Textbook Answers As

a n s w e r s t o s e l e c t e d q u e s t i o n s i n t h e t e x t b o o k

AS Unit 1

Introduction to Financial Accounting

1 What is financial accounting? 1

2 Double-entry book-keeping: first principles 1

3 Double-entry book-keeping: further transactions 3

4 Business documents 5

5 Balancing accounts – the trial balance 7

6 Division of the ledger – the use of subsidiary books 9

7 The main cash book 11

8 Bank reconciliation statements 12

9 Introduction to final accounts 14

10 The general journal and correction of errors 15

11 Control accounts 18

12 Adjustments to final accounts 19

AS Unit 2

Financial and Management Accounting

13 Business organisations 21

14 Accounting concepts and stock valuation 22

15 Further aspects of final accounts 23

16 Preparing sole trader final accounts 25

17 Financial statements of limited companies 28

18 Ratio analysis 31

19 Budgeting and budgetary control 34

20 The impact of computer technology in accounting 36

AS Accounting for AQAsecond edition

TUTOR SUPPORT MATERIAL:ANSWERS TO SELECTED QUESTIONS

© Osborne Books Limited 2010

All answers are the responsibility of the publisher.

Published by Osborne Books Limited

Tel 01905 748071

Email [email protected]

www.osbornebooks.co.uk

1.2 Purposes of accounting:1. To quantify items such as sales, expenses and profit2. To present the accounts in a meaningful way so as to measure the success of the business3. To provide information to the owner of the business and to other stakeholders

1.3 • documentsprocessing of source documents relating to accounting transactions

• initial recording of transactionsrecording accounting transactions in subsidiary books (or books of prime entry)

• double-entry accounts systemtransfer from subsidiary books into the double-entry book-keeping system of accounts in the ledger

• trial balanceextraction of figures from all the double-entry accounts to check their accuracy

• final accountsproduction of a trading and profit and loss account and a balance sheet

Information from the accounting system includes:

• purchases of goods for resale to date • assets owned

• turnover (cash and credit sales) to date • liabilities owed

• overheads and expenses to date • profit during a particular period

• debtors – total amount owed to the business, and individual debtors

• creditors – total amount owed by the business, and individual creditors

1.4 Other stakeholders – any four from

• providers of finance, eg the bank manager if the business wants to borrow from the bank

• suppliers, who wish to assess the likelihood of receiving payment from the business

• customers, who wish to ensure that the business has the financial strength to continue selling thegoods and services that they buy

• employees and trade unions, who wish to check on the financial prospects of the business

• the tax authorities, who will wish to see that tax due by the business on profits and for Value AddedTax has been paid

• competitors, who wish to assess the profitability of the business

• potential investors in the business

• the local community and national interest groups, who may be seeking to influence business policy

• government and official bodies, eg Companies House who need to see the final accounts of limitedcompanies

1.5 (a) Business entity – the accounts record and report on the financial transactions of a particularbusiness, and not the owner's personal financial transactions.

(b) Money measurement – the accounting system uses money as the common denominator in recordingand reporting all business transactions; thus the loyalty of a firm's workforce or the quality of a productcannot be recorded because these cannot be reported in money terms.

1.6 • assets – items owned by a business; liabilities – items owed by a business

• debtors – individuals or businesses who owe money in respect of goods or services supplied by thebusiness; creditors – individuals or businesses to whom money is owed by the business

• purchases – goods bought, whether on credit or for cash, which are intended to be resold later; sales– the sale of goods, whether on credit or for cash, in which the business trades

• credit purchases – goods bought, with payment to be made at a later date; cash purchases – goodsbought, with immediate payment made in cash, by cheque, debit card, credit card, or bank transfer

1.7 • asset of bank increases by £8,000capital increases by £8,000asset £8,000 – liability £0 = capital £8,000

• asset of computer increases by £4,000asset of bank decreases by £4,000asset £8,000 – liability £0 = capital £8,000

• asset of bank increases by £3,000liability of loan increases by £3,000asset £11,000 – liability £3,000 = capital £8,000

• asset of van increases by £6,000asset of bank decreases by £6,000asset £11,000 – liability £3,000 = capital £8,000

2.1 Dr Capital Account Cr

20-1 £ 20-1 £1 Feb Bank 7,500

Dr Computer Account Cr

20-1 £ 20-1 £6 Feb Bank 2,000

Dr Rent Paid Account Cr

20-1 £ 20-1 £8 Feb Bank 750

Dr Wages Account Cr

20-1 £ 20-1 £12 Feb Bank 42525 Feb Bank 380

Dr Bank Loan Account Cr

20-1 £ 20-1 £14 Feb Bank 2,500

Dr Commission Income Account Cr

20-1 £ 20-1 £20 Feb Bank 145

Dr Drawings Account Cr

20-1 £ 20-1 £23 Feb Bank 200

1

CHAPTER 1 What is financial accounting?

CHAPTER 2 Double-entry book-keeping: first principles

Dr Van Account Cr20-1 £ 20-1 £28 Feb Bank 6,000

2.3 Dr Bank Account Cr20-5 £ 20-5 £

1 Aug Capital 5,000 3 Aug Computer 1,80015 Aug S Orton: loan 1,000 7 Aug Rent paid 10020 Aug Office fittings 250 12 Aug Office fittings 2,00025 Aug Commission received 150 27 Aug S Orton: loan 150

Dr Capital Account Cr20-5 £ 20-5 £

1 Aug Bank 5,000

Dr Computer Account Cr20-5 £ 20-5 £

3 Aug Bank 1,800

Dr Rent Paid Account Cr20-5 £ 20-5 £

7 Aug Bank 100

Dr Commission Income Account Cr20-5 £ 20-5 £

10 Aug Cash 20025 Aug Bank 150

Dr Cash Account Cr20-5 £ 20-5 £10 Aug Commission received 200 17 Aug Drawings 100

Dr Office Fittings Account Cr20-5 £ 20-5 £12 Aug Bank 2,000 20 Aug Bank 250

Dr Sally Orton: Loan Account Cr20-5 £ 20-5 £27 Aug Bank 150 15 Aug Bank 1,000

Dr Drawings Account Cr20-5 £ 20-5 £17 Aug Cash 100

2.5 Dr Bank Account Cr

20-7 £ 20-7 £1 Nov Capital 75,000 3 Nov Photocopier 2,5007 Nov Bank loan 70,000 10 Nov Office premises 130,000

23 Nov Cash 100 12 Nov Business rates 3,00025 Nov Office fittings 200 14 Nov Office fittings 1,50028 Nov Commission received 200 20 Nov Wages 250

Dr Capital Account Cr

20-7 £ 20-7 £1 Nov Bank 75,000

Dr Photocopier Account Cr

20-7 £ 20-7 £3 Nov Bank 2,500

Dr Bank Loan Account Cr

20-7 £ 20-7 £7 Nov Bank 70,000

Dr Office Premises Account Cr

20-7 £ 20-7 £10 Nov Bank 130,000

Dr Rates Account Cr

20-7 £ 20-7 £12 Nov Bank 3,000

Dr Office Fittings Account Cr

20-7 £ 20-7 £14 Nov Bank 1,500 25 Nov Bank 200

Dr Cash Account Cr

20-7 £ 20-7 £15 Nov Commission received 300 18 Nov Drawings 125

23 Nov Bank 100


20-7 £ 20-7 £15 Nov Cash 30028 Nov Bank 200

Dr Drawings Account Cr

20-7 £ 20-7 £18 Nov Cash 125

Dr Wages Account Cr

20-7 £ 20-7 £20 Nov Bank 250

2

2.6 Bank Account 20-7 Debit Credit Balance

£ £ £1 Nov Capital 75,000 75,000 Dr3 Nov Photocopier 2,500 72,500 Dr7 Nov Bank loan 70,000 142,500 Dr

10 Nov Office premises 130,000 12,500 Dr12 Nov Rates 3,000 9,500 Dr14 Nov Office fittings 1,500 8,000 Dr20 Nov Wages 250 7,750 Dr23 Nov Cash 100 7,850 Dr25 Nov Office fittings 200 8,050 Dr28 Nov Commission received 200 8,250 Dr

2.7 Guidance to the trainee to include:• the use of accounts to record different types of transactions• the principles of double-entry book-keeping whereby one account is debited and one account is

credited for every business transaction• the debit entry is made in the account which gains value, or records an asset, or an expense• the credit entry is made in the account which gives value, or records a liability, or an income item• examples can be given using bank account where money in is recorded on the debit side, and money

out is recorded on the credit side• an explanation of various accounts including

– capital – the amount of money invested in the business by the owner– fixed assets – items purchased by a business for use on a long-term basis (noting the

distinction between capital expenditure and revenue expenditure)– expenses – the day-to-day running expenses (revenue expenditure) of the business– income – amounts of income received by the business– owner’s drawings – where the owner takes money in cash or by cheque (or sometimes goods)

from the business for personal use– loans – where a business receives a loan, eg from a relative or the bank

3.1 Dr Bank Account Cr20-2 £ 20-2 £

1 Oct Capital 2,500 2 Oct Purchases 2004 Oct Sales 150 6 Oct Purchases 908 Oct Sales 125 14 Oct Purchases 250

12 Oct K Smithson: loan 2,000 22 Oct Delivery van 4,00018 Oct Sales 155 25 Oct Wages 37530 Oct Sales 110

Dr Capital Account Cr20-2 £ 20-2 £

1 Oct Bank 2,500

Dr Purchases Account Cr20-2 £ 20-2 £

2 Oct Bank 2006 Oct Bank 90

14 Oct Bank 250

Dr Sales Account Cr20-2 £ 20-2 £



Dr J Smithson: Loan Account Cr20-2 £ 20-2 £

12 Oct Bank 2,000

Dr Delivery Van Account Cr20-2 £ 20-2 £22 Oct Bank 4,000

Dr Wages Account Cr20-2 £ 20-2 £25 Oct Bank 375

3.5 Dr Purchases Account Cr20-2 £ 20-2 £

2 Apr Wyvern Producers Ltd 2004 Apr A Larsen 250

Dr Wyvern Producers Ltd Cr20-2 £ 20-2 £

9 Apr Purchases returns 50 2 Apr Purchases 20020 Apr Bank 150

Dr A Larsen Cr20-2 £ 20-2 £26 Apr Purchases returns 45 4 Apr Purchases 250


5 Apr Pershore Patisserie 1507 Apr Bank 175

12 Apr Bank 11028 Apr Cash 100

Dr Pershore Patisserie Cr20-2 £ 20-2 £

5 Apr Sales 150 15 Apr Sales returns 2522 Apr Bank 125

Dr Bank Account Cr20-2 £ 20-2 £

7 Apr Sales 175 20 Apr Wyvern Producers Ltd 15012 Apr Sales 110 30 Apr Amery Scales Ltd 25022 Apr Pershore Patisserie 125

Dr Purchases Returns Account Cr20-2 £ 20-2 £

9 Apr Wyvern Producers Ltd 5026 Apr A Larsen 45

3

CHAPTER 3 Double-entry book-keeping: further transactions

Dr Sales Returns Account Cr20-2 £ 20-2 £15 Apr Pershore Patisserie 25

Dr Weighing Machine Account Cr20-2 £ 20-2 £17 Apr Amery Scales Ltd 250

Dr Amery Scales Ltd Cr20-2 £ 20-2 £30 Apr Bank 250 17 Apr Weighing machine 250

Dr Cash Account Cr20-2 £ 20-2 £28 Apr Sales 100 29 Apr Wages 90

Dr Wages Account Cr20-2 £ 20-2 £29 Apr Cash 90


2 Jun Designs Ltd 3507 Jun Mercia Knitwear Ltd 400

23 Jun Designs Ltd 285

Dr Designs Ltd Cr20-3 £ 20-3 £

6 Jun Purchases returns 100 2 Jun Purchases 35018 Jun Bank 250 23 Jun Purchases 285


4 Jun Bank 2205 Jun Cash 115

10 Jun Wyvern Trade Supplies 35012 Jun Bank 17520 Jun Cash 180

Dr Bank Account Cr20-3 £ 20-3 £

4 Jun Sales 220 18 Jun Designs Ltd 25012 Jun Sales 17528 Jun Wyvern Trade Supplies 300

Dr Cash Account Cr

20-3 £ 20-3 £5 Jun Sales 115 26 Jun Rent paid 125

20 Jun Sales 180

Dr Purchases Returns Account Cr

20-3 £ 20-3 £6 Jun Designs Ltd 100

17 Jun Mercia Knitwear Ltd 80

Dr Mercia Knitwear Ltd Cr

20-3 £ 20-3 £17 Jun Purchases returns 80 7 Jun Purchases 400

Dr Wyvern Trade Supplies Cr

20-3 £ 20-3 £10 Jun Sales 350 15 Jun Sales returns 50

28 Jun Bank 300

Dr Sales Returns Account Cr

20-3 £ 20-3 £15 Jun Wyvern Trade Supplies 50


20-3 £ 20-3 £26 Jun Cash 125

3.7 Transaction Account debited Account credited(a) purchases bank(b) bank sales(c) purchases Teme Traders(d) L Harris sales(e) Teme Traders purchases returns(f) sales returns L Harris(g) bank D Perkins: loan(h) cash bank

3.8 Answers to the trainee:

• Separate accounts for purchases and sales enable the business to know the amount of goods boughtand sold. A combined account for ‘goods’ would not provide this information so readily.

