de6635-accounting unit 3

HND Accounting Graded Unit 3

DE66 35

Tutor’s Support Pack

Olive Gardiner

Adam Smith College

January 2007

© COLEG

Accounting – Graded Unit 3 Tutor’s Support Pack

Acknowledgements First published January 2007 © Colleges Open Learning Exchange Group (COLEG) – Material developed by Adam Smith College. No part of this publication may be reproduced without the prior written consent of COLEG, except as authorised in the paper entitled ‘Intellectual Property Rights of COLEG Members’.


Contents

Tutor materials 1

Introduction to unit 2

Purpose of this unit 2

Assessment 2

Unit specification and assessment exemplars 2

Introduction to this pack 3

Student materials 5

Introduction to unit 6

Purpose of this unit 6

Financial reporting 7

Basic accounts preparation – standard year end adjustments 7

Incorporating long term work in progress adjustments 15

Incorporating revaluation adjustments 20

Incorporating finance lease adjustments 24

Incorporating issues of shares 27

Disclosure 30

Conceptual matters 36

Taxation 37

Appendices 47

Appendix 1 – SSAP 9 47

Appendix 2 – SSAP 21 51

Appendix 3 – FRS 15 55

Appendix 4 – FRS 3 61

Appendix 5 – SSAP25 65

Appendix 6 – FRS 18 – Theoretical matters 67


Appendix 7 – Adjusting the accounting profit 82

Appendix 8 – Capital allowances 88

Appendix 9 – Calculating the CT due 97

Appendix 10 – Relief for trading losses 99

Appendix 11 – solutions to revision exercises 104


1

Tutor materials


2

Introduction to unit Purpose of this unit This Group Award Graded Unit is designed to provide evidence that the candidate has achieved the following aims of the HND Accounting:

• To prepare students for progression to further study in accounting or a related discipline.

• To develop and integrate a range of contemporary vocational skills in addition to those developed at HNC level (ie evaluating and interpreting financial data; applying relevant legislation; providing information for decision-making).

• To enable students to integrate financial accounting with relevant business taxation. Assessment Students will be assessed in this unit by a three-hour written examination and will be allowed access to a taxation text book during the assessment. To achieve this unit, students should attain 50% of available marks with achievement being graded according to marks attained. Prior to undertaking this Group Award Graded Unit, students should have completed the following HND mandatory units:

• Financial Reporting and Analysis (DE5G 35)

• Accounting for Specialised Transactions (DE5E 35)

• Business Taxation (DE5L 35) Unit specification and assessment exemplars The Unit specification will be an essential document in the delivery of the unit. Exemplar instruments of assessment with marking guidelines have been produced to provide examples of the specific evidence required to demonstrate achievement of the aims of the HND Accounting group award which this Graded Unit is designed to cover, and to indicate the national standard of achievement required at SCQF 8.


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Introduction to this pack The purpose of this pack is to provide materials for use in the delivery of this Graded Unit. The main body of the student material consists of grouped revision exercises as per the contents list. Solutions are provided at the end. These are all together in one place – this was felt to be the most appropriate presentation, as they are more easily removed if you so wish. Some revision notes are included in the appendices to give easy reference for those students who have trouble remembering their original teaching materials on these topics. Those delivering the units will know to what extent they wish to make use of these. Note: Users of the pack should note that it is up to date as at the time of writing and reflects the changes in format required by the change in the Companies Act brought into force on 1st January 2005 and reflected in the version of the FRSSE at that date, whereby dividends paid during the year should be debited directly to equity and no longer be shown in the profit and loss account. The pack follows the format as laid down in the FRSSE and FRS 25, showing dividends paid in a simplified reconciliation of shareholders’ funds. It is recognised that there may be further changes in the very near future when the new Companies Act comes into force. As the Unit entitled Financial Reporting and Analysis is based on FRSSE companies, the pack also recognises:

• There is now no requirement for small companies to disclose staff numbers (financial years beginning on or after 1st January 2005).

• There is now no requirement for small companies to disclose wages and salaries, social security costs and other pension costs (financial years beginning on or after 1st January 2005).


4


5

Student materials


6

Introduction to unit Purpose of this unit This Group Award Graded Unit is designed to provide evidence that you have achieved the following aims of the HND Accounting:

• To prepare students for progression to further study in accounting or a related discipline.

• To develop and integrate a range of contemporary vocational skills in addition to those developed at HNC level (ie evaluating and interpreting financial data; applying relevant legislation; providing information for decision-making).

• To enable students to integrate financial accounting with relevant business taxation. Prior to undertaking this Group Award Graded Unit, you should have completed the following HND mandatory units:

• Financial Reporting and Analysis (DE5G 35)

• Accounting for Specialised Transactions (DE5E 35)

• Business Taxation (DE5L 35) You will be assessed in this unit by means of a three hour examination during which you will have access to a taxation text book. In order to achieve the unit you must obtain 50% or more of the available marks. Remember that your result in this unit will provide the grade that will appear on your HND certificate. It is therefore very important that you do yourself justice in your performance in this unit. The following material is designed to help you revise the material you have studied in the mandatory units specified above and to help you practise putting the material together, as you will have to in the examination – and of course in practice.


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Financial reporting Basic accounts preparation – standard year end adjustments Revision exercise 1 The following trial balance was extracted from the accounts of Castlepark at 31st March 20X9. £000 £000 General administrative expenses 29,610 Selling and delivery costs 11,205 Opening stock 79,519 Purchases 503,500 Interest on bank overdraft 2,496 Prepaid expenses 1,729 Bad debts written off 1,755 VAT account 3,229 Trade creditors 66,465 Bank overdraft 29,960 12% debenture stock 9,975 Ordinary share capital, issued and fully paid 78,750 Profit and loss account at 1/4/X8 7,498 Share premium account 29,400 Dividend paid 4,760 Sales (excl. VAT) 608,738 Trade debtors 136,620 Accruals 1,120 Freehold land 30,000 Freehold property:

cost 31,145 accumulated depreciation @ 1/4/X8 3,189

Equipment and vehicles: cost 10,553 accumulated depreciation @ 1/4/X8 4,568

842,892 842,892 Required: From the above trial balance and the information overleaf, prepare a profit and loss account for the year ended 31st March 20X9 and a balance sheet at that date.


8

Additional information: 1) Corporation tax has been estimated to be £22,050,000 based on the year's

profit. 2) The 12% debenture stock was issued at the end of the year. 3) The rates to be charged for the year as depreciation are:

Freehold property 2% (of which 25% is to be charged to Administration, 50% to cost of sales and the rest to Distribution)

Equipment and vehicles 15% (of which 50% is to be charged to cost of sales and 50% to Distribution)

4) Closing stock was valued at £72,500,000. 5) Auditors’ fees of £85,000 are to be accrued. 6) The company pays its annual insurance premiums in full on the 1st January every

year. This year’s payment was for £64,000.


9

Revision exercise 2 The following trial balance was extracted from the accounts of Andrene at 31st March 20X9. £000 £000 Ordinary share capital, issued and fully paid 23,000 Profit and loss account at 1/4/X8 5,000 General administrative expenses 21,000 Selling and delivery costs 6,600 Cost of goods sold 175,600 Interest on bank overdraft 670 Prepaid expenses 1,500 VAT account 1,450 Investments 31,400 Trade creditors 12,100 Bank overdraft 9,200 Closing stock of finished goods 83,940 10% debenture stock 5,000 Share premium account 3,650 Dividend paid Nov 'X8 1,200 Deferred tax 7,000 Sales (excl. VAT) 352,000 Trade debtors 60,200 Accruals 200 Investment income (rec'd Oct 'X8) 520 Proceeds of the disposal of equipment 50 Purchase of equipment and vehicles 560 Fixed assets, NBV at 1/4/X8 36,500 419,170 419,170 Required: From the above trial balance and the information overleaf, prepare a profit and loss account for the year ended 31st March 20X9 and a balance sheet at that date.


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Additional information: 1) Corporation tax has been estimated to be £8,600,000 based on the year's profit.

£28,000 is to be transferred to the deferred tax account representing the excess of capital allowances over depreciation charges.

2) The 10% debenture stock was in issue throughout the year. 3) The equipment and vehicles disposed of had a written down value of £40,000 and

originally cost £75,000.

The fixed assets at 1/4/X8 were:

Freehold property Equipment and vehicles

Cost or valuation 50,400,000 10,000,000

Accumulated depreciation 18,200,000 5,700,000 The rates to be charged for the year as depreciation are:

Freehold property 2% (of which 40% is to be charged to administration, 40% to cost of sales and the rest to distribution)

Equipment and vehicles 12% (of which 50% is to be charged to cost of sales and 50% to distribution)

4) Audit fees of £176,000 are to be accrued. 5) The accountant has decided that the amount included in debtors relating to FPB plc

(£200,000) should be written off as the company has gone into liquidation. He also considers a general doubtful debt allowance of 5% of the remaining debtors will be required to reflect the expected difficulties being experienced in the sector.


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Revision exercise 3 The following trial balance was extracted from the accounts of Milton at 31st March 20X7. £000 £000 Trade creditors 42,538 Bank overdraft 19,134 Closing stock of finished goods 60,856 12% debenture stock 6,384 General administrative expenses 13,518 Selling and delivery costs 17,171 Cost of goods sold 291,040 Ordinary share capital, issued and fully paid 54,400 Profit and loss account at 1/4/X6 5,454 Interest on bank overdraft 2,698 VAT account 2,066 Investments 26,643 Share premium account 14,224 Dividend paid 3,046 Sales (excl. VAT) 378,000 Trade debtors 98,077 Accruals 475 Investment income 177 Deferred tax 11,592 Fixed assets, NBV at 1/4/X6 21,395 534,444 534,444 Required: From the above trial balance and the information overleaf, prepare a profit and loss account for the year ended 31st March 20X7 and a balance sheet at that date.


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2) The 12% debenture stock was issued at par at the start of the year. 3) The fixed assets at 1/4/X6 were:



Accumulated depreciation 2,041,000 2,923,000

The amounts to be charged for the year as depreciation are:

Freehold property £226,000 (of which £81,000 is to be charged to administration, £56,000 to cost of sales and the rest to selling and distribution expenses)

Equipment and vehicles £605,000 (of which £202,000 is to be charged to Administration, £134,000 to cost of sales and the rest to selling and distribution expenses)

4) The following expenses are to be accrued:

General administrative expenses £23,000

Accountancy services £35,000


13

Revision exercise 4 The following trial balance was extracted from the accounts of Panico at 31st March 20X9. £000 £000 General administrative expenses 14,090 Selling and delivery costs 9,980 Purchases 220,960 Ordinary share capital, issued and fully paid 34,800 Profit and loss account at 1/4/X8 4,500 Share premium account 9,600 Dividend paid 6,942 VAT account 1,650 Trade creditors 25,400 Bank 15,980 Opening stock of finished goods 57,025 10% debenture stock 4,800 Corporation tax 35 Deferred tax 807 Sales (excl. VAT) 337,450 Trade debtors 65,955 Fixed assets, NBV at 1/4/X8 28,040 419,007 419,007 Required: From the above trial balance and the information overleaf, prepare a profit and loss account for the year ended 31st March 20X9 and a balance sheet at that date.


14

Additional information: 1) The fixed assets at 1/4/X8 were:




Freehold property 2% of cost (50% administration, 30% to cost of sales and 20% to selling and distribution)

Equipment and vehicles 16% of cost (50% to cost of sales and the rest to selling and distribution expenses)

2) Closing stock was estimated to be £85m 3) Corporation tax has been estimated to be £11,500,000 based on the year's profit.


Tax paid in January 20X9 (based on the profit of 20X8) was £8,900,000 which was £35,000 more than originally estimated.

4) The 12% debenture stock was in issue throughout the year. 5) Auditors’ fees of £125,000 are to be accrued.


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Incorporating long term work in progress adjustments The exercises contained in this section relate to organisations with long term work in progress. If you are unsure of the treatment, revision material is contained in appendix 1. Revision exercise 5 The trial balance for Gammon plc, extracted at 31st December 20X6 contains the following balances relating to a contract with Bilt Ltd:

Dr Cr

Bilt: contract account costs so far £450,000

Bilt: payments on account £550,000 You discover the following about the contract:

The contract was started on 1st July 20X6, and is expected to finish in November 20X7. The total contract price is £2m.

Expected costs to completion are £750,000 and the surveyor has confirmed that at the year end the contract was 30% complete. Required: Show how this contract will be reflected in the profit and loss account for the year ended 31st December 20X6 of Gammon plc, and in the balance sheet at that date. You should show all journal entries necessary.


16

Revision exercise 6 The following trial balance was extracted from the accounts of Acer at 31st March 20X9. £000 £000 Ordinary share capital, issued and fully paid 37,800 Profit and loss account at 1/4/x8 3,600 General administrative expenses 10,458 Selling and delivery costs 15,210 Cost of goods sold 203,280 Interest on bank overdraft 771 VAT account 1,500 Contract account 50 Investments property 10,212 Trade creditors 31,903 Bank overdraft 14,888 Closing stock of finished goods 58,956 12% debenture stock 4,000 Share premium account 9,785 Dividend paid 7,280 Directors total emoluments 270 Deferred tax 8,694 Sales (excl. VAT) 283,856 Trade debtors 73,526 Investment income 134 Proceeds of the disposal of equipment 48 Purchase of Equipment and vehicles 245 Fixed assets, NBV at 1/4/x8 16,050 396,258 396,258 Required: From the above trial balance and the information on the following page, prepare a profit and loss account for the year ended 31st March 20X9 and a balance sheet at that date.


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2) The 12% debenture stock was issued at the start of the year. 3) The directors' total emoluments of £270,000 are to be charged as £222,000 to

administrative expenses and £48,000 to distribution costs. 4) The equipment and vehicles disposed of had a written down value of £75,600 and

originally cost £132,600.

The fixed assets at 1/4/x8 were:

Freehold property Equipments and vehicles



Freehold property 2% of cost (50% administration, 30% to cost of sales and 20% to selling and distribution)

Equipment and vehicles 15% of cost (50% to cost of sales and the rest to selling and distribution expenses)

5) Included in stock are 20 items made as a special order for a customer who went

into liquidation before they were delivered. As they are of a specialist nature, they can only be sold for scrap. Their net scrap value is expected to be £1,000 each, although they originally cost £2,500 each to make.

6) The contract account balance of £50,000 represents the balance of £500,000 costs

so far incurred on a long term contract and £550,000 received from the contractee. No other entries have been made in respect of this contract. The details are as follows:

Total contract value £885,000

Value of work certified £600,000

Cost of work certified £400,000

Costs to date £500,000

Estimated cost to complete £ 90,000

The directors wish to recognise attributable profit in accordance with SSAP 9.


18

Revision exercise 7 The following trial balance was extracted from the accounts of Harebell at 31st March 20X9. £000 £000 Investment properties 10,396 General administrative expenses 12,070 Selling and delivery costs 8,866 Ordinary share capital, issued and fully paid 45,000 Purchases 242,000 Bank overdraft 16,834 Profit and loss account at 1/4/X8 14,566 Interest on bank overdraft 6,855 Trade creditors 37,980 Share premium account 12,700 Dividend paid 2,720 Opening stock 46,007 VAT account 1,845 Corporation tax 36 Deferred tax 10,350 Sales (excl. VAT) 337,500 Trade debtors 98,040 Rental income from investment properties 160 Contract account 550 Fixed assets, NBV at 31/3/X9 49,395 476,935 476,935 Required: From the above trial balance and the information on the following page, prepare a profit and loss account for the year ended 31st March 20X9 and a balance sheet at that date.


19

Additional information: 1) Closing stock was estimated to be £48.5m before taking account of the contract

mentioned below. 2) Harebell has one long term contract underway. The managing director wishes you

to calculate how much profit can prudently be recognised and include this in the accounts. The details are as follows:

Contract value £10m Start date 3 September 20X8

Costs so far £2.8m

Estimated costs to complete £4.0m Estimated completion Nov. 20Y0

Work certified complete £2.25m

(This last amount has been invoiced to the customer and he has paid it. It has not been included in sales however. The only entries in the books have been debits to the contract account of costs incurred, and a credit to the contract account of amount paid.) Profit is earned at a constant rate over the contract.

3) Corporation tax has been estimated to be £12,600,000 based on the year's profit.


Tax paid in January 20X9 (based on the profit of 20X8) was £7,936,000 which was £36,000 more than originally estimated.

4) Audit costs of £234,000 are to be accrued.


20

Incorporating revaluation adjustments The exercises contained in this section relate to organisations who revalue their fixed assets in accordance with FRS 15. If you are unsure of the treatment, revision material is contained in Appendix 3. Revision exercise 8 The following trial balance was extracted from the accounts of Bensven at 31st March 20X9. £000 £000 Ordinary share capital, issued and fully paid 30,000 Profit and loss account at 1/4/X8 3,737 General administrative expenses 11,500 Selling and delivery costs 4,900 Cost of goods sold 145,823 Salaries and wages 44,440 Interest on bank overdraft 667 VAT account 1,100 Investments 10,000 Trade creditors 22,160 Bank overdraft 9,618 Closing stock of finished goods 53,517 12% debenture stock 4,000 Share premium account 7,680 Revaluation reserve 2,240 Dividend paid 2,542 Deferred tax 7,050 Sales (excl. VAT) 252,500 Trade debtors 50,216 Investment income (rec'd Oct 'X8) 220 Fixed assets, NBV at 1/4/X8 16,700 340,305 340,305 Required: From the above trial balance and the information on the following page, prepare a profit and loss account for the year ended 31st March 20X9 and a balance sheet at that date.


21



2) The 12% debenture stock was issued at par at the start of the year. 12% is the

market rate for this type of debt. 3) The directors believe that the debtor’s balance of £15,000 relating to a customer

now in liquidation should be written off, and a general allowance of 3% of the remaining debtors figure made.

4) The fixed assets at 1/4/X8 were:



Accumulated depreciation 1,916,000 1,800,000 The rates normally charged for the year as depreciation are:



5) Wages and salaries are to be split between cost of sales, administration and selling

and distribution in the ratio 2:2:1. 6) On the first day of the year, the property was revalued by an external surveyor at

£30m. The directors wish to incorporate this value into the accounts. The surveyors have intimated that the buildings have a further 50 years of useful economic life.


22

Revision exercise 9 The following trial balance was extracted from the accounts of Jaqjas at 31st March 20X9. £000 £000 Ordinary share capital, issued and fully paid 42,840 Profit and loss account at 1/4/X8 9,963 General administrative expenses 11,524 Selling and delivery costs 6,096 Purchases 262,384 Salaries and wages 24,337 Interest on bank overdraft 1,358 VAT account 1,756 Investments 9,897 Trade creditors 36,157 Bank overdraft 16,314 Opening stock 43,228 Share premium account 12,090 Revaluation reserve 3,903 Dividend paid 3,000 Deferred tax 9,853 Sales (excl. VAT) 321,300 Trade debtors 74,321 Investment income 155 Fixed assets, NBV at 1/4/X8 18,186 454,331 454,331 Required: From the above trial balance and the information on the following page, prepare a profit and loss account for the year ended 31st March 20X9 and a balance sheet at that date.


