“A” LEVEL ACCOUNTING

TEACHING NOTES

INCLUDING EXAMPLES,

QUESTIONS

Tinofamba nevanofamba

CONTENTS

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TOPIC PAGE
USERS OF ACCOUNTING INFORMATION 3
ACCOUNTING CONCEPTS 4
INTERNATIONAL ACCOUNTING STANDARDS 6
DEPRECIATION 17
CONTROL ACCOUNTS 21
SUSPENSE ACCOUNT 24
INCOMPLETE RECORDS 27
INCOME AND EXPENDITURE 29
PARNTERSHIPS 31
MANUFACTURING ACCOUNT 41
STOCK VALUATION 46
CASH FLOW STATEMENTS 50
CAPITAL REDEMPTION 56
ACCOUNTING RATIOS 71
MARGINAL COSTING 77
ABSORPTION COSTING 91
STARDARD COSTING 99
BUDGETS 110
CAPITAL BUDGETING 113
STATEMENT OF CHANGES IN EQUITY 126

USERS OF ACCOUNTING INFORMATION

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Banks
They need to assess the quality of the assets upon which loans are secured that is collateral
security.

Shareholders
Need accounting information so as to ensure that they are getting a good return on their
investment. This will enable the shareholders to decide if they wish to increase or dispose
their investment.

Employees
Seek to assess how secure their future is and how much profit the company has made. This
information will be used to support their claim for a pay rise.

Customers
Want to know whether the company will be in existence in the near future by checking if it is
making a profit or loss. This will help customers when products need parts for servicing or
replacing.

Managers
Require accounting information so as to make quality decisions. Managers’ interest in the
accounts lies in whether the firm makes profit, which would normally result in their receiving
a good bonus or pay rise.

Public
Need to know how much profit the company has made as this will secure their jobs.

Suppliers
Need accounting information so as to know the profitability/liquidity position of the
company. This will enable suppliers to know how much to credit to offer basing on the
information provided in the financial statements.

Government
Need accounting information so as to assess economic growth and fiscal planning.

Tax authorities(ZIMRA)
Use the financial statements as the basis for tax computations.

ACCOUNTING CONCEPTS

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 GOING CONCERN CONCEPT
This concept is concerned with the amount at which assets are shown in the balance sheet. It
requires that business accounts shall be prepared on the assumption that a business is a going
concern.
MATERIALITY CONCEPT
This convention can be applied in two different ways, but the convention in essence, is that it
is not worthwhile spending hours or effort over small amounts. The effort is only worthwhile
if the item is of a reasonable (material) value.

COST CONCEPT
It states that figures shown in accounts must be valued at a figure that all parties can agree on.
It also states that the correct value to record items at is the only value to which all users
would agree, that is the amount paid for them, or initial cost of the item.

ACCRUALS CONCEPT
It states that items should be recorded when used and not paid for.

MONEY MEASUREMENT CONCEPT

It states that only items that that have a clear monetary value can be included in the
accounts ,all other items must be ignored.

MATCHING CONCEPT
The purpose of this concept is to ensure that revenue, other income and expenses are
recognised in the financial period in which they accrue or are incurred, for example
capitalisation of development of development costs.

CONCEPT OF REALIZATION
This concept states that revenue should not be recorded in the accounts before it has been
realised. Revenue should not be overstated by sales which have not been realised.

CONSISTENCY CONCEPT
This concept enable sensible comparisons to be made of the results of a business and its
financial position from one year to another. All items of a similar nature should be treated in
a similar manner both within the same accounting period and from one period to the next.

DUAL ASPECT CONCEPT

It states that every transaction will affect two items.

COST CONCEPT

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It states that figures shown in the accounts must be valued at a figure that all parties can agree
on. It also states that the correct value to record items at is the only value to which all users
would agree, that is the amount paid for them or initial cost of the item.

PRUDENCE CONCEPT
This concept states that profits should not be overstated and also losses must be provided as
soon as recognised. Valuing stock at the lower of cost or net realisable value is an application
of the prudence concept. Prudence is an overiding concept ,if in a given situation, the
application of another concept would conflict with prudence, prudence takes precedence
over that other concept.

SUBSTANCE OVER FORM

The term is mainly used to describe the accounting treatment of something that does not
reflect the legal position. It mainly relates to assets bought on hire purchase which remains
the property of the seller until the final instalment has been paid. The seller can repossess the
asset if the purchaser fails to pay the instalments on time.

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 INTERNATIONAL ACCOUNTING STANDARDS

Summaries of International Accounting Standards

The following list links to a brief summary of the individual International Accounting Standard
currently in force or issued recently and not yet effective. Where an IAS has been superseded by a
subsequent International Accounting Standard, it is not listed.

IAS 1: Presentation of Financial Statements

IAS 1: Presentation of Financial Statements supersedes:

 IAS 1, Disclosure of Accounting Policies;

 IAS 5, Information to be Disclosed in Financial Statements; and
 IAS 13, Presentation of Current Assets and Current Liabilities.

Summary of IAS 1

IAS 1 defines overall considerations for financial statements:

 Fair presentation
 Accounting policies
 Going concern
 Accrual basis of accounting
 Consistency of presentation
 Materiality and aggregation
 Offsetting
 Comparative information

Four basic financial statements: IAS 1 prescribes the minimum structure and content,
including certain information required on the face of the financial statements:

 Balance sheet (current/noncurrent distinction is not required)

 Income statement (operating/non operating separation is required)
 Cash flow statement (IAS 7: Cash Flow Statements sets out the details)
 Statement showing changes in equity. Various formats are allowed:
o The statement shows:
 (a) each item of income and expense, gain or loss, which, as required by
other IASC Standards, is recognised directly in equity, and the total of these
items (examples include property revaluations (IAS 16: Property, Plant and
Equipment), certain foreign currency translation gains and losses (IAS 21:
The Effects of Changes in Foreign Exchange Rates), and changes in fair
values of financial instruments (IAS 39: Financial Instruments: Recognition
and Measurement)); and
 (b) net profit or loss for the period, but no total of (a) and (b). Owners'
investments and withdrawals of capital and other movements in retained
earnings and equity capital are shown in the notes.

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 o Same as above, but with a total of (a) and (b) (sometimes called "comprehensive
income"). Again, owners' investments and withdrawals of capital and other
movements in retained earnings and equity capital are shown in the notes.
 The statement shows both the recognised gains and losses that are not
reported in the income statement and owners' investments and withdrawals of
capital and other movements in retained earnings and equity capital. An
example of this would be the traditional multicolumn statement of changes in
shareholders' equity.

Other matters addressed:

 Notes to financial statements

 Requires certain information on the face of financial statements
 Income statement must show:
--revenue
--results of operating activities
--finance costs
--income from associates and joint ventures
--taxes
--profit or loss from ordinary activities
--extraordinary items
--minority interest
--net profit or loss
 Offsetting (netting)
 Summary of accounting policies
 Illustrative Financial Statements
 Disclosure of compliance with IAS
 Limited "true and fair override" if compliance is misleading
 Requires compliance with Interpretations
 Definitions of current and noncurrent

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IAS 2: Inventories
IAS 2, Inventories, became effective for financial statements covering periods beginning on or after
1 January 1995.

Summary of IAS 2

 Inventories should be measured at the lower of cost and net realisable value. Net realisable
value is selling price less cost to complete the inventory and sell it.
 Cost includes all costs to bring the inventories to their present condition and location.
 If specific cost is not determinable, the benchmark treatment is to use either the first in, first
out (FIFO) or weighted average cost formulas. An allowed alternative is the last in, first out
(LIFO) cost formula. When LIFO is used, there should be disclosure of the lower of (i) net
realisable value and (ii) FIFO, weighted average or current cost.
 The cost of inventory is recognised as an expense in the period in which the related revenue is
recognised.
 If inventory is written down to net realisable value, the write-down is charged to expense.
Any reversal of such a write-down in a later period is credited to income by reducing that
period Vs cost of goods sold.
 Required disclosures include:
o accounting policy,
o carrying amount of inventories by category,
o carrying amount of inventory carried at net realisable value,
o amount of any reversal of a write-down,
o carrying amount of inventory pledged as security for liabilities,
o cost of inventory charged to expense for the period, and
o LIFO disclosures mentioned above.

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IAS 7: Cash Flow Statements
IAS 7, Cash Flow Statements, became effective for financial statements covering periods beginning
on or after 1 January 1994.

Summary of IAS 7

 The cash flow statement is a required basic financial statement.

 It explains changes in cash and cash equivalents during a period.
 Cash equivalents are short-term, highly liquid investments subject to insignificant risk of
changes in value.
 Cash flow statement should classify changes in cash and cash equivalents into operating,
investing, and financial activities.
 Operating: May be presented using either the direct or indirect methods. Direct method shows
receipts from customers and payments to suppliers, employees, government (taxes), etc.
Indirect method begins with accrual basis net profit or loss and adjusts for major non-cash
items.
 Investing: Disclose separately cash receipts and payments arising from acquisition or sale of
property, plant, and equipment; acquisition or sale of equity or debt instruments of other
enterprises (including acquisition or sale of subsidiaries); and advances and loans made to, or
repayments from, third parties.
 Financing: Disclose separately cash receipts and payments arising from an issue of share or
other equity securities; payments made to redeem such securities; proceeds arising from
issuing debentures, loans, notes; and repayments of such securities.
 Cash flows from taxes should be disclosed separately within operating activities, unless they
can be specifically identified with one of the other two headings.
 Investing and financing activities that do not give rise to cash flows (a nonmonetary
transaction such as acquisition of property by issuing debt) should be excluded from the cash
flow statement but disclosed separately.

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IAS 8: Net Profit or Loss for the Period, Fundamental Errors and
Changes in Accounting Policies
IAS 8 (revised 1993), Net Profit or Loss for the Period, Fundamental Errors and Extraordinary
Items, became effective for annual financial statements covering periods beginning on or after 1
January 1995.

Summary of IAS 8

 Separate disclosure of extraordinary items of profit or loss is required on the face of the
income statement, after the total of profit or loss from ordinary activities. Such extraordinary
items are rare and beyond management control. Examples are expropriation of assets and
effects of natural disasters.
 Items of income or expense arising from ordinary activities that are abnormal because of their
size, nature or incidence are separately disclosed, usually in the notes.
 A change in accounting estimate should be reflected prospectively. The nature and effect of
the change should be disclosed, even if the effect will only be significant in a future period. If
the effect cannot be quanitified, that fact should be disclosed.
 A correction of a fundamental error should be treated as a prior period adjustment
(benchmark) or recognised in current profit or loss (allowed alternative). The nature and
effect of the change in the current and prior periods should be disclosed.
 A change in accounting policy should be treated retrospectively by restating all prior periods
presented and adjusting opening retained earnings (benchmark). If the adjustments relating to
prior periods cannot be reasonably determined, the change may be accounted for
prospectively. An allowed alternative for the adjustment arising from a retrospective change
in accounting policy is to include it in the determination of the net profit or loss for the
current period.
 Disclosure is required of the reasons for and effect and accounting treatment of the change.
 A change in accounting policy should be made only if required by statute or by an accounting
standard-setting body, or if the change results in a more appropriate presentation of financial
statements.
 IAS 8 disclosure requirements for discontinued operations have been replaced by IAS 35

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IAS 10: Events After the Balance Sheet Date
IAS 10 was approved by the IASC Board in March 1999 and became effective for annual financial
statements covering periods beginning on or after 1 January 2000.

Summary of IAS 10

 an enterprise should adjust its financial statements for events after the balance sheet date that
provide further evidence of conditions that existed at the balance sheet;
 an enterprise should not adjust its financial statements for events after the balance sheet date
that are indicative of conditions that arose after the balance sheet date;
 if dividends to holders of equity instruments are proposed or declared after the balance sheet
date, an enterprise should not recognise those dividends as a liability;
 an enterprise may give the disclosure of proposed dividends (required by IAS 1: Presentation
of Financial Statements) either on the face of the balance sheet as an appropriation within
equity or in the notes to the financial statements;
 an enterprise should not prepare its financial statements on a going concern basis if
management determines after the balance sheet date either that it intends to liquidate the
enterprise or to cease trading, or that it has no realistic alternative but to do so;
 there should no longer be a requirement to adjust the financial statements where an event after
the balance sheet date indicates that the going concern assumption is not appropriate for part
of an enterprise;
 an enterprise should disclose the date when the financial statements were authorised for issue
and who gave that authorisation. If the enterprise Vs owners or others have the power to
amend the financial statements after issuance, the enterprise should disclose that fact; and
 an enterprise should update disclosures that relate to conditions that existed at the balance
sheet date in the light of any new information that it receives after the balance sheet date
about those conditions.

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IAS 16: Property, Plant and Equipment
IAS 16, Property, Plant and Equipment, became effective on 1 January 1995.

Summary of IAS 16

 Property, plant and equipment should be recognised when (a) it is probable that future
benefits will flow from it, and (b) its cost can be measured reliably.
 Initial measurement should be at cost.
 Subsequently, the benchmark treatment is to use depreciated (amortised) cost but the allowed
alternative is to use an up-to-date fair value.
 Depreciation:
o Long-lived assets other than land are depreciated on a systematic basis over their
useful lives.
o Depreciation base is cost less estimated residual value.
o The depreciation method should reflect the pattern in which the asset's economic
benefits are consumed by the enterprise.
o If assets are revalued, depreciation is based on the revalued amount.
o The useful life should be reviewed periodically and any change should be reflected in
the current period and prospectively.
o Significaant costs to be incurred at the end of an asset's useful life should either be
reflected by reducing the estimated residual value or by charging the amount as an
expense over the life of the asset.
 Revaluations (allowed alternative):
o Revaluations should be made with sufficient regularity such that the carrying amount
does not differ materially from that which would be determined using fair value at the
balance sheet date.
o If an item of PP&E has been revalued, the entire class to which the asset belongs
must be revalued (for example, all buildings, all land, all equipment).
o Revaluations should be credited to equity (revaluation surplus) unless reversing a
previous charge to income.
o Decreases in valuation should be charged to income unless reversing a previous credit
to equity (revaluation surplus).
o If the revalued asset is sold or otherwise disposed of, any remaining revaluation
surplus either remains as a separate component of equity or is transferred directly to
retained earnings (not through the income statement).
 If an asset's recoverable amount falls below its carrying amount, the decline should be
recognised and charged to income (unless it reverses a previous credit to equity).
 Gains or losses on retirement or disposal of an asset should be calculated by reference to the
carrying amount.
 Required disclosures include:
o Reconciliation of movements.
o Capital commitments.
o Items pledged as security.
o If assets are revalued, disclose historical cost amounts.
o Change in revaluation surplus.

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IAS 36: Impairment of assets
An impairment loss should be recognised whenever the recoverable amount of an asset is less
than its carrying amount (sometimes called "book value");

Other Requirements of IAS 36

 the recoverable amount of an asset is the higher of its net selling price and its value in
use, both based on present value calculations;
 net selling price is the amount obtainable from the sale of an asset in an armVs length
transaction between knowledgeable willing parties, less the costs of disposal;
 value in use is the amount obtainable from the use of an asset until the end of its
useful life and from its subsequent disposal. Value in use is calculated as the present
value of estimated future cash flows. The discount rate should be a pre-tax rate that
reflects current market assessments of the time value of money and the risks specific
to the asset;
 an impairment loss should be recognised as an expense in the income statement for
assets carried at cost and treated as a revaluation decrease for assets carried at
revalued amount;
 an impairment loss should be reversed (and income recognised) when there has been a
change in the estimates used to determine an asset Vs recoverable amount since the
last impairment loss was recognised;
 the recoverable amount of an asset should be estimated whenever there is an
indication that the asset may be impaired. IAS 36 includes a list of indicators of
impairment to be considered at each balance sheet date. In some cases, the
International Accounting Standard applicable to an asset may include requirements
for additional reviews;
 in determining value in use, an enterprise should use:
(a) cash flow projections based on reasonable and supportable assumptions that reflect
the asset in its current condition and represent management Vs best estimate of the set
of economic conditions that will exist over the remaining useful life of the asset.
Estimates of future cash flows should include all estimated future cash inflows and
cash outflows except for cash flows from financing activities and income tax receipts
and payments; and
(b) a pre-tax discount rate that reflects current market assessments of the time value of
money and the risks specific to the asset. The discount rate should not reflect risks for
which the future cash flows have been adjusted;
 if an asset does not generate cash inflows that are largely independent from the cash
inflows from other assets, an enterprise should determine the recoverable amount of
the cash-generating unit to which the asset belongs. A cash-generating unit is the
smallest identifiable group of assets that generates cash inflows that are largely
independent of the cash inflows from other assets or group of assets. Principles for

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 recognising and reversing impairment losses for a cash-generating unit are the same
as those for an individual asset. The concept of cash-generating units will often be
used in testing assets for impairment because, in many cases, assets work together
rather than in isolation. IAS 36 includes guidance and examples on how to identify
the cash-generating unit to which an asset belongs and further requirements on how to
measure an impairment loss for a cash-generating unit and to allocate this loss
between the assets of the unit;
 an impairment loss recognised in prior years should be reversed if, and only if, there
has been a change in the estimates used to determine recoverable amount since the
last impairment loss was recognised. However, an impairment loss should only be
reversed to the extent the reversal does not increase the carrying amount of the asset
above the carrying amount that would have been determined for the asset (net of
amortisation or depreciation) had no impairment loss been recognised. An impairment
loss for goodwill should only be reversed if the specific external event that caused the
recognition of the impairment loss reverses. A reversal of an impairment loss should
be recognised as income in the income statement for assets carried at cost and treated
as a revaluation increase for assets carried at revalued amount;
 when impairment losses are recognised or reversed an enterprise should disclose
certain information by class of assets and by reportable segments. Further disclosure
is required if impairment losses recognised or reversed are material to the financial
statements of the reporting enterprise as a whole; and
 on first adoption of IAS 36, the requirements should be applied prospectively only,
that is, prior periods will not be restated.

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IAS 38: Intangible Assets
Summary of IAS 38
IAS 38 applies to all intangible assets that are not specifically dealt with in other International
Accounting Standards. It applies, among other things, to expenditures on:

 advertising,
 training,
 start-up, and
 research and development (R&D) activities.

IAS 38 supersedes IAS 9, Research and Development Costs. IAS 38 does not apply to
financial assets, insurance contracts, mineral rights and the exploration for and extraction of
minerals and similar non-regenerative resources. Investments in, and awareness of the
importance of, intangible assets have increased significantly in the last two decades.

The main features of IAS 38 are:

 an intangible asset should be recognised initially, at cost, in the financial statements,

if, and only if:

(a) the asset meets the definition of an intangible asset. Particularly, there should be
an identifiable asset that is controlled and clearly distinguishable from an enterprise's
goodwill;

(b) it is probable that the future economic benefits that are attributable to the asset will
flow to the enterprise; and

(c) the cost of the asset can be measured reliably.