• Purchases and sales accounts follow the principles of book-keeping in that the debit side of purchasesaccount gains value when the business buys goods for resale, while the credit side of sales accountgives value when the business sells goods.

• The purchase of a new delivery van for use in the business is the purchase of a fixed asset, which willbe used on a long-term basis. As such the purchase of the van – which is an example of capitalexpenditure – is entered on the debit side of van account.

• Purchases returns (or returns out) is where we return goods to a creditor (supplier). The returnstransaction is recorded the opposite way round to a purchases transaction.

Sales returns (or returns in) is where a debtor (customer) returns goods to us. The transaction isrecorded the opposite way round to a sales transaction.

• Carriage inwards and carriage outwards are kept in separate accounts because they representdifferent transactions. Carriage inwards is where we pay the carriage cost of goods purchased to havethem delivered to us. Carriage outwards is where we pay the carriage charge for goods we have sold,that is we have sold the goods to our customers as ‘delivery free’.

4

4.2

Excel Fashions will pay £480.18 (£492.50 x 97.5%, rounded down) for settlement in full within 14 days.

4.3

The Card Shop will pay £185.25 (£190.00 x 97.5%) for settlement in full within 14 days.

5

invoice to

deliver to

invoice no 2451accountyour reference

date todayas above

product description quantity unit unit total trade netcode price discount %

£ £ £

Dresses 5 30.00 each 150.00 0.00 150.00Suits 3 45.50 each 136.50 0.00 136.50Coats 4 51.50 each 206.00 0.00 206.00

terms2.5% cash discount for full settlementwithin 14 daysNet 30 days

Excel Fashions49 Highland StreetLongtonMercia LT3 2XL

INVOICE

JANE SMITH, FASHION WHOLESALERUnit 21, Eastern Industrial Estate, Wyvern, Wyvernshire, WY1 3XJ

TOTAL 492.50

invoice to

deliver to

invoice no 8234accountyour reference

date todayas above


£ £ £

Assorted rubbers 5 5.00 box 25.00 0.00 25.00Shorthand notebooks 100 4.00 10 40.00 0.00 40.00Ring Binders 250 0.50 each 125.00 0.00 125.00

terms2.5% cash discount for full settlementwithin 14 daysNet 30 days

The Card Shop126 The CornbowTeamington SpaWyvernshire WY33 0EG

INVOICE

DEANSWAY TRADING COMPANYThe Model Office, Deansway, Rowcester, RW1 2EJ

TOTAL 190.00

CHAPTER 4 Business documents


2 Feb G Lewis 20016 Feb G Lewis 160


4 Feb L Jarvis 1507 Feb G Patel 240

Dr G Lewis Cr

20-4 £ 20-4 £10 Feb Bank 190 2 Feb Purchases 20010 Feb Discount received 10 16 Feb Purchases 16024 Feb Bank 15224 Feb Discount received 8

360 360

Dr L Jarvis Cr

20-4 £ 20-4 £4 Feb Sales 150 12 Feb Bank 147

12 Feb Discount allowed 3150 150

Dr G Patel Cr

20-4 £ 20-4 £7 Feb Sales 240 20 Feb Bank 234

20 Feb Discount allowed 6240 240

Dr Bank Account Cr

20-4 £ 20-4 £12 Feb L Jarvis 147 10 Feb G Lewis 19020 Feb G Patel 234 24 Feb G Lewis 152

Dr Discount Received Account Cr

20-4 £ 20-4 £10 Feb G Lewis 1024 Feb G Lewis 8

Dr Discount Allowed Account Cr

20-4 £ 20-4 £12 Feb L Jarvis 320 Feb G Patel 6

4.5 (a)

(b) Trade discount is given, if prearranged:

– to businesses, often in the same trade (but not to the general public)

– for buying in bulk (this discount is also known as bulk discount)

– by wholesalers, as a discount off list price to retailers

Cash discount (also known as settlement discount) is given, for prompt payment, if prearranged, andindicated on the invoice

(c) Fashion Shop will pay £748.12 (£787.50 x 95%, rounded down) for settlement in full within 7 days.

4.7 (a) A source document is used to update the book-keeping records.

(b) (i) An invoice is a source document prepared by the seller and states the value of goods sold and,hence, the amount to be paid by the buyer.

(ii) A credit note is a source document which shows that the buyer is entitled to a reduction in theamount charged by the seller; it is used if:

– some of the goods delivered were faulty, or incorrectly supplied

– the price charged on the invoice was too high

(c) Any three from:

– cheque counterfoils

– paying-in slip counterfoils

– cash receipts

– till rolls

– information from bank statements, such as standing orders, direct debits, BACS, credit transfers,bank charges

6


£ £ £

45B Trend tops (black) 30 12.50 each 375.00 10 337.50

35W Trend trousers (white) 20 25.00 each 500.00 10 450.00

terms5% cash discount for full settlement within 7 daysNet 30 days

TOTAL 787.50

5.1 (a) and (c)

Dr Bank Account Cr

20-9 £ 20-9 £1 Jan Capital 10,000 4 Jan Rent paid 500

11 Jan Sales 1,000 5 Jan Shop fittings 1,50012 Jan Sales 1,250 20 Jan Comp Supplies Ltd 5,00022 Jan Sales 1,450 31 Jan Balance c/d 6,700

13,700 13,7001 Feb Balance b/d 6,700 2 Feb Rent paid 5004 Feb Sales 1,550 15 Feb Shop fittings 850

10 Feb Sales 1,300 27 Feb Comp Supplies Ltd 6,35012 Feb Rowcester College 750 28 Feb Balance c/d 5,30019 Feb Sales 1,60025 Feb Sales 1,100

13,000 13,0001 Mar Balance b/d 5,300

Dr Capital Account Cr

20-9 £ 20-9 £1 Jan Bank 10,000


20-9 £ 20-9 £4 Jan Bank 500 28 Feb Balance c/d 1,0002 Feb Bank 500

1,000 1,0001 Mar Balance b/d 1,000

Dr Shop Fittings Account Cr

20-9 £ 20-9 £5 Jan Bank 1,500 28 Feb Balance c/d 2,350

15 Feb Bank 8502,350 2,350

1 Mar Balance b/d 2,350

Dr Purchases Account Cr

20-9 £ 20-9 £7 Jan Comp Supplies Ltd 5,000 31 Jan Balance c/d 11,500

25 Jan Comp Supplies Ltd 6,50011,500 11,500

1 Feb Balance b/d 11,500 28 Feb Balance c/d 17,00024 Feb Comp Supplies Ltd 5,500

17,000 17,0001 Mar Balance b/d 17,000

7

CHAPTER 5 Balancing accounts – the trial balance4.8 (a) • 5 computer desks were ordered (not 10 as shown on the invoice)

• 10 office chairs were ordered (not 5 as shown on the invoice)

• the unit price of the computer desks is £65.00 each (not £70.00 as shown on the invoice)

• the net amount for computer desks is £292.50 (not £350.00 as shown on the invoice)

• the net amount for office chairs is £180.00 (not £20.00 as shown on the invoice)

• the invoice total is £472.50 (not £370.00 as shown on the invoice)

(b)

(c) Wyvern Products Limited will pay £448.87 (£472.50 x 95%) for settlement in full within 14 days.

(b) Trial balance as at 31 January 20-9Dr Cr

Name of Account £ £Bank 6,700Capital 10,000Rent paid 500Shop fittings 1,500Purchases 11,500Comp Supplies Limited 6,500Sales 4,550Rowcester College 750Sales returns 100

21,050 21,050

(d) Trial balance as at 28 February 20-9Dr Cr

Name of Account £ £Bank 5,300Capital 10,000Rent paid 1,000Shop fittings 2,350Purchases 17,000Comp Supplies Limited 5,500Sales 11,150Rowcester College 1,050Sales returns 100Purchases returns 150

26,800 26,800

5.2 Trial balance of Jane Greenwell as at 28 February 20-1Dr Cr£ £

Name of accountBank 1,250Purchases 850Cash 48Sales 730Purchases returns 144Creditors 1,442Equipment 2,704Van 3,200Sales returns 90Debtors 1,174Wages 1,500Capital (missing figure) 6,000

9,566 9,566

8

Dr Comp Supplies Limited Cr

20-9 £ 20-9 £20 Jan Bank 5,000 7 Jan Purchases 5,00031 Jan Balance c/d 6,500 25 Jan Purchases 6,500

11,500 11,5005 Feb Purchases returns 150 1 Feb Balance b/d 6,500

27 Feb Bank 6,350 24 Feb Purchases 5,50028 Feb Balance c/d 5,500

12,000 12,0001 Mar Balance b/d 5,500

Dr Sales Account Cr

20-9 £ 20-9 £31 Jan Balance c/d 4,550 11 Jan Bank 1,000

12 Jan Bank 1,25016 Jan Rowcester College 85022 Jan Bank 1,450

4,550 4,55028 Feb Balance c/d 11,150 1 Feb Balance b/d 4,550

4 Feb Bank 1,55010 Feb Bank 1,30019 Feb Bank 1,60025 Feb Bank 1,10026 Feb Rowcester College 1,050

11,150 11,1501 Mar Balance b/d 11,150

Dr Rowcester College Cr

20-9 £ 20-9 £16 Jan Sales 850 27 Jan Sales returns 100

31 Jan Balance c/d 750850 850

1 Feb Balance b/d 750 12 Feb Bank 75026 Feb Sales 1,050 28 Feb Balance c/d 1,050

1,800 1,8001 Mar Balance b/d 1,050

Dr Sales Returns Account Cr

20-9 £ 20-9 £27 Jan Rowcester College 100


20-9 £ 20-9 £5 Feb Comp Supplies Ltd 150

PURCHASES LEDGER

Dr Softseat Ltd Cr

20-2 £ 20-2 £

1 Feb Purchases 320

19 Feb Purchases 160

Dr PRK Ltd Cr

20-2 £ 20-2 £

2 Feb Purchases 80

Dr Quality Furnishings Cr

20-2 £ 20-2 £

15 Feb Purchases 160

SALES LEDGER

Dr High Street Stores Cr

20-2 £ 20-2 £

8 Feb Sales 440

25 Feb Sales 200

Dr Peter Lounds Ltd Cr

20-2 £ 20-2 £

14 Feb Sales 120

Dr Carpminster College Cr

20-2 £ 20-2 £

18 Feb Sales 320

GENERAL LEDGER


20-2 £ 20-2 £

28 Feb Purchases Day Book 720

Dr Sales Account Cr

20-2 £ 20-2 £

28 Feb Sales Day Book 1,080

9

5.5 Four from:

• Error of omission

Business transaction completely omitted from the accounting records. For example, cash sale omittedfrom both cash account and sales account.

