FINANCIAL ACCOUNTING 1 - ACC 301

UNIT ONE

COMPANY ACCOUNTS

Limited Liability companies, which are normally referred to as limited companies came
into being because of the growth in the number of businesses and the need to have a
lot of people investing in an organization and who may not be directly involved in the
running of the business. The CAMA 1990 requires that a limited company must be
guided by the provisions of the law. The capital of a limited company is divided into
shares. Shares can be of any nominal value, ranging from N0.25 to N10 or any other
amount per share. In order to become a shareholder or a member of a limited
company, a person must buy one on more shares in the company. Where shareholders
have paid fully for their shares, their liability is limited to the amount of the shares. When
a company loses all its assets, the shareholders can only lose theirs shares contribution
in the company. The shareholders who have partly paid for theirs shares can be asked
to pay the balance remaining unpaid and no more, no less. In case of limited liability
companies, the shareholders are said to have ‘limited liability and this is why companies
are known as ‘limited liability’ or simply ‘ limited companies’. It is the need for investors
to have limited risk of financial loss and makes it possible to have both a large number
of owners and a large amount of capital invested in the company. In actual fact, the
capital raised in a limited liability companies are much larger than that of a sole trader
and partnership. This is so because many people will be involved in the companies.

PUBLIC AND PRIVATE COMPANIES

According to the provisions of CAMA 1990, companies are classified into two, the public
company and private company. In the Companies Act, a public company is defined as
one which fulfils the following conditions:

 Its memorandum and articles of association states that it is a public company and
that it is registered as such.
 It has an authorized share capital of at least N100,000.
 Membership should not be less than 20.
 Its name must end with the words ‘public limited company, or the abbreviation
‘PLC’.

Public companies do not have to offer their shares for sales on the Stock Exchange.
However, companies will be avail the opportunity of large pool of funds if shares are
sold on the floor of the stock exchange rather than private subscription. A private
company is usual a smaller business compared to public company and may be formed
by one or more persons. It is defined by the Act as a company which is not a public

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company. The main distinctions between a private company and a public company are
that a private company

 can have an authorized capital of less than N100,000, and

 cannot offer its shares for subscription to the public at large, whereas a public
company can.

For examples, where a person visit a bank or a ‘blue chip’ company and see a
prospectus offering shares for sales, then the company would be a public company. A
public company must issue a prospectus, approved by the Stock Exchange, before
such shares could be subscribed for by the public. It is part of the provisions of
Company Act. The shares that are traded on the Stock Exchange are all those of public
companies. The ones whose shares are traded on the floor of the Stock Exchange are
known as ‘quoted companies’ meaning that theirs shares have prices quoted on the
Stock Exchange. They have to comply with the rules and regulations of the Stock
Exchange in additions to the ones laid down by the Companies Act and accounting
standards.

DIRECTORS OF THE COMPANY

The running of the business of a company is normally carried out by elected people
among the shareholders of the company. The possession of share normally confers
voting rights on the holders, who is then able to attend the general meetings of the
company. At one the meetings, the shareholders vote for the directors of the company
whose responsibility it is to run the company on behalf of the shareholders. At each
Annual General Meeting (AGM), the directors report on their stewardship, and this
report is accompanied by a set of financial statements and other documents – the
‘annual report’.

THE LEGAL STATUS OF A COMPANY

A limited company is said to possess a ‘separate legal identity’ from that of its
shareholders. It simply means that a company is not seen as being exactly the same as
its shareholders. For instance, a company can sue and by sued. This concept is often
referred to as the veil of incorporation. In a decided case of Saloman vs Saloman & Co
Ltd, a company was formed by Mr. Saloman and runned in the same way as when he
was operating as a sole trader. He received all the profits and made all the decisions.
However, the veil of incorporation meant for the company was treated as completely
separate from him. When the business failed owing a large amount of money, Mr.
Saloman did not have to pay for the business debts personally. The debts were the
responsibility of the company, not of Mr. Salomon.

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TYPES OF CAPITAL

The capital structure of a company can be divided into various types. The commonly
forms of capital of a company are:

1. Ordinary share capital – these are shares which confer the right to receive the
remainder of the total profits available for dividends. There is no upper limit to
the amounts of dividends they can receive. The ordinary shareholders are
referred to as the ‘owners of the business’, and they would ‘sink and swim’ with
the company. In case of company’s failure, the ordinary shareholders bear the
greatest brunt of the loss. The ordinary shares could be divided into nominal
value ranging from N.10 to N10. The ordinary share capital can have any of the
following meanings:
 Authorized share capital – this is the total of the share capital which a company is
allowed to issued to shareholders. The authorized share capital is contained in
the Memorandum and Articles of Association.
 Issued share capital – this is the total of the share capital actually issued to
shareholders. All shares authorized by the Memorandum and Articles of
Association may not be fully issued by the company.
 Called-up capital. Where only part of the amount payable on each issued share
has been asked for, the total amount asked for on all the issued shares is known
as the called-up capital.
 Uncalled capital. This is the total amount which is to be received in future
relating to issued share capital, but which has not yet been asked for.
 Call in arrears. The total amount for which payment has been asked for (i.e.
called for), but has not yet been paid by shareholders.
 Paid-up capital. This is the total of the amount of share capital which has been
paid for by shareholders.

2. Preference shares capital – these shares are another form of capital. They are
meant for shareholders who required a fixed percentage of rate dividend on their
investment. The dividend payment is made before the ordinary shareholders.
This form of capital may appeal to some investors who require less-risky
investment because they are assured of dividend even when the company is
liquidated. There are two main types of preference shares. They are:
 Non-cumulative preference shares. These shareholders receive a dividend
up to an agreed percentage each year. If the amount paid is less than the
maximum agreed amount, the shortfall is lost by the shareholders. The
shortfall cannot be carried forward to a future period.
 Cumulative preference shares. These shares have an agreed rate of dividend
after the declaration of profit by the company. However, any shortfall

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 between the dividend paid, and dividend payable in any year is carried
forward to the next period. These arrears of preference dividends will have to
be paid before the ordinary shareholders receive anything at all.

3. Loan Capital. This form of capital is also referred to as Debenture stock or Loan
notes. This is where a company receives money on loan to finance its
operations and a debenture certificate is issued to the lender. The loan capital
attracts a fixed rate of interest and payable at the end of each financial period. It
should be noted that the interest payable on loan notes is an expense item and
would be charged against the profit and loss account for the period. In essence,
where interest is not paid on debenture in any year, the interest becomes a
liability and would be part of the balance items. The loan notes or loan capital is
normally redeemable at an agreed future dates. Interest on loan notes has to be
paid whether profits are made or not. They are, therefore, different from shares,
where dividends are paid only when a company made a profit. A debenture may
be classified into two:

 Redeemable loan notes or debenture – this is repayable at or by a particular

date, or
 Irredeemable loan notes or debenture – this is normally repayable only when
the company is officially terminated i.e. when going into liquidation. It is
usually referred to as perpetual loan notes or debenture.

The lender in respect of loan notes or debenture will be interested in the safety of his
investment, since he is assured that both the principal loan the accrued interests would
be settled, even when a company is in liquidation. Another attractiveness of the loan
notes or debentures is that it is tied to specific asset of the company. It means that in
the event of company’s failure, the floating asset would be available to the lender for the
settlement of the loan.

COMPANY’S FINANCIAL STATEMENTS

At this stage of our study, it would be essential for us to discuss the various statements
used in reporting the position of a company at any period of time. The CAMA l990
provides that at the end of any accounting period, the directors should present the
company’s financial statements. We shall, therefore discuss the following important
financial statements:

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Income Statements

These statements show the income generated during the period and the expenses of
the period. The name commonly used is ‘trading, profit and loss account’. In recent
term and because of the International Financial Reporting Standards (IFRS), income
statements are preferred. These income statements show the performance of the
company in term of profit added to the business. The more the profit a company made,
the higher the growth of the company and perhaps, added value to the wealth of the
shareholders.

Balance sheet

This statement shows the details of the net worth of the company at the end of each
financial year. The balance sheet is the statement that gives the overall picture of the
state of affairs of a company in terms of its assets and liabilities. The balance sheet are
structured in such a manner to present to the users and readers the opportunity to have
an holistic view of the company and probably used as an informed parameters for taking
business decision.

Illustration of Income Statement and Balance sheet

The following trial balance is extracted from the books of Omolara limited for the period
ended 3lst December, 20X1.

