THE NATIONAL UNIVERSITY OF SCIENCE AND TECHNOLOGY

FINANCIAL ACCOUNTING (CAC 1101) MODULE

 FINANCIAL ACCOUNTING (CAC 1101) MODULE

Table of Contents
CHAPTER ONE: INTRODUCTION TO ACCOUNTING................................................................1
1.0 Introduction....................................................................................................................2
1.1The nature, principles and scope of financial reporting..................................................3
1.2 Qualitative Characteristics of Financial Information.....................................................11
1.3 The users of financial statements and their information needs...................................12
1.4Regulatory framework...................................................................................................15
1.5 A Conceptual Framework............................................................................................. 18
1.5.1The objective of financial statements.........................................................................19
1.5.2 Underlying statements.............................................................................................. 19
1.5.3 Qualitative characteristics of financial statements....................................................19
1.5.4 The elements of financial statements........................................................................20
1.6 International Accounting Standards (IAS’s) and international Financial reporting
Standards(IFRS’s)................................................................................................................21
1.7 IAS 1: Presentation of financial statements..................................................................24
1.7.1 The Statement of Cash Flows.................................................................................25
1.7. 2. The Statement of Changes in Equity............................................................................25
1.7.3 Notes to financial statements....................................................................................27
1.7.4 The Statement of Financial Position (SOFP)...............................................................28
1.7.5 The Statement of Comprehensive Income................................................................33
1.8 IAS 16: Property, plant and equipment.........................................................................37
1.8.1 Depreciation...........................................................................................................38
1.8.2 Other important terms used in depreciation.........................................................38
1.8.3 When does the charge of depreciation begin and when does it end?...................40
1.8.4 Depreciation methods............................................................................................40
1.8.5 Accounting treatment of depreciation...................................................................46
1.8.6 Depreciation on assets acquired or disposed of in the middle of an accounting
year................................................................................................................................. 47
1.8.7 Measurement after recognition.............................................................................47
1.8.8 TREATMENT OF ACCUMULATED DEPRECIATION AFTER REVALUATION................48
1.9 IAS 18: Revenue............................................................................................................50

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1.9.1 Measurement of revenue.................................................................................51

1.9.2 Identification of the transaction.............................................................................51
CHAPTER TWO: BUSINESS ENTITIES..................................................................................53
2.0 Introduction..................................................................................................................53
2.1 Sole traders...................................................................................................................54
2.2 Partnerships..................................................................................................................54
2.3 Companies.................................................................................................................... 56
2.4 The legal differences between a sole trader, partnership and a limited liability
Company.............................................................................................................................57
CHAPTER 3: ACCOUNTING FOR PARTNERSHIPS..................................................................61
3.0 Introduction..................................................................................................................61
3.1 Partnership accounting.................................................................................................62
3.1.1 Financial statements for a partnership.............................................................63
3.2 Partnership changes..................................................................................................... 68
3.2.1 Change in a profit sharing ratio..............................................................................70
3.2.2 Admission of a new partner...................................................................................70
3.2.5 Liquidation/ dissolution of the partnership...........................................................76
3.2.6 Insolvent partner..............................................................................................84
CHAPTER FOUR: TRIAL BALANCE.....................................................................................100
4.0 Introduction................................................................................................................100
4.1 Purpose of a trial balance...........................................................................................101
4.2 The limitations of a trial balance.................................................................................102
4.3 Correction of errors....................................................................................................103
4.3.1 Errors that cannot be highlighted by preparing a trial balance............................104
4.3.2. Errors which would be highlighted by the extraction of a trial balance..............105
4.3.3 Correction of errors..............................................................................................106
4.4 Control accounts and reconciliations..........................................................................106
4.4.1 Purpose of control accounts................................................................................107
4.4.2 Receivables control account and individual receivable (customer) account........108
4.4.3 Reconciliation of control account to ledger accounts..........................................109
CHAPTER FIVE: ACCOUNTING FOR NOT- FOR-PROFIT ORGANISATIONS..........................118
5.0 Introduction................................................................................................................118

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5.2 Distinction between not-for-profit and commercial entities......................................120

5.3 Accounting for non- governmental not-for-profit organizations..............................121
5.3.1 Receipt and payment account..............................................................................122
5.3.2 Statement of activities (statement of activities)..................................................126

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CHAPTER ONE: INTRODUCTION TO ACCOUNTING

1.0 Introduction
From the start of a business, various transactions and events take place. All transactions
should have as their base, certain original source documents (such as invoices or receipts –
which you have already studied in your earlier studies at A’Level and maybe O’Level) from
which we record information in the business accounts. This information is then summarised
in the form of financial statements.

Definition: Accounting is the process of recording and reporting of financial transactions

including the origination of the transaction, its recognition, processing and summarisation in
the financial statements.

The accountant will be responsible for accounting of business transactions and reporting
them to external users.

Financial reporting (or accounting) will therefore consist of the following:

1. Recording
However good the memory of a businessman may be, he cannot remember each and every
transaction that takes place during the course of business. Hence, there is a need to record
the day to day transactions e.g. sales, purchases, expenses made, cash paid to someone,
cash received from someone and so on.

Recording refers to the actual writing of the transactions that take place in words and
figures so that reliable information regarding the position of the business can be made
available at any point of time. The books where this information is recorded are known as
the books of original entry.
2. Analysing
From the books of original entry, the transactions are analysed and posted to the ledgers.

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Every transaction has two effects e.g. when a trader purchases goods, there are two
transactions involved:
_ One transaction is that the goods are received and
_ the other transaction is that cash is paid.
As each transaction will have a double effect, two ledger accounts will be affected when a
transaction is posted.

3. Summarising
Thousands of transactions could occur during a year and therefore users of financial
accounts may not have the time to go through each one of these transactions. In certain
cases, owners of a business also may wish to keep certain transactions confidential.
Therefore transactions need to be summarised in a structured manner in order to
understand an entity’s financial position and performance at the end of a period.

The final products of financial reporting are the business financial statements.

During the accounting process, accountants identify record and analyse the financial
dealings of a company.

At the end of each period, accountants use the information they have collected to prepare
financial statements.

Thus financial reporting is the process of preparing and presenting the financial
statements.

1.1 The nature, principles and scope of financial reporting.

Accounting follows a certain framework of core principles which makes the information
generated through an accounting system valuable. Without these core principles accounting
would be irrelevant and unreliable.

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Generally, a principle is a fundamental truth that is always accepted. However in accounting,

principles relate to an accepted guidance or method.

These principals include:

1. Accrual Concept
Business transactions are recorded when they occur and not when the related payments are
received or made. This concept is fundamental to the usefulness of financial accounting
information because accounting standards strictly require accounting on accrual basis..

Examples:

 An airline sells its tickets days or even weeks before the flight is made, but it does
not record the payments as revenue because the flight, the event on which the
revenue is based has not occurred yet.
 An accounting firm obtained its office on rent and paid $120,000 on January 1. It
does not record the payment as an expense because the building is not yet used.
While preparing its quarterly report on March 31, the firm expensed out three
months' rent i.e. 30,00 [$120,000/12*3] because 3 months equivalent of time has
expired.
 A business records its utility bills as soon as it receives them and not when they are
paid, because the service has already been used. The company ignored the date
when the payment will be made.

2. Going Concern Concept

Financial statements are prepared assuming that the company is a going concern which
means that the company intends to continue its business and is able to do so.

The auditors of the company determine whether the company is a going concern or not at
the date of the financial statements.

Examples
 An oil and gas firm operating in Nigeria is stopped by a Nigerian court from carrying
out operations in Nigeria. The firm is not a going concern in Nigeria, because it has to
shut down.

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 A bank is in serious financial troubles and the government is not willing to bail it out.
The Board of Directors has passed a resolution to liquidate the business. The bank is
not a going concern.

3. Business Entity Concept

In accounting we treat a business or an organization and its owners as two separately
identifiable parties. This concept is called business entity concept. It means that personal
transactions of owners are treated separately from those of the business.

Businesses are organized either as a proprietorship, a partnership or a company (will be

discussed later in this module). They differ on the level of control the ultimate owners
exercise on the business, but in all forms the personal transactions of the owners are not
mixed up with the transactions and accounts of the business.

Example
 A accountant has 3 rooms in a house he has rented for $3,000 per month. He has
setup a single-member accounting practice and uses one room for the purpose.
Under the business entity concept, only 1/3rd of the rent or $1,000 should be
charged to business, because the other 2 rooms or $2,000 worth of rent is expended
for personal purposes.
4. Monetary Unit Assumption

In accounting we can communicate only those business transactions and other events which
can be expressed in monetary units. This is called monetary unit assumption.

There are certain other frameworks for reporting business performance such as triple
bottom line which focuses on "people, planet profit" the three pillars; corporate social
responsibility reporting, etc. Accounting focuses on the financial aspects of the business and
that too for matters which can be expressed in terms of currencies.

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Examples

 The BP oil spill in Gulf of Mexico was a natural disaster but accounting only reports
the financial impact in the form of claims paid, damages paid, cleanup costs, etc. This
is due to the limitation imposed by the monetary unit assumption.

5. Time Period Principle

Although businesses intend to continue in long-term, it is always helpful to account for their
performance and position based on certain time periods because it provides timely
feedback and helps in making timely decisions.

Under time period assumption, we prepare financial statements quarterly, half-yearly or

annually. The income statement provides us an insight into the performance of the
company for a period of time. The balance sheet (also known as the statement of financial
position) provides us a snapshot of the business' financial position (assets, liabilities and
equity) at the end of the time period. The statement of cash flows and the statement of
changes in equity provide detail of how the company's financial position changed during the
time period.

One implication of the time period assumption is that we have to make estimates and
judgments at the end of the time period to correctly decide which events need to be
reported in the current time period and which ones in the next.

6. Revenue Recognition Principle

Revenue recognition principle tells that revenue is to be recognized only when the rewards
and benefits associated with the items sold or service provided is transferred, where the
amount can be estimated reliability and when the amount is recoverable.
Examples
 A telecommunication company sells talk time through scratch cards. No revenue is
recognized when the scratch card is sold, but it is recognized when the subscriber
makes a call and consumes the talk time.

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Revenue is the item which is the easiest to misstate, hence more stringent rules and
guidance is required in this area.( IAS 18 Revenue deals with recognition of revenue as we
will see later).

7. Full Disclosure Principle

Full disclosure principle is relevant to materiality concept. It requires that all material
information has to be disclosed in the financial statements either on the face of the financial
statements or in the notes to the financial statements.
Examples
 Accounting policies need to be disclosed because they help in understanding the
basis of accounting.
 Details of property, plant and equipment cannot be presented on the face of the
balance sheet, but a detailed schedule outlining movement in cost and accumulated
depreciation should be presented in the notes.
8. Historical Cost Concept

Accounting is concerned with past events and it requires consistency and comparability that
is why it requires the accounting transactions to be recorded at their historical costs.

Historical cost is the value of a resource given up or a liability incurred to acquire an

asset/service at the time when the resource was given up or the liability incurred.

In subsequent periods when there is appreciation is value, the value is not recognized as an
increase in assets value except where allowed or required by accounting standards.

Examples

 100 units of an item were purchased one month back for $10 per unit. The price
today is $11 per unit. The inventory shall appear on balance sheet at $1,000 and not
at $1,100.
 The company built its building in 2008 at a cost of $40 million. In 2010 it is estimated
that the present value of the future benefits attributable to the building is $1 billion.
The building shall stand on the Statement Financial Position at its historical costs less
accumulated depreciation.

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The concept of historical cost is important because market values change so often that
allowing reporting of assets and liabilities at current values would distort the whole fabric of
accounting, impair comparability and makes accounting information unreliable.

9. Matching Principle

In order to reach accurate net income figure, the expenses incurred to earn the revenues
recognized during the accounting period should be recognized in that time period and not in
the next or previous. This is called matching principle of accounting.

Examples

 $2,000,000 worth of sales are made in 2010. Total purchases of inventory were
$1,000,000 of which $100,000 remained on hand at the end of 2010. The cost of
earnings is $2,000,000 revenue is $900,000 [$1,000,000 minus $100,000] and this
should be recognized in 2010 thereby yielding a gross profit of $1,100,000.

Matching principle is relevant to the time period assumption, the revenue recognition
principle and it is at the heart of accrual basis of accounting.

10. Materiality Concept

Financial statements are prepared to help the users with their decisions. Hence, all such
information which has the ability to affect the decisions of the users of financial statements
is material and this property of information is called materiality.

In deciding whether a piece of information is material or not requires considerable

judgment. Information is material either due to the amount involved or due to the
importance of the event.

Materiality is helpful in determining which figures are to be reported on income statement

and Statement of Financial Position and which one in the notes (Should be more clear later
when we deal with preparation of financial statements). It is also helpful in helping decide
which items should appear as line items and which ones are aggregated with others.

11. Substance Over Form

While accounting for business transactions and other events, we measure and report the
economic impact of an event instead of its legal form. This is called substance over form

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principle. Substance over form is critical for reliable financial reporting. It is particularly
relevant in case of revenue recognition, sale and purchase agreements, etc.

Examples

 A lease might not transfer ownership to the leasee but the leasee has to record the
leased items as an asset if it intends to use it for major portion of its useful life or
where the present value of lease payment is fairly equal to the fair value of the
asset, etc. Although legally the leasee is not the owner, so the leased item is not his
asset, but from the perspective of the underlying economics the leasee is entitled to
the benefits embedded in the use of the item and hence it has to be recorded as an
asset.
 If two companies swap their inventories they will not be allowed to record sales
because not sales has occurred even if they have entered into valid enforceable
contracts.

12. Consistency Concept

The concept of consistency means that accounting methods once adopted must be applied
consistently in future. Also same methods and techniques must be used for similar
situations.

It implies that a business must refrain from changing its accounting policy unless on
reasonable grounds. If for any valid reasons the accounting policy is changed, a business
must disclose the nature of change, the reasons for the change and its effects on the items
of financial statements.

Consistency concept is important because of the need for comparability, that is, it enables
investors and other users of financial statements to easily and correctly compare the
financial statements of a company.

Examples

 Company A has been using declining balance depreciation method for its IT
equipment. According to consistency concept it should continue to use declining
balance depreciation method in respect of its IT equipment in the following periods.
If the company wants to change it to another depreciation method, say for example
the straight line method, it must provide in its financial report, the reason(s) for the

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change, the nature of the change and the effects of the change on items such as
accumulated depreciation.

13. Prudence Concept

Accounting transactions and other events are sometimes uncertain but in order to be
relevant we have to report them in time. We have to make estimates requiring judgment to
counter the uncertainty. While making judgment we need to be cautious and prudent.
Prudence is a key accounting principle which makes sure that assets and income are not
overstated and liabilities and expenses are not understated.

Examples

 Bad debts are probable in many businesses, so they create a special contra-account
to accounts receivable called allowance for bad debts which brings the accounts
receivable balance to the amount which is expected to be realized and hence
prevents overstatement of assets. An expense called bad debts expense is also
booked to stop net income from being overstated.

1.2 Qualitative Characteristics of Financial Information

We have considered the principles that need to be followed when preparing financial
statements which are mainly concerned with the recognition and measurement of
transactions.

Financial information presented in financial statements needs to also have some key
qualities which make it useful for the users. International Accounting Standards normally
outline such qualities in their frameworks. A global committee called the International
Accounting Standards Board (IASB) in its Conceptual Framework categorizes these into
fundamental qualitative characteristics and enhancing qualitative characteristics. These
include;

i. Relevance
ii. Materiality
iii. Faithful representation
iv. Comparability

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v. Verifiability
vi. Timeliness
vii. Understandability

Relevance requires financial information to be relevant to the decision making needs of the
users.

Materiality requires accountants and auditors to focus on financial information which is

expected to affect the decisions of the users.

Faithful representation requires the financial information to be true and fair and free from
misstatement.

Comparability requires the financial information to be comparable across periods and across
companies.

Verifiability requires the information to communicate the underlying economics of the

company's business.

Timeliness requires disclosure of financial information not to be excessively delayed.

Understandability requires the financial information to be understandable by users with

reasonable knowledge of business and economic activities.

Accounting can be defined as an information system that provides information about the
results of a business' performance and its economic position.

Financial Accounting generates financial statements which provide information most

relevant to users which are outside the company.

1.3 The users of financial statements and their information needs

There are several stakeholders who study / use an organisation’s financial statements. The
main groups of stakeholders and their information needs are described below.

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1. Owners / shareholders and potential investors

The primary users of an organisation’s financial statements are its owners / shareholders.
This is because owners / shareholders have provided the capital that makes it possible for
an organisation to begin its operations. Naturally they want as much information and detail
as possible in order to determine if their investment is not only safe but also growing.
As a general rule of thumb, if the owners are satisfied with the contents of an organisation’s
financial statements, then other groups also feel comfortable.
The information that owners / shareholders are interested in include:
- how their capital has been utilised
- the number and type of assets the organisation owns
- the level of debt the organisation has taken on
- how profitable the operations of the organisation are and
- whether the financial condition and performance of the organisation is improving /
deteriorating over time

Potential investors would also be interested in the above information as this information
would help them decide if they could become the new owners / shareholders of the
business. In addition, they will use the financial statements to assess whether the
organisation represents a viable investment option (i.e. is the business likely to grow over
the course of time and increase the value of their investment).

2. Management
Management will use the financial statements of the organisation as a kind of “report card”
of their decisions / activities throughout the year. This is because the financial statements
reflect how profitable (or unprofitable) these decisions or activities have been for the
organisation.

3. Providers of finance e.g. banks or other financial institutions

Payables such as banks and other financial institutions typically provide the funding an
organisation needs to carry on its operations and / or expand its business. As a result, they
need to ascertain whether the organisation has the ability to repay its debts. As a result,

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they turn to the organisation’s financial statements to determine the general trends
followed by the organisation in terms of sales, profits, past scale of operations and cash
flows. The specific information they seek from the organisation’s financial statements
include:
- how profitable the organisation has been
- whether the company will continue to operate in the coming years, or is it likely that
it will go out of business
- whether the operations of the organisation have generated sufficient cash flow to
satisfy their debt repayments, going forward he value of the assets the organisation
may have pledged as security / collateral

4. Trade relations
Trade relations are the relations between the suppliers and customers of an organisation.
They will use these statements to determine the financial condition and performance of the
business in order to find out whether the organisation will be able to pay for the goods
/services it orders from them.

Customers are typically less interested in the financial statements of an organisation they
deal with. This is because normally their relationship with the organisation ends once the
sale of goods / services has been made. However customers who have an on-going
relationship with an organisation will be interested in the financial statements to determine
if the organisation will continue to operate for the coming years.

5. Employees
Employees of an organisation are interested in the financial condition and performance of
an organisation because that is the source of their salaries. In addition, organisations that
are performing poorly or are in a weak financial position are unlikely to offer much scope for
promotions, career development etc. Employees can figure out their career prospects from
the financial statements.

6. Government and its agencies

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Financial statements of organisations serve as a source of data for the government when it
is compiling national economic statistics such as the country’s GDP (Gross Domestic
Product). This helps the government in taking different policy decisions.