• Reversal of entries

Debit and credit entries on the wrong side of the two accounts concerned. For example, cash saleentered wrongly as debit sales account, credit cash account.

• Mispost/error of commission

Transaction entered to the wrong person's account. For example, a sale of goods on credit to A THughes has been entered as debit A J Hughes' account, credit sales account.

• Error of principle

Transaction entered in the wrong type of account. For example, cost of petrol for vehicles has beenentered as debit motor vehicles account, credit bank account.

• Error of original entry (or transcription)

Amount entered incorrectly in both accounts. For example, sale of £45 entered in both sales accountand the debtor's account as £54.

• Compensating error

Two errors cancel each other out. For example, balance of purchases account calculated wrongly at£10 too much, compensated by the same error in sales account.

6.2 (a) Purchases Day Book

Date Details Invoice Reference Amount

20-2 £

1 Feb Softseat Ltd 961 320

2 Feb PRK Ltd 068 80

15 Feb Quality Furnishings 529 160

19 Feb Softseat Ltd 984 160

28 Feb Total for month 720

Sales Day Book


20-2 £

8 Feb High Street Stores 001 440

14 Feb Peter Lounds Ltd 002 120

18 Feb Carpminster College 003 320

25 Feb High Street Stores 004 200

28 Feb Total for month 1,080

CHAPTER 6 Division of the ledger – the use of subsidiary books

GENERAL LEDGER


20-2 £ 20-2 £

31 May Purchases Day Book 1,118.00


20-2 £ 20-2 £

31 May Purchases Day Book 108.00

6.5 (a)

10

product quantity details unit price unit total amountcode

X24 96 Trend tops £8.50 each each 816.00

Y36 20 Jeans £15 each each 300.00

1,116.00

trade discount 20% 223.20

total 892.80

terms5% cash discount for full settlement within 7 daysNet 30 days

6.3 (a) Purchases Day Book


20-2 £

2 May M Roper & Sons 562 PL 302 190

4 May Wyper Ltd 82 PL 301 200





31 May Total for month 1,118.00

Purchases Returns Day Book

Date Details Credit Reference Amount Note

20-2 £




31 May Total for month 108

(b) and (c)PURCHASES LEDGER

Dr Wyper Ltd (account no 301) Cr20-2 £ 20-2 £23 May Purchases Returns 40 1 May Balance b/d 10031 May Balance c/d 710 4 May Purchases 200

10 May Purchases 21021 May Purchases 240

750 750

1 Jun Balance b/d 710

Dr M Roper & Sons (account no 302) Cr20-2 £ 20-2 £18 May Purchases Returns 30 1 May Balance b/d 8528 May Purchases Returns 38 2 May Purchases 19031 May Balance c/d 485 18 May Purchases 180

25 May Purchases 98553 553


7.3

Dr Cash Book Cr

Date Details Ref Disc Cash Bank Date Details Ref Disc Cash Bankallwd recd

20-7 £ £ £ 20-7 £ £ £1 Aug Balances b/d 276 4,928 5 Aug T Hall Ltd 24 5411 Aug Wild & Sons Ltd 398 8 Aug Wages 254

11 Aug Bank C 500 11 Aug Cash C 50012 Aug A Lewis Ltd 20 1,755 18 Aug F Jarvis 45721 Aug Harvey & Sons Ltd 261 22 Aug Wages 43629 Aug Wild & Sons Ltd 15 595 25 Aug J Jones 33 62829 Aug Bank C 275 27 Aug Salaries 2,043

28 Aug Telephone 27629 Aug Cash C 27531 Aug Balances c/d 361 3,217

35 1,051 7,937 57 1,051 7,9371 Sep Balances b/d 361 3,217

7.4

Dr Cash Book CrDate Details Ref Discount Cash Bank Date Details Ref Discount Cash Bank

allowed received20-5 £ £ £ 20-5 £ £ £

1 Mar Balances b/d 106 3,214 2 Mar Rent 10674 2503 Mar Sales* 100 950 5 Mar Cleaning expenses 358 Mar Sales 1,680 9 Mar Purchases 10675 1,200

11 Mar Bank C 150 11 Mar Cash 10676 C 15013 Mar Sales 1,800 16 Mar Postages 5022 Mar Bank C 150 18 Mar Telephone 10677 16825 Mar Sales 2,108 20 Mar Stationery 12829 Mar Sales* 200 2,000 22 Mar Cash 10678 C 15031 Mar Hobbs Ltd 30 720 26 Mar Misc expenses 7031 Mar Pratley & Co 50 1,160 27 Mar Wages 10679 2,000

30 Mar Electricity 10680 10631 Mar Evans & Co 10681 45 85531 Mar A Bennett 10682 26 49431 Mar Balances c/d 423 8,259

80 706 13,632 71 706 13,6321 Apr Balances b/d 423 8,259

* An alternative way of showing the transactions of 3 March and 29 March is to record the full amount of sales in the debitcash column, and then to show the amount banked as a separate transfer, ie debit bank, credit cash.

11

CHAPTER 7 The main cash book(b) (i) Purchases day book

(ii) Sales day book

(c) (i) Trade discount:

– given for bulk buying (also known as bulk discount), or for being in the trade, or for regularcustomers

– deducted from the invoice before entry in the books

– usually a larger percentage than cash discount

(ii) Cash discount (also known as settlement discount):

– given for prompt payment

– not deducted until account is paid

– can be disallowed if terms are not met

– usually a smaller percentage than trade discount

6.8

Source Subsidiary Account to Account to

Document Book be debited be credited

Invoice for goods sold on Sales day book V Singh Sales

credit to V Singh

(a) Invoice received for

goods bought on credit Purchases day Purchases Okaro Limited

from Okara Limited book

(b) Credit note issued to Sales returns Sales returns S Johnson

S Johnson day book

(c) Credit note received Purchases returns Roper & Purchases

from Roper & Company day book Company returns

8.2 (a)

Dr Cash Book (bank columns) Cr20-7 £ p 20-7 £ p

1 Jan Balance b/d 415.15 23 Jan Direct debit: Omni Finance 207.9513 Jan BACS credit: T K Supplies 716.50 31 Jan Balance c/d 923.70

1,131.65 1,131.651 Feb Balance b/d 923.70

(b) P GERRARDBANK RECONCILIATION STATEMENT AS AT 31 JANUARY 20-7

£ £

Balance at bank as per cash book 923.70

Add: unpresented cheques

Bryant & Sons cheque no. 001354 312.00

P Reid cheque no. 001355 176.50

488.50

1,412.20

Less: outstanding lodgement

G Shotton Limited 335.75

Balance at bank as per cash book 1,076.45

8.3 (a)

Dr Cash Book (bank columns) Cr

20-7 £ 20-7 £1 May Balance b/d 300 2 May P Stone 867714 287 May Cash 162 14 May Alpha Ltd 867715 50

16 May C Brewster 89 29 May E Deakin 867716 11023 May Cash 60 16 May Standing order: A-Z Insurance 2530 May Cash 40 31 May Bank charges 10

31 May Balance c/d 428651 651


(b) JANE DOYLE

BANK RECONCILIATION STATEMENT AS AT 31 MAY 20-7

£

Balance at bank as per cash book 428

Add: unpresented cheque

E Deakin cheque no. 867716 110

538


cash banked 40

Balance at bank as per bank statement 498

12

CHAPTER 8 Bank reconciliation statements7.6 (i) Standing orderMoney paid out of the bank directly, at regular intervals, on the business’s order.Usually for the same fixed amount for goods and services supplied

DR Supplier/Creditor CR Bank

(ii) Credit transfer for payment by a customerAmounts paid directly into the bank by a debtor, who has the necessary bank codeinformation.

DR Bank CR Customer/Debtor

7.8 (a) and (b)

Dr Cash Book Cr

Date Details Disc Cash Bank Date Details Disc Cash Bank20-6 £ £ £ 20-6 £ £ £

1 Jan Balance b/d 50 1 Jan Balance b/d 1,236

6 Jan R Reed 567 2 Jan Bilton Office Supplies 3 164

13 Jan B Brown 4 366 11 Jan Rent 450

14 Jan Sales 752 27 Jan Wages 75

28 Jan Sales 642 20 Jan British Gas S/O 200

24 Jan C Denton & Co Ltd C/T 248 21 Jan Bank interest 28

31 Jan Cash C 1,319 31 Jan Bank C 1,319

31 Jan Balances c/d 50 422

4 1,444 2,500 3 1,444 2,500

1 Feb Balance b/d 50 422

(c)

Dr Discounts Allowed Account Cr

20-6 £ 20-6 £

31 Jan Cash book 4

Dr Discounts Received Account Cr

20-6 £ 20-6 £

31 Jan Cash book 3

8.7 (a)

Dr Cash Book Cr

Date Details Bank Date Details Cheque Bank2003 £ p 2003 number £ p

1 Nov Balance b/d 2,459.35 1 Nov Banks Ltd 11346 134.37 √

3 Nov Toys for You 234.00 √ 1 Nov Books & Paints 11347 276.89 √

5 Nov B J Patel 3,219.00 √ 10 Nov Wages 11348 92.50 √

5 Nov Dolls and Things 1,142.00 √ 12 Nov Jones and Son 11349 3,781.95 √

23 Nov J A Smith Ltd 560.00 √ 23 Nov Smith and Son 11350 139.43 √

26 Nov Cash banked 340.00 25 Nov HGF Finance 11351 256.00

25 Nov Toy Designs 11352 1,245.98

30 Nov Balance c/d 2,027.23

7,954.35 7,954.35

30 Nov Balance b/d 2,027.23 12 Nov Business rates S/O 547.90

9 Nov J Black Ltd C/T 246.98 18 Nov Proper Ins Co S/O 145.65

23 Nov Bank charges 45.89

30 Nov Balance c/d 1,534.77

2,274.21 2,274.21

1 Dec Balance b/d 1,534.77

(b) JAMES JOLLY AND CO

BANK RECONCILIATION STATEMENT AS AT 30 NOVEMBER 2003

£ £

Balance at bank as per cash book 1,534.77

Add: unpresented cheques

HGF Finance 11351 256.00

Toy Designs 11352 1,245.98

1,501.98

3,036.75


cash banked 340.00

Balance at bank as per bank statement 2,696.75

13

8.5 (a) (i) Standing orders

Credit

Regular payments of the same amount made directly from the bank on behalf of the companyon the order of the company.

(ii) Direct debits

Credit

Payments made from the bank for the customer collected by the payee on the order of thecustomer usually for changing amounts.

(iii) Credit transfers

Debit or Credit

Receipts from customers paid directly into the bank of the payee. Payments to suppliers orwages into the bank of the payee.