Trial Balance as on 31 december, 20X1

Dr Cr
N N
10% Preference share capital 200,000
Ordinary share capital 700,000

10% loan notes (repayable 20X9) 300,000

Goodwill at cost 255,000

Buildings at cost 1,050,000

Equipment at cost 120,000

Motor vehicles at cost 172,000

Provision for depreciation: building 1.1.20X1 100,000

Provision for depreciation: equipment 1.1.20X1 24,000

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Provision for depreciation: motor vehicles 1.1.20X1 51,600

Inventory 1.1.20X1 84,912

Sales 1,022,000

Purchases 439,100

Carriage inwards 6,200

Salaries and wages 192,400

Directors remuneration 123,000

Motor expenses 3,120

Business rates and insurance 8,690

General expenses 5,600

Loan note interest 15,000

Accounts receivable 186,000

Accounts payable 113,700

Bank 8,390

General reserve 50,000

Share premium 100,000

Interim ordinary dividend paid 35,000

Retained profits 31.12.20X0 43,212

2,704,512 2,704,512

The following information are relevant:

i) Inventory at 31.12.20X1 was N91,413.

ii) Depreciate buildings N10,000; motor vehicles N18,000; equipment N12,000.
iii) Accrue loan note interest N15,000.
iv) Provide for preference dividend N20,000 and final ordinary dividend of 10 per
cent.
v) Transfer N10,000 to general reserve.
vi) Write-off goodwill impairment of N30,000.

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 vii) Authorized share capital is N200,000 in preference shares and N1 million in
ordinary shares.
viii) Provide corporation tax of N50,000.

SOLUTION

Omolara Limited

Income Statement for the year ending 31 december 19X1

N N
Revenue 1,022,000
Less cost goods sold:
Opening inventory 84,912
Add purchases 439,100
Add carriage inwards 6,200
539,212
Less Closing inventory (91,413)
(438,799)
Gross profit 583,201
Less Expenses:
Salaries and wages 192,000
Motor expenses 3,120
Business rates and insurance 8,690
General expenses 5,600
Directors’ remuneration (Note A) 123,000
Loan note interest (Note B) 30,000
Goodwill impairment 30,000
Depreciation: Buildings 10,000
Equipment 12,000
Motor vehicles 18,000
(432,810)

Profit for the year before taxation 150,391

Less: Corporation tax (50,000)
Profit after taxation 100,391
Dividend paid (ordinary share capital) ( Note C) (35,000)
Retained profits for the year 65,391
Retained profit b/f 43,212

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Retained profit c/f 108,603

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Notes
(A) Directors’ remuneration is shown as an expense in the income statement.
(B) Loan note interest is an expense to be shown in the income statement.
(C) The final dividend of 10 per cent is based on the issued ordinary share capital
and not on the authorized ordinary share capital. It is therefore, N70,000. However,
both it and the preference dividend of N20,000 should only be included as notes to
the income statement. They should be treated as current liabilities and should not
appear in both income statement and the balance sheet even as a liability. Only
interim dividend paid during the year would appear in the income statement as a
reduction in the equity shareholders’ fund.

ISSUES OF SHARES AND DEBENTURE

It is very important at this stage of our study to deal extensively on the issues of shares
and debenture. This will enable us understand the various steps involved when shares
and debentures are issued to the public. It will also allow the students to understand
the accounting treatment in relation to the issue of shares and debenture.

Issue of shares

When shares are issued, they may be payable, either immediately on application, or by
installments.

Issues of shares may take place on the following terms connected with the price of the
shares:

1. Shares issued at par. This means that a share of N1 nominal value would be
issued for N1 each.
2. Shares issued at a premium. In this case a share of N1 nominal value would be
issued for more than N1 each, say for N1.50 each.
3. Shares issued at a discount. This means that a share of N1 nominal value could
be issued for less than the par value, say N0.50 each.

Reasons for issuing share at a premium and at a discount.

Shares may be issued at a premium if the value of the company as reflected in its
performance, has greatly improved over the years, i.e. its value per share is enhanced.
In this situation, when a new investor is interested in acquiring the shares, a premium
could be added to give effect to the growth of the business. In the same vein, where a
company performance is declining as evident from the valuation of its assets, a
reduction in the par value of the share could be made to give effect to the declining

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fortune of the company and to also induce investors to purchase shares in the
company.

Issues of shares payable by installments

Shares could also be paid for on installment basis instead of paying for the shares at
once. This is more common in relation to the shares in public companies. It should be
noted that a public company is not allowed to allot a share unless a sum equal to at
least one-quarter of its nominal plus the whole of any premium has been paid on it.
Where the premium on the shares are large compared to the nominal value, this will
clearly affects the manner in which the installments are divided. The various stages,
after the initial invitation has been made to the public to buy shares by means of
advertisements (if it is a public company) etc. are as follows:

a) Applications are received together with the application monies.

b) The applications are vetted and the shares allotted, letters of allotment being
sent out.
c) The excess application monies from wholly unsuccessful applicants, or, where
the application monies received exceed both the application and allotment
monies required, from wholly and partly unsuccessful applicants, are returned to
them. Usually, if a person has been partly unsuccessful, his excess application
monies are held by the company and will reduce the amount needed to be paid
by him on allotment.
d) Allotment monies are received.
e) The next installment, known as the first call, is requested.
f) The monies are received from the first call.
g) The next installment, known as the second call, is requested.
h) The monies are received from the second call.

The reasons for the payments by installments become obvious if it is realized that a
company will not necessarily require the immediate use of all the money to be raised by
the issue. A decision may be made to match the timing of the payment of the
installments of the share issue to the timing of the requirement for funding. If so, the
share issue may be on the following terms:

Application money per share, payable immediately 10%

Allotment money per share, payable within 1 month 20%
First call, money payable in 12 months’ time 20%
Third call, money payable in 24 months’ time 30%
100%

The accounting entries in the share capital account should equal the amount of money
requested to that point in time. However, instead of one share applicants account

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opened when shares are paid for in full at once, there are usually several accounts each
representing one of the installments. For this purpose, application and allotment
accounts are usually opened to record the shares paid in installment basis. Therefore,
instead of refunding the excess monies paid on application the excess is used to meet
subsequent installments. It must be appreciated that instead of receiving all the amount
reasonable for the full price of the shares to be call for installmentally.

Illustration

A company is issuing 100,000 7% preference shares of N1 each, payable 10% on

application, 20% on allotment, 40% on the first call and 30% on the second call.
Applications are received for 155,000 shares. A refund of money is made in respect of
the 5,000 shares while, for the remaining 150,000 shares applied for, an allotment is to
be made on the basis of 2 shares for every 3 applied for (assume that this will not
involve any fractions of shares). The excess application monies are set off against the
allotment monies asked for. The remaining requested installments are all paid in full

Solution

Bank

Application and allotment: N N

Application monies 15,500 Application and allotment (Refund) 500

(N100,000 x 20% less excess

Application monies N5,000) 15,000

First call 40,000

Second call 30,000

Application and Allotment

N N

Bank refund of application monies 500 Bank 15,500

Preference share capital 30,000 Bank 15,000

30,500 30,500

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 First Call

N N

Preference share capital 40,000 Bank 40,000

Second Call

Preference share capital 30,000 Bank 30,000

7 per cent Preference Share Capital _____

Balance c/d 100,000 Application and Allotment 30,000

First Call 40,000
Second call 30,000
100,000 100,000
Balance b/d 100,000
Forfeited shares
There may be situations where some shareholders fail to pay the calls requested for on
their allotted shares on application. The articles of association, if well drawn up should
provide that the defaulting shareholders forfeits the shares allocated. When a
shareholder fails to pay for its call, the shares will be cancelled. The installments
already paid by the shareholder will be forfeited and retained in the company. After the
forfeiture, the company may or may not reissue the shares. There are regulations
governing the prices at which such shares can be reissued. The amount received on
reissue plus the amount received from the original shareholders should at least equal
the call-up value where the shares are not fully called up, or the nominal value where
the full amount has been called up. Any premium previously paid is disregarded in
determining the minimum reissue price.

Illustration

Let us use the same illustration above with the facts that all the calls being paid in full.
Shareholder A, the holder of 10,000 shares, fails to pay the first and second calls. He
had already paid the application and allotment monies on the required dates. The
directors conform to the provisions of the Articles of Association and shareholder A is
forced to suffer the forfeiture of his shares; also the amount still outstanding from
shareholder A will be written off; and the Directors when reissue the shares at 75 per
cent of nominal value to shareholder D and he pays for the shares in full.

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 First Call
N N
Preference share capital 40,000 Bank 36,000
Forfeited shares 4,000
40,000 40,000

Second Call
N N
Preference share capital 30,000 Bank 27,000
Forfeited shares 3,000
30,000 30,000

7 per cent Preference Share Capital

N N
Forfeited shares 10,000 Application and allotment 30,000
Balance c/d 90,000 First call 40,000
Second call 30,000
100,000 100,000
Balance c/d 100,000 Balance b/d 90,000
Shareholder D 10,000
100,000 100,000
Balance b/d 100,000

Forfeited Shares
N N
First call 4,000 preference share capital 10,000
Second call 3,000
Balance c/d 3,000
10,000 10,000

Bank
N N
First call (N90,000 x 40%) 36,000
Second call (N90,000 x 30%) 27,000
Shareholder D 7,500

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 Shareholder D
N N
Preference share capital 10,000 Bank 7,500
___ Forfeited shares (discount on reissue) 2,500
10,000 10,000

Note:
The transfer of N2,500 from the forfeited account to with D’s account is needed
because the reissue was entered in the preference share capital account. Therefore the
transfer of N2,500 is to close off Shareholder D’s account in the books of the company.

