f3 pdf

8/8/2019 f3 pdf

1/102

ACCA Paper F3

Financial Accounting(INT)

Class Notes

December 2009

8/8/2019 f3 pdf

2/102

www.studyinteract ive.org 2

Appendix

The following notes are suitable for both the international and UK streams. There will some

terminology differences between the two streams. These are summarised below:

International UK

Statement of comprehensive income Profit and loss account

Statement of financial position Balance sheet

Non-current assets Fixed assets

Inventory Stock

Trade receivables Debtors

Non-current liabilities Long term liabilities

Trade payables Creditors

Irrecoverable debts Bad debts

8/8/2019 f3 pdf

3/102


Contents

Paper background

Session 1 Introduction to accounting

Session 2 Financial statements

Session 3 Double entry book keeping

Session 4 Non-current assets

Session 5 Inventory

Session 6 Irrecoverable Debts

Session 7 Control Accounts

Session 8 Bank Reconciliations

Session 9 Accruals and prepayments

Session 10 Limited Company accounts

Session 11 Statements of cash flow

Session 12 Incomplete records

Session 13 Partnerships

8/8/2019 f3 pdf

4/102


Paper background

Aim

The aim of this paper is to develop knowledge and understanding of the underlying principles and

concepts relating to financial accounting and technical proficiency in the use of double-entry

accounting techniques including the preparation of basic financial statements.

Main capabilities

On completion of this paper, you should be able to:

Explain the context and purpose of financial reporting

Define the qualitative characteristics of financial information and the fundamental bases of

accounting

Demonstrate the use of double-entry and accounting systems

Record transactions and events

Prepare a trial balance (including identifying and correcting errors)

Prepare basic financial statements for incorporated and unincorporated entities

The assessment

The exam can be sat either written or computer based, both methods are 2 hours long.

Written

40 x 2 mark questions Multiple choice A / B / C / D

10 X 1 mark questions Multiple choice A / B or A / B / C

Computer based

40 x 2 mark questions Questions can be multiple choice, multiple response, matching or number

entry

10 x 1 mark questions Multiple response (correctly identify two from three right answers)

The pass mark is 50%

SESSION 1 INTRODUCTION TO ACCOUNTING

Learning outcomes

8/8/2019 f3 pdf

5/102


Understand the purpose of accounting Identify the different types of businesses Indentify the users of accounts Explain the qualitative characteristics of financial statements

Understand the underlying assumptions of financial statements

Introduction

WHAT IS ACCOUNTING?

Accounting is made up of two elements:

I. Recording business transactions - Book keepingII. Presenting the information

WHAT IS A BUSINESS?

A business is a commercial organisation which exists with a view to making a profit. There are

different types of businesses which will fall into 3 categories:

Sole Trader

This is a business that is owned and operated by one person

Partnership

This type of business is owned by several individuals, some of which will actively be involved in the

business

Companies

This type of business is owned by shareholders and is operated on their behalf by a nominated board

of directors. Companies will be covered in greater detail in later sessions

8/8/2019 f3 pdf

6/102


Users of accounts

The users of accounts will depend on the type of accounts that are produced. There are two main

types of accounts:

Management accounts Financial accounts

Management accounts

These are produced as often as a business wants them (usually monthly). They are produced for

internal use and will not, usually be seen by external people. Management accounts can be

prepared using the companys own internal policies.

Financial accounts

These accounts are usually produced annually. They are based on historical information and are

rarely used internally. Financial accounts are used by external users for several reasons:

Investors

Lenders

Employees

Government

Public

8/8/2019 f3 pdf

7/102


SESSION 2 FINANCIAL STATEMENTS

Learning outcomes

After completing this chapter, you should be able to:

Identify the layout of a Statement of Financial Position for a sole trader and a company Identify the layout of a Statement of Comprehensive income for a sole trader and a

company

Understand the principles and layout for a Statement of Changes in Equity

Introduction

There are four key financial statements:

Statement of Financial Position

This financial statement lists the assets and liabilities of a business at a point in time. It is a snapshot

of the companys position AS AT A POINT IN TIME

Statement of Comprehensive Income

This statement is a summary of the income and expenditure of the business for a PERIOD OF TIME.

Statement of Changes in Equity

This statement links the statements of comprehensive income and financial position.

Statement of Cash Flow

The statement of cash flow reports the cash generation and cash absorption for a PERIOD OF

TIME.

The starting point in the preparation of the financial statements is to produce a TRIAL BALANCE. The

trial balance is basically a list of ledger balances. A business will use a trial balance as an INDICATION

that all accounting entries have been recorded and all entries are correct.

A trial balance MUST balance. If there is an imbalance, this indicates an error in the initial entries. In

this case a suspense account is created until the errors can be detected.

8/8/2019 f3 pdf

8/102


Proforma set of financial statements for a sole trader.

Statement of Financial Position as at 31 December 2007

Non current assets

Cost Depn NBV

Buildings 150,000 (12,000) 138,000

Fixtures and fittings 45,000 (11,250) 33,750

Motor vehicles 26,000 (13,260) 12,740

221,000 (36,510) 184,490

Current assets

Inventory 13,777

Trade receivables 12,775

Prepayments 2,800

Cash 3,400 32,752

Total assets 217,242

Opening capital 152,465

Profit 51,787

Drawings (35,900) 168,352

Non current liabilities

Loan 20,000

Current liabilities

Trade payables 12,445

Accrued Loan interest 1,000

Other accruals 15,445 28,890

Total liabilities 217,242

8/8/2019 f3 pdf

9/102


Statement of Comprehensive Income for the year ended 31 December 2007

Revenue 233,000

Less: Cost of sales

Opening inventory 12,332

Purchases 119,098

Carriage inwards 1,009

132,439

Closing inventory (13,777) 118,662

GROSS PROFIT 114,338

Discounts received 5,111

Other income 4,000

123,449

Less: Expenses

Discounts allowed 3,444

Depreciation 10,710

Gas and electricity 14,122

Irrecoverable debts 7,134Loan interest 4,000

Carriage outwards 5,666

Water rates 8,444

Advertising 15,000

Other expenses 3,142 71,662

NET PROFIT 51,787

8/8/2019 f3 pdf

10/102


Proforma set of financial statements for a limited company or Plc

Statement of financial position as at 31 December 2007

Non current assets

Note

Intangible assets 6 200,000

Tangible assets 7 187,999

Current assets

Inventory 8 88,432

Trade receivables 9 97,455

Cash 13,400 199,287

Total assets 587,286

Equity and liabilities

Share capital 100,000

Retained earnings 220,497

Revaluation reserve 7 38,000 358,497


Interest bearing borrowings 10 100,000

Current liabilities


Taxation 5 51,000 128,789


8/8/2019 f3 pdf

11/102


Statement of comprehensive income for the year ended 31 December 2007

Note

Revenue (Sales) 385,000

Cost of sales 1 188,000


Distribution costs 2 38,500

Administration expenses 3 37,700

PROFIT FROM OPERATIONS 120,800

Finance costs 8,000

PROFIT BEFORE TAX 112,800

Income tax 53,000

PROFIT FOR THE PERIOD 59,800

Statement Of Changes In Equity for the year ended 31 December 2007 (SOCIE)

Share Retained Revaluation

Capital Earnings Reserve Total

Balance as at 1Jan 2007 100,000 188,697 40,000 328,697

Profit for the period 59,800 59,800

Surplus depreciation (not impt for F 3) 2,000 (2,000)

Dividend paid (30,000) (30,000)

Closing balance 100,000 220,497 38,000 358,497

The format for company accounts is laid down in I.A.S. 1 Presentation of Financial Statements. This

structured format aids comparability and makes information more useful.

Notes detailing the balances in the financial statements are provided giving a detailed breakdown of

the balance.

8/8/2019 f3 pdf

12/102


SESSION 3 DOUBLE ENTRY BOOK KEEPING

Learning outcomes

When you have completed this chapter, you should be able to:

Understand the principles of double entry bookkeeping Apply double entry bookkeeping to a list of transactions Prepare financial statements for a sole trader

Introduction

Bookkeeping is the recording of monetary transactions of a business.

