FINANCIAL ACCOUNTING (BBA/ BAF/ BCS/ BHRM)/ 106/ 107 / 206

UNIT 1-Explaining the nature and purpose of Accounting

1.1 Nature and purpose of Accounting
What is Accounting?
 Accounting is the language of business. It describes the various transactions
entered into by all kinds of organizations ( both profit and non- profit making
entities)
 As a language it serves as a means to communicate matters relating to various
aspects of business operations.
 As the individual business enterprises keep their accounting records separately,
the offer to communicate is essentially from a business enterprise to various
individuals, groups and institutions that have interest in the operations and results
of that enterprise.

1.2 Definition of the term ‘Accounting’

 Accounting is the process of identifying, measuring and communicating financial
information about an entity to permit informed judgements and decisions by users
of information( Pauline Weetman- 1999)
 Accounting is a set of techniques to record, analyze and summaries the
transactions of a business or other entity so as to provide information to assist the
management or owners of the entity to efficiently and effectively manage that
entity.
 Accounting is the process of collecting, recording, summarizing and
communicating relevant financial information to interested parties.
 Accounting is a system meant for measuring business activities , processing of
information into reports and making the findings available to decision makers.

1.3 Branches of Accounting

 Financial Accounting- It is the process of identifying, measuring, and recording.
Classifying, summarizing. analyzing, interpreting and communicating the financial
transactions and events of an entity/ enterprise. The purpose of this branch of
accounting is to maintain systematic records to ascertain financial performance and
financial position and to communicate the accounting information to both internal and
external parties of an enterprise.
 Cost Accounting – It is the process of accounting and controlling the cost of a
product, operation or function directly related to an enterprise. The purpose of this
branch of accounting is to ascertain the cost, to control the cost and communicate this
information for decision- making. Cost accounting information is used internally

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 (within the organization) by management at various levels to make appropriate
decisions about any area of activity that falls under their jurisdiction.
 Management accounting- this is the application of accounting techniques for
providing information designed to help all levels of management in planning and
controlling the activities of the business enterprise and in decision- making. The
purpose of this branch of accounting is to supply any and all information that
management may need in taking decisions and to evaluate the impact of its decisions
and actions. Management accounting is not only confined to the area of cost
accounting but also covers other areas such as capital expenditure decisions (Capital
Budgeting), Capital structure decision (Proportions of Equity and Debt in financing
the entity), and dividend decision.
Management accounting information is used internally within the organization by
management at different levels.
 Social Responsibility Accounting- It is the process of identifying, measuring
and communicating the social effects of business decisions to permit informed
judgement and decisions by the users of information. It is accounting for social
responsibility (SR) aspects of the enterprise.
Main differences between Financial Accounting and Management
Accounting
FINANCIAL ACCOPUNTING VS MANAGEMENT ACCOUNTING
Basis of Distinction Financial Accounting Management
Accounting
Primary user Outside parties and Business manager
manager of ( Internal )
business( External &
Internal)
Decision criterion Accounts are based on Comparison of costs
generally accepted and benefits of proposed
accounting principles action
Behavioral implications Concern about adequacy Concern about ho
of disclosure. reports will affect
Behavioral implications employee.
are secondary
Time focus Past orientation Future orientation
Reports Summary reports Detailed reports on the
regarding the whole parts of the entity.
entity

Source : Horngren, Harrison , and Robinson , Financial and Management

Accounting, Prentice Hall ,New Jersey,1994

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  Financial Accounting is the process of identifying, measuring, recording
classifying and summarizing .analyzing, interpreting and communicating
relevant economic information relating to a particular entity to various users to
enable them make economic decisions.
Financial Accounting – is concerned with the following activities:
 Identifying
 Transactions
 Events, directly related to the business.
 Measuring
 Transactions and events that are capable of being measured in monetary
form( money measurement is the basis of their value)
 Recording
 Identified and measured transactions and events are recorded in an orderly
and systematic manner in the books of account. This activity is referred to as
Book- keeping. The method of Book-keeping normally adopted is Double –
Entry Book-keeping system.
 Classifying
 Grouping transactions of similar type in form of accounts (Assets, Liabilities,
Equity, Income and Expenses)

 Summarizing
Preparing appropriate end of year financial statements:
 Income Statement- assess / ascertain financial performance (profitability) of
the enterprise’s activities(disclosing aggregate income earned and total
expenses incurred during the specified accounting period)
 Statement of Financial Position( Balance Sheet)- to ascertain the financial
position of the enterprise as at end of financial year( Disclosing all Assets ,
Liabilities and Equity as at that date)
 Statement of Cash flows- to record inflows and outflows of cash and cash
equivalents during the financial year- to assess the liquidity of the enterprise.
 Analyzing
Establishment of relationship between various items or group of items
taken from financial statements- to identify financial strengths and
weaknesses of the enterprise.
 Interpreting
 Explaining the meaning and significance of the items in the financial
statements.

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  To enable users to make economic decisions out of the alternative courses of
action.

 Communicating
Transmission of the summarized, analyzed and interpreted information to enable
users make appropriate economic decisions.
 Distinction between Book-keeping and Accounting
Book- keeping is a part of accounting and is concerned with record
keeping or maintenance of books of account which is often routine and
clerical in nature. It only covers the following four activities:
i. Identifying the transactions and events
ii. Measuring the identified transactions and events in a
common unit
iii. Recording the identified and measured transactions and
events in Proper Book of Account.
iv. Classifying the recorded transactions and events in
Ledger.
Accounting – it refers to the actual process of preparing and presenting
the accounts. It is the art of putting the academic knowledge of
accountancy into practice.
 Distinction between Accounting and Accountancy
 Although in practice Accountancy and Accounting are used
interchangeably, there is a thin line of demarcation between them.
Accountancy refer to a systematic knowledge of accounting. It explains
why to do and how to do of various aspects of accounting. It tells u why
and how to prepare the books of account and ho to summarize the
accounting information and communicate it to the interested parties.

1.4 Purpose, and Role of Accounting

Purpose of Accounting
The primary purpose of Financial Accounting is that of providing information which
will aid or assist various users make decisions. Thus, the purpose of an accounting
system is to provide fairy simple and accurate information to the users of the system.
As a key user, the business proprietor (owner) want his or her accounting system to
produce answers to the following key questions:
(i) How well has my business done - based on my decisions? (Profitability/
Financial performance)
(ii) What does the business own? (Assets)

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 (iii) What does the business owe to others? (Liabilities)
(iv) What is owed to the business by others? (Debtors)
(v) Does the business have adequate liquid funds to enable it to continue trading
or operating?
The recording – making phase of financial accounting is known as Book-keeping. It
is a vital aspect of financial accounting.
Book-keeping- is the recording of business transactions which involve the transfer of
money or money’s worth to or from the business, as they occur in the appropriate
books of account, whether manually or computerized.
A traditional purpose of accounting has been that of “Stewardship”, which implies
that financial statements are prepared to report events, financial performance and
financial position of the enterprise. Thus in regard, accounting has been viewed as
having a particular role to play in confirming that those who manage a business on
behalf of the owners take good care of all resources entrusted to them and earn a
satisfactory profit for the owner(s) by using those resources prudently.

 The Role of Accounting

Accounting plays an important and useful role by developing the information for
providing answers to many questions by the users of accounting information
Accounting is mainly concerned with the provision of economic information which
will be useful to those that directly (and to some extent indirectly) connected to an
organization. The information provided should be useful in assessing both the
performance of those who manage the organization and the performance and position
of the organization itself. Once these assessments have been carried out by interested
parties, they will be in a position to make appropriate economic decisions concerning
the organization.

1.5 The Scope of Accounting information

 Financial Accounting Statements are presented in monetary terms. This
means that these statements will only include items that are capable of
being expressed in monetary terms (items to which the monetary value
can be attributed)
 Any item, event or transaction that cannot be expressed in monetary
terms, will not find its way in any of the financial statements which are
made available to a variety of users to enable them to make appropriate
economic decisions.

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  Thus, Accounting Statements may cover:
 The Profit earned by a business in a particular period (Financial
performance)
 The assets and liabilities of a business at a particular date
(Financial Position)
 The cost of providing and/ or selling a particular product or a
range of products.
 The cost of running a particular department or division.
 The quantity of a product which must be sold in order for it to
pay its way ( break-even point)
 The amount of cash coming into and leaving the business over a
defined period.
 The expected overdraft requirement of a business at defined
intervals in the future
1.6 The Accounting information system.
Accounting – is viewed as a process by which economic information relating to a
business enterprise is gathered and then communicated to interested parties, referred
to as users.
In practice each entity will develop its own accounting system in a way in which the
management perceive best meet their requirements and those of other users of
accounting information. Common elements underlying any accounting system may
be identified as follows:
 Data collection- involves setting up appropriate procedures that ensure that
relevant economic information is properly identified and captured.
 Data recording- involves ensuring that the data collected is classified and
summarized in a logical and systematic manner.
 Data evaluation- involves the analysis and interpretation of the data collected.
 Reporting- involves shaping the information into reports which will satisfy
 Form of internal reporting (for management) or external reporting ( for
shareholders/ owners and other user groups).
 Thus, - an accounting system is a formal means of gathering data to aid and
co-ordinate collective decisions in light of the overall goals or objectives of
an organization or entity. Having an appropriate accounting system is not
optional. Accurate, up to-date and reliable accounting records are a product
of an appropriate accounting system.

1.7 Usefulness of Accounting information

Generally, it is difficult to assess the impact of accounting information on human
behavior. However, one situation arises where the impact of accounting information
can be observed and measured.

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 The principal purpose of accounting reports (products of the accounting system) is to
influence action that is behavior .It is anticipated that the very process accounting
information as well as the behavior of those who do the accounting will affect the
behavior of others. In short, by its very nature accounting is a behavioral process.

1.8 Users of accounting information

The users of accounting information are individuals, institutions, groups of people
who have an interest in the information disclosed in the financial statements prepared
by the organization. They include:
 Current Shareholders/ Owners
 Directors and Managers
 Employees
 Trade unions
 Customers
 Suppliers
 Financial Institutions( Lenders)
 Government
 Tax Authorities
 Competitors
 Local communities
 Regulatory Agencies
 Financial Analysts/ Advisors
 Potential Investors
 The General Public

USER NEED FOR INFORMATION

Present shareholders /Owners  Participate in distribution of
profit.
 Assess the value of their
investment- shares
 Buy additional shares or
transfer/ sell shares
 Voting rights of shares
 Election of Directors
Directors and Managers  Manage the entities- Business
enterprises , non – business entities
 Plan , control and make decisions
 Accountable to owners
 Perform a stewardship function

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 Employees  Seek economic , social and
psychological satisfaction in places of
work
 Job security.
 Assurance of their remuneration
 Negotiate for improved salaries and
working conditions
 Freedom to join trade unions and
participation in offering their services
through employment contract.
Trade Unions  Recognition as the negotiating agent
of employees
 Opportunity to continue representing
workers in the business.
 Use information disclosed in financial
Statements as basis for negotiating for
their members improved salaries and
working conditions.
Customers  Assurance of product quality and
supply of product or service.
 Suitable warranties
 Facilitation of consumer credit
 Safety use of product.
Suppliers  Continuing source of business
 Timely payment of trade credit
obligations
 Professional relationship in contacting
for, purchasing and receiving goods
and services.
 Assess the creditworthiness of the
business( potential customer)
Lenders  Assess credit worthiness
 Timely payment of interest and
repayment of borrowed funds
 Security of pledged assets( collateral )
 Relative priority in the event of
liquidation ( Bankruptcy)
Governments  Fair and free competition
 Legal obligation for business entities
to obey labor laws , pollution controls
and other laws.
Tax Authorities  Assessment for payment corporation
tax ( income )
 Remit appropriate amount of PAYE,
Property, VAT , Excise taxes .
Competitors  Assess performance of competitors

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  Comply to norms established by the
industry and society for competitive
market for product/ service
Local Communities  Safety of company products
 Safe / health conditions for workers
and fair pay.
 Participation of company in
community affairs- social
responsibility
 Local purchase of reasonable portion
of the local products.
 Favorable impact on environment.
 Avoid pollution of environment.
Regulatory Agencies  For companies listed on the Stock
Exchange – compliance with listing
requirement, reporting requirement
and corporate governance.
 Money market- Regulator Central
Bank- compliance with Financial
Services and Banking Act
 Other regulatory agencies- to ensure
that companies or organizations are
operating within prescribed rules
Financial Analysts and Advisors  Information for their clients about
investment opportunities.
 Information to assess the
creditworthiness of companies issuing
securities ( stock, bonds, debentures
and others)
 Information for readers.
The General Public  Participation in and contribution to the
government process of service
delivery to society as whole ( Good
Corporate Citizenship)
 Create communication between
government and business entities
designed for reciprocal understanding.
 Fair prices for goods and services
offered, and advancement of the state-
of the art in technology which the
product line offers .

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 1.9 Necessity of keeping accurate and proper books of Account
 Accounts have been kept for thousands of years because they help to keep
track of money- by showing where it came from (source) and how it has been
spent.
 The production of accurate accounting information plays a vital role in the
efficient running of the business.
 Managers- who are normally given the responsibility of the day-to-day
running of the business will be compelled to avail the appropriate financial
statements to the owners to enable the owners assess the performance of both
the managers and the business. Good performance of the business is an
indicator that managers’ decisions were right and these managers need to be
rewarded in form of bonuses and other incentives to motivate them.

SELF ASSESSMENT QUESTIONS

1. Identify and briefly explain the three branches of Accounting.
2. Explain the term “Financial Accounting “and briefly explain the
elements of this branch of accounting.
3. Explain the Purpose and Role of Financial Accounting in any Entity.
4. Briefly describe the Scope of Financial Accounting
5. Briefly explain the usefulness of accounting information.
6. Identify the main users accounting information and in each case state
their key interest(s)
7. Differentiate Financial Accounting and Management Accounting.

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 FINANCIAL ACCOUNTING (BBA/ BAF (106) / BCS (107) / (206)/BRAM

UNIT 3 . Explaining the Accounting System and Recording Business transactions

3.1 The Accounting information system

Accounting – is viewed as a process by which economic information relating to a

business enterprise is gathered and then communicated to interested parties, referred to as
users.

In practice each entity will develop its own accounting system in a way the
management perceive best meet their requirements and those of other users of accounting
information. Common elements underlying any accounting system may be identified as
follows:

 Data collection- involves setting up appropriate procedures that ensure that relevant
economic information is properly identified and captured.
 Data recording – involves ensuring that the data collected is classified and summarized in
a logical and systematic manner (Double –entry Book-keeping)
 Data evaluation – involves the analysis and interpretation of the data that has been
collected and recorded.
 Reporting- involves shaping the information into reports which will satisfy internal
reporting (for management) and external reporting ( for shareholders,/ owners, and other
user groups)

Thus the main features of an accounting system and how it helps in providing
information to the business are as follows:

 In a computerized system all information about the business transactions can be quickly
accessed. This will help in decision – making.
 It provides details of transactions of the business in the relevant account.

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  When accounts are closed off the balances for each outstanding account are determined.
This will give the value of assets and liabilities in the business.
 It gives a summary of outstanding balances.
 The summary can then be used for the preparation of Financial Statements.
 Normally the Financial Statements are prepared at regular intervals. Thus the accounting
system will allow the business to obtain the data and also prepare the financial statements
to determine profitability, financial position and liquidity.

3.2 The Accounting Process or Cycle

 Business Transactions

The art of recording business transactions in orderly manner is referred as

book- keeping.

 Business- transaction- Is the act of buying and selling goods/ or services. It

also includes the act of lending or borrowing money.
 There are basically two types of business transactions that you normally
encounter in financial accounting. These are Cash and credit transactions
 Cash transactions- these are transactions that involve the transfer of ownership of
goods or provision of services and payment for such goods or services takes place
immediately. This means the supplier of goods or provider of services is paid
without delay for the goods or services delivered.
 Credit transactions- These involve the transfer of ownership of goods or provision
of services and payment for them is delayed or deferred to a future date. Thus,
goods or services are provided now but payment for them is made a future agreed
date. The time interval between the supply of goods or provision of services and
the payment for the them is referred to as credit period. Credit transactions create
two parties. The supplier of goods or provider of services is referred to as a
creditor. The recipient of goods or services who promises to pay in future is
referred to as a debtor. The debtor owes the creditor. The debtor has a financial
obligation to settle or pay for the goods or services supplied by the creditor in
future, on a specified date.

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  The Accounting Process / Cycle

After identifying and measuring the financial transactions, the Accounting

Process or Cycle begins. This is the complete sequence of accounting activities
beginning with the recording of transactions and ending with the preparation of
end of year financial statements.

 The sequential steps involves in an accounting process or cycle are:

Step 1. Journalizing- Recording the transactions in the Journals or books of

prime entry- as they take place in chronological order (date order)

Step 2- Posting- Transfer the transactions recorded in the journals to the

respective or appropriate accounts opened in the Ledger (Main or Principal
book of account). This is done using the double entry book-keeping system.

Step 3- Balancing – ascertain the difference between the totals of the debit
and credit sides of Ledger account.

Debit side> Credit side = debit balance

Credit side> Debit side = Credit balance

Debi side = Credit side = No balance.

