection of distinct entities or funds in which each fund reflects financial aspects of a particular segment of the organisation’s activities. Separate funds are used to aggregate activities by functions because of the diverse nature of the services offered and because it is necessary to comply with legal provisions regarding activities of the government unit. Although funds are separate entities, the structure of funds is such that a single transaction may occasion entries in the accounts of several funds.

Definition

A fund is defined as a distinct accounting entity with a self-balancing set of accounts recording cash and other financial resources together with all related liabilities and residual equities or balances and charges therein.

In other words, a fund is a segregated collection of both assets and equity accounts, together with related revenue and expenditure accounts that describe a particular aspect of the organisation. Each fund is established to account for specific activities or objectives in accordance with applicable regulations and restrictions. Since each fund represents a distinct reporting entity, separate financial statements are prepared for each fund, in addition combined financial statements may also be prepared.

Types of funds

The types of funds recommended for use by central and local governments are classified in three categories:(i) Government funds;(ii) Proprietary funds; and(iii) Fiduciary funds.

In the first group, governmental funds, are: -

1. General FundsGeneral funds are funds established to account for resources devoted to financing the general services which the governmental unit performs for its citizens.

These include general administration, protection of life and property, sanitation and similar broad services. The general fund is sometimes described as the one use to account for all financial transactions not properly accounted for in another fund. Some activities, such as governmentally supported liberties, are often of sufficient importance and magnitude to have a special fund; when this is not true they become a function and responsibility of the general fund.

2. Special Revenue, or Special, FundsFunds of this class are created and operated to account for revenue designated by law for a particular purpose. For the specific purpose of function to which it is devoted, a special revenue fund is much in the nature of a general fund. Some of the governmental services for

Lesson Nine 473which special funds are frequently established are education, libraries, streets and bridges, welfare, etc.

3. Capital Projects FundsThe receipt and disbursements of all financial resources to be used for the acquisition of capital facilities other than those financed by special assessment funds, proprietary funds and trust funds is accounted for by capital projects funds.

4. Debt Service Funds (Sinking funds)A debt service fund is created to account for the resources devoted to the payment of interest and principal on long-term general obligation debt other than that payable from special assessments and that serviced by governmental enterprises.

5. Special Assessment FundsSpecial assessment funds are designed to account for the construction, or purchase through contract, of public improvements-streets, sidewalks and sewer systems, for example – which are financed in whole or in part by special levies against property owners adjudged to receive benefits from the improvements materially in excess of benefits received by the general body of taxpayers, and for the maintenance and upkeep of such assets.

The following two fund types are referred to as proprietary funds: -

6. Internal Service Funds (Working capital/Revolving funds)Internal service funds are established by governmental units as a means of providing services to other funds or departments of the same unit, or to other governmental units, on a cost-reimbursement.

7. Enterprise FundsInternal service funds are established to provide services for governmental customers, but enterprise funds are operated to provide electric, water, gas, or other services to the general public. Except for ownership, they bear a close resemblance to investor-owned utility or other service enterprises. Enterprise funds are also used to account for activities for which the governmental body desires periodic computation of revenues earned, costs incurred, or net income. The third category of funds recommended for use by state and local governmental units is fiduciary funds.

8. Fiduciary Funds (Trust/Agency funds) E.g. NSSF, NHIFFiduciary funds are used to account for transactions related to assets held by a governmental unit as a trustee or agent. In most cases the governmental unit does not have absolute title to the assets held; and in the remainder, they are owned with specific restrictions upon their use.

474 Revision AidIn addition to the eight generally recognised types of funds, governmental units employ two self-balancing groups of accounts which are accounting entities, but which are not fiscal entities and therefore, are not funds. These groups are called the “general fixed assets group” and the “general long-term debt group”. General fixed assets are those not used exclusively by any one fund, and general long-term debt is that long-term debt which is presently a liability of the municipality as a whole and not of individual funds.

Although funds are employed extensively and effectively to promote the use of governmental resources for their intended purposes, the practice can be carried to extremes. In the opinion of many, accounting and reporting are facilitated through use of the minimum number of funds consistent with legal and operating requirements.

Integration of budgetary Accounts

A second distinctive characteristic of governmental accounting resulting from the need to demonstrate compliance with laws governing the sources of revenues available to governmental units, and laws governing the utilisation of those revenues, is the formal recording of the legally approved budget in the accounts of funds operated on annual basis.

Briefly, Budgetary accounts are opened as of the beginning of each fiscal year and closed as of the end of each fiscal year; therefore they have no balances at year-end. During the year, however the budgetary accounts of a fund are integrated with its proprietary accounts. Proprietary accounts, in the governmental sense, include accounts similar to the real and nominal groups found in accounting for profit-seeking entities – that is, asset, liability, net worth, revenue, and expense (or expenditure) accounts.

The Basis of Accounting

Use of the accrual basis of accounting is considered appropriate for proprietary funds, non-expendable trust funds, and pension trust funds of governmental units. Accrual accounting means: -

1. That revenues should be recorded in the period in which the service is given, although payment is received in a prior or subsequent period, and

2. That expenses should be recorded in the period in which the benefit is received, although payment is made in a prior or subsequent period.

In business enterprise accounting, the accrual basis is employed to obtain a matching of costs against the revenue flowing from those costs, thereby producing a more useful income statement. In governmental entities, however, even for those funds which do attempt to

Lesson Nine 475determine net income, only certain trust funds have major interest in the largest possible amount of gain. Internal service and enterprise funds are operated primarily for service; they make use of revenue and expense accounts to promote efficiency of operations and to guard against impairment of ability to render the services desired. For these reasons, operating statements of proprietary funds, non-expendable trust funds, and pension trust funds are called statements of revenue and expenses, rather than income statements.

Funds of other types (general funds, special revenue funds, capital projects funds, debt service funds, special assessments funds, and expendable trust funds) are not concerned with income determination. These funds are concerned with matching expenditure of legal appropriations, or legal authorisations, with revenues available to finance expenditures. Accordingly, the “governmental” funds and expendable trust funds should use the “modified accrual” basis. The modified accrual basis is defined as:

Revenues should be recognised in the accounting period in which they become available and measurable. Expenditures should be recognised in the accounting period in which the fund liability is incurred, if measurable, except for unmatured interest on general long-term debt and on special assessment in-debtness secured by interest-bearing special assessment levies, which should be recognised when due.

The modified accrual basis is accepted by the American Institute of Certified Public Accountants as being consistent with generally accepted accounting principles. The AICPA recognises that it is not practicable to account on an accrual basis for revenues generated on a self assessed basis such as income taxes, gross receipts taxes, and sales taxes. For such taxes, determination of the amount of revenue collectible is ordinarily made at the time of the collection, thus placing the fund partially on the cash basis.

Number of Funds

Government units should establish and maintain those funds required by law and sound financial administration. Only the minimum number of funds consistent with legal and operating requirements should be established, since unnecessary funds result in inflexibility, undue complexity, and inefficient financial administration.

Accounting for Fixed Assets and Long-term Liabilities

A clear distinction should be made between;

(A) Fund fixed assets and general fixed assets; and(B) Fund long-term liabilities and general long-term debt

(i) Fixed assets related to specific proprietary funds or Trust Funds should be accounted for through those funds. All other fixed assets of a governmental unit should be accounted for through the General Fixed Assets Accounts Group.

(ii) Long-term liabilities of proprietary funds, special assessment funds, and Trust Funds should be accounted for through those funds.

476 Revision Aid

All other unmatured general long-term liabilities of the governmental unit should be accounted for through the General long-term debt account group.

Valuation of Fixed Assets

Fixed assets should be accounted for at cost or, if the cost is not practicably determinable, at estimated cost. Donated fixed assets should be recorded at their estimated fair value at the time received.

Depreciation of Fixed Assets

(a) Depreciation of general fixed assets should be recorded in the accounts of governmental funds. Depreciation of General Fixed Assets may be recorded in cost accounting systems or calculated for cost finding analysis; and accumulated depreciation may be recorded in the General Fixed Assets Account Group.

(b) Depreciation of fixed assets accounted for in a proprietary fund should be recorded in the accounts of that fund. Depreciation is also recognised in those Trust Funds where expenses, net income and/or capital maintenance are measured.

Accrual Basis in Governmental Accounting

The modified accrual or accrual basis of accounting as appropriate, should be utilised in measuring financial position and operating results.

(a) Governmental fund revenues and expenditures should be recognised on the modified accrual basis. Revenues should be recognised in the accounting period in which they become available and measurable. Expenditures should be recognised in the accounting period in which the fund liability is incurred, if measurable, except for unmatured interest on general long-term debt and on special assessment indebtness secured by interest-bearing special assessment levies, which should be recognised when due.

(b) Proprietary fund revenues and expenses should be recognised on the accrual basis. Revenues should be recognised in the accounting period in which they are earned and become immeasurable; expenses should be recognised in the period incurred, if measurable.

(c) Fiduciary fund revenues and expenses or expenditures (as appropriate) should be recognised on the basis consistent with funds accounting measurement objective. Non expendable Trust and Pension Trust Funds should be accounted for on the accrual basis; Expendable Trust Funds should be accounted for on the modified accrual basis. Agency Fund assets and liabilities should be accounted for on the modified accrual basis.

Lesson Nine 477

(d) Transfer should be recognised in the accounting period in which the interfund receivable and payable arise.

Budget and Budgetary Controls

Budgets are key elements of legislative control over government units. The executive branch of a government unit proposes the budget, the legislative branch reviews, modifies and enacts the budgets and finally the executive branch implements the budget. The two basic classifications of budgets for governmental units are the same as for commercial enterprises;

(i) Annual budgets – which include the estimated revenues and Appropriations for a specific fiscal year end;

(ii) Capital budgets – which are used to control the expenditures for construction projects or other planned asset acquisitions.

The operations of the two proprietary funds (i.e. enterprise and internal service) are similar to those of business enterprises. Consequently, annual budgets are used by these funds as a managerial planning and control rather than a legislative control tool. Thus, annual budgets of enterprise funds and internal service funds are NOT Recorded in ledger accounts by these funds.

PUBLIC SECTOR ACCOUNTINGThe Consolidated fund

This is the main fund operated by the government. The Exchequer and Audit Act states that all government revenue excluding income which a ministry is allowed to keep a cover part of its own expenses (i.e. Appropriation-In- Aid) must be put into this fund, and no money may be withdrawn form this fund without the authority of parliament.

Each year, the Parliament votes on the appropriations bill, which sets out:

a) The estimated total revenue of the government for the coming fiscal year (1st July – 30th June) and;

b) The amount of money which each ministry expects to be allocated for its needs in that fiscal year.

Thus the Appropriation Act for 1986/1987 Parliament authorised a gross sum f K£95,002,150 for the Ministry of Health in respect of recurrent expenditure. This was described in the 1986/87 estimates of recurrent expenditure as follows:

478 Revision Aid

K £

Gross vote 95,002,150

Appropriations-In-Aid (2,280,250)

Net Vote K£ 92,721,900

The above description means that the Ministry was authorised to spend K£92,721,900 being supplied form the consolidated fund, and the remainder coming from the ministry’s own Appropriations-In-Aid. Examples of Appropriations-In-Aid within Ministry of Health would include Hospital Boarding fees, X-ray fees, Lab fees etc.

Consolidated Fund Services

Certain government expenditure does not have to be voted every year by Parliament because Parliament has already given its approval for the specific items concerned in the past. These items are known as consolidated fund services, and include salaries and allowances of the Judiciary, subscriptions to international organisations, such as OAU, UN etc., payment of pension to civil servants, payments of national debt, etc.

Sources of Government Revenue

Government revenue falls into two categories

a) Recurrentb) Development

The main source of revenue are taxes, government borrowings (both domestic and foreign) and grants.

An example of revenue estimates for the year 1986/87 is:

Recurrent Revenue Estimates (K£ Millions)

Customs and excise duty 298.5

Income tax 370.0

Sales tax /Value Added Tax 437.0

Lesson Nine 479Export duty and other taxes 107.4

Miscellaneous (15 categories) 160.9

1,373.8

The development revenue estimates were 64.5

1,438.3

The annual estimates of expenditure for the fiscal year 1986/1987 were:

Recurrent expenditure 1,420.8

Development expenditure 292.6

1,713.4

There is a shortfall of K£275.1m expected for the 1986/87 fiscal year. The gap is normally closed by borrowing either from abroad or from the domestic market. Domestic borrowings usually take the form of Treasury Bills.

Government Expenditure

As with revenue, expenditure falls into two categories

(i) Recurrent expenditure(ii) Development expenditure

Recurrent Expenditure

This is expenditure on the day to day business of the government. In commercial accounting, it could be called revenue expenditure.

Recurrent expenditure may be referred to as maintenance expenditure as it covers items concerning the maintenance and operation of existing government services e.g. salaries to government officers, electricity, water, telephone etc.

Development Expenditure

This is expenditure concerning new projects e.g. construction of hospitals, roads, bridges etc.

Recording Government expenditure and revenues:

480 Revision Aid

(1) Government accounting is “cash-based” i.e. limits itself to transactions which have been entered in the cash book. Thus government accounting has no personal accounts for debtors/creditors, nor does it have accruals/prepayments. The only debtor-creditor relationship arises in transactions between the government and the ministries, but not third parties.

(2) Government Accounting does not make any distinction between fixed assets and a day-to-day expense. Both are treated as expenditure in the period in which they are paid (properly classified as either recurrent or development expenditure) and hence there are no fixed asset accounts.

(3) Since there are no fixed asset accounts, there is no such thing as depreciation in governmental accounting. The effect of passing fixed assets through the usual expenditure accounts is to write them off in the year of purchase.

The reason for this treatment of fixed assets is that the government is not aiming at realising profits or quantifying losses, and hence does not need to divide the benefits of capital expenditure over the financial years, nor to assess the loss of value in that asset in a given year.

There is also the difficulty of trying to value assets such as Nairobi-Mombasa Road etc.

Accounting for and individual ministry

In accordance with the normal rules of double entry book-keeping cash received is debited to the cash account (PMG) and the revenue account is credited. Thus in the books of Ministry X, the receipt of Ksh5,000 will be recorded as:

Pay Master General A/C (Cash)

Revenue A/C 5,000

Exchequer 5,000

Revenue

Pay Master General 5,000

Lesson Nine 481

The paymaster General is the cash account of all ministries. Since all revenue (apart from Appropriation-In-Aid) must be transferred immediately to the consolidated fund, funds received will be paid over immediately to the Treasury which administers the consolidated fund on behalf of the government. The Account within which the Treasury administers the consolidated fund is called the Exchequer Account.