Double entry bookkeeping

Double entry bookkeeping is the fundamental concept underlying accountancy. All accounting

transactions should be recorded using the double entry system. There are some basic rules that we

MUST follow:

1. Every debit must have a credit2. A debit entry is an ASSET in the STATEMENT OF FINANCIAL POSITION or an EXPENSE in the

STATEMENT OF COMPREHENSIVE INCOME

3. A credit entry is a LIABILITY in the STATEMENT OF FINANCIAL POSITION or an INCOME in theSTATEMENT OF COMPREHENSIVE INCOME

T accounts

In order to assist us with the preparation of the financial statements we use T accounts for

simplicity. The principles of T accounts are:

Every debit entry has a credit entry Every T account will belong to the statement of financial position or the statement of

comprehensive income

The closing balance of a T account at the end of the period is entered into a trial balance

8/8/2019 f3 pdf

13/102


EXAMPLE 1

George commences business on 1 April 2006. The following transactions take place in his first two

weeks of trading.

1 April He invests $50,000 in to a business 1 April He purchases $5,000 worth of goods on credit 2 April He sells half of the inventory for $6,000 cash 5 April He issues a cheque to pay for the goods he received on credit 4 April Pays his rent for April of $450 by cheque 7 April He sells his remaining stock for $6,000 on credit 10 April Purchased goods on credit for $7,000 14 April He purchases a delivery van for $7,000 cash

Required

For the first two weeks of trading prepare:

The T accounts for George (State if the account is Position or Income) The trial balance The Statement of Comprehensive Income The Statement of Financial Position

8/8/2019 f3 pdf

14/102


EXAMPLE 2

Tina starts her business on 1 January 2007. The following transactions take place in her first month

of trading:

1 Jan She invests $65,000 in to the business 2 Jan She purchases $8,000 worth of goods on credit 2 Jan She sells a quarter of the inventory for $4,000 cash 3 Jan Issues a cheque to pay for half of the goods she received on credit 14 Jan Pays her insurance for January by issuing a cheque for $75 15 Jan She sells the remaining inventory for $12,000 on credit 16 Jan Purchases inventory at a cost of $10,000 on credit 18 Jan Purchases some office equipment for $3,000 cash 20 Jan Pays her rent for January by cheque $150 21 Jan Sells half her inventory for $10,000 cash 25 Jan Withdraws $100 for petty cash 31 Jan Purchases office supplies worth $30 from petty cash

Required

For the first month of trading prepare:

The T accounts for Tina (state if the account is Position or Income) The trial balance The Statement of Comprehensive Income The Statement of Financial Position

8/8/2019 f3 pdf

15/102


ANSWER TO EXAMPLE 1 GEORGE

Bank Account

Dr Cr

1 April Capital 50,000 5 April Trade Payables 5,000

2 April Sales 6,000 4 April Rent 450

14 April Delivery Van 7,000

Carried Forward 43,550

56,000 56,000

Bought Forward 43,550

Capital Account

Dr Cr

1 April Bank 50,000

Purchases

Dr Cr

1 April Trade Payables 5,000

10 April Trade Payables 7,000 Carried Forward 12,000

12,000 12,000


Trade Payables

Dr Cr

5 April Bank 5,000 1 April Purchases 5,000

Carried Forward 7,000 10 April Purchases 7,000

12,000 12,000


Sales

8/8/2019 f3 pdf

16/102


Dr Cr

2 April Cash 6,000

Carried Forward 12,000 7 April Trade Receivables 6,000

12,000 12,000


Rent

Dr Cr

4 April Bank 450

Trade Receivables

Dr Cr

7 April Sales 6,000

Delivery Van

Dr Cr

14 April Bank 7,000

8/8/2019 f3 pdf

17/102


George Trial Balance

Statement Dr Cr

Bank Account FP 43,550

Capital Account FP 50,000

Purchases CI 12,000

Trade Payables FP 7,000

Sales CI 12,000

Rent CI 450

Trade Receivables FP 6,000

Delivery Van FP 7,000

Total 69,000 69,000

8/8/2019 f3 pdf

18/102


George


2 Week Period Ended 14 April 2007

Sales 12,000

Cost of sales

Opening inventory 0

Purchases 12,000

12,000

Closing inventory (7,000) 5,000

GROSS PROFIT 7,000

Less expenses

Rent 450

NET PROFIT 6,550

8/8/2019 f3 pdf

19/102


George


as at 14 April 2007

Non Current Assets

Delivery Van 7,000

Current Assets

Inventory 7,000

Trade Receivables 6,000

Bank Account 43,550

56,550

TOTAL ASSETS 63,550

Capital 50,000

Profit 6,550

56,550

Non Current Liabilities 0

Current Liabilities

Trade Payables 7,000

63,550

8/8/2019 f3 pdf

20/102


ANSWER TO EXAMPLE 2 TINA

Bank Account

Dr Cr

1 Jan Capital 65,000 3 Jan Trade Payables 4,000

2 Jan Sales 4,000 14 Jan Insurance 75

21 Jan Sales 10,000 18 Jan Office Equipment 3,000

20 Jan Rent 150

25 Jan Petty Cash 100

c/f 71,675

79,000 79,000

b/f 71,675

Capital Account

Dr Cr

1 Jan Bank 65,000

Purchases

Dr Cr

2 Jan Trade Payables 8,000

16 Jan Trade Payables 10,000 c/f 18,000

18,000 18,000

b/f 18,000

Trade Payables

Dr Cr

3 Jan Bank 4,000 2 Jan Purchases 8,000

c/f 14,000 16 Jan Purchases 10,000

18,000 18,000

b/f 14,000Sales

8/8/2019 f3 pdf

21/102


Dr Cr

2 Jan Bank 4,000

15 Jan Trade Receivables 12,000

c/f 26,000 21 Jan Bank 10,000

26,000 26,000

b/f 26,000

Insurance

Dr Cr

14 Jan Bank 75

Trade Receivables

Dr Cr

15 Jan Sales 12,000

Office Equipment

Dr Cr

18 Jan Bank 3,000

Rent

Dr Cr

8/8/2019 f3 pdf

22/102


20 Jan Bank 150

Petty Cash

Dr Cr

25 Jan Bank 100 31 Jan Office Supplies 30

c/f 70

100 100

b/f 70

Office Supplies

Dr Cr

31 Jan Petty Cash 30

8/8/2019 f3 pdf

23/102


Tina Trial Balance

Statement Dr Cr

Bank Account FP 71,675

Capital Account FP 65,000

Purchases CI 18,000

Trade Payables FP 14,000

Sales CI 26,000

Insurance CI 75

Trade Receivables FP 12,000

Office Equipment FP 3,000

Rent CI 150

Petty Cash FP 70

Office Supplies CI 30

Totals 105,000 105,000

8/8/2019 f3 pdf

24/102


Tina


For January 2007

Revenue 26,000

Cost of sales

Opening inventory 0

Purchases 18,000

18,000

Closing inventory (5,000)

GROSS PROFIT 13,000

Less expenses:

Insurance 75

Rent 150

Office supplies 30

255

NET PROFIT 12,745

8/8/2019 f3 pdf

25/102


Tina


as at 31 January 2007

Non Current Assets

Office Equipment 3,000

Current Assets

Inventory 5,000


Bank Account 71,675

Petty Cash 70

88,745

TOTAL ASSETS 91,745

Capital 65,000

Profit 12,745

77,745

Non Current Liabilities 0

Current Liabilities

Trade Payables 14,000

91,745

8/8/2019 f3 pdf

26/102


SESSION 4 NON CURRENT ASSETS

Learning outcomes


Define a non current asset Distinguish between tangible and intangible non-current assets Explain the differences between capital and revenue expenditure Understand the concepts of I.A.S. 16 Accounting for non-current assets Compile a non current asset register Calculate and account for depreciation Record the accounting entries for disposals of non-current assets

Introduction

A non-current asset is intended for continued use in a business. This would generally mean for

more than one accounting period. Non-currents assets can be either TANGIBLE or INTANGIBLE.

ACCA F3 concentrates on tangible non-current assets, however a knowledge of intangible non

current assets is needed.

Tangible non-current assets

These are assets that have physical substance. Examples of tangible non-current assets would be:

Land and buildings

Plant and equipment

Motor vehicles

Computers

Fixtures and fittings

Intangible non-current assets

These assets have no physical substance. An example of an intangible non-current asset would be:

Goodwill

Development

8/8/2019 f3 pdf

27/102


Non-current assets are normally of substantial value and their accounting can have a material impact

on the financial statements. As a result of this there are large numbers of accounting standards that

help the preparers of financial statements to account for them.

