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ACCA F3

FINANCIAL
ACCOUNTING
International Stream
TUITION
CLASS NOTES

FBT PUBLISHING ACCA F3 Financial Accounting Page 1


Appendix
The following notes are suitable for both the international and UK streams.
There will some terminology differences between the two streams. These
are summarised below:

International UK

Statement of comprehensive Profit and loss account


income

Statement of financial position Balance sheet

Non-current assets Fixed assets

Inventory Stock

Trade receivables Debtors

Non-current liabilities Long term liabilities

Trade payables Creditors

Irrecoverable debts Bad debts

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Contents

Paper background

Session 1 Introduction to accounting

Session 2 Financial statements

Session 3 Double entry book keeping

Session 4 Non-current assets

Session 5 Inventory

Session 6 Irrecoverable Debts

Session 7 Control Accounts

Session 8 Bank Reconciliations

Session 9 Accruals and prepayments

Session 10 Limited Company accounts

Session 11 Statements of cash flow

Session 12 Incomplete records

Session 13 Partnerships

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Paper background
Aim

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


underlying principles and concepts relating to financial accounting and technical
proficiency in the use of double-entry accounting techniques including the
preparation of basic financial statements.

Main capabilities

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

Explain the context and purpose of financial reporting

Define the qualitative characteristics of financial information and the


fundamental bases of accounting

Demonstrate the use of double-entry and accounting systems

Record transactions and events

Prepare a trial balance (including identifying and correcting errors)

Prepare basic financial statements for incorporated and unincorporated entities

The assessment

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

Written

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

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

Computer based

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


matching or number entry

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


right answers)

The pass mark is 50%

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SESSION 1 INTRODUCTION TO ACCOUNTING

Learning outcomes
• Understand the purpose of accounting

• Identify the different types of businesses

• Indentify the users of accounts

• Explain the qualitative characteristics of financial statements

• Understand the underlying assumptions of financial statements

Introduction

WHAT IS ACCOUNTING?

Accounting is made up of two elements:

I. Recording business transactions - Book keeping

II. Presenting the information

WHAT IS A BUSINESS?

A business is a commercial organisation which exists with a view to making a


profit. There are different types of businesses which will fall into 3 categories:

Sole Trader

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

Partnership

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

Companies

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


by a nominated board of directors. Companies will be covered in greater detail
in later sessions

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

• Management accounts

• Financial accounts

Management accounts

These are produced as often as a business wants them (usually monthly). They
are produced for internal use and will not, usually be seen by external people.
Management accounts can be prepared using the company’s own internal
policies.

Financial accounts

These accounts are usually produced annually. They are based on historical
information and are rarely used internally. Financial accounts are used by
external users for several reasons:

• Investors

• Lenders

• Employees

• Government

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• Public

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SESSION 2 FINANCIAL STATEMENTS

Learning outcomes
After completing this chapter, you should be able to:

• Identify the layout of a Statement of Financial Position for a sole trader


and a company

• Identify the layout of a Statement of Comprehensive income for a sole


trader and a company

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

Introduction
There are four key financial statements:

Statement of Financial Position

This financial statement lists the assets and liabilities of a business at a point in
time. It is a snapshot of the company’s position “AS AT A POINT IN TIME”

Statement of Comprehensive Income

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

Statement of Changes in Equity

This statement links the statements of comprehensive income and financial


position.

Statement of Cash Flow

The statement of cash flow reports the cash generation and cash absorption for a
“PERIOD OF TIME”.

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


TRIAL BALANCE. The trial balance is basically a list of ledger balances. A
business will use a trial balance as an INDICATION that all accounting entries
have been recorded and all entries are correct.

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A trial balance MUST balance. If there is an imbalance, this indicates an error in
the initial entries. In this case a suspense account is created until the errors can
be detected.

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Proforma set of financial statements for a sole trader.

Statement of Financial Position as at 31 December 2007

Non – current assets


Cost Dep’n NBV

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


Fixtures and fittings 45,000 (11,250) 33,750
Motor vehicles 26,000 (13,260) 12,740

221,000 (36,510) 184,490

Current assets

Inventory 13,777
Trade receivables 12,775
Prepayments 2,800
Cash 3,400 32,752

Total assets 217,242

Opening capital 152,465


Profit 51,787
Drawings (35,900) 168,352

Non – current liabilities

Loan 20,000

Current liabilities

Trade payables 12,445


Accrued Loan interest 1,000
Other accruals 15,445 28,890

Total liabilities 217,242

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Statement of Comprehensive Income for the year ended 31 December
2007

Revenue 233,000

Less: Cost of sales

Opening inventory 12,332


Purchases 119,098
Carriage inwards 1,009
132,439
Closing inventory (13,777) 118,662

GROSS PROFIT 114,338

Discounts received 5,111

Other income 4,000

123,449

Less: Expenses

Discounts allowed 3,444


Depreciation 10,710
Gas and electricity 14,122
Irrecoverable debts 7,134
Loan interest 4,000
Carriage outwards 5,666
Water rates 8,444
Advertising 15,000
Other expenses 3,142 71,662

NET PROFIT 51,787

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Proforma set of financial statements for a limited company or Plc

Statement of financial position as at 31 December 2007

Non – current assets


Note
Intangible assets 6 200,000
Tangible assets 7 187,999

Current assets

Inventory 8 88,432
Trade receivables 9 97,455
Cash 13,400 199,287

Total assets 587,286

Equity and liabilities

Share capital 100,000


Retained earnings 220,497
Revaluation reserve 7 38,000 358,497

Non – current liabilities

Interest bearing borrowings 10 100,000

Current liabilities

Trade payables 77,789


Taxation 5 51,000 128,789

Total liabilities 587,286

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Statement of comprehensive income for the year ended 31 December
2007

Note
Revenue (Sales) 385,000

Cost of sales 1 188,000

GROSS PROFIT 197,000

Distribution costs 2 38,500

Administration expenses 3 37,700

PROFIT FROM OPERATIONS 120,800

Finance costs 8,000

PROFIT BEFORE TAX 112,800

Income tax 53,000

PROFIT FOR THE PERIOD 59,800

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


(SOCIE)

Share Retaine Revaluat


d ion
Capital Earning Reserve Total
s

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

Profit for the period 59,800 59,800

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


F 3)

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

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

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


Financial Statements. This structured format aids comparability and makes
information more useful.

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

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SESSION 3 DOUBLE ENTRY BOOK KEEPING

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

• Understand the principles of double entry bookkeeping

• Apply double entry bookkeeping to a list of transactions

• Prepare financial statements for a sole trader

Introduction

Bookkeeping is “the recording of monetary transactions” of a business.

Double entry bookkeeping

Double entry bookkeeping is the fundamental concept underlying accountancy.


All accounting transactions should be recorded using the double entry system.
There are some basic rules that we MUST follow:

1. Every debit must have a credit

2. A debit entry is an ASSET in the STATEMENT OF FINANCIAL POSITION or an


EXPENSE in the STATEMENT OF COMPREHENSIVE INCOME

3. A credit entry is a LIABILITY in the STATEMENT OF FINANCIAL POSITION or


an INCOME in the STATEMENT OF COMPREHENSIVE INCOME

T accounts

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


accounts for simplicity. The principles of T accounts are:

• Every debit entry has a credit entry

• Every T account will belong to the statement of financial position or the


statement of comprehensive income

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

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EXAMPLE 1

George commences business on 1 April 2006. The following transactions take


place in his first two weeks of trading.

• 1 AprilHe invests $50,000 in to a business

• 1 AprilHe purchases $5,000 worth of goods on credit

• 2 AprilHe sells half of the inventory for $6,000 cash

• 5 AprilHe issues a cheque to pay for the goods he received on credit

• 4 AprilPays his rent for April of $450 by cheque

• 7 AprilHe sells his remaining stock for $6,000 on credit

• 10 April Purchased goods on credit for $7,000

• 14 April He purchases a delivery van for $7,000 cash

Required

For the first two weeks of trading prepare:

• The T accounts for George (State if the account is Position or Income)

• The trial balance

• The Statement of Comprehensive Income

• The Statement of Financial Position

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EXAMPLE 2

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

• 1 Jan She invests $65,000 in to the business

• 2 Jan She purchases $8,000 worth of goods on credit

• 2 Jan She sells a quarter of the inventory for $4,000 cash

• 3 Jan Issues a cheque to pay for half of the goods she received on credit

• 14 Jan Pays her insurance for January by issuing a cheque for $75

• 15 Jan She sells the remaining inventory for $12,000 on credit

• 16 Jan Purchases inventory at a cost of $10,000 on credit

• 18 Jan Purchases some office equipment for $3,000 cash

• 20 Jan Pays her rent for January by cheque $150

• 21 Jan Sells half her inventory for $10,000 cash

• 25 Jan Withdraws $100 for petty cash

• 31 Jan Purchases office supplies worth $30 from petty cash

Required

For the first month of trading prepare:

• The T accounts for Tina (state if the account is Position or Income)