Exchequer A/C

Pay Master General 5,000

At the end of each financial year, each ministry which has collected funds on behalf of the government makes out a “statement of revenue”.

Expenditure

A ministry operates within the strict limits of the vote allocated to it by Parliament. The Accounting system is merely used to reveal whether the ministry is keeping within the limits of voted expenditure or not. The ministry has no authority to spend over parliamentary allocations, and the authority to spend is only for the duration of the financial year.

If a ministry underspends in a financial year, or if there are any excess receipts, it may not retain the available funds, but must surrender them to the exchequer to be reincorporated into the consolidated fund and eventually re-distributed to the ministries as determined by Parliament.

If the ministry overspends, the only body empowered to ratify this overspending is Parliament. In the subsequent financial year the matter is presented in Parliament in the form of “excess vote” and Parliament decides whether to approve the excess vote or to recover it from the officers responsible for exceeding the vote.

The Pay Master General (PMG)

The PMG is an office rather than an officer, and no person bears the title “Pay-Master General”. The functions of the PMG are carried out by a section of the treasury.

The PMG is subordinate to the treasury and has the following functions: (which are regulated by the Minister of Finance)

1) It is the principal paying agent for the government and banker of all government departments as regards voted expenditures and payments on consolidated fund services.

482 Revision Aid

2) It arranges with the treasury at regular intervals (usually twice a month) for funds to be withdrawn from the exchequer and put to the credit of the PMG’s account in the Central Bank of Kenya;

3) It allows authorised signatures from these ministries to draw cheques on this account;4) It keeps a record of the above transaction and sends statements on a monthly basis to the

accounting officers (i.e. the Permanent Secretaries) of each accounting unit together with supporting vouchers;

5) It receiver monthly reconciliations of these statements from accounting officers;6) It supplies the treasury with the following:

a) A monthly statements and balance sheetb) Annual statements and balance sheet.

It should be noted that the PMG is just a single account kept at the Central Bank of Kenya and administered by the PMG’s office in the treasury.

All ministries are authorised to draw on this single PMG account. The PMG’s office is able to analyse the different payments and receipts to allocate to various ministries, and to send them monthly statements.

Cash book

There are significant differences between commercial accounting and government accounting as regards operation of the cash book.

These are: -

(1) Restricted analysis – The government cash book makes an analysis between “cash” and “bank” only, i.e. there is no further analysis into categories/classes of expenditure.

(2) The usage of the cash column – Cheques received are considered cash until they are banked. The book-keeping entry is: -

Debit Cash (Cash column of cash book)

Credit Revenue (or Appropriation- In-Aid)

When a cheque is banked,

Debit Bank Column

Credit Cash Column

A dishonoured cheque can be recorded as:

Lesson Nine 483Debit Cash Column

Credit Bank Column

Three cash books are maintained:

(i) Current revenue and expenditure cash book.(ii) Development revenue and expenditure cash book(iii) Deposits cash book.

Vote books: -

The cash book and vote book from the bank-bone of the accounting system. The vote book is essentially a book of prime entry, and does not form part of the double entry system. The totals of the vote book are transferred to the ledger:

Debit Expenditure item (as per vote book)

Credit Cash book

Year-end Accounts: -

By 31 October each year, 4 months after the end of the financial year, each ministry must present its final accounts to the Auditor General. These consist of

(a) Statements of Revenue(b) Appropriation Accounts(c) Final Accounts – These refer to the various funds administered by different ministries and

require an income and expenditure A/C as well as a statement of assets and liabilities for each fund.

Illustration 1:

Prepare a statement of revenue for the year ended 30.6.97 for Ministry of Domestic Affairs:

Exchange Control fees (Code 740) – Estimated receipts K£300,000

- Actual receipts K£3,460,968

Insurance premiums (Code 750) - Estimated receipts K£130,000

- Actual receipts K£174,000

484 Revision Aid

Other income (Code 679) - Estimated receipts K£20,000

- Actual receipts K£10,334

Extra exchequer income (Code 999) – Estimated receipts K£1,055,000

- Actual receipts K£6,843,238

Payments to exchequer K£8,68,422

Balance due to exchequer (1 July 96) K£249,529

Public Sector Accounting: Theory

This part of the lesson has been built up using the question and answer approach.

QUESTION ONE

Discuss the role and functions of the Treasury and its relationship with other Government department, in planning and controlling government expenditure.

Solution

The role and functions of the treasury include:

(1) Advising on the setting of objectives for economic policy.(2) Coordinating government expenditure towards the achievement of economic policy.(3) Ensuring the execution of Policies in the most economic fashion by Government

Departments.(4) The overall supervision of national finance.(5) Involvement in the process of settlement of levels of national expenditure and the raising of

revenue.(6) Controlling Government borrowing.(7) Management of pensions(8) Administration of contingency funds e.g. disbursements, distaden funds etc.(9) Payments forward – chief cashier to the government debts, incomes expenditures etc.

Lesson Nine 485

Links with other Government Departments

(1) Involvement in scrutinizing of annual estimates(2) Consultation on possible revisions of estimates.(3) Ensuring adequate financial controls exists within departments including adequate staffing

and accounting procedures.(4) Involvement jointly in preparation of annual budget.

Further points for Discussion

(1) Importance of Treasury control during periods of economic stringency.(2) Financial specialisation and expertise needed in dealing with estimates and financial control.(3) Criticism of Treasury

- Too much Treasury Control and interference stifling departmental initiative.- Staffing by career civil servants and injection of specialists from outside often resented.- Too narrow a view taken by Treasury is often over-cautious.

QUESTION TWO

Discuss the role of the Controller and Auditor General.

Solution

The Controller and Auditor General is an officer of Parliament (not a civil servant) who has two main functions:-

(1) As controller, he acts as Paymaster, controlling receipts and payments of public money through various accounts.

(2) As External Auditor, he audits the various departmental accounts reporting on the Appropriation Account, etc. to the parliament, which refers them to the Public Accounts Committee. This is a Select Committee whose duty is to consider the report and issues arising from it.

From Audit point of view, his work covers the following:

Financial and Regularity Audit

(a) Financial: - to ensure that accounting and financial control systems operate correctly so that all financial transactions are both properly authorised and properly accounted for.

(b) Regularity: - to ensure that expenditure is incurred on approved matters and is legal.

486 Revision Aid

(c) Value for money audit: - an examination based on economy and efficiency to curb extravagance expenditure and maximise receipts. The Public Accounts Committee also tends to concentrate on this question.

(d) Effectiveness of audit: - An examination to assess whether programmes undertaken to meet established policy objectives have achieved those objectives.

QUESTION THREE

Explain the main functions of an annual Budget for a public sector organisation with which you are familiar.

Solution

A budget may be defined as a financial and quantitative statement prepared prior to a definite period of time of the policy to be perused during that time for the purposes of attaining a given objective.

A statement of the organisation’s intention against which its achievement can be measured.

Main function of an annual budget of local authority:

1. To assist in fixing the general rate, local authority is required to levy a rate sufficient to cover the needs of the year.

2. To assist Policy making - to help members to making decisions on the provision of services.3. To assist control – or Income and expenditure.4. To authorise expenditure – authority to incur the expenditure or collect the income.5. To provide a standard against which to judge performance.

QUESTION FOUR

The independence of Internal Audit in a public sector organisation is considered to be essential to its effectiveness.

Explain what is meant by independence in this context and give examples of circumstances which might impair independence.

Lesson Nine 487

Solution

As the internal auditor is appointed within the organisation he cannot be completely independent of the organisation but he must be sufficiently independent to allow him to carry out his duties in a manner which allows his professional judgement and recommendations to be effective and impartial.

In order to operate effectively, the internal auditor should:

1) Be independent of all staff whose operations are under review.2) Not be involved in routine financial systems.3) Have direct access to all department heads, chief executive and the management board.4) Have full rights of access to records, assets and personnel and receive such information and

explanation as are necessary for the performance of their duties.

The chief internal auditor should have the right to report under his own name on any aspect of the financial work including that of finance department.

Impairment of Independence

(a) Having an interest in business which is involved in any way with the audit.(b) Having been previously involved e.g. as accountant in the operations; or(c) Personal relationship e.g. a spouse or other relative of persons being audited.

QUESTION FIVE

Discuss the main reasons for the growth in public expenditure.

Solution

1) Increase in range and volume of state activity – inflation.2) The effect of economic ideas and political theories – use of public expenditure by state as a

weapon of economic control.3) The effects of wars and social crises.4) With the development of the state has tended to come an increased expectation by the

public of more state activities: - Roads, transport, energy, water and sewerage services.5) The introduction and maintenance of the Welfare State.6) External involvement such as membership of OAU etc.

488 Revision Aid

7) Internal involvement in industry and commerce including nationalisation and control of socially significant industries and commerce and support for industries incurring heavy research and development costs, particularly new technology industries.

QUESTION SIX

(a) Explain the role and objectives of internal audit in a public sector organisation.

(b) What factors influence the size and organisation of an internal audit section in a Public Sector organisation.

Solution

The role and objectives of internal audit may vary between different parts of the Public Sector, depending on attitudes, statutory requirements, size etc. Definition of internal audit – Statement of internal audit practice.

“An independent appraisal function within an organisation for the review of activities as a service to all levels of management. It is a control which measures, evaluates and reports upon the effectiveness of internal controls, financial and otherwise as a contribution to the effective use of resources within an organisation.

It is the responsibility of internal audit to review, appraise and report upon the following matters:

a) The soundness, adequacy and application of internal controls – internal controls can be said to comprise the whole system of controls established by management in order to

1) Safeguard its assets2) Ensure reliability of records3) Promote operational efficiency and4) Monitor adherence to policies and directives.

b) The extent to which the organisation’s assets and interests are accounted for and safeguarded from losses of all kinds from:

Factors:

1) Fraud and other offences and

Lesson Nine 4892) Waste, extravagance and inefficient administration, poor value for money and other

causes. In recent years, increasing emphasis has been put on audits role in connection with avoidance of waste and obtain value for money.

3) The suitability and reliability of financial and other management data developed within the organisation.

Detailed procedures should exist for initiating, authorising, carrying through and recording transactions. These procedures will allow the principles of internal check and will be kept under review by internal auditor.

Factors:

1) Type of organisation2) The size3) The scope and objectives of internal audit4) Managerial attitude to internal audit5) The adequacy of internal control system

QUESTION SEVEN

Outline the differences between the financial objectives of:

1) Public Corporation i.e. state owned corporations, nationalised industries, and2) Limited companies

Solution

Financial objectives of commercial concerns:

- To maximise the value of the firms to its owners- Determined by management team- More financial than theoretical objective- Management is concerned with firms and share valuation as an indication of the level of

reward to shareholders group.- Management concentrate on the theoretical objectives – reporting on firm and share

valuation helps management in decision making and policy formation process.

Public Corporations

Financial objectives are specified by government rather than determined by management.

Such objectives are difficult to specify in value terms as:

- There is usually no observable market value of claims on, or right to participate in the entity.- It is difficult to identify the ownership group, whose value should be maximised.

490 Revision Aid

Financial objectives are usually specified in ‘non-value’ financial terms such as target, sometimes better described as financial constraints.

Main difference in objectives of Commercial/Public Corporations:

1. The freedom of the entity’s management determine the firm objectives.2. The nature of objectives set – value or accounting measures.

Financial management should be integrated with the firm and designed to assist in meeting the firm’s objectives.

Difference is due to considerable differences in the operation of firm.

- Technology- Type of market

QUESTION EIGHT

Outline the role played in Government accounting by:

(a) The Public Accounts Committee(b) The controller and auditor general(c) The government Ministries Accounting Officers.

Solution

Accounting has been described as a process whereby transactions of an operating entity are documented, classified and recorded for the purposes of accumulating and providing financial information essential to the conduct of designated activities. Government accounting is an essential element of the financial management function of government. In the main government accounting is directed towards satisfying the accountability and management requirements of officials responsible for the conduct of government activities and operations. It is therefore concerned with the proper recording of all receipts of government, with the maintenance of records that reflect the propriety of transactions and give evidence of accountability for assets and other resources available for use and with the classification of data in a way that provides useful information for control and effective and efficient management of government programme operations. Amongst the features of government accounting, are the specific roles played by the Public Accounts committee, the Controller and Auditor-General and the Ministries Accounting Officers to which we turn.

Lesson Nine 491a) The Public Accounts Committee

- A standing committee of a few selected members of Parliament.

- Charged with reviewing financial matters of government.

- This is in line with the constitutional requirement that all financial matters in government are subject to consideration, approval and review by the legislature.

- The deliberations and recommendations of the Public Accounts Committee are based on the report on funds and accounts by the Auditor-General.

- The proceedings at the meeting are recorded verbatim, the Auditor-General’s staff and those of accounting unit responsible for the deliberations reacting to the points raised in the report.

- Matters deliberated upon include serious ones concerning losses on a large scale, cases of thefts and Misappropriation, failure to observe regulations and ensure propriety of expenditure, cases of waste and other administrative inefficiencies which have led to wastage of funds and failure to obtain value for money.

- These serious matters require proper explanation on the part of the Accounting Officer and the reaction of the Public Accounts Committee in recommending surcharge of the principle of personal accountability of government officers handling public funds.

- The Public Accounts Committee’s recommendations are then debated in Parliament which often insists that the government takes necessary corrective action which often is done.

- The role played by the Public Accounts Committee ensures that the government be made accountable for financial matters to the legislature. It is a control measure ensuring that public funds are protected and used only for purposes intended by Parliament. It curbs any tendency by public officers to be lax and wasteful in their handling and management of public funds. It ensures that proper accounting methods and procedures and controls are instituted to safeguard public funds.

b) The Controller and Auditor General is appointed by the President and reports to Parliament.- He functions independently of executive council.

- He controls issues of funds from exchequer that is funds voted for use by Parliament and intended for by spending units to be withdrawn from the exchequer, must be sanctioned for by the controller who satisfies himself that there are adequate funds and that they will be used for the purpose intended by Parliament.

492 Revision Aid

- He carries out both statutory and non statutory audit.- The more serious audit queries known reference sheets are compiled in an audit report

which is presented to Parliament for reviewing the government’s financial management.