This requirement applies whether an intangible asset is acquired externally or

generated internally. IAS 38 also includes additional recognition criteria for internally
generated intangible assets;

 if an intangible item does not meet both the definition, and the criteria for the
recognition, of an intangible asset, IAS 38 requires the expenditure on this item to be
recognised as an expense when it is incurred. An enterprise is not permitted to include
this expenditure in the cost of an intangible asset at a later date;
 it follows from the recognition criteria that all expenditure on research should be
recognised as an expense. The same treatment applies to start-up costs, training costs
and advertising costs. IAS 38 also specifically prohibits the recognition as assets of
internally generated goodwill, brands, mastheads, publishing titles, customer lists and

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 items similar in substance. However, some development expenditure may result in the
recognition of an intangible asset (for example, some internally developed computer
software);
 in the case of a business combination that is an acquisition, IAS 38 builds on IAS 22:
Business Combinations, to emphasise that if an intangible item does not meet both the
definition and the criteria for the recognition for an intangible asset, the expenditure
for this item (included in the cost of acquisition) should form part of the amount
attributed to goodwill at the date of acquisition. This means that, among other things,
unlike current practices in certain countries, purchased R&D-in-process should not be
recognised as an expense immediately at the date of acquisition but it should be
recognised as part of the goodwill recognised at the date of acquisition and amortised
under IAS 22, unless it meets the criteria for separate recognition as an intangible
asset;
 after initial recognition in the financial statements, an intangible asset should be
measured under one of the following two treatments:

(a) benchmark treatment: historical cost less any amortisation and impairment losses;
or

(b) allowed alternative treatment: revalued amount (based on fair value) less any
subsequent amortisation and impairment losses. The main difference from the
treatment for revaluations of property, plant and equipment under IAS 16 is that
revaluations for intangible assets are permitted only if fair value can be determined by
reference to an active market. Active markets are expected to be rare for intangible
assets;

 intangible assets should be amortised over the best estimate of their useful life. IAS
38 does not permit an enterprise to assign an infinite useful life to an intangible asset.
It includes a rebuttable presumption that the useful life of an intangible asset will not
exceed 20 years from the date when the asset is available for use. IAS 38
acknowledges that, in rare cases, there may be persuasive evidence that the useful life
of an intangible asset will exceed 20 years. In these cases, an enterprise should
amortise the intangible asset over the best estimate of its useful life and:

(a) test the intangible asset for impairment at least annually in accordance with IAS
36: Impairment of Assets; and

(b) disclose the reasons why the presumption that the useful life of an intangible asset
will not exceed 20 years is rebutted and also the factor(s) that played a significant role
in determining the useful life of the asset;

 required disclosures on intangible assets will enable users to understand, among other
things, the types of intangible assets that are recognised in the financial statements

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 and the movements in their carrying amount (book value) during the year. IAS 38 also
requires disclosure of the amount of research and development expenditure
recognised as an expense during the year; and
 IAS 38 is operative for annual accounting periods beginning on or after 1 July 1999.
IAS 38 includes transitional provisions that clarify when the Standard should be
applied retrospectively and when it should be applied prospectively.

To avoid creating opportunities for accounting arbitrage in an acquisition by recognising an

intangible asset that is similar in nature to goodwill (such as brands and mastheads) as
goodwill rather than an intangible asset (or vice versa), the amortisation requirements for
goodwill in IAS 22: Business Combinations are consistent with those of IAS 38.

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 DEPRECIATION
It is the loss in value of a fixed asset during its useful life.
Causes of depreciation
Wear and tear-Assets become worn out through use.
Time factor-This affects assets with a fixed period of legal life, for example, copyrights and
leases.
Depletion-It refers to assets with a wasting nature, for example mines or oil wells.
Economic factors-Obsolescence(out of date),inadequacy of capacity.
Why providing for depreciation on fixed assets
 to spread the depreciation cost over the asset’s useful life.
 to set aside monies for replacement.
 to reflect that the fixed assets are of second hand value at the balance sheet date.

Methods of depreciation
Straight line method
Advantages
 it is easier to calculate
 same amount is charged each year
Disadvantages
 some assets are used on and off, so depreciation plan should reflect use not passage of
time.
 other assets operate faster, produce more when they are new. Therefore more
depreciation should be allocated in early years.

Reducing balance method

Advantages
 some assets operate faster, produce more when they are new so more depreciation
should be allocated in early years.
 in the latter years the assets become less efficient, therefore repair and maintenance
costs will be heavy during these years, thus the combined influence of depreciation
and repair costs will tend to equalise charges against profits – over the useful life of
the asset.
Disadvantages
 complicated since the depreciation charge will be different each year.
 the amount will not be depreciated fully that is not completely provided for.

Machine hours method

Advantages
 it relates to actual use of the asset
 easy and simple to use

Disadvantages

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  problem of excessive use, which may necesitate a more than normal rate of
depreciation.
 with this method when the asset is not in use there is no charge. Assets deteriorate
even if they are not in use.
DEPRECIATION QUESTIONS
QUESTION 1

Rapid Deliveries Ltd is a small parcels delivery company. In order to ensure a high level of
efficiency the vans used are usually replaced by the latest models. It is company policy not to
retain any van for more than four years. The depreciation applied relates to this policy. The
company uses the straight line method and calculates the annual depreciation charge on the
cost of the vans held at the year end. It assumes no residual value.

Details of the vans appearing in the balance sheet as at 31 December 1990 were:
$
Vans at cost (5 vans) 81 000
Less depreciation to date 38 750
42 250
During 1991 two vans of the fleet were sold and three were purchased. The following
details relate to these transactions:

Sales
Date sold Van Year Cost Sale
Reference bought proceeds
1 April 1991 1 1988 14 000 4 000
1 July1991 2 1988 15 000 3 350

Purchases
Date purchased
Van Cost
Reference
1 April 1991 6 19 000
1 August 1991 7 20 000
1 November 1991 8 21 000

Van 3 was bought in 1989 at a cost of $16 000 and vans 4 and 5 were purchased in
1990 at the same price each.

REQUIRED
a)The ledger accounts for the year ended 31 December 1991:
(i) vans at cost account;
(ii) vans provision for depreciation account;
(iii) vans disposal account.
b) Explain why it is important to provide for depreciation.
c) State two advantages and two disadvantages of using the straight line method of
depreciation and reducing balance method of depreciation.

QUESTION 2

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Hunter Ltd uses straight line depreciation on its motor vehicles. Depreciation is provided
from the date the vehicle is bought until the date it is sold.
The following information was extracted from Hunter Ltd’s fixed asset register on 1 January
2016.
Vehicle number Date of purchase Cost Useful life Residual value
AAA 0473 1 January 2014 $30 000 4 nil
AAI 8600 1 September 2014 $40 000 6 4 000

During the year ended 31 December 2016 the following events occured:
January 1
The estimated useful life of AAA 0473 was revised from 4 years to 5 years, with no residual
value.
June 30
Vehicle number AAK 9530 with an expected useful life of 6 years and a residual value of $2
000 was purchased on credit from Power and Chings for $50 000 to replace AAI 8600. A
trade-in price of $30 000 was agreed for AAI 8600.
Required

a. For the year ended 31 December 2016, prepare the Motor Vehicles Account, (5)
i. the Provision for Depreciation of Motor Vehicles account, (11)
ii. the Disposal account. (4)
b. The accountant for Hunter Ltd feels that the reducing balance method is a better
method of depreciating motor vehicles.
i. State two advantages of the reducing balance method. (2)
ii. Explain whether it is permissible for Hunter Ltd to change from the straight
line method to the reducing balance method. (3)

QUESTION 3

20 | P a g e T I N O F A M B A N E V A N O F A M B A
On 1 January 2017, the non current assets register of Chings Limited held the following
information on its taxis.

Date of purchase Taxi Cost Date of Cash received

Reg number disposal $

01/01/13 Vitz 28 000 31/03/2017 7 000

01/01/13 Honda 32 000 24/04/2017 10 000

01/01/14 Funcago 20 000 31/08/ 2017 10 500

01/01/14 Ipsum 20 000 30/11/2017 10 000

08/01/15 Chariot 25 000 - -

06/01/15 Mazda 28 000 23/11/2017 See below

25/01/16 Wish 30 000 - -

31/01/16 Corrolla 35 000 - -

On 23 November 2017, taxi Mazda was involved in an accident and was written off. The
insurance company has offered to pay 80% of the net book value of the taxi as at 31
December 2016. The company has agreed to accept the offer. The money is yet to be
received.

Depreciation is provided on taxis at 20% per annum using the reducing balance method. A
full year’s charge is made in the year of purchase but no depreciation applied in the year in
which a taxi is sold or otherwise disposed of.

a) Draw up for the year 2017,

i. The Taxis account, {4}

ii. The Provision for Depreciation Account on Taxis, {15}
iii. The Asset Disposal Account for taxi Mazda. {5}

21 | P a g e T I N O F A M B A N E V A N O F A M B A
 CONTROL ACCOUNTS
These are accounts which record all creditors and debtors accounts, in other words it is a
summary of all these transactions.

Purposes of control accounts

 to locate errors
 to deter fraud
 fraud or errors are easier to check
 checking is made easier as sectional ledgers are created
 to provide totals for creditors and debtors quickly

Reasons why a debtor’s account might have a credit balance

 payment in advance
 credit note issued
 overpayment

Limitations of control accounts

 control accounts do not guarantee the accuracy of individual accounts, which may
contain compensating errors, for example items posted to wrong accounts.
 control accounts may themselves contain errors.

What to note when amending and reconciling Control Accounts

TYPE OF ERROR ADJUSTED IN RECONCILIATION

CONTROL STATEMENT
ACCOUNTS

Errors in source documents Yes No

Complete omission of a transaction Yes Yes

Casting errors in books of original entry No Yes

Errors in personal account or Individual error yes yes

22 | P a g e T I N O F A M B A N E V A N O F A M B A
Preparation of control accounts
The information required for the preparation of the sales ledger control account (total debtors
account/debtors control account) can be found as follows:

Debits Source (book of prime entry)

Credit sales Sales day book
Bad debts recovered Journal
Dishonoured cheques Cash book
Dishonoured bills Journal
Refunds to debtors Cash book
Correction of errors Journal

Credits Source (book of prime entry)

Sales returns Sales returns book
Cash received from debtors Cash book
Cash received from bad debts recovered Cash book
Discounts allowed Cash book - discount column
Bad debts written off Journal
Bills receivable Journal
Contra entries Journal
Correction of errors Journal

The purchases ledger control account would be built up from the following sources:

Debits Source (book of prime entry)

Purchases returns Purchases returns book
Payments to creditors Cash book
Discounts received Cash book - discount column
Bills payable Journal
Contra entries Journal
Correction of errors Journal

Credits Source (book of prime entry)

Credit purchases Purchases day book
Refunds from creditors Cash book
Dishonoured bills payable Journal
Correction of errors Journal

Two different arrangements for control accounts in the ledger

Individual debtors/creditors are parts of the ledger while the control accounts
are only memorandum records.
The control accounts are parts of the ledger while the individual debtors/
creditors are subsidiary records only.
These different arrangements will not affect the preparation and reconciliation of the control accounts
but correction of errors may not be the same under these two systems.

23 | P a g e T I N O F A M B A N E V A N O F A M B A
 Sales Ledger Control Account

Date Details folio $ Date Details folio $

Balance b/d xxx Balance b/d xxx

Credit Sales xxx Sales Return xxx
Dishonoured Cheque xxx Bad Debts xxx
Interest received xxx Discount Allowed xxx
Balance c/d xxx Bank and Cash xxx
Set off: contra xxx
Balance c/d xxx
xxx xxx
Balance b/d xxx Balance c/d xxx

Purchase Ledger Control Account

Date Details folio $ Date Details folio $

Balance b/d xxx Balance b/d xxx

Purchases Return xxx Credit Purchases xxx
Set off: SL xxx Interest due xxx
Discount Received xxx Balance c/d xxx
Bank and Cash xxx
Balance c/d xxx
xxx xxx
Balance b/d xxx Balance c/d xxx

Uses / Advantages of Control Account

 Control accounts provide a check on the internal accuracy of the ledger accounts
 They identify the ledger or ledgers in which errors have been made when there is
difference on trial balance

 Provide the final balances of debtors or creditors

 Limit the frauds or deception with respect to sales and purchases or cash / cheque
payments or receipts

 Any missing figure such as credit sales or credit purchases can be identified

24 | P a g e T I N O F A M B A N E V A N O F A M B A
Limitations/Drawbacks of Control Account
 If control account itself is based on some errors such as posting or entering of data
from day books or ledgers, it might not restrict the errors.

 If the system of maintaining day books, ledgers and control accounts are prepared
by the same group or individuals, the frauds might not be restricted.

 Control accounts are only limited to debtors and creditors, they do not focus on
other items such as stocks, or accruals.

25 | P a g e T I N O F A M B A N E V A N O F A M B A
 CONTROL ACCOUNTS QUESTIONS

QUESTION 1
The books of Simon Peter gave the following information for the month of 31 May 2003. All
sales and purchases were on credit.
Sales ledger balance at 1 May 2003 5 627
Purchases ledger balance at 1 May 2003 4 388
Sales for the year 100 384
Purchases for the year 64 987
Sales returns 1 997
Purchases returns 864
Payments received from debtors( all banked ) 92 760
Payments made to creditors 63 520
Debtor’s dishonoured cheque 109
Discount allowed 4 082
Discount received 3 241
Bad debts written off 1 884
Debit balances transferred to purchases ledger control account 208

The total of Simon Peter’s sales ledger balances is $9 387, which differs from the closing
balance in the sales ledger control account.
Required
a) Extract the relevant information from the above and prepare the sales ledger control
account for the month ended 31 May 2003. {10}
The following errors have been discovered since the sales ledger control account was
prepared.
1. A sales invoice for $2 001 had been completely omitted from the books.
2. A page of the sales day book with entries totaling $7 820 had been omitted from the
total sales but the individual entries had been posted to the debtors account.
3. A debit balance of $4 020 had been omitted from the list of debtors.
4. A sales ledger account had been understated by $220
5. Discount allowed had been overstated by $620
6. An entry of $1 620 in the sales day book had been omitted from the debtors account.
7. A contra entry had been made in the purchases ledger for a debit balance of $1 412 in
the sales ledger, but no entry had been made in the control accounts.
8. A receipt of $1 210 was debited to bank but not posted to the debtors account.
9. A credit note for $720 sent to a debtor had been entered in the sales day book and
posted as a sale to both accounts.
10. A debtor owing $1 820 was declared bankrupty during May 2003. The debt was
written off in the control account but no entry have been made in the debtors account.
Required
b) Prepare an amended sales ledger control account, extracting relevant information
from the list of errors given above. {8}
c) Prepare a statement altering the total of the sales ledger balance to agree with the new
sales ledger control account balance. {7}

26 | P a g e T I N O F A M B A N E V A N O F A M B A
 QUESTION 2
The following information has been extracted from the accounts of Harvey Rabbit for the
year ended 31 March 2010.
$
Sales ledger balance at 1 April 2009 29 040
Credit sales 499 892
Cash sales 14 634
Credit sales returns 9 878
Receipts from debtors, banked 462 680
Discount allowed on credit sales 21 404
Bad debts written off 9 510
Debtors’ cheques dishonoured 662
Contra entries 1 153

REQUIRED
a. Prepare Harvey Rabbit’s sales ledger control account for the year ended 31 March
2010. [10]

The total of Harvey Rabbit’s sales ledger balances at 31 March 2010 was $26 845, which
did not agree with the closing balance of his sales ledger control account. On checking his
accounts he discovered the following errors.

1. A credit note for $420 which had been sent to a debtor had been entered in the sales
journal (day book) and posted as a sale to both accounts.
2. A debit entry in the sales ledger for $698 had been set off as a contra entry in the
purchases ledger, but no entry had been made in the control accounts.
3. The discount allowed account had been overstated by $310.
4. A sales invoice for $998 had been completely omitted from the accounts.
5. A debit balance of $2102 had been omitted from the list of debtors.
6. A debtor who owed $896 had been declared bankrupt during March 2010. The debt
had been written off in the control account, but no entry had been made in the
debtor’s account.
7. A receipt for $630 had been debited to the bank account but omitted from the
debtor’s account.
8. An entry for $816 in the sales journal (day book) had not been posted to the debtor’s
account.
9. A sales ledger account had been understated by $200.
10. A page of the sales journal (day book) with entries totalling $3856 had been omitted
from total sales. The amounts had, however, been posted to the debtors’ accounts.

REQUIRED
b. (i) Beginning with the closing balance which you have calculated in (a), prepare a
statement showing the amended balance on the control account. [6]

(ii) Beginning with Harvey Rabbit’s sales ledger balance of $26 845, prepare a
statement amending the total of the sales ledger balance to agree with the new
control account balance. [8]

c. State three advantages of keeping control accounts. [6]

[Total: 30]

27 | P a g e T I N O F A M B A N E V A N O F A M B A
 SUSPENSE ACCOUNTS
A suspense account is a temporary resting place for an entry that will end up somewhere else once
its final destination is determined. There are two reasons why a suspense account could be opened:

1. A bookkeeper is unsure where to post an item and enters it to a suspense account pending
instructions
2. There is a difference in a trial balance and a suspense account is opened with the amount of
the difference so that the trial balance agrees (pending the discovery and correction of the
errors causing the difference). This is the only time an entry is made in the records without
a corresponding entry elsewhere.

When the trial balance does not agree, the amount of the difference is entered in a suspense account.

Exhibit A

Trial Balance as on 31 December 2005

Dr. Cr.

$ $

Total after all the accounts have been listed 100,000 99,960

Suspense account 40

100,000 100,000

Types of Errors

There are two types of errors:

(i) Errors not affecting Trial Balance Agreement

(ii) Errors affecting Trial Balance Agreement

28 | P a g e T I N O F A M B A N E V A N O F A M B A
Types of errors

Identify the following errors whether they affect the trial balance agreement or not.

Error type Suspense account involved?

1 Error of Omission – a transaction is not recorded at all No

2 Error of commission – an item is entered to the correct side of the wrong account (there is a
debit and a credit here, so the records balance)
No
Example: P. Luen paid us by cheque $100, correctly entered in the cash book, but it entered
wrongly into the account of P. Lee.

3 Error of principle – an item is posted to the correct side of the wrong type (nature) of account

Example: when cash paid for plant repairs (expense) is debited to plant account (asset). No
(errors of principle are really a special case of errors of commission, and once again there is a
debit and a credit)

4 Error of original entry – an incorrect figure is entered in the records and then posted to the
correct account
No
Example: Cash HK$1,000 for plant repairs is entered as HK$100; plant repairs account is
debited with HK$100

5 Complete Reversal of entries – the amount is correct, the accounts used are correct, but the
account that should have been debited is credited and vice versa

Example: We paid cheque of $200 on 20 May 2005 to D.Chan. No

Debit: Bank

Credit: D. Chan

6 Compensating errors – two equal and opposite errors leave the trial balance balancing. (this
case is rare) No
Example: Purchases and Sales were overstated by $100.

7 Addition errors – figures are incorrectly added in a ledger account

Yes
e.g. overcast or undercast

8 Posting error – Yes

a) debit but no credit; credit but no debit
b) enter a different amount on the debit side from the amount on the credit side.

29 | P a g e T I N O F A M B A N E V A N O F A M B A
Example: cash HK$10,000 entered in the cash book for the purchase of a car is:
a) posted to Motor cars account as HK$1,000 only, no posted to cash book

9 Trial balance errors – a balance is omitted, posting an amount incorrectly, or posting a

Yes
balance to wrong side of the trial balance

Correcting errors (I) – Suspense account not involved

Errors 1 to 6, when discovered, will be corrected by means of a journal entries between the accounts
affected.

Types of
$ $
errors
1 Purchases 250
T. Hung 250
Purchase of $250 was omitted, now corrected.

2 P. Lee 100
P. Luen 100
Purchases entered in wrong personal account, now corrected

3 Plant repairs 5,500

5,50
Plant
0
Repairs of Plant were wrongly entered to Plant account, now corrected.

4 Plant repairs 900

Cash 900
Payment of $1,000 incorrectly entered as $100, now corrected.

5 D. Chan 400
Bank 400
Payment of $200 to D. Chan incorrectly credited to his account, and
debited to bank. Error now corrected

6 Sales 100
Purchases 100
Sales and purchases accounts were overcast by $100, now corrected.

NB: For public examinations, narrations are usually not required for this topic.

30 | P a g e T I N O F A M B A N E V A N O F A M B A
Correcting Errors (II) – Suspense account involved

Errors 7 to 8 also require journal entries to correct them. One side of the journal entry will be entered
to the suspense account opened for the difference in the records.

Error 9, trial balance errors- are different. As the suspense account records the difference, an entry to
it is needed, because the error affects the difference. However, there is no ledger entry for the other
side of the correction. Only single entry is needed.