Step 4. Extract a Trial Balance – Prepare a list showing the balances of

each and every account in the ledger to verify whether the sum of debit
balances is equal to the sum of credit balances. If the totals of the two
types of balances are equal , the Trial Balance is said to have balanced.

Step5. Income Statement – prepare Trading , Profit and Loss Account or

Income Statement on accrual basis to ascertain profit or loss of the entity

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 for the accounting period (reporting period). This is in conformity with the
periodicity principle.

When total Incomes earned > Expenses incurred = Net Profit

When total Expenses Incurred > Total incomes earned= Net Loss

 Impact of Net Profit on Accounting Equation

Assets= ( Capital + Net Profit ) + Liabilities

 Impact of Net Loss on Accounting Equation

Assets= (Capital – Net Loss) + Liabilities

Step 6. Statement of Financial Position- Prepare the Balance Sheet or

Statement of Financial position, to ascertain the financial position of the
entity as at the end the accounting or financial period.
The Balance Sheet will show all assets, liabilities and equity as at
the end of the financial year.

Step 7. Statement of CashFlows- Prepare Statement of Cash Flows (as per

IAS 7) for the period, showing, cash inflows and cashflows during
the accounting period to determine the Net Increase or Net decrease in
the cash and cash equivalents for the accounting period.

Step 8. Analyzing and Interpreting- The measurement and evaluation of the

information presented or disclosed in the of year Financial Statements, so
as to assist users of financial statement to make appropriate economic
decisions.

3.3 Necessary books of Account

Various books of account are necessary to record the various transactions of

the business.

 Books of Prime Entry

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 These are books in which transactions are first recorded before being posted
or transferred to the ledger. They form the record of all documented
transactions sent and received by the entity. Entries in these books are made
in chronological order (date order), hence, they sometimes referred to as “
Day Books” or “ Journals”.

 The number of books to be maintained by any business entity or

organization will normally depend on the nature of its business and the
size of the enterprise.
 Key books of account maintained by a fairy sizeable business:
 Purchases Journal or Purchases Day Book- to record transactions
relating to goods bought on credit (Credit purchases)- source document-
Purchases Invoices
 Sales Journal or sales Day Book- to record transitions relating to goods
on credit- Source document –Sales invoices
 Purchases Returns or Returns Out wards Journal- to record goods
returned to suppliers (creditors) for various reasons.source document-
Debit notes
 Sale Returns or Returns Inwards Journal or Returns Inwards Journal –
to record goods returned by credit customers (Debtors) for various
reasons. Source document- Credit notes.
 Cash Book- To record all cash and cheques received and all cash and
cheques paid out (Cash Transactions), during the specified period. Main
source- document – Receipts.
 Petty Cash Book- to record details of all payments for various small or
petty expenses of the entity. Maintained on the imprest system. Main
source documents- petty cash vouchers and receipts.
 Journal Proper or General Journal – to record all transactions that can
not be recorded in other journals. Various source documents.

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 Ledger- the main or principal book of account – where accounting
records- Ledger accounts are maintained on double entry Book –keeping
system.

Special Transactions to be recorded in Special Journals

( Books of Prime Entry )

Name of Journal Special transaction to be recorded

1. Cash Journals
( a ) Simple Cash Book Cash transactions
( b) Cash Book with Cash and Discount transactions
Discount Column
( c) Cash Book with Bank Cash, bank and discount
and discount column tranactions
( d ) Petty Cash Book
Petty cash transactions

2. Goods Journals
( a ) Purchases Journal Credit purchases of goods
( b)Sales Journal Credit sales of goods
( c) Sales Returns Journal Goods returned by credit
( d ) Purchases Returns customers
Journal Goods returned to those
supplliers from whom goods
were purchased on credit.
3. Journal Proper or General All transactions that cannot be
Journal recorded in any other journal.

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 Types of Ledgers:

 Sales or Debtors Ledger- to maintain all accounts of credit

customers or Debtors.
 Purchases or Creditors Ledger- to maintain all accounts of
suppliers or Creditors.
 General or Nominal Ledger- to maintain all accounts other
than those of Debtors and Creditors (Nominal and Real
accounts)

3.4 Starting a Business

Accounting Equation

Meaning – This is statement of equality between the

resources and the sources which finance the resources. It is
a simple expression of the fact that at any point in time the
assets of the business will be equal to its liabilities plus the
capital of the business.

 Resources mean Assets

 Sources of finance means Equity and Liabilities

(a). Financial accounting is based on the accounting equation.

 The rule of accounting equation is that the assets of a business will

at all times equal Capital and Liabilities.
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 Assets= Capital + Liabilities

 For accounting purposes, a business is completely separate from its

owner (s ). This is known as the separate entity principle. This
means that even though the individual owns the business the
accounting transactions of the business are kept completely separate
from the personal transactions of the owner.

(b) . If a firm of a business is to be set up and start its operations, then

it needs resources which it will control to carry out its activities . The
resources that the business needs to undertake its activities efficiently
and effectively are called assets.

 The total amount supplied by the owner to the firm or business to

enable it acquire assets is called capital. If the assets that business
need are financed by capital (resources supplied by the owner), the
accounting equation would be:

Assets = Capital

(c ). Most of the times not all the assets are acquired by the resources
provided by the owner of the business. Some assets are financed by
resources provided by people other than the owner of the business. The
indebtedness of the firm for these resources is known as

Liabilities. With the inclusion of Liabilities, the Accounting

Equation is expressed as:

Assets= Capital + Liabilities.

The totals of each side of the equation will always equal one another.
This will always be true no matter how many transactions there may be.
This is the duality concept .

The actual assets , capital and Liabilities may change , but the equality
of the assets with that of the total capital and liabilities will always hold
true.

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 Terminology (Key Terms)

Assets- These are resources controlled by the entity as a result of past

events and from which future economic benefits are expected to flow to
the entity. (framework)

Types

Non- Current Assets (Fixed Assets)

These are assets acquired for use within the business on a long-
term basis (more than one accounting year ) . They are not acquired
with a view to be resold ( the y are not meant for resale) . They are
acquired with a view of earning income or making profits from
their use either directly or indirectly over more than one accounting
period. They are used to make the business more efficient in carrying
out its operations.

Examples

Tangible Assets

 Land and Buildings

 Plant and Machinery
 Fixtures and Fittings
 Office Machinery
 Motor vehicles

Intangible Assets

 Goodwill
 Patents
 Trademarks
 Licenses

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 Current Assets

These are assets that are intended in the course of normal business
operations to be converted into cash within one year.

Examples

 Inventory(stocks of goods)
 Trade Receivables Debtors)
 Prepayments
 Cash at Bank
 Cash in hand.

Capital

This is the total amount that the owner (s) have invested in the
business. It represents transactions that create ownership in a
business entity. This can be through direct injection of funds
into the business or provision of equipment or other resources
which are retained by the enterprise. Capital is also known as
owner’s Equity.

Liabilities

These are an entity’s obligations to transfer economic

Benefits as a result of past transactions or events. They are

debts for which the business is liable. Thus, they are financial
obligations of the business to be paid or settled at specified
future time periods.

Types

Long –term Liabilities- (Non- Current Liabilities)

These are debts that will have to settled by the entity after more
than one year.

Examples
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  Long- term Bank loans
 Mortgages
 Debentures

Current Liabilities

These are debts that must be paid or settled by the entity

within one accounting period (within 12 months)

Examples

 Accounts Payables / Trade Payables/ Trade

Creditors.
 Short-term Bank loans
 Bank overdrafts
 Wages accrued
 Interest payables
 Taxation Payable.


BALANCE SHEET OR STATEMENT OF

FINANCIAL POSITION

 The elements of the Accounting Equation, Assets, Capital and

Liabilities are expressed in form of a financial statement called
Balance Sheet or Statement of Financial Position.
 Thus, a Balance Sheet may be defined as a financial statement that
shows the financial position of an entity as at any specified date. It
shows all the assets , liabilities and owner’s equity( Capital ) as at a
stated date.

SELF ASSESSMENT

1. Subsidiary books or Books of Prime Entry

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 For each of the transactions stated below , state the
appropriate book of prime entry in which it will be
recorded:

i. Started business with cash K200000

ii. Purchased goods on credit from K.Mwale , K9000
iii. Sold goods on credit to J.Ngoma, K4000
iv. Paid rent in cash , K1000
v. Sold goods for ccash , K8000
vi. Credit purchases to B. Bupe, K5000
vii. Credit sales to T. Manda , K5500
viii. Goods returned by credit customers, K900
ix. Goods returned to suppliers, K700
x. Owner of the business withdrew goods with a cost
of K1000, from business for personal use.
xi. Discounts allowed to credit customer for prompt
payment K800
xii. Debtor with an outstanding of K1000 , had his
account written off after all appropriate efforts to
obtain the amount owed failed.
xiii. Received discount from supplier for prompt
payment, K860
xiv. Deposited cash into Bank, K4000
xv. Bought office equipment from JHP Equipment
suppliers Ltd, K10000
xvi. Paid for motor vehicle repair petty cash float K380
xvii. Refund of taxi –fare to employee, K50 for
undertaking activities on behalf of the Enterprise.

22
 2 Provide the figures where there is question mark in the following
schedule :

ASSETS ( K ) CAPITAL(K) LIABILITES( K )

1500000 1300000 ?
? 5000000 400000
3000000 ? 600000
? 4600000 800000
6000000 4500000 ?
7500000 ? 700000
? 2900000 1000000
9100000 ? 230000
4500000 3000000 ?

FINANCIAL ACCOUNTING
UNIT 4;Preparing Ledger accounts using Double – entry Book-keeping System
4.1 Double- Entry
 Meaning
Definition – This is the system or method whereby entry transaction is recorded twice in
the Ledger accounts- i.e a debit and credit entry is made of each transaction at the same
time with the same amount.
 4.2 Golden rules of Double Entry Book- keeping

23
 i. Every debit entry must have a corresponding credit entry or evry credit entry must
have a corresponding debit entry.
ii. Debit the account that receives, credit the account that gives.
4.3 The rules for Double entry book- keeping –in relation to Assets, Liabilities, Income
and Expenses
 A debit entry is made when there is:
 An increase in the value of an asset
 A decrease in the amount of liability
 An increase in the amount in the amount of an expense
 A decrease in the amount of income.
 A credit entry is made when there is :
 A decrease in the value of an asset
 An increase in the amount of a liability
 A decrease in the amount of an Expense.
 A increase in the amount of income.
 Basic Accounting Rules
Personal Accounts
Personal account relates to persons with whom a business keeps dealings. A person can
be a natural person or a legal person.
Debit the Receiver
Credit the Giver

 Real Accounts
Real accounts relate to property which may either come into the business or go from the
business. If any property comes into the business, account of that property is to be debited
in the books of the business. If any property or goods go out from the business, the account
of that property or goods is to be credited in the books of business.
Debit - what comes in
Credit -what goes out
Nominal Account

24
 Nominal Account is an account that relates to business expenses, losses, incomes and gains.
 Nominal Accounts
Debit - all Expenses or Losses
Credit – all Incomes, Gains and profit.
Thus the double entry rules for the key classes of accounts are:
Type of Account Rules for Debit Rules for Credit
(a) Personal Accounts Debit the Receiver Credit the Giver
(b) Real accounts Debit what comes in Credit what goes out
( c) Nominal Accounts Debit expenses and Credit Incomes and gains
losses

4.4 The Ledger

 This is the main or principal book of account.
 Accounting records for various business transactions are maintained in the Ledger. Each
accounting record in the ledger is called a ledger account.
 Thus , a ledger is made up of a set accounts relating to Assets, Liabilities. Capital,
Incomes and Expenses.
 An Account
 This is the summary record of information relating to a particular item.
 It is a classified and summarized record of specific business transactions of the
enterprise.
 A Ledger account provides valuable information about a specific item which can
be used significantly by those interested in the accounting records of an
enterprise.
 Sides of a Ledger Account
 A Ledger account is said to capable of receiving and giving.
 It has two major sides namely, the debit side and credit side.
 The side that shows the receipt of values is called the Debit Side(Receiving
side)
 The side that shows giving of values is called the credit side (Giving side).
 Balancing of a Ledger Account
 The difference between the total of the debit side and total of thje credit side of
an account is called a Balance.
 If the Debit side is more than the Credit side, the balance is referred to as the
Debit Balance. It is entered on the credit side and brought forward(b/f) on the
debit side of same account the following month(If it is an Asset, Liability or
Capital)
 If the Credit side of an account is more than its Debit side, the balance is
referred to as the Credit Balance. It is entered on the Debit side.

25
  If the total of the debit side of an account is equal to the total of its credit side,
that account has no balance.
 The task of balancing the Ledger account ts is carried out at the end of the day,
end of the week, end of the , end of the accounting year ,depending on the
requirements of each particular enterprise.

4.5 TRIAL BALANCE

When all the Ledger accounts of an entity are balanced off, they are put in a list of debit
balances on one side and credit balances on the other side. This list of debit and credit
balances is called a Trial Balance.
 Definition- The Trial Balance may be defined as a list of Debit and Credit
balances extracted from the Ledger for a particular period , each totaled to see
whether the two types of balances agree.
 This means that the total of the Debit balances must equal the total of the credit
balances.Thus, the Trial Balance is schedule of account balances that help in the
confirmation that the rule of double entry was correctly applied. It NOT an
account to which amounts are posted to complete double entry.
 The preparation of a Trial Balance is an essential part of the accounting process
or cycle, as it is used as a test of the correctness of Double entry of the
transactions passed through the various Ledger Accounts.
 It must notedthat equalizing the two sides of the Trial Balance is NOT the sole
and conclusive proof of the correctness of books of account.
 Only when the Trial Balance has agreed or balanced can the next step of
preparing the Income Statement and Balance Sheet.
Note: When preparing the Trial Balance:
i. Asset balances- are entered in the debit column, because all asset
accounts have debit balances.
ii. Liability balances are entered in the credit column. Because all Liability
accounts have credit balances.
iii. Expenses/ Losses – are entered in the debit column, because all
expenses/ Losses accounts have debit balances.
iv. Incomes/ Gains – are entered in the credit column, because all
Incomes/Gains accounts have credit balances.
v. Capital balance – is entered in the credit column, because capital account
has a credit balance.
Objectives of the Trial Balance :
i. To check the Arithmetical accuracy of book of account
 According to the principle of double entry system of book –
keeping every business transaction has two aspects , debit and

26
 credit. So the agreement of the Trial Balance is a proof of the
arithmetical accuracy of the books.
ii. Helpful in preparing End of year Financial Statements
 The Trial Balance records the balances of all ledger accounts at
one place. This helps in the preparation of Income statement
and Statement of Financial Position (Balance Sheet).The relent
balances to be accounted for in the financial statements are
obtained from the Trial Balance.
iii. To serve an aid to the Management
 By comparing the Trial Balances of different years in figures of
certain important item such as purchases. Sales, Debtors,
Creditors,etc are ascertained and their analysis is made for
taking managerial decisions.

Limitations of Trial Balance

i. Trial Balance can be prepared only in those entities where double
entry system I adopted.
ii. Though Trial Balance gives arithmetical accuracy of books of
account, there may be errors that are not disclosed by Trial
balance. That is why it is said that the Trial Balance is not a
conclusive proof of the accuracy of the book of account.
iii. If the Trial Balance is not prepared correctly, then the Financial
Statements prepared will not reflect the True and Fair view of the
state of affairs of the business.

TRIAL BALANCE AS AT……………………………….

DR K000 CR K000
Assets XX

Liabilities XX
Expenses/Losses XX
Incomes/ Gains XX
Capital XX
XX XX

27
 SELF ASSESSMENT QUESTIONS
1. Double Entry
For each of the following transactions:
State the account to be debited and the account to be credited , and type
of accounts involved :
a) Owner commenced business by depositing K5 million into the
business bank account
b) Purchased goods on credit from K . Manda , K2million
c) Paid rent by cheque, K1.5 million.
d) Sold goods for cash K2million
e) Obtained a Loan K20million from ABY Financing Ltd
f) J .Mumba , a debtor settled his account K6 million by cheque.
g) Paid wages and salaries by cheque K18million
h) Bought office equipment from KMY Limited, K45 million.
i) Owner of the business withdrew cash K3million from business
bank account for private use.
j) Bough Motor vehicle by cheque K38 million
k) Owner of the business sold private possessions, and proceeds
amounting to K10 million , deposited into business bank account
2. Classification of ledger accounts
Classify the following into Personal , Real and Nominal Accounts:
i. Freehold Premises
ii. Investments
iii. Accrued interest on loan account
iv. Zambeef Plc
v. Long term loan from Bank
vi. Salaries and wages
vii. Purchases Account
viii. Zanaco PLC account
ix. Capital Account
x. Toll Tax Account
xi. Dividend Received Account
xii. Royalty Account
xiii. Sales Account
xiv. Cash Account
xv. Drawing Account

3 Double entry to Trial Balance

28
 The following transactions relate tothe business of G. Machayi , a sole
proprietor dealing in a variety of popular consumer goodsfor the month of
March , 2017
2017
1/03 Commenced business with:
Cash- K10000000
Motor vehicle K12000000
2/03 Bought goods for cash K400000
4/03 Sold goods by cheque K600000
5/03 Paid rent K50000
7/03 Paid for Stationery and Printing
K5000
9/03 Paid for sundry expenses K8000
11/03 Bought good on credit from
T.Manda K300000
13/03 Sold goods for cash K 250000
15/03 Paid for electricity K 10000
18/03 Sold goods on credit to J. Chanda,
K K70000
20/03 Bought office furniture from
JBYLtd K300000
24/03 Paid for postage K5000
23/ 03 Paid for repairs to motor vehicle
K9000
28/03 Bougt goods for cash , K50000
29/03 Cash sales K80000
3003 J.Chanda paid by cheque K 40000
of the amount owed
30/03 Paid wages by cheque to shop
attendants K70000
310/03 Deposited cash into bank K50000
31/ 03 Withdrew K 7000,cash from
business for personal use.

