CPA SECTION 1 & ATC
FINANCIAL ACCOUNTING
STUDY TEXT
ii
FINANCIAL ACCOUNTING
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S T U D Y
T E X T
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ACKNOWLEDGMENT
iii
S T U D Y
We gratefully acknowledge permission to quote from the past examination papers of Kenya
Accountants and Secretaries National Examination Board (KASNEB).
T E X T
Acknowledgment
S T U D Y
T E X T
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FINANCIAL ACCOUNTING
TABLE OF CONTENTS
v
TABLE OF CONTENTS ........................................................................................................ v
ACKNOWLEDGMENT ........................................................................................................ iii
CHAPTER ONE ................................................................................................................... 1
INTRODUCTION TO ACCOUNTING ................................................................................... 3
CHAPTER TWO ................................................................................................................. 17
ACCOUNTING PROCEDURES AND TECHNIQUES ....................................................... 19
CHAPTER THREE ............................................................................................................. 79
PREPARATION OF FINANCIAL STATEMENTS ............................................................... 81
CHAPTER FOUR ............................................................................................................. 129
SOLE PROPRIETORSHIP ............................................................................................... 131
CHAPTER FIVE ............................................................................................................... 139
PARTNERSHIP ACCOUNTS ........................................................................................... 141
CHAPTER SIX ................................................................................................................. 185
MANUFACTURING ACCOUNTS .................................................................................... 201
CHAPTER EIGHT ............................................................................................................ 215
FINANCIAL STATEMENT ANALYSIS ............................................................................. 217
CHAPTER NINE ............................................................................................................... 231
COMPANY ACCOUNTS .................................................................................................. 233
CHAPTER TEN ................................................................................................................ 267
INCOMPLETE RECORDS ............................................................................................... 269
CHAPTER ELEVEN ......................................................................................................... 285
COMPUTERISED ACCOUNTING ................................................................................... 287
CHAPTER TWELVE ........................................................................................................ 297
PUBLIC SECTOR ACCOUNTING ................................................................................... 299
ANSWERS TO EXAM TYPE QUESTIONS ..................................................................... 309
REVISION TEST PAPERS ............................................................................................... 349
ANSWERS TO TEST PAPERS ....................................................................................... 369
GLOSSARY ...................................................................................................................... 395
INDEX ............................................................................................................................... 399
S T U D Y
CHAPTER SEVEN ........................................................................................................... 199
T E X T
NON PROFIT MAKING ORGANIZATION ....................................................................... 187
1
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CHAPTER ONE
INTRODUCTION TO
ACCOUNTING
S T U D Y
T E X T
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FINANCIAL ACCOUNTING
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CHAPTER ONE
INTRODUCTION TO ACCOUNTING
OBJECTIVES
•
•
•
•
Deine accounting and explain the phases of accounting
Explain the branches of accounting
Identify the users of inancial information
Understand the basic inancial accounting equations and deine assets, liabilities and
capital
Prepare an account in the T form
Identify the characteristics of good information
List and explain the principles, concepts and conventions underlying the accounting
reports
Understand the regulation of accounting profession
INTRODUCTION
This chapter forms the basis of all accounting work.
The irst part deals with the nature of accounting and the phases of the accounting process.
The basic accounting equation will be introduced and the regulations of accounting profession
introduced.
DEFINITION OF KEY TERMS
1.
2.
3.
4.
5.
6.
Accounting: Accounting may be deined as the process of identifying, measuring,
recording and communicating inancial information in order to permit users to make
informed decisions.
Accounting equation: This is a mathematical description of the relationship between
assets, liabilities and capital.
Accounting policies are the speciic principles, bases, conventions, rules and practices
applied by an entity in preparing and presenting inancial statements.
Assets: Items of value to an organization.
Liabilities: Obligations by the organization to other parties.
Capital: Resources put into the business by its owners
S T U D Y
•
•
•
•
T E X T
After studying this chapter, you should be able to:
FINANCIAL ACCOUNTING
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EXAM CONTEXT
This is a very important chapter, which set the basis of accounting ideas and conventions. Expect
questions on all aspects, including the framework.
INDUSTRY CONTEXT
S T U D Y
T E X T
All professions require that one understands the basics. Accounts and its braches such as
auditing are not an exception. Most accounting fundamentals are contained in this chapter. A
clear understanding of this chapter’s content will not only help one pass the exam but also in
application of accounts in the industry.
1.1
NATURE AND PURPOSE OF ACCOUNTING
Accounting, as a preamble, could be termed the language of business. It is the common media
through which people of all walks can effectively communicate business matters and understand
one another equally.
It is the language accountants use to communicate i.e. record business transactions and
summarize results of business operations. Accounting can be deined as the art of recording,
classifying and summarizing in a signiicant manner, and in terms of money, transactions and
events which are of a inancial character, and interpreting the results thereof.
It encompasses the recording of information of economic value to a business. The information
then forms the basis for judgment by the users.
PHASES OF THE ACCOUNTING PROCESS
From the above deinition, we can clearly see that accounting is a process that can be divided
into four phases;
1.
Recording phase: involves the routine and mechanical process of writing business
transactions and events in the books of accounts – also called books of original entry
or simply journals - in a chronological order in accordance with the entity’s and other
established accounting rules and procedures.
NATURE, PURPOSE AND CLASSIFICATION OF LAW
2.
3.
5
Classifying phase: involves sorting and grouping of similar transactions into their
respective classes by posting them into a ledger.
A ledger is a group of accounts of a similar nature
An account is the basic record of accounting which measures increases or decreases
in a particular asset, liability, income or expense account.
Summarizing phase: this involves the preparation of inancial statements or reports. It
is usually done periodically e.g. monthly, annually etc.
4.
Interpretation: this refers to the analysis of the accounting information. It involves
communication of inancial information to help users in making economic decisions.
This is the reason why accounting is called the language of business.
BRANCHES OF ACCOUNTING
b.
c.
d.
e.
Financial accounting; concerns itself with the collection and processing of accounting
data and reporting to interested parties inside and outside the irm.
Tax accounting; deals with the determination of the irm’s tax liability which could be,
Value added tax (VAT), customs duty, Pay as you earn (PAYE), corporation tax etc.
Cost accounting; helps establish costs relating to the production of a good or service
and allocating it to the various factors that contributed to the cost of production.
Managerial accounting; deals with the generation of accounting information to be used
categorically by the irm’s internal management in their day-to-day decision making.
Auditing; concerns itself with the vouching and veriication of transactions from the
inancial accounting to determine that they are a true representation of the business’
activity i.e. the true and fair view of the company’s state of affairs.
USERS OF FINANCIAL INFORMATION
1)
Management – management of business entities need accounting information to assist
for planning and decision making. They will need the information to prepare budgets
and compare with the actual results of operations. They will also be interested in the
cost consequences of a particular course of action to assist them in making decisions
2)
Present and potential investors – they need accounting information to assess the
risk inherent in, and the return provided by their investments. They need information
to decide whether they should maintain, increase, decrease of dispose altogether their
investments.
3)
Employees are interested about the stability and proitability of their employer. It is
a source of stability for them and they need to know whether to start searching for
employment elsewhere or keep their current postings. They are also concerned about
the ability to provide remuneration, retirement beneits and employment opportunities.
S T U D Y
a.
T E X T
Accounting, in all its broadness, can be sub-divided into areas of specialization;
FINANCIAL ACCOUNTING
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4)
5)
6)
Lenders. They are the givers of some part of the company’s capital. They need to know
if the loans and the corresponding interests will be paid when due.
Customers. They require inancial data in order to anticipate price changes and to
seek alternative sources of supplies when necessary.
The government. Governments and their agencies require information to regulate the
activities of the enterprises. They also need the inancial information to determine level
of taxation and also in preparation of national statistics.
The general purpose of accounting can therefore be summarized into ive purposes;
S T U D Y
T E X T
i.
ii.
iii.
iv.
v.
Helps in decision making
Ascertain the value of the business
Know the proit and or loss position
Ascertain the assets and liabilities of the irm
Know the cash and wealth of the business
1.2
THE BASIC ACCOUNTING EQUATION
Fast forward Capital = Assets - liabilities
FINANCIAL STATEMENTS AND ELEMENTS OF FINANCIAL
STATEMENTS
There are two main inancial statements available to users; the statement of inancial position
and the income statement.
Balance sheet
It shows the inancial position of the entity at a given point in time.
The accounting equation is relected in the balance sheet. The equation, normally called the
book keeping equation is:
Assets – liabilities = capital
NATURE, PURPOSE AND CLASSIFICATION OF LAW
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The equation shows that for a irm to operate, it needs resources (assets) which have to be
supplied by external parties including creditors (liabilities) and from the owner (capital).
Business transactions will always affect two items of the accounting system.
Assets and liabilities are valued according to accounting conventions.
Assets could be deined as being resources controlled by an enterprise as a result of past events
and from which future economic beneits are expected to low to the enterprise.
Current assets are those assets whose beneits are expected to low within a period of less than
six months. They form part of the enterprise’s operating cycle or are held for trading purposes
e.g. inventory, accounts receivable (debtors), cash in hand and cash at bank.
Non-current assets have their beneits expected to low for a period of more than 12 months.
They are tangible and intangible assets acquired for retention by an entity for the purpose of
providing a service to the business.
Examples of tangible non-current assets include buildings, equipment, and machinery.
A liability is deined as a present obligation of the enterprise arising from past events, the
settlement of which is expected to result in an outlow of resources embodying economic beneits
from the enterprise.
T E X T
Intangible non-current assets include goodwill, copyrights, patents, royalties.
Current liabilities are expected to be settled in the normal course of the entity’ operating cycle
and within 12 months.
Equity is the residual interest in the assets of the enterprise after deducing all the liabilities.
THE ACCOUNTING EQUATION AND THE STATEMENT OF
FINANCIAL POSITION
The accounting equation is the basis of inancial accounting.
Transactions are recorded using the double entry system of book keeping showing the two-fold
effect that is done to maintain equality of the equation. The double entry system requires the use
of an account.
An Account is the most basic accounting record. It summarizes the increases and decreases in
a particular asset, liability, revenue, expense or a capital item.
An account is divided into two sides; the left being the debit and the other the credit side. To debit
therefore will mean to enter an amount on the left hand side of an account and vice-versa.
The double entry concept states that “for every debit entry, there is a corresponding credit
entry”.
S T U D Y
They represent claims on the business by the outsiders.
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The basic double entry rules for accounts are:
Accounts
To record
Entry in the account
Assets
An increase
Debit
A decrease
Credit
An increase
Credit
A decrease
Debit
An increase
Credit
A decrease
Debit
Revenue
An increase
Credit
Expenses
An increase
Debit
Liabilities
Capital
S T U D Y
T E X T
QUALITIES OF GOOD ACCOUNTING INFORMATION
For accounting information to be able to effect the purpose for which it was meant, there are
certain attributes that it must fulill. These include:
Understandability. For accounting information to be considered useful, it must be well
understood by the parties for which it was prepared for. The parties must be able to
derive satisfaction from the inancial data represented by accounting.
(b) Relevance. The accounting information should be able to inluence the important
decisions in the company. The information should be veriiable, neutral and truthful.
(c) Reliability. Reliability means that the accounting information should have differing
methods or ways of doing it and yet arrive at the same or similar conclusions.
(d) Comparability. The accounting information should be able to be compared with
other information from different organizations or of the same organization at differing
periods.
(e) Timely. If the accounting information is not availed to the deserving user at the time of
need, then it may as well be useless. For accounting information to be useful, it must
be presented to the party in need at the time of the need.
(a)
LIMITATIONS OF ACCOUNTING INFORMATION
o
Historical
Accounting information is prepared based from past period monetary transactions. It
is hardly feasible that what happened in the past will hold on in the future and so the
accounting information may be considered irrelevant on that basis alone.
o
Too quantitative rather than qualitative
Accounting information consists of too many igures and less of explanations. For
any system to be useful, it must strike a balance between quantitative and qualitative
measures.
NATURE, PURPOSE AND CLASSIFICATION OF LAW
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Only comparable to similar businesses
Accounting information makes it only comparable to businesses of similar nature. It is
dificult to compare a service oriented organization to a manufacturing based irm.
1.3
THE PRINCIPLES, CONCEPTS AND CONVENTIONS
UNDERLYING THE ACCOUNTING REPORTS
THE CONCEPTS
There are four main concepts:
Going concern
It is assumed that the operation will continue in operational existence into the foreseeable future.
This implies that the management should view all the available information in the light of the
foreseeable future, but not only for the current period.
Accounting period convention
Also known as the time concept. It is assumed that the continuous lifetime of the entity is divided
into small equal periods to ease the burden of reporting. These subdivisions are called the
inancial year.
Business entity concept
The assumption is that the business is a separate legal entity; distinct from the owners and the
management. The inancial affairs of the business entity are recorded and reported separately
from those of the owners of the capital or the managers
S T U D Y
After deining what accounting is all about, we now need to know the environment that accounting
operates. Just like any other ield of study, accounting has developed its own concepts that
govern its application. These concepts form the fundamental accounting assumptions underlying
the preparation of inancial statements.
T E X T
Fast forward – Prudence, substance over form and materiality should govern the selection and
application of accounting policies.
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FINANCIAL ACCOUNTING
Monetary principle
It is assumed that the inancial impact of the business entity is broken down into transactions that
are assessed and quantiied in some unit of measure. The underlying assumption is that, for the
sake of commonness, the unit of measure is a monetary one.
THE ACCOUNTING PRINCIPLES
Historical cost
S T U D Y
T E X T
Postulates that assets should be recorded at cost, at the purchase price or at the acquisition
price. This ignores the effects of inlation on cost as the assets are kept by the business over the
years.
It recognizes that for example a building purchased 40 years ago for Sh 29,000 would be reported
today in the statement of inancial position at that historical price even though its actual worth
today may be Sh 2.9 million.
However, this problem has been overcome by asset revaluation as an alternative to the historical
cost of accounting.
Monetary principle
This principle holds that accounting will only endeavor to deal with those items to which a
monetary value can be attached. As such, inancial statements relect only the items that can be
measured in monetary terms. Goodwill for example is never shown in the statements because it
has no monetary measurement.
Accrual concept
The accruals concept is also known as matching concept.
In the principle, revenues and costs are recognized when earned or incurred and not as the
monetary attachment is received or paid. What this means is that the time when the revenue
is received or the expense is incurred is completely disregarded. This leads into two scenarios;
prepayments and accruals
Prepayments occur when money is received for a period that it has yet to be earned, or an
expense is paid for but has not yet been incurred.
Accruals occur when the expense for the money is being paid for has already been incurred
i.e. the expense belongs to a past period, or when an income is received way after the period of
earning has expired.
NATURE, PURPOSE AND CLASSIFICATION OF LAW
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Revenue realization concept
It states that a sale should be recognized when the event from which it arises has taken place
and the receipt of cash from the transaction is reasonably certain. Revenue can be recognized
at different levels of selling such as when the inquiry is made, during delivery, at issue of invoice
or when payment is made.
Revenue realization demands that only when the money receivable is reasonably certain of
reception should accountants recognize it as income. For instance, it may not be prudent to
recognize a sale when a customer makes an inquiry because the requisition may be revoked well
before the goods are even ordered or delivered.
Prudence
Consistency
The items in the inancial statement should be presented and classiied in the same manner from
one period to the next unless there is a signiicant change in the nature of the operations of the
business, or a review of its inancial statement presentation demonstrates that relevance is better
achieved by presenting items in a different way, or a change is required by a new international
standard.
For instance, an entity is not allowed to change form LIFO to FIFO or otherwise unless:
-
there is a signiicant change in the business
there is a new accounting order
It helps present the information better.
Materiality
Information is material if its non-disclosure could inluence the decisions of users. Materiality
depends on the size and the nature of the item being judged. Strict adherence to accounting
rules is not necessary in accounting for trivial items such as loose tools, e.g. a stapler should not
be capitalized, and a bribe cannot be itemized under expenses.
S T U D Y
Where a losses foreseen, it should be anticipated and taken immediately into account. In other
words, accountants should never anticipate for gains but must always provide for losses.
T E X T
Prudence states that where alternatives exist, the one selected should be one that gives the most
cautious presentation of the inancial position of the business. Assets and proits should not be
overstated, but a balance must be achieved to prevent the material overstatement of liabilities
and losses.
FINANCIAL ACCOUNTING
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Duality
Duality principle emphasizes the double entry book-keeping entry that every transaction has two
effects, for every debit there is a corresponding, equal and opposite credit entry. As such it forms
the basis of the double entry system of book keeping.
Substance over form
Some transactions have a real nature that differs from their legal form. This principle states that
whenever it is legally possible, the real substance prevails over the legal form.
S T U D Y
T E X T
1.4
THE REGULATION OF ACCOUNTING PROFESSION
THE INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB)
The IASB is an independent, privately funded accounting standard setter based in London.
The 14 members of the IASB come from nine countries and have a variety of backgrounds with a
mix of auditors, preparers of inancial statements, users of inancial statements and an academic.
The board consists of 12 fulltime members and two part-time members.
In March 2001 the International Accounting Standards committee (IASC) was formed as a notfor-proit corporation incorporated in the USA. The IASC foundation is the parent entity of the
IASB.
From April 2001 the IASB assumed accounting standards setting responsibilities from its
predecessor body, IASC. This restructuring was based upon the recommendations on shaping
IASC for the future.
Objectives of the International Accounting Standards Board
1.
2.
3.
To develop, in the public interest, a single set of high quality, understandable and
enforceable global accounting standards that require high quality, transparent and
comparable information in general purpose inancial statements.
To provide the use and vigorous application of those standards.
To work actively with the national accounting standard setters to bring about convergence
of national accounting standards and IFRS to high quality solutions.
NATURE, PURPOSE AND CLASSIFICATION OF LAW
13
THE INTERNATIONAL FEDERATION OF ACCOUNTANTS (IFAC)
The IFAC is a private sector body established in 1977 and which now consists of over 100
professional accounting bodies from around 80 different countries. The IFAC’s main objective
is to co-ordinate the accounting profession on a global scale by issuing and establishing
international standards on auditing, management accounting, ethics, education and training. The
IFAC has separate committees working on these topics and also organizes the world congress of
accountants, which is held every ive years. The IASB is afiliated with the IFAC.
INTERNATIONAL PUBLIC SECTOR ACCOUNTING STANDARDS
BOARD (IPSAB)
It is important to put accounting into practical perspective. This will be made possible by looking
at the institutions that regulate the climate within which the accounting profession is practiced.
The Accounting Act was enacted by the parliament into chapter 531, Laws of Kenya in1977.
The Act then established the Institute of Certiied accountants of Kenya (ICPAK), the Registration
of Accountants Board (RAB) and the Kenya Accountants and Secretaries National Examinations
Board (KASNEB).
The three jointly form the framework of regulation of the accounting profession in Kenya.
Role of ICPAK
1.
2.
3.
4.
5.
6.
To provide standards of professional competence and practice among its members.
To promote research into the subjects of accountancy, inance and related matters, and
the publication of books, periodicals, articles and journals in that connection.
To promote the international recognition of the institute.
Advise the examinations board on matters relating to examination standards and
policies.
Carry out any other functions prescribed for it under any other provision or under other
written law
Do anything incidental or conducive to the performance of any of the preceding
functions
S T U D Y
Fast forward – ICPAK, RAB and KASNEB jointly form the framework of regulation of the
accounting profession in Kenya.
T E X T
Regulation of public not-for-proit entities, principally local and national governments and
governmental agencies, is by the IPSAB, which comes under the IFAC.
FINANCIAL ACCOUNTING
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Role of KASNEB
1.
2.
3.
Prepare syllabuses for accountants and secretaries examinations
Make rules in relation to the examinations
Issue certiicates to candidates who have satisied the examination requirements.
Role of RAB
1.
2.
Register the accountants that have been certiied by the examination body to have
fulilled the examination requirement.
Issuance of practicing certiicates to those wishing to render the accounting services to
the public
S T U D Y
T E X T
CHAPTER SUMMARY
Accounting may be deined as the process of identifying, measuring, recording and communicating
inancial information in order to permit users to make informed decisions.
More simply, accounting could be explained as keeping records about the transactions a business,
or other organisation, takes part in so as to be able to gauge how well the organisation is doing.
Accounting may be split into four main categories:
a)
b)
c)
d)
Financial accounting
Auditing
Cost accounting
Management accounting
The reason why the accounting process is carried out by organisations is to enable users of
inancial information such as the government and investors to take proitable courses of action
on the basis of the inancial information provided.
The accounting equation may be presented as follows:
Assets = Liabilities + Capital
Accounting information should be:
a)
b)
c)
d)
Comprehensible
Complete
Reliable
Relevant
NATURE AND CLASSIFICATION OF COMPANIES
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CHAPTER QUIZ
1. What is inancial reporting?
2. What are the two main inancial statements drawn by accountants?
3. List 5 general purposes of accounting?
4. Assets – Capital =………….?
S T U D Y
T E X T
5. List 5 qualities of good accounting information?
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ANSWERS TO CHAPTER QUIZ
1.
2.
3.
S T U D Y
T E X T
4.
5.
A way of recording, analyzing and summarizing inancial data.
The statement of comprehensive income and the statement of inancial position (also
known as the balance sheet).
- Helps in decision making.
- Ascertain the value of the business.
- Know the proit and loss position.
- Ascertain the assets and liabilities of the irm.
- Know the cash and wealth of the business.
Liabilities.
- Understandability.
- Relevance.
- Reliability.
- Comparability.
- Timely.
PAST PAPER ANALYSIS
12/07, 6/07, 12/06, 6/06, 12/05, 6/05, 12/04, 6/04
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ACCOUNTING PROCEDURES
AND TECHNIQUES
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T E X T
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CHAPTER TWO
ACCOUNTING PROCEDURES AND TECHNIQUES
OBJECTIVES
Deine bookkeeping and distinguish it from accounting
Explain the accounting cycle
Prepare book of original entry and the various ledgers
Distinguish between real, nominal and personal accounts
Understand and prepare two column, three column and petty cashbook
Prepare a bank reconciliation statement
Prepare initial accounts
Record transactions with regard to assets, liabilities, capital, income and expenses
Balance off accounts and extract a trial balance
Identify the different types of errors and pass journal entries to correct them
INTRODUCTION
In this chapter we will introduce bookkeeping, books of original entry and take you through the
accounting cycle. We will inally explain how to extract the trial balance and use it to detect errors
and how to correct them.
DEFINITION OF KEY TERMS
Assets: an asset can be deined as resources present in a business organization that have
probable future economic beneit. They include cash, land and buildings stock e.t.c.
Assets can either be deined as current, non-current or intangible.
Current Assets: these are assets consumed in one year or are expected to beneit the irm
within a period of not more than one inancial year e.g. stock, cash at hand, cash at bank,
debtors, prepayments e.t.c
Non-current Assets: these are assets whose economic beneits to the organization are achieved
for a period exceeding one inancial year. Examples would be land and buildings, motor vehicles,
plant and machinery, computers e.t.c
Intangible Assets: these are assets of economic value to the business enterprise but cannot be
physically felt or seen e.g. goodwill, patents, copyrights e.t.c
S T U D Y
•
•
•
•
•
•
•
•
•
•
T E X T
After studying this chapter, you should be able to:
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FINANCIAL ACCOUNTING
Liabilities
These are obligations that a business is expected to meet within a certain duration. They can
also be deined as total funds owed for assets supplied to a business or expense incurred but
not paid yet.
Liabilities can either be short term or long term. Short term liabilities are those that are expected
to be met within duration of one inancial year. Payment for accrued expense, creditors, dividends
to share holders e.t.c. on the other hand long term liabilities are those payable within a period
exceeding one inancial year e.g. long term loan, re-payment of debentures e.t.c
Capital: this is deined as the total of all resources invested and left in business by its owner.
Revenue/Income: this can be deined as the monetary value of all goods and services sold to
customers by a business enterprise
Expenses: This can be deined as the monetary equivalent of all resources/assets that have
been consumed during a given period to generate the revenues for the business organization in
a given accounting period.
S T U D Y
T E X T
EXAM CONTEXT
Most question set will require a thorough understanding of this chapter since it forms the basis
of most accounting work.
INDUSTRY CONTEXT
This chapter also acts as a foundation to more complex accounting. This chapter details simple
accounting, books of original entry and bank reconciliation. These are accounting activities done
on a daily basis by accounts assistant and act as source document for inal inancial statements.
Auditor will always assess these to be able to approve inal inancial statements.
2.1
BOOK KEEPING
Fast forward - Book keeping is intended to record all the accounting data in such a way that one
can make a deduction based on it.
Book keeping deined as the process of recording business transactions (data) in a systematic
manner. It can also be deined as that part of accounting that is concerned with recording data.
ACCOUNTING PROCEDURES AND TECHNIQUES
21
Book keeping is intended to record all the accounting data in such a way that one can make a
deduction based on it. The deductions could be such as:
•
•
•
How much sales has been achieved over a given period of time, be it a day, a month,
or a year.
How much is owed to the creditors.
How much is available in the bank, among others.
The whole process of book keeping is in the form of a cycle i.e. the accounting cycle.
The accounting process can be perceived as a cycle which starts with the occurrence of a
transaction, recording of the transaction and inally the preparation of the inancial statements.
Financial statements are reports on results of all the transactions that occur during the year
and the position of the business as at the last date of the accounting period. A transaction is an
activity which involves the exchange of goods and services for another thing of value e.g. when
the business purchases goods for sale, sells goods to customers on credit, pays for services e.g.
telephone.
A transaction is irst recorded in the source documents e.g. the cash sale receipt, the invoices
received from creditors, debit and credit notes issued and received etc
The daybooks as the name suggests they are illed daily showing all the transactions that occurred
during the day. Such information is obtained from the source documents.
The data in the day books is then illed in the ledger accounts and a trial balance extracted as
the end of the accounting period. Adjustments e.g. for prepayments and accruals are then made
and an adjusted trial balance is drawn relecting these changes.
From this trial balance, the inal statements are prepared i.e. the statement of comprehensive
income which reveals whether the company made a proit or loss from the transactions carried
out in the year, and the statement of inancial position which tells of the inancial position of the
business in terms of its assets and liabilities as at that closing date.
After these, the closing entries are made to prepare the accounts to receive the data for the
following inancial period and a closing trial balance extracted.
This marks the end of journals
For every transaction entered into the business enterprise, there is the primary book where it will
be initially recorded. This is known as books of original entry.
T E X T
THE ACCOUNTING CYCLE
S T U D Y
2.2
22
FINANCIAL ACCOUNTING
2.3
BOOKS OF ORIGINAL ENTRY
Fast forward - Accounts can be divided into personal accounts and impersonal accounts.
Books of original entry can be deined as the books in which we irst record a transaction. These
books essentially record the following details of a transaction:
•
•
•
•
•
date of the transaction
the name of the person/ irm with whom the transaction took place
the details of an item bought or sold e.g. a motor vehicle stock e.t.c
details for cross referencing
the amount (shown in monetary terms) of the transaction
S T U D Y
T E X T
Books of original entry are known as journals or daybooks. Both terms are used interchangeably.
The commonly used books of original entry are:
i. PURCHASES JOURNAL
This journal is used to record all purchases made on credit only.
Example
PURCHASES JOURNAL
Date
Details Folio
1/12/2006
A. Mbole
1/12/2006
4/12/2006
5/12/2006
8/12/2006
8/12/2006
J. Chege
J. Chege
B. Gummo
H. Njeri
A. Mbole
Amount (Sh)
PL 009
PL 011
PL 009
PL 010
PL 014
4,200
6,700
9,200
2,100
4,100
PL 011
10,400
6,100
9/12/2006
J. Chege
PL 009
10/12/2006
A. Mbole
PL 011
8,500
51,300
ACCOUNTING PROCEDURES AND TECHNIQUES
23
ii. SALES JOURNAL
A sales journal records credit sales only.
>>> Example
SALES JOURNAL
1/4/2006
1/4/2006
2/4/2006
3/4/2006
4/4/2006
J. Kamau
P. Otieno
E. Muteti
P. Otieno
J. Kamau
Folio
SL 001
SL 002
SL 003
SL 002
SL 001
5/4/2006
A. Kioko
SL 005
6/4/2006
J. Kamau
SL 001
Amount
(Sh)
5,000
4,000
3,200
4,700
4,200
6,700
2,800
30,600
iii. RETURN OUTWARDS JOURNAL
It records goods returned by the business to the suppliers for the reason that they are either
tampered with, are not of the kind ordered for, are damaged, or are in excess of the amount
ordered.
>>> Example
RETURN OUTWARDS JOURNAL
Date
9/12/2006
Details Folio
A. Mbole
Amount (Sh)
PL 011 1,100
T E X T
Details
S T U D Y
Date
24
FINANCIAL ACCOUNTING
iv. RETURN INWARDS JOURNAL
This journal is used to record all the goods that are returned to the business by the customers
because they were not the kind ordered for or were in excess e.t.c
>>> Example
RETURN INWARDS JOURNAL
Date
Details
Folio
Amount (Sh)
8/4/2006
J. Kamau
SL 001
800
9/4/2006
A. Akiko
SL 005
500
1,300
S T U D Y
T E X T
v. CASH BOOK
This is a book of original entry that is used to record all cash received or paid out by the business
via the cash till or via the business’ bank account. A cash book is a unique journal since it acts
both as a book of original entry as well as a ledger account where all transactions affecting cash
are recorded. It shall be dealt with in detail later on in this chapter.
vi.
GENERAL JOURNAL: (ALSO REFERRED TO AS THE
JOURNAL PROPER)
All other transactions not falling into any of the above journals are recorded in this journal.
In the general journal the following details relating to the transaction are included; date, the name
of the account to be debited, the name of the account to be credited and a brief narration or
description of the transaction as illustrated below.
GENERAL JOURNAL
Date
Details
Debit(Dr)
_/_/_
Account to be debited
*****
account to be credited
(a brief narrative to describe the above transaction)
Credit(Cr)
*****
ACCOUNTING PROCEDURES AND TECHNIQUES
25
A general journal has the following uses:
•
•
•
•
Recording the purchase or sale of ixed assets on credit
Correction of errors in the ledger accounts
Adjustment of ledger entries
Writing off of bad debts
POSTING
When all transactions have been entered into the speciic journals, they are then entered into
their respective accounts in the ledger in a process referred to as posting. An account is a place
where all details relating to a particular asset, liability or capital, is recorded. There could be an
account for motor vehicles, another for buildings, another one for a speciic creditor and yet other
separate accounts for each debtor e.t.c.
Accounts can be divided into two:
Personal accounts are accounts dealing with customers and suppliers i.e. debtors and creditors.
Impersonal accounts on the other hand can further be divided into:
Real account used for recording possessions like land, motor vehicles, buildings, furniture and
ittings.
Nominal account used for recording capital, income and expenses.
All accounts are prepared in a ‘T’ format and thus generally referred to as T- accounts. The Taccounts have two sides; the debit side on the left and the credit side on the right of the account
as shown below.
<Name of the account>
Dr
DATE PARTICULARS
Cr
AMOUNT (Sh) DATE
PARTICULARS AMOUNT (Sh)
Every transaction in a business affects two accounts. One of the accounts is debited while the
other is credited by the same amount giving rise to double entry book keeping i.e. for each entry
recorded in the journals there will be a debit and a credit entry in two separate accounts in the
ledger.
T E X T
Personal accounts
Impersonal accounts.
S T U D Y
•
•
FINANCIAL ACCOUNTING
26
A brief example would be when we buy a motor vehicle for cash. Two items will be
affected:
•
•
We will have a new asset; known as a car (a motor vehicle)
On the other hand, the asset cash will have reduced by the amount we pay for the
car.
Generally a transaction either increases or decreases an asset, liability or capital. This is relected
in the accounts as follows:
(i)
(ii)
(iii)
(iv)
When we increase an asset we make a debit entry to the asset account
When we decrease an asset we make a credit entry to that account
When we increase our liabilities or capital, we make a credit entry
When we decrease our liability or capital we make a debit entry to that account.
Uses of special journal
•
•
•
S T U D Y
T E X T
•
They facilitate grouping transactions which are alike together, recording them to provide
relevant transaction details.
It facilitates easier mechanization of the recording process
It makes the posting work easier because numerous ledger accounts take the totals.
They minimize possible errors.
2.4
THE LEDGER
Fast forward - All accounts that do not fall under either the sales or purchases ledger are
held under the general ledger.
The ledger is a book in which various accounts are kept. There are three main types of ledgers:
i.
ii.
iii.
Sales ledger
Purchases ledger
General ledger
(i) SALES LEDGER
After all transactions have been recorded in the sales journal, the next step is to post these
transactions using double-entry book keeping into the various ledgers. The sales ledger is made
up of individual accounts of the debtors i.e. customers who have purchased from us on credit.
27
ACCOUNTING PROCEDURES AND TECHNIQUES
To maintain double entry, the sales ledger is posted as follows:
i.
For all the customers in the sales journal, debit their individual accounts in the sales
ledger.
ii.
Make the corresponding credit entry in the sales account which is in the general
ledger.
To avoid having too many entries in the sales account, we sum up all the individual debtors
account and post the total to the credit side of the sales account in the general ledger. This total
should equal to the total as reported in the sales journal i.e. the irst book in which the all the
credit sales were initially recorded before being posted to the ledger accounts. The two totals will
however be equal if and only if double entry concept was adhered to in the posting process.
Recall the sales journal illustrated earlier. The transaction recorded in this journal can be posted
as follows in the sale ledger:
J. Kamau
PARTICULARS
sales
sales
sales
AMOUNT
5000
(Sh)
4200
2800
DATE
PARTICULARS
Cr
AMOUNT
(Sh)
S T U D Y
T E X T
Dr
DATE
1/4/2006
4/4/2006
6/4/2006
E. MUTETI
Dr
DATE
2/4/2006
PARTICULARS
Sales
AMOUNT
3200
(Sh)
DATE
PARTICULARS
Cr
AMOUNT
(Sh)
P. OTIENO
Dr
DATE
1/4/2006
3/4/2006
PARTICULARS
Sales
Sales
AMOUNT
4000
(Sh)
4700
DATE
PARTICULARS
Cr
AMOUNT
(Sh)
A. KIOKO
Dr
DATE
5/4/2006
PARTICULARS
sales
AMOUNT
6700
(Sh)
DATE
T
E
PARTICULARS
Cr
AMOUNT
(Sh)
T
28
FINANCIAL ACCOUNTING
(ii) PURCHASES LEDGER
After all the transactions have been entered on the purchases journal, the entries are then posted
in the purchases ledger. The purchases ledger is made up of individual creditors’ account. Every
credit purchase made by customers is recorded on the credit side of their individual account in
the purchases ledger. The totals of this ledger are then posted to the debit side of the purchases
account in the general ledger, again to avoid having too many individual creditors’ entries in
the purchases account. This total should equal the total of the purchases journal, if the posting
process was done correctly.
Recall the purchases journal illustrated earlier. The transaction recorded in this journal can be
posted as follows in the purchases ledger:
J. CHE E
Dr
DATE
PARTICULARS
AMOUNT
S T U D Y
T E X T
(Sh)
B.
DATE
1/12/2006
4/12/2006
9/12/2006
PARTICULARS
purchases
purchases
purchases
UMMO
Dr
Cr
AMOUNT
DATE
Cr
AMOUNT
4200
(Sh)
8500
9200
PARTICULARS
(Sh)
AMOUNT
DATE
PARTICULARS
(Sh)
5/12/2006
purchases
2100
A. MOLE
Dr
Cr
AMOUNT
DATE
PARTICULARS
(Sh)
AMOUNT
DATE
PARTICULARS
(Sh)
1/12/2006
Purchases
6700
8/12/2006
Purchases
6100
10/12/2006
Purchases
10400
ACCOUNTING PROCEDURES AND TECHNIQUES
29
. NJERI
Dr
Cr
Date
Partc ul ars
Amount
(Sh)
Date
Partcul ars
Amount (Sh)
8/12/2006
purchases
4100
(i)
(ii)
(iii)
(iv)
Fixed assets accounts e.g. furniture and ittings account, plant and equipment account
Expenses accounts e.g. electricity account insurance, expense account e.t.c
Return inwards account
Return outwards account
>>> Example 1
Given the following details; enter them in the sales journal, purchases journal, general journal,
and then post them to the relevant ledger accounts.
Year 2006
May 2
“2
“4
Credit sales to E. Kamau
Sh 12,800
Credit sales to J Omondi
Sh 11,700
Credit purchases to H Opati
“7
Credit sales to N.Kimanzi
“12
credit Credit purchases from M. Kibaki
“13
Credit Credit purchases from G.Njenga
“15
return Return inwards from J Hadija
“8
“13
“16
Credit sales to P.Amino
Credit sales to E. Kamau
return Return outwards to K Nyongesa
Sh 9,600
Sh 20,700
Sh. 4,900
Sh 7,200
Sh 42,000
Sh. 9,700
Sh. 200
Sh.1, 200
S T U D Y
All other accounts that do not fall under either the sales or purchases ledger are held under the
general ledger. Such accounts would include:
T E X T
(iii) GENERAL LEDGER
30
FINANCIAL ACCOUNTING
“20
credit Credit purchases from H. Opati
Sh. 11,200
“23
credit Credit purchases from O. Mbiyu
Sh. 4,500
“21
“27
“30
credit Credit purchases from E. Joe
Sh 4,900
bought Bought motor vehicle cash
Sh 20,000
Sales to E Williams
Sh. 10,600
Suggested solution:
Entries in the sales ledger
E. Kamau
2006
Sh
sales
12800
13/5
sales
42000
Sh
S T U D Y
T E X T
2/5
2006
J. Omondi
2006
4/5
Sh
sales
2006
Sh
11700
N.kimanzi
2006
7/5
Sh
sales
2006
Sh
20700
P. Amimo
2006
8/5
Sh
sales
4900
2006
Sh
ACCOUNTING PROCEDURES AND TECHNIQUES
31
E. Williams
2006
30/5
Sh
sales
2006
Sh
10600
J. Hadija
2006
Sh
2006
15/5
Sh
Return inwards
200
2006
Sh
2006
Sh
2/5
Purchases
9600
20 /5
Purchases
11200
M. Kibaki
2006
Sh
2006
12/5
Sh
Purchases
7200
G. Njenga
2006
Sh
2006
13/5
Sh
Purchases
9700
S T U D Y
H. Opati
T E X T
Entries in the Purchases ledger
32
FINANCIAL ACCOUNTING
E. Joe
2006
Sh
2006
21/5
Sh
Purchases
4900
O. Mbiyu
2006
Sh
2006
23/5
Sh
Purchases
4500
K. Nyongesa
2006
Return outwards
2006
Sh
1200
S T U D Y
T E X T
16/5
Sh
Entries in the General ledger
Purchases control a/c
2006
31/5
Sh
Credit purchases
2006
Sh
47100
Sales ledger control a/c
2006
Sh
2006
31/5
Sh
Credit sales
102700
Return inwards a/c
2006
31/5
Sh
Debtor Hadija
200
2006
Sh
ACCOUNTING PROCEDURES AND TECHNIQUES
33
Return outwards
2006
Sh
2006
315
Sh
Creditor K. Nyongesa
1200
Motor vehicle
Cash
2.5
2006
Sh
20000
CASH BOOKS
A cash book is a document or a record of all transactions involving cash in business organization.
It keeps track of all incoming and outgoing cash i.e. cash receipts and payments.
TWO COLUMN CASH BOOK
Usually a business maintains two cash books; cash-in-hand cash book and cash-at-bank cash
book. A cash-in-hand cash book records all transactions relating to cash paid out or received
through the cash till. The cash at bank cash book handles transactions relating to cash that goes
through the bank e.g. payments by cheque. Normally these two cash books are combined to
form a two column cash book, the two columns being the cash and bank column.
A contra entry, for cash book items, is where both the debit and the credit entries are shown in
the cash book, such when cash is paid into bank or withdrawn.
A withdrawal of cash from bank would appear in the cash book as a debit for cash and a credit
for bank of the same amount and vice versa for a deposit. Both the debit and credit entries are in
the same book. When this happens it is known as a contra item.
T E X T
27/5
Sh
S T U D Y
2006
34
FINANCIAL ACCOUNTING
Format of a two column cash book
Dr.
Date
TWO COLUMN CASH BOOK
Particulars
Folio
Cash
Bank
Date
Cr.
Particulars
Folio
Cash
Bank
>>> Example
S T U D Y
T E X T
Mr. Tamaa started a business on 1st January 2007.during the irst month of trading the following
transactions took place.
Wrote a personal cheque and deposited into the business bank account Sh800,000
Withdrew Sh200, 000 from the bank and put it into the cash till.
2nd Jan, Purchased goods by cheque Sh70,000
3rd Jan, Bought furniture for cash Sh25,000
3rd Jan, Bought equipment on credit Sh75,000
4th Jan, Sold goods for cash Sh100,000
5th Jan, Bought goods and paid by cheque Sh.200,000
6th Jan, Bought a motor van paying by cheque Sh.210,000
10th Jan, Obtain loan from the bank Sh.500,000
12th Jan, Sold goods on credit Sh75,000
16th Jan, Sold goods payment made by cheque Sh.100,000
16th Jan, Received a cheque from a debtor Sh.60,000
30th Jan, Took Sh10,000 from the cash till personal use.
Using the given details write up a two column cash book for Mr. Tamaa for the month of
January 2007
ACCOUNTING PROCEDURES AND TECHNIQUES
35
Mr.Tamaa
TWO COLUMN CASH BOOK
FOR THE MONTH OF JANUARY 2007
Dr.
Cr.
DATE
PARTICULARS
CASH
BANK
DATE
2005
2005
Jan
Jan
1
Capi al
2
Bank
4
Sales
10
Loan
500,000
05
16
Sales
100,000
06
16
Deb ors
60,000
©
200,000
02
Cash
CASH
©
BANK
200,000
30
u
furniure
Puhases
Moor van
Drawings
10,000
31
Balance c/d
265,000
780,000
300,000
1,460,000
200,000
02
100,000
03
p rchases
70,000
25,000
200,000
210,000
Feb 1
Balance b/d
300,000
1,460,000
265,000
780,000
Notes
(i)
It is important to note that only transactions involving cash are entered into the cash
book. Credit sales and credit purchases are not entered until the customer pays or the
supplier is paid.
(ii) When cash is withdrawn from bank and put in the cash till the entry made to capture
this transaction is referred to as a contra entry. A contra entry affects both sides of the
cashbook; the bank column on one side and a cash column on the other. A contra entry
may also arise if cash from the cash till is deposited into the bank account. It’s denoted
by a ‘c’ indicated in the folio column.
(iii) When all transactions have been entered into the cash book we then balance it off.
Normally the cashbook will have debit balance in both the cash and bank columns.
However, a bank overdraft will result into a credit balance in the bank column. A bank
overdraft is a facility offered by the bank where the account holder is allowed to withdraw
more cash than the remaining balance in his account.
(iv) The debit side of the cash book generally records cash/bank receipts while the credit
side records cash/bank payments.
S T U D Y
T E X T
PARTICULARS
36
FINANCIAL ACCOUNTING
THREE COLUMN CASH BOOKS
Sometimes businesses maintain a three column cash book. The additional column is the discounts
column, i.e. discount received on the credit side and the discount allowed on debit side.
Format of a three column cash book:
O M
THREE C LU N CASH B
OOK
Dr.
Cr.
Disc.
Partic lars
Cas
h
All
oed
k
Ban
Date
Partic lars
Cas
h
recei ed
S T U D Y
T E X T
Date
Disc
Example:
Enter the following transactions in a three column cash book.
(i)
Balance brought forward cash Sh 4700 bank Sh 17000
(ii)
Cash sales Sh 20000 (discount 8%)
(iii) Cash sales Sh 42000
(iv) Cash purchases Sh 18000 (discount 10%)
(v)
Sales paid for by cheque of Sh 40000 after deducting a 20% discount
(vi) Paid Sh 50000 by cheque after deducting 20% cash discount.
(vii) Purchases by cheque Sh 12000
k
Ban
ACCOUNTING PROCEDURES AND TECHNIQUES
Dr.
THREE COLUMN CASH BOOK
Da e
ic lars
.
Alloed
Disc
Cash
Bank
2006
Da e
ic lars
37
Cr.
Disc
.
Receied
Cash
Bank
2006
A l
A l
1
Balance b/f
-
4700
2
Sales
1600
18400
17000
-
4
5
hases
prchases
1800
12500
16200
-
50000
2
Sales
-
42000
-
6
5
Sales
30
Balance c/d
10000
-
11600
hases
-
Balance
40000
-
5000
65100
62000
30
c/d
12000
48900
-
14300
-
65100
62000
It is important to check whether the amounts of sales or purchases are shown as gross
or net of discount.
From (v) above, the amount is shown as net and for the purposes of knowing the
discount, we work backwards so as to ascertain the discount amount as follows:
Net amount = Sh 40,000
Discount allowed = 20%
Therefore the net amount = Gross amount (n) x (100-20) %
n = 40000 = Shs.50000
0.8 0.8
Therefore discount allowed = Sh 50,000 – 40,000 = Sh 10,000
(ii)
The amounts of both discounts allowed column and discounts received are treated as
follows:
Discount allowed
The totals will be posted to the debit side of the discount allowed account in the general ledger.
S T U D Y
(i)
T E X T
Notes
38
FINANCIAL ACCOUNTING
Dists
2006
30/4
Debtors
awd
S
2006
11600
/5
S
Discount received
The totals of the discounts received column will be posted to the credit side of the discounts
received account in the general ledger.
Dists rivd
S
2006
2006
Sundry creditors
14300
T E X T
30/4
S
S T U D Y
2.6
BANK AND CASH BOOK RECONCILIATION
Fast forward – Differences between the cash and the bank statement arise for three reasons;
errors, usually in the cash book, omissions, such as bank charges not posted in the cash book
and timing differences, such as un-presented cheques.
At the end of a particular period (mostly one month) the balances of the cash book should be
extracted and in many instances, the cash at bank balance in the cash book does not agree
with the bank statement over the same period though theoretically it should. This is a normal
occurrence and the two needs to be reconciled so that any material errors can be identiied as
early as possible. The causes of the disagreement may be as a result of:
(i)
(ii)
(iii)
(iv)
Items that appear on the cash book but not on the bank statement.
Items that appear on the bank statement but not on the cashbook
Errors when entering amounts in the cash book
Errors by the bank while posting transactions
ACCOUNTING PROCEDURES AND TECHNIQUES
39
Items that appear on the cash and not on the bank statement
(i) Un-credited amounts (cheques/deposits)
This item mainly affects the cheques. Due to the nature of the cheque clearing process, a irm
may deposit a cheque and thus debit the cashbook, but by the time the bank statement is being
prepared, the amounts are not yet available. The cheque could also bounce and before the bank
can communicate to the account holder, the balances in the bank statement and in the cash book
will not tally.
(ii) Un-presented cheques
These are the cheques issued to the suppliers by the irm and shown as payments in the cash
book. The suppliers may hold the cheque for a number of days before presenting it to the bank
for payment and thus the bank will not have recorded such a payment in the bank statement
hence will relect a different balance from that in the cash book.
ii)
iii)
iv)
v)
vi)
Direct Credits: when a customer deposits either cash or a cheque directly into the
business’ bank account without informing the business.
Bank Charges: when the bank debits (decreases) the account of the business with
charges e.g. cheque book charges, ledger fees, commissions on electronic funds
transfer both incoming and out going e.t.c.
Direct Debits; when the bank pays/ honors a standing order, deducts loan payment
from the account e.t.c
Interest Income; when the bank credits (increases) with the amount of interest earned
on the account.
Dishonored Cheques; when a cheque earlier deposited is dishonored
Interest charges with regard to bank facilities e.g. overdraft, credit card e.t.c.
Errors while entering the amounts in the cashbook would include
•
•
Overstatement/understatement of receipts and payments in the cash book
Mis-posting of deposits or payments in the cash book.
Bank reconciliation is used to bring the two balances into agreement i.e. the back balance in the
cash book and the bank balance in the bank statement.
The irst thing to do while reconciling a bank statement is to update the cashbook. This is done by
entering all the transactions that ought to be in the cashbook but were missing, as well as correct
all errors in the cash book.
S T U D Y
i)
T E X T
Items appearing in the bank statement and missing in the cash book
40
FINANCIAL ACCOUNTING
Such entries would include
•
•
•
•
•
•
Bank charges
Direct credits and debits
Dishonored cheques
Overstatement/understatement of receipts in the cashbook
Over/understatement of payments in the cash book
Misposting of deposits or payments in the cash book
The second step is to prepare a bank reconciliation statement which expected to make adjustments
on the balance in the bank statement to agree with the new balance obtained from the adjusted
cashbook.
The following items will now be shown under the bank reconciliation statement
S T U D Y
T E X T
•
•
•
•
Un-presented cheques
Un-credited deposits
Errors in the bank statement
The updated cash book balance
The Format of a bank reconciliation statement
Format 1
<Name of business>
BANK RECONCILIATION STATEMENT AS AT
Sh
Balance as per bank statement
Sh
xxx
Add:
Un-credited cheques
xxx
Errors that reduce bank balance
xxx
xxx
Less:
Un-presented cheques
xxx
Errors that increase bank balance
xxx
Balance as per updated cash book
(xxx)
xxx
xxx
ACCOUNTING PROCEDURES AND TECHNIQUES
41
Format 2
<Name of business>
BANK RECONCILIATION STATEMENT
Sh
Balance as per updated cash book
Sh
xxx
Add:
Un-presented cheques
xxx
Errors in the bank statement that increase bank balance
xxx
xxx
xxx
Less:
Errors on bank statement that reduce bank balance
xxx
Balance as per bank statement
(xxx)
xxx
Note:
Errors in the bank statement that reduce bank balance
Understatement of deposits into the bank account
Overstatement of payments from the bank account
Errors that increase bank balance
Overstatement of deposits
Understatement of payments
>>> Example:
On 31st December 2006 the cash book of H. Njeri showed a balance at the bank of Sh Sh8, 100.
The bank statement however showed a balance of Sh 6,700. Going through the bank statement
she found out that:
(i)
A cheque received from Taifa Ltd on 1st December for Sh 600 and entered into the
cash book did not appear on the bank statement
(ii) A cheque paid to E. Kamara Sh 700on 25th December had not been presented
(iii) A cheque received from N Njiru on 24th December Sh 600 and entered into the cash
book was returned dishonored. No entry in this regard was recorded I the cash book
(iv) Bank charges amounting to Sh 100 had not been entered into the cash book
(v) The bank received directly Sh 1000from E.A.B.L as dividends on 18th December on
behalf of H. Njeri
(vi) A cheque payment of Sh 2000 to Olivia had been entered in error Sh200 in the
cashbook
Required
(a)
(b)
Make the necessary entries to update the cash book
Prepare a bank reconciliation statement for H. Njeri for the month of December 2006
T E X T
xxx
S T U D Y
Uncredited cheques
FINANCIAL ACCOUNTING
42
Suggested solution
Corrected Cash Book
2006
/5
Sh
2006
Blnce b/f
8,100
/5
Direct credit
1,000
Sh
N. Njiru (dishonored)
n chrges
or in cheque to li!i
Blnce s per csh boo
9,100
600
100
1,800
6,600
9,100
BANK RECONCILIATION STATEMENT
S T U D Y
T E X T
H. NJERI
BANK RECONCILIATION STATEMENT AS AT 31ST DECEMBER 2006
Balance as per updated cash book
6,600
Add:
Un-presented cheques; E. Kamara
700
Errors that increase bank balance
xxx
Less: uncredited cheques; Taifa
600
Errors that reduce bank balance
xx
Balance as per bank statement as at 31st December 2006
700
7,300
(600)
6,700
November 1992 Q
A trainee accountant working for a sole trader, Juma Mambo Leo had prepared the following
summary of the cash book for the month of March 1999
Cash book
Sh
Receipts
3748000
Opening balance b/d
561000
4309000
Payments
Closing balance c/d
Sh
4,189,000
120,000
4309000
ACCOUNTING PROCEDURES AND TECHNIQUES
43
Whilst checking the cash book against t the bank statement you ind the following
discrepancies;
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
Bank charges of Sh 8000 shown in the bank statement have not been entered in the
cash book
The bank has debited a cheque of Sh 37000 in error in the account of Juma Mambo
Leo
Cheques totaling Sh 96000 have not been presented to the bank for payment.
Dividends received for Sh 4200 have been credited on the bank statement but not yet
recorded on Juma Mambo Leo’s cash book
There were cheques received of Sh 484000 which were entered in the cash book but
not yet credited by the bank.
A cheque of Sh 17000 has been returned by the bank marked as ‘refer to drawer’ but
no entry relating to this has been made in the books.
The opening balance in the cash book should have been Sh 651000 and not Sh
561000
The bank statement shows that there is n overdraft at 31st march 1999 of Sh 198000
Suggested solution
(i)
Purposes of a bank reconciliation statement
Bank reconciliation is an attempt to explain the differences between the cash
book’s cash at bank balance and the balance shown in the bank statement
It is prepared for the following reasons;
• • To update the cash book with some relevant entries appearing in the bank
statement e.g. bank charges, direct debit and credit dishonoureddishonored
cheques e.t.c
• • To detect or prevent errors or frauds that relate to the cash book
• • To prevent or prevent errors or frauds that relate to the bank
(ii) The irst step will be to update the cash book as follows:
Corrected Cash Book
2006
Sh
2006
Sh
Balance b/d
120000
Bank charges
8000
Dividend received
42000
Returned cheque
17000
Error in opening balance
90000
Balance as per cash book
227000
252000
252000
S T U D Y
(i) State and briely explain two purposes of a bank reconciliation statement.
(ii) Entries necessary to correct the cash book
(iii) A bank reconciliation statement as at 31st march 1999
(KASNEB)
T E X T
Required
44
FINANCIAL ACCOUNTING
Bank reconciliation statement
As at 31st march 1999
Sh
Sh
Balance as per updated cash book
227000
Add:
Un-presented cheques
Errors that increase bank balance
96000
--96000
Less:
Uncredited cheques
484000
Errors that reduce bank balance
37000
(521000)
(198000)
Reinforcement question may 2003 q2 (solution at the back)
S T U D Y
T E X T
Balance as per bank statement (overdraft)
2.7
THE PETTY CASH BOOK
Fast forward – Most businesses keep petty cash on the premises, which is topped up from the
main account.
Majority of business payments are made by cheque. However for some amounts, the cashier
need not write a cheque for each.
Examples of such payments includes when a staff member is given some bus fare from ofice to
town on oficial duty, when stationery is bought e.g. pens e,t,ce.t.c. Such transactions involve fairly
small amount s which does not warrant the writing of a cheque. For this reason most businesses
maintain a petty cash usually handled by the petty cashier. The petty cashier is usually given a
certain amount to use in the payments, called a cash loat. The petty cashier maintains records
of all the expenses paid out (either by keeping receipts or preparing petty cash vouchers which
are signed against). After some time the petty cashier will request to be reimbursed for all the
amounts paid out of the cash loat given to him. This system of reimbursing some amount to the
petty cashier after a certain period of time to maintain the cash loat is known as the imprest
system.
ACCOUNTING PROCEDURES AND TECHNIQUES
45
The petty cash book maintains columns relating to speciic expenses e.g. traveling entertainment,
stationery, general ofice expenditure, postage e.t.c. it is upon a business enterprise to determine
the number of expenses account to maintain under the petty cash system.
Format of a petty cash book
&$
Rece ts
Date
&' ()yme%t (ostage
amo*%t
Deta
"#$e%ses
Sta+&o%ery Ge%era'
e#$e%se
, ' "%terta&%me%t
Tra e
The
'edger
s
Given the information below write up a petty cash book with the following columns; :
i.
Postage and telegram
ii.
Stationery
iii.
Traveling
iv.
Ofice expenses
v.
The ledger
i) January 1 received petty cash Sh 20000
ii) January 1 paid for sugar Sh 700
iii) January 2 bought pencils and pens Sh 800
iv) January 4 bus fare Sh 400
v) January 5 telegram Sh 1500vi) January 8envelops Sh 900
vii) January 9paid David (trade creditor) Sh 6000
viii) January 9 coffee Sh 200
ix) January 15 cleaning Sh14000
S T U D Y
>>> Illustration
T E X T
The ledger column is used to record the amount paid by petty cash to a person/ business with
whom we have an account. A good example is when we pay creditors the amount owed using
the petty cash.