Types of Examples Correcting journal entries

errors
$
8 A credit sale of $150 to Mr. Chan has been Dr. Mr. Chan 150
omitted from his account.
Cr. Suspense 150

8 A sale to C. Lee for $250 was correctly Dr. Suspense 270

entered in the sales book but entered in C.
Lee’s account as $520. Cr. C. Lee 270

8 A credit sale of $100 has been credited to H. Dr. H. Cheung 200

Cheung’s account
Cr. Suspense 200

7 Sales day book was overcast by $200 Dr Sales 200

Cr Suspense 200

7 Sales account was undercast by $40 Dr Suspense 40

Cr Sales 40

9 The total of the sales account of $1,500 has Dr Suspense 1,500

been omitted from the trial balance
9 The total of the sales account of $1,500 has Dr. Suspense 300
been extracted as $1,200 in the trial balance.
9 The total of the sales account of $1,500 has Dr Suspense 3,000
been extracted to the debit column of the
trial balance ($1,500 x 2)

31 | P a g e T I N O F A M B A N E V A N O F A M B A
An illustrative example (involving errors 1 -9)
The book-keeper of YY Limited extracted a trial balance on 31 December 2006 which failed
to agree by $330, a shortage on the credit side of the trial balance. A suspense account was
opened for the difference.
In January 2007 the following errors made in 2006 were found:

(a) Sales day book had been undercast by $100.

(b) Sales of $250 to K. Hou had been debited in error to K. Hung’s account.
(c) Rent account had been undercast by $70.
(d) Discounts received account had been undercast $300.
(e) The sale of motor vehicle at book value had been credited in error to sales account $360.

(i) Show the journal entries necessary to correct the errors. (narrations not required)
(ii) Draw up the suspense account after the errors described have been corrected.
(iii) If the net profit had previously been calculated at $7,900 for the year ended 31
December 2006, show the calculation of the corrected net profit.

Suggested Solutions:

(i)
The Journal
Dr Cr
$ $
1. Suspense 100
P & L – Sales 100
2. K. Hou 250
K. Hung 250
3. P & L – Rent 70
Suspense 70
4. Suspense 300
P & L – Discount received 300
5. P & L – Sales 300
Motor vehicle 300
6. Suspense account 360
Discount received account 360

(ii)
Suspense Account
$ $
Sales 100 Bal b/f 330
Discounts received 300 Rent 70

32 | P a g e T I N O F A M B A N E V A N O F A M B A
 400 400

(iii) Leave for your own practice.

Some hints on preparing suspense accounts

 Does a correction involve the suspense account? The type of error determines this. Practice
and study of Exhibit B should ensure that you see immediately which errors affect the
balancing of the records and hence the suspense account.
 Which side of the suspense account must an entry go? This is one of the most awkward
problems in preparing suspense accounts. The best way of solving it is to ask yourself which
side the entry needs to be on in the other account concerned. The suspense account entry is
then obviously to the opposite side.
 Look out for errors with two aspects. An entry has been made to the wrong account, but also
to the wrong side of the wrong account. Both errors must be corrected. It is very easy to fall
into the trap of correcting only one of the errors, especially when working quickly under
examination conditions.

EXTRA EFFORT

When the accountant of CC Ltd. extracted a trial balance as at 31 December 2005, its totals did not
agree. However, a trading and profit and loss account had been prepared and a net profit of $479,280
was shown.

All the errors, which had been made in 2005, were discovered in the following year:

1. Discounts of $840 allowed to a debtor, H. Tong, had been posted to the wrong side of the
discounts allowed account.
2. The rent account had been undercast by $1,000.
3. A purchases invoice for $279 had been completely omitted from the books.
4. A total of $12,800 paid for wages had been incorrectly debited to the buildings account.
5. A receipt of bank interest, $390, had been correctly entered in the cash book but nowhere
else.
6. A payment of $1,556 to a creditor, D. Chen, had been entered in D. Chan’s account.
7. A payment for motor expenses of $377 had been entered in the motor vehicles’ account.
8. Returns from customers costing $1,999 had been entered in the personal accounts only.
9. A receipt of $940 from a debtor, C. Bau, had been correctly recorded in the cash book, but
had been entered in his personal account as $490.
10. A petty cash balance of $116 had been omitted from the trial balance.
Required:

(a) Prepare journal entries to record the above corrections.

(b) Show the corrections in the suspense account.
(c) Calculate the corrected figure of net profit. (Ignore depreciation)
Suspense Account & Correction of Errors

Debit ($) Credit ($) Net Profit ($)

1 Purchases of $600 by cheque from C. Pang Purchases Bank Overstated

33 | P a g e T I N O F A M B A N E V A N O F A M B A
 completely omitted from the books. ($600) ($600)

2 A sale of goods of $678 to H. Luen had been H. Luen H. Lui N/A

entered in H. Lui’s account.
($678) ($678)

3 The purchase of a machine on credit from L. Po Machinery L. Po Overstated

for $4,390 had been completely omitted from
the books. ($4,390) ($4,390) (Depreciation)

4 The purchase of a motor van $38,000 had been Motor van Motor expenses Understated
entered in error in the motor expenses account.
($38,000) ($38,000)

5 A sale of $250 to Frederick had been entered in Frederick Sales Understated

the books, both debit and credit, as $205.
($250 – $205) ($45)

6 Commission received $257 had been entered in Sales Commission N/A

error in the sales account. received
($257)

7 Cheque paid to H. Kwong $89 entered on the H. Kwong Bank N/A

debit side of the bank account and the credit
side of H. Kwong’s account. ($89 x 2) ($178)

8 Chang issues a cheque for $160 in respect of Drawings Bank Overstated

rent due to his landlord. Of this amount, one
hundred dollar is for rent of Chang’s private ($100) ($160)
apartment and the balance is rent of his business
premises. This transaction is completely
omitted from his accounting records. Rent

($60)

9 Returns inwards of $1,000 from Chan was Returns inwards Chan Overstated
omitted in his accounting records.
($1,000) ($1,000)

10 The wages and salaries figure includes $1,010 Drawings Wages and Understated
paid for work done on Cheng’s private salaries
residence. ($1,010)
($1,010)

11 No entries have been made for the goods taken Drawings Purchases Understated
for own use amounting to $1,033.
($1,033) ($1,033)

12 P. Lam paid us by cheque $50 was correctly P. Lam P. Lau N/A

entered in the bank account, but it is entered by
mistake in the account of P. Lau. ($50) ($50)

13 Sales of $150 to T. Lok has been entered as T. Lok Sales Understated

34 | P a g e T I N O F A M B A N E V A N O F A M B A
 $130 in both debit and credit entry. ($150 - $130) ($20)

14 Payment of $200 by cheque to Mr. Cheung was Mr. Cheung Bank N/A
incorrectly credited to his account and debited
to bank account. ($200 x 2) ($400)

15 Goods taken for own use $250 have been Drawings Purchases Understated
debited to purchases account and credited to
drawings account. ($250 x 2) ($500)

16 A loan from Mr. X $5,000 has been entered on Capital Loan – Mr. X N/A
the credit side of the capital account.
($5,000) ($5,000) (Loan interest
*)

17 Returns inwards of $833 have been entered on Returns inwards Returns N/A
the debit side of the returns outwards account. outwards
($833)
($833)

18 Goods amounting to $620 returned to a supplier Supplier Returns Overstated

have not been recorded. outwards
($620)
($620)

19 A credit purchase of $7,667 from Mr. B was Purchases Mr. B Overstated

entered as $6,776 in both purchases and Mr. B’s
account. ($7,667 - ($891)
$6,776)

20 Goods returned by Mr. C of $124 has been Returns inwards Mr. C. Overstated
credited to returns outwards account and debited ($124)
to Mr. C’s account. ($248)
Returns
outwards

($124)

QUESTION 1

Benjamin Hove, extracted a trial balance on 31 March 2000, which failed to agree. He
entered the difference in a suspense account to enable him to draft his final accounts. The
draft profit and loss account prepared by Benjamin showed :
Gross profit $130 000
Operating profit of $1 380 000.

35 | P a g e T I N O F A M B A N E V A N O F A M B A
After completing the draft final accounts, Benjamin consults you as accountant and you
discover the errors shown below:

i) An item for $1 076 in the Sales Day Book has been entered in Adbel’s account in the
Sales Ledger as $1 760.

ii) At 31 March 2000, Blessing’s account in the Sales Ledger showed a debit balance of
$900. There was also an account for her in the Purchases Ledger and it showed a
credit balance of $650. In offsetting these balances, the ledger clerk had debited
Blessing’s account in the Sales Ledger with $650 and credited her account in the
Purchases Ledger with the same amount.

iii) A purchase of goods costing $1 500 had been credited to the supplier’s account in the
Purchases Ledger but no other entry had been made in the books.

iv) A credit balance of $480 in the Sales Ledger had been included in the list of debtors as
a debit balance.

v) A sales invoice for $1 070 sent to Dunmore had been entered in the Sales Day Book
as $1 700.

vi) Discount receivable $300 in January 2000 had been debited in the Discount Allowed
account. Discount allowable of $800 for the same month had been credited in the
Discounts Received account.

vii) Some goods have been sent to Poppy, a customer, and invoiced to him for $2 450. The
mark-up on these goods was 40%. Poppy has notified Benjamin on 30 March 2000 tha
he has not ordered the goods and is returning them. No entries regarding the return of
these goods have been made in the books.

Required
a. Prepare the journal entries necessary to correct each of the errors given above.
(narratives not required) (8)
b. Write up the suspense account (5)
c. Prepare computations for the year ended 31 December 2003 of the following:
i) Corrected gross profit (7)
ii) Corrected net profit (7)

QUESTION 2
Hunter extracted a trial balance which failed to agree. He entered the difference in a suspense
account to enable him to draft his final accounts. The draft profit and loss account prepared
by Hunter showed a gross profit of $1 970 000 and a net profit of $1 380 000.

After completing the draft final accounts, Hunter consults you as accountant and you discover
the errors shown below:

36 | P a g e T I N O F A M B A N E V A N O F A M B A
 i. A credit balance in the purchases ledger, $62 000, had been omitted from the list of
balances extracted from the ledger.

ii. Goods returned by Hunter to Power, a supplier, had been credited to Power’s account
and debited to returns outwards account. The goods had cost $120 000.

iii. A debt of $28 000 had been written off as bad in the sales ledger but no other entry had
been made.

iv. Repairs to Hunter’s business motor vehicle, $605 000, had been debited in error to the
motor vehicle account as $650 000.

v. The opening stock figure at 1 January 2003 had been entered in the trial balance as $434
000 instead of $344 000 as shown in the stock account.

vi. Purchases from Peter amounting to $810 000 had been received on 31 December 2003.
These had been included in closing stock at that date, but the invoice had not been
entered in the purchases journal.

vii. In November 2003, Hunter purchases a large quantity of stock of stationery at a bargain
price of $420 000. Three fifths of this stationery was in stock on 31 December 2003 but
no adjustment has been made to the accounts.

viii. A delivery van held as a fixed asset had been sold during the year for $144 000. The
proceeds of the sale had been credited to the sales account. The original cost of the van,
$360 000 and the accumulated depreciation to date, $240 000 were included in the
motor vehicles account. The company depreciates delivery vehicles at 25% per annum
on a straight line basis with proportionate depreciation in the year of purchase but none
in the year of sale.
Required
a) Prepare the journal entries necessary to correct each of the errors given above.
(narratives not required) {10}
b) Write up the suspense account {5}
c) Prepare computations for the year ended 31 December 2003 of the following:
i) Corrected gross profit {7}
ii) Corrected net profit {6}

INCOMPLETE RECORDS (OR SINGLE ENTRY)

The businesses such as unincorporated businesses or the sole traders are run by the
businessmen who might not know the detailed accounting knowledge hence they do not
maintain the double entry system. However, they have scattered information about their
business. They might not know how much profit the business has earned or how much loss it

37 | P a g e T I N O F A M B A N E V A N O F A M B A
has sustained. The tax department asks them to submit their returns to calculate the tax
payable, they might not know the profits of the businesses, hence they have to get the
services of some experts in accounting who prepares their books of accounts using the
available scattered information.

Statement of Calculation of Net Profit

In the exam, you are asked to calculate net profit for the business, but not given any
information such as sales, cost of sales, and expenses. However you are provided the
information about opening capital, closing capital, and drawings, or any additional capital
invested. For this purpose, we prepare statement of calculation of net profit

Name of the business

Statement of Calculation of net profit / Loss
For the year ended --------------------------------------------------------
------------------------------------------------------------------------------------------------------------
$

Closing Capital xxx

Less: Opening Capital (xxx)
Add: Drawings xxx
Less: Additional Capital Introduced (xxx)
Net Profit / (Loss) xxx

Statement of Affairs

It is same as statement of financial position, only the title is written as Statement of Affairs.
The purpose of the statement at the opening and closing dates is to find out capitals, because
the sole trader business’ owners do not know how much capital they had in the beginning and
how much it has become now.

38 | P a g e T I N O F A M B A N E V A N O F A M B A
Credit and Total sales

In order to calculate credit sales, total debtors account is drawn; it is same as sales ledger
control account.
Total sales are calculated by adding cash and credit sales

Credit and Total Purchases

In order to calculate credit purchases, total creditors account is drawn; it is same as purchases
ledger control account.
Total purchases are calculated by adding cash and credit purchases

Expenses and Income Accounts

Always prepare expenses and incomes accounts to make adjustments for prepayments and
accruals amounts.
Cash and Bank Accounts

This is a great help in identifying the missing figures of cash or bank, if cash and bank
accounts are prepared. Also any payments received from debtors or paid to creditors can also
be found through these accounts.

Income statement can be prepared in both vertical and horizontal formats:

Horizontal Format

Name of the Business

Income Statement

39 | P a g e T I N O F A M B A N E V A N O F A M B A
 For the Year Ended ---------------------------

$ $
Opening Inventory (Stock) xxx Revenue (Sales) xxx
Add: Purchases xxx Less: Sales Return (xxx)
Less: Purchase Return (xxx)
Add: Carriage Inwards xxx
Less: Closing
Inventory(Stock) (xxx)

Cost of Sales xxx

Gross Profit c/d xxx
----------------- -------------------
xxxx Net Sales xxx
---------------- -----------------

Gross Profit b/ d xxx

Less: Expenses:
Add: Other Incomes
Salaries xxx
Rent xxx Commission Received xxx
Electricity Bill xxx Discount Received xxx
Depreciation xxx
Bad Debts xxx
Insurance xxx
Net Profit xxx

----------------- -------------------
xxxx -
----------------- xxx
-------------------

Name of the business

Balance Sheet

As at -------------------------------------

40 | P a g e T I N O F A M B A N E V A N O F A M B A
 Non-Current (Fixed) Assets $ Capital (Owner’s Equity) $
Land xxx Capital xxx
Building / Premises xxx Add: Net Profit xxx
Motor Vehicles xxx Less: Drawings xxx
Fixtures and Fitting xxx
Equipment xxx
Current Assets Current Liabilities
Inventory (Stock) xxx Accounts Payable (Creditors) xxx
Accounts Receivable (Debtors) xxx Bank Overdraft xxx
Bank xxx
Cash xxx

xxx xxx

Income Statement and Balance Sheet are prepared with the help of trial balance.

In trial balance, all the assets and expenses will always be debited, and all the incomes and
liabilities will be credited. Hence, find these items on their respective sides in trial balance.

Capital amount given in trial balance is called opening or old capital, which may change by
new investment, earning net profit or sustaining losses, and withdrawing money for personal
use (i.e. drawing). The new capital after adjustments of above items is closing capital.

Capital increases due to incomes, and decreases due to expenses.

New Capital = Old Capital +Net Profit + New Investment – Drawings

Vertical Format

Name of the Business

Income Statement

41 | P a g e T I N O F A M B A N E V A N O F A M B A
 For the Year Ended ---------------------------

$ $
Revenue (Sales) xxx
Less: Sales Returns xxx
-----------------
Net Sales - xxx

Less: Cost of Sales

Opening Inventory (Stock)
Add: Purchases xxx
Less: Purchase Return xxx
Add: Carriage Inwards (xxx)
Less: Closing Inventory(Stock) xxx
(xxx) (xxx)
----------------- -----------------
Gross Profit xxx
Less: Expenses
Electricity
Insurance xxx
Rent xxx
Bad Debts xxx
Depreciation on fixed assets xxx
xxx (xxx)
Add: Other Incomes -----------------
Commission Received
Discount Received xxx xxx
xxx --------------
Net Profit ---------------- xxx

Name of the business

Statement of financial position as at -------------------------------------

42 | P a g e T I N O F A M B A N E V A N O F A M B A
Non-Current (Fixed) Assets $ $
Land xxx
Building / Premises xxx
Motor Vehicles xxx
Fixtures and Fitting xxx
Equipment xxx
------------
Current Assets xxx
Inventory (Stock) xxx
Accounts Receivable (Debtors) xxx
Bank xxx
Cash xxx
-------------
xxx
Less: Current Liabilities
Bank Overdraft (xxx)
Accounts payable (xxx)
------------
Working Capital (or Non-current assets)
Net Assets xxx
------------
xxx
Financed By ------------
-
Capital
Add: Net Profit xxx
Less: Drawings xxx
(xxx)
-----------
xxx
----------

QUESTION 1

43 | P a g e T I N O F A M B A N E V A N O F A M B A
Sockaree does not keep a full set of accounting records. He never bothers to record personal drawings
although he keeps details of all expenses.
The following applies to 2016.

i) Opening and Closing balances were:

1 January 31 December
$ $
Machinery 36 000 ?
Stocks 81 000 109 800
Debtors 14 220 18 900
Creditors 45 540 55 260
Accrued rates 16 200 14 760
Prepaid rent 2 880 3 870
Cash 5 940 8 370

ii) Sockaree invested additional cash amounting to $252 000 in the business.
iii) A new machine was purchased to replace the old machine which was trade in at $21
600. A cash payment of $167 000 was made to complete the transaction. The new
machine is to be depreciated by 15% on cost.
iv) Other cash payments were:
$
Creditors 939 240
Rent ant rates 90 000
Wages 95 940
Sundry expenses 39 870
v) A margin of 25% was maintained throughout the year.
vi) Discounts allowed were $19 840, returns inwards $24 000 and returns outwards $30
000.
vii) A set-off was effected between an amount of $24 000 owed by Randal and an amount
of $22 480 owed to Randal.

REQUIRED
(a) Prepare Sockaree’s Trading and Profit and Loss Account for 2006
(b) Calculate Sockaree’s capital on 1January 2006
(c) Prepare Sockaree’s Cash Account for 2006, showing clearly the amounts of drawings
and receipts from debtors.

QUESTION 2

44 | P a g e T I N O F A M B A N E V A N O F A M B A
Adbel received a legacy from his Father so he was able to fulfil a long standing desire to open
a spare parts shop. On 1 January 1992 he opened a business bank account with the full
amount of the legacy. However he paid little attention about keeping proper accounting
records.
Also on 1 January 1992 he rented premises at a rental of $750 per month payable quarterly in
advance. The first payment was made on 3 January 1992. At 31 December 1992 a summary
of Adbel’s bank transactions revealed the following:

Receipts $ Payments $
Legacy 50 000 Rent 6 750
Cash banked 269 000 Fixtures/equipment 21 670
Business rates 2 400
Electricity 4 670
Telephone 690
Purchases 265 770
Holiday in Vumba 3 400

All Adbel’s takings were banked after the following cash expenses were paid and personal
drawings taken. These were:
Wages $410 per week (50 weeks);
Sundry expenses $15 per week (50 weeks);
Cash purchases $2 980 for the year.
Adbel always retained a cash float of $250 in the till.
Additional information:
i. Due to an oversight the last quarter’s rent due on 1 October 1992 was not paid until
January 1993.
ii. Selling prices were fixed by marking up the goods by 40% on cost price.
iii. Business rates of $1000 had been paid on 5 October 1992 to cover the period 1
October 1992 until 31 March 1993.
iv. It was estimated that Adbel owed $1 800 for electricity and an accountant’s fee of
$220 at 31 December 1992.
v. It was decided to depreciate the fixtures and equipment by $6 670.
vi. Creditors for purchases were $6 250 at 31 December 1992.
vii. Trade debtors amounted to $38 000 at the year ended 31 December 1992 and a
provision for doubtful debts of 5% was to be established at that date.
viii. Closing stock was valued at cost at $15 000.
After preparing Adbel’s final accounts for the year ended 31 December 1992 the accountant
suggested he should consider converting his business into a private limited company.
Required
a) A lncome statement for the year ended 31 December 1992 {14}
b) A statement showing the calculation of Adbel’s drawings {4}
c) A Statement of financial position as at 31 December 1992. {14}

45 | P a g e T I N O F A M B A N E V A N O F A M B A
 NON PROFIT MAKING ORGANIZATIONS

Non-trading organizations are not business-oriented organizations. Examples of such

organizations are clubs and associations. They are formed to provide services or benefits for
their members. Although these organizations are not primarily engaged in trading activities
externally, they may sometimes carry out activities for their members on a profitable basis.
Any profits made, however, are normally not distributed among members but retained for
development of the organizations.