CHANGES IN CAPITAL STRUCTURE

A limited company may alter its share capital in any of the following manners if
permitted by the Articles of Association and within the legal framework:

1. Increase its share capital by issuing new shares, e.g. increase authorized share
capital from N500,000 to N1 million and then issue more shares.
2. Consolidate and divide all or any of its share capital into shares of a larger
nominal value than its existing shares, for example, convert 500,000 ordinary
shares of N1 each into 100,000 ordinary shares of N5 each.
3. Change all or any of its paid-up shares into debentures, and reconvert those
debentures into shares of any denomination, e.g. convert 100,000 ordinary
shares of N1 each into 100,000 ordinary shares of N5 each.
4. Subdivide all, or any, of its shares of smaller denominations, e.g. convert 1
million ordinary shares of N1 each into 2 million ordinary shares of N0.50 each,
or 4 million ordinary shares of 25kobo each.
5. Cancel shares which have not been taken up. This is known as ‘diminution of
capital’, and is not to be confused with ‘reduction in capital’. A company with an
authorized share capital of N200,000 and an issued share capital of N175,000
can alter its share capital to authorized share capital of N175,000 and issued
share capital of N175,000.

BONUS SHARES
Also there could be changes in the capital structure of a company by the issue of bonus
shares to the existing shareholders free of charge. This issue is always from the
retained profit of a company. Another name given to this share is ‘scrip issue’. The
following may also be applied in the issuing of bonus shares:
1. The balance of the profit and loss appropriation account.
2. Any other revenue reserve.
3. Any capital reserve, e.g. share premium.

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RIGHT ISSUE

Another way of altering the share capital of a company is by the issue of right issue of
shares. The right issue is to existing shareholders at a price lower than the ruling
market price of the shares. The right issue is priced lower in order to compensate the
existing shareholders for the reduction in value of shares held previously. The price at
which the shares of a very profitable company are quoted on the stock exchange is
usually higher than the nominal value of the shares. For example, the market price of
the shares of a company might be quoted at N2.50 while the nominal value per share is
only N1.00. if the company has 800,000 shares of N1 each and declares a right issue
of one for every eight held at a price of N1.50 per share, it is certain that it will be
cheaper for the existing shareholders to buy the right issue at this price instead of
buying the same shares in the open market for N2.50 per share. Assume that all the
right issue were taken up, then the number of shares taken up will be 100,000 (i.e.
800,000 divided by 8),and the amount paid for them will be N150,000 and the journal
entries will be:

Journal Dr Cr

N N
Cash 150,000
Share capital 100,000
Share premium 50,000
Being the rights issue of 1 for every 8 shares held at a price of
N1.50 nominal value being N1.00.

As the nominal value of each share is N1.50 was paid, the extra 50kobo constitutes a
share premium to the company. Note also that the market value of the shares will be
reduced or ‘diluted’ by the rights issue as was the case for bonus shares. Before the
right issue there were 800,000 shares at a price of N2.50, giving a market capitalization
of N2 million. After the rights issue there are 900,000 shares and the assets have
increased by N150,000. The market value may now be N2.39 i.e. N2 million divided by
900,000 shares, although the precise market price after the right issue will be influenced
by the information given surrounding the sale about the future prospects of the company
and may not be exactly the N2.39 calculated above.

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REDUCTION OF CAPITAL
There may be situations where a company’s capital may be reduced. The following are
reasons for

1. Where capital is not represented by assets

2. Where some of the assets are no longer needed.

When a reduction in capital is being contemplated, it must go through legal processes

and must receive the consent of the court. Capital reduction means that the share
capital has been subjected to a lessening of its nominal value, or of the called-up part of
the nominal value. Thus:

(a) A N4 share might be converted to N3.

(b) A N5 share might be converted to N1

As earlier discussed, the reason for reduction in capital may be that the share capital is
not fully represented by the assets. For example, R Ltd may have a balance sheet for a
period as follows:

Net Assets N300,000

Ordinary share capital
100,000 ordinary shares of N5 each, fully paid N500,000
Profit and loss (N200,000)
N300,000

The net assets as shown at N300,000, and it is felt that the book value represents a true
and fair view of their actual value. The company will be prevented from paying dividend
to shareholders because it is making a loss. One of the reasons for purchasing shares
is to expect dividend payout as income on investment. Suppose, the company is now
making a profit after tax of N30,000 per annum, it will take about seven years before
dividend could be paid and this will have effect on the morale of the shareholders and
also the future prospect of the company. The best approach to this issue is to reduce
the capital which was no longer represented by the assets. In this case, N200,000 of
the share capital cannot lay claim to any assets. The share capital should therefore be
reduced by N200,000. This is done by converting the shares into N3 shares fully paid
instead of N5 shares. The balance sheet after the reduction would then be:

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 N

Net assets 300,000

Ordinary share capital 300,000

It is now seen that there will be no debit balance in the profit and loss account of the
company and N30,000 profit will be available for distribution as dividend to the
shareholders. In capital reduction both the preference and debenture holders are also
involved. Even creditors of the company can also occasionally sacrifice part of the
amount owing to them. The idea therefore is that the increase in working capital could
help the company to achieve the desired growth and in which case the creditors hope to
once again enjoy the profitable contact that they used to have with the company.
Capital reduction schemes are matters for negotiation between the various interested
parties. For example, preference shareholders may be quite content for the nominal
value of their shares to be reduced if the rate of interest they receive is increased
accordingly. As with any negotiation, the various parties will put forward their points of
view and discussions will take place until a compromise solution is reached. The
accounting entries of reduction in capital could be appreciated from the following journal
entries:

1 For amounts written off assets:

Dr Capital Reduction Account
Cr Various Assets Accounts
2 For reduction in liabilities (e.g. creditors):
Dr liability accounts
Cr Capital reduction account
3 The reduction in the share capital:
Dr Share capital accounts (each type)
Cr Capital reduction account
4 If a credit balance now exists on the capital reduction account:
Dr Capital reduction account (to close the account)
Cr Capital reserve

It should be noted that it is unlikely that there would be a debit balance on the capital
reduction account.

Where, of course, some of the assets of the company are no longer needed because of
a contraction in the company’s activities, a company may find itself with a surplus of
liquid assets. Subject to the legal formalities being observed, in this case the reduction
of capital is effected by returning cash to the shareholders. For example:

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 1 Dr Share capital account (with amount returnable)
Cr Sundry shareholders.

2 Dr Sundry shareholders
Cr Bank (amount actually paid)

This scheme may be objected to by the creditors particularly if their interests are
affected.

PRACTICE QUESTIONS

1. Peju limited has a nominal share capital of N200,000 comprising 200,000

ordinary shares of N1 each. The whole of the capital was issued at par on the
following terms:
Per share
Payable on application 15kobo
Payable on allotment 20kobo
First call 30kobo
Second call 35kobo

Applications were received for 250,000 shares and it was decided to allot the shares on
the basis of four for every five for which applications had been made. The balance of
application monies was applied to the allotment, no cash being refunded. The balance
of allotment monies was paid by the members. The calls were made and paid in full by
the members, with the exception of one who failed to pay the first and second calls on
the 1,000 shares allotted to him. A resolution was passed by the directors to forfeit the
shares. The forfeited shares were later issued to Funke at 80kobo each.

Show the ledger accounts recording all the above transactions, and the relevant
extracts from a balance sheet after all the transactions had been completed.

2. During the year to 30 September, 2007, Kudi plc made a new offer of shares.
The details are shown below:

a. 100,000 ordinary shares of N1 each were issued payable in installments

as follows:

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 Per share

On application a 1 November 2006 0.65

On allotment (including the share premium
Of N0.50 per share) on 1 December 2006 0.55
On first and final call on 1 June 2007 0.30
1.50

b. Applications for 200,000 shares were received and it was decided to deal
with them as follows:
> to return cheques for 75,000 shares

> to accept in full applications for 25,000 shares, and

> to allot the remaining shares on the basis of three shares for every four shares
applied for.

c. on the first and final call, one applicant who had been allotted 5,000
shares failed to pay the due

amount, and his shares were duly declared forfeited. They were then reissued to Abike
ltd on 1 September, 2007 at a price of N0.80 per share fully paid. Kudi ltd issued share
capital on 1 October 2006 consisted of 500,000 ordinary shares of N1 each.