• The trial balance

• The Statement of Comprehensive Income

• The Statement of Financial Position

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ANSWER TO EXAMPLE 1 GEORGE

Bank Account

Dr Cr

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

2 April Sales 6,000 4 April Rent 450

14 April Delivery Van 7,000

Carried Forward 43,550

56,000 56,000

Bought Forward 43,550

Capital Account

Dr Cr

1 April Bank 50,000

Purchases

Dr Cr

1 April Trade Payables 5,000

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

12,000 12,000

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Bought Forward 12,000

Trade Payables

Dr Cr

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

Carried Forward 7,000 10 April Purchases 7,000

12,000 12,000

Bought Forward 7,000

Sales

Dr Cr

2 April Cash 6,000

Carried Forward 12,000 7 April Trade 6,000


Receivables

12,000 12,000

Bought Forward 12,000

Rent

Dr Cr

4 April Bank 450

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Trade Receivables

Dr Cr

7 April Sales 6,000

Delivery Van

Dr Cr

14 April Bank 7,000

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George Trial Balance

Statem Dr Cr
ent

Bank Account FP 43,550

Capital Account FP 50,000

Purchases CI 12,000

Trade Payables FP 7,000

Sales CI 12,000

Rent CI 450

Trade Receivables FP 6,000

Delivery Van FP 7,000

Total 69,000 69,000

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George
Statement of Comprehensive Income
2 Week Period Ended 14 April 2007

Sales 12,000

Cost of sales

Opening inventory 0

Purchases 12,000

12,000

Closing inventory (7,000)


5,000

GROSS PROFIT 7,000

Less expenses

Rent 450

NET PROFIT 6,550

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George
Statement of Financial Position
as at 14 April 2007

Non Current Assets

Delivery Van 7,000

Current Assets

Inventory 7,000
Trade Receivables 6,000
Bank Account 43,550
56,550

TOTAL ASSETS 63,550

Capital 50,000
Profit 6,550
56,550

Non Current Liabilities 0

Current Liabilities

Trade Payables 7,000

63,550

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ANSWER TO EXAMPLE 2 TINA

Bank Account

Dr Cr
1 Jan Capital 65,000 3 Jan Trade Payables 4,000
2 Jan Sales 4,000 14 Jan Insurance 75
21 Jan Sales 10,000 18 Jan Office Equipment 3,000
20 Jan Rent 150
25 Jan Petty Cash 100
c/f 71,675

79,000 79,000

b/f 71,675

Capital Account

Dr Cr
1 Jan Bank 65,000

Purchases

Dr Cr
2 Jan Trade Payables 8,000
16 Jan Trade Payables 10,000 c/f 18,000

18,000 18,000

b/f 18,000

Trade Payables

Dr Cr
3 Jan Bank 4,000 2 Jan Purchases 8,000
c/f 14,000 16 Jan Purchases 10,000

18,000 18,000

b/f 14,000
Sales

Dr Cr

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2 Jan Bank 4,000
15 Jan Trade 12,000
Receivables
c/f 26,000 21 Jan Bank 10,000

26,000 26,000

b/f 26,000

Insurance

Dr Cr
14 Jan Bank 75

Trade Receivables

Dr Cr
15 Jan Sales 12,000

Office Equipment

Dr Cr
18 Jan Bank 3,000

Rent

Dr Cr
20 Jan Bank 150

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Petty Cash

Dr Cr
25 Jan Bank 100 31 Jan Office Supplies 30
c/f 70

100 100

b/f 70

Office Supplies

Dr Cr
31 Jan Petty Cash 30

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Tina Trial Balance

Statem Dr Cr
ent

Bank Account FP 71,675

Capital Account FP 65,000

Purchases CI 18,000

Trade Payables FP 14,000

Sales CI 26,000

Insurance CI 75

Trade Receivables FP 12,000

Office Equipment FP 3,000

Rent CI 150

Petty Cash FP 70

Office Supplies CI 30

Totals 105,000 105,000

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Tina
Statement of Comprehensive Income
For January 2007

Revenue 26,000

Cost of sales

Opening inventory 0

Purchases 18,000

18,000

Closing inventory (5,000)

GROSS PROFIT 13,000

Less expenses:

Insurance 75

Rent 150

Office supplies 30
255

NET PROFIT 12,745

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Tina
Statement of Financial Position
as at 31 January 2007

Non Current Assets

Office Equipment 3,000

Current Assets

Inventory 5,000
Trade Receivables 12,000
Bank Account 71,675
Petty Cash 70
88,745

TOTAL ASSETS 91,745

Capital 65,000
Profit 12,745
77,745

Non Current Liabilities 0

Current Liabilities

Trade Payables 14,000

91,745

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SESSION 4 NON CURRENT ASSETS

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

• Define a non current asset

• Distinguish between tangible and intangible non-current assets

• Explain the differences between capital and revenue expenditure

• Understand the concepts of I.A.S. 16 Accounting for non-current assets

• Compile a non current asset register

• Calculate and account for depreciation

• Record the accounting entries for disposals of non-current assets

Introduction

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


generally mean for more than one accounting period. Non-currents assets can
be either TANGIBLE or INTANGIBLE. ACCA F3 concentrates on tangible non-
current assets, however a knowledge of intangible non current assets is needed.

Tangible non-current assets

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

Land and buildings

Plant and equipment

Motor vehicles

Computers

Fixtures and fittings

Intangible non-current assets

These assets have no physical substance. An example of an intangible non-


current asset would be:

Goodwill

Development

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Non-current assets are normally of substantial value and their accounting can
have a material impact on the financial statements. As a result of this there are
large numbers of accounting standards that help the preparers of financial
statements to account for them.

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

Non-current asset register

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


imperative that effective control is kept over them. In order to ensure
management are aware exactly where each item is located and that they are
adequately maintained and serviced, a non current asset register is maintained.

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


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

A register would include the following information:

• Item code

• Date of purchase

• Item description

• Cost

• Estimated useful life

• Residual value (if any)

• Depreciation method

• Location

• Disposal details

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Capital and revenue expenditure

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

If it is capital expenditure it will be capitalised in the statement of financial


position and then depreciated over the useful economic life of the asset. If it is
revenue expenditure it will be expensed through the statement of
comprehensive income.

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


ensure appropriate accounting entries are made.

Capital expenditure is expenditure likely to increase the future earning capacity


of the organisation whereas revenue expenditure is regarded as maintaining the
organisation’s present earning capacity.

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


current asset:

• Initial cost

• Delivery costs

• Non-refundable import taxes

• Installation costs

• Any costs incurred in bringing the asset into intended use

• Initial training costs

• Subsequent expenditure that ENHANCES the performance of the asset

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

• Insurance costs

• Repairs

• Maintenance

EXAMPLE 1

Capital Revenue
Purchase of a motor
vehicle
Purchase of a tax disc
Fuel

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Insurance
C D player
Alloy wheels
New tyre
Early settlement discount

Depreciation

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


the consumption of an asset in a period.

By applying depreciation charges, we are consistent with the ACCRUALS /


MATCHING CONCEPT i.e. applying the cost of using the asset to the statement of
comprehensive income for the same period.

All tangible non-current assets should be depreciated on a systematic basis per


I.A.S. 16, with the exception of land. This is because land is seen to appreciate
in value.

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

Depreciation policies

Calculating depreciation in a given period are common questions in this paper.


The main methods of calculating depreciation are:

• Straight line

• Reducing balance

Straight line depreciation

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

To calculate the depreciation charge the following formula is used:

Depreciation per = Original cost – estimated


annum residual value
Estimated useful Life

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EXAMPLE 2

Company A purchased a non-current asset on 31st July for $150,000. The asset
has an expected useful life of 5 years and a residual value of $20,000.

Calculate the depreciation charges for the year ended 31st December on the
basis:

i. A full year’s charge is made in the year of acquisition and none in the year
of disposal.

ii. The company’s policy is to time-apportion depreciation charges.

EXAMPLE 3

Company B purchases a machine for $23,000. They expect to use it for four
years and then sell it for $3,000.

What is the annual depreciation charge?

Reducing balance

This method of depreciation is generally used for assets which tend to lose more
value in the initial years and require greater maintenance in the later years. A
good example would be a brand new motor vehicle. Motor vehicles tend to
depreciate rapidly in the earlier years and require very little maintenance.

A fixed percentage is charged to the net book value on an annual basis. Hence,
as the book value of an asset reduces, the depreciation charge reduces
accordingly.

EXAMPLE 4

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

Calculate the depreciation for the first three years.

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

The journal for depreciation is:

Dr Depreciation expense (Statement of comprehensive income)

Cr Accumulated Depreciation (Statement of financial position)

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Revaluations

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


However, over time these values may materially differ from their market value.

For example, if a company purchased a property 20 years ago and therefore


subsequently charged depreciation for 20 years, it would be safe to assume that
the book value of the asset would be significantly different from today’s market
value.

In order to overcome this issue I.A.S. 16 permits companies to reflect the market
value in the statement of financial position. This policy may be adopted, and if
so the following rules must be applied per the standard:

i. If a company chooses to revalue an asset they must revalue all assets in


that category

ii. Revaluations must be regular

iii. Subsequent depreciation must be based on the revalued amounts

iv. Gains from revaluations are not taken to the statement of comprehensive
income, as no gain as been realised. This is covered by the PRUDENCE
concept.

EXAMPLE 5

Company X purchased a building for $45,000 15 year ago, and charges


depreciation of 2% on a straight line basis.

The property has been valued by a qualified person at $150,000 during the
current financial year. The directors would like to encompass these figures in
the financial statements.

Required:

Complete the necessary journals to account for the revaluation.

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Disposal of a non-current asset

When a business disposes of an asset it is unlikely that the sale proceeds will
agree with the net book value. Therefore, a gain or loss will arise from the sale.

EXAMPLE 6

Company C has a motor vehicle with a book value of $6,000 (cost $22,000) and
disposes of it for $8,000.