REQUIRED
(a) In each of the above transactions state the account to be debited and
the account to be credited
(b) Write up the appropriate Ledger Accounts from the above transactions
on double entry basis , for the month of March 2017
(c) Balance the Ledger accounts as at 31March 2017.
(d) Extract the Trial Balance as at 31 March 2017

29
 Exercises
1. The following is list of balances extracted from the books of account of
M . Majoza , a sole proprietor , dealing in children’s toys and women
fashion shoes , as at 31 March 2018:
K
Capital , 1/04/ 2017 508880
Drawings 7600
Inventory, 1/04/ 2017 181600
Sales revenue 923400
Purchases 691850
Carriage inwards 4200
Carriage outwards 15700
Returns outwards 6400
Wages and Salaries 102400
Rent and rates 30150
Communication expenses 6240
Commission payable 2160
Insurance 4050
General expenses 3180
Buildings 200000
Trade receivables 143200
Trade Payables 81600
Fixtures and Fittings 28500
Cash at Bank 29700
Cash in hand 1150
Inventory at 31 March 2 018 223900

REQUIRED :
Prepare ,Mujoza’ s Trial Balance a at 31 March 2018

2. In the absence of his permanent book-Keeper , Ngogo temporally engaged

C. Muchopo , an inexperienced book- keeper to extract a Trial
balance from his books of account as 31 December 2019. Given below is
the Trial Balance prepared by C. Muchopo:
TRIAL BALANCE AS AT 31 DECEMBER 2019
DR CR
K K

30
 Cash in hand 7000
Purchases returns 8000
Wages and salaries 8000
Establishment 12000
expenses
Sales Returns 7000
Capital 1/01/ 2019 22000
Carriage outwards 2000
Discount received 1200
Commission 800
received
Machinery 20000
Inventory 1/01/2019 10000
Trade Receivables 8000
Trade Payables 12000
Sales Revenue 44000
Purchases 128000
Bankoverdraft 114000
Advertising 10000
General Expenses 4000
Long –term loan 14000
Carriage inwards 1000
Interest on 1000
investment
217000 217000

REQUIRED:
Prepare the corrected Trial Balance as at 31 December
2018

FINANCIAL ACCOUNTING( BAF 106/ BBA106/ BCS 107/

BHRM 206)
UNIT 5.Applying the Accounting Cycle in the preparation or production
ofend of year Financial Statements
A.At the end of its financial year or accounting year (reporting period), every
business entity is required to prepare end of year financial statements. This
is in conformity with the periodicity concept.
B. The main end of year financial statements prepared are:

31
 1. Income Statement or Statement of Profit /Loss
This is prepared to show the financial performance of the enterprise . It is
prepared on accrual accounting basis.
 This statement is also referred to as Trading , Profit and Loss Account.
 It has two main sections- the Trading Account and The Profit and Loss
Account.
 Trading Account- this account shows items related to trading activities of
the entity(Buying and Selling). The purpose of this account is to determine
or ascertain the Gross Profit or Gross Loss.
 The main items disclosed in this account are:
 Sales
 Sales returns or Returns inwards
 Opening inventory(stock)
 Purchases
 Carriage inwards or carriage on purchases and any other expense directly
related to purchases.
 Returns outwards
 Closing inventory
 Difference between Sales and Returns inwards is Turnover or Net Sales
 Purchases plus Carriage inwards minus Returns out wards = Net
purchases.
 Opening inventory plus Net purchases= Cost of goods available for sale
 Cost of goods available for sale minus Closing inventory= Cost of Sales
 Turnover minus Cost of Sales = Gross Profit
 Profit and Loss Account
 The Gross profit ascertained in the Trading Account is transferred to the
Profit and Loss Acoount.
 Any incomes/ gains – e.g discount received, commission received, rent
received etc. are added to the Gross Profit to arrive at Total Income earned.
 All operating expenses such as Wages and salaries, Heating and Lighting ,
bad debts, Discounts allowed, stationery , printing and postage, depreciation,
etc. are totaled.

32
  When Total Income earned for the period is more than Total expenses
incurred , the result is Net Profit, which is transferred to the Balance Sheet
where it is added to the Capital.
 When Total expenses incurred for the period is more than Total income
earned , the result is Net Loss. The Netloss is transferred to the Balance
Sheet where it is deducted from Capital.

INCOME STATEMENT OR STATEMENT OF PROFIT/ LOSS FOR THE

YEAR ENDED 31 DECEMBER ……………
K000 K000 K000
Sales Revenue XXX
Returns inwards (XXX)
Turnover ( Net sales) XXX
Opening inventory
XXX
Purchases
Carriage inwards
Returns outwards XXX
XXX
(XXX)
XXX
Cost of available for sale
XXX
Closing inventory (XXX)
Cost of sales (XXX)

Gross Profit XXX

Discount received XXX
Bad debts recovered

33
 XXX
Total Income XXX
Operating Expenses:
E.g Wages and salaries
XXX
Rent and rates XXX
Heating and Lighting
XXX
Advertising XXX
Bad debts XXX
Discount Allowed XXX
General Expenses XXX
Depreciation :
Building
Equipment
Motor vehicles

XXX
XXX
XXX
Total expenses ( XXX)
Net Profit (transferred to B/ Sor SOFP)

XXX

34
 2. BALANCE SHEET OR STATEMENT OF FINANCIAL POSITION
This is a financial statement which shows the financial position of the
entity as at the end of the financial year. It discloses all the Assets, Liabilities
and Capital as at the end of the financial year.
It is a statement which shows the financial status of the businessenterprise
as the end of the financial year .
STATEMENT OF FINANCIAL POSITION/BALANCESHEET
AS AT……………..

ASSETS K000 K000 K000

NON-CURRENT ASSETS COST DEP NBV
Tangible Assets
Land and Buildings XX (XX) XX
Plant and Machinery XX (XX) (XX)
Fixtures and Fittings XX (XX) XX
Motor vehicles XX (XX) XX
XX XX XX

Current Assets
Inventory XX
Trade Receivable XX
Allowance for irrecoverable debts (XX)
XX
Prepayments XX
Bank XX
Cash in hand XX
XX
Current Liabilities
Trade Payables XX
Accrued Expenses XX

35
 (XX)
XX
Net Assets XX
Financed by:
Capital –at start XX
Net Profit XX
Drawings (XX)
XX
Long-term Liabilities
Long-term loan XX
Capital Employed XX

SELF ASSESSMENT
1. State the concept or principle which is in preparing the financial
statements?
2. What accounting basis are the income statement and statement of financial
position prepared?
3. What I the main purpose of preparing the Income Statement ?
4. Why is the Statement of Financial Poition prepared ?
5. Identify the elements that are accounted for in the Income Statement
6. Identify the key element that are disclosed in the Statement of Financial
Position.

36
 SELF ASSESSMENT
MaimbaMwale operates a retail business that offers a variety of consumer
products. The Trail Balance extracted from his books of account as at 31 st
December 2018 was as follows :

DR CR
K K

37
 Capital, 1/01/2018 2256000
Purchases and Sales 2668000 3652000
Inventory 1/01/2018 233400
Returns 12000 16000
Wages and Salaries 461600
Rent and rates 130000
Insurance7600
Motor vehicle expenses 37200
Irrecoverable debts 1200
Trade Receivables and Payables
173300
230040
Heating and Lighting 30740
Discount allowed and Received
8640
16220
Bank overdraft interest 740
Allowance for irrecoverable debts 1/01/2018

5880
Bank 34120
Drawings208000
Motor vehicles at cost 240000
Accumulated depreciation 1/01/2018
122400
Land 1000000

38
 Fixtures and Fittings at cost
280000
Accumulated depreciation 1/01/2018
168000
Buildings at cost 1000000
Accumulated Depreciation 1/01/2018
60000
6526540 6526540

ADDITIONAL INFORMATION
i. Inventory at 31 December 2018 was valued at K 256800, cost.
ii. Rent amounting to K10000 was pre-paid as at 31 December 2018
iii. K4600 was owing for heating and lighting at 31 December 2018
iv. Land was revalued to K1500000 at December 2018
v. In the yearend review at 31 December 2018 , Mwale decided to write
off another debt of K1300. A 5% allowance for irrecoverable debts was to
be provided for on the remaining balance of Trade Receivables
vi. Depreciation I to be provided for as follows:
- Buildings at 4% per annum on straight line basis.
- Fixtures and fittings at 15% per annum on cost
- Motor vehicles at 30% per annum on reducing balance basis
REQUIRED :
Prepare , Mwale ‘s
( a ) Income Statement ( Statement of Profit / Loss ) for the
year ended 31 December 2018 ( 12 marks )
(b ) Statement of Financial Position ( Balance Sheet ) as at
31 December 2018
(8 marks)

39
 EXECISE
1 The following balances were extracted from the books of account of K .
Mumba , a retail trader dealing in a variety of consumer goods as at
31March 2018

K000
Capital -1/04/2017 107200
Purchases 250000
Inventory 1/04/2017 55000
Returns inwards 1800
Returns outwards 10000
Sales Revenue 400950
Discounts allowed 18000
Discounts received 4800
Wages and salaries 58800
Carriage outwards 2000
Carriage inwards1500
Heating andLighting 3000
Advertising 5000
Sundry expenses 3000
Building at cost 120000
Motor vehicles at cost 80000
Accumulated depreciation -1/04/2017:
- Buildings 15000
- Motor vehicles 43000
Allowance for irrecoverable debts 700

40
 Trade Receivables 36000
Trade Payables 38000
Bank (bfavourable balance ) 1500
Cash in hand 450
Drawings24000
10% Long –term loan ( 5 years) 45000

ADDITIONAL INFORMATION
i. Inventory at 31 March ,2018 was valued at K41000000.
ii. K800000 was owing for Wages and Salaries as at 31March 2018
iii. K300000 had been prepaid for Advertising as at 31March 2018
iv. Interest on 10% Long –term loan was outstanding
v. Allowance for irrecoverable debts is to be adjusted to 2% of the Trade
Receivables.
vi. Depreciation is to be provided for as follows:
Buildings – 4% perannum on straight basis
Motor vehicles – 15% per annum on reducing balance basis.
REQUIRED
Prepare ,KMumba’s
(a ) Income Statement or Statement of Profit / Loss for the year ended 31
March 2018 ( 12 marks)
( b ) Statement of Financial Position (Balance Sheet ) as at 31 March 2018

FINANCIAL ACCOUNTING- BAF 106

BAF/ BBA/ BCS/ BHRM /

41
 UNIT 6 Preparing Appropriate Accounts for the acquisition and
disposal of Tangible non – current Assets

6.1 Capital and Revenue Expenditure

In accounting an expenditure is classified capital or revenue expenditure based

on the length of period that benefit derived from such expenditure will be
available to the business.

 Capital Expenditure- expenditure which is incurred:

a. For acquiring or bringing into existence an asset or advantage of an
enduring benefit or
b. For extending or improving a fixed asset or
c. For substantial replacement of an existing fixed asset.
 Basically the capital expenditure is incurred with a view to bringing in
improvement in productivity or earning capacity.

Examples

 Any expenditure which results in the acquisition of fixed

assets ,such as land, Buildings, plant and machinery, furniture
and fittings , office equipment , copy right , etc
 Any expenditure incurred on a fixed asset which results in:
 Its expansion
 Substantial increase in its life
 Improvement in its revenue earing capacity
 Expenditure incurred during the early year on development of
mines and land plantation till they become operational
 Cost of experiments- which ultimately result in the acquisition
of a patent.
 Legal charges incurred in connection with acquiring or
defending suits for protecting assets, rights, etc.
 Revenue Expenditure – Expenditure which is incurred for
maintaining productivity or earning capacity of a business.

42
 Such expenditure yields benefits in the current accounting
period only . Thus benefit of an expenditure is not likely to be
available for f more than one year.
 All expenses which are incurred during the regular course of the business
are regarded as revenue expenditure.

Examples

 Expenses incurred in day –to- day conduct of the business-

such as wages, salaries. rent , postage , stationery , etc
 Expenditure incurred for buying goods for resale or raw
materials for manufacturing
 Expenditure incurred for maintaining fixed assets- such as
repairs and renewals of buildings, machinery etc.
 Depreciation of fixed assets
 Finance costs- interest on loans borrowed for running the
business

Note

 All Capital expenditure items are recognized in the Statement

of Financial Position when they are incurred.
 All the Revenue expenditure are recognized or accounted for in
the Income statement or Statement of Profit or Loss in the period
they are incurred.

Exercise

State each of whether each of the following expenditure is Capital

or Revenue Expenditure and state in which Financial Statement it
will be recognized, giving your reason:

I. K100000. expenses on foreign tour for purchasing a new

machinery.
II. K7000, freight and insurance on new machinery

43
 III. Customs duty , K11000 paid on import of a machinery
IV. Carriage amounting to K4000 paid to bring machinery
to factory
V. Wages , K 8000, paid to machine operatives
VI. K 2000, paid to Factory Supervisor
VII. K500, paid for repairs to Factory equipment
VIII. K2400, paid for lubricants for factory machinery
IX. K1500 paid for computer soft ware
X. Extension to Building amounting to K1000
XI. K5000, spent on repainting the factory
XII. K150000, spent on research for a particular product hich
ultimately did not result in success
XIII. K10000, paid as legal fees to lawyer engaged in the
acquisition of Land.
6.2.1 Depreciation

(a ) Meaning – Generally, the term depreciation is sued to denote

decrease in value , but in accounting , this term is used to denote
decrease in the book value of a fixed asset.

(b ) Definition

 American Institute of Certified Public Accountants ( AICPA) “

Depreciation Accounting is a system of accounting which aims to
distribute cost or the basic value of tangible capital assets less
salvage ( if any) over the estimated useful life of the unit ( which
may be group of assets) in a systematic and rational manner “.It is
a process of allocation and not valuation.
 IAS 16- defines depreciation as “ the measure of the cost or
revalued amount of the economic benefits of the tangible non-
current asset that has been consumed during the period “

In simpler terms- depreciation is a mechanism to reflect the cot of

using a non – current asset.

44
  An analysis of the definition highlights the characteristics of
depreciation as follows:
 It is related to fixed assets (Tangible Non- current assets )
only
 It is a fall in the book value of an assets.
 The fall in the book value of an asset is due to the use of the
asset in business operations, effluxion of time, obsolescence,
and expiration of legal rights or any other cause.
 It is a permanent decrease in the book value of an asset
 It is a continuous decrease in the book value of an asset.

(c ) Meaning of the terms: Depreciation, Depletion and Amortization

 Depreciation – This is concerned with charging the cost of

manmade fixed assets – to the operation (not with the
determination of asset value for the balance sheet). Thus, the
term depreciation is used when expired utility of physical asset
(Building, Machinery, motor vehicles, equipment) is to be
recorded.
 Depletion – This term is applied to the process of removing an
available but irreplaceable resource such as extracting of coal
from a coal mine or oil from oil well. Depletion differs from
depreciation in that the former implies removal of a natural
resource while the latter implies a reduction in the service
capacity of an asset.
 Amortization – the process of writing off intangible asset over its
estimated or expected life is termed amortization. The Intangible
assets like patents, copyrights, leaseholds and goodwill are
recorded at cost in the books of account. Many of these have a
limited useful life and are therefore written off ( amortized)

D. Causes of Depreciation – Main causes

(i ) Physical wear and tear

45
  When certain type of fixed assets are put to use, the value
of such assets may decrease. Such decrease in the value is
said to be due to physical wear and tear- e.g machinery,
motor vehicles, equipment.

(ii)Passage of time / Effluxion of time- When the asset is exposed to

the forces of nature like weather winds, rains , etc. the
value of such assets may decrease even if they are
not putto nay use. Examples- Buildings, Equipment.

(iii) Obsolescence

 It refers to the decline in the useful of an asset because of

factors like :
 Technological advantages
 Changes in the market demand of the product
 Legal or other restrictions
 Improvement in production process.

Examples – plant and machinery of a specialized nature.

(iv ) Expiration of legal rights

 When the use of an asset – e.g, patents, leases) is governed

by the time bound arrangement, the value of such assets
decrease with the passage of time.