Required:

Record the above transactions in the following ledger accounts:

(a) Ordinary share capital

(b) Share premium
(c) Application and allotment
(d) First and final call
(e) Forfeited shares and
(f) Abike Ltd’s account.

3 Derin Limited decided to reorganize its finances. On 31 December 2005 a

final trial balance extracted from the books showed the following position:

19
 N N
Share capital, authorized and issued:
150,000 6 per cent cumulative preference share
of N1 each 150,000
200,000 ordinary shares of N1 each 200,000

Profit and loss account 114,375

Preliminary expenses 7,250
Goodwill (at cost) 55,000
Trade creditors 43,500
Debtors 31,200
Bank overdraft 51,000
Leasehold property (at cost) 80,000
(provision for depreciation) 30,000
Plant and machinery (at cost) 210,000
(provision for depreciation) 62,500
Stock in hand 79,175
577,000 577,000

Approval of the court was obtained for the following scheme of capital reduction of
capital:
1. The preference shares to be reduced to N0.75 per share
2. The ordinary shares to be reduced to N0.125 per share
3. One N0.125 ordinary share to be issued for each N1 of gross preference
dividend arrears; the preference share dividend had not been paid for three
years.
4. The balance on share premium account to be utilized.
5. The plant and machinery to be written down to N75,000.
6. The profit and loss account balance and all intangible assets, to be written off.

At the same time as the resolution to reduce capital was passed, another resolution was
approved restoring the total authorized capital to N350,000, consisting of 150,000 6 per
cent cumulative preference shares of N0.75 each and the balance in ordinary shares of
N0.125 each. As soon as the above resolution had been passed 500,000 ordinary
shares were issued at par, for cash, payable in full upon application.

You are required:

(a) To show the journal entries necessary to record the above transactions in the
company’s books; and
(b) To prepare a balance sheet of the company; after completion of the scheme.

20
 4 The ledger balances of Tolulope Ltd at 31 March 2001 were as follows:

Freehold premises 90,000

Plant 300,000
Stock 82,000
Debtors 96,000
Development expenditure 110,000
Cash at bank 11,000
Profit and loss (debit balance) 121,000
250,000 8 per cent preference shares of N1 each 250,000
500,000 ordinary shares of N1 each 500,000
Creditors 60,000
A capital reduction scheme has been sanctioned under which 250,000 preference
shares are to be reduced to 80kobo each, fully paid; and the 500,000 ordinary shares
are to be reduced to 20kobo each, fully paid. Development expenditure and the debit
balance on profit and loss account are to be written off, the balance remaining being
used to reduce the book value of the plant.

Required:

Prepare the journal entries recording the reduction scheme and the balance sheet as it
would appear immediately after the reduction. Narrations are not required in connection
with journal entries.

21
UNIT 3

DISSOLUTION OF PARTNERSHIP

We may need to discuss briefly what a partnership is before delving into dissolution of
partnership. A partnership is formed when two or more people joined together to form a
business. A partnership has the following characteristics:

1. It is formed to make profits.

2. It must obey the law given in the partnership act 1890.
3. Normally there can be a minimum of two partners and a maximum of twenty
partners.
4. Each partner (except for limited partners, described below) must pay their share
of any debts that the partnership could not pay. If necessary, they could be
forced to sell all their private possessions to pay their share of the debts. This
can he said to be unlimited liability.
5. Partners who are not limited partners are known as general partners.

Reasons for dissolution of partnership

(a) Insolvency of partnership i.e. inability to continue because the partnership cannot
meet its financial obligations.
(b) A decision of the partners not to continue, in order perhaps that each may go his
own way.
(c) Where one of the partners owes money to the partnership in dissolution and
unable to pay.

Realization Account

In dissolution of partnership, it is mandatory to realize all the assets of the partnership

for distribution to all the partners. In this respect a realization account is opened for the
disposal of the assets. The dissolution of a partnership involves the disposal of the
assets. Inevitably the amounts realized may differ from the book value and a profit or
loss will certainly occur. The bookkeeping entries in a realization account will be:

(a) Debit the realization account with the book value of the assets being realized.
(b) Credit the realization account with the creditors who will be paid off.
(c) Debit the realization account with the amount paid to creditors.
(d) Credit the realization account with the proceeds of disposal of the assets.
(e) Distribute the overall difference (profit or loss) among the partners in the profit
sharing ratio.
(f) Complete the dissolution by paying to partners the balances on their
capital/current accounts.

22
Illustration

The balance sheet of Wura and Funmi at 31/12/2004 showed: N

Fixed assets 14,000

Current assets:
Stock 6,800
Debtors 4,750
Cash 150
25,700
Liabilities:
Capital accounts: Wura 10,000
Funmi 9,000
Current accounts: Wura 1,500
Funmi 1,700
Sundry creditors 3,100
25,700
The partnership was dissolved at 31/1/2005.

a. The motor vehicles included in the fixed assets were taken up by the partners at
agreed values as Wura N2,000, and Funmi N3,000.
b. The remainder of the fixed assets were sold for N12,000.
c. The stock was sold at auction for N4,300.
d. The debtors realized N4,600.
e. The creditors were paid off less a 5% discount.
f. Expenses of realization were N250.
g. The profit sharing formula is: 10% interest on capital, balance 3:2

Show the relevant accounts to give effect to the dissolution.

Solution
Realization Account
N N
Fixed assets 14,000 Car taken by Wura 2,000
Stock 6,800 Car taken by Funmi 3,000
Debtors 4,750 Proceeds of fixed assets 12,000
Creditors 2,945 proceeds sales of stocks 4,300
Expenses 250 Debtors 4,600
Profit on realization: creditors 3,100

23
 Wura 153
Funmi 102 255
29,000 29,000
Cash account
N N
Balance b/d 150 Creditors 2,945
Proceeds from fixed assets 12,000 Expenses 250
Proceeds from stocks 4,300 Wura 10,053
Proceeds from debtor 4,600 Funmi 7,802
21,050 21,050

Capital account

Wura Funmi Wura Funmi

N N N N
Cars taken over 2,000 3,000 Capital b/f 10,000 9,000
Cash 10,053 7,802 Current a/cs b/f 1,900 1,700
Share of profit on
realization of asset 153 102

12,053 10,802 12,053 10,802

Notes
a. Assets to be realized are debited to realization account.
b. The proceeds of the realization are credited to realization accounts and debited
to cash or in the case of partner’s cars to the partners capital accounts.
c. Creditors are usually put through the realization account if a profit or loss is
involved, as here.
d. There are often some expenses of realization.
e. The profit or loss is shared between the partners in their profit sharing ratio – the
interest on capital part of the formula is irrelevant as no effluxion of time is
involved.
f. The capital account and current accounts are pooled together in a dissolution
since their difference is no longer relevant. As a going concern capital accounts
are not payable to partners as they are permanent capital. Current accounts are
payable to partners as they are undrawn profits.

24
Garner v Murray Rules

The principles in Garner v Murray require that in the event of one partner is having a
debit balance in his current/capital accounts, the other partner will have to bear the loss
suffered by the partner who is in debit. In a decided case of Garner v Murray the court
ruled that, subject to any agreement to the contrary, such a deficiency was to be shared
by the other partners not in their profit sharing ratios but in the ratio of their ‘last agreed
capitals’. It means that the credit balances on the capital accounts of the solvent
partners will be used to determine the ratio of sharing the losses made by the insolvent
partner. Where a partnership deed is drawn up it is commonly found that agreement is
made to use normal profit and loss sharing ratios instead, thus rendering the Garner v
Murray rule in operatives.

Illustration

After the completion of the realization of all the assets in respect of a partnership a loss
of N14,000 was incurred, but before making the final payments to the partners, the
balance sheet appears:

Balance Sheet
N N
Cash at bank 91,000
Capitals: R 66,000
S 18,000
T 8,000
92,000
Less Q (debit balance) (1,000)
91,000

According to the last balance sheet drawn up before the dissolution, the partners’
capital account credit balances were: Q N5,000; R N70,000; S N20,000; T N10,000;
while the profits and losses were shared Q3:R2:S1:T1. Q is unable to meet any part of
his deficiency. Under the Garner v Murray rule, each of the other partners suffers the
deficiency as follows:
Own capital per balance sheet before dissolution
Total of all solvent partners’ capitals per same balance sheet x Deficiency

25
This can now be calculated.

R N70,000 x N1,000 = N700

N70,000 + N20,000 +N10,000

S N20,000 x N1,000 = N200

N70,000 + N20,000 +10,000

T N10,000 x N1,000 = N100

N70,000 + N20,000 + N10,000

When these amounts have been charged to the capital accounts, then the balances
remaining on them will equal the amount of the bank balance. Payments may therefore
be made to clear their capital accounts.

