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FINANCIAL REPORTING
PART 2
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CPA SECTION 3
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STUDY TEXT
www.someakenya.com Contact: 0707 737 890 Page 1

KASNEB SYLLABUS
PAPER NO. 9 FINANCIAL REPORTING
GENERAL OBJECTIVE
This paper is intended to equip the candidate with knowledge, skills and attitudes that will enable
him/her to prepare financial statements for various entities and account for specialised transactions in
both the public and private sectors
9. 0 LEARNING OUTCOMES
A candidate who passes this paper should be able to:
 Account for various assets and liabilities
 Prepare financial statements including published financial statements for various types of
organisations
 Account for specialised transactions
 Prepare group financial statements
 Apply International Financial Reporting Standards (IFRSs) and International Public Sector
Accounting Standards (IPSASs) in preparing non-complex financial statements.
CONTENT
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9.1 Assets and liabilities
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- Assets and liabilities covered in Paper No.1: Financial Accounting still examinable (in
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the context of published financial statements)
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- Non- current assets held for sale
- Borrowing costs
- Investment property
- Financial instruments (presentation, recognition, classes, measurement, de-recognition and
disclosures) (excluding impairment, hedging and embedded derivatives)
- Leases (all aspects including dealers and sale and leaseback)
- Income tax (current and deferred tax but not deferred tax in the case of groups)
- Provisions, contingent liabilities and contingent assets
9.2 Further aspects of partnerships
- Dissolutions (including piece-meal)

- Conversion of a partnership into a company
9.3 Specialized transactions
- Contracts with customers (revenue recognition): Hire Purchase/ Installment sales (split of
hire purchase profit into interest and gross profit and using actuarial method and sum of digits

to account for interest); sale of goods; construction contracts and real estate, provision of
services.
- Government grants
9.4 Financial statements of various types of organizations
- Farming
- Insurance
- Banks
- Professional firms (lawyers and accountants)
- Independent local, dependent and foreign branches
- Co-operative societies
9.5 Published financial statements
- Presentation of financial statements (income statement, statement of comprehensive incomes,

statement of changes in equity, statement of financial position and the notes to financial
statements)
- Accounting policies, changes in accounting estimates and errors (prior period errors)
- Events after the reporting period
- Discontinued operations (exclude disposal of subsidiaries)
9.6 Subsidiaries (groups), associates and jointly controlled entities
- Accounting for one subsidiary (consolidated income statement, consolidated statement of
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financial position and a statement of cash flows - group financial statements); consolidated
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statement of cash flows also covers associate companies and jointly controlled entities but
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excludes acquisition and disposal of subsidiaries during the year
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- Accounting treatment of associate companies
- Jointly controlled entity
9.5 Financial statements of public sector entities

(Provisions of the following IPSAS (emphasis on distinctions with equivalent IASs/IFRS)
- Presentation of financial statements
- Accounting policies, changes in accounting estimates and errors
- Borrowing costs
- Consolidated and separate financial statements
- Investments in associates
- Interests in joint ventures
- Events after the reporting date
- Construction contracts, leases and inventories
- Provisions, contingent liabilities and contingent assets
9.8 Emerging issues in financial reporting

TABLE OF CONTENTS
TOPIC PAGE
Topic 1: Assets and liabilities…....................................................................................................4
Topic 2: Further aspect of partnerships….....................................................................................86
Topic 3: Special transactions................................................................................…....................133
Topic 4: Financial statements for various types of organisations….............................................168
Topic 5: Published financial statements.........................................................…...........................235
Topic 6: Subsidiaries (groups), associates and jointly controlled entities.....................................266
Topic 7: Financial statements of public sector entities………………………………………......333
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Revised on: June 2016

TOPIC 1
ASSETS AND LIABILITIES
ASSETS AND LIABILITIES
Introduction
Property, plant and equipment are tangible items that are held for use in the production or supply of
goods or services, for rental to others, or for administrative purposes; and are expected to be used
during more than one period.
Recognition of Property, Plant and Equipment
IAS 16 states that the cost of an item of property, plant and equipment shall be recognized as an
asset if, and only if:
 it is probable that future economic benefits associated with the item will flow to the
entity; and
 The cost of the item can be measured reliably.
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This recognition principle shall be applied to all costs at the time they are incurred, both incurred
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initially to acquire or construct an item of property, plant and equipment and incurred
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subsequently after recognition to add to, replace part of or service it.
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Initial costs
Some items of property, plant and equipment might be necessary to acquire for safety or
environmental reasons. Although they do not directly increase the future economic benefits, they
might be inevitable to obtain future economic benefits from other assets and therefore, should be
recognized as an asset. For example, water cleaning station might be necessary in order to proceed
with some chemical processes within chemical manufacturer.
Subsequent costs
Day-to-day servicing of the item shall be recognized in profit or loss as incurred, because they just
maintain (not enhance) item’s capacity to bring future economic benefits.
However, some parts of the item of property, plant and equipment may require replacement at
regular intervals, for example, aircraft interiors. In such a case, an entity derecognizes carrying
amount of older part and recognizes the cost of new part into the carrying amount of the item. The
same applies to major inspections for faults, overhauling and similar items.

Measurement
Initial Measurement
An item of property, plant and equipment that qualifies for recognition as an asset shall be measured
at its cost.
The cost of an item of property, plant and equipment comprises:
1. its purchase price including import duties, non-refundable purchase taxes, after deducting
trade discounts and rebates
2. Any costs directly attributable to bringing the asset to the location and condition necessary
for it to be capable of operating in the manner intended by management. Examples of these
costs are: costs of site preparation, professional fees, initial delivery and handling, installation
and assembly, etc.,
3. The initial estimate of the costs of dismantling and removing the item and restoring the
site on which it is located.
The cost of an item of property, plant and equipment is the cash price equivalent at the recognition
date. If payment is deferred beyond normal credit terms, the difference between the cash price
equivalent and the total payment is recognized as interest over the period of credit (unless such
interest is capitalized in accordance with IAS 23).
If an asset is acquired in exchange for another non-monetary asset, the cost will be measured at the
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fair value unless (a) the exchange transaction lacks commercial substance or (b) the fair value of
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neither the asset received nor the asset given up is reliably measurable. If the acquired item is not
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measured at fair value, its cost is measured at the carrying amount of the asset given up.
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Subsequent Measurement
An entity may choose two accounting models for its property plant and equipment:
1. Cost model
An entity shall carry an asset at its cost less any accumulated depreciation and any
accumulated impairment losses.
2. Revaluation model
An entity shall carry an asset at a revalued amount. Revalued amount is its fair value at the
date of the revaluation less any subsequent accumulated depreciation and subsequent
accumulated impairment losses.
An entity shall revalue its assets with sufficient regularity so that the carrying amount does not differ
materially from its fair value at the end of the reporting period. If an item of property, plant and
equipment is revalued, the entire class of property, plant and equipment to which that asset belongs
shall be revalued.

The change of asset’s carrying amount as a result of revaluation shall be treated in the
following way:
Change in
Carying Where
Amount
Other comprehensive income Profit or loss if reverses previous revaluation
Increase
(heading “Revolution surplus”) decrease of the same value
Other comprehensive income if reduces previously
Decrease Profit or loss recognized revaluation surplus (heading
“Revaluation surplus”)
Depreciation (both models)
Depreciation is defined as the systematic allocation of the depreciable amount of an asset over its
useful life. The items of property, plant and equipment are usually depreciated in order to maintain
matching principle – as they are in operation for more than 1 year, they assist in producing the
revenues in more than 1 year and therefore, their cost shall be spread among those years in order to
match the revenue they help to produce.
When dealing with the depreciation the basic things considered are:
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 Depreciable amount: Depreciable amount is simply HOW MUCH you are going to
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depreciate. It is the cost of an asset, or other amount substituted for cost, less its
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residual value.
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Depreciation period: Depreciation period is simply HOW LONG you are going to
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depreciate and it is basically asset’s useful life. Useful life is the period over which an asset is
expected to be available for use by an entity; or the number of production or similar units
expected to be obtained from the asset by an entity.IFRS16 lists several factors that shall be
considered when establishing item’s useful life: expected usage of the item, expected physical
wear and tear, technical or commercial obsolescence of the item, and legal or other limits on
the use of the asset. Useful life and asset’s residual value (input to depreciable amount) shall
be reviewed at least at the end of each financial year. If there is a change in the
expectations comparing to previous estimates, then change shall be accounted for as a change
in an accounting estimate in line with IAS 8 (no restatement of previous periods).
 Depreciation method: Depreciation method is simply HOW, IN WHAT MANNER you are
going to depreciate. The depreciation method used shall reflect the pattern in which the
asset’s future economic benefits are expected to be consumed by the entity.An entity may
select from variety of depreciation methods, such as straight-line method, diminishing
balance method and the units of production methods. Selected method shall be reviewed at
least at the end of each financial year. If there is a change in the expected pattern of asset’s
usage, then the depreciation method shall be changed and be accounted for as a change in an
accounting estimate in line with IAS8 (no restatement of previous periods).Depreciation shall
be recognized in profit or loss unless it is capitalized into the carrying amount of another asset
(for example, inventories, or another item of property, plant and equipment).

Each part of an item of property, plant and equipment with a cost that is significant in relation
to the total cost of the item shall be depreciated separately. For example, aircraft interior cost
might be depreciated separately from the remaining airplane cost.
Methods for Providing Depreciation
Fixed assets differ from each other in their nature so widely that the same depreciation methods
cannot be applied to each. The following methods have therefore been evolved for depreciating
various assets:
1. Fixed Percentage on Diminishing Balar1!:e Method

2. Sum of the years Digits Method.
3. Annuity Method.
4. Depreciation Fund Method.
5. Insurance Policy Method.
6. Revaluation Method.
7. Machine Hour Rate Method.
8. Depletion Method.
9. Repairs Provision Method.
Fixed Installment or Straight Line or Fixed Percentage on Original Cost.
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Under this method, the Depreciation is calculated on the basis of either a fixed percentage of the
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original value of the asset or divides the original value of asset by the number of years of its
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estimated life. Every year, the same amount is written off as Depreciation so as to reduce the asset
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account to nil.
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ℎ −
=
ℎ
Diminishing Balance Method
Under the diminishing Balance method, depreciation is calculated at a fixed percentage on the
opening balance of each year. Each year the opening balance may be decreasing in value. This
decreasing book value is commonly known as written down value of the asset. While applying the
depreciation rate both salvage or scrap value and removal costs are ignored. There are no
possibilities to reduce the book value to zero.
Sum of the Years Digits Method
It gives decreasing depreciation charge year by year. For the purpose of obtaining yearly
depreciation diminishing percentages to the cost of the asset, less salvage value is applied. Under
this method, the rate of depreciation is a fraction having the sum of the digits representing the useful
life of the asset as its denominator and individual year as its numerator.

ℎ ( ℎ )
ℎ
ℎ ℎ ℎ
Annuity Method
Under the Annuity method, the annual depreciation charges would be ascertained with the help of
Annuity table. This method gives importance to interest factor. Other methods do not take into
account the interest factor while investing the assets. Fixed interest rate is charged on the opening
balance of each year and then cost of asset together with interest thereon is written off equally over
the life of the asset.
Depreciation Fund Method
Depreciation fund method provides an adequate financial requirement for the replacement of the
asset when the asset is replaced by a new one. Depreciation fund account is opened and the amount
of depreciation is credited to that account. The asset account stands year after year at its original
cost. At the end of each year, the amount of depreciation is debited and depreciation fund account is
credited and the corresponding amount is invested in securities of some reputed companies, for the
purpose of mobilizing funds for replacement.
Insurance Policy Method
Under this method, an insurance policy is taken from the insurance company for the purpose of
replacement of an asset. At the end of the definite period, the insurance company will pay the
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assured sum with the help of which asset can be repurchased.
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Revaluation Method
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This method is suitable for small and diverse items of asset such as bottles, corks, trade marks, loose
tools, livestock etc. Under this method the amount of depreciation is ascertained to find the
difference between the book value of the asset and the real value of the asset. At the end of the year
the difference is taken as depreciation.
Suppose on first January, 2005 the value of loose tools was Shs.1, 600 and during the year Shs.2,
000 worth of tools were purchased.
Now, if at the end of the year, the loose tools are considered to be worth only Shs.2, 400, the
depreciation comes to Shs.1, 200, i.e. Shs. 1,600 + 2,000 – 2,400
Machine Hour Rate Method
The Economic Life of the asset is estimated in terms of working hours. Hourly rate is determined by
dividing total cost of the asset by total number of hours to be operated in its life time. The annual
depreciation charge is calculated by applying this rate to the actual number of hours operated in the
particular accounting period.

(Cost – Scrap Value )
Machine hour rate =
Total hours (who1e lifetime)
Machine Hour value

Depreciation for the year =
Estimated Hours in a year
Depletion Method
The Economic Life of the asset is determined by geographical survey methods in terms of total units
of resource deposits. The depletion rate per unit is calculated by dividing the total cost of the asset
by the estimated available number of units.
Repairs Provision Method
Under this method, first the total repair and renewal costs are determined for the whole life of the
asset and then it is added to the capital cost to get a total value. Then, this value is divided by its
estimated life. The resultant value is treated as Repair, Renewals and depreciation. It has to be
charged to the profit and loss Account each year. The corresponding Credit is given to provision for
depreciation and Repairs account.
Impairment
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Here, IAS 16 refers to another standard, IAS 36 Impairment of Assets that prescribes rules for
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reviewing the carrying amount of assets, determining their recoverable amount and impairment loss,
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recognizing and reversing impairment loss and more.
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IAS 16 states that compensation from third parties for items of property, plant and equipment that
were impaired, lost or given up shall be included in profit or loss when the compensation becomes
receivable. For example, claim for compensation of damage on insured property from insurance
company is recognized to profit or loss when insurance company accepts claim, closes the case and
agrees to compensate (or after whatever procedure is agreed in the insurance contract).
Derecognition
IAS 16 prescribes that the carrying amount of an item of property, plant and equipment shall be
derecognized on disposal; or when no future economic benefits are expected from its use
or disposal.
The gain (not classified as revenue!) or loss arising from the derecognition of an item of property,
plant and equipment shall be included in profit or loss when the item is derecognized. The gain or
loss from the derecognition is calculated as the net disposal proceeds (usually income from sale of
item) less the carrying amount of the item.

Intangible Assets
An intangible asset is an identifiable non-monetary asset without physical substance and helps your
company make money. Examples include patents, copyrights, brands and franchises trademarks etc.
The International Accounting Standards Board, or IASB, further states that intangible assets must
arise out of a legal contract or be separable so that they can be sold. An example is a novel
copyright. It has no physical presence, but it enables the owner to profit from the sale of the book.
That copyright can be sold so that the new owner can profit from future book sales. The copyright is
therefore both valuable and separable and should be recorded as an intangible asset.
Nature of an intangible asset
The general meaning of the word intangible is ‘without physical substance’. There are some assets
that may not have physical substance, but are still a valuable resource for an entity.
They enable it to run the business and earn profits in the same manner as tangible assets do.e.g
An entity uses a machine to manufacture a patented product which is a special energy drink formula
that will accelerate bone growth without any known side-effects.
The chemicals and their combination that go into the making of this formula are ‘patented’ i.e.
registered with the patent office.
A ‘patent’ means an exclusive right over a certain design, process etc., which only the entity owning
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it can exercise.
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The patent is as essential an item as the machine. The patent ensures that no other company can use
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a similar machine without permission. This helps the entity get a good price for its product.
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As a result, the patent helps the entity generate economic benefits for the entity. Hence, although the
patent does not have any physical substance, it deserves to be recognized as an asset.
It is as much of an asset as the machine. This is because it meets the definition of an asset as it
brings future economic benefits, is controlled by the entity and its cost is measurable.
The only difference is that patent is an intangible asset while the machine is a tangible asset.
Another example of an intangible asset is Good will.
Goodwill
A business builds up some reputation after it has continued for some time. If the reputation is good,
it will come to acquire a fixed clientele in the sense that a number of customers will automatically
make their purchases from the firm.
This is a very valuable asset even if one cannot touch or feel or see it. The asset is intangible but not
fictitious.

This asset is known as goodwill and may be defined as the value of the reputation of a firm. Its
tangible effect is extra profit which firms not possessing equal reputation do not earn.
This reputation will depend on:
a) The personal reputation of the owners and / or management.

b) The reputation of the goods dealt in or the quality of the service rendered.
c) The peculiar advantage of the site of the business.
d) The peculiar advantage available to it as regards sales or supplies of materials.
e) The patents, copyrights or trademarks owned by the firm. ( but often a separate value is put
on these).
Those who purchase goodwill will acquire the name of the firm and also the site, the patents and
trademarks, etc. and existing contracts. All the factors named above result in extra profits and hence
goodwill will arise only when the business is profitable. A business running into losses will have,
generally, no goodwill.
What has to be particularly remembered is that it is the expectation of profits in future that makes
goodwill a valuable asset.
A firm which has made good profits by virtue of an exceptionally favorable contract, that is not to be
renewed, cannot expect to get much for its goodwill.
Valuation of Goodwill
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There are three methods are in use:
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a. Average Profits Basis
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In this case the profits of the past few years are averaged and adjusted for any change that is
expected to occur in the near future. The average (adjusted) is multiplied by a certain number (two
or three or five) as agreed.
It is expressed, for example, as three years’ purchase of five years’ profits. If, for example, the
profits for the years 2009 to 2012 ( inclusive) have been Shs.8,000, Shs.9,000, Shs.7,000, Shs.8,500
and Shs.10,000, the average is Shs. 8,500.
If goodwill is to be valued at three years’ purchase, goodwill will be Shs.25, 500, i.e. 3 x 8,500
b. Super Profits Basis
In this case, interest on capital employed at the rate prevailing in the market and also reasonable
salary of the proprietor or partners is deducted from the average profits.
What remains is “Super Profits” or profits which can be attributed to the special advantages of the
firm.

Suppose, in the case discussed above, the capital of the firm is Shs.80, 000 and that seven and a half
per cent is a reasonable return in the industry. The reasonable or normal profit is Shs. 6,000.
The average profits being Shs. 8,500, the super profits in this case come to Shs.2, 500.
Super Profits multiplied by the number of years’ purchase agreed upon gives goodwill. In the
example given above, if goodwill is to be calculated at three years’ purchase, the goodwill is Shs.7,
500, i.e. 2,500 x 3.
c. Capitalization Method
In this method, the value of the whole business is found out by the formula,
100
Then, from this figure, the net assets of the firm are deducted and the remainder is goodwill.
In the example given above, the value of the whole business is or Shs.113, 333.
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Net assets or capital is Shs. 80,000. Hence, the goodwill is Shs.33, 333, i.e. 113,333 – 80,000
The necessity for the valuation of goodwill in a firm arises in the following cases:
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a) When the profit-sharing ratio amongst the partners is changed
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b) When a new partner is admitted
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c) When a partner retires or dies
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d) When the business is dissolved or sold
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In the last case, obviously, the value of goodwill will be a matter of negotiation between the firm
and the intending purchaser.
In addition, the IAS specifies the following conditions to be satisfied by an asset, in order to be
called an intangible asset:
1. Identifiability
2. Control over the asset
3. Existence of future economic benefits
The difference between tangible assets and intangible assets
From the perspective of physical existence, assets can be of two types, i.e. tangible assets (those
with physical substance) and intangible assets (those with physical substance)
A majority of the assets of a business are tangible assets e.g. property, machinery, cars, furniture etc.
These assets have a physical existence i.e. we can see or touch them.

However, there are some assets that do not have a physical existence but are valuable for the
business. E.g. patents, copyrights etc. Such assets are called intangible assets.
Inventories ( IAS 2)
A primary issue in accounting for inventories is the amount of cost to be recognised as an asset and
carried forward until the related revenues are recognised. This Standard provides guidance on the
determination of cost and its subsequent recognition as an expense, including any write-down to net
realisable value. It also provides guidance on the cost formulas that are used to assign costs to
inventories.
Inventories shall be measured at the lower of cost and net realisable value.
Net realisable value is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the sale.
The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs
incurred in bringing the inventories to their present location and condition.
The cost of inventories shall be assigned by using the first-in, first-out (FIFO) or weighted average
cost formula. An entity shall use the same cost formula for all inventories having a similar nature
and use to the entity. For inventories with a different nature or use, different cost formulas may be
justified. However, the cost of inventories of items that are not ordinarily interchangeable and goods
or services produced and segregated for specific projects shall be assigned by using specific
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identification of their individual costs.
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When inventories are sold, the carrying amount of those inventories shall be recognised as an
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expense in the period in which the related revenue is recognized. The amount of any write-down of
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inventories to net realisable value and all losses of inventories shall be recognized as an expense in
the period the write-down or loss occurs. The amount of any reversal of any write-down of
inventories, arising from an increase in net realisable value, shall be recognised as a reduction in the
amount of inventories recognised as an expense in the period in which the reversal occurs.
Other Assets
Trade receivables
The term trade receivables refer to the amounts due to a business following the sale of goods or
services to another company. It is a subcategory of Accounts Receivable. Trade receivables are
considered a current asset on a company's balance sheet as they can be readily converted into cash.
Cash at Bank
The sum of all coins, currency and other unrestricted liquid funds that have been placed on deposit
with a financial institution. Cash in bank is considered a highly liquid form of current asset, and
when reported on a business balance sheet, it is combined with cash in hand for accounting
purposes.

Cash on hand
Funds that are immediately available to a business, and can be spent as needed, as opposed to assets
that must be sold to generate cash. The amount of cash on hand determines what projects a company
can undertake, or what financial hardships can be absorbed, without going into debt or arranging
other financing.
Accrued income
Accrued income is an amount that has been
1) Earned,
2) There is a right to receive the amount, and
3) It has not yet been recorded in the general ledger accounts. One example of accrued income is
the interest earned on a bond investment.
To illustrate, let’s assume that a company invested shs.100,000 on December 1 in a 6% shs.100, 000
bond that pays shs.3, 000 of interest on each June 1 and December 1. On December 31, the company
will have earned one month’s interest amounting to shs.500 (shs.100,000 x 6% per year x 1/12 of a
year, or 1/6 of the semiannual shs.3, 000). No interest will be received in December since it will be
part of the shs.3,000 to be received on June 1. The shs.500 of interest earned during December, but
not yet received or recorded as of December 31 is known as accrued income.
Under the accrual basis of accounting, accrued income is recorded with an adjusting entry prior to
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issuing the financial statements. In our example, there will need to be an adjusting entry dated
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December 31 that debits Interest Receivable (a balance sheet account) for shs.500, and credits
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Interest Income (an income statement account) for shs.500.
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Liabilities
Trade payables
Trade payables are also known as accounts payable and refers to money owed to creditors, lenders,
vendors or suppliers for products or services rendered. Payables are considered short-term if due
within 12 months whereas payables due longer than 12 months are considered long-term.
Loan
In finance, a loan is a debt evidenced by a note which specifies, among other things, the principal
amount, interest rate, and date of repayment. A loan entails the reallocation of the subject asset(s) for
a period of time, between the lender and the borrower.
In a loan, the borrower initially receives or borrows an amount of money, called the principal, from
the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later
time. Typically, the money is paid back in regular installments, or partial repayments; in an annuity,
each installment is the same amount.

The loan is generally provided at a cost, referred to as interest on the debt, which provides an
incentive for the lender to engage in the loan. In a legal loan, each of these obligations and
restrictions is enforced by contract, which can also place the borrower under additional restrictions
known as loan covenants. Although this article focuses on monetary loans, in practice any material
object might be lent.
Acting as a provider of loans is one of the principal tasks for financial institutions. For other
institutions, issuing of debt contracts such as bonds is a typical source of funding.
Prepaid income
Prepaid Income is an accounting concept that refers to a payment that has been received, but the
asset has not yet been fully delivered. The company receives a one-off payment for the asset, but
delivers its full value either in the future or over time. Prepaid Income is found on the Balance Sheet
of a company as a liability (as it is something which is owed), either with its own section or under
Other Current Liabilities.
Accrued expenses
Money spent or cost incurred in an organization's efforts to generate revenue, representing the cost
of doing business.
Expenses may be in the form of actual cash payments (such as wages and salaries), a computed
expired portion (depreciation) of an asset, or an amount taken out of earnings (such as bad debts).
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Expenses are summarized and charged in the income statement as deductions from the income
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before assessing income tax. Whereas all expenses are costs, not all costs (such as those incurred in
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acquisition of income generating assets) are expenses.
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NON-CURRENT ASSETS HELD FOR SALE
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
Non-current assets held for sale and discontinued operations. (IFRS 5)
The objectives of IFRS 5 are to:

1. Classify, measure and present non-current assets held for sale, in particular requiring that
such assets should be presented separately on the face of statement of financial position
2. Present separately the results of discontinued operations.
Classification as held for sale.
A non-current asset should be classified as held for sale if its carrying amount will be recovered
principally through a sale transaction rather than through continued use. The following conditions
should apply:
1. The asset must be available for sale in its present condition
2. The sale must be highly probable meaning that
(a) Management are committed to a plan to sell the assets
(b) There is an active plan to locate buyer
(c) The asset is being actively marketed
3. The sale is expected to be completed with 12 months of its classification as held for sale
4. It is highly unlikely that the plan will be significantly changed or withdrawn
Measurement and presentation of non-current assets held for sale.
i. Non-current assets held for sale should be measured at the lower of their carrying amount and
fair value less cost to sell.
ii. Held for sale non-current assets should be presented separately on the face of statement of
financial position and should not be depreciated
iii. On presentation on statement of financial position, they will qualify as current assets under
rules of IAS 1
Illustration 1:
On 1st January 20x1, john’s pizza company bought a chicken processing machine for ksh.200, 000.
It has an expected useful life of 10 years and a nil residual value. On December 20x2, after 2 years
of using the assets, john’s company decides to sell the machine and starts action to locate a buyer.
The machines are in short supply so john’s is confident that the machine to dismantle the machine
and market it available to the buyer.
Required:
At what value should the machine be stated in john’s company statement of financial position?
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Solution:
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Carrying amount = 8 x 200,000 = 160,000
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200,000 − 0
200,000 − 2 = 160,000
10
Fair value
= 150,000 − 5,000
= 145,000
The machine qualifies as held for sale, so it should be stated at lower of ksh. 160,000 which is ksh
145,000
The impairment loss of ksh.15, 000 incurred in writing down the machine to fair value less costs to
sell will be charged to the income statement.
Illustration 2:
On January 20x0, XYZ purchased a machine for ksh.100, 000. It was expected that it would have a
useful life of 8 years and a residual value ksh.20.000. However, during 20x1 December, the

directors decided to sell the machine. The company removes the machine from the farm in readiness
for quick disposal and prepares the machine for viewing by potential purchasers. They appoint an
agent to assist with marketing and advertising. The agent advises that the disposal may take two to
six months but should be sold for ksh. 45,000.
Required:
Show the movement on the machine during the year ended 31st 20x1. And describe how the asset
should be disclosed on the statement of financial position at year end.
Solution:
Machine
Opening balance 90,000
Depreciation (10,000)
Closing 80,000
Balance impairment (35,000)
Recoverable amount 45,000
A discontinued operating is a component of an entity that has either been disposed of or is classified
as held for sale and
 Represent a separate major line of business or geographical area of operations

 Is part of single co-ordinated plan to dispose of a separate major line of business or
geographical area of operation or
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 Is a subsidiary acquired exclusively for resale
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Discontinued operations are required to be shown separately in order to help users to predict future
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performance.
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Presentation of operations in the financial statement
An entity must disclose a single amount on the face of income statement, comprising a total of:
 The post-tax profit/loss of discontinued operations.
 The post-tax gain or loss recognized on the measurement of fair values less costs to sell on
disposal, of the assets constituting the discontinued operations.
An analysis for this single amount must be presented, either in the notes on the face of income
statement.
The analysis must disclose:

 The revenue, expenses and pretax profit or loss of the discontinued operations
 The related income expense
 The gain or loss recognized on the measurement to fair value less cost to sell, or on the
disposal, of the assets constituting the discontinued operations.

Illustration:
Valentine produced cards and sold roses. However, halfway through the year ended 31st march 20x6,
the rose business was closed and assets sold of incurring losses on disposal of non-current assets of
$76,000 and redundancy costs of $37,000. The directors reorganized the continuing business at a
cost of $98,000. Trading results may be summarized as follows:
$ ‘000’ $’000’
Turnover 650 320
Cost of sales 320 150
Administration 120 110
Distribution 60 90
Other trading information is as follows:
Interest payable 17
Tax 31
Required:
Draft the income statement for the year ended 31st march 20x6.
Income statement for valentine for the year ended 31st march 20x6
$’000’
Continuing operations 650
Cost of sales (320)
Gross profit 330
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Administration costs (120)
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Distribution costs (60)
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Operating profit 150
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Reorganization costs (98)
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52
Finance costs(interest payable) (17)
Profit before tax 35
Income tax (31)
Profit for the period from continuing operations 4
Discontinued operations
Loss for the period from total operations (143)
Loss for the period from total operations (139)
In the notes to the accounts disclose analysis of the discontinued operations figure
$’000’
Revenue 320
Cost of sales (150)
Gross profit 170
Distribution costs (90)
Operating loss (30)
Loss on disposal (76)
Redundancy costs (37)
Overall loss (143)

BORROWING COSTS (IAS 23)
IAS 23 Borrowing Costs
The objective of this Standard is to prescribe the accounting treatment for borrowing costs.
Borrowing costs are interest and other costs incurred by an entity in connection with the borrowing
of funds.
Benchmark treatment – Borrowing costs shall be recognised as an expense in the period in which
they are incurred.
Allowed alternative treatment – Borrowing costs shall be recognised as an expense in the period in
which they are incurred, except to the extent that they are capitalised in accordance with paragraph
11.
Borrowing costs that are directly attributable to the acquisition, construction or production of a
qualifying asset shall be capitalised as part of the cost of that asset. The amount of borrowing costs
eligible for capitalisation shall be determined in accordance with this Standard. [Paragraph 11]
A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its
intended use or sale.
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To the extent that funds are borrowed specifically for the purpose of obtaining a qualifying asset, the
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amount of borrowing costs eligible for capitalisation on that asset shall be determined as the actual
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borrowing costs incurred on that borrowing during the period less any investment income on the
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temporary investment of those borrowings.
To the extent that funds are borrowed generally and used for the purpose of obtaining a qualifying
asset, the amount of borrowing costs eligible for capitalisation shall be determined by applying a
capitalisation rate to the expenditures on that asset. The capitalisation rate shall be the weighted
average of the borrowing costs applicable to the borrowings of the entity that are outstanding during
the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset.
The amount of borrowing costs capitalised during a period shall not exceed the amount of borrowing
costs incurred during that period.
The capitalisation of borrowing costs as part of the cost of a qualifying asset shall commence when:
(a) expenditures for the asset are being incurred;

(b) borrowing costs are being incurred; and
(c) Activities that are necessary to prepare the asset for its intended use or sale are in progress.
Capitalisation of borrowing costs shall be suspended during extended periods in which active
development is interrupted.

Capitalisation of borrowing costs shall cease when substantially all the activities necessary to
prepare the qualifying asset for its intended use or sale are complete.
The financial statements shall disclose:
(a) the accounting policy adopted for borrowing costs;

(b) the amount of borrowing costs capitalised during the period; and
(c) the capitalisation rate used to determine the amount of borrowing costs eligible for
capitalisation.
Definitions:
1. Borrowing costs;are interest and other costs incurred by an enterprise in connection with the
borrowing of funds.
2. Qualifying asset; is an asset that necessary takes a substantial of time to get ready for its intended
use/ sale.
Accounting Treatment
Borrowings costs that are directly attributable to the acquisition, construction or production of a
qualifying asset must be capitalized as part of the cost of that asset.
The amount of borrowing cost available for capitalization is that actual amount incurred less any
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investment income from temporary investment.
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Criteria for determining which borrowing costs are eligible for capitalization is as follows:
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Those borrowing costs directly attributable to the acquisition, construction or production of
qualifying assets. These are the borrowing costs that could be avoided at the expenditure of the
qualifying asset not made.
Difficulties arise however, where the enterprise uses a range of debt instrument to finance a wide
range of assets so that there’s no direct relationship between particular borrowing and a specific
asset.
In a situation where borrowings are obtained generally but are applied in part to obtaining a
qualifying asset, then the amount of borrowing costs eligible for capitalization is found by applying
the capitalization rate to the expenditure on the asset.
The capitalization rate is the weighted average of the borrowing costs applicable to the enterprise’s
borrowings that are outstanding during the period excluding borrowings made specifically to obtain
a qualifying asset.
Presentation of grants related to income
These grants are credited as either profits or loss but there is a choice in the method of disclosure
e.g.
a) Present as a separate credit or under a general heading e.g. other incomes
b) Deduct from the related expense
In some cases it can be argued that offsetting incomes and expenses in the statement of
comprehensive income is not a good practice it may also be argued that expenses would not have
been incurred and the grant not been available so off -setting the two is acceptable.
Although both methods are acceptable, disclosure of the grant may be necessary for a proper
understanding of the financial statement particularly the effect of any item of income or expense
which is required to be separately disclosed.
Repayment of Government Grants
If a grant has to be paid it must be accounted for as a revision of an accounting estimate (IAS 8)
a) Repayment of a grant related to income – apply first against any unamortized deferred
income set up in respect of the grant,i.e. any excess should be recognized immediately as an
expense.
b) Repayment of a grant related to an asset- Increase the carrying amount of an asset or reduced
deferred income balance by the amount repayable.
The cumulative additional depreciation that would have been recognized to date in the absence of
the grant should immediately be recognized as an expense.
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It’s possible that the circumstances surrounding the repayment may require a review of the asset
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value and an impairment of the new carrying amount of the asset.
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Government Assistance
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Some forms on government assistance are excluded from the financial statement due to the
following:
a) They cannot reasonably have a value placed on them e.g. free technical or marketing advice.
b) There’re transactions with government which cannot be distinguished from the entity’s
normal trading transactions e.g. government procurement policy resulting in a portion of the
entity’s sales.
Any segregation would be arbitrary.
Disclosures of such assistance may be necessary because of its significance i.e. its nature, extent and
duration should be disclosed.
Ceasationof Capitalization
Capitalization of borrowing governments’ shall cease when:
- Substantially all the activities necessary to prepare the qualifying asset for its intended use/
sale are completed.
- When the construction of a qualifying asset is completed in parts and each part is capable or
being used while construction continues on other parts, capitalization of borrowing costs shall
cease when substantially all the activities necessary to prepare that part for its intended use/
sale are completed.
ILLUSTRATION
On 1/1/2010 XY Ltd borrowed sh.30, 000,000 to finance the production of two assets both of which
were expected to take a year to build. Production started during the year 2011. The loan facility was
drawn down on 1/1/2010 and was utilized as follows, with the remaining funds invested temporarily.
Asset A B
sh sh
1Jan – 30th June 2011 5,000,000 10,000,000
1st July – 31st Dec. 2011 5,000,000 10,000,000
10,000,000 20,000,000
Interest on borrowings was nine percent per annum and idle funds can be invested to earn an interest
of seven percent.
Required:
a) Calculate the amount of borrowing cost to be capitalized

b) Calculate the total cost of the asset A and B as it would be represented in the financial
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statement.
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a. Borrowing cost to be capitalized
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Asset A B 450,000
1Jan – 30 June 2011 9% x 5m x 6/12 225,0000 9% x 10m x 6/12 450,000
1st July – 31 Dec. 2011 225,0000 900 000
450 000
Less: Investment Income
1st Jan-30th June (175,000) 7%x10m x 6/12 (350,000)
7%x5mx6/12
Borrowing costs to be 275,000 550,000

capitalized
b. Total cost of the asset

Assets A B
Cost of the asset 10,000,000 20,000,000
Add; borrowing cost 275,000 550,000
Total cost of the asset 10,275,000 20,550,000

Commencement of Capitalization
The capitalization of borrowings costs as part of the cost of an asset shall commence when:
a) Expenditure on the asset is being incurred

b) Borrowing costs are being incurred
c) Activities that are necessary to prepare the asset for its intended use/ sale are in progress.
Disclosures
The following should be disclosed in the financial statement in relation to borrowing costs:
a) Accounting policy adopted

b) Amount of borrowing costs capitalized during the period.
c) Capitalization rate used to determine the amount of borrowing costs eligible for
capitalization.
The standard lists what may be included in borrowing costs:
i. Interest on bank overdraft, short and long term borrowings

ii. Amortization of discounts or premium relating to borrowing
iii. Amortization of auxiliary costs incurred in connection with arrangements of borrowings.
iv. Finance charges in respect of finance leases recognized in accordance with IAS 17.
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The standards also give examples of qualifying assets:
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a) Inventories that require a substantial period of time to bring them to a saleable condition.
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b) Manufacturing plants
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c) Power generation facilities
d) Investment properties
N/B: Inventories produced in bulk over short periods and on a regular basis are not qualifying assets
nor are assets ready for sale or their intended use when purchased.
Suspension of capitalization
If active developments are interrupted for any extended periods, capitalization for borrowing costs
should be suspended for those periods.
Suspension of capitalization of borrowing costs is not necessary for temporary delays or for periods
when substantial technical or administrative work is taking place.
Temporary delays occur when it’s a necessary process of getting an asset ready for its intended use/
sale.
For example, capitalization continues during extended periods needed for stocks.

INVESTMENT PROPERTY ( IAS 40)
Investment property is property (land or a building—or part of a building—or both) held (by the
owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both, rather
than for:
(a) Use in the production or supply of goods or services or for administrative purposes; or
(b) Sale in the ordinary course of business.
A property interest that is held by a lessee under an operating lease may be classified and accounted
for as investment property provided that:
a) The rest of the definition of investment property is met;

b) the operating lease is accounted for as if it were a finance lease in accordance with IAS 17
Leases; and
c) The lessee uses the fair value model set out in this Standard for the asset recognised.
Investment property shall be recognised as an asset when, and only when:
(a) It is probable that the future economic benefits that are associated with the investment
property will flow to the entity; and
(b) The cost of the investment property can be measured reliably.
An investment property shall be measured initially at its cost. Transaction costs shall be included in
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the initial measurement.
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The initial cost of a property interest held under a lease and classified as an investment property
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shall be as prescribed for a finance lease by paragraph 20 of IAS 17, i.e. the asset shall be recognised
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at the lower of the fair value of the property and the present value of the minimum lease payments.
An equivalent amount shall be recognised as a liability in accordance with that same paragraph.
The Standard permits entities to choose either:
(c) a fair value model, under which an investment property is measured, after initial
measurement, at fair value with changes in fair value recognised in profit or loss; or
(d) a cost model. The cost model is specified in IAS 16 and requires an investment property to be
measured after initial measurement at depreciated cost (less any accumulated impairment
losses). An entity that chooses the cost model discloses the fair value of its investment
property.
The fair value of investment property is the price at which the property could be exchanged between
knowledgeable, willing parties in an arm’s length transaction.
An investment property shall be derecognised (eliminated from the balance sheet) on disposal or
when the investment property is permanently withdrawn from use and no future economic benefits
are expected from its disposal.

Gains or losses arising from the retirement or disposal of investment property shall be determined as
the difference between the net disposal proceeds and the carrying amount of the asset and shall be
recognised in profit or loss (unless IAS 17 requires otherwise on a sale and leaseback) in the period
of the retirement or disposal.
FINANCIAL INSTRUMENTS ( IAS 32)
Financial instruments
A financial instrument gives rise to a financial asset of one entity and a financial liability or equity
instrument of another.
Introduction
If you read the financial press you will probably be aware of rapid international expansion in the use
of financial instrument/These vary from straightforward, traditional instruments, e.g. bonds, through
to various forms of so-called 'derivative instruments'.
We can perhaps summarize the reasons why a project on accounting for financial instruments was
considered necessary as follows.
a) The significant growth of financial instruments over recent years has outstripped the
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development of guidance for their accounting.
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b) The topic is of international concern; other national standard-setters are involved as well as
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the IASB.
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c) There have been recent high-profile disasters involving derivatives which, while not caused
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by accounting failures, have raised questions about accounting and disclosure practices.
Four accounting standards deal with financial instruments:
a) IAS 32 Financial instruments: presentation, which deals with:

i) The classification of financial instruments between liabilities and equity
i. ii) Presentation of certain compound instruments (instruments combining debt and equity)
b) IAS 39 Financial instruments: recognition and measurement, which deals with:
i) Recognition and derecognition
ii) The measurement of financial instruments
iii) Hedge accounting (not in your syllabus)
c) IFRS 7 Financial instruments: disclosure
d) IFRS 9 Financial instruments. IFRS 9 deals with recognition and measurement of financial
assets.
Liabilities are still accounted for in accordance with IAS 39 and assets can also still be accounted for
under IAS 39.

Financial asset:
Any asset that is:
(i) Cash;
(ii) An equity instrument of another entity;
(iii) A contractual right:
 To receive cash or another financial asset from another entity; or
 To exchange financial assets or financial liabilities with another entity under conditions that
are potentially favorable to the entity; or
 A contract that will or may be settled in the entity’s own equity instruments and is:
 A non-derivative for which the entity is or may be obliged to receive a variable number of
the entity’s own equity instruments; or
 A derivative that will or may be settled other than by the exchange of a fixed amount of cash
or another financial asset for a fixed number of the entity’s own equity instruments.
For this purpose an entity’s own equity instruments does not include instruments that are themselves
contracts for the future receipt or delivery of the entity’s own equity instruments.
Financial liability:
Any liability that is a contractual obligation:
 To deliver cash or another financial asset to another entity; or
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 To exchange financial assets or financial liabilities with another entity under conditions that
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are potentially unfavorable to the entity; or
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 A contract that will or may be settled in the entity’s own equity instruments
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Fair value:
The amount for which an asset could be exchanged or a liability settled, between knowledgeable,
willing parties in an arm’s length transaction.
The definition of financial instrument used in IAS 32 is the same as that in IAS 39.
Equity instrument:
It as any contract that evidences a residual interest in the assets of an entity after deducting all of its
liabilities.
The definitions of financial assets and financial liabilities may seem rather circular, referring as
they do to the terms financial asset and financial instrument. The point is that there may be a chain
of contractual rights and obligations, but it will lead ultimately to the receipt or payment of cash or
the acquisition or issue of an equity instrument.
Examples of financial assets include:

(a) Trade receivables
(b) Options
(c) Shares (when held as an investment)
Examples of financial liabilities include:
(a) Trade payables

(b) Debenture loans payable
(c) Redeemable preference (non-equity) shares.
IAS 32 makes it clear that the following items are non-financial instruments.
a) Physical assets, e.g. inventories, property, plant and Equipment, leased assets and intangible
assets (patents, trademarks etc.)
b) Prepaid expenses deferred revenue and most warranty obligations
c) Liabilities or assets that are not contractual in nature
Financial Instruments has become a very important area in accounting especially because of the
developments in financial markets as far new derivatives and other financial instruments. Many
companies had ignored the recording and accounting for such instruments and this has been
disastrous as big companies like Enron collapsed. There has been an issue with IAS 32 which deals
with Presentation, IAS 39 which deals with recognition and measurement and IFRS 7 which deals
with Disclosure. IFRS 7 applies to periods commencing from 2007 and supersedes the presentation
part of IAS 32.
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The main objectives of the three standards are to ensure that financial instruments are properly
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accounted for and adequate disclosure is made by the companies. The three standards are very
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comprehensive especially IAS 39 which includes detailed illustration on how to treat the financial
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instruments in the accounts.
Presentation of financial instruments
Scope
IAS 32 should be applied in the presentation and disclosure of all types of financial instruments.
Certain items are excluded for example subsidiaries, associates and joint ventures, pensions and
insurance contracts.
Liabilities and equity
The main thrust of IAS 32 is that financial instruments should be presented according to their
substance, not merely their legal form. In particular, entities which issue financial instruments
should classify them (or their component parts) as either financial liabilities, or equity.
The classification of a financial instrument as a liability or as equity depends on the following.
 The substance of the contractual arrangement on initial recognition

 The definitions of a financial liability and an equity instrument
How should a financial liability be distinguished from an equity instrument? The critical feature of a
liability is an obligation to transfer economic benefit. Therefore a financial instrument is a financial
liability if there is a contractual obligation on the issuer either to deliver cash or another financial
asset to the holder or to exchange another financial instrument with the holder under potentially
unfavorable conditions to the issuer.
Where the above critical feature is not met, then the financial instrument is. an equity instrument.
IAS 32 explains that although the holder of an equity instrument may be entitled to a pro rata share
of any distributions out of equity, the issuer does not have a contractual obligation to make such a
distribution.
For instance, a company is not obliged to pay a dividend to its ordinary shareholders. Although
substance and legal form are often consistent with each other, this is not always the case. In
particular, a financial instrument may have the legal form of equity, but in substance it is in fact a
liability. Other instruments may combine features of both equity instruments and financial liabilities.
For example, many entities issue preference shares which must be redeemed by the issuer for a fixed
(or determinable) amount at a fixed (or determinable) future date. Alternatively, the holder may have
the right to require the issuer to redeem the shares at or after a certain date for a fixed amount. In
such cases, the issuer has an obligation. Therefore the instrument is a financial liability and should
be classified as such.
The distinction between redeemable and non-redeemable preference shares is important. Most
preference shares are redeemable and are therefore classified as a financial liability.
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Compound financial instruments
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Some financial instruments contain both a liability and an equity element. In such cases, IAS 32
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requires the component parts of the instrument to be classified separately, according to the substance
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of the contractual arrangement and the definitions of financial liability and an equity instrument.
One of the most common types of compound instrument is convertible debt. This creates a primary
financial liability of thtis5uer and grants an option to the holder of the instrument to convert it into
an equity instrument (usually ordinary shares) of the issuer. This is the economic equivalent of the
issue of conventional debt plus a warrant to acquire shares in the future.
Although in theory there are several possible ways of calculating the split, IAS 32 requires the
following method:
a) Calculate the value for the liability component.

b) Deduct this from the instrument as a whole to leave a residual value for the equity
component.
The reasoning behind this approach is that an entity's equity is its residual interest in lts assets
amount after deducting all its liabilities.
The sum of the carrying amounts assigned to liability and equity will always be equal to the carrying
amount that would be ascribed to the instrument as a whole.

ILLUSTRATION 2
Valuation of Compound Instruments
RuthTimo Company issues 2,000 convertible bonds at the start of 2002. The bonds have a three year
term, and are issued at par with a face value of Sh. 1,000 per bond, giving total proceeds of Sh.
2,000,000. Interest is payable annually in arrears at a nominal annual interest rate of 6%. Each bond
is convertible at any time up to maturity into 250 ordinary shares.
When the bonds are issued, the prevailing market interest rate for similar debt without convers on
optic is 9%.
Required
What is the value of the equity component in the bond?
SOLUTION
The liability component is valued first, and the difference between the proceeds of the bond issue
and the fair value of the liability is assigned to the equity component. The present value of the
liability component is calculated using a discount rate of 9%, the market interest rate for similar
bonds having no conversion right as shown.
Sh.
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Present value of the principal: Sh. 2,000,000 payable at the end of three years 1,544,367
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(Sh. 2mx 0.772183)
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Present value of the interest: Sh. 120,000 payable annually in arrears for three years
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(Sh. 120,000x2.5313) 303,755
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Total liability component 1,848,122
Equity component (balancing figure) 151,878
Proceeds of the bond issue 2,000,000
These figures can be obtained from discount and annuity tables or simply calculated arithmetically
as follows.
Principal Sh. Sh.

Sh. 2,000,000 discounted at 9% over 3 years: 1,544,367
2,000,000 + 1.09 +1.09 + 1.09 (or 2,000,000 x 1/1.093)
Interest
Year 120,000 + 1.09 110,091
Year 2 110,091 + 1.09 101,002
Year 3 101,002 + 1.09 92,662 303,755
Value of liability component 1,848,122
Equity component (balancing figure) 151,878
Proceeds of bond issue 2,000,000

The split between the liability and equity components remains the same throughout the term of the
instrument, even if there are changes in the likelihood of the option being exercised. This is
because it is not always possible to predict how a holder will behave. The issuer continues to have
an obligation to make future payments until conversion, maturity of the instrument or some other
relevant transaction takes place.
ILLUSTRATION 3
Convertible Debt
A company issues Sh. 20m of 4% convertible loan notes at par on 1 January 2009. The loan notes
are redeemable for cash or convertible into equity shares on the basis of 20 shares per Sh.100 of debt
at the, option of the loan note holder on 31 December 2011. Similar but non-convertible loan notes
carry an interest rate of 9%.
The present value of shs 1 receivable at the end of the year based on discount rates of 4% and 9%
can be taken as:
4% 9%
Sh. Sh.
End of year 1 0.96 0.92
2 0.93 0.84
3 0.89 0.77
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Cumulative 2.78 2.53
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Required;
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Show how these loan notes should be accounted for in the financial statements at 31 December
2009.
SOLUTION;
Sh ‘000’
Income statement
Finance costs (W2) 1,568
Statement of financial position

Equity - option to convert (W1) 2,576
Non-current liabilities
4% convertible loan notes (W2) 18,192

Workings
1. Equity and Liability elements
Sh. ‘000’
3 years interest (20,000 x 4% x 2.53) 2,024
Redemption (20,000 x 0.77) 15,400
Liability element 17,424
Equity element 2,576
Proceeds of loan notes 20,000
2. Loan note balance
Sh. ‘000’
Liability element(W1) 17,424
Interest for the year at 9% 1,568
Less interest paid (20,000 × 4%) (800)
Carrying value at 31 December 2009 18,192
Interest, dividends, losses and gains
As well as looking at presentation in the statement of financial position, IAS 32 considers how
financial instruments affect the income statement or statement of comprehensive income (and
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movements in equity). The treatment varies according to whether interest, dividends, losses or gains
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relate to a financial liability or an equity instrument.
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a) Interest, dividends, losses and gains relating to a financial instrument (or component part)
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classified as a financial liability should be recognized as income or expense in profit or
loss.
b) Distributions to holders of a financial instrument classified as an equity instrument
(dividends to ordinary shareholders) should be debited directly to equity by the issuer.
These will appear in the statement of changes in equity.
c) Transaction costs of an equity transaction should be accounted for as a deduction from
equity, usually debited to the share premium account.
Summary
 Issuers of financial instruments must classify them as liabilities or equity

 The substance of the financial instrument is more important than its legal form
 The critical feature of a financial liability is the contractual obligation to deliver cash or
another financial asset
 Compound instruments are split into equity and liability parts and presented accordingly
 Interest, dividends, losses and gains are treated according to whether they relate to a
financial liability or an equity instrument

IFRS 7: Financial Instruments
The objective of this IFRS is to require entities to provide disclosures in their financial statements
that enable users to evaluate:
(a) The significance of financial instruments for the entity’s financial position and performance;
and
(b) The nature and extent of risks arising from financial instruments to which the entity is
exposed during the period and at the reporting date, and how the entity manages those risks.
The qualitative disclosures describe management’s objectives, policies and processes for
managing those risks. The quantitative disclosures provide information about the extent to
which the entity is exposed to risk, based on information provided internally to the entity's
key management personnel. Together, these disclosures provide an overview of the entity's
use of financial instruments and the exposures to risks they create.
As well as specific monetary disclosures, narrative commentary by issuers is encouraged by the

Standard. This will enable users to understand management's attitude to risk, whatever the current
transactions involving financial instruments are at the period end.
The standard does not prescribe the format or location for disclosure of information. A combination
of narrative descriptions and specific quantified data should be given, as appropriate.
The level of detail required is a matter of judgment. Where a large number of very similar financial
instrument transactions are undertaken, these may be grouped together. Conversely, a single
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significant transaction may require full disclosure.
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Classes of instruments will be grouped together by management in a manner appropriate to the
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information to be disclosed.
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Recognition of financial instruments
IAS 39 Financial instruments: recognition and measurement establishes principles for recognizing
and measuring financial; assets and liabilities. Financial assets are now also accounted for under
IFRS 9.
Scope
IAS 39 and IFRS 9 apply to all entities and to all types of financial Instruments except those
specifically excluded, for example investments in subsidiaries, associates and joint ventures.
Initial recognition
A financial asset or financial liability should be recognized in the statement of financial position
when the reporting entity becomes a party to the contractual provisions of the instrument.
Notice that this is different from the recognition criteria in the Framework and in most other
standards.

Items are normally recognized when there is a probable inflow or outflow of resources and the item
has cost or value that can be measured reliably.
Derecognition
Derecognition is the removal of a previously recognized financial instrument from an entity's

statement of financial position.
An entity should derecognize a financial asset when:
a) The contractual rights to the cash flows from the financial asset expire; or
b) It transfers substantially all the risks and rewards of ownership of the financial asset to
another party.
An entity should derecognize a financial liability when it is extinguished i.e., when the obligation
specified in the contract is discharged or cancelled or expires.
It is possible for only part of a financial asset or liability to be derecognized. This is allowed if the
part comprises:
a) Only specifically identified cash flows; or

b) Only a fully proportionate (pro rata) share of the total cash flows.
For example, if an entity holds a bond it has the right to two separate sets of cash inflows: those
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relating to the principal and those relating to the interest. It could sell the right to receive the interest
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to another party while retaining the right to receive the principal.
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On derecognition, the amount to be included in net profit or loss for the period is calculated as
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follows:
Shs Shs
Carrying amount of asset/liability( or the portion of asset/liability) transferred X X
Less; proceeds received/ paid
Any cumulative gain or loss reported in equity X (X)
Difference to net profit/loss
X
Where only part of a financial asset is derecognized, the carrying amount of the asset should be
allocated between the part retained and the part transferred based on their relative fair values on the
date of transfer.
A gain or loss should be recognized based on the proceeds for the portion transferred.

Summary
 All financial assets and liabilities should be recognized in the statement of financial position.
 Financial assets should be derecognized when the rights to the cash flows from the asset expire
or where substantially all the risks and rewards of ownership are transferred to another party.
 Financial liabilities should be derecognized when they are extinguished.
Measurement of financial instruments
Initial measurement - IFRS 9
Financial instruments are initially measured at the fair value of the consideration given or received
(i.e., cost) plus (or minus in the case of financial liabilities) transaction costs that are directly
attributable to the acquisition or issue of the financial instrument.
The exception to this rule is where a financial instrument is designated as at fair value through profit
or loss (this term is explained below). In this case, transaction costs are not added to fair value at
initial recognition.
The fair value of the consideration is normally the transaction price or market prices. If market
prices are not reliable, the fair value may be estimated using a valuation technique (for example, by
discounting cash flows).
Subsequent measurement -IFRS 9
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After initial recognition, IFRS 9 requires an entity to measure financial assets to either amortized
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cost or fair value, based on:
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a) The entity's business model for managing the financial assets; and
b) The contractual cash flow characteristics of the financial asset
A financial asset is measured at amortized cost if both of the following conditions are met:
a) The asset is held within a business model whose objective is-to hold assets in order to collect
contractual cash flows
b) The contractual terms of the financial asset give rise on specified dates to cash flows that are
solely payments of principal and interest on the principal amount outstanding.
After initial recognition, all financial assets other than those held at fair value through profit or loss
should be re-measured to either fair value or amortized cost.
IFRS 9 allows the option to initially measure a financial asset at fair value through profit or loss
where a mismatch would otherwise arise between the asset and a related liability. In this case, the
asset will also be subsequently measured at fair value through profit or loss.
A financial asset or liability at fair value through profit or loss meets either of the following
conditions:

a) It is classified as held for trading. A financial instrument is classified as held for trading if it
is:
i) Acquired or incurred principally for the purpose of selling or repurchasing it in tile near
term;
ii) Part of a portfolio of identified financial instruments that are managed together and for
which there is evidence of a recent actual pattern of short-term profit-taking
b) Upon initial recognition it is designated by the entity as at fair value through profit or loss.
Subsequent measurement -IAS 39
IAS 39 is still largely in use as mandatory application of IFRS 9 does not begin until January 2013.
IAS 39 classifies financial assets under the following additional categories:
Held-to-maturity investments are non-derivative financial assets with fixed or determinable

payments and a fixed maturity date, which the entity has the positive intent and ability to hold to
maturity.
Loans and receivables are non-derivative financial assets with fixed or determinable payments that
are not quoted in an active market.
Both held to maturity investments and loans and receivables are carried at amortized cost.
Available-for-sale financial assets are those financial assets that are not:
a) Loans and receivables originated by the entity
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b) Held-to-maturity investments
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c) Financial assets at fair value through profit or loss
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Available-for-sale financial assets are carried at fair value with gains and losses recognized directly
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in equity (other comprehensive income).
Amortized cost
Assets held at amortized cost is measured using the effective interest method.
Amortized cost of a financial asset or financial liability is the amount at which the financial asset or
liability is measured at initial recognition minus principal repayments, plus or minus the cumulative
amortization of any difference between that initial amount and the maturity amount, and minus any
write- down for impairment or uncollectability.
The effective interest method is a method of calculating the amortized cost of a financial instrument
and of allocating the interest income or interest expense over the relevant period.
ILLUSTRATION 4
Amortised Cost
On 1 January 2001 Abacus Co purchases a debt instrument for its fair value of Sh 1,000. The debt
instrument is due to mature on 31 December 2005. The instrument has a principal amount of Sh
1,250 and the instrument carries fixed interest at 4.72% that is paid annually. The effective rate of
interest is 10%.
How should Abacus Co account for the debt instrument over its five year term?
SOLUTION
Abacus Co will receive interest of Sh 59 (1,250×4.72%) each year and Sh 1,250 when the
instrument matures.
Abacus must allocate the discount of Sh 250 and the interest receivable over the five year term at a
constant rate on the carrying amount of the debt. To do this, it must apply the effective interest rate
of 10%. The following table shows the allocation over the years:
Year Amortised cost Income statement: Interest received Amortised cost

at Interest income for year during year (cash at end of year
beginning of (@10%) inflow) Sh
year Sh Sh
Sh
2001 1,000 100 (59) 1,041
2002 1,041 104 (59) 1,041
2003 1,086 109 (59) 1,086
2004 1,136 113 (59) 1,136
2005 1,190 119 (1,250+59) 1,190
Each year the carrying amount of the financial asset is increased by the interest income for the year
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and reduced by the interest actually received during the year.
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SUBSEQUENT MEASUREMENT OF FINANCIAL LIABILITIES
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After initial recognition, in accordance with IAS 39, alt financial liabilities should be" measured at
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amortised cost, with the exception of financial liabilities at fair value through profit or loss. These
should be measured at fair value, but where the fair value is not capable of reliable measurement,
they should be measured at cost.
ILLUSTRATION 5
Galaxy Co issues a bond for Sh 503,778 on 1 January 2002. No interest is payable on the bond, but
it will be held to maturity and redeemed on 31 December 2004 for Sh 600,000. The bond has not
been designated as at fair value through profit or loss. The effective interest rate is 6%.
Required;
Calculate the charge to the income statement of Galaxy Co for the year ended 31 December 2002
and the balance outstanding at 31 December 2002.

SOLUTION
The bond is a 'deep discount' bond and is a financial liability of Galaxy Co. It is measured at
amortised cost.
Although there is no interest as such, the difference between the initial cost of the bond and the price
at which it will be redeemed is a finance cost. This must be allocated over the term of the bond at a
constant/ate on the carrying amount. This is done by applying the effective interest rate.
The charge to the income statement is Sh 30,226 (503,778 ×6%)
The balance outstanding at 31 December 2002 is Sh 534,004 (503,778 + 30,226).
Gains and losses
Instruments at fair value through profit or loss: gains and losses are recognized in profit or loss (i.e.,
in the income statement).
Financial instruments held at fair value: gains and losses are recognized in profit or loss unless the
financial asset is an equity instrument and the entity made an election upon initial recognition to
present gains and losses directly in equity through the statement of comprehensive income.
Dividends from the investment will be recognised in profit or loss.
Financial instruments carried at amortized cost: gains and losses are recognized in profit or toss as a
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result of the amortization process and when the asset is derecognized.
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LEASES
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Accounting For Leases IAS 17
Most organizations use assets which they’ve not yet paid for them in full. Those assets would either
be taken back to the owner or would remain in possession of the enterprise.
Such types of arrangements are known as lease contracts.
Introduction
Lease is an agreement whereby the lessor conveys to the lessee, in return for rent, the right to use an
asset for an agreed period of time. The lessor remains the owner but lessee has a right to use the
equipment for agreed rentals to be paid over a period. Though the lessee has an unrestricted right of
use of the lease equipment but does not become the owner. The lease contract will cover lease
period, the amount and timing of payments to be made by the lessee, provision of payment of taxes,
insurance, maintenance expenses and provision for renewal of the lease or purchase of asset at the
expiration of the lease period.
This standard shall be applied in accounting for all leases other than:
i) Leases to explore for or use minerals or natural gas and similar non-regenerative resources.
ii) Licencing agreements for such items as motion picture films, video recordings, plays,
patents and copyrights.
Definitions of Terms
1. Lease
It’s an agreement whereby the lessor converges to the lessee in return for a payment or a series of
payments. The right to use an asset for a period of time.
2. Finance lease
Is an agreement that transfer substantially all the risks and rewards incidental to ownership of an
asset. Title may or may not eventually be transferred.
3. Operating lease
This is an agreement that do not transfer all risks and rewards incidental to ownership of an asset.
Title would number be transferred to the other party i.e. the asset remains as owned by the owner
therefore an operating lease is a lease other than a finance lease.
4. Minimum lease payments
These are payments over the lease term that the lease is or can be required to make excluding
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contingent, rent, costs for services and taxes to be paid by and reimbursed to the lessor.
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5. Guaranteed residual value
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i) For a lessee, that part of the residue value that is guaranteed by the lessee or by a party related to
the lessee (the amount of the guarantee being the maximum amount that would be in even event
become payable)
ii) For a lessor, that part of a residue value that is guaranteed by the lessee or by a third party and
related to the lessor i.e. financial capable of discharging the obligations under the guarantee.
6. Unguaranteed residual value
Is that portion of the residual value of the lease asset, the realization of which by the lessor, is not
assured or is guaranteed solely by a party related to the lessor.
7. Gross investment to the lease
This is the aggregate of:
i) Minimum lease payments receivable by the lessor under a finance lease.

ii) Any unguaranteed residue value accruing to the lessor
8. Net investment in the lease

Discounted at the interest rate implicit in the lease
9. Interest rate implicit in the lease
This is the discount rate at the inception of the lease causes the aggregate PV of:
a) The minimum lease payments

b) The unguaranteed residue, value to be equal to the sum of:
i) The fair value of the leased asset
ii) Any initial direct cost of the lessor
- Unearned residue:
This is the difference between:
a. The gross investment to the lease

b. The net investment to the lease
Classification of the Lease
In general lease means allowing a person to use a property on payment of a certain amount of money
in installment as agreed between the lessor and lessee. A contract of lease may be classified into
three types:
1. Finance lease
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2. Leveraged lease
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3. Operating lease
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1. Finance (Or Capital) Lease
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It’s a lease under which the present value of the minimum lease payments at the inception of the
lease exceeds or is equal to substantially the whole of the fair value of the leased asset. This method
of financing the asset is similar to that of borrowing for acquisition of an asset. The asset is acquired
immediately without making any payment for it. Contract made under this type of lease is
irrevocable or non-cancellable. The lessor will try to recover his original investment of equipment
plus a reasonable return on such investment during the lease term.
Characteristics of a finance lease
i. The lessor transfers ownership of the asset to the lessee at the end of the lease term.
ii. The lessee has the option to purchase the asset at a price that is expected to be sufficiently
lower than the fair value at the date the option becomes exercisable for it to be reasonably
certain at the inception of the lease that the option will be exercised.
iii. The lease term is for major part of economic life of the asset even if the title is not
transferred.
iv. At the inception of the lease, the present value of minimum lease payment approximates the
fair value above 90%.
v. If the leased asset is of a specialised nature such that it is only the lessee who can use it
without any major modification.
vi. If the lessee cancels the lease agreement at any time, any cancellation losses incurred by the
lessor will be borne by the lessee.
vii. If fluctuations gain or losses in relation to the residue value will be borne by the lessee.
Disclosure requirements for finance lease As per IAS 17
1. A reconciliation between the total future minimum lease payments and their present value.In
addition, an entity shall disclose the total of future minimum lease payments at the balance
sheet dates and their present value for each of the following period: -
i) Not later than one year
ii) Later than one year and not later than 5 years
iii) Later than five years
2. For each class of assets, the net carrying amount at the balance sheet date.
3. Contingent rents recognised as an expense.
4. The total of the future minimum sub-leases payment expected to be received under non-
cancellable sub-leases as at the balance sheet date.
5. A general description of significant leasing arrangements.
In the case of finance lease, the financial statements should include:

 The gross investment in the lease depicted by the sum of the minimum lease payments and
the estimated residual value
 The difference between the gross investment and its present value as unearned income to be
recognized as earned over the life of the lease
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The sale price will be shown at the present value of the minimum lease payments deducting from the
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same, the cost of sale comprising of the cost of the leased property and other initial direct cost
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incidental to the same less the present value of the residual.
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Presentation of financial statements
Disclosures in the financial statements of lessor

In the case of finance lease, the financial statements should include:
 The gross investment in the lease depicted by the sum of the minimum lease payments and
the estimated residual value
 The difference between the gross investment and its present value as unearned income to be
recognized as earned over the life of the lease
 The sale price will be shown at the present value of the minimum lease payments deducting
from the same, the cost of sale comprising of the cost of the leased property and other initial
direct cost incidental to the same less the present value of the residual.
Disclosures in the financial statements of lessee
 Disclosures should be made of the amount of the assets that are subject of finance leases at
each balance sheet date. Liabilities, differentiating between the current and long-term portions.

 Commitments for minimum lease payments under finance leases and under non-cancellable
operating lease with a term of more than one year should be disclosed in summary form giving
the amounts and periods in which the payments will become due.
 Disclosures should be made of significant financing restrictions, renewal or purchase options,
contingent rentals and other contingencies arising from leases.
 Disclosures should be made of the basis used for allocating income so as to produce a constant
periodic rate of return, indicating whether the return relates to the net investment outstanding
or the net cash investment outstanding in the lease. If more than one basis is used, the bases
should be disclosed.
 When a significant part of the lessor’s business comprises operating leases, the lessor should
disclose the amount of assets by each major class of asset together with the related
depreciation at each balance sheet date.
 Apart from the disclosures recommended above the lessor should disclose the accounting
policies followed with regard to accounting for income under finance lease, valuation of assets
given on the lease and charge for depreciation.
Accounting Entries in the Books ofthe Lessor
1. Gross Investment In The Lease
This is the total of:
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a) The minimum lease payments receivable by the lessor under finance leases.
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b) Any unguaranteed residue value accruing to the lessor.
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2. Net Investment In The Lease
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This is the gross investment in the lease discounted at the interest rate implicit in the lease i.e. it is
the present value of the gross investment discounted at the interest rate implicit in the lease.
3. Un Earned Finance Income
This is the difference between the gross investment in the lease and the net investment in the lease:
NB
i) The lessor should recognise the assets under finance leases in their balance sheet and present
them as receivables at an amount equal to the gross investment.
ii) The initial direct costs that may be incurred by the lessor e.g. legal fees for negotiating and
securing a lease agreement, commission etc. should be included in the initial measurement of
the finance lease receivable. Subsequently, the amounts received by the lessor should be
allocated over the lease term on a systematic basis.

