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FINANCIAL
ACCOUNTING
International Stream
TUITION
CLASS NOTES
International UK
Inventory Stock
Paper background
Session 5 Inventory
Session 13 Partnerships
Main capabilities
The assessment
The exam can be sat either written or computer based, both methods are 2
hours long.
Written
Computer based
Learning outcomes
• Understand the purpose of accounting
Introduction
WHAT IS ACCOUNTING?
WHAT IS A BUSINESS?
Sole Trader
Partnership
This type of business is owned by several individuals, some of which will actively
be involved in the business
Companies
• 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
Learning outcomes
After completing this chapter, you should be able to:
Introduction
There are four key financial statements:
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”
This statement is a summary of the income and expenditure of the business for a
“PERIOD OF TIME”.
The statement of cash flow reports the cash generation and cash absorption for a
“PERIOD OF TIME”.
Current assets
Inventory 13,777
Trade receivables 12,775
Prepayments 2,800
Cash 3,400 32,752
Loan 20,000
Current liabilities
Revenue 233,000
123,449
Less: Expenses
Current assets
Inventory 8 88,432
Trade receivables 9 97,455
Cash 13,400 199,287
Current liabilities
Note
Revenue (Sales) 385,000
Learning outcomes
When you have completed this chapter, you should be able to:
Introduction
T accounts
• The closing balance of a T account at the end of the period is entered into
a trial balance
Required
Tina starts her business on 1 January 2007. The following transactions take
place in her first month of trading:
• 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
Required
Bank Account
Dr Cr
56,000 56,000
Capital Account
Dr Cr
Purchases
Dr Cr
12,000 12,000
Trade Payables
Dr Cr
12,000 12,000
Sales
Dr Cr
12,000 12,000
Rent
Dr Cr
Dr Cr
Delivery Van
Dr Cr
Statem Dr Cr
ent
Purchases CI 12,000
Sales CI 12,000
Rent CI 450
Sales 12,000
Cost of sales
Opening inventory 0
Purchases 12,000
12,000
Less expenses
Rent 450
Current Assets
Inventory 7,000
Trade Receivables 6,000
Bank Account 43,550
56,550
Capital 50,000
Profit 6,550
56,550
Current Liabilities
63,550
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
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
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
Statem Dr Cr
ent
Purchases CI 18,000
Sales CI 26,000
Insurance CI 75
Rent CI 150
Petty Cash FP 70
Office Supplies CI 30
Revenue 26,000
Cost of sales
Opening inventory 0
Purchases 18,000
18,000
Less expenses:
Insurance 75
Rent 150
Office supplies 30
255
Current Assets
Inventory 5,000
Trade Receivables 12,000
Bank Account 71,675
Petty Cash 70
88,745
Capital 65,000
Profit 12,745
77,745
Current Liabilities
91,745
Learning outcomes
When you have completed this chapter, you should be able to:
Introduction
These are assets that have physical substance. Examples of tangible non-
current assets would be:
Motor vehicles
Computers
Goodwill
Development
The key accounting standard relevant at this level is I.A.S. 16 Non-Current Assets
• Item code
• Date of purchase
• Item description
• Cost
• Depreciation method
• Location
• Disposal details
One of the key areas of accounting for non-current assets is deciding whether
expenditure incurred is CAPITAL or REVENUE expenditure.
• Initial cost
• Delivery costs
• Installation costs
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
Depreciation
Intangible non-current assets are amortised over their useful economic life (this
is just another term for depreciation).
Depreciation policies
• Straight line
• Reducing balance
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.
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.
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.
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%.
Once the depreciation charge has been calculated it should be entered into the
accounts via a journal.
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:
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
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:
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.
Dr Bank $8,000
ANSWERS TO EXAMPLE 1
ANSWER TO EXAMPLE 2
Ii
26,000 x 5 = 10,833
12
ANSWER TO EXAMPLE 3
ANSWER TO EXAMPLE 4
45,000 X 2% X 15 = 13,500
Years
150,000 / 35 = 4,286
Years pa
Journals Required
Dr Depreciation 4,286
Cr Accumulated
Depreciation 4,286
Learning Outcomes
When you have completed this chapter you should be able to:
Introduction
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.
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.
In times of rising prices, closing inventory will have a higher cost and therefore
profit will be higher.
• All units are issued at the current weighted average cost per unit
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.
Net realisable value is the amount we can get from selling inventory less any
further costs to be incurred.
Accounting Entries
Navigator Office Supplies made the following purchases and sales in January:
Purchases
3,00 14,735
0
Sales
1,70 17,000
0
Required
• LIFO
• FIFO
• AVCO
L.I.FO.
IN OUT BALANCE
Date No. Cost Total No. Cost Total No. Cost Total
F.I.F.O
Valuation
= $6,960
IN OUT BALANCE
Date No. Cost Total No. Cost Total No. Cost Total
Cost of sales
Opening inventory 0 0 0
Purchases 14,735 14,735 14,735
Radiance Kitchenware has the following items in their financial statements for
the year ended 31st December 2007:
Purchases $98,000
• 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
ANSWER TO EXAMPLE 2
Stock Valuation
Less
Damaged inventory Table 500
Chairs 400 900
Add NRV
Table (200 – 50) 150
Chairs 80 230
42,130
Cost of Sales
Learning Outcomes
When you have completed this chapter, you should be able to:
• 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.
• Doubtful debt
Irrecoverable Debt
If this is the case we should not have this balance in our receivables, and would
therefore write the debt off.