Credit balance share of deficiency final credit

b/d now debited balances
N N N
R 66,000 700 = 65,300
S 18,000 200 = 17,800
T 8,000 100 = 7,900
Equals the bank balance 91,000

Piecemeal Realization of Assets

Sometimes the assets may take a long time to be turned into cash, i.e. assets to be
realized. The partners will naturally want payments made to them on account as cash
is received. They will not want to wait until the dissolution is completed just for the
convenience of the accountant. There is, however, a danger that if too much is paid to
a partner, and he is unable to repay it, then the person handling the dissolution could be
placed in a very awkward position. To employ a rational approach, the concept of
prudence is brought into play. This is done as follows:

(a) Each receipt of sales money is treated as being the final receipt, even though
more could be received.
(b) Any loss then calculated so far to be shared between partners in profit and loss
sharing ratios.
(c) Should any partner’s capital account after each receipt show a debit balance,
then he is assumed to be unable to pay in the deficiency. This deficit will be
shared (failing any other agreement) between the partners using the Garner v
Murray rule.

26
 (d) After payments of liabilities and the costs of dissolution the remainder of the cash
is then paid to the partners.
(e) In this manner, even if no further money were received, or should a partner
become insolvent, the division of the available cash would be strictly in
accordance with the legal representations. Let us use the illustration below to
demonstrate the piecemeal realization of the assets prior to the conclusion of
dissolution of partnership.

Illustration

The following is the summarized balance sheet of H, I, J and K as at 31 December,

2008. The partners had shared profits in the ratios H6: I4:J1:K1.

Balance Sheet as at 31 December, 2008

N
Assets 84,000
Accounts payable (18,000)
66,000
Capitals:
H 6,000
I 30,000
J 20,000
10,000
66,000

On 1 March 2009 some of the assets were sold for cash N50,000. Out of this the
creditors’ N18,000

and the cost of dissolution N800 are paid, leaving N31,200 distributable to the partners.
On 1 July 2009 some more assets are sold for N21,000. As all of the liabilities and the
costs of dissolution have already been paid, the whole of the N21,000 is available for
distribution between the partners. On 1 October 2009 the final sales of the assets
realized N12,000.

First distribution: 1 March 2009 H I J K Total

N N N N N
Capital balances before dissolution
Loss is no further assets realized:
Assets N84,000 – Sales N50,000 =
N34,000 + costs N800 = N34,800 loss
Shared in profit/loss ratios (17,400) (11,600) (2,900) (2,900) (34,800)

27
 11,400Dr 18,400Cr 17,100Cr 7,100Cr 31,200
H’s Deficiency shared in Garner v
Murray ratios 3/6(5,700) 2/6(3,800) 1/6(1,900)
Cash paid to partners 12,700 13,300 5,200 31,200

Second distribution: 1 July 2009 H I J K Total

N N N N N
Capital balance before dissolution 6,000 30,000 20,000 10,000 66,000
Loss if no further assets realized:
Assets N84,000 – sales (N50,000 +
N21,000) = N13,000 + costs N800
= N13,000 loss
Loss shared in profit/loss ratios (6,900) (4,600) (1,150) (1,150) (13,800)
900Dr 25,400Cr 18,850Cr 8,850Cr 52,500
H’s deficiency shared in Garner v Murray
Ratios 3/6(450) 3/6(300) 1/6(150)
24,950 18,550 8,700
Less: first distribution already paid (12,700) (13,300) (5,200) 31,200
Cash now paid to partners 12,250 5,250 3,500 21,000

Third and final distribution: 1 Oct 2009 H I J K Total

N N N N N
Capital balance before dissolution 6,000 30,000 20,000 10,000 66,000
Loss finally ascertained: assets (N84,000
- Sales (N50,000 + N21,000 +N12,000)
= N1,800 loss
Loss shared in profit sharing ratios (900) (600) (150) (150) (1,800)
5,100Cr 29,400Cr 19,850Cr 9,850Cr 64,200

(No deficiency now exists on any

Capital account)
Less first and second distributions ____ (24,950) (18,950) (8,700) 52,200
Cash now paid to partners 5,100 4,450 1,300 1,150 12,000

28
Practice questions
1. Peju and Bisi, who share profits and losses equally, decide to dissolve their
partnership as at 30 June 2001. Their balance sheet on that date was as follows:
N N

Buildings 80,000
Tools and fixtures 2,900
82,900
Accounts receivable 8,400
Cash 600
9,000
91,900
Sundry accounts payable 4,100
87,800
Capital account: Poole 52,680
Burns 35,120
87,800

The accounts receivable realized N8,200, the buildings N66,000 and the tools and
fixtures N1,800. The expenses of dissolution were N400 and discounts totaling N300
were received from creditors.
Required:

Prepare the accounts necessary to show the results of the realization and of the
disposal of the cash.

2. The following trial balance has been extracted from the books of Ganiyat and
Muinat as at 31 March, 2008; Ganiyat and Muinat are in partnership sharing
profits and losses in the ratio 3 to 2:

N N
capital accounts:
Ganiyat 10,000
Muinat 5,000
Cash at bank 1,550
Account payable 500
Current accounts:
Ganiyat 1,000
Muinat 2,000
Accounts receivable 2,000

29
 Land and buildings 30,000
Fixtures and fittings 2,000
Motor vehicles 4,500
Depreciation: fixtures & fittings 1,000
Motor vehicles 1,300
Net profit (for the year to 31 March 2008) 26,250
Inventory, at cost 3,00
45,050 45,050

In appropriating the net profit for the year, it has been agreed that Muinat should be
entitled to a salary of N9,750. Each partner is also entitled to interest on his opening
capital account balance at the rate of 10 per cent per annum. Ganiyat and Muinat
have decided to convert the partnership into a limited company, Platini Limited, as
from 1 April 2008, the Company is to take over all the assets and liabilities of the
partnership, except that Ganiyat is to retain for his personal use one of the motor
vehicles at an agreed transfer price of N1,000. The purchase consideration will
consist of 40,000 ordinary shares of N1 each in Plain Limited, to be divided between
the partners in profit sharing ratio. Any balance on the partners current accounts is
to be settled in cash.

You are required to:

Prepare the main ledger accounts of the partnership in order to close off the books
as at 31 March 2008.

30
UNIT 4

BRANCH ACCOUNTS

A branch is a segment of unit of a business organization not located witching the

same premises as the main office or head office. Branches fall into 3 categories namely:

1) Non independent or dependent branches

2) Independent branches

3) Foreign branches

Non-Independent Branches

A non-independent branch is a branch in which the head office sends the whole
or most of the goods sold by the branch to it. The goods are to be sent to the branch at
a transfer price which may be any of the following:

a) Cost

b) Cost plus mark-up or

c) Selling price

a) Cost Method

Under this method, the head office invoices, goods to the branch at cost. When
this method is used, the following accounts should be maintained for branch
transactions:

i) Branch stock account – all entries on this account, except branch

sales, are at cost and branch gross profit will also be ascertained on
this account.

ii) Goods sent to branch account – this account shows the cost of
goods sent to the branch less cost of goods returned to the head
office and all entries here are at cost.

iii) Branch debtors account – for branch credit sales.

31
 iv) Branch expenses account – shows the expenses incurred by or on
behalf of the branch.

v) Branch P & L – shows the net profit of the branch.

b) Cost Plus Mark-Up Method

Here, the head office invoices goods to the branch at a transfer price which
is cot plus a profit loading referred to as mark-up.

When using this method, the following accounts shall be maintained for the
branch:

i) Branch stock account – All entries in this account, except branch

sales and allowances off selling prices, are at transfer price. This
account also records the movement of stock in the branch.

ii) Goods sent to branch performs the same role as in cost method.

iii) Branch stock Adjustment/Mark-up account records profit loading on

goods. The opening and closing balances on this account
respectively represent the unrealized profit on the opening and
closing stock at the branch and the balancing figure represents the
branch profit and loss.

iv) Branch debtors’ accounts – same as in cost method

v) Branch expenses account – same as in cost method

vi) Branch P & L account – same as in cost method

c) Selling Price Method

In this case, the head office charges goods to the branch at a transfer price
which is the selling price.

The following accounts are required when adopting this method:

i) Branch stock account: same as in cost plus mark-up method

ii) Goods sent to branch account: serves as a contra account to branch

stock account.

32
 iii) Branch debtors account: same as in other methods.

iv) Branch expenses account: same as in other methods.

v) Branch trading account: shows the gross profit of the branch

vi) Profit and loss account: performs the same role as in other methods.

INDEPENDENT BRANCHES

An independent branch is a self-accounting branch i.e. it is a branch that

maintains its own accounting records. At the end of the year, its accounts are
consolidated with the head office and other branches.