Journal Entries
Accounting entries in the books of the lessor
When the equipment is purchased on lease
Dr: Equipment A/c

Cr: Cash A/c
When the contract is signed and property leased out to the lessee
Dr: Rent receivable A/c
Cr: Equipment a/c
When first instalment on lease is received
Dr: Cash A/c
Cr: Rent receivable A/c
At end of first year
When interest becomes receivable
Dr: Interest receivable a/c

Cr: Interest a/c
When the amount is received in respect of interest and rent
Dr: Cash a/c
Cr: Rent receivable a/c
Cr: Interest receivable a/c
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At the end of last year
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When the equipment is sold and lease is terminated
Dr: Cash a/c

Cr: Income on sale of equipment a/c
At the end of last year
When the equipment is purchased and lease is terminated
Dr: Equipment a/c

Cr: Cash a/c
When accumulated depreciation is transferred to equipment a/c at the time of termination of
the lease and purchase of the asset
Dr: Accumulated depreciation a/c
Cr: Equipment a/c
ILLUSTRATION 2
a) A lessor leases out an asset on terms which constitute a finance lease. The primary period is five
years commencing 1 July 2010 and the rental payable is Sh.3, 000,000 per annum (in arrears). The
lessee has the right to continue the lease after the five-year period referred to an indefinite period at a
nominal rent. The cash price of the asset in question as at 1 July 2010 can be assumed to be Sh.11,
372,000. The rate of interest implicit in the lease is 10%.
Required:
Show the accounting entries in the leaser’s books (Apply the requirements of IAS 17-Leases).
SOLUTION
1. Gross investment
5 instalments 5 x 3m = 15 million
Unguaranteed residual value –
15 million
2. Net investment
–( . )
5 instalments 3,000,000 × − 5 = 11.372,360
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3. Unearned finance income

Gross investment 15,000
Net investment (11,372)
3,628
4. Journal entry 1st July 2010
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Dr. Lease rental receivable 15,000,000
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Cr. Leased asset 11,372,000
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Cr. Unearned finance income (b.f) 3,628,000
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To record the inception of a finance lease in the books of the lessor
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5. Receipt schedule
Period Cash received Finance income Net invest. Bal. net invest
Shs ‘000' 10% Rec. Shs ‘000'
Shs ‘000' Shs ‘000'
At inception - - - 11,372
30th June 11 3,000 1,137 1,863 9,509
30th June 12 3,000 951 2,049 7,460
30th June 13 3,000 746 2,254 5,206
30th June 14 3,000 521 2,479 2,727
30th June 15 3,000 273 2,727 0

6.
30th June 11 30th June 12 30th June 13 30th June 14 30th June15
Dr. cash book 3,000 3,000 3,000 3,000 3,000
Cr. Leases asset rec. 3,000 3,000 3,000 3,000 3,000
To record receipts under finance lease

30th June 11 30th June 12 30th June 13 30th June 14 30th June 15
Dr. unearned finance Inc. 1,137 951 746 521 273
Cr. Earned finance Inc. 1,137 951 746 521 273
To record earned finance income
Accounting For Finance Leases In The Books Of The Lessee
Accounting transactions and other events should always be presented in accordance with economic
substance and financial reality and not merely in accordance with the legal interpretation. Although
the legal form of a finance lease is that the title may or may not eventually be transferred to the
lessee.
The following steps should be followed in accounting for finance leases in the books of the lease.
a) At the commencement of the lease term the lessee shall recognise the finance lease as an
asset and a liability at amounts equal to their fair value or if lower the present value of the
minimum lease payments.
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(The discounting rate to be used in calculating the present value of minimum lese payment
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should be the lessor’s implicit interest rate if this is practical to determine. Otherwise the
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lessee’s incremental borrowing rate should be used).
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Dr. leased Asset Lower of fair value
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Cr. Obligation under finance lease PV of minimum lease payment
b) Any initial direct loss of the lease incurred in connection with the leasing activities such as
negotiating and securing a lease agreement is added to the amount recognised as the asset.
c) Minimum lease payment made by the lessee should be apportioned between the
outstanding obligation under the finance lease and the finance cost. The finance cost
should be based on the remaining balance of the liability of each period.
d) Depreciation is to be provided for depreciable leased assets. The depreciation policy for
depreciable leased asset should be consistent with that used for depreciating assets that are
owned (freehold).
Journal Entries
When contract is signed and property acquired and the liability is assumed
Dr: Equipment a/c

Cr: Rent obligation a/c

When first instalment payment of rental obligation is made
Dr: Rental obligation a/c
Cr: Cash a/c
At the end of first year
When interest becomes payable

Dr: Interest a/c
Cr: Interest payable a/c
When the payment is made for rental and interest

Dr: Rental obligation a/c
Interest payable a/c
Cr Cash a/c
When depreciation at the end of the year is charged

Dr: Depreciation a/c
Cr: Accumulated depreciation a/c
When insurance, maintenance, taxes are paid

Dr: Insurance/maintenance/taxes a/c
Cr: Cash a/c
The above entries are repeated in each of the subsequent years.
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ILLUSTRATION 3
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ABC Ltd initiates the leasing of equipment from XYZ Ltd on 1st Jan 2008. The equipment had
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unexpected useful life of 3 years. It was to revert back to the lessor on the expiry of the lease
agreement on 31st Dec 2010.The fair value of the equipment at the inception of the lease was Sh.13.5
million. Three payments are due to the lessor at an amount of Sh. 5 million p.a beginning 31st Dec
2008.An additional sum of Sh. 1 million is paid annually by the lessee for insurance. ABC Ltd
guarantees a Sh. 1 million residue value on 31st Dec 2010 to the lessor ABC Ltd incremental
borrowing rate is 10% and XYZ Ltd implicit rate is unknown. The salvage value of the equipment
was Sh.100, 000.
Required:
i. Relevant journal entries to record the above transactions in the book of ABC Ltd.
ii. Prepare the balance sheet extract as at 31st Dec 2008 to 31st Dec 2010.
SOLUTION
Steps to be followed:
1. The classification: - The lease should be classified as a finance lease since the lease term
equals to the economic useful life.

2. PV of minimum lease payment Vs. fair value
- Fair value : 13.5 million

- Annual lease payment Sh. : 5 million
- Discounting factor : 10%
- Guaranteed residue value 1 million
a) Minimum lease payment
Annual lease payment 5 million × 3 years = 15 million

Guaranteed residue value I million
16 million
b) PV of minimum lease payment @ 10%
–( . )
- Annual lease 3,000,000 × − 5 = 11.372,360
.
- Guaranteed residual value 1m x (1 + 0.1)-3 = 751,315
PV of minimum lease payment 13,185,575
13,185,575
= 98%
13,500,000
The lease should be classified as a finance lease since the PV of minimum lease payment
approximately same as the fair value.
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3. Journal entry on 1st Jan 2008
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Dr. Leased asset 13,185,575
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Cr. Obligation under finance lease 13,185,575
To record the inception of a finance lease in the books of the lessee
4. Repayment schedule
Period Cash Finance cost Obligation Bal. of

payment 10% period obligation
At inception - - - 13,185,575
31st Dec 08 5,000,000 13,180,558 3,681,442 9,504,133
31st Dec 09 5,000,000 950,413 4,049,587 5,454,546
31st Dec 10 5,000,000 545,455 4,454,545 1,000,000
5. Depreciation charge
13,185,575
= 4, 361, 858
3

Journal Entries
2008 2009 2010

Dr. Obligation under finance lease 3,681,442 4,049,587 4,454,545
Dr. Finance cost 1,318,558 950,413 545,455
Dr. Insurance expense 1,000,000 1,000,000 1,000,000
Cr. Cash book 6, 000,000 6,000,000 6,000,000
(To record payment under finance lease)
Dr. Depreciation expense 4,361,858 4.361,858 4361858

Cr. Accumulated depreciation 4361858 4361858 4361858
(To record depreciation expense)
Dr. Accumulated Depreciation 13,085,574 (4361585 ×3)

Dr. Obligation under finance lease 1,000,000
Cr. leased asset 13,185,575
Cr.cash book 900,000
(To record the reversion of the leased asset to the lessor)
ABC Ltd Balance Sheet
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Assets 2008 2009
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Leased assets 13,185,575 13,185,575
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Accumulated depreciation (4,361,858) (8,723,716)
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8,823,717 4,461,859
Non-Current Liabilities -
Obligation under finance lease 5,454,546
Current Liabilities 4,049,587 5,454,546
2. Leverage Leases
A leveraged lease is a finance lease which has all the following characteristics:
 It involves at least three parties; a lessee, a lessor and one or more long term creditors
 The creditor’s recourse to the lessor in the event of default is restricted to the proceeds from
the disposal of the leased asset and any unremitted rentals relating thereto; and
 The lessor’s investment in the lease declines in the early years of the lease and rises in later
years before its final elimination.
This is used in those cases where huge capital outlays are required for acquiring assets. In this type
also, the lessee makes contract for periodical payments over the lease period and in turn is entitled to
use the asset over the period of time. Legal ownership of the leased asset remains with the lessor
who is, therefore, entitled to tax deductions such as depreciation and other allowances.

It is appropriate therefore, that the method of finance income recognition on leveraged lease should
take account of the cash flows resulting from the tax benefits. It is proposed to define leveraged
leases and require that finance income from such leases should be recognized using the net cash
investment method.
Net Cash Investment Method
The net cash investment in the lease is the balance of the cash outflows and inflows in respect of the
lease, excluding flows relating to insurance, maintenance and similar costs rechargeable to the
lessee. The cash outflow includes payments made to acquire that asset, tax payments, interest and
principal on third party financing. Inflows include rentals receipts, receipts from residual values and
grants, tax credits and other savings or repayments arising from the lease.
Under the net cash investment, a lessor recognizes finance income based on a pattern reflecting a
constant periodic return on its net cash investment outstanding in respect of the finance lease.
Lease rentals relating to the accounting period, excluding costs for services, are applied against gross
investment in the lease to reduce the principal and the unearned finance income. Hence, this method
usually involves using a net-of-tax basis for the allocation of income.
The net cash investment method is often considered to be the most appropriate method of accounting
for finance income from lease that have been entered into largely on the basis of the tax benefits that
are expected to flow from the lease.
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Net Investment Method
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The net investment in the lease is the gross investment in the lease less any unearned finance
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income. Remaining unearned income is allocated to revenue over the lease term so as to produce a
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constant periodic rate of return on the net investment in the lease. The use of the net investment
method is usually supported on the basis that the lessor earns income for lending money to the
lessee, which at any particular time is the amount of the outstanding net investment in a lease.
3. Operating Or (Cancellable Lease)
A lease is classified as an operating lease if it does not secure for the lessor the recovery of his
capital outlay plus a return on the funds invested during the lease term. Therefore, the asset should
be treated by the lessor as a fixed asset and rentals receivable should be included in income over the
lease term.
Costs, including depreciation, incurred in earning the rental income should be charged to income.
Initial direct costs incurred by lessor in negotiating and arranging the lease should be expensed in
the year in which they are incurred.
Lease rentals in the books of the lessee should be accounted for on accrual basis over the lease term
so as to recognise an appropriate charge in this respect in the profit and loss account with a separate
disclosure thereof. The excess of lease rentals paid over the amounts accrued in respect thereof
should be treated as prepaid lease rental and vice versa.

Presentation of financial statements
Financial Accounting Standards Board and International Accounting Standards Committee have
issued a number of guidelines in this regard. The following are the factors to be disclosed in the
financial statements under operating lease by the lessee:
 Future minimum rental payment required as on date on the presentation of the balance sheet,
both as aggregate and year wise for the succeeding 5 years
 The total minimum rental from lease to be received in future on sub-leases and
 Rental expenses for the period to which the income statement relates, classifying the amount
into minimum rental, consignment rental and sub-lease rentals
For finance lease, the gross amount of assets as on the date of balance sheet distinguishing according
to nature and functions disclosed. The amount of accumulated amortization expenses should be
disclosed in full. Again the total amount of future lease payments due in aggregate and for each year
for the succeeding five years is to be stated.
Accounting Entries in The Books Of Lessee
Accounting treatment
The operating lease payments excluding the cost of services i.e. insurance and maintenance cost are
recognised as an expense on a straight line basis over the lease term unless another systematic basis
that is more representative of the time pattern of the users benefits can be determined.
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In the books of the lessee
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i. The lessee will not recognize the leased asset in the statement of financial position.
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ii. Rentals of operating lease should be charged to P&L on a straight line basis over the term of
the lease.
iii. Any difference between the amounts charged and paid should be adjusted to prepayments or
accruals.
iv. Any incentives given by the lessor should also be recognized over the life of the lease on a
straight line basis.
When rent is paid on the leased property.
Dr: Rent A/c

Cr: Cash A/c
The entry will be repeated in subsequent years till the lease expires.
ILLUSTRATION 1
Leasing ltd had entered into a 6 year lease for a factory building. The lease period was agreed for 6
years since Leasing Ltd felt that at the end of that time period they would have expanded to a certain
extent that would require a larger premise. When leasing Ltd entered into the lease agreement on 1 st
January 2008,their business was experiencing cash flow problems, the leaser being reasonably

certain that leasing Ltd.’s cash flows would improve in future agreed to charge a lower rental in the
first 2 years and then increase the rent for the remaining 4 years. The lease rental P.a for the first 2
years was
Sh. 500,000 and the lease rental p.a for the remaining 4 years was Sh. 800,000.
Required:
Relevant journal entries in the books of leasing Ltd.
SOLUTION
1. Classification
This is an operating lease since it is a lease other than a finance lease.
2. Total lease payment
First 2 years 500,000 x 2 1,000,000

Next 4 years 800,000 x 4 3,200,000
6 years 4,200,000 (Total lease payment for 6 years)
3. Annual lease payment
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= ℎ. 700 000 .
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4. Journal entries
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2008 2009
Dr. Lease Rental 700,000 700,000

Cr. Cash book 500,000 500,000
Cr. Accrued lease rental 200,000 200,000
2010 2011 2012

Dr. lease rental 700,000 700,000 700,000
Dr. Accrued lease rental 100,000 100,000 100,000
Cr. Cash book 800,000 800,000 800,000
To record payment under operating leases
Accounting Entries in the Books of Lessor

Following factors are to be disclosed by the lessor under operating lease in financial
statements:
 He will recognize the asset as a non-current asset in its statement of financial position and
depreciation in the normal way.
 Rental income from operating leases will be recognized in P&L on a straight line basis over
the term of the lease.
 Any difference between the amounts charged and paid should be adjusted to receivables or
deferred incomes
 The initial direct cost of the lease could be spread over the life of the lease or charged when
incurred.
 Any incentive given by the lessor should be recognized over the life of the lease on a straight
line basis.
When rent is received under the lease contract
Dr: Cash A/c

Cr: Rental income
When depreciation is to be charged

Dr: Depreciation A/c
Cr: Accumulated depreciation A/c
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When insurance/maintenance/taxes are paid
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Dr: Insurance/maintenance/taxes A/c
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Cr: cash A/c
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Calculation of interest
The rate of interest implicit in the lease is the incremental rate of interest that would arise if the lease
was to borrow the same amount or money elsewhere to acquire the asset in cash.
Where the rate of interest isn’t given the following two methods would be used to ascertain the rate:
i. Actuarial method
Under this method the amount of loan advanced to the lessee would be divided by the annual rental
payments and the resultant figure is checked.
For under the annuity table account base period. The loan advanced is usually the cash price or the
lower of the fair value and the present value(pv) of the minimum lease payment less any deposits.
ii. Sum of year digit method
It’s normally applicable where actuarial method isn’t possible. It approximates the exact rates as
would be ascertained by the actuarial method.

Under this method the total interest payable on the lease agreement is spread in the years of the lease
term according to the weights.
The amount of interest apportioned for any given year would be divided by the balance of the
principle to ascertain the rate of interest.
ILLUSTRATION
On 1/1/2010 Bujumbura ltd a wine merchant owned by Qatar in ivory coast buys a small bottling &
leveling machine from Bagbor ltd co. under finance lease.The cash price of the machine was
sh.7,710,000 while the amount to be paid was sh.10,000,000.The agreement required an immediate
repayment of sh.2,000,000 with balance being settled in four equal annual installments commencing
1/12/2010.The interest charge was 15% p.a calculated on the remaining balance of the liability
during each accounting period
Required;
a) Loan armotisation schedule
b) Calculate interest using actuarial method
SOLUTION
Interest calculation Sh
Amount paid in cash 7,710,000
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Less;downpayment (2,000,000)
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Amount loaned 5,710,000
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Interest for 2010 856,500
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Less;installment to be paid(1st installment) (2,000,000)
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Balance 31/12/2010 4,566,500
Interest 15%x 4,566,500 684,975
Less; 2nd installment (2000,000)
Balance 3,251,475
Interest 15%x3,251,475 487,721
Less;installment 3rd (2000,000)
balance 1,739,196
interest 15%x 1,739,19 260,879
less; 4th installment (2000,000)
NIL
Loan Amortisation Schedule
Year amount at beginning instalments instalments paid principle amt bal b/d
2010 5,710,000 2,000,000 856,500 1,143,500 4,566,500
2011 4,566,500 2,000,000 684,975 1,315,025 3,251,475
2012 3,251,475 2,000,000 487,721 1,512,279 1,739,196
2013 1,739,196 2,000,000 260,879 1,739,121 -

Balance sheet Extract
LIABILITIES
2010
Finance lease 3,251,475
Current liabilities
4,566,500
2011
Current liability
3,251,475
Liabilities
2012
Current liability
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Sale and Leaseback Transactions
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In a sale and leaseback transaction, an asset is sold by a vendor and then the same asset is leased
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back to the same vendor. The lease payment and sale price are normally interdependent because they
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are negotiated as part of the same package. The accounting treatment for the lessee or seller should
be as follows, depending on the type of lease involved.
a) In a sale and leaseback transaction which results in a finance lease, any apparent profit or loss
(that is, the difference between the sale price and the previous carrying value) should be
deferred and amortized in the financial statements of the seller/lessee over the lease term. It
should not be recognized as income immediately.
b) If the leaseback is an operating lease:
i. Any profit or loss should be recognized immediately, provided it is clear that the transaction
is established at a fair value.
ii. Where the sale price is below fair value, any profit or loss should be recognized
immediately except that if the apparent loss is compensated by future lease payments at
below market price it should to that extent be deferred and amortized over the period for
which the asset is' expected to be used.
iii. If the sale price is above fair value, the excess over fair value should be deferred, and
amortized over the period over which the asset is expected to be used.
In addition, for an operating lease where the fair value of the asset at the time of the sale is less than
the carrying amount, the loss, (carrying value less fair value) should be recognized immediately.

The buyer or lessor should account for a sale and leaseback in the same way as other leases.
The disclosure requirements for both lessees and lessors should force disclosure of sale and
leaseback transactions, IAS 1 should be considered.
ILLUSTRATION
QUESTION 5
(a) Leasing is important to Holcombe, a public limited company as a method of financing the
business. The Directors feel that it is important that they provide users of financial statements with a
complete and understandable picture of the entity's leasing activities. They believe that the current
accounting model is inadequate and does not meet the needs of users of financial statements.
Holcombe has leased plant for a fixed term of six years and the useful life of the plant is 12 years.
The lease is non-cancellable, and there are no rights to extend the lease term or purchase the
machine at the end of the term. There are no guarantees of its value at that point. The lessor does not
have the right of access to the plant until the end of the contract or unless permission is granted by
Holcombe.
Fixed lease payments are due annually over the lease term after delivery of the plant, which is
maintained by Holcombe. Holcombe accounts for the lease as an operating lease but the directors are
unsure as to whether the accounting treatment of an operating lease is conceptually correct.
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Required;
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(i) Discuss the reasons why the current lease accounting standards may fail to meet the needs of
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users and could be said to be conceptually flawed.
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(ii) Discuss whether the plant operating lease in the financial statements of Holcombe meets the
definition of an asset and liability as set out in Conceptual Framework for Financial
Reporting.
(b) Holcombe also owns an office building with a remaining useful life of 30 years. The carrying
amount of the building is shs.120 million and its fair value is shs.150 million. On 1 May 2004,
Holcombe sells the building to Brook, a public limited company, for its fair value and leases it back
for five years at an annual rental payable in arrears of shs.16 million on the last day of the financial
year (30 April). This is a fair market rental. Holcombe's incremental borrowing rate is 8%,
On 1 May 2004, Holcombe has also entered into a short operating lease agreement to lease another
building. The lease will last for three years and is currently shs.5 million per annum. However an
inflation adjustment will be made at the conclusion of leasing years 1 and 2. Currently inflation is
4% per annum.

The following discount factors are relevant (8%)
Single cash flow Annuity

Year 1 0.926 0.926
Year 2 0.857 1.783
Year 3 0.794 2.577
Year 4 0.735 3.312
Year 5 0.681 3.993
Required;
i. Show the accounting entries in the year of the sale and lease back assuming that the operating
lease is recognized as an asset in the statement of financial position of Holcombe.
ii. State how the inflation adjustment on the short term operating lease should be dealt with in
the financial statements of Holcombe
SOLUTION
a) i). Problems with current standards on lease accounting
The different accounting treatment of finance and operating leases has been criticized for a number
of reasons.
(1) Many users of financial statements believe that all lease contracts give rise to assets and
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liabilities that should be recognized in the financial statements of lessees. Therefore these
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users routinely adjust the recognized amounts in the statement of financial position in an
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attempt to assess the effect of the assets and liabilities resulting from operating lease
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contracts.
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(2) The split between finance leases and operating leases can result in similar transactions being
accounted for very differently, reducing comparability for users of financial statements.
(3) The difference in the accounting treatment of finance leases and operating leases also
provides opportunities to structure transactions so as to achieve a particular lease
classification.
It is also argued that the current accounting treatment of operating leases is inconsistent with the
definition of assets and liabilities in the lASB's Conceptual Framework. An operating lease contract
confers a valuable right to use a leased item. This right meets the Conceptual Framework's
definition of an asset, and the liability of the lessee to pay rentals meets the Conceptual
Framework's definition of a liability. However, the right and obligation are not recognized for
operating leases.
Lease accounting is scoped out of IAS 32, IAS 39 and IFRS 9, which means that there are
considerable differences in the treatment of leases and other contractual arrangements.
The IASB is addressing this matter. An Exposure Draft Leases was issued in August 2010. The
proposed changes would put in place a consistent approach to lease accounting for both lessees and
lessors - a 'right-of-use' approach. Among other changes, this approach would result in the liability

for payments arising under the lease contract and the right to use the underlying asset being included
in the lessee's statement of financial position, thus providing more complete and useful information
to investors and other users of financial statements.
(ii) Holcombe's lease and framework definitions
The lASB Conceptual Framework definesan asset as 'a resource controlled by the entity as a result
of past events and from which future economic benefits are expected to flow to the entity'.
Holcombe's leased plant would appear to meet this definition:
1. Holcombe has the right to use the leased plant as an economic resource, which is to generate
cash inflows or reduce cash outflows.
2. Holcombe can be said-to control the resource because the lessor does not have the right of
access to the plant until the end of the contract without Holcombe's permission.
3. The control results from past events that are the signing of the lease contract.
4. Future economic benefits are expected to flow to Holcombe during the lease term.
In conclusion, the leased plant meets the Framework'sdefinition of an asset.
The Conceptual Framework definesa liability as 'a present obligation of the entity arising from
past events, the settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits'. Applying this to Holcombe's lease of plant:
1. There is a present obligation to pay rentals.
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2. The lessor has no contractual right (unless Holcombe breaches the contract) to take
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possession of the plant before the end of the contract, and similarly. Holcombe has no
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contractual right to terminate the contract and avoid paying rentals.
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3. The obligation to pay rentals arises from a past event, namely the signing of the lease.
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4. The obligation is expected to result in an outflow of economic benefits in the form of cash
payments.
In conclusion, the leased plant meets the Conceptual Frame work'sdefinition of a liability.
(b) i) Sale and leaseback
This is a sale and leaseback transaction involving an operating lease. It is assumed that the operating
lease is being treated as an asset, and will therefore be accounted for using the same principles as
IAS 17 currently uses for finance leases. It will be accounted for as follows in the financial
statements of Holcombe for the year ended 30 April 2005:
Sale of building on 1 May 2004
DEBIT Cash Kshs.150m

CREDIT Office building Kshs.120m
CREDIT Deferred income (SOFP) Kshs.30m
Being recognition of the gain on the sale of the building.
The gain is released over the five year lease period

DEBIT Deferred income (SOFP) Kshs.30m ÷ 5 Kshs.6m
CREDIT Deferred income (P/L) Kshs.6m
Being release of gain on sale of building.
DEBIT Operating lease asset Kshs.63.89m

CREDIT Obligation to pay rentals Kshs.63.89m
Being recognition of the leaseback at net present value of lease payments using 8% discount
factor (Kshs.16m ×3.993)
First year of leaseback to 30 April 2005
DEBIT Lease obligation: rentals Kshs.16m

CREDIT Cash Kshs.16m
Being recognition of payment of rentals
DEBIT Finance cost Kshs.5.11m

CREDIT Lease obligation Kshs.5.11m
Being recognition of interest expense (Kshs.63.89m ×8%)
DEBIT Depreciation expense Kshs.12.78m

CREDIT Operating lease asset Kshs.12.78m
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Being recognition of depreciation of operating lease asset over five years (shs.63.89m ÷ 5)
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In Holcombe's statement of financial position, the operating lease asset will be shown at a carrying
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value of shs.63.89m (initial recognition) less shs.12.78m (depreciation) = shs.51.11.
ii) Inflation adjustment
Inflation adjustments are not included in the minimum lease payment calculations. Instead they are
effectively contingent rent, defined in IAS 17 Leases as 'that part of the rent that is not fixed in
amount, but based on the future amount of a factor that changes other than with the passage of time'.
They should be recognized in the period in which they are incurred.
Holcombe would recognize operating rentals as follows:
Year1
Shs.5 million
Year 2
Shs.5 million plus (shs.5m×4%) = shs.5.2m
Year 3
Shs.5.2 million plus (shs.5.2m × 4%) = shs.5.408m

INCOME TAX {ACCOUNTING FOR DEFERRED TAX (IAS 12)}
In accounting for income taxes the main concerns will be;
1. Accounting for current tax corporation tax

Tax assessed on the taxable profits for the years at corporation tax rates.
2. Accounting for future tax consequences (deferred tax).
This is a provision for tax effect on the benefits being enjoyed currently but which are likely
to review in the future e.g. a provision where high capital allowance in the initial years of an
asset are replaced with high depreciation charge in the later years of an asset.
3. The differences between accounting profits and taxable profits. They are of two types.
(a) Permanent differences

They do not reverse in any period as therefore they do not give rise to deferred tax e.g.
some items may be used in accounting profit yet they are not reflected for tax.
(b) Temporary difference

They reverse in the future therefore resulting into deferred tax.
Methods of accounting for income taxes, they are of two broad categories.
i. Actual taxes payable method/flow through method/nil provision
Accounts for current taxes at corporation tax rates
iii. Deferred tax accounting methods
Account for future tax consequences (deferred tax)
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Temporary differences include differences between the fair values and the tax values of assets and
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liabilities acquired and the effect of revaluing assets and liabilities acquired and the effect of
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revaluing assets for accounting purposes.
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 Current and deferred tax is recognized in the income statement unless the tax arises from a
business combination that is an acquisition or a transaction or event that is recognized in
equity. The tax consequences which accompany a change in the tax status of an enterprise or
its controlling or significant shareholder should be taken to income, unless these consequences
directly relate to changes in the measured amount of equity.
Only those tax consequences that directly relate to changes in the measured amount of equity
in the same or different period should be charged or credited to equity and not taken to the
income statement.
 Deferred tax assets and liabilities should be measured at the tax rates that are expected to
apply to the period when the asset is realized or the liability is settled, based on tax rates (and
tax laws) that have been enacted or substantively enacted by the balance sheet date.
Discounting of deferred tax assets and liabilities is not permitted.
 The measurement of deferred tax assets and liabilities should reflect the tax consequences that
would follow from the manner in which the enterprise expects, at the balance sheet date, to
recover or settle the carrying amount of its assets and liabilities.
When a non-depreciable asset under IAS 16 (PPE) is re-valued, the deferred tax arising from
that revaluation is determined based on the tax applicable to the recovery of the carrying
amount of that asset through sale.

 An enterprise should recognize a deferred tax asset for all deductible temporary differences to
the extent that it’s probable that taxable profit will be available against which the deductible
temporary difference can be utilized. The same principles apply to recognition of deferred tax
assets for unused tax losses carried forward.
 For presentation purposes, current tax assets and liabilities should be offset if and only if the
enterprise has a legally enforceable right to set off and intends to either settle on a net basis, or
to realize the asset and settle the liability simultaneously. An enterprise is able to offset
deferred tax assets and liabilities if and only if it is able to offset current tax balances and the
deferred balances relate to income taxes levied by the same taxation authority.
Disclosures
 Tax expense (income) must be shown separately on the face of the income statement, with
separate disclosure made of its major components and any tax expense (income) relating to
extra ordinary items.
 Tax expense (income) relating to the gain or loss on discontinuance for discontinued
operations and to the profit or loss from the ordinary activities of the discontinued operation
for the period must also be disclosed.
 An explanation is required of the relationship between tax expense (or income) and accounting
profit either of numerical reconciliation between the average effective tax rate and the
applicable tax rate. An explanation is required of any changes in the applicable tax rate(s)
compared to the previous period.
 The aggregate amount of temporary differences for which both deferred tax assets and
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liabilities have not been recognized (i.e. for unremitted “re-invested” earnings of subsidiaries
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should be disclosed. For each type of temporary difference and for unused tax losses and
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credits, disclosure is required of the amount of deferred tax assets and liabilities recognized
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and the amount of deferred tax income or expense recognized.
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The amount of any deferred tax asset and evidence supporting its recognition must be
disclosed when its utilization is dependent on future taxable profits in excess of the profits
arising from the reversal of existing taxable temporary differences, and the enterprise has
suffered a loss in the current or previous period in the tax jurisdiction to which the deferred tax
asset relates. Separate disclosure is also required of the aggregate current and deferred tax
relating to items that are charged or credited to equity.
Accounting for income taxes
In accounting for income taxes, the principle issue is how to account for the current tax liability as
well as the future tax consequences (deferred tax).
The accounting income is the aggregate income or loss for a particular period including extra
ordinary items based on accounting assumptions, principles and procedures reported to the
shareholders before deducting the related tax charge. Taxable income (tax adjusted profits) is the
income for a period on which tax is assessed or ascertained in accordance with the rules established
by the tax authorities and upon which a provision for tax is determined and paid.
The reasons behind the differences between the accounting profits and taxable profits may broadly
be classified into two;-
- Permanent differences
- Temporary differences
Permanent differences
Are differences that arise from the items that are considered in one calculation but excluded in the
other i.e. items of income and expenses being included in accounting profits but are excluded from
taxable profits.
They do not reverse in any period therefore they do not give rise to deferred tax.
They usually arise from the following.
a) Certain types of income recognized in determining the accounting profits but no assessed
pretax purposes e.g. gains on disposed of capital assets, windfall gains, donations and
grants especially if not related to business.
iii) Certain types of expenditure recognized is determination of accounting profits but are not
allowed as expenses for tax purposes e.g. entertainment allowance not related to business
from expenditure, loss on disposal of capital assets etc.
Temporary differences
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They reverse on the foresee period and therefore they give rise to deferred tax (future tax
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consequences)
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IAS 12 (Revised) defines temporary differences as differences between the carrying amount of
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assets or liabilities in the statement of financial position and then tax base that are not of a
permanent nature.
Temporary carrying amounts of Assets or Tax base of assets or liabilities written

differences = liabilities NBV - down values (WDVs)
(Cost-accumulated depreciation) (cost-accumulated capital deductions)
The tax base of an asset or a liability is that amount attributed to that asset or liability for tax
purposes.
The carrying amount of an asset or a liability is the value of such asset or liability as per the draft
financial statements.
Tax base of an asset
This is the amount that will be deductible for tax purposes against any factors taxable economic
benefit that will flow to the enterprise when it recovers the carrying amount of that asset. In other
words, this is the amount on which future capital allowances will be based.

NB: If the economic benefits will not be taxable, then the tax base of the asset equals to its carrying
amount.
ILLUSTRATION 1
TAX BASE OF AN ASSET
An item of PPE costs Kshs 650,000 Kshs 275,000 WTA has already been deducted in the amount
and prior period for tax purposes. The revenue generated from the use of the asset is taxable if the
carrying amount of the item in the account is Kshs 520,000, what is its tax base?
SOLUTION
Cost Accounts Tax

Depreciation 650,000 650,000
(130,000) (275,000) WTA
520,000 375,000 WDV
The tax base of the item is Kshs 375,000. This is because that will be allowable for tax purposes in
future when the taxable economic benefit flows into the enterprises shs 375,000 i.e. the amount on
which future WTA will be based.
Interest income receivable has a carrying amount of shs. 250,000. If the related finance income is
taxed on cash basis, what is the tax base of the interest income receivable?
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SOLUTION
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The tax base will be nil because the economic benefit that will flow to the enterprise from the
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interest income receivable will be taxable when the related cash will be received. Therefore no
amount will be deductible or allowable against interest income receivable for tax purposes.
If the trade receivables have a carrying amount of shs 300,000, what is the taxation base for
the trade receivable?
SOLUTION
The tax base of trade receivables is the shs 300,000. This is because the economic benefits that will
accrue to the enterprise upon the recovery of trade receivables (receipt of cash) are not taxable
therefore the tax base is equal to the carrying amount.
A loan receivable has a carrying amount of shs 600,000. What is its tax base?
SOLUTION
The tax of the loan receivable is shs 600,000 because the benefits that will accrue for the repayment
of the loan are not taxable.

Inventory has a carrying amount of shs 320,000. What is its tax base?
SOLUTION
The tax base of the inventory is shs 320,000 because the amount that the tax authorities will allow
for tax purposes in future as opening stock shs 320,000
Tax Base of a Liability
This is the carrying amount of a liability less any amount that will be deductible or allowable for tax
purposes in respect of that liability in future periods.
Tax base of a liability = carrying value –amounts deductible for tax purposes in respect in
of a liability the liability in future
NB : In case of revenue received in advance, the tax base of the resulting liability is its carrying
amount less any amount of revenue that will not be taxable in future periods.
ILLUSTRATIONS 2
TAX BASE OF A LIABILITY
1. Current liabilities of an enterprise included accruals for expenses with a carrying amount of shs.
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200,000 which was deductible for tax purposes on cash basis. What is the tax base of the accruals?
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SOLUTION
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The tax base of accruals will be nil because the carrying amount is shs. 200,000 and the amount that
will be allowed for tax purposes in future when the cash will be paid is also sh. 200,000 (i.e. shs.
200,000 – shs. 200,000=0).
2. Revenue received in advance has a carrying value of shs. 160,000. The related revenue was taxed
on cash basis. What is the tax base of revenue received in advance?
SOLUTION
The tax base of revenue received in advance is nil. This is because the carrying amount is sh.
160,000 and there is no amount of revenue that will be taxable in the future i.e. the revenue was
assessed for tax purposes when it was received in advance on cash basis.
3. A loan payable has a carrying amount of sh. 600.000. What is its tax base?
SOLUTION
The tax base of loan payable is sh. 600,000. This is because the carrying amount is sh. 600,000 and
there is no amount that will be allowable in respect of loan payable for tax purposes in the future.

Type of Temporary Differences
Some items have a tax base but are not recognized as assets or liabilities e.g. research costs are
recognized as an expense in determination of a/c profit in the period in which they are incurred but
may not be permitted as allowable expenses in determination of taxable profit until a later date. This
gives rise to a temporary difference.
The temporary differences that arise may either be: -
(a) Taxable temporary differences

(b) deductible temporary differences
1. Taxable Temporary Difference
There are differences that will result in taxable amounts in the future when the carrying amounts of
the assets are recovered or the liabilities are settled. They give rise to deferred tax liability balances
at the year end.
Deferred tax liabilities are amounts of income taxes payable in future periods in respect of taxable
temporary differences.
They arise when,
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(i) The carrying amounts of assets exceed their tax bases.
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(ii) The carrying amounts of liabilities are less than their tax bases.
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IAS 12 (Revised) requires that a deferred tax liability be recognized for all taxable temporary
differences except to the extent that the deferred tax liability arises from the initial recognition of
good will or the initial recognition of an asset or a liability in a transaction in which either is not a
business combination or at the time of the transaction affects neither accounting profits nor the
taxable profits.
Transactions that affect the statement of comprehensive income
- Interest revenue received in arrears and included in accounting profit on the basis of time
apportionment. It is included in taxable profit, however, on a cash basis.
- Sale of goods revenue is included in accounting profit when the goods are delivered, but only
included in taxable profit when cash is received.
- Depreciation of an asset may be accelerated for tax purposes. When new assets are purchased,
allowances may be available against taxable profits which exceed the amount of depreciation
chargeable on the assets in the financial accounts for the year of purchase.
- Development costs which have been capitalized will be amortized in profit or loss, but they
were deducted in full from taxable profit in the period in which they were incurred.
- Prepaid expenses have already been deducted on a cash basis in determining the taxable profit
of the current or previous periods.

Transactions that affect the statement of financial position
· Depreciation of an asset is not deductible for tax purposes. No deduction will be available for
tax purposes when the asset is sold/ scrapped.
· A borrower records a loan at proceeds received (amount due at maturity) less transaction
costs.
· The carrying amount of the loan is subsequently increased by amortization of the transaction
costs against accounting profit. The transaction costs were, however, deducted for tax
purposes in the period when the loan was first recognised.
· A loan payable is measured on initial recognition at net proceeds (net of transaction costs).
The transaction costs are amortized to accounting profit over the life of the loan. Those
transaction costs are not deductible in determining the taxable profit of future, current or prior
periods.
· The liability component of a compound financial instrument (e.g. a convertible bond) is
measured at a discount to the amount repayable on maturity, after assigning a portion of the
cash proceeds to the equity component (see IAS 32). The discount is not deductible in
determining taxable profit.
Fair value adjustments and revaluations
 Current investments or financial instruments are carried at fair value. This exceeds cost, but
no
equivalent adjustment is made for tax purposes.
 Property, plant and equipment is revalued by an entity (under IAS 16), but no equivalent
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adjustment is made for tax purposes. This also applies to long-term investments.
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The standard also looks at the deferred tax implications of business combinations and
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consolidations. will There are two circumstances given in the standards where the rule that all
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taxable temporary differences give rise to a deferred tax liability does not apply.
a) The deferred tax liability arises from the initial recognition of goodwill.
b) The deferred tax liability arises from the initial recognition of an asset or liability in a transaction
which:
i. is not a business combination ,and

ii. at the time of the transaction affects neither accounting profit nor taxable profit.
Try to understand the reasoning behind the recognition of deferred tax liabilities on taxable
temporary
differences.
(a) When an asset is recognised, it is expected that its carrying amount will be recovered in
the form of economic benefits that flow to the entity in future periods.
(b) If the carrying amount of the asset is greater than its tax base, then taxable economic
benefits will also be greater than the amount that will be allowed as a deduction for tax
purposes.

(c) The difference is therefore a taxable temporary difference and the obligation to pay the
resulting income taxes in future periods is a deferred tax liability.
(d) As the entity recovers the carrying amount of the asset, the taxable temporary difference
will reverse and the entity will have taxable profit.
(e) It is then probable that economic benefits will flow from the entity in the form of tax
payments, and so the recognition of all deferred tax liabilities (except those excluded
above) is required by IAS 12.
ILLUSTRATION 3
Taxable Temporary Differences
A company purchased an asset costing shs.1,500 at the end of 2008 the carrying amount is
shs.1,000. The cumulative depreciation for tax purposes is shs.900 and the current tax rate is 25%.
Required;
Calculate the deferred tax liability for the asset.
SOLUTION
Firstly, what is the tax base of the asset? It is shs.1,500 – shs.900 = shs.600.
In order to recover the carrying value of shs.1,000, the entity must earn taxable income of shs.1,000,
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but it will only be able to deduct shs.600 as a taxable expense. The entity must therefore pay income
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tax of shs.400 × 25% = shs.100 when the carrying value of the asset is recovered.
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The entity must therefore recognize a deferred tax liability of shs.400×25% = shs.100, recognizing
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the difference between the carrying amount of shs.1,000 and the tax base of shs.600 as a taxable
temporary difference.
Revalued assets
Under IAS 16 assets may be revalued. If this affects the taxable profit for the current period, the tax
base of the asset changes and no temporary difference arises.
If, however (as in some countries), the revaluation does not affect current taxable profits, the tax
base of the asset is not adjusted. Consequently, the taxable flow of economic benefits to the entity as
the carrying value of the asset is recovered will differ from the amount that will be deductible for tax
purposes. The difference between the carrying amount of a revalued asset and its tax base is a
temporary difference and gives rise to a deferred tax liability or asset.
Initial recognition of an asset or liability
A temporary difference can arise on initial recognition of an asset or liability, e.g. if part or all of the
cost of an asset will not be deductible for tax purposes, The nature of the transaction which led to the
initial recognition of the asset is important in determining the method of accounting for such
If the transaction affects either accounting profit or taxable profit, an entity will recognise any
deferred tax liability or asset. The resulting deferred tax expense or income will be recognised in
profit or loss,
Where a transaction affects neither accounting profit nor taxable profit it would be normal for an
entity to recognise a deferred tax liability or asset and adjust the carrying amount of the asset or
liability by the same amount (unless exempted by IAS 12 as under Paragraph 3,3 above), However,
IAS 12 does not permit this recognition of a deferred tax asset or liability as it would make the
financial statements less transparent. This will be the case both on initial recognition and
subsequently, nor should any subsequent changes in the unrecognized deferred tax liability or asset
as the asset is depreciated be made.
2. Deductible temporary differences
They are temporary differences that will result in amounts that are tax deductible in the future when
the carrying amounts of assets are recovered or the liabilities are settled.
They give rise to deferred tax asset balances at the year end.
Deferred tax assets are amounts of income taxes recoverable in future periods in respect of;
i. Deductible temporary differences

ii. Carry forward of unused tax losses
iii. carry forward of unused tax credits
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Deductible temporary differences arise when;
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1. The carrying amounts of assets are less than their tax bases.
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2. The carrying amounts of liabilities exceed their tax bases
Transactions that affect the statement of comprehensive income
 Retirement benefit costs (pension costs) are deducted from accounting profit as service is
provided by the employee. They are not deducted in determining taxable profit until the entity
pays either retirement benefits or contributions to a fund. (This may also apply to similar
expenses.)
 Accumulated depreciation of an asset in the financial statements is greater than the
accumulated depreciation allowed for tax purposes up to the year end.
 The cost of inventories sold before the year end is deducted from accounting profit when
goods/services are delivered, but is deducted from taxable profit when the cash is received.
(Note.
There is also a taxable temporary difference associated with the related trade receivable, as
noted in Section 3 above.)
 The NRV of inventory or the recoverable amount of an item of property, plant and equipment
falls and the carrying value is therefore reduced, but that reduction is ignored for tax purposes
until the asset is sold.

 Research costs (or organization/other start-up costs) are recognised as an expense for
accounting purposes but are not deductible against taxable profits until a later period.
 Income is deferred in the statement of financial position, but has already been included in
taxable profit in current/prior periods.
 A government grant is included in the statement of financial position as deferred income, but it
will not be taxable in future periods. (Note. A deferred tax asset may not be recognised here
according to the standard.)
Fair value adjustments and revaluations
Current investments or financial instruments may be carried at fair value which is less than cost, but
no equivalent adjustment is made for tax purposes.
Other situations discussed by the standard relate to business combinations and consolidation
Recognition of deductible temporary differences
As with temporary taxable differences, there are also circumstances where the overall rule for
recognition of deferred tax asset is not allowed.
This applies where the deferred tax asset arises from initial recognition of an asset or liability in a
transaction which is not a business combination, and at the time of the transaction, affects neither
accounting nor taxable profit/ tax loss.
Let us layout the reasoning behind the recognition of deferred tax assets arising from deductible
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a) When a liability is recognised, it is assumed that its carrying amount will be settled in the
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form of outflows of economic benefits from the entity in future periods.
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b) When these resources flow from the entity, part or all may be deductible in determining
taxable
profits of a period later than that in which the liability is recognised.
c) A temporary tax difference then exists between the carrying amount of the liability and its
tax base.
d) A deferred tax asset therefore arises, representing the income taxes that will be recoverable
in future periods when that part of the liability is allowed as a deduction from taxable profit.
e) Similarly, when the carrying amount of an asset is less than its tax base, the difference gives
rise to a deferred tax asset in respect of the income taxes that will be recoverable in future
periods.
ILLUSTRATION 4
Deductible Temporary Differences
Paratha Co recognises a liability of shs.10,000 for accrued product warranty costs on 31 December
2007.
These product warranty costs will not be deductible for tax purposes until the entity pays claims.
The tax rate is 25%.

Required
State the deferred tax implications of this situation.
SOLUTION
What is the tax base of the liability? It is nil (carrying amount of shs.10,000 less the amount that will
be deductible for tax purposes in respect of the liability in future periods).
When the liability is settled for its carrying amount, the entity's future taxable profit will be reduced
by shs.10,000 and so its future tax payments by shs.10,000 × 25% = shs.2,500.
The difference of shs.10,000 between the carrying amount (shs.10,000) and the tax base (nil) is a
deductible temporary difference. The entity should therefore recognise a deferred tax asset of
shs.10,000 × 25% = shs.2,500 provided that it is probable that the entity will earn sufficient taxable
profits in future periods to benefit from a reduction in tax payments.
Taxable profits in future periods
When can we be sure that sufficient taxable profit will be available against which a deductible
temporary difference can be utilised? IAS 12 states that this will be assumed when sufficient taxable
temporary differences exist which relate to the same taxation authority and the same taxable entity.
These should be expected to reverse as follows.
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a) In the same period as the expected reversal of the deductible temporary difference.
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b) In periods into which a tax loss arising from the deferred tax asset can be carried back
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or forward. Only in these circumstances is the deferred tax asset recognised, in the
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period in which the deductible temporary differences arise.
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What happens when there are insufficient taxable temporary differences (relating to the same
taxation
authority and the same taxable entity)? It may still be possible to recognize the deferred tax asset,
but only to the following extent.
a) Taxable profits are sufficient in the same period as the reversal of the deductible temporary
difference (or in the periods into which a tax loss arising from the deferred tax asset can be
carried forward or backward), ignoring taxable amounts arising from deductible temporary
differences arising in future periods.
b) Tax planning opportunities exist that will allow the entity to create taxable profit in the
appropriate periods.
With reference to (b), tax planning opportunities are actions that an entity would take in order to
create or increase taxable income in a particular period before the expiry of a tax loss or tax credit
carry forward. For example, in some countries it may be possible to increase or create taxable profit
by electing to have interest income taxed on either a received or receivable basis, or deferring the
claim for certain deductions taxable profit.

In any case, where tax planning opportunities advance taxable profit from a later period to an earlier
period, the utilization of a tax loss or a tax credit carry forward will still depend on the existence of
future taxable profit from sources other than future originating temporary differences.
If an entity has a history of recent losses, then this is evidence that future taxable profit may not be
available
Unused tax losses and unused tax credits
An entity may have unused tax losses or credits (i.e. which it can offset against taxable profits) at the
end of a period. Should a deferred tax asset be recognised in relation to such amounts? IAS 12 states
that a deferred tax asset may be recognised in such circumstances to the extent that it is probable
future profit will be available against which the unused tax losses/credits can be utilized.
The criteria for recognition of deferred tax assets here is the same as for recognizing deferred tax
assets arising from deductible differences. The existence of unused tax losses is strong evidence,
however, that future taxable profit may not be available. So where an entity has a history of recent
tax losses, a deferred tax asset arising from unused tax losses or credits should be recognised only to
the extent that the entity has sufficient taxable temporary differences or there is other convincing
evidence that sufficient taxable profit will be available against which the unused losses/credits can
be utilized by the entity.
In these circumstances, the following criteria should be considered when assessing the probability
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taxable profit will be available against which unused tax losses/credits can be utilized.
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 Existence of sufficient taxable temporary-differences (same tax authority/taxable entity)
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against which unused tax losses/credits can be utilized before they expire
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 Probability that the entity will have taxable profits before the unused tax losses/credits expire
 Whether the unused tax losses result from identifiable causes, unlikely to recur
 Availability of tax planning opportunities (see above)
To the extent that it is not probable that taxable profit will be available, the deferred tax asset is not
recognised.
Reassessment of unrecognized deferred tax assets
For all unrecognized deferred tax assets, at each year end an entity should reassess the availability of
future taxable profits and whether part or all of any unrecognized deferred tax assets should now be
recognised. This may be due to an improvement in trading conditions which is expected to continue.
IAS 12(Revised) additionally requires that a deferred tax asset be recognized for all deductible
temporary differences to the extent that it is probable that taxable profits will be available against
which deductible temporary differences will be utilized until the deferred tax assets arises from the
initial recognition of an asset or a liability in a transaction that is not a business combination or at the
time of the transaction affects neither the accounting profits nor the taxable profits.

Timing differences
Some temporary differences arise when incomes and expenses are included in accounting profits in
one period but are included in the taxable profits in another period. Some temporary differences that
arise when incomes and expenses as included in accounting profits in one period but are included in
taxable profits in a different period.
They are said to originate where there is a benefit in terms of tax savings arising i.e. where the tax
depreciation are less than the accounting depreciation. This implies a tax income.
Examples of temporary timing differences
1. Interest revenue or expense included in accounting profits on accrual basis but included in
taxable profits on cash basis.
2. Depreciation used in determining taxable profits may differ from the one used in determining
the accounting profits.
3. Development costs may be capitalized and amortized over future periods in determining the
accounting profits but may be deducted in determining the taxable profits in the period in
which they are incurred.
Additionally, temporary differences arise when,
i. The cost of a business combination is allocated by recognizing the identifiable assets acquired
and liabilities assumed at their fair value but no adjustment is made for tax purposes.
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ii. Assets are revalued and no corresponding adjustments are made to their tax bases.
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iii. The tax base of an asset or a liability on initial recognition differs from the initial carrying
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amount. E.g. when an entity benefit from a taxable government grant related to the asset
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interest joint venture becomes.
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iv. The carrying amount of investment in subsidiaries, branches, associates or interest in joint
ventures becomes Goodwill arising from business combination. Goodwill has a tax base of nil
and therefore the difference between the carrying amount of goodwill of the tax base of nil is
a taxable temporary difference that will give rise to a tax liability difference.
However, IAS 12 (Revised) does not allow the recognition of the resulting deferral tax liability
arising from good will.
Methods of accounting for income tax expense
Income tax expense is the aggravate amount included in determination of profit or loss for the period
in respect of current tax is deferred tax.
There are two methods of accounting for income taxes.
1. Actual taxes payable method (flow through method)

2. Deferred tax accounting methods.

Actual taxes payable method
The method considers tax as an appropriation of income.
The income tax charge for the year recognized is limited to the tax payable (legal tax liability) for
that period.
No provision (nil provision) is made for deferred tax for the period.
The extent of and the potential tax effects of temporary differences (future tax consequences) are
sometimes disclosed in the financial statements by a way of notes to the accounts.
The main advantage of flow through method is that it is straight forward and concurs with the
simplicity cannon of taxation.
As the tax liability recognized is closer to many peoples understanding.
The main set back of this method is that it can lead to large fluctuations of tax charge and does not
allow for recognition of temporary differences that may give rise to deferred tax liabilities in the
future.
Deferred Tax Accounting Methods
Under these methods, the income tax is considered to be an expense incurred by an organization in
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earning its income thus the tax charge is to be recognized in the same period that the related
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revenues is recognized.
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The tax effect of temporary differences (deferred tax) is incorporated in the income tax charge for
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the year in the income statement of financial position. The deferred tax element in the income tax
charge may be calculated under;
a) Full provision
b) Partial provision
Full provision
This approach requires that full tax effects of temporary differences be recognized whether the
temporary differences will reverse in future or not. This is the most preferred approach under AIS 12
(Revised) of accounting for deferred taxes.
Merits of full provision method of Deferred Taxation
The effects of future taxes are accounted for in full i.e. the contingencies that may or may not arise
are recognized or accounted for in the financial statements.
The full provision approach concurs with the prudence concept of accounting where expenses or
losses are recognized whether incurred or contingent.

Demerits of full provision method
1. It accounts for future taxes consequences in full but we reversal of which is not certain.
2. The approach contradicts the matching concept of accounting where the income earned in the
current period is matched with expenses to be incurred in the future.
Partial provision
The partial provision method also starts from the premise that the future reversal of timing
differences gives rise to a tax asset or liability. However, rather than focusing on the individual
components of the tax computation, the partial provision method emphasizes the interaction of those
components in a single net assessment. To the extent that timing differences are expected to
continue in future (i.e. the existing timing differences being replaced by future timing differences as
they reverse), the tax is viewed as being deferred permanently.
Where, for example, fixed asset expenditure attracts tax deductions before the fixed assets are
depreciated, timing differences arise. The timing differences increase with time under conditions of
inflation or expansion, with the result that new timing differences more than replace those that
reverse. In consequence, effective tax rates are reduced. The partial provision method allows the
lower effective tax rates to be reflected in the profit and loss account, to the extent that the reduction
is not expected to reverse in future years.
The attraction of the partial provision method is that it reflects an entity’s ongoing effective tax rate.
It results in tax charges that reflect the amount of tax that it is expected will actually be paid and
excludes amounts that are expected to be deferred ‘permanently’.
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Reasons for rejecting the partial provision method
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The partial provision method allowed companies to avoid creating provisions for tax that they
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argued they were unlikely to pay. However, by the early 1990s, concerns were being expressed
about the method and the way in which it was being applied. It was noted in particular that:
1. The recognition rules and anticipation of future events were subjective and inconsistent with
the principles underlying other aspects of accounting.
2. The partial provision method had not been regarded as appropriate for dealing with the long-
term deferred tax assets associated with provisions for post-retirement benefits. As a result,
SSAP 15 had been amended in 1992 to permit such assets to be accounted for on a full
provision basis. The amendment introduced inconsistencies into SSAP 15.
3. There were variations in the way in which SSAP 15 was applied in practice. Different
entities within the same industry and with similar prospects seemed to take quite different
views on the levels of provisions necessary. There was evidence that some companies
provided for deferred tax in full for simplicity’s sake rather than because their circumstances
required it. The different approaches being taken reduced the comparability of financial
statements.
4. Because of its recognition rules and anticipation of future events, the partial provision
method was increasingly being rejected by standard-setters in other countries. The US
Financial Accounting Standards Board (FASB) had issued a standard FAS 109 ‘Accounting
for Income Taxes’ requiring full provision. The International Accounting Standards

Committee (IASC) had published proposals for similar requirements and other standard –
setters had started to move in the same direction.
When rejecting the partial provision method, the FASB and IASC argued in particular that:
a) Every tax timing difference represented a real liability, since everyone would reverse and,
whatever else happened, an entity would pay more tax in future as a result of the reversal than
it would have done in the absence of the timing difference.
b) It was only the impact of new timing differences arising in future that prevented the total
liability from reducing. It was inappropriate (and inconsistent with other areas of accounting)
to take account of future transactions when measuring an existing liability.
c) The assessment of the liability using the partial provision method relied on management
intentions regarding future events. Standard setters were uncomfortable with this, having
already embodied in a number of other standards the principle that liabilities be determined on
the basis of obligations rather than management decisions or intentions.
In view of the criticisms of the partial provision method, the Board decided to review SSAP 15. In
1995 it published a Discussion Paper, ‘Accounting for Tax’. The Discussion Paper proposed that
SSAP 15 should be replaced with an FRS requiring full provision for deferred tax.
Most respondents to the Discussion Paper opposed the move to full provision at that stage,
preferring instead to retain the partial provision method. In the meantime however, IASC had
approved its standard, IAS12 (revised, 1996) ’Income Taxes’, which required use of the full
provision method. The Board reconsidered the arguments and arrived at the view that:
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 Whilst it did not agree with all of the criticisms of the partial provision method expressed
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internationally and could see the logic for all three methods of accounting for tax, it shared
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some of the concerns regarding the subjectivity of the partial provision method and its
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reliance on future events; and
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 As more companies adopted international accounting standards, the partial provision method
would become less well understood and accepted, particularly as it was regarded as less
prudent than the internationally accepted method. Hence, the retention of the partial provision
method in the UK could damage the credibility of UK financial reporting.
Summary of Approaches to Deffered Tax

Approach Advantage Disadvantages
No Tax charge in P/L is based on tax Ignores reasoned assessment of what tax effects of transactions
provision payable and is objective will be.
Inconsistent with Companies Act and IAS 12
Possible understatement of tax liabilities
Full Recognizes full tax charge in P/L Possible distortion of tax liabilities in Balance Sheet
provision Calculations are objective Possible fictitious effects of transactions for remote occurring
in a period
Ignores reasoned assessment of what tax effects of transactions
will be.
Partial Realistic - deferred tax provision Calculations may depend on subjective opinions and estimates.
Provision takes account of circumstances of Difficult to apply to small companies.
the company

The deferred tax accounting methods may further be grouped into two main categories;
1. Deferral method
2. Liability method
1. Deferral method
The tax effects of temporary differences (deferred tax) originating in the previous period as well as
reversing in the current period are generally determined using the tax rate originally applied.
The deferred tax balance in the statement of financial PSN is viewed as a deferred tax revenue or
expenditure and therefore it is not adjusted to reflect any change in the tax rate or imposition of new
taxes.
Under this method, the income tax expenses for the year comprises of two elements.
(a) The tax liability for the period (current tax)

(b) Deferred tax amount transferred to or from the deferred tax account determined based on the
tax rate originally applied.
NB : IAS 12 (revised) prohibits the use of the deferral method in accounting for deferred taxation.
2. Liability method
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It is considered to be the most appropriate method of accounting for future taxes payable when
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calculating the deferred tax balance.
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This method differs from the deferral method in the sense that the balances appearing in the deferred
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tax account is considered either to be a liability for the taxes payable in the future or an asset
representing prepaid taxes. The deferred tax balance must therefore be adjusted from time to time to
represent the actual liability or prepaid taxes as at the reporting date.
Under this method, the income tax charge for the year comprises of the following:
(a) The provision for taxes payable for the year (current tax)
(b) The amount of taxes expected to be payable in the future or considered to be prepaid in
respect of temporary differences originally or reversing during the period.
(c) The adjustments to the deferred tax balances in the statement of financial position necessary
to reflect either a change in the tax rate or imposition of new taxes.
The liability method can further be categorized into two: -
(a) Income statement based liability method – which focuses on timing differences. It analysis
the items of incomes and expenses in accounting for deferred taxation which either originate
or reverse.
(b) Statement of financial position based liability method – which focuses on temporary
differences other than timing differences

It accounts for future tax consequences through the analysis of assets and liabilities by comparing
their carrying amounts with their tax bases in determination of temporary differences which are
either taxable or deductable.
IAS 12 (revised) recommends the use of statement of financial position based liability method.
Arguments in favour of providing for deferred tax on revaluation of fixed assets.
As period IAS 16 (PPE) where an item of Property, Plant and Equipment is revalued giving rise to a
revaluation surplus, the whole surplus may be realized on the retirement (derecognition) of such
item of Property, Plant and Equipment. In such a case, the revaluation surplus included in the equity
is transferred directly as a gain on disposal.
However, some of the revaluation surplus may be realized as the asset is being used by the
enterprise. This revaluation gain realized will be in terms of the increment in revenue generation by
the revalued asset.
Therefore a provision for future taxes should be made on this gain realized on the usage of the asset
as it is likely to reverse in the future. Therefore the advantage of providing for deferred tax on
revaluation gain is the amount of gain transferred direct to equity is not assessed for tax purposes in
the income statement.
Argument against providing for deferred tax on revaluation of fixed assets.
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Where the asset has been revalued downwards giving rise to a revaluation loss, the loss is not
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considered as an allowance expense for tax purposes and therefore the provision for deferred tax on
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revaluation loss is not appropriate.
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ILLUSTRATION 5
a) Maji Limited had a deferred tax liability of Sh. 105 million as at 1 June 2010. During the year
ended 31 May 2011, the company had the following items with regard to estimating deferred tax:
1. The carrying amount of property, plant and equipment as at 31 May 2011 was Sh.980 million.
This included some buildings which were revalued upwards by Sh 50 million at 31 May 2010
which had a remaining useful life of 10 years at that date. The company's accounting policy is
to treat revaluation surpluses as realised on disposal of the revalued assets. The tax base of
property, plant and equipment as at 31 May 2011 was Sh 640 million.
2. Deferred development expenditure amounted to Sh.45 million at year end (Sh.40 million as at
31 May 2010). Sh.10 million of additional development expenditure was incurred during the
year and the remaining difference between 2010 and 2011 figures relates to development
expenditure amortised for products that have started being commercially produced. All
development expenditure is allowed for tax purposes.
3. Included in current assets is an amount of Sh.40 million due in respect of some patent
royalties on one of the company's older products which is now being produced by other
companies. Patent royalties are taxed only when received.
4. The company’s tax rate proposals.

Required:
i) The deferred tax balance as at 31 May 2011 and the relevant journal entry.
ii) The directors of Maji Limited have proposed that deferred tax should be discounted and also
provided on the share of post-acquisition profits in its subsidiary and associate companies.
Comment on these proposals.
SOLUTION
a) i.
Asset Carrying amount Tax Base Temporary Difference

Sh. “Million” Sh. “Million” Sh. “Million”
Property, plant and equipment 980 640 340 TTD

Deferred Development expenditure 45 - 45 TTD
Patents 40 - 40 TTD
425
Balance c/d on deferred tax (30% x 425) 127.5 M
Less: Deferred tax balance b/f (1 June 2010) (105)
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Increase in deferred tax 22.5M
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Journal entry:
Dr. Income statement Sh 22.5M Sh. 21
CR Referred tax account 1.5
CR Revaluation reserve (5 x 30%)
NB: Annual depreciation charge on revalued amount = =5
ii) Discounting Deferred Tax
This is not allowed under IAS 12 “Income Taxes” because deferred tax balance is not exactly known
in terms of cash and time.
Post-acquisition profits in subsidiary and associates
The holding company has a potential tax liability on post-acquisition profits because there is a
possibility of receiving them when dividends are paid. However, IAS 12 prohibits providing
deferred tax in the case of subsidiary because the holding company has control on when these should
be paid. For Associates, a provision can be made.

PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS (IAS 37)
The objective of this Standard is to ensure that appropriate recognition criteria and measurement
bases are applied to provisions, contingent liabilities and contingent assets and that sufficient
information is disclosed in the notes to enable users to understand their nature, timing and amount.
IAS 37 prescribes the accounting and disclosure for all provisions, contingent liabilities and
contingent assets, except:
(b) Those resulting from executory contracts, except where the contract is onerous. Executory
contracts are contracts under which neither party has performed any of its obligations or
both parties have partially performed their obligations to an equal extent;
(c) Those covered by another Standard.
Provisions
A provision is a liability of uncertain timing or amount.
Recognition
A provision should be recognised when, and only when:
(a) An entity has a present obligation (legal or constructive) as a result of a past event;
(b) It is probable (ie more likely than not) that an outflow of resources embodying economic
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benefits will be required to settle the obligation; and
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(c) A reliable estimate can be made of the amount of the obligation. The Standard notes that it is
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only in extremely rare cases that a reliable estimate will not be possible.
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In rare cases it is not clear whether there is a present obligation. In these cases, a past event is
deemed to give rise to a present obligation if, taking account of all available evidence, it is more
likely than not that a present obligation exists at the balance sheet date.
Measurement
The amount recognised as a provision shall be the best estimate of the expenditure required to settle
the present obligation at the balance sheet date. The best estimate of the expenditure required to
settle the present obligation is the amount that an entity would rationally pay to settle the obligation
at the balance sheet date or to transfer it to a third party at that time.
Where the provision being measured involves a large population of items, the obligation is estimated
by weighting all possible outcomes by their associated probabilities. Where a single obligation is
being measured, the individual most likely outcome may be the best estimate of the liability.
However, even in such a case, the entity considers other possible outcomes.
Contingent liabilities
A contingent liability is:

(a) A possible obligation that arises from past events and whose existence will be confirmed only
by the occurrence or non-occurrence of one or more uncertain future events not wholly within
the control of the entity; or
(b) At present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
(ii) The amount of the obligation cannot be measured with sufficient reliability.
An entity should not recognise a contingent liability. An entity should disclose a contingent liability,
unless the possibility of an outflow of resources embodying economic benefits is remote.
Contingent assets
A contingent asset is a possible asset that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence of one or more uncertain future events not
wholly within the control of the entity.
An entity shall not recognise a contingent asset. However, when the realisation of income is virtually
certain, then the related asset is not a contingent asset and its recognition is appropriate.
REVISION EXERCISE
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QUESTION 1
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Julian recognized a deferred tax liability for the year end 31 December 2003 which related solely to
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accelerated tax depreciation on property, plant and equipment at a rate 30%. The net book value of
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the property, plant and equipment at that date was Shs. 310,000 and the tax written down value was
Shs. 230,000.
The following data relates to the year ended 31 December 2004:
i) At the end of the year the carrying value of property, plant and equipment was Shs. 460,000
and their tax written down value was Shs. 270,000. During the year some items were revalued
by Shs. 90,000. No items had previously required revaluation. In the tax jurisdiction in which
Julian operates revaluations of assets do not affect the tax base of an asset or taxable profit.
Gains due to revaluations are taxable on sale.
ii) Julian began development of a new product during the year and capitalized Shs. 60,000 in
accordance with IAS 38. The expenditure was deducted for tax purposes as it was incurred.
None of the expenditure had been amortized by the year end.
iii) Julian's income statement showed interest income receivable of Shs. 55,000, but only Shs.
45,000 of this had been received by the year end. Interest income is taxed on a receipts basis.
iv) During the year, Julian made a provision of Shs. 40,000 to cover an obligation to clean up
some damage caused by an environmental accident. None of the provision had been used by
the year end. The expenditure will be tax deductible when paid.