(e ) Basic elements of Depreciation

46
  Cost of the Asset- The knowledge about the cost of the
asset is very essential for determining the amount of
depreciation to be charged to the Income Statement or State
of Profit or Loss. The cost of the asset includes the invoce
price of the asset less any trade discount plus all costs
essential to make the asset usable.
 Estimated life of the asset
 Estimated life generally means how many years or hours as
asset could be used in business with ordinary repairs for
generating revenues.
 The physical life is based mostly on internal policies such
as intensity of used, repairs, maintenance and replacements.
 The economic life is based mostly on external factors such
as obsolescence from technological changes.
 In calculating the depreciation charge per annum for an
asset, the economic or useful life is preferred to physical
life.
 Scrap value or salvage value of the asset – the salvage value
or scrap value of the asset is that value which is estimated to
be realized on the sale of the asset at the end of its useful
life. This value should be calculated after deducting the
disposal costs from the sale value of the asset.

Note :

i. Land normally has an unlimited life (infinite life) and

so does not require depreciation, but buildings should
be depreciated.
ii. Depreciation of asset begins when it is available for use
by business.

47
 6.4 Methods of Depreciation

I. Straight line method or Fixed Instalment method

 This is the simplest and most popular method of
calculating depreciation.
 Under this method, a fixed and equal amount of
depreciation , according to a fixed percentage on the
original cost, is written off during each accounting
period over the expected useful life of the asset.
 To calculate the depreciation charge you require the following:
i. The original(historical ) cost of the asset
ii. An estimate of its useful life to the business
iii. An estimate of its residual value at the end of
its useful life.

The depreciation charge per annum = Original cost less Residual value

Expected useful life of asset (in years )

Rate of depreciation = Amount of Depreciation X100

Original cost

Example

P.L M wale , a sole trader whose accounting year ends on 31December,

On 1st January 2005 , he purchased a motor vehicle at cost of

K50000. Estimated that its useful life would be Five ( 5 ) years
after which he would trade it for K20000 .

48
 Task. Calculate the annual depreciation charge on the motor vehicle
using the straight line method.

The amount of depreciation and the rate of depreciation in each of the following alternative
cases

Case Purchase price Expenses to be Estimated Expected useful

of machine capitalized Residual value Life
K K K
a 80000 20000 40000 4 years
b 17000 3000 2000 10 years
c 45000 5000 10000 10 years
d 200000 50000 25000 5 years
e 90000 10000 20000 8 years

Note:

1. Depreciation is often expressed as a percentage of original cost. e.g 10%, 20%, 25%
etc.
2. Frequently residual value is not specified, in which case you should assume it to be
zero and the whole original cost will be written off over the life of the asset.
3. Suitability- This method is suitable for those assets in relation to which (a) repair
charges or less, and (b) the possibility of obsolescence is less. This method is suable
for furniture, patent, copyright, trademark, lease etc.

II .Reducing or Diminishing balance method

 Under this method, a fixed percentage , is applied on the reducing

( diminishing value ( book value or written down value) of the asset per
annum

49
  In the first year the percentage is applied to the cost but in subsequent
years it is applied to the asset’s net book value ( or written down value )
 Under this method the rate of depreciation remains constant year after year
whereas the amount of depreciation goes on decreasing.
 In cases where the rate of depreciation is not given , it is calculated as
follows:

R = 1−n√ s /c

Where , R= rate of depreciation in %

n= Useful life in years

s= Scrap value at the end of useful life of the asset

c= Cost of the asset

Example :

A trader purchases office equipment for K20000 on 1 January 2005 . He

depreciates his office equipment at 20% per annum using reducing
balance method .

Task – calculate the depreciation charge for each of the first five years.

SOLUTION

YEAR DEPRECITION CUMULATIVE

CHARGE (K) DEPRECIATION (K)
1. 20% x 20000 4000 4000
2. 20% (20000-
4000)

50
 3200 7200
3 20% ( 20000- 7200) 2560 9760
4 20% ( 20000- 9760) 2048 11808
5 . 20% ( 2000- 11808) 1638.4 13446.4

III.Sum of digits method or “ Rule of 78” method

 This is a variation on the reducing balance method, and the aim of this method is
show a higher depreciation charge in the early years of the life of an asset .
 Steps to follow
i. Number the years of the estimated life of the asset giving the highest digit yto
the first year, and digit 1 to the final year.
ii. Add the digits , to get the sum of digits
iii. Depreciation charge for each year is calculated as follows:

Digit for the year x Cost of the Asset

Sum of digits

Example

Cost of machine – K 8 400 000

Scrap value = K400000

Estimated useful life= 5 years

Task- Compute the depreciation charge per year using the sum of digits method.

Solution

Sum of digits = 5 + 4 + 3 + 2 + 1 = 15

Year 1 = 5/ 15 x (K 8400000- K400000) =

51
 Year 2= 4/15 x K8000000 =

Year 3= 3/15 X K8000000 =

Year4= 2/ 15 X K8000000=

Year 5 = 1/15 x K8000000=

Note – the method is known as the rule of 78 , because calculating depreciation

for one year on a monthly basis , the sum of digits would be :

January – 12 July- 6

February- 11 August- 5

March- 10 September- 4

April - 9 October- 3

May- 8 November - 2

June- 7 December- 1

78

6.5 Tangible Assets Disposal

 The Asset Disposal Account

 When non- current assets are disposed of , a disposal account is
opened. This account will reveal whether a profit or Loss has been
made on the asset sold The profit or Loss on disposal are reported in
the Income Statement.
 Accounting entries for the disposal of non- ccrrent asset:

Step1 Debit Asset Disposal Account

Credit – Asset Account , with value of asset at cost

Step 2- Debit- Allowance for Depreciation Account

52
 Credit- Asset Deposal Account , with accumulated depreciation at the
time of sale
Step 3 Debit - Receivable Account ( if sale is on credit ) or

Debit- Bank Account/ Cash Account ( if sale is by cheque or by cash)

Credit – Asset Disposal Account , with the sale price of the asset

Step 4- The balancing figure in Asset Disposal Account will be either

Profit or loss on disposal

 If the debit side of the Asset Disposal Account is more than its
credit side , the result is a Loss on Disposal.
 If the credit side of the Asset Disposal Account is more than
its debit side , the result is a Profit on Disposal.

Step 5- Profit on disposal – Debit – Asset Disposal Account

Credit – Income Statement

Loss on Disposal – Debit Income Statement

Credit - Asset Disposal Account

Example

G. Moonga, purchased a Motor vehicle on 1 January 2005 for K200000.He estimated that its
resale value on 31 December 2011, after six years use would be K80000 and depreciated it on
straight line basis . He would sell it on 30 June 2008 for K110000.

REQUIRED

Show the following :

( a) Motor vehicle Account

( b ) Allowance For Depreciation Account

( c)Asset Deposal Account

(d) Extracts of Income Statement

53
Solution

Amount of Depreciation per annum= Cost- Residual Value

Estimated economic Life

== K200000- K80000

6 years = K20000

Accumulated Depreciation of Motor Vehicle at time of Disposal

= K20000 x 2 .5 years = K50000.

FINANCIAL ACCOUNTING
(BAF 106)

UNIT 7 YEAR END ADJUSTMENTS

7.1 What are they?

 These are items of incomes and expenses that must be taken into
account in preparing the yearend financial statements.

 All adjustments are accounted for twice ( in conformity with double

entry )-both in the Income Statement and Statement of Financial Position .

7.2 Accruals basis of Accounting

 The accruals basis of accounting means that to calculate the profit or

Loss for the specified accounting period, we must include all the income, and
expenditure relating to the period, whether or not the cash has been received
or paid or an invoice received.

54
7.3 Accrued expenditure and accrued income.

 Accrued expenditure – An accrued arises where expenses of the

business, relating to the year, have not been paid by the year end. In this case ,
it is necessary to record the extra expense (owing) relevant to the year and
create a corresponding balance sheet liability ( called an accrual )

 Thus, Increase the relevant expense item in the income statement and
show the accrued amount in the Balance Sheet as current liability.

7.4 Accrued Income

 Accrued income arises where income has been earned in the accounting
period but has not yet been received.

 In this case, it is necessary to record the extra income ( not received) in

the income Statement and create a corresponding asset in the Balance Sheet
( called accrued income). Thus for an accrued income, increase the relevant
income item in the Income statement and show the accrued income as a
current asset in the Balance Sheet.

7.5 Prepaid Expenditure and Prepaid Income

 Pre-paid Expenditure – This arises where some of the subsequent

(following) year’s expenses have been paid in the current year. They relate to
expenses which have been paid for before the corresponding services have
been rendered to the business. In this case, it is necessary to remove that part,
of the expense which is not relevant for this year and create a corresponding
balance sheet (called a prepayment) .Thus, for any pre-paid expenditure.
Deduct the amount of pre-paid expense from the relevant expenditure item in

55
the Income Statement and show the pre-paid expense as a current asset in the
Balance Sheet.

 Pre-paid Income –This arises where income has been received in the
accounting period but which relates to the next accounting period. Pre-paid
income which has been received by the business before the corresponding
services have been rendered to the customer(s) . In this case, it is necessary to
remove the income not relating to the year from Income Statement and create
a corresponding liability in the Balance Sheet ( called pre-paid income) .

Accruals Concept

 Expenditure :

Accrued – Profit reduction

- Current Liability

 Pre-paid – Profit increase

- Current Asset

 Income :

Accrued – Profit increase

- Current Asset

Pre-paid- Profit reduction

- Current Liability

7.6 Irrecoverable debts and Allowance for irrecoverable debts

 Irrecoverable debts ( Bad debts )

56
 As a business expands in volume of activities, some of its sales may be
made on credit. These are credit sales and customers that are allowed to
access goods on credit from the later in the near future.

 Accruals concept dictates that when a sale is made, it is recognised in

the accounts, regardless of whether or not the cash has been received.

 By selling goods on credit , the business is taking a risk because some

customers may fail to pay for various reasons which may include :

 Restrictions by a country to transfer cash (foreign exchange) to another

country.

 The customers’ business may close down ( liquidated)

 Some customers may not be genuine and may just disappear without
paying.

 When a business fails to recover its money from credit customer after
making all necessary efforts , it is prudent to write off ,such as amounts as bad
debts or irrecoverable debts. Thus irrecoverable debts or bad debts are the
amounts that credit customers (Debtors) have failed to pay for various
reasons.

Accounting entries –for bad debts

Dr- Bad debts Account or Irrecoverable Debts Account – in general Ledger

Cr- Debtor’s Account – in Sales Ledger

7.6.Bad Debts Recovered

 A debt previously written off may be recovered in full or partially

57
 Steps to follow when a debt is recovered :

a) The debt must be reinstated

Dr- Receivable Account (Debtor) Account – Sales Ledger

Cr- Bad Debts Recovered Account – General ledger

b) When payment is received

Dr- Bank / Cash Account

Cr- Receivable (Debtor) Account

c) Yearend entries

Dr- Bad debts Recoverable Account

Cr- Income Statement

 Allowance for Irrecoverable debts

 Because of past experience where some debts become bad, some

organizations find it prudent to provide for future bad debts.

 If there is some doubt whether a customer can or will pay the debt owed
an Allowance for irrecoverable debts is created.

 This allowance is a general estimate of the percentage of debts which

are not expected to be repaid.

 It is calculated on the outstanding balance of Trade Receivables at the

end of the accounting year.

Accounting Entries

(a ) Dr- income Statement

58
 Cr- Allowance for irrecoverable debts Account

( b ) Year end

Balance on Allowance for irrecoverable debts Account is transferred to the

Balance Sheet where it is deducted from the Trade Receivables amount

Example

Trial Balance ( extract ) as at 31December 2018

Dr Cr

K000 K000

Trade Receivables 150000

Irrecoverable debt 1000

Discounts Allowed 500

Additional Information

59
An Allowance for irrecoverable debts of 5% is to be provided on Trade
Receivables

REQUIRED

Show extracts of the Income Statement and Statement of Financial Position

SOLUTION

Working

Allowance for irrecoverable debts = 5% x K150000= 7500

INCOME STATEMENT (extract) for the year ended 31 December 2018

K000 K000

Expenses:

Irrecoverable debt 1000

Discounts Allowed 500

Allowance for irrecoverable debt

7500

60
STATEMENT OF FINANCIAL POSITION ( extract ) as at 31 December
2018

K000 K000 K000

Current Assets

Trade Receivables 150000

Allowance for irrecoverable debts

( 7500)

142500

7.7 Discounts

A discount is a an amount of deduction from the sales value of the goods

or services

Types of Discount

I. Trade Discount – This is a reduction granted by a supplier from the list

price of goods or services on business considerations ( such as quantity bought
, trade practices )

61
 It is unconditional – it is ether given or not given by the supplier.

 It is recorded on the invoice, being deducted from the gross value of the
goods being supplied of bought. It never recorded in any ledger account of
any sort.

Example

10 packets of A at K200 each 2000

Less: trade discount at 10% 200

Net amount payable 1800

II. Cash Discount

 This is a reduction granted by a supplier from the invoice price (net

value) in consideration of immediate payment or payment within stipulated
period.

 It is deducted by the customer (debtor) from the net amount payable

when payment is made promptly.

 There are two types of cash discount :

i. Discounts Allowed- These are discounts allowed by a business to its

customers when they pay their accounts promptly

 Accounting entries

Dr- Discounts Allowed Account – General Ledger

Cr- Customer’s Account (Debtor) – Sales Ledger

At the end of the accounting period

62
 Dr – Income Statement

Cr- Discounts Allowed Account

ii- Discounts Received – These are discounts received by the firm or

business from it supplier when it pays their accounts promptly.

Accounting entries

 Dr- Supplier ( Creditor ) account – Purchases Ledger

Cr- Discounts Received Account – General Ledger

 Year end entries

Dr- Discounts Received Account

Cr- Income Statement

Allowance for Cash Discounts on

Receivables

 This is an allowance created to accommodate future cash discounts on

Trade Receivables (Debtors).

 The estimate of discounts to be allowed is based on the net figure of the

Trade Receivable after deducting allowance for irrecoverable debts

 It normally a percentage of the net Trade Receivable

K

Trade Receivable
100000

Allowance for irrecoverable debts

(20000) Net Trade

63
Receivable 180000
Allowance for Discounts Allowed (5000)

175000

Example

The following details are available in the books of account of JKM Ltd as at
31 December, end of financial year:

YEAR ENDED TRADE RECEIVABLE

K ALLOWANCE FOR IRRECOVERABLE DEBTS K

ALLOANCE FOR DICOUNTS ALLOWED %

2015 200000 100004

2016 250000 400004

2017 230000 200004

REQUIRED

(a ) Show the ledger Accounts for

i. Trade Receivables

ii. Allowance for Irrecoverable Debts

64
iii. Allowance for Discounts Allowed, for each of the accounting years
stated above.

( b) Show extracts of the Income Statement and Statement of

Financial Position for the year ended 31 December 2015, 2016
and 2017 respectively.

Exercise

The following details are available in the books of GML Ltd:

2015 2016 2017

K000 K000 K000

Sales (all on credit) 320000 400000 500000

Cash received from Debtors

200000

280000

350000

Bad debts 10000 8000 15000

Discounts Allowed 3000 4 000 6000

Allowance for irrecoverable debts

4%

6%

65
8%

Allowance for Discounts Allowed

3%

4%

5%

REQUIRED :

(a ) Show the following Ledger Accounts: for the year ending 31

December 2015, 2016 and 2017 respectively:

i. Trade Receivable Account

ii. Bad debts Account

iii. Discounts Allowed Account

iv. Allowance for Irrecoverable Debts Account

v. Allowance for Discounts Allowed Account

( b ) Extracts of Income Statement and Statement of Financial Position , for

2015, 2016 and 2017 respectively

7.9 Value Added Tax (VAT )

 This is a tax charged on supply of most goods and services sold by

business entities.

 The tax rate is decided by Parliament.

66
 Like most of the taxes , it is administered / implemented by the ta
Authority ( in Zambia , Zambia Revenue Authority )

 VAT is accounted for from two aspects :

 Input tax (Input VAT) – This VAT is levied or charged on goods and
services obtained or received by the firm

 Out put tax( Output VAT ) – This VAT that is charged on goods or
services offered or sold by the firm.

VAT Account – This account records both input tax and output tax. It
represents the Tax Authority with regard to VAT. The difference between the
Input tax and Output tax is an amount owed to the Tax Authority or Amount
refundable by the Tax Authority.

- This means that when the credit side of the VAT Account exceeds its credit
side, the firm owes the Tax Authority (Tax Authority is a creditor).

When the debit side of the VAT Account exceeds its credit side, the amount
represents a refund to the firm by the Tax Authority.

VAT ACCOUNT

Dr K CR
K

Input tax (on purchases) xx Output tax(out put)

xx

67
 Example:

The following details relate to BMK ltd for month of March 2016:

Total Purchases K500000 - impose vat of 16%

Total Sales K800000- impose vat of 16%

REQUIRED :

Prepare a VAT Account for the month of March 016 in the book of
BMK Ltd and comment on the balance determined.

General Ledger

VAT ACCOUNT

DATE (2016) PARTICULARS K DATE(2016) PARTICULARS

K

31 March Input tax 31 Mach Output tax

(500000x0.16) 80000 (800000 x 0.16) 128000

Balance c/d 48000

128000 128000

The balance of K48000 is a credit balance. It is the amount due to the Tax
Authority for Vat for the month of March 2016.