7. Financial analysts, stock brokers, financial journalists

This group of users study the financial statements of organisations to determine their
financial condition and performance. They also use these statements as a basis from which
they make predictions regarding the future financial condition and performance of the
organisation. Depending upon their predictions, they then advise their clients (potential
investors) on whether to invest in a particular organisation or not.

8. Tax authorities
Tax authorities use the financial statements to determine tax amounts. Income shown by
the SOCI is used as the starting point for calculating taxable income. Revenue and purchase
figures are used to determine VAT liability.

1.4 REGULATORY FRAMEWORK

The main objective of the accounting function is to produce comparable, consistent,
accurate and easily understandable financial statements and reports.

SOURCES OF REGULATIONSources for individual countries

 National company law
 National accounting standards
 Local stock exchange requirements
 IASs/IFRSs if applicable

To help ensure this is achieved, every country has an accounting body that produces a set of
standards and regulations that all financial statements must be produced in accordance
with.

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However these standards and regulations vary from country to country. Therefore it is often
difficult to compare and contrast the financial statements of organisations that operate in
different countries.

To solve this problem the concept of a Regulatory Framework was introduced in the early
1970s. The main aim was to produce a universal set of accounting standards and regulations
or International Financial Reporting Standards that would transcend borders and be
adopted internationally.

Initially many countries were unwilling to change over or adopt a set of global accounting
standards for a variety of reasons, however the growing forces of globalisation and the
increasing interconnectivity of the world economy have resulted in close to a hundred
countries today permitting their accountants to use International Financial Reporting
Standards when preparing financial statements a process popularly known as harmonisation
of accounting standards.

Therefore as an accountant it is important that you understand the various regulations and
regulatory bodies that govern the financial reporting process as well as how, where and why
International Financial Reporting Standards should be utilised.

At this level of your studies you will cover the concept and importance of a few International
Financial Reporting Standards as well as the regulatory framework and various bodies that
produce them.

1.4.1.1 APPROACHES TO DEVELOPMENT OF A REGULATORY FRAMEWORK

A rules-based approach to accounting, as the title suggests, provides rules for accounting
for particular transactions.

Accounting standards have to be very detailed to provide the rules which must be followed
in accounting for a particular transaction.

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In comparison, a principles-based approach sets out the accounting principles that must be
followed in accounting for particular types of transactions. The scope can be much wider,
for example, an accounting standard on provisions would require that provisions are
recognised when an entity has an obligation to transfer economic benefit. An entity can
then account for a provision if such an obligation exists.
There is not the need for detailed rules as the principle within the standard can be followed.
It is therefore less likely that an accounting standard will be circumvented as the principle of
the standard is set out clearly; in the case of provisions, that they are recognised if there is
an obligation and if no obligation exists then no provision should exist. A conceptual
framework underpins the preparation of financial statements.

1.4.1.2 The conceptual framework under IFRS’s/IAS’s

It is far better to have accounting principles in place which means accounting issues of a
particular type will be dealt with consistently.e

The conceptual framework is an essential part of effective financial reporting. It provides the
Framework/structure from which accounting standards can be developed and provides a
basis for dealing with transactions that are not covered by an accounting standard.

Key learning points

 A conceptual framework is useful in a principles-based accounting system as it
provides the principles on which accounting for transactions is based.
 A conceptual framework provides a theoretical basis for determining how
transactions are accounted for. It ensures that transactions are dealt with
consistently.
 Without a framework that provides the basic principles of accounting for
transactions, there is a risk that a fire fighting approach is taken. This means that
standards are applied to a particular accounting issue and aimed at fixing that issue
without considering the overall effect.
 There has been discussion as to whether there should be a separate framework for
different types of users. For example, in the UK, the ASB has considered whether to

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issue a separate conceptual framework for public benefit entities as their focus is
different from a trading entity
 In the US, the lack of a conceptual framework meant that very detailed, prescriptive
accounting standards had to be produced.
 A rules-based approach is easier to circumvent than a principles-based approach.

Advantages
 Avoids ‘patchwork’ or fire fighting approach
 Less open to criticism of political/external pressure
 Some standards may concentrate on the income statement, others on the
statement of financial position

Disadvantages
 Financial statements are intended for a variety of users - single framework may not
suit all
 May need different standards for different purposes
 Preparing and implementing standards is still difficult with a framework

1.5 A Conceptual Framework

It is a statement of generally accepted theoretical principles which form the frame of
reference for financial reporting.

A conceptual framework can be seen as a way of arranging GAAP into a formalised set of
principles.

In July 1989 the old IASC produced a document, Framework for the preparation and
presentation of financial statements. It was in effect a conceptual framework on which all
IAS’s and IFRS’s are based.

The framework contains several sections or chapters as follows;

 The objective of financial statements

 Underlying statements
 Qualitative characteristics of financial statements
 The elements of financial statements

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 Recognition of elements of financial statements

 Measurement of elements of financial statements
 Concepts of capital and capital maintenance

1.5.1 The objective of financial statements

The objective of financial statements is to provide information on the financial position,

performance and changes in financial position of an entity that is useful to a wide range of
users in making economic decisions (IAS 1).

 Financial position information is affected by the following and information about each
one can aid the user.
- Economic resources controlled: to predict the ability to generate cash
- Financial structure: to predict borrowing needs, the distribution of future
profits/cash and likely success in raising new finance
- Liquidity and solvency: to predict whether financial commitments will be met as
they fall due
 Information on the financial performance of an entity (income statement / statement
of comprehensive income) is used to assess potential changes in the economic resources
the entity is likely to control in future. Information about performance variability is
therefore important.
 Information on the changes in financial position (i.e statement of cash flows) is used to
assess the entity's investing, financing and operating activities. They show the entity's ability
to produce cash and the needs which utilise those cash flows.

1.5.2 Underlying statements

In the preparation of financial information there is an underlying assumption that must be
considered: going concern.
– Going concept: The entity is normally viewed as continuing in operation for the
foreseeable future. It is assumed that the entity has neither the intention nor the necessity
of liquidation or of curtailing materially the scale of its operations.

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- Accrual concept

1.5.3 Qualitative characteristics of financial statements

The qualitative characteristics are the attributes that make the information provided in
financial statements useful to users.
The fundamental qualitative characteristics are relevance and faithful representation.
 Relevance: Information has the quality of relevance when it influences the economic
decisions of users by helping them evaluate past, present or future events or confirming, or
correcting, their past evaluations. Relevance is affected by materiality.
 Materiality: Information is material if its omission or misstatement could influence
the economic decisions of users taken on the basis of the financial statements.
 Faithful representation: Information is a faithful representation when it is complete,
neutral and free from error and can be depended upon by users to represent faithfully that
which it either purports to represent or could reasonably be expected to represent.

The enhancing qualitative characteristics are:

 Comparability: This enables users to identify and understand similarities in, and
differences among, items.
 Verifiability: This assures users that information is a faithful representation.
 Timeliness: Information must be made available in time to influence the decisions of
users.
 Understandability: Can be understood by users who have a reasonable knowledge
of business and economic activities.

1.5.4 The elements of financial statements

Transactions are grouped into broad classes within the financial statements, these are the
elements of financial statements and include assets, liabilities, equity, income and expenses.
 Asset: A resource controlled by an entity as a result of past events and from which
future economic benefits are expected to flow to the entity.
 Liability: 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
 Equity: The residual interest in the assets of the entity after deducting all its
liabilities.

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 Income: Increases in economic benefits during the accounting period, other than
those relating to contributions from equity participants.
 Expenses: Decreases in economic benefits during the accounting period, other than
those relating to distributions to equity participants.

Items can be recognised in the financial statements providing they meet the following
criteria:
– It is probable that any future economic benefit associated with the item will flow to
or from the entity; and
– The item has a cost or value that can be measured with reliability.

A number of different measurement bases are used in financial statements, of which,

historical cost is the most common. They include:
– Historical cost: Assets and liabilities are recorded at the amount of paid / received to
acquire them at the time of their acquisition.
– Current cost: Assets and liabilities are carried at the amount of cash that would be
required to acquire / settle the same asset or liability at the current time.
– Present value: A current estimate of the present discounted value of the future net cash
flows in the normal course of business.
– Realisable settlement value: The amount of cash that could be obtained by selling an
asset and the undiscounted amount of cash expected to be paid to satisfy the liabilities in
the normal course of business.

1.6 International Accounting Standards (IAS’s) and international

Financial reporting Standards(IFRS’s)
The accounting principles that we discussed earlier are the building blocks that form the
basis of more complex and specialized principles called (GAAP) Generally Accepted
Accounting Principles such as the International Financial Reporting Standards, International
Accounting Standards, etc. They deal with specific matters like accounting for revenue,
accounting for income taxes, accounting for business combinations, etc

However with the adoption of IFRS or IAS’s, an organisation can produce one set of
statements that would satisfy the statutory requirements of all concerned countries.

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As we have seen above, various parties such as shareholders, investors, banks, payables etc
are interested in the financial statements of the organisation. If there is no uniformity in the
principles followed by different organisations in preparation of financial statements, nobody
will be in a position to interpret the financial statements and draw any conclusions.

To overcome this difficulty, certain standard principles for preparation of financial

statements are given. In accounting terminology we use the words “International
Accounting Standards (IAS), International Financial Reporting Standards (IFRS) or Generally
Accepted Accounting Practices (GAAP)” instead of ‘Principles’.

To achieve the objective of uniform international standards, the following bodies have been
formed
a. The International Accounting Standards Committee Foundation (IASCF);
b. The International Accounting Standards Board (IASB);
c. The Monitoring Board
d. The IFRS Council (IFRS AC); and
e. The IFRS Interpretations Committee (IFRS IC).

The International Accounting Standards (IASs) and International Financial Reporting

Standards (IFRSs) currently in force are listed below:

International Accounting Standards

IAS 1 Presentation of Financial Statements
IAS 2 Inventories
IAS 7 Statement of Cash Flows
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
IAS 10 Events after the Reporting Period
IAS 11 Construction Contracts
IAS 12 Income Taxes
IAS 16 Property, Plant and Equipment
IAS 17 Leases

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IAS 18 Revenue
IAS 19 Employee Benefits
IAS 20 Accounting for Government Grants and Disclosure of Government Assistance
IAS 21 The Effects of Changes in Foreign Exchange Rates
IAS 23 Borrowing Costs
IAS 24 Related Party Disclosures
IAS 26 Accounting and Reporting by Retirement Benefit Plans
IAS 27 Consolidated and Separate Financial Statements
IAS 28 Investments in Associates
IAS 29 Financial Reporting in Hyperinflationary Economies
IAS 31 Interests in Joint Ventures
IAS 32 Financial Instruments: Presentation
IAS 33 Earnings per Share
IAS 34 Interim Financial Reporting
IAS 36 Impairment of Assets
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
IAS 38 Intangible Assets
IAS 39 Financial Instruments: Recognition and Measurement
IAS 40 Investment Property
IAS 41 Agriculture

International Financial Reporting Standards

IFRS 1 First-time Adoption of International Financial Reporting Standards
IFRS 2 Share-based Payment
IFRS 3 Business Combinations
IFRS 4 Insurance Contracts
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
IFRS 6 Exploration for and Evaluation of Mineral Resources
IFRS 7 Financial Instruments: Disclosures
IFRS 8 Operating Segments
IFRS 9 Financial Instruments

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Don’t panic! You do not have to know and study all of these for your CAC 1101 exam! The
most important standards at this level are highlighted in bold. The remaining ones will be
covered in the higher financial accounting studies.

1.7 IAS 1: PRESENTATION OF FINANCIAL STATEMENTS

The financial effects of all transactions and events that take place in an organisation during a
particular period(typically one year) are captured in its accounting records. The purpose of
maintaining these records is to determine the financial position of the organisation.
However, if these records are to be of any use to anyone they need to be summarised in a
proper manner.
An organisation’s financial statements / financial reports are the accounting records of an
organisation summarised and presented in a predetermined format. The five main
components that make up an organisation’s financial reports are:
- the statement of financial position,
- the statement of comprehensive income,
- the statement of cash flows,
- the statement of changes in equity and
- the notes to the financial statements.

As a professional accountant, you will be continually involved in either preparing or

analysing an organisation’s financial reports. Therefore it is vital that you understand the
purpose that they serve, how they are prepared and how they can be used.

Each statement provides separate but complementary information about the financial
condition and performance of the organisation. Hence, to get a complete financial picture of
the organisation, all five statements need to be prepared.

Of the five summary statements never the less, the SOCI and the SOFP are most important.

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1.7.1 THE STATEMENT OF CASH FLOWS

The statement of cash flows provides details on the inflows and outflows of cash that have
occurred over a particular period of time (usually one year). Its main purpose is to identify
for the user:
- the activities which have generated cash for the organisation (e.g. sales) and
- the ones which have depleted or used cash up in the organisation (e.g. buying
machinery).

1.7. 2. THE STATEMENT OF CHANGES IN EQUITY

The statement of changes in equity summarises all the transactions the organisation has had
with its owners / shareholders. It is designed to show whether the owners / shareholders
have:
- maintained their original investment in the organisation and / or
- if this capital has been added to or reduced over a particular period In addition it
shows the level of profit earned by the organisation that has been:
- reinvested into the business and paid out to the owners / shareholders in the form
- of dividends.

THE POSSIBLE REASONS FOR CHANGES IN EQUITY ARE:

1. Income and expenses recognised during the period (i.e. profit is made and needs to be
attributed to the shareholders).
2. Other transactions between the entity and the shareholders (e.g. share capital payments
and withdrawals, buy back of shares, dividends distributed, and the transaction costs
directly related to such transactions etc.).
3. Transfer between different components of equity ( e.g. retained earnings to a reserve).
The statement gives details of all the movements from the opening balance, additions,
deductions and the closing balance of the following components:
a) Ordinary share capital (additional capital issued)
b) Share premium (additional capital issued)
c) Revaluation reserve (increases or decreases in values of individual assets)
d) Any other reserve
e) Retained earnings / accumulated profits (profits earned, dividends distributed, transfers
to or from reserves)

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XYZ limited

Statement of changes in equity for the year ended 31 December 20X0

Share Retained General reserve Revaluation Total equity

capital earnings $000 surplus $000
$000 $000 $000
Balance at 1 January 20X0 xxx xxx xxx -- Xxx
Issue of new share capital xxx --- --- --- xxx
Transfer to retained ---- xxx --- (xxx) ---
earning
Dividends -- xxx --- --- xxx
Total comprehensive -- xxx xxx xxx xxx
income for the year
Balance at 31 December xxx xxx xxx xxx xxx
20X0

A simple illustration is given below:

A company gives the following information: balances on 1 January 2010. Prepare a
statement of changes to equity for the year to 31 December 2010
$
Share capital 3,000
Retained earnings 5,400
Property revaluation account 700

During the year, property, plant and equipment were revalued and a surplus was
determined worth 1,500
Profit for the year 7,000
Dividends distributed 4,400
Issue of ordinary shares for cash 2,000

All investments were sold and the revaluation surplus was transferred to retained earnings.

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We shall prepare the statement in a columnar format - a column for each component of the
equity. At the top of the column is the opening balance of the component and at the
bottom, the closing balance.

All the movements of the component are shown in between.

– Statement of Changes in Equity – Year to 31 December 2010-

Share Retained Property Total
capital earnings revaluation
$’000 $’000 $’000 $’000
Bal at 01/10/2010 3,000 5,400 700 9,100
Issue of shares 2,000 2,000
*Total compr income 7,000 1,500 8,500
Ordinary dividends (4,400) (4,400)
Transfer to retained earnings 2,200 (2,200) -
Bal at 30/09/2010 5,000 10,200 - 15,200
*- Total comprehensive income = profit for the year + other comprehensive income
(includes revaluation surplus)

1.7.3 NOTES TO FINANCIAL STATEMENTS

The purpose of having notes to the financial statements is to allow the organisation to
disclose any relevant additional information to the reader, not covered in any of the other
statements. For instance, an explanation of the type of accounting policies the organisation
has used is usually found in this statement.
In addition to these five statements, annual financial reports often contain further
information such as:
- Chairman’s message
- Directors’ report or discussions and analysis by the management, or management
commentary
- Auditors’ report

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This type of information is usually provided to help readers gain a better understanding of
the financial position and performance of the organisation. However it should be noted that
there are no standardised principles or format for presenting this non-financial
information.

1.7.4 THE STATEMENT OF FINANCIAL POSITION (SOFP)

The statement of financial position shows the financial condition/position of an organisation
on a specific date in regards to what it owns and what it owes. Therefore, the main
elements in a SOFP are its:
1. Assets (everything the entity owns or controls), e.g. cash, machinery, inventory
2. Liabilities (everything the entity owes to third parties) e.g. amounts payable to vendors
and
3. Equity (everything the entity owes to the owners / shareholders including the initial
capital contributed by the owners and the profits generated by the business).

And now in more detail

1. Assets
An asset is 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.
a) Resource controlled
The assets of a company represent the resources it has under its direct control. This usually
means that they provide benefits to the organisation alone. The organisation has the power
to restrict others from using these assets and use them at its sole discretion.
b) Past events
For an asset to become a controlled resource for an organisation, a transaction or event
must have taken place in the past. Resources come under the control of an organisation
when they are purchased, produced or donated - these are the past events (from the
definition above).

The inventory of goods held by an organisation for trading purposes is its asset as they were
purchased in the past.

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c) Economic benefits
To be deemed assets, resources must also:
(i) Contribute to the cash inflows OR
(ii) Contribute to reducing the cash outflows (e.g. an organisation buys a photocopier so that
it can carry out its copying “in-house” at a rate which is much lower than what it has to pay
to outside parties).

Once a resource is deemed to be an asset it is then classified as either a current asset or a

non-current asset.

Current assets Non-current assets

Current assets are those assets that the organisation intends to turn into cash within one
year.

Non-current assets are assets that the organisation intends to hold i.e. not liquidate or turn
into cash for periods longer than one year. Examples include an organisation’s receivables
and inventory – the aim is to convert them into cash quickly.

Examples include an organisation’s premises, equipment and machinery.

2. Liabilities
The term liability represents the total amounts payable by the business to others such as
bank loans, trade payables, and expenses payable.

A liability is a present obligation of the entity arising from past events, which when paid is
likely to cause an outflow of resources from the entity.

a) Present obligation
An essential characteristic of a liability is that it must represent a present obligation to the
organisation. An obligation involves a duty or responsibility being placed on the organisation
to act or perform in a certain way.

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Present means that this obligation has to exist on the day it is going to be recorded as a
liability.
b) Past events
A liability has to arise out of a transaction or event that has happened in the past. This
transaction or event in turn must create an obligation on the part of the organisation. For
instance, merely having the intention topurchase an asset does not create an obligation and
correspondingly a liability for the organisation.

An obligation normally arises only when the asset is delivered or the entity enters into an
irrevocable agreement to acquire the asset. In the latter case, the irrevocable nature of the
agreement means that the organisation becomes legally bound to carry through the
agreement.