46
FINANCIAL ACCOUNTING
Receipts
20000
Date
Jan
1
1
2
3
4
5
8
9
9
15
Detail
Payment
Telegram
amount
Postage
Petty cash
Sugar
Stamps
Pencils
Bus pens
fare
and
Telegram
Envelopes
David
Coffee
Cleaning
700.00
1200.00
800.00
400.00
1500.00
900.00
6000.00
200.00
14000.00
Total
13100
Expenses
Stationery
Travel
Office
General
The
ledger
700.00
1200
800.00
400.00
1500.00
900.00
6000.00
200.00
14000.00
2700.00
800.00
400.00
2300.00
900.00
6000.00
S T U D Y
T E X T
The ledger column is used to record any payments made to supplier with whom we have an
account. inIn the illustration above David is one such supplier.
At the end of a certain period of time the respective expenses columns are summed up and
posted to speciic expenses accounts in the general ledger. The petty cashier is also given a
cheque/ cash as reimbursement for the amount expensed (in this case shsSh13100 Sh 13100
will be reimbursed to the cashier to make the original loat of shsSh20000Sh 20000)
Further exercises:
Q1 K.A.S.N.E.B. ADOPTED
(a)
(b)
(c)
Differentiate between a petty cash book and a three column cash book.
Explain why it is important for a bank to prepare a bank reconciliation statement.
You have recently been employed in a medium sized company and deployed in the
accounts department. Your section head has given you the following extracts form the
cashbook for the month of April 2003.
The head of section further informs you that all receipts are banked intact and all payment s are
made by cheque. On investigation you discover the following:
(i)
Bank commissions and charges amounting to shsSh272000 Sh 272000 entered on the
bank statement had not been entered in the cash book.
(ii) Cheques drew\an amounting to shsSh534000 Sh 534000 had not been presented to
the bank for payment.
(iii) Cheques amounting to shsSh Sh 1524000 had been entered in the cash book as paid
to the bank but had not been credited by the bank till may 2003
(iv) A cheque of shsSh44000 Sh 44000 had been entered in the cash book as receipt
instead of a payment
(v) A cheque of shsSh Sh 50000 had been debited by the bank by mistake
ACCOUNTING PROCEDURES AND TECHNIQUES
47
(vi) A cheque received for shsSh Sh 160000had been returned unpaid. No adjustment has
been made in the cashbook
(vii) All dividends receivable are credited directly into the bank account. During the month
of April 2003 divindedsdividends totaling shsSh142000were Sh 142000 were credited
into the bank account. No entries have been made in the cash book.
(viii) A cheque drawn for shsSh12000has Sh 12000 has been incorrectly entered into the
cash book as Sh 132000
(ix) The balance brought forward in the cash book should have been
(x) Sh (Conirm this) The bank statement as at 30th April showed an overdraft of
ShSh2,324,000
2.8
INTRODUCTION TO INITIAL ACCOUNTS
Impersonal accounts are either real or nominal. Real accounts record assets (things of value)
while nominal accounts record revenues, expenses and capital.
RECORDING TRANSACTIONS WITH REGARD TO LIABILITIES
When we increase our liabilities it means we have obligations to fulill in the future. On the other
hand for all these obligations we have an asset to be exchanged for the liability that we take up.
All increase in liabilities:
Dr. Asset account
Cr. Liability account
>>> Illustration (i)
On 3rd June 2004 Ramani stores bought stock on credit from Jitegemea stores. The stock was
worth shsSh200000Sh 200000
Dr. Purchase account 200000
Cr. Jitegemea Stores (creditor) shsSh200000Sh200000
(To record purchase of stock on credit)
For most businesses expenses, the services are irst offered and then paid for later.
S T U D Y
Personal accounts deal with individuals (debtors and creditors)
T E X T
So far we have looked at books of original entry. After the initial recording, the transactions
are then entered into individual accounts in the ledger. The accounts are either personal or
impersonal.
FINANCIAL ACCOUNTING
48
Illustration (ii)
Electricity for June 2005 was Sh.40000 it was paid for at a later date.
Dr. Electricity account Sh.40000
Cr. Accrued expenses shsSh.40000
RECORDING TRANSACTIONS WITH REGARD TO CAPITAL
When the owner injects more capital into the business
Dr. Cash/bank
S T U D Y
T E X T
Cr. Capital account
Sometimes however the capital may not be in the form cash but he may introduce his own asset
to be used in the business. In that case the particular asset account will be debited instead of
cash.
Illustration iii
On 1st January 2005 Mr. Makhoha started a business. He decided to make a building which he
previously rented out to be his operating premises. In addition, he deposited Shs1000000 Sh
1000000 into the business’ bank account. The building was worth Sh 400000.
The entry will be as follows.
Dr. bank Sh 1000000
Dr. Building Sh 400000
Cr. Capital SH 1400000
The entries will appear as follows in the speciic accounts.
Bank a/c
Sh
27/5
Capital
1000000
Sh
/5
ACCOUNTING PROCEDURES AND TECHNIQUES
49
Building a/c
Sh
27/5
Capital
1400000
Sh
/5
Capital a/c
Sh
27/5
Sh
Ba/0
/5
1000000
B1il2i/3
400000
•
When we make sales the following is possible:
•
•
The customer to pay in cash
The customer to purchase on credit
S T U D Y
•
T E X T
RECORDING TRANSACTIONS WITH REGARD TO INCOME
>>> Illustration
Lenana store sold goods worth shs Sh 90000 to Batian stores on 25th November 2006
Batian stores immediately paid for the goods worth Sh 20000 a cheque. The transaction will be
recorded as follows:
Bank a/c
Sh
sales
Sh
90000
Cash
20000
Sales
Sh
Sh
ba4k
90000
50
FINANCIAL ACCOUNTING
>>> Illustration II
If Batian stores did not pay immediately, the entries made by Lenana stores would have been as
follows.
Dr. Batian stores a/c debtor Sh 90000
Cr. Sales account Sh 90000
On the day that Batian stores will pay, the following g entries will be made.
Dr. Cash/ bank Sh 90000
Cr. Batian stores a/c debtor Sh 90000
Batian Stores debtor a/c
Sh
5ale5
S T U D Y
T E X T
27/5
Sh
60000
/5
Ca5h
60000
Sales a/c
Sh
Sh
27/5
/5
Batia7 5tore5 a/8 de:tor
60000
Bank a/c
Sh
27/5
:atia7 5tore5 a/8 de:tor
60000
Sh
/5
ACCOUNTING PROCEDURES AND TECHNIQUES
51
RECORDING TRANSACTIONS WITH REGARD TO EXPENSES
All expenses have debit entries.
If we incur a business expense and pay for it in cash,
Dr. Expenses account
Cr. Bank account
>>> Illustration
Kimuchu wholesalers’ motor vehicle was repaired at a cost of shsSh12000 which 12000 which
was paid immediately in cash.
The entries to record the above transactions would be as follows
Dr. Motor vehicle repairs Account Sh120000
Dr. Expenses account
Cr. Creditors account
>>> Illustration
If Dubai wholesalers took their motor vehicle for repair to Toyota E.A for repairs. The entries
would be as follows:
Dr. motor vehicle repairs account
Cr. Toyota E.A account (creditor)
When Dubai wholesalers later pay for the repairs, the following entries will be made.
Dr. Toyota E.A account (creditor)
CR cash account
This will eliminate the balance in the Toyota E.A account provided they pay for the repairs in
full.
However it is important to note that not all business expenses involve movement in cash. Some
do not involve movement of cash and are recognized in the book as provisions. An example
would be depreciation and doubtful debts provision. The entries in such accounts will be:
S T U D Y
If we incur one expense and pay for it later the entries made will be as follows.
T E X T
Cr. Cash account Sh 120000
52
FINANCIAL ACCOUNTING
Dr. Expenses account
Cr. Provision for (speciic expense)
>>> Illustration
For the month of May 2006 XYZ Co. Ltd incurred depreciation expense on motor vehicles
Sh.400000.
The entries will be as follows
Dr. Motor vehicle depreciation account Sh 40000
Cr. Provision for depreciation on motor vehicle account Sh 40000
Motor ;ehicle de<reciation acco=nt
27/5
Provision for depreciation on
40000
Sh
/5
Bank
90000
motor vehicle account
S T U D Y
T E X T
Sh
Pro;ision for de<reciation on >otor ;ehicle acco=nt
Sh
27/5
Sh
/5
Motor vehicle depreciation
40000
account
The provision for depreciation and for doubtful debts will be covered more comprehensively later
on in this course.
ACCOUNTING PROCEDURES AND TECHNIQUES
2.9
53
BALANCING OFF ACCOUNTS
When balancing off accounts we add up the debit side of each account and compare it with the
sum of the credit side of the same account. The difference is put as the balance carried down
(Balance c/d) on the side that is less such that the two sides now balance.
On the opposite side of the balance c/d and below the balancing totals, the opening balance for
the next accounting period is indicated as balance brought forward (balance b/f)
>>> Example I
Enter the following transactions in a cash account and then balance it off showing clearly the
balances c/d and balances b/f
1 May 2006
4 May 2006
11May 2006
7 May 2006
11May 2006
T E X T
Balance brought forward in the cash till at 2000
Cash sales of 10000
Cash received from debtors 2500
Expenses paid 4500
Cash purchases 9700
Cash acco?nt
2006
Sh
2006
Sh
1/5
Balance b/f
2000
7/5
Expenses
4500
4/5
Sales
10000
11/5
Purchases
9700
8/5
Debtor
2500
31/5
Balance c/d
300
14500
@/6
Balance b/f
14500
300
When balancing off accounts:
i)
The totals should appear on the same line on the credit and the debit side
ii)
A single line should be drawn above the totals and a double line below the totals on both
the credit and debit sides.
iii)
The balance C/D can be on either side depending on which side has the higher
amount.
S T U D Y
i)
ii)
iii)
iv)
v)
54
FINANCIAL ACCOUNTING
However in common practice the following can be deduced concerning the balance b/d of various
accounts:
•
•
•
•
•
All assets have debit balances
All liabilities Have credit balances
Capital always has credit balance
Income accounts have credit balances
Expenses accounts have debit balances.
A credit balance means that the totals on the credit side as higher than those on the debit side
hence the balancing igure (balance c/d) goes to the debit side. A debit balance occurs when
the debit side is higher than the credit side hence the balancing igure (balance c/d) goes to the
credit side.
The purposes of balancing off accounts would be
•
S T U D Y
T E X T
•
•
•
Identify how much is outstanding in a particular account. Ee.g. how much credit sales
are yet to be paid for?
Determine the expenses that have been incurred
To determine how much the business owes to the suppliers
To identify transactions that may have been omitted for debtors.
In balancing off accounts you will realize that not all accounts have a balance at the end of a
particular period. An example would be when a particular customer purchased goods on credit
worth Shs.400000and later paid the entire amount of Shs400000 before the accounts were
balanced off. His account will have no balance to carry forward to the next period and would not
be included in the balances appearing in the sales ledger.
>>> Example II
Mr. John Kimuto bought goods worth Sh 50000 from Katune Electronics on 1st January 2007. He
paid the amount on 15th January 2007.
On 18th and 20th of the same month he bought other goods on credit worth Sh 14000 and 40000
respectively, and paid shs Sh 54000 by cheque on 28th. Prepare John kimuto’s account in the
books of Katune Electronics as at 30th January 2007
MrC John KimDto a/c
2007
Sh
Sh
1/1
Sales
50000
15/1
bank
50000
18/1
Sales
14000
28/01
Bank
54000
20/1
sales
40000
104000
104000
ACCOUNTING PROCEDURES AND TECHNIQUES
55
However assuming the same transactions only that he was able to pay shsSh14000 instead of
shsSh54000 his account would appear as follows:
MrF Iohn LimNto
2007
Sh
Sh
1/1
Sales
50000
15/1
bank
50000
18/1
Sales
14000
28/01
Bank
14000
20/1
sales
40000
30/1
Balance c/d
40000
104000
01/2
balance b/d
104000
40000
All accounting in the business organization will fall under the deined terms.
Increase in an asset can be due to any of the following:.
i)
ii)
iii)
Buying a new asset either in cash/bank
Revaluing existing assets
Buying a new asset on credit
For all the above entries we make a debit to the assets account and credit to the respective
account as follows.
Cash purchase:
i)
ii)
iii)
Dr. Motor vehicle account
Cr. Cash/bank
Dr. Motor vehicle a/c` (with increase in value)
Cr. revaluation
Dr. Motor vehicle a/c
Cr. Creditor a/c
When we increase an asset, we make a debit entry into the account.
For example; on 7th June 2006, Mr. Matatu bought a motor vehicle for cashssh Sh hs50000. The
following will be the entry
S T U D Y
RECORDING TRANSACTIONS WITH REGARD TO ASSETS
T E X T
This balance of shs Sh.40000 will be included in the sales ledger at the end of the month. It will
be shown under John Katune. At the end of the period the total amount of the sales ledger will
represent the amount owed to the business by customers. i.e. debtors.
56
FINANCIAL ACCOUNTING
.
Dr. assetsAssets account (motor vehicle)
50000
Cr. Cash at bank account
50000
When we decrease an asset, we make a credit entry into the account.
Decrease in an asset can be as a result of of:
•
•
•
•
Selling an existing asset for cash
Selling an existing asset on credit
Revaluation of an asset below its net book value
Writing off an existing asset for no value.
The transaction is recorded as follows:
S T U D Y
T E X T
Selling an existing asset on cash:
Dr. Cash/bank account (with cash received)
Cr. Asset account
Selling an existing asset on credit:
Dr. Debtor account (with the sales value)
Cr. Asset account
Revaluation of existing assets:
Dr. Asset revaluation account
Cr. Asset account
Sometimes the current assets may be disposed at a value higher than their book value. This
results into a gain on disposal. The same asset can be disposed at a lower value than its book
value resulting to a loss on disposal.
ACCOUNTING PROCEDURES AND TECHNIQUES
57
In this case transactions are recorded as follows:
Gain on disposal:
Dr. Cash/ bank/ debtor account (selling price of the asset)
Cr. Asset account (with the book value of the asset)
Cr. Gain on disposal account (with the amount of the selling price above the
book value)
Loss on disposal:
Dr. Cash /bank/ debtor account (with the selling price of the asset)
Dr. Loss on disposal account (with the amount of selling price below the book value)
>>> Illustration 1
Doe Co. LTD sold on e of the existing machinery for Sh 200000. The machinery was received in
cash. The entry will be as follows:
Dr. cash
200000
Cr. Machinery
200000
MachinerQ a/c
Sh
27/5
Sh
/5
Sash
200000
Cash accoTnt
Sh
MachinerU
200000
Sh
S T U D Y
T E X T
Cr. Asset account (with the book value of the asset)
58
FINANCIAL ACCOUNTING
>>> Illustration 2
When preparing the inancial statements for the year 2005, Doe Co. Ltd hired the services of a
professional valuer, to revalue an existing motor vehicle which they thought had a book value
of less than what was shown as the net book value due to the bad state of the roads. The
professional valuer valued it for Sh 50000 while us the net book value was Sh 80000.
The recording will be as follows:
Dr. Revaluation account Sh (80000 - 50000) Sh 30000
Cr. Motor vehicle account
ShsSh30000
Machinery a/c
Sh
/5
revaluation account
30000
S T U D Y
T E X T
27/5
Sh
Revaluation account
Sh
27/5
Sh
/5
Cash
200000
2.10 EXTRACTION OF THE TRIAL BALANCE
At the end of a given period, all the accounts are balanced off and the balances brought forward
are then extracted and used to prepare what is known as a trial balance.
A trial balance can be deined as a list of account tittles and their balances in the ledger on a
speciic date shown in debit and credit columns.
If the double entry in the respective was done correctly then the trial balance should balance i.ei.
e. the debit and the credit balances should equal.
However strange, as it may seem, a balanced trial balance is no guarantee that posting was
done correctly since there are some errors that could pass unnoticed and the trial balance still
balances. These will be discussed later on this chapter.
ACCOUNTING PROCEDURES AND TECHNIQUES
59
A trial balance should have the exact date in which it was extracted. This is because, a trial
balance is a “snap-shot” of a particular day and any other day would have a trial balance with
totally different igures.
>>> Illustration
Record the following transaction s for the month of November for M.S Suppliers. Balance off all
the accounts and extract a trial balance as at 30th November 2006
Started Started business with Sh.175000 in cash
November 2
Put Put Sh140000 of the cash into the bank account
November 3
Bought goods for cash worth Sh.7500
November 4
Bought Bought stationery on credit Sh.17000 from Nzomo
November 6
Paid rent by cheque Sh.2750
November 5 Bought goods on credit from Isaac Sh 18000, Philips Sh.24500, Timothy Sh.5500
Mathew Sh17000
November 7 Sold goods on credit to Njeri Sh 4500, Onyango Sh7500 Muiru Sh 9500
Tinga Sh 8000
November 8
Bought Bought furniture from Irungu Suppliers on credit Sh 24000
November 12 Paid Paid salaries and wages Sh 6000 cash
November 14 Returned goods to Timothy Sh 3000, Philip Sh 2000
November 15 bought Bought an old motor van by cheque Sh 35000
November 16 received Received loan from Henry by cheque Sh 30000
November 17 Goods returned to us by Njeri Sh1000 Sh1000 Muiru Sh 2000
November 18 Cash sales Sh 450
November 21 Sold goods on credit to Pauline Sh5750, Onyango Sh 50100 Tinga Sh 4500
November 24 We paid the following by cheque Philips Sh 2250 Timothy Sh2500
November 25 Received a cheque from Pauline Sh 5750, onyango Sh 12500
November 28 Received a further loan from Henry Sh 10000 cash
November 30 Received Sh 25000 Received Sh 25000 from Tinga in cash.
S T U D Y
November 1
T E X T
Year 2006
60
FINANCIAL ACCOUNTING
Suggested solution
CaVh a/c
200W
X/XX CaYita
X8/XX ]ales
28/XX xenrz
30/XX ~in} a
X75000 2/XX
\500 3/XX
X0000 X2/XX
25000
30/XX
2X\500
WX000
alance Z/{
200W
30/XX
Sh
200W
alance c/{ X75000 X/XX
X/X2
Zan[
^_`jhases
]alaries an{ |a}es
alance c/{
Sh
X75000
alance Z/{ X75000
Cash
Ban account a/c
200W
2/XX
Sh
Caital a/c
S T U D Y
T E X T
X/X2/
200W
Sh
Sh
Cash
XW/XX oan xenrz
25/XX ^ uline
25/XX nz an}o
200W
X\0000 W/XX
30000
X5/XX
5750
2\/XX
X2500 2\/XX
30/XX
X88250
30/XX alance Z/{
X25500
Sh
2750
ent
otor van 35000
22500
^hiliYs
2500
~iothz
alance c/{ X25500
X88250
X\0000
7500
W000
WX000
2X\500
ACCOUNTING PROCEDURES AND TECHNIQUES
Sale return a/c
Sh
000
30/
Sh
alance c/
2000
3000
alance /
200
3/
5/
Cash a/c
saac
hilis
ioth
athe
3000
3000
urchae a/c
Sh
200
7500
30/
alance c/
8000
2500
200
30/
alance /
Sh
72500
5500
7000
72500
/2
3000
72500
72500
Sale a/c
Sh
alance c/ 750
200
7/
7/
7/
7/
8//
Sh
eri
nano
uiru
ina
cash
500
7500
500
8000
500
c
2/
2/
uline
nano
ina
/2
750
alance / 750
2/
02250
5750
5000
7000
T E X T
7/ eri
7/ uiru
200
S T U D Y
200
30/
61
62
FINANCIAL ACCOUNTING
urchae return a/c
200
3¡/¡¡
Sh
¢alance £/¤
200
¡¥/¡¡
¡¥/¡¡
5000
Sh
¦i§oth¨
ªhili«
5000
3000
2000
5000
¡/ ¡ 2
¢alance £/¤
5000
Furniture a/c
200
8/¡¡
¡/ ¡ 2
¬runu su««liers
¢alance £/¤
Sh
200
2¥000
3¡/¡¡
2¥000
Sh
¢alance c/¤
2¥000
Motor van a/c
S T U D Y
T E X T
200
¡5/¡¡ £an®
¡/¡2 ¢alance £/¤
Sh
200
35000
3¡/¡¡
Sh
¢alance c/¤
35000
35000
Rent a/c
200
/¡¡
¡/¡2
£an®
¢alance £/¤
Sh
200
2750
3¡/¡¡
Sh
¢alance c/¤
2750
2750
Salarie an¯ °a±e a/c
200
Sh
¡2/¡¡ cash
¡/¡2 ¢alance £/¤
200
000
3¡/¡¡
Sh
¢alance c/¤
000
000
Stationery a/c
200²
³/´´
´ /´ 2
Sh
µ¶o·o
¸alance º/¹
8500
8500
200²
3´/´´
Sh
¸alance c/¹
8500
ACCOUNTING PROCEDURES AND TECHNIQUES
¾/¾2
¿500
sales
Áalance Ã/Â
200½
7/¾¾
2¾/¾¾
sales
sales
2¾/¾¾
Àales returns ¾000
Áalance c/Â 3500
¿500
3500
ÄnyanÅo a/c
Sh
200½
Sh
ÃanÆ ¾2500
7500
25/¾¾
5000
¾2500
200½
7/¾¾
¿500
Sh
sales
sales
¾2500
ÇinÅa a/c
Sh
200½
8000
30/¾¾
¾7000
25000
Sh
Cash
25000
T E X T
7/¾¾
Sh
25000
Muiru a/c
200½
7/¾¾
¾/¾2
Sh
Àales
Áalance Ã/Â
È500
È500
200½
¾7/¾¾
3¾/¾¾
Sh
Àales returns
Áalance c/Â
3Í/ÍÍ
7500
È500
7500
ÉÊoËo a/c
200Ì
Sh
200Ì
3Í/ÍÍ Îalance c/Ï 8500
Ð/ÍÍ ÑÒationerÓ
Í/Í2 Îalance Ô/Ï
200Ì
2000
Sh
Îalance c/Ï Í8000
Sh
8500
8500
ÕÖaac a/c
200Ì
Sh
5/ÍÍ
×ØÙÚhases Í8000
Í/Í2 Îalance Ô/Ï Í8000
S T U D Y
200½
»¼eri a/c
200½
¾7/¾¾
3¾/¾¾
63
64
FINANCIAL ACCOUNTING
200Þ
ßà/ßß
2à/ßß
200Þ
ßà/ßß
2à/ßß
ÛÜiliÝ a/c
200Þ
Sh
áâãähase returns
åænç
Sh
5/ßß
2000
áâãähases
22500
2à500
2à500
èiéothy a/c
200Þ
Sh
áâãähase returns
êanç
3000
5/ßß
Sh
áâãähases
S T U D Y
5500
Matheë a/c
Sh
åalance ê/ì ß7000
T E X T
3ß/ßß
5500
2500
5500
200Þ
2à500
200Þ
5/ßß
ß/ ß 2
Sh
áâãähases ß7000
åalance ê/ì ß7000
írunîu ïuððlieï a/c
200ñ
Sh
200ñ
3ò/òò
óalance c/ô 2õ000 8/òò öurniture
ò/ò2 óalance ÷/ô
200ñ
2ò/òò
úales
øùuline a/c
Sh
200ñ
÷anû
5750
25/òò
Sh
2õ000
2õ000
Sh
5750
üoan Henry a/c
200ñ
Sh
200ñ
Sh
óalance ÷/ô õ0000 òñ/òò ÷anû
3ò/òò
30000
28/òò
Cash
ò0000
õ0000
õ0000
ò/ò2 óalance ÷/ô õ0000
ACCOUNTING PROCEDURES AND TECHNIQUES
65
M.S SýþþÿIE S
ÿ BAÿANCE AS AT 30 H NOVEMBER 2006
Dr.
Cash
61000
Bank
125500
Capital
Cr.
175000
Sales returns
3000
þurchases
72500
Sales
61750
þurchases returns
5000
Furniture
24000
Motor van
35000
Rent
2750
Salaries and wages
6000
40000
Henry loan account
ÿ)
Tinga ( Sÿ)
Muiru (ÿ)
Nz om o (þÿ)
Isaac (þÿ)
Mathew(þÿ)
Irungu(þÿ)
Njeri( S
3500
8500
S T U D Y
Stationery account
7500
8500
18000
17000
24000
349250
T E X T
TRIA
349250
Note:
So many businesses have a large number of suppliers and customers and hence instead of
bringing each individual debtor/ creditor balance in the trial balance, we bring total of the accounts
obtained form the sales ledger and the purchase ledger. These two show the igures of debtors
and creditors respectively.
66
FINANCIAL ACCOUNTING
2.11 ERRORS NOT AFFECTING THE TRIAL BALANCE
If double entry is followed when recording all transactions into the books of accounts, then the
trial balance would balance. However there are some errors that would occur while entering the
transactions but this would not affect the balancing of the trial balance.
The following are the errors that do not affect the balancing of the trial balance
(i) Errors of Omission
S T U D Y
T E X T
This is an error that occurs when a transaction is completely omitted from the books of accounts.
For example if we bought a motor van shs Sh 90000 cash and we neither debit the motor vehicle
account nor credit the cash account the trial balance would not be affected and it would still
balance.
(ii) Errors of Principle
This occurs when we enter a transaction in the wrong class of account, but still observe double
entry. For example we purchase furniture (ixed asset) worth shs Sh 200000 for cash. We debit
purchases account instead of debiting the furniture account and crediting the cash account. In
such an instance the trial balance would still balance.
iii) Errors of Commission
These types of errors occur when the correct amount is entered but in the wrong persns personal
account though the account is in the same class of accounts. For example sales of shs Sh 20000
sold to D. Waithaka but posted to P. Waithaka’s account in the sales ledger. The transaction
would be as follows.
Dr. P. Waithaka 20000
Cr. Sales 20000
The correct entry would have been
Dr. D Waithaka 20000
Cr sales 20000
ACCOUNTING PROCEDURES AND TECHNIQUES
67
To correct such an error, the following entry will be passed in the books.
Dr. D. Waithaka 20000
CR. D Waithaka 20000
This is just a reversing transaction that transfers the amount from P. Waithaka to the correct
account of D Waithaka. You will note that the sales entry is no affected by the reversal and since
both P. Waithaka and D. Waithaka are in the sales ledger, the trial balance would still balance.
iv) Compensating Errors
Dr. Purchases returns Sh 2000
Cr. Sales returns Sh 2000
Another example would be overstating purchases as well as sales by the same amount;
overstating both sides of a particular account by the same amount e.t.c.
v) Errors of Original Entry
These are errors that occur when the original igure is incorrect and yet double entry is still observed
using the incorrect igure. The igure cold eithercould either be understated or overstated.
>>> Example
Purchases worth shs20000 Sh 20000 recorded as Sh 200000 in both the purchase account and
the cash account.
The incorrect entry would appear as follows
Dr. Purchases 200000
Cr. Cash/ bank200000
S T U D Y
To correct the above error
T E X T
These are errors that cancel out each other e.g. an error that overstates booth the credits and
the debits or an error that understates both the debits and the credits by the same amount. E.g.
if If the purchases returns was overstated by shsSh2000 2000 and the sales return overstated
by Sh 2000. Since the purchases returns appear on the credit side and the sales returns appear
on the debit side of the trial balance, the two would cancel out each other.
68
FINANCIAL ACCOUNTING
The correct entry should have been
Dr. Purchases account 20000
CR. Cash/bank 20000
To correct the error, we make the following entries.
Dr. Cash at bank Sh 180000
Cr. Sh180000
vi) Complete Reversal of Entries
This is an error that occurs when the correct amount is posted in the correct account but in the
wrong side of the account. For Example: if we sold goods on credit to D. Kameme worth shsSh
100000 the wrong entry would appear as follows.
Dr. Sales 100000
S T U D Y
T E X T
Cr. P. Kameme 100000
The correct entry would have been
Dr P Kameme 200000
Cr. Sales 200000
Correcting the above error is done in two stages:
•
Canceling the initial recording
•
Recording the correct entry.
This is done as follows:
Dr P. Kameme 100000
Cr. Sales 100000
(To cancel the initial entry in the accounts)
Dr. P Kameme shsSh 100000
Cr. Sales 100000
(To Record the correct entry)
ACCOUNTING PROCEDURES AND TECHNIQUES
69
The accounts would appear as follows:
P. Kameme a/c
2006
Sh
2006
01/1
01/1
Sales (to cancel)
100000
01/1
Sales (to enter correct entry)
100000
Sh
Sales(to cancel)
100000
Sales
Sh
27/5
Sh
/5
P. Kameme a/c(to cancel)
100000
P. Kameme a/c(to enter
100000
This is a special type of an error of original entry. It occurs when the wrong sequence of individual
characters in a igure is entered. Example For exampleentering, entering shsS870 h 870 as shsS
h 780. itIt is an error that is very dificult to trace, however if it occurs only on one side of the entry
then the difference will be a number divisible by nine and hence easier to trace.
>>> Illustration
Cash sales Sh 9260 entered as Sh 6290 on both cash book and sales ledger
The wrong entry would appear as follows.
Dr. Cash Sh 6290
Cr. Sales Sh 6290
The correct entry would have been
Dr. Cash Sh 9260
Cr. Sales Sh 9260
S T U D Y
Vi) Transposition errors
T E X T
correct entry)
70
FINANCIAL ACCOUNTING
To correct the above entry
Dr. Cash (9260 - 6290) Sh 2970
Cr. Sales (9260 - 6290) Sh 2970
>>> Exercise: 1
Show the journal entries required to correct the following errors. Entries; narratives must
be shown.
1)
2)
3)
4)
5)
6)
S T U D Y
T E X T
7)
8)
Ccommissions received shs Sh 44000 had been credited to rent receivable account
bank Bank charges shsSh 3850 had been debited to rent account
Ccompletely omitted from the books of account is a payment of sundry expenses by
cheque shsSh 1150
purchase Purchase of ixtures Sh 23700 had been entered in purchases account
Rreturn inwards of shs Sh 41650 had been entered on the debit side of the return
outwards account
aA loan from R. Simiyu shsSh25000 had 25000 had been entered on the credit side
of capital account
Loan interest shs Sh 2500 had been debited in the premises account
Goods taken for own use shs1250had worth Sh 1250 had been debited to purchases
account and credited to drawings account.
Suggested solution:
1)
Dr Rent received account
44000
Cr. Commissions received
44000
(Correction of an error where commission received was credited to rent received)
2)
Dr. bank charges a/c
3850
Cr. rent a/c
3850
(To correct wrong debit of bank charges in the rent account
3)
Dr. Sundry expenses a/c
1150
Cr. Bank a/c
1150
(To record omitted payment of sundry expenses)
4)
Dr. Fixtures 23700
Cr. Purchases a/c 23700
(To correct error of principle where purchases of ixed assets is treated as purchase)
ACCOUNTING PROCEDURES AND TECHNIQUES
5)
71
Dr. Return outwards 41650
Cr. Return inwards 41650
(To correct entry return inwards in the debit of return outwards a/c)
6)
Dr Capital account 25000
Cr. R. Simiyu a/c 25000
(To correctly record loan received from R. Simiyu)
7)
Dr Loan interest a/c 2500
Cr. Premises a/c 2500
(To correctly record interest on loan)
Dr drawingsDrawings a/c (1250 x 2) 2500
2500
Note
We double the igures when correcting errors of complete reversal of entries like that in (8)
above. This is because if an amount was debited instead of being credited in the same account,
a single credit entry would just cancel the initial debit. However the second credit entry will now
enter the required credit entry. Instead of showing the two credit entries separately, the amount
involved is doubled and a single entry made but with a double value made.
2.12 SUSPENSE ACCOUNT
Due to poor double entry or other errors not falling in the category described above, the trial
balance may fail to balance. In most cases the error causing this may take long to be identiied.
Before then the accountant is allowed to open up an account known as the suspense account.
To this account, he assigns the balance equal to the difference between the credit and debit
sides of the trial balance to ensure that the trial balance balances. For example if the debit side
exceeds the credit side by Sh100000, suspense account will be assigned a credit balance equal
to Sh100000 thus balancing the trial balance. Later on when the cause of the error is identiied,
journal entries are passed against the suspense account till its balance is cleared thus eliminating
it from the books.
Basically all errors affecting the balancing of the trial balance necessitate the creation of a
suspense account. A few of such are discussed below.
T E X T
Cr. Purchases a/c (1250x2)
S T U D Y
8)
72
FINANCIAL ACCOUNTING
Failure to enter a corresponding entry for every debit or credit entry made
Making a wrong corresponding entry e.g. if cash sales of shs Sh 20000 are made and a debit
entry correctly made in the cash book. However the sales account is credited with Sh Sh2000.
This means that the credit side of the trial balance will be understated by Sh 18000. A suspense
account will thus be created and assigned accredit balance of Sh 18000 to make the trial balance
“appear’ balanced awaiting identiication and correct of the error.
Once the error is identiied then journal entries need to be passed topassed to remove the
suspense account as follows:
Dr. Suspense account 18000
Cr. Sales account
18000
(To correct the error understating the credit balances of the trial balance)
S T U D Y
T E X T
Students are however cautioned that the suspense account should not be used to balance the
trial balance unless the examiner speciically asks the students to do so.
2.13 VALUATION OF INVENTORY
There are three basis approaches to valuing inventory that are allowed by GAAP –
(a) First-in, First-out (FIFO):
Under FIFO, the cost of goods sold is based upon the cost of material bought earliest in the
period, while the cost of inventory is based upon the cost of material bought later in the year. This
results in inventory being valued close to current replacement cost. During periods of inlation, the
use of FIFO will result in the lowest estimate of cost of goods sold among the three approaches,
and the highest net income.
(b) Last-in, First-out (LIFO):
Under LIFO, the cost of goods sold is based upon the cost of material bought towards the end
of the period, resulting in costs that closely approximate current costs. The inventory, however,
is valued on the basis of the cost of materials bought earlier in the year. During periods of
inlation, the use of LIFO will result in the highest estimate of cost of goods sold among the three
approaches, and the lowest net income.
ACCOUNTING PROCEDURES AND TECHNIQUES
73
(c) Weighted Average:
Under the weighted average approach, both inventory and the cost of goods sold are based
upon the average cost of all units bought during the period. When inventory turns over rapidly
this approach will more closely resemble FIFO than LIFO.
Firms often adopt the LIFO approach for the tax beneits during periods of high inlation, and
studies indicate that irms with the following characteristics are more likely to adopt LIFO - rising
prices for raw materials and labor, more variable inventory growth, an absence of other tax loss
carry forwards, and large size. When irms switch from FIFO to LIFO in valuing inventory, there
is likely to be a drop in net income and a concurrent increase in cash lows (because of the tax
savings). The reverse will apply when irms switch from LIFO to FIFO.
S T U D Y
T E X T
Given the income and cash low effects of inventory valuation methods, it is often dificult to
compare irms that use different methods. There is, however, one way of adjusting for these
differences. Firms that choose to use the LIFO approach to value inventories have to specify in
a footnote the difference in inventory valuation between FIFO and LIFO, and this difference is
termed the LIFO reserve. This can be used to adjust the beginning and ending inventories, and
consequently the cost of goods sold, and to restate income based upon FIFO valuation.
74
FINANCIAL ACCOUNTING
CHAPTER SUMMARY
Book keeping deined as the process of recording business transactions (data) in a systematic
manner. It can also be deined as that part of accounting that is concerned with recording data.
The accounting process can be perceived as a cycle which starts with the occurrence of a
transaction recording of the transaction and inally the preparation of the inal statements which
report on results of all the transactions that occur during the year and the position of the business
as at the last date of the accounting period.
S T U D Y
T E X T
The commonly used books of original entry are:•
•
•
•
•
•
Purchases Journal.
Sales journal.
Return outwards journal.
Return inwards journal.
Cashbook.
General journal.
When all transactions have been entered into the speciic journals, they are then entered into
their respective accounts in the ledger in a process referred to as posting.
ACCOUNTING PROCEDURES AND TECHNIQUES
75
CHAPTER QUIZ
T E X T
What is the difference between the cash book and the petty cash book?
Which is the source document for petty cash book?
Name the reason for making a journal entry?
Which ledger is used to keep individual customer accounts?
What is the purpose of the trial balance?
S T U D Y
1.
2.
3.
4.
5.
76
FINANCIAL ACCOUNTING
ANSWERS TO CHAPTER QUIZ
1.
2.
3.
4.
5.
The cash book records amounts paid into out of the bank account. The petty cash book
records payment of small amounts of cash.
Receipt and claim forms.
Most commonly to correct an error.
Receivables ledger.
To test the accuracy of the double entry bookkeeping.
PAST PAPER ANALYSIS
S T U D Y
T E X T
12/06, 6/06, 12/04, 6/04, 6/03, 12/02
EXAM TYPE QUESTIONS
QUESTION 1
Skates drew up the following trial balance as at 30 September 2002. You are to draft the trading
and statement of comprehensive income for the year to end 30 September 2002 and a statement
of inancial position as at that date.
ACCOUNTING PROCEDURES AND TECHNIQUES
Dr
Cr
Sh
Caital
rai ngs
8 2, 000
Cash
311, 500
Cash in
han
ebtors
1,230,000
37, 000
Stoc 30 Setemb er 2001
Motor van
equiment
2,3 1,000
10, 000
625, 000
1,30 ,000
,210,000
Returns inars
55,000
Cai age inars
21,500
Returns
outars
Cai age
Motor
outars
exenses
Rent
30,700
3 0,
00
163, 000
2 7, 000
Telehone charges
Wages
an salaries
Insurance
ffice
T E X T
hases
exenses
Su nry
0,500
1,281,000
,200
137, 700
exenses
28, 00
17,153,200
17,153,200
S T U D Y
Sales
Pu
5,500
2 ,500
Creitors
ffice
Sh
3,0
at ban
77
78
FINANCIAL ACCOUNTING
QUESTION 2
A three-column cashbook is to be written up from the following details, balanced off, and the
relevant discount accounts in the general ledger shown.
19x8
Mar
1
Balances brought forward: Cash Sh .230; Bank Sh .4,756.
3
Discounts: R Burton Sh 140; E Taylor Sh. 220; R Harris Sh 800.
“
4
Paid rent by cheque Sh.120.
“
8
We paid the following accounts by cheque in each case deducting a 21⁄2 per
“
“
2
6
The following paid their accounts by cheque, in each case deducting 5 percent
J Cotton lent us Sh 1,000 paying by cheque.
cent cash discount: N Black Sh 360; P Towers Sh 480; C Rowse Sh 300.
“
“
10
12
Paid motor expenses in cash Sh 44.
H Hankins pays his account of Sh. 77, by cheque Sh 74, deducting Sh 3
S T U D Y
T E X T
cash discount.
“
“
15
18
Paid wages in cash Sh. 160.
The following paid their accounts by cheque, in each case deducting 5 per cent
cash discount: C Winston Sh 260; R Wilson & Son Sh 340; H Winter Sh 460.
“
21
Cash withdrawn from the bank Sh 350 for business use.
“
24
Cash Drawings Sh 120.
“
25
“
29
“
31
Paid T Briers his account of Sh 140, by cash Sh 133, having deducted
Sh 7 cash discount.
Bought ixtures paying by cheque Sh 650.
Received commission by cheque Sh 88.
79
S
T
S T
T SU
U TD
DUY
YD Y
T E
E TX
X ET
TX T
CHAPTER THREE
PREPARATION OF FINANCIAL
STATEMENTS
S T U D Y
T E X T
80
FINANCIAL ACCOUNTING
81
CHAPTER THREE
PREPARATION OF FINANCIAL STATEMENTS
OBJECTIVES
•
•
•
•
Understand and prepare statement of comprehensive income (income statement) and
statement of inancial position using the various formats
Make accounts’ adjustments for prepayments and accruals, discounts and account for
bad debts
Calculate depreciation chargeable using straight-line method, reducing balance method,
sum of years digit method, Depletion units method and units of output method and
account for it
Prepare a property, plant and equipment schedule
Deine the various statement of inancial position items; assets, liabilities and capital
INTRODUCTION
Fast forward - A statement of comprehensive income is the sales (revenue) for the business
less all the expenses incurred to generate the sales. The end product is ether proit or loss.
The main objective of every business organization is to make proit. However, in some instances,
businesses end up make losses. It is important to measure the performance of a business
organization in certain predeined periods to asses whether the business organization is making
proits or losses.
DEFINITION OF KEY TERMS
•
Statement of comprehensive income- formerly known as the income statement
basically represents the performance of a business. It is the sales (revenue) for the
business less all the expenses incurred to generate the sales. The end product is ether
proit or loss.
•
Statement of inancial position- formerly known as the balance sheet is a statement
which shows the assets of a business at a given point in time and the claim thereof
against the assets, the claims can either by the capital injected or liabilities to third
parties
S T U D Y
•
T E X T
After studying the following chapter you should be able to:
82
FINANCIAL ACCOUNTING
EXAM CONTEXT
This is a very important chapter and as you will see in past paper analysis at the end of this
chapter, it has been tested in every seating since June 2003.
INDUSTRY CONTEXT
S T U D Y
T E X T
All stakeholders of any entity will be very keen on the inancial statements because of the
simple fact that they shows to what extent the company made or lost money and its asset base.
Stakeholders will assess entity abilities by how much proit is reported in comparison to previous
years and rival entities to make mainly investment Decisions.
The main reasons for preparing the statement of comprehensive
income are:
i)
To compare the actual proit to the expected proits
ii)
For planning purposes i.e. to identify areas that need attention in future
iii)
To obtain funds from lenders based on one’s proitability
iv)
To inform prospective owners on the performance
v)
In computation of taxes to ensure that the correct amount is remitted to the tax
authorities.
PREPARATION OF FINANCIAL STATEMENTS
3.1
83
FORMAT OF THE STATEMENT OF COMPREHENSIVE
INCOME
A statement of comprehensive income basically represents the performance of a business. It is
the sales (revenue) for the business less all the expenses incurred to generate the sales. The
end product is ether proit or loss.
A statement of comprehensive income can be prepared in two formats; the vertical or horizontal
format. The horizontal format is however the most common one.
HORIZONTAL FORMAT
Xyz Statement of comprehensive income
less return outwards
net purchases
goods available for sale
less closing stock
cost of sales
gross proit
add other incomes
discount received
proit on disposal of assets
income from investments
other incomes e.g. interest received from bank
less expenses
administrative expenses
operating expenses
selling and distribution expenses
total expenses
net proit for the period
Sh
Xxx
S T U D Y
Sales
less return inwards
net sales
less cost of sales
opening stock
add purchases
carriage inwards
Sh
xx
(xx)
T E X T
For the period ended xxxxxx
xx
xx
xx
xx
(xx)
xx
xxx
(xx)
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
xx
xx
xx
(xxx)
Xxx
84
FINANCIAL ACCOUNTING
Notes
(i)
Carriage inwards forms part of the cost of sales. It represents the amount paid for the
transportation of goods into the business premises before they are sold.
(ii) Carriage outwards is a business expense. It represents the amount paid to transport
goods to the customer’s premises.
(iii) All costs incurred to put the goods into saleable condition form part of the cost of sales
e.g. cost of transportation to the warehouse, insurance while goods are on transit to the
warehouse, warehouse expenses.
(iv) Incase the net sales are less than cost of sales the difference is referred to as gross
loss.
(v) If the expenses are more than the gross proit the difference is referred to as net loss
(vi) Other incomes represent that portion of revenues not directly related to the main
business e.g. commissions, rent receivable e.tc
S T U D Y
T E X T
>>> Illustration 1
Given the following trial balance for BCD Ltd draw up a statement of comprehensive income
BCD Ltd for the year ended 31 December 2007
Sh
Sales
Purchases
Opening stock
Rent
Lighting expenses
General expenses
Fixture and ittings
Debtors
Creditors
Bank
Cash
Drawings
Capital
Commissions
Returns inwards
Return outwards
129,000
16,000
42,000
8,000
17,000
4,800
148,000
14,300
2,800
14,000
4,600
400,500
The closing stock as at 31st march 2007 was Sh 9000
Sh
205,500
37,000
128,000
24,000
6,000
400,500
PREPARATION OF FINANCIAL STATEMENTS
85
Suggested solution
BCD Company Ltd
Statement of comprehensive income
For the year ended 31 December 2007.
Sh
Net proits
(130000)
61900
24000
85900
42000
8000
17000
(67000)
18900
Notes
•
•
Closing stock is not found in the trial balance since there is no double entry in the stock.
The closing balance of the stock is obtained by actual counting of the stock at hand at
the end o the accounting period.
Opening businesses will have no opening stock, however for the subsequent periods
there may be opening stock. The closing stock at the end of one period becomes the
opening stock for the next period.
Sometimes items of income and expenses will not be expressly stated as income or expense. For
instance the commissions, rents e.t.c may not be indicated whether they are incomes expenses.
It will be upon you to identify whether it’s an income or an expense identifying the column under
which it falls. All income accounts have credit balances while the expenses have debit balances
in the trial balance. The same case applies to the returns inwards and outwards. Return inwards
which represent an increase in stock have a debit balance while return outwards have a credit
balance.
T E X T
Gross proit
Other incomes
Commission received
Total income
Expenses
Rent
Lighting expenses
General expenses
16000
129000
(6000)
139000
(9000)
S T U D Y
Sales
Less: return inwards
Net sales
Cost of sales
Opening stock
Add: purchases
Less: return outwards
Cost of goods available for sale
Less: closing stock
Sh
205500
(4600)
200900
86
FINANCIAL ACCOUNTING
3.2
ACCOUNTS ADJUSTMENTS
Before preparing a statement of comprehensive income for a particular period, there are
adjustments that are made to particular accounts to ensure the proit and loss statement shows
accurate results of proits and losses. These accounts include:
S T U D Y
T E X T
i)
ii)
iii)
iv)
v)
vi)
vii)
viii)
Prepayments accounts
Accruals accounts
Bad and doubtful debts accounts
Depreciation account
Discounts allowed accounts
Discounts received accounts
Commissions received accounts
Commissions paid account
PREPAYMENTS AND ACCRUAL ACCOUNTS
(I) PREPAYMENTS ACCOUNTS
These could either be prepaid incomes or prepaid expenses.
Prepaid expenses
For some businesses expenses may tend to be prepaid in nature. An example would be insurance
premiums or, rent and rates. This are usually paid for one year upfront. However the period for
which the expenses relate may not match with the accounting year. Take for instance a business
that commences operations on 1st January 2006. Beginning 1st April 2006 they pay for insurance
for one year. The premiums would thus cover the period 1st April2006 to 31st march2007. On the
other hand the business accounting period would cover from 1st January 2006 to 31st December
2006. Therefore by the end of the accounting period, premiums with respect to three months
would not have been expensed, yet they have already been paid for. This is what results to a
prepayment which is an asset to the business at the end of the accounting period.
Example:
Jumba Agro vet started business on 1st January 2005. On 1st May 2006 they acquired a go down
next to BOC Gas Suppliers. They immediately insured it against ire paying insurance premiums
Sh1200000 to cover the go down for the next one year.
Show the entries as they would appear in the accounts on 31st December2006.
PREPARATION OF FINANCIAL STATEMENTS
87
Bank a/c
2005
h
2005
1/5
h
insurance
1200000
Insurance a/c
2005
1/5
h
Bank
2005
1200000
h
31/12
Prepaid insurance
400000
31/12
P&L a/c
800000
Pre paid insurance
h
Insurance a/c
400000
The prepaid amount is arrived at as follows:
May – Dec = 8 months
Jan – April = 4 months
8 x 1200000 = Sh 800000 ……………..expenses for the year
12
4 x 1200000 = Sh 400000 ………………prepaid amount
12
The prepaid amount shown in the prepaid insurance account represents an asset that will be
under the current assets in the balance sheet. It represents the amount of money (current asset)
that could still be lying in the bank had the company opted to pay for 8 months only to the close
of the year i.e. May – December
(i)
prepaid income
Prepaid income on the other hand represents income already received yet the services or the
goods have not been delivered e.g. for a business dealing in renting out houses and they receive
rent for consequent periods then a certain portion of this rent at the end of the accounting period
will relate to the next accounting period. Such incomes received in advance form a liability to the
business since they remain indebted to deliver the service already paid for. It appears as under
the current liabilities section of the balance sheet.
S T U D Y
T E X T
31/12
h
88
FINANCIAL ACCOUNTING
Example
On 1st April 2006 Josmumo enterprise received rent for 12 months amounting to Sh 144000 for
a part of a building they had rented out since it was not being used. The rent money received
covered the period beginning 1st April 2006 and ending 31st March 2007. Show this transaction in
the books of Josmumo as at 31st December 2006 i.e. of inancial year
Solution:
On receiving cash
Dr. Cash/Bank Sh 144000
Cr. Rent income Sh 144000
At close of accounting period
Dr. rent income a/c 36000
Cash/bank
200
1/4
Sh
ent
inc oe
Sh
144000
S T U D Y
T E X T
Cr. Rent received in advance a/c 36000
Rent income
2007
30/5
Sh
ent
in advance
3 000
Sh
/5
Bank/ cash
144000
Rent received in advance a/c
Sh
Sh
/5
ent
inc oe
3 000
The balance in the rent received in advance account is posted in the statement of inancial
position as a short-term liability. This is simply because the money for the period 30th March has
been paid yet the services have not been delivered. This is in line with the revenue recognition
principle. The balance of Sh 36000would thereby be in the incoming years of income
PREPARATION OF FINANCIAL STATEMENTS
89
In the subsequent accounting period:
Dr. Rent received I advance a/c
Cr. Rent receivable (income) account
II) ACCRUAL ACCOUNTS
Accrual accounts affect both the incomes and expenses.
>>> Illustration
JKT Enterprises prepares its inancial statements for periods ending 31st December. On 31 st
December 2005 a bill for electricity amounting to Sh 27000 had been received by the accountant.
Other bills received for the period amounted to Sh 210000. These had been paid for as at 31st
December 2005.
Required:
Show the necessary entries with regard to electricity:
i)
Dr. Electricity expense a/c 210000
Cr. Cash/ bank 210000
(To record electricity expense for the year paid for)
ii)
Dr. Electricity expense 27000
Cr. Accrued electricity for the period
(To record accrued electricity expense for the period.)
You will note that there are two debits to the electricity expense account. This represents the total
of electricity expense incurred in the year. The entries will appear as follows in their respective
accounts:
S T U D Y
Accrued expenses represent that portion of expenses that has been used but has not been paid
for. It is common for established businesses to consume services irst and pay for them later, say
after 30 days e.g. motor vehicle repairs. On the other hand there are expenses that cannot be
determined in advance until they have been consumed e.g. electricity telephone e.t.c. A common
occurrence with such accounts is that by the time the inal statements are being prepared, a
portion of the expenses will not have been paid most likely because the bills have not been
received. These expenses need to be recognized in the period in which they were incurred.
This will be in line with the matching concept which states that expenses should matched with
income.
T E X T
Accrued expenses
90
FINANCIAL ACCOUNTING
Electricity expense a/c
Sh
Cash/bank/
210000
Accrued electricity
Sh
/5
P&L
237000
27000
Cash/bank
Sh
Sh
Electricity expense
210000
Accrued electricity expense
Sh
S T U D Y
T E X T
Balance c/d
27000
Sh
/5
Electricity expense
27000
Balance b/d
27000
The total of Sh 237,000 will be taken to the expenses account in the statement of comprehensive
income
The balance b/d in the accrued expenses account is taken as a current liability to the balance
sheet. Once the payment is made in the following period
Dr. accrued expenses a/c 27000
Cr. Cash/ bank 27000
This would then eliminate the accrued account (the liability will then have been paid off)
Accrued expense a/c
200
05/01
Cash/bank
Sh
200
27000
01/01
Sh
Balance b/d
27000
Cash/bank
Sh
200
05/01
Sh
Accrued expenses
27000
PREPARATION OF FINANCIAL STATEMENTS
91
Accrued income
It is usual phenomenon for business enterprises to sell goods on credit. This would then mean
that at the close of the inancial period, there are some amounts yet to be cleared by the customer.
For the main line of business this income is captured in the books of original entry i.e. general
ledger sales ledger. Therefore revenue owing for direct sales is already in the books (in the sales
account in the general ledger and the debtors account in the sales ledger) and no further entries
are needed.
However, there may be other types of revenues for the business all of which have not been
received at the end of the inancial period. Such would include rent and commission receivable
e.t.c. Since they do not form major part of the sales they are usually not systematically recorded
as the other business sales. There is need therefore at the end of the period to recognize them.
Rent received (income)
2006
Sh
2006
Sh
bank
ent
220000
receivable
20000
Bank/cash
Sh
ent
received
Sh
220000
Rent receivable
Sh
ent
inc me
20000
Sh
S T U D Y
Due to empty spaces in the warehouse XYZ Ltd Decided to sublet it at a monthly fee of Sh20000.
The payments were supposed to be made at the end of every month on 31st December when
XYZ was preparing its inancial statements. The rent for December was still outstanding. Adjust
for it in the books.
T E X T
>>> Example
92
FINANCIAL ACCOUNTING
3.3
DISCOUNT RECEIVED AND ALLOWED
Fast forward - Discounts given to encourage bulk purchasing are referred to as trade discounts
DISCOUNT ALLOWED
Represent an amount allowed to a customer on his sales amount usually given as an incentive
for bulk purchasing or for prompt payment.
S T U D Y
T E X T
Discount given to encourage bulk purchasing are referred to as trade discounts. Usually they do
not feature in the books of account since the invoiced amount is usually net of such discount and
the invoice itself is the source document for sales.
The discount given to encourage prompt payment is referred to as the cash discount. After a
credit purchase the customer is offered a discount at a certain rate if he /she pays within given
period e.g. a 2% discount if payment is made 10 days from the invoice date otherwise the credit
period may be 30days.
Such terms will be indicated as 2/10 net 30
The sale is recorded at the invoice value and if the customer qualiies for the discount it is
recognized in such a way as to reduce the customer’s account by the amount of the discount.
Discount allowed is deducted from the sales to get a net igure of sales in the trading account.
The conventional way of treating discounts in the P& L is to view them as inance charges. This
then makes discount allowed fall under operating expense and discount received as income.
The entries for discount allowed as follows:
Dr. Discount allowed
Cr. Debtors account
>>> Illustration
Mr. Jomens bought goods from us worth Sh100000. The terms were 5/15 net 30 days. Seven
days later he settled his account fully. Show the following entries in the ledger accounts.
PREPARATION OF FINANCIAL STATEMENTS
93
Solution:
The terms 5/15 net 30 days will be interpreted as follows:
Jomenes qualiies for a 5% cash discount if he pays within 15 days. The maximum credit period
is 30 days.
The discount then would be
5/100 x 100000 = Sh 5000
if he pays within 15 days
Since he paid d within 7 days he qualiies for the cash discount.
The entries for the discount allowed would be as follows:
Dr, discounts allowed a/c
5000
Cr. Jomenes a/c
5000
T E X T
If he paid on the 16th day he would have to settle the whole amounted Sh 100000 and would not
qualify for the discount.
The journal entries for the transaction as a whole would be:
S T U D Y
Dr. Jomenes account Sh 100000
Cr. Sales account Sh 100000
When he pays on the 7th day:
Dr. cash/Bank Sh 95000
Cr. Discounts allowed 5000
Cr. Jomenes account100000
The ledger account would appear as follows.
Sales a/c
Sh
Balance b/d
100000
Sh
Jomenes
100000
Cash a/c
Sh
Jomenes a/c
100000
Sh
Balance c/d
95000
94
FINANCIAL ACCOUNTING
Jomenes a/c
Sh
Sales
Sh
100000
Discount allowed
5000
Cash
95000
100000
100000
The balance in the discount allowed account is transferred to the statement of comprehensive
income as an expense.
S T U D Y
T E X T
Discounts received
The discount received represents cash discount received by a business when it pays its suppliers
for the amounts outstanding. They are given as incentive to encourage prompt payment of the
amounts owing to the suppliers. It is important to note that discount received do not represent a
Decrease in the purchase price of goods but rather as an income to the business. This is the most
conventional way of treating discount received. Some scholars however argue that discounts
received and allowed are a reduction to the purchase price and the selling price respectively.