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

The accounting entries will need to follow three steps

1. Clear the cost from the cost account

2. Clear the depreciation from the accumulated depreciation account

3. Enter the proceeds

The entries are therefore:

Dr Disposal Account $22,000

Cr Motor vehicle cost account $22,000

Dr Accumulated depreciation $16,000

Cr Disposal Account $16,000

Dr Bank $8,000

Cr Disposal Account $8,000

ANSWERS TO EXAMPLE 1

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Capital Revenue
Purchase of a motor √
vehicle
Purchase of a tax disc √
Fuel √
Insurance √
C D player √
Alloy wheels √
New tyre √
Early settlement discount √

ANSWER TO EXAMPLE 2

150,000 - 20,000 = 26,000


5

Ii

26,000 x 5 = 10,833
12

ANSWER TO EXAMPLE 3

23,000 - 3,000 = 5,000


4

ANSWER TO EXAMPLE 4

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


Year 2 25,000 - 6,250 x 25% = 4,688
Year 3 25,000 - 6,250 - 4,688 x 25% = 3,516

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ANSWER TO EXAMPLE 5

Pre Revaluation Post Revaluation


Building Accumulat Net Book Building Accumulat Net Book
Cost ed Value Cost ed Value
Account Depreciati Account Depreciati
on on

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

Accumulated depreciation pre revaluation

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

Accumulated depreciation post revaluation

150,000 / 35 = 4,286
Years pa

Journals Required

Dr Buildings Cost 105,000


Dr Accumulated
Depreciation 13,500

Cr Revaluation Reserve 118,500

Dr Depreciation 4,286
Cr Accumulated
Depreciation 4,286

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SESSION 5 INVENTORY

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

• Explain the principles of I.A.S. 2 Inventories

• Explain and apply the different methods of inventory valuation including


F.I.F.O., A.V.C.O. and L.I.F.O.

• Understand and apply the double entry for inventory

Introduction

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

In a business it is unlikely that all of the inventory will be sold at the end of an
accounting period, therefore there will be an adjustment needed in the financial
statements for the value of the closing inventory.

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


comprehensive income in order to calculate the cost of the goods sold with-in a
given period. The statement of financial position will show the value of the
inventory at the end of the accounting period (the closing inventory).

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


value our closing inventory.

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

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

Valuation of closing inventory

We will cover three methods of valuing the closing inventory:

F.I.F.O. – First In First Out

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


assume the items that were purchased first were the items sold first.

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

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Weighted average cost (AVCO)

Under this method we assume:

• All units are issued at the current weighted average cost per unit

• A new average cost is calculated whenever more items are purchased

L.I.F.O. – Last In First Out

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


assume the last item purchased is the first item to be sold.

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

From a practical perspective it is unlikely last items purchased will be sold first,
and as a result of this I.A.S. 2 does not permit L.I.F.O. method of stock valuation.

W.I.P. – Work in progress

In some cases, where a company has modified it’s inventory it is necessary to


take the cost of that modification into account when valuing closing inventory.

Net realisable value

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

Accounting Entries

The double entry to account for closing stock is:

Dr Inventory Statement of financial position

Cr Inventory Statement of comprehensive income

FBT PUBLISHING ACCA F3 Financial Accounting Page 43


EXAMPLE 1

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

Purchases

3rd 500 pens @ 4.00 = 2,000


12th 500 pens @ 4.60 = 2,300
16th 400 pens @ 4.75 = 1,900
22nd 700 pens @ 5.25 = 3,675
31st 900 pens @ 5.40 = 4,860

3,00 14,735
0

Sales

7th 300 pens @ 10.00 = 3,000


13th 400 pens @ 10.00 = 4,000
17th 300 pens @ 10.00 = 3,000
29nd 700 pens @ 10.00 = 7,000

1,70 17,000
0

Required

Assuming there is no opening inventories prepare the statement of


comprehensive income using the following:

• LIFO

• FIFO

• AVCO

FBT PUBLISHING ACCA F3 Financial Accounting Page 44


ANSWER TO EXAMPLE 1

L.I.FO.

IN OUT BALANCE

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

03/01 500 4.00 2000. 500 2000.


00 00

07/01 300 4.00 1200. 200 800.0


00 0

12/01 500 4.60 2300. 700 3100.


00 00

13/01 400 4.60 1840. 300 1260.


00 00

16/01 400 4.75 1900. 700 3160.


00 00

17/01 300 4.75 1425. 400 1735.


00 00

22/01 700 5.25 3675. 1100 5410.


00 00

29/01 700 5.25 3675. 400 1735.


00 00

31/01 900 5.40 4860. 1300 6595.


00 00

F.I.F.O

Total Purchases 3,000 pens

Total Sales 1,700 pens

Closing inventory 1,300 pens

Valuation

900 @ $5.40 each $4,860

FBT PUBLISHING ACCA F3 Financial Accounting Page 45


400 @ $5.25 each $2,100

= $6,960

FBT PUBLISHING ACCA F3 Financial Accounting Page 46


AVCO

IN OUT BALANCE

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

03/01 500 4.00 2000. 500 2000.


00 00

07/01 300 4.00 1200. 200 800.0


00 0

12/01 500 4.60 2300. 700 3100.


00 00

13/01 400 3100 1771. 300 1329.


divide 00 00
d by
700

16/01 400 4.75 1900. 700 3229.


00 00

17/01 300 3229 1384. 400 1845.


divide 00 00
d by
700

22/01 700 5.25 3675. 1100 5520.


00 00

29/01 700 5520 3513. 400 2007.


divide 00 00
d by
1100

31/01 900 5.40 4860. 1300 6867.


00 00

Therefore Income Statement is as follows:

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

Revenue 17,000 17,000 17,000

Cost of sales

Opening inventory 0 0 0
Purchases 14,735 14,735 14,735

FBT PUBLISHING ACCA F3 Financial Accounting Page 47


Closing inventory -6,595 -6,960 -6,867
8,140 7,775 7,868

8,860 9,225 9,132

FBT PUBLISHING ACCA F3 Financial Accounting Page 48


EXAMPLE 2

Radiance Kitchenware has the following items in their financial statements for
the year ended 31st December 2007:

Inventory @ 01/01/07 $45,678

Purchases $98,000

Inventory @ 31/12/07 $42,800

Closing inventory includes the following damaged items:

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

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

Required

Calculate the cost of sales for 2007.

ANSWER TO EXAMPLE 2

Stock Valuation

Closing valuation 42,800

Less
Damaged inventory Table 500
Chairs 400 900
Add NRV
Table (200 – 50) 150
Chairs 80 230

42,130

Cost of Sales

Opening inventory 45,678


Purchases 98,000
Closing inventory -42,130
101,548

FBT PUBLISHING ACCA F3 Financial Accounting Page 49


SESSION 6 IRRECOVERABLE DEBTS AND PROVISION
FOR DOUBTFUL DEBTS

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

• Explain the difference between a irrecoverable debt and a doubtful debt

• Compute the double entries required for irrecoverable debts and the
provision for doubtful debts

Introduction

The majority of companies sell their product on credit. The length of credit will
vary between companies, but the most common length of credit is 30 days.

If however, someone fails to pay we need to be able to account for this is our
ledgers. It would not be prudent to hold a receivable in our statement of
financial position if we were aware that they are unlikely to pay.

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

• Irrecoverable debt (bad debt)

• Doubtful debt

There is a clear distinction between irrecoverable and doubtful debts:

Irrecoverable Debt

This is a debt that you consider to be uncollectable. Circumstances where this


would occur are if the company has been fraudulent, gone bankrupt or
disappeared. Thus it is unlikely that we will receive the money due to us.

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

The double entry would be:

Dr Irrecoverable debtsStatement of comprehensive income

Cr Trade receivables Statement of financial position

FBT PUBLISHING ACCA F3 Financial Accounting Page 50


EXAMPLE 1

George has a small antiques business and at the end of the financial year ended
30th April 2007 has a receivables balance of $42,500. Included in the year end
balance is $4,000 that is owed by Zippy Traders. George has heard that they
have been closed down due to financial irregularities and that all the directors
have disappeared.

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

Required

How should George account for these items?

Recovering debts written off

If a debt that has been written off is later recovered, we will need to adjust the
ledgers to reflect this. The entry required would be:

Dr Bank

Cr Irrecoverable debts

Doubtful debt

A doubtful debt is a debt that is owed to a business, but they are dubious about
its collectability. The distinguishing factor is that this debt could be collected as
it is doubtful not bad. We therefore, make a provision for this amount.

The double entry would be:

Dr Irrecoverable debts Statement of comprehensive income

Cr Provision for doubtful debts Statement of financial position

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


debts the provision is for. As you can see the debt remains in the receivables
ledger, as a result the company can still actively chase the debt. If or when the
company pays the debt the double entry would be the normal entry for a receipt
i.e.

Dr Bank

Cr Trade receivables

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

FBT PUBLISHING ACCA F3 Financial Accounting Page 51


General allowance

In order to apply the prudence concept we need to review our receivables at the
end of the financial year and take a view of collectables. A large number of
companies have a constant provision for receivables. This would be calculated
as a percentage of the receivables balance.

EXAMPLE 2

For the year ended 31st December 2005 a company’s receivables balance was
$150,000. They had a general allowance of 5%. At the year ended 31st
December 2006 the company’s receivables are $135,000 – the company would
like to maintain a 5% general allowance.

Required

What is the impact on the statement of comprehensive income and how will the
receivables be presented in the statement of financial position?

FBT PUBLISHING ACCA F3 Financial Accounting Page 52


ANSWER TO EXAMPLE 1

Zippy Traders

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


needed would be:

Dr Irrecoverable debts $4,000

Cr Trade receivables $4,000

Bungle

This debt is neither an irrecoverable or doubtful debt at this stage. This is


because the debt is not yet due and we know where Bungle lives. We also have
no reason to suspect that Bungle cannot afford to repay the debt.