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
If a debt that has been written off is later recovered, we will need to adjust the
ledgers to reflect this. The entry required would be:
Dr Bank
Cr Irrecoverable debts
Doubtful debt
A doubtful debt is a debt that is owed to a business, but they are dubious about
its collectability. The distinguishing factor is that this debt could be collected as
it is doubtful not bad. We therefore, make a provision for this amount.
Dr Bank
Cr Trade receivables
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?
Zippy Traders
Bungle
ANSWER TO EXAMPLE 2
Double entry
Current assets
Receivables 150,000
General Allowance -7,500
142,500
Double entry
Current assets
Receivables 135,000
General Allowance -6,750
128,250
Learning outcomes
When you have completed this chapter, you should be able to:
• Prepare the control accounts for trade receivables and trade payables
Introduction
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:
• Cash book
• Journal entries
This book records all the sales we make on credit. Sales should be recorded net
of trade discount but before cash (settlement) discount.
If a credit customer returns goods, this will be recorded in the sales 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.
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.
L & M had the following transactions during the first week in December 2007.
• Purchased goods on credit from A Ltd for $595 receiving a trade discount
of 9.5%
3rd December
5th December
• Purchased goods on credit from A Ltd for $995, again with a 9.5% trade
discount
SOLUTION
The following are the balances on Explorers’ ledger accounts in the month of
January
Required
Solution
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
The following are the balances on a company’s ledger accounts in the month of
March:
Required
Calculate the closing balance for the payables account at the end of March.
Solution
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
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:
• Posting error
• An entry that has been made in the individual account but not in the
control accounts
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:
3. Goods returned of $1,590 had not been 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:
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
EXAMPLE 5
Payables 53,500
Receivables 51,500
Provision for doubtful debts 3,400
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:
Dr Cr
353,500 353,500
Dr Cr
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.
• Single entries – Only one side of the transaction has been posted
Although extracting a trial balance proves the above, there are certain errors
that a trial balance will not identify. These are:
• Compensating errors – Where two or more errors cancel each other. This
is extremely rare.
Journals
Example 6
3. A non-current asset has been purchased for $7,000 on credit, but has not
been recorded.
Solution
Peter has the following balances on its trial balance at the end of the financial
year:
Debit $213,852
Credit $212,390
The following errors have been identified by the accountant; after these errors
have been corrected the balance on the suspense account should be removed.
3. Other income of $3,742 has only been recorded in the cash book.
Required
Solution
Suspense Account
4,082 4,082
Learning Outcomes
When you have completed this chapter, you should be able to:
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.
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.
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.
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.
Cash Book
23,450 23,450
Bank Statement
Date Details Payme Receip Balanc
nt t e
Cash Book
23,595 23,595
Bank Reconciliation
21,595
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
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.
Cash Book
6,655 6,655
Bank Reconciliation
1,000
Learning Outcomes
When you have completed this chapter, you should be able to:
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.
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.
Gas Account
1,110 1.110
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
1,800 1.800
Assuming the insurance charge remains the same for the year ended 31st July
2009, the ledger account would look like this:
Insurance Account
1,800 1.800
2,850 2,850
Learning outcomes
When you have completed this chapter, you should be able to:
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:
Current assets
Inventory 8 88,432
Trade receivables 9 97,455
Cash 13,400 199,287
Current liabilities
Note
Revenue 385,000
A limited company must file their statutory accounts with companies’ house. A
full set of statutory accounts will include:
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.
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.
Required:
Solution
Ordinary shares
Preference shares
50,000 x 6% 3,000
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
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 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.
Cr Share capital
Dr Share premium
Dividends
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
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.
Ordinary shares
Preference shares
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 trial balance of Jewel Limited as at 31st March 2007 was as follows:
Dr Cr
896,598 896,598
Notes
6. A final dividend of 15c per share has been proposed before the year end.
Required
Journals
Dr Cr
5. Dr Taxation 25,000
Cr Taxation liability 25,000
Working 1
31/03/0 Admin
7 expenses
(written back to 3,688
I/S)
Revenue 365,000
Current assets
Inventory 28,990
Trade receivables (45,987 – 2,299) 43,688
Cash 73,958
146,636
Total assets 674,324
Debenture 100,000
Current liabilities
Revaluation
Learning outcomes
When you have completed this chapter, you should be able to:
Introduction
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
• 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
Cash
Cash that is available on demand. An example would be cash in the bank less
any overdraft.
Cash equivalents
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.
$ $
Adjustments for:
Interest payable X
Depreciation X
(Profit) / loss on the disposal of a non current asset (X) X
$ $
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
Required
Prepare the cash flow statement for the year ended 31st December 2007.
$ $
Adjustments for:
Interest payable -
Depreciation (92 – 78) 14
(Profit) / loss on the disposal of a non current asset -
Interest paid -
Taxation paid (working 1) (4)
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
Required:
Introduction
As the name suggests, incomplete records are any form of accounting records
other than the full double entry system.
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:
Or
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.
3,000 = 0 + ? - 2,500
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.
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.
Balancing figures
Required:
Account Receivables
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:
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:
95,000 95,000
80,000 80,000
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:
Solution:
63,000 63,000
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:
Solution:
25,500 25,500
Example 6
The following information relates to the rent and rates for Susan for the year
ended 31st December 2007.
Solution:
4,850 4,850
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:
Solution:
Cash Book
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
14,000 14,000
Example 9
Required:
$ %
Sales 1,000 100%
Required:
Example 11
Mark-up 10%
Sales $6,600
Required:
Cost of sales
Margin 5%
Purchases $2,840
Required:
Cost of sales
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.
Margin 20%
Sales $100,000
Purchases $82,000
Required:
Cost of sales
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.
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.
How do you think the profits should be shared amongst the partners?
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.
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.
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:
Profit 106,250
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.
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
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