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2) The fixed assets at 1/4/X8 were:



Accumulated depreciation 1,735,000 2,481,000

The rates to be charged for the year as depreciation are:




and distribution in the ratio 1:4:2. 4) On the last day of the year, the property was revalued by an external surveyor at

£26m. The directors wish to incorporate this value into the accounts. 5) Audit fees of £126,000 are to be accrued. 6) Closing stock was estimated to be £55m.


24

Incorporating finance lease adjustments The exercises contained in this section relate to organisations that lease some of their fixed assets and must therefore account for them in accordance with SSAP 21. If you are unsure of the treatment, revision material is contained in appendix 2. Revision exercise 10 Grant required a new computer system and decided to lease one from Bussols on the following terms:

Cash price: £15,600

Lease terms: Deposit of £3,900 on 1/4/X1 followed by two instalments of £4,680 payable on 1st April in each of the following two years and a final payment of £4,762 payable on 1/4/X4. The interest rate implicit in the lease is 10%.

Grant has decided to depreciate the computer using the straight line method over the life of the lease. Required: a) Make the necessary entries in the books of Grant for 20X1/2 and show extracts

from the Profit and loss account for the year to 31st March 20X2 and the balance sheet at that date. Spread the interest using the actuarial method.

b) Calculate the interest allocation for 20X1/2 under the sum-of-digits method.


25

Revision exercise 11 You are the financial accountant of ABC plc, a listed company engaged in the manufacture of garden equipment. The trial balance at 31st March 20X4 was as follows: £000 £000 Ordinary share capital (£1 shares) 8,000 15% debentures 3,000 Profit and loss account 1st April 20X3 5,670 Deferred taxation 1st April 20X3 2,500 Sales 66,980 Staff costs 17,780 Overheads 27,890 Raw materials purchases 12,255 Investments at cost 965 Amounts owing to HMRC – PAYE and NI 275 Dividends received 60 Interest paid (including debenture interest) 850 Ordinary dividend paid 530 Corporation tax underprovided 120 Bank 70 Trade debtors and creditors 29,290 13,760 Freehold land at cost 1,400 Freehold buildings at cost 800 Other fixed assets at NBV (31/3/X4) Plant and m/c 3,520 Motor vehicles 55 Fixtures and fittings 800 Stocks of raw materials 1/4/X3 950 Stocks of finished goods 1/4/X3 2,970 100,245 100,245 Required: Using the additional information provided overleaf, prepare for publication in the corporate report of ABC plc, the profit and loss account for the year ended 31st March 20X4 and a balance sheet at that date.


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Additional information: 1) Staff costs are apportioned 7:1:2 between the production, distribution and

administration functions respectively. 2) Overheads are split as follows: £000

Production 19,200

Distribution 6,610

Administration 2,080 27,890

Production overheads include two instalments in respect of plant and machinery acquired on 1st October 20X3 under a finance lease. The terms of the lease require sixteen quarterly instalments of £20,000 payable in arrears. The fair value of the machinery on 1st October 20X3 was £184,000. The company wishes to use the sum of digits method to account for the lease.

3) In the past, the company has not depreciated its freehold buildings. From 1st April

20X3, depreciation is to be provided retrospectively on these buildings. The buildings were acquired on 1st April 20X0 and have an estimated useful life of 40 years from that date. The depreciation is to be apportioned 80% production and 20% administration.

4) The estimate of £4,200,000 provided for corporation tax payable on the profits of

the previous year was agreed at £4,320,000 and this was paid on the due date. Taxation on the profits of the current year is estimated at £3,000,000.

5) Stock at 31st March 20X4 totalled £3,990,000. 6) The balance on the deferred taxation account at 1 April 20X3 relates to timing

differences due to the difference between capital allowances and depreciation. The required provision based on cumulative timing differences was £1,800,000 at 31st March 20X4.

7) The debentures are redeemable in two equal annual instalments commencing on

30th March 20X5.


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Incorporating issues of shares The exercises contained in this section relate to the accounting for the issue of share capital. If you are unsure of this aspect of your studies, revision notes are contained in Appendix 4. Revision exercise 12 Biscabee have the following shareholders’ funds at 1st January 20X7:

Ordinary share capital (£1 ordinary shares) 150,000 Share premium 75,000 Profit and loss account 560,000 785,000 On 2nd January, the directors decide to make a bonus issue of 1 share for every 3 held. They wish to do this in a way that maximizes distributable profit. Following the bonus issue, the directors decide to raise much needed funding for expansion by means of a rights issue on 5th January. The terms of the issue were as follows:

Two shares at £3.50 each for every 5 shares held. The rights issue was taken up by all shareholders. Required: Prepare journal entries to record the bonus and rights issues, and show the shareholders funds as they would appear on a balance sheet at 5th January, assuming no further profit or loss has arisen.


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Revision exercise 13 The following trial balance was extracted from the accounts of Nordheim at 31st March 20X9. £000 £000 Trade debtors 106,560 General administrative expenses 30,161 Salaries and wages 229,485 Bad debts written off 1,332 VAT account 1,920 Investment property 24,000 Trade creditors 74,640 Ordinary share capital, issued and fully paid 103,200 Profit and loss account at 1/4/X8 20,944 Bank 23,118 Closing stock of finished goods 72,600 8% debenture stock 4,800 Share premium account 3,755 Selling and delivery costs 10,968 Cost of goods sold 600,770 Dividend paid 2,880 Sales (excl. VAT) 912,025 Investment income 360 Suspense account 7,950 Proceeds of the disposal of equipment 144 Purchase of equipment and vehicles 1,584 Fixed assets, NBV at 1/4/X8 26,280 1,129,738 1,129,738 Required: From the above trial balance and the information on the following page, prepare a profit and loss account for the year ended 31st March 20X9 and a balance sheet at that date, including as far as possible, from the information provided, the necessary notes to the accounts.


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Additional information: 1) The 8% debenture stock was issued at the end of the year. 2) Corporation tax has been estimated to be £5m based on the year's profit. 3) The equipment disposed of had a written down value of £180,000 and originally

cost £216,000.

The fixed assets at 1/4/X8 were:







and distribution in the ratio 5:3:2. 5) The suspense account represents the cash proceeds of an issue of shares. 4m £1

ordinary shares were issued on 1st January 20X9. No entries have been made in the accounts other than to debit the bank and credit the suspense account with the proceeds.


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Disclosure Revision exercise 14 Belco plc started the year with tangible fixed assets with a net book value of £328,000, made up as follows:

Freehold land cost £90,000

Buildings cost £200,000 accumulated depreciation £20,000

Plant cost £70,000 accumulated depreciation £28,000

Vehicles cost £26,000 accumulated depreciation £10,000 During the year, the land was revalued to £120,000 as a result of a survey by ABC Chartered Surveyors and Co. Other transactions for the year included:

• New plant was acquired at a cost of £50,000

• A vehicle that had originally cost £10,000 and had been depreciated at 20% per year on cost for 3 years was sold for £3,000

• A new vehicle was acquired for £15,000. Belco’s depreciation policy is to charge a full year’s depreciation in the year of acquisition and none in the year of disposal. The rates used as:

Buildings: 2% per annum on cost

Plant: 15% per annum reducing balance method

Vehicles: 20% per annum on cost Required: Prepare the fixed asset schedule and associated notes for Belco plc.


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Revision exercise 15 Prepare the fixed asset schedule and associated disclosure notes required for Andrene in Revision exercise 2 which you worked on earlier. Revision exercise 16 Prepare the disclosure notes required by SSAP 21 in the case of Grant in revision exercise 10 which you worked on earlier. Revision exercise 17 Prando required a new computer system and decided to lease one from Bolshi on the following terms:

Cash price: £7,800

Lease terms: Deposit of £1,950 on 1/4/X0 followed by 2 instalments of £2,340 payable on 1st April in each of the following two years and a final payment of £2,381 payable on 1/4/X3. The interest rate implicit in the lease is 10%.

Prando has decided to depreciate the computer using the straight line method over the life of the lease. Required: a) Make the necessary entries in the books of Prando for 20X0/X1 and show extracts

from the profit and loss account for the year to 31st March 20X1 and the balance sheet at that date. Spread the interest using the actuarial method.

b) Calculate the interest allocation for 20X0/X1 under the sum-of-digits method. c) Prepare the disclosure notes required under SSAP 21 as a result of this

transaction.


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Revision exercise 18 The accounts of Biscabee include the following figures: Cost of sales Depreciation of production machinery: owned £85,000 Depreciation of production machinery: leased £24,000 Raw materials used £125,000 Labour costs £140,000 Sundry materials £54,000 Pension contributions on behalf of employees £12,500 Hire of specialist equipment £6,785 Utilities £12,870 Amortisation of development costs £4,500 Research costs £6,000 Administrative expenses Depreciation of office equipment (all owned) £35,000 Labour costs £70,000 Pension contributions £6,750 Stationery £10,453 Telephone £2,560 Insurance £1,400 Directors’ fees £15,000 Audit fees £35,000 Distribution costs Depreciation of fork lift trucks (all owned) £25,000 Labour costs £45,000 Pension contributions £3,750 Sundry expenses £10,000 Required: State which items must be disclosed individually in the notes to the accounts and prepare, as far as the information permits, a suitable disclosure note.


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Revision exercise 19 Biscabee’s stock figure at the end of the year is £450,000. Biscabee is a manufacturing organisation and this figure includes raw materials, work in progress and finished goods in the proportion 2:3:4. Biscabee revalue their head office property every three years in line with the requirements of FRS 15. All other fixed assets are held at cost and depreciated as follows:

Plant and machinery: 10% per annum, straight line

Vehicles: 25% per annum, straight line Required: a) Prepare a suitable note for inclusion in the published accounts relating to the stock

breakdown.

b) Prepare a suitable note for disclosing Biscabee’s accounting policy with regard to stock in line with the requirements of SSAP 9 and FRS 18.

c) Prepare a suitable note for disclosing Biscabee’s accounting policy with regard to fixed assets in line with the requirements of FRS 15 and FRS 18.


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Revision exercise 20 Harebell’s profit and loss account for the year ended 31 December is as follows: Trading profit and loss account for year ended 31 December £000 Turnover 608,738 Cost of sales (511,621) Gross profit 97,117 Admin expenses (31,558) Distribution costs (12,153) Operating profit 53,406 Interest payable (2,496) Profit before taxation 50,910 Taxation (22,050) Profit after taxation 28,860 During the year, Harebell discontinued a major segment of its business. This had accounted for 5% of turnover, 6% of the cost of sales, 6% of administrative expenses and 10% of the distribution costs. Required: Redraft the profit and loss account incorporating the requirements of FRS 3 with regard to discontinued activities.


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Revision exercise 21 Discuss the advantages users may gain from the additional disclosure required by SSAP 25 Segmental Information and briefly state the requirements of that standard.


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Conceptual matters Revision exercise 22 The historic cost model still dominates the production of financial information in the UK, despite attempts to find a more satisfactory model (eg by the introduction of SSAP 16, now withdrawn). FRS 15 and the Draft Statement of Principles both appear to suggest that a modified form of historic cost accounting will be with us for a long time yet. Required: Critically evaluate two alternative models which have been put forward and comment on the reasons for the continuing domination of historic cost accounting. Revision exercise 23 Identify the bodies that influence the setting of accounting standards in the UK and comment specifically on the role of:

• The FRC

• The ASB

• The UITF

• The FRRP. Revision exercise 24 The Statement of Principles emphasises the importance of the concepts of ‘accruals’ and ‘going concern’ in the preparation of financial statements. Required Briefly describe these two concepts and comment on whether you believe they contribute to the relevance of financial information to the users of accounts.


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Taxation Revision exercise 25 Al Cap Ltd Al Cap Ltd is a wine importing company. The most recent annual accounts show the following: £ £

Gross profit 51,929 Bank deposit interest 160 Dividends (net) 140 52,229 Expenses: Rent and business rates 2,740 Light and heat 120 Office salaries 19,660 Repairs to premises (note a) 2,620 Motor expenses 740 Depreciation – motor vans 2,800 equipment 750 Amortisation of lease 120 Loss on sale of equipment 40 Bad and doubtful debts (note b) 680 Professional charges (note c) 375 Interest on bank over draft (note d) 240 Sundry expenses (note e) 770 Salaries 15,450 47,105 Net profit 5,124

Notes: a) Repairs: £

Alterations to flooring in order to install new bottling machine 1,460 Decorations 475 Replastering walls due to damp 685

2,620 b) Bad and doubtful debt £

Trade debts w/o 500 Specific allowance for doubtful debt 180


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c) Professional charges: £ Accountancy 200 Cost of court action for failing to observe Customs regulations 110 Legal cost of obtaining new lease (see below) 20 Debt collection 45 375

d) The overdraft was obtained in order to finance the purchase of stock e) Sundry expenses £

Fine re breach of Customs bonding regulations 250 Subscription to wine retail trade association 50 Donation to police welfare fund 20 Entertaining customers 300 Calendars bearing firm’s name sent to 300 customers 120 Miscellaneous allowable expenses 30

770 f) On 25th March the company took out a lease on a new retail outlet for 99 years. Required: Compute Al Cap’s trading profit before capital allowances.


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Revision exercise 26 You are presented with the accounts of Cornelius Ltd for the year to 31st December 2006. Cornelius runs a small printing business and the managing director wishes to know the trading profit for the year ended 31st December 2006. Calculate Cornelius Ltd’s trading profit for taxation purposes. £ £ Gross profit from trading 25,620 Profit on sale of business premises (1) 1,750 27,370 Advertising 642 Debtors allowance (2) 75 Depreciation 2,381 Light and heat 372 Miscellaneous expenses (3) 347 Motor car expenses (4) 555 Rates 1,057 Repairs and renewals (5) 2,598 Staff wages (6) 12,124 Telephone 351 (20,502) Profit before tax 6,868 Notes: 1) The profit on the sale of premises relates to the sale of a small freehold industrial

unit in which the company stored paper before building the extension 2) The charge for debtors allowance is made up as follows:

£ Write-off of specific trade debts 42 Increase in general allowance for doubtful debtors 50 92 less: recovery of bad debt previously written off (17) Charge to the profit and loss account 75

3) Miscellaneous expenses include: £

Subscription to printers association 45 Contribution to Local Enterprise Agency 50 Gifts to customers Calendars costing £7.50 each (bearing the company’s name) 75 Two food hampers bearing the company’s name 95


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4) A director uses the motor car for 75% business and 25% private use 5) Repairs and renewals comprise the following expenditure:

£ Refurbishing a second hand press (before it could be used in the business) 522 Redecorating administration offices 429 Building extension to enlarge paper store 1,647 2,598

6) Staff wages include an amount for £182 for a staff Christmas lunch Required: Calculate Cornelius Ltd’s trading profit for the year ended 31st December 2006.


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Revision exercise 27 Your Company Ltd An examination of the draft accounts of Your Company for the year ended 31st March 2007 reveals the following details in respect of specific items of expenditure and income. The draft accounts showed a profit of £290,000. Expenditure 1) Throughout the year, two of the directors were seconded to work elsewhere. One

worked for Oxfam – a leading charity – and his salary, paid by your company, was £22,000. The other worked for a subsidiary company in the group and his salary, also paid by your company, was £24,000.

2) Damages of £30,000 were paid to a customer who was injured by a falling crate

while visiting your factory. Only £18,000 was recovered from your public liability insurers.

3) During the year the company purchased freehold offices for £40,000. Your chief

engineer estimated that it would cost £2,000 to get them ready for use. In the event it cost £12,000. The amount spent purchasing the offices was capitalised but the repair expenditure of £12,000 was deducted in the profit and loss account.

4) Bad debts were written off amounting to £6,000.The appropriate ledger account for

the year showed that these all related to specific identified debtors. 5) Because of the overall contraction in trade, a supervisor was made redundant and

given a severance payment of £18,000. His statutory redundancy entitlement was £11,000.

Income 6) Goods were sold to a subsidiary in the Caribbean for £80,000. Had they been sold

to a UK customer the price would have been £120,000 Required: Compute the adjusted trading profit starting with the profits of £290,000 shown by the accounts. Give reasons for your adjustments.


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Revision exercise 28 Able Ltd, a small company, prepares accounts to 31st December. The company's pool of unrelieved expenditure on plant and machinery brought forward on 1st January was £11,000. During the year FYAs of 50% were available to small companies when purchasing plant. During the year ended 31st December the following transactions took place:

15th June Purchased plant for £6,500. 31st August Purchased plant for £12,000. 30th November Sold plant for £2,800 (originally purchased for £4,600). Required: Compute the capital allowances for the year ended 31st December. Revision exercise 29 Flash Ltd, a medium-sized company, prepares accounts to 31st December. At 1st January the tax WDVs are as follows: £ Pool 21,200 Expensive motor car 13,600 The following transactions took place during the year ended 31st December:

10.5.05 Purchased plant for £6,600 25.6.05 Purchased a motor car for £10,600 28.6.05 Purchased an energy saving toilet for £600 15.2.06 Sold the expensive motor car for £9,400 16.2.06 Purchased a motor car for £18,000 18.2.06 Purchased an electrically propelled car for £16,500 Required: Calculate the capital allowances for the year to 31st December.


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Revision exercise 30 XY Ltd trades as a tool manufacturer and makes up accounts each year to 30th June. The company's agreed profits before the deduction of capital allowances for the year to 30th June 2006 were £120,000. At the start of the year, tax written down values were:

General plant and equipment £45,000 Expensive car £20,000 The following purchases and sales of capital items took place during the year:

£ Purchases:

September General plant and equipment 60,000 October Motor car for employee (no private use) 10,000 November Motor car (40% private use by director) 28,000 Sales:

August Plant sold for 25,000 September Employee's car 2,000 November Expensive car sold for 12,000 Required: a) Compute the capital allowances for the accounting year. b) Compute the trading profits for the year.


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Revision exercise 31 Simple Simon Ltd Simple Simon Ltd had the following income and expenditure for the year ended 31st March 2007: Property business income £10,000 Trading income £95,200 Chargeable gains £25,000 Investment income (interest – gross) £18,000 Charges on income £2,000 Dividends plus tax credit £15,000 Required: Calculate Simple Simon’s CT for the year ended 31st March 2007. Revision exercise 32 Peter Pieman Ltd Peter Pieman Ltd had the following income and expenditure for the year ended 31st March 2007: Property business income £70,500 Trading income £465,700 Chargeable gains £10,000 Investment income (interest-gross) £13,200 UK dividends received (gross) £100,000 Required: Calculate Peter Pieman’s CT for the year ended 31st March 2007.