ANSWER TO EXAMPLE 2

31ST December 2005

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

Double entry

Dr Irrecoverable debts 7,500

Cr Allowance for receivables 7,500

Extract from statement of financial position:

Current assets

Receivables 150,000
General Allowance -7,500
142,500

FBT PUBLISHING ACCA F3 Financial Accounting Page 53


31st December 2006

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

Provision bought forward = $7,500

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

Double entry

Cr Irrecoverable debts 750

Dr Allowance for receivables 750

Current assets

Receivables 135,000
General Allowance -6,750
128,250

FBT PUBLISHING ACCA F3 Financial Accounting Page 54


SESSION 7 CONTROL ACCOUNTS AND CORRECTION OF
ERRORS

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

• Understand the principles of control accounts

• Prepare the control accounts for trade receivables and trade payables

• Explain the function of a suspense account

• Prepare nominal ledger accounts

• Prepare journal entries

Introduction

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


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

However, in the real world of business the number of transactions is large, and to
help us detect errors we use control accounts. Therefore, daily entries are
normally made in a number of “Prime Entry” books and then a summary total is
transferred to the nominal ledger periodically. This could be done daily, weekly
or even monthly.

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

• Sales day book

• Purchase day book

• Sale returns day book

• Purchase returns day book

• Cash book

• Petty cash book

• Journal entries

FBT PUBLISHING ACCA F3 Financial Accounting Page 55


The transactions are recorded in the prime entry books. They are then
transferred to the nominal (general) ledger and we then extract a trial balance in
order to prepare our financial statements.

FBT PUBLISHING ACCA F3 Financial Accounting Page 56


Sales day book

This book records all the sales we make on credit. Sales should be recorded net
of trade discount but before cash (settlement) discount.

Purchase day book

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

Sale returns day book

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

Purchase returns day book

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

Cash book

This book will record all the money that we will pay into the bank account, and
any payments we make from the bank account. This will also record any cash
(settlement) discounts we allow or receive.

Petty cash book

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

Journal entries

These are used for ad hoc entries that do not fall into any of the above
categories. They are also used to correct errors, both temporary and permanent.

FBT PUBLISHING ACCA F3 Financial Accounting Page 57


EXAMPLE 1

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

1st December 2007

• Purchased goods on credit from A Ltd for $595 receiving a trade discount
of 9.5%

• Purchased goods on credit for $795 from KP Ltd

• Sold goods on credit to JK Ltd for $999

3rd December

• Returned KP Ltd goods as they were defective

• Sold goods on credit to A Jones for $995

5th December

• Sold goods on credit to A Jones for $795

• Purchased goods on credit from A Ltd for $995, again with a 9.5% trade
discount

NB Sales tax is 17.5%

SOLUTION

SALES DAY BOOK

DATE INV CUSTOMER NET SALES TOTAL


NO. TAX
@17.5%
01/12 100555 J K Limited 999.00 174.82 1173.82
03/12 100556 A Jones 995.00 174.12 1169.12
05/12 100557 A Jones 795.00 139.12 934.12

2789.00 488.06 3277.06

PURCHASE DAY BOOK

DATE INV SUPPLIER NET SALES TOTAL


NO. TAX
@17.5%
01/12 999241 A Limited 538.47 94.23 632.70
01/12 867544 K P Limited 795.00 139.12 934.12
05/12 999242 A Limited 900.47 157.58 1058.05

FBT PUBLISHING ACCA F3 Financial Accounting Page 58


2233.94 390.93 2624.87

PURCHASE RETURNS DAY BOOK

DATE INV SUPPLIER VALUE SALES TOTAL


NO. TAX

03/12 867544 K P Limited 795.00 139.12 934.12

795.00 139.12 934.12

FBT PUBLISHING ACCA F3 Financial Accounting Page 59


EXAMPLE 2

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

Opening receivables balance 22,500

Sales day book 88,650

Cash sales 23,950

Sale returns day book 5,555

Refunds to customers 3,325

Discounts allowed 6,786

Irrecoverable debts 4,455

Increase in provision 500

Purchase ledger contra 1,200

Required

Calculate total cash received from customers in January

Solution

RECEIVABLES CONTROL ACCOUNT

Dr Cr
All Jan All Jan
Opening balance 22,500 Returns book 5,555
Sales day book 88,650 Discounts 6,786
allowed
Refunds 3,325 Irrecoverable 4,455
debts
Contra 1,200
Closing balance 18,650
Receipts (bal fig) 77,829

114,475 114,475

Feb Opening balance 18,650

FBT PUBLISHING ACCA F3 Financial Accounting Page 60


EXAMPLE 3

The following are the balances on a company’s ledger accounts in the month of
March:

Opening payables balance 12,785

Purchase day book 44,999

Returns outwards daybook 3,950

Returns inwards day book 2,300

Cheques paid to suppliers 37,500

Discounts received 1,400

Sales ledger contras 900

Required

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

Solution

PAYABLES CONTROL ACCOUNT

Dr Cr
All All
March March
Returns 3,950 Opening balance 12,785
outwards
Payments 37,500 Purchase day
book 44,999
Discounts 1,400
received
Contra 900
Closing bal (bal
fig) 14,034

57,784 57,784

April Opening balance 14,034

FBT PUBLISHING ACCA F3 Financial Accounting Page 61


Reconciling the control accounts

Normally at the end of each month we check to ensure our control accounts
reconcile to the individual balances on our ledger accounts. We do this by:

Checking our list of individual balances tie into the control account balance. If
there is an imbalance then it must be investigated. The main discrepancies are
due to:

• Casting error in the day books

• Posting error

• A one sided contra

• An entry that has been made in the individual account but not in the
control accounts

• An entry being omitted from the control account

EXAMPLE 4

At the financial year end 31 December 2007 Explorer Rain Wear had a balance
on the payables control account of $22,550. The balance on their purchase
ledgers was $20,650. The management accountant found the following
discrepancies:

1. An invoice of $1,200 had been omitted from the control account

2. The purchase day book total was overstated by $1,000

3. Goods returned of $1,590 had not been recorded in the control account

4. Discounts received of $10 had not been posted

5. Contra entries of $500 need to be recorded in the control account

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

Solution

Until a full knowledge of double entry is known, the easiest way to tackle this
question is to identify where the error has occurred and amend accordingly. In
this case:

Error No. Location of Error Amend

1 Control Account Control Account

FBT PUBLISHING ACCA F3 Financial Accounting Page 62


2 Control Account Control Account
3 Control Account Control Account
4 Control Account Control Account
5 Control Account Control Account

PAYABLES CONTROL ACCOUNT

Dr Cr
All Dec All Dec
Error 2 1,000 Original balance 22,550
Error 3 1,590 Error 1 1,200
Error 4 10
Error 5 500
Amended 20,650
balance

23,750 23,750

Jan Opening balance 20,650

Balancer per list 20,650

EXAMPLE 5

Hippo Manufacturing had the following balances on their payables / receivables


for the financial year ended 30 June 2006.

Credit sales 450,000


Cash sales 22,000
Credit purchases 300,000
Cash purchases 4,500
Returns inwards 17,000
Returns outwards 14,000
Discounts allowed 11,000
Discounts received 12,000
Irrecoverable debts 2,500
Payments made to payables 263,100
Cash received from receivables 438,580
Contra’s 17,500

Balance at 1 July 2005:

Payables 53,500
Receivables 51,500
Provision for doubtful debts 3,400

FBT PUBLISHING ACCA F3 Financial Accounting Page 63


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

Required:

Compute the receivables and payables control account and extract the closing
balances for the financial year end.

SOLUTION

This is a common CBA question. It is designed to ensure you know exactly what
should go into control accounts and also your knowledge of double entry. Again
until you are comfortable with debits and credits it is easier to write exactly
where things will go before attempting to balance the accounts. In this case:

Receivables / Payables Debit / Credit

Credit sales Receivables Debit


Cash sales Neither n/a
Credit purchases Payables Credit
Cash purchases Neither n/a
Returns inwards Receivables Credit
Returns outwards Payables Debit
Discounts allowed Receivables Credit
Discounts received Payables Debit
Irrecoverable debts Receivables Credit
Payments made Payables Debit
Cash Received Receivables Credit
Contra Receivables / Payables Credit / Debit

PAYABLES CONTROL ACCOUNT

Dr Cr

Returns 14,000 Opening balance 53,500


outwards
Discounts 12,000 Credit purchases 300,000
received
Payments 263,100
Contra 17,500

Closing bal (bal 46,900


fig)

353,500 353,500

FBT PUBLISHING ACCA F3 Financial Accounting Page 64


RECEIVABLES CONTROL ACCOUNT

Dr Cr

Opening balance 51,500 Returns inwards 17,000


Credit sales 450,000 Discounts 11,000
allowed
Irrecoverable 2,500
debts
Cash received 438,580
Contra 17,500
Closing bal (bal 14,920
fig)

501,500 501,500

Correction of errors

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

The following are the main purposes of a trial balance:

• Account balances are reviewed to check for obscurities

• Reconcile all control account balances with the individual ledgers

• Ensure debits equal the credits.

If there is an imbalance a SUSPENSE ACCOUNT will be created. Therefore, a


suspense account may have a debit or credit balance.

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

• Transposition error – Entering figures the wrong way round

• Single entries – Only one side of the transaction has been posted

• Both entries entered on the same side of the ledger account

• Casting error – An account has been incorrectly added

Although extracting a trial balance proves the above, there are certain errors
that a trial balance will not identify. These are:

• Error of principle – An entry has been entered in the wrong financial


statement.