The following should be noted:

Current Accounts:

The link between the head office and the branch is the current account
maintained at both ends. The branch current account will normally have a debit
balance while the head office current account will normally have a credit balance.

Remittance Account:

This is sometimes maintained along with a current account but strictly for
money remittance between the branch and head office.

Items in Transit:

There could be disparity between the current accounts of the head office
and the branch due to stock in transit or cash in transit.

Unrealized Profit on Branch Stock:

Where goods are sent to the branch at the cost plus profit loading, the
profit element added thereto cannot be regarded as realized until the goods are
sold, therefore should be adjusted for.

Form of the Final Accounts:

The trading and profit and loss accounts are normally prepared on
columnar basis while only the combined balance is necessary except the
examiner requests otherwise.

33
FOREIGN BRANCHES

A foreign branch is an independent branch located in a country other than

the one in which the head office is located.

The three main methods of translation of the accounts of foreign

operations in accordance with SAS 7 are:

a) Closing rate method: Here, all the assets and liabilities are translated
at the rate ruling at the balance sheet date. Also referred to as
current rate method. Profit and loss items should be translated at the
exchange rate at the date of transaction or average rate.

b) Temporal method: Under this, current assets and liabilities are

translated at the rare ruling at the balance sheet date while non-
current assets and liabilities are translated at the applicable historical
rate at the dates they were acquired or incurred.

c) Monetary and non-monetary method: In this case, monetary assets

and liabilities are translated at the rate ruling at the balance sheet
date and non-monetary assets and liabilities at the historical rates
ruling at the dates they were acquired or incurred. Assets and
liabilities are regarded as monetary if their nominal values are fixed.
All other balance sheet items are classified as non-monetary.

Illustration on Department Branch:

Sokotoyokoto store operates from a head office in Lagos and a branch in

Ibadan. Goods are sent to the branch at cost plus mark-up of 25% which is the
branch selling price. The following are details of the Ibadan branch transactions
for the year ended 30th April, 2005.

Opening stock at branch at selling price 750,000

Goods sent to branch at selling price 6,750,000

Goods returned to head office by branch at selling price 675,000

Good returnable to head office by branch customers (All at

Normal selling prices) 150,000

34
Credit sales 4,500,000

Cash sales 1,440,000

Authorized allowances off selling prices 60,000

Good returned to branch by branch customers 300,000

Cheques/cash received from branch customers 3,000,000

Cash discount allowed to branch customers 150,000

Branch debt written off 120,000

Branch sundry expenses paid by head office 375,000

Cash stolen at branch 75,000

Goods stolen at branch at selling price 225,000

Closing stock at branch at selling price 825,000

Required:

Show the above transaction in a ledger using cost method, cost-plus

method and selling price method.

Question on Independent Branch:

A trading business, Ekusefa Enterprises, with Head Office in Ikoyi operates

a branch shop in Jalingo. The final balances as at 30th April, 2007 were:

Debits Head Office (Ikoyi) Branch (Jalingo)

N N

Fixed assets (at WDV) 38,000 15,400

Stocks at 1/05/06

- Head office (at cost) 28,000

- Brach (at transfer price) 17,000

35
Debtors 17,448 3,904

Bank and Cash 30,614 5,768

Purchases 195,900

Remittances to Ikoyi 112,860

Goods from Ikoyi (at transfer price) 69,940

General expenses 34,000 20,000

Janlingo branch Current Account 126,532

Total 470,494 244,872

Credits

Goods at Jalingo (at transfer price) 71,540

Remittance from Jalingo 112,380

Sales 194,020 119,400

Creditor 16,234 540

Ikoyi Current Accounts 124,932

Capital at 1/05/06 74,620

Provision for Unrealized profit on stocks on 1/05/06 1,700

Total 470,494 244,872

a) Ikoyi Invoices goods supplied to Jalingo branch at cost plus one-fifth.

b) At 30th April, 2007:

N
Stocks at head office (at cost) 75,400

36
 Stocks at branch (at transfer price) 9,600

Stocks in transit (at transfer price) 1,600

Cash in transit to head office 490

c) Provide for depreciation on fixed assets at 20% per annum on reducing balance.

Required:

Prepare a trading profit and loss account for the year ended 30th April 2007 and a
balance sheet at that date, separately for :

i) Head office ii) Branch iii) Combined

Question on Foreign Branch:

Multicultural Nigeria limited commenced business on 1 September, 2008

with the head office in Abuja, Nigeria and a branch in Dakar, Senegal for the
‘aboniki’ ointment exported to that country.

All ‘aboniki’ ointment are sent to Dakar at cost plus 25%.

The trial balance of the head office and branch at 31st August, 2008 were
as follows:

Abuja Head office Dakar Branch

N‘000 N‘000 N‘000 N‘000

Share capital 800,000

General Reserves 100,000

Profit and Loss Account 70,000

Creditors 88,500 246,624

Premises at Cost 450,000

37
Fixtures and fittings at cost 294,000 1,680,000

Provision for depreciation on

Fixtures and fittings 119,200

Stock at 1/10/07 287,572

Debtors 253,882 702,048

Bank 201,876 541,584

Cash 19,642 172,008

Sales 2,021,572 4,322,680

Purchases 1,173,070

Goods sent to branch 270,400

Current account with Abuja 3,130,000

Current account with Dakar 338,000

Provision for unrealized profit 67,600

Goods received from head office 3,130,000

Remittance from branch 220,000

Remittance from head office 2,587,000

Advances to branch 200,000 2,080,000

Administrative expenses 374,256 570,346

Distribution expenses 164,974 396,318

Total 3,757,272 3,757,272 9,779,304 9,779,304

You are given the following additional information:

i) Stock on hand at 31st August, 2008 were:

Abuja N283.2m; Dakar D526.

The goods sent to Dakar were based on a fixed conversion rate of D 10 to

the N

38
UNIT 4

VALUE ADDED STATEMENT

The value added statement is a way of presenting statement to other

interested group within the company. Such group will include
shareholders, employees, government etc. The following are some of the
identified groups considered as having a reasonable right to information
and it is important that their information needs are recognized by preparers
of accounts and corporate reports.

(a) The equity investor group i.e. shareholders

(b) The employee group i.e. existing, potentials and past employees
(c) The analysts - these are people who are capable of using value
added information to inform the public about the potential or
otherwise of the company.
(d) Creditors group – this consists of potential and existing holders of
debentures and loan stock and providers of short and long term
facilities.
(e) The government group – this includes the tax authority and other
government agencies who have the responsibility to collect
government rates and dues.
(f) The public – this include tax payers, consumers and other
stakeholders such as political parties and pressure groups.

It is agreed that the conventional financial statements focus on the interest

of the shareholders in their presentations and to some extent creditors of
the company. In view of these identified interest groups, it is imperative
that there is the need to have statements that will take care of their
information needs. The value added statement is therefore one such
statements, which show the wealth created by the collective efforts of
capital, employees, and the government and discloses how the value
added has been applied and the amount retained for future maintenance
and expansion of the business.

39
IMPORTANCE OF VALUE ADDED STATEMENTS

a. It shows the wealth created by the collective efforts of capital,

government, employees rather than the conventional financial
statements which only take care of the interest of the providers and
the fund – the shareholders and loan creditors. The profit and loss
accounts mainly disclose information of the increase in the revenue of
the company to the shareholders alone.
b. It is possible to compare the performance , activities or size of two or
more companies by reference to the value added by employees or
with reference to any other key figures in the valued added
statements.
c. It tends to be a more permanent measure of performance appraisal.
Profit is a residual item and it is arrived at after considering certain
items such as depreciation whose treatment differs from company to
company. The trend in profit figure reported from year to year is
affected by cost elements, where as value added is a function of two
variables, turnover and bought in goods and services.
d. Provision of financial data in a form more suitable to the needs of
other users of accounts, e.g. employees, government or the equity
investors, than is provided by the present disclosure requirements.
e. It is less easy to manipulate and more easily understood by users of
accounting information.

POSSIBLE FORMAT OF A VALUE ADDED STATEMENT

N N %

Sales or Turnover (Net) x

Bought in goods and services (BIG) (x)

Value Added x 100

Applied as follows

(a) To pay employees salaries,

40
 Wages and bonuses x
Profit sharing x
Pension x x a

(b) To pay providers of capital

Dividends (Interim + final) x
Interest x x b
(c) To pay governments

Corporation tax on profits x x c

(d) To provide for maintenance and expansion

Depreciation x
Retained profit for the year x x d
100

It should be explained that (brought in goods and services) is the same thing as the cost of
sales. In practice the value added statement is no longer in vogue as it is been gradually
ignored now in the presentation of financial statements. However, the knowledge of the
information contents of the statement will add value to the users of financial statements.