The key accounting standard relevant at this level is I.A.S. 16 Non-Current Assets

Non-current asset register

The majority of companies will own a number of non-current assets, and it is imperative that

effective control is kept over them. In order to ensure management are aware exactly where each

item is located and that they are adequately maintained and serviced, a non current asset register is

maintained.

A non-current asset register is generally maintained in the finance department. Companies can

purchase specifically designed packages or a register can simply be maintained on an Excel

spreadsheet.

A register would include the following information:

Item code Date of purchase Item description Cost Estimated useful life Residual value (if any) Depreciation method Location Disposal details

8/8/2019 f3 pdf

28/102


Capital and revenue expenditure

One of the key areas of accounting for non-current assets is deciding whether expenditure incurred

is CAPITAL or REVENUE expenditure.

If it is capital expenditure it will be capitalised in the statement of financial position and thendepreciated over the useful economic life of the asset. If it is revenue expenditure it will be

expensed through the statement of comprehensive income.

We need to classify expenditure incurred as either capital or revenue in order to ensure appropriate

accounting entries are made.

Capital expenditure is expenditure likely to increase the future earning capacity of the organisation

whereas revenue expenditure is regarded as maintaining the organisations present earning

capacity.

Per I.A.S. 16 the following costs may be capitalised on acquisition of a non-current asset:

Initial cost Delivery costs Non-refundable import taxes Installation costs Any costs incurred in bringing the asset into intended use Initial training costs Subsequent expenditure that ENHANCES the performance of the asset

Costs that are regarded as revenue expenditure and may not be capitalised per I.A.S. 16 are:

Insurance costs Repairs Maintenance

EXAMPLE 1

Capital Revenue

Purchase of a motor vehiclePurchase of a tax disc

Fuel

Insurance

C D player

Alloy wheels

New tyre

Early settlement discount

Depreciation

8/8/2019 f3 pdf

29/102


Depreciation is the charge to the statement of comprehensive income to reflect the consumption of

an asset in a period.

By applying depreciation charges, we are consistent with the ACCRUALS / MATCHING CONCEPT i.e.

applying the cost of using the asset to the statement of comprehensive income for the same period.

All tangible non-current assets should be depreciated on a systematic basis per I.A.S. 16, with the

exception of land. This is because land is seen to appreciate in value.

Intangible non-current assets are amortised over their useful economic life (this is just another term

for depreciation).

Depreciation policies

Calculating depreciation in a given period are common questions in this paper. The main methods of

calculating depreciation are:

Straight line Reducing balance

Straight line depreciation

Depreciation is charged on a straight line basis over the life of the non-current asset. Thus an equal

amount is charged in every accounting period over the life of the asset.

To calculate the depreciation charge the following formula is used:

Depreciation per annum = Original cost estimated residual value

Estimated useful Life

8/8/2019 f3 pdf

30/102


EXAMPLE 2

Company A purchased a non-current asset on 31st July for $150,000. The asset has an expected

useful life of 5 years and a residual value of $20,000.

Calculate the depreciation charges for the year ended 31

st

December on the basis:

i. A full years charge is made in the year of acquisition and none in the year of disposal.ii. The companys policy is to time-apportion depreciation charges.

EXAMPLE 3

Company B purchases a machine for $23,000. They expect to use it for four years and then sell it for

$3,000.

What is the annual depreciation charge?

Reducing balance

This method of depreciation is generally used for assets which tend to lose more value in the initial

years and require greater maintenance in the later years. A good example would be a brand new

motor vehicle. Motor vehicles tend to depreciate rapidly in the earlier years and require very little

maintenance.

A fixed percentage is charged to the net book value on an annual basis. Hence, as the book value of

an asset reduces, the depreciation charge reduces accordingly.

EXAMPLE 4

Company C purchases a motor vehicle for $25,000 and will depreciate it at a rate of 25%.

Calculate the depreciation for the first three years.

Once the depreciation charge has been calculated it should be entered into the accounts via ajournal.

The journal for depreciation is:

Dr Depreciation expense (Statement of comprehensive income)

Cr Accumulated Depreciation (Statement of financial position)

8/8/2019 f3 pdf

31/102


Revaluations

When a non-current asset is purchased we record them at their initial cost. However, over time

these values may materially differ from their market value.

For example, if a company purchased a property 20 years ago and therefore subsequently chargeddepreciation for 20 years, it would be safe to assume that the book value of the asset would be

significantly different from todays market value.

In order to overcome this issue I.A.S. 16 permits companies to reflect the market value in the

statement of financial position. This policy may be adopted, and if so the following rules must be

applied per the standard:

i. If a company chooses to revalue an asset they must revalue all assets in that categoryii. Revaluations must be regular

iii. Subsequent depreciation must be based on the revalued amountsiv. Gains from revaluations are not taken to the statement of comprehensive income, as no

gain as been realised. This is covered by the PRUDENCE concept.

EXAMPLE 5

Company X purchased a building for $45,000 15 year ago, and charges depreciation of 2% on a

straight line basis.

The property has been valued by a qualified person at $150,000 during the current financial year.

The directors would like to encompass these figures in the financial statements.

Required:

Complete the necessary journals to account for the revaluation.

8/8/2019 f3 pdf

32/102


Disposal of a non-current asset

When a business disposes of an asset it is unlikely that the sale proceeds will agree with the net

book value. Therefore, a gain or loss will arise from the sale.

EXAMPLE 6

Company C has a motor vehicle with a book value of $6,000 (cost $22,000) and disposes of it for

$8,000.

We can establish that there is a gain of $2,000 (proceeds book value).

The accounting entries will need to follow three steps

1. Clear the cost from the cost account2. Clear the depreciation from the accumulated depreciation account3. Enter the proceeds

The entries are therefore:

Dr Disposal Account $22,000

Cr Motor vehicle cost account $22,000

Dr Accumulated depreciation $16,000

Cr Disposal Account $16,000

Dr Bank $8,000

Cr Disposal Account $8,000

ANSWERS TO EXAMPLE 1

8/8/2019 f3 pdf

33/102


Capital Revenue

Purchase of a motor vehicle

Purchase of a tax disc

Fuel

Insurance

C D player Alloy wheels

New tyre

Early settlement discount

ANSWER TO EXAMPLE 2

i

150,000 - 20,000 = 26,000

5

Ii

26,000 x 5 = 10,833

12

ANSWER TO EXAMPLE 3

23,000 - 3,000 = 5,000

4

ANSWER TO EXAMPLE 4

Year 1 25,000 x 25% = 6,250

Year 2 25,000 - 6,250 x 25% = 4,688

Year 3 25,000 - 6,250 - 4,688 x 25% = 3,516

8/8/2019 f3 pdf

34/102


ANSWER TO EXAMPLE 5

Pre Revaluation Post Revaluation

Building CostAccount AccumulatedDepreciation Net BookValue Building CostAccount AccumulatedDepreciation Net BookValue

45,000 13,500 31,500 150,000 4,286 145,714

Accumulated depreciation pre revaluation

45,000 X 2% X 15 Years = 13,500

Accumulated depreciation post revaluation

150,000 / 35 Years = 4,286 pa

Journals Required

Dr Buildings Cost 105,000

Dr Accumulated Depreciation

13,500

Cr Revaluation Reserve 118,500

Dr Depreciation 4,286

Cr Accumulated Depreciation

4,286

8/8/2019 f3 pdf

35/102


SESSION 5 INVENTORY

Learning Outcomes

When you have completed this chapter you should be able to:

Explain the principles of I.A.S. 2 Inventories Explain and apply the different methods of inventory valuation including F.I.F.O., A.V.C.O.

and L.I.F.O.

Understand and apply the double entry for inventory

Introduction

Inventory is the product we purchase and sell in a business.

In a business it is unlikely that all of the inventory will be sold at the end of an accounting period,

therefore there will be an adjustment needed in the financial statements for the value of the closing

inventory.

Opening and closing inventory needs to be included in the statement of comprehensive income in

order to calculate the cost of the goods sold with-in a given period. The statement of financial

position will show the value of the inventory at the end of the accounting period (the closing

inventory).

I.A.S. 2 is the accounting standard that gives us detailed guidance on how to value our closing

inventory.