The corporate income tax rate recently enacted for the following year is 30% (unchanged from the
previous year).
The current tax charge was calculated for the year as Shs. 45,000. .
Current tax is settled on a net basis with the national tax authority.
Required;
a) Prepare a table showing the carrying values, tax bases and temporary differences for each for
the items above at 31 December 2004.
b) Prepare the income statement and statement of financial position notes to the financial
statements relating to deferred tax for the year ended 31 December 2004.
Solution:
a) Carrying value Tax base Temporary difference
Sh ‘000’ Sh ‘000’ Sh ‘000’

Property, plant and equipment 460 270 190
Development expenditure 60 60
Interest receivable (55 - 45) 10 10
Provision (40) (40)
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b) Notes to the statement of financial position
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Deferred tax liability
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Sh ‘000’
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Accelerated depreciation for tax purposes [(190 - 90)×30%] 30
Product development costs deducted from taxable-profit (60 ×30%) 18
Interest income taxable when received (10 ×30%) 3
Provision for environmental costs deductible when paid (40 × 30%) (12)
Revaluations (90 ×30%) 27
66
Sh ‘000’
At 1 January 2004 [(310 - 230) ×30%] 24
Amount charged to income statement (balancing figure) 15
Amount charged to equity (90 ×30%) 27
At 31 December 2004 (220×30%) 66
Note to the income statement
Income tax expenses
Sh ‘000’
Current tax 45
Deferred tax 15
60

QUESTION 2
IAS 32 “Financial Instruments: Disclosure and Presentation” states that the purpose of the
disclosures required by this standard is to provide information that will enhance understanding of the
significance of on-balance-sheet and off-balance-sheet financial instruments to an enterprise’s
financial position, performance and cashflow and assist in assessing the amounts, timing and
certainty of future cashflows associated with those instruments.
State and briefly describe three types of financial risks described in the standard, in relation to
transactions in financial instruments.
Solution:
Price risk. There are three types of price risk. Namely:- currency risk, interest risk and market risk.
1. Currency risk is the risk that the value of a financial instrument will fluctuate due to changes in
foreign exchange rates.
2. Interest risk is the risk that the value of a financial instrument will fluctuate due to changes in market
interest rates.
3. Market risk is the risk that the value of a financial instrument will fluctuate as a result of changes in
market prices whether those changes are caused by factors specific to the individual security or its
issuer or factors affecting all securities traded in the market.
Credit risk: The risk that is partly to a financial instrument will fail to discharge an obligation and cause the
other party to incur a financial loss.
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Liquidity risk (or funding risk): The risk that an enterprise will encounter difficulty in raising funds to
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meet commitments associated with financial instruments.
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Cash flow risk: The risk that future cash flows associated with a monetary financial instrument will
fluctuate in amount.
QUESTION 3
a) In the context of IAS 17 (Leases), briefly explain the meaning of the following terms:
i) Finance lease.
ii) Guaranteed residual value.
iii) Contingent rent.
b) Silversands Manufacturing Company Ltd. has entered into an agreement with a finance company,
to lease a machine for a four year period. Under the terms of the agreement, the machine is to be
made available to Silversands Manufacturing Company Ltd. on 1 January 2005, when an immediate
payment of Sh. 2,550,000 will be made, followed by seven semi-annual payments of an equivalent
amount.
The fair market price of the machine on 1 January 2005 is expected to be Sh. 16,320,000. The
estimated life of this type of machine is four years. The implicit rate of interest in the transaction is
6.94% payable semi-annually and the corporate tax rate is 30%. Silversands Manufacturing
Company Ltd. has a policy of depreciating machines of this type over a four year period on the
straight line basis.
Assume the lease is to be capitalized.
Required:
i) Show how the above transactions will be reflected in the profit and loss account of
Silversands Manufacturing Company Ltd. for each of the four years ending 31 December
2005, 2006, 2007 and 2008.
ii) Balance sheet extracts of Silversands Manufacturing Company Ltd. as at 31 December 2005
and 2006.
(Use the actuarial method to allocate the interest charge)
Solution:
(a) In IAS 17 context:
(i) Finance lease
This is a lease that transfers substantially all the risks and rewards incident to ownership of an
asset. Title may or may not eventually be transferred.
(ii) Guaranteed residual value is:
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- In the case of the lessee, that part of the residual value which is guaranteed by the lessee or by
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a party related to the lessee (the amount of the guarantee being the maximum amount that
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could, in any event become payable).
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- In the case of the lessor, that part of the residual value which is guaranteed by the lessee or by
a third party unrelated to the lessor who is financially capable of discharging the obligations
under the guarantee.
(iii) Contingent rent
This is that portion of the lease payments that is not fixed in amount but is based on a factor other
than just the passage of time (e.g. percentage of sales, amount of usage, price indices and market
rates of interest).
Alternatively: (Assuming interest quoted is paid).
(b) Using actual method.
Shs. ‘m’
Fair value of leased asset 16,320
Initial payment (2,550)
Balance 13,770
Remaining instalments over 7 months interest of 3.47 (6.94 x ½)

Year Bal b/f Interest Instalment Depr. Bal c/f
Sh. ‘m’ Sh. ‘m’ Sh. ‘m’ Sh. ‘m’ Sh. ‘m’
2005 1 13,770 478 2,250 1772 11,998
2005 2 11,998 416 2,250 1834 10,164
2006 1 10,164 353 2,250 1897 8,267
2006 2 8,267 287 2,250 1963 6,304
2007 1 6,304 219 2,250 2031 4,273
2007 2 4,273 148 2,250 2102 2,171
2008 1 2,171 75 2,250 2175 (4)
Payable (instalment) = 13,770
1 – (1 + 0.0347)- 7 = 2250
0.0347
Change to P & L AC.

Year Expenses Cost Depreciation Total
2005 894 4080 4974
2006 640 4080 4720
2007 367 4080 4447
2008 75 4080 4155
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Balance Sheet Extract
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Non – Current Assets
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Sh. ‘m’ Sh. ‘m’
Cost 16,320 16,320
Depreciation 4,080 8,160
Obligations under finance lease 12,240 8,160
Non-current liability 6,304 2,177
Current liability 3,860 4,133
(b) Silver sands Manufacturing Company Ltd.
(i) Actuarial method
Fair value of leased asset Sh. ‘000’

Initial payment 16,320
“Amount borrowed” 2,550
Instalment value 13,770
Number of instalments 2,550
7

Year Liabilities at Rental Sub-total Finance charge Liability at
beginning Payment Sh. ‘000’ at 6.94% end
Sh. ‘000’ Shs. ‘000’ Sh. ‘000’ Shs.‘000’
2005 16,320 2,550 13,770 955.57 14,725.57
14,725.57 2,550 12,175.57 845.07 13,020.64
2006 13,020.64 2,550 10,470.64 726.58 11,197.22
11,197.22 2,550 8,647.22 600.10 9,246.32
2007 9,247.32 2,550 6,697.32 464.95 7,162.27
7,162.27 2,550 4,612.27 320.11 4,932.38
2008 4,932.38 2,550 2,382.38 165.24 2,547.62
2,547.62 2,550 (2.38) 2.38 NIL
20,400 4,080
Fair value of leased asset 16 320
=
Estimated useful life 4
Gives sh.4 080 000 depreciation per annum
Charge to the profit and loss account
Year Finance Depreciation Total Charge against Timing
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charge Sh. ‘000’ taxable profits Difference
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Sh. ‘000’ Sh. ‘000’ Sh. ‘000’
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2005 1,800.64 4,080 5,880.64 5,100 780.64 O
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2006 1,326.68 4,080 5,406.68 5,100 306.68 O
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2007 785.06 4,080 4,865.06 5,100 (234.94) R
2008 167.62 4,080 4,247.62 5,100 (852.38) R
4,080__ 16,320 20,400 20,400 NIL
(ii) Extracts from published accounts
2005 2006
(b)(i) (b) (ii)
Sh. ‘000’ Shs. ‘000’
Profit and loss account

Provision for deferred tax 406.13 135.32
Operating profits stated after charging:
Depreciation on leased assets under finance leases 4,080 4,080
Interest payable on finance leases 1,800.64 589.9
Balance sheet
Deferred taxation account 406.13 589.90

Non-current assets
Cost 16,320 16,320
Depreciation to date 4,080 8,160
Net book value 12,240 8,160
Leasing Commitments
Minimum leasing commitments
2005 5,100 -
2006 5,100 5,100
2007 5,100 5,100
15,300 10,200
Less: Finance allocated to future periods 2,279.36 905.42
13,206.64 9,294.58
Current obligations under finance leases 3,603.32 4,371.55
* Non-current obligations under finance leases 9,417.32 4,922.52
* Contingent liability 2,279.36 905.42
Based on amount on premature cancellation of contract = Interest allocated to future periods or otherwise
specifically stated in terms of the lease.
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TOPIC 2
FURTHER ASPECTS OF PARTNERSHIPS
DISSOLUTION OF A PARTNERSHIP
Introduction:
The dissolution of partnership among all the partners of a firm is called the Dissolution of the Firm.
Dissolution of Partnership involves a change in the relation of partnership business, if the remaining
partners resolve to continue the concern. In such cases there will be a new partnership but the firm
will continue in a reconstituted form.
Dissolution of firm means complete breakdown of the relation of partnership among all the partners.
When all the partners resolve to dissolve the partnership, the dissolution of firm occurs, i.e. the firm
is wound up.
If the business comes to an end, it is said that the firm has been dissolved. Dissolution of firm means
the closing down of the business. Firm’s dissolution implies partnership dissolution but not vice
versa.
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That is dissolution of partnership does not mean dissolution of firm, but the dissolution of firm
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will be dissolved on any one of the following ways:
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(a) Dissolution by Agreement
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A firm may be dissolved at any time with the consent of all partners. For instance, when a firm does
not expect good prospects in the future, a firm can be dissolved by mutual consent of all partners.
(b) Compulsory Dissolution
A firm is compulsorily dissolved by operation of law when all the partners except one become
insolvent or when all the partners become insolvent or when business becomes illegal or when the
number of partners exceeds twenty in case of ordinary business or ten in case of banking.
(c) Dissolution on the Happening of Certain Contingencies
A firm is dissolved, in the absence of contrary, in the event of any of the following
circumstances:
(i) The expiry of the term for which it was formed.

(ii) The completion of the venture for which the partnership was constituted.
(iii) The death of a partner.
(iv) The adjudication of a partner as an insolvent.

(d) Dissolution by Notice of Partnership at Will
Where a partnership is at will, the firm may be dissolved by any partner giving notice in writing to
all the other partners of his intention to dissolve the firm.
(e) Dissolution by the Court
The court is empowered to order the dissolution of a firm consequent on a suit by a partner in
the following cases:
i) When a partner becomes insane or unsound of mind.

ii) When a partner becomes permanently incapable of performing his duties, be it mental or
physical.
iii) When a partner is proved guilty of misconduct which is likely to affect adversely the busi-
ness of the firm.
iv) When a partner conduct himself in such a way that it is not possible for the other partners to
carry on partnership with him.
v) When a partner transfers his interest or share to third party.
vi) When the business cannot be carried out except at a loss. (It must be remembered that the
object of partnership is to earn profits and if that object is not fulfilled, the firm can be
dissolved).
vii) When it appears to be just and equitable. For instance, continued quarrelling, deadlock in
the management, refusal to attend matters of business, absence of cooperation etc. among
the partners. (The court has wide discretionary powers).
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Liability for Acts Done After Dissolution
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When a firm is dissolved a public notice must be given of the dissolution. If it is not done, the
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partners continue to be liable as such to third parties for any act done by any of them after the disso-
lution, and in such a case, the act of a partner done after dissolution is deemed to be an act done
before the dissolution.
Settlement of Accounts
As soon as a firm is dissolved, it ceases to transact normal business. The mode of settlement of
accounts between partners after the dissolution of a firm is determined by the partnership agreement.
In the absence of any specific agreement as to the mode of settlement of accounts after the dissolu-
tion of the firm, the Partnership Act laid down the following provisions for settlement of accounts.
a) Losses, including deficiencies of capital, shall be paid first out of profit, next out of capital,
and lastly, if necessary, by the partners individually in their profit-sharing ratio.
b) The assets of the firm including any sums contributed by the partners to make up deficiencies
of capital shall be applied in the following manner and order:
i) In paying the debts of the firm to third parties.
ii) In paying each partner rateably what is due to him from the firm for advances.
iii) In paying to each partner rateably what is due to him on account of capital, and
iv) (iv)The surplus, if any, will be divided among the partners in their profit sharing ratio.

Dissolution Accounts:
When a business is discontinued, the firm is said to be dissolved. As a result, all the accounts be
closed. It is, therefore, necessary to open Realisation Account, Cash or Bank Account and Partners
Capital Accounts.
1. Realisation Accounts is opened for all transactions relating to realisation of assets and
payment of liabilities. That is, on dissolution, it is essential to make sale of assets of the
firm, realize cash and paying off the liabilities.
Realisation of assets and settlement of liabilities are centred round the Realisation
Account. It is a nominal Account. The transactions – realisation and settlement – are over,
the difference, being gain or loss will be transferred to Capital Accounts.
2. Cash/Bank Account is opened to record all cash transactions. When the purpose is over
the Cash Account shows a balance, which is equal to the amounts due to partners.
3. Capital Accounts are opened to make all entries connected with the partners’ accounts.
Current Accounts, if any, are transferred to Capital Accounts. Finally the Capital
Accounts are closed by receiving or paying cash.
Journal Entries
1. Close the current accounts to their capital accounts:

a. If a credit balance:
Dr: Partner’s current account xx
Cr: Partner’s capital account xx
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b. If a debit balance:
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Dr: Partners’ Capital account xx
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Cr: Partner’s Current account xx
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2. Close all assets at book values except cash bank to the realization account.
Thus:
Dr: Realization a/c xx
Cr: Individual assets a/c xx
3. To record cash proceeds on disposal of assets:

Dr: Bank a/c xx
Cr: Realization a/c xx
4. To record assets taken over by partners at agreed values

Dr: Partner’s Capital a/c xx
Cr: Realization a/c xx
5. With the dissolution expenses:

a. If paid by the firm;
Dr. Realization a/c xx
Cr.Bank a/c xx

b. If borne by the partner;
Dr.Realization a/c xx
Cr: Partner’s Capital a/c xx
6. With the liabilities paid. Thus;

Dr. Individual liabilities a/c xx
Cr. Bank a/c xx
a. If a discount if received from creditors. Thus;
Dr. Creditor’s a/c xx
Cr. Realization a/c xx
b. To record interest on liabilities paid
Cr. Bank a/c xx
7. with the balancing figure in the realization account being either profit or loss, share it
among the partners using the P&L ratio.
a. If a profit:
Cr: Partner’s Capital a/c xx
b. If a loss:
Dr. Partners’ Capital a/c xx
8. After all above adjustments the balances in the bank a/c and the partners’ capital a/c should
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be opposite and equal. If this is the case, then pay the partners by:
a.c
Dr. Partner’s capital a/c xx
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Cr.Bank a/c xx
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a. If one of the partners has a debit balance then he will be required to pay the same. Thus:
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Dr. Bank a/c xx
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Cr. Partner Capital a/c xx
b. If the partner has a debit balance and he’s unable to pay for the same. Then apply the rule of
GARNER VS MURRAY
If, at the time of dissolution, a partener owes a sum of money to the firm, he has to pay it to the firm.
But if he is insolvent, he will not be able to do so, at least not fully.
The sum which is irrecoverable from an insolvent partner is, therefore, a loss. The question arises
whether this loss is like the ordinary loss to be shared by the solvent partner in the profit sharing
ratio or whether it is an extraordinaryloss. Before the decision in Garner vs. Murray was made, such
a loss was treated as ordinary loss.
Illustration 1
Akinyi and Chinedu were in partnership sharing profit and losses in the ratio of 3:2 respectively.
Their statement of financial position as at 31 December 2010 was as follows:

Akinyi & Chinedu Enterprises
Statement of Financial Position as at 31st December 2010
Sh. “000”
Assets
Non-Current Assets
Plant and machinery 2,800,000
Fixtures and fittings 400,000
Investments 1,000,000
Total non-current assets 4,200,000
Current assets
Inventory 600,000
Trade receivable 2,000,000
Less: provision for bad debts (100,000)
Bank 1,900,000
Total Assets 1,150,000
7,850,000
Capital & Liabilities
Capital & Reserves 1,000,000
Capital: Akinyi 800,000
Chinedu 500,000
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Accumulated profits (750,000)
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Owner’s equity 1,550,000
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Liabilities
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Non-Current Liabilities
Loan from Akinyi 1,500,000
Loan from KCB 1,000,000
Current Liabilities
Creditors 3,800,000
7,850,000
Additional information
On 1st Jan 2011 the partners decided to dissolve the partnership after serious disagreements and the
following information was provided:
1. Akinyi took over the investment at Sh 800,000 and also agreed to pay the loan from KCB.
2. The assets realised the following amounts:
 Stocks sh 500,000
 Trade receivables sh 1,850,000
 Fixtures & fittings sh 450,000
 Plant & machinery sh 2500,000
3. Dissolution expenses amounted to sh 110,000
4. Creditors were paid an amount less 2.5% discount.
5. The loan from Akinyi was paid in full
Required
a) Realisation account
b) Capital account
c) Bank account
Partner’s Capital Account
Akinyi Chinedu Akinyi Chinedu

Owner’s Equity (3:2) 450,000 300,000 Bal. b/d 800,000 500,000
Realisation invest. 800,000 Accumulated profits 500,000 500,000
Realisation 369,000 246,000 Loan from KCB 1, 000,000 _
Bank (bal. Fig) 681,000 454,000 _____ _____
2,300,000 1,000,000 2,300,000 1,000,000
Realisation Account
Sh. “000” Sh. “000”

Plant and machinery 2800,000 Bank (stock) 500,000
Furniture and fittings 400,000 Bank (T. Receivables) 1850,000
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Investments 1000,000 Bank (Fix & fittings) 450,000
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Trade receivables 1900,000 Bank (Plant & machinery) 2500,000
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Bank (Distribution exp.) 110,000 Capital – Akinyi (Investment) 800,000
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Inventory 600,000 Discount received (2.5% x 3.8m) 95,000
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Capital: Akinyi 365,000
_____ Chinedu 246,000
6,810,000 6,810,000
Bank Account
Sh.“000” Sh. “000”

Bal. b/d 1150,000 Realisation (Dissolution exps) 110,000
Realisation (stock) 500,000 Creditors 3705,000
Realisation (trade receivables) 1850,000 Loan from Akinyi 1500,000
Realisation (furniture & fittings) 450,000 Bal. c/d
Realisation (plant & machinery) 2500,000 Capital: Akinyi 681,000
_____ Chinedu 454,000
6,450,000 6,810,000

Fixed Capital Balances and Fluctuating Capital Balances
When dissolving a partnership firm distinction should be made between fixed capital balances and
fluctuating capital balances.
If the partnership agreement allows the use of fixed capital balances on dissolution, then no
adjustment is required by interest on capital interest on drawings, profit share, partners’ salaries etc.
These adjustments are therefore made to the current accounts.
However, if fluctuating capital balances have been agreed upon then you will be required to make
adjustment to the capital balances with interest on capital, interest on drawings, profit share,
partner’s salaries etc.
For purposes of dissolution fluctuating capital balances are normally used in sharing the debit
balance of one of the partners in case it arises.
Piece Meal Dissolution
It has so far been presumed that dissolution which involves selling the firm’s assets takes a single
day. However, in actual practice, selling the firm’s assets may take some time then thereafter all
expenses are paid, creditors and other loans.
The following is the procedure of making payments on dissolution as and when realization has been
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made.
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a) Pay all dissolution expenses first
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b) The firm’s creditors are then paid
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c) Partner’s loans
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d) Partner’s capital balances are finally paid
Cash distributions are then made to the partners as and when realization is made using the either of
the following two approaches:
a) Maximum potential loss method

b) Capital surplus method
a. Maximum Potential / Possible Loss Method
Under this method the maximum possible loss is calculated after outside creditors and partners’
loans have been paid off. This loss is transferred to the capitals and thus the amount payable to a
partner would be known. If a partner’s share of the loss is more than the capital, he should be treated
as “insolvent” and, in accordance with Garner vs Murray, the loss should be transferred to the other
parnters in the ratio of the capitals just before dissolution.
The amount to the credit of partners will be equal exactly to the cash in hand and the cash will be
distributed among the partners according to the figure now resulting.Such calculation of of
maximum loss, whenever an instalment of cash is received, will show how much is to bepaid to
various partners.
Steps:
1. Pay off the dissolution expenses, creditors, partners’ loans and other liabilities first.
2. Then the partnership Capital balances are to be paid using the cash available. Find out the
difference between the cash available and partner’s capital balances. This difference is called
the maximum potential loss.
3. Distribute the maximum possible loss to the individual partners using the profit & loss ratio.
That is deducting the maximum possible loss from the individual capital balances.
4. If the balances from Step 3 are all credit balances then cash is distributed to partners using the
same balances but if one of the partners has a debit balance, then step 5.
5. If a debit balance, then share the debit balance among the remaining solvent partners using the
rule of Garner vs. Murray. If the rule of Garner vs. Murray is not applicable then share the debit
balance using the profit & loss ratio of the remaining solvent partners.
6. As and when realizations are made the above procedure is repeated (Step 2 – Step 4/5)
ILLUSTRATION 1
Nyoike, Kemei, Lasoi and Mutuku, who have been partners in a tile manufacturing business sharing
profits and losses in the ratio 4:3:2:1, had a serious disagreement on 15 January 2004 which
necessitated dissolution of the partnership.
For the purpose of dissolution, their accountant extracted a balance sheet as at 1 February 2004 as
follows:
Sh. ‘000’ Sh. ‘000’
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Non – current assets:
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Land and buildings 21,250.0
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Plant and machinery 19,802.5
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Furniture and fittings 7,500.0
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Investments 5,000.0
53,552.5
Current assets:
Inventory 15,870.0
Debtors 9,602.5
Balance at bank 782.5 26,255.0
Total assets 79,807.5
Capital and liabilities:

Capital account: Nyoike 10,000.0
Kemei 17,500.0
Lasoi 10,000.0
Mutuku 7,500.0
45,000.0
General reserves 17,500.0
Current liabilities:
Creditors 17307.5
79,807.5

Additional information:
1. The assets, which were sold on piecemeal basis, realized cash as follows:
Sh. ‘000’
10 February 2004 Inventory (partial) 8,750.00
16 February 2004 Debtors (partial) 7,330.00
27 February 2004 Investments 6,050.00
03 March 2004 Furniture and fittings 5,000.00
20 March 2004: Land and buildings 17,500.00
Debtors (partial) 1,250.00
Inventory (balance) 6,875.00
15 April 2004: Plant and machinery debtors (balance) 16,400.00
877.50
2. The partners agreed to set aside Sh. 1.25 million to meet realization expenses.
Any cash available for distribution thereafter was to be shared immediately the
3. creditors were paid in full.
The realization expenses which amounted to Sh. 1 million were paid on 15 April
2004.
Required:
Using the maximum possible loss method, prepare:

(a) Statement showing how the proceeds should be shared.
(b) Realization account and capital account to close off the book f the partners.
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SOLUTION
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Cash Distribution Statement
Total Nyoike Kemoi Lasoi Mutuku

Sh. ‘000’ Sh.‘000’ Sh. ‘000’ Sh. ‘000’ Sh. ‘000’
Bal. b/d 78.2
10 Feb 04 Realisation 8750
Total cash 22912.5
Less: Dissolution expenses (1250)
Creditors (17307.5)
Cash available 4355
Capital bal. 45,000 10,000 17500 10,000 7500
General reserves (4:3:2:1) ____ 7,000 5250 3500 1750
62500 22750 13500 9250
Less: Cash available (4355)
M.P.L (4: 3:2:1) 58145 (23,258) (17443.5) (11629) (5814.5)
(6258) 5306.5 1871 3435.5

Share the debt bal. (N) (22.75:13.5:9.25) 6258 (3129) (1856.8) (1272.2)
1st Cash distribution 4355 _____ 2177.5 14.2 2163.3
Capital bal. 58145 17,000 20,572.5 13485.8 7086.7
Less: 3rd March of Realisation (5000)
M.P.L 53145 (21258) (15943.5) (10629) (5314.5)
(4258) 4629 2856.8 1772.2
Debit bal. Shared (N;s) (22.75:13.5:9.25) 4258 (2129) (1263.4) (865.6)
2nd cash distribution 5000 _____ 2500 1593.4 906.6
Capital bal. 53145 17,000 18072.5 11892.4 6180.1
Less 20th March of Realisation (25625)
M.P.L 27520 11008 (8256) (5504) (2752)
3rd cash distribution 27625 5992 9816.5 6388.4 3428.1
Capital Bal. 27520 11008 8256 5504 2752
Less: 15/4/04 realisation (172775 + 250) (17527.5)
M.P.L 9992.5 (3997) (2997.8) (1998.5) (999.3)
4th final cash distribution 17527.5 7011 5258.2 3505.5 1752.7
Unpaid capital / loss on realisation 99927.5 3997 2997.8 1998.5 999.3
Partner’s Capital Accounts

Nyoike Kemoi Lasoi Mutuku Nyoike Kemoi Lasoi Mutuku
Less on Bal. b/d 10,000 17500 10,000 7500
realisation 3997 2997.8 1998.5 999.3 General reserve 7,000 5250 3500 1750
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Bank 1st cash - 2177.5 14.2 2163.3
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Bank 2nd cash - 2500 1593.4 906.6
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Bank 3rd cash 5992 9816.5 6388.4 3428.1
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Bank 4th cash
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7011 5258.2 3505.5 1752.7 ____ ____ ____ ____
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17000 227750 13500 9250 17,000 22750 13500 9250
Realisation Account
Sh. “000” Sh. “000”
Land and building 21,250 10 Feb 04 Bank 8,750
Plant and machinery 19,802.5 16 Feb 04 Bank 7,330
Furniture and fittings 7,500 27 Feb 04 Bank 6,050
Investments 5,000 3 March 04 Bank 5,000
Inventory 15,870 20 March 04 Bank 25,625
Debtors 9,602.5 15 April 04 Bank 17,277.5
Bank (Distribution exp.) 1,000 Capital: Nyoike 4/10 x 9992.5 3,997
_ Kemei 3/10 x 9992.5 2,997.8
Lasoi 2/10 x 9992.5 1,998.5
____ Mutuku 1/10 x 9992.5 999.3
80,025 80,025

Bank Account
Sh. “000” Sh. “000”
10 Feb 04 realisation 8,750 Dissolution exp. realisation 1,000
16 Feb 04 realisation 7,330 Creditors 17,307.5
27 Feb 04 realisation 6,050 Capital: Nyoike -
3 March 04 realisation 5,000 1st cash Kemei 2,177.5
20 March 04 realisation 25,625 Lasoi 14.2
15 April 04 realisation 17,277.5 Mutuku 2,163.3
nd
_ 2 cash Nyoike -
Kemei 2,500
Lasoi 1,593.4
Mutuku 906.6
3rd cash Nyoike 5,992
Kemei 9,816.5
Lasoi 6,388.4
Mutuku 3,428.1
4th cash Nyoike 7011
Kemei 5,258.2
Lasoi 3,505.5
____ Mutuku 1,752.7
70,815 70,815
ILLUSTRATION2
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The trial balance extracted from the books of Newel, Omar, Pokka and Tamar on 30 April 2009 was
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as follows:
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Sh. ‘000’ Sh. ‘000’
Freehold property (Net book value) 6,000
Plant and equipment (NBV) 1,395
Office equipment (NBV) 2,030
Vehicles (NBV) 1,075
Stocks 3,405
Debtors 1,590
Creditors 785
Bank overdraft 210
Capital account : Newel 6,750
Omar 4,050
Pokka 2,700
Tamar 2,700
Current account : Newel 250

Omar 1,350
Pokka 300
Tamar ___ 200
17,395 17,395

The business has been steadily declining in the past few years. The partners have been trying to sell
the business as a going concern but have been unable to do so. They decided to sell the assets on a
piece-meal basis, and cash would be distributed to partners as soon as possible in amounts which
would ensure that no partner would be called upon to repay any moneys he had received. In the
partnership agreement, profits and losses were shared between Newel, Omar, Pokka and Tamar in
the ratio 4:3:2:1 respectively and the application of the rule in Garner, v Murray was excluded.
Transaction has been taken place as follows:
15 May 2009 All the motor vehicle were sold at the car bazaar for sh 975,000 net of selling
costs. The money was put into the bank account.
31 May 2009 Cash collected from debtors sh 122,000 and stock sold to realise sh 1, 070,000
after costs. All creditors were paid and the first cash distribution was made.
30 June 2009 Cash collected from debtors sh 248,000 and stock sold to realise sh 955,000 net
second cash distribution was made.
31 July 2009 Cash collected from debtors sh 1,100,000 and from sale of stock (net) sh
1,465,000. Third cash distribution was made.
31 August 2009 Office equipment sold for sh 1,950,000 (net) and plant and equipment sold for
sh 1,610,000. Fourth cash distribution was made.
31 October 2009 The freehold property was sold for sh 6,600,000. Various distribution
experiences of sh 200,000 were paid, the final distribution of cash took place.
Required;
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Using surplus capital method and maximum possible loss method prepare.
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a) A partnership dissolution payments schedule.
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b) Summary bank, realisation and partners’ capital accounts
Amount payable to partners
Newel Omar Pokka Tamar

Capital account 6750 4050 2700 2700
Current account (250) (1350) (300) 200
Amount payable 6500 2700 2400 2900
Determine amount payable for distribution.

Bank bal b/d (210)
15/5/09 realisation 975
31/5/09 Realisation (122 + 1070) 765
Less creditors 1192
(785)
1,172

Cash Distribution Statement
Total Newel Omar Pokka Tamar
Sh. 000 Sh. 000 Sh. 000 Sh. 000 Sh. 000
Capital bal 14,500 6.500 2700 2400 2900
Cash available 1,172 (5331.2) (3998.4) (2665.6) (1332.8)
Debit balances 13,328 1168.8 (1298.4) (265.6) 1569.2
Share of debit bal ____ (1251.2) (1209.4) (265.6) (312.2)
Newel debt bal 1,174 52.4 - - 1254.4
1st cash dist 13,328 52.4 ____ _____ 52.4
Cash bal 1,203 - - - 1172
30/6/09 – realization 12,125 6500 2700 2400 1728
Max. possible loss ____ (4850) (3637.5) (2425) (1212.5)
Share of debit bal 1,203 1650 (937.5) 251 515.5
2nd cash dist 12,125 (770) (937.5) (25) 192.5
Capital bal 2565 880 - - 323
31/7/2009 – realization 9560 5620 2700 2400 1405
1,100 + 1,465 ____ (3824) (2868) (1912) (956)
Share of debit balance 2,565 1796 (168) 488 446
3rd cash distribution 9560 96 (168) (48) (24)
Capital bal b/d 3560 1,700 - 440 425
31/8/09 1950 + 1610 6000 3920 2700 1960 980
4th cash dist 3560 (2400) (1800) (1200) (1600)
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Capital bal b/d 6000 1520 900 760 380
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31/10/09 (6600 – 200) 6400 2400 1800 1200 600
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Current account 400 160 120 80 40
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Amount payable 2560 1920 1280 640
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Realisation Account
Sh. 000 Sh.000
Freehold property 6000 Bank account 975
Plant and equipment 1395 15/5/2009 1192
Office equipment 2030 31/5/2009 1203
Vehicle 1075 30/06/2009 2565
Stock 3405 31/7/2009 3560
Debtors 1590 31/8/2009 6000
Bk realisation expenses 200 31/10/2009 _
Capital account 160
Newel 4/10 x 400 120
Omar 3/10 x 400 80
Pokka 2/10 x 400 40 __
Jamar 1/10 x 400 16,095 16,095

Bank Account
Sh. 000 Sh.000
Realisation 975 Bal b/d 210
account 1192 Creditors 785
15/5/2009 1203 Realisation exp 200
31/5/2009 2565 Capital account 6660
30/06/2009 3560 Newel 2820
31/7/2009 6000 Omar 2480
31/8/2009 ___ Pokka 2940
31/10/2009 16095 Tamar 16095
Partners’ capital accounts

Newel Omar Pokka Tamar Newel Omar Pokka Tamar
Current A/C 250 1350 300 - Bal b/d 6750 4050 2700 2700
Bank 6600 2820 2480 2940 Current A/C - - - 200
_ _ _ _ Realistion
___ ___ ___ ___ profit 160 120 80 40
6910 4170 2740 2940 6910 4170 2780 2940
b) Capital Surplus Method
Under this approach, cash distributions are made to the partners’ capital balances are made to the
partners so as to bring their capital balances in the same ratio as their P&L sharing ratio.
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This is achieved by making payments to the strongest partner with the greatest capital per unit or
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profit an amount that will make them equal to the second.
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Strongest partner is that partner with the greatest capital per unit/ profit, is assumed to less likely to
fall into a debit balance as compared to the second strongest partner.
After payment has been made to the strongest partner then there will be two partners with the same
capital per unit or profit balance.
Cash distributions are made to the two strongest partners so as to make them equal to the third
strongest ranking partner.
This procedure is repeated until all the capital balances are the same. Once this has been achieved
then thereafter cash distributions is made to the partners using their profit & loss sharing ratio as and
when realizations are made.
Under this method, distribution of cash are made to partners so as to bring their capital balance
(amount payable) as at the date of dissolution into the ratio in which they share the profits and
losses.
Determine the amount payable to each partner as at the date of dissolution.

Divide this amount payable by the profit or loss sharing ratios of the partners.
The resultant fig is the capital per unit of profit. Rank the partners based on this capital per unit of
profit with the greatest capital per unit of profit being ranked the first and the one with the least as
last.
The partner with the greatest capital per unit of profit is assumed to be least likely to fall into a debit
capital balance.
Payment is made to the first ranking partners so as to make his capital balances to be in their profit
and loss ratio to that of the 2nd ranked partner.
Payment is made to the two partners whose capital balances are in their profit sharing ratio so as to
make their capital balances to be in their profit and loss ratio to that of the 3rd ranked partners.
This process is repeated until the capital balances of all the partners are in tier profit and loss sharing
ratios.
Any other cash, should be distributed to partners using their profit and loss sharing ratio
QUESTION (refer above)
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Solution
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Determine the amount payable to each partner
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Sh ‘000’ Sh ‘000’ Sh ‘000’ Sh ‘000’
Capital Account 6750 4050 2700 2700
Current Account (250) (1350) (300) 200
Amount payable 6500 2700 2400 2900
Determine the order of payment

Sh ‘000’ Sh ‘000’ Sh ‘000’ Sh ‘000’
Capital balances 6500 2700 2400 2900
Dividend by P & L rates 4 3 2 1
Capital per unit of profit 1625 400 1200 2900
1st payment ____ ____ ____ (1275)
2nd payment 1625 900 1200 1625
3rd payment (425) ___ ___ (425)
1200 900 1200 1200
(300) ___ (300) (300)
900 900 900 900

Summary of payment
1st Payment
Bank b/d 210
Creditors 785 995
Distribution to partners
1st distribution – tamar (1275 x 1) 1275
2nd distribution
Tamar 425 x 1 = 425
Pokkar 425 x 4 = 1700 2,125
3rd distribution
Tamar 300 x 1 = 300
Pokka 300 x 2 = 600
Newel 500 x 4 = 1200 2,100
6,495
Any cash in excess of sh 6,495,000 should be distributed to partners using profit or loss sharing
ratios.
Actual cash distribution
Sh. ‘000’
Bank bal b/d (210)
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15.5 Realisation 995
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31/5 – Realisation 1,192
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1,957
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Less creditors 1,172
1st distribution Jamar bal (103) (1,172)
30
30/6 – Realisation (248 + 455) 1,203
Payment to Tamar bal (103) (103)
1,100
Payment to:
Tamar 1/5 x 1100 = 220 bal 205 (1,100)
Newel 4/5 x 1100 = 880 bal 820 -
2,565
31/7 Realisation (110 + 1465)
3rd distribution
Newel bal 520
Tamar bal 205 (1,025)
1,540
Newel 4/7 x 1540 = 880 bal (320)
Pokka 2/7 x 540 = 440 bal (180)
Tamar ¼ x 1540 = 220 bal 80 1,540
31/8 – Realisation (1950 + 1610) 3,560

4th distribution 3,000
Newel bal 320
Pokkar bal 160
Tamar bal 80 560
3,000
Newel 4/10 x 300 = 1200
Omar 3/10 x 3000 = 900
Pokka 2/10 x 300 = 600
Tamar 1/10 x 300 = 300 3,000
0
31/10 – Realisation (6600 – 200) 6,400
5th distribution
Newel 4/10 x 6400 = 2560
Omar 3/10 x 6400 = 1920
Pokka 2/10 x 6400 = 1280
Tamar 1/10 x 6400 = 640 6,400
0
AMALGAMATION
When two or more firms are carrying on business of a similar nature, it would be natural if they
amalgamate their businesses to avoid competition. It is usual to revalue all assets and liabilities so
that true capital brought into the new firm by each of the partners is ascertained. Therefore-
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(a) Each firm should prepare a Revaluation Account relating to its own assets and liabilities
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and transfer the balance to the partners' capital accounts in the profit-sharing ratio.
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(b) Entries for raising Goodwill should be passed.
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(c) Assets and liabilities not taken over by the new firm should be transferred to the capital
accounts of partners in the ratio of capitals.
(d) The new firm should be debited with the difference between the value of assets and
liabilities taken over by it, the assets should be credited and liabilities debited.
(e) Partners' capital accounts should be transferred to the new firm's account.
The above steps will close the books of the old firm. To open the books of the new firm, the
following entry will be required:
Debit the assets taken over at the agreed values.

Credit the liabilities taken over.
Credit individual partners' capital accounts.
Books of the old firms
i. Partner’s capital / current a/c

ii. Revaluation a/c
iii. Assets and liabilities a/c
iv. New firm a/c

Accounting Entries/ Journal Entries
1. Each firm must revalue their assets and liabilities as follows:
a. With the increase in the value of an asset

Dr. Individual asset a/c xx
Cr. Revaluation a/c xx
b. With the decrease in the value of an asset

Dr. Revaluation xx
Cr. Individual asset a/c xx
c. With the increase in the value of a liability

Dr. Revaluation a/c xx
Cr. Individual liabilities a/c xx
d. With the decrease in the value of a liability

e. With the balancing figure in the revaluation account being either, a profit or a loss, share it
among the partners using their old P & L sharing ratio.
i. If a profit
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Dr. Revaluation a/c xx
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Cr: Partner’s capital a/c xx
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ii. If a loss
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Dr. Partners’ capital a/c xx
2. Each firm must recognize goodwill. Thus,

Dr. Goodwill a/c xx
Cr: Partner’s capital a/c (using old P&L) xx
3. With the assets taken over by a partner at agreed values

N/B: If an asset is taken over at a value other than the book value, then the difference is shared
among the partners using their old P&L ratio.
4. To record liabilities taken over by a partner

Cr. Partner’s capital a/c xx
5. With the assets neither taken over by a partner nor taken over by the new firm but instead
sold by the old partnership. Thus,

Dr. Bank a/c xx
N/B: If an asset is sold at a profit or loss, then share the profit or loss using the old P&L ratio to the
partners. i.e.
a. If a profit:
b. If a loss:
Dr. Individual asset a/c xx
Cr. Partner’s capital a/c xx


Cr. Bank a/c xx
Dr. New firm a/c xx

Cr. Individual assets a/c xx
6. If a liability is not taken over by either a partner or the new firm and instead settled by the
old firms.
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7. To record assets transferred to the new firm
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8. With the liabilities taken over by the new firm
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Cr. New firm a/c xx
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9. To record partner’s capital balances transferred to the new firm, thus:
Cr. New firm a/c xx
N/B: If a question has current a/c, then close them to their capital a/cs accordingly.
Books of the New Firm

a. Business purchase a/c
b. Partners’ capital a/c
c. Assets and liabilities a/c
Accounting Entries / Journals
1. To recognize assets taken over in the new firm.

Dr. Individual assets a/c xx
Cr. Business purchase a/c xx

2. To record liabilities taken over in the new firm
Dr. Business Purchase a/c xx
Cr. Individual Liabilities a/c xx
3. To recognize the partner’s capital balances transferred from the old firms. Thus:
Dr. Business purchase a/c xx
Cr. New Partner’s capital a/c xx
4. with an additional cash introduced by partners into the new business

Dr. Bank a/c xx
Cr. New partners’ capital a/c xx
5. If a partner withdraws from the new partnership, then with the withdrawal
Dr. New Partner’s capital a/c xx
Cr. Bank a/c xx
6. It is the policy of the new firm not to maintain goodwill a/c and hence it’s written off. Thus:
Dr. New partner’s capital a/c xx
Cr. Goodwill a/c (with new P&L ratio) xx
ILLUSTRATION
Question ... Amalgamation.
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A and B are in partnership trading as A and B Retailers. Similarly, C and D are in partnership
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trading as C and D Traders. It was mutually agreed that as at 1 January 2011 the partnership
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business be amalgamated into one firm, ABC and D Enterprises. The profit and loss sharing ratios of
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the partners both in the old and new partnership were as follows:
Old firms A B C D
New firm 4 3 3 2
6 5 4 3

As at 31 December 2010 the statement of financial positions of the firms was as follows:
A and B Retailers C and D Traders
Sh. Sh. Sh. Sh.
Non-current assets
Property 740,000 1,000,000
Fixtures and fittings 180,000 140,000
Motor vehicles 300,000 180,000
1,220,000 1,320,000
Current assets :
Stock 830,000 660,000
Investments 80,000 -
Debtors 680,000 580,000
Bank balance 340,000 -
1,930,000 1,240,000
Current liabilities
Creditors (520,000) (600,000)
Bank overdraft - 1,410,000 (90,000) 550,000
Net asset 2,630,000 1,870,000
Capital accounts
A 1,500,000 C 1,100,000
B 1,050,000 D 700,000
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Current accounts
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A 30,000 C 30,000
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B 50,000 80,000 D 40,000 70,000
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2,630,000 1,870,000
The agreement to amalgamate the firms contained the following provisions:
1. Provision for bad and doubtful debts at the rate of 5% was to be made in respect of debtors and a
provision for discounts receivable at the rate of 2 ½ % was to be made in respect of creditors.
2. ABC and D enterprises was to take over the old partnerships’ assets at the following values:
A and B Retailers C and B Traders

Stock 845,000 639,000
Fixture and fittings 160,000
Property 1,000,000
3. The property and fixtures and fittings of C and D traders were not to be taken over by the ABC
and D Enterprises. These assets were sold for sh 1,350,000 on 1 January 2011.
4. B was to take over his firm’s investments at a value of sh 76,000.
5. The total capital of ABC and D Enterprises was to be sh 5,400,000. This was to be contributed by
the partners in their profit or loss sharing ratios, any adjustment necessary being made in cash.

6. Goodwill relating to the two firms was to be recognised as follows:
A and B Retailers - Sh 630,000
C and D Retailers - Sh 450,000
Required
a) The relevant accounts to close off the books of A and B Retailers and C and traders.
b) The opening statement of financial position of ABC and D Enterprises as at 1 January 2011.
Solution;
Closing books of A and B Retailers
Revaluation Account
Sh. ‘000’ Sh. ‘000’

Provision for bad debts (5% x680,000) 34000 Provision for discount rec. 13000
Motor vehicle 20,000 Stock 15000
Fixtures&Fittings 20,000 Property 260,000
Investments 4000
Capital account
A 4/7 x 210,000 120,000
B 3/7 x 210,000 70,000 _____
288,000 288,000
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Provision for bad and doubtful debt Account
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Sh. ‘000’ Sh. ‘000’
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New firms 34000 Revaluation dc 34000
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____ ____
34000 34000
Provision for discount receivable Account

Sh. ‘000’ Sh. ‘000’
Revaluation ½ % x 5200 13000 New firm 1300
____ ____
13000 13000
Capital Account
A B A B
Sh. ‘000’ Sh. ‘000’ Sh. ‘000’ Sh. ‘000’

Investments - 76,000 Bal b/d 1,500,000 1030,000
New firm 2,010,000 1,384,000 Revaluation 120,000 90,000
Goodwill 3,600,000 270,000
_____ ____ Current account 50,000 50,000
2,010,000 1,460,000 2,010,000 1,460,000

Goodwill Account
Sh. ‘000’ Sh. ‘000’
Capital account New firm 630,000
A 4/7 x 630000 360,000
B 5/7 x 630000 270,000 ____
630,000 630,000
New firm Account (ABCD) Enterprises

Sh. ‘000’ Sh. ‘000’
Stock 875,000 Provision for bad debts 34000
Motor vehicle 280,0000 Creditors 520000
Fixtures& Fittings 160,000 Capital account
Property 1,000,000 A 2010000
Goodwill 630,000 B 1384000
Debtors 680,000
Bank 340,000
Provision discount 13,000 ____
3,948,000 3,948,000
Closing the books of C and D Retailers
Revaluation Account
om
a.c
Sh. ‘000’ Sh. ‘000’
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ea
Provision for bad debts 510 x 58000 29,000 Provision for discount rec. 15,000
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.so
Stock 21,000 Capital account
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50,000- C 3/5 x 85000
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Motor vehicle 51,000
Fixtures& Fittings ____ D 2/5 x 85000 38,000
100,000 100,000
Provision for bad and doubtful debts

Sh. ‘000’ Sh. ‘000’
New firm 29,000 Revaluation account 29,000
Provision for discount received account

Sh. ‘000’ Sh. ‘000’
Revaluation New firm
2 ½ % x 600000 15000 15000
Goodwill account
Sh. ‘000’ Sh. ‘000’
Capital account 270,000 New firm 450,000
C = 3/5 x 450,000 180,000 ______
D = 2/5 x 450,000 450,000 450,000

Capital Account
C D C D
Sh. ‘000’ Sh. ‘000’ Sh. ‘000’ Sh. ‘000’
Revaluation 51,000 34,000 Bal b/d 1,100,000 700,000
New firm 1,475,000 970,000 Revaluation 126,000 84,000
Goodwill 270,000 180,000
_____ ____ Current account 30,000 40,000
1,526,000 1004000 1,526,000 1004000
New Firm Account ABCD Enterprises

Sh. ‘000’ Sh. ‘000’
Stock 639000 Provision for bad debts 29,000
Motor vehicle 150000 Creditors 600,000
Prov. for disc 15000 Capital account
Debtors 580,000 C 147500
Goodwill 450,000 D 970,000
Bank 1260,000 ______
3074,000 3,075,000
Cash Account
Sh. ‘000’ Sh. ‘000’
Disposal 135000 Bal b/d 90,000
______ New firm 1260,000
om
a.c
1350,000 1,350,000
ny
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ea
m
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Requisition Account
w
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Sh. ‘000’ Sh. ‘000’
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Property 1,000,000 Cash 1,350,000
Fixtures& Fittings 140,000
Capital Account
C 3/5 x 210,000 126,000
D 2/5 x 210,000 84,000 ______
1,350,000 1,350,000

Opening books of ABCD Enterprises
Buisiness purchase Account

Sh. ‘000’ Sh. ‘000’
Creditors 1120000 Stock 845000 + 630,000 1,484,000
Provision for bad debts 36129 63000 Motor vehicle (280 + 130) 410,000
Capital account Fixtures& Fittings 160,000
A 2010,000 Property 1000000
B 1384,000 Goodwill (630 + 450) 1080,000
C 1475,000 Bank (340 + 1260) 1600,000
D 970,000 Prov. for disc (13 + 16) 280,000
debtors 1260,000
bal c/d 315
7589000 7589000
New capital balance in the new firm

A = 6/18 x 5400000 = 1,800,000
B = 5/18 x 5400000 = 1,500,000
C = 4/18 x 5400000 = 1,200,000
D = 3/18 x 5400000 = 900,000
Cash / Bank Account

Sh. ‘000’ Sh. ‘000’
om
B/s Purchase 1,600,000 Capital Account 210,000
a.c
ny
Capital 1160,000 A = 275,000
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ea
B ______ C= 70,0000
m
.so
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1,716,000 D = 1,161,000
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Bal c/d 1,716,000

ABCD Enterprise
Statement of Financial Position as at 1/1/2011
Shs
Assets
Non-Current
Goodwill 1080,000
Properties 1000,000
Furniture and fixtures 160,000
Current Assets
Trade Rec (1260 – 63) 1197000
Inventories stock 1484,000
Cash / Bank 1161,000
6492,000
Capital and liabilities
Capital Account
A 1800,000
B 1500,000
C 1200,000
D 900,000
Liability
om
Creditors 1160 – 28 1092,000
a.c
ny
6492,000
ke
ea
m
.so
w
w
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CONVERSION OF A PARTNERSHIP INTO A COMPANY LIMITED
Introduction
Frequently a private business is converted into a limited company. The partners give up their
partnership stakes in exchange for shares in the company. This conversation is usually seen as a
necessary stage of development of the growth of the business. A later stage may see the conversation
of the private company into a public limited company.
a. Books of the partnership
i. Partner’s capital and current accounts

ii. Assets and liabilities account
iii. Realization account
iv. Purchasing company account debtors
v. Shares and debenture account

Journal entries in the books of Partnership
1. Close all assets to the realization account at book values. Thus:

Cr.Individual assets a/c xx
2. To record assets taken over by a partner at agreed values:

3. To record liabilities taken over:

Dr. Individual’s liabilities a/c xx
4. To record purchase consideration

Dr. Purchasing company a/c xx
Cr.Realization a/c xx
5. The balancing figure in the realization account is either a profit or a loss. Then share it
among the partners using these P&L ratios.
a. If profit:
Cr. Individual partners’ capital a/c xx
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a.c
b. If a loss:
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Dr. Individual’s partners a/c xx
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.so
Cr.Realization a/c xx
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6. With the liabilities not taken over but paid by the firm. Thus:
Dr. Individual’s liabilities a/c xx
Cr. Bank a/c xx
7. With assets sold by the firm

Dr. Bank a/c xx
8. Upon receipt of purchase consideration paid in form of cash, shares, debentures. Thus:
Dr. Bank/ Shares/ Debentures a/c xx
Cr. Purchasing company a/c xx
9. Distribute the shares or/ and debentures received among the partner’s using the agreed
proportion thus:
Dr. Individual partners’ capital a/c xx
Cr. Shares/ Debentures a/c xx

10. The partners’ capital balances must be cleared by either a receipt from the partners or
payment to the partners.
a. If a partner’s capital balance is a credit balance, then pay the partners thus:-
Dr. Partners’ capital a/c xx
Cr.Bank a/c xx
b. If a partner’s capital balance is a debit balance then the individual partner would be
required to pay for the debit. Thus:
Dr. Bank a/c xx
Cr. Individual Partner’s Capital a/c xx
NOTE: if a question has current accounts, close them accordingly to the partner’s capital account.
Books of the Company
a) Business purchase account

b) Assets and liabilities account
c) Sellers/ vendors account
d) Ordinary share capital account, debentures account, share premium account.
Accounting entries in the books of the company
1. To record the purchase consideration:
om
a.c
ny
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ea
m
Cr. Sellers/ Vendors a/c xx
.so
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2. To recognize the liabilities taken over in the books of the company.
Cr. Individual liabilities a/c xx
3. To recognize assets taken over at taking over values

Dr. Individual’s assets a/c xx
Cr.Business purchase a/c xx
The balance figure in the business purchase account being either goodwill or capital reserves:
1. If the purchase consideration is more than the net assets taken over:
Dr. Goodwill a/c xx

Cr.Business purchase a/c xx
2. If the purchase consideration is less than the net assets taken over then: (i.e. the business
was purchased at a profit)
Cr. Capital reserve xx

3. With payment of cash consideration to the seller by either sh. / Debentures thus:-
Dr. Sellers/ Vendors a/c xx
Cr. Bank/ Debentures a/c xx
4. If purchase consideration was settled in terms of ordinary shares at a premium, thus:-
a. With the par value:

Cr.Ordinary Share Capital xx
b. With the premium

Cr. Share Premium xx
Alternatively (6 a & b)
Dr. Sellers/ Vendors a/c (totals) xx

Cr. Ordinary share capital (at par value) xx
Cr. Share premium (premium) xx
Methods of Calculating Purchase Consideration
om
a.c
1. Lump sum method
ny
ke
ea
m
Using this approach, purchase consideration is usually agreed at a particular and specific amount
.so
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between the buyers and sellers.
w
2. Net assets method
Under this approach purchase consideration is calculated by taking the total assets at agreed values
(taking over values) then subtracts the total taking over values of liabilities.
3. Payment method
Under this approach, purchase consideration is calculated by adding together all modes of payments,
e.g. cash, debentures and shares
Illustration Question
The following is the statement of financial position of financial position of Shika and Adabu who
share profits and losses to the ratio of 2:3 respectively.

Shika and Adabu Enterprises
Statement of Financial Position as at 31st December 2010
Sh.
Assets 960,000
Non Current Assets 250,000
Motor vehicle 1,110,000
Furniture 2,820,000
Investments
Current Assets
Stocks 3,420,000
Debtors 2,070,000
Bank 1,170,000
6,660,000
9,480,000
Capital liabilities
Capital – Shika 4,500,000
- Adabu 3,000,000
7,500,000
Liabilities
Current liabilities 1,920,000
Creditors 60,000
Electricity owing 1,980,000
om
9,480,000
a.c
ny
ke
ea
Additional Information
m
.so
w
w
On 31st December 2010 Shika Adabu Ltd was incorporated to take over the business of Shika..
w
1. All assets except cash at bank and all liabilities except for electricity owing to be taken over by
the company electricity owing was paid by the partnership firm.
2. Assets taken over by the company have been revalued as follows:
Kshs.
Motor vehicles 900,000
Furniture 300,000
Stocks 2,700,000
Debtors 1,800,000
Investment 1,620,000
3. The purchase consideration in Ksh 6,900,000 to be settled by issue of 240,000 ordinary shares of
Ksh 20 each at a premium of 20% fully paid and balanced in cash .
4. The company also invited the members of the public to subscribe for 150,000 ordinary shares of
Ksh 20 each at a premium of 25% the issue was fully subscribed and paid for in full.
5. The shares issued to the partners were distributed among the partners according to their P & L
sharing ratio.

Required
i) Entries in the books of partnership.

a) Entries in the books of the company.
b) An opening balance sheet of the company as at 1st January 2011.
Solution
Shika and Adabu Enterprises
Working for purchase consideration
Purchase consideration = Sh 6,900,000
Paid inform of;
1) Ordinary share capital

- Par value
240,000 x 20 = 4,800,000
- Premium
(240,000 x 20) 20% = 960,000 5,760,000
2) Cash (Bal.)
(6,900,000 – 5,760,000) = 1,140,000
om
a.c
6,900,000
ny
ke
ea
m
.so
a) Books of the Partnership:
w
w
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Realisation Account
Sh. “000” Sh. “000”

Motor vehicle 960,000 Creditors 1920,000
Furniture 750,000 Purchasing co. 6900,000
Investments 1110,000 (Purchase consideration) _____
Stocks 3420,000 8820000
Debtors 2070,000
Capital: Shika 2/5 x 510,000 204000
Adabu 3/5 x 510,00 306,000
8820,000
Purchasing Company Account (Shika & Adabu Ltd)

Sh. “000” Sh. “000”
Realisation Account 6900000 Shares 5,760,000
(Purchase consideration) _____ Bank 1140,000
6,900,000 6,900,000

Partner’s Capital Account
Shika Adabu Shika Adabu
Shares 2304000 3456000 Bal. b/d 4500,000 3000,000
Bank (bal. fig) 2400,000 - Realisation 204,000 306,000
_____ _____ Bank (bal. fig) _____ 150,000
4704,000 3456,000 4704,000 3456,000
Bank Account
Sh. “000” Sh. “000”
Bal. b/d 1170,000 Electricity owing 60,000
Purchasing company 1140,000 Capital: Shika 2400,000
Capital: Adabu 150,000 ______
2460,000 2,460,000
Electricity Owing Account

Sh. “000” Sh. “000”
Bank 60,000 Bal. b/d 60,000
Business purchase Account
Sh. “000” Sh. “000”

Purchasing company 5,760,000 Capital: Shika 2/5 x 5760,000 2304,000
_____ Adabu 3/5 x 5760,000 3456,000
om
a.c
6,900,000 5760,000
ny
ke
ea
b) Books of the company
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Shares Account
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Sh. “000” Sh. “000”
Sellers / vendors (purchaseconsid.) 6,900,000 Motor vehicle 900,000
Creditors 1,920,000 Furniture 300,000
Stocks 2700,000
Debtors 1800,000
Investment 1620,000
_____ Goodwill (bal. Fig) 1500,000
8,820,000 8,820,000
Seller / vendors Account

Sh. “000” Sh. “000”
Bank a/c 1,140,000 Business purchase 6,900,000
Ordinary shares 5,760,000 ______
6,900,000 6,900,000

Bank Account
Sh. “000” Sh. “000”
Ordinary share capital 3750,000 Sellers / vendors 1140,000
_____ Bal. c/d 2610,000
3,750,000 3,750,000
Ordinary Share Capital Account

Sh. “000” Sh. “000”
Bal. c/d 7,800,000 Sellers / vendors account 4,800,000
_____ Bank a/c 3,000,000
7,800,000 7,800,000
Shares Premium Account

Sh. “000” Sh. “000”
Bal. c/d 1,710,000 Sellers / vendors account 960,000
_____ Bank a/c 750,000
1,710,000 1,710,000
Shika Adabu Ltd

Opening Statement of Financial Position as at 1st Jan 2011
Sh. “000”
Assets
om
Non- Current Assets
a.c
ny
ke
ea
Furniture 300,000
m
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Investments 1,620,000
w
w
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Good will 1,500,000
4,320,000
Current Assets:
Stocks 2,700,000
Bank 2,610,000
Debtors 1,800,000
Total Assets 7,110,000
11,430,000
Capital and Liabilities
Capital and Reserves 7,800,000
Ordinary share capital 1,710,000
Share premium 9,510,000
Current liabilities
Creditors 1,920,000
Total capital and liabilities 11,430,000

Illustration
Kamau Maneno and Rotino have carried on partnership for several years, sharing profits and losses
equally after allowing for annual salaries as follows:
Sh .
Kamau 1,500,000
Maneno 900,000
Rotino 900,000
They decided to convert the partnership into limited company; Kamaro Ltd.as at 30 November 2001,
the following terms:
1. Goodwill to be valued at Sh.13,500,000
2. Other assets to be valued as follows:
Shs.
Freehold property 27,000,000
Furniture and fittings 2,400,000
Motor Vehicles 6,000,000
3. Each partner is becoming director of the company at the same salary as that previously allowed in
the partnership.
4. Maneno’s loan is to converted into share capital at par.
5. Shares are to be issued to each partner at parin respect of the amounts of their equity holdings at
30 November 2001.
6. The financial year of partnership ends on 30 May .No action has been taken to carryout the terms
om
a.c
of conversionof partnership into the limited company in the books of accounts.On 31 May 2002,
ny
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the trial balance showed the following position:
ea
m
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Sh ‘000’ Sh ‘000’
Capital accounts at 1 June 2001
Kamau 18,000
Maneno 9,000
Rotino 6,000
Stock -31 May 2002 14,400
Cost of sales 36,000
Sales 60,000
Administrative expenses 6,000
Selling expenses 3,000
Accounting &Audit expense 1,200
Incorporation expenses 600
Drawings:
Kamau 1,500
Maneno 900
Rotino 900
Freehold property at cost 25,800
Furniture and fittings at cost 6,000
Accumulated depreciation 3,600
Debtors and Creditors 9,000 7,200
Prepayments and Accruals 600 300
Loan from Maneno(10% interest per annum) 9,000
Motor Vehicles at cost 12,000
om
a.c
Bank balance ______ 1,200
ny
ke
ea
117,900 117,900
m
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Additional information;
i. The sales during the second half of the year were 60% of the total sales though the gross
profit percentage remained the same throughout the year.
ii. The selling expenses were proportional to the sales for each period. All the expenses were
incurred evenly throughout the year.
iii. Salary drawings were made evenly. Drawing made after incorporation were to be treated as
director’s salaries.
iv. There were no purchases or sales of fixed assets during the year .Depreciation is to be
provided on cost as follows;
Furniture and fittings 10% per annum

Motor vehicles 20% per annum
v. No dividends are paid or proposed but it is decided to write off the incorporation expenses
and also Sh.3,500,000 of the goodwill.
Required
(a) Trading and profit and loss account for Kamaro Ltd. for the six months ended 31 May 2002

(b) Calculation showing the value of shares to be issued to each partner.
(c) Balance sheet as at 31 May 2002.
Solution
Trading Profit and Loss Account
1st June – 30th Nov. 2001 1st Dec. – 31st May 2002
Partnership Kamaro Ltd
Sales (60,000 x 40%) 24,000 36,000
Less: Cost of sales (36,000 x 40%) (14,400) (21,600)
Less: Expenses 9,600 14,400
Admin. expenses (3,000) (3,000)
Selling expense (3000 x 40%) (1,200) (1,800)
Accounting and Audit expenses (600) (600)
Incorporation expenses - (600)
Director’s salaries (750 + 450 + 450) - (1,650)
Dep: Furniture and fittings (300) (120)
Motor vehicle (1,200) (600)
Interest on Maneno (10% x 900 x 6/12) (450) -
Goodwill written off ____ (3,500)
Net profit 2,850 2,530
om
a.c
Appropriation Account
ny
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Partner’s Salaries: Kamau 750
ea
m
Maneno 450
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Rotino 450 (1,650)
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1,200
Profit to be shared equally Kamau 400
Maneno 400
Rotino 400 (1,200)
Nil
Partner’s Capital Accounts

Kamau Maneno Rotino Kamau Maneno Rotino
Drawings 750 450 450 Bal. b/d 18,000 9,000 6,000
Shares Partners salaries 750 450 450
(Bal. Fig) 23,000 14450 11000 Profit share 400 400 400
Interest on loan - 450 -
____ ____ ____ Realisation 4600 4600 4600
23,750 14,900 11,450 23,750 14,900 11,450

Purchase consideration working by use of Net Asset Method Statement of affairs as at 1st
December 2001.
Sh. “000”
Assets:
Freehold property 27,000
Furniture and fittings 2,400
Goodwill 3,500
48,900
Less: Liabilities: Maneno’s loan (9,000)
Purchase consideration 39900
Realisation Account
Sh. “000” Sh. “000”
Freehold property 25800 Maneno’s loan 9,000
Furniture and fittings 2100 Purchase consideration 3,990
Motor vehicles 7200
Capital: Kamau 1/3 4600
Maneno 1/3 4600
Rotino 1/3 4600 _____
48,900 48,900
Books of the Company (Kamaro Ltd)
om
a.c
Business Purchase Account
ny
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Sh. “000” Sh. “000”
ea
m
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Purchase consideration 3,990 Freehold property 27000
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Maneno’s loan 9,000 Furniture and fittings 2400
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_____ Goodwill 13500
48,900 48900
Kamaro Ltd
Statement of Financial Position as at 31st May 2002
Sh. “000”
Assets:
Non-Current Assets
Furniture and fittings 2400 – (10% x 2400 x 6/12) 2,280
Motor vehicle 6000 – (20% x 600 x 6/12) 5,400
Goodwill (13500 – 3500) 10,000
44,680
Current Assets
Stock 14,400
Debtors 9,000
Prepayments 600

Total Assets 24,000
Capital and Liabilities 68,680
Capital and reserves
Ordinary share capital (23,000 + 1440 + 11000 + 9000) 57,450
Retained earnings 2,530
59,980
Liabilities
Current liabilities
Creditors 7,200
Accruals 300
Bank overd raft 1,200
Total capital and Liabilities 68,680
Illustration
Conversion into a company
A and B are in partnership selling necklace at the Malaysia market. They have agreed to share
profits and losses in the ratio of 3:2. The draft statement of financial position is as follows:
A and B Partnership Statement of financial position as at 30th June 2010
om
Sh. ‘000’ Sh. ‘000’
a.c
ny
Non-current assets
ke
ea
Freehold premises 3,000
m
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Fixtures and fittings 100
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Motor vehicles 300 3,400
Current assets
Account receivable 2,000
Cash in bank 60 2,060
5,460
Equity and liability
Capital and Reserves
Capital accounts A 2,000
B
Current accounts A 250 2,250
B 300
50 350
Non-current Liabilities 1,600
Loan from A
Current Liabilities
Accounts payables 1,260
5,460

AB Ltd was incorporated on 1st July 2010, for the purpose of taking over, the business of the
partnership. It is to acquire the freehold premises at sh 4,000,000 and other assets with the exception
of cash and motor vehicles at book values.
The current liabilities are also to be taken over by the new company the purchase consideration is sh
6 million and it is to be settled by issue of 20,000 ordinary shares whose par value is sh 100 each in
AB Ltd and a cash payment of Sh 3 million which AB Ltd plans to raise through a bank loan. A is to
take over the car at a valuation of sh 250,000. The partners have agreed to divide the shares received
in the ratio in which they share profits and losses. The loan from A is to be paid by the partnership.
Required
a) Receiving accounts to close the partnership books.

b) Business purchase account and the operating statement of financial position of AB Ltd.
Solution
Closing books of A and B
Realisation discount
Sh. ‘000’ Sh. ‘000’

Freehold premises 3000 Capital account 250
om
a.c
Fixtures& Fittings 100 Accounts payable 1260
ny
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Motor vehicle 300 Purchasing co. 6000
ea
m
Account Received 2000
.so
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Capital account
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A 3/5 x 2110 1266
B 2/5 x 2120 844 ____
7510 7510
Cash / Book Account

Sh. ‘000’ Sh. ‘000’
Bal b/d 60 Loan from A 1600
Purchasing co. 3000 Capital account A 1766
Capital account - B 306 ____
3366 3366
Capital Account
Sh. ‘000’ Sh. ‘000’ Sh. ‘000’ Sh. ‘000’
Realisation A/C - 250 Bal b/d 2000 250
Shares 1800 1200 Realisation profit 1260 844
1766 - Current account 300 50
_____ ____ Cash ____ 306
3566 1450 3566 1450

Purchasing Co A and B Ltd Account
Sh. ‘000’ Sh. ‘000’
Realisation 6,000 Cash 3,000
____ Shares 3,000
3,366 3,366
Shares in AB Ltd
Sh. ‘000’ Sh. ‘000’
Purchasing Co. 3,000 A 3/5 x 3000 1,800
____ B 2/5 x 3000 1,200
3,000 3,000
Opening the books of AB Ltd

Sh. ‘000’ Sh. ‘000’
A/c Payable 1,260 Freehold premises 4,000
Vendor 6,000 Fixt and fit 1,000
A/cs receivables 2,000
____ Goodwill 1,160
7,260 7,260
Vendor account A and B partnership
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a.c
Sh. ‘000’ Sh. ‘000’
ny
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Cash loan 3,000 B/s premises 6,000
ea
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Share capital 2,000
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Share premium 1,000 ____
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6,000 6,000
AB Ltd
Sh. ‘000’
Assets
Non-current
Freehold premises 4000
Fix and fit 100
Goodwill 1160
Current assets
Account receivable 2000
7260
Equity and liabilities
Ordinary share capital 2000
S/ Premium 1000