(b)

Dr Cash Book – Bank Account Cr£ £

Credit transfer 540 Balance b/d 378Balance c/d 534 Standing order 230

Direct debit 420Bank charges 46

1,074 1,074

Balance b/d 534

(c) A SMITH AND CO

BANK RECONCILIATION STATEMENT AS AT 31 MARCH 2001

£ £

Balance at bank as per cash book (534)

Add: unpresented cheques 469

(65)

Less: outstanding lodgement (uncleared bankings) 270

cheque query 265

535

Balance at bank as per bank statement (600)

Tutorial note: brackets indicate an overdraft

9.7 (a) (i) R MASTERS

PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 MARCH 2002

£ £Gross profit 56,231Add discount received 350

56,581Less expenses:Wages 23,980Carriage outwards 3,600Motor expenses 4,500Bank charges 450

32,530Net profit 24,051

(ii)

Dr Capital Account Cr2002 Details £ 2002 Details £

31 Mar Drawings 12,500 31 Mar Balance b/d 36,79031 Mar Balance c/d 48,341 31 Mar Net profit 24,051

60,841 60,841

1 Apr Balance b/d 48,341

(b) Two from:– increased by net profit– more capital introduced– reduced by losses– reduced by drawings

9.9 (a) Dr Sales Account Cr

2001 Details £ p 2001 Details £ p1 Dec Balance b/d 16,493.27

31 Dec Monthly total 4,560.30

Dr Returns Inwards Account Cr


31 Dec Monthly total 236.91



31 Dec Monthly total 2,769.56

Dr Returns Outwards Account Cr


31 Dec Monthly total 127.50

14

9.2

9.5 CLARE LEWISTRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 20-4

£ £Sales 144,810Opening stock 16,010Purchases 96,318

112,328Less Closing stock 13,735Cost of sales 98,593Gross profit 46,217Less expenses:Salaries 18,465Heating and lighting 1,820Rent and rates 5,647Sundry expenses 845Vehicle expenses 1,684

28,461Net profit 17,756

BALANCE SHEET AS AT 31 DECEMBER 20-4£ £ £

Fixed AssetsVehicles 9,820Office equipment 5,500

15,320Current AssetsStock 13,735Debtors 18,600

32,335Less Current LiabilitiesCreditors 12,140Bank overdraft 5,820

17,960Net Current Assets or Working Capital 14,375NET ASSETS 29,695

FINANCED BYCapitalOpening capital 25,250Add Net profit 17,756

43,006Less Drawings 13,311

29,695

CHAPTER 9 Introduction to final accounts

3. Telephone bill due to be paid in one month’s time

Section: Current liabilities

Reason: Short-term liability

– an amount owed by the business

– which needs to be paid within the next 12 months

Tutorial note: the accounting treatment for a bill which has not been paid at the balance sheetdate – called an accrual of expenses – is covered in detail in Chapter 12

4. Drawings for the year

Section: Capital/Financed by/Represented by

Reason: It is cash or goods taken out of the business by the owner,therefore it reduces the capital invested in the business.

10.2 (a)

Date Details Reference Dr Cr

20-8 £ £

31 Dec Stock GL 22,600

Trading GL 22,600

Stock valuation at 31 December 20-8

transferred to trading account

(b)


20-8 £ £

31 Dec Profit and loss GL 890

Telephone expenses GL 890

Transfer to profit and loss account

of expenditure for the year

(c)


20-8 £ £

31 Dec Drawings GL 200

Motoring expenses GL 200

Transfer of private motoring to

drawings account

15

CHAPTER 10 The general journal and correction of errors

(b) AMARYLLIS TRADING

TRADING ACCOUNT FOR THE THREE MONTHS ENDED 31 DECEMBER 2001

£ £ £Sales 21,053.57Less Returns inwards 1,506.34

19,547.23Less Cost of sales:Opening stock 2,560.87Add Purchases 13,045.97Less Returns out 1,166.91

11,879.06Add Carriage in 871.26

15,311.19Less Closing stock 2,640.96

12,670.23Gross profit 6,877.00

(c) (i) Cost of sales £12,670.23(ii) Goods available for sale £15,311.19(iii) Turnover £19,547.23

9.10 MEMORANDUM

Date Today

To Mary Arbuthnot, proprietor of Mary’s Doll Shop

From Financial Accounting Student

Subject Balance sheet queries

1. Cost of new delivery van

Section: Fixed assets

Reason: An asset purchased for use in the business

– not for resale

– used over a long period/more than one year

– will help generate profits

– will depreciate with use

– is a tangible asset

2. Stock of dolls for resale

Section: Current assets

Reason: An asset remaining in the business for the short-term

– less than one year

– the business is expected to sell them shortly

continued

(c) error of principle


£ £

Delivery van GL 10,000

Vehicle expenses GL 10,000

Correction of error – vehicle no ............

invoice no ...............

(d) reversal of entries


£ £

Postages GL 55

Bank GL 55

Postages GL 55

Bank GL 55

110 110

Correction of reversal of entries

on ...................

(e) compensating error


£ £

Purchases GL 100

Purchases returns GL 100

Correction of under-cast on purchases

account and purchases returns account

on .......(date).......

(f) error of original entry


£ £

L Johnson SL 98

Bank GL 98

Bank GL 89

L Johnson SL 89

187 187

Correction of error – cheque for £89

received on ....(date)....

16

(d)


20-8 £ £

31 Dec Drawings GL 175

Purchases GL 175

Goods taken for own use

by the owner

(e)


20-8 £ £

31 Dec Bad debts written off GL 125

N Marshall SL 125

Account of N Marshall written off as a

bad debt - see memo dated ...................

10.4 (a) error of omission


£ £

J Rigby SL 150

Sales GL 150

Sales invoice no ............. omitted from

the accounts.

(b) mispost/error of commission


£ £

H Price Limited PL 125

H Prince PL 125

Correction of mispost – cheque no .....:

to H Price Limited

(c)

Error Yes No

An error of principle has occurred. 3

The sales account has been totalled incorrectly. 3

An invoice has been completely omitted from the books. 3

A cheque has been debited in the cash book as £150

but credited in the customer’s account as £105. 3

10.10 (a)

Dr Suspense Account Cr

Date Details £ Date Details £2004 2004

30 Apr Balance per T/B 450 30 Apr Sales 20030 Apr Rent paid 250

450 450

Tutorial notes:

• Error (2) is an error of original entry which affects both the debit and credit side of the trial balance bythe same amount, and will not be revealed by the trial balance. Such an error is not entered in thesuspense account.

• Error (3) has been entered in the suspense account, above, as the net amount of £250(ie £650 – £400); as an alternative, it could have been entered as

– debit £400 (to take out the old amount in rent paid account)

– credit £650 (to enter the correct amount in rent paid account)

(b) Error of commission (or mispost):

• example – payment to A Brown entered to B Brown’s account

• explanation – although the entry has been misposted to the wrong person’s account, the trialbalance will still balance because the entry has been made on the correct side of the account.

(c) Sales ledger control account (see Chapter 11)

17

10.6 (a) Two from:– trial balance– bank reconciliation statement– control accounts (see Chapter 11)

(b) JOURNAL

Account Dr Cr

£ £

(1) Sales 270

Suspense 270

(2) Returns inwards 500

Suspense 500

Returns inwards 300

Suspense 300

(3) Suspense 400

Discount received 400

(4) J Jones 350

A Jones 350

Tutorial note: The mispost between J Jones and A Jones needs to be corrected in the sales ledger,

but has no effect on suspense account.

10.8 (a) and (b)H G PATEL: TRIAL BALANCE AS AT 30 APRIL 2003

Account Dr Cr£ £

Wages 23,890Administration costs 6,000Capital 60,000Premises 65,000Motor vehicles 5,000Motor expenses 1,650Purchases 38,900Sales 98,000Returns outwards 3,698Carriage inwards 367Carriage outwards 450Discount received 2,135Drawings 6,900Suspense 15,676TOTAL 163,833 163,833

(b)Dr Sales Ledger Control Account Cr

20-8 £ p 20-8 £ p

1 Feb Balances b/d 2,012.43 28 Feb Sales returns 221.67

28 Feb Credit sales 1,288.76 28 Feb Cheques receivedfrom debtors 911.43

28 Feb Cash discount allowed 23.37

28 Feb Set-off: purchases ledger 364.68

28 Feb Bad debts written off 59.28

28 Feb Balances c/d 1,720.76

3,301.19 3,301.19

1 Mar Balances b/d 1,720.76

(c) Reconciliation of sales ledger control account with debtor balances

1 February 20-8 28 February 20-8£ p £ p

Arrow Valley Retailers 826.40 338.59B Brick (Builders) Limited 59.28 –Mereford Manufacturing Company 293.49 –Redgrove Restorations 724.86 954.26Wyvern Warehouse Limited 108.40 427.91Sales ledger control account 2,012.43 1,720.76

11.5 Dr Purchase Ledger Control Account Cr

2001 £ 2001 £1 Mar Balance b/d 465 1 Mar Balance b/d 23,437

31 Mar Returns 4,679 31 Mar Purchases 245,897Set-off: sales ledger 475 Cash refunds 450Discounts 3,674 Balance c/d 749Cash paid 236,498Balance c/d 24,742

270,533 270,533

Balance b/d 749 Balance b/d 24,742

Tutorial note: The cash purchases figure of £25,679 is not shown in the control account because it does notinvolve the accounts of creditors – it is a cash purchase (ie debit purchases; credit bank/cash)

18

10.11 Jonathon SmithCorrected Profit for the year ended 30 November 2004

£

Profit calculated by Jonathon 26,790

1. Sales undercast add 450

2. Discount allowed (2 x £140) less 280

3. Wages less 2,500

4. Fixed asset add 9,500

5. Error of commission – no effect on profit

6. Closing stock (reduction in cost of sales) add 100

Corrected profit 34,060

11.3 (a) SALES LEDGER

Dr Arrow Valley Retailers Cr20-8 £ p 20-8 £ p1 Feb Balance b/d 826.40 20 Feb Bank 805.743 Feb Sales 338.59 20 Feb Discount allowed 20.66

28 Feb Balance c/d 338.591,164.99 1,164.99

1 Mar Balance b/d 338.59

Dr B Brick (Builders) Limited Cr20-8 £ p 20-8 £ p1 Feb Balance b/d 59.28 28 Feb Bad debts written off 59.28

Dr Mereford Manufacturing Company Cr20-8 £ p 20-8 £ p1 Feb Balance b/d 293.49 24 Feb Sales returns 56.293 Feb Sales 127.48 28 Feb Set-off: purchases ledger 364.68

420.97 420.97

Dr Redgrove Restorations Cr20-8 £ p 20-8 £ p

1 Feb Balance b/d 724.86 7 Feb Sales returns 165.3817 Feb Sales 394.78 28 Feb Balance c/d 954.26

1,119.64 1,119.64


Dr Wyvern Warehouse Limited Cr20-8 £ p 20-8 £ p

1 Feb Balance b/d 108.40 15 Feb Bank 105.6917 Feb Sales 427.91 15 Feb Discount allowed 2.71

28 Feb Balance c/d 427.91536.31 536.31


CHAPTER 11 Control accounts

12.1 (a) Expense in profit and loss account of £56,760; balance sheet shows wages and salaries accrued(current liability) of £1,120.

(b) Expense in profit and loss account of £2,852; balance sheet shows rates prepaid (current asset) of£713.

(c) Expense in profit and loss account of £1,800; balance sheet shows computer rental prepaid (currentasset) of £150.

12.2 SOUTHTOWN SUPPLIES

TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 20-9£ £

Sales 420,000Opening stock 70,000Purchases 280,000

350,000Less Closing stock 60,000Cost of sales 290,000Gross profit 130,000Less expenses:Rent and rates 10,250 – 550 9,700Electricity 3,100Telephone 1,820Salaries 35,600 + 450 36,050Vehicle expenses 13,750

64,420Net profit 65,580

12.7 HAZEL HARRISTRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 20-4


528,000Less Closing stock 88,000Cost of sales 440,000Gross profit 174,000Add Discount received 8,140

182,140Less expenses:Building repairs 8,480Vehicle expenses 2,680Wages and salaries 86,060 + 3,180 89,240Discount allowed 10,610Rates and insurance 6,070 – 450 5,620General expenses 15,860Depreciation: vehicles 12,000 x 20% 2,400

furniture and fittings 25,000 x 10% 2,500137,390

Net profit 44,750

19

CHAPTER 12 Adjustments to final accounts11.6 Dr Sales Ledger Control Account Cr

20-5 £ 20-5 £1 Jan Balance b/d 44,359 31 Jan Bank 23,045

31 Jan Sales 27,632 31 Jan Discount allowed 1,12631 Jan Returned cheque 275 31 Jan Sales returns 2,964

31 Jan Set-off: purchases ledger 24731 Jan Balance c/d 44,884

72,266 72,266

1 Feb Balance b/d 44,884

Tutorial note: The mispost of £685 between J Hampton and Hampton Limited needs to be corrected in thesales ledger, but has no effect on the control account.