- The institution of the office of the Controller and Auditor-General plays a very effective role in the management of public funds.

- The Controller and Auditor-General plays the role of a watchdog and the fact that he reports to Parliament ensures that spending units are not lax in handling public funds.

- His independence in performance of his duties ensures that he is not subjected to undue influence by the executive. He carries out his duties without fear or favour, he expresses his opinion, qualifies his report and on the whole the powers conferred upon him by the exchequer and Audit Act, ensures the accountability of the executive to the legislature. Without any doubt, the role of the Controller and Auditor-General is very essential in ensuring proper financial management.

- Although the role may be that of making of the report to Parliament, his officers carry out continuous audit inspection on the records of accounting units of the government, this minimises incidents of fraud, thefts and other misappropriations.

- The recent creation of the Auditor-General for statutory boards underscores the importance the government attaches to the auditing function, it is indispensable.

c)- The voted funds or the grants given by Parliament for use by the accounting officer

should be properly handled to ensure regularity and propriety of expenditure.

- The accounting officer is appointed by the Permanent Secretary Treasury personally and under the principle of personal accountability.

- The letter of appointment spells out his duties and functions, emphasising the fact he is answerable to the Public Accounts Committee on serious matters raised by the controller and Auditor-General.

- His responsibilities in management of public funds, safeguarding public property and running his accounting unit must be carried out with diligence, dedication, with due regard for efficiency and effectiveness.

Lesson Nine 493- Amongst his duties are to organise his accounting unit to ensure that functions are

carried out properly, to ensure that public property are safeguarded, to ensure that staff under him have the necessary technical skills for the proper performance of their duties, to plan and budget for the financial requirements of his unit as directed by Treasury, to instil cost-consciousness in the at all levels of management, to answer audit queries, to sign the appropriation accounts and so on.

The accounting officer

- The salient point of the role of the Accounting Officer is that he is personally held responsible for any undue happenings affecting public funds in his control. For example, should he differ with the Minister, his political head, on how to spend certain funds he has to obey the Minister’s directives but should write to Treasury, giving details of the dispute. This will absolve him of blame should a query arise.

- Public servants handling public funds should be held wholly responsible. As head of his accounting unit, this requirement ensures that funds are not handled with laxity, that services are provided efficiently and effectively, that evidence is produced on how the funds were spent and last but not least, the taxpayers have got value for money with regard to the taxes they pay.

QUESTION NINE

In relation to fund accounting, explain what is meant by the following special funds and explain fully how they are operated.

a) Revolving fundsb) Trust fundsc) Sinking funds

One basic feature amongst others, of government accounting, is the concept of fund entities, which has its origin in the fact that financial powers of the executive are subject to the control of the legislature. There is for example, a constitutional requirement that government receipts from revenue and borrowing should be accumulated into a general fund (consolidated fund) for use of the government as a whole, and any withdrawals from fund be subjected to sanction by the legislature.

Provision has also been made for separate treatment of monies received by the government in a trustee capacity. These are known as trust funds from which withdrawals are made in accordance with specific statutory provisions. Funds may also be established by law from the proceeds of earmarked taxes, with provisions for using such receipts to attain specified

494 Revision Aid

programme objectives – either with or without prior grant of authority from the legislature. Additionally, in some cases a contingency fund may be created to enable advances to be made for meeting necessary and unforeseen expenditures, subject to subsequent authorisation by the legislature. Funds are also established by legislative action which grants authority to spend for specified purposes and objectives. Such funds are legal entities. Like the National Social Security Fund and the National Hospital Insurance Fund, they have their own resources which include property, receivables, investments and other accountable assets. Any liabilities are set off against the assets to determine the network of the fund. Such a fund therefore is an independent accounting entity. An example of a trust fund is the Widows and Children’s Pension Fund to which all married Civil Servants must contribute a certain amount of their monthly salaries and on retirement or leaving the service, refunds are made.

Revolving Funds are also entities set up by legislative action to provide agencies with resources for the attainment of specified objectives. Government enterprises are usually set up in this manner. The initial appropriation is made out of the consolidated fund. The receipts generated in such funds are automatically used by the agency in accordance with the law that set up the fund. Annual legislative appropriations are not therefore required for the operation of such funds. However, the original financing required to the financing of a programme increase or an incurred deficit would be appropriated out of the central funds of the government. Similarly, any surplus that may result from the operations carried out under such authority should be deposited in the central fund as receipts of the government.

Sinking Funds are also entities set up by legislative action with the purpose of eventual liquidation or extinction of public debt. This requires annual appropriations into the fund thus building up the fund as maturation of the debt approaches, until the principal sum is repaid. There is necessity of investing the appropriations on a special account as the Sinking Fund is built up. Debt requiring such fund is known as Funded Debt. There is less use of these Funds these days as they entail tying down funds which would have been used elsewhere.

QUESTION TEN

One of the principle differences between non-profit and commercial organisations is that they have different reasons for their existence. Consequently, non-profit making organisations follow some accounting principles which differ from accounting principles followed by commercial organisations.

You are asked to state which are the principles followed by non-profit making organisations and why you think they are more appropriate than corresponding principles applicable to commercial organisations.

Solution

Lesson Nine 495Types of non-profit making organisations are the Central Government. Local Authorities, Trade associations, welfare clubs, religious organisations, and so on, whose motive of existence is not profit but to advance the welfare of the members or some other.

Take the example of the government accounting system (which includes Local Government accounting). The accounts are maintained on a receipts and payments basis. Actual receipts of revenues and actual expenditures incurred are the basis of the financial statements. These statements are produces by each accounting unit, not by the government as a whole. Each unit is charged with the task of providing a service, a function during a financial year, of a current or development nature. Since authority to raise revenue and spend public funds is vested in the legislature, the accounting unit merely has to satisfy accountability requirements while assuming that services were actually rendered. Any shortfalls in revenue collections or amounts owed to or by the accounting unit are not debtors or creditors per se but are a mere reflection on the performance of the unit. Its financial position at the end of the year is known as a statement of assets and liabilities vis a vis other units or balances held on hand (its assets) and any unused funds (its liabilities).

Revenues to be collected by way of taxes, fees and charges, rates borrowing etc. are estimated for, and also how those revenues will be expended are also estimated for. It would be difficult to single out individual taxpayers as debtors or some unpaid bill at the end of the year as a creditor, since the functions of the state do not stop, but are continuous. The reason for having a financial year is to emphasize the constitutional requirement that Parliament is supreme in finance matters and the government must receive annual authority (by way of the Appropriation Act) to raise and expend public funds). In this case, it would appear that the receipts and payments basis of accounting is appropriate.

The other non-profit accounting system is the income and expenditure system of accounting. Welfare clubs, Members clubs and religious organisations and trade associations rely mainly on member’s contributions and necessarily some members will default payment of their dues or the members may sometimes pay in advance. This is a clear case of creditors and debtors or accruals. A surplus or deficit may be reflect and a balance sheet drawn.

This income and expenditure accounting system would appear to be appropriate for such organisations in view of the fact that their area and scope of activities is limited, its assets are identifiable, and liabilities can be ascertained.

Although we have outlined the differences in approach between accounting in commercial and non commercial organisations, the dividing line is not straight and clear. It should be remembered that public sector accounting includes government commercial enterprises with a profit motive. More over, accounting by non-profit organisations is increasingly adopting practices similar to those employed in private industry. Such an operation involves setting up a “business type” financial system in which the relationship of receipts and expenditures and the

496 Revision Aid

financial results obtained continuously are highlighted for the attention of agency management and legislative review.

QUESTION ELEVEN

(a) “Without the profit motive there is an inevitable lack of budget motive”. Do you agree?

(b) Explain the administrative and accounting controls used to achieve the budgeted level of expenditure by the Government Ministries.

Solution

(a) Planning and control are two important management functions and accounting in the present day conceptions lays emphasis on these two functions.

In this sense, accounting is described as management accounting, which is any form of accounting which enables a business to be conducted more efficiently. This emphasis on accounting for efficiency, is in every area where accounting must be used, whether in an organisation with the profit motive or in non-profit motive organisations like the government.

Budgetary control refers to the use of budgets to control the activities of an organisation. Take the case of the government, the idea of budgetary control is in fact extensively used. Finance being such a scarce resource, no government can afford not to budget. Basically, the annual budget consists estimates of revenue and expenditure and each accounting unit or cost centre has to show its operational costs being limits beyond which no expenditure should be incurred without Treasury or Parliamentary approval. The government budget as whole should not be exceeded without parliamentary approval. All the estimates are broken up into minor budgets for ministries and/or departments. Vote control is in essence budgetary control and this is carried on without profit motive.

Therefore, we can emphasize that the profit motive is not necessary for the use of budgetary control.

(b) Budgeted levels of expenditure normally represent ceilings over and above which spending units of government must not go, without approval either by Parliament or Treasury.It is both legally and administratively binding for the government to present expenditure estimates to Parliament.

Lesson Nine 497The expenditure estimates are both of recurrent and development nature and pertain to one financial year.

Sitting as a committee of supply, parliament approves the estimates by way of the appropriation bill which is signed by the President to become an act.

QUESTIONTWELVE

(a) Compare and contrast the role of an accountant in a governmental accounting with that of an accountant in commercial accounting.

(b) Explain and illustrate the distinction extraordinary items and exceptional items.

Solution

In order to clearly understand the role an accountant plays in both government and commercial accounting, we need to make a brief comparison and contrast between the two accounting systems. Unlike private businesses, government activities are not governed by the profit motive. Private firms essentially are concerned with profits made, for such purposes as return on investment and expansion in a selected field of activity. In contrast, functions are undertaken by government in multiple fields of activity, for a variety of broader purposes such as service to the public, maintaining the financial stability of the nation, promoting trade and commerce, stimulating private action of national importance and accelerating the development of the economy and social welfare. Government activities encounter many kinds of problems that are of greater complexity. Costs of performance are of significant interest to management, but they are of importance primarily as a measure of operational efficiency and the degree to which planned programme results are achieved with funds made available. The above description highlights the environment in which an accountant works, both in private commercial sector and government.

In all government activities, accounting has to place emphasis on three aspects:

a) Control of the acts of public bodies and officers in their raising and expending of public funds.

b) Provide information that will assist in the economic planning of government functions and activities.

c) Provide information to parliament and the public relating to the activities of government operations in whatever form.

498 Revision Aid

The last aspect is in fact a statutory requirement that the accounting officers should produce financial statements in the form of revenue accounts, fund accounts, appropriation accounts in order to satisfy the accountability requirements. However, it has been argued that the role of the accountant in the government accounting system has been more or less that of a bookkeeper, having no central role of management decision-making. That view is slowly changing. The accountant is, owing to more sophisticate nature of his work, now more appreciated, considered as an expert, one of the management team. He is required to provide information that will assist in the economic planning of government functions and activities.

The role of the accountant in the commercial sector is of no less importance. Apart from the purpose for which financial statements are usually required, for example, under the Companies Act, or some other legislations, for assessments of taxation on profits or to support loans from banks or similar financial institutions, accounting in the present day conception lays particular emphasis on its use of two of the important management functions of planning and control. In this sense it is described as “Management Accounting” which may be very briefly referred to as any form of accounting which enables a business to be conducted more efficiently. These two management functions of planning and control are used in both government and commercial sector accounting. Accounting therefore serves the same purpose for all undertakings, both private and public. The accountant in all cases has to classify, record, summarise the many transactions and events usually in terms of money or money’s worth. The most important difference in the role of the accountant in government and commercial accounting is that profit is not the end product in government. But they use the same techniques and overall achievements of efficiency and effectiveness.

Example 1

(a) In accounting for Central Government and Local Government units, a fund called Capital Project Fund is usually created. What is the purpose of this fund? (5 marks)

(b) The City Council of Matopeni authorises the construction of a new city hall on 1 January 1991. This hall is expected to cost sh.100,000,000. Financing for the project is to beSh50,000,000 from 6½ per cent serial bond issue, Sh.40,000,000 from a Government Grant, and Sh.10,000,000 from the general fund (GF). Transactions and events during 1991 are as follows:(i) The city transfers Sh.10,000,000 from the GF to the City Hall Capital Project Fund (a

CPF created for the construction).(ii) Planning and architect’s fees are paid in the amount of Sh.4,000,000.(iii) The contract is awarded to the lowest bidder for Sh.95,000,000.(iv) The bonds are sold for Sh.50,200,000.(v) The amount of the premium is transferred to the debt service fund.(vi) The construction is certified to be 50 percent compete and a bill for Sh.47,500,000 is

received from the contractor.(vii) Contracts payable, less a 10 percent retained percentage, is paid.(viii) The books are closed and financial statements are prepared.

Required:

Lesson Nine 499(i) Journal entries to record the above transactions. (10 marks)(ii) Financial statement of the capital project fund for the year 1991.(5 marks)

(20 marks)

Solution

(a)Capital project fund (CPF)The purpose of capital project fund is to provide resources for the completion of some specific capital project. The main sources of financing include the proceeds of bond issues, grants and transfers from other funds. A separate capital project fund is created for each major project.

500 Revision Aid

(b)(i) JOURNAL ENTRIES

NO. PARTICULARS F Dr Cr1. Transfers to city call CPF

General FundCash A/C (Being the transfer to city hall CPF)

(Sh ‘000’)10,000

(Sh ‘000’)

10,000

2. Capital project fund (CPF):Cash accountGeneral Fund (GF) A/C(Being the receipt of funds from G.F)

10,00010,000

3. CPFPlanning and architect’s fees A/CCash A/C(Being the payment of planning and architect’s fees)

4,0004,000

4. CPFEncumbrancesReserve for encumbrances(Being the recording of encumbrances for the amount of contract)

95,00095,000

5. CPFCash accountBonds accountPremium on bonds etc.Being the proceeds from the issue of bonds)

50,20050,000

200

6. Premiums on bonds A/CCash A/C(Being the transfer of premium bonds to City Hall debt service fund)

200200

7. Reserve for encumbrances A/CEncumbrances A/C(Being the transfer of half of the amount encumbered)

47,50047,500

8. Contract expenditures A/CContract payable A/CContract payable – retention A/C(Being the expenditure on the City Hall contraction recorded)

42,50042,750

4,750

9. Contract payable A/CCash A/C(Being the partial payment to the contractor)

42,75042,750

10. CPF – Adjusting entry due from government grantRevenue A/C(Being the accrued revenue from the government grant.)

40,00040,000

Lesson Nine 501

11. CPF (Closing Entries)Revenue A/CGeneral Fund A/CProceeds from issue Expenditures Encumbrances Fund balance(To close the books at the end of 1994)

40,00010,00050,000

46,75047,500

5,750

(ii) CITY COUNCIL OF MATOPENI

A statement of Revenue and Expenditure and charges in the Fund Balance for the year ended 31st December 1991.