Illustration

The following information has been extracted from the annual report of Bolanle International Ltd
for the year ended 31st December, 2004:

N000

Depreciation 170,000

Dividends 60,000

Employees pay and pension 810,000

Extra ordinary items (net loss) 2,000

exchange gain on assets of overseas subsidiary 30,000

Government taxes (less grant) 120,000

Interest paid on borrowings 70,000

Minority interest 20,000

41
Materials and services used 1,800,000

Retained profit 120,000

Profit sharing bonus 20,000

Royalties received and other trading income 30,000

Sales (net) 3,120,000

Share of associated company’s profit 44,000

Reguired

(a) Prepare a Value Added Statement

(b) Explain how you would deal with the following items in calculating
Added Value. Bad debts, customs and excise duty, fixed assets built
by company, rent receivable, annual lease payment.
Solution:

(a)

Bolanle International Limited

Value Added Statement for the year Ended 31st December, 2004

N000 N000 %
Sales 3,120,000
Bought in materials and services 1,800,000
Value added from operations 1,320,000
Extra ordinary item (2,000)
Exchange gain on assets from overseas subsidiary 30,000
Share of associate profit 44,000
Royalties received 30,000 102,000
Total value added 1,422,000 100%
Applied as follows:
To pay employees:
Pay and pension 810,000
Profit sharing bonus 20,000 830,000 58.37%
To pay providers of capital:
Dividends 60,000
Interest 70,000 130,000 9.14%
To pay government:

42
Taxes less grant 120,000 8.44%
To provide for maintenance and expansion:
Depreciation 170,000
Retained profit 152,000
Minority interest 20,000 342,000 24.05%
1,422,000 100%
(b) the treatments of bad debts in the value added statement is to charge
it as part of the goods and services but it is viewed as financing the
company to attain a targeted sales level, then it could be charged as part
payment to providers of capital. normally customs and excise duty should
be charged to the profit and loss accounts and in the value added
statement treat as part of bought in goods and services, but some argued
that it should be treated as part to pay government. However, for the
purposes of this discourse, customs duty and excise should be part of
bought in goods and services.
The materials and overhead content of fixed assets built by the company
should be part of bought in goods and services and the labour content as
part to pay employee. Alternative treatment is to ignore it completely from
the value added statement. Rent receivable should be part of total value
added and the lease payment should be treated:

 Operating Lease: annual lease payment is an expense and it is

included in the bought goods and services.
 Finance lease: this is treated as part of the valued added applied to
provide for the maintenance and expansion of the business because
the annual lease payments will be ultimately culminate in ownership
of the assets so leased.

As an example, the profit and loss account of Growth Ltd shown below

43
is then restated in value added terms:

Growth Ltd
Profit and Loss Account for the year ended 31 December 19X1

N N
Turnover 765,000
Cost of sales* 439,000
Gross profit 326,000
Distribution costs* 93,00
Administrative expenses* 108,00 201,000
0 125,000
Interest payable 0 2,000
Profit on ordinary activities before taxation 123,000
Taxon profit on ordinary activities 44,000
Profit for the year on ordinary activities after 79,000
Undistributed profits from last year 55,000
taxation 134,000
Transfer to general reserve 15,00
Proposed ordinary dividend 75,000
Undistributed profits carried to next year 0 59,000
Note: Costs* include: 60,000

Wages, pensions and other employee benefits 220,000

Depreciation 74,000
All other costs were bought in from outside 346,000
(N439,000 + N93,000 + N108,000) N640,000

44
 Growth Ltd
Statement of Value Added for the year ended 31 December 19X1

N N
Turnover 765,000
Bought in materials and services 346,000
Value added4 19,000

Applied the following way:

To pay employee wages, pensions and other benefits 220,000
To pay providers of capital:
Interest on loans 2,000
Dividends to shareholders 60,000 62,000

To pay government:

Corporation tax payable 44,000

To provide for maintenance and expansion of assets:
Depreciation 74,000
Retained profits 19,000 93,000
419,000

The reader can see that the retained profits figure of N 19,000 is made up of the
increase in undistributed profits (N59,000 < N55,000) N4,000 + transfer to general
reserve N15,000 = N19,000.

45
UNIT 5
FOREIGN EXCHANGE TRANSACTIONS
Organizations in Nigeria usually do have business relationships with governments,
individuals or enterprises in other countries. These dealings may involve the payment,
receipt or transfers of foreign currency or the creation of foreign currency assets and
liabilities. In each of these transactions with a foreign entity, the invoice price is usually
quoted in terms of a foreign currency which is not necessarily the domestic currency of
that party. For the transaction to be reflected in the account of the Nigerian enterprises,
there must be conversion of the amount into Naira value.

In some instances, transactions between parties in different countries generally require

one party to purchase some foreign currency in order to settle its obligations. Between
the dates of the initial transaction and the final settlement, there may be fluctuations in
the exchange rate and this may result in a gain or loss.

Again, a Nigerian company maintaining a branch office in a foreign country or holding

an equity interest in a foreign company must translate the accounting data expressed in
a foreign currency into Naira before the financial statements can be consolidated or
combined.

The primary objectives of this statement on foreign exchange transactions are to provide
uniform accounting treatment for:

(i) Foreign exchange transactions, and

(ii) The translation by a Nigerian enterprise of the financial statements of its foreign
branches, subsidiaries, associates, or joint ventures based in a country other than
Nigeria.

TERMINOLOGIES IN FOREIGN EXCHANGE TRANSACTIONS

The following terms are used in foreign exchange transactions:

(a) Foreign currency – it is any currency other than the domestic currency, say in Nigeria,
Naira.
(b) Conversation – it is the process of expressing a foreign currency amount in Naira by the
issue of an appropriate rate of exchange.

46
(c) Translation – this is restating of account balances of foreign operations at their
equivalent in Naira.
(d) Exchange Rate – it is the rate at which the currency of a country is exchanged for the
currency of another country. Some exchange rates that are used in practice are
presented below:

(i) Official Exchange Rate – it is the rate that is established by the appropriate
governmental official rates, each of which is designated for used for a particular
economic activities and which also reflects governmental policies with respect to
desired economic goals. Before the introduction of the foreign exchange markets,
the Central Bank of Nigeria provided the only official exchange rate in Nigeria.

(ii) Spot Rate – this is the exchange rate prevailing on a particular day. This is usually
the rate used to settle accounts at the end of the day for immediate delivery of
currency.

(iii) Closing Rate of Exchange – it is the exchange rate of ruling at the balance sheet date.

(iv) Forwarding Rate – this is the rate quoted or agreed upon now for the future delivery
of currency between the parties involved.
(e) Reporting Currency – this is the currency in which financial transactions are recorded
and financial statements are presented. For Nigerian enterprises, the reporting
currency is the Naira.
(f) Foreign Operations – this is refer to the business activities based in a country other than
Nigerian, of a branch, subsidiary, associate or joint venture of a Nigerian enterprise.
These may or may not form an integral part of the activities of the parent body in
Nigeria. A foreign operation forms an integral part of a Nigerian enterprises if it has no
separate cash flows.
(g) A Foreign Entity is said to exist where the activities of a branch, a subsidiary, an
associated company or joint venture do not form an integral part of the activities of the
related enterprises in Nigeria.
(h) Monetary Items are monies held and items to be received or paid in money. All other
assets and liabilities are Non-monetary items.
(i) Foreign Currency Loan is an obligation repayment in foreign currency.
(j) An Authorized Dealer in Foreign Exchange is either a bank or a non-banking corporate
organization so appointed by the Federal Minister of Finance.

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CONVERSION OF FOREIGN CURRENCY

The conversion of foreign currency is done in the following manners:

1. Transactions in foreign currencies are normally converted at the rates ruling on the
transactions date.
2. Exchange gains or losses may arise on conversion and they usually require recognition in
the Profit and Loss Account.
3. Usually, gains or losses on transactions arise because of the movement in foreign
exchange rate between the date of initial transaction and the date of settlement. Such
gains or losses on conversion are taken to the profit and loss account as part of the
operations of the period.
4. At the balance sheet date, balances in foreign currencies including domiciliary accounts
are converted into Naira using the closing rates. However, where a balance is to be
settled at a contracted rate, that rate is used. All differences arising on conversion are
usually taken to the Profit and Loss account, except differences on long-term foreign
currency monetary items which may be deferred and taken to the Profit and Loss
account on a systematic basis over the remaining lives of the monetary items convened.
However, losses on such items are not usually deferred if is reasonable to expect that
exchange losses will recur on the same items in future.
5. Foreign operations may be conducted through a branch, a subsidiary, an associate or a
joint venture. Depending on the relationship, foreign operations may or may not form an
integral part of the activities of the related enterprise resident in Nigeria.
6. Usually, before the accounts of a foreign branch, a subsidiary, an associate or a Joint
Venture of a Nigerian enterprise are translated for the purpose of combining or
consolidating the financial statements, the relationship between them are carefully
analyzed. The nature of the relationships between each of the foreign entities will
determine whether the Temporal Method or the Closing Rate Method of translation is to
be used.
7. If the accounts of any foreign branch, subsidiary, associate or joint venture are not in
conformity with the statements of accounting standards, such accounts are adjusted to
conform with the Nigerian standards before combining or consolidating same with the
accounts of the Nigerian parent enterprise.
8. At present, most enterprises in Nigeria tend to carry out their foreign based business
activities through branches. However, because of exchange control restrictions, such
branches usually maintain separate cash flows. The actual movements of funds between
the branches and their Head Offices in Nigeria tend to be infrequent and mainly in an
outward direction. In such circumstances, it is usually to translate the accounts of such
foreign operations using the Closing Rate Method.