Non current liabilities
Loan from a bank 3000
Current liabilities
Account payable 1260
7260
REVISION EXERCISES
QUESTION 1
Aand B Advocates and M and N Advocates were practicing firms of advocates. On 1 January 2006,
they agreed to amalgamate the partnerships into one firm, Able and Mine Advocates. The accounts
of the separate partnerships have been prepared annually to 31 December 2005.
The agreed profit and loss sharing ratios in the old and the new firms were as follows:
A B M N
Old firms 3 2 2 1
New firms 4 3 2 1
The balance sheets extracts of the partnerships as at 31 December 2005 were as follows:
A and B Advocates M and N Advocates
Sh. '000' Sh. '000'
Non-current assets
om
a.c
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Office equipment 4,000 3,000
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ea
Goodwill 14,000 12,000
m
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6,000 5,000
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w
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Current assets:
Investments 7,500 -
Accounts receivable 20,000 13,000
Cash 2,500 -
Total assets 30,000 13,000
50,000 30,000
Capital accounts:
A 25,000 -
B 15,000 -
M - 15,000
N - 10,000
25,000
Client account 40,000 -
Accounts payable 5,000 -
Bank overdraft 5,000 3,500
Total capital and liabilities - 1,500
10,000 5,000
50,000 30,000

1 Provision or bad and doubtful debts was to be made at 5% of the accounts receivable.
2 Able and Mine Advocates was to take over the assets of the partnership at the following agreed
values:
A and B Advocates Sh. M and N Advocates Sh.
'000' '000'
Motor vehicles 9000 8000
Office equipment 3500 3000
Goodwill 7500 5000
3 The investments of A and B Advocates were sold on 1 January 2006 for sh.8,000,000.
4 The capital for Able and Mine Advocates amounted to sh.75,000,000 which was contributed by
the partners in their profit sharing ratios, any adjustments being made in cash.
5 The client account and the accounts payable were settled immediately on amalgamation.
Required:
Prepare the following accounts to record the above transactions:
i. Realization accounts
ii. Capital accounts
iii. Cash accounts
iv. Able and Mine Advocates account
Solution:
om
a.c
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b) 1)
ea
m
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A&B M and A& B M and
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Advocates NAssociates Advocates Associates
Sh,000 Sh 000 Sh 000 Sh 000

Motor vehicles 10,000 9,000 Motor vehicles 9,000 8,000
Office equipment 4,000 3,000 Office equip 3,500 3,000
Goodwill 6,000 5,000 Goodwill 7,500 5,000
Investments 7,500 - Acc Receivables 19,000 12,350
Accounts receivable 20,000 13,000 39,000 28,350
Cash Investment 8,000 -
47,000 28,350
Loss
A3 300
B2 200
M2 1,100
N1 550
47,500 30,000 47,500 30,000

ii)
Capital accounts
A B M N A B M N
Sh
Sh ‘000’ Sh ‘000’ Sh ‘000’ Sh ‘000’ Sh ‘000’ Sh ‘000’ ‘000’ Sh ‘000’
Realization account 300 200 1,100 550 Ba b/d 25,000 15,000 15,000 10,000
Cash 1,950 Cash 5,300 7,700 1,100
Transfer to Able and
mine Advocates 30,000 22,500 15,000 7,500
30,300 22,700 16,100 10,000 30,300 22,700 16,100 10,000
iii) Cash Accounts
A&B M and N A& B M and N

Advocates Advocates
Advocates Advocates
Sh,000 Sh 000
Sh 000 Sh 000
Balance b/d 2,500 Balance 1,500
Realisation a/c Accounts
Investment 8,000 Payable 5,000 3,500
Capital - A 5,300 Client a/c 5,000
B 7,700 Capital N 1,950
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M 1,100 Able and Mine
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Able and mine Advocates 13,500
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Advocates 5,850
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23,500 6,950 23,500 6,950
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iv)Able and Mine Advocates
A &B M and N A& B M and N

Advocates Associates Advocates Associates
Sh,000 Sh 000 Sh 000 Sh 000

Realisation a/c 39,000 28,350 Cash 5,850
Cash 13,500 Capital a/c
A 30,000
B 22,500
M 15,000
N 7,500
52,500 28,350 52,500 28,350

QUESTION 2
Jembe and Panga were sole traders manufacturing farm implements. On 31 March 2004, they
amalgamated and traded as partners sharing profits and losses in the ratio of 3:2. One year later on
31 March 2005, they converted the partnership into a limited liability company called Shamba Ltd.
No. adjustments have been made to record the amalgamation and conversion but the balance sheets
for the sole traders as at 31 March 2004 and the partnership as at 31 March 2005 were as follows:
Sole Traders balance Partnership balance

sheet as at 31 March sheet as at 31
2004 March2005
Jembe Panga
Sh. ‘000’ Sh. ‘000’ Sh. ‘000’
Assets
Freehold property 1,500 1,000 4,000
Plant and equipment 6,800 5,600 13,000
Fixtures and fittings 1,600 1,550 3,000
Inventory 1,800 350 3,350
Accounts receivable 1,900 1,000 6,420
Balance at bank 300 150 125
13,900 9,560 29,895
Liabilities
Accounts payable (6,800) (4,000) (9,920)
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Bank overdraft - - (5,625)
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7,1000 5,650 14,350
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Additional Information:
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1. On 1 April 2004, the partners agreed to take up the assets and liabilities of the individual traders at
book values except for freehold property, plant and equipment and fixtures and fittings which were
to be revalued as follows:
Jembe Panga
Sh. ‘000’ Sh. ‘000’
Freehold property 2,000 1,500
Plant and equipment 6,500 5,500
Fixtures and fittings 1,500 1,500
2. During the year ended 31 March 2005, Jembe made drawings of Sh. 2,390,000 while Panga drew
Shs. 610,000.
3. The partnership was converted into a limited company on the following terms:

i. The freehold property and accounts receivable were revalued to Sh.6,000,000 and
Sh.5,670,000 respectively.
ii. Jembe and Panga were to receive 15% unsecured debentures at par so as to provide each
partner with income equivalent to a 6% return on capital employed based on capital
balances as at 31 March 2005 (that is after accounting for the profit, drawings and
revaluation in note (i) above).
iii. Shamba Ltd. Authorized share capital was made up of 150,000 ordinary shares of Sh.50
each. Out of which 130,000 shares were to be issued to the partners in their profit sharing
ratio.
iv. Any balances in the partners’ capital accounts were to be settled in cash.
Required:
a) A computation showing the value of debentures and ordinary shares to be issued to the
partners.
b) Partners capital accounts as at 31 March 2005.
c) Balance sheet of Shamba Ltd. As at 31 March 2005 after completing the above transactions.
Solution:
(a) Computation of bond and ordinary shares to be issued to partners:
Determine the opening capital balances as 1 April 2004.
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Jembe Panga Partnership
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Assets less liabilities to partnerships Shs. ‘000’ Shs. ‘000’ Shs. ‘000’
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Freehold property 2,000 1,500 3,500
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Plant and equipment 6,500 5,500 12,000
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Fixtures and fittings 1,500 1,500 3,000
Inventory 1,800 350 2,150
Accounts receivable 1,900 1,000 2,900
Balance at bank 300 150 450
14,000 10,000 24,000
Accounts payable (6,800) 4,000 10,800
Capital balances 1.4.04 7,200 6,000 13,200
Compute the capital balances as at 31 March 2005 before conversion takes place.
Jembe Panga
Shs. ‘000’ Shs. ‘000’
Capital balance as at 1.1.04 7,200 6,000
Profit for year
(Net assets as at 31.3.05 – Total capital b/d + Drawings)
(14,350 – 13,200 + 2,390 + 610) = Sh. 4,150
Share in PSR 3:2 2,490 1,660
9,690 7,660
Less drawings: (2,390) (610)
Capital balance at 31.3.05 7,300 7,050
Bond to be issued

Sh. ‘000’ Sh. ‘000’
Capital balance as at 31.5.05 7,300 7,050
Add Revaluation gain
(6,000 + 5,670 – 4,000 – 6,420)1,250
Share in PSR 3:2 750 500
Updated capital balances 8,050 7,550
6% rate of return 483 453
15% Bond to be issued 3,220 3,020
Revaluation a/c
Jembe Panga Jembe Panga
Sh. ‘000’ ‘000’ ‘000’ ‘000’

Plant & 300 100Freehold property 500 500
Equipment
Fixtures 100 50
Capital-surplus 100 350 __ __
500 500 500 500
Capital A/C
Jembe Panga Jembe Panga
Bal b/d 7,100 5,650
Bal c/d 7,200 6,000Revaluation 100 350
7,200 6,000 7,200 6,000
Net profit for the year
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Change in capital = profit
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Capital bal as at 31/3/05 14,350
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Less: opening capital 13,200
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Change in capital 1,150
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Add: Drawings 3,000
Profit for the year 4,150
Profit share Jembe 2,490
1,660
Jembe Panga Total
Capital employed 7,200 6,000 13,200
Bal b/d 2,490 1,660 4,150
Add: share of profit 750 500 1,250
Add: revaluation (2,390) (610) (3,000)
Less: drawings 8,050 7,550 15,600
Debentures issued 3,220 3,020 6,240
Shares 3,900 2,600 6,500
Shares to be issued:
Jembe Panga
Sh. ‘000’ Sh. ‘000’
Total per value
130,000 x 50 = Sh. 6,500,000
Based on PSR 3:2 3,900,000 2,600,000

(b) Partners capital account as at 31 March 2005
Capital account
J P J P
Sh. ‘000’ Sh. ‘000’ Sh. ‘000’ Sh. ‘000’
Drawings 2,390 610Balance b/d 7,200 6,000
Bond 3,220 3,020Profit 2,490 1,660
Share capital 3,900 2,600Revaluation
Bank 930 1,930Gain 750 500
10,440 8,160 10,440 8,160
(c)
Shamba Ltd
Balance sheet as at 31 March 2005
Non-current assets Sh. ‘000’ Sh. ‘000’
Plant and equipment 13,000
Fixtures and fittings 3,000
22,0000
Current assets
Inventory 3,350
Accounts receivable 5,670
Bank 125 9,145
Total assets 31,145
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Share capital 6,500
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15% Bond 6,240
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Current liabilities
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Accounts payable 9,920
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Bank overdraft 8,485 18,405
31,145
Workings
Bank overdraft
Sh. ‘000’
Balance as at 31 May 2005 (5,625)
Less: Jembe 930
Panga 1,930
8,485

TOPIC 3
SPECIALISED TRANSACTIONS
CONTRACTS WITH CUSTOMERS (REVENUE RECOGNITION)
Meaning of ‘revenue’
IAS 18 defines revenue as
‘The gross inflow of economic benefits during the period arising in the course of the ordinary
activities of an entity when those inflows result in increases in equity, other than increases relating to
contributions from equity participants’
The following implications flow from this definition:
a) Revenue should be stated before deduction of costs of sale. For example if goods are sold for
ksh.100 000 that cost the seller ksh.60 000 to manufacture the revenue is ksh.1 000 00, not
ksh.40 000.
b) Revenue is recognised on the provision of goods and services that relate to the ordinary
activities of the entity. If an entity disposes of property, plant and equipment at the end of its
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useful economic life the proceeds of disposal are not revenue for the entity. Instead the profit
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or loss on disposal is treated as a deduction from operating expenses (or as a separate line
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item in the statement of profit or loss, if it is sufficiently material).
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c) Sales taxes that are collected from the customer and remitted to the relevant authorities are
not ‘revenue’. For example if goods are sold for ksh.110 000, inclusive of recoverable sales
taxes of 10%, the revenue is $100 000, not ksh.110 000.
d) If the seller is acting as agent, rather than as the principal, in a transaction, the revenue the
seller should recognise is the amount of commission receivable rather than the gross amount
collected from the customer. For example, if a travel agent sells a holiday to a customer for
ksh.10,000 plus a commission of ksh.1000, so that the customer pays ksh.11,000 and the
travel agent remits ksh.10,000 to the entity actually providing the holiday, then the travel
agent recognises revenue of ksh.1000.
Principles underpinning recognition of revenue
IAS 18 outlines the recognition principles in three parts:
1. Sale of goods:
Revenue is recognised when all the following conditions have been satisfied (2):

a) The seller has transferred the significant risks and rewards of ownership of the goods to the
buyer.
b) The seller does not retain control over the goods or managerial involvement with them to the
degree usually associated with ownership.
c) The amount of revenue can be measured reliably.
d) It is probable that the economic benefits associated with the transaction will flow to the seller
e) The costs incurred or to be incurred by the seller in respect of the transaction can be measured
reliably.
As far as these conditions are concerned, it is notable that:
 A number of the conditions ((a) and (b) particularly) are subject to a degree of interpretation
and therefore there can be some uncertainty about whether or not revenue should be
recognised.
 The conditions are such that all are likely to be satisfied at a particular point in time and so
there is a critical point at which all the revenue from the sale of goods would be recognised.
This approach contrasts with the approach taken to the recognition of revenue from the
provision of services (see below):
2. Provision of services:
As stated above, there is a different approach taken to the recognition of revenue from the provision
of services. IAS 18 states that ‘where the outcome of a transaction involving the rendering of
services can be estimated reliably, associated revenue should be recognised by reference to the stage
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of completion of the transaction at the end of the reporting period’. In other words, the revenue is
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recognised gradually, rather than all at one ‘critical point’, as is the case for revenue from the sale of
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goods. IAS 18 further states that the outcome of a transaction can be estimated reliably when all the
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following conditions are satisfied:
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a) The amount of revenue can be measured reliably.
b) It is probable that the economic benefits associated with the transaction will flow to the seller.
c) The stage of completion of the transaction at the end of the reporting period can be measured
reliably.
d) The costs incurred to date for the transaction and the costs to complete the transaction can be
measured reliably.
IAS 18 does not prescribe one single method that should be used for determining the stage of
completion of a service transaction. However the standard does provide some examples of suitable
methods (4):
a) Surveys of work performed.
b) Services performed to date as a percentage of total services to be performed.
c) The proportion that costs incurred to date bear to the estimated total costs of the transaction.
If it is not possible to reliably measure the outcome of a transaction involving the provision of
services (perhaps because the transaction is in its very early stages) then revenue should be
recognised only to the extent of costs incurred by the seller, assuming these costs are recoverable
from the buyer (5).

Construction contracts
IAS 18 does not adequately address the issue of revenue recognition on a construction contract.
However, IAS 11 applies the basic principles we have already identified to such contracts, which are
defined in IAS 11 as follows (6):
‘Contracts specifically negotiated for the construction of an asset or a combination of assets that are
closely interrelated or interdependent in terms of their design, technology and function or their
ultimate purpose or use’.
Most construction contracts are ‘fixed price contracts’. In such contracts the seller agrees to a fixed
contract price, or a fixed rate per unit of output, which in some cases could be subject to cost
escalation clauses (6).
Whilst a construction contract relates to the supply of goods, the ‘critical event basis’ used in IAS 18
as a means of determining the timing of the recognition of revenue on the supply of goods is not
really suitable. This is because the ‘supply’ by the seller in the case of a construction contract takes
place gradually over the term of the contract. Therefore IAS 11 basically requires that, where the
outcome of a construction contract can be recognised reliably, revenue on such contracts should be
recognised according to the stage of completion of the contract (7). IAS 11 imposes conditions very
similar to the ones included in IAS 18 for the provision of services (3) that need to be satisfied
before the outcome of a construction contract can be recognised reliably (8):
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a) Total contract revenue can be measured reliably.
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b) It is probable that the economic benefits associated with the contract will flow to the seller.
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c) Both the seller’s costs to complete the contract and the stage of contract completion at the
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end of the reporting period can be measured reliably.
d) The seller’s costs to date attributable to the contract can be clearly identified and measured
reliably so that actual costs incurred can be compared with prior estimates.
As is the case with service revenue recognition in IAS 18, IAS 11 does not prescribe one single
method of computing the stage of completion of a construction contract. IAS 11 provides the
following examples of methods that might be suitable (9):
a) The proportion that contract costs incurred for work performed to date bear to total estimated
contract costs.
b) Surveys of work performed.
c) Completion of a physical proportion of the contract work.
In another similarity with the treatment of revenue from the rendering of services under IAS 18, IAS
11 states that (10):
‘Where the outcome of a construction contract cannot be estimated reliably revenue shall be
recognised only to the extent of contract costs incurred that it is probable will be recoverable’.

In summary, then, IAS 11 very much applies the principles set out in IAS 18 (for the recognition of
revenue on the rendering of services) to the recognition of revenue from construction contracts.
3. Interest, royalties and dividends
IAS 18 states that entities should recognise revenue from the use of their assets yielding interest,
royalties and dividends when (11):
a) It is probable that the economic benefits associated with the transaction will flow to the entity.
b) The amount of the revenue can be measured reliably.
The exact basis for the recognition of revenue from the use by others of the ‘seller’s’ assets depends
on the type of transaction (12):
a) Interest revenue should be recognised on the ‘effective interest’ basis.

b) Royalties should be recognised on an accruals basis in accordance with amounts receivable as
a result of ‘asset use’ up to the reporting date.
c) Dividend revenue should be recognised when the right to receive payment is established.
Often this does not happen in the case of dividends until the shareholder actually receives the
dividend.
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HIRE PURCHASE/ INSTALLMENT SALES
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HIRE PURCHASE
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In hire purchase transactions, the buyer will be required to pay a deposit and the remaining balance
to be paid in form of installments.
As a result, the total amount paid by the buyer is called the Hire Purchase Price (H.P.P)
Accounting for Hire Purchase transactions will require both books of the buyer and the seller be
maintained.
Accounts maintained in Books of the Buyer
i. Asset account
ii. Hire Purchase Liability account/ Hire Purchase vendor account/ Hire Purchase sellers account.
iii. Interest expense account
iv. Depreciation account (provision)
Accounting Entries in the books of the Buyer
1. On purchase of the asset on hire purchase:

Dr. Asset a/c xx
Cr. Hire Purchase Liability xx

2. To record deposit on hire purchase transaction
Dr. Hire Purchase Liability a/c xx
Cr. Bank a/c xx
3. To recognize interest expense on hire purchase

Dr. Interest expense a/c xx
Cr. Hire Purchase liability/ HP vendor a/c xx
4. To record installment paid when due: Thus,

Dr. HP liability/ HP vendor a/c xx
Cr. Bank / Cash a/c xx
5. To record depreciation expense for the period

Dr. Depreciation a/c xx
Cr. Asset a/c xx
6. To close the interest expense a/c to P&L a/c xx

Dr.P&L a/c xx
Cr. Interest expenses a/c xx
7. To recognize depreciation expense in the P&L a/c

Dr. P&L a/c xx
Cr. Depreciation expense a/c xx
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Accounts maintained in Books of the seller
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- Hire Purchase Debtors a/c
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- Hire Purchase sales a/c
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- HP trading a/c
- Interest income/ receivable a/c
- Repossession a/c
- Provision for unrealized profit a/c
Accounting Entries in the books of the seller
1. To record sale of items on hire purchase with the cash prize:

Dr. HP Debtor’s a/c xx
Cr. HP sales a/c xx
2. To record deposits received from the buyer

Dr. Bank a/c xx
Cr. HP debtor’s a/c xx
3. To account for interest income receivable

Dr. HP debtor’s a/c xx
Cr. Interest income receivable a/c xx

4. To record installments received when due;
Dr. Bank a/c xx
Cr. HP debtor’s a/c xx
5. Close the interest income a/c to P&L a/c. Thus;

Dr. Interest Income/ Receivable a/c xx
Cr. P&L a/c xx
6. Close the HP sales a/c to the trading a/c

Dr. HP sales a/c xx
Cr. HP Trading a/c xx
N/B: The main challenge in Hire Purchase transactions is writing off of the Hire Purchase interest.
There are three methods normally used to apportion interest:
1. Straight line method
In this method, interest is apportioned on equal basis for each installment.
2. Sum of digits method
In this method, the number of installments are allocated interest accordingly to the digits of that
installment. Installments with the highest digit being allocated to the first installment and the
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smallest digit to the last installment.
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3. Actuarial method ( reducing balance method)
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In this method, interest is written / apportioned on a reducing balance basis.
To recognize interest, two methods are applicable:
a. Installment method:
This is where interest is to be apportioned/ recognized in the income statement where it’s actually
written off i.e. amount written off is similar to the amount recognized for that installment period.
b. Suspense method
In this method, the whole interest is first recognized in the interest suspense account and transfered
to the HP liability a/c.
However, for income statement purposes only the amount that’s to be charged in the year is treated
as expense.

Method used by the seller to recognize Gross Profit on sale
(In the Books of the seller)
- Cost recovery method

- Installment method
a. Cost Recovery Method
According to this method, no profit is recognized until the total cost is recovered.
b. Installment Method
According to this method gross profit is recognized on the basis of the installment paid.
Provision for unrealized profit =
N/B: The installment method is preferred to the cost recovery method because it agrees with the
matching concept of accounting.
ILLUSTRATION
On 1st January 2010 during a very dry season, Mr. Sonko Ltd bought an equipment without fear or
favour from Masikini Ltd an HP systems. The cash price of the equipment was Sh 680,000. The HP
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terms provided for a deposit of Sh 200,000 and the balance in 3 equal annual installments of sh
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240,000 payable on 31st December each year. Using the sum of digit method to apportion interest
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and suspense method to recognize interest, prepare the necessary accounts in the books of the buyer
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and seller.
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For revision purposes.
a) Apportion interest using straight line method
b) Sum of year digits
c) Actuarial method
Solution
Cash price = sh 680,000

Deposit = sh 200,000
Installments = sh 240,000 x 3 = sh 720,000
Therefore interest = H.P.P – Cash price
But H.P.P = Deposit + Installments
= 200,000 + 720,000
= 920,000
Therefore interest = 920,000 – 680,000
= Sh 240,000

a) Straight line method
240 000
= ℎ. 80 000
3
b) Sum of the digits method

Apportionment
st 3
1 Installment 1 /6 x 240,000 = sh 120,000
2nd Installment 2 2/6 x 240,000 = sh 80,000
3rd Installment 1/6 x 240,000 = sh 40,000
c) Actuarial Method
Cash price 680,000
Less: Deposit (200,000)
Loan amount 480,000
Add: Interest rate 10% (480,000 x 10%) 48,000
Less: 1st Installment (240,000)
Balance 288,000
2nd Interest (10%) 28,800
Less: 2nd installment (240,000)
Balance 76,800
Add: 3rd interest (10%) 7,680
Less: 3rd installment (240,000)
Balance
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Equipment Account
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Sh. Sh.
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2010 2010
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HP vendor account 680,000 Bal c/d 680,000
2011 2011
Bal b/d 680,000 Bal c/d 680,000
2012 2012
Bal b/d 680,000 Bal c/d 680,000
HP Vendor (Masikini Ltd) Account

Sh. Sh.
2010 2010
Bank (deposit) 200,000 Equipment account 680,000
Bank (Installment) 240,000 Interest suspense account 240,000
Bal c/d 480,000 920,000
920,000
2011 2011
Bank (Installment) 240,000 Bal b/d 480,000
Bal c/d 240,000 ______
480,000 480,000
2012 2012
Bank (Installment) 240,000 Bal b/d 240,000

Interest Suspense Account
Sh. Sh.
2010 2010 120,000
HP vendor account 240,000 Int. expenses account 120,000
Bal c/d 240,000
2011 2011
Bal b/d 120,000 Int. expense account 80,000
Bal c/d 40,000
2012 120,00
Bal b/d 40,000 2012
Int. expense account 40,000
Interest Expense Account

Sh. Sh.
2010 2010
Int. expenses account 120,000 Profit and loss account 120,000
2011 2011
Int. expense account 80,000 Profit and loss account 80,000
2012 2012
Int. expense account 40,000 Profit and loss account 40,000
Books of the Seller
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Sh. Sh.
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2010 2010
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HP sales account 680,000 Bank (deposit) 200,000
Int. suspense account 240,000 Bank (installment) 240,000
______ Bal c/d 480,000
920,000 920,000
2011 2011
Bal b/d 480,000 Bank (Installment) 240,000
Bal c/d 240,000
480,000
2012 240,000 2012
Bal b/d Bank (installment) 240,000
HP Sales
Sh. Sh.
2010 680,000 2010 680,000
HP trading account HP debtors Account

Sh. Sh.
2010 2010
Int. expenses account 120,000 HP debtors account 240,000
Bal c/d 120,000 ______
240,000 240,000
2011 2011 120,000
Int. expense account 80,000 Bal b/d ______
Bal c/d 40,000 120,00
120,00
2012 2012
Int. expense account 40,000 Bal b/d 40,000

Sh. Sh.
2010 2010
Profit and loss account 120,000 Int. expenses account 120,000
2011 2011
Profit and loss account 80,000 Int. expense account 80,000
2012 2012
Profit and loss account 40,000 Int. expense account 40,000
Illustration
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Tajiri Mjanja Ltd bought two motor vehicles at a garage without fear during a dry spell of 1st
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January 2006 from Masikini Mjinga on Hire purchase system. The cost of each vehicle was sh
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800,000 which was payable with a deposit of sh 170000 and the balance in three equal installment
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plus interest at the rate of 10%. The original cost of each of the vehicles from the manifacturerwas
640,000.Prepare the necessary accounts in the books of both the buyer and the seller.
NB: The actuarial method is used to apportion interest and installment method to recognize interest.
Cash price = Sh 1600,000

H.P.P = Deposit + Installment
But installment =
1 600 000 − 340 000
3
Installment = Sh 420,000
Interest (by use of Actuarial method)

Amount loaned 1260,000
Add: Installment interest 10% 126,000
1386,000
Less: 1st installment paid (420 + 126) (546,000)
Amount bal 840,000
Add: 2nd Installment interest 84,000

924,000
nd
Less: 2 Installment paid (420 + 84) (504,000)
Amount owing 420,000
Add: 3rd Installment interest 42,000
462,000
Less: 3rd Installment paid final (420 + 42) (462,000)
NIL
In the books of the Buyer .
Motor Vehicle Account
Sh. Sh.
2006 2006
H.P liability account 16,00,000 Bal. c/d 1,600,000
2007 2007
Bal. b/d 1,600,000 Bal. c/d 1,600,000
2008 2008
Bal. b/d 1,600,000 Bal c/d 1,600,000
HP Liability Account (Maskini Mjinga Ltd)

Sh. Sh.
2006 2006
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Bank (deposit) 340,000 Motor vehicle account 1,600,000
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Bank (installment) 546,000 Interest expenses account 126,000
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Bal. c/d 840,000 ______
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1,726,000 2007 1,726,000
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2007 Bal. c/d
Bal. b/d 420,000 2008 84,000
924,000 924,000
2008 Bal c/d
______ 42,000
462,000 462,000

Sh. Sh.
2006 2006
H.P liability account 126,000 Profit and loss account 126,000
2007 2007
Bal. b/d 84,000 Profit and loss account 84,000
2008 2008
Bal. b/d 42,000 Profit and loss account 42,000

Books of the seller
HP Liability Account (Maskini Mjinga Ltd)
Sh. Sh.
2006 2006
Interest income account 126,000 Bank (installment) 546,000
_______ Bal. c/d 840,000
1,726,000 1,726,000
2007 2007
Bal. b/d 840,000 Bank (installment) 504,000
Interest income a/c 84,000 Bal. c/d 420,000
924,000 924,000
2008 2008
Interest income account 42,000 ______
462,000 462,000
HP Sales Account
Sh. Sh.
2006 2006
H.P and Trading account 1,600,000 HP debtor’s account 1,600,000
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Interest Income Account
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Sh. Sh.
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2006 2006
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Profit and loss account 126,000 HP debtor’s account 126,000
2007 2007
2008 2008
HP Trading Account (Vertical format)

Shs.
HP sales 1,600,000
Less: cost of sales
(640,000 x 2) (1280,000)
G.P 320,000
Realized profits:
2006
= .
320 000
= ℎ 152,000
2007
Realized profit = 320 000
= ℎ 236,000
2008
Realized profit 320 000
= ℎ 320,000
Unrealized profits
.
2006
840 000
320 000 = 168 000
1 600 000
2007
420 000
320 000 = 84 000
1 600 000
2008 =
Provision for Unrealised Profits Account
Sh. Sh.
2006 2006
P & L (Realised profit) 152,000 Bal. c/d -
Bal c/d 168,000 HP Trading account 320,000
320,000 320,000
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2007 2007
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P & L Realised profit 84,000 Bal. c/d 168,000
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(236 – 152) 84,000 ______
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Bal. b/d 168,000 168,000
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2008 2008
P & L (Realised) 84,000 Bal. b/d 84,000
Balance Sheet Extract

Sh. Sh.
Assets:
Current Assets
2006
HP debtors 840,000
Less: provision for unrealized profits (168,000) 672,000
2007
HP debtors 420,000
Less: Provision for unrealized profits (84,000) 336,000
REPOSSESSION
This is when an asset purchased on Hire Purchase system by the buyer is taken back to the owner
(seller) basically because the buyer has contradicted the Hire Purchase terms e.g. defaulting to pay
any one given installment.

Books of the Buyer
When the buyer defaults in payment of any installment, the vendor has a right to repossess the goods
sold on Hire Purchase.
There may be a complete repossession or partial repossession.
i. Complete repossession
1. The entries for Hire Purchase interest would be passed as usual to the date of default.
2. The buyer will close the account of the seller by transferring the balance in the asset account.
Thus;
Dr. HP vendor a/c xx
Cr. Asset a/c xx
3. The buyer will also close the accumulated depreciation account by transferring it to the
a/c.Thus
Dr.Accumulated depreciation a/c
Cr.Asset a/c.
4. Any remaining balance in the asset a/c will be closed to the p/l a/c as either a profit or loss
ii. Partial repossession
1. The entries for hire purchase entries and repossession will be passed to the books of the buyer
as usual.
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2. The buyer will close the a/c of the seller.
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3. The buyer will adjust the asset at cost a/c to reflect a balance to be carried forward which
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should be equal to the historical cost of the not repossessed.
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4. All the account balances will be close into asset account and profit or loss ascertained.
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Books of the seller
1. On repossession the seller will close the a/c of the buyer by transferring the balance to goods
reposed a/c or repossession a/c.Thus;
Dr.Repossesion a/c
Cr.HP debtors a/c with balance amount unpaid
2. The repossession a/c will further be debited with repair overhaul or reconditioning expense and
it will also be credited with a resale if any. Thus
a)with repair cost overhaul/reconditionig
Dr.Repossession a/c
Cr.Bank a/c
b)with cash proceeds on resale
Dr.Bank a/c
Cr.Repossession a/c

Difference between Operating Lease and Hire Purchase:
Operating Lease Hire Purchase

1. Ownership of property does not pass to 1. Ownership passes to the buyer
the lease but remains on the lessor immediately on payment
2. Lease rentals are paid and is allowable 2. Interest is paid and only interest is a tax
for tax purposes allowable expense
3. The property under base is not 3. The asset purchased on Hire Purchase
recorded in the books of the lessee and system will be recorded as a non-
hence final accounts as a non-current current asset.
account as expense.
4. Maintenance cost incidental to asset is 4. Maintenance cost incidental to asset
incurred by the lessor. bought on Hire Purchase is incurred by
the buyer.
Illustration :
Tajiri Mjinga Ltd bought two tractors in January 2006 during a dry season without consulting a
section 3 student in OSMS on HP system. The cash price of the tractor was Sh 1M, the HP terms
provided for a deposit of Sh 340,000 and the balance in three equal installments of Sh 300,000 per
tractor payable annually on 31 December each year. The buyer paid the deposit and two installment
but could not pay the 3rd installment. The two tractors were repossessed by the seller immediately.
The policy of Tajiri Mjinga Ltd was to depreciate tractors at the rate of 20% on straight line basis.
The repossessed tractors were reconditioned at a total cost of sh 200,000 and later sold for sh 1M.
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Required
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Prepare the necessary account in the books of the seller and bonus of the buyer.
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NB: Interest was apportioned on straight line basis.
Solution
Cash price (1000, 000 x 2) = 2000,000

H.P.P = Deposit + Installment
= 340,000 x 2 + (300,000 x 2) 3
H.P.P = 680,000 + 1800,000
H.P.P = 2480,000
Therefore HP Interest = H.P.P – Cash Price
= 2480,000 – 200,000
HP interest = 480,000
Therefore interest per installment = = Sh 160,000

Depreciation: 20% straight line
= 2000,000 x 20%
= Sh 400,000 p.a

Books of the Buyer
Tractor Account
Sh. Sh.
2006 2006
H.P vendor account 2000,000 Depreciation 400,000
_______ Bal. c/d 1600,000
2000,000 2,000,0000
2007 2007
Bal. b/d 1,600,000 Depreciation 400,000
_______ Bal. c/d 1200,000
1,600,000 1,600,000
2008 2008
Bal. b/d 1200,000 Depreciation 400,000
______ HP vendor account 600,000
1,200,000 P & L (Bal. fig) 200,000
1,600,000
HP Vendor Account
Sh. Sh.
2006 2006
Bank (deposit) 680,000 Tractor account 2000,000
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Bank (installment) 600,000 Interest expense account 160,000
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Bal. c/d 880,000 _____
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2,160,000 2,160,0000
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2007 2007
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Bank (installment) 600,000 Depreciation 880,000
Bal. b/d 440,000 Bal. c/d 160,000
1,040,000 1,040,000
2008 2008
Bank (installment) 600,000 Bal b/d

Sh. Sh.
2006 2006
HP vendor account 160,000 Profit and loss account 160,000
2007 2007
2008 2008

Books of the Seller
HP Debtors Account
Sh. Sh.
2006 2006
Interest income account 160,000 Bank (installment) 600,000
_______ Bal. c/d 880,000
2,160,000 2,160,000
2007 2007
Interest income account 160,000 Bal. b/d 440,000
1,040,000 1,040,000
2008 2008
Bal. b/d 440,000 Repossession account 600,000
Interest income account 160,000
Repossession Account
Sh. Sh.
2008 2008
HP Debtors account 600,000 Bank (Resale) 1,000,000
Bank (repair) 200,000
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P & L (Profit) 200,000 ______
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1,000,000 1,000,000
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Interest Income Account
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Sh. Sh.
2006 2006
Profit and loss account 160,000 HP debtors account 160,000
2007 2007
2008 2008
CONSTRUCTION CONTRACTS
ACCOUNTING FOR CONSTRUCTION CONTRACTS (IAS II)
It’s a contract for the construction of an asset or of a combination of assets, which together
constitutes a single project. e.g. buildings, roads bridges etc. that often requires more than one year
to complete.

Features of a contract
1. A unique property is produced at the site.
2. The contract is obtained by bidding or negotiation.
3. The WIP is owned by the customer
4. The contract is financed by the client through progress biddings.
5. The original contract may be modified through changes in inflation rate. I.e. Escalation clause
is included that allows the adjustments of the contract price entries upwards or downwards.
Accounting Issues
1. Revenue recognition: there’s a problem of allocation of revenue and cost to the accounting
period i.e. the problem of how and when to recognize revenue
2. Revaluation of stock and work in progress(wip)
3. The treatment of progress biddings.
TYPES OF CONTRACTS
1. Fixed price contract
It’s a contract that provider for a single price to all works performed by the contractor.
It’s ideal for short term contract.
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2. Unit price contract
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This contract includes a fixed price for each unit of output under the contract.
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It’s possible where the contract is divisible into standard unit.
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3. Cost plus contract
It provides for reimbursement of specified cost incurred by the contractor plus a percentage of the
cost on a fixed fee for the contractor.
4. Time and material contract
It provides a fixed rate for the contract already on labor hours plus payment for cost or materials and
other specified items.
Accounting Approaches
There are two accounting approaches applied in contraction i.e.
i. Percentage on completion method

ii. Completed contract method

i. Percentage on completion method
According to this method, revenue is recognized on the basis of completion at the end of accounting
period i.e. based on percentage of completion.
Determination of percentage of completion can be done as follows:

a. Cost approach =
cost to date
100
Total cost estimated cost to completion
b. Unit approach
units completed to date
100
Total cost estimated units to completion
c. Effort approach
labor hours used to date
100
Total labor hours estimated to completion
d. Value approach
work certi ied
100
Contract price
N/B:
1. Physical inspection of the project may be required to substantiate the percent of completion
estimated by the forgone method.
2. If the percent of completion is less than 20%, no profit should be recognized but losses
recognized in full.
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3. Where completion stage is above 99% then contract is substantially completed and revenues
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are recognized in full.
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Advantages of Completion Method
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1. it’s consistent with the actual concept of accounting (matching concept) i.e. it recognizes
revenue when earned and not when received and expenses when incurred and hence it also
obeys the accrual concept.
2. It’s ideal for long-term contracts
3. It complies with prudence principle as far as losses are concerned i.e. any anticipated loss is
recognized in full.
Disadvantages of completion method
1. Its subject to the risk of error in making estimates

2. It recognizes profit before the contract is completed
3. It’s not ideal for short-term contracts
4. Difficult to determine the stage of completion

Definition of Terms
1. Retention money
It’s the amount retained by the client to be paid after the completion of the contract. It will be seen
as an asset to the contracting entity.
2. Escalation clause
It’s a clause that allows for the adjustments on the contract price due to changes in prices.
The objective is to protect both the client and the contractor due to advance changes in prices.
ii. Completed contract method
Under this method, revenue and profits are recognized when the contract is completed or
substantially completed i.e. when remaining costs and potential risks are insignificant in amount.
Costs and progress payments received are accumulated during the course of the contracts but profit
is not recognized until the contract activity is substantially completed.
It’s appropriate for financial accounting only if:
a. A contractor has primarily short-term contract which are completed in one year or less.
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b. If estimates of input/ output measures of completion are not reasonably dependable.
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Features of completed contract method
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1. Construction in progress is valued at cost.
2. No profit is recognized until the contract is completed and the work accepted.
3. During the year when the project is under construction. Only losses are reported to the
external operating expenses.
4. All other construction costs appear in the balance sheet as stock (WIP)
5. In the year when the contract is completed the entire profit is recognized although only a
small proportion of work would have been done that year.
Advantages of Completed Contract Method
The principle advantage of the completed contract method is that it is based on results as determined
when the contract is completed, or substantially completed rallies than on estimated which may
require subsequent adjustment as a result of unforeseen cost and possible losses.
The risk of recognizing profit that may have been earned is therefore minimized.
Disadvantages of completed contract method
The completed contract is inconsistent with the accrual of accounting because the period the income
is reported does not reflect the period of activity on contract during the period.

ACCOUNTING FOR GOVERNMENT GRANTS
Key terms
1. Government
Government agencies and similar bodies whether local, national or international e.g. Japan
International corporation Agency (JICA), Darnish International Development Corporation Agency
and Canadian Development Agency (CIDA)
2. Government Assistant
Is the government action i.e. assistance to give an economic benefit specifying to an entity under
certain criteria
3. Government Grants
They’re government assistance in the form of transfer of resources to an entity in return for past or
future compliance with certain conditions relating to the operations of an entity.
4. Grants related Assets
These are grants whose primary conditions are that an entity qualifying for them should purchase,
construct or otherwise acquire non-current assets.
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5. Grants related to income
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Are grants other than those related to assets e.g. grants to pay operating expenses or particular
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project/ contract.
6. Forgivable loans
These are loans which the lender undertakes to waive repayment with certain prescribed conditions.
An entity should not recognize government grants until it has reasonable assurance that the entity
will comply with any conditions attached to the grant and the entity will actually receive the grant.
Receiving a grant does not mean that prove that conditions attached to it.
The manner of receipt of the grant is irrelevant i.e. the treatment of the government is the same
whether received in cash or given as reduction in liability.
For a forgivable loan, it should be treated in the same way as a government grant. When there’s a
reasonable assurance that the entity will need the relevant term and for the forgiveness.

Accounting treatment for Government grants
There are two methods by which the government grants can be accounted for:
i. Capital approach
ii. Income approach
i) Capital approach
Credit the grants directly to the shareholder’s interest. Arguments for this approach under IAS 20
are:
a. Grants are not earned they’re incentives without related costs so it will be wrong to post them
in the profit & loss account.
b. Grants are a financing device so they should be posted to the statement of financial position.
ii) Income approach
Here grants are credited to the profit & loss over one or more periods.
Arguments for this approach under IAS 20 are:
a) Grants aren’t received from shareholders so they should not Credit to the shareholders
interest.
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b) Grants aren’t given or receipt for nothing, they are earned by compliance with.
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c) Grants are an extension for fiscal policies and so like income taxes and other taxes which are
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charged against income. Then grants should be credited to income.
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IAS 20 requires grants to be recognized under the income approach and hence match them with
related costs which they have been received to compensate.
It will be against the accrual assumption to credit grants to income on a receipt basis so a systematic
basis of matching must be used.
Non-Monetary Government Grants
A Non-monetary asset may be transferred by the government to an entity as a grant e.g. a piece of
land or other resources.
The fair value of such an asset is usually assessed and this is used to account for the assets and the
grant.
Presentation of Grants related to assets
There are two choices here on how government grants related to assets (including non-monetary
grants at fair value) should be shown in the statement of financial position.
a. Set up the grant as deferred income. (Income approach)

b. Deduct the grant in arriving the carrying amount of the asset (capital approach)
Accounting entries in the books
Income Approach (Setting up the grant as deferred income)
1. On receipt of government grant

Dr. Asset a/c
Cr. Grant a/c
2. For acquisition of the asset

Dr. Asset a/c
Cr. Cash a/c
With amount used less grant
3. To record dep. to reduce the grant receipt

Dr. Grant a/c
Cr. P&L a/c
Capital Approach
1. On receipt of government grant:
Dr. Cash a/c
Cr. Grant a/c
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2. To record the acquisition
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Dr. Asset a/c
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Cr. Cash a/c
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3. To record the depreciation for the period of the asset
Dr. Grant a/c
Cr. Asset a/c
Illustration:
A company receives a 20% grants towards the cost of a new item which costs Shs. 100,000 and has
a useful life of four years and a nil residue value.
The expected profit of the company is Sh. 50,000 per annum before accounting for depreciation in
each year.
Required:
Profit & loss account extract and statement of financial position extracts by:
a) Deducting the grant in arriving at the carrying amount of the asset. ( Capital Approach)
b) Set up the grant as a deferred income (Income approach)

SOLUTION
a. Capital approach
Cost of the asset =100,000

Government grant each at 20%×100,000
Reduced value of the asset cost

Cost 100 000
Less:Grant (20,000)
80,000
= = 20 000
Income statement extract
Yr 1 Yr2 Yr3 Yr4

Profit for the year 50,000 50,000 50,000 50,000
Less:depreciation (20,000) (20,000) (20,000) (20,000)
Profit 30,000 30,000 30,000 30,000
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Statement of financial position (Extract)
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Assets Yr1 Yr2 Yr3 Yr4
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Non-current assets
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Property,plant & equip 80,000 80,000 80,000 80,000
Less:acc dep (20,000) (40,000) (60,000) (80,000)
NBV 60,000 40,000 20,000
Income Approach
Grant = 20%×100,000=20,000
Income Statement Extract
Yr1 Yr2 Yr3 Yr4

Profit for the year 50,000 50,000 50,000 50,000
Add: Grant income 5,000 5,000 5,000 5,000
Total income 55,000 55,000 55,000 55,000
Less: Depreciation (25,000) (25,000) (25,000) (25,000)
Profit before tax 30, 000 30, 000 30, 000 30, 000

Statement of financial position Extract
Yr1 Yr2 Yr3 Yr4

Property plant&eqp 100,000 100,000 100,000 100,000
Less:acc depreciation (25000) (25000) (25000) (100000)
NBV (25000) (25000) (25000)
Liabilities
Deferred incomes 15000 15000 15000
Loans at a low or zero interest rates area form of government assistance but the computation of
interest does not fully quantity the benefit received.
Disclosure
Disclosure is required in the following areas:
1. Accounting policy adopted including method of presentation.

2. Nature and extent of government grants recognized and other forms of assistance received.
3. Unfulfilled conditions and other contingencies attached to recognized government assistance.
REVISION EXERCISES
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QUESTION 1
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a) Distinguish between “leasing” and “hire purchase” highlighting how each is accounted for.
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b) Kopesha Limited has been in business for several years dealing in electronic goods. All the firm’s
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goods are sold on hire purchase terms. The following trial balance extracted from the books of the
firm as at 31 March 2006:
Sh.’000’ Sh.’000’
Ordinary share capital 53,200
Cash at bank and in hand 1,800
Operating expenses 16,000
Property, plants and equipment (1 April 2005) 55,000
Depreciation (1 April 2005 20,000
Hire purchase installments receivable 34,200
Hire purchase sales 55,200
Purchases 24,600
Inventory (1 April 2005) 1,800 -
133,400 133,400
1. Inventory as at 31 March 2006 was valued at sh.2,400,000.

2. Property, plant and equipment should be depreciated at sh.5,000,000 for the year ended 31 March
2006.
3. Each unit was sold on hire purchase basis on the following terms:
Sh.
Cash price 40,000
Deposit (10,000)
Interest 30,000
6,000
36,000
4. Assume that all sales are made at the end of each quarter. The quarters end on 31 march, 30 June ,
30 September and 31 December respectively. The balance due on each hire purchase sale is
payable in four equal installments of Sh. 9,000 per quarter payable at the end of each quarter and
commencing in the quarter following that in which the sale was made.
5. The number of units sold during each quarter were made as follows:
Quarter to Number of units sold.
30-Jun-05 100
30-Sep-05 200
31-Dec-05 300
31-Mar-06 600
All installments were received on their due dates.
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6. The sum of digits method is to be used to apportion interest, the appropriate amount being
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credited to the quarter in which an installment is received.
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7. Included in the operating expense is a lease rental payment of Sh.2,000,000 paid at the
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commencement of the financial year. This relates to equipment whose fair value is Sh.8,000,000.
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The payment has been treated as an operating lease whereas it is a finance lease . The duration of
the lease is 5 years and interest is at 10% er annum. Lease rentals are paid in advance.
Required:
i) Trading, profit and loss account for the year ended 31 March 2006.
ii) Balance sheet as at 31 March 2006
Solution:
a) Leasing:
The Rights to use an asset by one party called the lessee in return for rentals paid to another party
called the lessor. The lessor retains ownership of the asset throughout the period of lease.
Hire Purchase:
An asset is acquired by way of installment payment, whereby ownership eventually passes to the
buyer when the last installment has been paid.

Accounting issues:
Leasing:
The main issues in leases is making a distinction between an operating lease and a finance lease, and
in addition in a finance lease how to deal with the interest i.e allocating in the interest over the lease
period.
Hire Purchase:
In hire purchase the main issue is on how to allocate Gross profit and interest over the installment
period by the seller and how to account for interest by the buyer.
b)
Kopesha limited
Trading profit and loss account for the year ended 31 March 2006.
Sh
Sales (55,200 – 7,200) 48,000
Cost of sales
Opening inventory 1,800
Purchase 24,600
Closing inventory 26,400
Gross profit (2,400) (24,000)
Interest on Hire Purchase sales 24,000
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2,100
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Expenses: 26,100
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Depreciation: Property, Plant and equipment 6,600
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Other operating expenses (16,000- 2,000) 14,000
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Interest in finance lease (8,000-2,000) x 10% 600 (21,200)
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Net profit 4,900
Kopesha limited
balance sheet as at 31 March 2006
Non-current assets: Sh’000’ Sh’000’
Property, Plant and Equipment: (55000+8000) 63,000
Depreciation (20000+5000+16000) (26,000)
36,400
Current Assets:
Inventory 2,400
Receivables (34200-5100) 29,100
Cash at bank and in hand 1,800 33,300
Total Assets 69,700

Net Profit 4,900
58,100
Non-Current Liabilities:

Obligations under finance leas 4,600
Current Liabilities
Obligations under finance lease 2,000 7,000
69,700
Workings:
i) interest included in hire purchase sales (in thousands of shillings)

(100+200+300+600) x 6000) = Sh. 7,200
ii) Sum of digits for instalments

(4 x (4+1))/2=10
iii) Interest earned

Shs ‘000’
Quarter ended June ((4+3+2)/10x (100x6000) 540
Quarter ended September ((4+3)/10x (200x6000) 840
Quarter ended December ((4/10x (300x6000) 720
Total interest on hire purchase 2,100
7,200
Less: Reported to profit and loss (2,100)
Interest outstanding (Deducted from Receivables) 5,100
(iv)
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Finance lease: Sh’000’
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Profit and Loss Expense
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Balance of Liability at 1.4.05 8,000
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Less:instalment paid (2,000)
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Balance outstanding 6,000
Interest at 10% per annum 600
Balance sheet Liability: Sh’000’
Total due as at 1.4.05 8,000
Less: installment paid (2,000)
6,000
Add: Interest accrued 600
Total due at 31March06 6,600
Current liability (next year’s installment) 2,000
No current liability (balance 6,600-2,000) 4,600
Depreciation on asset held on finance lease = 1 600 000
QUESTION 2
a) Explain the difference between the cost-recovery method and the instalment method of
recognising gross profit from instalment sales.
b) Bontex Enterprises sells its goods, both new and repossessed, on an instalment plan basis and
recognises gross profit on the sales using the instalment method.

Given below is the information extracted from the books of the business for the two financial years
ended 31 December 2001 and 2002:
2002 2001
Sh. Sh.
Instalment sales 800,000 480,000
Purchases 560,000 324,000
Opening stock 180,000
Closing stock 140,000 120,000
Depreciation charge 20,000
Instalment debtors:
From sales of year ended 31 December 2001 60,000 180,000
From sales of year ended 31 December 2002 280,000 -
1. When a customer defaults on his payments, the goods are repossessed and recorded at their
approximate market value in a separate inventory account.
The wholesale market value of repossessed goods is determined as follows:
• Repossessions made in the year of sale are valued at 50% of the original sale price.
• Repossessions made from the sales of previous years are valued at 30% of the original sale
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price.
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2. There were no defaults in the year ended 31 December 2001 but in the year ended 31 December
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2002, defaults occurred as follows:
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Original selling Defaulted
price amount
Sh. Sh.
From the sales of the year ended 31 40,000 20,000
December: 96,000 72,000
2001
2002
3. All the repossessed goods were resold in the year 2002.
Required:
a) Instalment debtors account and provision for unrealised gross profit account for the sales
made in the years to 31 December 2001 and 2002 as at 31 December 2002.
b) Repossessed goods account as at 31 December 2002.
c) Profit and loss account for the year ended 31 December 2002.

Solution:
(a) Cost recovery method and instalment method:
- Cost recovery method is a method whereby gross profit on an instalment sale is recognised after
collecting enough cash from the debtors to cover the cost of sale.
- No profit is recognised on an instalment sale before cash equal to the cost of sale is collected.
- Realised gross profit is any amount collected from the debtors over and above cash collected to cover
the cost of sale.
- Instalment sales method is a method whereby every cash collected from a debtor covers both gross
profit and cost of sales based on the gross profit percentage.
- Gross profit is not recognised on any uncollected debtors.
(b) (i)
Bontex Enterprises Debtors Account
2001 Sh. 2001 Sh.

1 January Bal b/d 180,000 Bank A/c 100,000
Repossession a/c (30% x Sh.40,000) 12,000
Unrealised GP a/c (20% x Sh.20,000) 4,000
_____ Loss on repossession

(80% x 20,000)-12,000 4,000
Bal c/d 60,000
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180,000 180,000
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Bontex Enterprises Debtors Account
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2002 Shs 2002 Shs
Sales 800,000 Bank A/c 448,000
Repossession a/c (50% x 48,000
Sh.96,000) 18,000
Unrealised G.P a/c (25% x
Sh.72,000)
_____ Loss on repossession 6,000
(75% x 72,000)-48,000 280,000
Bal c/d
800,000 800,000
Bontex Enterprises Unrealised Gross Profit A/c (2001)
Sh. Sh.
Debtors A/c 4,000 Balance b/d (20% x Sh.180,000) 36,000
P & L A/c (20% x Sh.100,000) 20,000
Bal c/d (10% x 60,000) 12,000 _____
36,000 36,000

Bontex Enterprises Unrealised Gross Profit A/c (2002)
Sh. Sh.
Debtors A/c 18,000 Profit and loss a/c 88,000
Bal c/d (25% x Sh.280,000) [25% x Sh.(800,000 – 448,000)]
70,000 _____
88,000 88,000
Bontex Enterprises Repossessions A/c
Sh. Sh.
Debtors A/c 2001 12,000 Trading A/c 60,000
2002
48,000 _____
60,000 60,000
(iii)
Bontex Enterprises
Profit and Loss Account for the year ended 31 December 2002
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2002 Sh. 2001 Sh.
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Sales 800,000 480,000
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Opening stock 120,000 180,000
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Purchases 560,000 324,000
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Repossessions 60,000 -
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740,000 504,000
Closing stock 140,000 120,000
600,000 384,000
Gross profit 200,000 96,000
Less: Net unrealised gross profit 68,000
Realised gross profit 132,000
Depreciation 20,000
Loss on repossession 10,000
Net profit 64,500
67,500
Note: The trading account for the year 2001 is prepared to help determine gross profit for calculation of
gross profit percentage.
Workings:
(a) Calculation of gross profit percentage:
Year 2001 = 100

= 20%
Year 2002 = 100
= 25%
(b) Calculation of net unrealised profit deducted from gross profit for the year 2002:
Shs
Unrealised gross profit in debtors of 2002 c/d (25% of 280,000) 70,000
Unrealised gross profit on defaulted debts of 2002 (25% of 72,000) 18,000
Unrealised gross profit b/d 88,000
Less: Realised gross profit on collections from debtors of 2001
(20% of 100,000) 20,000
Net unrealised gross profit 68,000
QUESTION 3
a) Explain the difference between a fixed price contract and a cost plus contract.
b) Jenga Ltd., is a construction company whose financial year ends on 31 March. The information
provided below was extracted from the books of the company in connection with the three
construction contracts undertaken by the company during the financial year ended 31 Mach
2005.
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Contract Contract Contract
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No.468 No.469 No.470
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Sh ‘000’ Sh. ‘000’ Sh. ‘000’
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Contract price 3,600 4,800 2,500
Cost incurred up to 31 March 1,800 3,000 1,500
2004
Cost incurred during the year 600 1,000 500
Estimated total cost of the 3,000 5,200 2,300
contract
Total billings to date 2,800 4,500 1,800
Total cash received to date 2,600 4,200 1,700
Total profit/(loss) reported on 360 30 (20)
the contract to date
General administration expenses 60 120 30
Required:
Using the percentage of completion method of accounting for long-term construction contracts:
a) Calculate the profit or loss realised on each contract for the year ended 31 Marcy 2005.
b) Prepare profit and loss account extracts for each contract for the year ended 31 March 2005.
c) Prepare balance sheet extracts as at 31 March 2005.

Solution:
a) Fixed price contract and cost plus contract
i) A fixed price contract is a construction contract which has either a fixed price for the whole contract
or per unit.
ii) Due to variations in the prices of inputs a fixed price contract may have a cost escalation clause
iii) A cost plus contract is a construction contract in which the contractor is refunded the cost incurred on
the contract and then added some amount agreed upon computed as proportion of the cost.
iv) The method is useful in a case where it is not possible to determine the cost of the contract at the
beginning especially when input prices are changing frequently.
b)
i) Realised gross profit or loss for the year
Sh. ‘000’
Contract No. 468 120
Contract No.469 (430)
Contract No.470 194
Profit and loss account extract
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CONTRACT
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Contract Contract No.469 Contract
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No.470
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No. 468
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Sh. ‘000’ Sh. ‘000’ Sh. ‘000’
Gross profit/(loss) 120 (430) 194
Less: General administration costs 60 120 30
Net profit/ (loss) 60 (550) 164
Alternative method
Revenue 720 570 694
Cost of sales (cost incurred in the year) 600 1,000 500
Gross profit/(loss) 120 (430) 194
Less: General administration expenses 60 120 30
Net profit/(loss) 60 (550) 164
Comment
Revenue for each contract is the sum of costs incurred in the year and realized gross profit or loss for the
year.

Balance sheet extracts
Calculation of work in progress
CONTRACT
No.470
No. 468
Sh. ‘000’ Sh. ‘000’ Sh. ‘000’
Cost incurred to date 2,400 4,000 2,000
Add/(less)
Gross profit/(loss) realized to date 480 (400) 174
2,880 3,600 1,826
Less: Total billings to date 2,800 4,500 1,800
Work in progress 80 (900) 26
Comment
Contract number 469 has no work in progress but instead excess billings over work in progress and is
therefore treated as current liability.
Calculation of debtors balance
CONTRACT
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No.470
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No. 468
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Sh. ‘000’ Sh. ‘000’ Sh. ‘000’
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Total billings to date 2,800 4,500 1,800
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Less: Total cash received 2,600 4,200 1,700
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Debtors 200 300 100
Balance Sheet Extract Sh. ‘000’
Current assets
Work in progress (80 + 26) 106
Debtors 600
706
Current liability
Excess of billings over work in progress 900
Comment
Debtors balance is alternatively called “due from customers” while excess of billings over work in progress
is alternatively called “due to customers”.

Workings
Contract Contract Contract

No. 468 No.469 No.470
Sh. ‘000’ Sh. ‘000’ Sh. ‘000’
Contract price 3,600 4,800 2,500
Cost incurred upto 31 March 2004 1,800 3,000 1,500
Costs incurred I the year 600 1,000 500
Total costs incurred to date (ii) + (iii) 2,400 4,000 2,000
Estimated total cost of contract 3,000 5,200 2,300
Estimated total gross profit/(loss) on the contract (i) – 600 (400) 200
(v)
Gross profit/(loss) realized to date (vi) x (iv) ÷ (v) 480 (400) 174
Profit /(loss) reported to date on contract 360 30 (20)
Realized profit/(loss) for the year (vii) – (viii) 120 (430) 194
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TOPIC 4
FINANCIAL STATEMENTS OF VARIOUS TYPES OF

ORGANISATIONS
FARMING
International Accounting Standards (IAS ) 41 describes the accounting treatment, financial

statements presentation and disclosures related to agricultural activities.
IAS 41 doesn’t cover all other activities covered by other IAS e.g. fixed assets held by agricultural
concerns.
Agriculture-related definitions
The following terms are used in this Standard with the meanings specified:
Agricultural activity is the management by an entity of the biological transformation and harvest of
biological assets for sale or for conversion into agricultural produce or into additional biological
assets.
 Agricultural produce - is the harvested product of the entity’s biological assets.

 A biological asset - is a living animal or plant.
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 Biological transformation -comprises the processes of growth, degeneration, production,
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and procreation that cause qualitative or quantitative changes in a biological asset.
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 A group of biological assets - is an aggregation of similar living animals or plants.
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 Harvest is the detachment of produce from a biological asset or the cessation of a biological
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asset’s life processes.
 Costs to sell are the incremental costs directly attributable to the disposal of an asset,
excluding finance costs and income taxes
Agricultural activity covers a diverse range of activities; for example, raising livestock, forestry,
annual or perennial cropping, cultivating orchards and plantations, floriculture, and aquaculture
(including fish farming). Certain common features exist within this diversity:
Capability to change
Living animals and plants are capable of biological transformation;
Management of change
Management facilitates biological transformation by enhancing, or at least stabilising,
conditions necessary for the process to take place (for example, nutrient levels, moisture,
temperature, fertility, and light). Such management distinguishes agricultural activity from
other activities. For example, harvesting from unmanaged sources (such as ocean fishing and
deforestation) is not agricultural activity; and

Measurement of change
The change in quality (for example, genetic merit, density, ripeness, fat cover, protein content,
and fibre strength) or quantity (for example, progeny, weight, cubic metres, fibre length or
diameter, and number of buds) brought about by biological transformation or harvest is
measured and monitored as a routine management function.
Recognition and measurement

An entity shall recognise a biological asset or agricultural produce when and only when:
a) The entity controls the asset as a result of past events;
b) It is probable that future economic benefits associated with the asset will flow to the entity
c) The fair value or cost of the asset can be measured reliably.
Initial recognition
Measurement
 Biological assets within the scope of IAS 41 are measured on initial recognition and at
subsequent reporting dates at fair value less estimated costs to sell, unless fair value cannot be
reliably measured.
 Agricultural produce is measured at fair value less estimated costs to sell at the point of
harvest. Because harvested produce is a marketable commodity, there is no 'measurement
reliability' exception for produce.
 The gain on initial recognition of biological assets at fair value less costs to sell, and changes
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in fair value less costs to sell of biological assets during a period, are included in profit or
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loss.
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 A gain on initial recognition (e.g. as a result of harvesting) of agricultural produce at fair
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value less costs to sell are included in profit or loss for the period in which it arises.
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 All costs related to biological assets that are measured at fair value are recognised as
expenses when incurred, other than costs to purchase biological assets.
 IAS 41 presumes that fair value can be reliably measured for most biological assets.
However, that presumption can be rebutted for a biological asset that, at the time it is initially
recognised, does not have a quoted market price in an active market and for which alternative
fair value measurements are determined to be clearly unreliable. In such a case, the asset is
measured at cost less accumulated depreciation and impairment losses. But the entity must
still measure all of its other biological assets at fair value less costs to sell. If circumstances
change and fair value becomes reliably measurable, a switch to fair value less costs to sell is
required.
Other issues
The change in fair value of biological assets is part physical change (growth, etc) and part unit price
change. Separate disclosure of the two components is encouraged, not required.
Agricultural produce is measured at fair value less costs to sell at harvest, and this measurement is
considered the cost of the produce at that time (for the purposes of IAS 2 Inventories or any other
applicable standard).

Agricultural land is accounted for under IAS 16 Property, Plant and Equipment. However, biological
assets (other than bearer plants) that are physically attached to land are measured as biological assets
separate from the land. In some cases, the determination of the fair value less costs to sell of the
biological asset can be based on the fair value of the combined asset (land, improvements and
biological assets).
Government grants
Unconditional government grants received in respect of biological assets measured at fair value less
costs to sell are recognised in profit or loss when the grant becomes receivable.
If such a grant is conditional (including where the grant requires an entity not to engage in certain
agricultural activity), the entity recognises the grant in profit or loss only when the conditions have
been met.
Disclosure requirements in IAS 41 include:
 Aggregate gain or loss from the initial recognition of biological assets and agricultural
produce and the change in fair value less costs to sell during the period
 description of an entity's biological assets, by broad group
 Description of the nature of an entity's activities with each group of biological assets and non-
financial measures or estimates of physical quantities of output during the period and assets
on hand at the end of the period
 Information about biological assets whose title is restricted or that are pledged as security
 Commitments for development or acquisition of biological assets
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 Financial risk management strategies
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 Reconciliation of changes in the carrying amount of biological assets, showing separately
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changes in value, purchases, sales, harvesting, business combinations, and foreign exchange
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difference
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Objectives of farm accounting
a) For control purposes e.g. the farmer can control his activities such as stock inputs.
b) To facilitate credit transactions with suppliers
c) To help in making managerial decisions
d) To evaluate the performance of the concern i.e. whether you are operating at a profit/ loss.
e) To help the farmer in obtaining a loan i.e. financial assistance from third parties.
Futures/ Characteristics of farm accounting
1. Inter-activity transfers;
Dr. Revenue a/c (input)
Cr. Revenue a/c (output).
Generally a farm is employed with different economic activities e.g. poultry, fishing, crops,
dairy cattle etc.
As a result the output of one economic activity may be used by another economic activity as an
input.

To account for this, the output of the farmer activity should be treated as an income for that
respective activity and as an expense for the latter activity.
2. Dominance of barter transactions/ payments in kind;

Dr. Wages/ revenue a/c,
Cr. Revenue a/c.
The transactions relating to agriculture are not controlled by money. In many cases the
payments are made in kind.
In order to account for this opportunity such as payments in kind should be qualified in money
terms of adjustments be made in respective accounts. e.g. if the workers received milk then
liters of milk so given would be valued as selling price an amount be treated as revenue in
livestock account and the same amount treated as wages in crop account.
3. Related items
e.g. In sale of related items, the proceedings on sale related items should be treated as revenue in
the same department e.g. sale of eggs and manure.
In Family Labour: This is usually provided for free. It should be valued at market price and
treated as capital i.e. the double entry would be:
Dr. Wages/ General P&L account
Cr. Capital a/c
4. Family consumption
The family may consume some of the products. The products consumed should be valued at
market price and treated as both revenue as well as drawings i.e.
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Dr. Drawings
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Cr. Sales a/c / Revenues
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5. Workers/ Labourers consumption
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Labourers may at some point consume some products while working in the farm. The products
consumed should be valued at market price and then treated as revenue in the respective
accounts and treated as well as general expense accounts to be transferred to P&L.
N/B:
i. At the end of accounting period all biological assets should be measured at their fair market
value less estimated point of sale cost.
ii. Stud animals:These livestock not meant for sale or meat production. They are also maintained
for other purposes such ploughing. They should be treated as fixed assets.

ILLUSTRATION
Joseph Mokua, a farmer extracted the following trial balance as at 31 October 2004:
Sh. ‘000’ Sh. ‘000’
Crop insurance 240
Stocks as at 1 November 2003
Growing crops, wheat, seeds and fertilizers 1,000
Livestock 1,250
Livestock feeds 300
Land and buildings at cost 10,000
Farm machinery (cost Sh. 5,400,000) 3,900
Profit and loss account balance (1 November 2003) 500
Loan from Farmers’ Bank Ltd 3,000
Sale of wheat 1,750
Sale of cattle 3,000
Sale of carcass 750
Manager’s personal account 100
Bank overdraft 150
Sundry creditors 750
Interest on loan from Farmers Bank Ltd 225
Office expenses 200
Crop expenses 500
Livestock wages 800
Other livestock expenses 615
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Purchase of seeds 200
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Livestock purchases 625
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Livestock feeds purchased 35
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Capital 13,500
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Farmhouse expenses 60
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Staff meals 25
Repairs to farm machinery 50
Tools and implements (1 November 2003) 125
Sundry debtors 1,500
Cash in hand 1,300
Manager’s salary 300
General farm labour wages 250 _____
23,500 23,500
1. The entire crop insurance was taken with effect from 1 November 2003 to provide an annual
risk cover against crop losses due to climatic risks such as floods, drought and plant diseases.
2. Manager’s salary and staff meals are charged to the livestock and crop activities in the ration
of 1:4 respectively.
3. Depreciation on tools and implements is to be apportioned equally between the crop and
livestock activities. The book value of tools and implements as at 31 October 2004 was Sh.
100,000.