The entries in the books of accounts are as follows:
Dr. Creditor accounts
Cr. Discounts received
>>> Illustration
Mabati enterprises ole Mlango suppliers Sh200000. it pays on time to qualify for a 10% cash
discount. Show how the entries would appear in the books of Mabati enterprises.
Amount of Discount = 200000 x 10/100 = Sh20000
The entry would appear as follows:
Dr. Mlango Enterprises
20,000
Cr. Discount received
20,000.
For a deeper understanding of the double-entry, all the entries since we bought the supplies to
the time full settlement was made on purchases would be:
Dr. Purchase’s a/c 200000
Cr. Mlango enterprises 200000
PREPARATION OF FINANCIAL STATEMENTS
95
On payment:
Dr. Mlango enterprises 200000
Cr. Cash/bank 180000
Cr. Discount received 20000
The accounts would appear as follows.
rchases
a/c
Sh
200000
200000
enerrses a/c
Sh
Cas/ban
180000
Discount ecei ed
20000
Sh
hases
200000
200000
200000
Cash/ban
Sh
!ent
income
20000
Sh
Mlango entepises
180000
"scon rece#e$
Sh
!ent
income
20000
Sh
Mlango entepises
20000
The balance in the discounts received account is taken to the statement of comprehensive income
as an income under other incomes.
T E X T
lano
Balance c/d
S T U D Y
Mlango entepises
Sh
96
FINANCIAL ACCOUNTING
PROVISION FOR BAD AND DOUBTFUL DEBTS
A large portion of sales for most of the business organizations are made on credit. The business
thus undertakes the risk that some of the sales may not end up being paid. Indeed some of the
sales are not paid for and such are referred to as bad debts.
They are a common business expense as long as credit sales exist. Usually they occur in the
following situations:
(i)
(ii)
(iii)
(iv)
Bankruptcy of a business enterprise
Debtor refusing to pay a particular invoice
Debtor refusing to pay part of the invoice.
After they have been outstanding for a long period of time as learnt from experience.
When it occurs a bad debt is treated as follows:
Dr. bad debts expense (to recognize an expense)
S T U D Y
T E X T
Cr. Debtors account (to clear the asset; debtor)
PROVISION FOR BAD DEBT
When it is certain that some amounts will not be collected, it is prudent to clear the debt from
the books and charge as an expense in the P& L account. However it’s hard to tell before hand
that a certain debt will not be paid. For this reason most business make an estimation of the
amount of debts that will not be paid in a given accounting period, and charge it as an expense
in the statement of comprehensive income of that accounting period This amount will usually be
very subjective sometimes based only on past experiences which might not necessarily recur
in future. The amount set aside to cater for future debts that might never be paid for in future is
referred to as the provision for bad debts. It’s also known as provision for doubtful debts.
Provision for bad debts should be recognized while preparing the inancial statements. It serves
two main purposes:
(i)
To match expenses and revenues by recognizing the part of a debt that will never be
paid for
(ii)
To recognize a igure of debtors that is close to the realizable amount of debtors as
possible.
PREPARATION OF FINANCIAL STATEMENTS
97
Decrease in provisions
As indicated earlier, the provision for bad debts is a very subjective estimate. As such it’s prone
to constant adjustments due changing circumstances under which it is made. For example:
Assume from the books of Mali Raha Stores the total amount of debtors for the previous period
was Sh 400000. Assume further that Mali Raha had estimated that out of this amount 50000 i.e.
(12.5%of the debtor’s balance) would not be bad debt. However after a careful consideration
they discover that this igure was overestimated. It’s agreed that a igure 10% of the balance of
debtors is what should be maintained as provision for bad debts. In the current period the balance
of debtors is Sh 450000.
The entries as they would appear in the books. Maintain a rate of 10% for provision of bad debts
would be:
The reduction in provision for is treated as income in under “other incomes” in the statement of
comprehensive income
The entries would be:
Dr. Provision for doubtful debts (50000 - 45000) 5000
Cr. Proit & loss account/statement of comprehensive income. 5000
To record reduction in provision for doubtful debts.
The accounts would appear as follows:
Provision for bad debts account
Sh
Sh
Statement of comprehensive
5000
Balance b/d
50000
income
45000
Balance c/d
______
______
50000
50000
S T U D Y
This would be the amount of the provision for the year. However in the previous year, Sh 50000had
already been provided for. Therefore instead of increase in the provision this time w reduce it
to Sh45000 as this is the balance that should appear in the closing balance of the provision
account.
T E X T
Provision for bad debts = 450000x 10/100 = Sh 45000
98
FINANCIAL ACCOUNTING
Extract of the Statement of comprehensive income for the current period
Sales
xxx
Less: cost of sales
(xx)
Gross proit
xxx
Other incomes:
Reduction in provision for depreciation
5000
Less
Expenses
Net proit
xxx
xxx
In the balance sheet, the balance of debtors should be net of provision of doubtful debts carried
forward.
T E X T
Statement of inancial position Extract As At ending date of the current period
S T U D Y
For the example earlier given:
Current assets:
Non current assets
xxx
Debtors
450000
Less Provision for bad debts
(45000)
(ii)
During the following accounting period the statement of inancial position would be as
follows (assume the case of increase in provision).
Increase in provision for bad debts
A company may ind it necessary to increase the amount asset aside for bad debts to a igure
higher than that provided for in the previous period. In such a case the amount by which the
provision is increased is treated as an expense in the statement of comprehensive income for
the period in which the increase is made.
The accounting entries would be:
Dr. Expense (an expense account in the P&L)
Cr. Provision for bad debts
PREPARATION OF FINANCIAL STATEMENTS
99
From the example of Mali Raha Store above, if the provision for bad debts was to be increased
from 50000 for the previous period to 55000 for the current period the increase of 5000 would be
accounted for as follows:
Dr. P&L account 5000
Cr. Provision for bad debts account 5000.
(To record the increase in the provision for bad debts by 5000)
Provision for a/c
55000
Balance b/d
50000
Profit and loss a/c
5000
______
______
55000
55000
Extract of the Statement of comprehensive income for the current period
Sales
xxx
Less: cost of sales
(xx)
Gross proit
xxx
Less expense:
Increase in provision for bad debts
Net proit
(5000)
xxx
The balance of debtors in the statement of inancial position would now be reported net of 55000
i.e. the new provision for bad debts. This is as shown in the following statement of inancial
position extract:
Statement of inancial position Extract As At ending date of the current period
Non current assets
xxx
Current assets:
Debtors
450000
Less Provision for bad debts
(55000)
T E X T
Balance c/d
Sh
S T U D Y
Sh
100
FINANCIAL ACCOUNTING
Points to note
(i)
The statement of inancial position igure for debtors is given as:
Gross igure less provision C/F or
Gross igure less doubtful debts as a percentage of debtors.
(ii)
The igure of provision of bad debts in the P&L should be balance of doubtful debts
carried forward less provision provided for in the previous year. i.e. the increase or
Decrease in the provision .
(iii) Incase during the year there were some bad debts written-off then the provision for bad
debts should be provided for after deducting such bad debts.
(iv) In cases of examination questions, if bad debts appear on the trial balance then the
igure of debtors in the statement of inancial position is net of such debts and should
not be adjusted further. This is so because of the rule of double entry. For bad debts to
appear in the trial balance the entries that have been passed are as follows:
Dr. bad debts a/c xxx
Cr. Debtors a/c xxxx
S T U D Y
T E X T
If however the bad debts appear in the additional information, then the following entries
need to be passed in the books to adjust the debtors igure:
Dr. bad debts
Cr. Debtors
After these the provision for bad debts is adjusted as usual.
3.4
DEPRECIATION
Fast forward - There are two major methods of charging depreciation:
•
•
straight line method
reducing balance method
Depreciation can be deined as that part of the original cost of ixed assets that are consumed
during its period of use in the business.
Depreciation can also be deined as the loss in the value due to of usage of an asset. Almost all
business assets have a given time duration for their existence and as they are used/ consumed
their value keeps on Declining.
PREPARATION OF FINANCIAL STATEMENTS
101
CAUSES OF DEPRECIATION
Physical deterioration
Economic factors
Time
Depletion
i)
Physical deterioration
Almost all assets are affected by wear and tear. Example motor vehicle, furniture used
in the ofice, e.t.c.
ii)
Economic factors
These are factors that are not related to the physical condition of an asset but are
largely due to economic conditions e.g.
a) Obsolescence: this is when an asset becomes out of date. For example, the
typewriters are fast becoming obsolete and being replaced with computers. Thus
even if it were new, it would be overtaken by events. Technological advancements
are the largest contributors to the obsolescence.
b) Inadequacy: this happens when an asset can no longer be used mainly due to
growth of size of a business. For example a start up business in the transportation
industry is using a small pick-up and as it grows it may ind large tracks more
economical and convenient.
iii)
Time
Time is also a key contributor to depreciation in the sense that even if an asset was left
unused; its value would fall considerably with passage of time.
iv)
Depletion
This is the case of exhaustion of natural resources with time. As extraction of such
assets continues they become of lesser value e.g. mines oil ields, quarries, e.t.c
DEPRECIATION AS AN EXPENSE
Depreciation is an operating expense in the business that relects the loss in value of an asset
during a given accounting period. Depreciation is recognized in line with such concepts as
matching concept whereby we match revenues of a particular period with the expenses incurred
in the same period.
Methods of charging depreciation
There are two major methods of charging depreciation;
i)
Straight line method
ii)
Reducing balance method
S T U D Y
i)
ii)
iii)
iv)
T E X T
Depreciation caused by the factors discussed below;
102
FINANCIAL ACCOUNTING
Other methods are:
•
•
•
•
Revaluation method
Depletion unit method
Machine hours method
Sum of years digit method
Depreciation is arrived at by simply taking the total cost of the assets less any amounts received
during its disposal. The resulting igure ids known as the residue value.
The depreciation will be the difference between the cost and the amount received. The problem
arises when an asset is used for more than one accounting period. We therefore can only estimate
how much to allocate to each accounting period. The methods used are:
Straight line method
This method assumes that an asset is depreciated uniformly over its useful life.
S T U D Y
T E X T
Useful life in this case is taken in form of years.
Depreciation is calculated as follows:
Depreciation = Cost estimated disposal value (residue value)
number of expected years of usage
The depreciation could also be calculated as a percentage of total cost. The percentage is
calculated as follows.
1
x 100
No. of expected years of usage
For example if the number of useful years is ive years, we can calculate the percentage of
depreciation each year as
1 x 100 = 20%
5
Therefore each year our calculation would be as follows:
(Cost-estimated residue value) x 20%
PREPARATION OF FINANCIAL STATEMENTS
103
>>> Example 1
X ltd bought furniture worth Sh 200000. The furniture was expected to last 8 years and would be
disposed off for Sh 40000 at the end of the eighth year. Show how depreciation to be allocated in
each of the accounting period for the 8 years using the straight line method of depreciation.
Depreciation = 200000 - 40000 = Sh 20000
8
Each year the depreciation charge would be Sh 20,000
If an asset is estimated not to have any residue value at the end of its life time, depreciation
equals to the total cost of the asset divided by its life time.
Depreciation = 200000 - 0 = Sh 25000
8
Reducing balance method
In this method, the depreciation is charged at a ixed percentage over the remaining cost of an
asset. It’s a method conveniently for assets that are assumed to have a higher depreciation
rate over their irst few years of use. More so, advocates of this method argue that the cost of
running an asset is not depreciation only but also costs to do with maintenance and repairs.
They argue that during the irst year, costs of repairs and maintenance will be minimal and hence
charge minimal depreciation during the irst years to match the low repairs and maintenance
cost. During later years, depreciation charge will be minimal whereas repairs and maintenance
will have increased signiicantly. This will therefore tend to give a uniform cost of running an
asset. However this is not always the case.
S T U D Y
If the furniture in example 1 had a nil residue value, depreciation allocated each year would be:
T E X T
>>> Example 2
104
FINANCIAL ACCOUNTING
>>> Example 3
An equipment is bought for Sh300000 and depreciation is to be charged at 25% on the reducing
balance method show the calculation of depreciation charge for the irst years of use.
1st year 300000 x 25% = 75000
2nd year (300000 - 75000)*25% = 56250
3rd year (225000 - 56250)*25% = 42187.5
You will realize that:
During the irst year depreciation was higher then becoming smaller and smaller as the years go
by.
S T U D Y
T E X T
To obtain the percentage for reducing balance we use the following formulae:
r=1-n s
c
Where:
r
Is the rate of depreciation to be applied
n
is the number of useful life
s
is the net residue value (this must be a signiicant igure or else the answer will be
absurd)
c
s the cost of the asset
Machine-hour method
Under this method, the asset is depreciated on the basis of the number of hours operated during
a speciic accounting period. Compared to the number of hours expected to run during its life
time.
>>> Example 4
XYZ Co. Ltd bought a machine for Sh 120000. The machine is expected to run for Sh 20000
during its life time and have a scrap value (residue value) of Sh 20000. During its irst year of
operation it was run for 5000 hours. Calculate the depreciation charge for that year.
PREPARATION OF FINANCIAL STATEMENTS
105
no. of hours run during the year
× depreciable amount = shs25000
total expected running hours
(during its life time)
depreciation =
Depreciable amount = cost – scrap (residue value)
= 120000 - 20000 = Sh 100000
depreciation =
50000
× 100000 = shs25000
20000
Alternatively we can get the depreciation amount per hour run and then multiply by the number of
running hours during accounting period.
depreciation amount per hour =
Total during the accounting period will be
Charge per hour X no of hours
= 5 X 5000
= Sh 25000
Sum of all years digit method
Under this method, a higher amount of depreciation is charged during the initial year of service
and a lower amount as the asset becomes old. The depreciation charge is calculated by taking
the sum of years the asset is expected to last and then comparing it with the number of years the
asset is expected to last during an accounting period as follows. For an asset expected to last 3
years it will be:
1st year expected to last
3 years
2nd year expected to last
2 years
3rd year expected to last
1 year
Sum
6 years
no . of no.
years
to last to
as last
at this
irst: year:
of expected
years expected
as year
at this
year x depreciable
duringduring
e amount amount
first year
depreciabl
sum ofsum
allof
years
expected
tolast
all years expected to last
: 3 x depreciable amount
3
: depreciable amount
6
6
T E X T
100000
= shs5 per hour
20000
S T U D Y
=
depreciable amount
total expected no. of running hours
106
FINANCIAL ACCOUNTING
>>> Illustration
Calculate the depreciation amount per year for a machine costing Sh225000
And expected to last for ive years with no residue value
Depreciable amount = cost – residue value
= 225000- 0
=225000
Sum of years 1st = 5yrs
2nd = 4yrs
3rd = 3yrs
4th = 2yrs
5th = 1yrs
Sum 5yrs
S T U D Y
T E X T
1st =
5 x 225000 = 75000
15
2nd =
4 x 225000 = 60000
15
3rd =
3 x 225000 = 45000
15
4th =
2 x 225000 = 30000
15
5th =
1 x 225000 = 15000
15
225000
Depletion unit method
This is a method mainly used in the extraction of minerals e.g. quarry, oil ields e.t.c.
Depreciation is calculated as:
Cost of the asset
expected total content in units
x no. of units taken in the period
PREPARATION OF FINANCIAL STATEMENTS
107
>>> Illustration
An oil ield is acquired for $1000000 and expected to produce 100000 litres of crude oil .during
the irst year a total of 20000 litres were extracted. Calculate the depreciation charge during the
year using the depletion unit method.
Depreciation = $1000000 x 20000 = $200000
10000
Units of output method
>>> Illustration
A machine is expected to produce 100,000 toys. During a particular accounting
Period ended 31st December 2007, a total of 10000 units were produced. The machine had cost
Sh180000 and was expected to have a salvage value of Sh 30000
Calculate depreciation as at 31st December 2007
depreciation =
10,000
× (180,000 − 30,000) = shs15,000
100,000
Revaluation method
This is a method used to calculate depreciation on small parts of equipment and tools in an
organization. An organization will ind it appropriate to group the tools together and have a single
igure and then revalue them at the end of the accounting period. For example, in the construction
industry, one would group together screw drivers, hammers mattocks, spades and all other small
equipments and then revalue after a certain period of time to arrive at the depreciation during a
speciic accounting period.
S T U D Y
Depreciation = No. of units during a particular period
x depreciable amount
total no. of units expected during life time
T E X T
Under this method, depreciation is measured in terms of expected output of an asset during its
lifetime compared to the output during a particular accounting period.
108
FINANCIAL ACCOUNTING
Depreciation will be
Cost/valuation as at the beginning of the year
xxx
Add
Purchases during the year
xxx
Less
Valuation as at the end of the year
(xxx)
Depreciation for the year
xxxx
S T U D Y
T E X T
3.5
ACCOUNTING FOR DEPRECIATION
So far we have looked at ways of calculating depreciation for assets. Of more importance is to
know how to account for this depreciation so as to give a igure that relects the true and fair view
of the state of affairs of a given company as to its P&L and balance sheet.
As earlier mentioned, depreciation is a business expense, and it’s accounted for in the same way
as all the expenses.
The two most commonly used methods of depreciation are straight line method (also known as
the cost approach) and the reducing balance method.
Once we have computed he depreciation amount, we account for it as follows in the books of
account:
Dr. Deprecation expense account xxxx
Cr. Provision for/accumulated depreciation account
We could also directly debit the P&L account while the credit is made in the provisions/accumulated
depreciation account.
Depreciation can be calculated pro-rata. This means with regard to the time of acquisition.
However it’s upon an enterprise to setup a policy that best its them e.g. charge a depreciation
pro-rata to time charge a full depreciation for the year on the year of acquisition, charge no
depreciation during the year of disposal.
>>> Example
XYZ Company bought equipment for Sh500000 on 1st April 2002. The company’s policy is to
charge depreciation using the straight line method pro-rata to time, what would be the depreciation
charged for the three consecutive years ending 31st December. Enter the above in the books of
accounts.
PREPARATION OF FINANCIAL STATEMENTS
109
(Depreciation rate 20, nil residue value)
1st year 31st Dec 2002 =
2nd year 31st Dec 2003 =
3rd year 31st Dec 2004 =
20
9
× 500000 ×
= 75000
100
12
20
100
20
100
× 500000 = 100000
× 500000 = 100000
2002: Dr. Equipment depreciation account 75000
Cr. Accumulated depreciation account 75000
2003: Dr. Equipment depreciation account 100000
Cr. Accumulated depreciation account 100000
Cr. Accumulated depreciation account 100000
Depreciation expense a/c
2002
Sh
Accumulated
2002
75000
Sh
P &L account
75000
P &L account
100000
P &L account
100000
depreciation
2003
2003
Accumulated
100000
depreciation
2004
2004
Accumulated
depreciation
100000
S T U D Y
T E X T
2004: Dr. Equipment depreciation account 100000
11 0
FINANCIAL ACCOUNTING
Accumulated depreciation a/c
2002
Sh
Balance c/d
2002
75000
Sh
Depreciation
for
the
75000
year
2003
2003
Balance c/d
175000
Balance b/d
Depreciation
75000
for
the
100000
year
175000
2004
175000
2004
Balance c/d
275000
Balance b/d
Depreciation
175000
for
the
100000
year
S T U D Y
T E X T
275000
Assuming the depreciation rate is reducing balance at rate of 2005
1st year 31st Dec 2002 = 9 x 500000 x 20 = 75000
12
100
2nd year 31st Dec 2003 = 20 x (500000 - 75000) = 85000
100
3rd year 31st Dec 2004 = 20 x (425000 - 85000) = 68000
100
Entries:
2002: Dr. Equipment depreciation account 75000
Cr. Accumulated depreciation account 75000
2003: Dr. Equipment depreciation account 85000
Cr. Accumulated depreciation account 85000
2004: Dr. Equipment depreciation account 68000
Cr. Accumulated depreciation account 68000
275000
PREPARATION OF FINANCIAL STATEMENTS
111
Depreciation expense a/c
2002
Sh
Accumulated depreciation
2002
75000
2003
Sh
P &L account
75000
P &L account
85000
P &L account
68000
2003
Accumulated depreciation
85000
2004
2004
Accumulated depreciation
68000
Accumulated depreciation a/c
2002
Sh
Balance c/d
2002
75000
Depreciation for the year
75000
Balance b/d
75000
Depreciation for the year
85000
Balance c/d
160000
160000
2004
160000
2004
Balance c/d
228000
Balance b/d
160000
Depreciation for the year
68000
228000
228000
At the end of the period, the amount of the equipment to be shown in the balance sheet net of
accumulated depreciation as at that time.
The extracts would be as follows:
2002 (straight line)
Equipment at cost
500000
Less: accumulated depreciation
75000
425000
2003
Equipment at cost
500000
Less: accumulated depreciation
175000
325000
2004
Equipment at cost
500000
Less: accumulated depreciation
275000
225000
T E X T
2003
S T U D Y
2003
Sh
11 2
FINANCIAL ACCOUNTING
Using Reducing balance method
2002
Equipment at cost
500000
Less: accumulated depreciation
75000
425000
2003
Equipment at cost
500000
Less: accumulated depreciation
160000
340000
S T U D Y
T E X T
2004
Equipment at cost
500000
Less: accumulated depreciation
228000
272000
For each asset bought by a business enterprise, an account for depreciation is opened. This is
because different assets are depreciated with different accounting policies as well as different
rates.
3.6
ACQUISITION OF AN ASSET
When we acquire a new asset in the business, there are various entries to be recorded. We irst
open an asset account by the following entry:
Dr. Assets account
Cr. cash/bank/creditor depending on purchases xxxx
At the end of an accounting period we will need to account for the deprecation so that we match
revenues against expenditure. We therefore open a depreciation account for the assets as
follows:
Dr. Asset depreciation account xxx
Cr. Accumulated depreciation account xxxx
If an assets is to be depreciated pro-rata to time, then we take the proportion of time the asset
was in existence and calculate depreciation with the predetermined policy (straight line/reducing
balance e.t.c) and at the pre determined rate.
PREPARATION OF FINANCIAL STATEMENTS
3.7
11 3
DISPOSAL OF AN ASSET
Disposal of assets in a business is a common occurrence. Assets could be disposed by a business
due to any of the following reasons:
i)
ii)
iii)
iv)
The asset is no longer required
The asset has been scrapped off
The asset capacity is no longer suficient and needs to be replaced
The asset’s useful life has come to an end.
When we dispose an asset the following will be of interest:
The following entries will be entered:
i)
Transfer the cost of the asset from the asset cost account to the asset disposal account
i.e.
Dr. Disposal account
Cr. Asset cost account
ii)
Transfer the accumulated depreciation from the accumulated depreciation account to
the asset disposal account
Dr. accumulated depreciation account
Cr. Asset disposal account
iii)
Record the amount of sale of the asset in the books of accounts
Dr. cash/bank (if sold on cash)
Dr. Debtor (if sold on credit)
Cr. Disposal account
iv)
Transfer the balancing amount of the disposal account to the P&L account as either
gainer loss
If the disposal account has a credit balance, this is a gain on disposal.
If the asset disposal account has a debit balance then this is a loss. in other words if the “beneits”
from the assets(accumulated depreciation and disposal value) exceed the initial cost of the asset
being disposed then the asset is said to be disposed at a gain. The opposite of this results in a
loss on disposal.
T E X T
ii)
iii)
To remove the cost of the assets from the books of accounts since its no longer an
asset to the business.
Remove all the accumulated depreciation earlier provided for the asset.
Determine whether the asset was disposed at a gain or a loss.
S T U D Y
i)
11 4
FINANCIAL ACCOUNTING
The asset disposal account will be as follows:
Disposal of asset a/c
Sh
Sh
Assets (cost value)
X%%
Accumulated depreciation
X%%
Gain on disposal(balance)
X%%
&ash/debtor
X%%
Loss on disposal(balance)
X%%
%%%%
X%%%
>>> Example
S T U D Y
T E X T
JJ traders bought a van in Jan 2003 for Sh 200,000. The policy of the company is to depreciate
motor vehicles at a rate of 25% using straight line method. The motor van was sold in March
2006 at a cash price of Sh 60,000 (full depreciation is charged on the year of acquisition and non
on the year of disposal)
Show the entries of depreciation expense, accumulated depreciation since 2003 as well as the
entries at the time of disposal in 2003.
S'l)*+'n
-'t'. /eh+cle
2005
de0.ec+ at+'n a/c
Sh
Accumulated depreciation
2005
50000
2007
Sh
P &L account
50000
P &L account
50000
P &L account
50000
P &L account
0
2007
Accumulated depreciation
50000
200:
200:
Accumulated depreciation
50000
200;
200;
Accumulated depreciation
0
PREPARATION OF FINANCIAL STATEMENTS
<cc=>=lated
200H
de?@ecBatBFG a/c
Sh
Balance c/d
11 5
200H
50000
200J
Sh
Depreciation for the year
50000
Balance b/d
50000
Depreciation for the year
50000
200J
Balance c/d
100000
100000
200K
100000
200K
Balance c/d
150000
Balance b/d
100000
Depreciation for the year
50000
150000
200L
150000
200L
Balance c/d
150000
Balance b/d
150000
Depreciation for the year
0
150000
Disposal of asset a/c
Sh
Sh
Motor van (cost value)
200000
Accumulated depreciation
150000
Gain on disposal
10000
Cash
60000
210000
210000
A special case where accounting for depreciation change in estimate
If we change the rate at which we were charging depreciation for an asset then we’ll need to
adjust for depreciation as follows.:
i)
Calculate for depreciation so far provided for
ii)
Cost of asset less this provided depreciation so far
iii)
The balance be provided for uniformly at the new rate
!
!
S T U D Y
T E X T
150000
11 6
FINANCIAL ACCOUNTING
>>> Example
If an asset is bought for Sh 100000, expected to be depreciated at a rate of 20% with no residue
value, and after being in use for 3 years the rate is changed to 10%, we would make the following
adjustments:
Depreciation so far = 100000 x 20 x 3 = 60000
100
Balance not depreciated = 100000 - 60000 = 40000
Depreciation over the remaining useful life = 10 x 40000 = 4000
100
S T U D Y
T E X T
3.8
CHANGE IN DEPRECIATION POLICY
When we change the depreciation policy, we need to adjust for the over/under charge previously
shown in the books of account (P&L and balance sheet) supposing it was an undercharge.
We calculate the correct amount of depreciation for the previous periods and then deduct the
difference in the retained earnings (proits) account. The other entry is passed in the credit of the
accumulated depreciation account as follows:
Dr. Retained proits (earnings)
Cr. Accumulated depreciation account
(With the amount of the under charge)
However if it was an overcharge, the entry would be:
Dr. accumulated deprecation account
Cr retained earnings account
(With the amount of the over charge)
>>> Illustration
Mkulima processing plant has a piece of equipment bought in 2003 at a cost Sh 200000.
Previously the equipment was being depreciated at a rate of 20% per annum on cost. However
in 2005 the management decided to change the policy after discovering that the appropriate rate
would have been reducing balance. Show the entries for adjustment that would appear in the
books of Mkulima processing plant in 2005.
PREPARATION OF FINANCIAL STATEMENTS
11 7
Notes
There will be entries:
i)
ii)
Recognize depreciation for the year
Adjusting for the amount of the under/over charge
Determination of the amount of under (over charge)
Year
Amount (cost)
Straight line
method
Reducing
balance method
Under
(overcharge)
2003
2000000
400000
400000
0
2004
2000000
400000
320000
(80000)
2005
2000000
400000
256000
(148000)
Dr. retained earnings
Dr. prepaid tax
Cr. accumulated depreciation
i.e. in the case of an under charge.
3.9
i)
ii)
iii)
iii)
REASONS FOR PROVIDING FOR DEPRECIATION
Matching: depreciation is an ordinary expense resulting from use of an asset to generate
revenue during a given period. Matching this expense against the revenue helps to
determine the real proit.
To determine inancial position
Depreciation should be deducted to present the present economic value so that a fair
inancial position of the irm is reached at.
Asset replacement
Providing for depreciation helps to check cash outlows in the form of drawings, taxes,
dividends, e.t.c which lead to accumulation of resources required later for replacement
of the asset. This is because the expense is provided for yet the cash does not low out
of the business allowing for cash to be used later.
Reservation of equity if we do not provide for depreciation there would be a risk of
distributing non-distributable funds and hence consuming our capital due to overstated
proits.
S T U D Y
The entries would be:
T E X T
However in advanced accounting levels you will realize that not all undercharge is to be deducted
from the proits. An element of tax should be recognized. This is because during the year of
undercharge, the company was being taxed on the “excess proits” and hence we should have
a pre paid tax asset.
11 8
FINANCIAL ACCOUNTING
3.10 PROPERTY, PLANT, AND EQUIPMENT SCHEDULE
This was formerly referred to as the ixed asset movement schedule. It is a tabular representation
of the movement of tangible assets cost within a given accounting period the schedule also
shows movement of depreciation for all tangible assets within the given accounting period IAS
16 property plant and equipment requires that the schedule be shown in the published account
of companies.
The format is as shown below:
Property plant and equipment schedule
Cost/QalUatioY
Z[eehol \
Leasehol \
]^aYt
aY\ Zi`tU[ e
p[ ope[ty
p[ ope[ty
_achiYe[y
total
cU[YitU[e
aY\
fittiYes
Short
lease
lease
Sh
Sh
Sh
Sh
Sh
Sh
1{ |alaYce as at}/}/~}
2{ Additions
{ evaluation gains
{ eclassi ications
)
5{ isposal
)
)
)
)
)
)
6{ Balance as at 1/12/01
``
``
`
``
``
``
8{ Balance at 1/1/01
{ Change or the ear
10 evaluation
)
)
)
)
)
11 Eliminated on disposal
)
)
)
)
)
12 Balance as at 1/12/01
)
)
)
)
)
1 N{{ V as at 1/1/01(18)
1 N{{ V as at 1/12/01(612)
`
`
`
`
`
`
S T U D Y
T E X T
hong
Dep[eciatioY/a_o[tiatioY
PREPARATION OF FINANCIAL STATEMENTS
11 9
>>> Example
Depreciation rate
Furniture
900000
300000
12.5
Trucks
3525000
1470000
25
Plant and machinery
7387500
4462500
10
Land
2775000
-
Nil
Buildings
2925000
292500
2.5
The following additional information was available:
1.
2.
3.
4.
5.
6.
It is the company’s policy to write off costs of the assets using the above percentage on
cost.
Depreciation is fully charged on the year of acquisition and non in the year of disposal.
A three year old machine acquired for Sh 187500 was sold for Sh 15750.
It has been decided to adjust and charge depreciation on buildings at 4 %
A used delivery van purchased three years ago for Sh 248250 was traded in during the
year at the value of 157500 in part exchange of the new delivery truck costing
Sh 450000
Land, buildings and machinery were acquired for Sh 1350000 from a company that went
out of business. At the time of acquisition Sh. 90000 was paid to have the assets by a
professional qualiied valuer. The revaluation indicated the following market value:
Land
Buildings
Machinery
Required:
Sh
900000
600000
300000
Reschedule of movement of ixed assets as requested by the chief accountant for inclusion in the
company’s accounts for the year ended 30 April 2000.
(10 marks)
S T U D Y
Acquisition cost Accumulated depreciation
T E X T
KASNEB adopted May 2000 question 3
a) Briely explain the nature and the purpose of accounting for depreciation (5 marks)
b) The chief accountant of Jitegemea Ltd has encountered dificulties while accounting
for ixed assets and the related depreciation in the company’s draft accounts for the
year ended 30th April 2000. He has decDecided to seek your professional advice and
presented the following balances of ixed assets as at 1 st may1999.
120
FINANCIAL ACCOUNTING
Solution:
a) Covered in the text
b)
Cost/valuation
Land
Plant
buildings
machinery
and
and Fixture
furniture
Total
and
fittings
Sh
Sh
Sh
Sh
15. Balance as at1/5/99
13087500
900000
3225000
17512500
16. Additions
1350000
-
450000
1800000
17. Revaluation gains
450000
-
-
450000
18. Disposal
(187500)
-
(248250)
(435750)
19. Balance as at 30/4/2000
14700000
900000
3726750
19326750
T E X T
21. Balance at 1/5/99
4755000
300000
1470000
6525000
22. Change for the year
1066500
112500
931687.5
2110687.5
23. Eliminated on disposal
(37500)
-
(124125)
(161625)
S T U D Y
machinery
24. Balance as at 30/4/2000
5784000
412500
2277562.5
8474062.5
25. N.B.V as at 1/5/99
8332500
600000
2055000
10987500
26. N.B.V as at 30/4/2000
8916000
487500
1449187.5
10852687.8
20. Depreciation/amortization
Workings:
Depreciation on furniture = 900000 x 12.5% = 112500
Motor vehicle =
cost
3525000
Add
450000
3726750 x 25 % = 931 687.5
Buildings
= (292500 + 600000) x 4% = 141000
At 2.5 % = 2925000 x 2.5 % x 4 = 292500
4%
= 292500 x 4% x 4
= 468000
175500
PREPARATION OF FINANCIAL STATEMENTS
121
Machinery cost C/F + additions – disposals = balance x 10%
73787500 + 300000 - (187500) = 7500000x 10%
= 750000
3.11 THE STATEMENT OF FINANCIAL POSITION
Fast forward - a statement of inancial position is based on the fundamental business equation
i.e. Assets = Capital + Liabilities A = C + L
If all double entry rules have been followed the statement of inancial position should balance
.A statement of inancial position is based on the fundamental business equation i.e. Assets
=capital + liabilities A=C+L
A statement of inancial position is divided into two:
The debit side and the credit side .the debit side represent the business assets while the credit
side represents liabilities and capital.
The main categories in balance sheet will be as follows
1. ASSETS
Fast forward - Assets can be classiied as current, non-current or ictitious assets.
These are economic resources created by past activities and are capable of bringing economic
beneits to the irm in future .assets can be identiied by:
i)
Have economic value i.e. can be measured in money terms
ii)
Ability to generate income, goods and services in the future
iii)
Generated by past activities but not dependent on future activities.
S T U D Y
The statement of inancial position can be deined as a statement which shows the assets of a
business at a given point in time and the claim thereof against the assets .The claims can either
be by the capital injected or liabilities to third parties.
T E X T
So far we have covered a majority of the expense items that are typical of any business
organization. We have also come across a trial balance and realized that all the entries in the
trial balance are used in one of two places i.e. the statement of comprehensive income and the
statement of inancial position.
122
FINANCIAL ACCOUNTING
Assets can be classiied as either:
a)
b)
c)
Non-Current (Long Term) Assets
These are assets expected to bring economic beneits to the irm in more than one
accounting period. They can either be tangible or intangible. Tangible non-current
assets include land motor vehicles, equipment, and computers e.t.c
Intangible assets include goodwill, patents, copy rights, trademark. Intangible assets
have the ability to make revenues for a business. If someone owns exclusive copyrights
over a given music item then the copy right ownership is an asset to such a business
even though not touchable.
Current Assets
These are assets that are expected to be consumed by an organization within a period
not exceeding one accounting period. The beneits from such assets is felt within one
accounting period e.g. stock, cash at bank or cash in hand, prepayments, debtors,
short-term investments e.t.c.
Current assets are also referred to as loating assets
Fictitious Assets: discounts on issue of shares, formation expense of a company.
S T U D Y
T E X T
2. LIABILITIES
These are inancial obligations arising from past agreements activity which is expected to be paid
or redeemed in future accounting periods
Liabilities can either be
a)
b)
c)
Current Liabilities
These are debts arising from ordinary trade activities and expected to be settled within
the next accounting period out current assets. Examples would include trade creditors,
accrued expenses, bank overdraft, and bills of exchange payable, unpaid
Non-Current Liabilities
These are inancial obligations the irm has undertaken to redeem or settle over a
period exceeding one accounting period. These liabilities arise from events outside the
ordinary trading activities. Non-current liabilities include bank loans, debentures, longterm bonds payable, long-term leases.
Contingent liabilities
These are liabilities whose timing and amount depend on the occurrence of an event in
the future. Examples include damages that could be suffered due to law suits in future
or pending in the courts. These liabilities are not recorded in the books unless the
amount and timing are clearly certain.
3. CAPITAL/EQUITY
This represents the amount contributed by owners of the business. Capital is usually a residue
after all other claims. For different business organizations capital could be referring to the
following:
•
•
Preference share capital
Ordinary share capital
PREPARATION OF FINANCIAL STATEMENTS
123
The format of the statement of inancial position
Xyz company Ltd
Statement of inancial position as at xxxxx
Sh
Cost
land and buildings
plant and equipment
less accumulated depreciation
ixtures, furniture and ittings
less accumulated depreciation
motor vehicles
less accumulated depreciation
Total non-current assets
xx
xxx
(xxx)
xxx
xxx
xxx
xxx
xxx
xxx
prepayments
short term investments
cash at bank
cash in hand
total current assets
less Current Liabilities
bank overdraft
creditors
accruals
T E X T
Current Assets
stock
debtors
less provision for doubtful debts
Sh
Sh
Accumulated
NBV
Depreciation
xxx
xx
(xx)
xx
xx
(xx)
xx
xx
(xx)
xx
xxx
S T U D Y
Non-current assets
xxx
xxx
xxx
(xxx)
net current assets
total assets
Capital
Add: net proit
Less: drawings
Non-current liabilities
loans
xxx
yyyyy
Xx
Xx_____
xx
(xx)____
xxx
xx
yyyy
124
FINANCIAL ACCOUNTING
Notes:
A statement of inancial position should present in an ordinary way so that users can make
deductions they would want to without taking too much time. Therefore statements of inancial
position of similar organization are prepared in the same way so as to enhance understandability
and compatibility.
Most organizations present their statements of inancial position with increasing order of liquidity
(also known as permanency). This means that for assets we start with those assets that are
less likely to be converted into cash in the near future and ending with those that are readily
convertible into cash e.g. for current assets:
Ø
Ø
Ø
Ø
CHAPTER SUMMARY
T E X T
S T U D Y
Stock
Debtors
Cash at bank
Cash in hand
Statement of comprehensive income- formerly known as the income statement basically
represents the performance of a business. It is the sales (revenue) for the business less all the
expenses incurred to generate the sales. The end product is ether proit or loss.
The main reasons for preparing the statement of comprehensive income are:
i)
ii)
iii)
iv)
v)
To compare the actual proit to the expected proits
For planning purposes i.e. to identify areas that need attention in future
To obtain funds from lenders based on one’s proitability
To inform prospective owners on the performance
In computation of taxes to ensure that the correct amount is remitted to the tax
authorities.
Statement of inancial position - formerly known as the balance sheet is a statement which
shows the assets of a business at a given point in time and the claim thereof against the assets,
the claims can either by the capital injected or liabilities to third parties
PREPARATION OF FINANCIAL STATEMENTS
125
CHAPTER QUIZ
T E X T
4.
5.
6.
What are the main reasons for preparing the statement of comprehensive income?
How is the cost of goods sold calculated?
What expense (accrual or prepayment) is charged against proit for a period even
though it has not yet been paid or invoiced?
If a receivable allowance is increased, what is the effect on the income statement?
What are the causes of depreciation?
What are the two major methods of charging depreciation?
S T U D Y
1.
2.
3.
126
FINANCIAL ACCOUNTING
ANSWERS TO CHAPTER QUIZ
-
2.
Opening inventory + purchases – closing inventory.
3.
Accrued expenses.
4.
Increase in expenses.
5.
-
Physical deterioration.
Economic factors.
Time.
Depletion.
6.
-
Straight line method.
Reducing balance method
S T U D Y
T E X T
1.
To compare the actual proit to the expected proits
For planning purposes i.e. to identify areas that need attention in future
To obtain funds from lenders based on one’s proitability
To inform prospective owners on the performance
In computation of taxes to ensure that the correct amount is remitted to the tax
authorities.
PAST PAPER ANALYSIS
12/7, 6/07, 12/06, 6/06, 12/05, 6/05, 12/04, 6/04, 12/03, 6/03
PREPARATION OF FINANCIAL STATEMENTS
127
EXAM TYPE QUESTION
Question 1
Mary
Statement of inancial position as at 31 December 2000
Sh.
Premises
Debtors
Cash at bank
Cash in hand
Current liabilities:
Creditors
Capital
Non Current Liabilities:
Loan from bank
37,000.00
11,000.00
10,000.00
5,000.00
3,000.00
T E X T
Stock
25,000.00
12,000.00
Plant
Current Assets:
Sh.
29,000.00
(12,000.00)
17,000.00
S T U D Y
Non Current Assets
54,000.00
34,000.00
20,000.00
54,000.00
During the year to 31 December 2001 the following total transactions occurred:
a) Mary withdrew a total of Sh.10,000.00 in cash
b) Stock in trade was bought, all on credit, for Sh.34,000.00
c) Sales were made totaling 60,000.00 of stock in trade which had cost Sh.37,000.00. Of
these sales Sh.51,000.00 were on credit and Sh.9,000.00 for cash.
d) A total of Sh.16,000.00 was drawn from the bank in cash to the cash till.
e) Electricity for the year paid by cheque totaled Sh.2,000.00
f)
Rates for the year paid by cheque totaled Sh.1,000.00
g) Wages for the year all paid cash totaled KSh.10,000.00
h) Sundry expenses all paid in cash totaled Sh.2,000.00
i)
Creditors were paid a total of Sh.36,000.00 all by cheque
j)
Debtors paid a total of Sh.54,000.00 all in cheques.
k) The bank charged interest on the loan deducting Sh.3,000.00.
Required:
Prepare a revised statement of inancial position.
(20 marks)
S T U D Y
T E X T
128
FINANCIAL ACCOUNTING
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129
CHAPTER FOUR
SOLE PROPRIETORSHIP
S T U D Y
T E X T
130
FINANCIAL ACCOUNTING
131
CHAPTER FOUR
SOLE PROPRIETORSHIP
OBJECTIVES
After studying this chapter, you should be able to:
•
•
•
Deine a sole trader and explain the advantages and disadvantages of sole proprietorship
form of business
Prepare inancial statements for sole proprietor form of business
Understand the operation of nonproit making organizations and operate
Sole traders can be said to be business people who start their own enterprises and run them for
themselves with the aim of making a proit. Sole proprietorship could be run family members or
even the owner and one or two employees. They are the most common businesses that you will
come across in any economic set-up. They include butcheries, kiosks, some wholesale shops
and supermarkets, e.t.c the main reasons why they are so common include:
i)
ii)
iii)
They are easy to set up (e.g. you only need a trading license)
They require less capital to put up
They are easy to manage
Advantages
i)
ii)
iii)
iv)
v)
They is ease in Decision making since only one party makes the Decision
There is a personal touch with the customers
It is easy to manage
No sharing of proits
Easy to start since minimal capital is required
Disadvantages
i)
ii)
Incase of incapacitation of the sole proprietor the business can easily collapse
It is hard to raise capital
S T U D Y
Fast forward - The only unique account in the statement of inancial position of a sole proprietorship
would be the drawings account.
T E X T
INTRODUCTION
132
FINANCIAL ACCOUNTING
iii)
There is no limited liability i.e. the private property of the proprietor can be sold to cover
the debts incurred by the business.
iv)
The sole proprietor suffers losses alone
DEFINITION OF KEY TERMS
Drawings are either cash or goods withdrawn from the business by the sole proprietor for his
own use.
A Sole proprietorship is a business run by a single individual with an aim of making proit.
S T U D Y
T E X T
EXAM CONTEXT
This is a very important chapter bearing in mind sole proprietorships are the most common type
of business in the country. Expect questions from this chapter.
INDUSTRY CONTEXT
Sole proprietorships are the most common types of businesses in Kenya, in the form of kiosks,
farms and other family run businesses. This is a sector that that has largely gone without
maintaining inancial statements. Sole traders have however seen the need of maintaining
inancial statements with Kenya Revenue Authority (KRA) requiring them to ile tax returns. This
has resulted in high demand for bookkeeping.
SOLE PROPRIETORSHIP
4.1
133
FINANCIAL STATEMENTS OF A SOLE
PROPRIET0RSHIP
The main objective of most business enterprises is to make proit. However, sometimes the
business ends up making losses. For a sole proprietorship, most important inancial statements
are:
a)
b)
The statement of comprehensive income
The statement of inancial position.
Refer to the general format of the Statement of comprehensive income and the statement
of inancial position.
The only unique account in the statement of inancial position of a sole proprietorship would be
the drawings account. A drawings account is used to record both cash and goods withdrawn
from the business by the sole proprietor for his/her own use. For example a shopkeeper will take
consumables from his shop and if it is not accounted for properly, one would end up deducing
the that the business is not making proits while us the truth is that the business is proitable only
that the proits are taken away from the business in the form of the goods or cash.
When one makes a withdrawal of cash the entries will be:
Dr. Drawings account
Cr. Cash/bank account
The drawings account is shown in the statement of inancial position on the credit side. The total
of the drawings account is deducted from capital to know how much is left thereafter.
When we make a withdrawal of goods the entries are as follows:
Dr. Drawing account
Cr. purchases account
This amount of goods should be shown at cost to avoid bringing in the element of unrealized
proits in the business.
S T U D Y
Fast forward - The total of the drawings account is deducted from capital to know how much is
left thereafter.
T E X T
DRAWINGS
134
FINANCIAL ACCOUNTING
The drawings are then deducted from the net proit in the statement of inancial position as
shown in the statement of inancial position extract shown below;
Statement of inancial position Extract
Capital
Add: net proit
Less: drawings
Non-current liabilities
loans
Xx
Xx
xx
(xx)
xxx
xx
S T U D Y
T E X T
yyyy
CHAPTER SUMMARY
The main reasons why sole proprietorships are so common include:
•
•
•
They are easy to set up (e.g. you only need a trading license)
They require less capital to put up
They are easy to manage
CASE STUDY
Most businesses in Kenya are sole proprietorships. These range from small scale farmers to
jua kali trader to kiosk owners. These small businesses have been responsible for the current
boom in the country of microinance, informal banking like M-pesa and the increased attention by
established banks like Equity bank to target small bankers (commonly known as the unbaked).
SOLE PROPRIETORSHIP
135
CHAPTER QUIZ
S T U D Y
T E X T
1. Why are sole traders common?
2. What are the advantages of sole trading?
3. If an owner takes goods out of inventory for his personal use, how is this dealt
with?
136
FINANCIAL ACCOUNTING
ANSWERS TO CHAPTER QUIZ
1.
-
They are easy to set up.
They require less capital to put up.
They are easy to manage.
2.
-
There is ease in decision making since only one party makes the decision
There is a personal touch with the customers
It is easy to manage
No sharing of proits
Easy to start since minimal capital is required
3.
The amount is debited to drawings at cost.
12/06, 6/04, 12/03, 6/02, 6/01, 12/00, 6/00
S T U D Y
T E X T
PAST PAPER ANALYSIS
EXAM TYPE QUESTIONS
QUESTION 1 (December, 2006 Q 1)
Mr. Hassan Baraka retired from employment on 1 October 2005 and was paid terminal beneits
of Sh 3,000,000 He utilized Sh 2,500,000 in purchasing business premises and deposited the
balance in a new business account at Faida Bank Ltd.”
Mr. Baraka did not maintain proper books of account. However, he kept iles of statements from
suppliers, cheque counter foils and unpaid invoices for purchases made. He also maintained
a note book in which he recorded sales to customers who had credit accounts and settled their
accounts by cheque. Cash collected from sales was banked at the end of each week after payment
of certain expenses. Mr. Baraka also maintained some petty cash for ofice use. Mr. Baraka
estimates to have paid the following business expenses from his personal bank account.
SOLE PROPRIETORSHIP
137
Sh ‘000’
Rent and rates for additional apace
100
Lighting expenses
50
Stationery and postage expenses
26
An analysis of the bank statements for the year ended 30 September 2006 was as
follows:
Receipts
Account opening
Weekly bankings
Cheques from customers
Cash refunded by a supplier
Sh.’000’
Payments
500
Petty cash withdrawn
382
Suppliers for goods
3,769
10
Fixtures and ittings
Insurance for inventory
Sh.’000’
20
300
3,728
40
Bank charges
110
463
4,661
4,661
Additional information:
1.
Baraka estimates that during the year ended 30 September 2006, he utilized cash
collected from sales for the following purposes:
Wages payment
Sundry expenses payment
Drawings
2
3
4
5
6
Sh.’000’
400
50
600
Cheques received from credit customers amounting to Sh 30, 000 had not been credited
by the bank as at 30 September 2006.
Insurance paid for inventory during the year includes Sh 20,000 relating to premium for
the year ending 30 September 2007.
Petty cash balance as at 30 September 2006 was Sh 15,000 which included a post
dated cheque of Sh 5,000 drawn by Mr. Baraka’s friend in exchange for cash advanced
from petty cash.
Credit customers owed Sh 172,000 as at 30 September 2006.
As at 30 September 2006, the following were due on accounts payable:
Sh ‘000’
Suppliers
Wages
Sundry expenses
403
10
6
S T U D Y
Balance carried down
T E X T
______
138
FINANCIAL ACCOUNTING
7
Depreciation is to be provided on a straight-line basis at the following rates:
Business premises
Fixtures and ittings
8
2%
10%
The value of inventory as at 30 September 2006 was Sh 360,000.
S T U D Y
T E X T
Required:
(a) Statement of comprehensive income for the year ended 30 September 2006.
(12 Marks)
(b) Statement of inancial position as at 30 September 2006.
(8 Marks)
(Total: 20 Marks)
139
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CHAPTER FIVE
PARTNERSHIP ACCOUNTS
S T U D Y
T E X T
140
FINANCIAL ACCOUNTING
141
CHAPTER FIVE
PARTNERSHIP ACCOUNTS
OBJECTIVES
After studying the following chapter, you should be able to:
•
•
•
•
INTRODUCTION
A partnership is deined as the relationship which exists between persons carrying on a business
in common with a view of making proits.
Advantages of partnerships
Advantages over sole traders
i.
Risks are distributed over a larger number of people
ii.
There is access to addition capital
iii.
Expertise; partners bring in experience from individual ields
iv.
Easier to raise funds from external sources
Advantages over limited liability companies
i.
Easier to establish and manage because there is no compliance to the Companies Act
Rules
T E X T
•
Deine partnership and highlight the advantages and disadvantages of partnership form
of business
Prepare current account and capital accounts for partnership form of business and
distribute proits to partners through the preparation of appropriation account
Account for change in partnership agreement
Understand the concept of goodwill; characteristics and Calculation of goodwill
Account for goodwill and revaluation proit or loss
Account for asset revaluation for assets taken over by a retiring partner
S T U D Y
•
142
FINANCIAL ACCOUNTING
Disadvantages
Against sole traders
i.
ii.
iii.
Possibility of dispute among partners
Less control in the management as many people are involved
Less amount of proits distributed
Against limited liability companies
i.
ii.
iii.
Liability of partners is unlimited. They can be called to contribute personal assets incase
the business cannot meet its obligations
Comparatively dificult to raise capital
Retirement or death of a partner leads to dissolution and reformation of the irm
S T U D Y
T E X T
DEFINITION OF KEY TERMS
Relationship - a partnership has more than one person, a differentiating factor from sole
proprietorship.
Business in common - all members to a partnership have a common purpose. This means they
cannot run parallel businesses.
Proits - key to every business undertaking, partnerships aim to make proits.
EXAM CONTEXT
As emphasized in every chapter, all chapters equally important. This chapter has been frequently
examined as seen in the past paper analysis the latest being June and December sitting for 2006
and 2007.
INDUSTRY CONTEXT
Unlike sole proprietorships where most traders don’t maintain proper or any accounts in
partnerships this is very crucial. Not all partner may be part of the day to day running of the
business, they will for this reason require true and fair inancial statements prepared and audited
for the purposes of proit sharing.
PARTNERSHIP ACCOUNTS
5.1
143
PARTNERSHIP AGREEMENTS
Fast forward – In the absence of the partners’ agreement, it is presumed that:
•
•
•
•
Proits will be shared equally
There are no partners’ salaries
No interest on capital is paid
Partners are entitled to interest of 4% per annum on any loans advanced to the irm
Amount of capital invested by each partner in the business
The proit sharing ratio
The interest on capital
Salaries to partners
Limits to drawings
Interest on drawings, etc.
Some partnership agreements may also guarantee minimum share of proits for one or
more partners. What this means is that if the amount allocated by the proit sharing ratio
is lower than that stipulated, the partner would receive the guaranteed minimum share
and the remainder of the proits would be share by the other partners according to the
agreement.
In the absence of the partners’ agreement, it is presumed that:
•
•
•
•
Proits will be shared equally
There are no partners’ salaries
No interest on capital is paid
Partners are entitled to interest of 4% per annum on any loans advanced to the irm
5.2
ACCOUNTING FOR PARTNERSHIPS
Fast forward – There are two very important accounts used in partnership accounting
a)
b)
Partners current account
Capital accounts
S T U D Y
•
•
•
•
•
•
•
T E X T
A partnership is usually established through a partnership agreement in which the terms of the
partnership are set out. The agreement covers the following items:
144
FINANCIAL ACCOUNTING
Four main transactions are recorded in these important accounts. They are; division of proits,
capital investments by partners, drawings, interest on capital and interest on drawings.
CAPITAL ACCOUNT
Partners’ capital account records the initial and additional investments made by the partners into
the business. In other words it records items of long-term nature. Each partner’s contribution is
shown separately i.e. each partner has a capital account.
Capital accounts have credit balances normally
Let’s take an initial example of two partners; Abdi and Jillo, the format of capital account would
be as follows:
Capital account
Abdi
Jillo
Goodwill written off
XX
XX
Revaluation Loss
XX
XX
S T U D Y
T E X T
Balance c/d
XX
XX
Abdi
Jillo
Balance b/f
XX
XX
Additional capital
XX
XX
Gains on Revaluation
XX
XX
Goodwill
XX
XX
This is called a ixed capital account
>>> Example
Abdi and Jillo intend to start a business of selling cattle. Abdi contributes Sh 100,000 and Jillo
Sh 150,000. Record these initial investments in the relevant accounts.
Solution
Just like sole proprietorship, capital contribution is recorded thus;
Dr. Cash
Cr. Capital account (with each partner’s contribution)
Capital, Abdi
Cash 100,000
Capital, Jillo
Cash 150,000
Capital; Abdi
Capital; Jillo
Cash account
100,000
150,000
PARTNERSHIP ACCOUNTS
145
CURRENT ACCOUNTS
The current accounts records movements in partners’ earnings. Items that increase earnings to
the partners are credited and those that decrease are debited.
They normally have a credit balance, just like the capital accounts.
The format of Current accounts is as follows
Balance b/d
interest on drawings
Drawings
Abdi
xx
xx
xx
Abdi
Note that the opening and closing balances are both on the credit and debit sides. The normal
balances should be on the credit side. It is therefore not normal to have debit balances on the
partners’ current account. It may arise when a partner has overdrawn in his/her account.
T E X T
xx
xx
xx
xx
xx
Jillo
xx
xx
xx
xx
xx
Salaries
S T U D Y
Balance c/d
Current Account
Jillo
Balance b/d
xx
Interest on Capital
Salaries
Proit share
xx
Loan Interest
Balance c/d
Some partners could render services to the partnership in areas that they are competently
qualiied. For example accountancy services, legal etc. They are thus remunerated for those
services in the form of salaries.
Salaries paid to partners increase their accounts. Therefore to record salaries paid to a partner,
we:
Dr. Salary account
Cr. Partner current account
Interest on capital
This is a form of ‘reward’ to the partners for contributing capital to the business. It therefore
increases partners’ incomes.
The entry is therefore as follows:
Dr. Proit and loss appropriation account
Cr. Current account.
146
FINANCIAL ACCOUNTING
Drawings
Drawings are goods meant for the business that owners take for personal use. They are therefore
not sold nor are they relected in the closing stock. They are normally removed at cost from the
trading account into a drawings account. At the end of the year, they are transferred into the
current account by the following entry;
Dr. Current account
Cr. Drawings account
Interest on drawings
S T U D Y
T E X T
Fast forward – Drawings are like advancement to the partners in form of goods.