68
FINANCIAL ACCOUNTING( BAF 106/ BBA106/ BCS 107/
BHRM 206)

UNIT 5.Applying the Accounting Cycle in the preparation or production

ofend of year Financial Statements

A.At the end of its financial year or accounting year (reporting period), every business entity
is required to prepare end of year financial statements. This is in conformity with the
periodicity concept.

B. The main end of year financial statements prepared are:

1. Income Statement or Statement of Profit /Loss

This is prepared to show the financial performance of the enterprise . It is prepared on

accrual accounting basis.

 This statement is also referred to as Trading , Profit and Loss Account.

 It has two main sections- the Trading Account and The Profit and Loss Account.
 Trading Account- this account shows items related to trading activities of the
entity(Buying and Selling). The purpose of this account is to determine or ascertain the
Gross Profit or Gross Loss.
 The main items disclosed in this account are:
 Sales
 Sales returns or Returns inwards
 Opening inventory(stock)
 Purchases
 Carriage inwards or carriage on purchases and any other expense directly related to
purchases.
 Returns outwards
 Closing inventory
 Difference between Sales and Returns inwards is Turnover or Net Sales
 Purchases plus Carriage inwards minus Returns out wards = Net purchases.
 Opening inventory plus Net purchases= Cost of goods available for sale

69
  Cost of goods available for sale minus Closing inventory= Cost of Sales
 Turnover minus Cost of Sales = Gross Profit
 Profit and Loss Account
 The Gross profit ascertained in the Trading Account is transferred to the
Profit and Loss Acoount.
 Any incomes/ gains – e.g discount received, commission received, rent
received etc. are added to the Gross Profit to arrive at Total Income earned.
 All operating expenses such as Wages and salaries, Heating and Lighting ,
bad debts, Discounts allowed, stationery , printing and postage,
depreciation, etc. are totaled.
 When Total Income earned for the period is more than Total expenses
incurred , the result is Net Profit, which is transferred to the Balance Sheet
where it is added to the Capital.
 When Total expenses incurred for the period is more than Total income
earned , the result is Net Loss. The Netloss is transferred to the Balance
Sheet where it is deducted from Capital.

INCOME STATEMENT OR STATEMENT OF PROFIT/ LOSS FOR

THE YEAR ENDED 31 DECEMBER ……………

K000 K000 K000

Sales Revenue XXX
Returns inwards (XXX)
Turnover ( Net XXX
sales)
Opening inventory
XXX
Purchases XXX
Carriage inwards XXX

70
 Returns outwards (XXX)
XXX
Cost of available
for sale XXX
Closing inventory (XXX)
Cost of sales (XXX)

Gross Profit XXX

Discount received XXX
Bad debts
recovered XXX
Total Income XXX
Operating
Expenses:
E.g Wages and
salaries XXX
Rent and rates XXX
Heating and
Lighting XXX
Advertising XXX
Bad debts XXX
Discount Allowed XXX
General Expenses XXX
Depreciation :
Building XXX
Equipment XXX
Motor vehicles XXX
Total expenses ( XXX)

Net Profit
(transferred to
XXX

71
 B/ Sor
SOFP)

2. BALANCE SHEET OR STATEMENT OF FINANCIAL POSITION

This is a financial statement which shows the financial position of the

entity as at the end of the financial year. It discloses all the Assets, Liabilities
and Capital as at the end of the financial year.

It is a statement which shows the financial status of the businessenterprise

as the end of the financial year .

STATEMENT OF FINANCIAL POSITION/BALANCESHEET AS

AT……………..

ASSETS K000 K000 K000

NON-CURRENT COST DEP NBV
ASSETS
Tangible Assets
Land and Buildings XX (XX) XX
Plant and Machinery XX (XX) (XX)
Fixtures and Fittings XX (XX) XX
Motor vehicles XX (XX) XX
XX XX XX

Current Assets
Inventory XX
Trade Receivable XX

72
 Allowance for (XX)
irrecoverable debts
XX
Prepayments XX
Bank XX
Cash in hand XX
XX
Current Liabilities

Trade Payables XX

Accrued Expenses XX

(XX)

XX

Net Assets XX

Financed by:

Capital –at start XX

Net Profit XX

Drawings (XX)

XX

Long-term Liabilities

Long-term loan XX

Capital Employed XX

73
SELF ASSESSMENT

1. State the concept or principle which is in preparing the financial statements?

2. What accounting basis are the income statement and statement of financial
position prepared?
3. What I the main purpose of preparing the Income Statement ?
4. Why is the Statement of Financial Poition prepared ?
5. Identify the elements that are accounted for in the Income Statement
6. Identify the key element that are disclosed in the Statement of Financial
Position.

74
SELF ASSESSMENT

MaimbaMwale operates a retail business that offers a variety of consumer products. The Trail
Balance extracted from his books of account as at 31 st December 2018 was as follows :

75
 DR CR

K K
Capital, 1/01/2018 2256000
Purchases and Sales 2668000 3652000
Inventory 1/01/2018 233400
Returns 12000 16000
Wages and Salaries 461600
Rent and rates 130000
Insurance 7600
Motor vehicle expenses 37200
Irrecoverable debts 1200
Trade Receivables and
Payables 173300 230040
Heating and Lighting 30740
Discount allowed and
Received 8640 16220
Bank overdraft interest 740
Allowance for
irrecoverable debts
1/01/2018 5880
Bank 34120
Drawings 208000
Motor vehicles at cost 240000
Accumulated
depreciation 1/01/2018 122400
Land 1000000

76
Fixtures and Fittings at
cost 280000
Accumulated
depreciation 1/01/2018 168000
Buildings at cost 1000000
Accumulated
Depreciation 1/01/2018 60000
6526540 6526540

ADDITIONAL INFORMATION

i. Inventory at 31 December 2018 was valued at K 256800, cost.

ii. Rent amounting to K10000 was pre-paid as at 31 December 2018
iii. K4600 was owing for heating and lighting at 31 December 2018
iv. Land was revalued to K1500000 at December 2018
v. In the yearend review at 31 December 2018 , Mwale decided to write off another
debt of K1300. A 5% allowance for irrecoverable debts was to be provided for on the
remaining balance of Trade Receivables
vi. Depreciation I to be provided for as follows:
- Buildings at 4% per annum on straight line basis.
- Fixtures and fittings at 15% per annum on cost
- Motor vehicles at 30% per annum on reducing balance basis
REQUIRED :
Prepare , Mwale ‘s
( a ) Income Statement ( Statement of Profit / Loss ) for the year ended 31
December 2018 ( 12 marks )
(b ) Statement of Financial Position ( Balance Sheet ) as at 31 December 2018
(8 marks)

77
 EXECISE
1 The following balances were extracted from the books of account of K .
Mumba , a retail trader dealing in a variety of consumer goods as at
31March 2018

K000
Capital -1/04/2017 107200
Purchases 250000
Inventory 1/04/2017 55000
Returns inwards 1800
Returns outwards 10000
Sales Revenue 400950
Discounts allowed 18000
Discounts received 4800
Wages and salaries 58800
Carriage outwards 2000
Carriage inwards 1500
Heating andLighting 3000
Advertising 5000
Sundry expenses 3000
Building at cost 120000
Motor vehicles at cost 80000
Accumulated depreciation -1/04/2017:
- Buildings 15000
- Motor vehicles 43000
Allowance for irrecoverable debts 700
Trade Receivables 36000
Trade Payables 38000
Bank (bfavourable balance ) 1500
Cash in hand 450
Drawings 24000
10% Long –term loan ( 5 years) 45000

ADDITIONAL INFORMATION
i. Inventory at 31 March ,2018 was valued at K41000000.
ii. K800000 was owing for Wages and Salaries as at 31March 2018
iii. K300000 had been prepaid for Advertising as at 31March 2018
iv. Interest on 10% Long –term loan was outstanding
v. Allowance for irrecoverable debts is to be adjusted to 2% of the Trade
Receivables.
78
 vi. Depreciation is to be provided for as follows:
Buildings – 4% perannum on straight basis
Motor vehicles – 15% per annum on reducing balance basis.
REQUIRED
Prepare ,KMumba’s
(a ) Income Statement or Statement of Profit / Loss for the year ended 31 March
2018 ( 12 marks)
( b ) Statement of Financial Position (Balance Sheet ) as at 31 March 2018

FINANCIAL ACCOUNTING- BAF 106

BAF/ BBA/ BCS/ BHRM /

UNIT 6 Preparing Appropriate Accounts for the acquisition and

disposal of Tangible non – current Assets

6.1 Capital and Revenue Expenditure

In accounting an expenditure is classified capital or revenue expenditure based

on the length of period that benefit derived from such expenditure will be
available to the business.

 Capital Expenditure- expenditure which is incurred:

d. For acquiring or bringing into existence an asset or advantage of an
enduring benefit or
e. For extending or improving a fixed asset or
f. For substantial replacement of an existing fixed asset.
 Basically the capital expenditure is incurred with a view to bringing in
improvement in productivity or earning capacity.
Examples

79
  Any expenditure which results in the acquisition of fixed
assets ,such as land, Buildings, plant and machinery, furniture
and fittings , office equipment , copy right , etc
 Any expenditure incurred on a fixed asset which results in:
 Its expansion
 Substantial increase in its life
 Improvement in its revenue earing capacity
 Expenditure incurred during the early year on development of
mines and land plantation till they become operational
 Cost of experiments- which ultimately result in the acquisition
of a patent.
 Legal charges incurred in connection with acquiring or
defending suits for protecting assets, rights, etc.
 Revenue Expenditure – Expenditure which is incurred for
maintaining productivity or earning capacity of a business.
Such expenditure yields benefits in the current accounting
period only . Thus benefit of an expenditure is not likely to be
available for f more than one year.
 All expenses which are incurred during the regular course of the business
are regarded as revenue expenditure.
Examples

 Expenses incurred in day –to- day conduct of the business-

such as wages, salaries. rent , postage , stationery , etc
 Expenditure incurred for buying goods for resale or raw
materials for manufacturing
 Expenditure incurred for maintaining fixed assets- such as
repairs and renewals of buildings, machinery etc.
 Depreciation of fixed assets
 Finance costs- interest on loans borrowed for running the
business
Note

80
  All Capital expenditure items are recognized in the Statement
of Financial Position when they are incurred.
 All the Revenue expenditure are recognized or accounted for in
the Income statement or Statement of Profit or Loss in the period
they are incurred.
Exercise

State each of whether each of the following expenditure is Capital

or Revenue Expenditure and state in which Financial Statement it
will be recognized, giving your reason:

XIV. K100000. expenses on foreign tour for purchasing a new

machinery.
XV. K7000, freight and insurance on new machinery
XVI. Customs duty , K11000 paid on import of a machinery
XVII. Carriage amounting to K4000 paid to bring machinery
to factory
XVIII. Wages , K 8000, paid to machine operatives
XIX. K 2000, paid to Factory Supervisor
XX. K500, paid for repairs to Factory equipment
XXI. K2400, paid for lubricants for factory machinery
XXII. K1500 paid for computer soft ware
XXIII. Extension to Building amounting to K1000
XXIV. K5000, spent on repainting the factory
XXV. K150000, spent on research for a particular product hich
ultimately did not result in success
XXVI. K10000, paid as legal fees to lawyer engaged in the
acquisition of Land.
6.2.2 Depreciation
(a ) Meaning – Generally, the term depreciation is sued to denote
decrease in value , but in accounting , this term is used to denote
decrease in the book value of a fixed asset.

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 (b ) Definition

 American Institute of Certified Public Accountants ( AICPA) “

Depreciation Accounting is a system of accounting which aims to
distribute cost or the basic value of tangible capital assets less
salvage ( if any) over the estimated useful life of the unit ( which
may be group of assets) in a systematic and rational manner “.It is
a process of allocation and not valuation.
 IAS 16- defines depreciation as “ the measure of the cost or
revalued amount of the economic benefits of the tangible non-
current asset that has been consumed during the period “
In simpler terms- depreciation is a mechanism to reflect the cot of
using a non – current asset.

 An analysis of the definition highlights the characteristics of

depreciation as follows:
 It is related to fixed assets (Tangible Non- current assets )
only
 It is a fall in the book value of an assets.
 The fall in the book value of an asset is due to the use of the
asset in business operations, effluxion of time, obsolescence,
and expiration of legal rights or any other cause.
 It is a permanent decrease in the book value of an asset
 It is a continuous decrease in the book value of an asset.
(c ) Meaning of the terms: Depreciation, Depletion and Amortization

 Depreciation – This is concerned with charging the cost of

manmade fixed assets – to the operation (not with the
determination of asset value for the balance sheet). Thus, the
term depreciation is used when expired utility of physical asset
(Building, Machinery, motor vehicles, equipment) is to be
recorded.

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  Depletion – This term is applied to the process of removing an
available but irreplaceable resource such as extracting of coal
from a coal mine or oil from oil well. Depletion differs from
depreciation in that the former implies removal of a natural
resource while the latter implies a reduction in the service
capacity of an asset.
 Amortization – the process of writing off intangible asset over its
estimated or expected life is termed amortization. The Intangible
assets like patents, copyrights, leaseholds and goodwill are
recorded at cost in the books of account. Many of these have a
limited useful life and are therefore written off ( amortized)
D. Causes of Depreciation – Main causes

(i ) Physical wear and tear

 When certain type of fixed assets are put to use, the value
of such assets may decrease. Such decrease in the value is
said to be due to physical wear and tear- e.g machinery,
motor vehicles, equipment.
(ii)Passage of time / Effluxion of time- When the asset is exposed to
the forces of nature like weather winds, rains , etc. the
value of such assets may decrease even if they are
not putto nay use. Examples- Buildings, Equipment.

(iii) Obsolescence

 It refers to the decline in the useful of an asset because of

factors like :
 Technological advantages
 Changes in the market demand of the product
 Legal or other restrictions
 Improvement in production process.

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 Examples – plant and machinery of a specialized nature.

(iv ) Expiration of legal rights

 When the use of an asset – e.g, patents, leases) is governed

by the time bound arrangement, the value of such assets
decrease with the passage of time.
(e ) Basic elements of Depreciation

 Cost of the Asset- The knowledge about the cost of the

asset is very essential for determining the amount of
depreciation to be charged to the Income Statement or State
of Profit or Loss. The cost of the asset includes the invoce
price of the asset less any trade discount plus all costs
essential to make the asset usable.
 Estimated life of the asset
 Estimated life generally means how many years or hours as
asset could be used in business with ordinary repairs for
generating revenues.
 The physical life is based mostly on internal policies such
as intensity of used, repairs, maintenance and replacements.
 The economic life is based mostly on external factors such
as obsolescence from technological changes.
 In calculating the depreciation charge per annum for an
asset, the economic or useful life is preferred to physical
life.
 Scrap value or salvage value of the asset – the salvage value
or scrap value of the asset is that value which is estimated to

84
 be realized on the sale of the asset at the end of its useful
life. This value should be calculated after deducting the
disposal costs from the sale value of the asset.

Note :

iii. Land normally has an unlimited life (infinite life) and

so does not require depreciation, but buildings should
be depreciated.
iv. Depreciation of asset begins when it is available for use
by business.
6.4 Methods of Depreciation

II. Straight line method or Fixed Instalment method

 This is the simplest and most popular method of
calculating depreciation.
 Under this method, a fixed and equal amount of
depreciation , according to a fixed percentage on the
original cost, is written off during each accounting
period over the expected useful life of the asset.
 To calculate the depreciation charge you require the following:
iv. The original(historical ) cost of the asset
v. An estimate of its useful life to the business
vi. An estimate of its residual value at the end of
its useful life.
The depreciation charge per annum = Original cost less Residual value

Expected useful life of asset (in years )

Rate of depreciation = Amount of Depreciation X100

Original cost

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 Example

P.L M wale , a sole trader whose accounting year ends on 31December,

On 1st January 2005 , he purchased a motor vehicle at cost of

K50000. Estimated that its useful life would be Five ( 5 ) years
after which he would trade it for K20000 .

Task. Calculate the annual depreciation charge on the motor vehicle

using the straight line method.

The amount of depreciation and the rate of depreciation in each of the following alternative
cases

Case Purchase price Expenses to be Estimated Expected useful

of machine capitalized Residual value Life
K K K
a 80000 20000 40000 4 years
b 17000 3000 2000 10 years
c 45000 5000 10000 10 years
d 200000 50000 25000 5 years
e 90000 10000 20000 8 years

Note:

4. Depreciation is often expressed as a percentage of original cost. e.g 10%, 20%, 25%
etc.
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 5. Frequently residual value is not specified, in which case you should assume it to be
zero and the whole original cost will be written off over the life of the asset.
6. Suitability- This method is suitable for those assets in relation to which (a) repair
charges or less, and (b) the possibility of obsolescence is less. This method is suable
for furniture, patent, copyright, trademark, lease etc.
II .Reducing or Diminishing balance method

 Under this method, a fixed percentage , is applied on the reducing

( diminishing value ( book value or written down value) of the asset per
annum
 In the first year the percentage is applied to the cost but in subsequent
years it is applied to the asset’s net book value ( or written down value )
 Under this method the rate of depreciation remains constant year after year
whereas the amount of depreciation goes on decreasing.
 In cases where the rate of depreciation is not given , it is calculated as
follows:
R = 1−n√ s /c

Where , R= rate of depreciation in %

n= Useful life in years

s= Scrap value at the end of useful life of the asset

c= Cost of the asset

Example :

A trader purchases office equipment for K20000 on 1 January 2005 . He

depreciates his office equipment at 20% per annum using reducing
balance method .