Therefore liabilities arise from past transactions or other past events. For example, the
acquisition of goods and the use of services give rise to trade payables (unless they are paid
for in advance or at delivery) and the receipt of a bank loan results in an obligation to repay
the loan.

c) Outflow of resources from the entity

Furthermore a liability requires an outflow of resources from the organisation to settle the
obligation. Instances or types of these outflows are:

3. Equity
Equity is the residual interest in the assets of the entity, after deducting all its liabilities.
The terms capital and equity can be used interchangeably.
Capital = Total assets – Total liabilities
The amount of balance left in a business after all its liabilities have been deducted from its
assets represents its equity. This equity or capital is also an obligation for the organisation. It
represents the amount that is due to the owners of the business after all other liabilities
have been settled (note an organisation must settle all of its liabilities first before it can
return this amount to its owners / shareholders).

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As a minimum IAS 1 requires the following items to be shown in 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, I.)
e) Investments in associates
f) Biological assets
g) Inventories
h) Trade and other receivables
i) Cash and cash equivalents
j) Assets classified as held for sale under IFRS 5
k) Trade and other payables
l) Provisions
m) Financial liabilities (other than j and k )
n) Current tax liabilities and assets
o) Deferred tax liabilities and assets
p) Liabilities included in disposal groups under IFRS 5
q) Non controlling interests (group accounts only)
r) Issued capital and reserves

XYZ limited

Statement of financial position at 31 December 20XX

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Non-current Asset

Property, plant and equipment xxx

Other intangible assets xxx xxx

Current assets

Inventories xxx

Trade receivables xxx

Other current assets xxx

Cash and cash equivalents xxx xxx

Total assets xxx

Equity and liabilities

Share capital xxx

Retained earnings xxx

Other components of equity xxx

Total equity xxx

Non-current liabilities

Long term borrowings xxx

Long term provisions xxx

Total non-current liabilities xxx

Current liabilities

Trade and other payables xxx

Short term borrowings xxx

Current tax payables xxx

Short term provisions xxx

Total current liabilities xxx

Total liabilities xxx

Total equity and liabilities xxx

1.7.5 The statement of comprehensive income

The purposes of an income statement
a) To summarise the financial performance of the entity during a certain period.

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b) To identify the various sources of income for the organisation and the corresponding
expenses the organisation has incurred in order to earning this income(s).

According to IAS 1 a single statement of comprehensive income can be prepared to present

all the items of income and expense recognised in a period.

Alternatively a separate income statement, consisting of components of profit / loss can be

presented along with a second statement starting with the profit / loss and consisting of
components of other comprehensive income called SOCI.

The SOCI provides information about the financial performance i.e. the profit or loss made
by an entity.

Clearly an entity may calculate profit for the year either in a separate SOCI or in the
statement of comprehensive income. In either case, the analysis of expenses recognised in
the profit or loss could be made using a classification based on either their nature or their
function within the entity, whichever provides information that is reliable and more
relevant.

a) Nature of expenses method

Under this method, expenses are presented in the SOCI according to their nature. For
example, depreciation, employee costs and rent. The expenses are not allocated to
functions and therefore, this method is simpler.

b) Function of expenses or cost of sales method

Expenses are classified on the basis of their function. For example, cost of sales, cost of
administration, cost of distribution and cost of finance.
This method can provide more relevant information to users than the classification of
expenses by nature.
However allocating costs to functions may require arbitrary allocations and involve
considerable judgement.

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An entity which uses the function of expenses method should disclose additional
information on the nature of expenses, including depreciation and amortisation expenses
and expenses incurred for employee benefits.

NB:Total comprehensive income

The revised IAS 1 brought in the concept of comprehensive income. Total comprehensive
income is the total of profit or loss for the period and other comprehensive income for the
period.

If there are no items of other comprehensive income, the profit or loss for the year will be
equal to the total comprehensive income. The items included in other comprehensive
income are the items which are not considered in the calculation of profit or loss e.g. gains
on property revaluations and actuarial gains and losses.

Information to be presented on the face of the SOCI

The information in the financial statements may be provided for on the face of the
statement or in the notes to the financial statements. Certain information, which is
important for the users of an entity’s financial statements, is required to be presented on
the face of the financial statements.

IAS 1: Presentation of Financial Statements, requires particular information to be

presented on the face of the income statement.

As a minimum, the face of the SOCI shall include line items that present the following
amounts for the period:
(a) revenue;
(b) finance costs;
(c) tax expense;
(d) profit or loss
(e) total comprehensive income.

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Additional line items, headings and subtotals shall be presented in the statement of
comprehensive income and the separate income statement (if presented), when such
presentation is relevant to an understanding of the entity’s financial performance.

Other comprehensive income

Other comprehensive income includes details of incomes and expenses that are not
included in the SOCI (i.e. not considered while calculating the profit or loss), for example,
gains on property revaluations and foreign exchange differences.

Total comprehensive income

Total comprehensive income consists of profit or loss for the period, plus other
comprehensive income.

The elements of the SOCI

As mentioned in the previous section, income and expenses (including taxes) are the
elements of an SOCI
1. Income
Income refers to increase in economic benefits during the accounting period in the form of:
- direct inflows OR
- enhancements of assets OR
- decreases of liabilities.

Broadly, incomes fall under the following three categories:

- Revenue: represents earnings through the ordinary activities of the business, for
example, sales, fees, interest, dividends, royalties and rent.
- Gains: represent other items of income that may not arise in the ordinary course of
business, for example, gains on disposal of property.
- Income: income (formally defined above) encompasses both revenues and gains.

2. Expense
Expenses are the costs incurred to earn income. Expenses are defined as: decreases in
economic benefits during the accounting period in the form of:

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- direct outflows OR
- depletion of an asset OR
- incurrence of a liability
Examples of expenses are:
a) Purchases of goods for cash (results in a direct cash outflow).
b) Purchases of goods on credit (results in incurrence of a liability payable to the supplier of
goods).
c) Discounts allowed to customers for early payment (an example of depletion i.e. a
decrease in an asset represented by the amount receivable from customers).

XYZ limited

Statement of profit and loss and other comprehensive income for the year ended 31
December 20XX

Revenue xxx
Cost of sales xxx
Gross profit xxx

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Other income xxx

Distribution costs xxx
Administrative expenses xxx
Other expenses xxx
Finance costs xxx
Profit before tax xxx
Income tax expense xxx
Profit for the year from continuing operations xxx
Loss for the year from discontinued operations xxx
Profit for the year xxx
Other comprehensive income;
Available for sale financial assets xxx
Gains on property revaluation xxx
Income tax relating to components of other comprehensive income xxx
Other comprehensive income for the year net of tax xxx
Total comprehensive income for the year ended xxx

1.8 IAS 16 Property, plant and equipment

The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and
equipment (PPE) so that users of the financial statements can discern information about the
entity’s investment in its PPE and any changes in those investments.

Property, plant, and equipment (PPE) are tangible assets that;

 Are held for use in the production or supply of goods and services, for rental to
others or administrative purposes
 Are expected to be used during more than one period.

1.8.1 Depreciation
Depreciation is the systematic allocation of the depreciable amount of an asset over its
useful life.
Non-current assets are acquired at a cost. However, it would be incorrect to charge the
entire cost in the first year itself. The asset is going to help generate income for many years.

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The matching principle requires that the expenses be recognised in the year in which the
revenue is recognised (cost is matched with the relevant revenue).

If the revenue from an asset is going to be earned over a number of years then its cost
should also be allocated over the same number of years. Hence, it is logical to charge the
cost of an asset to revenue over the useful life of the asset.

Physical wear and tear and obsolescence also result in the depreciating value of an asset.

The purpose of charging depreciation is not to record the decrease in the value of an asset.
If and when this adjustment is made to the value, it is called a revaluation adjustment.

Unlike what many accounting students feel, the purpose of depreciation is not setting aside
some funds to replace the asset at a later stage. However, it is a fact that indirectly, the
profits are reduced by the depreciation amount.

If this depreciation amount is invested in outside securities, it can actually provide an

amount for replacement of the asset.

1.8.2 Other important terms used in depreciation

1. Residual value is the value which the entity expects to realise from disposal of the asset
at the end of its useful life.

Residual value is likely to be immaterial and is therefore ignored. However, for exam
purposes, if it is given in the question, it must be considered.

2. Useful life is the period over which the asset is expected to be available for an entity’s
use.
While useful life is denoted in number of years, it may also be denoted in terms of number
of units expected to be produced by the asset.

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Equipment that is purchased today is expected to last for another 5 years. The useful life of
the equipment is 5 years.

Alternatively, it can also be said that the useful life of the equipment is 1,000,000 units of
the equipment it is expected to produce / last for the production of 1,000,000 units.

3. Derecognising an asset is to stop recognising the asset in the books.

‘Derecognition’ is the opposite of recognition. By ‘recognition’ of an asset, we mean
recognising the item as an asset in the accounting records and statement of financial
position.

Derecognition means removing it from property, plant and equipment in the statement of
financial position. It may be converted into either other assets (e.g. from non-current asset
to cash) or a loss / gain on derecognition, or both.
The carrying amount of an item of property, plant and equipment shall be derecognised:
i. on disposal; or
ii. when no future economic benefits are expected from its use or disposal.

1.4 Depreciable amount

Depreciable amount is the cost of an asset, or any other amount substituted for cost, less
its residual value.

According to IAS 16 Property, Plant and Equipment, the depreciable amount of an asset
should be allocated on a systematic basis over its useful life

The depreciable amount is determined after deducting the residual value from the cost.

The cost of a machine is $600,000 and its residual value is $20,000. Its depreciable amount
will be $580,000 ($600,000 - $20,000)

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1.8.3 When does the charge of depreciation begin and when does it end?
The depreciation charge begins when an asset is available for use at the location, and in a
condition intended by the management.

Depreciation does not end when the asset becomes idle or is retired from active use unless
the asset is fully depreciated.

An item of PP&E is removed from the Statement of Financial Position (that is, derecognized)
when it is disposed of or when no future economic benefits are expected from its use or
disposal. The gain or loss arising from derecognition is included in profit or loss when the
item is derecognized; moreover, gains are not to be classified as revenue

When depreciation is charged at a given percentage per annum, it is said that it is charged
on a time basis.

However, under usage-linked methods of depreciation if there is no production, the

depreciation charge can be zero.

1.8.4 Depreciation methods

“The depreciation method used shall reflect the pattern in which the asset’s future
economic benefits are expected to be consumed by the entity”

The method of charging depreciation selected is to be applied consistently from period to

period unless there is a change in the expected pattern of consumption of those future
economic benefits.

The method decided is to be reviewed at the end of each financial year. If there is a change
in the consumption pattern, the method may be changed. The impact of such a change shall
be accounted for as a change in accounting estimates in accordance with IAS 8. No changes
to earlier periods are required.

An entity selects the method that most closely reflects the expected pattern of
consumption of the future economic benefits embodied in the asset.

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There are a variety of depreciation methods including the following most widely used
methods of depreciation:
1. Straight-line Method
This method results in a constant charge over the useful life of the asset. The asset’s
residual value does not change and depreciation is calculated as a fixed amount every year
or a fixed percentage of the original cost.

If the depreciation rate is applied as a percentage, it will be applied to the original cost, and
not to the carried down value net of depreciation.

2. Diminishing or reducing balance method

Under this method, depreciation is charged as a percentage of the written down or book
value of the asset i.e. cost minus accumulated depreciation. This is also known as the
reducing balance method.

This method results in a decreasing charge over the useful life of the asset.
Depreciation = (Cost – Accumulated depreciation) x Depreciation rate

Comparison between straight-line method and reducing balance method

STRAIGHT-LINE METHOD REDUCING BALANCE METHOD

It charges a fixed amount each year to the It charges a higher amount during the
statement of comprehensive income initial years when the machine is new and
efficient and a lower amount in later years

It is suitable for assets which give the same It is suitable for assets which give a higher
efficiency year after year e.g. a building is efficiency in earlier years and a lower
used equally over the years efficiency in later years e.g. machinery
used in various manufacturing processes

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If repairs increase in later years, the charge

of depreciation plus repairs increases each
year (since the depreciation is constant).

The charge of depreciation plus repairs is In the initial years when repairs are low,
expected to be the depreciation is high, and in later years
same over the years when repairs are high,
depreciation is low.

It is simple to understand and operate. It is relatively difficult to understand and

operate.

3. The units of production method

This method would be appropriate where the economic benefits derived from the assets are
in proportion to the units produced and in cases where the pattern of production is not
uniform.

This method results in a charge based on the expected use or output of the asset. Under this
method of depreciation, the cost of the non-current asset is allocated in proportion to the
production achieved.
Depreciation rate = Cost of the asset - Estimated residual value
Total estimated units of output

1.8.4.1 CHANGE OF DEPRECIATION METHOD

We learnt earlier that;
- The depreciable amount is the cost of an asset, or other
amount substituted for cost (i.e. revalued amount),
- less its residual value, and
- The depreciable amount of an asset shall be allocated on
a systematic basis over its useful life.

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It is obvious that if the residual value changes, the depreciable amount will change and
therefore depreciation will change. Similarly, if the estimated useful life changes, then the
depreciation charged over the useful life of asset is bound to change. If any of these changes
happen, depreciation has to be recalculated.

IAS 16 requires that the residual value and the useful life of an asset are reviewed at least at
each financial year-end. If expectations differ from previous estimates, the change(s) should
be accounted for as follows:
Step 1 Calculate the depreciation until the date of change
Step 2 Calculate the book value until the date of change (Cost – accumulated depreciation)
Step 3 Calculate the new depreciable amount (Book value – residual value)
Step 4 Calculate the remaining useful life
Step 5 Calculate the new amount of depreciation. For a straight line method calculation, it is
= new depreciable amount / remaining useful life.

The depreciation method is expected to be followed consistently. However, if the pattern of

expected consumption of economic benefits has changed, then the method of depreciation
may be changed.

If the method of charging depreciation has been changed, then the change is prospective
and not retrospective.
This means:
- The net book value on the date of change is depreciated over the remaining period
according to the new method.
- Only the depreciation for the current period and the future periods will change.
- The calculations for the past periods are not restated.

QUESTION 1
A company purchased a non-current asset for $17,000. It was expected to have a residual
value of $1,000, and its useful life was estimated at 8 years. The company charges
depreciation under the straight-line method. After two years, it was discovered that the

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original estimate of useful life was wrong and that the actual total useful life would be only
6 years.

Calculate the revised depreciation.

QUESTION 2
The same procedure is followed if the residual value of the asset changes.
A company purchased a machine for $70,000. It was expected to have a residual value of
$2,400, and its useful life was estimated at 8 years. The company charges depreciation
under the straight-line method. After three years, it was discovered that the original
estimate of residual value was wrong and that the actual residual value would be only
$1,500.

The revised depreciation will be:

A $8,562.50
B $5,393.75
C $7,450.75
D $8,630.00

QUESTION 3
On 1 January 2007 NUST Ltd bought a new asset for $100,000 that was estimated to have a
working life of 5 years. Its realisable value after that was estimated at $20,000. It is expected
to produce 800,000 units of output during its useful life. The actual production for the five
years was as follows:
2007: 150,000; 2008: 200,000; 2009: 190,000; 2010: 150,000; 2011: 110,000
a) Calculate the depreciation provision under the units of production method.
b) Show the depreciation schedule.

The carrying value on 31 December 2011 is exactly $20,000 which is the selling value it is
expected to achieve.

QUESTION 4

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A lorry bought for an entity coat $17 000. It is expected to last for five years and then be
sold for scrap for $2 000. Usage over the 5 years is expected to be;
Year 1 200 days
Year 2 100 days
Year 3 100 days
Year 4 150 days
Year 5 40 days

Required:
a. The straight line method
b. The reducing balance method (using 35%)
c. The machine hour method

QUESTION 5
NUST bought an asset for $100 000 on 01 January 2009. It had an estimated useful life of
five years and it was depreciated using the reducing balance method at a rate of 40%. It had
no residual value. On 01 January 2011 the directors decided to change the method to
straight line as this would give a fairer presentation.
Show the depreciation charge for each year to 31 December of the asset’s life.

QUESTION 6
An entity purchased a non current asset costing $12 000 with an estimated life of four years
and no residual value. If it used the straight line method of depreciation, it would make an
annual provision for depreciation of 25% of $12 000= $3000.

Now what would happen if the business decided after 2 years that the useful life of the
asset has been underestimated and it still had 5 more years in use to come( making it a total
of 7 years)

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1.8.5 ACCOUNTING TREATMENT OF DEPRECIATION

1. If the SOCI is presented using the ‘nature of expenses’ method, then depreciation and
amortisation expenses are disclosed on the face of the SOCI as an expense.
2. Under the ‘function of expenses’ method of presentation of the SOCI, depreciation does
not appear on the face of the SOCI. The information is given in the notes.

Function of expense method presents expenses according to their function e.g. distribution
expenses, administration expenses and finance expenses.

Presentation in the statement of financial position

In the statement of financial position, property, plant and equipment is shown at the
carrying value in the following manner:

(Note: this calculation may be given on the face of the statement of financial position or in a
schedule. The carrying amount must never the less always appear on the face of the
statement of financial position).

In short,

Depreciation is normally treated as an expense;

DR: Depreciation expense (SOCI)

CR: Accumulated depreciation (SOFP)

1.8.6 DEPRECIATION ON ASSETS ACQUIRED OR DISPOSED OF IN THE

MIDDLE OF AN ACCOUNTING YEAR
Depreciation is charged pro-rata over the period of use i.e. depreciation is charged for that
part of the accounting period during which the asset is used. However, there are two other
methods of calculating the depreciation provisions for assets acquired and disposed of
during the accounting year which are sometimes followed for the purpose of
approximation.

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1. In the year of acquisition, calculate the depreciation for the whole year irrespective of
the date of acquisition. In the year of sale, ignore depreciation for the full year irrespective
of the date of sale of an asset.

2. Provide for depreciation on the asset on the basis of the number of months the asset is
used in the year of sale or purchase.

In years other than the years of sale and purchase (i.e. the years when the entity owns and
uses the asset), depreciation is provided for the whole year irrespective of the number of
months the asset is used.

1.8.7 MEASUREMENT AFTER RECOGNITION

An entity shall choose either the cost model or the revaluation model as its accounting
policy and shall apply that policy to an entire class of property, plant and equipment.

Cost model: After recognition as an asset, an item of property, plant and equipment shall be
carried at its cost less any accumulated depreciation

Revaluation model: After recognition as an asset, an item of property, plant and equipment
whose fair value can be measured reliably shall be carried at a revalued amount, being its
fair value at the date of the revaluation less any subsequent accumulated depreciation

Revaluations shall be made with sufficient regularity to ensure that the carrying amount
does not differ materially from that which would be determined using fair value at the end
of the reporting period.
If an asset’s carrying amount is increased as a result of a revaluation, the increase shall be
recognised in other comprehensive income and accumulated in equity under the heading of
revaluation surplus.

DR: PPE (SOFP)

CR: REVALUATION SURPLUS (SOFP)

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The revaluation surplus is part of the owners equity and so the credit to the revaluation
surplus will be seen as ‘other comprehensive income’ In the SOCI.