Interest is normally charged on Drawings. This relects an amount over and above the value of
the goods called the interest on drawings recorded thus:
Dr. Current account
Cr. Proit and loss appropriation account
Division on partnership proit
Proit from a partnership is divided among the partners in accordance with the partnership deed.
In case of no such deed, proits are shared equally as noted above.
To record partnership proits, we need to introduce a proit and loss appropriation account or
simply appropriation account.
To record proit share:
Dr. Proit and loss appropriation account
Cr. current account
Note
The capital account could either be ixed or luctuating. A ixed capital account is one that records
the long-term items alone. As the name suggests, the amounts do not change unless additional
capital is introduced by partners.
Fluctuating capital account is one where both the long-term and short-term (current account
items) items are recorded on the same account. Where luctuating capital accounts are kept,
current accounts do not exist; their items are passed onto the capital account.
The amount of the ending balance keeps on changing due to the inclusion of short-term items
hence the name luctuating account.
PARTNERSHIP ACCOUNTS
147
Note that the ixed format is highly preferred by examiners and unless told to use the luctuating
capital account, stick to the ixed capital account(s i.e. separate capital and current accounts).
The format of the luctuating capital account is as follows:
Abdi
Jillo
Drawings
xx
xx
interest on drawings
xx
xx
Balance c/d
xx
xx
Abdi
Jillo
Balance b/d
xx
xx
Additional capital
xx
xx
interest on Capital
xx
xx
salaries
xx
xx
loan interest
xx
xx
xx
xx
proit share
The end balances in a luctuating capital account keep changing even without injection of
additional capital due to the inclusion of current account items.
S T U D Y
In luctuating capital account, the current account does not exist.
T E X T
Fluctuating Capital Account
5.3
FINAL ACCOUNTS
In sole proprietorship, we learnt the two conventional inal accounts i.e. trading, statement of
comprehensive income and the balance sheet. The inanced by side of the statement of inancial
position records the partners’ capital and current accounts separately. We normally introduce
the proit and loss appropriation account or simply the appropriation account. The rest does not
change in partnerships.
APPROPRIATION ACCOUNT
Appropriation account is an extension of the statement of comprehensive income showing how
the partnership proit was shared. In arriving at the amount to be shared among the partners,
we include the four basic items discussed above; salaries to partners, interest on drawings and
interest on capital, the fourth item being the proit share.
The basic format of an appropriation account is as follows:
Let us use Abdi and Jillo again;
148
FINANCIAL ACCOUNTING
Abdi and Jillo Partnership
Proit and Loss Appropriation Account
For the period ended…
Net Proit for the year
Sh.
Add; Interest on Drawings; Abdi
XX
Jillo
XX
Sh.
XX
XX
XX
Less; Interest on Capital; Abdi
XX
Jillo
XX
(XX)
Less; Salaries; Abdi
XX
XX
Jillo
S T U D Y
T E X T
(XX)
Balance to be shared in ratio;
XX
Abdi
XX
Jillo
XX
(XX)
NIL
Note: The inal igure should be zero because the balance is fully shared among/between
the partners.
>>> Worked examples
You now know all you need to about partnership accounting.
Let us now look at some short examples:
>>> Example 1
Mogire, Waituka and Kipkorir are in partnership. Mogire does the accounting work while Waituka
offers legal services and for each earns a salary of Sh 10,000 per month. The proit or loss is
shared equally. The proit for the month was Sh 110,000.
Show the relevant accounts for the partnership:
PARTNERSHIP ACCOUNTS
149
Current Account
Mogire
Balance
c/d
Waituka
40,000
Kipkorir
40,000
40,000
30,000
40,000
30,000
Salary
Proit
Share
balance
b/d
Mogire
10,000
Waituka
30,000
10,000
Kipkorir
40,000
30,000
40,000
30,000
30,000
40,000
40,000 30,000
The appropriation account will be
MOGIRE, WAITUKA AND KIPKORIR PARTNERSHIP
PROFIT AND LOSS APPROPRIATION ACCOUNT
Mogire
Waituka
proit to be shared
Proit share
Mogire
Waituka
Kipkorir
10,000
10,000
(20,000)
90,000
30,000
30,000
30,000
(90,000)
NIL
>>> Example 2
Assume in the above example that a clause in the partnership deed guaranteed a minimum proit
to Mogire of Sh 35,000, show the new set of accounts.
Solution
In our discussion above, we noted that some partnership agreements could guarantee one or
more of the partners a minimum proit share beyond which his/hers share cant fall. In this example,
Mogire’s share can’t go below Sh 35,000. The remaining will be shared equally between Waituka
and Kipkorir as follows:
T E X T
less salaries
110,000
S T U D Y
Net proit for the month
FOR THE MONTH ENDED…
150
FINANCIAL ACCOUNTING
Current Account
Mogire
Balance c/d
45,000
45,000
Waituka
37,500
37,500
Kipkorir
27,500
27,500
Salary
Proit Share
balance b/d
Mogire
Waituka
Kipkorir
10,000
35,000
27,500
27,500
45,000
45,000
10,000
37,500
37,500
27,500
27,500
MOGIRE, WAITUKA AND KIPKORIR PARTNERSHIP
PROFIT AND LOSS APPROPRIATION ACCOUNT
FOR THE MONTH ENDED…
Net proit for the month
110,000
less salaries
10,000
Mogire
10,000
Waituka
proit to be shared
Proit share
T E X T
90,000
35,000
Mogire
27,500
Waituka
S T U D Y
(20,000)
27,500
Kipkorir
(90,000)
NIL
Let us now have a comprehensive example capturing all aspects up to inal accounts
>>> Example 3
Ochieng and Otieno are in partnership sharing proits and losses equally. The following is their
trial balance as at 30th June 2006:
Buildings (cost Sh. 80,000)
Fixture at
Provision for depreciation on ixtures
Debtors
Creditors
Cash at bank
Stock at 30th June 2005
Sales
Purchases
Carriage outwards
Discounts allowed
Loan from Oloo
Ofice expenses
Salaries
Bad debts
Provision for bad debts
Loan interest – Oloo
Capital – Ochieng
Capital – Otieno
Current account – Ochieng
Current account – Otieno
Drawings by Ochieng
Drawings by Otieno
TOTAL
Dr, Sh.
55,000
16,000
21,243
5,677
46,979
90,416
6,288
5,115
7,416
23,917
5,503
9,000
Cr. Sh
8,300
16,150
128,650
129,100
5,400
45,000
39,500
13,106
9,298
12,400
8,650
_______
394604
394604
PARTNERSHIP ACCOUNTS
151
Prepare a trading, proit and loss and appropriation account for the year ended 30th June 2006
and a statement of inancial position as at that date incorporating the following information:
Stock at 30th June 2006 was Sh 61,341
Ofice expenses and Wages of Sh 2596 and Sh 5717 respectively are for next year.
Depreciation is to be charged at 10% on reducing balance method on ixtures and Sh
750 on buildings.
Provision for bad debts is to be reduced to Sh 4000
Not yet entered in the books is salary of Sh 1,000 to Ochieng
Interest on drawings: Ochieng, Sh 5,180 and Otieno Sh 5,120
Interest on capital account balances is at 10%
Freehold land was purchased during the year at Sh 80,900 vide a cheque. While the
entry was passed in the cash at bank account, no other entry was made.
a.
b.
c.
d.
e.
f.
g.
h.
Solution
Workings:
Balance
Balance /d
7416 it and loss
Balance c/d
7416
4820
/d
23917
2596
it
and loss
Balance c/d
7416
23917
18200
5717
23917
Balance
Balance /d
2596
/d
Provision for bad debts
it
loss
1400
Balance /d
5717
Freehold land account
5400
Ban
80900
Balance c/d
80900
Balance
Balance c/d
4000
/d
5400
80900
5400
Balance /d
4000
rom your previous chapters prepayments and accruals are treated as alance carry do ns
From your previous chapters, prepayments and accruals are treated as balance carry downs
So that they appear in balance sheet. Note that the igure to the statement of comprehensive income is
the balancing igure.
T E X T
Salaries and ages
expenses account
S T U D Y
ffice
152
FINANCIAL ACCOUNTING
Depreciation on ixtures= 10% of NBV
NBV= Cost - Accumulated depreciation
Depreciation on ixtures
= 10% (16000 - 8300)
= 770
Interest on capital;
Ochieng, 10%X 45,000 = 4,500
Otieno, 10%X 39500 = 3950
S T U D Y
T E X T
Note that the statement of inancial performance includes the appropriation account. The title
should use the correct wording because we are presenting three accounts in continuation.
OCHIENG AND OTIENO PARTNERSHIP
STATEMENT OF FINANCIAL PERFORMANCE AND APPROPRIATION ACCOUNT
FOR THE YEAR ENDED 30TH JUNE 2006
Sh
Sh.
Opening stock
46,979
Sales
128,650
90,416
add purchases
cost of goods available
137,395
61,341
less closing stock
Cost of goods sold
76,054
52,596
Gross proit c/d
128,650
128,650
Ofice expenses
Gross
proit
b/d
4,820
52,596
Wages and salaries
18,200
Provision for bad debts
1,400
Depreciation on ixtures
770
Depreciation on Buildings
750
Carriage outwards
6,288
Discount allowed
5,115
Loan interest; Oloo
9,000
Bad debts
5,503
3,550
Net proit c/d
53,996
53,996
interest on Capital
Net proit b/d
3,550
Ochieng
4,500
Interest on Drawings;
Otieno
3,950
Ochieng
5,180
Salary; Ochieng
1,000
Otieno
5,120
Proit share
Ochieng
2,200
2,200
Otieno
13,850
13,850
153
PARTNERSHIP ACCOUNTS
Note that in partnership inal accounts, even when not asked to draw the capital and (especially
the) current account, they are almost being asked indirectly because you will need them to draw
your balance sheet.
Partnership Current account
Drawings
Interest on Drawings
Balance c/d
Otieno
12,400
Ochieng
8,650
5,180
Balance b/d
5,120
3,226
4,500
3,950
1,000
Salary
Interest on Capital
1,678
20,806
13,106
Otieno
Proit share
15,448
2,200
20,806
Balance b/d
3,226
9,298
2,200
15,448
1,678
T E X T
OCHIENG AND OTIENO PARTNERSHIP
STATEMENT OF FINANCIAL POSITION
AS AT 30TH JUNE 2006
Non Current assets
Freehold land
Buildings
Fixtures
Cost
Dep.
Net
Sh
Sh
Sh
80,900
80,000
16,000
25,750
9,070
80,900
54,250
6,930
142,080
Current Assets
Debtors
less provision for BD
Net debtors
Bank
Stock
Prepaid ofice expenses
Prepaid wages
Capital
Ochieng
Otieno
add current accounts;
Ochieng
Otieno
Long term liabilities
21,243
(4,000)
Loan from Oloo
Current liabilities
17,243
Creditors
5,677
Sh
45,000
39,500
3,226
1,678
129,100
16,150
61,341
2,596
5,717
92,574
234,654
234,654
S T U D Y
Ochieng
154
FINANCIAL ACCOUNTING
5.4
ACCOUNTING FOR CHANGE IN PARTNERSHIP
AGREEMENT
Fast forward – Changes in the partnership agreement will affect both the statement of
comprehensive income/statement of inancial performance and the statement of inancial
position.
Change they say is inescapable. Partners being as they can be may effect changes in their
partnership deed. A change may occur in three areas:
S T U D Y
T E X T
a)
b)
c)
Proit and loss sharing ratio
Entry of a new partner
Exit of an existing partner either through death or retirement
In any case a change will affect both the statement of comprehensive income and the statement
of inancial position.
Statement of Comprehensive Income
The statement of comprehensive income is separated up to the point of change and after the
point of change. Proits are then distributed according to the agreements before the change and
after the change.
The statement of inancial position
The capital accounts will have to be adjusted for goodwill and effects of revaluation.
>>> Example 1
Jane and John are in partnership sharing proits and losses equally. The partnership agreement
charges Sh 2000 per month to Jane.
In mid year, they agree to change the partnership deed to charge a higher salary of Sh 6000 to
Jane and also change the proit and loss sharing ratio into 3:2.
You are required to show the relevant accounts at the year end if the proit amounted to
Sh. 120,000.
PARTNERSHIP ACCOUNTS
155
The distribution of proits before change was as follows:
JANE AND JOHN PARTNERSHIP
PROFIT AND LOSS APPROPRIATION ACCOUNT
Net Proit
FOR THE PERIOD SIX MONTHS BEFORE CHANGE
(120,000/2)
(12,000)
(2,000X6)
Less salary to Jane
Balance to be shared
Proit Share
Jane
John
60,000
24,000
24,000
48,000
(48,000)
NIL
JANE AND JOHN PARTNERSHIP
PROFIT AND LOSS APPROPRIATION ACCOUNT
Net Proit
FOR THE PERIOD SIX MONTHS AFTER CHANGE
Less salary to Jane
Balance to be shared
Proit Share
(36,000)
(6000X6)
Jane (3/5X24,000)
John (2/5X24,000)
60,000
14,400
9,600
24000
(24,000)
NIL
>>> Example 2
Wanyika and Wathara are in partnership sharing proits and losses equally. Their year ends on
31st December. On September 30th 2007, Wawinja joined the partnership. Henceforth, the proit
and loss sharing ratio became 3:2:1 in Wanyika, Wathara and Wawinja respectively. No salaries
were payable to any partner. The proit as at 31st December 2007 was Sh 360,000.
Assuming that the proit accrues evenly over the year, show the appropriation account and the
partners’ current accounts.
S T U D Y
T E X T
Distribution of proits after change
156
FINANCIAL ACCOUNTING
Proit distribution before change will be:
WANYIKA AND WATHARA PARTNERSHIP
PROFIT AND LOSS APPROPRIATION ACCOUNT
FOR THE NINE MONTHS ENDED SEPTEMBER 30TH 2007
Net proit ( 360,000x9/12)
proit share
Wanyika
Wathara
270,000
135,000
135,000
(270,000)
NIL
S T U D Y
T E X T
Distribution after change will be:
WANYIKA AND WATHARA PARTNERSHIP
PROFIT AND LOSS APPROPRIATION ACCOUNT
FOR THE THREE MONTHS ENDED DECEMBER 31ST 2007
Net proit ( 360,000x3/12)
proit share
Wanyika (90,000X3/9)
Wathara (2/9X90,000)
Wawinja (1/9X90,000)
30,000
90,000
20,000
10,000
(90,000)
NIL
Let us now have a typical exam question on what we have already learnt.
>>> Example 3 (KASNEB Adapted)
Aloo and Bara are partners in the business of selling motor vehicle spare parts and accessories.
The trial balance given below was extracted from the books of the partnership on 30th June
1996.
PARTNERSHIP ACCOUNTS
Dr., Sh ‘000
Capital – Aloo
Capital – Bara (admitted as partner on 1.4.1996
Land and buildings at cost
Provision for depreciation – furniture and ittings
800
600
800
1,500
100
Provision for depreciation – land and buildings
200
480
Purchases
Returns inwards
3,390
120
Returns outwards
90
Stock as at 1.7.1995
450
Salaries and wages – selling
640
Salaries and wages – administrative
650
Salesmen commission
Cash at bank
35
50
100
Insurance
45
Rent and rates
20
General administrative expenses
80
____
8,925
8,925
TOTALS
Prior to his admission as a partner on 1st April 1996, Bara was the general manager of the irm
and was earning a salary of Sh 31250 per month. This salary has not been included in the
accounts. He brought in capital of Sh 200000 in cash and was thereafter entitled to one-ifth of
the irm’s proits. The partnership agreement provides for interest to be charged on drawings
made after the commencing of partnership at the rate of 10% per annum.
The following additional information is provided:
1.
T E X T
Provision for bad and doubtful debts(1.7.1995)
S T U D Y
Debtors
1,500
6,000
Creditors
Furniture and ittings at cost
Cr., Sh ‘000
200
Sales
Drawings – Aloo
157
The sales for the 9 months to 31stmarch 1996, including returns of Sh 96000 were Sh
4,800,000 whereas the purchases over the same period amounted to Sh 2,690,000.
there were no purchase returns the last three months of the period
158
FINANCIAL ACCOUNTING
2.
3.
4.
5.
Depreciation is to be provided on written down value of the building at 5% per annum
and on furniture at 20%per annum. Although the cost of the land on 30th June 1996 was
Sh 700,000 no depreciation is to be provided.
A debt of Sh 20,000 is to be written off, and the provision for bad and doubtful debts is
to be maintained at 5% of the remaining debtors.
The drawings by Aloo after the formation of the partnership are Sh 200,000 made on 1st
April 1996.
Expenses are to be apportioned between the two periods as follows;
Selling expenses
Administrative expenses
Depreciation
Other expenses
6.
S T U D Y
T E X T
7.
Base
net sales value
time basis
time basis
time basis
Insurance paid in advance and rates outstanding at 30th June 1996 are Sh 5,000 and
Sh 10,000 respectively
Stock in trade was Sh 600,000 at 31st March 1996 and Sh 750,000at 30th June 1996
Required:
Prepare the statement of comprehensive income for the 9 months ended 31st March 1996 and for
the 3 months ended 30th June 1996, and a statement of inancial position as at that date.
Solution
Does it look like rocket science, may be yes, but wait till we are through, just follow the steps we
have been using.
You should never forget your workings, they always start.
Look at what you are given in the additional information.
1.
The fact that those differentiations are given makes it easy for us, just post them.
2.
Depreciation
a). Buildings; 5% of written down value
Buildings at cost = 1500,000 – 700,000
= 800,000
Written down value = cost – accumulated dep.
= 800,000 – 200,000
= 600,000
Therefore, dep = 5% X 600,000
= 30,000
b) Furniture; 20% (800,000 – 100,000)
= 140,000
PARTNERSHIP ACCOUNTS
3.
159
We can do this without drawing the T accounts now,
We write off a bad debt by, Dr. Bad debts Sh 20,000
Cr. Trade debtors Sh 20,000
Provision for bad debts; 5 %( 480,000 – 20,000)
= 23,000
The difference (this time a decrease) goes to the statement of comprehensive income
= 35,000 – 23,000
= 12,000
4.
Apportioning of expenses;
Selling expenses are on basis of net sales value
Net sales = 5,880,000
For nine months, 4707, 000/5880,000 X 640,000 = 512,000
For 3 months, 1176, 000/5880,000 X 640,000 = 128,000
b/d
45000
and
loss
it
Balance
40000
b/d
20000
and
loss
30000
T E X T
it
Balance
Rent and rates account
Balance
balance c/d
45000
5000
45000
c/d
10000
30000
30000
Balance
b/d
5000
Balance b/d
10000
S T U D Y
Insurance account
160
FINANCIAL ACCOUNTING
ALOO AND BARA PARTNERSHIP
STATEMENT OF COMPREHENSIVE INCOME FOR
9 Months to 01.04.2006
3 Months to 30.06.2006
Sh.
Sh.
Sh.
Sh.
less returns inwards
less cost of sales
add purchases
less returns outwards
cost of goods available
less closing stock
(90,000)
3,050,000
(600,000)
Salaries – Selling
Salaries- Administrative expenses
Salesmen commission
Insurance
Rates
General administrative expenses
Salary to Bara
Total expenses
Net Proit
add interest on drawings; Aloo
Proit to be shared
Proit share
Aloo
Bara
T E X T
S T U D Y
1,300,000
(2,450,000)
(750,000)
3,000
35,000
105,000
7,500
22,500
5,000
15,000
128,000
512,000
162,500
487,500
10,000
40,000
10,000
30,000
7,500
22,500
20,000
60,000
281,250
(550,000)
626,000
2,254,000
9,000
add Decrease in provision for BD
less expenses
Bad debts
700,000
2,690,000
Gross proit
Depreciation on buildings
1,176,000
600,000
450,000
cost of sales
Depreciation on furniture
24,000
4,704,000
Net sales
Opening stock
1,200,000
4,800,000
96,000
Sales
385,500
1,575,750
243,500
687,250
198,800
49,700
5,000
248,500
(248,500)
NIL
PARTNERSHIP ACCOUNTS
161
Notes:
a.
b.
Bara will not get salary in the last three months because he is now a partner. If he was
still entitled to the same amount of salary even after becoming a partner, the amount
would appear in his current account but not the statement of comprehensive income
The appropriation account will only be for the last three months; the effective period of
partnership.
Partners’ Current account
Drawings
Balance c/d
600,000
281,050
886,050
49,700
Proit for 9 months
Proit for 3 months
49,700
Add working Capital
Current Assets
Debtors
Less provision for bad debts
Net debtors
Bank
Stock
Prepaid insurance
less current liabilities
Creditors
Accrued rates
Accrued salary to Bara
1,500,000
230,000
Current Accounts Aloo
Bara
198,800
Bara
49,700
49,700
Net
Sh.
560,000
1,830,000
1,270,000
460,000
(23,000)
800,000
10,000
281,250
437,000
100,000
750,000
5,000
1,292,000
(1,091,250)
Working capital
Financed by;
Capital Aloo
Bara
687,250
886,050
ALOO AND BARA PARTNERSHIP
STATEMENT OF FINANCIAL POSITION
AS AT 30TH JUNE 1996
Non-Current Assets
Cost
Dep.
Sh.
Sh.
Furniture
800,000
240,000
Land and Buildings
Aloo
T E X T
5,000
Interest on drawings
Bara
S T U D Y
Aloo
1,500,000
200,000
281,050
49,700
200,750
2,030,750
1,700,000
330,750
2,030,750
162
FINANCIAL ACCOUNTING
5.5
ADJUSTMENTS FOR GOODWILL AND REVALUATION
PROFIT OR LOSS
Fast forward – Purchased goodwill is the amount paid for a business in excess of its net
assets
Goodwill could be deined as any excess of the cost of acquisition over the acquirer’s interest
in the fair value of the identiiable assets and liabilities acquired as at the date of the exchange
transaction.
In layman terms, goodwill can be viewed as that amount over and above the value of assets
being purchased.
S T U D Y
T E X T
Goodwill should not be recognized in the books because it has no objective value and it keeps
on changing in value constantly.
Goodwill could either be purchased or non-purchased, purchased goodwill is recognized in the
books while non-purchased is not.
Purchased goodwill is the amount paid for a business in excess of its net assets. It arises when
a business is sold as a going concern.
Non purchased goodwill could be termed as the goodwill inherent in a business. It may not be
objectively measures. Some of its measures include:
•
•
•
•
•
•
Good reputation
Hospitable reception and staff attitude
High proitability
Good management
Strategic location
Promptness in response
It therefore becomes dificult to value.
In accounting for goodwill, we deal more with the purchased goodwill because of its ease to value
numerically (remember accounting is the science of numbers).
If a business K has net assets worth Sh 900, 000 and it is purchased at one million shillings, then
goodwill could be calculated as:
Goodwill = Sh 1,000,000 - 900,000=Sh 100,000. This captures our deinition of goodwill given
above.
PARTNERSHIP ACCOUNTS
163
METHODS OF CALCULATING GOODWILL
In calculating goodwill, the method varies according to the type of business whose goodwill is
being measured.
For retail businesses for instance, goodwill is customarily calculated at average weekly sales for
the previous year multiplied by a given igure.
For professional irms, the custom is to value goodwill at the gross annual fees multiplied by a
given igure.
It can also be valued by getting the average net annual proit for a speciied past number of years
multiplied by a given number.
In case of sole traders, goodwill is valued based on the super proits method. The net proit igure
is adjusted for a normal salary igure given to the proprietor and notional interest for capital.
iii.
iv.
v.
It is incapable of realization separately from the business as a whole
Its value has no reliable or predictable relationship to any costs which may have been
incurred
Its value arises from various intangible factors which cannot be valued
Its value can luctuate widely according to internal and external circumstances over
relatively short periods of time.
The assessment of the value of goodwill is highly subjective.
Accounting entries
As we have mentioned above, only purchased goodwill is passed into the accounts. Speciic to
partnerships, adjustments for goodwill in the accounts of the partners whenever a change in
the partnership takes place:a.
b.
c.
Change in proit and loss sharing ratios
Admission of a new partner
Retirement or death of a partner
The change may involve cash being paid by one partner to another, or an adjustment in the
books is made so that the changes in the partnership does not lead to partner losing his/her
ownership share without being compensated adequately.
While accounting for goodwill,
a) It could be shown in the books; or
b) It could be written off i.e. not shown the books
S T U D Y
i.
ii.
T E X T
CHARACTERISTICS OF GOODWILL
164
FINANCIAL ACCOUNTING
a) Where goodwill is shown in the books, the double entry is:
Dr. Goodwill
Cr. partners capital account (using the old proit sharing ratio)
>>> Example 1
Mutie, Mutua and Mutinda have always shared proits in the ratio of 4:2:2 respectively. They now
decide to alter that ratio to 5:2:1. Accompanying the change is a Sh 80,000 goodwill. The net
assets without the goodwill are Sh 100,000. The capital accounts are as follows:
Sh
Mutie
50,000
Mutinda
20,000
Mutua
30,000
T E X T
Old ratio 4:2:2
S T U D Y
If the partners decide to show goodwill in the accounts, show the statement of inancial position
as at 31st December 2006.
Dr. Goodwill
New Ratio 5:1:1
Share goodwill in the old ratio of Sh 80,000
80,000
Cr. Capital accounts; Mutie (4/8X80,000) 40,000
Mutua (2/8X80,000)
20,000
Mutinda (2/8X80,000) 20,000
Mutie, Mutua and Mutinda Partnership
Statement of inancial position as at 31st December 2006
Assets
Goodwill
100,000
80,000
180,000
Capital; Mutie
Mutua
Mutinda
90,000
50,000
40,000
180,000
>>> Example 1b
Suppose that after some days they decide to sell the business and receive Sh 180,000 in cash
show how the cash would be shared.
PARTNERSHIP ACCOUNTS
165
Solution
Each partner will receive an amount equal to their statement of inancial position balances
above:
Dr. Capital Accounts; Mutie
Mutua
Cr. Cash
Mutinda
90,000
50,000
40,000
180,000
b)
If goodwill is to be written off or is not to be shown in the accounts, the entries are made
in two steps:
b1) Dr. goodwill
Cr. partners’ Capital accounts
Using the old proit sharing ratio
>>> Example 2
Using the example 1 above, show the partners’ capital accounts and the statement of inancial
position if they decide to write off the goodwill account.
Solution
Step 1; use the old sharing ratio
Dr. Goodwill
80000
Cr. Capital accounts; Mutie(4/8X80,000)
Mutua(2/8X80,000)
40,000
20,000
Mutinda(2/8X80,000) 20,000
Step 2; write off goodwill using the new sharing ratio
Dr. Capital accounts: Mutie (5/8)
Mutua (2/8)
50,000
20,000
Mutinda (1/8) 10,000
Cr. Goodwill
80,000
This way goodwill will not appear in the books at all, let’s see it from the accounts
S T U D Y
To write off goodwill from the books, you will note that goodwill will appear nowhere in
the books of account.
T E X T
b2) Dr. Partners’ capital accounts using the new ratio
Cr. goodwill
166
FINANCIAL ACCOUNTING
Capital
accounts( in
old sharing ratio)
Goodwill account
Capital
Mutie
40,000
accounts(in
new sharing
Mutua
20,000
ratio)
Mutinda 20,000
80,000
Mutie
50,000
Mutua
20,000
Mutinda 10,000
80,000
Capital accounts
Mutie
Goodwill(new
ratio)
Balance c/d
50,000
40,000
90,000
Mutua
20,000
30,000
50,000
Mutinda
10,000
30,000
40,000
Mutie
Balance b/d
Goodwill(old
ratio)
40,000
90,000
40,000
Mutinda
20,000
20,000
30,000
50,000
30,000
20,000
40,000
30,000
MUTIE, MUTUA AND MUTINDA PARTNERSHIP
STATEMENT OF FINANCIAL POSITIONAT 31ST DECDECEMBER 2006
Assets
S T U D Y
T E X T
Balance b/d
50,000
Mutua
100,000
Capital
Mutie
Mutua
100,000
Mutinda
40,000
30,000
30,000
100,000
>>> Example 2b
If the business is sold on 1st January 2007 for Sh 100,000 cash show how the proceedings would
be shared among the partners.
Solution
Mutie
Mutua
Mutinda
Sh.
40,000
30,000
30,000
100,000
PARTNERSHIP ACCOUNTS
5.6
167
REVALUATION OF PARTNERSHIP ASSETS
Like goodwill, revaluation of partnership assets takes place under the similar conditions
of:
i.
ii.
iii.
A change in the proit and loss sharing ratio
Admission of a new partner
Exit of an existing partner
It is necessary to revalue partnership assets to ensure fairness. For instance when a new partner
is and the assets are not revalued, he/she may end up gaining unfairly from efforts of the other
existing partners. Similarly, when a partner exits the partnership and no revaluation is done, he
may forego beneits he helped plough into the partnership which is not fair.
Revaluation therefore becomes necessary in order to compensate the old partners for their
efforts.
Adjustments are then made to the old partners’ capital accounts in their old proit and loss sharing
ratio.
Accounting entries
a.
b.
c.
when asset values increase,
i. dr. Asset account
ii. Cr Revaluation account (with the amount of increase)
when asset value Decreases,
i. Dr, Revaluation account
ii. Cr. Asset account (with the amount of Decrease)
After all the entries are made, revaluation account is balanced. The balance could
either be a gain or a loss which is then passed o to the partners’ capital accounts in
the existing/old proit and loss sharing ratio. A proit is credited to the partners’ capital
account while a loss is debited.
>>> Example 1
Victor and Mary are in partnership sharing proits and losses in the ratio 2:1. Their statement of
inancial position as at 31st December 2005 was as follows:
Plant at cost
Fixtures
Stock
Debtors
Bank
12,000
8,460
5,500
1,530
2,250
29,740
Capitals;
Victor
Mary
19,820
9,920
29740
S T U D Y
T E X T
When revalued, asset values may increase or Decrease.
168
FINANCIAL ACCOUNTING
From January 1st, they decided to change their proit and loss into the ratio of their capitals.
Accompanying the change was a revaluation on the partnership assets as follows: Plant Sh18,000,
ixtures Sh. 8,000 and stock Sh. 5,000.
You are required to show the revaluation account and the statement of inancial position as at
January 1st 2006.
Solution
Plant account
Balance b/d
Revaluation
12,000
6,000
18,000
Balance c/d
18,000
18,000
Fixtures account
Balance
Revaluation
b/d
8,460
Balance c/d
8,640
460
8,000
8,460
Stock account
S T U D Y
T E X T
Balance
b/d
5,500
5,500
Revaluation
Balance c/d
500
5,000
5,500
Note that the being revalued is taken down as the closing balance. Revaluation gain or loss is
the difference between the book value and the revalued amount.
Let us now prepare the Revaluation account. We only take the gains or the losses to this account
in order to get the net revaluation gain or loss.
Revaluation account
Fixtures
460
Stock
500
(Rev. Gain = 5040)
Capital a/c Victor
Capital a/c Mary
Plant
6,000
3,360
1,680
6,000
6,000
The gain (or loss) on revaluation is never shown on the face of the revaluation account. It is
shared directly between/among the partners in their OLD proit sharing ratio. In this example, it
is shown in parentheses just to emphasize on its calculation.
PARTNERSHIP ACCOUNTS
169
Capital account
Victor
Mary
23,180
Balance b/d
23,180
Victor
11,600
11,600
Balance b/d
19,820
Mary
23,180
11,600
3,360
Revaluation gain
9,920
1,680
Victor and Mary Partnership
Statement of inancial position as at 1st January 2006
Assets
Plant
18,000
Capitals
5,000
Mary
8,000
Fixture
Stock
Victor
23,180
11,600
1,530
34,780
34,780
We now know almost everything we need to know about partnership accounting. Let us work out
a typical full examination question covering all we have learnt so far.
5.7
REVALUATION OF ASSETS TAKEN OVER BY A
RETIRING PARTNER
On retirement of a partner, his/her investment in the partnership is given back to him/her
together with balances due to him from his current account and any loan payable to him by the
partnership.
The payment is normally effected in cash. Sometimes the retiring partner may have so much to
be paid that a full settlement may not be possible or it could plunge the partnership into inancial
dificulties thereafter. In such a case, the partnership pays part of all the dues and the remainder
is held in the partnership as a loan to the partnership.
Some of this part payment may be in the form of the retiring partner taking over an asset or
assets from the partnership. Any such assets are deducted from the retiring partner’s amount
payable to him.
T E X T
2,250
Bank
S T U D Y
Debtors
170
FINANCIAL ACCOUNTING
Accounting entries
The asset being taken over is irst revalued and any revaluation gain or loss accounted for.
Then:
Dr. Capital account of the retiring partner (with the revalued amount)
Cr. Asset account
EXAMPLE 1 (KASNEB ADAPTED)
Kyamba, Onyango and Wakil were partners in a manufacturing and retail business sharing proits
and losses in the ratio of 2:2:1 respectively
S T U D Y
T E X T
Given below is the statement of inancial position of the partnership as at 31st March 2001.
Statement of inancial position as at 31st March 2001
Assets
Non-current assets
Fixed assets
465,000
Current assets
Stocks
294,000
209,000
Debtors
503,000
968,000
Capital and liabilities
Capital accounts
Kyamba
160,000
Onyango
140,000
200,000
Wakil
500,000
Current accounts
Kyamba
65,300
Onyango
49,000
53,000
Wakil
167,300
667,300
Current liabilities
Bank overdraft
48,700
252,000
Trade creditors
300,700
968,000
PARTNERSHIP ACCOUNTS
171
Additional information:
1.
2.
On April 1st, Wakil retired from the partnership and was to start a business as a sole
trader while Kyamba and Onyango continued with the partnership.
On retirement of Wakil, the manufacturing business was transferred to him while
Kyamba and Otieno continued with the retail business.
The assets and liabilities transferred to Wakil were as follows:
Net book value
Sh
Fixed Assets
260,000
Stocks
166,000
Debtors
172,000
Creditors
156,000
Transfer Value
Sh
306,000
157,000
165,000
156,000
Balance b/d
Balance b/d
Wakil
Balance c/d
Stock
Debtors
Capital,
Kyamba
Onyango
Wakil
306,000
205,000
511,000
Stock account
294,000 Revaluation
Wakil
Balance c/d
294,000
9,000
157,000
128,000
294,000
Debtors account
209,000 Revaluation
Wakil
Balance c/d
209,000
7,000
165,000
37,000
209,000
Creditors
156,000
96,000
252,000
252,000
Revaluation account
9,000 Fixed assets
7,000
12,000
12,000
6,000
46,000
252,000
46,000
46,000
S T U D Y
Balance b/d
Revaluation acc.
Fixed assets ac
465,000 Wakil
46,000 Balance c/d
511,000
T E X T
Wakil obtained a loan from a commercial bank and paid into the partnership the net due to him.
172
FINANCIAL ACCOUNTING
3.
4.
O3. On retirement of Wakil from the partnership, goodwill was valued at Sh. 200,000
but was not to be maintained in the books of partnership of Kyamba and Onyango
After retirement of Wakil on 1st April 2001, Kyamba and Onyango agreed on the following
terms and details of the new partnership:
• Kyamba and Onyango to introduce additional capital of Sh 48,000 and Sh 68,000
respectively
• Each partner was entitled to interest on capital at10% per annum w.e.f 1st April
2001 and the balance of the proits was to be shared equally after allowing for
annual salaries of Sh 72,000 to Kyamba and Sh 60,000 to Onyango.
5.
The proit of the new partnership before interest on capitals and partners’ salaries was
Sh 240,000 at the year ended 31st March 2002.
6.
The proits made by the new partnership increased stocks by Sh 100,000. Debtors by
Sh 90,000 and bank balance by Sh 50,000.
Drawings by the partners in the year were Kyamba Sh 85,000 and Onyango Sh
70,000.
Required:
S T U D Y
T E X T
7.
a.
b.
c.
d.
Proit and loss appropriation account for the year ended 31st March 2002
Capital accounts for the year ended 31st March 2002
Current accounts for the year ended 31st March 2002
Statement of inancial position of the new partnership as at 31st March 2002
Solution
Never forget your workings, however complicated the question might seem.
Before we prepare the current inal accounts, we need to close the books unto the point of
Wakil’s retirement. So, we close the current account of Wakil into his capital account
Capital
account
Goodwill
Fixed
assets
Stock
Debtors
Balance
c/d
Wakil, Current account
Balance
53,000
b/d
Kyamba
100,000
Onyango
100,000
152,000
132,000
252,000
232,000
53,000
Capital accounts
Wakil
Balance b/d
Kyamba
160,000
Onyango
140,000
Wakil
200,000
157,000 Goodwill
80,000
165,000 Wakil’s Current acc.
80,000
40,000
53,000
306,000 Revaluation
12,000
12,000
156,000
Liabilities
628,000
Bank (balancing igure)
252,000
6,000
232,000
173,000
628,000
PARTNERSHIP ACCOUNTS
173
Notice how Wakil’s current account has been closed into the capital account.
The balancing igure of represents the amount Wakil will have to pay the partnership because
he’s got more than he should have gotten. It could be looked at this way:
Capital acc
402,000
Current acc
53,000
455,000
Wakil should have got Sh 455,000, but from his capital account, he is to get Sh 628,000. The
balance therefore represents the amount he will have to pay the partnership of Sh 173,000.
We can now prepare the statement of inancial position immediately after the retirement of Wakil
using the capital accounts above.
KYAMBA AND ONYANGO PARTNERSHIP
205,000
Fixed assets
Current assets
128,000
Stock
Bank(173000 - 48700)
Less current liabilities
Creditors
S T U D Y
37,000
Debtors
124,300
289,300
96,000
193,300
393,300
Capital accounts(from Capital acc. Above)
Kyamba
Onyango
152,000
132,000
284,000
Current accounts
Kyamba
Onyango
T E X T
STATEMENT OF FINANCIAL POSITION AS AT 1ST APRIL 2001
65,300
49,000
114,300
393,300
We could now go ahead with the proit and loss appropriation account.
174
FINANCIAL ACCOUNTING
KYAMBA AND ONYANGO PARTNERSHIP
PROFIT AND LOSS APPROPRIATION ACCOUNT
FOR THE YEAR ENDED 31ST MARCH 2002.
Net proit
240,000
less salaries
72,000
Kyamba
60,000
Onyango
(132,000)
108,000
less interest on capital
20,000
Kyamba
20,000
Onyango
68,000
Balance to be shared
34,000
T E X T
Kyamba
S T U D Y
(40,000)
34,000
Onyango
(68,000)
NIL
At the end of the year, the capital accounts will be similar to those drawn above but with the
exclusion of Wakil’s column because he has since left and then the additional contributions of
capital by the remaining partners.
Capital accounts
Kyamba
Goodwill
100,000
Onyango
100,000
Balance b/d
Revaluation
Balance
c/d
200,000
300,000
200,000
300,000
Goodwill
Cash(more capital)
Kyamba
160,000
Onyango
12,000
80,000
12,000
80,000
48,000
140,000
68,000
300,000
300,000
Kyamba
65,300
Onyango
72,000
20,000
60,000
20,000
Current accounts
Kyamba
Drawings
85,000
Onyango
70,000
Balance b/d
Salary
Balance
c/d
106,300
191,300
93,000
163,000
Interest on capital
Proit share
34,000
191,300
49,000
34,000
163,000
PARTNERSHIP ACCOUNTS
175
And inally the statement of inancial position of the existing partnership
KYAMBA AND ONYANGO PARTNERSHIP
STATEMENT OF FINANCIAL POSITION AS AT 31ST MARCH 2002
205,000
Fixed assets
Current assets
228,000
Stock
127,000
Debtors
135,300
Bank
490,300
Less current liabilities
Creditors
96,000
393,300
599,300
Onyango
Current accounts
Kyamba
Onyango
200,000
200,000
400,000
106,300
93,000
199,300
599,300
T E X T
Kyamba
S T U D Y
Capital accounts
176
FINANCIAL ACCOUNTING
CHAPTER SUMMARY
A partnership is usually established through a partnership agreement in which the terms of the
partnership are set out. The agreement covers the following items:
S T U D Y
T E X T
•
•
•
•
•
•
Amount of capital invested by each partner in the business
The proit sharing ratio
The interest on capital
Salaries to partners
Limits to drawings
Interest on drawings
In the absence of the partners’ agreement, it is presumed that,
•
Proits will be shared equally
•
There are no partners’ salaries
•
No interest on capital is paid
•
Partners are entitled to interest of 4% per annum on any loans advanced to the irm
CASE STUDY
The most prominent forms of partnerships in the country are service based. These include audit
irms and law irms.
Examples of the big audit irms include Price water house Coopers (PWC), Deloitte, Ernst and
Young and KPMG in Kenya.
With the growing partnership between indigenous mid-level irms and leading global networks,
a shift in market structure is unfolding as the smaller companies continue to win contracts from
the top four. Though the top four multinationals control about 85 per cent of the market in terms
of deal value, the mid tier irms that have sought international afiliation have been growing their
client base at a faster rate than the multinationals.
Estimates from the Institute of Certiied Public Accountants of Kenya (ICPAK) show that the
mid-tier irms now control between 60-70 per cent of the industry’s client base up from about 40
per cent in 2000. In recent years, seven of the top 15 irms, excluding the big four, have formed
partnerships with local accounting irms as they seek to spread their foothold across the globe
with the emerging markets like Kenya being their focus. (Source, The Business Daily, 2008).
PARTNERSHIP ACCOUNTS
177
CHAPTER QUIZ
T E X T
What is a partnership?
What is a partner’s salary, an expense or an appropriation of proit?
How is proit shared between partners?
How is proit shared in the absence of the partnership agreement?
S T U D Y
1.
2.
3.
4.
178
FINANCIAL ACCOUNTING
ANSWER TO CHAPTER QUIZ
1.
PAST PAPER ANALYSIS
12/07, 6/07, 12/06, 6/06, 12/05, 6/05, 6/04, 6/03
S T U D Y
T E X T
2.
3.
4.
An agreement between two or more individuals to carry on the risk and rewards of a
business together.
An appropriation of proit.
According to the terms of the partnership agreement.
It is presumed that:- Proits will be shared equally
- There are no partners’ salaries.
- No interest on capital is paid.
- Partners are entitled to interest of 4% per annum on any loans advanced to the irm.
EXAM TYPE QUESTIONS
Question 1 (June 2006 Question 4)
(a)
Briely explain why goodwill should be paid under the following circumstances:
i.
ii.
By a partner on admission to a partnership.
To a partner on retirement from a partnership.
(2 marks)
(2 marks)
PARTNERSHIP ACCOUNTS
(b)
179
Akili, Busara and Chema are in partnership sharing proits sharing proits and losses
equally after allowing for interest on capital at 5% per annum to the partners and a
salary to Busara of Sh 20,000 per month.
The trial balance of the partnership as at 30 April 2006 was as follows:
Sh.’000’
Chema
1,000
2,000
Akili
200
Busara
300
Chema
200
Akili
300
Busara
400
Chema
200
Inventory as at 1 May 2005
Purchases
Operating expenses
3,000
10,300
6,400
Loan: Busara (Interest at 10% per annum)
Land
Chema (Interest at 10% per annum)
1,000
Buildings
Plant and machinery: Cost
Accounts receivable/accounts payable
Cash at Bank
1,000
2,000
5,000
Accumulated depreciation
(30 April 2006)
20,000
7,000
4,000
37,600
4,000
3,300
1,100
37,600
Additional Information
1.
2.
3.
Closing inventory as at 30 April was valued at Sh 2,400,000.
Interest on loans had not been paid.
Sales include credit sales of Sh 600,000 in respect of two items sold on the basis of
conirmation by the customers. The items had cost Sh 100,000 each. As at 30 April
2006, the customers had not conirmed whether they would buy the goods.
T E X T
Sales
2,500
Busara
Current accounts:
Drawings:
Akili
S T U D Y
Capital accounts:
Sh.’000’
180
FINANCIAL ACCOUNTING
4.
On 1 November 2005, the terms of the partnership agreement were changed. The new
terms provided for:
• Proit sharing ratio of 5:3:2 for Akili, Busara and Chema respectively.
• Interest on capital at 5% per annum.
• Salaries of Sh 10,000 per month to Busara and Chema.
For the purpose of the change, goodwill was valued at Sh 1,200,000 and was to be written
off immediately while the land buildings were valued at Sh 2,000,000 and Sh 6,400,000
respectively.
Required:
a)
b)
c)
Trading, Proit and loss and appropriation accounts for the year ended 30 April 2006
Partners’ capital and current accounts
Statement of inancial position as at 30 April 2006
(6 marks)
(6 marks)
(4 marks)
S T U D Y
T E X T
(Total: 20 marks)
Question 2 (December 2006 Question 3)
Grace and Beatrice were operating a retail business sharing proits and losses in the ratio of 2:1
respectively up to 31 March 2006 when they admitted Catherine to the partnership. The partners
allowed payment of interest on partners’ ixed capital accounts but did not allow for interest on
partners’ current accounts.
The following balances on the opposite page were extracted from the partnership’s book of
account as at 30 September 2006:
PARTNERSHIP ACCOUNTS
Leasehold premises (purchased 1 October 2005)
Purchases
Sales (Sh 14,000,000 to 31 March 2006)”
Motor vehicles at cost
Salaries
Sh.’000’
16,400
Motor vehicles
Shop ittings
3,400
1,200
400
Stocks (1 October 2005)
1,600
4,800
Shop itting at cost at cost
1,200
Accounts receivable
900
Grace
3,000
Beatrice
2,000
Catherine
1,500
Grace
1,600
Catherine
3,500
Beatrice
Professional charges
6,500
1,200
6,300
420
Rent, rates and electricity”
1,240
Accounts payable
4,280
General expenses (Sh 1,410,000 for six months to 31 March 2006)”
Shop wages
2,640
2,200
Additional information:
1
On 31 March 2006 when Catherine was admitted as a partner, the proit sharing ratio
changed to Grace 2/5, Beatrice 2/5 and Catherine 1/5. For the purpose of admission,
goodwill was valued at Sh 12,000,000 and was written off the books immediately. On
1 April 2006, Catherine paid Sh 5,000,000 which comprised her ixed capital of Sh
1,500,000 and her current account contribution of Sh 3,500,000.”
2
The partners also agreed that any apportionment of gross proit was to be made on the
basis of sales. The apportionment of expenses, unless otherwise indicated, was to be
on time basis.
T E X T
Fixed capital accounts:
9,280
S T U D Y
Balance at bank
Current accounts:
Sh.’000’
6,000
35,000
5,200
Provision for depreciation as at 1 October 2005:
181
182
FINANCIAL ACCOUNTING
3
On 30September 2006, stock was valued at Sh 5,100,000.
4
Provision was to be made for depreciation on motor vehicles and shop ittings at the
rate of 20% and 5% per annum respectively, based on cost.
5
Salaries included the following partner’s drawings during the year:
-
Sh 600,000
Sh 480,000
Sh 250,000”
6
At 30 September 2006, rates paid in advance amounted to Sh 260,000 while electricity
accrued amounted to Sh 60,000.
7
A difference in the books of Sh 120,000 that had been written off to general expenses
as at 30 September 2006 was later found to have been due to the following errors:
• Sales returns of Sh 180,000 had been debited to sales but were omitted from the
customers account.
• The purchase journal had been under cast by Sh 200,000.
8
Doubtful debts (for which full provision was required) as at 31 March 2006 amounted to
Sh120,000 and Sh 160,000 as at 30 September 2006.
9
Professional charges included Sh 200,000 paid in respect to the acquisition of leasehold
premises. These fees are to be capitalized as part of the lease, the total cost of which
was to be depreciated in 25 equal annual installments. Other premises owned by
Beatrice were leased to the partnership at Sh 600,000 per annum but no rent had been
paid or credited to her for the year to 30 September 2006.
S T U D Y
T E X T
Grace
Beatrice
Catherine
Required:
(a)
Statement of comprehensive income for the year ended 30 September 2006.
(10 Marks)
(b)
Statement of inancial position as at 30 September 2006.
(6 Marks)
(c ) Partners’ current accounts.
(4 Marks)
(Total: 20 marks)
Question 3 (June 2007 Question 2)
Ali and Bakari were in partnership sharing proits and losses in the ratio of 3:2 respectively. The
terms of the partnership entitled to the partners to interest on their capital balances at 5% per
annum. Bakari was also entitle to an annual salary of Sh,4 million.
The statement of inancial position extracted from the books of account of the partnership as at
1 January 2006 was as follows.
PARTNERSHIP ACCOUNTS
Sh. ‘000’
183
Sh. ‘000’
Non-current assets:
Business premises
20.800
Equipment at cost
8.000
Provision for depreciation-equipment
4.800
3.200
24.000
Current assets:
Inventory
5.600
Accounts receivable
2.200
Cash at bank
400
Total assets
8.200
32.200
Capital and liabilities:
16.000
Bakari
10.000
Ali
3.200
Bakari
(300)
26.000
2.900
Current liabilities:
Accounts payable
3.000
Accruals
300
3.300
Total capital and liabilities
32.200
On 1 April 2006 Chando was admitted as a partner. He has been a salaried employee of
the partnership and earned Sh 8 million per year. The terms of Chando’s admission were as
follows:
•
•
•
•
T E X T
Current accounts:
Ali
S T U D Y
Capital accounts:
Chando was to pay Sh 12 million to the partnership as his capital contribution. Goodwill
was valued at Sh 14 million and was to be written off the partners capital accounts
immediately.
The proit sharing ratio was to be 4/7 to Ali, 2/7 to Bakari and 1\7 to Chando. The partners’
interest on capital was to be raised from 5% per annum.
Bakari’s salary per annum was to be raised to Sh 6 million and Chando was to receive a
salary of Sh 6 million per annum.
The necessary transactions to effect the admission are to be made in the capital
accounts.
184
FINANCIAL ACCOUNTING
Additional information:
1.
The following balances were extracted from the partnership’s draft inancial statements
for the year ended 31 December 2006:
Sh. ‘000’
S T U D Y
T E X T
Net proit for the year
Inventory
Accounts receivable
Cash at bank
Accounts payable
Accruals
Drawings by partners
Ali
Bakari
Chando
23.705
19.525
8.250
Sh. ‘000’
55.155
12.555
3.500
8.800
3.080
400
15.480
2.
The closing inventory (Sh 12,555,000) included some stock items which had cost
Sh 750,000 but could only realize Sh 280.000.
3.
A provision for doubtful debts is to be made at 3% of the accounts receivable
4.
During the year depreciation on equipment was wrongly computed at the rate of 10%
based on cost instead of correct rate of 15% using the reducing balance method. I
addition, depreciation amounting to Sh 200.000 had not been provided on business
premises.
5.
The partners had taken goods for personal use as follows:
Ali
Bakari
Chando
6.
Accrued electricity as at 31 December 2006 amounted to Sh 120.000. This amount had
not been provided in the accounts.
Required:
a)
b)
c)
d)
Sh. ‘000’
1.000
900
600
A schedule showing the corrected net proit and appropriation account for the year
ended 31 December 2006.
Hint: Start with the net proit of Sh 55,155,000 as per draft accounts to compute the
corrected net proit)
(8 marks)
Partners’ current accounts.
(4 marks)
Partners capital accounts
(2 marks)
Statement of inancial position as at 31 December 2006
(6 marks)
185
S
T
S T
T SU
U TD
DUY
YD Y
T E
E TX
X ET
TX T
CHAPTER SIX
NON PROFIT MAKING
ORGANIZATIONS
S T U D Y
T E X T
186
FINANCIAL ACCOUNTING
187
CHAPTER SIX
NON PROFIT MAKING ORGANIZATIONS
OBJECTIVES
After studying this chapter, you should be able to:
INTRODUCTION
Fast forward - Since the non proit making organizations are not owned by a group of people,
they do not maintain a capital account.
These are some form of business organization that is set up to promote or to cater for the welfare
of the members involved and not to make proit. They include clubs, e.g. sports clubs, welfare
associations and charitable institutions e.t.c.
Since these organizations are not formed for purposes of trade they maintain different types of
accounts from the trading organizations.
Instead of preparing cash book the non proit making organizations prepare a receipts and
payments account whose entries however are similar to those made in the cash book.
The excess of income over expenditure is referred to as a surplus; the equivalent of a proit in
the P & L account. If expenditure exceeds income then a deicit results; the equivalent of a loss
in the P & L account.
Since the non proit making organizations are not owned by a group of people, they do not
maintain a capital account. Instead the member’s contributions, donations, investments e.t.c are
maintained as accumulated fund instead of capital.
T E X T
•
•
Prepare inancial statements for nonproit making organizations
Understand and explain the terminologies used in the inancial statements of nonproit
making organizations different from sole proprietorship
Understand the format of the inancial statement for a nonproit making organization
Understand the operation of nonproit making organizations such as clubs and explain
the sources of revenue to these form of business organizations
S T U D Y
•
•
188
FINANCIAL ACCOUNTING
The non proit making activities may however carry some trading activities in small scale to
inance some of the clubs activities e.g. a golf club may also be operating a bar. In such cases
then, in addition to the statement of comprehensive income the organization may also maintain a
trading account for such trading activities e.g. a bar’s trading account which will be similar to the
trading account of proit-making organizations.
DEFINITION OF KEY TERMS
Non proit making organizations are some form of business organization that is set up to
promote or to cater for the welfare of the members involved and not to make proit.
EXAM CONTEXT
S T U D Y
T E X T
As you can see in the past paper analysis at the end of this chapter, this is a frequently examined
chapter. Clear understanding of its content will be an obvious edge.
INDUSTRY CONTEXT
Examples of non-proit making organizations are the Kenya Red Cross, Strathmore University,
Muthaiga Country Club and many other entities that do not exists to make a proit and distribute
to share holders. Nonproit corporations exist solely to provide programs and services that are
of public beneit. While they are able to earn a proit, more accurately called a surplus; such
earnings must be retained by the organization for its future provision of programs and services.
Earnings may not beneit individuals or stake-holders.
NON PROFIT MAKING ORGANIZATIONS
189
THE FORMAT OF THE STATEMENT OF COMPREHENSIVE INCOME
<NAME OF ORGANISATION>
STATEMENT OF COMPREHENSIVE INCOME
FOR THE YEAR ENDED <DATE>
Incomes
Proit from trading activities
Sh
Sh
Xx
Xx
Income from investments
Xx
Donations
Income from other activities(e.g. dinner dance, rafles
e.t.c)
Xx
Xx
xxx
T E X T
Subscriptions
Depreciation
Xx
Salaries and wages
Xx
Expenses on other activities e.g. prizes
Xx
Loss from trading activities
Xx
All other expenses
xx
S T U D Y
Expenditure
(xxx)
SURPLUS/ (DEFICIT)
xxxx
190
FINANCIAL ACCOUNTING
FORMAT OF THE STATEMENT OF FINANCIAL POSITION
XYZ COMPANY LTD
STATEMENT OF FINANCIAL POSITION AS AT XXXXX
S T U D Y
T E X T
Sh
Non-current assets
land and buildings
plant and equipment
xx
Sh
Sh
Accumulated
Depreciation NBV
xxx
(xx)
xx
ixtures, furniture and ittings
xx
(xx)
xx
motor vehicles
xx
(xx)
xx
total non-current assets
Xx
Xx
xxx
Current Assets
stock
Debtors
less provision for doubtful debts
xxx
(xxx)
Cost
xx
xxx
Prepayments
short term investments
cash in hand(receipts and payments)
total current assets
less Current Liabilities
bank overdraft
Creditors
Accruals
Xxx
Xxx
xxx
xxx
xxx
xxx
xxx
(xxx)
xxx
yyyyy
net current assets
total assets
Accumulated fund b/f
Add/(less):surplus(deicit)
Xx
Xx_____
xx
(xx)____
xxx
Less: drawings
Other funds
Life membership fund
Building education fund
Xx
Xx
xx
yyyy
NON PROFIT MAKING ORGANIZATIONS
191
NOTES TO THE FORMAT ON THE OPPOSITE PAGE
1 SUBSCRIPTION
Fast forward - Any subscriptions prepaid are shown as creditors since the club is the one left with
a liability of providing the service already paid for.