Source of income

Common sources of income of a non-profit trading organization include:

 Entrance fees payable by members upon joining the organization

 Subscription / annual fees payable by members to the organization
 Donations from members or non-members
 Rental income from premises let out
 Trading profits from bar or restaurant operations
 Receipts from fund-raising activities

Expense items

Common expenses of a non-profit trading organization include:

 Rent and rates for the organization’s premises

 Staff salaries and wages
 Maintenance cost of the premises, equipment and other facilities of the organization
 Expenses for fund-raising activities

A conventional trading and profit and loss account is not an appropriate form in which to
present the final accounts of a non-trading entity. Clubs, institutions, societies, professional
bodies and similar concerns not formed with the intention of profit making will usually
prepare an income and expenditure account. Occasionally it may be called a revenue account.

46 | P a g e T I N O F A M B A N E V A N O F A M B A
Differences between ‘A Receipts and Payment Account’ and ‘An Income and Expenditure
Account’

Receipts and Payment Account Income and Expenditure Account

1. A summary of cash transactions and the 1. A balance representing the surplus or deficit
resultant cash or bank balance of income over expenditure for the period
under review

2. Contains all income and revenue

2. Contains only part of the income or expenditure attributable to the period of the
expenditure for the period, i.e., the part account, whether received or paid or not.
actually received or paid. It may also contain
receipts and payments belonging to preceding
or succeeding periods.

3. Contains revenue items only.

3. Contains both capital and revenue items if
received or paid.

4. Virtually a summarized statement of cash 4. Virtually a Trading and Profit and Loss
book Account.

There are a few points in particular that should be noted when attempting an income and expenditure
question in an examination.

1. In large clubs it is usual to prepare special Trading Accounts to show the results of bar trading,
sale of refreshments and similar operations.

2. The capital account is sometimes described as an Accumulated Fund. A surplus of income over
expenditure for the period is added to this fund, and a deficit is deducted.

3. A gift to the concern form of money should be added directly to the accumulated fund and not
shown in the income and expenditure account if it is a large and non-recurring amount. Small
gifts of money may be shown as income in the income and expenditure account if they are of little
individual significance and are a regular and recurring form of income. The principle to follow is
that the income and expenditure account should reflect the normal operations of the year.

4. A gift to the concern in the form of an asset should be added directly to the accumulated fund in
the balance sheet and listed as an asset if a value is stated.

5. Depreciation of fixed assets may or may not be required. If depreciation is required there will be
some indication of this, though it may be implicit rather than explicit.

6. If receipts are described as `bar receipts' or `dance receipts' or other `special effort receipts',
careful scrutiny is recommended to see if expenses are similarly identified. If is quite probable
that the examiner is looking for a separate `bar account' or `dance account', the profit and loss on
which should be transferred to the main income and expenditure account. Marks will be list if the
individual items are simply listed in the income and expenditure account. In the case of a bar
account, stocks at the beginning and the end of the year should of course be included, as should
items such as barman's wages.

47 | P a g e T I N O F A M B A N E V A N O F A M B A
7. Subscription in arrears in practice may not be brought in as income by clubs and societies as their
eventual recovery can be very uncertain. However, if an examination question indicates an
amount of subscription in arrear, the examiner obviously expects this amount to be brought into
the accounts. An adjustment should always be made for advance payment of subscriptions.

8. A payment for life membership should not be treated as income solely in the year in which the
member paid the money. It should be credited to a Life Membership Account, and transfers
should be made to the credit of the income and expenditure account of an appropriate amount
annually.

9. Entrance fees paid on application for membership should not be treated as income solely in the
year in which the member is admitted. It should be credited to Entrance Fees Account and
transfers should be made from that account to the income and expenditure account of an
appropriate amount annually.

Receipts and payments

A Receipts and Payments account is a summary of the cashbook (of a profit-making

organization) recording the actual cash and cheques received and paid. The receipts
side of the account contains all the details shown on the debit side of the cash book,
while the payments side contains all the details shown on the credit side of the cash book
for the period specified.

Bar Trading Account

Sometimes a non-profit making organization may carry out activities in order to make a
profit. Examples include running a bar, serving refreshments inside the club or
organization and fund-raising activities. A Bar Trading account (similar to the Trading
account in trading organizations) is prepared not to make a profit, but to support the
main purpose of the organization. Any profit or loss resulting from these activities would
be transferred to the income and expenditure account in order to work out the overall
surplus or deficit for the organization.

Total Debtors account

$ $
Opening balance X Cash received X
Sales (for the year) X Closing balance X
XX XX

The same concept applies to the purchases figure in the Bar Trading account. A ‘Total
Creditors account’ may need to be opened.

48 | P a g e T I N O F A M B A N E V A N O F A M B A
 Total Creditors account
$ $
Payments X Opening balance X
Closing balance X Purchases X
XX XX

Income and expenditure account

Generally speaking, the Income and Expenditure account is prepared in the same way
as a Profit and Loss account for a trading organization. The income is mainly derived
from subscriptions and donations received from members. Expenditure, on the other
hand, includes operating expenses (administration) like stationery, salaries, depreciation,
etc.

EXAMINATION NOTES

1. Capital expenditure and capital receipts – No entry to income and expenditure account

As the major source of accounting information for a club is the Receipts and
Payments Account, most questions start with a summary of this account and ask
candidates to prepare the Final Accounts. Using the Receipts and Payments
Account to prepare the Income and Expenditure Account, please remember not to
include Capital Expenditure items such as ‘purchase of motor van’ and Capital Receipt
such as ‘sale of club premises.’

2. Remember the bar profit obtained in bar trading account

Since the Bar Trading Account and Income and Expenditure Account will be
prepared separately, please remember to copy the Bar Profit from the Bar Trading
Account to the Income and Expenditure Account.

3. Statement of financial position

In a non-profit making organization, the Balance Sheet is prepared in the same way
as in a profit-making organization. This remains to be a record of the
organization’s assets, liabilities and capital.

49 | P a g e T I N O F A M B A N E V A N O F A M B A
 A non-profit making organization would have an accumulated fund. It is the same as the
capital for a profit-making organization. Any surplus for the period is added to the
accumulated fund while any deficit is deducted from it.

Accumulate fund, being the same as the capital, is therefore, the difference between assets
and liabilities.

Assets – Liabilities = Accumulated Fund

Examination notes (about Statement of financial position)

1. Opening and closing balance of receipts and payments account

The opening balance of the Receipts and Payments Account serves no purpose for the
year-end Balance Sheet (i.e. no need to enter in the Balance Sheet).
The closing balance of Receipts and Payments Account should be entered in the Balance
Sheet as Current Assets if it has a debit balance and Current Liabilities if it has a credit
balance (i.e. Bank overdraft)
Adjustments to Subscriptions

The Subscriptions Account shown in the Trail Balance may include:

1. Subscriptions received in advance

2. Subscriptions in arrears last year but received this year.

These items need to be adjusted. Besides, part of the subscriptions received this year may be
in arrears, or received in advance last year. These also need to be adjusted for ascertaining
the subscriptions earned for the year.

Example 1

Receipts and Payments account (31/12/2003)

Subscriptions $123,000

Additional Notes:
31/12/2002 31/12/2003
$ $
Subscription owing 7,000 18,900
Subscription in advance 4,000 8,900

50 | P a g e T I N O F A M B A N E V A N O F A M B A
 Subscriptions account
$ $
2003 2003
Jan. 1 In arrears b/d 7,000 Jan. 1 In advance b/d 4,000
Dec. 31 Income and exp a/c 19,300 Dec. 31 Bank 12,300
In advance c/d 8,900 In arrears c/d 18,900
35,200 35,200

Income and Expenditure account

for the year ended 31 Dec. 2003 (extract)

$ Income $

Subscriptions 19,300

Statement of Financial Position Extract

as at 31 Dec. 2003 (extract)

Current assets $ Current liabilities $

Subscriptions in arrears 18,900 Subscription in advance 8,900

Example 2

Receipts and Payments account (31/12/2003)

Subscriptions Received: $
2002 1,000
2003 5,500
2004 2,000

Additional Notes:

1. Subscriptions owing for 31 Dec. 2003 amounted to $800 and owing for 31 Dec. 2002
amounted to $1,000.
2. Subscriptions prepaid for 1 Jan. 2004 amounted to $2,000

51 | P a g e T I N O F A M B A N E V A N O F A M B A
 Subscriptions account
$ $
In arrears b/d 1,000 Bank 8,500
Income and exp account 6,300
In advance c/d 2,000 In arrears c/d 800
8,500 8,500

CLASS DISCUSSION
The treasurer of the Leisure Club has prepared the following receipts and payments account
for the year ended 31 December 1997:

Receipts and payments account

$ $
Balance b/d 15 330 Bar purchases 61 250
Subscriptions 49 000 Bar wages 7 420
Bank interest 92 Administration expenses 42 270
Bar sales 97 500 Insurance 6 250
Balance c/d 44 732
161 922 161 922

Additional information:
(i) The following balances were extracted from the club’s books at 31 December
1996:
$
Accrued bar wages 455
Bar debtors 1 000
Club premises 300 000
Creditors for bar supplies 8 190
Bar stock 9 425
Prepaid insurance 600
Subscriptions in arrears 2 405
Subscriptions in advance 1 120
(ii) Depreciation is to be charged on the cost of club premises at 5% per annum.
(iii) Bar stock at 31 December 1997, amounted on $9 620.
(iv) Accrued bar wages, prepaid insurance, bar debtors and creditors for bar supplies
amounted to $390; $400; $1 200 and $7 215 respectively at 31 December 1997.
(v) Subscriptions in advance and in arrears amounted to $2 600 and $1 360
respectively at 31 December 1997.
You are required to prepare for the Leisure Club:
a) A statement showing the accumulated funds of the club as at 1 January 1997, and
b) A bar trading account for the year ended 31 December 1997, and
c) An income and expenditure account for the year ended 31 December 1997,
d) A Statement of financial position as at 31 December 1997.

52 | P a g e T I N O F A M B A N E V A N O F A M B A
ANSWERS:

a) A statement showing the accumulated funds of the club as at 1 January 1997:

Assets: $ $
Club premises 300 000
Bar debtors 1 000
Bar stock 9 425
Prepaid insurance 600
Subscriptions in arrears 2 405
Cash and Bank 15 330
328 760
Liabilities:
Accrued bar wages 455
Creditors for bar supplies 8 190
Subscriptions in advance 1 120 9 765
Balance of the accumulated funds as at1.1.1997 318 995

b)

Leisure Club
Bar trading account for the year ended 31 December 1997
Opening stock 9 425 Sales (W1) 97 700
Purchases (W2) 60 275
69 700
Less: closing stock 9 620
Cost of goods sold 60 080
Gross profit c/d 37 620 ______
97 700 97 700
Bar wages (W3) 7 355 Gross profit b/d 37 620
Net profit 30 265 ______
37 620 37 620

53 | P a g e T I N O F A M B A N E V A N O F A M B A
Workings:

1.

Bar debtors
1997 1997
Jan 1 Balance b/d 1 000 Dec 31 Cash / Bank 97 500
Dec 31 Total sales (b.f.) 97 700 31 Balance c/d 1 200
98 700 98 700
2.

Bar creditors
1997 1997
Dec 31 Cash / Bank 61 250 Jan 1 Balance b/d 8 190
Dec 31 Balance c/d 7 215 Dec 31 Total purchases (b.f.) 60 275
68 465 68 465
3.

Bar wages
1997 1997
Dec 31 Cash / Bank 7 420 Jan 1 Accrued b/d 455
Dec 31 Accrued c/d 390 Dec 31 Bar trading (b.f.) 7 355
7 810 7 810

c)

Leisure Club
Income and expenditure account for the year ended 31 December 1997
Expenditure Income
Administration expenses 42 270 Subscription (W4) 46 475
Insurance (W5) 6 450 Bar profit 30 265
Depreciation 15 000 Bank interest received 92
Surplus of income over expenditure 13 112 ______
76 832 76 832

54 | P a g e T I N O F A M B A N E V A N O F A M B A
Workings :
4.

Subscription
1997 1997
Jan 1 In arrear b/d 2 405 Jan 1 In advance b/d 1 120
Dec 31 I&E a/c (b.f.) 46 475 Dec 31 Bank / Cash 49 000
31 In advance c/d 2 600 31 In arrear c/d 1 360
51 480 51 480
5.

Insurance
1997 1997
Jan 1 Prepaid b/d 600 Dec 31 I&E a/c (b.f.) 6 450
Dec 31 Cash / Bank 6 250 31 Prepaid b/d 400
6 850 6 850

d)

Leisure Club
Balance Sheet as at 31 December 1997
Fixed assets Accumulated funds
Club premises 300 000 At 1 January 1997 318 995
Accumulated depreciation 15 000 Add: Surplus for the year 13 112
285 000 332 107
Current assets Current liabilities
Bar stock 9 620 Bar creditors 7 215
Bar debtors 1 200 Accruals 390
Prepaid insurance 400 Subscription in advance 2 600 10 205
Subscription in arrear 1 360
Cash and Bank 44 732 57 312 _______
342 312 342 312

EXTRA PRACTICE

55 | P a g e T I N O F A M B A N E V A N O F A M B A
The treasurer of the International Club submitted the following Receipts and Payments
account to club members covering the year to 31 December 2002:

Receipts and Payments Account

for the year ended 31 December 2002
$ $
Balance (1 Jan. 2002) 32,000 Insurance 2,800
Subscriptions 45,000 Secretary’s expenses 5,100
Bar takings 28,000 Administration expenses 6,200
Sales of Dance tickets 18,800 Payment for bar supplies 10,100
Hire of hall and band 6,000
Wages of bar staff 2,700
Lighting and heating 5,000
Purchases of sports 5,000
equipment
Balance (31 Dec. 2002) 80,900
123,800 123,800

NOTES:
31/12/2001 31/12/2002
$ $
Stock of refreshment 12,000 13,000
Subscriptions due 600 1,700
Subscriptions in advance 500 800
Sports equipment 25,000 To be calculated
Administration expenses outstanding - 400
Lighting & Heating prepaid - 1,000
Creditors for Bar Supplies 13,000 8,200

* The club depreciate the sports equipment at the rate of 10%.

* Of the lighting & heating, one quarter will be regarded as bar expenses.

Required:

Prepare the Bar Trading account, Income & Expenditure account and the Statement of
financial position for the year ended 31 Dec. 2000

QUESTION 1

56 | P a g e T I N O F A M B A N E V A N O F A M B A
Nyamhunga Wrestling Club presented the following details for the year ended 31
December 2010.
$
(i) Receipts
Subscriptions 6 000
Bar sales 27 300
Entrance fees 1 200
Gate takings on tournaments 1 800
Sales of programmes 15

(ii) Payments:
Rates 1 200
Bar purchases 21 000
Barman’s wages 2 700
Hire of extra chairs 570
Other tournament expenses 300
Extension to clubhouse (1 April 2010) 12 000
Sundry clubhouse expenses 4 800
(iii) The clubhouse was bought on 1 January 2007 for $21 000. It is depreciated at
10% p.a. on cost.
(iv) Sundry assets and liabilities were:
1 Jan 2010 31 Dec 2010
$ $
Bar inventory 3 015 2 805
Trade payables
-bar purchases 2 760 2 925
-hire of chairs - 120
Prepaid rates 300 375
Clubhouse expenses due 105 135
Cash 945 7 200
Subscriptions in advance 270 360
Subscriptions in arrears 1 920 -

Required

a) Accumulated fund as at 1 January 2010. (5)

b) Bar trading account for the year ending 31 December 2010 (5)
c) Subscription account (5)
d) Income and expenditure account for the year ended 31 December 2010 (10)

PARTNESHIP ACCOUNTING
57 | P a g e T I N O F A M B A N E V A N O F A M B A
PARTNERSHIP FORMATION

A business which involves voluntary association of two to twenty people as partners in the
business. In order to form the partnership, partners have to invest in the entity. The
investment may be in the form of fixed assets which is taken in the partnership business at the
value as mutually decided among the partners. The investment may be in the form of cash as
well.

Reasons for Partnership Formation

There are many reasons for building a partnership firm. Most common are:

 larger amount of capital can be raised because more than one persons invest in the
business.

 it is very easy to form a partnership, even you can set it up in a day.

 partners contribute diverse skills, expertise and ideas into the business.

 workload is shared among partners, so each partner can focus on its specific areas.

Essentials Features of Partnership Agreement

Though, partnership can be created orally. But, in order to protect the interest of each partner,
it is always good to have the agreement in writing.

Agreement among partners is called Partnership Deed.

The deed must mention the way of distributing profits and losses among partners. They can
decide to share equally or in other agreed ratio.

Interest on profits may be shared among existing partners according to the ratio of capital
invested by each of them. Such amount is called Interest on Capital. Usually, this interest rate
is decided and mutually agreed among partners is written in the deed document.

Whenever a partner draws funds from the partnership, it is referred to as drawing. Partners
may decide to charge interest on drawing amount. Such interest is mentioned in the
partnership deed on per annum basis. It is a penalty amount which reduces the profit share of
the individuals in the firm.

If some of the partners take lead role or active role in managing the business, then he or she
may be allowed to take reward which is called Partnership Salary.

Partnership Deed

58 | P a g e T I N O F A M B A N E V A N O F A M B A
Also called partnership agreement; all the partners are required to sign a written partnership
agreement before starting partnership business so that in business disputes could be avoided.
A partnership agreement may include the following:

 The amount of capital invested in the business by all the partners

 The nature of work the partnership will carry out
 The profit and loss sharing ratio
 The duration of the partnership
 The arrangement for absence, retirement, and how new partner will be admitted
Advantages of partnership

 More capital than that of sole trader business as there are more than one person as
investor in the business (however in banking partnership, there could be more than
20 partners as investors, because the banking business needs as much capital as
possible)

 Responsibility of work, decision making, and burden of unlimited liability can be

shared among the partners

 Motivation for all the partners as greater the hard work and dedication is
contributed by the partners, the more profit is enjoyed by all the partners

Disadvantages of partnership

 Unlimited liability for all the partners, however in limited partnership, all the
partners will have limited liability except one partner who will be responsible for
the debts and losses of the business and he will be the one who will sell all of his
property to compensate the losses

 No separate legal identity which means in partnership also there will be a risk of
discontinuity but not as much as in sole trader ship. If there are two partners, one
dies, business could be at the risk of discontinuity.

 Risk of disagreement among partners on various decision making.

 Limited capital as the partners will only be limited to 20 partners except banking
partnership

Accounting Treatment

59 | P a g e T I N O F A M B A N E V A N O F A M B A
Income Statement – It will be same as sole trader accounts except the appropriation
accounts.