(Sh ‘000’)

Project authorisation 100,000

Sources of Financial Funds

Revenue from government grant 40,000

Transfers:

Proceeds from fund issue 50,000

Transfers from general fund 10,000

100,000

Use of Financial Resources

Expenditures 51,500

Excess of Revenue and Transfers over expenditure 48,500

Less: Increase in encumbrances 47,500

Fund Balances as at 31st December 1994 1,000

CITY OF MATOPENI

502 Revision AidCity Hall Capital Project Fund

Balance Sheet as at December 31, 1991

(Sh ‘000’)

Assets

Cash 13,250

Due from government grant 40,000

53,250

Liabilities:

Contracts payable – retention money 4,750

Fund equity:

Reserve for encumbrance 47,500

Fund balance 1,000 48,500

53,250

Example 2

The Ministry of Trade and Commerce had the following estimated revenues to collect during the financial year ended 30 June 1993.

Sh.

Hotel and Restaurant licences 900,000

Cattle traders licences 1,000,000

Licences under Trade Licensing Act 765,000

Liquor licenses 500,000

Professional licences 75,000

Licenses for registration of Insurance Companies320,000

During the year and prior to any issue of licences, it was found necessary to suspend the issue of liquor licences and professional licences. The Receiver of Revenue further found out that

Lesson Nine 503more people were interested in scrap metal business. The Treasury authorised the Receiver of Revenue to open a new head for scrap metal licences with an estimated collection of Sh.955,000.

At the close of the financial year, the Receiver of Revenue had collected the following amounts:

Sh.

Hotel and Restaurant licences 1,131,250

Cattle traders licences 2,261,250

Licences under Trade Licensing Act 705,000

Liquor licences -

Professional licenses -

Registration of insurance companies 255,000

Scrap metal licences 1,117,500

The Receiver of Revenue had provided the following additional information:

(i) The ministry had a balance of Sh.33,750 at the beginning of the financial year.(ii) An amount of Sh.335,000 in respect of scrap metal licences was still in the hands of agents

as at 30 June 1993.(iii) A sum of Sh.8,750 was due to the Exchequer at the end of the year.

Required

(a) A Statement of Assets and Liabilities for the year ended 30 June 1993 (5 marks)

Ministry Of Trade and Commerce

Statement of Assets and Liabilities as at 30 June 1992

Assets Sh.

504 Revision AidCash balance 5,503,750

Receivable from agents 335,000

5,838,750

Fund Balance and Liabilities

Fund balance (brought forward) 33,750

Fund balance (current year) (W – 1) 5,796,250

Payable to the exchequer 8,750

5,838,750

(b) STATEMENT OF REVENUE

For the year ended 30 June 1993

Head Estimates Actual Over (under)

Estimated

Sh. Sh. Sh.

011 – Hotel & Restaurants900,000 1,131,250 (231,250)

012 – Cattle traders licences1,000,000 2,261,250 (1,261,250)

013 – Licences under Trade

Licensing Act 765,000 705,500 60,000

014 – Liquor Licences 500,000 - 500,000

021 – Professional licences75,000 - 75,000

022 – Registration of Insurance

Companies 320,000 255,000 65,000

031 – Scrap metal licences 955,000 1,117,500 (162,500)

4,515,000 5,470,000 (955,000)

Lesson Nine 505Balance b/f from previous year 33,750

Amount payable to the exchequer 5,503,750

Amount transferred to exchequer (Bal. Fig) 5,495,000

Amount due to exchequer 8,750

(W – 1) Fund Balance Current year:

Amount transferred to exchequer 5,495,000

Add: Amount receivable from agents 335,000

5,830,000

Less: Balance b/f from previous year 33,750

5,796,250

(c) Footnotes:1. Introduction of a new source of revenue i.e. scrap metal licences.2. Withdrawal of two revenue sources i.e. liquor licences and professional licences.3. Reasons for material variations in actual receipts.4. Details about revenue with collector’s agents.

Example 3

The following data were taken from the accounting records of the Town of Ole Meka General Fund after the accounts had been closed for the fiscal year ended 30 September 1991.

Balances Fiscal Year 1991 Changes Balances

1 October 1990 Debit Credit 30 Sept. 1991

Assets Sh. Sh. Sh. Sh.

Cash 180,000 955,000 880,000 225,000

Taxes Receivable 20,000 809,000 781,000 48,000

Estimated uncollected tax(4,000) 6,000 9,000 (7,000)

196,000 296,000

506 Revision Aid

Liabilities, Reserves & Funds

Balances:

Vouchers payable 44,000 880,000 889,000 53,000

Due to intra governmental

Service fund 2,000 7,000 10,000 5,000

Due to Debt Service Fund10,000 60,000 10,000 50,000

Reserve for encumbrances40,000 40,000 47,000 47,000

Fund balance 100,000 20,000 61,000 141,000

19,000 2,777,000 2,777,000 296,000

The following additional data is available:

(i) The budget for fiscal year 1991 provided for estimated revenues of Sh.1,000,000 and appropriations of Sh.965,000.

(ii) Expenditure totalling sh.895,000 in addition to those chargeable against Reserve for Encumbrances, were made.

(iii) The actual expenditure chargeable against Reserve for Encumbrances was Sh.37,000.

Required:

Show journal entries to record the above transactions in the books of Town of Ole Meka General Fund.

(20 marks)

Lesson Nine 507Solution

TOWN OF OLE MEKA GENERAL FUND ----Journal Entries

S. No Dr Cr

(i) CashRevenue(Being revenue received)

Sh.995,000

Sh.

995,000

(ii) ExpenditureEncumbrancesBank(Being the record of payment made)

858,00022,000

880,000

(iii) Tax receivableFund Balance(Being the record of the increase in tax receivable)

28,00028,000

(iv) Fund BalanceIncollectable taxes

Fund BalanceVouchers(Being increase of vouchers payable)

3,000

9,000

3,000

9,000

(v) Fund BalanceIntra: government(Being the record of the net increase)

3,0003,000

(vi) Fund BalanceDebt Servicing Fund(Being the record of net appropriation to debt service fund).

40,00040,000

(vii) EncumbrancesFundFundEncumbrances(Being the record of net changes in encumbrances)

15,000

44,00015,000

44,000

(viii) RevenueExpenditure(Being the record of expenditure incurred against the revenue).

858,000858,000

(ix) RevenueFund(Being the transfer of net revenue to the Fund A/C).

97,00097,000

FINANCIAL STATEMENT

Town of Ole Meka

Assets

Sh.

Cash 225,000

508 Revision Aid

Tax received 48,000

Estimated uncollected tax ( 7,000)

296,000

Fund Balances

Sh.

Uncollected Tax 3,000

Voucher 9,000

Intra 3,000

Debt fund 40,000

Encumbrances 44,000

Balance c/d 141,000

Sh.

Balance b/f 100,000

Tax receivable 28,000

Reserve for Encumbrances 15,000

Reserve 97,000

______

240,000 240,000

Lesson Nine 509

REINFORCEMENT QUESTIONSQUESTION ONE

The Approved Estimates and Actual Expenditure details of the Ministry of Uchumi na Ufanisi for the year 19-7/8 were as follows:

Approved Actual

Estimates Expenditure

£ £

000 – Personal Emoluments 123,280 97,520

050 – House Allowances 19,550 14,260

080 – Passages and Leave 4,140 667

100 – Transport Maintenance 16,100 13,593

110 – Travelling and Accommodation 1,334 1,656

120 – Postal and Telecommunication Expenses 4,600 3,312

190 – Miscellaneous Charges 17,480 16,882

196 – Training Expenses 5,980 4,738

230 – Purchase of Equipment 21,000 39,800

620 – Appropriations-In-Aid 1,000 5,560

(Realised)

The Ministry made four (4) equal withdrawals from Exchequer in July 19-7, October 19-7, January 19-8 and May 19-8. In total the Ministry had withdrawn £200,000 by the end of the year.

Required:

(a)

510 Revision Aid(i) The General Account of Vote (G.A.V)(ii) The Exchequer Account.(iii) The Paymaster-General (PMG) Account.

(b) A statement of assets and liabilities as at 30 June, 19-8.(20 marks)

QUESTION TWO

(a) Distinguish between Commitment Accounting and Fund Accounting in relation to Public Sector Accounting. (8 marks)

(b) The Appropriation Account of the Government of the Republic of Kenya for 1992/1993 presented to Parliament in January 1994 included the following accounts for the Provincial Hospitals managed by the Ministry of Health.

Estimated 1992/1993

Gross Net

Expenditure Income Expenditure

Current Expenditure/Income 25,401,000 880,000 24,521,000

Other direct costs 357,000 - 357,000

Capital Expenditure 1,012,000 ____- 1,012,000

26,770,000 880,000 25,890,000

Lesson Nine 511Actual 1992/93

Gross Net

Expenditure Income Expenditure

Current Expenditure/Income 26,593,1465 920,951 25,672,194

Other direct costs 334,692 - 334,692

Capital Expenditure 1,082,683 ______- 1,012,000

28,010,520 920,951 27,089,569

These accounts were audited by the Controller and Auditor General who issued a clean certificate of findings.

Required

Discuss the usefulness of these published accounts from the point of view of:

(i) A Member of Parliament. (3 marks)(ii) A taxpayer. (3 marks)(iii) A patient of one of the hospitals. (3 marks)(iv) A creditor to one of the hospitals. (3 marks)

(Total: 20 marks)


512 Revision Aid

COMPREHENSIVE ASSIGNMENT NO.4TO BE SUBMITED AFTER LESSON 8

To Be Carried Out Under Examination Condition and Sent to the Distance Learning Administraton for Marking by the University

TIME ALLOWED: THREE HOURS ANSWER ALL QUESTION

QUESTION ONE (JUNE 2000 Q2)

You have been provided with the following summarised accounts of Golden Times Ltd. For the year ended 31 March 2000:Balance sheet as at 31 March 2000Fixed assets: Sh. Sh. Sh.Freehold property (Net book value)Plant and machinery (Net book value)Motor vehicles (Net book value)Furniture and fittings (Net book value)

Current Assets:StocksDebtorsInvestments

Current liabilities:Trade creditorsBank overdraftCorporation taxDividends payable

Financed by:Authorised share capital – 800,000Sh.1 ordinary sharesIssued and fully paid: 400,000 Sh.1 Ordinary sharesCapital reserveRevenue reserveLoan capital: 400,000 10% Sh.1 Debentures

238,400878,400176,000107,200

1,000,000400,000

120,000 1,500,000

(1,400,000)

480,000800,000200,000

200,000 1,680,000

120,000 1,800,000

400,000200,000800,000

400,000 1,800,000

Profit and loss account for the year ended 31 March 2000

Sh.Sales (credit)

Profit after charging all expenses except interest on debenturesLess: debenture interestProfit before taxCorporation tax

Less: ordinary dividend proposedRetained profit transferred to revenue reserve

4,000,000

440,000 40,000 400,000 176,000 224,000 107,200 116,800

The following additional information was available:

1. The purchases for the year were Sh.2,160,000 while the cost of sales was Sh.3,000,000.2. The market price for Golden Times Ltd. Ordinary shares as at 31 March 2000 was Sh.53. The company estimates the current value of its freehold property at Sh.1,100,000.

Lesson Nine 513Required:

(a) Compute the following ratios for Golden Times Ltd.:

(i) Return on capital employees ( 1 mark)(ii) The profit margin ( 2 marks)(iii) The turnover of capital ( 1 mark)(iv) Current ratio; ( 1 mark)(v) Liquid ratio; ( 2 marks)(vi) Number of days accounts receivable are outstanding; ( 1 mark)(vii) Property ratio; ( 2 marks)(viii) Stock turnover ratio; ( 1 mark)(ix) Dividend yield ratio; ( 1 mark)(x) Price earnings ratio. ( 2 marks)

(b) Comment on Golden Times Ltd. Liquidity stating the reference points to which relevant ratios can be compared. (6 marks)

(Total: 20 marks)

QUESTION TWO (MAY 2002 Q4)

(a) Briefly explain the objectives and scope of IAS 7 (Cash Flow Statements). (6 marks)(b) The following are extracts from the financial statements of Wewe Ltd. As at 31 March:

2002 2001Sh.’000’ Sh.’000

’Sh.’000’ Sh.’000’

Fixed assets:GoodwillFreehold land and buildingPlant and machinery (NBV)Investment at cost

Current assets:StocksAccounts receivableInvestmentsCash at hand and bank

Current liabilitiesBank overdraftAccounts payableProposed dividendsTaxation

Net current assets

15% debentures

Capital and reserves:Authorised, issued and paid Sh.10Ordinary sharesShare premiumRevaluation reserveRetained profit

10,0506,1401,710

200 18,100

(2,390)(5,850)

(450) (820) (9,510)

2,80016,8005,860

3,600 29,060

8,590 37,650

(7,500) 30,150

18,0001,5004,500

6,150

8,7007,800

840 430 17,770

(6,540)(5,250)

(380) (600)

(12,770)

2,90012,0006,350

3,750 25,000

5,000 30,000

(9,000) 21,000

15,000750

- 5,250

30,150 21,000

The profit and loss appropriation account for the year ended 31 March 2002 is given below:

514 Revision AidSh.’000’ Sh.’000’

Net profit before taxLess: Corporation taxProfit after taxDividends: Interim (paid) Proposed (paid)

150450

2,400 900 1,500

600 900

The following additional information is provided:

1. Profit for the year is arrived at after charging:SH.’000’

Depreciation on plant and machineryGoodwill amortisation

1,150 420

2. During the year, plant with a net book value of Sh.750,000 was sold for Sh.1,470,000. The plant had originally cost Sh.3,000,000.