4. Provisions for doubtful debts is to be maintained at 8% of the year end debtors and bad debts
of Sh. 25,000 are to be written off.
5. Farm machinery is to be depreciated at the rate of 20% per annum on cost.
6. Crops consumed by some of the farm labourers during the year ended 31 October 2004 were
valued at Sh. 50,000.
7. During the year ended 31 October 2004, Joseph Mokua’s family members provided general
farm labour valued at Sh. 100,000 the family also consumed crops valued at Sh. 160,000.
8. The loan from Farmers’ bank Ltd. was obtained on 1 January 2004 and was to be repaid in full
by the end of the fifth year. Interest was to be paid semi-annually on 30 June and 31 December
at the rate of 15% per annum. The entire loan was used on crop activities.
9. Assume there were no transfers of inputs between the main activities of crop farming and
livestock farming.
10. Stocks as at 31 October 2004 were as follows.
Shs. “000”
Growing crops 170
Wheat, seeds and fertilizers 300
Livestock 2,000
Livestock feeds 50
Required:
a) Crop account for the year ended 31 October 2004
b) Livestock account for the year ended 31 October 2004
c) General profit and loss account for the year ended 31 October 2004.
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d) Balance sheet as at 31 October 2004.
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SOLUTION
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(a)
Joseph Mokua
Crop account for the year ended 31 October 2004
Sh. ‘000’ Sh. ‘000’
Opening stocks: Growing crops, 1,000 Sale of wheat 1,750.0
Wheat seeds and fertilizers 200 Contra: Crops to workers 50.0
Purchases: seeds 1,200 Drawings 160.0
General P&L A/C 207.5
Closing stocks: Growing crops (170)
Wheat seeds and fertilizers (300)
Cost of crops, seeds & fertilizers 730.0
Crop insurance 240.0
Interest on loan from bank 375.0
Crop expenses 500.0
Contra: crops to workers 50.0
Staff meals 20.0
Depreciation: Tools and 12.5
implements 240.0 _____
Managers salary 2.167.5 2,167.5
(b)
Joseph Mokua
Livestock account for the year ended 31 October 2004
Sh. ‘000’ Sh. ‘000’
Opening stock: livestock 1,250.0 Sale of cattle 3,000
Feeding materials 300.0 Sale of carcasses 750
Purchases: Livestock 625.0
Feeding materials 35.0
2,210.0
Closing stock: Livestock (2,000).0
Livestock feeds (50).0
Cost of livestock & materials 160.0
Wages for rearing livestock 800.0
Other livestock expenses 615.0
Staff meals 5.0
Depreciation: Tools & 12.5
implements 60.0
Managers salary 2,097.5 ____
Profit & loss A/C 3,750.0 3,750
(c)
Joseph Mokua
General profit and loss account for the year ended 31 October 2004
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Sh. ‘000’ Sh. ‘000’
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Livestock profit 2,097.5
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Crop loss (207.5)
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1,890.0
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Less expenses :
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Office expenses 200
Farmhouse expenses 60
Machinery repairs 50
Farmlabour wages 250
Bad debts 25
Provision for b/debts 118
Depn: Farm machinery 1,080
Labour by family 100 1,883
Net operating profit 7

(d)
Joseph Mokua
Balance sheet as at 31 October 2004
Sh. ‘000’ Sh. ‘000’
Non-current assets:
Land and buildings 10,000
Farm machinery 2,820
Tools and implements 100
12,920
Current assets:
Stock: Growing crops 170
Wheat, seeds, fertilizers 300
Livestock 2,000
Livestock feeds 50
Cash in hand 1,300 5,177
18,097
Financed by:
Capital 13,600
Net Profit 507
14,007
Drawings (160)
13,847
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Loan 3,000
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16,847
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Labour by family 100
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Managers personal a/c 100
Bank overdraft 150
Accrued loan interest 150 1,250
18,097
INSURANCE FIRMS
Insurance companies
Insurance is a form of contract or agreement under which one party undertakes to indemnify another
party the losses suffered due to specified causes in consideration for a fixed sum of money known as
a premium. The party undertaking to indemnify another is called the insurer; whereas the party
paying the premiums in order to receive indemnity is called the insured. The document containing
the terms of the insurance contract is known as a policy.
Insurance is generally classified into two:
i) Life assurance
ii) General insurance
Otherwise insurance is categorized according to the type of risk:
Risk Type of Insurance
i) Loss through fire i) Fire insurance
ii) Risk of sea transport to goods and ship ii) Marine insurance
iii) Accidents insurance iii) Motor vehicle / accident insurance
iv) Loss by theft iv) Burglary insurance
v) Dishonesty of employee v) Fidelity insurance
vi) Damage to third parties vi) Third party insurance
vii) Injury or sickness or death to workers at place of work. vii) Workmen’s compensation
viii) Death at advanced age viii) Life assurance
i) ix) Loss of profits ii) Consequential loss insurance
Life Assurance
Life assurance guarantees that, on the policy holder (or the insured) attaining a certain age or on his
death, he will receive a certain amount of money paid to him by the insurer.
Throughout the period of the policy, the insured has to pay regular premiums. Life assurance is
known as assurance because ultimately the policy must be paid whether due to death or maturity.
Some of the commonly used terms in life assurance are:
1) Annuity: This is an annual payment, which a life insurance office guarantees to pay regularly
as long as one lives in consideration of a lump sum received at the beginning. It is almost the
reverse of a live policy contract. The amount payable depends upon the age of the person
concerned (called an annuitant) and the prevailing rate of interest. The regular payment
(annuity) is an expense, whereas the lump sum received at the beginning is called
‘consideration for annuities granted’ and is income.
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2) Whole life policy – is a policy, which matures on the policy holder attaining a certain age or
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on his death, whichever is earlier.
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3) Endowment policy is a policy, which matures on the policyholder attaining a certain age or
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on his death, whichever is earlier.
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4) With profits policies are those policies on which, in addition to a guaranteed sum payable on
maturity, a share of the profits of the life office will be payable.
5) Without profits policies are those which entitle the policy holder to get only a fixed sum of
money on maturity.
6) Bonus is the share of profit that the policyholder gets form the insurance company.
7) Reversionary bonus is that which is payable only on the maturity of the policy.
8) Bonus in cash is payable immediately.
9) Bonus in reduction of premimum is bonus which is payable in cash but the policyholder has
opted not to accept it in cash, and instead offset this against premiums due from him.
10) Reinsurance means insurance taken by an insurance company in order to cover itself against a
large risk.
11) Retrocession is where an insurance company reinsurance company reinsures one property
with more than on Reinsurance Company.
12) Commission on reinsurance ceded – when a company reinsures some of the risk, the
company will receive a commission from the reinsuring firm, such is known as commission
on reinsurance ceded and is income.
13) Commission on reinsurance accepted – when our insurance company decides to accept
reinsurance premiums from another insurance company because the other insurance company

decided to reinsure its business with us, we have to pay a commission to the other insurance
company. Such is known as commission on reinsurance accepted and is an expense.
14) Surrender value is the amount that a policyholder can get immediately in cash back from the
life assurance company if he stops paying premiums. It is the present cash value of the policy.
The other option to the policyholder is to get the policy.
15) Paid up – In this case, no further premiums are payable and the policy amount is reduced
proportionately to the number of premiums paid having regard to total number of premiums
payable. The policy will mature in its normal course.
16) Claim – means the amount payable due to the death of the policyholder it is called a ‘claim by
death’. If the claim is paid upon the policyholder attaining the age mentioned in the policy, it
is known as claims by maturity (or survivance)
Annual accounts of a life assurance business consist of the preparation of:

1. A revenue A/C and
2. Statement of financial position.
Format for revenue A/C

Sh. Sh.
Claims including claims, less claims Life assurance fund b/d x
recovered and recoverable from x Premiums received less premiums paid
reinsurance companies. x for reinsurance. x
Annuities paid and due x Consideration for annuities granted. x
Bonus paid in cash. x Interest received less withholding tax x
Bonus utilized in reduction of premium x Dividend received less withholding tax x
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Rent income x
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Expenses of management: Fines for getting lapsed policies revived x
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 Commissions to agents
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x Other gains incomes x
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 Salaries etc.
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x Registration fees x
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 Travelling expenses x
 Directors fees x
 Auditors fees x
 Printing and stationery x
 Rent for all offices occupied x
 Bad debts x
 Other expenses and losses x
Life assurance fund c/f x ___
xx xx
Explanation of items in revenue account
DEBIT SIDE ITEMS
1. Claims: Any amount payable by the insurance company is called a claim. In life assurance
business, claims may arise due to two reasons i.e. by death or maturity. While calculating the
figure for claims all claims intimated and accepted or not accepted at the end of the year,
expenses relating to claims are to be added and out of the total claims outstanding at the
beginning of the year and reinsurance recoveries are to be deducted. The amount of

reinsurance recoveries is received under reinsurance contract and it reduces the total claims to
be paid by the business.
2. Annuity: It is annual payment which a life insurance company guarantees to pay for lump
sum money received in the beginning. It is an expense and shown on the debit side of revenue
account.
3. Surrender value: if an insured is unable to pay the future premium he can get his policy paid
from the corporation. It is the present cash value of the policy, which a holder gets from the
corporation on surrendering all the rights of the policy. There is no surrender value in case of
general insurance policies.
4. Bonus in cash: If the insurer has with profit policy, he will get the bonus from the
corporation. If the bonus is paid in cash, it is shown on the debit side of the revenue account
as an expense. Interim bonus will not be shown anywhere while preparing final accounts.
Instead it will be adjusted while calculating true surplus and amount to be paid to policy
holders.
5. Bonus in reduction of premium. Instead of paying bonus in cash, the corporation may
deduct the bonus from the premiums due from the insured. This is known as bonus in
reduction or premium. It is shown both on the debit side and credit side (by adding to the
premium) of revenue account.
6. Expenses of management: These are to be shown in combining the details constituting such
expenses can be given either in the revenue account or in the form of an attached schedule of
working note.
7. Bad debts taxes and other expenditure: These are to be shown separately on the debit side
of the revenue account.
8. Life assurance fund: The difference between the credit and debit side or revenue account is
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not profit but life assurance fund at the end of the period.
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Credit Side Items
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1. Life assurance fund: This fund at the beginning of the period is to be shown on the credit
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side of the revenue account.
2. Premium: The premium received during the accounting period plus outstanding at the end
of the period plus, bonus in reduction of premium minus outstanding premium at the
beginning of the period minus reinsurance premium is to be shown under this heading.
3. Consideration for Annuities Granted: Any lump sum payment received by the insurance
company in lieu of granting annuity is called as consideration for annuity granted and will
be shown as an income on the credit side of revenue account.
4. Interest, Dividend and Rent: If the life insurance company has received any interest,
dividend and rent on its investment, income tax thereon should be deducted. Interest
accrued and outstanding is added to this item.
5. Registration fee: This is an item of income and shown on the credit side of revenue account.
6. Reinsurance: An insurance company may pass on some business to another insurance
company and therefore pass some element of risk to the other company. This is called
reinsurance. The company, which passes some business to the other company, gets some
commission, which is known as commission on reinsurance business ceded and is shown on
the credit side of revenue account. The company which accepts such business is required to
pay commission on reinsurance business accepted and such commission will become an
expense and will be shown on the debit side of revenue account.

Note: The debit side cannot be more than the credit side

Liabilities Shs. Assets Shs.
Share capital: Issued and paid up x Loans: On mortgages x
Reserve: Investment reserve x On policies x
Profit and loss c/f x On stock /shares x
Funds of other business: Investments
Fire business x In government securities x
Marine business x In securities where the interest is x
Other business x guaranteed by the government x
Debentures x Bonds, debentures, stocks and other
Other liabilities x securities. x
Bills payable x Outstanding premiums x
Claims outstanding – whether accepted x Accrued interests, dividends and rent. x
or intimated x Amounts due from other insurers. x
Annuities due and unpaid x Sundry debtors x
Outstanding dividends to shareholders x Bills receivable x
Premiums received in advance x Bank x
Sums dues to other insurance x Cash x
companies x
Sundry creditors + accrued expenses x ___
Contingent liabilities xx xx
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ILLUSTRATION
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QUESTION
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Tengo Insurance Company ltd. Engages in general insurance business. The following trial balance
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was extracted from its books as at 31 March 2004.
Trial balance as at 31 March 2004

Sh.’000’ Sh.’000’
Direct premiums received:
Marine 4,500
Fire 3,500
Re-insurance premium received:
Marine 1,200
Fire 800
Re-insurance premium paid:
Marine 800
Fire 500
Sundry debtors 730
Bank balance and cash in hand 110
Unearned premium as at 1 April 2003:
Marine 4,800
Fire 2,500
Claims outstanding as at 1 April 2003:
Marine 800
Fire 540
Claims paid:
Marine 2,470
Fire 1,800
Legal costs incurred on claims:
Marine 180
Fire 130
Survey expenses relating to claims:
Marine 320
Bad debts:
Marine 170
Fire 120
Investment in shares 1,400
Motor vehicles (net book value) 3,500
Machinery and equipment (net book value) 1,500
Furniture (net book value) 1,300
Audit fees 240
Directors’ fees 495
Depreciation of fixed assets 905
Sh.’000’ Sh.’000’
Management expenses: 650 330
Marine 580 280
Fire 800 3,000
Sundry creditors 700 1,000
Investment income 450
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Ordinary share capital _____
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Share premium
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Profit and loss account balance as at 1
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April 2003
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Premiums outstanding – 1 April 2003:
Marine
Fire
23,700 23,700
 Premiums outstanding as at 31 March 2004 amounted to Sh.1,500,000 and Sh.700,000 for

marine insurance and fire insurance respectively.
 Claims intimated and outstanding as at 31 March 2004 amounted to Sh.750,000 for marine
insurance and Sh.480,000 for fire insurance.
 Unearned premium (reserve for unexpired risk) is maintained at 100% and 50% of the net
premium for marine insurance and fire insurance respectively.
 Commission on both the re-insurance ceded and re-insurance accepted is at the rate of 5% of
the premium.
 The directors have proposed a dividend of 10% on the outstanding share capital as at 31
March 2004
 The tax rate applicable is 30%.

Required:
a) Revenue accounts for both marine and fire insurance for the year ended 31 March 2004.
b) Profit and loss account for the year ended 31 March 2004.
c) Balance sheet as at 31 March 2004.
SOLUTION
Tengo Insurance Company Ltd
Revenue Account for the year ended 31st March 2004
Marine Fire
Sh. “000” Sh. “000”
Net Premiums
Direct premium received 4500 3500
Reinsurance premium received 1200 800
Reinsuarance premium paid (800) (500)
Premiums outstanding b/d (900) (700)
Premiums o/s c/d 1500 700
Net premium received 5500 3800
Add: un earned premiums
Add: unearned premiums b/d 4800 2500
Less: unearned premiums c/d (5500) (1900)
Net premium 4800 4400
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Net Claims incurred
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Claims paid 2470 1800
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Claims outstanding b/d (800) (540)
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Claims intimated & outstanding c/d 750 480
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Legal cost 180 130
Survey expenses 320 ____
2920 1870
Net Expenses Incurred
Commissions: Ceded (40) (25)
Accepted 60 40
Bad debts 170 120
Management expenses 650 580
Underwriting profit / loss 840 715
1040 1815

Income Statement for the year ended 31st March 2004
Sh. “000” Sh. “000”
Incomes:
Underwriting profit: Marine 1040
; Fire 1815
Investment income 280
Less: General expenses 3135
Audit fees 240
Directors fees 495
Dep. Of fixed assets 905 (1640)
Less: Tax (448.5)
Profit after tax 1046
Less: Dividends: Proposed dividends (300)
Retained profit for the year 746.5
Retained earnings b/d 450
Retained profit c/d 1196.5

Statement of Financial Position for the year ended 31st March 2004
Sh. “000” Sh. “000”
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Assets
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Non-Current Assets
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Freehold property 4200
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Motor vehicle 3500
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Machinery and equipment 1500
Furniture 1300
Investment in shares 1400
11900
Current Assets
Commission ceded: Marine 40
Fire 25
Premiums o/s c/d: Marine 1500
Fire 700
Sundry debtors 730
Bank balance and cash in hand 110 3105
Total Assets 15,005
Capital + Liabilities
Capital and Reserves
Share premium 1000
Retained earnings old 1196.5
Owner’s equity 5196.5

Liabilities
Current liabilities
Commission Accepted : Marine 60
Fire 40
Claims o/s: Marine 750
Fire 480
Unearned premiums c/d: Marine 5500
Fire 1900
Proposed dividends 300
Corporation tax payable 448.5 9,808.5
Total equity and liabilities 15,005
BANKS
Bank means a company which carries on, or proposes to carry on, banking business in Kenya but
does not include the Central Bank;
Banking business means -
a. The accepting from members of the public of money on deposit repayable on demand or at
the expiry of a fixed period or after notice;
b. The accepting from members of the public of money on current account and payment on and
acceptance of cheques; and
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c. The employing of money held on deposit or on current account, or any part of the money, by
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lending, investment or in any other manner for the account and at the risk of the person so
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employing the money.
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Accounts and Audit
Financial Year
 The financial year of every institution shall be the period of twelve months ending on the 31st
December in each year.
 Where the financial year of an institution is different from that prescribed in this section, the
institution shall, within twelve months of the commencement of this section, change its
financial year to comply with the provisions of this section.
Form of accounts.
 All entries in any books and all accounts kept by an institution shall be recorded and kept in
the English language, using the system of numerals employed in Government accounts.
 The Central Bank may, at any time, issue directions to an institution requiring it to maintain
such books, records or information, in addition to any books, records or information then
already maintained by it, as the Central Bank may consider to be necessary.

Accounts to be exhibited
- Every institution shall exhibit throughout the year in a conspicuous position in every office
and branch in Kenya a copy of its last audited balance sheet and last audited profit and loss
statements (which shall be in conformity with the minimum financial disclosure requirements
prescribed from time to time by the Central Bank and shall include a copy of the auditor’s
report) together with the full and correct names of all persons who are officers of the
institution in Kenya, and shall, within three months of the end of each financial year, cause a
copy of the balance sheet and last audited profit and loss statements for that financial year to
be published in a national newspaper.
Submission of accounts to the Central Bank

- An institution shall, not later than three months after the end of its financial year, submit to
the Central Bank an audited balance sheet, showing its assets and liabilities in Kenya, and an
audited profit and loss account covering its activities in Kenya together with a copy of the
auditor’s report, in the prescribed form.
- An institution which is incorporated outside Kenya, and an institution which is incorporated
in Kenya and maintains subsidiaries or branches outside Kenya, shall submit to the Central
Bank, with the balance sheet and accounts referred to in subsection (1), an audited balance
sheet and an audited profit and loss account of the institution as a whole.
Appointment of auditors
- Every institution shall appoint annually an auditor qualified under section 161 of the
Companies Act and approved by the Central Bank, whose duty it shall be to audit and make a
report upon the annual balance sheet and profit and loss account which are to be submitted to
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the Central Bank under section 23 (1).
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- -If an institution fails to appoint an approved auditor under subsection (1), or to fill any
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vacancy for an auditor which may arise, the Central Bank may appoint an auditor and fix the
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remuneration to be paid by the institution to him.
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- The Central Bank may require an auditor to undertake the following duties in addition to
those provided under subsection (1) –
a. to submit such additional information in relation to his audit as the Central Bank may
consider necessary;
b. to carry out any other special investigation; and
c. to submit a report on any of the matters referred to in paragraphs (a) and (b);
d. And the institution concerned shall remunerate the auditor in respect of the discharge
by him of all or any of such additional duties.
- If the auditor of an institution, in the course of the performance of his duties under this Act, is
satisfied that -
a) there has been a serious breach of or non-compliance with the provisions of this Act,
the Central Bank of Kenya Act or the regulations, guidelines or other matters
prescribed by the Central Bank;
b) a criminal offence involving fraud or other dishonesty has been committed by the
institution or any of its officers or employees;
c) losses have been incurred which reduce the core capital of the institution by fifty per
cent or more;
d) serious irregularities have occurred which may jeopardize the security of depositors or
creditors of the institution; or
e) he is unable to confirm that the claims of depositors and creditors of the institution are
capable of being met out of the assets of the institution, He shall immediately report
the matter to the Central Bank.
- The Central Bank may arrange trilateral meetings with an institution and its auditor from time
to time, to discuss matters relevant to the Central Bank’s supervisory responsibilities which
have arisen in the course of the statutory audit of the institution including relevant aspects of
the institution’s business, its accounting and control system and its annual accounts.
- If an auditor of an institution fails to comply with the requirements of this Act, the Central
Bank may remove him from office and appoint another person in his place.
- A person shall not be qualified for appointment as an auditor of an institution if he is -
a) a director, officer or employee of that institution; or
b) a person who is a partner of a director, officer or employee of that institution; or
c) a person who is an employer or an employee of a director, officer or employee of that
institution; or
d) a person who as a director, officer or employee of an associate of that institution; or
e) a person who, by himself, or his partner or his employee, regularly performs the duties
of secretary or book-keeper for that institution; or
f) a firm or member of a firm of auditors of which any partner or employee falls within
the above categories.
Change of auditors to be notified to the Central Bank.

- No institution shall remove or change its auditor except with the prior written approval of the
Central Bank.
- An auditor of an institution shall forthwith give written notice to the Central Bank if he -
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 resigns from office;
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 does not seek to be re-appointed; or
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 Includes in his report or draft report on the institution’s accounts any qualification
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which did not appear in the accounts for the preceding financial year.
- An institution aggrieved by a decision of the Central Bank under subsection (1) may appeal
to the Minister within 14 days.
- The decision of the Minister under subsection (3) shall be final.

Bank Accounts
Profit and loss account at a bank
Profit and loss account for the year ended (date)
Current year Previous
Sh. ‘000’ Sh. ‘000’ Sh. ‘000’ Sh. ‘000’
Income
Interest on advances (loan, overdrafts, etc) x x
Interest on government securities x x
Interest on placement and bank balances (with other)
Less:
Interest paid on deposits (fixed and savings) x x x
Interest paid on other bank borrowings x x x x
Net interest income x (x) (x)
Other incomes
· Dividend income x x
· Fee and commission on income x x
· Net gain from dealing securities x x
· Discounts on bills purchased x x
· Net gain arising from investment securities x x
· Net gain arising from foreign currency dealings x x
· Profit on disposal of collaterals
Operating income
Other expenses
Fee and commission expense x x
Net losses arising from dealing with securities x x
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Net losses arising from foreign currency dealings x
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Loss on disposal of collaterals x
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General admin. Expenses:
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· Staff costs x x
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· Director’s emoluments as directors x x
· Director’s emoluments as executives x x
· Equipment and property expenses x x
- Depreciation x x
· Auditor’s remuneration x x
· Contribution to deposit protection fund (DFF) x x
· Operating lease rentals x x
· Legal and professional fees x x
Other operating expenses x x
x
Other operating before provisions (x) (x)
Movement in provision for bad and doubtful debts x x
Profit before tax x x
Taxation x x
Transfer to reserves x x
Dividends to shareholders x x
Retained profit for the year x (x) (x)
Retained profit B/F x x
Retained profit C/F x x
x x

Interest on government securities includes – Interest earned on Treasury Bills and Treasury Bonds,
interest may also be earned on CBK deposits.
Format for balance sheet.

Balance sheet as at (date)
Current year Previous
Sh. ‘000’ Sh. ‘000’ Sh. ‘000’ Sh. ‘000’
Assets
Cash in hand and with CBK x
Placements and balances due from other banks x x
Investment in government securities x x
Investment in securities for dealing purposes (shares,
debentures, etc) x x
Advances: Loans x x
 Overdrafts x x
 Cash credits x x
Bills: Bills discounted and purchased x x
Bills receivable and for collection x x
Acceptance, endorsements and other obligations x x
Accrued: Interest and other sundry debtors x x
PPE: Premises x x
 Furniture x x
 Equipment x x
 Vehicles x x
xx xx
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Liabilities
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Deposits from other banks x x
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Customer deposits:
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 Savings deposits x x
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 Current and demand deposits x x
 Fixed deposits x x
 Negotiable CDs x x
Bills payable x x
Bills for collection x x
Acceptances, endorsements and other obligations x x
Other liabilities:
Tax payable x x
Interest payable and other obligations x x
Other payable x x
Interest payable and other accruals (exp) x x
Proposed dividends x x
Rebate on bills discounted x x
TOTAL LIABILITIES (xx) (xx)
NET ASSETS xx xx
Share capital x x
Reserves x x
Retained profits x x
Shareholders’ funds xx xx
Notes on the balance sheet: (to be disclosed below balance sheet)

i) Contingent Liabilities
Sh. ‘000’ Sh. ‘000’
Acceptance and letters of credit x x
Guarantees and performance bonds x x
Liability on bills of exchange discounted x x
ii) Commitments: In respect of forward exchange contracts

Sh. ‘000’ Sh. ‘000’
Sale x x
Purchase x x
In respect of operating leases x x
Capital expenditure contracted for x x
ILLUSTRATION
QUESTION
The following trial balance was extracted from the books of Regional Commercial Bank Ltd as at 31
March 2006:
Sh.’000’ Sh.’000’
Property and equipment 14,427
Interest on loans and advances 8,395
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Interest on customers’ 5,308
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Customers deposits 82,230
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Shares capital 10,000
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Revaluation reserve 2,480
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Staff costs 2,184
Borrowed funds 3,520
Directors emoluments 645
Depreciation on property and equipment 815
Other interest income 430
Specific provision for doubtful debts 2,750
Interest on government securities 4,768
Other operating expenses 1,630
Repair and maintenance 210
Printing and stationary 278
Deposits and placements due from banking
institutions 8,560
Loans and advances to customers 67,655
Deposits and placements due to other
banking institutions 6,410
Interest on deposit and placements
with other banking institutions 3,800
Other interest expense 314
Interest paid on deposits and
placements from other banking institutions 1,280
Cash and balances with the

Central Bank of Kenya 3,630
Interim dividend paid 400
Bad debts written off 279
Share premium 3,000
Fees and commission income 764
Dividend income 408
Investment in securities 5,460
Miscellaneous accruals 140
Government securities 13,200
Retained profit (1 April 2005) 2,480
Other assets 5,300
131,575 131,575
Additional information :
1. An analysis of the debtors balances as at the end of the year showed that an additional
provision of sh.1,850,000 for non-performing loans should be made.
2. A provision of sh.1,050,000 should be made for tax on the profit for the year ended 31 March
2006.
3. Interest accrued and not accounted for in the books as at 31 March was as follows:
 On loans and advances sh.642,000
 On customers’ deposits sh.448,000
4. The directors of the bank have proposed a final dividend of 6%.
Required:
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i. Profit and loss account for the year ended 31 March 2006
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ii. Balance sheet as at 31 March 2006.
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SOLUTION
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Regional Commercial Bank Ltd
Income Statement for the year ended 31st March 2008
Sh. Sh.
Interest Income
Interest on loan & advances (8395 + 642) 9037
Interest on government securities 4768
Interest on deposits and placement with other banking institutions 3,800
Other interest income 430
Gross interest income 18,035
Less: Interest Expenses
Customers deposits 5308
Add: Accrued 448
Deposits and placements from other banks
Other interest expenses 5756
Net interest income 1280 (7,350)
Non-Interest Income 314 10,685)
Fees and Commission income
Dividend income
Total income 764
Less: Non-Interest Expenses 408
Staff costs 11,857

Director’s emoluments 2184
Dep. On property and equipment 645
Specific provisions for doubtful 815
Repairs and maintenance 1850
Printing and stationery 210
Bad debts written off 278
Other operating expenses 279
Operating profit 1630 7891
Less: Taxation 3966
1050
Less: Dividend: Interim 2916
: Proposed 400
Retained profit 600 (1000)
Add: Retained earnings b/d 1916
Retained profit c/d 2480
4396
Regional Commercial Bank Ltd

Statement of Financial Position as at 31st March 2008
Sh. ‘000’ Sh. ‘000’
Assets:
Cash and balances with the central bank of Kenya 3630
Government securities 13200
Deposits and placements due from other banking institutions 5460
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Loans and advances to customers 67,655 8560
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Less: Provision (4600) 63,055
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Accrued interest and advances 642
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Property and equipment 14427
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Other assets 5300
114 274
Capital + Liabilities:
Shareholder’s equity
Share capital 10,000
Revaluation reserve 2480
Share premium 3,000
Retained earnings 4396
19,876
Liabilities
Customer deposit 32230
Accrued interest on customer deposits 443
Miscellaneous accruals 140
Deposit and placements due to other banks 6410
Borrow funds 3520
Tax 1050
Proposed dividends 600
94393
Total equity and liabilities 114 274

PROFESSIONAL FIRMS
A profession is a recognized specialized area of study involving training and examination by a

recognized examining body for a long period of time.
A profession is different from a vocation which is a talent, either acquired in-born or in practice.
Most profit professions do not keep proper accounts simply because they don’t have time or their
transactions are very few and they can easily memorize them.
A professional should keep accounts that will assist him in the determination of profits and losses
and the financial position of the business.
Most professionals are regulated by their various professional bodies. These bodies give regulations
to the professional and some of these regulations are:
i. Treatment of client’s funds.
ii. Conduct with professional colleagues and clients
iii. Annual reporting
iv. Annual membership and renewal contributions
Professionals are required to maintain books and that include:
a. Cash book: Records all cash transactions involving the profession
b. Stock register: Records all items- purchased for use in the conduct of the profession and not
meant for sale. Goods purchased for resale e.g. retired doctor might buy goods for resale.
c. Income and expenditure: It’s like P&L account in merchandise. This will assist in the
representation.
a. Accounting for lawyers

They should open a client account to record transactions on behalf of the clients.
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Separate records of receipts and payments may also be kept for office in the client.
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The lawyer would also open a separate client account in the clients name to record the following:
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i. Deposits and withdrawals on behalf of the clients.
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ii. Payment of expenditure on behalf of the client.
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iii. Withdrawals of professional fee as authorized by the client.
iv. Money required for payment to the client or payment authorized by the client.
v. Money to be transferred to a separate account by error
vi. Money to be transferred to a separate account.
vii. Money required towards payment of debt due to the advocate from the client.
NB: A bill of cost journal may also be maintained by lawyers on behalf of the clients and main
purpose is to record expenses incurred by lawyers on behalf of the clients.
Terminologies:
1. Work – in – progress
This constitutes the value of uncompleted work on behalf of the client not yet charged to the client.
In order to determine the fees charged for the period (total income), the closing Work-In-Progress
will be added while the opening Work-In-Progress subtracted from fees/ cost account.
2. Disbursements
These are payments made by the lawyers on behalf of the clients who have sufficient funds in their
accounts.

Journal Entries
1. To record cash received on behalf of the client:
Dr. Cashbook (Client’s column)
Cr. Clients a/c (Client’s column)
2. To record payment of expenses on behalf of clients:
a. With sufficient funds:
Dr. Client’s a/c (Client’s column)
Cr. Cash Book (Client’s column)
b. With insufficient funds:
Dr. Client’s a/c (office column)
Cr. Cash Book (office column)
3. With the office expenses paid:
Dr. Respective expense account / P&L account
Cr. Cash Book (Office Column)
4. To record fees charged for professional services rendered
a)
Dr. Client’s a/c (Office Column)
Cr. Fees/ Costs a/c
b) Close the fees/ costs account to P&L account
Dr. Fees/ Costs a/c
Cr. P&L a/c
5. To record professional fees and disbursements received from the clients:
Dr. Cash Book (office column)
Cr. Client’s a/c (office column)
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6. To record transfers of funds from the clients’ account to office account on authority from the
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clients. Thus:
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a. Record the transfer in cash book
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Dr. Cash Book (office column)
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Cr. Cash Book (client’s column)
b. Then record the contra in the client’s account
Dr. Client’s account (client’s column)
Cr. Client’s account (office column)
ILLUSTRATION
Juma and Company Advocates is a law firm operating in an upcountry town.

Provided below is the balance sheet of the firm as at 30 June 2003.
Juma and Company Advocates

Balance sheet as at June 2003
Sh. ‘000’ Sh. ‘000’
Assets
Non-current assets
Equipment 800
Furniture 350
Library books 280 1,430

Current assets
Work-in-progress 210
Stationary 140
Debtors for fee and disbursements 330
Cash at bank:
Office 300
Client 250 1,230
2,660
Capital 1,800
Loan 500
Current liabilities
Creditors 110
Clients- for money held on their behalf 250 360
2,660
The following transactions were carried out by Juma and Company Advocates in the year ended 30
June 2004.
1. 1.Received Sh. 850,000 on behalf of their clients.
2. 2.Spent the amounts shown below on behalf of clients who had sufficient cash held by the
firm:
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Sh. ‘000’
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Purchase of equipment 260
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Payment of rent 130
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Payment of repair costs 80
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3. Purchased new equipment for office use for Sh. 400,000 and paid Sh. 100,000 cash, the
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balance remaining as a loan.
4. Spent Sh. 350,000 on the purchase of land on behalf of a client who had a credit balance of
Sh. 120,000 with the firm.
5. Charged clients Sh. 1,050,000 for services rendered in the year ended 30 June 2004.
6. Received Sh. 680,000 from clients settlement of amounts due for services rendered. The firm
received authority from clients to transfer Sh. 240,000 from the clients account to the office
account in the settlement of amounts due to the firm.
7. The following expenses were incurred by the firm in the year ended 30 June 2004, all were
settled in cash:
Sh.
‘000’
Rent 120
Salaries and wages 360
Office expenses 90
Interest on loan 30
Loan repayment 300
8. During the year ended 30 June 2004, the firm received Sh. 480,000 from the clients as
settlement of disbursements made on their behalf by the firm.
9. Purchased library books worth Sh. 160,000 and paid for them in cash.
10. Purchased stationery on credit for Sh. 210,000 and paid the creditors a total of Sh. 240,000 in
the year ended 30 June 2004.
11. Drawings for personal use in the year ended June 2004 amounted to Sh. 180,000.
12. On 30 June 2004, stationery in the store valued at Sh. 160,000. On the same date, work-in-
progress not yet charged to clients was valued at Sh. 350,000.
The firm provides depreciation at the following rates based on books value:
Equipment - 5% per annum
Furniture - 10% per annum
Library books - 12.5% per annum
Required:
(a) Profit and loss account for the year ended 30 June 2004.
(b) Balance sheet as at 30 June 2004
SOLUTION
Cash book
Details Office Client ‘000’ Details Office ‘000’ Client ‘000’
‘000’
Bal. b/d 300 250 Purchase of equ. - 260
Client account. - 850 Rent - 130
Receipts clients 680 - Repair costs - 80
Funds transfer (Contra) 240 - Equipment 100 -
Client’s account Disburse 480 - Land 230 120
Bal. c/d 110 _ Fund transfer© - 240
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Rent 120 -
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Salaries & wages 360 -
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Office expenses 90 -
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Interest on loan 30 -
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_ Loan repayment 300 -
Library books 160 -
Creditors 240 -
Drawings 180 -
__ Bal. c/d ___ 270
1810 1100 1810 1100
Client’s Account
Details Office Client Details Office Client
‘000’ ‘000’ ‘000’ ‘000’
Bal. b/d 330 260 Bal. b/d - 250
Equipment - 130 Cash book - 850
Rent - 80 Cash book 680 -
Repair costs - 120 Fund, transfer 240 -
Land 230 - & 480 -
Fees / costs 1050 240 Cash book 21 __
& Bal. c/d - 270 Bal. c/d
_____ ____
1610 1100 1610 1100

Equipment Account
Sh. “000” Sh. “000”
Bal. b/d 800 Bal. c/d 1200
Bank 400 _____
1200 1200
Fees / Cost Account

Sh. “000” Sh. “000”
Profit and Loss 1050 Clients 1050
Creditor’s Account
Sh. “000” Sh. “000”
Cash book 240 Bal. b/d 110
Bal. c/d 80 Stationery 210
320 320
Drawings Account
Sh. “000” Sh. “000”
Bal. c/d 180 Cash book 180
Loan Account
om
Sh. “000” Sh. “000”
a.c
ny
Cash book 300 Bal. b/d 500
ke
ea
Bal. c/d 500 Equipment 300
m
.so
800 800
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Library Books Account
Sh. “000” Sh. “000”
Bal. b/d 280 Bal. c/d 440
Cash 160 ___
440 440
Stationery Account
Sh. “000” Sh. “000”
Bal. c/d 140 P & L 190
Creditors 210 Bal. c/d 160
350 350

Juma & Co. Advocates
Profit and Loss Account for the year ended 30th June 2004
Sh. “000” Sh. “000”
Income
Fees / costs 1050
Add: closing w/p 350
Less: opening w/p (210)
Total income 1190
Less: expenditure
Dep. Equipment (5% x 1200) 60
Furniture (10% x 350) 35
Library bonuses (12.5% x 440) 55
Loss of stationery 190
Rent 120
Salaries and wages 360
Office expenses 90
Interest on loan 30 (940)
Net profit 250
Juma & Co. Advocates

Profit and Loss Account for the year ended 30th June 2004
Sh. “000” Acc. Dep N.B.V
Sh. “000” Sh. “000”
om
Non-current assets:
a.c
Equipment 1200 60 1140
ny
ke
Furniture 350 35 315
ea
m
.so
Library books 440 55 385
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1840
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Current assets
Works in progress 350
Stationery 160
Debtors for fees & disbursement 210
Cash at bank: clients 270 990
Total assets 2830
Capital + liabilities
Capital 1800
Less: Drawings (180)
Add: Net Profit 250
1870
Liabilities
Loan
Current liabilities 500
Creditors
Bank overdraft 80
Clients – for money held on behalf 110
Total equity & liabilities 270 960
2830

INDEPENDENT LOCAL AND FOREIGN BRANCHES
BRANCH ACCOUNTING
A branch is a segment of or a component of a business situated/ located in the same town, in the
same country or different country with the head office. Branches do not have share capital or
contributed capital. They are owned by the businesses which establish them.
There are there types of branches:
a. Dependent branches
These are branches which don’t maintain their own accounting records. They are maintained in the
Head Office.
b. Independent branches
Are branches that maintain their own accounting records like any other independent business only
that they do not have share capital or contributed capital; instead they have what is referred to as
head office current account which shows the net investment by the head office in the branch.
c. Foreign branches
Are branches which operate in other countries other than the country of the head office (main
business)
They may be either dependent or independent branches.
Dependent branches
Are small branches whose main activity is to sell the goods supplied by the head office. They are
om
a.c
therefore referred to as selling agents.
ny
ke
They do not maintain accounting records and the transactions between them and head office is
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recorded by the head office.
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As mentioned above, they sell goods supplied by head office and so it is important to determine the
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value at which such goods sent are recorded/ invoiced by the head office.
There are two alternative ways of invoicing/ recording goods sent to branches. These are:
i. At cost
ii. At cost plus mark up
iii. At selling price
The method used to record the goods sent to branches determines the records maintained by the head
office.
Ledger accounts maintained where goods are sent to branch (at cost)
a. Branch stock/ inventory account

This account is used to record goods sent to the branch, sales made by the branch, returns by the
branch to head office and by customers to branch.
-Abnormal losses e.g. goods stolen, lost, cash stolen, and normal losses.
-Branch inventory / closing stock
b. Good sent to branch account

This account is used to record the cost of the goods sent by the head office to the branch and the cost
of goods returned by the branch to the head office.
c. Branch debtors account
This is only maintained where the branch is permitted to sell goods on credit to the local customers.
d. Branch creditors account

This is maintained where the branch is allowed or permitted to purchase goods locally from
appointed suppliers.
e. Branch expenses account

Used to record expenses of the branch.
f. Branch trading P&L account

Used to determine the profit or loss of the branch.
Journal Entries
1. Goods sent to branch
Dr. Branch stock a/c
Cr. Goods sent to branch a/c
2. Returns of goods to head office by branch
Dr. Goods sent to branch a/c
Cr. Branch stock a/c
3. Sales made by the branch
Dr. Cashbook cash/ bank a/c or debtors a/c
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a.c
4. Goods stolen at the branch
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Dr. Goods stolen account/ goods lost/ abnormal loss a/c
ea
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.so
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5. Goods returned by customers
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Cr. Branch debtors’ a/c
6. Cash stolen in the branch
Dr. Cash stolen a/c
7. Reduction of price of goods in the branch
Dr. P&L account/ cost stock a/c
8. Transfer of goods from one branch to another branch
Dr. Branch stock a/c of the receiving branch
Cr. Branch stock a/c of the sending branch
9. Balancing the goods sent to Branch a/c
The balance in this account represents goods sent to the branch and that remained in the branch for
sale.
This balance should be transferred to the purchase account.
Cr. Purchases a/c

10. Branch closing stock
Any closing stock in the branch should be shown as a balance carried down (Bal c/d) on the credit
side of the branch stock a/c
The balance which remains in the branch stock account is the branch gross profit. Therefore, branch
stock a/c where goods are sent to the branch as cost acts as a branch trading account.
ILLUSTRATION 1
Invoicing of goods at cost

Nair Matt Ltd operates a branch at Mombasa. The following information relates to Mombasa branch
for the year ended 31st December 2010.
Sh.
st
Opening balances 1 January 2010
Branch inventory (at cost) 550,000
Branch debtors 400,000
st
Closing balances 31 December 2010
Branch inventory (at cost) 700,000
Transactions for the year
Goods sent by head office to branch (at cost) 6,000,000
Goods returned by branch to head office (at cost) 150,000
Cash sales 2,500,000
Credit sales 7,000,000
Goods stolen at branch at cost 50,000
om
Cash sales stolen at branch (included in other sales) 35,000
a.c
ny
Returns from branch debtors (at selling price) 300,000
ke
ea
Cash received from branch debtors 6,300,000
m
.so
Discount allowed to debtors 120,000
w
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Bad debts written off 75,000
Expenses of branch paid by head office. 780,000
Required
i) Branch inventory account
ii) Goods sent to branch account
iii) Branch debtors account
iv) Branch trading, profit and loss account
SOLUTION;
Branch Stock Account
Shs. Shs.
Bal b/d 550,000 Goods sent 150,000
Goods sent to branch 600,000 Cash sales 2,500,000
Debtors 300,000 Debtors – sales 7,000,000
Profit & Loss Account Goods stolen 50,000
Gross profit 3,550,000 Bal c/d 7,000,000
10,400,000 10,400,000

Goods sent to branch Account
Shs. Shs.
Branch stock 150,000 Branch stock account 6,000,000
Purchases 585,000 ______
6,000,000 6,000,000
Branch debtors Account

Shs. Shs.
Bal b/d 400,000 Branch stock 300,000
Branch 7,000,000 Cash 6,300,000
Discount allowed 120,000
Bad debts 75,000
_______ Bal c/d 605,000
7,400,000 7,400,000
Goods stolen Account

Shs. Shs.
Branch stolen 50,000 Profit and loss 50,000
Cash stolen Account

Shs. Shs.
Branch stock 35,000 Profit and loss 35,000
om
a.c
ny
Branch Trading Profit and Loss Account
ke
ea
Sales – Cash sales 2,500,000
m
.so
w
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Less: Return inwards (300,000) 6700,000
Total sales 9,200,000
Less: cost of sales
Opening stock 550,000
Add: goods sent 6,000,000
Less: Returns to head office (150,000) 5850,000
Goods available for sales 6400,000
Less: goods stolen (50,000)
Closing stock (700,000)
Cost of sales 5650,000 (5650,000)
Gross Profit 3,550,000
Less: Expenses
Goods stolen 50,000
Cash stolen 35,000
Bad debts 75,000
Branch expenses 780,000 ______
Branch profit 2,490,000

Ledger Accounts Maintainted Where Goods Are Sent At Cost Plus Mark Up Or At Selling
Price
Other than the Head Office sending the goods to branch at cost, it may add a profit to the cost and
send the goods at cost plus profit.
The profit is usually a certain percentage on the cost of goods. (mark-up) or a certain percentage on
the selling price of the goods (margin).
When recording it is important to split the invoice price into cost and profit. This profit charged is
recorded separately into an account referred to as branch mark-up account/ branch adjustment
account/ provision for unrealized profit account.
This account is used to determine the realized gross profit and the unrealized profit on branch
closing stock at the end of the period.
The ledger accounts maintained include:
i. Branch stock account
ii. Goods sent to branch account
iii. Branch mark-up account
iv. Branch debtors account
v. Branch creditors account
vi. Branch expenses account
vii. Branch profit and loss account
Possible transaction between the branch and head office

1. Goods sent to branch
Dr. Branch stock a/c – at invoice price
Cr. Goods sent to branch at cost
om
a.c
Cr. Branch mark-up a/c – at mark-up
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2. Goods returned to head office by the branch
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.so
Dr. Goods sent to branch at cost
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Dr. Mark-up a/c – at mark-up
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Cr. Branch stock a/c – at total invoice price
3. Sale of goods by branch
Dr. Branch debtors account / cashbook
Cr. Branch stock account
4. Returns of goods by branch debtors to the branch
Cr. Branch debtors
5. Returns of goods by branch debtors direct to head office
Dr. Goods sent – at cost
Dr. Branch mark-up a/c – mark-up
Cr. Branch debtors – total value
6. Increase in price of goods at the branch
Cr. Branch mark-up with the increase
7. Transfer of goods to other branches
Dr. Branch mark-up a/c – at mark-up
Cr. Branch stock a/c – at invoice price
8. Receipt of goods from other branches
Dr. Branch stock a/c – at invoice price
Cr. Branch mark-up – at mark-up
9. Goods stolen at the branch
Dr. Goods stolen a/c at cost
Dr. Branch markup - at mark-up
Cr. Branch stock a/c – at invoice price
10. Cash sale stolen
Dr. Cash stolen a/c
11. Reduction in price/ mark down of goods in the branch
If price of goods is reduced at the branch, it is important to determine whether the new selling
price is still above the cost of the good or it is below the cost of the goods.
If the new selling price is still above the cost or at cost, the reduction is only an elimination of the
profit that could have been earned on such goods thus with the reduction.
Dr. Branch mark-up a/c
If the price of goods is reduced below the cost, then
a. With the reduction from the original selling price to the cost of the goods.
(This is an elimination of the profit that would have been earned on sale of the goods)
b. With the reduction from cost to the new selling price which is below the cost,
Dr. P&L a/c
(This is a loss to the company)
om
a.c
12. Balancing the goods sent to branch account
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The balancing figure in the goods sent to branch account should be transferred to the purchases
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account/ goods available for sale a/c.
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Cr. Purchases account/ goods available for sale.
13. Balancing the branch stock a/c
Where goods are sent to the branch at selling price, the closing stock in the branch is not given
and it is determined as a balance carried down.
Where it is given, it should be shown as a balance carried down on the credit side of the branch
stock account. Then, the branch stock account may or may not balance.
If it does not balance, and the balancing figure is on the debit side, the balance is taken as a
normal stock difference which may arise as a result of the branch selling goods at a price higher
than the invoice price thus with this difference;
Cr. Branch mark-up a/c
If it does not balance, and the balancing figure is on the credit side, this balance may be either a
normal or abnormal loss.
If it is a normal loss:
If it is an abnormal loss
Dr. Branch mark-up a/c - with mark-up
Dr. Abnormal loss a/c - cost
Cr. Branch stock a/c - at invoice value price.
14. Balancing the branch mark-up a/c
The mark-up on branch closing stock/ unrealized profit on branch closing stock should be
determined and be shown as a balance carried down on the debit side of the branch mark-up a/c.
The branch mark-up a/c is then balanced and the balancing figure represents the branch gross profit
realized during the period.
Illustration Question
Tamim Gowns is a fashionable ladies-wear chain of clothing stores, started in Kakamega but not
present in all the major towns in Kenya and in Kampala, Uganda and Dar-es-salaam, Tanzania. The
accounts of all the branches are maintained in the books of the head office, now situated in Nairobi.
The figures below that refer to goods are stated at selling prices. The following figures to
transactions carried out by the Mombasa branch in the year ended 31 May 2001
Sh. ‘000’
Opening stock at commencement of the year 5,280
Goods received from head office 116,728
Goods received from Voi branch 560
Goods sent to Taita branch 720
Goods returned to Mombasa branch by credit customer (normal goods) 880
Goods returned to Voi branch by Mombasa credit customer (approved
by) Head office: All these goods had been marked up by 15% 322
Goods returned by Mombasa branch to Head office 1,360
om
Cash sales 52,800
a.c
ny
Cash stolen from Mombasa branch on 12 December 2000 240
ke
ea
Goods stolen from Mombasa branch on 12 December 2000 960
m
.so
Credit sales (mainly to boutiques in beach hotels) 61,686
w
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Mombasa branch administrative expenses. 12,802
Mombasa branch distribution costs 17,072
1. The Mombasa branch is managed by a particularly competent group of women. Other than the
thefts stated above, there were no shortages or surpluses of goods or cash during the year.
2. Demand for certain casual wear has been high during the year; to prevent stock-outs from
occurring, these lines are normally marked up in price using a formula linked to the number of
items sold in the preceding week. Included in the opening stock were goods with a normal selling
price of sh 800,000 but which had been marked up by a further 10% of this price. The normal
selling price of the goods is head office cost plus 60% of cost. All these marked-up goods were
sold in the year. Goods with a normal selling price of sh 1,200,000 had been marked up by an
additional 15%. Three quarters of these goods had been sold by 31 May 2001.
3. In the income statements produced for management, cash stolen and goods stolen are shown as
separate line items.
Required
Prepare the Mombasa Branch Stock Account and the Mombasa Branch Mark-up Account in the
books of the Head Office, and the Memorandum Trading and Profit and Loss Account for the
Mombasa Branch for the year ended 31 May 2001.
SOLUTION;
Branch Stock Account
Sh. “000” Sh. “000”
Bal. b/d 5280 Goods to Taita 720
Goods sent to Branch 116728 Returns to h/o 1360
Goods from voi 560 Cash sales 52800
Returns inward by debtor 880 Cash stolen 240
Additional M-up Good stolen 960
(1120 x 15%) 168 Credit sales 61686
____ Bal. c/d 5850
123616 123616
Workings
1. Opening stock
Selling price(sp) Mark-up Cost
Normal goods 4400 1650 2750
Normalized goods 800 300 500
Anomaly: (10% x 800) 80 80 ____
Total 5280 2030 3250
2. Mark-up on Returns by debtors to voi

New selling price = Sh 322
Normal S.P + 15% Normal selling price = New selling price.
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a.c
ny
Let normal selling price be x
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ea
m
.so
w
Therefore x + 0.15x = 322
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322
= = ℎ. 280
1.15
Mark-up= 280 + (280 15%) = 147
Branch Mark-Up Account

Sh. “000” Sh. “000”
M-up on goods to Taita 270 Bal. b/d 2030
M-up on returns by debtor to Voi 147 M-up on goods to branch 43773
M-up on returns to head office 510 M-up on goods from Voi 210
M-up on goods stolen 360 Additional M-up 168
Gross profit 42674
Bal. c/d 2220 _____
46181 46181
Mark-up on closing stock: 5850 + + = ℎ. 2220

Tamim Gowns
Mombasa Branch
Memorandum Income Statement For the year Ended 31st May 2001
Sh. “000” Sh. “000” Sh.
“000”
Sales: Cash banked 52800
Cash stolen 240 53040
Credit 61686
Less: Returns: to Mombasa 880
To Voi 322 (1202) 60484
Total sales 113524
Less: Cost of Sales
Opening stock 72955 3250
Goods sent to Branch. (116728x 5/8) 350
Goods from Voi (560x 5/8) (850)
Less; Returns to head office (1360x 5/8) (450)
Goods Taita (720x 5/8) (175)
By debtor to Voi (322 – 147) 71830
Goods available for sale 75080
Less: Closing stock (5850 –2220) (3630)
Cost of goods stolen (600) (70850)
Branch Gross Profit 42674
Less: Expenses
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Cash stolen 240
a.c
ny
Cost of goods stolen 600
ke
ea
Admin. Expenses 12802
m
.so
Distribution costs 17072 (30714)
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Branch Net Profit 11960
ILLUSTRATION
Invoicing of goods at cost plus mark up
X Ltd deals in electronic goods. The head office is in Nairobi and there are five branches in main
town of Kenya. All purchases are made by the head office and goods are charged to branches at cost
plus 25%. The following information relates to Voi branch for the year ended 31/12/2010.
Sh.
st
Opening balances 1 January 2010
Branch inventory (invoice price) 300,000
Branch debtors 450,000
Closing balances 31st December 2010 250,000
Branch inventory (invoice price)
Transactions for the year
Good sent by head office to branch (invoice price) 2,500,000
Goods returned by branch to head office (invoice price) 200,000
Cash sales 800,000

Return from customers to the branch 100,000
Bad debts written off 20,000
Branch expenses 500,000
Goods stolen at branch 30,000
Cash sales stolen at branch (not included in other sales) 15,000
Cash received from branch debtors 2,450,00
Required
i) Branch inventory account
ii) Branch adjustment / mark up account
iii) Goods sent to branch account
iv) Branch debtors account
v) Branch trading, profit and loss account
Solution;
Notes
Invoice price = Cost + Profit
125% = 100 + 25
Mark-up = = 25% =
Mark-up = = 25% =
om
a.c
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Profit = Mark-up x cost
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.so
Profit = Margin x Selling price
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Goods sent to branch Account
Shs. Shs.
Returns to h/o (200,000 – 40,00) 160,000 Branch stock 2,000,000
Purchases 1,840,000 ______
2,000,000 2,000,000
Branch Inventory Account

Shs. Shs.
Bal. b/d 300,000 Returns to h/o 200,000
Goods sent 2,500,000 Cash sales 800,000
Debtors – returns 100,000 Debtors – sales 2,700,000
Bal mark-up 10,950,000 Goods stolen 30,000
3,995,000 Cash stolen 15,000
Bal c/d 250,000
3,995,000

Branch Mark-up Account
Shs. Shs.
Returns to h/o by branch 40,000 Bal b/d (1/5 x 300,000) 60,000
Goods stolen (1/5 x 30,000) 6,000 Branch stock (1/5 x 2,500,000) 500,000
Gross profit 1,559,000 Branch stock 1,095,000
Bal c/d (1/5 x 250,000) 50,000
1,655,000 1,655,000
Branch debtors a/c

Shs. Shs.
Bal b/d 450,000 Returns 100,000
Credit sales 2,700,000 Discount allowed 30,000
Bad debts 20,000
Cash 2,450,000
Bal c/d 550,000
3,150,000 3,150,000
Goods stolen Account

Shs. Shs.
Branch stock 24,000 Profit and loss 24,000
Cash stolen Account

Shs. Shs.
om
Cash sales 15,000 Profit and loss 15,000
a.c
ny
ke
ea
X Limited
m
.so
Voi Branch Profit and Loss Account
w
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Sales – Cash sales 800,000
Cash sales stolen 15,000
Returns inwards (100,000) 2,600,000
Total sales 3,415,000
Less: cost of sales – (At cost)
Opening stock (300,000 – 60,000) 240,000
Goods sent (2,500,000 – 50,000) = 2,000,000
Less: Returns (200,000 – 40,000) = (160000) 1,840,000
Goods available for sales 2,080,000
Less: goods stolen (30,000 – 60,000) (24,000)
Closing stock (250,000 – 50,000) (200,000)
Cost of sales 1,856,000 1,856,000
Gross Profit 1,559,000
Less: Expenses
Goods stolen 24,000
Cash stolen 15,000
Bad debts 20,000
Branch expenses 500,000
Profit 970,000

INDEPENDENT BRANCHES
These are branches which maintain their own books of accounts. They operate as independent
businesses only that they do not have share capital or contributed capital.
Instead they have what we call Head Office current account which shows the amount the branch
owes the Head Office.
In some cases, these branches transacts with the Head Office. Such transactions include:
i. Receipt of goods from Head Office
ii. Expenses of branch paid by Head Office
iii. Branch customer paying to Head Office etc.
Such transactions are recorded in an account called/ referred to as the current account.
Where the Head Office has several branches, a current account is maintained for each branch. The
current account maintained by Head Office is referred to as branch current account and the current
account maintained by branch is referred to as Head Office current account.
Possible transactions between branch and head office

Books of the Head Office
i. Goods sent to branch
Dr. Branch current account
Cr. Goods sent to branch account at invoice price
ii. Goods returned to Head Office
Dr. Goods sent to branch account
Cr. Branch current account
om
iii. Cash received from branch
a.c
Dr. Cashbook
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ea
m
.so
iv. Cash remitted to branch
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Cr. Cashbook
v. Branch expense paid by Head Office
Cr. Cashbook
vi. Head Office expense paid by branch
Dr. Appropriate expense account / Profit and Loss account
vii. Branch creditors paid by Head Office
Cr. Cashbook
viii. Head Office creditor paid by branch
Dr. Creditors account
ix. Branch debtor paying direct to Head Office
Dr. Cashbook
x. Head Office debtor paying direct to branch
Cr. Debtor account
xi. At the end of accounting period the branch profit/ loss should be transferred to Head Office
books
Cr. Head Office income statement
Books of the branch
1. Goods received from Head Office

Dr. Goods received account
Cr. Head Office current account
2. Returns of goods to Head Office
Dr. Head Office current account
Cr. Goods received account
3. Cash remitted to Head Office
Cr. Cashbook
4. Cash received from Head Office
Dr. Cash account
5. Branch expense paid by Head Office
Dr. Appropriate expense account/ Profit and Loss account
om
6. Head Office expense paid by branch
a.c
ny
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Cr. Cashbook
ea
m
.so
7. Branch creditor paid by Head Office
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Dr. Creditors account
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8. Head Office creditors paid by branch
Cr. Cashbook
9. Branch debtor paying direct to Head Office
Cr. Debtors account
10. Head Office debtor paying direct to branch
Dr. Cashbook cash/ bank account
11. To transfer branch profit
Dr. Income statement
As can be observed from above entries all transactions must pass through the current account thus
the current accounts will have equal business but on opposite sides it but at the end of the period.
Sometimes the current account balances may fail to agree due to the following reasons:
i. Errors made when recording
ii. Goods in transit
iii. Cash in transit
Errors should be corrected.
Goods in transit
These should be recorded in either the branch books or the Head Office books but not in both books.
If recorded in branch books:

Dr. Goods in transit account
If recorded in Head Office books

Dr. Goods in transit account
Cash in transit
These should be recorded in either the branch books or Head Office books not in both books.
If recorded in branch books:

Dr. Cash in transit account
If recorded in Head Office books

Dr. Cash in transit
om
a.c
ny
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The Head Office may have a policy of maintaining the fixed asset ledger such that all fixed assets in
ea
m
.so
the Head Office and in the branch are recorded in the Head Office books. In this case,
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i. When the branch acquires a fixed asset:
Cr. Cashbook (cash/ bank account)/ creditors (credit) account
(In the branch books)
In the Head Office books
Dr. Asset account
Cr .Branch current account
ii. With the depreciation expense on such assets

In the branch books
Dr. Depreciation expense account/ Profit and Loss account
In the Head Office books
Cr. Provision for depreciation account

ILLUSTRATION
United unity ltd operates in Nairobi and has a branch in Webuye. The following transactions were
carried out between the Nairobi head office and the Webuye branch during the year ended 31st
December 20xx.
a) Goods sent to branch ksh 1,500,000.
b) Goods received by branch ksh 1,400,000.
c) Cash remitted to head office ksh 1,300,000.
d) Cash received by head office ksh 1,250,000.
e) Branch current account balance b/d 250,000.
f) Head office current account balance b/d 50,000.
1) The branch made a profit of Ksh 400,000 during the year.
2) During the year the branch paid ksh 100,000 for the head office electricity expense, neither
the head office nor the branch had recorded this transaction.
3) A head office debtor paid to branch ksh 200,000, the head office recorded this transaction
correctly and the branch debited its cash book and credited its debtors.
Required
i) Journal entries to record the above transactions
ii) Branch current account
iii) Head office current account.
.
om
SOLUTION
a.c
Head office books
ny
ke
ea
Dr Cr
m
.so
Shs Shs
w
w
w
1. Branch current account 1,500,000
Goods sent to branch 1500,000
2. Cash / bank account 1250,000
Branch current account 1250,000
3. Branch current account 400,000
Income statement 400,000
4. Electricity account profit /loss 100,000
Branch current account 100,000
5. No entry - -
Branch books
Dr Cr
Shs Shs
1. Goods received account 1,400,000
Head office current account 1400,000
2. Head office current account 1,300,000
Cash / bank account 1,300,000
3. Income statement 400,000

4. Head office current account 100,000
Cash / bank account 100,000
5. Debtors 200,000
Head office books

Branch current Account
Shs. Shs.
Bal b/d 250,00 Cash 1250,000
Goods sent (Branch) 1,500,000 Electricity 100,000
Profit & loss 40,000 Cash in transit 50,000
______ Bal c/d 750,000
2,150,000 2,150,000
Branch Books
Head office current Account
Shs. Shs.
Cash/ bank 1,300,00 Bal b/d 50,000
Cash/ bank 100 ,000 Good received 1,400,000
Bal c/d 750,000 Profit and loss 400,000
______ Debtors 200,000
2,350,000 Goods in transit 100,000
2,350,000
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Head office books
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Dr Cr
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Shs Shs
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1. No entry - -
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2. i) Equipment account 2500
Branch current account 2500
ii) Branch current account 250
Provision for depriciation account 250
3. Branch current account 180
Debtors - 180
4. No entry -
5. Nanyuki branch current account 328
Bungoma branch current account 212
Nakuru branch current account 540
6. No entry
7. Goods sent to branch 606
8. Goods sent to branch account 240
9. Branch current account 1306
Profit and loss account 1360

Branch Books
Dr Cr
Shs Shs
1. Profit and loss account 1680
H.O current account 1680
2. H.O current account 2500
Branch inventory account 2500
3. Debtors account 180
4. Profit and loss account 120
5. No entry
6. Goods in transit account 800
7. H.O current account 606
Goods received 606
8. No entry - -
9. Profit and loss 1300
Statement of corrected profit

Sh ‘000’
Reported loss (1680)
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Add: Overstated purchases 2,500
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Overstated invoices 606
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Less: Insurance premium (120)
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Corrected profit 1306
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Financial Statements of Independent Branches
At the end of the accounting period, the independent branches will prepare a trial balance from
which the financial statements will be prepared. A combined / consolidated financial statement will
be prepared for the business as a whole.
The financial statements are prepared the same way as for other businesses except for the following
terms:
i. Goods sent to the branch

These are reported as values by the Head Office but are not included in the sales of the enterprise as
a whole.
ii. Goods received from Head Office

These forms part of goods available for sale in the branch but should be excluded in the goods
available for sale for the business as a whole.
iii. Goods in transit

Goods in transit are not part of the closing stock of neither the Head Office nor the branch but are
part of closing stock of the enterprise as whole / combined business.

iv. Provision for unrealized profit
Unrealized profit arises where the Head Office sends goods to the branch at cost plus profit and the
goods remains in the stocks of the branch at the end of the period.
Such profits held up in closing stock is considered unrealized until the goods are sold by the branch.
The unrealized profit on closing stock should be provided for i.e.
Dr. Head Office Profit and Loss account
v. Current account
The branch current account balance represents the Head Office investment in the branch, thus should
be carried as an asset of the head office but not for the enterprise as a whole.
Head Office current account balance represents the amount the branch owes the Head Office thus
should be carried as a liability of the branch but not for the enterprise as a whole.
FOREIGN BRANCHES
These are branches situated in foreign countries other than the country of the Head Office.
An entity may carry out foreign activities in two ways:
i. It may have foreign currency transactions
ii. It may have a foreign operation
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i. Foreign currency transaction
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These are transactions which are dominated in foreign currency. They may include:
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a. Buying or selling of goods denominated in foreign currency
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b. Acquisition or disposal of assets denominated in foreign currency
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c. Borrowing or lending of funds in foreign currency
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IAS 21 requires a foreign currency transaction to be initially recognized all in the books using the
functional currency of the entity.
Functional currency is the currency of the primary economic environment in which an entity
operates. This means that the foreign currency transaction must be translated using the foreign
currency exchange rate prevailing as at the date the foreign currency transaction takes place.
At the year end, monetary items which remain unsettled should be retranslated using the rate as at
the date the statement of financial position is prepared i.e. closing rate.
Monetary items settled during the period are translated at the exchange rate prevailing as at the date
of settlement.
Any exchange difference resulting from the translation and the retranslation should be reported to
the income statement during the period it arises.
Exchange difference is the difference arising from translating a given number of units of one
currency at different exchange rates.