These are the amounts received by the club from the members to renew their membership. It is
often paid on an annual basis. Usually this is income for the club and is therefore reported in the
statement of comprehensive income. Depending on the policy of a club, any subscriptions due
but not received are shown as accrued income (debtors for subscriptions) in the balance sheet.
Fast forward – If investment income is for a speciic purpose and relates to a speciic fund it will
not be reported in the statement of comprehensive income, but credited directly to the fund.
Some clubs invest excess cash in the bank (ixed deposit account), shares of limited companies,
treasury bills and any other investment that may be available.
If the club is investing with no speciic intention (i.e. a general investment) then the income from
this investment should be reported in the statement of comprehensive income. However if the
investment is for a speciic purposed and relates to a speciic fund (e.g. building fund) it will not
be reported in the statement of comprehensive income but credited directly to the fund.
3. OTHER FUNDS
These are fund set up for a speciic purpose. They will be shown together with the accumulated
fund. Any incomes relating to these funds will be credited directly to the funds net of any expenses
incurred in generating the funds. Such funds include building funds, educational funds e.t.c
S T U D Y
2. INCOME FROM INVESTMENT
T E X T
Any subscriptions prepaid are shown as creditors since the club is the one left with a liability
of providing the service already paid for. Some clubs however will not report subscriptions as
income until it is received in form of cash.
192
FINANCIAL ACCOUNTING
LIFE MEMBERSHIP FUND
Some members may pay some amount to become full life members of the club and if this happens,
there may be a need to spread out these amounts over the expected life of the members in the
club. Depending on the policy of the club, the following accounting treatment may be allowed:
i)
ii)
S T U D Y
T E X T
iii)
The full amount is reported in the statement of comprehensive income in the year it is
receive and therefore no balance is retained in the life membership account.
The amount is shown separately in the life membership fund with no transfer in the
statement of comprehensive income and hence no balance in the life membership
account.
Some amount is transferred to the income and expenditure from the life membership
fund over the expected life of the members in the club.
CHAPTER SUMMARY
Non proit making organizations are organizations which do not exist primarily to make proit
but to fulil some other purpose such as the general welfare of society, or to promote sports,
religion or some other lawful activity.
They may carry out some trading activity, but this would be strictly to assist them in achieving
their objectives.
They maintain two main accounts: the receipts and payments account and the income and
expenditure account.
CASE STUDY
The K-Rep Company is a holding company, whose primary function is to own the K-Rep NGO
and hold majority shares in the K-Rep Bank. It is a non-proit company registered as a company
limited by guarantee. Its income mostly constitutes dividends and income on fee notes from the
K-Rep Bank. This income is channeled to the NGO for product development and experimentation
in keeping with the mission of K-Rep.
NON PROFIT MAKING ORGANIZATIONS
193
CHAPTER QUIZ
S T U D Y
T E X T
1. Why do non- proit making organizations exist?
2. Why don’t non- proit making organizations maintain a capital account?
194
FINANCIAL ACCOUNTING
ANSWERS TO CHAPTER QUIZ
1.
2.
To promote or to carter for the welfare of the members involved and not to make proit.
They are not owned by individuals or groups for proit generation. They instead have
accumulated funds from members.
PAST PAPER ANALYSIS
S T U D Y
T E X T
6/07, 6/06, 6/05, 12/03, 12/02
NON PROFIT MAKING ORGANIZATIONS
195
EXAM TYPE QUESTIONS
Question 1 (June 2006 Question2)
Umoja Women’s Welfare Society sells water tanks at subsidized prices to its members and the
general public. The members’ contributions are used to meet the cost of manufacturing the water
tanks.
The trial balance extracted from the books of account of the society as at 30 April 2006 was as
follows:
Stock of raw materials as at 30 April 2006
20,000
Motor vehicle: Cost
10,000
Machinery:
22,000
Accumulated depreciation
Cost
Accumulated depreciation
Donations from members
Raw materials used in production of water tanks
Sale of water tanks
Selling expenses
Factory wages
Factory overheads
Creditors for raw materials
Cash at bank and in hand
Society’s ofice expenses
Membership fees fund
Sale of Rafle tickets
10,000
4,000
5,000
2,500
35,000
2,000
45,000
600
1,000
2,800
500
4,100
Rafle prizes paid
1,200
Suspense account
7,900
Cost of rafle tickets
25,000
T E X T
Annual subscriptions received
Sh.’000’
CR
S T U D Y
Accumulated fund as at 1 may 2005
Sh.’000’
DR
7,500
2,800
300
104,600
104,600
196
FINANCIAL ACCOUNTING
Additional information:
1
An investigation carried out on the suspense account revealed that it comprised:
S T U D Y
T E X T
Subscriptions in arrears as at 30 April 2005
Bonus paid to factory staff during the year
Rent for factory building
Rent for the society’s ofices
Subscriptions in advance as at 30 April 2005
Sh.’000’
3,500
1,500
1,000
4,000
2,100
7,900
2
Annual subscriptions in arrears as at 30 April 2006 amounted to Sh 2,000,000 while
subscriptions received in advance as at 30 April 2006 amounted to Sh 1,500,000.
3
The membership fee is levied every ten years. The membership fees attributable to the
year ended 30 April 2006 amounted to Sh 800,000
4
Accrued society’s ofice expenses as at 30 April 2006 amounted to Sh 400,000.
5
The motor vehicle usage should be apportioned to the factory and society’s ofices at
80% and 20% respectively. Depreciation should be provided on cost at 5% per annum
on machinery and 10% per annum on motor vehicles.
Required:
(a) Water tanks trading and statement of comprehensive income for the year ended 30
April 2006
(6 marks)
(b)
Income and expenditure account for the year ended 30 April 2006
(c ) Statement of inancial position as at 30 April 2006.
(8 marks)
(6 marks)
(Total: 20 marks)
Question 2 (June 2007 Question 3)
Bahari Sailors Club is an association for sailors. It provides the following services to the members
and the public:
•
•
•
•
A club house with a bar for drinks and other social functions
Yacht racing competitions
Hire of boats
A sailing training school for all age groups.
NON PROFIT MAKING ORGANIZATIONS
197
The following inancial information relates to the club as at 1 June 2006:
5000
40000
8000
3000
35000
Current assets and liabilities:
Members’ subscriptions:
Outstanding
Prepaid
Bank balance
Bar stocks
Creditors for bar purchases
400
560
11.070
3.100
500
The club’s receipts and payments for the year ended 31 May 2007 were as follows:
Sh ‘000’
Payments
Sh ‘000’
Receipts
Receipt from training school
2.050
Boat hire charges:
For members
Purchase of two new club yachts 5.000
Repairs to yachts and boats
900
1.920
Purchase of bar stocks
5.010
For non-members
Members’ subscriptions
1.960
20.090
Bar and social functions’ takings
(Cash collections)
8.000
Fees and charges from yacht racing
Competitions
Salvage proceeds from sunk boat
Additional information:
1)
3.080
Prizes paid on yacht racing
competitions
1.870
Wages to barmen
1.260
salary to training school staff and
bar attendants
1.500
General expenses
2.200
200
During the year, a club boat whose net book value was Sh 2,000,000 was involved in a
collision while sea. The boat sunk and the salvage was disposed of for Sh 200,000.
S T U D Y
Fixed assets (Net book value):
Repairs workshop
Freehold premises
Boatyard and launch facilities
Fixtures and ittings
Club-owned boats and yachts
T E X T
Sh ‘000’
198
FINANCIAL ACCOUNTING
2)
Depreciation is provided on reducing balance basis at the following annual rates:
3)
Full years’ depreciation is provided in the year of acquisition but none in the year of
disposal. Bar stocks as at 31 May 2007 were valued at Sh 2850000.
4)
Outstanding creditors as at 31 May 2007 were as follows:
Sh. ‘000’
Bar purchases
610
Bar wages
35
Repairs to boats
320
5)
Non-members are allowed to hire boats at an extra charge of 20%. During the year,
25% of the 20% extra charge received from hire of boats to non-members was donated
to a local charity. This donation had not yet been paid to the local charity.
T E X T
Rate
5%
5%
5%
10%
10%
6)
S T U D Y
Asset:
Freehold premises
Boatyard and launch facilities
Club boats and yachts
Fixtures and ittings
Repairs workshop
A retired club member died recently and bequeathed (left by his will) two boats to the
club. The boats were valued at Sh 3000000 and were formally acquired on 1 May
2007.
7)
As at 31 May 2007 outstanding and prepaid member’s subscripts amounted to Sh
350000 and Sh 790000 respectively.
Required:
a)
Income and expenditure account for the year ended 31 May 2007.
b)
Statement of inancial position as at 31 May 2007.
(12 Marks)
(8 marks)
199
S
T
S T
T SU
U TD
DUY
YD Y
T E
E TX
X ET
TX T
CHAPTER SEVEN
MANUFACTURING ACCOUNT
S T U D Y
T E X T
200
FINANCIAL ACCOUNTING
201
CHAPTER SEVEN
MANUFACTURING ACCOUNTS
OBJECTIVES
After studying this chapter, you should be able to:
Identify the various types of costs and their classiication for purposes of preparing the
manufacturing account
Distinguish between production and non production costs, prime cost and overhead costs
Prepare manufacturing, trading and statement of comprehensive income for a manufacturing
irm
Earlier we dealt with sole proprietors; most sole proprietors are merchandising entities since
they buy goods in a form when they are ready for sale. They resale the goods and hence a
majority of them are distributive agents. Another form of business enterprise is manufacturing
business. These are businesses that manufacture the goods themselves and later distribute
them. Such enterprises in Kenya include Unilever (K) Ltd, Bidco Oil Reineries e.t.c. for such
business enterprises an account known as a manufacturing account is prepared in addition to
the statement of comprehensive income
A manufacturing enterprise will utilize a manufacturing account to determine production cost. In
the trading, statement of inancial performance will be used instead of a purchases account.
DEFINITION OF KEY TERMS
Prime cost: These are costs that can be directly related attributed to a unit of product. The sum
of direct costs is referred to as prime costs.
EXAM CONTEXT
This is a very important chapter. Though not tested very frequently, examiners have repeatedly
stressed that students must know the whole syllabus. If you miss out a syllabus area, you will
severely limit your chances of passing the exam.
S T U D Y
INTRODUCTION
T E X T
Understand the concept of unrealized proit and pass journal entries to account for the
provision
202
FINANCIAL ACCOUNTING
INDUSTRY CONTEXT
This is a very important chapter bearing in mind the number of manufacturing industries in the
country. All the concepts that will be discussed in this chapter are very important.
S T U D Y
T E X T
7.1
PRODUCTION COSTS
In manufacturing enterprises the total costs of production is divided into two:
i)
ii)
Prime cost/ direct cost
Indirect cost
I) DIRECT MANUFACTURING COST
Fast forward – Direct costs are costs that are easily traced into a unit of a product.
Direct costs are also known as prime costs. These are costs that can be directly related attributed
to a unit of product. The sum of direct costs is referred to as prime costs. The costs are easily
traced into a unit of a product.
They include:
a) Direct materials
b) Direct labor
c) Direct expenses
Other direct costs include: hire purchase of special machinery for production, carriage inwards
on raw materials.
MANUFACTURING ACCOUNT
203
II) INDIRECT MANUFACTURING COSTS.
These are incurred during the production process but cannot be easily traced to unit of a product
made. This cost must be incurred for production to be complete. They include:
a)
b)
c)
d)
e)
f)
Factory lighting and heating
Rent of factory
Deprecation on plant and equipment
Factory power
Wages for factory casuals
Maintenance of factory forklifts
III) OTHER EXPENSES
Other expenses incurred by a manufacturing enterprise include:
Salaries and wages for staff (administration staff)
Legal expenses
Accountancy expenses
Depreciation of ofice equipment
ii) Selling and Administration Expense
Ø
Ø
Ø
Ø
Ø
Salaries and wages for the sales and marketing team
Depreciation for distribution vehicles
Advertising expense
Carriage outwards,
Commissions paid out on sales
iii) Finance charges
Ø
Ø
Ø
Ø
Discount allowed
Bank charges
Bank interest on loan
Debenture interest
S T U D Y
Ø
Ø
Ø
Ø
T E X T
i) Administration Expense
204
FINANCIAL ACCOUNTING
7.2
THE MANUFACTURING STATEMENT OF
COMPREHENSIVE INCOME
Fast forward – The statement of comprehensive income will be similar to that of a sole
proprietorship except for a few areas that are covered below.
The manufacturing statement of comprehensive income will be divided into three:
•
•
•
Manufacturing section
Trading account
Proit and loss account
These sections are clearly shown in the format below:
S T U D Y
T E X T
Format of a manufacturing account:
XYZ LTD
MANUFACTURING ACCOUNT
FOR THE PERIOD ENDED XX XX XX
Production cost for the period:
Direct material
Direct labor
Direct expenses
Prime costs
Indirect manufacturing costs
Indirect labor
Indirect materials
Factory rent
Depreciation for factory machinery and plant
Salary for factory manager
Heating and lighting expenses
Total cost of production during the period
Sh
Sh
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
MANUFACTURING ACCOUNT
205
Sometimes we may have the balances of raw materials from previous year’s production. These
could also be Work In Progress (WIP) brought in at the beginning of the period as well as some
work in progress at the end of the period. In this case the format would appear as follows:
XYZ LTD
MANUFUCTURING ACCOUNT
FOR THE PERIOD ENDED XXXXXX
xxx
(xxx)
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
T E X T
Indirect Expenses
Indirect labor
Indirect expenses
Heating expenses
Lighting expenses
Depreciation of factory equipment
Depreciation of factory van
Factory salaries/wages
Factory rent
Total indirect expense
Add opening work in progress
Less closing work in progress
Total Cost of production
Manufacturing gross proit added
Finished goods at transferred price
xxx
xxx
xxx
(xxx)
S T U D Y
Opening stock raw materials
Add: purchased raw materials
Carriage inwards (raw materials)
Less: return outwards (raw materials)
Cost of materials available for production
Less closing stock (R.M)
Cost of raw materials used
Add direct labor
Direct expenses
Prime costs
xxx
xxx
(xxx)
xxx
xxx
xxx
The statement of comprehensive income will be similar to that of a sole proprietorship
except for the following:
i)
The purchases will be replaced by inished goods at transfer price. This is because
inished from manufacturing are now the ones being put up for sales.
ii)
The opening sock to be used in the statement of comprehensive income is the opening
stock of inished goods.
206
FINANCIAL ACCOUNTING
iii)
After obtaining gross proit we add the element of factory proit if we had marked up
the goods before transferring them from the factory. If there was no transfer then this
need not be done. This arises because once we marked them up; the costs of goods
available for sale as well as cost of sales were increased by the element of proit and
consequently reducing our gross proit.
>>> Illustration I:
Given the following:
Sales = 200000
Cost of production
Opening stock of inished goods = 20000
Closing stock of inished goods = 25000
Determine the gross proit, assuming the goods were transferred at cost:
Sales
200000
Cost of sales
Opening stock
20000
Add cost of production
100000
Goods available for sale
120000
Less closing stock
(25000)
Cost of sales
(95000)
Gross proit
105000
ii)
Calculate the gross proit, assuming the cost of production was marked up by 25%
before transfer from manufacturing.
S T U D Y
T E X T
i)
Cost of production = 100000
Transfer mark up = 100000x 20/100 = 20000
Transfer price = 100000 + 20000 = 120000
Sales
Cost of sales
Opening stock
Add: transfer price of inished goods
Cost of goods available for sale
Less; closing stock
Cost of sales
Gross proit
Add: manufacturing gross proit
Total gross proit
Sh
200000
20000
120000
140000
(25000)
(115000)
85000
20000
115000
You will realize that if we mark up the cost of goods manufactured, we end up understating the
gross proit by the amount of mark up and hence the need to mark back the manufacturing gross
proit to normal sales gross proit.
MANUFACTURING ACCOUNT
7.3
207
PROVISION FOR UNREALIZED PROFIT
Fast forward – a high value of closing stock will lead to a lesser value of cost of goods and
consequently higher proits (overstated proits).
For irms that take up the policy of marking up goods during manufacturing, there will be an
element of unrealized proit in the value of the closing stock for inished goods. This needs to
be adjusted for so that we can relect statements that are reliable and accurate. If the element
of unrealized proit is not deducted from closing stock of inished goods we end up overstating
closing stock which in effect overstates our gross proit. This is because a high value of closing
stock will lead to a lesser value of cost of goods and consequently higher proits (overstated
proits)
The adjustment is done as follows:
Cr. Finished goods account
T E X T
xxx
xxx
(With amount of unrealized proit)
>>> Illustration
ABC Co. LTD manufactures food products for the local market. The factory applies \ mark up of
25% on goods transferred to the selling department. For the year just ended, the closing stock of
inished goods was found to be Sh 1000000. Calculate and show the adjustments necessary:
amountof unrealised profit =
25
= 200000
125
Dr. P&L account (unrealized proit) 200000
Cr. Finished goods account 200000
If during the previous year a provision for unrealized proit had been made at Sh 50000, then this
year we would only require making an extra Sh 150000. The account would appear as follows:
Unrealied profits a/c
Sh
P&L account
150000
Sh
Provision for unrealized profits
a/c
150000
S T U D Y
Dr. P&L account
208
FINANCIAL ACCOUNTING
Proision for unreali ed profits
Sh
Balance c/d
200000
Sh
Profit for the year
150000
Balance c/d
50000
______
______
200000
200000
The statement of inancial position of manufacturing enterprises is similar to that of other
organizations. The only difference is that may arise is that there will be there will be three classes
of stock under current assets. These are:
Closing stock of inished goods
Closing stock of raw materials
Closing stock of work in progress
S T U D Y
T E X T
i)
ii)
iii)
CHAPTER SUMMARY
In manufacturing enterprises the total costs of production is divided into two:
i)
ii)
Prime cost/ direct cost
Indirect cost
If the element of unrealized proit is not deducted from closing stock of inished goods we end
up overstating closing stock which in effect overstates our gross proit. This is because a high
value of closing stock will lead to a lesser value of cost of goods and consequently higher proits
(overstated proits).
MANUFACTURING ACCOUNT
209
CASE STUDY
The Chandaria Group of Industries is a family-owned manufacturing company (with the three key
players being Maganlal and his two sons, Dinesh and Mahesh) that relies on a strong professional
team being involved in every sector of specialization. A committed team of senior, middle and
junior managers ensure a drive of excellence in all the departments such as global research,
production, sales and marketing and inance.
One of the main reasons why Chandaria Group of Industries is successful is its ability to account
for all its investments and processes.
S T U D Y
1. How is the total cost of production divided in manufacturing enterprises?
2. What are prime/ direct costs?
T E X T
CHAPTER QUIZ
210
FINANCIAL ACCOUNTING
ANSWERS TO CHAPTER QUIZ
1. - Prime/ direct costs
- Indirect costs.
2. These are costs that can be directly related to a unit of production.
PAST PAPER ANALYSIS
S T U D Y
T E X T
12/07, 12/06, 6/06, 6/04, 6/03
MANUFACTURING ACCOUNT
2 11
EXAM TYPE QUESTION
Question 1 (December 2007 Question2)
The following balances were extracted from the books of Taba Ltd., a manufacturing and trading
company, as at 31 October 2007:
Sh “000”
Business premises at cost
20.000
Plant and equipment at cost
18.000
Motor vehicles at cost
6.400
Accumulated depreciation as at 1 November 2006:
10.000
Motor vehicles
2.400
Ordinary shares (Sh.10 each)
15.000
Share premium
Retained earnings (1 November 2006)
5.000
28.300
Inventory as at 1 November 2006:
Direct materials
Work in progress
Finished goods
1.200
800
1.600
Purchases of direct materials sales
16.400
Production overhead
67.100
Administration overhead
10.400
Trade receivables
4.900
Trade payables
4.600
Other payables: PAYE
1.300
VAT
2.800
Cash in hand 300
Bank balance
32.900
Direct manufacturing wages
18.000
Selling overhead
200
T E X T
Plant and equipment
3.200
S T U D Y
Business premises
212
FINANCIAL ACCOUNTING
Additional information:
1.
On 1 November 2006, the company sold an item of plant for Sh 600.000. The item of
plant had cost the company Sh 2.000.000 on 1 November 2003. The proceeds from the
sale were recorded as a credit to the sales account and a debit to the bank account.
2.
Depreciation for the year ended 31 October 2007 is to be provided using the following
annual rates:
S T U D Y
T E X T
Asset
Business premises
Plant and equipment
Motor vehicles
Rate
4% based on cost
20% based on cost
25% on reducing balance basis
3.
Depreciation on motor vehicles is to be apportioned as follows:
Rate
Production overhead
50%
Selling overhead
25%
Administration overhead
25%
Depreciation on other assets is to be allocated to production overhead.
4.
Inventory of raw materials as at 31 October 2007 was valued at Sh 1400000. This
inventory included raw material which cost Sh 300000 and could only realized a scrap
value of Sh 100000.
5.
Closing work-in progress as at 31 October 2007 was valued as follows:
Sh.
Direct labour
500000
Direct material
125000
Production overhead
200000
Total
1700000
6.
The year end stock taking for inished goods was done on 3 November 2007. These
goods were valued at Sh 1300000 being the cost production.
7.
The following transactions took place between 1 November 2007 before the stock
taking of the inished goods was carried out.
Sh.
• Sales to customers at selling price
500,000
• Returns by customers at selling price
125,000
• Completed work-in progress at total production cost 200,000
The goods sold to customers during the period 1 November 2oo7 to 3 November 2007 were at a
uniform mark-up of 25% on the production cost.
Required:
a)
b)
Manufacturing, trading and statement of comprehensive income for the year ended 31
October 2007.
(12 marks)
Statement of inancial position as at 31 October 2007.
(8 marks)
(Total 20 marks)
MANUFACTURING ACCOUNT
213
Question 1 (June 2003 Question 1)
The following balances have been extracted from the books of Limuru Manufacturers, a small
scale manufacturing enterprise, as at 31 December 2002:
Sh.
‘000’
Raw materials
Work in progress
Finished goods
Purchases of raw materials
Rent and rates
Lighting
Stationery and postage
Staff salaries
Sales
Plant and machinery:
At cost
Provision for depreciation
Motor vehicles (for sales deliveries):
6,900
38,000
At cost
Provision for depreciation
Creditors
16,000
9,000
19,000
6,000
2,000
19,380
192,000
30,000
12,000
16,000
4,000
5,500
28,000
Debtors
Drawings
Balance at bank
Capital at 1 January 2002
Provision for unrealized proit at 1 January
2002
Motor Vehicle running costs
11,500
16,600
48,000
1,380
4,500
Additional information:
1.
Stocks at 31 December 2002 were as follows:
Sh.
‘000’
Raw materials
Work in progress
Finished goods
2.
9,000
8,000
10,350
The factory output is transferred to the trading account at factory cost plus 25% of
factory proit.
T E X T
Variable
Fixed
Administrative expenses:
5,000
28,000
Direct labour
Factory overheads:
7,000
S T U D Y
Stocks as at 1 January 2002:
214
FINANCIAL ACCOUNTING
3.
4.
Depreciation is provided at the rates shown below on the original cost of ixed assets
held at the end of each inancial year.
Plant and machinery
10% per annum
Motor vehicles
25% per annum
Amounts accrued at 31 December 2002 for direct labour amounted to Sh 3,000,000
and rent and rates prepaid at 31 December 2002 amounted to Sh 2,000,000.
Required:
(a)
(b)
Manufacturing, trading and proit and loss account for the year ended
31 December 2002.
Statement of inancial position as at 31 December 2002.
(12 marks)
S T U D Y
T E X T
(8 marks)
(Total: 20 marks)
215
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CHAPTER EIGHT
FINANCIAL STATEMENT
ANALYSIS
S T U D Y
T E X T
216
FINANCIAL ACCOUNTING
217
CHAPTER EIGHT
FINANCIAL STATEMENT ANALYSIS
OBJECTIVES
After you have studied this chapter, you should be able to:
•
INTRODUCTION RATIO ANALYSIS
Fast forward - A inancial ratio is a relationship between inancial variables and helps ascertain
inancial condition of the irm.
Ratio analysis is a means of comparing and quantifying relationships between inancial variables
in the statement of comprehensive income and the Statement of inancial position. A inancial
ratio is a relationship between inancial variables and helps ascertain inancial condition of the
irm. With ratios, inancial statements can be interpreted and usefully applied to satisfy the needs
of the users of inancial statements.
EXAM CONTEXT
This like all chapters is a very important chapter. It has been examined frequently and can be
tested in any sitting.
INDUSTRY CONTEXT
Financial statements analysis reports give a frank inancial account into the current state of the
business, regarding stock turnover and the ability to meet short and long term debts. Managers,
Shareholders, Creditors etc all take an interest in Ratio Analysis. For example, managers can
use the information to see if the company’s liquidity is struggling and they may have to take out
short term inance such as an overdraft to overcome this.
T E X T
•
•
•
Explain how the use of ratios can help to analyze the proitability, liquidity, eficiency and
capital structure of a irm.
Calculate the main accounting ratios.
Interpret the results of calculating accounting ratios
Explain the advantages and disadvantages of the gearing of an organization being high
or low.
Explain how the proportion of costs that are ixed and variable impacts proit at different
levels of activity.
S T U D Y
•
218
FINANCIAL ACCOUNTING
However its drawbacks include that it purely only covers the inancial aspects of how a business
is performing and therefore managers should take into account the current state of the market. Is
it in a period of recession? This may relect depressing ratios - depressing ratios may also mean
that the company is growing and investing heavily into marketing or research and development
which means it will have very small amounts of working capital. It should also be used as part of
a trend of data for example - Gearing over a number of years, is it decreasing or increasing - and
why and what is the result of this?
CLASSIFICATION OF RATIOS
S T U D Y
T E X T
Ratios can be classiied into:
a)
b)
c)
d)
Liquidity ratios.
Leverage or gearing ratios.
Activity ratios.
Proitability ratios.
USERS OF RATIOS
There are a vast number of parties interested in analyzing inancial statements including
shareholders, lenders, customers, employees, government, and competitors. In many occasions,
they will be interested in different things therefore there is no any deinite, all-encompassing list
of points for analysis that would be useful to all these stakeholders. However, it is possible to
construct a series of ratios that together will provide all of them with something that they ind
relevant and from which they can investigate further if necessary.
Ratio category
Examples of interested parties
Proitability
Shareholders, management, employees, creditors, potential investors
Liquidity
Shareholders, potential purchasers, competitors
Eficiency
Shareholder
Shareholders, suppliers, creditors, competitors
Shareholders, potential investors
Capital structure Shareholders, lenders, creditors, potential investors
Liquidity ratios
These measure irm’s ability to meet its short-term maturing obligations as and when
they fall due. The lower the ratio, the higher the liquidity risk and vice versa. Failure to
meet short term liabilities due to lack of liquidity may lead to poor credit worthiness,
litigation by creditors and insolvency.
2.
Leverage or gearing ratios
These measure extent to which a company uses its assets which have been inanced
by non owner supplied funds. They measure inancial risk of the company. The higher
the ratio, the higher the inancial risk. Gearing refers to the amount of debt inance a
company uses relative to its equity inance.
3.
Activity ratios
These measure the eficiency with which a irm uses its assets to generate sales. They
are also called turnover ratios as they indicate the rate at which assets are converted
into sales.
4.
Proitability ratios
They measure the management’s effectiveness as shown by returns generated on sales
and investment. They indicate how successful management has been in generating
proits of the company.
5.
Investment or equity ratios
These are used to evaluate the overall performance of a company. E.g. in determining
company’s dividend policy, determining theoretical value of company’s securities and
predicting effects of rights issue.
1.
LIQUIDITY RATIOS
Fast forward – These measure irm’s ability to meet its short term maturing obligations as and
when they fall due.
§
Current ratio. This is computed by dividing total current assets by total current
liabilities:
Current ratio = Current assets
Current liabilities
Current ratio of more than one means that a company has more current assets than
current liabilities.
§
Acid test or quick ratio. This is calculated by dividing total current liabilities excluding
stock by current liabilities. A irm with a satisfactory current ratio may actually be in a
poor liquidity position when inventories form most of the total current assets.
Acid test ratio = Current assets less stock
Current liabilities
T E X T
1.
219
S T U D Y
FINANCIAL STATEMENT ANALYSIS
220
FINANCIAL ACCOUNTING
2. GEARING OR LEVERAGE RATIOS
Fast forward - These measure extent to which a company uses its assets which have been
inanced by non-owner supplied funds.
§
Debt ratio or capital gearing ratio. This measure the proportion of debt inance to
capital employed by a company. A company is highly geared if the ratio is greater than
50%.
Debt ratio = Total long term debt x 100%
Capital employed
§
Debt equity ratio. This measures the proportion of non owner supplied funds to
owner’s contribution to the company. A company is highly geared if the debt equity ratio
is greater than 100%.
Debt equity ratio =
S T U D Y
T E X T
§
Long term debt
Equity or Net worth
Times interest cover. This shows number of times earnings by a company cover its
current payments. The higher the ratio, the lower the gearing position and thus the
lower the inancial risk.
Times interest cover = Earnings before interest and tax + Depreciation
Interest charged
3.
PROFITABILITY RATIOS
Fast forward - These measure management’s effectiveness as shown by returns generated on
sales and investment.
§
Return on capital employed (ROCE). This measures the eficiency with which a company
uses long term funds or permanent assets to generate returns to shareholders.
ROCE = Proit before interest and tax or operating proit
Total capital employed
Capital employed consists of shareholders funds (ordinary share capital, preference
share capital, share premium and retained earnings) and long term debts. Capital
employed can also be calculated as ixed assets plus net working capital.
FINANCIAL STATEMENT ANALYSIS
§
221
Gross proit margin. This ratio shows how well cost of production has been controlled
in relation to distribution and administration costs.
Gross proit margin = Gross proit X 100%
Sales
§
Net proit margin. This measures irm’s ability to control its production, operating and
inancing costs.
Net proit margin = Net proit X 100%
Sales
Net assets turnover. This gives a guide to productive eficiency i.e. how well assets
have been used in generating sales.
Net assets turnover =
Operating proit/margin ratio. This indicates eficiency with which costs have been
controlled in generating proit from sales.
Operating proit ratio = Proit before interest and tax or operating proit X 100%
Sales
§
Operating expenses ratio. This indicates a irm’s ability to control production and
operating costs to generate a given level of sales.
Operating expenses ratio = Operating expenses X 100%
Sales
§
Return on investment. This measures the eficiency with which a company uses its
total funds in capital employed to generate returns to owner’s funds.
Return on investment = Net proit after tax X 100%
Capital employed
§
Return on equity. (ROE) This measures the eficiency with which a company other
supplier’s funds to generate returns to shareholders.
Return on equity = Earnings attributable to equity shareholders X 100%
Equity
Equity comprises of ordinary share capital, share premium and reserves.
T E X T
§
Sales
Capital employed
S T U D Y
§
222
FINANCIAL ACCOUNTING
4. ACTIVITY RATIOS
Fast forward - These measure the eficiency with which a irm uses its assets to generate sales
§
Debtor’s turnover. This shows the number of times debtors pay within the year. It
indicates how eficient the irm is in management of credit. The higher the ratio, the
more eficient management is in managing its credit policy.
Debtor’s turnover =
§
Credit sales
Average debtors
Debtor’s days or ratio. This is also called the average collection period. It shows
the average period of credit taken by customers who buy on credit. It is compared the
company’s allowed credit period by suppliers to give an indication of credit administration
eficiency.
S T U D Y
T E X T
Debtor’s days or ratio = Average debtors X Number of days in a year.
Credit sales
=
§
Number of days in a year
Debtor’s turnover
Creditor’s turnover. This indicates the number of times creditors are paid by a company
during a year.
Creditor’s turnover =
§
Credit Purchases
Average creditors
Creditor’s days or ratio. This is also called the average deferral period. It indicates the
average time that suppliers allow a company to settle its dues.
Creditor’s days or ratio = Average creditors
Credit purchases
=
§
X Number of days in a year.
Number of days in a year
Creditor’s turnover
Stock or inventory turnover. This indicates the eficiency of a irm in selling its products
so as to generate sales. It shows the times stock is turned over or converted into sales
within a year. It shows how rapidly stock is being turned into cash through sales.
Stock or inventory turnover =
Cost of sales
Average stock
FINANCIAL STATEMENT ANALYSIS
§
223
Stock days/inventory conversion period. This indicates the number of days it takes
to convert inventory into sales. The fewer the number of days, the more eficient a
company is in converting stock into sales.
Stock days/inventory conversion period =
Average stock
Cost of sales
X Number of days in a year.
= Number of days in a year
Inventory turnover
Average collection period
Add inventory conversion period
Less average deferral period
Working capital cycle
§
xxx
xxx
(xxx)
xxx
Cash turnover/Operating turnover. This shows number of times a company needs to
replenish its working capital in a year.
Cash turnover/Operating turnover = Number of days in a year
Working capital cycle
§
Fixed assets turnover. This indicates level of sales generated by ixed asset base of
a company. It shows the eficiency with which a company utilizes its assets to generate
sales.
Fixed assets turnover =
Sales
Total ixed assets
T E X T
Cash working cycle/Working capital cycle/Operating cycle. This is the period for
which working capital inancing is needed. The higher the working capital cycle, the
higher the investment in working capital. It is the period of time that elapses between
the point at which cash is spent on production or purchase of raw materials/stock to
time stock is converted into cash or cash is collected from a customer.
S T U D Y
§
224
FINANCIAL ACCOUNTING
5.
INVESTMENT OR EQUITY RATIOS
Fast forward - These are used to evaluate the overall performance of a company
§
Earnings Per Share (EPS). This indicates the amount shareholders expect to generate
in form of earnings for every share invested. It shows proitability of a company on a per
share basis.
EPS = Earnings attributable to equity shareholders
Number of ordinary shares
§
Dividend Per Share (DPS) This represents the amount of cash dividend that
shareholders expect to receive for every share invested in the company.
Dividend Per Share =
T E X T
§
Total ordinary dividends
Number of ordinary shares
Dividend pay out ratio. This indicates proportion of earnings attributable to equity
shareholders that are paid out to common shareholders as dividends. It is used in
analysis of dividend policy of the irm.
S T U D Y
Dividend pay out ratio =
Total common dividends
Earnings attributable to equity shareholders
=
§
Retained earnings
X 100
Earnings attributable to equity shareholders
Dividend cover.
Dividend cover
§
Dividend per share X 100
Earnings per share
Dividend retention ratio.
Dividend retention ratio =
§
X 100
= Earnings per share
Dividend per share
Earnings yield. This measures the potential return that shareholders expect to earn for
every share invested in a company. It evaluates the shareholders returns in relation to
the market value of a share.
Earnings yield =
Earnings per share
Market price per share
X 100
FINANCIAL STATEMENT ANALYSIS
§
Dividend yield. This ratio measures how much an investor expects to receive from
cash dividends for every share purchased or invested in a company.
Dividend yield =
§
225
Dividend per share
Market price per share
X 100
Price earnings ratio. This indicates how much an investor is prepared to pay for a
company’s share given its current earnings per share. The higher the price earnings
ratio, the more conident investors are that the company will perform well in future.
Price earnings ratio =
Market price per share
Earnings per share
Subjectivity. Ratios are subjective to accounting information that depends on the
accounting policies adopted by a particular organization hence making it impossible for
cross sectional analysis if a company uses different accounting policies. It is dificult to
categorize irms due to diversiications i.e. some companies have more than one line of
business and thus will fall into several industries thus dificult in ratio comparison.
o
Irrelevance. Ratios are historical igures which may irrelevant in making future
decisions.
o
Qualitative aspects are ignored. Qualitative aspects such competent management,
experience and motivation of employees are not captured in computation of ratios.
o
o
o
Ambiguity. Different people will use different stances to describe inancial information
e.g. including preference share capital in equity or return on capital being referred to as
gross capital employed.
Usefulness. Ratios are computed at a speciic point in time. By the time they are
analyzed for decision making, circumstances may have changed thus ratios are only
useful in the short term
Monopoly. For a company without competitor, it may not be .possible to analyze its
performance with other companies in the same industry.
S T U D Y
o
T E X T
LIMITATIONS OF RATIOS
226
FINANCIAL ACCOUNTING
CHAPTER SUMMARY
Ratios can be classiied into:
•
•
•
•
Liquidity ratios.
Leverage or gearing ratios.
Activity ratios.
Proitability ratios.
Ratio category
Examples of interested parties
Proitability
Shareholders, management, employees, creditors, potential investors
Liquidity
Shareholders, potential purchasers, competitors
Eficiency
Shareholder
Shareholders, suppliers, creditors, competitors
Shareholders, potential investors
S T U D Y
T E X T
Capital structure Shareholders, lenders, creditors, potential investors
CASE STUDY
Comparative Analysis of Barclays, KCB & Stanchart (2008)
Proitability
Barclays recorded the highest Proit Before Tax (PBT) of Sh7.1 billion followed by Standard
chartered with Sh 4.9 billion and KCB with Sh 4.2 billion. KCB and Standard Chartered
registered impressive growth levels of 33% and 29% in PBT compared to Barclays 9%.
Reason for proitability difference
KCB’s impressive growth was attributed to a 42% increase in loans and advances to it
customers given their wide branch network and aggressive marketing. Its operational expenses
rose by 20% as the bank opened 11 branches across Kenya and a new subsidiary in Kampala
Uganda.
Standard Chartered Bank’s remarkable growth is attributed to a 49% rise in foreign exchange
income. However the bank had a rise of 23% in operational expenses as it opened 2 new branches
and increased its number of employees.
Barclays’ dismal growth in PBT is attributed to a 43% rise in operational expenses. The bank
increased its network by 95 new Automatic Teller Machine (ATM), 47 branches and 3,003
employees.
FINANCIAL STATEMENT ANALYSIS
227
Balance sheet reviews
Standard Chartered has a healthy balance sheet and recorded the lowest cost to income ratio
of 46% followed by Barclays at 59% and KCB at 65%.This means that Standard Chartered is
able to generate more income at a lower cost.
Barclays
Standard chartered
KCB
Sh.
Sh
Sh
Earnings Per Share
3.6
12.14
1.49
Dividend Per Share
1.65
10
0.7
Price/Earning Ratio
20.28
17.3
20.13
Yield Curve
2.26
4.76
2.67
Average stock price
73
210
30
S T U D Y
(Source, http://markets.nairobist.com/)
T E X T
Lending
Capacity
Standard Chartered is able to lend more as its gross loans and advances to deposits ratio stood
at 56% compared to Barclays whooping 99% and KCBs 77%.In essence Barclays has lend out
most of the customer deposits.
CHAPTER QUIZ
1. What do the proitability ratios measure?
2. What are the limitations of ratios?
3. How is dividend cover calculated?
228
FINANCIAL ACCOUNTING
ANSWERS TO CHAPTER QUIZ
1.
Proitability ratios measure management’s effectiveness as shown by returns generated
on sales and investment. They indicate how successful management has been in
generating proits of the company.
2.
-
Irrelevance
Qualitative aspects are ignored.
Ambiguity.
Can’t be used by monopolies for comparison.
Subjectivity.
3.
Earnings per share
Dividend per share
S T U D Y
T E X T
Dividend cover =
PAST PAPER ANALYSIS
12/06, 6/05, 6/05, 12/04, 12/03
EXAM TYPE QUESTIONS
Question 1 (June 2005 Question 5)
a)
Explain the importance of ratio analysis to a business enterprise.
b)
Identify with reasons, one party who may be interested in each of the following ratios:
(i) Current ratio
(ii) Net proit margin
(iii) Stock turnover
(2 marks)
(2 marks)
(2 marks)
(2 marks)
FINANCIAL STATEMENT ANALYSIS
c)
d)
Citing suitable examples, briely explain of the following terms:
(i)
Accounting concepts
(ii)
Accounting policies
(iii)
Accounting standards
229
(2 marks)
(2 marks)
(2 marks)
Explain the accounting treatment that would be applicable in dealing with the following
transactions relating to the accounts of Mlachake Ltd. for the year ended 31 December
2004:
Question 2 (December 2005 Question 3)
(a)
(b)
State four purposes of ratio analysis
The following information was extracted from the inancial statements of Sunrise Ltd.
and Sunset Ltd. in respect of the year ended 30 September 2005:
Statement of comprehensive income extracts for the year
ended 30 September 2005:
Sales
Cost of sales
Operating proit
Interest expense
Sunrise Ltd.
Sunset Ltd.
Sh. ‘000’
Sh. ‘000’
258,000
153,000
497,000
138,000
19,000
371,000
79,000
-
S T U D Y
T E X T
(i) A debtor who owed the company Sh 200,000 was declared bankrupt on
1 February 2005. 25% of the debt had been recovered when the accounts were
approved by the directors on 15 March 2005.
(2 marks)
(ii) Some items of inventory purchased for Sh 300,000 were damaged in the
warehouse during the year. These items were repaired at Sh 50,000 and sold to a
customer on 2 February 2005 at 75% of the normal selling price of Sh.400,000
(2 marks)
(iii) On 10 December 2004, the company secured an order worth Sh 1.2 million from a
foreign based company. The goods were shipped on 10 January 2005 and
included in sales for December 2004.
(2 marks)
(Total: 20 marks)
230
FINANCIAL ACCOUNTING
Statement of inancial position extracts
as at 30 September 2005:
Non-current assets
Sunrise Ltd.
Sh. ‘000’
142,000
Sunset Ltd.
Sh. ‘000’
92,000
Current assets:
Inventory
Debtors
Cash at bank
100,000
46,000
40,000
87,000
42,000
44,000
33,000
197,000
157,000
Current liabilities
Long-term loan
Shareholders funds
98,000
108,000
Required:
S T U D Y
T E X T
For each company, compute the following ratios:
(i)
(ii)
(iii)
(iv)
(v)
(c)
Acid test ratio
Inventory turnover
Average collection period
Return on capital employed
Debt equity ratio
(2 marks)
(2 marks)
(2 marks)
(2 marks)
(2 marks)
(i) On the basis of the ratios computed in (b) above, comment on the overall
performance of Sunrise Ltd. and Sunset Ltd. and advise which of the two
companies would provide better investment.
(3 marks)
(ii) Explain the possible shortcomings of relying on your analysis in (b) above.
(3 marks)
(Total: 20 marks)
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CHAPTER NINE
COMPANY ACCOUNTS
S T U D Y
T E X T
232
FINANCIAL ACCOUNTING
233
CHAPTER NINE
COMPANY ACCOUNTS
OBJECTIVES
After you study this chapter, you should be able to:
•
•
•
•
•
Deine a company and understand the capital structure of a company and issuance of
share capital by a company
Compare and contrast a Company and other forms of business
Prepare inancial statements for a limited liability company and understand the true and
fair view requirements
Account for forfeiture of shares and reissue of forfeited shares
Calculate rights and determine number of shares issuable give in speciic number
A company is greater in size and complexity than either the sole proprietorship or the partnership
discussed earlier. It’s also a more recent form of business. It actually came into existence after
the partnership in an effort to cover the shortfalls of a partnership form of business.
Partnership’s draw back
• Partnership membership is limited
to 20 hence thus limiting the capital
raising capability
•
•
The liabilities of the members are
unlimited.
The death of partner may cause the
dissolution of a partnership
Have dificulties in securing loans and
contracts since the law doesn’t recognize
it as a separate entity with contractual
capacity.
Limited growth due to limited capital
available
Solution offered by a Company
• There is no limit to the number of
members for a public company hence
more capital can be raised
•
•
The liability of the members is limited to
the capital contributed
A company’s life is not pegged on the
life of the members and can only be
terminated through a legal winding up
procedure.
Can easily secure loans and contracts since
the law recognizes it as an artiicial person with
contractual capacity
Can expand rapidly since capital is readily
available from the large number of members
S T U D Y
A company form of business formed by a group people called the promoters. Once formed,
the law recognizes the company as a legal person separate from the owners by all means.
This means that it can sue or be sued in its own name; it can borrow funds in its own name or
even enter into contract in its own name. This concept is sometimes referred to as the veil of
incorporation.
T E X T
INTRODUCTION
234
FINANCIAL ACCOUNTING
DEFINITION OF KEY TERMS
Capital is the amount of money or other assets introduced by the owner of the business
A Company is an organization that is a legal entity and has limited liability
EXAM CONTEXT
This chapter is very important for this papers preparation for exams and forms a basis for more
in-depth company accounting that we will look into in other inancial accounting papers that
we shall tackle. This include consolidating accounts for subsidiaries and associates to parent
companies
S T U D Y
T E X T
INDUSTRY CONTEXT
Most private and public companies in Kenya will require that inancial statements be prepared and
audited by independent auditors. All companies listed in the Nairobi Stock Exchange are required
to prepare true and fair inancial statements and have them audited by independent auditors.
This stresses the need to understand very well this chapter not just for audit and accounting
careers, but also to be able to interpret company inancial statements as shareholders.
COMPANY ACCOUNTS
9.1
235
PUBLIC AND PRIVATE COMPANIES
Fast forward - Companies can be classiied as either public company or private company.
The major differences between the two are:
Public company
Private company
They have no maximum limit for membership
Can raise capital through the issue of shares to
the public
Has a maximum limit of 50 members
Membership open only for relatives or
close associates of the existing members
Cannot raise capital from the general
public
There is free transfer of shares amongst
shareholders
Transfer of shares is restricted and must
be authorized.
S T U D Y
T E X T
Their membership is open to the public
9.2
THE BOARD OF DIRECTORS
Fast forward – Company owners delegate the running of their business to a group of people
referred to as the directors who together form the board of directors.
In the sole proprietorship and partnerships, the owners of the business i.e. the sole proprietor
and the partners respectively, oversee the day to day running of the business
In the case of a company, such an arrangement is impossible to maintain due to the large number
of owners (shareholders) and the complexity of the activities undertaken by the company. For
this reason the owners delegate the running of their business to a group of people referred to
as the directors who together form the board of directors. They may be shareholders as well
but not necessarily. They combine their expertise to manage the affairs of the company on the
shareholders behalf.
236
FINANCIAL ACCOUNTING
9.3
THE COMPANY’S CAPITAL
The major types of capitals that a company has are:
Loan capital (debentures)
This is capital borrowed from creditors which will be repaid later at an interest. It’s actually a
liability to the company. This will be discussed later in this topic.
S T U D Y
T E X T
SHARE CAPITAL
To become an owner of any company a person must have contributed to its capital. To facilitate
this there total capital required by the company is divided into small units or shares. One becomes
a member of a company (shareholder) by purchasing one or more of the shares. Share capital is
thus the capital raised from members of the company. As expected shareholders expect return
on their investment. Thus the proits made by the company are distributed to the shareholders in
proportion to the number of shares held. The proit distributed to the shareholders is referred to
as a divided. This amount is determined and proposed to the share holders for approval by the
directors. The shareholders; however, are only allowed to review the proposal downwards. The
accounting for and distribution of proits shall be covered comprehensively later on.
Share capital can be divided into two types of shares:
i)
ii)
Preference shares
Ordinary shares
Preference shares; holders of these shares receive their dividend at an agreed rate before the
ordinary shareholders receive anything.
Ordinary shares the ordinary shareholders receive their dividends after the preference
shareholders, if there is any proit left.
The preference shares are further divided into:
Cumulative preference shares: these are preference shares whose agreed percentage of
dividend accumulates over the period they are fully paid.
COMPANY ACCOUNTS
237
Non-cumulative preference shares: these are preference shares which if not paid the
percentage of divided agreed upon in a given period lose the right to claim such dividends ever
again in future periods.
Participating preference shares: these are shares that receive an agreed percentage of
dividends before the ordinary shareholders and still receive a portion of the remaining proits
being distributed to the ordinary shareholders.
Non participating preference shares these are the preference shares that receive only the
agreed percentage of dividend, no more.
SHARE CAPITAL
Authorized share capital
Issued share capital
Called up capital
Calls in arrears
Paid up capital.
In this section we shall consider the process of obtaining share capital and the accounting entries
involved. However, for better understanding, it’s important to deine the following terms irst:
i)
Authorized/registered/normal share capital: this is the amount of capital that the
company is allowed to issue as indicated in its Articles of Association. A company may
issue only a portion of the authorized share capital to shareholders. The remaining
capital not issued remains as security to the company incase more capital is needed in
future, and only then shall it be issued. However, no company is allowed to issue more
shares than the amount authorized. The authorized share capital is normally shown in
the statement of inancial position under the equities section but its value is not summed
up together with the rest of the equity items.
ii)
Issued share capital: this is the part of the share capital that has already been issued
to the shareholders.
iii)
Called up share capital: once the company issues the capital to the shareholders it
may not require them to pay for the whole amount for the shares purchased. Instead
it may prescribe that certain amounts be paid irst and the rest to be paid when the
company requires. The total amount that a company has already requested to be paid
on the shares, up to a speciied date is referred to as the called up share capital. The
part remaining unpaid on the shares is referred to as the uncalled share capital.
iv)
Paid up share capital: It’s that part of the issued share capital for which calls have
been made and payments of the calls actually received by the company.
S T U D Y
a)
b)
c)
d)
e)
T E X T
Fast forward – Share capital can be;
238
FINANCIAL ACCOUNTING
v)
vi)
Calls in arrears: out of the called up capital, not all of it is paid for. The balance of
called up capital that remains unpaid is referred to as calls in arrears.
Calls in advance; some shareholders may pay for the outstanding amount on their
shares even before makes the calls for it. Such payments are referred to as the calls in
advance.
The following example will help illustrate the above terms.
Intel Solutions Ltd was formed with the legal right to be able to issue 400000 shares of Sh 4 each.
However they actually issued 300000 of which none was fully paid.
So far Intel Solutions Ltd has made calls of Sh 3 per share. All shares have been paid by the
shareholders except for Sh 150000 shares whose shareholders have only paid Sh 1 per share.
Required:
S T U D Y
T E X T
Determine
a)
b)
c)
d)
e)
Authorized share capital
Issued share capital
Called up capital
Calls in arrears
Paid up capital.
Solution:
Authorized share capital:
400,000 x 4 = 1,600,000
Issued share capital
300000 x 4 = 1200000
Called up capital
300000 x 3 = 900000
Calls in arrears
150000 x (3 – 1) = 300000
Paid capital
900000 (obtained from d above) – 300000 = 600000
COMPANY ACCOUNTS
239
RESERVES
These are funds that the business sets aside for purposes of future inancial obligations and
appear in the inanced-by section of the Statement of inancial position.
They are categorized into two:
Capital reserves
Revenue reserves
Revenue reserves: these are the reserves which can be distributed to the shareholders if need
be in a form such as bonus shares. They are generally used for the expansion or purchase of
non-current assets. They include:
§
§
Retained proits – the balance after appropriation
General reserves
•
•
Share premium –representing the amount paid on the issued shares above their par
value.
Revaluation reserve – representing the amounts by which assets appreciate after a
revaluation is done.
Capital redemption reserve fund – representing the amount transferred from the retained
earnings to inance the redemption of preference shares. If the amount is transferred to
cater for the redemption of debentures, the reserve created for that purpose is referred
to as the Debenture redemption fund. These shall be explained further in later section
of the topic.
9.4
FINANCIAL STATEMENTS OF A LIMITED COMPANY
STATEMENT OF COMPREHENSIVE INCOME
Like any other business entity, the company is formed with the intention of making proit. This proit
is reported in the company’s statement of comprehensive income just like in sole proprietorship
or partnership form of business. However some expense items are unique to the company’s
proit and loss statement e.g. director’s remuneration, audit fee. Companies are also required to
pay tax on the proits earned in the form of a corporation tax which currently stands at 30% of the
net proit earned in one trading period.
Unlike in sole proprietorship and partnership, a company’s statement of comprehensive income
statement also includes an extra section which shows how the proits made by the company are
distributed or appropriated. This section is referred to as the appropriation account.
S T U D Y
•
T E X T
Capital reserves: capital reserves on the other hand cannot be distributed to the share holders.
They include:
240
FINANCIAL ACCOUNTING
Generally the Trading and Statement of comprehensive income will have the following format:
XYZ STATEMENT OF COMPREHENSIVE INCOME
FOR THE PERIOD ENDED XXXXXX
S T U D Y
T E X T
Sales
less return inwards
net sales
less cost of sales
opening stock
add purchases
carriage inwards
less return outwards
net purchases
goods available for sale
less closing stock
cost of sales
gross proit
add other incomes
discount received
proit on disposal of assets
income from investments
other incomes e.g. interest received from bank
Sh
xx
(xx)
Xxx
xx
xx
xx
xx
(xx)
xx
xxx
(xx)
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
Xxx
less expenses
administrative expenses
operating expenses
selling and distribution expenses
debenture interest
audit fees
directors remuneration
amortization of goodwill
total expenses
net proit for the period before tax
corporation tax
net proit for the period after tax
xx
xx
xx
xx
xx
xx
xx
(xxx)
Xxx
(xxx)
Xxx
appropriation section:
net proit for the period after tax
add retained proit b/f
less transfers to general reserves
preference dividend
interim paid
inal proposed
Sh
Xxx
Xxx
Xxx
xxx
xx
xx
xxx
ordinary dividend
interim paid
inal proposed
retained proit c/d
xx
xx
xxx
(xxx)
Xxx
COMPANY ACCOUNTS
241
THE STATEMENT OF FINANCIAL POSITION
The Statement of inancial position of a company is also similar to that of a partnership except for
the capital section of the Statement of inancial position. For company the capital section is also
referred to as the ‘inanced by’ section. Just as the name suggests, this section shows the funds
used to inance the net assets. This stems from the basic accounting equation where:
Capital = assets – liabilities = net assets
Therefore the igure obtained for net assets must necessarily tally with that in the inanced by
section i.e. all other factors e.g. errors held constant, the statement of inancial position should
balance.
The general format of a statement of inancial position is as follows:
XYZ COMPANY LTD
STATEMENT OF FINANCIAL POSITION AS AT XXXXX
Sh
Sh
Non-current assets
land and buildings
plant and equipment
less accumulated depreciation
xx
(xx)
ixtures, furniture and ittings
less accumulated depreciation
xx
(xx)
motor vehicles
less accumulated depreciation
xx
(xx)
Sh
xx
xx
xxx
total non-current assets
Current Assets
stock
Debtors
less provision for doubtful debts
xx
xxx
(xxx)
xxx
xxx
xxx
xxx
xxx
xxx
Prepayments
short term investments
cash at bank
cash in hand
total current assets
less Current Liabilities
bank overdraft
Creditors
Accruals
interest payable (debenture interest)
tax payable
dividends payable
xxx
xxx
xxx
xxx
xxx
xxx
(xxx)
net current assets
total assets
xxx
yyyyy
S T U D Y
xx
T E X T
xxx
242
FINANCIAL ACCOUNTING
Financed By
authorized share capital
1,000,000 ordinary shares of Sh 1 each
1,000,000 preference shares of Sh 1
each
issued and fully paid
800,000 ordinary shares of Sh 1 each
500,000 10% preference shares of Sh 1
each
xxx
xxx
xxx
capital reserves
share premium
revaluation reserve
capital redemption reserve
xxx
xxx
xxx
xxx
revenue reserves
general reserve
proit and loss account
xxx
xxx
xxx
xxx
S T U D Y
T E X T
non current liabilities
10% debentures
9.5
xxx
yyyy
TRUE AND FAIR VIEW
Fast forward - A basic requirement for the inancial statements of the company is that they must
portray a true and fair view of the company.
It is expected that the Trading and Statement of comprehensive income will portray a true and
fair view of the results of trading activities over a given accounting period. The statement of
inancial position is also expected to give a true and fair view of status of the company’s assets
vis-à-vis the company’s liabilities as at the statement of inancial position date. Actually this forms
part of the major objectives of an audit of a company’s inancial statements. The auditor states
in his report whether or not in his opinion the inancial statements are a true and fair relection of
the company’s results and state of affairs.