87
 Task – calculate the depreciation charge for each of the first five years.

SOLUTION

YEAR DEPRECITION CUMULATIVE

CHARGE (K) DEPRECIATION (K)
3. 20% x 20000 4000 4000
4. 20% (20000-
4000) 3200 7200
3 20% ( 20000- 7200) 2560 9760
4 20% ( 20000- 9760) 2048 11808
5 . 20% ( 2000- 11808) 1638.4 13446.4

III.Sum of digits method or “ Rule of 78” method

 This is a variation on the reducing balance method, and the aim of this method is
show a higher depreciation charge in the early years of the life of an asset .
 Steps to follow
iv. Number the years of the estimated life of the asset giving the highest digit yto
the first year, and digit 1 to the final year.
v. Add the digits , to get the sum of digits
vi. Depreciation charge for each year is calculated as follows:
Digit for the year x Cost of the Asset

Sum of digits

Example

Cost of machine – K 8 400 000

Scrap value = K400000

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 Estimated useful life= 5 years

Task- Compute the depreciation charge per year using the sum of digits method.

Solution

Sum of digits = 5 + 4 + 3 + 2 + 1 = 15

Year 1 = 5/ 15 x (K 8400000- K400000) =

Year 2= 4/15 x K8000000 =

Year 3= 3/15 X K8000000 =

Year4= 2/ 15 X K8000000=

Year 5 = 1/15 x K8000000=

Note – the method is known as the rule of 78 , because calculating depreciation

for one year on a monthly basis , the sum of digits would be :

January – 12 July- 6

February- 11 August- 5

March- 10 September- 4

April - 9 October- 3

May- 8 November - 2

June- 7 December- 1

78

6.5 Tangible Assets Disposal

 The Asset Disposal Account

 When non- current assets are disposed of , a disposal account is
opened. This account will reveal whether a profit or Loss has been

89
 made on the asset sold The profit or Loss on disposal are reported in
the Income Statement.
 Accounting entries for the disposal of non- ccrrent asset:
Step1 Debit Asset Disposal Account

Credit – Asset Account , with value of asset at cost

Step 2- Debit- Allowance for Depreciation Account

Credit- Asset Deposal Account , with accumulated depreciation at the

time of sale
Step 3 Debit - Receivable Account ( if sale is on credit ) or

Debit- Bank Account/ Cash Account ( if sale is by cheque or by cash)

Credit – Asset Disposal Account , with the sale price of the asset

Step 4- The balancing figure in Asset Disposal Account will be either

Profit or loss on disposal

 If the debit side of the Asset Disposal Account is more than its
credit side , the result is a Loss on Disposal.
 If the credit side of the Asset Disposal Account is more than
its debit side , the result is a Profit on Disposal.
Step 5- Profit on disposal – Debit – Asset Disposal Account

Credit – Income Statement

Loss on Disposal – Debit Income Statement

Credit - Asset Disposal Account

Example

G. Moonga, purchased a Motor vehicle on 1 January 2005 for K200000.He estimated that its
resale value on 31 December 2011, after six years use would be K80000 and depreciated it on
straight line basis . He would sell it on 30 June 2008 for K110000.

REQUIRED

90
Show the following :

( a) Motor vehicle Account

( b ) Allowance For Depreciation Account

( c)Asset Deposal Account

(d) Extracts of Income Statement

Solution

Amount of Depreciation per annum= Cost- Residual Value

Estimated economic Life

== K200000- K80000

6 years = K20000

Accumulated Depreciation of Motor Vehicle at time of Disposal

= K20000 x 2 .5 years = K50000.

FINANCIAL ACCOUNTING (BAF 106)

UNIT 7 YEAR END ADJUSTMENTS
7.1 What are they?
 These are items of incomes and expenses that must be taken into account in
preparing the yearend financial statements.
 All adjustments are accounted for twice ( in conformity with double entry )-both in
the Income Statement and Statement of Financial Position .
7.2 Accruals basis of Accounting
 The accruals basis of accounting means that to calculate the profit or Loss for the
specified accounting period, we must include all the income, and expenditure
relating to the period, whether or not the cash has been received or paid or an
invoice received.
7.3 Accrued expenditure and accrued income.
 Accrued expenditure – An accrued arises where expenses of the business, relating
to the year, have not been paid by the year end. In this case , it is necessary to

91
 record the extra expense (owing) relevant to the year and create a corresponding
balance sheet liability ( called an accrual )
 Thus, Increase the relevant expense item in the income statement and show the
accrued amount in the Balance Sheet as current liability.
7.4 Accrued Income
 Accrued income arises where income has been earned in the accounting period but
has not yet been received.
 In this case, it is necessary to record the extra income ( not received) in the income
Statement and create a corresponding asset in the Balance Sheet ( called accrued
income). Thus for an accrued income, increase the relevant income item in the
Income statement and show the accrued income as a current asset in the Balance
Sheet.
7.5 Prepaid Expenditure and Prepaid Income
 Pre-paid Expenditure – This arises where some of the subsequent
(following) year’s expenses have been paid in the current year. They relate to
expenses which have been paid for before the corresponding services have
been rendered to the business. In this case, it is necessary to remove that part,
of the expense which is not relevant for this year and create a corresponding
balance sheet (called a prepayment) .Thus, for any pre-paid expenditure.
Deduct the amount of pre-paid expense from the relevant expenditure item in
the Income Statement and show the pre-paid expense as a current asset in the
Balance Sheet.
 Pre-paid Income –This arises where income has been received in the
accounting period but which relates to the next accounting period. Pre-paid
income which has been received by the business before the corresponding
services have been rendered to the customer(s) . In this case, it is necessary to
remove the income not relating to the year from Income Statement and create
a corresponding liability in the Balance Sheet ( called pre-paid income) .
Accruals Concept
 Expenditure :
Accrued – Profit reduction
- Current Liability
 Pre-paid – Profit increase
- Current Asset
 Income :
Accrued – Profit increase
- Current Asset
Pre-paid- Profit reduction
- Current Liability

92
 7.6 Irrecoverable debts and Allowance for irrecoverable debts
 Irrecoverable debts ( Bad debts )
 As a business expands in volume of activities, some of its sales may be
made on credit. These are credit sales and customers that are allowed to
access goods on credit from the later in the near future.
 Accruals concept dictates that when a sale is made, it is recognised in the
accounts, regardless of whether or not the cash has been received.
 By selling goods on credit , the business is taking a risk because some
customers may fail to pay for various reasons which may include :
 Restrictions by a country to transfer cash (foreign exchange) to another
country.
 The customers’ business may close down ( liquidated)
 Some customers may not be genuine and may just disappear without
paying.
 When a business fails to recover its money from credit customer after
making all necessary efforts , it is prudent to write off ,such as amounts
as bad debts or irrecoverable debts. Thus irrecoverable debts or bad
debts are the amounts that credit customers (Debtors) have failed to pay
for various reasons.
Accounting entries –for bad debts
Dr- Bad debts Account or Irrecoverable Debts Account – in general Ledger
Cr- Debtor’s Account – in Sales Ledger

7.6.Bad Debts Recovered

 A debt previously written off may be recovered in full or partially
 Steps to follow when a debt is recovered :
a) The debt must be reinstated
Dr- Receivable Account (Debtor) Account – Sales Ledger
Cr- Bad Debts Recovered Account – General ledger
b) When payment is received
Dr- Bank / Cash Account
Cr- Receivable (Debtor) Account
c) Yearend entries
Dr- Bad debts Recoverable Account
Cr- Income Statement

93
  Allowance for Irrecoverable debts
 Because of past experience where some debts become bad, some
organizations find it prudent to provide for future bad debts.
 If there is some doubt whether a customer can or will pay the debt owed
an Allowance for irrecoverable debts is created.
 This allowance is a general estimate of the percentage of debts which are
not expected to be repaid.
 It is calculated on the outstanding balance of Trade Receivables at the
end of the accounting year.
Accounting Entries
(a ) Dr- income Statement
Cr- Allowance for irrecoverable debts Account
( b ) Year end
Balance on Allowance for irrecoverable debts Account is transferred to the
Balance Sheet where it is deducted from the Trade Receivables amount

Example
Trial Balance ( extract ) as at 31December 2018
Dr Cr
K000 K000
Trade Receivables 150000
Irrecoverable debt 1000
Discounts Allowed 500

Additional Information
An Allowance for irrecoverable debts of 5% is to be provided on Trade
Receivables
REQUIRED

94
 Show extracts of the Income Statement and Statement of Financial Position

SOLUTION
Working
Allowance for irrecoverable debts = 5% x K150000= 7500
INCOME STATEMENT (extract) for the year ended 31 December 2018
K000 K000
Expenses:
Irrecoverable debt 1000
Discounts Allowed 500
Allowance for
irrecoverable debt 7500

STATEMENT OF FINANCIAL POSITION ( extract ) as at 31 December

2018
K000 K000 K000
Current Assets
Trade Receivables 150000
Allowance for
irrecoverable
debts ( 7500)
142500

7.7 Discounts
A discount is a an amount of deduction from the sales value of the goods or services
Types of Discount

95
 I. Trade Discount – This is a reduction granted by a supplier from the list price of
goods or services on business considerations ( such as quantity bought , trade
practices )
 It is unconditional – it is ether given or not given by the supplier.
 It is recorded on the invoice, being deducted from the gross value of the goods
being supplied of bought. It never recorded in any ledger account of any sort.
Example
K
10 packets of A at K200 each 2000
Less: trade discount at 10% 200
Net amount payable 1800
II. Cash Discount
 This is a reduction granted by a supplier from the invoice price (net value) in
consideration of immediate payment or payment within stipulated period.
 It is deducted by the customer (debtor) from the net amount payable when
payment is made promptly.
 There are two types of cash discount :
i. Discounts Allowed- These are discounts allowed by a
business to its customers when they pay their accounts
promptly
 Accounting entries
Dr- Discounts Allowed Account – General Ledger
Cr- Customer’s Account (Debtor) – Sales Ledger
At the end of the accounting period
Dr – Income Statement
Cr- Discounts Allowed Account
ii- Discounts Received – These are discounts received by the
firm or business from it supplier when it pays their
accounts promptly.
Accounting entries
 Dr- Supplier ( Creditor ) account – Purchases Ledger
Cr- Discounts Received Account – General
Ledger
 Year end entries

96
 Dr- Discounts Received Account
Cr- Income Statement
Allowance for Cash Discounts on Receivables
 This is an allowance created to accommodate future
cash discounts on Trade Receivables (Debtors).
 The estimate of discounts to be allowed is based on
the net figure of the Trade Receivable after deducting
allowance for irrecoverable debts
 It normally a percentage of the net Trade Receivable
K
Trade Receivable 100000
Allowance for irrecoverable debts (20000)
Net Trade Receivable 180000
Allowance for Discounts Allowed
(5000)
175000

Example
The following details are available in the books of
account of JKM Ltd as at 31 December, end of financial
year:
YEAR TRADE ALLOWANCE ALLOAN
ENDE RECEIVAB FOR CE FOR
D LE IRRECOVERA DICOUNT
K BLE DEBTS K S
ALLOWE
D %
2015 200000 10000 4
2016 250000 40000 4
2017 230000 20000 4

REQUIRED
(a ) Show the ledger Accounts for

97
 i. Trade Receivables
ii. Allowance for Irrecoverable Debts
iii. Allowance for Discounts Allowed, for each of the accounting years
stated above.
( b) Show extracts of the Income Statement and Statement of Financial Position for the
year ended 31 December 2015, 2016 and 2017 respectively.

Exercise
The following details are available in the books of GML Ltd:

2015 2016 2017

K000 K000 K000
Sales (all on credit) 320000 400000 500000
Cash received from
Debtors 200000 280000 350000
Bad debts 10000 8000 15000
Discounts Allowed 3000 4 000 6000
Allowance for
irrecoverable debts 4% 6% 8%
Allowance for
Discounts Allowed 3% 4% 5%
REQUIRED :
(a ) Show the following Ledger Accounts: for the year ending 31 December 2015, 2016
and 2017 respectively:
i. Trade Receivable Account
ii. Bad debts Account
iii. Discounts Allowed Account
iv. Allowance for Irrecoverable Debts Account
v. Allowance for Discounts Allowed Account
( b ) Extracts of Income Statement and Statement of Financial Position , for 2015, 2016
and 2017 respectively

7.9 Value Added Tax (VAT )

 This is a tax charged on supply of most goods and services
sold by business entities.
 The tax rate is decided by Parliament.

98
  Like most of the taxes , it is administered / implemented by
the ta Authority ( in Zambia , Zambia Revenue Authority )
 VAT is accounted for from two aspects :
 Input tax (Input VAT) – This VAT is levied or
charged on goods and services obtained or
received by the firm
 Out put tax( Output VAT ) – This VAT that is
charged on goods or services offered or sold by
the firm.

VAT Account – This account records both input tax and output tax. It represents the Tax
Authority with regard to VAT. The difference between the Input tax and Output tax is an amount
owed to the Tax Authority or Amount refundable by the Tax Authority.
- This means that when the credit side of the VAT Account exceeds its credit side, the firm
owes the Tax Authority (Tax Authority is a creditor).
When the debit side of the VAT Account exceeds its credit side, the amount represents a
refund to the firm by the Tax Authority.
VAT ACCOUNT
Dr K CR K
Input tax (on purchases) xx Output tax(out put) xx

Example:
The following details relate to BMK ltd for month of March 2016:
Total Purchases K500000 - impose vat of 16%
Total Sales K800000- impose vat of 16%

REQUIRED :
Prepare a VAT Account for the month of March 016 in the book of BMK Ltd and
comment on the balance determined.
General Ledger
VAT ACCOUNT

99
 DATE PARTICULAR K DATE(2016) PARTICULARS K
(2016) S
31 March Input tax 31 Mach Output tax
(500000x0.16) 80000 (800000 x 0.16) 128000
Balance c/d 48000
128000 128000

The balance of K48000 is a credit balance. It is the amount due to the Tax Authority for Vat
for the month of March 2016.

UNIT 8- PREPARING BANK RECONCILIATION STATEMENT

BANK RECONCILIATION STATEMENT
A. A business entity should maintain a separate Cash book for every commercial bank
account it operates.
The bank will maintain its own record of the customers’ accounts. The bank will
avail the details of the customers ‘account in its books on request or agreed
intervals, by sending a copy of Bank Statement.
B. In the customer’s Cash Book- Bank Account is maintained as follows:
 Receipts(deposits-cash and cheques) are debited
 Payments (withdrawals) are credited.
C. A Bank Statement - a copy from the bank, entries are as follows:
 Receipts (deposits) are credited.
 Payments (withdrawals and charges) are debited.
D. Theoretically- What is recorded in the cash book (Bank A/C) is also recorded on the
Bank Statement. Thus, the cash book balance is supposed to be the same or identical to
the balance as shown on the Bank statement. However, in practice, this usually not the
case.

100
 E. There are several reasons why the Cash Book balance may not agree with the balance as
per Bank Statement. In order to explain why there is a difference between the balance as
per cash book, with the balance as per Balance Statement, a statement called Bank
Reconciliation Statement, is prepared .Usually a reconciliation statement is prepared
every month but can be prepared more frequently depending on the requirement of the
concerned entity .Thus, a Bank Reconciliation Statement is prepared to bring into
agreement (reconcile) the Cash Book balance with that of a Bank Statement.
F. Relationship between the customer (Business) and the Bank- it is that of a creditor
and a debtor. Thus a positive (favorable) balance will appear as a debit in the Cash Book,
while on the Bank Statement it will appear as a credit. This is because the Bank statement
reflects the view point. when the business deposits funds with the bank , it shows the
deposit as an asset, i.e. a debit. The bank, however, has received the business money, so it
has a liability to the business and will show this liability as a credit.
G. Why does the Cash Book balance differ from the Bank Statement balance?
1 Timing differences
 Unpresented cheques- These are cheques written out (paid) by
the business (drawer) to various people but which have not yet
been presented for payment at the time the Bank Statement is being
prepared. They are credited in the cash book, but are not reflected
on the debit in the Bank Statement.
 Uncredited Lodgments- These are cheques and cash that have
been deposited into the bank but are not cleared or credited at the
time Bank statement is being prepared. They appear as a debit in the
cash book but are not shown on the Bank Statement as credit.
2 Standing orders / direct debits (D/D)
Standing order
These are written instructions to the bank by its customer to certain sum of
money to a certain person or organization on a certain date. Such amounts
appear on the debit of the bank statement but may not be shown as
accredit in the cash book.
A standing order – a long term arrangement between the customer and the
bank. This is normally evidenced by signing the Standing order
mandate.
Direct debit-
This is a short –term written instruction from a customer (business)
authorizing the entity to paid (creditor) to collect varying amounts from
the bank. Normally, the person or institution who directly draws the funds
(payee) instructs his/ her / its bank to collect (debit) an amount directly
from another’s ( the payer’s) bank account designated by the payer and

101
 pays the funds into a bank account designated by the payee(creditor). It is
used as a means to settle a variety of bills for services / goods offered by
various entities.
3. Credit Transfers
These are amounts (cash and cheques) deposited directly into the
bank account by third parties (normally debtors to the customer). They
appear on the credit side of the bank statement, but are not reflected on the
debit side of the cash book.
4. Bank charges and interest
These are charges (fees) levied on the customer‘s account by the bank
for services being provided. They appear on the debit side of the Bank
Statement but are not reflected on the credit side of the customer’s Cash
Book, as the customer is normally not aware of these charges, The
customer comes to know about these charges when he/she / it
receives a Bank Statement .