3. The investments portfolio was reduced by selling one block of shares at a profit of sh.160,000.

Required:

Cash flow statement in accordance with IAS 7. (14 marks)(Total: 20 marks)

QUESTION THREE (DEC 2002 Q5)

(a) Explain briefly the meaning of the terms listed below in relation to Government accounting:

(i) The Exchequer account ( 3 marks)(ii) The General account of Vote ( 3 marks)(iii) The Paymaster General ( 3 marks)(iv) Appropriations in Aid. ( 3 marks)

(b) The approved estimates and actual expenditure details for the Ministry of Planning and Development for the year 2001/2002 were as follows:

Sh. Sh.Personal emolumentsHouse allowancesPassage and leaveTraveling and accommodationTransport and maintenancePostage and telephone expensesMiscellaneous chargesTraining expensesPurchase of equipmentAppropriations in Aid

14,793,6002,346,0004,024,800

160,0801,932,000

552,0002,097,600

717,6002,520,000

120,000

11,702,4001,711,200

80,040198,720

1,631,160397,440

2,025,840568,560

4,776,000667,200

Lesson Nine 515The ministry made four equal withdrawals from the exchequer in July 2001, October 2001, January 2002 and May 2002. In total, the ministry had withdrawn Sh.24,000,000 by the year end.

Required:(i) The General Account of Vote. ( 2 marks)(ii) The Exchequer Account ( 1 mark)(iii) The Paymaster General Account. ( 2 marks)(iv) Statement of assets and liabilities as at 30 June 2002. ( 3 marks)

(Total: 20 marks)

(a) Explain briefly the meaning of the terms listed below in relation to Government accounting:

(v) The Exchequer account ( 3 marks)(vi) The General account of Vote ( 3 marks)(vii) The Paymaster General ( 3 marks)(viii) Appropriations in Aid. ( 3 marks)

(b) The approved estimates and actual expenditure details for the Ministry of Planning and Development for the year 2001/2002 were as follows:

Sh. Sh.Personal emolumentsHouse allowancesPassage and leaveTraveling and accommodationTransport and maintenancePostage and telephone expensesMiscellaneous chargesTraining expensesPurchase of equipmentAppropriations in Aid

14,793,6002,346,0004,024,800

160,0801,932,000

552,0002,097,600

717,6002,520,000

120,000

11,702,4001,711,200

80,040198,720

1,631,160397,440

2,025,840568,560

4,776,000667,200

The ministry made four equal withdrawals from the exchequer in July 2001, October 2001, January 2002 and May 2002. In total, the ministry had withdrawn Sh.24,000,000 by the year end.

Required:(v) The General Account of Vote. ( 2 marks)(vi) The Exchequer Account ( 1 mark)(vii) The Paymaster General Account. ( 2 marks)(viii) Statement of assets and liabilities as at 30 June 2002. ( 3 marks)

(Total: 20 marks)QUESTION FOUR (JUNE 2001 Q5)

Write brief notes on the following:

(a) Controller and Auditor General (5 marks)(b) Sinking fund (5 marks)(c) Trust fund ( 5 marks)(d) Revolving fund ( 5 marks)

(Total: 20 marks)

QUESTION FIVE (DEC 2001 Q5)

516 Revision Aid

(a) In the context of accounting and financial reporting for the public sector define the term “fund” (3 marks)

(b) Write explanatory note son the specific funds falling under each of the categories listed below:

(i) Governmental funds; ( 2 marks)(ii) Proprietary funds; ( 2 marks)(iii) Fiduciary funds. ( 2 marks)

(c) For each of the three categories listed in (b) above, explain how the accounting practice adopted for each is guide by:

(i) Accruals basis of accounting; ( 3 marks)(ii) Budgets and budgetary control. ( 3 marks)

(Total: 15 marks)

END OF COMPREHENSIVE ASSIGNMENT No.4NOW SEND YOUR ANSWERS TO THE DISTANCE LEARNING CENTRE FOR MARKING

Lesson Nine 517

LESSON NINE

REVISION AID

INDEX

KASNEB SYLLABUS

MODEL ANSWERS TO REINFORCING QUESTIONS

LESSON 1

LESSON 2

LESSON 3

LESSON 4

LESSON 5

LESSON 6

LESSON 7

LESSON 8

MOCK EXAMINATION

518 Revision Aid

SOLUTIONS TO REINFORCEMENT QUESTIONS

Question 1Check the balances on your ledger accounts with the trial balance as shown below:

DR CR£ £

Cash at bank 1,703Cash in hand 12Drawings 560Postage and stationery 129Traveling expenses 104Cleaning expenses 260Sundry expenses 19Telephone 214Electricity 190Motor vas 2,000Rates 320Fixtures ad fittings 806Capital 2,308Purchases 3,163Discounts received 419Credit sales 830Cash sales 4,764Discount allowed 81Provision for depreciation:Motor vanFixtures ad fittings

700 250

Stock at 1 January 20X1 366Loan - Frey 250Debtors – Brown 12 Blue 150 Stripe 48Creditors – Live 602 Negative _____ 64

10,207 10,207

Workings

Cash at bank £Opening balances 672

Lesson Nine 519Bankings of cash (908 + 940 + 766 + 1,031) 3,643Capital introduced 500Received from customers (160 + 66 + 22 + 10 + 40 + 120 + 140 + 150 + 20 + 44 + 38 + 20) x 90%

729

5,546Less cheque payments (telephone, electricity, rates and van)Payments to suppliers(143 + 468 + 570 + 390 + 80 + 87 + 103 + 73 + 692 + 187)

(2,374)

1,703

Cash at Bank

££

Bal b/d 5 Bank 3,645Sales (bal) 4,764 Drawings 560

Stationery 73Travel 40Petrol ad van 104Sundry 19Postage 56Cleaner 260Bal c/d _12

4,769 4,769

Question 2Mary CarterBalance Sheet as at 31.12.2001

Non current assets £ £ £Freehold premises 25,000Plant 12,000

37,000Current assetsStock 8,000Debtors 7,000Cash at Bank 1,000Cash in hand 6,000

22,000Current liabilitiesCreditors (10,000) 12,000

49,000

Capital [34,000 + 5,000 – 10,000]

29,000

Non current liabilitiesLoan from bank 20,000

49,000

520 Revision Aid

WorkingsStock: 11,000 + 34,000 – 37,000 = 8,000Debtors: 10,000 + 51,000 – 54,000 = 7,000Cash at bank: 5,000 – 16,000 – 2,000 – 1,000 – 36,000 + 54,000 – 3,000 = 1,000Cash hand: 3,000 – 10,000 + 9,000 + 16,000 – 10,000 – 2,000 = 6,000

Capital Bal b/f 34,000Add profit _5,000


29,000

Profit:Sales 60,000Cost of sales (37,000)Electricity (2,000)Rates (1,000)Wages (10,000)Sundry expenses (2,000)Bank interest (3,000)Net profit 5,000

Creditors= 12,000 + 34,000 – 36,000 = 10,000

Question 3Apparent from the textProfit is determined by redrafting the second section of the balance sheet.Remember that net assets will be the same as capital.

Capital b/f + additional

25,000

Add net profit 6,000(missing figure) 31,000Less drawings (4,500)Capital c/f 26,500

Profit may be also computed as follows:

Net profit = closing capital (net assets) – opening capital + drawings – additional capital= 26,500 – 20,000 + 4,500 – 5,000= £6,000

Lesson Nine 521Question 4Brian BarmouthTrial balance as at 30 June 2000

£ £Sales 47,600Purchases 22,850Office expenses 1,900Insurance 700Wages 7,900Rates 2,800Heating and lighting 1,200Telephone 650Discounts allowed 1,150Opening stock 500Return inwards 200Returns outwards 150Premiums 40,000Plant and machinery 50,000Motor vehicle 12,000Debtors 12,500Bank balance 7,800Creditors 3,400Loan – long term loan 10,000Capital 60,000Drawings for the year __4,000 ______

121,150 121,150

NB: The closing stock does not appear in the trial balance.

522 Revision Aid

LESSON 2

Question 1(a)

£ £1-May Capital 5,000 1-May Store fitments 2,00013-May Sales 200 19-May Abel 65016-May Bruce 700 20-May Rent 20024-May hill 200 21-May Delivery exp 50

30-May Drawings 20030-May Wages 32031-May Green 300

_____ 31-May Balance c/d 2,3806,100 6,100

(b) SALES DAYBOOK£

4 – May Bruce 70011 – May Hill 58018 - May Nailor 360

1,640

(c) PURCHASES DAYBOOK£

2 – May Abel 6509 – May Green 30017 - May Kaye 800

1,750

Check the account balances with the balances shown on the trial balance.

(d)Dr Cr£ £

Cash 2,380Sales 1,840Purchases 1,750Debtors 740Creditors 800Capital 5,000Fixtures and fittings 2,000Rent 200Delivery expenses 50Drawings 200Wages _320 ____

7,640 7,640

Lesson Nine 523

Question 2End PapersTrading, Profit & Loss Account for the year ended 31.12.02

£ £ £Sales 15,500Less returns inwards (1,500)

150,000Cost of salesOpening stock 46,000Purchases 103,500Less returns outwards (3,500) 100,000

146,000Less closing stock (41,000) (105,000)Gross profit 45,000Discount received 200Rent received 2,000

47,200ExpensesSalaries and wages 18,700Office expenses 2,500Insurance 1,100Electricity 600Stationery 2,400Advertising 3,500Telephone 800Rates 3,000Discount allowed __100 (32,700)Net profit 14,500

End PapersBalance Sheet as at 31 December 2002Non current assets £ £ £Premises 80,000Fixtures and fittings 5,000

85,000Current assetsStocks 41,000Debtors 4,800Cash in hand 200

46,000Current liabilitiesBank overdraft 12,000Creditors 7,500 (19,500)

26,500111,500



111,500

524 Revision Aid

Question 3K Smooth Trading, Profit and Loss Account for the year ended 31.3.2002

£ £ £Sales 9,234,000Less: Cost of salesOpening stock 1,816,000Purchases 6,918,500Add carriage inwards 42,000

6,960,500Less returns outwards (64,000) 6,896,500

8,712,500Less closing stock (2,239,000) (6,473,500)

2,760,500Less expensesWages and salaries 1,024,000Carriage outwards 157,000Rent and rates 301,500Communication expenses

62,400

Commission payable 21,600Insurance 40,500Sundry expenses 31,800 (1,638,800)Net profit 1,121,700

K SmoothBalance Sheet as at 31 December 2002Non current assets £ £ £Buildings 2,000,000Fixtures 285,000

2,285,000Current assetsStocks 2,239,000Debtors 1,432,000Bank 297,000Cash 11,500


5,448,500


6,210,500Less drawings 762,000

5,448,500

Lesson Nine 525

Question 4SkatesTrading, Profit and Loss Account for the year ended 31 September 2002

£ £ £Sales 13,090,000Less: returns outwards __(55,000)

13,035,000Cost of sales:Opening stock 2,391,000Purchases 9,210,000Add carriage inwards ___21,500

9,231,500Less returns outwards __(30,700) 9,200,800

11,591,800Less closing stock (2,747,500) (8,844,300)

4,190,700Less expensesWages and salaries 1,282,000Carriage outwards 30,900Motor expenses 163,000Rent and rates 297,000Telephone 40,500Insurance 49,200Office expenses 137,700Sundries 28,400 (2,027,700)Net profit _2,163,000

SkatesBalance Sheet as at 30September 2002Non current assets £ £ £Office equipment 625,000Motor van 410,000

1,035,000Current assetsStocks 2,747,500Debtors 1,239,000Bank 311,500Cash __29,500


4,416,500


5,258,500Less drawings (842,000)

4,416,500

LESSON 3

526 Revision Aid

Question 1-Adequately covered in the text.Question 2Also covered adequately in the text.Question 3MaterialityInformation is material if its omission or misstatement could influence users’ decisions taken on the basis of the financial statements. The materiality of the omission or misstatement depends on the size and nature of the item in question judged in the particular circumstances of the case. Only items material in amount or in nature will affect the true and fair view given by a set of accounts.Example:If a business has a bank loan of £50,000 and a £55,000 balance on bank deposit account, it might well be regarded as a material misstatement if these two amounts were displayed on the balance sheet as ‘cash at bank £5,000’. In other words, incorrect presentation may amount to material misstatement even if there is no monetary error.ComparabilityUsers must be able to compare the financial statements of an enterprise over time to identify trends and with other enterprise’s statements to evaluate their relative financial position, performance and changes in financial position. It is therefore necessary for similar events and states of affairs to be represented in a similar manner.Compliance with accounting standards helps to achieve comparability by ensuring that different entities account for similar transactions and events in a similar way.Example:Depreciation policy must be consistent from one period to the next, unless it becomes inappropriate.PrudenceThe prudence concept states that where alternative procedures, or alternative valuations, are possible, the one selected should be the one which gives the most cautious presentation of the business’s financial position or results.IAS 1 describes the prudence concept as being that ‘revenue and profits are not anticipated, but are recognized by inclusion in the profit and loss account only when realized in the form either of cash or of other assets, the ultimate cash realization of which can be assessed with reasonable certainty; provision is made for all known…….expenses and losses whether the amount of these is known with certainty or is a best estimate in the light of the information available.’Example:If there is any doubt as to the recoverability of debts outstanding at the year-end, a provision should be made so that the amount in question is not included in the profit for the year.

Objectivity:This means that accountants must be free from bias. They must adopt a neutral stance when analyzing accounting data. This means that they should try to strip their answers of any personal opinion or prejudice and should be as precise and as detailed as the situation warrants. The result of this should be that any number of accountants will give the same answer independently of each other.

Lesson Nine 527

Example:Internally generated good will should not be capitalized in the balance sheet, as its value cannot be determined objectively.RelevanceThe Statement of Principles for Financial Reporting states that to be useful, information must be relevant to the decision-making needs of users. Information is relevant when it has the ability to influence the decisions of users by helping them to evaluate past, present or future events or to confirm or correct their past evaluations.Example:Suppliers and other creditors would like to have information that enables them to determine if to lend to the firm or supply on credit.

Question 4Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.Factors affecting materiality are:

The size of the item; The nature of the item.

To be useful, information must be relevant to the decision-making needs of users. Information is relevant when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting their past evaluations.

Neutrality means that the information in financial statements should be free from deliberate or systematic bias. Prudence means that a degree of caution is needed in making estimates about certain items.