COMPANY ACCOUNTS
243
Examples on preparation of inancial statements
The following is the trial balance of Transit Ltd as at March 19x8
Sh
Ordinary share capital (Sh 1 each)
75,000
Leasehold property at cost
2,500
Motor vans at cost(used for distribution)
Provision for depreciation motor van to 31 march 19x7
7,650
Administration expenses
1,000
12,000
Sales
25,000
Director’s remuneration
Rent receivables
6,750
Investment at cost
Investment income
206,500
3,600
340
7% debentures
1,050
Debenture interest
Bank interests
15,000
162
Bank overdraft
31,000
Debtors and creditors
1,260
Interim dividend paid
Proit and loss account
311,122
730
24,100
17,852
311,122
You ascertain the following:
All the motor vans were purchased on 1 April 19x5. Depreciation has been and is to be provided
at the rate of 20% per annum on cost from the date of purchase to the date of sale. On 31 march
19x8 one van, which had cost £ 900 was sold for £550,as part settlement of the price of £ 800 of
a new van, but no entry with regard to this transactions were made in the cashbooks.
The estimated corporation tax liability for the year to March 10x8 is £12700
It is proposed to pay a inal dividend of 10% for the year to 31 march 19x8
Stock at the lower of cost or net realizable value on 31 March 19x8 is £16700
Required:
Prepare without taking into account the relevant statutory provisions:
a)
b)
Proit and loss statement for the year ended 31 march 19x8.
A statement of inancial position as at that date.
T E X T
138,750
S T U D Y
Purchases
42,000
10,000
Distribution expenses
Stock 31 march 19x7
Sh
244
FINANCIAL ACCOUNTING
Transit Ltd
Proit and loss statement for the year ended 31st March 19x8
£
Gross proit
Proit on disposal of van
Rent receivable
Less: expenses
Depreciation on motor van
Administration expense
Distribution expense
Debenture interest
Bank interest
500
32,650
10,000
1,050
162
S T U D Y
T E X T
Trading proit for the year
Add: investment income
Proit before tax
Taxation
Proit after tax
Less: dividends
Interim paid
Final proposed
1,260
4,200
Retained proit for the year
Retained proit b/f
Retained proit c/f
£
72,450
190
3,600
76,240
(44,362)
31,878
340
32,218
12,700
19,518
(5,460)
14,058
17,852
31,910
Transit Ltd
Statement of inancial position as at 31.3.19x8
non-current assets
Leasehold property
Motor vans
Investments
£
75,000
2,400
77,400
Financed by :
Authorized issued and fully paid
4200 ordinary shares of £ 1
Revenue reserves
Statement of comprehensive income c/f
Non current liabilities
7% debentures
960
960
16,700
31,000
47,700
Current assets
Stock
Debtors
Current liabilities
Bank overdraft
Creditors
Tax payable
Proposed dividend
£
980
24,100
12,700
4,200
(41,980)
£
75,000
1,440
76,440
6,750
83,190
5,720
88,910
42,000
31,910
73,910
15,000
88,910
COMPANY ACCOUNTS
245
Workings:
206,500
Sales
Less: cost of sales
Opening stock
Purchases
12,000
138,750
150,750
(16,700)
Less: closing stock
Gross proit
134,050
72,450
Motor vehicle depreciation
Bal b/d
Bal c/d
960
P&L
1,500
1,000
500
1,500
Motor vehicle
Bal b/f
2,500
Disposal
550
Cash book
250
Disposal
Bal c/d
3,300
900
2,400
3,300
Motor vehicle disposal
Disposal
900
motor vehicle
550
P&L
960
depreciation
540
1,090
1,090
T E X T
540
S T U D Y
Disposal
246
FINANCIAL ACCOUNTING
9.6
ISSUANCE OF SHARES
Proit to a company is earned by using the resources at its disposal in the most eficient manner.
These resources are contributed by the shareholders in the form share capital and from creditors
in the form of loan capital also called debentures.
The shareholder provides the share capital buying shares issued by a company. For public limited
companies such shares are offered through the stock exchange.
The share issuing process
S T U D Y
T E X T
The process of issuing shares to the public starts with the company issuing a prospectus. This
is a document that invites the public to purchase shares from the company. It contains details of
the companies operations and the beneits that shall accrue from investing in the company.
Once the prospectus is issued, applications follow. Shareholders respond to the prospectus by
applying to purchase the shares. In most cases more shares are applied for than the company
had initially offered for sale i.e. there is an over-subscription. If the shares applied for are less
than what the company had offered this will be referred to as under-subscription.
Allotment
At this stage successful applicants are awarded the shares for in a process called allotment. In
the event of an over subscription the issuing company allots to the share holders only a proportion
of the shares applied for in the most equitable manner to cater for all the successful applicants.
Refund to unsuccessful applicants
For the unsuccessful applicants any fees paid on application is refunded. For the applicants
allotted fewer shares than applied for, they may as well be refunded their application fee or
the same could be used to offset future payments on the shares if they were issued payable in
installments.
The call stage
If shares are issued payable in installments, only a certain portion of the shares issue price is
payable on application. The rest becomes payable as and when the company feels the need to
request for the payment. The placement of a request for the payment of the amount due on the
shares by a company to its shareholders is referred to as a call. The company may make several
calls e.g. irst, second, third calls.
COMPANY ACCOUNTS
247
Forfeiture of shares
If share holder fails to respond to the calls made within the stipulated time, the company may
decide to cancel the shares allotted to such a share holder. This is what is referred to as forfeiture
of shares. A shareholder whose shares are forfeited foregoes any amounts previously paid to the
company on the shares.
Reissue of forfeited shares
The company may decide to offer the shares forfeited to any other willing buyer at a price which
should be at least equal to the called up amount.
ACCOUNTING ENTRIES TO RECORD ISSUE OF SHARES
§
§
Share can be issued at a premium or a discount (at a price higher or lower than the par
value respectively)
The shares may not necessarily be payable in full on application they may be issued on
installment basis each installment carrying a given proportion of the issue price of the
share e.g. 20% on application 25% on allotment, 30% on irst call and 15% on second
and inal call.
When shares are issued at a premium and on installment basis, the share premium
may be attached uniformly throughout the installments or may be attached to certain
installment, say on allotment.
I. Accounting for shares payable fully on application
a)
Issued at par:
i)
Dr Bank account
xxx
Cr. Share applications account
(To record cash received on application)
xxx
ii) Dr Share applications account xxx
Cr. Bank account
xxx
(To record refunds to unsuccessful applicants)
iii) Dr. Share applications account
xxx
Cr. Ordinary share capital account
xxx
(To transfer application fees to the ordinary share capital account)
S T U D Y
§
T E X T
Before handling the accounting entries it is important to note the following:
248
FINANCIAL ACCOUNTING
b) Issued at a premium
i) Dr Bank account
xxx
Cr. Share applications account
(To record cash received on application)
xxx
ii) Dr Share applications account xxx
Cr. Bank account
xxx
(To record refunds to unsuccessful applicants)
iii) Dr. Share applications account
xxx
Cr. Ordinary share capital account (par value)
xxx
Cr. Share premium account (share premium)
xxx
(To transfer application fees to the ordinary share capital account and recognize
share premium)
S T U D Y
T E X T
II accounting for shares issued on installment basis with only two calls
made
a) At par
On application:
i)
Dr Bank account
xxx
Cr. Share applications account
(To record cash received on application)
xxx
ii)
Dr Share applications account
xxx
Cr. Bank account
xxx
(To record refunds to unsuccessful applicants)
iii)
Dr. Share applications account
xxx
Cr. Ordinary share capital account
xxx
(To transfer application fees to the ordinary share capital account)
On Allotment:
iv)
Dr. Bank account xxx
Cr. Allotment account xxx
(To record amount payable on allotment)
Note if some of the excess cash paid on application is used to offset amounts
payable on allotment instead of being refunded the entry would have been:
Dr. Bank account xxx
Dr. Applications account (excess amount on application) xxx
Cr. Allotment account xxx
COMPANY ACCOUNTS
v)
249
Dr. Allotment account xxx
Cr. Ordinary share capital account xxx
(To transfer amount paid on allotment to the ordinary share capital account)
On First call:
vi)
Dr. Bank xxx
Cr. First call account xxx
(To record cash received on irst call)
vii) Dr. irst call account xxx
Cr. Ordinary share capital account xxx
(To transfer irst call to the ordinary share capital account)
On second and inal call:
vii) Dr. second and inal call account xxx
Cr. Ordinary share capital account xxx
(To transfer second and inal call to the ordinary share capital account)
b) At a premium payable on allotment
All other entries for the application, irst call, and second and inal call would remain as above.
However the entries on allotment would be:
On Allotment:
iv)
Dr. Bank account xxx
Cr. Allotment account xxx
(To record amount payable on allotment)
Dr. Allotment account xxx
Cr. Ordinary share capital account xxx
Cr. Share premium account (share premium) xxx
(To transfer amount paid on allotment to the ordinary share capital account as
Well as recognize the premium paid together with the allotment money)
>>> Illustration 1
Markers Ltd issued 1000 shares to the public at Sh 10 each payable as to sh. 2.5 on application,
Sh 5 on allotment and Sh 2.5 on irst and inal call. They received applications for 2000 shares of
which they returned one half and then proceeded to allot the rest.
Required:
i)
ii)
Show the journal entries to record the issue
Show the accounts as they would appear in Markers Ltd’s books.
T E X T
Dr. Bank xxx
Cr. Second and inal call account xxx
(To record cash received on irst call)
S T U D Y
vi)
250
FINANCIAL ACCOUNTING
Suggested Solution:
a) Journal entries;
S T U D Y
T E X T
On application:
i)
Dr Bank account
Cr. Share applications account
(To record cash received on application)
Sh.
5,000
Sh.
ii)
Dr Share applications account
Cr. Bank account
(To record refunds to unsuccessful applicants)
2,500
iii)
Dr. Share applications account
2,500
Cr. Ordinary share capital account
2,500
(To transfer application fees to the ordinary share capital account)
5,000
2,500
On Allotment:
iv)
Dr. Bank account
Cr. Allotment account
(To record amount payable on allotment)
5,000
v)
Dr. Allotment account
5,000
Cr. Ordinary share capital account
5,000
(To transfer amount paid on allotment to the ordinary share capital account)
5,000
On First and inal call:
vi)
Dr. Bank
Cr. First call account
(To record cash received on irst call)
2,500
vii) Dr. irst call account
2,500
Cr. Ordinary share capital account
(To transfer irst call to the ordinary share capital account)
2,500
2,500
COMPANY ACCOUNTS
Dr
Bank account
Sh
Cr
Sh
Application a/c
5000
Application a/c
2500
Allotment a/c
5000
Balance c/d
10000
First and final call
2500
12500
Dr
Bank a/c
12500
Share application account
Cr
Sh
Sh
2500
251
Bank a/c
5000
Ordinary share capital
2500
T E X T
a/c
Dr
Ordinary share capital a/c
Dr
5000
Allotment account
Cr
Sh
Sh
5000
Bank a/c
First and final call
5000
Cr
Sh
Ordinary share capital a/c
12500
Bank a/c
12500
S T U D Y
5000
252
FINANCIAL ACCOUNTING
Dr
Balance c/d
Ordinary share capital account
Cr
Sh
Sh
10000
Application a/c
2500
Allotment a/c
5000
First and final call
2500
10000
10000
>>> Illustration 2
S T U D Y
T E X T
Chakaza Ltd issued 1000 shares to the public at Sh 25 each payable as to Sh 5 on application,
Sh 15 on allotment and Sh 5 on irst and inal call. They received applications for 4000 shares
of which they rejected 1000 half and then proceeded to allot the rest of the applicants one share
for every three held.
Required:
Show the journal entries to record the issue
Suggested solution:
a) Journal entries;
On application:
Sh.
20,000
i)
Dr Bank account
Cr. Share applications account
(To record cash received on application)
ii)
Dr Share applications account
Cr. Bank account
(To record refunds to unsuccessful applicants)
iii)
Dr. applications account (excess amount on application) 10,000
Cr. Allotment account
(To record excess amount paid on application used to
off-set amount due on allotment)
iv)
Dr. Share applications account
5,000
Cr. Ordinary share capital account
(To transfer application fees to the ordinary share capital account)
5,000
Sh.
20,000
5,000
10,000
5,000
COMPANY ACCOUNTS
253
On Allotment:
iv)
Dr. Bank account
5,000
Dr. Applications account (excess amount on application) 10,000
Cr. Allotment account
15,000
(To record amount payable on allotment)
v)
Dr. Allotment account
15,000
Cr. Ordinary share capital account
15,000
(To transfer amount paid on allotment to the ordinary share capital account)
On First and inal call:
5,000
5,000
vii) Dr. irst call account
5,000
Cr. Ordinary share capital account
5,000
(To transfer irst call to the ordinary share capital account)
9.7
FORFEITURE OF SHARES
So far we have assumed that the share holders were very cooperative and paid all the due
calls as and when required to do so. Sometimes; however, a shareholder may fail to pay the
calls requested from him within the stipulated time in which case the shares will be forfeited.
Any amounts already paid will be lost to him. Between the time of call and the forfeiture time the
amounts due will be in a debtor’s account; the calls in arrears account from where they will be
transferred to the forfeiture account.
The journal entries for forfeiture are as follows:
Dr. Calls in arrears a/c
Cr. (the call not paid for) for the amount owing
(To record the accrual of calls made but not paid for)
Dr. Forfeiture account
Cr. Calls in arrears a/c
(To record forfeiture of shares whose calls have remained in arrears for a period
exceeding the allowed limit.)
Dr. Ordinary capital share capital
Cr. Forfeiture account
(To record the cancellation of the shares from the issued share capital)
T E X T
Dr. Bank
Cr. First call account
(To record cash received on irst call)
S T U D Y
vi)
254
FINANCIAL ACCOUNTING
Note: any balance in the forfeiture account id transferred to the share premium account.
>>> Illustration 3
Assume that 100 Sh 10 shares were allotted to member who paid Sh 7.5 on application and
allotment but who failed the irst and inal call of Sh 2.5. How would such forfeiture be shown in
the books of account?
Suggested solution
Dr. Calls in arrears a/c
250
Cr. First and inal call
(To record the accrual of calls made but not paid for)
250
S T U D Y
T E X T
Dr. Forfeiture account
250
Cr. Calls in arrears a/c
250
(To record forfeiture of shares whose calls have remained in arrears for a period
exceeding the allowed limit.)
Dr. Ordinary capital share capital a/c
Cr. Forfeiture account
1,000
1,000
(To record the cancellation of the shares from the issued share capital)
Reissue of forfeited shares
If the forfeited shares are reissued to another shareholder, the following entries will be made:
Dr. Bank a/c
Cr. Reissue of forfeited shares a/c
(To record the amount paid for the shares by the new shareholders)
Dr. Reissue of forfeited shares a/c
Cr. Ordinary share capital a/c
(To record the reissue of shares)
Dr. Forfeiture a/c
Cr. Reissue of forfeited shares a/c
(To transfer the balance in the Reissue of forfeited shares a/c to the forfeiture account)
Dr. Forfeiture account
Cr. Share premium account
(To transfer the balance in the forfeiture a/c to the share premium account)
COMPANY ACCOUNTS
255
>>> Illustration 3 - continued
Assume that the shares forfeited were reissued at Sh 5. The entities would follow as thus.
Dr. Bank a/c 500
Cr. Reissue of forfeited shares a/c 500
(To record the amount paid for the shares by the new shareholders)
Dr. Reissue of forfeited shares a/c 1000
Cr. Ordinary share capital a/c 1000
(To record the reissue of shares)
Dr. Forfeiture a/c500
Cr. Reissue of forfeited shares a/c 500
(To transfer the balance in the Reissue of forfeited shares a/cTo the forfeiture account)
Dr. Forfeiture account 250
Cr. Share premium account 250
(To transfer the balance in the forfeiture a/c to the share Premium account)
T E X T
The accounts showing the forfeiture and re issue of the shares would appear as follows:
Calls in arrears a/c
First and final call
Sh.
250
Forfeit¡re acco¡nt
250
First and final call
Sh
Sh.
Calls in arrears a/c
250
Forfeiture account
Sh
Calls in arrears a/c
250
¢eiss¡e
500
of forfeited shares a/c
Share premi¡m acco¡nt
Sh.
Ordinary capital share capital a/c
1000
250
1000
1000
S T U D Y
Sh
256
FINANCIAL ACCOUNTING
Ordinary capital share capital a/c
Sh
Forfeit£re acco£nt
Sh.
¤eiss£e
1000
of forfeited shares a/c
1000
Bank a/c
Sh
¤eiss£ e
of forfeited shares a/c
Sh.
500
¥eissue
of forfeited shares a/c
Sh
T E X T
ordinary capital share capital a/c 1000
Sh.
Bank a/c
500
Forfeit¦re acco¦ nt
500
S T U D Y
1000
9.8
1000
RIGHTS ISSUE
Fast forward – rights are normally given on pro-rata basis.
A rights issue is an option on the side of the shareholder given by the company given to existing
shareholders to purchase the company’s shares at a price lower than the prevailing market value
of the share. The option is normally given on pro-rata basis.
In response to the rights issue the shareholder may:
§
§
§
§
Buy the shares and exercise the rights
Sell the rights to a third party in the market or
Ignore the rights, in which case the directors may decide to issue the shares in any
other way.
The rights issue is beneicial to a company since it provides a cheap means to raise
new long term capital via the issue of shares.
COMPANY ACCOUNTS
257
ISSUE OF DEBENTURES
As explained earlier, a debenture is a loan capital to the business. The entries for issue of
debentures are similar to those for the shares. Actually if the word debenture was to replace the
word share capital, the entries in the accounts would be identical.
Redemption of Redeemable Preference Shares and Redeemable
Debentures
Redeemable preference shares
Redeemable preference shares are shares that can be redeemed (bought back by the company
from the shareholders) at later date as stipulated in the terms laid down.
During redemption the following should be observed:
1.
The preference shares being redeemed must be fully paid
2.
There must be funds to cater for the redemption provided from:
§
§
§
New issue of shares
Proit reserves
Partly from the issue of new shares and partly from the proit reserves.
If funds are obtained from the proit reserves, they are irst transferred to a capital
redemption reserve fund. This account replaces the redeemed preference shares in
the Financed-by section of the Statement of inancial position.
3.
If the shares are redeemed at a premium e.g. Sh 10 preference shares being redeemed
at Sh 15, the funds to cater for the premium on redemption should be obtained from:
§
§
Share premium account if one exists
In the absence or insuficiency of share premium then use the proit reserves
In the section following, we shall consider the journal entries necessary to record the
redemption as well as statement of inancial position extracts showing the effect of the
redemption of the preference shares. Actually, most examiners will require students to
prepare journal entries showing the redemption of the shares.
S T U D Y
Preference shares are not a cheap source of capital considering that ixed dividends have to be
paid to them in each period dividend is declared. Redemption of preference shares is thus a relief
to the company.
T E X T
The redemption is necessitated by the fact that the company might have been in need of large
amounts of capital initially but not indeinitely since accumulated proits will take its place.
258
FINANCIAL ACCOUNTING
>>> Illustration I
During the year ended 31 December 2007 ABC company ltd redeemed 1000 Sh 5 preference
shares at par.
As at 31 December 2006 the statement of inancial position revealed:
Sh
S T U D Y
T E X T
Other assets
13000
Bank
7000
Ordinary share capital
5000
Redeemable preference share capital
5000
Statement of comprehensive income
7000
Creditors
3000
Required:
a) make journal entries to record the above information
b) prepare the statement of inancial position as at 31 December 2007
Assuming that:
1.
2.
3.
To cater for this Abc company issued 1000 Sh 5 new ordinary shares.
No new shares are issued to cater for the redemption
500 Sh 5 ordinary shares are issued
Suggested solution:
1. a)
Journal entries
Dr. bank
5000
Cr ordinary share capital
(To record issue of ordinary shares at par)
Dr. redeemable preference shares
Cr. Bank
(To record redemption at par)
5000
5000
5000
COMPANY ACCOUNTS
259
1 b)
Statement of inancial position extract:
Abc company ltd
Statement of inancial position as at 31st December 2007
Other assets
13,000
7,000
Bank
20,000
Financed by
10,000
Ordinary share capital
Statement of comprehensive
income
Creditors
7,000
3,000
20,000
Dr. Proit and loss account
5,000
Cr. Capital redemption reserve fund
5,000
(To record transfer of funds to the capital redemption reserve fund)
Dr redeemable preference shares
Cr. Bank
(To record redemption at par)
5,000
5,000
2 b)
Statement of inancial position extract:
Abc company ltd
Statement of inancial position as at 31 December 2007
Other assets
Bank
Financed by
Ordinary share capital
Statement of comprehensive
income
Capital redemption reserve
fund
Creditors
13,000
2,000
15,000
5,000
2,000
5,000
3,000
15,000
S T U D Y
2 a)
T E X T
Solution
260
FINANCIAL ACCOUNTING
Solution
3 a)
Dr. bank
Cr ordinary share capital
(To record issue of ordinary shares at par)
2,500
2,500
Dr. Proit and loss account
2,500
Cr. Capital redemption reserve fund
2,500
(To record transfer of funds to the capital redemption reserve fund)
Dr redeemable preference shares
Cr. Bank
(To record redemption at par)
T E X T
3 b)
5,000
Statement of inancial position extract:
Abc company ltd
Statement of inancial position as at 31 December 2007
Other assets
Bank
S T U D Y
5,000
Financed by
Ordinary share capital
Statement of comprehensive
income
Capital redemption reserve
fund
Creditors
13,000
4,500
17,500
7,500
4,500
2,500
3,000
17,500
COMPANY ACCOUNTS
261
CHAPTER SUMMARY
The major types of capital that a company has are:-
•
•
Share capital – Both preference and ordinary share holdings.
Loan capital.
The major differences between the public and private companies are:
Public company
Private company
They have no maximum limit for membership
Has a maximum limit of 50 members
Membership open only for relatives or close
associates of the existing members
Can raise capital through the issue of shares to Cannot raise capital from the general
the public
public
There is free transfer of shares amongst Transfer of shares is restricted and must be
shareholders
authorized.
The announcement by Equity Bank that their shares will trade on the NSE beginning 7th August,
2006 surprised many, mostly because they had refused to sell new shares to an expecting public.
The bank may have been motivated to take this path for several reasons:•
•
Fear to dilute the stake of anchor shareholders.
The bank’s ownership structure now stands as: IFC & AFRICAP 18%, BRITAK 12%
OTHERS 75%.
If the bank was to loat new shares, they would have to reduce the stakes of these
three. This must have been a scaring prospect for these shareholders as they would
like to maintain the control they now have over the bank
CMA, NSE & brokers' fees.
By avoiding to list new shares, the bank have deftly avoided a substantial chunk of the
fees payable to these institutions while at the same getting to trade at the NSE. They
have also managed to escape to pay fees to a myriad of market operatives including
brokers, lawyers, and agents (read banks). In the Scanad IPO which is much smaller,
this is a hefty Sh 70m. Equity’s would have hit nearly Sh 200m in fees alone.
(Source, http://gathinga.blogspot.com)
CHAPTER QUIZ
1.
2.
Which share holders received dividend irst?
What is the difference between Participating and non participating preference shares?
S T U D Y
CASE STUDY
T E X T
Their membership is open to the public
262
FINANCIAL ACCOUNTING
S T U D Y
T E X T
ANSWERS TO CHAPTER QUIZ
1.
Preference shares are the shareholders who receive their dividend at an agreed rate
before the ordinary shareholders receive anything.
2.
Participating preference shares are shares that receive an agreed percentage of
dividends before the ordinary shareholders and still receive a portion of the remaining
proits being distributed to the ordinary shareholders, while Non participating
preference shares only receive the agreed percentage of dividend, no more.
PAST PAPER ANALYSIS
6/07, 6/06, 12/05, 6/05, 12/04, 6/04, 6/03, 12/02
EXAM TYPE QUESTION
Question 1 (June 2007 Question 1)
a)
(I)
(ii)
distinguish between share premium and revaluation reserves.
Briely explain how a company can utilize its share premium
(2 marks)
(2 marks)
COMPANY ACCOUNTS
b)
263
The following trial balance was extracted from the books of pata Ltd., as at 31 December
2006:
Sh. ‘000’
Ordinary shares of Sh 10 each
Sh. ‘000’
150.000
8% preference shares of Sh 10 each
50.000
7% debentures
100.000
Share premium
20.000
General reserves
65.000
Retained earnings (1 January 2006)
35.000
Land at cost
111.000
Plant and machinery at cost
382.000
Provision for depreciation – plant and machinery
85.500
3.200
4.600
Accounts receivable/payable
48.000
27.000
Inventory (1 January 2006)
35.000
T E X T
290.000
1.000
S T U D Y
Sales
Discounts allowed/received
Cash at bank
7.500
Carriage inwards
Purchases
165.000
Salaries and wages
32.100
Electricity
2.900
Interest on debentures
7.000
Directors fees
12.000
Provision for bad and doubtful debts
General expenses
1.500
11.900
Interim dividends paid Ordinary
Preference
Suspense account
7.500
2.000
_____
829.000
Additional information:
1.
400
829.000
During the year, land was revalued to Sh 180 million by the directors, the revaluation
reserve arising from land revaluation was partly utilized to inance the issue of Sh 1
bonus share for every 10 ordinary shares held
The bonus shares were issued to the existing ordinary shareholders on 29 December
2006 although no entry had been recorded in the books of Pata Ltd.
264
FINANCIAL ACCOUNTING
2.
3.
4.
5.
6.
7.
8.
Inventory as at 31 December 2006 was valued at Sh 41 million.
Corporation tax is estimated at Sh 3 million while unpaid wages as at 31 December
200t amounted to Sh 150 000.
General expenses include an insurance premium amounting to Sh 200.000 for the
period 1 April 200t to 31 March 2006.
A machine which had cost Sh 2 million was disposed of on 1 January 2006. The
accumulated depreciation on disposal of the machine was Sh 1.5 million. The cash
received in respect of the sale was Sh 400.000 which was recorded in a suspense
account.
A provision is to be made for bad and doubtful debts at the rate of 2 ½ % of the accounts
receivable.
The company depreciates its plant and machinery on straight line basis at the rate of
10% per annum.
The directors propose to pay a inal ordinary dividend of 5% and also transfer Sh 5
million to general reserves.
Required:
i.
S T U D Y
T E X T
ii.
Trading, statement of comprehensive income for the year ended 31 December 2006.
(8 marks)
Statement of inancial position as at 31 December 2006.
(8 marks)
(Total: 20marks)
Question 2 (December 2005 Question1)
Araka Ltd., a company dealing in retail products, extracted from the following trial balance as at
30 September 2005:
Freehold land: Cost
Buildings:
Cost
Accumulate depreciation
Plant and machinery: Cost
Accumulated depreciation
Sales
Purchases
Cash in hand
Creditors ledger control account
Electricity
Ordinary share capital
Cash at bank
Debtors ledger control account
Suspense account
Inventory as at 1 October 2004
Retained proits
Motor vehicle expenses
Sundry expenses
Salaries and wages
Directors remuneration
Bank charges
Motor vehicles: Cost
Accumulated depreciation
Sh. ‘000’
121,500
431,000
64,172
839,004
1,268
6,917
1,210
61,074
4,300
41,912
4,174
2,002
121,600
48,999
1,621
28,900
________
1,779,542
Sh. ‘000’
68,960
16,074
1,312,567
21,172
50,000
296,057
14,712
1,779,542
COMPANY ACCOUNTS
265
Additional information:
Sh. ‘000’
Bad debts written off during the year
Motor vehicle purchased on 1 April 2005
Less: motor vehicle sold on 1 April 2005
Amounts received in respect of a bad debt recovered
3.
4.
5.
6.
7.
8.
9.
3,000
612
Sh. ‘000’
512
7,400
7,912
(3,612)
4,300
The motor vehicle sold during the year had been purchased on 1 February 2002 for Sh
6,500,000.
Bank statement as at 30 September 2005 showed bank charges of Sh 533,000. This
had not been recorded in the cash book.
The debtors’ ledger control account did not agree with the list of balances in personal
accounts. You ascertain that some invoices for October 2005 had been posted in the
personal accounts as at September 2005. The list of balances was overstated by Sh
4,300,000.
Estimated corporation tax for the year ended 30 September 2005 was Sh131,700,000.
The value of inventory as at 30 September 2005 was amounted to Sh 62,047,000.
The directors proposed to pay ordinary dividend of 10%.
The following petty cash expenditure had not been recorded:
Sh. ‘000’
Motor vehicle expenses
412
Sundry expenses
91
Casual workers wages
36
10. Depreciation is provided at the following rates:
Buildings – 2% per annum on cost
Plant and machinery – 20% per annum on reducing balance basis.
Motor vehicle – 25% per annum on cost
Full year’s depreciation is provided in the year of purchase and none in the year of
disposal.
Required:
a)
b)
Statement of comprehensive income for the year ended 30 September 2005.
(12 marks)
Statement of inancial position as at 30 September 2005
(8 marks)
(Total: 20 marks)
T E X T
2.
Provision for doubtful debts should be made at 2% of the debtors ledger balances after
writing of bad debts amounting to Sh 1,370,000.
The suspense account was analyzed as follows:
S T U D Y
1.
S T U D Y
T E X T
266
FINANCIAL ACCOUNTING
S
T
S T
T SU
U TD
DUY
YD Y
T E
E TX
X ET
TX T
267
CHAPTER TEN
INCOMPLETE RECORDS
S T U D Y
T E X T
268
FINANCIAL ACCOUNTING
269
CHAPTER TEN
INCOMPLETE RECORDS
OBJECTIVES
After you study this chapter, you should be able to:
•
•
•
To calculate igures of cost revenue and proit for a business that is not maintained
through double entry using the various methods.
Use control accounts to check the accuracy of posting in the ledgers.
Explain why we maintain control accounts.
With incomplete records however, we may still be able to compute values for revenues, costs
and proits. This will usually be done by adopting a backward approach.
EXAM CONTEXT
Incomplete records can be tested in all forms of accounts; manufacturing accounts, partnership
accounts and company accounts are just example of other chapters that can be examined
together with this chapter.
INDUSTRY CONTEXT
Buildings do burn and all or part of the records lost. In such a case we still have with the limited
records available have to provide inancial statements for all stakeholders.
Incomplete records are therefore very crucial. They could be used by insurance companies to
back up claims on damages.
S T U D Y
As we discussed previously, recording of business transactions in the company’s books is a
systematic process. Information is transferred from one stage to the next for further processing
and analysis. In some cases however we may not be able to identify the process from its start to
its end. This may be as a result of the business having incomplete records due to failure to keep
proper accounting records or the records being destroyed accidentally
T E X T
INTRODUCTION
270
FINANCIAL ACCOUNTING
10.1 WORKING WITH INCOMPLETE RECORDS
Fast forward – incomplete records can be used to prepare inancial statements by adopting a
backward approach
S T U D Y
T E X T
To arrive at the igures of cost revenue and proit for a business that is not maintaining double
entry, the following methods can be used:
•
Use of control accounts
•
Use of ratios
•
Estimating income from net assets
•
Use of simple cashbook and bank statement
Most business enterprises use a blend of methods i) and iv) to arrive at the igure of inancial
statement presentation. Control accounts are largely divided into two:
a)
Debtors ledger control account
b)
Creditors ledger control account
The two accounts help one to arrive at the igure of both sales and purchases respectively.
The cashbook and the bank statement help one to account for transactions involving cash receipts
and cash payments. This include expenses paid in cash, cash purchases, cash sales etc
Method (iii) is usually a simper method. It is based on the fundamental accounting equation.
A=C+L
This would mean that for a business that does not generate proits in a given period the assets
at the beginning should be equivalent to assets as to the end.
INCOMPLETE RECORDS
271
Assuming there is no new capital injected into a business enterprise, then any increase in the net
assets will be brought about by proits and if net assets decrease it could be as a result of either
losses or drawings or both.
Proit /loss = Closing Capital – Opening Capital – Drawing – Capital injected during period.
>>> Examples:
Rongai traders had the following opening balances as at the beginning of the year 2005
Sh
Land and buildings(N.B.V)
200,000
Motor vehicles(N.B.V)
120,000
Debtors
Creditors
Bank overdraft
Long-term loan
Stock
7,000
42,000
64,000
78,000
50,000
28,000
The closing balances at the end of the year were as follows:
Sh
land and buildings (N.B.V)
180,000
motor vehicles (N.B.V)
100,000
furniture and ittings (N.B.V)
cash in hand
Cash at bank
Debtors
Creditors
long-term loan
Stock
70,000
21,000
87,000
96,000
72,000
40,000
18,000
Drawings made during the year amounted to Sh 14200
Compute the proit for the year 2005.
Solution:
We know that,
Proit/loss = closing capital – opening capital – drawings – capital injected
To get the opening capital, we use the equation
A=C+L
Hence C = A – L
T E X T
Cash in hand
75,000
S T U D Y
Furniture and ittings(N.B.V)
272
FINANCIAL ACCOUNTING
Computation of opening capital
Assets
Sh
land and buildings(N.B.V)
200,000
motor vehicles(N.B.V)
120,000
furniture and ittings(N.B.V)
75,000
7,000
cash in hand
42,000
Debtors
28,000
Stock
472,000
less liabilities
Creditors
bank overdraft
long-term loan
64,000
78,000
50,000
-192,000
280,000
beginning capital
S T U D Y
T E X T
Closing capital balance:
Assets
Sh
land and buildings(N.B.V)
180,000
motor vehicles(N.B.V)
100,000
furniture and ittings(N.B.V)
70,000
21,000
cash in hand
87,000
Cash at bank
96,000
Debtors
18,000
Stock
572,000
long term loan
Creditors
40,000
72,000
-112,000
460,000
From the above:
Proit = 460000 – 280000 – 14200
= Sh 165800
To estimate the beginning or ending balance, we can use a Statement of affairs. As the name
suggests a statement of affairs is a statement from which the capital of an owner can be found by
estimating assets and liabilities as at a given time. A statement of affairs adopts the same format
as that of a statement of inancial position only that the objective of this statement is to obtain the
igure for the capital balance.
INCOMPLETE RECORDS
273
XYZ Limited
Statement of affairs as at xx xx xx
Sh
Non-current assets
Cost
land and buildings
plant and equipment
less
accumulated
depreciation
Sh
Sh
Accumulate
NBV
depreciation
xxx
xx
(xx)
xx
ixtures, furniture and ittings
less
accumulated
depreciation
xx
(xx)
xx
motor vehicles
less
accumulated
depreciation
xx
(xx)
total non-current assets
xxx
xxx
xxx
xxx
xxx
xxx
prepayments
short term investments
cash at bank
cash in hand
total current assets
less Current Liabilities
bank overdraft
creditors
accruals
interest payable (debenture
interest)
tax payable
dividends payable
xx
S T U D Y
Current Assets
stock
debtors
xxx
less provision for doubtful
(xxx)
debts
T E X T
xx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
(xxx)
net current assets
total assets
Financed By
long term liabilities
6% long term loan
10% debenture
Capital difference
xxx
yyyyy
xxx
xxx
xxx
(xxxx)
xxxx
274
FINANCIAL ACCOUNTING
10.2 DRAWING FINANCIAL STATEMENTS
From the preceding example you will realize that we only obtain proits as the difference between
the opening and the closing capital balances (net of drawings)
However, you will also realize that the igures only give the proit for the period. There is no other
information that can be deducted from it.
Financial statements are meant to give a true and fair view of the results of the operations. This
enables the management to make informed decisions. Apart from the proitability for a given
period, an organization will be interested in knowing the following:
Total sales during the period
Total cost of sales during the period
Total operating expenses on an item to item basis
The proit mark-up margin
This therefore raises the need for more comprehensive/detailed inancial statements and more
so a detailed P & L account.
To achieve this objective when dealing with incomplete records, we make use of control
accounts.
S T U D Y
T E X T
i)
ii)
iii)
iv)
10.3 CONTROL ACCOUNTS
Fast forward – Control accounts are basically used to check the accuracy of posting in the
ledgers.
TYPES OF CONTROL ACCOUNTS
We are going to cover two control accounts:
i)
ii)
Sales ledger control account
Purchases ledger control account
Control accounts operate on the principle that if the opening balance of an account is known,
additions and deductions are known, and then the closing balance can be calculated. Put in
another way, when we have the opening balance of a control account, we know some of the
items affecting both the credit and the debit side of the account as well as the closing balance,
and then we can obtain the missing balances.
275
INCOMPLETE RECORDS
i)
Sales Ledger Control Account
This also referred to as the debtors control account. A sales ledger control account is similar to
the account of an individual debtor only that the items that will be relected in the account will be
for all the debtors and the transactions affecting them during a speciic period of time.
This account comprises the following entries:
•
opening balances of debtors
•
credit sales during the period
•
•
set-off’s
cash received from debtors(both cash
and cheque)
discounts allowed
•
•
•
•
•
•
returns by debtors
•
bad debts recovered
bad debts written off
cash received from bad
recovered
purchases ledger contra
debts
allowances to customer
refund to customers
In most cases, all the igures will be available from the information given apart from the total
credit sales. It is for this reason that we prepare the sales ledger control account to help us obtain
the igure for credit sales that will assist us in obtaining total sales to be used in the statement of
comprehensive income
Format for the sales ledger control account
Dr
Cr
balance b/d (debit balance)
xx
balance b/d (credit balance)
xx
credit sales during the period
xx
cash received from debtors
xx
refund to customers
xx
cheques received from debtors
xx
bad debts recovered
xx
total returns by debtors
xx
dishonored cheque
xx
discounts allowed
xx
allowances to customer
xx
cash received from bad debts
xx
recovered
bad debts written off
xx
purchases ledger contra
total credit balance c/d (balancing
xx
igure)
xxx
xx
total debit balance c/d (balancing
xxx
igure)
xxx
T E X T
•
closing balance of debtors
dishonored cheque
S T U D Y
•
•
276
FINANCIAL ACCOUNTING
Notes:
S T U D Y
T E X T
i)
It is possible to have balances brought forward in the sales ledger control account as
both a debit and a credit balance.
Debit balance is the normal total of the account. A credit balance will arise when one or
more debtor accounts have a credit balance i.e. the company owes them refund. This
is most common when there is overpayment by a debtor.
ii) Purchases ledger contra;
This is also termed as set-off. It occurs when companies/individuals trade with each
other in such a way that both companies sell products to each other and also buy from
each other. E.g. assume a hardware that sells timber to a carpenter. One day, it orders
for a set of tables to be made by the carpenter. They could enter into an agreement
whereby the carpenter will take the timber and make the table then net off what is to be
paid to the hardware.
iii) Allowances
These are price reductions in excess of discounts allowed to customers.
iv) Refund to customers
This happens when a customer has a credit balance in his account. This could happen
when goods have been returned to us or there had been an overpayment.
v) Cash sales are not included in the sales ledger control account. Only credit sales and
cash received from credit sales is included.
vi) Provision for doubtful debts is not including in the sales ledger control account.
vii) Only cash discounts allowed are entered in the sales ledger control, trade discounts are
not included.
ii) Purchases ledger control account
This account is also known as total creditors control account. This account is similar to an
individual; creditors account only that it will include details and transactions entered into by all
the creditors, hence the name ‘total creditors account’.
The account comprises the following entries:
total credit balance brought forward
total debit balance brought forward
total cheques paid to creditors (for credit purchases)
total cash paid to creditors (for credit purchases)
total discounts received
allowances by suppliers
sales ledger control
total return outwards
total credit purchases from the journal
refund from suppliers
total credit balance and total debit balances
277
INCOMPLETE RECORDS
Format of a purchases ledger control account
Dr
total debit balance brought forward
xx
total cheques paid to creditors
xx
(for credit purchases)
total cash paid to creditors (for credit
xx
purchases)
total cash discounts received
xx
allowances by suppliers
xx
sales ledger
xx
total return outwards
xx
total credit balance c/d(balancing igure)
xx
refund from suppliers
xx
total debit balance c/d(balancing
xxx
igure)
xxx
T E X T
xxx
Cr
total credit balance brought
xx
forward
total credit purchases from the
xx
journal
i)
ii)
It is possible as was the case with the sales ledger to have both a debit and credit
balance brought forward in the total creditors account. This is because we could have
over paid our suppliers and thus has a debit balance in our account. We could also
have returned goods for which we had paid.
For cash paid and cheques paid to creditors, we only consider the amount paid for the
credit sales. Cash sales are not part of the creditors control account since this account
only records purchase on credit. Cash purchases are accounted for differently to arrive
at the total purchases igure for the period.
iii)
Refund from suppliers: This happens incase we overpaid the suppliers or we returned
goods we had paid for among other reasons.
iv)
Allowance by suppliers this reduction in price in excess of cash discounts received.
v)
We only consider the cash discount received. Trade and other discounts are not
considered in the purchases ledger control.
S T U D Y
Notes
278
FINANCIAL ACCOUNTING
10.4 REASONS FOR MAINTAINING CONTROL ACCOUNTS
-
Ensures arithmetic check on the accounting record
Incases of incomplete records
Provides a quick igure for total balances as at a given time to be relected in the
statement of inancial position as debtors and debtors respectively
Detect and prevent fraud In the suppliers and the customers accounts
Facilitate allocation of duties among the debtors and creditors-handling staff.
The same principle of preparing the purchases ledger control account and the sales ledger
control account applies when preparing inancial statements. However, in the case of incomplete
records, of utmost importance is to obtain the igure for credit purchases and credit sales. In
most cases, we can trace in some way the other balance and hence our balancing igures would
be credit sales in the sales ledger control account and credit purchases in the purchases ledger
control account.
S T U D Y
T E X T
Having obtained the above igure, the next step would be to obtain the following:
i)
ii)
iii)
Expenses for the period
Cash sales for the period
Credit sales for the period
When there is no accrual or prepayment of expenses, the amount shown in the cashbook as paid
for the period will amount to total expenses for the period. However, incase there are accruals, or
prepayments, we would need to prepare the speciic expenses accounts that would help us get
the actual expenses for the period.
10.5 STOCK LOSS
Fast forward – to estimate stock loss we would have to use a gross proit percentage where
there are no stock record documents.
Sometimes stock could be lost, or even destroyed through ire. We would need to establish the
amount of stock loss for our purpose of establishing proits. Possible scenarios are that:
i)
ii)
We could be keeping perpetual stock taking records and hence it would be easy to
extract the igure of stock stolen, lost or destroyed.
We would have had a stock count before the loss
However in most business organizations and especially the small business organizations there
are no stock record documents. Therefore to identify the amount of stock loss, we would have to
use a gross proit percentage.
INCOMPLETE RECORDS
279
>>> Example
On 29th November 2005 there was a ire out break at the premises of Wajibu enterprises. The
whole of his stock, purchases and sales journal all got burnt in the ire except for stock worth Sh
24600 that was in the loading bay even though cleared in by the supplier. However the sales
ledger and the purchases ledger were salvaged.
The following igures were available on 30th November 2005:
Stock at the last statement of inancial position date 31st December 2004
was Sh 249000
b)
Receipts from debtors during the period to 29th November was Sh 634900
Debtors were Sh 285560 on 31st December 2004 and Sh 246660 on 29th November
2005
c)
Payments to creditors during the period 1st January 05 – 29th November 05 was Sh
345400. Creditors were Sh 152000on 31st December 04 and 125780 on
29th November 2005
d)
The gross proit margin on all sales has been constant at 25%
T E X T
a)
S T U D Y
All sales were made on credit and all purchases made on credit
Required
Compute the amount of stock destroyed by ire on 29th November 2005
Solutions:
First compute the amount of credit sales and credit purchases
Sales ledger control account
Dr
balance b/f
credit sales
285,560
596,000
Bank
Cr
634,900
balance c/d
246,660
881,560
881,560
Purchases ledger control account
Dr
bank
345,400
balance c/d
125,780
471,180
balance b/f
credit purchases
Cr
152,660
318,520
471,180
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WAJIBU ENTERPRISES
TRADING ACCOUNT FOR THE PERIOD ENDED 30TH NOVEMBER 2005
Sh
sales
less cost of sales
opening stock
add purchases
Sh
596,000
249,600
318,520
goods available for sale
568,120
less closing stock
x
cost of sales
gross proit at 25%
xx
149,000
S T U D Y
T E X T
G.P - 25 x 596000 = 149,000
100
596,000 – (Cost of sales) = 149,000 (gross proit)
Cost of sales = 596,000 – 149,000 = 447,000
Goods available for sale - closing stock = cost of sales
Closing stock = goods available for sale – cost of sales
Closing stock = 568,120 – 447,000 = 121,120
Stock destroyed = closing stock – salvaged stock
= 121,120 – 24,620
= Sh 96,500
INCOMPLETE RECORDS
281
CHAPTER SUMMARY
To arrive at the igures of cost revenue and proit for a business that is not maintaining double
entry, the following methods can be used.
i)
ii)
iii)
iv)
Use of control accounts
Use of ratios
Estimating income from net assets
Use of simple cashbook and bank statement
Control accounts are basically used to check the accuracy of posting in the ledgers. The major
types of control accounts used are:
CASE STUDY
A good example closer home would be the Nakumatt Downtown Store that burned down in
February, 2009. Most of the records for the day must have burned down; stocks worth millions
were lost in the furnace. The stock had to be accounted for so that all stakeholders could be given
a igure on how much was lost. These stakeholders include owners, bankers and the insurance
company that would need good backing before compensating any damages.
Incomplete records accounting had to come into play to give correct information on the losses for
inclusion into the chains inancial statements.
CHAPTER QUIZ
1. In the absence of a sale account or sales day book, how can a igure of sales
for the year be computed?
2. What methods can be used to arrive at the igure of cost revenue and proit
for a business that is not maintaining double entry?
3. A business has opening payables of Sh 75 million and closing payable of
Sh 65 million and discounts received of Sh 3 million. What is the igure for
purchases?
T E X T
Sales ledger control account
Purchases ledger control account
S T U D Y
i)
ii)
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ANSWERS TO CHAPTER QUIZ
1.
By using the trade accounts receivable control account to calculate sales as a balancing
igure.
2.
- Use of control accounts
- Use of ratios.
- Estimating income from net assets.
- Use of simple cash book and bank statement.
3.
Payables control
Sh (millions)
Bank
65
Discounts received
3
S T U D Y
T E X T
Closing payables
65
133
PAST PAPER ANALYSIS
6/07, 12/06, 12/04, 12/03
Sh Millions
Opening payables
75
Purchases
58
133
INCOMPLETE RECORDS
283
EXAM TYPE QUESTIONS
QUESTION 1
Crown Garments Wholesalers Ltd., was burgled on the night of 14 December 2006. The burglars
stole all the cash takings for the day together with the petty cash and some of the expensive
clothing.
On 30 November 2006, the owner had taken a physical stock count which established the value
of stock at Sh 32540000. The stock of clothing left after the burglary amounted to sh11300000
at cost. Deliveries of additional stock items from suppliers between 1 December 2006 and 14
December 2006 were invoiced at Sh 5784000 after deducting trade discounts of sh 732000.
Sales to retail customers (at selling prices) were as follows:
Sh.
Credit sales
Sh
1 December 2006 to 6 December 2006
1429710
6.250.290
7 December 2006 to 13 December 2006
1644500
8.079.500
259320
1200680
14 December 2006
Additional information:
1)
2)
3)
4)
5)
6)
The cash takings from 1 December 2006 to 13 December 2006 (inclusive) had been
banked intact.
Cheques for Sh.168.920 and Sh 192670 had been drawn to pay staff wages.
Credit customer had paid cheques amounting to Sh 15867110 (all of which had been
banked) in full settlement of accounts totaling Sh 16102830.
The company had paid credit suppliers a total of Sh 17118360 (all of which had been
presented to bank) in full settlement of accounts totaling Sh 17532800.
The petty cash imprest account had been replenished to its established level of
sh.25.000 on 1 December 2006 by withdrawal from the bank of Sh 9740. Subsequent
disbursements to 14 December 2006 had amounted to Sh 13690.
The cash book balances in the irms records on 30 November 2006 were as follows:
Sh.
Balance at bank
6.625.080 (debit)
Cash in hand
129.600
Petty cash
15.260
7) The gross proit margin had been at the rate of 30% throughout the year 2006. However,
from 7 December 2006 the company reduced the mark-up on cost to 331/3% as a
strategy to boost sales.
Required:
a) The amount of cash stolen.
(6 marks)
b) The value of stock (at cost) stolen.
(8marks)
c) The balance at bank close of business on 14 December 2006.
(6 marks)
T E X T
Cash sales
S T U D Y
Period
S T U D Y
T E X T
284
FINANCIAL ACCOUNTING
285
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CHAPTER ELEVEN
COMPUTERIZED
ACCOUNTING
S T U D Y
T E X T
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FINANCIAL ACCOUNTING
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CHAPTER ELEVEN
COMPUTERISED ACCOUNTING
OBJECTIVES
After studying this chapter, you should be able to:
INTRODUCTION
Keeping accurate accounting records is a vital part of managing an organization. Apart from
helping to keep it aloat inancially and legally, it is also a requirement of funding bodies. Smaller
groups can usually manage with simple book-keeping procedures but bigger groups juggling with
larger sums of money and more complex inancial transactions may ind their workload eased
by using a computerized accounting system. The good news is that there are easy to use and
reasonably priced computerized accounting package are available on the market.
DEFINITION OF KEY TERMS
1.
2.
Portfolio - In inance, a portfolio is an appropriate mix of collection of investments held
by institutions or a private individual.
Coniguration - In communications or computer systems, a coniguration is an
arrangement of functional units according to their nature, number, and chief characteristics.
Often, coniguration pertains to the choice of hardware, software, irmware, and
documentation. The coniguration affects system function and performance.
EXAM CONTEXT
This is a new chapter. It has not been examined in the past and could be examined considering
the fact that most entities have moved to computerized accounting and this is what accountants
and auditor are using.
T E X T
Identify the different accounting packages.
Explain the rationale for computerized accounting system.
List the components of a computerized accounting system.
Select a good computerized accounting system.
Explain the challenges of a computerized system.
Explain current trends in computerized accounting software.
S T U D Y
•
•
•
•
•
•
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INDUSTRY CONTEXT
S T U D Y
T E X T
Most entities have moved to computerized accounting owing to its advantages (notably high
speed and accuracy). It’s therefore increasingly become a requirement that accountants and
auditors be conversant with computerized accounting.
11.1 CLASSIFICATIONS OF COMPUTERISED ACCOUNTING
Fast forward - Accounting software that is designed for home use is often referred to as personal
accounting software.
There are many types of accounting software applications on the market today. Some applications
are intended to perform accounting functions for large corporate organizations. Others are meant
for personal use. Still other applications fall somewhere in between, performing functions suited
to small businesses, as well as those suited to the average person. Available software ranges
from the very simple to the very complex, with much variation in price as well.
Accounting software can be useful in such functions as recording and processing accounts
receivable and accounts payable transactions. Some software applications can be used in
payroll processing, the documentation of tax transactions, and the creation of related reports.
Accounting software can also be used in billing clients and customers and debt collection. Some
accounting programs even provide for timesheet record keeping, useful for professionals who
need to keep track of the hours they work.
Accounting software that is designed for home use is often referred to as personal accounting
software. This type of software is used mostly in managing household budgets and expenses.
Some personal accounting software makes it possible to download bank account information
directly from the Internet for use with the software.
Low-end accounting software is generally used by smaller businesses and can typically be
found for sale by a variety of retailers. Usually, software in this class is not highly speciic and can
be used for a wide range of businesses. This type of accounting program is usually adequate for
such uses as generating invoices, reconciling accounts, and handling payroll.
COMPUTERIZED ACCOUNTING
289
The next step up in the realm of accounting software consists of applications capable of
performing a variety of functions important to business accounting. Referred to as mid-market
software, accounting applications in this class perform general business accounting functions
and frequently include integrated management information systems. Many software applications
at this level are capable of providing for accounting in several different currencies. Mid-market
accounting software is usually purchased from a dealer.
Higher-end accounting software is more expensive than other types and is usually much more
complex. Generally designed for use by large businesses with millions of dollars in transactions,
high-end accounting programs usually have very sophisticated features and options. Software
in this class also allows for a high level of customization. Typically, higher-end software is sold
through a dealer.
1. QuickBooks
QuickBooks is a line of business accounting software developed and marketed by Intuit. Small
businesses use QuickBooks for most inancially-related business processes, from entering sales
receipts, tracking expenses, preparing and sending invoices, sales tax tracking and payment,
preparation of basic inancial statements and reports, and inventory management. The program
does not include MICR line printing, but does include check printing and options for employee
payroll and time tracking. For most tasks, QuickBooks doesn’t require users to understand
standard accounting procedures, including double-entry bookkeeping. Most transactions are
recorded using on-line screens that closely resemble paper based forms such as invoices or
checks.
Options now include versions for manufacturers, wholesalers, professional service irms,
contractors, non-proit entities and retailers, in addition to one speciically designed for
professional accounting irms who service multiple small business clients. In May 2002 Intuit
launched QuickBooks Enterprise Solutions for medium-sized businesses.
2. Sage Pastel
Sage Pastel is a leading developer of accounting, payroll, ERP and business management
software for the small, medium and large enterprise market. Founded in 1989, Sage Pastel has
developed an in-depth knowledge and understanding of the industry, establishing itself as the
market leader.
S T U D Y
11.2 TYPES OF ACCOUNTING PACKAGES
T E X T
Some companies choose to develop their own accounting software, gearing it completely towards
their unique needs. Other companies choose to purchase ready-made software packages.
Many organizations employ a combination of the two, purchasing software and applying local
modiications to make it more eficient.
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Sage pastel has been developed to provide comprehensive accounting and business solutions
for start-up, small, medium and larger sized companies. Sage Pastel Accounting also offers a
range of add-on modules that can assist your business with CRM, Business Intelligence, legal
and auditing solutions.
4. CreditQuest
CreditQuest is an end-to-end commercial Credit Management System that brings origination,
inancial analysis, underwriting, documentation and executive reporting together in a collaborative,
streamlined worklow. It combines a uniied, relationship-centric view of the customer’s inancial
data and supporting documents with portfolio management capability. Data from CreditQuest
passes seamlessly to LaserPro Harland Financial Solutions’ industry-leading documentation
solution.
S T U D Y
T E X T
CreditQuest is composed of four key functional areas, supported by a robust Report Manager
and over 40 standard reports.
•
•
•
•
•
•
Credit Manager
Decision Manager
Financial Analyzer
Project Analyzer
Report Manager
Portfolio Manager
CreditQuest is mainly used by banks for credit and inancial analyses.
11.3 FEATURES OF A GOOD COMPUTERIZED SYSTEM
1. Scalability
It is always very important to remember that as the company business expands, the business
accounting software should also change accordingly. This is particularly true pertaining to the
increase in products and services offered and the number of employees.
Wherever possible, when we choose our accounting package we should try to visualize our
business in 3 or 5 years time and how different it will be. Use this information to guide the
purchase decision. It may well be better to pay a little more now for the software knowing that it
can be easily upgraded when needed with minimum disruption and cost to our business
COMPUTERIZED ACCOUNTING
291
2. Support
It is important that any software has great support for when something goes wrong (and it always
does).
Secondly, we should ensure that the support should be local or as close as possible to us.
Imagine that things need done with the software by someone trying to help you over the phone.
Wherever possible, make some enquiries with other businesses about the package they use and
who helps them.
3. Accountant Interface
It’s most unlikely we will handle every aspect of our businesses accounting. The accountant is
an important factor in making the right decision. What software are they used to working with and
what do they prefer?
4. Best Value for Money
Once we have selected the right package for your business the most logical step is to shop for
the best value for money.
Shop around as the price can vary greatly and the product is exactly the same unless the price
differential is with good support or installation assistance.
5. Major Brands
Wherever possible, we should choose the most popular and major brand to avoid the hustle of
dealing with some unknown accounting software house.
Furthermore by choosing a major brand we can get regular updates and also know that the
company will be around as long as your business needs them.
6. Ease of Use
Ease of use is a personal thing but it is worth trying the software before you buy it if you can.
Remember to get the person who will be the main user to test the software as well.
S T U D Y
We should interface with them when we are thinking of buying the accounting software.
T E X T
Can we easily supply them data and reports from our accounting package without the need for
any extra work (which we will have to pay for)?
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Also consider how well the package can interact with other software we are using.
Nowadays, the modern accounting software should come with the import and export data function
where the import and export of data to spreadsheet or vice versa are easily done. With these
capabilities, just in case, there can be more detailed analysis to be done.
7. Features Needed
Most accounting software packages come in several different versions.
If we don’t need certain features now and can’t see a need for them in the future then we need
not buy them.