5. Dishonored Cheques
These are of two kinds:
 Cheques received from customers of the business and deposited
into Bank , but not honored by drawers ‘ bank. These are debited
in the Cash Book, and appear on the Bank statement both as a
credit and debit. These cheques are returned to the business
marked R/D (Refer to Drawer).
 Cheques presented at bank to withdraw money by the business
( pay self ) but not honored by the bank ,normally because of
insufficient funds in the bank account. They are credited in the
Cash book and appear on the Bank statement both as a debit and
credit.
6. Errors- Errors may be made by either the business in its Cash
Book or the Bank on its Bank Statement, or by both parties. The
common errors are misposting , transposition of figures, and of
commission . The party that commits an error , is supposed to
correct that error in its books.

102
 Steps recommended in preparing a Bank Reconciliation
Statement:
i. If presented with both Cash Book and Bank Reconciliation
Statement
 Initial reconciliation – tick all those items that appear
on both the Cash Book and Bank Statement, with
 identical figures on the right sides.
 Unticked items on the Bank Statement – are used for
the preparation of a Revised or Adjusted Cash Book.
 Unticked items in the Cash Book, normally unpresented
cheques and uncredited lodgments are used for the
preparation of the Bank Reconciliation Statement.

Formats- Bank Reconciliation Statement

1 . Starting with the Cash Book Balance
BANK RECONCILIATION STATEMENT AS AT
……………………………………………………..
K K K
Balance as per adjusted
Cash Book xxx
Add; Un presented Cheques:
Cheque No 0005 xxx
0007 xxx
0009 xxx

103
 xxx
Less: Uncredited
Lodgements xxx
Balance as per Bank Statement xxx

2. Starting with Bank Statement Balance

BANK RECONCILIATION STATEMENT AS AT
…………………………………………………
K K K
Balance as per Bank Statement xxx
Add. Uncredited Lodgements xxx
xxx
xxx
xxx
Less: Unpresented Cheques:
Cheque Nos. 0005 xxx
0007 xxx
0009 xxx

xxx
Balance as per adjusted Cash Book
xxx

Features of a Bank Reconciliation Statement

I. This is a periodical Statement
II. It is merely a Statement not an account
III. It is prepared on a particular day or this Statement is valid on the
day it is prepared.

104
 IV. The preparation of Bank Reconciliation Statement is not a part of
the double entry book-keeping
V. The causes which are responsible for the disagreement of the two
balances can easily be found out or detected.

Examples
1. On 10 the January 2019, C. Banda received his monthly Bank Statement for
the month of December 2018. The Statement showed the following :

DATE PARTICULARS DEBIT CREDIT BALANCE

2018 K000 K000 K000
Dec.1 Balance 18620
Dec. 5 317864 2430 16190
Dec. 5 Dividend 260 16450
Dec. 5 Credit Transfer 2120 18570
Dec.8 317866 1740 16830
Dec. 10 317867 170 16660
Dec. 12 Sundry credit 1850 18510
Dec. 14 Standing order 320 18190
Dec.20 317865 3070 15120
Dec. 20 Credit Transfer 1180 16300
Dec.21 317868 950 15350
Dec. 21 317870 1610 13740
Dec. 24 Bank charges 180 13560
De. 27 Credit transfer 470 14030
Dec. 28 Direct Debit 880 13150
Dec. 29 317878 120 13030
Dec. 29 Credit transfer 2790 15820
Dec. 31 317871 250 15570

C. Banda’s Cash book for the corresponding period showed the following
2018 Details K000 2018 Details Cheque K000
No
Dec 1 Balance
b/d 18620 Dec. 1 Electricity 317864 2430
Dec. 4 J. Kunda 2120 Dec. 2 P. Lombe 317865 3070
Dec. 9 M. 1850 Dec. 5 T.
Simps Chilonga 317866 1740
Dec. 19 G. 1180 Dec.6 Z. Chela 317867 170
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 Mumba
Dec. 26 N. Bupe 470 Dec.10 B. 3178868 950
Mwenzi
Dec.27 J. Banda 2790 Dec.14 T. Chito 137869 710
Dec. 29 V. 980 Dec. 16 Rent 317870 1610
Kombe
Dec.30 B. 1340 Dec. 20 M. Chulu 137871 250
Wilima
Dec. 21 T. Tumulo 137872 370
Dec.22 W. Mutati 137873 120
Dec. 31 Balance
c/d 17930
29350 29350

REQUIRED
( a ) Prepare an Adjusted Cash Book as at 31 st December 2018
( 12 marks)
( b) Draw up a Bank Reconciliation Statement as at 31 st December 2018
( 8 marks )

( Total =-20 marks )

2 The following information was extracted from the books of account J.

Mwiinga
CASH BOOK
BANK ACCOUNT
2017 DETAILS K000 2017 CHEQUE
NO K000
1/03 Balance b/f 2000 5/03 00020 813
2/03 L0dgement 412 10/03 00021 407
9/03 Lodgement 509 11/03 00022 96
9/03 Lodgement 106 19/03 00023 421
15/03 Lodgement 735 20/03 00024 549
22/03 Cash sales 175 21/03 00025 123
28/03 Lodgement 404 28/03 00026 42
31/03 Lodgement 276 31/03 Balance c/d 2166
4617 4617

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 BANK STATEMENT - BKL BANK
DATE PARTICULARS DEBIT CREDIT BALANCE
K000 K000 K000
1/03 Balance b/f 1971
2/03 Lodgement 129 2100
2/03 Cheque No
00015 100 2000
2/03 Lodgement 412 2412
6/03 Cheque No
00020 813 1590
9/03 Lodgement 615 2214
12/03 Cheque No
00022 96 2118
15/03 Standing order –
Long term loan 100 2018
22/03 Lodgement 755 2753
22/03 Cheque No
00025 231 2522
24/03 Lodgement 185 2707
24/03 Bank charges 25 2682

Note: The informs you that all entries on the Bank statement are correct.
REQUIRED
( a) Prepare an opening Statement to reconcile the opening balance in the Cash
book with the bank Statement balance ( 4 marks )
( b ) Prepare an Adjusted Cash Book as at 31 M arch 2017
( 10 marks )
(c ) Prepare a Bank Reconciliation Statement as at 31 March 2017
( 6 marks )

(Total= 20 marks )

Exercises

107
 1 . On 31 December 2018 the Bank column of J. Sichamba ‘s Cash book
showed a debiot balnce of K15000.
The monthly Bankl Statement written up to 31 December 2018 showed a
credit balnce of K29500.
On checking the Cash Book with the Bank Statement the following were
discovered :
i. Dividends amounting to K 2400 had been paid directly to the bank.
ii. A credit transfer of VAT refund of K2600 had been collected by
the bank
iii. Bank charges amounted to K300
iv. A Direct debit of K700 for Sichamba’s membership subscription to
a Traders Association had been paid by the bank.
v. A Standing order 0f K2000 for Sichamba’s long –term loan had
been paid by the bank.
vi. Sichamba’s Deposit account of K14000 was transferred into his
Bank current account.
vii. Two cheques drawn in favour of B. Chulu , K2500 and H. Mainga
K2900 had been entered in the cash book but had not been
presented for payment by the payees.
viii. Cash and cheques amounting to K6900 had been paid into the bank
On 31 December 2018 but had yet been credited by the bank as at
December 2018.

REQUIRED
Prepare :
( a ) An adjusted Cash Book as at 31 December 2018
( 12 marks )
( b ) Bank Reconciliation Statement as at 31 December 2018
( 8 marks )

( Total = 20 marks )

2. The following is the |Cash Book ( Bank columns ) of E. Kabimba for 31

March 2017
2017 Details K000 2017 Details Cheque K000

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 No
Mar- 6 J.Nguni 1550 Mar. 1 Baance 38720
b/f
Mar. 20 C. Chewe 1890 Mar. 10 K. Manda 00060 2060
Mar. 30 P. Mule 2110 Mar. 19 M.
Mwamba 00061 3150
Mar. 31 Balance
c/d 39220 Mar. 29 G. Shonga 00062 840
44770 44770

The Bank Statement for the month of March 2017, revealed the following:
2017 DETAILS DEBIT CREDIT BALANCE
K000 K000 K000
Mar. 1 Balance 38720 O/ D
Mar. 6 Deposit 1550 37170 O/D
Mar. 13 Cheque 2060 39230 O/D
00060
Mar. 20 Deposit 1890 37340 O/D
Mar. 22 Cheque 00061 3150 40490 O/D
Mar. 30 Standing order 2000 42490 O/ D
Mar. 31 Credit trnsfer 1800 40690 O/D
Mar. 31 Bank chages 650 41340 O/ D

REQUIRED :
( a ) Write up the adjusted Cash book as at 31 March 2017
( b ) Prepare a Bank Reconciliation Statement as at #1 March 2017

109
 UNIT 9 ACCOUNTS OF NON- PROFIT MAKING ENTITIES OR NOT-FOR PROFIT
ENTITIES

9.1 Meaning of Not – For Profit Organizations

 These are organizations which :

 Are formed for the purpose of promoting commerce, art, religion.
Charity or any other useful venture
 Intend to spend their income in promoting their objectives and
 Prohibit the payment of any dividend to their members
 They are normally membership based as opposed to ownership.

9.2 Falling under the category of non- profit making entities or not-for Profit- entities
include:

 Professional Associations- eg ZICA, LAZ, ZIM, ZIHRM and others.

 Sports Associations- eg FAZ, BAZ, ZAA, NAZ, RAZ, and others.
 Political organizations,- eg UNIP, MMD, PF, UPND, NAREP, FDD, and
others.
 Trade Unions- eg SETUZ , ZNUT, BESTUZ, MUZ, ZULAWU, ZFIAU, and
others.
 Faith based organizations- eg UCZ, SDA, CATHOLIC, PENTECONTAL
ASSEMBLIES, and others.
 Civil Society Organizations or NGOS with different dimensions –eg
FAWEZA, YMCA, WMCA, Women for Change(WFC), and others.
9.3 How majority of Non- Profit making Organizations regulate themselves

Most of the Non- profit making entities activities are based on the provisions of their
individual constitutions. The executive committee or officer bearers will normally assume the
various positions as provided for by the constitution. These executive members are normally
elected by bonfire members to provide leadership for such organizations. Some of the key
office bearers include President, Chairperson, secretary, Treasurer/ Financial Secretary and
others. These office bearers draw their powers from provisions of their constitution. All

110
 members of these entities are expected to abide by the provisions of the constitution. In fact
the members normally draw up their own constitutions.

Thus the majority of Non- Profit making entities are formed or established to promote the
interests of their members or pursue one or a number of activities that are not meant to
generate profit.

9.3 Accounts to be prepared for a Non- Profit Making Entity.

I. Receipts and Payments Account
 This account is simply a summary of the amounts received (cash and
cheques) and amounts paid (cash and cheques) during the accounting period.
 It is the simplest way a Treasurer/ Financial Secretary can account for funds
of Non- Profit making entity.
 It is a summarized statement of all the receipts and all the payments that
appear in the Cash Book of Non-Profit making entity.

Note:

 Items in this account are treated in the same way as they accounted for in
the Cash or Bank A/C
 It is prepared on Cash accounting basis- It shows the actual amounts
received and the actual amounts spent during the accounting period ( does
not take into account prepayments and accruals)
 No distinction is made between capital receipts and revenue receipts, and
capital expenditure and revenue expenditure.
 The difference between Total Receipts and Total Payments is either cash
surplus or cash deficit

III .Income and Expenditure Account

 This is the “Profit and Loss Account” of a Non- Profit making entity.
 It is prepared on accrual accounting basis- It shows income s earned
expenses incurred during the accounting year.

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  It does not include capital receipts and capital expenditure.
 The balance on this account is either the Excess of Income over
Expenditure (Surplus) or Excess of Expenditure over Income
(Deficit).
 The surplus is transferred to the Balance Sheet where it is added to the
Accumulated Fund. On the other hand, if is deficit, it is deducted from
the Accumulated Fund in the Balance Sheet.
IV. Balance Sheet

This continues to be called a Balance sheet. It will show all

assets , all liabilities and accumulated fund as at the end of the
financial year. It is prepared in the same way as a Balance Sheet
of a Sole trader.

. Accumulated Fund

Many Non-Profit making organizations own various kinds of assets and these
are represented in the Balance Sheet by a Capital Fund known as Accumulated
Fund. Since the majority of Non- Profit making entities do not maintain
their accounting records on Double entry booking system, the Capital Fund or
Accumulated Fund figure is in most cases not available. So there need to
determine or calculate this important figure .In fact majority of questions on
Non- Profit Making entities do not give the amount of Accumulated Fund Thus
this amount has to be calculated.

Calculation of Accumulated Fund

 This is calculated in same way the capital of a Profit- making entity is determined,
through the Accounting Equation Approach:
 Assets- Liabilities = Accumulated Fund , Thus
 Accumulated Fund at start of the Accounting year is calculated as follows:
 Total Assets at start Less Total Liabilities at start = Accumulated Fund at start.
This amount is transferred to the Balance Sheet.

9.4 Sources of income for Non- Profit Making Organizations

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  Membership Subscriptions- from both new and old members, normally annually.
This is the most common and main source of income for majority of Non- Profit
making entities.
 Payment by members for life membership- Certain Non- Profit making
organizations may have a Life Membership Scheme or fund, to which those
members who would like to enjoy life membership status are required to pay a
specified amount for a specified number of years. For example, an entity may
have a Life membership fund to which a member who satisfies the condition is
required to pay K20 Million for 10 years.
 “Profit’ from business ventures established to supplement to the liquidity position
of the entity. These include, profit from bar sales, Refreshment sales, Cafeteria
sales and others.
 Funds from – fund raising activities such as dinner dances, fund raising walks,
raffles, fetes , competitions , and others.
 Income earned from investment made- eg, interest, dividends, etc.
 Government Grants- if any

UNIT 10 PREPARING PARTTNERSHIP ACCOUNTS

10.1 Definition of a Partnership
 It is the relationship which subsist amongst persons carrying on a business in common
with a view of making profit.
 It is a relation between persons who have agreed to share the profits of a business carried
on by all or any one of them acting for all.
10.2 Nature of Partnership
 Two or more persons join hands to set up a business and share profits and
Losses

113
  Agreement – Partnership is the result of an agreement between two or more
persons to do business and hare it profits and losses. The agreement becomes
the basis of the relationship between the partners. The agreement can be either
oral (verbal) or written one. In order to avoid disputes it is preferred that the
partners have a written agreement.
 Business- The agreement should be to carry on some business. Mere co-
ownership of property does not amount to partnership. Example – if Mwaba
and Manda jointly purchase a plot of land,they become the joint owners of the
property and not the partners . But if they are in the business of purchase and
sale of land for the purpose of making profit, they ill be called partners.
 Mutual Agency- The business of a partnership concern may be carried on by
all the partners or any one of them for all. Thestatement has to important
implications.First, every partner is entitled to participate in the conduct of
affair of it business .Second , that there exists a relationship of mutual agency
between all the partners . each partner carrying on the business is the principal
as well as the agent for all the other partners. He/ she canbound other partners
by his/her acts and also is bound by the acts of other partners with regard to the
business of the firm.
 Sharing of Profits- The agreement between partners must be to share profits
and losses of a business. If some persons join hands for the purpose of some
charitable activity, it will not be termed as partnership.
 Liability of Partners-Each partner is liable jointly with all the other partners
and also severally to the third party for all the cats of the firm done while
he/she is a partner. Not only that the liability of a partner for acts of the firm is
also unlimited .This implies his/her private assets can be used for paying of the
firm’s debts.
10.3Partnership Agreement ( Partnership Deed )
 Partnership comes into existence as a result of agreement among the
partners. The agreement can be either oral or written .The Partnership Act
does not require that the agreement must be in writing .Whenever it is in
writing , the document which contains terms of the agreement is normally
referred to as Partnership Deed.
 Partnership Deed – generally contains the details about all the aspects
affecting the relationship between the partners including the objective of
business. The clauses of Parrtnership Deed can be altered with the consent
of all the partners.
10.4 Main clauses in the Partnership Deed
The Partnership Deed usually contain, the following details orclauses :
 Name and address of the firm and its main business
 Names and Addresses of all Partners.
 Amount of Capital to be contributed by each partner.