RULE: Closing inventory should be valued at the lower of cost and net realisable value (N.R.V.)

By applying the I.A.S. 2 rule we ensure our inventory is never overstated in the statement of financial

position, hence the PRUDENCE concept.

Valuation of closing inventory

We will cover three methods of valuing the closing inventory:

F.I.F.O. First In First Out

The closing inventory consists of items purchased at the latest dates, as we assume the items that

were purchased first were the items sold first.

In times of rising prices, closing inventory will have a higher cost and therefore profit will be higher.

8/8/2019 f3 pdf

36/102


Weighted average cost (AVCO)

Under this method we assume:

All units are issued at the current weighted average cost per unit A new average cost is calculated whenever more items are purchased

L.I.F.O. Last In First Out

The closing inventory consists of items purchased at the earliest date, as we assume the last item

purchased is the first item to be sold.

In times of rising prices the closing inventory will have a lower value and therefore profit will be

lower.

From a practical perspective it is unlikely last items purchased will be sold first, and as a result of this

I.A.S. 2 does not permit L.I.F.O. method of stock valuation.

W.I.P. Work in progress

In some cases, where a company has modified its inventory it is necessary to take the cost of that

modification into account when valuing closing inventory.

Net realisable value

Net realisable value is the amount we can get from selling inventory less any further costs to be

incurred.

Accounting Entries

The double entry to account for closing stock is:

Dr Inventory Statement of financial position

Cr Inventory Statement of comprehensive income

8/8/2019 f3 pdf

37/102


EXAMPLE 1

Navigator Office Supplies made the following purchases and sales in January:

Purchases

3rd 500 pens @ 4.00 = 2,000

12th

500 pens @ 4.60 = 2,300

16th 400 pens @ 4.75 = 1,900

22nd 700 pens @ 5.25 = 3,675

31st 900 pens @ 5.40 = 4,860

3,000 14,735

Sales

7th 300 pens @ 10.00 = 3,00013

th400 pens @ 10.00 = 4,000

17th

300 pens @ 10.00 = 3,000

29nd 700 pens @ 10.00 = 7,000

1,700 17,000

Required

Assuming there is no opening inventories prepare the statement of comprehensive income using the

following:

LIFO FIFO AVCO

8/8/2019 f3 pdf

38/102


ANSWER TO EXAMPLE 1

L.I.FO.

IN OUT BALANCE

Date No. Cost Total No. Cost Total No. Cost Total

03/01 500 4.00 2000.00 500 2000.00

07/01 300 4.00 1200.00 200 800.00

12/01 500 4.60 2300.00 700 3100.00

13/01 400 4.60 1840.00 300 1260.00

16/01 400 4.75 1900.00 700 3160.00

17/01 300 4.75 1425.00 400 1735.00

22/01 700 5.25 3675.00 1100 5410.00

29/01 700 5.25 3675.00 400 1735.00

31/01 900 5.40 4860.00 1300 6595.00

F.I.F.O

Total Purchases 3,000 pens

Total Sales 1,700 pens

Closing inventory 1,300 pens

Valuation

900 @ $5.40 each $4,860

400 @ $5.25 each $2,100

= $6,960

8/8/2019 f3 pdf

39/102


AVCO

IN OUT BALANCE

Date No. Cost Total No. Cost Total No. Cost Total

03/01 500 4.00 2000.00 500 2000.00

07/01 300 4.00 1200.00 200 800.00

12/01 500 4.60 2300.00 700 3100.00

13/01 400 3100

divided

by 700

1771.00 300 1329.00

16/01 400 4.75 1900.00 700 3229.00

17/01 300 3229

divided

by 700

1384.00 400 1845.00

22/01 700 5.25 3675.00 1100 5520.00

29/01 700 5520

dividedby

1100

3513.00 400 2007.00

31/01 900 5.40 4860.00 1300 6867.00

Therefore Income Statement is as follows:

All $ L.I.F.O. F.I.F.O. AVCO

Revenue 17,000 17,000 17,000

Cost of sales

Opening inventory 0 0 0

Purchases 14,735 14,735 14,735

Closing inventory -6,595 -6,960 -6,867

8,140 7,775 7,868

8,860 9,225 9,132

8/8/2019 f3 pdf

40/102


EXAMPLE 2

Radiance Kitchenware has the following items in their financial statements for the year ended 31st

December 2007:

Inventory @ 01/01/07 $45,678

Purchases $98,000

Inventory @ 31/12/07 $42,800

Closing inventory includes the following damaged items:

A table was purchased for $500. Due to fire damage the maximum it can be sold for is $200after a wax product costing $50 has been applied.

Four chairs costing $100 each were also damaged in the fire. They can be sold for $20.Required

Calculate the cost of sales for 2007.

ANSWER TO EXAMPLE 2

Stock Valuation

Closing valuation 42,800

Less

Damaged inventory Table 500

Chairs 400 900

Add NRV

Table (200 50) 150

Chairs 80 230

42,130

Cost of Sales

Opening inventory 45,678

Purchases 98,000

Closing inventory -42,130

101,548

8/8/2019 f3 pdf

41/102


SESSION 6 IRRECOVERABLE DEBTS AND PROVISION FOR DOUBTFUL DEBTS

Learning Outcomes


Explain the difference between a irrecoverable debt and a doubtful debt Compute the double entries required for irrecoverable debts and the provision for doubtful

debts

Introduction

The majority of companies sell their product on credit. The length of credit will vary between

companies, but the most common length of credit is 30 days.

If however, someone fails to pay we need to be able to account for this is our ledgers. It would not

be prudent to hold a receivable in our statement of financial position if we were aware that they are

unlikely to pay.

There are 2 types of debts that we need to consider:

Irrecoverable debt (bad debt) Doubtful debt

There is a clear distinction between irrecoverable and doubtful debts:

Irrecoverable Debt

This is a debt that you consider to be uncollectable. Circumstances where this would occur are if the

company has been fraudulent, gone bankrupt or disappeared. Thus it is unlikely that we will receive

the money due to us.

If this is the case we should not have this balance in our receivables, and would therefore write the

debt off.

The double entry would be:

Dr Irrecoverable debts Statement of comprehensive income

Cr Trade receivables Statement of financial position

EXAMPLE 1

8/8/2019 f3 pdf

42/102


George has a small antiques business and at the end of the financial year ended 30th April 2007 has a

receivables balance of $42,500. Included in the year end balance is $4,000 that is owed by Zippy

Traders. George has heard that they have been closed down due to financial irregularities and that

all the directors have disappeared.

Also included in the amount is $500 owed by Bungle who is Georges brother-in-law. Bungle has leftGeorges sister and George is not sure if he will pay his debt which is due in 2 weeks time.

Required

How should George account for these items?

Recovering debts written off

If a debt that has been written off is later recovered, we will need to adjust the ledgers to reflect

this. The entry required would be:

Dr Bank

Cr Irrecoverable debts

Doubtful debt

A doubtful debt is a debt that is owed to a business, but they are dubious about its collectability.

The distinguishing factor is that this debt could be collected as it is doubtful not bad. We therefore,make a provision for this amount.


Dr Irrecoverable debts Statement of comprehensive income

Cr Provision for doubtful debts Statement of financial position

This type of provision is called a specific allowance as we know exactly which debts the provision is

for. As you can see the debt remains in the receivables ledger, as a result the company can still

actively chase the debt. If or when the company pays the debt the double entry would be thenormal entry for a receipt i.e.

Dr Bank

Cr Trade receivables

We would then reverse the provision we had for this debt.

General allowance

8/8/2019 f3 pdf

43/102


In order to apply the prudence concept we need to review our receivables at the end of the financial

year and take a view of collectables. A large number of companies have a constant provision for

receivables. This would be calculated as a percentage of the receivables balance.

EXAMPLE 2

For the year ended 31st December 2005 a companys receivables balance was $150,000. They had a

general allowance of 5%. At the year ended 31st December 2006 the companys receivables are

$135,000 the company would like to maintain a 5% general allowance.

Required

What is the impact on the statement of comprehensive income and how will the receivables be

presented in the statement of financial position?