ILLUSTRATION
A limited company sold goods to a US based customer for $100,000 on credit on 1/9/29011. On
31/10/2011, a limited company received $60,000 and the balance was received on 20/2/2012.
The year of the company ends on 31st December each year.
The rate of exchange prevailing at different selected dates were as follows:

Date 1 US $ =Ksh. 120
1/9/2011 1 US $ =Ksh. 125
31/10/2011 1 US $ =Ksh. 130
31/12/2011 1 US $ =Ksh. 127
20/12/2012
Required:
i. Journal entries to record the above transaction
ii. Exchange gains/ losses
iii. Receivables account
Journal Entries
1. 1/9/2011
Sales = US$ 100,000 x 120 = ksh. 12,000,000
Dr. Receivables Ksh. 12, 000, 0000
Cr.Sales Ksh. 12, 000, 000
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2. 31/10/2011
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Receipt of cash US $ 60,000 x 125 = Ksh. 7, 500, 000
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Dr. Cash book 7,500,000
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Cr.Receivables 7,500,000
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Exchange difference
On recognition US $ 6,000,000 x 120 = 7,200,000/=
On receipt US $ 60,000 x 125 = 7,500,000/=
Exchange difference (gain) 300,000
This is a realized exchange gain.
Dr. Receivables Account 300,000
Cr.Income statement (P&L) 300,000
3. 31/12/2011
As at the year end,
Receivable $100,000 - $60,000 = $40,000
Retranslated amount = $40,000 x 130 = Ksh. 5,200,000
On recognition= $40,000 x 120 = Ksh. 4,800,000
Exchange difference (gain) 400,000
This is an unrealized gain (but not yet settled) which is reported to P&L.
Dr. Receivable a/c 400,000
Cr. Profit and Loss a/c 400,000

4. 20/2/2012
On settlement of the balance:
Amount received= $40,000 x 127 = ksh. 5,080,000
Retranslated amount= $40,000 x 130 = ksh. 5,200,000
Exchange (loss) (120,000)
This is a realized loss.
Dr. P&L account 120,000
Cr. Receivable 120,000
Receivables A/C
Sales Ksh. Cash Ksh.
P&L (gain) 1,200,000 Bal c/d 7,500,000
Bal b/d 700,000 Cash/ Bank 5,200,000
12,700,000 P&L (loss) 12,700,000
5200000 5,080,000
5,200,000 120,000
5,200,000
ii. Foreign Operations

This is a branch, subsidiary, associate or joint ventures whose activities are carried out in a foreign
country other than the country of the reporting entity.
In order to incorporate the results (the operating results) of a foreign operation. With those of the
reporting entity, the financial statement of the foreign operation must be translated to the currency of
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the reporting entity.
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There are two methods used in the translation of the financial statements of the foreign operation.
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i. Temporal method/ functional currency method
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ii. Closing rate method/ presentation method/ net investment method.
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Temporal / Functional Currency Method
This method is applied where the functional currency of the foreign operation is the same as the
functional currency of the reporting entity.
The functional currency of the foreign operation is the same as that of the reporting entity where:
i. The foreign operation does not operate with a significant degree of autonomy i.e. the
foreign operation operates as an extension of the reporting entity.
ii. The cash flows of the foreign operation directly affect the cash flows of the reporting
entity.
iii. Transactions between the foreign operation and the reporting entity are of high proportion.
The method is operated as follows:

i. Monetary items of the foreign operation are translated at closing rate.
ii. Non-monetary items that are carried at fair value/ revalued amount are translated at
exchange rates as at the date the items were revalued.
iii. Non-monetary items that are carried at cost are translated at exchange rates which were
prevailing as at the date of acquisition.
iv. Depreciation is translated at exchange rates used to translate the related assets.
v. Incomes and expense are translated at exchange rate prevailing as at the date of
transaction (spot rate)
vi. An average rate may be used where the exchange rates does not fluctuate greatly.
vii. Any exchange difference is reported to the income statement as a gain or a loss.
Closing Rate/ Presentation Currency/ Net Investment Method

This method is applicable when the foreign operation operates with a significant degree of autonomy
and cash flows of the foreign operation have no direct effect to the operations of the reporting entity.
This method is applied as follows:
i. Both monetary and non-monetary items are translated at closing rate.
ii. Revenues and expenses are translated at rates which were prevailing as at the date of the
transaction (spot rate)
Any resulting exchange difference is carried out as a separate component of equity (translation
res.)until the disposal of the foreign operation where it is transferred to the
ACCOUNTING FOR COOPERATIVES

A cooperative society is a group of individuals who get together in order to pursue a common
objective. In order to facilitate the attainment of such objective, members contribute resources
normally referred to as member’s shares.
A distinction must be made between member’s shares and member’s loan to the society. This is
because member’sshares attract dividends while member’s loan attracts interest.
The members delegate the day to day running of the society to a management committee which is
charged with the responsibility of steering the member’s objective and accounting for all the
resources received from members and from member’s activity.
The objectives of the members define the primary goals of each cooperative and the kind of books of
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accounts that should be maintained.
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Distinction should be made between the society general and the activities undertaken by the society.
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The activities of each cooperative society is determined by the members produce e.g. coffee, cotton,
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tea etc.
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i) Marketing members produce e.g. coffee, cotton, tea etc.
ii) Trading services where the cooperative society store and sell to members certain products
i.e. animal feeds, farm implements, fertilizers etc.
iii) Training extension and research services which involve the society expanding the members
capacity to enhance their produce.
iv) Loans and advance where members can borrow cash.
The management committee should maintain proper book of accounts which depends on the primary
activity of the cooperative society.
On regular basis the management committee should provide members with information that can help
them to evaluate:
 The fulfilment of members objectives.
 Evaluate the actual financial performance against budgets.
 Evaluate performance of the management committee.
 Evaluate any weaknesses or strengths in the control system.
The information provided to the members should help them to make decisions as to whether to
change the management committee, implement new control procedures or to expand the members
activity. Such information are classified into two categories:
1. Economic report
2. Annual financial statements
Economic report
This is a summary of the economic and financial performance of each activity of the cooperative
society. It analysis the performance of the prior period against the actual performance of the current
period in order to indicate trend.
The current period performance are also compared with the budgeted performance in order to
indicate the variance from the expectation. Explanation for significant variance should also be
provided.
Illustration
The following information has been extracted from the books of Ungula Cotton Farmers Co-
operative Society Limited for the third quarter ended 30 September 2008. The central management
committee (CMC) of the co-operative society has requested the manager of the society to carry out a
detailed analysis of the actual performance of the co-operative society and compare this performance
with the budget and present a comprehensive economic report during the next CMC meeting.
Ungula Cotton Farmers Co-operative Society Limited

Adjusted Trial Balance Report as at 30 September 2008
Trail balance Budget
Sh. ‘000’ Sh. ‘000’
Sale of cotton 4,858,520 4,645,250
Ginnery expenses 311,756 142,355
Local authority levies 122,450 136,495
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Salaries and wages for permanent staff 18,250 16,210
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Casual labour wages 113,650 128,590
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Statutory deductions 1,925 1,495
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Other staff expenses 5,265 5,495
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Administration expenses 83,770 49,380
Other direct costs 61,215 34,540
Marketing expense 38,945 16,395
Repairs and maintenance ginnery 195,865 114,500
Freight charges 159,650 36,590
Payments to farmers 3,643,890 3,716,200
a) Quantity of cotton sold in Tonnes
i) Actual 421,675
ii) Budget 500,000
b) All the cotton is exported to the United States (US). The Kenya shilling has been weakening
against the US dollar.
c) The co-operative society operates under stiff competition
d) Ginnery equipment is due for replacement
e) The government is encouraging farmers to grow more cotton.
Required;
Economic report for the quarter ended 30 September 2008

SOLUTION
Ungula Cotton Farmers Coop Society
Economic Report for year-end 30th September 2008.
Actual Actual Budget Difference
Sale of cotton 4,855,520 4,645,250 213,270
Expenses
Ginery 311,756 142355 (169,401)
Taxes / local authority 122,450 136495 14045
Sale and wages 18,250 16210 (2040)
Lab wages 113, 650 128,520 14,940
Statutory deductions 1,925 1495 (430)
Other expenses 5265 5495 230
Administration 83770 49,380 (34,390)
Other direct costs 61,215 34,540 (26,675)
Marketing expenses 38,945 16,395 (22,550)
Rep. and maintenance 195,505 117,500 (81,365)
Freight charges 159,650 36,590 (123,060)
Payments to firm 3,643,890 3,716,200 72,310
Total expenses 4,756,631 4,398,245 (358386)
Surplus 101,889 247,605 (145,116)
Annual Financial Statement

In addition to the economic report, members should be provided with annual financial statement
which should be tabled in the annual general meeting for discussion and adoption.
The financial standard which must be audited comprises of:
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i. Activity income standard which indicates the performance of each activity.
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ii. Society general income standard which including surplus or deficiencies from cooperative
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activities and other investment incomes.
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iii. Appropriation account statement of changes in equity which indicates the distribution of the
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surplus 20% of which is retained as statutory reserve which helps to ensure the society is
solvent and liquid.
iv. Statement of financial position
v. Statement of cash flows.
Accounting policies, notes and explanation of one financial statement
ILLUSTRATION
The following is the trial balance report of Mwanzo Mpya Farmers Co-operative Society as at 31st
December 2008.
Sh. Sh.
Activity:coffee
Sale of clean coffee 6,900,000
Sale of mbuni 5,000,000
Payments to producers 11,050,000
Grading charges 5,800
Transport charges 24,200
Salaries of factory workers 90,000
Casual labour wages 55,000
Depreciation of coffee equipment 105,000
General expenses 1,000
Activity: Stores for resale
Sales 650,000
Cost of sales 300,000
Salaries and wages 80,000
Overtime 2,000
NSSF 3,000
Electricity 125,000
Repairs and Maintenance 60,000
Insurance 10,000
Depreciation 40,000
Trade licences 15,000
Activity: Society General
Interest: Income 4,000
Rental income 60,000
Dividend from C.I.C 2,500
Travelling and subsistence allowances 12,000
Education – staff 68,000
Depreciation 100,000
Audit fees 50,000
Bank charges 6,200
Committee sitting allowance 20,000
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Entertainment 3,800
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Printing and stationery 8,000
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Postage and telephone 2,000
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Assets, capital and liabilities
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Buildings 600,000
Equipment 300,000
Furniture 20,000
Shares in KUSCCO 10,000
Shares in C.I.C 10,000
Stock of stores 15,000
Members debtors 65,000
Prepayments 30,000
Cash in hand 100,000
Entrance fees 50,000
Statutory reserve fund 5,000
Long-term loan 150,000
Payment due to members 9,500
Creditors and accruals _____ 20,000
13,651,000 13,651,000

Required
i. Statement of comprehensive income for the year ended 31/12/2008
ii. Appropriation account for the year ended 31/12/2008
iii. Statement of financial position as at 31/12/2008.
(Ignore taxation)
Solution
Mwanzo Mpya Farmers Co-op Society
Coffee Activity Income Statement for year end
Incomes 6,900,000
Sale of clean coffee 5,000,000
Sale of Mbuni 11,900,000
Expenses
Total exp. 11,331,000
505,000
Stores Activity Income Statement for year ended 31st December 2008.
Incomes
Sales 650,000
Cost of sales (300,000)
Gross profit 350,000
Expenses
Salaries and wages (80,000)
O/T (2000)
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NSSF (3000)
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Electricity (125,000)
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Repairs and maintenance (60,000)
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Insurance (10,000)
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Depreciation (40,000)
Trade incomes (15000)
Net profit 15000

Statement of Comprehensive Income for year ended 31st December 2008.
Sh. Sh.
Incomes
Profit from coffee activity 569,000
Profit from stores 15000
Interest income 4000
Dividends from CIC 2500
590,500
Rental income 60,000 650,500
Expenses
Travelling 12,000
Education 68,000
Dep. 100,000

Audit fees 50,000
Bank charges 6200
Commission sitting Au. 20,000
Entertainment 3800
Printing and stationery 8000
Post and telephone 2000 _
290,500

Appropriation Account for the year ended 31st December 2008 .
Surplus 290,500
Transfer to statutory Reserve.. 20% x 290500 (58,100)
Retained profit 232,400

Statement of Financial Position as at 31st December 2008.
Sh.
Non-Current
Buildings 600,000
Equipment 300,000
Furniture 20,000
Shares in KUSCCO 10,000
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Shares in CIC 10,000
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Current Assets
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Stock of stores 15,000
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Member debtors 65,000
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Prepayments 100,000
Cash 30,000
1,325,000
Equity and Liabilities
S/capital 800,000
Entrance fees 50,000
Statutory Res fund (5,000 + 58,100) 63,100
Retained profits 232,400
Non-Current Liabilities
Long term loan 150,000
Current liabilities 9500
Payment due to members 20,000
Creditors and accruals 1,325,000

REVISION EXERCISES
QUESTION 1
a) In the context of IAS 41 (Agriculture), explain 6the meaning of the following terms:
i. Biological transformation
ii. Agricultural activity
b) Wakulima Ltd. is a farming business carrying out livestock, poultry and crop farming activities.
The information provided below was extracted from the books of the company as at 30 June 2006:
Sh.’000’ Sh.’000’
Stock - 1 July 2005
Fertilizers 2,600
Growing crops 6,800
Cattle 8,300
Cattle feed 3,200
Seeds 2,050
Poultry 3,800
Poultry feed 1,800
Eggs 200
Land and buildings (net book value) 40,000
Machinery and equipment ( net book value) 20,000
Furniture (net book value) 5,000
Farm tools 4,000
Cash at bank 850
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Share premium 20,000
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Profit and loss account (1 July 2005) 6,850
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Purchases:
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Poultry 18,000
Cattle 47,000
Cattle feed 14,.000
Seeds 5,000
Poultry feed 6,000
Fertilizers 11,500
Sales:
Crops 35,650
Milk 15,200
Cattle 78,000
Poultry 35,00
Eggs 2,800
Salaries and wages:
Crops 6,000
Cattle 7,200
Poultry 4,800
Expenses:
Crops 2,500
Cattle 4,000
Poultry 3,000
Manager’s salary 6,000

Postage and stationery 800
Insurance 3,700
Finance costs 1,750
Depreciation on assets 6,000
Accrued expenses 1,500
Sundry creditors 3,300
Bank loan 20,000
258,300 258,300
1. As at 30 June 2006, stocks were valued as follows:
Sh.’000’
Poultry 2,150
Cattle 6,500
Cattle feed 2,800
Seeds 1,800
Poultry feed 1,200
Fertilizers 2,200
Growing crops 7,100
Eggs 150
2. During the year ended 30 June 2006, the workers consumed products whose values were as
shown below:
Sh.’000’
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Poultry 800
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Cattle 1,500
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Crops 1,200
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Eggs 150
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3. Depreciation expense for the year ended 30 June 200-6 is to be apportioned in the ratio of 3:2:1
between the crops activity, livestock activity respectively.
4. The directors of the company have recommended a dividend of 10%.
Required:
i) Crops account, livestock account and poultry account fro the year ended 30 June 2006.
ii) General profit and loss account for the year ended 30 June 2006.
Solution:
a) (i) Biological transformation
Comprises the process of growth, degeneration, production and procreation that cause qualitative and
quantitative changes in a biological asset.
ii) Agricultural activity
It is the management by an enterprise of the biological transformation of biological assets for sale into
agricultural produce or into additional biological assets.

b) i) Crop Account
Sh.000 Sh,000
Opening stock Sales 35,650
Growing crops 6,800 Wages in kind 1,200
Seeds 2,050
Fertilizers 2,600
Purchases
Seeds 5,000
Fertilizers 11,500
Salaries and wages
Cash 6,000 Closing stock
In kind 1,200
Expenses 2,500 Growing crops 7,100
Depreciation 3,000 Seeds 1,800
Profit to general profit Fertilizer 2,200
and loss account 7,300 -
47,950 47,950
Livestock Account
Sh.000 Sh.000
Opening stock Sales
- Cattle 8,300 Cattle 78,000
- Cattle feed 3,200 Milk 15,200
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Wages in kind 1,500
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Purchases Closing stock
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- Cattle 47,000 - Cattle 6,500
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- Cattle feed 14,000 - Cattle feed 2,800
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Salaries and wages
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- In cash 7,200
- In kind 1,500
Expenses 4,000
Depreciation 2,000
Profit to general profit and loss 16,800
account
104,000 104,000
Poultry account
Sh.000 Sh.000
Opening stock Sales
- Poultry 3,800 Poultry 35,000
- Poultry feed 1,800 Eggs 2,800
- Eggs 200 Wages in kind
Purchases - Poultry 800
- Poultry 18,000 - Eggs 150
- Poultry feed 6,000 Closing stock
Salaries and wages -Poultry 2,150
- In cash 4,800 - Poultry feed 1,200
- In kind 950 - Eggs 150
Expenses 3,000
Depreciation 1,000
Profit to general profit and loss account 2,700
42,250 42,250
ii) Wakulima Ltd
General Profit and Loss Account for the year ended 30 June 2006
Sh,000 Sh.000
Profit from
-Crop activity 7,300
-Cattle activity 16,800
Poultry activity 2,700
26,800
Expenses
Managers salary 6,000
Postage and stationery 800
Insurance 3,700
Finance cost 1,750
Net profit 19.250
Proposed dividend 4,000
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QUESTION 2
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The following trial balance has been extracted from the books of Lina Insurance Company Ltd as at
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31 December 2002:
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Sh. ‘000’ Sh. ‘000’
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Net premium written: Fire 53,816
Motor 107,691
Unearned premiums as at 1 January 2002: Fire 36,018
Motor 72,037
Net commissions paid: Fire 1,733
Motor 3,469
Net claims paid: Fire 27,892
Motor 55,781
Net claims outstanding as at 1 January 2002: Fire 36,018
Motor 72,037
Management expenses to be charged to revenue account 77,554
Management expenses not to be charged to revenue account 10,000
Bad and doubtful debts 2,500
Treasury bills 99,550
Treasury bonds 5,693
Motor vehicle (Net book value) 500
Deposits in banks 237,050
Equipment (Net book value) 7,207
Bank overdraft 8,000
Amounts due to other insurance companies 2,000
Amounts due from other insurance companies 3,470

Investment income 36,000
Other income 8,782
Retained earnings as at 1 January 2002 ______ 15,000
532,399 532,399
1. Management expenses to be charged to revenue account are to be apportioned on the basis of net
premiums written:
2. The management made the following estimates as at 31 December 2002:
Sh.000
• Unearned Premiums: Fire 20,000
Motor 30,000
• Net claims outstanding: Fire 45,000
Motor 79,000
Required:
a) Revenue accounts, showing results of the fire and motor departments and combined business, for
the year ended 31 December 2002.
b) Profit and loss account for the year ended 31 December 2002
c) Balance sheet as at 31 December 2002
Solution:
Revenue Account
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Net claim paid Fire Motor CombinedUnearned Fire Motor Combined
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Claims outstanding c/d 27,892 55,781 83,673premium b/d 36,018 72,037 108,055
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Claims outstanding b/d 45,000 79,000 124,000Net premium 53,816 107,691 161,507
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Incidental cost (36,018) (72,037) (198,055) ____ _____ _____
Net claims - - - 89,834 179,728 269,562
Less: Expenses 36,874 62,744 99,618
Management 25,842 51,712 77,554
Net commission ceded 1,733 3,469 5,202
paid 5,385 11,803 17,188
Profit 20,000 50,000 70,000
Unearned premium c/d 89,834 179,729 269,562
Profit and loss Account

Shs.‘000’
Revenue 17,188
Investment 36,000
Other incomes 8,782
61,970
Less Expense
Management Expenses 10,000
Bad debts 2,500 (12,500)
Add: retained profit b/d 49,470
Retained profit c/d 15,000
64,470

Balance Sheet
Fixed Assets: - motor vehicle Shs‘000’ Shs‘000’
Equipment’s 500
Investments - treasury bills 7,207
- Treasury bonds 99,550
Current assets – deposit in bank 237,050 5,693
Amount due from other insurances 3,470 240,520
353,470
Revaluation reserves 25,000
Retained earning 64,470
Underwriting provision 149,470
Unearned premium c/d (20+50) 70,000
Outstanding claims c/d (45+79) 124,000
Other liabilities
Bank overdrafts 8,000
Amount due to other insurances 2,000
353,470
QUESTION 3
Hazina Bank Ltd., a registered commercial bank, prepares its accounts to 30 June each year. The
trial balance of the bank as at 30 June 2003 was as follows:
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Sh.’000’ Sh.’000’
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Treasury bills 2,344,000
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Loans to customers 5,946,400
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Other money market placements 34,600
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Property, plant and equipment 1,008,000
Cash and balances with the Central Bank 1,257,000
Interest on loans 870,800
Interest on treasury bills and bonds 476,400
Foreign exchange income 144,000
Fees and commissions income 340,400
Deposits with other banks 230,000
Other fixed assets 64,000
Interest on placements and bank balances 72,000
Non-operating income 34,000
Customers’ deposits 8,480,000
Deposits and balances due to other banks 430,000
Depreciation charges 84,000
Directors emoluments 25,000
Bad and doubtful debts 68,000
Interim dividends paid 50,000
Interest on borrowed funds 70,000
Interest on customers deposits 230,000
Auditors fees 7,000

Contribution to staff pension scheme 29,000
Loss on sale of fixed assets 43,600
Reserves 1,058,000
Legal fees 40,000 _______
12,405,600 12,405,600
1. Current tax has been estimated at Sh.200,000,000
2. A final dividend of 15% has been proposed.
3. Unrecorded accrued interest expense on customers’ deposits at 30 June 2003 was
sh.70,000,000.
4. Interest income on loans and advances to customers of Sh.150,000,000 at 30 June 2003 was
omitted from the books.
Required:
(a) Profit and loss account for the year ended 30 June 2003.
(b) Balance sheet as at 30 June 2003.
(These statements should be presented in accordance with IAS 30 – Disclosures in the Financial
Statements of Banks and Similar Financial Institutions).
Solution:
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Hazina Bank Ltd.
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Profit and Loss account for the year ended 30 June 2003
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Income Sh. ’000’ Sh. ’000’
Interest on loans (150 + 870.8) 1,020,800
Interest on treasury bills and bonds 476,400
Fees and commissions 340,400
Foreign fees and commissions 144,000
Foreign exchange income 72,000
Interest on placement and bank balances 2,053,600
Operating income 34,000
Non-operating income 2,087,600
Expenditure
Staff costs 590,000
Contribution to staff provident fund 29,000
Directors emoluments 25,000
Depreciation expense 84,000
Interest on deposits from customers 300,000
Interest on borrowed funds 70,000
Auditors fees 7,000
Loss on sale of fixed assets 43,600
Legal fees 40,000
Administrative expenses 285,000 (1,473,600)

Operating profit before provisions 614,000
Provision for bad and doubtful debts (68,000)
Profit before tax 546,000
Income tax expense (200,000)
Profit attributable to shareholders 346,000
Reserves brought forward 1,058,000
Less: Interim dividends paid 50,000
Proposed 75,000 (125,000)
Reserves c/f 1,279,000
(b) Hazina Bank Ltd.
Balance Sheet as at 30 June 2003
Sh.’000’
Cash and bank balances 1,257,000
Treasury bills and bonds 2,344,000
Deposits with other banks 230,000
Interest receivable 150,000
Other money market placements 34,600
Loans and advances to customers 5,946,400
Property, plant and equipment 1,008,000
Other fixed assets 64,000
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11,034,000
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Liabilities
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Customers deposits (8,480 + 70) 8,550,000
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Deposits and balances due to other banks 430,000
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Taxation 200,000
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Proposed dividends 75,000
9,255,000
Reserves 1,279,000
Shareholders funds 1,779,000
11,034,000
QUESTION 4
a) Briefly explain the following terms as used in the accounts of professional practitioners:
i. Office account
ii. Client account
iii. Costs charged to clients
iv. Work-in-progress.
b) Given below is a trial balance extracted from the books of Kamau and Nyambati, a firm of
practicing advocates as at 31 October 2002:

Kamau and Nyambati Advocates
Trial Balance
Sh. Sh.
Capital account 204,000
Disbursements on behalf of clients 12,000
Drawings 60,000
Salaries 72,000
Rent and rates 60,000
Costs charged to clients 250,000
Work in progress on 1 November 2001 36,800
Clients: for the moneys held on their behalf 24,800
Creditors 27,200
Debtors 78,000
Sundry office expenses 8,500
Furniture, fittings and library books 45,000
Cash at bank:
Clients’ account
Office account 24,800 ______
55,700
506,000 506,000
1) The uncompleted work on 31 October 2002 was valued at Sh.23,500.
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2) It is estimated that debts amounting to Sh.5,500 are uncollectible and should be written off.
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3) Depreciation should be provided at 20% per annum on the book value of the furniture, fittings
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and library books.
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Required:
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i. Profit and loss account for the year ended 31 October 2002.
ii. Balance sheet as at 31 October 2002.
Solution:
a) i) Office Account
This is an account opened by a professional practitioner separate form those of the client to serve as bank
account which would deal with operation of the office only e.g. Fee received or charged and expenses paid
for the office.
ii) Client Account

It is separate account through which all transactions concerning the clients are recorded. No office dealings
are charged in this account except where disbursement of the professionals being charged or fees being
charged to client. It may contain amount of money held on the client behalf.
iii) Cost Charged To Clients

These are amounts, which are owed to the professionals by their clients charged to their accounts. They are
disbursements fees charged or other expenses incurred on client behalf and charged to them. They reduce the
amounts of money that the professional is holding on behalf of clients.

iv) Work-In-Progress
This means work that remains uncompleted at the year-end e.g. a lawyer may be handling some cases at the
end of the year where the judgment has not been heard. It must be accounted for in the profit and loss
account.
Kamau and Nyambati Advocates
Profit and loss A/C
For the year ended 31.10.2002
Debts 5,500 Cost charged to clients 250,000

Disbursement on behalf of clients 12,000 (fees)
Salaries 72,000
Rent and rates 60,000
Sundry expenses 8,500
Depreciation
20% x 45,000 9,000
Profit c/d 298,000
250,000 250,000
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Opening work in progress 36,800 29,800
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Profit c/d for the year 16,500 Profit b/d 23,500
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53,300 Closing work in progress 53,300
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Kamau and Nyamati Advocates
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Balance sheet as at 31.10.2002
Capital 204,000 Fixed assets Cost Dep. NBV

Profit 16,500 220,500 Furniture fittings 45,000 9,000 36,000
Less drawings 60,000
Current 160,000 Current assets
liabilities 27,200 Debtor less B. debts 72,500
creditor 24,800 52,000 Cash at bank: client A/C 24,800
_ :office 55,700
____ work in progress 23,500 176,500
212,500 212,500
Note: all adjustments concerning the office account and client account have already been affected.
QUESTION 5
(a) Explain the following terms as used in bankruptcy acts:
i) Voluntary transfers
ii) Doctrine of reputed ownership

(b) Wafanyakazi Retirement Benefit Scheme has provided you with the following extract of the trial
balance for the year ended 31 October 2002:
Sh.’000’ Sh.’000’
Accumulated fund as at 1 November 2001 461,560
Accrued expenses 240
Administration expenses 2,840
Cash and demand deposits 23,460
Change in market value of investments 22,640
Lumpsum retirement benefits 4,820
Contributions due in 30 days 4,940
Normal contributions by:
Employer 36,480
Employees 18,240
Transfer in from other schemes 3,150
Individual transfers out to other schemes 1,860
Immovable property 132,320
Government securities (long-term) 263,605
Members’ voluntary contributions 4,560
Pension 7,640
Equity investments: Quoted 87,835
Unquoted 19,900
Unpaid benefits ______ 320
571,950 571,950
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Required:
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(i) Statement of changes in net assets for the year ended 31 October 2002.
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(ii) Statement of net assets as at 31 October 2002.
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Solution:
(a) The first meeting of creditors’ voluntary winding up should be held on the same day when the members
have passed a resolution to wind up the company or on the day after. In this meeting the creditors shall:
- Appoint amongst them a chairman

- Join the members to appoint a liquidator
- Join the members to appoint a committee of inspection of up to 5 people.
- The directors must present to the members the statement of affairs and the list of creditors. The
creditor may also terminate the liquidator earlier appointed by the members
- When the liquidation commenced the creditors shall meet one year after commencement to review
the progress and attend to any pending matters. Such meetings are called by the liquidator.
- If the liquidation is not complete after one year the creditors shall meet after lapse of one year for all
years in which the liquidation is incomplete.
- When the liquidation is complete the liquidator must call a final meeting and lay before the company
and creditors the accounts of winding up.

(b) (i) Wafanyakazi retirement benefit Scheme
Statement of changes in net assets for the year ended 31 October 2002
Sh. Sh.
Contributions received
From employer: Normal 18,240 36,480
From members: Normal 4,560 22,800
Additional voluntary
Transfer in 3,150
From other sources (individual transfers in) 47,400
Benefits payable 7,640
Pensions 4,820
Commutations of pensions and lumpsum benefits 1,860 (14,320)
Payments on accounts of leavers: individual transfer out 95,510
Changes in market value of investments (22,640)
72,870
Payments: Administration expenses (2,840)
70,030
Wafanyakazi retirement benefit Scheme

Statement of net assets as at 31 October 2002
Sh. Sh.
Investment assets
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Fixed interest securities
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Kenya Government securities 263,605
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Equity investments
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Quoted 87,835
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Unquoted 19,990 107,825
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Cash and demand deposits 23,460
394,890
Fixed Assets :
Current Assets 527,210
Contributions due within 30 days
Current liabilities 4,940
Unpaid benefits (320)
Accrued expenses (240)
(560) 4,380
531,590
Accumulated fund as at 01.11.01 461,560
Net change for the year 70,030
531,590

TOPIC 5
PUBLISHED FINANCIAL STATEMENTS
IAS 1 — Presentation of Financial Statements
OVERVIEW
IAS 1 Presentation of Financial Statements sets out the overall requirements for financial
statements, including how they should be structured, the minimum requirements for their content
and overriding concepts such as going concern, the accrual basis of accounting and the current/non-
current distinction. The standard requires a complete set of financial statements to comprise a
statement of financial position, a statement of profit or loss and other comprehensive income, a
statement of changes in equity and a statement of cash flows.
IAS 1 was reissued in September 2007 and applies to annual periods beginning on or after 1 January
2009.
SUMMARY OF IAS 1
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Objective of IAS 1
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The objective of IAS 1 (2007) is to prescribe the basis for presentation of general purpose financial
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statements, to ensure comparability both with the entity's financial statements of previous periods
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and with the financial statements of other entities. IAS 1 sets out the overall requirements for the
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presentation of financial statements, guidelines for their structure and minimum requirements for
their content. Standards for recognizing, measuring, and disclosing specific transactions are
addressed in other Standards and Interpretations.
Scope
Applies to all general purpose financial statements based on International Financial Reporting
Standards
General purpose financial statements are those intended to serve users who are not in a position to
require financial reports tailored to their particular information needs.
Objective of financial statements
The objective of general purpose financial statements is to provide information about the financial
position, financial performance, and cash flows of an entity that is useful to a wide range of users in

making economic decisions. To meet that objective, financial statements provide information about
an entity's:
 assets
 liabilities
 equity
 income and expenses, including gains and losses
 contributions by and distributions to owners
 cash flows
That information, along with other information in the notes, assists users of financial statements in
predicting the entity's future cash flows and, in particular, their timing and certainty.
Components of financial statements

A complete set of financial statements should include:
 a statement of financial position (balance sheet) at the end of the period

 a statement of comprehensive income for the period (or an income statement and a statement
of comprehensive income)
 a statement of changes in equity for the period
 a statement of cash flows for the period
 notes, comprising a summary of accounting policies and other explanatory notes
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When an entity applies an accounting policy retrospectively or makes a retrospective restatement of
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items in its financial statements, or when it reclassifies items in its financial statements, it must also
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present a statement of financial position (balance sheet) as at the beginning of the earliest
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comparative period.
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An entity may use titles for the statements other than those stated above.
Reports that are presented outside of the financial statements – including financial reviews by
management, environmental reports, and value added statements – are outside the scope of IFRSs.
Fair presentation and compliance with IFRSs
The financial statements must "present fairly" the financial position, financial performance and cash
flows of an entity. Fair presentation requires the faithful representation of the effects of transactions,
other events, and conditions in accordance with the definitions and recognition criteria for assets,
liabilities, income and expenses set out in the Framework. The application of IFRSs, with additional
disclosure when necessary, is presumed to result in financial statements that achieve a fair
presentation.
IAS 1 requires that an entity whose financial statements comply with IFRSs make an explicit and
unreserved statement of such compliance in the notes. Financial statements shall not be described as
complying with IFRSs unless they comply with all the requirements of IFRSs (including
Interpretations).

Inappropriate accounting policies are not rectified either by disclosure of the accounting policies
used or by notes or explanatory material.
IAS 1 acknowledges that, in extremely rare circumstances, management may conclude that
compliance with an IFRS requirement would be so misleading that it would conflict with the
objective of financial statements set out in the Framework. In such a case, the entity is required to
depart from the IFRS requirement, with detailed disclosure of the nature, reasons, and impact of the
departure.
Going concern
An entity preparing IFRS financial statements is presumed to be a going concern. If management

has significant concerns about the entity's ability to continue as a going concern, the uncertainties
must be disclosed. If management concludes that the entity is not a going concern, the financial
statements should not be prepared on a going concern basis, in which case IAS 1 requires a series of
disclosures.
Accrual basis of accounting
IAS 1 requires that an entity prepare its financial statements, except for cash flow information, using
the accrual basis of accounting.
Consistency of presentation
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The presentation and classification of items in the financial statements shall be retained from one
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period to the next unless a change is justified either by a change in circumstances or a requirement of
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a new IFRS.
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Materiality and aggregation
Each material class of similar items must be presented separately in the financial statements.
Dissimilar items may be aggregated only if they are individually immaterial.
Offsetting
Assets and liabilities, and income and expenses, may not be offset unless required or permitted by an
IFRS.
Comparative information
IAS 1 requires that comparative information shall be disclosed in respect of the previous period for
all amounts reported in the financial statements, both face of financial statements and notes, unless
another Standard requires otherwise.
If comparative amounts are changed or reclassified, various disclosures are required.

Structure and content of financial statements in general
Clearly identify:
 the financial statements

 the reporting enterprise
 whether the statements are for the enterprise or for a group
 the date or period covered
 the presentation currency
 The level of precision (thousands, millions, etc.)
Reporting period
There is a presumption that financial statements will be prepared at least annually. If the annual
reporting period changes and financial statements are prepared for a different period, the entity must
disclose the reason for the change and a warning about problems of comparability.
Statement of Financial Position (Balance Sheet)
An entity must normally present a classified statement of financial position, separating current and
non-current assets and liabilities. Only if a presentation based on liquidity provides information that
is reliable and more relevant may the current/non-current split be omitted. In either case, if an asset
(liability) category combines amounts that will be received (settled) after 12 months with assets
(liabilities) that will be received (settled) within 12 months, note disclosure is required that separates
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the longer-term amounts from the 12-month amounts.
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Current assets are cash; cash equivalent; assets held for collection, sale, or consumption within the
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entity's normal operating cycle; or assets held for trading within the next 12 months. All other assets
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are non-current.
Current liabilities are those expected to be settled within the entity's normal operating cycle or due
within 12 months, or those held for trading, or those for which the entity does not have an
unconditional right to defer payment beyond 12 months. Other liabilities are non-current.
When a long-term debt is expected to be refinanced under an existing loan facility and the entity has
the discretion the debt is classified as non-current, even if due within 12 months
If a liability has become payable on demand because an entity has breached an undertaking under a
long-term loan agreement on or before the reporting date, the liability is current, even if the lender
has agreed, after the reporting date and before the authorization of the financial statements for issue,
not to demand payment as a consequence of the breach. However, the liability is classified as non-
current if the lender agreed by the reporting date to provide a period of grace ending at least 12
months after the end of the reporting period, within which the entity can rectify the breach and
during which the lender cannot demand immediate repayment.
Minimum items on the face of the statement of financial position
(a) property, plant and equipment

(b) investment property
(c) intangible assets
(d) financial assets (excluding amounts shown under (e), (h), and (i))
(e) investments accounted for using the equity method
(f) biological assets
(g) Inventories
(h) trade and other receivables
(i) cash and cash equivalents
(j) assets held for sale
(k) trade and other payables
(l) Provisions
(m) financial liabilities (excluding amounts shown under (k) and (l))
(n) liabilities and assets for current tax
(o) deferred tax liabilities and deferred tax assets
(p) liabilities included in disposal groups
(q) non-controlling interests, presented within equity and
(r) issued capital and reserves attributable to owners of the parent
Additional line items may be needed to fairly present the entity's financial position.
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IAS 1 does not prescribe the format of the balance sheet. Assets can be presented current then non-
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current, or vice versa, and liabilities and equity can be presented current then non-current then
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equity, or vice versa. A net asset presentation (assets minus liabilities) is allowed. The long-term
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financing approach used in UK and elsewhere – fixed assets + current assets - short term payables =
long-term debt plus equity – is also acceptable.
Regarding issued share capital and reserves, the following disclosures are required:
 numbers of shares authorized, issued and fully paid, and issued but not fully paid
 par value
 reconciliation of shares outstanding at the beginning and the end of the period
 description of rights, preferences, and restrictions
 treasury shares, including shares held by subsidiaries and associates
 shares reserved for issuance under options and contracts
 a description of the nature and purpose of each reserve within equity

FORMAT
ABC group - statement of financial position
As at 31 December 2013
2013
Shs ‘000’
Assets
Non-current assets
Property, plant and equipment Xx
Goodwill Xx
Other intangible assets Xx
Investments in associates Xx
Available-for-sale financial assets Xx
Current assets
Inventories Xx
Trade receivables Xx
Other current assets Xx
Cash and cash equivalents Xx
Total assets XX

Equity attributable to owners of the parent Xx
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Share capital Xx
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Retained earnings Xx
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Other components of equity Xx
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Non-controlling interest Xx
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Total equity Xx
Xx
Long-term borrowings
Deferred tax Xx
Long-term provisions Xx
Long-term provisions Xx
Total non-current liabilities Xx
Xx
Current liabilities
Trade and other payables
Short-term borrowings Xx
Current portion of long-term borrowings Xx
Current tax payable Xx
Short-term provisions Xx
Total current liabilities Xx
Total liabilities Xx
Total equity and liabilities Xx
Xx

Information presented either on the face of the statement of financial position or by note
Further sub-classification of the line items listed above should be disclosed either on the face of the
statement of financial position or in the notes. The classification will depend upon the nature of the
entity's operations As well as each item being sub-classified by its nature, any amounts payable to or
receivable from any group company or other related party should also be disclosed separately.
The sub-classification details will in part depend on the requirements of IFRSs. The size, nature and
function of the amounts involved will also be important and the factors listed above should be
considered.
Disclosures will vary from item to item and IAS'1 gives the following examples.
a) Property, plant and equipment are classified by class as described in IAS 16, Property, plant
and equipment
b) Receivables are analyzed between amounts receivable from trade customers, other members
of the group, receivables from related parties, prepayments and other amounts.
c) Inventories are sub-classified, in accordance with IAS 2 Inventories, into classifications such
as merchandise production supplies, materials, work in progress and finished goods.
d) Provisions are analyzed showing separately provisions for employee benefit costs and any
other items classified in a manner appropriate to the entity's operations
e) Equity capital and reserves are analyzed showing separately the various classes of paid in
capital, share premium and reserves
The standard then lists some specific disclosures which must be made, either on the face of the
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statement of financial position or in the related notes.
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Share capital disclosures (for each class of share capital)
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i. Number of shares authorized
ii. Number of shares issued and fully paid, and issued but not fully paid
iii. Par value per share, or that the shares have no par value
iv. Reconciliation of the number of shares outstanding at the beginning and at the end of the year
v. Rights, preferences and restrictions attaching to that class including restrictions on the
distribution of dividends and the repayment of capital.
vi. Shares in the entity held by the entity itself or by related group companies
vii. Shares reserved for issuance under options and sales contracts, including the terms and
amounts
Description of the nature and purpose of each reserve within owners' equity
Some types of entity have no share capital, e.g partnerships. Such entities should disclose
information which is equivalent to that listed above. This means disclosing the movement during the
period in each category of equity interest and any rights, preferences or restrictions attached to each
category of equity interest.

The Current/Non-Current Distinction
An entity must present current and non-current assets as separate classifications on the face of the
statement of financial position. A presentation based on liquidity should only be used where it
provides more relevant and reliable information, in which case all assets and liabilities must be
presented broadly in order of liquidity.
In either case, the entity should disclose any portion of an asset or liability which is expected to be
recovered or settled after more than twelve months. For example, for an amount receivable which is
due in instilments over 18 months, the portion due after more than twelve months must be disclosed.
The IAS emphasizes how helpful information on the operating cycle is to users of financial
statements:
Where there is a clearly defined operating cycle within which the entity supplies goods or services,
then information disclosing those net assets that are continuously circulating as working capital is
useful.
This distinguishes them from those net assets used in the long-term operations of the entity. Assets
that are expected to be realized and liabilities that are due for settlement within the operating cycle
are therefore highlighted.
The liquidity and solvency of an entity is also indicated by information about the maturity dates of
assets, and liabilities. Under IFRS 7 Financial instruments; disclosures requires disclosure of
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maturity dates of both financial assets and financial liabilities. (Financial assets include trade and
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other receivables; financial liabilities include trade and other payables.)
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Current Assets
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An asset should be classified as a current asset when it:
 is expected to be realized in, or is held for sale or consumption in, the normal course of the
entity's operating cycle; or
 is held primarily for trading purposes or for the short-term and expected to be realized within
twelve months of the end of the reporting period; or
 Is cash or a cash equivalent asset which is not restricted in its use.
All other assets should be classified as non-current assets.
Non-current assets include tangible, intangible, operating and financial assets of a long-term nature.
Other terms with the same meaning can be used (e.g 'fixed', 'long-term').
The term 'operating cycle' has been used several times above and the standard defines it as follows.
The operating cycle of an entity is the time between the acquisition of assets for processing and their
realization in cash or cash equivalents.

Current assets therefore include inventories and trade receivables that are sold, consumed and
realized as part of the normal operating cycle. This is the case even where they are not expected to
be realized within twelve months.
Current assets will also include marketable securities if they are expected to be realized within
twelve months after the reporting period. If expected to be realized later, they should be included in
non-current assets.
Current Liabilities
A liability should be classified as a current liability when it:
 is expected to be settled in the normal course of the entity's operating cycle; or

 is held primarily for the. purpose of trading; or
 is due to be settled within twelve months after the end of the reporting period; or when
 The entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the end of the reporting period.
All other liabilities should be classified as non-current liabilities.
The categorization of current liabilities is very similar to that of current assets. Thus, some current
liabilities are part of the working capital used in the normal operating cycle of the business (i.e. trade
payables and accruals for employee and other operating costs). Such items will be classed as current
liabilities even where they are due to be settled more than twelve months after the end of the
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reporting period.
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There are also current liabilities which are not settled as part of the normal operating cycle, but
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which are due to be settled within twelve months of the end of the reporting period. These include
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bank overdrafts, income taxes, other non-trade payables and the current portion of interest-bearing
liabilities. Any interest- bearing liabilities that are used to finance working capital on a long-term
basis, and that are not due for settlement within twelve months, should be classed as non-current
liabilities.
A non-current financial liability due to be settled within twelve months of the end of the reporting
period should be classified as a current liability, even if an agreement to refinance, or to reschedule
payments, on a long-term basis is completed after the end of the reporting period and before the
financial statement are authorized for issue.
A non-current financial liability that is payable on demand because the entity breached a condition
of it loan agreement should be classified as current at the end of the reporting period even if the
lender has agreed after the end of the reporting period, and before the financial statements are
authorized for issue not to demand payment as a consequence of the breach.
However, if the lender has agreed by the end of the reporting period to provide a period of grace
ending at least twelve months after the end of the reporting period within which the entity can rectify
the breach and during that time the lender cannot demand immediate repayment, the liability is
classified as non- current.

Statement of Comprehensive Income
The revision of IAS 1 in 2007 introduced a new statement, the statement of comprehensive income.
This shows both income statement items and items which would previously have gone to the
statement of recognized income and expense.
Statement of comprehensive income - format
IAS 1 (revised) allows income and expense items to be presented either:
a) in a single statement of comprehensive income; or

b) In two statements: a separate income statement and statement of other comprehensive
income.
The format for a single statement of comprehensive income is shown as follows in the standard. The
section down to 'profit for the year' can be shown as a separate 'income statement' with an additional
'statement of other comprehensive income'.
FORMAT
ABC Group - Statement of Comprehensive Income for The Year Ended 31 December 2013
2013
Revenue Xx
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Cost of sales Xx
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Gross profit Xx
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Other income Xx
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Distribution costs Xx
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Administrative expenses Xx
Other expenses Xx
Finance costs Xx
Share of profit of associates Xx
Profit before tax Xx
Income tax expense Xx
Profit for the year from continuing operations Xx
Loss for the year from discontinued operations Xx
Profit for the year Xx
Other comprehensive income:

- Exchange differences on translating foreign operations Xx
Available-for-sale financial assets Xx
- Cash flow hedges Xx
- Gains on property revaluation Xx
- Actuarial gains (losses) on defined benefit pension plans Xx
Share of other comprehensive income of associates Xx
Income tax relating to components of other Xx
comprehensive income Xx
Other comprehensive income for the year, net of tax
Total comprehensive income for the year Xx

Profit attributable to: Xx
Owners of the parent Xx
Non-controlling interest
Total comprehensive income attributable to; Xx
Owners of the parent Xx
Xx
Earnings per share (in currency units) Xx
Xx
Xx
Information presented in the statement of comprehensive income of separate income statement
The standard lists the following as the minimum to be disclosed on the face of the income statement.
a) Revenue
b) Finance costs
c) Share of profits and losses of associates and joint ventures accounted for using the equity
rnethod.
d) Pre-tax gain or loss recognized on the disposal of assets or settlement of liabilities attributable
to discontinued operations
e) Tax expense
f) Profit or loss
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The following items must be disclosed in the income statement as allocations of profit or loss for the
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period.
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(a) Profit or loss attributable to non-controlling interest
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(b) Profit or loss attributable to owners of the parent
The allocated amounts must net be presented as items of income or expense. (These relate to group
accounts, covered later in this text.)
Income and expense items can only be offset when and only when:
a) It is permitted or required by an IFRS, or

b) Gains, losses and related expenses arising from the same or similar transactions and events
are immaterial, in which case they can be aggregated.
Information presented either in the statement or in the notes
An analysis of expenses must be shown either in the income statement section (as above, which is
encouraged by the standard) or by note, using a classification based on either the nature of the
expenses or their function. This sub-classification of expenses indicates a range of components of
financial performance; these may differ in terms of stability, potential for gain or loss and
predictability.

Nature of expense method
Expenses are not reallocated amongst various functions within the entity, but are aggregated in the
income statement according to their nature (e.g purchase of materials, depreciation, wages and
salaries, transport costs). This is by far the easiest method, especially for smaller entities.
Function of expense/cost of sales method
You are likely to be more familiar with this method. Expenses are classified according to their
function as part of cost of sales, distribution or administrative activities. This .method often gives
more relevant information for users, but the allocation of expenses by function requires the use of
judgement and can be arbitrary. Consequently, perhaps, when this method is used, entities should
disclose additional information on the nature of expenses, including staff costs, and depreciation and
amortization expense.
Which of the above methods is chosen by an entity will depend on historical and industry factors,
and also the nature of the organisations. Under each method, there should be given an indication of
costs which are likely to vary (directly or indirectly) with the level of sales or production. The
choice of method should fairly reflect the main elements of the entity's performance. This is the
method you should expect to see in your exam that you get no marks for writing out the format for a
financial statement. However, you must write the format so that you can then fill in the numbers and
earn the marks.
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Dividends
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IAS 1 also requires disclosure of the amount of dividends per share for the period covered by the
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financial statements. This may be shown either in the income statement or in the statement of
changes in equity.
Further points
a) All requirements previously set out in other Standards for the presentation of particular line
items in the statement of financial position and income statement are now dealt with in IAS 1.
These line items are: biological assets; liabilities and assets for current tax and deferred tax; and
pre-tax gain or loss recognized on the disposal of assets or settlement of liabilities attributable
to discontinued operations.
b) An entity must disclose, in the summary of significant accounting policies and/or other notes,
the judgement made by management in applying the accounting policies that have the most
significant effect on the amounts of items recognized in the financial statements.
c) An entity must disclose in the notes information regarding key assumptions about the future,
and other sources of measurement uncertainty, that have a significant risk of causing a material
adjustment to the carrying amounts of assets and liabilities within the next financial year.

Changes in equity
IAS 1 requires a statement of changes in equity. This shows the movement in the equity section of
the statement of financial position. A full set of financial statements includes a statement of changes
in equity.
FORMAT
This is the format of the statement of changes in equity as per IAS 1 (revised).
ABC GROUP - STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31

DECEMBER 2007
Share Retained Available for Revaluation Total Non- Total

capital earnings sale financial controlling equity
assets Surplus interest
Balance at 1 January 20X6 Xx Xx Xx - Xx Xx Xx
Changes in accounting policy - Xx - - Xx Xx Xx
Restated balance Xx Xx Xx - Xx Xx Xx
Changes in equity
Dividends - Xx - - Xx Xx Xx
Total comprehensive income - - - - Xx Xx Xx
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for the year· - Xx Xx Xx Xx Xx Xx
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Balance at 31 December2006 Xx Xx Xx Xx Xx Xx Xx
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Changes in equity for 2007
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Issue of share capital Xx - - - Xx - Xx
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Dividends - Xx - - Xx - Xx
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Total comprehensive
income for the year - Xx Xx Xx Xx Xx Xx
Transfer to retained earnings - Xx Xx Xx - - -
Balance at 31 December 2007 Xx Xx Xx Xx Xx Xx Xx
NOTES TO THE FINANCIAL STATEMENTS
Contents of notes
The notes to the financial statements will amplify the information given in the statement of financial
position, statement of comprehensive income and statement of changes in equity. We have already
note above the information which the IAS allows to be shown by note rather than in the statements.
To some extent, then, the contents of tile notes will be determined by the level of detail shown on
the face of the statements.
Structure
The notes to the financial statements should perform the following functions.

a) Provide information about the oasis on which the financial statements were prepared and
which specific accounting policies were chosen and applied to significant transactions/events.
b) Disclose any information, not shown elsewhere in the financial statements, which is required
by IFRSs
c) Show any additional information that is relevant to understanding which is not shown
elsewhere the financial statements
The way the notes are presented is important. They should be given in a systematic manner and
cross referenced back to the related figure(s) in the statement of financial position, statement of
comprehensive income or statement of cash flows.
Notes to the financial statements will amplify the information shown therein by giving the
following;
a) More detailed analysis or breakdowns of figures in the statements

b) Narrative information explaining figures in the statements
c) Additional information, e.g contingent liabilities and commitments
IAS 1 suggests a certain order for notes to the financial statements. This will assist users when
comparing the statements of different entities.
a) Statement of compliance with IFRSs

b) Statement of the measurement basis (bases) and accounting policies applied
c) Supporting information for items presented in each financial statement in the same order as
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each line item and each financial statement is presented
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d) Other disclosures, e.g:
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i. Contingent liabilities, commitments and other financial disclosures
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ii. Non-financial disclosures
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The order of specific items may have to be varied occasionally, but a systematic structure is still
required
PRESENTATION OF ACCOUNTING POLICIES
The accounting policies section should describe the following.
a) The measurement basis (or bases) used in preparing the financial statements
b) The other accounting policies used, as required for a proper understanding of the financial
statements
This information may be shown in the notes or sometimes as a separate component of the financial
statements.
The information on measurement bases used is obviously fundamental to an understanding of the

financial statements. Where more than one basis is used, it should be stated to which assets or
liabilities each basis has been applied.

OTHER DISCLOSURES
An entity must disclose in the notes:

a) The amount of dividends proposed or declared before the financial statements were
authorized for issue but not recognized as a distribution to owners during the period, and the
amount per share.
b) The amount of any cumulative preference dividends not recognized
IAS 1 ends by listing some specific disclosures which will always be required if they are not shown
elsewhere in the financial statements.
a) The domicile and legal form of the entity, its country of incorporation and the address of the
registered office (or, if different, principal place of business)
b) A description of the nature of the entity's operations and its principal activities
c) The name of the parent entity and the ultimate parent entity of the group
ILLUSTRATION
Basweta Ltd, which manufactures footwear, makes up its accounts to 31 March each year. The
company has an authorised share capital of Sh. 600,000,000 divided into 15,000,000 6.5%
preference shares of Sh. 20 each and 30,000,000 ordinary shares of Sh. 10 each. The following trial
balance was extracted as at 31 March 2002.
Trial balance as at March 2002
Sh ‘000’ Sh ‘000’
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Cost of Sales 699,992
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Motor vehicle expenses 59,684
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Selling and distribution costs 78,840
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Depreciation of motor vehicles – for the year 12,580
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Wages and salaries 95,834
Administration expenses 11,492
Audit fees 1,400
Sales 1,191,864
Discounts received 812
Investment income – trade investments 1,072
- others 1,608
Preference dividends paid 13,000
Debenture interest 1,600
Corporation tax paid – instalment 8,615
Compensation to director for loss of office 8,500
Depreciation of fixtures for the year) 1,040
8% debentures 20,000
Cash in hand 3,000
Ordinary share capital issued and paid-up) 200,000
Bank balance 11,745
Preference share capital issued and paid-up) 200,000
Inventory 31 March 2002) 204,132
Debtors/creditors 336,440 102,000
Deferred tax 3,000
Motor vehicles net book value) 24,800

Provision for doubtful debts 14,400
Fixtures and fittings net book value) 11,300
Profit and loss account 1 April 2001) 110,848
General reserves 60,000
Freehold land and building cost) 270,000
Investments – trade market value Sh.35,000,000) 30,000
Others market value Sh.62,000,000) 61,610
1,945,604 1,945,604
1. Wages and salaries include salary paid to Managing Director of Sh. 30,000,000 and salary paid
to Sales Director of Sh. 25,000,000.
2. Provision is due to be made for directors’ fees Sh. 150,000,000.
3. Provision for doubtful debts is to be adjusted to Sh. 16,822,000.
4. Timing differences of Sh. 4,000,000 are expected to reverse in the near future.
5. The directors recommended an ordinary dividend of Sh.1.35 per share.
6. Corporation tax for the year is Sh.11; 820,000.The corporation tax rate is 30%on adjusted profit.
7. Land and buildings were professionally valued at Sh.300, 000,000 at the year end. The directors
wish to incorporate the valued amount in the financial statements.
8. Information about other fixed asset is as follows:
Motor vehicles Fixtures &
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fittings
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Cost (including additions during the year) 51,200,000 20,800,000
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Additions during the year 2,240,000 1,600,000
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Cost of assets disposed of during the year (No entry made yet) 2,800,000 1,455,000
Accumulated depreciation of asset disposed of during the year 2,150,000 905,000
Proceeds of asset disposed of (including in sales in the trial 715,000 500,000
balance)
Required
(a) Income statement for the year ended 31 March 2002
(b) Balance sheet as at 31 March 2002
(The above two statement should be presented in the form suitable for publication in accordance
with the requirements of International Accounting Standards .IASs)
SOLUTION
(a) Basweta Ltd

Income statement for the year ended 31 March 2003
Sh.’000’ Sh.’000’
Turnover (W1) 1,190,694
Other Incomes : Discount received 812

Profit on disposal 15
Investment income 2,680 3,507
494,164
Selling and distribution expenses 176,104
Finance costs 1,600 (423,392)
Income tax expense: Current 11,820
Deferred (1,800) (10,020)
Profit for the period 60,752
Basweta Ltd
Statement of Changes In Equity As At 31.03.02
Ordinary Preference Share General F.A Rev. Retained Total
share capital share capital premium reserve Reserve earnings Sh.’000’
Sh.’000’ Sh.’000’ Sh.’000’ Sh.’000’ Sh.’000’ Sh.’000’
Bal b/f 200,000 200,000 400,000 600,000 - 110,848 610,848
Prior adjustment - - - - - - -
200,000 200,000 400,000 600,000 - 110,848 610,848
Restated - - - - - -
Rev. gain on NCA - - - - 30,000 - 30,000
Rev. gain on
investment - - - - 390 - 390
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Rev. gain on - - - - - - -
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foreign
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Net profit: year - - - - - 60,752 60,752
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Dividends:
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Interim - - - - - (13,000) (13,000)
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Bal b/d 200,000 200,000 40,000 60,000 30,390 158,600 68,8990
b)
Basweta Ltd
Balance sheet as at 31 March 2002
Sh.’000’ Sh.’000’
Non Current Assets
Plant, property and equipment 334,900
Investments Other 62000
396900
Current Assets
Stock 204,132
Debtors (336,440 – 16,822) 319,618
Trade investments 30,000
Cash and bank (11,745 + 3,000) 14,745 568,495
965395

Financed by:
Authorised share capital
15m shares 6.5% preference @ Sh.20 300,000
50m share ordinary @ Sh.10 300,000
Issued and fully paid 600,000
10m 6.5% preference shares @ Sh.20 200,000
20m Ordinary shares @ Sh.10 200,000
400,000
Reserves
General reserve 60,000 130,390
Retained profit 158,600 158,600
Shareholders funds 688,990
Non current liabilities

Deferred tax 1,200 21,200
710,190
Current liabilities
Trade creditors 102,000
Tax payable (11,820 – 8,615) 3,205
Accrued directors’ fee 150,000 255,205
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Total Equity And Liabilities 965,395
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Workings
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1. Turnover Sh.’000’
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As per trial balance 1,191,864
Less proceeds and disposals (1,215)
1,190,649
2. Selling and distribution costs
As per TB 78,840
Motor vehicle expenses 59,864
Wages 25,000
Depreciation: Motor vehicle 12,580
176,104
3. Administrative expenses
Wages and salaries 70,834
As per TB 11,492
Audit fees 1,400
Depreciation: fixtures 1,040
Compensation of director for loss of office 8,500
Provision for doubtful debts (16,822 – 14,400) 2,422
Director’s fee 150,000
245,688

Profit on assets disposed
4.
Cost Motor Fixtures & Fittings Total
vehicles
Acc. Dep. 2,800 1,455 4,255
NBV 2,150 905 3,055
Proceeds 650 550 1,200
Profit & Loss 715 500 1,215
6,500
Deferred Tax A/C
Sh.’000’ Sh.’000’
Profit U Loss 1,800Bal b/d 3,000
Bal c/d (30% x 4,000) 1,200
3,000 3,000
Notes to the accounts
Note 1 Accounting policies
These financial statements have been prepared under the historical cost basis of accounting which is
modified to accommodate the revaluation of certain properties and in accordance with the applicable
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IFRSs.
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Property plant and equipment is shown at cost or revalued amount less the total accumulated
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depreciation, which is based on the estimated useful life of the assets.
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Inventory has been stated at the lower of cost and net realizable value.
Note 2 Profit before tax
The profit before tax has been arrived at after charging the following expenses
Sh. ‘000’
Directors fee 205,000
Compensation to director for loss of office 8,500
Depreciation 13,650
Auditors fee 1,400
Staff costs 40,834
Note 3 Taxation
Corporation tax is based on the adjusted profits for tax purpose at a corporation tax rate of 30%

Note 4 Propety plant and equipment
`Cost/Valuation Freehold land Motor Fixtures & Total

& Buildings vehicles Fittings Sh. ‘000’
Sh. ‘000’ Sh. ‘000’ Sh. ‘000’
Bal as at 01.04.01 270,000 48,960 19,200 338,160
Additions - 2,240 1,600 3,840
Disposals - (2,800) (1,455) (4,255)
Revaluations 30,000 - - 30,000
Bal as at 31.03.02 300,000 48,400 19,345 367,745
Accumulated Depreciation
Bal as at 01.04.01 - 13,820 8,460 22,280
Eliminated on disposal - (2,150) (905) (3,055)
Charge for the year - 12,580 1,040 13,650
Bal as at 31.03.02 - 24,250 8,595 32,845
NBV as at 31.03.02 300,000 24,150 10,750 315,880
NBV as at 01.04.01 270,000 35,140 10,740 315,880
Note 5 Dividends
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During the year the company paid a dividend of sh.1.30 on the preference shares outstanding. The
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directors are now proposing a dividend of sh.1.35 per s share on the number of ordinary shares
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outstanding at the end of the year.
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ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS
(IAS 8)
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
The objective of this Standard is to prescribe the criteria for selecting and changing accounting
policies, together with the accounting treatment and disclosure of changes in accounting policies,
changes in accounting estimates and corrections of errors. The Standard is intended to enhance the
relevance and reliability of an entity’s financial statements, and the comparability of those financial
statements over time and with the financial statements of other entities.
Accounting policies
Accounting policies are the specific principles, bases, conventions, rules and practices applied by an
entity in preparing and presenting financial statements. When a Standard or an Interpretation
specifically applies to a transaction, other event or condition, the accounting policy or policies

applied to that item shall be determined by applying the Standard or Interpretation and considering
any relevant Implementation Guidance issued by the IASB for the Standard or Interpretation.
In the absence of a Standard or an Interpretation that specifically applies to a transaction, other event
or condition, management shall use its judgement in developing and applying an accounting policy
that results in information that is relevant and reliable. In making the judgement management shall
refer to, and consider the applicability of, the following sources in descending order:
(a) The requirements and guidance in Standards and Interpretations dealing with similar and
related issues; and
(b) The definitions, recognition criteria and measurement concepts for assets, liabilities, income
and expenses in the Framework.
An entity shall select and apply its accounting policies consistently for similar transactions, other
events and conditions, unless a Standard or an Interpretation specifically requires or permits
categorisation of items for which different policies may be appropriate. If a Standard or an
Interpretation requires or permits such categorisation, an appropriate accounting policy shall be
selected and applied consistently to each category.
An entity shall change an accounting policy only if the change:
(a) Is required by a Standard or an Interpretation; or

(b) Results in the financial statements providing reliable and more relevant information about the
effects of transactions, other events or conditions on the entity’s financial position, financial
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performance or cash flows.
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An entity shall account for a change in accounting policy resulting from the initial application of a
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Standard or an Interpretation in accordance with the specific
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transitional provisions, if any, in that Standard or Interpretation. When an entity changes an
accounting policy upon initial application of a Standard or an Interpretation that does not include
specific transitional provisions applying to that change, or changes an accounting policy voluntarily,
it shall apply the change retrospectively. However, a change in accounting policy shall be applied
retrospectively except to the extent that it is impracticable to determine either the period-specific
effects or the cumulative effect of the change.
Change in accounting estimate
The use of reasonable estimates is an essential part of the preparation of financial statements and
does not undermine their reliability. A change in accounting estimate is an adjustment of the
carrying amount of an asset or a liability, or the amount of the periodic consumption of an asset, that
results from the assessment of the present status of, and expected future benefits and obligations
associated with, assets and liabilities. Changes in accounting estimates result from new information
or new developments and, accordingly, are not corrections of errors. The effect of a change in an
accounting estimate, shall be recognised prospectively by including it in profit or loss in:
(a) The period of the change, if the change affects that period only; or

(b) The period of the change and future periods, if the change affects both.
Prior period errors
Prior period errors are omissions from, and misstatements in, the entity’s financial statements for
one or more prior periods arising from a failure to use, or misuse of, reliable information that:
(a) was available when financial statements for those periods were authorised for issue; and
(b) Could reasonably be expected to have been obtained and taken into account in the preparation
and presentation of those financial statements.
Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies,
oversights or misinterpretations of facts, and fraud.
Except to the extent that it is impracticable to determine either the period-specific effects or the
cumulative effect of the error, an entity shall correct material prior period errors retrospectively in
the first set of financial statements authorised for issue after their discovery by:
(a) restating the comparative amounts for the prior period(s) presented in which the error
occurred; or
(b) if the error occurred before the earliest prior period presented, restating the opening balances
of assets, liabilities and equity for the earliest prior period presented.
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Omissions or misstatements of items are material if they could, individually or collectively,
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influence the economic decisions of users taken on the basis of the financial statements.
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EVENTS AFTER THE REPORTING PERIOD (IAS 10)
IAS 10 Events after the Balance Sheet Date

The objective of this Standard is to prescribe:
(a) when an entity should adjust its financial statements for events after the balance sheet date;
and
(b) the disclosures that an entity should give about the date when the financial statements were
authorised for issue and about events after the balance sheet date.
The Standard also requires that an entity should not prepare its financial statements on a going
concern basis if events after the balance sheet date indicate that the going concern assumption is not
appropriate.
Events after the balance sheet date are those events, favourable and unfavourable, that occur
between the balance sheet date and the date when the financial statements are authorised for issue.
Two types of events can be identified:
(a) those that provide evidence of conditions that existed at the balance sheet date (adjusting
events after the balance sheet date); and

(b) those that are indicative of conditions that arose after the balance sheet date (non-adjusting
events after the balance sheet date).
An entity shall adjust the amounts recognised in its financial statements to reflect adjusting events
after the balance sheet date.
An entity shall not adjust the amounts recognised in its financial statements to reflect non-adjusting
events after the balance sheet date. If non-adjusting events after the balance sheet date are material,
non-disclosure could influence the economic decisions of users taken on the basis of the financial
statements. Accordingly, an entity shall disclose the following for each material category of non-
adjusting event after the balance sheet date:
(a) the nature of the event; and

(b) an estimate of its financial effect, or a statement that such an estimate cannot be made.
If an entity receives information after the balance sheet date about conditions that existed at the
balance sheet date, it shall update disclosures that relate to those conditions, in the light of the new
information.
DISCONTINUED OPERATIONS
Discontinued operations
Discontinued operation is a component (a part of an entity) that either has been disposed off or is
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classified as held for sale and;
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(a) Represents a separate major line of business or geographical area of operation.
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(b) Part of single coordinated plain to dispose off separate major line of business or geographical
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area of operation.
(c) It is a subsidiary acquired exclusively with a view to resale it
Presentation of a discontinued operation
IFRS 5 requires an entity to present the income statement of a group with separate columns for
continuing operations, discontinued operations and enterprise as a whole disclosing the following in
respect of a discontinued operation:
1. A single amount on the face of the income statement comprising of;

(a) Profit/loss after tax from discontinued operations
(b) Post-tax gain or loss on disposal of discontinued operation.
(c) Post – tax gain/loss on measurement to fair value of discontinued operations less cost
to sell.
2. The analysis of the single amount in (1) above either on the face of the income statement or in
the notes to the income statement. The single amount should be analyzed into;
(i) The revenue, expenses and pre-tax profits or loss of discontinued operation
(ii) The related tax expense.
(iii) The gain/loss on disposal of discontinued operations
(iv) The related tax expenses of discontinued operations.
REVISION EXERCISES
QUESTION1
Bara Ltd, a company quoted on the stock exchange, extracted the following trial balance as at 31
October 2006.
Sh. '000' Sh. '000'
Land and buildings at cost 270,000
Plant at cost 156,000
Purchases 78,200
Distribution 10,000
Loan interest paid 2,000
Leased plant rental 22,000
Dividend paid 15,000
Inventories (1November 2005) 37,800
Accounts receivable 53,200
Investments (long-term) 90,000
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Revenue 278,400
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Income from investment 4,500
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Ordinary shares of sh.10 each 150,000
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Accumulated depreciation: Buildings 60,000
Plant 26,000
Differed payable 12,500
Balance at bank 5,400
739,700 739,700
1. The land and buildings were purchased on 1 November 1990. The cost of land was sh.70
million or buildings have been purchased by Bara Ltd. since then. However, on 1 November
2005,the land and buildings were professionally valued at sh.80 million respectively. The
estimated useful life buildings before the revaluation was 50 years. However, the revaluation
did not change the useful life of the buildings. Plant is depreciated at 15% per annum using
the reducing balance method. Depreciation expense is to be included under cost of sales in the
income statement.