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Revision exercise 33 Charles Ltd has the following PCTCT for the year ended 31st March 2007: £ Trading income 360,000 Property business income 10,000 370,000 less Gift Aid donation (80,000) PCTCT 290,000 Required: What is the corporation tax liability if:

a) no dividends are received from UK companies?

b) £9,000 of dividends are received from UK companies?

c) £45,000 of dividends are received from UK companies? Revision exercise 34 Ross McHugh Ltd has the following results for the two years to 31st March 2007: Year Ended 31.3.06 31.3.07 £ £ Trading profit/(loss) (20,000) 18,000 Interest income 6,000 9,000 Capital loss (2,000) Chargeable gains 7,000 Required: Calculate the PCTCT for the two periods, assuming that the loss is relieved under S393(1) ICTA 1988 showing any losses carried forward at 1st April 2007.


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Revision exercise 35 Duck Soup Ltd has the following results for the year ended 31st March 2007: £ Trading loss before capital allowances (note 1) (96,000) Interest income 3,500 Chargeable gain 14,500 Net loss (78,000) Notes: 1) The trading loss is after charging: £

Depreciation 10,800 Entertaining customers 1,200

2) All other expenses are allowable for corporation tax. 3) The tax written down value of plant and machinery on 1st April 2005 was £16,000.

There were no purchases or sales during the year ended 31st March 2006. 4) Duck Soup Ltd has the following results for the previous year ending 31st March

2006: £

Trading profit 40,000 Interest income 2,000 Chargeable gains -------- 42,000

Required: Compute the allowable trading loss for the year ended 31st March 2007 and show how it can be relieved.


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Appendices

Appendix 1 – SSAP 9 SSAP 9 Stocks and long term work in progress This SSAP is based on the accruals/matching concept – costs must be allocated between the cost of goods sold (matched against current revenue) and costs of closing stock (carried in the balance sheet to be matched against future revenue). Main points:

• Stock should be valued at the lower of cost and net realisable value (NRV).

• Costs should include those incurred in the normal course of business in bringing a product or service to its present position and location.

• Costs include direct costs (labour, materials), production overheads and other attributable overheads.

• NRV is the actual or estimated selling price less further costs to be incurred in marketing selling and distribution.

• The principle instances where NRV will be less than cost will be where:

• there have been increases in cost or falls in selling price

• physical deterioration of stock has occurred

• products are obsolescent

• the company has decided to make and sell a product at a loss.


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Long term work in progress The most controversial aspect of SSAP 9 is its regulation concerning work in progress for incomplete long term contracts. Usually long term contracts will exceed one year. According to ‘prudence’, it would seem correct to treat all costs incurred on these contracts simply as WIP (unless it was foreseen that the costs would not be recovered), not recognising any profit until the contract is complete. SSAP 9, however, allows a proportion of profit to be recognised in stages over the life of the contract, provided that:

• it is expected to be profitable in the final analysis

• the contract is far enough advanced to enable the end result to be foreseen with reasonable assurance

• prudent estimates are used. Thus the matching concept, while apparently over-ruling prudence on this occasion, must still be applied prudently! The rules are as follows:

a) Turnover and profit must reflect the proportion of work carried out at the accounting date.

b) Where the outcome cannot be foreseen with reasonable certainty, no profit must be recognised.

c) If there is any expected loss on a contract, provision must be made for the loss as soon as it is foreseen.

For the profit and loss account:

• First ascertain the total estimated profit or loss on a contract.

• Ascertain attributable profit on the basis that it is prudent to recognise such profit.

• Calculate turnover:

The standard does not prescribe a method of calculating turnover. Recognise as turnover the same proportion of the total contract value as applied to the total estimated profit for ascertaining attributable profit to date. This is often given as the amount of work certified.

• Associated costs of achieving the turnover recognised should be deducted from total costs to date in the contract account and charged in the profit and loss account as cost of sales to give, as gross profit, the attributable profit or foreseeable loss on a contract as calculated.

You will be given information to calculate attributable profit or foreseeable loss. You will also be given a basis for recognising either turnover or cost of sales (or both). Given the basis for turnover, take cost of sales as the balancing item. Given the basis for cost of sales, take turnover as the balancing item.


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Foreseeable loss If a loss is foreseen on the contract as a whole, this loss must be taken into account immediately. It is never appropriate to recognise an attributable profit at one stage of the contract if an overall loss is expected on the contract as a whole. Further provisions for foreseeable loss should be included with cost of sales. Remember:

When, in the early stages of a contract, it is not possible to foresee its outcome with reasonable certainty, turnover will equal the costs that are charged to cost of sales. Therefore no profit from the contract will be recognised in the profit and loss account. However, when in the later stages of the contract the outcome can be assessed with reasonable certainty, turnover should include profit prudently recognised as earned at that stage of completion.

For the balance sheet:

• Long-term contracts in the balance sheet will comprise: £

Total costs to date x Less: Amounts transferred to cost of sales in respect of work carried out to date (x) Net costs x Less: any foreseeable losses (if costs remaining need to be further written down) (x) Less: any applicable payments on account (x)

X • Debtors: amounts recoverable on contracts will arise when turnover recognised is

greater than payments on account received and receivable.

• Where payments on account received and receivable are greater than turnover recognised, the excess should first be applied against any net costs remaining in the contract account (as above). Any further excess should be classified as ‘payments on account’ and separately disclosed in ‘creditors’.

• When foreseeable losses exceed net costs, the excess should be included in the balance sheet in either accruals or provisions.


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Disclosure The Companies Act requires that, either on the face of the balance sheet, or in a note to the accounts, the stock figure must be broken down into its components as follows (for all companies except those qualifying as small):

1) Raw materials and consumables

2) Work in progress

3) Finished goods and goods for resale Where amounts recoverable on contracts are included in debtors, these too must be split out in a note to the accounts.


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Appendix 2 – SSAP 21 SSAP21 – Hire purchase and leasing This SSAP covers the appropriate accounting treatment for assets which are used by a business but payment for the asset is spread over time. Principle:

the accounting treatment should reflect the commercial substance of the transaction, not its legal form.

There are basically four types of transaction possible:

• credit sale

• hire purchase

• finance lease

• operating lease. Only in the case of an operating lease does the user of the asset not record the asset as a fixed asset in his books at the start of the agreement. The decision as to whether a lease is an operating lease or a finance lease is an important one, as this will affect the accounting treatment and therefore the reported profit figure and balance sheet ratios such as ROCE, gearing etc. Definition:

a finance lease is a lease that transfers substantially all the risks and rewards of ownership of an asset to the lessee.

Step 1: calculate minimum lease payments (including initial payment) Step 2: discount the answer to step 1 using the rate of interest implicit in the lease Step 3: calculate the fair value of the asset at the start of the lease If the answer to step 2 amounts to 90% or more of the answer to step 3, it is a finance lease.


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Principles of accounting treatment – books of the lessee Operating leases:

• payments are debited to the profit and loss account as incurred

• no asset is recorded in the books. All others:

• asset is recorded at fair value and a corresponding liability set up

• payments are split between repayment of capital amount and payment of finance charges

• finance charges are debited to the profit and loss account

• repayment of the capital amount reduces the balance sheet liability

• depreciation is calculated and charged over the shorter of the lease period and the useful life of the asset.

Acceptable methods of splitting payment between capital repayment and finance charges include:

• straight line: only acceptable for short term credit agreements

• sum of the digits: also known as the rule of 78

• actuarial method: the most accurate and hence the favoured treatment Principles of accounting treatment – books of the lessor Operating leases:

• asset included in fixed assets under "assets held for operating leases" and depreciated in normal way

• rental income credited as operating income to the profit and loss account All others:

• asset treated as sold for fair value and corresponding debtor set up as "net investment in finance leases"

• payments split as for lessee between payment of principle and finance charge

• credit finance charge to profit and loss account; payment of principle reduces the debtor


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Disclosure requirements of SSAP 21 The treatment used in the accounts, including the method chosen to allocate the finance charges, should be disclosed in the accounting policies note to the accounts. Also, in the books of the lessee: • Finance leases and HP:

• Assets

These either show by each major class of assets the gross amounts of assets held and the related accumulated depreciation or integrate these with owned fixed assets and disclose by way of an additional note the NBV of assets held under finance leases and HP agreements.

• Liabilities

The amounts of obligations due under finance leases/HP agreements should be disclosed separately from other liabilities either on the face of the balance sheet or in the notes to the accounts.

These amounts should be shown analysed between due in next year, due in the second to fifth years inclusive, and due thereafter (this analysis can be shown separately or as part of an equivalent analysis of the total liabilities of which they form part).

• Profit and loss account

The total depreciation charge and aggregate finance charges for the period in respect of finance leases and HP contracts should be disclosed by way of note.

• Operating leases:

Disclose by way of a note to the profit and loss account the total operating lease rentals, split between hire of plant and machinery and other.

In the books of the lessor: The standard requires disclosure of the net investment in a) finance leases and b) HP agreements at each balance sheet date. These should be disclosed separately in a note to the accounts analysed between receivable within one year and receivable after one year. For assets held for use in operating leases, the cost/valuation and accumulated depreciation should be shown, either as part of the fixed asset schedule or in a separate table.


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Dealing with finance leases in published accounts Balance sheet:

Step 1: The leased asset should be capitalised in the fixed asset account at fair value (ie list price or PV of minimum lease payments).

Step 2: Calculate and charge depreciation over the lease period.

Step 3: Calculate NBV for balance sheet.

Step 4: Set up a lease creditor for the same amount as the leased asset in step 1.

Step 5: Calculate total finance charge (the difference between the total of the minimum lease payments and the fair value of the asset.

Allocate the finance charge to accounting periods over the term of the lease using either:

• actuarial method

• sum of the digits method; or

• straight line method.

Step 6: Reduce the lease creditor by the difference between the lease payment and the finance charge.

Profit and loss account: Step 1: Annual depreciation charged as normal to cost of sales, administration or

distribution. Step 2: Finance charge allocated to current period included in ‘Interest paid and

payable’ but disclosed separately in the notes.


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Appendix 3 – FRS 15 FRS 15 – Tangible fixed assets FRS 15 came into force in April 2000 and replaced SSAP 12. It is intended to give guidance on the initial valuation of tangible fixed assets for balance sheet purposes and the treatment appropriate for arriving at subsequent carrying value. Definition:

Tangible fixed assets are assets that have physical substance and are held for use in the production or supply of goods and services, for rental to others, or for administrative purposes on a continuing basis in the reporting entity’s activities.

Initial value FRS 15 states that a tangible fixed asset should initially be measured at its cost. In practice, an asset’s cost is:

purchase price less trade discounts or rebates plus any further costs directly attributable to bringing it into working condition for its intended use.

Costs which might be included in the initial valuation include:

• stamp duty and other duties

• legal fees

• delivery and handling costs

• installation costs. If the entity has constructed the fixed asset rather than buying it, it might incur other costs:

• materials

• labour

• architects’/designers’ fees

• direct overheads. Only those costs that are directly attributable to bringing the asset into working condition for its intended use should be included, never an apportioned amount of general overhead. FRS 15 also states that ‘abnormal’ costs should not be included. These might include additional costs caused by faulty workmanship, industrial disputes, design errors, etc.


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One of the more controversial aspects of initial valuation concerns the capitalisation of interest costs. FRS 15 leaves this as optional, but lays down rules which must be followed if interest costs are capitalised. Arguments for:

• finance costs are just as much a cost of constructing a tangible fixed asset as other directly attributable costs

• the accounts are more likely to reflect the true success or failure of projects involving the construction of fixed assets

• failure to capitalise borrowing cost means that profits may be reduced in periods when fixed assets are acquired. This is misleading as capital investment should increase profit in the long run.

Arguments against:

• borrowing costs are incurred in support of the whole of the activities of an enterprise. Any attempt to associate such costs with a particular asset is necessarily arbitrary.

• capitalisation of borrowing costs may lead to the same type of asset having a different carrying value, depending on the method of finance adopted by the enterprise.

• treating borrowing costs as a charge against income results in financial statements giving more comparable results from period to period, thus providing a better indication of the future cash flows of an enterprise.

• capitalisation leads to higher tangible fixed asset values, which could exceed the recoverable amount of the asset.

The rules:

• Only finance costs that are directly attributable to the construction of a tangible fixed asset should be capitalised as part of the cost of that asset.

• The total amount of finance cost capitalised during a period should not exceed the total amount of finance cost incurred during the period.

• Capitalisation should begin when:

i) finance costs are being incurred

ii) expenditures for the asset are being incurred

iii) activities that are necessary to get the asset ready for use are in progress.

• Capitalisation should be suspended during extended periods in which active development is interrupted.

• Capitalisation should cease when substantially all the activities that are necessary to get the tangible fixed asset ready for use are complete.


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Disclosures When finance costs are capitalised, the following disclosures must be made:

i) the accounting policy adopted

ii) the aggregate amount of finance costs included in the cost of the tangible fixed assets

iii) the amount capitalised during the period

iv) the amount recognised in the profit and loss account during the period

v) the interest rate used to determine the amount capitalised. Subsequent expenditure can only be capitalised if it enhances an asset, by, for example, extending its useful economic life, increasing its capacity or achieving a significant improvement in quality of output. Revaluation of fixed assets The Companies Act, 1985 allows tangible fixed assets to be carried either at historic cost or at a valuation. Many entities take advantage of this rule and revalue some of their fixed assets (normally property). Other entities continue to carry all assets at historic cost. There are strong arguments for carrying assets at current value and the ASB wishes to encourage this as it believes this provides more relevant information to users of financial information. However, until the issue of FRS 15 there was no accounting standard that gave guidance on revaluation. This has led to the following problems:

• valuations are not kept up to date

• entities ‘cherry pick’ ie revalue certain assets and not others

• some entities do not depreciate revalued fixed assets. Basic rules:

• revaluation is optional

• if one asset is revalued, so must all assets in that class be revalued

• the carrying value of a revalued fixed asset should be its current value at the balance sheet date (current value = lower of replacement cost and recoverable amount).


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FRS 15 does not insist on annual revaluations but requires the following:

• a full valuation every five years with an interim valuation in year 3 or in other years when there has been a material change in value

Five-yearly valuations should be carried out by a qualified external or internal valuer. If an internal valuer is used, the valuation should be reviewed by a qualified external valuer. Bases of valuation Non-specialised properties should be valued on the basis of existing use value plus directly attributable acquisition costs, if material. Open market value should be disclosed if materially different. Specialised properties should be valued on the basis of depreciated replacement cost. Properties surplus to requirement should be valued at open market value less expected direct selling costs (NRV). All other revalued assets should be valued on the basis of open market value where available, or depreciated replacement cost. Gains and losses on revaluation The Companies Act states that only realised gains can be recognised in the profit and loss account. Revaluation gains are not realised until and unless the asset is sold. They are therefore recognised in the Statement of Recognised Gains and Losses (we shall meet this third primary statement later when we consider FRS 3 requirements) and accounted for using a revaluation reserve. Losses are treated according to the cause:

• revaluation losses which are caused by a clear consumption of economic benefits should be recognised in the profit and loss account (they are akin to depreciation)

• other losses (perhaps caused by a market slump) should normally be recognised in the Statement of Total Recognised Gains and Losses and accounted for in the revaluation reserve until the carrying amount reaches its depreciated historic cost. Any further loss should be shown in the profit and loss account.


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Depreciation Depreciation is redefined by FRS 15 as:

the measure of cost or revalued amount of the economic benefits of the tangible fixed asset that have been consumed during the period.

The depreciable amount should be allocated on a systematic basis over the life of the asset, reflecting as fairly as possible the pattern in which the asset’s economic benefits are consumed by the entity. This is no change from the requirements of SSAP 12. However, there is an attempt to address the problem of companies which did not depreciate certain revalued assets. In the past, many entities did not charge depreciation on revalued properties on the grounds that the assets were being maintained or refurbished regularly so that the economic life of the property was limitless (this treatment was common in the hotel, brewing, public house and retail sectors). It had been expected that FRS 15 would insist on depreciation in all circumstances. The ASB has recognised, however, that there may be rare cases where tangible fixed assets do have very long useful economic lives. FRS 15 says that in these rare cases the entity need not charge depreciation but will have to hold annual impairment reviews instead (FRS 11). These reviews are time consuming, costly and complex and may result in reduced profit (due to showing an impairment loss). This will discourage non-depreciation more effectively than a ban! Disclosure In the note to the accounts, a company must disclose (for each class of assets):

a) the depreciation method used

b) the useful economic lives or rates used

c) the total depreciation charge for the period

d) the effect of any change in estimate of useful economic lives or residual value, if material.


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Fixed asset schedule The Companies Act gives the following schedule as a disclosure note to be used for all major classes of fixed assets. It can also be an excellent working note to help you ensure that you have dealt with all aspects of the accounting.

Land and property

Plant and equipment

Total

£000 £000 £000

At cost/revaluation

Opening balances

Additions

Disposals

Transfers

Revaluations

Closing balances

Depreciation

Opening balances

Disposals

Revaluations

Charge for year

Closing balances

NBV at end

NBV at start


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Appendix 4 – FRS 3 FRS 3 – Reporting financial performance The objective of FRS 3 is stated as:

to require reporting entities falling within its scope to highlight a range of important components of financial performance to aid users in understanding the performance achieved by a reporting entity in a period and to assist them in forming a basis for their assessment of future results and cash flows.

Why was FRS 3 necessary? The profit and loss account is arguably the most significant single indicator of a company's success or failure. It is very important to ensure that it is not presented in such a way as to be misleading. This could happen either through an inadvertent lack of consistency within a company or between different companies; or it could arise as a result of deliberate manipulation of accounting figures by unscrupulous directors. FRS 3 applies to all financial statements intended to give a true and fair view, unless the entity is obliged to prepare accounts under a statutory framework which does not permit such treatment. FRS 3 Profit and loss account A layered format is to be used for the profit and loss account to highlight a number of important components of financial performance:

a) results of continuing operations

b) results of discontinued operations

c) profits or losses on the sale or termination of an operation, costs of a fundamental reorganisation or restructuring and profit or losses on the disposal of fixed assets

d) extraordinary items. The following points must be noted:

a) The analysis of results between continued and discontinued operations should be disclosed to the level of operating profit.

b) All exceptional items (except those in c) below) should be included under the statutory format heading to which they relate and disclosed by way of a note.

c) The following items must be shown separately on the face of the profit and loss account after operating profit and before interest:

i) profits or losses on the sale or termination of an operation

ii) costs of a fundamental reorganisation or restructuring

iii) profits or losses on the disposal of fixed assets.