The major differences are usually - number of users allowed, number of reports available and
others.
S T U D Y
T E X T
11.4 Comparison Of The Steps Of An Accounting Cycle Under The
Manual System and Under The Computerized System
Fast forward – All accounting processes in manual systems are manual.
Steps In Accounting Cycle
Manual System
Computerized System
1.
Analyze source documents
Manual
2.
Record transactions in journal
Manual
3.
Post to Ledger accounts
Manual
Manual
Manual data entry
includes manual electronic
coding
Automatic
4.
Prepare Unadjusted Trial Balance
Manual
Automatic
5.
Journalize adjusting entries
Manual
Manual
6.
Post adjusting entries
Manual
Automatic
7.
Prepare adjusted Trial Balance
Manual
Automatic
8.
Journalize closing entries
Manual
Automatic
9.
Post closing entries
Manual
Automatic
10.
Prepare post-closing Trial Balance
Manual
Automatic
Manual
Automatic
11.
Prepare inancial statements
COMPUTERIZED ACCOUNTING
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Advantages of a computerized accounting system
a)
b)
c)
d)
e)
f)
Faster and eficient in processing of information.
Automatic generation of accounting documents like invoices, cheques and statement of
account.
With the larger reductions in the cost of hardware and software and availability of userfriendly accounting software package, it is relatively cheaper like maintaining a manual
accounting system.
More timely information can be produced.
No more manual processing of the data- all automatically been posted to the various
ledgers/accounts.
Many types of useful reports can be generated for management to use in decision
making.
b)
c)
d)
Power failure, computer viruses and hackers are the inherent problems of using
computerized systems.
Once data been input into the system, automatically the output are obtained hence the
data being input needs to be validated for accuracy and completeness, we should not
forget concept of GIGO (Garbage In (Input) Garbage out (Output).
Accounting system not properly set up to meet the requirement of the business due to
badly programmed or inappropriate software or hardware or personnel problems can
cause more havoc.
Danger of computer fraud if proper level of control and security whether internal and
external are not properly been instituted.
Fast forward – like manual accounting, computerized accounting also has controls.
11.5 CONTROLS IN COMPUTERIZED ACCOUNTING
SYSTEM
a)
b)
c)
d)
Proper transaction authorization. Input control needs to be instituted like input data
needs to be veriied for accuracy and completeness by a person different from the one
who is keying in the data.
Besides the above input control, there should be processing and output controls to
ensure integrity of the transaction data is intact.
No unauthorized access to computer iles, data, etc. All kept under lock and key and
proper log is maintained.
Uses of password control to access data.
S T U D Y
a)
T E X T
Disadvantages/ Challenges of a computerized accounting system
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CHAPTER SUMMARY
The fact that this is a new chapter and the trend in the industry it is a very important chapter both
for your exams and industrial use.
S T U D Y
T E X T
Most companies have moved to computerized accounting, even the small companies have their
computerized need catered for by affordable off the shelf software as mentioned earlier.
COMPUTERIZED ACCOUNTING
295
CHAPTER QUIZ
S T U D Y
T E X T
1. Analyzing source documents in both manual and automated accounting
systems is done manually. True or false?
2. Preparation of post-closing trial balance is done automatically in both manual
and computerized accounting systems. True or False?
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CHAPTER QUIZ ANSWERS
1. True.
2. False, like all other processes in the manual system it’s done manually.
EXAM TYPE QUESTION
T E X T
(a)
S T U D Y
You started work in ABC Company Ltd. The management is asking you to implement a
computerized accounting system. The following questions were posed to you:-
(b) There are so many different packages on the market. What should I be looking for when
selecting a computerized package? List seven factors.
(7marks)
What beneits will a computerized accounting system bring your company? State up to
ive possible beneits.
(5 marks)
(c)
If we get a Sales Ledger package what kind of reports should we expect? List six types
of report you would expect.
(6marks)
(d)
What’s the difference between a stand-alone package and an integrated package?
What are the advantages and disadvantages of each? State the difference and give
two advantages and two disadvantages of an integrated package.
(10 marks)
(d)
Our computer support staff says that we’ll have to conigure the package before we can
use it. What do they mean by that? Explain what coniguration involves. (5 marks)
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CHAPTER TWELVE
PUBLIC SECTOR
ACCOUNTING
S T U D Y
T E X T
298
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CHAPTER TWELVE
PUBLIC SECTOR ACCOUNTING
OBJECTIVES
After studying this chapter, you should be able to:
INTRODUCTION
There is increasing demand for public accountability and transparency by all stakeholders in the
Public Sector in Kenya. Revelations during the Public Accounts Committee (PAC) hearings and
in the Auditor-General’s reports raise issues of inancial accountability and transparency.
In the past, inancial reporting by the Government has largely been seen as inadequate,
government ministries/bodies do not provide understandable inancial reports. The reports have
been complex, confusing, and voluminous.
The preparation of transparent and understandable inancial statements is an important way
for Government departments/other agencies to demonstrate their accountability to citizens who
fund them through taxes, as well as development partners.
DEFINITION OF KEY TERMS
1.
Stewardship - is personal responsibility for taking care of another person’s property or
inancial affairs or in religious orders taking care of inances.
2.
Transparency - is a management approach in which (ideally) all decision making is
carried out publicly.
T E X T
•
•
•
•
List and explain the features of public sector accounting.
Explain the relevance of accounting concepts, basis and policies to public sector
accounting.
Explain what fund accounting is and its relationship with entity theory.
Explain the different ways of income measurement and valuation in the public sector.
Prepare, analyze and interpret inancial statements of government units.
Deal with accounts of state corporations and similar organizations.
S T U D Y
•
•
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EXAM CONTEXT
This is a new chapter. It has not been examined in the past and could be examined considering
the fact that most public sector accounting has increasingly become important with donors and
taxpayers demanding transparency.
INDUSTRY CONTEXT
The number of qualiied accountants in Kenya has increased tremendously over the years.
However, the IPSAS is a new concept which is not understood by many. The Government, as the
leading user of these standards, will therefore require undertaking massive training to enlighten
its accountants on IPSAS.
S T U D Y
T E X T
There has been an increasing need for transparent and understandable inancial statements by
both taxpayers and donors. This has created the demand for public sector accounting hence the
need for all accountants to understand, be able to prepare and interpret public sector accounts.
12.1 FEATURES OF PUBLIC SECTOR ACCOUNTING
Fast forward – The International Public Sector Accounting Standard Board (IPSASB) is the
global organization for the accounting profession founded in 1977.
International Public Sector Accounting Standards (IPSAS) are a set of high quality,
independently developed, accounting standards aimed at meeting inancial reporting needs of
the public sector.
IPSAS are developed by the International Public Sector Accounting Standard Board (IPSASB),
which is an arm of the International Federation of Accountants (IFAC); the global organization
for the accounting profession founded in 1977.
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301
IFAC has 157 member bodies drawn from 122 countries. It represents 2.5 million accountants
around the world. Transition to IPSAS as an accounting framework is designed to improve
the quality and consistency of inancial reporting, enhance transparency and accountability;
facilitate better decision making, inancial management and good governance in our entire
public sector.
The above reform in inancial reporting will mean that the Government will now be able to
produce a consolidated set of general purpose inancial statements — it will be interesting and
encouraging seeing the Government’s consolidated inancial statements just like those that
companies listed on the Nairobi Stock Exchange prepare.
Anne Owuor is Kenya nominee to the IPSASB; she became a member of the International Public
Sector Accounting Standards Board in January 2008. She was nominated by the Institute of
Certiied Public Accountants of Kenya (ICPAK).
The IPSASB’s objective, scope of activities and membership are set out in its Terms of Reference.
They are also summarized in a fact sheet. The IPSASB’s Strategic and Operational Plan, 20072009 sets out the direction for the board in fulilling these objectives.
Adoption and implementation of IPSAS is not a requirement for the Government or any of its
entities, it is a best practice issue, IPSASB or even IFAC cannot enforce compliance.
S T U D Y
Members of the IPSASB are nominated by IFAC member bodies (like ICPAK) and, for public
members, through nominations from member bodies, other organizations, and the general
public.
T E X T
The International Public Sector Accounting Standards Board (IPSASB) focuses on the accounting
and inancial reporting needs of national, regional and local governments, related governmental
agencies, and the constituencies they serve. It addresses these needs by issuing and promoting
benchmark guidance and facilitating the exchange of information among accountants and those
who work in the public sector or rely on its work. A key part of the IPSASB’s strategy is to
converge the IPSASs with the International Financial Reporting Standards (IFRSs) issued by the
IASB. To facilitate this strategy, the IPSASB has developed guidelines or “rules of the road” for
modifying IFRSs for application by public sector entities.
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12.2 FUND ACCOUNTING AND ITS RELATIONSHIP WITH
ENTITY THEORY
Fast forward – in the fund theory accountability is measured instead of proitability.
FUND ACCOUNTING
T E X T
Fund accounting serves any non-proit organization or the public sector. These organizations
have a need for special reporting to inancial statements users that show how money is spent,
rather than how much proit was earned.
System used by nonproit organizations, particularly governments. Because there is no proit
motive, Accountability is measured instead of proitability. The main purpose is stewardship of
inancial resources received and expended in compliance with legal requirements. Financial
reporting is directed at the public rather than investors.
S T U D Y
The accounting equation is Assets = Restrictions on Assets.
Funds are established to ensure accountability and expenditure for designated purposes.
Revenues must be raised and expended in accordance with special regulations and restrictions.
Budgets are adopted and recorded in the accounts of the related fund. Contractual obligations
are given effect in some funds.
ENTITY THEORY
View in which a business or other organization has a separate accountability of its own.
It is based on the equation:
Assets = Liabilities + Stockholders’ Equity
The entity theory considers liabilities as equities with different rights and legal standing in the
business. Under the theory, assets, obligations, revenues, and expenses and other inancial
aspects of the business entity are accounted for separately from its owners. In other words, the
company has an identity distinct from its owners or managers. The irm is viewed as an economic
and legal unit.
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Relationship Between entity and fund theory
Both the fund theory will focus on ensuring that assets availed to the entity in question are used
appropriately (according to restriction). In the case of fund theory according restriction on assets
(without having to make a proit), this will also be the case for entity theory only that in this theory
it has to be for maximum proits within the restrictions.
12.3 FINANCIAL ACCOUNTING TECHIQUES
Public sector organizations may adopt different accounting techniques; the most important
being:-
Under budgetary accounting, the concept is based on the forecasted cash lows; ad operations
must be limited to the budget estimates. The organization cannot spend above budget restrictions
without parliamentary approval.
The executive branch of the government unit proposes the budget, the legislature branch reviews,
modiies and enacts the budget and inally the executive branch implements the budget.
Budget accounting therefore aims to achieve the following:
a.
b.
c.
d.
Ensure eficiency of managers.
Communicate the objectives of the organization to the employees.
Provide controls.
Provide a yardstick for measuring performance of employees.
2. CASH ACCOUNTING
Under this system only cash inlows and outlows are recognized and recorded. The system does
not recognize any revenue or expenditure that has not been received or paid (i.e. accrued).
S T U D Y
Budgetary accounting is the preparation of operating accounts in form of budgets. A budget is a
management plan that has been transformed into igures necessary to evaluate the achievement
of the organization’s objectives.
T E X T
1. BUDGETARY ACCOUNTING
304
FINANCIAL ACCOUNTING
3. ACCRUALS ACCOUNTING
The accruals concept states that revenues and costs are recognized as they are earned and
incurred. Most of the organizations in the private sector prefer this method. However, under
public sector accounting, both cash and accruals accounting can be used by different entities or
kinds of organizations e.g. if part of an organization is charged with the responsibility of running
activities on the same basis as commercial organization s, such an entity may adopt accrual
accounting irrespective of the accounting techniques adopted by the main organization.
4. COMMITMENT ACCOUNTING
S T U D Y
T E X T
This accounting system recognizes transactions when the organization is committed to them. It
means the transaction is not recognized when cash is paid or received, nor when an invoice is
received or issued, but at an early stage where orders are received and placed. This accounting
method is meant to ensure that government units do not overspend because transactions will
only be entered into after checking committed balances.
5. FUND ACCOUNTING
An organization may be composed of various entity funds; each fund will have its own books of
account as if it was completely independent from the whole organization.
12.4 ANNUAL ACCOUNTS FOR GOVERNMENT
Every government unit will prepare inancial statements to account for the money allocated to
them. The inancial statements differ according to the nature of the activities undertaken by
the government unit. However the following types of accounts are common among government
units:
1. INCOME AND EXPENDITURE ACCOUNTS
This is similar to income and expenditure accounts for nonproit making organizations. It’s
however prepared by government units, which provide commercial services e.g. a staff canteen
or student’s welfare
PUBLIC SECTOR ACCOUNTING
305
2. STATEMENT OF ASSETS AND LIABILITIES
Just shows the assets and liabilities in the organization.
3. GENERAL ACCOUNTS OF VOTE (GAV)
During a budget speech, the Minister for Finance will give detailed appropriation (allocations)
of funds to different governmental units. Through an appropriation bill, Parliament will approve
different estimates to individual governmental units. The amount approved to each governmental
unit by parliament is then recorded into a particular account known as “General Account of vote”
(GAV). This account therefore records funds allocated to various governmental units.
5. PAYMASTER GENERAL ACCOUNT (PMG)
The Paymaster General Account (PMG) is the cash account operated by the individual
governmental units. It records amounts so far withdrawn from the exchequer.
6. APPROPRIATION- IN- AID (AIA)
AIA is the amount to be generated by the governmental unit from its internal activities. It is
subtracted from the gross estimate (gross vote) to arrive at net estimate of (net vote) which
is approved by parliament to be released from the consolidated fund. An AIA account may be
maintained,
Where: when AIA is received from own operations:
DR
PMG account
CR
AIA account
At the end of the year:
DR
AIA account
CR
GAV account
S T U D Y
All incomes of the government are received and recorded into an account called the “Exchequer
account”. The total amount available in the exchequer represents the consolidated fund, i.e. the
consolidated fund operates an account called exchequer.
T E X T
4. THE EXCHEQUER ACCOUNT
306
FINANCIAL ACCOUNTING
7. APPROPRIATION ACCOUNT
Shows the following in tabular form:
•
•
•
•
Approved estimates
Actual expenditure
Amounts under-spent
Amounts over-spent
8. REVENUE ACCOUNT
S T U D Y
T E X T
A revenue account records only the estimated revenue and actual revenue from each particular
revenue source for the governmental unit. The difference between the two, if signiicant must be
explained by the accounting oficer. Alternatively the signiicant difference between two can be
used to correct future estimations by the governmental unit. It could also represent new factors
emerging during the year which were not taken into account during the previous budget.
CHAPTER SUMMARY
IPSAS 1, Presentation of Financial Statements, sets out the overall considerations for the
presentation of inancial statements, guidance for the structure of those statements and minimum
requirements for their content under the accrual basis of accounting.
PUBLIC SECTOR ACCOUNTING
307
CHAPTER QUIZ
1. Which accounting equation is used in the fund theory?
S T U D Y
T E X T
2. Which accounting equation is used in the entity theory?
308
FINANCIAL ACCOUNTING
S T U D Y
T E X T
CHAPTER QUIZ ANSWERS
1.
The accounting equation is Assets = Restrictions on Assets
2.
Assets = Liabilities + Stockholders’ Equity
309
S
T
S T
T SU
U TD
DUY
YD Y
T E
E TX
X ET
TX T
CHAPTER THIRTEEN
ANSWERS TO EXAM TYPE
QUESTIONS
S T U D Y
T E X T
310
FINANCIAL ACCOUNTING
3 11
ANSWERS TO EXAM TYPE
QUESTIONS
CHAPTER ONE
Question One
Mary
Statement of inancial position as at
31.12.2003
Non current assets
Sh.
Freehold premises
Sh.
25,000
12,000
Plant
Stock
8,000
7,000
Debtors
1,000
Cash at Bank
6,000
Cash in hand
22,000
59,000
Capital [34,000 + 5,000 – 10,000] W2
29,000
Non current liabilities
20,000
Loan from bank
Current liabilities
10,000
Creditors W4
59,000
Workings
W1
Stock:
Debtors:
11,000 + 34,000 – 37,000
10,000 + 51,000 – 54,000
= 8,000
= 7,000
Cash at bank: 5,000 – 16,000 – 2,000 – 1,000 – 36,000 + 54,000 – 3,000 = 1,000
Cash hand:
3,000 – 10,000 + 9,000 + 16,000 – 10,000 – 2,000 = 6,000
S T U D Y
Current assets W1
T E X T
37,000
312
FINANCIAL ACCOUNTING
W2
Capital
Balance b/f
Add proit W3
Less drawings
W3
Proit:
Sales
Cost of sales
Electricity
Rates
Wages
Sundry expenses
Bank interest
Net proit
Sh.
34,000
5,000
39,000
(10,000)
29,000
60,000
(37,000)
(2,000)
(1,000)
(10,000)
(2,000)
(3,000)
5,000
S T U D Y
T E X T
W4
Creditors = 12,000 + 34,000 – 36,000 = 10,000
Question Two
Accounting is deined as the process of identifying, measuring and reporting economic information
to the users of this information to permit informed judgment
Many businesses carry out transactions. Some of these transactions have a inancial implication
i.e. either cash is received or paid out. Examples of these transactions include selling goods,
buying goods, paying employees and so many others.
Accounting is involved with identifying these transactions measuring (attaching a value) and
reporting on these transactions. If a irm employs a new staff member then this may not be an
accounting transaction. However when the irm pays the employee salary, then this is related
to accounting as cash involved. This has an economic impact on the organization and will be
recorded for accounting purposes. A process is put in place to collect and record this information;
it is then classiied and summarized so that it can be reported to the interested parties.
Accounting equation
A business owns properties. These properties are called assets. The assets are the business
resources that enable it to trade and carry out trading. They are inanced or funded by the owners
of the business who put in funds.
These funds, including assets that the owner may put is called capital. Other persons who are
not owners of the irm may also inance assets. Funds from these other sources are called
liabilities.
The total assets must be equal to the total funding i.e. both from owners and non-owners. This is
expressed in form of accounting equation, which is stated as follows:
ASSETS = LIABILITIES + CAPITAL
ANSWERS TO EXAM TYPE QUESTIONS
313
Proit is determined by redrafting the second section of the Statement of inancial position.
Remember that net assets will be the same as capital.
Opening and closing capital are determined as follows:
Total assets
Current Liabilities:
Creditors
Overdraft
Current Assets:
Debtors
Cash
4,000
1,000
5,000
31,000
Net assets
5,000
6,000
11,000
20,000
Opening capital
20,000
Opening Capital
Add additional capital
Add net proit (Missing igure)
Less drawings
Closing Capital
Total assets
Current Liabilities:
Creditors
Overdraft
Sh.
20,000
9,000
29,000
8,000
1,500
9,500
38,500
Net assets
3,000
9,000
12,000
26,500
Closing capital
26,500
Sh
20,000
5,000
6,000
31,000
(4,500)
26,500
Proit may be also computed as follows:
Using the extended accounting equation
Net proit = closing capital (net assets) – opening capital + drawings – additional capital
= 26,500 – 20,000 + 4,500 – 5,000
= Sh 6,000
T E X T
Current Assets:
Debtors
Cash
31.12.2003
Non – Current Assets
Property
Machinery
Sh.
20,000
6,000
26,000
S T U D Y
01.01.2003
Non –Current Assets
Property
Machinery
314
FINANCIAL ACCOUNTING
CHAPTER 2
Question 1
Skates
Trading, Statement of comprehensive income for the year ended 31 September 2002
Sh.
Sh.
Sales
Less: returns outwards
Cost of sales:
Opening stock
Purchases
Add carriage inwards
Less returns outwards
9,210,000
___21,500
9,231,500
__(30,700)
S T U D Y
T E X T
Less closing stock
Less expenses
Wages and salaries
Carriage outwards
Motor expenses
Rent and rates
Telephone
Insurance
Ofice expenses
Sundries
Net proit
Sh.
13,090,000
__(55,000)
13,035,000
2,391,000
9,200,800
11,591,800
(2,747,500)
1,282,000
30,900
163,000
297,000
40,500
49,200
137,700
28,400
(8,844,300)
4,190,700
(2,027,700)
_2,163,000
Skates
Statement of inancial position as at 30 September 2002
Non current assets
Ofice equipment
Motor van
Current assets
Stocks
Debtors
Bank
Cash
Current liabilities
Creditors
Capital
Add net proit
Less drawings
Sh.
Sh.
2,747,500
1,239,000
311,500
__29,500
4,318,500
(937,000)
Sh.
625,000
410,000
1,035,000
3,381,500
4,416,500
3,095,500
2,163,000
5,258,500
(842,000)
4,416,500
ANSWERS TO EXAM TYPE QUESTIONS
315
Question 2
Disct
Bank
Bal b/d
R Burton
E Taylor
R Harris
J Cotton: loan
H Hankins
C Winston
R Wison & Son
H Winter
Bank
Commission
Cash
230
7
11
15
3
13
17
23
350
89
580
Cash Book
Bank
Disct
4756
133
209
285
1000
74
247
323
437
Rent
N Black
P Towers
C Rowse
Motor expenses
Wages
Cash
Drawings
T Briers
Fixtures
88 Balances c/d
7,552
Cash
Bank
120
351
468
780
9
12
20
44
160
350
7
120
133
48
123
580
650
4833
7,552
Discounts Received
Discounts Allowed
3/1
Sundry
Debtors
89
48
T E X T
Sundry Creditors
S T U D Y
3/1
316
FINANCIAL ACCOUNTING
CHAPTER 3
Question 1
Mary Carter
Statement of inancial position as at 31.12.2001
Non current assets
Freehold premises
Plant
Sh.
Sh.
8,000
7,000
1,000
6,000
22,000
Current assets
Stock
Debtors
Cash at Bank
Cash in hand
(10,000)
Current liabilities
Creditors
S T U D Y
T E X T
Capital [34,000
10,000]
+
5,000
–
Stock:
Debtors:
12,000
49,000
29,000
20,000
49,000
Non current liabilities
Loan from bank
Workings
Sh.
25,000
12,000
37,000
11,000 + 34,000 – 37,000
10,000 + 51,000 – 54,000
= 8,000
= 7,000
Cash at bank: 5,000 – 16,000 – 2,000 – 1,000 – 36,000 + 54,000 – 3,000 = 1,000
Cash hand:
3,000 – 10,000 + 9,000 + 16,000 – 10,000 – 2,000 = 6,000
Capital
Bal b/f
Add proit
Less drawings
Proit:
Sales
Cost of sales
Electricity
Rates
Wages
Sundry expenses
Bank interest
Net proit
34,000
_5,000
39,000
(10,000)
29,000
60,000
(37,000)
(2,000)
(1,000)
(10,000)
(2,000)
(3,000)
5,000
Creditors
= 12,000 + 34,000 – 36,000 = 10,000
ANSWERS TO EXAM TYPE QUESTIONS
317
CHAPTER 4
QUESTION 1 (December, 2006 Q 1)
(a) Baraka
Statement of comprehensive income for year to 30 September 2006
4,121
(360)
410
100
50
20
26
56
110
50
30
Sh“.000”
5,398
(3,761)
1,637
T E X T
Sh “.000”
4,814
584
(852)
785
(b) Baraka
Statement of inancial position as at 30 September 2006
Non Current assets
Premises
Fixtures and ittings
Sh. “000”
2,500
300
2,800
Current assets
Inventory
Receivables
Prepayments
Cash at bank
Cash in hand
Current liabilities
Payables
Accrued expenses
Capital
Net proit for year
Less: Drawings
Sh “.000”
(50)
(30)
80
Sh. “000”
2,450
270
2,720
360
177
20
493
10
1,060
403
16
(419)
641
3,361
3,176
785
3361
(600)
3,361
S T U D Y
Sales: Cash
Credit
Cost of sales:
Purchases
Less: Closing inventory
Gross proit
Expenses
Wages
Rent and rates
Lighting expenses
Insurance
Stationery and postage
Sundry expenses
Bank charges
Depreciation: Premises
Fixtures and ittings
Net proit
318
FINANCIAL ACCOUNTING
Workings
1.
Capital
Bank contra
Suppliers
Customers
Banking-contra
Customers
Uncredited
amount
Cash sales
Cash and Bank
Cash
Sh.000
500
20
4,814
4,834
Bank
Sh.000
Cash
Sh.000
Cash Contra
Fixtures and ittings
10 Suppliers – purchases
382 Insurance of inventory
3,769 Bank charges
Wages
400
30 Lighting expenses
50
4,691
Drawings
Bank contra
Bal. c/d (inclusive-5000)
2.
S T U D Y
T E X T
Receivables
Sales
Sh.000
584
Cash
Cash
Balance c/d
584
Sh.000
382
30
172
584
3.
Cash
Balance c/d
Sh.000
3,728
403
4,131
Cash
Purchases
Sh.000
10
4,121
4,131
4.
Sh.000
Balance c/d
3,176
3,176
Sh.000
Premises
2,500
Cash at bank
500
Rent and rates
100
Lighting expenses
50
Stationery and postage 26
3,176
600
3,769
15
4,834
Bank
Sh.000
20
300
3,728
40
110
493
4,691
ANSWERS TO EXAM TYPE QUESTIONS
319
CHAPTER 5
Question 1 (June 2006 Question2)
(a)
Umoja Women’s Welfare Society
Water tank statement of comprehensive income for the year ended 30 April 2006
Sh. ‘000’
Gross proit
Selling expenses
Net proit
(41,000)
4,000
(2,000)
2,000
T E X T
Cost of sales
45,000
(b)
Umoja Women’s Welfare Society
Income and expenditure account for the year ended 30 April 2006
Income
Net proit from water tank
Sh .’000’
Sh .’000’
2,000
Subscriptions
9,100
Donations from members
2,500
Rafle tickets
2,800
800
Membership fees
Expenditure
Ofice expenses (4,100+400)
Rent - Ofice
Depreciation of Motor vehicle
Rafle prizes paid
Cost of rafle tickets
Surplus for the year
17,200
4,500
4,000
200
1,200
300
(10,200)
7,000
S T U D Y
Sales
320
FINANCIAL ACCOUNTING
(c)
Umoja Women’s Welfare Society
Statement of inancial position as at 30 April 2006
Non current assets
Machinery
Motor Vehicles
Sh ‘000’
22,000
10,000
32,000
Current assets
Raw materials
Subscriptions receivable
Cash at bank
T E X T
2,800
1,500
400
(4,700)
Accumulated fund b/f
Surplus for the year
Membership
note)
fees
fund
Sh .‘000’
15,900
5,000
20,900
20,000
2,000
500
22,500
Current liabilities
Payables
Subscriptions paid in advance
Accrued ofice expenses
S T U D Y
Sh .‘000’
(6,100)
(5,000)
11,100
17,800
38,700
25,000
7,000
32,000
6,700
(see
38,700
Note on Membership fees fund
Note number 3 on the membership fee fund is ambiguous. The examiner does not indicate clearly
the source of the fund (whether it is from the surplus from the period, whether there are donations
made or whether it is funded by the members of the society). Therefore we have ignored the
note, but other alternatives may apply and this will depend on the assumption. For example if we
assume that the members are meant to fund the amount of Sh 800,000 , then we can increase
the fund to Sh 7,500,000 and have a receivable of Sh 800,000 as part of the current assets.
Other workings
(i)
Cost of sales
Raw materials used
Factory wages
Factory overheads
Factory rent
Factory staff bonus
Depreciation – Machinery (5%X22m)
- Motor vehicles (80% X1m)
Sh.’000’
35,000
600
1,000
1,000
1,500
1,100
800
41,000
ANSWERS TO EXAM TYPE QUESTIONS
(ii)
321
Subscriptions
Balance b/d
Income &
(bal)
Balance c/d
Sh.‘000’
3,500 Balance b/d
Sh.‘000’
2,100
1,500 Balance c/d
14,100
2,000
14,100
9,100 Cash
Expenditure
10,000
Question 2
Workings
Wk 1
Statement of affairs
Bakari Sailors club
As at 1st June 2006
Liabilities
Members subscription prepaid
Creditors for bar
Accumulated fund (bal.. ig)
Net book value
2,000,000
(200,000)
Cash
Less to income and expenditure a/c
1,800,000
Wk 3
Depreciation (reducing balance)
Free hold premises
Boatyard and Lunch facility
Fixtures and ittings
Repairs Workshop
40,000 x 5%
8,000 x 5%
300 x 10%
5,000 x 10%
91,000
400
11,070
3,100
105,570
560
500
104,510
105,570
Wk 2
Disposal of boat
Sh .‘000’
‘000’
2,000
400
300
500
T E X T
Sh.‘000’
5,000
40,000
8,000
3,000
35,000
S T U D Y
Assets
Repairs workshop
Freehold premises
Boatyard and lunch facility
Fixtures and ittings
Club-owned boats and yachts
Members subscription accrued
Bank balance
Bar stocks
322
FINANCIAL ACCOUNTING
Wk 4
Bar trading account for the year ended 31st May 07
Sh ‘000’
Bar sales
Opening inventory
3,100
Closing inventory
(2,850)
Purchases (5,010 + 610)
Sh. ‘000’
8,000
5,620
Bar gross proit
(5,870)
2,130
Less bar wages (35 + 1,260)
(1,295)
Bar Net proit
835
Wk 5
Repair of boats
T E X T
Receipts and payments
320
1,920
2,240
S T U D Y
Wk 6
120% - 1,960
100% - ?
20% - ?
(20 x 1960)/ 120 = 81.75 = 82
Wk 7
Balance b/d
Receipts and payments
5,000
Fixtures & ittings
Club owned boats and yachts
35,000 Disposal
3,000
Depreciation
Bal c/ld
38,950
2,000
2,050
ANSWERS TO EXAM TYPE QUESTIONS
323
Bahari Sailors club
Income and expenditure a/c
For year 31st May 2007
Sh ‘000’
Incomes
Subscription W7
Bar proits W3
Receipts from training school
Boat hire charges M.
W.M
Yacht racing
20,370
835
2,050
900
1,960
3,080
29,195
Expenses
Repairs of boats Wk 4
Donations Wk 5
Depreciation Club owned Wk 6
Premises
Boat yard and lunch facility
I and F
Repairs workshop
Loss on disposal
Yacht racing competition
Salaries
General expenses
2,240
82
2, 050
2,000
400
300
500
1,800
1,870
1,500
2,200
(14,942)
14,303
S T U D Y
T E X T
Sh ‘000’
324
FINANCIAL ACCOUNTING
Bahari Sailors club
Statement of inancial position
As at 31st May 2007
S T U D Y
T E X T
Sh ‘000’
Non-current assets (N B V)
Repairs workshop
Depreciation
Free hold Premises
Depreciation
Boat facility L.F
Depreciation
F&F
Depreciation
N.B.V. (W6)
5,000
(500)
40,000
(2,000)
8,000
(400)
3,000
(300)
Current Assets
Bar stocks
Accrued subscription
Bank balance
2,850
350
28,590
Current Liabilities
Donations
Creditors (610+35+320)
Prepaid subscription
Accumulated fund
Surplus
Donated boat
(82)
(965)
(790)
104,510
14,313
3,000
Sh ‘000’
4500
38000
7600
2700
38,950
91,750
29,953
121,703
121,703
ANSWERS TO EXAM TYPE QUESTIONS
325
CHAPTER 6
Question 1 (December 2007 Question2)
Taba Ltd
Manufacturing Trading and loss a/c for the year ended 31 October 2006
Less: cost of sales
Opening stock
Add: Cost of inished goods
Less: Closing stock of inished goods
Gross proit
Less: Expenses: Loss on disposal
Administration o/heads (4,900 + 250)
Selling O/heads (2,600 + 250)
Net proit
10,400
3,200
800
500
19,100
800
(1,700)
48,200
67,100
(600)
66,500
1,600
48,200
19,800
(1,300)
18,000
200
5,150
2,850
9,800
Sh’000’
14,900
48,500
(8,200)
T E X T
Sh’000’
1,200
16,400
17,600
(1,400)
16,200
18,000
34,200
S T U D Y
Raw materials
Opening stock of R .M
Purchases of R.M
Cost of R.M available for use
Less: closing stock of R.M
Raw materials consumed
Direct manufacturing wages
PRIME COST
Factory overheads
Production overheads
Depreciation plant
Depreciation Business premises
Depreciation M. Vehicle
Total cost of production
Add: Opening W.I.P
Less: Closing W.I.P
Cost of inished goods
Sales
Less: Proceeds from sale of plant
326
FINANCIAL ACCOUNTING
Taba Ltd
Statement of inancial position as at 31 October 2006
Non-current assets
Business premises
Plant and equipment
Motor vehicle
Cost
20,000
18,000
6,400
S T U D Y
T E X T
Current assets
Trade receivables
Cash in hand
Bank Balance
Stock: Raw materials
Work in progress
Finished goods
Current liabilities
Trade payables
Other payables: PAYE
VAT
Ordinary share capital
Share premium
Retained earnings b/f
Proit for the year
Retained earnings c/f
Acc. Depreciation
4,000
12,200
3,400
NBV
16,000
5,800
3,000
24,800
4,600
300
32,900
1,400
1,700
1,200
40,000
2,800
1,300
2,800
(6,900)
28,300
9,800
33,300
58,100
15,000
5,000
38,100
58,100
ANSWERS TO EXAM TYPE QUESTIONS
327
Question 2 (June 2003 Question 1)
LIMURU MANUFACTURERS
MANUFACTURING ACCOUNT FOR THE YEAR ENDED 31ST DEC 2002
Add: Factory overheads
Variable & ixed
Depreciation of plant & machinery
25,000
_3,000
Add: Opening WIP
Less: Closing WIP
Production cost
Add: Manufacturing proit (25% Production cost)
Market value of manufactured goods
28,000
95,000
5,000
_(8,000)
92,000
_23,000
115,000
LIMURU
STATEMENT OF COMPREHENSIVE INCOME
FOR THE YEAR ENDED 31 DEC 2002
Sh’000
Sales
Less Cost of sales
Opening stock inished goods
Market value of goods produced
Less Closing stock of inished goods
Gross proit
Add: Manufacturing proit
Less: Expenses
Rent & rates
Lighting
Stationery & postage
Staff salaries
Depreciation of motor vehicles
Motor vehicle running costs
Add: Opening stock igure - unrealized proit
Less: Closing stock igure – unrealized proit
Net proit
6,900
115,000
(10,350)
17,000
6,000
2,000
19,380
4,000
4,500
T E X T
Opening stock of raw materials
Add: Purchases of raw materials
Less Closing stock of raw materials
Cost of raw materials consumed
Direct labour
PRIME COST
Sh’000
7,000
38,000
(9,000)
36,000
31,000
67,000
S T U D Y
Sh’000
Sh’000
192,000
(111,550)
80,450
_23,000
103,450
(52,880)
50,570
1,380
(2,070)
49,880
328
FINANCIAL ACCOUNTING
LIMURU MANUFACTURERS
BALANCE SHEET
AS AT 31ST DECEMBER 2002
Sh’000
NON CURRENT ASSETS
Plant and machinery
Motor vehicles
CURRENT ASSETS
Stock : Raw materials
WIP
Finished goods
Less; provision for unrealized proit
Debtors
Prepayments
Bank
30,000
16,000
10,350
(2,070)
Sh’000
15,000
8,000
9,000
8,000
8,280
28,000
2,000
16,600
S T U D Y
T E X T
TOTAL ASSETS
EQUITY & LIABILITIES
Capital
Opening balance
Add: Net proit
Less: Drawings
CURRENT LIABILITIES
Creditors
Accruals
TOTAL EQUITY & LIABILITIES
Sh’000
15,000
_8,000
23,000
71,880
94,880
48,000
49,880
(11,500)
86,380
5,500
3,000
_8,500
94,880
CHAPTER 7
Question 1 (June 2006 Question 4)
(a)
Goodwill is that advantage that an existing business may have over a newly established
business. The advantage is in the form of the ability to generate revenue and proits as
a result for example customer loyalty, location and marketing.
(i)
On admission of a new partner, the new partner will start enjoying the beneits of the
existing partnership as a result of the goodwill created by the previous partners. The
newly admitted partner should therefore pay for his share of the goodwill.
On retirement of one of the partners, the remaining partners will continue enjoying the
beneits that the retired partner helped create. Therefore it will be important for the
retiring partner to be paid his share of the goodwill.
(ii)
ANSWERS TO EXAM TYPE QUESTIONS
329
(b)
Akili, Busara and Chema
Trading, proit, loss and appropriation account for the year ended 30April 2006
Sh’000’
Inventory
Expenses
Interest(10%
Operating
Net proit
Int. on cap.
A
B
C
Salaries
A
B
C
Balance
A
B
C
300
6,400
X 3m)
1st six
62.5
50
25
0
120
0
247.5
247.5
247.5
Months
1000
(137.5)
862.5
(120)
742.5
(742.5)
0
2nd six
71.5
71
49
0
60
60
341.25
204.75
136.5
Months
1000
(197.5)
802.5
(120)
682.5
(682.5)
0
(10,700)
8,700
(6,700)
2,000
2000
140
121
74
(335)
1,665
0
180
60
588.75
453.25
384
(240)
1,425
(1,425)
0
(b)
Capital account
Goodwill
Bal.c/d
A
Sh.’000’
600
3,100
3,700
B
Sh.’000’
360
2,840
3,200
C
Sh.’000’
240 Bal.b/d
Goodwill
1,960 Rev.gain
2,200
A
Sh.’000’
2,500
400
800
3,700
B
Sh.’000’
2,000
400
800
3,200
C
Sh.’000’
1,000
400
800
2,200
A
Sh.’000’
200
140
0
588.75
0
3,700
B
Sh.’000’
3,00
121
180
452.25
100
3,200
C
Sh.’000’
200
74
60
384
200
2,200
Current account
Drawings
Bal.c/d
A
Sh.’000’
300
B
Sh.’000’
400
628.75
3,700
753.25
3,200
C
Sh.’000’
200 Bal.b/d
Int. –cap
Salaries
Proits
718 Int.Loan
2,200
T E X T
Closing
Gross proit
3,000
10,300
13,300
(2,600)
Inventory
Sh’000’
19,400
S T U D Y
Sales (20-0.6)
Cost of sales
Opening
Purchases
330
FINANCIAL ACCOUNTING
(c)
Akili, Busara and Chema
Statement of inancial position as at 30 April 2006
Non Current assets
Land and buildings
Plant and Machinery
Sh.’000’
8,000
Sh.’000’
Sh.’000’
7,000
0
15,000
(4,000)
3,000
Current assets
Inventory (2,400+200)
Bank Overdraft
Payables
3,400
6,000
1,100
3,300
(4,400)
T E X T
Capital Accounts
S T U D Y
11,400
2,600
Receivables
Current liabilities
(4,000)
8,400
1,600
13,000
3,100
Akili
2,840
Busara
1,960
Chema
7,900
Current account
Akili
628.75
Busara
753.25
Chema
718
Non current liabilities
10% Loan : Busara
: Chema
1,000
2,000
2,100
10,000
3,000
13,000
ANSWERS TO EXAM TYPE QUESTIONS
331
Question 2 (December 2006 Question 3)
Statement of comprehensive income for the year ended 30 September 2006
Sh “.000”
Sales:
14,000
1 October 2005 to 31 March 2006
21,000
4,800
Purchases (16,400 + 200)
16,600
Closing inventory
(5,100)
21,400
Gross proit
Gross proit ( ratio of 14:21)
Expenses:
Salaries (5,200 – 1,330)
Rent, rates and electricity
1,240 + 600 +60 – 260)
Shop wages
35,000
(16,300)
Six months 1.10.2005
to 31.3.2006)
(7,480)
18,700
Six months (1.4.2005
to 30.9. 2006)
(11,220)
(1,935)
(1,935)
(820)
(820)
(1,100)
(1,100)
(110)
(1,410)
(110)
(1,110)
(340)
(340)
(30)
(30)
(1/25 x (6,000 +200)
(124)
(124)
Provision for doubtful debts
(120)
(40)
Professional charges (420-210)
General expenses (2,640 – 120)
Depreciation: Motor vehicles 680
Shop ittings
60
Amortization of lease
Net proit (Shared in PSR)
1,491
5,611
2,244.4
Grace
2:2
994
Beatrice
1: 2
497
Catherine
0: 1
0
2,244.4
1,122.2
T E X T
1 April 2006 to September 2006
Opening Inventory
Sh “.000”
S T U D Y
a)
332
FINANCIAL ACCOUNTING
b) Statement of inancial position as at 30 September 2006
Non-Current Assets:
Leasehold premises
Motor vehicles
Shop ittings
Current Assets:
Stocks
Accounts receivable
(900 – 180)
Provision for bad debts
Cost
Sh ‘.000’
Depreciation
Sh ‘.000’
Net book value
Sh ‘.000’
6,200
3,400
1,200
10,800
248
1,880
460
2,588
5,952
1,520
740
8,212
5100
760
160
S T U D Y
T E X T
Prepayments
Cash at bank
Suspense
Capital:
Fixed capital
560
260
9.280
100
15,300
23,512
3,000
2,000
1,500
6,500
Grace
Beatrice
Catherine
Current account
Grace
Beatrice
Catherine
7,438.4
3,261.4
1,972.2
Accounts payable (4,280+60
12,672
4, 340
23,512
c) Current accounts
Goodwill
Drawings
Bal. c/f
G
Sh ‘.000’
4,800
600
7,438.4
B
Sh ‘.000’
4,800
480
3,261.4
12,838.4
8,541.4
C
Sh ‘.000’
2,400 Bal. b/d
250 Proit
1,972.2 Goodwill
Rent
Cash
4,622.2
G
Sh ‘.000’
1,600
3,238.4
8,000
B
Sh ‘.000’
1,200
2,741.4
4,000
600
12,838.4
8,541.4
C
Sh ‘.000’
1,122.2
3,500
4,622.2
ANSWERS TO EXAM TYPE QUESTIONS
333
Question 3 (June 2007 Question 2)
(a)
Ali, Bakari, Chando Partnership
Proit and loss and appropriation a/c
As at 31st December 2006
Sh ‘000’
55,155
320
55,475
Less
Salary to Chando
Less loss in stock realization
2,000
470
Provision for bad debts
Drawing of stock
Depreciation of business premises
Telephone expenses
105
2500
200
120
Less
Interest on capital
Ali
Bakari
Chando
938
647
450
Less:
Salaries
Bakari
Chomba
5,500
4,500
Residue proit shared
Ali (4/7)
Bakari (2/7)
Chando (1/7)
21,740
10,870
5,435
5,395
50,080
(2,035)
48,045
10,000
38,045
38,045
T E X T
Proit as per draft a/c
Add
Reduction in provision for depreciation
Sh ‘000’
S T U D Y
Sh ‘000’
334
FINANCIAL ACCOUNTING
Ali, Bakari, Chando Partnership
Statement of inancial position
As at 31st December 2006
Non-current assets
Business premises
Equipment
Current assets
Inventory
Account receivable
T E X T
Sh ‘000’
Sh. ‘000’
20,800
8,000
200
5,280
20,600
2,720
23,320
3,500
Less provision for bad debts
Cash at bank
S T U D Y
Sh ‘000’
Current liabilities
Accounts payable
Accruals
(105)
3,080
2,250
12,085
3,395
8,800
24,280
(5,600)
Financed by:
Capital: Ali
Bakari
Chando
16,400
11,600
10,000
Current accounts
Ali
Bakari
Chando
1,173
(3,708)
1,535
(b)
Bal b/d
Drawings
Stock
Drawing
Balance c/d
Ali
Sh
.‘000’
23,705
1,000
1,173
25,878
Bakari
Sh
.‘000’
300
19,525
Current a/c
Chando
Sh
.‘000’
8,250
900
600
20,725
10,385
Balance
Interest
on capital
Salaries
Proit
share
Bal c/d
18,800
42,000
38,000
(1,000)
37,000
Ali
Sh .‘000’
3,200
938
Bakari
Sh
.‘000’
Chando
Sh
.‘000’
647
450
21,740
10,870
25,878
5,500
4,500
3,708
20,725
10,385
5,435
ANSWERS TO EXAM TYPE QUESTIONS
335
CHAPTER 8
Question 1 (June 2005 Question 5)
a) The importance of Ratio analysis
I.)
II.)
Evaluation of performance
By use of ratio analysis, a company is able to compare its present and past performance
(vertical analysis) or even with other companies falling in the same industry (horizontal
analysis)
Acts as control
Ratios are at times used as controls by companies. The employees of a company
are given goals which they need to attain. At the end of the accounting period their
performance is reviewed with an aim of inding what the problem might have been.
c) Brief explanation of the following:
I)
II)
III)
Accounting concepts
These are broad assumptions which underlie preparation of inancial statements of a
company.
Examples of accounting concepts include the Historical Concept, Prudence, Accrual
Basis etc.
Accounting standards
They are authoritative statements of how particular types of transactions and events
should be relected in inancial statements. They are developed to achieve comparability
of inancial information between and among different organizations.
Accounting policies
These are the principles, bases, conventions, rules and practices applied by an entity
that specify how the effects of transactions and other events are to be relected in its
inancial statements though:
i) Recognizing
ii) Selecting measurement basis for a/c
iii) Presenting assets, liabilities, gains, losses and charges to shareholders funds.
S T U D Y
I)
Current Ratio
The current ratio measures the liquidity position of a business. The creditors would be
interested in it so as to know the probability of their debt being paid.
II) Net Proit Margin
This measures the proitability of a company. Almost all parties are interested in this ratio
from the company itself to the government, employers, creditor, the general public at
large, potential investors etc.,. It helps to know whether to invest in the company i.e. the
investors and public; future prospects for the employees etc.
III) Stock Turnover
This represents how fast the company is able to turn stocks to sales. The company
management and even potential investors are interested in this. Further the suppliers
would like to know this so as to know how frequently they ought to supply goods.
T E X T
b) Parties interested in the following Ratios
336
FINANCIAL ACCOUNTING
d) Explanation of Accounting Treatments
I)
III)
S T U D Y
T E X T
II)
The debtor declared bankrupt
In the books of Mlachake ltd by 31 December 2004, the statement of inancial position
shows debtor’s igure of Sh. 200,000. This was on assumption that such debtors
would be recoverable. The declaration of the debtor bankrupt reduced the chances of
realization of the debt. However this declaration is done after the statement of inancial
position date. In accordance to International Financial Reporting Standards, this is an
event after the statement of inancial position and it provides additional evidence of the
conditions as they existed at the statement of inancial position date. This therefore is
an adjusting event and therefore the following adjustments should be made:
(I)
75% of the debt (Sh 200,000) should be written off in the statement of
comprehensive income as a bad debt
(II) Bad debts recovered of 25% of Sh 200,000 should be recognized.
However, if the inancial statements had been inalized to the point that the reports
had been sent to stakeholders and shareholders, then it should be disclosed by way of
note.
The inventory which got damaged
Such inventory which has been damaged should be valued at the lower of cost and net
realizable value. Further the cost of repairing the inventory should be incorporated in
the cost of the inventory. As such, this would be consistent with Accounting Standard
No.2 which deals with inventories.
The secured order of Sh 12 million
In accordance to the Prudence concept, revenue/gains are recognized if their realization
can be determined with reasonable certainty. In this case, the fact that a foreign based
company secured an order for goods to be later demonstrates commitment of the
customer to buy the goods. However the commitment is not enough to warrant the
recognition of the sale in our books of account.
Therefore it was not proper for the sale to be recognized in December as it was since
as at December 19th the Sale was still uncertain.
Those goods should only have been recognized for the month of January which is when
their sale became certain.
Question 2 (December 2005 Question3)
a)
Purposes of ratio analysis
•
Assessing the company’s inancial performance
•
To evaluate inancial stability of a company
•
To predict future performance and stability of a business entity
•
To compare performance of the irm with past performance and within the
industry.
•
To detect and investigate inconsistencies due to errors and fraud.
ANSWERS TO EXAM TYPE QUESTIONS
337
Formula
Sunrise Ltd.
Sunset Ltd.
i)
Current asset – Inventory
Current Liability
186 – 100
98
= 0.88:1
173 – 87
108
= 0.80:1
ii) Inventory turnover
Cost of sales
Average stock
258
100
= 2.58
153
87
= 1.76
iii) Average collection period
365 x Average debtors
Credit sales
365 x 46
497
= 34 days
365 x 42
371
= 41 days
157* x 100
230
= 68.2%
79 x 100
157
= 50.3%
Acid test ratio
iv) Return on capital employed
(ROCE)
Proit before interest & tax x 100
Capital employed
Note that the operating proit is net of interest expense an this to be arrived at proits before
interest. The interest expense must be added back. 19 + 138 = 157*
*
v) Debt equity ratio
Debt Capital
Equity Capital
33 x100
197
= 17%
0 x 100
197
= 0%
(c)
(i)
Comments on Performance
•
•
•
•
•
(ii)
Sunrise Ltd. has a better performance gauging by the return on capital employed.
Sunset Ltd. has a low gearing and thus less risky with high access to capital market.
Sunrise Ltd. has better management of inventory.
Sunrise Ltd. has a better credit policy.
Overall sunrise has a better performance but a higher risk and thus for risk takers
sunrise is the best and for risk averse investors sunset would be the irm, to invest in.•
Shortcomings of relying on analysis in (b) above
•
•
•
•
Ratios are historical since they use past data.
Comparison of ratios for companies maybe misleading due to different bases adopted
e.g. in valuation of stock or depreciation.
Ratios alone do not provide all the information required by users
Ratios computed from inaccurate information will be misleading.
S T U D Y
Ratio
T E X T
b)
338
FINANCIAL ACCOUNTING
CHAPTER 9
Question 1 (June 2007 Question 1)
a)
i)
T E X T
ii)
b) Workings
(W1)
Dr. hand
69,000,000
Cr. Re-evaluation reserve
W2
S T U D Y
Share Premium
This arises when a company issues shares at a price that is more than the par value.
Revaluation reserve
The unrealized gain when the amount at which non-current assets are carried is
increased above last.
How a company can utilize share premium
(i) Finance a fully paid bonus issue
(ii) Write off preliminary expenses
(iii) Write off expenses or commission paid or discount allowed on any issue of share
or debentures.
(iv) Provide for premium payable on redemption of redeemable preference shares or
debentures.
69,000,000
Dr. Re evaluation reserve 150,000,000
Cr. Ordinary share
150,000,000
No. of Shares = 150,000,000
10
Total no of share = 165,000,000
WK3
Salaries & wages
Add Accrued
32,100,000
150,000
32,250,000
WK 4
General Expenses
Insurance premium
11,900,000
200,000
11,700,000
Insurance premium 200,000 X 9
12
Prepayment of insurance premium
= 150,000
= 50,000
ANSWERS TO EXAM TYPE QUESTIONS
339
WK5
2,000,000
Machine A/c
2,000,000
7,500,000
400,000
WK6
Correction of error
Dr. cash
Cr. Suspense
Dr. Suspense
Cr. Cash
400,000
400,000
400,000
400,000
WK7
Provision for bad debts
Debtors = 48,000,000
Provision = 2 ½ % X 48,000,000 = 1,200,000
P&C
Balance c/d
Provision for Bad debts & doubtful debts
Sh ‘000’
300,000
Balance b/d
1,200,000
2,000,000
Sh ‘000’
1,500,000
2,000,000
WK 8
Depreciation – Plant & Machinery
10% X 380,000,000
= 38,000,000
Machine a/c
Sh ‘000’
Disposal
382,000
Balance c/d
Balance c/d
382,000
Disposal
Balance c/d
Provision for Depreciation
Sh ‘000’
1,500
Balance b/d
122,000
Depreciation
123,500
W9
Dividends = 5% 16,500,000
= 825,000
pne = 8% x 50,000 = 4,000
int = 7% x 100,000,000
700,000
Sh ‘000’
2,000
380,000
382,000
Sh ‘000’
85,500
38,000
123,500
T E X T
=
=
S T U D Y
Cash at bank
Cash in hand
1,500,000
400,000
100,000
2,000,000
Disposal a/c
Provision for Depreciation
Cash
Loss on disposal(P&L)
340
FINANCIAL ACCOUNTING
a)
PATA LTD
STATEMENT OF COMPREHENSIVE INCOME A/C
FOR THE YEAR ENDEND 31ST DECEMBER 2006
Sales
Less cost of sales
Opening stock
Purchases
Add carriage in
Sh ‘000’
35,000
165,000
1,100
Less closing stock
S T U D Y
T E X T
Gross proit
Add incomes
Discount received
Decrease in provision for doubtful debts
Less expenses
General expenses
Insurance premium
Loss and disposal
Depreciation of plant and machinery
Discount allowed
Salaries and wages
Electricity
Debenture interest
Directors fees
Sh ‘000’
166,100
201,100
(41,000)
4,600
300
4,900
11,700
150
100
38,000
3,200
32,250
2,900
7,000
12,800
Proit before tax
Taxation (corporation tax)
Proit after tax
Less transfer to general reserve
Less: Dividends.
Preference Dividends: Interim paid
Final proposed
Ordinary dividends: Interim paid
Final proposed
Retained Proit for the year
Retained earnings b/d
Retained earnings c/d
Sh ‘000’
290,000
(160,100)
129,900
134,800
108,000
26,700
3,000
23,700
(5,000)
18,700
2,000
2000
7,500
8,250
19,750
(1,050)
35,000
33,950
ANSWERS TO EXAM TYPE QUESTIONS
341
b)
Pata Ltd
Statement of inancial position
As at 31st December 2006
Sh ‘000’
Sh ‘000’
180,000
380,000
122,000
180,000
258,000
438,000
Current liabilities
Account payable
Proposed dividends: ordinary
Preference
Tax payable
Accrued wages
48,000
(1200)
27,000
8,250
2,000
3,000
150
41,000
46,800
50
7,500
95,350
T E X T
Current assets
Stock
Account receivable
Less provision for bad debts
Prepaid insurance premium
Cash at bank
(40,400)
Financed by:
Authorized share capital issued
Ordinary share capital of Sh.10 each
8% preference share capital of Sh.10 each
54,950
492,950
165,000
50,000
215,000
Capital reserve
Share premium
Revaluation reserve
20,000
54,000
74,000
Capital Redemption reserve
General reserve
Statement of comprehensive income
70,000
33,950
103,950
Non currents liabilities
7% Debenture interest
100,000
492,950
S T U D Y
Non –Current assets
Land
Plant and machinery
Sh ‘000’
342
FINANCIAL ACCOUNTING
2)
Workings
Wk 1
Interest on capital
Ali = 5% x 16,000,000 x 3/12 = 200,000
= 6% x 16,400,000 x 9/12 = 738,000
938,000
Bakari = 5% x 10,000,000 x 3/12 = 125,000
= 6% x 11,600,000 x 9/12= 522,000
647,000
Chando = 6% x 10,000,000 x 9/12 = 450,000
‘000’
Capital a/c: Ali
Bakari
S T U D Y
T E X T
Wk 2
Goodwill a/c
Sh.
‘000’
8,400 Capital: Ali
5,600
Sh.