1.8.8 TREATMENT OF ACCUMULATED DEPRECIATION AFTER REVALUATION

When an asset is revalued we arrive at its present fair value that is comparable to its
carrying value, i.e. Cost less depreciation. This raises the issue of how the accumulated
depreciation should be treated.
IAS 16 gives two options:
1. The accumulated depreciation may be either restated proportionately so that the
carrying amount of the asset after revaluation equals its revalued amount. This method is
normally used when an asset is revalued by applying an index to its depreciated
replacement cost.

Illustration
An entity adopts a revaluation model. Its building has a carrying value of $500,000 (arrived
at after deducting accumulated depreciation of $100,000 from the gross value of $600,000).
The fair value of the building is $700,000.

There is a 40% increase in the net value ($200,000/$500,000 x 100) of the building.
The cost value as well as the accumulated depreciation shall be increased by 40%, to
$840,000 ($600,000 + 40% of $600,000) and $140,000 ($100,000 + 40% of $100,000)
respectively.

This will give a carrying amount of $700,000 (i.e. $840,000 - $140,000), which is equal to the
revalued amount.
Building account
Balance b/d ($700,000 - $500,000) 600,000
Revaluation surplus(gain) (40% of
600,000) 240,000 Balance c/d 840,000
840,000 840,000

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Accumulated depreciation account

Balance b/d 100,000
Balance c/d 140,000 SOCI (40% of 100,000) 40,000
140,000 140,000

Revaluation surplus account

Retained earnings 40,000 Balance b/d -
Balance c/d 200,000 Building account 240,000
240,000 240,000

2. The original net carrying amount of the asset is calculated and this amount is then
increased or decreased to make it equal to the revalued amount of the asset. This is the
more common method.

(i) At present there are two ledger accounts: a building account with a debit balance of
$600,000 and an accumulated depreciation account with a credit balance of $100,000.
(ii) The balance in the accumulated depreciation account will be transferred to the building
account. Therefore the balance of the building account will be reduced from $600,000 to
$500,000 (its net carrying amount).

This net amount is then increased by $200,000 to make it equal to the revalued amount of
$700,000.

$100,000 accumulated depreciation is transferred to the revaluation surplus account.

Building account
Balance b/d 600,000 Accumulated depreciation 100,000
(transfer)
Revaluation
surplus (gain) 200,000 Balance c/d 700,000
800,000 800,000

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Accumulated depreciation account

Building account(transfer) 100,000 Balance b/d 100,000

QUESTION 7
An entity bought an asset for $10 000 at the beginning of 2006. It had a useful life of five
years. On 1 January 2008 the asset was revalued to $12 000. The expected useful life hs
remained unchanged ( that is 3 years remain).

Required:
Account for the revaluation and state the treatment for depreciation from 2008 onwards

1.9 IAS 18: REVENUE

This Standard shall be applied in accounting for revenue arising from the following
transactions and events:
i. the sale of goods;
ii. the rendering of services; and
iii. the use by others of entity assets yielding interest, royalties and dividends.

Income is defined in IAS 1 as increases in economic benefits during the accounting period in
the form of inflows or enhancements of assets or decreases of liabilities that result in
increases in equity, other than those relating to contributions from equity participants.

Income encompasses both revenue and gains. Revenue is income that arises in the course
of ordinary activities of an entity and is referred to by a variety of different names including
sales, fees, interest, dividends and royalties.

1.9.1 Measurement of revenue

Revenue shall be measured at the fair value of the consideration received or receivable.*
The amount of revenue arising on a transaction is usually determined by agreement
between the entity and the buyer or user of the asset. It is measured at the fair value of the
consideration received or receivable taking into account the amount of any trade discounts
and volume rebates allowed by the entity.

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In most cases, the consideration is in the form of cash or cash equivalents and the amount
of revenue is the amount of cash or cash equivalents received or receivable. However when
goods or services are exchanged or swapped for goods or services which are of a similar
nature and value, the exchange is not regarded as a transaction which generates revenue.

When goods are sold or services are rendered in exchange for dissimilar goods or services,
the exchange is regarded as a transaction which generates revenue.

The revenue is measured at the fair value of the goods or services received, adjusted by the
amount of any cash or cash equivalents transferred.

When the fair value of the goods or services received cannot be measured reliably, the
revenue is measured at the fair value of the goods or services given up, adjusted by the
amount of any cash or cash equivalents transferred.

1.9.2 IDENTIFICATION OF THE TRANSACTION

The recognition criteria in this Standard are usually applied separately to each transaction.

However, in certain circumstances, it is necessary to apply the recognition criteria to the

separately identifiable components of a single transaction in order to reflect the substance
of the transaction. For example, when the selling price of a product includes an identifiable
amount for subsequent servicing, that amount is deferred and recognised as revenue over
the period during which the service is performed.

Conversely, the recognition criteria are applied to two or more transactions together when
they are linked in such a way that the commercial effect cannot be understood without
reference to the series of transactions as a whole. For example, an entity may sell goods
and, at the same time, enter into a separate agreement to repurchase the goods at a later
date, thus negating the substantive effect of the transaction; in such a case, the two
transactions are dealt with together.

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1.9.2.1 SALE OF GOODS

Revenue from the sale of goods shall be recognised when all the following conditions have
been satisfied:
a. the entity has transferred to the buyer the significant risks and rewards of ownership
of the goods;
b. the entity retains neither continuing managerial involvement to the degree usually
associated with ownership nor effective control over the goods sold;
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 entity; and
e. the costs incurred or to be incurred in respect of the transaction can be measured
reliably.

QUESTION 8
Given that prudence is the main consideration, explain under what circumstances, if any,
revenue might be recognise at the following stages of a sale;
i. Goods are acquired by the entity which it confidently expects to resell very quickly
ii. A customer places a firm order for goods
iii. Goods are delivered to the customer
iv. The customer is invoiced for goods
v. The customer pays for goods

CHAPTER TWO: BUSINESS ENTITIES

2.0 INTRODUCTION
The established objective of financial statements is to provide information on the financial
position, performance and changes in financial position that is useful to a wide range of
users in making economic decisions where;

 Financial position is reflected in the Statement of financial position

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 Financial performance is reflected in the Statement of profit or loss and other

comprehensive income and Statement of cash flows
 Changes in financial position is reflected in the;
- Statement of profit or loss and other comprehensive
income
- Statement of cash flows
- Statement of changes in equity
- Notes to the financial statements
- Directors’ report

There are basically four types of business entity which we are going to deal with for our
accounting studies.

Entities’ is the generic term used internationally and includes the following:
- sole trader,
- partnership,
- limited liability Company
- Not for profit organisations

2.1 Sole traders

Sole trader is a ‘one-man-band’, where one person or ordinarily one family usually manages
and owns the business - for example: a hairdresser, a plumber, an accountant, a lawyer, a
trainer.

Advantages of a sole trading form of organisation

 No sharing of profits: the business is owned by a proprietor who enjoys the whole
profits.
 No chances of disputes: all business decisions are taken by the proprietor hence
there is no scope for disputes.

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 Few legal formalities: generally there are only a few legal formalities required to be
fulfilled to start a business as a sole proprietor.
 Simple accounting procedures: a ‘sole trader’ form of organisation is not bound by a
specific set of accounting rules.

Limitations of a sole trading form of organisation

 All business risks are borne by one person.

 No scope for sharing of authority and responsibility
 Low growth rate: the resources employed in a sole trader business are limited and
hence the growth rate is low when compared to any other form of business.
 Unlimited liability: in the case of bankruptcy, owner’s personal assets are used to
repay loans or other debts of the business e.g. for making payments to trade
payables, the sole trader might have to sell his house, car, personal jewellery etc.

2.2 Partnerships

Partnership is when two or more persons come together and share the profits and losses for
example: professional firms: lawyers, doctors, accountants etc.

A partnership is defined as ‘the relationship between persons carrying on a business in

common with a view of profit.’ This definition is taken from the UK Partnership Act of 1890.
Partners are entitled to share all the profits of the partnership in a ratio agreed between
them from the beginning. They also jointly bear all the risks i.e. if there are debts due to
others which cannot be paid from business funds; they share the amount to be paid to
others. In the absence of any agreement to the contrary, the profit sharing ratio is assumed
to be equal among the partners.

Another form of partnership is an limited liability partnership (LLP). In an LLP, the partners
have limited liability.

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However, depending on the jurisdiction under which the partnership firm is incorporated,
one or more partners must have unlimited liability.
Advantages

 Sharing of business risk: unlike a sole trader, who bears all the business risks, in a
partnership the business risks are shared between the partners.
 Skills and experience: apart from contributing capital to the business, a partnership
also provides a better opportunity for a group of individuals to pool their knowledge,
skills and experience.
 Improvement in business: all the business responsibilities can be distributed
amongst the partners who have a larger skill base than a sole trader.
 Higher investment: the amount of capital invested in the business is generally higher
for a partnership, compared to a sole trader. This gives more scope for expansion.
 Fewer legal formalities: a partnership firm is not required to comply with stringent
legal formalities as compared to a limited liability company.
Disadvantages

 Sharing of profits: the profits earned by the business are distributed among the
partners. Determining a fair split-up of profits may be difficult as some partners may
work harder than others.
 Chances of disputes: while managing the affairs of a business, all the partners need
to reach a consensus. However, sometimes this does not happen and disputes occur.
 Unlimited liability of the partners: in the case of bankruptcy, the partner’s personal
assets are taken away to repay loans or other debts of the business.

2.3 Companies
A company is a business entity registered under the Companies Act or any other relevant
local law specific to companies. The owners buy shares in the entity and this money is used
by the entity to carry out its activities. The owners are known as shareholders.

A peculiar feature of an entity incorporated as a company is that unlike partnership or sole

trader form of organisations, the liability of the investor is limited to the amount that has
been invested in the business.

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An entity may be incorporated as:

a. an Private limited liability company (Pvt Ltd) that has restrictions as far as
transference of shares to the public is concerned and is limited to between 2 to 50
members or
b. a (PLC) Public Limited company – listed on a Stock Exchange – these companies can
have thousands of shareholders and they are generally medium to large entities).
Advantages

 Large amount of capital: as there is no limit on the number of owners, large

amounts of capital can be amassed. This will allow the business to expand.
 Better management: as ownership and management are different, usually
professional managers are appointed to manage the running of the company e.g.
finance function may be handled by a professional in finance such as a Certified
Accountant.
 Limited liability: the liability of each member of the company is always limited to the
nominal value of the shares purchased by him. The nominal value is the amount
printed on the shares. If the company goes bankrupt, the members are not required
to use their personal assets for repaying the debts of the company.
 Transfer of shares: shares can be easily transferred from one individual to another.
This gives liquidity to the investors.

Disadvantages

 More legal restrictions: since a company enjoys the benefit of limited liability, many
restrictions are imposed by law e.g. a company dealing in computers cannot sell any
other item if it is not stated in the memorandum of the company.
 Double taxation: profits earned by a company are taxed. However, in some
countries, tax is imposed yet again when the above taxed profits are distributed to
the shareholders in the form of dividends.
 Fraud: the day to day management of affairs does not rest with the owners and
hence there is greater scope for committing fraud without the owners’ knowledge.

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2.4 The legal differences between a sole trader, partnership and a

limited liability Company.

The 3 types of legal entities will be compared on the basis of 4 points of view:
1. Raising capital
Sole traders and partnerships are principally financed by the owners and generally have
limited capacity for raising capital from other sources (obtaining loans or other finance for
expanding the business).

Partnerships have greater access to sources of finance compared to sole traders since the
partners can pool their resources.

Companies tend to have greater access to sources of finance because they have numerous
shareholders. In addition, companies can also apply for loans and other sources of finance,
similar to partnerships and sole traders. However, unlike partnership firms and sole traders,
companies can also raise finance from the market through debt and equity issues.

2. Authority
Sole traders and partnerships are generally owned and run by the same individuals.
Although the owners can employ other staff, ultimately they retain complete control,
responsibility and ownership of the business.
If they employ other people, they pay them a salary (resulting in an expense in the SOCI).
However, the reward of the sole trader / partner is called withdrawals / drawings and is an
SOFP item. This is distinguishable from the salary or interest that a sole trader / proprietor
would additionally receive

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Although the reward of the sole trader / partner is the salary paid to the sole trader /
partner, it is treated as drawings / interest / profits. You will understand these terms better
as you read through this module.

Within companies, the owners (shareholders) do not usually run the business but appoint a
board of directors who, in turn, appoint managers.

One has to subscribe or buy shares in the company to become a shareholder / owner. A
company has a corporate or separate legal status i.e. if an owner / shareholder dies or sells
his shares, the company still continues to exist. Managers are appointed by the board of
directors who run the company on behalf of the shareholders.

The owners check whether their wealth has increased and their resources are properly
safeguarded and utilised by management by analysing the financial statements.

The reward of the shareholders is in the form of dividends – each shareholder receives an
amount of money, paid out of the profits made by the company. The shareholders may also
make profits when they sell shares.

3. Liability
Sole traders and partnerships have an unlimited liability i.e. if the company is liquidated
(closed down) or if the entity becomes bankrupt they are liable to repay the liabilities of the
business with their own personal assets and belongings. From a legal point of view, sole
traders and partnership firms are regarded as an entity inseparable from their owners. For
example, if the sole trader dies, the business comes to an end. In the case of LLPs, one or
more partners have unlimited liability – the liability of the rest of the partners is limited to
the extent of their investment in the partnership.
Shareholders of a limited liability company have limited liability i.e. if the business goes into
liquidation, they stand to lose only the amount of capital they had introduced into the
business (the amount they had paid for their shares in the company) and are not liable to
pay for business liabilities with their own personal assets.

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Only if a part of the nominal value of shares is unpaid, that amount may be called for from
the shareholders.

Unlimited liability is the main difference between unincorporated entities (i.e. sole traders
and partnerships) and incorporated businesses (companies). Remember, companies have
limited liability.

4. Other legal requirements

Unincorporated entities are generally not required to publish their financial statements.
They are also generally not required to have their financial statements audited.
However, legal organisation form of business entities as well as other related legal
requirements (such as the obligation to audit financial statements) may differ from country
to country. For example partnerships in certain countries may be required to have an audit
for their financial statements if their profit / turnover is above a certain limit.

Question

Sibs Traders keeps incomplete records. The following is a summary of cash transactions for
the year ended 31 December 2011:

DR CR

Balance b/d 10 800 Creditors 50 000

Receipts from receivables 72 500 Rent 3 200

Cash sales 4 800 Wages 2 200

Stationery 500

Drawings 7 500

Motor vehicles 12 000

Miscellaneous expenses 50

The following information is also available:

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1. During the year return inwards were $5 300

2. Bad debts written off were $1 500
3. Discount allowed was $1 800
4. Returns outwards were $6 400
5. Discount received was $4 000

You are also provided with the following list of balances:

01 January 2011 31 December 2011

Inventory $5 700 $12 400

Receivables $9 100 $8 500

Payables $6 800 $7 200

Rent paid in advance $800 $630

Wages accrued $200 $350

Stationery $250 $150

You are also told that on 1 January 2011 the Motor vehicles (at cost) account had a balance
of $50 000 and the Motor vehicles Provision for depreciation account had a balance of $12
500 . It is the firms’ policy to provide for depreciation at a rate of 10% on cost at the end of
the accounting period.

Required:

Prepare a Statement of Comprehensive Income for the year ended 31 December 2011 and
the Statement of Financial Position as at that date.

CHAPTER 3: ACCOUNTING FOR PARTNERSHIPS

3.0 INTRODUCTION
Chapter 2 has alluded on the differences between the different forms of organisation, the

advantages and disadvantages. This chapter will examine the accounting practices involved

in the partnership form of business organization. The major differences between

corporations, sole traders and partnerships appear in the equity section of the SOFP.

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The accounting principles involved have been in use for many years; they are a prime

example of principles that are not the subject of professional pronouncements or

regulation, but rather are generally accepted by virtue of their use by similar organizations

over time.

Accounting for assets and liabilities in a partnership is much similar to accounting in a sole
traders business. The main difference exist in accounting for equity. Since there are two or
more owners, separate capital accounts are maintained for each owner and special journal
entries are required to account for withdrawals, distribution of income, introduction of new
partners, and retirement of partners and liquidation of the partnership.

Normally the formation of a partnership does not require government approval — indeed, it
does not even require a written agreement among the partners, although a carefully
formulated contract is highly desirable.

Some other important characteristics of partnerships are briefly discussed next.

1. Limited Life A partnership legally ceases to exist upon the withdrawal or death of an
existing partner, the admission of a new partner, or the voluntary dissolution of the
entity.
2. Mutual Agency Each partner co-owns the assets and liabilities of the partnership.
Each partner may act as an agent for the partnership and legally enter into contracts
on its behalf.
3. Unlimited Liability In case of insolvency, each partner is individually responsible for
the liabilities of the partnership, regardless of the amount of equity that the partner
has in the partnership. This feature is one of the major differences between
partnerships and the corporate form of organization, where shareholders are not
personally liable for the company’s debts. This major disadvantage of unlimited
liability can be circumvented by the formation of a limited partnership, but the acts
that allow this type of partnership require that at least one partner be a general

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partner and that the partnership name not contain any of the names of the limited
partners.
4. Income Tax Aspects Partnerships are not taxed as separate entities; rather, each
partner is taxed on his or her share of the yearly net income whether it has been
distributed or not. This may be viewed as a major disadvantage, and one that could
be avoided by using the corporate form of organization.

3.1 PARTNERSHIP ACCOUNTING

In our discussion of partnership accounting we will examine partners’ accounts in the
accounting records, the distribution of periodic net income, the admission of new and the
retirement of existing partners, the liquidation of the partnership and purchase of a
partnership by a partnership.

Partners’ Accounts
Traditionally, partnership accounting records contain two accounts for each partner;
1. A capital account
A capital account records the partner’s equity investment at any point in time.

It is credited initially with the fair market value of the assets contributed by the partner at
the time of formation of the partnership; subsequent changes reflect the partner’s share of
net income earned, additional assets invested, and assets withdrawn.
2. A partner’s current account
A partner’s current account would be used to record incomes earned (salary**, profit
shares, interest earned on capital, any gains on revaluation, amounts withdrawn in
anticipation of yearly profits and interest charged thereon.

There are two possibilities regarding partners salaries;

1. The salary maybe paid out monthly in cash where the accounting treatment is;
DR: Salary account
CR: Bank/cash account
In this case the salary is not included in the partners current account as this will be a
payment(s) to the partner(s)

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2. Provisions are made for salaries but are not actually paid out to the partners and
the accounting treatment is;
DR: Salary account
CR: Partners current account

The distribution of net income to the partners’ equity accounts is made in accordance with
the partnership agreement. An important component of any distribution plan is the profit
and loss sharing ratio. If the partnership agreement does not contain such a ratio, the acts
state that the ratio is one that will provide an equal distribution to each partner.

3.1.1 FINANCIAL STATEMENTS FOR A PARTNERSHIP

i. Income statement
ii. Statement of division of profit
iii. Statement of Financial Position
iv. Statement of changes in equity
v. Statement of cashflows

The Income Statement for a partnership is exactly the same as that for a sole trader.