2. On 1 November 2005, Bara Ltd. entered into a five year lease agreement for an item of plant.
This item had an estimated useful life of five years. The annual rental which was payable in
advance with effect from 1 November 2005 was sh.22 million.
The fair value of the plant is sh.92 million and the implicit interest rate is 10% per annum.
3. The 8% debentures were issued on 1 January 2006 and interest is payable six months in
arrears.
4. The income tax for the year to 31 October 2006 estimated at sh.28.3 million. The differed tax
provision as at 31 October 2006 was increased to sh.14.1 million.
5. Inventories were valued at sh.43.2 million as at 31 October 2006.
Required:
Prepare in accordance with International Financial Reporting Standards (IFRSs)

(a) Income statement for the year ended 31 October 2006
(b) Statement of changes in equity for the year ended 31 October 2006
(c) Balance sheet as at 31 October 2006
Solution:
a)
Bara Ltd
Income statement for the year ended 31 October 2006
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Sh,000 Sh,000
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Revenue 278,400
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Other incomes: investment income 4,500
167,200
Expenses
Distribution costs 10,000
Profit for the period 111,800
b) Bara Ltd
Statement of changes in equity for the year ended 31 October 2006
Ordinary Revaluation Retained profit Total

Shares reserve
Balance as at 1.11.05 150,000 119,500 269,500
Profit for the period 111,800 111,800
Revaluation of PPE 45,000 45,000
Dividends paid 15,000 15,000

Balance as at 31.10.06 150,000 45,000 216,300 411,300
c) Bara Ltd
Balance Sheet as at 31 October
Sh,000 Sh,000
Non current assets 434,100
Property, plant and equipment 90,000
Investments 524,100
Current assets
Inventory 43,200
Accounts receivables 53,200 96,400
Total assets 620,500
Equities and liabilities
Ordinary share capital 150.000
Reserves
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Shareholder funds 411,300
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Deferred tax 14,100
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Obligation under finance lease 55,000 119,000
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Current liabilities
Accounts/payables 33,400
Accrued loan interest 1,000
Obligation under finance lease 22,000
Current tax 28,300 90,100
Total equity and liabilities 620,500
Workings:
i) Cost of sales
Sh ‘000’
Opening inventory 37,800
Purchases 78,200
Depreciation: buildings 5,000
Plant: owned 19, 500
Leased 18,400
Closing inventory 43,000
115,700

ii) Finance lease Sh ‘000’
Net obligation at start (92-22) 70,000
Accrued interest at 10% 7,000
Total outstanding at year end 77,000
Current liability (next inst.) 22,000
Non current: balance 55,000
iii) PPE / depreciation

Land and buildings
At the date of revaluation land and buildings had a net book valus of Sh 210 million
(270-60). With a revaluation of sh million, this gives a surplus of Sh 45 million. (255- 210)
The accumulated depreciation (60m) represents a 15 years revaluation at Sh 4 million each. The remaining
life is 35 years thus depreciation of buildings will now be 175/35 years
Summary PPE is made up as follows
Cost/evaluation depreciation NBV

Sh 000 Sh 000 Sh 000
Land and buildings 255,000 (5,000) 250,000
Plant owned 156,000 (45,500) 110,500
leased 92,000 (18,400) 73,600
434,100
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QUESTION 2
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HAPA Ltd. manufactures and sells a wide range of food products for both wholesale and retail
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outlets. Its authorized ordinary share capital is 5 million shares of Sh 100 par value.
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The company has extracted the following trail balance as at 31 October 2004.
Sh “000” Sh “000”
Ordinary share capital: issued and fully paid 300,000
10% debentures (secured on buildings) 50,000
8% debentures (secured on a floating charge) 50,000
freehold buildings: Cost 150,000
Plant and machinery: Cost 220,000
Depreciation 40,000
Additions-plant and machinery 40,000
Motor vehicles: Cost 25,000
Land 100,000
Trade and other payables 31,400
Trade and other receivables 101,600
Inventories 163,000
Balance at Faida Bank 47,000
Directors remuneration 52,000

Balance at Faulu Bank 3,800
Investment ( market value: Sh. 35 million) 49,620
Interest received 32,000
Interim dividends paid 2,100
Tax paid 21,000
Dividend received 5,700
1,400
963,720 963,720
1. Trading profit has been derived as

follows:
Sales Sh. ‘000’ Sh. ‘000’
Cost of sales 927,420 1,432,000
Distribution costs 82,670 (1,146,180)
Administrative expenses 136,090 285,820
2. The 10% debentures are redeemable at par in ten equal annual instalments commencing
1 November 2004, while the 8% debentures are due on 31 July 2005.
3. The corporation tax at 30% on the adjusted profit for the year has been computed at Sh.
53 million.
During the year, an item of plant which cost Sh. 20 million on 20 September 2000 was
disposed of for Sh. 5 million. The disposal proceeds have netted off against the amount
incurred in acquiring new plant and machinery.
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4. Depreciation on property, plant and equipment is to be provided on cost and allocated as
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follows:
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Freehold buildings Rate Basis of allocation
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1
Plant and machinery 2 /2% per annum Administrative expenses
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Motor vehicles 15% per annum Cost of sales
20% per annum Distribution costs
A full year’s depreciation is charged in the year of acquisition but none in the year of
disposal.
5. Inventories comprise:
Raw materials Sh. ‘000’
Work-in-progress 50,900
Finished goods 24,875
87,225
6. Employees costs included in relevant functional expenses are:
Salaries and wages Sh. ‘000’
Social security costs 478,770
Pension costs 67,500
42,000
Directors’ fees amounting to Sh. 3 million have not been provided for.
7. The directors propose to pay a final dividend of Sh. 8 per share.
Required:
(a) Income statement for the year ended 31 October 2004
(b) Balance sheet as at 31 October 2004. include relevant notes, using only the
information provided, to ensure that the financial statements are in conformity
with International Financial Reporting Standards
Note: Do not prepare a statement of changes in equity.
Solution:
(a) Hapa Ltd

Income statement for year ended 31/10/2004
Sh. ‘000’ Sh. ‘000 ’
Turnover 1432,000
Other incomes 31,500
468,330
Expenses
Distribution costs 87,670
Administration costs 198,640
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Profit after tax 120,020
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Dividends paid (21,000)
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Retained profit for the year 99,020
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(b) Hapa Ltd Sh.(000) Sh.(000)
Balance sheet as at 31/0ctober 2004
Non current assets
Property /plant equipment 421,500
Investments 35,000
456,500
Current assets
Inventories 163,000
Trade & other receivable 101,600
Bank balance 49,620 314,220
Total assets 770,720

Revaluation Reserve 3000
Retained profits 230,020
Shareholders funds 533,020
10% Debentures 45,000
Current liabilities

Trade payables & accounts 43,400
Tax payable 47,300 192,700
Total equity & liabilities 770,720
Notes to the accounts
Note 1: Accounting policies
a) These financial statements have been prepared under the historical cost basis of accounting and in
accordance with the applicable IFRSs.
b) Inventory is valued at the lower of cost and net realizable value.
c) Depreciation is based on the estimated useful life of the assets at the following rates;
Asset Rates
Buildings 2 ½%
Plants and machinery 15%
Motor vehicles 20%
Note 2 Profit for the year is arrived at after changing the following expenses.
Sh.’000’ Sh. ‘000’
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Directors emoluments: fees 3,000 52,000
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Others 52,000 48,500
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Depreciation 3,800
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Addition remuneration 588,270
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Staff costs
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Note 3 property, plant and equipment
Cost/valuation Free hold and Plant and Motor Total
buildings machinery vehicles
Sh.’000’ Sh.’000’ Sh.’000’ Sh.’000’
Balance as at 1.11.03 250,000 220,000 25,000 495,000
Additions - 45,000 - 45,000
Disposals - (20,000) - (20,000)
Balance as at 31.12.04 250,000 245,000 25,000 520,000
Depreciation
Balance as at 1.11.03 15,000 40,000 10,000 65,000
Change for year 3,750 36,750 5,000 45,000
Eliminated disposal - (12,000) - (12,000)
Balance as at 31.10.04 18,750 64,750 15,000 98,500
NBV as at 31.10.04 231,250 18,250 10,000 421,500
NBV as at 1.11.03 235,000 180,000 15,000 430,000
Note 4 inventory
Inventory is made up as follows
Sh.’000’

Row materials 50,900
Work in progress 24,875
Finished goods 87,225
163,000
Workings
Expenses
Cost of sales Distribution costs Administration expenses

Sh.’000’ Sh.’000’ Sh.’000’
As per question 927,420 82,670 136,090
Depreciation: plant 36,750
Vehicles 5,000
Buildings 3,750
Loss on sale of plant 3,000
Directors salaries 52,000
- fees 3,000
Audit fees and expenses ________ _______ 3,800
967,170 87,670 198,640
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Depreciation of plant for the year Sh. ‘000’
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(15% x (220 – 45 – 20) 36,750
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loss on disposal (20 - 12 - 5) 3,000
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TOPIC 6
SUBSIDIARIES (GROUPS), ASSOCIATES AND JOINTLY

CONTROLED ENTITIES
INTRODUCTION
Key Definitions
Subsidiary: an entity, including an unincorporated entity such as a partnership, that is controlled by

another entity (known as the parent).
Parent: an entity that has one or more subsidiaries.
Holding/parent company – this is an entity that has one or more subsidiaries.
Group – This is the parent and all its subsidiaries
Non-controlling interest (NCI) – It is that portion of net assets of a subsidiary attributable to equity
interest which are not owned directly or indirectly through subsidiaries by the parent.
Institutional Requirement
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Consolidated financial statements: the financial statements of a group presented as those of a
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single economic entity.
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Control: the power to govern the financial and operating policies of an entity so as to obtain
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benefits from its activities
A subsidiary company is a company in which the investing company (also called parent or parent
company) controls the financial and operating policies of the subsidiary company.
Control is usually based on ownership of more than 50% of voting power, but other forms of control
are possible.
Other forms include:

According to IAS 27 four other situations where control can exist are when the parent has power to:
1. Over more than half the voting rights by virtue of an agreement with other investors.
2. To govern the financial and operating policies of an entity under statute or an agreement
3. To appoint or remove the majority of the members of the board of directors
4. To cast the majority of votes at a meeting of the board of directors
Example:
Z is considering an investment on west, the capital structure of which is as follows 10,000 A voting
ordinary shares 10,000 B non-voting ordinary shares. Both classes of shares have the same dividend
rights:

Describe the appropriate group accounting for west if
i. Z purchases 6,000 of A ordinary shares.__(60%)
ii. Z purchases 10,000 B and 4,000 A ordinary shares__(associate)
Answer to Example
i. It is the voting share that gives Z the influence on west. Z should control west in this case.
West will therefore be treated as a subsidiary because Z owns 60% of the voting shares in
west.
ii. As Z has less than 50% of the voting shares this time Z will not probably be able to control
west therefore west will not be treated as a subsidiary
IAS 27 requires that consolidated financial statements shall include all subsidiary of the parent. The
two exceptions to these rules are:
1. Lack of effective control – the excluded should be accounted for as an investment in
accordance with IAS 39
Subsidiary held for resale – held for resale subsidiary is treated as a current asset investment and
valued at lower of the carrying amount and fair value less cost to sell
In most cases, control is evidenced (but not limited) to owning more than 50% of the ordinary share
capital of the subsidiary company. Control may also be exercised in the following ways;
i) The parent company owning more than 50% or the voting rights in the company or subsidiary
company.
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ii) The parent company being able to appoint majority of the directors in the board of directors.
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iii) The parent company carrying out favourable transactions with the subsidiary e.g. sale and
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purchase of goods at a price below the market value.
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The substance of the relationship between parent company and subsidiary company is the
effectively, the parent company controls the subsidiary company. This means that the parent
company controls the assets of the subsidiary company and is liable to the debts of the subsidiary
company.
1AS 27 therefore requires that the parent a company should include the financial results of the
subsidiary company in its own financial statements. The process involves adding the assets,
liabilities and incomes and expenses of the subsidiary company to those of the parent company
while excluding inter-company transactions and balances. This process is called consolidation and
the combined financial statements are called Group accounts or consolidated accounts.
The purpose of consolidated accounts is to:

1. Present financial information about a parent undertaking and its subsidiary undertakings as a
single economic unit.
2. Show the economic resources controlled by the group
3. Show obligations of the group and
4. Show the results the group achieves with its resources

Consolidated financial statements under the entity concept
Consolidated financial statements are prepared by replacing the cost of investments with the
individual assets and liabilities underlying the investment. If the subsidiary is partly owned, all
assets and liabilities of subsidiaries are consolidated, but the non-controlling shareholders interest in
those net assets is presented.
Principles of consolidation
1. Non-conterminous
Some companies in the group may have differing accounting dates in practice; such companies will
often prepare financial statements up to the group accounting date for consolidation purposes.
For purpose of consolidation, IAS allows use of financial statements made up to date not more than
three months earlier or later than the parent reporting date, with due adjustment for significant
transactions or other events between the dates.
2. Uniform accounting policies

All groups companies should have the same accounting policies. If the group member uses different
accounting policies, its financial statements must be adjusted to achieve consistency before they are
consolidated
3. Eliminating intra-group transactions

This must be eliminated on consolidation in order to achieve the main objective of group financial
statements, i.e. to show the position of the group as if it were a single economic entity. A group
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cannot trade with itself, nor can it make a profit out of itself. In a similar way cannot increase its
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sales or its net assets by transferring assets and liabilities between members of the group
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Related parties
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Two parties are considered related if
1. One party has the ability to control the other party or
2. One party has the ability to exercise significant influence over the other party or
3. The parties are under common control. Therefore
1. A company that is a subsidiary is a related party of its parent company
2. This means that the financial statement may have been affected by related party
transactions
Types of transactions that may occur between the parent and subsidiary (related parties) and their
impact on the financial statements of the individual company and the group are:
Transactions Potential impact

Sales and purchases Favourable prices, affecting profits, advantageous
settlement terms, affecting receivables and payables
Finance Favourable rates of interest, affecting profits
Non-current assets Favourable terms for cost financing
Promotion services At minimal or no cost, affecting profits
Guarantees for loans and Without which they wouldn’t have been granted
overdrafts
Even when related party transactions are at arm’s length, it’s important to realize that they are
related party transactions. This is because it is quite possible that they would not have occurred but
for the relationship.
ACCOUNTING FOR ONE SUBSIDIARY
Preparation of Consolidated Financial Statements

IFRS 3 requires that the acquisition method of accounting be applied in accounting for business
combinations.
This entails;
1. Identifying the acquirer (parent)
2. Measure the cost of business combination (cost of investment)
3. Allocate at the date of acquisition the cost of business combination to the assets acquired and
liabilities or contingent liabilities assumed i.e. the net identifiable assets representing the
equity interest acquired.
Preparation of consolidated statements of financial position (CSFP)

In the preparation of consolidated statement of financial position, the draft statement of financial
position of the parent company and those of the subsidiary (ies) are combined on a line by line basis
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by adding together like items of assets, liabilities and equity.
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However, in order that Consolidated statement of financial position presents financial information
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about a group as that of a single enterprise, the following adjustments or considerations have to be
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made;
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1. Investment in the subsidiary.
The investment in the subsidiary appearing as a Non-current asset in the parent books does not
appear in consolidated statements. However it is credited to the Cost of control account in the
determination of goodwill or discount on acquisition.
2. Goodwill on acquisition
Goodwill is the difference between the value placed upon a firm and the value of its net asset.
IFRS 3 defines goodwill as the future economic benefits that are not separately identifiable.
Net Assets = Asset – Liabilities
Net Assets is the shareholder’s interest in a company which can also be determined by considering
the shareholders fund.
Share holders fund comprises of; Ordinary share capital, Share premium, Reserves and Retained TI.

Goodwill is then determined as follows
Cost of investment xxx

Less: Fair value of Net Account acquired (xxx)
xx
Goodwill on acquisition can be determined using two methods;
i) Partial method – This is where only the goodwill of the parent portion of net assets in the
subsidiary is considered or is determined.
ii) Full method – Where goodwill of the subsidiary as a whole is considered. In this case
NCI is measured at fair /full value.
Negative goodwill
Goodwill arising on acquisition is one form of purchased goodwill. It is the different between the
cost of investment and the fair value of net assets acquired. This difference can be negative i.e. the
fair value of net assets acquired may exceed the cost of acquisition. IFRS refer to these as Burgan
purchase and in this case the entity should re-asses the amount at which it has measured the cost of
investment and the fair value of the acquiree net assets in order to identify any error.
Any excess after the reassessment should be recognised in the income statement as an income,
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immediately during the period it arises.
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ILLUSTRATION
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H limited acquired 75% of the ordinary shares in S limited on 1st January 2011 when S limited
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retained earnings was sh 15,000. The market of S limited ordinary shares as at that date was sh 1.6
share. H limited and S limited statement of financial position as at 31st December 2011 was as
follows:
H ltd S Ltd H Ltd S Ltd

Sh Sh Sh. Sh.
Assets Equity and Liabilities
Non – Current Ordinary share capital (Sh1
Property,plant & equipment 60,000 50,000 loss) 100,000 50,000
Investment in S Ltd 68,000 - Returned earnings 70,000 25,000
Current Assets 20,000 15,000 Accounts payables 10,000 10,000
Inventory 32,000 20,000 ____ ____
Cash and bank bal 180,000 85,000 180,000 85,000
Required
a) Determine the value of goodwill using the two methods

b) Consolidated H of financial position on the assumption that Non-controlling interest (NCI) is
valued at fair value
Solution
Determine the net asset in S limited as at 1/12011 and as at 31/12/2011.
Net Assets = Assets - Liabilities
As at 1/1/2011
Ordinary shares 50,000
65,000
As at 31/12/2011
75,00 0
Goodwill on acquisition
Using partial method
Cost of investment 68,000
Less: Net Assets acquired (65,000 x 75%)
19,250
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Using full method
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Parent goodwill 19,250
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Add: Non-controlling Interest goodwill
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Fair value of Non-Controling Interest (25% x 5000) = 12500 x 1.6 20,000
Less: NCI portion of net asset (25% x 65000) 16,250
N.C.I Goodwill 3750
Full Goodwill 23,000
Value of Non-Controling Interest as at 31st December 2011.
i) At their proportional share of Net Assets

25% x 75000 = 18,750
ii) At fair value
Proportionate share of net Asset 18,750

Add: Non-Controling Interest goodwill 3750
Fair value of Non-Controling Interest 22,500

Property, plant &equipment Account
Shs. Shs.
H Ltd 60,000 Bal c/d 110,000
S Ltd 50,000
110,000 525,057
Inventory Account
Shs. Shs.
H Ltd 15,000 Bal c/d 35,000
S Ltd 20,000
35,000 35,000
Investment Account
Shs. Shs.
H Ltd 68,000 Cost of control 68,000
Cash and Bank Account

Shs. Shs.
H Ltd 32,000 Bal c/d 52,000
S Ltd 20,000
52,000 52,000
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Account Payables
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Shs. Shs.
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Bal c/d - H Ltd 10,000
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20,000 S Ltd 10,000
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20,000 20,000
Ordinary sharecapital Account

Shs. Shs.
Cost of con. (75%x50,000) 37,500 H Ltd 100,000
Non-Controling Int.(25% x 50,000) 12,500 S Ltd
Bal c/d 50,000 50,000
150,000 150,000
Retained Account
Shs. Shs.
Cost of control(75%x15) 11,250 H Ltd 70,000
NCI(25%X25) 6250 S Ltd 25,000
Bal c/d 77,500 ______
95,000 95,000

Goodwill Account
Shs. Shs.
Cost of control 19,250 Bal c/d 23,000
Non-controlling intrest 3,750
23,000 23,000
Non- Controlling Interest Account

Shs. Shs.
Bal c/d 22,500 Ordinary share capital 12,500
Goodwill 3,750
22,500 22,500
H. Group
Statement of financial Position as at 31st December 2010
Sh.
Assets
Non – Current Asset
Property,plant & equipment 110,000
Goodwill 23,000
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Current Assets
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Inventory 35,000
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Cash and bank bal. 52,000
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220,000
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Net Asset attributable to parent shareholders 177,500
Net Asset attributable to NCI 22,500
Current liabilities
Accounts payables 20,000
220,000
3. Inter-company debts and inter-company transactions

At times the parent company and the subsidiary Company may transact with each other. These
transactions between companies in the same group are referred to as intra group transactions which
can either be upstream or downstream.
If the inter-company transactions are on credit basis they may give rise to intercompany balances.
However, intercompany balances should be eliminated in full in the consolidated process.

Where the intercompany balances are not the same in the books of the parent and the subsidiary, this
is a result of items in transit which could either be goods in transit or cash in transit.
The adjusting entries should be made in the group account balances for these items in transit before
intragroup balances are eliminated in full;
a. With the goods in transit,
Debit: Group inventory
Credit: Group creditors
b. With cash in transit,
Debit: Group cash and cash equivalents
Credit: Group debtors.
Goods are usually sold between members of the group at prices above the original cost incurred by
the selling company. It is possible that goods sold between the members of the group are not sold to
third parties by the purchasing company at the close of the financial year i.e. they remain in the
inventory of the purchasing company. This gives rise to the element of unrealized profits. The
accounting treatment of intra-group transactions in relation to incomes, expenses and even dividends
is that they should be eliminated in full in the consolidation process. Similarly, profits or losses
arising from inter-company transactions that are not recognized or realized from the assets. E.g.
stocks are eliminated in full.
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Therefore, with unrealized profits on stock;
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Debit: Group income statement
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Credit: Group inventory
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However, if the stock of goods relates to an upstream sale, the unrealized profits should be
eliminated in full from the profits of the subsidiary and from the group inventory with the
Non-controlling interest recognized with its share i.e.

Debit: Group income statement (parent share)
Credit: Group Inventory
4. Pre-acquisition and post-acquisition profits

The pre-acquisition reserves are reserves/ profits that exist in the subsidiary company as at the date
of acquisition. These pre acquisition profits should be capitalized as at the date of acquisition as part
of equity interest acquired in the subsidiary. Therefore, they are credited to the cost of control
account and are not readily available to the holding company as income.
Post – acquisition reserves/ profits are made by the subsidiary after the date of acquisition. The
holding company should therefore share in this post-acquisition profits/ reserves. Thus, the group
share of post- acquisition profits is combined with the retained earnings of the parent company in the
determination of group retained earnings carried forward.

5. Unrealised profit on closing stock
This arises when a group company sells goods to another group company at a profit and the goods
remains in stock of the other company / buying company. Any profit made by the selling company
as considered unrealised and should be eliminated in full on consolidation i.e.
DR Profit and Loss account
Cr. Inventory account
During the post acquisition period H ltd. Sold goods to its subsidiary S ltd.for shs.750 making a
profit of 50% on cost.All the foods remained in store of S ltd as at the year end. The investors of H
Ltd and S Ltd as at the year end were sh 1025 and Sh 2040 respectively.
Required;
Group inventory
Group Inventory Account
Shs. Shs.
1
H Ltd 1025 Profit and loss ( /3 x 750) 250
S Ltd 2040 Bal c/d 2815
3065 3065
6. Preference shares in the subsidiary

Where the parent company acquires preference shares in the subsidiary in addition to ordinary
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shares, the nominal value of the preference shares acquired is treated as part of the equity interest
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acquired and is credited to the cost of control.
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The cost of investment in the preference shares is debited to the Cost of Control (COC) account. The
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nominal value of the preference shares not acquired by the group is closed to the Non-Controlling
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Interest account.
NB: The proportion of preference shares acquired by the parent in the subsidiary does not determine
controlling interest in the subsidiary.
7. Debentures in the subsidiary

A parent company may also invest in the debt instrument issued by the subsidiary. The nominal
value of the debt instrument acquired by the parent company is the subsidiary is credited to the cost
of control account while the amounts paid to acquirer the debt instrument is debited to the Cost of
Control account.
The nominal value of the debentures not acquired by the parent is shown as a separate line item of
non-current liabilities in the CSFP rather than being closed to the Non-controlling interest (NCI)
account.
8. Inter- company dividends

These are dividends paid or payable by the subsidiary company to the parent company.

Interim dividends paid out of post – acquisition profits will not affect the consolidation process. The
accounting entries passed in relation to intercompany interim dividends are;
In the books of the parent

Debit: Cash at bank
Credit: Income statement
In the books of the subsidiary

Debit: Income statement
Credit: Cash at bank
However, care should be taken when dealing with dividends payable appearing as current liability in
the subsidiary books and as dividends receivable in the holding company books.
The amounts of dividend owing to the holding company are an inter-company balance which should
be eliminated in the preparation of group Financial Statement.
When dividends are paid from pre-acquisition profits, they should be considered as a return on
investment rather than income. Therefore, those dividends paid from pre- acquisition profits (pre-
acquisition dividends) should be used to reduce the amounts of original investment in the investee.
Thus pre- acquisition dividends are credited to the Cost of Control (COC) account as part of the
equity interest acquired by the subsidiary.
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The amounts of pre- acquisition dividends can be calculated based upon any of the following three
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situations:
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i. The subsidiary company pays interim dividends as well as declares final dividends both
events taking place after the date of acquisition.
ii. The subsidiary company pays interim dividends and declares final dividends but interim
dividends paid before date of acquisition.
iii. The subsidiary company only declares a first and final dividend during the post – acquisition
period.
ILLUSTRATION 1
SITUATION 1
Investee Company pays interim dividends and declares final dividends during the post – acquisition
period.
H.Ltd acquired 75% shareholding in S.Ltd on 1 April 2011. The group year-end on 31 December
each year S.Ltd paid an interim dividend of Sh. 50,000 on 1 September 2011 and declares a final
dividend of Sh.90, 000 on 31 December 2011.

Required:
Show how H.Ltd will account for the dividends from S.Ltd
Shs
Debit: Dividend receivable 75% × 90,000 67,500
Debit: Cash at bank 75% × 50,000 37,500
105,000
Credit: Income statement 75% × (50,000 + 90,000) × 9/ 12 78,750
Credit: Cost of control(pre-acquisition
acquisition dividends) 26,250
105,000
Pre – acquisition dividends = Total dividends (received and receivable) – Dividend income (earned)
SITUATION 2
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Subsidiary company pays interim dividends before date of acquisition and declares a final dividend
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at the year end.
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Using illustration in situation (i) and assuming that the interim dividends were paid on 31 March
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2011 and H. Ltd acquired the subsidiary S.Ltd on 30 June 2011.
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Required:
Show how the parent could account for the dividends.
Shs Shs
Debit: Dividend receivable 75% × 90,000 67,500
Credit: Cost Of Control (bal) 52,500
Credit: Profit and Loss (75% × (90,000 + 50,000) × 6/12 15,000

Being amounts of dividends receivable by H.Ltd from S.Ltd
SITUATION 3
Investee Company only declares a first and final dividend.
H.Ltd acquired 80% shareholding in S.Ltd on 1 Sep. 2011, the group year ends on 31 Dec each year.
S.Ltd declared
eclared a first and final dividend of Sh.120, 000
Required;
Shs Shs
Debit: Dividend receivable 80% × 120,000 × 4/ 96,000
Credit: Profit and Loss 12 64,000
Credit: COC account (bal) 80% × 120,000 32,000
Being the amount of dividends receivable by H. Ltd from S. Ltd
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9. Bonus shares in subsidiary
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When a subsidiary company issues bonus shares and the holding company receives its shares, then
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the holding company will not make any double entry in its books since the bonus shares were not
paid for by the holding company.
The only entry the holding companypany will make is to increase the number of shares held in its
subsidiary.
When consolidation workings are to be done it is necessary for the holding company to determine
which profits financed the bonus shares i.e. whether bonus shares were financed from the acquisition
profits or post acquisition profit. The profits used to finance bonus shares have an effect in the
preparation of the cost of control account.
10. Fair value adjustment

When holding company acquires investment n subsidiary, the assets of of the subsidiary should always
be stated at the fair value. When this happens, there are two options to be adopted:
a. The subsidiary may opt to incorporate revaluation adjustment in the books of accounts.
Thus;
i. With an upward revaluation
Debit: Property
erty Plant Equipment (PPE) Account
Credit: Revaluation reserve Account

ii. With a downward revaluation
Debit: Revaluation reserve Account
Credit: PPE Account
The revaluation reserve is a pre-acquisition reserve because the revaluation adjustment takes place at
the date of acquisition. The balance of the revaluation reserve created should be eliminated by
transfer to the cost of control account and Non-controlling Interest (NCI) account.
If a revaluation gain:
Debit: Revaluation reserve account
Credit: Cost of Control account (parent share)
Credit: NCI account (minority shares)
b. The subsidiary company may opt not to incorporate the revaluation adjustment in its books of
account.
If the fair value adjustment has not been incorporated in the subsidiary books then whenever
consolidated Financial Statements are to be prepared, two adjustments have to be carried out;
i. Fair value adjustments ( as in option a(i) above)
Debit: PPE account
Credit: Revaluation reserve account
And
Debit: Revaluation reserve account
Credit: COC account
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Credit: NCI account
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ii. Depreciation adjustments
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Whenever there is a fair value adjustment, a depreciation adjustment on revaluation must be
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made as from the date of acquisition up to the date of consolidation.
The depreciation adjustment affects the profits of the subsidiary and therefore those profits must be
adjusted for depreciation before the Non-controlling interest share. Thus, those profits must be
adjusted for depreciation before the Non-controlling interest share. Thus, with the depreciation
adjustment on revaluation, if upward revaluation;
Debit: Retained earnings (understatement in depreciation)
Credit: PPE account
If on downward revaluation:
Debit: PPE account
Credit: Retained earnings (excess depreciation).
11. Inter- company purchase of Property Plant And Equipment (PPE)

Sometimes PPE items are sold by holding company to the subsidiary and vice versa.
If PPE items are sold at a profit, two adjustments shall be made,

a. Unrealized profit adjustment
This adjustment is made in the income statement of the selling company and the asset account so as
to eliminate it in the books of the purchasing company.
Thus;
i. With the unrealized profit.
Debit: Profit and Loss (selling Co.)
Credit: PPE (purchasing Co.)
ii. With the unrealized loss
Debit: PPE (purchasing Co.)
Credit: Profit and Loss (Selling Co.)
b. Depreciation adjustment
When one group member sells PPE to another group member at a profit, the purchasing company
would end up overstating depreciation because of using over valued amount. Thus, the depreciation
adjustment should be made in the books of the purchasing company from the date of transaction.
To do adjustment one is required to first calculate whether the purchasing company has been
overcharged or undercharging depreciation,
The adjustment will be as follows

a) With the total overcharge of depreciation Debit provision for depression Account or Group
Profit and loss account
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b) With the total undercharge Debit Group profit and loss account
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N.B It is advisable to do the necessary adjustment before distributing retained profits of the
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subsidiary into amounts to be passed to the cost of control, Non-Controlling Interest and profit and
loss account.
IFRS 3 requires the application of full method of accounting of goodwill on acquisition. This entails
recognition of goodwill on acquisition attributable for the holding company and also attributable to
the Non-controlling interest. Therefore, goodwill on acquisition includes the share of goodwill on
acquisition attributable for the holding company and also attributable to the Non-controlling interest.
Therefore goodwill on acquisition includes the share of goodwill on acquisition of Non-controlling.
This is opposed to partial method of accounting for goodwill on acquisition where goodwill on
acquisition only comprises of the group share of goodwill on acquisition as determined through the
cost of control account. Impairment losses are recognized as expenses in the period. When using full
method, the impairment loss arising should be allocated to the group and the Non-controlling
interest based on the percentage shareholding.

Inter Company Sale of fixed Assets .
This is where group companies sells non-current assets to each other. Any profit or loss on disposal
reported by the selling company should be eliminated in full on consolidation, such profit is
considered unrealised because the asset still belongs to the group.
In case the asset disposed is included in the profit and loss a depreciable asset, any depreciation
provided on the profit and loss on disposal should be adjusted. Such depreciation is considered as
depreciation on charge or undercharge.
ILLUSTRATION:
H ltd acquired a controlling interest in S ltd several years ago. During the year ended 31st December
2011 H ltd sold an item of plant to S ltd as 1 April 2011 for Sh20000. H ltd made a profit of 25% on
cost S ltd depreciate similar plant at the rate of 25% p.a on cost.
property,plant&equipment balance as at 31st December were sh 1025 m and 870 respectively.
Required
Group Property, plant & equipment Account
Group Property,plant & equipment Account
Shs. Shs.
H Ltd 1025 Profit and loss (Profit as dep) 4
S Ltd 870 Bal c/d 1895.75
Profit and Loss 0.75
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1895.75 1895.75
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Profit on disposal of plant
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1
/5 x 20 = 4m
Dr. Profit & loss – 4m
Cr. Proprty,plant & equipment – 4m
Depreciation
Depreciation for the year 25% x 20x 9/12 =3.75
Depreciation on cost = 25% x 16 x 4/12 = 3
Depreciation on profit (25% x 4 x 9/12) = 0.75
Dr. Property, plant& equipment = 0.75
Cr. Profit & Loss = 0.75
12. Consolidating Assets and Liabilities

In order that the assets and liabilities of the group are presented as if they are of a single entity, the
full adjustments required to be made are the group assets and liabilities.
Intragroup balances: This refers to intragrouped indebtedness where group companies owes each
other.
Intragroup balances should be eliminated in full when consolidating
Any cash in transit should be adjusted before eliminating the intragroup balance.
H Limited acquired a controlling interest in S1 Limited and S2 Ltd several years ago. During the year
ended 31st December 2011, the debtors and creditors balances at the three companies were as
follows:
H Ltd S Ltd Se Ltd
Debtors 4000 3600 2000
Creditors 2800 2400 1600
The following intragroup balances are included in the debtors and creditors balances of the three
companies.
 Debtors of H Ltd include Sh 800 due from S Ltd
 Debtors of S2 Ltd includes Sh 400 due from H Ltd
 Debtors of S1 Ltd include Sh 600 due from S2 Ltd
As at 31st December 2011 S1 Ltd remitted sh 800 to H Ltd which was received by N. sh as at 3rd Jan
2012
Required
Group debtors and creditors balances
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Group Debtors
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Shs. Shs.
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H LTD 4000 Cash in transit 200
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S LTD 3600 Intragroup 1600
S2 LTD 2000 Bal c/d 7800
9600 9,600
Group Creditors
Shs. Shs.
Intragroup 1600 H Ltd 2800
Bal c/d 5200 S1 Ltd 2400
S2 Ltd 1600
6800 6800

CONSOLIDATED INCOME STATEMENT
In the preparation of consolidated income statement, a number of adjustments need to be done to the
draft income statement so that the group income statement presents information as that of a single
economic entity.
These adjustments are:
i. Inter- company transactions (trading)

When one company in the group sells goods to the other group member, the selling company will
include this sell in its sales and the purchasing company will include these intercompany purchases
in its purchases. From a broad perspective of the group neither sales nor purchases has taken place
and therefore the amount sold in intercompany sales should be eliminated from the group sales as
well as from group cost of sales.
When goods as well as from group cost of sales.
When goods are sold by one company in the group to the other and remain unsold at the end of the
financial year, the amounts of unrealized profits on unsold at the end of the financial year the
amounts of unrealized profits on stock must be ascertained. If unrealized profit is on the closing
stock, the intercompany adjustment made is to add the amount to the group cost of sales.
If the unrealized profit is on the opening stock, the amount is deducted from group cost of sales on
the assumption that profits are realized on FIFO basis.
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Therefore; group sales will be:-
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Parent Company sales XX
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Subsidiary company sales (XX)
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XX
Less: intercompany sales XX
XX
Group cost of sales will be;-

Parent Company sales XX
Subsidiary company cost sales XX
XX
Less: intercompany purchases (XX)
Add: Unrealized Profit on Closing Stock XX
Less: Unrealized Profit on opening Stock (XX)
ILLUSTRATION 2
P Co acquired 75% of the ordinary shares of S Co on that company's incorporation in 2003. The
summarised income statements and movement on retained earnings of the two companies for the
year ending 31 December 2006 are set out below.

P Co P Co
Sh Sh
Sales revenue 75,000 38,000
Cost of sales (30,000) (20,000)
Gross profit 45,000 18,000
Administrative expenses ( 14,000) (18,000)
Profit before tax 31,000 10,000
Income tax expense (10,000) (2,000)
Profit for the year 21,000 8,000
Note: Movement on retained earnings
Retained earnings brought/forward 87,000 17,000
Profit for the year 21,000 8,000
Retained earnings carried forward 108,000 25,000
Suppose that S Co had recorded sales of Sh. 5,000 to P Co during 2006. S Co had purchased these
goods from outside suppliers at a cost of Sh. 3,000. One half of the goods remained in P Co's
inventory at 31 December 200 6. Prepare the revised consolidated income statement.
Required;
Prepare the consolidated income statement and extract from the statement of changes in equity
showing retained earnings and non-controlling interest.
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SOLUTION
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The consolidated income statement for the year ended 31 December 2006 would now be as follows.
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Sh.
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Sales revenue (75 + 38-5) 108,000
Cost of sales (30,000 + 20,000 – 5,000 + 1,000 ) (46,000)
Gross profit (45,000+ 18,000-1,000) 62,000
Administrative expenses (22,000)
Profit before taxation 40,000
Profit attributable to:

Owners of the parent 26,250
Non-controlling interest (8,000 - 1,000) x 25% 1, 750
28,000
Note:
Retained earnings brought forward 99,750
Retained earnings carried forward 126,000
Unrealised Profit ½ ×( Sh. 5,000 – Sh. 3,000)

An adjustment will be made for the unrealised profit against the inventory figure in the consolidated
ii. Non – controlling interest(NCI)

The NCI in group income statement is recognized with its share of equity interest in the subsidiary
of the profit after tax reported by the subsidiary. However, the net profit after tax of the subsidiary
should be adjusted for the following before NCI share;
a. Unrealized Profit on opening Stock in case of upstream intercompany trading (add)
b. Unrealized Profit on Closing Stock in case of upstream intercompany trading (less)
c. Depreciation adjustment in case of fair value adjustment (less)
d. Unrealised profits incase of upstream transactions(less)
e. Unrealised losses incase of upstream transactions(add)
f. Under depreciation adjust incase of down stream intercompany purchase of PPE
g. Excess depreciation adjust incase of down stream intercompany purchase of PPE
Therefore:
iii. Inter – company dividends

It is only dividends paid or payables by the parent company which appear on the Consolidated
Income Statement.
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Dividend paid or payable by the subsidiary are partly intercompany (i.e. to the parent and therefore
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should be eliminated in full) and partly belong to the NCI (whom already have been recognized with
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their share of the entire PAT of the subsidiary)
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iv. Group retained earnings brought
This comprises of;
a) The parent company retained earnings b/f subject to adjustment for prior period, ups and
impairment losses.
b) Group share of the post- acquisition retained earnings b/f of the investee companies subject to
adjustments from:
1. Unrealized profit closing stock in case of upstream intercompany trading in the previous year.
2. Prior year depreciation adjustment on fair value adjustment and intercompany sale of Property
Plant and Equipment.
ILLUSTRATION 3
Agano Ltd. acquired 72% of the ordinary shares of Dando Ltd. on 1 July 2009 for Sh.250 million.
On 31 August 2009, the statements of financial position of the two companies were as follows:
Agano Ltd Dando Ltd

Sh. ‘million’ Sh. ‘million’
Non-current assets:
Property, plant and equipment 223 270
Investment in Dando Ltd. 250 __
473 270
Current assets:
Inventory 50 62
Trade receivables 60 48
Cash and cash equivalents 19 14
129 124
Total assets 602 394
Equity and liabilities:

Ordinary shares of Sh. 1 each 300 200
Share premium 40 10
Retained earnings brought forward 150 40
Profit for the year 60 24
210 64
550 274
Non-current liabilities:
3% debentures 40 100
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Trade payables 12 20
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Total equity and liabilities 602 394
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1. On 31 July 2009, Dando Ltd. sold an item of property, plant and equipment to Agano Ltd.
realising a profit on sale of Sh.20 million. Agano Ltd. was depreciating this item over its
remaining useful life of 4 years. It is the group's policy to charge a full year's depreciation in
the year of purchase and none in the year of disposal.
2. On 29 August 2009, Agano Ltd. sold goods to Dando Ltd. for Sh.26 million. Agano Ltd. sells
goods at a mark-up of 30%. Dando Ltd. had sold a quarter of these goods by 31 August 2009.
3. As at 31 August 2009, the trade receivables of Agano Ltd. included Sh.12 million due from
Dando Ltd. while the trade payables of Dando Ltd. included Sh.7 million due to Agano Ltd.
4. Goodwill was impaired by 25% as at 31 August 2009.
5. Agano Ltd. and Dando Ltd. had declared dividends of Sh.I5 million and Sh.10 million
respectively before 31 August 2009, but had not adjusted for them.
6. Goodwill attributable to the non-controlling interest was valued at Sh.9.4 million.
Required;
Consolidated statement of financial position/or Agano group as at 31 August 2009,

SOLUTION;
Agano Ltd
Statement of financial position as at 31 August 2009
Sh. ‘million’ Sh. ‘million’
Non-current assets
Property, plant and equipment 478
Goodwill (49.6+9.4-14.75) 44.25
522.25
Current assets
Inventory 107.5
Receivables 96
Cash in transit 5
Cash at bank 33 241.5
Total assets 763.75

Share premium 40
Retained profits 167.36
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Shareholders’ funds attributable to holding 507.36
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Shareholders’ funds attributable to NCI 73.59
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Total shareholders’ funds 580.95
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3% debentures 140
Current liabilities
Dividends Payable 17.8
Payables 25
Total payables and liabilities 763.75

Workings
Cost of control
Shs “millions” Shs “millions”
Cost of investment in Dando Ltd 250

Share premium 10
Pre-acquired profits 40 + ( 24) 60
270
(194.4)
Pre-acquisition dividends 72%x270
72%x10x
(6)
49.6
Impairment Loss 25%x (49.6+9.4)m =14.75m

Group’s share 72%x14.75m =10.62m
N.C.I share 28%×14.75m =4.13m
Group Profit And Loss Account

Shs ‘m’ Shs ‘m’
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Cost of control (Pre-acquisition profits) Bal B/d 210
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(72%x60m) 43.2 Dando 34
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N.C.I (28% x 34) 9.52 Post acquired dividend 1.2
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Proposed Dividend 15 Depreciation overcharge 5
Impairment Loss 10.62 -
Unrealized profits 4.5
Bal c/d (C.S.F.P) 107.36
250.2 250.2

Non-Controlling Interest
Impairment Loss Shs ‘m’ Ordinary shares (28% x 200) Shs ‘m’
Bal c/d (C.S.F.P) 4.13 Share premium (28% x 10) 56
73.59 Profit and loss Account 2.8
- (28%x34) 9.52
Goodwill 9.4
77.72 77.72
PPE Inventory Receivables Cash Payables
Agano 223 50 60 19 12
Dando 270 62 48 14 20
Adjustments
Plant (20) - - - -
Extra depn 5 - - - -
UPCI - (4.5) - - -
Intercompany debts - - (7) - -
Cash in Transit - - (5) - (7)
478 107.5 96 33 25
Illustration
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Supposing you are given the following statement of financial position as at 31st December 2010
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H Ltd S Ltd
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Sh, “000” Sh, “000”
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Assets
Property,plant & equipment 14,000 8,000
Patents 5,000 2,000
19,000 10,000
Current Assets
Inventory 5,000 4,000
Bank 18,000 6,000
Acc. Receivables 4,000 4,000
27,000 14,000
46,000 24,000
Liabilities and Equity
Ordinary S. Capital Sh 100 15,000 10,000
Retained earnings 25,000 6,000
Acc. Payables 40,000 16,000
6,000 8,000
46,000 24,000

On 1st January 2011, the directors of H Ltd purchased 100% share-holding in S Ltd for Sh
17,000,000 by paying cash to the shareholders of S Ltd.
Required
Present the new statement of financial position of both companies immediately after the purchase of
shares.
Solution
Statement of Financial Position
H Ltd S Ltd
Sh, “000” Sh, “000”
Non- Current Assets 14,000 8,000
Property,plant & equipment 5,000 2,000
Patents 17,000 _____
Investments 36,000 10,000
Current Assets
Inventory 5,000 4,000
Bank 1,000 6,000
Acc. Receivables 4,000 4,000
10,000 14,000
46,000 24,000
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Ordinary S. Capital Sh 10@ 15,000 10,000
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40,000 16,000
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Liabilities
A/c Payables 6,000 8,000
46,000 24,000
Observations
1. It can be seen clearly that the new statement of financial position of H Ltd has a new non-
current asset called investments in an amount of Sh 17,000,000. This represents the amount
that was used to purchase the shares in S Ltd. This is supported by a similar reduction in the
amount in the bank account.
2. It can also be seen clearly that there is no change in the new statement of financial position of
S Ltd. Even though, the shareholding has changed hands. This is because changes regarding
shareholding is not recorded in the accounts but in the shareholding register as required by
the separate entity principle.
Illustration
Using Previous Illustration;
Required;
Prepare a consolidated statement of financial position of H and its subsidiary as at 2.1.2011/

Workings
Cost of Control Account
Shs Shs
Investment in S Ltd 17,000 Ordinary S. Capital 10,000
_ Retained earnings 6,000
___ Goodwill 1,000
17,000 17,000
Consolidated Retained Earnings Account

Shs Shs
Cost of Control (C.O.C) 6,000 H Ltd bal. b/d 25,000
Consolidated st of fin position 25,000 S Ltd bal. b/d 6,000
31,000 ____31,000
H Group
Consolidated Statement of Financial Position as at 2/1/2011
Sh, “000”
Assets
Non-Current Assets
Property, Plant and equipments 22,000
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Patents 7,000
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Goodwill 1,000
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Total Non-Current Assets 30,000
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Current Assets
Inventory 9,000
Bank 7,000
Total current Assets 24,000
Total Assets 54,000

Owner’s equity 40,000
Liabilities
Total current liabilities 14,000
Total equity and Liabilities 54,000

Illustration III
Suppose H Ltd purchased 100% shareholding of S Ltd on 31 September 2009 at Sh 17,000,000
when the retained earnings of S Ltd stood at sh 4,000,000. During the post aquisition period, H Ltd
made sales on credit to S Ltd and as at 31 December 2010, S Ltd owed H Ltd Sh 1,500,000 which is
included in the accounts payable of S Ltd and the same amount is included in the accounts
receivable of H Ltd.
Required
Consolidated statement of financial position of H and its subsidiary as at 31st December 2010
Accounts Receivable
Shs Shs
H Ltd b/d 4,000 Intragrouping 1,500
S Ltd b/d 4,000 C.S.F.P 6500
8,000 8,000
Accounts Payable
Shs Shs
Intragrouping 1,500 H Ltd b/d 6,000
C.S.F.P 12,500 S Ltd b/d 8,000
14,000 14,000
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H Group
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Consolidated Statement of Financial Position as at 31st December 2010
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Sh, “000”
Assets
Non-Current Assets
Property,plant & equipment 22,000
Patents 7,000
Goodwill 3,000
32,000
Current Assets
Inventory 9,000
Bank 7,000
22500
54,000
42,000
Liabilities
54,500

ACCOUNTING TREATMENT OF ASSOCIATE COMPANIES
IAS 28 applies to all investments in which an investor has significant influence but not control or
joint control except for investments held by a venture capital organization, mutual fund, unit trust,
and similar entity that (by election or requirement) are accounted for as held for trading under IAS
39. Under IAS 39, those investments are measured at fair value with fair value changes recognized
in profit or loss.
The following are important definitions in IAS 28:-
Associate: An enterprise in which an investor has significant influence but not control or joint
control.
Significant influence: Power to participate in the financial and operating policy decisions but not
control them.
Equity method: A method of accounting by which an equity investment is initially recorded at cost
and subsequently adjusted to reflect the investor's share of the net profit or loss of the associate
(investee).
Investments in associates
This type of investment is something less than a subsidiary, but more than a simple investment. The
key criterion here is significant influence. This is defined as the 'power to participate', but not 'to
control' (which would make the investment a subsidiary).
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Significant influence can be determined by the holding of voting rights (usually attached to shares)
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in the entity. IAS 28 states that if an investor holds 20% or more of the voting power of the investee,
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it can be presumed that the investor has significant influence over the investee, unless it can be
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clearly shown that this is not the case.
Significant influence can be presumed not to exist if the investor holds less than 20% of the voting
power of the investee, unless it can be demonstrated otherwise.
The existence of significant influence is evidenced in one or more of the following ways.
a) Representation on the board of directors (or equivalent) of the investee
b) Participation in the policy making process
c) Material transactions between investor and investee
d) Interchange of management personnel'
e) Provision of essential technical information
Thus, an interest of holding of 20% or more but less than 50% of the voting rights is presumed to
create an associate.
Accounting treatment in group accounts

IAS 28 requires the use of the equity method of accounting for investments in associates. This
method will be explained in detail in Chapter 11.
Preparation of Financial statements involving an associate
In its consolidated financial statements, an investor should use the equity method of accounting for
investments in associates, other than in the following three exceptional circumstances:
(i) An investment in an associate that is acquired and held exclusively with a view to its disposal
within 12 months from acquisition should be accounted for as held for trading under IAS 39.
Under IAS 39, those investments are measured at fair value with fair value changes
recognized in profit or loss.
(ii) A parent that is exempted from preparing consolidated financial statements by paragraph 10
of IAS 27 may prepare separate financial statements as its primary financial statements. In
those separate statements, the investment in the associate may be accounted for by the cost
method or under IAS 39.
(iii) An investor need not use the equity method if all of the following four conditions are met:
a) the investor is itself a wholly-owned subsidiary, or is a partially-owned subsidiary of
another entity and its other owners, including those not otherwise entitled to vote, have
been informed about, and do not object to, the investor not applying the equity method;
b) the investor’s debt or equity instruments are not traded in a public market;
c) the investor did not file, nor is it in the process of filing, its financial statements with a
securities commission or other regulatory organization for the purpose of issuing any class
of instruments in a public market; and
d) the ultimate or any intermediate parent of the investor produces consolidated financial
statements available for public use that comply with International Financial Reporting
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Standards.
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'Upstream' and 'downstream' transactions
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Upstream transactions are, for example, sales of assets from an associate to the investor.
'Downstream' transactions are, for example, sales of assets from the investor to an associate.
Profits and losses resulting from 'upstream' and 'downstream' transactions between an investor
(including its consolidated subsidiaries) and an associate are eliminated to the extent of the investor's
interest in the associate. This is very similar to the procedure for eliminating intra-group transactions
between a parent and a subsidiary. The important thing to remember is that only the group's share is
eliminated.
The double entry is as follows, where A% is the parent's holding in the associate, and PUP is the
provision for unrealised profit.
DEBIT Retained earnings of parent Pup×A% PUP ×A%

CREDIT Group inventories
For upstream transactions (associate sells to parent/subsidiary) where the parent holds the
inventories.
Or

DEBIT Retained earnings of parent /subsidiary Pup x A% PUP x A%
CREDIT Investment in associate
For downstream transactions, (parent/subsidiary sells to associate) where the associate holds the
inventory.
ILLUSTRATION 10
Downstream Transaction
A Co, a parent with subsidiaries, holds 25% of the equity shares in B Co. During the year, A Co
makes sales of Sh 1,000,000 to B Co at cost plus a 25% mark-up. At the year-end, B Co has all these
goods still in inventories.
Solution
A Co has made an unrealised profit of Sh 200,000 (1,000,000 × 25/125) on its sales to the associate.
The group's share of this is 25%, ie Sh 50,000. This must be eliminated.
The double entry is:
DEBIT A: Retained earnings Sh 50,000 Sh 50,000

CREDIT Investment in associate (B)
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Because the sale was made to the associate, the group's share of the unsold inventories forms part of
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the investment in associate at the year end. If the sale had been from the associate B to A, i.e. an
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upstream transaction, the double entry would have been.
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DEBIT A: Retained earnings Sh 50,000 Sh 50,000
CREDIT A: Inventories
If preparing the consolidated income statement, you would deduct the $50,000 from the group share
of the associate's profit.
Associate's losses
When the equity method is being used and the investor's share of losses of the associate equals or
exceeds its interest in the associate, the investor should discontinue including its share of further
losses. The investment is reported at nil value. The interest in the associate is normally the carrying
amount of the investment in the associate, but it also includes any other long-term interests, for
example, preference shares or long term receivables or loans.
After the investor's interest is reduced to nil, additional losses should only be recognised where the
investor has incurred obligations or made payments on behalf of the associate (for example, if it has
guaranteed amounts owed to third parties by the associate).
Impairment losses
IAS 39 sets out a list of indications that a financial asset (including an associate) may have become
impaired.
Any impairment loss is recognised in accordance with IAS 36 Impairment of assets for each
associate individually. An impairment loss is not allocated to any asset, including goodwill, that
forms part of the carrying amount of the investment in associate. Accordingly any reversal of that
impairment loss is recognised in accordance with IAS 36 to the extent that the recoverable amount
of the investment subsequently increases.
Non-controlling interest/associate held by a subsidiary

Where the investment in an associate is held by a subsidiary in which there are non-controlling
interest, the non-controlling interest shown in the consolidated financial statements of the group
should include the non-controlling interest of the subsidiary's interest in the results and net assets of
the associated company.
This means that the group accounts must include the 'gross' share of net assets, pre-tax profits and
tax, in accounting for the non-controlling interest separately! For example, we will suppose that P
Co owns 60% of S Co which owns 25% of A Co, an associate of P Co. The relevant amounts for
inclusion in the consolidated financial statements would be as follows.
1. Consolidated income statement

The results and the operations of the associate are not included in the group consolidated income
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statement. It is only group share of the associate profit before taxation and group share of associate
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tax that are accounted for.
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Since an associate is not a group members the inter-company sales/purchases are supposed to be
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eliminated to the extent that they relate to the group (UPCS and UPOS are eliminated to the extent
that they relate to the group).
The following is a suggested layout (for an income statement for a company having subsidiaries as
well as associates.
Income statement: parent with no subsidiaries

The treatment required by the standard is given above. The following layout is suggested
Sh ‘000’
Sales revenue X
Cost of sales (X)
Gross profit X
Distribution costs/administrative expenses (X)
Interest payable and similar charges X
Share of profit after tax of associate X
Profit before taxation (X)
Taxation X
Profit for the year X
X
2. Consolidated statement of financial position
The Consolidated Statement of Financial Position will only recognize the net investment in the
associate as a non-current asset and dividends receivable from the associate as a current asset.
Inter – company balances are not eliminated since the associate is not a group member.
I A S 28 explain that the net investment in the associate is supposed to be computed based on the
equity method of consolidation (benchmark treatment).
The equity method can be applied as follows:
Alternative 1
Group share of associate net identifiable assets (year-end) XX
Add premium on a acquisition of associate XX
Less: premium impairment loss XX
Net investment in associate (CSFP) XX
Alternative 2 XX
Cost of investment in associate XX
Group share of associate post-acquisition reserves (P and L XX
revaluation) XX
Less: premium impairment loss (XX)
Net investment in associate XX
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ILLUSTRATION 11
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Consolidated statement of financial position
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On 1 January 2006 the net tangible assets of A Co amount to Sh 220,000, financed by 100,000 Sh
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1ordinary shares and retained earnings of Sh 120,000. P Co, a company with subsidiaries, acquires
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30,000 of the shares in A Co for Sh 75,000. During the year ended 31 December 2006 A Cos profit
after tax is Sh 30,000, from which dividends of Sh 12,000 are paid.
Show how P Co’s investment in A Co would appear in the consolidated statement of financial
position at 31 December 2006.
SOLUTION
Consolidated Statement of Financial Position as At 31 December 2006(Extract)
Sh ‘000’
Non-Current assets
Investment in associate 75,000
Cost
Group share of post-acquisition retained earnings 5,400
(30%×Sh 18,000)
80,400

Transactions with associates:
If an associate is accounted for using the equity method, unrealized profits and losses resulting from
upstream (associate to investor) and downstream (investor to associate) transactions should be
eliminated to the extent of the investor’s interest in the associate. However, unrealized losses should
not be eliminated to the extent that the transaction provides evidence of an impairment of the asset
transferred.
Date of associate’s financial statements:

In applying the equity method, the investor should use the financial statements of the associate as of
the same date as the financial statements of the investor unless it is impracticable to do so.
If it is impracticable, the most recent available financial statements of the associate should be used,
with adjustments made for the effects of any significant transactions or events occurring between the
accounting period ends. However, the difference between the reporting date of the associate and that
of the investor cannot be longer than three months
Distributions and other adjustments to carrying amount:

Distributions received from the investee reduce the carrying amount of the investment. Adjustments
to the carrying amount may also be required arising from changes in the investee’s equity that have
not been included in the income statement (for example, revaluations).
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Potential voting rights:
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Although potential voting rights are considered in deciding whether significant influence exists, the
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investor’s share of profit or loss of the investee and of changes in the investee’s equity is determined
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on the basis of present ownership interests. It should not reflect the possible exercise or conversion
of potential voting rights.
Implicit goodwill and fair value adjustments:
On acquisition of the investment in an associate, any difference (whether positive or negative)
between the cost of acquisition and the investor’s share of the fair values of the net identifiable
assets of the associate is accounted for like goodwill in accordance with IFRS 3, Business
Combinations. Appropriate adjustments to the investor’s share of the profits or losses after
acquisition are made to account for additional depreciation or amortization of the associate’s
depreciable or amortizable assets based on the excess of their fair values over their carrying amounts
at the time the investment was acquired. Any goodwill shown as part of the carrying amount of the
investment in the associate is no longer amortized but instead tested annually for impairment in
accordance with IFRS 3.
Discontinuing the equity method:

Use of the equity method should cease from the date that significant influence ceases. The carrying
amount of the investment at that date should be regarded as a new cost basis

ILLUSTRATION 12
Set out below are the draft accounts of Parent Co and its subsidiaries and of Associate Co. Parent Co
acquired 40% of the equity capital of Associate Co three years ago when the latter’s retained
earnings stood at Sh 40,000.
Summarised Statement of Financial Position

Parent Co & Subsidiaries Associate Co
Sh ‘000’ Sh ‘000’
Property, plant and equipment 220 170

Investment in Associate at cost 60 -
Loan to Associate Co. 20 -
Current assets 100 50
Share capita (Sh 1 Shares) 400 220
Retained earnings 250 100
Loan from Parent Co. 150 100
- 20
400 50
Summarized Income Statement
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Parent Co & Subsidiaries Associate Co
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Sh ‘000’ Sh ‘000’
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Net profit 95 80
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Taxation 35 30
60 220
You are required to prepare the summarized consolidated accounts of Parent Co.
NB;
1) Assume that the associate's assets/liabilities are stated at fair value.
2) Assume that there are no non-controlling interests in the subsidiary companies.

SOLUTION
Parent co
Consolidated income statement
Sh ‘000’
Net profit 95
Share of profits of associate (50 ×40%) 20
Income tax expense 35
Profit attributable to the owners of Parent Co 80
Parent co
Sh ‘000’
Assets 220
Property, plant and equipment 104
Interest in associate (see note) 100
Current assets 424
Total assets 250
Equity and liabilities 174
Share capital 424
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Retained earnings (W)
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Total equity and liabilities
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Note
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Sh ‘000’
Interest in associate 60
Cost 24
Share of post-acquisition retained earnings 40% × (100 - 34
40) 20
Loan to associate 104
Workings: retained earnings

Parent & Subsidiaries Associate Co
Sh ‘000’ Sh ‘000’
Per question 150 100
Pre-acquisition 24 40
Post-acquisition 174 60
Group share in associate
(Sh60×40%)
Group retained earnings

IAS 7 STATEMENT OF CASH FLOWS
Statements of cash flows are a useful addition to the financial statements because it is recognised
that accounting profit is not the only indicator of a company's performance.
Introduction
It has been argued that 'profit' does not always give a useful or meaningful picture of a company’s
operations. Readers of a company’s financial statements might even be misled by a reported profit
figure
a) Shareholders might believe that if a company makes a profit after tax, of say, shs.100,000
then this is the amount which it could afford to pay as a dividend. Unless the company has
sufficient cash available 10 stay in business and also to pay a dividend, the shareholders'
expectations would be wrong.
b) Employees might believe that if a company makes profits, it can afford to pay higher wages
next year, This opinion may not be correct the ability 10 pay wages depends on the
availability of cash.
c) Survival of a business entity depends not so much on profits as on its ability to pay its debts
when they fall due. Such payments might include 'revenue' items such as material purchases,
wages, interest and taxation etc., but also capital payments for new non-current assets and the
repayment of loan capital when this falls due (for example on the redemption of debentures).
From these examples, it may be apparent that a company's performance and prospects depend not so
much on the profits earned in a period, but more realistically on liquidity or cash flows
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Funds flow and cash flow
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Some countries, either currently or in the past, have required the disclosure of additional statements
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based on funds flow rather than cash flow. However, the definition of funds can be very vague and
such' statements often simply require a rearrangement of figures already provided in the statement of
financial position and income statement By contrast, a statement of cash flows is unambiguous and
provides information which is additional to that provided in the rest of the accounts. It also lends
itself to organization by activity and not by classification in the statement of financial position.
Statements of cash flows are frequently given as an additional statement, supplementing the
statement of financial position, statement of comprehensive Income and related notes.
Objective of IAS 7
The aim of IAS 7 is to provide information to users of financial statements about the entity s ability
to generate cash and cash equivalents, as well as indicating the cash needs of the entity. The
statement of cash flows provides historical information about cash and cash equivalents, classifying
cash flows between operating, investing and financing activities
Scope
A statement of cash flows should be presented as an Integral part of an entity’s financial statements.
All types of entity can provide useful information about cash flows as the need for cash is universal,
whatever the nature of the revenue-producing activities. Therefore all entities are required by the
standard to produce a statement of cash flows.
Benefits of cash flow information

The use of statements of cash flows is very much in conjunction with the rest of the financial
statements. Users can gain further appreciation of the change in net assets of the entity s financial
position (liquidity and solvency) and the entity’s ability to adapt to changing circumstances by
affecting the amount and timing of cash flows Statements of cash flows enhance comparability as
they are not affected by differing accounting policies used for the same type of transactions or
events.
Cash flow information of a historical nature can be used as an indicator of the amount, timing and
certainty of future cash flows. Past forecast cash flow information can be checked for accuracy as
actual figures emerge, the relationship between profit and cash flows can be analyzed as can changes
in prices over time
Key Terms
The standard gives the following definitions the most important of which are cash and cash
equivalents.
Cash comprises cash on hand and demand deposits

Cash equivalents are short-term, highly liquid investments that are readily convertible to known
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amounts of cash and which are subject to an insignificant risk of changes in value.
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Cash flows are inflows and outflows of cash and cash equivalents
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Operating activities are the principal revenue-producing activities of the entity and other activities
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that are not investing or financing activities
Investing activities are the acquisition and disposal of non-current assets and other statements not
included in cash equivalents.
Financing activities are activities that result in changes in the size and composition of the equity
capital and borrowings of the entity
Cash and cash equivalents

The standard expands on the definition of cash equivalents hey are not held for Investment or other
long- term purposes, but rattler to meet short term cash commitments. To fulfill the above definition
an investments maturity date should normally be within three months from its acquisition date It
would usually be the case then that equity investments (re share In other companies) are not cash
equivalents
An exception would be where preferred shares were acquired with a very close maturity date.
Loans and other borrowings from banks are classified as financing activities. In some countries,
however bank overdrafts are repayable on demand and are treated as part of an entity's total cash
management system, in these circumstances an overdrawn balance will be included in cash and cash

equivalents. Such banking arrangements are characterized by a balance which fluctuates between
overdrawn and credit.
Movements between different types of cash and cash equivalent are not included in cash flows. The
investment of surplus cash in cash equivalents is part of cash management not part of operating,
investing or financing activities.
Presentation of a statement of cash flows

IAS 7 requires statements of cash flows to report cash flows during the period classified by;-
 Operating activities,
 Investing activities and
 Financing activities
The manner of presentation of cash flows between operating, investing and financing activities
depends on the nature of the entity. By classifying cash flows between different activities in this way
users can see the impact on cash and cash equivalents of each one, and their relationships with each
other. We can look at each in more detail.
Operating activities
This is perhaps the key part of the statement of cash flows because it shows whether, and to what
extent, companies can generate cash from their operations. It is these operating cash flows which
must, in the end pay for all cash outflows relating to other activities, i.e. paying loan interest,
dividends and so on.
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Most of the components of cash flows from operating activities will be those items which determine
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the net profit or loss of the entity, i.e. they relate to the main revenue-producing activities of the
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entity. The standard gives the following as examples of cash flows from operating activities.
(a) Cash receipts from the sale of goods and the rendering of services
(b) Cash receipts from royalties, fees, commissions and other revenue
(c) Cash payments to suppliers for goods and services
(d) Cash payments to and on behalf of employees.
Certain items may be included in the net profit or loss for the period which do not relate to
operational cash flows, for example the profit or loss on the sale of a piece of plant will be included
in net profit or loss, but the cash flows will be classed as investing.
Investing activities
The cash flows classified under this heading show the extent of new investment in assets which will
generate future profit and cash flows. The standard gives the following examples of cash flows
arising from investing activities.
a) Cash payments to acquire property, plant and equipment, intangibles and other non-current
assets, including those relating to capitalized development costs and sell-constructed
property, plant and equipment

b) Cash receipts from sales of property, plant and equipment, intangibles and other non-current
assets
c) Cash payments to acquire shares or debentures of other entities
d) Cash receipts from sales of shares or debentures of other entities
e) Cash advances and loans made to other parties
f) Cash receipts from the repayment of advances and loans made to other parties
Financing activities
This sections of the statement of cash flows shows the share of cash which the entity's capital
providers have claimed during the period. Tl1is is an indicator of likely future interest and dividend
payments. The standard gives the following examples of cash flows which rnigl1t arise under this
heading.
a) Cash proceeds from issuing shares
b) Cash payments to owners to acquire or redeem the entity’s shares
c) Cash proceeds from issuing debentures, loans notes, bonds, mortgages and other short or
long- term borrowings.
d) Principal repayments of amounts borrowed under finance leases
Item (d) needs more explanation. Where the reporting entity uses an asset held under a finance lease,
the amounts to go in statement of cash flows as financing activities are repayments of the principal
(capital) rather than the interest. The interest paid will be shown under operating activities.
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ILLUSTRATION 1
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The notes lo the financial statements of Ashley Co show the following in topped of obligations
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under finance leases.
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Year ended 30 June 2005 2004
Sh ‘000’ Sh ‘000’
Amounts payable within the year 12 8
Within two to five years 110 66
Less finance charges allocated to future periods 122 74
(14) (8)
108 66
Additions to tangible non-current assets acquired under finance leases were shown in the non-
current asset note at Sh 56,000.
Required
Calculate the capital repayment to be shown in the statement of cash flows of Hayley Co for the year
to 30 June 2005.