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Statement of total recognised gains and losses This is a new primary financial statement of equal status with the profit and loss and balance sheet. It shows the profit or loss for the period along with all other movements on reserves which reflect recognised gains and losses attributable to shareholders. It does not deal with the realisation of gains in previous periods, nor with transfers between reserves. This means that the excess of the revalued amount over historical cost will never be recognised in the profit and loss account. Profit or loss on disposal will be calculated as the difference between the net proceeds and the net carrying amount. Earnings per share EPS is now calculated on the profit attributable to equity shareholders after minority interest, extraordinary items, preference dividends and other appropriations in respect of preference shares. If an EPS figure is given based on any other level of earnings, then it cannot be given greater prominence than the proper EPS figure and a reconciliation between the two figures must be disclosed. Required notes:

• Note of historical cost profits and losses

This is a memorandum item which helps comparison between the results of companies which have revalued their assets with the results of those which have not. It shows the results for the period as if no revaluation had been made. The note should be shown immediately after the profit and loss or after the statement of recognised gains and losses.

• Reconciliation of movements in shareholders' funds

This brings together the results of the period, shown in the statement of total recognised gains and losses with all other changes in shareholders' funds in the period, including capital contributed by or repaid to shareholders.

• Prior period adjustments

Prior period adjustments should be accounted for by restating the comparative figures for the preceding period in the primary statement and notes and adjusting the opening balance of reserves for the cumulative effect. The cumulative effect of the adjustments should also be noted at the foot of the statement of total recognised gains and losses of the current period. The effect of prior period adjustments on the results for the preceding period should be disclosed where practicable.

These are rare and limited to occasions where:

a) there has been a change in accounting policy;

b) there has been a fundamental error in the past which must now be corrected.


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Effect of FRS 3 a) Extraordinary items will be much rarer (non-existent? Sir David Tweedie famously

said that after the introduction of FRS 3 “little green men from Mars are extraordinary – all else is exceptional”).

b) A new format has been introduced for the profit and loss splitting continuing

operations and discontinued operations. Disclosure will be much fuller. c) A new statement has been introduced – the statement of recognised gains and

losses. The ASB's aim has been to turn attention away from particular numbers or indicators and to encourage users to make their own judgments about a company's performance. This statement cannot be lost in the notes as the reserve note was under SSAP 6.

Note that one of the main reasons for the FRS was the collapse of Polly Peck. The size of the exchange movements going through reserves was considerable and although they had been disclosed, they had not been highlighted.

FRS 3 – Additional information FRS 3 introduced a new statement and a variety of new notes to expand the information required in published accounts – and to help the user of the published information get a clear picture of the company’s performance. Statement of Total Recognised Gains and Losses It is important to understand that the profit and loss account can only deal with realised profits. A company may also make substantial unrealised gains or losses. These may be recognised in the accounts, even although they have not been realised. For example, gains on the revaluation of fixed assets are recognised by increasing the carrying value of the assets in the balance sheet, with the double entry being to a revaluation reserve. The new primary statement, the statement of recognised gains and losses, brings together realised gains/losses from the profit and loss account and recognised but unrealised gains/losses from the balance sheet. Statement of Total Recognised Gains and Losses (STRGL) £m Profit for the financial year (profit after tax) 29 Unrealised surplus on revaluation of properties 4 Unrealised loss on revaluation of trade investment (3) 30 Foreign currency translation differences (2) Total gains and losses recognised since last annual report 28 Prior year adjustment 10 38


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In addition to this statement, FRS 3 brought in the requirement for the following two notes:

a) Reconciliation of movement in shareholders’ funds

This simple reconciliation is designed to clarify exactly what has caused shareholders’ funds to change during the period. Shareholders’ funds include all reserves and, of course, share capital itself. Typically: £m Profit for the financial year (profit after tax) 29 Dividends (8) 21 Other recognised gains and losses (per STRGL) (1) Prior year adjustment 10 New share capital 20 Addition to shareholders’ funds 50 Opening shareholders’ funds 365 Closing shareholders’ funds 405

b) Note of historic cost profits and losses

If a company has adopted the policy of revaluing fixed assets, permitted under the rules of FRS 15, the reported profit figure will be different from that which would have been reported under the historic cost convention. If this difference is material, then the financial statements must include a reconciliation statement after the STRGL or the profit and loss.

The profit figure to be reconciled is the profit before taxation; however, the retained profit for the year must also be restated. Typically: £m Reported profit before taxation 45 Realisation of property revaluation gains of previous years 9 Difference between historic cost depreciation and the actual charge for the period calculated on revalued amounts 5 59 Retained profit under historic cost convention 35


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Appendix 5 – SSAP25 SSAP25 – Segmental reporting Now enshrined in SSAP 25, segmental reports were a recommendation of “The Corporate Report”. Definition:

The analysis of general corporate information between separate divisions or classes of business which are individually of economic significance.

Purpose:

To provide information to assist the user of financial statements:

a) to appreciate more thoroughly the results and financial position of the entity by permitting a better understanding of the entity’s past performance and thus a better assessment of its future prospects; and

b) to be aware of the impact that changes in significant components of a business may have on the business as a whole.

A segment is significant if:

a) its third party turnover is over 10% of the entity’s turnover

b) its segment profit or loss is over 10% of the entity’s profit or loss

c) its net assets are more than 10% of the total assets of the entity. These should be reviewed annually and re-defined as appropriate. Segments can be ‘class of business’ or geographical. Classes of business:

A distinguishable component of an entity that provides a separate product or service or separate group of products or services.

Geographical segments:

A geographical area comprising a country or group of countries in which an entity operates, or to which it supplies goods or services.


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Disclosure Group information should be disclosed about each class of business and each geographical segment as follows:

1) Turnover by origin and destination

2) Profit/loss before taxation

3) Common costs

4) Segment net assets Advantages of disclosure:

• rates of profitability, opportunities for growth, risk etc may vary between segments

• provides data which gives users a better basis for making important decisions. However:

Such information may be of great use to competitors and there is a ‘get out’ clause, allowing directors to withhold such a breakdown if it would do commercial harm to the business.


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Appendix 6 – FRS 18 – Theoretical matters FRS 18 – The Statement of Principles Alternative accounting models The search for a conceptual framework What is a ‘conceptual framework’?

A statement of generally accepted theoretical principles which form the frame of reference for a particular field of inquiry.

More specifically:

A constitution: a coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function and limits of financial accounting and financial statements.

USA

A framework to provide a consistent approach for making decisions about choices of accounting practice and for setting standards.

UK Why was the search begun? There was a growing perception towards the end of the 1980s that standards had been developed in a haphazard manner, leading to conflicts between standards and lack of consensus in various aspects of financial reporting. International pressure grew for a conceptual framework which would concentrate on meeting the needs of the users of accounts. The Solomon’s report of 1989 formalised the feelings that the form and content of financial reports had been determined without resolving the following fundamental issues:

• What are the objectives of financial reports?

• Who are the users of financial reports?

• What are the true information needs of these user groups?

• What types of reports will satisfy these needs?

• How can business profit be measured and reported accurately and consistently?

• How should assets and liabilities be valued? In 1991, the newly formed ASB addressed the need for a conceptual framework, working closely with the international standards committee. The result is the Statement of Principles.


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The stated purposes of the Statement of Principles:

a) To assist the ASB in the development of future accounting standards and in its review of existing accounting standards.

b) To assist the ASB by providing a basis for reducing the number of alternative accounting treatments permitted by law and accounting standards.

c) To assist preparers of financial statements in applying accounting standards and in dealing with topics that do not form the subject of an accounting standard.

d) To assist auditors in forming an opinion on whether financial statements conform with accounting standards.

e) To assist users of financial statements in interpreting the information contained in financial statements prepared in conformity with accounting standards.

f) To provide those who are interested in the work of the ASB with information about its approach to the formulation of accounting standards.

The Statement of Principles does not have the status of an accounting standard and, therefore, does not override any specific accounting standard. If there were to be a conflict (unlikely hopefully) the requirements of the accounting standard prevail over those of the Statement of Principles. The Statement of Principles The Statement of Principles contains eight chapters:

1) The objective of financial statements

2) The reporting entity

3) The qualitative characteristics of financial information

4) The elements of financial statements

5) Recognition in financial statements

6) Measurement in financial statements

7) Presentation of financial information

8) Accounting for interests in other entities.


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Main points Chapter 1 The objective of financial statements is to provide information about the financial position, performance and financial adaptability of an enterprise that is useful to a wide range of users for assessing the stewardship of management and for making economic decisions. The chapter emphasises the ways financial statements provide information about the financial position of an enterprise. The main elements which affect the position of the company are:

i) the economic resources it controls

ii) its financial structure

iii) its liquidity and solvency

iv) its capacity to adapt to changes in the environment in which it operates. The chapter discusses the importance of each of these elements and how they are disclosed in the financial statements. Chapter 2 This chapter addresses which entities ought to prepare and publish financial statements and what determines the boundary when circumscribing the relevant activities and resources on which the entity reports. Chapter 3 This chapter discusses characteristics of information in relation to content and presentation:

• Relevance and reliability are key in relation to content.

• Comparability and understandability are key in relation to presentation.


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Chapter 4 Definitions of key terms are given. These definitions are already appearing in new FRSs and their presence has been widely welcomed. Their inclusion makes this a vital chapter. Definitions of key terms:

Assets are rights or other access to future economic benefits controlled by an entity as a result of past transactions or events.

Liabilities are obligations of an entity to transfer economic benefits as a result of past transactions or events.

Ownership is the residual amount found by deducting all of the entity’s liabilities interest from all of the entity’s assets.

Gains are increases in ownership interest other than those relating to contributions from owners.

Losses are decreases in ownership interest other than those relating to distributions to owners.

Chapter 5 This chapter explains what is meant by recognition. It discusses the three stages of recognition of assets and liabilities and then goes on to describe the criteria which determine each of these stages. These stages are:

a) Initial recognition

An element should be recognised if there is sufficient evidence that the change in assets or liabilities inherent in the element has occurred and evidence that a future inflow or outflow of benefit will occur.

b) Subsequent remeasurement

A change in the amount at which an asset or liability is recorded should be recognised if there is sufficient evidence that the amount of an asset or liability has changed and the new amount can be measured with reasonable certainty.

c) Derecognition

A asset or liability should cease to be recognised if there is no longer sufficient evidence that the entity has access to future economic benefits or an obligation to transfer economic benefit.


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Chapter 6 This chapter deals with the measurement of assets for valuation on the balance sheet. It also deals with the influence of capital maintenance on the measurement of gains and losses. Initially the asset should be recorded at historical cost (ie transaction cost). This is as at present. However, the chapter then goes on to suggest that assets and liabilities should regularly be “remeasured” in order to include them at a current value – value to the business. This is not a popular idea due to its unfamiliarity and, some say, lack of verifiability. This chapter forms the basis of FRS 15. Chapter 7 This chapter looks at the set of financial statements and supplementary data provided at present and looks at the factors which affect the arrangement of data within this set. In particular it looks at:

• Aggregation: how transactions are condensed and simplified

• Classification: whether analysis is facilitated by the groupings in the statements

• Structure: proper structuring will ensure prominence is given to the correct items

It sets out the primary statements:

• the profit and loss account

• the statement of total recognised gains and losses

• the balance sheet

• the cash flow statements and describes the role of the supporting notes to these statements. Chapter 8 This chapter deals with the measurement and presentation issues of the effect on a reporting entity’s financial performance and position of its interest in other entities. It considers both single entity and consolidated financial statements.


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Advantages of a statement of principles: 1) ‘Principles are powerful. A single principle, consistently applied, can suggest

solutions to many issues. A principled approach to different issues not only ensures solutions are consistent with each other; if the principle is soundly framed, the solutions will be the right ones.’

(Technical director, ASB) 2) The statement helps reduce scope for individual judgment and the potential

subjectivity that this implies. 3) Financial statements should be more comparable. 4) The statement should provide guidelines for procedures not the subject of a

standard.


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FRS 18 – Accounting policies Issued December 2000 Effective 22 June 2001 FRS 18 sets out the principles to be followed in selecting accounting policies and the disclosures needed to help users to understand the accounting policies adopted and how they have been applied. Objective The objective of FRS 18 is to ensure that for all material items:

a) an entity adopts the accounting policies most appropriate to its particular circumstances for the purpose of giving a true and fair view;

b) the accounting policies adopted are reviewed regularly to ensure that they remain appropriate, and are changed when a new policy becomes more appropriate to the entity’s particular circumstances; and

c) sufficient information is disclosed in the financial statement to enable users to understand the accounting policies adopted and how they have been implemented.

Definitions Accounting policies Those principles, bases, conventions, rules and practices applied by an entity that specify how the effect of transactions and other events are to be reflected in its financial statements through:

i) recognising,

ii) selecting measurement bases for, and

iii) presenting assets, liabilities, gains, losses and changes to shareholders’ funds. Accounting policies do not include estimation techniques.


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Estimation techniques The methods adopted by an entity to arrive at estimated monetary amounts, corresponding to the measurement bases selected, for assets, liabilities, gains, losses and changes to shareholders’ funds. Estimation techniques implement the measurement aspects of accounting policies. They include, for example:

a) methods of depreciation, such as straight line and reducing balance, applied in the context of a particular measurement basis, used to estimate the proportion of the economic benefits of a tangible fixed asset consumed in a period.

b) different methods used to estimate the proportion of trade debtors that will not be recovered, particularly where such methods consider a population as a whole rather than individual balances.

Measurement bases Those monetary attributes of the elements of financial statements that are reflected in financial statements. This might for instance be historic cost or current value. Applying the definitions in practice Often legislation or accounting standards will prescribe the measurement bases to be used in respect of particular assets and liabilities. Some standards allow a degree of choice concerning what is to be recognised in the financial statements. Whether prescribed or chosen, measurement bases are a matter of accounting policy, and the basis used must be disclosed. The choice of method used to arrive at a monetary amount corresponding to a measurement basis is not a matter of accounting policy, but a matter of estimation technique.


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Choice of accounting policies An entity should adopt accounting policies that enable its financial statement to give a true and fair view of the entity’s financial performance and position. If in exceptional circumstances compliance with the requirements of an accounting standard is inconsistent with the requirement to give a true and fair view, the requirements of the standard should be departed from to the extent necessary to give a true and fair view. In such circumstances, the disclosures mentioned later must be made – this has become known as the “true and fair view override”. Concepts According to FRS 18, two concepts – the going concern assumption and accruals – play a pervasive role in financial statements and hence in the selection of accounting policies. Going concern An entity should prepare its financial statements on a going concern basis unless:

a) the entity is being liquidated or has ceased trading; or

b) the directors have no realistic alternative but to liquidate the entity or cease trading. The going concern assumption mainly affects the valuation of assets. Accruals An entity should prepare its financial statements, except for cash flow information, on the accrual basis of accounting. This requires the non-cash effects of transactions and other events to be reflected as far as possible in the accounting period to which they relate, and not in the period in which any cash involved is received or paid. Judging the appropriateness of selected accounting policies The standard sets the test for acceptability of a policy as adopted by discussing the four main required qualities of information:

• relevance

• reliability

• comparability

• understandability. The standard discusses these in some detail and points out that the four may be incompatible at times. At such times, sense must be used. The two most common conflicts envisaged are: Relevance versus reliability (if the most relevant policy is not the most reliable, the appropriate one to use is the most relevant of those that are reliable).


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Neutrality versus prudence within the context of reliability (prudence can cause bias, and policy selection must not cause deliberate understatement of assets and gains or overstatement of liabilities and losses). Reviewing and changing accounting policies The standard recommends frequent review of accounting policies and change to more appropriate treatments if they are consistent with the requirements of statute and standards. Where appropriate, previous year's figures will be adjusted to aid comparability and although frequent change in policy may be seen as inconsistent, this should not deter the entity from making changes if they are desirable from the point of view of appropriateness. Disclosures FRS 18 is principally a disclosure standard and this is in some respects the most important part of the standard. The following information must be disclosed:

a) a description of each of the accounting policies that is material in the context of the entity’s financial statements.

b) a description of those estimation techniques that are significant.

c) details of any changes to the accounting policies that were followed in preparing the financial statements for the preceding years, including:

i) a brief explanation of why each new accounting policy is thought more appropriate

ii) where practicable, the effect of a prior period adjustment on the results for the previous period, in accordance with FRS 3

iii) where practicable, an indication of the effect of a change in accounting policy on the results for the current period.

d) where the effect of a change in an estimation technique is material, a description of the change and, where practicable, the effects on the results for the current period.

The objective of the disclosure requirements is to enable the accounting policies adopted by an entity to be understood by users having a reasonable knowledge of business and economic activities and accounting and a willingness to study with reasonable diligence the information provided. There must also be disclosure of any circumstances which might throw doubt on the appropriateness of the going concern assumption and details of the use of any true and fair view override described previously.


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Alternative accounting models At various times (usually when we are undergoing a period of high inflation) users of accounts will call into question the usefulness of a set of accounts based on historic cost – especially because most, if not all, users are interested more in the future than the past. Accountants have at various times sought to introduce alternatives to the historic cost model, but these have not proved successful and with inflation very low now, the search has all but ceased. The Canadian accountancy profession is considering research that suggested a version of current cost accounting might be a better way forward – but so far they have not found many supporters. We do now have a standard (as a result of the international harmonisation process) that gives instruction on accounting during hyperinflationary times – FRS 24 – but this does not apply to the UK at the present time and would only affect UK companies with overseas subsidiaries in such economies. The basic rule remains that we account on a modified historic cost basis. The problems of historic cost accounting:

• It ignores current value of assets and therefore understates the value of resources used in the business.

• As no account is taken of the changing value of money over time, it is difficult to interpret trends.

• Profit may be overstated as current revenue is matched with out of date costs. This could lead to an imprudent distribution, eg if a business buys an item of stock for £10 and sells it for £20, historic cost accounting would show a distributable profit of £10. However, if the replacement cost of the item has risen to £13, that would leave insufficient funds to remain in business.

• Ratios based on historic cost accounts (which tend to overstate profit and understate asset values) can be misleading.

• No attempt is made to recognise the loss that arises through holding assets of fixed monetary value and the gain that arises through holding liabilities of fixed monetary value.

Modified historic cost accounts still prevail, partly because of the difficulty of finding an acceptable alternative. The benefits of historic cost accounting:

• They are generally understood and accepted by the business community.

• They are relatively objective.

• They are verifiable.


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The concept of profit/income The basic question – How much better off are you after the period in question? In a set of accounts:

Opening capital + profit = Closing capital

OR Opening net assets + profit = Closing net assets Thus the increase in net assets can be described as profit/income and, conversely, profit/income is reflected by an increase in net assets (or in wealth?). The measurement of income and the valuation of assets are therefore interlinked. The concept of capital maintenance The above calculation of income can only be regarded as true if it reflects a real increase, ie it measures how much better off the owner is after the period in question in some real way. There are two ways of regarding this ‘maintenance’ of wealth:

• Financial capital maintenance

Capital = the purchasing power of owners' equity

Income = the amount that can be consumed while maintaining capital so defined

This concept underlies current purchase power (CPP) accounting

• Physical capital maintenance

Capital = net operating assets = the operating capability of the entity

Income = the amount that can be consumed while maintaining the operating capability of the entity

This concept underlies current cost (CCA) accounting


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HCA, CPP and CCA compared Alan sets up business on 1st January with £1,000, which he immediately uses to buy goods for resale. On 31st January he sells these goods for £1,500. At this date, the replacement price of the goods to Alan is £1,200. During January the retail price index (RPI) rose by 30%. In historic cost terms: £ Sales 1,500 Cost of sales 1,000 Profit/Income 500 In real terms, how much better off is Alan? He began with £1,000. To maintain his purchasing power, he would have had to increase this by 30% to £1,300 by 31 January. In fact he has £1,500. Thus, in current purchasing power terms: £ Capital at 31st January 1,500 Capital required to maintain purchasing power 1,300 Profit/income 200 If Alan wishes to remain in business at the same level he must replace the goods he has sold with new stock, costing £1,200. If the profit and loss account is to show the amount which can reasonably be distributed while maintaining the operating capability of the business, the profit would more sensibly be based on a current cost basis: £ Sales 1,500 Cost of sales 1,200 Profit/income 300


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Current Cost Accounting Intention To show the effect of changing price levels on the results and net asset position disclosed by HC accounts, in particular on:

• operating profit

• distributable profit

• operating asset valuation. The profit and loss account Four adjustments are made to the profit and loss account:

i) The depreciation adjustment – the extra depreciation charge required to reflect the replacement cost of fixed assets

ii) The cost of sales adjustment – the adjustment required to match revenue with current cost of sales at the time the sale was made

iii) The monetary working capital adjustment – the additional/reduced amount of finance required to maintain the monetary working capital as a result of changes in input prices of goods and services used and financed by the business.

The operating profit is adjusted by the net effect of these three adjustments iv) The gearing adjustment – limiting the effect of the above three adjustments on

equity to take account of the fact that if the company has long term debt, and interest is paid out of pre-tax profit, the effect will be lessened by the tax shield.

This further adjustment will then give the profit available to ordinary shareholders. The balance sheet Fixed assets – adjust value to reflect value to the firm, ie the lower of net replacement cost or recoverable amount. The recoverable amount is the higher of realisable value or deprival value. Stock – adjust value to reflect value to the firm, ie the lower of net replacement cost or net realisable value. The net effect of the adjustments is transferred to a CC reserve from the profit and loss account, thus reducing the amount of distributable profit to that amount which will not reduce the operating capability of the company. The main problem with this approach is the complexity and the difficulty of arriving at objective values for the assets.


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Current Purchasing Power Accounting CPP takes the historic cost accounts and adjusts them to show the effects of inflation, especially on the capital value of the enterprise from the owners' point of view. Historic cost accounts are adjusted to current monetary value by application of the RPI to all non-monetary items. Underlying principles • Owners' capital = purchasing power of owners' capital • Profit = the amount that can be consumed while maintaining capital as

defined above Advantages:

• Simple to apply and understand

• The RPI is easily obtainable and regularly updated. It is therefore objective.

• It shows the direct effect of inflation on the enterprise's profit and valuations.

• It does not attempt to examine whether or not assets will be replaced; it simply updates their apparent economic value, taking inflation into account.

Disadvantages:

• The RPI is not necessarily relevant to the specific assets of the company.

• Subjectivity in the preparation of the historic cost accounts is aggravated by CPP.

• The effects of technological change etc on asset values are ignored.

• Because of this, CPP does not give a realistic measure for distributable profit.


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Appendix 7 – Adjusting the accounting profit The taxable trading profit of a company is rarely the same as the accounting profit shown in the company’s profit and loss account – unfortunately! This is partly because we have the room within accounting standards to exercise judgement about how certain items are treated and this may (would?) result in manipulation if choices were available that reduced the tax charge. Nevertheless, the before tax accounting profit is the starting point for the series of adjustments that are normally necessary. Adjustments There are four types of adjustment that need to be made to move from accounting profit to the taxable trading profit (or taxable profit):

1) Expenditure which tax law prevents from being an allowable deduction may have been charged in the profit and loss account.

2) Income taxable as trading profit may not be charged in the profit and loss account.

3) Expenditure that is deductible for tax purposes may not be charged in the profit and loss account.

4) Income may be included in the profit and loss account that is not taxable as trading profit.

The first two types of adjustments increase the profit figure and the second two reduce it. The format often used is: £ £ Net profit as per accounts (profit before tax) X Add: Expenditure charged in the accounts which is not deductible from trading profits X Income taxable as trading profits but which has not been included in the accounts X X X Less: Expenditure which is deductible from trading profits but not charged in the accounts (X) Profits included in the accounts but are not taxable trading profits (X) Capital allowances (X) (X) Taxable trading profit (X)


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Before you start to make adjustments, two important points need to be emphasised:

• It is only the company’s taxable trading profit that is being calculated. The fact that an item of income (such as rental income) is excluded does not mean that it is not taxable, only that it is not taxable as trading profits.

• The starting point in deciding whether or not an adjustment is necessary is the principle of normal commercial accountancy. These apply unless overridden by tax law.

Non-deductible expenditure Non-deductible expenditure (also known as disallowable expenditure) is by far the most common form of adjustment that has to be made to the profit and loss account and includes the following:

• Expenditure not incurred wholly and exclusively for trading purposes

Such expenditure may be disallowed because it is too remote from the purposes of the trade (the remoteness test) or because it has more than one purpose and one of them is not trading (the duality principle).

• Capital expenditure

Expenditure on capital assets is not allowed in computing trading profits, so any amount charged to the profit and loss account for capital expenditure or depreciation, loss on the sale of fixed assets, or amortisation of a lease, must be added back to the accounting profit figure for the computation of trading profits.

The distinction between revenue expenditure, which is allowable, and capital expenditure, which is disallowed, is not always clear-cut, especially when deciding if expenditure is repairs (revenue therefore allowable) or enhancement (capital therefore disallowed).

The cost of initial repairs is deductible if the asset can be put into use before the repairs are carried out. For example, a taxpayer obtained a deduction for the cost of renovating newly acquired cinemas. The work was done to make good normal wear and tear and the purchase price was not reduced to take into account the necessary repair work.

However, the costs of initial repairs to an asset are not deductible where they are necessary to make the asset usable for trade. For example, a taxpayer failed to obtain a deduction for repair work on a newly bought ship in order to make it seaworthy prior to using it.


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Deductible expenditure Expenditure on certain categories of fixed assets (plant and machinery and industrial buildings) attracts capital allowances which are tax allowances for the cost of purchasing such assets and replaces depreciation as a deduction in the trading profits calculation. Subscriptions and donations Trade or professional association subscriptions are normally deductible since they will be made wholly and exclusively for the purposes of trade. Charitable donations are allowed if they meet the following tests:

• it must be wholly and exclusively for trading purposes (eg promoting the company)

• it must be local and reasonable in size in relation to the company making the donation

• it must be made to an educational, religious, cultural, recreational or benevolent organisation.

If the donation is disallowed by reason of failing one or both of the first two tests (but is still made to a charity) a company can instead claim relief under the gift aid scheme and will be treated as a charge on income. Subscriptions or donations to political parties are not deductible. Non-charitable gifts are not allowed, except in the following circumstances: Gifts and entertainment Entertainment expenditure is disallowed. The only exception is for expenditure relating to employees, provided it is not merely incidental to the entertainment of others. Expenditure on gifts and entertainment needs to be looked at in terms of the recipient. Gifts to employees They would normally be allowed as regards the company making the gift, however the gift may result in an income tax charge for the employee under the benefits rules. Gifts to customers Gifts to customers are only allowed if:

• they cost less than £50 per recipient per year

• the gift is not of food, alcohol, tobacco or vouchers which can be exchanged for goods

• the gift carries conspicuous advertising for the company making the gift. If a gift fails any or all of the above criteria it is disallowed.


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Legal and professional charges Legal and professional charges are allowable provided that they are incurred in connection with the trade and are not related to capital items. So, for example, the following types of professional charges are allowed:

• Legal fees to collect trade debts

• Charges incurred in defending the title to fixed assets The following are not allowed:

• Fees incurred when purchasing new fixed assets

• Fees arising as a result of using new share capital The cost of registering patents is allowable. Also, the expense of renewing a short lease is allowable, although the expense of initial granting of the lease is not. Charges on income and gift aid Charges on income are deducted in arriving at PCTCT. Consequently, in computing trading profits, they must be disallowed. Interest payable Interest paid on borrowings for trading purposes is allowable on an accruals basis. Provided the accounts have been correctly prepared, no adjustment is therefore required. A company may pay interest on debenture loans, bank overdrafts or hire purchase contracts. For companies, interest on overdue corporation tax is allowable under the loan relationship rules and is, therefore, added back to the trading profits. Car leasing Lease rentals in respect of cars costing more than £12,000 are restricted for trading purposes, lease payments for cars costing less than £12,000 are allowed in full. The allowable portion of the lease payment is calculated as follows: Annual rental charge in profit and loss account x

( )( )( )newwhencarofcost

£12,000newwhencarofcost£12,000 −+


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Other items The items dealt with so far are the important ones you should know, however the following items may also require adjustment.

Item of expenditure Treatment in computation Notes

Compensation for the loss of office

Allow Only if for the benefit of trade

Cost of registering patents and trademarks

Allow

Cost of seconding employees to charities

Allow

Counselling services provided in the UK for redundant employees

Allow

Damages paid Allow Only if paid in connection with trade matter

Defalcations (eg theft/fraud) Allow* Only if by employee, not director

Educational courses Allow Only if for trade purposes

Fines Disallow* Unless on parking fines incurred on business by employee (not director)

Payment that constitutes a criminal offence

Disallow

Pension contributions to an approved pension scheme

Allow Provided paid (not accrued) by the year end

Premiums for insurance against an employee’s death or illness

Allow

Redundancy pay in excess of statutory amount

Allow On the cessation of trading the limit is 3 x the statutory amount

Removal expenses Allow Provided not an expansionary move

Salaries accrued at the year end Allow Provided paid not more that nine months after the year end


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Income taxable as trading profit but not included in profit and loss account The only situation where an adjustment will be necessary in a company’s accounts is where there has been an error due to faulty accounting. Deductible expenditure not charged in the profit and loss account The most important item of deductible expenditure not charged in the profit and loss account is capital allowances. These are deductible as if they were a trading expense. Income included in the profit and loss account but not taxable as trading profits These fall into three categories as follows:

1. Capital receipts (which may be chargeable gains). In addition any profit on the sale of fixed assets should be deducted in calculating taxable trading profit, as this is purely an accounting profit and not a real profit.

2. Income taxed as another source of income other than trading profits (such as rents or interest on bank accounts).

3. Income that is exempt from tax (such as dividends from UK companies). Such receipts must be deducted in arriving at the trading profit. However, they may form part of the PCTCT under another source of income.


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Appendix 8 – Capital allowances Capital allowances are given on qualifying expenditure on certain fixed assets. Allowances are given on original cost, plus any subsequent qualifying expenditure of a capital nature and are available on the following:

• Plant and machinery

• Industrial buildings

• Qualifying hotels. Note:

• Capital allowances are given as a trading expense in calculating the taxable trading profits.

• Capital allowances are given for a period of account instead of a tax year.

• Where there is a short or long period of account the writing down allowance is contracted or expanded on a pro rata basis.

• If the period of account exceeds 12 months it must be divided for capital allowance purposes into a 12 month period of account and a second period for the remainder.

Meaning of plant and machinery There is no statutory definition of plant. The most informative definition was given in the case of Yarmouth v France (1887). Plant was said to include:

Whatever apparatus is used by a businessman for carrying out his business – not his stock-in-trade that he makes for sale – but all goods and chattels, fixed or moveable, live or dead, which he keeps for permanent employment in his business.

This is obviously a very far reaching definition. It includes not only the obvious items of plant and machinery, but also items such as moveable partitions, office furniture and carpets, heating systems, motor vehicles, computers, lifts and any expenditure incurred to enable the proper functioning of the item such as reinforced floors or air conditioning systems for computers. If it is part of the setting, or premises, then it is not plant, and thus no capital allowances area available, but if it fulfils a function it is plant. There are various types of expenditure that would not be thought of as plant using the approach set out above but are treated as plant by specific legislation. These include:

• the cost of complying with fire legislation;

• the costs of altering buildings required for the installation of plant;

• expenditure on acquiring computer software outright.


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Statutory exclusions Although there is no statutory definition of plant, provisions have been introduced with the intention of making the issue clearer by providing that land, buildings and structures cannot be plant. In particular the provisions give detailed lists of items associated with buildings that are part of the building and not plant. The term ‘buildings’ include:

• walls, floors ceilings, doors, windows and stairs

• mains services, and systems of water, electricity and gas

• waste disposal, sewerage and drainage systems

• shafts or other structures for lifts etc. Structures Expenditure on structures and on works in the alteration of land does not qualify as expenditure on plant apart from the follow exceptions. A structure is a fixed structure of any kind other than a building. Exceptions The following may fall within the definition of expenditure on a building but will nevertheless normally qualify as plant:

• electrical, cold water and gas systems provided mainly to meet the particular requirements of the trade, or to serve particular machinery used for the purposes of the trade

• space or water heating systems, systems of ventilation and air cooling, and any ceiling or floor comprised in such systems

• manufacturing or processing equipment, storage equipment, display equipment, counters, check outs and similar equipment

• cookers, washing machines, dishwashers, refrigerators and similar equipment

• wash basins, sinks, baths, showers, sanitary ware and similar equipment

• furniture and furnishings

• lifts and escalators

• sprinkler equipment and fire alarm systems;

• movable partition walls

• decorative assets provided for the enjoyment of the public in a hotel, restaurant or similar trade


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• advertising hoardings, signs and similar displays

• sound insulation provided to meet the particular requirements of the trade

• computer, telecommunication and surveillance systems

• strong rooms in bank or building society premises, safes

• glasshouses which have, as an integral part of their structure, devices which control the plant growing environment automatically

• swimming pools (including diving boards) and structures for rides at amusement parks

• caravans provided mainly for holiday lettings

• moveable buildings intended to be moved in the course of the trade

• expenditure on altering land for the purposes only of installing plant or machinery

• dry docks and jetties

• pipelines and also underground ducts or tunnels with a primary purpose of carrying utility conducts

• silos provided for temporary storage and storage tanks, slurry pits and silage clamps

• fish tanks, ponds and zoo cages

• a railway or tramway. Statutory inclusions The following expenditure is deemed to be expenditure on plant and machinery:

• expenditure incurred by a trader in complying with fire regulations

• expenditure by a trader on thermal insulation of an industrial building

• expenditure by a trader in meeting statutory safety requirements for sports grounds

• expenditure (by an individual or partnership but not a company) on security assets provided to meet a special threat to an individual security that arises wholly or mainly due to the particular trade concerned. Cars, ships, aircraft and dwellings are specifically excluded from the definition of a security asset.

Capital expenditure on computer software (programs and data) qualifies as expenditure on plant and machinery regardless of whether:

• the software is supplied in a tangible form such as a disc or electronically, or

• the purchaser buys the software or a licence to use it.


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Calculating the allowances The pool of expenditure Generally, the cost of all plant and machinery purchased by a company becomes part of a pool of expenditure on which capital allowances may be claimed. When an addition is made, the pool increases; on a disposal the pool is reduced by the sale proceeds (limited to the original cost of the asset). Exceptionally, certain items are not included in the pool. For companies, these are:

• motor cars costing more than £12,000

• expenditure incurred on short-life plant where an election to de-pool is made

• expenditure incurred on long-life assets. Writing down allowances (WDA) An annual WDA of 25% is given on a reducing balance basis by reference to the unrelieved expenditure in the pool brought forward at the beginning of the accounting period. This is known as the written down value (WDV). The unrelieved expenditure is the cost of all pooled assets (less allowances already given against the pool). This is then adjusted for additions and disposals during the period. Looking at a pro-forma layout will help to understand how the WDA is calculated. Suppose that Boat Ltd prepares accounts to 31st March each year, and has a balance of unrelieved expenditure brought forward at 1st April 2006.

Year ended 31 March 2007: Pool £ WDV b/f (say) at 1.1.06 41,000 Additions 9,000 50,000 Less: Disposals (14,000) 36,000 WDA @ 25% (9,000) WDV c/f at 31.3.07 27,000 The important point to note is the order in which additions and disposals are dealt with. The WDA is calculated on the balance remaining after excluding disposals. If the accounting period is less than 12 months long, then the WDA is scaled down proportionately. You should remember that companies cannot have an accounting period of longer than 12 months. Where the period of account is longer than 12 months, then it will be split into two accounting periods. There will therefore be two separate capital allowance computations (one for each accounting period).


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Length of ownership in the accounting period The WDA is never restricted by reference to the length of ownership of an asset in the accounting period. For example, if a company's accounting period is the year ended 31st March 2007, the same WDA is given whether an asset is purchased on 1st April 2006 or on 31st March 2007. This is because it is ownership of an asset on the last day of the accounting period that qualifies it for allowance. Sale of plant and machinery As you have already seen, where plant and machinery is sold during the accounting period, the disposal value (sale proceeds) is deducted from the balance of unrelieved expenditure in the pool. The WDA for the year is then calculated on the resultant figure. The sale proceeds deducted from the pool must never exceed the original cost of the asset that has been sold. An excess of sale proceeds over original cost may be charged as a capital gain. Thus on a disposal always deduct from the pool the lower of the sale proceeds and the original cost. Balancing charges If, on disposal of an asset in the pool, disposal proceeds exceed the pool balance brought forward, the excess allowances previously given will be recovered and charged to tax by means of a balancing charge. A balancing charge is assessed as an addition to the trading profits. Balancing allowances The basic idea underlying capital allowances is that over the life of a business a company will obtain relief for the fall in value of an asset between the original cost and subsequent sale proceeds (if any). When the business is permanently discontinued and there is still a balance of unrelieved expenditure in the pool (after deducting final sale proceeds), a company is entitled to claim relief for that unrelieved balance by means of a balancing allowance. It is effectively a last year allowance. The only time a balancing allowance will arise in the pool is when the trade is permanently discontinued. A balancing allowance is computed by reference to the excess of the pool balance at the end of the final accounting period over the sale proceeds received on the ultimate disposal of plant and machinery. No WDAs are available in the final accounting period. This is logical, since relief for unrelieved expenditure will instead be given by means of a balancing allowance.