Appropriation part of the income statement shows the distribution of profit / loss
among the partners

Name of the Firm

Profit and Loss Appropriation Account
For the year ended ---------------------------------------------
----------------------------------------------------------------------------------------------------------------
----- $
$
Net Profit xxx
Add: Interest on Drawings
Hunter xxx
Power xxx xxx
xxx
Less: Interest on Capital
Hunter xxx
Power xxx
Salary – Hunter / Power xxx (xxx)
xxx
Share of profit/loss : Hunter xxx
Power xxx xxx

Partners’ Current account is prepared to maintain the records of partners’ incomes and
expenses. The debit balance of partners’ current account shows a negative balance and
partners have withdrawn more than their incomes; the credit balance of partners’ current
account shows a positive balance means partners have not overdrawn from the business.

Partners’ Current Account

Hunter Power Hunter Power

Balance b/d Xxx xxx Balance b/d xxx xxx

Drawings xxx xxx Interest on capital xxx xxx
Interest on drawings xxx xxx Salary xxx xxx
Balance c/d xxx xxx Share of Profit xxx xxx

Xxx xxx xxx xxx

Balance b/d xxx xxx

Important points to be noted

60 | P a g e T I N O F A M B A N E V A N O F A M B A
  If no profit or loss ratio is being given, assume equal distribution;
 If interest on loan is not given, assume it is 5%

Statement of financial position in partnership

It is same as common balance sheet, however financed by will include only current account
balances and capital balance. Current account balances can be either calculated in the
separate current account or in the balance sheet itself.

Statement of financial position (Extract)

Capitals Hunter Power Totals

Xxx xxx xxx

Current accounts Hunter Power

Balance b/d xxx xxx

Interest on capital xxx xxx
Salary xxx xxx
Share of Profit xxx xxx

Xxx xxx
Less : Interest on drawings xxx xxx
Drawings xxx xxx
Xxx xxx xxx
Loan : Power Bank xxx
xxx

PARTNERSHIP DISSOLUTION
61 | P a g e T I N O F A M B A N E V A N O F A M B A
This will be probably the last sub-topic for partnership account and will be relevant to ‘A’
Level.

You will need to be able to realise that any profit or loss on dissolution should be shared by
all the partners in their profit and sharing ratios. If there are circumstances where the
partner’Ss final balance on his capital and current accounts is in deficit, the partner will have
to pay that amount into the partnership bank account.

When dissolving the business, you will need to get rid of the assets by either 1) disposing it
or 2) the partner(s) to take it. All this entries will need to be made into realisation account.

Realisation Account

Non current assets{net book value} Note 1 Assets sold

Buildings xxxx Buildings xxxx

Motor van xxxx Motor van xxxx

Stock xxxx Stock xxxx

Debtors xxxx Debtors xxxx

Etc xxxx Etc xxxx

Assets taken by partner

Dissolution costs xxxx Adbel xxxx

Benjy xxxx

Note 3 Profit on realisation Note 3 Loss on realisation

Adbel xxxx Adbel xxxx

Benjy xxxx Benjy xxxx

Note 4 xxxx Note 4 xxxx

Note 1

62 | P a g e T I N O F A M B A N E V A N O F A M B A
Assets sold will give you a credit entry in the realisation account because you are receiving
cash { and a debit entry in the bank account}. Make you use the net realisable amount.

Note 2

You will need to include dissolution costs because there are an expense to the business, so
you debit it in realisation account and credit it in your bank account.

Note 3

If debit side is more than credit side the you will have a loss on realisation. If there is more
credit side amount than debit side, then you will have a profit on realisation. Do remember to
split it according to the profit sharing ratio.

Note 4

This will be the totals.

Finally, you will need to open a bank account. Bank account will be your last step in
dissolution because there are no more extra calculations required, you only need to put all the
numbers in the right places. It therefore act as your check if you have done everything
correctly.

Net realisable amount is the amount that you will receive in disposing assets. You will need
to use this amount because it will be the actual amount that the business will receive.

Do not forget about dissolution costs! You must include them in the realisation account
(debit) and bank account (credit).

T-accounts for disposing the assets are only recommended if the question asks you to do so!
Otherwise, there is no need to do so.

Next, you will need to open up capital account for each partner. This is to calculate how
much each partner will receive or pay the business as a result of the dissolution. Remember
that all partners have unlimited liability, if the business runs out of cash in dissolving the
business, all the partners will have to settle the additional liabilities from their own pockets.

Here is the format for capital account.

63 | P a g e T I N O F A M B A N E V A N O F A M B A
 Capital Account

Note 1 Balance b/d xxxx Note 1 Balance b/d xxxx

Note 2 Realisation: Share of loss xxxx Note 2 Realisation: Share of profit xxxx
Note 3 Realisation: Assets taken xxxx
Note 4 {balancing figure} xxxx Note 4 {balancing figure} xxxx

Total xxxx Total xxxx

It will be easier to put columns in the capital account to accommodate each partner.

Note 1

Balance b/d will usually be on the credit side{the nature of transaction}but it is possible for it
to appear in debit side also. This is so when the partner withdraws too much money/goods for
its own use that he/she exhausted his/her capital in the business.

Note 2

Double entry from realisation account.

Note 3

Assets taken by any partners must be debited to their account, this is also a double entry from
realisation account.

Note 4

This will be the balancing figure. A debit side will mean that the business has to pay the
partner and a credit side is where the partner has to pay the business.

Finally, you will need to open a bank account. Bank account will be your last step in
dissolution because there are no more extra calculations required, you only need to put all the
numbers in the right places. It therefore act as your check if you have done everything
correctly.

Bank Account

64 | P a g e T I N O F A M B A N E V A N O F A M B A
 Balance b/d xxxx Balance b/d xxxx
Note 2 Realisation : Assets sold Note 1 Creditors xxxx
Buildings xxxx Note 2 Dissolution costs xxxx
Motor van xxxx Loan xxxx
Stock xxxx
Debtors xxxx
Etc xxxx

Note 3 Capital Account

Adbel xxxx Note 3 Capital Account
Benjy xxxx Adbel xxxx
Benjy xxxx
Note 4 xxxx Note 4 xxxx
Note 1

Since you are dissolving the business, do not forget to pay the creditors.

Note 2

Double entry from realisation account.

Note 3

Double entry from bank account.

Note 4

Once all the figures are in place, you should have both debit and credit side balanced. If it
doesn’t balance, you will need to recheck.

Things to note in order to score well,

 You must include dissolution costs.

 You must be able to remember all the formats (including the bank account).
 Remember to use only net book value in the debit side and net realisable amount in
the realisation account.
 Do remember to include asset taken by partner into their respective capital account.
 You must pay your creditors from your bank account.

Work out the following question.

QUESTION 1

65 | P a g e T I N O F A M B A N E V A N O F A M B A
Chido and Chenai, who have in partnership for many years, decided to retire and dissolve the
partnership on 30 September 2003. Profits and losses were shared in the ratio of the
partners’Capital account balances, which were fixed at Chido $80 000 and Chenai $40 000.
The partnership Statement of financial position at 30 September 2003 was as follows.
Fixed assets (net book value) $ $
Buildings 104 000
Fixtures and fittings 35 000
Motor vehicles 26 000
165 000
Current assets
Inventory 10 500
Trade receivables 17 230
Bank 950
28 680
Current liabilities
Trade payables 9 230 19 450
184 450

Capital accounts: Chido 80 000

Chenai 40 000 120 000

Current accounts: Chido 14 430

Chenai (2 580) 11 850
Loan from: Chido 52 600
184 450

The partnership ceased trading on 30 September 2003 and the assets were realized a follows:
$
Buildings 100 000
Fixtures and fittings 37 000
One motor vehicle 15 000
The remaining motor vehicle was taken by Chido at an agreed valuation of 9 500
Inventories 5 200

All debts were collected and banked except for bad debts totalling $900.
Discount allowed amounted to $200
Creditors were paid in full
Dissolution expenses of $1 200 were paid by cheque
Chido’s loan was repaid from the bank account.
Partners’ Current account balances were transferred top their Capital accounts.

Required
Prepare the following accounts for the month of October 2003.
a. Dissolution account {8}
b. Partners’Current accounts, in columnar form {4}
c. Partners’Capital accounts, in columnar form {4}
d. The partnership Bank account {8}

QUESTION 2

66 | P a g e T I N O F A M B A N E V A N O F A M B A
 Adam, Eve and Pinchmee are in partnership sharing profits and losses in the ratio 3:2:1.
At 31 December 19-1 their balance sheet was as follows:
$ $
Non current assets 106 644
Current assets
Inventory 71 116
Trade receivables 42 655
Bank 24 863
138 634
Less current liabilities
Trade payables 35 278 103 356
210 000
Capital accounts
Adam 100 000
Eve 50 000
Pinchmee 25 000
175 000
Current accounts
Adam 24 000
Eve 10 000
Pinchmee 1 000 35 000
210 000
Adam decided to retire from the partnership on 1 January 19-2
Accordingly it was agreed between the partners that:
1. The balances on their current accounts would be transferred to their respective capital
accounts.
2. Goodwill would be valued at $24 000, but no goodwill would be recorded in the
firm’s ledgers.
3. Non current assets would be revalued at $100 000, inventory at $60 000 and a trade
receivables for $240 would be written as bad.
4. Of the amount due to Adam $100 000 would be transferred to a Loan account and the
balance settled in cash immediately. A bank overdraft facility would be available for
this purpose, if necessary. The loan would be repayable to Adam in for equal annual
instalments, the first being due on 31 December 19-2.
Eve and Pinchmee decided to form a limited company, Evenmee Ltd, to acquire the
partnership business on 2 January 19-2. The company had an authorised share capital
of 100 000 ordinary shares of $1 each and acquired the partnership assets and
liabilities, including the loan from Adam, at their revised book values. Shares were
issued to Eve and Pinchmee at par value in the ratio 3:2. An appropriate cash payment
was made by one of these partners to the other to adjust their rights, and the
partnership receiving the payment immediately used the cash to subscribe for further
shares in Evenmee Ltd. at par.
Required

a) The capital accounts of Adam, Eve and Pinchmee showing the entries in respect of
Adam’s retirement and the aquisition of the business by Evenmee Ltd. (18)

b) The opening balance sheet of Evenmee Ltd as at 2 January 19-2. (7)

67 | P a g e T I N O F A M B A N E V A N O F A M B A
 MANUFACTURING ACCOUNTS
Companies which manufacture products will need to know the costs associated with
producing a single product as this will help them in fixing selling price so as to obtain
profit. These companies will have to first prepare a manufacturing account before
preparing a trading account. In other words the main purpose of preparing a
manufacturing account is to ascertain the cost of production.
Manufacturing account sections
a) Prime cost section
I. Direct material
II. Direct labour
III. Other direct expenses
b) Factory overheads section
I. Indirect material
II. Indirect labour
III. Other indirect expenses
Preparing a Manufacturing Account
There are other costs which relate to both Manufacturing Account and Income
Statement Account and they need to be apportioned using the ratios given on the
question. Adjustments for accruals and prepayments should be done first before
apportioning the overheads.
Profits/losses on manufacture
Firms producing their own goods usually do so because they can make them more
cheaply than they can buy them from outside. The difference between costs of
manufacture and costs of goods bought outside is factory profit. If cost of production
is greater than the cost of buying similar products from outside this will result in a
loss.
Elimination of unrealised manufacturing profit from unsold stocks of unfinished
goods
Manufactured goods may be transferred to the Income Statement Account at cost plus
manufacturing profit . The issue will be on unsold stock which will include factory
profit. The profit can only be realised when stock is sold. This profit need to be
eliminated through the creation of a provision for unrealised profit. This is done in
order to comply with the prudence concept. Adjustment for unrealised profit on stock
should only be made if required by the question.

68 | P a g e T I N O F A M B A N E V A N O F A M B A
 LAYOUT OF A MANUFACTURING ACCOUNT

Opening stock of raw materials XX

Add Purchases of raw materials XX
Carriage inwards of raw materials XX
Less Returns inwards on raw materials (XX) XX
Less closing stock of raw materials (XX)
Cost of raw materials consumed XX
Add Direct wages XX
Direct labour XX
Direct expenses (royalties) XX
Patent fees XX XX
Prime cost XX

Add Factory overhead expenses

Indirect material XX
Indirect labour XX
Rent and rates XX
Heating and lighting XX
Depreciation-machinery XX XX
Gross manufacturing cost XX
Add Opening work in progress XX
Less Closing work in progress (XX) XX
Cost of goods manufactured XX
Add Manufacturing profit/(loss) XX
Market value of goods manufactured XX

Income Statement for the year ended ………

Sales of finished goods XX
Less returns inwards of finished goods XX
Net sales/ turnover XX

Less cost of goods sold

Opening stock of finished goods XX
Add market value of goods manufactured XX
Goods available for sale XX
Less closing stock of finished goods XX XX
Gross profit on trading XX
Add discount received XX
Total income XX
Less Administration overheads i.e office salaries XX
Dep of non production fixed assets XX XX
Net profit XX
Add Manufacturing profit/ (loss) XX
Less Increase in provision for unrealised profit XX XX
Overal profit XX

69 | P a g e T I N O F A M B A N E V A N O F A M B A
Statement of financial position extract of current assets

Current assets
Inventory: Raw materials XX
Work in progress XX
Finished goods XX
Less : Provision for unrealised profit XX XX
XX

EXAM TIPS - MANUFACTURING ACCOUNTS

 It is vital that you learn the correct sections of the final accounts of the manufacturing
organisation - prime cost, factory overheads, and trading and profit and loss account.
 Only items directly linked to the level of output will appear in the prime cost
calculations.
 Items related to production but not directly will appear in the factory overheads
section of the manufacturing account.
 When considering depreciation, only depreciation of productive assets (such as
machinery) will appear in the manufacturing account.
 Show all your workings for adjustments (e.g. show the calculations for cost of raw
materials consumed).
 Look out for any factory profits which will be 'marked-up' at the end of the
manufacturing account.
 If factory profit has been added then make sure you add it again at the end of the
profit and loss account - to cancel out of the effect of increasing production cost.
 It is the change in the provision of unrealised profits that will appear in the profit and
loss account!
 The full provision for unrealised profits will be deducted form finished goods on the
balance sheet.
 Show all kinds of (closing) stocks on the balance sheet.
 Never put items in twice - you will automatically get no marks for this item - if you
don't know then take an (educated) guess.

70 | P a g e T I N O F A M B A N E V A N O F A M B A
EXTRA WORK
Hunter Power Limited decided to start manufacturing their own products in order to minimise
costs. Table below shows the firm’s balances at 31 December 2013.
$
Plant and machinery at cost 150 000
Provision for depreciation: plant and machinery(at 1 January) 8 000
Motor vehicles at cost 62 000
Provision for depreciation: motor vehicles(at 1 January) 6 000
Furniture and fittings at cost 10 000
Raw material purchases 210 000
Inventory(stock) at 1 January 2013:
Raw materials 32 500
Work in progress 24 000
Finished goods 52 800
Patent fees 5 800
Selling expenses 22 100
Factory salaries 12 000
Turnover (sales) 400 000
Capital: Tana 120 000
Chana 140 000
Cash and cash equivalents 64 000
Lubricant oils 15 000
Notes:
1. Inventory(stock) at 31 December 2013
Raw materials $19 800
Work in progress $21 300
Finished goods (to be determined)
On 29 December 2013,a fire broke out in the warehouse and destroyed raw materials
valued at $11 000. The inventory was not insured.
2. No record was made in the books for $3 000 spent during the year on putting extra
headlights on the motor vehicles.
3. The firm’s depreciation policy was as follows:
Plant and machinery - 10% per annum reducing balance
Motor vehicles - 20% per annum straight line
The furniture and fittings were purchased on 2 January and their useful life is ten
years, scrap value $500.
4. Depreciation on motor vehicles is a factory expense whilst depreciation on furniture
and fittings is an administrative expense.
5. On 1 January 2013, $1 200 was owed for lubricants whilst $800 was outstanding at 31
December 2013.
6. Goods are transferred to the warehouse at a mark up of 10%.
7. The partnership maintains a provision for unrealised profit account. The balance on
this account was $4 800 on 1 January 2013 and $6 000 on 31 December 2013. The
rate of factory profit remained unchanged during the year.
Required
a) For the year ended 31 December 2013, the partnership
(i) Manufacturing account, {12}
(ii) Statement of comprehensive income(profit and loss account) {9}
An appropriation account is not required.

71 | P a g e T I N O F A M B A N E V A N O F A M B A
 STOCK VALUATION
QUESTION 1

Simba, a retailer whose financial year ends on 31 May, failed to check his stock until 8 June
2009. At that date his stock at cost was valued at $72 200. Simba’s mark up is 30% on cost.

During the first ten days of June, the following transactions took place;

i) Purchases of goods for resale 21 200

ii) Purchases returns 515
iii) Sales 25 740
iv) Sales returns ( at selling price) 273
v) Goods taken for personal use, at cost 700

After taking stock, Simba discovered that the following items had
been included in the valuation at 8 June:

vi) A parcel of stock which had been water –damaged. This had been on
sale for $390 but was now worthless.
vii) Stock which cost $1 200 but was now out of fashion and would have to
be sold for $400 less than cost.
viii) Goods costing $950 which Simba had acquired on a sale or return
basis. He had not decided whether or not to keep them.
ix) Goods, sold during May for $1 560, which were awaiting collection by
a customer.

Required

(a) The value of inventory at cost, at 31 May 2009. (13)

(b) What is the basis for stock valuation (3)

72 | P a g e T I N O F A M B A N E V A N O F A M B A
 QUESTION 2

The annual stock taking of Square Deals Limited, retailers, did not take place on 30
September 1997 owing to staff illness.

The company’s books and records for the year ended 30 September 1997 reveal :

1. Sock at 1 October 1996, at cost, of $17 800.

2. Purchases of $165 000.
3. Purchases returns of $8 500.
4. Sales of $182 000.
5. Sales returns of $3 600.
6. In July 1997, stock costing $10 000 was stolen. As the company’s insurance did not
fully cover the loss, the amount received from the insurance company in full
settlement of the loss claim was only $4 500.
7. In August 1997 a quantity of stock which had cost $3 700, was found to be of no
value and therefore destroyed.
8. The company earns a gross profit of 35% on all sales.
9. In September 1997, goods costing $6 500 were sent on a sale or return basis to
Thomas Strong. 90% of these goods were sold by 30 September 1997 and these were
additional to the sales given in 4. above.
Thomas Strong receives from Square Deals Limited, a commission of 10% on the
selling price of all sales.

REQUIRED

(a) Calculate
i. The company’s Stock at 30 September 1997;
ii. The company’s Gross Profit for the year ended 30 September 1997
iii. The amount of Commission payable to Thomas Strong on 30 September 1997.

(b) i. Explain briefly why stocks in annual accounts are usually valued ‘at cost’.
ii. State an alternative to cost for stock valuation and explain when this
alternative method would be used.

73 | P a g e T I N O F A M B A N E V A N O F A M B A
 CASH FLOW STATEMENTS
A cash flow statement shows sources of cash and how cash has been spent. In other words
cash flow statements explain the reasons for cash increases/decreases over a specified period
of time.
Importance of cash flow statements
-lt shows: -stability of the business
-ability of a business to generate cash internally
-how much cash has been raised externally
-viability of the business whether it can generate cash to service finance
-liquidity and solvency of a business

Differences between Cash flow statement and Income Statement

Cash flow statement Income Statement

Do not include non cash items like Include non cash items like depreciation

depreciation

Cash flows records capital expenditure Capital expenditure items are not recorded
items

Cash flows are prepared on cash basis Profit and loss accounts are prepared on
accrual basis

Differences between Cash flow statement and Budget

Cash flow statement Budgets

Based on historical data Based on future plans

Cannot(legally) be manipulated May be adjusted to reflect management

policy

May be used internally or externally For internal use

Preparing cash flow statements

The easiest way to prepare a cash flow statement is to first prepare ledger accounts where
necessary these are asset account, provision for depreciation account, disposal account, tax
paid and dividends paid. What you will need to do is compare the figures of the two balance
sheets to check for any decrease or increase but do not ignore these ledger accounts. The
asset account, provision for depreciation account, disposal account have been dealt with
earlier on the topic of depreciation.