An extra statement is required in which the profit from the income statement is shared
between the partners. This is referred to as a Statement of Division of Profit:
Partner Partner Total
A B
$ $ $
Net profit from Income Statement X
Salaries X (X)
Interest on Capital X X (X)
Interest on Drawings (X) (X) X
Residual profit X
Residual Profit share ratio 3:2 X X X

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The profits allocated to each partner are credited to the partners' Current Account.
Drawings are also recorded in this account:
CURRENT ACCOUNT
Ptnr Ptnr Ptnr Ptnr
A B A B
Balance b/f X X
Drawings X X Salary X X
Int on Drawings X X Int on Capital X X
Residual Profit share
(from statement of X X
Division of profit)
Balance c/f X X
–––––––––– – ––––––––––––
X X X X
–––––––––– – ––––––––––––
Balance b/f X X

The partner's Capital Account records the initial capital invested in the business by each
partner. Transactions in this account are rare, being the injection of further capital or
withdrawal of capital by a partner:

CAPITAL ACCOUNT
Ptnr Ptnr Ptnr Ptnr
A B A B
Balance b/f X X
Cash/bank X X Cash/Bank X X
Asset X X
Balance c/f X X
–––––––––– – ––––––––––––
X X X X
–––––––––– – ––––––––––––
Balance b/f X X

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The closing balances on the partners' Current and Capital Accounts form the Capital section
of the Statement of Financial Position:

Statement of Financial Position extract:

CAPITAL AND LIABILITIES
$ $
Capital Accounts Partner A X
Partner B X
––––––
X
Current Accounts Partner A X
Partner B X
––––––
X
––––––
X
The remainder of the Statement of Financial Position (assets and liabilities) is as for a sole
trader.

QUESTION 1

The following information relates to Jack and Daniel:

Pre-adjustment Trial Balance at 3o September 2011

DEBIT CREDIT

Capital accounts: Jack 20 000

Daniel 5 000

Current accounts: Jack 1 060

Daniel 2 800

Drawings during the year: Jack 9 000

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Daniel 3 000

6% loan 10 000

Payables 24 150

Bank overdraft 6 160

Land and buildings (cost) 19 500

Plant and equipment (cost) 19 840

Motor vehicles (cost) 900

Office furniture 350

Accumulated depreciation1 October 2010:

Plant and equipment 5 000

Motor vehicles 500

Office furniture 50

Inventory 30 September 2011 21 069

Receivables 16 020

Allowance for bad debts 600

Cash on hand 32

Gross profit 34 628

Advertising 4 409

Office salaries and wages 12 189

Office expenses 622

Insurance 364

Delivery expenses 2 203

Interest on loan 450

109 948 109 948

Additional information

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Terms of the partnership agreement

1. The partners Jack and Daniel share profits and losses in the ratio of their capital
2. Interest is 5% per annum is to be allowed on the opening balance of the partners
capital and current accounts
3. Interest is to be charged at 5% per annum on the average monthly amount
outstanding on the drawings account. Amounts are given, see item 7 below
4. Daniel is entitled to a salary of $1 000 per annum plus a commission of 10% on the
net profit after his salary has been debited and after the adjustments for interest on
capital, current and drawings account.

Year-end adjustments

1. An outstanding debt of $20 is irrecoverable and must be written off

2. The allowance for bad debts must be adjusted to 5% of outstanding receivables
3. Depreciation is to be provided as follows:
Plant and equipment: 15% per annum on reducing balance method. A new machine
was purchased on 1 April 2011 for $1 560
Motor Vehicles: 20% on cost
Office furniture: 10% per annum on reducing balance method
4. Interest has been paid on the loan up to 30 June 2011.
5. Office salaries of$69 have not been paid or taken into account in the balance
6. The following expenses have been prepaid:

Insurance $62

Advertising $948

7. Interest calculated on the partners drawings accounts amounted to $320 for Jack
and $80 for Daniel.
8. In terms of the partnership agreement, the following must be provided for:
- Interest on partners capital and current accounts
- Daniel’s salary and management omission.

Required:

a. Income statement for the year ended 30 September 2011

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b. Statement of changes in equity for the year ended 30 September 2011

c. Statement of financial position as at 30 September 2011

3.2 PARTNERSHIP CHANGES

Part ownership in a partnership is an investment and it is bound to change at any given
point in time due to;

1. Change in a profit sharing ratio

2. The admission of new partnership;
3. Retirement of existing partners;
4. Death of an existing partner; and;
5. Purchase of a partnership by a partnership.

In all situations the business usually carries on, but legally the old partnership is dissolved
and a new partnership is formed. This factor could provide justification for the adjusting
accounting entries that are then required whenever there is a partnership change even
though the business itself is undisturbed, but because legally a new entity exists.. These
include;
 Valuation of goodwill
 Revaluation of net asset

Accounting treatment for goodwill

Goodwill is accounted for in two different ways, either by;
1. Maintaining the goodwill account
DR: Goodwill account
CR: Capital account……………. with the OPSR

2. Not Maintaining the goodwill account

DR: Goodwill account
CR: Capital account with the OPSR and then to close of the goodwill account

DR: Capital account

CR: Goodwill account ……………with the NPSR

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Or alternatively the goodwill adjustments are done using a goodwill schedule(As will be
discussed in class).

Accounting treatment for revaluation net assets

1. For increase in the value of assets
DR: Asset account
CR: Revaluation account
2. For increase in the value of assets
DR: Revaluation account
CR: Asset account
3. For increase in provisions and liabilities
DR: Revaluation account
CR: Provision/liabilities account
4. For decrease in provisions and liabilities
DR: Provision/liabilities account
CR: Revaluation account
5. The balance in the revaluation account is then transferred to the capital account
where capital accounts are adjusted according to the partners OPSR

3.2.1 CHANGE IN A PROFIT SHARING RATIO

Because nothing is really changing besides the profit sharing, the only adjustments that will
be necessary are just book entries for goodwill and maybe revaluation as already shown in
section 4.2.

3.2.2 ADMISSION OF A NEW PARTNER

The admission of a new partner requires the unanimous consent of the existing partners. A
new partner could be admitted through;
 the acquisition of a portion of the interests of the existing partners;
 through the investment of additional net assets into the partnership;
 The new partner pays a premium representing the benefit he will receive from the
businesses already generated goodwill or the new partner receives a discount
partnership negative goodwill

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3.2.2.1 THE ACQUISITION OF A PORTION OF THE INTERESTS OF THE EXISTING

PARTNERS
When the new partner purchases interest from existing partners at book value, the
transaction is recorded by crediting the capital account of the new partner and debiting the
capital account of existing partner(s). The transaction is reported in the books for the
partnership at the book value of the share transferred and it has nothing to do with the
price which the new partner has paid to the existing partner(s).

DR: Capital account (existing partners)

CR: Capital account (new partner)

3.2.2.2 THROUGH THE INVESTMENT OF ADDITIONAL NET ASSETS INTO THE

PARTNERSHIP

When the new partner brings in new assets, the assets are debited at the value agreed by
the partners for the purpose and the partner's capital account is credited for the total value
of those assets.
DR: Specific asset account

CR: Partners capital account with the fair value of the assets bought in

QUESTION 2

Oprah and Ellen have been in partnership for some years, sharing profits and losses in the
ratio 2 : 1. The Partnership Statement of Financial Position as at 31 January 2011 was as
follows: Statement of Financial Position at 31 January 2011

$ $ $

Non-Current Assets at Carrying amount

Motor vehicles 58 200

Office equipment 35 400

Fixtures and fittings 39 000

132 600

Goodwill 10 000

142 600

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Current Assets

Inventory 64 000

Trade receivables 45 600

Bank 19 200

128 800

Current liabilities

Trade payables 22 400

Net current assets 106 400

249 000

Capital accounts

Oprah 80 000

Ellen 120 000

200 000

Current accounts

Oprah 35 400

Ellen 13 600 49 000 249 000

Oprah and Ellen, who had been renting business premises, accepted an offer by Phil to
move to his premises on 1 February 2011 on condition that he would be accepted into the
partnership on that date.

Additional information:

i. The new partnership commenced on 1 February 2011 with Oprah, Ellen and Phil sharing
profits and losses in the ratio 2 : 1 : 1.

ii. The new partnership took ownership of Phil’s premises on 1 February 2011 at a valuation
of $196 000.

iii. The following revaluations were to take place on 1 February 2011;

-Goodwill was revalued at $30 000 and would still be maintained in the books of accounts .

-Office equipment was revalued at $34 100

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-Inventory was valued at $63 000.

REQUIRED

a. Prepare the partnership Goodwill account at 1 February 2011 following the amendments

b. Prepare the partnership Revaluation account at 1 February 2011 following the

amendments

c. Prepare Capital accounts for Oprah, Ellen and Phil

d. Prepare the Statement of Financial Position for the Partnership as at 1 February 2011

3.2.2.3 PAYMENT/DISCOUNT OF SHARE OF GOODWILL

The payment of a premium is paid by a the new partner to the old partners to compensate
them on the shift in the profit sharing ratio.

In rare circumstances when a partner is unable to pay for the premium then the old
partners are compensated by raising the value of goodwill

3.2.3 RETIREMENT OF EXISTING PARTNERS

A partner can retire from an existing partnership by either selling his share of the
partnership or to the remaining partners. Either way he expects to leave with a share of the
business since he was part in creating it. This includes his;

- Capital account balance

- Share of goodwill
- Gains on revaluation of assets
- Current account balance

As explained earlier all assets and liabilities would need to be revalued and goodwill valued
if any which must then be transferred to the capital accounts using the PSR.

If the remaining partners takeover the interests of the retiring partner, they are entitled to
settle the retiring partners interest by utilising the partnership funds.

ACOUNTING TREATMENT ON RETIREMENT

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1. Goodwill and revaluation as explained in section 3.2

2. DR: Current account of retiring partner
CR: Capital account of retiring partner
3. Payment of his share of the company
(a) When he is given cash
DR: Capital account of retiring partner
CR: Cash/bank account
(b) When he is given an asset
DR: Capital account of retiring partner
CR: Specific asset account
4. On retirement, there might be insufficient funds to pay the retiring partner so the
partner might leave part of his share of the business as a loan to the new
partnership, in that case the accounting treatment will be as follows
DR: Capital account of retiring partner
CR: Loan account

QUESTION 3

Britney, Justin and Cameron had been in partnership sharing profits and losses in the ratio
5:3:2 respectively. Their Statement of Financial Position as at 31 July 2011 is as follows;

$ $ $

Non-current assets

Motor vehicles 50 000 8 000 42 000

Fixtures and Fittings 40 000 4 000 36 000

Buildings 25 000 - 25 000

115 000 112 000 103 000

Current assets

Inventory 16 800

Trade receivables 12 000

Cash and cash equivalents 10 000

38 800

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Current liabilities

Trade payables 1 600

Net current assets 37 200

140 200

Current accounts

Britney 3 600

Justin 4 400

Cameron 2 200

10 200

Capital accounts

Britney 50 000

Justin 40 000

Cameron 30 000

120 000

Long term Liabilities

Loan- Justin 10 000

140 200

On 1 September 2011 Justin retired and the following changes took place:

i. Motor vehicles were valued at $50 000

ii. Fixtures and Fittings were reduced by $6 000
iii. Buildings were valued at $ 35 000
iv .Inventory was reduced by $1 800
v. Bad debts of $1000 were written off
vi. Goodwill was valued at $ 20 000 and was not to be maintained in the partnership
books
vii. Justin was paid $25 000 cash and also took a revalued vehicle worth $5 000
viii. Balance remaining was transferred to the loan account

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ix. On the same date Mary was admitted as a new partner, she paid $45 000 cash capital
plus a share of goodwill
x. Britney, Cameron and Mary share profits and losses in the ratio 4:3:1
Required:

a) Prepare detailed capital accounts to show the above changes

b) Prepare a Statement of Financial Position after the changes

3.2.4 DEATH OF AN EXISTING PARTNER;

The death of a partner dissolves the partnership. But partnership agreements usually
contain a provision for the surviving partners to continue operations.

When a partner dies, it usually is necessary to determine the partner's equity at the date of
death.

The surviving partners may agree to purchase the deceased partner's equity from their
personal assets. Or they may use partnership assets to settle with the deceased partner's
estate. In both instances, the entries to record the withdrawal of the partner are similar to
those presented for retirement.

3.2.5 LIQUIDATION/ DISSOLUTION OF THE PARTNERSHIP

Liquidation of a partnership business involves selling the assets of the firm (realization of the
assets), paying liabilities, and distributing any remaining assets. Liquidation may result from;

- the sale of the business by mutual agreement of the partners,

- from the death of a partner, or
- from bankruptcy.

From an accounting standpoint, the partnership should complete the accounting cycle for
the final operating period prior to liquidation. This includes preparing adjusting entries and
financial statements. It also involves preparing closing entries and a post-closing trial

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balance. Thus, only balance sheet accounts should be open as the liquidation process
begins.

In liquidation, the sale of non-cash assets for cash is called realization. Any difference
between book value and the cash proceeds is called the gain or loss on realization.

To liquidate a partnership, it is necessary to:

1. Sell non-cash assets for cash and recognize a gain or loss on realization.
2. Allocate gain/loss on realization to the partners based on their PR.
3. Pay partnership liabilities in cash.
4. Distribute remaining cash to partners on the basis of their capital balances.
Each of the steps must be performed in sequence. The partnership must pay creditors
before partners receive any cash distributions. Also, an accounting entry must record each
step.

When a partnership is liquidated, all partners may have credit balances in their capital
accounts. This situation is called no capital deficiency.

Or, one or more partners may have a debit balance in the capital account. This situation is
termed a capital deficiency.

ACCOUNTING TREATMENT ON DISSOLUTION

TRANSACTIONS DEBIT CREDIT

Realization
1. Assets transferred at book value Assets A/c
A/c

Liabilities
2. Liabilities assumed by purchaser Realization A/c
A/c

3. Liabilities paid off Liabilities Cash A/c

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A/c

Purchaser’s
4. Purchase consideration Realization A/c
A/c

5.Repayment of loan to an partner Loan A/c Bank A/c

Current (for Capital A/c

6.Transfer any balances in partners’ credit
balance) A/c
current accounts

OR
Current (for debit
Capital A/c balance) A/c

Realization
7. Expenses of realization Cash A/c
A/c

Realization
9. Profit on realization Capital A/c
A/c

10. Payments to partners to close the (a) Asset account

Capital A/c
book (b) Cash A/c

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3.2.5.1 PURCHASE OF A PARTNERSHIP BY A COMPANY.

When a partnership is taken over by a limited company, the partnership is considered as

dissolved and the business is sold as a going concern to the limited company.

Accounting entries for the seller or the partnership will show;

1. Realization Account,
2. Purchaser’s Account and
3. Partners Capital Account.

The discharge of purchase consideration by the limited company will close the partnership
book.

The purchase consideration is discharged by the limited company (buyer) to partners(seller)

to take over the business at which point goodwill can arise.

Goodwill = Purchase consideration – (assets at take-over value – liabilities at take-over

value)

ACCOUNTING TREATMENT IN THE PARTNERSHIP’S OR SELLER’S BOOK

TRANSACTIONS DEBIT CREDIT

Realization
1. Assets transferred at book value Assets A/c
A/c

Liabilities
2. Liabilities assumed by purchaser Realization A/c
A/c

Liabilities
3. Liabilities paid off Cash A/c
A/c

Purchaser’s
4. Purchase consideration Realization A/c
A/c

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5.Repayment of loan to an partner Loan A/c Bank A/c

Current (for Capital A/c

6.Transfer any balances in partners’ credit
balance) A/c
current accounts

OR
Current (for debit
Capital A/c balance) A/c

Realization
7. Expenses of realization Cash A/c
A/c

Realization
9. Profit on realization Capital A/c
A/c

(a) Shares A/c

10. Payments to partners to close the
Capital A/c (b) Debentures A/c
book
(c) Cash A/c

TRANSACTIONS ACCOUNTING ENTRIES

FOR OPENING ENTRIES OF NEW COMPANY (BUYER)

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Assets taken over Dr Assets

Cr Business Purchase

Liabilities taken over Dr Business Purchase

Cr Liabilities

The purchase consideration offered Dr Business Purchase

Cr Vendor (seller)

The purchase consideration settled by Dr Vendor (seller)

cheques, shares and debentures Cr Bank/Shares/Debentures

QUESTION 4:
Mr A, Mr B & Mr C are partners who share profits and losses in the ratio of 3:2:1. They have
agreed to convert the partnership into a limited company called ABC Pvt Ltd

Statement of Financial Position for ABC Partnership $

Freehold premises 30,000

Plant & machinery 30,000

Stock 40,000

Bank 20,000

Total Assets 150,000

Capital – Mr A 80,000

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Capital – Mr B 20,000

Capital – Mr C 20,000

120,000

Trade Payables 30,000

150,000

Additional information:

i. Total purchase consideration is agreed at $180,000, payable as follows:

$90,000 in ordinary shares of $1 each fully paid,

$30,000 in 6% preference shares of $1 each fully paid,

$10,000 in 5% debentures and the balance in cash

REQUIRED:

a. Show the ledger accounts closing the partnership’s book

b. Show the opening journal entries in ABC Pvt Ltd/ Purchaser’s book

QUESTION 5

Akram, Bhupesh and Chuck were in partnership. Their partnership agreement provided that:
1 Akram received a partnership salary of $8000 per annum
2 Partners be credited with interest on capital at 6% per annum
3 Residual profits be shared in the ratio 3 : 2 : 1 respectively
4 Chuck be guaranteed a minimum share of residual profits of $7 200.

The partnership trial balance at 31 March 2010, after the preparation of the partnership
trading account, was as follows.
Dr Cr

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$ $
Gross profit 383 000
Trade receivables (debtors) 24 000
Trade payables (creditors) 18 000
Inventories (stock) at 31 March 2010 37 000
Non-current (fixed) assets at cost
Buildings 310 000
Machinery 170 000
Vehicles 120 000
Provisions for depreciation
Buildings 105 000
Machinery 68 000
Vehicles 77 000
General expenses 327 000
Bank 14 000
Capital accounts:
Akram 160 000
Bhupesh 110 000
Chuck 80 000
Current accounts:
Akram 14 000
Bhupesh 27 000
Chuck 37 000
Drawings:
Akram 40 000
Bhupesh 30 000
Chuck 35 000
1 093 000 1 093 000

Additional information
1 A family holiday taken by Bhupesh, costing $3400, had been entered in general expenses.

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2 A bad debt of $500 was written off during the year. It had not been entered in the books
of account.
3 A bad debt of $400 written off in the year ended 31 March 2009 was partially recovered.
The debtor paid, by cheque, $0.50 for each $1 owed. No entries had been made in the
books of account.
4 A machine purchased in January 2010 for $17 000 had been included in general expenses.
5 Depreciation is to be provided at the following rates:
Buildings at 2% per annum on cost
Machinery at 10% per annum on cost
Vehicles at 40% per annum reducing balance.
A full year’s depreciation is provided on non-current (fixed) assets acquired during the
year.
REQUIRED
(a) Prepare an income statement (profit and loss account) and an appropriation account for
the year ended 31 March 2010.
(b) Prepare the partners’ current accounts at 31 March 2010.
At the close of business on 31 March 2010 the partnership was taken over by EDC Ltd. The
company took over all the assets and liabilities, with the exception of the bank balance, for a
purchase consideration of $600 000.
The purchase consideration comprised:
$30 000 in cash;
150 000 $1 debentures at par shared equally between the partners;
300 000 ordinary shares of $1 in EDC Ltd. These were shared among the partners in their
profit sharing ratios.
The partnership expenses incurred in the takeover amounted to $20 200.
REQUIRED
(c) Prepare the partners’ capital accounts to close the books of account of the partnership.