11.7 (a)

Dr Sales Ledger Control Account Cr

2003 Details £ 2003 Details £

1 Nov Balance b/d 5,476 30 Nov Returns inwards 59030 Nov Sales 26,500 30 Nov Bank (receipts from customers) 18,900

30 Nov Set-off: purchases ledger 40030 Nov Balance c/d 12,086

31,976 31,976

1 Dec Balance b/d 12,086

Dr Purchases Ledger Control Account Cr

2003 Details £ 2003 Details £

30 Nov Returns outwards 450 1 Nov Balance b/d 2,96030 Nov Bank (payments to 30 Nov Purchases 19,600

suppliers) 16,30030 Nov Set-off: sales ledger 40030 Nov Balance c/d 5,410

22,560 22,560

1 Dec Balance b/d 5,410

(b) • The balances of the individual accounts of debtors in the sales ledger are totalled.

• The balances of the individual accounts of creditors in the purchases ledger are totalled.

• These totals should agree with the balances of sales ledger control account and purchases ledgercontrol account respectively.

(c) • Some types of errors (such as a mispost/error of commission) will not be revealed by the controlaccount. Thus the accounts will be thought to be correct when they are not.

• A control account may indicate that there is an error within a ledger section but it will not pinpointwhere the error has occurred.

BALANCE SHEET AS AT 31 DECEMBER 20-8

£ £ £

Fixed AssetsShop fittings at cost 12,000

Less provision for depreciation 2,400 + 2,400 4,800

Net book value 7,200

Current AssetsStock 28,176

Debtors 3,641

Cash 163

Prepayment of expenses 310

32,290

Less Current LiabilitiesCreditors 10,290

Bank 3,084

Accrual of expenses 85

13,459

Net Current Assets or Working Capital 18,831

NET ASSETS 26,031

FINANCED BYCapital 20,806

Add Net profit 27,421

48,227

Less Drawings 22,196

26,031

12.10 (a)

Dr Telephone Account Cr

Date Details £ Date Details £

2007 2007

31 May Cash/bank 2,400 31 May Profit and loss account 2,320

31 May Balance c/d 130 31 May Balance c/d 210

2,530 2,530

1 Jun Balance b/d 210 1 Jun Balance b/d 130

20

BALANCE SHEET AS AT 31 DECEMBER 20-4£ £ £

Fixed Assets Cost Prov for dep'n Net book value

Freehold land 100,000 – 100,000

Vehicles 12,000 4,800 7,200

Furniture and fittings 25,000 5,000 20,000

137,000 9,800 127,200

Current AssetsStock 88,000

Debtors 52,130


140,580

Less Current LiabilitiesCreditors 41,850

Accrual of expenses 3,180

Bank 2,000

47,030


220,750

Less Long-term LiabilitiesBank loan 75,000

NET ASSETS 145,750

FINANCED BYCapitalOpening capital 125,000


169,750


145,750

12.9 BETH DAVIS

PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 20-8£ £

Gross profit 95,374

Less expenses:

Wages and salaries 55,217

Heating and lighting 1,864

Rent and rates 5,273 – 310 4,963

Advertising 2,246

Bad debts written off 395

General expenses 783 + 85 868

Depreciation of shop fittings 12,000 x 20% 2,400

67,953

Net profit 27,421

13.2 • The final accounts of a sole trader comprise:

– trading and profit and loss account

– balance sheet

• The trading and profit and loss account shows:

income minue expenses equals net profit (or loss)

• The trading account shows gross profit, while the profit and loss account shows net profit (or loss)

• The balance shows shows:

assets minus liabilities equals capital

• Assets are items owned by the business; liabilities are amounts owed by the business; capital is theamount of the owner’s investment.

13.3 (a) The Partnership Act 1890 defines a partnership as “the relation which subsists between personscarrying on a business in common with a view of profit”.

(b) Where no partnership agreement exists, then the following accounting rules from the Partnership Act1890 must be followed:

• profits and losses are to be shared equally between the partners

• no partner is entitled to a salary

• partners are not entitled to receive interest on their capital

• interest is not to be charged on partners’ drawings

• when a partner contributes more capital than agreed, he or she is entitled to receive interest atfive per cent per annum on the excess

Note: the question asks for any three provisions.

13.5 Points to cover include:

* Definition of a limited company

– separate legal entity

– owned by shareholders

– managed by directors

• Types of companies

– public limited company

– private limited company

– company limited by guarantee

• Advantages of forming a limited company

– limited liability

– separate legal entity

– ability to raise finance

– membership

– other factors

21

(b)

MEMORANDUM

To: The Owner, Beta Batteries

From: Student Accountant

Date: Today

Subject: Account of J Booth

I note that a customer of Beta Batteries, J Booth, has been declared bankrupt whilst owing you£350. You are of the opinion that none of the debt will be recovered.

The accounting treatment is that the amount of £350 should be treated as a bad debt written off. Todo this you will need to:

– debit bad debts written off account

– credit J Booth’s account in your sales ledger

If you use a sales ledger control account you should also credit this memorandum account with theamount.

For the year end accounts, you will need to transfer the amount of the bad debt to profit and lossaccount as an expense:

– debit profit and loss account

– credit bad debts written off account

The effect of writing off this bad debt will be to reduce your net profit by £350 and, at the same time,the debtors’ figure in your balance sheet will be reduced by the amount, so reducing the net assetsof the business.

CHAPTER 13 Business organisations

14.1 • Going concern concept

This presumes that the business to which the final accounts relate will continue to trade in the foreseeablefuture. The trading and profit and loss account and balance sheet are prepared on the basis that there isno intention to reduce significantly the size of the business or to liquidate the business. If the business wasnot a going concern, assets would have very different values, and the balance sheet would be affectedconsiderably.

Example: As a going concern, fixed assets are valued at cost, less accumulated depreciation to date; stockis valued at cost (unless net realisable value is lower).

• Accruals concept

This means that expenses and income for goods and services are matched to the same time period.

Examples: The accrual of an expense in profit and loss account which has been used in the accountingperiod but not yet paid for. The prepayment of an expense for the next accounting period. The recording ofopening and closing stocks in the trading account. The use of debtors' and creditors' accounts to recordamounts owing to the business, or owed by the business.

• Materiality concept

This means that some items in accounts have such a low monetary (money) value that it is not worthwhilerecording them separately. Examples include:

– small expense items which may not justify their own separate expense account and are, instead,grouped together in a sundry expenses account

– end-of-year stocks of office stationery are often not valued for the purpose of final accounts becausethe amount is not material and does not justify the time and effort involved

– low-cost fixed assets are often charged as an expense in profit and loss account because, whilestrictly these should be treated as fixed assets and depreciated each year, in practice they are treatedas profit and loss account expenses as the amounts involved are not material – such as a calculator,a stapler

Materiality depends very much on the size of the business – what is material and what is not becomes amatter of judgement.

• Business entity concept

This refers to the fact that final accounts record and report on the activities of a particular business. Forexample, the personal assets and liabilities of those who play a part in owning or running the business arenot included on the business balance sheet.

14.2 (a) The concept of prudence means

– not anticipating profit until it is reasonably certain that it will be realised

– providing for all known liabilities

– not giving an over-optimistic presentation of the business

– not overstating the value of assets

(b) Examples (question asks for one example):

– valuation of stock, at the lower of cost and net realisable value

– depreciation of fixed assets, to measure the amount of the fall in value of fixed assets over time

– bad debts written off, to reduce the debtors’ figure to give a realistic view of the amount that thebusiness can expect to receive

– provision for doubtful debts (see Chapter 15), to reduce the debtors’ figure

(c) The concept of consistency means that, when a business adopts particular accounting policies, itshould continue to use such policies consistently

(d) Examples (question asks for one example)

– valuation of stock

– depreciation of fixed assets

– bad debts written off

– provision for doubtful debts (see Chapter 15)

By applying the consistency concept, direct comparison between the final accounts of different yearscan be made.

14.5 (a) The kettle should be valued at £16.

Workings: £31 – £15 = £16 net realisable value (which is lower than the cost of £18)

(b) Stock should be valued at the lower of cost or net realisable value whichever is the lower.

This is an example of using the prudence concept.

14.8

Concept Gross Net Current Current CapitalProfit Profit Assets Liabilities

1. Accruals no decrease no increase decreasechange £4,000 change £4,000 £4,000

2. Consistency no decrease no no decreasechange £15,000 change change £15,000

3. Prudence or decrease decrease decrease no decreaseConsistency £18,000 £18,000 £18,000 change £18,000

4. Business no increase no no noentity change £13,000 change change change

14.10 (a) jacket, £40 (note: replacement cost is not applicable here)

shirt, £25

suit, £80

trousers, £25 – £10 = £15

electric trouser press, £80

(b) • The prudence concept says that final accounts should always, where there is any doubt, report aconservative figure for profit or the valuation of assets.

• In stock valuation it is applied by using the lower of cost and net realisable value. (Note that netrealisable value is the selling price of the goods, less further costs to get the stock into a saleablecondition.)

• A lower closing stock figure means that profits are not overstated – thus the amount drawn by theowner(s) will be reduced, so helping to ensure the continued financial viability of the business.

22

CHAPTER 14 Accounting concepts and stock valuation

15.2


20-7 £ 20-7 £31 Dec Balance b/d 100 31 Dec Bank/Cash 1,250

(accrual of income) (receipts for year)31 Dec Profit and loss account 1,150

1,250 1,250

Dr Advertising Income Account Cr

20-7 £ 20-7 £31 Dec Balance b/d 150 31 Dec Bank/Cash 2,720

(accrual of income) (receipts for year)31 Dec Profit and loss account 2,820 31 Dec Balance c/d 250

(accrual of income)2,970 2,970

20-8 20-81 Jan Balance b/d 250

(accrual of income)

Dr Rent Income Account Cr

20-7 £ 20-7 £31 Dec Profit and loss account 19,260 31 Dec Balance b/d 850

(prepayment of income)31 Dec Bank/Cash 18,290

(receipts for year)31 Dec Balance c/d 120

(accrual of income)19,260 19,260

20-8 20-81 Jan Balance b/d 120

(accrual of income)

15.4 (a)

Dr Bad Debts Written Off Account Cr

20-9 £ 20-9 £31 Dec Webster Limited 110 31 Dec Profit and loss account 42031 Dec T Smith 21031 Dec Khan and Company 100

420 420

(b)

Dr Provision for Doubtful Debts Account Cr

20-9 £ 20-9 £31 Dec Balance c/d 1,000 31 Dec Profit and loss account 1,000

20-0 20-01 Jan Balance b/d 1,000

(c) • Profit and loss account (expenses)

debit bad debts written off £420

debit provision for doubtful debts £1,000

Explanation: profit for the year is reduced by £1,420

• Balance sheet

debtors £39,000

Workings: £40,420 – £420 bad debts = £40,000 – £1,000 provision for doubtful debts = £39,000 netdebtors

Explanation: current assets are reduced by £420 + £1,000 = £1,420

15.6

Year Profit and loss account Balance sheet

Expense Income Debtors Less prov for Net(after bad doubtful debts debtors

Bad Increase in Bad Decrease in debtsdebts provision for debts provision for written off)

written off doubtful debts recovered doubtful debts

£ £ £ £ £ £ £

20-5 1,800 2,585 103,400 2,585 100,815

20-6 2,400 245 113,200 2,830 110,370

20-7 1,400 150 110 108,800 2,720 106,080

Workings for doubtful debts provision:

20-5 (£105,200 – £1,800) x 2.5% = £2,585 creation of provision

20-6 (£115,600 – £2,400) x 2.5% = £2,830 – £2,585 = £245 increase in provision

20-7 (£110,200 – £1,400) x 2.5% = £2,720 – £2,830 = £110 decrease in provision

23

CHAPTER 15 Further aspects of final accounts

15.8 (a) Straight-line method Reducing balance method£ £

Year 1 3,000 3,600

Year 2 3,000 1,440 (60%)or

2,400 (to disposal)

(b) • Depreciation is a non-cash expense

• It is an accounting adjustment

• Depreciation is not a method of providing a fund of cash which can be used to replace the assetat the end of its life

• Profits are lower after depreciation has been deducted – this may discourage drawings from thebusiness

15.11 (a)Dr Vehicles Account Cr

20-8 £ 20-8 £1 Jan Balance b/d 12,000 1 Oct Disposals 12,0001 Oct Disposals 5,500 31 Dec Balance c/d 15,000

(part-exchange allowance)1 Oct Bank 9,500

(balance paid by cheque)27,000 27,000

20-9 £ 20-9 £1 Jan Balance b/d 15,000

(b)

Dr Provision for Depreciation Account – Vehicles Cr

20-8 £ 20-8 £1 Oct Disposals 7,200 1 Jan Balance b/d 7,20031 Dec Balance c/d 3,000 31 Dec Profit and loss account 3,000

10,200 10,20020-9 £ 20-9 £

1 Jan Balance b/d 3,000(c)

Dr Disposals Account – Vehicles Cr

20-8 £ 20-8 £1 Oct Vehicles 12,000 1 Oct Vehicles 5,50031 Dec Profit and loss account 700 (part-exchange allowance)

(profit on sale) 1 Oct Prov for depreciation 7,20012,700 12,700

(d) BALANCE SHEET EXTRACT AS AT 31 DECEMBER 20-8

£ £ £Cost Prov for dep’n Net book value

Fixed assetsVehicles 15,000 3,000 12,000

15.12 (a) £20,000 – £12,500 – £4,000 = loss of £3,500

(b) BALANCE SHEET EXTRACT AS AT 31 DECEMBER 20-9

Fixed Assets £

Vehicle at cost 25,000

Less provision for depreciation 3,125


Tutorial note: Do not deduct the trade in allowance from the cost price of the new vehicle – thecost price is £25,000.