• Errors of omission – A transaction has been missed out.

FBT PUBLISHING ACCA F3 Financial Accounting Page 65


• Errors of commission – Entering an amount in the wrong account, but in
the correct financial statement.

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

Journals

Journals are used for several reasons:

• Post unique, one off transactions

• Transfer items between accounts

• Adjust balances that are incorrect

• Correct items that have been incorrectly posted

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

Example 6

Correct the following errors using journals:

1. A sales day book has been under cast by $1,000.

2. Inventory purchased for $1,000 has been posted to stationery

3. A non-current asset has been purchased for $7,000 on credit, but has not
been recorded.

Solution

Account Name Description Debit Credit

Sales Revenue SDB under cast 1,000


Trade Receivables 1,000

Stationery Incorrectly coded 1,000


Purchases 1,000

Non-current asset Capital purchased 7,000


Other payables 7,000

FBT PUBLISHING ACCA F3 Financial Accounting Page 66


Example 7

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

Debit $213,852

Credit $212,390

A suspense account has been created for the difference.

The following errors have been identified by the accountant; after these errors
have been corrected the balance on the suspense account should be removed.

1. A payment for stationery for $440 was debited to stationery as $780.

2. Discounts allowed of $1,310 have been recorded as a credit.

3. Other income of $3,742 has only been recorded in the cash book.

Required

Correct the entries and clear the suspense account.

Solution

Account Name Description Debit Credit

Suspense Incorrect total posted 340


Stationery 340

Discounts allowed Posting to incorrect side 2,620


Suspense 2,620

Suspense One sided entry 3,742


Other income 3,742

Suspense Account

Journal 1 340 Opening 1,462


Balance

FBT PUBLISHING ACCA F3 Financial Accounting Page 67


Journal 3 3,742 Journal 2 2,620

4,082 4,082

FBT PUBLISHING ACCA F3 Financial Accounting Page 68


SESSION 8 BANK RECONCILIATIONS

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

• Prepare cash and bank accounts

• Prepare a bank reconciliation

Introduction

Within the ledger account is a bank account ledger, and it is important that the
balance in the ledger reconciles to the balance on the actual bank statement.
We call this exercise a bank reconciliation.

Dependant on the size of the company, this can be done on a weekly or monthly
basis, and in some larger companies even daily.

Preparing a bank reconciliation has many advantages. They include:

• Provides a check on accuracy of recordings in the cash book

• Highlights any errors

• Assists in the day to day cash management

• Any differences can be identified quickly

Debits and Credits

On a bank statement the balances will be from the perspective of the bank not
that of the business. Therefore, if a bank statement shows a credit balance, the
bank has a creditor. In other words the bank owes the business money and is
therefore in a positive position.

If the bank statement shows a debit balance this indicates the business is
overdrawn. i.e. it is an asset from the bank’s point of view.

FBT PUBLISHING ACCA F3 Financial Accounting Page 69


Reconciling Items

It is extremely unlikely that the balance on the ledger account and the balance
on the bank statement will agree. This can be due to the following reasons:

• Cheques issued by the company are immediately entered into the cash
book, but they will not appear on the bank statement until they are
presented to the bank. These are called unpresented cheques.

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

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

Proforma bank reconciliation

Balance per bank statement 65,455

Less : Unpresented cheques (1,950)

Add: Outstanding lodgements 1,700

Balance per cash book 65,205

Preparing a bank reconciliation

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

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

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

UNLESS OTHERWISE TOLD, ASSUME FIGURES ON THE BANK STATEMENT ARE


CORRECT.

FBT PUBLISHING ACCA F3 Financial Accounting Page 70


FBT PUBLISHING ACCA F3 Financial Accounting Page 71
Example 1

Cash Book

01/04/0 b/d 14,500 01/04/0 1437 450


7 7
03/04/0 27 3,650 01/04/0 1438 600
7 7
05/04/0 28 1,200 01/04/0 1439 750
7 7
12/04/0 29 1,100 01/04/0 1440 150
7 7
29/04/0 30 3,000 12/04/0 1441 250
7 7
12/04/0 1442 350
7
27/04/0 1443 395
7
27/04/0 1444 165
7
27/04/0 1445 245
7
30/04/0 c/d 20,095
7

23,450 23,450

30/04/0 b/d 20,095


7

Bank Statement
Date Details Payme Receip Balanc
nt t e

01/04/0 Opening balance 14,500


7
04/04/0 1437 450 14,050
7
05/04/0 1438 600 13,450
7
08/04/0 27 3,650 17,100
7
10/04/0 28 1,200 18,300
7
11/04/0 Standing Order – P.S.L. 750 17,550
7
12/04/0 1439 750 16,800
7
14/04/0 Direct Debit – Direct Line 750 16,050
7
17/04/0 1441 250 15,800
7

FBT PUBLISHING ACCA F3 Financial Accounting Page 72


17/04/0 BACS (Bank Automated
7 Clearance System) Transfer 3,500 19,300
18/04/0 1442 350 18,950
7
20/04/0 29 1,100 20,050
7
24/04/0 Bank Charges 500 19,550
7

FBT PUBLISHING ACCA F3 Financial Accounting Page 73


Solution

Cash Book

30/04/0 b/d 20,095 11/04/0 Standing Order 750


7 7
17/04/0 BACS 3,500 14/04/0 Direct Debit 750
7 7
24/04/0 Bank Charges 500
7
30/04/0 c/d 21,595
7

23,595 23,595

30/04/0 b/d 21,595


7

Bank Reconciliation

Balance per bank statement 19,550

Less: unpresented cheques 1440 150


1443 395
1444 165
1445 245 (955)

Add: Outstanding lodgements 30 3,000

21,595

FBT PUBLISHING ACCA F3 Financial Accounting Page 74


Example 2

The assistant accountant of Rainbow is trying to prepare a bank reconciliation as


at 30th November 2007. The cash book has a credit balance of $2,400 and the
bank statement at that date has an overdrawn balance of $1,550.

As his manager he has asked you for help with the following items:

1. He has discovered cheque number 100678 has been entered into the cash
book twice for $459.

2. A direct debit of $225 has been taken from the account and not been
entered into the cash book

3. There are unpresented cheques totalling $5,840.

4. There are outstanding lodgements of $8,390.

5. A cheque receipt for $1,450 has been dishonoured by the bank.

6. Bank charges of $1,400 have been charged by the bank.

7. A BACS transfer of $6,196 has been received by the bank and not been
accounted for in the cash book.

8. He has entered cheque payment number 100600 into the cash book as
$1,680, when the correct amount is $1,860.

Required:

Correct the cash book with the above and prepare a bank reconciliation.

FBT PUBLISHING ACCA F3 Financial Accounting Page 75


Solution:

Cash Book

30/11/0 Chq 100678 (1) 459 30/11/0 b/d 2,400


7 7
30/11/0 BACS 6,196 30/11/0 Direct Debit (2) 225
7 7
30/11/0 Dishonoured
7 Cheque (5) 1,450
30/11/0 Bank Charges
7 (6) 1,400
30/11/0 Chq 100600 (8) 180
7
30/11/0 c/d 1,000
7

6,655 6,655

30/11/0 b/d 1,000


7

Bank Reconciliation

Balance per bank statement (1,550)

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

Add: Outstanding lodgements (4) 8,3


90

1,000

FBT PUBLISHING ACCA F3 Financial Accounting Page 76


SESSION 9 ACCRUALS AND PREPAYMENTS

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

• Explain why adjustments are necessary when preparing financial


statements

• Compute the adjustments needed

Introduction

The matching concepts states that income and expenses incurred in the period
should be accounted for in that period, regardless of when invoices are raised or
received.

The fundamental rule is that income and expenditure are recognised as they are
earned or incurred, not as money is received or paid.

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


often necessary to adjust the financial statements.

Example 1 - Accruals

A sole trader receives his business gas bill quarterly in arrears. In the year
ended 31st December 2007 the following bills were received and paid on the
dates indicated.

• 30/04/07 $300

• 31/07/07 $310

• 31/10/07 $300

When preparing the accounts for the year end the accountant must adjust the
Gas ledger account to reflect that not all charges have been recorded. In this
case charges for November and December need to be included.

Accruals and prepayments will be the estimate of the adjustment needed. The
adjustment is calculated using the most up to date information available. In the
example above this will be the 31/10/07 bill. Therefore the adjustment needed
would be 2/3 x $300.

The entry needed would be:

Dr Gas account $200

FBT PUBLISHING ACCA F3 Financial Accounting Page 77


Cr Accruals $200

FBT PUBLISHING ACCA F3 Financial Accounting Page 78


The ledger account would therefore look like this:

Gas Account

30/04/0 Cash 300


7
31/07/0 Cash 310
7
31/10/0 Cash 300
7
31/12/0 Accrual 200 31/12/0 Inc Statement 1,110
7 7

1,110 1.110

01/01/0 Accrual b/d 200


8

It is important to remember to carry forward any accrual or prepayment


to the next accounting period.

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

FBT PUBLISHING ACCA F3 Financial Accounting Page 79


Example 2 - Prepayments

Julie starts her business on 1st August 2007, and pays her business insurance for
the year to 31st July 2008 totalling $1,800. Her year end is 31st December each
year.

What charges for insurance would be stated in the income statement for the
period ended 31st December 2007?