(d) Prepare the partnership bank account to close the books of account.

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3.2.6 INSOLVENT PARTNER

It occasionally happens that when a partnership dissolves one of the partners capital
account is in debit for one reason or another. In such cases the partner is expected to repay
the partnership the amount of the deficit in his capital account.

Even worse it is possible that this partner will prove to be insolvent and unable to meet his
or her obligation towards the partnership, if this is the case, the remaining partners
naturally have to bear the loss of this shortfall inthe insolvent partner’s capital using the
PSR.

3.2.6.1 GARNER VS MURRAY RULE

We have said that if there is a deficit capital account at dissolution the remaining partners
naturally have to bear the loss of this shortfall in the insolvent partner’s capital using the
PSR. In a case heard in England some years ago, however the judge handed down a
completely different verdict; this was the Garner Vs Murray case.

The judge decided the solvent partners are obliged to compensate the partnership for the
loss in respect of a fellow partners insolvency in proportion to their respective capital in the
business before its dissolution.

The general opinion is that this rule is contrary to recognised accounting principles namely
that all profits and loses have to be divided in accordance with PSR.

QUESTION 10

A, B & C are in partnership sharing profits and losses in the ratio 2:2:1. On 30 June 2011 they
decided to dissolve the partnership. At that date the Statement of Financial Position was as
follows:

ABC

Statement of Financial Position as at 30 June 2011

ASSETS

Non-current assets $

PPE 6 000

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Current assets

Cash and cash equivalence 900

Total Assets 6 900

EQUITY AND LIABILITIES

Capital account: A 3 000

:B 300

:C 1 000

4 300

Current liabilities

Payables 2 600

Total equity and liabilities 6 900

Sundry assets were sold for $3 000. B was insolvent and unable to contribute to his deficit

Required:

Prepare the journal entries required to close off the books of the partnership.

3.2.6.2 PIECEMEAL LIQUIDATTION

With the previous example the assumption was that assets were being sold simultaneously.
Naturally this is an oversimplification of what happens in practice.

In practice when there is dissolution it is not always possible to realise the assets within a
relatively short period of time. The partners may therefore decide to liquidate the business
piecemeal, in which case the business continues normally, but on a steadily decreasing
scale.

This creates the opportunity to sell inventories and other assets at the most favourable
prices and to collect debts inthe ordinary course of business. As the assets in the business
are realised, cash funds will accumulate and will not be used again for business purposes
and partners are entitled to make periodic capital withdrawals from the funds.

There are mainly two methods according to which payments can be made namely;

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- Surplus capital method

- Loss absorption method

3.2.6.2 .1 SURPLUS CAPITAL METHOD

According to this method the amount realized for assets which are sold from time to time is
used s follows;

1. Settlement of creditors claims which are payable and realization costs to date and a s
a reserve for creditors claims which are not yet payable.
2. Repay the partners the amounts in their capital accounts which exceed their profit
sharing ratio
3. Distribution to partners in accordance with their PSR after the capital accounts have
been reduced to the PSR

ILLUSTRATION

A, B & C are in partnership sharing profits and losses in the ratio 5:3:2. They decided to
dissolve the partnership. At that date the Statement of Financial Position was as follows:

ABC

Statement of Financial Position as at 30 June 2011

ASSETS

Non-current assets $

PPE 18 000

Total Assets 18 000

EQUITY AND LIABILITIES

Capital account: A 8 000

:B 5 000

:C 2 000

15 000

Current liabilities

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Payables 3 000

Total equity and liabilities 18 000

The assets are being liquidated piecemeal, and as soon as cash becomes available from the
realization of assets it is paid to the partners.

The sundry assets realized as follows follows;

First realization: Carrying amount $2 500 Cash received $2 500

Second realization: Carrying amount $5 600 Cash received $5 000

Third realization: Carrying amount $6 000 Cash received $6 000

Fourth realization: Carrying amount $3 900 Cash received $4 000

$18 000 $17 500

Step 1

Determine the amount of amounts of the partners capital which exceeded the profit-sharing
ratio as follows:

 Determine partners’ PSR

 Determine partners’ original capital balances.
 Divide each partner’s by his profit-sharing ratio see a)
 Multiply the lowest capital by each partners profit sharing figure to give you the
partners capital in the highest profit -sharing ratio see b)
 Subtract partners capital in the profit-sharing ratio from their original capitals, which
will give you capitals that exceed the profit sharing ratio see c)
 Follow the some procedure as above in respect of excess capitals, eliminate the
partners one by one and then calculate the final excess capital where the capital of
one partner exceeds that of all the others( see d, e, f)

PARTNERS REF A B C

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Profit- sharing ratio A 5 3 2

$ $ $
Original capital balances B 8 000 5 000 2 000
a. Divided by the Profit sharing C 1 600 1 666 1 000
figure
(B/A)
b. Multiply the lowest capital (that D 5 000 3 000 2 000
of
C) by the profit sharing ratio
figures i.e ($1 000 x A) which will
give you the maximum capital in
the profit sharing ratio
c. Subtract from original capital E 3 000 2 000 -------
balances and obtain the first
excess of capitals above the
profit sharing ratio ( B- D)
d. Divide by profit sharing ratio F 600 666 --------
figures (E/A)
e. Multiply the lowest capital, that G 3 000 1 800 --------
of A, by the profit sharing ratio of
A & B (F X A)
f. Subtract from excess capitals per H ------------ 200 ----------
E above and obtain final excess
of B (E – G)

Step 2

Arrange partners’ capitals for repayment

REF $ $ $
st
1 : B- Final excess H ----- 200 ------
2nd: A & B excess in PSR G 3 000 1 800 ------

3rd: A,B,& C in PSR D 5 000 3 000 2 000

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B 8 000 5 000 2 000

Step 3

Distribution of available cash

CASH ALLOCATED
AVAILABLE PAYABLES A B C
$ $ $ $ $

First realisation 2 500 2 500 ------ ----------- ------------

---
Second realization ∑5 000
Final amount to creditors 500 500
First option (H) 200 200
Second option (G) 2 688 2
A( 3000) x (5000-500-200) 688
( 3 000 + 1 800)
B ( 1 800) x (5000-500-200) 1 612 1 612
( 3 000 + 1 800)

Third realization ∑6 000

Balance of second option G
( 3 000 + 1 800)- (2 688 +1612)= 500
A (3 000 -2 688) 312 312
B (1 800-1612) 188 188
Third option (D)
A ( 5000) x (6000-312-188) 2750 2750
(5 000 + 3 000+ 2000)

B( 3 000) x (6000-312-188) 1650 1650

(5 000 + 3 000+ 2000)

C( 2000) x (6000-312-188) 1100 1100

(5 000 + 3 000+ 2000)

Fourth realization ∑4 000

A ( 5000) x 4000 2 000 2000
(5 000 + 3 000+ 2000)

B ( 3000) x 4000 1200 1200

(5 000 + 3 000+ 2000)

C ( 2000) x 4000 800 800

(5 000 + 3 000+ 2000)

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17 500 3 000 7750 4 850 1 900

3.2.6.2 .2 LOSS ABSORPTION/ASSUMED LOSS/NOTIONAL LOSS METHOD

This is possible loss by assuming that the remaining assets after the first realization do not
have any scrap value. The resultant deficit is divided amongst the partners in their profit
sharing ratio and every resultant debit balance which appears in any partners capital
account is redistributed amongst the remaining partners according with their PSR

Steps on Piecemeal Dissolution

1. Find out the maximum possible loss

 Maximum possible loss

= NBV of assets to be realized - Total proceeds from disposal

OR

 Maximum possible loss

= Total capital balances - Total cash to be distributed to partners( i.e. cash available)

2. The maximum possible loss is shared by the partners according to the profit-sharing
ratio

3. Apply the Garner vs. Murray rule if there is any capital deficiency

4. Distribute any available cash to the partners according to their remaining capital
balances

5. Repeat the process until all assets have been realized

ILLUSTRATION

The Statement of Financial Position for X,Y and Z who share profits and losses in the ratio
5:3:2 respectively appeared as follows as at 30 June 2010

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ABC

Statement of Financial Position as at 30 June 2011

ASSETS

Non-current assets $

PPE 18 000

Total Assets 18 000

EQUITY AND LIABILITIES

Capital account: A 8 000

:B 5 000

:C 2 000

15 000

Current liabilities

Payables 3 000

Total equity and liabilities 18 000

The assets are being liquidated piecemeal, and as soon as cash becomes available from the
realization of assets it is paid to the partners.

The sundry assets realized as follows follows;

First realization: Carrying amount $2 500 Cash received $2 500

Second realization: Carrying amount $5 600 Cash received $5 000

Third realization: Carrying amount $6 000 Cash received $6 000

Fourth realization: Carrying amount $3 900 Cash received $4 000

$18 000 $17 500

Procedures at time of realisation

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 Open the applicable accounts in columnar form with the balance as at the
commencement of liquidation
 Divide the cash received from each realisation according to the prescribed rank
order
 Apportion the profits and losses which arise after each realisation of assets to the
capital accounts of the partners according to the profit sharing ratio
 After each realisation, draw up a liquidation schedule to determine what amount
can be paid out to each partner
 Assume the assets that have not yet been realised as worthless and apportion the
“potential deficit” to the partners according to their PSR
 Any deficit which may arise in a partners capital account must be transferred to the
remaining partners capital accounts according to their respective PSR
 Transfer the amounts as calculated in the liquidation schedule to the partners capital
accounts
 Once the partnership accounts have reached the point where they correspond to the
partners PSR, all the succeeding payments to payments to partners canbe allocated
in that proportion

PSR BANK PAYABLES PPE A B C

5 3 2
$ $ $ $ $ $
Bal @commencement (3000) 18 (8000) (5000) (2000)
of liquidation 000
Sale of assets 2 500
Payment of creditors (2500) 2500 (2500)
Sale of assets and 5000 300 180 120
allocation of loss 5600
Payment of creditors (500) 500
∑ 4500 - (7700) (4820) (1880)
9900
Distribution from (4500) - 2688 1812

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liquidation schedule(See
a) below)
∑ - - 9900 5012 3008 1880
Sale of assets 6000 (6000)
∑ 6000 3900 (5012) (3008) (1880)

Distribution from (6000) 3062 1838 1100

liquidation schedule
(see b below)
∑ - - 3900 (1950) (1170) (780)
Sale of assets and 4000 - (3900) (50) (30) (20)
allocation of profits
∑ 4000 - - (2000) (1200) (800)
Distribution to partners (4000) - 2000 1200 800
Liquidation schedule
a)Balances before first 4500 9900 (7700) (4820) (1880)
distribution
Possible deficit (9900) 4950 2970 1980
∑ 4500 - (2750) (1850) 100
Transfer deficit to
remaining partners
(5) : (3)
(5+3) (5+3) 62 38 (100)
∑ 4500 - (2688) (1812) -
Transfer to accounts (4500) 2688 1812

b) balances before 2nd

distribution 6000 3 900 (5012) (3008) (1880)

Possible deficit(5:3:2) (3900) (1950) (1170) 780

∑ 6000 - (3062) (1838) (1100)

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Transfer to accounts (6000) 3062 1838 1100

Question 6

At 31 December 2009 the condensed Statement of Financial Position of the partnership of

A,B &C who share profits and losses in the ratio 5:3:2 respectively, were as follows.

ABC

Statement of Financial Position as at 31 December 2009

Property 42000 capital: A 7000

Goodwill 3000 B 14000

Bank 5000 C 18000

Trade creditors 11000

50000 50000

The partners decided to dissolve the partnership on 1 January 2010. The assets will be
released and net proceeds apportioned among the partners in such a way that no partner
finds it necessary to repay any amount which he has already received.

REALISATION OF ASSETS CARRYING AMOUNT PROCEEDS

1 February 2010 13000 9000

2 march 29000 33000

Required

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Prepare a columunar statement showing the distribution of cash among the partners and
their capital accounts for the period 1 January 2010 to 31 March 2010 according to the
surplus capital method. Garner versus Murray doesn’t apply

Question 7

A,B &C are partners and share profits and losses in the ratio of 4;3;1 respectively.

On 31 May 2010 they decided to dissolve the partnership and pay the cash out to the
partners as and when it becomes available during the liquidation process.

At 31 May 2010 the list of balances was as follows

Capital : A 7500

B 12000

C 4000

Current account: A 1500

B 1000

C 2000

Loan (B ) 10000

Property 20000

Goodwill 5000

Inventory 10000

Trade debtors 7000

Trade creditors 8000

Required

Calculate and show the order of preference in which the cash will be distributed amount the
partners according to the surplus method

Garner versus Murray doesn’t apply

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Question 8

At 31 December 2009 the condensed balance sheet of the partnership of Tom, Dick and
Harry, who share profits and losses in the ratio 5:3:2 respectively was as follows

TOM, DICK AND HARRY

STATEMENT OF FINANCIAL POSITION AT 31 DECEMBER 2009

Property 42000 capital: Tom 7000

Goodwill 3000 Dick 14000

Bank 5000 Harry 18000

Trade creditors 11000

50000 50000

The partners decided to dissolve the partnership on 1 January 2010. The assets will be
released and net proceeds apportioned among the partners in such a way that no partner
finds it necessary to repay any amount which he has already received.

REALISATION OF ASSETS CARRYING AMOUNT PROCEEDS

1 February 2010 13000 9000

2 march 29000 33000

Required

Prepare a columnar statement showing the distribution of cash among the partners and
their capital accounts for the period 1 January 2010 to 31 March 2010 according to the loss
absorption method.

Garner versus Murray doesn’t apply

Question 9

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A, B & C condensed balance sheet immediately before dissolution of the partnership at 31

December 2010 was as follows.

Assets $

Non-current assets

Property plant and equipment 36000

Goodwill 16000

52000

Current assets

Inventory 128000

Trade debtors 152000 280000

Total assets 332000

EQUITY AND LIABILITIES

Capital and reserves

Capital: A 40000

B 120000

C 80000

General reserves 32000

272000

Current liabilities

Trade debtors 48000

Bank 12000 60000

Total equity and liabilities 332000

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A, B &C share profits and losses in the ratio of 5:3:2 respectively. The partners decide to
dissolve the partnership on 1 January 2011

The assets are sold and the proceeds divided among the partners at the end of each month
in such a way that it will not be necessary for any partner to repay amounts which he has
already received.

Realization of assets

Date Assets Carrying amounts Cash

15/1/2001 Inventory 80000 48000

31/1/2001 sundry debtors 124000 120000

28/2/2001 remaining assets ? 64000

The partnership was bound by a contract to pay a rental of $3200 for the building each
month up to the end of 31 may 2011. The lessor agreed to accept three months notice with
effect from 31 December 2010 on condition that new tenants could be found. The partners
were informed on 2 February that new tenants would move into the premises from 1 April
2011. The partners complied strictly with the conditions of the amended lease.

All creditors were paid within 30 days of the date of statement after a 2% rebate had been
granted throughout.

Purchases of inventories during November 2010 amounting to 8000 have still to be

provided for at 31 December 2010. This amount was recovered during January 2011 at a
discount of 2%.

All the partners are solvent and they are all able to pay any deficit that may occur in their
capital accounts as the final settlement.

REQUIRED

Prepare a columnar statement showing the calculations for the distribution of cash among
the partners as well as the capital accounts for the period 1 January 2011 to 28 February
2011 according to the loss absorption capacity method.

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CHAPTER FOUR: TRIAL BALANCE

‘Every debit entry has a corresponding credit entry.’ – is the main principle of the double-
entry system of accounting.

4.0 INTRODUCTION
Hence if there are no errors, then the total debit balances and total credit balances of all the
ledger accounts of a company should be equal.

Before preparing its financial statements, a company should check the arithmetical accuracy
of its accounting records.

A list of all the ledger accounts and their respective balances as at a specified point is called
a trial balance.

A trial balance ensures the arithmetical accuracy of the accounting records. If the trial
balance does not balance (i.e. debit totals are not equal to credit totals) then it means that
there is definitely an error in the accounts.

These errors need to be determined and rectified before the company can prepare its
financial statements.

However if the totals of both sides of the trial balance equal each other, it does not
automatically mean that there are no errors. This is because there could be compensating
errors.

Preparation of financial statements is the main object of the entire accounting exercise. The
importance of the trial balance stems from the fact that financial statements cannot be
prepared without a trial balance.

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A trial balance is the summary of all the ledger account balances at a particular point in
time.

Under the double entry system of accounting, every debit has a corresponding credit and
vice-versa. This means that the total of the debit balances of all accounts in the ledger must
equal the total of all credit balances.

Though it has debit and credit columns, the trial balance is a statement, not a ledger
account. It is prepared periodically, usually at the end of every reporting period. Note that,
the trial balance is not a part of the financial statements.

4.1 PURPOSE OF A TRIAL BALANCE

After preparing all required ledgers, a trial balance is prepared, to list out at one place, the
balances of all the ledger accounts. This helps the accountant to check the arithmetic
accuracy of accounting.

When preparing a trial balance, the debit and credit balances for each ledger account are
totalled. If the totals of the debit column and the credit column of the trial balance do not
balance, we know at once that there is some error in the ledger balance.

The fact that the trial balance agrees is a preliminary assurance that there are no
mathematical / arithmetic errors in the preparation of the accounts.

Checking for mathematical / arithmetical accuracy is the primary purpose of the trial
balance. However, because a trial balance presents the ledger account balances in a readily
available format it is often used to prepare the financial statements.
A trial balance is prepared in order to -
1. confirm the arithmetical accuracy of the ledger accounts
2. help in locating errors
3. provide a basis for preparing the financial statements

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Relationship of the trial balance with the accounting cycle

The entire accounting exercise is summarised below:
1. Transactions are identified and recorded in day books (journal, sales book, purchase
book, cash book, etc.).
2. Transactions are recorded from day books to ledger accounts.
3. A trial balance is prepared from the ledger accounts. It is a list of the balances of all ledger
accounts where total debits = total credits.
4. A trial balance contains
- Ledger balances that affect the SOCI – balance of expense accounts and income
accounts
- Ledger balances that affect the SOFP– balance of asset accounts and liability
accounts
5. Balances that affect the SOCI are recorded in it and profit earned or loss incurred during
the period is determined.
6. Balances that affect the SOFP along with the profit or loss determined by the SOCI are
recorded in it.
7. The asset and liability side of the SOFP is totalled. The total of the assets side should be
equal to the total of the liabilities side.

4.2 THE LIMITATIONS OF A TRIAL BALANCE.

The fact that the trial balance balances is a preliminary assurance that the accounts are free
from any mathematical / arithmetic errors. However it is not conclusive proof of the
absence of errors. It only shows arithmetical accuracy i.e. every debit has been provided a
corresponding credit.