74 | P a g e T I N O F A M B A N E V A N O F A M B A
 Calculating tax paid and dividends paid

Taxation Account
$ $
Tax paid (balancing figure) XX Tax(1st balance sheet) XX
Tax paid (2nd balance sheet) XX Profit and loss(tax in P/L Account) XX
XX XX

Dividends Account
$ $
Dividends paid (balancing figure) XX Proposed dividends(1st balance sheet) XX
Proposed dividends (2nd balance sheet)XX Profit and loss(dividends in P/L account) XX
XX XX

NB: Please when preparing the dividends account make sure you take into account interim
dividends, final dividends , dividends proposed and paid.

At times a question may require you to calculate operating profit or may be silent on this
aspect hence you need to know how it is calculated.

Calculating operating profit

$ $
nd
Retained profit c/d {2 date- Statement of financial position} xx
Less: Retained profit b/d {1st date- Statement of financial position} xx
xx
Add Transfer to general reserve xx
Capital Redemption Reserve xx
Debenture interest xx
Interim dividends paid xx
Proposed dividends paid xx xx
Operating profit xx

75 | P a g e T I N O F A M B A N E V A N O F A M B A
 QUESTION 1

The Quartet is a partnership which owns a manufacturing firm. The balance sheets of the firm
as at 31 December 2004 and 2005 are given below.

As at 31December 2004 2005

Assets $000 $000 $000 $000
Non-current asset
Premises at cost 1 000 1 300
Provision for depreciation (375) 625 (26) 1 274

Plant and equipment at cost 600 1 400

Provision for depreciation (240) 360 (700) 700

Motor vehicles at cost 840 1440

Provision for depreciation (504) 336 (864) 576
1 321 2 550
Current assets
Inventory 750 810
Trade receivables 649 540
Bank 400 1 799 380 1 730
3 120 4 280

Equity and liabilities

Partner’s capitals at 1 January2 330 2 600
Add revaluation - 675
Net profit 566 739
2 896 4 014
Less drawings 296 2 600 334 3 680

Trade payables 520 600

3 120 4 280
Notes
i. The premises were revalued on 1 July 2005.
ii. During 2005, motor vehicles which had cost $180 000 (net book value $36 000)
were sold for $30 000.

Required
a. A cash flow statement for the year ended 31 December 2005. (12)
b. State and explain five benefits of preparing cash flow statements.(10)

76 | P a g e T I N O F A M B A N E V A N O F A M B A
 QUESTION 2

The balance sheets of Magnum Ltd as at 31 December 19-8 and 19-7 are as follows:
31.12.19-7 31.12.19-8
$ $
45 000 Fixed assets(net book value) 60 000
Current assets:
25 000 Stock 27 000
10 000 Debtors 12 000
7 000 Bank -
87 000 99 000
Share capital:
22 000 Ordinary shares of 25cents each 27 000
24 000 Preference shares of $1each 7 000
- Capital Redemption Reserve 17 000
280 Share Premium Account 420
18 460 Retained Earnings 25 060
64 740 76 480
Current liabilities:
13 860 Creditors 8 500
5 600 Taxation 7 000
2 800 Proposed dividends 4 200
- Bank 2 820
87 000 99 000
Notes:

1) A summary of the company’s fixed assets account in the general ledger for the year
ended 31 December 19-8 is shown below.
$ $
1 Jan 19-8 Cost b/f 106 400 31 Dec 19-8 Disposal A/c 11 200
31 Dece 19-8 Additions 30 800 31 Dec 19-8 Cost c/f 126 000
137 200 137 200

The assets were sold for $2 520, which represented a loss of $4 480 compared with
their book value.
2) A bonus (scrip) issue of 1 000 shares was made during the year, the shares being paid
up from the balance standing to the credit of the Share Premium Account.
3) The preference shares were redeemed at par in November 19-8

Required

a) Profit and Loss Appropriation account for the year ended 31 December 19-8 {5}
b) Cash flow statement for the year ended 31 December 19-8 {15}
c) Differences between bonus issue and a rights issue {6}

77 | P a g e T I N O F A M B A N E V A N O F A M B A
 REDEMPTION OF SHARES
SHARE REDEMPTION

1. Redemption of shares and payment

Dr Preference shares
Cr Bank

2. Premium on redemption financed from the share premium

Dr Share premium
Cr Bank

3. Premium on redemption financed from the profit and loss reserves

Dr Profit and loss
Cr Bank

4. Transfer from the profit and loss reserve to the capital redemption resesrve
Dr Profit and loss
Cr Capital Redemption Reserve

When a question asks you to utilize the reserves in such a way as to leave the
remaining reserves in the most flexible form you use.

SH RE CA GAP

SH –Share premium

RE –Revaluation reserves

CA-Capital reserve

G-General reserve and

P-Profit/Retained earnings

Statement of changes in equity for the year ended

Ordinary Share General Retained Total

Share Premium Reserve Earnings Equity
Capital
$ $ $ $ $
Balance at start XX XX XX XX XX
Transfer to general res XX (XX) -
Dividends paid (XX) (XX)
Issue of ordinary shares XX XX XX
Profit for the year XX XX
Balance at end XX XX XX XX XX
Entries in a statement of changes in equity will depend on the requirements of a question
But above is a mere layout that will give you direction when preparing one.

78 | P a g e T I N O F A M B A N E V A N O F A M B A
 ISSUE AND REDEMPTION OF SHARES

Reserves
There are different types of reserves.

Revenue reserves
These are profits which are ploughed back into the company by debiting profit and loss
account and crediting the appropriate account. They can also be used in future years to help
increase profits. However they are available for dividend purposes as well as issue of bonus
issues. Examples include retained earnings and general reserve.

General reserves
These reserves are necessary when reinforcing the financial position of the company.

Capital reserves
These are specifically used when issuing bonus shares and they cannot be used to pay cash
dividends or transferred to the profit loss account.

Revaluation reserve
It is created when an asset has been revalued to reflect an increase or decrease in value. The
journal entry will be to debit the asset account with the increase and then credit the
revaluation account or vice versa when there is a decrease.

Capital redemption reserve

This reserve is created when shares are redeemed out of internally generated funds so as to
protect the interests of creditors. It is created by transferring amount equal to the nominal
value of shares being redeemed from a suitable reserve to the capital redemption reserve. It is
also used when a company redeems shares otherwise than out of the proceeds of a new issue
of shares. It can be recorded by debiting the profit and loss account and crediting capital
redemption reserve.

Share premium
It is the amount above the face value of a share at which it may be issued, for example a $1
share may be issued at $1.10.The $1 is credited to the share capital account whilst the $0.10
is credited to the share premium account. It is used as follows:
-to write off preliminary expenses on formation of the new company
-to pay up unissued shares as fully paid up bonus shares
-to write off expenses incurred in shares issue
-to provide any premium payable on the redemption of shares or debentures

Bonus issue
It is the issue of additional shares to existing shareholders in proportion to their
current shareholders by the utilisation of capital reserves.

Rights issues
This is the issue of shares to existing shareholders at the price lower than the ruling
market price.

79 | P a g e T I N O F A M B A N E V A N O F A M B A
 Differences between bonus shares and rights issues
Bonus shares Rights issues

Total shareholders funds remain the Total shareholders funds increases

same

Issued free of charge Issued at a price less than the market value of
shares

Bonus issue has no effect on current Increases current assets(bank balance)

assets

All ordinary shareholders participate in In a rights issue some shareholders may

choose not to take up their rights
a bonus issue

Differences between revenues reserves and capital reserves

Revenue Reserves Capital Reserves

Created voluntarily out of trading Created under the provisions of the

profit by debiting P/L Appropriation Companies Act and by case law

A/C and crediting reserve accounts

Can be distributed as cash dividends Cannot be distributed as cash dividends

Used for purposes for which they were Uses specified by law

created or at the discretion of the Directors

REDEMPTION OF SHARE
80 | P a g e T I N O F A M B A N E V A N O F A M B A
A per Companies Act 1985 (Amended 1989):

 A company is not allowed to redeem its share capital (repurchase of shares) unless the shares
were originally issued as redeemable.
 The Article of Association of the Company should permit the company to issue redeemable
shares.
 The Company is required to first issue irredeemable (permanent) shares before issuing the
redeemable shares.
 The company may redeem its Redeemable shares as follows:
1. Through issue of new shares to provide funds for the redemption.
2. Through internal funds by creating a “Capital Redemption Reserve”.
3. Combination of both – a partial issue of new shares and the balance from internal funds.

Rules for creation of Capital Redemption Reserve:

(i) Creation of CRR, if no new shares are issued to financed the redemption:

A company redeeming its share capital from internal funds, that is without issue of new shares to
finance the redemption, is required by the Companies Act to create a Capital Redemption Reserve
equal to the nominal value of share capital redeemed, out of distributable profits. It means the profits,
which were available for payment of cash dividends to the ordinary shareholders, are no more
available due to redemption of share capital and they have been blocked into Capital Redemption
Reserve account. The purpose of creating the Capital Redemption Reserve is to protect the creditors.

(ii) Creation of CRR, if the redemption is financed partially:

In case, the company finances the redemption of share capital partially, then the amount of Capital
Redemption Reserve will be equal to the difference between the nominal value of share capital
redeemed and cash received from issue of new shares, including share premium.

Rules for treatment of Redemption premium:

The redeemable shares may be redeemed at par or at premium. The premium paid on redemption of
shares may be charged to share premium account, subject to following rules:

1. The shares being redeemed at premium should have originally been issued at premium and
redemption premium should not exceed the amount of premium received originally.
2. The shares being redeemed at premium are financed, fully or partially, through issue of new
shares.
3. There should be sufficient balance in the share premium account. The share premium account
should not end up with a debit balance.

REDEMPTION OF DEBENTURES:

81 | P a g e T I N O F A M B A N E V A N O F A M B A
There is no legal obligation to create a “Debenture Redemption Reserve” on redemption of
debentures, because the debentures are themselves creditors. However, it is purely a matter of
discretion to the company to create a Debenture Redemption Reserve, to preserve the capital structure
of the company.

Any premium paid on redemption of debentures may be charged to Share Premium account, provided
a balance exists in share premium account, irrespective of whether the debentures were original issued
at premium or not, or the redemption is being financed by issue of new debentures or not.

DIFFERENT SITUATIONS OF CAPITAL REDEMPTION:

Situation 1
A company redeemed its 200,000 6% Preference share capital of $1 each at a premium of $0.10.
Originally these shares were issued at a premium of $0.05 per share. There was no issue of new shares
to finance the redemption.

Debit Credit
6% Preference Share Capital (200,000 x $1) 200,000
Profit and Loss A/c (200,000 x $0.10) 20,000
Bank A/c (200,000 x $1.10) 220,000

Profit and Loss A/c 200,000

Capital Redemption Reserve 200,000

Although the preference shares being redeemed were originally issued at premium but the
redemption is not being financed by issue of new shares, therefore, the entire redemption
premium will be charged to the Profit and Loss Account.
Since the redemption is not financed by issue of new shares, therefore, it is required to create a
CRR equal to the nominal value of share capital redeemed.

Situation 2
82 | P a g e T I N O F A M B A N E V A N O F A M B A
 To finance the redemption, a company issued 150,000 ordinary shares of $1 each at a premium of
$0.25 per share. There were 100,000 8% Preference shares of $0.75 each, which were redeemed at a
premium of $0.10 per share. These shares were originally issued at par.

Debit Credit
Bank A/c (150,000x$1.25) 187,500
Ordinary Share Capital (150,000x$1.00) 150,000
Share Premium A/c (150,000x$0.25) 37,500

8% Preference Share Capital (100,000x$0.75) 75,000

Profit and Loss A/c (100,000x$0.10) 10,000
Bank A/c (100,000x$0.85) 85,000
Since the redemption is financed through issue of new shares and cash received is more than
the nominal value of share capital redeemed, therefore, this situation does not involve creation
of any CRR.

The Preference Shares being redeemed at premium were originally issued at par, therefore, the
redemption premium will be charged to Profit and Loss Account.

Situation 3
A company redeemed its 180,000 8% Preference share capital of $1 each at a premium of $0.15 per
share by issuing equal number of 6% Preference shares of $0.50 per share at par. The shares being
redeemed were originally issued at a premium of $0.25 and there exist sufficient balances in share
premium and Profit & Loss accounts.

Debit Credit
Bank A/c (180,000x$0.50) 90,000
6% Preference Share Capital (180,000x$0.50) 90000

8% Preference Share Capital (180,000x$1.00) 180,000

Share Premium A/c (180,000x$0.15) 27,000
Bank A/c (180,000x$1.15) 207,000

Profit and Loss A/c (180,000 -90,000) 90,000

Capital Redemption Reserve 90,000
The redemption is being financed partially, that is, the cash received from issue of new shares is less then
the nominal value of capital redeemed, therefore, a CRR for the difference will be created.

Since the redemption premium of $27,000 (180,000 x $0.15) is less then the amount of share premium
received originally at the time of issue of these share i.e. $45,000 (180,000 x $0.25), and there exist
enough balance in the share premium account, therefore, the entire redemption premium will be charged
to the Share Premium Account.
Situation 4

83 | P a g e T I N O F A M B A N E V A N O F A M B A
 A company issued 100,000 6% Preference share of $1 at a premium of $0.15 per share to finance
the redemption of 200,000 8% Preference shares of $0.50 at a premium of $0.15 per share.
Originally, these shares were issued at a premium of $0.10 per share, which was utilized for issue
bonus shares to the ordinary shareholders and there is no balance in the share premium account.

Debit Credit
Bank A/c (100,000x$1.15) 115,000
6% Preference Share Capital (100,000x$1.00) 100,000
Share Premium A/c (100,000x$0.15) 15,000

8% Preference Share Capital (200,000x$0.50) 100,000

Share Premium A/c 15,000
Profit and Loss A/c 15,000
Bank A/c (200,000x$0.65) 130,000

Since the redemption is financed through issue of new shares and cash received is more than the
nominal value of share capital redeemed, therefore, this situation does not involve creation of CRR.

Although the share capital, being redeemed, was issued at premium of $20,000 (200,000 x $0.10)
and now being redeemed at a premium of $30,000 (200,000 x $0.15), therefore, $20,000 could be
charged to share premium account subject to a balance in the share premium account, but there is no
balance available in the share premium account. Therefore, the redemption premium to be charged
to the share premium account will be equal to the premium received from issue of new share that is
$15,000, so that the share premium account should not end up with a debit balance. The balance of
redemption premium will be charged to Profit and Loss account

Situation 5
A company, which had issued 100,000 8% Preference share capital of $1 at par, redeemed its
share capital at premium of $.15 per share. To finance the redemption, the company issued
100,000 6% Preference shares of $0.50 each at $1.15.
Debit Credit
Bank A/c 115,000
6% Preference Share Capital 50,000
Share Premium A/c 65,000

8% Preference Share Capital 100,000

Profit and Loss A/c 15,000
Bank A/c 115,000
Since the redemption is financed through issue of new shares and cash received is more than the
nominal value of share capital redeemed, therefore, this situation does not involve creation of
CRR.

The Preference Shares being redeemed at premium were originally issued at par, therefore, the
redemption premium will be charged to Profit and Loss Account.
QUESTION 1

84 | P a g e T I N O F A M B A N E V A N O F A M B A
Digits Ltd’s Statement of financial position at 30 April 2010 was as follows:

$000
Non-current assets 1 300
Net current assets 740
2 040

Ordinary shares of $1$ 1 200

10% preference shares of $1 300
Share premium account 200
Profit and Loss Account 340
2040
On 1 May 2010, before any further transactions had taken place, it was decided to redeem all
the preference shares at a premium of $30. The shares had been originally been issued at
$1.20 per share. In order to provide funds for the redemption, the company issued a further
100 000 ordinary shares at a premium of $0.25.

REQUIRED

Prepare Digits Ltd’s Statement of financial position as it will appear immediately after the
issue of additional ordinary shares and the redemption of the preference share capital.

QUESTION 2
Larry Ltd’s summarised Statement of financial position (Balance Sheet) at 30 June 2010 was
as follows:
$000
Ordinary shares of $2 each 2 400
10% Preference shares of $2 each 600
Share premium 400
Profit and loss account 680
4 080
Non-current(Fixed) assets 2 600
Net current assets 1 480
4 080

On 1 July 2010, fixed assets were revalued to $2 850 000 and the company decided to redeem
all the preference shares at a premium of $0,60 per share. These shares have been issued at
$2,40 each. In order to provide funds for the redemption, the company issued a further 100
000 ordinary shares at a premium of $0,50 per share.
Required
Larry Ltd’s Statement of financial position (Balance sheet) immediately after the capital
reconstruction.

ACCOUNTING RATIOS
85 | P a g e T I N O F A M B A N E V A N O F A M B A
Benefits of ratios
 help to analyse past results
 to compare company/business perfomances

Shortfalls of ratios
 they are based on historical figures
 they need to be analysed for successful conclusion
 ratios only show the results of carrying on a business but do not indicate the causes of
poor ratios hence further.
 ratios can only be used to compare same type of businesses that is like-with-like
business
 ratios may be misleading if there are not adjusted for inflation.
 ratios ignore seasonal fluctuations.

TYPES OF RATIOS

1.PROFITABILITY RATIOS

Gross profit percentage

Gross profit
x 100
sales
Net profit percentage

Net profit
x100
sales

Return on capital employed (ROCE)

Profit before interest

x 100
capital employed
Return on equity

Profit afetr interest , tax∧preference dividends

x 100
ordinary s h are capital plus reserves

2.LIQUIDITY RATIOS

Current ratio (working capital ratio)

Current Assets
Current liabilities

Quick ratio/ Acid test/ Liquid ratio

Current Assets less Inventory

Current liabilities
Rate of stockturn

86 | P a g e T I N O F A M B A N E V A N O F A M B A
 Cost of sales
Average stocks

Debtors ratio
Debtors
x 365
Credit sales

Creditors ratio
Creditors
x 365
Credit purc h ases

3.INVESTMENT RATIOS

This group of ratios is commonly used by listed companies to assist investors with more
information. These types of ratios tend to trouble pupils a lot and a clear explanation have
been given on each ratio.

Interest cover
This ratio shows the ability of the company to service its long term borrowing out of current
profits.

Profit before interest ∧tax

lnterest c h arges
Earnings per share
This ratio is often used by potential investors when deciding whether the return on their
investment is worth the risk taken. It is a measure of how successful a company is.

Profit after interest , tax∧preference s h ares

Total number of ordinary s h ares

Price earnings ratio

This ratio measures the number of times the current market price exceeds the current earnings
per share. It shows how many current year’s dividends would be needed to purchase the
shares at today’s price.

Market price of s h are

Earnings per s h are

Dividend cover
This ratio indicates the number of times current dividends can be paid out of the
profits after tax.

Profit after interest , tax less preference dividend

Ordinary dividend paid

87 | P a g e T I N O F A M B A N E V A N O F A M B A
Dividend yield
It expresses the shareholders dividend as a percentage of the market value of the share. It
shows the investors return on investment.

Norminal value of s h are

x 100
Market price ofs h are

Declared rate of dividend is found by

Ordinary dividend paid

x100
Number of Ordinary S h ares

Earnings yield
This ratio expresses the earnings of a company as a percentage of the market price
of its share.

Profit after interest , tax∧preference dividends

Market price per s h are X Numberof s h ares

Or

Dividend yield X Dividend cover

Dividend per share

This ratio is concerned with dividend paid in an accounting period per share.

Ordinary divedend paid

x 100
Total number ofordinary s h ares

Gearing ratio

¿ cost capital
x 100
Total capital

It refers to the extend or degree to which a business is financed by debt capital. A firm is said
to be highly geared if it depends more on debt capital than equity. Debt capital (Fixed cost
capital) includes debentures, long term bank loans and preference share capital. Equity is
made up of Ordinary Shares Capital and Reserves.

88 | P a g e T I N O F A M B A N E V A N O F A M B A
 QUESTION 1

Abel Ltd Ticks Ltd

Operating profit $360 000 $252 000

Dividend cover 5 times 7 times

Transferred to General Reserve $100 000 $60 000

Additional information for the year ended 31 December 2017:

Abel Ltd Ticks Ltd

Share capital: ordinary shares of $1.00 $1 000 000

ordinary shares of $0.25 $600 000

5% preference shares of $10 $400 000

8% preference shares of $1 $300 000

10% debenture stock 2018/2019 $300 000 $180 000

Required
a) prepare an extract of the Income Statement for the year ended 31 December 2017 for :
i. Abel Ltd
ii. Ticks Ltd {12}
At 31 March 2003 the market prices of the ordinary shares were as follows:
i. Abel Ltd $1.60
ii. Ticks Ltd $1.35

b) Calculate the following ratios for each company, showing all workings.
i. Interest cover
ii. Earnings per share
iii. Dividend paid per share
iv. Price earnings ratio
v. Dividend yield {10}
c) Compare and comment briefly on the rations for Power Ltd and Hunter Ltd in
(b) {10}

89 | P a g e T I N O F A M B A N E V A N O F A M B A
 QUESTION 2

The Statement of financial position of Boyd Limited on 31 December 2007 showed the
following information:

$ (000)
Ordinary shares of $2 each 36 000
8% Preference shares of $1 each 18 000
General reserve 3 600
Profit and loss account 7 440
12% Debentures 24 000

During the year ended 31 December 2008, Boyd made an operating profit of $10 080 000.
The directors made the following recommendations on 31 December 2008:

1. An amount of $1 200 000 was to be transferred to the general reserve.

2. An ordinary dividend of 20 cents per share was to be paid.
The market value of ordinary shares was $4,80 on 31 December 2008.
Required
a. Boyd’s appropriation account for the year ended 31 December 2008

b. Calculate the following ratios for 2008 showing all workings.

i) Return on ordinary shareholders’ funds

ii) Gearing
iii) Earnings per share
iv) Interest cover
v) Dividend cover
vi) Price earnings ratio
vii) Dividend yield

90 | P a g e T I N O F A M B A N E V A N O F A M B A
 MARGINAL COSTING
It is the cost of producing one additional unit.

Marginal costing income statement

Sales XX
Less: Variable costs
Direct materials XX
Direct labour XX
Variable overheads XX
XX
less closing stock XX XX
Gross profit margin XX
Less: Variable Selling and distribution expenses XX
Contributioin XX
Less : Fixed costs XX
Net profit XX

Marginal costing valuing of closing stock

Closing units
x Direct production costs
Total units produced

Advantages of marginal costing

 leads to stable price setting
 it ensures that all costs will be covered in the long run
 it values stock so that costs are matched with revenues

Disadvantages of marginal costing

 it is not good for tactical pricing since it puts much emphasis on contribution
 ignores fixed costs when calculating marginal cost
 it is not good for strategic planning since it ignores fixed costs

Differences between marginal costing and absorption costing

Marginal Costing Absorption Costing

-not so good for product pricing -good for product pricing

-it is good for tactical decision making -it is good for strategic decision making

-excludes fixed manufacturing -fixed production overheads are included in

overheads from stock valuation finished goods stock

91 | P a g e T I N O F A M B A N E V A N O F A M B A
 CLASSIFICATION OF COSTS

Variable costs
These are costs that will increase in direct proportion to the number of units produced.

Semi-variable costs

These costs have a relationship with the number of units produced but not in direct proportion
to them. These costs increase in stages. A firm may need one foreman for every five workers
but as production increases so do the number of workers. If three more workers are added the
foreman will have to cope with supervising a large group of workers. Five more workers will
need another foreman.

Fixed costs

These are costs which have no relationship with production and are generally payable at the
same amount whether the firm makes no products or thousands of products.

Assumptions and limitations of break-even charts

Assumptions Limitations

Fixed costs remain fixed Rent and other expenses may increase

Selling price is constant Competition may force lower prices

Sales mix does not change Demand forces change

Breakeven based on one product Few produce only one product

Costs are either fixed or variable Some costs are semi-variable

EXAMPLE SEPARATING FIXED AND VARIABLE COSTS

The following are results of the last two months trading at Fictitious limited.
Revenue Total costs Profit
Month 1 $220 000 $200 000 $20 000
Month 2 $280 000 $245 000 $35 000
Total costs consists of fixed costs which do not vary from month to month and variable costs
which vary directly with sales revenue.
Required
i. Monthly fixed costs
ii. Contribution to sales ratio
iii. Break even level of sales
Solution
92 | P a g e T I N O F A M B A N E V A N O F A M B A
 I. Use of high low method to solve for fixed costs
High Low Difference
Sales $280 000 $220 000 $60 000
Costs $245 000 $200 000 $45 000

C h ange ∈costs
Variable costs =
C h ange ∈sales

$ 45 000
 = $0.75 Month 1 sales :$220 000 x $0,75=$165 000
$ 60 000

 Total costs - Total variable costs= Fixed costs

$200 000 - $165 000 = $35 000

II. Contribution to sales ratio

Sales−variables costs
Sales

$ 220 000−$ 165 000

$ 220 000

=$0,25
III. Break even level of sales

¿ costs $ 35 000
= $140 000
Contribution sales ratio $ 0 ,25

Mathematical approach

93 | P a g e T I N O F A M B A N E V A N O F A M B A
 a) Contribution to sales ratio
Contribution
Sales

b) Break even point(units)

Total ¿ costs ¿
Contribution per unit

c) Break even point(sales $)

Total ¿ costs ¿
Contribution sales ratio

or

Break even point(units) x selling price (unit)

d) Number of units to be sold to earn a target profit

Total ¿ costs+ profit ¿

Contribution per unit = number of units

e) Selling price to make a profit ‘P’ (30%)

Total ¿ costs+ profit ¿

Price−Variable costs

Selling price to include net profit by 30%

f) Margin of safety (units)

Budgeted output-Break even point(units)

g) Margin of safety($)

Budgeted sales-Break even point($)

Or

Profit
Contribution
ratio
sales

94 | P a g e T I N O F A M B A N E V A N O F A M B A
 h) Margin of safety ratio(percentage)

Margin of safety (units)

x 100%
Budgeted ouput

Margin of safety ($)

x 100%
Budgeted sales

HINT
Where opening stock, closing stock and sales figures are given one should be able to
determine number of units produced.

 Opening stock(units) + production(units)-closing stock(units)= sales(units)

 Sales + closing stock – opening stock = production

Applications of marginal costing

a) Pricing decision
Pricing decisions are based on a number of factors such as:
 The need to make profit
 The need to increase market share
 Economic conditions
 Utilization of resources
 Political factors, for example price regulations

b) Acceptance of order below normal selling price

A firm may be producing below capacity. Due to space capacity well wishers may
make a special request at prices less than normal offer. Management is then faced by a
scenario of deciding whether to accept or reject a special offer. The grounds of
decision are based on the added contribution obtained on condition that the fixed costs
remain unchanged. However there are other factors to consider such as:
I. The reaction of other customers to this lower price.
II. Other alternatives to this special order as the price will be lower than
normal.
Worked example
Dizzy Limited manufactures and markets drinks for $2 per can. Current output is 800
000 cans per month which represents 80% of capacity. There is an opportunity to
utilize the spare capacity by selling the product at $1,3 per can to a supermarket chain
who will sell it as an “own label” product. Total costs for the last month were $1 200
000 of which $320 000 000 were fixed costs. These represented a total cost of $1,5
per can.
Required

Based on the above data should Dizzy Ltd accept the supermarket order.

95 | P a g e T I N O F A M B A N E V A N O F A M B A
 Solution
Income statement to calculate profit
$
Sales(800 000 X $2) 1 600 000
Less: marginal cost(total costs- fixed costs)
$1 200 000-$320 000 880 000
Contribution 720 000
Less: fixed costs 320 000
Net profit 400 000

Marginal cost per unit

$ 880 000
= $1,1
800 000

Spare capacity

80% = 800 000

100
100% = full capacity x 800 000 = 1 000 000
80

1 000 000 – 800 000 = 200 000

Special offer from supermarket

$
Sales(200 000 X $1,30) 260 000
Less: Marginal cost( 200 000 X 1,1) 220 000
Contribution 40 000

Thus the offer looks worthwhile because there is a positive contribution hence it will help
in covering part of fixed costs.

c) Make or buy decision

This should mainly focus on relevant costs in a particular given scenario. The relevant
cost comparison is between marginal cost of manufacture and the buying in price. If
there is spare capacity the choice is simple, it is worth buying a component only if the
marginal costs incurred in production are greater than the purchase price.
Worked example
Blessing Ltd.manufactures an electric component Zim 2020 and costs for the current
production level of 1 000 units are:
Cost per unit Total cost
$ $
Direct material 1 10 000
Direct labour 2 20 000
Variable overheads 1,50 15 000
Fixed overheads 3 30 000

The buying in price for Zim 2020 is $6 per unit.

Required

96 | P a g e T I N O F A M B A N E V A N O F A M B A
 Should component Zim 2020 be bought in or manufactured?
Solution
What need to be calculated is the marginal cost per unit because whether the company
manufactures or do not manufacture they will have to pay fixed overheads.

$
Direct material 1
Direct labour 2
Variable overheads 1,5
Marginal cost per unit 4,50

Blessing Ltd. should manufacture the component Zim 2020 since the marginal cost of
manufacture is less than the buying in price.

d) Optimum use of scarce resources

Making the most profitable use of limited resources. Anything which limit the
quantity of goods that a business may produce is called a limiting factor. Raw
materials, skilled labour or shortage of demand for a particular product are all limiting
factors. When faced with limited resources a company making several different
products should use the limited resources in a way that produces the most profit.
Step 1
Calculate contribution per product/per unit
Step 2
Calculate contribution per limiting factor
Step 3
Rank the products starting with the one with the highest contribution per limiting
factor.
Step 4
Production schedule then a revised income statement

Example on material and labour shortage

Material shortage

Worked example
Mugova Ltd manufactures two products namely A and B using the same raw
materials which cost $4 per kg. The following are details relating to the products:
A B
Sales unit per period 10 000 15 000
Selling price per unit $52 $60
Unit cost : Direct material $8 $12
Direct labour $10 $14
Direct expenses $12 $16

Fixed costs for the period will be $300 000. The company was advised by its suppliers
that only 60% of its requirements will be made available during the period.
Required
a. Calculate the number of kilogrammes required per unit.
b. Determine the maximum net profit for the period taking into account the
material shortage.

97 | P a g e T I N O F A M B A N E V A N O F A M B A
 Solution

a)Kilogrammes required per unit

A B
$ $
Direct material cost per unit 8 12
Material cost per unit 4 4

Kgs per unit 2 3

b)Calculating net profit

Step 1 Calculating contribution per unit

A B
$ $
Selling price 52 60
Less: variable costs
Direct material (8) (12)
Direct labour (10) (14)
Direct expenses (12) (16)
Contribution per unit 22 18

Step 2 Contribution per limiting factor

$ 22
2 kg
$ 18
3 kg

= $11 =$ 6

Step 3 Rank order

A B
(1) (2)

Step 4
Number of kgs required (10 000unitsx 2kg) +(15 000unitsx3kg) = $ 65 000kg
Under normal circumstances the products would require:

Product A 20 000kgs
Product B 45 000kgs

Number of kgs available 60% of 65 000kg = 39 000kg

The product with a better contribution will be the one to get the first allocation
of the material that is A and then B.

Product Units Raw materials

98 | P a g e T I N O F A M B A N E V A N O F A M B A
 1 A 10 000 20 000kg
2 B 6 333 19 000kg

Product B will get the last share: workings

19 000units
= 6 333units
3 kg

Income statement to calculate profit

Product Units Contribution per unit Total contribution

$
A 10 000 22 220 000
B 6 333 18 113 994
Total contribution 333 994
Less: fixed costs 300 000
Profit 33 994

Labour shortage

Power limited makes products A, B and C. All three products are made from a
common material called ‘bee’. Planned production in units is as follows:
A B C
2 000 3 000 4 000
Additional information is as follows:

A B C
Selling price per unit $54 $50 $105
Direct material per unit 2kg 4kg 5kg
Direct labour hours per unit 3 2 6

Direct materials cost $6 per kg

Direct labour cost $10 per hour
Fixed expenses $72 000
Power limited has discovered that direct labour hours available is limited to 33 000.

Required
Revised production schedule and income statement.

Solution

Step 1 Calculating contribution per unit

A B C
$ $ $
Selling price 54 50 105
Less: variable costs
Direct material (12) (24) (30)
Direct labour (30) (20) (60)
Contribution per unit 12 6 15

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Step 2 Contribution per limiting factor

$ 12 $6
Direct labour hours
3 2
$ 15
6

= $4 p/hour =$3 p/hour =$2.5p/hour

Step 3 Rank order

A B C
(1) (2) (3)

Step 4 Production schedule

Product Units Hours

A 2 000 x 2 6 000
B 3 000 x 2 6 000
C 3 500 x 6 21 000

Product C will get the last share: workings

21000
= 3 500units
6
Income Statement

Product Units Contribution per unit Total contribution

$
A 2 000 12 24 000
B 3 000 6 18 000
C 3 500 15 52 500
Total contribution 94 500
Less: fixed costs 72 000
Profit 22 500

e) Dropping a product/ closing a department

From mere speculation of a company producing a range of products it might appear
from the net operating loss or income that one department is not profitable. It is not
appropriate to make a guess but a proper managerial decision has to be undertaken to
make precise conclusions. It is appropriate to consider whether the sales revenue
covers the variable and fixed costs. If the costs are covered then the product should
not be dropped and no department should be closed.

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 Example
Patony Ltd produces three types of washing machines A, B and C.
The following information is for the year ended 31 December 2014.
A B C

$ $ $
Sales 400 000 140 000 185 000
Less: Variable costs 300 000 100 000 110 000
Fixed costs 80 000 49 000 65 000
Profit/ (loss) 20 000 (9 000) 10 000

Patony Ltd has proposed to drop washing machine B since it is making a loss.

Required
Should Patony Ltd drop washing powder B, giving reasons

Solution
From mere looking at the example of the income statement washing machine B need
to be dropped with immediate effect. However using marginal costing approach all
the three washing machines are giving a positive contribution hence there is a profit of
$ 21 000. If washing machine B is dropped A and B will share all the fixed costs and
the profit will turn into a loss of $19 000. In summation Patony Ltd should continue
producing all the three washing machines.

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 QUESTION 1

Summer Ltd makes three products : Microne, Tetrone and Zitrone for which the following
details are given :

Product Microne Tetrone Zitrone

Direct materials {kilos per unit} 10 5 7

Direct labour {hours per unit} 8 4 6
Direct expenses {per unit} $9 $7 $4
Selling price {per unit} $115 $74 $85
Additional information

i. All three products are made from material Bitrone

ii. Bitrone costs $3 per kilo.
iii. All three products require the same type of labour which is paid at $7 per hour.
iv. Total fixed costs amount to $70 000.
v. Budgeted production {based upon maximum demand} is :

Microne 2 000 units

Tetrone 2 400 units

Zitrone 1 800 units

It has now been discovered that the supply of material Bitrone is limited to 38 000 kilos.

REQUIRED

a. Calculate the contribution per kilo of material Bitrone used for each product.
b. Prepare a revised production budget which gives the maximum profit from the
material available.

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 QUESTION 2

Golden Ltd manufactures and sells radios. The unit selling price and production costs are as
follows:
$
Selling price 800

Direct materials 100

Direct labour 90

Variable overheads 50

Fixed overheads 160

The fixed production overheads assume a monthly production of 2 000units.

The following monthly costs are also incurred:

Fixed administrative overheads $80 000
Variable sales overheads 10% of sales value
Fixed sales overheads $120 000

During the month of December 2010 a total of 2 400 units were produced of which 1 800
were sold. There was no stock on hand at the beginning of December.

Required
Combined profit statements of Marginal costing and Absorption costing. {20}

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 ABSORPTION COSTING
Absorption costing bases the cost of production on total costs that is variable costs and fixed
costs.

Absorption costing income statement

Sales XX
Less: Cost of sales
Direct materials XX
Direct labour XX
Variable overheads XX
Fixed costs-production XX
XX
Less closing stock XX XX
Gross profit XX
Less: Selling and distribution expenses XX
Net profit XX

The above Income Statement assumes that there will be closing stock.

Absorption costing valuing of closing stock

Closing units
x total production costs
Total units produced

Advantages of absorption costing

 it leads to stable price setting
 it ensures that all costs will be covered in the long run
 it values stock so that costs are matched with revenues

Disadvantages of absorption costing

 it treats all costs as the same (variable and fixed)

KEY TERMS

Overheads
This is a term used to describe the indirect and fixed expenses such as rent and rates or
depreciation. These expenses cannot be directly attributed to a specific job.

Allotment
It is the charging of costs to a cost centre when the cost was made specifically for that cost
centre.

Allocation

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If the amount of a cost is known with certainity and the department causing the overhead can
be specifically identified the cost is allocated to that department.

Apportionment
Some costs cannot be identified as arising from the activities of one specific department. The
unallocated costs are apportioned to the various production departments using area, usage,
number of staff and so on.

Under –absorption
It occurs when expenditure is higher than budgeted production or less than the planned level.

Over- absorption
It occurs when expenditure is lower than budgeted production or actual production is more
than planned level.

How overheads are apportioned

1. First identify the production and service departments.
Production departments-these departments make a direct contribution into the final
being of the product.
Service departments-theses departments render services to production departments
Yet they do not directly contribute to the actual production.

2. Allocate overheads that are clearly stated for each department(do not split the amount)

3. Apportion the remaining overheads amongst the departments which obtain benefit
from such costs.
After allocation and apportionment the totals of the production and service
departments should be worked out. Next will be secondary apportionment.

4. Secondary apportionment
Remember that service departments do not produce goods but only exist to provide a
service to production departments. The service department costs are then apportioned
to the production departments.
Other service departments render services to each other hence they are reciprocal
departments. The one rendering services to another will be the first to be eliminated.

5. After completing all the above stages(1-4) the next step is to charge these overheads
to cost units.

Formular for Overhead Absorption Rate (OAR)

Total budgeted overheads as shown on the overhead analysis sheet over Total expected level
of activity for the cost centre

Hint : The numerator is the total of the overhead analysis sheet that is after stage four. The
denominator varies with the department.

105 | P a g e T I N O F A M B A N E V A N O F A M B A
 Apportionment of overheads
Common basis of apportionment
Nature of overhead Basis of apportionment

Rent, rates e.t.c Floor area

Personel expenses Number of employers

Power expenses Number of kwh

Stores overhead Number of requisitions

Cleaning expenses Floor area

Depreciation of plant and machinery Book value of plant

Insurance of plant Replacement cost

Insurance of building Floor area

Factory supervisor’s salary Number of employees

Under-absorption will occur when:

 Actual activity is below budget or actual overheads are above budget.
Over-absorption will occur when:
 Actual activity is above budget or actual overheads are below budget.

CALCULATION OF OVER/UNDER ABSORPTION

Budgeted overheads $200 000

Production (units) 80 000

Actual results
Expenditure $215 000
Goods produced 76 000

Solution
$ 200 000
80 000
Divide budgeted overheads and units

Overhead Absorption Rate (OAR) =$2.50

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 Overhead recovered
76 000 X $2.50

= $190 000

$215 000-$190 000

= $25 000

Under absorption

However, in most cases, the actual levels of activity and actual levels of expenditure
will not be the same as the budgeted activity and expenditure.