8/8/2019 f3 pdf

44/102


ANSWER TO EXAMPLE 1

Zippy Traders

This debt should be treated as an irrecoverable debt. Therefore the entry needed would be:

Dr Irrecoverable debts $4,000

Cr Trade receivables $4,000

Bungle

This debt is neither an irrecoverable or doubtful debt at this stage. This is because the debt is not

yet due and we know where Bungle lives. We also have no reason to suspect that Bungle cannotafford to repay the debt.

ANSWER TO EXAMPLE 2

31ST December 2005

General provision 5% x $150,000 = $7,500

Double entry

Dr Irrecoverable debts 7,500

Cr Allowance for receivables 7,500

Extract from statement of financial position:

Current assets

Receivables 150,000General Allowance -7,500

142,500

8/8/2019 f3 pdf

45/102


31st December 2006

General Provision 5% x $135,000 = $6,750

Provision bought forward = $7,500

Therefore overprovision = $750 (7,500 6,750)

Double entry

Cr Irrecoverable debts 750

Dr Allowance for receivables 750

Current assets

Receivables 135,000

General Allowance -6,750

128,250

8/8/2019 f3 pdf

46/102


SESSION 7 CONTROL ACCOUNTS AND CORRECTION OF ERRORS

Learning outcomes


Understand the principles of control accounts Prepare the control accounts for trade receivables and trade payables Explain the function of a suspense account Prepare nominal ledger accounts Prepare journal entries

Introduction

In session 3 we prepared financial statements from T accounts. The number of transactions was

limited, and therefore the process was simple to follow. If an error had been made it would have

been easy to detect.

However, in the real world of business the number of transactions is large, and to help us detect

errors we use control accounts. Therefore, daily entries are normally made in a number of Prime

Entry books and then a summary total is transferred to the nominal ledger periodically. This could

be done daily, weekly or even monthly.

The following have a large volume of transactions on a daily basis and are used as prime entries:

Sales day book Purchase day book Sale returns day book Purchase returns day book Cash book Petty cash book Journal entries

The transactions are recorded in the prime entry books. They are then transferred to the nominal

(general) ledger and we then extract a trial balance in order to prepare our financial statements.

8/8/2019 f3 pdf

47/102


Sales day book

This book records all the sales we make on credit. Sales should be recorded net of trade discount

but before cash (settlement) discount.

Purchase day book

This book of prime entry records all purchases we make on credit.

Sale returns day book

If a credit customer returns goods, this will be recorded in the sales returns day book.

Purchase returns day book

This book will record all the credit purchases that we return to suppliers.

Cash book

This book will record all the money that we will pay into the bank account, and any payments we

make from the bank account. This will also record any cash (settlement) discounts we allow or

receive.

Petty cash book

This records all the small sundry transactions occurring in a business on a day to day basis.

Journal entries

These are used for ad hoc entries that do not fall into any of the above categories. They are also

used to correct errors, both temporary and permanent.

8/8/2019 f3 pdf

48/102


EXAMPLE 1

L & M had the following transactions during the first week in December 2007.

1st December 2007

Purchased goods on credit from A Ltd for $595 receiving a trade discount of 9.5% Purchased goods on credit for $795 from KP Ltd Sold goods on credit to JK Ltd for $999

3rd December

Returned KP Ltd goods as they were defective Sold goods on credit to A Jones for $995

5th December

Sold goods on credit to A Jones for $795 Purchased goods on credit from A Ltd for $995, again with a 9.5% trade discount

NB Sales tax is 17.5%

SOLUTION

SALES DAY BOOK

DATE INV NO. CUSTOMER NET SALES TAX [email protected]%

01/12 100555 J K Limited 999.00 174.82 1173.82

03/12 100556 A Jones 995.00 174.12 1169.12

05/12 100557 A Jones 795.00 139.12 934.12

2789.00 488.06 3277.06

PURCHASE DAY BOOK

DATE INV NO. SUPPLIER NET SALES TAX TOTAL

@17.5%

01/12 999241 A Limited 538.47 94.23 632.70

01/12 867544 K P Limited 795.00 139.12 934.12

05/12 999242 A Limited 900.47 157.58 1058.05

2233.94 390.93 2624.87

PURCHASE RETURNS DAY BOOK

8/8/2019 f3 pdf

49/102


DATE INV NO. SUPPLIER VALUE SALES TAX TOTAL

03/12 867544 K P Limited 795.00 139.12 934.12

795.00 139.12 934.12

8/8/2019 f3 pdf

50/102


EXAMPLE 2

The following are the balances on Explorers ledger accounts in the month of January

Opening receivables balance 22,500

Sales day book 88,650

Cash sales 23,950

Sale returns day book 5,555

Refunds to customers 3,325


Irrecoverable debts 4,455

Increase in provision 500

Purchase ledger contra 1,200

Required

Calculate total cash received from customers in January

Solution

RECEIVABLES CONTROL ACCOUNT

Dr Cr

All Jan All Jan

Opening balance 22,500 Returns book 5,555

Sales day book 88,650 Discounts allowed 6,786

Refunds 3,325 Irrecoverable debts 4,455

Contra 1,200

Closing balance 18,650Receipts (bal fig) 77,829

114,475 114,475

Feb Opening balance 18,650

8/8/2019 f3 pdf

51/102


EXAMPLE 3

The following are the balances on a companys ledger accounts in the month of March:

Opening payables balance 12,785

Purchase day book 44,999

Returns outwards daybook 3,950

Returns inwards day book 2,300

Cheques paid to suppliers 37,500


Sales ledger contras 900

Required

Calculate the closing balance for the payables account at the end of March.

Solution

PAYABLES CONTROL ACCOUNT

Dr Cr

All March All March

Returns outwards 3,950 Opening balance 12,785

Payments 37,500 Purchase day book

44,999


Contra 900

Closing bal (bal fig)

14,034

57,784 57,784

April Opening balance 14,034

Reconciling the control accounts

8/8/2019 f3 pdf

52/102


Normally at the end of each month we check to ensure our control accounts reconcile to the

individual balances on our ledger accounts. We do this by:

Checking our list of individual balances tie into the control account balance. If there is an imbalance

then it must be investigated. The main discrepancies are due to:

Casting error in the day books Posting error A one sided contra An entry that has been made in the individual account but not in the control accounts An entry being omitted from the control account

EXAMPLE 4

At the financial year end 31 December 2007 Explorer Rain Wear had a balance on the payables

control account of $22,550. The balance on their purchase ledgers was $20,650. The management

accountant found the following discrepancies:

1. An invoice of $1,200 had been omitted from the control account2. The purchase day book total was overstated by $1,0003. Goods returned of $1,590 had not been recorded in the control account4. Discounts received of $10 had not been posted5. Contra entries of $500 need to be recorded in the control account

After these adjustments are made, the control account should balance.

Solution

Until a full knowledge of double entry is known, the easiest way to tackle this question is to identify

where the error has occurred and amend accordingly. In this case:

Error No. Location of Error Amend

1 Control Account Control Account2 Control Account Control Account

3 Control Account Control Account




Dr CrAll Dec All Dec

8/8/2019 f3 pdf

53/102


Error 2 1,000 Original balance 22,550

Error 3 1,590 Error 1 1,200

Error 4 10

Error 5 500

Amended balance 20,650

23,750 23,750

Jan Opening balance 20,650

Balancer per list 20,650

EXAMPLE 5

Hippo Manufacturing had the following balances on their payables / receivables for the financial

year ended 30 June 2006.

Credit sales 450,000

Cash sales 22,000

Credit purchases 300,000

Cash purchases 4,500

Returns inwards 17,000

Returns outwards 14,000


Discounts received 12,000Irrecoverable debts 2,500

Payments made to payables 263,100

Cash received from receivables 438,580

Contras 17,500

Balance at 1 July 2005:

Payables 53,500

Receivables 51,500

Provision for doubtful debts 3,400

Bad debt provision is to be maintained @ 1.5% of credit sales

Required:

Compute the receivables and payables control account and extract the closing balances for the

financial year end.