SOLUTION
Obligations under Finance Leases
Sh ‘000’ Sh ‘000’
Capital repayment (bal fig) 14 Bal 1.7 .04 66
Bal 30.6. 05 108 Additions 56
122 122
Reporting cash flows from operating activities

The standard offers a choice of method for this part of the statement of cash flows
a) Direct method: disclose major classes of gross cash receipts and gross cash payments
b) Indirect method; net profit or loss is adjusted for the effects of transactions of a non-cash
nature, any deferrals of accruals of past or future operating cash receipts or payments, and
items of income or expense associated with Investing or financing cash flows
The direct method is the preferred method because discloses information not available elsewhere the
financial statements, which could be of use in estimating future cash flows. The example below
shows both methods.
Using the direct method

There are different ways in which the information about gross cash receipts and payments can be
obtained. The most obvious way is simply to extract the information from the accounting records.
This may be a laborious task, however, and the indirect method below may be easier. The example
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and Question above used the direct method
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Using the indirect method
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This method is undoubtedly easier from the point of view of the preparer of the statement of cash
flows.
The net profit or loss for the pence is adjusted for the following;
a) Changes during the period in inventories, operating receivables and payables
b) Non-cash items, e.g. depreciation, provisions, profits/losses on the sates of assets
c) Other the cash flows from which should be classified under investing or financing activities
A proforma of such a calculation, taken from the IAS, is as follows and this method may be more
common in the exam (The proforma has been amended to reflect changes to IFRS)
Cash flows from operating activities Shs

Profit before taxation Xx
Adjustments for: Xx
Depreciation Xx
Foreign exchange loss (Xx)
Investment income Xx
Interest expense Xx
Increase in trade and other receivables Xx
Decrease in inventories Xx

Decrease in trade payables Xx
Cash generated from operations Xx
Interest paid Xx
Income taxes Xx
Net cash from operating activities Xx
It is important to understand why certain items are added and others subtracted. Note the following
points;-
a) Depreciation is not a cash expense, but is deducted in arriving at profit. It makes sense,
therefore, to eliminate it by adding it back.
b) By the same logic, a loss on a disposal of a non-current asset (arising through under provision
of depreciation) needs to be added back and a profit deducted.
c) An increase in inventories means less cash you have spent cash on buying inventory.
d) An increase in receivables means the company's debtors have not paid as much and therefore
there is less cash.
e) If we payoff payables, causing the figure to decrease, again we have less cash.
Interest and dividends

Cash flows from interest and dividends received and paid should each be disclosed separately. Each
should be classified in a consistent manner from period to period as either operating, investing or
financing activities.
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Dividends paid by the entity can be classified in one of two ways;
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a) As a financing cash flow, showing the cost of obtaining financial resources.
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b) As a component of cash flows from operating activities so that users can assess the entity's
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ability to pay dividends out of operating cash flows.
Taxes on income
Cash flows arising from taxes on income should be separately disclosed and should be classified as
cash flows from operating activities unless they can be specifically identified with financing and
investing activities.
Taxation cash flows are often difficult to match to the originating underlying transaction. So most of
the time all tax cash flows are classified as arising from operating activities.
Components of cash and cash equivalents

The components of cash and cash equivalents should be disclosed and reconciliation should be
presented, showing the amounts in the statement of cash flows reconciled with the equivalent items
reported in the statement of financial position.
It is also necessary to disclose the accounting policy used in deciding the items included in cash and
cash equivalents in accordance with IAS 1 Presentation of Financial Statements, but also because of
the wide range of cash management practices worldwide

Other disclosures
All entities should disclose, together with a commentary by management, any other information
likely to be of importance for example:
a) Restrictions on the use of or access to any part of cash equivalents
b) The amount of undrawn borrowing facilities which are available
c) Cash flows which increased operating capacity compared to cash flows which merely
maintained operating capacity.
d) Cash flows arising from each reported industry and geographical segment
Preparing a statement of cash flows
NOTE;
You need to be aware of the format of the statement as laid out in IAS 7; setting out the format is an
essential first stage in preparing the statement, so this format must be learnt.
Introduction
In essence, preparing statement of cash flows is very straightforward. You should therefore simply
learn the format and apply the steps noted in the example below. Note that the following items are
treated in a way that might seem confusing, but the treatment is logical if you think in terms of cash.
a) Increase In inventory is treated as negative (in brackets). This is because it represents a cash
outflow; cash is being spent on inventory.
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b) An Increase in receivables would be treated as negative for the same reasons; more
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receivables mean less cash.
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c) By contrast an increase in payables is positive because cash is being retained and not used to
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settle accounts payable. There is therefore more of it.
ILLUSTRATION 2
Kane Co’s income statement for the year ended 31 December 2002 and statements of financial
position at 31 December 2001 and 31 December 2002 were as follows:

Kane co
Income statement for the year ended 31 December 2002
Sh ‘000’ Sh ‘000’
Sales 720
Raw materials consumed 70
Staff costs 94
Depreciation 118
Loss on disposal of non-current assets 18
300
Operating profit 420
Interest payable 28
Taxation 124
Profit for the year 268
Kane co statements of financial as 31 December 2002

2002 2001
Sh ‘000’ Sh ‘000’
Non-Current asset 1,596 1,560
Cost Depreciation (318) (224)
1,278 1,336
Current assets
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Inventory 24 20
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Trade receivables 76 58
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Bank 48 56
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Total assets 148 134
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1,426 1,470
Equity
Share capital 360 340
Share premium 36 24
1,112 878
Long-term loans 200 500
Current liabilities 12 6
Trade payables. 102 86
Taxation 114 592
Total equity and liabilities 1,426 1,470
Dividends paid were Shs. 66.000
During the year, the company paid Sh 90,000 for a new piece of machinery.

Required;
Prepare a statement of cash flows for Kane Co for the year ended 31 December 2002 in accordance
with the requirements of IAS 7, using the indirect method.
SOLUTION
Step 1:
Set out the proforma statement of cash flows with the headings required by IAS 7. You should
leave plan y of space. Ideally, use three; or more sheets of paper, one for the main statement one for
the notes and one for your workings. It is obviously essential to know formats very well.
Step 2:
Begin with the cash flows from operating activities as far as possible. When preparing the
statement from statements of financial position, you will usually have to calculate such items as
depreciation, loss on sale of non -current assets, profit for the year and tax paid (see Step 4). Note
that you may not be given the tax charge m the income statement. You will then have to assume that
the tax paid in the year is last year’s year-end provision and calculate the charge as the balancing
figure.
Step 3:
Calculate the cash flow figures for purchase or sale of non-current assets, issue of shares and
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repayment of loans it these are not already given for you (as they may be).
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Step 4:
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If you are not given the profit figure, open up a working for profit or loss. Using the opening and
closing balances of retained earnings, the taxation charge and dividends paid and proposed, you will
be able to calculate profit for the yea; as the balancing figure to put in the cash flows from operating
activities section.
Step 5:
You will now be able to complete the statement by slotting in 'lie figures given or calculated.

Kane co
Statement of cash flows for the year ended 31 December 2002
Sh ‘000’ Sh ‘000’
Cash flows from operating activities
Depreciation charges 118
Loss on sales of tangible non-current assets 18
Interest expense 28
Increase in inventories (4)
Increase in receivables (18)
Increase in payables 6
Cash generated from operations 540
Interest paid (28)
Dividends paid (66)
Tax paid (86 + 124 – 102) (108)
Net cash from operating activities 338
Cash flows from investing activities
Payments to acquire tangible non-current assets (90)
Receipts from sales of tangible non- current assets (W) 12
Net cash used in investing activities
Cash flows from financing activities
Issues of share capital (360 + 36 – 340 – 24) 32
Long-term loans repaid (500 – 200) (300)
Net cash used in financing activities (268)
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Decrease in cash and cash equivalents (8)
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Cash and cash equivalents at1.1. x 2 56
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Cash and cash equivalents at 31.12 x 2 48
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Workings: non-current asset disposals
Cost
Sh ‘000’ Sh ‘000’
At1.1. 02 1,560 At 31.12.02 1,596
Purchases 90 Disposals (balance) 54
1,650 1,650
Accumulated Depreciation
Sh ‘000’ Sh ‘000’
At 31.12.02 318 At 1.1.02 224
Depreciation on disposals 24 Charge for year 118
(balance) ___
342 342
NBV of disposals 30
Net loss reported (18)
Proceeds of disposals 12

Note; there are a number of issues you might deal with In the statement of cash flows in an exam.
Examples are
 Share capital issues. The proceeds will be split between share capital and share premium
 Bonus Issues. These do not involve cash.
 Revaluation of non-current assets. This must be taken into account in calculation
acquisiuons and disposals.
 Movement on deferred tax . This must be taken into account in calculating tax paid
 Finance leases. Assets acquired under finance leases must be adjusted for in non-current
asset calculations and the amount paid under the finance lease must appear as a cash flow.
CONSOLIDATED STATEMENT OF CASH FLOWS
Consolidated statements of cash flows follow the same principles as for single company statements,
with some additional complications.
Cash flows that are internal to the group should be eliminated in the preparation of a consolidated
statement of cash flows. Where a subsidiary undertaking joins or leaves a group during a financial
year the cash flows of the group should include the cash flows of the subsidiary undertaking
concerned for the same period as that for which the group's income statement includes the results of
the subsidiary undertaking.
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Acquisitions and disposals of subsidiaries and other business units
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An entity should present separately the aggregate cash flows arising from acquisitions and from
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disposals of subsidiaries or other business units and classify them as investing activities.
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Disclosure is required of the following, in aggregate, in respect of both acquisitions and disposals of
subsidiaries or other business units during the period.
 Total purchase/disposal consideration
 Portion of purchase/disposal consideration discharged by means of cash/cash equivalents
 Amount of cash/cash equivalents in the subsidiary or business unit disposed off
 Amount of assets and liabilities other than cash/cash equivalents in the subsidiary or business
unit acquired or disposed of, summarized by major category
The amounts shown in the statements of cash flows for purchase or disposal of subsidiaries or
business units will be the amounts paid or received net of cash/cash equivalents acquired or disposed
of.
Consolidation adjustments and non-controlling interest

The group statement of cash flows should only deal with flows of cash and cash equivalents external
to the group, so all intra-group cash flows should be eliminated. Dividends paid to non-controlling
interest should be included under the heading 'cash flow from financing' and disclosed separately.
ILLUSTRATION 3
NON-CONTROLLING INTEREST
The following are extracts of the consolidated results for Jamvi Co for the year ended 31 December
2008.
Consolidated Income Statement (Extract)

Sh ‘000’
Group profit before tax 90
Income tax expense (30)
Profit for the year 60
Profit attributable to: 45
Owners of the parent 15
Non-controlling interest 60
Consolidated Statement of Financial Position (Extract)

2001 2002
Sh ‘000’ Sh ‘000’
Non-controlling interest 300 306
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SOLUTION
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Calculate the dividends paid to the non-controlling interest during the year
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Sh ‘000’ Sh ‘000’
Dividend paid 9 Balance b/d 300
Balance c/d 306 Profit for period (I/S) 15
315 315
Associates and joint ventures

Where an interest in a jointly controlled entity (see IAS 31) is accounted for using proportionate
consolidation the reporting entity's proportionate share of the jointly controlled entity's cash flows
in the consolidated statement of cash flows
When the equity method is used, only the actual cash flows from sales or purchases between the
group and the associate/joint venture, and investments in and dividends from the entity should be
included. Dividends should be included in operating cash flows, where they are shown within
operating profit in the statement of comprehensive income.

ILLUSTRATION 4
ASSOCIATE
The following are extracts of the consolidated results of Pripon Co for the year ended 31 December
2008.
Consolidated Income Statement (Extract)

Shs ‘000’
Group profit before-tax 150
Share of associate's profit after tax (60 - 30) 30
Tax (group) 180
Profit after tax 75
105
Consolidated Statement of Financial Position (Extract)

2001 2002
Shs. ‘000’ Shs. ‘000’
Investment in associate 264 276
Calculate the dividend received from the associate
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Solution
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Associate
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Sh ‘000’ Sh ‘000’
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Balance b/fwd 264 Dividend from associate 18
Profit after tax(60-30) 30 Balance c/fwd 276
294 294
ILLUSTRATION 5
Topiary Co is a 40 year old company producing garden statues carved from marble. Twenty two
years ago it acquired a 100% interest in a marble importing company, Hardstuff Co. In 20x 9 it
acquired a 40% interest in a competitor Landscapes Co and on 1 January 20 x 7 it acquired a 75%
interest in Garden Furniture Designs. The draft consolidated accounts for the Topiary Group are as
follows.

Draft Consolidated Income Statement for the Year Ended 31 December 2007
Sh ‘000’
Operating profit 4,455
Share of profit after tax of associate 1,050
Income from long-term investment 600
Interest payable (450)
Profit before taxation 5,655
Tax on profit
Income tax 1,173
Deferred taxation 312
Tax attributable to investment income 135
(1,620)
Attribute to: Owners of the parent 3,735
Non-controlling interest 300
4,035
Draft Consolidated Statement of Financial Position as at 31 December

2006 2007
Sh ‘000’ Sh ‘000’ Sh ‘000’ Sh ‘000’
Assets
Non-current assets
Tangible assets
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Buildings at net book value 6,600
a.c
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Machinery: cost 4,200 9,000
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aggregate depreciation (3,300) (3,600)
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net book value 900 5,400
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7,500 11,625
Goodwill 300
Investments in associates 3,000 3,300
Long-term investments 1,230 1,230
11,730 16,455
Current assets
Inventories 3,000 5,925
Receivables 3,825 5,550
Cash 5,460 13,545
12,285 25,020
Equity and liabilities 24,015 41,475
Equity
Share capital: 25c shares 6,000 11,820
Share premium account 6,285 8,649
Total equity 19,785 30,804
Non-controlling interest - 345
19,785 31,149
Obligations under finance leases 510 2,130
Loans 1,500 4,380

Deferred tax 39 2,049 90 6,600
Current liabilities
Trade payables 840 1,500
Obligations under finance leases 600 720
income tax 651 1,386
Accrued interest and finance charges 90 2,181 120 3,726
24,015 41,475
Note
1. There had been no acquisitions or disposals of buildings during the year. Machinery costing
Sh 1.5m was sold for Sh 1.5m resulting in a profit of. Sh 300,000. New machinery was
acquired in 2007 including additions of Sh 2.55m acquired under finance leases.
2. Information relating to the acquisition of Garden Furniture Designs
Sh ‘000’
Machinery 495
Inventories 96
Trade receivables 24
Cash 336
Trade payables 204)
Income tax (51)
756
Non-controlling interest (189)
567
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a.c
Goodwill 300
ny
ke
867
ea
m
2,640,000 shares issued as part consideration 825
.so
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Balance of consideration paid in cash 42
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867
3. Loans were issued at a discount in 2007 and the carrying amount of the loans at 31 December
2007 included Shs. 120,000 representing the finance cost attributable to the discount and
allocated in respect of the current reporting period.
Required
Prepare a consolidated statement of cash flows for the Topiary Group for the year ended 31
December 2007 as required by IAS 7, using the indirect method. There is no need to provide notes
to the statement of cash lows.

SOLUTION
Topiary Group Consolidated Statement of Cash Flows For the Year Ended 31 December 2007
Sh ‘000’ Sh ‘000’
Cash flows from operating activities
Net profit before tax 5,655
Adjustments for:
Depreciation (W1) 975
Profit on sale of plant (300)
Share of associate's profits (1,050)
Investment income (600)
Interest payable 450
Operating profit before working capital changes 5,130
Increase in trade and other receivables (5,550 - 3,825 - 84) (1,641)
Increase in inventories (5,925 - 3,000 - 96) (2,829)
Increase in trade payables (1,500 - 840 - 204) 456
Cash generated from operations Interest paid (W2) 1,116
Income taxes paid (W3) (300)
(750)
Net cash from operating activities 66
Cash flows from investing activities

Purchase of subsidiary undertaking (W4) 294
Purchase of property, plant and equipment (W5) (3,255)
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Proceeds from sale of plant 1,500
a.c
Dividends from investment (600 - 135) 465
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Dividends from associate (W6) 750
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Dividends paid to non-controlling interest (W7) (144)
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Net cash used in investing activities
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(390)
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Cash flows from financing activities
Issue of ordinary share capital (W8) 7,359
Issue of loan notes (W9) 2,760
Capital payments under finance leases (W10) (810)
Dividends paid (3,735 + 7,500 -10,335) (900 )
Net cash flows from financing activities 8,409
Net increase in cash and cash equivalents 8,085

Cash and cash equivalents at 1.1. 07 5,460
Cash and cash equivalents at 31.12. 07 13,545
Workings
1 Depreciation charges
Plant and Equipment
Sh '000’ Sh '000’
Balance brought forward 3,300 Depreciation on disposal 300
Charge for year 600 Balance c/d 3,600
3,900 3,900

Freehold buildings (Sh 6,600,000 – Sh 6,225,000) = Sh 375,000
Total charge: (Sh 375,000 + Sh 600,000) = Sh 975,000
2. Interest
Interest Payable
Sh '000’ Sh '000’
Discount 120 Accrued interest b/d 90
Interest paid 300 Expenses 450
Accrued interest c/d 120 540
540
3. Taxation
Income Tax Payable
Sh '000’ Sh '000’
Cash outflow 750 b/d – current tax 651
c/d – Current tax 1,386 - deferred tax 39
- deferred tax 90 Income statement transfer 1,485
(1,173 + 312)
On acquisition 51
2,226 2,226
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4. Purchase of subsidiary
a.c
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Sh '000’
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Cash received on acquisition 336
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Less cash consideration (42)
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Cash inflow 294
5. Purchase of property, plant and equipment, machinery

Machinery
Sh '000’ Sh '000’
Balance B/d 4,200 Disposal 1,500
On acquisition 495 Bal c/d 9,000
Leased 2,550
Cash outflow 3,255
10,500 10,500
6. Dividends from associate

Investment in Associate
Sh '000’ Sh '000’
Balance B/d 3,000 Dividends received 750
Share of profit after tax 1,050 Balance C/d 3300
4,050 4050

7. Non-controlling interest
Sh '000’ Sh '000’
Dividend paid 144 Balance b/fwd Nil
Balance c/fwd 345 Profit for year 300
___ On acquisition 189
489 489
8. Issue of ordinary share capital

Share Capital
Sh '000’ Sh '000’
C/fwd 11,820 B/fwd Shares 6,000
Shares 8,649 B/fwd Premium 6,285
Premium Non-cash consideration:
Shares 600
Premium 165
Cash inflow 7,359
20,469 20469
9. Issue of loan notes

Loan Notes
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Sh '000’ Sh '000’
a.c
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Balance b/fwd 1,500 Balance c/fwd 4,380
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ea
Finance cost 120
m
.so
Cash inflow 2,760
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4,380 4,380
10. Capital payments under finance leases

Financial Leases
Sh '000’ Sh '000’
Cash outflow 810 Bal /fwd:
Carried forward: Current 600
Current 720 Long-term 510
Long-term 2,130 New lease commitment 2,550
3,660 3,660
IAS 31-JOINTLY CONTROLLED FIRMS
Joint venture is form of business combination where the acquirer obtains joint control of the
acquiree. In this case the acquirer together with another entity (co-venturer) obtains the joint control
of the net assets and operations of the acquiree. Therefore the acquirer obtains 50% shareholding in
the acquiree.

Key Terms
Venturer; A party to a joint venture and has joint control over that joint venture.
Investor in a joint venture: A party to a joint venture and does not have joint control over that
joint venture.
Control: Refers to the power to govern the financial and operating policies of an activity so as to
obtain benefits from it
Under IAS 31 the types of joint ventures are;-
(i) Jointly Controlled Operations

Jointly controlled operations involve the use of assets and other resources of the venturers rather
than the establishment of a separate entity. Each venturer uses its own assets, incurs its own
expenses and liabilities, and raises its own finance. IAS 31 requires that the venturer should
recognise in its financial statements the assets that it controls, the liabilities that it incurs, the
expenses that it incurs, and its share of the income from the sale of goods or services by the joint
venture. [IAS 31.15]
(ii) Jointly Controlled Assets

Jointly controlled assets involve the joint control, and often the joint ownership, of assets dedicated
to the joint venture. Each venturer may take a share of the output from the assets and each bears a
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share of the expenses incurred. IAS 31 requires that the venturer should recognise in its financial
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statements its share of the joint assets, any liabilities that it has incurred directly and its share of any
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liabilities incurred jointly with the other venturers, income from the sale or use of its share of the
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output of the joint venture, its share of expenses incurred by the joint venture and expenses incurred
directly in respect of its interest in the joint venture.
(iii) Jointly Controlled Entities

A jointly controlled entity is a corporation, partnership, or other entity in which two or more
venturers have an interest, under a contractual arrangement that establishes joint control over the
entity. Each venturer usually contributes cash or other resources to the jointly controlled entity.
Those contributions are included in the accounting records of the venturer and recognised in the
venturer’s financial statements as an investment in the jointly controlled entity.
Accounting for interest in joint venture

Under IAS 31, there are two methods of accounting for interest in joint venture.
a) Proportionate consolidation method(the benchmark treatment)

Under this method, the assets, liabilities, equity, incomes and expenses of the joint venture are
combined with venturers assets, liabilities, equity, incomes and expenses.

Under this method, two reporting formats of presentation of consolidated financial statement may be
adopted.
i. Line by line reporting format

Where the items of the financial statements of the venturer are combined on a line by line basis with
the share of the joint venture items of assets, liabilities, equity, income and expenses.
ILLUSTRATION
Set out below are the draft accounts of Parent Co and its subsidiaries and of Joint Venture Co. Parent
Co acquired 50% of the equity capital of Joint Venture Co three years ago when the latter's retained
earnings stood at Sh 40,000.
Summarised Statement of Financial Position

Parent Co &Subsidiaries Joint Venture Co
Sh ‘000’ Sh ‘000’
Tangible non-current assets 220 170
Investment in joint venture 75 -
Current assets 100 50
Loan to Joint Venture 20 -
415 220
Share capital (Sh1 shares) 250 100
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a.c
Loan from Parent Co - 20
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415 220
ea
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Summarised Income Statements
Parent Co & Joint Venture
Subsidiaries Co
Sh ‘000’ Sh ‘000’
Profit before tax 95 170
income tax expense 35 30
Profit for the year 60 50
Dividends paid in the year 50 10
Parent Co has taken credit for the dividend paid by Joint Venture Co.
You are required to prepare the summarised consolidated statement of financial position of Parent
Co, under both the formats of proportionate consolidation recommended by IAS 31.

Solution: Line-by-line format
Parent Co
Sh ‘000’
Goodwill (W1) 5
Tangible non-current assets (220 + (50% x 170) 305
Current assets (100 + (50% x 50)) 125
Loan to joint venture (note) 10
445
Share capital 250
Retained earnings (W2) 195
445
Note: The loan is the proportion of the Sh 20,000 lent to the other venture.
Workings
1. Goodwill
Sh ‘000’
Consideration transferred 75
Share of net assets acquired (50% x 140) 70
Premium on acquisition 5
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2. Retained earnings
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Parent Co & Subsidiaries Joint Venture Co
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Sh ‘000’ Sh ‘000’
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Per question 165 100
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Pre-acquisition (40)
Post-acquisition 60
Group share in joint venture
(Sh 60 x 50%) 30
Group retained earnings 195
ii. Separate line reporting format

Where the venturers assets, liabilities, equity, incomes and expenses and the share of the joint
venture are shown as separate line items in preparation of group financial statements
ILLUSTRATION
Considering the question above the presentation for separate line method will be as follows

Solution: Separate line method
Parent co
Sh ‘000’ Sh ‘000’
Goodwill (as above) 5
Tangible non-current assets
Group 220
Joint venture (170×50%) 85 305
Current assets
Group 100
Joint venture (50%×50) 25 125
Loan to joint venture 10
445
250
Share capital 195
Retained earnings (as above) 445
In both these cases the consolidated income statements would be shown in the same way.
The use of the proportionate consolidation method should be discontinued from the date the venture
ceases to have joint control over the entity.
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b) Equity method of consolidation( allowed alternative treatment)
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This is the allowed alternative treatment under IAS 31 and the benchmark treatment under IAS 38
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(investment in associates). Therefore, under this method the interest in joint venture is accounted for
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as if it were an investment in associate.

REVISION EXERCISE
QUESTION 1
Given below are the comparative balance sheets of Tausi Ltd., a trading company, for the years
ended 31 October 2000 and 2001:
2001 2000
Assets Sh.’000’ Sh.’000’ Sh.’000’ Sh.’000’
Non-current assets:
Goodwill 23,500 32,650
Premises 200,000 80,000
Plant and machinery 290,100 278,200
Office equipment 126,250 639,850 87,360 478,210
Current assets:
Stock 88,890 67,815
Debtors 57,890 52,015
Bank 9,210 155,990 - 119,830
795,840 598,040
Capital and Liabilities
Capital: 425,000 250,000
Ordinary shares 75,000 160,000
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10% redeemable preference shares 33,000 -
a.c
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Share capital 30,000 -
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Capital redemption reserve 38,000 12,000
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General reserve 22,300 11,200
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Profit and loss account 623,300 433,200
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Non-current liability
Bank loan 63,000 50,000
Current liabilities
Creditors 49,820 40,290
Current tax 30,500 28,500
Proposed ordinary dividends 26,000 18,000
Accruals 3,200 5,420
Bank overdraft - 109,540 22,630 114,840
795,840 598,040
The following additional information is provided:

1. Some of the redeemable preference shares which had been issued at par, were redeemed at a
premium of 2%. To finance the redemption and comply with the Companies Act requirements,
the company simultaneously carried out the following:
 Issued 5,500,000 additional ordinary shares of Sh.10 at a total premium of Sh.34,700,000.
 Transferred sufficient amounts to the capital redemption reserve.

 Financed the premium on redemption out of the premium received on issue of the additional
ordinary shares.
2. Preference dividends are paid at the end of each financial year on shares outstanding then.
3. Part of plant and machinery which had cost Sh.60,000,000 on acquisition and on which
Sh.42,000,000 accumulated depreciation had been provided was sold for Sh.25,000,000 during
the year.
4. Included in the depreciation charge for the year is Sh.15,100,000 in respect of plant and
machinery.
5. New office equipment was purchased in the year for Sh.55,000,000. There was no disposal of
office equipment during the year.
6. It is the company’s policy not to depreciate premises. The change in the premises account balance
was due to a revaluation of the asset.
7. The revaluation reserve arising in (6) above was all to finance the issue of fully paid-up bonus
shares of Sh.10 each to ordinary shareholders.
8. A new bank loan of Sh.25,000,000 was received in the year. Bank interest of Sh.8,000,000 was
also paid in the year.
9. Current tax liability is in respect of the tax charge for the respective year.
10. During the year ended 31 October 2001 an interim dividend of Sh.14,000,000 was paid.
Required:
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Cash flow statement in accordance with IAS 7.
a.c
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Solution:
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Tausi Limited
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Cash Flow Statement
“Shs 000” “Shs 000”
Net profit before 145,100
Adjusted for – depreciation – equipments 16,110
Plant & machinery 15,100
Gain on disposal (7,000)
Goodwill amortized 9,150
Interest 8,000
Cash flow from operation before working capital 186,460
changes (21,075)
Increase in stock (2,200)
Decrease in accruals (5,875)
Increase in debtors 9,530
Increased in debtors 166,840
Less tax paid (28,500)
Net cash flow from operating activities 138,340
Cash Flow From Investing Activities
Purchase of equipment (55,000)
Purchase of plant & machinery (45,000)
Sale of plant & machinery 25,000
Net cash outflow from investing activities (75,000)

Cash Flow From Financing Activities
Issue of ordinary shares 89,700
Redemption of preferential shares (86,700)
Loan repayment (12,000)
Dividend paid – preference (7,500)
-ordinary (32,000)
loan acquisition 25,000
interest paid (8,000)
net cash outflow from financing activities (31,500)
change in cash and cash equivalent 31,840
cash and cash equivalent of the beginning (22,630)
cash and cash equivalent at the end 9,210
ii) Issue of shares

5,500,000 x 10 = 5,500,000 – nominal value
34,700,000 – Premium on issue
Total receipt 89,700,000
85,000,000 – Nominal value
55,000,000 – Redemption
30,000,000 – Redemption reserve
Workings
1) Redeemed shares
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Bal b/d 160,000
a.c
Bal c/d 75,000
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Redeemed 85,000 x 102% = 86700
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– Premium on redemption =
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2)Preference dividends
10% x 75,000,000 = 7,500,000
3) Gain on Disposal
42,000,000 – All depreciation
25,000,000 – Proceeds
67,000,000
60,000,000 – Cost
7,000,000 - Gain
QUESTION 2
During the month of March 2001, a manufacturing firm advertised in the local press that it had
bonded goods which were to be auctioned. On reading the advertisement, Mr Michael Karanja and
Mr. Joseph Abuya agreed to pool their resources together and participate in the auction. They agreed
to share the joint venture profits and losses. Karanja and Abuya in the ration of 3:2 respectively

Karanja sent Abuya a cheque of Sh. 2,400,000 on 15 March 2001 to provide him with funds for
Karanja’s participation in the joint venture.
Karanja and Abuya successfully bought goods and managed to sell all of the goods purchased by the
end of April 2001. Their cash transactions appeared as follows:
Karanja Abuya
Sh. Sh.
Sales 3,840,000 2,520,000
Travelling expenses 392,400 555,600
Advertising 123,600 109,200
City Council charges 102,000 84,000
Salaries and wages 57,600 78,100
Sundry expenses 70,800 34,800
Purchases 1,920,000 1,320,000
Telephone expenses 33,700 28,900
Insurance 12,300 11,200
Transportation of goods 157,000 121,500
Settlement between Karanja and Abuya was done by cheque on 30 April 2001.
Required:
a) Memorandum joint venture account.
b) Joint Venture account with Abuya in Karanja’s ledger
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c) Joint Venture account with Karanja in Abuya’s ledger
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Solution:
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(a) Joint venture with Abuya a/c
Shs Shs
Remittance 2,400,000 Bank (sales) 3,840,000
Traveling expenses 392,400 Bank A/c (final remittance) 2,117,780
Advertising 123,600
City council expenses 102,000
Sundry expenses 70,800
Salaries charges 57,600
Purchases 1,920,000
Telephone 33,700
Insurance 12,300
Transport 157,000
Share of profit 688,380 -
5,957,780 5,957,780

b)
Joint venture with Karanja A/C
Shs Shs
Traveling 555,600 Bank a/cRemittance 2,400,000
Advertising 109,200 Sales 2,520,000
City council 84,000
Salaries wages 78,100
Sundry charges 34,800
Purchases 1,320,000
Telephone 28,900
Insurance 11,200
Transport 121,500
Share of profit 458,920
Bank(final remittance) 2,117,780
4,920,000 4,920,000
c)
Memorandum joint venture a/c
Shs Sales Shs

Traveling exp 948,000 6,360,000
Advertising 232,000
City council 186,000
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Salaries + wages 135,700
a.c
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Sundry charges 105,600
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Purchases 3,240,000
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Telephone expenses 62,600
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Insurance 23,500
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Transport 278,500
Share of profit
- Karanja 688,380
- Abuya 458,920
6,360,000 6,360,000
QUESTION 3
On 1 January 2003; Hassan and Kamau entered into a joint venture to buy and sell goods. It was
agreed that Hassan should receive a commission of 2% on all sales in consideration for which he
was to bear all losses from bad debts. Profits and losses were to be shared equally.
The following transactions took place:
 2 January 2003: Hassan purchased goods for Sh. 680,000 paying Sh. 480,000 in cash and
accepted two bills of exchange, one for Sh. 80,000 and the other for Sh. 120,000.
 3 January 2003: Hassan sent to Kamau goods which had cost Sh. 275,000 and Kamau
transferred Sh. 350,000 to Hassan in cash.

 9 January 2003: Hassan sold goods to Otieno for Sh. 42,000 and to Wafula for Sh. 25,000 and
they accepted bills of exchange for the amounts respectively due from them. Hassan endorsed
both bills to Kamau who discounted them incurring discounting charges of Sh. 2,000.
 3 February 2003:Hassan sold goods for Sh. 180,000. On delivery, the customer rejected
goods invoiced at Sh. 9,000 and these goods were collected by Kamau who sold them to
another customer for Sh. 11,000.
 11 Feb 2003:Otieno met his bill but Wafula’s bill was dishonoured. Wafula could not meet
his debt and it was written off as a bad debt.
 5 March 2003: Kamau paid the bill for Sh.80,000 which had been accepted by Hassan and
Hassan paid the second bill for Sh. 120,000.
 20 March 2003: Hassan sold the remainder of the goods in his possession for Sh. 291,000 and
Kamau’s sales on the same date amounted to Sh. 340,000. Bad debts (apart from the amount
due from Wafula) were Sh. 4,200 of which Sh. 3,000 was in respect of sales by Hassan.
- On 30 April 2003, the venture was closed. Kamau took over the stock in his
possession at a valuation of Sh. 50,000 and the sum required to settle accounts
between the venturers was paid by the relevant venturer.
Required:
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a) Joint venture accounts which would appear in the books of Hassan and Kamau for the period
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ended 30 April 2003.
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b) Memorandum joint venture account showing the distribution of profit for the period ended 30
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April 2003.
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Solution:
Hassan Books
Joint venture with Kamau a/c
3.1.2003 Bank A/C (purchases 480,000 3.1.2003 bank A/c Cash from Kamau 350,000
5.3.2003 Bank A/C (purchases) 120,000 3.2.2003 Bank (sales) 171,000
20.3.2003 Commission income A/C 17,600 20.3.2003 Bank (sales) 291,000
Share of profit 155,200 20.3.2003 Stock A/c (stock to
20.3.2003 Bank A/c (cash from Kamau) 275,000
Kamau) 403,250 20.3.2003 Stock to Kamau 9,000
_______ 20.3.2003 Bill to Kamau __80,000
1,176,000 1,176,000

Kamau’s Books
Joint Venture with Hassan A/C
3.1.2003 Bank A/C (Cash to House) 350,000 9.1.2003 bank A/c (sales) 67,000
9.1 2003 Bank A/C (Discharges) 2,000 3.2.2003 bank (sales) 11,000
5.3.2003 Bank (purchases) 80,000 20.3.2003 bank (sales) 340,000
3.1.2003 stock A/C (stock) 284,000 20.3.2003 bal. C/d (closing stock) 50,000
3.1.2003 share of profit 155,200 20.3.2003 bank A/C (Cash fromHassan) 403,2000
871,200 871,200
b) Memorandum Joint Venture A/C

Sh Sales Sh
Purchases 600,000 Closing stock 880,000
Discounting charges 2,000 50,000
Commission to Hassan 17,600
Share of profit: Hassan 155,200
:Kamau 135,200 _____
930,000 930,000
QUESTION 4
a) Briefly explain the meaning of the following terms in relation to bills of exchange:
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i. Accommodation bill.
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ii. Noting charges.
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b) On 1 April 2005, Limo, Tergat, Wambani and Gachara entered into a joint venture for the
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purposes of importing second had cars from Dubai and selling them in Eldoret town. The profit
or loss from the venture was to be shared as follows: Limo 10%. Tergat 20%. Wambani 30%
and Gachara 40%.
Limo was assigned the responsibility of going to Dubai to buy the cars. Tergat was to clear the cars
at the port of Mombasa. Wambani was to transport the cars from Mombasa to Eldoret and Gachara
was to sell the cars once they were received in Eldoret.
The following is a summary of the transactions undertaken:
1. Gachara remitted Sh.4million to Limo and Wambani remitted Sh.500,000 to Tergat towards the
joint venture.
2. Limo incurred the following expenses on behalf of the joint venture:
Sh.
• Travelling expenses 45,000
• Entertainment 45,000
• Purchase of cars 3,600,000
• Shopping expenses 1,710,000

3. Tergat received the purchase and consignment documents from Limo and incurred the following
expenses to clear the cars:
Sh.
• Customs duty 1,860,000
• Clearing agents’ fees 200,000
4. While transporting the cars from Mombasa, Wambani incurred the following expenses:
Sh.
• General expenses 162,000
• Haulage 135,000
• Insurance 235,800
5. In order to sell the cars, Gachara incurred the following expenses:
Sh.
• Security 126,000
• Storage charges 81,000
• Sales commissions 264,600
6. Gachara sold some cars for Sh.7,900 and the remaining ones were taken over by Tergat for his
own use at a value of Sh.1,350,000
7. All the transactions were completed by 31 May 2005.
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Required:
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i) Memorandum joint venture profit and loss account for the two months ended 31 May 2005.
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ii) The joint venture accounts in the books of Limo, Tergat, Wambani and Gachara for the two
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months ended 31 May 2005.
Solution:
a) An accommodation bill may be described as a bill which is drawn, accepted or endorsed without
consideration but simply to oblige and help to raise money by discounting or negotiating it. Accommodation
bills are also known as kite bills.
i. Noting or notary charges: the cost formally presenting a dishonoured bill to the acceptor (drawee)
usually by a lawyer acting as a notary public.

b) Limo, Tergat, Wambani and Gachara joint venture
i) Statement showing the result of the venture
Sh. Sh.
Sale of cars 7,900,000
Add value of cars retained by Tergat 1,350,000
9,250,000
Less: expenses by Limo
Purchases 3,600,000
Travelling expenses 45,000
Entertainment 45,000
Shipping expenses 1,710,000 (5,400,000)
Expenses by Tergat:
Customs duty 1,860,000
Clearing agents fees 200,000 (2,060,000)
Expenses by Wambani:
Transport (Haulage) 135,000
Insurance 235,800 (532,800)
Expenses by Gachara:
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Security 126,000
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Storage 81,000
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Sales commissions 264,600 (471,600)
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Profit of the venture 785,600
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Share of profit: Limo - 10% 78,560
Tergat – 20% 157,120
Wambani – 30% 235,680
Gachara – 40% 314,240 785,600
ii) In the books of Limo
Joint Venture with Tergat, Wambani and Gachara

Sh. Sh.
Travelling expenses 45,000 Bank – Gachara 4,000,000
Entertainment 45,000
Purchases 3,600,000
Shipping expenses 1,710,000
Profit of venture 10% 78,560 Balance carried down 1,478,560
5,478,560 5,478,560
Balance brought down 1,478,560 Cash from Gachara 1,478,560

In the books of Tergat

Sh. Sh.
Customs duty 1,860,000 Bank – Wambani 500,000
Clearing agents fees 200,000 Purchases – cars 1,350,000
Profit and loss-20% 157,120 Balance carried down 367,120
2,217,120 2,217,120
Balance brought down 367,120 Cash from Gachara 367,120
In the books of Wambani

Sh. Sh.
Bank – remitted – Tergat 500,000
Haulage 135,000
Insurance 235,800
Profit – 30% 235,680 Balance carried down 1,268,480
1,268,480 1,268,480
Balance brought down 1,268,480 Cash from Gachara 11,268,480
In the books of Gachara
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Bank remitted – Limo 4,000,000 Bank – sales 7,900,000
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Security 126,000
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Storage 81,000
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Sales Commissions 264,600
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Profit – 40% 314,240
Balance carried down 3,114,160
7,900,000 7,900,000
Cash to Limo 1,478,560 Balance brought down 3,114,160
Cash to Tergat 367,120
Cash to Wambani 1,268,480 _______
3,114,160 3,114,160

TOPIC 7
FINANCIAL STATEMENTS OF PUBLIC SECTOR ENTITIES
INTERNATIONAL PUBLIC SECTOR ACCOUNTING STANDARDS (IPSASS)
International Public Sector Accounting Standards (IPSAS) are a set of accounting standards
issued by the IPSAS Board for use by public sector entities around the world in the preparation of
financial statements. These standards are based on International Financial Reporting Standards
(IFRS) issued by the International Accounting Standards Board (IASB).
The International Public Sector Accounting Standards (IPSAS) are a set of currently (February
2015) 38 accrual-based standards and one comprehensive cash-based standard on accounting
for public sector entities. The Standards are developed and published by the so-called
"International Public Sector Accounting Standards Board" (IPSASB or IPSAS-Board).
The IPSAS aim to: improve the quality and transparency of public sector financial reporting as well
to enhance governments' financial management capabilites.
All standards are principally published in English. In terms of content, most IPSAS have a
corresponding International Accounting Standards (IAS)/International Financial Reporting Standard
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(IFRS) on which they are based. These IAS/IFRS are primarily designed for enterprises - and not
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for public sector entities - which is why the IAS/IFRS were adjusted to public sector
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characteristics. IPSAS are designed to be used by public sector entities (e.g. state government,
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municipal government). However, they should not be applied by government business enterprises
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(GBE). GBEs are supposed to apply IAS/IFRS.
One major problem of the International Public Sector Accounting Standards is that they primarily
focus on accounting, i.e. ex-post financial reporting. A true modernisation of public financial
management, however, requires the implementation of accrual-based accounting as well as accrual-
based budgeting. In the public sector, the annual budget is one of the most (if not the most)
important financial governance instrument(s). Hence, reforming public sector budgeting is
absolutely essential for modernising public financial management. The IPSAS can function as a
suitable basis for reforming and harmonising public sector accounting. Yet for the purposes of
reforming and harmonising public sector budgeting, new public sector budgeting standards need to
be developed (e.g. also inspired by existing national budgetary laws that are already based on
accrual principles)
IPSASB activities
The IPSASB's current activities are focused on the development of International Public Sector
Accounting Standards (IPSAS) for financial reporting by governments and other public sector
entities (the Standards Project).

The IPSASB's Standards Project was established in late 1996. The objectives of the initial stage of
the project were to develop by the end of November 2001:
 A background paper identifying current practices and issues in public sector financial
reporting
 A core set of IPSAS based (to the extent appropriate) on the International Accounting
Standards in place as at August 1997
 An IPSAS on the cash basis of accounting
 Guidance on the transition from the cash to the accrual basis of accounting.
The Preface to International Financial Reporting Standards issued by the International Accounting
Standards Board explains that International Financial Reporting Standards (IFRSs) are designed to
apply to the general purpose financial statements of all profit-oriented entities. Government Business
Enterprises (GBEs) as defined by the IPSASB are profit-oriented entities. Accordingly, they are
required to comply with IFRS.
A Government Business Enterprise (GBE)
 Is an entity with the power to contract in its own name

 Has been assigned the financial and operational authority to carry on a business
 Sells goods and services, in the normal course of its business, to other entities at a profit or
full cost recovery
 Is not reliant on continuing government funding to be a going concern (other than purchases
of outputs at arm's length)
 Is controlled by a public sector entity.
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Convergence of IPSAS with IFRSs
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The IPSASB develops accrual-based International Public Sector Accounting Standards (IPSAS) to
address public sector financial reporting issues in two different ways:
1. By addressing public sector financial reporting issues

 that have not been comprehensively or appropriately dealt with in existing International
Financial Reporting Standards (IFRSs) issued by the International Accounting Standards
Board (IASB), or
 for which there is no related IFRS; and
2. By developing IPSAS that are converged with IFRSs by adapting them to the public sector
context.
There are two types of IPSAS;
Cash basis:
Allows for transparent financial reporting of cash receipts, payments and balances, under the cash
basis of accounting

Accrual Accounting:
Focuses on revenue, cost, assets, liability and equity, instead of cash flow only
Most IPSAS are on accrual basis which is in line with IFRS
THE BENEFITS OF ADOPTING IPSAS
Quality and comparability

The adoption of IPSASs by governments improves both the quality and comparability of financial
information reported by public sector entities around the world. It improves the comparability of
reports between various government agencies, parastatals, donor funded projects etc. Reports
prepared in accordance with IPSASs provide for comparability between different financial periods,
even within the same institutions, hence facilitating management decisions.
Transparency
Disclosure information requirements of various reports facilitate transparency in the financial
dealings of public institutions. These disclosures enables users of financial information interpret the
reports in the right context and better decision making processes.
Consistency
IPSASs also improve consistency in preparation and reporting of financial information. This in turn
enables users to draw consistent conclusions given similar sets of financial statements.
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Accountability
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Adoption of IPSASs improves accountability and ease the audits of public institutions. This
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translates into timely audit reports, better information to donors and countries providing external
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assistance, better quality and credibility of financial reports.
Governance
IPSASs results in stronger governance procedures and a framework for the accounting practise in
the public sector. This strengthens the financial management of public institutions.

IPSAS Summary
The following is a summary of the provisions of all International Public Sector Accounting
Standards (IPSAS) outstanding at 1 February 2012. These standards are based on accrual
accounting.
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IPSAS Standard Based on
IPSAS 1 Presentation of Financial Statements IAS 1

IPSAS 2 Cash Flow Statements IAS 7
IPSAS 3 Accounting Policies, Changes in Accounting Estimates and Errors IAS 8
IPSAS 4 The Effects of Changes in Foreign Exchange Rates IAS 21
IPSAS 5 Borrowing Costs IAS 23
IPSAS 6 Consolidated and Separate Financial Statements IAS 27
IPSAS 7 Investments in Associates IAS 28
IPSAS 8 Interests in Joint Ventures IAS 31
IPSAS 9 Revenue from Exchange Transactions IAS 18
IPSAS 10 Financial Reporting in Hyperinflationary Economies IAS 29
IPSAS 11 Construction Contracts IAS 11
IPSAS 12 Inventories IAS 2
I PSAS 13 Leases IAS 17
IPSAS 14 Events After the Reporting Date IAS 10
IPSAS 15 Financial Instruments: Disclosure&Presentation-superseded by IPSAS 28 and IPSAS 30
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IPSAS 16 Investment Property IAS 40
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IPSAS 17 Property, Plant and Equipment IAS 16
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IPSAS 18 Segment Reporting IAS 14
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IPSAS 19 Provisions, Contingent Liabilities and Contingent Assets IAS 37
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IPSAS 20 Related Party Disclosures IAS 24
IPSAS 21 Impairment of Non-Cash-Generating Assets IAS 36
IPSAS 22 Disclosure of Financial Information About the General Government Sector N/A
IPSAS 23 Revenue from Non-Exchange Transactions (Taxes and Transfers) N/A
IPSAS 24 Presentation of Budget Information in Financial Statements N/A
IPSAS 25 Employee Benefits IAS 19
IPSAS 26 Impairment of Cash-Generating Assets IAS 36
IPSAS 27 Agriculture IAS 41
IPSAS 28 Financial Instruments: Presentation IAS 32
IPSAS 29 Financial Instruments: Recognition and Measurement IAS 39
IPSAS 30 Financial Instruments: Disclosures IFRS 7
IPSAS 31 Intangible Assets IAS 38
IPSAS 32 Service Concession Arrangements: Grantor IFRIC 12

IPSAS 1 PRESENTATION OF FINANCIAL STATEMENTS
Effective date
Annual periods beginning on or after January 1, 2008
Objective
To set out the manner in which general purpose financial statements shall be prepared under the
accrual basis of accounting, including guidance for their structure and the minimum requirements
for content.
Summary
 Fundamental principles underlying the preparation of financial statements, including going
concern assumption, consistency of presentation and classification, accrual basis of
accounting, aggregation and materiality.
 A complete set of financial statements comprises:
• Statement of financial position;
• Statement of financial performance;
• Statement of changes in net assets/equity;
• Cash flow statement;
• When the entity makes it approved budget publicly available, a comparison of budget
and accrual amounts;
• Notes, comprising a summary of significant accounting policies and other explanatory
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notes.
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 An entity whose financial statements comply with IPSASs shall make an explicit and
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unreserved statement of such compliance in the notes. Financial statements shall not be
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described as complying with IPSASs unless they comply with all the requirements of
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IPSASs.
 Assets and liabilities, and revenue and expenses, may not be offset unless offsetting is
permitted or required by another IPSAS.
 Comparative prior-period information shall be presented for all amounts shown in the
financial statements and notes. Comparative information shall be included when it is relevant
to an understanding of the current period's financial statements. In the case presentation or
classification is amended, comparative amounts shall be reclassified, and the nature, amount
of, and reason for any reclassification shall be disclosed.
 The statement of changes in net assets/equity shows all changes in net assets/equity.
 Financial statements generally to be prepared annually. If the date of the year end changes,
and financial statements are presented for a period other than one year, disclosure thereof is
required.
 Current/non-current distinction for assets and liabilities is normally required. In general,
subsequent events are not considered in classifying items as current or non-current. An entity
shall disclose for each assets and liability item that combines amounts expected to be
recovered or settled both before and after 12 months from the reporting date, the amount to be
recovered or settled after more than 12 months.
 IPSAS 1 specifies minimum line items to be presented on the face of the statement of
financial position, statement of financial performance and statement of changes in net

assets/equity, and includes guidance for identifying additional line items, headings and sub-
totals.
 Analysis of expenses in the statement of financial performance may be given by nature or by
function. If presented by function, classification of expenses by nature shall be provided
additionally.
 IPSAS 1 specifies minimum disclosure requirements for the notes. These shall include
information about:
• accounting policies followed;
• the judgments that management has made in the process of applying the entity's
accounting policies that have the most significant effect on the amounts recognized
in the financial statements;
• the key assumptions concerning the future, and other key sources of estimation
uncertainty, that have a significant risk of causing a material adjustment to the
carrying amounts of assets and liabilities within the next financial year;
• the domicile and legal form of the entity;
• a description of the nature of the entity's operations;
• a reference to the relevant legislation; and
• The name of the controlling entity and the ultimate controlling entity of the
economic entity.
 An appendix to IPSAS 1 provides illustrative statements of financial position, statements of
financial performance and statements of changes in net assets/equity.
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IPSAS 3 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS
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Effective date
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Objective
To prescribe the criteria for selecting and changing accounting policies, together with the accounting
treatment and disclosure of changes in accounting policies, changes in accounting estimates, and
corrections of errors.
Summary
• In the absence of an IPSAS that specifically applies to a transaction, other event or condition,
management shall use judgement in developing and applying an accounting policy that results
in information that is:
 Relevant to the decision-making needs of users, and
 Reliable, in that the financial statements:
- Represent faithfully the financial position, financial performance and
cash flows of the entity;
- Reflect the economic substance of transactions, other events and
conditions and not merely the legal form;
- Are neutral, i.e., free from bias;
- Are prudent; and
- Are complete in all material aspects.
• IPSAS 3 prescribes a hierarchy for choosing accounting policies:
 IPSASs, taking into account any relevant implementation guidance;
 in the absence of a directly applicable IPSAS, look at the requirements and
guidance in IPSASs dealing with similar and related issues; and the definitions,
recognition and measurement criteria for assets, liabilities, revenue and
expenses described in other IPSASs; and
 management may also consider the most recent pronouncements of other
standard-setting bodies, and accepted public and private sector practices.
• Apply accounting policies consistently to similar transactions.
• Make a change in accounting policy only if it is required by an IPSAS, or it results in reliable
and more relevant information.
• If a change in accounting policy is required by an IPSAS, follow that pronouncement's
transition requirements. If none are specified, or if the change is voluntary, apply the new
accounting policy retrospectively by restating prior periods. If restatement is impracticable,
include the cumulative effect of the change in net assets/equity. If the cumulative effect
cannot be determined, apply the new policy prospectively.
• Changes in accounting estimates (for example, change in useful life of an asset) are
accounted for in the current period, or the current and future periods (no restatement).
• In the situation a distinction between a change in accounting policy and a change in
accounting estimate is unclear, the change is treated as a change in an accounting estimate.
• All material prior period errors shall be corrected retrospectively in the first set of financial
statements authorized for issue after their discovery, by restating comparative prior period
amounts or, if the error occurred before the earliest period presented, by restating the opening
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IPSAS 5 Borrowing Costs
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Effective date
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Periods beginning on or after July 1, 2001
Objective
To prescribe the accounting treatment for borrowing costs.
Summary
 Borrowing costs include interest, amortization of discounts or premiums on borrowings, and
amortization of ancillary costs incurred in the arrangement of borrowings.
 Two accounting treatments are allowed:
 expense model: charge all borrowing costs to expenses in the period when they are
incurred; and
 Capitalization model: capitalize borrowing costs which are directly attributable to the
acquisition or construction of a qualifying asset, but only when it is probable that these
costs will result in future economic benefits or service potential to the entity, and the
costs can be measured reliably. All other borrowing costs that do not satisfy the
conditions for capitalization are to be expensed when incurred.
 Where an entity adopts the capitalization model, that model shall be applied consistently to
all borrowing costs that are directly attributable to the acquisition, construction or production

of all qualifying assets of the entity. Investment income from temporary investment shall be
deducted from the actual borrowing costs.
 A qualifying asset is an asset which requires a substantial period of time to make it ready for
its intended use or sale. Examples include office buildings, hospitals, infrastructure assets
such as roads, bridges and power generation facilities, and some inventories.
 If funds are borrowed generally and used for the purpose of obtaining the qualifying asset,
apply a capitalization rate (weighted average of borrowing costs applicable to the general
outstanding borrowings during the period) to outlays incurred during the period, to determine
the amount of borrowing costs eligible for capitalization.
IPSAS 6 Consolidated and Separate Financial Statements
Effective date
Objective
To prescribe requirements for preparing and presenting consolidated financial statements for an
economic entity under the accrual basis of accounting. To prescribe how to account for investments
in controlled entities, jointly controlled entities and associates in separate financial statements
Summary
 A controlled entity is an entity controlled by another entity, known as the controlling entity.
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Control is the power to govern the operating and financial policies. Consolidated financial
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statements are financial statements of an economic entity (controlling entity and controlled
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entities combined) presented as those of a single entity.
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 Consolidated financial statements shall include all controlled entities, except when there is
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evidence that:
 control is intended to be temporary because the controlled entity is acquired and held
exclusively with a view to its subsequent disposal within twelve months from
acquisition; and
 Management is actively seeking a buyer.
 No exemption for controlled entity that operates under severe long-term funds transfer
restrictions. A controlled entity is not excluded from consolidation because its activities are
dissimilar to those of the other activities within the economic entity.
 Balances, transactions, revenue and expenses between entities within the economic entity are
eliminated in full.
 Consolidated financial statements shall be prepared using uniform accounting policies for like
transactions and other events in similar circumstances.
 Reporting dates of controlled entities cannot be more than three months different from
reporting date of the controlling entity.
 Minority interest is reported in net assets/equity in the consolidated statement of financial
position, separately from the controlling entity's net assets/equity, and is not deducted in
measuring the economic entity's revenue or expense. However, surplus or deficit of the
economic entity is allocated between minority and majority interest on the face of the
statement of financial performance.

 In the controlling entity's separate financial statements: account for all of its investments in
controlling entities, associates and joint ventures either using the equity method, at cost or as
financial instruments.
IPSAS 7 Investments in Associates
Effective date
Objective
To prescribe the investor's accounting for investments in associates where the investment in the
associate leads to the holding of an ownership interest in the form of a shareholding or other formal
equity structure
Summary
 Applies to all investments in which an investor has significant influence unless the investor
is:
 a venture capital organization, or
 a mutual fund or unit trust or a similar entity, such as an investment-linked insurance
fund that is measured at fair value, with changes in fair value recognized in surplus or
deficit in the period of the change, in accordance with the relevant international or
national accounting standard dealing with the recognition and measurement of financial
instruments.
 When there is evidence that the investment is acquired and held exclusively with a view to its
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disposal within twelve months from acquisition and that management is actively seeking a
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buyer, the investment shall be classified as held for trading and accounted for in accordance
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with the relevant international or national accounting standard dealing with the recognition
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and measurement of financial instruments.
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 Otherwise, the equity method is used for all investments in associates over which the entity
has significant influence.
 Rebuttable presumption of significant influence if investment held, directly or indirectly, is
20% or more of the voting power of the associate.
 Under the equity method, the investment is initially recorded at cost. It is subsequently
adjusted by the investor's share of the investee's post acquisition change in net assets/equity.
Investor's statement of financial performance reflects its share of the investee's post-
acquisition surplus or deficit.
 The investor's financial statements shall be prepared using uniform accounting policies for
like transactions and events in similar circumstances.
 Reporting dates of associates cannot be more than three months different from the investor's
reporting date.
 Even if consolidated accounts are not prepared, for example, because the investor has no
controlled entities, equity accounting is requiredlf application of the requirements in the
relevant international or national accounting standard dealing with the recognition and
measurement of financial instruments indicates that the investment may be impaired, an
entity applies IPSAS 21.

IPSAS 8 Interests in Joint Ventures
Effective date
Objective
To prescribe the accounting treatment required for interests in joint ventures, regardless of the
structures or legal forms of the joint venture activities
Summary
 Applies to all investments in which investor has joint control unless the investor is:
 a venture capital organization, or
 a mutual fund or unit trust or a similar entity, such as an investment-linked insurance
fund that is measured at fair value, with changes in fair value recognized in surplus or
deficit in the period of the change, in accordance with the relevant international or
national accounting standard dealing with the recognition and measurement of financial
instruments.
 The key characteristic of a joint venture is a binding arrangement whereby two or more
parties are committed to undertake an activity that is subject to joint control. Joint ventures
may be classified as jointly controlled operations, jointly controlled assets and jointly
controlled entities. Different accounting treatments apply for each type of joint venture.
 Jointly controlled operations: venturer recognizes the assets it controls, and expenses and
liabilities it incurs, and its share of revenue earned, in both its separate and consolidated
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financial statements.
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 Jointly controlled assets: venturer recognizes in its financial statements its share of the jointly
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controlled assets, any liabilities that it has incurred, and its share of any liabilities incurred
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jointly with the other venturers, revenue earned from the sale or use of its share of the output
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of the joint venture, its share of expenses incurred by the joint venture, and expenses incurred
directly in respect of its interest in the joint venture. These rules apply to both separate and
consolidated financial statements.
 Jointly controlled entities: two accounting policies are permitted:
 Proportionate consolidation: under this method, the venturer's statement of financial
position includes its share of the assets that it controls jointly and its share of the
liabilities for which it is jointly responsible. Its statement of financial performance
includes its share of the revenue and expenses of the jointly controlled entity; and
 The equity method, as described in IPSAS 7.
 When there is evidence that the interest in a joint venture is acquired and held exclusively
with a view to its disposal within twelve months from acquisition and that management is
actively seeking a buyer, the interest shall be classified as held for trading and accounted for
in accordance with the relevant international or national accounting standard dealing with the
recognition and measurement of financial instruments.

IPSAS 11 Construction Contracts
Effective date
Periods beginning on or after July 1, 2002
Objective
To prescribe the accounting treatment for revenue and costs associated with construction contracts in
the financial statements of the contractor.
Summary
• Contract revenue shall comprise the initial amount agreed in the contract together with
variations in contract work, claims, and incentive payments to the extent that it is probable
that they will result in revenues and can be measured reliably.
• Contract revenue is measured at the fair value of the consideration received or receivable
• Contract costs shall comprise costs that relate directly to the specific contract, costs that are
attributable to general contract activity and that can be allocated to the contract on a
systematic and rational basis, together with such other costs as are directly attributable to the
customer under the terms of the contract.
• Where the outcome of a construction contract can be estimated reliably, revenue and costs
shall be recognized by reference to the stage of completion of contract activity at the
reporting date (the percentage of completion method of accounting).
• If the outcome cannot be estimated reliably, no surplus shall be recognized. Instead, contract
revenue shall be recognized only to the extent that contract costs incurred are expected to be
recovered, and contract costs shall be expensed as incurred.
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• In respect of construction contracts in which it is intended at inception of the contract that
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contract costs are to be fully recovered from the parties to the construction contract: if it is
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probable that total contract costs will exceed total contract revenue, the expected deficit shall
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be recognized immediately.
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IPSAS 12 Inventories
Effective date
Objective
To prescribe the accounting treatment of inventories, including cost determination and expense
recognition, including any write-down to net-realizable value. It also provides guidance on the cost
formulas that are used to assign costs to inventories.
Summary
• Inventories are required to be measured at the lower of cost and net realizable value. Where
inventories are acquired through a non-exchange transaction, their cost shall be measured as
their fair value as at the date of acquisition. However, inventories are required to be measured
at the lower of cost and current replacement cost where they are held for:
— Distribution at no charge or for a nominal charge; or
— Consumption in the production process of goods to be distributed at no charge or for
a nominal charge.
• Costs include all purchase cost, conversion cost (materials, labor and overhead), and other
costs to bring inventory to its present location and condition, but not foreign exchange
differences and selling costs. Trade discounts, rebates and other similar items are deducted in
determining the costs of purchase.
• For inventory items that are not interchangeable, specific costs are attributed to the specific
individual items of inventory.
• An entity shall apply the same cost formula for all inventories having similar nature and use
to the entity; a difference in geographical location of inventories by itself is not sufficient to
justify the use of different cost formulas.
• For interchangeable items, cost is determined on either a FIFO or weighted average basis.
LIFO is not permitted.
• For inventories with a different nature or use, different cost formulas may be justified.
• When inventories are sold, exchanged or distributed, the carrying amount shall be recognized
as an expense in the period in which the related revenue is recognized. If there is no related
revenue, the expense is recognized when the goods are distributed or related services have
been rendered.
• Write-downs to net realizable value are recognized as an expense in the period the loss or the
write-down occurs. Reversals arising from an increase in net realizable value are recognized
as a reduction of the inventory expense in the period in which they occur.
I PSAS 13 Leases
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Objective
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To prescribe, for lessees and lessors, the appropriate accounting policies and disclosures to apply in
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relation to finance and operating leases
Summary
 A lease is classified as a finance lease if it transfers substantially all risks and rewards
incidental to ownership of an asset. The title may or may not be eventually transferred.
Examples:
 Lease covers substantially all of the asset's life; and/or
 Present value of lease payments is substantially equal to the asset's fair value.
 All other leases are classified as operating lease. The land and building elements of a lease of
land and buildings are considered separately for the purposes of lease classification.
 Finance leases — Lessee's Accounting:
 Recognize asset and liability at the lower of the present value of minimum lease
payments and the fair value of the asset, determined at the inception of the lease. The
discount rate applicable for calculating the present value shall be the interest rate
implicit in the lease or the incremental borrowing rate;
 depreciation policy — as for owned assets; and
 Finance lease payment — apportioned between interest and reduction in outstanding
liability.

 Finance leases — Lessor's Accounting:
 recognize as a receivable in the statement of financial position at an amount equal to
the net investment in the lease; and
 Recognize finance revenue based on a pattern reflecting a constant periodic rate of
return on the lessor's net investment.
 Operating leases — Lessee's Accounting:
 Recognize lease payments as an expense in the statement of financial performance on
a straight-line basis over the lease term, unless another systematic basis is
representative of the time pattern of the user's benefit.
 Operating leases — Lessor's Accounting:
 Assets held for operating leases shall be presented in the lessor's statement of financial
position according to the nature of the asset; and
 Lease revenue shall be recognized on a straight-line basis over the lease term, unless
another systematic basis is more representative of the time pattern of the benefits.
 Lessors of operating leases shall add initial direct costs incurred in negotiating and arranging
an operating lease to the carrying amount of the leased asset and recognize them as an
expense over the lease term on the same basis as the lease revenue.
 Accounting treatment of sale and leaseback transactions depends on whether these are
essentially finance or operating leases.
IPSAS 14 Events after the Reporting Date
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Effective date
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Objective
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To prescribe:
• When an entity shall adjust its financial statements for events after the reporting date.
• Disclosures that an entity should give about the date when the financial statements were
authorized for issue, and about events after the reporting date.
Summary
 Events after the reporting date are those events, both favorable and unfavorable, that occur
between the reporting date and the date when the financial statements are authorized for
issue.
 Adjusting events after the reporting date, those that provide evidence of conditions that
existed at the reporting date — adjust the financial statements to reflect those events that
provide evidence of conditions that existed at the reporting date (e.g., settlement of a court
case after the reporting date, that confirms that the entity had an obligation at the reporting
date).
 Non-adjusting events after the reporting date, those that are indicative of conditions that arose
after the reporting date — do not adjust the financial statements to reflect events that arose
after the reporting date (e.g. , a decline in the fair value of property after year end, which does
not change the valuation of the property at the reporting date).

 Dividends proposed or declared after the reporting date shall not be recognized as a liability
at the reporting date. Disclosure is required.
 An entity shall not prepare its financial statements on a going concern basis if events after the
reporting date indicate that the going concern assumption is not appropriate (e.g., if there is
an intention to liquidate the entity or cease operations after the reporting date, or that there is
no realistic alternative but to do so).
 An entity shall disclose the date its financial statements were authorized for issue and who
gave that authorization. If another body has the power to amend the financial statements after
issuance, the entity shall disclose that fact.
 If an entity obtains information after the reporting date, but before the financial statements are
authorized for issue, about conditions that existed at the reporting date, the entity shall update
disclosures that relate to these conditions in light of the new information.
 An entity shall disclose the following for each material category of non-adjusting event after
the reporting date:
 The nature of the event, and
 An estimate of its financial effect, or a statement that such an estimate cannot be made.
IPSAS 19 Provisions, Contingent Liabilities and Contingent Assets
Effective date
Periods beginning on or after January 1, 2004
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Objective
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To prescribe appropriate recognition criteria and measurement bases for provisions, contingent
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liabilities and contingent assets, and to ensure that sufficient information is disclosed in the notes to
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the financial statements to enable users to understand their nature, timing and amount. IPSAS 19
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thus aims to ensure that only genuine obligations are dealt with in the financial statements. Planned
future expenditure, even where authorized by management, is excluded from recognition, as are
accruals for self-insured losses, general uncertainties, and other events that have not yet taken place.
Summary
 Recognize a provision only when:
 A past event has created a present legal or constructive obligation,
 An outflow of resources embodying economic benefits or service potential required to
settle the obligation is probable,
 And the amount of the obligation can be estimated reliably.
 Amount recognized as a provision is the best estimate of settlement amount of the
expenditure required to settle the obligation at reporting date.
 Requires a review of provisions at each reporting date to adjust for changes to reflect the
current best estimate.
 If it is no longer probable that an outflow of resources embodying economic benefits or
service potential is required to settle the obligation, the provision shall be reversed.
 Utilize provisions only for the purposes for which they were originally intended.
 Examples of provisions may include onerous contracts, restructuring provisions, warranties,
refunds and site restoration.
 A restructuring provision shall include only the direct expenditures arising from the
restructuring, which are those that are both:
 Necessarily entailed by the restructuring, and
 Not associated with the ongoing activities of the entity.
 Contingent liability arises when:
 there is a possible obligation to be confirmed by a future event that is outside the control
of the entity; or
 A present obligation may, but probably will not, require an outflow of resources
embodying economic benefits or service potential; or
 A sufficiently reliable estimate of the amount of a present obligation cannot be made (this
is rare).
 Contingent liabilities require disclosure only (no recognition). If the possibility of outflow is
remote, then no disclosure.
 Contingent asset arises when the inflow of economic benefits or service potential is probable,
but not virtually certain, and occurrence depends on an event outside the control of the entity.
 Contingent assets require disclosure only (no recognition). If the realisation of revenue is
virtually certain, the related asset is not a contingent asset and recognition of the asset and
related revenue is appropriate.
 If an entity has an onerous contract, the present obligation (net of recoveries) under the
contract shall be recognized and measured as a provision.
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FINANCIAL REPORTING

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- Dissolutions (including piece-meal)

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9.4 Financial statements of various types of organizations

- Presentation of financial statements (income statement, statement of comprehensive incomes,

- Accounting for one subsidiary (consolidated income statement, consolidated statement of

9.5 Financial statements of public sector entities

9.8 Emerging issues in financial reporting

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Topic 1: Assets and liabilities…....................................................................................................4

Topic 2: Further aspect of partnerships….....................................................................................86

Topic 3: Special transactions................................................................................…....................133

Topic 4: Financial statements for various types of organisations….............................................168

Topic 5: Published financial statements.........................................................…...........................235

Topic 6: Subsidiaries (groups), associates and jointly controlled entities.....................................266

Topic 7: Financial statements of public sector entities………………………………………......333

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ASSETS AND LIABILITIES

Recognition of Property, Plant and Equipment

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The cost of an item of property, plant and equipment comprises:

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Depreciation (both models)

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Methods for Providing Depreciation

1. Fixed Percentage on Diminishing Balar1!:e Method

Fixed Installment or Straight Line or Fixed Percentage on Original Cost.

Diminishing Balance Method

Sum of the Years Digits Method

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Depreciation Fund Method

Insurance Policy Method

Machine Hour Rate Method

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Machine Hour value

Repairs Provision Method

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Nature of an intangible asset

Another example of an intangible asset is Good will.

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This reputation will depend on:

a) The personal reputation of the owners and / or management.

b. Super Profits Basis

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The difference between tangible assets and intangible assets

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Accrued income is an amount that has been

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IFRS 5 Non-current Assets Held for Sale and Discontinued Operations

Non-current assets held for sale and discontinued operations. (IFRS 5)

The objectives of IFRS 5 are to:

Classification as held for sale.

Measurement and presentation of non-current assets held for sale.

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 Represent a separate major line of business or geographical area of operations

The analysis must disclose:

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IAS 23 Borrowing Costs

(a) expenditures for the asset are being incurred;

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The financial statements shall disclose: