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TheInstituteofCharteredAccountantsinEnglandandWales
ACCOUNTING
Forexamsupto31July2016
StudyManual
www.icaew.com
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Accounting TheInstituteofCharteredAccountantsinEnglandandWales ISBN:978-1-78363-197-1
PreviousISBN:978-0-85760-977-9 Firstedition2007 Ninthedition2015 Allrightsreserved.Nopartofthispublicationmaybereproduced,storedina retrievalsystemortransmittedinanyformorbyanymeans,graphic, electronicormechanicalincludingphotocopying,recording,scanningor otherwise,withoutthepriorwrittenpermissionofthepublisher. BritishLibraryCataloguing-in-PublicationData AcataloguerecordforthisbookisavailablefromtheBritishLibrary OriginallyprintedintheUnitedKingdombyPolestarWheatonsonpaper obtainedfromtraceable,sustainablesources. PolestarWheatons HennockRoad MarshBarton Exeter EX28RP
©TheInstituteofCharteredAccountantsinEnglandandWales
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WelcometoICAEW IamdelightedthatyouhavechosenICAEWtoprogressyourjourneytowardsjoiningthechartered accountancyprofession.ItisoneofthebestdecisionsIalsomade. Theroleoftheaccountancyprofessionintheworld’seconomieshasneverbeenmoreimportant. Peoplemakingfinancialdecisionsneedknowledgeandguidancebasedonthehighesttechnicaland ethicalstandards.ICAEWCharteredAccountantsprovidethisbetterthananyone.Theychallengepeople andorganisationstothinkandactdifferently,toprovideclarityandrigour,andsohelpcreateand sustainprosperityallovertheworld. Asaworldleaderoftheaccountancyandfinanceprofession,weareproudtopromote,developand supportover144,000charteredaccountantsworldwide.Ourmembershavetheknowledge,skillsand commitmenttomaintainthehighestprofessionalstandardsandintegrity.Theyarepartofsomething special,andnow,soareyou.It’swithoursupportanddedicationthatourmembersandhopefully yourself,willrealisecareerambitions,maintainaprofessionaledgeandcontributetotheprofession. Youarenowonyourjourneytowardsjoiningtheaccountancyprofession,andahighlyrewardingcareer withendlessopportunities.So,ifyouarestudyingforourCertificateinFinance,Accountingand Business(ICAEWCFAB)orourworld-leadingcharteredaccountancyqualification,theACA,youtoo havemadethefirstofmanygreatdecisionsinyourcareer. Youareingoodcompany,withanetworkofover26,000studentsaroundtheworldmadeupoflikemindedpeople,youareallsupportedbyICAEW.Weareheretosupportyouasyouprogressthrough yourstudiesandcareer,wewillbewithyoueverystepoftheway,visitpagextoreviewthekey resourcesavailableasyoustudy. Iwishyouthebestofluckwithyourstudiesandlookforwardtowelcomingyoutotheprofessioninthe future. MichaelIzza ChiefExecutive ICAEW
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Contents
Introduction
vii
Accounting
viii
Keyresources
ix
1.
Introductiontoaccounting
1
2.
Theaccountingequation
31
3.
Recordingfinancialtransactions
61
4.
Ledgeraccountinganddoubleentry
79
5.
Preparingbasicfinancialstatements
111
6.
Controlaccounts,errorsandsuspenseaccounts
137
7.
Costofsalesandinventories
177
8.
Irrecoverabledebtsandallowances
213
9.
Accrualsandprepayments
231
10. Non-currentassetsanddepreciation
255
11. Limitedcompanyfinancialstatements
291
12. Statementofcashflows
321
13. CompanyfinancialstatementsunderUKGAAP
345
14. SoletraderandpartnershipfinancialstatementsunderUKGAAP
367
391
Index
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1 Introduction ACAqualification TheICAEWcharteredaccountancyqualification,theACA,isaworld-leadingprofessionalqualificationin accountancy,financeandbusiness. TheACAhasintegratedcomponentsthatgiveyouanin-depthunderstandingacrossaccountancy, financeandbusiness.Combined,theyhelpbuildthetechnicalknowledge,professionalskillsand practicalexperienceneededtobecomeanICAEWCharteredAccountant. Eachcomponentisdesignedtocomplementeachother,whichmeansthatyoucanputtheoryinto practiceandyoucanunderstandandapplywhatyoulearntoyourday-to-daywork.Progression throughalltheelementsoftheACAsimultaneouslywillenableyoutobemoresuccessfulinthe workplaceandexams. Thecomponentsare:
Professionaldevelopment Ethicsandprofessionalscepticism 3-5yearspracticalworkexperience 15accountancy,financeandbusinessmodules
TofindoutmoreonthecomponentsoftheACAandwhatisinvolvedintraining,visityourdashboard aticaew.com/dashboard
ICAEWCertificateinFinance,AccountingandBusiness TheICAEWCertificateinFinance,AccountingandBusiness(ICAEWCFAB)teachesessentialskillsand knowledgeinthethreekeyareasoffinance,accountingandbusiness. ICAEWCFABconsistsofthesamesixmodulesasthefirstlevelofourworld-leadingqualification,the ACA.Thismeans,itcanserveasastand-alonequalificationorasasteppingstoneonyourjourney towardscharteredaccountancy. YoucanfindoutmoreabouttheICAEWCFABexamsandsyllabusaticaew.com/cfabstudents TolearnmoreabouttheACAqualificationandcharteredaccountancy,visiticaew.com/careers
Introduction
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2 Accounting Thefullsyllabusandtechnicalknowledgegridscanbefoundwithinthemodulestudyguide.Visit icaew.com/dashboardforthisandmoreresources.
2.1 Moduleaim Toensurethatstudentshaveasoundunderstandingofthetechniquesofdoubleentryaccountingand canapplyitsprinciplesinrecordingtransactions,adjustingfinancialrecordsandpreparingnon-complex financialstatements. Oncompletionofthismodule,candidateswillbe:
Proficientintheuseofdoubleentryaccountingtechniquesandthemaintenanceofaccounting records
Abletoidentifyandcorrectomissionsanderrorsinaccountingrecordsandfinancialstatements
Abletospecifythecomponentsoffinancialstatements,andprepareandpresentnon-complex accountsforsoletraders,partnershipsandlimitedcompanies
2.2 MethodofAssessment TheAccountingmoduleisassessedbya1.5hourcomputer-basedexam.40%ofthemarksare allocatedfromthepreparationofasinglecompanyfinancialstatements;eitheranincomestatement andstatementoffinancialpositionorastatementofcashflows,usingapro-formatemplate.The remaining60%ofthemarksarefrom24multiple-choiceormultiple-responsequestions.
2.3 Specificationgrid Thisgridshowstherelativeweightingsofsubjectswithinthismoduleandshouldguidetherelative studytimespentoneach.Overtimethemarksavailableintheassessmentwillequatetotheweightings below,whileslightvariationsmayoccurinindividualassessmentstoenablesuitablyrigorousquestions tobeset. Maintainingfinancialrecords Adjustmentstoaccountingrecordsandfinancialstatements Preparingfinancialstatements
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Weighting (%) 30 35 35 100
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3 KeyResources Studentsupportteam Ourstudentsupportteamareheretohelpyou,providingfullsupportthroughoutyourstudies. T+44(0)1908248250 F+44(0)1908248069 E[email protected]
Studentwebsite Thestudentareaofourwebsiteprovidesthelatestinformation,guidanceandexclusiveresourcesto helpyouasyouprogressthroughtheACA.Findeverythingyouneed(fromsamplepaperstoerrata sheets)aticaew.com/dashboard. IfyouarestudyingfortheICAEWCFABqualification,youcanaccessexamresourcesandsupportat icaew.com/cfab.
Onlinestudentcommunity Theonlinestudentcommunityprovidessupportandpracticaladvice–whereveryouare,wheneveryou needit.Withregularblogscoveringarangeofwork,lifeandstudytopicsaswellasaforumwhereyou canpostyourquestionsandshareyourowntips.ACAandICAEWCFABstudentscanjointhe conversationaticaew.com/studentcommunity.
Tuition TheICAEWPartnerinLearningschemerecognisestuitionproviderswhocomplywithourcoreprinciples ofqualitycoursedelivery.IfyouarereceivingstructuredtuitionwithanICAEWPartnerinLearning, makesureyouknowhowandwhenyoucancontactyourtutorsforextrahelp.Ifyouarenotreceiving structuredtuitionandareinterestedinclassroom,onlineordistancelearningtuition,takealookatour recognisedPartnerinLearningtuitionprovidersinyourarea,onourwebsiteicaew.com/dashboard.
FacultiesandSpecialInterestGroups Facultiesandspecialinterestgroupssupportanddevelopmembersandstudentsinareasofworkand industrysectorsthatareofparticularinterest. Oursevenfacultiesprovideknowledge,eventsandessentialtechnicalresources.AsanACAorICAEW CFABstudent,youcanregistertoreceiveacomplimentarye-newsletterfromonefacultyofyourchoice eachyearthroughoutyourstudies. Findoutmoreaboutfacultiesandspecialinterestgroupsaticaew.com/facultiesandsigs.
Library&InformationService(LIS) TheLibrary&InformationServiceisICAEW’sworld-leadingaccountancyandbusinesslibrary.Thelibrary providesaccesstothousandsofresourcesonlineandadocumentdeliveryservice,you’llbesuretofind ausefuleBook,relevantarticleorindustryguidetohelpyou.Findoutmoreaticaew.com/library.
Introduction
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Accounting
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CHAPTER1
Introductiontoaccounting
Introduction Examinationcontext TopicList 1 Thepurposeofaccountinginformation 2 Themainfinancialstatements 3 Theregulationofaccountingandethicalconsiderations 4 Qualitativecharacteristicsofusefulaccountinginformation 5 Accountingconceptsandconventions 6 Capitalandrevenueitems SummaryandSelf-test Technicalreference AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Specifywhyanentitymaintainsfinancialrecordsandpreparesfinancialstatements
Specifytheethicalconsiderationsforpreparersoffinancialstatements
Recordandaccountfortransactionsinaccordancewiththelaws,regulationsand accountingstandardsapplicabletothefinancialstatements
Specifythekeyaspectsoftheaccrualbasisofaccounting,cashaccountingandbreak-up basisofaccounting
Specificsyllabuslearningoutcomesare:1a,b,d,3b
Syllabuslinks Thematerialinthischapterwillbedevelopedfurtherinthispaper,andlaterintheProfessionallevel moduleofFinancialAccountingandReporting.
Examinationcontext Questionsontopicsinthischapterwillbeknowledge-typemultiplechoicequestions.Intheexamyou mayberequiredto:
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Identifycapitalasopposedtorevenueexpenditure Specifythedistinctionsbetweenthedifferentqualitativecharacteristics Identifytheprinciplesthatrelatetoeachqualitativecharacteristic Identifythedifferentinterestsofstakeholders
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1 Thepurposeofaccountinginformation
C H A P T E R
Sectionoverview
Accountingisawayofrecording,analysingandsummarisingthetransactionsofanentity.
Thethreemaintypesofbusinessentityaresoletraders,partnershipsandcompanies.
Userswhoneedfinancialinformationinclude:managers,owners,customers,suppliers,lenders, employees,tradeunions,HMRevenueandCustoms,financialanalystsandadvisers,government agenciesandthepublic.
Managersand(presentandpotential)ownersaretheprimeusersofpublishedfinancial statements.
Peopleneedfinancialinformationonacompanytomakeeconomicdecisions,toassessmanagers' stewardshipofthecompany'sresources,andtoassessthelevel,timingandcertaintyofitsfuture cashflows.
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1.1 Whatisaccounting? Accountingisawayofrecording,analysingandsummarisingtransactionsofanentity(atermweshall usetodescribeanybusinessorganisation).
Thetransactionsarerecordedin'booksoforiginalentry'(seeChapter3). Thetransactionsarethenanalysedandpostedtotheledgers(seeChapter4). Finallythetransactionsaresummarisedinthefinancialstatements(seeChapter5).
Oneoftherolesofanaccountantistomeasuretherevenueandexpenditureofanentityand,ifitisa business,itsprofit.Thisisnotasstraightforwardasitmayseemandinlaterchapterswewilllookat sometheoreticalandpracticaldifficulties.
1.2 Typesofbusinessentity Therearethreemaintypesofprofit-makingbusinessentity.
Soletraders Partnerships Limitedliabilitycompanies
Soletradersarepeoplewhoworkforthemselves.Examplesincludealocalshopkeeper,plumberor hairdresser.Thetermsoletraderreferstotheownershipofthebusiness;soletraderscanhave employees. Partnershipsoccurwhentwoormorepeopledecidetosharetherisksandrewardsofabusiness together.Examplesincludeanaccountancy,medicalorlegalpractice.Apartnershipcantakeoneoftwo forms:ageneralpartnership(liketwoormoresoletraders)andaLimitedLiabilityPartnershipLLP (morelikeacompany). Limitedliabilitycompaniesareincorporatedtotakeadvantageof'limitedliability'fortheirowners (shareholders).Thismeansthat,whilesoletraders(always)andpartners(usually)arepersonally responsiblefortheamountsowedbytheirbusinesses,theowners(shareholders)ofalimitedliability companyareonlyresponsiblefortheamounttobepaidfortheirshares.
1.3 Theobjectiveoffinancialstatements TheConceptualFrameworkforFinancialReporting(fromnowonreferredtoastheConceptualFramework) wasissuedbytheInternationalAccountingStandardsBoard(IASB)inSeptember2010. TheConceptualFrameworksetsoutconceptsthatunderliethepreparationandpresentationoffinancial statementsforawiderangeofusers,manyofwhomhavetorelyonfinancialstatementsastheirmajor
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sourceoffinancialinformationonanentity.Inrealitykeyusergroupswillvarybetweenlargeandsmall entities.However,theConceptualFrameworkfocusesonlargerentities. Whydobusinessesneedtoproduceaccountinginformationintheformoffinancialstatements?Ifa businessisbeingrunefficiently,whyshouldithavetogothroughallthebotherofaccounting proceduresinordertoproducefinancialinformation?TheConceptualFrameworkstatesthat: 'Theobjectiveofgeneralpurposefinancialreportingistoprovidefinancialinformationaboutthe reportingentitythatisusefultoexistingandpotentialinvestors,lendersandothercreditorsinmaking decisionsaboutprovidingresourcestotheentity.' Inotherwords,abusinessshouldproduceinformationaboutitsactivitiesbecausethereareusergroups whowantorneedtoknowthatinformationinordertomakeeconomicdecisions. Whenmakingeconomicdecisions,usersneedtoassess:
Theabilityofthebusinesstogeneratecash Thetimingandcertaintyofcashflows
Whetherthebusinesscangeneratecashoftherightamountdetermineswhetheritcan:
Payitsemployeesandsuppliers Meetinterestpayments Repayloans Paysomethingtoitsowners
TheobjectivestatedabovefromtheConceptualFrameworkisconcernedwithfinancialreportingin general.ItisInternationalAccountingStandard1(IAS1)PresentationofFinancialStatementsthat providestheobjectiveoffinancialstatements.Itstatesthat‘theobjectiveoffinancialstatementsis:
Toprovideinformationaboutthefinancialposition,financialperformanceandcashflowsofan entitythatisusefultoawiderangeofusersinmakingeconomicdecisions.’
Furthermore,IAS1statesthat'thefinancialstatementsalso:
Showtheresultsofmanagement'sstewardshipoftheresourcesentrustedtoit,and
Assistusersoffinancialstatementsinpredictingtheentity'sfuturecashflowsand,inparticular, theirtimingandcertainty.'
Largebusinessesareofinteresttoagreatervarietyofpeopleandsowewillconsiderthecaseofalarge publiccompany,whosesharescanbepurchasedandsoldonastockexchange.
1.4 Whoneedsfinancialinformation? Thefollowingpeoplearelikelytobeinterestedinfinancialinformationaboutalargecompanywith listedshares.
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Managers/directorsappointedbythecompany'sownerstosupervisethedaytodayactivitiesof thecompany.Theyneedinformationaboutthecompany'spresentandfuturefinancialsituation. Thisenablesthemtomanagethebusinessefficiently(exercisingthestewardshipfunction)andto makeeffectivedecisionsaboutmatterssuchaspricing,output,employmentandfinancing.
Ownersofthecompany(shareholders)wanttoassessmanagementperformance.Theywantto knowhowprofitablethecompany'soperationsareandhowmuchprofitisavailablefor distributiontotheshareholdersthroughadividend.Inaddition,thevalueoftheirinvestmentin thecompanyisaffectedbythecompany'sprofitability.
Tradecontactsincludesupplierswhoprovidegoodsoncreditandcustomerswhopurchasegoods orservices.Supplierswanttoknowaboutthecompany'sabilitytopayitsdebts;customersneed toknowthatthecompanyisasecuresourceofsupply,sothatrepeatpurchasesandafter-sales carewillbeavailable.
Financeprovidersincludebankswhichallowthecompanytooperateanoverdraft,orprovide longertermloanfinancesecuredonthecompany'sassets.Abankwantstoensurethatthe companyisabletokeepuploanpayments.
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HMRevenueandCustoms(HMRC)wanttoknowaboutbusinessprofitsinordertoassessthe company'staxliabilities.
Employeeshaveaninterestinthecompany'sfinancialsituation,becausetheircareersand remunerationdependonit.
Financialanalystsandadvisersneedinformationfortheirclientsoraudience.Forexample, stockbrokersneedinformationtoadviseinvestors;creditagencieswantinformationtoadvise potentialsuppliersofgoodstothecompany;andjournalistsneedinformationfortheirreading public.
Governmentagenciesareinterestedintheefficientallocationofresourcesandthereforeinthe activitiesofenterprises.Theyalsorequireinformationinordertoprovideabasisfornational statistics.
Thepublic.Businessentitiesaffectmembersofthepublicinavarietyofways.Forexample,they maymakeasubstantialcontributiontoalocaleconomybyprovidingemploymentandusinglocal suppliers.Anotherimportantfactoristheeffectofanentityonthenaturalenvironment,for exampleasregardspollution.
BodiessuchastheFinancialConductAuthority(FCA)whoregulatethefinancialservicesindustry, requireinformationtoensurecompliancewithregulationsandthelaw.
C H A P T E R
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Accountinginformationissummarisedinfinancialstatementstosatisfytheinformationneedsofthese differentgroups.However,someoftheseindividualusersoffinancialinformationmayhaveconflicting needs,sotheIASBstatesintheConceptualFrameworkthatindevelopingfinancialreportingstandardsit ‘seekstoprovidetheinformationsetthatwillmeettheneedsofthemaximumnumberofprimary users’. ItisalsorecognisedintheConceptualFrameworkthatprovidingfinancialinformationhasacost,and thatthebenefitstotheusersshouldbejustified. Managersofabusinessneedthemostinformation,tohelpthemmakeplanningandcontroldecisions. Theyhavegreateraccesstobusinessinformation,becausetheyareabletoreviewinternallyproduced statements.Managerscanobtainextrainformationthroughthecostandmanagementaccounting system.
Interactivequestion1:Accountinginformation
[Difficultylevel:Intermediate]
Itiseasytoseehow'internal'peoplegetholdofaccountinginformation.Amanager,forexample,can justgoalongtotheaccountsdepartmentandaskthestafftheretopreparewhateveraccounting statementssheneeds.Butexternalusersofaccountscannotdothis.How,inpractice,canabusiness contactorafinancialanalystaccessaccountinginformationaboutacompany? SeeAnswerattheendofthischapter. Inadditiontomanagementinformation,additionalfinancialstatementsarepreparedforthebenefitof otherusergroups,whomaydemandparticularinformation.
HMRCwillreceiveinformationtomaketaxassessments. Abankmightdemandacashflowforecastasapreconditionofgrantinganoverdraft.
TheIASBisresponsibleforissuingInternationalAccountingStandardsandInternationalFinancial ReportingStandards(IASsandIFRSs)andtheserequirecompaniestopublishcertainadditional information.Accountants,asmembersofprofessionalbodies,areplacedunderanobligationtoensure thatcompanyfinancialstatementsconformtotherequirementsofIAS/IFRS,whererelevant. Overtime,generallyacceptedaccountingpracticehasdevelopedintheUKtoformUKGAAP.Many companies,aswellassoletradersandpartnerships,preparetheiraccountinginformationfollowingUK GAAPratherthanIFRS. Note.InthisStudyManual,wewillrefertothecollectivebodyofstandardsissuedbytheIASBasIASs.
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1.4.1 Not-for-profitentities Itisnotonlybusinessesthatneedtopreparefinancialstatements.Charitiesandclubs,forexample, preparefinancialstatementseveryyear.Financialstatementsalsoneedtobepreparedforgovernment (publicsector)organisations.
1.5 Usersandtheirinformationneeds AswellasidentifyingtheobjectivesoffinancialreportingtheConceptualFrameworkidentifiesusersof financialstatementsandtheirspecificinformationneeds. BelowweconsiderthoseusersidentifiedbytheConceptualFrameworkalongwithotherpotentialusers offinancialstatements,aswellastheaspectsoffinancialstatementstheyarelikelytobeinterestedin.
Investors(currentandpotentialowners)aretheprovidersofriskcapitalforthecompany,sothey areinterestedintherisktotheircapitalpresentedbytheinvestment,andthereturntheywillget fortakingthatrisk.Theyneedinformationtohelpthemdeterminewhethertheyshouldbuy,hold orsellshares.Ownersarealsointerestedininformationwhichenablesthemtoassesstheabilityof theentitytopaydividends.
Employeesandtheirrepresentativegroupsneedinformationaboutthestabilityandprofitabilityof theiremployers,sotheycanassesstheentity'sabilitytoprovideremuneration,retirementbenefits andemploymentopportunities.
Lendersneedinformationthatenablesthemtodeterminewhethertheirloans,andtheinterest attachedtothem,willbepaidwhendue.
Suppliersandothercreditorsneedinformationthatenablesthemtodeterminewhetheramounts owingtothemwillbepaid.Tradecreditorsarelikelytobeinterestedinanentityoverashorter periodthanlenders,unlesstheyaredependentuponthecontinuationoftheentityasamajor customer.
Customersneedinformationabouttheentity'scontinuance,especiallywhentheyhavealongterminvolvementwith,oraredependenton,theentity.
Governmentsandtheiragencieshavetheneedslistedinsection1.4.Theyalsorequire informationinordertoregulatetheactivitiesofentities,anddeterminetaxationpolicies.
Public.Membersofthepublichavetheneedslistedinsection1.4,thatistheywishtoseehowthe companywillbeabletocontinueemployinglocalpeopleandusinglocalsuppliers.Financial statementsmayassistthepublicbyprovidinginformationaboutthetrendsandrecent developmentsintheprosperityoftheentityandtherangeofitsactivities.
Themanagementofareportingentitywillbeinterestedinfinancialinformationabouttheentitybut doesnotneedtorelyongeneralpurposefinancialreportsbecauseitisabletoobtainthefinancial informationitneedsinternally. Thereforeinsteadofbeingthoughtofasusersofthefinancialstatements,managementareprimarily responsibleforthepreparationandpresentationofthefinancialstatements.
1.5.1 Ethicalconsiderations Ethicalconsiderationsshouldunderpintheworkofallprofessionalaccountants,includingthosein businesswhopreparefinancialstatementsandthosewhosettherulesandregulationsoffinancial reporting. Inorderfortheworkofaccountantstocontinuetobevaluable,thefinancialinformationthatthey providemustbeperceivedasbeingtrustworthy.Ifthisreliabilitybecomescompromisedthenuserswill nolongerdependontheinformationandthevalueoftheprofessionwillbedamaged. Byadheringtoacodeofconductandethicalbehaviour,accountantscanmaintainpublicconfidencein theprofessionandthusmaintainthevalueofaccounting.Ethicalconsiderationsarediscussedfurtherin section3ofthischapter.
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2 Themainfinancialstatements
C H A P T E R
Sectionoverview
FinancialstatementspreparedunderIASscollectivelycompriseastatementoffinancialposition,a statementofcomprehensiveincomeincludingastatementofprofitorloss(previouslyreferredto asanincomestatement),astatementofchangesinequity,astatementofcashflows,notesand (incertaincircumstances)arevisedstatementoffinancialpositionfromanearlierperiod.
IAS1PresentationofFinancialStatementssetsouttheformandcontentofthefinancialstatements.
1
IAS1PresentationofFinancialStatementsidentifiesacompletesetoffinancialstatementsforareporting period(typicallyayear)ascomprising:
Astatementoffinancialpositionasattheendofthereportingperiod(asweshallseeinChapter 13,underUKGAAPthisiscalledabalancesheet),
Astatementofcomprehensiveincomeforthereportingperiod,whichcanbeinatwo-partformat includingaseparatestatementofprofitorloss(asweshallseeinChapter13,underUKGAAP thisiscalledaprofitandlossaccount),
Astatementofchangesinequityforthereportingperiod,
Astatementofcashflowsforthereportingperiod,
Notescomprisingasummaryofsignificantaccountingpoliciesandotherexplanatory information,and
Astatementoffinancialpositionasatthebeginningoftheearliestcomparativeperiodwhenan entityappliesanaccountingpolicyretrospectively,makesarestatementofitemsinitsfinancial statements,orreclassifiesitems.
InthisStudyManualweareonlyconcernedwiththestatementoffinancialposition,thestatement ofprofitorlosspartofthestatementofcomprehensiveincome,thestatementofcashflowsandthe summaryofaccountingpoliciesnote. IAS1makesitclearthatanentitymayusetitlesforthestatementsotherthanthoseusedinthe Standard.Manyentitieswillnodoubtcontinuetousetheterm'balancesheet'insteadof'statementof financialposition','statementofprofitorloss'insteadof'statementofcomprehensiveincome'and 'cashflowstatement'insteadof'statementofcashflows'.HoweverinthisStudyManualweshalluse theIAS1terminologyuntilChapter13,whenweshallusetheterminologyoffinancialstatements preparedunderUKGAAP('balancesheet'and'profitandlossaccount').
2.1 Statementoffinancialposition Definitions Statementoffinancialposition:Alistofalltheassetscontrolledandalltheliabilitiesowedbya businessasataparticulardate:itisasnapshotofthefinancialpositionofthebusinessataparticular moment.Monetaryamountsareattributedtoassetsandliabilities.Italsoquantifiestheamountofthe owners'interestinthecompany:equity. Equity:Theamountinvestedinabusinessbytheowners(IAS1refersto'owners'ratherthan'equity holders'or'shareholders'). AssetsandliabilitiesareexplainedinmoredetailinChapter2.However,thesumoftheassetswill alwaysbeequaltothesumoftheliabilitiesplusequity/capital. Thereareanumberoffactorsaffectingacompany'sfinancialpositionatanyonetimewhichinclude: (a) Theeconomicresourcesitcontrols(cash,labour,materials,machinery,skills) (b) Itsfinancialstructure(whetheritisfundedbyowners,lenders,suppliers,orbyallthree)
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(c) Itsliquidity(short-termavailabilityofcash)andsolvency(long-termaccesstofunds) (d) Itsadaptabilitytochangesinitsoperatingenvironment TheConceptualFrameworkfocusesonhowinformationaboutthenatureandamountsofanentity’s economicresourcesandclaims(liabilities)canhelpuserstoidentifythereportingentity’sfinancial strengthsandweaknesses. Inparticularitpointsoutthatinformationaboutthenatureandamountsofanentity’seconomic resourcesandclaimscanhelpuserstoassess:
Theentity’sliquidityandsolvency Theentity’sneedforadditionalfinancing Howsuccessfultheentityislikelytobeinobtainingthatfinancing
Additionallybygainingknowledgeoftheeconomicresourcesabusinesscontrols,userswillbeina betterpositiontopredicttheentity’sabilitytogeneratecashinthefuture. Informationaboutanentity’sfinancialstructureandliquidity/solvencycanalsohelpfinancialstatement users. Factor
Informationonthishelpsusers
Financialstructure
Topredictfutureborrowingneeds Topredicthowfutureprofitsandcashflowswillbedistributedamong ownersandlenders Topredicthowsuccessfullyitwillbeabletoraisefuturefinance
Liquidity/solvency
Topredictitsabilitytomeetfinancialcommitmentsastheyfalldue
2.2 Statementofprofitorloss IntheUK,thestatementofprofitorlosspartofthestatementofcomprehensiveincomeiscalledthe profitandlossaccount.
Definition Statementofprofitorloss:Astatementdisplayingitemsofincomeandexpenseinareporting periodascomponentsofprofitorlossfortheperiod.Thestatementshowswhetherthebusinesshas hadmoreincomethanexpense(aprofitfortheperiod)orviceversa(alossfortheperiod). Thereportingperiodchosenwilldependonthepurposeforwhichthestatementisproduced.The statementofprofitorlosswhichformspartofthepublishedannualfinancialstatementsofalimited liabilitycompanywillusuallybefortheperiodofayear,commencingfromthedateoftheprevious year'sfinancialstatements.Ontheotherhand,managementmightwanttokeepaclosereyeona company'sprofitabilitybymakingupquarterly,monthly,weeklyorevendailystatements. TheConceptualFrameworksetsouthowinformationaboutthebusiness'sfinancialperformance,ieits profitsorlosses,isneededbyusers.
Tounderstandthereturnthattheentityhasproducedonitseconomicresources
Toassesshowwellmanagementhasdischargeditsresponsibilitiestomakeefficientand effectiveuseofthereportingentity’sresources
Tohelppredictthebusiness'sfuturereturnsonitseconomicresources
Thelinkbetweenthestatementoffinancialpositionandthestatementofcomprehensiveincomeis providedbythestatementofcashflowsandthestatementofchangesinequity.Thesearecovered indetaillaterinyourprofessionalstudies.However,youwillfindanintroductiontothestatementof cashflowsinChapter12.Thestatementofcashflowsshowstheactualcashflowingintoandpaidout ofthebusiness.
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2.3 Presentationoffinancialstatements Boththestatementoffinancialpositionandthestatementofprofitorlossaresummariesof accumulateddata.Forexample,thestatementofprofitorlossshowsafigureforrevenueearnedfrom sellinggoodsandservicestocustomers.Thisisthetotalrevenueearnedfromallsalesmadeduringthe period.Anaccountantdevisesmethodsofrecordingsuchtransactions,soastoproducesummarised financialstatementsfromthem.
C H A P T E R
Thestatementoffinancialpositionandthestatementofprofitorlossformthebasisoffinancial statementsformostbusinesses.Forlimitedliabilitycompanies,otherinformationbywayofstatements (suchasthestatementofcashflowsandthestatementofchangesinequity)andnotesisrequired bystatuteandaccountingstandards.
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3 Theregulationofaccountingandethicalconsiderations Sectionoverview
Financialstatementsareregulatedbylegislation,theapplicationofjudgementusingestablished accountingconcepts,accountingandfinancialreportingstandards,generallyaccepted accountingpractice(GAAP)andtheneedforfairpresentation(oratrueandfairview).
Anumberoffactorshaveshapedthedevelopmentofaccounting. Theregulatoryframeworkofaccounting,andthetechnicalaspectsofthechangesmade,willbe coveredlaterinthisStudyManualandinyourprofessionalstudies.Thepurposeofthissectionistogive ageneralpictureofsomeofthefactorswhichhaveshapedaccounting.Wewillconcentrateonthe financialstatementsoflimitedliabilitycompanies,asthesearetheonesmostcloselyregulatedby statuteorotherwise. Thefollowingfactorscanbeidentified.
Legislation Accountingconceptsandindividualjudgement Accountingstandards Generallyacceptedaccountingpractice(GAAP) Trueandfairview/fairpresentation
3.1 Legislation LimitedliabilitycompaniesarerequiredbytheCompaniesAct2006toprepareandpublishfinancial statementsannually.Theirformandcontentareregulatedbylegislationbutmustcomplywith acceptedaccountingandfinancialreportingstandards.Forlistedgroupsthismeanscompliancewith IASandIFRS.Non-listedcompaniesmayfollowUKstandardswhicharegraduallyconvergingwith internationalones.
3.2 Accountingconceptsandindividualjudgement Manyfiguresinfinancialstatementsarederivedfromtheapplicationofjudgementinapplying fundamentalaccountingconcepts. Differentpeopleexercisingtheirjudgementonthesamefactscouldarriveatverydifferentconclusions.
Interactivequestion2:Valueofreputation
[Difficultylevel:Intermediate]
Anaccountancytrainingfirmhasanexcellentreputationamongststudentsandemployers.Howwould youvaluethisandincludethisassetinthefinancialstatements? SeeAnswerattheendofthischapter.
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Otherexamplesofareaswherethejudgementofdifferentpeoplemayvaryareasfollows.
Valuationofbuildingsintimesofchangingpropertyprices.
Researchanddevelopment(R&D):isitrighttotreatthisonlyasanexpense?Inasenseitisan investmenttogeneratefuturerevenue.
Brandssuchas'Snickers'or'iPod'.Aretheyassetsinthesamewaythataforklifttruckisanasset?
Workingfromthesamedata,differentgroupsofpeoplemayproduceverydifferentfinancial statements,butifjudgementiscompletelyunregulated,therewillbenocomparabilitybetweenthe financialstatementsofdifferentorganisations.Thiswillbeallthemoresignificantincaseswhere deliberatemanipulationoccurs,inordertopresentfinancialstatementsinthemostfavourablelight. Weshallcomebacktoaccountingconceptsandconventionsinsection5ofthischapter. Theexerciseofjudgementinaccountingmattersshouldalwaysbeunderpinnedbyethicalprinciples. TothisendboththeInternationalFederationofAccountants(IFAC)andtheICAEWhaveproduced codesofethicsthatstatethefundamentalethicalprinciplesthatallprofessionalaccountantsshould adhereto.
IFACCodeofEthicsforProfessionalAccountants–fundamentalprinciples IFACistheglobalorganisationfortheaccountingprofession.Itaimstoensurethattheglobal accountancyprofessionisvaluedinthedevelopmentofstrongandsustainableorganisations.TheIFAC CodeofEthicsforProfessionalAccountantsdescribesfivefundamentalprinciplesofprofessionalethics thataccountantsmustadhereto.Theseare:
Integrity.Aprofessionalaccountantshouldbestraightforwardandhonestinallprofessionaland businessrelationships.
Objectivity.Aprofessionalaccountantshouldnotallowbias,conflictofinterestorundueinfluence ofotherstooverrideprofessionalorbusinessjudgements.
Professionalcompetenceandduecare.Aprofessionalaccountanthasacontinuingdutyto maintainprofessionalknowledgeandskillatthelevelrequiredtoensurethataclientoremployer receivescompetentprofessionalservicebasedoncurrentdevelopmentsinpractice,legislationand techniques.Aprofessionalaccountantshouldactdiligentlyandinaccordancewithapplicable technicalandprofessionalstandardswhenprovidingprofessionalservices.
Confidentiality.Aprofessionalaccountantshouldrespecttheconfidentialityofinformation acquiredasaresultofprofessionalandbusinessrelationshipsandshouldnotdiscloseanysuch informationtothirdpartieswithoutproperandspecificauthorityunlessthereisalegalor professionalrightordutytodisclose.Confidentialinformationacquiredasaresultofprofessional andbusinessrelationshipsshouldnotbeusedforthepersonaladvantageoftheprofessional accountantorthirdparties.
Professionalbehaviour.Aprofessionalaccountantshouldcomplywithrelevantlawsand regulationsandshouldavoidanyactionthatdiscreditstheprofession.
TheIFACCode,whichisalsoknownastheInternationalEthicsStandardsBoardforAccountants(IESBA) Code,wasrevisedin2009andthenewCodebecameeffectiveon1January2011.Thepurposeofthe revisionwastoclarifytherequirementsingeneralandtostrengthentheindependencerequirementsin particular.TheICAEWCodeofEthics,outlinedbelow,isderivedfromtheIFACCode,andwasalso revisedwiththenewCodebecomingeffectiveonthesamedate.
Interactivequestion3:Ethics
[Difficultylevel:Intermediate]
SusanworksasanauditorforaclientcalledPlasmaScreenLtd.Duringtheaudit,theCEOofPlasma ScreenLtdoffersSusantheirnewestmodeloftelevision,whichisabouttobereleasedonthemarket, forfreeasathankyouforcarryingouttheaudit.IfSusanacceptsthetelevision,whichofIFAC's fundamentalprinciplesofprofessionalethicsmaybethreatened?
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ICAEWCodeofEthics TheICAEWCodestatesthat’CharteredAccountantsareexpectedtodemonstratethehigheststandards ofprofessionalconductandtotakeintoconsiderationthepublicinterestandtomaintainthereputation oftheaccountingprofession’. ItshouldbenotedthattheguidanceappliestoICAEWmembers,students,affiliates,employeesof memberfirmsandmemberfirmsthemselves.Alloftheseare‘expectedtofollowtheguidance containedinthefundamentalprinciplesinalloftheirprofessionalandbusinessactivitieswhethercarried outwithorwithoutrewardandinothercircumstanceswheretofailtodosowouldbringdiscreditto theprofession.’
C H A P T E R
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Therefore,theCodemayapplynotonlytothepaidactivitiesoftheprofessionalaccountantbutalsoto thelifeoftheprofessionalaccountant,particularlyifheisinvolvedinmattersrelevanttohisprofession, suchasbeingaTrusteeofacharityorclub. TheCodealsostatesthatprofessionalaccountantsarerequiredtofollowthespiritaswellastheletterof theguidance.Inotherwords,aspecificmatterbeingexcludedfromtheguidancedoesnotmeanthat theaccountantdoesnothavetothinkaboutit;ratherhemustdetermineifthespiritoftheguidance wouldalsoapplytothatsituation. Professionalcompetenceandduecare Theprincipleofprofessionalcompetenceandduecareisofparticularrelevancetopreparersoffinancial statements. Professionalaccountantshaveadutytoachievealevelofprofessionalknowledgeandskillandmust ensurethattheydonotoperatebeyondtheircurrentlevelofcompetence. Inordertocontinueofferingservicesinaparticularfieldtheprofessionalaccountantmustmaintaintheir competence.Thiscanbeachievedthroughacontinuedawarenessoftherelevanttechnical,professional andbusinessdevelopments. Aspartoftherequirementfordiligencetheprofessionalaccountantshoulddowhatisrequiredto delivertheagreedservice,shouldensurethatanystaffworkingundertheirauthorityarecompetentand adequatelytrainedandsupervisedandwhereappropriateshouldensurethattheclientoremployer understandsthelimitationsoftheservicesthatarebeingprovided.
3.3 Principlesbasedsystem Ratherthancontainingasetofrules,theethicscodesdiscussedaboveareprinciplesbased.Therearea numberofadvantagestoaframeworkoverasystemofethicalrules.Theseareoutlinedinthetable below. Advantagesofaprinciplesbasedoverarulesbasedsystemofethics Aprinciplesbasedsystemplacestheonusontheindividualtoactivelyconsiderindependencefor everygivensituation,ratherthanjustagreeingachecklistofforbiddenitems.Evenifsomethingisnot expresslystatedintheguidance,professionalaccountantsarerequiredtofollowthespiritaswellasthe letteroftheguidance. Aprinciplesbasedsystempreventsindividualsinterpretinglegalisticrequirementsnarrowlytoget aroundtheethicalrequirements.Thereisanextenttowhichrulesengenderdeception,whereas principlesencouragecompliance. Aprinciplesbasedsystemallowsforthevariationsthatarefoundineveryindividualsituation.Each situationislikelytobedifferent. Aprinciplesbasedsystemcanaccommodatearapidlychangingenvironment,suchastheonethat professionalaccountantsregularlyface. Aprinciplesbasedsystemcancontainprohibitionswherethesearenecessaryassafeguardsarenot feasible.
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Interactivequestion4:ICAEWCodeofEthics
[Difficultylevel:Intermediate]
DiscussthemeritsanddrawbacksoftheICAEWCodeofEthicsbeingaprinciplesbasedsystem.
Accountingstandards Whileethicalprinciplesunderpintheapproach,differentpeoplecouldstillinterpretsituations differently.Inordertodealwithsomeofthissubjectivity,andtoachievecomparabilitybetween differentorganisations,accountingstandardsweredeveloped.Theseweredevelopedatan internationallevel,bytheIASBandataUKlevelbytheAccountingStandardsBoard(ASB),an operatingbodyoftheFinancialReportingCouncil(FRC).TheFRCchangeditsstructurerecentlyandthe responsibilityforaccountingstandardsisnowwiththeAccountingCounciloftheFRC ThestandardsandinterpretationsthatareissuedbytheIASBcomprise:
InternationalFinancialReportingStandards(IFRS) InternationalAccountingStandards(IAS) IFRICInterpretations SICInterpretations
InthisStudyManualweareconcernedwithpartsofIAS1PresentationofFinancialStatements.Wealso covertheConceptualFramework,mentionedearlierinthischapter.
3.4 GenerallyAcceptedAccountingPractice(GAAP) GAAP,asaterm,hassprungupinrecentyearsandsignifiesalltherules,fromwhateversource,which governaccounting.UKGAAPrulesderivefrom:
TheCompaniesAct2006 UKandinternationalaccountingandfinancialreportingstandards Statutoryrequirementsinothercountries(particularlytheUS) Stockexchangelistingrequirements
WeshalllookatUKGAAPinChapter13,sinceitonlyappliesto(some)unlistedcompanies.
3.5 Trueandfairview/faithfulrepresentation Financialstatementsarerequiredtogiveatrueandfairvieworpresentfairlyinallmaterialrespects thefinancialresultsoftheentity.Thesetermsarenotdefinedandtendtobedecidedincourtsoflaw onthefacts.
TheConceptualFrameworkstatesthatiffinancialinformationistobeuseful,itmustberelevantand faithfullyrepresentwhatitpurportstorepresent.
TheCompaniesAct2006requiresthatthefinancialstatementsshouldgiveatrueandfairviewof thefinancialpositionoftheentityataparticularpointintime.
IntermsofIAS1,financialstatementsshouldpresentfairlythefinancialpositionandperformance, andthecashflows,oftheentity.Thisrequiresfaithfulrepresentationoftheeffectsoftransactions.
4 Qualitativecharacteristicsofusefulaccounting information Sectionoverview
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Financialinformationshouldberelevantandfaithfullyrepresentwhatitpurportstorepresent. Theusefulnessoffinancialinformationisenhancedifitiscomparable,verifiable,timelyand understandable.
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Whattypeofinformationthenshouldfinancialstatementscontain?Whatshoulditsmainqualitiesbe fromtheuser'spointofview?
4.1 Thefundamentalqualitativecharacteristics TheConceptualFrameworkidentifiesthefundamentalqualitativecharacteristicstoberelevanceand faithfulrepresentation.Informationmustbebothrelevantandfaithfullyrepresentedtobeuseful.
Relevance.Relevantfinancialinformationiscapableofmakingadifferenceinthedecisionsmade byusers.Informationmaybecapableofmakingadifferenceinadecisionevenifsomeusers choosenottotakeadvantageofitorarealreadyawareofitfromothersources.
C H A P T E R
1
Financialinformationcanmakeadifferencetodecisionsifithas: –
Predictivevalue.Itcanbeusedtopredictfutureoutcomes.
–
Confirmatoryvalue.Itprovidesfeedbackaboutpreviousevaluations(itconfirmswhether pastpredictionswerereasonable).
Information'srelevanceisaffectedbyitsnatureandmateriality.(Weshallcomebackto materiality;fornowyoucanthinkofitas'important').Youshouldnotethatinformationmay becomelessrelevantifthereisunduedelayinitsreporting.
Faithfulrepresentation.Ifinformationistobeuseful,itmustrepresentfaithfullythetransactions andothereventsitpurportstorepresent.Afaithfulrepresentationwillbe: –
Complete.Allinformationnecessaryforausertounderstandthetransactionsoreventsbeing depictedisincluded.
–
Neutral(unbiased)
–
Freefromerror.Freefromerrorinthecontextoffaithfulrepresentationdoesnotmeanthe informationisperfectlyaccurateinallrespects.Insteaditmeanstherearenoerrorsor omissionsinthedescriptionofitandtheprocessusedtoproducethereportedinformation hasbeenselectedandappliedwithnoerrorsintheprocess.
4.2 Enhancingqualitativecharacteristics AccordingtotheConceptualFrameworkinformationthatisrelevantandfaithfullyrepresentedcanbe enhancedbythefollowing'enhancing'qualitativecharacteristics:
Comparability.Comparabilityisthequalitativecharacteristicthatenablesuserstoidentifyand understandsimilaritiesin,anddifferencesamong,items.Informationshouldbeproducedsothat validcomparisonscanbemadewithinformationfrompreviousperiodsandwithinformation producedbyotherentities(forexample,thefinancialstatementsofsimilarcompaniesoperatingin thesamelineofbusiness).Comparabilityshouldnotbeconfusedwithconsistency.Applying consistency(usingthesamemethodsforthesameitems)isameansofachievingcomparability (comparabilityisthegoal).
Verifiability.Verifiabilityhelpstoassureusersthatinformationisafaithfulrepresentationofthe transactionsoreventsitpurportstorepresent.Ifinformationisverifiableitessentiallymeansthatit canbeproven,forexampleyoumaybeabletocheckitistruebyexamination,inspectionor comparison.TheConceptualFrameworkstatesthat'verifiabilitymeansthatdifferentknowledgeable andindependentobserverscouldreachconsensus,althoughnotnecessarilycompleteagreement, thataparticulardepictionisafaithfulrepresentation'.
Timeliness.Timelinessmeanshavinginformationavailabletodecision-makersintimetobe capableofinfluencingtheirdecisions.Asageneralruleolderinformationislessusefulthanrecent information.However,youshouldnotethatsomeinformationmaystillbetimelyforalongtime aftertheendofareportingperiod.Thisistrueofinformationforusersoffinancialinformationwho needtoidentifyandassesstrends.
Understandability.Informationisunderstandableifitisclassified,characterisedandpresented clearlyandconcisely.Whenconsideringwhetherinformationisunderstandableyoushouldbearin mindthatfinancialreportsarepreparedforuserswhohaveareasonableknowledgeofbusiness andeconomicactivities.
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5 Accountingconceptsandconventions Sectionoverview
Thefundamentalassumptionsbehindledgeraccountingandthepreparationoffinancial statementsarecontainedinIAS1andtheConceptualFramework.
IAS1isconcernedwiththepresentationoffinancialstatementssothattheyarecomparable acrosstimeandwithothercompanies.
Theobjectiveoffinancialstatementsistoprovideusefulinformationtousersmakingeconomic decisions.Toachievethisinformationmustbepresentedfairlyorfaithfully,whichgenerallymeans itshouldbepresentedinaccordancewithIASs.
Eachentityneedstoselectandapplyaccountingpoliciesinordertopresentitsfinancial statements.Theresultwillbeinformationthatisrelevantandfaithfullyrepresentswhatitpurports torepresent.
Manyaccountingproceduresareoperatedautomaticallybypeoplewhohaveneverquestionedwhether alternativemethodsexistwhichhaveequalvalidity.Infacttheproceduresincommonuseimplythe acceptanceofcertainconceptswhicharebynomeansselfevident,noraretheytheonlypossible conceptswhichcouldbeusedtobuildupanaccountingframework. Ournextstepistolookatsomeofthemoreimportantconceptswhichareusedinpreparingfinancial statements. WebeginbyconsideringthefundamentalassumptionswhicharethesubjectofIAS1Presentationof FinancialStatements(andwhicharealsocoveredintheConceptualFramework).
5.1 Fairpresentation InthissectionwelookatthegeneralrequirementsofIAS1'sassumptions.TherestofIAS1,onthe formatandcontentoffinancialstatementswillbecoveredinChapter11whenwelookindetailatthe preparationofcompanyfinancialstatements.
5.1.1 ObjectivesandscopeofIAS1 ThemainobjectiveofIAS1is: 'toprescribethebasisforpresentationofgeneralpurposefinancialstatements,toensurecomparability bothwiththeentity'sfinancialstatementsofpreviousperiodsandwiththefinancialstatementsofother entities.' IAS1appliestoallgeneralpurposefinancialstatementspreparedandpresentedinaccordancewith InternationalFinancialReportingStandards(IFRSs–thisreferstoIASsaswell,thecollectivetermthatwe useinthisStudyManual).Generalpurposefinancialstatementsarethoseintendedtomeettheneedsof userswhoarenotinapositiontodemandreportstailoredtomeettheirparticularinformationneeds.
5.1.2 Purposeoffinancialstatements Theobjectivesoffinancialstatementsare:
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Toprovideinformationaboutthefinancialposition,performanceandcashflowsofanentitythatis usefultoawiderangeofusersinmakingeconomicdecisions
Toshowtheresultofmanagement'sstewardshipoftheresourcesentrustedtoit
Toassistusersinpredictingtheentity'sfuturecashflowsand,inparticular,theirtimingand certainty
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Tofulfiltheseobjectives,financialstatementsmustprovideinformationabouttheentity's:
Assets Liabilities Equity Incomeandexpenses(includinggainsandlosses) Otherchangesinequity Cashflows
AsdefinedinChapter2,theseare calledtheelementsoffinancial statements
Acompletesetoffinancialstatementsincludes:
C H A P T E R
1
Statementoffinancialposition
Statementofprofitorloss(partofthestatementofcomprehensiveincome)
Accountingpoliciesnote
Statementofcashflows
Statementofchangesinequity
Explanatorynotes
Afurtherstatementoffinancialpositionfromanearlierperiodwheretherehasbeenretrospective applicationofanaccountingpolicy,areclassificationoraretrospectiverestatement–issuesthatwe shallcomebacktoinChapter11.
Coveredinthe Accountingsyllabus
CoveredintheFinancialAccounting andReportingsyllabus
Preparationofthefinancialstatementsistheresponsibilityoftheboardofdirectors.IAS1also recognisesthevalueofafinancialreviewbymanagementandtheproductionofanyotherreportsand statementswhichmayaidusers,butthesefalloutsidetheAccountingsyllabusscope.
5.1.3 FairpresentationandcompliancewithIASs Mostimportantly,financialstatementsshouldpresentfairlythefinancialposition,financial performanceandcashflowsofanentity.ApplyingIASsispresumedtoresultinfairpresentation.
Definition Fairpresentation:Thefaithfulrepresentationoftheeffectsoftransactions,othereventsandconditions inaccordancewiththeConceptualFramework. ThefollowingpointsmadebyIAS1expandonthisprinciple.
CompliancewithIASsshouldbeexplicitlystatedinanotetothefinancialstatements.
AllrelevantIASsmustbefollowedifcompliancewithIASsisdisclosed.
Useofaninappropriateaccountingtreatmentcannotberectifiedeitherbydisclosureof accountingpoliciesornotes/explanatorymaterial.
IAS1stateswhatisrequiredforafairpresentation.
Selectionandapplicationofaccountingpolicies.
Presentationofinformationinamannerwhichprovidesrelevant,reliable,comparableand understandableinformation.
Additionaldisclosureswhererequiredtoenableuserstounderstandtheimpactofparticular transactions,eventsandconditionsontheentity'sfinancialpositionandperformance.
5.1.4 DeparturesfromIASs Theremaybe(veryrare)circumstanceswhenmanagementdecidesthatcompliancewitharequirement ofanIASwouldbesomisleadingthatfinancialstatementswouldnotmeettheirobjectives.Departure fromtheIASmaythereforeberequiredtoachieveafairpresentation.Thefollowingshouldbe disclosedinsuchanevent.
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Managementconfirmationthatthefinancialstatementsfairlypresenttheentity'sfinancialposition, performanceandcashflows.
StatementthatallIASshavebeencompliedwithexceptinrespectofdeparturefromindividual IASs,requiredtoachieveafairpresentation.
Detailsofthenatureofthedeparture,whytheIAStreatmentwouldbemisleading,andthe treatmentadopted.
Financialeffectofthedeparture.
5.2 Goingconcern(IAS1) Definition Goingconcern:Theentityisviewedascontinuinginoperationfortheforeseeablefuture.Itisassumed thattheentityhasneithertheintentionnorthenecessityofliquidationorceasingtotrade. Thisconceptassumesthat,whenpreparinganormalsetoffinancialstatements,thebusinesswill continuetooperateinapproximatelythesamemannerfortheforeseeablefuture(atleast,butnot limitedto,thenext12months).Inparticulartheentitywillnotgointoliquidationorceasetrading,or havenorealisticalternativebuttoliquidateorceasetrading. Whenanentityisnotagoingconcern,thefinancialstatementsmuststatethattheyarepreparedona basisotherthangoingconcern,andclarifywhatthisbasisentails.Whenpresentingfinancialstatements usingabreakupbasisofaccounting,anentity'sassetsarevaluedattheir'breakup'value:theamount theywouldsellfor(theirnetrealisablevalue)iftheyweresoldoffindividuallyinaforcedsaleandthe businesswerebrokenup.Sincethisforcedsaleisnecessarybecausethebusinesshasforeseenproblems inthenext12months,financialstatementspreparedonabreak-upbasiswillcontainneithernoncurrentassetsnornon-currentliabilities.Allassetswillbedeemedtobeforsaleandallliabilitieswillbe treatedasbecomingduewithin12monthsofthedateofthestatementoffinancialposition.
Interactivequestion5:Goingconcern
[Difficultylevel:Intermediate]
Aretailercommencesbusinesson1Januaryandbuys20washingmachines,eachcosting£100.During theyearhesells17machinesat£150each.Howshouldtheremainingmachinesbevaluedat 31Decemberinthefollowingcircumstances? (a) Heisforcedtoclosedownhisbusinessattheendoftheyearandtheremainingmachineswill realiseonly£60eachinaforcedsale. (b) Heintendstocontinuehisbusinessintothenextyear. SeeAnswerattheendofthischapter. Ifthegoingconcernassumptionisnotfollowed,thatfactmustbedisclosed,togetherwith:
Thebasisonwhichthefinancialstatementshavebeenprepared. Thereasonswhytheentityisnotconsideredtobeagoingconcern.
Whenthereisuncertaintyastowhethertheentityisagoingconcern,thisshouldbedisclosedalong withthenatureoftheuncertainty.
5.3 Accrualbasisofaccounting(IAS1) Anentityshouldprepareitsfinancialstatements,exceptforcashflowinformation,usingtheaccrual basisofaccounting.
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Definition Accrualbasisofaccounting:Itemsarerecognisedasassets,liabilities,equity,incomeandexpenses (theelementsoffinancialstatements)whentheysatisfythedefinitionsandrecognitioncriteriaforthose elementsintheConceptualFramework. Entitiesshouldpreparetheirfinancialstatementsonthebasisthattransactionsarerecordedinthem, notasthecashispaidorreceived(cashaccounting),butastheincomeorexpensesareearnedor incurredinthereportingperiodtowhichtheyrelate.
C H A P T E R
1
Accordingtotheaccrualbasis,whencomputingprofitincomeearnedmustbematchedagainstthe expensesincurredinearningit.
Workedexample:Accrualbasis Emmapurchases20T-shirtsinherfirstmonthoftrading(May)atacostof£5eachoncredit.Shesells allofthemoncreditfor£10each.Emmahasthereforemadeaprofitof£100,bymatchingtheincome (£200)earnedagainstthecost(£100)ofacquiringthem. If,however,Emmaonlysells18T-shirts,itisincorrecttochargeherstatementofprofitorlosswiththe costof20T-shirts,asshestillhastwoT-shirtsinhand.IfshesellstheminJune,sheislikelytomakea profitonthesale.Therefore,onlythepurchasecostof18T-shirts(£90)shouldbematchedwithher salesincome(£180),leavingherwithaprofitof£90. HerstatementoffinancialpositionwilllooklikethisattheendofMay. Assets Inventory(twoT-shirtsatcost,ie2£5) Receivables(18£10) Capitalandliabilities Proprietor'scapital(profitfortheperiod) Payables(20£5)
£
10 180 190 90 100 190
However,ifEmmahaddecidedtogiveupsellingT-shirtsattheendofMay,thenthegoingconcern assumptionwouldnolongerapplyandthetwoT-shirtsinthestatementoffinancialpositionshouldbe attheirbreakupvaluation,notcost.Similarly,ifthetwounsoldT-shirtsareunlikelytobesoldatmore thantheircostof£5each(say,becauseofdamageorafallindemand)thentheyshouldberecorded onthestatementoffinancialpositionattheirnetrealisablevalue(iethelikelyeventualsalespriceless anyexpensesincurredtomakethemsaleable)ratherthancost. Inthisexample,theconceptsofgoingconcernandaccrualarelinked.Sincethebusinessisassumed tobeagoingconcern,itispossibletocarryforwardthecostoftheunsoldT-shirtsasachargeagainst profitsofthenextperiod.
Definition Cashaccountingbasisofaccounting:Underthismethod,acompanyrecordscustomerreceiptsinthe periodthattheyarereceived,andexpensesintheperiodinwhichtheyarepaid.Itiseasiertouseand canbeusefulforasmallercompany,especiallyfortaxpurposeswherecashflowmaybeanissue.Under theaccrualsbasis,acompanymayhavetopaytaxonprofitsbeforethecashisactuallyreceivedbythe business. Applyingthecashaccountingbasistotheaboveexample,noprofitorexpenseswouldberecoreded untilcashchangedhands.Therefore,ifEmmabought20tshirtsoncreditfor£5each,andsoldthemon creditfor£10eachinMay,noprofitorlosswouldberecordedinMay.If,inJuneEmmareceived paymentforthetshirtsshehadsoldoncredit,andinJulyshepaidforthetshirtsshehadpurchasedon credit,aprofitof£200wouldberecordedinJune,andalossof£100wouldberecordedinJuly.
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5.4 Consistencyofpresentation(IAS1) Tomaintainconsistency,thepresentationandclassificationofitemsinthefinancialstatementsshould staythesamefromoneperiodtothenext,unless:
Thereisasignificantchangeinthenatureoftheoperations,orareviewofthefinancial statementsindicatesamoreappropriatepresentation.
AchangeinpresentationisrequiredbyanIAS.
Byhavingconsistentpresentationthecomparabilityoffinancialstatementsisenhanced,bothovera periodoftime,andalsobetweendifferentcompanies.
5.5 Materialityandaggregation(IAS1) Definition Material:Omissionsormisstatementsofitemsarematerialiftheycould,individuallyorcollectively, influencetheeconomicdecisionsofuserstakenonthebasisofthefinancialstatements.Materiality dependsonthesizeandnatureoftheomissionormisstatementjudgedinthesurrounding circumstances.Thesizeorthenatureofanitem,oracombinationofboth,couldbethedetermining factor. Eachmaterialclassofsimilaritemsshallbepresentedseparatelyinthefinancialstatements.Itemsof adissimilarnatureorfunctionshallbepresentedseparatelyunlesstheyareimmaterial. AspecificdisclosurerequirementinanIASneednotbesatisfiediftheinformationisimmaterial. TheConceptualFrameworklinksmaterialityparticularlytothequalitativecharacteristicofrelevance. Financialstatementsresultfromprocessinglargenumbersoftransactionsorothereventsthatarethen aggregatedintoclassesaccordingtotheirnatureorfunction,suchas'revenue','purchases','trade receivables'and'tradepayables'.Thefinalstageintheprocessofaggregationandclassificationisthe presentationofcondensedandclassifieditemsonthefaceofthestatementoffinancialpositionor statementofprofitorloss.Ifanitemisnotindividuallymaterialitisaggregatedwithotheritemsonthe faceoffinancialstatements,thoughitmaybeseparatelyclassifiedinthenotes. Thereisnoabsolutemeasureofmateriality.Inrelationtomaterialitybysizeitiscommontoapplya convenientruleofthumb(forexamplematerialitemsarethosewithavaluegreaterthan5%ofnet profits).Howeversomeitemsareregardedasparticularlysensitiveandthereforeasbeingmaterialby nature.Evenaverysmallmisstatementofsuchanitemistakenasamaterialerror;anexampleisthe amountofremunerationpaidtodirectorsofacompany.
5.6 Offsetting(IAS1) Assetsandliabilities,andincomeandexpendituremustbepresentedseparatelyinthefinancial statements.IAS1doesnotallowtheseitemstobeoffsetagainsteachotherunlesssuchatreatmentis requiredorpermittedbyanotherIFRS. Incomeandexpensescanbeoffsetonlywhen:
AnIFRSrequiresorpermitsit,or
Gains,lossesandrelatedexpensesarisingfromthesame/similartransactionsarenotmaterial(in aggregate).
5.7 Thebusinessentityconcept Thisconcepthasalreadybeendiscussedinthecontextoftheseparateentityprinciple:that accountantsregardabusinessasaseparateentity,distinctfromitsownersormanagers.Theconcept applieswhetherthebusinessisalimitedliabilitycompany(andsorecognisedinlawasaseparate entity),asoletraderorapartnership(inwhichcasethebusinessisnotlegallyrecognisedasseparate fromitsowners).
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5.8 Thehistoricalcostconvention Abasicprincipleofaccountingisthatthemonetaryamountatwhichitemsarenormallymeasuredin financialstatementsisathistoricalcost,ieattheamountwhichthebusinesspaidtoacquirethem.An importantadvantageofthisconceptisthattheobjectivityoffinancialstatementsismaximised:thereis usuallyasourcedocumenttoprovetheamountpaidtopurchaseanassetorpayanexpense.
C H A P T E R
Definition Historicalcost:Transactionsarerecordedattheircostwhentheyoccurred.
1
Itiseasiertodealwithcostswhenmeasuringitems,ratherthanwith'values',asvaluationstendtobe subjectiveandtovaryaccordingtowhatthevaluationisfor.
Workedexample:Costorvaluation Acompanyacquiresamachinetomanufactureitsproducts.Thecompanyexpectstousethemachine forfouryears.Attheendoftwoyearsthecompanyispreparingastatementoffinancialpositionand hastodecidewhatmonetaryamounttogivethemachine(theFrameworkreferstothisprocessas 'measurement'). Numerouspossibilitiescanbeconsidered.
Theoriginalcost(historicalcost)ofthemachine
Halfofthehistoricalcost,onthegroundthathalfofitsusefullifehasexpired
Theamountthemachinemightfetchonthesecondhandmarket(realisablevalue)
Theamountneededtoreplacethemachinewithanidenticalmachine(replacementcost)
Theamountneededtoreplacethemachinewithamoremodernmachineincorporatingthe technologicaladvancesoftheprevioustwoyears
Themachine'seconomicvalue,ietheamountoftheprofitsitisexpectedtogenerateforthe companyduringitsremaininglife(presentvalue)
Allofthesevaluationshavesomethingtocommendthem,butthegreatadvantageofthefirsttwois thattheyarebasedonafigure(themachine'shistoricalcost)whichisobjectivelyverifiable. Therearemanyproblemsassociatedwiththeuseofhistoricalcostvaluationsbuttheseareoutsidethe scopeoftheAccountingsyllabus.
Interactivequestion6:Accountingconcepts
[Difficultylevel:Intermediate]
(a) Yourofficeequipmentwillbeused,onaverage,forfiveyears,soyoucharge20%ofitscostas depreciationeachyearinyourstatementofprofitorloss.Thisyearyourbusinessprofitabilityis downandyouthinkyoucansqueezeanextrayear'slifeoutofyourequipment.Isitacceptablenot tomakeanychargethisyear? (b) Youhaverecentlypaid£4.95forawastepaperbinwhichshouldbeusedforaboutfiveyears. Shouldyoutreatitasanon-currentasset? SeeAnswerattheendofthischapter.
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6 Capitalandrevenueitems Sectionoverview
Capitalandrevenueincomeandexpendituremustbedistinguishedfromeachother.
6.1 Capitalandrevenueexpenditure Definition Capitalexpenditure:Expenditurewhichresultsintheacquisitionoflong-termassets,oran improvementorenhancementoftheirearningcapacity. Long-termassetsarethosewhichwillbekeptintheentityformorethanoneyear.
Capitalexpenditureisnotchargedasanexpenseinthestatementofprofitorloss(althougha 'depreciation'chargewillusuallybemadetowriteoffthecapitalexpendituregraduallyovertime; depreciationexpenseisshowninthestatementofprofitorloss).
Capitalexpenditureonlong-termassetsappearsinthestatementoffinancialposition.
Definition Revenueexpenditure:Expenditurewhichisincurredeither:
Fortradepurposes.Thisincludespurchasesofrawmaterialsoritemsforresale,expenditureon wagesandsalaries,sellinganddistributionexpenses,administrativeexpensesandfinancecosts,or
Tomaintaintheexistingearningcapacityoflong-termassets.
Revenueexpenditureischargedtothestatementofprofitorlossofaperiod,providedthatitrelatesto thetradingactivityandsalesofthatparticularperiod.
Workedexample:Revenueexpenditure Ifabusinessbuystensteelbarsfor£200(£20each)andsellseightofthemduringareportingperiod,it willhavetwosteelbarsleftattheendoftheperiod.Thefull£200isrevenueexpenditurebutonly£160 isthecostofthegoodssoldduringtheperiod.Theremaining£40(costoftwounits)willbeincludedin thestatementoffinancialpositionas'inventory'valuedat£40.
Workedexample:Capitalexpenditure Abusinesspurchasesabuildingfor£300,000.Itthenaddsanextensiontothebuildingatacostof £100,000.Afterafewmonthsthebuildingneedstohaveafewbrokenwindowsmended,itsfloors polishedandsomemissingrooftilesreplaced.Thesecleaningandmaintenancejobscost£900. Inthisexample,theoriginalpurchase(£300,000)andthecostoftheextension(£100,000)arecapital expenditure,becausetheyareincurredtoacquireandthenimprovealong-termasset.Theothercosts of£900arerevenueexpenditure,becausethesemerelymaintainthebuildingandthusits'earning capacity'. Capitalexpenditurecanincludecostsincurredinbringingalong-termassettoitsfinalconditionand location,suchaslegalfees,dutiesandcarriagecostsbornebytheasset'spurchaser,plusinstallation costs.Repair,maintenanceandstaffcostsinrelationtolong-termassetsarerevenueexpenditure.
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6.2 Capitalincomeandrevenueincome
C H A P T E R
Theprofits(orlosses)fromthesaleoflong-termassetsareincludedinthestatementofprofitorlossfor thereportingperiodinwhichthesaletakesplace.Forinstance,thebusinessmaysellmachineryor propertywhichitnolongerneeds.
1
Definition Capitalincome:Proceedsfromthesaleofnoncurrentassets.
Definition Revenueincome:Incomederivedfrom
Thesaleoftradingassets,suchasgoodsheldininventory Theprovisionofservices Interestanddividendsreceivedfrombusinessinvestments
6.3 Capitaltransactions Thecategorisationofcapitalandrevenueitemsgivenabovedoesnotmentionraisingadditionalfunds fromtheowner(s)ofthebusiness,orraisingandrepayingloans.
Thesetransactionsaddtothecashassetsofthebusinessandcreatecorrespondingcapitalor liabilities(loans).
Whenaloanisrepaid,itreducestheliabilities(loan)andtheassets(cash).
Noneofthesetransactionswouldbereportedthroughthestatementofprofitorloss.
6.4 Whyisthedistinctionbetweencapitalandrevenueitemsimportant? Calculatingprofitforanyreportingperioddependsonthecorrectandconsistentclassificationof revenueorcapitalitems.Youmustgetusedtotheterminologyhereasthesewordsappearinthe accountingandfinancialreportingstandardsthemselves.
Interactivequestion7:Capitalorrevenue?
[Difficultylevel:Intermediate]
Statewhethereachofthefollowingitemsshouldbeclassifiedas'capital'or'revenue'expenditureor income. (a) Thepurchaseofaproperty(eganofficebuilding) (b) Propertydepreciation (c) Solicitors'feesinconnectionwiththepurchaseofproperty (d) Thecostsofaddingextramemorytoacomputer (e) Computerrepairsandmaintenancecosts (f) Profitonthesaleofanofficebuilding (g) Revenuefromsalespaidforbycreditcard (h) Thecostofnewmachinery (i)
Customsdutychargedonmachinerywhenimportedintothecountry
(j)
The'carriage'costsoftransportingthenewmachineryfromthesupplier'sfactorytothepremises ofthebusinesspurchasingit
(k) Thecostofinstallingthenewmachineryinthepremisesofthebusiness (l)
Thewagesofthemachineoperators
SeeAnswerattheendofthischapter.
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SummaryandSelf-test
Summary
Statementof financialposition
Conceptual Framework: fundamental qualitative characteristics
Relevance
UK GAAP (Chapters 13+14)
Faithful representation - Complete - Free from error - Unbiased
Materiality Enhancing qualitative characteristics
Comparability
Verifiability
Timeliness
Understandability
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Self-test
C H A P T E R
Answerthefollowingquestions. 1
Anentity'stransactionsarerecordedfirstin A B C D
2
Asnapshotoftheentity'sfinancialpositionataparticularpointintime Arecordofanentity'sfinancialperformanceoveraperiodoftime Alistofalltheincomeandexpensesoftheentityataparticularpointintime Alistofalltheassetsandliabilitiesoftheentityoveraperiodoftime
Inapplyingfundamentalaccountingconceptsthepreparersoffinancialinformationarealsousing A B C D
7
Whethertheentityhaspaidadividend Whethertheentitywillrepayaloanwhenitfallsdue Whethertheentitywillcontinuetobeabletoemploypeople Whethertheentitypatroniseslocalsuppliers
Astatementoffinancialpositionisbestdescribedas: A B C D
6
Toprovideinformationtoinvestorsinmakingeconomicdecisions Toprovideinformationtomanagersinmakingbusinessdecisions Toshowtheresultsofmanagement'sstewardshipoftheresourcesentrustedtoit Tohelpuserspredicttheentity'sfuturecashflows
Whichoneofthefollowingissuesinanentity'sfinancialstatementsislikelytobeofmostinterest toanentity’slender? A B C D
5
Asoletrader Partnersinageneralpartnership Alimitedliabilitycompany Ownersofalimitedliabilitycompany
AccordingtoIAS1whichofthefollowingdoesnotrepresentanobjectiveoffinancialstatements? A B C D
4
1
Liabilityforthedebtsofthebusinessdoesnotfallon A B C D
3
Booksoforiginalentry Ledgeraccounts Thestatementofprofitorloss Thestatementoffinancialposition
Legislation Accountingstandards Judgement Financialreportingstandards
Matchthefundamentalethicalprincipletothecharacteristic. A
Integrity
B
Objectivity
(i)
Membersshouldbestraightforwardandhonestinallprofessionalandbusinessrelationships.
(ii) Membersshouldnotallowbias,conflictorinterestorundueinfluenceofotherstooverride professionalorbusinessjudgements. 8
WhichofthefollowingwouldNOTbeasuitablequestiontoaskyourselfwhenresolvinganethical dilemma? A B C D
Wouldmycolleaguesthinkmysolutionisreasonable? HaveIthoughtaboutallthepossibleconsequencesofmysolution? CouldIdefendmysolutionunderpublicscrutiny? Doesmysolutionbenefitmycareer?
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9
TheICAEWCodeonlyappliestothepaidactivitiesoftheprofessionalaccountant.
True
False
10 WhichofthefollowingisnotasourceoftheaccountingrulesembodiedinUKGAAP? A B C D
TheCompaniesAct2006 UKaccountingstandards ListingrequirementsoftheLondonStockExchange Accountingrequirementsofanentity'sUSparentcompany
11 Whichofthefollowingfactorshavenotinfluencedfinancialreporting? A B C D
Nationallegislation Economicfactors Accountingstandards GAAP
12 Materialityisanentity-specificaspectofwhichqualitativecharacteristic? A B C D
Relevance Understandability Faithfulrepresentation Comparability
13 Whichofthefollowingisanitemofcapitalexpenditure? A B C D
Costofgoodssold Purchaseofamachine Repairstoamachine Wagescost
Now,gobacktotheLearningObjectivesintheIntroduction.Ifyouaresatisfiedthatyouhaveachieved theseobjectives,pleasetickthemoff.
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Technicalreference 1
Thepurposeofaccountinginformation
Theobjectiveofgeneralpurposefinancialreportingistoprovidefinancial informationaboutthereportingentitythatisusefultoexistingandpotential investors,lendersandothercreditorsinmakingdecisionsaboutproviding resourcestotheentity. Toprovideinformationaboutthefinancialposition,performanceandcash flowsofanentitythatisusefultoawiderangeofusersinmakingeconomic decisions Toshowtheresultsofmanagement'sstewardshipoftheresourcesentrustedto it Assistsusersofthefinancialstatementsinpredictingtheentity'sfuturecash flowsand,inparticular,theirtimingandcertainty
2
Themainfinancialstatements
Informationaboutthenatureandamountsofanentity’seconomicresources andclaimscanhelpuserstoassesstheentity’sliquidityandsolvency,itsneed foradditionalfinancingandhowsuccessfultheentityislikelytobein obtainingthatfinancing. Informationaboutareportingentity’sfinancialperformanceisneededbyusers tounderstandthereturnthattheentityhasproducedonitseconomic resources.Informationaboutthereturntheentityhasproducedprovidesan indicationofhowwellmanagementhasdischargeditsresponsibilitiestomake efficientandeffectiveuseofthereportingentity’sresources.Informationabout thevariabilityandcomponentsofthatreturnisalsoimportant,especiallyin assessingtheuncertaintyoffuturecashflows.
Conceptual
C H A P T E R
Framework ParaOB2
1
IAS1para9
IAS1para9 IAS1para9
3
Theregulationofaccounting
Astatementoffinancialposition,astatementofcomprehensiveincome,a statementofchangesinequity,astatementofcashflows,notesand(incertain circumstances)arevisedstatementoffinancialpositionfromanearlierperiod
Conceptual Framework paraOB13 Conceptual Framework paraOB16
IAS1para10
IAS1para15;
Conceptual
Fairpresentation/faithfulrepresentation
Framework parasQC12-QC16
4
Thequalitativecharacteristicsofusefulfinancialinformation
Fundamentalqualitativecharacteristics:relevanceandfaithfulrepresentation. Enhancingqualitativecharacteristics:comparability,verifiability,timelinessand understandability.
5
ObjectivesandscopeofIAS1
Toprescribethebasisforpresentationofgeneralpurposefinancialstatements, toensurecomparabilitybothwiththeentity'sfinancialstatementsofprevious periodsandwiththefinancialstatementsofotherentities Tobeappliedtoallgeneralpurposefinancialstatementspreparedand presentedinaccordancewithInternationalFinancialReportingStandards (IFRSs) Generalpurposefinancialstatementsarethoseintendedtomeettheneedsof userswhoarenotinapositiontodemandreportstailoredtomeettheir particularinformationneeds.
6
Thepurposeoffinancialstatements
Toprovideinformationaboutthefinancialposition,performanceandcash flowsofanentitythatisusefultoawiderangeofusersinmakingeconomic decisions
Conceptual Framework parasQC6-QC34 IAS1para1
IAS1para2
IAS1para7
IAS1para9
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Toshowtheresultsofmanagement'sstewardshipoftheresources entrustedtoit
–
Toassistusersinpredictingtheentity'sfuturecashflowsand,inparticular, theirtimingandcertainty
–
Toprovideinformationabouttheentity'sassets,liabilities,equity,income andexpenses(includinggainsandlosses),otherchangesinequityand cashflows
7
Componentsoffinancialstatements
Astatementoffinancialpositionattheendofthereportingperiod,a statementofprofitorloss,anaccountingpoliciesnote,astatementofchanges inequity,astatementofcashflows,explanatorynotesandastatementof financialpositionatanearlierdatewheretherehasbeenretrospective application,retrospectiverestatementorreclassification
8
Fairpresentation(IAS1)
Thefaithfulrepresentationoftheeffectsoftransactions,othereventsand conditionsinaccordancewiththedefinitionsandrecognitioncriteriainthe Framework.TheapplicationofIASs,withadditionaldisclosurewhennecessary, ispresumedtoresultinfinancialstatementsthatachieveafairpresentation.
IAS1para15
CompliancewithIASsmustbeexplicitandcomplete.
IAS1para16
Fortheretobefairpresentation:
IAS1para17
IAS1para10
–
Accountingpoliciesmustbeselectedandapplied.
–
Informationmustbepresentedinamannerwhichprovidesrelevant, reliable,comparableandunderstandableinformation.
–
Toenableuserstounderstandtheimpactofparticulartransactions,events andconditionsontheentity'sfinancialpositionandperformance additionaldisclosuresmayberequired.
Useofaninappropriateaccountingtreatmentcannotberectifiedeitherby disclosureofaccountingpoliciesornotes/explanatorymaterial
IAS1para18
InsomecircumstancesdeparturefromtheIASsmayberequiredtoachievea fairpresentation
IAS1para23
9
Underlyingassumptions
Financialstatementsshallbepreparedonagoingconcernbasisunless managementeitherintendstoliquidatetheentityortoceasetrading,orhas norealisticalternativebuttodoso.Assessmentofwhetherthegoingconcern assumptionisappropriatemusttakeintoaccountallavailableinformationfor atleast12monthsfromtheendofthereportingperiod.Anyuncertaintymust bedisclosed.
IAS1para25and
Anentityshouldprepareitsfinancialstatementsusingtheaccrualbasisof accounting,recognisingtheelementsoffinancialstatementsinlinewiththe Framework.
IAS1para27and
26
–
26
28
Tomaintainconsistency,thepresentationandclassificationofitemsinthe financialstatementsshouldstaythesamefromoneperiodtothenext,unless thereissignificantchangeinthenatureoftheoperations,orareviewofthe financialstatementsindicatesamoreappropriatepresentation,orachangein presentationisrequiredbyanIAS.
IAS1para45
Omissionsormisstatementsofitemsarematerialiftheycould,individuallyor collectively,influencetheeconomicdecisionsofuserstakenonthebasisofthe financialstatements.Materialitydependsonthesizeandnatureofthe omissionormisstatementjudgedinthesurroundingcircumstances.Thesizeor thenatureofanitem,oracombinationofboth,couldbethedetermining factor.
IAS1para7
Eachmaterialclassofsimilaritemsshallbepresentedseparatelyinthefinancial statements.Itemsofadissimilarnatureorfunctionshallbepresented separatelyunlesstheyareimmaterial,butaspecificdisclosurerequirementin anIASneednotbesatisfiediftheinformationisimmaterial.
IAS1paras29and
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AnswerstoInteractivequestions
C H A P T E R
AnswertoInteractivequestion1 Limitedliabilitycompanies(thoughnototherformsofbusinesssuchasgeneralpartnerships)are requiredtomakecertainaccountinginformationpublic.Thisisdonebyfilinginformationcentrally,asa CompaniesAct2006requirement.
1
AnswertoInteractivequestion2 Thefirmmayhaverelativelylittleintheformofthingsyoucantouch,perhapsabuilding,desksand chairs.Ifyousimplydrewupastatementoffinancialpositionshowingthecostofthethingsowned, thenthebusinesswouldnotseemtobeworthmuch,yetitsincomeearningpotentialmightbehigh. Thisistrueofmanyserviceorganisationswherethepeopleareamongthemostvaluableassets,but justifyingtheirexactvalueisextremelyproblematic.
AnswertoInteractivequestion3 Objectivity.Unlessthevalueofthegift/hospitalityisclearlyinsignificant,afirmoramemberofan assuranceteamshouldnotacceptit.Itclearlythreatensobjectivity.Inadditiontheremayalsobean intimidationthreatifthereisasuggestionthatthereceiptofthegiftwillbemadepublic.
AnswertoInteractivequestion4 Thekeymeritofthecodebeingprinciplesbasedisthatitisflexible.Professionalaccountantsmust considerthespiritoftheguidance,evenwherethereisnoexplicitguidanceforagivenscenario.Thisis necessaryintherapidlychangingenvironmentinwhichICAEWmembersoperate. Rulesbasedsystemstendtogiverisetochecklists,whichareoftenunsuitablewhenconsideringthe ethicalimplicationsofdecisions.Undertheprinciplesbasedsystem,memberscannotsimplyengagein abox-tickingexercise,andtheriskofloopholesarisinginethicalguidanceisreduced. Disadvantages Criticswouldarguethattheprinciplesbasedsystemmayallowindividualstogetawaywithnoncomplianceunchallenged,astheyapplytheirownindividualinterpretationtotheguidance.
AnswertoInteractivequestion5 (a) Ifthebusinessistobecloseddown,theremainingthreemachinesmustbevaluedattheamount theywillrealiseinaforcedsale,ie3×£60=£180. (b) Ifthebusinessisregardedasagoingconcern,themachinesunsoldat31Decemberwillbevalued asanassetatcost,3×£100=£300.
AnswertoInteractivequestion6 (a) No,becauseoftheneedforconsistency.Oncethedepreciationpolicyhasbeenestablished,it shouldnotbechangedwithoutgoodcause. (b) No,becauseofthematerialityconcept.Thecostofthebinisverysmall.Ratherthanclutteringup thestatementoffinancialpositionforfiveyears,treatthe£4.95asanexpenseinthisyear's statementofprofitorloss.
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AnswertoInteractivequestion7 (a) Capitalexpenditure (b) Depreciationisrevenueexpenditure (c) Legalfeesassociatedwithpurchasingapropertymaybeaddedtothepurchasepriceandclassified ascapitalexpenditure (d) Capitalexpenditure(enhancinganexistinglong-termasset) (e) Revenueexpenditure(restoringanexistinglong-termasset) (f) Capitalincome(netofthecostsofsale) (g) Revenueincome (h) Capitalexpenditure (i)
Ifcustomsdutiesarebornebythepurchaserofthelong-termasset,theyshouldbeaddedtothe purchasecostofthemachineryandclassifiedascapitalexpenditure
(j)
Ifcarriagecostsarepaidforbythepurchaserofthelong-termasset,theyshouldbeincludedinthe costofthelong-termassetandclassifiedascapitalexpenditure
(k) Installationfeesofalong-termassetarealsoaddedtocostandclassifiedascapitalexpenditure (l)
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Revenueexpenditure
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AnswerstoSelf-test 1
A
Booksoforiginalentryformtheprimaryrecordoftransactions.Theseareanalysedandposted totheledgeraccountsandsummarisedinthefinancialstatements,includingthestatementof profitorlossandthestatementoffinancialposition.
2
D
Soletradersandpartnersbearfullliabilityforthedebtsofthebusinessentity,asdoesa limitedliabilitycompanyitself.Theliabilityoftheshareholdersorownersforthedebtsofa companyis,however,limited.
3
B
IAS1identifiesA,CandDasanobjectiveTheuseofaccountinginformationbymanagersin makingbusinessdecisionsisnotidentifiedasanobjective.
4
B
Aisofinteresttoinvestors;Cisofinteresttoemployees,Disofinteresttosuppliers.
5
A
Astatementoffinancialpositionisalistofassetsandliabilitieswhichrepresenttheentity's financialpositionataparticularpointintime.Diswrongbecauseitrefersto'aperiodof time';Creferstoincomeandexpenses,notassetsandliabilities;Bdefinesthestatementof profitorloss.
6
C
Manyfiguresinfinancialstatementsarederivedfromtheapplicationofjudgementinputting fundamentalaccountingconceptsintopractice.
7
A
(i)
B
(ii)
8
D
9
False.TheCodemayapplynotonlytothepaidactivitiesoftheprofessionalaccountantbutalso tothelifeoftheprofessionalaccountant,particularlyifheisinvolvedinmattersrelevanttohis profession,suchasbeingaTrusteeofacharityorclub.
C H A P T E R
1
Thebestsolutiontoanethicaldilemmashouldbetakenwhetherornotitimprovesyour career.
10 D
UKGAAPrelatestogenerallyacceptedaccountingpractice;therulesappliedasaresultof internalrequirementscanthereforenotbepartofGAAP.
11 B
Economicfactorsdonotinfluencethedevelopmentoffinancialreporting;alltheothersdo (seesection3).
12 A
Informationismaterialifomittingormisstatingitcouldinfluencethedecisionsoftheusers. Ifinformationisdeemedmaterialthenitisrelevanttotheusers.TheConceptualFramework statesthatmaterialityisanentity-specificaspectofrelevance.
13 B
Thisresultsintheacquisitionofalong-termasset.Alltheothersarerevenueexpenditure.
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CHAPTER2
Theaccountingequation
Introduction Examinationcontext TopicList 1 Assets,liabilitiesandthebusinessentityconcept 2 Theaccountingequation 3 Credittransactions 4 Thestatementoffinancialposition 5 Preparingthestatementoffinancialposition 6 Thestatementofprofitorloss SummaryandSelf-test Technicalreference AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Recordandaccountfortransactionsandeventsresultinginincome,expenses,assets, liabilitiesandcapitalinaccordancewiththeappropriatebasisofaccountingandthelaws, regulationsandaccountingstandardsapplicabletothefinancialstatements
Identifythemaincomponentsofasetoffinancialstatementsandspecifytheirpurpose andinterrelationship
Specificsyllabuslearningoutcomesare:1d,3a
Syllabuslinks Thematerialinthischapterwillbedevelopedfurtherinthispaper,andthenintheProfessionalLevel moduleofFinancialAccountingandReporting.
Examinationcontext Questionsonthetopicsinthischapterwillbesetasmultiplechoicequestions,someofwhichmay involvecalculationssothatthecorrectanswercanbeselected. Intheexamyoumayberequiredto:
32
Identifyandmanipulatetheaccountingequation
Specifytransactionsaffectingtheelementsoffinancialstatements:assets,liabilities,capital,income andexpenditure
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1 Assets,liabilitiesandthebusinessentityconcept Sectionoverview
Anassetisaresourcecontrolledbytheentityasaresultofpasteventsfromwhichfuture economicbenefitsareexpectedtoflow.
Assetsmaybeheldforthelong-term(non-currentassets)orfortheshorttermastradingassets (currentassets).
Aliabilityisapresentobligationarisingfrompastevents,thesettlementofwhichisexpectedto resultinanoutflowofresourcesfromthebusinessembodyingeconomicbenefits.
Liabilitiesmaybecurrentornon-current.
Abusinessentityisaseparateentityfromitsownersfromanaccountingpointofview,whatever thelegalpositionmaybe.
C H A P T E R
1.1 Assetsandliabilities 2
Definition Asset:TheConceptualFrameworkstatesthatanassetisaresourcecontrolledbytheentityasaresultof pasteventsfromwhichfutureeconomicbenefitsareexpectedtoflowtotheentity.Assetsarekey elementsoffinancialstatements. Examplesofassets:
Landandbuildings:factories,officebuildings,storageanddistributioncentres(warehouses)
Motorvehicles
Plantandmachinery
Fixturesandfittings:computerequipment,officefurnitureandshelving
Cash:inabankaccountorheldasnotesandcoins
Inventory:goodsheldinstoreawaitingsaletocustomers,andrawmaterialsandcomponentsheld instorebyamanufacturingbusinessforuseinproduction
Receivables(ordebtors):amountsowedbycustomersandotherstotheentity
Someassetsareheldandusedinoperationsforalongtime.Anofficebuildingisoccupiedby administrativestaffforyears;similarly,amachinehasaproductivelifeofmanyyearsbeforeitwearsout. Thesearelong-termornon-currentassets. Otherassetsareheldforonlyashorttime.Anewsagent,forexample,hastosellhisnewspapersonthe samedaythathegetsthem.Thequickerabusinesssellsgoods,themoreprofititislikelytomake, provided,ofcourse,thatthegoodsaresoldatahigherpricethanwhatitcostthebusinesstoacquire them.Short-termassetsarecalledcurrentassets.
Definition Liability:TheConceptualFrameworkstatesthataliabilityisapresentobligationarisingfrompastevents, thesettlementofwhichisexpectedtoresultinanoutflowfromtheentityofresourcesembodying economicbenefits.Liabilitiesarekeyelementsoffinancialstatements.
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Examplesofliabilities:
Abankloanoroverdraft.Theliabilityistheamounteventuallyrepaidtothebank.
Payables(orcreditors):amountsowedtosuppliersforgoodspurchasedbutnotyetpaidfor (purchases'oncredit').Forexample,aboatbuilderbuyssometimberoncreditfromatimber merchant,sothattheboatbuilderdoesnotpayforthetimberuntilsometimeafterithasbeen delivered.Untiltheboatbuilderpayswhatheowes,thetimbermerchantisacreditorforthe amountowed.
Taxationowedtothegovernment.Abusinesspaystaxonitsprofitsbutthereisagapintime betweenwhenabusinessdeclaresitsprofits(andbecomesliabletopaytax)andthepayment date.
1.1.1 AnoteonterminologyinthisStudyManual FormostofthisStudyManualweshallbeemployingtheterminologyusedinIASs.Financialstatements preparedunderUKGAAP(formostsoletradersandpartnerships,andformanysmallercompanies)use differentterminologyasfollows: IASterm
UKGAAPterm
Non-currentasset
Fixedasset
Inventory
Stock
Receivables
Debtors
Payables
Creditors
Statementoffinancialposition
Balancesheet
Statementofprofitorloss
Profitandlossaccount
Tomakeexplanationsofbasicaccountingstraightforward,weshallusesomesoletradersinexamples usinginternationalterminology.InChapter14howeverweshallshowasetofsoletraderfinancial statementsusingtheUKGAAPformatthatiscurrentlymorelikelytoapplytosoletradersinpractice.
1.2 Thebusinessasaseparateentity Youmayhavewonderedwhetheranintangibleentity,suchasabusiness,canownassetsorhave liabilitiesinitsownname.Therearetwoaspectstothisquestion:thestrictlegalpositionandthe conventionadoptedbyaccountants. Manybusinessesarecarriedonintheformoflimitedliabilitycompanies.Theownersofalimited companyareitsshareholders,whomaybefewinnumber(aswithasmall,familyownedcompany)or verynumerous(aswithalargepubliccompanywhosesharesarelistedonastockexchange). Thelawrecognisesacompanyasalegalentity,quiteseparatefromitsowners.Acompanymay,inits ownname,acquireassets,incurdebts,andenterintocontracts.Ifacompany'sassetsbecame insufficienttomeetitsliabilities,thecompanyasaseparateentitybecomes'insolvent'.However,the ownersofthecompanyarenotusuallyrequiredtopaythedebtsfromtheirownprivateresources:the debtsarenotdebtsoftheowners,butofthecompany. Thecaseisdifferentwhenabusinessiscarriedonbyanindividual(asoletrader).Thereisnolegal separationbetweenasoletraderandthebusinesshe/sheruns.Inmostpartnerships–,thereisalsono legaldistinction.
Workedexample:Soletrader RodneyQuiffstartsbusinessasahairdresser,tradingunderthebusinessname'Quiff'sHairSalon'.The lawrecognisesnodistinctionbetweenRodneyQuiff,theindividual,andthebusinessknownas'Quiff's HairSalon'.Anydebtsofthebusinesswhichcannotbemetfrombusinessassetsmustbemetfrom Rodney'spersonalresources.
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Howeverinaccounting,anybusinessistreatedasaseparateentityfromitsowner(s).Thisapplies whetherornotthebusinessisrecognisedinlawasaseparateentity,ieitapplieswhetherthebusinessis carriedonbyacompanyorbyasoletrader.Thisisknownasthebusinessentityconcept(orseparate entityconcept,orjustentityconcept).
Definition Businessentityconcept:Abusinessisaseparateentityfromitsowner. Althoughthismayseemillogicalandunrealisticyoumusttrytoappreciateit,asitisthebasisofa fundamentalruleofaccounting,whichisthattheliabilitiesplusthecapitalofthebusinessmustalways equalitsassets.Wewilllookatthisruleinmoredetaillaterinthischapter,butasimpleexamplenow willclarifytheideaofabusinessasaseparateentityfromitsowners.
Workedexample:Thebusinessasaseparateentity On1July20X6,LizaDoolittleopenedaflowerstall.Shehadsavedup£2,500andopenedabusiness bankaccountwiththisamount. Whenthebusinesscommences,anaccountant'spicturecanbedrawnofwhatitownsandwhatit owes.ThebusinessbeginsbyowningthecashthatLizahasputintoit,£2,500.
C H A P T E R
2
Thebusinessisaseparateentityinaccountingterms.Ithasobtainedassets,inthisexamplecash, fromLizaDoolittle.ItthereforeowesthisamountofmoneytoLiza.IfLizachangedhermindand decidednottogointobusiness,thebusinesswouldbedissolvedbythe'repayment'ofcashtoLiza. Theamountowedbyabusinesstoitsownersisknownas(equity)capital.
Definition Capital:TheConceptualFrameworkstatesthatcapital(whichitcallsequityinthecontextofacompany, asweshallseeinChapter11)istheresidualinterestintheassetsoftheentityafterdeductingallits liabilities.Equityisakeyelementoffinancialstatements.
2 Theaccountingequation Sectionoverview
Thebasicaccountingequationstatesthatassets=capital+liabilities. Capitalistheamountthattheentityowestoitsowners.
2.1 Whatistheaccountingequation? Definition Accountingequation:ASSETS=CAPITAL+LIABILITIES. Wewilluseanexampletoillustratetheaccountingequation,ietherulethattheassetsofabusiness willatalltimesequalitsliabilitiespluscapital.Thisisalsoknownasthebalancesheetequation.
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2.2 Assets=capital+liabilities Workedexample:Assets=capital ThebusinessbeganbyowningthecashthatLizahasputintoit,£2,500.Thebusinessisaseparate entityinaccountingtermsandsoitowesthemoneytoLizaascapital. Inaccounting,capitalisaninvestmentofmoney(funds)withtheintentionofearningareturn.A businessownerinvestscapitalwiththeintentionofearningprofit.Aslongasthatmoneyisinvested, accountantswilltreatthecapitalasmoneyowedtotheownerbythebusiness. WhenLizaDoolittlesetsupherbusiness: Cashatbank Capitalinvested
£ 2,500 2,500
WecanexpressLiza'sinitialaccountingequationasfollows: ForLizaDoolittle,asat1July20X6: Assets £2,500(cashatbank)
= =
Capital £2,500
+ +
Liabilities £0
Workedexample:Differenttypesofasset=capital LizapurchasesamarketstallfromLenTurnipfor£1,800. Shealsopurchasessomeflowersfromatraderinthewholesalemarket,atacostof£650. Thisleaves£50incash,afterpayingforthestallandgoodsforresale,outoftheoriginal£2,500.Liza keeps£30inthebankandholds£20insmallchangefortrading.Sheisnowreadyforherfirstdayof markettradingon3July20X6. Theassetsandliabilitiesofthebusinesshavenowaltered,andat3July,beforetradingbegins,thestate ofherbusinessisasfollows. Assets Stall Flowers Cashatbank Cashinhand
£ 1,800 650 30 20 2,500
= =
Capital £2,500
+ +
Liabilities £0
Thestallandtheflowersarephysicalitems,buttheymustbegivenamoneyvalue.Thismoneyvalueis usuallywhattheycostthebusiness(calledhistoricalcostinaccountingterms).
Definition Historicalcost:Transactionsarerecordedattheircostwhentheywereincurred.
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2.3 Wheredoprofits/lossesfitintotheaccountingequation? Workedexample:Assets=capital+profit On3JulyLizasellsallherflowersfor£900cash. SinceLizahassoldgoodscosting£650toearnincomeof£900,wecansaythatshehasearnedaprofit of£250ontheday'strading. Profitsareaddedtotheowner'scapital.Inthiscase,the£250belongstoLizaDoolittle.However,so longasthebusinessretainstheprofitsanddoesnotpayanythingouttoitsowner,theretainedprofits areaccountedforasanadditiontotheowner'scapital. Assets Stall Flowers Cashinhandandat bank(30+20+900)
£ 1,800 0 950 2,750
= Capital Originalinvestment Retainedprofit (900–650)
£ 2,500 250 2,750
+ +
Liabilities
£0
C H A P T E R
Wecanrearrangetheaccountingequationtohelpustocalculatethecapitalbalance. Assets–liabilities(netassets)=Capital
2
Atthebeginningandendof3July20X6,LizaDoolittle'sfinancialpositionwasasfollows. (a) (b)
Atthebeginningoftheday: Attheendoftheday:
Netassets £(2,500–0)=£2,500 £(2,750–0)=£2,750
=
Capital £2,500 £2,750
Therehasbeenanincreaseof£250innetassets,whichistheamountofprofitearnedduringtheday.
Definitions Profit:Theexcessofincomeoverexpenses. Loss:Theexcessofexpensesoverincome. Income:Increasesineconomicbenefitsoveraperiodintheformofinflowsorincreasesofassets,or decreasesofliabilities,resultinginincreasesinequity/capital(ConceptualFramework).Itcanincludeboth revenueandgains.Incomeisakeyelementoffinancialstatements. Expenses:Decreasesineconomicbenefitsoveraperiodintheformofoutflowsordepletionofassets, orincreasesinliabilities,resultingindecreasesinequity/capital(ConceptualFramework).Expenseisa keyelementoffinancialstatements. Thus:
Profitsareaddedtoowner'scapital Lossesaredeductedfromowner'scapital
NotethattheConceptualFrameworkidentifiesincomeandexpenses,andassets,liabilitiesandequity, astheelementsoffinancialstatements.Eachelementrepresentsaclassoftransactionsorotherevents thataregroupedtogetheraccordingtotheireconomiccharacteristics.
2.4 Appropriationofprofits:soletraderdrawings Theownerofasoletradershipdoesnotgetpaidawage;they'drawout'orappropriatesomeoftheir capitalasdrawings.
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Definition Drawings:Moneyandgoodstakenoutofabusinessbyitsowner.
Workedexample:Assets=capital+profit–drawings Businessowners,likeeveryoneelse,needincomeforlivingexpenses.Lizathereforedecidestopay herself£180in'wages'. Thepaymentof£180isregardedbyLizaasafairrewardforherday'sworkandshemightthinkofthe sumas'wages'.However,the£180shedrawsisnotanexpensetobedeductedinarrivingatthefigure ofnetprofitbecauseanyamountspaidbyabusinesstoitsowneraretreatedbyaccountantsas withdrawalsorappropriationsofprofitandnotasexpensesincurredbythebusiness.Inthecaseof Liza'sbusiness,thetruepositionis: £ 250 (180) 70
Netprofitearnedbythebusiness LessprofitwithdrawnbyLiza Netprofitretainedinthebusiness
Profitsarecapitalaslongastheyareretainedinthebusiness.Oncetheyareappropriated,thebusiness suffersareductionincapital. Thewithdrawalsofprofitaretakenincash,andsothebusinessloses£180ofitscashassets.Afterthe withdrawalhasbeenmade,theaccountingequationwouldberestated. (a) Assets Stall Goods Cash(950–180)
£ 1,800 0 770 2,570
Capital = Originalinvestment Retainedprofit (250–180)
£ 2,500 70 2,570
+ +
Liabilities
£0
(b) Alternatively Netassets
=
Capital
£(2,570–0)
=
£2,570
Theincreaseinnetassetssincetradingoperationsbeganisnowonly£(2,570–2,500)=£70,whichis theamountoftheretainedprofits.
Workedexample:Assets=capital On10JulyLizapurchasesflowersforcash,atacostof£740.ShedecidestoemployhercousinEthelfor awageof£40fortheday. On10JulyLizaandEthelsoldalltheirflowersfor£1,100cash.LizapaidEthel£40anddrewout£200 forherself. Afterthepurchaseofthegoodsfor£740theaccountingequationis: Assets Stall Flowers Cash(770–740)
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£ 1,800 740 30 2,570
= =
Capital
£2,570
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On10July,alltheflowersaresoldfor£1,100cash,andEthelispaid£40.Theprofitforthedayis calculatedasfollows: Sales Less costofgoodssold Ethel'swage Profit Assets Stall Flowers Cash(30+1,100–40)
£ 740 40 £ 1,800 0 1,090 2,890
Capital = Atbeginningof10July Profitsearnedon 10July =
£ 2,570 320 2,890
+ +
£ 1,100 (780) 320
Liabilities
£0
AfterLizahaswithdrawn£200incash,retainedprofitswillbeonly£(320–200)=£120. Assets Stall Flowers Cash(1,090–200)
£ 1,800 0 890 2,690
Capital = Atbeginningof10July Retainedprofitsfor 10July =
£ 2,570 120 2,690
+ +
Liabilities
£0
C H A P T E R
2
Interactivequestion1:Capital
[Difficultylevel:Easy]
Fillinthemissingwords. Capital=........................................less........................................ SeeAnswerattheendofthischapter.
3 Credittransactions Sectionoverview
Acreditorisanypersontowhomtheentityowesmoney.
Atradepayableisacreditorwhichhasarisenfollowingapurchaseoncreditbytheentity.
Atradepayableisaliabilityoftheentity.
Adebtorisanypersonwhoowesmoneytotheentity.
Atradereceivableisadebtorthathasarisenfollowingasaleoncreditbytheentity.
Atradereceivableisanassetoftheentity.
Thematchingoraccrualsconceptrequiresthatincomeismatchedwiththeexpensesincurredin earningit.Thisconceptisthereasonwhyweaccountforcredittransactionsbeforetheyare realisedintheformofcash.
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3.1 Tradepayables(creditors) Definition Creditor:Persontowhomabusinessowesmoney. Atradecreditorisapersontowhomabusinessowesmoneyfortradingdebts.Intheaccountsofa business,debtsstilloutstandingwhicharisefromthepurchasefromsuppliersofmaterials,components orgoodsforresalearecalledtradepayables. Abusinessdoesnotalwayspayimmediatelyforgoodsorservicesitbuys.Itiscommonbusinesspractice tomakecreditpurchases,withapromisetopaywithin30/60/90days,ofthedateofthebillor'invoice' forthegoods.Forexample,Abuysgoodscosting£2,000oncreditfromB,BsendsAaninvoicefor £2,000,dated1March,withcredittermsthatpaymentmustbemadewithin30days.IfAthendelays paymentuntil31March,BwillbeacreditorofAbetween1and31Marchfor£2,000.FromA'spointof view,theamountowedtoBisatradepayable. Atradepayableisaliabilityofabusiness.Whenthedebtisfinallypaid,thetradepayable'disappears' asaliabilityandthebalanceofcashatbankandin-handdecreases.
3.2 Tradereceivables(debtors) Definition Debtor:Personwhoowesmoneytothebusiness. SupposethatCsellsgoodsoncredittoDfor£6,000ontermsthatthedebtmustbesettledwithintwo monthsoftheinvoicedate,1October.DwillbeadebtorofCfor£6,000from1Octoberuntilthedate paymentismade.Intheaccountsofthebusiness,amountsowedbydebtorsarecalledtrade receivables. Adebtorisanassetofabusiness.Whenthedebtisfinallypaid,thedebtor'disappears'asanasset,to bereplacedby'cashatbankandinhand'.
Workedexample:Assets=capital+liabilities Lookattheconsequencesofthefollowingtransactionsintheweekto17July20X6.(SeeWorked example:Assets=capitalforthesituationasattheendof10July.) (a) LizaDoolittlerealisesthatsheisgoingtoneedmoremoneyinthebusinessandsoshemakesthe followingarrangements. (i)
Sheinvestsafurther£250ofherowncapital.
(ii) ShepersuadesherUncleHenrytolendher£500.UncleHenrytellsherthatshecanrepaythe loanwhenevershelikes,butinthemeantime,shemustpayhiminterestof£5eachweekat theendofthemarketday.Theyagreethatitwillprobablybequitealongtimebeforethe loaniseventuallyrepaid. (b) Shedecidestobuyavantopickupflowersfromhersupplierandbringthemtohermarketstall. Shefindsacardealer,LaurieLoader,whoagreestosellheravanoncreditfor£700.Lizaagreesto payforthevanafter30days'trialuse. (c) Duringtheweek,Liza'sUncleGeorgetelephoneshertoaskwhethershewouldsellhimsome gardenfurniture.Lizatellshimthatshewilllookforasupplier.ShebuyswhatUncleGeorgehas askedfor,paying£300incash.UncleGeorgeacceptsdeliveryofthegoodsandagreestopay £350,butheasksifshecanwaituntiltheendofthemonthforpayment.Lizaagrees. (d) Lizabuysflowerscosting£800.Ofthesepurchases£750arepaidincash,withtheremaining£50 onsevendays'credit.LizadecidestouseEthel'sservicesagain,atanagreedwageof£40forthe day.
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(e) On17July,Lizasellsallhergoods,for£1,250(cash).Shedecidestowithdraw£240forherweek's work.ShealsopaysEthel£40incash.ShedecidestomaketheinterestpaymenttoherUncle Henrythenexttimesheseeshim. (f) Therearenovanexpensesfortheweek.
Solution Dealwithtransactionsoneatatimeinchronologicalorder.(Inpractice,itispossibletodoonesetof calculationswhichcombinesalltransactions.) (a) TheadditionofLiza'sextracapitalandUncleHenry'sloan AninvestmentanalystmightcallUncleHenry'sloanacapitalinvestment,onthegroundsthatit willprobablybeforthelongterm.UncleHenryisnottheownerofthebusiness,however,even thoughhehasmadeaninvestmentinit.HewouldonlybecomeanownerifLizaofferedhima partnershipinthebusiness,andshehasnotdoneso.Tothebusiness,UncleHenryisalongterm creditor,anditisappropriatetodefinehisinvestmentasaliabilityandnotbusinesscapital. Theaccountingequationafter£(250+500)=£750cashisputintothebusinesswillbe: Assets Stall Goods Cash(890+750)
£ 1,800 0 1,640 3,440
Capital = Asatendof10July Additionalcapital =
£ 2,690 250 2,940
Liabilities + Loan +
£ 2,690 250 2,940
Liabilities + £ Loan 500 Payables 700 + 1,200
£ 500 500
C H A P T E R
2
(b) Thepurchaseofthevan(cost£700)oncredit Assets Stall Van Cash
£ 1,800 700 1,640 4,140
Capital = Asatendof10July Additionalcapital =
(c) ThesaleofgoodstoUncleGeorgeoncredit(£350)whichcostthebusiness£300(cashpaid) Assets Stall Van Receivable Cash(1,640–300)
£ 1,800 700 350 1,340 4,190
Capital = Asatendof10July Additionalcapital Profitonsaleto UncleGeorge (350–300) =
£ 2,690 250 50 2,990
Liabilities + £ Loan 500 Payables 700 + 1,200
(d) Afterthepurchaseofgoodsfortheweeklymarket(£750paidincashand£50ofpurchaseson credit) Assets Stall Van Goods(750+50) Receivable Cash(1,340–750)
£ 1,800 700 800 350 590 4,240
Capital = Asatendof10July Additionalcapital Profitonsaleto UncleGeorge =
£ 2,690 250 50 2,990
Liabilities + £ Loan 500 Payables (van) 700 Payables (goods) 50 + 1,250
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(e) Aftermarkettradingon17July Goodscosting£800earnedincomeof£1,250incash.Ethel'swageswere£40(paid),Uncle Henry'sinterestchargeis£5(notpaidyet)anddrawingswere£240(paid).Theprofitfor17July maybecalculatedasfollows,takingthefull£5ofinterestasacostonthatday.
£
Sales Costofgoodssold Wages Interest Profitearnedonmarkettradingon17July ProfitonsaleofgoodstoUncleGeorge Profitfortheweek Drawings Retainedprofit Assets Stall Van Goods(800–800) Receivable Cash(590+ 1,250–40–240)
£ 1,800 700 0 350 1,560 4,410
Capital = Asatendof10July Additionalcapital Profitsretained =
800 40 5
£ 2,690 250 215 3,155
£ 1,250 (845) 405 50 455 (240) 215
Liabilities + £ Loan 500 Payables (van) 700 Payables (goods) 50 Payables (interest payment) 5 + 1,255
3.3 Accrualsconcept Theaccruals(ormatching)conceptrequiresthatincomeearnedismatchedwiththeexpensesincurred inearningit. InLiza'scase,wehave'matched'theincomeearnedwiththeexpensesincurredinearningit.Soinpart (e),weincludedallthecostsofthegoodssoldof£800,eventhough£50hadnotyetbeenpaidin cash.Alsotheinterestof£5wasdeductedfromincome,eventhoughithadnotyetbeenpaid.
Interactivequestion2:Theaccountingequation
[Difficultylevel:Intermediate]
Howwouldeachofthesetransactionsaffecttheaccountingequationintermsofincreaseordecreasein asset,capitalorliability? (a) (b) (c) (d)
Purchasing£800worthofgoodsoncredit Payingthetelephonebill£25 Selling£450worthofgoodsfor£650 Paying£800toasupplier
SeeAnswerattheendofthischapter. Weshalllooknowathowthebusinessentityconceptandaccrualstogetherresultinthestatementof financialposition.
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4 Thestatementoffinancialposition Sectionoverview
Thestatementoffinancialpositionshowstheentity'sfinancialpositionataparticularmomentin time.
Thestatementoffinancialpositionrepresentstheaccountingequation:assetsareinonehalfand capitalandliabilitiesintheother.
Themoredetailedaccountingequation,representedintheIAS1formatforthestatementof financialposition,statesthatnon-currentassets+currentassets=capital+profit–losses– drawings+non-currentliabilities+currentliabilities.
Netassets=assets–liabilities,thereforenetassets=capital.
Anon-currentassetisacquiredforlongtermuseinthebusiness,withaviewtoearningprofits fromitsuse,eitherdirectlyorindirectly.
Non-currentassetsmaybetangible(withaphysicalreality)orintangible.
Currentassetsareeithercashoritemswhichareheldbytheentitytobeturnedintocashshortly.
Capitalcomprisesopeningcapital+capitalintroduced+profits–losses–drawingsof capital/profitstakenbytheowners.
Non-currentliabilitiesarepayableafteroneyear,suchassecuredloans.
Currentliabilitiesarepayablewithinoneyear,suchastradepayablesandbankoverdrafts.
C H A P T E R
2
4.1 Whatisastatementoffinancialposition? Thebusiness'sstatementoffinancialpositionshowsitsfinancialpositionatagivenmomentintime.It containsthreekeyelementsoffinancialstatements:liabilities,capitalandassetsatthatmoment.It isa'financialsnapshot',sinceitcapturesonpaperastillimageofsomethingwhichisdynamicand continuallychanging.Typically,astatementoffinancialpositionispreparedattheendofthereporting periodtowhichthefinancialstatementsrelate. Astatementoffinancialpositionisverysimilartotheaccountingequation.Infact,theonlydifferences betweenastatementoffinancialpositionandanaccountingequationare:
Themannerorformatinwhichtheliabilitiesandassetsarepresented. Theextradetailwhichisusuallycontainedinastatementoffinancialposition.
Thedetailsshowninastatementoffinancialpositionwillnotbedescribedinfullinthischapter.Instead wewillmakeastartinthischapterandaddmoredetailinlaterchaptersaswegoontolookatother ideasandmethodsinaccounting. Astatementoffinancialpositionisdividedintotwohalves,andispresentedineitherofthefollowing ways.
Capitalandliabilitiesinonehalfandassetsintheother(theIAS1formatthatweadoptinthis StudyManual).
Capitalinonehalfandnetassetsintheother(theUKGAAPformatforthebalancesheetthatis lookedatinChapters13and14).
Definition Netassets:Assetslessliabilities
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InthisStudyManualwewillfollowtheassets=capital+liabilitiesformatgivenbyIAS1Presentationof FinancialStatements. NAMEOFBUSINESS STATEMENTOFFINANCIALPOSITIONASAT(DATE) Assets(itembyitem) Capital Liabilities
£ X X X X
Thetotalvalueinonehalfofthestatementoffinancialpositionequalsthetotalvalueintheotherhalf. Sinceeachhalfofthestatementoffinancialpositionhasanequalvalue,onesidebalancestheother. Capital,liabilitiesandassetsareusuallyshowninsomedetailinastatementoffinancialposition.The followingparagraphsdescribethesortofdetailwemightexpecttofind.
4.2 Capital(soletrader) Thesoletrader'scapitalisusuallyanalysedintoitscomponentparts. Capitalatthebeginningofthereportingperiod (iecapitalbroughtforward) Addadditionalcapitalintroducedduringtheperiod Addprofitearnedduringtheperiod(orlesslossesincurredintheperiod) Lessdrawings Retainedprofitfortheperiod Capitalasattheendofthereportingperiod(iecapitalcarriedforward)
£ X (X)
£ X X X X X
'Broughtforward'meansthattheamountisbroughtforwardfromthepreviousperiod.Similarly, 'carriedforward'meanscarriedforwardtothenextperiod.Thecarriedforwardamountattheendof oneperiodisthereforethebroughtforwardamountofthenextperiod.
4.2.1 Equity(company) Thecapitalorequitysideofacompany'sstatementoffinancialpositionismorecomplicatedthana soletrader's.WeshalllookatitindetailinChapter11.
4.3 Liabilities AdistinctionisrequiredbyIAS1inthestatementoffinancialpositionbetweennon-currentliabilities andcurrentliabilities.
Currentliabilitiesaredebtswhicharepayablewithinoneyear Non-currentliabilitiesaredebtswhicharepayableafteroneyear
4.3.1 Non-currentliabilities Definition Non-currentliability:Adebtwhichisnotpayablewithinoneyear.Anyliabilitywhichisnotcurrent mustbenon-current. Examplesofnon-currentliabilities:
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Loanswhicharenotrepayableformorethanoneyear,suchasabankloanoraloanfroman individualtoabusiness.
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Loanstockordebentures.Thesearecommonwithlimitedcompanies.Loanstocksordebentures aresecuritiesissuedbyacompanyatafixedrateofinterest.Theyarerepayableonagreedterms byaspecifieddateinthefuture.Holdersofloanstocksarethereforelendersofmoneytoa company.Theirinterests,includingsecurityfortheloan,areprotectedbythetermsofatrust deed.Iftheloanisrepayableoverseveralyearsthentheportionrepayablewithinoneyearis shownasacurrentliability(seebelow).
4.3.2 Currentliabilities Definition Currentliabilities:Debtsofthebusinessthatmustbepaidwithinoneyear,orwithintheentity's normaloperatingcycle,orthatareheldtobetraded. Examplesofcurrentliabilities:
Loansrepayablewithinoneyear,includingtheelementofalongtermloanthatisrepayable withinoneyear.
Abankoverdraft,whichisusuallyrepayableondemand.
Tradepayablesrepresentsupplierstowhichthebusinessowesmoneyforgoodsorservices boughtoncreditaspartofthebusiness'stradingactivities.
Otherpayablesareduetoanyoneelsetowhomthebusinessowesmoney,suchasHMRevenue andCustoms(HMRC)inrespectofVAT,pensiontrusteesinrespectofpensioncontributions,and employeesinrespectofunpaidremuneration,forexamplesalescommissions.
TaxationpayabletoHMRCwithrespecttocorporationtaxonthecompany'sprofits.
Accruals.Theseareexpensesalreadyincurredbythebusiness,forwhichnoinvoicehasyetbeen received,orforwhichthedateofpaymenthasnotyetarrived.Anexampleofaccruedchargesis thecostofgasorelectricityused.Ifabusinessendsitsaccountingyearon31December,butdoes notexpectitsnextquarterlygasbilluntiltheendofJanuary,therewillbetwomonthsofaccrued gaschargestorecordinthestatementoffinancialpositionasaliability.Accrualswillbedescribed morefullyinChapter9.
C H A P T E R
2
4.4 Assets Thestatementoffinancialpositiondistinguishesbetweennon-currentassetsandcurrentassets(again asrequiredbyIAS1).
Non-currentassetsareacquiredforlong-termusewithinthebusiness.Theyarenormallyvalued atcostlessaccumulateddepreciation.
Currentassetsareexpectedtobeconvertedintocashwithinoneyear.
4.4.1 Non-currentassets Definition Non-currentassets:Assetsacquiredforcontinuingusewithinthebusiness,withaviewtoearning incomeormakingprofitsfromtheiruse,eitherdirectlyorindirectly,overmorethanonereporting period. Non-currentassetsinthestatementoffinancialpositionusuallycomprise:
Property,plantandequipment(ie'Tangible'assets) Intangiblenon-currentassetssuchasgoodwill Long-terminvestments
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Anon-currentassetisnotacquiredforsaletoacustomer.
Inamanufacturingindustry,aproductionmachineisanon-currentasset,becauseitmakesgoods whicharethensold.
Inaserviceindustry,equipmentusedbyemployeesgivingservicetocustomersisanon-current asset(egtheequipmentusedinagarage,orfurnitureinahotel).
Lessobviouslyfactorypremises,officefurniture,computerequipment,companycars,deliveryvans orpalletsinawarehouseareallnon-currentassets.
Tobeclassedasanon-currentassetinthebusiness'sstatementoffinancialposition,anitemmustsatisfy twofurtherconditions.
Itmustbeusedbythebusiness.Forexample,theowner'sownhousewouldnotnormallyappear onthebusinessstatementoffinancialposition.
Theassetmusthavea'life'inuseofmorethanonereportingperiodoryear.
Atangiblenon-currentassetisaphysicalassetthatcanbetouched.Alloftheexamplesofnon-current assetsmentionedaboveare'tangible'assets.Theyareoftenreferredtoasproperty,plantand equipment. Intangiblenon-currentassetsareassetswhichdonothaveaphysicalexistence;theycannotbe 'touched'.Anexampleisapatent,whichprotectsanidea,andgoodwill. Aninvestmentcanalsobeanon-currentasset.CompanyAmightinvestinanothercompany,B,by purchasingsomeofB'sshares.TheseinvestmentswillearnincomeforAintheformofdividendspaid outbyB.IftheinvestmentsarepurchasedbyAwithaviewtoholdingontothemformorethanone year,theywouldbeclassifiedasnon-currentassetsofA. Inthischapter,weshallrestrictourattentiontotangiblenon-currentassets.
4.4.2 Non-currentassetsanddepreciation Non-currentassetsareheldandusedbyabusinessforanumberofyears,buttheywearoutorlose theirusefulnessinthecourseoftime.Everytangiblenon-currentassethasalimitedlife.Theonly exceptionisfreeholdland,althoughthistoocanbeexhaustedifitisusedbyextractiveindustries(eg mining). Thefinancialstatementsofabusinessreflectthatthecostofanon-currentassetisgraduallyconsumed astheassetwearsout.Thisisdonebygradually'writingoff'theasset'scostinthestatementofprofitor lossoverseveralreportingperiods.Forexample,inthecaseofamachinecosting£1,000andexpected towearoutaftertenyears,itisappropriatetoreducethevalueinthestatementoffinancialpositionby £100eachyear.Thisprocessisknownasdepreciation. Ifastatementoffinancialpositionweredrawnupfouryearsaftertheassetwaspurchased,theamount ofdepreciationaccumulatedoverfouryearswouldbe4×£100=£400.Themachinewouldthen appearinthestatementoffinancialpositionasfollows. £ Machineatoriginalcost 1,000 Lessaccumulateddepreciation (400) Carryingamount* 600 *iethevalueoftheassetinthebooksofaccount,netofaccumulateddepreciation.Aftertenyearsthe assetwouldbefullydepreciatedandwouldappearinthestatementoffinancialpositionwithacarrying amountofzero. Theamountthatiswrittenoffovertimedoesnothavetobethefullcostoftheassetifitisexpectedto havearesale–or'residual'–valueattheendofitsusefullife.
Interactivequestion3:Residualvalue
[Difficultylevel:Examstandard]
Supposeabusinessbuysacarfor£10,000.Itexpectstokeepthecarforthreeyearsandthentosellit for£3,400.Howmuchdepreciationshouldbeaccountedforineachyearofthecar'susefullife? SeeAnswerattheendofthischapter. Weshallstudynon-currentassetsindetailinChapter10.
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4.4.3 Currentassets Currentassetstakeoneofthefollowingforms. (a) Itemsownedbythebusinesswiththeintentionofturningthemintocashinashorttime,usually withinoneyear(seetheworkedexamplebelow). (b) Cash,includingmoneyinthebank,ownedbythebusiness. Theseassetsare'current'inthesensethattheyarecontinuallyflowingthroughthebusiness;theyare alwaysrealisableinthenearfuture.
Definition Currentasset:Anassetiscurrentwhenitisexpectedtoberealisedin,orintendedforsaleor consumptionin,theentity'snormaloperatingcycle,oritisheldforbeingtraded,oritisexpectedtobe realisedwithin12monthsofthedateofthestatementoffinancialposition,oritiscashoracash equivalent.
C H A P T E R
Workedexample:Currentassets DavidWickesrunsabusinesssellingcars.Hepurchasesashowroom,whichhestockswithcarsforsale. Heobtainsthecarsfromamanufacturerandpaysforthemincashondelivery.
Ifhesellsacarinacashsale,thegoodsareimmediatelyconvertedintocash.Thecashcanthen beusedtobuymorecarsforresale.
Ifhesellsacarinacreditsale,thecarwillbegiventothecustomer,whothenbecomesatrade receivable.Eventually,thecustomerwillpaywhattheyoweandDavidWickeswillreceivecash. Onceagain,thecashcanthenbeusedtobuymorecarsforre-sale.
2
Currentassetsareasfollows.
Thecars(goods)heldininventoryforre-salearecurrentassets,becauseDavidWickesintendsto sellthemwithinoneyearinthenormalcourseoftrade.
Anytradeandotherreceivablesarecurrentassets,iftheywillbepaidwithintheusualcash operatingcycleoflessthanoneyear.
Cashisacurrentasset.
Interactivequestion4:Assetclassification
[Difficultylevel:Intermediate]
Identifywhichofthefollowingassetsfallsintothenon-currentcategoryandwhichshouldbetreatedas current.Couldanybetreatedaseither? Asset
Business
Currentornon-current
Van
Deliveryfirm
Machine
Manufacturingcompany
Car
Cartrader
Investment
Any
SeeAnswerattheendofthischapter.
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CarsarecurrentassetsforDavidWickesbecauseheisinthebusinessofbuyingandsellingthem,ieheis acartrader.Ifhealsohasacarwhichhekeepsandusesforbusinesspurposes,thiscarwouldbeanoncurrentasset.Thedistinctionbetweenanon-currentassetandacurrentassetisnotwhattheassetis physically,butforwhatpurposeitisobtainedandusedbythebusiness. Therearesomeothercategoriesofcurrentasset.
Shortterminvestments.Thesearestocksandsharesofotherbusinesses,ownedwiththe intentionofsellingtheminthenearfuture.Forexample,ifabusinesshasalotofsparecashfora shorttime,itsmanagersmightdecidetoinvestshort-terminthestockexchange.Theshareswill laterbesoldwhenthebusinessneedsthecash.Ifsharepricesriseinthemeantime,thebusiness willmakeaprofitfromitsshortterminvestment.Suchsharesmustbereadilyrealisable(ieeasyto sell)tobeshort-term.
Prepayments.Theseareamountsofmoneypaidbythebusinessinonereportingperiodfor benefitswhichhavenotyetbeenenjoyed,butwhichwillbeenjoyedwithinthenextreporting period.Forexample,abusinesspaysanannualinsurancepremiumof£240,andthepremiumis payableannuallyinadvanceon1December.Ifthebusinesshasanaccountingyearendof31 December,itwillpay£240on1Decemberbutonlyenjoyonemonth'sinsurancecoverbythe yearend.Theremaining11months'cover(£220cost,at£20permonth)willbeenjoyedinthe nextyear.Theprepaymentof£220isshowninthestatementoffinancialposition,at31 December,asacurrentasset.PrepaymentswillbedescribedmorefullyinChapter7.
4.4.4 Tradeandotherreceivables Areceivablecanbeduefromanyonewhoowesthebusinessmoney.Forexample,ifabusinessmakes aninsuranceclaim,theinsurancecompanyisareceivableforthemoneypayableontheclaim.Ifthe businessmakesloanstostafftobuyrailseasontickets,staffarereceivablesfortheamountoutstanding. Adistinctioncanbemadebetweentwotypesofreceivable.
Tradereceivablesrepresentcustomerswhoowemoneyforgoodsorservicesboughtoncreditin thecourseofthetradingactivitiesofthebusiness.
Otherreceivablesareduefromanyoneelseowingmoneytothebusiness,suchasaninsurance company,HMRCforVAT,oremployeesforseasonticketloans.
5 Preparingthestatementoffinancialposition Sectionoverview
Thestatementoffinancialpositionlistsoutandtotalsnon-currentpluscurrentassets,thenitlists outandtotalscapitalplusnon-currentliabilitiespluscurrentliabilities.
5.1 Howisabasicstatementoffinancialpositionprepared? Weshallnowlookathowthevarioustypesofassetsandliabilitiesareshowninabusiness'sstatement offinancialposition(IAS1format).Youmightliketoattempttoprepareityourselffromtheinformation providedbeforereadingthesolutionwhichfollows.
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Workedexample:Statementoffinancialposition PrepareastatementoffinancialpositionforSunkenArchesasat31December20X6,giventhe informationbelow. £ 51,100 8,000 50,000 9,000 8,000 25,000 2,000 16,000 500 100 1,200 4,000 600 300
Capitalasat1January20X6 Profitfortheyearto31December20X6 Premises,carryingamountat31December20X6 Motorvehicles,carryingamountat31December20X6 Fixturesandfittings,carryingamountat31December20X6 Non-currentloan Bankoverdraft* Inventories Tradereceivables Cashinhand* Tradepayables Drawings Accruedcostsofrent Prepaymentofinsurancepremium
C H A P T E R
*Ashopmighthavecashinitscashregisters,butanoverdraftatthebank. 2
Solution SUNKENARCHES STATEMENTOFFINANCIALPOSITIONASAT31DECEMBER20X6 ASSETS Non-currentassets Property,plantandequipment Premises Fixturesandfittings Motorvehicles Currentassets Inventories Tradeandotherreceivables Prepayments Cashandcashequivalents Totalassets
£
16,000 500 300 100
£
50,000 8,000 9,000 67,000 16,900 83,900
CAPITALANDLIABILITIES Capital Asat1January20X6 Profitfortheyear Lessdrawings At31December20X6 Non-currentliabilities Long-termborrowings Currentliabilities Short-termborrowings(bankoverdraft) Tradeandotherpayables Accruedcosts Totalcapitalandliabilities
£ 51,100 8,000 (4,000) 2,000 1,200 600
£ 55,100 25,000 3,800 83,900
ThelayoutisinthepreferredformatfromIAS1,adaptedforasoletrader,andwewilluseitthroughout thisStudyManual,forsoletradersaswellascompanies,untilwelookatUKGAAPinChapters13and 14.
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Interactivequestion5:Preparingastatementoffinancialposition1 [Difficultylevel:Intermediate] YouaregiventhefollowinginformationaboutLizaDoolittleattheendofherfirstfullmonthoftrading, 31July20X6: Capitalat1July20X6 Additionalcapitalintroduced Profitforthemonth Stallatcost Vanatcost Drawingsinmonth Loan Inventories Cashinhand Tradepayables Cashatbank Tradereceivables
£ 2,500 250 3,620 1,800 700 960 50 1,250 20 675 1,475 890
Requirement PrepareastatementoffinancialpositionforLizaDoolittleasat31July20X6. SeeAnswerattheendofthischapter.
6 Thestatementofprofitorloss Sectionoverview
Thestatementofprofitorlosssetsouttheentity'sfinancialperformanceoveraperiodoftime.
Itmatchesincomeandexpensestoarriveatafigureforprofitorloss.
Tradingincomelessthecostsoftradingrepresentsgrossprofit.
Grossprofitlessexpensesrepresentsnetprofit.
Profitfortheyearperthestatementofprofitorlossisaddedtothecapitalsectioninthe statementoffinancialposition;drawingsaredeductedasappropriationsofprofitinordertoarrive attheowner'stotalcapital.
6.1 Whatisthestatementofprofitorloss? Thestatementofprofitorlossisastatementinwhichtwokeyelementsoffinancialstatements– incomeandexpenses–arematchedtoarriveatprofitorloss.Manybusinessesdistinguishbetween:
Grossprofitearnedontrading(revenuelesscostofsales) Profitfortheyear(sometimesreferredtoasNetprofit)afterotherincomeandexpenses
Inthefirstpartofthestatementofprofitorlossrevenuefromsellinggoodsiscomparedwithdirect costsofacquiringorproducingthegoodssoldtoarriveatagrossprofitfigure.Fromthis,deductions aremadeinthesecondhalfofthestatement(whichwewillcalltheexpensessection)inrespectof indirectcosts(overheads).Additionsmayalsobemadetogrossprofitinrespectofnon-trading income. Grossprofit = Profitfortheyear=
revenuefromsales,lesscostofsales grossprofitlessexpensesplusnon-tradingincome
Businessownerswanttoknowhowmuchprofitorlosshasbeenmade,butthereisonlylimited informationvalueintheprofitfigure.Inordertoexercisefinancialcontroleffectively,managersmust knowhowmuchrevenueandotherincomehasbeenearned,whatcostshavebeen,andwhetherthe performanceofsalesorthecontrolofcostsappearstobesatisfactory.
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Thestatementofprofitorlossmatchesincomeearnedtotheexpensesofearningthatincome.This iswhyprepaymentsandaccruedexpensesappearinthefinancialstatements.Prepaymentsare excludedfromexpensesinthestatementofprofitorlossandareincludedinreceivablesinthe statementoffinancialposition,becausetheyrelatetofutureperiods. Accruedexpensesareaddedtoexpensesinthestatementofprofitorlossandshownaspayablesin thestatementoffinancialposition,becausetheyrelatetothecurrentperiodbuthavenotbeenpaidas cashintheperiod.
6.1.1 Grossprofit Grossprofitisthedifferencebetween:
Thevalueofsalesrevenueand Thepurchaseorproductioncostofthegoodssold:costofsales
Inaretailbusiness,thecostofthegoodssoldistheirpurchasecostfromsuppliers.Inamanufacturing business,theproductioncostofgoodssoldisthecostofrawmaterialsinthefinishedgoods,plus labourcostsrequiredtomakethegoods,plusanamountofproduction'overhead'costs.Inmany typesofbusinessthecostofsalesalsoincludes:
Thecostofemployingthosepeopledirectlyinvolvedinmakingorprovidingaservice
Maintenanceanddepreciationonnon-currentassetsuseddirectlyinmakingsales,pluslosseson theirdisposal
C H A P T E R
2
Grossprofitrepresentstheprofitmadedirectlyfromthesaleofgoodsorservices.Itcanberepresented asapercentageofrevenue,calledthegrossprofitmargin. Grossprofitmargin=
Gross profit 100 Re venue
Thegrossprofitmargincanbeusedtocomparetheresultsofdifferentperiodstoseehowwellthecosts ofsalesarebeingcontrolledasrevenuechanges.Itcanalsobeusedtocomparetheresultsofdifferent businessesinthesameindustry. WeshallseemoreaboutmarginsinChapter7.
6.1.2 Profitfortheyear Thesecondpartofthestatementofprofitorlossshowsthenetprofitforthereportingperiod.Thenet profitis: Grossprofit Plusanyotherincomefromsourcesotherthanthesaleofgoods Minusotherbusinessexpenses,notincludedinthecostofgoodssold Incomefromothersourceswillinclude:
X X (X) X
Profitondisposalsofnon-currentassets
Dividendsorinterestreceivedfrominvestments
Rentalincomefrompropertyownedbutnototherwiseusedbythebusiness
Amountsdueinrespectofinsuranceclaims
Discountsreceivedfromsuppliersforearlypaymentoftheirdebt.(Seeunderadministrativecosts belowforabriefexplanationofdiscounts.)
Businessexpensesnotdirectlyrelatedtocostofsalesappearinthestatementofprofitorlossunder oneofthreeheadings.
Distributioncosts.Expensesassociatedwithsellinganddeliveringgoodstocustomers.They includethefollowing. –
Salaries,wagesandsalescommissionofemployees
–
Marketingcosts(egadvertisingandsalespromotionexpenses)
–
Thecostsofrunningandmaintainingdeliveryvans,includingdepreciationontheseandany lossesontheirdisposal
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Administrativecosts.Expensesofprovidingmanagementandadministrationforthebusiness. Examplesinclude: –
Managementandofficestaffsalaries
–
Rentandlocalbusinessorpropertytaxes
–
Insurance
–
Telephoneandpostage
–
Printingandstationery
–
Heatingandlighting
–
Discountsallowedtocustomersforearlypaymentoftheirdebt.Forexample,abusinesssells goodstoacustomerfor£100andoffersa5%discountforpaymentincash.Ifthecustomer takesthediscount,recordrevenueatthefull£100,withanadministrativecostfordiscounts allowedof£5.DiscountsaredescribedmorefullyinChapter3.
–
Irrecoverabledebtswrittenoff.Sometimescustomersfailtopaywhattheyoweandabusiness hastodecideatsomestagethatthereisnownoprospectofeverbeingpaid.Thedebthasto bewrittenoffas'irrecoverable'.Theamountofthedebtwrittenoffischargedasanexpense inthestatementofprofitorloss.IrrecoverabledebtsarealsodescribedmorefullyinChapter 8.
–
Thecostofrunningandmaintainingothernon-currentassetssuchasofficebuildings,plus depreciationandlossesondisposalofthese.
Financecosts.Theseinclude: – –
Interestonloans Bankoverdraftinterest
Asfaraspossible,itemsofexpenseshouldbegrouped(distributioncosts,administrativeexpenses,and financecosts)butthisisnotsomethingthatyouneedworryaboutatthisstage.
Workedexample:Preparingastatementofprofitorloss On1June20X5,JockHeisscommencedtradingasanicecreamsalesman,usingavan. (a) Heborrowed£2,000fromhisbank,andtheinterestcostoftheloanwas£25permonth. (b) Herentedthevanfor£1,000forthreemonths.Runningexpensesforthevanaveraged£300per month. (c) Hehiredanassistantfor£100permonth. (d) Hismainbusinesswastosellicecreamtocustomersinthestreet,buthealsodidspecialcatering forbusinesscustomers,supplyingicecreamsforofficeparties.Salestothesecustomerswere usuallyoncredit. (e) Forthethreemonthsto31August20X5,histotalsaleswereasfollows. (i) Cashsales (ii) Creditsales
£8,900 £1,100
(f) Hepurchasedhisicecreamfromalocalmanufacturer,FloorsCo.Thepurchasecostinthethree monthsto31August20X5was£6,200,andat31Augusthehadsoldeveryitem.Hestillowed £700toFloorsCoforunpaidpurchasesoncredit. (g) Oneofhiscreditsalecustomershasgonebankrupt(insolvent),owingJock£250.Jockhasdecided towriteoffthedebtinfull,withnoprospectofgettinganyofthemoneyowed. (h) Heusedhisownhomeforhisofficework.Telephoneandpostageexpensesforthethreemonths to31Augustwere£150,whichhepaidincash. (i)
Duringtheperiodhepaidhimself£300permonth.
Astatementofprofitorlosscanbepresentedinvariousformats,butherewewilluseaverticalformat similartotheoneusedinIAS1.(Itisnotexactlythesame.)
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JOCKHEISS STATEMENTOFPROFITORLOSS FORTHETHREEMONTHSENDED31AUGUST20X5 Revenue(8,900+1,100) Costofsales Grossprofit Expenses Wages(3100) Vanrental Vanexpenses(3300) Irrecoverabledebtwrittenoff Telephoneandpostage Interestcharges(325) Profitfortheyear
£
300 1,000 900 250 150 75
£ 10,000 (6,200) 3,800 (2,675) 1,125
6.2 Relationshipbetweenthestatementofprofitorlossandthestatementof financialposition
Netprofitistheprofitfortheperiod.Forasoletraderitistransferredtothestatementoffinancial positionasanadditiontotheowner'scapital.Anetlosswouldbetransferredasadeductionfrom capitalinthestatementoffinancialposition.
Drawingsareappropriationsofprofitandnotexpenses.Theymustnotbeincludedinthe statementofprofitorloss.ThepaymentsthatJockHeissmakestohimself(£900)areshownas deductionsfromcapitalinthestatementoffinancialposition.
Thecostofsalesis£6,200,eventhough£700ofthecostshavenotyetbeenpaidfor.The£700 owedtoFloorsCowillbeshowninthebalancesheetasatradepayable.Thisisanexampleofthe accrualsconcept.
C H A P T E R
2
Interactivequestion6:Preparingastatementoffinancialposition2 [Difficultylevel:Intermediate] Prepareastatementoffinancialpositionasat31August20X5forJockHeiss,usingtheinformationfrom theWorkedexampleabove. SeeAnswerattheendofthischapter.
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SummaryandSelf-test
Summary
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Self-test Answerthefollowingquestions. 1
Whichofthefollowingisanasset? A B
2
C D
Theentityowestoitscreditors Theentity'owes'toitsowners
Tradepayables Tradereceivables Bankoverdraft
D E
Cashinhand Fundsintroducedbytheowner
Assetsarematchedwithliabilities Incomeismatchedwithexpenses
C H A P T E R
2
C D
Expensesarematchedwithassets Incomeismatchedwithliabilities
Abankoverdraft Abankloanrepayablewithinayear
C D
Amortgagerepayableinfiveyears'time Atradepayable
Financialpositionoveraperiodoftime Financialperformanceoveraperiodoftime Financialpositionatonepointintime Financialperformanceatonepointintime
Whichofthefollowingexpensesisincludedincostofsales? A B
9
Theentity'sownersowetoit Theentity'scustomersowetoit
Thestatementoffinancialpositionsetsouttheentity's A B C D
8
Cashatbank Plantandmachinery
Whichofthefollowingisanon-currentliability? A B
7
C D
Whichofthefollowingbestdescribestheaccrualsconcept? A B
6
Depreciation Anaccrual
Whichofthefollowingareassetsofanentity? A B C
5
Drawings Aprepayment
Capitalistheamount: A B
4
C D
Whichofthefollowingisaliability? A B
3
Atradepayable Aloan
Salespeople'ssalaries Managementsalaries
C D
Overdraftinterest Costofrawmaterial
Abusinesshassalesof£100,000,costofsalesof£60,000andexpensesof£20,000.Thegross profitmarginis: A B
60% 40%
C D
20% 80%
10 Whichfigurefromasoletrader'sstatementofprofitorlosswouldappearinitsstatementof financialposition? A B
Grossprofit Drawings
C D
Revenue Netprofit
Now,gobacktotheLearningObjectivesintheIntroduction.Ifyouaresatisfiedyouhaveachievedthe objectives,pleasetickthemoff.
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Technicalreference
Basicformatofthestatementoffinancialpositionandstatementofprofitor loss
IAS1 IG Conceptual
Elementsoffinancialstatements
Framework paras4.2to4.3 Conceptual
Definitionofasset,liability,equity
Framework para4.4 Conceptual
Definitionofincome,expense
Framework para4.25
56
Current/non-currentdistinctioninthestatementoffinancialposition
Definitionofcurrentasset
Definitionofcurrentliability
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AnswerstoInteractivequestions
AnswertoInteractivequestion1 Assets=capital+liabilities.Thereforecapital=assets–liabilities
AnswertoInteractivequestion2 (a) Increaseinliabilities(payables) Increaseinassets(inventory) (b) Decreaseinassets(cash) Decreaseincapital(anexpensereducesprofit)
£800 £800
C H A P T E R
£25 £25
(c) Decreaseinassets(inventory) Increaseinassets(cash) Increaseincapital(profit)
£450 £650 £200
(d) Decreaseinliabilities(payables) Decreaseinassets(cash)
£800 £800
2
AnswertoInteractivequestion3 Thepointinthiscaseisthatthecarhasaresidualvalueof£3,400.Itwouldbeinappropriatetoaccount fordepreciationinsuchawayastowriteofftheassetcompletelyoverthreeyears;theaimshouldbeto accountonlyforitslossofvalue(£10,000–£3,400=£6,600),whichsuggestsdepreciationof£2,200 peryear.
AnswertoInteractivequestion4 Asset
Business
Currentornon-current
Van
Deliveryfirm
Non-current
Machine
Manufacturingcompany
Non-current
Car
Cartrader
Current
Investment
Any
Either*
*Theclassificationoftheinvestmentwilldependonthepurposeforwhichitisheld.Iftheintentionis tomakeanon-currentinvestmentitwillbeanon-currentasset,butifitisashort-termwayof investingsparecashitwillbeacurrentasset.
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AnswertoInteractivequestion5 LIZADOOLITTLE STATEMENTOFFINANCIALPOSITIONASAT31JULY20X6 ASSETS Non-currentassets Stall Van Currentassets Inventories Tradereceivables Cashinhand Cashatbank Totalassets
1,250 890 20 1,475
1,800 700 2,500 3,635 6,135
CAPITALANDLIABILITIES Capital Openingcapital Additionalcapitalintroduced Profitformonth Lessdrawings Non-currentliabilities Loan
2,500 250 3,620 (960)
2,750 2,660 5,410 50
Currentliabilities Tradepayables Totalcapitalandliabilities
£
£
675 6,135
AnswertoInteractivequestion6 JOCKHEISS STATEMENTOFFINANCIALPOSITIONASAT31AUGUST20X5 ASSETS Currentassets Tradereceivables(1,100–250) Cashatbankandinhand (2,000+8,900–(6,200–700)–300–1,000–900–150–75–900) Totalassets CAPITALANDLIABILITIES Capital Openingcapital Netprofit Drawings Closingcapital
850 2,075 2,925 0 1,125 (900) 225
Non-currentliabilities Loan
2,000
Currentliabilities Tradepayables Totalcapitalandliabilities
700 2,925
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AnswerstoSelf-test 1
D
AandBareliabilities;Cisanappropriationofprofit.
2
B
CandDareassets,depreciationisanexpenseandareductioninthevalueofanasset.
3
D
BisanassetwhileCisaliability;Aisthewrongwayround.Abetterwayofthinkingofcapital isthatitistheowners'residualinterestintheentity'snetassets.
4
BandD.AandCarecurrentliabilities;Eiscapital.
5
B
Theaccrualsconceptisbestdescribedasthematchingofincomewithexpenses.
6
C
Themortgageisrepayableinoverayear'stimeand,therefore,isanon-currentliability.The bankoverdraftisrepayableondemand,atradepayableisusuallypaidwithinayearandthe bankloanisrepayablewithinoneyear,sotheseareallcurrentliabilities.
7
C
Bdescribesthestatementofprofitorlossaccurately.
8
D
Theothersareexamplesofsellingexpenses(A),administrationexpenses(B)andfinancecost (C).
9
B
10 D
Grossprofit (100,000 60,000) 100% 100% 40% Grossprofitmargin= Sales 100,000
C H A P T E R
2
Grossprofit(A)andrevenue(C)areincludedinthecalculationofnetprofit;drawingsare appropriationsofnetprofitthatappearinthestatementoffinancialpositiononly.
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CHAPTER3
Recordingfinancial transactions
Introduction Examinationcontext TopicList 1 Sourcedocumentsforrecordingfinancialtransactions 2 Booksoforiginalentry 3 Salesandpurchasesdaybooks 4 Cashbook 5 Pettycashbook 6 Thepayroll 7 Thejournal SummaryandSelf-test AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Identifythesourcesofinformationforthepreparationofaccountingrecordsandfinancial statements
Recordtransactionsandeventsresultinginincome,expenses,assets,liabilitiesandequity
Specificsyllabuslearningoutcomesare:1c,d
Syllabuslinks Thematerialinthischapterwillbedevelopedfurtherinthispaper,andthenintheProfessionalLevel moduleofFinancialAccountingandReporting.
Examinationcontext Questionsonthetopicsinthischapterwillbesetasmultiplechoicequestions,someofwhichmay involvecalculationssothatthecorrectanswercanbeselected. Intheexamyoumayberequiredto:
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Specifysourcedocumentsfortheaccountingsystem Identifythepurposeofbooksoforiginalentry Identifythebooksoforiginalentryinwhichspecifictransactionsarerecorded Identifyanaccuratedescriptionofthepettycashimprestsystem Calculatenetorgrosspay,ortheamountsowedtoHMRC
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1 Sourcedocumentsforrecordingfinancialtransactions Sectionoverview
Creditsalesmakeuseofsalesorders,deliverynotestothecustomerandsalesinvoices(whichis thesourcedocumentthatisthenrecorded).
Creditpurchasesmakeuseofpurchaseorders,goodsreceivednotesandsalesinvoicesfromthe supplier(whichbecomepurchaseinvoicestoberecorded).
Invoicesshow,amongotherthings,whathasbeensoldatwhatprice.TradediscountsandVAT arealsoshown,sothatthetotalreflectsthefullamountthatremainstobepaid.
Creditnotesarenegativeinvoices.
1.1 Whataresourcedocumentsusedfor? Wheneverabusinesstransactiontakesplaceinvolvingsalesorpurchases,receivingorpayingmoney,or owingorbeingowedmoney,itisusualforthetransactiontoberecordedonasourcedocument. Thesedocumentsarethesourceofallinformationrecordedbyabusiness,butonlyinvoicesandcredit notesaresourcedocumentsfortheaccountingsystem.
C H A P T E R
3
Recordingfinancialtransactions
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Inmanybusinessesacustomerwritesoutorsignsasalesorderforgoodsorservicesherequires. Similarly,abusinesswillplacepurchaseorderswithotherbusinessesforgoodsorservices,suchas materialsupplies. Whilesalesandpurchaseordersareveryimportantfromapracticalpointofview,theyarenottreated assourcedocumentsforrecordingfinancialtransactionsinthebusinessaccounts.
1.2 Invoices Invoicesareusedtorecordtransactionswhichhavebeenmadeoncredit.Thisiswheregoodsor servicesaresuppliedbutpaymentisnotmadestraightawayasthereisa'periodofcredit'beforethey areactuallydueforpayment.
Whenabusinesssellsgoodsorservicesoncredittoacustomer,itsendsoutasalesinvoice.The invoicedetailsshouldmatchthesalesorderdetails.Theinvoiceisarequestforthecustomertopay whatisowed.
Whenabusinessbuysgoodsorservicesoncredititreceivesapurchaseinvoicefromthesupplier. Thedetailsontheinvoiceshouldmatchthedetailsonthepurchaseorder.
Aninvoicemayrelatetoasalesorpurchaseorder.Invoicesaresourcedocumentsforcredit transactions. Mostsalesinvoicesarenumbered,sothatthebusinesscankeeptrackofallthesalesinvoicesitsends out.Informationusuallyshownonaninvoiceincludesthefollowing.
Invoicenumber
Nameandaddressofsellerandpurchaser
Saledate
Product/servicedescription
Quantityandunitpriceofwhathasbeensold(eg20pairsofshoesat£25apair)
Detailsoftradeorbulkdiscount,ifany(eg10%reductionincostifbuyingover100pairsofshoes)
Totalinvoiceamountincluding(usually)VATdetails
Thedatebywhichpaymentisdue,andothertermsofsale
Atear-offremittanceadvice,forthecustomertosendtothebusinessalongwithpaymentsothat thebusinesscanidentifywhatoutstandingamountsarebeingsettled.
Purchaseinvoicesreceivedwillshowexactlythesamedetailsasasalesinvoice–becauseitisofcourse thesupplier'ssalesinvoicestous!Mostbusinesseswillgiveuniquereferencenumberstopurchase invoicesreceivedsothattheycanbe'tracked'withinthebusiness.
1.3 Creditnotes SupposeChinaSuppliessentoutasalesinvoicetoacustomer(ashop)for20dinnerplates,butthe personcreatingtheinvoiceaccidentallytypedinatotalof£162.10,insteadof£62.10.Theshophas beenoverchargedby£100.WhatisChinaSuppliestodo? Anothershopreceived15platesfromChinaSuppliesbutfoundthattheyhadallbeenbrokeninthe post.Althoughtheshophasreceivedaninvoicefor,say,£45.60,ithasnointentionofpayingitbecause theplatesweresubstandard.Again,whatisChinaSuppliestodo? TheansweristhatChinaSuppliessendsoutacreditnote.Itwillbemadeoutinthesamewayasan invoice,butwitha'creditnotenumber'insteadofa'salesinvoicenumber'.
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Definition Creditnote:Adocumentissuedtoacustomerrelatingtoreturnedgoods,orrefundswhenacustomer hasbeenoverchargedforwhateverreason.Itcanberegardedasanegativeinvoice.Itisasource documentforcredittransactions.
1.3.1 Debitnotes Adebitnotemightbeissuedtoasupplierasameansofformallyrequestingacreditnotefromthat supplier.Adebitnoteisnotasourcedocument.
1.4 Deliverynotes Whengoodsorservicesaredeliveredtoacustomerinrespectofasale,theyareusuallyaccompanied byadeliverynotepreparedbytheseller.Thissetsout:
Thegoods/servicedelivered Thequantitiesdelivered Thedateofthedeliveryand Thedeliveryaddress
Thedeliverynoteismostoftenpreparedwithreferencetothesalesorder.Oncethedeliveryiscomplete thedeliverynoteisusedtoprovideinformationforcreatingthesalesinvoice.Thedeliverynoteisnota sourcedocumentforcredittransactions.
1.5 Goodsreceivednotes Agoodsreceivednote(GRN)recordsareceiptofgoodspurchased,mostcommonlyinawarehouse. Theymaybeusedinadditiontosuppliers'deliverynotes.Oftentheaccountsdepartmentwillasktosee theGRNbeforepayingapurchaseinvoice.EvenwhereGRNsarenotroutinelyused,thedetailsofa deliveryfromasupplierwhicharriveswithoutadeliverynotemustalwaysberecorded.AGRNisnota sourcedocumentforcredittransactions.
Interactivequestion1:Creditnote
C H A P T E R
3
[Difficultylevel:Easy]
Fillintheblanks. 'ChinaSuppliessendsouta........................................toacreditcustomerinordertocorrectanerror whereacustomerhasbeenoverchargedona.........................................' SeeAnswerattheendofthischapter.
1.6 VAT Valueaddedtax(VAT)isasalestaxaddedtomostsalesinvoicesintheUK.Detailsforcalculatingand recordingVATarediscussedinChapter4.Aswellasthesaleorpurchaseamount,thebusinessalso normallyneedstorecordVAToneachinvoiceorcreditnote.Thisamountwillultimatelybepaidtoor receivedfromHMRC.
1.7 Othersourcedocuments Sofarwehaveonlyconsideredsourcedocumentsforinitialrecordingofsalesandpurchasesoncredit, iesalesandpurchaseinvoicesandcreditnotes.Othersourcedocumentsfortransactionsinvolving settlementofcredittransactions(bycheque,debitcardortransfer),cash,wagesandothermattersare alsoused,asweshallsee.
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2 Booksoforiginalentry Sectionoverview
Booksoforiginalentryrecordinformationaboutatransactionshowninasourcedocument.
Thekeybooksoforiginalentryaresalesandpurchasesdaybooks,thecashbook,thepettycash book,thejournalandthepayroll.
2.1 Whatarebooksoforiginalentryusedfor? Sourcedocumentsneedtobesummarised,asotherwisethebusinessmightforgettoaskforsome money,forgettopaysome,orpaysomethingtwice.Itneedstokeeprecordsoftransactionsas documentedininvoicesandcreditnotes.Suchrecordsaremadeinbooksoforiginal(orprime)entry.
Definition Booksoforiginalentry:Therecordsinwhichthebusinessfirstrecordstransactions. Themainbooksoforiginalentryare:
Salesdaybook Purchasesdaybook Cashbook
Pettycashbook Thepayroll Thejournal
Tohelpyouvisualisewhatisgoingon,thischapterdescribesbooksoforiginalentryasiftheyareactual bookswrittenbyhand.Infact,booksoforiginalentryarenearlyalwayscomputerfiles.However,the principlesremainthesamewhethertheyaremanualorcomputerised.
3 Salesandpurchasesdaybooks Sectionoverview
Salesinvoicesandcreditnotesarerecordedinthesalesdaybook. ThesalesdaybookisusuallyanalysedtoshowthetypesofsaleandVAT. Purchaseinvoicesandcreditnotesarerecordedinthepurchasesdaybook. ThepurchasesdaybookisusuallyanalysedtoshowthetypesofpurchaseandVAT.
Invoicesandcreditnotesarerecordedindaybooks.
3.1 Salesdaybook Definition Salesdaybook:Thebookoforiginalentryinrespectofcreditsales,includingbothinvoicesandcredit notes.
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Thesalesdaybooklistsallinvoicesandcreditnotessentouttocustomers.Anextractfromasalesday bookmightlooklikethis. SALESDAYBOOK Date 20X0 Jan10
Invoice/credit notenumber I247 I248 CN004 I249
Customer Jones&Co SmithCo Alex&Co EnorCollege
Total £ 107.04 88.32 (32.16) 1,291.68 1,454.88
Mostbusinesses'analyse'theirsales.Forexample,thisbusinesssellsbootsandshoes.Theinvoiceto SmithCowasentirelyboots,thecreditnotetoAlex&Cowasentirelyshoes,andtheothertwoinvoices wereamixtureofboth.AllcontainedanelementofVAT.WelookatVATindetailinSection9of Chapter4andinparticularwecoverVATratesinSection9.3ofChapter4.Howeveratthisstageyou shouldnotethatVATistypicallychargedatarateof20%oftherelatedsalesvalueandisanalysed separatelyonsalesinvoices.AseparatecolumnisusedinthesalesdaybooktoaccountforVAT. Theanalysedsalesdaybookmightlooklikethis. Date 20X0 Jan10
SALESDAYBOOK Invoice/credit notenumber I247 I248 CN004 I249
Customer Jones&Co SmithCo Alex&Co EnorCollege
Folio:SDB48
Total £ 107.04 88.32 (32.16) 1,291.68 1,454.88
VAT £ 17.84 14.72 (5.36) 215.28 242.48
Boots £ 50.00 73.60 – 800.30 923.90
Shoes £ 39.20 – (26.80) 276.10 288.50
Theanalysisgivesbusinessmanagersusefulinformationwhichhelpsthemtodecidehowbesttorun thebusiness.ItalsofulfilsinparttheirdutytorecordandaccountforVAT.
C H A P T E R
3
3.2 Purchasesdaybook Definition Purchasesdaybook:Thebookoforiginalentryinrespectofcreditpurchases,includingbothinvoices andcreditnotes. Anextractfromapurchasesdaybookmightlooklikethis.VATonpurchasesisalsoseparatelyanalysed onpurchaseinvoicesandaVATcolumnisincludedinthepurchasedaybook. Date 20X8 Mar15
PURCHASEDAYBOOK Invoice/credit notenumber I4192 CN048 I4193 I4194
Supplier Cook Butler Telcom Show
Folio:PDB37 Total £ 321.60 (30.24) 119.04 102.24 512.64
VAT £ 53.60 (5.04) 19.84 17.04 85.44
Purchases £ 268.00 (25.20) – 85.20 328.00
Expenses £ – – 99.20 – 99.20
Inthe'invoice/creditnotenumber'columnanumberisallocatedbythebusiness;thepurchasesday bookrecordsotherpeople'sinvoices,whichhaveallsortsofdifferentnumberswhichitcannotusually record.
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Thepurchasesdaybookanalysesinvoicesandcreditnoteswhichhavebeenreceived.Inthisexample, twooftheinvoicesandthecreditnoterelatedtogoodswhichthebusinessintendstoresell(called simply'purchases')andthethirdinvoicewasaphonebill.AllincludedVAT.
4 Cashbook Sectionoverview
Thecashbookrecordsallpaymentsfromandreceiptsintotheentity'sbankaccount.
Paymentsandreceiptsmaybeviacash,cheque,cardpayment,BACStransferoronlinetransfer.
Ideally,paymentsandreceiptsshouldbeevidencedbyaremittanceadviceasthesource document.
Thecashbookisanalysedtoshowthetypesofpaymentandreceipt,andanyVAT.
Discountallowedandreceivedisrecordedinmemorandumcolumnsinthecashbook.
Definition Cashbook:Thebookoforiginalentryforreceiptsandpaymentsinthebusiness'sbankaccount.
4.1 Whatisthecashbookusedfor? Thecashbookisusedtorecordmoneyreceivedandpaidoutbythebusinessthroughthebusiness bankaccount.Thiscouldbemoneyreceivedonthebusinesspremisesinnotes,coinsandcheques,and subsequentlypaidintothebank.Thesourcedocumentsforsuchitemsareusuallyremittanceadvices, whichidentifywhatisbeingsettled.Therearealsoreceiptsandpaymentsmadebycard,banktransfer, standingorder,directdebitandonlinetransfer,plusbankinterestandchargesmadedirectlybythe bank.Thesourcedocumentsforsuchitemsareremittanceadvicesorreceipts,thoughthefirstthe businessmayknowofsometransactionsiswhentheyappearonthebusiness'sbankstatement. Somecash,innotesandcoins,isusuallykeptonthebusinesspremisesinordertomakeoccasional paymentsforodditemsofexpense.Thiscashisusuallyaccountedforseparatelyinapettycashbook. Onepartofthecashbookrecordscashreceipts,andanotherpartrecordspayments.Thebestwayto seehowthecashbookworksistofollowthroughanexample.
Workedexample:Cashbook Atthebeginningof1September20X7,RobinPlentyhad£900inthebank. On1September,Robinhadthefollowingreceiptsandpayments. (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m)
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Cashsale:receiptof£96(includingVATof£16) PaymentfromcreditcustomerHay£380 PaymentfromcreditcustomerBeen£720 PaymentfromcreditcustomerSeed£140 ChequereceivedasashorttermloanfromLenDinger£1,800 Cashsale:receiptof£144(includingVATof£24) Cashreceivedforsaleofmachine£200(noVAT) PaymenttosupplierKew£120 PaymenttosupplierHare£310 Paymentoftelephonebill£384(includingVATof£64) Paymentofgasservicecharge£288(includingVATof£48) £100incashwithdrawnfrombankforpettycash Paymentof£1,500toHessfornewplantandmachinery(noVAT)
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Thereceiptspartofthecashbookfor1Septemberwouldlooklikethis. CASHBOOK(RECEIPTS) Date 20X7 1Sept
Narrative Balanceb/d* Cashsale(a) Receivables:Hay(b) Receivables:Been(c) Receivables:Seed(d) Loan:LenDinger(e) Cashsale(f) Saleofnon-currentassets(g) Total
Total receipts £ 900 96 380 720 140 1,800 144 200 4,380
VAT £
Receivables £
Cash sales £
Other £
*'b/d'=broughtdown(iebroughtforward) Thereisusuallyspaceontherighthandsideofthecashbooksothatthereceiptscanbeanalysed–for example,'VAT','(cashfrom)receivables','cashsales'and'other(receipts)'. Thecashreceivedinthedayamountedto£3,480.Addedtothe£900atthestartoftheday,thiscomes to£4,380.Thisisnottheamounttobecarriedforwardtothenextday,becausefirstwehaveto subtractallthepaymentsmadeon1September. Thepaymentspartofthecashbookfor1Septemberwouldlooklikethis. CASHBOOK(PAYMENTS) Date 20X7 1Sept
Narrative Payables:Kew(h) Payables:Hare(i) Telephonebill(j) Servicechargebill(k) Pettycash(l) Machinerypurchases(m) Totalpayments Balancec/d (4,380–2,702) Total
Total payment £ 120 310 384 288 100 1,500 2,702 1,678 4,380
VAT £
Payables £
Petty cash £
Wages £
Other £
C H A P T E R
3
Theanalysisontherightwouldbeunderheadingslike'VAT','(paymentsto)payables,'(paymentsinto) pettycash','wages'and'other(payments)'. Paymentsduring1Septembertotalled£2,702.Weknowthatthetotalofreceiptswas£4,380.That meansthatthereisabalanceof£4,380–£2,702=£1,678tobe'carrieddown'tothestartofthenext day.Asyoucanseethis'balancecarrieddown'isnotedattheendofthepaymentscolumn,sothatthe totalreceiptsandtotalpaymentcolumnsshowthesamefigureof£4,380attheendof1September. Withanalysiscolumnscompleted,thecashbookgivenintheexampleabovewouldlookasfollows.
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CASHBOOK(RECEIPTS) Date 20X7 1Sept Date 20X7 1Sept
Narrative Balanceb/d Cashsale(a) Receivables:Hay(b) Receivables:Been(c) Receivables:Seed(d) Loan:LenDinger(e) Cashsale(f) Saleofnon-currentassets(g) Narrative Payables:Kew(h) Payables:Hare(i) Telephonebill(j) Servicechargebill(k) Pettycash(l) Machinerypurchases(m) Totalpayments Balancec/d (4,380–2,702)
Total receipts £ 900 96 380 720 140 1,800 144 200 4,380
VAT £ 16 24 40
Receivables £ 380 720 140 1,240
CASHBOOK(PAYMENTS) Total payment VAT Payables £ £ £ 120 120 310 310 384 64 288 48 100 1,500 2,702 112 430 1,678 4,380
Petty cash £ 100 100
Cash sales £ 80 120 200
Other £ 1,800 200 2,000
Wages £ –
Other £ 320 240 1,500 2,060
4.2 VATinthecashbook InthecashbookVATwasincludedinonlythecashsalesandthetelephoneandservicecharge payments.Therearetworeasons:
SometransactionsdidnotfallunderthescopeofVATatall(thesaleofnon-currentassets,theloan receipt,thepettycashpaymentandthepurchaseofmachinery).
ForallothertransactionstheVAThadalreadybeenrecordedinthesalesorpurchasesdaybook. Subsequentreceiptsfromcustomersorpaymentstosuppliersaresimplyofthetotalamountowed.
ThecashbookonlyrecordsVATinrespectofreceiptsorpaymentswhich:
FallunderthescopeofVAT,and Arenotrecordedinanyotherbookoforiginalentry,becausetheyarenotcredittransactions.
4.3 Discountsinthecashbook Discountsmaybeofferedinrespectofcredittransactions.
Adiscountallowedariseswhenabusinessrecordsoneamountasbeingduefromacustomer,but thenallowsthecustomertopayslightlylessinfullsettlement(inreturnforthecustomerpaying early).
Adiscountreceivedariseswhenabusinessrecordsoneamountasbeingduetoasupplier,but thenreceivesnoticefromthesupplierthatslightlylesscanbepaidinfullsettlement(again,usually inreturnforpayingearly).
Whenareceiptisforlessthanthetotalamountowedbythecustomer,theamountofthediscount(the differencebetweentheamountowedandthereceipt)isrecordedinaspecial'memorandum'columnof thecashbook.
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Workedexample:Discountallowed Supposethatintheexampleabove,Hay'spaymentof£380wasinfullsettlementofaninvoicethathad beenrecordedat£385intotalinthesalesdaybook.Thecashbookwouldbewrittenupasfollows, withanadditional'discountallowed'column. Date
Narrative Receivables:Hay
Total receipts £ 380
VAT £
Receivables £ 380
Cash sales £
Other £
Discount allowed £ 5
Thereisusuallyaverticallinetoseparatediscounts,asthediscountcolumnisnotincludedinthe additiontothetotalreceiptscolumn(itisnot'cross-cast').
Workedexample:Discountreceived Supposenowthat,intheexampleabove,thepaymenttoKewof£120wasinfullsettlementofan invoicewhichhadbeenrecordedinthepurchasesdaybookat£123intotal.Thecashbookwouldbe writtenupasfollows,withanadditional'discountreceived'column. CASHBOOK(PAYMENTS) Date
Narrative Payables:Kew
Total payments £ 120
VAT £
Payables £ 120
Petty cash £
Wages £
Other £
Discount received £ 3
5 Pettycashbook Sectionoverview
C H A P T E R
3
Thepettycashbookrecordsallpaymentsoutofandreceiptsintopettycash.
Pettycashisthecash(notesandcoins)thatanentitykeepsonthepremisesforincidental expenditure.
Underanimprestsystem,pettycashiskeptatafixed'float'amount,whichismadeupofnotes, coinsandvouchersrepresentingpaymentsfromandreceiptsofpettycash.
Theamountofnotesandcoinsusedto'topup'pettycashwillbeequaltothetotalofthe vouchersissuedforpettycashreceiptsandpayments.
ThepettycashbookisanalysedtorecordthedifferenttypesofpettycashexpenseplusVATon pettycashpurchases.
5.1 Whatisthepettycashbookusedfor? Mostbusinesseskeepasmallamountof'pettycash'onthepremisestomakeoccasionalsmallpayments incash,egstaffrefreshments,postagestamps,taxifares,etc.Thisisoftencalledthecashfloatorpetty cash.Pettycashcanalsobetherestingplaceforoccasionalsmallreceipts,egcashpaidbyavisitorto makeaphonecall,etc.
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Definition Pettycashbook:Thebookoforiginalentryforsmallpaymentsandreceiptsofcash. Pettycashtransactions–includingVATonpaymentswhererelevant–stillneedtoberecorded, otherwisepettycashcouldbeabusedforpersonalexpensesorevenstolen. Thereareusuallymorepaymentsthanreceipts,andpettycashmustbe'toppedup'fromtimetotime withcashfromthebusinessbankaccount.Atypicallayoutisasfollows. PETTYCASHBOOK Receipts £ 250 250
Date 20X7 1Sept
Narrative Balb/d Milkbill Postagestamps Taxifare Flowers-sick staff Balc/d
Payments £ 25 5 10 15
VAT £
Milk £ 25
Postage £ 5
195 250
0
25
5
Travel £ 10 10
Other £ 15 15
Underwhatiscalledtheimprestsystem,theamountofmoneyinpettycashiskeptatanagreedsum or'float'(say£250).Expenseitemsarerecordedonvouchersastheyoccur,sothatatanytime: £ 195 55 250
Cashstillheldinpettycash Plusvouchersforpayments(25+5+10+15) Mustequaltheagreedsumorfloat
Thetotalfloatismadeupregularly(to£250,orwhatevertheagreedsumis)bymeansofacash paymentfromthebankaccountintopettycash.Theamountofthe'topup'intopettycashwillbethe totalofthevoucherpaymentssincetheprevioustopup.
Interactivequestion2:Booksoforiginalentry
[Difficultylevel:Intermediate]
Statewhichbooksoforiginalentrythefollowingtransactionswouldbeenteredinto. (a) (b) (c) (d) (e) (f) (g) (h)
YourbusinesspaysABrown(asupplier)achequefor£450.00. YousendDSmith(acustomer)aninvoicefor£650. Youraccountsmanagerasksyoufor£12tobuyenvelopes. YoureceiveaninvoicefromABrownfor£300. YoupayDSmith£500byonlinetransfer. FJones(acustomer)returnsgoodsvalued£250. YoureturngoodstoJGreenvalued£504. FJonespaysyouachequefor£500.
SeeAnswerattheendofthischapter.
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6 Thepayroll Sectionoverview
Thepayrollisthebookoforiginalentryforwagesandsalariescosts.
Theamountactuallypaidtoemployeesiscallednetpay;thisislessthangrosspaysincethe employerpaysoverwhattheemployeeowestoHMRC(forincometaxunderPAYE,and employees'NI)andthepensiontrustees(foranypensioncontribution)directly.
Grosspayrollcostismorethanemployees'grosspaysincetheemployerhastopayadditional employmenttax(employer'sNI)toHMRCplusadditionalpensioncontributionstothepension trustees.
6.1 Whatisthepayrollusedfor? Definition Payroll:Thebookoforiginalentryforrecordingstaffcosts. Thepayrollrecordsalltheindividualamountsthatappearonemployees'payslips,namely:
– – – –
C H A P T E R
Grosspaytoemployees: PAYEincometax Employee'sNIcontributions Employee'spensioncontributions Netpay(cashpaidtoemployees)
Additionalcostsfortheemployer: – –
3
Employer'sNIcontributions Pensioncontributions
Grosspayisnottheamountpaidtotheemployee.Theemployerneedstomakedeductionsfromgross paybeforepayingnetpaytotheemployee.
Workedexample:Payroll SunnyClimesLtdemploysthreepeople:Anjaearns£36,000ayear,Markearns£33,000ayearand Dipakearns£30,000ayear.ThegrosspayinSeptemberforeachemployeeisasfollows. Anja Mark Dipak
£ 3,000 2,750 2,500
However,thesearenottheamountsthateachemployeewillreceive.SunnyClimesLtdfirstofallhasto deductincometaxfromgrosspayunderthePAYEschemetobepaidtoHMRC.ItdeductsNational Insurance(employeeNI)fromgrosspay,againtobepaidtoHMRC.Asitrunsapensionscheme,ithas todeducteachemployee'spensioncontribution,tobepaidtopensionfundtrustees.
Anja Mark Dipak
Deductions PAYE £ 550 500 460 1,510
NI £ 250 230 210 690
Pension £ 150 135 125 410
Netpay £ 2,050 1,885 1,705 5,640
Grosspay £ 3,000 2,750 2,500 8,250
Deductions+Netpay=Grosspay
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Theemployeeswillreceivethenetpay;thisamountwillbeshowninthecashbook. Theemployerhasdeductedamountstheemployeesowetootherpeoplefromthegrosspaythe employerowestothem.Thisisnottheendofthestoryhowever;theemployeralsoowesadditionalNI toHMRC,andpensioncontributionsofitsowntothetrustees,overandabovetheamountofgross pay.Thefinalpayrollwillbeasfollows. Anja Mark Dipak
PAYE £ 550 500 460 1,510
Deductions Employee NI Pension £ £ 250 150 230 135 210 125 690 410
Netpay £ 2,050 1,885 1,705 5,640
Grosspay £ 3,000 2,750 2,500 8,250
Employer NI £ 310 265 230 805
Employer Pension £ 200 180 165 545
Total payrollcost £ 3,510 3,195 2,895 9,600
Grosspay+EmployerNI+Employerpension=Totalpayrollcost ThetotalpayrollcostforSunnyClimesLtdis£9,600.Thisispaidoutasfollows: £ 5,640 1,510 1,495 955 9,600
Employees(netpay) HMRC:IncometaxPAYE HMRC:EmployeeandemployerNI(690+805) Pensiontrustees:Employeeandemployerpension(410+545) Totalpayrollcost
Interactivequestion3:Payroll
[Difficultylevel:Examstandard]
FantabLtdhas10employeeswhohadgrosspayof£190,000perannumbetweenthemin20X4.In thatyear,FantabLtdmadenetpaypaymentstoemployeesof£129,200,andpaid£20,900tothe pensiontrustees.Itstotalpayrollcostwas£220,400.HowmuchdidFantabLtdpaytoHMRCinrespect ofNIandPAYE? SeeAnswerattheendofthischapter.
7 Thejournal Sectionoverview
Thejournalrecordstransactionsthatarenotrecordedinanyotherbookoforiginalentry.
7.1 Whatisthejournalusedfor? Thefinalbookoforiginalentryisthejournal.Thisistherecordoftransactionswhichdonotappearin anyoftheotherbooksoforiginalentry.Non-currentassetpurchasesareusuallyrecordedviathe journal.
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SummaryandSelf-test
Summary
C H A P T E R
3
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Self-test Answerthefollowingquestions. 1
Salesordersaresourcedocumentsthatarerecordedinthesalesdaybook.Trueorfalse?
2
Whenanentityreturnsgoodstoasupplieritwillexpecttoreceivefromthesupplier A B C D
3
Whatisthepurchasesdaybookusedtorecord? A B C D
4
Thesalesdaybook Thepurchasesdaybook Thecashbook Thepettycashbook
Thecashbookisthebookoforiginalentryfor A B C D
6
Suppliers'invoicesandcreditnotes Invoicesandcreditnotestocustomer Deliverynotes Goodsreceivednotes
IfacreditsaleismadebyanentitywhichisVATregistered,theVATduefromthecustomeris recordedinitiallyin A B C D
5
Aninvoice Acreditnote Apurchaseorder Agoodsreceivednote
Receiptsofamountsintotheentity'sbankaccountonly Paymentsfromtheentity'sbankaccountonly Bothreceiptsandpaymentsfortheentity'sbankaccount Allcashtransactionsfortheentity
Theamountofcashdiscountallowedonatransactionwillberecordedinitiallyinthe A B C D
Cashbook(paymentsside) Salesdaybook Purchasesdaybook Cashbook(receiptsside)
7
InputVATcannotbereclaimediftheexpenditurehasbeenmadeviapettycash.Trueorfalse?
8
Pettycashiscontrolledunderanimprestsystem.Theimprestamountis£100.Duringaperiod, paymentstotalling£53havebeenmade.Howmuchneedstobereimbursedattheendofthe periodtorestorepettycashtotheimprestaccount? A B C D
9
£100 £53 £47 £50
Thecostofemployer'sNIispartofacompany's A B C D
Netpay Grosspay Grosswagesandsalariescost Corporationtaxcharge
10 Atransactionwhichdoesnotinvolvepayroll,cashorcredittransactionsislikelytoberecordedin A B C D
Thecashbook Thepettycashbook Thesalesdaybook Thejournal
Now,gobacktotheLearningObjectivesintheIntroduction.Ifyouaresatisfiedyouhaveachievedthe objectives,pleasetickthemoff.
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AnswerstoInteractivequestions
AnswertoInteractivequestion1 Creditnote;salesinvoice
AnswertoInteractivequestion2 (a) (b) (c) (d) (e) (f) (g) (h)
Cashbook Salesdaybook Pettycashbook Purchasesdaybook Cashbook Salesdaybook Purchasesdaybook Cashbook
AnswertoInteractivequestion3 Totalpayrollcost Employees(netpay) Pensiontrustees AmountpaidtoHMRC
£ 220,400 (129,200) (20,900) 70,300
C H A P T E R
3
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AnswerstoSelf-test 1
False.Thesalesinvoiceisrecordedinthesalesdaybook.
2
B
Aninvoice(A)isreceivedinrespectoftheoriginalpurchase,afterapurchaseorder(C)has beenplacedandagoodsreceivednote(D)hasbeencreatedinrespectofthedeliveryof goods.
3
A
Customers'invoicesandcreditnotes(B)arerecordedinthesalesdaybook.Deliverynotes andgoodsreceivednotes(CandD)arenotrecordeddirectlyinanydaybooks.
4
A
VAToncreditsalesisrecordedinthesalesdaybookinitially(A),notthepurchasedaybook (B)whichrelatestocreditpurchases,northecashbook(C)whichrecordsthereceiptfrom thecustomerwhentheysettlethebill.Thepettycashbook(D)isnotnormallyabookof originalentryinrespectofcreditsales.
5
C
Thecashbookrecordsbothreceiptsandpaymentsviathebankaccount.Itdoesnotrecordall cashtransactionssincethepettycashbookrecordspettycashtransactions.
6
D
Cashdiscountisallowedtocustomers,soitwillbefirstrecordednotwhentheinvoiceis recordedinthesalesdaybook(B)butwhencashisreceivedfromthecustomer.Discounts receivedwouldberecordedinthecashbook(paymentsside)(A).
7
False.PettycashbooksoftenhaveacolumnforVATonsmallitemsofexpenditure.
8
B
Undertheimprestsystem,areimbursementismadeoftheamountofthevouchers(or paymentsmade)fortheperiod.
9
C
Thecostofemployer'sNIisaddedtogrosspay(B)(whichincludesnetpay(A))toformthe grosswagesandsalariescost.Payrolltaxesarenotincludedinthecompany'scorporationtax charge(D).
10 D
Thejournalrecordsitemswhicharenotrecordedinanyotherbookoforiginalentry.
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CHAPTER4
Ledgeraccountingand doubleentry
Introduction Examinationcontext TopicList 1 Ledgeraccounts 2 Thenominalledger 3 Doubleentrybookkeeping 4 Thejournal 5 Thepettycashimprestsystem 6 Daybookanalysis 7 Thereceivablesandpayablesledgers 8 Accountingfordiscounts 9 AccountingforVAT SummaryandSelf-test AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Identifythesourcesofinformationforthepreparationofaccountingrecordsandfinancial statements
Recordandaccountfortransactionsandeventsresultinginincome,expenses,assets, liabilitiesandequity
Preparejournalsfornominalledgerentry
Specificsyllabuslearningoutcomesare:1c,d;2d
Syllabuslinks Thematerialinthischapterwillbedevelopedfurtherinthispaper,andthenintheProfessionalLevel moduleofFinancialAccountingandReporting.
Examinationcontext Questionsonthetopicsinthischapterwillbesetasmultiplechoicequestions,someofwhichmay involvecalculationssothatthecorrectanswercanbeselected.Veryoftendoubleentryquestionsare phrasedintermsofpreparingajournal. Intheexamyoumayberequiredto:
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Identifytheeffectofdebitandcreditentriesinledgeraccountsfortheelementsoffinancial statements
Specifythedoubleentryneededtorecordparticulartransactions
Identifyhowtoposttransactionstoboththenominalandmemorandumledgers
IdentifyentriesinledgeraccountsforVAT,payablesandreceivables
Useledgeraccountstoidentifybalancingfigures
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1 Ledgeraccounts Sectionoverview
Ledgeraccountssummarisealltheindividualtransactionslistedinthebooksoforiginalentry. Recordsshouldbekeptinledgeraccountsinchronologicalorder,withcumulativetotalsbuiltup.
1.1 Whydoweneedledgeraccounts? Abusinessiscontinuallymakingtransactions,egbuyingandselling.Toprepareastatementofprofitor lossandastatementoffinancialpositiononcompletionofeveryindividualtransactionwouldbeatime consumingandcumbersomeadministrativetask. Ifabusinessrecordsandanalysesthetransactionsitmakes,assetsitacquiresandliabilitiesitincurs then,whenthetimecomestoprepareastatementofprofitorlossandastatementoffinancialposition, therelevantinformationcanbetakenfromthoserecords. Therecordsoftransactions,assetsandliabilitiesshouldbekeptinthefollowingways.
Inchronologicalorder,anddatedsothattransactionscanberelatedtoaparticularperiodof time.
Builtupincumulativetotals. – – – –
Daybyday(egtotalsalesonMonday,totalsalesonTuesday) Weekbyweek Monthbymonth Yearbyyear
Thefirststepinthisprocessistolistallthetransactionsinvariousbooksoforiginalentry,aswehave seen.Nowwewilllookatthemethodusedtoanalysetheserecords:ledgeraccountinganddouble entry.
2 Thenominalledger Sectionoverview
Thenominalledgeristheaccountingrecordwhichanalysesalltheentity'sfinancialrecords.
LedgeraccountsforeachtypeoftransactioncantaketheformofaTaccount,thelefthandsideis thedebitside,andtherighthandsideisthecreditside.
2.1 Whatisthenominalledgerusedfor?
C H A P T E R
4
Definition Nominalledger:Anaccountingrecordwhichanalysesthefinancialrecordsofabusiness. Thenominalledgercontainsdetailsofassets,liabilities,capital,incomeandexpenditure,andsoprofit andloss.Itconsistsofalargenumberofdifferentledgeraccounts,eachaccounthavingitsown purposeor'name'andanidentityorcode. Theremaybevarioussubdivisions,whetherforconvenience,easeofhandling,confidentiality,security, ortomeettheneedsofcomputersoftwaredesign.Forexample,theledgermaybesplitalphabetically, withdifferentclerksresponsibleforsectionsA-F,G-M,N-RandS-Z.Thiscanhelptoreducefraud,as therewouldhavetobecollusionbetweenthedifferentsectionclerks.
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Examplesofledgeraccountsinthenominalledgerinclude:
Plantandmachineryatcost(non-currentasset) Motorvehiclesatcost(non-currentasset) Plantandmachinery,provisionforaccumulateddepreciation(deductionfromnon-currentasset) Motorvehicles,provisionforaccumulateddepreciation(deductionfromnon-currentasset) Owner'scapital(capital) Inventories–rawmaterials(currentasset) Inventories–finishedgoods(currentasset) Totaltradereceivables(currentasset) Totaltradepayables(currentliability) Wagesandsalaries(expense) Rentandlocaltaxes(expense) Advertisingexpenses(expense) Bankcharges(expense) Motorexpenses(expense) Telephoneexpenses(expense) Sales(income) Totalcash/bankoverdraft(currentasset/liability)
Whenitcomestodrawingupthefinancialstatements,theincomeandexpenseledgeraccountswill togetherformthestatementofprofitorloss,whiletheasset,capitalandliabilityledgeraccountsgointo thestatementoffinancialposition.
2.2 Theformatofaledgeraccount Ifaledgeraccountweretobekeptinanactualbook,ratherthanasacomputerrecord,itwouldlook likethis. ADVERTISINGEXPENSES Date 20X6
Narrative JFKAgencyforquarter to31March
Ref. PL348
£ 2,500
Date
Narrative
Ref.
£
Therearetwosidestotheaccount,withanaccountheadingontop.Thelinesforma'T',soitis convenienttothinkintermsof'T'accounts.
Ontopoftheaccountisitsname. Thereisalefthand,ordebitside. Thereisarighthand,orcreditside. NAMEOFACCOUNT £
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Debitside
£
Creditside
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3 Doubleentrybookkeeping Sectionoverview
Theprincipleofdoubleentrybookkeepingisthat,foreachtransaction,everydebithasacredit.
Debitentriesincreaseassetsandexpenses,anddecreaseliabilities,capitalandincome.
Creditentriesincreaseliabilities,capitalandincome,anddecreaseassetsandexpenses.
Areceiptofcashisadebitinthecashledgeraccount.
Apaymentofcashisacreditinthecashledgeraccount.
Acreditsaleisrecordedasdebitreceivables(increaseasset),creditsales(increaseincome).
Acreditpurchaseisrecordedasdebitpurchases(increaseexpenses),creditpayables(increase liabilities).
Discountallowedtocustomersiscreditedtoreceivablesalongwithpaymentsreceived,and debitedtoadiscountallowedledgeraccount.
Discountsreceivedfromsuppliersisdebitedtopayablesalongwithpaymentsmade,andcredited toadiscountreceivedledgeraccount.
Definition Doubleentrybookkeeping:Eachtransactionhasanequalbutoppositeeffect.Everyaccountingevent mustbeenteredinledgeraccountsbothasadebitandacredit.
3.1 Dualeffect(dualityconcept) Doubleentrybookkeepingisthemethodusedtotransfertotalsfromthebooksoforiginalentryinto thenominalledger. Centraltothisprocessistheideathateverytransactionhastwoeffects,thedualeffect(alsoknownas thedualityconcept).Thisfeatureisnotsomethingpeculiartobusiness.Ifyouweretopurchaseacar for£1,000cash,forinstance,youwouldbeaffectedintwoways.
Youownacarworth£1,000. Youhave£1,000lesscash.
Ifinsteadyougotabankloantomakethepurchase:
Youownacarworth£1,000. Youowethebank£1,000.
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Amonthlaterifyoupayagarage£50tohavetheexhaustrepaired:
Youhave£50lesscash. Youhaveincurredarepairsexpenseof£50.
Ledgeraccounts,withtheirdebitandcreditsides,arekeptinawaywhichallowsthetwosidednature ofeverytransactiontoberecorded.Thisisknownasdoubleentrybookkeeping,becauseevery transactionisrecordedtwiceintheledgeraccounts.
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3.2 Therulesofdoubleentrybookkeeping Adebitentrywill:
Increaseanasset
Decreasealiability
Increaseanexpense
Decreasecapital
Decreaseincome
Acreditentrywill:
Decreaseanasset
Increasealiability
Decreaseanexpense
Increasecapital
Increaseincome
Thebasicrule,whichmustalwaysbeobserved,isthateveryfinancialtransactiongivesrisetotwo accountingentries,oneadebitandtheotheracredit.Thetotalvalueofdebitentriesinthenominal ledgeristhereforealwaysequaltothetotalvalueofcreditentries.Whichaccountreceivesthecredit entryandwhichreceivesthedebitentrydependsonthenatureofthetransaction.
Anincreaseinanexpense(egapurchaseofstationery)oranincreaseinanasset(egapurchase ofofficefurniture)isadebit.
Anincreaseinincome(egasale)oranincreaseinaliability(egbuyinggoodsoncredit)or capitalisacredit.
Adecreaseinanasset(egmakingacashpayment)oradecreaseinanexpenseisacredit.
Adecreaseinaliability(egpayingacreditor)orcapitalorincomeisadebit.
Intermsof'T'accounts,forassets,liabilitiesandcapital:
ASSET
DEBIT Increase
£
LIABILITY
£ CREDIT Decrease
DEBIT Decrease
£
CAPITAL
CREDIT Increase
£
DEBIT Decrease
£ CREDIT Increase
£
Forincomeandexpenses,thinkaboutprofit.Profitretainedinthebusinessincreasescapital.Income increasesprofitandexpensesdecreaseprofit.
INCOME
DEBIT Decrease
£
CREDIT Increase
EXPENSE £
DEBIT Increase
Interactivequestion1:Debitsandcredits
£
CREDIT Decrease
£
[Difficultylevel:Intermediate]
Completethefollowingtablerelatingtothetransactionsofabookshop.(Thefirsttwoaredonefor you.) (a) Purchaseofbooksoncredit
Payablesincrease
CREDIT
payables
(increaseinliability)
Purchasesincrease
DEBIT
purchases
(increaseinexpense)
(b) Purchaseofcashregisterbycheque
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Ownacashregister
DEBIT
non-currentasset
(increaseinasset)
Cashatbankdecreases
CREDIT
cashatbank
(decreaseinasset)
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(c) Paymentreceivedfromacredit customer
Receivablesdecrease
Cashatbankincreases
(d) Sellbooksforcash
Revenueincreases
Cashatbankincreases
SeeAnswerattheendofthischapter.
3.3 Doubleentryforcashtransactions Agoodstartingpointisthecashaccount,iethenominalledgeraccountinwhichreceiptsand paymentsofcasharerecorded,orposted,fromthebookoforiginalentry,thecashbook.
Acashpaymentisacreditentryinthecashaccount.Herecashisdecreasing.Cashmaybepaid out,forexampletopayanexpense(suchasinsurance)ortopurchaseanasset(suchasa machine).Thematchingdebitentryisthereforemadeintheappropriateexpenseorassetaccount.
Acashreceiptisadebitentryinthecashaccount.Herecashisincreasing.Cashmightbe received,forexample,byaretailerwhomakesacashsale.Thecreditentrywouldthenbemadein therevenueaccount(andtheVATaccountifrelevant).
Workedexample:Cashtransactions Inthecashbook,thefollowingtransactionshavebeenrecorded(ignoreVATfornow). (a) (b) (c) (d)
Acashsale(ieareceipt)of£250 Paymentofarentbilltotalling£150 Buysomegoodsforcashof£100 Buysomeshelvesforcashof£200
Howwouldthesefourtransactionsbeentered(or'posted')totheledgeraccounts,andtowhichledger accountsshouldtheybeposted?Remembereachtransactionwillbepostedtwice,inaccordancewith doubleentryrules.
Solution (a) Thetwosidesofthetransactionare:
£250cashisreceived(debitcashaccount). Salesincreaseby£250(creditsalesaccount).
C H A P T E R
4
CASHACCOUNT Salesa/c
£ 250
£
SALESACCOUNT
£
Casha/c
£ 250
(Thecashaccountentryiscrossreferencedtothesalesaccountandviceversa.Thisenablesaperson lookingatoneoftheledgeraccountstotracewheretheotherhalfofthedoubleentryisfound.)
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(b) Thetwosidesofthetransactionare:
Cashispaid(creditentryinthecashassetaccount). Rentexpenseincreasesby£150(debitentryintherentexpenseaccount). CASHACCOUNT
£
Renta/c
£ 150
RENTACCOUNT Casha/c
£ 150
£
(c) Thetwosidesofthetransactionare:
Cashispaid(creditentryinthecashassetaccount). Purchasesincreaseby£100(debitentryinthepurchasesexpenseaccount). CASHACCOUNT
£
Purchasesa/c
£ 100
PURCHASESACCOUNT Casha/c
£ 100
£
(d) Thetwosidesofthetransactionare:
Cashispaid(creditcashaccount). Assets–inthiscase,shelves–increaseby£200(debitshelvesaccount). CASHACCOUNT
£
Shelvesa/c
£ 200
SHELVESACCOUNT Casha/c
£ 200
£
Ifallfourofthesetransactionsrelatedtothesamebusiness,thecashaccountofthatbusinesswould enduplookingasfollows. CASHACCOUNT Salesa/c
£ 250
Renta/c Purchasesa/c Shelvesa/c
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3.4 Doubleentryforcredittransactions Notalltransactionsaresettledimmediately.Abusinesscanpurchasegoodsornon-currentassetson creditterms,sothatsupplierswouldbetradepayablesuntilsettlementwasmadeincash.Equally,the businessmightgrantcustomerscreditterms,sotheywouldthenbetradereceivablesofthebusiness. Noentriescanbemadeinthecashbookwhenacredittransactionoccurs,becausenocashhasbeen receivedorpaid. Insteadofthecashaccountweusereceivablesandpayablesaccounts.Whenabusinessacquires goodsorservicesoncredit,thecreditentryispostedfromthepurchasesdaybooktoa'tradepayables' accountinsteadofthecashaccount.Thedebitentryispostedtotheexpenseorassetaccount,exactly asinthecaseofcashtransactions.Similarly,whenasaleismadetoacreditcustomer,entriesposted fromthesalesdaybookareadebittothetradereceivablesaccount(insteadofcashaccount),anda credittothesalesrevenueaccount.
3.4.1 Doubleentrywhencredittransactionsareenteredinto Workedexample:Doubleentryforcredittransactions Recordedinthesalesdaybookandthepurchasesdaybookforabusinessarethefollowing transactions. (a) ThebusinesssellsgoodsoncredittoMrAfor£2,000. (b) ThebusinessbuysgoodsoncreditfromBLtdfor£100. Howandwherearethesetransactionspostedintheledgeraccountsfromthebooksoforiginalentry?
Solution (a)
TRADERECEIVABLES(MRA)
Salesa/c
£ 2,000
SALESACCOUNT
£
(b)
£
Tradereceivablesa/c(MrA)
£ 2,000
TRADEPAYABLES(BLTD)
£
Purchasesa/c
£ 100
4
PURCHASESACCOUNT
Tradepayablesa/c(BLtd)
£ 100
C H A P T E R
£
3.4.2 Doubleentrywhencashispaidbycustomersortosuppliers Whathappenswhenacredittransactioniseventuallysettledincash?Supposethat,intheexample above,thebusinesspaid£100toBLtdonemonthafterthegoodswereacquired,recordedinthecash book.Thetwosidesofthisnewtransactionare: (a) Cashispaid(creditentryinthecashaccount). (b) Theamountowingtotradepayablesisreduced(debitentryinthetradepayablesaccount).
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CASHACCOUNT
£
Tradepayablesa/c(BLtd)
£ 100
TRADEPAYABLES(BLTD) Casha/c
£ 100
£
Ifwenowbringtogetherthetwopartsofthisexample,theoriginalpurchaseofgoodsoncreditand theeventualsettlementincash,wefindthattheaccountsappearasfollows. CASHACCOUNT
£
Tradepayablesa/c(BLtd)
£ 100
PURCHASESACCOUNT Tradepayablesa/c(BLtd)
£ 100
£
TRADEPAYABLES(BLTD) Casha/c
£ 100
Purchasesa/c
£ 100
Thetwoentriesintradepayablescanceleachotherout,indicatingthatnomoneyisowingtoBLtd.A cashaccountcreditentryof£100andadebitpurchasesaccountentryof£100remain.Thesearethe sameastheentriesusedtorecordacashpurchaseof£100.Thisiswhatwewouldexpect:afterthe businesshaspaidoffitstradepayables,itisinexactlythesamepositionasifithadmadeacash purchase,andtheaccountingrecordsreflectthis. Similarreasoningapplieswhenacustomersettlesadebt.Intheexampleabove,whenMrApayshis debtof£2,000anditisrecordedinthecashbook,thetwosidesofthetransactionare: (a) Cashisreceived(debitentryinthecashaccount). (b) Theamountowedbytradereceivablesisreduced(creditentryinthetradereceivablesaccount). CASHACCOUNT Tradereceivables(MrA)
£ 2,000
£
TRADERECEIVABLES(MRA)
£
Casha/c
£ 2,000
Theaccountsrecordingthissaleto,andpaymentby,MrAnowappearasfollows. CASHACCOUNT Tradereceivables(MrA)
£ 2,000
£
SALESACCOUNT
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£
Tradereceivablesa/c(MrA)
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TRADERECEIVABLES Salesa/c
£ 2,000
Casha/c
£ 2,000
Thetwotradereceivablesentriescanceleachotherout,whiletheentriesinthecashatbankaccount andsalesaccountreflectthesamepositionasifthesalehadbeenmadeforcash(seeabove).
Interactivequestion2:Debitsandcredits
[Difficultylevel:Intermediate]
Identifythedebitandcreditentriesinthefollowingtransactions(ignoreVAT). (a) (b) (c) (d) (e) (f) (g) (h) (i)
BoughtamachineoncreditfromA,cost£8,000. BoughtgoodsoncreditfromB,cost£500. SoldgoodsoncredittoC,value£1,200. PaidD(acreditsupplier)£300. Collected£180fromE,acreditcustomer. Paidnetpay£4,000. Receivedrentbillof£700fromlandlordG. Paidrentof£700tolandlordG. Paidinsurancepremium£90.
SeeAnswerattheendofthischapter.
3.4.3 Doubleentryfordiscounts InChapter3wesawhowdiscountsallowedtocustomersandreceivedfromsuppliersarerecordedina memorandumcolumnofthecashbook.Thismeansthatneitherthedebitnorthecreditentryis madeinthecashaccount;instead,thememorandumcolumnisusedtopostthedoubleentrytotwo nominalledgeraccounts,asfollows.
Discountsallowedtocustomers DEBIT CREDIT
Discountsallowed(administrativeexpenseaccount) Tradereceivables
Thediscountallowedreducesthebalanceowedbycustomers,soitisacreditinthereceivablesasset account.Theothersideoftheentryisasadebittothediscountallowedexpenseaccount.
Discountsreceivedfromsuppliers DEBIT CREDIT
Tradepayables Discountreceived(otherincomeaccount)
Thediscountreceivedreducestheliabilitytosuppliers,soitisadebitinthepayablesliabilityaccount. Theothersideoftheentryisasacreditinthediscountreceivedincomeaccount.
Interactivequestion3:Ledgerentries
C H A P T E R
4
[Difficultylevel:Intermediate]
RonKnucklesetupabusinesssellingfitnessequipment.Heput£7,000ofhisownmoneyintoa businessbankaccount(transactionA)andinhisfirstperiodoftrading,thefollowingtransactions occurred.
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Transaction B C D E F G H I J K L
Paidrentofshopfortheperiod Purchasedequipment(inventories)oncredit Loanfrombank Purchaseofshopfittings(forcash) Salesofequipment:cash Salesofequipment:oncredit Paymentsfortradepayables(discountreceived£50) Receiptfromtradereceivables(discountallowed£20) Interestonloan(paid) Otherexpenses(allpaidincash) Drawings
£ 3,500 5,000 1,000 2,000 10,000 2,500 4,950 2,480 100 1,900 1,500
IgnoreVAT. PreparetheledgeraccountsforRonKnucklebyopeningupthefollowingaccountsandcompleting them:
Cashatbank Capital Loan Purchases Tradepayables Rent Shopfittings
Sales Tradereceivables Discountreceived Discountallowed Loaninterest Otherexpenses Drawings
SeeAnswerattheendofthischapter.
4 Thejournal Sectionoverview
Journalentrieshaveaparticularformatthatyoushoulduse.
Journalscanbeusedtorecordanytypeoffinancialtransaction,inwhichcasethejournalactsas thebookoforiginalentryforthattransaction.
Journalsareparticularlyusefulforrecordinginternaltransfersbetweenledgeraccounts.
4.1 Whatarejournalentriesusedfor? Thejournalrecordstransactionsnotrecordedinanyotherbookoforiginalentry,suchascredit purchasesofnon-currentassets.Inparticularthejournalkeepsarecordofunusualmovements betweenledgeraccounts.Itisusedtorecordanydoubleentriesmadewhichdonotarisefromthe otherbooksoforiginalentry,suchaswhenerrorsarediscoveredandneedtobecorrected. Whatevertypeoftransactionisbeingrecorded,theformatofajournalentryisasfollows. Date Accounttobedebited Accounttobecredited
Debit £ X
Credit £ X
Narrativetoexplainthetransaction Induecourse,theledgeraccountswillbewrittenuptoincludethetransactionslistedinthejournal. Anarrativeexplanationshouldaccompanyeachjournalentry.Itisrequiredforauditandcontrol,to indicatethepurposeandauthorityofeverytransactionwhichisnotfirstrecordedinabookoforiginal entry.
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Workedexample:Journalentriestorecordtransactions ThefollowingisasummaryofthetransactionsofHairbyFionaMiddletonhairdressingbusiness,of whichFionaisthesoleowner. 1January
Putincashof£2,000ascapital Purchasedbrushesandcombsforcash£50 PurchasedhairdriersfromGilroyLtdoncredit£150
30January
Paidthreemonthsrentto31March£300 Collectedandpaidintakings£600
31January
GaveMrsSullivanaperm,highlightsetconcredit£80
31January
Tookout£100forpersonalexpenses
Showthetransactionsbymeansofjournalentries.
Solution JOURNAL 1January
DEBIT Cashatbank CREDIT FionaMiddleton–capitalaccount Initialcapitalintroduced
£ 2,000
1January
DEBIT Brushesandcombsaccount(non-currentasset) CREDIT Cashatbank Thepurchaseforcashofbrushesandcombs
1January
DEBIT Hairdryeraccount(non-currentasset) CREDIT Tradepayables(GilroyLtd) Thepurchaseoncreditofhairdriersasnon-currentassets
30January
DEBIT Rentexpenseaccount CREDIT Cashatbank Thepaymentofrentto31March
30January
DEBIT CREDIT Cashtakings
Cashatbank Salesrevenueaccount
31January
DEBIT Tradereceivables CREDIT Salesrevenueaccount Theprovisionofhairtreatmentoncredit
31January
DEBIT Drawings CREDIT Cashatbank Owner'sdrawings
£ 2,000
50
50
150
150
300
300
600
600
80
80
100
100
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4.2 Journalentriestocorrecterrors Errorscorrectedbythejournalmustbecapableofcorrectionbymeansofdoubleentryintheledger accounts.Inotherwords,theerrormustnothavecausedtotaldebitsandtotalcreditstobeunequal. Specialrules,coveredinChapter6,applytocorrectingerrorswhichbroketheruleofdoubleentry.
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5 Thepettycashimprestsystem Sectionoverview
Thedoubleentryfortransactionsrecordedinthepettycashbookworksinthesamewayasthe cashbook.
5.1 Doubleentryforpettycashtransactions InChapter3,wesawhowthepettycashbookwasusedtooperatetheimprestsystem.Itisnowtime toseehowthedoubleentryworks. Abusinessstartswithacashfloat(imprest)on1.3.20X7of£250.Thiswillbeapaymentfromcashat banktopettycash: DEBIT CREDIT
Pettycash Cashatbank
£250
£250
SupposefivepaymentsweremadeoutofpettycashduringMarch20X7,noneofwhichattractedVAT. Thepettycashbookmightlookasfollows. Total receipts £ 250.00 250.00
Date 1.3.X7 2.3.X7 8.3.X7 19.3.X7 23.3.X7 28.3.X7
Narrative Cash Stamps Stamps Travel Travel Stamps
Total payments £ 12.00 10.00 16.00 5.00 11.50 54.50
Postage £ 12.00 10.00 11.50 33.50
Travel £ 16.00 5.00 21.00
Attheendofeachmonth(oratanyothersuitableinterval)thetotalpaymentsinthepettycashbook arepostedtonominalledgeraccounts.Thisjustmeansthatthetotalsofthecolumnsareenteredas appropriatedebitandcreditentriesintheledgeraccounts.ForMarch20X7,£33.50wouldbedebited tothepostageaccountand£21.00tothetravelaccount.Thetotalpaymentsof£54.50arecreditedto thepettycashaccount.Thiscompletesthedoubleentry. DEBIT DEBIT CREDIT
Postage Travel Pettycash
£ 33.50 21.00
£ 54.50
Next,thecashfloatneedstobetoppeduptotheimprestamountbyapaymentof£54.50fromthe mainbankaccount: DEBIT CREDIT
Pettycash Cashatbank
£54.50
£54.50
Sodoubleentryruleshavebeensatisfied,andthepettycashbookforthemonthofMarch20X7will looklikethis.
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Receipts £ 250.00 250.00
Date 1.3.X7 2.3.X7 8.3.X7 19.3.X7 23.3.X7 28.3.X7 31.3.X7
Narrative Cash Stamps Stamps Travel Travel Stamps Balancec/d
195.50 54.50
1.4.X7 1.4.X7
Balanceb/d Cash
Payments £ 12.00 10.00 16.00 5.00 11.50 195.50 250.00
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Postage £ 12.00 10.00 11.50 33.50
Travel £ 16.00 5.00 21.00
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Thecashfloatisbackupto(£195.50+£54.50)=£250impreston1.4.X7,readyformorepaymentsto bemade. Thepettycashaccountinthenominalledgerwillbeasfollows. PETTYCASH 20X7 1.3 1.4
Cash Cash
£ 250.00 54.50 304.50
20X7 31.3 1.4
Payments Balancec/d
1.4
Balanceb/d
250.00
Interactivequestion4:Pettycash
£ 54.50 250.00 304.50
[Difficultylevel:Examstandard]
SummitGlazingoperatesanimprestpettycashsystem.Theimprestamountis£150.00.Attheendof theperiodthetotalsofthefouranalysiscolumnsinthepettycashbookwereasfollows. Column1 Column2 Column3 Column4
£ 23.12 6.74 12.90 28.50
Howmuchcashisrequiredtorestoretheimprestamount? SeeAnswerattheendofthischapter.
6 Daybookanalysis Sectionoverview
Whendaybooksareanalysed,totalsarecalculatedforeachcolumnwhicharethenpostedtothe ledgeraccountsthatarerelevanttothatcolumn.
6.1 Howaredaybooksposted? InChapter3weusedthefollowingexampleoffourtransactionsinthesalesdaybook. SALESDAYBOOK Date 10.1.X0
Invoice/credit noteno. I247 I248 CN004 I249
Customer Jones&Co SmithCo Alex&Co EnorCollege
Total £ 107.04 88.32 (32.16) 1,291.68 1,454.88
VAT £ 17.84 14.72 (5.36) 215.28 242.48
Boots £ 50.00 73.60 – 800.30 923.90
Shoes £ 39.20 – (26.80) 276.10 288.50
C H A P T E R
4
Thebusinesswouldopenupa'saleofshoes'accountanda'saleofboots'accountaswellasaVAT accountandthetradereceivablesaccount.Thenthesalesdaybooktotalswouldbepostedtothe nominalledgeraccountsasfollows. DEBIT CREDIT CREDIT CREDIT
Tradereceivables Saleofshoesaccount Saleofbootsaccount VATaccount
£ 1,454.88
£ 288.50 923.90 242.48
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Thatiswhytheanalysisofsalesiskept.Exactlythesamereasoningliesbehindtheanalyseskeptinthe otherbooksoforiginalentry.
7 Thereceivablesandpayablesledgers Sectionoverview
Individualledgeraccountsforeachcreditcustomer(personalaccounts)aremaintainedinthe receivablesledger.
Atotalreceivablesaccountisheldinthenominalledger,calledthereceivablescontrolaccount.
Individualledgeraccountsforeachcreditsupplier(personalaccounts)aremaintainedinthe payablesledger.
Atotalpayablesaccountisheldinthenominalledger,calledthepayablescontrolaccount.
7.1 Nominalledgeraccountsandpersonalaccounts Nominalledgeraccountsrelatetotypesofincome,expense,asset,capitalandliability–rent,sales, tradereceivables,payablesandsoon–ratherthantothepersontowhomthemoneyispaidorfrom whomitisreceived.However,thereisalsoaneedforpersonalaccounts,mostcommonlyfor receivablesandpayables,andthesearecontainedinthereceivablesledgerandthepayablesledger. Thesearememorandumaccountsonly,inmemorandumledgers;theyarenotpartofthedoubleentry system.Insteadsummaryreceivablescontrolandpayablescontrolaccountsarekeptinthenominal ledger. Keepingeachcreditcustomer'saccountseparatelyenablesustoidentifyatanymomenthowmuchthat customerowesus;similarly,thetechniqueenablesustotellexactlyhowmuchweoweeachcredit supplier.Anydisputeswithcustomersorsupplierscantherebybemoreeasilyresolved.
7.2 Receivablesledger Thesalesdaybookprovidesachronologicalrecordofinvoicesandcreditnotessentoutbyabusinessto creditcustomers.Thismightinvolveverylargenumbersofinvoices/creditnotesperdayorperweek. Thesamecustomermightappearinseveraldifferentplacesinthesalesdaybook,forsalesmadeon creditatdifferenttimessoacustomermayowemoneyonseveralunpaidinvoices.Similarly,the customermaymakepaymentsandtakediscountsatdifferenttimes. Inadditiontokeepingachronologicalrecordofinvoices/creditnotesandcashreceived/discount allowed,abusinessshouldalsokeeparecordofhowmuchmoneyeachindividualcreditcustomer owes,andwhatthistotaldebtconsistsof.Theneedforapersonalaccountforeachcustomerisa practicalone.
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Acustomermightaskhowmuchtheycurrentlyowe.Staffmustbeabletotellthem.
Itisacommonpracticetosendoutstatementstocreditcustomersattheendofeachmonth, showinghowmuchtheyowe,anditemisingnewinvoicesorcreditnotessentoutandpayments receivedduringthemonth.
Thebusinessmanagerswillwanttocheckthecreditpositionofindividualcustomers,andto ensurethatnocustomerisexceedingtheircreditlimit.
Mostimportantistheneedtomatchpaymentsreceivedagainstdebtsowed.Ifacustomermakes apayment,thebusinessmustbeabletosetoffthepaymentagainstthecustomer'sdebtand establishhowmuchhestillowesonbalance.
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Definition Receivablesledger:Thememorandumledgerforcustomers'personalaccounts.Itisnotpartofthe nominalledgernorthedoubleentrysystem,butdoubleentryrulesapplytothereceivablesledger accounts. Receivablesledgeraccountsarewrittenupasfollows.
Wheninvoicesorcreditnotesaresentout,entriesaremadeinthesalesdaybook.Eachoneisthen subsequentlyalsoenteredintherelevantcustomeraccountinthereceivablesledger:invoiceson thedebitside,andcreditnotesonthecreditside.
Whenreceiptsaredebitedinthecashbook(cash/chequesetcreceived),eachoneisalsoentered inthecreditsideoftherelevantcustomeraccount.
Eachcustomeraccountisgivenareferenceorcodenumber,anditisthatreferencewhichappearsin thesalesdaybookandcashbook. Hereisanexampleofhowareceivablesledgeraccountislaidout.ThesalesdaybookreferenceisSDB 48. ENORCOLLEGE Balanceb/f 10.1.X0
SalesSDB48(I249)
11.1.X0
Balanceb/d
£ 250.00 1,291.68 1,541.68
1,291.68
10.1.X0 10.1.X0 Balancec/d
A/cno:RL9 £ CreditnoteSDB48(CN012) 50.00 CashCB48 200.00 1,291.68 1,541.68
7.3 Payablesledger Thepayablesledger,likethereceivablesledger,consistsofanumberofpersonalaccounts.Theseare separateaccountsforeachindividualsupplier,andtheyenableabusinesstokeepacontinuousrecord ofhowmuchitoweseachsupplieratanytime.
Definition Payablesledger:Thememorandumledgerforsuppliers'personalaccounts.Itisnotpartofthe nominalledgernorpartofthedoubleentrysystem,butdoubleentryrulesapplytothepayablesledger accounts.
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Afterentriesaremadeinthepurchasesdaybookandcashbook,theyarealsomadeintherelevant supplieraccountinthepayablesledger.Entriesarepostedtothesupplier'spersonalaccountsinthe payablesledgerfromthebooksoforiginalentry(thepurchasesdaybookandthecashbook). Hereisanexampleofhowapayablesledgeraccountislaidout. COOK 15.3.X8 CashCB48 Balancec/d
£ 100.00 421.60 521.60
Balanceb/f 15.3.X8 InvoiceI4192PDB37 16.3.X8 Balanceb/d
A/cno:PL31 £ 200.00 321.60 521.60 421.60
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7.4 Controlaccountsforthereceivablesandpayablesledgers Havingpersonalaccountsforeverycustomerandsupplierinthenominalledgercanbecomevery unwieldy,so:
Detailsoftransactionsarepostedfromthebookoforiginalentryusingdoubleentryprinciplesto thememorandumreceivablesandpayablesledgers.
Onlytotalsarepostedfrombooksoforiginalentrytonominalledgercontrolaccountsaspartof thedoubleentrysystem.
WeshallreturntocontrolaccountsinChapter6.
8 Accountingfordiscounts Sectionoverview
Tradediscountreducesthegoodstotalamountonaninvoice.Itisnotrecordedseparately anywhereintheaccountingsystem.
Cashdiscountisrecordedonlywhenitreducestheamountpaidbythebusiness(discount received)orreceivedbyit(discountallowed).
Discountreceivedfromsuppliersisrecordedonthepaymentssideofthecashbook.Itisdebited topayablescontrolandcreditedtodiscountsreceived(anincomeaccount).
Discountallowedtocustomersisrecordedonthereceiptssideofthecashbook.Itisdebitedto discountsallowed(anexpenseaccount)andcreditedtoreceivablescontrol.
Definition Discount:Areductioninthepriceofgoodsbelowtheamountatwhichthosegoodswouldnormallybe soldtoothercustomers. Therearetwotypesofdiscount:tradediscountandcashdiscount.
8.1 Tradediscount Definition Tradediscount:Areductioninthecostofgoods,owingtothenatureofthetradingtransaction.It usuallyresultsfrombuyinggoodsinbulk.Itisdeductedfromthelistpriceofgoodssold,toarriveata finalsalesfigure.Thereisnoseparateledgeraccountfortradediscount.
8.1.1 Examplesoftradediscount
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Acustomerisquotedapriceof£1perunitforaparticularitem,butalowerpriceof95pperunitif theitemisboughtinquantitiesof100unitsormoreatatime.Thisissometimescalledbulk discount.
Animportantcustomeroraregularcustomerisofferedadiscountonallthegoodstheybuy, regardlessofthesizeofeachindividualorder,becausethetotalvolumeoftheirpurchasesover timeissolarge.
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8.2 Cashdiscount Definition Cashdiscount:Areductionintheamountpayableinreturnforimmediatepaymentincash,orfor paymentwithinanagreedperiod.Thereareseparateledgeraccountsforcashdiscounts:onefor discountallowedtocustomers,andonefordiscountreceivedfromsuppliers. Forexample,asuppliercharges£1,000forgoods,butoffersadiscountof5%ifthegoodsarepaidfor immediatelyincash.
8.3 Accountingfortradediscount Atradediscountisareductionintheamountofmoneyinitiallydemandedonaninvoice.
Ifatradediscountisreceivedbyabusinessforgoodspurchasedfromasupplier,theamountof moneydemandedfromthebusinessbythesupplierwillbenetofdiscount(ieitwillbethenormal salesvaluelessthediscount).
Ifatradediscountisgivenbyabusinessforgoodssoldtoacustomer,theamountofmoney demandedofthecustomerbythebusinesswillbeafterdeductionofthediscount.
Tradediscountshouldthereforebeaccountedforasfollows.
Tradediscountsreceivedshouldbedeductedfromthegrosscostofpurchasesbythesupplier. Thecostofpurchasesinthepayablesledgerwillbestatedatgrosscostminusdiscount,iethe invoicedamount.
Tradediscountsallowedshouldbedeductedfromthegrosssalespricebythebusiness,sothat revenuewillbereportedatinvoicevaluenetoftradediscount,ietheinvoicedamount.
8.4 Accountingforcashdiscountreceived Whethertotakeadvantageofacashdiscountforpromptpaymentisamatteroffinancingpolicy.
Workedexample:Takingcashdiscount Ifthebusinessreceives,say,£80cashdiscountforpayingadebtof£2,000early,weaccountforthisas follows:
Inthepurchasesaccount,wedebittheinvoicedpriceof£2,000,andthesubsequentfinancing decisionaboutacceptingthecashdiscountisignored.Thecreditistotradepayables.
Whenwepay(£2,000–£80)=£1,920andtakethediscount,wecreditcashanddebittrade payableswith£1,920.
Toaccountforthediscountwedebittradepayables£80,soeliminatingthe£2,000debtentirely, andcredit£80tothediscountreceivedaccount(anincomeaccount).
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Interactivequestion5:DiscountsI
[Difficultylevel:Easy]
SoftSuppliesCorecentlypurchasedfromHardImportsCo10printersoriginallypricedat£200each. A10%tradediscountwasnegotiatedtogetherwitha5%cashdiscountifpaymentwasmadewithin 14days.Calculatethefollowing. (a) Thetotalofthetradediscount (b) Thetotalofthecashdiscount SeeAnswerattheendofthischapter.
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8.5 Accountingforcashdiscountallowed Thesameprincipleisappliedinaccountingforcashdiscountsallowedtocustomers.Goodsaresoldata tradeprice,andtheofferofadiscountonthatpriceisamatteroffinancingpolicyforthebusiness.
Interactivequestion6:DiscountsII
[Difficultylevel:Intermediate]
YouarerequiredtopreparethestatementofprofitorlossofSeesawTimberMerchantsfortheyear ended31March20X6,giventhefollowinginformation. Purchasesatgrosscost Tradediscountsreceived Cashdiscountsreceived Cashsales Creditsalesatinvoiceprice Cashdiscountsallowed Distributioncosts Administrativeexpenses Drawingsbyowner,TimBurr
£ 120,000 4,000 1,500 34,000 150,000 8,000 32,000 40,000 22,000
SeeAnswerattheendofthischapter.
9 AccountingforVAT Sectionoverview
VATonsales(outputVAT)isdebitedtoreceivablesaspartofthepostingfromthesalesdaybook andcreditedtotheVATliabilityaccount(itisowedtoHMRC).
VATonpurchases(inputVAT)isdebitedtotheVATliabilityaccount(itisduefromHMRC)and creditedtopayablesaspartofthepostingfromthepurchasesdaybook.
ThenetamountofVATowedtoHMRCispaidtoHMRCregularly.
9.1 WhatisVAT? VATisanindirecttaxonthesupplyofgoodsandservices.Taxiscollectedateachtransferpoint inthechainfromprimeproducertofinalconsumer.Eventually,theconsumerbearsthetaxinfull andanytaxpaidearlierinthechaincanberecoveredbyaregisteredtraderwhopaidit.
Workedexample:VAT Amanufacturingcompany,ALtd,purchasesrawmaterialsatacostof£1,000plusVATatthestandard rateof20%.FromtherawmaterialsALtdmakesfinishedproductswhichitsellstoaretailoutlet,Bplc, for£1,600plusVATat20%.Bplcsellstheproductstocustomersatatotalpriceof£2,000plusVATat 20%.HowmuchVATispaidateachstageinthechain?
Solution SupplytoALtd(ALtdpays£200VATbutrecoversit) ValueaddedbyALtd SaletoBplc(Bplcpays£320VATbutrecoversit) ValueaddedbyBplc Saleto'consumers'(customerspay£400VAT,andcannotrecoverit)
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9.2 HowisVATcollected? AlthoughitisthefinalconsumerwhoeventuallybearsthefullVATof£400,thesumiscollectedand paidbythetraderswhomakeupthechain,providedtheyareregisteredforVAT.Eachtradermust assumethathiscustomeristhefinalconsumer:
HemustcollectandpayoverVATattheappropriaterateonthefullsalesvalue(knownasoutput tax)ofthegoodssold.
HeisnormallyentitledtoreclaimVATpaidonhisownpurchasesofgoods,expensesandnoncurrentassets(knownasinputtax)andsomakesanetpaymenttotheHMRCequaltothetaxon valueaddedbyhimself.
Intheexampleabove,thesupplierofrawmaterialscollectsfromALtdoutputVATof£200,allofwhich hepaysovertoHMRC.WhenALtdsellsgoodstoBplc,outputVATischargedattherateof20%on £1,600=£320.Only£120,however,ispaidbyALtdtoHMRC,becausethecompanyisentitledto deductinputtaxof£200sufferedonitsownpurchases.Similarly,Bplcmustchargeitscustomers£400 inoutputVAT,butneedonlypayovertoHMRCthenetamountof£80afterdeductingthe£320input VATsufferedonitspurchasefromALtd.
9.3 Registeredandnon-registeredpersons Traderswhosesales(outputs)arebelowacertainlevelneednotregisterforVATalthoughthey maydosovoluntarily.UnregisteredtradersneitherchargeVATontheiroutputsnorareentitledto reclaimVATontheirinputs.Theyareinthesamepositionasafinalconsumer. Alloutputsofregisteredtradersareeithertaxableorexempt.Traderscarryingonexemptactivities (suchasbanks)cannotchargeVATontheiroutputsandconsequentlycannotreclaimVATpaidontheir inputs. Taxableoutputsarechargeableatoneofthreerates.
Zerorate(onprintedbooksandnewspapersforinstance) Reducedrate(5%ondomesticfuel) Standardrate:20%
HMRCidentifiessuppliesfallingintoeachcategory.Personscarryingontaxableactivities(even activitiestaxableatzerorate)areentitledtoreclaimVATpaidontheirinputs. Sometraderscarryonamixtureoftaxableandexemptactivities.Suchtradersneedtoapportionthe VATsufferedoninputsandcanusuallyonlyreclaimtheproportionofinputtaxthatrelatesto taxableoutputs. MosttradersaccountquarterlytoHMRCforVAT.
ThemostusualpositionistohavetopaythenetbalancetoHMRC(whenoutputtaxexceeds inputtax)ieHMRCisapayable.
Atraderwhomakeszero-ratedsupplieswillhavepaidmoreinputtaxthanithasreceivedoutput tax,sowillrecovercashfromHMRC,ieHMRCisareceivable.
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9.4 AccountingforVAT AsageneralprinciplethetreatmentofVATinthetrader'sledgeraccountsshouldreflectthetrader'srole astaxcollector,soVATshouldnotbeincludedinincomeorinexpenses,whetherofacapitalora revenuenature.
9.4.1 IrrecoverableVAT WherethetradersuffersirrecoverableVATasacost,asinthefollowingcases,VATshouldbeincluded asanexpense.(Itcannotbeclaimedasinputtax.)
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PersonsnotregisteredforVATwillsufferVAToninputsasacost.Thiswillincreasetheirexpenses andthecostofanynon-currentassetstheypurchase.
RegisteredpersonswhoalsocarryonexemptedactivitiesmayhavearesidueofinputVATwhich fallsdirectlyonthem.Inthissituationthecoststowhichthisresidueapplieswillbeinflatedbythe irrecoverableVAT.
Non-deductibleinputswillbebornebyalltraders. –
VAToncarspurchasedandusedinthebusinessisnotreclaimable(VATonacaracquired newforresale,iebyacartrader,isreclaimable).
–
VATonbusinessentertainingisnotdeductibleasinputtaxotherthanVATonentertaining staff.
WhereVATisnotrecoverableitmustberegardedaspartofthecostoftheitemspurchasedand includedinthestatementofprofitorlossorstatementoffinancialpositionasappropriate.
9.5 VATanddiscounts VATischargedonthegoodsorservicestotalonaninvoice(orcreditnote)netofboth:
Tradediscount Cashdiscount
Thisgeneralprincipleiscarriedtotheextentthatwhereadiscountisofferedatthepointofsale,VATis chargedontheamountnetoftheoffereddiscountevenwhereitissubsequentlynottakenup.
Workedexample:VATanddiscounts Mattsellsusuallysellsgoodsat£130each,hegivesAnilatradediscountof£10sohesellsgoodstoAnil for£120.Healsooffersacashdiscountof5%forpromptpayment.MattisregisteredforVAT.This meansthat£120×5%=£6cashdiscountisavailable. HowmuchoutputVATshouldMattincludeonAnil'sinvoice?
Solution IfthediscounthadnotbeenofferedoutputVATof£120×20%=£24.00wouldbedue.Butbecauseof thediscount,Matt'ssalesinvoicewillshow: INVOICE Listprice Tradediscount Goodsvalue VAT(12095%20%) Invoicetotal
Cashdiscountavailable(£1205%)
£ 130.00 (10.00) 120.00 22.80 142.80 £6.00
IfAniltakesupthediscount,heneedonlypay£136.80infullsettlement(£142.80–£6),butevenifhe doesnottakethediscount,theamountofVATisnotadjusted.
9.6 VATandirrecoverabledebts MostregisteredpersonsareobligedtorecordVATwhenasupplyismadeorreceived(effectivelywhen asalesinvoiceisraisedorapurchaseinvoicerecorded).Thismayhavetheeffectthatoutputtaxhasto bepaidtoHMRCbeforeithasallbeenreceivedfromcustomers.Ifanamountduefromacustomer issubsequentlywrittenoffasirrecoverable,theVATelementmaynotberecoverablefromHMRCfor sometimeafterthesale.
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9.7 SummaryofaccountingentriesforVAT InChapter3wesawhowVATisinitiallyrecordedinthebooksoforiginalentry.Let'ssummariseitnow. (a) SalesrevenueshowninthestatementofprofitorlossmustexcludeoutputVAT.Howevertrade receivableswillincludeVAT,astheyreflectthetotalamountduefromcustomers.Thesalesday bookisthebookoforiginalentryforVAToncreditsales. Thedoubleentrypostedfromthesalesdaybookforsalesof£500,000oncreditis: DEBIT CREDIT
Tradereceivablesa/c(includingVAT,calledgross) Salesa/c(excludingVAT,callednet) VATa/c(20%£500,000)–outputtax
£ 600,000
£ 500,000 100,000
(b) ExpensesshowninthestatementofprofitorlossmustexcludeinputVAT.However,trade payableswillincludeinputVAT,astheyreflectthetotalamountpayabletosuppliers.The purchasesdaybookisthebookoforiginalentryforVAToncreditpurchases.Thedoubleentry postedfromthepurchasesdaybookforpurchasesof£400is: DEBIT CREDIT
Purchasesexpense(net) VATa/c(20%£400)–inputtax Tradepayables(gross)
£ 400 80
£ 480
(c) Salesrevenuereceivedandexpensespaidascashtransactionsinthecashbookorpettycashbook musthavetheVATrecordedinthesebooksoforiginalentry,andthenpostedasabovein(a)and (b). (d) IrrecoverableVATonexpensesornon-currentassetsmustbeincludedinthecostoftheexpense ornon-currentassetinthestatementofprofitorlossorstatementoffinancialposition. (e) ThenetamountduetoHMRCshouldbeincludedinotherpayables(orotherreceivables)inthe statementoffinancialposition.
9.8 CalculatingVATfromagrossamount IfyouaretoldthatanamountincludesVATat20%(agrossamount),youcancalculatetheVAT elementbymultiplyingthegrossamountby20%/120%or1/6.Thereforethenetamountwillalways be5/6ofthegrosselement.
Workedexample:VATcalculation Asaleof£200attractsVATat20%,ie£40.Thegrossamountis£240.TogetbacktotheVATelement: £2401/6=£40
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Interactivequestion7:VAT
[Difficultylevel:Examstandard]
Musselispreparingfinancialstatementsfortheyearended31May20X9.Includedinitsstatementof financialpositionasat31May20X8wasabalanceforVATduefromHMRCof£15,000. Mussel'ssummarystatementofprofitorlossfortheyearto31May20X9isasfollows. Revenue(net)(allstandardrated) Purchases(net)(allstandardrated) Grossprofit Expenses(seenote) Netprofit Note:expenses Wagesandsalaries(exemptofVAT) Entertainmentexpenditure(£40+irrecoverableVAT£8) Other(net)(allstandardratedat20%)
£'000 500 (120) 380 (280) 100 £'000 162 48 70 280
InrespectofVATpaymentsof£5,000,£15,000and£20,000havebeenmadeintheyeartoHMRCand arepaymentof£12,000wasreceived. Requirement WhatisthebalanceforVATinthestatementoffinancialpositionasat31May20X9?Assumea20% standardrateofVAT.(Hint:UseaTaccountforVAT.) SeeAnswerattheendofthischapter.
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SummaryandSelf-test
Summary
C H A P T E R
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Self-test Answerthefollowingquestions. 1
Togetherledgeraccountinganddoubleentry A B C D
2
Thenominalledger A B C D
3
Decreaseanasset Increaseanexpense
C D
Decreasealiability Decreasecapital
£120 £100
C D
£20 Nil
Tradepayables Tradereceivables
C D
Discountreceived Purchases
Ajournaldoesnotneedtocontain A B C D
9
Increasealiability Decreasecapital
Discountreceivedfromsuppliersthatisrecordedinitiallyinthecashbookisdebitedto A B
8
C D
Whenacreditcustomerpaysaninvoicefor£120includingVATat20%,thecreditentryintheVAT ledgeraccountwillbe A B
7
Decreaseanasset Decreaseanexpense
AcreditentryinaTaccountwill A B
6
Lefthandside Righthandside
AdebitentryinaTaccountwill A B
5
Isthebookoforiginalentryforalltransactionsnotrecordedinotherbooksoforiginalentry Summarisesalltransactionsrelatingtoreceivables Summarisesalltransactionsrelatingtopayables Summarisesalltheentity'sfinancialtransactions
InaTaccountadebitentrywouldbemadeinthe A B
4
Recorddirectlyallthesourcedocuments Summarisethetransactionslistedinthebooksoforiginalentry Recordalltheentity'scredittransactions Recordalltheentity'scashtransactions
Thenameoftheledgeraccounttobedebited Thenameoftheledgeraccounttobecredited Narrative Thenameofthebookoforiginalentrywheretherelevantsourcedocumentisrecorded
Whenpettycashistoppeduptotheimprestamountthecreditentryismadeto A B
Thepettycashbook Tradereceivables
C D
Thecashbook Tradepayables
10 Individualcustomeraccountsarekeptinwhichledger? A B
Payablesledger Tradereceivables
C D
Receivablesledger Nominalledger
Now,gobacktotheLearningObjectivesintheIntroduction.Ifyouaresatisfiedthatyouhaveachieved theseobjectives,pleasetickthemoff.
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AnswerstoInteractivequestions
AnswertoInteractivequestion1 (c) Paymentreceivedfromacreditcustomer
Receivablesdecrease Cashatbankincreases
CREDIT DEBIT
Receivables Cashatbank
(decreaseinasset) (increaseinasset)
CREDIT DEBIT
Sales Cashatbank
(increaseinincome) (increaseinasset)
(d) Sellbooksforcash
Revenueincreases Cashatbankincreases
AnswertoInteractivequestion2 (a) (b) (c) (d) (e) (f) (g) (h) (i)
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
£ 8,000 500 1,200 300 180 4,000 700 700 90
Machineaccount(non-currentasset) Tradepayables Purchasesaccount Tradepayables Tradereceivables Sales Tradepayables Cashatbank Cashatbank Tradereceivables Wagesaccount Cashatbank Rentaccount Tradepayables Tradepayables Cashatbank Insuranceexpense Cashatbank
£ 8,000 500 1,200 300 180 4,000 700 700 90
AnswertoInteractivequestion3 Inthisanswerwehavecalculatedthebalancingfigureonthecashatbankaccount.Weshallcomeback tothisinChapter5.Fornow,justmakesurethatyoucompletedallthenecessarystepscorrectly.
C H A P T E R
CASHATBANK Capital(A) Bankloan(D) Sales(F) Tradereceivables(I)
Rent(B) Shopfittings(E) Tradepayables(H) Bankloaninterest(J) Otherexpenses(K) Drawings(L) Balancingfigure(theamountofcash leftoverafterpaymentshavebeen made)–carrieddown 20,480 £ 7,000 1,000 10,000 2,480
Debitbalancebroughtdown
6,530
£ 3,500 2,000 4,950 100 1,900 1,500 13,950 6,530 20,480
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CAPITAL(RONKNUCKLE)
£
Cashatbank(A)
£ 7,000
BANKLOAN
£
Cashatbank(D)
£ 1,000
PURCHASES Tradepayables(C)
£ 5,000
£
TRADEPAYABLES Cashatbank(H) Discountreceived(H)
£ 4,950 50 5,000
Purchases(C)
£ 5,000 5,000
RENT Cashatbank(B)
£ 3,500
£
SHOPFITTINGS Cashatbank(E)
£ 2,000
£
SALES
£
Cashatbank(F) Tradereceivables(G)
£ 10,000 2,500
TRADERECEIVABLES Sales(G)
£ 2,500 2,500
Cashatbank(I) Discountallowed(I)
£ 2,480 20 2,500
DISCOUNTRECEIVED
£
Tradepayables(H)
£ 50
DISCOUNTALLOWED Tradereceivables(I)
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£ 20
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BANKLOANINTEREST Cashatbank(J)
£ 100
£
OTHEREXPENSES Cashatbank(K)
£ 1,900
£
DRAWINGSACCOUNT Cashatbank(L)
£ 1,500
£
(a) Ifyouwanttomakesurethatthissolutioniscomplete,youshouldgothroughthetransactionsA toLandtickoffeachofthemtwiceintheledgeraccounts,onceasadebitandonceasacredit. Whenyouhavefinished,alltransactionsinthe'T'accountshouldbeticked,withonlytotalsand thebalancingfigureinthecashatbankaccountleftover. (b) Infact,thereisaneasierwaytocheckthatthesolutiontothissortofproblemdoes'balance' properly,whichwewillseeinChapter5. (c) Onasset,capitalandliabilityaccounts,thedebitorcreditbalancerepresentstheamountofthe asset,capitalorliabilityoutstandingattheperiodend.Forexample,onthecashatbankaccount, debitsexceedcreditsby£6,530andsothereisabalanceonthecreditsidecarrieddowntobea debitbalanceofcashinhandof£6,530.Onthecapitalaccount,thereisacreditbalanceof£7,000 andsothebusinessowesRon£7,000. (d) Thebalancesontheincomeandexpenseaccountsrepresentthetotalofeachtypeofincomeor expensefortheperiod.Forexample,salesrevenuefortheperiodtotals£12,500.
AnswertoInteractivequestion4 £71.26.Thisisthetotalamountofcashthathasbeenused. C H A P T E R
AnswertoInteractivequestion5 (a) £200(£2001010%) (b) £90(£2001090%5%)
AnswertoInteractivequestion6 SEESAWTIMBERMERCHANTS STATEMENTOFPROFITORLOSS FORTHEYEARENDED31MARCH20X6
4
Revenue(150,000+34,000) Purchases(120,000–4,000) Grossprofit Discountsreceived Expenses Distributioncosts Administrativeexpensesincludingdiscountallowed(40,000+8,000) Netlosstransferredtothestatementoffinancialposition
£ 32,000 48,000
£ 184,000 (116,000) 68,000 1,500 (80,000) (10,500)
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AnswertoInteractivequestion7
VAT
Balanceb/d Inputtax–Purchases(£120,00020%) Inputtax–Otherexpenses(£70,000 20%) CashpaidtoHMRC(5,000+15,000+ 20,000) Balancec/d
£ 15,000 24,000 14,000 40,000 19,000 112,000
Outputtax–(£500,00020%) CashreceivedfromHMRC Balanceb/d
£ 100,000 12,000
112,000 19,000
ThereforethereisabalanceowingtoHMRCof£19,000,whichisshownonthestatementoffinancial positionasanotherpayable.
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AnswerstoSelf-test 1
B
Thenominalledgercontainssummariesofbothcashandcredittransactions(CandD). Sourcedocumentsarerecordeddirectlyinbooksoforiginalentry,notthenominalledger(A).
2
D
Thenominalledgercontainssummariesoftransactionsrelatingtobothreceivablesand payables(BandC)aswellasothertransactions.Answer(A)describesthejournal.
3
A
Acreditentryismadeintherighthandside.
4
D
AnswersA,BandCalldescribecreditentries.
5
A
AnswersB,CandDalldescribedebitentries.
6
D
TheVATisrecordedintheVATaccountwhentheinvoiceisfirstenteredinthesalesdaybook, notwhenthecustomerpays.
7
A
Thedoubleentryisdebittradepayables,creditdiscountreceived(C).Ithasnoeffecton purchases(D)norontradereceivables(B).
8
D
Thejournalisthebookoforiginalentry.ItemsA,BandCareallrequiredinajournalentry, thoughnarrativeisoftenomittedwhenthejournalisroutine.
9
C
Thedoubleentryisdebitpettycash(A),creditcashatbank.Tradereceivablesandpayables (BandD)areunaffected.
10 C
Thereceivablesledgercontainstheindividualcustomeraccounts.Thenominalledger(D) containsthetradereceivablesaccount(B)whichisthetotalofalltheindividualcustomer accounts.Thepayablesledgercontainsindividualsuppliers'accounts.
C H A P T E R
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CHAPTER5
Preparingbasicfinancial statements
Introduction Examinationcontext TopicList 1 Balancingledgeraccounts 2 Thetrialbalance 3 Preparingthestatementofprofitorloss 4 Preparingthestatementoffinancialposition 5 Preparingbasicfinancialstatements 6 Theextendedtrialbalance(ETB) SummaryandSelf-test AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Prepareatrialbalancefromaccountingrecordsandidentifytheusesofatrialbalance
Prepareanextendedtrialbalance
Prepareandpresentastatementoffinancialposition,statementofprofitorlossand statementofcashflows(orextractstherefrom)fromtheaccountingrecordsandtrial balanceinaformatwhichsatisfiestheinformationrequirementsoftheentity
Specificsyllabuslearningoutcomesare:1f;2c;3c
Syllabuslinks Thematerialinthischapterwillbedevelopedfurtherinthispaper,andthenintheProfessionalLevel moduleofFinancialAccountingandReporting.
Examinationcontext Questionsonthetopicsinthischapterwillbesetasmultiplechoicequestions,someofwhichmay involvecalculationssothatthecorrectanswercanbeselected. Intheexamyoumayberequiredto:
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Specifythenatureofitemsinthestatementoffinancialposition:non-currentandcurrentassets, non-currentandcurrentliabilities,andcapital
Identifythecorrectbalancesonledgeraccounts
Identifyhowledgeraccountbalanceswouldappearinthetrialbalance
Useaprofitandlossledgeraccounttocalculategrossprofitorprofitfortheyear
Usetheextendedtrialbalancetocalculatefiguresforbasicfinancialstatements
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1 Balancingledgeraccounts Sectionoverview
Aledgeraccountisbalancedbytotallingbothsidesoftheaccount,thensubtractingthesmaller amountfromthelargeroneandinsertingthisasabalanceonthesidewhichhadthesmaller total.Thesebalancesarethenextractedattheendofareportingperiodforeachnominalledger account.
LookbackattheRonKnuckle'sledgeraccountsintheanswertoInteractivequestion3inChapter4to illustratehowthecashatbankaccountisbalanced.
First,thedebits,andthenthecreditsaretotalled,givingtwoseparatetotals.
Thelargertotalisplacedinthetotalcolumnsonboththedebitandcreditsideoftheaccount.
Thesmallertotalisthensubtractedfromthelargertotal,andthisamountisinsertedasabalance onthesidewhichhadthesmallertotal.
Attheendofareportingperiodsuchasamonthorayear,abalanceisextractedforeachnominal ledgeraccount.
Alldebitsandcredits,includingopeningbalances,ontheaccountaretotalled. Iftotaldebitsexceedtotalcreditsthereisadebitbalanceontheaccount. Iftotalcreditsexceedtotaldebitstheaccounthasacreditbalance.
InRonKnuckle'sledgeraccounts,therewasverylittlebalancingtodo
Bothtradepayablesandtradereceivablesbalanceofftozero. Thecashatbankaccounthasadebitbalanceof£6,530(totaldebitsexceedtotalcredits). Thetotalonthesalesaccountis£12,500,whichisacreditbalance.
Otherwise,theaccountshaveonlyoneentryeach,sothereisnototallingtodotoarriveatthebalance oneachaccount.
2 Thetrialbalance Sectionoverview
Thebalancesattheendofaperiodonallthenominalledgeraccountsarelistedonatrial balance:debitbalancesappearinthedebitcolumnandcreditbalancesinthecreditcolumn. Whenaddedup,thetwocolumnsshouldbeequal.
Extractingatrialbalanceservesasacheckthatcertaintypesoferrorhavenotoccurredinposting theaccounts.
Thetrialbalancedoesnotinitselfdetecterrorsofomission,commissionorprinciple,nor compensatingerrors.
Aninitialtrialbalancecanbeadjustedwithjournalsusinganextendedtrialbalancetocreatea statementofprofitorlossandstatementoffinancialposition.
Definition Trialbalance:Alistofnominalledgerbalancesshownindebitandcreditcolumns,asamethodof testingtheaccuracyofdoubleentrybookkeeping.Thetrialbalanceisnotpartofthedoubleentry system.
C H A P T E R
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Todrawupatrialbalance,youneedasetofledgeraccounts.Forthesakeofconvenience,wewill continuetouseRonKnuckle'saccounts,whichwedrewupinChapter4.
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2.1 Listingledgeraccountbalancesinthetrialbalance Ifdoubleentryprincipleshavebeencorrectlyappliedthroughouttheperiod,totalcreditbalanceswill equaltotaldebitbalancesandsothetotalswillbalance. HerearethebalancesonRonKnuckle'saccounts. Cashatbank Capital Bankloan Purchases Tradepayables Rent Shopfittings Sales Tradereceivables Discountreceived Discountallowed Bankloaninterest Otherexpenses Drawings
Debit £ 6,530 5,000 3,500 2,000 0 20 100 1,900 1,500 20,550
Credit £ 7,000 1,000 0 12,500 50 20,550
Itdoesnotmatterinwhatorderthevariousaccountsarelistedinthetrialbalance.
2.2 Whatifthetrialbalancefailstobalance? Ifthetwocolumntotalsonthetrialbalancearenotequal,theremustbeanerrorinrecording transactionsintheledgeraccounts,orintheadditionofthetrialbalance. Evenifthetrialbalancebalances,thefollowingerrortypesmaystillhavearisenintheledgeraccounts.
Omissionerrors:atransactioniscompletelyomitted,eitherinthenominalledger,orthetrial balanceitself,soneitheradebitnoracreditismade.
Commissionerrors:adebitorcreditispostedtothecorrectsideofthenominalledger,buttoa wrongaccount.Eg,wagespaidaredebitedtotherentaccountinsteadofthewagesaccount.
Compensatingerrors:oneerrorisexactlycancelledbyanothererrorelsewhere.
Errorsofprinciple,suchascashfromreceivablesbeingdebitedtotradereceivablesandcredited tocashatbankinsteadoftheotherwayround.
Weshallcomebacktotheseerrors,andwhathappenswhenthetrialbalancefailstobalance,in Chapter6.
2.3 Makingadjustmentsafterthetrialbalanceisextracted Weoftenneedtomakeadjustmentsafterallledgerbalanceshavebeencalculatedandlistedonthetrial balance.Adjustmentjournalsareneededforthis.
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Workedexample:Trialbalanceandadjustmentjournals Asat31.3.20X7,abusiness,whichisnotregisteredforVAT,hasthefollowingnominalledgerbalances. Balance £ 12,000 11,700 13,000 1,880 11,200 12,400 34,600 1,620 12,000 1,400 11,020 22,020
Bankloan Cashatbank Capital Rent Tradepayables Purchases Sales Otherpayables Tradereceivables Bankloaninterest Otherexpenses Non-currentassets
On31.3.X7thebusinessmadethefollowingtransactionsafterthebalanceslistedabovehadbeen calculated.
Boughtmaterialsfor£1,000,halfforcashandhalfoncredit Madesalesof£1,040,£800ofwhichwereoncredit Paidwagestoshopassistantsof£260incash
Drawupatrialbalanceshowingthebalancesasattheendof31.3.X7.
Solution Todrawupaninitialtrialbalancewesplittheoriginalbalancesintodebitandcreditbalances.You needtouseyourknowledgeofassets,capital,liabilities,expensesandincomeforthis. Bankloan Cashatbank Capital Rent Tradepayables Purchases Sales Otherpayables Tradereceivables Bankloaninterest Otherexpenses Non-currentassets
Debit £ 11,700 1,880 12,400 12,000 1,400 11,020 22,020 72,420
Credit £ 12,000 13,000 11,200 34,600 1,620 72,420
£
£
1,000 240 800 260
500 500 1,040 260
Nextpreparejournalsforthetransactionson31.3.X7.
(a) (b) (c)
DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
Purchases Cashatbank Tradepayables Cashatbank Tradereceivables Sales Otherexpenses Cashatbank
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Nowwecanproducethefinaltrialbalance
Debit £ 11,180 1,880 13,400 12,800 1,400 11,280 22,020 73,960
Bankloan Cashatbank(11,700+240–500–260) Capital Rent Tradepayables(11,200+500) Purchases(12,400+1,000) Sales(34,600+1,040) Otherpayables Tradereceivables(12,000+800) Bankloaninterest Otherexpenses(11,020+260) Non-currentassets
Credit £ 12,000 13,000 11,700 35,640 1,620 73,960
2.4 Theextendedtrialbalance Analternativewayofpresentingthisinformationistouseanextendedtrialbalance.Thishasdebitand creditcolumnsfortheinitialtrialbalance,plusdebitandcreditcolumnsforadjustmentjournals.A revisedtrialbalanceisthencreatedbycross-castinghorizontally.
ToadebitbalanceintheTB,adddebitsandsubtractcreditsfromtheadjustmentcolumns.Ifthe resultispositive,insertitinthedebitcolumnoftherevisedtrialbalance.Ifitisnegative,insertitin thecreditcolumnoftherevisedtrialbalance.
ToacreditbalanceintheTB,subtractdebitsandaddcredits.Iftheanswerispositive,insertitin thecreditcolumnoftherevisedtrialbalance.Ifitisnegative,insertitinthedebitcolumnofthe revisedtrialbalance. Trialbalance Debit Credit £ £ 12,000 11,700 13,000 1,880 11,200 12,400 34,600 1,620 12,000 1,400 11,020 22,020 72,420 72,420
Ledgerbalance Bankloan Cashatbank Capital Rent Tradepayables Purchases Sales Otherpayables Tradereceivables Bankloaninterest Otherexpenses Non-currentassets
Adjustments Debit Credit £ £ 240 760* 500 1,000 1,040 800 260 2,300 2,300
*500+260
Revisedtrialbalance Debit Credit £ 12,000 11,180 13,000 1,880 11,700 13,400 35,640 1,620 12,800 1,400 11,280 22,020 73,960 73,960
Weshallseehowacompleteextendedtrialbalanceworkslaterinthischapter.
3 Preparingthestatementofprofitorloss Sectionoverview
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Topreparethestatementofprofitorloss,alltheincomeandexpenseaccountbalancesare transferredtoanewledgeraccountinthenominalledger,calledtheprofitandlossledger account.Thebalanceonthisaccountistheprofit/(loss)fortheperiod.
Theinformationsummarisedintheprofitandlossledgeraccountisthentransferredintothe verticalstatementofprofitorlossformattoshow:revenue,costofsales,grossprofit,expenses andprofit/(loss).
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3.1 Preparingtheprofitorlossledgeraccount Thefirststepinpreparingthestatementofprofitorlossistocreateanewledgeraccountinthe nominalledger,calledtheprofitandlossledgeraccount.Tothisaccountalltheledgeraccount balancesrelatingtothestatementofprofitorloss,bothincomeandexpense,aretransferred.Theprofit andlossledgeraccountispartofthedoubleentrysystem,sothebasicruleofdoubleentrystillapplies: everydebitmusthaveanequalandoppositecreditentry. Theprofitandlossledgeraccountcontainsthesameinformationasthestatementofprofitorloss,and thereareveryfewdifferencesbetweenthetwo.However,thestatementofprofitorlosslaysthe informationoutdifferently. Thefirststepistoidentifytheledgeraccountswhichrelatetoincomeandexpenses.ForRonKnuckle, theseaccountsconsistofpurchases,rent,sales,discountallowedandreceived,bankloaninterest,and otherexpenses. Next,wetransferthesebalancestotheprofitandlossledgeraccount.Forexample,thebalanceonthe purchasesaccountis£5,000DR.Totransferthisbalance,wewrite£5,000onthecreditsideofthe purchasesaccount,and£5,000onthedebitsideoftheprofitandlossledgeraccount.Nowthebalance onthepurchasesaccounthasbeenmovedtotheprofitandlossledgeraccount. IfwedothesamethingwithalltheseparateaccountsofRonKnuckledealingwithincomeand expenses,theresultisasfollows.(Whenwetransferor'clear'theseaccountstotheprofitandlossledger account(P/La/c)wedoubleunderlinebothsidesoftheledgeraccountwearetransferringfromto showthatthebalanceisnowzero.) PURCHASES Tradepayables
£ 5,000
£ 5,000
P/La/c
RENT Cashatbank
£ 3,500
£ 3,500
P/La/c
SALES P/La/c
£ 12,500 12,500
£ 10,000 2,500 12,500
Cashatbank Tradereceivables
DISCOUNTRECEIVED P/La/c
£ 50
£ 50
Tradepayables
DISCOUNTALLOWED Tradereceivables
£ 20
£ 20
P/La/c
BANKLOANINTEREST Cashatbank
£ 100
£ 100
P/La/c
OTHEREXPENSES Cashatbank
£ 1,900
£ 1,900
P/La/c
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PROFITANDLOSSLEDGERACCOUNT(P/La/c) Purchases Rent Discountallowed Bankloaninterest Otherexpenses Profitfortheperiod
£ 5,000 3,500 20 100 1,900 2,030 12,550
£ 12,500 50 12,550
Sales Discountreceived
Thebalanceontheprofitorlossledgeraccountistheprofitfortheperiod.
3.2 Preparingthestatementofprofitorloss Theitemsintheprofitandlossledgeraccountarethesameitemsthatweneedtodrawupthe statementofprofitorloss.
Salesandpurchasesareincludedingrossprofit. Allotherincomeisadded,andallotherexpensesarededucted,toarriveatprofitfortheperiod.
Interactivequestion1:Statementofprofitorloss
[Difficultylevel:Intermediate]
DrawupRonKnuckle'sstatementofprofitorloss. SeeAnswerattheendofthischapter.
4 Preparingthestatementoffinancialposition Sectionoverview
Topreparethestatementoffinancialposition,theprofitandlossledgeraccountbalanceis transferredtothecapitalledgeraccount.
Alltheremainingbalances(ontheasset,capitalandliabilitiesaccounts)inthenominalledgerare thenlistedoutintheverticalformatstatementoffinancialpositiontoshow:non-currentand currentassets(totalassets),whichareequaltocapitalplusnon-currentandcurrentliabilities(total capitalandliabilities).
4.1 Transferringprofit/lossfortheperiodtothecapitalaccount Theowner'scapitalcomprisesanycashintroduced,plusanyprofitsmadebythebusiness,lessany drawings.Atthestagewehavenowreached,thesethreeelementsarecontainedindifferentledger accounts:cashintroducedof£7,000appearsinthecapitalaccount;drawingsof£1,500appearinthe drawingsaccount;andtheprofitmadebythebusinessisrepresentedbythe£2,030creditbalanceon theprofitandlossaccount.Todeterminetheclosingcapitalbalancewecombinetheseinthecapital account. DRAWINGS Cashatbank
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£ 1,500
Capitala/c
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PROFITANDLOSSLEDGERACCOUNT £ 5,000 3,500 100 1,900 20 2,030 12,550
Purchases Rent Bankloaninterest Otherexpenses Discountallowed Capitala/c
£ 12,500 50 12,550
Sales Discountreceived
CAPITAL £ 1,500 7,530 9,030
Drawings Balancec/d
Cashatbank P/La/c
£ 7,000 2,030 9,030
Balanceb/d
7,530
4.2 Preparingthestatementoffinancialposition Wenowjusthavethecash,capital,bankloan,tradepayables,non-currentassetsandtradereceivables accounts. Theseaccountsrepresentassets,capitalandliabilitiesofthebusiness(notincomeandexpenses)sotheir balancesarecarrieddowninthebooksofthebusiness.Thismeansthattheybecomeopening balancesforthenextreportingperiod. Theconventionalmethodofrulingoffaledgeraccountattheendofareportingperiodandcarrying downthebalancetothenextaccountingperiodisillustratedbyRonKnuckle'sbankloanaccount. BANKLOANACCOUNT Balancecarrieddown(c/d)
£ 1,000 1,000
Cashatbank Balancebroughtdown(b/d)
£ 1,000 1,000 1,000
RonKnucklethereforebeginsthenewreportingperiodwithacreditbalancebroughtdownof£1,000 ontheloanaccount.
Acreditbalancebroughtdowndenotesaliability. Adebitbalancebroughtdowndenotesanasset.
Interactivequestion2:Statementoffinancialposition
[Difficultylevel:Intermediate]
CompleteRonKnuckle'ssimplestatementoffinancialposition. SeeAnswerattheendofthischapter. C H A P T E R
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5 Preparingbasicfinancialstatements Sectionoverview
Topreparethestatementofprofitorlossandstatementoffinancialpositiontogether,youneed tofollowthroughmethodicallythestepsinvolved: –
Calculatebalancesonallnominalledgeraccounts
–
Preparetrialbalance
–
Transferincomeandexpensebalancestotheprofitandlossledgeraccountandcalculate profit/(loss)fortheperiod
–
Preparestatementofprofitorloss
–
Transferprofitandlossledgeraccountanddrawingsbalancetocapitalaccount
–
Preparestatementoffinancialposition
Wecannowworkthroughafullexampleofpreparingasetofbasicfinancialstatements.Thisisbyfar themostimportantexampleintheStudyManualsofar.Itcoversalltheaccountingstepsfromentering upledgeraccountstopreparingthestatementofprofitorlossandstatementoffinancialposition.You musttrythisexampleyourselffirst,beforecarefullyfollowingthroughthesolution.
Workedexample:Preparingfinancialstatements Abusinessisestablishedwithcapitalof£2,000paidbytheownerintoabusinessbankaccount,which hasanoverdraftfacility.Duringthefirstyear'strading,thefollowingtransactionsoccurred: Purchasesofgoodsforresale,oncredit Paymentstosuppliers Sales,alloncredit Paymentsfromcustomers Non-currentassetspurchasedforcash Otherexpenses,allpaidincash
£ 4,300 3,600 5,800 3,200 1,500 900
Prepareledgersaccounts,astatementofprofitorlossfortheyearandastatementoffinancialposition asattheendoftheyear.
Solution Thefirstthingtodoistoopenledgeraccounts.Theaccountsneededare:cashatbank;capital;trade payables;purchases;non-currentassets;sales;tradereceivables;otherexpenses. Thenextstepistoperformthedoubleentrybookkeepingforeachtransaction.Normallyyouwould writethemstraightintotheaccounts,buttomakethisexampleeasiertofollow,theyarelistedbelow.
(a) Establishingbusiness(£2,000) (b) Creditpurchases(£4,300) (c) Paymentstosuppliers(£3,600) (d) Creditsales(£5,800) (e) Paymentsfromcustomers(£3,200) (f) Non-currentassets(£1,500) (g) Other(cash)expenses(£900)
Debit
Credit
Cashatbank
Capital
Purchases
Tradepayables
Tradepayables
Cashatbank
Tradereceivables
Sales
Cashatbank
Tradereceivables
Non-currentassets
Cashatbank
Otherexpenses
Cashatbank
Sofar,theledgeraccountswilllooklikethis.
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CASHATBANK Capital Tradereceivables
£ 2,000 3,200
Tradepayables Non-currentassets Otherexpenses
£ 3,600 1,500 900
CAPITAL
£
Cashatbank
£ 2,000
TRADEPAYABLES Cashatbank
£ 3,600
Purchases
£ 4,300
PURCHASES Tradepayables
£ 4,300
£
NON-CURRENTASSETS Cashatbank
£ 1,500
£
SALES
£
Tradereceivables
£ 5,800
TRADERECEIVABLES Sales
£ 5,800
Cashatbank
£ 3,200
OTHEREXPENSES Cashatbank
£ 900
£
Nextwebalancetheledgeraccountsanddrawupatrialbalancetomakesurethedoubleentryis accurate. Debit £ 4,300 1,500 2,600 900 9,300
Cashatbank Capital Tradepayables Purchases Non-currentassets Sales Tradereceivables Otherexpenses
Credit £ 800 2,000 700 5,800 9,300
Nextthebalancesrelatingtoincomeandexpenses(iesales,otherincome,purchasesandother expenses)areclearedtoaprofitandlossledgeraccount.Atthispoint,theledgeraccountswillbeas follows.
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CASHATBANK £ 2,000 3,200 800 6,000
Capital Tradereceivables Balancec/d
Tradepayables Non-currentassets Otherexpenses Balanceb/d
£ 3,600 1,500 900 6,000 800*
*Acreditbalanceb/donthecashatbankledgeraccountmeansthatthiscashitemisaliability,notan asset.Thisindicatesabankoverdraftof£800. PROFITANDLOSSLEDGERACCOUNT £ 4,300 1,500 5,800
Purchasesaccount Grossprofitc/d Otherexpenses
900
Profitfortheyear (transferredtocapitalaccount)
Sales
£ 5,800 5,800
Grossprofitb/d
1,500
600 1,500
1,500
CAPITAL Balancec/d
£ 2,600 2,600
Cashatbank P/La/c(profitfortheyear)
£ 2,000 600 2,600
Balanceb/d
2,600
TRADEPAYABLES Cashatbank Balancec/d
£ 3,600 700 4,300
Purchases Balanceb/d
£ 4,300 4,300 700
PURCHASESACCOUNT Tradepayables
£ 4,300
P/La/c
£ 4,300
NON-CURRENTASSETS Cashatbank
£ 1,500
Balancec/d
Balanceb/d
1,500
£ 1,500
SALES P/La/c
£ 5,800
Tradereceivables
£ 5,800
TRADERECEIVABLES Sales Balanceb/d
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£ 5,800 5,800 2,600
Cashatbank Balancec/d
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OTHEREXPENSES £ 900
Cashatbank
£ 900
P/La/c
Thestatementofprofitorlossandstatementoffinancialpositionareasfollows. Statementofprofitorloss £ 5,800 (4,300) 1,500 (900) 600
Sales Costofsales(purchases) Grossprofit Expenses Profitfortheyear Statementoffinancialposition Assets Non-currentassets Currentassets Tradereceivables Totalassets
£
£ 1,500 2,600 4,100
Capitalandliabilities Capital Atstartofperiod Profitforperiod Atendofperiod Currentliabilities Bankoverdraft Tradepayables Totalcapitalandliabilities
2,000 600 800 700
2,600 1,500 4,100
Interactivequestion3:Profitandlossledgeraccount
[Difficultylevel:Intermediate]
Pollyhadthefollowingtransactionsinherfirstyearoftradingasabeautytherapistvisitingclientsat home. 1.1.X1
Openedabankaccountwith£400.Tookoutbankloanfor£5,000,andagreedan overdraftlimitofthesameamount
1.1.X1
Boughtcarfor£2,500cash.Insureditfor£300cash.Boughtotherequipmentfor £1,500,andconsumableitemsfor£500,bothoncredit
Duringyear:
Chargedcustomers£15,945,alloncredit.
Duringyear:
Purchasedfurtherconsumablesfor£3,690oncredit,anddieselforcarfor£650in cash.
Duringyear:
Took£1,250incashfromATMsforherself
Byendofyear:
Received£12,935fromcustomersandpaid£3,250tosuppliers
PreparePolly'sledgeraccountsincludingaprofitandlossledgeraccount,anddrawupastatementof profitorlossandstatementoffinancialpositioninrespectofherfirstyearoftrading.
C H A P T E R
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6 Theextendedtrialbalance(ETB) Sectionoverview
Wecanpreparethestatementofprofitorlossandstatementoffinancialpositionwithouta separateprofitandlossledgeraccountifweusetheextendedtrialbalance(ETB).
TheETBcross-castsfromthetrialbalanceandanyadjustingjournalsstraighttodebitandcredit columnsforthestatementofprofitorloss(allincomeandexpenseitems)andthestatementof financialposition(allasset,liabilityandcapitalitems).
Iftheentityhasmadeaprofitthisisshowninthedebitcolumnforthestatementofprofitorloss, andinthecreditcolumnforthestatementoffinancialposition.
Iftheentityhasmadealossthisisshowninthecreditcolumnforthestatementofprofitorloss, andinthedebitcolumnforthestatementoffinancialposition.
InSection2.4wesawhowtheextendedtrialbalance(ETB)helpedustoadjustaninitialtrialbalanceto createarevisedone.ThefullwayinwhichweusetheETBistohelpusdrawupastatementofprofitor lossandstatementoffinancialposition,withouttheneedtocreateaprofitandlossledgeraccount.
Workedexample:Extendedtrialbalance TakingtherevisedtrialbalancefromSection2.4andusingitasthetrialbalancecolumnoftheETB,we 'extend'itacrosssothat:
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Alltheincomeandexpenseitemsaretakenintotheappropriatedebitandcreditcolumnsofthe statementofprofitorloss.
Aprofitfortheyeariscalculatedinthedebitcolumnofthestatementofprofitorloss.
Thisprofitfortheyearisinsertedinthecreditcolumnofthestatementoffinancialpositionto completethedoubleentry.
Alltheotheritemsaretakentotheappropriatedebitandcreditcolumnsofthestatementof financialposition.Notethatwetaketheopeningcapitalbalanceandthedrawingsbalancestraight fromthetrialbalancetothestatementoffinancialposition.
Allcolumnsareaddeduptoensurethedoubleentryhasbeencarriedoutproperly.
ThestatementofprofitorlossandstatementoffinancialpositioninIAS1formatareprepared fromtherelevantcolumnsoftheETB.
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Solution Ledgerbalance Bankloan Cashatbank Capital Rent Tradepayables Purchases Sales Otherpayables Tradereceivables Bankloaninterest Otherexpenses Non-currentassets Profitfortheyear
Revisedtrialbalance Debit Credit £ £ 12,000 11,180 13,000 1,880 11,700 13,400 35,640 1,620 12,800 1,400 11,280 22,020
73,960 Statementofprofitorloss Revenue Costofsales Purchases Grossprofit Expenses Otherexpenses Rent Financecosts(interest) Profitfortheyear Statementoffinancialposition Non-currentassets Currentassets Tradereceivables Cashatbank Totalassets
73,960
Statementofprofitor loss Debit Credit £ £ 1,880 13,400 35,640 1,400 11,280 35,640 27,960 7,680 35,640 35,640
Statementoffinancial position Debit Credit £ £ 12,000 11,180 13,000 11,700 1,620 12,800 22,020 7,680 46,000 46,000 £
11,280 1,880 1,400 £
Capitalandliabilities Openingcapital Profitforyear(fromstatementofprofitorloss) Drawings Closingcapital Non-currentliabilities Bankloan Currentliabilities Tradepayables Otherpayables Totalcapitalandliabilities
£ 35,640 (13,400) 22,240 (14,560) 7,680
12,800 11,180
£ 22,020 23,980 46,000
11,700 1,620
13,000 7,680 0 20,680 12,000 13,320 46,000
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Interactivequestion4:Extendedtrialbalance
[Difficultylevel:Intermediate]
PrepareanextendedtrialbalanceforPolly,forwhomwepreparedastatementofprofitorlossand statementoffinancialpositioninInteractivequestion3. SeeAnswerattheendofthischapter.
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SummaryandSelf-test
Summary
Statementofprofitorloss
Statementofprofitorloss
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Self-test Answerthefollowingquestions. 1
Inaperiod,salesare£140,000,purchases£75,000andotherexpenses£25,000.Whatisthefigure forprofitfortheperiodtobetransferredtothecapitalaccount? A B C D
2
£40,000 £65,000 £75,000 £140,000
DuringMarch,Chanhadthefollowingitemsinthecashatbankaccount. Balanceat1March(overdrawn) Receiptsfromreceivables Paymentstopayables Paymentsforexpenses Cashdrawnforownuse
£ 500 12,000 7,000 3,000 1,200
WhatisthebalanceonChan'scashatbankaccounton31March? A B C D 3
£300 £300 £1,300 £1,300
Whichthreeofthefollowingitemswillbelistedasacreditbalanceonatrialbalance? A B C D E F
4
Debit Credit Debit Credit
Tradepayables Purchases Discountsreceived Sundryexpenses Capital Drawings
Selectwhetherthefollowingbalanceswillbeinthedebitorthecreditcolumnsofthetrialbalance.
5
Credit
Machinery
Tradepayables
Drawings
Discountallowed
Revenue
Discountreceived
Bankoverdraft
Rentalincome
Whenanerrorinadebitentryiscancelledoutbyanerrorinacreditentry,thisiscalled A B C D
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Debit
Acommissionerror Acompensatingerror Anomissionerror Anerrorofprinciple
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6
AnerrorhasledtoErica'strialbalancefailingtobalance.Thiscouldhavebeencausedbyanerror ofcommission. True False
7
8
ThebalanceonTim'sloanaccountis£1,200.Hehasjustrealisedthata£100loanrepaymentthat hemadeduringtheyearwaspostedfromthecashbooktodrawings.Ontheloanaccountlineof theextendedtrialbalance,adjustingforthismistakewillmean: A
Acreditentryintheadjustmentscolumnsandacreditbalanceof£1,100inthestatementof financialpositioncolumns
B
Adebitentryintheadjustmentscolumnsandacreditbalanceof£1,100inthestatementof financialpositioncolumns
C
Acreditentryintheadjustmentscolumnsandacreditbalanceof£1,300inthestatementof financialpositioncolumns
D
Adebitentryintheadjustmentscolumnsandacreditbalanceof£1,300inthestatementof financialpositioncolumns
Mannyhasanetlossof£400.Thisshouldbe A B C D
9
Creditedtotheprofitandlossledgeraccountanddebitedtothecapitalaccount Debitedtotheprofitandlossledgeraccountandcreditedtothecapitalaccount Creditedtotheprofitandlossledgeraccountanddebitedtothedrawingsaccount Debitedtotheprofitandlossledgeraccountandcreditedtothedrawingsaccount
At31December20X6Richard'stotalassetsare£20,376andhisnon-currentliabilitiesare£10,000. Ifhiscurrentliabilitiesare£6,290thenhiscapitalbalanceat31December20X6mustbe A B C D
£4,086 £16,666 £24,086 £36,666
10 ThestatementofprofitorlosscolumnsonJude'sETBare£57,390forthedebitcolumnand £84,928forthecreditcolumn.WhatfinalentrydoesJudeneedtomake? A B C D
Credit£27,538profitfortheperiod Credit£27,538lossfortheperiod Debit£27,538profitfortheperiod Debit£27,538lossfortheperiod
Now,gobacktotheLearningObjectivesintheIntroduction.Ifyouaresatisfiedthatyouhaveachieved theseobjectives,pleasetickthemoff.
C H A P T E R
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AnswerstoInteractivequestions
AnswertoInteractivequestion1 RONKNUCKLE:STATEMENTOFPROFITORLOSSFORFIRSTTRADINGPERIOD Revenue(=sales) Costofsales(=purchases) Grossprofit Otherincome:discountreceived Expenses Rent Discountallowed Bankloaninterest Otherexpenses Profitfortheyear(thebalanceontheprofitandlossledgeraccount)
£ 3,500 20 100 1,900
£ 12,500 (5,000) 7,500 50 (5,520) 2,030
AnswertoInteractivequestion2 RONKNUCKLE STATEMENTOFFINANCIALPOSITIONATENDOFFIRSTTRADINGPERIOD Assets Non-currentassets Currentassets Cashatbank Totalassets
£ 2,000 6,530 8,530
Capitalandliabilities Owner'scapital Non-currentliabilities Bankloan Totalcapitalandliabilities
7,530 1,000 8,530
AnswertoInteractivequestion3 CASHATBANK 1.1.X1 1.1.X1 31.12.X1
Capital Loan Tradereceivables
£ 400 5,000 12,935 18,335
1.1.X1 1.1.X1 31.12.X1 31.12.X1 31.12.X1 31.12.X1
Insurance Non-currentassets Carexpenses Drawings Tradepayables C/d
31.12.X1
B/d
10,385
£ 300 2,500 650 1,250 3,250 10,385 18,335
CAPITAL
130
31.12.X1 31.12.X1
Drawings C/d
£ 1,250 9,955 11,205
1.1.X1 31.12.X1
Cashatbank P/Laccount
31.12.X1
B/d
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LOAN 31.12.X1
C/d
£ 5,000 5,000
1.1.X1
Cashatbank
£ 5,000 5,000
31.12.X1
B/d
5,000
NON-CURRENTASSETS(NCA) 1.1.X1 1.1.X1
Cashatbank Tradepayables
£ 2,500 1,500 4,000
31.12.X1
C/d
31.12.X1
B/d
4,000
£ 4,000 4,000
TRADEPAYABLES 31.12.X1 31.12.X1
Cashatbank C/d
£ 3,250 2,440 5,690
1.1.X1 1.1.X1 31.12.X1
NCA Purchases Purchases
31.12.X1
B/d
£ 1,500 500 3,690 5,690 2,440
INSURANCE 1.1.X1
Cashatbank
£ 300 300
31.12.X1
P/Laccount
£ 65300 300
P/Laccount
£ 650 650
P/Laccount
£ 4,190 4,190
CAREXPENSES 31.12.X1
Cashatbank
£ 650 650
31.12.X1
PURCHASES 1.1.X1 31.12.X1
Tradepayables Tradepayables
£ 500 3,690 4,190
31.12.X1
SALES 31.12.X1
P/Laccount
£ 15,945 15,945
Tradereceivables
£ 15,945 15,945
31.12.X1 31.12.X1
Cashatbank C/d
£ 12,935 3,010 15,945
31.12.X1
TRADERECEIVABLES 31.12.X1
Sales
31.12.X1
B/d
£ 15,945 15,945 3,010
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DRAWINGS 31.12.X1
Cashatbank
£ 1,250 1,250
31.12.X1
Capital
£ 1,250 1,250
£ 15,945 15,945
PROFITANDLOSSLEDGERACCOUNT 31.12.X1 31.12.X1 31.12.X1 31.12.X1
Purchases Carexpenses Insurance Capital
£ 4,190 650 300 10,805 15,945
31.12.X1
Sales
POLLY:STATEMENTOFPROFITORLOSSFORYEARENDED31DECEMBER20X1 Revenue Costofsales Purchases Grossprofit Expenses Carexpenses Insurance Profitforthe year
£ 15,945 (4,190) 11,755 (650) (300)
10,805
POLLY:STATEMENTOFFINANCIALPOSITIONASAT31DECEMBER20X1 Non-currentassets Currentassets Tradereceivables Cashatbank Totalassets
3,010 10,385
Capitalandliabilities Openingcapital Profitforyear Drawings Closingcapital Non-currentliabilities Bankloan Currentliabilities Tradepayables Totalcapitalandliabilities
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£ 4,000 13,395 17,395
£
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AnswertoInteractivequestion4 Ledgerbalance Cashatbank Openingcapital Loan Non-currentassets Tradepayables Insurance Carexpenses Purchases Sales Tradereceivables Drawings Profitfortheyear
Trialbalance Debit Credit £ £ 10,385 400 5,000 4,000 2,440 300 650 4,190 15,945 3,010 1,250 23,785 23,785
Statementofprofitor loss Debit Credit £ £ 300 650 4,190 15,945 10,805 15,945 15,945
Statementoffinancial position Debit Credit £ £ 10,385 400 5,000 4,000 2,440 3,010 1,250 10,805 18,645 18,645
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AnswerstoSelf-test 1
A
PROFITORLOSSLEDGERACCOUNT
Purchases Grossprofitc/d Otherexpenses Profitfortheyear–tocapital a/c
£ 75,000 65,000 140,000
£ 140,000 140,000
Sales
25,000 40,000
Grossprofitb/d
65,000
65,000
65,000
Bisthegrossprofitfigure,whileCisthefigureforpurchasesandDisthefigureforsales. 2
A
CASHATBANK
Receivables B/d
£ 12,000 12,000 300
3
A,C,E Purchases,sundryexpensesanddrawingsarealldebitbalances.
4
Machinery Tradepayables
Debit
Credit
Drawings Discountallowed Revenue
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£ 500 7,000 3,000 1,200 300 12,000
B/d Payables Expenses Drawings C/d
Discountreceived
Bankoverdraft
Rentalincome
5
B
6
False.Anerrorofcommissiondoesnotleadtothetrialbalancefailingtobalance.
7
B
The£100paymentwasdebitedtodrawingsfromcash.Itneedstobecreditedtodrawings anddebitedtotheloanaccount,leadingtoareductionintheloanbalanceonthestatement offinancialpositionto£1,100.
8
A
Anetlossisdebitedtothecapitalaccount,reducingtheowner'sinterestinthebusiness,and iscreditedtotheprofitandlossledgeraccount.
9
A
£20,376–£10,000–£6,290=£4,086
Acommissionerror(A)occurswhenthedoubleentryiscomplete,buttheentriesaremadein thewrongaccount(s).Anomissionerror(C)occurswhenatransactioniscompletelyomitted fromtheaccountingrecords.Anerrorofprinciple(D)occurswhenthedoubleentryis performedbutthewrongtreatmentisappliedtoatransaction.Withallfourerrorsthetrial balancewillstillbalance.
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10 C
Thedifferencebetweenthetwocolumnsisadebit,sothismustappearinthedebitcolumn ofthestatementofprofitorlossasaprofitfortheyear;acreditentrywouldmakeitalossfor theyear.
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CHAPTER6
Controlaccounts,errorsand suspenseaccounts
Introduction Examinationcontext TopicList 1 Whatarecontrolaccounts? 2 Operatingcontrolaccounts 3 Thepurposeofcontrolaccounts 4 Thecashatbankaccount,thecashbookandthebankstatement 5 Thebankreconciliation 6 Typesoferrorinaccounting 7 Correctingerrors 8 CorrectingerrorsviatheETB SummaryandSelf-test AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Prepareatrialbalancefromaccountingrecordsandidentifytheusesofatrialbalance
Identifyomissionsanderrorsinaccountingrecordsandfinancialstatementsand demonstratehowtherequiredadjustmentswillaffectprofitsorlosses
Correctomissionsanderrorsinaccountingrecordsandfinancialstatementsusingcontrol accountreconciliationsandsuspenseaccounts
Prepareanextendedtrialbalance
Preparejournalsfornominalledgerentryandtocorrecterrorsindraftfinancialstatements
Specificsyllabuslearningoutcomesare:1f;2a,b,c,d
Syllabuslinks Theaccuracyoffinancialstatementsisthebedrockonwhichtherestofyourstudiesforthispaper,and fortheProfessionalLevelmoduleofFinancialAccountingandReporting,arebuilt.
Examinationcontext Questionsonthetopicsinthischapterwillbesetasmultiplechoicequestions,someofwhichmay involvecalculationssothatthecorrectanswercanbeselected.Veryoftendoubleentryquestionsare phrasedintermsofpreparingajournal. Intheexamyoumayberequiredto:
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Identifydistinctionsbetweenerrorsthatcausetrialbalanceimbalancesandthosethatdonot
Identifyajournaltocorrecterrors
Calculateasuspenseaccountbalance
Identifythecorrectjournaltoclearasuspenseaccount
Identifytheeffectsofcorrectingerrorsondraftgrossornetprofit
Usethetechniquesofbankreconciliationstoidentifythecorrectcashatbankbalanceinthe financialstatements
Usereconciliationtechniquestoidentifythecorrectreceivablesandpayablesbalancesinthe financialstatements
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1 Whatarecontrolaccounts? Sectionoverview
Controlaccountsinthenominalledgerforreceivablesandpayablesrecordtotalamountsin respectofallcustomers/suppliers.
Thememorandumreceivablesandpayablesledgersrecordeachtransactionforindividual customersandsuppliersintheirpersonalaccounts.Thesearenotpartofthedoubleentrysystem ifcontrolaccountsaremaintained.
Thetotalofallthebalancesineachmemorandumledgershouldequalthebalanceonthe relevantcontrolaccount.
C H A P T E R
6
InChapter4whenwelookedatthememorandumreceivablesandpayablesledgers(ietheledgers containingpersonalaccountsforcustomersandsuppliers,whicharenotpartofthenominalledger doubleentrysystem)webrieflyintroducedtheideaofcontrolaccounts.
Definitions Controlaccount:Nominalledgeraccountinwhicharecordiskeptofthetotalvalueofanumberof similarindividualitems.Controlaccountsareusedchieflyfortradereceivablesandpayables.
Areceivablescontrolaccountisanominalledgeraccountinwhichrecordsarekeptof transactionsinvolvingallreceivablesintotal.Thebalanceonthereceivablescontrolaccountatany timewillbethetotalamountduetothebusinessfromallitscreditcustomers.
Apayablescontrolaccountisanominalledgeraccountinwhichrecordsarekeptoftransactions involvingallpayablesintotal,andthebalanceonthisaccountatanytimewillbethetotalamount owedbythebusinesstoallitscreditsuppliers.
Controlaccountsarealsokeptforwagesandsalaries,cash,VATandnon-currentassets.Themost importantideatoremember,however,isthatacontrolaccountisanaccountwhichkeepsatotal recordforacollectiveitem(egreceivables),whichinrealityconsistsofmanyindividualitems(eg individualtradereceivables).
1.1 Controlaccounts(nominalledger)andpersonalaccounts(memorandum ledgers) Theamountowedbyeachcreditcustomerisabalanceontheirpersonalaccountinthereceivables ledger,whichaswesawinChapter4isamemorandumledgeronly,outsidethedoubleentrysystemof thenominalledger.Theamountowedbyallthecreditcustomerstogether(ieallthetradereceivables) isthebalanceonthereceivablescontrolaccount. Atanytimethebalanceonthereceivablescontrolaccountshouldbeequaltothesumofthe individualpersonalaccountbalancesonthereceivablesledger. Mostcustomerswillhaveadebitbalanceontheirpersonalaccountinthereceivablesledger,asthey owethebusinessmoneyforgoods/servicessupplied.Sometimesacustomermayhaveacredit balance,perhapsbecauseithasoverpaidthebusiness,orpaidforgoodsandthenreturnedsome. Whilecreditbalanceswillshowuponthereceivablesledgerbalancesquiteclearly,thebalanceonthe receivablescontrolaccountinthenominalledgerisanaggregatebalanceandwillalwaysbeadebit balance.
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Workedexample:Receivablescontrolaccount Abusinesshasthreetradereceivables:AArnoldowes£80,BBagshawowes£310andCCloningowes £200. Receivablesledgerpersonalaccounts AArnold BBagshaw CCloning
£ 80 310 200 590
Thebalanceonthenominalledgerreceivablescontrolaccountshouldbethetotal,£590. Whathashappenedhereisthatthreeentriesof£80,£310and£200werefirstenteredintothesales daybook.TheywerepostedindividuallytothethreepersonalaccountsofArnold,BagshawandCloning inthereceivablesledger,butthesearenotpartofthedoubleentrysystem. Later,thetotalof£590waspostedfromthesalesdaybooktothenominalledger,whichisthedouble entrysystem: DEBIT CREDIT
Receivablescontrolaccount Sales
£ 590
£ 590
2 Operatingcontrolaccounts Sectionoverview
Individualentriesinreceivablesandpayablesledgersaresummarisedandpostedtorelevant controlaccountsinthenominalledger.
Forsales:debitreceivables,creditsales&VAT.
Forreceiptsfromcustomersanddiscountallowed:creditreceivables,debitcash/discountallowed.
Forpurchases:creditpayables,debitpurchases&VAT.
Forpaymentstosuppliersanddiscountreceived:debitpayables,creditcash/discountreceived.
Otherentriesinreceivablesaccounts:creditreceivables,debitpayables(contrawithpayables ledger);creditreceivables,debitirrecoverabledebts(debtwrittenoff);debitreceivables,credit cash(customer'schequedishonoured,orrefundtocustomer).
Otherentriesinpayablesaccounts:creditpayables,debitcash(refundfromsupplier);debit payables,creditreceivables(contrawithreceivablesledger).
Thewagescontrolaccountisusedasaclearingaccountforallthepostingsfromthepayroll;at theendofeachperiodthebalanceshouldbezero.
Thetwomostimportantcontrolaccountsarethoseforreceivablesandpayables.Theyarepartofthe doubleentrysystem;thereceivablesandpayablesledgerarememorandumledgersonly.
2.1 Accountingforreceivables Transactionsinvolvingreceivablesareaccountedforbypostingfrombooksoforiginalentrytoboththe personalaccountsinthereceivablesledger,andthereceivablescontrolaccountinthenominalledger. Referencenumbersareshownintheaccountstoillustratecross-referencingasfollows:
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SDBrefertoasalesdaybookpage RLrefertoareceivablesledgeraccount NLrefertoanominalledgeraccount CBrefertoacashbookpage
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Workedexample:Accountingforreceivables At1July20X2,theOuterBusinessCompany(notregisteredforVAT)hadnotradereceivables.During July,thefollowingtransactionsaffectingcreditsalesandcustomersoccurred. (a) July3:invoicedAArnoldforthesaleoncreditofhardwaregoods:£100 (b) July11:invoicedBBagshawforthesaleoncreditofelectricalgoods:£150
C H A P T E R
(c) July15:invoicedCCloningforthesaleoncreditofhardwaregoods:£250 (d) July10:receivedpaymentfromAArnoldof£90,insettlementofhisdebtinfull,havingtakena permittedcashdiscountof£10forpaymentwithinsevendays
6
(e) July18:receivedapaymentof£72fromBBagshawinpartsettlementof£80ofhisdebt;acash discountof£8wasallowedforpaymentwithinsevendaysofinvoice (f) July28:receivedapaymentof£120fromCCloning,whowasunabletoclaimanydiscount (g) July31:receivednoticethatBBagshawhadbecomeinsolvent,sonomorepaymentscouldbe expectedfromhim.Thebalanceofhisdebtwastobe'writtenoff'asirrecoverable(£70) Accountnumbers: RL4 RL9 RL13 NL1 NL6 NL7 NL21 NL22 NL30
AArnold BBagshaw CCloning Cashatbank Receivablescontrolaccount Discountallowed Sales:hardware Sales:electrical Irrecoverabledebtsexpense
Firstweindicateinthesalesdaybookwherethecolumntotalsaretobeposted,usingthenominal ledgeraccountcode,and'Dr'fordebitand'Cr'forcredit.Wealsonotewhereeachinvoicetotalistobe postedinthereceivablesledger.
SALESDAYBOOK
Date 20X2 July 3 11 15
Name AArnold BBagshaw CCloning
Receivablesledgerref RL4Dr RL9Dr RL13Dr
SDB35 Total £ 100.00 150.00 250.00 500.00
Hardware £ 100.00 250.00 350.00
Electrical £ 150.00 150.00
NL6DR
NL21CR
NL22CR
Note:Thepersonalaccountsinthereceivablesledgerareusuallydebitedonthedaytheinvoicesare sentout.Thedoubleentryinthenominalledgeraccountsmightbemadeattheendofeachday,week ormonth;hereitismadeattheendofthemonth,bypostingfromthesalesdaybookasfollows. DEBIT CREDIT
NL6 NL21 NL22
Receivablescontrol Sales:hardware Sales:electrical
£ 500
£ 350 150
Nextwedothesameforthecashbook.Rememberthatdiscountsallowedandreceivedarerecordedin thecashbookasabookoforiginalentryonly;theyarenotincludedinthecross-casttotalcolumn.
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CASHBOOKEXTRACT RECEIPTS–JULY20X2
Date 20X2 July 10 18 28
Narrative AArnold BBagshaw CCloning
CB23 Total £ 90.00 72.00 120.00 282.00
Receivableledgerref RL4CR RL9CR RL13CR
NL1DR
Discount allowed £ 10.00 8.00 – 18.00
Receivables control £ 90.00 72.00 120.00 282.00
NL6CR NL7DR
NL6CR
Note:Postingdiscountallowedandcashseparatelytothereceivablescontrolaccountandtoeach receivablesledgerpersonalaccountallowsustocross-checkpostingsmoreeasily. AttheendofJuly,thecashbookispostedtothenominalledger. DEBIT CREDIT
NL1 Cashatbank NL7 Discountallowed NL6 Receivablescontrol(282+18)
£ 282.00 18.00
£ 300.00
BBagshaw'sirrecoverabledebthastoberemovedfromthenominalledgeraccount,viathejournal, usingaspecialnominalledgerexpenseaccountcalledirrecoverabledebtexpense.Thecreditentry willalsobepostedfromthejournaltoBBagshaw'spersonalaccountinthereceivablesledger. DEBIT CREDIT
NL30Irrecoverabledebtexpense NL6 Receivablescontrol(RL9)
£ 70
£ 70
Thepersonalaccountsinthereceivablesledgerarenotpartofthedoubleentrysystem,butwilllookas followsafterthepostingsfromthesalesdaybook,thecashbookandthejournal. Date 20X2 July3
MEMORANDUMRECEIVABLESLEDGER AARNOLD Narrative Sales
Ref. SDB35
£ 100.00 100.00
Date 20X2 July11
Date 20X2 July10
Narrative Cash Discount
A/cno:RL4 Ref. CB23 CB23
BBAGSHAW Narrative Sales
Ref. SDB35
£ 150.00 150.00
Date 20X2 July18 July31
A/cno:RL9 Narrative Cash Discount Irrecoverable Debt
Ref. CB23 CB23 Jnl
CCLONING
Date 20X2 July15
Narrative Sales
Ref. SDB35
Aug1
Balance
b/d
£ 250.00 250.00 130.00
£ 90.00 10.00 100.00
£ 72.00 8.00 70.00 150.00 A/cno:RL13
Date 20X2 July28 July31
Narrative Cash Balance
Ref. CB23 c/d
£ 120.00 130.00 250.00
Inthenominalledger,thetotalaccountingentriesaremadefromthebooksoforiginalentrytothe ledgeraccountsattheendofthemonth.
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NOMINALLEDGER(EXTRACT) RECEIVABLESCONTROLACCOUNT
Date 20X2 July31
Narrative Sales
Ref. SDB35
£
500.00 500.00
Date 20X2 July31 July31 July31 July31
Aug1
Balance
b/d
130.00
A/cno:NL6
Narrative Cash Discountallowed Irrecoverabledebt Balance
Ref. CB23 CB23 Jnl c/d
£ 282.00 18.00 70.00 130.00 500.00
C H A P T E R
6
Soat31Julytheclosingbalanceonthereceivablescontrolaccount(£130)isthesameasthetotalof theindividualbalancesonthepersonalaccountsinthereceivablesledger(£0+£0+£130). Theothernominalledgeraccountsarewrittenupasfollows. Date 20X2 July31
DISCOUNTALLOWED Narrative Receivables
Ref. CB23
Date 20X2 July31
£ 18.00
Date
A/cno:NL7
Narrative
Ref.
CASHATBANKACCOUNT Narrative Cashreceived
Ref. CB23
£ 282.00
Date
£
A/cno:NL1
Narrative
Ref.
£
Notethatdiscountallowedisnotpostedtothecashatbankaccount.Itonlyaffectsthediscount allowedandreceivablescontrolaccount. Date
SALES:HARDWARE Narrative
Ref.
Date
Date 20X2 July31
Narrative Receivables
Ref. £ SDB35 350.00
SALES:ELECTRICAL Narrative
Ref.
£
Date 20X2 July31
Date 20X2 July31
£
A/cno:NL21
A/cno:NL22
Narrative Receivables
Ref. £ 150.00 SDB35
IRRECOVERABLEDEBTS Narrative Receivables
Ref. Jnl
£ 70.00
Date
A/cno:NL30 Narrative
Ref.
£
Thetrialbalanceat31July20X2–forthenominalledgeronly–isasfollows. TRIALBALANCE Debit £ 282 130 18 70 500
Cash(allreceipts) Receivables Discountallowed Irrecoverabledebts Sales:hardware Sales:electrical
Credit £ 350 150 500
Thetrialbalanceisshownheretoemphasisethepointthatatrialbalanceincludesthebalanceonthe controlaccount,butexcludesthebalanceonthepersonalaccountsinthereceivablesledger.
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2.2 Accountingforpayables Referbacktorevisetheentriesmadeinthepurchasesdaybook,thepayablesledgerpersonalaccounts andthepayablescontrolaccountinthenominalledger.Suchentriesaremirrorimagesofthewaywe accountforreceivables,thoughtherewillbenoirrecoverabledebtentriesinthepayablesaccounts.
2.3 Entriesinreceivables/payablescontrolaccounts Typicalentriesinthereceivablesandpayablescontrolaccountsaresetoutbelow.Thereference'Jnl' indicatesthatthetransactionisfirstenteredinthejournalbeforepostingtothecontrolaccountand otheraccountsindicated.
Definitions Contra:Whenapersonorbusinessisbothacustomerandasupplier,amountsowedbyandowedto thepersonmaybe'nettedoff'bymeansofacontra: DEBIT CREDIT
Payablescontrolaccount(andpersonalaccountinthepayablesledger) Receivablescontrolaccount(andpersonalaccountinthereceivablesledger)
Irrecoverabledebt:Whenadebtowedbyacustomerwillneverbepaid,thetotalamountisremoved fromreceivables: DEBIT CREDIT
Irrecoverabledebtexpense Receivablescontrolaccount(andpersonalaccountinthereceivablesledger)
Dishonouredcheque:Whenacustomer'schequeispaidintothebusiness'sbankbutthecustomer's bankrefusestohonourpaymentofit,itis'writtenback'(theoriginalentryisreversed)soastoremove thereceiptofthechequefromthebooksandrecreatethedebtthathasstillnotbeenpaid: DEBIT CREDIT
Receivablescontrolaccount(andpersonalaccountinthereceivablesledger) Cash
RECEIVABLESCONTROLACCOUNT Openingbalance Sales/VAT Dishonouredcheques fromcustomers Refundspaidtocustomers
Ref. b/d SDB Jnl CB
£ 6,800 51,590 1,000 110 59,500
Balance
b/d
5,550
Cashreceived Discountsallowed Contrawithpayables ledger Irrecoverabledebts Balance
Ref. CB CB Jnl Jnl c/d
£ 52,250 1,250 150 300 5,550 59,500
*Sometimescustomersoverpayandareleftwithacreditbalanceontheirpersonalaccounts.Thiscan besettledbythebusinessrefundingtheoverpaymentsincash. PAYABLESCONTROLACCOUNT Cashpaid Discountsreceived Contrawithreceivables ledger Closingbalance
Ref. CB CB Jnl c/d
£ 29,840 30 150 9,170 39,190
Openingbalance Purchases/VAT Refundsreceived fromsuppliers* Balance
Ref. b/d PDB CB b/d
£ 8,230 30,940 20 39,190 9,170
*Aswithrefundstocustomers,sotoothebusinessmayreceivearefundincashfromasupplier regardinganoverpayment.
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Aswesawabove,postingfromthejournaltothereceivables(orpayables)ledgersandtothenominal ledgermaybeeffectedatthesametime,asinthefollowingexample,whereCCloninghasreturned goodswithasalesvalueof£50. Journalentry DEBIT Sales:hardware CREDIT Receivablescontrol CCloning(personalaccount) Returnofhardwaregoods
Ref. NL21 NL6 RL13
£ 50
£ 50 50
DR £ 150 150
CR £ 150 150
C H A P T E R
6
HereisanexampleofajournalrecordingthecontraentryinrespectofPerchLtd. Journalentry DEBIT Payablescontrol CREDIT Receivablescontrol PerchLtd:payablesledgera/c PerchLtd:receivablesledgera/c
Ref. NL14 NL6 PL82 RL49
ContrabetweenPerchLtd'sreceivablesandpayablesledgeraccounts.
Interactivequestion1:Payablescontrolaccount
[Difficultylevel:Examstandard]
Apayablescontrolaccountcontainsthefollowingentries: £ 79,500 83,200 3,750 4,000 12,920
Bank Creditpurchases Discountreceived Contrawithreceivablescontrolaccount Balancec/dat31December20X8
Therearenootherentriesintheaccount.Whatwastheopeningbalancebroughtdownat1January 20X8? SeeAnswerattheendofthischapter.
Interactivequestion2:Receivablescontrolaccount
[Difficultylevel:Examstandard]
Thetotalofthebalancesinacompany'sreceivablesledgeris£800morethanthedebitbalanceonits receivablescontrolaccount.Whichoneofthefollowingerrorscouldbyitselfaccountforthe discrepancy? A
Thesalesdaybooktotalcolumnhasbeenundercastby£800
B
Cashdiscountstotalling£800havebeenomittedfromthenominalledger
C
Onereceivablesledgeraccountwithacreditbalanceof£800hasbeentreatedasadebitbalance inthelistofbalances
D
Thecashreceiptsbookhasbeenundercastby£800
SeeAnswerattheendofthischapter.
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Figure6.1shouldhelpyounowtoseehowthereceivablesledgerandreceivablescontrolaccountare used.NotethatAoverpaidby£20inerror,whileBonlypaidpartofwhatheowed.
Figure6.1Accountingforreceivables Thetotalofthebalancesonthereceivablesledger(iethepersonalaccountbalancesofAandBadded up)equalsthebalanceonthereceivablescontrolaccount.
Interactivequestion3:Receivablesandpayablescontrolaccounts [Difficultylevel:Examstandard] ForExportsCoon1October20X8thereceivablesledgerbalanceswere£8,024debitand£57credit, andthepayablesledgerbalancesonthesamedatewere£6,235creditand£105debit.Thesebalances havebeencheckedandarecorrect.
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Fortheyearended30September20X9thefollowingparticularsareavailable. Sales Purchases Cashfromcreditcustomers Cashtocreditsuppliers Discountreceived Discountallowed Irrecoverabledebtswrittenoff Cashreceivedinrespectofdebitbalancesinpayablesledger(refundsfromsuppliers) Amountduefromcustomerasshownbyreceivablesledger,offsetagainstamountdueto thesamefirmasshownbypayablesledger(settlementbycontra)
£ 62,514 39,439 55,212 37,307 1,475 2,328 326 105
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£ 434
Whatarethebalancesasat30September20X9on: (a) Receivablescontrolaccount (b) Payablescontrolaccount? SeeAnswerattheendofthischapter.
2.4 Accountingforwages:thewagescontrolaccount InChapter3welookedatpayrollasabookoforiginalentryforthetotalcostsofemployingandpaying staff.Wenowlookathowpayrollisaccountedforinthenominalledger,andhowthewagescontrol accountisused:
Tomaintaintheaccuracyofpayrolldoubleentry Toidentifyerrorsinpayrolldoubleentry
Workedexample:Ledgeraccountingforpayroll ThepayrolllookedatinChapter3wasasfollows.
Anja Mark Dipak
PAYE £ 550 500 460 1,510
Deductions Ees'NI Ees'pension £ £ 250 150 230 135 210 125 690 410
Net pay
£ 2,050 1,885 1,705 5,640
Gross pay
£ 3,000 2,750 2,500 8,250
Er's NI £ 310 265 230 805
Er's pension £ 200 180 165 545
Total payrollcost £ 3,510 3,195 2,895 9,600
Whenusingthewagescontrolaccounttheobjectiveisthatattheendoftheprocesstheaccount balanceclearstozero:itisaclearingaccount.Thiswillaffirmthatthedoubleentryhasbeenmade correctly,thoughcompensatingerrorscouldstillexist. Thefirststepistoaccountfornetpay.Netpayisgrosspaylessdeductions;wecoulddebititstraightto thenominalledgerwagesexpenseaccount,butinsteadwe'collect'alltheentriesinthewagescontrol account: DEBIT CREDIT
Wagescontrolaccount Cashatbank Paymentofnetpaytostaff
£ 5,640
£ 5,640
Thenextstepistorecordthoseamountswhichwillbepaidtooutsideagenciesonbehalfofemployees. Allemployees'wagesdeductionshavetobepaideventuallytoeitherHMRCorpensiontrustees,soat somepointthesewillneedtobecreditedtoliabilityaccounts–butwherewillthedebitgoto?Again, theanswerisinitiallytothewagescontrolaccount:
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DEBIT CREDIT
Wagescontrolaccount(1,510+690+410) HMRC(1,510+690) Pensiontrustee Deductionsfrompay
£ 2,610
£ 2,200 410
Finally,werecordtheamountswhicharepayabletoexternalagenciesdirectlybytheentity.The employers'NIandpensioncontributionsalsoneedtobecreditedtoliabilityaccounts–butwherewill thedebitgoto?Again,theanswerisinitiallytothewagescontrolaccount: DEBIT CREDIT
Wagescontrolaccount(805+545) HMRC Pensiontrustee Additionalemployercosts
£ 1,350
£ 805 545
Aftertheseentrieshavebeenmadethewagescontrolaccountwilllooklikethis: WAGESCONTROLACCOUNT Cashatbank(netpay) HMRC(PAYE) HMRC(Ees'NIC) Pensiontrustee(Ees'pension) HMRC(Er'sNIC) Pensiontrustee(Er'spension)
£ 5,640 1,510 690 410 805 545 9,600
£ 9,600 9,600
Balance
Thewagescontrolaccountbalancerepresentsthetotalpayrollcosttothebusiness,whichshouldbea debitinitswagesexpenseaccount.Therefore,thefinalentrytobringthewagescontrolaccounttozero is: DEBIT CREDIT
Wagesexpense Wagescontrol Totalpayrollcostsforperiod
£ 9,600
£ 9,600
Wecouldhaveomittedthewagescontrolaccountentirelyandjustdoneonebigjournalasfollows: DEBIT CREDIT
Wagesexpense(grosspay+er'sNIander'spension) Cashatbank(netpay) HMRC(PAYE+ees'NI+er'sNI) Pensiontrustee(ees'ander's) Totalpayrollcostsforperiod
£ 9,600
£ 5,640 3,005 955
Manybusinessesuseawagescontrolaccountsothattheaccuracyoftheinitialpostingscanbeverified beforemakingthefinalpostingtowagesexpense.
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3 Thepurposeofcontrolaccounts Sectionoverview
Controlaccountsduplicateinsummaryformtheindividualentriesinthememorandumledgers: provideacheckontheaccuracyofpostings;helptolocateerrors;provideaninternalcheck;allow atotalbalancetobeextractedquicklyandeasily;keepthenumberofnominalledgeraccountsto aminimum.
Thereceivablesandpayablesledgercontrolaccountsmustbereconciledtothelistofindividual balancesontherelevantmemorandumledger:strikeabalanceonallpersonalaccounts;totalthe balancesinthememorandumledger;comparethistotalwiththecontrolaccountbalance; identifyreasonsforfailuretoagree;preparereconciliationstatement;drawupcorrectingjournals andpost.
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3.1 Whydoweusecontrolaccounts?
Theyhelpchecktheaccuracyofentriesmadeinthepersonalaccounts.Withhundredsofentries tomakeitisveryeasytomakeamistakepostingentries.Figurescangettransposed.Someentries mightbeomittedaltogether,sothataninvoiceorapaymenttransactiondoesnotappearina personalaccountasitshould.Byperforming(i)and(ii)below,itispossibletoidentifythefactthat sucherrorshavebeenmade. (i)
Thereceivablescontrolaccountbalanceiscomparedwiththetotalofindividualbalanceson thepersonalaccountsinthereceivablesledger.
(ii) Thepayablescontrolaccountbalanceiscomparedwiththetotalofindividualbalancesonthe personalaccountsinthepayablesledger.
Theyhelpuslocateerrorsinpostingspromptly.Ifaclerkfailstorecordaninvoiceorapaymentin apersonalaccount,ormakesatranspositionerror,itwouldbedifficulttolocatetheerrororerrors attheendofayear,say,giventhenumberoftransactions.Byusingthecontrolaccountregularly, acomparisonwiththeindividualbalancesinthereceivablesorpayablesledgercanbemadefor everyweekordayofthemonth,andtheerrorfoundmuchmorequicklythanifcontrolaccounts didnotexist.
Theyprovideaninternalcheckwherethereisaseparationofclerical(bookkeeping)duties.The personpostingentriestothecontrolaccountswillactasacheckonthedifferentperson(s)whose jobitistopostentriestothereceivablesandpayablesledgeraccounts.
Theyprovidetotalreceivablesandpayablesbalancesmorequicklyforproducingatrialbalance orstatementoffinancialposition.Asinglebalanceonacontrolaccountisextractedmoresimply andquicklythanindividualbalancesinthereceivablesorpayablesledger.
Theykeepthenumberofaccountsinthetrialbalancedowntoamanageablesize,sincethe personalaccountsarememorandumaccountsonly.
Incomputerisedsystemsreceivablesandpayablesledgersareoftenusedwithoutseparatecontrol accounts.Insuchsystems,thereceivablesorpayablesledgerprintoutsproducedbythecomputer constitutethelistofindividualbalancesaswellasprovidingthetotalcontrolaccountbalance. Unlesstoldotherwiseintheexam,youshouldassumethatacontrolaccountispartofthe nominalledger,withindividualpersonalaccountskeptinmemorandumledgers.
3.2 Balancingandagreeingcontrolaccountswiththememorandumledgers Thecontrolaccountsshouldbebalancedregularlyandthebalanceagreedwiththesumofthe individualcustomers'orsuppliers'balancesextractedfromthereceivablesorpayablesledgers respectively. Thebalanceonthecontrolaccountmaynotagreewiththesumofbalancesextracted,foroneormore ofthefollowingreasons.
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Thetotalcolumninthebookoforiginalentrymaybemiscastsoanincorrectamountis postedtothecontrolaccount(ieaddingupincorrectlythetotalvalueofinvoices,receiptsor payments). Effect: –
Thenominalledgerdebitandcreditpostingswillbalance,asbothnominalledgeraccounts willbeincorrect.
–
Thecontrolaccountbalancewillnotagreewiththe(correct)sumofindividualbalances extractedfromthereceivablesledgerorpayablesledger.
Correction: –
Ajournalentrymustbemadeinthenominalledgertocorrectthecontrolaccountandthe correspondingsales/VATorexpense/VATaccounts.
Anincorrectamountmaybepostedtoanindividual'spersonalaccountfromthebookoforiginal entrytothememorandumledger,egasaletoCCloningof£250mightbepostedtohisaccount as£520. Effect: –
Thenominalledgerwouldnotbeaffected,as£250wouldbecorrectlyincludedinthetotalof thesalesdaybookandposted.
–
Thereceivablesledgerwouldbeincorrect,sinceitcontainsatranspositionerrorinrecording £250as£520.Itistoohigh.
–
Thetwowouldnotagree.
Correction: –
Thesumofthememorandumledgerbalancesmustbecorrected,sointhiscasethetotalwill decreaseby£270.Noentryinthenominalledgerisrequired.
Atransactionmayberecordedinthecontrolaccountandnotinthememorandumledger,or viceversa.Thisrequiresanentryintheledgerthathasbeenmissedout,whichmeansadouble entrypostingifthecontrolaccounthastobecorrected,andasingleentryifitistheindividual's personalaccountinthememorandumledgerthatisatfault.
Thelistofbalancesextractedfromthememorandumledgermaybeincorrectlyextractedor miscast.Thiswouldinvolvesimplycorrectingthetotalofthebalances.
Workedexample:Agreeingcontrolaccountbalancewiththeledger Reconcilingthecontrolaccountbalancewiththesumofthebalancesextractedfromthereceivables ledgershouldbedoneintwostages,thoughthesestagescanbecompletedsimultaneously. (1) Correctthetotalofthebalancesextractedfromthememorandumledger.(Theerrorsmustbe locatedfirstofcourse.) Receivablesledgertotal Originaltotalextracted Adddifferencearisingfromtranspositionerroron SDBpostingofinvoice(£95writtenas£59) Less Creditbalanceof£60extractedasadebitbalance(£60×2) Overcastoflistofbalances
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£ 120 90
£ 15,320 36 15,356 (210) 15,146
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(2) Bringdownthebalanceonthecontrolaccount,andadjustorposttheaccountwithcorrecting entries. RECEIVABLESCONTROLACCOUNT Balancebeforeadjustments Undercastoftotalinvoicesissued insalesdaybook
£ 15,091 100 15,191
£ Cashbook:postingomitted 10 Creditnote:IndividualpostingfromSDB omittedfromcontrolaccount 35 Balancec/d(nowinagreement withthecorrectedtotalof individualbalancesin(1)) 15,146 15,191
Balanceb/d
15,146
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Interactivequestion4:Receivablescontrolaccount
[Difficultylevel:Intermediate]
AprilShowerssellsgoodsoncredittomostofitscustomersandmaintainsareceivablescontrolaccount. Fortheyearto30October20X3theaccountantdiscoversthatthetotalofallpersonalaccountsinthe receivablesledgeris£12,802,whereasthereceivablescontrolaccountbalanceis£12,550. Thefollowingerrorsarediscovered. (a) Salesfortheweekending27March20X3amountingto£850hadbeenomittedfromthecontrol account. (b) Acustomer'sdebitbalanceof£300hadnotbeenincludedinthelistofbalances. (c) Cashreceivedof£750hadbeenenteredinapersonalaccountas£570. (d) Discountallowedtotalling£100hadnotbeenenteredinthecontrolaccount. (e) Apersonalaccountdebitbalancehadbeenundercastby£200. (f) Acontraitemof£400withthepayablesledgerhadnotbeenenteredinthecontrolaccount. (g) Anirrecoverabledebtof£500hadnotbeenenteredinthecontrolaccount. (h) Cashreceivedof£250hadbeendebitedtoapersonalaccount. (i)
Discountsreceivedof£50hadbeendebitedtoBell'sreceivablesledgeraccount.
(j)
ACreditnotefor£200hadbeenomittedfromthecastingofthesalesdaybook.
(k) Cashreceivedof£80hadbeencreditedtoapersonalaccountas£8. (l)
Achequefor£300receivedfromacustomerandenteredinthecontrolaccountandpersonal accounthadbeendishonouredbythebank,butnoadjustmenthadbeenmadeinthecontrol account.
Requirements (a) Prepareacorrectedreceivablescontrolaccount,bringingdowntheamendedbalanceasat1 November20X3. (b) Prepareastatementshowingtheadjustmentsthatarenecessarytothelistofpersonalaccount balancessothatitreconcileswiththeamendedreceivablescontrolaccountbalance. SeeAnswerattheendofthischapter.
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4 Thecashatbankaccount,thecashbookandthebank statement Sectionoverview
Thecashatbankaccountinthenominalledgeristhecontrolaccountforthecashbook,although oftentheyareoneandthesame.
Thecashatbankaccount,thecashbookandthebankstatementallreflecttransactionsthrough thebusiness'sbankaccount.
Inmanybusinesses,thecashbook(comprisingbothreceiptsandpayments)actsasboththebookof originalentryforalltransactionsaffectingthebankaccount,andasthenominalledgeraccountforcash atbank. Wherethereisaseparatecashatbankaccountinthenominalledger,makingsurethatitsbalanceat theendofaperiodagreeswiththebalancecarrieddownonthecashbookatthesametimeisauseful accuracyandcompletioncheck. Inthecaseofcashatbank,thereisanotherimportantcontrolcheck:agreeingthecashbookbalance inthebusiness'sledgeraccountswiththebalancereportedtoitbythebankstatement.
4.1 Thecashbookandthecashatbankaccount SofarinthisStudyManualwehaveseenthat:
Thecashbookisthebookoforiginalentryforalltransactionsrelatedtothecompany'sbank account.
Thecashatbankaccountisthenominalledgeraccount(partofthedoubleentrysystem)thatis thepermanentrecordofthebusiness'sbanktransactions.
Insomeaccountingsystemsthecashatbankaccountispostedonlymonthlyorsofromthecashbook, withtotals: DR CR
Cashatbank(withcash received) Cashatbank(withcashpaid)
CR
Correspondingincome,asset,liabilityandcapital accounts DR Correspondingexpense,asset,liabilityandcapital accounts
Oncethesepostingshavebeenmadethebusinesscanbesurethatitsnominalledgeraccountsareup todate,butinpracticethereisalotofworkinvolvedingettingthecashbookrightbeforethepostings canbemade.Thisisbecausethecashbookisessentiallyarecordofwhatgoesoninthebusiness'sbank account,andtherearequiteoftendiscrepanciesthatneedtoberesolved,withthehelpofthebank statement. Inpractice,itiscommonforthecashbooktobetreatedasaledgeraccountinthatbalancesare regularlyextracted.Thebusinessalwayswantstoknowitscashbalance,asthisisavitalasset.
4.2 Thebankstatement Definition Bankstatement:Arecordoftransactionsonthebusiness'sbankaccountmaintainedbythebankinits ownbooks.
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4.2.1 Mirrorimageofthecashbook Thebankstatementisthemirrorimageofthecashbook:
Cashisanasset(adebitbalance)inthebusiness'sledgeraccounts.Asfarasthebankisconcerned itowesthebusinessmoney.Thuseveryitemrecordedasadebitinthebusiness'sbooks–a positivebankbalance,andanyreceiptsofcash–willbeshownasacreditonthebank statement.
Whencashisaliability(acreditbalance)inthebusiness'sbooks,asfarasthebankisconcernedit isowedmoney.Thuseverycreditentryinthebusiness'sbooks–anegativebankbalance,and anypaymentsofcash–willbeshownasadebitonthebankstatement.
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6
4.2.2 Disagreementwiththecashbook Itisrareforthebalanceasshownonthebankstatementtobethesameasthatonthecashbook. Therearefivecommonexplanationsfordifferencesbetweencashbookandbankstatement.
Error.Errorsincalculation,orrecordingrevenueandpayments,mayhavebeenmadeinthe businesscashbook,bythebank,orbyboth.
Unrecordedbankchargesorbankinterest.Thebankmightchargeinterestormakechargesfor itsservices,whichthecustomerisnotinformedaboutandsocannotrecorduntilthebank statementisreceived.
Automatedpaymentsandreceipts.Paymentsprocessedautomaticallybythebankingsystem (directdebitsandstandingorders),andreceiptsprocessedautomatically,maybeshownonthe bankstatement,butnotyetrecordedinthecashbook.
Dishonouredcheques.Whenacustomersendsinachequeanditisbanked,thebusinessdebits thecashbook.However,itmaybereturnedunpaidor'dishonoured'bythecustomer'sbank, usuallybecausethecustomerhasinsufficientfunds.Thedishonourofthechequewillappearon thebankstatementandwillneedtobe'writtenback'intheledgeraccounts: DEBIT CREDIT
Receivables Cashatbank
£X £X
Timingdifferences –
Theremaybesomechequesreceived,recordedinthecashbookandpaidintothebank,but whichhavenotyetbeen'cleared'(paidbythebank)andaddedtotheaccountbythebank. Soalthoughthebusiness'srecordsshowthatsomecashhasbeenaddedtotheaccount,ithas notyetbeenacknowledgedbythebank–althoughitwillbesoon,oncethechequehas cleared.
–
Similarly,thebusinessmighthavemadesomepaymentsbycheque,andreducedthe balanceinthecashbookaccordingly,butthepersonwhoreceivesthechequemightnot bankitforawhile.Evenwhenitisbanked,ittakesadayortwoforthebanktoprocessitand forthemoneytobedeductedfromtheaccount.
Allthesedifferencesneedtobeidentifiedanderadicated,usingthebankreconciliationprocess.
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5 Thebankreconciliation Sectionoverview
Thecashbookneedstoberegularlyreconciledtothebankstatement.
Thecashbookandbankstatementusuallyfailtoagreebecauseof:errorsinthecashbookorby thebank;bankchargesandinterestnotenteredinthecashbook;automatedpaymentsand receiptsnotenteredinthecashbook;customers'chequesdishonouredorreturnedunpaidbythe bank,notenteredinthecashbook;timingdifferencesbetweenthecashbookandthebank statement(thecashbookisusuallymoreup-to-date:unpresentedchequesanduncredited lodgements).
Oftencorrectingoradditionalentriesareneededinthecashbookasaresultofthebank reconciliation;thebankstatementthenagrees/reconcileswiththecorrectedcashbookbalance oncetimingdifferencesaretakenintoaccount.
Definition Bankreconciliation:Acomparisonofabankstatement(sentmonthly,weeklyorevendailybythe bank)withthecashbook.Differencesbetweenthebalanceonthebankstatementandthebalancein thecashbookshouldbeidentifiedandsatisfactorilyreconciled. Whendoingabankreconciliation,youwillhavetolookforthefollowingitemsonthebankstatement andinthecashbook. (a) Errorsinthecashbook,suchastranspositionerrors(egwriting£36and£63)orchequessentout butomittedfromthecashbook.Thecorrectamountappearsonthebankstatementandthecash bookmustbeupdated. (b) Correctionsandadjustmentstothecashbook (i)
Paymentsmadeintoorfromthebankaccountbywayofdebitcard,standingorder,direct debitoronlinetransferwhichhavenotyetbeenenteredinthecashbook.
(ii) Bankinterestandbankcharges,notyetenteredinthecashbook. (iii) Dishonouredchequesnotyetenteredinthecashbook. (c) Errorsinthebankstatement,suchastranspositionerrors,paymentsorreceiptsrecordedtwiceor interestandfeesdeductedincorrectly.Thecorrectamountappearsinthecashbookandthe balanceperthebankstatementmustbecorrected. (d) Itemsreconcilingthecorrectcashbookbalancetothebankstatement(timingdifferences) (i)
Chequespaidoutbythebusinessandcreditedinthecashbookwhichhavenotyetbeen presentedtothebank,or'cleared',andsodonotyetappearonthebankstatement.These areknownas'unpresentedcheques'.
(ii) Chequesreceivedbythebusiness,paidintothebankanddebitedinthecashbook,but whichhavenotyetbeenclearedandenteredinthebankaccount,andsodonotyetappear onthebankstatement.Theseareknownas'unclearedlodgements'.
Workedexample:BankreconciliationI At30September20X6,thebalanceinWordsworthCo'scashbookwas£805.15debit.Abank statementon30September20X6showedWordsworthCotobeincreditatthebankby£1,112.30.
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Oninvestigationofthedifference,itwasestablishedthat:
Weneedtoshowthecorrectiontothecashbook,thenprepareastatementreconcilingthebalanceper thebankstatementtothebalanceperthecashbook.
C H A P T E R
Solution
6
(a) Thecashbookhadbeenundercastby£90.00onthedebitside. (b) Chequespaidinbutnotyetcreditedbythebankwere£208.20. (c) Chequesdrawnnotyetpresentedtothebankwere£425.35.
(a) £ 805.15 90.00 895.15
Cashbookbalancebroughtforward Add Correctionofundercast Correctedcashbookbalance (b)
£ 1,112.30 208.20 1,320.50 (425.35) 895.15
Balanceperbankstatement Add Unclearedlodgements Less Unpresentedcheques Balancepercorrectedcashbook
Workedexample:BankreconciliationII Athisyearendof30June20X0,Cook'scashbookshowedthathehadanoverdraftof£300onhis currentaccountatthebank.Abankstatementasat30June20X0showedthatCookhasanoverdraftof £35. Oncheckingthecashbookandthebankstatementyoufindthefollowing. (a) Chequesdrawn,amountingto£500,hadbeenenteredinthecashbookbuthadnotyetbeen presented. (b) Chequesreceived,amountingto£400,hadbeenenteredinthecashbook,buthadnotyetbeen creditedbythebank. (c) OninstructionsfromCookon30June20X0thebankhadtransferred£60interestreceivedonhis savingsaccounttohiscurrentaccount,butitonlyrecordedthetransferon5July20X0.This amountwascreditedinthecashbookon30June20X0. (d) Bankchargesof£35showninthebankstatementhadnotbeenenteredinthecashbook. (e) Thepaymentssideofthecashbookhadbeenundercastby£10. (f) Dividendsreceivedof£200hadbeenpaiddirectintothebankandnotenteredinthecashbook. (g) Achequefor£50fromSunilwasrecordedandbankedon24June.Thiswasreturnedunpaidon30 Juneandthenshownasadebitonthebankstatement.Noentryhasbeenmadeinthecashbook fortheunpaidcheque. (h) AchequeissuedtoJonesfor£25wasreplacedwhenitwasmorethansixmonthsold,atwhich timeithadbecome'outofdate'andthebankwouldhaverefusedtopayit.Itwasenteredagainin thecashbook,nootherentrybeingmade.Bothchequeswereincludedinthetotalofunpresented chequesshownabove. Weneedtomaketheappropriateadjustmentsinthecashbook,thenprepareastatementreconciling theamendedbalancewiththatshowninthebankstatement.
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Solution Theerrorstocorrectinthecashbookaregiveninnotes(c),(e),(f),(g)and(h)oftheproblem.Bank charges(note(d))alsocallforanadjustment. Item(c)israthercomplicated.Thetransferofinterestfromthedeposittothecurrentaccountwasgiven asaninstructiontothebankon30June20X0,probablybecausethatisCook'syearendandhewants tomakesurethatalltransactionsarerecorded.Sincethecorrectentryshouldhavebeentodebitthe currentaccount(andcreditthedepositaccount)thecorrectioninthecashbookshouldbetodebitthe currentaccountwith2£60=£120–ietocancelouttheincorrectcreditentryinthecashbook,and thentomakethecorrectdebitentry.However,thebankdoesnotrecordthetransferuntil5July,andso itwillnotappearinthebankstatement. Item(h)alsorequiresexplanation.TwochequeshavebeenpaidtoJones,butoneisnowcancelled. Sincethecashbookiscreditedwheneverachequeispaid,itshouldbedebitedwheneverachequeis cancelled.Theamountofunpresentedchequesshouldbereducedbytheamountofthecancelled cheque. CASHBOOK 20X0 Jun30
Savingsinterest602(c) Dividendspaiddirect tobank(f) ChequeissuedtoJones cancelled(h) Balancec/d
£ 120 200 25 50 395
20X0 Jun30
Balanceb/d Bankcharges(d) Correctionofundercast(e) Dishonouredcheque(g)
£ 300 35 10 50 395
BANKRECONCILIATIONSTATEMENTAT30JUNE20X0 £ 400 60 500 (25)
Balanceperbankstatement Add Outstandinglodgements Savingsinterestnotyetcredited Less Unpresentedcheques LesschequetoJonescancelled Balancepercorrectedcashbook
£ (35) 460 425 (475) (50)
Inabankreconciliationyoushouldbeginwiththebalanceshownbythebankstatementandendwith thebalanceshownbythecorrectedcashbook.Thiscorrectedcashbookbalancewillappearinthe statementoffinancialpositionas'cashatbank'. Inansweringanexamquestionhowever,youshouldexpecttoworktheotherwayroundon occasion.
Interactivequestion5:BankreconciliationI
[Difficultylevel:Examstandard]
Abankreconciliationstatementisbeingprepared.Usingthetableselecttheeffectofeachofthe followingontheclosingbalanceshownbythebankstatementof£388inhand.(Theclosingbalance shownbythecashbookis£106inhand.)Tickoneboxforeachfinding.
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A
Increase
Decrease
Noeffect
Thebankhasmadeamistakeincreditingtheaccount with£110belongingtoanothercustomer–anerror notyetrectified.
B
£120receivedbythebankunderastandingorder arrangementhasnotbeenenteredinthecashbook.
C
Chequestotalling£5,629havebeendrawn,entered inthecashbookandsentouttosuppliersbutthey havenotbeenpresentedforpayment.
Chequestotalling£5,577havebeenreceivedand enteredinthecashbookbutnotyetcreditedinthe bankstatements.
D
C H A P T E R
6
SeeAnswerattheendofthischapter.
Interactivequestion6:BankreconciliationII
[Difficultylevel:Examstandard]
Tilfer'sbankstatementshows£715directdebitsand£353investmentincomenotrecordedinthecash book.Thebankstatementdoesnotshowacustomer'schequefor£875enteredinthecashbookonthe lastdayofthereportingperiod.Thecashbookhasacreditbalanceof£610. Whatbalanceappearsonthebankstatement? SeeAnswerattheendofthischapter.
6 Typesoferrorinaccounting Sectionoverview
Errorscanbeclassifiedas:errorsofcommissionoromission,compensatingerrors,errorsof principleandtranspositionerrors.
Manyerrorsintheledgeraccountsaredetectedduringthecontrolaccountreconciliationand bankreconciliationprocesses.
Therearefivebroadtypesoferrorasfollows.
Transpositionerrors Errorsofomission Errorsofprinciple Errorsofcommission Compensatingerrors
Onceanerrorhasbeendetected,itneedstobeputright.
Ifthecorrectioninvolvesadoubleentryinthenominalledgeraccounts,thenitisrecordedviaan entryinthejournal.
Whentheerrorbreakstheruleofdoubleentry,thenitiscorrectedviaajournalentryusinga suspenseaccounttocompletethedoubleentry.
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6.1 Transpositionerrors Definition Transpositionerrors:Whentwodigitsinanamountareaccidentallyrecordedthewrongwayround.
Asaleiscreditedinthesalesaccountas£6,843,buthasbeenincorrectlydebitedinthereceivables controlaccountas£6,483.Inconsequencetotaldebitswillnotequaltototalcredits:creditswill exceeddebitsby6,843–6,483=360.Youcanoftendetectatranspositionerrorbychecking whetherthedifferencebetweendebitsandcreditscanbedividedexactlyby9(£360÷9=£40).
6.2 Errorsofomission Definition Errorofomission:Failingtorecordatransactionatall,ormakingadebitorcreditentry,butnotthe correspondingdoubleentry.
Abusinessreceivesaninvoicefromasupplierfor£250,andthetransactionisomittedfromthe books.Asaresult,bothtotaldebitsandcreditswillbewrongby£250.
Abusinessreceivesaninvoicefromasupplierfor£300,thepayablescontrolaccountiscredited butnodebitentryismade.Inthiscase,thetotalcreditswouldnotequaltotaldebits(becausetotal debitsare£300lessthantheyoughttobe).
6.3 Errorsofprinciple Definition Errorofprinciple:Makingadoubleentryinthebeliefthatthetransactionisbeingenteredinthe correctaccounts,butsubsequentlyfindingoutthattheaccountingentrybreaksthe'rules'ofan accountingprincipleorconcept.Atypicalexampleofsuchanerroristotreatrevenueexpenditure incorrectlyascapitalexpenditure.
Machinerepairscosting£150(whichshouldbetreatedasrevenueexpenditure)aredebitedtothe costofanon-currentasset(capitalexpenditure).Althoughtotaldebitsstillequaltotalcredits,the repairsaccountis£150understatedandthecostofthenon-currentassetis£150overstated.
Abusinessownertakes£280cashoutofthetillforhispersonaluse.Thebookkeeperincorrectly debitssalesby£280,whentheyshouldhavedebiteddrawings.Thisisanerrorofprinciple,sothat drawingsandsalesarebothunderstatedby£280.
6.4 Errorsofcommission Definition Errorofcommission:Amistakeismadeinrecordingtransactionsintheledgeraccounts.
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Puttingadebitentryoracreditentryinthewrongaccount.Telephoneexpensesof£540are debitedtotheelectricityexpenseaccount,anerrorofcommission.Althoughtotaldebitsand creditsbalance,telephoneexpensesareunderstatedby£540andelectricityexpenseisoverstated bythesameamount.
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Castingerrors(addingup).Dailycreditsalesinthesalesdaybookof£28,425areincorrectly addedup('miscast')as£28,825.Thisamountiscreditedtosalesanddebitedtoreceivables control.Althoughtotaldebitsandtotalcreditsarestillequal,thenominalledgerisincorrectby £400.Notethatifthecorrectindividualentriesaremadeinthereceivablesledger,thetotalonthe listofbalanceswillberight,butitwillnotagreewiththereceivablescontrolaccountbalance.
6.5 Compensatingerrors
C H A P T E R
6
Definition Compensatingerrors:Errorswhichare,coincidentally,equalandoppositetooneanother. Compensatingerrorshidetrialbalanceerrors.
Administrativeexpensesof£2,822areenteredas£2,282intheadministrativeexpensesledger account.Atthesametime,incomeof£8,931isshowninthesalesaccountas£8,391.Bothdebits andcreditsare£540toolow,andthemistakewouldnotbeapparentwhenthetrialbalanceis cast.
7 Correctingerrors Sectionoverview
Errorswhichhavenotcausedanimbalancearecorrectedviajournals.
Errorswhichhavebrokentherulesofdoubleentrybookkeepingandresultinthetrialbalance failingtobalancecanbecorrectedby(1)settingupasuspenseaccountandthen(2)clearingit withcorrectingjournals.
Asuspenseaccountmayalsobedeliberatelysetupwhenabookkeeperdoesnotknowwhereto putonesideofanentry.
Suspenseaccountsarealwaystemporaryandshouldneverappearinfinancialstatements;these shouldnotbeprepareduntiltheerrorshavebeencorrectedandthesuspenseaccounthasbeen cleared.
Somecorrectionsoferrorswillresultinadjustmentstoadraftprofitcalculatedwhiletherewere stillerrorsintheaccounts.
Errorswhichleavetotaldebitsandcreditsintheledgeraccountsinbalancecanbecorrectedjustusing journalentries. Whereerrorsmeanthatthetrialbalancedoesnotbalance,asuspenseaccounthastobeopenedfirst, laterclearedbyajournalentry.
7.1 Journalentries Thejournalrequiresadebitandanequalcreditentryforeachcorrection.
Iftotaldebitsequaltotalcreditsbeforeajournalentryismadethentheywillstillbeequalafterthe journalentryismade,aswouldbethecaseif,forexample,theoriginalerrorwasadebitwrongly postedasacreditandviceversa.
Iftotaldebitsandtotalcreditsareunequalbeforeajournalentryismade,thentheywillstillbe unequal(bythesameamount)afteritismade.
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Workedexample:Correctingerrorswithjournalentries Abookkeeperaccidentallypostsaninvoicefor£40tothelocalpropertytaxesaccountinsteadoftothe electricityaccount.Atrialbalanceisdrawnup.Totaldebitsare£40,000andtotalcreditsare£40,000.A journalentryismadetocorrectthemispostingerrorasfollows. DEBIT CREDIT
Electricityaccount Localpropertytaxesaccount
£40
£40
Tocorrectamispostingof£40fromthelocalpropertytaxesaccounttoelectricityaccount Afterthejournalhasbeenposted,totaldebitsandcreditswillstillbeequalat£40,000. Nowsupposethat,becauseofsomeerrorwhichhasnotyetbeendetected,totaldebitswereoriginally £40,000buttotalcreditswere£39,900.Ifthesamejournalcorrectingthe£40isputthrough,total debitswillremain£40,000andtotalcreditswillremain£39,900.Totaldebitsweredifferentby£100 beforethejournal,andtheyarestilldifferentby£100afterthejournal. Thismeansthatjournalsalonecanonlybeusedtocorrecterrorswhichrequirebothacreditand (anequal)debitadjustment. Inaquestionwhichrequiresa'correctingjournal'
Workoutfirstwhattheoriginalentrywas Thenwhattheoriginalentryshouldhavebeen Andfinallywhatthecorrectingentryshouldbe
Interactivequestion7:Journalentries
[Difficultylevel:Intermediate]
Writeoutthejournalentrieswhichwouldcorrecttheseerrors. (a) Abusinessreceivesaninvoicefor£250fromasupplierwhichwasomittedfromthebooksentirely. (b) Repairsworth£150wereincorrectlydebitedtothenon-currentasset(machinery)accountinstead oftherepairsaccount. (c) Thebookkeeperofabusinessreducescashsalesby£280becausehewasnotsurewhatthe£280 represented.Infact,itwasdrawings. (d) Telephoneexpensesof£540areincorrectlydebitedtotheelectricityaccount. (e) Apageinthesalesdaybookhasbeenaddedupto£28,425insteadof£28,825. SeeAnswerattheendofthischapter.
7.2 Suspenseaccounts Definition Suspenseaccount:Anaccountshowingabalanceequaltothedifferenceinatrialbalance. Asuspenseaccountisatemporaryaccountwhichcanbeopenedforthefollowingreasons.
Atrialbalanceisdrawnupwhichdoesnotbalance(ietotaldebitsdonotequaltotalcredits).
Thebookkeeperofabusinessknowswheretopostonesideofatransaction,butdoesnotknow wheretoposttheotherside.Forexample,acashpaymentmustobviouslybecreditedtocash, butthebookkeepermaynotknowwhatthepaymentisfor,andsowillnotknowwhichaccountto debit.Tocompletethedoubleentry,hedebitssuspense.
Inboththesecases,asuspenseaccountisopenedupuntiltheproblemisresolved.
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7.3 Usingasuspenseaccountwhenthetrialbalancedoesnotbalance Whenanerrorhasoccurredwhichresultsinanimbalancebetweentotaldebitsandtotalcreditsinthe ledgeraccounts:
Step1 Openasuspenseaccountwiththeamountoftheimbalance
C H A P T E R
Step2 Useajournalentrytoclearthesuspenseaccountandcorrecttheerror.Itisgoodpracticeforthe correctingsideofthedoubleentrytoappearfirstinthejournal,thenthesuspenseaccountentry.
6
Workedexample:Suspenseaccount Anaccountantdrawsupatrialbalanceandfindsthattotaldebitsexceedtotalcreditsby£162. Heknowsthatthereisanerrorsomewhere,butforthetimebeingheopensasuspenseaccountwitha creditbalanceof£162.Thisservestwopurposes.
Asthesuspenseaccountnowexists,theaccountantwillnotforgetthatthereisanerror(of£162) tobesortedout.
Nowthatthereisacreditof£162inthesuspenseaccount,thetrialbalancebalances.
Whenthecauseofthe£162discrepancyistrackeddown,itiscorrectedbymeansofajournalentry. Supposetheerrorwasanomittedcreditof£162tothepurchasesaccount.Thecorrectingjournalentry is: CREDIT Purchases DEBIT Suspensea/c Tocloseoffsuspensea/candcorrecterrorofomission
£162
£162
Workedexample:Suspenseaccountandtranspositionerror Insteadofenteringthecorrectamountof£37,453inthesalesaccount,abookkeeperentered£37,543 Tradereceivableswerepostedcorrectly,soonthetrialbalancecreditsexceededdebitsby £(37,543–37,453)=£90.
Step1 Equalisethetotaldebitsandcreditsbypostingadebitof£90tothesuspenseaccount.
Step2 Correctingjournalentry:salesneedtobereduced,andthesuspenseaccountneedstobecleared. DEBIT CREDIT
Sales Suspensea/c
£90
£90
Tocloseoffsuspensea/candcorrecttranspositionerror
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Workedexample:Errorofomission Achequepaymentof£250wascorrectlycreditedtothecashaccount,butthebookkeeperomittedto debittheexpenseaccount.Onthetrialbalance,creditsexceededdebitsby£250.
Step1 Debit£250tothesuspenseaccount,toequalisethetotaldebitsandtotalcredits.
Step2 Correctingjournalentry:expensesneedtobeincreased,andthesuspenseaccountcleared. DEBIT CREDIT
Expenseaccount Suspensea/c
£250
£250
Tocloseoffsuspensea/candcorrecterrorofomission
Workedexample:Errorofcommission Achequereceivedfor£460isdebitedtocashbutalsodebitedtoreceivablescontrol,insteadofbeing credited. Thetotaldebitbalancesnowexceedthetotalcreditsby2£460=£920.
Step1 Makeacreditentryof£920inasuspenseaccount,toequalisedebitsandcredits.
Step2 Correctingjournalentry:decreasetradereceivables,andclearthesuspenseaccount. CREDIT DEBIT
Tradereceivables Suspensea/c
£920
£920
Tocloseoffsuspensea/candcorrecterrorofcommission
7.4 Usingasuspenseaccounttocompletethedoubleentry Whenabookkeeperdoesnotknowwheretopostonesideofatransaction,itcanbetemporarily recordedinasuspenseaccount.Atypicalexampleiswhenthebusinessreceivescashthroughthepost fromasourcewhichcannotbedetermined.Thedoubleentryintheaccountswouldbeadebitinthe cashbook,andacredittoasuspenseaccount.
Workedexample:Notknowingwheretopostatransaction WindfallGarmentsbanksachequefor£620fromRJBeasley.Thebusinesshasnoideawhothisperson is,norwhyheshouldbesending£620.Thebookkeeperopensasuspenseaccount: DEBIT CREDIT
Cash Suspensea/c
£620
£620
IttranspiresthatthechequewasinpaymentforadebtowedbytheHauteCoutureCornerShopand paidoutoftheowner'spersonalbankaccount.Thesuspenseaccountcannowbecleared,asfollows. CREDIT DEBIT
Tradereceivables Suspensea/c
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7.5 Suspenseaccountsmightcontainseveralitems Allerrorsandunidentifiablepostingsinareportingperiodaremergedtogetherinthesuspense account;untilthecauseofeacherrorisdiscovered,thebookkeeperisunlikelytoknowexactlyhow manyerrorsthereare. Anexamquestionmightgiveyouasuspenseaccountbalance,togetherwithinformationtomake correctionswhichwillleaveanilbalanceonthesuspenseaccountandcorrectbalancesonthe nominalledgeraccounts.
C H A P T E R
6
7.6 Suspenseaccountsaretemporary Itmustbestressedthatasuspenseaccountshouldonlybetemporary.Postingstoasuspenseaccount areonlymadewhenthebookkeeperdoesn'tknowyetwhattodo,orwhenanerrorhasoccurred. Thereshouldbenosuspenseaccountwhenitcomestopreparingthestatementofprofitorloss andstatementoffinancialposition.Thesuspenseaccountshouldbeclearedandallcorrecting entriesmadebeforethefinalfinancialstatementsaredrawnup.
7.7 Adjustmentofprofitsforerrors Correctingerrorscanaffecteitherthestatementoffinancialposition,thestatementofprofitorloss,or sometimesboth.Anerrorofomissioncorrectedbydebitingsalesandcreditingsuspensewith£90 meantthatsalesdecreased,sogrossprofitwasreducedby£90asaresultoftheerrorbeingcorrected. Iftherearestillerrorstobecorrectedafterthetrialbalanceandinitialstatementofprofitorlossand statementoffinancialpositionhavebeenprepared,thencorrectionswillalterthosedraftfinancial statements. Youmayneedtodemonstratehowdraftfinancialstatementsareaffectedbyerrorcorrectionsby calculating:
Howmuchgrossornetprofitisincreasedorreducedasaresultoferrorcorrection Thefinalgrossornetprofitaftertheerrorcorrection
Interactivequestion8:Errors
[Difficultylevel:Examstandard]
AtTDown&Coyearend,thetrialbalancecontainedasuspenseaccountwithacreditbalanceof £1,040. Investigationsrevealedthefollowingerrors. (i)
Asaleofgoodsoncreditfor£1,000hadbeenomittedfromthesalesaccount.
(ii) Deliveryandinstallationcostsof£240onanewitemofplanthadbeenrecordedasrevenue expenditureinthedistributioncostsaccount. (iii) Cashdiscountof£150hadbeentakenonpayingasupplier,JW,eventhoughthepaymentwas madeoutsidethetimelimit.JWisinsistingthat£150isstillpayable. (iv) Arawmaterialspurchaseof£350hadbeenrecordedinthepurchasesaccountas£850,butthe tradepayablesaccountwascorrectlywrittenup. (v) Thepurchasesdaybookincludedacreditnotefor£230asaninvoiceinthetotalcolumn.The correctentrywasmadeinthepurchasesaccount. Requirements (a) Preparejournalentriestocorrecteachoftheaboveerrors.Narrativesarenotrequired. (b) Openasuspenseaccountandshowthecorrectionstobemade. (c) Beforetheerrorswerecorrected,TDown&Co'sgrossprofitwascalculatedat£35,750andthe netprofitfortheyearat£18,500.Calculatetherevisedgrossandnetprofitfiguresaftercorrection oftheerrors. SeeAnswerattheendofthischapter.
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8 CorrectingerrorsviatheETB Sectionoverview
Thejournalswhichcorrecterrorsandmakeotheradjustmentscanbeputthroughthe adjustmentscolumnsoftheextendedtrialbalance.
InChapter5wesawhowanextendedtrialbalancemadethepreparationofthestatementofprofitor lossandstatementoffinancialpositioneasierandmoreclear-cut.TheETBisalsousefulwhenrecording correctingjournalsmadeatthefinalstagesofpreparingfinancialstatements,aftertheinitialtrial balancehasbeenprepared.Thisisespeciallythecasewhereasuspenseaccounthadtobeusedtomake thetrialbalanceagree. AswellasdebitandcreditcolumnsfortheTB,thestatementofprofitorlossandthestatementof financialposition,inafullETBweincludedebitandcreditcolumnsforadjustmentsbetweentheTBand thestatementofprofitorloss;wedon'tbotherwitharevisedTB,asweinitiallyusedinChapter5. Insteadtheentriesintheadjustmentcolumnsjustgetincludedinthecross-castingtothestatementof profitorlossandstatementoffinancialpositioncolumns.
Workedexample:ErrorcorrectionontheETB Handleextractedatrialbalanceandcreatedasuspenseaccount.HeinsertedtheTBonhisextended trialbalanceasfollows: Ledgerbalance Cashatbank Openingcapital Loan Non-currentassets Tradepayables Expenses Purchases Sales Tradereceivables Suspense Drawings Netprofit
Trialbalance Debit Credit £ £ 5,415 10,000 5,000 30,000 18,689 6,781 21,569 38,974 9,445 6,400 5,853 79,063 79,063
Adjustments Debit Credit £ £
Statementof profitorloss Debit Credit £ £
Statementof financialposition Debit Credit £ £
Handlehasnowdiscoveredthefollowingmatters: (a) Anamountof£1,000wascreditedonthebankstatementintheyearandenteredinthecash book,butnootherentrywasmadeasthebookkeeperdidnotknowwhatthereceiptwasin respectof.Handletellsyouitwasapaymentonaccountfromamajorcustomer. (b) Anon-currentassetwaspurchasedoncreditjustbeforetheyearend,for£9,300.Thiswas incorrectlyenteredinthetradepayablesaccountviaajournalas£3,900,butthecorrectentrywas madeinnon-currentassets. TocorrecttheseerrorsHandleusesthefollowingjournals: (a) (b)
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CREDIT DEBIT CREDIT DEBIT
Tradereceivables Suspense Tradepayables Suspense
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£ 1,000 5,400
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TheseareenteredintheadjustmentscolumnsoftheETB,whichisthencross-casttoproduceHandle's statementofprofitorlossandstatementoffinancialposition: Ledgerbalance Cashatbank Openingcapital Loan Non-currentassets Tradepayables Expenses Purchases Sales Tradereceivables Suspense Drawings Netprofit
Trialbalance Debit £ 5,415 30,000 6,781 21,569 9,445 5,853 79,063
Adjustments
Credit Debit £ £ 10,000 5,000 18,689 38,974 6,400 6,400 79,063 6,400
Credit £ 5,400 1,000 6,400
Statementofprofit Statementof financialposition orloss Debit Credit Debit Credit £ £ £ £ 5,415 10,000 5,000 30,000 24,089 6,781 21,569 38,974 8,445 5,853 10,624 10,624 38,974 38,974 49,713 49,713
C H A P T E R
6
Nobalanceremainsonthesuspenseaccount.
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SummaryandSelf-test
Summary(1/2)
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Summary(2/2)
C H A P T E R
6
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Self-test Answerthefollowingquestions. 1
OnitsreceivablescontrolaccountACohas:sales£125,000,cashreceived£50,000,discounts allowed£2,000.Thebalancecarrieddownis£95,000.Whatwastheopeningbalanceatthe beginningoftheperiod? A B C D
2
Abankstatementshowsabalanceof£1,200incredit.Anexaminationofthestatementshowsa £500chequepaidinperthecashbookbutnotyetonthebankstatementanda£1,250cheque paidoutbutnotyetonthestatement.Inadditionthecashbookshowstheowner'scorrect calculationofsavingsinterestof£50whichshouldhavebeenreceived,butwhichisnotonthe statement.Whatisthebalanceperthecashbook? A B C D
3
£1,900overdrawn £500overdrawn £1,900inhand £500inhand
Salesof£460havebeendebitedtopurchases,althoughthecorrectentryhasbeenmadeto receivablescontrol.Thebalanceonthesuspenseaccountthatneedstobesetupisfor: A B C D
4
£22,000debit £22,000credit £18,000debit £20,000debit
£460debit £460credit £920debit £920credit
Sutton&Cohadadifferenceonitstrialbalance.Afterinvestigationthefollowingerrorswere discovered. 1
Asalesinvoicefor£500wasmis-readbytheclerkas£600andenteredassuchintotheledger accounts.
2
Bankchargesof£145hadbeendebitedtothecashatbankaccountas£154.
Howmuchwastheoriginaldifferenceonthetrialbalance? A B C D 5
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Debitsgreaterthancreditsby£9 Debitsgreaterthancreditsby£199 Debitsgreaterthancreditsby£299 Creditsgreaterthandebitsby£91
Gresham&Sonshasdrawnupatrialbalancewhichshowscreditsgreaterthandebitsby£250. Whichtwoofthefollowingarepossibleexplanationsforthisdifference? A
Rentpaidof£250hadbeencreditedtotherentaccount
B
Thedebitsideofthetrialbalancehadbeenundercastby£250
C
Cashdrawingsof£125hadbeendebitedtothecashanddrawingsaccounts
D
£250paidformotorrepairshadbeendebitedtothemotorvehicles(non-currentassets) account
E
Asalesinvoicefor£250hadbeenenteredtwiceinthesalesaccount
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6
ThetrialbalanceofZLtdasextractedfromthebookshasadifferenceof£812,andthishasbeen postedtothecreditofasuspenseaccount.Someerrors,assetoutbelow,havenowbeen discovered. 1
Theyearendbankoverdraftof£756hasbeenenteredinthetrialbalanceasadebitbalance.
2
Thetotalofdiscountsreceivableforthelastmonthoftheyearof£13,400hasbeenpostedto thediscountsreceivableaccountas£14,300.
3
Apurchaseinvoicetotalling£2,015hasbeencorrectlycreditedtothecontrolaccount,but thisamounthasbeendebitedtolightandheat.
C H A P T E R
6
Aftercorrectionoftheseerrors,whatistheremainingbalancebroughtdownonthesuspense account? A B C D 7
£1,815DR £200CR £956CR £1,424CR
Onreconcilingthepurchasescontrolaccountwiththelistofpayablesledgerbalances,the accountantofMoorediscoveredthatthereweretworeconcilingitems. 1
ApurchaseinvoicefromPollytotalling£158hadbeenenteredonheraccountas£258,but wascorrectlyenteredinthepurchasesdaybook.
2
Thepurchasesdaybookhadbeenundercastby£100.
Tocompletethereconciliation,whichofthefollowingshouldhappen? A
Purchases Payablesledgercontrolaccount
£ 200
£
200
B
DR Payablesledgercontrolaccount 100 CR Purchases andreducetheamountshownasowedtoPollyandthelistofbalancesby£100
100
C
DR Payablesledgercontrolaccount 200 CR Purchases andreducetheamountshownasowedtoPollyandthelistofbalancesby£100
200
D
DR Purchases 100 CR Payablesledgercontrolaccount andreducetheamountshownasowedtoPollyandthelistofbalancesby£100
100
8
DR CR
Duetoafaultinthecompany'scomputersoftwareEastCowesLtd'spurchasesdaybookwas undercastby£8,800,anditssalesdaybookwasundercastby£3,800.Inaddition,debitbalances of£580hadbeenomittedfromthelistofsalesledgerbalances,creditbalancesof£280omitted fromthelistofpayablesledgerbalances,andcontrasof£750hadnotbeenenteredanywherein thebooks.AfterthecorrectionoftheseerrorsEastCowesLtd'sprofitwill A B C D
Decreaseby£5,000 Decreaseby£4,700 Decreaseby£3,400 Increaseby£5,000
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9
On31January20X8Randall'scashbookforitscurrentaccountshowedacreditbalanceof£150 whichdidnotagreewiththebankstatementbalance.Inperformingthereconciliationthe followingpointscometolight. Notrecordedinthecashbook Bankcharges Transferfromsavingsaccounttocurrentaccount
Notrecordedonthebankstatement Unpresentedcheques Unclearedlodgements
£ 36 500
116 630
ItwasalsodiscoveredthatthebankhaddebitedRandall'saccountwithachequefor£400inerror. ThisshouldhavebeendebitedtoHopkirk'saccount. Whatwastheoriginalbalanceonthebankstatement? A B C D
£200DR £428DR £600CR £1,600CR
10 AbankreconciliationstatementforWorthLtdat31December20Y1isincourseofpreparation.In thelightoftheinformationgivenbelow,computethefinalbalanceshownbythecashbook. 1
Overdrawnbalanceperbankstatementis£1,019.
2
Anamountof£250creditedinthebankstatementunderastandingorderarrangementhas notbeenenteredinthecashbook.
3
Chequesdrawnandenteredbutnotpresentedtotal£2,467.
4
Bankchargesof£1,875debitedbythebankhavenotbeenenteredinthecashbook.
5
Cashandchequesreceivedandenteredbutnotcreditedinthebankstatementtotal£4,986.
6
Anuncorrectedbankerrorhasresultedinachequefor£397debitedtoWorth'saccount insteadoftotheaccountofthedrawer.
Thefinalbalanceshownbythecashbook,aftermakingallnecessarycorrections,shouldbe A B C D
£6,831DR £3,141DR £1,897DR £228DR
Now,gobacktotheLearningObjectivesintheIntroduction.Ifyouaresatisfiedthatyouhaveachieved theseobjectives,pleasetickthemoff.
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AnswerstoInteractivequestions
C H A P T E R
AnswertoInteractivequestion1 PAYABLESCONTROLACCOUNT £ 79,500 3,750 4,000 12,920 100,170
Bankpayments Discountreceived Contrawithreceivables Balancec/d
Balanceb/d(balancingfigure) Purchases
£ 16,970 83,200 100,170
6
AnswertoInteractivequestion2 A
Thetotalofsalesinvoicesinthedaybookisdebitedtothecontrolaccount.Ifthetotalis understatedby£800,thedebitsinthecontrolaccountwillalsobeunderstatedby£800.OptionsB andDwouldhavetheoppositeeffect:creditentriesinthecontrolaccountwouldbeunderstated. OptionCwouldleadtoadiscrepancyof2×£800=£1,600.
AnswertoInteractivequestion3 (a) 20X8 Oct1 20X9 Sept30
RECEIVABLESCONTROLACCOUNT Balancesb/d(8,024–57) Sales
(b) 20X8 Sept30
£ 7,967 62,514 70,481
20X9 Sept30
Cashreceivedfrom creditcustomers Discountallowed Irrecoverabledebts writtenoff Contra Balancec/d
£ 55,212 2,328 326 434 12,181 70,481
PAYABLESCONTROLACCOUNT £ 37,307 1,475 434 6,458 45,674
Cashpaidtocredit suppliers Discountreceived Contra Balancec/d
20X8 Oct1 20X9 Sept30
Balanceb/d (6,235–105) Purchases Cashrefund
£ 6,130 39,439 105 45,674
AnswertoInteractivequestion4 (a)
RECEIVABLESCONTROLACCOUNT
Uncorrectedbalanceb/d Salesomitted(a) Bank:chequedishonoured(l)
£ 12,550 850 300 13,700
Discountomitted(d) Contraentryomitted(f) Irrecoverabledebtomitted(g) Creditnoteomitted(j) Amendedbalancec/d
Balanceb/d
12,500
£ 100 400 500 200 12,500 13,700
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Note:Items(b),(c),(e),(h),(i)and(k)aremattersaffectingthepersonalaccountsofcustomers. Theyhavenoeffectonthecontrolaccount. (b) STATEMENTOFADJUSTMENTSTOLISTOFBALANCES Originaltotaloflistofbalances Add debitbalanceomitted(b) debitbalanceundercast(e) Less transpositionerror(c):understatementofcashreceived cashdebitedinsteadofcredited(2×£250)(h) discountsreceivedwronglydebitedtoBell(i) understatementofcashreceived(k) Correctedtotalonlistofbalances
£ 300 200 180 500 50 72
£ 12,802 500 13,302 (802) 12,500
AnswertoInteractivequestion5 A B C D
Decrease Noeffect.Adjustmenttocashbook. Decrease Increase CASH
£ 106 120 226
b/d Standingorder
£ 226 226
c/d
£ 388 (5,629) 5,577 (110) 226
Balanceperbankstatement Unpresentedcheques Unclearedlodgements Bankerror Balancepercashaccount
AnswertoInteractivequestion6 Balancepercashbook Itemsonstatement,notincashbook Directdebits Investmentincome Correctedbalancepercashbook Itemincashbooknotonstatement: Customer'scheque(unclearedlodgements) Balanceperbankstatement
£
(715) 353
£ (610) (362) (972) (875) (1,847)
AnswertoInteractivequestion7 (a) DEBIT CREDIT
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£250 £250
Atransactionpreviouslyomitted
(b) DEBIT CREDIT
Purchases Tradepayables
Repairsaccount Non-currentasset(machinery)a/c
£150
Thecorrectionofanerrorofprinciple:repairscostsincorrectlyaddedtonon-currentassetcosts
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£150
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(c) DEBIT CREDIT
£280 £280
C H A P T E R
Anerrorofprinciple,inwhichsaleswerereducedtocompensateforcashdrawingsnotaccountedfor
(d) DEBIT CREDIT
Drawings Sales
Telephoneexpense Electricityexpense
£540 £540
Correctionofanerrorofcommission:telephoneexpenseswronglychargedtotheelectricityaccount
(e) DEBIT CREDIT
Tradereceivables Sales
£400 £400
6
Thecorrectionofacastingerrorinthesalesdaybook (£28,825–£28,425=£400)
AnswertoInteractivequestion8 (a) (i)
DEBIT CREDIT
DR £ 1,000
CR £ 1,000
Suspensea/c Sales
(ii)
DEBIT CREDIT
Non-currentasset Distributioncosts
240
240
(iii) DEBIT CREDIT
Discountreceived Tradepayables
150
150
(iv) DEBIT CREDIT
Suspensea/c Purchases
500
500
(v)
Tradepayables Suspensea/c
460
460
DEBIT CREDIT
(b) SUSPENSEA/C £ 1,000 500 1,500
(i) Sales (iv) Purchases
Endofyearbalance (vi) Tradepayables
£ 1,040 460 1,500
(c) £ 35,750 1,000 500 37,250
Grossprofitoriginallyreported Salesomitted(i) Incorrectrecordingofpurchases(iv) Adjustedgrossprofit
Netprofitoriginallyreported Adjustmentstogrossprofit£(37,250–35,750) Cashdiscountincorrectlytaken(iii) Non-currentassetcostswronglyclassified Adjustednetprofit
18,500 1,500 (150) 240 20,090
Controlaccounts,errorsandsuspenseaccounts
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AnswerstoSelf-test 1
A
RECEIVABLESCONTROL
Balb/f(balfigure) Sales
£ 22,000 125,000 147,000
£ 50,000 2,000 95,000 147,000
Cash Discountsallowed Balc/f
IfyouhadanswerB,youreversedthedoubleentryandsoproducedapayablescontrolaccount.In answerD,youomittedthediscountsallowedfigure;whileinanswerCyouputdiscountsallowed onthedebitinsteadofthecreditsideofthecontrolaccount. 2
D
Balanceperbankstatement Addoutstandinglodgements depositinterestnotyetcredited Lessunpresentedcheques Balancepercashbook
£ 1,200 550 1,750 (1,250) 500
3
D
Salesof£460havebeendebitedtoaccountsreceivableandalso£460hasbeendebitedto purchases.Thereforethetrialbalanceneedsacreditof2£460=£920tobalance.
4
C
1
Thiserrorwillnotleadtoadifferenceinthetrialbalance.Bothreceivablesandsaleswill beoverstated.
2
Thecashatthebankaccounthasbeendebited(itshouldhavebeencredited)with £154,bankchargesdebitedwith£145therefore£299moredebitsthancredits.
5
BandE A B C
D
E 6
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£ 500 50
Shouldhave
Have
Result
DRRent£250
CRRent£250
CRBank£250
CRBank£250
–
–
DRDrawings£125
DRBank£125
CRBank£125
DRDrawings£125
DRRepairs£250
DRNon-currentassets£250
CRBank£250
CRBank£250
DRReceivables£250
DRReceivables£250
CRSales£250
CRSales£500
£500moreCRsthanDRs £250moreCRsthanDRs
B
SUSPENSE
Bankoverdraft(2756) C/d()
£ 1,512 200 1,712
£250moreDRsthanCRs DRs=CRs(eventhough entryiswronginprinciple) £250moreCRsthanDRs
Openingbalance Discounts
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7
D
1 2
8
Aspurchasesdaybookentryiscorrect,subsequentdoubleentryiscorrect.Personal accountisincorrect. Doubleentryincorrect.
A Undercastofpurchasedaybook Undercastofsalesdaybook
Bookkeeping DRPurchases CRPurchaseledgercontrolaccount DRSalesledgercontrolaccount CRSales
Effectonprofit £ –8,800 +3,800 –5,000
C H A P T E R
6
Contraswillnotaffecttheprofitfortheyear,whilsterrorsinthesalesandpurchaseledgers, notbeingpartofthedoubleentrysystem,cannotdoso. 9
C
CASHATBANKACCOUNT Transferfromsavingsa/c
£ 500 500
Balanceb/d Charges Balancec/d
£ 150 36 314 500 £ 314 116 (630) (400) (600)
Balancepercashbook Addunpresentedcheques Lessunclearedlodgements Lesserrorbybank* Balanceperbankstatement *Onthebankstatementadebitisapaymentoutoftheaccount. 10 C
£ (1,019)o/d (2,467) (3,486) 4,986 1,500 397 1,897
Balanceperbankstatement Chequesnotpresented Amountnotcredited Bankerror Debitbalancepercashbook
Controlaccounts,errorsandsuspenseaccounts
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CHAPTER7
Costofsalesandinventories
Introduction Examinationcontext TopicList 1 Costofsales 2 IAS2Inventories 3 Accountingforopeningandclosinginventories 4 InventoriesontheETB 5 Countinginventories 6 Valuinginventories 7 Usingmark-up/marginpercentagestoestablishcost 8 Writingoffinventories,andinventorydrawings SummaryandSelf-test AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Recordandaccountfortransactionsandeventsresultinginincome,expenses,assets, liabilitiesandequityinaccordancewiththeappropriatebasisofaccountingandthelaws, regulationsandaccountingstandardsapplicabletothefinancialstatements
Prepareanextendedtrialbalance
Identifythemaincomponentsofasetoffinancialstatementsandspecifytheirpurpose andinterrelationship
Prepareandpresentastatementoffinancialposition,statementofprofitorlossand statementofcashflows(orextractstherefrom)fromtheaccountingrecordsandtrial balanceinaformatwhichsatisfiestheinformationrequirementsoftheentity
Specificsyllabuslearningoutcomesare:1d,2c,3a,3c
Syllabuslinks Thematerialinthischapterwillbedevelopedfurtherinthispaper,andthenintheFinancialAccounting andFinancialReportingpaperslaterintheProfessionalstage.
Examinationcontext Questionsonthetopicsinthischapterwillbesetasmultiplechoicequestions,someofwhichmay involvecalculationssothatthecorrectanswercanbeselected.Veryoftendoubleentryquestionsare phrasedintermsofpreparingajournal. Intheexamyoumayberequiredto:
Identifytheaccountingprinciplesbehindcostofsales
Specifythecomponentsofcostofsalesinthestatementofprofitorloss
Usemarginandmark-uptocalculaterevenueorcostofsales
Identifytheaccountingprinciplesbehindaccountingforinventory
Identifythepurposeofaninventorycount
Specifywhatisincludedinthecostofinventory
IdentifythecorrectvalueforinventoryusingFIFOandAVCO
Calculatenetrealisablevalues
Usemarginandmark-uptocalculateclosinginventory
Identifyhowtoaccountfordrawingsofinventoryandforsubstantiallossesofinventory
Identifyhowtoaccountforclosinginventoryintheledgeraccountsandontheextendedtrial balance
Calculatethefigureinthestatementoffinancialpositionforinventory
Identifytheeffectsofopeningandclosinginventoryongrossandnetprofitinthestatementof profitorloss
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1 Costofsales Sectionoverview
Costofsalescomprises:
Openinginventory Purchases Carriageinwards Closinginventory Costofsales
Costofsalesisdeductedfromrevenuetoarriveatgrossprofit.
Whenalargeamountofpurchasedormanufactureditemsarestolenorlost,weremovethem fromthecostofsalesandtreatthemasanexpense,soasnottodistortgrossprofit.
X X X (X) X
Thecostofsalesisdeductedfromrevenueinanentity'sstatementofprofitorloss.Becauseitresults inthegrossprofitithaslongbeenregardedasakeyfigureinthefinancialstatements.
C H A P T E R
Definition
7
Costofsales:Openinginventory+purchases+carriageinwards–closinginventory=costofsales.This amountisthendeductedfromrevenuetoariseatthebusiness'sgrossprofit. Inventory,bothopeningandclosing,featuresinthestatementofprofitorlosswhereasyoumight expectittofeatureonlyinthestatementoffinancialposition,asanasset.Howisthisso?
1.1 Unsoldgoodsattheendofareportingperiod Goodsmightbeunsoldattheendofareportingperiodandsostillbeheldininventory.Underthe accrualconcept,thecostofthesegoodsshouldnotbeincludedincostofsales,insteaditshouldbe carriedforwardandmatchedagainstrevenueinsubsequentperiods.
Workedexample:Closinginventory TheUmbrellaShop'sfinancialyearendson30Septembereachyear.On1October20X4ithadno goodsininventory.Duringtheyearto30September20X5,itpurchased30,000umbrellascosting £60,000fromumbrellasuppliers.Itresoldtheumbrellasfor£5each,andsalesfortheyearamountedto £100,000(20,000umbrellas).At30Septembertherewere10,000unsoldumbrellasleftininventory, valuedatcostof£2each. Requirement WhatwasTheUmbrellaShop'sgrossprofitfortheyear?
Solution Itpurchased30,000umbrellas,butonlysold20,000.Purchasecostsof£60,000andsalesof£100,000 donotrelatetothesamequantityofgoods. Thegrossprofitfortheyearshouldbecalculatedby'matching'thesalesvalueof20,000umbrellassold withthecostofthose20,000umbrellas.Thecostofsalesinthisexampleisthereforethecostof purchasesminusthecostofgoodsininventoryattheyearend. £ £ 100,000 Sales(20,000unitsat£5) Purchases 30,000unitsat£2 60,000 Lessclosinginventory (10,000)unitsat£2 (20,000) Costofsales 20,000unitsat£2 (40,000) Grossprofit 60,000
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Workedexample:Openingandclosinginventory Initsnextreportingperiod,1October20X5to30September20X6,TheUmbrellaShoppurchased 40,000umbrellasatatotalcostof£95,000,andsold45,000umbrellasfor£230,000.At30September 20X6ithad(10,000+40,000–45,000)=5,000umbrellasleftininventory,whichtogetherhadcost £12,000. Requirement WhatwasTheUmbrellaShop'sgrossprofitforthesecondperiod?
Solution Inthisreportingperiod,itpurchased40,000umbrellastoaddtothe10,000italreadyhadininventory atthestartoftheyear.Itsold45,000,leaving5,000umbrellasininventoryattheyearend.Onceagain, grossprofitshouldbecalculatedbymatchingthevalueof45,000unitsofsaleswiththecostofthose 45,000units. Thecostofsalesisthevalueofthe10,000umbrellasininventoryatthebeginningoftheperiod,plus thecostofthe40,000umbrellaspurchased,lessthecostofthe5,000umbrellasininventoryatthe periodend. Sales(45,000units) Openinginventory* Addpurchases Lessclosinginventory Costofsales Grossprofit
10,000unitsat£2 40,000units (5,000)units 45,000units
£ 20,000 95,000 (12,000)
£ 230,000 (103,000) 127,000
*Takenfromtheclosinginventoryvalueofthepreviousreportingperiod.
1.2 Costofsales Openinginventoryvalue Addcostofpurchases(or,foramanufacturingcompany,thecostofproduction) Addcostofcarriageinwards(seebelow) Lessclosinginventoryvalue Equalscostofsales
£ X X X (X) X
Inotherwords,tomatch'sales'and'costofsales',itisnecessarytoadjustthecostofgoodspurchased ormanufacturedtoallowforincreasesorreductionininventorylevelsduringtheperiod.
Interactivequestion1:Grossprofit
[Difficultylevel:Easy]
On1January20X6,GrandUnionFoodStoreshadgoodsininventoryvaluedat£6,000.During20X6its ownerpurchasedsuppliescosting£50,000.Salesfortheyearto31December20X6amountedto £80,000.Thecostofgoodsininventoryat31December20X6was£12,500. Requirement Calculatethebusiness'sgrossprofitfortheyear. SeeAnswerattheendofthischapter.
1.3 Carriageinwardsandoutwards 'Carriage'referstothecostoftransportingpurchasedgoodsfromthesuppliertothepremisesofthe businesswhichhasboughtthem.Someonehastopayforthesedeliverycosts:sometimesthesupplier pays(inwhichcasethepurchaserhasnocoststorecord)andsometimesthepurchaserpays.Whenthe
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purchaserpays,thecosttothepurchaseriscarriageinwardswhenthegoodsarecomingintothe business,andcarriageoutwardswhenthegoodsaregoingoutofthebusiness.
Thecostofcarriageinwardsisaddedtothecostofpurchases,andisthereforeincludedinthe calculationofcostofsalesandgrossprofit.
Thecostofcarriageoutwardsisadistributioncostdeductedfromgrossprofitinthestatement ofprofitorloss.
Workedexample:Carriageinwardsandcarriageoutwards GwynTringimportsandresellsclocks.Hepaysforthecostsofdeliveringtheclocksfromhissupplierin Switzerlandtohisshop,calledClicketyClocks,inWales. Heresellsclockstoothertradersthroughoutthecountry,payingcarriagecostsfordeliveriesfromhis businesspremisestohiscustomers. On1July20X5,hehadclocksininventoryvaluedat£17,000.Duringtheyearto30June20X6he purchasedmoreclocksfor£75,000.Carriageinwardsamountedto£2,000.Salesfortheyearwere £162,100.Otherbusinessexpensesamountedto£56,000,excludingcarriageoutwardswhichcost £2,500.Thevalueofclocksininventoryattheyearendwas£15,400.
C H A P T E R
Requirement 7
PreparethestatementofprofitorlossofClicketyClocksfortheyearended30June20X6.
Solution CLICKETYCLOCKS STATEMENTOFPROFITORLOSSFORTHEYEARENDED30JUNE20X6 £ 17,000 75,000 2,000 94,000 (15,400) 2,500 56,000
Revenue Openinginventory Purchases Carriageinwards Lessclosinginventory Costofsales Grossprofit Carriageoutwards Otherexpenses Netprofit
£ 162,100 (78,600) 83,500 (58,500) 25,000
1.4 Inventorywrittenofforwrittendown Atradermightbeunabletosellallthegoodspurchased,becausebeforetheycanbesoldtheymight:
Belostorstolen Bedamagedandbecomeworthless Becomeobsoleteoroutoffashion.Thesemightbethrownaway,orsoldoffatalowprice
Whengoodsarelost,stolenorthrownawayasworthless,thebusinesswillmakealossonthosegoods becausetheir'salesvalue'willbenil. Similarly,whengoodslosevaluebecausetheyhavebecomeobsoleteoroutoffashion,thebusinesswill makealossiftheirnetrealisablevalueislessthancost.Forexample,ifgoodswhichoriginallycost £500arenowobsoleteandcouldonlybesoldfor£150,thebusinesswouldsufferalossof£350.
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If,attheendofareportingperiod,abusinessstillhasgoodsininventorywhichareeitherworthlessor worthlessthantheiroriginalcost,thevalueoftheinventoriesshouldbewrittendownto:
Nothing,iftheyareworthless,or Theirnetrealisablevalue,ifthisislessthantheiroriginalcost.
Thecostofinventorywrittenofforwrittendowndoesnotusuallycauseanyproblemsincalculatingthe grossprofitofabusiness,becausethecostofsalesalreadyincludesthecostofinventorieswrittenoffor writtendown,asthefollowingexampleshows.
Workedexample:Inventorieswrittenoffandwrittendown LucasWaggendshisfinancialyearon31March.At1April20X5hehadgoodsininventoryvaluedat £8,800.Duringtheyearto31March20X6,hepurchasedgoodscosting£48,000.Fashiongoodswhich cost£2,100wereheldininventoryat31March20X6,andLucasWaggbelievesthatthesecanonly nowbesoldatasalepriceof£400.Goodsstillheldininventoryat31March20X6(includingthe fashiongoods)hadanoriginalpurchasecostof£7,600.Salesfortheyearwere£81,400. Requirement CalculateLucasWagg'sgrossprofitfortheyearended31March20X6.
Solution Initialcalculationofclosinginventoryvalues: Fashiongoods Othergoods(balancingfigure)
Atcost £ 2,100 5,500 7,600
LUCASWAGG GROSSPROFITFORTHEYEARENDED31MARCH20X6 Revenue Openinginventory Purchases Lessclosinginventory(400+5,500) Costofsales Grossprofit
Realisable value £ 400
£ 8,800 48,000 (5,900)
Amount written down £ 1,700
£ 81,400 (50,900) 30,500
Byusingthefigureof£5,900forclosinginventories,thecostofsalesautomaticallyincludesthe inventorywrite-downof£1,700.
1.5 Inventorydestroyedorstolenandsubjecttoaninsuranceclaim Whereamaterialamountofinventoryhasbeenstolenordestroyed,includingtheircostingrossprofit willgiveaverydistortedideaofthebusiness'sbasicprofitability:
Purchaseswillincludethecostofgoodsthatcouldnotbesold,sotheaccrualprincipleisbroken, yettheyarenotinclosinginventoryeither,soitwilllookasifthebusiness'sgrossmarginonsales hasfallencatastrophically.
Theremaybeanamountofincomeasaresultofaninsuranceclaim,whichcannotbeincludedin costofsalesunderthe'nooffsetting'principle.
Theseproblemsareovercomebytakingthecostofgoodsstolenordestroyedoutofpurchases,and includingitunderexpenses.Theinsuranceclaimistreatedasotherincomeincalculatingnetprofit;if ithasnotyetbeenreceivedintheformofcashitisdisclosedas'otherreceivables'onthestatementof financialposition.
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Workedexample:Materialamountofinventorystolen Ethelbertahad£15,000ofinventoryasat1January20X2.Duringtheyearto31December20X2she purchasedinventoryfor£98,000,incurringcarriageinwardsof£150.Shemadesalesof£150,000, incurringdeliverycoststohercustomersof£2,400.At31December20X2sherealisesthatshehas inventorycostingonly£200left;goodscosting£18,000havebeenstolen.Theinsurancecompanyhas agreedtopayherclaimfor75%ofthecost. WeshallprepareEthelberta'sstatementofprofitorlosson(a)thebasissetoutinSection1.5above, andcomparethiswith(b)thealternativeinSection1.4.
Solution Revenue Openinginventory Purchases Carriageinwards Inventorystolen Closinginventory Costofsales Grossprofit Otherincome(18,00075%) Costofgoodsstolen Distributioncosts(carriageout) Netprofit
15,000 98,000 150 (18,000) (200)
Grossprofitmargin(Grossprofit/Revenue) Netprofitmargin(Netprofit/Revenue)
£
(a)
£ 150,000 (94,950) 55,050 13,500 (18,000) (2,400) 48,150
£
36.7% 32.1%
(b)
15,000 98,000 150 0 (200)
£ 150,000 (112,950) 37,050 13,500 0 (2,400) 48,150
C H A P T E R
7
24.7% 32.1%
Bothtreatmentsresultinthesamenetprofit.However,thetreatmentin(a)matchesrevenuewiththe costofthegoodsthatgeneratedtherevenueingrossprofit,andalsomatchesthecostofthegoods stolenwiththeinsurancereceiptinrespectoftheminarrivingatnetprofit.Thetreatmentin(b)does notmatchrevenueandexpensesoeffectively.
Interactivequestion2:Insuranceclaim
[Difficultylevel:Examstandard]
Wasalostinventorythatcost£64,500inafire.Thegoodswereinsuredfor60%oftheircost. Requirement PrepareajournaltoaccountforthisinWasa'sbooks. SeeAnswerattheendofthischapter.
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2 IAS2Inventories Sectionoverview
IAS2prescribestheaccountingtreatmentforinventories
Inventoriesareassetsthatare: –
Heldforsaleintheordinarycourseofbusiness
–
Intheprocessofproductionforsuchsale
–
Intheformofmaterialsorsuppliestobeconsumedintheproductionprocessorinthe renderingofservices
2.1 Objectiveandscope TheobjectiveofIAS2Inventoriesistoprescribetheaccountingtreatmentforinventories.Inparticularit providesguidanceonthedeterminationofcostanditssubsequentrecognitionasanexpense, includinganywrite-downtonetrealisablevalue. IAS2appliestoallinventoriesexceptthefollowing:
Workinprogressunderconstructioncontracts Financialinstruments(egshares,bonds) Biologicalassets
ThetreatmentoftheabovearealloutsidethescopeoftheAccountingsyllabus. Certaininventoriesareexemptfromthestandard'smeasurementmethods,iethoseheldby:
Producersofagricultural,forestandmineralproducts Commodity-brokertraders
2.2 Inventories Definition Inventories.Assets:
Heldforsaleintheordinarycourseofbusiness
Intheprocessofproductionforsuchsale
Intheformofmaterialsorsuppliestobeconsumedintheproductionprocessorintherendering ofservices
Inventoriescaninclude:
Goodspurchasedandheldforresale Finishedgoods Workinprogressbeingproduced Rawmaterialsawaitinguse
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3 Accountingforopeningandclosinginventories Sectionoverview
Ineachreportingperiod,openinginventoryisanexpenseinthestatementofprofitorloss:
DEBIT CREDIT
Closinginventoryisdeductedfromcostofsalesinthereportingperiod,soitcanbecarried forwardandmatchedagainsttherevenueitearnsinthenextperiod:
DEBIT CREDIT
Costofsales Inventoryaccount
Inventoryaccount(statementoffinancialposition) Costofsales
£X
£X
£X
£X
Inordertocalculategrossprofititisnecessarytoworkoutthecostofsales.Tocalculatethecostof salestheaccrualsprinciplenecessitatesdeterminingvaluesforopeninginventory(ieinventoryinhand atthebeginningofthereportingperiod)andclosinginventory(ieinventoryinhandattheendofthe reportingperiod).Thisallowsustocarryforwardthelattertothenextaccountingperiodwhereitwill bematchedwiththeincomeitearns. Thecostofsalesfigureinthestatementofprofitorlossissummarisedas:
C H A P T E R
7
£ X X X (X) X
Openinginventory Pluspurchases Pluscarriageinwards Lessclosinginventory Costofsales However,writingdownthisformulahidesthreebasicproblems.
Howdoyoumanagetogetaprecisecountofinventoriesisheldatanyonetime?
Oncecounted,howdoyouvalueinventory?
Assumingtheinventoryisgivenavalue,howdoesthedoubleentrybookkeepingforinventory work?
Thepurposeofthischapteristoanswerallthreeofthesequestions.Inordertomakethepresentationa littleeasiertofollow,weshalltakethelastquestionfirst.
3.1 Ledgeraccountingforinventories Purchasesareintroducedtotheprofitandlossledgeraccountviathefollowingdoubleentry: DEBIT CREDIT
Profitandlossledgeraccount Purchasesaccount
£X
£X
Butwhataboutopeningandclosinginventories?Howaretheirvaluesaccountedforinthedoubleentry bookkeepingsystem?Theansweristhataninventoryaccountmustbekept,butitisonlyusedatthe endofareportingperiod,whenthebusinesscountsandvaluesinventory,inaninventorycount. (a) Onceaninventorycountismadeandthebusinesshasavalueforitsclosinginventory,thedouble entryis: DEBIT CREDIT
Inventory(asset)account Profitandlossledgeraccount
£X
£X
Ratherthanshowingclosinginventoryasa'plus'valueinthestatementofprofitorloss(byadding ittorevenue)itisshownasa'minus'figureinarrivingatcostofsales,asillustratedabove.The debitbalanceontheclosinginventoryaccountrepresentsacurrentassetinthestatementof financialposition.
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(b) Closinginventoryattheendofoneperiodbecomesopeninginventoryatthestartofthenext period.Theinventoryaccountremainsunchanged,withadebitbalanceuntiltheendofthenext period.Thisvalueisnowtheopeninginventoryfigureandistakentotheprofitandlossledger account: DEBIT CREDIT
Profitandlossledgeraccount Inventoryaccount(openinginventoryvalue)
£X
£X
Workedexample:Accountingforinventories Abusinesshasopeningcapitalof£2,000,representedentirelybyinventory.Duringthefirstyear's trading,whentheownertooknodrawings,thefollowingtransactionsoccurred. Purchasesofgoodsforresale,oncredit Paymentsfortradepayables Sales,alloncredit Receiptsfromtradereceivables Non-currentassetspurchasedforcash Otherexpenses,allpaidincash
£ 4,300 3,600 8,000 3,200 1,500 900
All'otherexpenses'relatetothecurrentyear. Closinginventoryisvaluedat£1,800. Requirement Preparetheledgeraccounts,includingaprofitandlossledgeraccount,forthe12monthreporting periodandastatementoffinancialpositionasattheendofthereportingperiod. CASH Tradereceivables Balancec/d
£ 3,200 2,800 6,000
Tradepayables Non-currentassets Otherexpenses
£ 3,600 1,500 900 6,000
Balanceb/d
2,800
CAPITAL Balancec/d
£ 4,600 4,600
Inventory Profitandloss
£ 2,000 2,600 4,600
Balanceb/d
4,600
TRADEPAYABLES Cash Balancec/d
£ 3,600 700 4,300
Purchases Balanceb/d
£ 4,300 4,300 700
PURCHASES Tradepayables
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£ 4,300
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NON-CURRENTASSETS Cash
£ 1,500
Balancec/d
Balanceb/d
1,500
£ 1,500
SALES £ 8,000
Profitandloss
£ 8,000
Tradereceivables
TRADERECEIVABLES £ 8,000 8,000 4,800
Sales Balanceb/d
£ 3,200 4,800 8,000
Cash Balancec/d
OTHEREXPENSES £ 900
Cash
£ 900
Profitandloss
C H A P T E R
7
INVENTORY Capital Profitandloss(closinginventory) Balanceb/d
£ 2,000 1,800 3,800 1,800
Profitandloss(openinginventory) Balancec/d(closinginventory)
£ 2,000 1,800 3,800
PROFITANDLOSSLEDGERACCOUNT Openinginventory(inventorya/c) Purchases Grossprofitc/d Otherexpenses Netprofit(transferredto capitalaccount)
£ 2,000 4,300 3,500 9,800 900 2,600 3,500
Sales Closinginventory(inventorya/c) Grossprofitb/d
£ 8,000 1,800 9,800 3,500 3,500
STATEMENTOFFINANCIALPOSITIONASATTHEENDOFTHEPERIOD ASSETS Non-currentassets Currentassets Inventory Tradereceivables Totalassets CAPITALANDLIABILITIES Capital Atstartofperiod Profitforperiod Atendofperiod Currentliabilities Bankoverdraft Tradepayables Totalcapitalandliabilities
£ 1,800 4,800 2,000 2,600 2,800 700
£ 1,500 6,600 8,100 4,600 3,500 8,100
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Theclosingdebitbalanceontheinventoryaccountis£1,800,whichappearsinthestatementof financialpositionasacurrentasset. Theopeninginventoryof£2,000waseliminatedbytransferringitasadebitbalancetotheprofitand lossledgeraccount,ie: DEBIT CREDIT
Profitandlossledgeraccount(withvalueofopeninginventory) Inventoryaccount(withvalueofopeninginventory)
Thedebitintheprofitandlossledgeraccountthenincreasedthecostofsales,ieopeninginventoryis addedtopurchasesincalculatingcostofsales.
Interactivequestion3:Journalsforinventory
[Difficultylevel:Intermediate]
InitsnominalledgerWickhamplchadabalanceonitsinventoryaccountat1July20X2of£23,490.At 30June20X3ithadinventoryof£40,285. Prepareajournaltorecordthesituationasattheendofthereportingperiodinthenominalledgerof Wickhamplc,inpreparationfordrawingupthestatementofprofitorlossandstatementoffinancial position. SeeAnswerattheendofthischapter.
4 InventoriesontheETB Sectionoverview
TheclosinginventoryisenteredintobothadjustmentcolumnsoftheETBforinventory.Thedebit istakenacrosstothestatementoffinancialposition;thecreditistakentothestatementofprofit orloss.
Openinginventoryistakenstraighttothestatementofprofitorlossasadebit.
Theclosinginventoryfigureisgenerallyaccountedforaftertheinitialtrialbalancehasbeenextracted. Therefore,onlyopeninginventoryappearsontheinitialtrialbalance.Analternativewayof incorporatingtherelevantfiguresistousetheETB.
Calculatethevalueofclosinginventories(seebelow).
Preparetheyear-endjournalsforopeningandclosinginventoriesasusual(seeabove).
EnterthejournalforclosinginventoryonlyintheadjustmentscolumnsoftheETBusingthe inventoriesline.(Thereisadebitandacreditforthesameamountonthisline:thedebitcasts acrosstothestatementoffinancialposition,andthecredittothestatementofprofitorloss.)
IncludetheseadjustmentsintheETBcross-casttopreparethefinancialstatements.
Enterthejournalsforbothopeningandclosinginventoriesintheledgeraccounts.
InsomeETBsthereisnoseparatelineforclosinginventories,sotheadjustmentismadeontheopening inventoriesline:thisistheapproachtakenintheworkedexamplethatfollows.
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Workedexample:InventoriesontheETB Sam'sMusicShoptrialbalanceasat31December20X5isasfollows. Trialbalance Debit Credit £ £ 5,123 10,000 12,000 20,000 6,800 12,785 18,425 38,745 3,546 8,754 9,158 72,668 72,668
Ledgerbalance Cashatbank Openingcapital Loan Non-currentassets Tradepayables Expenses Purchases Sales Tradereceivables Inventoriesat1.1.X5 Drawings
C H A P T E R
Closinginventoriesat31December20X5cost£13,855. 7
Requirement CompleteSam'sETBandcalculatehisnetprofitfortheyear.
Solution
Step1 ToaccountforclosinginventoriesontheETBpreparetheyear-endjournalforclosinginventory: DEBIT CREDIT
Inventory(statementoffinancialposition) Profitandlossledgeraccount Recordingclosinginventoryasanassetattheyearend
£ 13,855
£ 13,855
Step2 EnterthisjournalinthedebitandcreditadjustmentcolumnsontheETBontheinventoryledger accountline.
Step3 Cross-casttheETBasfollows:
Openinginventoryisrecordedasadebitinthestatementofprofitorloss.
Thedebitsideoftheadjustmentjournalisrecordedasadebitinthestatementoffinancial position.
Thecreditsideoftheadjustmentjournalisrecordedasacreditinthestatementofprofitor loss.
Step4 Preparethefinancialstatements.
Step5 Recordbothjournalsintheledgeraccountsasusual.
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Sam'sETBwillbeasfollows: Trialbalance Adjustments Debit Credit Debit Credit £ £ £ £ 5,123 10,000 12,000 20,000 6,800 12,785 18,425 38,745 3,546 8,754 13,855 13,855 9,158 72,668 72,668 13,855 13,855
Ledgerbalance Cashatbank Openingcapital Loan Non-currentassets Tradepayables Expenses Purchases Sales Tradereceivables Inventories Drawings Netprofit
Statementofprofit orloss Debit Credit £ £ 12,785 18,425 38,745 8,754 13,855 12,636 52,600 52,600
Statementof financialposition Debit Credit £ £ 5,123 10,000 12,000 20,000 6,800 3,546 13,855 9,158 12,636 46,559 46,559
SAM'SMUSICSHOP–STATEMENTOFPROFITORLOSSFORYEARENDED31DECEMBER20X5 £ 8,754 18,425 (13,855)
Revenue Costofsales Openinginventories Purchases Closinginventories Costofsales Grossprofit Expenses Netprofit
£ 38,745 (13,324) 25,421 (12,785) 12,636
SAM'SMUSICSHOP–STATEMENTOFFINANCIALPOSITIONASAT31DECEMBER20X5 ASSETS Non-currentassets Currentassets Inventories Tradereceivables Totalassets
CAPITALANDLIABILITIES Openingcapital Profitforyear Drawings Closingcapital Non-currentliabilities Bankloan Currentliabilities Tradepayables Bankoverdraft Totalcapitalandliabilities
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£ 13,855 3,546
£ 20,000 17,401 37,401
6,800 5,123
10,000 12,636 (9,158) 13,478 12,000 11,923 37,401
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5 Countinginventories Sectionoverview
Theinventorycountestablishesquantitiesheldininventoryattheendofthereportingperiod.
Businesstradingisacontinuousactivity,butfinancialstatementsmustbedrawnupataparticulardate. Inpreparingastatementoffinancialpositionitisnecessaryto'freeze'theactivityofabusinesssoasto determineitsassets,capitalandliabilitiesatthatgivenmoment.Thisincludesestablishingthequantities ofinventoriesheld. Insimplecases,whenabusinessholdseasilycountedandrelativelysmallamountsofinventory, quantitiesofinventoriesheldatthedateofthestatementoffinancialpositioncanbedeterminedby physicallycountingtheminaninventorycount. Inmorecomplicatedcases,whereabusinessholdsconsiderablequantitiesofvariedinventory,an alternativeapproachtoestablishingquantitiesistomaintaincontinuousinventoryrecords.Thismeans thatarecordiskeptforeveryitemofinventory,showingreceiptsandissuesfromthestores,anda runningtotal.Afewinventoryitemsarecountedeachdaytomakesuretherecordsarecorrect–thisis calleda'continuous'countbecauseitisspreadoutoverthereportingperiodratherthancompletedin onecountatadesignatedtime.
C H A P T E R
7
Oncethequantityofinventoriesisdeterminedthenapolicyisrequiredforvaluingindividualitems.
6 Valuinginventories Sectionoverview
Inventoryisvaluedatthelowerof(historical)costofpurchase,andnetrealisablevalue(NRV).
NRVistheexpectedsellingpricelessanycoststobeincurredinachievingthatsale.
Costcomprises:purchaseprice,carriage,dutiesandconversioncoststobringitemtoitspresent locationandcondition.
6.1 Basicvaluation:valuationathistoricalcost Thereareseveralmethodswhich,intheory,mightbeusedforvaluingitemsofinventory:
Attheirhistoricalcost(iethecostatwhichtheywereoriginallybought)
Attheirexpectedsellingprice
Attheirexpectedsellingprice,lessanycostsstilltobeincurredingettingthemreadyforsale.This amountisreferredtoasinventory'snetrealisablevalue(NRV)
Attheamountitwouldcosttoreplacethem(replacementcost)
Theuseofsellingpricesininventoryvaluationisruledoutbytherealisationconceptbecausethis wouldcreateaprofitforthebusinessbeforetheinventoryhasbeensold.Usingreplacementcostsis problematicastheseareverydifficulttoestablish.Themostobviousroutethenistovaluethemat historicalcost.ButwhataboutNRV?
Workedexample:Valuinginventoryathistoricalcost Atraderbuystwoitemsofinventory,eachcosting£100.Hecansellthemfor£140each,butinthe reportingperiodweshallconsider,hehasonlysoldoneofthem.Theotherisclosinginventory. Sinceonlyoneitemhasbeensold,youmightthinkitiscommonsensethatprofitoughttobe£40.But ifclosinginventoryisvaluedatsellingprice,profitwouldbe£80,ieprofitwouldbetakenontheclosing inventoryaswell.
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Thiswouldcontradicttheaccountingconceptofrealisation,ietoclaimaprofitbeforetheitemhas actuallybeensold. £ £ Revenue 140 Openinginventory – Purchases(2×£100) 200 200 Lessclosinginventory(atsellingprice) (140) Costofsales (60) Grossprofit 80 ThesameobjectionusuallyappliestotheuseofNRVininventoryvaluation.Supposetheitem purchasedfor£100requires£5offurtherexpenditureingettingitreadyforsaleandthensellingit(eg £5ofprocessingcostsanddistributioncosts).Ifitsexpectedsellingpriceis£140,itsNRVis£(140–5)= £135.Tovalueitat£135inthestatementoffinancialpositionwouldstillbetoanticipatea£35profit. Weareleftwithhistoricalcostasthenormalbasisofinventoryvaluation.
6.2 Basicvaluation:lowerofcostandNRV Theonlytimewhen(historical)costisnotusediswhencostneedstobereducedtoNRV.
Workedexample:LowerofcostandNRV Supposethatthemarketintheaboveexampleslumpsandtheexpectedsellingpriceis£90.Theitem's NRVisthen£(90–5)=£85andthebusinesswillmakealossof£15(£100–£85)ontheitem.Assets shouldnotbeoverstated,sothesolosswillberecognisedbyvaluingtheiteminthestatementof financialpositionatitsNRVof£85. Inventoryshouldbevaluedatthelowerofcostandnetrealisablevalue.
6.3 ApplyingthelowerofcostandNRV IfabusinesshasmanyinventoryitemsonhandthecomparisonofcostandNRVshouldbecarriedout foreachitemseparately.Itisnotsufficienttocomparethetotalcostofallinventoryitemswiththeir totalNRV.
Workedexample:Valuingeachinventoryitemseparately Acompanyhasfouritemsofinventoryattheendofitsreportingperiod.TheircostandNRVsareas follows. Inventoryitem 1 2 3 4
Cost £ 27 14 43 29 113
NRV £ 32 8 55 40 135
Lower ofcost /NRV £ 27 8 43 29 107
Itwouldbeincorrecttocomparetotalcost(£113)withtotalNRV(£135)andtostateinventoriesat £113inthestatementoffinancialposition.Thecompanycanforeseealossof£6onitem2andthis shouldberecognisedimmediately.Ifthefouritemsaretakentogetherintotalthelossonitem2is maskedbytheanticipatedprofitsontheotheritems.Byperformingthecost/NRVcomparisonforeach itemseparatelytheappropriatevaluationof£107canbederived.Thisisthevaluewhichshouldappear inthestatementoffinancialposition.
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Interactivequestion4:Inventoryvaluation
[Difficultylevel:Examstandard]
Thefollowingfiguresrelatetoinventoryheldattheendofthereportingperiod. Cost Sellingprice Modificationcosttoenablesale Marketingcosts Unitsheld
Item A £20 £30 – £7 200
Item B £9 £12 £2 £2 150
Item C £14 £22 £8 £2 300
Requirement Calculatethevalueofinventoryforinclusioninthefinancialstatements. C H A P T E R
SeeAnswerattheendofthischapter.
6.4 Determiningthecostofinventory Inventoriesmaybe:
Rawmaterialsorcomponentsboughtfromsuppliers Finishedgoodswhichhavebeenmadebythebusinessbutnotyetsold. Partcompleteditems(thistypeofinventoryiscalledworkinprogressorWIP).
7
Definitions Costofinventories:Allcostsofpurchase,ofconversion(eglabour)andofothercostsincurredin bringingtheitemstotheirpresentlocationandcondition. Costofpurchase:Thepurchaseprice,importdutiesandothernon-recoverabletaxes,transport, handlingandothercostsdirectlyattributabletotheacquisitionoffinishedgoodsandmaterials.
6.4.1 Whatisincludedinthetotalcostofanitem? Thetotalcostofanitemincludesallcostsincurredinbringingtheitemtoitspresentlocationand condition.Thisconsistsof
Thepurchasecostofrawmaterials Carriage Importtaxesandduties Conversioncosts
Definition Conversioncosts:Anycostsinvolvedinconvertingrawmaterialsintofinalproduct,includinglabour, expensesdirectlyrelatedtotheproductandanappropriateshareofproductionoverheads(butnot sales,administrativeorgeneraloverheads).
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Workedexample:Costofmanufacturedgoods Abusinesshasthefollowingdetailsrelatingtoproductionandsalesforareportingperiod: Sales:900unitsat£600each 1,000unitsareproducedwiththefollowingcostsbeingincurred: Openinginventoryofrawmaterials:200unitsat£100each Purchasesofrawmaterials:1,050unitsat£100each Closinginventoryofrawmaterials:250unitsat£100each Productionwages Productionoverheads Generaladministration,sellinganddistributioncosts
£150,000 £100,000 £100,000
Thecostofproductionshouldincludeanappropriateshareofproductionwagesandproduction overheads,butnotnon-productionexpenses. Thestatementofprofitorlossofthisbusinessforthereportingperiodisasfollows: Sales(900units£600) Costofproduction(1,000units) Rawmaterials Openinginventory(200£100) Purchases(1,050£100) Lessclosinginventory(250£100) Costofrawmaterialsused Productionwages Productionoverheads Costofproduction(1,000unitscost£350,000/1,000=£350each) Lessclosinginventory,finishedgoods(100£350) Costofsales Grossprofit Generaladministration,sellinganddistributioncosts Netprofit
£
20,000 105,000 (25,000) 100,000 150,000 100,000 350,000 (35,000)
£ 540,000 (315,000) 225,000 (100,000) 125,000
Thecostofproductionisspreadovertheunitsproduced.Anyunsoldunitsarevaluedatafigurethat reflectsashareofthesecosts.Whentheinventoryiseventuallysold,theproductionoverheads associatedwithitsmanufacturewillbetherebyproperlymatchedwiththerevenuesearned.
6.4.2 Whatisthetotalcostofitemsleftininventory? Abusinessmaybecontinuallyaddingitemstofinishedgoodsinventory,orpurchasingaparticular component.Aseachconsignmentisreceivedfromsuppliers,oreachfinishedgoodsbatchisaddedto inventory,theyarestoredintheappropriateplace,wheretheywillbemingledwithitemsalreadythere. Whenthestorekeeperissuesitemstoproductionortodespatchtheywillsimplypulloutthenearest itemtohand,whichmayhavearrivedinthelatestconsignment/batch,inanearlierconsignment/batch orinseveraldifferentconsignments/batches. Thereareseveraltechniqueswhichareusedinpracticetoattributeacosttoinventoryitems;remember thatactualmaterials,componentsandfinishedgoodsitemscanbeissuedinanyorderatallirrespective ofwheneachoneenteredinventory.
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Definitions FIFO(firstin,firstout):Itemsareusedintheorderinwhichtheyarereceivedfromsuppliers,sooldest itemsareissuedfirst.Inventoryremainingisthereforetheneweritems. LIFO(lastin,firstout):Itemsissuedoriginallyformedpartofthemostrecentdelivery,whileoldest consignmentsremaininthebin.ThisisdisallowedunderIASs. AVCO(averagecost):Aspurchasepricescanchangewitheachnewconsignmentreceived,the averagevalueofanitemisconstantlychanging.Eachitematanymomentisassumedtohavebeen purchasedattheaveragepriceofalltheitemstogether,soinventoryremainingisthereforevaluedat themostrecentaverageprice. Standardcost:Allinventoryitemsarevaluedatapredeterminedcost.Ifthisstandardcostdiffersfrom pricesactuallypaidduringtheperiodthedifferenceiswrittenoffasa'variance'inthestatementof profitorloss. Replacementcost:Thecostofaninventoryunitisassumedtobetheamountitwouldcostnowto replaceit.Thisisoften(butnotnecessarily)theunitcostofinventoriespurchasedinthenext consignmentfollowingthedateofthestatementoffinancialposition.
C H A P T E R
IntheexamyoucanexpecttouseFIFOorAVCOforthevaluationofinventoryinthestatementof financialpositionandthestatementofprofitorloss.
7
Workedexample:FIFOandAVCOcost Toillustratethevariouspricingmethods,thefollowingtransactionswillbeusedineachcase. TRANSACTIONSDURINGMAY20X7 Openingbalance1May Receipts3May* Issues4May** Receipts9May Issues11May Receipts18May Issues20May Closingbalance31May * Receiptsmeangoodsarereceivedintostore. ** Issuesrepresenttheissueofgoodsfromstore.
Quantity Units 100 400 200 300 400 100 100 200
Unitcost £ 2.00 2.10 2.12 2.40
Totalcost £ 200 840 636 240 1,916
Theproblemistoputavaluationonthefollowing. (a) Theissuesofmaterials (b) Theclosinginventory Requirement Howwouldissuesandclosinginventorybevaluedusingeachofthefollowinginturn? (a) FIFO (b) AVCO
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Solution (a) FIFOassumesthatmaterialsareissuedoutofinventoryintheorderinwhichtheywere deliveredintoinventory,ieissuesarepricedatthecostoftheearliestdeliveryremainingin inventory. Thecostofissuesandtheclosinginventoryvalueintheexample,usingFIFO,wouldbeasfollows. Date 4May 11May 20May Closinginventoryvalue
Quantity Units 200 400 100 200
Valueissued 100at£2.00 100at£2.10 200 300at£2.10 100at£2.12 400 100at£2.12 100at£2.12 100at£2.40 200
Costofissues £ £ 200 210 410 630 212 842 212 1,464 212 240 452 1,916
Notethatthecostofmaterialsissuedplusthevalueofclosinginventoryequalsthecostof purchasesplusthecostofopeninginventory(£1,916). (b) AVCOmaybeusedinvariouswaysinpricinginventoryissues.Themostcommonisthe cumulativeweightedaveragepricingmethodillustratedbelow.
Aweightedaveragepriceforallunitsininventoryiscalculated.Issuesarepricedatthis averagecost,andthebalanceofinventoryremaininghasthesameunitvaluation.
Anewweightedaveragepriceiscalculatedwheneveranewdeliveryofmaterialsintostoreis received.
Date Received Issued Balance Units Units Units Openinginventory 100 3May 400 500 4May 200 300 9May 300 600 11May 400 200 18May 100 300 20May 100 Closinginventoryvalue 200
Totalinventory value £ 200 840 1,040 (416) 624 636 1,260 (840) 420 240 660 (220) 440
Unitcost £ 2.00 2.10 2.08* 2.08** 2.08 2.12 2.10* 2.10** 2.10 2.40 2.20* 2.20** 2.20
Priceofissue £ 416 840 220 1,476 440 1,916
* Anewunitcostofinventoryiscalculatedwheneveranewreceiptofmaterialsoccurs. ** Wheneverinventoriesareissued,theunitvalueoftheitemsissuedisthecurrentweightedaverage costperunitatthetimeoftheissue. Forthismethodtoo,thecostofmaterialsissuedplusthecostofclosinginventoryequalsthecostof purchasesplusthecostofopeninginventory(£1,916).
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6.5 Inventoryvaluationsandprofit FIFOandAVCOeachproduceddifferentcosts,bothofclosinginventoriesandalsoofmaterialsissues. Sincerawmaterialcostsaffectthecostofproduction,andthecostofproductionworksthrough eventuallyintothecostofsales,itfollowsthatdifferentmethodsofinventoryvaluationwillprovide differentprofitfigures.
Workedexample:Inventoryvaluationsandprofit On1November20X2acompanyheld300unitsoffinishedgoodsininventory.Thesecost£3,600. DuringNovember20X2threebatchesoffinishedgoodswerereceivedintostorefromtheproduction department,asfollows. Date
Unitsreceived
Productioncostperunit
10November
400
£12.50
20November
400
£14
25November
400
£15
C H A P T E R
FinishedgoodssoldduringNovemberwereasfollows. Date
Unitssold
7
Salepriceperunit
14November
500
£20
21November
500
£20
28November
100
£20
1,100
IdentifytheprofitfromsellinginventoryinNovember20X2,applyingtheprinciplesof: (a) FIFO (b) AVCO Ignoreadministration,salesanddistributioncosts.
Solution (a) FIFO Date 14November 21November 28November Closinginventory
Issuecosts (300units×£12)+(200units×£12.50) (200units×£12.50)+(300units×£14) 100units×£14 400units×£15
Issuecost £ 6,100 6,700 1,400 14,200
Closing inventory £ 6,000 6,000
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(b) AVCO
1NovemberOpeninginventory 10November 14November 20November 21November 25November 28November 30NovemberClosinginventory
Units 300 400 700 (500) 200 400 600 (500) 100 400 500 (100) 400
Unitcost £ 12.000 12.500 12.286 12.286 12.286 14.000 13.428 13.428 13.428 15.000 14.686 14.686 14.686
Balancein inventory £ 3,600 5,000 8,600 (6,143) 2,457 5,600 8,057 (6,714) 1,343 6,000 7,343 (1,469) 5,874
Totalcost ofissues £ 6,143 6,714 1,469 14,326
Closing inventory £ 5,874
FIFO £ 3,600 16,600 (6,000) 14,200 22,000 7,800
AVCO £ 3,600 16,600 (5,874) 14,326 22,000 7,674
Summary:profit Openinginventory Costofproduction(400£12.50)+(400£14)+(400£15) Closinginventory Costofsales Sales(1,100×£20) Profit
Differentinventoryvaluationsproducedifferentcostofsalesandprofitsfigures.Hereopening inventoryvaluesarethesame,thereforethedifferenceintheamountofprofitundereach methodisthesameasthedifferenceinthevaluationsofclosinginventory. Theprofitdifferencesareonlytemporary.TheopeninginventoryinDecember20X2willbe£6,000 or£5,874,dependingontheinventoryvaluationused.Differentopeninginventoryvalueswill affectthecostofsalesandprofitsinDecember,sothatinthelongruninequalitiesincostofsales eachmonthwilleventhemselvesout.
Interactivequestion5:FIFO
[Difficultylevel:Examstandard]
AfirmhasthefollowingtransactionswithrespecttoitsproductR. Year1 Openinginventory:nil Buys10unitsat£300perunit Buys12unitsat£250perunit Sells8unitsat£400perunit Buys6unitsat£200perunit Sells12unitsat£400perunit Year2 Buys10unitsat£200perunit Sells5unitsat£400perunit Buys12unitsat£150perunit Sells25unitsat£400perunit
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Requirement UsingFIFO,calculatethefollowingonanitembyitembasisforbothyear1andyear2.
Closinginventory Sales Costofsales Grossprofit
SeeAnswerattheendofthischapter.
7 Usingmark-up/marginpercentagestoestablishcost Sectionoverview
Mark-upiscalculatedoncost. Marginiscalculatedonsales. Marginandmark-upcanhelpustoestablishthecostofanitemofinventory.
Itiscommontoestablishstandardgrossprofitpercentagesinrelationtocosttosetthesalesprice:
Inventorythatcost£120maybesoldatamarginof40%,sothesalesvalueis£120×100/60= £200,andtheprofitis£120×40/60=£80.
Inventorythatcost£120maybesoldatamark-upof40%toreachasalespriceof£168(120× 140/100).
C H A P T E R
7
Thesestandardpercentagescanbesetoutasfollows,usingtheaboveasanexample: Sales Cost Grossprofit
Marginonsales (salesisthe100%figure) % £ 100 200 120×100/60 (60) (120) 40 80 120×40/60
Mark-uponcost (costisthe100%figure) % £ 120×140/100 140 168 (100) 120 40 120×40/100 48
Anexamquestionmayaskyoutousegrossprofitpercentagesinordertocorrectanerrorin recordinginventoryattheendofareportingperiod.
Interactivequestion6:Mark-up
[Difficultylevel:Examstandard]
Abusinesshasvalueditsinventoryat£1,000,beingthesellingpriceoftheitems. Requirement Whatisthecostofclosinginventoryatcostassumingthebusinessoperates: (a) Onamarginof25%? (b) Onamark-upof25%? SeeAnswerattheendofthischapter.
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8 Writingoffinventories,andinventorydrawings Sectionoverview
ProvidedinventoryactuallyheldisvaluedatthelowerofcostandNRV,noinventorywrite-off entriesareneeded.
Whenanownerdrawsoutinventory:debitdrawings,creditpurchases.
Inventoryheldattheendofthereportingperiodmaybefaultyinsomeway,soitwouldappearthatan amountneedstobewrittenoff.Howdoweaccountforthis? Infact,ifthecost:NRVvaluationmethodisfollowed,itisnotnecessarytowriteanythingoffinventory attheendofthereportingperiodasalldamagedinventorywouldhavebeenreduceddowntoitsNRV whencomputingthevalueofclosinginventory.Itfollowsthenthatwedonotneedtomakeanyyearendaccountingentriesatallforinventorywrite-offs:wesimplyincludetheappropriatelow valuationofclosinginventoryinouryear-endjournal. Rememberthatmateriallossofinventoryduringthereportingperiodisaccountedforbyreducing purchasesandincreasingexpensesinthestatementofprofitorloss:referbacktoChapter8ifyouneed torefreshyourmemoryonthis.Noentriesareneededintheinventoryaccount.
8.1 Inventorydrawings Ifanownertakesitemsofinventoryfromthebusinessasdrawings,wedonotneedtoadjustopeningor closinginventoryatall.Insteadwereducethepurchasesfigureincostofsaleswiththecostofitems withdrawn. DEBIT CREDIT
Drawings Purchases
£X £X
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SummaryandSelf-test
Summary(1/2)
C H A P T E R
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Summary(2/2)
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Self-test Answerthefollowingquestions. 1
Whichofthefollowingisthecorrectcalculationforcostofsales? A B C D
Sales–purchases Openinginventory+purchases+closinginventory+carriageinwards Openinginventory+purchases–closinginventory+carriageinwards Sales–openinginventory-purchases+closinginventory–carriageinwards
2
Distinguishbetweencarriageinwardsandcarriageoutwards.
3
Costofsalesis£14,000.Purchasesfortheperiodare£14,000,carriageinwardsis£1,000,carriage outwardsis£1,500andclosinginventoryis£13,000.Whatwastheopeninginventoryfigure? A B C D
C H A P T E R
£10,500 £11,500 £12,000 £13,000
4
Givethreereasonswhygoodspurchasedmighthavetobewrittenoff.
5
CarlislehasthefollowinginventorymovementsduringMay. Openinginventory 2May Goodsin 10May Goodsout 15May Goodsin 18May Goodsout 24May Goodsin
Units 40 60 50 70 45 80
£perunit 9 10 11 11
7
AssumingthatthebusinessvaluesinventoryonaFIFObasis,whatwillbethevalueofclosing inventoryattheendofthemonth? A B C D 6
£1,615 £1,655 £1,700 £1,705
AtraderusedtheLIFOmethodtovalueinventoryattheendofJulyat£3,110.Salesandpurchases inJulywereasfollows. Date 3July 6July 10July 15July 22July 27July
Purchases(units) 100at£20/unit 50at£22/unit 80at£25/unit
Sales(units) 80 40 20
Theopeninginventoryat1Julywas50unitsvaluedat£15perunit.Thetraderneedstoadoptthe FIFOmethod. Whatistheeffectofthischangeonthetrader'sprofit? A B C D 7
£190decrease £420decrease £420increase £190increase
TheinventoryrecordsforSimmonslastmonthwereasfollows. Date 2February 13February 21February 29February
Purchases(units) 800
Sales(units) 500 400 200
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Openinginventorywas600unitsvaluedat£12,000.PurchasesinFebruarywereat£31.25per unit. ThetotalcostofsalesinFebruary,usingtheAVCOmethod,is(tothenearest£): A B C D 8
Whatwouldbetheeffectonabusiness'sprofitofdiscoveringthatinventorywithacostof£1,250 andanetrealisablevalueof£1,000hadbeenomittedfromtheinventorycountattheendofthe reportingperiod? A B C D
9
£37,000 £28,000 £17,625 £22,000
Anincreaseof£1,250 Anincreaseof£1,000 Adecreaseof£250 Noeffect
JuneLtdhasthreelinesofinventoryattheendofitsreportingperiod. Originalpurchaseprice(perunit) Estimatedfuturesellingprice(perunit) Sellinganddistributioncosts(perunit) Unitsininventory
X £1.50 £4.25 £0.75 100
Y £6.50 £8.00 £2.00 200
Z £5.00 £3.50 £0.50 250
Atwhatvalueshouldinventoryappearinthefinancialstatementsattheendofthereporting period? A B C D
£2,700 £2,325 £2,300 £2,100
10 Breconmanufacturescosmeticsandtoiletries.Ithasdecidedtorepackageitspuffertalcproductin newcovers,anddiscountthesellingprice. Thedetailsofpuffertalcareasfollows. Costofmanufacture Repackagingcosttobeincurred Sellingprice Discountonsellingprice
Peritem £2.50 £0.75 £3.00 10%
Atwhatamountshouldeachitemofpuffertalcbeincludedininventory? A B C D
£3.00 £2.70 £2.25 £1.95
11 DuringthereportingperiodMalcolmtookitemswithasellingpriceof£280forhisownuse.He tradesata40%mark-upandhadadraftprofitof£15,800beforemakinganyadjustmentsforthis matter.Hisfinalprofitis A B C D
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£15,520 £15,800 £15,600 £16,000
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12 PercyPilbeamisabookwholesaler.Commissionof4%onsellingpriceispayablebyPercyforeach sale. Thefollowinginformationisavailableinrespectoftotalinventoryofthreeofhismostpopulartitles attheendofhisreportingperiod. HenryVIII–Shakespeare Dissuasion–JaneArmstrong-Siddeley Pilgrim'sPainfulProgress–JohnBunion
Cost £ 2,280 4,080 1,280
Selling price £ 2,900 4,000 1,300
WhatisthetotalvalueoftheseinventoriesinPercy'sstatementoffinancialposition? A B C D
£7,368 £7,400 £7,560 £7,640
13 RobertaWickhamdecidestodiscountsomeoftheslower-sellingitemsinhermusicshop.These itemsat31March20X0areasfollows. Item
Cost £ 50 70 150 30
Liszt–ToPort Delius–Myth Offenbach–UptheWrongTree Bax–TotheWall
Current price £ 70 55 225 35
Discountto beapplied (%ofcurrent price) % 20 10 10 50
C H A P T E R
7
Whatisthetotalinventoryvalueoftheaboveitemsat31March20X0? A B C D
£267.00 £274.00 £300.00 £325.50
14 Fromtheinformationbelow,calculatethevalueofJock'sclosinginventoryoffoamliquidat31 October20X2usingeachmethodofpricingtheissueofmaterialstoproduction. Jockhad100litresoffoamliquidat1October20X2,purchasedat£3perlitre.Duringthemonth to31October20X2thefollowingchangesoccurred. Purchases Issues
Date 7October20X2 14October20X2 21October20X2 28October20X2 4October20X2 11October20X2 18October20X2 25October20X2
Quantity (litres) 200 300 50 100 650 80 70 250 200 600
Costper litre £ 2.50 3.00 4.00 3.50
Valueofclosinginventory: FIFObasis
£......................................
AVCObasis
£......................................
Now,gobacktotheLearningObjectivesintheIntroduction.Ifyouaresatisfiedthatyouhaveachieved theseobjectives,pleasetickthemoff.
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AnswerstoInteractivequestions
AnswertoInteractivequestion1 GRANDUNIONFOODSTORES STATEMENTOFPROFITORLOSS(EXTRACT)FORTHEYEARENDED31DECEMBER20X6 £ £ 80,000 6,000 50,000 (12,500) (43,500) 36,500
Revenue Openinginventories Addpurchases Lessclosinginventories Costofsales Grossprofit
AnswertoInteractivequestion2 DEBIT CREDIT
Expenses Otherreceivables Purchases Otherincome
£ 64,500 38,700
£
64,500 38,700
AnswertoInteractivequestion3 30.6.X3 30.6.X3
DEBIT CREDIT DEBIT CREDIT
Profitandlossledgeraccount Inventory(asset) Clearingopeninginventorytocostofsales Inventory(asset) Profitandlossledgeraccount Recordingclosinginventoryasanassetattheendof thereportingperiod
£ 23,490 40,285
£ 23,490 40,285
Thisjournalcouldeasilybeamalgamatedtodebittheincreaseininventoryduringthereportingperiod totheassetaccount,andtocreditthistotheprofitandlossledgeraccount: 30.6.X3
DEBIT CREDIT
Inventory(asset) 16,795 Profitandlossledgeraccount 16,795 Recordingclosinginventoryasanassetattheendofthereportingperiod,andas adeductionfromthecostofsales
AnswertoInteractivequestion4 Item A(NRV:30–7) B(NRV:12–2–2) C(NRV:22–8–2)
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Lowerof cost/NRV Valuation £ 20 8 12
NRV £ 23 8 12
Cost £ 20 9 14
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Quantity units 200 150 300
Totalvalue £ 4,000 1,200 3,600 8,800
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AnswertoInteractivequestion5 Year1 Purchases (units) 10 12 6
Sales (units) 8 12
Balance (units) 10 12 22 (8) 14 6 20 (12) 8
Unit cost £ 300 250 300 200
Inventory value £ 3,000 3,000 6,000 (2,400) 3,600 1,200 4,800 (3,100)* 1,700
Costof sales £ 2,400 3,100 5,500
Sales £ 3,200 4,800 8,000
Balance (units) 8 10 18 (5)* 13 12 25 (25)** 0
Unit cost £ 200 150
Inventory value £ 1,700 2,000 3,700 (1,100)* 2,600 1,800 4,400 (4,400)** 0
Costof sales £ 1,100 4,400 5,500
Sales £ 2,000 10,000 12,000
£ 0 7,200 (1,700)
£ 8,000 (5,500) 2,500
1,700 3,800 0
12,000 (5,500) 6,500
*2@£300+10@£250=£3,100 Year2 Purchases (units) B/f 10 12
Sales (units) 5 25
C H A P T E R
7
* 2@£250+3@£200=£1,100 ** (3+10)@£200+12@£150=£4,400 Statementofprofitorloss Year1 Sales Openinginventory Purchases(3,000+3,000+1,200) Closinginventory Costofsales Grossprofit
Year2 Sales Openinginventory Purchases(2,000+1,800) Closinginventory Costofsales Grossprofit
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AnswertoInteractivequestion6 (a) Sales COS GP
% 100 (75) 25
£ 1,000 (750)1,000×75/100 250
Inventoryshouldbevaluedat£750whenamarginof25%operates. (b) Sales COS GP
% 125 (100) 25
£ 1,000 (800)1,000×100/125 200
Inventoryshouldbevaluedat£800whenamark-upof25%operates.
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AnswerstoSelf-test 1
C
Openinginventory+purchases–closinginventory+carriageinwards=costofsales
2
Carriageinwardsispaidongoodscomingintothebusinessandisaddedtothecostofpurchases. Carriageoutwardsispaidongoodsgoingoutofthebusinesstocustomersandischargedto sellingexpenses.
3
C £ 12,000 15,000 27,000 (13,000) 14,000
Openinginventoryvalue(balancingfigure) Addpurchases(inc.carriageinwards) Lessclosinginventory Costofgoodssold
IfyoupickedA,thenyouwronglyincludedcarriageoutwardsincostofgoodssold.IfyouchoseB, thenyouusedthecarriageoutwardsinsteadofthecarriageinwardsfigureinyourcalculations. WithD,youignoredcarriageinwardsandoutwardsaltogether! 4
Goodsarestolenorlost Goodsaredamaged Goodsareobsolete
5
C
Closinginventory=40+60–50+70–45+80=155units
C H A P T E R
7
ValuedonaFIFObasis Units 80 70 5() 155
Dateofpurchase 24May 15May 2May 6
D
£perunit 11 11 10
Totalcost £ 880 770 50 1,700
Closinginventory=50+100+50+80–80–40–20=140units ClosinginventoryunderFIFO 80@£25= 50@£22= 10@£20=
£ 2,000 1,100 200 3,300
Soprofitis(£3,110–£3,300)=£190moreunderFIFO 7
B
Closinginventory=600+800–500–400–200=300units ValuedonanAVCObasis:
Dateofpurchase Openinginventory 2Feb 13Feb
Units 600 (500) 100 800 900
Openinginventory Purchases(800£31.25) Closinginventory(300£30.00) Costofsales
£perunit 20.00 20.00 31.25 30.00
Totalcost £ 12,000 (10,000) 2000 25,000 27,000 £ 12,000 25,000 (9,000) 28,000
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8
B
Itshouldnowbeincludedinclosinginventoryat£1,000(lowerofcostandNRV).Thiswill increaseprofitby£1,000.
9
D
X Y Z
10 D
11 D
Lowerofcost andNRV £ 150 1,200 750 2,100
Atcost(1001.50) AtNRV(200(8.00–2.00)) AtNRV(250(3.50–0.50))
Inventoryvaluation–Lowerof –Cost –Netrealisablevalue(sellingpricelessdiscountlessrepackagingcost)
12 A
Draftprofit Addback:drawingsatcost£280x100/140
13 A
Shakespeare Armstrong-Siddeley Bunion Liszt Delius Offenbach Bax
Cost £ 2,280 4,080 1,280 Cost £ 50.00 70.00 150.00 30.00
£2.50 £1.95 £ 15,800 200 16,000
NRV SP×0.96 £ 2,784 3,840 1,248
Lowerofcost andNRV £ 2,280 3,840 1,248 7,368
NRV SP×(100–disc) £ 56.00 49.50 202.50 17.50
Lowerofcost andNRV £ 50.00 49.50 150.00 17.50 267.00
14 At31October20X2Jockhas100+650–600=150litresininventory Firstinfirstoutmethod(FIFO) Quantityininventory(litres) 100 50 150
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Acquisitiondate 28October 21October
Costper litre £ 3.50 4.00
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Closinginventory value £ 350 200 550
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Weightedaveragecost(AVCO) Date
Quantity(litres)
Openingbalance 4OctIssue 7OctPurchase 11OctIssue 14OctPurchase 18OctIssue 21OctPurchase 25OctIssue 28OctPurchase
100 (80) 20 200 220 (70) 150 300 450 (250) 200 50 250 (200) 50 100 150
Costperlitre 3.00 3.00 2.50 2.55 3.00 2.85 4.00 3.08 3.50
Value £ 300 (240) 60 500 560 (178) 382 900 1,282 (712) 570 200 770 (616) 154 350 504
Averagecostperlitre £ 3.00 3.00 2.55 2.55 2.85 3.08 3.36
7
Closinginventoryvalue=150litres@£3.36=£504
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CHAPTER8
Irrecoverabledebtsand allowances
Introduction Examinationcontext TopicList 1 Irrecoverabledebts 2 Allowancesforreceivables 3 Accountingforirrecoverabledebtsandreceivablesallowances 4 IrrecoverabledebtsandallowancesontheETB SummaryandSelf-test AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Recordandaccountfortransactionsandeventsresultinginincome,expenses,assets, liabilitiesandequityinaccordancewiththeappropriatebasisofaccountingandthelaws, regulationsandaccountingstandardsapplicabletothefinancialstatements
Prepareanextendedtrialbalance
Identifythemaincomponentsofasetoffinancialstatementsandspecifytheirpurpose andinterrelationship
Prepareandpresentastatementoffinancialposition,statementofprofitorlossand statementofcashflows(orextractstherefrom)fromtheaccountingrecordsandtrial balanceinaformatwhichsatisfiestheinformationrequirementsoftheentity
Specificsyllabuslearningoutcomesare:1d,2c,3a,3c
Syllabuslinks Thematerialinthischapterwillbedevelopedfurtherinthispaper,andthenintheProfessionalLevel moduleofFinancialAccountingandReporting.
Examinationcontext Questionsonthetopicsinthischapterwillbesetasmultiplechoicequestions,someofwhichmay involvecalculationssothatthecorrectanswercanbeselected.Veryoftendoubleentryquestionsare phrasedintermsofpreparingajournal. Intheexamyoumayberequiredto:
214
Identifytheaccountingprinciplesbehindaccountingforirrecoverabledebtsandallowances
Identifyjournalsforwritingoffirrecoverabledebts,receivingcashinrespectofdebtspreviously writtenoff,andsettinguporadjustingspecificallowancesforreceivables
Calculatethefigureinthestatementoffinancialpositionfigureforreceivables
Identifythestatementofprofitorlossfigureforirrecoverabledebtsexpense
Identifytheeffectsofirrecoverabledebtsandallowancesforreceivablesongrossandprofitforthe periodinthestatementofprofitorloss
Specifyhowyear-endirrecoverabledebtsandallowancesforreceivablesareaccountedforonthe extendedtrialbalance
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1 Irrecoverabledebts Sectionoverview
Writingoffanirrecoverabledebt
DEBIT CREDIT
Accountingforreceiptofcashinrespectofadebtpreviouslywrittenoff:
DEBIT Cash CREDIT Irrecoverabledebtsexpense
Thefactthatacustomer'schequeisreturnedunpaiddoesnotautomaticallymeanthecustomer's debtshouldbewrittenoff.
Irrecoverabledebtsexpense Tradereceivables
£X £X
£X £X
Customerswhobuygoodsoncreditmightfailtopayforthem,perhapsoutofdishonesty,orbecause theyhavegonebankruptandcannotpay,orbecausethereisadisputebetweenthepartiesaboutthe amountpayable. Foronereasonoranother,abusinessmightdecidetogiveupexpectingpaymentofthedebtandto writeitoff.
Definitions
C H A P T E R
Irrecoverabledebt:Adebtwhichisnotexpectedtobepaid. Writingoff:Chargingthecostofthedebtagainsttheprofitfortheperiod.
1.1 Writingoffirrecoverabledebts Whenabusinessdecidesthataparticulardebtwillnotbepaid,thewholeamountofthereceivablein questionis'writtenoff'asanexpenseinthestatementofprofitorloss: DEBIT CREDIT
Irrecoverabledebtsexpense(statementofprofitorloss) Tradereceivables(statementoffinancialposition)
8
£X £X
Irrecoverabledebtswrittenoffarepresentedforasfollows.
Salesareshownattheirfinalinvoicevalueinthestatementofprofitorloss.Thesalehasbeen made,expensehasbeenincurredmakingitandgrossprofitshouldbeearned.Thesubsequent failuretocollectthedebtisaseparateadministrativematter.
Irrecoverabledebtsexpenseisshownasanadministrativeexpense.
Thereceivableisremovedfromthereceivablescontrolaccountandledger.
Supposeaninvoiceforservicesrenderedtoacustomerfor£300isnevergoingtobepaid.Thenet effectofthewayweaccountforthisasfollows: £ 300 (300) 0
Revenue(inthestatementofprofitorloss) Irrecoverabledebtwrittenoff(administrativeexpense)
Overallhoweveralossismadeonthetransactionsincetheentityhasincurredcostsinrenderingthe service,andthesewillnotberecovered.Thebusinesshasalsoforegonetheprofititcouldhavemadeon thetransactioninsellingthegoodorservicetoadifferentcustomer. Whenadebtiswrittenoff,thevalueofthereceivableasacurrentassetiszero.Itisnolonger recognisedasanassetbecausethebusinessisunlikelytogenerateanybenefitsfromit.
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1.1.1 Irrecoverabledebtswrittenoffandsubsequentlypaid Anirrecoverabledebtwhichhasbeenwrittenoffmightbeunexpectedlypaid. Whetheritispaidinthesamereportingperiodorasubsequentone,theentryis DEBIT CREDIT
Cash Irrecoverabledebtsexpense
£X
£X
Wedonotneedtocreditreceivablesasthishasalreadybeendonewhenthedebtwasinitiallywritten off.
Workedexample:Irrecoverabledebtsubsequentlypaid WehavethefollowinginformationonBlacksmith'sForgefortheyearto31December20X5. Inventory,1January20X5 Purchases Inventory,31December20X5 Cashsales Creditsales Discountsallowed Discountsreceived Irrecoverabledebtsexpense Debtspaidin20X5whichwerepreviouslywrittenoffasirrecoverablein20X4 Otherexpenses
£ 6,000 122,000 8,000 100,000 70,000 1,200 5,000 9,000 2,000 31,800
Wecanpreparethestatementofprofitorlossasfollows: BLACKSMITH'SFORGE STATEMENTOFPROFITORLOSSFORTHEYEARENDED31.12.20X5 Sales(100,000+70,000) Openinginventory Purchases Lessclosinginventory Costofsales Grossprofit Add discountsreceived Expenses Discountsallowed Irrecoverabledebtsexpense(9,000–2,000) Otherexpenses Profitfortheyear
£
6,000 122,000 (8,000) 1,200 7,000 31,800
£ 170,000 (120,000) 50,000 5,000 55,000 (40,000) 15,000
1.2 Dishonouredchequesandirrecoverabledebts Wehaveseenthatwhenacustomer'schequeisdishonoured,wedebittradereceivables(reinstating thedebt)andcreditcash(removingthe'receipt'). Inanexamquestion,unlessyouarespecificallytoldotherwise,youshouldNOTautomatically treatadishonouredchequeasanirrecoverabledebt.Chequesmaybedishonouredfor administrativereasonsthathavenothingtodowithacustomer'sactualinabilitytopayitsdebt,sodo notpresumethatitwillneverbepaid.
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2 Allowancesforreceivables Sectionoverview
Ifthereisdoubtthataspecificdebtwillberecoveredanallowancecanbemade,whichissetoff againstreceivablesinthestatementoffinancialposition.
Onsettingupanallowanceforirrecoverabledebts,andonincreasinganexistingallowance:
DEBIT Irrecoverabledebtsexpense(statementofprofitorloss) £X CREDIT Allowanceforreceivables(statementoffinancialposition)
Whenasmallerallowanceisneededattheendofasubsequentreportingperiod,theentriesare reversed:
DEBIT Allowanceforreceivables CREDIT Irrecoverabledebtsexpense
£X
£X £X
Specificdebtsowedtothebusinessareidentifiedascertainnevertobecollectedwhenirrecoverable debtsarewrittenoff. However,becauseoftherisksinvolvedinsellinggoodsoncredit,thebusinessmayconcludethatsome otherspecificdebtshaveariskofbeingirrecoverable.Wecallsuchbalances'doubtfulreceivables'.We leavethemasanassetonthestatementoffinancialposition,butcreateanallowance(acreditbalance) whichwesetoffagainstthereceivable.
Definition Allowanceforreceivables:Anamountinrelationtospecificdebtsthatreducesthereceivablesassetto itsprudentvaluationinthestatementoffinancialposition.Itisoffsetagainsttradereceivables,which areshownatthenetamount.
C H A P T E R
Anallowanceforreceivablesprovidesforpotentialirrecoverabledebts,asaprecautionbythebusiness. Thebusinesswilltherebybemorelikelytoavoidclaimingprofitswhichsubsequentlyfailtomaterialise becausesomespecificdebtsturnouttobeirrecoverable.
8
Whenanallowanceisfirstmade,itischargedasanexpenseinthestatementofprofitorlossalong withtheirrecoverabledebtexpensefortheperiodinwhichtheallowanceiscreated.Theother sideoftheentrycreditsanaccountinthestatementoffinancialposition,theallowancefor receivables.Thedoubleentryis: DEBIT CREDIT
Irrecoverabledebtsexpense(statementofprofitorloss–administrativeexpense) £X Allowanceforreceivables(statementoffinancialposition) £X
Whenanallowancealreadyexists,butissubsequentlyincreased,theamountoftheincreasein allowanceisdebitedtoirrecoverabledebtexpense,andcreditedtotheallowance.
Whenanallowancealreadyexists,butissubsequentlyreduced,theamountofthedecreasein allowanceiscreditedtoirrecoverabledebtexpenseinthestatementofprofitorlossforthe periodinwhichthereductioninallowanceismade,anddebitedtotheallowance.
Workedexample:Allowanceforreceivables1 Abusinesscommencesoperationson1July20X4,andinthetwelvemonthsto30June20X5makes creditsalesof£300,000andwritesoffirrecoverabledebtsof£6,000.Cashreceivedfromcustomers duringthereportingperiodis£244,000.
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£ 300,000 0 300,000 (244,000) 56,000 (6,000) 50,000
Creditsalesduringthereportingperiod Addreceivablesat1July20X4 Totaldebtsowedtothebusiness Lesscashreceivedfromcreditcustomers Lessirrecoverabledebtswrittenoff Tradereceivablesoutstandingat30June20X5 Oftheseoutstandingdebtscollectionofanamountof£5,000isdoubtful. Thebusinessaccountsforitsirrecoverableanddoubtfuldebtsasfollows: DEBIT CREDIT
£ Irrecoverabledebtsexpense(£6,000+£5,000) Allowanceforreceivables Tradereceivables
£
11,000
5,000 6,000
Inthestatementoffinancialposition,thevalueoftradereceivables(afterthedebtwrite-off,ie£50,000) mustbeshownwiththeallowanceforreceivablesnettedoff. Totalreceivablesat30June20X5 Less,allowanceforreceivables Amountinthestatementoffinancialposition
£ 50,000 (5,000) 45,000
Workedexample:Allowanceforreceivables2 CorinFlakeownsandrunstheAerobicHealthFoodsShop.Hecommencedtradingon1January20X1, sellinghealthfoodstocustomers,mostofwhommakeuseofacreditfacilitythatCorinoffers. (Customersareallowedtopurchaseupto£200ofgoodsoncreditbutmustrepayacertainproportion oftheiroutstandingdebteverymonth.) Thiscreditsysteminitiallygivesrisetoalargenumberofirrecoverabledebts,butexperiencehelpsCorin tocontrolthembythethirdyear.CorinFlake'sresultsforhisfirstthreeyearsofoperationsareas follows. Yearto31December20X1 Grossprofit Irrecoverabledebtswrittenoff Debtsowedbycustomersasat31December20X1 Allowanceforreceivables Otherexpenses Yearto31December20X2 Grossprofit Irrecoverabledebtswrittenoff Debtsowedbycustomersasat31December20X2 Allowanceforreceivables Otherexpenses Yearto31December20X3 Grossprofit Irrecoverabledebtswrittenoff Debtsowedbycustomersasat31December20X3 Allowanceforreceivables Otherexpenses
£27,000 £8,000 £40,000 £1,000 £20,000 £45,000 £10,000 £50,000 £1,250 £28,750 £60,000 £7,000 £30,000 £800 £32,850
Requirement Foreachofthesethreereportingperiods,calculatethebusiness'sprofitfortheperiod,andstatethe valueoftradereceivablesappearinginthestatementoffinancialpositionasat31December.
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Solution AEROBICHEALTHFOODSSHOP STATEMENTOFPROFITORLOSSFORTHEYEARSENDED31DECEMBER Grossprofit Expenses: Irrecoverabledebtswrittenoff Increase/decreasein allowanceforreceivables* Otherexpenses Profit/(loss)fortheyear
£
20X1
8,000 1,000 20,000
£ 27,000 (29,000) (2,000)
£
20X2
10,000 250 28,750
£ 45,000 (39,000) 6,000
£
20X3
7,000 (450) 32,850
£ 60,000 (39,400) 20,600
*Wecalculatethestatementofprofitorlossamountby:
PreparingaTaccountfortheallowance
Carryingdownthefigurethatwerequireattheendofeachreportingperiod'sstatementof financialposition
Treatingthebalancingfigureinthereportingperiodasthechargeorthewritebackrequiredin thestatementofprofitorlossforthatreportingperiod. ALLOWANCEFORRECEIVABLES
31.12.X1 Balancec/d
£ 1,000 1,000
31.12.X1
31.12.X2 Balancec/d
1,250 1,250
31.12.X3 Irrecoverabledebt expense(balfig) 31.12.X3 Balancec/d
£
Irrecoverabledebt expense
1,000 1,000
1.1.X2 31.12.X2
Balanceb/d Irrecoverabledebt expense(balfig)
1,000 250 1,250
450 800 1,250
1.1.X3
Balanceb/d
1,250 1,250
1.1.X4
Balanceb/d
800
C H A P T E R
8
VALUEOFTRADERECEIVABLESINTHESTATEMENTOFFINANCIALPOSITION Totalvalueofreceivables Lessallowanceforreceivables Valueinthestatementoffinancialposition
Asat Asat Asat 31.12.20X1 31.12.20X2 31.12.20X3 £ £ £ 40,000 50,000 30,000 (1,000) (1,250) (800) 39,000 48,750 29,200
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3 Accountingforirrecoverabledebtsandreceivables allowances Sectionoverview
Theirrecoverabledebtsexpenseaccountwillbedebitedwithdebtswrittenoffandwithincreases inallowancesforreceivables.Itwillbecreditedwithamountsreceivedinrespectofdebtswritten off,andwithreductionsinreceivablesallowances.
Thetradereceivablesaccountisonlyaffectedwhenitiscreditedwhenadebtiswrittenoff.Itis unaffectedbyaccountingentriesrelatedtotheallowanceforreceivables.
3.1 Irrecoverabledebtswrittenoff:ledgeraccountingentries Thedoubleentrybookkeepingissplitintotwoseparatetransactions.Torecap:
Whenitisdecidedthataparticulardebtwillnotbepaid,thecustomerisnolongercalledan outstandingreceivable,andbecomesanirrecoverabledebt. DEBIT CREDIT
Irrecoverabledebtsexpenseaccount Tradereceivables
£X £X
Inthereceivablesledger,personalaccountsofthecustomerswhosedebtsareirrecoverablewillbe creditedofftheledger.
Attheendofthereportingperiod,thebalanceontheirrecoverabledebtexpenseaccountis transferredtotheprofitandlossledgeraccount(likeallotherexpenseaccounts). DEBIT CREDIT
Profitandlossledgeraccount Irrecoverabledebts
£X £X
Whereanirrecoverabledebtissubsequentlyrecovered,theaccountingentrieswillbeasfollows. DEBIT CREDIT
Cash Irrecoverabledebtsexpenseaccount
£X £X
Interactivequestion1:Irrecoverabledebtswrittenoff
[Difficultylevel:Intermediate]
At1October20X5abusinesshadtotaloutstandingdebtsof£8,600.Duringthe12monthreporting periodto30September20X6thefollowingtransactionstookplace. (a) Creditsales£44,000. (b) Paymentsfromcustomers£49,000. (c) Twodebts,for£180and£420,weredeclaredirrecoverableandthecustomersarenolonger purchasinggoodsfromthecompany.Thesearetobewrittenoff. Requirement Preparethetradereceivablesaccountandtheirrecoverabledebtsaccountforthereportingperiod. SeeAnswerattheendofthischapter.
3.2 Allowanceforreceivables:ledgeraccountingentries Ifparticularcustomersareregardedasbeinglesslikelytopaybutthedebtisnotseenasirrecoverableas such,thetradereceivablesbalanceiscompletelyuntouched.Anallowanceaccountissetupbythe followingentries: DEBIT CREDIT
220
Irrecoverabledebtsexpense Allowanceforreceivables
£X
£X
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Whenpreparingthestatementoffinancialposition,thecreditbalanceontheallowanceaccountis deductedfromthebalanceonthereceivablesaccount. Insubsequentreportingperiods,theallowancewillbeadjustedasfollows.
Carrydownthenewallowancerequiredintheallowanceforreceivablesaccount.
Calculatethechargeorcredittothestatementofprofitorloss. –
Iftheallowancehasrisen: CREDIT DEBIT
Allowanceforreceivables Irrecoverabledebtsexpense
£X £X
withtheamountoftheincrease. –
Iftheallowancehasfallen: DEBIT CREDIT
Allowanceforreceivables Irrecoverabledebtsexpense
£X £X
withtheamountofthedecrease.
Workedexample:Accountingentriesforallowanceforreceivables AlexGulliblehastotalreceivablesoutstandingat31December20X2of£28,000.Hebelievesthereisa chancethat£280ofthesebalancesmaynotbecollectedandwishestomakeanappropriateallowance. Beforenow,hehasnotmadeanyallowanceforreceivablesatall. On31December20X3histradereceivablesare£40,000.Hebelievesanallowanceof£2,000needsto bemadeagainstspecificdebtsinthereceivablesledger. WhataccountingentriesshouldAlexmakeon31December20X2and31December20X3,andwhat figuresfortradereceivableswillappearinhisstatementsoffinancialpositionasatthosedates?
C H A P T E R
Solution At31December20X2
8
Alexwillmakethefollowingentries: DEBIT CREDIT
Irrecoverabledebtsexpense Allowanceforreceivables
£280
£280
Inthestatementoffinancialpositionreceivableswillappearasfollows. £ 28,000 (280) 27,720
Tradereceivables Lessallowanceforreceivables At31December20X3 Followingtheproceduredescribedabove,Alexwillcalculateasfollows. ALLOWANCEFORRECEIVABLES Balancec/d(2)
£ 2,000 2,000
Balanceb/d(1) Irrecoverabledebtsexpense(3)
£ 280 1,720 2,000
Sooncompletingstep(3)hewillmakethefollowingentries: DEBIT CREDIT
Irrecoverabledebtsexpense Allowanceforreceivables
£1,720
£1,720
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Inthestatementoffinancialpositiontradereceivableswillbeshownasfollows. £ 40,000 (2,000) 38,000
Tradereceivables Lessallowanceforreceivables
Inpractice,astatementoffinancialpositionwouldnormallyshowonlythenetfigure(£27,720in20X2, £38,000in20X3).
Workedexample:Accountingentriesforspecificallowancesubsequentlywrittenoff AlexGulliblehasdoubtsaboutacustomer'sabilitytopayandmakesanallowanceforthewholeofhis debtof£3,000at31December20X4.Duringtheyearended31December20X5,thecustomerpays £2,000andthebalanceof£1,000istobewrittenoffasirrecoverable.Howisthisaccountedforduring theyearended31December20X5?
Solution Theanswerarisesinthreestages. 1 2 3
Setuptheallowance Receivecashandwriteoffthebalance Writebackallowanceasayearendadjustment ALLOWANCEFORRECEIVABLES
Irrecoverabledebts
£ 3,000
£ 3,000
Specificallowanceb/f
RLCA(EXTRACT)
£
£ 2,000 1,000
Cashreceived Irrecoverabledebt
IRRECOVERABLEDEBTS RLCA I/S
£ 1,000 2,000 3,000
£ 3,000 3,000
Allowanceforreceivables
Soduringtheyearended31December20X4,£3,000ischargedtothestatementofprofitorlossand duringtheyearended31December20X5,£2,000isrecovered.Thisleavesanetchargeforthetwo yearsof£1,000,theamountoftheirrecoverabledebt.
Interactivequestion2:Receivablesallowance
[Difficultylevel:Examstandard]
HoraceGoodrunningrealisesthathisbusinesswillsufferanincreaseincustomersnotpayinginthe futureandsohedecidestomakeanallowanceagainstthosewhoareatgreaterriskattheendofeach reportingperiod. Y/e28.2.20X6 Y/e28.2.20X7 Y/e28.2.20X8
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Balanceon receivables account £ 15,200 17,100 21,400
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Balanceat riskof default £ 304 342 214
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Requirements Foreachofthethreereportingperiods: (a) Whataretheclosingtradereceivablesandallowanceforreceivablesbalances? (b) Whatchargeismadetothestatementofprofitorloss? (c) Howwouldreceivablesappearinthestatementoffinancialposition? SeeAnswerattheendofthischapter.
4 IrrecoverabledebtsandallowancesontheETB Sectionoverview
Anadjustmentjournalforwritingoffadebtdebitstheirrecoverabledebtsexpenselineandcredits tradereceivables.Thedebitincreasesthestatementofprofitorlossexpense;thecreditreduces tradereceivablesattheendofeachreportingperiod.
Adjustmentjournalforsettinguporincreasingareceivablesallowance:debitirrecoverabledebts, creditareceivablesallowanceline.Thedebitincreasesthestatementofprofitorlossexpense;the creditsetsuptheallowancetobesetagainsttradereceivablesinthestatementoffinancial position.
Sofarwehavelookedathowirrecoverabledebtsandallowancesarecalculatedthenaccountedforin theledgeraccounts.Becausedecisionsaboutirrecoverabledebtsanddoubtfuldebtsareusuallymade andaccountedforaftertheinitialtrialbalancehasbeenextracted,aneaterwayofincorporatingthe relevantfiguresistousetheETB.
Calculatetheamountofirrecoverabledebtsandtheleveloftheallowanceasusual
Preparetheyearendjournalsasusual
EnterthesejournalsintheadjustmentscolumnsoftheETB,openingnewlinesforirrecoverable debtsexpenseandallowanceforreceivablesifnecessary
IncludetheseadjustmentsintheETBcross-casttopreparethefinancialstatements
Enterthejournalsintheledgeraccountsasusual
C H A P T E R
8
Workedexample:IrrecoverabledebtsandallowancesontheETB Lorrainerunsabookshop.Shehasextractedthefollowinginitialtrialbalanceasat31December20X9: DR £
Cashatbank Openingcapital Loan Non-currentassets Tradepayables Irrecoverabledebtexpense Expenses Purchases Sales Tradereceivables Allowanceforreceivables Drawings Suspense Profitfortheyear(tobedetermined)
4,391 30,000 50 3,896 42,875 8,622 38,833 ? 128,667
CR £
20,000 2,000 9,642 96,475 350 200 128,667
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Sheneedstotakeaccountofthefollowingmatters: (a) Asattheendofthereportingperiodthereisadebtof£695tobewrittenoff. (b) Oftheremainingreceivables,Lorraineisconcernedthatoneamountof£250mayprovedifficultto recover,sowishestomakeanallowanceagainstit. (c) Duringthereportingperiod,£200wasbankedinrespectofadebtwhichhadbeenwrittenoffin thereportingperiodended31December20X8.Theonlyentryinrespectofthiswasinthecashat bankaccount. CompleteLorraine'sETBtocalculateherprofitforthereportingperiod.
Solution Ledgerbalance Trialbalance DR CR £ £ Cashatbank 4,391 Openingcapital 20,000 Loan 2,000 Non-currentassets 30,000 Tradepayables 9,642 Irrecoverabledebt expense 50 Expenses 3,896 Purchases 42,875 Sales 96,475 Tradereceivables 8,622 Allowancefor receivables 350 Drawings 38,833 Suspense 200 Profitfortheperiod 128,667 128,667
Adjustments DR CR £ £ 695 300 695 100 200 995 995
StatementofprofitorStatementoffinancial loss position DR CR DR CR £ £ £ £ 4,391 20,000 2,000 30,000 9,642 445 3,896 42,875 96,475 7,927 250 38,833 49,259 49,259 96,475 96,475 81,151 81,151
Theadjustingjournalsareasfollows:
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£
£
(a) DEBIT CREDIT
Irrecoverabledebtexpense Tradereceivables
695
695
(b) DEBIT CREDIT
Allowanceforreceivables(350–250) Irrecoverabledebtexpense
100
100
(c) DEBIT CREDIT
Suspensea/c Irrecoverabledebtexpense
200
200
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SummaryandSelf-test
Summary
C H A P T E R
8
Irrecoverabledebtsandallowances
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Self-test Answerthefollowingquestions. 1
Anirrecoverabledebtarisesinwhichofthefollowingsituations? A B C D
2
Acustomerpayspartoftheaccount Aninvoiceisindispute Thecustomergoesbankrupt Achequereceivedinsettlementisdishonouredbythecustomer'sbank
Anallowanceforreceivablesattheendofareportingperiodof£4,000isrequired.Theallowance forreceivablesbroughtforwardfromthepreviousperiodis£2,000.Whatchangeisrequiredthis reportingperiod? A B C D
Increaseby£4,000 Decreaseby£4,000 Increaseby£2,000 Decreaseby£2,000
3
Ifareceivablesallowanceisincreased,whatistheeffectonthestatementofprofitorloss?
4
Whatisthedoubleentrytorecordanirrecoverabledebtwrittenoff?
5
On1January20X5Ploddhadadoubtfuldebtallowanceof£1,000.During20X5hewroteoff debtsof£600andwaspaid£80bytheliquidatorofacompanywhosedebtshadbeenwrittenoff completelyin20X4.Attheendof20X5itwasdecidedtoadjustthedoubtfuldebtsallowanceto £900. Whatisthenetexpenseforirrecoverabledebtsinthestatementofprofitorlossfor20X5? A B C D
6
£420 £580 £620 £780
Smithhasreceivablestotalling£16,000afterwritingoffirrecoverabledebtsof£500,andhehasan allowanceforreceivablesbroughtforwardof£2,000.Hewishestocarryforwardanallowanceof £800. Whatwillbetheeffectonprofitofadjustingtheallowance? A B C D
7
£700decrease £700increase £1,200decrease £1,200increase
At31December20X9Folland'sreceivablestotalled£120,000.Follandwishestohaveanallowance againstspecificreceivablesof£3,600,whichis25%higherthanitwasbefore.Duringtheyear irrecoverabledebtsof£3,200werewrittenoffandirrecoverabledebts(writtenoffthreeyears previously)of£150wererecovered. Whatisthenetchargeforirrecoverabledebtsforthe12monthreportingperiodended 31December20X9? A B C D
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£720 £900 £3,770 £3,950
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8
Duringthe12monthreportingperiodended31December20X8Keeledecreaseditsreceivables allowanceby£600.Anirrecoverabledebtwrittenoffinthepreviousreportingperiodamounting to£300wasrecoveredin20X8. Iftheprofitofthereportingperiodafteraccountingfortheaboveitemsis£5,000,whatwasit beforeaccountingforthem? A B C D
9
£4,100 £4,700 £5,300 £5,900
Bodkinhadthefollowingbalancesinitstrialbalanceat30June20X1. Tradereceivables Irrecoverabledebtsexpense Allowanceforreceivablesat1July20X0
£ 70,000 500 5,000
Bodkinwishestocarryforwardat30June20X1anallowanceequalto10%oftradereceivables. Whatistheirrecoverabledebtsfigureinthestatementofprofitorlossforthe12monthreporting periodended30June20X1? A B C D
Chargeof£2,450 Creditof£2,450 Chargeof£2,500 Creditof£2,500
10 Wackohadareceivablesallowanceat1January20X0of£1,000.Hecalculatesthatat 31December20X0areceivablesallowanceof£1,500isrequired.Inaddition£2,000ofdebtswere writtenoffduringthereportingperiod,whichincludes£50previouslyprovidedfor. HowmuchshouldbeincludedinWacko'sstatementofprofitorlossinrelationtoirrecoverable debtsforthe12monthreportingperiodended31December20X0? A B C D
£1,500 £2,450 £2,500 £2,550
C H A P T E R
8
Now,gobacktotheLearningObjectivesintheIntroduction.Ifyouaresatisfiedthatyouhaveachieved theseobjectives,pleasetickthemoff.
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AnswerstoInteractivequestions
AnswertoInteractivequestion1 TRADERECEIVABLES Openingbalanceb/fd Sales
£ 8,600 44,000 52,600
Openingbalanceb/d
3,000
Cash Irrecoverabledebtsexpense(180+420) Closingbalancec/d
£ 49,000 600 3,000 52,600
IRRECOVERABLEDEBTS £ 600 600
Receivables
£ 600 600
P&L
AnswertoInteractivequestion2 Theentriesforthethreereportingperiodsareshownbelow. TRADERECEIVABLES(EXTRACT) 28.2.20X6 28.2.20X7 28.2.20X8
£ 15,200 17,100 21,400
Balance Balance Balance
£
ALLOWANCEFORRECEIVABLES 28.2.20X6 Balancec/d
£ 304 304
28.2.20X6 P&Laccount
£ 304 304
28.2.20X7 Balancec/d
342 342
1.3.20X6 Balanceb/d 28.2.20X7 P&Laccount(balfig)
304 38 342
28.2.20X8 28.2.20X8
128 214 342
1.3.20X7 1.3.20X8
P&Laccount(balfig) Balancec/d
Balanceb/d Balanceb/d
342 342 214
PROFITANDLOSSLEDGERACCOUNT(EXTRACT) 28.2.20X6 Allowancefor receivables 28.2.20X7 Allowancefor receivables
£
304 38
£
28.2.20X8 Allowanceforreceivables
128
STATEMENTOFFINANCIALPOSITION:EXTRACTASAT Currentassets Tradereceivables Lessallowanceforreceivables
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20X6 £
20X7 £
20X8 £
15,200 (304) 14,896
17,100 (342) 16,758
21,400 (214) 21,186
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AnswerstoSelf-test 1
C
Whenacustomerbecomesbankruptthereisnomoneywithwhichtosettlethedebt,soit mustberegardedasbeingirrecoverable.Acustomersettlingonlypartofanaccount,an invoicebeingindisputeandachequebeingdishonouredbythecustomer'sbank(ieitbeing returnedunpaid)mayallbecausedbyadministrativeproblems;furtheranalysisofthe situationwillneedtobedonebeforeconcludingthatthedebtisirrecoverable.
2
C
Theallowanceinthestatementoffinancialpositionneedstobeincreasedby£2,000to £4,000;thiswillbeachargeinthestatementofprofitorloss.
3
Theincreaseintheallowanceischargedasanexpenseinthestatementofprofitorloss.
4
DEBIT Irrecoverabledebtsaccount(expenses) CREDITTradeaccountsreceivable
5
A
ALLOWANCEFORRECEIVABLES
Irrecoverabledebts c/d
£ 100 900 1,000
b/d
£ 1,000 1,000
IRRECOVERABLEDEBTSEXPENSE Receivables 6
£ 600 600
D
£ 80 100 420 600
ALLOWANCEFORRECEIVABLES
Irrecoverabledebtsexpense c/d 7
Cash Allowanceforreceivables Statementofprofitorloss
C
£ 1,200 800 2,000
C H A P T E R
8
b/d
£ 2,000 2,000
IRRECOVERABLEDEBTSEXPENSE
Receivables Allowanceforreceivables
£ 3,200 720 3,920
Cash Statementofprofitorloss
£ 150 3,770 3,920
ALLOWANCEFORRECEIVABLES c/d 8
£ 3,600 3,600
b/d(3,600×100/125) Irrecoverabledebtsexpense
£ 2,880 720 3,600
A £ 4,100 600 300 5,000
Profitbeforeirrecoverabledebts(balancingfigure) AddDecreaseinallowance AddIrrecoverablerecovered Profitafterirrecoverabledebts
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9
C
ALLOWANCEFORRECEIVABLES
c/d(10%×70,000)
£ 7,000 7,000
b/d Irrecoverabledebtsexpense
£ 5,000 2,000 7,000
IRRECOVERABLEDEBTSEXPENSE
b/d Allowanceforreceivables 10 C
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Statementofprofitorlosscharge
£ 2,500 2,500
IRRECOVERABLEDEBTSEXPENSE
£ 500 2,000 2,500
Allowanceforreceivables Receivables
£ 500 2,000 2,500
Statementofprofitorlosscharge
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£ 2,500 2,500
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CHAPTER9
Accrualsandprepayments
Introduction Examinationcontext TopicList 1 Theprinciplebehindaccrualsandprepayments 2 Accruals 3 Prepayments 4 Accountingforaccrualsandprepayments 5 Theaccrualsprincipleandincome 6 Accruals,prepayments,advancesandarrearsontheETB SummaryandSelf-test AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Recordandaccountfortransactionsandeventsresultinginincome,expenses,assets, liabilitiesandequityinaccordancewiththeappropriatebasisofaccountingandthelaws, regulationsandaccountingstandardsapplicabletothefinancialstatements
Prepareanextendedtrialbalance
Identifythemaincomponentsofasetoffinancialstatementsandspecifytheirpurpose andinterrelationship
Prepareandpresentastatementoffinancialposition,statementofprofitorlossand statementofcashflows(orextractstherefrom)fromtheaccountingrecordsandtrial balanceinaformatwhichsatisfiestheinformationrequirementsoftheentity
Specificsyllabuslearningoutcomesare:1d,2c,3a,3c
Syllabuslinks Thematerialinthischapterwillbedevelopedfurtherinthispaper,andthenintheProfessionalLevel moduleofFinancialAccountingandReporting.
Examinationcontext Questionsonthetopicsinthischapterwillbesetasmultiplechoicequestions,someofwhichmay involvecalculationssothatthecorrectanswercanbeselected.Veryoftendoubleentryquestionsare phrasedintermsofpreparingajournal. Intheexamyoumayberequiredto:
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Identifytheaccountingprinciplesbehindaccrualsandprepayments
Identifythepurposeofaninventorycount
Specifywhatisincludedinthecostofinventory
IdentifythecorrectvalueforinventoryusingFIFOandAVCO
Calculatenetrealisablevalues
Usemarginandmark-uptocalculateclosinginventory
Identifyhowtoaccountfordrawingsofinventoryandforsubstantiallossesofinventory
Identifyhowtoaccountforclosinginventoryintheledgeraccountsandontheextendedtrial balance
Calculatethefigureinthestatementoffinancialpositionforinventory
Identifytheeffectsofopeningandclosinginventoryongrossandnetprofitinthestatementof profitorloss
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1 Theprinciplebehindaccrualsandprepayments Sectionoverview
Theaccrualprinciplerequiresthatwematchexpenseswiththerevenuegeneratedbythem.
Wesometimesthereforeneedtocarryforwardactualexpendituretoasubsequentperiod(a prepayment),oraccountforexpenditureincurredbeforeitisactuallypaidfor(anaccrual).
Grossprofitshouldbecalculatedbymatchingrevenueandcostofsales.Netprofitshouldbecalculated bychargingtheexpenseswhichrelatetothatperiod.Forexample,inpreparingthestatementofprofit orlossforasixmonthperiod,itwouldbeappropriatetochargesixmonths'expensesforrent,local propertytaxes,insuranceandtelephonecosts,etc. However,expensesmaynotactuallybepaidforduringtheperiodtowhichtheyrelate.
Workedexample:Accrualprinciple Abusinessrentsashopfor£20,000perannumandpaysthefullannualrenton1Aprileachyear.Ifwe calculatetheprofitofthebusinessforsixmonthsto30June20X7,thecorrectchargeforrentinthe statementofprofitorlossis£10,000,eventhoughtherentpaidis£20,000inthatperiod.Similarly,the rentchargeinthestatementofprofitorlossforthesecondsixmonthsof20X7is£10,000,eventhough norentisactuallypaidinthatperiod. Weusetheaccrualprincipleheretomatchexpensestotherelevanttimeperiod.
Definitions Accruals(accruedexpenses):Expenseswhicharechargedagainsttheprofitforaparticularperiod,even thoughtheyhavenotyetbeenpaidfor. Prepayments(prepaidexpenses):Expenseswhichhavebeenpaidinonereportingperiod,butarenot chargedagainstprofituntilalaterperiod,becausetheyrelatetothatlaterperiod. Thefollowingexamplesclarifytheprincipleinvolved,thatexpensesshouldbematchedagainst incomeintheperiodtowhichtheyrelate.Accrualsandprepaymentsarethemeansbywhichwe movechargesintothecorrectreportingperiod.
Ifwepayinthisperiodforsomethingwhichrelatestothenextreportingperiod,weusea prepaymenttotransferthatchargeforwardtothenextperiod.
Ifwehaveincurredanexpenseinthisperiodwhichwillnotbepaidforuntilthenextperiod,we useanaccrualtobringthechargebackintothisperiod.
C H A P T E R
9
2 Accruals Sectionoverview
Tosetupanaccrual DEBIT CREDIT
Expense(statementofprofitorloss) Accrual(liabilityonthestatementoffinancialposition)
£X £X
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Workedexample:Accruals1 HoraceGoodrunningendshismotorsparesbusiness'sreportingperiodon28Februaryeachyear.His telephonewasinstalledon1April20X6andhereceiveshistelephonebillquarterlyattheendofeach quarter.Weneedtocalculatethetelephoneexpensetobechargedtothestatementofprofitorlossfor theyearended28February20X7. Telephoneexpenseforthethreemonthsended: 30.6.20X6 30.9.20X6 31.12.20X6 31.3.20X7
£ 23.50 27.20 33.40 36.00
Allthebillswerepaidonthefinaldayofeachthree-monthperiod.
Solution Asat28February20X7,notelephonebillhadbeenreceivedinrespectof20X7becauseitwasnotdue foranothermonth.However,theaccrualprinciplemeanswecannotignorethetelephoneexpensesfor JanuaryandFebruary,andsoanaccrualof£24ismade,beingtwothirdsofthefinalbillof£36. Thetelephoneexpensesfortheyearended28February20X7areasfollows: 1March–31March20X6(notelephone) 1April–30June20X6 1July–30September20X6 1October–31December20X6 1January–28February20X7(twomonths:£362/3)*
£ 0.00 23.50 27.20 33.40 24.00 108.10
*Thechargefortheperiod1January–28February20X7istwothirdsofthebillreceivedon31March. Theaccrualwillalsoappearinthestatementoffinancialpositionofthebusinessasat28February 20X7,asacurrentliability.Thejournaltosetthisupisasfollows: DEBIT CREDIT
Electricity Accrual(currentliability)
£24 £24
Interactivequestion1:AccrualsI
[Difficultylevel:Examstandard]
Cleverleystartedinbusinessasapaperplateandcupmanufactureron1January20X2,preparing financialstatementsto31December20X2.HeisnotregisteredforVAT.Electricitybillsreceivedwereas follows. 31January 30April 31July 31October
20X2 £ – 279.47 663.80 117.28
20X3 £ 491.52 400.93 700.94 620.00
20X4 £ 753.24 192.82 706.20 156.40
Requirement Whatshouldtheelectricitychargebefortheyearended31December20X2?Prepareajournalto recordtheaccrualorprepaymentasat31December20X2. SeeAnswerattheendofthischapter.
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3 Prepayments Sectionoverview
Tosetupaprepayment DEBIT Prepayment(assetinthestatementoffinancialposition) CREDIT Expense(statementofprofitorloss)
£X £X
Workedexample:PrepaymentsI Abusinessopenson1January20X4inashopwheretherentis£20,000peryear,payablequarterlyin advanceatthebeginningofeachthreemonthperiod.Paymentsweremadeasfollows. £ 5,000 5,000 5,000 5,000 5,000
1January20X4 31March20X4 30June20X4 30September20X4 31December20X4 Requirement Whatwilltherentalchargebefortheyearended31December20X4?
Solution Thetotalamountpaidintheyearis£25,000.Theyearlyrental,however,isonly£20,000.Thelast paymentwasaprepaymentasitisapaymentinadvanceforthefirstthreemonthsof20X5.Thecharge for20X4istherefore: £ 25,000 (5,000) 20,000
Paidinyear Prepayment Thedoubleentryforthisprepaymentis: DEBIT CREDIT
Prepayments(currentasset) Rent
£5,000
£5,000
C H A P T E R
4 Accountingforaccrualsandprepayments 9
Sectionoverview
Bothaccrualsandprepaymentsareusuallyincludedascurrentliabilities/assetsastheynearly alwaysclearverysoonaftertheendofthereportingperiod.
Inordernottodoublecountaccruedexpenditure,orfailtoaccountforprepaidexpenditureat all,closingaccrualsandprepaymentsmustbereversedatthestartofthenextreportingperiod: DEBIT
Accruals
DEBIT
Expense
£X £X
CREDIT
Expense
CREDIT
Prepayment
£X £X
Youcanseefromthedoubleentryshownforboththeseexamplesthattheothersideoftheentryis takentothestatementoffinancialposition:anassetoraliabilityaccountthatareneededonlyatthe endofeachreportingperiod.
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Prepaymentsareincludedincurrentassetsinthestatementoffinancialpositionastheyrepresent moneythathasbeenpaidoutinadvanceoftheexpensebeingincurred.Theyusuallyclearwithin 12monthsofthedateofthestatementoffinancialposition.Thebalanceontheprepayment ledgeraccountisbroughtdownasadebitbalanceatthebeginningofthenextperiod.
Accrualsareincludedincurrentliabilitiesastheyrepresentliabilitieswhichhavebeenincurred butforwhichnoinvoicehasyetbeenreceived.Theynearlyalwaysclearsoonaftertheendofthe reportingperiod.Thebalanceontheaccrualsaccountisbroughtdownasacreditbalanceatthe beginningofthenextperiod.
Transaction
DR
CR
Description
Accrual
Expense
Liability(accrual)
Expenseincurredinperiod,not paid/recorded
Prepayment
Asset(prepayment)
(Reductionin)expense
Expensepaid/recordedinperiod, notincurreduntilnextperiod
4.1 Reversingaccrualsandprepaymentsinnewperiod Prepaymentsandaccrualsmustbereversedbyanopeningjournalinthenewperiod,otherwisethe entitywillchargeitselftwiceforthesameexpense(accruals)orwillneverchargeitself(prepayments). Transaction
DR
CR
Description
Reverseaccrual
Accrual(opening creditbalanceon liabilityaccount)
Expense(newperiod)
Reversingaccrualofexpensesetup inpreviousperiod
Reverse prepayment
Expense(new period)
Prepayment(opening debitbalanceonasset account)
Reversingprepaymentofexpense setupinpreviousperiod
Oncetheseopeningjournalsarewrittenup,thebalanceontheaccrualsandprepaymentsaccounts willbezero.Theywillnotbeusedagainuntiltheendofthenewperiod. Mostaccountingsystemsallowyoutosetupspecialjournalscalledreversingjournalswhichareflagged toautomaticallybereversedbythesystemafteraspecificdate.
4.1.1
Reversingaccruals WeshallusetheelectricityaccountfromInteractivequestion3above,plusanewaccrualledger account,andseehowtheaccrualisreversedatthebeginningofthenewperiod,thenanewoneisset upatitsend. ACCRUALACCOUNT 20X2 31.12Balancec/d 20X3 1.1Electricityaccount(accrualreversed)
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£ 327.68 327.68 327.68
20X2 31.12Electricityaccount 20X3 1.1Balanceb/d
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£ 327.68 327.68 327.68
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ELECTRICITYACCOUNT £
279.47
20X2 31.12
Cash Cash Accrualaccount Cash Cash
663.80 117.28 327.68 1,388.23 491.52 400.93
20X3 1.1 31.12
Cash Cash Accrualaccount
700.94 620.00 502.16 2,715.55
20X2 30.4
Cash
31.7 31.10 31.12 20X3 31.1 30.4 31.7 31.10 31.12
£ 1,388.23
Statementofprofit orloss Accrualreversed Statementofprofit orloss
1,388.23 327.68 2,387.87 2,715.55
Thestatementofprofitorlosschargeandaccrualfor20X3of£2,387.87and£502.16respectivelycan becheckedasfollows. Invoicepaid £ 31.1.X3 491.52 30.4.X3 400.93 31.7.X3 700.94 31.10.X3 620.00 31.1.X4 753.24 Chargetostatementofprofitorlossin 20X3
4.1.2
Proportionchargedin20X3 1/3 all all all 2/3
£ 163.84 400.93 700.94 620.00 502.16 2,387.87
Reversingprepayments Usingtherentaccountfromtheprepaymentworkedexample,the£5,000rentprepaidin20X4willbe reversedbyanopeningjournalinthenewperiod.Therentaccountwillbeaddedtobythepayments in20X5,andthenreducedbyajournalsettinguptheprepaymentattheendof20X5inthesameway. PREPAYMENTACCOUNT £ 5,000.00 5,000.00 5,000.00
20X4 31.12Renta/c 20X5 1.1Balanceb/d 31.12Renta/c
5,000.00 10,000.00
£ 5,000.00 5,000.00 5,000.00 5,000.00 10,000.00
20X4 31.12Balancec/d 20X5 1.1Renta/c (prepaymentreversed) 31.12Balancec/d
C H A P T E R
9
RENT 20X4 InyearCash(5payments) 20X5 1.1Renta/c(prepaymentreversed) InyearCash(5payments)
£ 25,000.00 25,000.00 5,000.00 20,000.00 25,000.00
20X4 31.12Prepaymenta/c 31.12Statementofprofitorloss 20X5 31.12Prepaymenta/c 31.12Statementofprofitorloss
£ 5,000.00 20,000.00 25,000.00 5,000.00 20,000.00 25,000.00
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Interactivequestion2:AccrualsII
[Difficultylevel:Examstandard]
Ratsnufferisabusinessdealinginpestcontrol.Itsowner,RoyDent,employsateamofeightpeople whowerepaid£12,000perannumeachintheyearto31December20X5.Atthestartof20X6he raisedsalariesby10%to£13,200perannumeach. On1July20X6,hehiredatraineeatasalaryof£8,400perannum. Hepayshisworkforceonthefirstworkingdayofeverymonth,onemonthinarrears,sothathis employeesreceivetheirsalaryforJanuaryonthefirstworkingdayinFebruary,etc. Requirements (a) CalculatethecostofsalarieschargedinRatsnuffer'sstatementofprofitorlossfortheyearended 31December20X6. (b) Calculatetheamountactuallypaidinsalariesduringtheyear(ietheamountofcashreceivedby theworkforce). (c) StatetheamountoftheaccrualforsalarieswhichwillappearinRatsnuffer'sstatementoffinancial positionasat31December20X6. SeeAnswerattheendofthischapter.
Workedexample:Prepayments2 TheSquareWheelsGaragepaysfireinsuranceannuallyinadvanceon1Juneeachyear.Thefirm's reportingperiodistheyearended28February.Fromthefollowingrecordofinsurancepaymentsyou arerequiredtocalculatetheinsurancechargetothestatementofprofitorlossforthe12month reportingperiodended28February20X8. Insurancepaid 1.6.20X6 1.6.20X7
£ 600 700
Solution (a) 3months,1March–31May20X7(3/12£600)(openingprepayment) (b) 9months,1June20X7–28February20X8(9/12£700) Insurancecostfortheyearto28February20X8,chargedtothestatementofprofitorloss
£ 150 525 675
At28February20X8thereisaprepaymentforinsurance,coveringtheperiod1March–31May20X8. Thisinsurancepremiumwaspaidon1June20X7,butonlyninemonthsworthoftheannualcostis chargeabletothereportingperiodended28February20X8.Theprepaymentof(3/12×£700)£175as at28February20X8willappearasacurrentassetinthestatementoffinancialpositionoftheSquare WheelsGarage. Inthesameway,therewasaprepaymentof(3/12×£600)£150inthestatementoffinancialposition oneyearearlierasat28February20X7. Summary Prepaidinsurancepremiumsasat28February20X7 Addinsurancepremiumspaid1June20X7 Lessinsurancecostschargedtothestatementofprofitorlossfortheyearended28February 20X8 Equalsprepaidinsurancepremiumsasat28February20X8(assetinstatementoffinancial position)
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£ 150 700 850 (675) 175
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Interactivequestion3:Accrualsandprepayments
[Difficultylevel:Examstandard]
TheBatleyPrintShop,whichisnotregisteredforVAT,rentsaphotocopyingmachine.Itmakesa quarterlypaymentasfollows: (a) Threemonthsrentalinadvance (b) Achargeof2pencepercopymadeduringthequarterjustended Therentalagreementbeganon1August20X4.Thefirstsixquarterlybillswereasfollows. Billsdated 1August20X4 1November20X4 1February20X5 1May20X5 1August20X5 1November20X5
Rental £ 2,100 2,100 2,100 2,100 2,700 2,700
Costof copiestaken £ 0 1,500 1,400 1,800 1,650 1,950
Total £ 2,100 3,600 3,500 3,900 4,350 4,650
Thebillsarepaidpromptly,assoonastheyarereceived. Requirements (a) Calculatethechargeforphotocopyingexpensesfortheyearto31August20X4andtheamount ofprepaymentsand/oraccruedchargesasatthatdate. (b) Calculatethechargeforphotocopyingexpensesforthefollowingyearto31August20X5,andthe amountofprepaymentsand/oraccruedchargesasatthatdate. SeeAnswerattheendofthischapter.
Workedexample:Accruals3
Markopensashopon1May20X6tosellcampingequipment.Theshoprentis£12,000perannum, payablequarterlyinarrears(withthefirstpaymenton31July20X6).Hisreportingperiodendson31 Decembereachyear. Therentledgeraccountasat31December20X6willrecordonlytworentalpayments(on31Julyand 31October)andtherewillbetwomonths'accruedrentalexpensesforNovemberandDecember20X6 (£2,000),sincethenextrentalpaymentisnotdueuntil31January20X7. Thechargetothestatementofprofitorlossfortheperiodto31December20X6willbeforeight months'rent(MayDecemberinclusive),£8,000. Sofar,therentaccountappearsasfollows.
C H A P T E R
RENTACCOUNT 20X6 31July 31Oct
Cash Cash
£ 3,000 3,000
20X6 31Dec
Statementofprofitorloss
£ 8,000
9
Tocompletethepicture,theaccrualof£2,000hastobeputin,tobringthebalanceontheaccountup tothefullchargefortheyear.Atthebeginningofthenextyeartheaccrualisreversed. RENTACCOUNT 20X6 31July 31Oct 31Dec
Cash Cash Accruals
£ 3,000 3,000 2,000 8,000
20X6 31Dec 20X7 1Jan
Statementofprofitorloss Accrualreversed
£ 8,000 8,000 2,000
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Thecorrespondingcreditentrywouldbecashifrentispaidwithouttheneedforaninvoice–egwith paymentbystandingorderordirectdebitatthebank.Ifthereisalwaysaninvoicewhenrentbecomes payable,thedoubleentrywouldbe: DEBIT CREDIT
Rentaccount Payables
£2,000
£2,000
£2,000
Thenwhentherentispaid,theledgerentrieswouldbe: DEBIT CREDIT
Payables Cash
£2,000
Therentaccountforthenextyearto31December20X7,assumingnoincreaseinrentinthatyear, wouldbeasfollows. RENTACCOUNT 20X7 31Jan 30Apr 31Jul 31Oct 31Dec
£
20X7 1Jan 31Dec 20X8 1Jan
3,000 3,000 3,000 3,000 2,000 14,000
Cash Cash Cash Cash Accruals
£ 2,000 12,000 14,000 2,000
Accrualreversed
Statementofprofitorloss Accrualreversed
Afulltwelvemonths'rentalchargeistakenasanexpensetothestatementofprofitorloss.
Workedexample:Prepayments3 TerryTrunkcommencesbusinessasalandscapegardeneron1September20X5.Heimmediately decidestojoinhislocaltradeassociation,theConfederationofLutonGardeners,forwhichtheannual membershipsubscriptionis£180,payableannuallyinadvance.Hepaidthisamounton1September 20X5.Inthefollowingyearheexpectsthesubscriptiontoriseby£12.Terrydecidesthathisreporting periodshouldendon30Juneeachyear. Inthefirstreportingperiodto30June20X6(10months),afullyear'smembershipwillhavebeenpaid, butonlytentwelfthsofthesubscriptionshouldbechargedtotheperiod(10/12×£180=£150).There isaprepaymentoftwomonthsofmembershipsubscription(ie2/12×£180=£30). Thejournaltosetuptheprepaymentisasfollows. DEBIT CREDIT
Prepaymentaccount Subscriptionsaccount
£30
£30
Thebalanceonthesubscriptionsaccount(£150)shouldthenbetakentothestatementofprofitorloss. Thebalanceontheprepaymentaccountwillappearasacurrentassetinthestatementoffinancial positionasat30June20X6,andwillbereversedon1July20X6. SUBSCRIPTIONSACCOUNT 20X5 1Sept 20X6 1Jul
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£ Cash
Prepaymentreversed
180 180 30
20X6 30Jun 30Jun
Statementofprofitorloss Prepayment
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Thesubscriptionaccountforthenextreportingperiodwillbe: SUBSCRIPTIONSACCOUNT 20X6 1Jul 1Sept 20X7 1Jul
£ Prepaymentreversed Cash Prepaymentreversed
30 192 222 32
20X7 30Jun 30Jun
£ 190
Statementofprofitorloss (balfig) Prepayment(1922/12)
32 222
Interactivequestion4:Statementofprofitorlossandstatementoffinancialposition [Difficultylevel:Intermediate] TheUmbrellaShophasthefollowingtrialbalanceasat30September20X8. Sales Purchases Non-currentassets Inventoryat1.10.X7 Cashatbank Tradereceivables Tradepayables Distributioncosts Cashinhand Administrativeexpenses Financecosts Carriageinwards Carriageoutwards Capitalaccountat1.10.X7
£ 65,000 200,000 10,000 12,000 54,000 10,000 2,000 15,000 5,000 1,000 2,000 376,000
£ 156,000 40,000 180,000 376,000
Thefollowinginformationisavailable: (a) Closinginventoryat30.9.X8is£13,000,afterwritingoffdamagedgoodsof£2,000. (b) Includedinadministrativeexpensesismachineryrentalof£6,000coveringtheyearto 31December20X8. (c) Alateinvoicefor£12,000coveringrentfortheyearended30June20X9hasnotbeenincludedin thetrialbalance. Requirement Prepareastatementofprofitorlossandstatementoffinancialpositionfortheyearended30 September20X8.
C H A P T E R
9
SeeAnswerattheendofthischapter.
Interactivequestion5:Administrativeexpensesaccount
[Difficultylevel:Examstandard]
Xbathasposted£10,500fromitspurchasesdaybooktoitsadministrativeexpensesledgeraccount during20X2,and£250directfromitscashbook.At31December20X2thebusinessestimatesthatthe year-endaccrualshouldbe£100lessthantheaccrualbroughtforward,andtheprepaymentshouldbe £150less. Requirement Whatisthetotalcostofadministrativeexpensesintheyearended31December20X2? SeeAnswerattheendofthischapter.
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5 Theaccrualprincipleandincome Sectionoverview
Theaccrualprinciplealsoappliestoincome.
Accruedincomeariseswhenreceiptofincome(suchasrentorsubscription)isinarrearsatthe yearend.
Deferredincomeariseswhenincomehasbeenreceivedinadvanceattheendofthereporting period,soitneedstobecarriedforwardandtreatedasincomeofthefollowingreportingperiod.
Accountingforaccruedincome DEBIT CREDIT
Accruedincome(assetinthestatementoffinancialposition) Otherincome(statementofprofitorloss)
£X £X
Accountingfordeferredincome: DEBIT CREDIT
Revenueorotherincome(statementofprofitorloss) Deferredincome(liabilityinthestatementoffinancialposition)
£X £X
Sofarwehaveconcentratedonaccruedandprepaidexpensesarisingfromtheneedtomatchexpenses withtheincometowhichtheyrelate.Itisalsonecessarysometimestotreatincomeinlinewiththe accrualsprinciple.
Cashmaybereceivedinoneperiodalthoughtheactualsaletowhichitrelatesoccursinthe subsequentperiod.Anexampleisadeposit(oradvancepayment,orpaymentonaccount) receivedfromacustomeronanitemwhichwillbedeliveredinthefuture.Thedepositisbanked butuntiltheactualsaleisrecognisedthecashshouldbetreatedasstillbeingowingtothe customer,notasincome.Thisisknownasdeferredincome,acurrentliabilityinthestatementof financialposition.
Cashmaybereceivedinoneperiodinrelationtoaneventwhicharoseinapreviousperiod.An exampleiswhereasuppliermakesarefundinrelationtoapurchaseinapreviousperiod.Thisis knownasaccruedincome,acurrentassetonthestatementoffinancialposition.
Thetreatmentissimilartoaccrualsandprepaymentsofexpenses:
Calculatetheamountofthedeferredoraccruedincome.
Attheendofthereportingperiod,writeupajournalwhichupdatestherelevantstatementof profitorlossaccounts,andwhichsetsuptherelevantassetandliabilityaccounts.
Atthebeginningofthenextreportingperiod,reversethedoubleentry.
Workedexample:Deferredandaccruedincome SunriseCarpetssellsfloorcoveringstothepublic.Attheendofits12monthreportingperiod, 31December20X4,ithasrecordedassales£1,200receivedfromcustomersasdepositsoncarpets whicharenotduetobeinvoiceduntilFebruary20X5.InJanuary20X5itrecordsa£500refundfrom oneofitsmainsuppliersasaresultofexceedingtheagreedlevelofcustomduring20X4. Requirement Preparejournals: (a) Recordingthesetransactionsintheledgeraccountsforthereportingperiodended31December 20X4. (b) Recordingthesetransactionsintheledgeraccountsforthereportingperiodended31December 20X5.
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Solution
Thereversalofdeferredincomein20X5isnottoastatementofprofitorlossaccountbuttotrade receivables.Thisisbecausewearedealingwithcredittransactions:thefullamountofthesalewill beinvoicedinFebruary20X5(DebitReceivables,CreditSales),sothedepositshouldbecreditedto tradereceivablesinthenewreportingperiodinanticipation
Thefullamountofpurchaseswasoriginallyinvoicedbythesupplierin20X4,sotherefundis treatedasadeductionfromwhatisowedtothesupplierbybeingdebitedtotradepayablesin 20X5.
(a) 31.12.X4 31.12.X4
DEBIT CREDIT DEBIT CREDIT
Sales Deferredincome(liability) Depositsfromcustomers Accruedincome(asset) Purchases Refundfromsupplier
1.1.X5 1.1.X5
DEBIT CREDIT DEBIT CREDIT
Deferredincome(liability) Tradereceivables Reversalofdeferredincome Tradepayables Accruedincome(asset) Reversalofaccruedincome
£ 1,200 500
£ 1,200 500
(b)
£ 1,200 500
£ 1,200 500
Mostfrequentlythissituationisseeninrelationtosubscriptionstoclubsorassociations,whichdonot generallymaintainareceivablesledgerandsojustusecashaccounting.Somememberspayanannual subscriptionearlierthantheyneedto(inadvance),andotherspaylate(inarrears).Attheendofthe yearthereareboundtobeamountsinarrearsandamountspaidinadvance,buttheclubwill neverthelessneedtomakesurethattheincomefigureitshowsrelatesonlytotheactualreporting period.Thetreatmentisasfollows.
Openasubscriptionsreceivableledgeraccount.
Enteralltheamountsyouknowegannualincomeorcashreceived.
Calculatethebalancingfigure–inanexamthebalancingfigurewillbetheamountyouare lookingfor.
C H A P T E R
SUBSCRIPTIONSRECEIVABLE Openingarrears Annualincome Closingadvances
X X X X
Openingadvances Cashreceivedinyear Irrecoverableamounts Closingarrears
X X X X X
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Interactivequestion6:Accruedincome
[Difficultylevel:Examstandard]
TheDronesClubhasareportingperiodof12monthsto30June.Itsannualsubscriptionfortheyear ended30June20X7was£100,andthisroseto£120perannumfortheyearto30June20X8.Asat 1July20X6theClub'smembershadpaid£2,380inadvance,andwere£4,840inarrears.TheClubonly has200members,andtherearenoirrecoverableamounts.Itreceived£23,620inrespectof subscriptionsintheyearto30June20X7,andfourmembersareknowntobeinarrearsat30June 20X8. Requirement Howmanymembershavepaidtheirsubscriptionsforthereportingperiodended30June20X8in advance? [Hint:UsethesubscriptionsreceivableTaccount.] SeeAnswerattheendofthischapter. Youmayalsoencounterdeferredincome/advancesandaccruedincome/arrearsinrelationtorent receivableintheexam.Again,asinglerentreceivableledgeraccountisthebestwaytomakethe requiredcalculations.
6 Accruals,prepayments,advancesandarrearsontheETB Sectionoverview
AnadjustmentjournalforaccruedexpensesontheETBdebitstheexpenseslineandcreditsanew accruedline.Thedebitisaddedtothestatementofprofitorlossexpense.Thecreditisaliability inthestatementoffinancialposition.
Adjustmentjournalforprepaidexpenses:debitnewprepaymentsline,creditexpensesline.The debitisanassetinthestatementoffinancialposition.Thecreditisdeductedfromthestatement ofprofitorlossexpense.
Sofarwehavelookedathowaccrualsandprepayments/advancesandarrearsareaccountedforinthe ledgeraccounts,usingclosingandopeningjournals.Thesearenecessarytokeeptheledgeraccounts up-to-date,butfromthepointofviewofpreparingthestatementofprofitorlossandstatementof financialpositiontheprocedurecanberathercumbersome.Thisisbecauseaccruals,prepayments, advancesandarrearsattheperiodendareusuallycalculatedandaccountedforaftertheinitialtrial balancehasbeenextracted.AneaterwayofincorporatingtherelevantfiguresistousetheETB.
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Wecalculatetheamountsoftheaccruedandprepaidexpenses,andthedeferredoraccrued income,asusual.
Wepreparetheperiod-endjournalsasusual.
WeenterthesejournalsintheadjustmentscolumnsoftheETB,openinguplinesinthestatement offinancialpositioncolumnforaccruals,prepayments,accruedincomeanddeferredincomeas necessary.
WeincludetheseadjustmentsintheETBcross-casttopreparethefinancialstatements.
Weentertheclosingjournalsintheledgeraccountsasusual.
Weprepareandentertheopeningjournals.
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Workedexample:AccrualsandprepaymentsontheETB Jezebelmakesandsellsclothingtoorder.Herreportingperiodisthe12monthsended31December. Shehasextractedthefollowingtrialbalanceasat31December20X1: Debit £ 6,541
Cashatbank Openingcapital Loan Non-currentassets Tradepayables Expenses Purchases Sales Otherincome Tradereceivables Drawings
45,000 10,877 62,975 22,854 49,143 197,390
Credit £ 15,000 8,000 16,758 157,632 0 197,390
Sheneedstotakeaccountofthefollowingmatters: (a) Herquarterlypowerbillsare£822.Thelastbillshepaidwasinrespectofthequarterending 31October20X1. (b) Herannualrentbillof£2,970waspaidon1May20X1inrespectoftheyearto30April20X2. (c) Salesinclude£350receivedfromcashcustomersinDecemberinrespectofitemsofclothingthat JezebelwillcompleteinJanuary20X2. (d) Aroyaltyof£58isduefromafashionmagazinewhichusedJezebel'sproductsinafashionshoot. Jezebelwishestoaccountforthisasother/accruedincomeratherthantradereceivables. WeneedtocompleteJezebel'sETBtocalculatehernetprofitforthereportingperiod.
Solution Ledgerbalance Cashatbank Openingcapital Loan Non-currentassets Tradepayables Expenses(a),(b) Purchases Sales(c) Otherincome(d) Tradereceivables Drawings Accruals (822x2/3)(a) Prepayments (2,970x4/12)(b) Accruedincome(d) Deferredincome(c) Netprofit
Trialbalance Debit £ 6,541 45,000 10,877 62,975 22,854 49,143 197,390
Credit £ 15,000 8,000 16,758 157,632 197,390
Adjustments Debit £ 548 350 990 58 1,946
Credit £ 990 58 548 350 1,946
Statementofprofitor loss Debit Credit £ £ 10,435 62,975 157,282 58 83,930 157,340 157,340
Statementoffinancial position Debit Credit £ £ 6,541 15,000 8,000 45,000 16,758 22,854 49,143 548 990 58 350 83,930 124,586 124,586
C H A P T E R
9
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SummaryandSelf-test
Summary
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Self-test Answerthefollowingquestions. 1
Ifabusinesshaspaidpropertytaxof£1,000fortheyearto31March20X9,whatisthe prepaymentinthefinancialstatementsforthe12monthreportingperiodendingon31December 20X8? A B C D
2
£0 £250 £750 £1,000
Rupahasthefollowingbalancesinherledgeraccounts. Purchases Carriageoutwards Carriageinwards Discountsreceived Openinginventory Closinginventory
£ 75,000 800 1,000 2,000 10,000 12,000
WhatisRupa'scostofsales? A B C D 3
£72,000 £73,000 £74,000 £74,800
On5May20X8Portalspaysarentbillof£1,800fortheeighteenmonthsended30June20X9. Whatisthechargeinthestatementofprofitorlossandtheentryforrentinthestatementof financialpositioninrespectofthe12monthreportingperiodended31March20X9? A B C D
4
£1,200withprepaymentof£300 £1,200withaccrualof£600 £1,500withaccrualof£300 £1,500withprepaymentof£300
Afirmmadethefollowingrentpayments. £9,000forthesixmonthsended31March20X6 £12,000forthesixmonthsended30September20X6 £11,196forthe12monthsended30September20X7 Thechargetothestatementofprofitorlossforthe12monthreportingperiodended31 December20X6was A B C D
5
£13,299 £19,299 £24,897 £22,098
C H A P T E R
9
Elizabethpaid£2,500forgasduringthereportingperiod.Atthebeginningoftheperiodsheowed £500;attheendsheowed£1,000. Whatchargeshouldhaveappearedinherstatementofprofitorlossforthatreportingperiod? A B C D
£2,000 £2,500 £3,000 £3,500
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6
AtthebeginningofSeptemberBarney&Cowereowed£200inrent.AttheendofSeptember theywereowed£400.£800cashforrentwasreceivedduringSeptember. WhatentrywillbemadeinthestatementofprofitorlossforSeptemberforrentreceivable? A B C D
Debit£600 Debit£1,000 Credit£600 Credit£1,000
Now,gobacktotheLearningObjectivesintheIntroduction.Ifyouaresatisfiedthatyouhaveachieved theseobjectives,pleasetickthemoff.
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AnswerstoInteractivequestions
AnswertoInteractivequestion1 Thethreeinvoicesreceivedduring20X2totalled£1,060.55,butthisisnotthefullchargeforthe reportingperiod:theNovemberandDecemberelectricitychargewasnotinvoiceduntiltheendof January20X3.Toshowthecorrectchargeforthereportingperiod,weaccruethechargeforNovember andDecemberbasedonJanuary'sbill.Thechargefor20X2is: £ 1,060.55 327.68 1,388.23
Paidinyear Accrual(2/3£491.52) Thedoubleentryfortheaccrualwillbe: DEBIT CREDIT
Electricityaccount Accruals
£327.68
£327.68
AnswertoInteractivequestion2 (a) Salarieschargeinthestatementofprofitorlossyearended31December20X6 £ 105,600 4,200 109,800
Costof8employeesforafullyearat£13,200each Costoftraineeforahalfyear(£8,400/2) (b) Salariesactuallypaidin20X6 December20X5salariespaidinJanuary(8employees£1,000permonth) Salariesof8employeesforJanuary–November20X6paidinFebruary–December (8employees£1,100permonth11months) Salaryoftrainee(forJuly–NovemberpaidinAugust–December: 5months£700permonth) Salariesactuallypaid
£ 8,000 96,800 3,500 108,300
(c) Accruedsalaryasat31December20X6
C H A P T E R
(iecostschargedintheStatementofprofitorloss,butnotyetpaid) £ 8,800 700 9,500
8employees1month£1,100permonth 1trainee1month£700permonth
9
Summary Accruedsalariesasat1January20X6(December20X5salaries) Addsalariescostfor20X6(Statementofprofitorloss(a)) Lesssalariespaid(b) Equalsaccruedsalariesasat31December20X6(liabilityinstatementoffinancial position(c))
£ 8,000 109,800 117,800 (108,300) 9,500
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SALARIESACCOUNT £ 108,300 9,500 117,800
20X6 Cashpaid 31.12Accrual
£
20X6 1.1Accrualreversed 31.12Statementofprofitorloss
8,000 109,800 117,800
AnswertoInteractivequestion3 (a) Yearto31August20X4 £ 700 500 1,200
Onemonths'rental(1/3£2,100)* Accruedcopyingcharges(1/3£1,500)** Photocopyingexpense(Statementofprofitorloss) *Fromthequarterlybilldated1August20X4 **Fromthequarterlybilldated1November20X4
Thereisaprepaymentfor2months'rental(2/3×£2,100=£1,400)asat31August20X4,andan accrualforcopyingchargesof£1,500/3=£500 (b) Yearto31August20X5 Rentalfrom1September20X4–31July20X5(11monthsat £2,100perquarteror£700permonth) Rentalfrom1August–31August20X5(1/3£2,700) Rentalchargefortheyear Copyingcharges: 1September–31October20X4(2/3£1,500) 1November20X4–31January20X5 1February–30April20X5 1May–31July20X5 AccruedchargesforAugust20X5(1/3£1,950) Photocopyingexpense(statementofprofitorloss)
£ 1,000 1,400 1,800 1,650 650
£ 7,700 900 8,600 6,500 15,100
Thereisaprepaymentfor2months'rental(2/3×£2,700=£1,800)asat31August20X5,andan accrualforcopyingchargesof£1,950/3=£650. Summaryofreportingperiod1September20X4–31August20X5 Prepaymentasat31.8.20X4(2/3£2,100) Accruedchargeasat31.8.20X4 Billspaidduringthereportingperiod 1November20X4 1February20X5 1May20X5 1August20X5 Prepaymentasat31.8.20X5(2/3£2,700) Accruedchargeasat31.8.20X5 ChargetotheStatementofprofitorlossforthereportingperiod Itemsinthestatementoffinancialpositionasat31August20X5 Prepaidrental(currentasset) Accruedcopyingcharge(currentliability)
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Rental charges £ 1,400
Copying costs £
2,100 2,100 2,100 2,700 (1,800) 8,600 1,800
(500) 1,500 1,400 1,800 1,650 650 6,500 650
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AnswertoInteractivequestion4 THEUMBRELLASHOP STATEMENTOFPROFITORLOSSFORTHEYEARENDED30SEPTEMBER20X8 Sales Openinginventory Purchases Carriageinwards Closinginventory(W1) Costofsales Grossprofit Distributioncosts(10,000+2,000) Administrativeexpenses(W2) Financecosts Netprofitfortheyear
THEUMBRELLASHOP STATEMENTOFFINANCIALPOSITIONASAT30SEPTEMBER20X8 Assets Non-currentassets Currentassets Inventory(W1) Tradereceivables Prepayments(W4) Cashatbankandinhand(12,000+2,000) Totalassets Capitalandliabilities Owner'scapital Balancebroughtforward Profitfortheyear Currentliabilities Tradepayables Accruals(W3) Totalcapitalandliabilities
£ 10,000 65,000 1,000 (13,000) 12,000 16,500 5,000
£ 156,000 (63,000) 93,000 (33,500) 59,500
£ 13,000 54,000 1,500 14,000
£ 200,000 82,500 282,500
180,000 59,500
239,500 43,000 282,500
40,000 3,000
C H A P T E R
WORKINGS (1) Closinginventory
9
Asthefigureof£13,000isafterwritingoffdamagedgoods,nofurtheradjustmentsarenecessary. Rememberthatyouarecreditingclosinginventorytothestatementofprofitorlossandthe correspondingdebitistothestatementoffinancialposition. (2) Administrativeexpenses Pertrialbalance Addaccrual(W3) Lessprepayment(W4)
£ 15,000 3,000 (1,500) 16,500
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(3) Accrual £ 12,000 3,000
Rentforyearto30June20X9 3 Accrualforperiodto30September20X8( /12£12,000) (4) Prepayment Machineryrentalfortheyearto31December20X8 3 Prepaymentforperiod1Octoberto31December20X8( /12£6,000)
£ 6,000 1,500
AnswertoInteractivequestion5 ADMINISTRATIVEEXPENSES £ 10,500 250 150 10,900
Purchasesdaybook Cashbook Decreaseinprepayment
Decreaseinaccruals Statementofprofitorloss
£ 100 10,800 10,900
AnswertoInteractivequestion6 SUBSCRIPTIONSRECEIVABLE 1.7.X6 30.6.X7 30.6.X7
Arrears(accruedincome reversed) Statementofprofitor loss (200£100) Advances(deferredincome) balfig
£
4,840
1.7.X6 Year
Advances(deferred incomereversed) Cash
£ 2,380 23,620
20,000 1,560 26,400
30.6.X7
Arrears(4£100) (accruedincome)
400 26,400
Advancestotal£1,560,whichrepresents13members'payments(13×£120=£1,560).
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AnswerstoSelf-test 1
B
2
C
3
/12×£1,000=£250 £ 10,000 75,000 1,000 (12,000) 74,000
Openinginventory Purchases Carriageinwards Less Closinginventory 3
A £ 1,200 300
Statementofprofitorloss12/181,800 Closingprepayment:3/181,800 4
B Statementofprofitorloss:(3/69,000)+12,000+(3/1211,196)
5
C £ (500) 2,500 1,000 3,000
Openingaccrual Cashpaid Closingaccrual 6
£ 19,299
D
RENTRECEIVABLE
Otherreceivables(reversalof openingaccruedincome) Statementofprofitorloss(bal fig)
£
200 1,000
Cash Accruedincome
£ 800 400
1,200
1,200
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CHAPTER10
Non-currentassetsand depreciation
Introduction Examinationcontext TopicList 1 Non-currentassetsanddepreciation(IAS16) 2 Theobjectiveofdepreciation 3 Calculatingdepreciation 4 Accountingfordepreciation 5 Non-currentassetdisposals 6 Theassetregister 7 Intangiblenon-currentassets 8 Thenon-currentassetsnotetothestatementoffinancialposition SummaryandSelf-test AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Recordandaccountfortransactionsandeventsresultinginincome,expenses,assets, liabilitiesandequityinaccordancewiththeappropriatebasisofaccountingandthelaws, regulationsandaccountingstandardsapplicabletothefinancialstatements
Prepareanextendedtrialbalance
Identifythemaincomponentsofasetoffinancialstatementsandspecifytheirpurpose andinterrelationship
Prepareandpresentastatementoffinancialposition,statementofprofitorlossand statementofcashflows(orextractstherefrom)fromtheaccountingrecordsandtrial balanceinaformatwhichsatisfiestheinformationrequirementsoftheentity
Specificsyllabuslearningoutcomesare:1d,2c,3a,3c
Syllabuslinks Thematerialinthischapterwillbedevelopedfurtherinthispaper,andthenintheProfessionalLevel moduleofFinancialAccountingandReporting.
Examinationcontext Questionsonthetopicsinthischapterwillbesetasmultiplechoicequestions,someofwhichmay involvecalculationssothatthecorrectanswercanbeselected.Frequentlydoubleentryquestionsare expressedintermsofpreparingajournal. Intheexamyoumayberequiredto:
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Identifytheaccountingprinciplesbehindaccountingfornon-currentassetsanddepreciation
Specifywhatisincludedinthecostofanon-currentasset
Usethestraightlineandreducingbalancemethodstocalculatedepreciation
Calculateprofitsandlossesondisposalofnon-currentassets,includingpart-exchangedisposals
Specifytheeffectsofchangingresidualvalues,usefullivesanddepreciationmethodsonamounts inthestatementofprofitorlossandstatementoffinancialposition
Identifyhowtoaccountfornon-currentassets,depreciationanddisposalsinledgeraccountsand theextendedtrialbalance
Calculatethefigureinthestatementoffinancialpositionfornon-currentassets,andthefigures thatappearinthenon-currentassetsnote
Calculatethedepreciationchargeandthefigureforprofitsorlossesondisposalsinthestatement ofprofitorloss
Identifytheeffectsofdepreciationanddisposalsongrossandnetprofitinthestatementofprofit orloss
Specifytheusesoftheassetregister
Identifytheaccountingtreatmentsofintangibleassets,includinggoodwillanddevelopment expenditure
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1 Non-currentassetsanddepreciation(IAS16) Sectionoverview
Whereanassethasausefullifethatextendsbeyondonereportingperiod,theaccrualprinciple apportionsthevalueusedinaperiodagainsttheincomeithashelpedtocreate.Thesearenoncurrentassets
Thecostofanon-currentassetincludes:purchaseprice;deliverycosts;taxesandduties; irrecoverableVAT;installationandassemblycosts;professionalfees;testingcosts.
Enhancementexpendituremaybeaddedtothecostsubsequently.
Partofanasset'scostmaybesettledbytradinginanoldassetinpart-exchange.
Allassetsexceptfreeholdlandhaveafiniteusefullife.
Manyassetswillhavearesidualvalueattheendoftheirusefullives.
Depreciationallocatestheasset'scostlessitsresidualvalueoveritsusefullife.
1.1 IAS16Property,PlantandEquipment TheobjectiveofIAS16istoprescribeinrelationtoproperty,plantandequipmenttheaccounting treatmentfor:
Therecognitionofassets Thedeterminationoftheircarryingamounts Thedepreciationchargesrelatingtothem
Thisprovidestheusersoffinancialstatementswithinformationaboutanentity'sinvestmentinits property,plantandequipmentandchangesinsuchinvestments. IAS16shouldbefollowedwhenaccountingforPPEunlessanotherIASorIFRSrequiresadifferent treatment,egIFRS5Non-currentAssetsHeldforSaleandDiscontinuedOperations.
1.2 Costofanon-currentasset Thecostofanon-currentassetincludesallamountsincurredtoacquiretheassetandanyamounts thatcanbedirectlyattributabletobringingtheassettothelocationandconditionnecessaryforit tobecapableofoperatinginthewayintendedbymanagement.Withtheexceptionofcars,where theVATisnotusuallyrecoverable,theamountcapitalisedwillexcludeVAT. Directlyattributablecostsinclude:
Purchaseprice Deliverycosts Stampdutyandimportduties(andirrecoverableVAToncars) Costsofpreparingthesiteforinstallationandassemblyoftheasset Professionalfees,suchaslegalandarchitects'fees Costsoftestingwhethertheassetisfunctioning
Expensessuchasgeneraloverheadcosts,administrationcosts,trainingcostsforstaff,fuelinavehicle ondeliveryandlicencefeesforoperatingtheassetarenotincludedaspartofthetotalcostsofthenoncurrentasset. Thecostofsubsequentcapitalexpenditureonanon-currentassetwillbeaddedtothecostofthe asset,providedthisexpenditureenhancesthebenefitsofthenon-currentassetorrestoresanybenefits consumed.Itisthereforecalledenhancementexpenditure. Thismeansthatcostsofmajorimprovementsoramajoroverhaulmaybecapitalised.However,the costsofrepairsthatarecarriedoutsimplytomaintainexistingperformancemaynotbecapitalised: theywillbetreatedasexpensesofthereportingperiodinwhichtheworkisdone,andchargedinfullas anexpenseinthatperiod.
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1.3 Payingforanon-currentasset Abusinessmightpurchaseanewnon-currentassetforcashoroncredit,oritmayhandoveranold assetinpart-exchange.Thisiscommon,forexample,withmotorvehicles.Thesupplierofthenew assetagreestotaketheoldasset,andgivesthebuyerareductioninthepurchasepriceofthenew asset.Thisreductionisthepart-exchangevalueoftheoldasset.
Workedexample:Part-exchange Abusinesspurchasesanewdeliveryvan,tradinginanoldvaninpart-exchange.Thecostofthenew vanis£25,000andthepart-exchangevalueoftheoldvanis£10,000,sothebusinesswillpaythevan dealer£15,000. Becausepayingforanewnon-currentassetisrarelystraightforward,non-currentassetpurchasesare usuallyrecordedinthejournalasthebookoforiginalentry.
1.4 Usefullife Anassetmaybeseenashavingaphysicallifeandaneconomiclife. Mostnon-currentassetssufferphysicaldeteriorationthroughusageandthepassageoftime.Although careandmaintenancemaysucceedinextendingthephysicallifeofanasset,typicallyitwill, eventually,reachaconditionwherethebenefitshavebeenexhausted. However,abusinessmaynotwishtokeepanassetuntiltheendofitsphysicallife.Theremaybea pointwhenitbecomesuneconomictocontinuetousetheasseteventhoughthereisstillsomephysical lifeleft.Theeconomiclifeoftheassetwillbedeterminedbysuchfactorsastechnologicalprogressand changesindemand.
Definition Usefullife:Theestimatedeconomiclife(ratherthanthepotentialphysicallife)ofthenon-current asset. Theonlyassetthatisdeemedtohaveanunlimitedusefullifeisfreeholdland.
1.5 Whatisdepreciation? Definition Depreciation:Thesystematicallocationofthecostofanasset,lessitsresidualvalue,overitsusefullife. Indeterminingtheexpensesforaperiod,itisimportanttoincludeanamounttorepresentthe consumptionofnon-currentassetsduringthatperiod(thatis,depreciation). Tocalculatethedepreciationchargeforareportingperiod,thefollowingfactorsarerelevant:
Assetcost(seesection1.1above) Usefullife(seesection1.3above) Assetresidualvalue
1.6 Residualvalue Attheendofanon-currentasset'susefullifethebusinesswilldisposeofitandanyexpectedamounts receivedrepresentitsresidualvalue.Forinstance,anassetthatisexpectedtobesoldfor£500atthe endofitsusefullifehasaresidualvalueof£500.Ifitisunlikelytobeasignificantamount,aresidual
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valueofzerowillbeassumed.Thecostofanon-currentassetlessitsresidualvaluerepresentsthetotal amounttobedepreciatedoveritsestimatedusefullife(itsdepreciableamount). Note.Forexampurposes,alwaysassumetheresidualvalueiszerounlesstoldotherwise.
Definition Residualvalue:Theestimatedamountthattheentitywouldcurrentlyobtainfromdisposingofthe asset,afterdeductingestimateddisposalcosts.
Interactivequestion1:Depreciableamount
[Difficultylevel:Examstandard]
ArundelEnterprisespurchasedanewcarforasalesrepresentative.Theinvoicereceivedcontainedthe followinginformation:
Listpriceofthecar Depositpaid Amountdue
£ 18,720 (6,200) 12,520
Itisestimatedthatthenewcarwillhaveausefullifeofthreeyearsandwillhavearesidualvalueof £6,360. Calculatethetotalamounttobedepreciatedinrespectofthenewcar. SeeAnswerattheendofthischapter.
2 Theobjectiveofdepreciation Sectionoverview
Depreciationarisesfromtheapplicationoftheaccrualprinciple.Themethodchosenshouldbe appliedconsistently.
Thedepreciableamountiscostlessresidualvalue,andtheusefullifeprovidesthetimeperiodover whichtheassetshouldbedepreciated.Sohowmuchofthisdepreciableamountischargedagainst profitsineachreportingperiod?
2.1 Accountingconceptsanddepreciation Consistencyisimportant.Thedepreciationbasisormethodselectedshouldbeappliedconsistently fromperiodtoperiodunlessalteredcircumstancesjustifyachange.Whenthebasisischanged,the effectoncurrentandfutureperiodsshouldbequantifiedanddisclosed,andthereasonforthechange shouldbestated. Variousmethodsofallocatingdepreciationtoreportingperiodsareavailable,butwhicheverischosen mustbeappliedconsistently(asrequiredbyIAS1:seeChapter1),toensurecomparabilityfrom periodtoperiod.Achangeofbasisisnotallowedsimplybecauseoftheprofitabilitysituationofthe enterprise. Theneedtodepreciatenon-currentassetsarisesfromtheaccrualprinciple.Ifmoneyisexpendedin purchasinganassetthenthisamountmustatsometimebechargedagainstprofits.Iftheassetisone whichcontributestoanentity'srevenueoveranumberofreportingperiodsitwouldbeinappropriate tochargeanysingleperiod(egtheperiodinwhichtheassetwasacquired)withthewholeofthe expenditure.Instead,somemethodmustbefoundofspreadingthecostoftheassetoveritsusefullife.
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2.2 Commondepreciationmisconceptions (a) Itdoesnotreflectthefallinvalueofanassetoveritslife. (b) Itisnot'settingasidemoney'toreplacetheassetattheendofitsusefullife.Eveniftheasset wasnotgoingtobereplaced,itscostshouldstillbeallocatedoveritsusefullife.
3Calculatingdepreciation Sectionoverview
Chargedepreciationtostatementofprofitorloss,andsetupanaccountinthestatementof financialpositioncalledaccumulateddepreciation.Whenthisisoffsetagainsttheasset'scost accountinthestatementoffinancialposition,wehaveitscarryingamount.
Depreciationmaybecalculatedonthestraightlinebasis:
Asset cost – residual value Monthly depreciation charge Months of useful life
Reducingbalancedepreciation:
Carryingamount×%tobeapplied=Annualdepreciationcharge.
Thedepreciationmethodusedshouldbeappliedconsistently.Achangeinmethodmaycausean increasedcharge.
Whentherehasbeenenhancementexpenditure,thiswouldusuallybedepreciatedoverthe remainingusefullifeofthewholeasset.
Thecarryingamountofanassetshouldbereviewedandiftherehasbeenanimpairmentthis impairmentlossshouldbeaccountedforimmediately.
Ifthereisachangeintheestimateoftheasset'susefullifeorresidualvalue,thistoowillcausea changeinthedepreciationcharge.
Whenanon-currentassetisdepreciated,twothingsmustbeaccountedfor. (a) Thechargefordepreciationisacostorexpenseofthereportingperiodinthestatementofprofit orloss. (b) Atthesametime,thenon-currentassetiswearingoutandbeingconsumed,andsoitscostinthe statementoffinancialpositionmustbereducedbytheamountofdepreciationcharged.The valueofthenon-currentassetinthestatementoffinancialpositionwillbeitscarryingamount.
Definition Carryingamount:Costlessaccumulateddepreciation. Theamountofdepreciationdeductedfromthecostofanon-currentassettoarriveatitscarrying amountwillbuildup(or'accumulate')overtime,asmoredepreciationischargedineachsuccessive reportingperiod.Thisiscalledaccumulateddepreciation.
Workedexample:Accumulatingdepreciationonanon-currentasset Ifanon-currentassetcosting£40,000hasanexpectedusefullifeoffouryearsandanestimatedresidual valueofnil,itmightbedepreciatedby£10,000perannum.
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Atbeginningofitslife Year1 Year2 Year3 Year4
Depreciation chargeforthe year(income statement) (A) £ – 10,000 10,000 10,000 10,000 40,000
Accumulated depreciation atendofyear (B) £ – 10,000 20,000 30,000 40,000
Cost ofthe asset (C) £ 40,000 40,000 40,000 40,000 40,000
Carrying amount atend ofyear (C–B) £ 40,000 30,000 20,000 10,000 0
Attheendofyear4,thefull£40,000ofdepreciationchargeshavebeenmadeinthestatementofprofit orlossofthefouryears.Thecarryingamountofthenon-currentassetisnownil.
3.1 Methodsofdepreciation Thereareseveraldifferentmethodsofdepreciation.Ofthese,theoneswhicharerelevantforAccounting are:
Straightlinemethod Reducingbalancemethod
Rememberthatifanentitychangesfromonemethodtoanotherthiscountsasachangeinaccounting estimate.Thereisnochangeinaccountingpolicy,whichremains:todepreciatenon-currentassets.
3.2 Thestraightlinemethodofdepreciation Definition Straightlinedepreciation:Thedepreciableamount(costlessresidualvalue)ischargedinequal instalmentstoeachreportingperiodovertheexpectedusefullifeoftheasset.(Inthisway,thecarrying amountofthenon-currentassetdeclinesatasteadyrate,orina'straightline'overtime.) Theannualdepreciationchargeis: Cost of asset minus residual value Expected useful life of the asset in years
Themonthlydepreciationchargeis: Cost of asset – residual value Useful life in years 12
Sincestraightlinedepreciationischargedmonthlyyoushouldmakethesecond,monthly, calculationinanexam.
Workedexample:Straightlinedepreciation (a) Anon-currentassetcosting£24,000withausefullifeof10yearsandnoresidualvaluewouldbe depreciatedattherateof: £24,000 =£200permonth,or£2,400perannum. 10 12
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(b) Anon-currentassetcosting£60,000hasausefullifeoffiveyearsandaresidualvalueof£6,000. Themonthlydepreciationchargeusingthestraightlinemethodis: £(60,000 6,000) =£900permonth,or£10,800perannum 5 12
Thecarryingamountofthenon-currentassetwouldbeasfollows: Costoftheasset Accumulateddepreciation Carryingamount
After1 year £ 60,000 (10,800) 49,200
After2 years £ 60,000 (21,600) 38,400
After3 years £ 60,000 (32,400) 27,600
After4 years £ 60,000 (43,200) 16,800
After5 years £ 60,000 (54,000) 6,000*
*ieitsestimatedresidualvalue. Sincethestraightlinedepreciationchargeperannumisthesameamountevery12monthreporting period,itisoftenconvenienttostatethatdepreciationischargedattherateofxpercentperannum ontheasset'sdepreciableamount.Intheexamplein(a)above,thedepreciationchargeperannumis 10%ofcost(ie10%of£24,000=£2,400).In(b),itis20%ofthedepreciableamount(20%×(60,000 –6,000)=£10,800) Thestraightlinemethodallocatesthetotaldepreciableamountinequalamountsbetweendifferent reportingperiods.
Workedexample:Monthlydepreciationonthestraightline Abusinesshasareportingperiodfrom1Januaryto31Decemberandpurchasesanon-currentasseton 1April20X1,atacostof£24,000.Theexpectedlifeoftheassetisfouryears,anditsresidualvalueis nil.Whatisthedepreciationchargeforthereportingperiodto31December20X1?
Solution Themonthlydepreciationchargewillbe
£24,000 =£500permonth 4 12
Sincetheassetwasacquiredon1April20X1,thebusinesshasonlybenefitedfromtheuseoftheasset for9monthsinsteadofafull12months.Wethereforechargedepreciationin20X1of: 9×£500=£4,500
3.3 Thereducingbalancemethodofdepreciation Definition Reducingbalancedepreciation:Theannualdepreciationchargeisafixedpercentageofthebrought forwardcarryingamountoftheasset. WhencalculatingreducingbalancedepreciationinanexamyouwillNOTbeconcernedwiththe asset'sresidualvaluenorhowtocalculatethepercentage:justthecarryingamountandthe reducingbalancepercentagegiventoyou. Thereducingbalancemethodmightbeusedtoallocateagreaterproportionofthetotaldepreciable amounttotheasset'searlieryearsandalowerproportiontoitslateryears,asthebenefitsobtainedby thebusinessfromusingtheassetdeclineovertime.
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Workedexample:Reducingbalancemethod Abusinesspurchasesanon-currentassetatacostof£10,000on1January20X1,whichitplanstokeep forthreeyearsto31December20X3.Thebusinesswishestousethereducingbalancemethodto depreciatetheasset,andcalculatesthattherateofdepreciationshouldbe40%ofthereducingbalance (carryingamount)oftheasset. Thedepreciationchargeperannumandthecarryingamountoftheassetasattheendofeach reportingperiodwillbeasfollows. Assetatcost Depreciationin20X1(40%) Carryingamountatendof20X1 Depreciationin20X2(40%ofcarryingamount6,000) Carryingamountatendof20X2 Depreciationin20X3(40%3,600) Carryingamountatendof20X3
£ 10,000 (4,000) 6,000 (2,400) 3,600 (1,440) 2,160
Accumulated depreciation £ 4,000 6,400 (4,000+2,400) 7,840 (6,400+1,440)
Theannualchargeforreducingbalancedepreciationishigherintheearlierreportingperiodsofthe asset'slife,andlowerinthelaterreportingperiods(£4,000,£2,400and£1,440respectively). Thebalanceremainingattheendofthethreeyearusefullifeof£2,160istheestimatedresidualvalue whichwastakenintoaccountwhencalculatingthat40%reducingbalancewasappropriate. Inanexamquestion,youwillnothavetocalculatewhatamountofreducingbalancedepreciation shouldbechargedmonthly.
3.4 Applyingadepreciationmethodconsistently Abusinesscanchoosewhichmethodofdepreciationtoapplytoitsnon-currentassets.Oncethis decisionhasbeenmadeitshouldbeappliedconsistentlyfromreportingperiodtoreportingperiod. Abusinesscandepreciatedifferentcategoriesofnon-currentassetsindifferentways.Forexample,ifa businessownsthreecars,theneachcarwouldnormallybedepreciatedinthesameway(egbythe straightlinemethod);butanothercategoryofnon-currentasset,sayphotocopiers,mightbe depreciatedusingadifferentmethod(egbythereducingbalancemethod).
Interactivequestion2:Depreciation
[Difficultylevel:Examstandard]
Alorryboughtforabusinesscost£17,000plusVATat20%.Itisexpectedtolastforfiveyearsandthen tobesoldfor£2,000plusVAT. Requirement Workoutthedepreciationtobechargedeach12monthreportingperiodunder: (a) Thestraightlinemethod (b) Thereducingbalancemethod,usingarateof35%
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SeeAnswerattheendofthischapter.
3.5 Depreciatingenhancementexpenditure Whereexpenditureisincurredtoenhanceanassetafteritsinitialpurchase,thisisaddedtotheasset's costanddepreciatedovertheasset'sremainingusefullife.
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Workedexample:Depreciatingenhancementexpenditure Malcolmbuysabuildingon1.1.X0for£200,000.On1.1.X2headdsanextensionthatcost£50,000. Calculatetheannualdepreciationchargebeforeandaftertheextensionisbuilt,onthebasisofstraight linedepreciationover10years,withnoresidualvalue.
Solution Beforeextension:
£200,000 =£20,000pa 10
Afterextension:
£200,000 £50,000 £26,250 10 8
Intheexamyouwillnotberequiredtodepreciateenhancementexpenditureusingthereducing balancebasis.
3.6 Reviewingandchangingthedepreciationmethod Thedepreciationmethodusedandthecarryingamountshouldbereviewedannuallyfor appropriateness.Ifthereareanychangesintheexpectedpatternofuseoftheasset(andhence economicbenefit),thenthemethodusedshouldbechanged.Theremainingcarryingamountis depreciatedunderthenewmethod,ieonlycurrentandfutureperiodsareaffected.
Workedexample:Changeinmethodofdepreciation JakobCopurchasedanassetfor£100,000on1.1.X1.Ithadanestimatedusefullifeof5yearsandit wasdepreciatedusingthereducingbalancemethodatarateof40%.On1.1.X3itwasdecidedto changethedepreciationmethodtostraightline.Therewasnochangetotheusefullife,andnoresidual valueisanticipated. Showthedepreciationchargeforeachyear(to31December)oftheasset'slife.
Solution Year 20X1 20X2 20X3 20X4 20X5
£100,000×40% £60,000×40% £100,000 – £64,000 3 remaining years
Depreciation charge £ 40,000 24,000 12,000 12,000 12,000
Accumulated depreciation £ 40,000 64,000 76,000 88,000 100,000
Interactivequestion3:Changeindepreciationmethod
[Difficultylevel:Examstandard]
Fordplcpreparesitsfinancialstatementsforthe12monthreportingperiodto31Decembereachyear. On1January20X0itboughtamachinefor£100,000anddepreciateditat10%perannumonthe reducingbalancebasis. On31December20X3,themachinewillbeincludedinFordplc'sfinancialstatementsat: Cost Accumulateddepreciation(10,000+9,000+8,100+7,290) Carryingamount
£ 100,000 (34,390) 65,610
On1January20X4,thecompanydecidedtochangethebasisofdepreciationtostraightlineovera totallifeofnineyears,iefiveyearsremainingfrom1January20X4.Thereisnoresidualvalue. Calculatetherevisedannualdepreciationcharge. SeeAnswerattheendofthischapter.
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3.7 Reviewingandchangingcarryingamount:fallinvalue(impairmentloss) Whenthevalueofanon-currentassetfallstolessthanitscarryingamountandthefallinvaluewillnot berecoveredfromfutureuseoftheasset,itissaidtohavesufferedanimpairmentlossandshouldbe writtendowntoitsnewvalue.Thestatementofprofitorlosschargefortheimpairmentintheasset's valueduringthereportingperiodshouldbe: Carryingamountatthebeginningoftheperiod Lessreducedvalue(thenewcarryingamountattheendoftheperiod) Equalsthechargeforimpairmentintheasset'svalueintheperiod(impairmentloss)
£ X (X) X
Workedexample:Impairmentloss Abusinesspurchasedabuildingon1January20X1atacostof£100,000.Thebuildinghada20year life.On31December20X5thebusinessdecidesthatsincepropertypriceshavefallensharplyand futuretradingprospectsarepoor,thebuildingisnowworthonly£60,000,andthevalueoftheasset shouldbereducedaccordinglyinthefinancialstatementsofthebusinessforthe12monthreporting periodended31December20X5. Thebuildingwasbeingdepreciatedover20years,attherateof5%perannumoncost. Beforetheassetisreducedinvalue,theannualdepreciationchargeis: £100,000 =£5,000perannum 20 years
Thiswillbechargedin20X1,20X2,20X3,20X4and20X5. Asat31December20X5theaccumulateddepreciationisthus£25,000andthecarryingamountofthe buildingis£75,000,whichis£15,000morethanthenewassetvalue.This£15,000shouldbewritten offasanimpairmentlossin20X5,sothatthetotalchargein20X5is: £ 5,000 15,000 20,000
'Normal'depreciationchargein20X5 Impairmentlossrecognisedin20X5 Chargeagainstprofitin20X5 Analternativemethodofcalculationisasfollows: Carryingamountofthebuildingin31December20X4£(100,000–20,000) Revisedassetvalueatendof20X5 Chargeagainstprofitin20X5
£ 80,000 (60,000) 20,000
Thebuildinghasafurtherlifeof15years,anditsvalueisnow£60,000.From20X6to20Y0,theannual chargefordepreciationwillbe: £60,000 =£4,000perannum 15 years
3.8 Reviewingandchangingusefullifeorresidualvalue Thedepreciationchargeonanon-currentassetdependsnotonlyontheasset'scostbutalsoon residualvalueanditsestimatedusefullife.Theseshouldalsobereviewedandchangediftheyareno longerappropriate.
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Workedexample:Changeinusefullife Abusinesspurchasedanon-currentassetcosting£12,000withanestimatedusefullifeoffouryearsand noresidualvalue.Ifitusedthestraightlinemethodofdepreciation,itwouldmakeanannual depreciationchargeof25%of£12,000=£3,000. Thebusinessdecidesaftertwoyearsthattheusefullifeoftheassethasbeenunderestimated,anditstill hasfivemoreyearsinusetocome,makingitstotallifesevenyears. Forthefirsttwoyears,theassetisdepreciatedby£3,000perannum,sothatitscarryingamountafter twoyearsis£(12,0006,000)=£6,000.Iftheremaininglifeoftheassetisnowrevisedtofivemore years,theremainingamounttobedepreciated(£6,000)isspreadovertheremainingusefullife,giving anannualdepreciationchargeforthefinal5yearsof: Carrying amount at time of change Re vised useful life
=
£6,000 =£1,200peryear 5 years
Interactivequestion4:Changeinresidualvalue
[Difficultylevel:Examstandard]
Anassethadacostof£1,000,anestimatedusefullifeof10yearsandaresidualvalueof£200.Atthe startofyear3areviewshowsitsremainingusefullifewasunchangedbuttheresidualvaluewas reducedtonil. Calculatethedepreciationchargeforeachofyears1to3onthestraightlinebasis. SeeAnswerattheendofthischapter. Whenanimpairmentlossisrecognised(see3.7above),theasset'sremainingusefullifeandresidual valueshouldalsobereviewedandpossiblyrevised(ifstraightlinedepreciationisbeingused).The reducingbalancepercentagerateshouldberevisedifrelevant.
Interactivequestion5:Impairment
[Difficultylevel:Examstandard]
On1January20X1Tigerbuysanon-currentassetfor£120,000,withanestimatedusefullifeof20years andnoresidualvalue.Tigerdepreciatesitsnon-currentassetsonastraightlinebasis.Itsreporting periodisthe12monthsended31December. On31December20X3theassetwillbeincludedinthestatementoffinancialpositionasfollows: Non-currentassetatcost Accumulateddepreciation(3(£120,00020)) Carryingamount
£ 120,000 (18,000) 102,000
Requirements Considereachofthesealternativesseparately. (a) On1January20X4theremainingusefullifeisrevisedto15yearsfromthatdate. Calculatetherevisedannualdepreciationcharge. (b) On1January20X4theremainingusefullifeisrevisedto10yearsfromthatdate.Animpairment reviewshowsthatthevalueis£95,000asat1January20X4. Showhowtheimpairmentlosswouldberecordedandcalculatetherevisedannualdepreciation charge. SeeAnswerattheendofthischapter.
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4 Accountingfordepreciation Sectionoverview
Accountingfordepreciation:
DEBIT CREDIT
Depreciationexpense(statementofprofitorloss) Accumulateddepreciation(statementoffinancialposition)
£X
£X
Definition Accumulateddepreciation:Thetotalamountoftheasset'sdepreciationamountthathasbeen allocatedtoreportingperiodstodate.
4.1 Accountingfordepreciation Therearetwobasicaspectsofaccountingfordepreciationtoremember. (a) Adepreciationchargeismadeinthestatementofprofitorlossineachreportingperiodforevery depreciablenon-currentasset.Nearlyallnon-currentassetsaredepreciable,themostimportant exceptionbeingfreeholdland. (b) Thetotalaccumulateddepreciationonanon-currentassetbuildsupastheassetgetsolder.The totalaccumulateddepreciationisalwaysgettinglarger,untilthenon-currentassetisfully depreciated. Accountingfordepreciationisasfollows.
Setupanaccumulateddepreciationaccountforeachseparatecategoryofnon-currentasset,for exampleplantandmachinery,landandbuildings,fixturesandfittings,motorvehicles.
Withthedepreciationchargefortheperiod: DEBIT CREDIT
Depreciationexpense(statementofprofitorloss) Accumulateddepreciationaccount(statementoffinancialposition)
£X £X
Thebalanceontheaccumulateddepreciationaccountisthetotalaccumulateddepreciation.This isalwaysacreditbalancebroughtforwardintheledgeraccount.
Thenon-currentassetcostaccountsareunaffectedbydepreciation.
Inthestatementoffinancialposition,thebalanceontheaccumulateddepreciationaccountisset againstthenon-currentassetcostaccountstoderivethecarryingamountofthenon-current assets.
Thisishowthenon-currentassetcost,accumulateddepreciationanddepreciationchargeaccounts mightappearinatrialbalance: DR £ Freeholdbuilding – cost 2,000,000 Freeholdbuilding – accumulateddepreciation(£20,000currentreporting period) Motorvehicles – cost 70,000 Motorvehicles – accumulateddepreciation(£15,000currentreporting period) Officeequipment – cost 25,000 Officeequipment – accumulateddepreciation(£3,000currentreporting period) Depreciationexpense (20,000+15,000+3,000) 38,000
CR £ 500,000 40,000 15,000
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Theywouldbeshownatthefollowingcarryingamountsinthestatementoffinancialposition: Non-currentassets Freeholdbuilding Motorvehicles Officeequipment
1,500,000 30,000 10,000
Inthestatementofprofitorlossthedepreciationchargewouldbeincludedpartlyinadministrative expensesandpartlyindistributioncosts: Administrativeexpenses(20,000+3,000) Distributioncosts
23,000 15,000 38,000
Workedexample:AccountingfordepreciationI BrianBoxsetuphisowncomputersoftwarebusinesson1March20X6.Hepurchasedacomputer systemoncreditfromamanufacturerfor£16,000.Thesystemhasanexpectedlifeofthreeyearsanda residualvalueof£2,500.Usingthestraightlinemethodofdepreciation,thenon-currentassetaccount, accumulateddepreciationaccountandstatementofprofitorloss(extract)andstatementoffinancial position(extract)wouldbeasfollows,foreachofthenextthreereportingperiodsending28February 20X7,20X8and20X9. NON-CURRENTASSET:COMPUTEREQUIPMENTCOST Date 1.3.X6
Tradepayables
£ 16,000
Date 28.2.X7
Balancec/d
£ 16,000
1.3.X7
Balanceb/d
16,000
28.2.X8
Balancec/d
16,000
1.3.X8
Balanceb/d
16,000
28.2.X9
Balancec/d
16,000
1.3.X9
Balanceb/d
Theannualdepreciationchargeis
16,000
£(16,000 2,500) =£4,500pa 3 years
ACCUMULATEDDEPRECIATION Date 28.2.X7
28.2.X8
Balancec/d
£ 4,500
Date 28.2.X7
Statementofprofitor loss
Balancec/d
9,000
1.3.X7 28.2.X8
9,000
Balanceb/d Statementofprofitor loss
28.2.X9
Balancec/d
13,500
1.3.X8 28.2.X9
13,500
Balanceb/d Statementofprofitor loss
1.3.X9
Balanceb/d
£ 4,500
4,500 4,500 9,000
9,000 4,500 13,500
13,500
Attheendofthreereportingperiods,theassetisfullydepreciateddowntoitsresidualvalue(£16,000– £13,500=£2,500).IfitcontinuestobeusedbyBrianBox,itwillnotbedepreciatedanyfurther(unless itsestimatedresidualvalueisreduced). STATEMENTOFPROFITORLOSS(EXTRACT) Yearending: 28Feb20X7 28Feb20X8 28Feb20X9
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Depreciationexpense Depreciationexpense Depreciationexpense
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STATEMENTOFFINANCIALPOSITION(EXTRACT)ASAT28FEBRUARY 20X7 £ 16,000 (4,500) 11,500
Computerequipmentatcost Lessaccumulateddepreciation Carryingamount
20X8 £ 16,000 (9,000) 7,000
20X9 £ 16,000 (13,500) 2,500
Intheory,thenon-currentassetisnowattheendofitsusefullife.However,untilitissoldoffor scrapped,theassetwillstillappearinthestatementoffinancialpositionatcost(lessaccumulated depreciation)anditshouldremainintheledgeraccountsforcomputerequipmentuntildisposal.
Workedexample:AccountingfordepreciationII BrianBoxprospersinhiscomputersoftwarebusiness,andbeforelonghepurchasesacarforhimself, andlateroneforhischiefassistantBillOckhead.Relevantdataisasfollows. BrianBoxcar BillOckheadcar
Dateofpurchase 1June20X6 1June20X7
Cost £20,000 £15,500
Estimatedlife 3years 3years
Estimatedresidualvalue £2,000 £2,000
Thestraightlinemethodofdepreciationistobeused. Preparethevehiclesaccountandvehiclesaccumulateddepreciationaccountforthereportingperiods to28February20X7and20X8. Calculatethecarryingamountofthevehiclesasat28February20X8.
Solution (a) (i) £(20,000 – 2,000) = 3 12 Depreciation1June20X6–28February20X7(9£500) 1March20X7–28February20X8(12×£500)
BrianBoxcar
Monthlydepreciation=
£500pm £4,500 £6,000
(ii)
£(15,500 – 2,000) = 3 12 Depreciation1June20X7–28February20X8(9£375) BillOckheadcar
Monthlydepreciation=
(b) Date 1Jun20X6
£3,375
MOTORVEHICLES Payables(orcash) (carpurchase)
£ Date 20,000 28Feb20X7
1Mar20X7 1Jun20X7
Balanceb/d Payables(orcash) (carpurchase)
20,000 15,500 35,500
1Mar20X8
Balanceb/d
35,500
£375pm
28Feb20X8
Balancec/d
Balancec/d
£
20,000
35,500 35,500
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MOTORVEHICLES–ACCUMULATEDDEPRECIATION Date 28Feb20X7 Balancec/d
£ Date 4,500 28Feb20X7
28Feb20X8 Balancec/d
13,875 28Feb20X8
13,875
Statementofprofitor loss
£ 4,500 4,500
1Mar20X7
Balanceb/d
1Mar20X8
Statementofprofitor loss (6,000+3,375)
13,875
Balanceb/d
13,875
9,375
STATEMENTOFFINANCIALPOSITION(WORKINGS)ASAT28FEBRUARY20X8 Assetatcost Accumulateddepreciation Yearto28Feb20X7 Yearto28Feb20X8 Carryingamount
BrianBoxcar £ £ 20,000 4,500 6,000 (10,500) 9,500
BillOckheadcar £ £ 15,500 – 3,375 (3,375) 12,125
Total £ 35,500 (13,875) 21,625
4.2 DepreciationontheETB Becausethefinaldepreciationcalculationisusuallyaccountedforaftertheinitialtrialbalancehasbeen extracted,theonlyfigureforaccumulateddepreciationontheinitialtrialbalanceistheoneforthe balancebroughtforward.WecanincorporatetherelevantfiguresusingtheETB.
Calculatetheamountofdepreciationtobecharged
Preparetheyear-endjournaltorecorddepreciationexpense(andimpairmentlossifrelevant)
EnterthejournalintheadjustmentscolumnsoftheETBusingtheaccumulateddepreciationline plusalinefordepreciationexpense
IncludetheseadjustmentsintheETBcross-casttopreparethefinancialstatements
Enterthejournalsfordepreciationintheledgeraccountsandbringdownthebalanceonthe accumulateddepreciationaccount.
5 Non-currentassetdisposals Sectionoverview
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Adisposalaccountisusedtocalculatetheprofitorlossondisposalofanasset,whichisthe amountbywhichthesalesproceedsoftheassetdiffersfromitscarryingamountatthedateof disposal.
Accountingfordisposals:
DEBIT CREDIT DEBIT DEBIT CREDIT
WhenanoldassethasbeenattributedanNRVwhengiveninpart-exchangeforanewone,the part-exchangevalueisaccountedforastheoldasset'sdisposalproceeds.
Disposalaccountwithasset'scarryingamount Disposalaccountwithsalesproceeds Cashwithproceeds Accumulateddepreciation Assetcost
£X £X £X £X
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Non-currentassetsmightbesoldoffatsomestageduringtheirlife,eitherwhentheirusefullifeisover orbeforethen. Wheneverabusinesssellssomething,itwillmakeaprofitoraloss.Whennon-currentassetsare disposedof,therewillbeaprofitorlossondisposal.Asitisacapitalitembeingsold,theprofitorloss willbecapitalincomeoracapitalexpense.Profitsareshownasotherincome,andlossesarereported asadministrativeexpensesordistributioncostsinthestatementofprofitorlossofthebusiness,notas partofgrossprofit.Theyarecommonlyreferredtoas'profit(orloss)ondisposalofnon-current assets'.
5.1 Theprinciplesbehindcalculatingtheprofitorlossondisposal Theprofitorlossonthedisposalofanon-currentassetisthedifferencebetween:
Thecarryingamountoftheassetatthetimeofitssale,and Itsnetdisposalproceeds,thevaluereceivedlessanycostsofmakingthesale.
Aprofitismadewhenthenetdisposalproceedsexceedthecarryingamount.Alossismadewhenthe netdisposalproceedsarelessthanthecarryingamount.
Workedexample:Disposalofanon-currentassetI Abusinesspurchasedanon-currentasseton1January20X1for£25,000.Ithadanestimatedlifeofsix yearsandanestimatedresidualvalueof£7,000andisdepreciatedonthestraightlinebasis.Theasset wassoldafterthreeyearson1January20X4toanothertraderwhopaid£17,500forit. Whatwastheprofitorlossondisposal?
Solution Annualdepreciation
=
£(25,000 7,000) =£3,000perannum 6 years
£ 25,000 (9,000) 16,000 17,500 1,500
Costofasset Lessaccumulateddepreciation(3£3,000) Carryingamountatdateofdisposal Disposalproceeds Profitondisposal
Thisprofitwillbeshowninthestatementofprofitorlossasanitemofotherincome,addedtothe grossprofittoarriveatnetprofit.
Workedexample:Disposalofanon-currentassetII Abusinesspurchasedamachineon1July20X1for£39,000.Themachinehadanestimatedresidual valueof£3,000andalifeofeightyears.Themachinewassoldfor£18,600on31December20X4.To makethesale,thebusinesshadtoincurdismantlingcostsandcostsoftransportingthemachinetothe buyer'spremisesof£1,200. Thebusinessusesthestraightlinemethodofdepreciation.Whatwastheprofitorlossondisposalofthe machine?
Solution Depreciationexpense
£(35,000 3,000) =£375permonth,and£4,500perannum 8 years
In20X1onlysixmonthsdepreciationwascharged,becausetheassetwaspurchasedsixmonthsinto thereportingperiod.
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£
Non-currentassetatcost Depreciationin20X1(6×£375) 20X2,20X3and20X4(3£4,500) Accumulateddepreciation Carryingamountatdateofdisposal Disposalproceeds Costsincurredinmakingthesale Netdisposalproceeds Lossondisposal
2,250 13,500 18,600 (1,200)
£ 39,000 (15,750) 23,250 (17,400) (5,850)
Thislosswillbeshownaspartofadministrativeexpensesinthestatementofprofitorlossofthe business.Itisacapitalexpense,notatradingloss,anditshouldnotthereforebepartofthecalculation ofgrossprofit.
5.2 Accountingfornon-currentassetdisposals Werecordthedisposalofnon-currentassetsinadisposalsledgeraccount. (a) Thefollowingitemsappearinthedisposalsaccount: (i) Thevalueoftheasset(atcost) (ii) Theaccumulateddepreciationuptothedateofsale (iii) Thedisposalproceeds,ifany (b) Theprofitorlossondisposalisthedifferencebetween: (i) Thedisposalproceedsand (ii) Thecarryingamountoftheassetatthetimeofdisposal. (c) Theledgeraccountingentriesareasfollows. (i)
DEBIT Disposalaccount CREDIT Non-currentassetcostaccount
£X £X
withthecostoftheassetdisposedof(thecostoftheassetisremovedfromthestatementof financialposition). (ii) DEBIT Accumulateddepreciationaccount CREDIT Disposalaccount
£X £X
withtheaccumulateddepreciationontheassetasatthedateofsale(theaccumulated depreciationontheassetisremovedfromthestatementoffinancialposition). (iii) DEBIT Cashbook(orreceivables) CREDIT Disposalaccount
£X £X
withthedisposalproceedsoftheasset. Thebalanceonthedisposalaccountistheprofitorlossondisposalandthecorrespondingdouble entryisrecordedintheprofitandlossledgeraccountitself,ieinthestatementofprofitorloss.
Workedexample:Accountingforthedisposalofnon-currentassets Abusinesshas£110,000worthofmachineryatcost.Itspolicyistodepreciateat20%perannum straightline.Thetotalaccumulateddepreciationnowstandsat£70,000.Thebusinesssellsfor£19,000 amachinewhichitpurchasedexactlytwoyearsagofor£30,000. Showtherelevantledgerentries.
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Solution MACHINERY–COST £ 110,000 110,000
Balanceb/d Balanceb/d
£ 30,000 80,000 110,000
Disposals Balancec/d
80,000 MACHINERY–ACCUMULATEDDEPRECIATION
Disposals(20%of£30,000for 2years) Balancec/d
£ 12,000 58,000 70,000
Balanceb/d
£ 70,000 70,000
Balanceb/d
58,000
DISPOSALACCOUNT Machinery–cost Statementofprofitorloss(profiton sale)
£ 30,000 1,000
Machinery–accumulateddepreciation Cash
£ 12,000 19,000
31,000
31,000
Check: Assetatcost Accumulateddepreciationattimeofsale Carryingamountattimeofsale Disposalproceeds Profitondisposal
£ 30,000 (12,000) 18,000 19,000 1,000
5.3 Accountingfordisposalsofnon-currentassetsgiveninpart-exchange Quiteoftenabusinessdoesnotreceivecashfortheasset,butinsteadgeta'part-exchange'or'trade-in value'foritagainstthecostofanewasset.Insteadofdisposalproceedsbeingreceivedintheformof cashorpromisedintheformofareceivable,usethepartexchangevaluegiventotheassetbythe otherpartyasitsdisposalvalue.
Workedexample:Accountingforpart-exchangedisposalsI AssetA,costing£20,000isacquiredbyabusinessfor£12,000cash,plusitsoldAssetB.ThepartexchangevalueattributedtoAssetBis£20,000–£12,000=£8,000.Thisamountmustbecompared withAssetB'scarryingamountinordertoestablishtheprofitorlossonAssetB'sdisposal. AssetBcost£15,000andhashad£4,000depreciationchargedinrespectofit,soitscarryingamountat thedateofthepart-exchangedisposalis£11,000.Thebusinesshasmadealossof£11,000–£8,000= £3,000onAssetB'sdisposal. The£8,000part-exchangevaluemustbeincludedinthecostofAssetA,alongwiththe£12,000cash handedover. (a) DEBIT CREDIT CREDIT
AssetAcost Cash Disposalaccount(AssetB'spart-exchangevalue)
£ 20,000
£ 12,000 8,000
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(b) DEBIT CREDIT DEBIT CREDIT
AssetBaccumulateddepreciation Disposalaccount(AssetB) Disposalaccount(AssetB) AssetBcostaccount
£ 4,000 15,000
£ 4,000 15,000
£ 3,000
£ 3,000
BeingtheremovalofAssetBfromtheledgeraccounts (c) DEBIT CREDIT
Statementofprofitorloss Disposalaccount
BeingthelossondisposalofAssetB(8,000–(15,000–4,000)) DISPOSALSACCOUNT £ 15,000 15,000
AssetBcost(b)
Disposalproceeds(partexchange value)(a) AssetBaccumulateddepreciation(b) Statementofprofitorloss(c)
£ 8,000 4,000 3,000 15,000
Workedexample:Accountingforpart-exchangedisposalsII Abusinesstradesinanassetthatcost£30,000twoyearsagoforanewassetthatcosts£60,000.A chequefor£41,000wasalsohandedoverinfullsettlement.Assetsaredepreciatedonthestraightline basisoverfiveyears.Whataretherelevantledgeraccountentries?
Solution MACHINERYACCOUNT Balanceb/d Cash Disposals (partexchangevalue£(60,000– 41,000))
£ 30,000 41,000 19,000 90,000
Disposals Balancec/d
Balanceb/d
60,000
£ 30,000 60,000 90,000
Thenewassetisrecordedinthenon-currentassetaccountatcost£(41,000+19,000)=£60,000. MACHINERYACCUMULATEDDEPRECIATION Disposals(20%of£30,000for 2years)
£ 12,000
Balanceb/d
£ 12,000
DISPOSALS Cost Statementofprofitorloss(profiton sale)
£ 30,000 1,000
Accumulateddepreciation Cost–part-exchangevalue
£ 12,000 19,000
31,000
31,000
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Interactivequestion6:Non-currentassetledgeraccounts [Difficultylevel:Examstandard] Abusinesspurchasedtwomachineson1January20X5atacostof£15,000each.Eachhadan estimatedlifeoffiveyearsandanilresidualvalue.Thestraightlinemethodofdepreciationisused. Owingtoanunforeseenslumpinmarketdemandforitsendproduct,thebusinessdecidedtoreduceits output,andswitchtomakingotherproductsinstead.On31March20X7,onemachinewassold(on credit)toabuyerfor£8,000. Laterinthereportingperiod,however,itwasdecidedtoabandonproductionaltogether,andthe secondmachinewassoldon1December20X7for£2,500cash. Preparethemachineryaccount,accumulateddepreciationofmachineryaccountanddisposalaccount forthe12monthreportingperiodto31December20X7todeterminetheprofitorlossondisposalof eachmachine. SeeAnswerattheendofthischapter.
5.4 Accountingfornon-currentassetsontheETB EarlierwesawhowdepreciationisaccountedforontheETB.Wecannowdrawtogethera comprehensiveexampleofentriesontheETBinrespectofnon-currentassets,madeaftertheextraction ofaninitialtrialbalance.
Workedexample:Non-currentassetsontheETB Rodrigo'sinitialtrialbalanceasat31December20X0isasfollows. Ledgerbalance Currentassets Capitalat1.1.X0 Freeholdlandandbuildings–costat1.1.X0 Freeholdlandandbuildings–accumulateddepreciationat1.1.X0 Plantandequipment–costat1.1.X0 Plantandequipment–accumulateddepreciationat1.1.X0 Motorvehicles–costat1.1.X0 Motorvehicles–accumulateddepreciationat1.1.X0 Currentliabilities Expenses Purchases Sales Drawings Suspense
Trialbalance Debit Credit £ £ 87,420 100,000 100,000 15,000 45,000 18,750 25,000 14,650 15,420 5,830 58,740 205,640 47,670 200 369,660 369,660
Thefollowingmattershavenowbeendiscovered: (a) On1January20X0Rodrigodisposedofanitemofplantthathadcost£10,000andonwhich £1,250depreciationhadbeencharged.Hereceivedachequefor£7,950.Theonlyaccounting entrymadewastodebitcash. (b) On1January20X0healsotradedinacarthathadcost£8,000andonwhich£4,500depreciation hadbeenchargedforanewcarcosting£13,300.Hehandedoverachequeinadditionfor£7,750. Theonlyentrywithregardtothistransactionwasinthecashbook. (c) Withregardtotheassetsheldat31December20X0,depreciationonthefreeholdbuildingof £5,000,onplantandequipmentof£5,290,andonmotorvehiclesof£6,900,istobecharged. Requirement
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PrepareRodrigo'syear-endjournalsasat31December20X0inrespectofthesematters,andcomplete theETB.
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Solution (a) DEBIT CREDIT DEBIT CREDIT
Suspense Disposal–plant Plantandequipment–accumulateddepreciation Disposal–plant(carryingamount) Plantandequipment–cost
£ 7,950 1,250 8,750
£ 7,950 10,000
Beingthecorrectrecordingofcashreceivedondisposalofplant,andtheremovaloftheasset'scostand accumulateddepreciation (b) £ £ DEBIT Motorvehicles–cost 13,300 CREDIT Suspense 7,750 Disposal–cargiveninpartexchange(13,300–7,750) 5,550 Beingthecorrectrecordingofpurchaseofanewcarfor£13,300 DEBIT CREDIT
Motorvehicles–accumulateddepreciation Disposal–cargiveninpartexchange(carryingamount) Motorvehicles–cost
£ 4,500 3,500
£ 8,000
Beingtheremovalofthecostandaccumulateddepreciationinrelationtoacar,giveninpartexchange foranewone (c) £ £ DEBIT Expenses(depreciation) 17,190 CREDIT Freeholdlandandbuildings–accumulateddepreciation 5,000 Plantandequipment–accumulateddepreciation 5,290 Motorvehicles–accumulateddepreciation 6,900 Beingthedepreciationchargeforthereportingperiod Ledgerbalance Currentassets Capitalat1.1.X0 Freeholdlandand buildings–cost Freeholdlandand buildings– accumulated depreciation Plantand equipment–cost Plantand equipment –accumulated depreciation Motorvehicles– cost Motorvehicles– accumulated depreciation Currentliabilities Expenses Purchases Sales Drawings Suspense Disposal–plant Disposal–car Netprofit
Trialbalance Debit Credit £ £ 87,420 100,000 100,000 15,000 45,000 18,750 25,000 14,650 15,420 5,830 58,740 205,640 47,670 200 369,660 369,660
Adjustments Debit Credit £ £ 5,000 10,000 1,250 5,290 13,300 8,000 4,500 6,900 17,190 7,950 7,750 8,750 7,950 3,500 5,550 56,440 56,440
Statementofprofitor loss Debit Credit £ £ 23,020 58,740 205,640 800 2,050 125,130 207,690 207,690
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Statementof financialposition Debit Credit £ £ 87,420 100,000 100,000 20,000 35,000 22,790 30,300 17,050 15,420 47,670 125,130 300,390 300,390
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6 Theassetregister Sectionoverview
Theassetregisterlistsoutallthedetailsofeachnon-currentasset.Itstablesshouldreconcileto theledgeraccountfornon-currentassetsinthenominalledger.
Definition Assetregister:Alistingofallnon-currentassetsownedbytheorganisation,brokendownby department,locationorassettype,andcontainingnon-financialinformation(suchaschassisnumbers andsecuritycodes)aswellasfinancialinformation. Anassetregisterismaintainedprimarilyforinternalcontrolpurposes.Itshowsanorganisation's investmentincapitalequipmentinfinancialterms,andallowsthebusinesstotracefromitsledger accountsfornon-currentassetstoindividualassets.
6.1 Datakeptinanassetregister Detailsabouteachnon-currentassetincludethefollowing.
Theinternalreferencenumber(forphysicalidentificationpurposes) Manufacturer'sserialnumber(formaintenancepurposes) Descriptionofasset Locationofasset Departmentwhichusestheasset Purchasedate(forcalculationofdepreciation) Cost,andanyenhancementexpenditure Depreciationmethodandestimatedusefullife(forcalculationofdepreciation) Carryingamount
Itisgoodpracticeto'reconcile'oragreethenetcarryingamountsofalltheassetsontheassetregister withthenetcarryingamountofnon-currentassetsrecordedinthenominalledger: £ X (X) X
Assetsatcost(fromthenon-currentassetcostledgeraccount) Accumulateddepreciation(fromtheledgeraccount) Totalofcarryingamountslistedintheassetregister
Anydifferenceshouldbeinvestigatedandcorrected.Theseusuallyarisefromcomputationalerrorsor fromitemsbeingtakenoutoftheassetregisterwithnoequivalentchangebeingmadeinledger accounts,orviceversa,forinstancebecause:
Assetshavebeenstolen,damagedorscrapped(fornilproceeds). Assetsareobsolete. Therearenewassets,notyetrecordedintheregister. Therehavebeenenhancementsnotyetrecordedintheregister. Thereareerrorsintheregister.
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7 Intangiblenon-currentassets Sectionoverview
Purchasedgoodwillmayappearasanassetinacompany'sstatementoffinancialposition.It representstheamountpaidforabusinessinexcessofwhatitsnetassetsareworth.
Somedevelopmentcostsarecapitalisedonthestatementoffinancialposition.
Intangiblenon-currentassetsshouldbesubjecttoreviewsforimpairmentoftheirvalue.
Notallassetsheldforthelongtermcanbetouched;someareintangible.
7.1 Goodwill Ifabusinesshasgoodwillitmeansthatthevalueofthebusinessasagoingconcernisgreaterthanthe bookvalueofitsassetslessitsliabilities. Goodwilliscreatedbygoodrelationshipsbetweenabusinessanditscustomers,forexample:
Bybuildingupareputation(bywordofmouthperhaps)forhighqualityproductsorhigh standardsofservice
Byrespondingpromptlyandhelpfullytoqueriesandcomplaintsfromcustomers
Throughthepersonalityofthestaff,theirattitudestocustomersandtheirskills
Althoughthevalueofgoodwilltoabusinessmightbeextremelysignificantitisnotusuallyvaluedin thefinancialstatements. Forexample,thewelcomingsmilesofshopstaffmaycontributemoretoasupermarket'sprofitsthan thefactthatanewelectroniccashregisterhasrecentlybeenacquired;evenso,whereasthecash registerwillberecordedintheledgeraccountsasanon-currentasset,thevalueofstaffwouldbe ignoredforaccountingpurposes.
Goodwillisinherentinthebusinessbutithasnotbeendirectlypaidfor,sovaluationisdifficult.
Goodwillchangesfromdaytoday.Oneactofbadcustomerrelationsmightdamagegoodwilland oneactofgoodrelationsmightimproveit.Staffwithafavourablepersonalitymightretireorleave, tobereplacedbystaffwhoneedtimetobecomeestablished.Sincegoodwilliscontinually changinginvalue,itcannotreliablyberecordedintheaccounts.
7.2 Purchasedgoodwill Theexceptiontothegeneralrulethatgoodwillhasnoobjectivevaluationariseswhenanexisting businessispurchased.Thebuyerhastopayfornotonlyitsnon-currentassetsandinventories(and perhapstakeoveritspayablesandreceivablestoo)butalsoforitsgoodwill.Thisiswhythepurchase considerationformostbusinessesismorethanthevalueoftheirnetassets.
Workedexample:Goodwill TonyTycoonpurchasesCliveDunwell'sbusinessfor£30,000.Clive'sbusinesshastotalassetsless liabilitiesof£25,000,allofwhicharetakenoverbyTony.Tonywillbepaying(£30,000–£25,000)= £5,000moreforthebusinessthanitsnetassetsareworth,becauseheispurchasingthegoodwillof thebusinesstoo.ThestatementoffinancialpositionofTony'sbusinesswhenitbeginsoperations (assumingthathedoesnotchangethevalueofwhathehasacquired)willbeasfollows:
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TONYTYCOON STATEMENTOFFINANCIALPOSITIONASATTHESTARTOFBUSINESS Intangiblenon-currentasset:goodwill Othernetassetsacquired Netassets
£ 5,000 25,000 30,000
Capital
30,000
Purchasedgoodwillisshowninthisstatementoffinancialpositionbecauseithasbeendirectlypaidfor. Ithasnotangiblesubstance,andsoitisanintangiblenon-currentasset.
Definition Purchasedgoodwill:Theexcessofthepurchaseconsiderationpaidforabusinessoverthefairvalueof theindividualassetsandliabilitiesacquired.
7.3 Accountingforpurchasedgoodwill Purchasedgoodwillisapremiumpaidfortheacquisitionofabusinessasagoingconcern:itisoften referredtoasa'premiumonacquisition'.Apurchaserpayssuchapremiumbecausetheybelievethat thetruevalueofthebusinessincludesgoodwill,whichhasvalueinadditiontoitstangiblenetassets. Goodwillcontinuallychanges.Abusinesscannotlastforeveronitspastreputation;itmustcreatenew goodwillastimegoeson. Ifthegoodwilllosessomeorallofitsvalue,itisdeemedtohavebecome'impaired'.Itsvalueinthe statementoffinancialpositionisthenwrittendownbytheamountoftheimpairmentandthe impairmentlossischargedagainsttheprofitoftheperiod. Goodwillshouldbetreatedasanintangiblenon-currentasset.Itiskeptatcostinthestatementof financialpositionsubjecttoanannualreviewforimpairment.Itisnotdepreciated.
7.4 Howisthevalueofpurchasedgoodwilldecided? Thevalueofthegoodwillisamatterforthepurchaserandsellertoagreeuponinfixingthepurchase consideration.However,twomethodsofvaluationareworthmentioninghere. (a) Thesellerandbuyeragreeonapricewithoutspecificallyquantifyingthegoodwill.Thepurchased goodwillwillthenbethedifferencebetweenthepriceagreedandthevalueofthenetassetsinthe booksofthenewbusiness. (b) Thecalculationofgoodwillmayprecedefixingthepurchaseconsiderationandmaybecomea centralelementofnegotiation.Therearemanywaysofarrivingatavalueforgoodwillandmostof themarerelatedtotheprofitrecordofthebusinessinquestion.Forinstance,theymayagreeto valuegoodwillas2×profitofthepreviousreportingperiod,orasimilarcalculation. Goodwillshownbythepurchaserintheiraccountswillbethedifferencebetweenthepurchase considerationandtheirownvaluationofthetangiblenetassetsacquired.IfAvalueshistangiblenet assetsat£40,000andgoodwillisagreedat£21,000thenBagreestopay£61,000forthebusiness. Whensettingupaccountsfortheassetacquired,Bmayvaluethetangiblenetassetsatonly£38,000, sothegoodwillinB'sbookswillbe£61,000–£38,000=£23,000. WeshallcomebacktogoodwillinChapter14.
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Interactivequestion7:Goodwill
[Difficultylevel:Intermediate]
Toadgoesintobusinesswith£10,000capitalandagreestobuyThrush'sshopfor£6,500.Thrush's recentfinancialstatementsshowtotalassetslessliabilitiesof£3,500,whichToadvaluesat£4,000. Requirement PreparethestatementoffinancialpositionofToad'sbusinessatthefollowingtimes. (a) BeforehepurchasesThrush'sbusiness (b) Afterthepurchase SeeAnswerattheendofthischapter.
7.5 Developmentcosts Largecompaniesspendsignificantamountsofmoneyondevelopmentactivitiesfromwhichtheyhope togeneraterevenuesinfutureperiods.Theseamountsarecreditedtocashorpayablesanddebitedto anaccountfordevelopmentexpenditure.Theaccountingproblemishowtotreatthedebitbalance onthedevelopmentcostaccountatthedateofthestatementoffinancialposition. Therearetwopossibilities.
Thedebitbalancemaybeclassifiedasanexpenseandtransferredtothestatementofprofitor loss.Thisisreferredtoas'writingoff'theexpenditure.Theargumenthereisthatitisanexpense justlikerentorwagesanditsaccountingtreatmentshouldbethesame.
Thedebitbalancemaybeclassifiedasanassetandincludedinthestatementoffinancialposition. Thisisreferredtoas'capitalising'or'carryingforward'or'deferring'theexpenditure.Thisargument isbasedontheaccrualprinciple.Ifdevelopmentactivityeventuallyleadstoneworimproved productswhichgenerateincome,thecostsshouldbecarriedforwardtobematchedagainstthat incomeinfuturereportingperiods. Whendevelopmentexpenditureiscarriedforwardasanassettheaccountingentriesare: DEBIT CREDIT
Non-currentassets Cash/payables
£X
£X
Thecostofthisnon-currentassetwillneedtobeallocatedtothestatementofprofitorlossasitis matchedagainsttheincomeithelpstogenerate.Thisprocessisessentiallythesameasfordepreciation oftangiblenon-currentassets,butitiscalledamortisation.
7.6 Otherintangibleassets Abusinessmayhaveothertypesofintangibleasset:
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Patentsonideasordesignsthatthebusinesshasdevelopedorbought.Theseareusedtogenerate incomeovermanyreportingperiods.Theyarevaluedatcostandaresubjecttoamortisationinline withthebusiness'spolicy,andtoregularimpairmentreviews,whichmayresultinanimpairment loss.
Investmentsheldforthelongterm.Thevaluationofthesefallsoutsidethescopeofthe Accountingsyllabus.
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8 Thenon-currentassetsnotetothestatementoffinancial position Sectionoverview
Thenon-currentassetsnotetothestatementoffinancialpositionprovidesthedetailsbehindthe singlefigurefortangiblenon-currentassetsinthestatementoffinancialposition.
Thereisusuallyadetailednotetothefinancialstatementsinrespectofproperty,plantand equipment,withjustthesummarisedfigureinthestatementoffinancialposition.Foreachclassof property,plantandequipmentthenoteshows:
Costandaccumulateddepreciationbroughtforward Additionsduringthereportingperiod Disposalsduringthereportingperiod,andtherelatedaccumulateddepreciation Depreciationchargeforthereportingperiod Closingbalancecarriedforward
Notethatdisposalproceeds,andgains/lossesondisposal,donotappearinthenon-currentassetsnote.
Workedexample:Thenon-currentassetsnote WepreparedRodrigo'sETBearlierinthischapter.Wecannowpreparehisnon-currentassets(property, plantandequipment)notefromhisETBasfollows. Cost At1.1.X0 Additions Disposals At31.12.X0 Accumulateddepreciation At1.1.X0 Chargeforthereportingperiod Disposals At31.12.X0 Carryingamount At1.1.X0 At31.12.X0
Freeholdland andbuildings £ 100,000 100,000
Plantand equipment £ 45,000 (10,000) 35,000
Motor vehicles £ 25,000 13,300 (8,000) 30,300
Total £ 170,000 13,300 (18,000) 165,300
15,000 5,000 20,000
18,750 5,290 (1,250) 22,790
14,650 6,900 (4,500) 17,050
48,400 17,190 (5,750) 59,840
85,000 80,000
26,250 12,210
10,350 13,250
121,600 105,460
OnRodrigo'sstatementoffinancialpositionat31December20X0therewilljustbeasinglefigure,for 'Property,plantandequipment',of£105,460.
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SummaryandSelf-test
Summary(1/2)
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Summary(2/2)
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Self-test Answerthefollowingquestions. 1
MaterialspurchasedandusedbyP&Coforrepairstoofficebuildingshavebeenincludedinthe draftfinancialstatementsaspurchases. Thenecessaryamendmentwill A B C D
2
Increasegrossprofitwithnoeffectonnetprofit Increasegrossprofitandreducenetprofit Havenoeffectoneithergrossprofitornetprofit Reducegrossprofitandincreasenetprofit
Marcellusacquirednewpremisesatacostof£250,000on1January20X1.Marcelluspaidthe followingfurthercostsduringtheyearended31December20X1. Costsofinitialadaptation Legalcostsrelatingtopurchase Monthlycleaningcontract Officefurniture
£ 13,900 1,200 9,600 6,500
Whatamountshouldappearasthecostofpremisesinthecompany'sstatementoffinancial positionat31December20X1? A B C D 3
Whyisdepreciationprovidedonnon-currentassets? A B C D
4
£250,000 £263,900 £265,100 £271,600
Toensurethatsufficientfundsareavailabletoreplacetheassets Toshowtheassetsatreplacementcostonthestatementoffinancialposition Tospreadthecostoftheassetsovertheirusefullives Toshowthefallinmarketvalueoftheassetsinthestatementofprofitorloss
ABC,whosereportingperiodisthe12monthsended31December,hasprovideddepreciation monthlyattherateof10%perannumoncostonapieceofplantboughton1September20X0 costing£15,000.Thedepreciationmethodwaschangedfromstraightlineto10%reducing balanceattheendof20X3. Thedepreciationchargeonthisassetfor20X5was A B C D
5
£1,500 £945 £900 £889
Abusinesswithareportingperiodofthe12monthsended30Junebuysanon-currentasseton1 July20X3for£200,000.Depreciationischargedat15%perannumonthereducingbalancebasis. On30June20X5theassetwassoldfor£54,800. Whatwasthelossonsaleoftheasset? A B C D
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£89,700 £85,200 £68,025 £55,200
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Intheyearended31December20X7Btradedinfor£6,860avehiclecosting£12,000on1 November20X5againstthecost(£9,600)ofareplacementvehicle.Thebalancedueforthenew vehiclehasbeenpaidincashanddebitedtothecostofvehiclesaccount,nootherentriesrelating tothetransactionhavingbeenmade. Whatnetadjustmentisrequiredtothecompany'scostofvehiclesaccountasaresultofthis transaction? A B C D
7
£9,600DR £12,000CR £6,800DR £5,140CR
Abusinessacquiredacaron1October20X5for£117,000andhasdepreciateditonareducing balancebasisat20%perannum.On30September20X7thecarwassoldfor£58,000. Whatisthelossondisposalofthecarinthefinancialstatementsforthe12monthreportingperiod to30September20X7? A B C D
8
£14,560 £14,800 £16,880 £29,360
Abusinessbuysamachineon1January20X1for£10,000anddepreciatesitat10%perannum straightline.Attheendof20X2themachine'sremainingusefullifeisreassessedatsixyears remaininganditisnowbelievedthatthemachinehasaresidualvalueof£500. Whatisthedepreciationchargeforthethirdyearofthemachine'suse? A B C D
9
£950 £1,250 £1,267 £1,350
ThefollowinginformationrelatestothedisposaloftwomachinesbyPaddock. Cost Disposalproceeds Profit/(loss)ondisposal
Machine1 £ 120,000 90,000 30,000
Machine2 £ 140,000 80,000 (40,000)
Whatwasthetotalcarryingamountofbothmachinessoldatthedateofdisposal? A B C D
£100,000 £160,000 £180,000 £240,000
10 On1June20X1Quandryboughtanon-currentassetfor£50,000whichhadanestimateduseful lifeof10yearsandaresidualvalueof£2,000.Quandrydepreciatesitsnon-currentassetsona straightlinebasis.Quandry'sreportingperiodisthe12monthsended31December. On1January20X4theasset'sremainingusefullifeisrevisedtoeightyearsfromthatdatewithno residualvalue.Animpairmentreviewatthatdateshowsthattherecoverableamountoftheassetis consideredtobeonly£25,000. Whatisthetotaldepreciationandimpairmentlosschargeforthisassetin20X4? A B C D
£3,125 £12,400 £15,725 £18,000
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Now,gobacktotheLearningObjectivesintheIntroduction.Ifyouaresatisfiedthatyouhaveachieved theseobjectives,pleasetickthemoff.
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AnswerstoInteractivequestions
AnswertoInteractivequestion1 Cost LessEstimatedresidualvalue Totalamounttobedepreciated
£ 18,720 (6,360) 12,360
Thedepositrepresentspartofthepaymentforthenewvehicleandisnotrelevantincalculatingthe depreciableamountofthenewcar.
AnswertoInteractivequestion2 (a) Underthestraightlinemethod,depreciationforeachofthefiveyearsis: Annualdepreciation=
£(17,000 2,000) =£3,000 5
RememberthatVATonlorriesisrecoverable;itisonlyinrespectofcarsthatitisirrecoverable. (b) Underthereducingbalancemethod,depreciationforeachofthefiveyearsisasfollows: Year 1 2 3 4 5
Depreciation 35%×£17,000 35%×(£17,000£5,950)=35%×£11,050 35%×(£11,050£3,868)=35%×£7,182 35%×(£7,182£2,514)=35%×£4,668 35%×(£4,668–£1,634)=35%×£3,034
= = = = =
£ 5,950 3,868 2,514 1,634 1,062
AnswertoInteractivequestion3 Newannualchargefrom20X4=
£65,610 =£13,122perannum 5 years
AnswertoInteractivequestion4 Cost Accumulateddepreciation Carryingamount Chargefortheyear(W)
Year1 £ 1,000 (80) 920 80
Year2 £ 1,000 (160) 840
Year3 £ 1,000 (265) 735
80
105
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1,000 200 1,000 200 10 10
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AnswertoInteractivequestion5 (a) Revisedannualdepreciationcharge Revisedannualcharge
=
Carrying amount at revision Residual value Revised remaining life £102,000
=
=£6,800perannum
15
(b) Impairmentlossandrevisedannualdepreciationcharge 31December20X4 Impairmentloss(102,000–95,000)
£ 7,000
£95,000 Annualcharge
9,500
10
=16,500
Totalstatementofprofitorlosschargein20X4
AnswertoInteractivequestion6 MACHINERYACCOUNT 20X7 1Jan
Balanceb/d(2£15,000)
£ 20X7 30,000 31Mar 1Dec 30,000
£ 15,000 15,000 30,000
Disposalofmachinery account Disposalofmachinery account
MACHINERY–ACCUMULATEDDEPRECIATION 20X7 31Mar
Disposalaccount(W1)
£ 20X7 6,750 1Jan
1Dec
Disposalaccount(W2)
£
Balanceb/d(24 30,000 ) 5 12
15,000 3 8,750 31Mar Chargetodisposal
1Dec 15,500
60 15,000 Chargetodisposal
60
11
12,000 750 2,750 15,500
WORKING 1 2
Depreciationatdateofdisposal=(15,000/60)×27=£6,750 Depreciationatdateofdisposal=(15,000/60)×35=£8,750 DISPOSALACCOUNT
20X7 31Mar 1Dec
Machinery Machinery
£ 15,000 15,000 30,000
20X7 31Mar 31Mar 31Mar 1Dec 1Dec 31Dec
Receivables(proceeds) Accumulateddepreciation Lossondisposal Cash(proceeds) Accumulateddepreciation Lossondisposal
£ 8,000 6,750 250 2,500 8,750 3,750 30,000
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AnswertoInteractivequestion7 (a) Toad'sstatementoffinancialpositionbeforethepurchaseis: £ 10,000 10,000
Cash Capital
(b) Thrush'svaluationoftheassetstobeacquiredisirrelevanttoToad,whoseesthesituationthus: £ 6,500 (4,000) 2,500
Consideration(cashtobepaid) Lesstotalassetslessliabilitiesacquired(atToad'svaluation) Difference(purchasedgoodwill)
Toadmustputthroughthefollowingjournalonacquisition,openingupagoodwillledger account. DEBIT DEBIT CREDIT
Assets/liabilities(shop) Goodwill Cash
£ 4,000 2,500
£ 6,500
Toad'sstatementoffinancialpositionimmediatelyafterthepurchaseistherefore: Goodwill Assets/liabilitiesacquiredinshop Cash(£10,000–£6,500) Capital
£ 2,500 4,000 3,500 10,000 10,000
(Normallyonewouldhavemoredetailastothebreakdownoftheassetsandliabilities,butthisisnot relevanthere.Themainpointisthattheassets/liabilitiesacquiredaretangiblewhereasthegoodwillis not.) Thisquestionhighlightsthedifferencebetween'internallygenerated'goodwill,which(asinThrush's caseabove)isnotshowninthebooksand'purchased'goodwill,whichis.Thepurchasedgoodwillin thiscaseissimplyThrush'sinternallygeneratedgoodwill,whichhaschangedhands,boughtbyToadat theconsiderationshowninToad'saccounts.
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AnswerstoSelf-test 1
A
Tocorrectreducepurchases(increasetoGPandNP),increaserepairs(decreaseNP,noeffect onGP). ThedecreaseandincreasetoNPcancelout.OveralleffectonGPisanincrease.
2
C £ 250,000 13,900 1,200 265,100
Purchaseprice Adaptation Legalcosts 3
C
4
C
Depreciationspreads(cost–residualvalue)overusefullife £ 15,000
Cost
5
Accumulateddepreciationto31December20X3( 15,000 40)
(5,000)
Carryingamountatdateofchange Depreciationfor20X4(10,00010%) Depreciationfor20X5@10%
10,000 (1,000) 9,000 900
120
A £ 200,000 (30,000) 170,000 (25,500) 144,500 (54,800) 89,700
Cost1July20X3 Depreciationto30June20X4 Depreciationto30June20X5 LessProceeds Lossonsale 6
D
Debitwithtradeinallowance(togettototalcostofnewvehicleof£9,600) Creditwithcostofoldvehicle(toremovecostofoldvehicle) Netadjustment
7
C
£ 6,860DR (12,000)CR (5,140)CR
£ 117,000 (23,400) 93,600 (18,720) 74,880 16,880
Cost1October20X5 Depreciationto30September20X6 Depreciationto30September20X7 Lossonsale(58,000–74,880)
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B £ 10,000 (1,000) 9,000 (1,000) 8,000
Cost 20X1(10%10,000) Depreciation 20X2(10%10,000) Carryingamountatend20X2 8,000 500 ) Depreciationchargefor20X3( 6 9
1,250
C Disposalproceeds Carryingamount() Profit/(loss)ondisposal
Machine1 £ 90,000 (60,000) 30,000
Machine2 £ 80,000 (120,000) (40,000)
Total £ (180,000)
10 C £ 50,000
Cost 50,000 – 2,000 Accumulateddepreciationto31December20X3 31
(12,400)
Carryingamountat31December20X3
37,600
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Impairmentloss(37,600–25,000) Annualcharge(25,0008)
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CHAPTER11
Limitedcompanyfinancial statements
Introduction Examinationcontext TopicList 1 Thenatureofalimitedcompany 2 Equity:sharecapital 3 Equity:retainedearningsandotherreserves 4 Rightsissuesandbonusissuesofshares 5 Non-currentliabilities(debtcapital) 6 Provisions(IAS37) 7 Tax 8 Theregulatoryframeworkforcompanyfinancialstatements 9 Thestatementofprofitorloss(IAS1) 10Thestatementoffinancialposition(IAS1) 11ApplyingtheIAS1formats SummaryandSelf-test Technicalreference AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Recordandaccountfortransactionsandeventsresultinginincome,expenses,assets, liabilitiesandequityinaccordancewiththeappropriatebasisofaccountingandthelaws, regulationsandaccountingstandardsapplicabletothefinancialstatements
Recordandaccountforchangesintheownershipstructureandownershipinterestsinan entity
Prepareanextendedtrialbalance
Identifythemaincomponentsofasetoffinancialstatementsandspecifytheirpurpose andinterrelationship
Prepareandpresentastatementoffinancialpositionandstatementofprofitorloss(or extractstherefrom)fromtheaccountingrecordsandtrialbalanceinaformatwhich satisfiestheinformationrequirementsoftheentity
Specificsyllabuslearningoutcomesare:1d,e,2c,3a
Syllabuslinks ThematerialinthischapterwillbedevelopedfurtherintheProfessionalLevelmoduleofFinancial AccountingandReporting.
Examinationcontext 40%oftheassessmentwillbethepreparationofsinglecompanyfinancialstatements.Intheassessment youwillbeaskedtoproduceeitherastatementofprofitorlossandstatementoffinancialposition,ora statementofcashflows.YouwillbegivenanextractfromaTBorsomedraftfinancialstatements,with additionalinformationandberequiredtocompletecalculationsinordertofillinapro-formatemplate. Thecalculationsandworkingswillincludeaspectsfromotherchapters,asthepreparationofthe accountswillbringtogetherknowledgefrommostpartsofthesyllabus. Youmayalsobeexaminedonthecontentsofthischapterbymultiplechoicequestions,whichmay involvecalculationssothatthecorrectanswercanbeselected.Veryoftendoubleentryquestionsare phrasedintermsofpreparingajournal. Intheexamyoumayberequiredto:
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Specifytheuniquefeaturesofcompanyfinancialstatements:equity(sharecapitalandreserves), provisionsandtax
Specifythedistinctionsbetweenequityshares,andredeemableandirredeemablepreference shares
Identifyhowtoaccountforissuesofshares
Identifyhowloansshouldbesplitintotheircurrentandnon-currentliabilitycategoriesforthe statementoffinancialposition
Identifyhowtoaccountfortax,includingunder-provisionsandover-provisions
Identifyhowexpensesshouldbecategorisedintocostofsales,administrativeexpenses, distributioncostsandfinancecosts
SpecifytherequirementsofIAS1inrelationtocompanyfinancialstatements
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1 Thenatureofalimitedcompany Sectionoverview
Companiesarelegallyseparatefromtheirowners,sothepresentationofowners'capitalis particularlyimportant.
Acompany'sinitialcapitalisdividedintoshareswhichhaveaparor'nominal'value,andanissue valuethatcanexceedthatamount.
Aprivatecompanymaynotissuesecurities(sharesandloanstock)tothepublicatlarge.Apublic companymaydoso,eitherthroughapubliclistingorotherwise.
Particularfeaturesofcompanyaccountingrelateto:owners'capital(equity);debtcapital; provisions;tax.
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Limitedcompaniesarethemostcommonformofprivatesectorbusinessorganisation.Businessesthat arenotlimitedcompaniestendtobesmallinsize,orprovidespecialisedprofessionalservices,suchas firmsofaccountantsorsolicitors. Acompanyhasaseparatelegalexistence,independentofitsowner(s).Itcanentercontractsinits ownname,itcansueorbesued,anditisliabletothetaxauthoritiesfortaxontheprofitsthatitearns. Theprofitsavailabletotheownersofacompanyareprofitsafterdeductingtaxation. Becauseacompanyhasthislegalidentity,separatefromitsowners,thewayitraisescapitalfromits owners,andisaccountabletoitsownersforthecapitalthatitholds,ismoreformalisedthanforsole tradersorpartnerships.
1.1 Sharecapitalandshareholders Acompany'sinitialcapitalisdividedintounitsofequalsize,knownasshares,issuedtoindividualsor companies,calledshareholders.Thetotalcapitalraisedisreferredtoasequitysharecapital. Ownershipofashareentitlestheshareholdertoreceivepaymentofashareofprofit,ordividend. Bylaw,sharesmusthaveaparvalue(theCompaniesAct2006callsthisthe'nominalvalue'),whichcan beanyamount,forexample1p,5p,10p,25p,50p,£1andsoon.However,allsharesofthesametype ('class')havethesameparvalue.Forexample,£100,000parvalueofsharecapitalmightberepresented by100,000sharesof£1each,or200,000sharesof50peach,or1,000,000sharesof10peach,andso on.Itispossibletohavedifferingclassesofsharewhichcarrydifferentrightsfortheirowners. Theparvalueofshareswillrarelybearanyrelationshiptoeither:
Theissuepriceatwhichthesharewasoriginallyissuedbythecompany,toraisecapital;or
Thecurrentmarketvalueoftheshareifthesharesofthecompanyaretradedonastockmarket.
Theoriginalissuepriceofasharematterstoacompanybecauseitistheamountofcashraisedfor eachshareissued.Acompanywilloftenissuesharesatabove('atapremiumto')parvalue.For example,acompanywithsharesof£1mightissuesharesat£1.50persharewhenthecompanyisfirst incorporated,thenmakeafurtherissueofsharessomeyearslaterat,say,£2each,andthenafurther issuesometimeafterthatat,say,£3.50each. Thecurrentmarketvalueofasharehasnobearingoncompanyfinancialstatementsatall,because thisisthepriceatwhichanexistingshareholdingissoldbyoneperson(notthecompany)toanother person(notthecompany).Suchtransactionsdonotgiverisetoanythingthathastoberecordedinthe company'saccountingrecords.
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1.2 Publicandprivatecompanies Companiesareeitherpublicorprivatecompanies.
Apubliccompanyhas'plc'initsname.Apubliccompanymayofferitssecurities(sharesandloan stocksuchasbonds)forsaletopersonswhoareunrelatedtothecompany('thepublic'),butis subjecttostricterregulationthanprivatecompanies.Inparticular,apubliccompanymusthave issuedcapitalofatleast£50,000.Beforeitcantrade,atleast£12,500plusthewholeofany premiumonissuemusthavebeenreceivedascash.Effectivelythismeansthatapubliclimited companymusthavenetassets(assetslessliabilities)ofatleast£12,500.Notethatallcompanies whosesharesaretradedonastockmarketmustbe'plcs',butnotallplcshavetheirsharestraded onastockmarket.
Aprivatecompanyendsitsnamewith'Limited'or'Ltd'.Aprivatecompanyisanycompanythatis notapubliccompany.Privatecompaniescannotoffertheirsecuritiesforsaletothepublicatlarge. Thereisnominimumlevelofnetassets.
1.3 Accountingforcompanies Companieshavedistinctivecharacteristicstobeaccountedfor.Thefollowingareexaminablein Accounting:
Equity(owners'capitalcomprisingsharecapital,retainedearningsandotherreserves),rightsissues andbonusissues
Formsofdebtcapital(non-currentliabilities)
Provisions
Taxonprofits
2 Equity:sharecapital Sectionoverview
Sharecapitalcanbesplitinto: – –
Equityshares(noentitlementtoasetamountofdividend) Irredeemablepreferenceshares(setentitlementtodividends)
Redeemablepreferencesharesareentitledtoasetamountofdividendbutaretreatedasnoncurrentliabilities(debtcapital).
Thefigureforcalled-upsharecapitalatparvalueappearsonthestatementoffinancialposition. Thismaybelessthanthefigureforissuedsharecapital.Ifanamountofcalled-upcapitalis unpaid,thisistreatedasan'otherreceivable'.
Oftheissueprice,anyexcessor'premium'receivedoverparvalueiscreditedtosharepremium(a reserveor'othercomponentofequity').
2.1 Equitysharesandpreferenceshares Companiesoftenhavejustoneclassofshare,ordinaryshares,whicharereferredtointheCompanies Act2006as'equitysharecapital'becauseeachsharerepresentsanequalinterestintheownershipof thecompany.(Occasionally,acompanymighthavetwoclassesofequityorordinaryshare,usually knownas'Aordinary'and'Bordinary'shares.MostpubliccompaniesintheUK,however,havejustone classofequityshare.) Acompanymightalsoissuepreferenceshares,whichentitletheirholderstoadividendoutofprofits (preferencedividend)beforeequityshareholdersareentitledtoanyequitydividend. Oncethepreferencedividendhasbeenpaid,theremainingprofit'belongs'totheequityshareholders. However,thedirectorswillusuallydecidetoretainsomeprofits(retainedearnings)withinthe
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company,andtheequitydividendwillbeanamountdeclaredbythedirectorsasbeingappropriateand affordable.
2.2 Issuedandcalled-upsharecapital Theissuedsharecapitalofacompany(alsoknownasitsallottedsharecapital)istheparvalueofthe sharesthathaveactuallybeenissuedtoshareholders. Ifacompanyissuessharesbut'callsup'theissueamountsininstalments,insteadofraisingcash immediately,itthenhascalled-upsharecapitalthatislessthanitsissuedsharecapital.
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Workedexample:Called-upsharecapital Acompanyissues100,000sharesof£1atparvalue,butonlycallsup75ppershareasafirstinstalment. Theissuedsharecapitalis£100,000,butthecalled-upsharecapitalisonly£75,000.Thefigureinthe statementoffinancialpositionwillbe£75,000. Inacompany'sstatementoffinancialposition,thefigureforsharecapitalisthecalled-upshare capital. Onthefaceofthecompany'sstatementoffinancialposition,orinanote,called-upequitysharecapital andirredeemablepreferencesharecapitalatparvalueareshownseparately. STATEMENTOFFINANCIALPOSITION(EXTRACT) Equity Sharecapital:equitysharesof50peach(81.5mshares) Sharecapital:6%irredeemablepreferencesharesof£1(9mshares)
£'000 40,750 9,000 49,750
Ifacompanyhascalled-upsharecapital,butiswaitingforpaymentfromsomeshareholders,ithaspaid upcapitaloflessthanitscalled-upcapital.
Workedexample:Paidupcapital Acompanyissuesonemillionsharesof£1atpar,andasksforpaymentinfullonissue,butitisstill owed£5,000byshareholderswhohaveyettopaywhattheyowe.Thecalled-upsharecapitalis £1,000,000,butthepaidupsharecapitalisonly£995,000.Inthestatementoffinancialposition,the sharecapital(acreditbalance)isthecalled-upsharecapitalof£1,000,000,andtheunpaidcapitalof £5,000isshownasan'otherreceivable'(adebitbalance).
2.3 Irredeemableandredeemablepreferenceshares
Onlypreferenceshareswhichthecompanyisnotentitledtobuybackorredeematsomestagein thefuture,knownasirredeemablepreferenceshares,aretreatedassharecapital.
Preferenceshareswhichthecompanyisentitledtobuybackfromitsshareholdersor'redeem'at somefuturetimearecalledredeemablepreferenceshares,treatedasnon-currentliabilities (debtcapital).
Inanexamquestionitwillbespecifiedwhetherpreferencesharesareredeemableor irredeemable.
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2.4 Accountingforsharecapital
Whensharesareissuedattheirparvalueandtheyarefullypaid: DEBIT CREDIT
£ X
Cash Sharecapital(parvalue) Sharepremium(excessoverparvalue)
£ X
£ X X
Whensharesareissuedattheirparvaluebutanamountremainsuncalledbythecompany DEBIT CREDIT
£ X
Whensharesareissuedatapremiumtotheirparvalue,andthefullamountispaid: DEBIT CREDIT
Cash Sharecapital(parvalue)
Cash Sharecapital(called-upamountofissuedshares)
£ X
£ X
Whensharesareissuedandcalled-upattheirparvaluebutanamountremainsunpaid: DEBIT CREDIT
Cash Otherreceivables(unpaidcapital) Sharecapital(parvalue)
£ X X
£ X
3 Equity:retainedearningsandotherreserves Sectionoverview
Retainedearnings:builtupwitheachreportingperiod'sprofits,depletedbydividendsandlosses. Amountsmayalsobetransferredtoorfromotherreserves,orreclassifiedassharecapitalina bonusissue.
Sharepremium:setupwithpremiumoverparvalueofissuedsharecapital(equityand irredeemablepreferenceshares).Theaccountmaybereducedbyabonusissue.
Generalreserve:createdbyatransferfromretainedearnings.
Sharecapitalisshowninthestatementoffinancialpositionatitscalled-upvalue.Anyotheramounts attributabletoowners(equityshareholders)areshownseparatelyasreserves(referredtoinIAS1as either'retainedearnings'or'othercomponentsofequity'). Acompanymighthaveanumberofdifferentreserves,eachsetupforadifferentpurpose,includingthe followingwhichareexaminableinAccounting:
Retainedearnings Sharepremium Generalreserve
3.1 Retainedearnings Definition Retainedearnings:Areserveusedtoaccumulatethecompany'sretainedearnings. Retainedearningscomprisetheincome(profitsandgainslesslosses)thatthecompanyretainswithin thebusiness,ieincomethathasnotbeenpaidoutasdividendsortransferredtoanyotherreserve.
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Theretainedearningsledgeraccountwouldlooklikethis(notethatiftherewasalossthiswouldbe debitedtotheledgeraccount): RETAINEDEARNINGS Dividendsoftheperiod Transferstogeneralreserve Balancec/d(closingstatementof financialposition)
£ X X X X
Balanceb/d(openingstatementof financialposition) Profitforthereportingperiod (fromstatementofprofitorloss)
£ X X X
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Weshalllookatthetransfertogeneralreserveshortly. Thebalancecarrieddownontheretainedearningsledgeraccountrepresentsthecompany's accumulatedprofitsandlossesovertimeoutofwhichitmay,ifitwishes,paydividendstoits shareholdersinthefuture.
3.2 Sharepremium TheCompaniesAct2006prohibitssharesfrombeingissuedatapricebelow('atadiscountto')their parvalue.Commonlytheyareissuedatapriceaboveparvalue.Whenthishappens,theexcessofthe issuepriceabovetheparvalueisaddedtoasharepremiumreserve.
Workedexample:Sharepremium Acompanyissues1million50pequitysharesatapriceof£4.20pershareforcash. Thesharesareissuedatapremiumof£3.70(£4.20–£0.50)abovetheirparvalue,andtheshareissue shouldberecordedintheledgeraccountsasfollows. DEBIT: Cash CREDIT: Sharecapital:equitysharesof50p Sharepremium
£ £ 4,200,000 500,000 3,700,000
Therearetightlegalrestrictionsontheuseofthesharepremiumreserve.Dividendscannotbepaidout fromit,butitmaybereclassifiedassharecapitalviaabonusissue,asweshallseeshortly.
3.3 Generalreserve Acompanymightholdretainedearningsthatithasnointentionofdistributingtoownersasadividend atanytimeinthefutureinageneralreserveratherthaninretainedearnings.Thisisadecisionthatthe companymakesinlinewithitsconstitution.Unlessthereisaspecificruleintheconstitution,general reservesremaindistributableasdividends. Acompanymighthaveotherreservesinitsfinancialstatements.Itissufficientforyoutoknowatthis stagethatsuchreservesmightexist,withoutneedingtoknowwhyandhowtheyareused.
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4 Rightsissuesandbonusissuesofshares Sectionoverview
Arightsissueofsharesismadetoexistingownersinproportiontotheirshareholdings.
Amountsfromretainedearningsandsharepremiummaybereclassifiedassharecapitalina bonusissue:
DR CR
Sharepremium Retainedearnings Sharecapital
£ X X
£
X
4.1 Rightsissuesofshares Largeshareissuestoraisenewcashareoftenintheformofarightsissue.
Definition Rightsissue:Newsharesareofferedtoexistingownersinproportiontotheirexistingshareholding, usuallyatadiscounttothecurrentmarketprice. Forexample,acompanywith20millionsharesinissuedecidestoraisemorecashbyissuing5million newshares.Itcanofferthenewsharestoexistingownersina'1for4'rightsissue:eachexistingowner isofferedonenewshareforeveryfourcurrentlyheld(20million/5million=4).
Interactivequestion1:Rightsissue
[Difficultylevel:Examstandard]
ThestatementoffinancialpositionofOmnibusplccontainsthefollowinginformation. ASSETS Non-currentassets Currentassets Totalassets
£'000 18,600 2,900 21,500
EQUITYANDLIABILITIES Equity Sharecapital:equitysharesof20peach Sharepremium Retainedearnings Totalequity Totalliabilities Totalequityandliabilities
6,000 5,700 7,000 18,700 2,800 21,500
Thecompanydecidestomakea1for3rightsissueforcash,fullypaid,atapriceof£1.80pershare. Requirement Whatarethebalancesfor(a)currentassets,(b)sharecapitaland(c)sharepremiumaftertherights issue? SeeAnswerattheendofthischapter.
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4.2 Bonusissuesofshares Definition Bonusissue(orcapitalisationissueorscripissue):Anissueoffullypaidsharestoexistingowners,free ofcharge,inproportiontotheirexistingshareholdings.
C H A P T E R
Abonusissuedoesnotinvolveanycashinflowforthecompany.Thecompanyconvertssomeofits reserves(sharepremiumorretainedearningsorboth)intonewfully-paidsharecapitalissuedatitspar value.Thedoubleentryfortheparvalueofthebonussharesissuedis: DEBIT CREDIT
11
SharepremiumORretainedearnings(ORboth) Sharecapital
Thebalanceonsharepremiumcannot(bylaw)bepaidtoownersasdividends.Thereareonlyafew transactionsthatcaneverreducesharepremium.Oneoftheseisabonusissueofshares. Inanexamyoushouldassumethatacompanyusesthesharepremiumaccountasfullyasitcan beforeusingretainedearnings,unlesstoldotherwise.
Workedexample:Bonusissue Acompanyhasthefollowingstatementoffinancialposition. £'000 30,000 5,000 1,300 9,700 16,000 14,000 30,000
ASSETS EQUITYANDLIABILITIES Equity Sharecapital:equitysharesof£1each Sharepremium Retainedearnings Totalequity Totalliabilities Totalequityandliabilities Thecompanydecidestomakea2for5bonusissueofshares.
Thecompanyisissuing(£5m/52)=2,000,000newsharesof£1eachtoitsowners,inproportionto theirexistingshareholdings.Itwill: DEBIT Sharepremium(totalbalanceofthesharepremiumreserve) DEBIT Retainedearnings(remainder) CREDIT Sharecapital
£ 1,300,000 700,000
£
2,000,000
Thestatementoffinancialpositionaftertheissueshowsnochangeinassetsorliabilities,butequityhas changed,asfollows. £'000 30,000 7,000 0 9,000 16,000 14,000 30,000
ASSETS EQUITYANDLIABILITIES Equity Sharecapital:equitysharesof£1each(£5m+£2m) Sharepremium(£1.3m–£1.3m) Retainedearnings(£9.7m–£0.7m) Totalequity Totalliabilities Totalequityandliabilities
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Interactivequestion2:Bonusissue
[Difficultylevel:Intermediate]
ThestatementoffinancialpositionofCanvatplcat31December20X1isasfollows: £'000 2,000 400 500 300 1,200 800 2,000
ASSETS EQUITYANDLIABILITIES Equity Sharecapital:800,00050pequityshares Sharepremium Retainedearnings Totalequity Totalliabilities Totalequityandliabilities
Thedirectorsdecidetomakea1for5bonusissue,followedbya1for3rightsissueat£1.60pershare. ShowtherevisedstatementoffinancialpositionofCanvatplcafterbothshareissueshavetakenplace. SeeAnswerattheendofthischapter.
5 Non-currentliabilities(debtcapital) Sectionoverview
Non-currentliabilitiescomprisedebtsecurities(debentures,loanstockandbonds),plusbank loansandredeemablepreferenceshares.
Interestonnon-currentliabilitiesisacontractualobligationandmustbeaccruedforinthe calculationofprofitbeforetax.
Anyamountsthatarerepayableinlessthan12monthsmustbeclassifiedascurrentliabilities.The balanceistreatedasnon-currentliabilities:long-termborrowings.
Acompanyisalegalpersonsowhenitborrowsitissolelyliableforthedebt(asoletraderandpartners arepersonallyliableforloanstotheirbusinesses). Acompanymayborrowdirectlyfromabankoritmayborrowintheformofdebtsecurities(loan stock,debentureloansorbonds).Thesesecuritiesarenormallyissuedascertificates,eachwithapar value,inreturnforcash(theloanprincipal).Thecertificate'sownerislegallyentitledtointerestonits parvalue,andisentitledtorepaymentoftheprincipal'atmaturity',iewhentheloanperiodreachesits endataspecifiablefuturedate.Thisisknownasredemption.Itisacontractualobligationtopay interestondebtsecurities. Debtsecuritiesaresimilarinconcepttoanyothertypeofloan.Unlesstheyareduetoreachmaturity within12months,theyareincludedinnon-currentliabilitiesinthestatementoffinancialposition. Anyamountdueforredemptionwithin12monthsisshownundercurrentliabilities.Interestispartof financecostsinthestatementofprofitorloss;unpaidinterestatthestatementoffinancialposition dateisshownasotherpayables.
5.1 Accountingfornon-currentliabilities Onissueofdebt: DEBIT CREDIT
Cash Non-currentliabilities
£X
£X
£X
£X
Onrepaymentofdebt: DEBIT CREDIT
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Rememberthat:
Anyredeemablepreferencesharesinissuewillalsobetreatedasliabilities(eithercurrentornoncurrent)ratherthanequity
Anydebtthatisdueforrepaymentinlessthan12monthsafterthestatementoffinancialposition dateisreclassifiedfromnon-currenttocurrentliabilities.
6 Provisions(IAS37)
C H A P T E R
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Sectionoverview
Provisionsareliabilitiesthatcanonlybemeasuredusingestimation,sotheyaredisclosed separatelyfromotherliabilities.
IAS37Provisions,ContingentLiabilitiesandContingentAssetsprovidesguidanceonwhenprovisions andcontingenciesshouldberecognisedandifso,atwhatamount.
Provisionsareliabilitiesofacompanythatareshownseparatelyfromotherliabilitiesbecausethe amountofaprovisioncanbemeasuredonlybyusingasubstantialdegreeofestimation. IAS37aimstoensurethat:
Appropriaterecognitioncriteriaandmeasurementbasesareappliedtoprovisions,contingent assetsandcontingentliabilities.
Sufficientinformationisdisclosedinthenotestothefinancialstatementstoenableusersto understandtheirnature,timingandamount.
Definitions Aprovision:isaliabilityofuncertaintimingoramount. Aliability:isapresentobligationoftheentityarisingfrompastevents,thesettlementofwhichis expectedtoresultinanoutflowfromtheentityofresourcesembodyingeconomicbenefits. NotethatwhilethisdefinitioninIAS37meansthatprovisionsareviewedasasub-classofliabilities,a provisiondiffersfromanactualaccrualfor,say,gassupplies,whereitisknownthattherewillbeone gasbill,tobepaidXweeksaftertheendofthereportingperiodforroughly£Y. Anexampleisaprovisionforclaimsunderwarranty,whereamanufactureragreestomakegoodany deficienciesinaproductbecomingapparentwithin,say,12monthsofthedateofsale.Itisknownthat warrantyclaimswillarisebuttheprecisenumber,valueandtimingareunknown.Sojudgementhasto beusedindecidinghowmuchthewarrantyprovisionshouldbefor.Provisionsmaybeincludedas currentornon-currentliabilities,dependingonthecircumstances.
7 Tax Sectionoverview
Anytaxdueonprofitsisthecompany'sliabilityandthereforemustbeshown: – –
Asadeductioninthestatementofprofitorloss Asapayableinthestatementoffinancialposition.
Anyover-provisionorunder-provisioninpreviousreportingperiodsiscredited/debitedinthe currentreportingperiod'sstatementofprofitorloss.
AcompanyasaseparatelegalentityisliabletopaytaxonitsprofitstoHMRCitself:theliabilityisnot thatofitsowners'.Taxisthereforetreatedasadeductionfromprofit.Anyoutstandingliabilityfor
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unpaidtaxisshownasaliabilityonthestatementoffinancialposition(taxpayable),eithercurrentor non-currentdependingonthecircumstances.
7.1 Accountingfortax Differentmethodsofaccountingfortax(excludingVAT)canbeused,butinthisStudyManualasingle taxpayableledgeraccountisusedforboththeexpenseinthestatementofprofitorlossandthe liabilityinthestatementoffinancialposition. Whenataxliabilityarisesandisidentified,thedoubleentrytorecorditis: DEBIT Taxexpense(statementofprofitorloss) CREDIT Taxpayableaccount
£X
£X
£X
£X
Whenataxpaymentismade: DEBIT Taxpayableaccount CREDIT Cash
Attheendofthereportingperiod,anybalanceonthetaxpayableaccountiscarrieddown.Usuallythis isacreditbalanceandisshownas'Taxpayable'undercurrentliabilitiesonthestatementoffinancial position.
Workedexample:TaxI Hardworkplchasestimatedthat£90,000ispayableintaxontheprofitsearnedintheyearended31 December20X1.Noneofthistaxhasbeenpaidbythedateofthestatementoffinancialposition. Thetaxwillbeaccountedforasfollows: TAXPAYABLEACCOUNT 20X1 Balancec/d
£ 90,000
90,000
20X1 Taxexpense(statementofprofitor loss) 20X2 Balanceb/d
£ 90,000 90,000 90,000
Sinceacompany'sstatementofprofitorlossisusuallypreparedbeforethetaxdueisfinallyagreedwith HMRC,theexpenseinthestatementofprofitorlossisanestimate.Itnearlyalwaysprovestobetoo high(over-provision)ortoolow(under-provision).Insteadofgoingbacktothefinancialstatements forthereportingperiodandchangingthem:
Anyover-provisionfromthepreviousreportingperiodreducesthetaxexpenseforthe subsequentreportingperiod.
Anyunder-provisionfromthepreviousreportingperiodincreasesthetaxexpenseforthe subsequentreportingperiod.
Workedexample:TaxII Intheyearto31December20X2,Hardworkplchasacreditbalancebroughtdownonitstaxpayable accountof£90,000(1).ItagreeswithHMRCthatthetaxdueon20X1'sprofitsis£87,000,whichit paysinFebruary20X2(2).Itsover-provisionfor20X1istherefore£3,000(3).Itestimatesthatitstax dueon20X2'sprofitsshouldbe£100,000(4). Hardworkplc'snettaxexpenseinthestatementofprofitorlossfortheyearto31December20X2will be£100,000(4)lesstheover-provisionof£3,000(1)inthepreviousreportingperiod,ie£97,000.Its statementoffinancialpositioncurrentliabilityis£100,000(5). Theledgeraccountisasfollows.
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TAXPAYABLEACCOUNT 20X2 Cash(2) Statementofprofitorloss:overprovision 20X1(3) Balancec/d(5)
£ 87,000 3,000 100,000 190,000
20X2 Balanceb/d(1) Statementofprofitorloss:charge for 20X2(4) 20X3 Balanceb/d:Taxpayable
£ 90,000 100,000 190,000 100,000
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NotethatanybalanceowedtoHMRCinrespectofVATorPAYE/NICisdisclosedasotherpayables,not astaxpayable.
8 Theregulatoryframeworkforcompanyfinancial statements Sectionoverview
Extensiveregulationcoversthecontentandformatofcompanyfinancialstatements,andthe methodsusedtopreparesome,ifnotall,ofthefigures.
Prescribedformatsenableuserstofindinformationandtomakecomparisonsmoreeasily.
Statementofprofitorlossshouldusuallycoverareportingperiodof12months.Boththe statementofprofitorlossandthestatementoffinancialpositionmustbeclearlynamedand dated.
Companyfinancialstatementspreparedforexternalpublicationareextensivelyregulatedtoprotect investorswhouseinformationtomakeeconomicdecisions,especiallywhencomparingdifferent companies.Publishedfinancialstatementsarethereforepreparedonthesamebasisbyallcompanies soinvestorscanmakemeaningfulcomparisons.Rulesandregulationsareappliedto:
Content:whatinformationthefinancialstatementsshouldcontain,andwhatsupporting informationshouldgowiththem
Accountingconcepts:howfiguresshouldbeprepared
Presentation:howthefinancialstatementsshouldbepresented
Themainsourcesofaccountingregulationsforcompaniesare:
Accountingstandards(IASsandIFRSs); Legislation,inparticulartheCompaniesAct2006.
InthisStudyManualwehavealreadycoveredmostofwhatyouneedtoknowatthisstageofyour studiesregardingthecontent,conceptsandpresentationoffinancialstatementspreparedunderIASs. WenowneedtodrawitalltogetherintotheIAS1formatsforthestatementofprofitorlossand statementoffinancialpositionandIAS8AccountingPolicies,ChangesinAccountingEstimatesandErrors.
8.1 WhydoesIAS1includeformats? Thepurposeofsettingoutformatsforastatementofprofitorlossandstatementoffinancialpositionis tomakeiteasierfortheusersoffinancialstatements:
Tofindtheitemstheyareparticularlyinterestedin:companiesarepreventedfromusing complexlayoutsandformatsthatmakethefinancialstatementsmoredifficulttounderstand
Tomakecomparisonsoftheresultsofdifferentcompanies,orbetweentheresultsofthesame companyfromonereportingperiodtothenext.
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ItisforthissecondreasonthatIAS1requirescomparativefiguresforthepreviousreportingperiod tobeshown,aswellasthefiguresforthereportingperiodbeingreported.Insomecasesastatement offinancialpositionfromanevenearlierreportingperiodmayberequiredaswell.
8.2 Structureandcontentoffinancialstatements
Oneachstatementoffinancialpositionandstatementofprofitorloss,thefollowinginformation needstobeprominentlydisplayed: –
Nameofthecompany
–
Dateofthestatementoffinancialposition/reportingperiodcovered–financial statementsshouldnotnormallycoverreportingperiodslongerthan12months
Thestatementoffinancialpositionmustdistinguishbetweencurrentandnon-currentassetsand currentandnon-currentliabilities.Currentitemsaretobesettledwithin12monthsofthedate ofthestatementoffinancialposition.
Intheaccountingpoliciesnotetothefinancialstatementstheentitymustdisclosethe measurementbasisusedintheirpreparation(historicalcostornetrealisablevalue,forinstance), andtheotheraccountingpoliciesusedthatarerelevanttoanunderstandingofthefinancial statements.
8.3 IAS8AccountingPolicies,ChangesinAccountingEstimatesandErrors IAS8prescribesthecriteriaforselectingandchangingaccountingpolicies,togetherwiththe accountingtreatmentanddisclosureofchangesinaccountingpolicies,changesinaccountingestimates andcorrectionoferrors. TheapplicationofIAS8enhancestherelevance,faithfulrepresentationandcomparabilitybyensuring that:
Informationisavailableabouttheaccountingpoliciesadoptedbydifferententities.
Differententitiesadoptacommonapproachtothedistinctionbetweenachangeinaccounting policyandachangeinanaccountingestimate.
Thescopeforaccountingpolicychangesisconstrained.
Changesinaccountingpolicies,changesinaccountingestimatesandcorrectionsoferrorsaredealt withinacomparablemannerbydifferententities.
8.4 Ethicsasanissueforregulators AsdiscussedinChapter1,trustinthefinancialinformationproducedbyaccountantsisessential.How toensurethatinformationisreliableandfitforpurposeisthereforeakeyconcernofregulatorsand government.Oneofthewaysinwhichthistrustcanbeachievedisbyensuringthattheindividuals involvedintheproductionofthematerialareactingwithintegrity,whichcanbedefinedasactingina straightforwardandhonestmanner. Professionalbodiescaninstilintegrityintheirmembersthroughtheirleadership,policies,the informationandtrainingtheyprovide,andtheethicalstandardswhichmembersareexpectedto adhereto. Theoverallregulatoryframeworkwithinacountryormarketcanbeverycomplexandneedstobe underpinnedbyethicalvalues.Theprocessalsoneedstobe: `
Honestandtruthful Transparentandadaptable Legallycompliant Consistent
Whilethedevelopmentofpolicyandguidancecanbeusefulinachievingthis,arules-basedapproach canalsodevaluetherequirementsontheindividualstoactethically,astheemphasiscanshiftto keepingwithintheletterorthelaw,ratherthanthespiritofit.
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9 Thestatementofprofitorloss(IAS1) Sectionoverview
ThestatementofprofitorlossmustshowbalancesassetoutintheIAS1format,includinggross profit,profitbeforetaxand(post-tax)profitforthereportingperiod.
TheIAS1statementofprofitorlossfunctionalformattobelearnedisshownintheexamplebelow (Ducatplc).ThisincludestheminimumdisclosurerequirementsofIAS1.Themainrequirementisthat allitemsofincomeandexpenserecognisedinaperiodshallbeincludedinprofitorloss.
C H A P T E R
11
Notethatthestatementofprofitorlossstopsatprofit(orloss)forthereportingperiod. Thepresentationofthefinalretainedearningsfigureforthereportingperiod,asseeninthe statementoffinancialposition,isbeyondthescopeofAccounting,asitispresentedinaseparate statementwhichisnotexaminable,calledthestatementofchangesinequity(SCE).
Workedexample:Statementofprofitorloss Ducatplc'sstatementofprofitorlossispresentedbelow. DUCATPLC STATEMENTOFPROFITORLOSSFORTHEYEARENDED31DECEMBER20X3 £ 623,000 (414,000) 209,000 26,000 (73,000) (32,000) (15,000) 115,000 (35,000) 80,000
Revenue Costofsales Grossprofit Otherincome Distributioncosts Administrativeexpenses Financecosts Profitbeforetax Taxexpense Profitfortheyear
9.1 Revenue Revenueincludesbothcreditandcashsales,netoftradediscount,refundsandVAT.Cashdiscounts allowedtocustomersarenotdeductedwhenarrivingattherevenuefigure(thesearenormallyshown asadministrativeexpenses). IAS18Revenueprescribestheaccountingtreatmentofrevenuerecognitionincommontypesof transaction.Itstatesthatingeneraltermsrevenueshouldberecognised:
Whenitisprobablethatfutureeconomicbenefitswillflowtotheentityand Thesebenefitscanbemeasuredreliably.
Revenueshouldbemeasuredatthefairvalueoftheconsiderationreceivedorreceivable. IAS18appliesto:
Saleofgoods(manufactureditemsanditemspurchasedforresale).
Therenderingofservices(whichtypicallyinvolvestheperformancebytheentityofacontractually agreedtaskoveranagreedperiodoftime).
Theusebyothersofentityassetsyieldinginterest,royaltiesanddividends.
IncomeisdefinedintheIASB’sConceptualFrameworkas'increasesineconomicbenefitsintheformof inflowsorenhancementsofassetsordecreasesofliabilitiesthatresultinincreasesinequity.'Revenueis simplyincomearisingintheordinarycourseofanentity'sactivitiesanditmaybereferredtoas:
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Sales Turnover Interest Dividends Royalties
RevenueisdefinedbyIAS18asfollows:
Definition Revenue:Thegrossinflowofeconomicbenefitsduringtheperiodarisinginthecourseoftheordinary activitiesofanentitywhenthoseflowsresultinincreasesinequity,otherthanincreasesrelatingto contributionsfromequityparticipants.
9.2 Costofsales,distributioncostsandadministrativeexpenses Theallocationofexpensestoeachofthesethreeheadingscallsforjudgement.Inpracticetherulesare notrigid.IAS1statesthatanentityshallpresentananalysisofexpensesusingaclassificationbasedon eitherthenatureofexpensesortheirfunctionswithintheentity,whicheverprovidesinformationthatis reliableandmorerelevant.Theformatandclassificationusedhereisthefunctionalone.Additional disclosuresonthenatureofexpenses,includingdepreciationandamortisation,arerequired. FortheAccountingexamyoushouldexpecttomakethefollowingclassifications. Costofsales
Distributioncosts
Wagesetcofmarketingand Purchasespluscarriageinwards adjustedforopeningandclosing distributionstaff. inventory,andanysubstantial Salescommission lossesofinventory. Distributionexpensessuchasvehicle Inamanufacturingcompany runningcostsandcarriageoutwards. wagesofproductionstaff,and maintenanceanddepreciation Depreciationofmotorvehiclesused expensesofproductionnonfordistribution,andmarketingcosts currentassets,pluslosseson suchasadvertisingandpromotion, theirdisposal,arealsoincluded. andanylossondisposalofsuch assets.
Administrativeexpenses Wagesofadministrative staff. Depreciationofnon-current assetsusedbynonproductionandnondistributionoperations,and anylossondisposalofsuch assets. Amortisationofintangible assets.
Cashdiscountallowedto Depreciationofothernon-current assetsusedbydistributionoperations customers. andanylossondisposalofsuch Expenseofsubstantialloss assets. ofinventory Thecostofadvertisingandselling Irrecoverabledebtsexpense activities,sincetheseareapartof distributinggoodsandservicesto customers.
9.3 Otherincome Incomeotherthanincomeclassifiedasrevenueshouldbeshownseparately.Examplesofotherincome include:
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Dividendsreceivedoninvestments Interestreceivedonsavings Rentreceivedfromproperty Discountsreceivedfromsuppliers Insuranceclaimproceeds Profitsondisposalofnon-currentassets
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9.4 Financecosts
C H A P T E R
Interestpayableonbankloansandoverdrafts Interestondebtsecurities
10 Thestatementoffinancialposition(IAS1) Sectionoverview
11
Thestatementoffinancialpositionissplitbetweentotalassetsandtotalequityplusliabilities. Bothassetsandliabilitiesmustshowthecurrent/non-currentsplit.
TheIAS1statementoffinancialpositionformatisasfollows. DUCATPLC STATEMENTOFFINANCIALPOSITIONASAT31DECEMBER20X3 £
ASSETS Non-currentassets Property,plantandequipment Goodwill Otherintangibleassets Currentassets Inventories Tradeandotherreceivables Othercurrentassets(egprepayments) Cashandcashequivalents Totalassets EQUITYANDLIABILITIES Equity Sharecapital:£1equityshares Sharecapital:10%£1irredeemablepreferenceshares Reserves:sharepremium Reserves:retainedearnings Reserves:general Totalequity Non-currentliabilities Long-termborrowings Currentliabilities Tradeandotherpayables(includingaccruals) Short-termborrowings Provisions Currenttaxpayable Totalequityandliabilities
£
51,000 102,000 20,000 33,000
427,000 15,000 110,000 552,000 206,000 758,000
36,000 22,000 10,000 11,000
150,000 20,000 125,000 161,000 65,000 521,000 158,000 79,000 758,000
Pointstonote
Alltangibleassets(includinglandandbuildings)arecombinedundertheheading'property,plant andequipment'.Theuserwouldrefertothenon-currentassetsnote,ascoveredinChapter10,for detail.
Tradereceivablesandanyotherreceivables(includingVATdue)arecombinedas'tradeandother receivables';prepaymentsareincludedintheheading'othercurrentassets'.Theallowancefor receivablesissetoffhere.
Cashinhandandatbankarecombinedas'cashandcashequivalents'.
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Anylong-termliabilitiessuchasbankloansordebtsecuritiesthatarenotrepayablewithin12 monthsarecombinedas'long-termborrowings'under'non-currentliabilities'.Redeemable preferenceshareswouldbeincludedhere.
TherearedetaileddisclosurerequirementsforsharecapitalinIAS1,inparticularoftheissued,fully paidandpartlypaidsharecapital,andoftheparvalue.Thefigureincludedinthestatementof financialpositionisthecalled-upsharecapital,bothpaidandunpaid.
Bankoverdrafts,whicharetechnicallyrepayableondemand,arecalled'short-termborrowings'. Theyarenotoffsetagainstanycashandcashequivalentassetbalances.
Tradepayablesandotherpayables(includingVAT,PAYE/NICandsalescommissionowed,interest payableandaccruals)arecombinedas'tradeandotherpayables'.
Currentamountsoftaxpayableareeachshownasaseparateitemundercurrentliabilities.
11 ApplyingtheIAS1formats Sectionoverview
ToapplytheIAS1formats: –
Extractatrialbalance
–
Drawupadjustmentjournals
–
CompletetheETB
–
Gathertheledgeraccountstogetherappropriatelyregardingthestatementofprofitorloss costofsales,administrativeexpensesanddistributioncostheadings
–
Completetheformatsforstatementofprofitorlossandstatementoffinancialposition
TheformatsweusehereareadaptedfromIAS1.TheStandardsetsoutaminimumrequirementfor whatshouldappearonthefaceofthestatementoffinancialposition,althoughadditionalitemsare allowedtomaketheinformationmorerelevant.NosetorderofitemsispresentedinIAS1;entitiesare encouragedtoadapttheorderandthedescriptionstoenhancerelevance,thoughinpractice comparabilityencouragessimilarentitiestoadoptsimilarpresentations. Whereasinglefigureor'lineitem'appearsinthestatementoffinancialposition,thecompanymust disclosefurthersub-classificationsinthenotesinamannerthatisappropriatetoitsoperations.
Workedexample:PreparingIAS1formatfinancialstatements Todrawtogethereverythingwehavecoveredsofarweshallworkthroughafullexampleofhowtouse theETBtoprepareanIAS1formatstatementofprofitorlossandstatementoffinancialposition. ThechiefaccountantofFormatplchasextractedthefollowingtrialbalancefromtheledgerasat 31December20X2. FORMATPLC TRIALBALANCEASAT31DECEMBER20X2 Issuedequitysharesof£1 10%irredeemablepreferencesharesof£1each Tradereceivablesandtradepayables Bank Inventoryat1.1.X2 6%debentures Sales Rentalincome Debentureinterest(sixmonthsto30.6.X2) Administrationandgeneralexpenses,excludingsalaries Administrationsalaries
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£'000 1,820 80 1,950 30 650 275
£'000 800 200 1,866 1,000 9,500 200
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£'000 616 5,125 300 100 300 2,120 2,000 300 15,666
Distributionexpenses Purchases Salariesassociatedwithmanufactureofgoods Carriageinwards Propertycosts Retainedearnings Freeholdland,atcost Fixturesandfittings,atcost Accumulateddepreciation,fixturesandfittings Allowanceforirrecoverabledebts Goodwill
£'000 1,100 900 100 15,666
C H A P T E R
11
Thefollowingitemshaveyettobedealtwith. 1.
Aninventorycounthasrevealedtheclosinginventoryfiguretobe£2,020,000.
2.
Thecompanydepreciatesfixturesandfittingsat20%straightlinecost.
3.
Animpairmentreviewhasshownthat10%shouldbewrittenoffgoodwill.Thechargeshouldbe toadministrativeexpenses.
4.
Thecreditcontrollerhassaidthatadebtof£15,000shouldbewrittenoffasirrecoverable,andthe allowanceforreceivablesshouldbeincreasedto£200,000.
5.
Thetaxdueonprofitsfortheyearisestimatedat£750,000.
6.
Theallocationofexpenditurebetweencostofsales,distributioncostsandadministrativeexpenses shouldbeasfollows. Propertycosts Depreciation
7.
Distribution % 25 50
Administrative % 75 50
Thedebenturesarerepayableinfullintenyearstime.Interestispaidintwoequalinstalmentsper annum.
Requirement Prepareyear-endjournalsandanETBforFormatplc,andpresentastatementofprofitorlossforFormat plcfortheyearended31December20X2andastatementoffinancialpositionasatthatdate.
Solution Theyear-endjournalstobeputthroughintheadjustmentscolumnareasfollows: 1 DEBIT CREDIT 2and6 DEBIT CREDIT
Closinginventory(statementoffinancialposition) Closinginventory(statementofprofitorloss) Administrativeexpenses Distributioncosts Fixturesandfittings–accumulateddepreciation(2,00020%)
3 DEBIT CREDIT
Administrativeexpenses Goodwill(30010%)
4 DEBIT CREDIT 5 DEBIT CREDIT
£'000 2,020 200 200
£'000 2,020 400
30
30
Administrativeexpenses Tradereceivables Allowanceforirrecoverabledebts(200–100)
115
15 100
Taxexpense(statementofprofitorloss) Taxpayable(statementoffinancialposition)
750
750
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6 DEBIT CREDIT
Administrativeexpenses(3000.75) Distributioncosts(3000.25) Propertycosts
7 DEBIT CREDIT
Debentureinterest Tradeandotherpayables
£'000
£'000
225 75
300
30
30
Theextendedtrialbalanceisasfollows:
£1equityshares 10%£1irredeemable preferenceshares Tradereceivables Tradepayables Bank Inventory 6%debentures Sales Rentalincome Debentureinterest Administrativeexpenses Administrationsalaries Distributionexpenses Purchases Manufacturingsalaries Carriageinwards Propertycosts Retainedearnings Freeholdland–cost Fixturesandfittings– cost F&F–accumulated depreciation Allowancefor irrecoverabledebts Goodwill Tax Profit
* **
Trialbalance Debit Credit £'000 £'000
800 200 1,820 1,866 80 1,950 1,000 9,500 200 30 650 275 616 5,125 300 100 300 1,100 2,120 2,000 900 100 300 15,666 15,666
Adjustments Debit Credit £'000 £'000 2,020 30 570* 275** 750 3,645
15 30 2,020 300 400 100 30 750 3,645
Statementof profitorloss Debit Credit £'000 £'000
Statementof financialposition Debit Credit £'000 £'000
1,950 60 1,220 275 891 5,125 300 100 750 1,049 11,720
1,805 80 2,020 2,120 2,000 270 8,295
2,020 9,500 200 11,720
800 200 1,896 1,000 1,100 1,300 200 750 1,049 8,295
200(Jnl2)+30(Jnl3)+115(Jnl4)+225(Jnl6)=570 200(Jnl2)+75(Jnl6)=275
FORMATPLC STATEMENTOFPROFITORLOSSFORTHEYEARENDED31DECEMBER20X2 Revenue Costofsales(W1) Grossprofit Otherincome Administrativeexpenses(W1) Distributioncosts(W1) Financecosts Profitbeforetax Taxexpense Profitfortheperiod
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£'000 9,500 (5,455) 4,045 200 (1,495) (891) (60) 1,799 (750) 1,049
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FORMATPLC STATEMENTOFFINANCIALPOSITIONASAT31DECEMBER20X2 £'000 2,020 1,605 80
ASSETS Non-currentassets Property,plantandequipment(W3) Goodwill Currentassets Inventories Tradeandotherreceivables(1,805–200allowance) Cashandcashequivalents Totalassets
EQUITYANDLIABILITIES Equity Equitysharecapital:£1equityshares Preferencesharecapital:10%£1shares Retainedearnings(W2) Totalequity Non-currentliabilities Long-termborrowings:6%debentures Currentliabilities Tradeandotherpayables Taxpayable Totalequityandliabilities
1,896 750
£'000 2,820 270 3,090 3,705 6,795
C H A P T E R
11
800 200 2,149 3,149 1,000 2,646 6,795
WORKINGS (1) Analysisofexpenses Costof sales £'000 1,950 300 5,125 100 (2,020) 5,455
Openinginventory Administrativeexpenses Salaries Distributioncosts Purchases Carriageinwards Closinginventory
Distribution costs £'000 891 891
Admin expenses £'000 1,220 275 1,495
(2) RETAINEDEARNINGS Balancec/d
£'000 2,149 2,149
Balanceb/d Profitfortheperiod(income statement)
£'000 1,100 1,049 2,149
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(3) Property,plantandequipmentnote Cost At1.1.X2 Additions Disposals At31.12.X2 Accumulateddepreciation At1.1.X2 Chargefortheyear(£2,00020%) Disposals At31.12.X2 Carryingamount At1.1.X2 At31.12.X2
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Freeholdland £'000 2,120 2,120 2,120 2,120
Fixturesand fittings £'000 2,000 2,000 900 400 1,300 1,100 700
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Total £'000 4,120 4,120 900 400 1,300 3,220 2,820
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SummaryandSelf-test
C H A P T E R
Summary(1/2) Statementof profitorloss
11
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Summary(2/2) 1
Statementofprofitorlossforthe reportingperiod
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Self-test Answerthefollowingquestions. 1
Acompany'sassetsandliabilitiesatthebeginningandendofareportingperiodwereasfollows. Beginning £ 85,000 120,000 100,000 5,000 50,000 30,000 20,000
Non-currentassets(carryingamount) Currentassets Equitysharesof£1 Sharepremium Retainedearnings Tradeandotherpayables Taxpayable
End £ 150,000 110,000 125,000 10,000 67,000 40,000 18,000
C H A P T E R
11
Duringthereportingperiodthecompanyissuedafurther25,000sharesat£1.20each.£22,000 fortaxexpensewasshowninthestatementofprofitorloss. Thecompany'sprofitbeforetaxforthereportingperiodwas A B C D 2
£17,000 £20,000 £27,000 £39,000
YouaresuppliedwiththefollowingextractfromNitonplc'sstatementsoffinancialpositionat31 January20X9and20X8. Equitysharesof£1each Sharepremium
31January20X9 £m 120 260
31January20X8 £m 100 220
Notes (1) On1July20X8therewasa1for10bonusissue (2) On30September20X8therewasarightsissue (3) Therearenootherreservebalances Whatwasthetotalamountreceivedfromtheissueofsharesfortheyearended31January20X9? A B C D 3
ThefigureforequityintheIAS1statementoffinancialpositionisrepresentedby A B C D
4
£10m £20m £50m £60m
Called-upsharecapitalplussharepremium Totalassetslesscurrentliabilities Paidsharecapitalplusretainedearnings Totalassetslesstotalliabilities
Whichofthefollowingwouldcauseacompany'sprofitfortheperiodtoincrease? A
Issueof100,000£1equitysharesat£1.02
B
Discountallowedof£255
C
Disposalfor£8,500ofafork-lifttruckwhichoriginallycost£15,000andhasacarrying amountof£9,250
D
Receiptof£25inrespectofareceivablepreviouslywrittenoffasirrecoverable
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5
Whichtwoofthefollowingtransactionscouldaffectacompany'sretainedearningsforthe reportingperiod? A B C D E
6
Rightsissueofshares Transfertothegeneralreserve Purchaseofland Repaymentofdebenturesattheirparvalue Increaseoftaxdue
Thefollowinginformationisavailableinrelationtothetaxfigurestobeincludedinthefinancial statementsofGodshillplc. Taxpayable Statementofprofitorlosstaxexpense
31December20X7 £ 271,500 269,700
31December20X6 £ 237,600 219,800
Whatisthetotaltaxpaidduringtheyearended31December20X7? A B C D 7
Iftaxisunder-providedinthestatementofprofitorlossfor20X7,inthefollowingyear'sstatement ofprofitorlosstheeffectwillbe: A B C D
8
£185,900 £235,800 £237,600 £269,700
Areductioninprofitforthereportingperiod Anincreaseinprofitforthereportingperiod Areductioningrossprofit Anincreaseingrossprofit
Raymondplcissues135,000equityshareswithaparvalueof£3eachatapriceof£5eachfor cash. Whichofthefollowingsetsofentrieswouldbemadetorecordthistransaction? A B C D
9
CreditBank£675,000,DebitSharecapital£405,000,DebitSharepremium£270,000 DebitBank£675,000,CreditSharecapital£135,000,CreditSharepremium£540,000 DebitBank£675,000,CreditSharecapital£405,000,CreditSharepremium£270,000 CreditBank£675,000,DebitSharecapital£135,000,DebitSharepremium£540,000
Minceplcispreparingitsfinancialstatementsfortheyearended30September20X6,having preparedaninitialtrialbalance.Theinitialtrialbalanceshowsthefollowingbalances: Administrativeexpensespaid(includingrent) Discountsallowed(tobeincludedinadministrativeexpenses) Prepaymentofrentat1October20X5
£ 32,874 1,085 2,894
On31August20X6Minceplcpaiditsquarterlyrentinadvanceof£5,400.InMinceplc's statementofprofitorlossthefigureforadministrativeexpenseswillbe: A B C D
£31,453 £32,495 £32,874 £33,253
Now,gobacktotheLearningObjectivesintheIntroduction.Ifyouaresatisfiedthatyouhaveachieved theseobjectives,pleasetickthemoff.
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Technicalreference
1Structureandcontentofcompanyfinancialstatements
Comparativefiguresforthepreviousreportingperiodmustbeshown.
IAS1para38
Nameofthecompany,andthedateofthestatementoffinancialposition orthereportingperiodcovered,mustbeprominentlydisplayed.
IAS1para51
Financialstatementsshouldnotnormallycoverreportingperiodslonger thanoneyear.
IAS1para36
Thestatementoffinancialpositionmustdistinguishbetweencurrentand non-currentassetsandcurrentandnon-currentliabilities.Currentitems aretobesettledwithin12monthsofthedateofthestatementof financialposition.
IAS1paras60
Sharecapitalandreservesdisclosures.
Minimumrequirementsandadaptationofformatofstatementof financialposition;additionaldisclosures.
IAS1para79 IAS1paras54, 55,57,77 IAS1paras81,82
Anentityshallpresentananalysisofexpensesusingaclassificationbased oneitherthenatureofexpensesortheirfunctionwithintheentity,which providesinformationwhichismorereliableandrelevant.Additional disclosuresonthenatureofexpenses,includingdepreciationand amortisation,arerequired.
IAS1paras99,
Anotemustdisclosethemeasurementbasesusedinpreparingthe financialstatements,andotheraccountingpoliciesthatarerelevanttoan understandingofthem.
IAS1para117
2Formatofstatementofprofitorlossandstatementoffinancialposition
and88
103and104
IAS1
Formats,includingstatementofprofitorlossinfunctionalformat.
IG6 IAS1para39
3Additionalcomparativeinformation
11
and61
Allitemsofincomeandexpenserecognisedinareportingperiodshallbe includedinprofitorloss;minimumdisclosurerequirementsaresetout.
C H A P T E R
Whenanentityappliesanaccountingpolicyretrospectively,makesa retrospectiverestatementofitemsinitsfinancialstatementsorreclassifies itemsinitsfinancialstatements,anadditionalstatementoffinancial positionasatthebeginningoftheearliestcomparativeperiodmustbe presented.
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AnswerstoInteractivequestions
AnswertoInteractivequestion1 Thereare30millionsharesof20pinissue(£6million/20ppershare).A1for3rightsissueinvolvesan issueof30million/3=10millionsharesat£1.80,toraisecashof£18million.Theissuedsharecapital goesupby10millionsharesat20peach,£2m.Thesharepremiumontheissueis£1.80–20p=£1.60 pershare,or£16millionintotal. ASSETS Non-currentassets Currentassets(2.9m+18m)(a) Totalassets
£'000 18,600 20,900 39,500
EQUITYANDLIABILITIES Equity Sharecapital:equitysharesof20peach((6m/3)+6m)(b) Sharepremium((6m/(0.23))£1.60)+5.7m)(c) Retainedearnings Totalequity Totalliabilities Totalequityandliabilities
8,000 21,700 7,000 36,700 2,800 39,500
AnswertoInteractivequestion2 Canvatplc:statementoffinancialpositionat31December20X1 ASSETS TOTALASSETS(2m+(320,0001.60))
£'000 2,512
EQUITYANDLIABILITIES Equity Sharecapital(400+80+160) Sharepremium(500+352–80) Retainedearnings Totalequity Totalliabilities Totalequityandliabilities
640 772 300 1,712 800 2,512
Thebonusissueisof800,000/5=160,00050pshares: DEBIT CREDIT
Sharepremium Sharecapital
£80,000
£80,000
Therightsissueisof(800,000+160,000)/3=320,00050psharesat£1.60each,ie£512,000: DEBIT CREDIT
Cash Sharecapital(320,00050p) Sharepremium(320,000(1.60–0.50))
£ 512,000
£ 160,000 352,000
Theledgeraccountsareasfollows: SHARECAPITAL Balancec/d
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Number 1,280,000 1,280,000
£ 640,000 640,000
Balanceb/d 1for5bonusissue 1for3rightsissue
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Number 800,000 160,000 320,000 1,280,000
£ 400,000 80,000 160,000 640,000
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Bonusissue Balancec/d
SHAREPREMIUM £ 80,000 772,000 852,000
Balanceb/d Rightsissue:cash
£ 500,000 352,000 852,000
C H A P T E R
£ 300,000
11
RETAINEDEARNINGS Balancec/d
£ 300,000
Balanceb/d
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AnswerstoSelf-test 1
D Openingnetassets(85,000+120,000–30,000–20,000)or(100+5+50) Closingnetassets(150,000+110,000–40,000–18,000) Increaseinnetassets Lessproceedsofshareissue(25,000£1.20) Retainedprofitforreportingperiod(67,000–50,000) Addtaxcharged Profitbeforetax
2
D
£ 155,000 202,000 47,000 (30,000) 17,000 22,000 39,000
SHARECAPITAL £m 120 120
c/d
b/d Bonusissue(10010) Rightsissue()
£m 100 10 10 120
SHAREPREMIUM £m 10 260 270
Bonusissue c/d
£m 220 50 270
b/d Rightsissue()
Therefore,therightsissuewasof10,000,000sharesatapremiumof£5pershare.Total raisedwas£60,000,000. 3
D
Totalequity=sharecapitalandreserves=netassets(assetslessliabilities).
4
D
Thepremiumontheissueofsharesmustbecreditedtosharepremium.Discountallowedto suppliersisanexpensethatdecreasesprofits.Thedisposalofthetruckresultsinalosswhich reducesprofit.Reductioninirrecoverabledebtsexpenseincreasesprofits.
5
BandE A B C D E
6
B
DR DR DR DR DR
CR CR CR CR CR
Sharecapital/sharepremium Generalreserve Cash Cash Taxpayable
TAXPAYABLE Paid() c/d
320
Cash Retainedearnings Non-currentassets Debentures Statementofprofitorloss(taxexpense)
£ 235,800 271,500 507,300
b/d Statementofprofitorloss
£ 237,600 269,700 507,300
7
A
Apreviousreportingperiod'sunder-provisionmeansanadditionalexpenseinthecurrent reportingperiod'sstatementofprofitorloss.Thishasnoeffectongrossprofit;itisprofitfor thisreportingperiodthatisreduced.
8
C
Cashraisedis135,000£5=£675,000,whichisdebitedtocashatbank.Thecredittoshare capitalis135,000£3parvalue=£405,000,whilethecredittosharepremiumis135,000 £2=£270,000.
9
D
Theopeningprepaymentofrentof£2,894needstobedebitedtoadministrativeexpenses, andtheclosingprepaymentof£5,4002/3=£3,600needstobecredited.Total administrativeexpenseswillthereforebe£32,874+£1,085+£2,894–£3,600=£33,253.
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CHAPTER12
Statementofcashflows
Introduction Examinationcontext TopicList 1 Statementofcashflows(IAS7) 2 Formatofthestatementofcashflows 3 Preparingastatementofcashflows SummaryandSelf-test Technicalreference AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Prepareandpresentastatementofcashflows(orextractstherefrom)fromtheaccounting recordsandtrialbalanceinaformatwhichsatisfiestheinformationrequirementsofthe entity
Specificsyllabuslearningoutcomeis:3c
Syllabuslinks ThematerialinthischapterwillbedevelopedfurtherintheProfessionalLevelmoduleofFinancial AccountingandReporting. Thisisthefirsttimethatyouwillhavecomeacrossastatementofcashflowsinyourstudies.However, asyouwillseeintherestofthechapter,mostoftheinformationneededtoproduceastatementof cashflowsiscontainedinthestatementofprofitorlossandstatementoffinancialposition,bothof whichyouwillbefamiliarwithfromyourstudiessofar.
Examinationcontext 40%oftheassessmentwillbethepreparationofsinglecompanyfinancialstatements.Intheassessment youwillbeaskedtoproduceeitherastatementofprofitorlossandstatementoffinancialposition,ora statementofcashflows.YouwillbegivenanextractfromaTBorsomedraftfinancialstatements,with additionalinformationandberequiredtocompletecalculationsinordertofillinapro-formatemplate. ThecalculationsandworkingswillincludeaspectsfromotherChapters,asthepreparationofthe accountswillbringtogetherknowledgefrommostpartsofthesyllabus. Youmayalsobeexaminedonthecontentsofthischapterbymultiplechoicequestions,whichmay involvecalculationssothatthecorrectanswercanbeselected.Veryoftendoubleentryquestionsare phrasedintermsofpreparingajournal. Intheexamyoumayberequiredto:
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Prepareextractsfromacashflowstatement
Calculatethecashflowfromoperatingactivities
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1 Statementofcashflows(IAS7) Sectionoverview
Thestatementofcashflowsshowsmovementsincashandcashequivalents. Allentitiesarerequiredtoproduceastatementofcashflows.
Thestatementofcashflowsisausefuladditiontothefinancialstatementsbecauseaccounting profitisnottheonlyindicatorofperformance.
Thestatementofcashflowsconcentratesonthesourcesandusesofcashandisausefulindicator ofliquidityandsolvency.
1.1 IAS7StatementofCashFlows TheobjectiveofIAS7StatementofCashFlowsistoprovidehistoricalinformationaboutchangesincash andcashequivalents,classifyingcashflowsbetweenoperating,investingandfinancingactivities.This willprovideinformationtousersoffinancialstatementsabouttheentity'sabilitytogeneratecashand cashequivalents,aswellasindicatingthecashneedsoftheentity. IAS7setsoutthestructureofastatementofcashflowsanditsetstheminimumlevelofdisclosure.In theassessmentyoumaybeaskedtoprepareastatementofcashflowsinapro-formatemplate.Youwill beprovidedwithfinancialinformation,usuallyintheformofdraftfinancialstatements,andyouwillbe givensomeadditionalinformationabouttransactionsthatyouneedtomakeadjustmentsforinorderto insertthenumbersintothepro-forma.
C H A P T E R
12
1.2 PurposeofIAS7 IAS7beginswiththefollowingstatement. ‘Informationaboutthecashflowsofanentityisusefulinprovidingusersoffinancialstatementswitha basistoassesstheabilityoftheentitytogeneratecashandcashequivalentsandtheneedsoftheentity toutilisethosecashflows.’ Ithasbeenarguedthat'profit'doesnotalwaysgiveausefulormeaningfulpictureofacompany's operations.Readersofacompany'sfinancialstatementsmightevenbemisledbyareportedprofit figure.Considerthefollowingexamples. (a) Shareholdersmightbelievethatifacompanymakesaprofitaftertaxof,say,£100,000thenthisis theamountwhichitcouldaffordtopayasadividend.Unlessthecompanyhassufficientcash availabletostayinbusinessandalsotopayadividend,theshareholders'expectationswouldbe wrong. (b) Employeesmightbelievethatifacompanymakesprofits,itcanaffordtopayhigherwagesnext year.Thisopinionmaynotbecorrect:theabilitytopaywagesdependsontheavailabilityofcash. (c) Cashisthelifebloodofthebusiness.Survivalofabusinessentitydependsnotsomuchonprofits asonitsabilitytopayitsdebtswhentheyfalldue.Suchpaymentsmightinclude'profitandloss' itemssuchasmaterialpurchases,wages,interestandtaxationetc,butalsocapitalpaymentsfor newnon-currentassetsandtherepaymentofloancapitalwhenthisfallsdue(forexample,onthe redemptionofdebentures). Fromtheseexamples,itisclearthatacompany'sfutureperformanceandprospectsdependnotso muchonthe'profits'earnedinaperiod,butmorerealisticallyonliquidityorcashflows. Thestatementofcashflowsshouldbeusedinconjunctionwiththerestofthefinancialstatements. Userscangainfurtherappreciationof:
Thechangeinnetassets
Theentity'sfinancialposition(liquidityandsolvency)
Theentity'sabilitytoadapttochangingcircumstancesandopportunitiesbyaffectingtheamount andtimingofcashflows
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Statementsofcashflowsenhancecomparabilityastheyarenotaffectedbydifferingaccounting policiesusedforthesametypeoftransactionsorevents. Cashflowinformationofahistoricalnaturecanbeusedasanindicatoroftheamount,timingand certaintyoffuturecashflows.Pastforecastcashflowinformationcanbecheckedforaccuracyasactual figuresemerge.Therelationshipbetweenprofitandnetcashflowandtheimpactofchangingprices canbeanalysedovertime.
1.3 Scope IAS7requiresallentitiestoincludeastatementofcashflowsasanintegralpartoftheirfinancial statement. Alltypesofentitycanprovideusefulinformationaboutcashflowsastheneedforcashisuniversal, whateverthenatureoftheirrevenue-producingactivities.
Definition Cashflows:Theseareinflowsandoutflowsofcashandcashequivalents. Cash:Comprisescashonhandanddemanddeposits. Cashequivalents:Short-term,highlyliquidinvestmentsthatarereadilyconvertibletoknownamounts ofcashandwhicharesubjecttoaninsignificantriskofchangesinvalue(maturityofthreemonthsor lessfromthedateofacquisition).
2 Formatofthestatementofcashflows Sectionoverview
Thestatementofcashflowssummarisesallmovementsofcashintoandoutofthebusiness duringtheaccountingperiod.Thecashinflowsandoutflowsareclassifiedunderthefollowing headings: –
Operatingactivities:Theseareprimarilyderivedfromtheprincipalrevenue-producing activitiesoftheentityandotheractivitiesthatarenotinvestingorfinancingactivities.
–
Investingactivities:Thesearethecashflowsderivedfromacquisitionanddisposalofnoncurrentassetsandotherinvestmentsnotincludedincashequivalents.
–
Financingactivities:Theseareactivitiesthatresultinchangesinthesizeandcompositionof theequitycapitalandborrowingsoftheentity.
Thetotalcashflowsforeachheadingaretotalledtogivethenetinfloworoutflowofcashand cashequivalentsfortheperiod.
2.1 Cashflowsfromoperatingactivities IAS7definesoperatingactivitiesastheprincipalrevenueproducingactivitiesoftheentityandother activitiesthatarenotinvestingorfinancingactivities.Thisisanindicationofhowwelltheentitycan generateenoughcashflowstomaintainitsoperationsandmeetitsdebtswithoutrelyingonexternal finance. Cashflowsfromoperatingactivitiescanconsistof:
Cashreceiptsfromthesaleofgoodsandtherenderingofservices Cashreceiptsfromroyalties,fees,commissionsandotherrevenue Cashpaymentstosuppliersforgoodsandservices Cashpaymentstoandonbehalfofemployees
Cashflowsfrominterestpaidandincometaxespaidarealsodealtwithhere.
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IAS7allowstwopossiblelayoutsforcashgeneratedfromoperations
Theindirectmethod Thedirectmethod
ThedirectmethodispreferredbyIAS7butisnotcompulsory.Inpracticaltermstheindirectmethod islikelytobeeasierandlesstimeconsumingtoprepareandismorelikelytobeexamined.Intheexam youshouldusetheindirectmethodunlessthequestionspecifiesotherwise.
2.2 Directmethod Usingthedirectmethod,cashgeneratedfromoperationswouldbeanalysedasfollowsandshownasa notetothestatementofcashflows: GrossoperatingcashflowsfortheyearendedDecember20X4 £ X (X) (X) X
Cashreceivedfromcustomers Cashpaymentstosuppliers Cashpaymentstoandonbehalfofemployees Cashgeneratedfromoperations
Thereasonsforcertainitemsbeingaddedandothersbeingdeductedisverystraightforwardwiththis method–cashinflowsareaddedandcashoutflowsarededucted.Entitiesareencouragedtousethis methodasitprovidesinformationthatisnotavailableundertheindirectmethodwhichmaybeuseful inestimatingfuturecashflows.
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2.3 Indirectmethod Usingtheindirectmethod,cashgeneratedfromoperationsiscalculatedbyperformingareconciliation between:
Profitbeforetaxasreportedinthestatementofprofitorloss Cashgeneratedfromoperations
Thisreconciliationisproducedasfollows: Reconciliationofprofit/lossbeforetaxtocashgeneratedfromoperationsfortheyearended 31December20X7 Profit/(loss)beforetax Financecost Investmentincome Depreciationcharge Amortisationcharge Loss/(profit)ondisposalofnon-currentassets (Increase)/decreaseininventories (Increase)/decreaseintradeandotherreceivables (Increase)/decreaseinprepayments Increase/(decrease)intradeandotherpayables Increase/(decrease)inaccruals Increase/(decrease)inprovisions Cashgeneratedfromoperations
£ X X (X) X X X/(X) (X)/X (X)/X (X)/X (X)/X (X)/X (X)/X X
Taxpaid Interestpaid Netcashfrom/usedinoperatingactivities
(X) (X) X
2.4 Explanation Cashflowsfromoperatingactivitiesalsoincludepaymentsandrefundsofincometaxunlesstheycanbe specificallyidentifiedwithinvestingorfinancingactivities.Corporationtaxpaymentsrelatetoprofits fromoperationsandsotheyareacashflowfromoperatingactivities.
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Itisimportanttounderstandwhycertainitemsareaddedandotherssubtracted.Notethefollowing points. (a) Depreciationisnotacashexpense,butisdeductedinarrivingattheprofitfigureinthestatement ofprofitorloss.Itmakessense,therefore,toeliminateitbyaddingitback. (b) Bythesamelogic,alossonadisposalofanon-currentasset(arisingthroughunderprovisionof depreciation)needstobeaddedbackandaprofitondisposalneedstobededucted. (c) Anincreaseininventorymeanslesscash–youhavespentcashonbuyinginventory. (d) Anincreaseinreceivablesmeansreceivableshavenotpaidasmuch,thereforelesscash. (e) Ifwepayoffpayables,causingthefiguretodecrease,againwehavelesscash.
Workedexample:Cashflowsfromoperatingactivities QuestLtdhasprofitbeforetaxfortheyearto31December20X6of£850,aftercharging£650for depreciationandmakingaprofitonsaleofacarof£120. Thestatementoffinancialpositionfortheyearshowsthefollowingentries: Inventories Tradeandotherreceivables Tradeandotherpayables
20X6 586 1,021 443
20X5 763 589 1,431
Requirement Calculatethenetcashfromoperatingactivities
Solution £ 850 650 (120) 177 (432) (988) 137
Profitbeforetax Depreciation(add) Gainonsaleofproperty,plantandequipment(deduct) Movementininventories(addadecrease) Movementintradereceivables(deductanincrease) Movementintradepayables(deductadecrease) Netcashfromoperatingactivities
Workedexample:Directmethod Hailplccommencedtradingon1January20X7followingashareissuewhichraised£35,000.During theyearthecompanyenteredintothefollowingtransactions:
Purchasesfromsupplierswere£19,500,ofwhich£2,550wasunpaidattheyearend. Wagesandsalariesamountedto£10,500,ofwhich£750wasunpaidattheyearend. Salesrevenuewas£29,400,including£900receivablesattheyearend.
Solution Cashgeneratedfromoperationswouldbecalculatedanddisclosedasfollows: Grossoperatingcashflowsfortheyearended31December20X7 Cashreceivedfromcustomers(29,400–900) Cashpaidtosuppliersandemployees Cashgeneratedfromoperations
£ 28,500 (26,700)(W) 1,800
WORKING Cashpaidtosuppliers(19,500–2,550) Cashpaidtoandonbehalfofemployees(10,500–750) Cashpaidtosuppliersandemployees
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2.5 Paymentsofinterestandincometax Theadjustmentsinthestatementofcashflowsto'cashgeneratedfromoperations'toarriveat'net cashfromoperatingactivities'consistofpaymentsofinterestandincometax. Asimilarmethodcanbeusedtocalculatethecashflowsforinterestpaidandincometaxpaid.Foreach item,theinformationavailablemightbe:
Openingbalanceatthestartoftheperiod(openingstatementoffinancialposition) Statementofprofitorloss(theamountoftheitem,asreported) Closingbalanceattheendoftheperiod(closingstatementoffinancialposition)
Thecashflowisabalancingfigureobtainedfromthesethreefigures. ATaccountcanbeusedasaworking.
Workedexample:Interestpaid Acompany'sfinancialstatementsshowthefollowinginformation:
Interestpayable Interestcharge
At1Jan 20X2 £ 54,000
At31Dec 20X2 £ 63,000
Fortheyear 20X2 £ 240,000
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Interestpaidiscalculatedasfollows. INTERESTPAID Cashpayment(balancingfigure) Balancec/d
£ 231,000 63,000 294,000
Balanceb/d Statementofprofitorloss
£ 54,000 240,000 294,000
Alternatively,thiscouldbecalculatedasfollows: (54,000+240,000–63,000)=£231,000 Asimilartechniquecanbeusedtocalculatepaymentsofincometaxintheyear.Thetaxationpayment referstopaymentsofincometax,nottopaymentsofsalestax(VAT)ortaxpaidbyemployees. Theopeningandclosingstatementsoffinancialpositionwillshowaliabilityforincometax.Theincome taxchargefortheyearisshowninthestatementofprofitorloss.Thefigureforincometaxespaid duringtheyearisderivedasabalancingfigure.
Interactivequestion1:Incometax
[Difficultylevel:Intermediate]
Acompanyhadaliabilityforincometaxat31December20X6of£940,000andaliabilityforincome taxat31December20X7of£1,125,000.Theincometaxchargefortheyearto31December20X7 was£1,270,000.Whatamountofincometaxwaspaidduringtheyear? INCOMETAXPAID SeeAnswerattheendofthischapter.
£
£
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2.6 Investingactivities Cashflowsfrominvestingactivitiesarecalculatedseparatelyinthestatementofcashflowsinorderto identifytheextenttowhichexpenditureshavebeenmadeonresourcesintendedtogeneratefuture incomeandcashflows.Thesearetheacquisitionanddisposaloflong-termassetsandotherinvestments notincludedincashequivalents. Thiscouldincludethefollowingitems:
Cashpaymentstoacquireproperty,plantandequipment,intangiblesandothernon-current assets,includingthoserelatingtocapitaliseddevelopmentcostsandself-constructedproperty, plantandequipment
Cashreceiptsfromsalesofproperty,plantandequipment,intangiblesandothernon-current assets
Cashpaymentstoacquireequityordebtofotherentities
Cashreceiptsfromsalesofequityordebtofotherentities
Interestreceived
Dividendsreceived
Cashreceiptsfromsalesofproperty,plantandequipment ATaccountcanbeusedforcalculatingthecashreceiptsfromsalesofproperty,plantandequipment (PPE).Thecompany'saccountswillincludetheamountofanyprofitorlossondisposal.Anotetothe accountsonnon-currentassetswillshowthecostandtheaccumulateddepreciationforproperty,plant andequipmentdisposedofduringtheyear.Thecashreceivedfromthesaleisthebalancingfigureinthe Taccount. PROPERTY,PLANTANDEQUIPMENT–DISPOSALACCOUNT Cost/valuationofassetdisposedof Profitondisposal
£ X X X
Accumulateddepreciation Lossondisposal Cashreceived(balancingfigure)
£ X X X X
Workedexample:CashreceiptsfromsaleofPPE Acompany'sstatementoffinancialpositionasatthebeginningandtheendoftheyearshowedthe following. Property,plantandequipment Cost At1January20X7 Disposals At31December20X7
£ 760,000 (240,000) 520,000
Depreciation At1January20X7 Disposals Chargeforyear At31December20X7
270,000 (180,000) 50,000 140,000
Carryingamount At31December20X7 At31December20X6
380,000 490,000
Theproperty,plantandequipmentwasdisposedofatalossof£7,000.Whatwasthecashflowfrom thedisposal?
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Solution Thebalancingfigurecanbeobtainedbyconstructingadisposalofproperty,plantandequipment accountasaworking.
PROPERTY,PLANTANDEQUIPMENT–DISPOSALACCOUNT Accumulateddepreciation Lossondisposal Cashreceived(balancingfigure)
£ 240,000 240,000
Cost
£ 180,000 7,000 53,000 240,000
Cashpaymentsforpurchaseofproperty,plantandequipment Purchaseofproperty,plantandequipmentduringaperiodcanbecalculatedbymeansofaTaccount oraworkingtable. PROPERTY,PLANTANDEQUIPMENT Balanceb/d Additions(balancingfigure)
Disposals Balancec/d
£ X X X
Interactivequestion2:CashpaymentsforPPE
£ X X X
C H A P T E R
12
[Difficultylevel:Intermediate]
Acompany'saccountsshowthatat31December20X7,ithadproperty,plantandequipmentatcostof £6,800,000.Duringtheyear,itdisposedofassetsthathadacostof£850,000.At31December20X6, thecompany'sproperty,plantandequipmentatcosthadbeen£5,100,000. Whatwerepurchasesofproperty,plantandequipmentduringtheyear? PROPERTY,PLANTANDEQUIPMENT
£
£
SeeAnswerattheendofthischapter.
Interestanddividendsreceived Returnsreceivedincashfrominvestmentswillincludeinterestanddividendsreceived.Thecashflows canbecalculatedbyusinganinterestreceivedordividendsreceivedTaccount.BothTaccountsare verysimilarandarepreparedasfollows: INTEREST/DIVIDENDSRECEIVED Balanceb/d(receivable) Statementofprofitorloss
£ X X X
Cashreceipt(balancingfigure) Balancec/d(receivable)
£ X X X
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Interactivequestion3:Interestreceived
[Difficultylevel:Intermediate]
Acompanyhadinterestreceivableof£35,000atthestartoftheyearandinterestreceivableof£42,000 attheendoftheyear.Thestatementofprofitorlossfortheyearshowsinterestincomeof£90,000. Whatwerethecashreceiptsforinterestreceivedintheyear? INTERESTRECEIVED
£
£
SeeAnswerattheendofthischapter. Thepro-formaforinvestingactivities Cashflowsfrominvestingactivities
Purchaseofproperty,plantandequipment
Purchaseofintangibleassets
Proceedsfromsaleofproperty,plantandequipment
Proceedsfromsaleofintangibles
Interestreceived
Netcashfrom/usedininvestingactivities
Workedexample:Cashflowsfrominvestingactivities PearlLtdacquiredanewfactoryintheyearto30June20X6foracostof£805,000.Theysoldtheirold factoryfor£425,000.Theyalsoreceivedinterestonsurplusfundsof£350,000.Calculatecashflows frominvestingactivities.
Solution Cashflowsfrominvestingactivities Purchaseofproperty,plantandequipment Proceedsfromsaleofproperty,plantandequipment Interestreceived Netcashflowsfrominvestingactivities
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£ (805,000) 425,000 350,000 30,000
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2.7 Cashflowsfromfinancingactivities Thissectionofthestatementofcashflowsshowstheshareofcashwhichtheentity'scapitalproviders haveclaimedduringtheperiod.Thisisanindicatoroflikelyfutureinterestanddividendpayments. Thestandardgivesthefollowingexamplesofcashflowswhichmightariseunderthisheading Cashflowsfromfinancingactivities
Proceedsfromissueofshares
Movementinborrowings
Dividendspaid
Netcashfrom/usedinfinancingactivities
Cashreceivedfromissuingshares Theamountofcashreceivedfromnewissuesofsharescanusuallybecalculatedfromtheopeningand closingstatementoffinancialpositionfiguresforsharecapitalandsharepremium.
C H A P T E R
Asageneralrule: SHARECAPITALANDPREMIUM £ X X
Balancec/d
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£ X X X
Balanceb/d Cashreceipt(balancingfigure)
Thisruledoesnotapplyfullywhenthecompanymakesabonusissueofsharesduringtheyear,and someofthenewsharecapitalisobtainedbymeansofreducingareserveaccountotherthantheshare premium.Tocalculatecashreceiptsfromshareissuesintheyear,theamounttransferredtoshare capitalfromtheotherreserveaccountshouldbesubtracted.
Workedexample:Cashreceivedfromshareissue Rustlerplc'sannualaccountsfortheyearto31December20X7showthefollowingfigures. Sharecapital:Ordinarysharesof50p Sharepremium
At31.12.X7 £ 6,750,000 12,800,000
At31.12.X6 £ 5,400,000 7,300,000
Therewerenobonusissuesofsharesduringtheyear.Whatamountofcashwasraisedfromshares issuedduringtheyear?
Solution
SHARECAPITALANDPREMIUM
Balancec/d (6,750,000+12,800,000)
£ 19,550,000 19,550,000
Balanceb/d (5,400,000+7,300,000) Cashreceipt(balancingfigure)
£ 12,700,000 6,850,000 19,550,000
Interactivequestion4:Bonusissue
[Difficultylevel:Examstandard]
Groatplc'saccountsfortheyearto31December20X7showthefollowingfigures. Sharecapital:Ordinarysharesof10p Sharepremium
At31.12.X7 £ 22,500,000 900,000
At31.12.X6 £ 10,000,000 4,800,000
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Thecompanymadeaonefortwobonusissueofsharesatthestartoftheyear.Itusedtheshare premiumaccountand£200,000fromretainedearningstodothis. Whatamountofcashwasraisedfromshareissuesduringtheyear? SHARECAPITALANDPREMIUM
£
£
SeeAnswerattheendofthischapter.
Workedexample:Cashflowsfromfinancingactivities SpearLtdissued87,500£1sharesatparduringtheyearto31December20X6.Loanstakenout increasedfrom£18,000atthebeginningoftheyearto£30,000attheendoftheyear.Thecompany declaredadividendof10ppershare.Calculatethecashflowsfromfinancingactivities. Proceedsfromissueofshares Movementsinborrowings Netcashfromfinancingactivities
£ 87,500 12,000 99,500
Notethatonlydividendspaid(asopposedtodeclared)intheperiodrepresentcashflows.Interestpaid ontheloanswillbeshownundercashflowsfromoperatingactivities.
Cashfromraisingaloan Thecashderivedfromobtaininganewloanduringtheyearshouldbeapparentfromacomparisonof theopeningandclosingstatementoffinancialpositionfiguresfornon-currentinterest-bearing borrowings.Anincreaseduringtheyearrepresentsnewfinancing,andshouldbetakenasthe amountofcashreceivedfromfinancing. Itisimportantthatallloansinthestatementoffinancialpositionshouldbetakeninto considerationinthecalculation.Theremaybealoanthatiswithin12monthsofrepayment.Ifso,it willbeincludedwithincurrentliabilitiesintheyear-endstatementoffinancialpositionas'short-term borrowings',whenitwouldhavebeenanon-currentliabilityinthestatementoffinancialpositionatthe startoftheyear.Theloanhasnotbeenrepaidduringtheyear,merelyre-classifiedfromnon-current liabilitytocurrentliability.
Repaymentofnon-currentinterest-bearingborrowings Inthesameway,areductionininterest-bearingborrowingsindicatesthataloanhasbeenrepaid,or thatloanstockordebentureshavebeenredeemed.Itshouldbeassumedthattheloansarerepaidor loanstockisredeemedforcash.
Dividendspaid Cashflowsfromdividendspaidshouldbedisclosedseparately. Dividendspaidbytheentitycanbeclassifiedinoneoftwoways. (a) Asafinancingcashflow,showingthecostofobtainingfinancialresources(asintheexample statementofcashflowsinsection2above).ThisisthepresentationadoptedintheseLearning Materials. (b) Asacomponentofcashflowsfromoperatingactivitiessothatuserscanassesstheentity'sability topaydividendsoutofoperatingcashflows. CashflowsfordividendspaidcanbecalculatedusingaTaccount.
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Workedexample:Dividendspaid Acompanyhasdeclaredpreferencedividendsfortheyearof£7,000(basedonits7%£100,000 redeemablepreferencesharesinissue).Atthestartoftheyearthestatementoffinancialposition includedaliabilityof£3,500forpreferencedividendspayable.Attheendoftheyearnoamountwas owingtopreferenceshareholdersinrespectofdividends. Thepreferencedividendpaidfortheyearisnotsimplythe£7,000declaredandreflectedinretained earningsasthisamountneedstobeadjustedforanyopeningandclosingliabilities. DIVIDENDSPAID Cashpayment(balancingfigure) Balancec/d
£ 10,500 0 10,500
£ 3,500 7,000 10,500
Balanceb/d Retainedearnings
Thecashpaidduringtheyearof£10,500isthesecondhalfyearpreferencedividendduefromlastyear andthewholeofthisyear'spreferencedividend(allpaidduringtheyear). Pointtonote:Anydividendsfortheyearwillbedisclosedinthestatementofchangesinequity. Ordinarydividendsinthestatementofchangesinequitywillhavebeenpaidduringtheyear. Preferencedividendscouldhavebeenpaidorcouldbealiabilityattheperiodend(asintheexample above).
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2.8 Example:Directmethod ThefollowingexamplestatementsofcashflowsareprovidedbyIAS7usingthedirectmethodandthe indirectmethod. XYZLIMITED Statementofcashflows(directmethod) Cashflowsfromoperatingactivities Cashreceiptsfromcustomers Cashpaidtosuppliersandemployees Cashgeneratedfromoperations Interestpaid Incometaxespaid
£'000 30,150 (27,600) 2,550 (270) (900)
Netcashfromoperatingactivities
1,380
Cashflowsfrominvestingactivities Purchaseofproperty,plantandequipment Proceedsfromsaleofequipment Interestreceived Netcashusedininvestingactivities
(700) 20 200
Cashflowsfromfinancingactivities Proceedsfromissueofsharecapital Proceedsfromlong-termborrowings Paymentoffinanceleaseliabilities Dividendspaid Netcashusedinfinancingactivities
250 250 (90) (1,200)
Netincreaseincashandcashequivalents Cashandcashequivalentsatbeginningofperiod Cashandcashequivalentsatendofperiod
£'000
(480) (790) 110 120 230
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Example:Indirectmethod Statementofcashflows(indirectmethod) Cashflowsfromoperatingactivities Profitbeforetaxation Depreciation Investmentincome Interestexpense Increaseintradeandotherreceivables Decreaseininventories Decreaseintradepayables Cashgeneratedfromoperations Interestpaid Incometaxespaid Netcashfromoperatingactivities
£'000 3,350 450 (500) 400 3,700 (500) 1,090 (1,740) 2,550 (270) (900)
Cashflowsfrominvestingactivities Purchaseofproperty,plantandequipment Proceedsfromsaleofequipment Interestreceived Netcashusedininvestingactivities
(700) 20 200
Cashflowsfromfinancingactivities Proceedsfromissueofsharecapital Proceedsfromlong-termborrowings Paymentoffinanceleaseliabilities Dividendspaid Netcashusedinfinancingactivities
250 250 (90) (1,200)
Netincreaseincashandcashequivalents Cashandcashequivalentsatbeginningofperiod Cashandcashequivalentsatendofperiod
£'000
1,380 (480)
(790)
110 120 230
3 Preparingastatementofcashflows Sectionoverview
Inessence,preparingastatementofcashflowsisverystraightforward.Youshouldtherefore simplylearntheformatandapplythestepsnotedintheexamplebelow.
Rememberthewaythatthefollowingitemsaretreated.Itmightseemconfusingatfirst,butthe treatmentislogicalifyouthinkintermsofcash. (a) Increaseininventoryistreatedasnegative(inbrackets).Thisisbecauseitrepresentsacash outflow;cashisbeingspentoninventory. (b) Anincreaseinreceivableswouldbetreatedasnegativeforthesamereasons;morereceivables meanslesscash. (c) Bycontrastanincreaseinpayablesispositivebecausecashisbeingretainedandnotusedtopay offpayables.Thereisthereforemoreofit.
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Workedexample:Preparationofastatementofcashflows KaneLtd'sstatementofprofitorlossfortheyearended31December20X2andstatementoffinancial positionat31December20X1and31December20X2wereasfollows. KANELIMITED STATEMENTOFPROFITORLOSSFORTHEYEARENDED31DECEMBER20X2 £'000 70 94 118 18
Sales Rawmaterialsconsumed Staffcosts Depreciation Lossondisposal Operatingprofit Interestpayable Profitbeforetax Taxation Profitfortheyear
£'000 720 ((300) 420 (28) 392 ((124) 268
KANELIMITED STATEMENTOFFINANCIALPOSITIONASAT31DECEMBER Non-currentassets Cost Depreciation Currentassets Inventory Tradereceivables Recoverablecorporationtax Bank Currentliabilities Tradepayables Taxation Netcurrentassets Long-termliabilities Long-termloans
12
20X2 £'000 £'000 1,596 318 1,278 24 66 10 48 148 12 102 114 34 1,312 200 1,112
Sharecapital Sharepremium Profitandloss
C H A P T E R
360 36 716 1,112
20X1 £'000 £'000 1,560 224 1,336 20 50 8 56 134 6 86 92 42 1,378 500 878
340 24 514 878
Dividendstotalling£66,000werepaidduringtheyear. Duringtheyear,thecompanypaid£90,000foranewpieceofmachinery. Requirement PrepareastatementofcashflowsforKaneLtdfortheyearended31December20X2inaccordance withtherequirementsofIAS7.
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Solution
Step1. Setoutthepro-formastatementofcashflowswithalltheheadingsrequiredbyIAS7.Intheassessment thiswillbeprovidedforyou.
Step2. Completethecashflowsfromoperatingactivitiesasfaraspossible.Whenpreparingthestatementfrom thestatementoffinancialposition,youwillusuallyhavetocalculateitemssuchasdepreciation,profitor lossonsaleofnon-currentassetsandprofitfortheyear(seeStep4).
Step3. Calculatethefiguresfortaxpaid,purchaseorsaleofnon-currentassets,issueofsharesandrepayment ofloansifthesearenotalreadygiventoyou(astheymaybe).Notethatyoumaynotbegiventhetax chargeinthestatementofprofitorloss.Youwillthenhavetoassumethatthetaxpaidintheyearislast year'syear-endprovisionandcalculatethechargeasthebalancingfigure.
Step4. Ifyouarenotgiventheprofitfigure,openupaworkingforthestatementofprofitorloss.Usingthe openingandclosingbalances,thetaxationchargeanddividendspaidyouwillbeabletocalculate profitfortheyearasthebalancingfiguretoputinthestatement.
Step5. Completethegrosscashflows,ifaskedforit.Alternatively,theinformationmaygostraightintothe statement.
Step6. Youwillnowbeabletocompletethestatementbyslottinginthefiguresgivenorcalculated.
Step7. Checkthatthenetincreaseincashandcashequivalentsthatyouhavecalculatedplusthecashand cashequivalentsatthebeginningoftheperiodtotalstothecashandcashequivalentsattheendofthe period. KANELIMITED STATEMENTOFCASHFLOWSFORTHEYEARENDED31DECEMBER20X2 Statementofcashflows(indirectmethod) Cashflowsfromoperatingactivities Profitbeforetaxation Lossonsaleofproperty,plantandequipment Depreciation Investmentincome Interestexpense Increaseintradeandotherreceivables Increaseininventories Increaseintradepayables Cashgeneratedfromoperations Interestpaid Incometaxespaid(W1) Netcashfromoperatingactivities
Cashflowsfrominvestingactivities Purchaseofproperty,plantandequipment Proceedsfromsaleofequipment(W2) Interestreceived Netcashusedininvestingactivities
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£'000 392 18 118 28 (16) (4) 6 542 (28) (110)
(90) 12
£'000
404 (78)
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Cashflowsfromfinancingactivities Proceedsfromissueofsharecapital(360+36–340–24) Proceedsfromlong-termborrowings(500–200) Paymentoffinanceleaseliabilities Dividendspaid Netcashusedinfinancingactivities Netincreaseincashandcashequivalents Cashandcashequivalentsatbeginningofperiod Cashandcashequivalentsatendofperiod
32 (300) (66)
(334) (8) 56 48
WORKINGS (1) Corporationtaxpaid £'000 78 124 (92) 110
OpeningCTpayable(86–8) Chargeforyear NetCTpayableat31.12.X2(10210) Paid
C H A P T E R
12
(2) Non-currentassetdisposals
COST £'000 1,560 90 1,650
At1.1.X2 Purchases
At31.12.X2 Disposals
£'000 1,596 54 1,650
ACCUMULATEDDEPRECIATION At31.1.X2 Depreciationondisposals
£'000 318 24 342
At1.1.X2 Chargeforyear
Carryingvalueofdisposals Netlossreported Proceedsofdisposals
£'000 224 118 342 30 (18) 12
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SummaryandSelf-test
Summary
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Self-test Answerthefollowingquestions. 1
WhichoneofthefollowingoptionsbestdescribestheobjectiveofIAS7StatementofCashFlows? A B C D
2
3
Whichoneofthefollowingstatementsgivesthebestdefinitionofcashequivalentsassetoutin IAS7StatementofCashFlows? A
Cashequivalentsarecash,overdrafts,short-termdeposits,optionsandotherfinancial instrumentsandequitiestradedinanactivemarket
B
Cashequivalentsareshort-termhighlyliquidinvestmentssubjecttoinsignificantrisksof changeinvalue
C
Cashequivalentsarereadilydisposableinvestments
D
Cashequivalentsareinvestmentswhicharetradedinanactivemarket
Inacompany'sstatementofcashflowspreparedinaccordancewithIAS7StatementofCashFlows, arevaluationofnon-currentassetsduringtheyearwillbe: A B C D
4
Toaidcomparisonofcashflowsbetweenentities Toassistuserstounderstandthecashmanagementandtreasurypracticesofanentity Toassistuserstoconfirmthegoingconcernofanentity Toenableentitiestoreportcashinflowsandoutflowsanalysedunderstandardheadings
C H A P T E R
12
Entirelyexcluded Shownundercashflowsfromoperatingactivities Disclosedunderinvestingactivities Shownasacashinflow
Informationconcerningthenon-currentassetsofEalingplcisdetailedinthetable.Duringtheyear non-currentassetswhichhadcost£80,000andwhichhadacarryingvalueof£30,000weresold for£20,000.Netcashfromoperatingactivitiesfortheyearwas£300,000. Cost Aggregatedepreciation Carryingamount
Startofyear £ 180,000 (120,000) 60,000
Endofyear £ 240,000 (140,000) 100,000
Therewasnoothercashactivity.Asaresultoftheabove,cashincreasedovertheyearby A B C D 5
£240,000 £260,000 £320,000 £180,000
Waterlooplcacquiredafreeholdbuildingforcash,financedinfullbyissuingforcash166,000£1 ordinarysharesatapremiumof£2pershare. InitsstatementofcashflowspreparedinaccordancewithIAS7StatementofCashFlowsthis transactionshouldbestatedas: A B C D
Inflow£498,000,outflownil Inflownil,outflownil Inflow£498,000,outflow£498,000 Inflownil,outflow£498,000
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6
InformationfromthestatementofcashflowsandrelatednotesofGreshamplcfortheyearended 31December20X1canbefoundinthetablebelow. £ Depreciation 30,000 Profitonsaleofproperty,plantandequipment 5,000 Proceedsfromsaleofproperty,plantandequipment 20,000 Purchaseofproperty,plantandequipment 25,000 Ifthecarryingamountofproperty,plantandequipmentwas£110,000on31December20X0, whatwasiton31December20X1? A B C D
£85,000 £90,000 £70,000 £80,000
NowgobacktotheLearningObjectiveintheIntroduction.Ifyouaresatisfiedyouhaveachievedthis objective,pleasetickitoff.
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Technicalreference
1Objectiveofthestatementofcashflows
Thestatementofcashflowsshouldshowthehistoricalchangesincashand cashequivalents.
Cashcomprisescashonhandanddemanddeposits.
IAS7(6)
Cashequivalentsareshort-term,highlyliquidinvestmentsthatarereadily convertibletoknownamountsofcashandwhicharesubjecttoaninsignificant riskofchangesinvalue.
IAS7(6)
2Presentationofastatementofcashflows
Cashflowsshouldbeclassifiedbyoperating,investingandfinancingactivities.
Cashflowsfromoperatingactivitiesareprimarilyderivedfromtheprincipal revenue-producingactivitiesoftheentity.
Therearetwomethodsofpresentationforcashflowsfromoperatingactivities:
AppendixA IAS7(10) IAS7(13–14)
–
Directmethod
IAS7(19)
–
Indirectmethod
IAS7(20)
Cashflowsfrominvestingactivitiesarethoserelatedtotheacquisitionor disposalofanynon-currentassets,ortradeinvestmentstogetherwithreturns receivedincashfrominvestments(iedividendsandinterestreceived).
Financingactivitiesinclude:
12
IAS7(16)
–
Cashproceedsfromissuingshares
–
Cashproceedsfromissuingdebentures,loans,notes,bonds,mortgages andothershortorlong-termborrowings
–
Cashrepaymentsofamountsborrowed
–
Repaymentofcapitalofamountsborrowedunderfinanceleases
–
Dividendspaidtoshareholders
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C H A P T E R
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AnswerstoInteractivequestions
AnswertoInteractivequestion1 INCOMETAXPAID Cashpayment(balancingfigure) Balancec/d
£ 1,085,000 1,125,000 2,210,000
Balanceb/d Statementofprofitorloss
£ 940,000 1,270,000 2,210,000
Alternativelythiscouldbecalculatedasfollows: (£940,000+£1,270,000–£1,125,000)=£1,085,000
AnswertoInteractivequestion2 PROPERTY,PLANTANDEQUIPMENT £ 5,100,000 2,550,000 7,650,000
Balanceb/d Additions(balance)
Disposals Balancec/d
£ 850,000 6,800,000 7,650,000
ThecompanystartedtheyearwithPPEatcostof£5,100,000.Itboughtafurther£2,550,000ofPPE, givingatotalof£7,650,000atcost.However,thereweredisposalsofPPEwithacostof£850,000, bringingtheyear-endfiguredownto£6,800,000.
AnswertoInteractivequestion3 INTERESTRECEIVED Balanceb/d Statementofprofitorloss
£ 35,000 90,000 125,000
Cashreceived(balancingfigure) Balancec/d
£ 83,000 42,000 125,000
AnswertoInteractivequestion4 SHARECAPITALANDPREMIUM Balancec/d
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£
23,400,000 23,400,000
Balanceb/d Retainedearnings Cashreceived(balance)
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£ 14,800,000 200,000 8,400,000 23,400,000
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AnswerstoSelf-test 1
D
Toenableentitiestoreportcashinflowsandoutflowsanalysedunderstandardheadings.(IAS 7)
2
B
Cashequivalentsareshort-termhighlyliquidinvestmentssubjecttoinsignificantrisksof changesinvalue.
3
A
Arevaluationofnon-currentassetsduringtheyearwillbeentirelyexcluded. Revaluationshavenocashflowimplications.
4
D
Thecorrectansweris£180,000. NON-CURRENTASSETS–COST Balanceb/d Thereforepurchases
£ 180,000 140,000 320,000
£ 80,000 240,000 320,000
Disposals Balancec/d
C H A P T E R
DEPRECIATION 12
Disposals Balancec/d
£
50,000 140,000 190,000
£ 120,000 70,000 190,000
Balanceb/d Thereforecharge
DISPOSALS £ 80,000 80,000
Cost
Cashfromoperations Cashinflow: Disposalproceeds Cashoutflow:purchasesofnon-currentassets Thereforenetcashincrease
Accumulateddepreciation Proceeds Thereforeloss
£ 50,000 20,000 10,000 80,000 £ 300,000 20,000 320,000 (140,000) 180,000
Notethatadjustmentsfordepreciationandlossondisposalwillalreadybeincludedinnet cashfromoperatingactivities. 5
C
Inflow£498,000,outflow£498,000. Theoutflowisclassifiedunder'Purchaseofproperty,plantandequipment'. Theinflowisclassifiedunder'Proceedsfromissuanceofsharecapital'.
6
B
£90,000 PROPERTY(carryingamount) Balanceb/d Additions
£ 110,000 25,000 135,000
Depreciation Disposals Balancec/d(bal.fig.)
£ 30,000 15,000 90,000 135,000
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CHAPTER13
Companyfinancial statementsunderUKGAAP
Introduction Examinationcontext TopicList 1 WhatisUKGAAP? 2 Publishedaccounts 3 UKGAAPterminologyandformats SummaryandSelf-test AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Recordandaccountfortransactionsandeventsresultinginincome,expenses,assets, liabilitiesandequityinaccordancewiththeappropriatebasisofaccountingandthelaws, regulationsandaccountingstandardsapplicabletothefinancialstatements
Prepareanextendedtrialbalance
Identifythemaincomponentsofasetoffinancialstatementsandspecifytheirpurpose andinterrelationship
Prepareandpresentbalancesheet,profitandlossaccountandcashflowstatement(or extractstherefrom)fromtheaccountingrecordsandtrialbalanceinaformatthatsatisfies theinformationrequirementsoftheentity
Specificsyllabuslearningoutcomesare:1d;2c;3a,c
Syllabuslinks Thematerialinthischapterwillbedevelopedfurtherinthispaper,andreferredtointheProfessional LevelmoduleofFinancialAccountingandReporting.
Examinationcontext Questionsonthetopicsinthischapterwillbesetasmultiplechoicequestions,someofwhichmay involvecalculationssothatthecorrectanswercanbeselected.Veryoftendoubleentryquestionsare phrasedintermsofpreparingajournal. Intheexamyoumayberequiredto:
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IdentifywhatcomprisesUKGAAP
SpecifythekeydifferencesbetweenUKGAAPandIASformatsoffinancialstatements,especiallyin termsofthenetassetsUKGAAPbalancesheet
UseUKGAAPwhenidentifyingbalancesinpreparingtheprofitandlossaccountandbalancesheet ofacompany
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1 WhatisUKGAAP? Sectionoverview
FinancialstatementsarepreparedunderUKGAAPformostprivate,unlistedcompanies, partnershipsandsoletraders.
InthisStudyManualsofarwehavelookedathowfinancialtransactionsarerecordedinbooksof originalentryandinledgers,andatthetechniquesthatarethenused(suchastheprofitandlossledger accountand/ortheextendedtrialbalance)tosummarisethoseledgersandproducestatements
Ofthebusiness'sfinancialperformanceoveraperiodoftime(whichwehavecalleditsstatement ofprofitorloss),and
Ofthebusiness'sfinancialpositionattheendofthattimeperiod(whichwehavecalledits statementoffinancialposition)
Thesetechniquesareuniversal,arisingoutofthekeyaccountingprinciplesof:
Accruals Goingconcern Doubleentrybookkeeping
However,therearequiteanumberofissuesinrelationtowhichaccountingpracticearoundtheworld isdiverse,inparticular:
Terminology Theformatsusedtopresentfinancialstatements
Wehavesofaradoptedanapproachtotheseissuesbasedoninternationalaccountingandfinancial reportingstandards(specificallyIAS1)andontheConceptualFramework.Youneedtobeaware howeverthatthis'internationalstandards'approachcurrentlyonlyappliesintheUKtoalimitednumber ofcompanies;theremainderstillproducetheirfinancialstatementsunderwhathascometobecalled UKgenerallyacceptedaccountingpractice,orUKGAAP.
C H A P T E R
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Definition UKGAAP:Therules,fromwhateversource,thatgovernaccountingandfinancialreportingintheUK.
1.1 TheconstituentsofUKGAAP IntheUKgenerallyacceptedaccountingpracticeisacombinationof:
Companylaw(theCompaniesAct2006)
UKaccountingstandards
Theeffectsofstockexchangelistingrequirements(whichapplydirectlytolistedcompaniesbut whichareinfluentialmorewidely)and
Theeffectsofinternationalaccountingandfinancialreportingstandards
UKaccountingstandardshavemoreimpactthanIASsinUKGAAP,butUKstandardsareincreasingly being'converged'withinternationalones,sothedifferencesbetweenthemaredisappearing. GAAPisinfactadynamicconcept:itchangesconstantlyascircumstancesalterthroughnewlegislation, standardsandpractice.ThisideathatGAAPisconstantlychangingisrecognisedbytheUK'sASBinits StatementofAims,whereitstatesthatitexpectstoissuenewstandardsandamendoldonesinresponse to'evolvingbusinesspractices,neweconomicdevelopmentsanddeficienciesidentifiedincurrent practice.'
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Theproblemofwhatis'generallyaccepted'isnoteasytosettle,becausenewpracticesareobviously notgenerallyadoptedyet.Thecriteriaforapracticebeing'generallyaccepted'dependonfactorssuch aswhetherthepracticeisaddressedbyUKaccountingstandardsorlegislation,ortheirinternational equivalents,andwhetherothercompanieshaveadoptedthepractice.Mostimportantlyperhaps,the questionshouldbewhetherthepracticeisconsistentwiththeneedsofusersandtheobjectivesof financialstatements,andwhetheritisconsistentwiththe'trueandfair'concept(seebelow). TounderstandbettertheimportanceofUKGAAPweneedtolookbrieflyatwhyandhowcompaniesin theUKarerequiredtopublishannualfinancialstatements,or'publishedaccounts'.
2 Publishedaccounts Sectionoverview
UKcompaniesarerequiredbylawtopublishfinancialstatementsannuallyandfilethemwiththe RegistrarofCompanies('publishedaccounts').
Suchaccountsmustshowatrueandfairview.
ListedcompaniesarerequiredbytheListingRulestoapplyIASsinpreparingandpresentingtheir publishedaccounts.UnlistedcompaniesmaychoosetouseUKstandards,whichareconverging withIASs.
2.1 Publishingannualaccounts UndertheCompaniesAct2006UKlimitedcompaniesmustproduceaccounts(financialstatements) annually,andlargecompaniesmustappointanindependentpersontoauditandreportonthem.Once prepared,acopyoftheaccountsmustbesenttotheRegistrarofCompanies,whomaintainsaseparate fileforeverycompany.TheRegistrar'sfilesmaybeinspectedforanominalfee,byanymemberofthe public.Thisiswhythe'statutoryaccounts'areoftenreferredtoaspublishedaccounts.
Definition Statutoryaccounts:Financialstatementswhichlimitedcompaniesareobligedbylawtopublishina particularform. Thecompany'sdirectorsmustpublishaccountswhichshowatrueandfairview(aphraseusedins393 CompaniesAct2006)ofthecompany'sassets,liabilities,financialpositionandprofitorloss(profitand lossaccountandbalancesheet)forafinancialyear.Theboardevidencesitsapprovaloftheaccountsby thesignatureofonedirectoronthebalancesheet.Oncethishasbeendone,andtheauditorshave completedtheirreport,theaccountsaresenttoshareholdersand,inthecaseofapubliccompany,are presentedtothebodyofshareholdersatageneralmeeting.Whentheshareholdershaveadoptedthe accountstheyaresenttotheRegistrarforfiling.
2.2 Trueandfairview TheCompaniesAct2006requirementthattheaccountsshowatrueandfairviewisparamount.A company'saccountscanshowatrueandfairviewwhenpreparedusingeitherCompaniesAct(UK GAAP)formatsorIASformats. AlthoughtheCompaniesAct2006laysdownnumerousrulesontheinformationtobeincludedin publishedaccountsandtheformatofitspresentation,anysuchrulemaybeoverriddenifcompliance withitwouldpreventtheaccountsfromshowingatrueandfairview.
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WhenpreparedunderUKGAAPtheaccountsmustinclude:
Aprofitandlossaccount(equivalenttoastatementofprofitorloss)
Abalancesheetasatthedatetowhichtheprofitandlossaccountismadeup(equivalenttoa statementoffinancialposition)
Adirectors'report,andadirectors'remunerationreportinthecaseofaquotedcompany
Anauditors'reportaddressedtothemembers(nottothedirectors)ofthecompany
AllweareconcernedwithintheAccountingsyllabusistheprofitandlossaccountandbalancesheet.
2.3 Publishedaccountsoflistedandunlistedcompanies ListedcompaniesmustcomplywiththeListingRulessetoutbytheUKListingAuthority(partofthe FinancialServicesAuthority).Theserequirethatlistedcompaniesshouldpreparetheirpublished accountsunderinternationalaccountingstandards.ThisispermittedbytheCompaniesAct2006,aswe haveseenabove. Theterminologyandformatsofinternationalfinancialstatementsaredifferentfromtheonessetout intheCompaniesAct2006andUKGAAP,however.IntheUKthereforethereiscurrentlythesituation whereby:
Listedcompaniesproduceastatementofprofitorlossandstatementoffinancialposition followinginternationalterminologyandformats.
Non-listedcompaniescanchoosebetweenUKGAAPorinternationalterminologyandformatsfor theirpublishedaccounts.
3 UKGAAPterminologyandformats
C H A P T E R
Sectionoverview
UKterminologyandIASterminologyvaryinanumberofareas
UKformatssetdownintheCompaniesAct2006applyanetassetsapproachtothebalance sheet:totalassets–totalliabilities=totalequity.
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SofarinthisStudyManualwehaveexclusivelyusedtheinternationalterminologyandformats:we neednowtointroducetheUKGAAPversions.
3.1 UKGAAPterminology UKGAAPusesdifferentterminologyinmanyimportantrespectsregardingfinancialstatements,as follows: Internationalterm
UKGAAPterm
Statementofprofitorloss
Profitandlossaccount
Statementoffinancialposition
Balancesheet
Non-currentasset
Fixedasset
Carryingamount
Netbookvalue
Inventories
Stock
Receivables
Debtors
Irrecoverabledebt
Baddebt
Irrecoverabledebtexpense
Badanddoubtfuldebtsexpense
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Internationalterm
UKGAAPterm
Allowanceforirrecoverabledebts
Allowancefordoubtfuldebts
Retainedearnings
Retainedprofits(reserve)
Payables
Creditors
Non-currentliabilities
Creditors:amountsfallingdueaftermorethanoneyear
Currentliabilities
Creditors:amountsfallingdueinlessthanoneyear
Revenue
Turnover
Financecosts
Interestpayable
3.2 UKformats TheformatofthebalancesheetandprofitandlossaccountofalimitedcompanyundertheCompanies Act2006isshownbelow,withsomesimplifications(itisderivedfromtheformatssetdownbythe CompaniesAct1985,whichareadoptedbythe2006Act).NoteinparticularthattheUKGAAPbalance sheetpresentsnetassets,withcurrentliabilitiesdeductedfromcurrentassets,andlong-termliabilities deductedtoarriveatnetassets.Thelowerhalfofthebalancesheetcomprisestheowners'interests only. TYPICALLIMITEDCOMPANY BALANCESHEETASAT… Fixedassets Intangibleassets Developmentcosts Concessions,patents,licences,trademarks Goodwill Tangibleassets Landandbuildings Plantandmachinery Fixtures,fittings,toolsandequipment Motorvehicles Currentassets Stocks Debtorsandprepayments Cashatbankandinhand Creditors:amountsfallingduewithinoneyear Debentureloans(nearingtheirredemptiondate) Bankoverdraftandloans Tradecreditors Provisions Taxation Accruals Netcurrentassets Totalassetslesscurrentliabilities Creditors:amountsfallingdueaftermorethanoneyear Debentures Netassets
Capitalandreserves Equityshares Preferenceshares Sharepremiumaccount Otherreserves Retainedprofits
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£ X X X X X X
£ X X X X X X X X X X X (X)
£ X X X X X (X) X
X X X X X X
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TheUKGAAPprofitandlossaccountisasfollows. TYPICALLIMITEDCOMPANY PROFITANDLOSSACCOUNTFORTHEYEARENDED… Turnover* Costofsales Grossprofit Distributioncosts Administrativeexpenses Otheroperatingincome Operatingprofit Interestpayableandsimilarcharges Profitbeforetaxation Taxation Profitaftertaxation
£ X (X) X (X) (X) X X X (X) X (X) X
* Notethattheturnoverfigureisnetoftradediscount,refundsandVAT,astherevenuefigureis underIASs.
3.3 Fixedassets 3.3.1 Intangiblefixedassets Intangiblefixedassetsrepresentamountsofmoneypaidbyabusinesstoacquirebenefitsofalongterm nature.Goodwillanddeferreddevelopmentexpenditurearetwointangibleassets;thesewere discussedindetailinChapter10andthesameprinciplesapplyunderUKGAAP. Ifacompanypurchasessomepatentrights,oraconcessionfromanotherbusiness,ortherighttouse atrademark,thecostofthepurchasecanbeaccountedforasanintangiblefixedasset.Theseassetsare subjecttoamortisationovertheirusefullives(called'economiclife'underUKGAAP).
3.3.2 Tangiblefixedassets
C H A P T E R
13
Tangiblefixedassetsareshowninthebalancesheetattheirnetbookvalue(ieatcostlessaccumulated depreciation). UnderUKGAAPafixedassetnoteisnormallyneededtogivetherequireddetail.Alternativelyonthe faceofthebalancesheetwecanpresenteachitemasfollows: Landandbuildings Plantandmachinery Fixturesandfittings Motorvehicles
Cost £ X X X X X
Accumulateddepreciation £ (X) (X) (X) (X) (X)
Netbookvalue £ X X X X X
3.4 Currentandlong-termliabilities Theterm'creditors:amountsfallingduewithinoneyear'isusedintheCompaniesAct2006tomean 'currentliabilities'. Similarly,theterm'creditors:amountsfallingdueaftermorethanoneyear'istheCompaniesAct 2006termfornon-currentliabilities.
CompanyfinancialstatementsunderUKGAAP
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Workedexample:Companyfinancialstatements ToseehowUKGAAPisusedwhenpreparingfinancialstatements,weshallworkthroughafullpractical example. TheaccountantofHartpeaceLtdhaspreparedthefollowingtrialbalanceasat31December20X7. 50pequityshares(fullypaid) 7%£1irredeemablepreferenceshares(fullypaid) 10%debentures Retainedprofit1.1.X7 Generalreserve1.1.X7 Freeholdlandandbuildings1.1.X7(cost) Plantandmachinery1.1.X7(cost) Accumulateddepreciation: Freeholdbuildings1.1.X7 Plantandmachinery1.1.X7 Stock1.1.X7 Sales Purchases Debentureinterestpaid Wagesandsalaries Lightandheat Sundryexpenses Suspenseaccount Debtors Creditors Cashatbank
£'000 350 100 200 242 171 430 830 20 222 190 2,695 2,152 10 254 31 113 420 464 195 141
Notes (a) Sundryexpensesinclude£9,000paidinrespectofinsurancefortheyearending1September 20X8.Lightandheatdoesnotincludeaninvoiceof£3,000forelectricityforthethreemonths ending1January20X8,whichwaspaidinFebruary20X8.Lightandheatincludes£20,000 relatingtosalescommissionpayabletoemployees. (b) Thesuspenseaccountisinrespectofthefollowingitems: Proceedsfromtheissueof100,000equityshares Proceedsfromthedisposalofplanton1.1.X7
£'000 120 300 420
(c) Thefreeholdpropertywasacquired10yearsago,thebuildingselementbeing£100,000.Their estimatedeconomiclifewas50yearsatthetimeofpurchase.
(d) Theplantdisposedofon1.1.X7cost£350,000andhadanetbookvalueof£274,000.£36,000 depreciationistobechargedonplantandmachineryfor20X7. (e) Thedebenturesarenotredeemableforsomeyears. (f) Thedirectorswishtoprovidefor: (i) Debentureinterestdue (ii) Atransfertogeneralreserveof£16,000 (iii) Auditfeesof£4,000 (g) Stockasat31December20X7wasvaluedatcostof£220,000. (h) Taxationistobeignored. Requirement PreparejournalsandanETBforHartpeaceLtd,plusadraftprofitandlossaccountandbalancesheet.
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Solution WORKINGforadjustment(f) £'000 20 (10) 10
Chargeneededinprofitandlossaccountfordebentureinterest(10%×£200,000) Amountpaidsofar,asshownintrialbalance Accrual–presumablysixmonths'interestnowpayable £'000 6 (a) DEBITPrepayment(9,0008/12) CREDITSundryexpenses DEBITLightandheat 3 CREDITAccrual Accrualofelectricityandprepaymentofinsurance DEBITWagesandsalaries 20 CREDITLightandheat Correctionofmispostingofsalescommission (b)
DEBITSuspense CREDITSharecapital(100,0000.5) Sharepremium Beingcorrecttreatmentofproceedsofshareissue DEBITSuspense CREDITDisposals Beingcorrecttreatmentofsalesproceedsreplant
(c) DEBITDisposals Accumulateddepreciation–Plantandmachinery(350–274) CREDITPlantandmachinery:cost Beingdisposalofplanton1.1.X7 DEBITDepreciationexpense CREDITFreeholdproperty:accumulateddepreciation(£100,000/50) CREDITPlantandmachinery:accumulateddepreciation Beingdepreciationfor20X7 (d)
DEBITDebentureinterest Auditfee CREDITAccruals Beingaccrualsofdebentureinterestandauditfeefor20X7 DEBITRetainedprofit CREDITGeneralreserve Beingtransfertogeneralreserve
(e)
DEBITStock(balancesheet) CREDITStock(profitandlossaccount) Beingclosingstockat31.12.X7
£'000 6 3 20
120 300
50 70 300
274 76 38
350 2 36
10 4 16
14 16
220
220
C H A P T E R
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HereisHartpeaceLtd'sETBfromwhichwecanprepareitsprofitandlossaccountandbalancesheet:
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HereisHartpeaceLtd'sdraftprofitandlossaccountandbalancesheet,takendirectfromtheETBbefore being'tidiedup'forpublication. HARTPEACELTD PROFITANDLOSSACCOUNT FORTHEYEARENDED31DECEMBER20X7 Sales Lesscostofsales Openingstock Purchases Lessclosingstock Grossprofit Profitondisposalofplant Lessexpenses Wagesandsalaries Sundryexpenses Lightandheat Depreciationexpense:freeholdpropertyandplant Auditfees Debentureinterest Netprofit
£'000 190 2,152 (220) 274 107 14 38 4 20
£'000 2,695 (2,122) 573 26 599 (457) 142
HARTPEACELTD BALANCESHEETASAT31DECEMBER20X7 Fixedassets Tangibleassets Freeholdproperty Plantandmachinery Currentassets Stock Debtors Prepayments Cash Creditors:amountsfallingduewithinoneyear Creditors Accruedexpenses Netcurrentassets Totalassetslesscurrentliabilities Creditors:amountsfallingdueaftermorethanoneyear 10%debentures Capitalandreserves Calledupsharecapital 50pequityshares 7%£1preferenceshares Reserves Sharepremium Generalreserve Retainedprofits(226+142)
Cost/val'n £'000 430 480 910 195 17
Dep'n £'000 (22) (182) (204) 220 464 6 141 831 (212) 400 100 70 187 368
£'000 408 298 706 619 1,325 (200) 1,125 500 625 1,125
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C H A P T E R
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3.5 Companyfinancialstatementsforpublication HartpeaceLtd'sfinancialstatementswouldappearasfollowsifpresentedforexternalpurposesusing thefullstandardCompaniesAct2006formats. HARTPEACELTD PROFITANDLOSSACCOUNTFORTHEYEARENDED31DECEMBER20X7 Turnover Costofsales Grossprofit Administrativeexpenses(274+107+14+38+4) Operatingprofit Otheroperatingincome Interestpayableandsimilarcharges Profitbeforetaxation Taxation Profitaftertaxation
£'000 2,695 (2,122) 573 (437) 136 26 (20) 142 0 142
HARTPEACELTD BALANCESHEETASAT31DECEMBER20X7 Fixedassets Tangibleassets
Currentassets Stocks Debtors Prepayments Cashatbankandinhand
Creditors:amountsfallingduewithinoneyear Netcurrentassets Totalassetslesscurrentliabilities Creditors:amountsfallingdueaftermorethanoneyear Capitalandreserves Calledupsharecapital Sharepremiumaccount Otherreserves Retainedprofits
£'000 220 464 6 141 831
£'000 706
(212)
NotethatunderUKGAAPinfinancialstatementsforpublicationthereislessdetailonthefaceofthe balancesheet;thedetailthatwesawearlierintheCompaniesAct2006formatisnormallyshownin notestothefinancialstatements.
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619 1,325 (200) 1,125 500 70 187 368 1,125
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Interactivequestion1:UKGAAPfinancialstatementsI
[Difficultylevel:Examstandard]
ThefollowingisanextractfromthetrialbalanceofTaffordLtd,at30September20X1: Machinery: Cost: Accumulateddepreciationat1October20X0 Motorvehicles: Cost Accumulateddepreciationat1October20X0 Stockat1October20X0 Sales Purchases Distributioncosts Administrativeexpenses Allowancefordoubtfuldebts,1October20X0 Baddebtswrittenoff 10%Debentures(issued20W9) Interestpaidondebentures Suspenseaccount
£'000 3,000 1,180 13,000 22,600 6,000 5,000 600 500
£'000 1,700 500 41,600 1,300 10,000 100
Notes (1) Closingstockat30September20X1was£15,600,000. (2) Baddebtswrittenoffandthemovementontheallowancefordoubtfuldebtsaretobeincludedin administrativeexpenses.Theallowancefordoubtfuldebtsistobereducedto£500,000. (3) Thebalanceonthesuspenseaccountisthedisposalproceedsofmotorvehicles,enteredtothe suspenseaccountpendingcorrecttreatmentintherecords. Thevehiclesweresoldon1October20X0.Theyhadcost£180,000andat1October20X0their netbookvaluewas£60,000.Thevehiclessoldwereallusedindistributingthecompany'sgoods. Anyprofitorlossistobeincludedindistributioncosts. (4) Depreciationistobeprovidedforonthestraightlinebasisasfollows: Machinery
10%
Motorvehicles
25%
C H A P T E R
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Depreciationofmotorvehiclesistobedividedequallybetweendistributioncostsand administrativeexpenses,anddepreciationofmachineryistobechargedwhollytodistribution costs. (5) Prepaymentsandaccrualsat30September20X1wereasfollows: Distributioncosts Administrativeexpenses
Prepayments £'000 200 100
Accruals £'000 100 60
(6) Theestimatedtaxchargefortheyearis£3,000,000. Requirement ForTaffordLtd'sprofitandlossaccountfortheyearended30September20X1calculatethefiguresto beincludedfor(a)costofsales,(b)distributioncosts,(c)administrativeexpensesand(d)interest payable. SeeAnswerattheendofthischapter.
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Interactivequestion2:UKGAAPfinancialstatementsII
[Difficultylevel:Examstandard]
ThefollowinginformationisavailableaboutthebalancesandtransactionsofAlpacaLtd: BALANCESAT30APRIL20X1 Fixedassets–cost –accumulateddepreciation Stocks Debtors Cashatbank Creditors Issuedsharecapital–equitysharesof£1each Retainedprofits 10%Debentures Debentureinterestowing
£'000 1,000 230 410 380 87 219 400 818 200 10
TRANSACTIONSDURINGYEARENDED30APRIL20X2 Sales Purchases Expenses Interestondebenturespaidduringyear Issueof100,000£1equitysharesatapremiumof50ppershare
£'000 4,006 2,120 1,640 20
Therewerenopurchasesordisposalsoffixedassetsduringtheyear. ADJUSTMENTSAT30APRIL20X2 (1) Depreciationof£100,000istobecharged. (2) Baddebtsof£20,000aretobewrittenoff. BALANCESAT30APRIL20X2 Stocks Debtors(beforewritingoffbaddebtsshownabove) Cashatbank Creditors
£'000 450 690 114 180
Requirement PrepareAlpacaLtd'sbalancesheetasat30April20X2underUKGAAPasfarastheinformationavailable allows,includingaworkingshowinghowtheretainedprofitsfigureinthebalancesheetiscalculated. SeeAnswerattheendofthischapter.
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SummaryandSelf-test
Summary
C H A P T E R
13
CompanyfinancialstatementsunderUKGAAP
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Self-test Answerthefollowingquestions. 1
YLtdpurchasedsomeplanton1January20X0for£38,000.Thepaymentfortheplantwas correctlyenteredinthecashbookbutwasenteredonthedebitsideofplantrepairsaccount. YLtdchargesdepreciationonthestraightlinebasisat20%perannum. HowwillY'sprofitfortheyearended31March20X0beaffectedbytheerror? A B
2
Understatedby£30,400 Understatedby£36,100
C D
Understatedby£38,000 Overstatedby£1,900
TheclosingstockofXLtdwas£116,400excludingthefollowingtwostocklines:
400itemswhichcost£4each,butwhichwereexpectedtosellfor£3each,withselling expensesof£200intotal.
200differentitemswhichhadcost£30each,butwhicharedefective.Rectificationworkwill cost£1,200,afterwhichtheycanbesoldfor£35each,withsellingexpensestotalling£300.
WhatwillappearonXLtd'sbalancesheetforstock? A B 3
£122,300 £121,900
C D
£122,900 £123,300
At1January20X0thecapitalstructureofQLimitedwasasfollows: Issuedsharecapital1,000,000equitysharesof50peach Sharepremiumaccount
£ 500,000 300,000
On1April20X0thecompanymadeanissueof200,00050psharesat£1.30each,andon1July thecompanymadea1for4bonusissue. Whichofthefollowingcorrectlystatesthecompany'ssharecapitalandsharepremiumaccountat 31December20X0? A B C D 4
Sharecapital £750,000 £875,000 £750,000 £750,000
Sharepremiumaccount £230,000 £285,000 £310,000 £610,000
WLtdboughtanewprintingmachineatacostof£80,000.Theinstallationcostswere£5,000and theemployeesreceivedtrainingonhowtouseprintingmachinesatacostof£2,000.Aregulatory testtoensurethemachinefunctionedsafelycost£1,000. Whatisthecostofthemachineinthecompany'sbalancesheet? A B
5
£80,000 £85,000
C D
£86,000 £88,000
Theelectricityaccountfortheyearended30June20X1wasasfollows. Openingbalanceforelectricityaccruedat1July20X0 Paymentsmadeduringtheyear 1August20X0forthreemonthsto31July20X0 1November20X0forthreemonthsto31October20X0 1February20X1forthreemonthsto31January20X1 30June20X1forthreemonthsto30April20X1
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£ 300 600 720 900 840
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Whichofthefollowingistheappropriateentryforelectricity? A B C D 6
Accrued at30June20X1
Chargetoprofitandlossaccount yearended30June20X1
£Nil £460 £560 £560
£3,060 £3,320 £3,320 £3,420
TheyearendofMLtdis30November20X1.Thecompanypaysforitsgasbyastandingorderof £600permonth.On1December20X0thestatementfromthegassuppliershowedthatMLtd hadoverpaidby£200.MLtdreceivedgasbillsforthefourquarterscommencingon1December 20X0andendingon30November20X1for£1,300,£1,400,£2,100and£2,000respectively. WhichofthefollowingisthecorrectchargeforgasinMLtd'sprofitandlossaccountfortheyear ended30November20X1? A B
7
£6,800 £7,000
C D
£7,200 £7,400
TeasdaleLtd,whoseyearendis31December,boughtacaron1January20X0for: £ 10,000 150 10,150
Cost Roadtax Total
Thecarwasdepreciatedat25%perannumreducingbalancethentradedinforareplacement vehicleon1January20X3atanagreedvalueof£5,000. Whatwastheprofitondisposalofthecar? A B 8
C D
£1,788 £1,836
WhichofthefollowingitemsdoesNOTappearundertheheading'reserves'onacompanybalance sheet? A B
9
£718 £781
Sharepremiumaccount Retainedprofits
C D
C H A P T E R
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Debentures Generalreserve
Whichofthefollowingstatementsregardingacompanyprofitandlossaccountiscorrect? A
TheCompaniesAct2006definestheexpenseswhicharereportedunder'costofsales'
B
'Depreciation'appearsasaseparateheadingintheprofitandlossaccount
C
Interestpayableisdeductedfromprofitaftertaxation
D
Baddebtsareincludedunderoneofthestatutoryexpenseheadings(usuallyadministrative expenses)
10 Attheendofitsfirstyearoftradingon30June20X7LindmanLtd'snetassetsare£324,854.Ithas equity25psharecapitalof£100,000issuedat50peach,andaretainedprofitsreserveof£59,854. InrelationtoLindmanLtd'sbalancesheetwhichofthefollowingstatementscouldbetrue? A B C D
Ithassharepremiumof£115,000 Ithasageneralreserveof£65,000 Ithassharecapitalof£200,000 Ithasageneralreserveof£115,000
Now,gobacktotheLearningObjectivesintheIntroduction.Ifyouaresatisfiedthatyouhaveachieved theseobjectives,pleasetickthemoff.
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AnswerstoInteractivequestions
AnswertoInteractivequestion1 TAFFORDLIMITED PROFITANDLOSSACCOUNTFORTHEYEARENDED30SEPTEMBER20X1 Turnover (a) Costofsales(W1) Grossprofit (b) Distributioncosts(W2) (c) Administrativeexpenses(W3) Operatingprofit (d) Interestpayable(10%£10,000,000) Profitbeforetaxation Taxation Profitaftertaxation
£'000 41,600 (20,000) 21,600 (6,285) (4,885) 10,430 (1,000) 9,430 (3,000) 6,430
WORKINGS (1) Costofsales Openingstock Purchases Lessclosingstock
£'000 13,000 22,600 35,600 (15,600) 20,000
(2) Distributioncosts Distributioncosts(6,000–200+100) Depreciation:machinery(10%£3,000) motorvehicles(25%½£(1,180–180)) Profitonsaleofvehicles(100–60)
£'000 5,900 300 125 (40) 6,285
(3) Administrativeexpenses Administrativeexpenses(5,000–100+60) Baddebts Reductioninallowancefordoubtfuldebts Depreciation:motorvehicles(25%½£(1,180–180))
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AnswertoInteractivequestion2 ALPACALIMITED BALANCESHEETASAT30APRIL20X2 Fixedassets Cost/Accumulateddepreciation(230+100)
Currentassets Stock Debtors(690–20) Bank LessCreditors:amountsfallingdueinlessthanoneyear Creditors Accruals(W1) Netcurrentassets LessCreditors:amountsfallingdueaftermorethanoneyear 10%Debentures
£'000 1,000
£'000 (330)
£'000 670
180 10
450 670 114 1,234 (190)
1,044 1,714 (200) 1,514
Capitalandreserves Sharecapital(400+100) Sharepremium(100×50p) Retainedprofits(W2) WORKINGS
500 50 964 1,514
£'000 10 20 30
(1) Accruals
C H A P T E R
DEBENTUREINTEREST Bank Balc/d(balfig)
£'000 20 10 30
Balb/d P+L
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(2) Retainedprofits
Balb/f Sales Openingstock Purchases Closingstock Grossprofit Expenses Depreciation Baddebtswrittenoff Debentureinterestpayable(W1) Netprofitforyear Balancec/f
£'000 410 2,120 (450) 1,640 100 20 20
£'000 4,006 (2,080) 1,926 (1,780)
£'000 818 146 964
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AnswerstoSelf-test 1
B
DEBIT CREDIT DEBIT CREDIT
Fixedassets Plantrepairs Dep'nexpense(3/1220%£38,000) Accumulateddep'n
£38,000 £38,000 £1,900 £1,900
Profitisunderstatedby£38,000–£1,900=£36,100 2
3
4
C Draftfigure Line1:(400£3)–£200 Line2:(200£35)–£300–£1,200 Finalvaluation
£ 116,400 1,000 5,500 122,900
Sharecapital@1.1.20X0 Issueon1.4.20X0(200,000@50p) Bonusissue(1.2m/4)@50p Sharecapitalasat31.12.20X0
£ 500,000 100,000 150,000 750,000
C
Sharepremium@1.1.20X0 1.4.20X0200,000shares@(130p–50p) Bonusissue(asabove)
£ 300,000 160,000 (150,000) 310,000
Costofmachine Installation Testing
£ 80,000 5,000 1,000 86,000
C
Theemployeetrainingwasgeneralandnotspecificallyrelatedtobringingtheassetintouse, soitscostcannotbeincluded. 5
C ELECTRICITYACCOUNT 20X0: 1August 1November 20X1: 1February 30June 30June
£ Paidbank 600 Paidbank 720 Paidbank 900 Paidbank 840 2 560 Accrual£840 /3 3,620
Balanceb/fwd Profitandlossa/c
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A GASSUPPLIERACCOUNT £ 200 7,200 7,400
Balanceb/fwd Bank£600x12
28February 31May 31August 30November 30November
invoice invoice invoice invoice bal.c/d
£ 1,300 1,400 2,100 2,000 600 7,400
GASACCOUNT 28February 31May 31August 30November 7
invoice invoice invoice invoice
£ 1,300 1,400 2,100 2,000 6,800
30November
Profit and loss a/c
B £ 10,000 (2,500) 7,500 (1,875) 5,625 (1,406) 4,219 (5,000) 781
Cost 20X0Depreciation25% 20X1Depreciation25% 20X2Depreciation25% 20X3Partexchangevalue Profitondisposal 8
£ 6,800 6,800
C
C H A P T E R
13
Thisiscorrectbecausedebenturesareaccountedforasliabilitiesinthefinancialstatements. AandBarestatutoryreserves,whilethegeneralreservecanbecreatedbythecompanyifits constitutionallows.
9
D
Correct,companywillusuallyincludethisunderdistributioncostsoradministrativeexpenses.
A
Incorrect,theexpensesincostofsalesarenotdefinedbystatute.
B
Incorrect,depreciationisincludedundertherelevantstatutoryexpenseheading(egoffice equipmentdepreciationgoesintoadministrativeexpenses).
C
Incorrect,profitaftertaxationiscalculatedafterinteresthasbeendeducted.
10 B £ 100,000
Sharecapital 100,000 Sharepremium 25p 25p Retainedprofitsreserve Balancingfigure Netassets
100,000 59,854 65,000 324,854
Thisfigurecouldbeageneralreserveof£65,000.
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CHAPTER14
Soletraderandpartnership financialstatementsunder UKGAAP Introduction Examinationcontext TopicList 1 Soletraderfinancialstatements 2 Partnerships 3 Preparingpartnershipaccounts 4 Accountingforchangesinpartnershipstructure SummaryandSelf-test AnswerstoInteractivequestions AnswerstoSelf-test
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Introduction
Learningobjectives
Tickoff
Recordandaccountfortransactionsandeventsresultinginincome,expenses,assets, liabilitiesandequityinaccordancewiththeappropriatebasisofaccountingandthelaws, regulationsandaccountingstandardsapplicabletothefinancialstatements
Recordandaccountforchangesintheownershipstructureandownershipinterestsinan entity
Prepareanextendedtrialbalance
Identifythemaincomponentsofasetoffinancialstatementsandspecifytheirpurpose andinterrelationship
Prepareandpresentabalancesheet,profitandlossaccountandcashflowstatement fromtheaccountingrecordsandtrialbalanceinaformatwhichsatisfiestheinformation requirementsoftheentity
Specificsyllabuslearningoutcomesare:1d,e;2c;3a,c
Syllabuslinks Youwillencountertheaccountingprinciplesrelatedtochangesinownershipstructurelaterininthe ProfessionalLevelmoduleofFinancialAccountingandReporting.
Examinationcontext Questionsonthetopicsinthischapterwillbesetasmultiplechoicequestions,someofwhichmay involvecalculationssothatthecorrectanswercanbeselected.Veryoftendoubleentryquestionsare phrasedintermsofpreparingajournal. Intheexamyoumayberequiredto:
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Manipulateopeningandclosingbalancesheetsforsoletraderstoidentifyprofitfortheyearusing theaccountingequation
UseUKGAAPterminologywhenidentifyingfiguresintheprofitandlossaccountandbalance sheetofasoletraderorpartnership
Identifytheuniquefeaturesofaccountingforgeneralpartnerships,especiallycapitalandcurrent accounts,drawings,profitsharingratios,interestoncapitalanddrawings,salaries,theprofit appropriationstatement,guaranteedshares,andloansfrompartners
Identifyfigureswhenaccountingforchangesinpartnershipstructure,includinggoodwill
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1 Soletraderfinancialstatements Sectionoverview
Soletraderfinancialstatementsaresimilarinterminologyandformattothoseofcompanies preparedunderUKGAAP,butthereareimportantdifferences.
Taxisnotincludedinsoletraderaccounts.
Therearenoformalrequirementsastoheadingsintheprofitandlossaccount.
Theownershipinteresthalfofthebalancesheetshowsopeningcapital,pluscapitalintroduced, lessdrawings,plusprofits,lesslossestoarriveattheclosingnetassetsfigureatthebalancesheet date.
Interminologysoletraderfinancialstatementsareverysimilartoaprofitandlossaccountandbalance sheetpreparedunderUKGAAPforalimitedcompany.Wheretheydifferisinrelationto:
Tax:abusinessoperatedbyasoletraderhasnolegalidentityseparatefromitsowner,sothe liabilitytopaytaxonprofitsistheowner'sandnotthebusiness's.Thismeansthatthereisnotax expenseintheprofitandlossaccount,andnotaxcreditorinthebalancesheet.
Theformatoftheprofitandlossaccount:thereisnoneedtoaggregateexpensesunderset headings.
Theownershipinteresthalfofthebalancesheet:soletradersdonothavesharecapitalor reserves.Insteadtheyshowthefollowing(thisshouldlooksimilartothecapitalpartofthe accountingequation):
£ X X X/(X) (X) X
Openingcapital=netassetsatstartofperiod Capitalintroducedintheperiod Netprofit/netlossoftheperiod Drawings(ofcash,orofstockatcost) Closingcapital=netassetsatendofperiod
Workedexample:Soletraderfinancialstatements Wastohadthefollowingtrialbalanceasat31December20X4: Owner'scapitalat1.1.X4 Bankloan Freeholdlandandbuildings Freeholdlandandbuildings–accumulateddepreciation Plantandmachinery–cost Plantandmachinery–accumulateddepreciation Stock Sales Purchases Loaninterest Wagesandsalaries Drawings Sundryexpenses Suspenseaccount Debtors Creditors Cash
£'000 430 830 190 2,152 10 254 31 113 464 141 4,615
£'000 450 613 20 222 2,695 420 195 4,615
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Thefollowingmattershavenowbeendiscovered: (a) On1January20X4Wastoinjectedafurther£190,000intothebusiness.Theonlyentrymadewas todebitcash. (b) On1January20X4anitemofplantthathadcost£350,000andonwhichdepreciationof£74,000 hadbeenchargedwasdisposedoffor£230,000.Theonlyentrymadewastodebitcash. (c) Depreciationof£36,000needstobechargedontheremainingplantandmachinery,and£5,000 onthelandandbuildings. (d) Loaninterestof£10,000shouldbeaccruedat31December20X4. (e) Stockonhandat31December20X4cost£220,000. Requirement PrepareWasto'sETB,hisprofitandlossaccountfortheyearended31December20X4andhisbalance sheetatthatdate.
Solution Wasto'sETBisasfollows: Owner'scapitalat1.1.X4 Bankloan Freeholdlandandbuildings Freeholdlandandbuildings– accumulateddepreciation Plantandmachinery–cost Plantandmachinery– accumulateddepreciation Stock Sales Purchases Loaninterest Wagesandsalaries Drawings Sundryexpenses Suspenseaccount Debtors Creditors Cash Capitalintroduced Disposals Depreciationexpense Accruals Netprofit
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Trialbalance Adjustments Debit Credit Debit Credit £'000 £'000 £'000 £'000 450 613 430 20 5 830 350 222 74 36 190 220 220 2,695 2,152 10 10 254 31 113 420 420 464 195 141 190 276 230 41 10 4,615 4,615 1,041 1,041
P&Laccount Balancesheet Debit Credit Debit Credit £'000 £'000 £'000 £'000 450 613 430 25 480 184 190 220 220 2,695 2,152 20 254 31 113 464 195 141 190 46 41 10 2,816 2,915 99 99 2,915 2,915 1,766 1,766
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WASTO:PROFITANDLOSSACCOUNTFORYEARENDED31DECEMBER20X4 Sales Costofsales Openingstock Purchases Closingstock Grossprofit Expenses Loaninterest Wagesandsalaries Sundryexpenses Lossondisposal Depreciationexpense Netprofit
£'000 190 2,152 (220) 20 254 113 46 41
£'000 2,695 (2,122) 573 (474) 99
Acc.depn. £'000 25 184 209 220 464 141 825 10 195 205
£'000 405 296 701
WASTO:BALANCESHEETASAT31DECEMBER20X4 Cost £'000 430 480 910
Fixedassets Freeholdlandandbuildings Plantandmachinery Currentassets Stock Debtors Cash Currentliabilities Accruals Creditors Netcurrentassets Non-currentliabilities Bankloan Ownershipinterest Openingcapital Capitalintroduced Profitforyear Drawings Closingcapital
620 (613) 708 450 190 99 (31) 708
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Interactivequestion1:Soletraderfinancialstatements
[Difficultylevel:Examstandard]
In20X5Wastotakesdrawingsof£40,000andends20X5withnetassetsof£850,000.Hedidnot introduceanycapitalintheyear. WhatwasWasto'snetprofitin20X5? SeeAnswerattheendofthischapter.
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2 Partnerships Sectionoverview
Apartnershipisabusinessrunbytwoormorepeopletogether;unlessitisalimitedliability partnership(LLP)itisnotaseparatelegalentitysotaxdoesnotappearintheaccounts.
Partiesagreehowtoappropriatetheprofitsmadebythebusinesseachyear.Sometimesthereare salaries,andthereisalwaysaprofitsharingratio(PSR).
Ageneralpartnershipisanarrangementbetweentwoormoreindividualsinwhichtheysharetherisks andrewardsofajointbusinessoperation,asiftheywerejointsoletraders.
Definition Partnership:Therelationshipwhichexistsbetweenpersonscarryingonabusinessincommonwitha viewofprofit. Usuallyageneralpartnershipisestablishedformallywithawrittenpartnershipagreement.However,if individualsactasthoughtheyareinpartnershipevenifnowrittenagreementexists,thenitispresumed thatapartnershipdoesexistandthatitstermsareaslaiddowninthePartnershipAct1890.
2.1 Thepartnershipagreement Apartnershipagreementcontainsthetermsofthepartnership,inparticularthefinancialarrangements betweenpartnersandhowprofit/lossshouldbeappropriated.Itshouldcoverthefollowingissues.
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Capital.Eachpartnerputsinashareofthecapital.Anyminimumfixedamountshouldbestated.
Interestoncapital.Partnerscanpaythemselvesinterestatanagreedrateonthecapitaltheyput intothebusiness.Interestoncapitalistreatedasaprofitappropriation.
Partners'salaries.Partnerscanpaythemselvessalaries.Thesearenotsalariesinthesamewaythat anemployeeofthebusinessispaidawageorsalary;partners'salariesareanappropriationof profit,andnotaprofitandlossaccountexpense.Payingsalariesgiveseachpartneranincome beforetheresidualprofitsaresharedoutinPSR.
Profit-sharingratio(PSR).Partnerscanagreetoshareresidualprofitsandlossesafterinterest andsalariesinanyprofit-sharingratiotheychoose.Forexample,threepartnersmightagreeto shareprofitsequally,butifonepartnerdoesagreatershareofthework,orhasmoreexperience andability,orputsinmorecapital,theratioofprofitsharingmightbedifferent.
Guaranteedminimumprofitshares.Partnerscanagreethatoneormorepartnersshouldgeta guaranteedminimumprofitshare,evenifthepartnershipmakesasmallerthanexpectedprofit,or aloss.Iftheamountallocatedbyusinginterestoncapital,salariesandtheprofit-sharingratio (PSR)islowerthanthis,thepartnerreceivestheguaranteedminimumprofitshareandthe remainingprofitsaresharedbetweentheotherpartnersintheprofit-sharingratio.Occasionally, onepartnerwillguaranteeanotherpartner'sminimumprofitshare.Thatpartnerwillalone makeupthedifference.
Drawings.Partnerscanwithdrawprofitsfromthebusinessjustlikesoletraders.Theycanagreeto putalimitonhowmuchtheyshoulddrawoutinanyperiod,andtheycanbechargedintereston theirdrawingsduringtheyear.Interestondrawingsistreatedasanegativeappropriationof profit.
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2.2 Appropriatingpartnershipprofit Thepartnership'snetprofitiscalculatedinthesamewayasforasoletraderusingaprofitandloss ledgeraccount,ortheETB.Wethenprepareanappropriationstatement,which:
Allocatesinterestoncapital,interestondrawings,andsalariestoeachpartner SharesouttheresidualprofitinthePSR
Workedexample:Appropriatingpartnershipprofits BillandBenarepartnerssharingprofitsinthePSR2:1,aftertheyeachtakeasalaryof£10,000peryear. Netprofitbeforedeductingsalariesis£26,000. Howmuchprofitisappropriatedtoeachpartner?
Solution First,thetwosalariesaredeductedfromprofit,leaving£6,000(£26,000–£20,000). This£6,000hastobedistributedbetweenBillandBenintheratio2:1,soBillwillreceivetwiceasmuch asBen.(£4,000:£2,000) Profitappropriationstatement Ratio Salary Shareofresidualprofits(£6,000inratio2:1) Totalprofitshare
2 1 : Bill Ben £ £ 10,000 10,000 4,000 2,000 14,000 12,000
Total £ 20,000 6,000 26,000
Interactivequestion2:Profitshare
[Difficultylevel:Examstandard]
Tom,DickandHarrywanttoshareoutnetprofitof£170,000,intheratio7:3:5.Dickgetsasalaryof £20,000pa.Howmuchwouldeachpartnerget? SeeAnswerattheendofthischapter.
2.3 Guaranteedminimumprofitshare Partnerscanagreethatoneormorepartnerswillreceiveaminimumappropriationofprofit,evenif thebusinessmakesaloss,oronepartnerisappropriatedalosswhiletheotherstakealltheprofit.
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Workedexample:Guaranteedminimumprofitshare Sita,NishaandZeldashareprofitsintheratioof2:2:1butZeldahasaguaranteedminimumprofitof £18,000.Thenetprofitfortheyearis£75,000. Thesumoftheratio'parts'is2+2+1=5.Eachpartisworth£15,000soifwejustusedthePSRthe profitswouldbeallocatedasfollows: Ratio Initialprofitshare
2 : Sita £ 30,000
2 : Nisha £ 30,000
1 Zelda £ 15,000
Total £ 75,000
However,thisleavesZeldawithlessthanherguaranteedminimum,soafurtherreallocationofprofitsis madefromtheothertwopartnersequally,becausetheyshare2:2,togivehertheminimumamount.
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Ratio PSR Reallocation(2:2) Totalprofitshare
2 Sita £ 30,000 (1,500) 28,500
:
2 : 1 Nisha Zelda £ £ 30,000 15,000 (1,500) 3,000 28,500 18,000
Total £ 75,000 0 75,000
Interactivequestion3:Profitappropriation
[Difficultylevel:Examstandard]
Anna,BrianandClarehaveaprofit-sharingratioof3:2:1,withClaredueasalaryof£8,000.Brianhasa minimumprofitshareof£16,000guaranteedbyAnna.Thepartnershipmadeaprofitof£26,000inthe year. Howmuchprofitwillbeappropriatedtoeachpartner? SeeAnswerattheendofthischapter.
3 Preparingpartnershipaccounts Sectionoverview
Eachpartner'sinterestinthepartnershipisshowninacapitalaccountandacurrentaccount.
Ifapartnerhasmadealoantothepartnership,thisistreatedthesameasathirdpartyloan,with interestdeductedbeforearrivingatnetprofit.Interestmaybecreditedtothepartner'scurrent accountratherthanbeingpaidincash.
Aprofitappropriationstatementisusedasaworkingtoappropriatesalaries,interestoncapital, interestondrawingsandresidualprofitsharetoeachpartner.
3.1 Howdoesaccountingforpartnershipsdifferfromaccountingforsole traders? Partnershipaccountsareidenticalinmanyrespectstotheaccountsofsoletraders. (a) Assetsandliabilitiesarelikethenetassetsofanyotherbusiness,andareaccountedforinthesame way.Evenwherealoantoapartnershipcomesfromapartner,thisisaccountedforasifitwerea thirdpartyloan,inthetophalfofthebalancesheet. (b) Netprofitiscalculatedinthesamewayasthenetprofitofasoletrader.Ifapartnermakesaloan tothebusiness(asdistinctfromacapitalcontribution)theninterestontheloanisanexpensein theprofitandlossaccount,inthesamewayasinterestonanyotherloanfromathirdparty. (c) Justlikeasoletradertaxdoesnotappearinpartnershipaccounts. Therearetworespectsinwhichpartnershipaccountsaredifferent,however. (a) Theownershipinterestofeachpartnermustbeshown. (b) Thenetprofitmustbeappropriatedbetweenthepartnersandshownintheaccounts.
Definition Appropriationofprofit:Sharingoutprofitsinaccordancewiththepartnershipagreement.
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3.2 Accountingforeachpartner'sownershipinterest
Initialcapitalcontributionsarerecordedincapitalaccountsforeachpartner.(Sinceeachpartneris ultimatelyentitledtorepaymentofcapitalitisclearlyvitaltokeeparecordofhowmuchisowed towhom.)
Profitsandlossesappropriatedovertime,lessdrawings,areshowninacurrentaccountforeach partner.
Definition Currentaccount:Arecordoftheprofitsretainedinthebusinessbythepartner. Acurrentaccountincreaseswhenthepartnershipmakesprofits,anddecreaseswhenthepartnermakes drawings,orwhenthepartnershipmakesaloss. Differencesbetweencapitalandcurrentaccountsareasfollows.
Thebalanceonthecapitalaccountremainsstaticfromyeartoyear(withoneortwoexceptions).
Thebalanceonthecurrentaccountiscontinuallyfluctuatingupanddown,asthepartnership makesprofitsandlosseswhicharesharedoutbetweenthepartners,andaseachpartnertakesout drawings.
Ifthepartnershipagreementprovidesforinterestoncapital,partnersreceiveinterestonthebalancein theircapitalaccount,butnotonthebalanceontheircurrentaccount. Iftheamountofapartner'sdrawingsexceedsthebalanceonhis/hercurrentaccount,thecurrent accountwillshowadebitbalancebroughtforwardatthebeginningofthenextperiod. Theownershipinterestsideofthepartnershipbalancesheetwillthereforeconsistof:
Capitalaccountsforeachpartner. Currentaccountsforeachpartner.
3.3 Accountingforloansbypartners Apartnermakingaloantothepartnershipbecomesitscreditor.Onthebalancesheettheloanisshown separatelyasalongtermliability(unlessrepayablewithintwelvemonths,inwhichcaseitisacurrent liability).Interestontheloanisadeductionfromprofittoarriveatnetprofit,notan appropriationofprofit.Interestispayableat5%. Interestonpartners'loansisusuallycreditedtothepartner'scurrentaccountasthisis administrativelymoreconvenient,especiallywhenthepartnerdoesnotparticularlywanttobepaidthe loaninterestincashimmediatelyitbecomesdue.
C H A P T E R
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3.4 Accountingforappropriationofnetprofit/loss ThenetprofitofapartnershipissharedoutinthePSRinanappropriationaccount,whichfollowson fromtheprofitandlossledgeraccountitself. Theaccountingentriesforanindividualshareofprofitsforeachpartnerare: (a) DEBIT CREDIT
P&Lledgeraccountwithnetprofitc/d P&Lappropriationaccountwithnetprofitb/d
(b) DEBIT CREDIT
P&Lappropriationaccount Thecurrentaccountsofeachpartner
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Thestepstotakeareasfollows.
Step1 Establishthenetprofit,afterdeductinginterestonloansfrompartners.
Step2 Appropriateinterestoncapitalandsalariesfirst.Theseitemsareappropriationsofprofitanddonot appearintheP&Laccount.
Step3 Chargepartnersinterestontheirdrawingswhererelevant.
Step4 ResidualprofitsaresharedoutbetweenpartnersinthePSR.
Step5 Eachpartner'sshareofprofitsiscreditedtohis/hercurrentaccount. Thecalculationsinvolvedinsteps2to4aremadeinaprofitappropriationstatement. Inpracticeeachpartner'scapitalaccountwillbeaseparateledgeraccount,aswilltheircurrentaccount, buttheexampleswhichfollowuseacolumnarformtoshowhowitworks.
Workedexample:Partnershipaccounts Locke,NieceandMunsterareinpartnershipandshareprofitsintheratio3:2:1.Theyalsoagreethat: (a) Allthreeshouldreceiveinterestat12%oncapital. (b) Munstershouldreceiveasalaryof£6,000perannum. (c) Interestwillbechargedondrawingsattherateof3%(afullyearchargedonanydrawingsinthe year). (d) Theinterestrateonthe£6,000loanfromLockeis5%. Theircapitalandcurrentaccountsasat1January20X5areasfollows: Capitalaccountsasat1.1.X5 Locke Niece Munster Currentaccountsasat1.1.X5 Locke Niece Munster Drawingsmadeduringtheyearto31December20X5were: Drawingsin20X5 Locke Niece Munster
£ 20,000 8,000 6,000 9,500 3,300 8,800 (6,000) (4,000) (7,000)
£ 34,000 21,600
(17,000) 38,600
Thenetprofitfortheyearto31December20X5was£24,870beforedeductingloaninterest. Requirement Prepareaprofitandlossappropriationstatementfortheyearto31December20X5,andthepartners' capitalaccountsandcurrentaccountsatthatdate.
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Solution TheinterestpayabletoLockeonhisloanis: 5%of£6,000=£300 ThisisdebitedtonetprofitintheprofitandlossaccountandcreditedtoLocke'scurrentaccount.Asa result,theprofittobeappropriatedis: £ 24,870 (300) 24,570
Draftnetprofit Interest Theinterestpayablebyeachpartnerontheirdrawingsduringtheyearis: Locke Niece Munster
£ 180 120 210 510
3%of£6,000 3%of£4,000 3%of£7,000
LOCKE,NIECEANDMUNSTER:PROFITAPPROPRIATIONSTATEMENT 3: Locke £ (180) 2,400 7,500 9,720
Ratio Interestchargedondrawings Salary Interestoncapital 12%£20,000 12%£8,000 12%£6,000 Shareofresidualprofit:(24,570+510– 6,000–4,080)=£15,000in3:2:1ratio Totalprofitshare
2: Niece £ (120) 960 5,000 5,840
1 Munster Total £ £ (210) (510) 6,000 6,000 720 4,080 2,500 15,000 9,010 24,570
PARTNERS'CURRENTACCOUNTS Drawings Balc/d
Locke £ 6,000 13,520 19,520
Niece £ 4,000 5,140 9,140
Munster £ 7,000 10,810 17,810
Balb/d Interest Profitshare
Locke £ 9,500 300 9,720 19,520
Niece £ 3,300 5,840 9,140
Munster £ 8,800 9,010 17,810
PARTNERS'CAPITALACCOUNTS
Balanceb/d
Locke £ 20,000
Niece Munster £ £ 8,000 6,000
C H A P T E R
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3.5 PartnershipaccountsontheETB TheETBcanbeusedtohelppreparepartnershipaccounts.ThedifferencestosoletraderETBsareas follows:
Accruedinterestonapartner'sloanisaccountedforintheadjustmentscolumnandincludedin thecross-casts,sothenetprofitfigureinthedebitcolumnoftheprofitandlossaccountisthen theamounttobeappropriated DEBIT CREDIT
Interestexpense Currentaccount
£X £X
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Eachpartner'sdrawingsaretransferredintheadjustmentscolumnsfromthedrawingsaccountsto thecurrentaccount DEBIT CREDIT
Currentaccounts Drawingsaccounts
£X £X
Theprofitappropriationstatementispreparedasaseparateworking,theneachpartner'stotal profitshareisaccountedforasfollows DEBIT CREDIT
Profitandlossaccount Currentaccounts(balancesheet)
£X £X
Workedexample:PartnershipaccountsontheETB FrankandMyraareinpartnershipsharingprofits2:1.Eachpartnerhasanannualsalaryof£6,750. Frank'sloantothepartnershipattractsinterestat5%perannum.Theirtrialbalanceat30June20X4is asfollows LoanfromFrank Fixedassets–NBV Stockat1July20X3 Debtors Creditors Sales Purchases Loaninterest Expenses Drawings Frank Myra Cash Capitalaccounts Frank Myra Currentaccountsat1July20X3 Frank Myra Youaretoldthatclosingstockcost£16,500. Requirement PrepareFrankandMyra'sextendedtrialbalanceat30June20X4.
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Debit £ 100,000 15,000 18,000 52,000 12,500 14,000 15,000 6,300 232,800
Credit £ 20,000 14,000 85,000 20,000 20,000 38,400 35,400 232,800
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Solution Weprocesstheadjustmentforinterestandthetransferofdrawingsasabove,thenmaketheadjustment forclosingstock.NextweextendtheETBtocalculatethenetprofitforappropriation: LoanfromFrank Fixedassets–NBV Stock Debtors Creditors Sales Purchases Loaninterest Expenses Drawings Frank Myra Cash Capitalaccounts Frank Myra Currentaccounts Frank Myra Netprofitfor appropriation
Trialbalance Debit Credit £ £ 20,000 100,000 15,000 18,000 14,000 85,000 52,000 12,500 14,000 15,000 6,300 20,000 20,000 38,400 35,400 232,800 232,800
Adjustments Debit Credit £ £ 16,500 16,500 1,000 14,000 15,000 14,000 1,000 15,000 46,500 46,500
P&Laccount Balancesheet Debit Credit Debit Credit £ £ £ £ 20,000 100,000 15,000 16,500 16,500 18,000 14,000 85,000 52,000 1,000 12,500 6,300 20,000 20,000 21,000 101,500 101,500
PROFITAPPROPRIATIONSTATEMENT Ratio Salaries PSR(2:1) Totalprofitshare
2 Frank £ 6,750 5,000 11,750
1 Myra £ 6,750 2,500 9,250
Total £ 13,500 7,500 21,000
ThefinalETBisasfollows: LoanfromFrank Fixedassets–NBV Stock Debtors Creditors Sales Purchases Loaninterest Expenses Drawings Frank Myra Cash Capitalaccounts Frank Myra Currentaccounts Frank* Myra** Appropriatednet profit Frank Myra
Trialbalance Debit Credit £ £ 20,000 100,000 15,000 18,000 14,000 85,000 52,000 12,500 14,000 15,000 6,300 20,000 20,000 38,400 35,400 232,800 232,800
Adjustments Debit Credit £ £ 16,500 16,500 1,000 14,000 15,000 14,000 1,000 15,000 46,500 46,500
P&Laccount Balancesheet Debit Credit Debit Credit £ £ £ £ 20,000 100,000 15,000 16,500 16,500 18,000 14,000 85,000 52,000 1,000 12,500 6,300 20,000 20,000 37,150 29,650 11,750 9,250 101,500 101,500 140,800 140,800
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* Frank'scurrentaccountbalanceis38,400–14,000+1,000+11,750=37,150 ** Myra'scurrentaccountbalanceis35,400–15,000+9,250=29,650 Theprofitandlossaccountforthepartnershipwillbepresentedasforsoletraders.Thebalancesheetis asfollows: FRANKANDMYRA BALANCESHEETASAT30JUNE20X4 £ 16,500 18,000 6,300 40,800 (14,000)
Fixedassets Currentassets Stock Debtors Cash Currentliabilities Creditors Netcurrentassets Non-currentliabilities LoanfromFrank Capitalaccounts Frank Myra Currentaccounts Frank Myra
£ 100,000 26,800 (20,000) 106,800 20,000 20,000 37,150 29,650 106,800
4 Accountingforchangesinpartnershipstructure Sectionoverview
Whenapartnerdiesorretires,theremainingpartiesnormallycarryonthebusiness,buyingout thedepartingpartner'sshareofthenetassets,includinggoodwill.
4.1 Retirementordeathofapartner Anychangesinapartnershiprequireanewagreement.Unlesstheagreementspecificallystates otherwise,legallytheoldpartnershipisdissolvedandanewpartnershipiscreated.However,froman accountingviewpoint,itismorerealistictotreatthepartnershipascontinuingbutwithachangeinthe partnersandthePSR. Ontheretirementordeathofapartner,weneedto:
CalculatetheprofitsuptothedateofchangeandappropriatethemaccordingtotheoldPSR. AppropriatetheprofitsafterthedateofchangeaccordingtothenewPSR.
Workedexample:Retirement ReturningtotheexampleofLocke,NieceandMunster,assumethatLockeretiredon30September 20X5andNieceandMunsterdecidedtocontinuethepartnershiponthesametermsasbefore,but withaPSRof1:1.Locke'sdrawingsof£6,000weretakenintheperiodto30September20X5and Locke'sloanremainedwiththepartnershipafterhisretirement.
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Requirement Preparetherelevantprofitappropriationstatementsfortheyearto31December20X5.
Solution Weneedtotreattheaccountingyearasbeingintwosections: (a) Periodto30September20X5(9months),withpartnersLocke,NieceandMunster. (b) Periodfrom1Octoberto31December20X5(3months),withpartnersNieceandMunster. Uptothedateofretirementtheprofittobeappropriatednetofinterestis£24,5709/12=£18,427, sincetheloanwasnotrepaidatretirementandwecanassumethatinterestaccruesevenlyoverthe year. Locke,NieceandMunster:Profitappropriationstatement Ratioto30September20X5 Interestchargedondrawings(9/12forN&M) Salary9/12 Interestoncapital 12%£20,0009/12 12%£8,0009/12 12%£6,0009/12 Shareofresidualprofit:(18,427+428– 4,500–3,060)=£11,295in3:2:1ratio Totalprofitshare
3: Locke £ (180) 1,800 5,648 7,268
2: Niece £ (90) 720 3,765 4,395
1 Munster £ (158) 4,500 540 1,882 6,764
Total £ (428) 4,500 3,060 11,295 18,427
FromLocke'sretirementtheprofittobeappropriatednetofinterestis£24,5703/12=£6,143. Ratiofrom30September20X5 Interestchargedondrawings(3/12) Salary3/12 Interestoncapital 12%£8,0003/12 12%£6,0003/12 Shareofresidualprofit:(6,143+82–1,500–420) =£4,305in1:1ratio Totalprofitshare
1: Niece £ (30) 240 2,152 2,362
1 Munster £ (52) 1,500 180 2,153 3,781
Total £ (82) 1,500 420 4,305 6,143
C H A P T E R
4.2 Goodwillinthepartnershipaccounts Usuallyonapartner'sretirementordeathavaluationofthepartnership'snetassetsiscarriedout,or thepartnerssimplyagreethataswellasashareoftheprofitstothedateofretirementtheretiring partnershouldalsotakeashareinthepartnership'sgoodwill,intheformofasettlementincashor otherassetsfromtheotherpartners.Oncethepartnerhasgonethegoodwillisthenremovedfromthe accounts.
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Theprinciplesbehindhowweaccountforretirementordeathofapartnerwhenthereisasettlement whichincludesrecognitionofthevalueofthepartnership'sgoodwillarethesameasweusedwhen convertingandsellingasoletrader'sbusiness. Intheexamplethatfollowswecombineeachpartner'scapitalandcurrentaccountsforeaseof explanation.
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Workedexample:Deathofapartner George,AmandaandHenryhavebeeninpartnershipformanyyears,sharingprofitsequallyand preparingaccountsto31Decembereachyear.Asat1January20X2eachpartner'scombinedcapital andcurrentaccountswereasfollows: £ 138,540 95,400 125,950 359,890
George Amanda Henry
During20X2thepartnershipmadeprofitsof£584,580andeachpartnertookdrawingsof£50,000. On31December20X2Henrydied.Theremainingpartnersvaluegoodwillat£300,000atthatdate, butdonotwishthisvaluationtoremainintheaccounts.GeorgeandAmandawillcontinuein partnership,sharingprofitsequally.
Solution Henry'sestateisentitledtoreceivepaymentforhisownershipofashareinthepartnership.WhenHenry diestherearetwooptions:
BreakupthepartnershipbysellingalltheassetsandsharingoutthenetproceedsamongGeorge, AmandaandHenry'sestate.
A'buyout'ofHenry'sshareofthepartnershipbyGeorgeandAmanda
Thepartieshaveagreedonthesecondoption,butneedtodeterminehowmuchHenry'sshareisworth, andthereforehowmuchhisestateshouldbepaidasconsideration. Itispossibletodeterminehowmuchtheremainingpartnerswillneedtopaysimplybyusingthe capital/currentaccounts. (a) (b) (c) (d) (e)
Appropriateprofits(£584,580/3=£194,860each) ShareoutthegoodwillinoldPSR:£300,000/3=£100,000each CalculatetheamountHenry'sestatewillbepaidincash,beingthebalancingfigureontheaccount RemovethegoodwillinthenewPSR:£300,000/2=£150,000each Carrydownthebalancesontheremainingtwopartners'accounts PARTNERS'CAPITALANDCURRENTACCOUNTS
George Amanda £ £ Drawings 50,000 50,000 Cash(balfig)(c) Goodwill(d) 150,000 150,000 Balc/d(e) 233,400 190,260 433,400 390,260
Henry £ 50,000 370,810 420,810
George Amanda £ £ Balb/d 138,540 95,400 Profitshare(a) 194,860 194,860 Goodwill(b) 100,000 100,000 433,400 390,260
Henry £ 125,950 194,860 100,000 420,810
Toprovethesecalculationsarecorrectwecanreconstructthebalancesheetafterthepaymenthasbeen made: Openingnetassets=totalofthethreecapital/currentaccountsat1.1.X2 Addnetprofitfortheyear Lessdrawings(3£50,000) Closingnetassetsat31.12.X2 LesscashpaidtoHenry'sestate
George'scapital/currentaccount Amanda'scapital/currentaccount
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£ 359,890 584,580 (150,000) 794,470 (370,810) 423,660 233,400 190,260 423,660
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4.3 Admissionofapartner Whenanewpartnerisadmitted,anewagreementisneededtocovertheappropriationofprofits. Ifthenewpartnerintroducesadditionalcapitalintothepartnership,thetotalamounttheybringin mustbecreditedtotheircapitalaccount. Theexistingpartners'shareofthepartnership'sgoodwillatthedateofadmissioniscreditedtothemin theoldPSRandthen(assumingtheydonotwishtoretaingoodwillintheaccounts)debitedinthenew PSR.Theresultisthatthenewpartnerwillbeshowntohavepurchasedashareofthegoodwillby introducingcash.
Workedexample:Admissionofapartner OilandGrease,equalpartnersinavehiclerepairbusiness,agreetoDetergentbecomingapartneron 1January20X1.AtthatdateOilandGreasevaluethebusiness'sgoodwillat£5,000andtheircapitals areOil–£12,000;Grease–£9,000.Detergentagreestointroduce£2,000capital.Thepartnersagreeto shareprofitsintheratio–Oil2:Grease2:Detergent1,andnottoretaingoodwillintheaccounts. Thepartners'capitalaccountsareasfollows,showingthat£1,000ofDetergent'scashintroducedhas actuallybeenpaidinequalsharestoOilandGreaseinrespectoftheirsharesofthebusiness'sgoodwill: CAPITALACCOUNTS Ratio
2: 2: 1 1: 1 Oil Grease Detergent Oil Grease Detergent £ £ £ £ £ £ Balancesb/d 12,000 9,000 GoodwillinnewPSR 2,000 2,000 1,000 GoodwillinoldPSR 2,500 2,500 Balancesc/d 12,500 9,500 1,000 Cashintroduced 2,000 14,500 11,500 2,000 14,500 11,500 2,000
C H A P T E R
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SummaryandSelf-test
Summary(1/2)
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Self-test Answerthefollowingquestions. 1
A,BandCareinpartnershipwithaprofitsharingratioof3:2:1.Fortheyearended31.12.X9,the partnershipprofitsare£18,000.WhatisB'sshareoftheprofits? A B C D
2
Madrohadnetassetsof£35,000at1January20X8,andthesegrewby£22,500intheyear.He tookdrawingsof£14,000andmadeanetprofitof£23,900.HowmuchcapitaldidMadroinjectin theyear? A B C D
3
£30,000 £44,730 £74,730 £117,030
Rene,HughieandPaularepartnerssharingprofit4:3:1.Paulgetsasalaryof£12,000.Hughie retires3monthsinto20X4.In20X4aprofitof£67,040ismade.Howmuchprofitisappropriated toHughiewhenheretires? A B C D
6
£0 £10,000 £12,500 £17,500
Pam'scapitalaccountis£10,000attheendof20X3,andherpartnerMike'sis£20,000.Their currentaccountsare£27,820and£16,910respectively.In20X3thepartnershipmadeanetprofit of£42,300.Whatareitsnetassetsattheendof20X3? A B C D
5
£9,900 £12,600 £67,400 £102,400
Serkocommencedtradingasasoletraderin20X6andmadeaprofitof£20,000inthatyear.He madeanetprofitof£50,000in20X7.Hehascalculatedthattaxat25%isdueonthe20X7profit. Serkotookdrawingsof£40,000in20X7.WhatisthetaxchargeinSerko'sprofitandlossaccount for20X7? A B C D
4
£3,000 £6,000 £9,000 £18,000
£5,160 £6,285 £6,880 £20,640
Sarahhasaminimumprofitshareof£10,000guaranteedbyRichard.Oninitialappropriation Sarahisallocated£8,000andRichardisallocated£16,000.WhatisRichard'sfinalappropriationof profit? A B C D
£10,000 £14,000 £16,000 £18,000
Now,gobacktotheLearningObjectivesintheIntroduction.Ifyouaresatisfiedthatyouhaveachieved theseobjectives,pleasetickthemoff.
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AnswerstoInteractivequestions
AnswertoInteractivequestion1 £'000 708 0 182 (40) 850
Openingcapital Capitalintroducedintheperiod Netprofitoftheperiod(balancingfigure) Drawings Closingcapital=netassets
AnswertoInteractivequestion2 Tom,DickandHarry:Profitappropriationstatement Ratio Salary Shareofresidualprofit((£170,000–£20,000)in 7:3:5PSR) Totalprofitshare
7: Tom £ 0 70,000 70,000
3: Dick £ 20,000 30,000 50,000
5 Harry £ 0 50,000 50,000
Total £ 20,000 150,000 170,000
2: Brian £ 0 6,000 6,000 10,000 16,000
1 Clare £ 8,000 3,000 11,000 0 11,000
Total £ 8,000 18,000 26,000 0 26,000
AnswertoInteractivequestion3 Anna,BrianandClare:Profitappropriationstatement Ratio Salary Shareofresidualprofit(£26,000–£8,000)in 3:2:1 Initialprofitshare ReallocationfromAnnatoBrian Totalprofitshare
3: Anna £ 0 9,000 9,000 (10,000) (1,000)
C H A P T E R
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AnswerstoSelf-test £18,000 =£3,000.B'sshareis,therefore,£6,000. 6
1
B
Each'share'isworth
2
B
35,000+23,900–14,000–(35,000+22,500)
3
A
Asthebusinessisasoletradership,notaxchargeortaxliabilitywillappearinthefinancial statements
4
C
(10,000+20,000+27,820+16,910)=£74,730.Weignorethenetprofitfigureaswehave beengiventheyear-endcapitalandcurrentaccountfigures,afterappropriation.
5
A
(67,040 – 12,000) / 4 3=£5,160 (4 3 1)
6
B
16,000–(10,000–8,000)=£14,000
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A Accounting,3 Accountingconcepts,9 Accountingconceptsanddepreciation,259 Accountingequation,35 Accountingforappropriationofnetprofit/loss, 375 Accountingforchangesinpartnership structure,380 Accountingforcompanies,294 Accountingfordebtcapital,300 Accountingfordepreciation,267 Accountingfordiscounts,96 Accountingfordisposalsofnon-currentassets, 272 Accountingforirrecoverabledebtsand receivablesallowances,220 Accountingforloansbypartners,375 Accountingforpart-exchangedisposals,273 Accountingforpayables,144 Accountingforpurchasedgoodwill,279 Accountingforreceivables,140,217 Accountingfortax,302 AccountingforVAT,98,99 Accountingforwages,147 Accountingpolicies,304 Accountingpoliciesnote,304 Accountingstandards,12 Accrualbasisofaccounting,16 Accruals,45,233 Accrualsconcept,42 Accruedexpenses,51 Accumulateddepreciation,46,260,267 Adaptability,8 Additionaldisclosures,15 Additionalinformation,5 Adjustmentjournals,114 Adjustmentofprofitsforerrors,163 Administrativecosts,52 Administrativeexpenses,306 Admissionofapartner,383 Allowanceforreceivables,217,220,307 Amortisation,280,351 ApplyingIASs,15 Appropriatingpartnershipprofit,373 Appropriationaccount,375 Appropriationofprofit,37,53,374 ASB,347 Asset,15,33,45 Assetregister,277 Automatedpaymentsandreceipts,153 AVCO(averagecost),195
B Baddebt,220,349 Balancebroughtdown,119 Balancesheet,7,15 Balancesheetequation,35
Balancesheetpreparation,48 Balancingandagreeingcontrolaccountswith thememorandumledgers,149 Balancingledgeraccounts,113 Bankaccount,68 Bankcharges,153 Bankinterest,153 Bankloan,34 Bankreconciliation,153,154 Bankstatement,152 Bonusissue,299 Booksoforiginalentry,66 ‘Breakup’value,16 Businessentertaining,100 Businessentityconcept,18,35,42
C Calculatingdepreciation,260 Called-upsharecapital,295,308 Capital,35,372 Capital(soletrader),44 Capitalaccount,118 Capitalexpenditure,20 Capitalexpense,271 Capitalincome,21,271 Capitalintroduced,369 Capitaltransactions,21 Capitalisationissue,299 Carriage,193 Carrieddown,119 Carryingamount,46,260,271 Cash,33,47,324 Cashaccounting,17 Cashaccountingbasisofaccounting,17 Cashatbankaccount,152 Cashbook,68,152 Cashdiscount,97,305 Cashequivalents,324 Cashfloat,71 Cashflowstatement,7,8,323 Cashflows,324 Cashflowsfromfinancingactivities,324 Cashflowsfrominvestingactivities,324 Cashflowsfromoperatingactivities,324 Cashgeneratedfromoperations directmethod,325 indirectmethod,325 Changeinresidualvalue,266 Changeinusefullife,266 Changingcarryingamount,265 Changingthedepreciationmethod,264 Chargefordepreciation,260 Closingcapital,369 Closinginventory,185 Commissionerrors,114 CompaniesAct,12 Companylaw,347 Company’sfinancialposition,7 Comparability,13,259
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Comparativefigures,304 Compensatingerrors,114,159 Completesetoffinancialstatements,7 CompliancewithIASs,15 ConceptualFramework,3,12,14,33,35,37 ConceptualFrameworkforFinancialReporting, 13 Confidentiality,10 Consistency,13,259 Consistencyofpresentation,18 Continuousinventoryrecords,191 Contra,144 Controlaccount,96,139 Conversioncosts,193 Conversionorsaleofapartnershiptoa company,323 Correctingerrors,159 Costofanon-currentasset,257 Costofinventories,193 Costofmanufacturedgoods,194 Costofpurchase,193 Costofsales,51,179,185,306 Countinginventories,191 Creditbalance,113 Creditentry,84 Creditnote,64,65 Credittransactions,39,64 Creditor,34,40,350 Credits,113 Cumulativeweightedaveragecosting,197 Cumulativeweightedaveragepricing,196 Currentaccount,375 Currentasset,33,45,47 Currentliabilities,44,45,351 Currentmarketvalue,293 Customers,6
D Daybookanalysis,93 Daybooks,66 Debitbalance,113 Debitentry,84 Debitnote,65 Debits,113 Debitsandcredits,84 Debtcapital,295 Debtor,33,34,40,349 Deferreddevelopmentexpenditure,351 Deliverynote,63 DeparturesfromIASs,15 Deposit,242 Depreciation,20,46,258 Depreciationcharge,267 Directlyattributablecosts,257 Directorsreport,349 Disclosurerequirementsforsharecapital,308 Discount,89,96 Discountreceived,70,97 Discountsallowed,70,98,306
392
Discountsinthecashbook,70 Discountsreceived,51,306 Dishonouredcheque,144,153,216 Disposalsledgeraccount,272 Disposingofnon-currentassets,270 Distributioncosts,51,306 Dividend,293 Doubleentrybookkeeping,83,114 Doubleentryforcashtransactions,85 Doubleentryforcredittransactions,87 Doubleentryfordiscounts,89 Doubleentryforpettycashtransactions,92 Doubtfulreceivables,217 Drawings,37,38,53,369,372 Dualeffect,83 Dualityconcept,83
E Economicdecisions,4,14 Economiclife,258,351 Economicresources,7 Employees,6 Enhancementexpenditure,257,263 Enhancingqualitativecharacteristics,13 Entity,3 Entityconcept,35 Entriesinreceivables/payablescontrol accounts,144 Equity,7,15,35 Equity(company),44 Equityshare,294 Errorofomission,158 Errorofprinciple,158 Errorsofcommission,158 Errorsofomission,158 Errorsofprinciple,114 ETB,164,189,223,244,270,275,373 Expectedsellingprice,191 Expenses,15,37 Extendedtrialbalance(ETB),116,124
F Fairpresentation,15 Faithfulrepresentation,12,13 FIFO(firstin,firstout),195 Financecosts,52,300,307 Financialposition,7,43 Financialstructure,7 Finishedgoods,193 Fixedasset,34,349,351 Fixedassetnote,351 Fixturesandfittings,33 Formatofajournalentry,90 Formatofaledgeraccount,82 Formatoftheprofitandlossaccount,369 Framework,6,8 Freeholdland,46,258 Fundamentalassumptions,14
Accounting
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Fundamentalprinciplesofprofessionalethics, 11 Fundamentalqualitativecharacteristics,13 Futurecashflows,14
G GAAP,12,347 Generalpurposefinancialstatements,14 Generalreserve,297 Generatecash,4 Goingconcern,16 Goodsreceivednote,63 Goodwill,45,278,351 Goodwillinthepartnershipaccounts,381 Governments,6 Grosspay,73 Grossprofit,50,180,185 Grossprofitmargin,51 Grossprofitpercentages,199 Guaranteedminimumprofitshare,372,373
Interestoncapital,372 Interestonpartners’loans,375 Interestpayable,350 Interestreceived,306 InternationalAccountingStandardsBoard,3,5 Inventories,184 Inventory,33,179,181 Inventorycount,191 Inventorydrawings,200 Inventorywrite-offs,200 Inventorywrittenoff,181 Investment,46 Investmentsheldforthelongterm,280 Investors,6 Invoices,64 Irrecoverabledebt,144,215,220,306 IrrecoverableVAT,99 IrrecoverableVAToncars,257 Irredeemablepreferenceshares,295 Issueprice,293 Issuedsharecapital,295
J
H Historicalcost,19,36,191 HMRevenueandCustoms(HMRC),5,45,48, 65
I (IAS1)PresentationofFinancialStatements,4, 7,12,14 IAS,5,34 IAS1format,43,48,303 IAS2Inventories,184 IAS37Provisions,ContingentLiabilitiesand ContingentAssets,301 IAS7CashFlowStatements,323 IAS8,259 IASB,3 IASBFrameworkforthePreparationand PresentationofFinancialStatements,305 IASs,5,34 ICAEWCodeofEthics,11 IFACCodeofEthics,10 IFRS,5 IFRS5Non-currentAssetsHeldforSaleand DiscontinuedOperations,257 Impairment,266 Imprestsystem,72,92 Income,15,37,305 Indirectmethod,324 Initialtrialbalance,116 Inputtax,99 Insuranceclaimproceeds,306 Insuranceclaims,51 Intangiblefixedassets,351 Intangiblenon-currentassets,46,278 Integrity,10
Journal,74,90 Journalentries,159 Journalentriestocorrecterrors,91 Judgement,9
L Landandbuildings,33 Ledgeraccountingforinventories,185 Ledgeraccounts,81 Legislation,9 Lenders,6 Liability,15,33,44,301 LIFO(lastin,firstout),195 Limitedcompanies,293 Limitedliabilitycompanies,3,34 Liquidity,8 Listingrequirements,347 Loan,41,44 Loanstock,45,300,307 Long-termassets,20 Long-termborrowings,308 Loss,37 LowerofcostandNRV,192
M Majoroverhaul,257 Marginonsales,199 Mark-uponcost,199 Matching,42 Material,18 Materiallossofinventoryduringtheyear,200 Materiality,13 Materialityandaggregation,18
Index
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Measurementbasis,304 Methodsofdepreciation,261 Motorvehicles,33
N Netassets,37,43 Netbookvalue,349,351 Netpay,73 Netprofit,50,53 Netrealisablevalue,16,182,191 NIcontributions,73 Nominalledger,81 Nominalvalue,293 Non-currentassets,33,45 Non-currentassetsnote,281,307 Non-currentliability,44,300,308,351 Not-for-profitentities,6 NRV,192
O Objectiveoffinancialstatements,3,14 ObjectiveofIAS1,14 Objectivity,10 Omissionerrors,114 Omissionoftransaction,114 Openingandclosingstocks,185 Openingbalances,119 Openinginventory,185 Ordinaryshares,293,294 Otherpayables,45 Otherreceivables,48,307 Outputtax,99 Overdraft,34,45 Over-provision,302
P Paidupcapital,295 Parvalue,293 Partcompleteditems,193 Part-exchange,273 Part-exchangevalueoftheoldasset,258 Partners’salaries,372 Partnership,3,34,372 PartnershipaccountsontheETB,377 PartnershipAct1890.,372 Partnershipagreement,372 Patent,46,280 Patentrights,351 Payable,34,40,87 Payablescontrolaccount,139 Payablesledger,95 PAYE/NIC,303 Payingforanon-currentasset,258 Payroll,73 Pensioncontributions,73 Personalaccounts,94,139
394
Pettycashbook,72 Pettycashimprestsystem,92 Physicallife,258 Plantandmachinery,33 Predictingtheentity’sfuturecashflows,4 Preferenceshares,294 Premiumtotheirparvalue,296 Preparingacashflowstatement,334 Preparingpartnershipaccounts,374 Preparingthebalancesheet,118 Preparingthestatementofprofitorloss,118 Prepayments,48,51,233,235,236,307 Presentationoffinancialstatements,9 Presentationofinformation,15 Privatecompany,294 Professionalbehaviour,10 Professionalcompetenceandduecare,10,11 Profit,37 Profitandlossaccount,8,34 Profitandlossaccount(reserve),350 Profitandlossledgeraccount,117 Profitappropriation,372 Profitappropriationstatement,376 Profitorlossondisposal,271 Profitsondisposalofnon-currentassets,306 Profit-sharingratio(PSR),372 Property,plantandequipment,45,307 Provision,301 Provisionfordoubtfuldebts,220,350 Public,6 Publiccompany,294 Publishedaccounts,348 Publishedaccountsoflistedandunlisted companies,349 Publishedfinancialstatements,303 Purchaseinvoice,63 Purchaseorder,63 Purchasedgoodwill,278,279 Purchasesdaybook,67 Purposeofcontrolaccounts,149 Purposeoffinancialstatements,14
Q Qualitativecharacteristicsofusefulaccounting information,12
R Rawmaterials,193 Realisation,191 Receivables,33,40,87 Receivablescontrolaccount,139 Receivablesledger,94,95,139 Redeemablepreferenceshares,295,308 Reducedrate,99 Reducingbalancedepreciation,262 Refunding,144 Refunds,305
Accounting
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Refundspaidtocustomers,144 Refundsreceivedfrom,144 Registeredtraders,99 RegistrarofCompanies,348 Regulationofaccounting,9 Regulatoryframeworkforcompanyfinancial statements,303 Relevance,13 Remittanceadvice,64 Rentreceived,306 Replacementcost,191,195 Reportingperiod,8 Residualprofit,373 Residualvalue,46,258,259 Retainedearnings,294,296 Retirementordeathofapartner,380 Revenue,305,306 Revenueexpenditure,20 Revenueincome,21 Rightsissue,298
S Salescommission,306 Salesdaybook,66,93 Salesinvoice,63 Salesoforder,63 Scripissue,299 Selectionandapplicationofaccounting policies,15 Separateentity,34 Separateentityprinciple,18 Separatelegalexistence,293 Sharecapital,293 Sharepremium,296 Sharepremiumaccount,297 Shareholders,3,293 Soletrader,3,34 Solvency,8 Sourcedocument,63 Standardcost,195 Standardrate,99 Statementofcashflows,7 Statementofchangesinequity,7,8 Statementoffinancialposition,7 Statementoffinancialpositionformat,307 Statementofprofitorloss,8,15,50 Statutoryaccounts,348 Stewardship,4,14 Stock,34,349 Straightlinedepreciation,261 Structureandcontentoffinancialstatements, 304 Subsequentcapitalexpenditure,257 Suppliers,6 Suspenseaccount,160,162
T ‘T’accounts,82 Tangiblefixedassets,351 Tangiblenon-currentasset,46 Tax,369 Taxpayable,302 Taxableoutputs,99 Taxation,34 Taxationpayable,45 Theobjectiveofdepreciation,259 Timeliness,13 Timingdifferences,153 Tradediscount,96,305 Tradepayables,40,45 Tradereceivables,40,48,307 Tradings,incomeandexpenseaccount,117 Transpositionerrors,158 Trialbalance,113 Trialbalancefailstobalance,114 Trueandfairview,12,348 Turnover,350 Typesoferrorinaccounting,157
U UKaccountingstandards,347 UKGAAP,5,12,34,347 UKGAAPbalancesheet,350 UKGAAPformat,43 UKGAAPprofitandlossaccount,351 UKGAAPterminology,349 Unclearedlodgements,154 Under-provision,302 Understandability,13 Unlimitedusefullife,258 Unpaidcapital,295 Unpresentedcheques,154,155 Usefullife,258 Usersandtheirinformationneeds,6
V ValuationruleI:valuationathistoricalcost,191 Valuinginventories,191 VAT,45,48,64,65,70,98,303,305 VATanddiscounts,100 VATandirrecoverabledebts,100 VATcalculation,101 VAToncars,100 Verifiability,13
W Wagescontrolaccount,147 Warrantyprovision,301 WIP,193 Workinprogress,193 Writingoff,215
Index
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Writingoffinventories,200 Writtenoffandsubsequentlypaid,216 Wrongaccount,114
396
Z Zerorate,99
Accounting
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