SOLUTION

8/8/2019 f3 pdf

54/102


This is a common CBA question. It is designed to ensure you know exactly what should go into

control accounts and also your knowledge of double entry. Again until you are comfortable with

debits and credits it is easier to write exactly where things will go before attempting to balance the

accounts. In this case:

Receivables / Payables Debit / Credit

Credit sales Receivables Debit

Cash sales Neither n/a

Credit purchases Payables Credit

Cash purchases Neither n/a

Returns inwards Receivables Credit

Returns outwards Payables Debit

Discounts allowed Receivables Credit

Discounts received Payables Debit

Irrecoverable debts Receivables Credit

Payments made Payables DebitCash Received Receivables Credit

Contra Receivables / Payables Credit / Debit


Dr Cr

Returns outwards 14,000 Opening balance 53,500

Discounts received 12,000 Credit purchases 300,000

Payments 263,100Contra 17,500

Closing bal (bal fig) 46,900

353,500 353,500

8/8/2019 f3 pdf

55/102


RECEIVABLES CONTROL ACCOUNT

Dr Cr

Opening balance 51,500 Returns inwards 17,000

Credit sales 450,000 Discounts allowed 11,000

Irrecoverable debts 2,500

Cash received 438,580

Contra 17,500

Closing bal (bal fig) 14,920

501,500 501,500

Correction of errors

At the end of an accounting period we extract a trial balance, and use this as a basis for preparing

the financial statements.

The following are the main purposes of a trial balance:

Account balances are reviewed to check for obscurities Reconcile all control account balances with the individual ledgers Ensure debits equal the credits.

If there is an imbalance a SUSPENSE ACCOUNT will be created. Therefore, a suspense account mayhave a debit or credit balance.

Errors that will cause a difference in the trial balance are:

Transposition error Entering figures the wrong way round Single entries Only one side of the transaction has been posted Both entries entered on the same side of the ledger account Casting error An account has been incorrectly added

Although extracting a trial balance proves the above, there are certain errors that a trial balance will

not identify. These are:

Error of principle An entry has been entered in the wrong financial statement. Errors of omission A transaction has been missed out. Errors of commission Entering an amount in the wrong account, but in the correct financial

statement.

Compensating errors Where two or more errors cancel each other. This is extremely rare.

Journals

8/8/2019 f3 pdf

56/102


Journals are used for several reasons:

Post unique, one off transactions Transfer items between accounts Adjust balances that are incorrect Correct items that have been incorrectly posted

Journals should have a unique number and should be clearly labelled.

Example 6

Correct the following errors using journals:

1. A sales day book has been under cast by $1,000.2. Inventory purchased for $1,000 has been posted to stationery3. A non-current asset has been purchased for $7,000 on credit, but has not been recorded.

Solution

Account Name Description Debit Credit

Sales Revenue SDB under cast 1,000


Stationery Incorrectly coded 1,000

Purchases 1,000

Non-current asset Capital purchased 7,000

Other payables 7,000

Example 7

Peter has the following balances on its trial balance at the end of the financial year:

8/8/2019 f3 pdf

57/102


Debit $213,852

Credit $212,390

A suspense account has been created for the difference.

The following errors have been identified by the accountant; after these errors have been corrected

the balance on the suspense account should be removed.

1. A payment for stationery for $440 was debited to stationery as $780.2. Discounts allowed of $1,310 have been recorded as a credit.3. Other income of $3,742 has only been recorded in the cash book.

Required

Correct the entries and clear the suspense account.

Solution

Account Name Description Debit Credit

Suspense Incorrect total posted 340

Stationery 340

Discounts allowed Posting to incorrect side 2,620

Suspense 2,620

Suspense One sided entry 3,742Other income 3,742

Suspense Account

Journal 1 340 Opening Balance 1,462

Journal 3 3,742 Journal 2 2,620

4,082 4,082

8/8/2019 f3 pdf

58/102

8/8/2019 f3 pdf

59/102


It is extremely unlikely that the balance on the ledger account and the balance on the bank

statement will agree. This can be due to the following reasons:

Cheques issued by the company are immediately entered into the cash book, but they willnot appear on the bank statement until they are presented to the bank. These are called

unpresented cheques.

Receipts by the business are immediately entered in the cash book and then banked. Thiscan take a number of days to clear.

There may be items in the bank statement that have not been processed through the cashbook e.g. BACS transfer, standing orders, direct debits, dishonoured cheques and bank

charges.

Proforma bank reconciliation

Balance per bank statement 65,455

Less : Unpresented cheques (1,950)

Add: Outstanding lodgements 1,700

Balance per cash book 65,205

Preparing a bank reconciliation

1. Compare the cash book and bank statement and tick matching items

2. Post corrections to the cash book i.e. items on the bank statement that have not beenprocessed through the ledger

3. Put in items that are in the cash book that have yet to be presented to the bank as areconciling item.

UNLESS OTHERWISE TOLD, ASSUME FIGURES ON THE BANK STATEMENT ARE CORRECT.

8/8/2019 f3 pdf

60/102


Example 1

Cash Book

01/04/07 b/d 14,500 01/04/07 1437 450

03/04/07 27 3,650 01/04/07 1438 60005/04/07 28 1,200 01/04/07 1439 750

12/04/07 29 1,100 01/04/07 1440 150

29/04/07 30 3,000 12/04/07 1441 250

12/04/07 1442 350

27/04/07 1443 395

27/04/07 1444 165

27/04/07 1445 245

30/04/07 c/d 20,095

23,450 23,450

30/04/07 b/d 20,095

Bank Statement

Date Details Payment Receipt Balance

01/04/07 Opening balance 14,500

04/04/07 1437 450 14,050

05/04/07 1438 600 13,450

08/04/07 27 3,650 17,100

10/04/07 28 1,200 18,300

11/04/07 Standing Order P.S.L. 750 17,550

12/04/07 1439 750 16,800

14/04/07 Direct Debit Direct Line 750 16,050

17/04/07 1441 250 15,800

17/04/07 BACS (Bank Automated Clearance

System) Transfer 3,500 19,300

18/04/07 1442 350 18,950

20/04/07 29 1,100 20,050

24/04/07 Bank Charges 500 19,550

8/8/2019 f3 pdf

61/102


Solution

Cash Book

30/04/07 b/d 20,095 11/04/07 Standing Order 750

17/04/07 BACS 3,500 14/04/07 Direct Debit 75024/04/07 Bank Charges 500

30/04/07 c/d 21,595

23,595 23,595

30/04/07 b/d 21,595

Bank Reconciliation

Balance per bank statement 19,550

Less: unpresented cheques 1440 150

1443 395

1444 165

1445 245 (955)

Add: Outstanding lodgements 30 3,000

21,595

8/8/2019 f3 pdf

62/102

8/8/2019 f3 pdf

63/102


Solution:

Cash Book

30/11/07 Chq 100678 (1) 459 30/11/07 b/d 2,400

30/11/07 BACS 6,196 30/11/07 Direct Debit (2) 225

30/11/07 Dishonoured

Cheque (5) 1,450

30/11/07 Bank Charges (6)

1,400

30/11/07 Chq 100600 (8) 180

30/11/07 c/d 1,000

6,655 6,655

30/11/07 b/d 1,000

Bank Reconciliation

Balance per bank statement (1,550)

Less : Unpresented cheques (3) (5,840)

Add: Outstanding lodgements (4) 8,390

1,000

8/8/2019 f3 pdf

64/102


SESSION 9 ACCRUALS AND PREPAYMENTS

Learning Outcomes


Explain why adjustments are necessary when preparing financial statements Compute the adjustments needed

Introduction

The matching concepts states that income and expenses incurred in the period should be accounted

for in that period, regardless of when invoices are raised or received.

The fundamental rule is that income and expenditure are recognised as they are earned or incurred,

not as money is received or paid.

In order to ensure income and expenditure is recorded in the correct period, it is often necessary to

adjust the financial statements.

Example 1 - Accruals

A sole trader receives his business gas bill quarterly in arrears. In the year ended 31st December

2007 the following bills were received and paid on the dates indicated.

30/04/07 $300 31/07/07 $310 31/10/07 $300

When preparing the accounts for the year end the accountant must adjust the Gas ledger account to

reflect that not all charges have been recorded. In this case charges for November and December

need to be included.

Accruals and prepayments will be the estimate of the adjustment needed. The adjustment is

calculated using the most up to date information available. In the example above this will be the

31/10/07 bill. Therefore the adjustment needed would be 2/3 x $300.

The entry needed would be:

Dr Gas account $200

Cr Accruals $200

8/8/2019 f3 pdf

65/102


The ledger account would therefore look like this:

Gas Account

30/04/07 Cash 300

31/07/07 Cash 310

31/10/07 Cash 300

31/12/07 Accrual 200 31/12/07 Inc Statement 1,110

1,110 1.110

01/01/08 Accrual b/d 200

It is important to remember to carry forward any accrual or prepayment to the next accounting

period.