8,000
Bakari
Chando
14,000
4000
2,000
14,000
Capital a/c
Goodwill c/f
Balance c/d
Sh
‘000’
Sh
.‘000’
Sh
‘000’
Sh
.‘000’
Sh
.‘000’
Sh
.‘000’
Ali
8,000
16,000
Bakari
4,000
11,600
Chando
2,000
Balance b/d
10,000
Ali
16,000
8,400
Bakari
10,000
5,600
Chando
24,400
15,600
12,000
24,400
15,600
Wk 3
Salaries:
Bakari = 3/12x 4,000,000 = 1,000,000
= 9/12 x 6,000,000 = 4,500,000
5,500,000
Chomba = 9/12 x 6,000,000 = 4,500,000
Wk 4
Salaries expense = 3/12 x 8,000,000 = 2,000,000
12,000
12,000
ANSWERS TO EXAM TYPE QUESTIONS
343
Wk 5
Loss in sales of stock = 750,000 – 280,000
= 470,000
Wk 6
Provision for bad and doubtful debts
= 3% x 3,500,000 = 105,000
Wk 7
Equipment
= 10% x 8,000,000 =800,000 (wrong provision)
Correct
= 15% x 3,200,000 = 480,000
Reduction in provision for depreciation
320,000
Drawings in goods
= 100,000 + 900,000 + 600,000 = 2,500,000
Expenses
Electricity
Motor expenses (4,174 + 412)
Sundry expenses (2,002 + 91)
Salaries and wages (121,600 + 36)
Directors’ remuneration
Bank charges (1,621 + 533)
Depreciation: Freehold building W3
Plant and machinery
W3
Motor vehicle W3
Bad debts (1,370 + 512)
Provision for bad debts W2
Proit before tax
Corporation tax
Proit after tax
Less proposed dividend
Retained proit for the year
Retained proit b/f
Retained proit c/f
6,917
4,586
2,093
121,636
48,888
2,154
8,620
9,620
7,450
1,882
1,194
Sh. ‘000
1,312,567
(818,869)
493,698
1,375
612
495,685
(215,040)
280,645
(131,700)
148,945
(5,000)
143,945
296,057
440,002
S T U D Y
ARAKA LIMITED
STATEMENT OF COMPREHENSIVE INCOME
For the year ended 30/9/2005
Sh. ‘000’
Sales
Less cost of sales
Opening inventory
41,912
839,004
Purchases
880,916
Less closing inventory
(62,047)
Gross proit
Gain on disposal
Bad debt recovered
T E X T
Question 2 (December 2005 Question1)
344
FINANCIAL ACCOUNTING
Araka Limited
Statement of inancial position
As at 30/9/2005
Sh. ‘000’
Cost
121,500
431,000
64,172
29,800
646,472
Non-current assets
Freehold land
Freehold buildings
Plant and machinery
Motor vehicles
S T U D Y
T E X T
Current assets
Inventory
Accounts receivable (59,704 – 1,194)
Cash in hand [1,268 – (412 + 91 +36)]
N9
Cash at bank (1,210 – 533) N4
Current liabilities
Accounts payable
Tax payable
Proposed dividends
Sh. ‘000’
Depreciation
(77,580)
(25,694)
(17,287)
120,561
Sh. ‘000’
NBV
121,500
353,420
38,478
12,513
525,911
62,047
58,510
729
677
121,963
21,172
131,700
5,000
(157,872)
Ordinary share
Retained proits
(35,909)
490,002
50,000
440,002
490,002
Workings:
1.
Gain on sale of motor vehicles
Disposal of vehicles A/c
Dr.
Cost
Proit and loss
Cr.
Sh.
‘000’
6,500 Depreciation
1,375 Bank
____
7,875
Sh. ‘000’
4,875
3,000
____
7,875
Depreciation = 6,500 x 25% x 3 years = Sh 4,875
2.
Accounts receivable
As per trial balance
Less bad debts W/o
General provision 2% x (61,074 – 1,370)
3.
Sh. ‘000’
1,370
1,194
Sh. ‘000’
61,074
(2,564)
58,510
Depreciation of non-current assets
Freehold building
20% x 431,000
Plant and machinery 20% x[64,172 – 16,074]
Motor vehicles
25% [28,900 – 6,500 + 7,400]
Sh. ‘000’
8,620
9,620
7,450
ANSWERS TO EXAM TYPE QUESTIONS
345
CHAPTER 10
QUESTION 1
a) Amount of cash stolen
Cash in hand
Petty cash balance
Reimbursement of petty cash
Cash from sales 14th DecDec
129600
15260
9740
259320
413920
(13690)
400,230
Value of stock (at cost) stolen
Opening stock 1st December
Additional stock
Less stock sold
1st December - 6th December
7th December – 13th December
14th December
(Sh000)
32,540
5784
5376
3091333
486.667
Stolen stock
Balance in store
(8954)
29370
(18070)
11300
Value of stolen stock is 18,070,000
c) Bank Balance
Balance b/f
Cash banked
1st December – 6th December
7th Dec. – 13th Dec.
Cheques from customers
Withdrawals and payments
Staff Wages
Suppliers
Petty cash
Balance in bank
6,625,080
1,429,710
1,644,500
15,867,110
25,566,400
361590
17118360
9749
(17,489,690)
8,076,710
T E X T
b)
S T U D Y
Disbursements
Cash in store/Stolen
346
FINANCIAL ACCOUNTING
CHAPTER 11
QUESTION 1
(a) What beneits will a computerized accounting system bring your company?
•
•
•
•
•
S T U D Y
T E X T
(b)
What should I be looking for when selecting a computerized package?
•
•
•
•
•
•
(c)
easy to use
suitable range of reports
capable for the storage to store large amount of data
provided security length
expandability
suficient ield length
If we get a Sales Ledger package what kind of reports should we expect?
•
•
•
•
•
•
•
•
(d)
automatic posting
automatic reports generation
automatic documents printing
more accuracy
more faster to prepare an accounting report
sales daybook/journal
sales invoices
sales analysis
VAT analysis
aged debtor analysis
customer mailing lists
statement of accounts
examinations of accounts details
What’s the difference between a stand-alone package and an integrated package?
What are the advantages and disadvantages of each?
Stand-alone package is an accounting software that have used to prepare a report and no
updating of the reports.
Integrated package is an accounting software package where the insertion of one record can
automatic update the other records.
ANSWERS TO EXAM TYPE QUESTIONS
347
Advantages of integrated packages:
•
•
Automatic updating of report - faster
Better for a large irm which has large amount of customers and employees - the irm
can save more money.
Disadvantages
•
•
Inserted a wrong type of accounting is not easy to correct them
Dificult to know which employee had done the error
Our computer support staff say that we’ll have to conigure the package before we
(e)
can use it. What do they mean by that? Explain what coniguration involves.
A typical system coniguration involved:
o company name and address
o computer hardware coniguration
o printer coniguration
o page format coniguration
o tax rate
o alter user table
T E X T
•
Coniguration the package means that before we used the integrated package, we must
match the software and hardware devices.
S T U D Y
•
S T U D Y
T E X T
348
FINANCIAL ACCOUNTING
349
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CHAPTER FOURTEEN
REVISION TEST PAPERS
S T U D Y
T E X T
350
FINANCIAL ACCOUNTING
351
REVISION TEST PAPERS
Test paper 1
Question 1
NMGC Company is issuing one million 7% preference shares of Sh 1 each, payable 10% on
application, 20% on allotment, 40% on irst call and 30% on second call. Applications are received
for 1550 shares. A refund of the money is made in respect of 50 shares, while for the remaining
1500 applied for, an allotment is to be made on the basis of 2 shares for every 3 applied for.
The excess application monies are set off against allotment monies asked for. The remaining
requested installments are all paid in full.
You are required to show the journal entries of the above issue and then draw the relevant
(20 marks)
Question 2
The directors of Chimney, a limited liability company, wish to compare the irm’s most recent
inancial statements with those of the previous year. The company’s inancial statements are
given as follows:
Chimney income statements
Year ended
31st March
Sales Revenue(80% on credit, 20% on
2006
Sh. ‘000
31st March
2007
Sh . ‘000
cash)
1,800
2,500
cost of sales(see note below)
1,200
1,800
Gross Proit
600
700
Distribution costs
160
250
S T U D Y
T E X T
accounts.
352
FINANCIAL ACCOUNTING
Administrative expenses
200
200
operating proits
240
250
Finance cost
Proit before tax
50
190
200
Income tax expense
Net proit for the year
50
44
146
46
154
S T U D Y
T E X T
Note; cost of sales igures are made as
follows
Year ended
31st March
31st March
Opening stock
Purchase( all on credit)
Less closing inventory
Cost of sales
2006
Sh . ‘000
2007
Sh. ‘000
180
200
1,220
1,960
1,400
2,160
200
360
1,200
1,800
REVISION TEST PAPERS
353
Statements of inancial position
As at
31st March 2006
Sh. ‘000
Sh. ‘000
Assets
Non current assets at cost
Less accumulated depreciation
31st March 2007
Sh. 000
Sh. ‘000
3100
1214
3674
1422
1886
2252
Current assets
200
400
100
700
2586
1230
3482
1000
400
168
1200
600
322
1568
2122
500
500
Non current liability
10% Loan notes
Current liabilities
Trade payables
Sundry payables
Tax payable
•
210
260
48
380
430
50
518
860
2586
2586
*The additional share capital was issued on 1st April, 2006
Required
a) Calculate, for each of the two years, eight accounting ratios that should assist the directors
in their comparison, using the closing igures for the statement of inancial position items
needed.
b) Comment on the ratios.
(16 marks)
(4 marks)
T E X T
total assets
Equities and Liabilities
Capital and reserves
Issued ordinary share capital*
Share premium account*
Income statement
360
750
120
S T U D Y
Inventory
Trade receivables
Cash at bank
354
FINANCIAL ACCOUNTING
Question 3
Chemilil Sugar Company, a leading manufacturer of sugar had a trial balance as at 31st December
2006 as follows,
Sh
Delivery van expense
7,500
Lighting and heating; ofice
3,330
Lighting and heating; factory
Manufacturing wages
General expenses; factory
Ofice
Sales representative commission
S T U D Y
T E X T
Purchases
Rent; factory
Ofice
Machinery (cost of Sh 150,000)
Sh
8,577
136,410
16,920
11,448
23,580
117,162
14,400
6,600
97,500
Ofice equipment (cost of Sh 45,000)33,000
Ofice salaries
18,855
Debtors
85,110
Bank
40,011
Premises (cost of Sh 150,000)
120,000
Creditors
Sales
58,350
409,500
Stocks as at 31st December 2005
Raw materials
Finished goods
Drawings
Capital
25,695
88,440
25,680
412,368
REVISION TEST PAPERS
355
Additional information;
a. Stocks as at 31st December 2006:
Raw materials
Finished goods
Sh 27,150
Sh 93,600
There is no work in progress.
b. Depreciate machinery for Sh 6,000, equipment for Sh 4,500 and premises for Sh 3,000.
c. Manufacturing wages due but unpaid at 31st December 2006 are Sh. 915, prepaid ofice
rent, Sh 324
Required
Prepare the manufacturing, statement of comprehensive income s for the year ended 31st
Question 4
a)
List three errors that affect control accounts separately, three that affect ledger
balance separately and two that affect both the control accounts and ledger balances.
(8 marks)
b)
The balances and transactions affecting Abramovich’s control accounts for the month
of May 2005 are listed below. You are required to prepare sales ledger and purchases
ledger control accounts for the month of May. (12 marks)
S T U D Y
T E X T
December 2006 and a statement of inancial position as at that date.
356
FINANCIAL ACCOUNTING
Billion Pounds
Balances as at May 1st, 2005
Sales ledger
91,230 debit
Purchases ledger
44,900 credit
2,110 credit
880 debit
Transactions during May,
Credit purchases
181,350
Banking by customers
273,700
Returns outwards
Credit sales
S T U D Y
T E X T
Discounts received
Bankings to suppliers
Contra
Returns inwards
Bills of exchange receivable
Customers’ cheques dishonored
6,290
367,550
11,050
154,130
30,460
17,200
65,060
4,890
Cash receipts from credit customers 42,010
Refunds to customers for overpayments530
Discounts allowed
Balances as at 31st May, 2005
7,320
Sales ledger
1,360 credit
Purchases ledger
670 debit
REVISION TEST PAPERS
357
Question 5
Differentiate between the following terms, giving examples where possible.
i
Matching concept and Realization concept
ii.
Capital expenditure and Revenue expenditure
iii.
Accrual concept and Prudence concept.
iv.
Proitability ratios and Solvency ratios
v.
Business entity concept and Going concern concept.
(Each 4 marks)
Test paper two
Question 1
The reconciled bank balance by the books as at November 1st 1999was an overdraft of Sh 52,240.
The bank statement had a debit balance of Sh 19,740 at 31st October 2000.
Victoria J., a boutique operator in Westlands has no enough expertise to reconcile her bank
account to her cashbook. She has requested for your expertise with the following information:
a) Cheques in respect to purchase of hair products on the following dates had not yet been
presented to the bank prior to 31st October 2000:
28th August, 2000
3,300
14th September, 2000 3,920
25th September, 2000 10,520
26th September, 2000 400
29th October, 2000
1,580
b) Bank charges of Sh 4,100 have been debited by the bank in the bank statement but no
corresponding entries in the cashbook have been made.
c) A subtotal of the credit side of the cashbook of Sh 444,000 had been carried forward to the
subsequent page as Sh 440,400.
S T U D Y
2000. Her cashbook at that date had a credit balance of Sh 27,780.
T E X T
Victoria J is having problems reconciling her bank account with the cash book as at 31st October
358
FINANCIAL ACCOUNTING
d) In August 2000, Victoria took an 8% loan from Beckham of Sh 138,000. The loan interest
payments were to fall due on the 2nd of each month, the irst one falling due on August
2nd. All payments have to be made by standing orders on the due dates, but no payments
relating to the payments have been made in the cashbook.
e) A cheque amounting to Sh 1,580 lodged in the bank on May 31st 2000 were returned by
the bank marked ‘refer to drawer’. Though it was not presented to the bank by 31st October
2000, it was subsequently paid but no adjustments have been made in the cashbook in
respect of the return of the cheque by the bank.
f)
A bank lodgment of Sh 18,620on October 6th 2000 has been entered in the cashbook as
Sh 18,260.
bank statement amount for her as at 31st October 2000. (20 marks).
S T U D Y
T E X T
Using your accounting expertise, update Victoria’s cashbook balance and reconcile it with the
Question 2
Merv Fishback, a trader in shipping business had the following inancial position on March 1st,
2004.
Premises
$42,000
Cash at bank
$10,500
Motor vehicles
$41,300
Cash in hand
$112
Trade creditors
$420
Trade debtors
Stock
$490
$22,470
REVISION TEST PAPERS
359
a) Enter the entries in the general journal and post the necessary accounts
The following transactions were carried out during the month of March 2004:
1. Sold goods on credit to Victor for $5,800 and to Moore for $6,100.
2. Anthony, a debtor by March 1st 2004 owing $280 was Declared bankrupt and his debt
written off.
3. Purchased goods on credit from Rose worth $1,820 and from Frank for $3,500
4. Paid Charles, the only creditor as at 1st March 2004 all his dues by cheque.
5. Withdrew $2,590 from bank for ofice use.
6. Received goods being returns from Moore $840.
7. David, a debtor by March 1st 2004 sent a cheque for $140 and was allowed $35 cash
9. Settled Rose’s account by cheque, receiving a 10% cash discount.
10. Purchased motor vehicle on credit from General Motors company limited for $21,000
11. Paid rent by cash $392.
12. Banked $9,450.
13. Purchased Plant and Machinery for $11,900 paying by cheque.
14. Fishback deposited $14,000 in the business bank account from his own money and
immediately made $2,800 purchases by cheque.
15. Paid wages for $2,177 by cash.
Required
b) Enter the above transactions in the appropriate books of original entry using a triplecolumn cashbook.
c) Post the entries from the books of original entry to the appropriate ledgers.
d) Extract a trial balance as at 31st March, 2005.
S T U D Y
8. Sold goods for cash amounting to $9,800.
T E X T
discount.
360
FINANCIAL ACCOUNTING
Question 3
a)
Differentiate between the free-loating petty cash system and the imprest system.(5
marks)
b) The petty cashier of Mugo and Farm Company had the following transactions in the month
of April 2007.
April
1. Received cash loat Sh 35,000
2. Paid sundry expenses of Sh 350 and hotel charges of Sh 1,050
3. Paid Muhindi’s account Sh 1,575
4. Settled Gorogoro account Sh.700
5. Paid for vehicle fuel Sh 350 and bought ofice envelopes Sh 525
S T U D Y
T E X T
6. Paid sundry expenses Sh 700 and hotel expenses Sh 1,225.
7. Made postages worth Sh 875
8. Fueled the company’s vehicles for Sh 700 and settled Michael’s ledger account for
Sh 350
9. Purchased stationery for Sh 525, fuelled the manager’s oficial car for Sh 350 and paid for
hotel charges while on oficial duty Sh 1,225
10. Made sundry expenses Sh 175 and hotel charges Sh 1,575
11. Paid for petrol Sh 700, purchased postage stamps Sh 1,050 and settled Mutua’s ledger for
Sh 1,225.
12. Purchased ofice stationery for Sh 525
13. Received an amount to maintain the imprest.
Required
Enter the above in a petty cashbook with analysis columns for hotel charges, postages and
stationery, motor vehicle expenses, sundry and ledger accounts (15 marks)
REVISION TEST PAPERS
361
Question 4
Maendeleo ya Wanaume Society is a not-for proit organization that arranges for forums for its
members. The society also runs school for the members’ children. Subscriptions are separate for
the school and for general membership. The society has given you the following information for
the year ended 31stDecember 2001.
a) Salaries and wages amounting to Sh 19,000 were outstanding at the start of the year and
Sh 15,000 at the year end.
b) Books for the school were purchased costing Sh 21,800, normally included in postage and
stationery in the general accounts of the society.
c) Salaries and wages paid to the school staff amounted to Sh 13,000
d) Amounts owing to the society for vacancy adverts were Sh 14,400 at the start of the year
at the end of the year.
f)
Subscriptions for the school for the year of 2001 received in 2000 were Sh 47,600 and for
2002 received in 2001 were Sh 37,000.
g) The society had ofice equipment in its assets at the start of the year at a cost of Sh
192,000 and an investment of Sh 878,000 also at cost.
h) Annual subscriptions received include Sh 7,400 for 2000 and Sh 47,000 for 2002.
i)
Ofice equipment at the end of the year was valued at Sh 198,000.
S T U D Y
e) Sh. 51,800 is owing to suppliers of school stationery at the start of the year and Sh. 55,800
T E X T
and Sh 22,000 at year end.
362
FINANCIAL ACCOUNTING
Alongside the above information, the society treasurer also hands you the following account for
the year ended 31st December 2001.
Receipts and Payments account
Sh.
Bank balance, January
Sh.
118,000
School stationery
203,000
Annual subscriptions
371,000
Society seminar costs
47,000
Investment income
65,800
Postage and stationery
57,400
School adverts
89,000
Telephone
14,400
School subscriptions
189,800
Sundry expenses
57,800
New equipment
28,000
Rent and rates
41,000
S T U D Y
T E X T
1
Salaries and wages
Bank balance,
December 31
835,600
197,000
190,000
835,600
Required
a. prepare the statement of comprehensive income for the school for the year ended 31st
December 2001.( 6 marks)
b. Prepare the general statement of comprehensive income for the same period.(6
marks)
c. A statement of inancial position as at the end of 2001. (8marks)
REVISION TEST PAPERS
363
Question 5
a) Name six users of accounting information, the information is useful to each.(12 marks)
b) Give four advantages of historical cost accounting (4 marks)
c) Differentiate between a general ledger and the sales ledger. (4 marks)
Test paper 3
Question 1
a) Give a brief overview of the accounting process (8 marks)
i. Purchased goodwill and non-purchased goodwill (4 marks)
ii. Bonus shares and rights issue ( 4 marks)
iii. Interim dividends and proposed dividends. ( 4 marks)
Question 2
(a) The net assets of Altese, a trader, at 1 January 2002 amounted to $128,000.
During the year to 31 December 2002 Altese introduced a further $50,000 of capital and made
drawings of $48,000.
At 31 December 2002 Altese’s net assets totaled $184,000.
Required:
Using this information compute Altese’s total proit for the year ended 31 December 2002.
(3 marks)
T E X T
Write short notes on:
S T U D Y
b)
364
FINANCIAL ACCOUNTING
(b) Senji does not keep proper accounting records, and it is necessary to calculate her total
purchases for the year. Ended 31 January 2003 from the following information:
Trade payables 31 January 2002
130,400
Payment to suppliers
888,400
31 January 2003
171,250
Cost of goods taken from inventory by Senji for her personal use 1,000
Refunds received from suppliers
Discounts received
2,400
11,200
Required:
S T U D Y
T E X T
Compute the igure for purchases for inclusion in Senji’s inancial statements. (3 marks)
(c) Aluki ixes prices to make a standard gross proit percentage on sales of 331/3%.
The following information for the year ended 31 January 2003 is available to compute her sales
total for the year.
Inventory: 1 February 2002
31 January 2003
Purchases
Purchases returns
243,000
261,700
595,400
41,200
Required:
Calculate the sales igure for the year ended 31 January 2003. (3 marks)
(9 marks)
REVISION TEST PAPERS
365
QUESTION THREE
(a) The term ‘reserves’ is frequently found in company statements of inancial position.
Required:
(i)
Explain the meaning of ‘reserves’ in this context:
(ii)
Give two examples of reserves and explain how each of your examples comes
into existence.
(b) A company’s issued share capital may be increased by a bonus (capitalization) issue or by a
rights issue.
Required:
S T U D Y
these two types of share issue.
T E X T
Deine ‘bonus issue’ and ‘rights issue’ and explain the fundamental difference between
366
FINANCIAL ACCOUNTING
QUESTION FOUR
Extracts from the inancial statements of Apillon for the years ended 31 March 2002 and 2003 are
given below:
Year ended 31 March
Statement of comprehensive income
2002
Sh
Sh
2003
Sh
Sh
3,100,000
3,800,000
Sales revenue (including cash sales
($300,000 in 2002 and $100,000 in 2003)
Cost of sales
Opening inventory
S T U D Y
T E X T
Purchases (all on credit)
Less: closing inventory
Gross proit
360,000
540,000
2,080,000
2,580,000
2,440,000
3,120,000
————
540,000
————
Expenses
————
(1,900,000)
720,000 (2,400,000)
———— ————
1,200,000
1,400,000
(900,000)
(1,100,000)
300,000
300,000
—————
Net proit
————
—————
—————
—————
BALANCE SHEET
Current assets
Inventory
540,000
Trade receivables 450,000
————
720,000
700,000
990,000 ————
1,420,000
Current liabilities
Trade payables
Bank overdraft
410,000
20,000
690,000
430,000
————
170,000
860,000
————
REVISION TEST PAPERS
367
Required:
(a) Calculate the following for each of the two years:
(i) Current ratio;
(ii) Quick ratio (acid test);
(iii) Inventory turnover period (use closing inventory);
(iv) Average period of credit allowed to customers;
(v) Average period of credit taken from suppliers.
Calculate items (iii), (iv) and (v) in days.
(b) Make four brief comments on the changes in the position of the company as revealed by
the changes in these ratios and/or in the given igures from the inancial statements.
QUESTION FIVE
Mr. Ancentus Okwengo is the sole proprietor of a small business. The following trial balance was
Capital
Land
Plant and machinery
Provision on depreciation of plant and machinery
Delivery vans
Provision for depreciation of delivery vans
Loose tools at valuation on April 1 199nce 9
Stocks on 1 April 1999
Purchases
Loose tools
Sales
Wages and salaries
Rates and insurance
Repairs and maintenance of buildings
Sales expenses including vehicle running costs
Electricity and power
Industrial training levy
Administration expenses
Provision for doubtful debts
Debtors and creditors
Sh ‘000’
S T U D Y
Sh ‘000’
T E X T
extracted from his books at March 2000
S T U D Y
T E X T
368
FINANCIAL ACCOUNTING
369
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CHAPTER FIFTEEN
ANSWERS TO TEST PAPERS
S T U D Y
T E X T
370
FINANCIAL ACCOUNTING
371
ANSWERS TO TEST PAPERS
Question 1
General Journal
Application
Bank
To record refund on oversubscription
Application
Allotment
to move over application funds to offset allotment receivable
Application
7% Preference Share Capital
To transfer Application account into 7% Preference share capital
account
Bank
155,000
5,000
50,000
100,000
150,000
Allotment account
To record reception of allotment money
Allotment account
7% Preference Share Capital
To transfer Allotment account into 7% Preference share capital
account
First call account
200,000
400,000
7% Preference Share Capital
To record the making of the First call
Bank
First Call account
To record reception of First Call on Preference shares
Second Call account
7% Preference Share Capital
To record the making of the Second Call on shares
Bank
Second Call account
To record reception of Second Call monies
400,000
300,000
300,000
155,000
5,000
50,000
100,000
150,000
200,000
400,000
400,000
300,000
300,000
T E X T
Bank
Application account
To record reception of application money
Credit
Sh
S T U D Y
Debit
Sh.
372
FINANCIAL ACCOUNTING
Bank
Application
Allotment
First Call
Second Call
Bank
Allotment
7% Preference Share
Capital
155,000
150,000
400,000
300,000
1,005,000
Application
Balance c/d
Application account
5,000
Bank
50,000
100,000
155,000
T E X T
S T U D Y
Capital
200,000
200,000
1,000,000
1,005,000
155,000
155,000
Allotment account
Bank
7% Preference Share
5,000
Application
150,000
50,000
200,000
First Call account
7% Preference Share
Capital
400,000
Bank
400,000
Second Call account
7% Preference Share
Capital
Balance c/d
300,000
Bank
7% Preference Share Capital
Application
Allotment
First Call
1,000,000
Second Call
1,000,000
30,000
100,000
200,000
400,000
300,000
1,000,000
ANSWERS TO TEST PAPERS
373
Question two
Gross proit margin
600/1800X 100
700/2500X100
i)
operating proit margin
240/1800X100
ii)
2006
33.30%
28.00%
13.30%
250/2500X100
Return on capital employed
190/1568X 100
200/2122X100
iii)
2007
10.00%
12.10%
9.40%
Current ratio
Quick/ Acid test ratio
500:518
870:860
v)
Inventory turnover(days)
200/1200X 365
360/1800 X 365
vi)
1.35:1
1.43:1
0.96:1
1.01:1
60.8 days
73.0 days
Trade receivables - Average collection period in days
400/1440 X 365
101.4 days
750/2000 X 365
vii)
136.9 days
Trade payables - Average time to pay
viii) in days
210/1200 X 365
380/1960 X 365
b)
62.8 days
70.8 days
i)
Gross proit percentage on sales has declined from 33.3% to 28.0%, a substantial
drop. This could possibly be due to a decision to lower prices in order to increase sales
revenue, which has risen by38.9%. A drop in the gross proit percentage might be an
indicator of possible error or fraud if another explanation such as lowering prices cannot
be found.
ii)
Net proit as a percentage of sales revenue is down from 13.3% t0 10%. This is a large
drop, but not as large as the drop in gross proit percentage. A large rise in distribution
costs as a percentage of sales helps to explain this drop.
T E X T
700:518
1230:860
S T U D Y
iv)
374
FINANCIAL ACCOUNTING
iii)
Return on capital employed has declined from 12.1% to 9.4%. It is a relection of the
decline in proitability as shown by ratio (ii) above.
(iv
and v) The two liquidity ratios have changed minimally between the two periods. This
may be suggesting that the liquidity position is satisfactory in both periods.
vi)
The inventory turnover ratio has increased because the inventory level has risen faster
than the increases in cost of sales and sales revenue. The higher inventory level could
be relecting slowing demand for the company’s products towards the end of the period
and/ or slackness in the company’s inventory control procedures.
vii) The average receivables collection period has increased considerably from 101.4 days
to a higher level of 136.9 days. The increase suggests slackness in the company’s
credit control and debt collecting procedures.
S T U D Y
T E X T
viii) There has been a relatively small increase in the average time to pay suppliers. The
increase I perhaps due to pressure on the company’s liquid resources as a result of
increased inventory and trade receivables.
Question 3
CHEMILIL SUGAR COMPANY
MANUFACTURING ACCOUNT
FOR THE YEAR ENDED 31ST DECEMBER 2006
Sh
Sh
25,695
117,162
Opening stock of Raw materials
add purchases
(27,150)
115,707
less closing stock of raw materials
Cost of Raw materials used
137,325
253,032
add direct wages
Prime cost
Add factory overheads
Lighting and heating
General expenses
Rent
Depreciation on machinery
Production cost
8,577
16,920
14,400
6,000
45,897
298,929
ANSWERS TO TEST PAPERS
375
CHEMILIL SUGAR COMPANY
STATEMENT OF COMPREHENSIVE INCOME
FOR THE YEAR ENDED 31ST DECEMBER 2006
Sh
Sh
409,500
Sales
less cost of sales
(93,600)
(294,769)
115,731
Gross proit
less expenses
Ofice salaries
18,855
General expenses
Ofice rent
11,448
6,276
Delivery van expenses
Depreciation on equipment
7,500
4,500
Ofice lighting and heating
Commission
Depreciation on premises
T E X T
less closing stock
88,440
298,929
3,330
23,580
S T U D Y
Opening stock of inished goods
add production cost
3,000
(78,489)
37,242
376
FINANCIAL ACCOUNTING
CHEMILIL SUGAR COMPANY
STATEMENT OF FINANCIAL POSITION AS AT 31ST
Non Current assets
DECEMBER 2006
Sh.
150,000
33,000
117,000
Machinery
Equipment
150,000
45,000
58,500
16,500
91,500
28,500
345,000
108,000
237,000
93,600
27,150
85,110
324
40,011
Debtors
Prepayment
Bank
T E X T
Sh.
Premises
add working capital
Current assets
Stock, inished goods
Stock, raw materials
S T U D Y
Sh.
less current liabilities
Creditors
Accrual
58,350
915
246,195
59,265
186,930
Financed by;
Capital;
Opening balance
add net proit
less drawings
423,930
412,368
37,242
25,680
423,930
Question 4
a)
Errors that affect the control accounts
•
Errors in the totals of the journals; overcastting and undercasting errors
•
Errors of omissions; transactions not recorded in the control accounts
•
Errors in posting entries in the control accounts e.g. total of sales journal posted
to the credit side of the control account
ANSWERS TO TEST PAPERS
377
Errors that affect ledger balances
•
Balances omitted from the list or entered wrongly e.g. a debit balance entered as
a credit balance
•
Arithmetical errors in calculating individual balances
•
Errors of omission i.e. transactions not recorded in the ledgers
Errors that affect both
•
Error of original entry; when the entry in the journal is incorrect and the incorrect
igure is carried forward to the ledger.
•
Errors of complete omission from both the control accounts and in the ledger
balances.
Sales Ledger Control account
Balance b/d
Sales
Dishonored cheques
Refund
Balance c/d
£, billion
93030
367550
4890
530
1360
Balance b/d
Bank receipts
Contra
Returns inwards
Bills Receivable
Cash receipts
Discount allowed
Balance c/d
467360
Purchases Ledger Control account
Balance b/d
Payments
Returns outwards
Contra
Discount received
Balance c/d
£, billion
880 Balance b/d
154130 Purchases
6290 Balance c/d
30460
11050
24110
226920
£,
billion
2110
273700
30460
17200
65060
42010
7320
29500
467360
£,
billion
44900
181350
670
226920
S T U D Y
T E X T
b)
378
FINANCIAL ACCOUNTING
Question 5
i)
Matching concept states that revenues of a certain period should be compared with
the expenses incurred in that period to earn the revenues. It dictates for exclusion
of any prior period payments or the payments for future period expenses. It requires
recognition of cost as expenses when the goods or services represented by the cost
contribute to revenue.
Realization concept states that a sale should be recognized when the event from which
it arises has taken place and the receipt of cash from the transaction is reasonably
certain. For example, a sale should not be recognized when the order is placed by a
prospective customer as there is no conirmation of the sale yet. The placing of an order
should not be treated as a sale yet as the customer may decide to cancel the order.
Instead the sale should be recognized when the when the sales invoice is prepared or
when the goods are delivered to the customer.
S T U D Y
T E X T
ii)
Capital expenditure is made when a irm spends money either to buy a new ixed asset
or to add to the value of an existing one. Included in such amounts includes the cost
of acquiring the asset, installation, delivery costs, legal costs of buying property and
any other costs necessary to get the asset in a condition ready for use like testing and
inspection fees, architect’s fees, demolition costs of a building. Capital expenditure is
shown in the Statement of inancial position.
Revenue expenditure is incurred when money is spent for the day-to-day running of the
business. They are amounts to restore and repair rather than to acquire and install. A
repair to an existing motor vehicle is a revenue expenditure because it adds no value
but restores the asset to its original value.
iii)
In accrual concept, revenues and costs should be recognized when earned or incurred
and not when the money is received or paid.
Prudence states that when alternatives exist, the one selected should be that which gives the
most cautious presentation of the inancial position or result of the business. Assets and proits
should not be overstated, but a balance must be achieved to prevent the material overstatement
of liabilities and losses. It means that accountants should not anticipate for gains but should
provide for losses.
iv)
Proitability ratios are used to measure proit growth. Most of the values used to measure
the proitability ratio are found in the income statement. Examples include gross proit
margin ratio, net proit margin ratio and return on capital employed.
Solvency ratios on the other hand measure a irm’s capacity to pay its debts. The debt ratio
indicates how much the company owes in relation to its size. It measures the proportion of
liabilities to total assets. Gearing ratio measures the company’s long-term capital structure.
Gearing is the proportion of a company’s total capital provided by loan capital as opposed to
equity.
ANSWERS TO TEST PAPERS
v)
379
Business entity concept states that a business is a separate entity, distinct from its
owners and managers. It means that the inancial affairs of the business should not be
mixed with those of its owners and other businesses. For example the withdrawal of a
business asset for personal use should be recognized as a withdrawal of capital.
Going concern concept assumes that an enterprise will continue in operational existence for
the foreseeable future. It guides the management towards the appropriateness of the inancial
statements. It means that the business is not assumed to close down, or at least the closure of
the business is currently uncertain. The available inancial information should be considered for
the foreseeable future covering, but not limited to, the twelve months from the reporting date.
Test paper 2 answers
Balance c/d
39460
39800
Bank charges
4100
31880
Victoria J
Bank Reconciliation Statement
As at 31st October 2000
Updated cashbook balance
Add unpresented cheques
Balance as per the bank statement
SHSSh
27780
2760
1560
3600
(39,460)
19,720
(19,740)
S T U D Y
Cashbook error
Updated Cashbook
Sh
340
Balance b/d
Standing order
Dishonored cheques
Cashbook error
T E X T
Question 1
380
FINANCIAL ACCOUNTING
Question 2
a)
General Journal
Date
Particulars
Debit
Sh
42,000
2004
1-Mar Premises
41,300
10,500
112
Motor vehicles
Cash at bank
Cash in hand
490
15,400
Trade debtors
Stock
Trade creditors
109,802
To record opening balances
T E X T
420
109,382
Capital
S T U D Y
Credit
Sh
109,802
Motor Vehicle account
2004
1-Mar Balance b/d
General Motors
1-Apr Balance b/d
Sh
41,300
21,000
62,300
62,300
2004
Sh
Balance
31-Mar c/d
62,300
62,300
Stock account
2004
1-Mar Balance b/d
1-Apr Balance b/d
2004
Sh
22,470
22,470
2004
Sh
Balance
31-Mar c/d
Capital account
Sh
2004
22,470
Sh
Balance
31-Mar Balance c/d
123,382
123,382
1-Mar b/d
Bank
Balance
1-Apr b/d
109,382
14,000
123,382
123,382
ANSWERS TO TEST PAPERS
381
b) Books of original entry.
5,800
6,100
11,900
Purchases Journal
Invoice No.
Amount, Sh
Date
Particulars
2004
March Rose
Frank
1,820
3,500
5,320
Sales Returns Journal
Credit note no.
Amount,$
T E X T
840
840
Triple-column Cashbook
Disc.
Date
2004
Particulars
1-Mar
Balance b/d
5
Bank
7
8
14
David
Cash sales
Capital
Discount
Allowed.
Sh
Cash
Sh
112
Date
2004
Particulars
Sh
Bank
10,500
4-Mar
Charles
420
5
Cash
2,590
9
10
12
Rose
Rent
Bank
13
Plant& Mach
14
15
Purchases
Wages
2,177
31
Balance c/d
483
2,590
35
35
9,800
140
14,000
12,502
24,640
483
5,992
April
1
Balance b/d
Received
Cash
Bank
Sh
Sh
Sh
1,638
182
392
9,450
11,900
182
12,502
2,800
5,292
24,640
S T U D Y
Date
Particulars
2004
March Moore
Amount,Sh
Sales Journal
Invoice No.
Date
Particulars
2004
March Victor
Moore
382
FINANCIAL ACCOUNTING
c) Ledgers
Purchases ledger
Creditor Rose
Bank
1,638
Discount Received
182 Purchases
1,820
1,820
1,820
Creditor Frank
3,500 Purchases
Balance b/d
Balance c/d
3,500
3,500
Sales Ledger
S T U D Y
T E X T
Debtor Victor
Sales
Balance
b/d
5,800
Balance c/d
5,800
5,800
Debtor Moore
Sales
Sales
Balance
b/d
6,100
6,100
Returns
840
Balance c/d
5,260
6,100
5,260
General Ledger
Creditors
Bank
Balance b/d
Balance c/d
Purchases account
5,320
2,800 Balance c/d
8,120
8,120
8,120
8,120
Sales account
Debtors
21,700 Cash
21,700
Balance b/d
11,900
9,800
21,700
21,700
ANSWERS TO TEST PAPERS
Bank
Balance b/d
Plant and Machinery
11,900
Balance c/d
11,900
11,900
Cash
Balance b/d
Wages
2,177 Balance c/d
2,177
2,177
Cash
Balance b/d
392
392
Rent
Balance c/d
383
392
d)
Wages
Purchases
Motor Vehicles
Rent
Debtors
Creditors
Returns Inwards
Plant and Machinery
Stock
Capital
Bad debts
Cash
Bank
General motors
Discount allowed
Discount received
Sales
Premises
2,177
8,120
Credit, Sh
62,300
392
11,095
3,500
840
11,900
22,470
1,960
483
5,992
123,382
21,000
35
182
42,000
169,764
21,700
169,764
S T U D Y
As at 31st 2004
Debit, Sh
T E X T
Merv Fishback
Trial Balance
384
FINANCIAL ACCOUNTING
Question 3
a)
In free-loating petty cash system, the petty cashier makes payments ininitely getting
refunds of whatever amounts he/she requests from the petty cash fund. There is
normally no ixed time of refunding nor is there a ixed amount to be maintained by the
petty cashier.
Imprest system on the other hand requires a reimbursement to the petty cashier only
the amounts that have been used away from the set amount such that the opening
balance is always at a ixed amount. The petty cashier also receives replenishments at
certain speciic times like at the end of each week, month or a fortnight.
Mugo and Farm com
Petty Cashboo
Receipts
Sh
35,000
Folio Date
2007
CB2
1-Apr
2
2
Cash
Sundry expenses
Hotel charges
3
4
5
5
6
6
7
Muhindi
Gorogoro
Fuel
Envelopes
Sundry expenses
Hotel charges
Postages
1,575
700
350
525
700
1,225
875
8
8
9
9
9
10
10
Petrol
Michael
Stationery
Petrol
Hotel charges
Sundry expenses
Hotel charges
700
350
525
350
1,225
175
1,575
11
11
11
12
Petrol
Postages
Mutua
Stationery
700
1,050
1,225
525
S T U D Y
T E X T
b)
15,750
50,750
35,000
Particulars
13 Cash
13 Balance c/d
CB5
14 Balance b/d
Voucher no.
Total
Sh
350
1,050
35,000
50,750
Hotel charges
Sh
1,050
1,225
1,225
1,575
5,075
GL 10
525
3,500
2,100
GL 16
PL4
PL5
1,225
GL 22
1,225
3,850
14 Balance b/d
1,225
1,050
Hotel charges
Sh
1,575
1,225
5,075
GL 10
700
35,000
50,750
350
1,050
1,575
700
350
525
700
1,225
875
700
350
525
350
1,225
175
1,575
700
1,050
1,225
525
700
PL2
PL3
13 Cash
13 Balance c/d
350
Total
Sh
875
350
175
T E X T
1,575
700
S T U D Y
525
3,500
GL 15
1,050
525
875
525
Postages & stationery
Sh
350
Leger folio
CB5
GL 15
350
Sundrya/cs
Sh
35,000
700
Cash
Sundry expenses
Hotel charges
Muhindi
Gorogoro
Fuel
Envelopes
Sundry expenses
Hotel charges
Postages
Petrol
Michael
Stationery
Petrol
Hotel charges
Sundry expenses
Hotel charges
Petrol
Postages
Mutua
Stationery
Voucher no.
525
Motor exp.
Sh
50,750
1,050
Particulars
Postages & stationery
Sh
15,750
Folio Date
2007
CB2
1-Apr
2
2
3
4
5
5
6
6
7
8
8
9
9
9
10
10
11
11
11
12
525
Mugo and Farm company
Petty Cashbook
2,100
GL 16
700
350
700
350
Motor exp.
Sh
mpany
ok
Receipts
Sh
35,000
b)
1,225
GL 22
175
700
350
Sundrya/cs
Sh
PL5
PL4
PL2
PL3
Leger folio
3,850
1,225
350
1,575
700
Ledger a/cs
Sh
ANSWERS TO TEST PAPERS
385
Ledger a/cs
Sh
386
FINANCIAL ACCOUNTING
Question 4
Workings
Accumulated Fund calculation
39,083
39,447
118,000
190,000
Salaries and expenses owing
19,000
15,000
School adverts owing
14,400
22,000
School stationery owing
51,800
55,800
Prepaid subscription income(school)
47,600
37,000
Equipment
192,000
198,000
Investment
878,000
S T U D Y
T E X T
Bank
7,400
Annual subscription income owing
47,000
Annual subscription income prepaid
1,091,400
Accumulated Fund
Annual subscription income a/c
Arrear b/d
Income and Expenditure
Prepaid C/d
7,400 Cash
310,600
47,000
371,000
371,000
371,000
ANSWERS TO TEST PAPERS
387
School Subscription income
Prepaid
37,000 Cash
239,400
Expenditure
School stationery
Books
School staff salary
Surplus
47,600
191,800
239,400
School Statement of comprehensive income
Sh. Income
207,000 School subscription
21,800 School adverts
13,000
57,200
299,000
Expenditure
Genera Income and Expenditure
Sh. Income
Sh.
202,400
96,600
299,000
Sh
180,000 Surplus from school
57,200
Seminar costs
47,000 Annual subscription
316,600
Postage and stationery
Telephone
Sundry expenses
rent and rates
35,600 Investment income
14,400
57,800
41,000
65,800
Salaries
Depreciation
Surplus
22,000
41,800
439,600
439,600
T E X T
Prepaid c/d
202,400 b/d
S T U D Y
Income and expenditure
388
FINANCIAL ACCOUNTING
MAENDELEO YA WANAUME SOCIETY
STATEMENT OF FINANCIAL POSITION AS AT 31ST DECEMBER 2001
Non-Current
assets
Equipment cost
Less
220,000
Accumulated Fund
Surplus
1,091,400
41,800
accumulated
depreciation
22,000
198,000
878,000
Investment
Current assets
Adverts owing
Bank
subscription
Annual subscription
prepaid
School stationery
22,000
190,000
owing
Salaries
T E X T
212,000
S T U D Y
1,288,000
1,133,200
Current liabilities
Prepaid school
37,000
47,000
55,800
15,000
154,800
1,288,000
Question 5 answer
a) Users of accounting information.
(i)
Management – management of business entities need accounting information to assist
for planning and decision making. They will need the information to prepare budgets
and compare with the actual results of operations. They will also be interested in the
cost consequences of a particular course of action to assist them in making decisions
(ii)
Present and potential investors – they need accounting information to assess the
risk inherent in, and the return provided by their investments. They need information to
decide whether they should maintain, increase, Decrease of dispose altogether their
investments.
(iii) Employees are interested about the stability and proitability of their employer. It is a
source of sustainability for them and they need to know whether to start searching for
employment elsewhere or keep their current postings. They are also concerned about
the ability to provide remuneration, retirement beneits and employment opportunities.
(iv) Lenders. They are the givers some part of the company’s capital. They need to know if
ANSWERS TO TEST PAPERS
389
the loans and the corresponding interests will be paid when due.
(v)
Customers. They require inancial data in order to anticipate price changes and to
seek alternative sources of supplies when necessary.
(vi) The government. Governments and their agencies require information to regulate the
activities of the enterprises. They also need the inancial information to determine level
of taxation and also in preparation of national statistics.
c)
They can be determined with greater precision than those of other bases of
measurements. Their veriiability makes them more reliable.
b.
If current value accounting were to be adopted, a irm’s assets and liabilities would
have to be revalued each time the inancial statements were prepared. This would be
expensive and time consuming.
c.
Historical accounting is closely related to objectivity and revenue realization principle.
Historical costs are regarded as relatively objective measurements and that accountants
normally ignore increases in the values of recorded assets until the increases have
been validated by a sale.
d.
Historical cost igures provide a basis for comparison with the other enterprises of
similar periods
A general ledger usually records the nominal accounts while the other ledgers, including
sales ledger and purchases ledger records personal accounts.
The general ledger will keep such nominal accounts such as purchases account, sales
accounts, expenses accounts.
Sales ledger on the other hand contained personal accounts such as the individual
debtor accounts. It generates its data from the books of original entry.
S T U D Y
a.
T E X T
b) Advantages of historical cost accounting
390
FINANCIAL ACCOUNTING
Test paper 3 answers
Question 1
Overview of accounting process
1. Recording phase
1)
Appropriate business documents are prepared or received. The documentation provides
the basis for making an initial record of each transaction. Examples of such documents
are sales invoices, cash register, cheques etc
2)
Basing upon the supporting document, each transaction is recorded in a chronological
order in the books of original entry or journals.
3)
Each transaction, as classiied and recorded in the journals, is posted to the appropriate
accounts in the ledgers.
S T U D Y
T E X T
2. Summarizing phase
4)
A trial balance of the accounts in the ledger is taken. It provides a summary of the
information as classiied in the ledger, as well as a general check on the accuracy of the
recording and posting.
5)
The data required to bring the accounts up to date are compiled. This is done through
the adjusting entries.
6)
Accounts are closed. Balances in the nominal accounts are closed and transferred to
the income statement. Balances of the real accounts are carried forward to the next
period.
7)
Financial statements are prepared. At this stage, the two main statements are prepared;
the statement of comprehensive income and the Statement of inancial position.
8)
A post-closing trial balance is prepared
9)
Reversing entries are made for accruals and prepayments to start a new accounting
period.
i)
Purchased goodwill and non purchased goodwill.
Non purchased goodwill is the goodwill inherent in the business. It is extremely dificult
to measure such goodwill because the business is a going concern. It is a goodwill not
yet paid for and therefore has a no objective value. It keeps on changing. One bad act
by an employee might damage it instantly.
b)
ANSWERS TO TEST PAPERS
391
Purchased goodwill on the other hand occurs when the business is being sold. When a
buyer purchases an existing business, he will buy not only the existing tangible assets
but also the goodness the existing business has ploughed to itself over the period of
existence. It appears in the statement of inancial position as a long-term intangible
(ictitious) asset.
ii)
Bonus and rights issue.
A bonus issue is one in which a proportional distribution of additional shares to the
company’s existing shareholders. Also called a script issue, it is a way of issuing
dividends without giving soft cash. It can be termed as being issue of capital to the
exiting shareholders for free.
A rights issue on the other hand is an issue of shares for cash to the existing shareholders.
The rights are offered to the existing shareholders who may decide to sell them, exercise
them or do nothing. Rights issues give the shareholder an option to acquire a speciied
number of shares under speciied conditions within a speciied period.
Proposed dividends represent the proportion of the year’s dividends that the directors
indicate will be transferred from the retained earnings. This proposal is made during the
annual general meeting and there fore they are not payable by the year end. They are
shown in the statement of inancial position alongside other payables within a year.
Question 2
3 (a)
$
Opening capital
Capital introduced
Less: Drawings
Closing capital
Proit is therefore
128,000
50,000
————
178,000
48,000
————
130,000
184,000
————
54,000
————
T E X T
Interim dividends and proposed dividends.
Interim dividends are issued during the period for which they are payable and an actual
payment in cash is made to the shareholders.
S T U D Y
iii)
392
FINANCIAL ACCOUNTING
(b)
Payments to suppliers
Discounts received
Balance carried forward
Purchases Control Account
Balance brought forward
888,400 Goods taken by Senji
11,200 Refunds from suppliers
Purchases
171,250
———
1,070,850
———
130,400
1,000
2,400
937,050
———
1,070,850
———
(c)
Cost of sales:
Opening inventory
Purchases
T E X T
Less: Returns
S T U D Y
Less: Closing inventory
243,000
595,400
41,200
————
554,200
————
797,200
261,700
————
535,500
————
Sales igure is therefore $535,500 x 3/2 = $803,250
Question 3
(a)
(i)
Reserves are balances in a company’s statement of inancial position forming part of
the equity interest and representing surpluses or gains, whether realized or not.
(ii)
Share premium account
The surplus arising when shares are issued at a price in excess of their par values.
(iii) Revaluation reserve
The unrealized gain when the amount at which non-current assets are carried is
increased above cost.
ANSWERS TO TEST PAPERS
393
(b)
A bonus issue is the conversion of reserves into share capital, with shares being issued to
existing members in proportion to their shareholdings, without any consideration being given by
the shareholders.
S T U D Y
T E X T
A rights issue is again an issue of shares to existing members in proportion to their shareholdings,
but with payment being made by the shareholders for the shares allotted to them. The fundamental
difference between them is that the rights issue raises funds for the company whereas the bonus
issue does not.
S T U D Y
T E X T
394
FINANCIAL ACCOUNTING
REFERENCES
395
S
T
S T
T SU
U TD
DUY
YD Y
T E
E TX
X ET
TX T
S T U D Y
T E X T
396
FINANCIAL ACCOUNTING
397
BPP (2008) Financial Accounting.
2.
BPP (2008) Financial Reporting (Int).
3.
Rose and Kolari 1995.
4.
Accounting an introduction, 2002.
5.
Frank Wood’s Business Accounting 1 and 2
6.
KASNEB http://www.kasneb.or.ke/bboard.htm
7.
Business Daily http://www.businessdailyafrica.com/
8.
http://basiccollegeaccounting.com/category/computerised-accounting/
9.
http://www.softwareforbusiness.net/accounting-software/types-of-accountingsoftware.html
10.
http://web.ifac.org/download/IPSASB_Process_Final_version_Oct_08.pdf
S T U D Y
1.
T E X T
REFERENCES
S T U D Y
T E X T
398
FINANCIAL ACCOUNTING
GLOSSARY
399
S
T
S T
T SU
U TD
DUY
YD Y
T E
E TX
X ET
TX T
S T U D Y
T E X T
400
FINANCIAL ACCOUNTING
401
GLOSSARY
Accounting
- the process of identifying, measuring, recording and communicating inancial
information in order to permit users to make informed decisions
Sales
- this term is used to refer to the transfer of goods in return for money
Purchases
- these are goods bought by a business in order to be resold
Journal
- this is the irst record of a transaction that is made in a irm’s books
Ledger
- this is an account in which transactions initially recorded in journals are
- an organisation that exists in order to make proit
Debtor
- a person that owes the business money
Creditor
- a person that the business owes money
Cashbook
- an account in which transactions concerning cash are recorded, such as
payments made or amounts received from debtors
Carriage in
- the cost of transporting goods from a supplier to the business
Carriage out
- the cost of transporting goods from the business to a customer who has
bought them
Returns inwards - goods returned by customers to the business
Returns outwards
- goods returned by the business to the supplier
Transactions
- activities of buying and selling that the business engages in
Proit
- the excess of incomes made over expenditure
Loss
- the excess of expenditure over income
Assets
- things of value to the business
Liabilities
- amounts owed by the business to external parties
Capital
- the amount of money or other assets introduced by the owner of the business
Partnership
- a business venture whereby two or more persons run a business together
with the objective of making proit
Company
- an organization that is a legal person and has limited liability
Sole proprietorship - a business run by a single individual with an aim of making proit
Financial statements - a business run by two or more people together in order to make a proit
S T U D Y
Business
T E X T
transferred (or posted) to
S T U D Y
T E X T
402
FINANCIAL ACCOUNTING
INDEX
403
S
T
S T
T SU
U TD
DUY
YD Y
T E
E TX
X ET
TX T
S T U D Y
T E X T
404
FINANCIAL ACCOUNTING
405
INDEX
A
Account:7, 462
Accounting equation:7
accounting information:8
Accounting Principles:10
Accrual concept:10
Accrual expenses:89
Accrued income:91
Acid test or quick ratio:219
Activity ratios:219
Allotment:246, 429
Auditing:5
Auditors:455, 456
average collection period:222
B
BALANCE SHEET:121
Balance sheet:479
balance sheet:121
be work in progress:205
board of directors:235
Branches of accounting:5
Business entity concept:9
C
Calls:238
Capital:416, 479
Capital clause:416
Capital reserves:239
Cash turnover/Operating turnover:223
Cash working cycle/Working capital cycle/Operating cycle.:223
Charges:424
Class:441, 442, 479
S T U D Y
Audit:479
T E X T
Assets:121
406
FINANCIAL ACCOUNTING
Classifying phase:5
Comparability:8
Concepts of Accounting:9
Consistency:11
Cost accounting:5
Creditor’s turnover:222
Customers.:6
D
Debentures:427, 428
Debtor’s days:222
Debtor’s turnover.:222
Debt equity ratio:220
Debt ratio:220
Directors:442, 443, 445
S T U D Y
T E X T
Discounts received:94
Discount allowed:92
Disposal of an a:113
Dividend cover:224
Dividend pay out ratio:224
Dividend per share:224
Dividend retention ratio:224
Dividend yield.:225
DRAWINGS:133
drawings account:131, 133
Duality:12
E
Employees:5
Equitable mortgage:480
Equity:7
equity ratios:219
Estoppel:430, 480
F
Finance charges:203
Financial accounting:5
Floating charge:480
INDEX
407
Forfeiture:431, 480
Formation:413
G
GEARING OR LEVERAGE RATIOS:220
gearing ratio. See debt ratio
gearing ratios. See Liquidity ratios
General meetings:480
Going concern:9
Goodwill:162
Gross proit margin:221
Group accounts:480
H
Historical cost:10
I
Interest on capital:145
Interest on drawings:146
Interpretation:5
Investment ratios. See equity ratios
ISSUANCE OF SHARES:246
L
Lenders:6
Leverage ratio:219
LIABILITIES:122
Liability:7, 414, 416, 426
Lien:416, 481
Life Membership fund:192
Limited liability:480
Liquidation:432
LIQUIDITY RATIOS:219
Liquidity ratios:219
Loan capital:236
M
Managerial accounting:5
S T U D Y
INDIRECT MANUFACTURING COSTS.:203
T E X T
Increase in provision for bad debts:98
408
FINANCIAL ACCOUNTING
MANUFACTURING ACCOUNT:201
Materiality:11
Member:430, 481
Memorandum of association:481
Monetary principle:10
N
Name clause:416
Negligence:481
Net assets turnover:221
Net proit margin:221
Non- cumulative preference shares:237
NON PROFIT MAKING ORGANIZATIONS:187, 188
Non purchased:162
O
T E X T
Operating proit/margin ratio:221
S T U D Y
Operating expenses ratio:221
Ordinary shares:236
Oppression:481
P
partnership:142
capital account, current account:142
Partnership agreements:143
Phases of the accounting process:4
Premium:481
Prepaid expenses:86
Prepayments:10
Present and potential investors:5
Price earnings ratio:225
PRODUCTION COSTS:201, 202
Proitability ratios:219, 228
PROFIT AND LOSS ACCOUNT:83
Prospectus:481
PROVISION FOR UNREALIZED PROFIT.:207
Proxy:481
Prudence:11
INDEX
409
Purchased goodwill:162
Q
Qualiication shares:482
Quorum:442, 482
R
RATIO ANALYSIS:218
Recording phase:4
Redeemable preference shares:482
Reduction:422
Registrar:453
Reissue of forfeited shares:247
Relevance.:8
Reliability:8
Removal:445
Return on equity:221
Return on investment:221
Revenue realization concept:11
Revenue reserves:239
S
Secured:428, 482
Share capital:236
Sole traders:132
Stamp duty:473
SUBSCRIPTION.:191
Substance over form:12
Summarizing phase:5
T
Tax accounting;:5
Termination:414
The government.:6
Timely:8
Times interest cover:220
Transfer:413, 416, 429, 430, 482
S T U D Y
Return on capital employed:220
T E X T
Resolutions:423
410
FINANCIAL ACCOUNTING
Transmission:430
Trust:425, 426
U
Ultra vires:482
Understandability:8
Users of inancial information:5
V
veil of incorporation.:234
Voting:416, 442
W
S T U D Y
T E X T
Warrant:482