114
  The Accounting period of the firm.
 The date of commencement of partnership
 Rules regarding operation of Bank accounts
 Profit and Loss sharing ratio.
 Rate of interest onCapital, Loan , drawings ,etc
 Salaries, commission .etc. if payable to any partner.
 The rights, duties and Liabilities of each partner.
 Treatment of loss arising out of insolvency of one or more partners.
 Mode of Auditor’s appointment
 Settlement of accounts of dissolution of the firm
 Method of Settlement ofdisputes among the partners
 Rules or guidelines to be followed in case of admission, retirement
or death of a partner .
 Any other matter relating to the conduct of business.
Provisions Relevant For accounting
i. Profit sharing ratio (PSR ) – if the partnership deed is
silent about the profit sharing ratio , the profits and losses
of the firm are to be shared equally by partners ,
irrespective of their capital contribution in the firm.
ii. Interest on capital –This must stated , normally as
percentage per annum , say 10%, 15%, 20% etc. No
interest on capital is payable if the Partnership deed is silent
on the issue.
iii. Interest Partner’s Drawings – This is stated as a percentage
per annum , say 5% , 10% , 15% ,etc. to be applied pro-
rata on the drawings made by each partner. No interest is
charged on partners’ drawings , if there is no mention in the
Deed .
iv. Interest on advances – If any partner has advanced money
to the firm beyond the amount of his / her capital for the
purpose of business , this amount will be treated like a
loan and will attract an interest of 6% per annum.
v. Remuneration for firm’s work – Partners who actively take
part in the conduct of the business activities will normally
be entitled to a salary per annum . If not included in the
Deed , no partner is entitled to get a salary or other
remuneration for taking part in the conduct of the business
of the firm .
In the absence of a Partnership Deed or Agreement ,
Partnership Act , 1890 states that :
i. Partners shall contribute to the capital of the firm
equally.

115
 ii. No partner should be receive a salary or remuneration
for carrying out work of the firm.
iii. No interest on partners capital account should be
allowed .
iv. Not interest to be charged on Partners Drawings .
v. Partners should share profits and losses equally.
10.5 Legal Status of a Partnership
 In some countries there may legal provisions that permit partnerships to
incorporated. This will allow partnership to operate as legal entities separate
from the owners (Partners).
 In the majority of countries there are no legal provisions ( Statute ) that allow
partnerships to be incorporated. This means legally the partnership and partners
are not separate entities. This means, generally that partners have unlimited
liability.
 However, for accounting purposes, the partnership and partners will treated as
separate entities. This is in conformity with Separate Entity Concept.
10.6 Types of Partnership in a Partnership Relationship
1. Limited Partners – These are partners with limited liability. This means
that these partners are only liable or accountable to the debts of the
partnership up to the amount of capital that each partner has contributed to
the partnership. These partners do not participate in the management of the
partnership.
2. General Partners- These are sometimes referred to as ordinary partners.
They have unlimited liability. This means that they are liable to the debts
of the partnership beyond the amount of capital that each one has
contributed to the partnership. Such partners are normally responsible for
the day-to- day running of the business.
Note- In any Partnership there must be at least a general partner.

10.7 Types of Accounts to be prepared;

(a ). Basic Partnership Accounts
1. Profit and Loss Appropriation Account or Statement of Division of
Profit
 This is merely an extension of the Income Statement of the firm.
 It is an account prepared on the basis of the accounting clauses of
the Partnership Agreement.
 It shows how profits generated by the firm are appropriated or
distributed among the partners.

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  All items relating to interest on drawings, partnership
salary,partners’ commission, interest on capital etc are accounted
for in this account.

PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31

DECEMBER………………….
K K
Net profit xx
Interest Drawings:
A xx
B xx
C xx
xx
Total amount to be xx
appropriated
Appropritions :
Salary- A xx
C xx
Interest on Capital :
A xx
B xx
C xx
(xx)
Residual shared : xx
A xx
B xx
C xx
(xx)
0

2. Partners Capital Accounts

 A Capital account will be maintained for each partner.
 A partner’s capital account records the initial capital invested in
the business by each partner.
 Partner’s Capital Account can either be a fixed capital account or
a Fluctuating capital account.
 Under the fixed capital method , the capital of the partners hall
remain fixed unless additional capital is introduced or part of the
capital is withdrawn as pert agreement amongst the partners.,.

117
 When fixed capital accounts are maintained, a Current Account
will be maintained for each partner.
 Fluctuating Capital method – Under this method, only one
account is normally maintained for each partner. All entries for
the year are recorded in this account . This makes the balance in
the capital account to fluctuate from time to time.
3. Partners’ Current Accounts
 A Partner’s Current account is used to account for regular
transactions between the partner and the firm.
 The common items recorded in this account are Drawings,
interest on Drawings , Partner’s salary ( if any) , interest on
partners capital.
 The balances on the Current accounts fluctuate from year
to ye
Example
I. Kaiko ,Bupe and Ndumbo sat up a partnership firm as general
partners, to buy and sell a variety of consumer products., on 1
April 2015 .
II. They contributed , K50000, K40000, and K30000 respectively
as their capitals
III. The other provisions of the Partnership Agreement were:
a) Kaikowas entitled to a salary of K1000 per
month.
b) Bupea entitled to a commission of K5000 per
annum.
c) Interest at a rate of 10% was to be paid on
partners’ Capital Accounts.
d) Interest at a rate of 5% per annum was to be
charged on partners ‘drawings
e) Partners were to share profits and losses in the
ratio of 3:2: 1 respectively.
The partners’ drawings for the year to 31March 2016 were:
Kaiko- K6000
Bupe- K 4000
Ndumbo- K2000
The Net Trading Profit earned for the year ended 31March 2016
,amounted to K130000.

REQUIRED:

118
 Prepare:
( a ) Profit and Loss Appropriation Account for the year ended 31March
2016 ( in vertical format)
( b) Partners’ Current Accounts ( in columnar format )
( c ) Partners’ Capital Account (in columnar format )

SOLUTION (a ) PROFIT AND LOSS APPROPRIATION

ACCOUNT FOR THE YEAR ENDED 31M ARCH 2016
K K K
Net profit 130000
Interest on Drawings:
Kaiko( 6000 x 0.05) 300
Bupe ( 4000 x0.05 ) 200
Ndumbo (
2000 x0.05) 100
600
Total earnings or 130600
profit for approprition
Appropriations:
Salary- Kaiko
( 1000 x12) 12000
Commission- Bupe 5000
Interest on capital:
Kaiko
(.10 x K50000) 5000
Bupe (.10x 40000) 4000
Ndumbo
(0.10 x 30000) 3000
(29000)
Residue shared: 101600
Kaiko (3/6 x 101600) 50800
Bupe ( 2/6 x 101600) 33867

Ndumbo (1/6 x
101600) 16933
( 101600)
0

(b ) CURRENT ACCOUNT
Kaiko Bupe Ndumbo Kaiko Bupe Ndumbo

119
 K K K K K K
Drawings 6000 4000 2000 salary 12000
Intert on Commission 5000
Draings 300 200 100
Balance Interest on
c/d 61500 38667 17833 Capital 5000 4000 3000
Hare of
Residual 50800 33867 16933
67800 42867 19933 67800 42867 19933

CAPITAL ACCOUNT
Kaiko Bupe Ndumbo Kaiko Bupe Ndumbo
K K K K K K
Balance 50000 Bank 50000 40000 30000
c/d 40000 30000
50000 40000 30000 50000 40000 30000

Exercise
Banda and Chongo had been in partnerhip for several years dealing in assorted popular
consumer products.
The followingdetails are available regarding the partners business:
i. As at 1 January 2018, partners’ Capital and Current Accounts revealed the
following balances:

CAPITAL ACCOUNT CURRENT ACCOUNT

K K
Banda 200000 5000( Cr )
Chongo 400000 7000 ( cr )

ii. Other provisions of the Partnership Agreement were :

(a ) Partners were hare profits and losses equally
( b) Interet at the rate of 15% per annum was to be paid on partner capital amounts.

120
 ( c ) Banda and Chongo were entitled to annual salaries of K 3000 and K5000
respectively
(d ) Interest at a rate of 5% per annum was to be charged on partners’ drawings .
Drawings by partners during the year were as follows :
Banda K8000 ( all on 30th June 2018 )
Chongo K 6000( all on 31 March 2018)
The Net Trading profit for the year ended 31 December 2018 , amounted
to K150000
REQUIRED
Prepare :
( a) Partner’ Profit and Loss Appropriation Account for the year ended 31
December 2018
( b) Partners’ Current Accounts ( in columnar format )
( c ) Partners’ Capital Accounts ( in columnar format )

END OF YEAR FINANCIAL STATEMENTS FOR A PARTNERSHIP ENTITY

(a)Partnerships like other business entities are required to prepare end of year financial
statements. This is in conformity with the Periodicity Concept Accounting period
convention) .

(b)The main end of year financial statements for a partnership entity is as follows:
I. Income Statement or Trading and Profit and Loss Account- This is prepared to show
the financial performance of e entity .It will show all the incomes earned all the
expenses incurred for the period. The main purpose of this account is to ascertain either
the Net profit or Net loss. When total incomes earned exceed total expenses incurred
for the same period, the result is Net profit. On the other hand when total expenses
incurred exceed total incomes earned for the same period. The result is Net Loss.
II. The Appropriation Account-The Net trading profit ascertained in the Income Statement
is transferred to the Appropriation Account. This account shows how the Net trading

121
 profit is distributed of appropriated in accordance with the provisions or clauses of the
Partnership agreement. Therefore in preparing this account one has to comply with the
provisions or clauses of the Partnership Agreement.
III. Partners’ Current Accounts- A partner’s Current Account will show all the necessary
items that have a direct impact on each partner during a specified accounting period.
Thus items .such as Drawings, Interest on drawings, partnership salary (if any), interest
on partner’s capital and share of residual are recorded in this account. A balance will be
ascertained in each partner’s current account. A balance on each Partner’s current
account is transferred to the Balance Sheet or Statement of Financial Position.
IV. Balance Sheet or Statement of Financial Position- This is prepared to show the financial
position of the entity as at the end of the financial year. It will show all Assets, all
liabilities and Partners’ current and capital accounts
Thus, full Partnership Accounts are:
 Trial Balance or a List of balances provided
 Additional notes relating to adjustments given
 Task :
i. Income Statement to determine either Net profit or Net loss for the
specified accounting period.
ii. Appropriation Account to the distribution of profit among the partners
on the basis of accounting clauses of the Partnership Agreement
iii. Partners Current Accounts to determine the closing balances to be
transferred to the Statement of Financial Position or Balance Sheet.
iv. Statement of Financial Position or Balance Sheet , showing all Assets,
Liabilities and separate partners’ Capital and Current Accounts.
Example
Pinto,Banda and Chato have been in partnership for several years as general partners
dealing in a variety of retail product. They share profits and losses in the ratio 6:1:3
respectively. The firm’s Trial Balance as at 31 March 2017 was as follows
Dr Cr
K K
Sales revenue 334618
Purchases 196239
Carriage inwards 3100
Returns inwards 10200
Discount allowed 190
Bad debts 1620
Inventory 1/04/ 2016 68127

122
 Salaries and wages 54117
Allowance for irrecoverable
debts 1/04/2016 950
Advertising 2900
General expenses 1017
Potage 845
Motor vehicle at cost 8400
Office Equipment at cost 5700
Accumulated depreciation
1/04/201:
Motor vehicles 3600
Office equipment 2900
Trade payables 36480
Trade Receivables 51320
Cash at Bank 5214
Drawings:
Pinto 39000
Banda 16000
Chato 28000
Current Accounts:
Pinto 5940
Banda 2117
Chato 9618
Capital Accounts:
Pinto 60000
Banda 10000
Chato 30000
494106 494106

ADDITIONAL INFORMATION:
i. Inventory at 31March 2017 was valued at K 74500 , cost
ii. K200 was paid in advance for advertising as at 31March 2017
iii. K 500 was accrued for salaries and wages as at 31 March 2017
iv. Allowance for irrecoverable debts is to adjusted to 5% of Trade
receivables.
v. Partners salaries were payable to Banda and Chato at K18000 and
K16000 respectively perannum.
vi. Interest at 15% per annum allowed on Partners’ capital amounts.
vii. Interest at a rate of 10 % per annum was charged on partners’
drawings.
viii. Deprecationis to be provided for as follows:
Motor vehicles- 15% per annum on reducing balance basis

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 Office equipment- 5% per annum on straight line basis.
REQUIRED:
Prepare:
( a ) Income Statement and Appropriation Account for the year
ended 31March 2017
(b) Partners’ Current Accounts
( c) Statement of Financial Position as at 31 March 2017

UNIT 12 : Analyzing and Interpreting financial statements to aid decision

making for users of Accounting information

12.1 Financial Statements provide valuable historical information in respect of the financial
position on a particular date (Statement of Financial Position), the financial performance for
the specified accounting period (Income Statement/ Statement of Comprehensive Income
/Statement of Profit or Loss) and the generation and utilization of cash during a specified
reporting period (Statement of Cashflows )

12.2 Information in the financial statements, though summarized assist interested

parties (users) to make certain decisions about the entity. These decisions are

economic decisions. These decisions can only be made after the information

has been measured and evaluated. The measurement and evaluation of information

disclosed in the financial statements is referred to as Analysis and Interpretation of financial

statements , and is regarded as the last phase in the accounting process

Or cycle.

12.3 Purpose

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The purpose of the analysis and interpretation of financial statements is depended upon the users
needs or interest. This could be one of the following:

 To determine whether the enterprise/ organization achieved its main objectives, namely,
the maximization of profit/ maximization of shareholders’ wealth.
 To determine whether the enterprise / organization will be able meet the interest and
debt (loan) commitments of their non- current liabilities.
 To determine whether the enterprise/ organization will be to settle its current liabilities
using their liquid funds (funds available from its current assets).
 To determine whether a specific investment produced a reasonable and acceptable return.
 To determine the potential of a company or enterprise to issue financial instruments-
equity/ debt instruments (shares, bonds, debentures) to raise long –term finance.
 To identify the problem areas (weaknesses) where the enterprise’s performance is below
average.

Analysis and Interpretation is the link between the financial statements and decision making
process.

12.4 Purpose of Analysis and Interpretation

The purpose of the analysis and interpretation of financial statements is to provide useful
(relevant) information to support decisions about the organization. Thus, analysis and
interpretation of information disclosed in the end of year financial statements is for the
benefit of different users of who have different interests or needs to make economic decisions
about the organization.

12.5 Financial Ratios or Accounting Ratios

One technique or method that is widely used in analyzing and interpreting financial statements
is the use of Financial Ratios or Accounting Ratios.

Financial ratios are calculated using information disclosed in financial statements

In key performance areas of the entity to interprete and analyse the performance

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of the entity for particular accounting period. Financial ratios provide a quick and relatively
simple means of analyzing the financial performance and financial position of the business or
enterprise for the specified accounting period(s).

By calculating a relatively small number of ratios, it is often possible to build up or deduce a

reasonable good picture of the financial performance and financial position of the enterprise.
Ratios will be an indicator of the financial strengths, and weaknesses of the business, though
they can not by themselves explain why certain strengths and weaknesses exist or why certain
events have occurred.

12.6 Users of Accounting information disclosed in the financial statements

The users of information disclosed in the end of year financial statements include:

 Present or Current owners of the enterprise (Shareholders)

 Management
 Employees
 Trade unions
 Trade contacts- Suppliers and Customers
 Government agencies- e. g Tax authority, Central statistical office(CSO), etc.
 Financial Institutions- Banks and other providers of Long term loans(Debt-capital)
 Potential investors
 Financial Analysts/ Financial advisors
 Competitors
 The public
 Donors (Financial Sponsors)
 Pressure Groups or Civil Society Organizations.

12.7 The main uses of Financial or Accounting Ratios

 1 To compare the performance of different companies in the same industry.It is vital

to assess or discover how well a firm is performing in relation to other firms in the

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 same industry and also compare the performance of the firm with average
performance of that of the industry to which the firm belong. Ratios computed will
be used to establish as to whether the firm’s performance is above or below that of
the other firms in the same industry or that of the industry.
 To compare the performance of the same firm or company in different time
periods (Trend analysis). It is an acceptable practice for each enterprise or firm to
assess or evaluate its performance in different accounting periods. Ratios computed
will provide a clue of the trend of the firm’s performance over a number of years
(accounting periods) .The main concern in this regard is to assess the company’s
performance whether it is improving, declining or stable.
 To compare the performance of one segment or division of a business with others to
establish which parts of the business are achieving their objectives.
 To compare the current performance of the enterprise to standard or bench mark
performance.

12.8 Broad categories of basic Financial Ratios

i Profitability and Return Ratios

ii Efficiency (Turnover ratios)

iii Short-term solvency/ Liquidity Ratios

iv Long-term solvency and financial stability / risk ratios

v. Shareholders’/ Investment ratios.

12.9 Limitations/ Drawbacks of Financial Ratios

I Differences between different units (segments/ divisions)- different units in an

organization can function under different circumstances and different accounting policies.
This reduces comparability.

II. Interpretation Techniques

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 These depend on assessments and estimates. Minor mistakes in identifying and
quantifying relevant information can have a major adverse effect on the results of analysis
and interpretation of financial ratios.

III Financial Statements

These contain historical information which may not be relevant to the future. . Morever,

historical cost accounting ignores the effects of inflation.

IV Comparison with industry Averages

This may be difficult if the firm operates many different divisions.

v Size- The size of a company affects its operations. Larger companies enjoy economies of
scale and attract professional man power. This may enhance their profitability.

vi Sometimes financial statements are manipulated to present particular results or ratios.

Such cosmetic financial statements deceive or cheat the investors and other users.

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