Therefore, even if the totals of the debit column and the credit column agree, certain errors
may remain unnoticed. Such errors are:
1. Errors of omission: these are errors caused by failure to record a transaction.
2. Errors of commission: these are errors caused due to incorrect recording of a transaction
in the day book, from day books to ledger, inaccurate totalling/ balancing etc.

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3. Errors of principle: these include the types of errors which result from the violation of
fundamental principles of accountancy e.g. capital expenditure treated as revenue
expenditure and vice-versa.
4. Compensating errors: when two or more errors are committed in such a way that the net
effect of these errors on the debit and credit of accounts is nil,.

Similarly, if items were incorrectly analysed in the ledger account or posted to the incorrect
account, the trial balance will not identify this.

Therefore, even when a trial balance agrees, there is always a chance for hidden errors
which can be revealed only after a thorough scrutiny of the accounts.

A trial balance is not a financial statement. It does not reflect the financial position of a
company.

A trial balance does not explain the financial position and performance of the entity. To
enable us to understand and interpret the financial data, other financial statements e.g. the
SOCI and the SOFP are prepared using the trial balance as their source of information.

4.3 CORRECTION OF ERRORS

It is rightly said that “to err is human”. As a result, there is plenty of scope for errors to
creep into any accounting exercise.
There are about two types of errors:
- Errors that can be highlighted by the extraction of the trial balance – the debit and
credit column of the trial balance are not equal when these errors exist
- Errors that cannot be highlighted by the extraction of the trial balance – the debit
and credit column of the trial balance will balance inspite of these errors

The trial balance is prepared to check the arithmetical accuracy of the accounts. If the trial
balance does not balance, it implies that there are arithmetical errors in the accounts which
require detection and correction.

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Even if the trial balance agrees, there may still be errors.

From the point of view of correction, errors are classified into two types:

4.3.1 ERRORS THAT CANNOT BE HIGHLIGHTED BY PREPARING A TRIAL

BALANCE
(Also known as errors that do not affect the agreement of a trial balance).
The main purpose of the trial balance is to ensure that double entry book keeping has been
followed correctly and that debits = credits. If using a manual system, it is possible to post
just one side of the entry or even to write in an incorrect amount. The trial balance will
highlight this if it occurs, as debits will not equal credits.

While it is simple to identify that an error has been made, there is often a long and difficult
task of cross checking balances to find out where the error is!

When the totals of debits and credits are equal in a trial balance, this does not assure the
correctness of accounting. There may still be errors, which do not create a difference in the
debit and credit totals of a trial balance. These errors distort the financial statements, but
the trial balance total of debits and credits is equal.

These errors are difficult to detect compared to those errors that affect the agreement of
the trial balance.
1. Error of omission to record
Under this type of error, a transaction is completely omitted in the financial records.

2. Error of commission
These are basically the clerical errors committed at the time of recording and / or posting
the transactions. This includes errors such as the recording of a transaction to the wrong
account or recording a transaction with the wrong amount.

3. Error of principle
Errors of principle are errors resulting from the violation of generally accepted accounting
principles.
4. Compensating error

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Under this type of error, two errors are committed, in such a way that the total debits
remain equal to the total credits in the trial balance.

5. Errors of prime entry

Under this type of error, the error is committed while recording the transaction from the
source document to the books of prime entry.

6. Complete reversal of entry

Under this type of error a transaction is recorded in exactly the reverse manner.

4.3.2. ERRORS WHICH WOULD BE HIGHLIGHTED BY THE EXTRACTION OF A

TRIAL BALANCE.
(Also known as errors that affect the agreement of a trial balance).

Under the double entry book keeping system, we record the two effects of all transactions
as debits and credits.

Hence the trial balance totals of debits and credits are equal. Whenever the total of all
debits and credits do not match, it means that there is an error in accounting. Common
errors of this kind are:
- Casting error
- Over-casting
- Under-casting
- Posting error
- Posting to the wrong amount
- Omission to post either credit or debit entry
- Posting to wrong side of correct ledger
- Wrong carry over to trial balance
- Transposition errors
Each of these will be looked at in turn.

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4.3.3 CORRECTION OF ERRORS

Correcting the errors that can be highlighted by extraction of a trial balance
Errors can be rectified by passing correct journal entries and recording them in the ledgers.

A suspense account is used to rectify these errors.

Correcting the errors that cannot be highlighted by extraction of a trial balance

These errors do not affect the balancing of the trial balance. In other words, in spite of these
errors, the trial balance will show debit totals = credit totals. Hence, we need to make
journal entries to correct these errors.

4.4 CONTROL ACCOUNTS AND RECONCILIATIONS

There is another method of maintaining total payables and receivables accounts using
‘control accounts’.

In large companies where customers and suppliers are large in number it is not sensible to
include all the customer accounts in the nominal ledger. The nominal ledger will become too
big! The way out is to have just one account called the receivable control account for all the
receivables, and one account called the payables control account for all the payables.

The individual receivable ledger accounts and the individual payable ledger accounts for
individual customers and suppliers are maintained separately. Only the total of the debits
and credits of these individual accounts are posted in the control accounts.

This serves a dual purpose. The nominal ledger does not become too bulky and one can
have an effective control on the individual receivables and payables account as well.

A Control Account is an account maintained in the general ledger that records only the total
value of different subsidiary ledgers.

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In a normal business there may be hundreds of individual accounts, and innumerable

transactions and under such circumstance it would be very difficult not to make an error!

Even the most careful accountant would make an error – for example a mathematical error,
error of transposition, omission etc.

To make it easier for the accountant a control account is prepared.

4.4.1 PURPOSE OF CONTROL ACCOUNTS

A control account keeps a record of the total sales and the total receipts from customers. It
keeps the general ledger free of details, yet has the correct balance for the financial
statements.

For example, for the accounts in the receivable ledger, we can have a receivable control
account. This account is updated with the following information for a period
- total collections
- total credit sales
- total returns and
- total discounts etc
The period for which the information is recorded is decided keeping in mind the number of
transactions and the requirements of the entity. The period can range from a day to a year.

The details about each customer and each transaction will not be recorded in the receivable
control account.

These details will be recorded in the receivable subsidiary ledger.

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4.4.2 RECEIVABLES CONTROL ACCOUNT AND INDIVIDUAL RECEIVABLE

(CUSTOMER) ACCOUNT

After all the postings to the receivable control account are completed; the total of the
individual customer balances = the balance in the receivable control account (in the
receivable subsidiary ledger).

If the total of the individual customer balances does not equal the balance in the receivable
control account (in the receivable subsidiary ledger) then it means that there is some error
in the customers’ accounts in the receivable ledger.

These amounts will be reflected in receivables control account

The benefits of preparing control accounts are:
1. They provide a mathematical check on the accuracy of the individual ledger accounts. If
the total of the individual accounts within the ledger account do not agree with the balance
of the respective control account, this denotes the existence of an error which needs to be
identified and corrected.
2. Control accounts can be prepared quickly to provide the total outstanding balance in
customers’ and suppliers’ accounts, without having to add up all the individual accounts. As
a result, the control account is often used as the account for double entry, and the
individual ledger accounts are maintained as memorandum accounts. This is explained in
detail in the next learning outcome.
3. If control account reconciliations are prepared on a regular basis they can be used to
locate the errors.
Regular reconciliations will reduce the amount of data you need to check in order to identify
the discrepancies.
4. In a large company, one person may not post all the transactions. E.g. purchase invoices
are posted by the purchases ledger clerk and cash payments are posted by the cashier. The
control account provides an internal check to ensure that all entries are being correctly
posted.

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Receivables control account is also known as total receivables account or sales ledger
control account.

Payables control account is also known as total payables account or purchases ledger
control account.

A transaction is first recorded in the books of prime entry and then posted to respective
ledger accounts.

The control accounts are prepared from the books of prime entry as summaries of a group
of accounts.
The totals posted in a control account should agree with the total of all the individual
accounts in that group.

One must perform reconciliations on a regular basis to ensure this relationship holds true.
Any errors or discrepancies must be investigated and resolved.

As discussed, if the control accounts are maintained, these accounts are used for double
entry purposes. The individual payables ledgers become memorandum books of accounts
i.e. additional books of accounts which do not form part of a double entry book keeping
system. In the trial balance only one figure of total payables will be taken, that of the ledger
control account.

4.4.3 RECONCILIATION OF CONTROL ACCOUNT TO LEDGER ACCOUNTS

The closing total of all individual accounts in the payables ledger account should be equal
to the balance in payables control account.

In a trial balance, the closing total of the payables or receivables control account will be
taken. The customer’s or supplier’s closing balances will not be taken to the trial balance.
These individual accounts do not form part of the double entry book keeping system, but
are memorandum accounts.

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The word ‘reconcile’ means to settle, make consistent or agree. In accounting, the term
reconciliation means to agree the discrepancies between two balances.

While preparing control account reconciliations for receivables and payables accounts the
two balances which have to be reconciled are:
- Closing balance in receivables / payables control account
- Total of all individual ledger account balances in receivables / payables ledger

These two balances must agree with each other. If they do not agree, then there are errors
in the accounting exercise. In the reconciliation process we locate the errors and rectify
them. After rectification of the errors the two balances have to agree with each other.

4.4.3.1 HOW TO RECONCILE

Stage 1: the first stage is to locate any errors / omissions in the preparation or total of
ledger balances and control accounts.
The following errors can be identified by performing control account reconciliation:
Possible errors in maintaining control accounts
ERROR SOLUTION

1. posting incorrect amount to control post rectification accounting entry

account due to miscast of totals in the
books of prime entry
2. transactions omitted in control account post rectification accounting entry
but recorded in ledger accounts
3. transactions omitted in ledger accounts rectify the ledger accounts
but recorded in control account
4. recording / casting errors in control post rectification accounting entry
account
5. recording / casting errors in ledger rectify the ledger accounts
account
6. “exclusion of customer’s / supplier’s “include the customer’s / supplier’s

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account” in the list of ledger accounts balance” in the “list of total customers /
suppliers’ balances”

It is impossible to give a full and complete list of every error that a person can make when
posting entries to the control account and recording items in the individual ledger. Put
simply, a person can record the wrong amount, fail to record a transaction, incorrectly enter
a debit as a credit or simply just take wrong totals.

However, it is important to remember that if an item is incorrectly entered in the wrong

individual ledger account (i.e. an error of commission), but the value is correct; no error will
be identified in the control account reconciliation. Remember, a reconciled control account
does not guarantee that there are no errors, but it does reduce the number and type of
errors that may be embedded within the financial statements.

Stage 2: the next stage is to rectify the errors / omissions located in stage one
When an error is made, it must be rectified. The method required, will depend on the type
of error made. Not all errors will require a journal entry.

Stage 3: reconciliation
If all the errors \ omissions in the memorandum ledger accounts and control accounts are
rectified correctly then the total of the ledger balances must agree with the control account
balance.

Limitations of control accounts

- Complex: the system is complex and there is some duplication of work.
- Does not identify all errors
- Maintaining control accounts requires additional recording which can increase both
time consumption and costs. Many small businesses may find this additional
recording a burden, and difficult to maintain.

QUESTION 1

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Balances on customers accounts at 01 August 2012

Debit: $41 580

Credit: $600

Balances on suppliers accounts at 01 August 2012 $27 020

Credit sales invoiced during the month $46 950

Invoices for goods purchased during the month $26 380
Contra settlements between suppliiers for credit transactions $750
Cash sales during the month $14 150
Cash paid to suppliers for credit transactions $25 260
Cash discount deducted from payments to suppliers $590
Provision for doubtful debts $950
Customer balances written off as bad debts $450
Goods returned to suppliers $620
Credit notes issued to customers for goods returned $1220
Cash received from credit customers in full settlement of debts $42230
Cash at Bank on 31 August $5100
Debit Balances on suppliers a/c at 31 August $230
Credit balances on customers accounts at 31 August $120

Required:

a) Using such of above data as is relevant,prepare a sales ledger control account and a
purchases ledger control account for the month of March
b) Explain the ways in which control accounts can be used to manage the business.

QUESTION 2

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The following transactions relate to the sales ledger for the year ended 30 April 2010;

Balances on the sales ledger on 01 May 2009 $19 340

Sales $188 216

Receipt on customers $150 750

Discount allowed $4 800

The total of the balances within the ledger at 30 April 2010;

Debit balance $57 006

Credit Balances $300

Investigations reviewed the following;

1. Bad debts written off totalled $2500, although correct entries have been made in the
personal account, no entry had been made in the control account
2. A cheque received from P Tony for $240 had been posted mistakenly to the cash sales in
the General ledger instead of his personal account in the debtors ledger
3. Debts settled by set off against creditors totalled $840
4. A cheque for$4000 from Brown had been returned by the bank because he had
insufficient funds available in his account to meet the cheque. No record of this had
been made when compiling the control accounts, although Brown’s personal account in
the sales ledger had been adjusted.
5. Goods to the value of $1600 had been returned by the customer, but no record of his
had been made
6. A credit balance of $200 had been omitted from the list of balances extracted at year
end
7. The total of the sales shown in the sales day book had been recorded as $5900 instead
of $9500

Required:

a) Prepare the sales ledger control account

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b) Prepare a statement showing the reconciliation of the original total of the sales
ledger balances with the revised control account balances.

QUESTION 3
Black Ltd has a receivable control account balance of $17,500 on 30 June 2010. However,
the total of the customers’ ledger balance is $17,670. Upon investigation, the accountant
finds the following errors:
1. Sales amounting to $1,190 were omitted from the control account.
2. The total of the customers’ memorandum ledger balances was under cast by $420.
3. Discount of $140 allowed to customer Ted, had not been recorded in the control account.
4. A bad debt of $700 had not been recorded in the control account.
5. Cash of $112 was received from customer Jack, but was recorded in his account as $12.
6. A customer account balance had been undercast by $280.
7. Goods of $280 were returned by customer John, but were not entered in the control
account.
8. Cash received of $350 had been debited to Trish’s memorandum ledger account.

Required;
Reconcile
Question 4

The following is a Statement of Financial Position as at 31 December 2011

Statement of Financial Position as at 31 December as at 31 December 2011

NON- CURRENT ASSETS

Premises (at carrying amount) 50 000

Machinery (at carrying amount) 20 000

70 000

CURRENT ASSETS

Inventory 8 800

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Receivables 5 644

Bank 9 800

Cash 1 108

Suspense 448

25 800

Total assets 95 800

CAPITAL AND LIABILITIES

Capital 84 000

Net profit 21 000

105 000

Drawings (16 000)

89 000

CURRENT LIABILITIES

Payables 6 800

95 800

Although the trial balance did not agree and a suspense account was opened, the Statement
of Financial position was prepared. An audit later reviewed the following

1. Sales day book had been over-cast by $400

2. Payment by a receivable of $112 had not been posted to the personal account
3. Discount allowed to Tendai of $30 had been posted to the wrong side of the
account
4. Bank charges of $170 had not been entered in the books
5. Inventory had been under-cast by $2000 on 31 December 2011
6. An invoice for $170 for repairs from Autoworks had been paid by the business and
posted to sundry account
7. Cash of $100 had not been included in the cash balance

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Required:

a. Prepare the necessary journal entries to record the following errors

b. Suspense account
c. Statement to show corrected net profit
d. Amended Statement of Financial Position

QUESTION 5
Munandi Ltd, wholesale fruit and vegetable merchant does not keep a full set of accounting
records. However, the following information has been provided from the business records.

a) Summary of the bank account for the year ended 31 August 2010

$ $

1 Sept 2009 Balance b/d 1 970 Payment to suppliers 72 000

Cash from trade receivables 96 000 Purchase of Motor van (Vtz) 13 000

Sale of private yatch 20 000 Rent and local taxes 2 600

Sale of motor van (Demio) 2 100 Wages 15 100

Motor Vehicle expenses 3 350

Postages and Stationary 1 360

Drawings 9 200

Repairs and renewals 650

Insurances 800

Bal c/d 31 August 2010 2 010

120 070 120 070

1 September 2010 Balance b/d 2 010

b) Assets and Liabilities other than balance at bank

1 Sept 2009 31 Aug 2010

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$ $

Trade accounts payable 4 700 2 590

Trade accounts receivable 7 320 9 500

Rent and Local Taxes accrued 200 260

Motor vans :Demio At cost 10 000

Accumulated depreciation 8 000

: Vitz At cost 13 000

Accumulated depreciation to be
determined

Inventory 4 900 5 900

Insurance prepaid 160 200

c) All receipts are banked and all payments are made from the business bank account.

d) A trade debt of $300 owing by J Ltd and included in trade accounts receivable at 31
August 2010(see b) above),is to be written off as an irrecoverable debt.

e) It is Munandi policy to provide depreciation at the rate of 20% on the cost of motor vans
held at the end of each financial year; no depreciation is provided in the year of sale or
disposal of a motor van.

f) Discounts received during the year ended during the year ended 31 August 2010 from
trade accounts payable amounted to $ 1 100

Required:

a) Prepare Munandi ‘s Statement of Comprehensive for the year ended 31 August 2010

b) Prepare Munandi Statement of Financial Positions for the year ended 31 August
2010

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CHAPTER FIVE: ACCOUNTING FOR NOT- FOR-

PROFIT ORGANISATIONS

5.0 INTRODUCTION
So far you have studied about accounting of the transactions of Business Organizations,
which are profit-making and follow accrual system of accounting.

This chapter seeks to explain the concepts and procedures of accounting followed by not-
for-profit organizations. Not-for-profit organizations follow usually the Cash system of
accounting and partly the Accrual system of accounting and hence, the system is hybrid in
nature or Modified Accrual Accounting.

A not-for-profit organization does not restrict itself from earning surplus from its activities.
Rather such surplus is used for the furtherance of the activities emanating from the
objectives for which the organization was created.

Not-for-profit organizations are those organizations, which operate with the purpose of
achieving the objectives for which they are created and not necessarily for profit motive. It
can be defined as “an entity that provides, without profit, a service beneficial to society and
that has an equity interest that cannot be sold or traded.”

When such addition takes place to the net assets, it is used to implement and enlarge the
services of the organization.

Equity to Not-for-profit organizations is provided by membership contributions, allocations,

contributions, grants or membership solicitations. It is to be noted that this is true only in
case of Non-Governmental Not-for-profit organizations such as clubs, hospitals, colleges,
sports-boards (such as Cricket Control Board), Museums, Temples and Churches.

In case of Not-for-profit organizations in Government sector (Universities, Research

Institutions, Scientific Institutions, Municipal Corporations) do not have equity in the same

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sense as that in the case of commercial enterprises. Since there is no equity in Government
sector, financing is done through tax-collections, surpluses from Public enterprises and
borrowings.

COMMERCIAL ENTITIES
→ PRIMARY MOTIVES is carry on activities and thereby bring financial gain to the owner(s)

→PROPRIETORSHIP or interest of the owner(s) or owners equity represents the proprietors

investment in the business which consists of the original money put into the business plus
the profits not withdrawn
→ RESULT OF ENTITY’S ACTIVITIES is profit, which represents the difference between sales
revenue and other incomes, if any, over the cost of sales and financial charges. The profit
and may either be withdrawn, or retained in the business.