15.13 (a) Profit on disposal of old machine = £2,000

Workings

£24,000 – £18,000 depreciation = £6,000 net book value

£

Trade-in value 8,000

Net book value at date of trade-in 6,000

Profit on disposal 2,000

(b) GORG HAMMAN

BALANCE SHEET AS AT 31 DECEMBER 2003

£

Fixed AssetsMachinery at cost 176,000 (£170,000 – £24,000 + £30,000)

Less prov for depreciation 123,500 (£105,000 – £18,000 + £36,500)


Current LiabilitiesCreditor – instalment due on machine (11,000)

Tutorial notes:

• depreciation for 2003 is calculated at 25% straight-line method (being the rate applied to the oldmachine)

• therefore depreciation on remaining machinery is £170,000 – £24,000 = £146,000 x 25% = £36,500

24

15.16 THOMAS SALMON

PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 30 NOVEMBER 2004

£ £

Gross profit 68,772

Add income:

Discount received 119

Rent receivable 720

69,611

Less expenses:

Wages 26,320

Bad debts 340

Rent and rates 4,630

Other expenses 21,435

Discount allowed 286

Income in provision for doubtful debts *230

Depreciation of fixed assets **9,000

Loss on sale of van ***100

62,341

Net profit 7,270

* £1,120 – £890 = £230

** £27,000 provision for depreciation at start of year – £6,000 depreciation on van sold = £21,000,which is deducted from £30,000 provision for depreciation at end of year = £9,000 depreciationfor year (as shown in profit and loss account)

*** £Net book value (£8,000 – £6,000) 2,000Sale price 1,900Loss on sale 100

16.1 (a) Capital expenditure £

cost of van 11,650

air conditioning 550

fitted shelving 350

total 12,550

(b) Revenue expenditure

tax disc 165

cost of extended warranty 220

tank of fuel 40

insurance premium 450

total 875

16.4 (a) ABEL BROWN

TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2001£ £

Sales 278,400Less Cost of sales:

Opening stock 12,700Purchases 153,900

166,600Less Closing stock 14,100 152,500Gross profit 125,900Less expenses:

Wages 75,400Rent 2,280Other expenses 25,120Depreciation 15,000 117,800

Net profit 8,100

Workings: • Wages £74,750 + £650 owing

• Rent £2,500 – £220 prepaid

• Depreciation £150,000 x 10%

(b) New net profit: £11,100

Workings:

• Depreciation, using the straight-line method, at present is £15,000 (see above)

• Reducing balance depreciation will be 20% (£150,000 – £90,000) = 20% x £60,000 = £12,000

• Therefore reducing balance depreciation is £3,000 less this year than straight-line method, soprofits will increase from £8,100 (see above) to £11,100.

16.5 JOHN HENSONTRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 20-8


77,850Less Closing stock 8,500Cost of sales 69,350Gross profit 52,650Add income:

Discounts received 28552,935

Less expenses:Vehicle running expenses 1,480 + 230 1,710Rent and rates 5,650Office expenses 2,220 – 120 2,100Wages and salaries 18,950Depreciation: office equipment 1,000

vehicle 3,00032,410

Net profit 20,525

25

CHAPTER 16 Preparing sole trader final accounts

BALANCE SHEET AS AT 31 DECEMBER 20-8

£ £ £

Fixed Assets Cost Prov for dep'n Net book value

Office equipment 10,000 1,000 9,000

Vehicle 12,000 3,000 9,000

22,000 4,000 18,000

Current Assets

Stock 8,500

Debtors 5,225


Bank 725

14,570

Less Current Liabilities

Creditors 4,910

Accrual of expenses 230

5,140


NET ASSETS 27,430

FINANCED BY

Capital

Opening capital 20,000


40,525


27,430

16.6 (a) KEN TUCKY

TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31 MARCH 2006

£ £

Sales 587,461

Less Returns inwards 837

586,624

Opening stock 39,771

Purchases 280,797 – 2,170 goods for own use 278,627

318,398

Less Closing stock 40,135

Cost of sales 278,263

Gross profit 308,361

Less expenses:

Wages 128,528 + 1,383 129,911

Motor expenses 47,870 – 18,500 29,370

Rates 7,810

Insurances 7,780 – 286 7,494

Bad debts written off 1,368

General expenses 33,713

Provision for depreciation:

premises 2,900

equipment 1,140

motor vehicles 13,448

227,154

Net profit 81,207

Depreciation calculations

• Premises: £145,000 x 2% = £2,900

• Equipment: £11,400 x 10% = £1,140

• Motor vehicles £42,000 + £18,500 acquisition = £60,500 – £26,880 depreciation to date =£33,620 x 40% = £13,448

(b) Additional information 4

• This is a prepayment of expenses.

• The amount is deducted from the expense to be shown in profit and loss account, ie £7,780expense – £286 prepayment = £7,494 to profit and loss account.

• The amount will be shown as a current asset in the balance sheet.

• The £286 will be included in the cost for insurances charged to next year’s profit and lossaccount.

• The accounting concept is accruals (or matching) – expenses and revenues for goods andservices are matched to the same time period, here the year ended 31 March 2006.

26

(b) Additional information 5

• The owner has taken some of the goods in which the business trades for his own use.

• The amount, here £2,170, is deducted from purchases and added to the owner’s drawings(which will be deducted from capital in the balance sheet).

• The reason for reducing purchases is to ensure that only those purchases used in the businessare recorded, which are then matched to the sales derived from them.

• The accounting concept is business entity which keeps separate from the business the personalassets and liabilities of the owner.

(c) • A provision for doubtful debts should be created so that the balance sheet figure of net debtorsis a reliable estimate of the amount that will be received.

• If a provision is not made, then profits will be overstated by the amount of doubtful debts.

• Creation of a provision for doubtful debts is shown as an expense in profit and loss account, anddeducted from debtors in the balance sheet.

• The accounting concept is prudence.

16.8 (a) SIOBHAN HUGGETT

TRADING AND PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 30 APRIL 2004

£ £

Sales 293,100

Opening stock 7,800

Purchases 123,400

131,200

Less Closing stock 8,700

Cost of sales 122,500


Add income:

Reduction in provision for doubtful debts 40

170,640

Less expenses:

Wages and general expenses 117,800

Business rates 13,330



fixtures and fittings 10,800

vehicles 31,840

174,520

Net loss 3,880

Workings:

• Purchases: £149,400 – £3,000 goods for own use – £23,000 fixtures = £123,400

• Closing stock: valued at the lower of cost, £8,700, and net realisable value, £11,500

• Provision for doubtful debts: £9,000 debtors x 3% provision = £270, which is deducted from £310existing provision = £40 reduction in provision for doubtful debts

• Wages and general expenses: £116,200 + £1,600 accrual = £117,800

• Business rates: £13,510 – £180 prepayment = £13,330

• Provision for depreciation of fixtures and fittings: £85,000 + £23,000 acquisition = £108,000 x 10% = £10,800

• Provision for depreciation of vehicles: £160,000 – £80,400 depreciation to date = £79,600 x 40%= £31,840

(b) Example of capital expenditure: purchase of fixtures

Example of revenue expenditure: wages and general expenses

(c) Capital expenditure is expenditure incurred on the purchase, alteration or improvement of fixedassets.

Revenue expenditure is expenditure incurred on running expenses.

Capital expenditure is shown on the balance sheet (subject to the accounting concept of materiality),while revenue expenditure is an expense in the profit and loss account. It is important to classify theseitems of expenditure correctly in the accounting system so that the final accounts report reliably onthe financial state of the business – profit is stated accurately and the balance sheet shows the assetsowned by the business.

16.9 (a) WULLIE McDUFF

PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 30 SEPTEMBER 2005

£ £


Add income:

Bad debts recovered 100

Reduction in provision for doubtful debts 65

808,015

Less expenses:

Wages 748,432

Rent and rates 12,140

General expenses 37,898


Loss on sale of vehicle 200


premises 2,400

vehicles 7,500

809,330

Net loss 1,315

27

Workings:

• Provision for doubtful debts: £35,000 debtors x 2.5% provision = £875, which is deducted from£940 existing provision = £65 reduction in provision for doubtfut debts.

• Rent and rates: £12,460 – £320 prepayment = £12,140

• General expenses: £36,980 + £918 accrual = £37,898

• Loss on sale of vehicle: £20,000 cost – £15,000 depreciation to date = £5,000 net book value atdate of sale – £4,800 sale proceeds = £200 loss on sale.

• Provision for depreciation of premises: £120,000 x 2% = £2,400

• Provision for depreciation of vehicles: £60,000 – £30,000 depreciation to date = £30,000 x 25%= £7,500

(b) The private limited is the most common form of limited company and is defined as ‘any company thatis not a public company’ (Companies Act 2006). Many private limited companies are smallcompanies, often in family ownership and it would seem appropriate for Wullie McDuff to consider thisform of business organisation.

Advantages include:

• limited liability – the shareholders of the company can only lose the amount of their investment(together with any money unpaid on their shares); the personal assets of the shareholders arenot available to the company’s creditors

• separate legal entity – a limited company is separate from the owners

• ability to raise finance – the smaller company can raise funds from venture capital companies,relatives and friends; debentures can be issued to raise long-term finance from lenders andinvestors

• a limited company may have a higher standing and status in the business community, allowing itto benefit from economies of scale, and making it of sufficient size to employ specialists

Disadvantages include

• membership – all ordinary shareholders have voting rights, so Wullie may lose some control ofthe business

• documentation – there is more documentation – eg the preparation of formal annual accounts –for a company to produce than for a sole trader business; the costs of administering a companyare higher than for a sole trader

Conclusion

• Wullie must consider the advantages and disadvantages of changing his business into a privatelimited company. If he is seeking to expand the business and raise finance, it would be sensibleto consider this option. At the same time he would gain the benefit of limited liability.

17.1 (a) • Ordinary shares are the most commonly issued class of share. They take a share of the profitswhich remain after all other expenses of the business. The main risk of ordinary shares is that partor all of the value of the shares will be lost if the company loses money or becomes insolvent.

• Preference shares usually carry a fixed rate of dividend which is paid in preference to that ofordinary shareholders. In the event of the company ceasing to trade, the preference shareholderswill also receive repayment of capital before the ordinary shareholders.