Insurance Account

01/08/0 Cash 1,800 31/12/0 Prepayment 1,050


7 7 (7/12)
31/12/0 Inc Statement 750
7

1,800 1.800

01/01/0 Prepayment b/d 1,050


8

Assuming the insurance charge remains the same for the year ended 31st July
2009, the ledger account would look like this:

Insurance Account

01/08/0 Cash 1,800 31/12/0 Prepayment 1,050


7 7 (7/12)
31/12/0 Inc Statement 750
7

1,800 1.800

01/01/0 Prepayment b/d 1,050


8
01/08/0 Cash 1,800 31/12/0 Prepayment 1,050
8 8 (7/12
31/12/0 Inc Statement 1,800
8

2,850 2,850

01/01/0 Prepayment b/d 1,050


9

FBT PUBLISHING ACCA F3 Financial Accounting Page 80


SESSION 10 LIMITED COMPANY ACCOUNTS

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

• Prepare a statement of comprehensive income

• Prepare a statement of changes in equity

• Prepare a statement of financial position

Introduction

Many businesses are constituted in the form of limited companies. The owners
of limited companies are referred to as shareholders and are often different from
the people that run the company.

The shareholders have very little, if any involvement in the day to day running of
the business and employ directors to run it on their behalf.

Limited company financial statements have very strict requirements which must
be followed by all companies. These are governed by:

• Companies Act 2006 (or local country legislation)

• The International Accounting Standards Board

FBT PUBLISHING ACCA F3 Financial Accounting Page 81


The format to be adhered to per I.A.S. must be the format we adopt in our
studies. The proforma financial statements for limited companies were given in
session 2, however a copy is given below for reference:

Proforma set of financial statements for a limited company or Plc

Statement of financial position as at 31 December 2007

Non – current assets


Note
Intangible assets 6 200,000
Tangible assets 7 187,999

Current assets

Inventory 8 88,432
Trade receivables 9 97,455
Cash 13,400 199,287

Total assets 587,286

Equity and liabilities

Share capital 100,000


Retained earnings 220,497
Revaluation reserve 7 38,000 358,497

Non – current liabilities

Interest bearing borrowings 10 100,000

Current liabilities

Trade payables 77,789


Taxation 5 51,000 128,789

Total liabilities 587,286

FBT PUBLISHING ACCA F3 Financial Accounting Page 82


Statement of comprehensive income for the year ended 31 December
2007

Note
Revenue 385,000

Cost of sales 1 188,000

GROSS PROFIT 197,000

Distribution costs 2 38,500

Administration expenses 3 37,700

PROFIT FROM OPERATIONS 120,800

Finance costs 8,000

PROFIT BEFORE TAX 112,800

Income tax 53,000

PROFIT FOR THE PERIOD 59,800

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

Share Retaine Revaluat


d ion
Capital Earning Reserve Total
s

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

Profit for the period 59,800 59,800

Excess depreciation 2,000 (2,000)

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

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

A limited company must file their statutory accounts with companies’ house. A
full set of statutory accounts will include:

FBT PUBLISHING ACCA F3 Financial Accounting Page 83


1. Statement of comprehensive income

2. Statement of changes in equity

3. Statement of financial position

4. Cash flow statement

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

One of the key differences between a company and a sole trader is that a
company is classed as a separate legal entity. This means that a company is
deemed to be a person in its own right. Therefore, a company can sue
individuals and can also be sued. The name limited company comes from the
fact that the shareholders have limited liability, in other words their liability is
restricted to the amount they have paid for their shares.

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


payments are at the directors’ discretion.

Example 1

Freedom Limited has 100,000 ordinary shares in issue. The nominal value (par
value) is $1.00 and the directors decide to pay a dividend of 75c per share.

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

Preference shares

This type of share is known as a non-equity share, and gets a fixed return on the
value of the share. Preference share holders will receive their dividend every
year providing the company has distributable profit.

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

FBT PUBLISHING ACCA F3 Financial Accounting Page 84


Example 2

The following information relates to Voyager Limited

Year ended 31st December 2007 $

Share capital (25c shares) 100,000


6% Preference shares 50,000

The directors propose an ordinary dividend of 75c per share.

Required:

Calculate the dividend payable.

Solution

Ordinary shares

100,000 / 0.25 = 400,000 shares in issue

400,000 x 0.75 300,000

Preference shares

50,000 x 6% 3,000

Total dividends paid 303,000

FBT PUBLISHING ACCA F3 Financial Accounting Page 85


Share premium

If a company issues shares after the initial incorporation, it is unlikely they will
issue them at a nominal/par value. As the company has established itself, the
net worth of the company would increase. This would be reflected in the share
price.

Example 3

The following relates to Radiance Limited

Capital and reserves

Share capital ($1.00) 200,000

Retained earnings 233,456

Revaluation reserve 125,000

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

The double entry would be:

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

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

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

The Capital and reserves would now be:

Share capital ($1.00) 250,000

Share premium 142,500

Retained earnings 233,456

Revaluation reserve 125,000

FBT PUBLISHING ACCA F3 Financial Accounting Page 86


Capital reserve

The share premium account is classed as a Capital reserve. This means that the
account cannot be used to pay out dividends. The use of capital reserves is very
limited. The key use of the reserve would be to finance a bonus issue of shares.
This is when the directors distribute free shares to existing shareholders.

The accounting entry for this would be:

Cr Share capital

Dr Share premium

Dividends

As we have seen previously in this chapter, dividend payments are used to


distribute profit to shareholders. In order that a dividend can be paid, the
company must have reserves that are distributable i.e. they cannot be paid out
of any reserve that is not realised (Revaluation reserve).

Final dividends are paid after the year end; once the financial statements have
been completed, and the directors have decided the dividend amount.

An interim dividend can also be paid mid way through the year.

Example 4

Share capital (50c) 200,000

10% Preference shares 25,000

An interim dividend of 8c per share was paid during the year and the directors
would like to propose a final dividend of 9c per share.

Required:

Calculate the total dividend payable for the year ended 31st May 2007.

FBT PUBLISHING ACCA F3 Financial Accounting Page 87


Solution

Ordinary shares

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

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

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

Preference shares

10% x $25,000 2,500

70,500

Taxation

All companies have to pay tax on the taxable profits. The tax charge is normally
estimated at the end of the financial year and charged to the statement of
comprehensive income, and is paid in the following year.

The accounting entry for taxation would be:

Dr Taxation Comprehensive income

Cr Taxation liability Financial position

FBT PUBLISHING ACCA F3 Financial Accounting Page 88


Example 5

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

Dr Cr

Share capital (50c) 100,000


6% Preference shares ($1.00) 50,000
Retained earnings at 01/04/06 234,666
Debenture 10% 100,000
Inventory at 01/04/06 32,000
Trade receivables 45,987
Receivables provision 5.987
Trade payables 39,945
Cash 73,958
Building cost account 150,000
Plant and machinery at net book value 422,987
Debenture interest 5,000
Administrative expenses 48,000
Distribution expenses 49,000
Profit on disposals 1,000
Purchases 69,666
Revenue 365,000

896,598 896,598

Notes

1. Depreciation on building is to be charged at 2%

2. Depreciation on plant and machinery is to be charged at 10% reducing


balance

3. Closing inventory was valued at $28,990

4. A provision of 5% of receivables is to be maintained

5. Tax charge is estimated at $25,000

6. A final dividend of 15c per share has been proposed before the year end.

Required

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


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

FBT PUBLISHING ACCA F3 Financial Accounting Page 89


Solution

Journals
Dr Cr

1. Dr Depreciation charge (150,000 x 2%) 3,000


Cr Accumulated depreciation -
Buildings 3,000

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


10%)
Cr Accumulated depreciation – P & M 42,299

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


Cr Closing inventory (financial 28,990
position)

4. Dr Receivables provision account Work 3,688


1
Cr Administration expenses 3,688

5. Dr Taxation 25,000
Cr Taxation liability 25,000

6. Dr Pref Dividends 3,000


Cr Proposed Div (prefs) 3,000

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


15c) 30,000
Cr Proposed dividends 30,000

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


Cr Debenture interest accrual 5,000

Working 1

Receivables Provision Account

01/04/0 b/d 5,987


6

31/03/0 Admin
7 expenses
(written back to 3,688
I/S)

31/03/0 c/d (45,987 x


7 5%) 2,299

FBT PUBLISHING ACCA F3 Financial Accounting Page 90


5,987 5,987

FBT PUBLISHING ACCA F3 Financial Accounting Page 91


Jewel Limited
Statement of Comprehensive Income
Year ended 31st March 2007

Revenue 365,000

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


)

GROSS PROFIT 292,324

Distribution costs (49,000


)

Administration expenses (48,000 + 3000 + 42,299 –


3688 + 1000) (88,611
)

PROFIT FROM OPERATIONS 154,713

Finance costs (10,000


)

PROFIT BEFORE TAX 144,713

Income tax (25,000


)

PROFIT FOR THE PERIOD 119,713

FBT PUBLISHING ACCA F3 Financial Accounting Page 92


Jewel Limited
Statement of financial position
As at 31st March 2007

Non – current assets

Tangible assets (150,000 + 422,987 –


3,000 – 42,299) 527,688

Current assets

Inventory 28,990
Trade receivables (45,987 – 2,299) 43,688
Cash 73,958
146,636
Total assets 674,324

Equity and liabilities

Ordinary share capital 100,000


Preference share capital 50,000
Retained earnings (234,666 + 119,713 –
30,000 – 3,000 Pref Div) 321,379
471,379

Non – current liabilities

Debenture 100,000

Current liabilities

Trade payables 39,945


Debenture accrual 5,000
Proposed dividend 33,000
Taxation 25,000
102,945

Total liabilities 674,324

FBT PUBLISHING ACCA F3 Financial Accounting Page 93


Ordinary Preferen Revaluat Retained Total
Shares ce ion Earnings
Shares Reserve

Balance @ 100,000 50,000 234,666 384,666


01/04/06

Profit for the year 119,713 119,713

Dividends: ord (30,000) (30,000)


pref (3,000) (3,000)
Shares issued

Revaluation

Balance @ 100,000 50,000 321,379 471,379


31/03/07

FBT PUBLISHING ACCA F3 Financial Accounting Page 94


SESSION 11 STATEMENTS OF CASH FLOW

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

• Explain the purpose of producing a cash flow statement

• Discuss the advantages of a cash flow statement

• Explain the principles of I.A.S. 7

• Produce a cash flow statement

Introduction

The cash flow statement is a primary financial statement and provides


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

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

Prior to this session we have focused on profit, but cash is equally vital for the
success of a business, especially in the short term. If a business has limited cash
funds available it will struggle to survive in the short term.