48
9. In those special cases where foreign operations are carried on as an integral part of the
activities of the parent enterprises in Nigeria with no separate cash flows being
maintained by the foreign operations, the accounts of such foreign operations are
sometimes translated using either.
10. In some enterprises, revenue and expense accounts of their foreign operations are
translated at year end, under the closing rate method, using the simple average of the
opening and the closing rates. If the activities of the foreign operations are seasonal, a
weighted average exchange rate is sometime used.
11. Some enterprises, under the closing rate method, translate both fixed assets and their
associated depreciation charges into Naira at the rate ruling at the balance sheet date.
Sometimes, a weighted average exchange rate is used where additions or disposals of
fixed assets are carried out at different times.
12. A few enterprises use the Monetary and Non-Monetary Method. A clear distinction is
usually made between monetary assets and liabilities. Monetary items are translated at
the rates ruling on the balance sheet date. Non-monetary assets and liabilities, on the
other hand, are translated at the historical rates ruling at the dates they were acquired or
incurred.
13. Accruals and repayments, resulting from services rendered or received, are usually
translated to the reporting currency at the closing rate. Any exchange differences
between the rate ruling on the translation date and settlement date are usually taken to
the profit and loss account.
14. Exchange gains or losses may arise on translation and usually require recognition in the
Profit and Loss Account. Revenue reserve account or capital Reserve Account. However
exchange gains or losses resulting from translating the accounts of foreign entities that
do not form an integral part of the activities of the Nigerian parent enterprise are
sometimes taken to revenue or Capital Reserve.
15. If a foreign branch, a subsidiary or an associated company operates as an integral part of
the operations of its Nigerian enterprise, the financial statements of such a branch, a
subsidiary or an associated company are translated using the temporal Method.
16. Exchange gains or losses on such translations are taken to the Profit and Loss Account as
part of the results of the operations of the period.

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TRANSLATION OF THE ACCOUNTS OF FOREIGN OPERATIONS

Several methods of translating the foreign currency account balances representing assets,
liabilities, revenue and expenses of foreign operations, are in use. These are:

(i) Closing Rate Method: Under this method, all assets and liabilities are translated at the
closing rate.
(ii) Current/non-current Method: This method translates the current assets and liabilities at
the closing rate and all other assets and liabilities at the historical rate.
(iii) Monetary/non-monetary method: Under this method, monetary assets and liabilities,
such as debtors, creditors, loans etc, are translated at the closing rates ruling at the
balance sheet date and non-monetary items, such as fixed assets and inventory, are
translated at the historical rates.

THE TRANSLATION PROBLEM

Translation of currency presents problems because exchange rates are not fixed. If, for
example, the exchange rate between the Naira and Dollar were always that N160 was equal to
$1.00, there would be no grounds for differences of opinion as to the translated Naira value of
a US asset with a dollar value of $100. However, exchange rates are not fixed. In view of the
differences in the rate in which currency are purchased and sold at various time within the
accounting period, there are bound to be fluctuation in the translation of currency of different
countries. The fact that exchange rates are not fixed creates two major problems for the
Accountant:

1. What is the appropriate rate to use when translating an asset/liability denominated in a

foreign currency?
2. How should one account for the gain or loss that arises when exchange rates change?

TRANSLATION OF TRANSACTIONS VERSUS TRANSLATION OF FINANCIAL STATEMENTS

The accountant may be confronted with the problem of translation in two ways:

(a) Translation of transactions. This refers to the recording of transactions denominated in

foreign currency in the books of account of a company and the eventual preparation of
the financial statements of that company from the records.
(b) Translation of financial statements. This is the preparation of the consolidated financial
statements of a group of companies, where the financial statements of the parent
company and those of one or moiré of its subsidiaries are not denominated in the same
currency.

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In the issue of ‘translation of transactions’ there is only one set of accounting records and one
set of financial statements, which are denominated in the company’s reporting currency. That
is, the company’s home currency, for example in case of a Nigerian company, the currency is
the Naira. The problem of the translation of financial statements arises when a parent company
owns an interest in an entity which maintains its books of account and draws up its financial
statements in a foreign currency. Typically this entity will be located in a foreign country and
will carry out its principal activities there. The problem of translation arises at the end of the
period, when the foreign currency financial statements are translated in order to enable them
to consolidate the financial information of the group which are generally denominated in the
parent company’s ‘home’ currency.

The ‘accruals principle’ and the ‘prudence principle’

There should be the need to consider the basis on which the three known methods of
translation are established and to also choose the methods which are considered appropriate in
the translation of currency. In this context, we are going to discuss the accruals and prudence
concepts of accounting.

The accruals principle. Under this basis, the effects of transactions and other events are
recognized when they occur and not as cash or its equivalent is received or paid) and they are
recorded in the accounting records and reported in the financial statements in the periods to
which they relate. If the accruals principle is to be followed, the accountant should not wait
until the foreign monetary asset of liability has been turned into case (in home currency) before
recognizing the change in its value. Provided that there is practical evidence of the current
value (given by the exchange rate quoted on the market) the accountant should recognize the
change in value now. The loss or gain that arises from the recognition of the current value
relates to the current period since it was caused by the change in exchange rates that occurred
during that period. It does not relate to the future period when the monetary asset or liability
will be liquidated.

The prudence principles. This is based on the fact that the preparer of financial statements
have to contend with the reality that they cannot establish the value of assets and liabilities
with complete certainty, hence there should be caution when reporting financial transactions.
The accounting standards define prudence as ‘ the inclusion of a degree of caution in the
exercise of the judgments needed in making estimates required under conditions of uncertainty
such that assets or income are not overstated and liabilities and expenses are not understated’.

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SUMMARY AND CONCLUSION

In this unit, the issue of translation of currency has been dealt with. It has come into focus that
translation is the process whereby financial date expressed in terms of one currency is
restated in terms of another currency and this becomes necessary in two situations:

 Translation of transactions, when transactions denominated in foreign currency are

accounted for in the books of account and financial statements of an individual
company.
 Translation of financial statements, when a parent company owns a foreign subsidiary
and needs to incorporate its foreign currency statements in consolidated statements.

For translation of transactions, there is general agreement that the historical rate should be
used for the translation of non-monetary assets. For monetary assets and for liabilities, the
closing rate is generally used, except under the national rules in some countries that prefer the
prudence principle to the accruals principle.

The traditional methods of translation of financial statements are (a) the closing rate method,
which uses only current rates; (b) the current/non-current method which uses historical rates
for non-current balances; and (c) the monetary/non-monetary method, which uses historical
rates for non-monetary balances. Naturally, as exchange rates changes, different methods lead
to different results, including the size of gains and losses on translation.

PRACTICE QUESTIONS

1. Baba Limited is a Nigerian company that buys and sells catering equipment. The
following information is available for foreign currency translations entered into by Baba
limited during the year ended 31 December 2010:

1/11 buys goods for $30,000 on credit from Nevada Inc.

15/11 sells goods for $40,000 on credit to Union Inc.

15/11 pays Nevada Inc $20,000 for on account for the goods purchased.

10/12 receives $25,000 on account from Union Inc. in payment for the goods sold

10/12 buys machinery for $80,000 from Florida Inc on credit.

10/12 borrowed $60,000 from an American bank.

52
 22/12 pays Florida Inc $80,000 for the machinery.

22/12 enters into a foreign exchange contract for the acquisition of 100,000 French
francs in three months time.

The exchange rates at the relevant dates were:

1/11 N1 = $200

15/11 N1 = $220

10/12 N1 = $240

22/12 N1 = $250 or 100 French francs

31/12 N1 = $260 or 105 French francs

Assuming that all foreign currency transactions on Baba Limited account are instantly converted

into Naira. There is therefore no exchange gain or loss in holding foreign currency.

Required:

Calculate the profit or loss on foreign currency to be reported in the financial statements of

Baba Limited at 31/12/2010.

2. Why has there been so much controversy over currency translation methods for group
accounting? Which method do you prefer.
3. Is there a single best method of currency translation?

53