(b) • Nominal value is the face value of a share which is entered in the accounts, eg 5p, 10p, 25p, 50por £1.

• Market value is the price at which issued shares are traded, ie bought and sold.

(c) • Capital reserves are created as a result of a non-trading profit; examples include revaluationreserve, share premium account.

• Revenue reserves are retained profits from the profit and loss account; examples include profit andloss account, retained profits, general reserve.

(d) • A bonus issue is the capitalisation of reserves – either capital or revenue – in the form of free sharesissued to existing shareholders in proportion to their holdings; no cash flows into the company.

• A rights issue is the raising of cash by offering shares to existing shareholders, in proportion to theirholdings, at a favourable price.

17.2 (a) debenture interest is shown as an expense in profit and loss account

(b) directors' remuneration is shown as an expense in profit and loss account

(c) corporation tax is shown in the appropriation section of the profit and loss account, and any amountnot yet paid is shown as a current liability on the balance sheet

(d) dividends proposed are shown in the appropriation section of profit and loss account and as acurrent liability on the balance sheet

(e) revaluation reserve is shown as a capital reserve as a part of the shareholders' funds section of thebalance sheet

(f) goodwill is shown as an intangible asset in the fixed assets section of the balance sheet; it isamortised in the same way as tangible fixed assets are depreciated

17.4 (a) MASON MOTORS LTDPROFIT AND LOSS APPROPRIATION ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 20-1

£

Net profit before taxation 75,000

Less corporation tax 20,050

Profit for year after taxation 54,950

Less final ordinary dividend proposed 10,000

44,950

Less transfer to general reserve 20,000

Retained profit for year 24,950

Add balance of retained profits at beginning of year 100,000

Balance of retained profits at end of year 124,950

28

CHAPTER 17 Financial statements of limited companies

(b) Retained profits is profit which has been kept in the company. It belongs to the shareholders, but isrepresented by assets in the balance sheet and is not a bank balance available to rebuild thegarage forecourt.

17.7 (a) SRIAN PLCPROFIT AND LOSS APPROPRIATION ACCOUNT FOR THE YEAR ENDED 31 MAY 2003

£ £

Net profit before taxation *9,300,000

Less corporation tax 2,600,000

Profit for year after taxation 6,700,000

Less ordinary dividends – paid 800,000

– proposed 1,300,000

2,100,000

4,600,000

Less transfer to general reserve 1,000,000

Retained profit for year 3,600,000

* Draft profit 12,000,000Less:

directors’ fees 1,500,000debenture interest 1,200,000

Net profit 9,300,000

(b) Issue of ordinary shares

– ordinary shares are not normally repayable, so the company will have the finance for theforeseeable future

– the new shareholders will have voting rights

– not essential to pay dividends every year, although a failure to do so might cause difficulties withfuture share issues

– the power of the existing shareholders will be diluted because there will be more shares in issue

– the company’s gearing ratio will be improved

Issue of debentures

– a different type of financing based on loans and interest, rather than shares and dividends

– the interest charge will rise by £1,800,000 from £1,200,000 to £3,000,000

– interest must be paid whether or not profits are made

– a failure to pay interest could lead the company into insolvency

– no voting rights, so no dilution of shareholders’ power

– debentures must be repaid at an agreed date in future

– interest rate is fixed, whatever may happen to the level of interest rates

– debenture holders likely to require security for their loan in the form of a mortgage over companyassets; this may restrict the use the company can make of the assets

– if repayment not made at due date, debenture holders can realise assets to obtain repayment

– the company’s gearing ratio will be worsened

Gearing ratio

Without having information on the company’s revenue reserves (retained profit and general reserve), thegearing ratio is currently:

Loan capital = £20,000,000 = 0.8:1 or 80%Share capital £25,000,000

This is already a high gearing ratio which investors will not wish to see going above 1:1 or 100%.

If ordinary shares are issued to raise the money for expansion, the gearing ratio (including sharepremium account) becomes:

£20,000,000 = 0.36:1 or 36%£55,000,000*

* ordinary shares £25,000,000 + £20,000,000 and share premium account £10,000,000

This is a much improved gearing ratio.

If debentures are issued, the gearing ratio becomes:

£50,000,000* = 2:1 or 200%£25,000,000

* 6% debentures £20,000,000 + £30,000,000

This is an extremely high gearing ratio, well above the ‘normal’ maximum of 1:1 or 100% acceptable toinvestors. It may be that Srian plc will have difficulty in meeting the annual interest costs of this option.

Conclusion

It seems to be preferable for Srian to finance its expansion scheme with an issue of ordinary shares.This has a much lower gearing ratio than the issue of debentures – the company may have difficulty inthe future meeting the extra annual interest cost of £1,800,000.

17.9 (a) STOULBY LIMITEDPROFIT AND LOSS APPROPRIATION ACCOUNT FOR THE YEAR ENDED 31 DECEMBER 2006

£ £

Net profit before taxation 650,000

Less corporation tax 155,000

Profit for year after taxation 495,000

Less ordinary dividends – paid 63,000

– proposed *100,000

163,000

332,000


Retained profit for year 212,000

Add balance of retained profits (profit and loss account) at beginning of year 410,000

Balance of retained profits at end of year 622,000

* 4,000,000 ordinary shares x 2.5 pence per share

29

(b) SHARE CAPITAL AND RESERVES AT 31 DECEMBER 2006

£ £

Issued Share capital

4,000,000 ordinary shares of 50p each 2,000,000

Capital Reserve

Share premium account 500,000

Revenue Reserves

General reserve *420,000

Profit and loss account 622,000

1,042,000

SHAREHOLDERS’ FUNDS 3,542,000

* £300,000 + £120,000 transfer

(c) Revenue reserves are profits from trading activities which have been retained in the company to helpbuild the company for the future.

(d) Profit and loss account or general reserve

(e) Revenue reserves can be used to fund dividend payments or to provide bonus shares to shareholders.

17.10 (a)

£

Retained profit for year as per draft final accounts 150,000


Less ordinary dividend 35,000

Less preference dividend 4,000

Corrected retained profit for year 66,000

(b) DAVID MARK LIMITED

SUMMARISED BALANCE SHEET AS AT 31 DECEMBER 2002

£ £ £

Fixed Assets 700,000

Current Assets

Stock 85,000

Debtors 60,000

Bank balance 167,000

312,000

Less Current Liabilities

Trade creditors 37,000

Proposed dividends *39,000

76,000


NET ASSETS 936,000

FINANCED BY

Ordinary shares 350,000

8% Preference shares 100,000


General reserve 120,000

Profit and loss account 316,000

SHAREHOLDERS’ FUNDS 936,000

* £35,000 + £4,000

(c) • Limited company, or• Private Limited Company

(d) • The term ‘Ltd’ means that the shareholders of David Mark Limited have limited liability.• This means that they could lose their investment but cannot be asked to contribute further in the

case of liquidation (unless the shares are not fully paid).• Thus the risk taken by shareholders is limited.

30

18.3 Exton Frimley

(a) gross profit margin 13.4% 44.0%

(b) gross profit mark-up 15.5% 78.7%

(c) overheads in relation to revenue 12.0% 39.8%

(d) net profit margin (profit in relation to revenue) 1.4% 4.2%

(e) rate of inventory turnover 33 days or 95 days or

10.9 times per year 3.8 times per year

(f) net current asset (current) ratio 1.3:1 2.4:1

(g) liquid capital (acid test) ratio 0.05:1 1.3:1

(h) trade receivable days 1 day* 60 days

(i) return on capital employed 11% 8.1%

* revenue figure used for this calculation; this is unrealistic because most supermarket sales will be for cashrather than on credit

Exton is the supermarket; Frimley is the engineering company

Reasons:

Exton low overheads/revenue and net profit margin; high inventory turnover; quick trade receivabledays, low net current asset and liquid capital ratios; few trade receivables

Frimley higher overheads/revenue and net profit margin and low inventory turnover; slow tradereceivable days; good net current asset and liquid capital ratios; high figures for non-currentassets and trade receivables

18.4 (a) gross profit margin

Gross profit x 100Revenue 1

This ratio expresses, as a percentage, the gross profit in relation to revenue.

gross profit mark-up

Gross profit x 100Cost of sales 1

This ratio expresses, as a percentage, the gross profit in relation to cost of sales; often used bybusinesses to establish selling price.

(b) net current assets

Current assets – Current liabilities

Net current assets or working capital, are needed by all businesses in order to finance day-to-daytrading activities. Sufficient net current assets enable a business to hold adequate inventories, allowa measure of credit to its customers (trade receivables) and to pay its suppliers (trade payables) aspayments fall due.

liquid capital

(Current assets – Inventories) – Current liabilities

Liquid capital is calculated in the same way as net current assets, except that inventories are omitted.This is because inventories are the most illiquid current asset. Liquid capital provides a directcomparison between the short-term assets of trade receivables and cash and short-term liabilities.

(c) cash

This is the actual amount of money held in the bank or as cash.

profit

This is a calculated figure which shows the surplus of income over expenditure for the year. It takesnote of adjustments for accruals and prepayments and non-cash items such as depreciation andprovision for doubtful receivables.

(d) return on capital employed

Net profit x 100Capital employed* 1

* limited companies: ordinary share capital + reserves + preference share capital + loan capital

sole traders: the amount of the owner’s capital in the business

Return on capital employed (ROCE) expresses the profit of a business in relation to the amount ofcapital in the business by the owner.

gearing

Debt (loan capital + preference shares, if any)Equity (ordinary shares + reserves)

Gearing is concerned with the long-term financial stability of a business. It measures how much of thebusiness is financed by debt (including preference shares) against capital – gearing is often referredto as the debt/equity ratio. The higher the gearing, the less secure will be the ordinary share capital ofthe business and, therefore, the future of the business. This is because debt is costly in terms ofinterest payments.

In general terms, investors and lenders would not wish to see debt exceeding equity; thus a gearingratio of greater than 1:1 is undesirable.

18.6 (a) Trade receivables x 365 days Revenues

(b) Trade payables x 365 days Purchases

(c) trade receivable days 20-1 20-2

£43,000 x 365 days £32,550 x 365 days£680,000 £660,000

= 23.08 days = 18 days

(d) trade payable days 20-1 20-2

£28,500 x 365 days £38,500 x 365 days£520,000 £540,000

= 20 days = 26.02 days

(e) 20-1Trade payables are paid more quickly than trade receivables are paying, which will cause cashmanagement problems.

20-2Trade payables are paid more slowly than trade receivables are paying, which aids cashmanagement.

Note: The figure for trade receivables has fallen during the period, while the figure for trade payables hasincreased. The reasons for the changes need to be investigated to include:– has sales revenue reduced, or is collection from trade receivables more efficient?– does the company have the money to pay trade payables, or have generous credit terms been offered

by a supplier?

31

CHAPTER 18 Ratio analysis

18.7 (a) • Net current assets (current) ratio = Current assets Current liabilities

• Liquid capital (acid test) ratio = (Current assets – inventories)Current liabilities

• Net profit margin (profit in relation = Net profit x 100to revenue) Revenue 1

• Rate of inventory turnover = Average inventories x 365 daysCost of sales

or Cost of sales = number of times per yearAverage inventories

• Return on capital employed = Net profit x 100Capital employed 1

(b) Green Ltd is the supermarket, while Hawke Ltd is the furniture store.

Green Ltd has a low net profit margin and a high inventory turnover. This is a characteristic of the wayin which supermarkets operate – low profit margins, but a high level of revenue. Liquidity ratios arelower than the norms as supermarkets usually have few trade receivables.

Hawke Ltd has a higher net profit margin with a lower inventory turnover. This indicates a businessthat sells higher value items which are not purchased on a regular basis. The liquidity ratios are closeto the norms indicating a business with higher inventories and trade receivables than a supermarket.

(c) • If inventory turnover could be increased above 20 times per year, this would generate more cashand improve the liquidity ratios of the business (provided that selling prices do not have to becut to encourage sales).