Advantages

• Cash flow balances are a matter of fact and are not distorted by
accounting policies

• Cash flow balances are objective, unlike profit which is subjective

• Users of financial statements can establish exactly the cash generation of


a business

• Users can identify exactly how this cash has been utilised

• Users can assess the liquidity of a business and assess its ability to repay
debts as they fall due

• Loans repaid and received are clearly listed in the cash flow statement

• Users can assess management attitude to capital expenditure

• Interest payments are highlighted in the cash flow

FBT PUBLISHING ACCA F3 Financial Accounting Page 95


I.A.S. 7

I.A.S. 7 lays down the requirements of a cash flow statement. It gives us a


detailed proforma and certain definitions:

Cash

Cash that is available on demand. An example would be cash in the bank less
any overdraft.

Cash equivalents

Short term, highly liquid investments (will be stated as current assets in


Statement of Financial Position)

I.A.S. 7 has three main headings. Students should familiarise the layout of a
cash flow as questions in the exam will test this area.

The three main headings are:

• Cash flows from operating activities

• Cash flows from investing activities

• Cash flows from financing activities

FBT PUBLISHING ACCA F3 Financial Accounting Page 96


Proforma

Statement of Cash Flow for year to …….

$ $

Cash flows from operating activities

Profit before tax X

Adjustments for:

Interest payable X
Depreciation X
(Profit) / loss on the disposal of a non current asset (X) X

Operating profit before working capital changes X

Working capital changes

(Increase) / Decrease in inventories (X) X


(Increase) / Decrease in receivables (X) X
Increase / (Decrease) in payables X (X)

Cash generated from operations X

Interest paid (X)


Taxation paid (X)

NET CASH FROM OPERATING ACTIVITIES X

FBT PUBLISHING ACCA F3 Financial Accounting Page 97


Proforma continued

$ $

NET CASH FROM OPERATING ACTIVITIES X

Cash flow from investing activities

Purchase of a non-current asset (X)


Disposal of a non-current asset X
Interest received X
Dividends received X

CASH FLOW FROM INVESTING ACTIVITIES X

Cash flow from financing activities

Proceeds from the issue of shares X


Receipt of loans X
Repayment of loans (X)
Dividends paid (X)

CASH FLOW FROM FINANCING ACTIVITIES X

NET CASH FLOW X

Cash and cash equivalents at the beginning of the


period X

Cash and cash equivalents at the end of the period X

FBT PUBLISHING ACCA F3 Financial Accounting Page 98


Example 1

Radiance Limited
Statement of Financial Position
As at 31 December 2007
2006 2007
Non-current assets
Cost 180 220
Accumulated depreciation (78) (92)
102 128
Current assets
Inventory 12 17
Trade receivables 2 10
Bonds 10 10
Cash 3 16
129 181
Capital and reserves
Share capital 45 65
Share premium 10 12
Accumulated profits 24 68

Non-current liabilities
Loan 30 20

Current liabilities
Payables 19 13
Tax 1 3
129 181

Notes

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

Loan was repaid at the end of the financial year.

Required

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

FBT PUBLISHING ACCA F3 Financial Accounting Page 99


Solution

$ $

Cash flows from operating activities

Profit before tax (68 – 24) + 6 50

Adjustments for:

Interest payable -
Depreciation (92 – 78) 14
(Profit) / loss on the disposal of a non current asset -

Operating profit before working capital changes 64

Working capital changes

(Increase) in inventory (17 – 12) (5)


(Increase) in receivables (10 – 2) (8)
(Decrease) in payables (19 – 13) (6)

Cash generated from operations 45

Interest paid -
Taxation paid (working 1) (4)

NET CASH FROM OPERATING ACTIVITIES 41

FBT PUBLISHING ACCA F3 Financial Accounting Page 100


$ $

NET CASH FROM OPERATING ACTIVITIES 41

Cash flow from investing activities

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


Disposal of a non-current assets -
Interest received -
Dividends received -

NET CASH USED IN INVESTING ACTIVITIES (40)

Cash flow from financing activities

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


10)
Receipt of loans -
Repayment of loans (10)
Dividends paid -

CASH FLOW FROM FINANCING ACTIVITIES 12

NET CASH FLOW 13

Cash and cash equivalents at the beginning of the


period (10+3) 13

Cash and cash equivalents at the end of the period


(10+3) 26

FBT PUBLISHING ACCA F3 Financial Accounting Page 101


Working 1

Taxation Liability

01/01/0 b/d 1
7
Cash paid (Bal 4 31/12/0 Charge for year 6
Fig) 7
31/12/0 c/d 3
7

7 7

01/01/0 b/d 7
8

Direct Method

The direct method involves adding together the cash inflows and deducting the
cash outflows.

Example 2

The following information relates to Empress Limited:

Cash sales 55,000


Cash received from customers 44,000
Cash purchases 33,000
Cash paid to suppliers 12,000
Cash expenses 11,000
Cash wages and salaries 20,000

Required:

Calculate the cash generation for Empress Limited

FBT PUBLISHING ACCA F3 Financial Accounting Page 102


Solution

Cash sales 55,000


Cash received from customers 44,000

Total cash received 99,000

Cash purchases 33,000


Cash paid to suppliers 12,000
Cash expenses 11,000
Cash wages and salaries 20,000

Total cash paid 76,000

Cash generated 23,000

FBT PUBLISHING ACCA F3 Financial Accounting Page 103


SESSION 12 INCOMPLETE RECORDS

Introduction

As the name suggests, incomplete records are any form of accounting records
other than the full double entry system.

In reality, accountants come across incomplete records almost daily. This is


because their clients are not likely to fully understand the double en try system.
We still however, need to prepare a set of financial statements for the client.

During the exam, students will often come across incomplete records. The main
reason is often due to a flood or fire at the business premises.

Calculating profit

If a business has very little information about its transactions, it may only be
possible to calculate its net profit for the year. This can be done by using the
accounting equation (this is very important). The accounting equation can be
written as:

Net Assets = Capital + Profit - Drawings

Or

Change in net assets = Capital introduced + Profit – Drawings

You may realise that this is very similar to the statement of financial position.

Example 1

A sole trader’s statement of financial position at 31st December 2006 shows that
the business has net assets of $5,000. The statement of financial position at 31st
December 2007 shows that the business has net assets of $8,000. The owner’s
drawings for the year amounted to $2,500 and he didn’t introduce any further
capital in the year

Required

Calculate the profit for the year ended 31st December 2007.

FBT PUBLISHING ACCA F3 Financial Accounting Page 104


Solution:

Change Capital Profit Drawin


in net introdu for the g in
assets ced year period

3,000 = 0 + ? - 2,500

This can be written as:

3,000 - 0 + 2,500 = Profit

Profit = 5,500

As you can see it is impossible to know the make-up of the net profit figure due
to lack of information.

Preparing financial statements from incomplete records

In the majority of cases a small business will keep limited amount of records.

In these types of questions you will be given information regarding the opening
and closing balances of assets and liabilities of the business. You will also be
given information about certain transactions during the period; this is usually a
summary of the cash book.

There are two main techniques used in incomplete records:

1. Balancing figures in ledger accounts

2. Ratios for mark-up (based on cost) or margin (based on selling price)

Balancing figures

The balancing figure approach is commonly used the following way:

Ledger Account Missing Figure


Accounts receivable • Sales
• Money received from
accounts receivable
Accounts payable • Purchases
• Money paid to accounts
payable
Cash at bank • Drawings
• Money stolen
Cash in hand • Cash sales
• Cash stolen
Example 2

FBT PUBLISHING ACCA F3 Financial Accounting Page 105


Suppose that the opening balance on the accounts receivables ledger was
$50,000, there had been receipts from account receivables in the year of
$45,000, irrecoverable debts have been written off worth $5,000 and the closing
balance was $55,000.

Required:

What were the credit sales for the year?

Account Receivables

Opening b/d 50,000 Receipts 45,000


Sales (Bal Fig) 55,000 Bad debts 5,000
Closing c/d 55,000

105,000 105,000

Example 3

Suppose that the opening accounts receivables balance was $30,000, there have
been total receipts from customers of $55,000 of which $15,000 relates to cash
sales and $40,000 relates to receipts from accounts receivables. Discounts
allowed in the year totalled $3,000 and the closing balance was $37,000.

Required:

What are the total sales for the year?