Under-absorption will occur when:

 Actual activity is below budget or actual overheads are above budget.
Over-absorption will occur when:
 Actual activity is above budget or actual overheads are below budget

EXTRA WORK
Budgeted labour hours 10 000
Budgeted overheads $150 000

Actual labour hours 9 500

Actual overheads $160 000

SOLUTION
Budgeted overheads over budgeted labour hours

$150 000
10 000

OAR $ 15

Actual hours by OAR 9 500 X $15 = $142 500

$160 000 - $142 500 = $17 500 under absorption

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This is under absorption because actual activity is below budget and actual overheads are
above budget.

QUESTION 1

Data Ltd manufactures laptops. It has two production departments and two service
departments.

The following information for the month of May is available:

Production departments Service departments

Machining Assembly Maintenance Canteen
Overheads $400 000 $310 000 $190 000 $100 000
Number of employees 50 40 10 8
Maintenance hours 3 000 1 000
Machine hours 40 000 2 000
Direct labour hours 2 500 50 000

a. Explain the following terms:

i. Overhead allocation
ii. Overhead apportionment
iii. Overhead reapportionment {3}
b. Prepare an overhead analysis sheet to show the apportionment of service department’s
costs to the production departments. {8}
c. Calculate the overhead absorption rate (OAR) for each department, give your answer
two decimal places. {6}
d. The following information relates to the costs of producing a laptop – Digits.

Per unit data Machining Assembly

Direct materials $49 $18
Direct labour 15 minutes 3 hours
Machine hours 2 hours 10 minutes
Direct labour rate $12 per hour $12 per hour

The company achieves a mark up of 25% on all laptops.

Calculate the selling price of the Digits laptop. {9}

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 STANDARD COSTING
It is the use of standard costs in the preparation of budgets.

Standard costs-these are predetermined costs.

Standard time-this is time in minutes or hours in which a given quantity of work should be
completed.

Standard hour-this is amount of work done in an hour under efficient conditions.

Benefits of standard costing

 it enables responsibility accounting
 it provides the basis for comparing target and actual performance
 it is a motivational effect if standards are realistically set
 it also results in better quality standards because standards will have been set

Possible causes of adverse variances

Materials
Price
 poor buying decisions
 more expensive supplier
 errors
 purchasing in small quantities
 use of high quality material

Usage
 Theft
 errors
 excessive usage
 defective material

Labour
Labour rate
 use of higher grade labour
 rise in wage rate
 use of overtime labour -

labour efficiency

 use of wrong methods

 short production runs

109 | P a g e T I N O F A M B A N E V A N O F A M B A
  use of lower grade or untrained labour

Possible causes of favourable variances

Favourable price
 purchasing inferior materials
 purchasing in large quantities and getting quantity discounts

Favourable efficiency
 high morale among workers
 high grade/quality of labour
 high quality materials

Flexible budget
A flexible budget is a budget which recognises different behaviours of fixed and variable
costs at varying levels of activity.

Flexing a budget
At Advanced Level most if not all questions will require pupils to flex budgtes. A budget can
only be flexed if actual activity differs from the budgeted activity.

Example on flexing a budget

If given a budget for two levels of activity one should be able to:
 Check for direct materials per unit
 Check for direct labour per unit
 Split the overheads into variable and fixed costs

C h ange ∈costs
=?
C h ange∈units

 Multiply the answer by units of each level of activity in order to obtain the
variable costs.

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A detailed example
Power Electronics makes and sales a range of electronic motors. The following are budgets
for one of its latest models for the month of December 2015 for 300 units and 500 units.

Budget for Budget for

300units 500units
$ $
Direct materials 120 000 200 000
Direct labour 420 000 700 000
Variable overheads 360 000 600 000
Production overheads 450 000 570 000
Administration 290 000 290 000
Selling and distribution 340 000 450 000
Total 1 980 000 2 810 000

Required

A budget for 450 units

Solution
1. Direct material
$ 120 000 $ 200 000
300 500

=$400/unit =$400/unit

2. Direct labour

$ 420 000 $ 700 000

400 500

=$1 400/unit =$1 400/unit

3. Variable overheads

$ 360 000 $ 360 000

300 500

=$1 200/unit =$1 200/unit

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From the above workings you can notice that cost per unit was same hence for the 450 units
will also be same.

4. Production overheads

$ 450 000 $ 570 000

300 500

=$1 500/unit =$1 140

5. Administration
These are fixed costs since the total costs does not change because budget for
300units and 500units is $290 000.

6. Selling and distribution

$ 340 000 $ 450 000

300 500

=$1 133 =$900

One will notice that production overheads and selling and distribution expenses produced
different answers hence the need to use the high low method to separate fixed and variable
costs.

Hig h est cost−Lowest cost

= variable cost
Hig h est no . of units−Lowest no . of units

Separating production overheads

$ 570 000−$ 450 000 $ 120 000

>>>> >>> =$600/unit
500−300 200

Fixed costs = $270 000

Variable costs $600 X 450 = $270 0 00

Total costs $270 000 + $270 000 = $540 000(450units)

Separating selling and distribution expenses

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 $ 450 000−$ 340 000 $ 110 000
>>>>>>> =$550/unit
500−300 200

Fixed costs = $175 000

Variable costs $550 X 450 = $247 500

Total costs $175 000 + $247 500 = $422 500 (450units)

This is the budget for 450 units

Budget for
450units

$
Direct materials 180 000
Direct labour 630 000
Variable overheads 540 000
Production overheads 540 000
Administration 290 000
Selling and distribution 422 500
Total 2 602500

SUB-VARIANCES
MATERIAL VARIANCE

Material price variance = (standard price-actual price) x actual usage

Material usage variance = (standard usage-actual usage) x standard price

Total materials variance = (standard price x standard usage) – (actual price x actual usage)

Total materials variance can also be found by combining (adding/ subtracting ) material price
variance and material usage variance.

LABOUR VARIANCE

Labour rate variance = (standard rate - actual rate) x actual hours

Labour efficiency variance = (standard hours - actual hours) x standard rate

Total labour variance = (standard hours x standard rate) – (actual hours x actual rate)

Total materials variance can also be found by combining (adding/ subtracting) material price
variance and material usage variance.

113 | P a g e T I N O F A M B A N E V A N O F A M B A
From the sub-variances it should be noted that the actual results are deducted from the
standard (planned budget). If it produces a positive variance then it will be a favourable
balance (F) but if it produces a negative variance then it will be an unfavourable (adverse)
balance (A). After calculating variances make sure you state whether the answer(s) produced
is favourable by putting (F) or unfavourable by using (A), otherwise you will lose marks for
not indicating your answers.
Example
A. Wilkinson Limited uses a system of standard costing. The following information relates to
the week ending 4 January 1992, when standard output was achieved:

Standard Actual
Price of materials (litre) $1.50 $1.60
Usage of materials (litre) 220 200
Labour hours worked 45 48
Wage rate/hour $5.30 $5.00

From the figures above calculate the following variances. In each case state clearly
whether the variance is adverse or favourable.

a) The total labour variance

b) The wage rate variance
c) The labour efficiency variance
d) The total materials variance
e) The materials price variance
f) The materials usage variance
Solution

a) The total labour variance

(45 x $5.30) - (48 x $5) = $1.50 (A)

b) The wage rate variance

($5.30- $5) x 48 = $14.40 (F)

c) The labour efficiency variance

(45 – 48) x 5.30 = $15.90 (A)

d) The total materials variance

(220 x 1.50) - (200 x 1.60) = $10 (F)

e) The materials price variance

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 (1.50 – 1.60) x 200 = $20 (A)

f) The materials usage variance

(220 - 200) x 1.50 = $30 (F)

QUESTION 1

Sisa and Justice are concerned at the cost of manufacture. Consequently at the beginning of
2017 they decided to introduce a standard costing system.

The standard cost card for a reading desk included the following:
Direct materials - 2m3 of timber at $150/m3 = $300
1
Direct labour - 4 hours at $80 per hour = $360
2

During the year ended 31 March 2017, 2 500 reading desks were manufactured.
Actual expenditure was as follows:
5 750m3 timber at $851 000
10 500 direct labour hours at $892 500
Required
a. i. Total direct material cost variance {2}
ii. Direct material price variance {2}
iii. Direct material usage variance {2}
iv. Total direct labour cost variance {2}
v. Direct labour rate variance {2}
vi. Direct labour efficiency variance {2}

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 QUESTION 2
Kilia manufactures garden ornaments.

Budgeted revenue and costs for 10 000 units of a garden ornament are as follows:

Revenue 300 000

Costs
Direct materials (10 000kilos) 60 000
Direct labour ( at $11 per hour) 132 000
Fixed overheads 70 000

The actual revenue and costs for 18 000 units were as follows:
$
Revenue 504 000

Costs
Direct materials (17 560kilos) 119 408
Direct labour (23 000 hours) 233 450
Fixed overheads 70 000

Required
a. Prepare a flexed budget to show the difference between the budgeted profit and the
actual profit for 18 000 units. {12}

b. Prepare a standard cost statement to reconcile the budgeted profit and the actual
profit. It should clearly show the following variances:

Sales volume variance

Sales price variance
Direct material usage variance
Direct material price variance
Direct material efficiency variance
Direct material rate variance
{16}

116 | P a g e T I N O F A M B A N E V A N O F A M B A
 QUESTION 3

Musendo Power Limited manufactures garden furniture. One of the lines it produces is a bird
table and the contribution made by the bird tables to the overall company results for the year
ended 30 June 2017 was as follow :
Contribution statement for the bird tables for the year to 30 June 2017.
$ $
Sales 162 000
Less: Variable costs
Raw materials 53 280
Direct labour 47 680 100 960
61 040

Additional information

1) No opening or closing stocks of bird tables.

2) Budget and standard costs for the year ended 30 June 2017.
i) Budgeted sales of bird tables: 15 000@ $10 each.
ii) Each bird table would require 4kg of materials at a cost of 80cents per kg
iii) Three bird tables should be made per hour of direct labour.
iv) The direct labour rate is $7.20 per hour.

3) The additional results for the year ended 30 June 2017 revealed the following:
i) 18 000 bird tables were sold.
ii) 74 000 kg of raw material was used.
iii) Direct labour amounted to 6 400 hours.
Required
a) i) Sales volume variance {2}
ii) Sales price variance {2}
iii) Total sales variance {2}
iv) Raw material usage variance {2}
v) Raw materials price variance {2}
vi) Total raw materials variance {2}
vii) Direct labour efficiency variance {2}
viii) Direct labour rate variance {2}

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 h) Total direct labour variance {2}

b) Prepare a statement that shows the budgeted contribution for the year ended 30 June
2017. {4}

BUDGETS
A budget is a plan expressed in quantitative terms.

Types of budgets
Sales budget-it shows the number of sales the firm expects to make in the coming months

Production budget
It is based on the sales budget and on the necessity of keeping budgets . The production
department will state that in order to sell and produce the quantities stated by the sales
department it has to buy more materials. Usually there are two types of production budgets
that is even and uneven.

Even budget: will require a constant amount of units to be produced regularly.(hourly, daily,
monthly or yearly)

Uneven budget: units produced will not be the same always as demand will force an increase
or decrease in production.

Production budget template (units)

Production budget for 3 months to March 31

January February March

Opening stock XX XX XX
Production XX XX XX
XX XX XX
Sales XX XX XX
Closing stock XX XX XX

Stock purchasing budget

It is based on the materials and components necessary to achieve the production budget. For
production to take place there is need to purchase the material required for the purpose. The
layout is the same with that of a production budget but however a stock purchasing budget
can be prepared either in units or with the amount of purchases.

January February March

Opening stock XX XX XX
Production XX XX XX
XX XX XX
Sales XX XX XX

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 Closing stock XX XX XX

Cash budget
It includes all receipts and payments of cash based. The information used in preparing a cash
budget can be used when preparing Trade receivables and Trade payables budgets. Sales and
purchases are either sold for cash and credit.

Master budget
It is a budgeted set of final accounts drawn up on all budgeted figures.

All budgets play a pivotal role in any organisation but one need to understand that each
department will have to produce its own budget. For example if the sales department requires
5 000units of beds to sell in one month this means the production department will have to
produce a minimum of 5 000units. These shows that all budgets are important as they are
linked to each other.

QUESTION 1

(a) State three benefits of budgeting. (3)

Use the following information to answer questions (b) and (c)

Chings supplies the following budgeted information for the five months ended 31 December
2011:
Aug Sep Oct Nov Dec
$ $ $ $ $
Sales 60 000 72 000 87 000 102 000 129 000
Purchases 36 000 39 000 45 000 72 000 105 000
Rent 1 200 1 200 1 350
Wages 13 500 13 500 13 500 18 000 19 500
Sundry expenses 5 250 5 550 10 200 4 800 2 940
Provision for bad debt 3 450 3 600 4 350 5 100 6 450
Dep office furniture 1 350 1 350 1 350 1 350 1 350
Purchase of office equipment 50 000

Chings expects that:

(i) The cash balance on 1 October will be $2 010;
(ii) 10% of all sales will be on credit;
(iii) 10% of purchases will be for cash;
(iv) Trade receivables will settle their accounts in the month following sale;

119 | P a g e T I N O F A M B A N E V A N O F A M B A
 (v) Trade payables will be paid two months after purchase;
(vi) Wages, rent and other expenses will be paid as incurred;
(i) Inventory will be $21 000 on 1 October and $24 000 on 31 December.

(b) Prepare a Cash budget for each of the three months ending 31 December 2011. (14)
(c) Prepare a budgeted Income Statement for the three months ending 31 December 2011 (8)
QUESTION 2

Doctor Clarence runs a business which retails high quality clothing. It is particularly busy
during the festive season.
The budgeted sales and purchases figures for September 2015 to January 2016 are as follows:

September October November December January

$ $ $ $ $
Sales 215 000 225 000 310 000 425 000 195 000
Purchases 175 000 190 000 245 000 135 000 135 000

Additional information:

1. 50% of sales are expected to be paid for cash and these customers will receive a 6%
discount.
50% of the remaining sales are expected to be paid in the following month and these
customers will receive a 3% discount.
The remainder will pay 2 months after the sale.
2. 30% of purchases are expected to be paid for in the month of purchase and will
receive a 4% discount.
40% of purchases are expected to be paid in the month after purchase will receive a
2% discount.
The remainder are paid for 2 months after purchase.
3. The inventories held on 1 November 2015 are budgeted at $180 000.
The inventories held on 31 January 2016 are budgeted at $129 000.
4. The general expenses are budgeted at $18 000 in November 2015 with an expected
10% rise in December and a 15% reduction { on the December total} in January
2013. All general expenses are expected to be paid in full in the month in which they
occur.
5. The depreciation on the non-current assets acquired before November 2015 will be
$1 750 per month.
6. On 1 November 2015 Doctor will acquire a new storage system at a cost of $24 000
and will pay 50% of the cost immediately. The remainder will be paid in equal
instalments over the following 12 months without any interest charges.
This new non-current asset will be depreciated at 10% per annum on a monthly basis.
7. Doctor will make drawings of $3 000 every month except for December 2015. In this
month he expects to draw 1,5% of the month’s expected sales.
8. The bank balance at 1 November 2015 is expected to be $34 850.

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REQUIRED

a. A cash budget in columnar form, for the 3 months commencing with November 2015.
b. To show the Sales, Purchases, Trade receivables and Trade payables figures to be
included in the budgeted income statement and statement of financial position for this
3 month period ending in January 2016.

CAPITAL BUDGETING
Methods of investment appraisal

ACCOUNTING RATE OF RETURN (ARR)

This method uses average investment and profits. Scrap value should be added at the
end of its life including the profit of that year.
Advantages
 easy to calculate
 profitability of a project may be compared with present profitability of
business
Disadvantages
 ignores time value of money
 it ignores duration of the project
 profit is subjective(depreciation is ignored)

PAYBACK
Time taken by cash inflows to pay cash outflows. It is the time (in years) required by
the firm to recover its initial outlay. Non-cash items are ignored.
Advantages
 short payback period benefits a firm’s liquidity
 easy to calculate

Disadvantages
 time value of money is ignored that is money received after payback is not
taken seriously.
 life expectancy of project is ignored.

NET PRESENT VALUE (NPV)

This method takes into consideration the cash flows of the whole life of the
investment project and also considers the time value of money. A dollar received
today, if invested at 12% interest per annum will amount to $1,12 after a year.
Therefore a dollar in the future is less than $1 received today.
The NPV is the difference between the present value of future cash flows. It is the
present value of its expected cash flows discounted at the cost of capital. If the NPV is
positive, the project should be accepted since the present value of cash flows is
greater than the present value of cash outflows. Hence it is a gain so it should be
accepted.
However if the NPV is negative, the project should be rejected because it does not
add value to the firm.

Advantages

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  it considers all the available cash flows of the project
 it considers the time value of money by discounting future cash flows

Disadvantages
 it is too complicated to understand
 the cost of capital used by NPV is difficult to estimate

INTERNAL RATE OF RETURN

This is the actual rate of return earned by the project. It is a rate such that if it is used
to discount cash flows,the NPV of the project shall be equal to zero. To calculate IRR
two distinct and far apart discounting rates should be used to give a posiyive and
negative NPV.
A project with an IRR greater than the cost of capital should be accepted since it will
be earning more than what is being paid to the providers of finance.
This method has got an advantage over the NPV method in that it does not use an
assumed discount rate,but instead calculate the discount rate which would result in the
NPV of discounted cash flows being zero.

Advantages
 recognise time value of money
 may assist in ranking different proposals
 recognise time value of money

Disadvantages
 it is more difficult to calculate than NPV

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 QUESTION 1

Randal Ltd is considering expanding its business and has to decide between taking on Project
A or Project B. Both projects have a life of four years. Equipment is expected to have no
scrap value.

Other information about the projects is as follows:

Project A Project B
$ $
Initial cost $150 000 $ 140 000
Annual sales $100 000 $ 120 000
Annual purchases $40 000 $65 000
Other costs as a percentage of sales 8% 5%
Increase in working capital $10 000 $18 000

Randal Ltd uses a cost of capital of 10%. Discounting factors at 10% are as follows :

Year 1 0.909
Year 2 0.826
Year 3 0.751
Year 4 0.683

Using a cost of capital of 10% Project B has a net present value of $15 281.

REQUIRED
a. For each of the two projects calculate the following :
i. The annual net cash flow
ii. The Accounting Rate of Return
iii. The Payback period
b. Calculate the Net Present Value for Project A only.
c. State two benefits and two drawbacks of each of the following.
i. Accounting Rate of Return.
ii. The Payback period.
iii. The Net Present Value.
d. State which of the two projects Randal Ltd should select. Give reasons for your
answer.

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 STATEMENT OF CHANGES IN EQUITY
QUESTION 1

The directors of Dunmore plc are preparing the end of year financial statements including the
notes to the accounts.
The following information is available at 1 January 2017:
$
Ordinary share capital (shares of $2 each) 2 000 000
Share premium 300 000
Revaluation reserve 400 000
General reserve 100 000
Retained earnings 1 500 000

During the year ended 31 December 2017 the following took place:

1. On 1 June an interim dividend of $0.20 per ordinary share was paid.

2. On 1 October an issue of 500 000 ordinary shares was made at $2.40 per share to raise
money to purchase an additional factory.

3. On 1 November there was a rights issue of 2 shares for every 5 currently held at $2.25.
The rights issue was necessary to fund the unexpected costs on the purchase of the
factory. The issue was fully subscribed.

4. On 1 December there was a bonus issue of 4 shares for every 10 held on that date. The
reserves were maintained in their most flexible form.

On 31 December 2017 the finance director informed the other directors that:

1 The profit from operations for the year was $520 000.
2 Finance charges of $64 000 had been paid during the year.
3 The end of year tax liability on profits had been calculated as $93 000.
4 There had been a transfer to the general reserve of $47 000.
5 A final dividend of $0.10 per ordinary share had been proposed.

Required
(a) State three uses of the notes to the accounts within the financial statements. [3]
(b) Prepare the statement of changes in equity for the year ended 31 December 2017. [15]

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