(Assumption: business began on 1. 2. 07)

8/8/2019 f3 pdf

66/102


Example 2 - Prepayments

Julie starts her business on 1st August 2007, and pays her business insurance for the year to 31st July

2008 totalling $1,800. Her year end is 31

st

December each year.

What charges for insurance would be stated in the income statement for the period ended 31st

December 2007?

Insurance Account

01/08/07 Cash 1,800 31/12/07 Prepayment (7/12) 1,050

31/12/07 Inc Statement 750

1,800 1.800

01/01/08 Prepayment b/d 1,050

Assuming the insurance charge remains the same for the year ended 31st July 2009, the ledger

account would look like this:

Insurance Account

01/08/07 Cash 1,800 31/12/07 Prepayment (7/12) 1,050

31/12/07 Inc Statement 750

1,800 1.800


01/08/08 Cash 1,800 31/12/08 Prepayment (7/12 1,050

31/12/08 Inc Statement 1,800

2,850 2,850


8/8/2019 f3 pdf

67/102


SESSION 10 LIMITED COMPANY ACCOUNTS

Learning outcomes


Prepare a statement of comprehensive income Prepare a statement of changes in equity Prepare a statement of financial position

Introduction

Many businesses are constituted in the form of limited companies. The owners of limited

companies are referred to as shareholders and are often different from the people that run the

company.

The shareholders have very little, if any involvement in the day to day running of the business and

employ directors to run it on their behalf.

Limited company financial statements have very strict requirements which must be followed by all

companies. These are governed by:

Companies Act 2006 (or local country legislation) The International Accounting Standards Board

8/8/2019 f3 pdf

68/102

8/8/2019 f3 pdf

69/102


Statement of comprehensive income for the year ended 31 December 2007

Note

Revenue 385,000

Cost of sales 1 188,000


Distribution costs 2 38,500

Administration expenses 3 37,700


Finance costs 8,000


Income tax 53,000


Statement Of changes in equity for the year ended 31 December 2007

Share Retained Revaluation

Capital Earnings Reserve Total

Balance as at 1Jan 2007 100,000 188,697 40,000 328,697

Profit for the period 59,800 59,800

Excess depreciation 2,000 (2,000)

Dividend paid (30,000) (30,000)

Closing balance 100,000 220,497 38,000 358,497

A limited company must file their statutory accounts with companies house. A full set of statutory

accounts will include:

1. Statement of comprehensive income

8/8/2019 f3 pdf

70/102


2. Statement of changes in equity3. Statement of financial position4. Cash flow statement

These statements are supported by notes explaining the balances in the financial statements.

One of the key differences between a company and a sole trader is that a company is classed as a

separate legal entity. This means that a company is deemed to be a person in its own right.

Therefore, a company can sue individuals and can also be sued. The name limited company comes

from the fact that the shareholders have limited liability, in other words their liability is restricted to

the amount they have paid for their shares.

Profits of a company are distributed by way of dividend payments. These payments are at the

directors discretion.

Example 1

Freedom Limited has 100,000 ordinary shares in issue. The nominal value (par value) is $1.00 and

the directors decide to pay a dividend of 75c per share.

If this is the case the company would pay $75,000 (100,000 x 0.75) in dividends

Preference shares

This type of share is known as a non-equity share, and gets a fixed return on the value of the share.

Preference share holders will receive their dividend every year providing the company has

distributable profit.

Ordinary share holders will receive a dividend if the directors decide to pay one.

8/8/2019 f3 pdf

71/102

8/8/2019 f3 pdf

72/102


Share premium

If a company issues shares after the initial incorporation, it is unlikely they will issue them at a

nominal/par value. As the company has established itself, the net worth of the company would

increase. This would be reflected in the share price.

Example 3

The following relates to Radiance Limited

Capital and reserves

Share capital ($1.00) 200,000


Revaluation reserve 125,000

Say the market value price per share is $3.85 and the directors wish to issue a further 50,000 shares

for cash injection purposes.


Cr Share Capital (50,000 x $1.00) 50,000

Cr Share Premium (50,000 x $2.85) 142,500

Dr Bank (50,000 x $3.85) 192,500

The Capital and reserves would now be:

Share capital ($1.00) 250,000

Share premium 142,500


Revaluation reserve 125,000

8/8/2019 f3 pdf

73/102

8/8/2019 f3 pdf

74/102


Solution

Ordinary shares

$200,000 /$ 0.50 = 400,000 shares in issue

Interim dividend (400,000 x 8c) 32,000

Final dividend (400,000 x 9c) 36,000

Preference shares

10% x $25,000 2,500

70,500

Taxation

All companies have to pay tax on the taxable profits. The tax charge is normally estimated at the

end of the financial year and charged to the statement of comprehensive income, and is paid in the

following year.

The accounting entry for taxation would be:

Dr Taxation Comprehensive income

Cr Taxation liability Financial position

8/8/2019 f3 pdf

75/102


Example 5

The trial balance of Jewel Limited as at 31st March 2007 was as follows:

Dr Cr

Share capital (50c) 100,000

6% Preference shares ($1.00) 50,000

Retained earnings at 01/04/06 234,666

Debenture 10% 100,000

Inventory at 01/04/06 32,000

Trade receivables 45,987

Receivables provision 5.987


Cash 73,958

Building cost account 150,000

Plant and machinery at net book value 422,987Debenture interest 5,000

Administrative expenses 48,000

Distribution expenses 49,000

Profit on disposals 1,000

Purchases 69,666

Revenue 365,000

896,598 896,598

Notes

1. Depreciation on building is to be charged at 2%2. Depreciation on plant and machinery is to be charged at 10% reducing balance3. Closing inventory was valued at $28,9904. A provision of 5% of receivables is to be maintained5. Tax charge is estimated at $25,0006. A final dividend of 15c per share has been proposed before the year end.

Required

Prepare the statement of comprehensive income, statement of changes in equity and the statement

of financial position for Jewel Limited for the year ended 31st March 2007.

8/8/2019 f3 pdf

76/102


Solution

Journals

Dr Cr

1. Dr Depreciation charge (150,000 x 2%) 3,000Cr Accumulated depreciation - Buildings

3,000

2. Dr Depreciation charge (422,987 x 10%) 42,299

Cr Accumulated depreciation P & M 42,299

3. Dr Closing inventory (comp income) 28,990

Cr Closing inventory (financial position) 28,990

4. Dr Receivables provision account Work

1

3,688

Cr Administration expenses 3,688

5. Dr Taxation 25,000

Cr Taxation liability 25,000

6. Dr Pref Dividends 3,000

Cr Proposed Div (prefs) 3,000

7. Dr Dividends in SOCIE (100,000 / 0.5 x 15c)

30,000Cr Proposed dividends 30,000

8. Dr Debenture interest (10,000 5,000) 5,000

Cr Debenture interest accrual 5,000

Working 1

Receivables Provision Account

01/04/06 b/d 5,987

31/03/07 Admin expenses

(written back to

I/S) 3,688

31/03/07 c/d (45,987 x 5%)

2,299

5,987 5,987

8/8/2019 f3 pdf

77/102


Jewel Limited


Year ended 31st March 2007

Revenue 365,000

Cost of sales (32,000 + 69666 28990) (72,676)


Distribution costs (49,000)

Administration expenses (48,000 + 3000 + 42,299 3688 + 1000)

(88,611)


Finance costs (10,000)


Income tax (25,000)


8/8/2019 f3 pdf

78/102


Jewel Limited

Statement of financial position

As at 31st March 2007

Non current assets

Tangible assets (150,000 + 422,987 3,000 42,299)

527,688

Current assets

Inventory 28,990

Trade receivables (45,987 2,299) 43,688

Cash 73,958

146,636Total assets 674,324

Equity and liabilities

Ordinary share capital 100,000

Preference share capital 50,000

Retained earnings (234,666 + 119,713 30,000

3,000 Pref Div) 321,379

471,379


Debenture 100,000

Current liabilities


Debenture accrual 5,000

Proposed dividend 33,000

Taxation 25,000

102,945


8/8/2019 f3 pdf

79/102

8/8/2019 f3 pdf

80/102


SESSION 11 STATEMENTS OF CASH FLOW

Learning outcomesWhen you have completed this chapter, you should be able to:

Explain the purpose of producing a cash flow statement Discuss the advantages of a cash flow statement Explain the principles of I.A.S. 7 Produce a cash flow statement

Introduction

The cash flow statement is a primary financial statement and provides fundamental information to

the user of accounts. It highlights the key areas where a business has generated and spent physical

cash.