Due to the information given in the question we can approach this in 2 different
ways. We can calculate credit sales as above and then add on cash sales, or we
can use the ledger account to calculate total sales. Both methods are shown
below:

Solution 1 - Total sales

Account Receivables (Total Sales a/c)

01/01/0 b/d 30,000 31/12/0 Total receipts 55,000


7 7
31/12/0 Total sales (Bal 31/12/0 Discounts 3,000
7 fig) 65,000 7 allowed
31/12/0 c/d 37,000
7

95,000 95,000

Solution 2 - Separate sales

FBT PUBLISHING ACCA F3 Financial Accounting Page 106


Account Receivables

01/01/0 b/d 30,000 31/12/0 Credit receipts 40,000


7 7
31/12/0 Credit sales 50,000 31/12/0 Discounts 3,000
7 7 allowed
31/12/0 c/d 37,000
7

80,000 80,000

Credit sales 50,000


Cash sales 15,000
Total sales 65,000

Example 4

The opening balance on the accounts payable ledger was $30,000. Payments
made to account payables during the year were $33.000, discounts received are
$4,000 and the closing balance was $26,000.

Required:

What was the total purchases figure for the year?

Solution:

Payables Control a/c

31/12/0 Payments 33,000 01/12/0 b/d 30,000


7 7
31/12/0 Discounts 4,000
7 received
31/12/0 c/d 26,000 31/12/0 Purchases 33,000
7 7

63,000 63,000

FBT PUBLISHING ACCA F3 Financial Accounting Page 107


Example 5

Suppose the opening accounts payable balance is $15,000, the total payments
made to suppliers was $14,000 of which $10,000 related to credit purchases.
Discounts received were $500 and the closing balance was 11,000.

Required:

What was the total purchases figure for the year?

Solution:

Total Purchases a/c (Account Payables)

31/12/0 Total payments 14,000 01/12/0 b/d 15,000


7 7
31/12/0 Discounts 500
7 received
31/12/0 c/d 11,000 31/12/0 Purchases 10,500
7 7

25,500 25,500

Example 6

The following information relates to the rent and rates for Susan for the year
ended 31st December 2007.

Opening balance Rent prepaid 300


Rates accrued 500
Cash paid during the Rent and rates 4,100
year
Closing balance Rent prepaid 350
Rates accrued 450

Solution:

Rent and Rates

01/01/0 Rent b/d 01/01/0 Rates b/d


7 (Prepaid) 300 7 (Accrued) 500
31/12/0 Cash paid 4,100 31/12/0 Charge (Bal 4,000
7 7 Fig)
31/12/0 Rates accrued 450 31/12/0 Rent prepaid 350
7 7

4,850 4,850

FBT PUBLISHING ACCA F3 Financial Accounting Page 108


FBT PUBLISHING ACCA F3 Financial Accounting Page 109
Example 7

On 1st January the bank is overdrawn by $1,367, payments in the year totalled
$8,536 and on 31st December the closing balance was a positive balance of
$2,227.

Required:

What is the total receipts figure for the year?

Solution:

Cash Book

31/12/0 Receipts 12,130 01/01/0 b/d 1,367


7 7
31/12/0 Payments 8,536
7
31/12/0 c/d 2,227
7

12,130 12,130

Example 8

Scott has a cash float at the beginning of the year of $900. During the year cash
of $10,000 was banked, $1,000 was paid out for drawings and wages of $2,000
was paid. Scott decided to increase the float to $1,000 at the end of the year.

Required:

How much cash was received from customers during the year?

Solution:

Cash Account

01/01/0 b/d 900 31/12/0 Banked 10,000


7 7
31/12/0 Drawings 1,000
7
31/12/0 Receipts 13,100 31/12/0 Wages 2,000
7 7
31/12/0 c/d 1,000
7

14,000 14,000

FBT PUBLISHING ACCA F3 Financial Accounting Page 110


Ratios – Mark-up and Margin

The gross profit of a company can be expressed as a percentage. This


percentage can be calculated based on the sales figure or the cost of sales
figure.

• Gross Profit Mark-up Based on Cost of Sales

• Gross Profit Margin Based on Sales

If we look at the following trading account:

Sales REvenue 5,000

Cost of sales 4,000

Gross profit 1,000

Gross profit mark-up 1,000 / 4,000 x 100 = 25%

Gross profit margin 1,000 / 5,000 x 100 = 20%

Example 9

Margin 25% Sales $1,000

Required:

What is the gross profit and cost of sales?

$ %
Sales 1,000 100%

Cost of sales (1,000 / 100 x 75) (Bal fig) 750 75%

Gross profit 250 25%

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Example 10

Mark-up 25% Cost of sales $600

Required:

What is gross profit and sales?

Sales (600 / 100 x 125) 750 125%

Cost of sales 600 100%

Gross profit 150 25%

Example 11

Mark-up 10%

Sales $6,600

Opening inventory $300

Closing inventory $500

Required:

Complete a trading account from the above information.

Sales 6,600 110%

Cost of sales

Opening inventory 300


Purchases (Balancing Figure) 6,200
Closing inventory (500)
6,000 100%

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

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Example 12

Margin 5%

Purchases $2,840

Opening inventory $800

Closing inventory $600

Required:

Complete a trading account from the above information.

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

Cost of sales

Opening inventory 800


Purchases 2,840
Closing inventory (600)
3,040 95%

Gross profit 160 5%

Cost of lost inventory

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

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

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

Therefore, to work out the cost of lost inventory, complete the trading account
from the information given and then lost inventory can be calculated as a
balancing figure.

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Example 13

Margin 20%

Sales $100,000

Opening inventory $10,000

Closing inventory (after fire) $3,000

Purchases $82,000

Required:

Complete a trading account from the above information.

Sales 100,000 100%

Cost of sales

Opening inventory 10,000


Purchases 82,000
Closing inventory (3,000)
Inventory lost in fire (balancing figure) (9,000)
80,000 80%

Gross profit (100,000 / 100 x 20) 20,000 20%

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SESSION 13 PARTNERSHIPS
Definition

“The relationship which subsists between persons carrying on a business in


common with a view to profit”

A partnership therefore has two or more partners or owners. In the same way as
for a sole trader, the profits of the business are owned by the partners. This
makes it necessary to share the profits of the business amongst the partners.

A partnership will usually have a “Partnership Agreement” which will state how
the profits are to be shared amongst other things.

THE SHARING STORY

A partnership has four partners – Jason, Howard, Gary and Mark. In the year to
30th June 2007 the partnership has made profits totalling $106,250.

Jason is rich but stupid. He was made a partner because he could invest
$100,000 into the partnership. He withdrew $30,000 from the business on 1st
July 2006.

Howard is poor but clever and could only invest $20,000 into the partnership.
Due to him being clever and completing work quicker than the other partners he
took responsibility for hiring and firing staff in the business. He withdrew
$30,000 on 30th June 2007.

Gary invested $50,000 into the partnership. He has a liking for designer clothes
and fast cars. Consequently he withdrew $25,000 on 1st July 2006 and a further
$25,000 on 1st January 2007.

Mark also invested $50,000 and withdrew $30,000 on 1st July 2006. Mark’s wife
has just had a baby and he would therefore like to have a guaranteed share of
the profits.

The partners have decided that profits should be distributed at a ratio of 2 : 1 :


3 : 4 (Jason : Howard : Gary : Mark)

How do you think the profits should be shared amongst the partners?

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Interest on capital

To reward partners who have invested more into the business, the partnership
may allocate some of the profits based on the level of capital invested. This is
called interest on capital.

Salaries

To reward those partners who take on extra responsibilities with-in the business,
they may receive a salary. A partners’ salary is not a business expense like the
salary of an employee, but a way in which profits are allocated.

Interest on drawings

To penalise those partners who take out more drawings from the business, the
partnership may charge interest on drawings. Interest on drawings results in a
reduction in the amount of profit the partner is allocated.

Profit sharing ratio

This is the ratio in which any remaining profits should be shared amongst the
partners after they have been allocated interest on capital, salaries and interest
on drawings.

Guaranteed minimum profit share

A partner may be guaranteed a minimum share of the profits. If the partner has
not received this share after allocating profits in accordance to the above, the
shortfall should be given to the partner. The short fall is then taken from the
other partners in accordance with the profit sharing ratio.

Example 1

Using the amounts detailed in the sharing story, allocate the profits of the
business in accordance with the following partnership agreement:

a) Interest on capital is 5% per annum

b) Howard is to receive a salary of $5,000

c) Interest on drawings is 10% per annum

d) Profit sharing ratio is as stated 2 : 1 : 3 : 4

e) Mark has a guaranteed minimum profit share of $42,500

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Appropriation of Profit Account

Jason Howar Gary Mark Total


d

Profit 106,250

Interest on capital 5,000 1,000 2,500 2,500 (11,000


)
Salaries - 5,000 - - (5,000)
Interest on drawings (3,000) - (3,750) (3,000) 9,750
100,000
P.S.R. 2 : 1 : 3 : 4 20,000 10,000 30,000 40,000 (100,00
0)
22,000 16,000 28,750 39,500 -
Guaranteed share (1,000) (500) (1,500) 3,000
21,000 15,500 27,250 42,500

Financial statements for a partnership

The format of the financial statements for a partnership will be the same as for a
sole trader except for the capital section of the statement of financial position.

Each partner will have a capital account and a current account.

Capital account

This will record the assets that have been introduced into the partnership. The
account will remain fixed unless more assets are introduced. The capital account
will have a credit balance.

Capital Accounts
A B C A B C

Balance b/d X X X

Bank X X X

Balance c/d X X X

X X X X X X

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Current account

The current account will record the partners’ share of profits and drawings. The
current account will usually have a credit balance but may have a debit balance
indicating that they have withdrawn more than the profits they are entitled to.

Current Accounts
A B C A B C

Balance b/d X X X
Share of X X X
profits
Drawings X X X Loan interest X X X
Balance c/d X X X

X X X X X X

The capital section of the statement of financial position will look like:

Capital Accounts A X
B X
C X
X
Current Accounts A X
B X
C X
X

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