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First year allowances First year allowances (FYAs) can be claimed in respect of expenditure on certain types of plant and machinery. However, FYAs are only available to small and medium-sized companies (see definition below). In the year of acquisition, a FYA at the rate of 40% is given instead of the WDA. For small companies only this is on occasion increased to 50%. You must check the date of acquisition with the tax tables in your book to establish the correct rate. The balance of expenditure remaining after claiming the FYA is then added into the pool, and will qualify for WDA in subsequent periods. FYAs cannot normally be claimed in respect of motor cars or long-life assets. Unlike the WDA, the FYA is still available in full even if the accounting period is less than 12 months. Small and medium-sized companies FYAs are only available to small and medium-sized companies. The definition of small and medium-sized companies is that used for Companies Act purposes. To qualify, two out of the following conditions must be met in the current or previous year:

Turnover not exceeding

Balance sheet total not

exceeding

Number of employees not

exceeding

Small company £5.6m £2.8m 50

Medium sized company £22.8m £11.4m 250


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100% First Year Allowances A 100% FYA is available to all businesses for expenditure incurred on designing energy saving technologies and on plant and equipment meeting strict water-saving or efficiency criteria (eg water meters, flow controllers, efficient toilets). The equipment must be used in the person’s business. A first year allowance of 100% is also available for certain motor cars. This is available to all businesses. To qualify a motor car must be registered between 17th April 2002 and 31st March 2008 and meet one of the following criteria:

• emit less than 120 grams per kilometre of carbon dioxide CO2

• it is electrically propelled. A 100% FYA is available to all businesses in respect of expenditure incurred on plant to refuel vehicles with compressed natural gas or hydrogen (expenditure between 17th April 2002 and 31st March 2008). Equipment acquired for leasing does not normally qualify for the 100% FYA but equipment meeting the above criteria will qualify. A 100% FYA was available for small companies on information and communication technology equipment during the period from 1st April 2000 to 31st March 2004 and included:

• computers and peripherals such as printers and modems

• computer software

• internet-enabled mobile telephones. First year allowances are given in place of the WDA and are not scaled down if the accounting period is less than 12 months.


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Motor cars Motor cars costing less than £12,000 are added to the general pool. Motor cars do not qualify for FYA. The cost of a motor car, where it exceeds £12,000, must not be brought into the pool. The capital allowances on each such car must be separately computed. The WDA is restricted to a maximum (for a 12-month accounting period) of £3,000. Once the motor car has been written down to below £12,000 the WDA will be computed in the normal way (25% of WDV) but the motor car remains in its separate column of the computation. It must not be brought into the pool. Each 'expensive' motor car costing over £12,000 is deemed to be used in a separate trade so that when the motor car is sold a balancing allowance or charge must be computed on the difference between the WDV and the sale proceeds. Short-life assets An election (written application to the Inland Revenue) can be made to leave short-life assets out of the pool. This is known as de-pooling. The election is designed to enable companies to accelerate capital allowances on short-life plant and machinery, where it is the intention to sell or scrap the item within four years of the end of the accounting period in which the asset is acquired. An election must be made within two years of the end of the accounting period in which the expenditure was incurred. The treatment of short-life assets corresponds in most respects to that applied to motor cars costing over £12,000. Thus:

• each short life asset is the subject of a separate computation

• on disposal within four years of the end of the accounting period in which the asset was acquired a separate balancing allowance is given or balancing charge arises.

However, unlike the treatment of expensive cars, if no disposal has taken place within four years of the end of the accounting period in which the acquisition took place, the unrelieved balance is transferred back to the pool. The transfer takes place in the first accounting period following the four-year anniversary. The making of a short-life asset election has no bearing on whether or not FYA can be claimed.


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Long-life assets The WDA for plant and machinery with a working life of 25 years or more is 6% rather than 25%, although the allowance is still given on a reducing balance basis. FYA is not given in respect of expenditure on long-life assets. The 25-year working life is from the time that the asset is first brought into use to the time that it ceases to be capable of being used. It is not sufficient to just look at the expected life in the hands of the current owner. The reduced rate of WDA does not apply to companies that spend less than £100,000 per annum on long-life assets. This limit is reduced for accounting periods of less than twelve months and for companies with associated companies. The following can never be classed as long-life assets:

• motor cars

• plant and machinery situated in a building that is used as a retail shop, showroom, hotel or office

• ships and railway assets bought before 1 January 2011

• second-hand machinery in respect of the vendor obtaining allowances at 25%. Long-life assets are kept in a separate pool, which operates in exactly the same way as the plant and machinery pool. Examples of long-life assets might include aircraft used by an airline and agricultural equipment used by a farm. Hire purchase and leasing There are special rules for capital allowances on hired or leased assets. Any asset bought on hire purchase is treated as if purchased outright for the cash price, therefore:

• the buyer normally obtains capital allowances on the cash price when the agreement begins

• they may write off the finance charge as a trade expense over the term of the HP contract.

Leased assets do not normally become the property of the lessee as the asset is only hired over a period. The hire charge can be deducted in computing trade profits. An expensive car costing more that £12,000 will attract WDAs limited to £3,000 per year if bought and, likewise, if it is leased the lease rental is restricted in computing the taxable trading profits.

Rental charge x ( )( )carofprice2

carofprice£12,000×

+


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Appendix 9 – Calculating the CT due This is divided into two steps:

• Determining PCTCT and ‘Profits’ (P), a term which is used to determine the tax rates that will apply

• Apply relevant rates to calculate the liability Step 1 £ PCTCT X ‘I’ Add: Dividends plus tax credit X Profits for determining tax rate X ‘P’ Dividends plus tax credit is the term used to describe UK dividends received in the

current period, grossed up by the tax credit of 90

100 .

‘P’ is used to determine the rate of tax Step 2 The tax calculation is based on two main factors:

• ‘Profits’ – P

• the financial year (FY) which matches the CAP. For each FY the following information is provided: FY05 Lower limit 300,000 Upper limit 1,500,000

Fraction 40011

Small company rate 19% Ordinary rate 30% There are three situations that can apply:

• where ‘profits’ (P) do not exceed the lower limit the SCR applies to PCTCT

• where ‘profits’ (P) are at or above the upper limit, the ordinary rate applies to PCTCT

• where ‘profits’ (P) are between the limits than the following calculation is needed.


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PCTCT at ordinary rate X Less marginal relief (X) X Marginal relief is found by using the formula:

Fraction x (M –‘P’) x PI

where:

I = PCTCT,

M = upper limit Note:

• For accounting periods of less than 12 months the lower and upper limits have to be time-apportioned to fit the length of the accounting period.

• If a company’s accounting year straddles the 31st March in a year when the tax rates change, profits must be split between the two FY to which they relate.

Associated companies If a company has any associates, the starting rate limits and the small companies limits are divided by the number of companies associated with each other. Long accounting periods If the financial accounts cover more than 12 months two chargeable accounting periods are required. One for the first 12 months and one for the balance.


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Appendix 10 – Relief for trading losses Companies can claim relief for losses, in a variety of ways:

• Carry forward of trading losses (S393(1))

• Loss relief against total profits (S393A)

• Terminal loss relief Carry forward of trading losses (S393(1) ICTA 1988) Where a company incurs a trading loss, it may carry the loss forward and set it off against profits from the same trade in future accounting periods. The loss can be carried forward indefinitely and there is no time limit for obtaining relief – but it must be set-off against the first available trading profits. A claim to establish the amount of the loss available to carry forward should be made within six years of the end of the loss-making accounting period. Computation of the loss A company's trading loss is computed in the same way as a company's trading profit, ie after adjusting for non-allowable expenditure and deducting capital allowances. Loss relief against total profits (S393A ICTA 1988) Where a company incurs a trading loss it may claim to set the loss against total profits (before charges) of the accounting period producing the loss. Any trading loss remaining unrelieved may then be carried back and set against total profits (before charges) of accounting periods of the 12 months preceding the loss-making period. If a company has prepared accounts for a period other than 12 months during the 12 months preceding the loss-making accounting period, then the results of the accounting period that fall partially outside the 12 month period are apportioned. Loss relief is limited to the proportion of profits which falls within the 12-month period. Companies can claim to relieve a loss against current year profits and not to claim to carry the loss back against earlier profits. However, if the loss is carried back, it must be relieved as far as possible within the carry-back period. If a claim is made to carry back the loss, the set off is against later period before earlier periods. This is relevant where there is an accounting period of less than 12 months immediately before the loss-making period. Any loss remaining unrelieved after a S393A ICTA claim is carried forward under S393(1) ICTA 1988 and relieved against future trading profits of the same trade.


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Unrelieved charges cannot be carried forward and relieved against future trading profits. A claim for loss relief under S393A ICTA 1988 (either against current year profits, or carried back to the previous 12 months) must be made within two years of the end of the loss-making accounting period. A claim under S393A ICTA 1988 must be for the whole loss, including capital allowances. The amount of the loss may be reduced by not claiming the full amount of capital allowances available. A company may claim any amount of capital allowances, up to the full amount; a reduced claim would leave a higher tax written down value on which to claim allowances next year. Loss-making period of less than 12 months Where the loss-making period is less than 12 months, then no apportionment is necessary. The loss can be carried back in full against profits falling within the preceding 12-month period. Losses carried back and carried forward Care needs to be taken over the order of set-off when there are losses for more than one year. Losses carried forward under S393(1) ICTA 1988 are set-off before loss claims against current year profits or losses carried back under S393A ICTA 1988. If the correct layout is used, then the order of set-off is dealt with automatically.


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Terminal loss relief When a company incurs a trading loss during the final 12 months of trading, then it is possible to make a claim under S393A ICTA 1988. However, such a loss can be carried back and set against total profits of the three years preceding the loss making period, rather than the preceding 12 months. Relief available Terminal loss relief applies to trading losses incurred during the final 12 months of trading.

• The company must first claim to set the trading loss against total profits (before charges) of the accounting period of the loss.

• The terminal loss can then be carried back and set against total profits (before charges) of the three years preceding the loss-making period.

• Unrelieved charges are wasted.

• The set-off is against later periods before earlier periods. Apportionment will be necessary in two circumstances:

• Where the loss-making accounting period falls partly outside the final 12 months of trading, only that proportion of the loss falling within the final 12 months can be carried back for three years. The proportion falling outside the 12 months can only be carried back under S393A ICTA 1988 for 12 months.

• Where the company has prepared accounts for a period other than 12 months during the three years preceding the loss-making period, apportionment will be necessary in the same way as for a normal S393A ICTA 1988 loss claim, so that losses are only carried back against the proportion of profits falling within the three-year period.


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Layout of PCTCT calculation incorporation loss relief Dealing with losses may seem daunting at first but if you use a systematic, calculated and clear approach the answers will be easily calculated. Use a step by step process:

1) Prepare a PCTCT format for the relevant accounting periods. In the proforma leave spaces to enter relief under S393(1) ICTA 1988 and S393A ICTA in the appropriate places as follows:

£ Trading profit X Less: S393(1) ICTA 1988 relief (X) X Property business income, interest income etc X Chargeable gains X X Less: S393A ICTA 1988 relief (carry back) (X) X Charges (X) PCTCT X

2) The various amounts of income are then entered into the proforma.

3) Identify the losses. Remember that normally losses may only be carried back for 12 months.

4) Relieve the losses and complete a loss memorandum, detailing how the loss has been relieved and how much loss, if any, is left to be carried forward at the end.


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Factors influencing choice of loss relief There may be several alternative loss reliefs available for a loss and various factors will influence the loss relief chosen. These include:

• Rate of relief

The rate of tax at which relief will be given depends on the level of profits before the claim is made.

It will normally be beneficial to claim relief against profits subject to corporation tax at the marginal rate of 32.75% or at the full rate of 30%, in preference to profits subject to corporation tax at the rates 19%.

• Cash flow

Relief under S393A ICTA 1988 will probably result in a repayment of corporation tax, whereas relief under S393(1) ICTA 1988 will only result in a reduction of a future tax liability.

• Charges

Unrelieved charges cannot be carried forward and relieved against future trading profits. Therefore, certain claims for loss relief may lead to relief for charges being lost.


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Appendix 11 – solutions to revision exercises Revision exercise 1 Working notes (£000) – Castlepark

Cost of sales

Administration expenses

Distribution costs

Per trial balance 29,610 11,205 Opening stock 79,519 Purchases 503,500 Bad debts 1,755 Closing stock (72,500) Audit fees accrued 85 Insurance prepaid (48) Depreciation – buildings 311 156 156 Depreciation – equipment and vehicles 791 792 511,621 31,558 12,153 Creditors – amounts falling due within one year: Trade creditors 66,465 Accruals (1,120 + 85) 1,205 Taxation 22,050 Overdraft 29,960 VAT account 3,229 122,909 Fixed assets Buildings – depreciation for year:

31145 x 2% = 623

NBV 31145 - (623+3189) = 27,333 Equipment and vehicles – depreciation for year:

10553 x 15% = 1,583

NBV 10553 - (4568 + 1583) = 4,402


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Journals: Dr Tax in P/L 22,050 Cr Creditors 22,050 Dr Admin expenses 156 Cost of sales 311 Distribution costs 156 Cr Provision for depreciation (buildings) 623 Dr Cost of sales 791 Distribution costs 792 Dr Admin expenses (auditor) 85 Accruals 85 Dr Prepayments 48 Cr Admin expenses (insurance) 48 Trading profit and loss account – Castlepark for year ended 31st March 20X9 £000 Turnover 608,738 Cost of sales (511,621) Gross profit 97,117 Admin expenses (31,558) Distribution costs (12,153) Operating profit 53,406 Interest payable (2,496) Profit before taxation 50,910 Taxation (22,050) Profit after taxation 28,860 Profit and loss reserve Retained profit b/f 7,498 Profit for year 28,860 Dividends: Paid (4,760) Retained profit c/f 31,598


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Balance sheet – Castlepark at 31st March 20X9 £000 £000 Fixed assets Land 30,000 Property 27,333 Equipment and vehicles 4,402 61,735 Current assets Stock 72,500 Debtors 136,620 Prepayments (1729+48) 1,777 210,897 Creditors: amounts falling due within one year (122,909) Net current assets 87,988 Total assets less current liabilities 149,723 Creditors: amounts falling due after more than one year Debentures (9,975) 139,748 Share capital and reserves Ord share capital 78,750 Share premium 29,400 Profit and loss account 31,598 139,748


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Revision exercise 2 Working notes (£000) – Andrene

Cost of sales


Distribution costs

Audit fees 176 Per trial balance 175,600 21,000 6,600 Bad debt written off 200 Allowance for doubtful debt 3,000 Depreciation of property 403 403 202 Depreciation of equipment 629 629 176,632 24,779 7,431 Creditors – amounts falling due within one year: Trade creditors 12,100 Accruals 200 Accrued audit fees 176 Acrued interest 500 Taxation 8,600 Overdraft 9,200 VAT account 1,450 32,226 Tax charge in P/L: Tax on profit for year 8,600 Transfer to/from deferred tax 28 8,628 Deferred taxation: Opening balance 7,000 Transfer 28 Closing balance 7,028


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Fixed assets: Disposal: Proceeds 50 NBV (40) Profit on sale 10

Equipment and vehicles Premises Total

Cost

At start 10,000 50,400 60,400 Additions 560 560 Disposals (75) (75) At end 10,485 50,400 60,885

Depreciation

At start 5,700 18,200 23,900 Disposals (35) (35) Charge for year 1,258 1,008 2,266

At end 6,923 19,208 26,131

NBV at start 4,300 32,200 36,500

NBV at end 3,562 31,192 34,754


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Trading profit and loss Andrene for year ended 31st March X9 £000 Turnover 352,000 Cost of sales (176,632) Gross profit 175,368 Admin expenses (24,779) Distribution costs (7,431) Profit on sale of equipment 10 Operating profit 143,168 Interest paid and payable (670 + 500) (1,170) Interest receivable 520 Profit before taxation 142,518 Taxation (8,628) Profit after taxation 133,890 Profit and loss reserve Retained profit b/f 5,000 Profit for year 133,890 Dividend paid (1,200) Retained profit c/f 137,690


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Balance sheet – Andrene At 31st March X9 £000 £000 Fixed assets Tangible 34,754 Investments 31,400 66,154 Current assets Stock 83,940 Debtors (60,200-200-3000) 57,000 Prepayments 1,500 142,440 Creditors: amounts falling due within one year (32,226) Net current assets 110,214 Total assets less current liabilities 176,368 Creditors: amounts falling due after more than one year Debentures (5,000) Provisions for liabilities and charges Deferred taxation (7,028) 164,340 Share capital and reserves Ord share capital 23,000 Share premium 3,650 Profit and loss account 137,690 164,340


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Revision exercise 3 Working notes (£000) – Milton

Cost of sales


Distribution costs

Accrued expenses 58 Per trial balance 291,040 13,518 17,171 Depreciation 81 56 89 Depreciation 202 134 269 291,323 13,766 17,529 Creditors: amounts falling due within one year: Trade creditors 42,538 Accruals 475 Accrued interest 766 Accrued expenses 58 Taxation 14,100 Overdraft 19,134 VAT account 2,066 79,137 Tax charge in P/L: Tax on profit for year 14,100 Transfer to/from deferred tax 120 14,220 Deferred taxation: Opening balance 11,592 From P/L 120 11,712 Provide for debenture interest: Dr Interest payable 766 Cr Accrued interest 766 Fixed assets Equipment and vehicles: Dr Admin expenses 81 Dr Cost of sales 56 Dr Distribution costs 89 Cr Accumulated depreciation 226


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Balance sheet 6426 - (2923+226) 3,277 Freehold property Dr Admin expenses 202 Dr Cost of sales 134 Dr Distribution costs 269 Cr Accumulated depreciation 605 Balance sheet 19933 - (2041+605) 17,287 Trading profit and loss account - Milton for year ended 31/3/X7 £000 Turnover 378,000 Cost of sales (291,323) Gross profit 86,677 Admin expenses (13,766) Distribution costs (17,529) Operating profit 55,382 Interest paid and payable (766+2698) (3,464) Interest receivable 177 Profit before taxation 52,095 Taxation (14,220) Profit after taxation 37,875 Profit and loss reserve Retained profit b/f 5,454 Profit for the year 37,875 Dividends (3,046) Retained profit c/f 40,283