The potential conflict between the two is that neutrality requires freedom from bias while the exercise of prudence is a potentially biased concept since judgment is required.In resolving the conflict, a balance should be found that neither overstates nor understates assets, gains, liabilities and losses.Safeguards to ensure that a company’s financial statements are free from material error:The fact that the financial statements have been audited by an independent professional;The existence of sound internal controls within the company;The existence of an internal audit function within the company.

528 Revision Aid

LESSON FOURQuestion 1David DouglleuTrading and Profit and Loss Account for the year ended 31 March 2001

£ £ £Sales 378,500Less returns inwards

(4,100)

374,400Less cost of salesOpening stock 120,600Purchases 261,700Less returns out (7,700) 254,000

374,600Less closing stock

102,500 272,100

Gross profit 102,300AddDiscount received

2,400

Rent received 7,500112,200

Less expensesSalaries and wages

45,700

Office expenses 8,400Insurance premiums

2,200

Electricity 2,300Stationery 6,200Advertising 8,900Telephone 2,100Business rates 6,000Discounts allowed

600 (82,400)

Net profit 29,800

Lesson Nine 529

Balance Sheet as at 31 March 2001Non current assets £ £ £Warehouse shop and office

210,000

Fixtures and fittings 12,800222,800

Current assetsStocks 102,500Debtors 13,000Prepayments 2,400Cash in hand 500

118,400Current liabilitiesCreditors 18,700Accrued expenses 1,200Bank overdraft 30,000 (49,900) 68,500

291,300

Capital 287,500Add Net Profit 29,800


291,300

Question 2Donald BrownTrading and Profit and Loss Account fro the year ended 31 December 20X0

£ £Sales 491,620Less cost of salesOpening stock 18,460Purchases 387,936

406,396Closing stock 19,926

386,470Gross profit 105,150Discounts received 1,175

106,325Less expenses:Discounts allowed 1,304Lighting and heating 6,184Motor expenses 3,080Rent 8,161General expenses 7,413Depreciation (w) 13,146

39,288Net profit 67,037

530 Revision Aid

Working: Depreciation charge:

Motor vehicles: £45,730 x 20% = £9,146Fixtures and fittings: 10% x £(42,200 – 2,200) = £4,000Total: £4,000 + £9,146 = £13,146

Donald BrownBalance Sheet as at 31 December 20X0

Cost Depreciation NetNon current assets

£ £ £

Fixtures and fittings

42,200 6,200 36,000

Motor vehicles 45,730 24,438 21,29287,930 30,638 57,292

Current assetsStock 19,926Debtors 42,737Prepayments 680Cash in hand 1,411

64,754Current liabilitiesCreditors 35,404Accruals 218Bank overdraft 19,861

55,483Net current assets

9,271

Net assets 66,563Financed byCapital 26,094Net Profit for year

67,037

Less drawings 93,13126,56866,563

Lesson Nine 531Question 3Brenda BaileyTrading and Profit and Loss Account for the year ended 30 June 20X9

£ £Sales 427,726Opening stock 15,310Purchases 302,419Carriage inwards 476

318,205Less closing stock 16,480Cost of sales 301,725Gross profit 126,001Carriage outwards 829Wages and salaries 64,210Rent and rates (12,466 – 620)

11846

Heat and light (4,757 + 350)

5,107

Depreciation – equipment

10,200

Motor vehicles

8,654

Sundry expenses 8,426109,272

Net profit for the year 16,729

Brenda BaileyBalance Sheet as at 30 June 20X9

Cost Depreciation Net book value

Non current assets

£ £ £

Equipment 102,000 32,450 69,550Motor vehicles 43,270 17,574 25,696

145,270 50,024 95,246Current assetsStock 16,480Debtors 50,633Prepayments 620Cash __477

68,210Current liabilitiesBank overdraft 3,295Creditors 41,792Accruals 350

45,437Net current assets 22,773

118,019CapitalBalance at 1 July 20X8

122,890

Add Profit for year 16,729

532 Revision Aid139,619

Less drawings 21,600Balance at 30 June 20X9

118,019

Question 4Frank Mercer Cash book20X8 £ 20X8 £Dec 31 Balance b/f 1,793 Dec 31 Bank

charges18

Dec 31 Dividend 26 Dec 31 Standing order

32

Dec 31 Direct debit

88

____ Balance c/d

1,681

1,819 1,819

Bank reconciliation as at 31 December 20X8

£ £Balance per bank statement

1,557

Add unrecorded lodgments: V Owen 98 K Walters 134

232Less unpresented cheques:B Oliver (869) 71L Philips (872) 37

(108)Balance per cash book (corrected)

1,681

Lesson Nine 533LESSON FIVE

Question 1

Sales Ledger Control A/C£ £

Bal b/d 386,430 Bal b/d 190Sales (163,194 + 1,386)

164,580 Cash received 158,288

Cash refund 350 Discounts allowed

2,160

Returns inwards 590Contra 870Bad debts written off

1,360

______ Balance c/d 388,272551,730 551,730

Sales Ledger Control A/C£ £

Bal b/d 520 Bal b/d 184,740Cash paid (103,040 – 350) 102,690 Purchases (98,192

+ 36)98,228

Discounts received 990 Bad debts 2,160Returns outwards (1,370 + 2,000)

3,370

Contra 870Balance c/d 175,048 Balance c/d ___100

283,488 283,488

Question 2

(a) Sales Ledger Control A/C£ £

Uncorrected balance b/f 12,550 Discounts omitted (d) 100Sales omitted (a) 850 Contra entry omitted

(f)400

Bank – cheque dishonored (1)

300 Bad debt omitted (g) 500

Returns inwards omitted (j)

200

_____ Amended balance c/d 12,50013,700 13,700

Balance b/d 12,500

Note: Items (b), (c), (e), (h), (i) and (k) are matters affecting the personal accounts of customers. They have no effect on the control account.

534 Revision Aid

(b)Statement Of Adjustments To List Of Personal Account Balances

£ £Original total of list of balances 12,802Add: debit balance omitted (b) 300 debit balance understated (e) 200

50013,302

Less: transposition error (c ): understatement of cash received

180

cash debited instead of credited (2 x £250) (h)

500

discounts received wrongly debited to Bell (i)

50

Understatement of cash received (i) _72__802

12,500

Question 3(a)

George – Cash book £ £

Balance 4,890 Bank charges (3) 320Correction of error - interest

320 Plant (4) 10,000

Balance 11,890Cheque dishonored

980

Correction of error in entering cheque (6)

4,800

_____ Error in addition (7)

1,000

17,100 17,100

(b) Bank reconciliation

£Balance per bank statement 12,800Less lodgments not credited (2) 2,890

9,910Add: dishonored cheque 980Add: outstanding cheque (1) 1,000Balance per cash book - overdrawn 11,890

Lesson Nine 535Statement of effect on profit

£ £Profit per draft accounts 81,208Bank charges (3) 320Depreciation (4) 1,000Bad debt (5) 980Motor expenses (6) 2,100Additional depreciation (6) 600Purchases understated (7) 1,000Interest adjustment (8) 320Repairs to premises (9) __870 ____

82,398 6,300_6,30076,098

(d) Journal

£ £George – drawings 870 Repairs to premises 870Repairs to George’s house mistakenly charged as a business expense

*Paul – accounts payable ledger account

540

George – drawings 540

Business account paid by personal cheque

*Note: a debit to accounts payable ledger control account is also acceptable for this entry.

Question 4Four errors not disclosed by the Trial Balance:Error of Omission: This is where a transaction is completely omitted from the records i.e. not posted at all.Error of Commission: A transaction is posted in the wrong account but of the same class e.g. a credit sale posted in a wrong debtors account (e.g. to debtor 1 instead of debtor 2)Error of Principle: A transaction is not only posted to the wrong account but also the class e.g. an expense of plant repair posted to the plant account (an asset).Error of Original Entry: A transaction is posted to the correct accounts but the amount is incorrect e.g. a credit sale of £250 is posted to the debtor and sales account as £520.

(Refer to the text for further details)

536 Revision Aid

(b)

(i)DR (Sh) CR (Sh)

Suspense 10,000 ABD Bank – loan 10,000

Cashbook 4,000 P& L – Rent received 4,000

P& L –Trading account 1,500 Closing stock 1,500

P& L – discount allowed 500 P&L – discount received 500

P& L – Trading a/c opening stock 3,200 Suspense 3,200

Prepayments (prepaid insurance)) 220 P& L 220

Insurance receivable 12,000 P& L - income 12,000

(ii) Statement of Corrected net profit

(Sh) (Sh)Net profit 64,000Add: Rent received 4,000Discount received 500Prepaid insurance 220Insurance receivable 12,000 16,720

80,720Less: closing stock overvalued 1,500Discount allowed 500Opening stock 3,200 (5,200)Adjusted net profit 75,520

(iii) Suspense A/cSh Sh

ABD Loan 10,000 Balance b/d 6,800_____ Opening stock 3,200

10,000 10,000

Lesson Nine 537

Question 5

WORKSHEETACCOUNTS Pre-Adjusted

Trial BalanceAdjustmen

tsAdjusted

Trial BalanceT & P & L

AccountBalance sheet

Dr Cr Dr Cr Dr Cr Dr Cr Assets

Liab.

£ £ £ £ £ £ £ £ £ £Capital 40,00

040,00

040,00

0Purchases 26,15

426,15

426,15

4Sales 36,24

636,24

636,24

6Salaries 4,814 350 5,164 5,164Opening stock

4,307 4,307 4,307

Insurance 820 205 615 615Rent income 965 165 800 800Buildings 25,00

025,00

025,00

0Furniture 14,50

01,45

013,05

013,05

0Debtors 6,140 307 5,833 5,833Other expenses

1,060 1,060 1,060

Creditors 4,638 4,638 4,638Commission 946 120 1,066 1,066

82,795

82,795

Salaries due 350 350 350Prepaid insurance

205 205 205

Rent rec’d in adv.

165 165 165

Accrued commission

120 120 120

Depreciation 1,450

1,450 1,450

Bad debts 307 307 307Closing stock 5,008 5,008Net profit 4,063

2,597

2,597

83,265

83,265

43,120

43,120

49,216

49,216

Column numbers

1 2 3 4 5 6 7 8 9 10

Question 6 Purpose of Control Accounts

i. To provide for arithmetic check on the postings made in the individual account i.e. either the sales ledger or the purchases ledger.

538 Revision Aidii. To provide a quick total of the debtors and creditors balances to be shown in the trial

balance.iii. To detect and prevent errors and frauds on the debtor and creditors account.iv. To facilitate delegation of duties especially where the debtors and creditors are many.

Lesson Nine 539

Sales Ledger Control A/CSh Sh

Bal b/d 6,185,000 Bal b/d 52,500Sales 8,452,000 Returns inwards 203,500Bills received dishonored

88,500 Bank 7,985,000

Charges payable 10,000 Cash 153,000Bad debt 64,500Discounts allowed 302,000

Bal c/d 44,000 Bal c/d 5,404,00014,779,000 14,779,00

0

Purchases ledger control a/cSh Sh

Bal b/d 16,500 Bal b/d 4,285,000Returns outwards 284,000 Purchases 5,687,500Bills payable 930,000 Bills payable

dishonored400,000

Bank 473,200Cash 88,500Balance c/d _4,196,500 Balance c/d ___23,500

10,396,000 10,396,000

540 Revision Aid

LESSON SIX

Question 1(a)DareStatement of Capital as at 1 January 1996Assets £ £Stocks 4,500Debtors 2,800Rates prepaid 40Fixtures 2,500

10,140LiabilitiesBank overdraft (add unpresented cheques)

1,172

Accrued expenses 240Creditors 1,800Loan 4,000Accrued interest [4,000 x 3% x 3

/12]30

Heating and lighting 80 (7,322)2,818

(b)

DareProfit and loss account for the year ended 31 December 1996

£ £Gross profit 9,000Discounts received 480

9,480Less expensesRent and rates 465Fixtures and fittings (depreciation)

350

Lighting and heating 200General expenses 450Loan interest 120Wages 2,914Sundry expenses 140Discounts allowed 520Bad debt 200 (5,659)Net profit 3,821

Lesson Nine 541(c)

DareBalance Sheet as at 31 December 19X6Non current assets £ £ £Fixtures and fittings 2,550Current assetsStocks 5,800Debtors 3,000Prepayments 50Bank (less unpresented cheques)

673

Cash __209,543

Current liabilitiesCreditors 2,200Accruals _290 (2,490)

7,0539,603

Capital 2,818Net profit 3,821


5,603Non current liabilitiesLoan – 3% 4,000

9,603

Question 2AB Sport and Social ClubIncome and Expenditure Account for the year ended 31 December 20X5

£ £IncomeSubscriptions (W1) 10,690Bar and café profit (W2) 9,200Sale of sportswear (W3) 1,400Hire of sportswear (W5) 1,700Deposit account interest 800

23,790ExpenditureRent of clubhouse 6,000Groundsperson 10,000Heating oil (W6) 4,500Depreciation 5,000 x 10% 500

(21,000)Surplus of income over expenditure for the year

2,790

542 Revision Aid

AB Sport and Social ClubBalance Sheet as at 31 December 20X5

£ £Non current assetsEquipment for grounds person: cost 5,000 Depreciation (3,500 + 500)

(4,000)

1,000Current assetsHeating oil 700Bar and café stocks 5,000Sports equipment for sale (4,000 – 2,000) 2,000Sports equipment for hire (1,000 + 500) 1,500Subscriptions in arrears 90Bank deposit account 16,000Bank current account 1,300

26,590Current liabilitiesCreditors for bar and café purchases 800Creditors for sportswear 450Creditors for heating oil 200Subscriptions in advance _200

1,650Net current assets 24,940Net assets 25,940Accumulated fund b/f 23,150Surplus for the year 2,790Accumulated fund c/f 25,940

Workings:

SubscriptionsSUBSCRIPTIONS

£ £Arrears b/f 1.1.X5 (10 + 230) 240 Advance b/f

1.1.X540

Subscription income for year (bal fig)

10,690 Cash received 11,000

Advance c/f 31.12X5 __200 Arrears c/f 31.12.X5

___90

11,130 11,130Note: The write off of the 20X3 arrears (£10) is dealt with in the above working.