Good cash management ensures a business has sufficient cash to run its day to day operations.

Prior to this session we have focused on profit, but cash is equally vital for the success of a business,

especially in the short term. If a business has limited cash funds available it will struggle to survive in

the short term.

Advantages

Cash flow balances are a matter of fact and are not distorted by accounting policies Cash flow balances are objective, unlike profit which is subjective Users of financial statements can establish exactly the cash generation of a business Users can identify exactly how this cash has been utilised Users can assess the liquidity of a business and assess its ability to repay debts as they fall

due

Loans repaid and received are clearly listed in the cash flow statement Users can assess management attitude to capital expenditure Interest payments are highlighted in the cash flow

8/8/2019 f3 pdf

81/102

8/8/2019 f3 pdf

82/102

8/8/2019 f3 pdf

83/102


Proforma continued

$ $

NET CASH FROM OPERATING ACTIVITIES X

Cash flow from investing activities

Purchase of a non-current asset (X)

Disposal of a non-current asset X

Interest received X

Dividends received X

CASH FLOW FROM INVESTING ACTIVITIES X

Cash flow from financing activities

Proceeds from the issue of shares X

Receipt of loans X

Repayment of loans (X)

Dividends paid (X)

CASH FLOW FROM FINANCING ACTIVITIES X

NET CASH FLOW X

Cash and cash equivalents at the beginning of the period

X

Cash and cash equivalents at the end of the period X

8/8/2019 f3 pdf

84/102


Example 1

Radiance Limited


As at 31 December 2007

2006 2007Non-current assets

Cost 180 220

Accumulated depreciation (78) (92)

102 128

Current assets

Inventory 12 17

Trade receivables 2 10

Bonds 10 10

Cash 3 16129 181

Capital and reserves

Share capital 45 65

Share premium 10 12

Accumulated profits 24 68

Non-current liabilities

Loan 30 20

Current liabilities

Payables 19 13

Tax 1 3

129 181

Notes

The tax charge in the statement of comprehensive income is $6,000.

Loan was repaid at the end of the financial year.

Required

Prepare the cash flow statement for the year ended 31st December 2007.

8/8/2019 f3 pdf

85/102


Solution

$ $

Cash flows from operating activities

Profit before tax (68 24) + 6 50

Adjustments for:

Interest payable -

Depreciation (92 78) 14

(Profit) / loss on the disposal of a non current asset -

Operating profit before working capital changes 64

Working capital changes

(Increase) in inventory (17 12) (5)

(Increase) in receivables (10 2) (8)

(Decrease) in payables (19 13) (6)

Cash generated from operations 45

Interest paid -

Taxation paid (working 1) (4)

NET CASH FROM OPERATING ACTIVITIES 41

8/8/2019 f3 pdf

86/102


$ $

NET CASH FROM OPERATING ACTIVITIES 41

Cash flow from investing activities

Purchase of a non-current asset (220 180) (40)

Disposal of a non-current assets -

Interest received -

Dividends received -

NET CASH USED IN INVESTING ACTIVITIES (40)

Cash flow from financing activities

Proceeds from the issue of shares (65 45) + (12 10) 22

Receipt of loans -

Repayment of loans (10)

Dividends paid -

CASH FLOW FROM FINANCING ACTIVITIES 12

NET CASH FLOW 13

Cash and cash equivalents at the beginning of the period (10+3)

13

Cash and cash equivalents at the end of the period (10+3)

26

8/8/2019 f3 pdf

87/102

8/8/2019 f3 pdf

88/102


Solution

Cash sales 55,000

Cash received from customers 44,000

Total cash received 99,000

Cash purchases 33,000

Cash paid to suppliers 12,000

Cash expenses 11,000

Cash wages and salaries 20,000

Total cash paid 76,000

Cash generated 23,000

8/8/2019 f3 pdf

89/102

8/8/2019 f3 pdf

90/102

8/8/2019 f3 pdf

91/102


Suppose that the opening balance on the accounts receivables ledger was $50,000, there had been

receipts from account receivables in the year of $45,000, irrecoverable debts have been written off

worth $5,000 and the closing balance was $55,000.

Required:

What were the credit sales for the year?

Account Receivables

Opening b/d 50,000 Receipts 45,000

Sales (Bal Fig) 55,000 Bad debts 5,000

Closing c/d 55,000

105,000 105,000

Example 3

Suppose that the opening accounts receivables balance was $30,000, there have been total receipts

from customers of $55,000 of which $15,000 relates to cash sales and $40,000 relates to receipts

from accounts receivables. Discounts allowed in the year totalled $3,000 and the closing balance

was $37,000.

Required:

What are the total sales for the year?

Due to the information given in the question we can approach this in 2 different ways. We can

calculate credit sales as above and then add on cash sales, or we can use the ledger account to

calculate total sales. Both methods are shown below:

Solution 1 - Total sales

Account Receivables (Total Sales a/c)

01/01/07 b/d 30,000 31/12/07 Total receipts 55,000

31/12/07 Total sales (Bal fig)

65,000

31/12/07 Discounts allowed 3,000

31/12/07 c/d 37,000

95,000 95,000

Solution 2 - Separate sales

Account Receivables

8/8/2019 f3 pdf

92/102

8/8/2019 f3 pdf

93/102

8/8/2019 f3 pdf

94/102


Example 7

On 1st January the bank is overdrawn by $1,367, payments in the year totalled $8,536 and on 31st

December the closing balance was a positive balance of $2,227.

Required:

What is the total receipts figure for the year?

Solution:

Cash Book

31/12/07 Receipts 12,130 01/01/07 b/d 1,367

31/12/07 Payments 8,536

31/12/07 c/d 2,227

12,130 12,130

Example 8

Scott has a cash float at the beginning of the year of $900. During the year cash of $10,000 was

banked, $1,000 was paid out for drawings and wages of $2,000 was paid. Scott decided to increase

the float to $1,000 at the end of the year.

Required:

How much cash was received from customers during the year?

Solution:

Cash Account

01/01/07 b/d 900 31/12/07 Banked 10,000

31/12/07 Drawings 1,000

31/12/07 Receipts 13,100 31/12/07 Wages 2,00031/12/07 c/d 1,000

14,000 14,000

8/8/2019 f3 pdf

95/102

8/8/2019 f3 pdf

96/102


Example 10

Mark-up 25% Cost of sales $600

Required:

What is gross profit and sales?

Sales (600 / 100 x 125) 750 125%

Cost of sales 600 100%

Gross profit 150 25%

Example 11

Mark-up 10%

Sales $6,600

Opening inventory $300

Closing inventory $500

Required:

Complete a trading account from the above information.

Sales 6,600 110%

Cost of sales

Opening inventory 300

Purchases (Balancing Figure) 6,200

Closing inventory (500)

6,000 100%

Gross profit (6,600 / 110 x 10) 600 10%

8/8/2019 f3 pdf

97/102


Example 12

Margin 5%

Purchases $2,840

Opening inventory $800

Closing inventory $600

Required:

Complete a trading account from the above information.

Sales (3,040 / 95 x 100) 3,200 100%

Cost of sales

Opening inventory 800

Purchases 2,840

Closing inventory (600)

3,040 95%

Gross profit 160 5%

Cost of lost inventory

In incomplete record questions, it is likely that inventory has been lost due to the infamous fire or

flood.

Closing inventory that has not been lost is subtracted in cost of sales because by definition, the

inventory has not been sold in the year.

Lost inventory has also not been sold in the year and therefore also needs subtracting within cost of

sales.

Therefore, to work out the cost of lost inventory, complete the trading account from the information

given and then lost inventory can be calculated as a balancing figure.

8/8/2019 f3 pdf

98/102

8/8/2019 f3 pdf

99/102

8/8/2019 f3 pdf

100/102

8/8/2019 f3 pdf

101/102

8/8/2019 f3 pdf

102/102

f3 pdf

Documents