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Balance sheet – Milton At 31/3/X7 £000 £000 Fixed assets Tangible 20,564 Investments 26,643 47,207 Current assets Stock 60,856 Debtors 98,077 158,933 Creditors: amounts falling due within one year (79,137) Net current assets 79,796 Total assets less current liabilities 127,003 Creditors: amounts falling due after more than one year Debentures (6,384) Provisions for liabilities and charges Deferred taxation (11,712) 108,907 Share capital and reserves Ord share capital 54,400 Share premium 14,224 Profit and loss account 40,283 108,907


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Revision exercise 4 Working notes (£000) – Panico

Cost of sales


Distribution costs

Per trial balance 14,090 9,980 Purchases 220,960 Opening stock 57,025 Closing stock (85,000) Audit fees accrued 125 Insurance prepaid (48) Depreciation – property 168 280 156 Depreciation – equipment 624 624 193,777 14,495 10,716 Creditors – amounts falling due within one year: Trade creditors 25,400 Accrual: Interest 480 Accrual: auditor 125 Taxation 11,500 VAT account 1,650 39,155 Tax charge in P/L: Under/over provision 35 Tax on profit for year 11,500 Transfer to/from deferred tax 50 11,585 Deferred taxation: Opening balance 807 Transfer 50 Closing balance 857 Fixed assets Freehold property Dr Admin 280 Dr Cost of sales 168 Dr Distribution 112 Cr Accumulated depreciation 560 Balance sheet: 28,000 – (5040 + 560) 22,400


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Equipment and vehicles Dr Cost of sales 624 Dr Distribution 624 Cr Accumulated depreciation 1248 Balance sheet: 7,800 – (2720 + 1248) 3,832 Trading profit and loss account – Panico for year ended 31st March X9 £000 Turnover 337,450 Cost of sales (193,777) Gross profit 143,673 Admin expenses (14,495) Distribution costs (10,716) Operating profit 118,462 Interest payable (480) Profit before taxation 117,982 Taxation (11,585) Profit after taxation 106,397 Profit and loss reserve Retained profit b/f 4,500 Profit for year 106,397 Dividends: Paid (6,942) Retained profit c/f 103,955


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Balance sheet – Panico at 31st March X9 £000 £000 Fixed assets Tangible 26,232 Current assets Stock 85,000 Debtors 65,955 Bank 15,980 166,935 Creditors: amounts falling due within one year (39,155) Net current assets 127,780 Total assets less current liabilities 154,012 Creditors: amounts falling due after more than one year Debentures (4,800) Provisions for liabilities and charges Deferred taxation (857) 148,355 Share capital and reserves Ord share capital 34,800 Share premium 9,600 Profit and loss account 103,955 148,355


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Revision exercise 5 £000 Total contract value 2,000 Costs to date (450) Estimated costs to complete (750) Expected profit 800 Attributable profit = 30% x 800 = 240 This will be achieved by: Turnover 30% x 2,000 600 Cost of sales (balancing figure) 360 Profit 240 The journal entries are therefore: Dr Bilt Ltd (contractee) 600 Cr Turnover 600 Dr Cost of sales 360 Cr Contract account 360 This leaves the following balances to be reflected in the balance sheet: Bilt Ltd 600 – 550 paid = 50 This amount will be included in debtors as “Amounts Recoverable on Contracts” Contract account 450 – 360 transferred to cost of sales = 90 This amount will be included in stock as long-term WIP


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Revision exercise 6 Working notes (£000) – Acer

Cost of sales


Distribution costs

Contract 400

Per trial balance 203,280 10,458 15,210 Directors remuneration 222 48 Stock write-down 30 Depreciation – equipment and vehicles 370 370 Depreciation – property 89 150 60 204,169 10,830 15,688 Creditors: amounts falling due within one year: Trade creditors 31,903 Accrued interest 480 Taxation 10,580 Overdraft 14,888 VAT account 1,500 59,351 Tax charge in P/L: Tax on profit for year 10,580 Transfer to/from deferred tax 90 10,670 Deferred taxation: Opening balance 8,694 Transfer 90 Closing balance 8,784 Stock write-down Shown at 50 (£2,500 x 20) NRV 20 Writedown 30 Dr Cost of sales 30 Cr Stock 30


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Contract Total contract value 885 Costs so far (500) Estimated cost to complete (90) Total profit 295 Value of work certified 600 Cost of work certified (400) 200 This appears reasonable as contract is 67.80% finished and 67.8% x 295 = 200 Dr Contractee 600 Cr Turnover 600 Dr Cost of sales 400 Cr Contract account 400 This leaves the following balances: Contractee: Turnover 600 Bank 550 Debtor 50 Contract: Costs to date 500 Transfer to cost of sales 400 Work in progress 100


120

Fixed asset schedule


Cost


Depreciation

At start 2,188 1,530 3,718 Disposals (57) (57) Charge for year 740 299 1,039

At end 2,871 1,829 4,700

NBV at start 2,630 13,420 16,050

NBV at end 2,060 13,121 15,181


121

Trading profit and loss account Acer for year ended 31st March 20X9 £000 Turnover (283,856 + 600) 284,456 Cost of sales (204,169) Gross profit 80,287 Admin expenses (10,830) Distribution costs (15,688) Loss on sale of equipment (28) Operating profit 53,742 Interest payable (771 + 480) (1,251) Investment income 134 Profit before taxation 52,625 Taxation (10,670) Profit after taxation 41,955 Retained profit b/f 3,600 Profit for year 41,955 Dividends: Paid (7,280) Retained profit c/f 38,275


122

Balance sheet – Acer at 31st March 20X9 £000 £000 Fixed assets Tangible 15,181 Investments 10,212 25,393 Current assets Stock (58,956 + 100 - 30) 59,026 Debtors (73,526 + 50) 73,576 132,602 Creditors: amounts falling due within one year (59,351) Net current assets 73,251 Total assets less current liabilities 98,644 Creditors: amounts falling due after more than one year Debentures (4,000) Provisions for liabilities and charges Deferred taxation (8,784) 85,860 Share capital and reserves Ordinary share capital 37,800 Share premium 9,785 Profit and loss account 38,275 85,860


123

Revision exercise 7 Working notes (£000) – Harebell

Cost of sales


Distribution costs

Audit costs 234 Per trial balance 242,000 12,070 8,866 Contract 1,530 Opening stock 46,007 Closing stock (48,500) 241,037 12,304 8,866 Creditors: amounts falling due within one year: Trade creditors 37,980 Accruals 234 Taxation 12,600 Overdraft 16,834 VAT account 1,845 69,493 Tax charge in P/L: Underprovision 36 Tax on profit for year 12,600 Transfer to/from deferred tax 112 12,748 Deferred taxation: Opening balance 10,350 Transfer 112 10,462 Contract Total contract value 10,000 Costs to date (2,800) Estimated costs to complete (4,000) Total profit 3,200

Attributable £3.2m X 10

2.25 = £0.72m

Dr Contractee 2,250 Cr Sales 2,250 Dr Cost of sales 1,530 Cr Contract 1,530


124

The debtor has already paid and this has been credited to contract Dr Contract 2,250 Cr Contractee 2,250 The only balance left will be on the contract account: Costs so far 2,800 Less transferred to cost of (1,530) WIP 1,270 Trading profit and loss - Harebell for year ended 31 March 20X9 £000 £000 Turnover (337,500 + 2,250) 339,750 Cost of sales (241,037) Gross profit 98,713 Admin expenses (12,304) Distribution costs (8,866) Operation profit 77,543 Interest paid and payable (6,855) Investment income 160 Profit before taxation 70,848 Taxation (12,748) Profit after taxation 58,100 Retained profit b/f 14,566 Profit for year 58,100 Dividends (2,720) 69,946


125

Balance sheet – Harebell At 31st March X9 £000 £000 Fixed assets Tangible 49,395 Investments 10,396 59,791 Current assets Stock (48,500 + 1,270) 49,770 Debtors 98,040 147,810 Creditors: amounts falling due within one year (69,493) Net current assets 78,317 Total assets less current liabilities 138,108 Provisions for liabilities and charges Deferred taxation (10,462) 127,646 Share capital and reserves Ordinary share capital 45,000 Share premium 12,700 Profit and loss account 69,946 127,646


126

Revision exercise 8 Working notes (£000) – Bensven

Cost of sales


Distribution costs

Costs

Per trial balance 145,823 11,500 4,900 Wages and salaries 17,776 17,776 8,888 Bad debts 15 Allowance 1,506 Depreciation – equipment and vehicles 640 640 Depreciation – property 240 240 120 164,479 31,037 14,548 Creditors: amounts falling due within one year: Trade creditors 22,160 Accruals 480 Taxation 7,640 Overdraft 9,618 VAT account 1,100 40,998 Tax charge in P/L: Tax on profit for year 7,640 Transfer to/from deferred tax 52 7,692 Deferred taxation: Opening balance 7,050 Transfer 52 Closing balance 7,102 Debtors Opening balance 50,216 Less bad debt (15) 50,201 Allowance (1,506) 48,695 Debenture interest Accrue 4,000 x 12% = 480


127

Fixed asset schedule – Bensven


Cost

At start 8,000 12,416 20,416 Revaluation 17,584 17,584 At end 8,000 30,000 38,000

Depreciation

At start 1,800 1,916 3,716 Revaluations (1,916) (1,916)

Charge for year 1,280 600 1,880

At end 3,080 600 3,680

NBV at start 6,200 10,500 16,700

NBV at end 4,920 29,400 34,320 Revaluation reserve: Opening balance 2,240 From premises at cost 17,584 From Accumulated depreciation 1,916 21,740


128

Trading profit and loss account – Bensven for year ended 31st March 20X9 £000 Turnover 252,500 Cost of sales (164,479) Gross profit 88,021 Admin expenses (31,037) Distribution costs (14,548) Operating profit 42,436 Interest payable (667 + 480) (1,147) Interest receivable 220 Profit before taxation 41,509 Taxation (7,692) Profit after taxation 33,817 Retained profit b/f 3,737 Profit for year 33,817 Dividends: Paid (2,542) Retained profit c/f 35,012


129

Balance sheet – Bensven At 31 March 20X9 £000 £000 Fixed assets Tangible 34,320 Investments 10,000 44,320 Current assets Stock 53,517 Debtors 48,695 102,212 Creditors: amounts falling due within one year (40,998) Net current assets 61,214 Total assets less current liabilities 105,534 Creditors: amounts falling due after more than one year Debentures (4,000) Provisions for liabilities and charges Deferred taxation (7,102) 94,432 Share capital and reserves Ordinary share capital 30,000 Revaluation reserve 21,740 Share premium 7,680 Profit and loss account 35,012 94,432


130

Revision exercise 9 Working notes (£000) – Jaqjas

Cost of sales


Distribution costs

Per trial balance 262,384 11,524 6,096 Wages and salaries 3,477 13,907 6,953 Opening stock 43,228 Closing stock (55,000) Audit 126 Depreciation – equipment and vehicles 410 409 Depreciation – property 118 153 68 254,617 25,710 13,526 Creditors: amounts falling due within one year: Trade creditors 36,157 Accruals 126 Taxation 12,000 Overdraft 16,314 VAT account 1,756 66,353 Tax charge in P/L: Tax on profit for year 12,000 Transfer to/from deferred tax 103 12,103 Deferred taxation: Opening balance 9,853 Transfer 103 Closing balance 9,956


131



Cost

At start 5,462 16,940 22,402 Revaluation 9,060 9,060 At end 5,462 26,000 31,462

Depreciation

At start 2,481 1,735 4,216 Revaluations (2,074) (2,074)

Charge for year 819 339 1,158

At end 3,300 0 3,300

NBV at start 2,981 15,205 18,186

NBV at end 2,162 26,000 28,162 Revaluation reserve: Opening balance 3,903 Cost 9,060 Depreciation 2,074 15,037 Note:

Because the revaluation took place on the last day of the year, depreciation is calculated on the original cost.


132

Trading profit and loss account – Jacjas for year ended 31st March 20X9 £000 Turnover 321,300 Cost of sales (254,617) Gross profit 66,683 Admin expenses (25,710) Distribution costs (13,526) Operating profit 27,447 Interest payable (1,358) Interest receivable 155 Profit before taxation 26,244 Taxation (12,103) Profit after taxation 14,141 Retained profit B/F 9,963 Profit for year 14,141 Dividends: Paid (3,000) Retained profit C/F 21,104


133

Balance sheet – Jacjas at 31st March 20X9 £000 £000 Fixed assets Tangible 28,162 Investments 9,897 38,059 Current assets Stock 55,000 Debtors 74,321 129,321 Creditors: amounts falling due within one year (66,353) Net current assets 62,968 Total assets less current liabilities 101,027 Provisions for liabilities and charges Deferred taxation (9,956) 91,071 Share capital and reserves Ord share capital 42,840 Revaluation reserve 15,037 Share premium 12,090 Profit and loss account 21,104 91,071


134

Revision exercise 10 Grant Allocation of interest Year Opening

balance Payment Interest Closing

balance

1 15,600 (3,900) 1,170 12,870 2 12,870 (4,680) 819 9,009 3 9,009 (4,680) 433 4,762 4 4,762 (4,762) (0) (0)

Computer

Creditor 15,600 Bal c/d 15,600 Bal b/d 15,600

Accumulated depreciation Creditor 3,900 Depreciation 3,900 Bal b/d 3,900

Depreciation Accumulated Depreciation 3,900 P/L 3,900

Lease creditor Cash 3,900 Fixed asset 15,600 Bal c/d 14,122 Interest suspense 2,422 18,022 18,022

Interest suspense Creditor 2,422 P/L (Interest) 1,170 Bal c/d 1,252 2,422 2,422 Bal b/d 1,252 Profit and loss extracts Depreciation 3,900 Interest paid 1,170


135

Balance sheet extracts Fixed assets (15,600 – 3,900) 11,700 Creditors due within one year 3,861 (Next year’s instalment – interest element = 4,680 – 819) Creditors due after more than one year 9,009 (Total creditor – balance on interest suspense – 3861) (Or: Read from table – closing balance year 2!) Sum of digits allocation After initial deposit, there are 3 payments, thus: Sum of digits = 3+2+1 = 6 Total interest = Total payments – cash price = £18,022 - £15,600 = £2,422 Allocation: Yr 1 (3/6) x 2422 = £1,211 Yr 2 (2/6) x 2422 = £807 Yr 3 (1/6) x 2422 = £404 £2,422


136

Revision exercise 11 ABC plc Working notes (£000)

Cost of sales


Distribution costs

Staff costs 12,446 3,556 1,778 Overhead per TB 19,200 2,080 6,610 Purchases 12,255 Opening stock 3,920 Closing stock (3,990) Lease payments (40) Depreciation – leased machinery 23 409 Depreciation – property 16 4 0 43,830 5,640 8,388 Creditors: amounts falling due within one year: Trade creditors 13,760 Lease creditor (see below) 30 Taxation 3,000 Debentures (1/2 due within year) 1,500 PAYE etc 275 18,565 Tax charge in P/L: Underprovided 120 Tax on profit for year 3,000 Transfer to/from deferred tax (700) 2,420 Deferred taxation: Opening balance 2,500 Transfer (700) Closing balance 1,800


137

Fixed assets Annual depreciation on building:

40800 = 20

Prior period adjustment: 3 x 20 = 60 This year: 20: 16 to cost of sales; 4 to admin Total for balance sheet: Land 1,400 Buildings (800 - 80) 720 Leased machine (184-23) 161 Plant 3,520 Motor vehicles 55 Fixtures and fittings 800 6,656 Dealing with the lease (£000) Opening entry: Dr Fixed asset 184 Cr Creditor 184 Dr Interest suspense 136 (16 x £20,000 -

184,000) Cr Creditor 136 When payments made: These must be removed from the overhead account Payment 1 Dr Creditor 20 Cr Production overhead 20 Payment 2 20 Dr Creditor 20 Cr Production overhead


138

Spreading the interest: Total interest = 136 Total number of payments = 16 Sum of the digits = 16+15+14+13+12+11+10+9+8+7+6+5+4+3+2+1 = 136

Allocated to first payment: 13616 x 136 = 16

Allocated to second payment: 13615 x 136 = 15

31 Dr P/L interest 31 Cr Interest suspense 31 Depreciation Dr depreciation (P/L) 23

× 2

16184

Cr accumulated depreciation 23

Fixed asset Creditor 184 P/L 184 Bal b/d 184 - -

Lease creditor Payments 40 Fixed asset 184 Bal c/d 280 Interest suspense 136 320 320 Bal b/d 280

Interest suspense Creditor 136 P/L 31 Bal c/d 105 136 136 Bal b/d 105 Splitting the creditor: Net creditor: (280 - 105) = 175 Payments within year 80 (4 x 20,000) Less: interest element 50 [ ]

×+++

13613611121314

Creditor due within one year 30 Creditor due after more than one year 145


139

Trading profit and loss account – ABC plc for year ended 31st March 20X4 £000 Turnover 66,980 Cost of sales (43,830) Gross profit 23,150 Admin expenses (5,640) Distribution costs (8,388) Operating profit 9,122 Interest paid and payable (850 + 31) (881) Investment income 60 Profit before taxation 8,301 Taxation (2,420) Profit after taxation 5,881 Retained profit b/f 5,670 Prior period adjustment (60) Profit for year 5,881 Dividends: Paid (530) Retained profit c/f 10,961


140

Balance sheet – ABC plc At 31st March 20X4 £000 £000 Fixed assets Tangible 6,656 Investments 965 7,621 Current assets Stock 3,990 Debtors 29,290 Bank 70 33,350 Creditors: amounts falling due within one year (18,565) Net current assets 14,785 Total assets less current liabilities 22,404 Creditors: amounts falling due within one year Debentures (1,500) Finance lease creditor (145) Provisions for liabilities and charges Deferred taxation (1,800) 18,961 Share capital and reserves Ord share capital 8,000 Profit and loss account 10,961 19,961


141

Revision exercise 12 January 2 £ £ Dr Share premium 50,000 Cr Ordinary share capital 50,000 Being the issue of 50,000 bonus shares January 5 Dr Cash 280,000 Cr Share capital 80,000 Cr Share premium 200,000 Balance sheet Share capital (£1 ordinary shares) 280,000 Share premium 225,000 Profit and loss account 560,000 1,065,000 Working

Bonus issue: 3

150,000 = 50,000 shares

Share premium account used as this leaves maximum distributable profit Rights issue: Share capital now at 200,000

Issue: 5

200,000 x 2 shares = 80,000 shares

Cash received = 80,000 x £3.50 = £280,000


142

Revision exercise 13 Working notes (£000) – Nordheim

Cost of sales


Distribution costs

Per trial balance 600,770 30,161 10,968 Salaries and wages 114,743 68,846 45,897 Bad debts 1,332 Depreciation – Equipment and vehicles 3,353 3,353 Depreciation – Property 113 85 85 718,979 100,423 60,303 Creditors – amounts falling due within one year: Trade creditors 74,640 Taxation 5,000 VAT account 1,920 81,560 Share issue Dr Suspense account 7,950 Cr Share capital 4,000 Cr Share premium 3,950