• If expenses could be reduced, the net profit margin would improve, and also return on capitalemployed.

• A review of buying prices and selling prices may reveal opportunities for increasing profits andreturn on capital employed.

• Advertising could increase sales, but only if the extra revenue generated covers the cost ofadvertising.

• Inventory levels could be reduced, so improving the net current asset ratio.

• Any surplus non-current assets could be sold to improve liquidity ratios.

18.10 (a) Formula

Return on capital employed = Net profit x 100Capital employed 1

(b) Ratio calculation

Proposal 1

£30,000 x 100 = 5%*£600,000 1

* £300,000 ordinary shares (£200,000 + £100,000)£160,000 share premium (£140,000 + £120,000)£140,000 retained earnings

Proposal 2

£30,000 x 100 = 5.56%**£540,000 1

** £380,000 equity (ordinary shares + capital and revenue reserves)£160,000 long-term bank loan

Tutorial note: bank overdraft is a current liability and is not included in the figure of capital employed.

(c)Report

To: Ordinary shareholderFrom: Student AccountantDate: TodaySubject: Proposals to raise finance

Proposal 1

• This proposal to issue more ordinary shares means that ownership of the company will bediluted.

• Unless the amount paid out by the company in dividends is increased, then your dividend pershare will fall.

• Return on capital employed will be reduced from 7.89% (£30,000 ÷ £380,000) to 5%.

• The company’s gearing ratio is lowered (because equity has increased from £380,000 to£600,000); no interest to pay on the share issue.

• Reserves will increase to £300,000, ie £160,000 share premium and £140,000 retainedearnings. the company may decide to make a bonus issue of shares in the future.

Proposal 2

• The proposal is to fund the expansion entirely from external borrowing – your ownership of thecompany will not be diluted.

• Your dividend per share should remain the same and, if profits are increased after payinginterest on the loans, will increase.

• The company’s gearing ratio is increased by the borrowing, and the company must pay intereston the borrowing.

• The overdraft is a current liability which will have the effect of reducing the company’s netcurrent asset (current) ratio and liquid capital (acid test) ratio.

• Return on capital employed will be reduced from 7.89% to 5.56% (a smaller reduction thanproposal 1).

• The company will need a repayment scheme for the external borrowing – this could causeliquidity and cash flow problems in the future.

32

18.11 (a)FALCON LIMITED

BALANCE SHEET AS AT 31 MARCH 2007

£ £

Non-Current Assets Net book value

Premises 200,000

Fixtures and fittings 17,500

217,500

Current Assets

Inventories 14,560

Trade receivables 5,456

Cash and cash equivalents 31,058

51,074

Current Liabilities

Trade payables (7,842)

Tax liabilities (7,900)

(15,742)

Net Current Assets 35,332

252,832

Non-Current Liabilities

Debentures (2011-2013) (28,000)

NET ASSETS 224,832

EQUITY

Issued Share Capital

75,000 ordinary shares of £1 each 75,000

Capital Reserves


Revaluation reserve 120,000

130,000

Revenue Reserve

Retained earnings 19,832

TOTAL EQUITY 224,832

Tutorial notes:

• bank £1,058 + £30,000 (£25,000 + £5,000 premium) rights issue = £31,058

• share premium £5,000 + £5,000 premium on rights issue = £10,000

• revaluation reserve £200,000 revaluation – £80,000 net book value = £120,000

(b) Gearing ratio = Debt (loan capital + preference shares, if any) or Debt Equity (ordinary shares + reserves) Equity

Before adjustments = £28,000 = 37.42%*£74,832

* £50,000 + £19,832 + £5,000

After adjustments = £28,000 = 12.45%*£224,832

* total equity from balance sheet

(c) • The rights issue has added £30,000 (£25,000 + £5,000 premium) to total equity.

• Revaluation of the premises has added £120,000 (£200,000 – £80,000) to total equity.

• The level of debt has remained at £28,000.

• The impact of the rights issue and the revaluation of the premises has been to reduceconsiderably the gearing ratio from 37.42% to 12.45%. Even before the adjustments, thecompany was relatively low-geared; the ratio is much lower after the adjustments.

• A lower gearing ratio reduces the level of risk to the company and enables it to borrow furtherfunds in the future if required.

18.12 (a) • profit is a calculated figure which shows the surplus of income over expenditure for the year.

• cash is the actual amount of money held in the bank or as cash

(b) Example of how a business can make a good profit during a year when the bank balance reduces orthe bank overdraft increases (the question asks for two examples):

• purchase of non-current assets – cash decreases; no effect on profit (but there is likely to be anamount for provision for depreciation in the income statement

• repayment of a loan – cash decreases; no effect on profit

• payment of drawings/dividends – cash decreases; no effect on profit

• an increase in trade receivables – cash decreases; no effect on profit

• a decrease in trade payables – cash decreases; no effect on profit

• an increase in inventory – cash decreases; profit increases

33

19.1 (a) Benefits of budgetary control

• planning – by formalising objectives through a budget, a business can ensure that its plansare achievable

• communication – because a budget is agreed by the business, all the relevant managersand staff will be working towards the same end

• co-ordination – when a budget is being set, any anticipated problems should be resolved

• decision-making – by planning ahead through budgets, a business can make decisions onhow much output can be achieved

• monitoring – management is able to monitor and compare the actual results against thebudget

• control – action can be taken to modify the operation of the business

• motivation – a budget can be part of the techniques for motivating managers and otherstaff to achieve the objectives of the business

(b) Any three budgets

• purchases budget

• sales budget

• production budget

• labour budget

• debtor budget

• creditor budget

• cash budget

The most likely three budgets for a small business such as Classic Furniture would be cash, salesand production

(c) Relevant factors when implementing budgetary control

• costs and benefits – benefits must exceed the cost

• accuracy – of information used

• demotivation – of staff may occur if they have not been involved in planning the budgetand/or where budgets are set at too high a level

• disfunctional management – ensure that the budgets co-ordinate

• set too easy – ensure that budgets are set at realistic levels to enable the business to useits resources to best advantage

19.3 (a)

Sunshine Ltd

Cash budget for four months ending 31 October 2002

July Aug Sept Oct

£000 £000 £000 £000

Sales – cash 5.2 5.6 4.8 4.0

– 1 month 12.0 15.6 16.8 14.4

– 2 months 3.2 4.0 5.2 5.6

20.4 25.2 26.8 24.0

Purchases 16.0 18.0 14.0 12.0

Overheads 8.0 8.0 8.0 4.0

24.0 26.0 22.0 16.0

Net inflow/outflow (3.6) (0.8) 4.8 8.0

Opening balance (7.2) (10.8) (11.6) (6.8)

Closing balance (10.8) (11.6) (6.8) 1.2

(b) (i) • At 31 October 2002, the bank balance is budgeted to be £1,200.

• Thus, over the four-month period there is expected to be a change from an overdraftof £7,200 at the start, through a maximum overdraft of £11,600 in August, to £1,200money in the bank at the end of October.

• The company sells beach buckets and spades, so the seasonal effect is over quickly.

• Expected amounts due from debtors in November are:

£

1 month £20,000 x 60% 12,000

2 months £24,000 x 20% 4,800

16,800

• It is likely that the company will go into overdraft again quite quickly, from Novemberonwards.

(ii) • The company needs to make arrangements for an overdraft facility for July, August andSeptember, with a limit of approximately £12,000.

• Other measures to improve the company’s cash position include:

– offering discounts to encourage increased sales

– allowing one month’s credit only, so receiving payment from sales quicker

– encouraging cash sales

– reducing purchases as the summer season draws to a close

– reducing overheads

34

CHAPTER 19 Budgeting and budgetary control

19.5 (a)

July August September October November December

£ £ £ £ £ £

Income

Cash from debtors 20,000 24,000 28,500 32,500 38,500 *47,760

Expenditure

Payments to creditors 10,000 11,000 14,000 18,000 24,500 12,500

Operating expenses 12,000 12,000 12,000 12,000 12,000 12,000

Purchase of fixed assets 8,500 19,510

Repayment of loan 20,000

22,000 31,500 26,000 30,000 36,500 64,010

Net cash flow (2,000) (7,500) 2,500 2,500 2,000 (16,250)

Opening balance 980 (1,020) (8,520) (6,020) (3,520) (1,520)

Closing balance (1,020) (8,520) (6,020) (3,520) (1,520) (17,770)

cash from December sales: £60,000 x 20% x 98% = £11,760

cash from November sales: £50,000 x 60% = £30,000

cash from October sales: £30,000 x 20% = £6,000

£47,760

(b) £980 (opening balance 1 July) + £17,770 overdraft (closing balance 31 December)

= £18,750 total net cash outflow

(c)

Memorandum

To: The Directors of Hawk LimitedFrom: Student AccountantDate: TodaySubject: Making profits whilst having a bank overdraft

Reasons

a company can make a profit but have a bank overdraft for a number of reasons, including:

• the application of the realisation concept – timing of receipts and payments

• purchase of fixed assets

• repayment of loans

Explanation

• receipts from debtors and payments to creditors are likely to occur some weeks after the salesand purchases have been recorded in the trading account

• the purchase of fixed assets affects cash but has no effect on profit

• repayment of loans affects cash but has no effect on profits

Hawk Limited

• 20% of cash from sales is received in the month of sale; then 60% is paid in the next month,with 20% two months after sale

• the sales of £60,000 forecast to be made in December are higher than each of October andNovember; the cash received from December’s sales will be £11,760 in December, £24,000 inJanuary and £12,000 in February – thus, at the end of December, £36,000 is outstanding

• in December, the company plans to buy new fixed assets at a cost of £19,510

• in December, the company plans to make a repayment on the loan of £20,000

(d) See Chaper 20.

• Automatic updating – as amendments are made, the entire budget is changed easily.

• What-if calculations – the effect of possible changes can be considered, eg a reduction in theperiod of credit allowed to customers.

19.7 (a)

35

JIM SMITH

CASH BUDGET FOR THE SIX MONTHS ENDING 30 JUNE 20...

Jan Feb Mar Apr May Jun

£ £ £ £ £ £

Receipts

Capital introduced 10,000

Debtors – 1,250 3,000 4,000 4,000 4,500

Total receipts for month 10,000 1,250 3,000 4,000 4,000 4,500

Payments

Van 6,000

Creditors – 4,500 4,500 3,500 3,500 3,500

Expenses 750 600 600 650 650 700

Total payments for month 6,750 5,100 5,100 4,150 4,150 4,200

Net cash flow 3,250 (3,850) (2,100) (150) (150) 300

Add bank balance (overdraft)at beginning of month – 3,250 (600) (2,700) (2,850) (3,000)

Bank balance (overdraft) at endof month 3,250 (600) (2,700) (2,850) (3,000) (2,700)

Notes:

• no depreciation – a non-cash expense – is shown in the cash budget

• customers pay one month after sale, ie debtors from January settle in February

• suppliers are paid one month after purchase, ie creditors from January are paid in February

(b) The cash budget shows the maximum bank overdraft to be £3,000 in May.

Jim Smith could avoid the need for a bank overdraft in one or more of the following ways (the questionasks for two ways):

• by commencing his business with a higher initial capital, eg £13,000

• by buying the van on hire purchase or leasing instead of outright purchase

• by reducing his purchases to £3,000 for each of January and February

• by asking his suppliers for two months’ credit for the initial purchases of £4,500 made in January

• by asking his customers to pay more quickly

20.6 Two from each of:

(a) - single entry system which automatically makes entries in all relevant accounts

- accounts are normally already set up in the system

- all arithmetic in account entries is performed automatically

(b) - provided that the original figure entered is correct, all account entries will be correct

- all calculations are automatic and therefore accurate

(c) - error of omission (entries which have been left out in error)

- error of original entry (the wrong figure entered in error)

- error of principle (entry in the wrong type of account)

- mispost (entry in the wrong person’s account)

36

CHAPTER 20 The impact of computer technology in accounting

Documents

Textbook Answers As