→ ACCOUNTING STATEMENT prepared to serve the information needs of decision makers

include all or some of the following: SOCI
SOFP
SOCE
SOCF
Notes and Disclosures
NOT-FOR-PROFIT ENTITIES
→ PRIMARY MOTIVES is to provide services to the members or to the society at large.
Profits arising out of any trading activities are used to further service objectives.

→ PROPRIETORSHIP or interest of the members is known as Capital Fund or Accumulated

Fund which represents the Accumulated surplus of subscriptions, donations and profits
from trading and social activities over expenses.

→ RESULT OF ENTITY’S ACTIVITIES is the surplus, which represents the excess of revenue
income over revenue expenditure during a period, and indicates the extent of utilization of
incomes for the pursuit of service objects. It increases the Accumulated Fund of the
members and cannot be withdrawn by them.

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→ ACCOUNTING STATEMENTS prepared to serve the information needs of decision makers

include:
(i) Receipt & Payment Account,
(ii) Income & Expenditure Account,
(iii) Statement of Financial Position.

5.2 DISTINCTION BETWEEN NOT-FOR-PROFIT AND COMMERCIAL

ENTITIES
A Not-for-profit organization can be differentiated from a profit seeking organization on the
following basis:
Basis Commercial entity Not-for-Profit entity
1. Primary motive To carry on the activities for To provide services to the
earning profits members or to the public at
large.

Profits earned out of any

trading activities are used to
further the service
objectives.

2. Ownership Proprietors of business are Subscribers to the

owners and hence, entitled membership of the Not-for-
to share the profits. profit entity are called the
members.

3. Distributions of profit. Profits are distributed Profits are not distributed

among the owners. among the members.

4. Result Result of the entity’s Result of the entity’s

activities is called profit, activities is called the
which is the difference surplus, which is the excess

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between sales and other of income over expenses. It

incomes, if any, over the increases the Capital Fund
expenses. and cannot be withdrawn
by the members.
The profit can either be
withdrawn or retained in a The excess of expenses over
business. incomes is called deficit.

Excess of expenses over

incomes is called loss.

5.3 ACCOUNTING FOR NON- GOVERNMENTAL NOT-FOR-PROFIT

ORGANIZATIONS
The Not-for-Profit organization being a different type of entity necessitates a different type
of accounting treatment. This need arises on account of the type of information required to
be generated to support the various decisions of the management. Besides, their funding
pattern is also different as these entities receive money from members and other agencies
to promote their activities, which is usually not in the case of business enterprises.

All the accounts are compiled at the end of the financial year and presented in the form of
following statements:
1. Receipt and payment account (also known as Receipt and Disbursement account) stating
the actual receipts and payments made during the year.
This includes for revenue receipts and payments.
2. Statement of Activities
3. Statement of Financial Position

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5.3.1 RECEIPT AND PAYMENT ACCOUNT

Receipt and Payment account is a similar to cashbook; therefore it serves the purpose of
cashbook. Proper classification of receipts and payments help in differentiating receipt of
capital nature and revenue nature and of the expenses.

Apart from this, it indicates the opening and closing balance of cash. Such a classification
can help in the preparation of cashbook from the receipt and payment account. It is also
called Receipt and Disbursement Account. The Receipt and Payment Account is generally
presented horizontally (in T format) with cash receipts on the left hand or debit side

5.3.1.1 PREPARATION OF RECEIPT AND PAYMENT ACCOUNT

Receipt and payment account is prepared by keeping in view the following points:
1. This account starts with the opening balance of cash in hand and cash at bank. Cash in
hand always have a debit balance and, therefore, appears on the debit side. Cash at bank
have either a debit or favourable balance or a credit (overdraft) or on favourable balance. If
it has a favourable balance (debit balance) it will be shown on the debit side and an
overdraft (credit balance) will be shown on the credit side.

2. All cash collections made during the accounting year as shown on the receipts or debit
side and all cash payment made during the year as shown on the payments (credit) side. The
period to which the transactions may belong (i.e. previous year (s), current year or future
years (s)) and the nature of the transaction, (whether capital or revenue) is recorded on the
debit side. For example the payment of rent, (revenue item) outstanding rent or prepaid
rent will be shown on the credit side. Similarly, the payment for the purchase of furniture
(capital item) will also be shown on the credit side.

3. Only actual receipt of cash and payment of cash are recorded. All non-cash items such as
outstanding expenses, depreciation on fixed assets and accrued incomes do not form the
part of the Receipts and Payments account.
4. The Receipts and Payments account is balanced at the end of the accounting year to show
the closing balance of cash in hand and at bank or bank overdraft, as the case may be. The
format of the Receipt and Payment Account is as given below:
Receipt and Payment Account

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Receipts Amount Payments Amount

Donations xxx Salary xxx
Locker Room Rent xxx Wages xxx
Cloak Rent xxx Honorarium xxx
Hall Rent xxx Rent xxx
Sale of old news papers xxx Taxes xxx
and magazines xxx Insurance xxx
Sale of refreshments xxx Electric Changes xxx
Profit from anciliary activities xxx Printing xxx
Life membership xxx Postage and Stationary xxx
Tournament Fund xxx Repairs xxx
Subscriptions xxx Refreshments purchased xxx
Admission Fee xxx Conveyance xxx
Specific Donations xxx Tournament xxx
Grants xxx Interest on Loan xxx
Loan Obtained xxx Interest on Bank xxx
Sale of Investments xxx Overdraft xxx

Sale of Fixed Assets xxx Building xxx

Furniture xxx
Office Equipment xxx
Books xxx
Sports Goods xxx
Sports Equipment xxx
Investments xxx
Loan Advanced xxx
Fixed Deposit xxx
Balance c/f xxx

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5.3.1.2 USES OF RECEIPT AND PAYMENT ACCOUNT

On the basis of accounting system adopted by an organization the Receipt and Payment
account can be used in two alternative ways.
i. Those organizations, which follow cash basis of accounting, this account plays a vital role.
On the one hand, it serves the purpose of cashbook, while on the other hand it provides
support in the preparation of financial statements, income statement, and statement of
affairs to be presented to the members at the year-end as a result of the enterprise’s
activities. In such a case, the surplus will be the difference of receipts and payments. When
payments will be more than receipts then it will be a situation of deficit.
ii. In organizations using accrual basis of accounting the Receipt and Payment account works
as a summarized cashbook and is a supplement to the Statement of Activities and the
Balance Sheet. These are the basic statements presented to the members to show surplus
or deficit and the financial position respectively.

QUESTION 1
Membership subscription received by Modern Cricket Club during the year 2011 amounted
to $15,600, which includes $ 900 received in arrears for the year 2010 and $1,200 received
in advance for 2012.

It is found that $2,500 has not been received as subscription for the current year (2011) and
that $1,000 was received in advance in 2010 as subscription for 2011.
Required:
Calculate the income from subscription for the year 2011.

Solution: $
Amount collected for subscription in cash. 15,600
Add subscriptions received in 2010 for 2011 1,000
Add subscriptions receivable in 2011 not yet received 2,500
________
18,100
Less subscriptions received in arrears for 2010 900
Subscriptions received in advanced for 2012 1,200

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2,100
Income from subscriptions to be transferred to Statement of Activities 17000

In the above illustration the total subscription of the current year have been worked out by
doing additions subtractions of the items of information to the subscriptions received in
cash during the current year. The total amount of subscriptions due for the current year can
also be prepared by preparing subscriptions account as has been illustrated in the Questions
given below:

QUESTION 2
$51 500 subscriptions were received by NUST Athletics Club during the year 2011, which
includes $ 1,500 received in arrears for the year 2010 and $2,500 received in advance for
the year 2012. It is found that $3000 has not been received as subscriptions for the current
year and that $ 1,800 was received in advance in the 2010 for the year 2011. Find out the
income from subscriptions for the year 2011 by preparing a subscription account.

Dr. Subscription Account Cr.

Date Particulars Amount Date Particulars Amount
$. $
1 Bal b/f Arriers 1,500 subscription received 51,500
Advance 2,500 Advance b/d 1,800
I &E 52,300 Arriers c/d 3,000
56,300 56,300

QUESTION 3
With the help of the following information extracted from the books of NUST Club, Calculate
Sub-scriptions for the Current Year, 2011. Subscriptions received during the year $50,000
Additional Information
Year 2010 Year 2011
$. $.
Outstanding Subscription 3,700 4,200

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Advance Subscriptions 3,900 5,000

QUESTION 4

From the following particulars relating to Golden Gim, prepare a Receipts and Payments
account for the year ending 31st March 2012.
$
Sale of old sports materials 1,200
Donation received for pavilion 4,600
Opening cash balance 8 200
Rent paid 3,000
Sports materials purchased 4,800
Purchase of refreshments 600
Subscriptions collected for: 2009 500
2010 7,600
2011 900
Expenses for maintenance of tennis court 2,000
Salary paid. 9,000
Tournament expenses 2,500
Furniture purchased 1,500
Office expenses 1,200
Sale of refreshments 1,000
Closing cash in hand 400
Entrance fees received 1,000

5.3.2 STATEMENT OF ACTIVITIES (STATEMENT OF ACTIVITIES)

The Statement of activities is a revenue account of a Not-for-Profit entity, like a charitable or
cultural society, educational institutions, hospitals, sports club etc. It is a type of income
statement similar to The Statement of Comprehensive income of other business
organizations.

The Statement of Activities is prepared on the basis of some principles, which are

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applicable in the preparation of profit and loss account. Fund based expenses are first
matched against the income arising/ accrued from the same fund.

5.3.2.1 PREPARATION OF STATEMENT OF ACTIVITIES

(i) This account is generally prepared in a vertical form where in incomes are first shown and
added up. There after, the expenditures are presented and added up. From the totals of the
income s the totals of expenditure are deducted to ascertain surplus or deficit
(ii) It can also be prepared in ‘T’ form with revenue expenditure on the debit side (left hand
side) and revenue income on the credit side (right hand side).

5.3.2.2 DIFFERENCE BETWEEN RECEIPT AND PAYMENT ACCOUNT AND

STATEMENT OF ACTIVITIES
Basis Receipt and Payment Statement of Activities
Account
1. Assets v/s Revenue It is a summary of the cash It is the revenue account of
transactions of a not-for- a not -for –profit
profit organization showing organization similar to
cash inflows (Receipt) on Statement of
the debit side and cash out Comprehensive Income of a
flows (Payments) a the profit seeking organization.
credit side as in case of a Incomes are shown on the
cash book. credit side and expenditure
on the debit side.

2. Opening balance It starts with an opening It does not start with any
balance of cash in hand and balance.
cash at bank.

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3. Capital v/s Revenue Capital receipt and payment Capital receipts and
in cash are included in this payments are excluded from
account. this account only.

4. Cash v/s Non-cash Revenue receipts and Revenue receipts and

payments in cash are also payments in cash
included in this account. concerning the current year
Non-cash expenses such as are also shown in this
depreciation on fixed assets; account and hence capital
bad debts, provisions etc. receipt is
are not included in this excluded.
account.
Non-cash expenses relating
to the current accounting
year are also included in this
account.

5 Cash balance v/s Surplus/ The closing balance of this The closing balance of this
deficit account represent the account excess of income
closing cash in hand and at over expenditure i.e.
bank or bank overdraft. surplus. When expenditure
is more than income the
difference
is called deficit.

5.3.2.3 DIFFERENCE BETWEEN STATEMENT OF ACTIVITIES AND STATEMENT

OF COMPREHENSIVE INCOME
Though Statement of Activities and Statement of Comprehensive Income are seems to be
similar still they differentiate on the following grounds:
● Type of organizations
● End results

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● Sharing surplus and profit

No. Statement of Activities Statement of Comprehensive Income

1. It is presented to ascertain the It is prepared to ascertain the net profit
amount of surplus or deficit as a earned which will be paid out to the
result of the not-for-profit entity’s proprietors, partners, or shareholders, as
activities. the case may be, or retained in the
business.

2. The surplus always increases the The net profit obtained belongs to the
capital fund of the entity and can owner(s) who may withdrawn it or retain
be used for further enhancing the in the business.
objectives of the organization. It
can never be distributed among
the members in any form.

5.3.2.4 ACCOUNTING TREATMENT FOR SPECIAL ITEMS

Donations
Donations may have been raised either for meeting some revenue or capital expenditure;
those intended for the first mentioned purpose are credited directly to the Statement of
Activities but others, if the donors have declared their specific intention, are credited to
special fund account and in the absence thereof, to the Capital Fund Account.

If any investments are purchased out of a special fund or an asset is acquired therefrom,
these are disclosed separately. Any income received from such investments or any
donations collected for a special purpose are credited to an account indicating the purpose
and correspondingly the expenditure incurred in carrying out the purpose of the fund is
debited to this account.

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The term "Fund" is strictly applicable to the amounts collected for a special purpose when
these are invested, e.g. Scholarship Fund, Prize Fund etc. In other cases, when the amounts
collected are not invested in securities or assets distinguishable from those belonging to the
institution, the word "Account" is more appropriate e.g. Building Account, Tournament
Account etc.

QUESTION 5
Miscellaneous expenses actually paid during the year, 2011 amounted to $12,650.
Information about prepaid and outstanding expenses is as under:
$.
Prepaid expenses on 31.12.2010 1,500
Expenses Outstanding on 31.12.2010 2,300
Expenses Outstanding on 31.12.2011 2,500
Prepaid Expenses on 31.12.2011 1,400
Required:
Ascertain the amount of expenses, which will be debited to the Statement of Activities for
the year, 2011.

QUESTION 6
From the following particulars of Youth Sports Club, prepare the Statement of Activities for
the year ending 31 March 2012
Subscriptions collected (including $2,000 for 2011 and $ 1,500 for 2003) 30,000
Subscriptions due but not received in 2012 3,000
Salary paid (including $300 for 2011 4,500
Salary outstanding for 2012 400
Donations received 1,000
Entrance fees (of which 40 percent is to be treated as capital receipt) 2,000
Entertainment expense 600
Tournament expense 1,500
Rent 1,800
Printing, postage and stationary 1,200

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Purchase of sports equipment 5,000

QUESTION 7
The following is the Receipts and Payments Account of NUST Club for the year ended 31st
March, 2012:
Receipts $. Payments $.
Opening balance (1.4.2011) 89 100 Sports materials 304 500
Salaries 315 000
Equipment purchased on 1.10.2010 60 000
Subscriptions: Bank on 31.3.2012 150 000
For the year 2010-11 18 000 Rent 148 500
For the year 2011-12 963 000 Ground maintenance 22 120
For the year 2012-13 4 500 Insurance 38 400
Interest on bank Stationery 3 450
Fixed deposits @10% 45 000 Sundry expenses 5 880
Closing balance as on 31.3.2012 71 750
1 119 600 1 119 600
The following additional information is provided to you:
i. The club has 220 members. The annual subscription is $4 500 per member.
ii. Depreciation to be provided on furniture at 10% p.a. and on sports equipment at
15% p.a.
iii. On 31st March, 2012 , stock of sports material in hand (after members use during
the year) is valued at $78 000 and stock of stationery at $3 150.
iv. Rent for 1 month is outstanding.
v. Unexpired insurance amounts to $9 600.
vi. On 31st March, 2011 the club had the following assets:
 Furniture $270 000
 Sports equipment $180 000
 Bank $450 000
 Stock of stationery $1 500
 Stock of sports material $73 500

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 Unexpired insurance $8 400

 Subscription in arrear $22 500
Note: There was no liability on 31.3.2011.

Required :
a. Statement of Activities and
b. Statement of Financial Position as at 31st March, 2012.

Question 8
The following is the Receipts and Payments Account of NUST Sports Club for the year ended
31st March, 2012:
Receipts Amount ($.) Payments Amount ($.)
Opening balance: 13 850 Salaries 120 000
Subscription received 202 750 Creditors 1 520 000
Entrance donation 100 000 Printing and stationery 70 000
Interest received 58 000 Postage 40 000
Sale of fixed assets 8 000 Telephone and fax 52 000
Miscellaneous income 9 000 Repairs and maintenance 48 000
Receipts at coffee room 1 070 000 Glass and table linen 12 000
Swimming pool 80 000 Crockery and cutlery 14 000
Wines and spirits 510000 Membership fees 4 000
Tennis court 102 000 Garden upkeep 8 000
Insurance 5 000
Electricity 28 000
Closing balance: 232 600
2 153 600 2 153 600
The following additional information is provided to you:
i. Assets and liabilities as on 31.3.2012 were as follows:
$.
Non-current assets 500 000
Inventory 380 000
Investment in 12% Government securities 500 000

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Outstanding subscription 12 000

Gratuity fund 150 000
Prepaid insurance 1 000
Sundry creditors 112 000
Subscription received in advance 15 000
Entrance donation received pending membership 100 000

ii. Subscription received in advance as on 31.3.11 was $18,000.

iii. Outstanding subscription as on 31.3.12 was $7 000.
iv. Outstanding expenses as on 31.3.12 are:
Salaries : $.8 000
Electricity : $15 000
v. 50% of the entrance donation was to be capitalized. There was no pending
membership as on 31.3.12.
vi. The cost of assets sold as on 1.4.11 was $10 000.
vii. Depreciation was provided @ 10% p.a. on fixed assets on written down value basis.
viii. A sum of $20,000 received in October, 2011 as entrance donation from an applicant
was to be refunded, as he has not fulfilled the requisite membership qualification.
The refund was made on 3.6.12.
ix. Purchases made during the year 2011-12 amounted to $1 500 000.
x. The value of closing stock as on 31.3.12 was $210 000.
xi. The Club as a matter of policy charges off to Income and Expenditure account, all
purchases made on account of crockery, cutlery, glass and linen in the year of
purchase.
Required:
a. Statement of Activities for the year ended 31st March, 2012.
b. Statement of Financial Position as on 31st March, 2012.

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QUESTION 9
The following information is available for Nust Tennis Club for the year ended 31 March
2009.

1. Cash received during the year:

$

Membership fees 12 300

Sale of tennis balls 2 400

Hiring out of tennis courts 4 020

Sale of refreshments 10 500

Entrance fees 300

2. Cash payments for the year:

$

Wages 4 500

Purchases of refreshments 8 700

Purchases of tennis balls 2 100

Repairs to the tennis courts 1 260

Construction of the tennis courts 9 000

Nets purchased 2 100

3. Current assets and current liabilities as at:

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31 March 2008 31 March 2009

$ $

Cash in the bank 6 900 8 760

Inventories: tennis balls 540 960

Refreshments 600 780

Payables for refreshments 480 660

Membership fees receivables 720 600

Membership fees received in advance - 300

4. The carrying amount of the tennis courts was $ 21 000 on 31 March 2008. The new
tennis court was completed on 30 September 2008. Depreciation at 10% per annum
on carrying amount must still provided for.

5. The nets were purchased on 1 April 2008. The carrying amount of the old nets was $
1 200 on that date. Depreciation must be written off at 20% per annum on carrying
amount of the nets.

6. Entrance fees should be capitalized.

Required:

a) Prepare the Statement of Activities for the year ended 31 March 2009.
b) Prepare the statement of financial position as at 31 March 2009.

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THE END

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