Bar and café profit£ £

Sales 20,000Cost of sales 7,000Opening stock 8,800Purchases* 15,800

(5,000)Closing stock 10,800Profit 9,200

Lesson Nine 543*Note: Purchases are 9,000 + 800 – 1,000 = £8,800

544 Revision Aid

Sale of sportswear£ £

Sales 5,000Opening stock 3,000Purchases (W4) 3,100

6,100Closing stock (4,000)Closing stock (2,100)Gross Profit 2,900Sportswear written down

(1,500)

Net profit 1,400

Purchases of sportswear£

Bank 4,500Add closing creditors 450Less opening creditors (300)

4,650For sale 2/3: £3,100 For hire 1/3: £1,550

Hire of sportswear£ £

Receipts 3,000Costs*Opening stock 750Purchases (W4) 1,550

2,300Closing stock (1,000)

(1,300)Profit 1,700

*Note: While there is a case for treating the sportswear for hire as non current assets, in club accounts it is more usual to treat such items as stock in trade.

Heating Oil£

Opening stock 1,000

Purchases (4,000 + 200)

4,200

5,200

Less closing stock (700)

Expense for year 4,500

Lesson Nine 545Question 3Mr CheronoManufacturing Profit and loss Account for the year ended 30 June 1988Raw materialsOpening stock 40,0000Purchases 855,000

895,000Less closing stock (80,000)Raw materials consumed 815,000Wages _50,000

865,000Factory overheadsWages 96,000Rent and rates 22,500Water and electricity 13,000 131,500Cost of goods completed 996,500Factory profit ___3,500Transfer price 1,000,000

Sales 4,100,000

Less cost of salesOpening stock 348,000Purchases and cost of goods produced

3,400,000

3,748,000Less closing stock (282,000) (3,466,000)Gross profit 634,000Profit on disposal of motor vehicle

4,000

Factory profit 3,500641,500

Less expensesInterest on loan 36,000Depreciation – fixtures and fittings

90,000

Motor vehicles 38,000Wages 108,000Rent and rates 67,500Water and electricity 39,000Motor expenses 60,800Bad debt 14,000Repairs 12,000Bank charges 4,000Insurance 13,500Sundry expenses 25,200Commission to lampshade employee

318

Less UPCS __120 (508,438)Net profit 133,062

546 Revision Aid

CheronoBalance Sheet as at 30 June 1998Non current assets Cost Depreciatio

nNBV

Fixtures and fittings 900,000 (440,000) 460,000Motor vehicles 152,000 (38,000) 114,000

1,052,000 (478,000) 574,000Current assetsStock: Raw materials 80,000 Lampshades 30,000 Less UPCS (120) Other goods 252,000 361,880Debtors 108,000Prepayments 10,500Bank balance _98,000

578,380Current liabilitiesCreditors 107,000Accruals 27,318 (134,318) 444,062

1,018,062



778,062Add loan _240,000

1,018,062

Lesson Nine 547Question 4Olympiad Athletics ClubIncome and Expenditure Account for year ended 31 October 1983

£ £IncomeAnnual subscriptions (4,680 + 70 + 230 – (140 + 100))

4,740

Entrance fees 250Life membership fees credited (850 + 53) 903

5,893Training ground fees (7,660 – 470 + 325) 7,515Sales of sporting requisites 8,774Investment interest received 626Insurance commissions received (53 – 11 + 13)

55

Advertising revenue 603Profit on sale of furniture (370 – 350) 20Total income 23,486Expenditure:Cost of sporting requisites sold (5,270 + 202 – 163 = 5,309 (purchases)5,309 + 811 – 1,064 = 5,056) 5,056Damaged stock etc 137Wages of grounds man (250 + 3,600 – 300)

3,550

Postages (692 – 4) 688Stationery (55 + 629 – 36) 648Rates (300 + 846 – 380) 766Subscriptions in arrear written off 40World-wide Athletics Club affiliation fee 50Training ground upkeep 1,200Depreciation: buildings 3,500 Furniture, equipment etc (10% x (7,900 – 800) __710Total expenditure 16,345Surplus of income over expenditure £7,141

548 Revision Aid

Olympiad Athletics ClubBalance Sheet as at 31 October 1983

£ £ £Non current assets Cost Depreciati

onNet

Land 4,000 - 4,000Buildings 35,000 12,900 22,100Furniture, equipment, etc 7,100 4,410 2,690

46,100 17,310 28,790InvestmentsInvestments at cost (7,400 + 5,600)(current valuation £13,150) 13,000Current assetsStocks – sporting requisites 927 - stationery 36 - stamps 4Debtors – subscriptions 230 - insurance commissions 13Prepayments (300 + 380) 680Bank – deposit account 3,000 - current account 2,563Cash 122

7,575Current LiabilitiesCreditors – prepaid subscriptions 100- Prepaid training- Ground fees 470- Premiums 160- Sporting requisites 202

932Working capital 6,643Net assets employed 48,433Financed by:Accumulated fund: as at 31 October 1982

36,945

Add:Surplus of income over expenditure for the year

7,141

As at 31 October 1983 44,086Life membership fund (4,720 + 530 – (850 + 53)

4,347

£48,433

Lesson Nine 549

Accumulated fund b/fAssets: Land 4,000Buildings 25,600Furniture 3,750Investment 7,400Stocks 866Debtors 191Prepayments 550cash ___73

42,430LiabilitiesCreditors: Subscriptions 70Training 325Premiums 102Sporting requisites 163Bank overdraft 105Membership fund 4,720 (5,485)

36,945

550 Revision Aid

LESSON 7

Question 1Kimeu & MwangiManufacturing,Trading Profit and Loss account for the year to 31.3.x 2

Shs ShsRaw materialsOpening stock 100,700Purchases 716,250

816,950Less stock of raw materials (79,500)Raw materials consumed 737,450Factory wages 382,500Prime cost 1,119,950Add opening w/p 85,000Less closing w/p (126,250) (41,250)

1,078,700Factory overheadsDepreciation on plant 84,375Factory expenses 354,000 438,375Factory cost of completed goods 1,517,075Add factory profit ( missing figure) 192,925Transfer price given in the question (par) (38,000 x 45)

1,710,000

Sales 2,775,500Cost of salesOpening stock of finished goods 1,200,000Transfer price 1,710,000

2,910,000Less closing stock of finished goods (10,125,000

)(1,897,500)

878,000Add factory profit 192,925

1,070,925ExpensesDepreciation on delivery van 80,250Sales department wages 150,750Selling department expenses 277,500Increase for provision for bad debts 5,000Provision for unrealized profits 112,500 (626,000)Net profit 444,925Share of factory profits K 154,340 M 38,585 (192,925)Share of remaining profit 252,000 K 100,800 M 151,200 252,000

Lesson Nine 551

Workings for closing stock of completed units

Completed units b/f 30,000Units manufactured 38,000Less units sold (45,500)Closing stock 22,500 x 45 =

10,125,000

K M K MDrawings 15,00

0125,000

Share of factory profit

154,340

38,585

Bal c/d 105,140

54,785 Balance of profit 100,800

51,200

255,140

189,785

255,140

189,785

Kimeu & MaingiBalance Sheet as at 31 March 1992Non current assets Shs ShsProperty, plant and equipmentFreehold factory 1,053,750Factory plant ( 843,750 – 151,250 – 84,375 = 608,125)

608,125

Delivery van ( 401,250 – 80,250 – 86,250 = 234,750)

234,750

1,896,625Current Assets:Stock: Raw materials 79,500 W.I.P 126,250 Finished goods 900,000 Debtors 405,000

1,510,750Current LiabilitiesBank overdraft (176,200)Trade creditors (150,000)Accrued expenses and deferred income (86,250)

(412,450)Net current assets 1,098,300

2,994,925Capitals: K 1,400,000 M 1,425,000

2,825,000Current A/c: K 105,140 M 64,785 169,925

2,994,925

The finished good is net of the unrealized profit on closing stock.

552 Revision Aid

Question 2Amis Lodge and PymTrading, Profit and loss appropriation account for year ended 31 March 19-8

£ £ £Sales 404,500LessOpening stock 30,000Purchases 225,000Carriage inwards 4,000 229,000Plant depreciation 259,000Closing stock (35,000)Cost of sales (224,000)Gross profit 180,500Discount received 4,530Interest received ____750

185,780ExpensesCarriage outwards 12,000Vehicle depreciation[25% x (80,000 – 20,000)]

15,000

Depreciation of plant[20% x 100,000]

20,000

Discounts allowed 10,000Office expenses [30,000 + 405] 30,805Rent, rates , heat and light [8,800 – 1,500]

7,300

Provision for bad debts increase[(5% x 14,300) – 420] 295

(95,400)Net profit for year 90,380Interest charged on drawings etc Amis 1,000 Lodge 900 Pym 720

2,62093,000

LessSalary – Pym 13,000Interest on capital accounts Amis 8,000 Lodge 1,500 Pym 500

23,000Residual profit 70,000LessShare of residual profit Amis ( 5/10) 35,000 Lodge (3/10) 21,000 Pym (2/10) 14,000

70,000

Lesson Nine 553

(b) Current Accounts

A L P A L P£ £ £ £ £ £

Balances 1,000

500 400 Appropn – salary

13,000

Drawings 25,000

22,000

15,000

- Interest

8,000

1,500 500

Appropn – interest

1,000

900 720 - Residue

35,000

21,000

14,000

Bal c/d 16,000

_____ -

11,380

Bal c/d _____-

900 ____-

43,000

23,400

27,500

43,000

23,400

27,500

Question 3Amber, Beryl and CoralTrading, Profit and Loss Account for the year to 31 December 1996

£’000 £’000Sales 2,000Cost of salesOpening stock 180Purchases 1,400

1,580Closing stock (200)

1,380Gross profit 620ExpensesWages and salaries (228 + 12)

240

Sundry expenses 120Bad and doubtful debts 26Depreciation: Building 5 Plant and equipment

24

Interest on loan – Amber

__5

420Net profit 200

Assume profit is earned proportionately throughout the year

Profit and Loss Appropriation Account

Amber Beryl Coral Total£’000 £’000 £’000 £’000

1/1X6 to 30.6.X6Salaries 10 10 20Share of profit: £80,000 (60:40) 48 32 801.7.X6 to 31.12.X6

554 Revision Aid

£100,000 (40:40:20)40 40 20 100

98 82 20 200

Amber, Beryl and CoralBalance Sheet as at 31 December 1996

Cost or valuation

Aggregate depreciatio

n

Net book value

Non current assetsLand at valuation 280 Nil 280Buildings 250 35 215Plant, equipment and vehicles

240 74 166

770 109 661Current assetsStock 200Debtors (420 – 16) 404Less: provision for doubtful debts

30

374Cash at bank 38

612Current liabilitiesTrade creditor 350Bonus 12

362 250Net current assets 911Long term loan – Amber 50

861Represented by:

Capital accounts: Amber 368 Beryl 242 Coral 100

710Current accounts: Amber 82 Beryl 64 Coral _5

151Proprietor funds 861

CAPITAL ACCOUNTSA B C A B C

£’000

£’000

£’000

£’000 £’000 £’000

Balances b/f 280 210Goodwill 80 80 40 Cash 140

Lesson Nine 555Balances c/f 368 242 100 Goodwill

(W1)120 80

Revaluation 48 32448 322 140 448 322 140

Balances b/f 368 242 100

556 Revision Aid

CURRENT ACCOUNTSA B C A B C

£’000

£’000

£’000

£’000 £’000 £’000

Drawings 28 24 15 Balances b/f 7 6Balances c/f 82 64 5 Profit for

year98 82 20

__ __ __ Loan interest

_5 __ __

110 88 20 110 88 20

Question 4The solution provided has the workings shown beside the accounts to make the comparison easier. Remember to adhere to previous partnerships and departmental formats.(a) Aristocratic AutosTrading and Profit and Loss Account for year ended 30 September 1986Workings

Workshop

Petrol/oil Showroom

Total

£ £ £ £Sales and charges:

32,125 32,964 8,500 Cash 73,58965,892 41,252 81,914 Credit 189,05

898,017 74,216 90,414 Total turnover 262,64

7

Less materials:1,932 3,018 20,720 Opening stock 25,670

23,860 41,805 52,100 Purchases 117,765

25,792 44,823 72,820 143,435

(2,752) (2,976) (25,310) Closing stock (31,038)

23,040 41,847 47,510 Usage 112,397

(2) 34,163 5,685 ____- Direct wages 39,84857,203 47,532 47,510 Cost of sales 152,24

540,814 26,684 42,904 Gross profit 110,40

2(1) 1,333 - - Profit on sale of

plant1,333

42,147 26,684 42,904 111,735

Less(3) 7,024 - 4,391 Indirect wages 11,415

- - 10,200 Salaries 10,200(4) 2,613 2,945 7,880 Rates 13,438(5) 1,939 2,185 5,846 Electricity 9,970(6) 4,477 3,389 4,130 General expenses 11,996(7) 16,898 8,324 11,302 Depreciation 36,524

32,951 16,843 43,749 Total 93,543

Lesson Nine 5579,196 9,841 (845) Net profit/loss for

year18,192

Less appropriationsInterest on capitalsDuke (5% x £50,0000

(2,500)

Earl (5% x £40,000) (2,000)Residual profit* 13,692Duke (6,846)Earl (6,846)

-*The equal division stipulated by the Partnership Act applies in the absence of agreement to the contrary.