143



Cost

At start 32,160 14,160 46,320 Additions 1,584 1,584 Disposals (216) (216) At end 33,528 14,160 47,688

Depreciation

At start 18,000 2,040 20,040 Disposals (36) (36) Charge for year 6,706 283 6,989

At end 24,670 2,323 26,993

NBV at start 14,160 12,120 26,280

NBV at end 8,858 11,837 20,695 Disposal: NBV of equipment disposed of 180 Proceeds (144) Loss 36


144

Trading profit and loss account – Nordheim for year ended 31st March 20X9 £000 Turnover 912,025 Cost of sales (718,979) Gross profit 193,046 Admin expenses (100,423) Distribution costs (60,303) Loss on sale of equipment (36) Operating profit 32,284 Interest receivable 360 Profit before taxation 32,644 Taxation (5,000) Profit after taxation 27,644 Retained profit B/F 20,944 Profit for year 27,644 Dividends: Paid (2,880) Retained profit C/F 45,708


145

Balance sheet – Nordheim At 31st March 20X9 £000 £000 Fixed assets Tangible 20,695 Investments 24,000 44,695 Current assets Stock 72,600 Debtors 106,560 Bank 23,118 202,278 Creditors: amounts falling due within one year (81,560) Net current assets 120,718 Total assets less current liabilities 165,413 Creditors: amounts falling due within one year Debentures (4,800) Share capital and reserves Ordinary share capital 107,200 Share premium 7,705 Profit and loss account 45,708 160,613


146

Revision exercise 14 Fixed asset schedule

Land Buildings Plant Vehicles Total £ £ £ £ £

COST/VALUATION Opening balance 90,000 200,000 70,000 26,000 386,000Additions 50,000 15,000 65,000Disposals (10,000) (10,000)Revaluation 30,000 30,000Closing balance 120,000 200,000 120,000 31,000 471,000 DEPRECIATION Opening balance 20,000 28,000 10,000 58,000Disposals (6,000) (6,000)Charge for year 4,000 13,800 6,200 24,000Closing balance 24,000 41,800 10,200 76,000 NBV at start 90,000 180,000 42,000 16,000 328,000 NBV at end 120,000 176,000 78,200 20,800 395,000 The freehold land was revalued during the year by ABC Chartered Surveyors and Co. Accounting policy note: Tangible fixed assets are stated at cost less depreciation, except in the case of freehold land which is periodically revalued by external surveyors. Freehold land is not depreciated. Depreciation is calculated on other tangible fixed assets in such a way as to write off the cost to residual value over the expected useful lives of the assets as follows: Buildings: 2% per annum on cost Plant: 15% per annum on reducing balance basis Vehicles: 20% per annum on cost


147

Revision exercise 15


Cost


Depreciation

At start 5,700 18,200 23,900 Disposals (35) (35) Charge for year 1,258 1,008 2,266

At end 6,923 19,208 26,131

NBV at start 4,300 32,200 36,500

NBV at end 3,562 31,192 34,754 Accounting policy note: Tangible fixed assets are stated at cost less depreciation. Depreciation is calculated on tangible fixed assets in such a way as to write off the cost to residual value over the expected useful lives of the assets as follows: Premises: 2% per annum on cost Equipment and vehicles: 12% per annum on cost


148

Revision exercise 16 Notes to the profit and loss: Operating profit is after charging: Depreciation on leased assets 3,900 Interest paid includes: Interest paid on finance leases 1,170 Notes to the balance sheet: Plant and equipment include assets held under finance leases with a net book value of £11,700. Finance lease creditors Due within one year Due within 2-5 years Gross creditor 4,680 9,442 Less interest element (819) (433) Net creditor 3,861 9,009


149

Revision exercise 17 Prando a) Allocation of interest Year Opening

balance Payment Interest Closing

balance 1 7,800 (1,950) 585 6,435 2 6,435 (2,340) 410 4,505 3 4,505 (2,340) 216 2,381 4 2,381 (2,381) (0) (0)

Computer

Creditor 7,800 Bal c/d 7,800 Bal b/d 7,800

Provision for depreciation Bal c/d 1,950 Depreciation 1,950 Bal b/d 1,950

Depreciation Provision 1,950 P/L 1,950

Lease creditor Cash 1,950 Computer 9,011 Bal c/d 7,061 9,011 9,011 Bal b/d 7,061

Interest suspense Computer 1,211 P/L (Interest) 585 Bal c/d 626 1,211 1,211 Bal b/d 626

Cash extract Creditor 1,950 Profit and loss extracts Depreciation 1,950 Interest paid 585


150

Balance sheet extracts Fixed assets 5,850 Creditors due within one year 1,930 Creditors due after more than one year 4,505 b) Sum of digits = 6 Allocation: Yr 1 (3/6) = 606 Yr 2 (2/6) = 404 Yr 3 (1/6) = 202 £1,211 c) Notes to the profit and loss: Operating profit is after charging: Depreciation on leased assets 1,950 Interest paid includes: Interest paid on finance leases 585 Notes to the balance sheet: Plant and equipment include assets held under finance leases with a net book value of £5,850. Finance lease creditors Due within one year Due within 2-5 years Gross creditor 2,340 4,721 Less interest element (410) (216) Net creditor 1,930 4,505


151

Revision exercise 18 The items which must be disclosed separately for Biscabee are:

• Depreciation of owned assets

• Depreciation of leased assets

• Amortisation of development expenditure

• Research costs

• Equipment hire costs

• Directors’ fees – these will be further expanded on in the Directors’ Remuneration report.

• Audit fees

• Amounts paid to and on behalf of employees (non-FRSSE companies only) Operating profit is after charging: Depreciation of owned assets £145,000 Depreciation of leased assets £24,000 Amortisation of development expenditure £4,500 Research costs £6,000 Hire of equipment £6,785 Directors’ fees £15,000 Audit fees £35,000 Employment costs £278,000 (including £23,000 in pension contributions).


152

Revision exercise 19 a) Stock comprises: £ Raw materials 100,000 Work in progress 150,000 Finished goods 200,000 450,000 b) Stock is valued at the lower of cost and net realisable value. cost includes all direct expenditure and production overheads incurred in bringing the stock to its current condition and location under normal working conditions. Net realisable value is calculated as estimated selling price less any costs of selling such goods. c) Tangible fixed assets are stated at cost less depreciation, except in the case of Freehold property which is revalued every three years by external surveyors. Freehold land is not depreciated. Depreciation is calculated on other tangible fixed assets in such a way as to write off the cost to residual value over the expected useful lives of the assets as follows: Plant: 10% per annum on cost Vehicles: 25% per annum on cost


153

Revision exercise 20 Trading profit and loss account – Harebell for year ended 31st December 20X9

£000 £000 £000 Continuing

activities Discontinued

activities

Turnover 578,301 30,437 608,738 Cost of sales (480,924) (30,697) (511,621) Gross profit 97,377 (260) 97,117 Admin expenses (29,665) (1,893) (31,558) Distribution costs (10,938) (1,215) (12,153) Operating profit 56,775 (3,369) 53,406 Interest payable (2,496) Profit before taxation 50,910 Taxation (22,050) Profit after taxation 28,860


154

Revision exercise 21 Segmental reports tell users:

i) The relative sizes of the sectors in which the organisation operates.

ii) The profitability of each sector

iii) Which sectors depend most heavily on inter-segment sales

iv) The extent to which the group depends on export sales; the extent to which the group trades in politically difficult areas. This indicates the group’s exposure to exchange risks and economic risks.

The information is designed to help users assess the impact of risk on the organisation’s results. It does, however, leave the user to determine which areas are the most risky! As with ratio analysis, segmental reporting does not give us the whole story - but it points us in the direction of questions that may need to be asked if we want to make informed investment decisions. Purpose of SSAP 25 To provide information to assist the user of financial statements:

a) to appreciate more thoroughly the results and financial position of the entity by permitting a better understanding of the entity’s past performance and thus a better assessment of its future prospects; and

b) to be aware of the impact that changes in significant components of a business may have on the business as a whole.

A segment is significant if:

a) its third party turnover is over 10% of the entity’s turnover

b) its segment profit or loss is over 10% of the entity’s profit or loss

c) its net assets are more than 10% of the total assets of the entity These should be reviewed annually and re-defined as appropriate. Segments can be ‘class of business’ or geographical. Classes of business: A distinguishable component of an entity that provides a separate product or service or separate group of products or services. Geographical segments: A geographical area comprising a country or group of countries in which an entity operates, or to which it supplies goods or services.


155

Group information should be disclosed about each class of business and each geographical segment as follows:

1. Turnover by origin and destination

2. Profit/loss before taxation

3. Common costs

4. Segment net assets Advantages of disclosure:

• rates of profitability, opportunities for growth, risk etc may vary between segments

• provides data which gives users a better basis for making important decisions.

However, such information may be of great use to competitors and there is a ‘get out’ clause, allowing directors to withhold such a breakdown if it would do commercial harm to the business.


156

Revision exercise 22 Current Cost Accounting Intention:

To show the effect of changing price levels on the results and net asset position disclosed by HC accounts, in particular on:

• operating profit

• distributable profit

• operating asset valuation. The profit and loss account Four adjustments are made to the profit and loss account:

i) The depreciation adjustment – the extra depreciation charge required to reflect the replacement cost of fixed assets.

ii) The cost of sales adjustment – the adjustment required to match revenue with current cost of sales at the time the sale was made.

iii) The monetary working capital adjustment – the additional/reduced amount of finance required to maintain the monetary working capital as a result of changes in input prices of goods and services used and financed by the business.

The operating profit is adjusted by the net effect of these three adjustments. iv) The gearing adjustment – limiting the effect of the above three adjustments on

equity to take account of the fact that if the company has long term debt, and interest is paid out of pre-tax profit, the effect will be lessened by the tax shield.

This further adjustment will then give the profit available to ordinary shareholders. The balance sheet Fixed assets – adjust value to reflect value to the firm, ie the lower of net replacement

cost or recoverable amount. The recoverable amount is the higher of realisable value or deprival value.

Stock – adjust value to reflect value to the firm, ie the lower of net replacement

cost or net realisable value. The net effect of the adjustments is transferred to a CC reserve from the profit and loss account, thus reducing the amount of distributable profit to that amount which will not reduce the operating capability of the company.


157

The main problem with this approach is the complexity and the difficulty of arriving at objective values for the assets. This introduces subjectivity rather than objectivity and could detract from the credibility of a set of financial statements. Current Purchasing Power Accounting CPP takes the historic cost accounts and adjusts them to show the effects of inflation, especially on the capital value of the enterprise from the owners' point of view. Historic cost accounts are adjusted to current monetary value by application of the RPI to all non-monetary items. Underlying principles • Owners' capital = purchasing power of owners' capital.

• Profit = the amount that can be consumed while maintaining capital as defined above.

Advantages:

• Simple to apply and understand.

• The RPI is easily obtainable and regularly updated. It is therefore objective.

• It shows the direct effect of inflation on the enterprise's profit and valuations.

• It does not attempt to examine whether or not assets will be replaced; it simply updates their apparent economic value, taking inflation into account.

Disadvantages:

• The RPI is not necessarily relevant to the specific assets of the company.

• Subjectivity in the preparation of the historic cost accounts is aggravated by CPP.

• The effects of technological change etc on asset values are ignored.

• Because of this, CPP does not give a realistic measure for distributable profit. Modified historic cost accounts still prevail, partly because of the difficulty of finding an acceptable alternative:

• They are generally understood and accepted by the business community.

• They are relatively objective.

• They are verifiable, and therefore auditable.

• Inflation has ceased to be the problem it was in the 1970s.


158

Revision exercise 23 The Financial Reporting Council

Responsible for promoting and enforcing financial reporting standards, auditing standards and standards of professional behaviour within the accountancy and actuarial professions. This body has overall responsibility for ensuring that appropriate standards are set and enforced. The Accounting Standards Board

Responsible for setting accounting standards – primarily in the private sector, although it has sub-committees to advise on the adaptability of standards for other bodies. The Urgent Issues Task Force

Assists the ASB where unsatisfactory or conflicting interpretations have developed (or seem likely to develop) about a requirement of an accounting standard or the Companies Act. Provides a quicker way of getting guidance issued when the development of a new standard may take time.

The Financial Reporting Review Panel

Responsible for examining alleged departure from the accounting requirements of the standards and Company Law. Originally it investigated only when a complaint was raised, but now pro-actively examines cases of concern with guidance from the Financial Services Authority.

Financial Reporting Council

The Auditing Practices Board

The Financial Reporting Review Panel

The Investigation and Discipline Board

The Professional Oversight Board

The Accounting Standards Board

The Urgent Issues Task Force

The Public Sector and Not-for-profit Committee

The Financial & Other Special Industries Committee

The Committee on Accounting for Smaller Entities


159

Revision exercise 24 Going concern Accountants assume that, unless there is evidence to the contrary,

a company is going to continue in business at a level similar to that of its current operations. This has important implications for the valuation of assets and liabilities.

Matching Income should be properly ‘matched’ with the expenses of earning (or ‘Accruals’) it. Thus, sales should be matched with the cost of goods sold, and

expenses should be those incurred during the period in question, whether paid for or not.

Relevance This implies that, to be useful, accounting information must assist

a user to form, confirm or maybe revise a view – usually in the context of making a decision (eg should I invest, should I lend money to this business? Should I work for this business?).

Going concern is important in giving a true picture of the assets and liabilities of the company in this context – for an investor it is not usually the break-up value they are concerned with, but the value in terms of a continuing operation. The accruals concept ensures that as accurate a picture as possible is given of the performance of the operation over the period in question.


160

Revision exercise 25 £ Net profit per accounts 5,124 Less: Income not included in trading profit Bank deposit interest (160) Dividends received (140) 4,824 Add: Expenses not allowed for tax purposes Alteration to flooring 1,460 Depreciation 3,550 Amortisation 120 Loss on sale of equipment 40 Court action 110 New lease – legal fees 20 Fine 250 Entertainment 300 Trading profit 10,674 Revision exercise 26 £ Net profit per accounts 6,868 Less: Income not included in trading profit Profit on sale of premises (1,750) 5,118 Add: Expenses not allowed for tax purposes Increase in general allowance 50 Depreciation 2,381 Food hampers 95 Refurbishment 522 Extension 1,647 Trading profit 9,813


161

Revision exercise 27 £ Net profit per accounts 290,000 Add: Expenses not allowed for tax purposes Salary 24,000 (Secondment to charity allowable; secondment to subsidiary not wholly and exclusively for trade of company) Damages (net) 12,000 (Held to be too remote from trade) Repairs 12,000 (Capital) Goods sold abroad 40,000 (Must transfer at market price) Trading profit 378,000 Revision exercise 28 Able Ltd

Pool Allowances £ £ £

Year ended 31 December WDV b/f 11,000 Sale proceeds – plant (2,800) 8,200 WDA 25% (2,050) 2,050 Additions qualifying for FYA 15 June 6,500 31 August 12,000 18,500 FYA 50% (9,250) 50,910 9,250 WDV c/f 15,400 11,300


162

Revision exercise 29 Flash

Pool Expensive car 1

Expensive car 2

Allowances

£ £ £ £ £ Year ended 31st December WDV b/f 21,200 13,600 Additions (no FYA) 10,600 18,000 31,800 Disposal of expensive car (9,400) Balancing allowance (4,200) 4,200 WDA 25% (7,950) 7,950 WDA restricted (3,000) 3,000 23,850 Additions qualifying for FYA @ 40% 10.5.05 plant 6,600 FYA 40% (2,640) 2,640 3,960 27,810 Additions qualifying for FYA @ 100% 28.6.05 toilet 600 18.2.06 car 16,500 17,100 FYA 100% (17,100) 17,100 - 27,810 15,000 34,890


163

Revision exercise 30 XY Ltd

Pool Expensive car 1

Expensive car 2

Allowances

£ £ £ £ £ Year ended 31 June 2006 WDV b/f 45,000 20,000 Additions (no FYA) 10,000 28,000 31,800 Disposals: Plant (25,000) Cars (2,000) (12,000) Balancing allowance (8,000) 8,000 4,800 WDA 25% (1,200) 1,200 WDA restricted (3,000) 3,000 3,600 Additions qualifying for FYA @ 40% Plant 60,000 FYA 40% (24,000) 24,000 36,000 39,600 25,000 36,200 Trading profit (120,000 – 36,200) = 83,800


164

Revision exercise 31 Simple Simon Ltd £ Trading income 95,200 Investment income 18,000 Property business income 10,000 Chargeable gains 25,000 148,200 less: Charges on income (2,000) PCTCT 146,200 Dividends plus tax credit 15,000 161,200 This final figure is under £300,000 and so the CT payable is simply: £146,200 x 19% = £27,778 Revision exercise 32 Peter Pieman Ltd £ Trading income 465,700 Investment income 13,200 Property business income 70,500 Chargeable gains 10,000 PCTCT 559,400 Dividends plus tax credits 100,000 659,400 £659,400 falls between £300,000 and £1,500,000. CT at 30% £559,400 @ 30% = 167,820 Less marginal relief:

( )659,400559,400659,4001,500,00

40011

×−× (19,611)

148,209


165

Revision exercise 33 Charles Ltd Step 1 (a) (b) (c) £ £ £ PCTCT 290,000 290,000 290,000 Dividends plus tax credit NIL 10,000 50,000 ------------- ------------ ------------ ‘P’ 290,000 300,000 340,000 ------------ ----------- ------------ Step 2 Identify the FY(s) which applies and determine the tax rate CT at 30% - - 87,000 CT at 19% 55,100 55,100 MR - - (27,209) CT liability 55,100 55,100 59,791 Revision exercise 34 Ross McHugh Ltd Year ended 31/3/06 31/3/07 Trading profit 18,000 Less S393(1) loss relief (18,000) Nil Interest income 6,000 9,000 Chargeable gains (7,000 – 2,000) 5,000 PCTCT 6,000 14,000 Loss carried forward under S393(1) (£20,000-£18,000) 2,000


166

Revision exercise 35 Duck Soup Ltd. Year ended 31 March 2006 2007 Trading profit 40,000 - Interest income 2,000 3,500 Chargeable gain 14,500 42,000 18,000 Less S393A relief (42,000) (18,000) Nil Nil Loss memorandum Loss for year to 31/3/07 88,000 Less S393A relief to 31/3/07 (18,000) Less S393A relief to 31/3/06 (42,000) Loss c/f under S393(1) 28,000 Trading loss: £ Per accounts (96,000) Add back depreciation 10,800 Add back entertaining 1,200 Less capital allowances (4,000) (88,000)

de6635-accounting unit 3

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