558 Revision Aid

Aristocratic AutosBalance Sheet as at 30 September 1986Workings

Workshop

Petrol/oil Showroom

Total

£ £ £ £Non current assets at written down value:

(8) 5,020 4,260 11,010 Freehold buildings 20,290(8) 24,891 4,859 5,357 Plant, equipment and

vehicles35,107

29,911 9,119 16,367 55,397Current assets:

2,752 2,976 25,310 Stocks 31,0381,365 537 - Debtors 1,902

(4) 2,586 2,915 7,799 Prepayments 13,300316 1,605 30,470 Bank and cash 32,391

7,019 8,033 63,579 78,631Current liabilities:

4,225 5,602 15,250 Creditors 25,077(9) 915 564 983 Accruals 2,462

5,140 6,166 16,233 27,5391,879 1,867 47,346 Working capital 51,092

31,790 10,986 63,713 Net assets employed 106,489

Financed byCapital accountsDuke 50,000Earl 40,000

90,000Current accounts:

(10) Duke 6,906

(10) Earl 9,853

16,489106,48

9

Workings(1) Plant disposal: Cost

Accumulated depreciation19,500

(15,633)

Written down value 3,867Proceeds 5,200Profit on sale 1,333

Workshop

Petrol/oil showroom

Total

Lesson Nine 559£ £ £ £

(2) Direct wages:34,050 5,602 ___- Per list 39,652113 83 ___- Accrual ___19634,163 5,685 - Total 39,848

(3) Indirect wages:6,810 - 4,160 Per list 10,970214 - 231 Accrual 4457,024 - 4,391 11,415

(4) Rates (apportioned on basis of freehold buildings at (8) below:

5,199 5,860 15,679 Per list 26,738(2,586) (2,915) (7,799) Prepayment (13,300

)2,613 2,945 7,880 Total 13,438

(5) Electricity apportioned on same basis as (4) above:

1,838 2,072 5,543 Per list 9,453101 113 303 Accruals 5171,939 2,185 5,846 Total 9,970

(6) General expenses (apportioned on basis of turnover:

3,990 3,021 3,681 Per list 10,692487 368 449 Accruals 1,3044,477 3,389 4,130 Total 11,996

(7) Depreciation:Charge for year per (8) below:

2,520 2,840 7,600 Freehold buildings 12,96014,378 5,484 3,702 Plant, equipment etc 23,56416,898 8,324 11,302 Total 36,524

Workshop

Petrol/oil Showroom

£ £ £(8) Freehold buildings (cost):

12,600 14,200 38,000 At 1 October 1985 64,800- - - Additions during year -_____- _____- _____- Disposals during year _____-12,600 14,200 38,000 At 30 September 1986 64,800

Provision for depreciation on freehold buildings:

5,060 7,100 19,390 At 1 October 1985 31,550- - - Disposals during year -2,520 2,840 7,600 Charge for year 12,9607,580 9,940 26,990 At 30 September 1986 44,510

5,020 4,260 11,010Written down value at 30 September 1986 20,290Plant, equipment etc. (cost):

560 Revision Aid

65,18022,900 17,450 At 1 October 1985 105,53

026,210 4,520 1,060 Additions during year 31,790(19,500) _____- ____- Disposals during year (19,500

)71,890 27,420 18,510 At 30 September 1986 117,82

0

Provision for depreciation on plant, equipment etc

48,254 17,077 9,451 At 1 October 1985 74,782(15,633) - - Disposals during year (15,633

)14,378 5,484 3,702 Charge for year 23,56446,999 22,561 13,153 At 30 September 1986 82,713

Written down value24,891 4,859 5,357 At 30 September 1986 35,107

(9) Accruals (per workings above):

113 83 - (2) 196214 - 231 (3) 445101 113 303 (5) 517487 368 449 (6) 1,304915 564 983 2,462

(10) Current accounts: Duke

Earl

Opening balance 9,750

10,477

Interest on capital 2,500

2,000

Residual profit 6,846

6,846

Drawings (12,190)

(9,740)

Closing balance 6,906

9,583

Question 5WORKINGSThe first step is to derive the profit for the period:-

£Closing Assets minus external liabilities

(17,000 + 3,480 + 1,100 + 2,230 + 3,370 – 980)

26,200

Add back drawings (2,000 + 1,600 + 1,800)

5,400

31,600Opening Less assets minus external liabilities

(26,060 – 820)25,240

Profit for period (1st July to 31st October) 6,360

Lesson Nine 561

CAPITAL ACCOUNTSR S T A R S T A£ £ £ £ £ £ £ £

Goodwill w/o - 3,000

3,000

1,500

Opening balances

9,000 8,000

8,000

-

Goodwill raised

2,500 2,500

2,500

-

Closing balances

- 7,500

7,500

4,000

Bank 4,000

4,000

Exors of Capital 1,500

1,500

R decd 11,500

- - - Premium (1/5 x 7,500)

11,500

10,500

10,500

5,500

11,500

10,500

10,500

5,500

CURRENT ACCOUNTSR S T A R S T A£ £ £ £ £ £ £ £

Balance b/d - - 100 - Balances b/d 140 200 - -Drawings 2,00

01,60

01,80

0- Appropriation

a/c2,12

02,12

02,12

0-

Closing balance

- 720 720 - (profit)

Exors of R (decd)

260 - - -

2,260

2,320

2,120

- 2,260

2,320

2,120

-

The Capital and Current Accounts are given as workings for the Balance sheet figures.

LESSON 8

Question 1 (a)

AZ LtdManufacturing , Trading Profit and Loss Account for the year ended 31 October 1999Raw Materials Sh’000 Sh’000Opening stock – Raw material 380Purchases – Raw material 9,500

9,880Less closing stock – Raw material (465)Cost of raw materials consumed 9,415Add: direct wages 1,350 direct expenses _395 1,745Prime Cost 11,160Factory overheadsFactory expenses 290

562 Revision Aid

Indirect materials350

Factory insurance 150Depreciation – plant and machinery

5,160 5,950

Total cost of production 17,110Add opening W.I.P 560

17,670Less closing W.I.P – Finished goods

(695)

Factory cost of production – finished goods

16,975

Sales 28,550Less cost of salesOpening stock – finished goods 420Factory cost of production – finished goods

16,975

17,395Less closing stock – finished goods

(610) (16,785)

Gross profit 11,765Less expensesSales room expenses 485Administration expenses 620Office salaries and wages 898Vehicle running expenses 656Bad debts w/o 64Overdraft interest 725Debenture interest 800Depreciation: furniture and equipment

89

Motor vehicles 4,125 (8,462)3,303

Less dividend (4,000)Net profit for the year (697)Add retained profit b/d 5,500

4,803Less transfer to general reserve (2,000)Retained profit c/d 2,803

Lesson Nine 563AZ Ltd

Balance Sheet as at 31 October 1999Non current assets Sh’000 Sh’000 Sh’000Land & Buildings 30,000 - 30,000Plant and machinery 25,800 (11,460) 14,340Furniture and equipment 890 (274) 616Motor vehicles 16,500 (7,525) 8,975

73,190 19,259 53,931Current AssetsStock – Finished goods 610 Raw materials 465 WIP 695

7,3609,130

Current LiabilitiesBank overdraft 1,175Creditors 1,000Accruals 783Debenture interest 800Dividends accrued 4,000 (7,758) 1,372

55,303Financed by:Authorized and issued capital

40,000

Capital reserveShare premium 500Revenue reserveGeneral reserve 2,000Retained profit 2,803

45,303Non current liability8% debenture 10,000

55,303

564 Revision Aid

STABalance Sheet as at 1 November 19-6

£ £Buildings 17,000Equipment 3,480

20,480Current assetsStock 1,100Debtors 2,230Bank 4,950

8,280Current liabilitiesCreditors (980) 7,300

27,780Capital: Sam 7,500 Ted 7,500 Abe 4,000

19,000Current accounts: Sam

720

Ted 220 Abe __- 940

19,940Estate of Reg. 7,840

27,780

Lesson Nine 565

KK LtdBalance Sheet as at 31 October 1998

Shs ‘000’ Shs ‘000’ Shs ‘000’

Non Current AssetsFreehold property 44,500 - 44,500Furniture and fittings 1,540 (292) 1,248Motor vehicles 3,500 (965) 2,535

49,540 (1,257) 48,283

Goodwill 500

Current AssetsStock 4,398Debtors 1,540Less provision for doubtful debts (77) 1,463Rent receivable 35Cash at bank 10,492

16,388Current LiabilitiesCreditors 332Accrued expenses 189Debenture interest 350Tax payable 8,960Proposed dividends 4,500 (14,331) 2,057

50,840Authorized and issued share capital 1,500,000 ordinary shares of Sh. 20 each fully paid 30,000

Capital reservesShare premium 350

Revenue reservesGeneral reserve 4,500Profit and loss account 12,490 16,990

47,34010% debenture 3,500

50,840

566 Revision Aid

Question 3(a)

1995 1996Gross profit percentage Gross profit Sales

24,000 = 37.5%64,000

32,400 = 30%108,000

Current ratio Current assets Current liabilities

23,900 = 1.68:114,200

31,000 = 1.52:120,400

Quick ratio Current assets less stock Current liabilities

23,900 – 12,000 = 0.84:1 14,200

31,000 – 15,000 = 0.78:1 20,400

Debtors collection period Debtors x 365 Sales

10,500 x 365 = 60 days64,000

14,000 x 365 = 47 days108,000

Creditors payment period Trade creditors x 365 Purchases (W)

6,800 x 365 = 59 days42,000

9,400 x 365 = 44 days78,600

Gearing ratio Loan capital Total capital

60,000____ = 70%60,000 + 26,000

60,000____ = 55%60,000 + 49,000

1995 1996£’000 £’000

Cost of sales 40,000 75,600Add: closing stock 12,000 15,000

52,000 90,600Deduct: opening stock 10,000 12,000Purchases 42,000 78,600

(b) The gross profit margin has fallen when compared with last year, although in absolute

terms, both profit and sales are higher. Possibly the firm has lowered the price of goods to increase sales, although there may be other explanations (see part (c) below).

There has been a reduction in liquidity as evidenced by a fall in both the current and the quick ratios. However, this is no immediate cause for concern as the company appears to be paying its creditors more promptly than last year.

The debtors’ collection period, already satisfactory, has decreased still further from 60 to 47 days. There is not enough information to say whether this is all due to good credit control, or whether some sales are being made on shorter credit terms or for cash.

Lesson Nine 567 The creditors payment period has shortened. Possibly the company has become more

efficient at paying creditors, or perhaps it is purchasing goods on shorter credit terms. The gearing ratio has reduced but it is still too high. The reduction is mainly due to an

increase in retained profits and in the revaluation reserve. High gearing involves greater risk for the shareholders.

Any two of the following:

An error in counting closing stock An increase in prices from suppliers not passed on to customers Deliberate reduction in margin in an attempt to increase sales volume

(d)The position is not quite as clear-cut as this statement would suggest. Liquidity is important, and a company ought to be able to pay its debts as they fall due. However, an excessively high current ratio means that resources are tied up in stock, debtors and cash instead of producing profits. Current assets should generally be kept as low as is compatible with efficient production and paying creditors as they fall due.

There is some truth in this statement. High gearing means greater risk, but also, in good times, greater returns. It is important that the percentage return to shareholders is greater than the percentage rate of interest being paid on the borrowings.

Question 4

Application and allotment account19X1 £ 19X1 £11 Feb Cash 4,000 10 Feb Cash11 Feb Share capital

(50,000 @ 70p)

35,000 16 Feb Cash

Share premium(50,000 @ 20p)

10,000 ______

£49,000 £49,000

19X1 £ 19X1 £29 Sep Forfeited

shares 500 11 Feb Application and

allotment account(50,000 @ 70p)

35,000

1 Nov Balance carried down

50,0001 May Call account

(50,000 @ 30p) 15,000

______1 Nov Forfeited

shares reissued ___500£50,500

£50,500

19X1 £11 Feb Application and

allotment account 10,000

568 Revision Aid(50,000 @ 20p)

Bal c/d 10,250

1 Nov Forfeited shares reissued account

___250

£10,250

£10,250

Call account19X1 19X1 £1 May Share

capital15,000 1 May Cash 14,850

_____ 29 Sep Forfeited shares

___150

£15,000

£15,000

Forfeited Shares19X1 19X1 £29 Sep Call account 150 29

SepShare capital (500 @ £1)

500

1 Nov Forfeited shares reissued

350 ____

£500 £500

Forfeited Shares

LESSON 8(PUBLIC SECTOR)

MINISTRY OF UCHUMI NA UFANISI

General Account of Vote19-8 £

June 30 Cash (P.M.G.) A/C Expenditure 192,428

June 30 Excess A.I.A A/C 4,560

June 30 Balance c/d 22,036

19-7 £

July 1 Exchequer A/C 213,464

19-8June 30 Appropriations in Aid A/C

5,560

219,024

219,024

Exchequer Account

19X1 £ 19X1 £1 Nov Share

capital 500 1 Nov Cash 400

1 Nov Share premium

250 1 Nov Forfeited shares 350

£750 £750

Lesson Nine 56919-7 £

July 1 General Account of Vote 213,464

19-8 £ June 30 Cash (P.M.G.) A/C

200,000June 30 Balance c/d

13,464 213,464 213,464

Paymaster-General (P.M.G.) Account19-8 £

June 30 Exchequer A/C 200,000

June 30 General Account of vote – A.I.A 5,560

19-8 £ June 30 General Account of vote

192,428June 30 Balance c/d

13,132

205,560 205,560

Statement of Assets and Liabilities at 30th June 19-8 £Liabilities

G.A.V 22,036

Excess Appropriation in Aid 4,560

£ Assets

Exchequer A/C 13,464

Paymaster – General A/C 13,132

26,596 26,596

NotesTotal of approved estimates is obtained by adding up the approved estimates in respect of expenditure of different heads. Appropriation in Aid is not included.

Total expenditure is obtained by adding up the actual expenditure of different heads. Appropriation-in-Aid (realised) is not included.

ANSWER TWO

Commitment Accounting and Fund Accounting in relation to Public Sector are distinguished as under: -

Commitment AccountingThis accounting system recognises transactions when the organisation is committed to them. This means that the transaction is not recognised neither when cash is not paid or received, nor when an invoice is received or issued but at an earlier stage when orders are issued or received. Under this system, the organisation is recognising the issue of an order as a commitment to incur expenditure and accounts continuously record commitments. The main purpose of commitment accounting is the budgetary control rather than financial reporting.

Fund AccountingThis system refers to the method of accounting which reports in terms of funds rather than in terms of organisations. This indicates the extent to which different funds are utilized and the form and extent to which individual fund accounts are consolidated in the final accounts. For example, if ten funds are used but they are all consolidated into one operating statement and one balance sheet, then the results might be the same as accounts for a business.

A Member of Parliament

570 Revision Aid

The interest of a Member of Parliament will be on fiscal compliance. This refers to the extent to which the organisation has complied with conditions laid down in the authority to spend.

A Tax PayerThe main interest of a taxpayer will be to evaluate the management and performance. This refers to the need to know whether the money was spent wisely. In other words, this refers to the measurement of efficiency of the Government as regards the expenditure incurred and resultant increase in level of output.

A Patient of one of the HospitalsA patient’s interest is on the services provided in the Government Hospitals. He can find out whether the expenditure incurred on health reflects the improvement in delivery of services.

A Creditor to one of the HospitalsThe interest of a creditor will be on the financial viability. He should find out whether the state has enough ability to pay against the goods supplied to the hospitals.